From 61c86d992d670b6f6b82e1774cf305f7b34d20fd Mon Sep 17 00:00:00 2001 From: awinml <97467100+awinml@users.noreply.github.com> Date: Sun, 25 Dec 2022 22:57:42 +0530 Subject: [PATCH] Add data --- ...t-base-uncased-finetuned-sst-2-english.csv | 50 ++ datasets/final/final_combined_dataset.csv | 50 ++ ...ataframe_sshleifer_distilbart-cnn-12-6.csv | 50 ++ datasets/final/topic_extraction_rakeNLTK.csv | 50 ++ .../sentement_analysis_final_labeled_data.csv | 442 ++++++++++++++++++ .../summarization_final_labeled_data.csv | 248 ++++++++++ datasets/raw/abbvie.csv | 6 + datasets/raw/alphabet.csv | 5 + datasets/raw/coca-cola.csv | 6 + datasets/raw/costco.csv | 6 + datasets/raw/mastercard.csv | 6 + datasets/raw/merck.csv | 6 + datasets/raw/meta.csv | 6 + datasets/raw/microsoft.csv | 6 + datasets/raw/pepsico.csv | 6 + datasets/raw/pfizer.csv | 6 + 16 files changed, 949 insertions(+) create mode 100644 datasets/final/classification_distilbert-base-uncased-finetuned-sst-2-english.csv create mode 100644 datasets/final/final_combined_dataset.csv create mode 100644 datasets/final/summarized_dataframe_sshleifer_distilbart-cnn-12-6.csv create mode 100644 datasets/final/topic_extraction_rakeNLTK.csv create mode 100644 datasets/labeled/sentement_analysis_final_labeled_data.csv create mode 100644 datasets/labeled/summarization_final_labeled_data.csv create mode 100644 datasets/raw/abbvie.csv create mode 100644 datasets/raw/alphabet.csv create mode 100644 datasets/raw/coca-cola.csv create mode 100644 datasets/raw/costco.csv create mode 100644 datasets/raw/mastercard.csv create mode 100644 datasets/raw/merck.csv create mode 100644 datasets/raw/meta.csv create mode 100644 datasets/raw/microsoft.csv create mode 100644 datasets/raw/pepsico.csv create mode 100644 datasets/raw/pfizer.csv diff --git a/datasets/final/classification_distilbert-base-uncased-finetuned-sst-2-english.csv b/datasets/final/classification_distilbert-base-uncased-finetuned-sst-2-english.csv new file mode 100644 index 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Business Overview Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. We build technology that helps people connect, find communities, and grow businesses. Our useful and engaging products enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality (VR) headsets, wearables, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products. Meta is moving beyond 2D screens toward immersive experiences like augmented and virtual reality to help build the metaverse, which we believe is the next evolution in social technology. We report financial results for two segments: Family of Apps (FoA) and Reality Labs (RL). For FoA, we generate substantially all of our revenue from selling advertising placements to marketers. Ads on our platforms enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. RL generates revenue from sales of consumer hardware products, software and content. Our products include: Family of Apps Facebook. Facebook helps give people the power to build community and bring the world closer together. It's a place for people to share life's moments and discuss what's happening, nurture and build relationships, discover and connect to interests, and create economic opportunity. They can do this through News Feed, Stories, Groups, Watch, Marketplace, Reels, Dating, and more. Instagram. Instagram brings people closer to the people and things they love. Instagram Feed, Stories, Reels, Video, Live, Shops, and messaging are places where people and creators can express themselves and push culture forward through photos, video, and private messaging, and connect with and shop from their favorite businesses. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, audio and video calls, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Reality Labs Reality Labs. Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Meta Quest lets people defy distance with cutting-edge VR hardware, software, and content. Facebook Portal video calling devices help friends and families stay connected and share the moments that matter in meaningful ways. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection, sharing, discovery, and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Alphabet (Google and YouTube), Amazon, Apple, ByteDance (TikTok), Microsoft, Snap (Snapchat), Tencent (WeChat), and Twitter. We compete to attract, engage, and retain people who use our products, to attract and retain businesses who use our free or paid business and advertising services, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual and augmented reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, including as part of efforts to develop the metaverse, we may become subject to additional competition. Technology Our product development philosophy centers on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video and VR increases, and as we deepen our investment in new technologies like artificial intelligence, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate in more than 80 cities around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, many of which are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These laws and regulations involve matters including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, civil rights, telecommunications, product liability, e-commerce, taxation, economic or other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, consumer protection, and other laws and regulations can impose different obligations, or penalties or fines for non-compliance, or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices, or otherwise relating to content that is made available on our products, could adversely affect our financial results. In the United States, there have been, and continue to be, various efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and any such changes may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect our business and financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. For example, the Privacy Shield, a transfer framework we relied upon for data transferred from the European Union to the United States, was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Meta relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. In August 2020, we received a preliminary draft decision from the Irish Data Protection Commission (IDPC) that preliminarily concluded that Meta Platforms Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the General Data Protection Regulation (GDPR) and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. We believe a final decision in this inquiry may issue as early as the first half of 2022. If a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or rely upon other alternative means of data transfers from Europe to the United States, we will likely be unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, which would materially and adversely affect our business, financial condition, and results of operations. We have been subject to other significant legislative and regulatory developments in the past, and proposed or new legislation and regulations could significantly affect our business. For example, the GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, requires submission of personal data breach notifications to our lead European Union privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The GDPR is still a relatively new law, its interpretation is still evolving, and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. In addition, Brazil, the United Kingdom, and other countries have enacted similar data protection regulations imposing data privacy-related requirements on products and services offered to users in their respective jurisdictions. The California Consumer Privacy Act, which took effect in January 2020, and its successor, the California Privacy Rights Act, which will take effect in January 2023, also establish certain transparency rules and create new data privacy rights for users. In addition, effective December 2020, the European Union's ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these or similar developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. For example, the proposed Digital Markets Act in the European Union and pending proposals to modify competition laws in the United States and other jurisdictions could cause us to incur significant compliance costs and could potentially impose new restrictions and requirements on companies like ours, including in areas such as the combination of data across services, mergers and acquisitions, and product design. In addition, some countries, such as India, are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. New legislation or regulatory decisions that restrict our ability to collect and use information about minors may also result in limitations on our advertising services or our ability to offer products and services to minors in certain jurisdictions. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, civil rights, content moderation, and competition, as we continue to grow and expand our operations. We are also currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into with the U.S. Federal Trade Commission (FTC), which took effect in April 2020 and, among other matters, requires us to maintain a comprehensive privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. For additional information about government regulation applicable to our business, see Part I, Item 1A, ""Risk Factors"" in this Annual Report on Form 10-K. Human Capital At Meta, we design products to bring the world closer together, one connection at a time. As a company, we believe that people are at the heart of every connection we build. We are proud of our unique company culture where ideas, innovation, and impact win, and we work hard to build strong teams across engineering, product design, marketing, and other areas to further our mission. We had a global workforce of 71,970 employees as of December 31, 2021, which represents a 23% year-over-year increase in employee headcount. We expect headcount growth to continue for the foreseeable future, particularly as we continue to focus on recruiting employees in technical functions. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. Our headquarters are located in Menlo Park, California and we have offices in more than 80 cities around the globe. The vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, and in the long term, we expect some personnel to continue to transition to working remotely on a regular basis. We offer most of our full-time employees the option to work remotely on a regular basis. Diversity, Equity and Inclusion Diversity, equity and inclusion are core to our work at Meta. We seek to build a diverse and inclusive workplace where we can leverage our collective cognitive diversity to build the best products and make the best decisions for the global community we serve. While we have made progress, we still have more work to do. As part of our diversity and inclusion report, we publish our global gender diversity and U.S. ethnic diversity workforce data annually. As of June 30, 2021, our global employee base was comprised of 36.7% females and 63.3% males, and our U.S. employee base was comprised of the following ethnicities: 45.7% Asian, 39.1% White, 6.5% Hispanic, 4.4% Black, 3.9% two or more ethnicities, and 0.4% additional groups (including American Indian or Alaska Native and Native Hawaiian or Other Pacific Islander). In recent years, we also announced our goals to have 50% of our workforce made up of underrepresented groups by 2024, and to increase the representation of people of color in leadership positions in the United States, including Black leadership, by 30% from 2020 to 2025. We will also continue our ongoing efforts to increase the representation of women in leadership. We work to support our goals of diversifying our workforce through recruiting, retention, people development, and inclusion. We employ our Diverse Slate Approach in our global recruitment efforts, which ensures that teams and hiring managers have the opportunity to consider qualified people from underrepresented groups for open roles. We have seen steady increases in hiring rates of people from underrepresented groups since we started testing this approach in 2015. We also continue to develop inclusive internship programs, and Meta University, our training program for college freshmen and sophomores with an interest in Computer Science, also utilizes a proactive and inclusive approach to promote participation by people from underrepresented groups. To help build community among our people and support their professional development, we invest in our internal Meta Resource Groups and our annual Community events such as Women's Community Summit, Black Community Summit, Latin Community Summit, and Pride Community Summit. We also offer Managing Unconscious Bias, Managing Inclusion, Be the Ally, and other trainings to promote an inclusive workplace by helping people understand the issues that affect underrepresented communities and how to reduce the effects of bias in the workplace. Compensation and Benefits We offer competitive compensation to attract and retain the best people, and we help care for our people so they can focus on our mission. Our employees' total compensation package includes market-competitive salary, bonuses or sales incentives, and equity. We generally offer full-time employees equity at the time of hire and through annual equity grants because we want them to be owners of the company and committed to our long-term success. We have conducted pay equity analyses for many years, and continue to be committed to pay equity. In 2021, we announced that our analyses indicate that we continue to have pay equity across genders globally and race in the United States for people in similar jobs, accounting for factors such as location, role, and level. Through Life@ Meta, our holistic approach to benefits, we provide our employees and their loved ones with resources to help them thrive. We offer a wide range of benefits across areas such as health, family, finance, community, and time away, including healthcare and wellness benefits, family building benefits, family care resources, retirement savings plans, access to tax and legal services, Meta Resource Groups to build community at Meta, family leave, and paid time off. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is currently listed on the Nasdaq Global Select Market under the symbol ""FB."" In October 2021, we changed our corporate name from Facebook, Inc. to Meta Platforms, Inc. We expect our Class A common stock to cease trading under the symbol ""FB"" and begin trading under the new symbol, ""META,"" on the Nasdaq Global Select Market in the first half of 2022. Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Meta, the Meta logo, Facebook, FB, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Meta Platforms, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and about.fb.com/news/ websites as well as Mark Zuckerberg's Facebook Page (www.facebook.com/zuck) and Instagram account (www.instagram.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission (FTC); Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding capital stock by our founder, Chairman, and CEO. Risks Related to Our Product Offerings If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement across our products are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products that deliver ad impressions, particularly for Facebook and Instagram. We anticipate that our active user growth rate will continue to generally decline over time as the size of our active user base increases. In addition, we have experienced, and expect to continue to experience, fluctuations and declines in the size of our active user base in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. User growth and engagement are also impacted by a number of other factors, including competitive products and services, such as TikTok, that have reduced some users' engagement with our products and services, as well as global and regional business and macroeconomic conditions. For example, beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen these pandemic-related trends subside. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and these trends may continue to be subject to volatility. In the fourth quarter of 2021, we experienced a slight decline on a quarter-over-quarter basis in the total number of DAUs on Facebook, as well as a slight decline on a quarter-over-quarter basis in the number of DAUs on Facebook in the United States Canada region. Any future declines in the size of our active user base may adversely impact our ability to deliver ad impressions and, in turn, our financial performance. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products, or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, concerns about the nature of content made available on our products, or concerns related to privacy, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with our products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely affect our products or users; we are unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, or are otherwise limited in our business operations, as a result of European regulators, courts, or legislative bodies determining that our reliance on Standard Contractual Clauses (SCCs) or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; there is decreased engagement with our products, or failure to accept our terms of service, as part of privacy-focused changes that we have implemented or may implement in the future, whether voluntarily, in connection with the General Data Protection Regulation (GDPR), the European Union's ePrivacy Directive, the California Consumer Privacy Act (CCPA), or other laws, regulations, or regulatory actions, or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, or we take, or fail to take, actions to enforce our policies, that are perceived negatively by our users or the general public, including as a result of decisions or recommendations from the independent Oversight Board regarding content on our platform; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement (for example, we have announced plans to focus product decisions on optimizing the young adult experience in the long term); we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are scaled back or discontinued, or the pricing of data plans otherwise increases; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, particularly for our significant revenue-generating products like Facebook and Instagram, our revenue and financial results may be adversely affected. Any significant decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our ability to deliver ad impressions and, accordingly, our revenue, business, financial condition, and results of operations. As our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives, or if they are not satisfied for any other reason. We have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, such as our feed and Stories products, including as a result of increased usage of our Reels or other video or messaging products; reductions of advertising by marketers due to our efforts to implement or enforce advertising policies that protect the security and integrity of our platform; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated, or otherwise more effective products; limitations on our ability to offer a number of our most significant products and services, including Facebook and Instagram, in Europe as a result of European regulators, courts, or legislative bodies determining that our reliance on SCCs or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; changes in our marketing and sales or other operations that we are required to or elect to make as a result of risks related to complying with foreign laws or regulatory requirements or other government actions; decisions by marketers to reduce their advertising as a result of announcements by us or adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, our interpretation, implementation, or enforcement of policies relating to content on our products (including as a result of decisions or recommendations from the independent Oversight Board), developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content made available on our products by third parties, questions about our user data practices or the security of our platform, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations (for example, a number of marketers announced that they paused advertising with us in July 2020 due to concerns about content on our products); the effectiveness of our ad targeting or degree to which users opt in or out of the use of data for ads, including as a result of product changes and controls that we have implemented or may implement in the future in connection with the GDPR, ePrivacy Directive, California Consumer Privacy Act (CCPA), other laws, regulations, regulatory actions, or litigation, or otherwise, that impact our ability to use data for advertising purposes; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; the success of technologies designed to block the display of ads or ad measurement tools; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic and geopolitical conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. For example, macroeconomic conditions have affected, and may in the future affect, marketers' ability or willingness to spend with us, as we experienced in 2020 with the regional and worldwide economic disruption related to the COVID-19 pandemic and associated declines in advertising activity on our products. The effects of the pandemic previously resulted in reduced demand for our ads, a related decline in pricing of our ads, and additional demands on our technical infrastructure as a result of increased usage of our services, and any similar occurrences in the future may impair our ability to maintain or increase the quantity or quality of ads shown to users and adversely affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory developments, such as the GDPR, ePrivacy Directive, and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In particular, we have seen an increasing number of users opt to control certain types of ad targeting in Europe following adoption of the GDPR, which will increase further with expanded control over certain third-party data as part of our ePrivacy Directive compliance, and we have introduced product changes that limit data signal use for certain users in California following adoption of the CCPA. Regulatory guidance or decisions or new legislation in these or other jurisdictions may require us to make additional changes to our products in the future that further reduce our ability to use these signals. In addition, mobile operating system and browser providers, such as Apple and Google, have implemented product changes and/or announced future plans to limit the ability of websites and application developers to collect and use these signals to target and measure advertising. For example, in 2021, Apple made certain changes to its products and data use policies in connection with changes to its iOS operating system that reduce our and other iOS developers' ability to target and measure advertising, which has negatively impacted, and we expect will continue to negatively impact, the size of the budgets marketers are willing to commit to us and other advertising platforms. In addition, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of certain product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform and negatively impacted our advertising revenue. For example, our advertising revenue in the second half of 2021 was negatively impacted by marketer reaction to targeting and measurement challenges associated with iOS changes. If we are unable to mitigate these developments as they take further effect in the future, our targeting and measurement capabilities will be materially and adversely affected, which would in turn significantly impact our future advertising revenue growth. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature our products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of our products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of our products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and also released changes to iOS that limit our ability to target and measure ads effectively. We expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers, and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use our products on their mobile devices, or if our users choose not to access or use our products on their mobile devices or use mobile products that do not offer access to our products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, other business partners, or advertisers, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. We have in the past experienced challenges in operating with mobile operating systems, networks, technologies, products, and standards that we do not control, and any such occurrences in the future may negatively impact our user growth, engagement, and monetization on mobile devices, which may in turn materially and adversely affect our business and financial results. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny, litigation, or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we are moving forward with plans to implement end-to-end encryption across our messaging services, as well as facilitate cross-app communication between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which reduces our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we also change the size, frequency, or relative prominence of ads as part of our product and monetization strategies. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on our products. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization, such as our feed products. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. For example, we plan to continue to promote Reels, which we do not currently monetize at the same rate as our feed or Stories products. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. We may not be successful in our metaverse strategy and investments, which could adversely affect our business, reputation, or financial results. We believe the metaverse, an embodied internet where people have immersive experiences beyond two-dimensional screens, is the next evolution in social technology. In 2021, we announced a shift in our business and product strategy to focus on helping to bring the metaverse to life. We expect this will be a complex, evolving, and long-term initiative that will involve the development of new and emerging technologies, continued investment in privacy, safety, and security efforts, and collaboration with other companies, developers, partners, and other participants. However, the metaverse may not develop in accordance with our expectations, and market acceptance of features, products, or services we build for the metaverse is uncertain. In addition, we have limited experience with consumer hardware products and virtual and augmented reality technology, which may enable other companies to compete more effectively than us. We may be unsuccessful in our research and product development efforts, including if we are unable to develop relationships with key participants in the metaverse or develop products that operate effectively with metaverse technologies, products, systems, networks, or standards. Our metaverse efforts may also divert resources and management attention from other areas of our business. We expect to continue to make significant investments in virtual and augmented reality and other technologies to support these efforts, and our ability to support these efforts is dependent on generating sufficient profits from other areas of our business. In addition, as our metaverse efforts evolve, we may be subject to a variety of existing or new laws and regulations in the United States and international jurisdictions, including in the areas of privacy and e-commerce, which may delay or impede the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. As a result of these or other factors, our metaverse strategy and investments may not be successful in the foreseeable future, or at all, which could adversely affect our business, reputation, or financial results. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, data use, encryption, content, product design, algorithms, advertising, competition, and other issues, including actions or decisions in connection with elections or the COVID-19 pandemic, which has in the past adversely affected, and may in the future adversely affect, our reputation and brands. For example, beginning in September 2021, we became the subject of media, legislative, and regulatory scrutiny as a result of a former employee's allegations and release of internal company documents relating to, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being. In addition, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise enforce our policies or address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the pandemic or elections in the United States and around the world, by decisions or recommendations regarding content on our platform from the independent Oversight Board, by research or media reports concerning the perceived or actual impacts of our products or services on user well-being, or by our decisions to remove content or suspend participation on our platform by persons who violate our community standards or terms of service. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our actions, such as the foregoing matter regarding developer misuse of data and concerns around our handling of political speech and advertising, hate speech, and other content, as well as user well-being issues, have eroded confidence in our brands and may continue to do so in the future. If we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we conduct investigations and audits of platform applications from time to time, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Risks Related to Our Business Operations and Financial Results The COVID-19 pandemic has previously had, and may in the future have, a significant adverse impact on our advertising revenue and also exposes our business to other risks. The COVID-19 pandemic has resulted in authorities implementing numerous preventative measures from time to time to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in certain affected countries and regions, which have previously significantly impacted our business and results of operations. For example, in the second quarter of 2020, our advertising revenue grew 10% year-over-year, which was the slowest growth rate for any fiscal quarter since our initial public offering. While our advertising revenue growth rate improved in subsequent quarters, there can be no assurance that it will not decrease again as a result of the effects of the pandemic. In addition, we believe that the pandemic previously contributed to an acceleration in the growth of online commerce, which in turn increased demand for our advertising services. More recently, we believe this growth has moderated in many regions, and we may experience reduced advertising demand and related declines in pricing in future periods to the extent this trend continues, which could adversely affect our advertising revenue growth. The demand for and pricing of our advertising services may be materially and adversely impacted by the pandemic for the foreseeable future, and we are unable to predict the duration or degree of such impact with any certainty. In addition to the impact on our advertising business, the pandemic exposes our business, operations, and workforce to a variety of other risks, including: volatility in the size of our user base and user engagement, particularly for our messaging products, whether as a result of shelter-in-place measures or other factors; delays in product development or releases, or reductions in manufacturing production and sales of consumer hardware, as a result of inventory shortages, supply chain or labor shortages; increased misuse of our products and services or user data by third parties, including improper advertising practices or other activity inconsistent with our terms, contracts, or policies, misinformation or other illicit or objectionable material on our platforms, election interference, or other undesirable activity; adverse impacts to our efforts to combat misuse of our products and services and user data as a result of limitations on our safety, security, and content review efforts while our workforce is working remotely, such as the necessity to rely more heavily on artificial intelligence to perform tasks that our workforce is unable to perform; significant volatility and disruption of global financial markets, which could cause fluctuations in currency exchange rates or negatively impact our ability to access capital in the future; negative impact on our workforce productivity, product development, and research and development due to difficulties resulting from our personnel working remotely; illnesses to key employees, or a significant portion of our workforce, which may result in inefficiencies, delays, and disruptions in our business; and increased volatility and uncertainty in the financial projections we use as the basis for estimates used in our financial statements. Any of these developments may adversely affect our business, harm our reputation, or result in legal or regulatory actions against us. The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business and may materially and adversely impact our business, financial condition, and results of operations. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies providing connection, sharing, discovery, and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Alphabet (Google and YouTube), Amazon, Apple, ByteDance (TikTok), Microsoft, Snap (Snapchat), Tencent (WeChat), and Twitter. We compete to attract, engage, and retain people who use our products, to attract and retain businesses that use our free or paid business and advertising services, and to attract and retain developers who build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual and augmented reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, including as part of efforts to develop the metaverse, we may become subject to additional competition. Some of our current and potential competitors may have greater resources, experience, or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. For example, some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. In addition, Apple has released changes to iOS that limit our ability, and the ability of others in the digital advertising industry, to target and measure ads effectively. As a result, our competitors may, and in some cases will, acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which would negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; our ability to attract and retain businesses who use our free or paid business and advertising services; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base, level of user engagement, and ability to deliver ad impressions may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Unfavorable media coverage negatively affects our business from time to time. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, terms of service, or other policies, the actions of our users, the quality and integrity of content shared on our platform, the perceived or actual impacts of our products or services on user well-being, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, we have been the subject of significant media coverage involving concerns around our handling of political speech and advertising, hate speech, and other content, as well as user well-being issues, and we continue to receive negative publicity related to these topics. Beginning in September 2021, we became the subject of significant media coverage as a result of allegations and the release of internal company documents by a former employee. In addition, we have been, and may in the future be, subject to negative publicity in connection with our handling of misinformation and other illicit or objectionable use of our products or services, including in connection with the COVID-19 pandemic and elections in the United States and around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and marketer demand for advertising on our products, which could result in decreased revenue and adversely affect our business and financial results, and we have experienced such adverse effects to varying degrees from time to time. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement, particularly for our products that deliver ad impressions; our ability to attract and retain marketers in a particular period; our ability to recognize revenue or collect payments from marketers in a particular period, including as a result of the effects of the COVID-19 pandemic; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, including the COVID-19 pandemic, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts, including as a result of implementing changes to our practices, whether voluntarily, in connection with laws, regulations, regulatory actions, or decisions or recommendations from the independent Oversight Board, or otherwise; costs and expenses related to the development, manufacturing, and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy, data protection, and content, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which is affected by the mix of income we earn in the U.S. and in jurisdictions with different tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, the effects of changes in our business or structure, and the effects of discrete items such as legal and tax settlements and tax elections; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our investments in marketable securities, in the valuation of our equity investments, and in interest rates; changes in U.S. generally accepted accounting principles; and changes in regional or global business or macroeconomic conditions, including as a result of the COVID-19 pandemic, which may impact the other factors described above. Our rates of growth may be volatile in the near term as a result of the COVID-19 pandemic, and we expect they will decline over time in the future. We have in the past experienced, and may in the future experience, volatility in our user and revenue growth rates as a result of the COVID-19 pandemic, although we are unable to predict the duration or degree of such volatility with any certainty. In the long term, we expect that our user growth rate will generally decline over time as the size of our active user base increases, and the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We also expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates experience volatility or decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments, particularly our investments in virtual and augmented reality, have the effect of reducing our operating margin and profitability. If our investments are not successful longer-term, our business and financial performance will be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies, including as we continue our efforts related to building the metaverse. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability, and we expect the adverse financial impact of such investments to continue for the foreseeable future. For example, our investments in Reality Labs reduced our 2021 overall operating profit by approximately $10 billion, and we expect our investments to increase in future periods. If our investments are not successful longer-term, our business and financial performance will be harmed. We plan to continue to make acquisitions and pursue other strategic transactions, which could impact our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies, and from time to time may enter into other strategic transactions such as investments and joint ventures. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions or other strategic transactions on favorable terms, or at all, including as a result of regulatory challenges. For example, in 2021, the United Kingdom Competition and Markets Authority issued an order directing us to divest our Giphy acquisition, which we have appealed. In some cases, the costs of such acquisitions or other strategic transactions may be substantial, and there is no assurance that we will realize expected synergies from future growth and potential monetization opportunities for our acquisitions or a favorable return on investment for our strategic investments. We may pay substantial amounts of cash or incur debt to pay for acquisitions or other strategic transactions, which has occurred in the past and could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions or other strategic transactions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities, deficiencies, or other claims associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition or other strategic transaction, including tax and accounting charges. Acquisitions or other strategic transactions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience, and we may not manage these processes successfully. We continue to make substantial investments of resources to support our acquisitions, which has in the past resulted, and we expect will in the future result, in significant ongoing operating expenses and the diversion of resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service, including as a result of the COVID-19 pandemic, could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. We have experienced such issues to varying degrees from time to time. For example, in October 2021, a combination of an error and a bug resulted in an approximately six-hour outage of our services. In addition, as the amount and types of information shared on our products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. Global climate change could result in certain types of natural disasters occurring more frequently or with more intense effects. Any such events may result in users being subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. We also have been, and may in the future be, subject to increased energy or other costs to maintain the availability or performance of our products in connection with any such events. In 2020, the increase in the use of our products as a result of the COVID-19 pandemic increased demands on our technical infrastructure. We may not be able to accommodate any such demands in the future, including as a result of our reduced data center operations and personnel working remotely during the pandemic. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. Due to the effects of the COVID-19 pandemic, we have experienced, and expect to continue to experience, supply and labor shortages and other disruptions in logistics and the supply chain for our technical infrastructure. As a result, we have had to make certain changes to our procurement practices, and in the future we may not be able to procure sufficient components, equipment, or services from third parties to satisfy our needs, or we may be required to procure such components, equipment, or services on unfavorable terms. Any of these developments may result in interruptions in the availability or performance of our products, require unfavorable changes to existing products, delay the introduction of future products, or otherwise adversely affect our business and financial results. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers, subsea and terrestrial fiber optic cable systems, and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations around the world, including in emerging markets that expose us to increased risks relating to anti-corruption compliance and political challenges, among others. We have in the past suspended, and may in the future suspend, certain of these projects as a result of the COVID-19 pandemic. Additional unanticipated delays or disruptions in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, whether as a result of the pandemic, trade disputes, or otherwise, may lead to increased project costs, operational inefficiencies, interruptions in the delivery or degradation of the quality or reliability of our products, or impairment of assets on our balance sheet. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Further, much of our technical infrastructure is located outside the United States, and it is possible that action by a foreign government, or our response to such government action, could result in the impairment of a portion of our technical infrastructure, which may interrupt the delivery or degrade the quality or reliability of our products and lead to a negative user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Family metrics (DAP, MAP, and average revenue per person (ARPP)) and Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Family metrics and Facebook metrics estimates will differ from estimates published by third parties due to differences in methodology. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. The timing and results of such user surveys have in the past contributed, and may in the future contribute, to changes in our reported Family metrics from period to period. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our reported Family metrics, as well as our ability to report these metrics at all. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2021, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. We also regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2021, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2021, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia, Nigeria, and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data may be unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics and estimates, including those relating to the reach and effectiveness of our ads. Many of our metrics involve the use of estimations and judgments, and our metrics and estimates are subject to software bugs, inconsistencies in our systems, and human error. Such metrics and estimates also change from time to time due to improvements or changes in our terminology or methodology, including as a result of loss of access to data signals we use in calculating such metrics and estimates. We have in the past been, and may in the future be, subject to litigation as well as marketer, regulatory, and other inquiries regarding the accuracy of such metrics and estimates. Where marketers, developers, or investors do not perceive our metrics or estimates to be accurate, or where we discover material inaccuracies in our metrics or estimates, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to our products that deliver ad impressions, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 71,970 as of December 31, 2021 from 58,604 as of December 31, 2020, and we expect headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. Additionally, the vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, which limits their ability to perform certain job functions and may negatively impact productivity. In the long term, we may experience such challenges to productivity and collaboration as some personnel transition to working remotely on a regular basis, and we may experience difficulties integrating recently hired personnel when our offices re-open. To effectively manage our growth, we must continue to adapt to a remote work environment; improve our operational, financial, and management processes and systems; and effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business, economic, and legal risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, several of our products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, supply chain, competition, consumer protection, intellectual property, environmental, health and safety, licensing, and infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, content moderation, data localization, data protection, e-commerce and payments, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations, including difficulties arising from personnel working remotely during the COVID-19 pandemic; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes and pandemics. In addition, we must manage the potential conflicts between locally accepted business practices in any given jurisdiction and our obligations to comply with laws and regulations, including anti-corruption laws or regulations applicable to us, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. We also must manage our obligations to comply with laws and regulations related to import and export controls, trade restrictions, and sanctions, including regulations established by the U.S. Office of Foreign Assets Control. Government agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against companies for violations of anti-corruption laws or regulations, import and export controls, trade restrictions, sanctions, and other laws, rules, and regulations. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We also may be required to or elect to cease or modify our operations or the offering of our products and services in certain regions, including as a result of the risks described above, which could adversely affect our business, user growth and engagement, and financial results. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell from time to time have had, and in the future may have, quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. Our brand and financial results could be adversely affected by any such quality issues, other failures to meet our customers' expectations, or findings of our consumer hardware products to be defective. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products, which subjects us to a number of risks that have been exacerbated as a result of the COVID-19 pandemic. We have experienced, and may in the future experience, supply or labor shortages or other disruptions in logistics and the supply chain, which could result in shipping delays and negatively impact our operations, product development, and sales. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties, manufacturing or supply constraints, or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing, distribution, and sale of our consumer hardware products also may be negatively impacted by macroeconomic conditions, geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, supply chain disruptions, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. The demand for our products can also change significantly between the time inventory or components are ordered and the date of sale. While we endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell, from time to time we have experienced difficulties in accurately predicting and meeting the consumer demand for our products. In addition, when we begin selling or manufacturing a new consumer hardware product or enter new international markets, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of the foregoing factors may adversely affect our operating results. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. We are involved in numerous lawsuits, including stockholder derivative lawsuits and putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user, advertiser, and developer base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user or entity harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on claims related to advertising, antitrust, privacy, biometrics, content, algorithms, employment, activities on our platform, consumer protection, or product performance or other claims related to the use of consumer hardware and software, including virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; our acquisitions of Instagram and WhatsApp, as well as other alleged anticompetitive conduct; and a former employee's allegations and release of internal company documents beginning in September 2021. The results of any such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Meta. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are litigating this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. The issuance of additional regulatory or accounting guidance related to the Tax Act, or other executive or Congressional actions in the United States or globally could materially increase our tax obligations and significantly impact our effective tax rate in the period such guidance is issued or such actions take effect, and in future periods. In addition, many countries have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. Over the last several years, the Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project that, if implemented, would change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. In 2021, more than 140 countries tentatively signed on to a framework that imposes a minimum tax rate of 15%, among other provisions. As this framework is subject to further negotiation and implementation by each member country, the timing and ultimate impact of any such changes on our tax obligations are uncertain. Similarly, the European Commission and several countries have issued proposals that would apply to various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several jurisdictions have proposed or enacted taxes applicable to digital services, which include business activities on digital advertising and online marketplaces, and which apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain member states, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2021, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.13 billion and our effective tax rate by two percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings. We review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at the reporting unit level at least annually. If such goodwill or intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or intangible assets is determined, which would negatively affect our results of operations. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly for engineering talent, whether as a result of competition with other companies or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. In addition, restrictive immigration policies or legal or regulatory developments relating to immigration may negatively affect our efforts to attract and hire new personnel as well as retain our existing personnel . If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or, in some cases, the replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Government Regulation and Enforcement Actions by governments that restrict access to Facebook or our other products in their countries, censor or moderate content on our products in their countries, or otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor or moderate content available on Facebook or our other products in their country, restrict access to our products from their country partially or entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. For example, in June 2020, Hong Kong adopted a National Security Law that provides authorities with the ability to obtain information, remove and block access to content, and suspend user services, and if we are found to be in violation of this law then the use of our products may be restricted. In addition, if we are required to or elect to make changes to our marketing and sales or other operations in Hong Kong as a result of the National Security Law, our revenue and business in the region will be adversely affected. It is also possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues or information requests in Hong Kong or elsewhere, or for other reasons, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. Similarly, if we are found to be out of compliance with certain legal requirements for social media companies in Turkey, the Turkish government could take action to reduce or eliminate our Turkey-based advertising revenue or otherwise adversely impact access to our products. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, we are required to or elect to make changes to our operations, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety and consumer protection, e-commerce, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our products and business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, civil rights, telecommunications, product liability, e-commerce, taxation, economic or other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, consumer protection, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but the Privacy Shield was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Meta relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the CJEU considered the validity of SCCs as a basis to transfer user data from the European Union to the United States following a challenge brought by the Irish Data Protection Commission (IDPC). Although the CJEU upheld the validity of SCCs in July 2020, our continued reliance on SCCs will be the subject of future regulatory consideration. In particular, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Meta Platforms Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Meta Platforms Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. In May 2021, the court rejected Meta Platforms Ireland's procedural challenges and the inquiry subsequently recommenced. We believe a final decision in this inquiry may issue as early as the first half of 2022. If a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or rely upon other alternative means of data transfers from Europe to the United States, we will likely be unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, which would materially and adversely affect our business, financial condition, and results of operations. In addition, we have been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Meta products and services, including a lawsuit currently pending before the Supreme Court of India, and also became subject to government inquiries and lawsuits regarding the 2021 update to WhatsApp's terms of service and privacy policy. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. We have been subject to other significant legislative and regulatory developments in the past, and proposed or new legislation and regulations could significantly affect our business in the future. For example, we have implemented a number of product changes and controls as a result of requirements under the European General Data Protection Regulation (GDPR), and may implement additional changes in the future. The GDPR also requires submission of personal data breach notifications to our lead European Union privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The GDPR is still a relatively new law, its interpretation is still evolving, and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. In addition, Brazil, the United Kingdom, and other countries have enacted similar data protection regulations imposing data privacy-related requirements on products and services offered to users in their respective jurisdictions. The California Consumer Privacy Act (CCPA), which took effect in January 2020, and its successor, the California Privacy Rights Act (CPRA), which will take effect in January 2023, also establish certain transparency rules and create new data privacy rights for users, including limitations on our use of certain sensitive personal information and more ability for users to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, regulators continue to issue guidance concerning the ePrivacy Directive's requirements regarding the use of cookies and similar technologies. In addition, effective December 2020, the ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these or similar developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. For example, the proposed Digital Markets Act in the European Union and pending proposals to modify competition laws in the United States and other jurisdictions could cause us to incur significant compliance costs and could potentially impose new restrictions and requirements on companies like ours, including in areas such as the combination of data across services, mergers and acquisitions, and product design. In addition, some countries, such as India, are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. New legislation or regulatory decisions that restrict our ability to collect and use information about minors may also result in limitations on our advertising services or our ability to offer products and services to minors in certain jurisdictions. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. We receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, civil rights, content moderation, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union and other jurisdictions have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing. Beginning in September 2018, we also became subject to IDPC and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. We also notify the IDPC, our lead European Union privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. In addition, we are subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions, which relate to many aspects of our business, including with respect to users and advertisers, as well as our industry. Such inquiries, investigations, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice and state attorneys general. Beginning in December 2020, we also became subject to lawsuits by the FTC and the attorneys general from 46 states, the territory of Guam, and the District of Columbia in the U.S. District Court for the District of Columbia alleging that we violated antitrust laws, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform, among other things. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to allegations and the release of internal company documents by a former employee. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business, and we have experienced some of these adverse effects to varying degrees from time to time. Compliance with our FTC consent order, the GDPR, the CCPA, the ePrivacy Directive, and other regulatory and legislative privacy requirements require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including in connection with our modified consent order with the FTC, requirements of the GDPR, and other regulatory and legislative requirements around the world, such as the CCPA and the ePrivacy Directive. In particular, we are maintaining a comprehensive privacy program in connection with the FTC consent order that includes substantial management and board of directors oversight, stringent operational requirements and reporting obligations, prohibitions against making misrepresentations relating to user data, a process to regularly certify our compliance with the privacy program to the FTC, and regular assessments of our privacy program by an independent third-party assessor, which has been and will continue to be challenging and costly to maintain and enhance. These compliance and oversight efforts are increasing demand on our systems and resources, and require significant new and ongoing investments, including investments in compliance processes, personnel, and technical infrastructure. We are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner has been and will continue to be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. The requirements of the FTC consent order and other privacy-related laws and regulations are complex and apply broadly to our business, and from time to time we notify relevant authorities of instances where we are not in full compliance with these requirements or otherwise discover privacy issues, and we expect to continue to do so as any such issues arise in the future. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, ePrivacy Directive, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other applicable requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. We may incur liability as a result of information retrieved from or transmitted over the internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices and may adversely affect our business and financial results. We have faced, currently face, and will continue to face claims relating to information or content that is published or made available on our products, including our policies and enforcement actions with respect to such information or content. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, harassment, intellectual property rights, rights of publicity and privacy, personal injury torts, laws regulating hate speech or other types of content, online safety, consumer protection, and breach of contract, among others. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive (the European Copyright Directive) expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states are currently implementing into their national laws. In addition, the European Union revised the European Audiovisual Media Service Directive to apply to online video-sharing platforms, which member states are expected to implement by 2021. In the United States, there have been, and continue to be, various legislative and executive efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, as well as to impose new obligations on online platforms with respect to commerce listings, user content, counterfeit goods and copyright-infringing material, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines, orders restricting or blocking our services in particular geographies, or other government-imposed remedies as a result of content hosted on our services. For example, legislation in Germany and India has resulted in the past, and may result in the future, in the imposition of fines or other penalties for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Numerous other countries in Europe, the Middle East, Asia-Pacific, and Latin America are considering or have implemented similar legislation imposing potentially significant penalties, including fines, service throttling, or advertising bans, for failure to remove certain types of content or follow certain processes. For example, we have been subject to fines and may in the future be subject to other penalties in connection with social media legislation in Russia and Turkey. Content-related legislation also has required us in the past, and may require us in the future, to change our products or business practices, increase our costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. Member states' laws implementing the European Copyright Directive may also require online platforms to pay for content. In addition, our compliance costs may significantly increase as a result of the Digital Services Act proposed in the European Union, which is expected to take effect in 2023, and other content-related legislative developments such as online safety bills in Ireland and the United Kingdom. In the United States, changes to Section 230 of the Communications Decency Act or new state or federal content-related legislation may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect user growth and engagement. Any of the foregoing events could adversely affect our business and financial results. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Several of our products offer Payments functionality, including enabling our users to purchase virtual and digital goods from developers that offer applications using our Payments infrastructure, send money to other users, and make donations to certain charitable organizations, among other activities. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, stored value, gift cards and other prepaid access instruments, electronic funds transfer, virtual currency, consumer protection, charitable fundraising, trade sanctions, and import and export restrictions. Depending on how our Payments products evolve, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain payments licenses in the United States, the European Economic Area, and other jurisdictions, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we are subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have also launched certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our digital payments initiatives subject us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. We are pursuing digital payments initiatives, such as Novi, a digital wallet that we expect to offer as both a standalone application and subsequently integrated in other Meta products. These initiatives may use blockchain-based assets, such as the USDP stablecoin issued by Paxos Trust Company, which is being used in a Novi pilot program in the United States and Guatemala beginning in October 2021. Our future initiatives to support commerce in the metaverse also may use blockchain-based assets in digital payments. Use of blockchain-based assets in payments are a relatively new and unproven technology, and the laws and regulations surrounding them are uncertain and evolving. These digital payments efforts have drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. We are participating in responses to inquiries from governments and regulators related to our digital payments initiatives, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As our digital payments initiatives evolve, we may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, virtual currency, anti-money laundering, counter-terrorism financing, trade sanctions, data protection, tax, consumer protection, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. In addition, Novi has also received state money transmitter licenses in the United States, with more pending approval, and has other financial services license applications pending in certain other countries that would allow us to conduct digital wallet activities in those countries. These licenses, laws, and regulations, as well as any associated inquiries or investigations, may delay or impede the development of digital payments products and services we offer, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of digital payments products and services is subject to significant uncertainty. As such, there can be no assurance that digital payments products and services we offer will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based technology, which may adversely affect our ability to successfully develop and market such digital payments products and services. We will also incur increased costs in connection with these efforts, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. Risks Related to Data, Security, and Intellectual Property Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (such as spear phishing attacks), scraping, and general hacking continue to be prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data and content on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from nation states and highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. The changes in our work environment as a result of the COVID-19 pandemic could also impact the security of our systems, as well as our ability to protect against attacks and detect and respond to them quickly. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with our products. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We experience such cyber-attacks and other security incidents of varying degrees from time to time, and we incur significant costs in protecting against or remediating such incidents. In addition, we are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under our modified consent order with the FTC. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. The events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications, as well as other enforcement efforts. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data or technical limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, challenges related to our personnel working remotely during the COVID-19 pandemic, the allocation of resources to other projects, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our modified consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper advertising practices, activities that threaten people's safety on- or offline, or instances of spamming, scraping, data harvesting, unsecured datasets, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Consequences of any of the foregoing developments include negative effects on user trust and engagement, harm to our reputation and brands, changes to our business practices in a manner adverse to our business, and adverse effects on our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Our products and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, or failures to address or mitigate technical limitations in our systems, could adversely affect our business. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely, or human error in using such systems, have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property or other data, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. In addition, any errors, bugs, vulnerabilities, or defects in our systems or the software and hardware on which we rely, failures to properly address or mitigate the technical limitations in our systems, or associated degradations or interruptions of service or failures to fulfill our commitments to our users, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, litigation, or liability for fines, damages, or other remedies, any of which could adversely affect our business and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $384.33 through December 31, 2021. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock has in the past fluctuated and may in the future fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results for either of our reportable segments; the financial projections we may provide to the public, any changes in these projections, or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; adverse government actions or legislative or regulatory developments relating to advertising, competition, content, privacy, or other matters, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war, incidents of terrorism, pandemics, and other disruptive external events, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; and a former employee's allegations and release of internal company documents beginning in September 2021. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2021, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 69 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Europe, the Middle East, Africa, Asia Pacific, and Latin America. We also own 18 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. On December 20, 2021, the district court granted our motion to dismiss the third amended complaint, with prejudice. On January 17, 2022, the plaintiffs filed a notice of appeal of the order dismissing their case. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020 and required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing and could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On July 16, 2021, a stockholder derivative action was filed in Delaware Chancery Court against certain of our directors and officers asserting breach of fiduciary duty and related claims relating to our historical platform and user data practices, as well as our settlement with the FTC. On July 20, 2021, other stockholders filed an amended derivative complaint in a related Delaware Chancery Court action, asserting breach of fiduciary duty and related claims against certain of our current and former directors and officers in connection with our historical platform and user data practices. On November 4, 2021, the lead plaintiffs filed a second amended and consolidated complaint in the stockholder derivative action. We believe the lawsuits described above are without merit, and we are vigorously defending them. We also notify the Irish Data Protection Commission (IDPC), our lead European Union privacy regulator under the General Data Protection Regulation (GDPR), of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. For example, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Meta Platforms Ireland's reliance on Standard Contractual Clauses in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Meta Platforms Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. On May 14, 2021, the court rejected Meta Platforms Ireland's procedural challenges, and the inquiry subsequently recommenced. We believe a final decision in this inquiry may issue as early as the first half of 2022. For additional information, see Part I, Item 1A, ""Risk FactorsOur business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety and consumer protection, e-commerce, and other matters"" in this Annual Report on Form 10-K. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleged that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. On June 28, 2021, the court granted our motions to dismiss the complaints filed by the FTC and attorneys general, dismissing the FTC's complaint with leave to amend and dismissing the attorneys general's case without prejudice. On July 28, 2021, the attorneys general filed a notice of appeal of the order dismissing their case. On August 19, 2021, the FTC filed an amended complaint, and on October 4, 2021, we filed a motion to dismiss this amended complaint. On January 11, 2022, the court denied our motion to dismiss the FTC's amended complaint. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking damages and unspecified injunctive relief. Several of the cases brought on behalf of certain advertisers and users were consolidated in the U.S. District Court for the Northern District of California. On January 14, 2022, the court granted, in part, and denied, in part, our motion to dismiss the consolidated actions. We believe these lawsuits are without merit, and we are vigorously defending them. The result of such litigation, investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to a former employee's allegations and release of internal company documents concerning, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being . Beginning on October 27, 2021, multiple putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the same matters. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil, Russia, and other countries in Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. We expect our Class A common stock to cease trading under the symbol ""FB"" and begin trading under the new symbol, ""META,"" on the Nasdaq Global Select Market in the first half of 2022. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2021, there were 3,258 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $336.35 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2021, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2021: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2021 21,703 $ 326.20 21,703 $ 50,893 November 1 - 30, 2021 21,606 $ 335.09 21,606 $ 43,653 December 1 - 31, 2021 14,728 $ 329.97 14,728 $ 38,793 58,037 58,037 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Meta Platforms, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2021. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2016 in the Class A common stock of Meta Platforms, Inc., the DJINET, the SP 500, and the Nasdaq Composite and data for the DJINET, the SP 500, and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States (GAAP), we present revenue on a constant currency basis and free cash flow, which are non-GAAP financial measures. Revenue on a constant currency basis is presented in the section entitled "" Revenue Foreign Exchange Impact on Revenue."" To calculate revenue on a constant currency basis, we translated revenue for the full year 2021 using 2020 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. For a full description of our free cash flow non-GAAP measure, see the section entitled "" Liquidity and Capital ResourcesFree Cash Flow."" These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from nonGAAP financial measures used by other companies, limiting their usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe these non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable comparison of financial results between periods where certain items may vary independent of business performance, and allow for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2021 Results Our key community metrics and financial results for 2021 are as follows: Family of Apps metrics: Family daily active people (DAP) was 2.82 billion on average for December 2021, an increase of 8% year-over-year. Family monthly active people (MAP) was 3.59 billion as of December 31, 2021, an increase of 9% year-over-year. Facebook daily active users (DAUs) were 1.93 billion on average for December 2021, an increase of 5% year-over-year. Facebook monthly active users (MAUs) were 2.91 billion as of December 31, 2021, an increase of 4% year-over-year. Ad impressions delivered across our Family of Apps increased by 10% year-over-year in 2021, and the average price per ad increased by 24% year-over-year in 2021. Consolidated and segment results: Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp, and other services. RL includes our augmented and virtual reality related consumer hardware, software, and content. Family of Apps Reality Labs Total Year Ended December 31, Year-over-Year % Change Year Ended December 31, Year-over-Year % Change Year Ended December 31, Year-over-Year % Change 2021 2020 2021 2020 2021 2020 (dollars in millions) Revenue $ 115,655 $ 84,826 36% $ 2,274 $ 1,139 100% $ 117,929 $ 85,965 37% Costs and expenses $ 58,709 $ 45,532 29% $ 12,467 $ 7,762 61% $ 71,176 $ 53,294 34% Income (loss) from operations $ 56,946 $ 39,294 45% $ (10,193) $ (6,623) (54)% $ 46,753 $ 32,671 43% Operating margin 49% 46% (448)% (581)% 40% 38% Net income was $39.37 billion with diluted earnings per share of $13.77 for the year ended December 31, 2021. Capital expenditures, including principal payments on finance leases, were $19.24 billion for the year ended December 31, 2021. Effective tax rate was 16.7% for the year ended December 31, 2021. Cash and cash equivalents and marketable securities were $48.0 billion as of December 31, 2021. Headcount was 71,970 as of December 31, 2021, an increase of 23% year-over-year. Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. In 2021, we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We also continued to invest based on the following company priorities: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. Our advertising revenue growth in the second half of 2021 was adversely affected by reduced marketer spending as a result of limitations on our ad targeting and measurement tools arising from changes to the iOS operating system. We expect that future advertising revenue growth will continue to be adversely affected by these and other limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers. Our business and results of operations have also been impacted by the COVID-19 pandemic and the preventative measures implemented by authorities from time to time to help limit the spread of the illness, which have caused, and are continuing to cause, business slowdowns or shutdowns in certain affected countries and regions. Beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen these pandemic-related trends subside, particularly in certain developed markets. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty and these trends may continue to be subject to volatility. The COVID-19 pandemic has also had a varied impact on the demand for and pricing of our ads from period to period. While we experienced a reduction in demand and a related decline in pricing during the onset of the pandemic, we believe the pandemic subsequently contributed to an acceleration in the growth of online commerce, particularly during the second half of 2020, and we experienced increasing demand for advertising as a result of this trend. More recently, we believe this growth has moderated in many regions, which to some extent adversely affected our advertising revenue growth in the second half of 2021. We may experience reduced advertising demand and related declines in pricing in future periods to the extent this trend continues, which could adversely affect our advertising revenue growth. However, the impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain for the foreseeable future. User growth and engagement were also impacted by a number of other factors in the second half of 2021. For example, competitive products and services have reduced some users' engagement with our products and services, and in response to competitive pressures, we have introduced new features such as Reels, which is growing in usage but is not currently monetized at the same rate as our feed or Stories products. We also saw a deceleration in our community growth rates as the size of our community continued to increase. In addition, we experienced year-over-year declines in ad impressions delivered in the United States Canada region. These trends adversely affected advertising revenue growth in the second half of 2021 and we expect will continue to affect our advertising revenue growth in the foreseeable future. Other global and regional business and macroeconomic conditions also have had, and we believe will continue to have, an impact on our user growth and engagement and advertising revenue growth. We anticipate that additional investments in our data center capacity, servers, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, including in our Reality Labs initiatives, will continue to drive expense growth in 2022. We expect 2022 capit al expenditures to be in the range of $29-34 billion and total expenses to be in the range of $90-95 billion. In 2022, we also expect that our year-over-year total expense growth rates may significantly exceed our year-over-year revenue growth rates, which would adversely affect our operating margin and profitability. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as DAP or MAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. DAP/MAP: 78% 79% 79% 79% 79% 79% 79% 78% 79% Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 40 million DAP to our reported worldwide DAP in June 2020. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 60 million DAP to our reported worldwide DAP in March 2021. Worldwide DAP increased 8% to 2.82 billion on average during December 2021 from 2.60 billion during December 2020. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 50 million MAP to our reported worldwide MAP in June 2020. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 70 million MAP to our reported worldwide MAP in March 2021. As of December 31, 2021, we had 3.59 billion MAP, an increase of 9% from 3.30 billion as of December 31, 2020. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. We estimate that the share of revenue from users who are not also MAP was not material. ARPP: $7.38 $6.03 $6.10 $6.76 $8.62 $7.75 $8.36 $8.18 $9.39 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Our annual worldwide ARPP in 2021, which represents the sum of quarterly ARPP during such period, was $33.68, an increase of 22% from 2020. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. DAU/MAU: 66% 67% 66% 66% 66% 66% 66% 66% 66% DAU/MAU: 77% 77% 77% 77% 76% 75% 75% 75% 74% DAU/MAU: 75% 75% 74% 74% 74% 73% 73% 73% 72% DAU/MAU: 62% 62% 61% 62% 62% 62% 62% 63% 63% DAU/MAU: 65% 65% 65% 65% 65% 65% 65% 66% 65% Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 5% to 1.93 billion on aver age during December 2021 from 1.84 billion during December 2020. Users in India, Bangladesh, and Vietnam represented the top three sources of growth in DAUs during December 2021, relative to the same period in 2020. Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2021, we had 2.91 billion MAUs, an increase of 4% from December 31, 2020. Users in India, Vietnam, and Bangladesh represented the top three sources of growth in 2021, relative to the same period in 2020. Trends in Our Monetization by Facebook User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware products are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. While the share of revenue from users who are not also Facebook or Messenger MAUs has grown over time, we estimate that revenue from users who are Facebook or Messenger MAUs represents the substantial majority of our total revenue. See ""Average Revenue Per Person (ARPP)"" above for our estimates of trends in our monetization of our Family products. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2021 in the United States Canada region was more than 12 times higher than in the Asia-Pacific region. ARPU: $8.52 $6.95 $7.05 $7.89 $10.14 $9.27 $10.12 $10.00 $11.57 ARPU: $ 41.41 $ 34.18 $ 36.49 $ 39.63 $ 53.56 $ 48.03 $ 53.01 $ 52.34 $ 60.57 ARPU: $13.21 $10.64 $11.03 $12.41 $16.87 $15.49 $17.23 $ 16.50 $ 19.68 ARPU: $3.57 $3.06 $2.99 $3.67 $4.05 $3.94 $4.16 $4.30 $4.89 ARPU: $2.48 $1.99 $1.78 $2.22 $2.77 $2.64 $3.05 $3.14 $3.43 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in Note 2 Revenue in our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplemental Data"" where revenue is geographically apportioned based on the addresses of our customers. Our annual worldwide ARPU in 2021, which represents the sum of quarterly ARPU during such period, was $40.96, an increase of 28% from 2020. For 2021, ARPU increased by 40% in Rest of World, 35% in Europe, 31% in the United States Canada, and 26% in AsiaPacific, as compared with 2020. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the impact of the estimates and assumptions on our consolidated financial statements is material. We believe that the assumptions and estimates associated with gross vs. net in revenue recognition, valuation of equity investments, income taxes, loss contingencies, and valuation of long-lived assets including goodwill, intangible assets, and property and equipment, and their associated estimated useful lives, when applicable, have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Gross vs. Net in Revenue Recognition For revenue generated from arrangements that involve third parties, there is significant judgment in evaluating whether we are the principal, and report revenue on a gross basis, or the agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. The assessment of whether we are considered the principal or the agent in a transaction could impact our revenue and cost of revenue recognized on the consolidated statements of income. Valuation of Equity Investments For our equity securities without readily determinable fair values accounted for using the measurement alternative, determining whether an equity security issued by the same issuer is similar to the equity security we hold may require judgment in (a) assessment of differences in rights and obligations associated with the instruments such as voting rights, distribution rights and preferences, and conversion features, and (b) adjustments to the observable price for differences such as, but not limited to, rights and obligations, control premium, liquidity, or principal or most advantageous markets. In addition, the identification of observable transactions will depend on the timely reporting of these transactions from our investee companies, which may occur in a period subsequent to when the transactions take place. Therefore, our fair value adjustment for these observable transactions may occur in a period subsequent to when the transaction actually occurred. For equity investments, we perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; regulatory, economic or technological environment; operational and financing cash flows; and other relevant events and factors affecting the investee. When indicators of impairment exist, we estimate the fair value of our equity investments using the market approach and/or the income approach and recognize impairment loss in the consolidated statements of income if the estimated fair value is less than the carrying value. Estimating fair value requires judgment and use of estimates such as discount rates, forecast cash flows, holding period, and market data of comparable companies, among others. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research and development tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world, and we regularly become subject to new laws and regulations in the jurisdictions in which we operate. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the merits of our defenses and the impact of negotiations, settlements, regulatory proceedings, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Certain factors, in particular, have resulted in significant changes to these estimates and judgments in prior quarters based on updated information available. For example, in certain jurisdictions where we operate, fines and penalties may be the result of new laws and preliminary interpretations regarding the basis of assessing damages, which may make it difficult to estimate what such fines and penalties would amount to if successfully asserted against us. In addition, certain government inquiries and investigations, such as matters before our lead European Union privacy regulator, the IDPC, are subject to review by other regulatory bodies before decisions are finalized, which can lead to significant changes in the outcome of an inquiry. As a result of these and other factors, we reasonably expect that our estimates and judgments with respect to our contingencies may continue to be revised in future quarters. The ultimate outcome of these matters, such as whether the likelihood of loss is remote, reasonably possible, or probable or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of losses, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 11 Commitments and Contingencies and Note 14 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets, and Property and Equipment and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill to reporting units based on the expected benefit from the business combination. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite-lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. We have two reporting units subject to goodwill impairment testing. As of December 31, 2021, no impairment of goodwill has been identified. Long-lived assets, including property and equipment and finite-lived intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any material impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of our server and network assets category. The effect of the 2021 change was a reduction in depreciation expense of $620 million and an increase in net income of $516 million, or $0.18 per diluted share. The impact from the changes in our estimates was calculated based on the asset bases existing as of the effective dates of the changes and applying the revised useful lives prospectively. See Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K, for additional information regarding changes in the estimated useful lives of our property and equipment. Components of Results of Operations Revenue Family of Apps (FoA) Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total advertising revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Reality Labs (RL) RL revenue is generated from the delivery of consumer hardware products, such as Meta Quest , Facebook Portal, and wearables, and related software and content. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as depreciation expense from servers, network infrastructure and buildings, as well as payroll and related expenses which include share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions; RL cost of products sold; and content costs. Research and development. Research and development expenses consist primarily of payroll and related expenses which include share-based compensation, facilities-related costs for employees on our engineering and technical teams who are responsible for developing new products as well as improving existing products, and professional services. Marketing and sales. Marketing and sales expenses consist primarily of marketing and promotional expenses and payroll and related expenses which include share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist primarily of legal-related costs, which include accruals for estimated fines, settlements, or other losses in connection with legal and related matters, as well as other legal fees; payroll and related expenses which include share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; other taxes, such as digital services taxes, other tax levies, and gross receipts taxes; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2021 compared to the year ended December 31, 2020. For a discussion of the year ended December 31, 2020 compared to the year ended December 31, 2019, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2020. The following table sets forth our consolidated statements of income data (in millions): Year Ended December 31, 2021 2020 2019 Revenue $ 117,929 $ 85,965 $ 70,697 Costs and expenses: Cost of revenue 22,649 16,692 12,770 Research and development 24,655 18,447 13,600 Marketing and sales 14,043 11,591 9,876 General and administrative 9,829 6,564 10,465 Total costs and expenses 71,176 53,294 46,711 Income from operations 46,753 32,671 23,986 Interest and other income, net 531 509 826 Income before provision for income taxes 47,284 33,180 24,812 Provision for income taxes 7,914 4,034 6,327 Net income $ 39,370 $ 29,146 $ 18,485 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, 2021 2020 2019 Revenue 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 19 18 Research and development 21 21 19 Marketing and sales 12 13 14 General and administrative 8 8 15 Total costs and expenses 60 62 66 Income from operations 40 38 34 Interest and other income, net 1 1 Income before provision for income taxes 40 39 35 Provision for income taxes 7 5 9 Net income 33 % 34 % 26 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses (in millions): Year Ended December 31, 2021 2020 2019 Cost of revenue $ 577 $ 447 $ 377 Research and development 7,106 4,918 3,488 Marketing and sales 837 691 569 General and administrative 644 480 402 Total share-based compensation expense $ 9,164 $ 6,536 $ 4,836 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, 2021 2020 2019 Cost of revenue % 1 % 1 % Research and development 6 6 5 Marketing and sales 1 1 1 General and administrative 1 1 1 Total share-based compensation expense 8 % 8 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue The following table sets forth our revenue by segment. For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Advertising $ 114,934 $ 84,169 $ 69,655 37 % 21 % Other revenue 721 657 541 10 % 21 % Family of Apps 115,655 84,826 70,196 36 % 21 % Reality Labs 2,274 1,139 501 100 % 127 % Total revenue $ 117,929 $ 85,965 $ 70,697 37 % 22 % Family of Apps FoA revenue in 2021 increased $30.83 billion, or 36%, compared to 2020. The increase was mostly driven by an increase in advertising revenue. Advertising Advertising revenue in 2021 increased $30.76 billion, or 37%, compared to 2020 as a result of increases in both the average price per ad and the number of ads delivered. In 2021, the average price per ad increased by 24%, as compared with a decrease of approximately 10% in 2020. The increase in average price per ad in 2021 was mainly caused by a recovery from declines in advertising demand in the first two quarters of 2020, due to the onset of the COVID-19 pandemic. Additionally, overall advertising demand increased, as compared to 2020, across our ad products and in all regions in part due to the continued growth of online commerce. In 2021, the number of ads delivered increased by 10%, as compared with an approximate 34% increase in 2020. The increase in the ads delivered in 2021 was driven by increases in users and the number and frequency of ads displayed across our products. We anticipate that future advertising revenue growth will be driven by a combination of price and the number of ads delivered. Reality Labs RL revenue increased $1.14 billion, or 100%, from 2020 to 2021, and $638 million, or 127%, from 2019 to 2020. The increases in both periods were mostly driven by increases in the volume of our consumer hardware products sold. Revenue Seasonality and Customer Concentration Revenue is traditionally seasonally strong in the fourth quarter of each year due in part to seasonal holiday demand. We believe that this seasonality in both advertising revenue and RL consumer hardware sales affects our quarterly results, which generally reflect significant growth in revenue between the third and fourth quarters and a decline between the fourth and subsequent first quarters. For instance, our total revenue increased 16%, 31%, and 19% between the third and fourth quarters of 2021, 2020, and 2019, respectively, while total revenue for the first quarters of 2021, 2020, and 2019 declined 7%, 16%, and 11% compared to the fourth quarters of 2020, 2019, and 2018, respectively. We note the decline in total revenue in the first quarter of 2020 was exacerbated by the non-seasonal impact of the onset of the COVID-19 pandemic. No customer represented 10% or more of total revenue during the years ended December 31, 2021, 2020, and 2019. Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2021 compared to the same period in 2020 had a favorable impact on revenue. If we had translated revenue for the full year 2021 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $116.29 billion and $113.31 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $1.64 billion and $1.62 billion lower than actual total revenue and advertising revenue, respectively, for the full year 2021. Using the same constant rates, full year 2021 total revenue and advertising revenue would have been $30.32 billion and $29.15 billion, respectively, higher than actual total revenue and advertising revenue for the full year 2020. Cost of revenue Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Cost of revenue $ 22,649 $ 16,692 $ 12,770 36 % 31% Percentage of revenue 19% 19% 18% Cost of revenue in 2021 increased $5.96 billion, or 36%, compared to 2020. The majority of the increase was due to an increase in Reality Labs cost of products sold and an increase in operational expenses related to our data centers and technical infrastructure, partially offset by a decrease in the depreciation growth rate mostly due to increases in the useful lives of servers and network assets. To a lesser extent, costs associated with partner arrangements, including traffic acquisition and payment processing costs, also increased. See Note 1 Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information regarding changes in the estimated useful lives of our servers and network assets. In 2022, we anticipate that cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth and engagement and the delivery of new products and services, and, to a lesser extent, due to higher content costs. Research and development Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Research and development $ 24,655 $ 18,447 $ 13,600 34 % 36 % Percentage of revenue 21% 21% 19% Research and development expenses in 2021 increased $6.21 billion, or 34%, compared to 2020. The increase was primarily due to an increase in payroll and related expenses as a result of a 30% growth in employee headcount from December 31, 2020 to December 31, 2021 in engineering and other technical functions supporting our continued investment in our family of products and Reality Labs. To a lesser extent, Realty Labs technology development costs also increased. In 2022, we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives in our family of products and in Reality Labs. Marketing and sales Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Marketing and sales $ 14,043 $ 11,591 $ 9,876 21 % 17% Percentage of revenue 12% 13% 14% Marketing and sales expenses in 2021 increased $2.45 billion, or 21%, compared to 2020. The increase was primarily due to increases in marketing and promotional expenses, payroll and related expenses, and product and community operations expenses. Our payroll and related expenses increased as a result of a 9% increase in employee headcount from December 31, 2020 to December 31, 2021 in our marketing and sales functions. In 2022, we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts, and we anticipate marketing expenses will increase. General and administrative Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Legal accrual related to FTC settlement $ $ $ 5,000 NM NM Other general and administrative 9,829 6,564 5,465 50 % 20 % General and administrative $ 9,829 $ 6,564 $ 10,465 50 % (37) % Percentage of revenue 8% 8% 15% General and administrative expenses in 2021 increased $3.27 billion, or 50%, compared to 2020. The increase was primarily due to increases in legal-related costs and payroll and related expenses. Our payroll and related expenses increased as a result of a 25% increase in employee headcount from December 31, 2020 to December 31, 2021 in our general and administrative functions. See Note 11 Commitments and Contingencies in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding estimated fines, settlements, or other losses in connection with legal-related costs. In 2022, we plan to continue to increase general and administrative expenses to support overall company growth. We may also incur significant discrete charges such as legal-related accruals and settlement costs in general and administrative expenses. Segment profitability The following table sets forth income (loss) from operations by segment. For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Family of Apps $ 56,946 $ 39,294 $ 28,489 45 % 38 % Reality Labs (10,193) (6,623) (4,503) (54) % (47) % Total income from operations $ 46,753 $ 32,671 $ 23,986 43 % 36 % Family of Apps FoA income from operations in 2021 increased $17.65 billion, or 45%, compared to 2020 . The increase was due to the growth in advertising revenue partially offset by an increase in costs and expenses, the majority of which was due to an increase in payroll and related expenses as a result of higher employee headcount, higher legal-related costs, and increases in costs related to our data centers and technical infrastructure. FoA income from operations in 2020 increased $10.81 billion, or 38%, compared to 2019. The increase was due to the growth in advertising revenue and a one-time $5.0 billion FTC settlement accrual recorded in 2019, partially offset by an increase in costs and expenses, the majority of which was due to an increase in payroll and related expenses as a result of higher employee headcount, increases in costs related to our data centers and technical infrastructure, and higher marketing and promotional expenses. Reality Labs RL loss from operations in 2021 increased $3.57 billion, or 54%, compared to 2020, and in 2020 increased $2.12 billion , or 47%, compared to 2019 . The majority of the increases in loss from operations in both periods were driven by increases in payroll and related expenses primarily due to the growth in RL research and development headcount and higher gross losses from increases in volume of consumer hardware sales. Interest and other income, net Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Interest income, net $ 461 $ 672 $ 904 (31) % (26) % Foreign currency exchange losses, net (140) (129) (105) (9) % (23) % Other income (expense), net 210 (34) 27 NM NM Interest and other income, net $ 531 $ 509 $ 826 4 % (38) % Interest and other income, net in 2021 increased $22 million, or 4%, compared to 2020. The increase was due to an increase in other income from net unrealized gains recognized for our equity investments, partially offset by a decrease in interest income as a result of lower interest rates compared to 2020. Provision for income taxes Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Provision for income taxes $ 7,914 $ 4,034 $ 6,327 96 % (36) % Effective tax rate 16.7% 12.2% 25.5% Our provision for income taxes in 2021 increased $3.88 billion, or 96%, compared to 2020, primarily due to an increase in income from operations and the effects of the tax election described below. Our effective tax rate in 2021 increased compared to 2020, mostly due to the effects of the tax election described below and tax effects of a shift in jurisdictional mix of earnings. In the third quarter of 2020, as part of finalizing our U.S. income tax return, we elected to capitalize and amortize certain research and development expenses for U.S. income tax purposes. As a result, we recorded a total of $1.07 billion income tax benefit for the year ended December 31, 2020. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion between the following items and income before provision for income taxes: U.S. tax benefits from foreign-derived intangible income, tax effects from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the effects of changes in tax law. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return, which depend upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 28, 2022 price, and absent U.S. tax legislation changes and other one-time events, we expect our effective tax rate for the full year 2022 to be similar to the effective tax rate for the full year 2021. This includes the effects of the mandatory capitalization and amortization of research and development expenses starting in 2022, as required by the 2017 Tax Cuts and Jobs Act (Tax Act). The mandatory capitalization requirement increases our cash tax liabilities but also decreases our effective tax rate due to increasing the foreign-derived intangible income deduction. If the mandatory capitalization requirement is deferred, our effective tax rate in 2022 could be a few percentage points higher when compared to current law and our cash tax liabilities could be several billion dollars lower. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. See Note 14 Income Taxes in the notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K for additional information regarding income tax contingencies. Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Cash and cash equivalents and marketable securities were $48.0 billion as of December 31, 2021, a decrease of $13.96 billion from December 31, 2020. The decrease was primarily due to $44.54 billion for repurchases of our Class A common stock, $19.24 billion for capital expenditures, including principal payments on finance leases, and $5.51 billion of taxes paid related to net share settlement of employee restricted stock units (RSU) awards, offset by $57.68 billion of cash generated from operations for the year ended December 31, 2021. Cash paid for income taxes was $8.52 billion for the year ended December 31, 2021. As of December 31, 2021, our federal net operating loss carryforward was $10.61 billion and our federal tax credit carryforward was $527 million. We anticipate the utilization of a significant portion of these net operating losses and credits within the next two years. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In 2021, we repurchased and subsequently retired 136 million shares of our Class A common stock for $44.81 billion. As of December 31, 2021, $38.79 billion remained available and authorized for repurchases. As of December 31, 2021, $10.61 billion of the $48.0 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds and cash flow from operations will be sufficient to meet our operational cash needs and fund our share repurchase program for at least the next 12 months and thereafter for the foreseeable future. The following table presents our cash flows (in millions): Year Ended December 31, 2021 2020 2019 Net cash provided by operating activities $ 57,683 $ 38,747 $ 36,314 Net cash used in investing activities $ (7,570) $ (30,059) $ (19,864) Net cash used in financing activities $ (50,728) $ (10,292) $ (7,299) Cash Provided by Operating Activities Cash provided by operating activities during 2021 mostly consisted of $39.37 billion net income adjusted for certain non-cash items, including $9.16 billion of share-based compensation expense and $7.97 billion of depreciation and amortization. The increase in cash flow from operating activities during 2021 compared to 2020 was primarily du e to higher net income as adjusted for certain non-cash items, such as share-based compensation expense and deferred income taxes, partially offset by changes in working capital. Cash Used in Investing Activities Cash used in investing activities during 2021 primarily consisted of $18.57 billion of purchases of property and equipment as we continued to invest in data centers, servers, office facilities, and network infrastructure offset by $12.18 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2021 compared to 2020 was mostly due to decreases in net purchases of marketable securities and equity investments, partially offset by an increase in purchases of property and equipment. We anticipate making capital expenditures of approximately $29 billion to $34 billion in 2022. Cash Used in Financing Activities Cash used in financing activities during 2021 mostly consisted of $44.54 billion for repurchases of our Class A common stock and $5.51 billion of taxes paid related to net share settlement of RSUs. The increase in cash used in financing activities during 2021 compared to 2020 was mostly due to the increase in repurchases of our Class A common stock. Free Cash Flow In addition to other financial measures presented in accordance with U.S. GAAP, we monitor free cash flow (FCF) as a non-GAAP measure to manage our business, make planning decisions, evaluate our performance, and allocate resources. We define FCF as net cash provided by operating activities reduced by net purchases of property and equipment and principal payments on finance leases. We believe that FCF is one of the key financial indicators of our business performance over the long term and provides useful information regarding how cash provided by operating activities compares to the property and equipment investments required to maintain and grow our business. We have chosen our definition for FCF because we believe that this methodology can provide useful supplemental information to help investors better understand underlying trends in our business. We use FCF in discussions with our senior management and board of directors. FCF has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash provided by operating activities. FCF is not intended to represent our residual cash flow available for discretionary expenses. Some of the limitations of FCF are: FCF does not reflect our future contractual commitments; and other companies in our industry present similarly titled measures differently than we do, limiting their usefulness as comparative measures. Management compensates for the inherent limitations associated with using the FCF measure through disclosure of such limitations, presentation of our financial statements in accordance with GAAP, and reconciliation of FCF to the most directly comparable GAAP measure, net cash provided by operating activities, as presented below. The following is a reconciliation of FCF to the most comparable GAAP measure, net cash provided by operating activities (in millions): Year Ended December 31, 2021 2020 2019 Net cash provided by operating activities $ 57,683 $ 38,747 $ 36,314 Less: Purchases of property and equipment (18,567) (15,115) (15,102) Less: Principal payments on finance leases (677) (604) (552) Free cash flow $ 38,439 $ 23,028 $ 20,660 Off-Balance Sheet Arrangements As of December 31, 2021, we did not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations Our principal commitments consist mostly of obligations under operating leases and other contractual commitments. Our operating lease obligations mostly include among others, certain of our offices, data centers, colocations and land. Our other contractual commitments are primarily related to our investments in servers, network infrastructure and Reality Labs. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2021 (in millions): Payment Due by Period Total 2022 2023-2024 2025-2026 Thereafter Operating lease obligations, including imputed interest (1) $ 25,410 $ 1,559 $ 3,966 $ 3,837 $ 16,048 Finance lease obligations, including imputed interest (1) 2,303 678 603 322 700 Transition tax payable 1,537 848 689 Other contractual commitments 23,080 14,502 5,426 609 2,543 Total contractual obligations $ 52,330 $ 16,739 $ 10,843 $ 5,457 $ 19,291 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. Additionally, as part of the normal course of business, we may also enter into multi-year agreements to purchase renewable energy that do not specify a fixed or minimum volume commitment or to purchase certain server components that do not specify a fixed or minimum price commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $8.06 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. Our other liabilities also include $4.40 billion related to the uncertain tax positions as of December 31, 2021. Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 11 Commitments and Contingencies and Note 14 Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and equity investment risk. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $140 million, $129 million, and $105 million were recognized in 2021, 2020, and 2019, respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $714 million and $794 million in the market value of our available-for-sale debt securities as of December 31, 2021 and December 31, 2020, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial markets, including recent and ongoing effects related to the impact of the COVID-19 pandemic, which requires significant judgments, could result in a material impairment charge on our equity investments. Equity investments accounted for under the equity method were immaterial as of December 31, 2021 and December 31, 2020. Our total equity investments had a carrying value of $6.78 billion and $6.23 billion as of December 31, 2021 and December 31, 2020, respectively. For additional information about our equity investments, see Note 1 Summary of Significant Accounting Policies, Note 5 Equity Investments, and Note 6 Fair Value Measurements in the notes to the consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part II, Item 7, ""Managements Discussion and Analysis of Financial Conditions and Results of Operations Critical Accounting Policies and Estimates"" contained in this Annual Report on Form 10-K. "," Item 8. Financial Statements and Supplementary Data META PLATFORMS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm (PCAOB ID No. 42 ) Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Meta Platforms, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Meta Platforms, Inc. (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 11 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above. When applicable, the Company discloses an estimate of the amount of loss or range of possible loss that may be incurred. However, for certain other matters, the Company discloses that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, these loss contingencies was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure regarding any range of possible losses, including when the Company believes it cannot be reasonably estimated at this time, we read the minutes or a summary of the meetings of the committees of the board of directors, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained representations from management. We also evaluated the appropriateness of the related disclosures included in Note 11 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 14 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 14 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California February 2, 2022 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Meta Platforms, Inc. Opinion on Internal Control over Financial Reporting We have audited Meta Platforms, Inc.'s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Meta Platforms, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California February 2, 2022 META PLATFORMS, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, 2021 2020 Assets Current assets: Cash and cash equivalents $ 16,601 $ 17,576 Marketable securities 31,397 44,378 Accounts receivable, net 14,039 11,335 Prepaid expenses and other current assets 4,629 2,381 Total current assets 66,666 75,670 Equity investments 6,775 6,234 Property and equipment, net 57,809 45,633 Operating lease right-of-use assets 12,155 9,348 Intangible assets, net 634 623 Goodwill 19,197 19,050 Other assets 2,751 2,758 Total assets $ 165,987 $ 159,316 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 4,083 $ 1,331 Partners payable 1,052 1,093 Operating lease liabilities, current 1,127 1,023 Accrued expenses and other current liabilities 14,312 11,152 Deferred revenue and deposits 561 382 Total current liabilities 21,135 14,981 Operating lease liabilities, non-current 12,746 9,631 Other liabilities 7,227 6,414 Total liabilities 41,108 31,026 Commitments and contingencies Stockholders' equity: Common stock, $ 0.000006 par value; 5,000 million Class A shares authorized, 2,328 million and 2,406 million shares issued and outstanding, as of December 31, 2021 and 2020, respectively; 4,141 million Class B shares authorized, 413 million and 443 million shares issued and outstanding, as of December 31, 2021 and 2020, respectively Additional paid-in capital 55,811 50,018 Accumulated other comprehensive income (loss) ( 693 ) 927 Retained earnings 69,761 77,345 Total stockholders' equity 124,879 128,290 Total liabilities and stockholders' equity $ 165,987 $ 159,316 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2021 2020 2019 Revenue $ 117,929 $ 85,965 $ 70,697 Costs and expenses: Cost of revenue 22,649 16,692 12,770 Research and development 24,655 18,447 13,600 Marketing and sales 14,043 11,591 9,876 General and administrative 9,829 6,564 10,465 Total costs and expenses 71,176 53,294 46,711 Income from operations 46,753 32,671 23,986 Interest and other income, net 531 509 826 Income before provision for income taxes 47,284 33,180 24,812 Provision for income taxes 7,914 4,034 6,327 Net income $ 39,370 $ 29,146 $ 18,485 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 13.99 $ 10.22 $ 6.48 Diluted $ 13.77 $ 10.09 $ 6.43 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,815 2,851 2,854 Diluted 2,859 2,888 2,876 Share-based compensation expense included in costs and expenses: Cost of revenue $ 577 $ 447 $ 377 Research and development 7,106 4,918 3,488 Marketing and sales 837 691 569 General and administrative 644 480 402 Total share-based compensation expense $ 9,164 $ 6,536 $ 4,836 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2021 2020 2019 Net income $ 39,370 $ 29,146 $ 18,485 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax ( 1,116 ) 1,056 ( 151 ) Change in unrealized gain (loss) on available-for-sale investments and other, net of tax ( 504 ) 360 422 Comprehensive income $ 37,750 $ 30,562 $ 18,756 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2018 2,854 $ $ 42,906 $ ( 760 ) $ 41,981 $ 84,127 Issuance of common stock for cash upon exercise of stock options 1 15 15 Issuance of common stock for settlement of RSUs 32 Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income 271 271 Net income 18,485 18,485 Balances at December 31, 2019 2,852 45,851 ( 489 ) 55,692 101,054 Issuance of common stock for settlement of RSUs 38 Shares withheld related to net share settlement ( 14 ) ( 2,369 ) ( 1,195 ) ( 3,564 ) Share-based compensation 6,536 6,536 Share repurchases ( 27 ) ( 6,298 ) ( 6,298 ) Other comprehensive income 1,416 1,416 Net income 29,146 29,146 Balances at December 31, 2020 2,849 50,018 927 77,345 128,290 Issuance of common stock for settlement of RSUs 45 Shares withheld related to net share settlement ( 17 ) ( 3,371 ) ( 2,144 ) ( 5,515 ) Share-based compensation 9,164 9,164 Share repurchases ( 136 ) ( 44,810 ) ( 44,810 ) Other comprehensive loss ( 1,620 ) ( 1,620 ) Net income 39,370 39,370 Balances at December 31, 2021 2,741 $ $ 55,811 $ ( 693 ) $ 69,761 $ 124,879 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Cash flows from operating activities Net income $ 39,370 $ 29,146 $ 18,485 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,967 6,862 5,741 Share-based compensation 9,164 6,536 4,836 Deferred income taxes 609 ( 1,192 ) ( 37 ) Other ( 127 ) 118 39 Changes in assets and liabilities: Accounts receivable ( 3,110 ) ( 1,512 ) ( 1,961 ) Prepaid expenses and other current assets ( 1,750 ) 135 47 Other assets ( 349 ) ( 34 ) 41 Accounts payable 1,436 ( 17 ) 113 Partners payable ( 12 ) 178 348 Accrued expenses and other current liabilities 3,357 ( 1,054 ) 7,300 Deferred revenue and deposits 187 108 123 Other liabilities 941 ( 527 ) 1,239 Net cash provided by operating activities 57,683 38,747 36,314 Cash flows from investing activities Purchases of property and equipment ( 18,567 ) ( 15,115 ) ( 15,102 ) Purchases of marketable securities ( 30,407 ) ( 33,930 ) ( 23,910 ) Sales of marketable securities 31,671 11,787 9,565 Maturities of marketable securities 10,915 13,984 10,152 Purchases of equity investments ( 47 ) ( 6,361 ) ( 61 ) Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 851 ) ( 388 ) ( 508 ) Other investing activities ( 284 ) ( 36 ) Net cash used in investing activities ( 7,570 ) ( 30,059 ) ( 19,864 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 5,515 ) ( 3,564 ) ( 2,337 ) Repurchases of Class A common stock ( 44,537 ) ( 6,272 ) ( 4,202 ) Principal payments on finance leases ( 677 ) ( 604 ) ( 552 ) Net change in overdraft in cash pooling entities 14 24 ( 223 ) Other financing activities ( 13 ) 124 15 Net cash used in financing activities ( 50,728 ) ( 10,292 ) ( 7,299 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash ( 474 ) 279 4 Net increase (decrease) in cash, cash equivalents, and restricted cash ( 1,089 ) ( 1,325 ) 9,155 Cash, cash equivalents, and restricted cash at beginning of the period 17,954 19,279 10,124 Cash, cash equivalents, and restricted cash at end of the period $ 16,865 $ 17,954 $ 19,279 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 16,601 $ 17,576 $ 19,079 Restricted cash, included in prepaid expenses and other current assets 149 241 8 Restricted cash, included in other assets 115 137 192 Total cash, cash equivalents, and restricted cash $ 16,865 $ 17,954 $ 19,279 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Supplemental cash flow data Cash paid for income taxes, net $ 8,525 $ 4,229 $ 5,182 Non-cash investing and financing activities: Property and equipment in accounts payable and accrued expenses and other current liabilities $ 3,404 $ 2,201 $ 1,887 Acquisition of businesses in accrued expenses and other current liabilities and other liabilities $ 73 $ 118 $ Other current assets through financing arrangement in accrued expenses and other current liabilities $ 508 $ $ Repurchases of Class A common stock in accrued expenses and other current liabilities $ 340 $ 68 $ 43 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business We were incorporated in Delaware in July 2004. In October 2021, we changed our corporate name from Facebook, Inc. to Meta Platforms, Inc. Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. W e report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL) . The segment information aligns with how the chief operating decision maker (CODM), who is our Chief Executive Officer (CEO), reviews and manages the business. W e generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Meta Platforms, Inc., its subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill, intangible assets, and property and equipment, and their associated estimated useful lives, credit losses of available-for-sale (AFS) debt securities, credit losses of accounts receivable, fair value of financial instruments, and leases. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of selected cohorts of servers and network assets from three years to four years in prior years as well as in 2021 as a result of longer refresh cycles in our data centers. Prior year changes individually or in aggregate did not have a material impact to the consolidated financial statements. The effect of the 2021 changes was a reduction in depreciation expense of $ 620 million and an increase in net income of $ 516 million, or $ 0.18 per diluted share for the year ended December 31, 2021. The impact from the changes in our estimates was calculated based on the asset bases existing as of the effective dates of the changes and applying the revised estimated useful lives prospectively. Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition by applying the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. In general, we report advertising revenue on a gross basis, since we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers. For revenue generated from arrangements that involve third-party publishers, we evaluate whether we are the principal or the agent, and for those advertising revenue arrangements where we are the agent, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives, credits, or refunds, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We estimate these amounts and reduce revenue based on the amounts expected to be provided to customers. We believe that there will not be significant changes to our estimates of variable consideration. Reality Labs Revenue RL revenue is generated from the delivery of consumer hardware products, such as Meta Quest, Facebook Portal, and wearables, and related software and content. Revenue is recognized at the time control of the products is transferred to customers, which is generally at the time of delivery, in an amount that reflects the consideration RL expects to be entitled to in exchange for the products. Other Revenue Other revenue consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Deferred Revenue and Deposits Deferred revenue and deposits mostly consists of billings and payments we receive from marketers in advance of revenue recognition, revenue not yet recognized for unspecified software upgrades and updates for various RL products. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once the unused balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue and deposits balance for the year ended December 31, 2021 was driven by cash payments from customers in advance of satisfying our performance obligations in RL sales and advertising revenue, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We expense sales commissions when incurred if the amortization period is one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as depreciation expense from servers, network infrastructure and buildings, as well as payroll and related expenses which include share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions; RL cost of products sold; and content costs. Content Costs Our content costs are mostly related to payments to content providers from whom we license video and music to increase engagement on the platform. For licensed video, we expense the cost per title when the title is accepted and available for viewing if the capitalization criteria are not met. Video content costs that meet the criteria for capitalization were not material to date. For licensed music, we expense the license fees over the contractual license period. Expensed content costs are included in cost of revenue on the consolidated statements of income. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be marketed or sold to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Share-based Compensation Share-based compensation expense consists of the company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. We account for forfeitures as they occur. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses on the consolidated statements of income. We incurred advertising expenses of $ 2.99 billion, $ 2.26 billion, and $ 1.57 billion for the years ended December 31, 2021, 2020, and 2019, respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. We classify our marketable securities as available-for-sale (AFS) investments in our current assets because they represent investments of cash available for current operations. Our AFS investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. AFS debt securities with an amortized cost basis in excess of estimated fair value are assessed to determine what amount of that difference, if any, is caused by expected credit losses. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income, net on our consolidated statements of income, and any remaining unrealized losses, net of taxes, are included in accumulated other comprehensive income (loss) in stockholders' equity. The amounts of credit losses recorded for the years ended December 31, 2021 and 2020 were not material. There was no impairment charge for any unrealized losses in 2019. We determine realized gains or losses on sale of marketable securities on a specific identification method and include such gains or losses in interest and other income, net on the consolidated statements of income. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the consolidated balance sheets based upon the term of the remaining restrictions. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value from observable transactions for identical or similar investments of the same issuer as of the respective transaction dates. The change in carrying value, if any, is recognized in interest and other income, net on our consolidated statements of income. We periodically review our equity investments for impairment. If indicators exist and the estimated fair value of an investment is below the carrying amount, we will write down the investment to fair value. In addition, we also held equity investments accounted for under the equity method which were immaterial as of December 31, 2021 and 2020. Fair Value Measurements We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our cash equivalents and marketable securities are classified within Level 1 or Level 2 of the fair value hierarchy because their fair value is derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Our equity investments accounted for using the measurement alternative are recorded at fair value on a non-recurring basis. When indicators of impairment exist or observable price changes of qualified transactions occur, the respective equity investment would be classified within Level 3 of the fair value hierarchy because the valuation methods include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates of expected credit and collectibility trends for the allowance for credit losses and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, reasonable and supportable forecasts of future economic conditions, and other factors that may affect our ability to collect from customers. Expected credit losses are recorded as general and administrative expenses on our consolidated statements of income. As of December 31, 2021 and 2020, the allowances for accounts receivable were immaterial. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, which are amortized, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment and amortization periods of finance lease right-of-use assets are described below: Property and Equipment Useful Life/ Amortization period Servers and network assets Four years Buildings 25 to 30 years Equipment and other One to 25 years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term We evaluate at least annually the recoverability of property and equipment for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of property and equipment assets is not recoverable, and the asset's fair value is less than the carrying amount, an impairment charge is recognized. We have not recorded any material impairment charges during the years presented. The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. See section ""Use of Estimates"" above for additional information regarding changes in the estimated useful lives of our servers and network assets. Servers and network assets include property and equipment mostly in our data centers, which is used to support production traffic. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We have operating leases comprised of certain offices, data centers, land, colocations, network infrastructure, and other equipment. We also have finance leases for certain network infrastructure. We determine if an arrangement is a lease at inception. Most of our leases contain lease and non-lease components. Non-lease components include fixed payments for maintenance, utilities, real estate taxes, and management fees. We combine fixed lease and non-lease components and account for them as a single lease component. Our lease agreements may contain variable costs such as contingent rent escalations, common area maintenance, insurance, real estate taxes, or other costs. Such variable lease costs are expensed as incurred on the consolidated statements of income. For certain colocation and equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. For leases with a lease term greater than 12 months, ROU assets and lease liabilities are recognized on the consolidated balance sheets at the commencement date based on the present value of the remaining fixed lease payments and includes only payments that are fixed and determinable at the time of commencement. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be in a similar economic environment. Operating leases are included in operating lease ROU assets, operating lease liabilities, current, and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, net, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Operating lease costs are recognized on a straight-line basis over the lease terms. Finance lease assets are amortized on a straight-line basis over the shorter of the estimated useful lives of the assets or the lease terms. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world, and we regularly become subject to new laws and regulations in the jurisdictions in which we operate. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the merits of our defenses and the impact of negotiations, settlements, regulatory proceedings, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Certain factors, in particular, have resulted in significant changes to these estimates and judgments in prior quarters based on updated information available. For example, in certain jurisdictions where we operate, fines and penalties may be the result of new laws and preliminary interpretations regarding the basis of assessing damages, which may make it difficult to estimate what such fines and penalties would amount to if successfully asserted against us. In addition, certain government inquiries and investigations, such as matters before our lead European Union privacy regulator, the IDPC, are subject to review by other regulatory bodies before decisions can be finalized, which can lead to significant changes in the outcome of an inquiry. As a result of these and other factors, we reasonably expect that our estimates and judgments with respect to our contingencies may continue to be revised in future quarters. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill to reporting units based on the expected benefit from the business combination. Allocation of purchase consideration to identifiable assets and liabilities affects the amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite-lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Acquisition-related expenses are recognized separately from business combinations and are expensed as incurred. Goodwill and Intangibles Assets We allocate goodwill to reporting units based on the expected benefit from business combinations. We evaluate our reporting units annually, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. We have two reporting units subject to goodwill impairment testing. As of December 31, 2021, no impairment of goodwill has been identified. We evaluate the recoverability of finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation of these intangible assets are performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of finite-lived intangible assets is not recoverable, and the assets fair value is less than the carrying amount, an impairment charge is recognized. We have not recorded any material impairment charges during the years presented. Our finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. Indefinite-lived intangible assets are not amortized. If an indefinite-lived intangible asset is subsequently determined to have a finite useful life, the asset will be tested for impairment and accounted for as a finite-lived intangible asset prospectively over its estimated remaining useful life. We routinely review the remaining estimated useful lives of finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of stockholders' equity. As of December 31, 2021, we had a cumulative translation loss, net of tax of $ 677 million and as of December 31, 2020, we had a cumulative translation gain, net of tax of $ 439 million. Foreign currency transaction gains and losses from transactions denominated in a currency other than the functional currency of the subsidiary involved are recorded within interest and other income, net on our consolidated statements of income. Net losses resulting from foreign currency transactions were $ 140 million, $ 129 million, and $ 105 million for the years ended December 31, 2021, 2020, and 2019, respectively. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. The amount of credit losses recorded for the year ended December 31, 2021 was not material. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 41 %, 42 %, and 43 % of our revenue for the years ended December 31, 2021, 2020, and 2019, respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, Brazil, and Thailand. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses, and bad debt expense on these losses was not material during the years ended December 31, 2021, 2020, or 2019. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2021, 2020, and 2019. Recently Adopted Accounting Pronouncements On January 1, 2021, we adopted Accounting Standards Update (ASU) No. 2020-01, InvestmentsEquity Securities (Topic 321), InvestmentsEquity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) (ASU 2020-01), which clarifies the interaction of the accounting for equity securities under Topic 321, the accounting for equity method investments in Topic 323, and the accounting for certain forward contracts and purchased options in Topic 815. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2021, we early adopted ASU No. 2020-06, DebtDebt with Conversion and Other Options (Subtopic 470-20) and Derivatives and HedgingContracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entitys Own Equity (ASU 2020-06), which simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments. This guidance also eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. The new standard was effective for us beginning January 1, 2022, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2021, we early adopted ASU No. 2021-05, Leases (Topic 842): Lessors Certain Leases with Variable Lease Payments (ASU 2016-02), which requires a lessor to classify a lease with variable lease payments that do not depend on an index or rate as an operating lease if specified criteria are met. The new standard was effective for us beginning January 1, 2022, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Accounting Pronouncements Not Yet Adopted In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASU 2021-08), which clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606) . This guidance will be effective for us in the first quarter of 2023 on a prospective basis, with early adoption permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. In November 2021, the FASB issued ASU No. 2021-10, Government Assistance (Topic 832): Disclosure by Business Entities about Government Assistance (ASU 2021-10), which improves the transparency of government assistance received by most business entities by requiring the disclosure of: (1) the types of government assistance received; (2) the accounting for such assistance; and (3) the effect of the assistance on a business entity's financial statements. This guidance will be effective for us in the year ended December 31, 2022, with early adoption permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source and by segment consists of the following (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 Advertising $ 114,934 $ 84,169 $ 69,655 Other revenue 721 657 541 Family of Apps $ 115,655 $ 84,826 $ 70,196 Reality Labs 2,274 1,139 501 Total revenue $ 117,929 $ 85,965 $ 70,697 Revenue disaggregated by geography, based on the addresses of our customers, consists of the following (in millions): Year Ended December 31, 2021 2020 2019 United States and Canada (1) $ 51,541 $ 38,433 $ 32,206 Europe (2) 29,057 20,349 16,826 Asia-Pacific 26,739 19,848 15,406 Rest of World (2) 10,592 7,335 6,259 Total revenue $ 117,929 $ 85,965 $ 70,697 _________________________ (1) United States revenue was $ 48.38 billion, $ 36.25 billion, and $ 30.23 billion for the years ended December 31, 2021, 2020, and 2019, respectively. (2) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Our total deferred revenue was $ 596 million and $ 371 million as of December 31, 2021 and 2020, respectively. As of December 31, 2021, we expect $ 517 million of our deferred revenue to be realized in less than a year. Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method. As the liquidation and dividend rights for both Class A and Class B common stock are identical, the undistributed earnings are allocated on a proportionate basis to the weighted-average number of common shares outstanding for the period. Basic EPS is computed by dividing net income by the weighted-average number of shares of our Class A and Class B common stock outstanding. For the calculation of diluted EPS, net income for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS is computed by dividing the resulting net income by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2021, 2020, and 2019. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, 2021 2020 2019 Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 33,328 $ 6,042 $ 24,607 $ 4,539 $ 15,569 $ 2,916 Denominator Shares used in computation of basic earnings per share 2,383 432 2,407 444 2,404 450 Basic EPS $ 13.99 $ 13.99 $ 10.22 $ 10.22 $ 6.48 $ 6.48 Diluted EPS: Numerator Net income $ 33,328 $ 6,042 $ 24,607 $ 4,539 $ 15,569 $ 2,916 Reallocation of net income as a result of conversion of Class B to Class A common stock 6,042 4,539 2,916 Reallocation of net income to Class B common stock ( 93 ) ( 58 ) ( 18 ) Net income for diluted EPS $ 39,370 $ 5,949 $ 29,146 $ 4,481 $ 18,485 $ 2,898 Denominator Shares used in computation of basic earnings per share 2,383 432 2,407 444 2,404 450 Conversion of Class B to Class A common stock 432 444 450 Weighted-average effect of dilutive RSUs 44 37 22 1 Shares used in computation of diluted earnings per share 2,859 432 2,888 444 2,876 451 Diluted EPS $ 13.77 $ 13.77 $ 10.09 $ 10.09 $ 6.43 $ 6.43 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, 2021 2020 Cash and cash equivalents: Cash $ 7,308 $ 6,488 Money market funds 8,850 9,755 U.S. government securities 25 1,016 U.S. government agency securities 108 Certificates of deposit and time deposits 250 305 Corporate debt securities 60 12 Total cash and cash equivalents 16,601 17,576 Marketable securities: U.S. government securities 10,901 20,921 U.S. government agency securities 5,927 11,698 Corporate debt securities 14,569 11,759 Total marketable securities 31,397 44,378 Total cash and cash equivalents and marketable securities $ 47,998 $ 61,954 The gross unrealized gains on our marketable securities were not material and $ 641 million as of December 31, 2021 and 2020, respectively. The gross unrealized losses and the allowance for credit losses on our marketable securities were not material as of December 31, 2021 and 2020. The following table classifies our marketable securities by contractual maturities (in millions): December 31, 2021 Due within one year $ 3,352 Due after one year to five years 28,045 Total $ 31,397 Note 5. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. On July 7, 2020, we completed our equity investment in Jio Platforms Limited (Jio), a subsidiary of Reliance Industries Limited, for $ 5.82 billion. The following table summarizes our equity investments that were measured using measurement alternative and equity method (in millions): December 31, 2021 2020 Equity investments under measurement alternative: Initial cost $ 6,480 $ 6,171 Cumulative upward adjustments 311 26 Cumulative impairment/downward adjustments ( 50 ) ( 25 ) Carrying value 6,741 6,172 Equity investments under equity method 34 62 Total equity investments $ 6,775 $ 6,234 Note 6. Fair Value Measurements The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2021 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents: Money market funds $ 8,850 $ 8,850 $ U.S. government securities 25 25 U.S. government agency securities 108 108 Certificates of deposit and time deposits 250 250 Corporate debt securities 60 60 Marketable securities: U.S. government securities 10,901 10,901 U.S. government agency securities 5,927 5,927 Corporate debt securities 14,569 14,569 Total cash equivalents and marketable securities $ 40,690 $ 25,811 $ 14,879 Fair Value Measurement at Reporting Date Using Description December 31, 2020 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents: Money market funds $ 9,755 $ 9,755 $ U.S. government securities 1,016 1,016 Certificates of deposit and time deposits 305 305 Corporate debt securities 12 12 Marketable securities: U.S. government securities 20,921 20,921 U.S. government agency securities 11,698 11,698 Corporate debt securities 11,759 11,759 Total cash equivalents and marketable securities $ 55,466 $ 43,390 $ 12,076 We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. We also have assets and liabilities classified within Level 3 because factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. As of December 31, 2021, included in the total $ 6.78 billion of equity investments, $ 913 million was measured at fair value and was classified within Level 3 of the fair value measurement hierarchy on a non-recurring basis. As of December 31, 2020, our Level 3 equity investments were not material. For information regarding equity investments, see Note 5 Equity Investments. Note 7. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, 2021 2020 Land $ 1,688 $ 1,326 Servers and network assets 25,584 20,544 Buildings 22,531 17,360 Leasehold improvements 5,795 4,321 Equipment and other 4,764 3,917 Finance lease right-of-use assets 2,840 2,295 Construction in progress 14,687 11,288 Property and equipment, gross 77,889 61,051 Less: Accumulated depreciation ( 20,080 ) ( 15,418 ) Property and equipment, net $ 57,809 $ 45,633 Construction in progress includes costs mostly related to construction of data centers, network infrastructure, and office buildings. Prior year balances of certain property and equipment categories have been reclassified to conform to the current year's presentation. Depreciation expense on property and equipment was $ 7.56 billion, $ 6.39 billion, and $ 5.18 billion for the years ended December 31, 2021, 2020, and 2019, respectively. The majority of the property and equipment depreciation expense was from servers and network assets depreciation of $ 4.94 billion, $ 4.38 billion, and $ 3.69 billion for the years ended December 31, 2021, 2020, and 2019, respectively. Note 8. Leases We have entered into various non-cancelable operating lease agreements mostly for certain of our offices, data centers, colocations, and land. We have also entered into various non-cancelable finance lease agreements for certain network infrastructure. Our leases have original lease periods expiring between 2022 and 2093. Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs are as follows (in millions): Year Ended December 31, 2021 2020 2019 Finance lease cost Amortization of right-of-use assets $ 344 $ 259 $ 195 Interest 15 14 12 Operating lease cost 1,540 1,391 1,139 Variable lease cost and other, net 272 269 160 Total lease cost $ 2,171 $ 1,933 $ 1,506 Supplemental balance sheet information related to leases is as follows: December 31, 2021 2020 Weighted-average remaining lease term Finance leases 13.9 years 14.9 years Operating leases 13.0 years 12.2 years Weighted-average discount rate Finance leases 2.7 % 2.9 % Operating leases 2.8 % 3.1 % The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2021 (in millions): Operating Leases Finance Leases 2022 $ 1,425 $ 90 2023 1,542 65 2024 1,513 45 2025 1,354 45 2026 1,295 45 Thereafter 9,995 406 Total undiscounted cash flows 17,124 696 Less: Imputed interest ( 3,251 ) ( 115 ) Present value of lease liabilities $ 13,873 $ 581 Lease liabilities, current $ 1,127 $ 75 Lease liabilities, non-current 12,746 506 Present value of lease liabilities $ 13,873 $ 581 The table above does not include lease payments that were not fixed at commencement or lease modification. As of December 31, 2021, we have additional operating and finance leases, that have not yet commenced, with lease obligations of approximately $ 8.34 billion and $ 1.62 billion, respectively, mostly for offices, data centers, and network infrastructure. These operating and finance leases will commence between 2022 and 2028 with lease terms of greater than one year to 30 years. Supplemental cash flow information related to leases is as follows (in millions): Year Ended December 31, 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows for operating leases $ 1,406 $ 1,208 $ 902 Operating cash flows for finance leases $ 15 $ 14 $ 12 Financing cash flows for finance leases $ 677 $ 604 $ 552 Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 4,466 $ 1,158 $ 5,081 Finance leases $ 160 $ 121 $ 193 Note 9. Goodwill and Intangible Assets During the year ended December 31, 2021, we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, individually and in aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2021 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. Changes in the carrying amount of goodwill by reportable segment for the years ended December 31, 2021 and 2020 are as follows (in millions): Family of Apps Reality Labs Total Balance as of December 31, 2019 $ 18,715 Acquisitions 322 Effect of currency translation adjustment 13 Balance as of December 31, 2020 19,050 Acquisitions 210 Adjustments/transfer ( 191 ) Effect of currency translation adjustment ( 4 ) Segment allocation in the fourth quarter of 2021 (1) $ 18,455 $ 610 19,065 Acquisitions in the fourth quarter of 2021 128 128 Effect of currency translation adjustment 3 1 4 Balance as of December 31, 2021 $ 18,458 $ 739 $ 19,197 _________________________ (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2021. See Note 15 Segment and Geographical Information for further details. The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2021 December 31, 2020 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 0.0 $ 2,057 $ ( 2,057 ) $ $ 2,057 $ ( 1,840 ) $ 217 Acquired technology 2.6 1,412 ( 1,169 ) 243 1,297 ( 1,088 ) 209 Acquired patents 3.4 827 ( 722 ) 105 805 ( 677 ) 128 Trade names 3.0 644 ( 633 ) 11 636 ( 622 ) 14 Other 12.1 176 ( 167 ) 9 223 ( 168 ) 55 Total finite-lived assets 5,116 ( 4,748 ) 368 5,018 ( 4,395 ) 623 Total indefinite-lived assets N/A 266 266 Total intangible assets, net $ 5,382 $ ( 4,748 ) $ 634 $ 5,018 $ ( 4,395 ) $ 623 Amortization expense of intangible assets for the years ended December 31, 2021, 2020, and 2019 was $ 407 million, $ 473 million, and $ 562 million, respectively. As of December 31, 2021, expected amortization expense for the unamortized finite-lived intangible assets for the next five years and thereafter is as follows (in millions): 2022 $ 164 2023 103 2024 61 2025 18 2026 13 Thereafter 9 Total $ 368 Note 10. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, 2021 2020 Legal-related accruals (1) $ 3,254 $ 1,622 Accrued compensation and benefits 3,152 2,609 Accrued property and equipment 1,392 1,414 Accrued taxes 1,256 2,038 Other current liabilities 5,258 3,469 Accrued expenses and other current liabilities $ 14,312 $ 11,152 _________________________ (1) Includes accruals for estimated fines, settlements, or other losses in connection with legal and related matters, as well as other legal fees. For further information, see Legal and Related Matters in Note 11 Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, 2021 2020 Income tax payable $ 5,938 $ 5,025 Other liabilities 1,289 1,389 Other liabilities $ 7,227 $ 6,414 Note 11. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Meta Platforms, Inc. Other Contractual Commitments We have $ 23.08 billion of non-cancelable contractual commitments as of December 31, 2021, which are primarily related to our investments in servers, network infrastructure, and Reality Labs. These commitments are primarily due within five years . Legal and Related Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. On December 20, 2021, the district court granted our motion to dismiss the third amended complaint, with prejudice. On January 17, 2022, the plaintiffs filed a notice of appeal of the order dismissing their case. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $ 5.0 billion which was paid in April 2020 upon the effectiveness of the modified consent order. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing. On July 16, 2021, a stockholder derivative action was filed in Delaware Chancery Court against certain of our directors and officers asserting breach of fiduciary duty and related claims relating to our historical platform and user data practices, as well as our settlement with the FTC. On July 20, 2021, other stockholders filed an amended derivative complaint in a related Delaware Chancery Court action, asserting breach of fiduciary duty and related claims against certain of our current and former directors and officers in connection with our historical platform and user data practices. On November 4, 2021, the lead plaintiffs filed a second amended and consolidated complaint in the stockholder derivative action. We believe the lawsuits described above are without merit, and we are vigorously defending them. We also notify the Irish Data Protection Commission (IDPC), our lead European Union privacy regulator under the General Data Protection Regulation (GDPR), of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. The GDPR is still a relatively new law and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. Although we are vigorously defending our regulatory compliance, we have accrued significant amounts for loss contingencies related to these inquiries and investigations in Europe, and we believe there is a reasonable possibility that additional accruals for losses related to these matters could be material in the aggregate. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to a former employee's allegations and release of internal company documents concerning, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being. Beginning on October 27, 2021, multiple putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the same matters. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil, Russia, and other countries in Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. For example, we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleged that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. On June 28, 2021, the court granted our motions to dismiss the complaints filed by the FTC and attorneys general, dismissing the FTC's complaint with leave to amend and dismissing the attorneys general's case without prejudice. On July 28, 2021, the attorneys general filed a notice of appeal of the order dismissing their case. On August 19, 2021, the FTC filed an amended complaint, and on October 4, 2021, we filed a motion to dismiss this amended complaint. On January 11, 2022, the court denied our motion to dismiss the FTC's amended complaint. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking damages and unspecified injunctive relief. Several of the cases brought on behalf of certain advertisers and users were consolidated in the U.S. District Court for the Northern District of California. On January 14, 2022, the court granted, in part, and denied, in part, our motion to dismiss the consolidated actions. We believe these lawsuits are without merit, and we are vigorously defending them. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these other legal proceedings, claims, regulatory, tax, or government inquiries and investigations, and other matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. The ultimate outcome of the legal and related matters described in this section, such as whether the likelihood of loss is remote, reasonably possible, or probable, or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of loss, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 14 Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2021, there was not a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2021. Note 12. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2021, we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2021, we have not declared any dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2021, there were 2,328 million shares of Class A common stock and 413 million shares of Class B common stock issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2020, $ 8.60 billion remained available and authorized for repurchases under this program. In January 2021 and October 2021, additional $ 25.0 billion and $ 50.0 billion of repurchases were authorized under this program, respectively. In 2021, we repurchased and subsequently retired 136 million shares of our Class A common stock for an aggregate amount of $ 44.81 billion. As of December 31, 2021, $ 38.79 billion remained available and authorized for repurchases. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans Since 2020, we have maintained one active share-based employee compensation plan, the 2012 Equity Incentive Plan, which was amended in each of June 2016, February 2018 (Amended 2012 Plan). Our Amended 2012 Plan provides for the issuance of incentive and nonqualified stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors, and consultants. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our stock plan are added to the reserves of the Amended 2012 Plan. As of December 31, 2021, there were 116 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. Pursuant to the automatic increase provision under our Amended 2012 Plan, the number of shares reserved for issuance increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 20 million shares of Class A common stock reserved for issuance effective January 1, 2022. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2021: Number of Shares Weighted-Average Grant Date Fair Value Per Share (in thousands) Unvested at December 31, 2020 96,733 $ 181.88 Granted 59,127 $ 305.40 Vested ( 44,574 ) $ 198.95 Forfeited ( 12,438 ) $ 211.58 Unvested at December 31, 2021 98,848 $ 244.32 The weighted-average grant date fair value of RSUs granted in the years ended December 31, 2020 and 2019 was $ 188.73 and $ 173.66 , respectively. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2021, 2020, and 2019 was $ 14.42 billion, $ 9.38 billion, and $ 6.01 billion, respectively. The income tax benefit recognized related to awards vested or exercised during the years ended December 31, 2021, 2020, and 2019 was $ 3.08 billion, $ 1.81 billion, and $ 0.98 billion, respectively. As of December 31, 2021, there was $ 22.77 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 13. Interest and Other Income, Net The following table presents the detail of interest and other income, net (in millions): Year Ended December 31, 2021 2020 2019 Interest income, net $ 461 $ 672 $ 904 Foreign currency exchange losses, net ( 140 ) ( 129 ) ( 105 ) Other income (expense), net 210 ( 34 ) 27 Interest and other income, net $ 531 $ 509 $ 826 Note 14. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, 2021 2020 2019 Domestic $ 43,669 $ 24,233 $ 5,317 Foreign 3,615 8,947 19,495 Income before provision for income taxes $ 47,284 $ 33,180 $ 24,812 The provision for income taxes consists of the following (in millions): Year Ended December 31, 2021 2020 2019 Current: Federal $ 4,971 $ 3,297 $ 4,321 State 548 523 565 Foreign 1,786 1,211 1,481 Total current tax expense 7,305 5,031 6,367 Deferred: Federal 585 ( 859 ) ( 39 ) State 43 ( 122 ) 19 Foreign ( 19 ) ( 16 ) ( 20 ) Total deferred tax (benefits)/expense 609 ( 997 ) ( 40 ) Provision for income taxes $ 7,914 $ 4,034 $ 6,327 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, 2021 2020 2019 U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 % State income taxes, net of federal benefit 1.0 0.8 1.8 Share-based compensation 0.5 0.2 4.5 Excess tax benefits related to share-based compensation ( 2.2 ) ( 1.6 ) ( 0.7 ) Research and development tax credits ( 1.3 ) ( 1.3 ) ( 0.8 ) Foreign-derived intangible income deduction ( 3.5 ) ( 1.9 ) Effect of non-U.S. operations 0.9 ( 2.4 ) ( 5.8 ) Non-deductible FTC settlement accrual 4.5 Research and development capitalization ( 3.0 ) Other 0.3 0.4 1.0 Effective tax rate 16.7 % 12.2 % 25.5 % Our deferred tax assets (liabilities) are as follows (in millions): December 31, 2021 2020 Deferred tax assets: Net operating loss carryforward $ 2,443 $ 2,437 Tax credit carryforward 1,385 1,055 Share-based compensation 319 243 Accrued expenses and other liabilities 1,195 1,108 Lease liabilities 2,597 2,058 Capitalized research and development 1,691 1,922 Other 449 340 Total deferred tax assets 10,079 9,163 Less: valuation allowance ( 1,586 ) ( 1,218 ) Deferred tax assets, net of valuation allowance 8,493 7,945 Deferred tax liabilities: Depreciation and amortization ( 4,425 ) ( 3,811 ) Right-of-use assets ( 2,339 ) ( 1,876 ) Total deferred tax liabilities ( 6,764 ) ( 5,687 ) Net deferred tax assets $ 1,729 $ 2,258 The valuation allowance was approximately $ 1.59 billion and $ 1.22 billion as of December 31, 2021 and 2020, respectively, primarily relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2021, the U.S. federal and state net operating loss carryforwards were $ 10.61 billion and $ 2.11 billion, which will begin to expire in 2028 and 2027, respectively, if not utilized. We have federal tax credit carryforwards of $ 527 million, which will begin to expire in 2029, if not utilized, and state tax credit carryforwards of $ 3.18 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, 2021 2020 2019 Gross unrecognized tax benefits beginning of period $ 8,692 $ 7,863 $ 4,678 Increases related to prior year tax positions 328 356 2,309 Decreases related to prior year tax positions ( 86 ) ( 253 ) ( 525 ) Increases related to current year tax positions 963 1,045 1,402 Decreases related to settlements of prior year tax positions ( 90 ) ( 319 ) ( 1 ) Gross unrecognized tax benefits end of period $ 9,807 $ 8,692 $ 7,863 These unrecognized tax benefits were primarily accrued for the uncertainties related to transfer pricing with our foreign subsidiaries, which include licensing of intellectual property, providing services and other transactions, as well as for the uncertainties with our research tax credits. During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2021 and 2020 were $ 960 million and $ 774 million, respectively. If the balance of gross unrecognized tax benefits of $ 9.81 billion as of December 31, 2021 were realized in a future period, this would result in a tax benefit of $ 5.70 billion within our provision of income taxes at such time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2019 tax years and by the Irish tax authorities for our 2016 through 2018 tax years. Our 2020 and subsequent tax years remain open to examination by the IRS. Our 2019 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010 and has done so in years covered by the second Notice described below. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS's amendment to answer was filed stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first session of the trial was completed in March 2020 and a second session commenced in October 2021. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes (ASC 740), that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act. As of December 31, 2021, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 15. Segment and Geographical Information Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp, and other services. RL includes augmented and virtual reality related consumer hardware, software, and content. As of December 31, 2021 , our operating segments are the same as our reportable segments. The CODM, who is our CEO, allocates resources to and assesses the performance of each operating segment using information about the operating segment's revenue and income (loss) from operations. The CODM does not evaluate operating segments using asset or liability information. Revenue and costs and expenses are generally directly attributed to our segments. These costs and expenses include certain product development related operating expenses, costs associated with the partnership arrangements, consumer hardware product costs, content costs, and legal-related costs. Indirect costs are allocated to segments based on a reasonable allocation methodology, when such costs are significant to the performance measures of the operating segments. Indirect cost of revenue is allocated to our segments based on usage, such as costs related to the operation of our data centers and technical infrastructure. Indirect operating expenses, such as facilities, information technology, certain shared research and development activities, recruiting, and physical security expenses, are mostly allocated based on headcount. The following table sets forth our segment information of revenue and income (loss) from operations (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 Revenue: Family of Apps $ 115,655 $ 84,826 $ 70,196 Reality Labs 2,274 1,139 501 Total revenue $ 117,929 $ 85,965 $ 70,697 Income (loss) from operations: Family of Apps $ 56,946 $ 39,294 $ 28,489 Reality Labs ( 10,193 ) ( 6,623 ) ( 4,503 ) Total income from operations $ 46,753 $ 32,671 $ 23,986 For information regarding revenue disaggregated by geography, see Note 2 Revenue. The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets (in millions): December 31, 2021 2020 United States $ 55,497 $ 43,128 Rest of the world (1) 14,467 11,853 Total long-lived assets $ 69,964 $ 54,981 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2021, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2021 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2021 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +1,Meta,2020," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook and build community, including Facebook News Feed, Stories, Groups, Shops, Marketplace, News, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, and connect with and shop from their favorite businesses and creators. They can do this through Instagram Feed, Stories, Reels, IGTV, Live, Shops, and messaging. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, video, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Facebook Reality Labs. Facebook Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Oculus Quest lets people defy distance with cutting-edge virtual reality (VR) hardware, software, and content, while Portal helps friends and families stay connected and share the moments that matter in meaningful ways. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Google, Apple, YouTube, Tencent, Snap, Twitter, ByteDance, Microsoft, and Amazon. We compete to attract, engage, and retain people who use our products, to attract and retain businesses who use our free or paid business and advertising services, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video and VR increases, and as we deepen our investment in new technologies like artificial intelligence, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate in more than 80 cities around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, many of which are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These laws and regulations involve matters including privacy, data use, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, e-commerce, taxation, economic or other trade prohibitions or sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices, or otherwise relating to content that is made available on our products, could adversely affect our financial results. In the United States, there have been, and continue to be, various efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and any such changes may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect our business and financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. For example, the Privacy Shield, a transfer framework we relied upon for data transferred from the European Union to the United States, was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Facebook relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. In August 2020, we received a preliminary draft decision from the Irish Data Protection Commission (IDPC) that preliminarily concluded that Facebook Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. While we also rely upon alternative legal bases for data transfers, if a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or validly rely upon other alternative means of data transfers from Europe to the United States, we may be unable to operate material portions of our business in Europe as a result of the CJEU's invalidation of the Privacy Shield and any final decision of IDPC, which would materially and adversely affect our business, financial condition, and results of operations. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. The Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements similar to GDPR on products and services offered to users in Brazil. The California Consumer Privacy Act, which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users. In addition, effective December 2020, the European Union's ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are also currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into with the U.S. Federal Trade Commission (FTC), which took effect in April 2020 and, among other matters, requires us to implement a comprehensive expansion of our privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. For additional information about government regulation applicable to our business, see Part I, Item 1A, ""Risk Factors"" in this Annual Report on Form 10-K. Human Capital At Facebook, we design products to bring the world closer together, one connection at a time. As a company, we believe that people are at the heart of every connection we build. We are proud of our unique company culture where ideas, innovation, and impact win, and we work hard to build strong teams across engineering, product design, marketing, and other areas to further our mission. We had a global workforce of 58,604 employees as of December 31, 2020, which represents a 30% year-over-year increase in employee headcount. We expect headcount growth to continue for the foreseeable future, particularly as we continue to focus on recruiting employees in technical functions. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. Our headquarters are located in Menlo Park, California and we have offices in more than 80 cities around the globe. The vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, and in the long term, we expect some personnel to transition to working remotely on a regular basis. Diversity and Inclusion Diversity and inclusion are core to our work at Facebook. We seek to build a diverse and inclusive workplace where we can leverage our collective cognitive diversity to build the best products and make the best decisions for the global community we serve. While we have made progress, we still have more work to do. We publish our global gender diversity and U.S. ethnic diversity workforce data annually. In 2020, we announced that as of June 30, 2020, our global employee base was comprised of 37% females and 63% males, and our U.S. employee base was comprised of the following ethnicities: 44.4% Asian, 41% White, 6.3% Hispanic, 4% two or more ethnicities, 3.9% Black, and 0.4% additional groups (including American Indian or Alaska Native and Native Hawaiian or Other Pacific Islander). We also announced our goals to have 50% of our workforce made up of underrepresented populations by 2024, and to increase the representation of people of color in leadership positions in the United States, including Black leadership, by 30% from 2020 to 2025. We will also continue our ongoing efforts to increase the representation of women in leadership. We work to support our goals of diversifying our workforce through recruiting, retention, people development, and inclusion. We employ our Diverse Slate Approach in our global recruitment efforts, which ensures that teams and hiring managers have the opportunity to consider qualified people from underrepresented groups for open roles. We have seen steady increases in hiring rates of people from underrepresented groups since we started testing this approach in 2015. We also continue to provide diversity and inclusion training for our recruiting team and develop inclusive internship programs. Facebook University, our training program for college freshmen and sophomores with an interest in Computer Science, also utilizes a proactive and inclusive approach to promote participation by people from underrepresented groups. To help build community among our people and support their professional development, we invest in our internal Facebook Resource Groups and our annual Community events such as Women's Community Summit, Black Community Summit, Latin Community Summit, and Pride Community Summit. We also offer Managing Unconscious Bias, Managing Inclusion, and Be the Ally trainings to promote an inclusive workplace by helping people understand the issues that affect underrepresented communities and how to reduce the effects of bias in the workplace. Compensation and Benefits We offer competitive compensation to attract and retain the best people, and we help care for our people so they can focus on our mission. Our employees' total compensation package includes market-competitive salary, bonuses or sales commissions, and equity. We generally offer full-time employees equity at the time of hire and through annual equity grants because we want them to be owners of the company and committed to our long-term success. We have conducted pay equity analyses for many years, and continue to be committed to pay equity. In 2020, we announced that our analyses indicate that we continue to have pay equity across gender globally and race in the United States for people in similar jobs, accounting for factors such as location, role, and level. Through Life@ Facebook, our holistic approach to benefits, we provide our employees and their loved ones resources to help them thrive. We offer a wide range of benefits across areas such as health, family, finance, community, and time away, including healthcare and wellness benefits, adoption and surrogacy assistance, family care resources, a 401(k) plan, access to tax and legal services, Facebook Resource Groups to build community at Facebook, family leave, and paid time off. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and about.fb.com/news/ websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission; Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding capital stock by our founder, Chairman, and CEO. Risks Related to Our Product Offerings If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen user growth and engagement returning to pre-pandemic trends, and in each of the third and fourth quarters of 2020, we experienced slight declines on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and we expect these trends to continue to be subject to volatility. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products, or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, concerns about the nature of content made available on our products, or concerns related to privacy, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely affect our products or users; we are unable to operate material portions of our business in Europe, or are otherwise limited in such operations, as a result of European regulators, courts, or legislative bodies determining that our reliance on Standard Contractual Clauses (SCCs) or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; there is decreased engagement with our products, or failure to accept our terms of service, as part of privacy-focused changes that we have implemented or may implement in the future, whether voluntarily, in connection with the General Data Protection Regulation (GDPR), the European Union's ePrivacy Directive, the California Consumer Privacy Act (CCPA), or other laws, regulations, or regulatory actions, or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, or take actions to enforce our policies, that are perceived negatively by our users or the general public, including as a result of decisions or recommendations from the independent Oversight Board regarding content on our platform; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, particularly for our significant revenue-generating products like Facebook and Instagram, our revenue and financial results may be adversely affected. Any significant decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of increased usage of the Stories format or our messaging products; reductions of advertising by marketers due to our efforts to implement or enforce advertising policies that protect the security and integrity of our platform; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated, or otherwise more effective products; limitations on our ability to operate material portions of our business in Europe as a result of European regulators, courts, or legislative bodies determining that our reliance on SCCs or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; changes in our marketing and sales or other operations that we are required to or elect to make as a result of risks related to complying with foreign laws or regulatory requirements or other government actions; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, our efforts to implement or enforce policies relating to content on our products (including as a result of decisions or recommendations from the independent Oversight Board), developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content made available on our products by third parties, questions about our user data practices, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations (for example, a number of marketers announced that they paused advertising with us in July 2020 due to concerns about content on our products); the effectiveness of our ad targeting or degree to which users opt out of the use of data for ads, including as a result of product changes and controls that we have implemented or may implement in the future in connection with the GDPR, ePrivacy Directive, California Consumer Privacy Act (CCPA), other laws, regulations, or regulatory actions, or otherwise, that impact our ability to use data for advertising purposes; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; the success of technologies designed to block the display of ads or ad measurement tools; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. For example, macroeconomic conditions have affected, and may in the future affect, marketers' ability or willingness to spend with us, as we have seen with the regional and worldwide economic disruption related to the COVID-19 pandemic and associated declines in advertising activity on our products. The effects of the pandemic previously resulted in reduced demand for our ads, a related decline in pricing of our ads, and additional demands on our technical infrastructure as a result of increased usage of our services, and any similar occurrences in the future may impair our ability to maintain or increase the quantity or quality of ads shown to users and adversely affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory developments, such as the GDPR, ePrivacy Directive, and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In particular, we have seen an increasing number of users opt out of certain types of ad targeting in Europe following adoption of the GDPR, and we have introduced product changes that limit data signal use for certain users in California following adoption of the CCPA. Regulatory guidance or decisions or new legislation may require us to make additional changes to our products in the future that further reduce our ability to use these signals. In addition, mobile operating system and browser providers, such as Apple and Google, have announced product changes as well as future plans to limit the ability of application developers to collect and use these signals to target and measure advertising. For example, in June 2020, Apple announced that it plans to make certain changes to its products and data use policies in connection with the release of its iOS 14 operating system that will reduce our and other iOS developers' ability to target and measure advertising, which we expect will in turn reduce the budgets marketers are willing to commit to us and other advertising platforms. In addition, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of certain product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform, and negatively impacted our advertising revenue, and if we are unable to mitigate these developments as they take further effect in the future, our targeting and measurement capabilities will be materially and adversely affected, which would in turn significantly impact our future advertising revenue growth. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and more recently announced changes to iOS 14 that will limit our ability to target and measure ads effectively. We expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers, and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, other business partners, or advertisers, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. We have in the past experienced challenges in operating with mobile operating systems, networks, technologies, products, and standards that we do not control, and any such occurrences in the future may negatively impact our user growth, engagement, and monetization on mobile devices, which may in turn materially and adversely affect our business and financial results. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny, litigation, or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we are moving forward with plans to implement end-to-end encryption across our messaging services, as well as facilitate cross-app communication between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which reduces our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook or our other products. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we previously introduced the Stories format, which we do not currently monetize at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, data use, encryption, content, advertising, competition, and other issues, including actions or decisions in connection with elections or the COVID19 pandemic, which has in the past adversely affected, and may in the future adversely affect, our reputation and brands. For example, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the pandemic or elections in the United States and around the world, by decisions or recommendations regarding content on our platform from the independent Oversight Board, or by our decisions to remove content or suspend participation on our platform by persons who violate our community standards or terms of service. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data and concerns around our handling of political speech and advertising, hate speech, and other content, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we conduct investigations and audits of platform applications from time to time, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Risks Related to Our Business Operations and Financial Results The COVID-19 pandemic has had, and may in the future have, a significant adverse impact on our advertising revenue and also exposes our business to other risks. The COVID-19 pandemic has resulted in authorities implementing numerous preventative measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas, both regionally and worldwide, which have significantly impacted our business and results of operations. For example, in the second quarter of 2020, our advertising revenue grew 10% year-over-year, which was the slowest growth rate for any fiscal quarter since our initial public offering. While our advertising revenue growth rate improved in subsequent quarters, there can be no assurance that it will not decrease again as a result of the effects of the pandemic. In addition, we believe that the pandemic has contributed to an acceleration in the shift of commerce from offline to online, as well as increasing consumer demand for purchasing products as opposed to services, which in turn have increased demand for our advertising services; however, it is possible that this increased demand may not continue in future periods and may even recede as the effects of the pandemic subside, which could adversely affect our advertising revenue growth. The demand for and pricing of our advertising services may be materially and adversely impacted by the pandemic for the foreseeable future, and we are unable to predict the duration or degree of such impact with any certainty. In addition to the impact on our advertising business, the pandemic exposes our business, operations, and workforce to a variety of other risks, including: volatility in the size of our user base and user engagement, particularly for our messaging products, whether as a result of shelter-in-place measures or other factors; decreased user engagement as a result of users' inability to purchase data packs or devices to access our products and services; interruptions in the accessibility or performance of our products and services due to capacity constraints from increased usage, or product changes we implement to maintain accessibility of our services, such as reducing the quality of video to reduce bandwidth usage; delays in product development or releases, or reductions in manufacturing production and sales of consumer hardware, as a result of inventory shortages, supply chain or labor shortages, or diversion of our efforts and resources to projects related to COVID-19; increased misuse of our products and services or user data by third parties, including improper advertising practices or other activity inconsistent with our terms, contracts, or policies, misinformation or other illicit or objectionable material on our platforms, election interference, or other undesirable activity; adverse impacts to our efforts to combat misuse of our products and services and user data as a result of limitations on our safety, security, and content review efforts while our workforce is working remotely, such as the necessity to rely more heavily on artificial intelligence to perform tasks that our workforce is unable to perform; our inability to recognize revenue, collect payment, or generate future revenue from marketers, including from those that have been or may be forced to close their businesses or are otherwise impacted by the economic downturn; increased expenses resulting from our initiatives or donations related to the pandemic; significant volatility and disruption of global financial markets, which could cause fluctuations in currency exchange rates or negatively impact our ability to access capital in the future; negative impact on our workforce productivity, product development, and research and development due to difficulties resulting from our personnel working remotely; illnesses to key employees, or a significant portion of our workforce, which may result in inefficiencies, delays, and disruptions in our business; and increased volatility and uncertainty in the financial projections we use as the basis for estimates used in our financial statements. Any of these developments may adversely affect our business, harm our reputation, or result in legal or regulatory actions against us. The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business and may materially and adversely impact our business, financial condition, and results of operations. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies providing connection and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Google, Apple, YouTube, Tencent, Snap, Twitter, ByteDance, Microsoft, and Amazon. We compete to attract, engage, and retain people who use our products, to attract and retain businesses that use our free or paid business and advertising services, and to attract and retain developers who build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. For example, some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. In addition, Apple has announced changes to iOS 14 that will limit our ability, and the ability of others in the digital advertising industry, to target and measure ads effectively. As a result, our competitors may, and in some cases will, acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which would negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; our ability to attract and retain businesses who use our free or paid business and advertising services; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Unfavorable media coverage negatively affects our business from time to time. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, we have been the subject of significant media coverage involving concerns around our handling of political speech and advertising, hate speech, and other content, and we continue to receive negative publicity related to these topics. In addition, we have been, and may in the future be, subject to negative publicity in connection with our handling of misinformation and other illicit or objectionable use of our products or services, including in connection with the COVID-19 pandemic and elections in the United States and around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and marketer demand for advertising on our products, which could result in decreased revenue and adversely affect our business and financial results, and we have experienced such adverse effects to varying degrees from time to time. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; our ability to recognize revenue or collect payments from marketers in a particular period, including as a result of the effects of the COVID-19 pandemic; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, including the COVID-19 pandemic, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts, including as a result of implementing changes to our practices, whether voluntarily, in connection with laws, regulations, regulatory actions, or decisions or recommendations from the independent Oversight Board, or otherwise; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which is affected by the mix of income we earn in the U.S. and in jurisdictions with different tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, the effects of changes in our business or structure, and the effects of discrete items such as legal and tax settlements and tax elections; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our investments in marketable securities, in the valuation of our equity investments, and in interest rates; changes in U.S. generally accepted accounting principles; and changes in regional or global business or macroeconomic conditions, including as a result of the COVID-19 pandemic, which may impact the other factors described above. We expect our rates of growth to be volatile in the near term as a result of the COVID-19 pandemic and to decline over time in the future. We expect our user and revenue growth rates to be volatile in the near term as a result of the COVID-19 pandemic, although we are unable to predict the duration or degree of such volatility with any certainty. In the long term, we expect that our user growth rate will generally decline over time as the size of our active user base increases, and the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We also expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates experience volatility or decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments, particularly our investments in virtual and augmented reality, have the effect of reducing our operating margin and profitability. If our investments are not successful longer-term, our business and financial performance will be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability, and we expect the adverse financial impact of such investments to continue for the foreseeable future. If our investments are not successful longer-term, our business and financial performance will be harmed. We plan to continue to make acquisitions and pursue other strategic transactions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies, and from time to time may enter into other strategic transactions such as investments and joint ventures. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions or other strategic transactions on favorable terms, if at all, including as a result of regulatory challenges. In some cases, the costs of such acquisitions or other strategic transactions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions or other strategic transactions. We may pay substantial amounts of cash or incur debt to pay for acquisitions or other strategic transactions, which has occurred in the past and could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions or other strategic transactions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities, deficiencies, or other claims associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition or other strategic transaction, including tax and accounting charges. Acquisitions or other strategic transactions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service, including as a result of the COVID-19 pandemic, could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. For example, the increase in the use of our products as a result of the COVID-19 pandemic increased demands on our technical infrastructure. Additional product development efforts during this time have put additional pressure on our technical infrastructure. We may not be able to accommodate these demands, including as a result of our reduced data center operations and personnel working remotely during the pandemic. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. The effects of the COVID-19 pandemic have increased the risk of supply or labor shortages or other disruptions in logistics or the supply chain for our technical infrastructure. As a result, we may not be able to procure sufficient equipment or services from third parties to satisfy our needs, or we may be required to procure such services or equipment on unfavorable terms. Any of these developments may result in interruptions in the availability or performance of our products, require unfavorable changes to existing products, delay the introduction of future products, or otherwise adversely affect our business and financial results. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers, subsea and terrestrial fiber optic cable systems, and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations around the world, including in emerging markets that expose us to increased risks relating to anti-corruption compliance and political challenges, among others. We have in the past suspended, and may in the future suspend, certain of these projects as a result of the COVID-19 pandemic. Additional unanticipated delays or disruptions in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, whether as a result of the pandemic, trade disputes, or otherwise, may lead to increased project costs, operational inefficiencies, interruptions in the delivery or degradation of the quality or reliability of our products, or impairment of assets on our balance sheet. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Further, much of our technical infrastructure is located outside the United States, and it is possible that action by a foreign government, or our response to such government action, could result in the impairment of a portion of our technical infrastructure, which may interrupt the delivery or degrade the quality or reliability of our products and lead to a negative user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)) and Family metrics (DAP, MAP, and average revenue per person (ARPP)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Facebook metrics and Family metrics estimates will differ from estimates published by third parties due to differences in methodology. We regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2020, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2020, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. The timing and results of such user surveys have in the past contributed, and may in the future contribute, to changes in our reported Family metrics from period to period. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our reported Family metrics. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2020, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics and estimates, including those relating to the reach and effectiveness of our ads. Many of our metrics involve the use of estimations and judgments, and our metrics and estimates are subject to software bugs, inconsistencies in our systems, and human error. Where marketers, developers, or investors do not perceive our metrics or estimates to be accurate, or where we discover material inaccuracies in our metrics or estimates, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook or our other products, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 58,604 as of December 31, 2020 from 44,942 as of December 31, 2019, and we expect headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. Additionally, the vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, which limits their ability to perform certain job functions and may negatively impact productivity. In the long term, we may experience such challenges to productivity and collaboration as some personnel transition to working remotely on a regular basis, and we may experience difficulties integrating recently hired personnel when our offices re-open. To effectively manage our growth, we must continue to adapt to a remote work environment; improve our operational, financial, and management processes and systems; and effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business, economic, and legal risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, competition, consumer protection, intellectual property, and infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, payments, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations, including difficulties arising from personnel working remotely during the COVID-19 pandemic; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes and pandemics. In addition, we must manage the potential conflicts between locally accepted business practices in any given jurisdiction and our obligations to comply with laws and regulations, including anti-corruption laws or regulations applicable to us, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. We also must manage our obligations to comply with laws and regulations related to export controls, sanctions, and embargoes, including regulations established by the U.S. Office of Foreign Assets Control. Government agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against companies for violations of anti-corruption laws or regulations, export controls, and other laws, rules, sanctions, embargoes, and regulations. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell from time to time have had, and in the future may have, quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. Our brand and financial results could be adversely affected by any such quality issues, other failures to meet our customers' expectations, or findings of our consumer hardware products to be defective. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products, which subjects us to a number of risks that have been exacerbated as a result of the COVID-19 pandemic. We may experience supply or labor shortages or other disruptions in logistics or the supply chain that could result in shipping delays and negatively impact our operations, product development, and sales. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties, manufacturing constraints, or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing, distribution, and sale of our consumer hardware products also may be negatively impacted by macroeconomic conditions, geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. The demand for our products can also change significantly between the time inventory or components are ordered and the date of sale. While we endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell, from time to time we have experienced difficulties in accurately predicting and meeting the consumer demand for our products. In addition, when we begin selling or manufacturing a new consumer hardware product or enter new international markets, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of the foregoing factors may adversely affect our operating results. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. We are involved in numerous lawsuits, including stockholder derivative lawsuits and putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user, advertiser, and developer base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user or entity harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on claims related to advertising, antitrust, privacy, content, employment, or product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; and our acquisitions of Instagram and WhatsApp, as well as other alleged anticompetitive conduct. We also agreed to settle certain lawsuits in connection with the ""tag suggestions"" facial recognition feature on Facebook and a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. The results of any such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are litigating this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. The issuance of additional regulatory or accounting guidance related to the Tax Act, or other executive or Congressional actions in the United States, could materially affect our tax obligations and effective tax rate in the period such guidance is issued or such actions take effect. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and blueprints in 2020 that, if implemented, would change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would apply to various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several countries have proposed or enacted taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and which apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2020, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $656 million and our effective tax rate by two percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located, whether as a result of competition with other companies, challenges due to the high cost of living, facilities and infrastructure constraints, or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or, in some cases, the replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Government Regulation and Enforcement Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. For example, in June 2020, Hong Kong adopted a National Security Law that provides authorities with the ability to obtain information, remove and block access to content, and suspend user services, and if we are found to be in violation of this law then the use of our products may be restricted. In addition, if we are required to or elect to make changes to our marketing and sales or other operations in Hong Kong as a result of the National Security Law, our revenue and business in the region will be adversely affected. It is also possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues or information requests in Hong Kong or elsewhere, or for other reasons, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. Similarly, if we are found to be out of compliance with certain legal requirements for social media companies in Turkey, the Turkish government could take action to reduce or eliminate our Turkey-based advertising revenue or otherwise adversely impact access to our products. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, we are required to or elect to make changes to our operations, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data use, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, e-commerce, taxation, economic or other trade prohibitions or sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but the Privacy Shield was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Facebook relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the CJEU considered the validity of SCCs as a basis to transfer user data from the European Union to the United States following a challenge brought by the Irish Data Protection Commission (IDPC). Although the CJEU upheld the validity of SCCs in July 2020, our continued reliance on SCCs is contingent on SCCs being held to satisfy certain new conditions that are yet to be clearly defined and will be the subject of future regulatory guidance (and the European Commission has recently proposed new SCCs, which are currently subject to consultation). In addition, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Facebook Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020, and the court ordered the IDPC not to take further steps in respect of the inquiry until the judicial review proceedings conclude (subject to the IDPC's right to apply to vary or lift this order), which we expect to occur in the coming months. While we also rely upon alternative legal bases for data transfers, if a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or validly rely upon other alternative means of data transfers from Europe to the United States, we may be unable to operate material portions of our business in Europe as a result of the CJEU's invalidation of the Privacy Shield and any final decision of IDPC, which would materially and adversely affect our business, financial condition, and results of operations. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of personal data breach notifications to our designated European privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. Similarly, the Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements on products and services offered to users in Brazil. The California Consumer Privacy Act (CCPA), which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users, including more ability to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, regulators have recently issued new guidance concerning the ePrivacy Directive's requirements regarding the use of cookies and similar technologies. In addition, effective December 2020, the ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union and other jurisdictions have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Beginning in September 2018, we also became subject to IDPC and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. From time to time we also notify the IDPC, our designated European privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. In addition, from time to time, we are subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions, which relate to many aspects of our business, including with respect to users and advertisers, as well as our industry. Such inquiries, investigations, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice, the U.S. House of Representatives, and state attorneys general. In December 2020, the FTC and the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed complaints against us in the U.S. District Court for the District of Columbia alleging that we violated antitrust laws by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform, among other things. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business, and we have experienced some of these adverse effects to varying degrees from time to time. Compliance with our FTC consent order, the GDPR, the CCPA, the ePrivacy Directive, and other regulatory and legislative privacy requirements require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including in connection with our modified consent order with the FTC, requirements of the GDPR, and other regulatory and legislative requirements around the world, such as the CCPA and the ePrivacy Directive. In particular, we are implementing a comprehensive expansion of our privacy program in connection with the FTC consent order, including substantial management and board of directors oversight, stringent operational requirements and reporting obligations, prohibitions against making misrepresentations relating to user data, a process to regularly certify our compliance with the privacy program to the FTC, and regular assessments of our privacy program by an independent third-party assessor, which has been and will continue to be challenging and costly to implement. These compliance and oversight efforts are increasing demand on our systems and resources, and require significant new and ongoing investments, including investments in compliance processes, personnel, and technical infrastructure. We are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner has been and will continue to be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. The requirements of the FTC consent order and other privacy-related laws and regulations are complex and apply broadly to our business, and from time to time we notify relevant authorities of instances where we are not in full compliance with these requirements or otherwise discover privacy issues, and we expect to continue to do so as any such issues arise in the future. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, ePrivacy Directive, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other applicable requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices and may adversely affect our business and financial results. We have faced, currently face, and will continue to face claims relating to information or content that is published or made available on our products, including our policies and enforcement actions with respect to such information or content. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, harassment, intellectual property rights, rights of publicity and privacy, personal injury torts, laws regulating hate speech or other types of content, and breach of contract, among others. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states are required to implement by June 2021. In addition, the European Union revised the European Audiovisual Media Service Directive to apply to online video-sharing platforms, which member states are expected to implement by 2021. In the United States, there have been, and continue to be, various Congressional and executive efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, as well as to impose new obligations on online platforms with respect to commerce listings, counterfeit goods and copyright-infringing material, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines, orders restricting or blocking our services in particular geographies, or other government-imposed remedies as a result of content hosted on our services. For example, legislation in Germany has in the past, and may in the future, result in the imposition of fines for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Numerous other countries in Europe, Asia-Pacific, and Latin America are considering or have implemented similar legislation imposing penalties, including fines, service throttling, or advertising bans, for failure to remove certain types of content or follow certain processes. For example, we have been subject to fines and may in the future be subject to other penalties in connection with social media legislation in Turkey. In addition, Australia recently announced proposed legislation that would, among other matters, require us to pay publishers for certain news content that is shared on Facebook and Instagram. Content-related legislation also has required us in the past, and may require us in the future, to change our products or business practices, increase our compliance costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. In addition, changes to Section 230 of the Communications Decency Act may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect user growth and engagement. Any of the foregoing events could adversely affect our business and financial results. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger and WhatsApp, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we are subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have also launched certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our participation in the Diem Association subjects us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. In June 2019, we announced our participation in the Diem Association, which will oversee a proposed digital payments system powered by blockchain technology, and our plans for Novi, a digital wallet for Diem which we expect to launch as a standalone application and subsequently in Messenger and WhatsApp. Diem is based on relatively new and unproven technology, and the laws and regulations surrounding blockchain-based payments are uncertain and evolving. Diem has drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. As a sponsor of the initiative and a proposed digital wallet service provider, we are participating in responses to inquiries from governments and regulators, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As this initiative evolves, both Diem and Novi may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, anti-money laundering, counter-terrorism financing, economic sanctions, data protection, tax, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. To mitigate regulatory uncertainty, Diem has applied for a payment system operator license with the Swiss Financial Market Supervisory Authority (FINMA), and Novi has applied for money transmitter licenses in the United States and certain other countries, and other financial services licenses in certain other countries, that would allow us to conduct digital wallet activities in these countries using the Diem network. These licenses, laws, and regulations, as well as any associated inquiries or investigations, may delay or impede the launch of the Diem digital payments system as well as the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of such a digital payments system is subject to significant uncertainty. As such, there can be no assurance that Diem or our associated products and services will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based payments technology, which may adversely affect our ability to successfully develop and market these products and services. We will also incur increased costs in connection with our participation in the Diem Association and the development and marketing of associated products and services, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. Risks Related to Data, Security, and Intellectual Property Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), scraping, and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data and content on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from nation states and highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We experience such cyber-attacks and other security incidents of varying degrees from time to time, and we incur significant costs in protecting against or remediating such incidents. In addition, we are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under our modified consent order with the FTC. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. The events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, the changes in our work environment as a result of the COVID-19 pandemic could impact the security of our systems, as well as our ability to protect against attacks and detect and respond to them quickly. The rapid adoption of some third-party services designed to enable the transition to a remote workforce also may introduce security risk that is not fully mitigated prior to the use of these services. We may also be subject to increased cyber-attacks, such as phishing attacks by threat actors using the attention placed on the pandemic as a method for targeting our personnel. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data or technical limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, challenges related to our personnel working remotely during the COVID-19 pandemic, the allocation of resources to other projects, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our modified consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper advertising practices, activities that threaten people's safety on- or offline, or instances of spamming, scraping, data harvesting, unsecured datasets, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Our products and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, or failures to address or mitigate technical limitations in our systems, could adversely affect our business. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property or other data, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. In addition, any errors, bugs, vulnerabilities, or defects in our systems or the software and hardware on which we rely, failures to properly address or mitigate the technical limitations in our systems, or associated degradations or interruptions of service or failures to fulfill our commitments to our users, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, litigation, or liability for fines, damages, or other remedies, any of which could adversely affect our business and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $304.67 through December 31, 2020. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections, or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; adverse government actions or legislative or regulatory developments relating to advertising, competition, content, privacy, or other matters, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war, incidents of terrorism, pandemics, and other disruptive external events, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2020, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Latin America, Europe, the Middle East, Africa, and Asia Pacific. We also own 17 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Any other government inquiries regarding these matters could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which provided for a payment of $550 million by us and was subject to court approval. On or about May 8, 2020, the parties executed a formal settlement agreement, and plaintiffs filed a motion for preliminary approval of the settlement by the district court. On June 4, 2020, the district court denied the plaintiffs' motion without prejudice. On July 22, 2020, the parties executed an amended settlement agreement, which, among other terms, provides for a payment of $650 million by us. On August 19, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. On November 15, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. For example, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Facebook Ireland's reliance on Standard Contractual Clauses in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020, and the court ordered the IDPC not to take further steps in respect of the inquiry until the judicial review proceedings conclude (subject to the IDPC's right to apply to vary or lift this order), which we expect to occur in early 2021. For additional information, see Part I, Item 1A, ""Risk FactorsOur business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters"" in this Annual Report on Form 10-K. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleges that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. The result of such litigation, investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2020, there were 3,471 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $273.16 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2020, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2020: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2020 2,310 $ 270.12 2,310 $ 9,921 November 1 - 30, 2020 2,100 $ 276.32 2,100 $ 9,341 December 1 - 31, 2020 2,670 $ 276.38 2,670 $ 8,603 7,080 7,080 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In January 2021, an additional $25 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2020. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2015 in the Class A common stock of Facebook, Inc., the DJINET, the SP 500 and the Nasdaq Composite and data for the DJINET, the SP 500 and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2020 using 2019 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2020 Results Our key community metrics and financial results for 2020 are as follows: Community growth: Facebook daily active users (DAUs) were 1.84 billion on average for December 2020, an increase of 11% year-over-year. Facebook monthly active users (MAUs) were 2.80 billion as of December 31, 2020, an increase of 12% year-over-year. Family daily active people (DAP) was 2.60 billion on average for December 2020, an increase of 15% year-over-year. Family monthly active people (MAP) was 3.30 billion as of December 31, 2020, an increase of 14% year-over-year. Financial results: Revenue was $85.97 billion, up 22% year-over-year, and advertising revenue was $84.17 billion, up 21% year-over-year. Total costs and expenses were $53.29 billion. Income from operations was $32.67 billion and operating margin was 38%. Net income was $29.15 billion with diluted earnings per share of $10.09. Capital expenditures, including principal payments on finance leases, were $15.72 billion. Effective tax rate was 12.2%. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020. Headcount was 58,604 as of December 31, 2020, an increase of 30% year-over-year. Our mission is to give people the power to build community and bring the world closer together. In response to the COVID-19 pandemic, we have focused on helping people stay connected, assisting the public health response, and working on the economic recovery. We have also continued to invest based on the following company priorities: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. In 2020, we also continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. Our business has been impacted by the COVID-19 pandemic, which has resulted in authorities implementing numerous preventative measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas, both regionally and worldwide, which have significantly impacted our business and results of operations. Beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen user growth and engagement returning to pre-pandemic trends, particularly in the United States Canada region. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and we expect these trends to continue to be subject to volatility. The COVID-19 pandemic has also previously caused a reduction in the demand for advertising, as well as a related decline in the pricing of our ads, particularly in the second quarter of 2020. More recently, we believe the pandemic has contributed to an acceleration in the shift of commerce from offline to online, as well as increasing consumer demand for purchasing products as opposed to services, and we experienced increasing demand for advertising as a result of these trends. However, it is possible that this increased demand may not continue in future periods and may even recede as the effects of the pandemic subside, which could adversely affect our advertising revenue growth. The impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain for the foreseeable future. In addition, we expect that future advertising revenue growth will continue to be adversely affected by limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers. We intend to continue to invest in our business based on our company priorities, and we anticipate that additional investments in our data center capacity, servers, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, will continue to drive expense growth in 2021. We expect 2021 capital expenditures to be in the range of $21-23 billion and total expenses to be in the range of $68-73 billion. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. DAU/MAU: 66% 66% 66% 66% 66% 66% 66% 66% 66% 67% 66% 66% 66% DAU/MAU: 77% 77% 77% 76% 77% 77% 77% 77% 77% 77% 77% 77% 76% DAU/MAU: 75% 75% 74% 74% 74% 74% 74% 74% 75% 75% 74% 74% 74% DAU/MAU: 60% 61% 61% 61% 61% 61% 61% 62% 62% 62% 61% 62% 62% DAU/MAU: 64% 64% 64% 64% 64% 64% 64% 65% 65% 65% 65% 65% 65% Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 11% to 1.84 billion on average during December 2020 from 1.66 billion during December 2019. Users in India, the Philippines, and Indonesia represented key sources of growth in DAUs during December 2020, relative to the same period in 2019. Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2020, we had 2.80 billion MAUs, an increase of 12% from December 31, 2019. Users in India, Indonesia, and the Philippines represented key sources of growth in 2020, relative to the same period in 2019. Trends in Our Monetization by Facebook User Geography We calculate our revenue by Facebook user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. The share of revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2020 in the United States Canada region was more than 11 times higher than in the Asia-Pacific region. ARPU: $7.37 $6.42 $7.05 $7.26 $8.52 $6.95 $7.05 $7.89 $10.14 ARPU: $34.86 $30.12 $33.27 $34.55 $41.41 $34.18 $36.49 $39.63 $53.56 ARPU: $10.98 $9.55 $10.70 $10.68 $13.21 $10.64 $11.03 $12.41 $16.87 ARPU: $2.96 $2.78 $3.04 $3.24 $3.57 $3.06 $2.99 $3.67 $4.05 ARPU: $2.11 $1.89 $2.13 $2.24 $2.48 $1.99 $1.78 $2.22 $2.77 Note: Our revenue by Facebook user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our Facebook users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the billing address of the customer. Our annual worldwide ARPU in 2020, which represents the sum of quarterly ARPU during such period, was $32.03, an increase of 10% from 2019. Over this period, ARPU increased by 18% in the United States Canada, 15% in Europe, and 9% in AsiaPacific, and ARPU was flat in Rest of World. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as MAP or DAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. DAP/MAP: 77% 78% 78% 78% 78% 79% 79% 79% 79% Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 40 million DAP to our reported worldwide DAP in June 2020. Worldwide DAP increased 15% to 2.60 billion on average during December 2020 from 2.26 billion during December 2019. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 50 million MAP to our reported worldwide MAP in June 2020. As of December 31, 2020, we had 3.30 billion MAP, an increase of 14% from 2.89 billion as of December 31, 2019. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. The share of revenue from users who are not also MAP was not material. ARPP: $6.52 $5.66 $6.20 $6.33 $7.38 $6.03 $6.10 $6.76 $8.62 Our annual worldwide ARPP in 2020, which represents the sum of quarterly ARPP during such period, was $27.51, an increase of 8% from 2019. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the impact of the estimates and assumptions on our consolidated financial statements is material . We believe that the assumptions and estimates associated with gross vs. net in revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In response to the economic slowdown caused by the COVID-19 pandemic, we believe that the assumptions and estimates associated with collectibility assessment of revenue and credit losses of accounts receivable could have a material impact to our consolidated financial statements in future periods, depending on the duration or degree of the impact of the COVID-19 pandemic on the global economy. Collectibility Assessment of Revenue Under Topic 606, we recognize revenue using a five-step model. In step one, for a revenue contract to exist, it must be probable that substantially all of the consideration to which we are entitled to will be collected. In performing such collectibility assessment, we consider various facts and circumstances including future expectations about our customer's ability and intention to pay. Collectibility assessment uses a probable threshold which requires estimation based on several objective and subjective factors, such as probability of default, customers intention to pay, payment history, financial strength, geography, and industry sub-vertical risks. The collectibility assessment has become uncertain during the current economic environment caused by the COVID-19 pandemic, and our actual experience in the future may differ from our past experiences or current assessment. Credit Losses of Accounts Receivable On January 1, 2020, we adopted Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost that an entity does not expect to collect over the asset's contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions. For accounts receivable measured at amortized cost, we use aging analysis, probability of default methods and incorporate macroeconomic variables that are most relevant to evaluating and estimating the expected credit losses. These macroeconomic variables may vary by geography, customer-type, or industry sub-vertical. The contractual life of our trade accounts receivable is generally short-term; however, we may experience increasing credit loss risks from accounts receivable in future periods depending on the duration or degree of economic slowdown caused by the COVID-19 pandemic, and our actual experience in the future may differ from our past experiences or current assessment. Gross vs. Net in Revenue Recognition For revenue generated from arrangements that involve third-party publishers, there is significant judgment in evaluating whether we are the principal, and report revenue on a gross basis, or the agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. The assessment of whether we are considered the principal or the agent in a transaction could impact our revenue and cost of revenue recognized on the consolidated statements of income. Valuation of Equity Investments For our equity securities without readily determinable fair values accounted for using the measurement alternative, determining whether an equity security issued by the same issuer is similar to the equity security we hold may require judgment in (a) assessment of differences in rights and obligations associated with the instruments such as voting rights, distribution rights and preferences, and conversion features, and (b) adjustments to the observable price for differences such as, but not limited to, rights and obligations, control premium, liquidity, or principal or most advantageous markets. In addition, the identification of observable transactions will depend on the timely reporting of these transactions from our investee companies, which may occur in a period subsequent to when the transactions take place. Therefore, our fair value adjustment for these observable transactions may occur in a period subsequent to when the transaction actually occurred. For equity investments, we perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; regulatory, economic or technological environment; operational and financing cash flows; and other relevant events and factors affecting the investee. When indicators of impairment exist, we estimate the fair value of our equity investments using the market approach and/or the income approach and recognize impairment loss in the consolidated statements of income if the estimated fair value is less than the carrying value. Estimating fair value requires judgment and use of estimates such as discount rates, forecast cash flows, holding period, and market data of comparable companies, among others. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. The ultimate outcome of these matters, such as whether the likelihood of loss is remote, reasonably possible, or probable or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of losses, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 12Commitments and Contingencies and Note 15Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2020, no impairment of goodwill has been identified. Long-lived assets, including property and equipment and intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of revenue from the delivery of consumer hardware devices, net fees we receive from developers using our Payments infrastructure, and revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Research and development. Research and development expenses consist primarily of salaries and benefits, share-based compensation, and facilities-related costs for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. Marketing and sales. Marketing and sales expenses consist of salaries and benefits, and share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures and professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist of legal-related costs; salaries and benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2020 compared to the year ended December 31, 2019. For a discussion of the year ended December 31, 2019 compared to the year ended December 31, 2018, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2019. The following table sets forth our consolidated statements of income data (in millions): Year Ended December 31, 2020 2019 2018 Revenue $ 85,965 $ 70,697 $ 55,838 Costs and expenses: Cost of revenue 16,692 12,770 9,355 Research and development 18,447 13,600 10,273 Marketing and sales 11,591 9,876 7,846 General and administrative 6,564 10,465 3,451 Total costs and expenses 53,294 46,711 30,925 Income from operations 32,671 23,986 24,913 Interest and other income, net 509 826 448 Income before provision for income taxes 33,180 24,812 25,361 Provision for income taxes 4,034 6,327 3,249 Net income $ 29,146 $ 18,485 $ 22,112 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, 2020 2019 2018 Revenue 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 18 17 Research and development 21 19 18 Marketing and sales 13 14 14 General and administrative 8 15 6 Total costs and expenses 62 66 55 Income from operations 38 34 45 Interest and other income, net 1 1 1 Income before provision for income taxes 39 35 45 Provision for income taxes 5 9 6 Net income 34 % 26 % 40 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses (in millions): Year Ended December 31, 2020 2019 2018 Cost of revenue $ 447 $ 377 $ 284 Research and development 4,918 3,488 3,022 Marketing and sales 691 569 511 General and administrative 480 402 335 Total share-based compensation expense $ 6,536 $ 4,836 $ 4,152 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, 2020 2019 2018 Cost of revenue 1 % 1 % 1 % Research and development 6 5 5 Marketing and sales 1 1 1 General and administrative 1 1 1 Total share-based compensation expense 8 % 7 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue Year Ended December 31, 2020 vs 2019 % Change 2019 vs 2018 % Change 2020 2019 2018 (in millions) Advertising $ 84,169 $ 69,655 $ 55,013 21 % 27 % Other revenue 1,796 1,042 825 72 % 26 % Total revenue $ 85,965 $ 70,697 $ 55,838 22 % 27 % 2020 Compared to 2019. Revenue in 2020 increased $15.27 billion, or 22%, compared to 2019. The increase was mostly due to an increase in advertising revenue as a result of an increase in the number of ads delivered, partially offset by a decrease in the average price per ad. In 2020, the number of ads delivered increased by 34%, as compared with approximately 33% in 2019. The increase in the ads delivered was driven by an increase in the number and frequency of ads displayed across our products, and an increase in users. In 2020, the average price per ad decreased by 10%, as compared with a decrease of approximately 5% in 2019. The decrease in average price per ad during the year ended December 31, 2020 was primarily driven by a decrease in advertising demand globally during the first two quarters of 2020 due to the COVID-19 pandemic and, to a lesser extent, by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. In the near-term, we anticipate that future advertising revenue growth will be determined primarily by several factors: the extent to which we continue to see increasing advertising demand in connection with the shift of commerce from offline to online, as well as increased consumer demand for purchasing products as opposed to services, as a result of the COVID-19 pandemic; the status of the economic recovery from the slowdown caused by the COVID-19 pandemic and the magnitude of fiscal stimulus; and the extent to which changes to the regulatory environment and third-party mobile operating systems and browsers result in limitations on our ad targeting and measurement tools. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 28%, 19%, and 23% between the third and fourth quarters of 2020, 2019, and 2018, respectively, while advertising revenue for both the first quarters of 2020 and 2019 declined 16% and 10% compared to the fourth quarters of 2019 and 2018, respectively. No customer represented 10% or more of total revenue during the years ended December 31, 2020, 2019, and 2018. Foreign Exchange Impact on Revenue The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2020 compared to the same period in 2019, had an unfavorable impact on revenue. If we had translated revenue for the full year 2020 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $86.08 billion and $84.30 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $120 million and $129 million, respectively, higher than actual total revenue and advertising revenue for the full year 2020. Using the same constant rates, full year 2020 total revenue and advertising revenue would have been $15.39 billion and $14.64 billion, respectively, higher than actual total revenue and advertising revenue for the full year 2019. Cost of revenue Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Cost of revenue $ 16,692 $ 12,770 $ 9,355 31 % 37% Percentage of revenue 19% 18% 17% 2020 Compared to 2019. Cost of revenue in 2020 increased $3.92 billion, or 31%, compared to 2019. The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure, higher cost associated with partner arrangements, including traffic acquisition and content costs and, to a lesser extent, an increase in cost of consumer hardware devices sold. In 2021, we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with partner arrangements and consumer hardware devices. Research and development Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Research and development $ 18,447 $ 13,600 $ 10,273 36 % 32 % Percentage of revenue 21% 19% 18% 2020 Compared to 2019. Research and development expenses in 2020 increased $4.85 billion, or 36%, compared to 2019. The increase was primarily due to increases in payroll and benefits expenses as a result of a 40% growth in employee headcount from December 31, 2019 to December 31, 2020 in engineering and other technical functions supporting our continued investment in our Family of products and consumer hardware products. In 2021, we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Marketing and sales $ 11,591 $ 9,876 $ 7,846 17 % 26% Percentage of revenue 13% 14% 14% 2020 Compared to 2019. Marketing and sales expenses in 2020 increased $1.72 billion, or 17%, compared to 2019. The increase was primarily driven by increases in marketing expenses and payroll and benefits expenses, which were partially offset by a decrease in travel-related expenses due to the COVID-19 pandemic. Our payroll and benefits expenses increased as a result of a 16% increase in employee headcount from December 31, 2019 to December 31, 2020 in our marketing and sales functions. In 2021, we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts, and we anticipate marketing expenses will increase. General and administrative Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Legal accrual related to FTC settlement $ $ 5,000 $ NM NM Other general and administrative 6,564 5,465 3,451 20 % 58 % General and administrative $ 6,564 $ 10,465 $ 3,451 (37) % 203 % Percentage of revenue 8% 15% 6% 2020 Compared to 2019. Excluding the $5.0 billion FTC settlement accrual recorded in 2019, general and administrative expenses in 2020 increased $1.10 billion, or 20%, compared to 2019. The increase was primarily due to higher professional services costs and an increase in payroll and benefits expenses as a result of a 23% increase in employee headcount from December 31, 2019 to December 31, 2020 in our general and administrative functions. In 2021, we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income, net Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (in millions) Interest income, net $ 672 $ 904 $ 652 (26) % 39 % Foreign currency exchange losses, net (129) (105) (213) (23) % 51 % Other income (expense), net (34) 27 9 NM NM Interest and other income, net $ 509 $ 826 $ 448 (38) % 84 % 2020 Compared to 2019. Interest and other income, net in 2020 decreased $317 million compared to 2019. The majority of the decrease was due to a decrease in interest income related to lower interest rates compared to 2019. Provision for income taxes Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Provision for income taxes $ 4,034 $ 6,327 $ 3,249 (36) % 95 % Effective tax rate 12.2% 25.5% 12.8% 2020 Compared to 2019. Our provision for income taxes in 2020 decreased $2.29 billion, or 36%, compared to 2019, mostly due to the additional tax expense incurred in 2019 from the Altera Ninth Circuit Opinion and the effects of a tax election to capitalize and amortize certain research and development expenses for U.S. income tax purposes, both discussed below. Our effective tax rate in 2020 decreased compared to 2019, primarily due to the 2019 legal accrual related to the FTC settlement that was not tax-deductible, the additional tax expense incurred in 2019 from the Altera Ninth Circuit Opinion, and the effects of a tax election to capitalize and amortize certain research and development expenses for U.S. income tax purposes. In the third quarter of 2020, as part of finalizing our U.S. income tax return, we elected to capitalize and amortize certain research and development expenses for U.S. income tax purposes. As a result, we recorded a total of $1.07 billion income tax benefit for the year ended December 31, 2020. The income tax benefit resulted from recording a deferred income tax asset that was greater than the current income tax liability due to different tax rates applicable for the periods in which capitalized expenses will be amortized versus the period in which the increased current tax liability was accrued. We do not believe this election will materially affect our effective tax rate trend in the future. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer requested a hearing before the Supreme Court of the United States and the request was denied on June 22, 2020. Since we started to accrue income tax for share-based compensation cost-sharing expense in the second quarter of 2019, the denial of the request by the Supreme Court did not have a material impact to our financial results in 2020. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion between the following items and income before provision for income taxes: U.S. tax benefits from foreign derived intangible income, tax effects from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the effects of changes in tax law. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 22, 2021 price, we expect our effective tax rate for the full year of 2021 will be in the high-teens. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. Unrecognized Tax Benefits. As of December 31, 2020, we had net unrecognized tax benefits of $3.48 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a material change to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first sessions of the trial began in February 2020, and additional sessions are expected to continue in 2021. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2020, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740, Income Taxes, for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2020. We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 (in millions, except per share amounts) Revenue: Advertising $ 27,187 $ 21,221 $ 18,321 $ 17,440 $ 20,736 $ 17,383 $ 16,624 $ 14,912 Other revenue 885 249 366 297 346 269 262 165 Total revenue 28,072 21,470 18,687 17,737 21,082 17,652 16,886 15,077 Costs and expenses: Cost of revenue 5,210 4,194 3,829 3,459 3,492 3,155 3,307 2,816 Research and development 5,208 4,763 4,462 4,015 3,877 3,548 3,315 2,860 Marketing and sales 3,280 2,683 2,840 2,787 3,026 2,416 2,414 2,020 General and administrative 1,599 1,790 1,593 1,583 1,829 1,348 3,224 4,064 Total costs and expenses 15,297 13,430 12,724 11,844 12,224 10,467 12,260 11,760 Income from operations 12,775 8,040 5,963 5,893 8,858 7,185 4,626 3,317 Interest and other income (expense), net 280 93 168 (32) 311 144 206 165 Income before provision for income taxes 13,055 8,133 6,131 5,861 9,169 7,329 4,832 3,482 Provision for income taxes 1,836 287 953 959 1,820 1,238 2,216 1,053 Net income $ 11,219 $ 7,846 $ 5,178 $ 4,902 $ 7,349 $ 6,091 $ 2,616 $ 2,429 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 3.94 $ 2.75 $ 1.82 $ 1.72 $ 2.58 $ 2.13 $ 0.92 $ 0.85 Diluted $ 3.88 $ 2.71 $ 1.80 $ 1.71 $ 2.56 $ 2.12 $ 0.91 $ 0.85 The following tables set forth our consolidated statements of income data (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Revenue: Advertising 97 % 99 % 98 % 98 % 98 % 98 % 98 % 99 % Other revenue 3 1 2 2 2 2 2 1 Total revenue 100 % 100 % 100 % 100 % 100 % 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 20 20 20 17 18 20 19 Research and development 19 22 24 23 18 20 20 19 Marketing and sales 12 12 15 16 14 14 14 13 General and administrative 6 8 9 9 9 8 19 27 Total costs and expenses 54 63 68 67 58 59 73 78 Income from operations 46 37 32 33 42 41 27 22 Interest and other income (expense), net 1 1 1 1 1 1 Income before provision for income taxes 47 38 33 33 43 42 29 23 Provision for income taxes 7 1 5 5 9 7 13 7 Net income 40 % 37 % 28 % 28 % 35 % 35 % 15 % 16 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 (in millions) Cost of revenue $ 120 $ 116 $ 117 $ 94 $ 90 $ 91 $ 109 $ 87 Research and development 1,361 1,297 1,261 999 931 907 927 723 Marketing and sales 175 180 187 149 147 148 160 113 General and administrative 128 129 130 93 105 103 107 87 Total share-based compensation expense $ 1,784 $ 1,722 $ 1,695 $ 1,335 $ 1,273 $ 1,249 $ 1,303 $ 1,010 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Cost of revenue % 1 % 1 % 1 % % 1 % 1 % 1 % Research and development 5 6 7 6 4 5 5 5 Marketing and sales 1 1 1 1 1 1 1 1 General and administrative 1 1 1 1 1 1 Total share-based compensation expense 6 % 8 % 9 % 8 % 6 % 7 % 8 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Liquidity and Capital Resources Year Ended December 31, 2020 2019 2018 (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 38,747 $ 36,314 $ 29,274 Net cash used in investing activities $ (30,059) $ (19,864) $ (11,603) Net cash used in financing activities $ (10,292) $ (7,299) $ (15,572) Purchase of property and equipment and principal payments on finance leases $ 15,719 $ 15,654 $ 13,915 Depreciation and amortization $ 6,862 $ 5,741 $ 4,315 Share-based compensation $ 6,536 $ 4,836 $ 4,152 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020, an increase of $7.10 billion from December 31, 2019. The increase was mostly due to $38.75 billion of cash generated from operations, offset by $15.72 billion for capital expenditures, including principal payments on finance leases, $6.36 billion for purchases of equity investments, $6.27 billion for repurchases of our Class A common stock, and $3.56 billion of taxes paid related to net share settlement of employee restricted stock units (RSU) awards. Cash paid for income taxes was $4.23 billion for the year ended December 31, 2020. As of December 31, 2020, our federal net operating loss carryforward was $10.62 billion and our federal tax credit carryforward was $424 million. We anticipate the utilization of a significant portion of these net operating losses and credits within the next three years. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $4.90 billion remained available and authorized for repurchases under this program. In 2020, we repurchased and subsequently retired 27 million shares of our Class A common stock for $6.30 billion. As of December 31, 2020, $8.60 billion remained available and authorized for repurchases. In January 2021, an additional $25 billion of repurchases was authorized under this program. As of December 31, 2020, $7.18 billion of the $61.95 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. In July 2019, we entered into a settlement and modified consent order to resolve the inquiry of the FTC into our platform and user data practices, which was approved by the federal court and took effect in April 2020. We paid the penalty of $5.0 billion in April 2020 upon the effectiveness of the modified consent order. On April 21, 2020, we entered into a definitive agreement to invest in Jio Platforms Limited, a subsidiary of Reliance Industries Limited. The transaction closed on July 7, 2020, and we paid approximately $5.8 billion at the then-current exchange rate. We currently anticipate that our available funds and cash flow from operations will be sufficient to meet our operational cash needs and fund our share repurchase program for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2020 mostly consisted of net income adjusted for certain non-cash items, including $6.86 billion of depreciation and amortization and $6.54 billion of share-based compensation expense, and offset by a cash payment of $5.0 billion for the FTC legal settlement. The increase in cash flow from operating activities during 2020 compared to 2019 was mostly due to higher net income as adjusted for certain non-cash items, such as depreciation and amortization, share-based compensation expense and deferred income tax, partially offset by the payment of $5.0 billion for the FTC legal settlement. Cash flow from operating activities during 2019 primarily consisted of net income, adjusted for certain non-cash items, including $5.74 billion of depreciation and amortization and $4.84 billion of share-based compensation expense. The increase in cash flow from operating activities during 2019 compared to 2018 was primarily due to higher net income prior to the effect of the $5.0 billion FTC legal settlement accrual, an increase in taxes payable as well as increases in the non-cash items, including depreciation and amortization, and share-based compensation expense. Cash Used in Investing Activities Cash used in investing activities during 2020 mostly resulted from $15.11 billion of purchases of property and equipment as we continued to invest in data centers, servers, office facilities, and network infrastructure, $8.16 billion of net purchases of marketable securities, and $6.36 billion of purchases of equity investments. The increase in cash used in investing activities during 2020 compared to 2019 was due to increases in purchases of equity investments and in net purchases of marketable securities. Cash used in investing activities during 2019 mostly resulted from $15.10 billion of net purchase of property and equipment as we continued to invest in data centers, servers, network infrastructure, and $4.19 billion of net purchases of marketable securities. The increase in cash used in investing activities during 2019 compared to 2018 was mostly due to increases in the net purchases of marketable securities and property and equipment. We anticipate making capital expenditures of approximately $21 billion to $23 billion in 2021. Cash Used in Financing Activities Cash used in financing activities during 2020 mostly consisted of $6.27 billion for repurchases of our Class A common stock and $3.56 billion of taxes paid related to net share settlement of RSUs. The increase in cash used in financing activities during 2020 compared to 2019 was due to increases in repurchases of our Class A common stock and in taxes paid related to net share settlement of RSUs. Cash used in financing activities during 2019 mostly consisted of $4.20 billion used to settle repurchases of our Class A common stock, and $2.34 billion of taxes paid related to net share settlement of equity awards, and $552 million of principal payments on finance leases. The decrease in cash used in financing activities during 2019 compared to 2018 was mostly due to a decrease in repurchases of our Class A common stock. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations Our principal commitments consist mostly of obligations under operating leases and other contractual commitments. Our obligations under operating leases include among others, certain of our offices, data centers, land, colocations, and equipment. Our other contractual commitments are mostly related to our investments in network infrastructure, consumer hardware, content costs, and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2020: Payment Due by Period Total 2021 2022-2023 2024-2025 Thereafter (in millions) Operating lease obligations, including imputed interest (1) $ 20,751 $ 1,316 $ 3,017 $ 3,065 $ 13,353 Finance lease obligations, including imputed interest (1) 1,088 249 214 100 525 Transition tax payable 1,543 300 1,243 Other contractual commitments 7,504 4,213 1,071 244 1,976 Total contractual obligations $ 30,886 $ 5,778 $ 4,602 $ 4,652 $ 15,854 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. Additionally, as part of the normal course of the business, we may also enter into multi-year agreements to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.94 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. Our other liabilities also include $3.48 billion related to net uncertain tax positions as of December 31, 2020. Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 12Commitments and Contingencies and Note 15Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, equity investment risk, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $129 million, $105 million, and $213 million were recognized in 2020, 2019, and 2018, respectively, as interest and other income (expense), net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $794 million and $525 million in the market value of our available-for-sale debt securities as of December 31, 2020 and December 31, 2019, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial markets, including recent and ongoing effects related to the impact of the COVID-19 pandemic, which requires significant judgments, could result in a material impairment charge on our equity investments. Equity investments accounted for under the equity method were immaterial as of December 31, 2020 and December 31, 2019. Our equity investments had a carrying value of $6.23 billion as of December 31, 2020. For additional information about our equity investments, see Note 1 Summary of Significant Accounting Policies, Note 5 Equity Investments, and Note 6 Fair Value Measurements in the notes to the consolidated financial statements included in Part II, Item 8, and ""Financial Statements and Supplementary Data"" and Part II, Item 7, ""Managements Discussion and Analysis of Financial Conditions and Results of Operations Critical Accounting Policies and Estimates"" contained in this Annual Report on Form 10-K. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 27, 2021 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 12 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory, tax or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above. For certain of these matters, the Company discloses an estimate of the amount of loss or range of possible loss that may be incurred. However, for certain other matters, the Company discloses that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, loss contingencies related to the various legal proceedings was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure regarding any range of possible losses, including when the Company believes it cannot be reasonably estimated at this time, we read the minutes or a summary of the meetings of the committees of the board of directors, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained representations from management. We also evaluated the appropriateness of the related disclosures included in Note 12 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 15 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 15 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California January 27, 2021 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.'s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated January 27, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California January 27, 2021 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, 2020 2019 Assets Current assets: Cash and cash equivalents $ 17,576 $ 19,079 Marketable securities 44,378 35,776 Accounts receivable, net of allowances of $ 114 million and $ 92 million as of December 31, 2020 and 2019, respectively 11,335 9,518 Prepaid expenses and other current assets 2,381 1,852 Total current assets 75,670 66,225 Equity investments 6,234 86 Property and equipment, net 45,633 35,323 Operating lease right-of-use assets, net 9,348 9,460 Intangible assets, net 623 894 Goodwill 19,050 18,715 Other assets 2,758 2,673 Total assets $ 159,316 $ 133,376 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 1,331 $ 1,363 Partners payable 1,093 886 Operating lease liabilities, current 1,023 800 Accrued expenses and other current liabilities 11,152 11,735 Deferred revenue and deposits 382 269 Total current liabilities 14,981 15,053 Operating lease liabilities, non-current 9,631 9,524 Other liabilities 6,414 7,745 Total liabilities 31,026 32,322 Commitments and contingencies Stockholders' equity: Common stock, $ 0.000006 par value; 5,000 million Class A shares authorized, 2,406 million and 2,407 million shares issued and outstanding, as of December 31, 2020 and 2019, respectively; 4,141 million Class B shares authorized, 443 million and 445 million shares issued and outstanding, as of December 31, 2020 and 2019, respectively Additional paid-in capital 50,018 45,851 Accumulated other comprehensive income (loss) 927 ( 489 ) Retained earnings 77,345 55,692 Total stockholders' equity 128,290 101,054 Total liabilities and stockholders' equity $ 159,316 $ 133,376 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2020 2019 2018 Revenue $ 85,965 $ 70,697 $ 55,838 Costs and expenses: Cost of revenue 16,692 12,770 9,355 Research and development 18,447 13,600 10,273 Marketing and sales 11,591 9,876 7,846 General and administrative 6,564 10,465 3,451 Total costs and expenses 53,294 46,711 30,925 Income from operations 32,671 23,986 24,913 Interest and other income, net 509 826 448 Income before provision for income taxes 33,180 24,812 25,361 Provision for income taxes 4,034 6,327 3,249 Net income 29,146 18,485 22,112 Less: Net income attributable to participating securities ( 1 ) Net income attributable to Class A and Class B common stockholders $ 29,146 $ 18,485 $ 22,111 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 10.22 $ 6.48 $ 7.65 Diluted $ 10.09 $ 6.43 $ 7.57 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,851 2,854 2,890 Diluted 2,888 2,876 2,921 Share-based compensation expense included in costs and expenses: Cost of revenue $ 447 $ 377 $ 284 Research and development 4,918 3,488 3,022 Marketing and sales 691 569 511 General and administrative 480 402 335 Total share-based compensation expense $ 6,536 $ 4,836 $ 4,152 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2020 2019 2018 Net income $ 29,146 $ 18,485 $ 22,112 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax 1,056 ( 151 ) ( 450 ) Change in unrealized gain (loss) on available-for-sale investments and other, net of tax 360 422 ( 52 ) Comprehensive income $ 30,562 $ 18,756 $ 21,610 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2017 2,906 $ $ 40,584 $ ( 227 ) $ 33,990 $ 74,347 Impact of the adoption of new accounting pronouncements ( 31 ) 172 141 Issuance of common stock for cash upon exercise of stock options 2 15 15 Issuance of common stock for settlement of RSUs 44 Shares withheld related to net share settlement ( 19 ) ( 1,845 ) ( 1,363 ) ( 3,208 ) Share-based compensation 4,152 4,152 Share repurchases ( 79 ) ( 12,930 ) ( 12,930 ) Other comprehensive loss ( 502 ) ( 502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 42,906 ( 760 ) 41,981 84,127 Issuance of common stock for cash upon exercise of stock options 1 15 15 Issuance of common stock for settlement of RSUs 32 Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income 271 271 Net income 18,485 18,485 Balances at December 31, 2019 2,852 45,851 ( 489 ) 55,692 101,054 Issuance of common stock for settlement of RSUs 38 Shares withheld related to net share settlement ( 14 ) ( 2,369 ) ( 1,195 ) ( 3,564 ) Share-based compensation 6,536 6,536 Share repurchases ( 27 ) ( 6,298 ) ( 6,298 ) Other comprehensive income 1,416 1,416 Net income 29,146 29,146 Balances at December 31, 2020 2,849 $ $ 50,018 $ 927 $ 77,345 $ 128,290 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Cash flows from operating activities Net income $ 29,146 $ 18,485 $ 22,112 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,862 5,741 4,315 Share-based compensation 6,536 4,836 4,152 Deferred income taxes ( 1,192 ) ( 37 ) 286 Other 118 39 ( 64 ) Changes in assets and liabilities: Accounts receivable ( 1,512 ) ( 1,961 ) ( 1,892 ) Prepaid expenses and other current assets 135 47 ( 690 ) Other assets ( 34 ) 41 ( 159 ) Accounts payable ( 17 ) 113 221 Partners payable 178 348 157 Accrued expenses and other current liabilities ( 1,054 ) 7,300 1,417 Deferred revenue and deposits 108 123 53 Other liabilities ( 527 ) 1,239 ( 634 ) Net cash provided by operating activities 38,747 36,314 29,274 Cash flows from investing activities Purchases of property and equipment ( 15,115 ) ( 15,102 ) ( 13,915 ) Purchases of marketable securities ( 33,930 ) ( 23,910 ) ( 14,656 ) Sales of marketable securities 11,787 9,565 12,358 Maturities of marketable securities 13,984 10,152 4,772 Purchases of equity investments ( 6,361 ) ( 61 ) ( 25 ) Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 388 ) ( 508 ) ( 137 ) Other investing activities ( 36 ) Net cash used in investing activities ( 30,059 ) ( 19,864 ) ( 11,603 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 3,564 ) ( 2,337 ) ( 3,208 ) Repurchases of Class A common stock ( 6,272 ) ( 4,202 ) ( 12,879 ) Principal payments on finance leases ( 604 ) ( 552 ) Net change in overdraft in cash pooling entities 24 ( 223 ) 500 Other financing activities 124 15 15 Net cash used in financing activities ( 10,292 ) ( 7,299 ) ( 15,572 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash 279 4 ( 179 ) Net increase (decrease) in cash, cash equivalents, and restricted cash ( 1,325 ) 9,155 1,920 Cash, cash equivalents, and restricted cash at beginning of the period 19,279 10,124 8,204 Cash, cash equivalents, and restricted cash at end of the period $ 17,954 $ 19,279 $ 10,124 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 17,576 $ 19,079 $ 10,019 Restricted cash, included in prepaid expenses and other current assets 241 8 10 Restricted cash, included in other assets 137 192 95 Total cash, cash equivalents, and restricted cash $ 17,954 $ 19,279 $ 10,124 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Supplemental cash flow data Cash paid for income taxes $ 4,229 $ 5,182 $ 3,762 Non-cash investing activities: Acquisition of businesses in accrued expenses and other current liabilities and other liabilities $ 118 $ $ Property and equipment in accounts payable and accrued expenses and other current liabilities $ 2,201 $ 1,887 $ 1,955 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc., its subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current year's presentation. None of these reclassifications had a material impact to our consolidated financial statements. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives, collectibility of accounts receivable, credit losses of available-for-sale (AFS) debt securities, fair value of financial instruments, and leases. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. The COVID-19 pandemic has created and may continue to create significant uncertainty in macroeconomic conditions, which may cause further business slowdowns or shutdowns, depress demand for our advertising business, and adversely impact our results of operations. During the year ended December 31, 2020, we faced uncertainties around our estimates of revenue collectibility and accounts receivable credit losses. We expect uncertainties around our key accounting estimates to continue to evolve depending on the duration and degree of impact associated with the COVID-19 pandemic . Our estimates may change as new events occur and additional information emerges, and such changes are recognized or disclosed in our consolidated financial statements . Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition by applying the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. In general, we report advertising revenue on a gross basis, since we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers. For revenue generated from arrangements that involve third-party publishers, we evaluate whether we are the principal or the agent, and for those advertising revenue arrangements where we are the agent, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives, credits, or refunds, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue. We believe that there will not be significant changes to our estimates of variable consideration. Other Revenue Other revenue consists of revenue from the delivery of Facebook Reality Labs (FRL) consumer hardware devices, net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue mostly consists of billings and payments we receive from marketers in advance of revenue recognition as well as revenue not yet recognized for unspecified software upgrades and updates for various FRL products. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2020 was driven by cash payments from customers in advance of satisfying our performance obligations in FRL sales and advertising revenue, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Content Costs Our content costs are mostly related to payments to content providers from whom we license video and music to increase engagement on the platform. For licensed video, we expense the cost per title when the title is accepted and available for viewing if the capitalization criteria are not met. Video content costs that meet the criteria for capitalization were not material to date. For licensed music, we expense the license fees over the contractual license period. Expensed content costs are included in cost of revenue on the consolidated statements of income. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be marketed or sold to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses on the consolidated statements of income. We incurred advertising expenses of $ 2.26 billion, $ 1.57 billion, and $ 1.10 billion for the years ended December 31, 2020, 2019, and 2018, respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. We classify our marketable securities as available-for-sale (AFS) investments in our current assets because they represent investments of cash available for current operations. Our AFS investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. AFS debt securities with an amortized cost basis in excess of estimated fair value are assessed to determine what amount of that difference, if any, is caused by expected credit losses. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income (expense), net on our consolidated statements of income, and any remaining unrealized losses, net of taxes, are included in accumulated other comprehensive income (loss) in stockholders' equity. The amount of credit losses recorded for the year ended December 31, 2020 was not material. There was no impairment charge for any unrealized losses in 2019 and 2018. We determine realized gains or losses on sale of marketable securities on a specific identification method and record such gains or losses as interest and other income (expense), net on the consolidated statements of income. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the consolidated balance sheets based upon the term of the remaining restrictions. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. The change in carrying value, if any, is recognized in interest and other income (expense), net on our consolidated statements of income. We periodically review our equity investments for impairment. If indicators exist and the estimated fair value of an investment is below the carrying amount, we will write down the investment to fair value. In addition, we also held equity investments accounted for under the equity method which were immaterial as of December 31, 2020 and 2019. Equity investments had a carrying value of $ 6.23 billion and $ 86 million as of December 31, 2020 and 2019, respectively. There was no material impairment in 2020, 2019 and 2018. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of cash equivalents and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates of expected credit and collectibility trends for the allowance for credit losses and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, reasonable and supportable forecasts of future economic conditions, and other factors that may affect our ability to collect from customers. Expected credit losses are recorded as general and administrative expenses on our consolidated statements of income. As of December 31, 2020 and 2019, our accounts receivable, net were $ 11.33 billion and $ 9.52 billion, respectively, and the allowances of accounts receivable were immaterial. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We have operating leases comprised of certain offices, data center, land, colocations, and equipment leases. We also have finance leases for certain network equipment. We determine if an arrangement is a lease at inception. Most of our leases contain lease and non-lease components. Non-lease components include fixed payments for maintenance, utilities, real estate taxes, and management fees. We combine fixed lease and non-lease components and account for them as a single lease component. Our lease agreements may contain variable costs such as contingent rent escalations, common area maintenance, insurance, real estate taxes or other costs. Such variable lease costs are expensed as incurred on the consolidated statements of income. For certain colocation and equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. For leases that have greater than 12-month lease term, ROU assets and lease liabilities are recognized on the consolidated balance sheet at commencement date based on the present value of remaining fixed lease payments. We consider only payments that are fixed and determinable at the time of commencement. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be in a similar economic environment. Operating leases are included in operating lease ROU assets, operating lease liabilities, current and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, net, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under Topic 842 , while prior period amounts have not been adjusted and continue to be reported under Topic 840. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects Company amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-lived Assets Including Goodwill and Other Acquired Intangibles Assets We evaluate the recoverability of property and equipment and acquired finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2020, no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of stockholders' equity. As of December 31, 2020 we had a cumulative translation gain, net of tax of $ 439 million and as of December 31, 2019, we had a cumulative translation loss, net of tax of $ 617 million. Net losses resulting from foreign exchange transactions were $ 129 million, $ 105 million, and $ 213 million for the years ended December 31, 2020, 2019, and 2018, respectively. These losses were recorded as interest and other income (expense), net on our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. The amount of credit losses recorded for the year ended December 31, 2020 was not material. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 42 % of our revenue for the year ended December 31, 2020 and 43 % of our revenue for the years ended December 31, 2019 and 2018 from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, Japan, Vietnam and Brazil. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses and bad debt expense on these losses was not material during the years ended December 31, 2020, 2019, or 2018. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2020, 2019, and 2018. Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements Fair Value Measurements On January 1, 2020, we adopted Accounting Standards Update No. 2018-13, Changes to Disclosure Requirements for Fair Value Measurements (Topic 820) , which improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard removes, modifies, and adds certain disclosure requirements. The adoption of this new standard did not have a material impact on our consolidated financial statements. Credit Losses On January 1, 2020, we adopted Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326) : Measurement of Credit Losses on Financial Instruments , using the modified retrospective transition method. Upon adoption, we changed our impairment model to utilize a current expected credit losses (CECL) model in place of the incurred loss methodology for financial instruments measured at amortized cost, including our accounts receivable. In addition, we modified our impairment model for AFS debt securities and to discontinue using the concept of ""other than temporary"" impairment on AFS debt securities. CECL estimates on accounts receivable are recorded as general and administrative expenses on our consolidated statements of income. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income (expense), net on our consolidated statements of income. The cumulative effect adjustment from adoption was immaterial to our consolidated financial statements. We continue to monitor the financial implications of the COVID-19 pandemic on expected credit losses. Income Taxes On October 1, 2020, we early adopted Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes. This guidance was effective beginning January 1, 2021, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Accounting Pronouncements Not Yet Adopted In January 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2020-01, InvestmentsEquity Securities (Topic 321), InvestmentsEquity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) (ASU 2020-01), which clarifies the interaction of the accounting for equity securities under Topic 321, the accounting for equity method investments in Topic 323, and the accounting for certain forward contracts and purchased options in Topic 815. We will adopt the new standard effective January 1, 2021 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In August 2020, the FASB issued Accounting Standards Update No. 2020-06, DebtDebt with Conversion and Other Options (Subtopic 470-20) and Derivatives and HedgingContracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entitys Own Equity (ASU 2020-06), which simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments. This guidance also eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. This guidance will be effective for us in the first quarter of 2022 on a full or modified retrospective basis, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source consists of the following (in millions): Year Ended December 31, 2020 2019 2018 Advertising $ 84,169 $ 69,655 $ 55,013 Other revenue 1,796 1,042 825 Total revenue $ 85,965 $ 70,697 $ 55,838 Revenue disaggregated by geography, based on the billing address of our customers, consists of the following (in millions): Year Ended December 31, 2020 2019 2018 Revenue: United States and Canada (1) $ 38,433 $ 32,206 $ 25,727 Europe (2) 20,349 16,826 13,631 Asia-Pacific 19,848 15,406 11,733 Rest of World (2) 7,335 6,259 4,747 Total revenue $ 85,965 $ 70,697 $ 55,838 _________________________ (1) United States revenue was $ 36.25 billion, $ 30.23 billion, and $ 24.10 billion for the years ended December 31, 2020, 2019, and 2018, respectively. (2) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Deferred revenue and deposits consists of the following (in millions): December 31, 2020 2019 Deferred revenue $ 335 $ 234 Deposits 47 35 Total deferred revenue and deposits $ 382 $ 269 Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In 2018, the calculation of diluted EPS also included the effect of inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2020, 2019, and 2018. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, 2020 2019 2018 Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,411 $ 3,701 Less: Net income attributable to participating securities ( 1 ) Net income attributable to common stockholders $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,410 $ 3,701 Denominator Weighted-average shares outstanding 2,407 444 2,404 450 2,406 484 Basic EPS $ 10.22 $ 10.22 $ 6.48 $ 6.48 $ 7.65 $ 7.65 Diluted EPS: Numerator Net income attributable to common stockholders $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,410 $ 3,701 Reallocation of net income attributable to participating securities 1 Reallocation of net income as a result of conversion of Class B to Class A common stock 4,539 2,916 3,701 Reallocation of net income to Class B common stock ( 58 ) ( 18 ) ( 16 ) Net income for diluted EPS $ 29,146 $ 4,481 $ 18,485 $ 2,898 $ 22,112 $ 3,685 Denominator Number of shares used for basic EPS computation 2,407 444 2,404 450 2,406 484 Conversion of Class B to Class A common stock 444 450 484 Weighted-average effect of dilutive RSUs and employee stock options 37 22 1 31 3 Number of shares used for diluted EPS computation 2,888 444 2,876 451 2,921 487 Diluted EPS $ 10.09 $ 10.09 $ 6.43 $ 6.43 $ 7.57 $ 7.57 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, 2020 2019 Cash and cash equivalents: Cash $ 6,488 $ 4,735 Money market funds 9,755 12,787 U.S. government securities 1,016 815 U.S. government agency securities 444 Certificate of deposits and time deposits 305 217 Corporate debt securities 12 81 Total cash and cash equivalents 17,576 19,079 Marketable securities: U.S. government securities 20,921 18,679 U.S. government agency securities 11,698 6,712 Corporate debt securities 11,759 10,385 Total marketable securities 44,378 35,776 Total cash and cash equivalents and marketable securities $ 61,954 $ 54,855 The gross unrealized gains on our marketable securities were $ 641 million and $ 205 million as of December 31, 2020 and 2019, respectively. The gross unrealized losses on our marketable securities were not material as of December 31, 2020 and 2019. The allowance for credit losses was not material as of December 31, 2020. The following table classifies our marketable securities by contractual maturities (in millions): December 31, 2020 2019 Due in one year $ 12,826 $ 12,803 Due after one year to five years 31,552 22,973 Total $ 44,378 $ 35,776 Note 5. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. On July 7, 2020, we completed our equity investment in Jio Platforms Limited (Jio), a subsidiary of Reliance Industries Limited, for $ 5.82 billion. There was no material impairment for the years ended December 31, 2020, 2019 or 2018. The changes in the carrying value of equity investments for the year ended December 31, 2019 were not material. The changes in the carrying value of equity investments for the year ended December 31, 2020 were as follows (in millions): Balance as of December 31, 2019 $ 86 Jio 5,824 Other investments 323 Adjustments 1 Balance as of December 31, 2020 $ 6,234 Note 6. Fair Value Measurement The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2020 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 9,755 $ 9,755 $ $ U.S. government securities 1,016 1,016 Certificate of deposits and time deposits 305 305 Corporate debt securities 12 12 Marketable securities: U.S. government securities 20,921 20,921 U.S. government agency securities 11,698 11,698 Corporate debt securities 11,759 11,759 Total cash equivalents and marketable securities $ 55,466 $ 43,390 $ 12,076 $ Fair Value Measurement at Reporting Date Using Description December 31, 2019 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 12,787 $ 12,787 $ $ U.S. government securities 815 815 U.S. government agency securities 444 444 Certificate of deposits and time deposits 217 217 Corporate debt securities 81 81 Marketable securities: U.S. government securities 18,679 18,679 U.S. government agency securities 6,712 6,712 Corporate debt securities 10,385 10,385 Total cash equivalents and marketable securities $ 50,120 $ 39,437 $ 10,683 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Beginning in 2020, we had other assets and liabilities classified within Level 3 because factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. The aggregate absolute value of these Level 3 assets and liabilities was not material to our consolidated financial statements as of December 31, 2020. On July 7, 2020, we completed our equity investment in Jio and noted observable transactions in similar securities subsequent to the date of our investment. Based on our assessment, we concluded no change in fair value from the initial carrying value of $ 5.82 billion was required as a result of these observable transactions. Had there been a change in the fair value, our investment in Jio would be classified within Level 3. For information regarding our investment in Jio, see Note 5 Equity Investments. Note 7. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, 2020 2019 Land $ 1,326 $ 1,097 Buildings 17,360 11,226 Leasehold improvements 4,321 3,112 Network equipment 22,003 17,004 Computer software, office equipment and other 2,458 1,813 Finance lease right-of-use assets 2,295 1,635 Construction in progress 11,288 10,099 Total 61,051 45,986 Less: Accumulated depreciation ( 15,418 ) ( 10,663 ) Property and equipment, net $ 45,633 $ 35,323 Depreciation expense on property and equipment were $ 6.39 billion, $ 5.18 billion, and $ 3.68 billion for the years ended December 31, 2020, 2019, and 2018, respectively. The majority of the property and equipment depreciation expense was from network equipment depreciation of $ 4.58 billion, $ 3.83 billion, and $ 2.94 billion for the years ended December 31, 2020, 2019, and 2018, respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. Note 8. Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data centers, land, colocations, and equipment. We have also entered into various non-cancelable finance lease agreements for certain network equipment. Our leases have original lease periods expiring between 2021 and 2093. Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs for the years ended December 31, 2020 and 2019 are as follows (in millions): December 31, 2020 2019 Finance lease cost Amortization of right-of-use assets $ 259 $ 195 Interest 14 12 Operating lease cost 1,391 1,139 Variable lease cost and other, net 269 160 Total lease cost $ 1,933 $ 1,506 Operating lease expense was $ 629 million for the year ended December 31, 2018 under Topic 840. Supplemental balance sheet information related to leases is as follows: December 31, 2020 2019 Weighted-average remaining lease term Operating leases 12.2 years 13.0 years Finance leases 14.9 years 15.3 years Weighted-average discount rate Operating leases 3.1 % 3.2 % Finance leases 2.9 % 3.1 % The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2020 (in millions): Operating Leases Finance Leases 2021 $ 1,300 $ 68 2022 1,394 51 2023 1,266 41 2024 1,163 41 2025 1,001 41 Thereafter 7,206 401 Total undiscounted cash flows 13,330 643 Less: Imputed interest ( 2,676 ) ( 120 ) Present value of lease liabilities $ 10,654 $ 523 Lease liabilities, current $ 1,023 $ 54 Lease liabilities, non-current 9,631 469 Present value of lease liabilities $ 10,654 $ 523 The table above does not include lease payments that were not fixed at commencement or lease modification. As of December 31, 2020, we have additional operating and finance leases, that have not yet commenced, with lease obligations of approximately $ 7.41 billion and $ 443 million, respectively, mostly for offices, data centers and network equipment. These operating and finance leases will commence between 2021 and 2025 with lease terms of greater than one year to 30 years. Supplemental cash flow information related to leases for the years ended December 31, 2020 and 2019 are as follows (in millions): December 31, 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows for operating leases $ 1,208 $ 902 Operating cash flows for finance leases $ 14 $ 12 Financing cash flows for finance leases $ 604 $ 552 Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 1,158 $ 5,081 Finance leases $ 121 $ 193 Note 9. Goodwill and Intangible Assets During the year ended December 31, 2020, we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2020 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2020 and 2019 are as follows (in millions): Balance as of December 31, 2018 $ 18,301 Goodwill acquired 408 Effect of currency translation adjustment 6 Balance as of December 31, 2019 18,715 Goodwill acquired 322 Effect of currency translation adjustment 13 Balance as of December 31, 2020 $ 19,050 The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2020 December 31, 2019 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 0.8 $ 2,057 $ ( 1,840 ) $ 217 $ 2,056 $ ( 1,550 ) $ 506 Acquired technology 2.8 1,297 ( 1,088 ) 209 1,158 ( 986 ) 172 Acquired patents 4.0 805 ( 677 ) 128 805 ( 625 ) 180 Trade names 1.4 636 ( 622 ) 14 635 ( 604 ) 31 Other 3.2 223 ( 168 ) 55 162 ( 157 ) 5 Total intangible assets $ 5,018 $ ( 4,395 ) $ 623 $ 4,816 $ ( 3,922 ) $ 894 Amortization expense of intangible assets for the years ended December 31, 2020, 2019, and 2018 was $ 473 million, $ 562 million, and $ 640 million, respectively. As of December 31, 2020, expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): 2021 $ 387 2022 121 2023 53 2024 29 2025 17 Thereafter 16 Total $ 623 Note 10. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, 2020 2019 Legal-related accruals (1) $ 1,622 $ 5,998 Accrued compensation and benefits 2,609 1,704 Accrued property and equipment 1,414 1,082 Accrued taxes 2,038 624 Other current liabilities 3,469 2,327 Accrued expenses and other current liabilities $ 11,152 $ 11,735 _________________________ (1) Includes accrued legal settlements and fines as well as other legal fees. In 2020 and 2019, the amounts include accrued legal settlement for Illinois Biometric Information Privacy Act (BIPA) of $ 650 million and $ 550 million, respectively. In 2019, the amount includes accrued legal settlements for U.S. Federal Trade Commission (FTC) of $ 5.0 billion. For further information, see Legal and Related Matters in Note 12 Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, 2020 2019 Income tax payable $ 5,025 $ 5,651 Other liabilities 1,389 2,094 Other liabilities $ 6,414 $ 7,745 Note 11. Long-term Debt In May 2016, we entered into a $ 2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility would be due and payable on May 20, 2021. No amount had been drawn down under this credit facility, and it was terminated on December 24, 2020. As of December 31, 2020, we had no outstanding long-term debt. Note 12. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other Contractual Commitments We also have $ 7.50 billion of non-cancelable contractual commitments as of December 31, 2020, which are mostly related to our investments in network infrastructure, consumer hardware, content costs and data center operations. The majority of these commitments are due within five years . Legal and Related Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $ 5.0 billion which was paid in April 2020 upon the effectiveness of the modified consent order. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which provided for a payment of $ 550 million by us and was subject to court approval. On or about May 8, 2020, the parties executed a formal settlement agreement, and plaintiffs filed a motion for preliminary approval of the settlement by the district court. On June 4, 2020, the district court denied the plaintiffs' motion without prejudice. On July 22, 2020, the parties executed an amended settlement agreement, which, among other terms, provides for a payment of $ 650 million by us. On August 19, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. The settlement amount is reflected in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2020. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. On November 15, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Although we are vigorously defending our regulatory compliance, we believe there is a reasonable possibility that the ultimate potential loss related to the inquiries and investigations by the IDPC could be material in the aggregate. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. For example, from time to time we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleges that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these other legal proceedings, claims, regulatory, tax, or government inquiries and investigations, and other matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. The ultimate outcome of the legal and related matters described in this section, such as whether the likelihood of loss is remote, reasonably possible, or probable, or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of loss, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 15Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2020, there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2020. Note 13. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2020, we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2020, we have not declared any dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2020, there were 2,406 million shares of Class A common stock and 443 million shares of Class B common stock issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $ 4.90 billion remained available and authorized for repurchases under this program. In January 2020, an additional $ 10.00 billion of repurchases was authorized under this program. In 2020, we repurchased and subsequently retired 27 million shares of our Class A common stock for $ 6.30 billion. As of December 31, 2020, $ 8.60 billion remained available and authorized for repurchases. In January 2021, an additional $ 25 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans In 2020, we maintained one active share-based employee compensation plan, the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan). Our Amended 2012 Plan provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our stock plan are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. Share-based compensation expense mostly consists of the Company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. As of December 31, 2020, there were 129 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. Pursuant to the automatic increase provision under our Amended 2012 Plan, the number of shares reserved for issuance increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 16 million shares reserved for issuance effective January 1, 2021. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2020: Number of Shares Weighted-Average Grant Date Fair Value (in thousands) Unvested at December 31, 2019 78,851 $ 165.74 Granted 62,032 $ 188.73 Vested ( 38,857 ) $ 162.27 Forfeited ( 5,293 ) $ 165.72 Unvested at December 31, 2020 96,733 $ 181.88 The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2020, 2019, and 2018 was $ 9.38 billion, $ 6.01 billion, and $ 7.57 billion, respectively. As of December 31, 2020, there was $ 16.50 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 14. Interest and Other Income, Net The following table presents the detail of interest and other income, net, is as follows (in millions): Year Ended December 31, 2020 2019 2018 Interest income, net $ 672 $ 904 $ 652 Foreign currency exchange losses, net ( 129 ) ( 105 ) ( 213 ) Other income (expense), net ( 34 ) 27 9 Interest and other income, net $ 509 $ 826 $ 448 Note 15. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, 2020 2019 2018 Domestic $ 24,233 $ 5,317 $ 8,800 Foreign 8,947 19,495 16,561 Income before provision for income taxes $ 33,180 $ 24,812 $ 25,361 The provision for income taxes consisted of the following (in millions): Year Ended December 31, 2020 2019 2018 Current: Federal $ 3,297 $ 4,321 $ 1,747 State 523 565 176 Foreign 1,211 1,481 1,031 Total current tax expense 5,031 6,367 2,954 Deferred: Federal ( 859 ) ( 39 ) 316 State ( 122 ) 19 34 Foreign ( 16 ) ( 20 ) ( 55 ) Total deferred tax (benefits)/expense ( 997 ) ( 40 ) 295 Provision for income taxes $ 4,034 $ 6,327 $ 3,249 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, 2020 2019 2018 U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 % State income taxes, net of federal benefit 0.8 1.8 0.7 Research and development tax credits ( 1.3 ) ( 0.8 ) ( 1.0 ) Share-based compensation 0.2 4.5 0.3 Excess tax benefits related to share-based compensation ( 1.6 ) ( 0.7 ) ( 2.6 ) Foreign-derived intangible income deduction ( 1.9 ) Effect of non-U.S. operations ( 2.4 ) ( 5.8 ) ( 5.9 ) Non-deductible FTC settlement accrual 4.5 Research and development capitalization ( 3.0 ) Other 0.4 1.0 0.3 Effective tax rate 12.2 % 25.5 % 12.8 % Our deferred tax assets (liabilities) are as follows (in millions): December 31, 2020 2019 Deferred tax assets: Net operating loss carryforward $ 2,437 $ 2,051 Tax credit carryforward 1,055 1,333 Share-based compensation 243 135 Accrued expenses and other liabilities 1,108 798 Lease liabilities 2,058 1,999 Capitalized research and development 1,922 Other 340 149 Total deferred tax assets 9,163 6,465 Less: valuation allowance ( 1,218 ) ( 1,012 ) Deferred tax assets, net of valuation allowance 7,945 5,453 Deferred tax liabilities: Depreciation and amortization ( 3,811 ) ( 2,387 ) Right-of-use assets ( 1,876 ) ( 1,910 ) Total deferred tax liabilities ( 5,687 ) ( 4,297 ) Net deferred tax assets $ 2,258 $ 1,156 The valuation allowance was approximately $ 1.22 billion and $ 1.01 billion as of December 31, 2020 and 2019, respectively, mostly relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2020, the U.S. federal and state net operating loss carryforwards were $ 10.62 billion and $ 2.19 billion, which will begin to expire in 2028 and 2027, respectively, if not utilized. We have federal tax credit carryforwards of $ 424 million, which will begin to expire in 2029, if not utilized, and state tax credit carryforwards of $ 2.65 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, 2020 2019 2018 Gross unrecognized tax benefits beginning of period $ 7,863 $ 4,678 $ 3,870 Increases related to prior year tax positions 356 2,309 457 Decreases related to prior year tax positions ( 253 ) ( 525 ) ( 396 ) Increases related to current year tax positions 1,045 1,402 831 Decreases related to settlements of prior year tax positions ( 319 ) ( 1 ) ( 84 ) Gross unrecognized tax benefits end of period $ 8,692 $ 7,863 $ 4,678 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2020 and 2019 were $ 774 million and $ 747 million, respectively. If the balance of gross unrecognized tax benefits of $ 8.69 billion as of December 31, 2020 were realized in a future period, this would result in a tax benefit of $ 4.85 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $ 1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer requested a hearing before the Supreme Court of the United States and the request was denied on June 22, 2020. Since we started to accrue income tax for share-based compensation cost-sharing expense in the second quarter of 2019, the denial of the request by the Supreme Court did not have a material impact to our financial results in 2020. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 and 2018 tax years and by the Irish tax authorities for our 2016 through 2018 tax years. Our 2017 and subsequent tax years remain open to examination by the IRS. Our 2019 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first session of the trial began in February 2020 and a second session is expected to continue in 2021. It is not clear how the IRS intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2020, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 16. Geographical Information The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets, net (in millions): December 31, 2020 2019 Long-lived assets: United States $ 43,128 $ 35,858 Rest of the world (1) 11,853 8,925 Total long-lived assets $ 54,981 $ 44,783 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2020, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2020 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2020 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +2,Meta,2019," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed, Stories, Marketplace, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, including through Instagram Feed and Stories, and explore their interests in businesses, creators and niche communities. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing heavily in other consumer hardware products and a number of longer-term initiatives, such as augmented reality, artificial intelligence (AI), and connectivity efforts, to develop technologies that we believe will help us better serve our mission over the long run. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. Companies that provide regional social networks and messaging products, many of which have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video increases, and as we deepen our investment in new technologies like AI, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate more than 70 offices around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, anti-corruption law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. The Brazilian General Data Protection Law will impose requirements similar to GDPR on products and services offered to users in Brazil, effective in August 2020. The California Consumer Privacy Act, which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into in July 2019 with the U.S. Federal Trade Commission (FTC) which is pending federal court approval and which, among other matters, will require us to implement a comprehensive expansion of our privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. Employees As of December 31, 2019 , we had 44,942 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, or concerns related to privacy and sharing, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, regulatory authorities, or litigation that adversely affect our products or users; there is decreased engagement with our products, or failure to accept our terms of service, as part of changes that we implemented in connection with the General Data Protection Regulation (GDPR) in Europe, other similar changes that we implemented in the United States and around the world, or other changes we have implemented or may implement in the future in connection with other regulations, regulatory actions or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have recently implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of our efforts to promote the Stories format or increased usage of our messaging products; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated or otherwise more effective products; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties, questions about our user data practices, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that we implemented in connection with the GDPR, California Consumer Privacy Act (CCPA), or other similar changes that we implemented in the United States and around the world (for example, we have seen an increasing number of users opt out of certain types of ad targeting in Europe following adoption of the GDPR), or other product changes or controls we have implemented or may implement in the future, whether in connection with other regulations, regulatory actions or otherwise, that impact our ability to target ads; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory changes, such as the GDPR and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In addition, mobile operating system and browser providers, such as Apple and Google, have announced product changes as well as future plans to limit the ability of application developers to use these signals to target and measure advertising on their platforms. Similarly, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform, and any additional loss of such signals in the future will adversely affect our targeting and measurement capabilities and negatively impact our advertising revenue. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and we expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. We also compete with companies that provide regional social networks and messaging products, many of which have strong positions in particular countries. Some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues, or otherwise, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we have announced plans to implement end-to-end encryption across our messaging services, as well as facilitate interoperability between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have recently implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which will reduce our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we plan to continue to promote the Stories format, which is becoming increasingly popular for sharing content across our products, but our advertising efforts with this format are still under development and we do not currently monetize Stories at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, encryption, content, advertising, and other issues, including actions or decisions in connection with elections, which may adversely affect our reputation and brands. For example, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the 2020 U.S. presidential election or other elections around the world. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. We experience cyber-attacks and other security incidents of varying degrees from time to time, and we may incur significant costs in protecting against or remediating such incidents. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under the modified consent order we entered into in July 2019 with the U.S. Federal Trade Commission (FTC), which is pending federal court approval. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. While we took steps to remediate the attack, including fixing the vulnerability, resetting user access tokens and notifying affected users, we may discover and announce additional developments, which could further erode confidence in our brand. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications that previously accessed information of a large number of users of our services. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten people's safety on- or offline, or instances of spamming, scraping, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, beginning in March 2018, we were the subject of intense media coverage involving the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and we have continued to receive negative publicity. In addition, we may be subject to negative publicity if we are not successful in our efforts to prevent the illicit or objectionable use of our products or services in connection with the 2020 U.S. presidential election or other elections around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments have the effect of reducing our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability. If our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2019 , excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $313 million and our effective tax rate by one percentage point as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, anti-corruption law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this framework is subject to an annual review that could result in changes to our obligations and also is subject to challenge by regulators and private parties, including a pending legal challenge by a private party. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has referred this challenge to the Court of Justice of the European Union for decision. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated or the transfer frameworks are amended, if we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of personal data breach notifications to our designated European privacy regulator, the Irish Data Protection Commission, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The Brazilian General Data Protection Law will impose requirements similar to GDPR on products and services offered to users in Brazil, effective in August 2020. The California Consumer Privacy Act (CCPA), which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users, including more ability to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Beginning in September 2018, we also became subject to Irish Data Protection Commission (IDPC) and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. From time to time we also notify the IDPC, our designated European privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. In addition, competition authorities in the United States, Europe, and other jurisdictions have initiated formal and informal inquiries and investigations into many aspects of our business, including with respect to users and advertisers, as well as our industry. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice, the U.S. House of Representatives, and state attorneys general. These inquiries and investigations concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. Compliance with our FTC consent order, the GDPR, the CCPA, and other regulatory and legislative privacy requirements will require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including as a result of the modified consent order we entered into in July 2019 with the FTC, as well as our efforts to comply with the GDPR and other regulatory and legislative requirements around the world, including the CCPA. In particular, we have agreed with the FTC to implement a comprehensive expansion of our privacy program, including substantial management and board of directors oversight, stringent operational requirements and reporting obligations, and a process to regularly certify our compliance with the privacy program to the FTC, which will be challenging and costly to implement. We expect that these enhancements will result in both improved privacy compliance and oversight and the discovery of additional privacy issues, at least in the near-term, and we expect to continue to notify the FTC of such issues from time to time in accordance with our reporting obligations under the consent order. These compliance and oversight efforts will increase demand on our systems and resources, and will require significant investments, including investments in compliance processes, personnel, and technical infrastructure. In the near-term, we are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts will require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner will be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on advertiser claims, antitrust claims, employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We also recently agreed to settlements in principle to resolve certain lawsuits in connection with the ""tag suggestions"" facial recognition feature on Facebook and a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. We believe the remaining lawsuits are without merit and are vigorously defending them. However, the results of such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states must implement by June 2021. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, legislation in Germany has in the past, and may in the future, result in the imposition of fines for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Other countries, including Australia, France, Singapore, and the United Kingdom, are considering or have implemented similar legislation imposing penalties for failure to remove content or follow certain processes. Such legislation also has in the past, and may in the future, require us to change our products or business practices, increase our compliance costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. If any of the foregoing events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, the technology and products we acquired from Oculus were relatively new to Facebook at the time of the acquisition, and we did not have significant experience with, or structure in place to support, such technology and products prior to the acquisition. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations. Unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Our products and internal systems rely on software and hardware that is highly technical, and if these systems contain errors, bugs, or vulnerabilities, or if we are unsuccessful in addressing or mitigating technical limitations in our systems, our business could be adversely affected. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. If our systems contain bugs or errors or if we do not properly address or mitigate the technical limitations in our systems, we may fail to fulfill our commitments to our users and be subject to regulatory scrutiny or litigation that could harm our business and result in fines, damages, or other remedies. In addition, errors, bugs, vulnerabilities, or defects in the software and hardware on which we rely, and any associated degradations or interruptions of service, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)) and Family metrics (DAP, MAP, and average revenue per person (ARPP)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Facebook metrics and Family metrics estimates will differ from estimates published by third parties due to differences in methodology. We regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2019, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2019, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, or other factors, also may impact the stability or accuracy of our reported Family metrics. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2019, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook or our other products, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 44,942 as of December 31, 2019 from 35,587 as of December 31, 2018 , and we expect such headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors in order to address various privacy, safety, security, and content review initiatives. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located, whether as a result of competition with other companies, challenges due to the high cost of living, facilities and infrastructure constraints, or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we are conducting investigations and audits of a large number of platform applications, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We also intend to launch certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our participation in the Libra Association will subject us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. In June 2019, we announced our participation in the Libra Association, which will oversee a proposed digital payments system powered by blockchain technology, and our plans for Calibra, a digital wallet for Libra which we expect to launch in Messenger, WhatsApp, and as a standalone application. Libra is based on relatively new and unproven technology, and the laws and regulations surrounding blockchain-based payments are uncertain and evolving. Libra has drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. As a primary sponsor of the initiative, we are participating in responses to inquiries from governments and regulators, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As this initiative evolves, we may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, anti-money laundering, counter-terrorism financing, economic sanctions, data protection, tax, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. These laws and regulations, as well as any associated inquiries or investigations, may delay or impede the launch of the Libra currency as well as the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of such currency is subject to significant uncertainty. As such, there can be no assurance that Libra or our associated products and services will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based payments technology, which may adversely affect our ability to successfully develop and market these products and services. We will also incur increased costs in connection with our participation in the Libra Association and the development and marketing of associated products and services, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, competition, consumer protection, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our consumer hardware products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products. We may experience supply shortages or other disruptions in logistics or the supply chain in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing and sale of our consumer hardware products also may be negatively impacted by geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new consumer hardware product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017, and the issuance of additional regulatory or accounting guidance related to the Tax Act could materially affect our tax obligations and effective tax rate in the period issued. In addition, a three-judge panel from the Ninth Circuit Court of Appeals issued a decision in Altera Corp. v. Commissioner regarding the treatment of share-based compensation expense in a cost sharing arrangement, which had a material effect on our tax obligations and effective tax rate for the second quarter of 2019. As the taxpayer may appeal the decision to the Supreme Court of the United States, the final outcome of the case is uncertain and could have a material effect on our tax obligations and effective tax rate in future quarters. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and is expected to continue to issue guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would change various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several countries have proposed or enacted taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and would likely apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $218.62 through December 31, 2019 . In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; developments in anticipated or new legislation or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2019 , we owned and leased approximately nine million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in approximately 70 cities across North America, Latin America, Europe, the Middle East, Africa and Asia Pacific. We also own 15 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, an amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Any other government inquiries regarding these matters could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $550 million by us and is subject to approval by the court. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time we are subject to inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. These investigations and inquiries concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. The result of such investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2019 , there were 3,624 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $205.25 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2019 , there were 39 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2019 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2019 2,415 $ 184.42 2,415 $ 5,757 November 1 - 30, 2019 2,100 $ 195.74 2,100 $ 5,346 December 1 - 31, 2019 2,205 $ 202.02 2,205 $ 4,901 6,720 6,720 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $4.90 billion remained available and authorized for repurchases. In January 2020, an additional $10.0 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2019 . The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2014 in the Class A common stock of Facebook, Inc., the DJINET, the SP 500 and the Nasdaq Composite and data for the DJINET, the SP 500 and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2019 using 2018 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2019 Results Our key community metrics and financial results for 2019 are as follows: Community growth: Facebook daily active users (DAUs) were 1.66 billion on average for December 2019 , an increase of 9% year-over-year. Facebook monthly active users (MAUs) were 2.50 billion as of December 31, 2019 , an increase of 8% year-over-year. Family daily active people (DAP) was 2.26 billion on average for December 2019 , an increase of 11% year-over-year. Family monthly active people (MAP) was 2.89 billion as of December 31, 2019 , an increase of 9% year-over-year. Financial results: Revenue was $70.70 billion , up 27% year-over-year, and advertising revenue was $69.66 billion , up 27% year-over-year. Total costs and expenses were $46.71 billion . Income from operations was $23.99 billion and operating margin was 34% . Net income was $18.48 billion with diluted earnings per share of $6.43 . Capital expenditures, including principal payments on finance leases, were $15.65 billion . Effective tax rate was 25.5% . Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 . Headcount was 44,942 as of December 31, 2019 , an increase of 26% year-over-year. In 2019 , we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We invested based on the following company priorities that we believe will further our mission to give people the power to build community and bring the world closer together: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. We intend to continue to invest based on these priorities, and we anticipate that additional investments in our data center capacity, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, will continue to drive expense growth in 2020. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 9% to 1.66 billion on average during December 2019 from 1.52 billion during December 2018 . Users in India, Indonesia, and the Philippines represented key sources of growth in DAUs during December 2019 , relative to the same period in 2018 . Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2019 , we had 2.50 billion MAUs, an increase of 8% from December 31, 2018 . Users in India, Indonesia, and the Philippines represented key sources of growth in 2019 , relative to the same period in 2018 . Trends in Our Monetization by Facebook User Geography We calculate our revenue by Facebook user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. The share of revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2019 in the United States Canada region was more than 11 times higher than in the Asia-Pacific region. Note: Our revenue by Facebook user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our Facebook users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the billing address of the customer. Our annual worldwide ARPU in 2019, which represents the sum of quarterly ARPU during such period, was $29.25 , an increase of 17% from 2018 . Over this period, ARPU increased by 24% in the United States Canada, 20% in Europe, 18% in AsiaPacific, and 16% in Rest of World. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as MAP or DAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Worldwide DAP increased 11% to 2.26 billion on average during December 2019 from 2.03 billion during December 2018. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. As of December 31, 2019, we had 2.89 billion MAP, an increase of 9% from 2.64 billion as of December 31, 2018. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. The share of revenue from users who are not also MAP was not material. Our annual worldwide ARPP in 2019, which represents the sum of quarterly ARPP during such period, was $ 25.57 , an increase of 14% from 2018. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income, and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability of loss and the estimated amount of loss. The outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 11Commitments and Contingencies and Note 14Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2019 , no impairment of goodwill has been identified. Long-lived assets, including property and equipment and intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of revenue from the delivery of consumer hardware devices and net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Research and development. Research and development expenses consist primarily of salaries and benefits, share-based compensation, and facilities-related costs for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We currently expense all of our research and development costs as they are incurred. Marketing and sales. Marketing and sales expenses consist of salaries and benefits, and share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures and professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist of legal-related costs; salaries and benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2019 compared to the year ended December 31, 2018. For a discussion of the year ended December 31, 2018 compared to the year ended December 31, 2017, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2018. The following table sets forth our consolidated statements of income data: Year Ended December 31, (in millions) Revenue $ 70,697 $ 55,838 $ 40,653 Costs and expenses: Cost of revenue 12,770 9,355 5,454 Research and development 13,600 10,273 7,754 Marketing and sales 9,876 7,846 4,725 General and administrative 10,465 3,451 2,517 Total costs and expenses 46,711 30,925 20,450 Income from operations 23,986 24,913 20,203 Interest and other income, net Income before provision for income taxes 24,812 25,361 20,594 Provision for income taxes 6,327 3,249 4,660 Net income $ 18,485 $ 22,112 $ 15,934 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income, net Income before provision for income taxes Provision for income taxes Net income % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 3,488 3,022 2,820 Marketing and sales General and administrative Total share-based compensation expense $ 4,836 $ 4,152 $ 3,723 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (in millions) Advertising $ 69,655 $ 55,013 $ 39,942 % % Other revenue 1,042 % % Total revenue $ 70,697 $ 55,838 $ 40,653 % % 2019 Compared to 2018 . Revenue in 2019 increased $14.86 billion , or 27% , compared to 2018 . The increase was almost entirely due to an increase in advertising revenue as a result of an increase in the number of ads delivered, partially offset by a slight decrease in the average price per ad. In 2019 , the number of ads delivered increased by 33% , as compared with approximately 22% in 2018 . The increase in the ads delivered was driven by an increase in the number and frequency of ads displayed across our products, and an increase in users and their engagement. In 2019 , the average price per ad decreased by 5% , as compared with an increase of approximately 13% in 2018 . The decrease in average price per ad was primarily driven by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. We anticipate that future advertising revenue growth will be determined by a combination of the number of ads delivered and price. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 19%, 23%, and 26% between the third and fourth quarters of 2019 , 2018 , and 2017 , respectively, while advertising revenue for both the first quarters of 2019 and 2018 declined 10% and 8% compared to the fourth quarters of 2018 and 2017 , respectively. No customer represented 10% or more of total revenue during the years ended December 31, 2019 , 2018 , and 2017 . Foreign Exchange Impact on Revenue The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2019 compared to the same period in 2018 , had an unfavorable impact on revenue. If we had translated revenue for the full year 2019 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $72.37 billion and $71.32 billion , respectively. Using these constant rates, total revenue and advertising revenue would have been $1.67 billion and $1.66 billion , respectively, higher than actual total revenue and advertising revenue for the full year 2019 , and $16.53 billion and $16.31 billion higher than actual total revenue and advertising revenue, respectively, for the full year 2018 . Cost of revenue Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Cost of revenue $ 12,770 $ 9,355 $ 5,454 % % Percentage of revenue % % % 2019 Compared to 2018 . Cost of revenue in 2019 increased $3.42 billion , or 37% , compared to 2018 . The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure, as well as higher cost of consumer hardware devices sold and traffic acquisition costs. In 2020 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with various partner arrangements. Research and development Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Research and development $ 13,600 $ 10,273 $ 7,754 % % Percentage of revenue % % % 2019 Compared to 2018 . Research and development expenses in 2019 increased $3.33 billion , or 32% , compared to 2018 . The increase was primarily due to increases in payroll and benefits expenses and facilities-related costs as a result of a 31% growth in employee headcount from December 31, 2018 to December 31, 2019 in engineering and other technical functions. In 2020 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Marketing and sales $ 9,876 $ 7,846 $ 4,725 % % Percentage of revenue % % % 2019 Compared to 2018 . Marketing and sales expenses in 2019 increased $2.03 billion , or 26% , compared to 2018 . The increase was primarily driven by increases in marketing expenses, payroll and benefits expenses, and community and product operations expenses. Our payroll and benefits expenses increased as a result of a 23% increase in employee headcount from December 31, 2018 to December 31, 2019 in our marketing and sales functions. In 2020 , we anticipate that marketing expense will increase and plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in community and product operations to support our security efforts. General and administrative Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Legal accrual related to FTC settlement $ 5,000 $ $ NM NM Other general and administrative 5,465 3,451 2,517 % % General and administrative $ 10,465 $ 3,451 $ 2,517 % % Percentage of revenue % % % 2019 Compared to 2018 . General and administrative expenses in 2019 increased $7.01 billion , or 203% , compared to 2018 . The majority of the increase was due to the $5.0 billion FTC settlement expense recorded in the first six months of 2019. In addition, other general and administrative expense increased in 2019 compared to 2018 primarily due to an increase in other legal-related costs and higher payroll and benefits expenses as a result of a 31% increase in employee headcount from December 31, 2018 to December 31, 2019 in our general and administrative functions. In 2020 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income, net Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (in millions) Interest income, net $ $ $ % % Other income (expense), net (78 ) (204 ) (1 ) NM NM Interest and other income, net $ $ $ % % 2019 Compared to 2018 . Interest and other income, net in 2019 increased $378 million compared to 2018 . The increase was due to an increase in interest income driven by higher investment balances and interest rates and a decrease in other expense as a result of lower foreign exchange losses as compared to 2018 due to foreign currency transactions and re-measurement. Provision for income taxes Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Provision for income taxes $ 6,327 $ 3,249 $ 4,660 % (30 )% Effective tax rate 25.5 % 12.8 % 22.6 % 2019 Compared to 2018 . Our provision for income taxes in 2019 increased $3.08 billion , or 95% , compared to 2018 , a majority of which is due to an increase in income taxes from the Altera Ninth Circuit Opinion discussed below, an increase in income from operations prior to the effect of the legal accrual related to the FTC settlement that is not expected to be tax-deductible, and a decrease in excess tax benefits recognized from share-based compensation. Our effective tax rate in 2019 increased compared to 2018, primarily due to an increase in income taxes from the Altera Ninth Circuit Opinion, the legal accrual related to the FTC settlement that is not expected to be tax-deductible, and a decrease in excess tax benefits recognized from share-based compensation. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer has until February 10, 2020 to request a hearing before the Supreme Court of the United States. As a result, the final outcome of the case is uncertain. In November 2019, we made a $1.64 billion payment related to this matter and recorded the payment to net against the tax liability included within other liabilities in our consolidated balance sheets. If the Altera Ninth Circuit Opinion is reversed, we would anticipate recording an income tax benefit at that time. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of changes in tax law. The proportion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 23, 2020 price, we expect our effective tax rate for 2020 will be in the high-teens. The range reflects expected effects from a transfer of intellectual property rights between Facebook entities that we anticipate implementing in 2020. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. Unrecognized Tax Benefits. As of December 31, 2019 , we had net unrecognized tax benefits of $3.74 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a material change to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. The case is scheduled for trial beginning in February 2020. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2019 , we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740, Income Taxes, for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2019 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (in millions, except per share amounts) Revenue: Advertising $ 20,736 $ 17,383 $ 16,624 $ 14,912 $ 16,640 $ 13,539 $ 13,038 $ 11,795 Other revenue Total revenue 21,082 17,652 16,886 15,077 16,914 13,727 13,231 11,966 Costs and expenses: Cost of revenue 3,492 3,155 3,307 2,816 2,796 2,418 2,214 1,927 Research and development 3,877 3,548 3,315 2,860 2,855 2,657 2,523 2,238 Marketing and sales 3,026 2,416 2,414 2,020 2,467 1,928 1,855 1,595 General and administrative 1,829 1,348 3,224 4,064 Total costs and expenses 12,224 10,467 12,260 11,760 9,094 7,946 7,368 6,517 Income from operations 8,858 7,185 4,626 3,317 7,820 5,781 5,863 5,449 Interest and other income, net Income before provision for income taxes 9,169 7,329 4,832 3,482 7,971 5,912 5,868 5,610 Provision for income taxes 1,820 1,238 2,216 1,053 1,089 Net income $ 7,349 $ 6,091 $ 2,616 $ 2,429 $ 6,882 $ 5,137 $ 5,106 $ 4,988 Less: Net income attributable to participating securities (1 ) Net income attributable to Class A and Class B common stockholders $ 7,349 $ 6,091 $ 2,616 $ 2,429 $ 6,882 $ 5,137 $ 5,106 $ 4,987 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 2.58 $ 2.13 $ 0.92 $ 0.85 $ 2.40 $ 1.78 $ 1.76 $ 1.72 Diluted $ 2.56 $ 2.12 $ 0.91 $ 0.85 $ 2.38 $ 1.76 $ 1.74 $ 1.69 The following tables set forth our consolidated statements of income data (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (as a percentage of revenue) Revenue: Advertising % % % % % % % % Other revenue Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income, net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ 1,273 $ 1,249 $ 1,303 $ 1,010 $ $ 1,040 $ 1,186 $ Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (as a percentage of revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 36,314 $ 29,274 $ 24,216 Net cash used in investing activities $ (19,864 ) $ (11,603 ) $ (20,118 ) Net cash used in financing activities $ (7,299 ) $ (15,572 ) $ (5,235 ) Purchase of property and equipment and principal payments on finance leases $ 15,654 $ 13,915 $ 6,733 Depreciation and amortization $ 5,741 $ 4,315 $ 3,025 Share-based compensation $ 4,836 $ 4,152 $ 3,723 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 , an increase of $13.74 billion from December 31, 2018 . The majority of the increase was due to $36.31 billion of cash generated from operations, offset by $15.65 billion for capital expenditures, including principal payments on finance leases, $4.20 billion for repurchases of our Class A common stock, $4.19 billion for net purchases of marketable securities, and $2.34 billion of taxes paid related to net share settlement of equity awards. Cash paid for income taxes was $5.18 billion for the year ended December 31, 2019 , of which $1.64 billion was related to the Altera Ninth Circuit Opinion. As of December 31, 2019 , our federal net operating loss carryforward was $9.06 billion , and we anticipate that none of this amount will be utilized to offset our federal taxable income in 2019. As of December 31, 2019 , we had $357 million of federal tax credit carryforward, of which none will be available to offset our federal tax liabilities in 2019 . In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2019 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2018, $9.0 billion remained available and authorized for repurchases under this program. In 2019, we repurchased and subsequently retired 22 million shares of our Class A common stock for $4.10 billion . As of December 31, 2019 , $4.90 billion remained available and authorized for repurchases. In January 2020, an additional $10.0 billion of repurchases was authorized under this program. As of December 31, 2019 , $19.01 billion of the $54.86 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. In July 2019, we entered into a settlement and modified consent order to resolve the inquiry of the FTC into our platform and user data practices, which is pending federal court approval. The settlement requires us to pay a penalty of $5.0 billion, which is included in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2019 . We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2019 primarily consisted of net income adjusted for certain non-cash items, such as $5.74 billion of depreciation and amortization and $4.84 billion of share-based compensation expense. The increase in cash flow from operating activities during 2019 compared to 2018 was primarily due to higher net income prior to the effect of the $5.0 billion FTC legal settlement accrual, an increase in taxes payable, as well as increases in the non-cash items discussed above. Cash flow from operating activities during 2018 mostly consisted of net income, adjusted for certain non-cash items, such as total depreciation and amortization of $4.32 billion and share-based compensation expense of $4.15 billion. The increase in cash flow from operating activities during 2018 compared to 2017 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization, deferred income tax and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a higher tax liability in 2017, which partially offset the increase in cash flow from operating activities in 2018. Cash Used in Investing Activities Cash used in investing activities during 2019 mostly resulted from $15.10 billion of net purchases of property and equipment as we continued to invest in data centers, servers, office buildings, and network infrastructure, and $4.19 billion of net purchases of marketable securities. The increase in cash used in investing activities during 2019 compared to 2018 was mostly due to increases in net purchases of marketable securities and property and equipment. Cash used in investing activities during 2018 mostly resulted from $13.92 billion of capital expenditures as we continued to invest in data centers, servers, network infrastructure, and office buildings, offset by $2.47 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2018 compared to 2017 was mostly due to a decrease in the net purchases of marketable securities, partially offset by an increase in capital expenditures. We anticipate making capital expenditures of approximately $17 billion to $19 billion in 2020 . Cash Used in Financing Activities Cash used in financing activities during 2019 mostly consisted of $4.20 billion cash used to settle repurchases of our Class A common stock, $2.34 billion of taxes paid related to net share settlement of equity awards, and $552 million of principal payments on finance leases. The decrease in cash used in financing activities during 2019 compared to 2018 was mostly due to a decrease in repurchases of our Class A common stock. Cash used in financing activities during 2018 consisted of $12.88 billion paid for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by $500 million in overdraft balances in cash pooling entities. The increase in cash used in financing activities during 2018 compared to 2017 was mostly due to an increase in repurchases of our Class A common stock, partially offset by an increase in overdraft balances in cash pooling entities. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2019 . Contractual Obligations Our principal commitments consist primarily of obligations under operating leases, which include among others, certain of our offices, data centers, land, and colocation leases, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2019 : Payment Due by Period Total 2021-2022 2023-2024 Thereafter (in millions) Operating lease obligations, including imputed interest (1) $ 18,267 $ 1,085 $ 2,510 $ 2,577 $ 12,095 Finance lease obligations, including imputed interest (1) Transition tax payable 1,579 Other contractual commitments (2) 4,542 2,792 Total contractual obligations $ 25,308 $ 4,123 $ 3,242 $ 3,715 $ 14,228 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. (2) The majority of other contractual commitments were related to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.99 billion . The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities also include $3.74 billion related to net uncertain tax positions as of December 31, 2019 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 11Commitments and Contingencies and Note 14Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have negatively affected, and may continue to negatively affect, our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $105 million , $213 million , and $6 million were recognized in 2019 , 2018 , and 2017 , respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $525 million and $468 million in the market value of our available-for-sale debt securities as of December 31, 2019 and December 31, 2018 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 29, 2020 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 11 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory, tax or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above, but that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, loss contingencies related to the various legal proceedings was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure that a range of possible losses cannot be reasonably estimated at this time, we read the minutes of the meetings of the board of directors and its committees, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained a representation letter from the Company. We also evaluated the appropriateness of the related disclosures included in Note 11 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 14 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 14 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California January 29, 2020 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.'s internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated January 29, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California January 29, 2020 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 19,079 $ 10,019 Marketable securities 35,776 31,095 Accounts receivable, net of allowances of $206 and $229 as of December 31, 2019 and December 31, 2018, respectively 9,518 7,587 Prepaid expenses and other current assets 1,852 1,779 Total current assets 66,225 50,480 Property and equipment, net 35,323 24,683 Operating lease right-of-use assets, net 9,460 Intangible assets, net 1,294 Goodwill 18,715 18,301 Other assets 2,759 2,576 Total assets $ 133,376 $ 97,334 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 1,363 $ Partners payable Operating lease liabilities, current Accrued expenses and other current liabilities 11,735 5,509 Deferred revenue and deposits Total current liabilities 15,053 7,017 Operating lease liabilities, non-current 9,524 Other liabilities 7,745 6,190 Total liabilities 32,322 13,207 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,407 million and 2,385 million shares issued and outstanding, as of December 31, 2019 and December 31, 2018, respectively; 4,141 million Class B shares authorized, 445 million and 469 million shares issued and outstanding, as of December 31, 2019 and December 31, 2018, respectively. Additional paid-in capital 45,851 42,906 Accumulated other comprehensive loss ( 489 ) ( 760 ) Retained earnings 55,692 41,981 Total stockholders' equity 101,054 84,127 Total liabilities and stockholders' equity $ 133,376 $ 97,334 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 70,697 $ 55,838 $ 40,653 Costs and expenses: Cost of revenue 12,770 9,355 5,454 Research and development 13,600 10,273 7,754 Marketing and sales 9,876 7,846 4,725 General and administrative 10,465 3,451 2,517 Total costs and expenses 46,711 30,925 20,450 Income from operations 23,986 24,913 20,203 Interest and other income, net Income before provision for income taxes 24,812 25,361 20,594 Provision for income taxes 6,327 3,249 4,660 Net income $ 18,485 $ 22,112 $ 15,934 Less: Net income attributable to participating securities ( 1 ) ( 14 ) Net income attributable to Class A and Class B common stockholders $ 18,485 $ 22,111 $ 15,920 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 6.48 $ 7.65 $ 5.49 Diluted $ 6.43 $ 7.57 $ 5.39 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,854 2,890 2,901 Diluted 2,876 2,921 2,956 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 3,488 3,022 2,820 Marketing and sales General and administrative Total share-based compensation expense $ 4,836 $ 4,152 $ 3,723 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 18,485 $ 22,112 $ 15,934 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax ( 151 ) ( 450 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax ( 52 ) ( 90 ) Comprehensive income $ 18,756 $ 21,610 $ 16,410 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2016 2,892 $ $ 38,227 $ ( 703 ) $ 21,670 $ 59,194 Issuance of common stock related to acquisitions Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement ( 21 ) ( 1,702 ) ( 1,544 ) ( 3,246 ) Share-based compensation 3,723 3,723 Share repurchases ( 13 ) ( 2,070 ) ( 2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 40,584 ( 227 ) 33,990 74,347 Impact of the adoption of new accounting pronouncements ( 31 ) Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement ( 19 ) ( 1,845 ) ( 1,363 ) ( 3,208 ) Share-based compensation 4,152 4,152 Share repurchases ( 79 ) ( 12,930 ) ( 12,930 ) Other comprehensive loss ( 502 ) ( 502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 42,906 ( 760 ) 41,981 84,127 Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income Net income 18,485 18,485 Balances at December 31, 2019 2,852 $ $ 45,851 $ ( 489 ) $ 55,692 $ 101,054 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 18,485 $ 22,112 $ 15,934 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,741 4,315 3,025 Share-based compensation 4,836 4,152 3,723 Deferred income taxes ( 37 ) ( 377 ) Other ( 64 ) Changes in assets and liabilities: Accounts receivable ( 1,961 ) ( 1,892 ) ( 1,609 ) Prepaid expenses and other current assets ( 690 ) ( 192 ) Other assets ( 159 ) Accounts payable Partners payable Accrued expenses and other current liabilities 7,300 1,417 Deferred revenue and deposits Other liabilities 1,239 ( 634 ) 3,083 Net cash provided by operating activities 36,314 29,274 24,216 Cash flows from investing activities Purchases of property and equipment, net ( 15,102 ) ( 13,915 ) ( 6,733 ) Purchases of marketable securities ( 23,910 ) ( 14,656 ) ( 25,682 ) Sales of marketable securities 9,565 12,358 9,444 Maturities of marketable securities 10,152 4,772 2,988 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 508 ) ( 137 ) ( 122 ) Other investing activities, net ( 61 ) ( 25 ) ( 13 ) Net cash used in investing activities ( 19,864 ) ( 11,603 ) ( 20,118 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 2,337 ) ( 3,208 ) ( 3,246 ) Repurchases of Class A common stock ( 4,202 ) ( 12,879 ) ( 1,976 ) Principal payments on finance leases ( 552 ) Net change in overdraft in cash pooling entities ( 223 ) Other financing activities, net ( 13 ) Net cash used in financing activities ( 7,299 ) ( 15,572 ) ( 5,235 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash ( 179 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 9,155 1,920 ( 905 ) Cash, cash equivalents, and restricted cash at beginning of the period 10,124 8,204 9,109 Cash, cash equivalents, and restricted cash at end of the period $ 19,279 $ 10,124 $ 8,204 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 19,079 $ 10,019 $ 8,079 Restricted cash, included in prepaid expenses and other current assets Restricted cash, included in other assets Total cash, cash equivalents, and restricted cash $ 19,279 $ 10,124 $ 8,204 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid for income taxes, net $ 5,182 $ 3,762 $ 2,117 Non-cash investing activities: Net change in prepaids and liabilities related to property and equipment $ ( 153 ) $ $ Property and equipment in accounts payable and accrued liabilities $ 1,887 $ 1,955 $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc., subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to income taxes, loss contingencies, fair value of acquired intangible assets and goodwill, collectability of accounts receivable, fair value of financial instruments, leases, useful lives of intangible assets and property and equipment, and revenue recognition. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition through the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We believe that there will not be significant changes to our estimates of variable consideration. Other Revenue Other revenue consists of revenue from the delivery of consumer hardware devices, net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue mostly consists of billings and payments we receive from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2019 was driven by cash payments from customers in advance of satisfying our performance obligations, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, the capitalized amounts are limited to the greater of estimated net realizable value or cost on a per title basis. We expense the cost per title in cost of revenue on the consolidated statements of income when the title is accepted and available for viewing, and before the capitalization criteria are met. For original content, we expense costs associated with the production, including development costs and direct costs as incurred, unless those amounts are determined to be recoverable. Expensed original content costs are included in cost of revenue on the consolidated statements of income. Content acquisition costs that meet the criteria for capitalization were not material to date. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $ 1.57 billion , $ 1.10 billion , and $ 324 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses are charged against interest and other income, net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income, net. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the accompanying consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of cash equivalents and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations On January 1, 2019, we adopted Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02) using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under Topic 842 , while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under Topic 840. We elected the package of practical expedients permitted under the transition guidance, which allowed us to carryforward our historical lease classification, our assessment on whether a contract was or contains a lease, and our initial direct costs for any leases that existed prior to January 1, 2019. We also elected to combine our lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. Upon adoption, we recognized total ROU assets of $ 6.63 billion , with corresponding lease liabilities of $ 6.35 billion on the consolidated balance sheets. This included $ 761 million of pre-existing finance lease ROU assets previously reported in the network equipment within property and equipment, net. The ROU assets include adjustments for prepayments and accrued lease payments. The adoption did not impact our beginning retained earnings, or our prior year consolidated statements of income and statements of cash flows. Under Topic 842 , we determine if an arrangement is a lease at inception. ROU assets and lease liabilities are recognized at commencement date based on the present value of remaining lease payments over the lease term. For this purpose, we consider only payments that are fixed and determinable at the time of commencement. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be. The ROU asset also includes any lease payments made prior to commencement and is recorded net of any lease incentives received. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. Our lease agreements may contain variable costs such as common area maintenance, insurance, real estate taxes or other costs. Variable lease costs are expensed as incurred on the consolidated statements of income. Our lease agreements generally do not contain any residual value guarantees or restrictive covenants. Operating leases are included in operating lease ROU assets, operating lease liabilities, current and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We evaluate the developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability of loss and the estimated amount of loss. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects Company amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-lived Assets Including Goodwill and Other Acquired Intangibles Assets We evaluate the recoverability of property and equipment and acquired finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2019, no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive loss as a component of stockholders' equity. As of December 31, 2019 and 2018 , we had a cumulative translation loss, net of tax of $ 617 million and $ 466 million , respectively. Net losses resulting from foreign exchange transactions were $ 105 million , $ 213 million , and $ 6 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. These losses were recorded as interest and other income, net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 43 % of our revenue for the years ended December 31, 2019 and 2018 and 44 % of our revenue for the year ended December 31, 2017 from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Brazil, and Australia. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses. Bad debt expense was not material during the years ended December 31, 2019 , 2018 , or 2017 . In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2019 , 2018 , and 2017 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements On January 1, 2019, we adopted Topic 842 , as amended, which supersedes the lease accounting guidance under Topic 840, and generally requires lessees to recognize operating and financing lease liabilities and corresponding ROU assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We adopted the new guidance using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged. For information regarding the impact of Topic 842 adoption, see Significant Accounting Policies - Leases above and Note 7 - Leases. On October 1, 2019, we early adopted Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04) using the prospective approach, which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance was effective beginning January 1, 2020, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2019, we early adopted Accounting Standards Update No. 2019-02, Entertainment-Films-Other Assets-Film Costs (Subtopic 926-20) and Entertainment-Broadcasters-Intangibles-Goodwill and Other (Subtopic 920-350 ): Improvements to Accounting for Costs of Films and License Agreements for Program Materials (ASU 2019-02) using the prospective approach, which eliminates certain revenue-related constraints on capitalization of inventory costs for episodic television that existed under prior guidance. In addition, the balance sheet classification requirements that existed in prior guidance for film production costs and programming inventory were eliminated. This guidance was effective beginning January 1, 2020, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Recent Accounting Pronouncements Not Yet Adopted In June 2016, the Financial Accounting Standards Board ( FASB) issued Accounting Standard Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. We will adopt the new standard effective January 1, 2020 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In August 2018, the FASB issued Accounting Standard Update No. 2018-13, Changes to Disclosure Requirements for Fair Value Measurements (Topic 820) (ASU 2018-13), which improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard removes, modifies, and adds certain disclosure requirements. We will adopt the new standard effective January 1, 2020 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In December 2019, the FASB issued Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes. This guidance will be effective for us in the first quarter of 2021 on a prospective basis, and early adoption is permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source consists of the following (in millions): Year Ended December 31, 2017 (1) Advertising $ 69,655 $ 55,013 $ 39,942 Other revenue 1,042 Total revenue $ 70,697 $ 55,838 $ 40,653 _________________________ (1) Prior period amounts have not been adjusted under the modified retrospective method of the adoption of Topic 606. Revenue disaggregated by geography, based on the billing address of our customers, consists of the following (in millions): Year Ended December 31, 2017 (1) Revenue: United States and Canada (2) $ 32,206 $ 25,727 $ 19,065 Europe (3) 16,826 13,631 10,126 Asia-Pacific 15,406 11,733 7,921 Rest of World (3) 6,259 4,747 3,541 Total revenue $ 70,697 $ 55,838 $ 40,653 _________________________ (1) Prior period amounts have not been adjusted under the modified retrospective method of the adoption of Topic 606. (2) United States revenue was $ 30.23 billion , $ 24.10 billion , and $ 17.73 billion for the years ended December 31, 2019 , 2018 , and 2017 . (3) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In 2018 and 2017, the calculation of diluted EPS also included the effect of inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 15,569 $ 2,916 $ 18,411 $ 3,701 $ 13,034 $ 2,900 Less: Net income attributable to participating securities ( 1 ) ( 12 ) ( 2 ) Net income attributable to common stockholders $ 15,569 $ 2,916 $ 18,410 $ 3,701 $ 13,022 $ 2,898 Denominator Weighted-average shares outstanding 2,404 2,406 2,375 Less: Shares subject to repurchase ( 2 ) Number of shares used for basic EPS computation 2,404 2,406 2,373 Basic EPS $ 6.48 $ 6.48 $ 7.65 $ 7.65 $ 5.49 $ 5.49 Diluted EPS: Numerator Net income attributable to common stockholders $ 15,569 $ 2,916 $ 18,410 $ 3,701 $ 13,022 $ 2,898 Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 2,916 3,701 2,898 Reallocation of net income to Class B common stock ( 18 ) ( 16 ) ( 13 ) Net income attributable to common stockholders for diluted EPS $ 18,485 $ 2,898 $ 22,112 $ 3,685 $ 15,934 $ 2,885 Denominator Number of shares used for basic EPS computation 2,404 2,406 2,373 Conversion of Class B to Class A common stock Weighted-average effect of dilutive RSUs and employee stock options Shares subject to repurchase Number of shares used for diluted EPS computation 2,876 2,921 2,956 Diluted EPS $ 6.43 $ 6.43 $ 7.57 $ 7.57 $ 5.39 $ 5.39 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 4,735 $ 2,713 Money market funds 12,787 6,792 U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 19,079 10,019 Marketable securities: U.S. government securities 18,679 13,836 U.S. government agency securities 6,712 8,333 Corporate debt securities 10,385 8,926 Total marketable securities 35,776 31,095 Total cash and cash equivalents and marketable securities $ 54,855 $ 41,114 The gross unrealized gains on our marketable securities were $ 205 million and $ 24 million as of December 31, 2019 and 2018 , respectively. The gross unrealized losses on our marketable securities were $ 24 million and $ 357 million as of December 31, 2019 and 2018 , respectively. In addition, gross unrealized losses that had been in a continuous loss position for 12 months or longer were $ 17 million and $ 332 million as of December 31, 2019 and 2018 , respectively. As of December 31, 2019 , we considered the unrealized losses on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 12,803 $ 9,746 Due after one year to five years 22,973 21,349 Total $ 35,776 $ 31,095 Note 5. Fair Value Measurement The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2019 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 12,787 $ 12,787 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 18,679 18,679 U.S. government agency securities 6,712 6,712 Corporate debt securities 10,385 10,385 Total cash equivalents and marketable securities $ 50,120 $ 39,437 $ 10,683 $ Fair Value Measurement at Reporting Date Using Description December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 6,792 $ 6,792 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 13,836 13,836 U.S. government agency securities 8,333 8,333 Corporate debt securities 8,926 8,926 Total cash equivalents and marketable securities $ 38,401 $ 29,105 $ 9,296 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Note 6. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, Land $ 1,097 $ Buildings 11,226 7,401 Leasehold improvements 3,112 1,841 Network equipment 17,004 13,017 Computer software, office equipment and other 1,813 1,187 Finance lease right-of-use assets 1,635 Construction in progress 10,099 7,228 Total 45,986 31,573 Less: Accumulated depreciation ( 10,663 ) ( 6,890 ) Property and equipment, net $ 35,323 $ 24,683 Depreciation expense on property and equipment were $ 5.18 billion , $ 3.68 billion , and $ 2.33 billion for the years ended December 31, 2019 , 2018 , and 2017 , respectively. The majority of the property and equipment depreciation expense was from network equipment depreciation of $ 3.83 billion , $ 2.94 billion , and $ 1.84 billion for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. No interest was capitalized for any period presented. Note 7. Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data center, land, colocations, and equipment. We have also entered into various non-cancelable finance lease agreements for certain network equipment. Our leases have original lease periods expiring between 2020 and 2093 . Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease commencement. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs, lease term and discount rate for the year ended December 31, 2019 are as follows (in millions): Finance lease cost Amortization of right-of-use assets $ Interest Operating lease cost 1,139 Variable lease cost and other, net Total lease cost $ 1,506 Weighted-average remaining lease term Operating leases 13.0 years Finance leases 15.3 years Weighted-average discount rate Operating leases 3.2 % Finance leases 3.1 % Operating lease expense was $ 629 million and $ 363 million for the years ended December 31, 2018 and 2017, respectively, under Topic 840. The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2019 (in millions): Operating Leases Finance Leases $ 1,060 $ 2021 1,244 2022 1,141 2023 1,116 2024 1,039 Thereafter 7,572 Total undiscounted cash flows 13,172 Less: Imputed interest ( 2,848 ) ( 120 ) Present value of lease liabilities $ 10,324 $ Lease liabilities, current $ $ Lease liabilities, non-current 9,524 Present value of lease liabilities $ 10,324 $ As of December 31, 2019 , we have additional operating and finance leases for facilities and network equipment that have not yet commenced with lease obligations of approximately $ 5.04 billion and $ 317 million , respectively. These operating and finance leases will commence between 2020 and 2023 with lease terms of greater than one year to 25 years. The table above does not include lease payments that were not fixed at commencement or lease modification. Supplemental cash flow information related to leases for the year ended December 31, 2019 are as follows (in millions): Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ Operating cash flows from finance leases $ Financing cash flows from finance leases $ Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 5,081 Finance leases $ Note 8. Goodwill and Intangible Assets During the year ended December 31, 2019 , we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2019 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2018 are as follows (in millions): Balance as of December 31, 2017 $ 18,221 Goodwill acquired Effect of currency translation adjustment ( 8 ) Balance as of December 31, 2018 18,301 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2019 $ 18,715 The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2019 December 31, 2018 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 1.8 $ 2,056 $ ( 1,550 ) $ $ 2,056 $ ( 1,260 ) $ Acquired technology 2.6 1,158 ( 986 ) 1,002 ( 871 ) Acquired patents 4.6 ( 625 ) ( 565 ) Trade names 2.0 ( 604 ) ( 517 ) Other 3.3 ( 157 ) ( 147 ) Total intangible assets $ 4,816 $ ( 3,922 ) $ $ 4,654 $ ( 3,360 ) $ 1,294 Amortization expense of intangible assets for the years ended December 31, 2019 , 2018 , and 2017 was $ 562 million , $ 640 million , and $ 692 million , respectively. As of December 31, 2019 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2021 2022 2023 2024 Thereafter Total $ 93 Note 9. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued legal settlements for FTC and BIPA (1) $ 5,550 $ Accrued compensation and benefits 1,704 1,203 Accrued property and equipment 1,082 1,531 Accrued taxes Overdraft in cash pooling entities Other current liabilities 2,498 1,784 Accrued expenses and other current liabilities $ 11,735 $ 5,509 _________________________ (1) Includes accrued legal settlements for U.S. Federal Trade Commission (FTC) of $ 5.0 billion and Illinois Biometric Information Privacy Act (BIPA) of $ 550 million . For further information, see Legal Matters in Note. 11Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 5,651 $ 4,655 Deferred tax liabilities 1,039 Other liabilities 1,055 Other liabilities $ 7,745 $ 6,190 Note 10. Long-term Debt In May 2016, we entered into a $ 2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2019 , no amounts had been drawn down and we were in compliance with the covenants under this facility. Note 11. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other contractual commitments We also have $ 4.54 billion of non-cancelable contractual commitments as of December 31, 2019 , which is primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Legal Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, an amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $ 5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. We have recognized the penalty in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2019. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $ 550 million by us and is subject to approval by the court. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Although we are vigorously defending our regulatory compliance, we believe there is a reasonable possibility that the ultimate potential loss related to the inquiries and investigations by the IDPC could be material in the aggregate. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these other matters, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. However, the outcome of the legal matters described in this section is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 14Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2019 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2019 . Note 12. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2019 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2019 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2019 , there were 2,407 million shares and 445 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2018, $ 9.0 billion remained available and authorized for repurchases under this program. In 2019, we repurchased and subsequently retired 22 million shares of our Class A common stock for $ 4.10 billion . As of December 31, 2019 , $ 4.90 billion remained available and authorized for repurchases. In January 2020, an additional $ 10.0 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our Amended 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our Stock Plans are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. Share-based compensation expense mostly consists of the Company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. As of December 31, 2019 , there were 111 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. The number of shares reserved for issuance under our Amended 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 60 million shares reserved for issuance effective January 1, 2020. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2019 : Number of Shares Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in thousands) (in years) (in millions) Balance as of December 31, 2018 1,137 $ 13.74 Stock options exercised ( 1,137 ) $ 13.74 Balances at December 31, 2019 $ $ There were no options granted, forfeited, or canceled for the year ended December 31, 2019 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2019 , 2018 , and 2017 was $ 185 million , $ 315 million , and $ 359 million , respectively. All of our outstanding options had vested by December 31, 2018 . The total grant date fair value of stock options vested during the years ended December 31, 2018 , and 2017 was not material. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2019 : Number of Shares Weighted-Average Grant Date Fair Value (in thousands) Unvested at December 31, 2018 67,298 $ 144.77 Granted 54,379 $ 173.66 Vested ( 33,501 ) $ 142.04 Forfeited ( 9,325 ) $ 145.86 Unvested at December 31, 2019 78,851 $ 165.74 The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2019 , 2018 , and 2017 was $ 6.01 billion , $ 7.57 billion , and $ 6.76 billion , respectively. As of December 31, 2019 , there was $ 12.21 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 13. Interest and other income, net The following table presents the detail of interest and other income, net, for the years ended December 31, 2019 , 2018 , and 2017 are as follows (in millions): Year Ended December 31, Interest income $ $ $ Interest expense ( 20 ) ( 9 ) ( 6 ) Foreign currency exchange losses, net ( 105 ) ( 213 ) ( 6 ) Other Interest and other income, net $ $ $ 98 Note 14. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, Domestic $ 5,317 $ 8,800 $ 7,079 Foreign 19,495 16,561 13,515 Income before provision for income taxes $ 24,812 $ 25,361 $ 20,594 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 4,321 $ 1,747 $ 4,455 State Foreign 1,481 1,031 Total current tax expense 6,367 2,954 5,034 Deferred: Federal ( 39 ) ( 296 ) State ( 33 ) Foreign ( 20 ) ( 55 ) ( 45 ) Total deferred tax (benefits)/expense ( 40 ) ( 374 ) Provision for income taxes $ 6,327 $ 3,249 $ 4,660 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 21.0 % 21.0 % 35.0 % State income taxes, net of federal benefit 1.8 0.7 0.6 Research tax credits ( 0.8 ) ( 1.0 ) ( 0.9 ) Share-based compensation 4.5 0.3 0.4 Excess tax benefits related to share-based compensation ( 0.7 ) ( 2.6 ) ( 5.8 ) Effect of non-U.S. operations ( 5.8 ) ( 5.9 ) ( 18.6 ) Effect of U.S. tax law change (1) 11.0 Non-deductible FTC settlement accrual 4.5 Other 1.0 0.3 0.9 Effective tax rate 25.5 % 12.8 % 22.6 % _________________________ (1) Due to the 2017 Tax Cuts and Jobs Act, provisional one-time mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 2,051 $ 1,825 Tax credit carryforward 1,333 Share-based compensation Accrued expenses and other liabilities Lease liabilities 1,999 Other Total deferred tax assets 6,465 3,403 Less: valuation allowance ( 1,012 ) ( 600 ) Deferred tax assets, net of valuation allowance 5,453 2,803 Deferred tax liabilities: Depreciation and amortization ( 2,387 ) ( 1,401 ) Right-of-use assets ( 1,910 ) Purchased intangible assets ( 195 ) Total deferred tax liabilities ( 4,297 ) ( 1,596 ) Net deferred tax assets $ 1,156 $ 1,207 The valuation allowance was approximately $ 1.01 billion and $ 600 million as of December 31, 2019 and 2018 , respectively, mostly relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2019 , the U.S. federal and state net operating loss carryforwards were $ 9.06 billion and $ 2.37 billion, which will begin to expire in 2033 and 2027 , respectively, if not utilized. We have federal tax credit carryforwards of $ 357 million, which will begin to expire in 2029 , if not utilized, and state tax credit carryforwards of $ 2.28 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The 2017 Tax Cuts and Jobs Act (Tax Act) imposed a mandatory transition tax on accumulated foreign earnings and generally eliminated U.S. taxes on foreign subsidiary distribution. As a result, accumulated earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits beginning of period $ 4,678 $ 3,870 $ 3,309 Increases related to prior year tax positions 2,309 Decreases related to prior year tax positions ( 525 ) ( 396 ) ( 34 ) Increases related to current year tax positions 1,402 Decreases related to settlements of prior year tax positions ( 1 ) ( 84 ) ( 13 ) Gross unrecognized tax benefits end of period $ 7,863 $ 4,678 $ 3,870 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2019 and 2018 were $ 747 million and $ 340 million , respectively. If the balance of gross unrecognized tax benefits of $ 7.86 billion as of December 31, 2019 were realized in a future period, this would result in a tax benefit of $ 4.71 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $ 1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer has until February 10, 2020 to request a hearing before the Supreme Court of the United States. As a result, the final outcome of the case is uncertain. In November 2019, we made a $ 1.64 billion payment related to this matter and recorded the payment to net against the related tax liability included within other liabilities in our consolidated balance sheets. If the Altera Ninth Circuit Opinion is reversed, we would anticipate recording an income tax benefit at that time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 tax years and by the Ireland tax authorities for our 2012 through 2015 tax years. Our 2017 and subsequent tax years remain open to examination by the IRS. Our 2016 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. The case is scheduled for trial beginning in February 2020. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. As of December 31, 2019 , we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 15. Geographical Information The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets, net (in millions): December 31, Long-lived assets: United States $ 35,858 $ 18,950 Rest of the world (1) 8,925 5,733 Total long-lived assets $ 44,783 $ 24,683 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2019 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2019 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +3,Meta,2018," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram brings people closer to the people and things they love. It is a community for sharing photos, videos, and messages, and enables people to discover interests that they care about. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality (VR) products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in other consumer hardware products and a number of longer-term initiatives, such as connectivity efforts, artificial intelligence (AI), and augmented reality, to develop technologies that we believe will help us better serve our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on the web, mobile devices and online generally. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. Companies that provide regional social networks, many of which have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video increases, and as we deepen our investment in new technologies like AI, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate more than 60 offices around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing To date, our communities have grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are currently, and may in the future be, subject to regulatory orders or consent decrees. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. Employees As of December 31, 2018 , we had 35,587 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, or concerns related to privacy and sharing, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, regulatory authorities, or litigation that adversely affect our products or users; there is decreased engagement with our products, or failure to accept our terms of service, as part of changes that we implemented in connection with the General Data Protection Regulation (GDPR) in Europe, other similar changes that we implemented in the United States and around the world, or other changes we may implement in the future in connection with other regulations, regulatory actions or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of apps; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, or other actions by governments that may affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have recently implemented, and we may continue to implement, changes to our user data practices. Some of these changes will reduce marketers ability to effectively target their ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue could also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of our efforts to promote the Stories format or increased usage of our messaging products; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver or target advertising; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated or otherwise more effective products; adverse government actions or legal developments relating to advertising, including legislative and regulatory developments and developments in litigation; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties, questions about our user data practices, concerns about brand safety, or uncertainty regarding their own legal and compliance obligations; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that we implemented in connection with the GDPR, other similar changes that we implemented in the United States and around the world, or other product changes or controls we may implement in the future, whether in connection with other regulations, regulatory actions or otherwise, that impact our ability to target ads; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. The occurrence of any of these or other factors could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple recently released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on the web, mobile devices and online generally. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. We also compete with companies that provide regional social networks, many of which have strong positions in particular countries. Some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, Facebook products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments of one or more countries in which we operate from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies, and we will incur increased costs in connection with the development and marketing of such products and technologies. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products. We have historically monetized messaging in only a very limited fashion, and we may not be successful in our efforts to generate meaningful revenue from messaging over the long term. If these or other new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have recently implemented, and we may continue to implement, changes to our user data practices. Some of these changes will reduce marketers ability to effectively target their ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. Similarly, we previously announced changes to our News Feed ranking algorithm to help our users have more meaningful interactions, and these changes have had, and we expect will continue to have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we plan to continue to promote the Stories format, which is becoming increasingly popular for sharing content across our products, but our advertising efforts with this format are still under development and we do not currently monetize Stories at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of apps, it is possible that these efforts may from time to time reduce engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, content, advertising, and other issues, including actions or decisions in connection with elections, which may adversely affect our reputation and brands. For example, we previously announced our discovery of certain ads and other content previously displayed on our products that may be relevant to government investigations relating to Russian interference in the 2016 U.S. presidential election. In addition, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit, objectionable, or illegal ends. Maintaining and enhancing our brands may require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches and improper access to or disclosure of our data or user data, or other hacking and phishing attacks on our systems, could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users data or to disrupt our ability to provide service. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss or misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, and the types and volume of personal data on our systems, we believe that we are a particularly attractive target for such breaches and attacks. Our efforts to address undesirable activity on our platform may also increase the risk of retaliatory attacks. Such attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance; government surveillance; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, and we may incur significant costs in protecting against or remediating cyber-attacks. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. Affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper disclosure of data, which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. While we took steps to remediate the attack, including fixing the vulnerability, resetting user access tokens and notifying affected users, we may discover and announce additional developments, which could further erode confidence in our brand. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing investments in safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications that previously accessed information of a large number of users of our services. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, including as a result of our data limitations or the scale of activity on our platform, and we may be notified of such incidents or activity via the media or other third parties. Such incidents and activities may include the use of user data in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading misinformation. The discovery of the foregoing may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such discoveries may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit, objectionable, or illegal ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, beginning in March 2018, we were the subject of intense media coverage involving the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and we have continued to receive negative publicity. Such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our safety, security, and content review efforts; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, which could reduce our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on safety, security, and content review. We will continue to invest in our messaging, video content, and global connectivity efforts, as well as other initiatives that may not have clear paths to monetization. In addition, we will incur increased costs in connection with the development and marketing of our consumer hardware and virtual and augmented reality products and technologies. Any such investments may not be successful, and any such increases in our costs may reduce our operating margin and profitability. In addition, if our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2018, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $717 million and our effective tax rate by approximately three percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to an alternative transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this new framework is subject to an annual review that could result in changes to our obligations and also is subject to challenge by regulators and private parties. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has referred this challenge to the Court of Justice of the European Union for decision. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApps terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated, if we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of breach notifications to our designated European privacy regulator, the Irish Data Protection Commissioner, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The California Consumer Privacy Act, or AB 375, was also recently passed and creates new data privacy rights for users, effective in 2020. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with and may delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection and consumer protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. Beginning in September 2018, we also became subject to Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense or may not be feasible. Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we may be subject to additional class action lawsuits based on employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, the disclosure of our earnings results for the second quarter of 2018, and a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. We believe these lawsuits are without merit and are vigorously defending them. Any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. Although the results of such lawsuits and claims cannot be predicted with certainty, we do not believe that the final outcome of those matters relating to our products that we currently face will have a material adverse effect on our business, financial condition, or results of operations. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, there have been recent legislative proposals in the European Union that could expose online platforms to liability for copyright infringement. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, recently enacted legislation in Germany may result in the imposition of significant fines for failure to comply with certain content removal and disclosure obligations, and other countries are considering or have implemented similar legislation imposing penalties for failure to remove content. If any of these events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, the technology and products we acquired from Oculus were relatively new to Facebook at the time of the acquisition, and we did not have significant experience with, or structure in place to support, such technology and products prior to the acquisition. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed with the necessary reliability and redundancy to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations, and unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Our products and internal systems rely on software that is highly technical, and if it contains undetected errors or vulnerabilities, our business could be adversely affected. Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immense amounts of data. The software on which we rely has contained, and will in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, vulnerabilities, or other design defects within the software on which we rely have in the past, and may in the future, result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in targeting, measurement, or billing errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or all of our services. In addition, any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our user and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our DAUs, MAUs, and average revenue per user (ARPU), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly evaluate these metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as similar IP addresses or user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Our estimates may change as our methodologies evolve, including through the application of new data signals or technologies, which may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2018, we estimate that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2018, we estimate that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we may make product changes or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. Our data limitations may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. Our estimates for revenue by user location and revenue by user device are also affected by these factors. We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. In addition, our DAU and MAU estimates will differ from estimates published by third parties due to differences in methodology. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 35,587 as of December 31, 2018 from 25,105 as of December 31, 2017, and we expect such headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors in order to address various safety, security, and content review initiatives. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant competition from other companies in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located and where the cost of living is high. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our investment in safety and security, we are conducting investigations and audits of a large number of platform applications, and we also recently announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We also intend to launch certain payments functionality on WhatsApp, which may subject us to many of the foregoing risks. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our consumer hardware products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products. We may experience supply shortages or other disruptions in logistics or the supply chain in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We may face inventory risk with respect to our consumer hardware products. We may be exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new consumer hardware product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017, and the issuance of additional regulatory or accounting guidance related to the Tax Act could materially affect our tax obligations and effective tax rate in the period issued. In addition, the Ninth Circuit Court of Appeals is expected to issue a decision in Altera Corp. v. Commissioner regarding the treatment of share-based compensation expense in a cost sharing arrangement, which could have a material effect on our tax obligations and effective tax rate for the quarter in which the decision is issued. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and is expected to continue to issue guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would change various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, the United Kingdom, Spain, Italy, and France have each proposed taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and would likely apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $218.62 through December 31, 2018. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; developments in anticipated or new legislation or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors determined not to have a separate and independent nominating function and chose to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2018 , we owned and leased approximately six million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 89 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately seven million square feet. We also own and lease data centers throughout the United States and in various locations internationally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018, and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2018 , there were 3,780 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $131.09 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018 , there were 41 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2018 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2018 $ $ 3,544 November 1 - 30, 2018 $ $ 3,544 December 1 - 31, 2018 25,708 $ 137.87 25,708 $ 9,000 25,708 25,708 (1) In November 2016, our board of directors authorized a share repurchase program that commenced in January 2017 and does not have an expiration date. We completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock during the second quarter of 2018. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion, and we completed repurchases under this authorization during the fourth quarter of 2018. In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program, all of which remained available for future repurchases as of December 31, 2018. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Standard Poor's 500 Stock Index (SP 500 Index) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2018. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2013 in the Class A common stock of Facebook, Inc., the SP 500 Index and the Nasdaq Composite and data for the SP 500 Index and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2018 using 2017 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2018 Results Our key user metrics and financial results for 2018 are as follows: User growth: Daily active users (DAUs) were 1.52 billion on average for December 2018 , an increase of 9% year-over-year. Monthly active users (MAUs) were 2.32 billion as of December 31, 2018 , an increase of 9% year-over-year. Financial results: Revenue was $55.84 billion , up 37% year-over-year, and ad revenue was $55.01 billion , up 38% year-over-year. Total costs and expenses were $30.93 billion . Income from operations was $24.91 billion . Net income was $22.11 billion with diluted earnings per share of $7.57 . Capital expenditures were $13.92 billion . Effective tax rate was 13% . Cash and cash equivalents, and marketable securities were $41.11 billion as of December 31, 2018 . Headcount was 35,587 as of December 31, 2018 , an increase of 42% year-over-year. In 2018 , we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We continued to invest, based on our roadmap, in: (i) our most developed ecosystems, Facebook and Instagram, (ii) driving growth and building ecosystems around our products that already have significant user bases, such as Messenger and WhatsApp, as well as continuing to grow features like Stories, and (iii) long-term technology initiatives, such as connectivity, artificial intelligence, and augmented and virtual reality, that we believe will further our mission to give people the power to build community and bring the world closer together. We intend to continue to invest based on this roadmap and we anticipate that additional investments in the following areas will continue to drive significant year-over-year expense growth in 2019: (i) expanding our data center capacity, network infrastructure, and office facilities as well as scaling our headcount to support our growth, and (ii) investments in safety and security, marketing, video content, and our long-term technology initiatives. Expense growth exceeded revenue growth in 2018, which we anticipate will continue in 2019. Trends in Our User Metrics The numbers for our key metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 9% to 1.52 billion on average during December 2018 from 1.40 billion during December 2017 . Users in India, Indonesia, and the Philippines represented key sources of growth in DAUs during December 2018 , relative to the same period in 2017. Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2018 , we had 2.32 billion MAUs, an increase of 9% from December 31, 2017 . Users in India, Indonesia, and the Philippines represented key sources of growth in 2018 , relative to the same period in 2017. Trends in Our Monetization by User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. Revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2018 in the United States Canada region was more than ten times higher than in the Asia-Pacific region. Note: Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the location of the customer. For 2018 , worldwide ARPU was $24.96 , an increase of 24% from 2017 . Over this period, ARPU increased by 34% in Europe, 33% in United States Canada, 21% in Rest of World, and 20% in Asia-Pacific . In addition, user growth was more rapid in geographies with relatively lower ARPU, such as Asia-Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and business combinations and valuation of goodwill and other acquired intangible assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount of loss. The outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 9Commitments and Contingencies and Note 12Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Business Combinations and Valuation of Goodwill and Other Acquired Intangible Assets We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2018 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized over their estimated useful lives. We evaluate the recoverability of our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of our finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Payments and other fees. Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Our other fees revenue consists primarily of revenue from the delivery of consumer hardware devices, as well as revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware device inventory sold. Research and development. Research and development expenses consist primarily of share-based compensation, salaries, and benefits for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We expense all of our research and development costs as they are incurred. Marketing and sales. Our marketing and sales expenses consist of salaries, share-based compensation, and benefits for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures, and professional services such as content reviewers. General and administrative. The majority of our general and administrative expenses consist of salaries, benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees. In addition, general and administrative expenses include legal-related costs and professional services. Results of Operations The following tables set forth our consolidated statements of income data: Year Ended December 31, (in millions) Consolidated Statements of Income Data: Revenue $ 55,838 $ 40,653 $ 27,638 Costs and expenses: Cost of revenue 9,355 5,454 3,789 Research and development 10,273 7,754 5,919 Marketing and sales 7,846 4,725 3,772 General and administrative 3,451 2,517 1,731 Total costs and expenses 30,925 20,450 15,211 Income from operations 24,913 20,203 12,427 Interest and other income (expense), net Income before provision for income taxes 25,361 20,594 12,518 Provision for income taxes 3,249 4,660 2,301 Net income $ 22,112 $ 15,934 $ 10,217 Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 3,022 2,820 2,494 Marketing and sales General and administrative Total share-based compensation expense $ 4,152 $ 3,723 $ 3,218 The following tables set forth our consolidated statements of income data (as a percentage of revenue): Year Ended December 31, Consolidated Statements of Income Data: Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % Share-based compensation expense included in costs and expenses (as a percentage of revenue): Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % Revenue Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (in millions) Advertising $ 55,013 $ 39,942 $ 26,885 % % Payments and other fees % (6 )% Total revenue $ 55,838 $ 40,653 $ 27,638 % % 2018 Compared to 2017 . Revenue in 2018 increased $15.19 billion , or 37% , compared to 2017 . The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2018 , we estimate that mobile advertising revenue represented approximately 92% of total advertising revenue, as compared with approximately 88% in 2017 . The increase in advertising revenue for 2018 was due to increases in the number of ads delivered and the average price per ad. In 2018 compared to 2017 , the number of ads delivered increased by 22%, as compared with approximately 15% in 2017 , and the average price per ad increased by 13%, as compared with approximately 29% in 2017 . The increase in the ads delivered was driven by an increase in users and their engagement, and an increase in the number and frequency of ads displayed across our products. The increase in average price per ad was driven by an increase in demand for our ad inventory. Factors contributing to the increase in demand for our ad inventory include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. We anticipate that future advertising revenue growth will be driven by a combination of price and the number of ads displayed. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 23%, 26%, and 27% between the third and fourth quarters of 2018 , 2017 , and 2016 , respectively, while advertising revenue for both the first quarters of 2018 and 2017 declined 8% and 9% compared to the fourth quarters of 2017 and 2016 , respectively. 2017 Compared to 2016 . Revenue in 2017 increased $13.02 billion, or 47%, compared to 2016. The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2017, we estimate that mobile advertising revenue represented approximately 88% of total advertising revenue, as compared with approximately 83% in 2016. Factors that influenced our advertising revenue growth in 2017 included (i) an increase in average price per ad, (ii) an increase in users and their engagement, and (iii) an increase in the number and frequency of ads displayed on mobile devices. In 2017 compared to 2016, the average price per ad increased by 29%, as compared with approximately 5% in 2016, and the number of ads delivered increased by 15%, as compared with approximately 50% in 2016. The increase in average price per ad was driven by an increase in demand for our ad inventory; factors contributing to this include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. The increase in the ads delivered was driven by an increase in users and their engagement and an increase in the number and frequency of ads displayed on News Feed, partially offset by increasing user engagement with video content and other product changes. No customer represented 10% or more of total revenue during the years ended December 31, 2018 , 2017 , and 2016 . Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2018 compared to the same period in 2017 , and in the full year 2017 compared to the same period in 2016, had a favorable impact on our revenue. If we had translated revenue for the full year 2018 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $55.44 billion and $54.61 billion , respectively. If we had translated revenue for the full year 2017 using 2016 monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $40.36 billion and $39.65 billion, respectively. Using these constant rates, both total revenue and advertising revenue would have been $401 million lower than actual revenue and advertising revenue for the full year 2018 , and $293 million and $292 million lower than actual revenue and advertising revenue, respectively, for the full year 2017. Cost of revenue Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Cost of revenue $ 9,355 $ 5,454 $ 3,789 % % Percentage of revenue % % % 2018 Compared to 2017 . Cost of revenue in 2018 increased $3.90 billion , or 72% , compared to 2017 . The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure and higher costs associated with partnership agreements, including traffic acquisition and content acquisition costs. 2017 Compared to 2016 . Cost of revenue in 2017 increased $1.67 billion, or 44%, compared to 2016. The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with partnership agreements, including content acquisition costs, and ads payment processing. In 2019 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with ads payment processing and various partnership agreements. Research and development Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Research and development $ 10,273 $ 7,754 $ 5,919 % % Percentage of revenue % % % 2018 Compared to 2017 . Research and development expenses in 2018 increased $2.52 billion , or 32% , compared to 2017 . The majority of the increase was due to an increase in payroll and benefits expense as a result of a 43% growth in employee headcount from December 31, 2017 to December 31, 2018 in engineering and other technical functions, and, to a lesser extent, an increase in professional service expenses. Payroll and benefits expense growth was less than headcount growth partially due to a $473 million decrease in share-based compensation related to the acquisitions completed in 2014. 2017 Compared to 2016 . Research and development expenses in 2017 increased $1.84 billion, or 31%, compared to 2016. The majority of the increase was due to an increase in payroll and benefits as a result of a 49% growth in employee headcount from December 31, 2016 to December 31, 2017 in engineering and other technical functions, partially offset by a $262 million decrease in share-based compensation related to the acquisitions completed in 2014. In 2019 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. We expect payroll and related expenses growth to be more consistent with headcount growth as share-based compensation related to the acquisitions completed in 2014 are now substantially recognized. Marketing and sales Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Marketing and sales $ 7,846 $ 4,725 $ 3,772 % % Percentage of revenue % % % 2018 Compared to 2017 . Marketing and sales expenses in 2018 increased $3.12 billion , or 66% , compared to 2017 . The increase was mostly driven by marketing, community operations, and payroll and benefits expenses. Our payroll and benefits expenses increased as a result of a 33% increase in employee headcount from December 31, 2017 to December 31, 2018 in our marketing and sales functions. 2017 Compared to 2016 . Marketing and sales expenses in 2017 increased $953 million, or 25%, compared to 2016. The majority of the increase was due to increases in payroll and benefits expenses as a result of a 35% increase in employee headcount from December 31, 2016 to December 31, 2017 in our marketing and sales functions, and increases in our consulting and other professional service fees. In 2019 , we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in community operations to support our security efforts. General and administrative Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) General and administrative $ 3,451 $ 2,517 $ 1,731 % % Percentage of revenue % % % 2018 Compared to 2017 . General and administrative expenses in 2018 increased $934 million , or 37% , compared to 2017 . The increase was primarily due to increases in payroll and benefits expenses as a result of a 32% increase in employee headcount from December 31, 2017 to December 31, 2018 in general and administrative functions. 2017 Compared to 2016 . General and administrative expenses in 2017 increased $786 million, or 45%, compared to 2016. The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 58% increase in employee headcount from December 31, 2016 to December 31, 2017 in general and administrative functions, and to a lesser extent, higher legal-related costs. In 2019 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income (expense), net Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (in millions) Interest income, net $ $ $ 66% 136% Other income (expense), net (204 ) (1 ) (75 ) NM 99% Interest and other income (expense), net $ $ $ 15% NM 2018 Compared to 2017 . Interest and other income, net in 2018 increased $57 million compared to 2017 . The increase in 2018 was due to an increase in interest income driven by higher interest rates, partially offset by an increase in other expense as a result of foreign exchange impact occurring from the periodic re-measurement of our foreign currency balances. 2017 Compared to 2016 . Interest and other income, net in 2017 increased $300 million compared to 2016. The majority of the increase in 2017 was due to an increase in interest income driven by higher invested cash balances and interest rates. In addition, foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities also contributed to the increase in 2017. Provision for income taxes Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Provision for income taxes $ 3,249 $ 4,660 $ 2,301 (30 )% % Effective tax rate % % % 2018 Compared to 2017 . Our provision for income taxes in 2018 decreased $1.41 billion , or 30% , compared to 2017 , primarily due to a one-time expense of approximately $2.27 billion in 2017 resulting from the Tax Act, partially offset by an increase in income before provision for income taxes. Our effective tax rate in 2018 decreased compared to 2017, primarily due to a one-time tax expense of approximately $2.27 billion related to the Tax Act in 2017. 2017 Compared to 2016 . Our provision for income taxes in 2017 increased $2.36 billion , or 103% , compared to 2016 , mostly due to the effects of the Tax Act that was enacted on December 22, 2017 and an increase in income before provision for income taxes, partially offset by an increase in excess tax benefits recognized from share-based compensation. As a result of the Tax Act, we recognized a one-time mandatory transition tax on accumulated foreign subsidiary earnings, remeasured our U.S. deferred tax assets and liabilities, and reassessed the net realizability of our deferred tax assets and liabilities, which increased our provision for income taxes in 2017 by $2.27 billion. Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of changes in tax law. The proportion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. The accounting for share-based compensation will increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 28, 2019 price, we expect our effective tax rate for 2019 will be a few percentage points higher than our 2018 rate. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion in Altera Corp v. Commissioner (Tax Court Opinion), which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Opinion was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On July 24, 2018, the Ninth Circuit issued an opinion (Ninth Circuit Opinion) that reversed the Tax Court Opinion. The Ninth Circuit Opinion was subsequently withdrawn and the case is being reheard. Since the Ninth Circuit Opinion was withdrawn, we continue to treat our share-based compensation expense in accordance with the Tax Court Opinion. We also continue to monitor developments in this case and any impact the final opinion could have on our consolidated financial statements. Had the Ninth Circuit not withdrawn its opinion, our effective tax rate for 2018 would have been higher. Unrecognized Tax Benefits. As of December 31, 2018, we had net unrecognized tax benefits of $3.07 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below, the current status of tax audits in various jurisdictions, and excluding the effects of the Altera Corp v. Commissioner case that we are monitoring, we do not anticipate a significant impact to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices. In addition, if the IRS prevails in its positions, related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. As of December 31, 2018, we have not resolved these matters, and proceedings continue in Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2018 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (in millions, except per share amounts) Consolidated Statements of Income Data: Revenue: Advertising $ 16,640 $ 13,539 $ 13,038 $ 11,795 $ 12,779 $ 10,142 $ 9,164 $ 7,857 Payments and other fees Total revenue 16,914 13,727 13,231 11,966 12,972 10,328 9,321 8,032 Costs and expenses: Cost of revenue 2,796 2,418 2,214 1,927 1,611 1,448 1,237 1,159 Research and development 2,855 2,657 2,523 2,238 1,949 2,052 1,919 1,834 Marketing and sales 2,467 1,928 1,855 1,595 1,374 1,170 1,124 1,057 General and administrative Total costs and expenses 9,094 7,946 7,368 6,517 5,620 5,206 4,920 4,705 Income from operations 7,820 5,781 5,863 5,449 7,352 5,122 4,401 3,327 Interest and other income (expense), net Income before provision for income taxes 7,971 5,912 5,868 5,610 7,462 5,236 4,488 3,408 Provision for income taxes 1,089 3,194 Net income $ 6,882 $ 5,137 $ 5,106 $ 4,988 $ 4,268 $ 4,707 $ 3,894 $ 3,064 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 6,882 $ 5,137 $ 5,106 $ 4,987 $ 4,266 $ 4,704 $ 3,890 $ 3,059 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 2.40 $ 1.78 $ 1.76 $ 1.72 $ 1.47 $ 1.62 $ 1.34 $ 1.06 Diluted $ 2.38 $ 1.76 $ 1.74 $ 1.69 $ 1.44 $ 1.59 $ 1.32 $ 1.04 Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ $ 1,040 $ 1,186 $ $ $ 1,010 $ 1,032 $ Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (as a percentage of total revenue) Consolidated Statements of Income Data: Revenue: Advertising % % % % % % % % Payments and other fees Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (as a percentage of total revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 29,274 $ 24,216 $ 16,108 Net cash used in investing activities $ (11,603 ) $ (20,118 ) $ (11,792 ) Net cash used in financing activities $ (15,572 ) $ (5,235 ) $ (310 ) Purchases of property and equipment, net $ (13,915 ) $ (6,733 ) $ (4,491 ) Depreciation and amortization $ 4,315 $ 3,025 $ 2,342 Share-based compensation $ 4,152 $ 3,723 $ 3,218 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents, and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents, and marketable securities were $41.11 billion as of December 31, 2018 , a decrease of $597 million from December 31, 2017 , mostly due to $13.92 billion for purchases of property and equipment, $12.88 billion for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by $29.27 billion of cash generated from operations and a $500 million increase in overdraft in cash pooling entities. Cash paid for income taxes was $3.76 billion for the year ended December 31, 2018 . As of December 31, 2018 , our federal net operating loss carryforward was $7.88 billion , and we anticipate that none of this amount will be utilized to offset our federal taxable income in 2018. As of December 31, 2018 , we had $290 million of federal tax credit carryforward, of which none will be available to offset our federal tax liabilities in 2018. In addition, we are monitoring the Altera Corp. v. Commissioner case as it applies to our facts and circumstances as it could increase our cash paid for income taxes. In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2018 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. Our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date. During the second quarter of 2018, we completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion , and we completed repurchases under this authorization during the fourth quarter of 2018. In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program. During the year ended December 31, 2018 , we repurchased and subsequently retired 79 million shares of our Class A common stock for $12.93 billion . As of December 31, 2018 , $9.0 billion remained available and authorized for repurchases. In 2018, we paid $3.21 billion of taxes related to the net share settlement of equity awards. In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. See Note 9Commitments and Contingencies of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K for additional information regarding our notional cash pooling arrangement. As of December 31, 2018 , $16.28 billion of the $41.11 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2018 mostly consisted of net income, adjusted for certain non-cash items, such as total depreciation and amortization of $4.32 billion and share-based compensation expense of $4.15 billion . The increase in cash flow from operating activities during 2018 compared to 2017 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization, deferred income tax and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a higher tax liability in 2017, which partially offset the increase in cash flow from operating activities in 2018. Cash flow from operating activities during 2017 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.72 billion and total depreciation and amortization of $3.03 billion. The increase in cash flow from operating activities during 2017 compared to 2016 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings, which also contributed to the increase in 2017 compared to 2016. Cash flow from operating activities during 2016 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.22 billion and total depreciation and amortization of $2.34 billion. The increase in cash flow from operating activities during 2016 compared to 2015, was mostly due to an increase in net income, including the impact of ASU 2016-09 adoption, as adjusted for depreciation and amortization, deferred income taxes, and share-based compensation expense. Cash Used in Investing Activities Cash used in investing activities during 2018 mostly resulted from $13.92 billion of capital expenditures as we continued to invest in data centers, servers, network infrastructure, and office buildings, offset by $2.47 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2018 compared to 2017 was mostly due to a decrease in the net purchases of marketable securities, partially offset by an increase in capital expenditures. Cash used in investing activities during 2017 mostly resulted from $13.25 billion for net purchases of marketable securities and $6.73 billion for capital expenditures as we continued to invest in servers, data centers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2017 compared to 2016 was due to increases in net purchases of marketable securities and capital expenditures. Cash used in investing activities during 2016 mostly resulted from $7.19 billion for net purchases of marketable securities and $4.49 billion for capital expenditures as we continued to invest in data centers, servers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2016 compared to 2015 was mostly due to increases in capital expenditures and net purchases of marketable securities. We anticipate making capital expenditures in 2019 of approximately $18 billion to $20 billion. Cash Used in Financing Activities Cash used in financing activities during 2018 consisted of $12.88 billion paid for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by a $500 million overdraft in cash pooling entities. The increase in cash used in financing activities during 2018 compared to 2017 was mostly due to an increase in repurchases of our Class A common stock, partially offset by an increase in overdraft balances in cash pooling entities. Cash used in financing activities during 2017 mostly consisted of $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion paid for repurchases of our Class A common stock. The increase in cash used in financing activities during 2017 compared to 2016 was mostly due to taxes paid related to net share settlement of equity awards and repurchases of our Class A common stock that commenced in 2017. Cash used in financing activities during 2016 mostly consisted of principal payments on capital lease and other financing obligations. The increase in cash used in financing activities was due to full repayment of our capital lease and other financing obligations in 2016. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2018 . Contractual Obligations Our principal commitments consist of obligations under operating leases, which include among others, certain of our offices, data centers, land, and colocation leases, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2018 (in millions): Payment Due by Period Total 2020-2021 2022-2023 Thereafter Operating lease obligations $ 14,651 $ $ 2,001 $ 2,102 $ 9,850 Transition tax payable 1,587 1,263 Other contractual commitments (1) 6,173 3,377 1,135 1,423 Total contractual obligations $ 22,411 $ 4,075 $ 3,136 $ 2,664 $ 12,536 (1) Other contractual commitments primarily relate to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $6.0 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities include $3.07 billion related to net uncertain tax positions as of December 31, 2018 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 9Commitments and Contingencies and Note 12Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We will adopt the new standard effective January 1, 2019 on a modified retrospective basis and will not restate comparative periods. We will elect the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification, our assessment on whether a contract is or contains a lease, and our initial direct costs for any leases that exist prior to adoption of the new standard. We will also elect to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. We estimate approximately $6 billion would be recognized as total right-of-use assets and total lease liabilities on our consolidated balance sheet as of January 1, 2019. Other than disclosed, we do not expect the new standard to have a material impact on our remaining consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $213 million , $6 million , and $76 million in 2018 , 2017 , and 2016 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $468 million and $611 million in the market value of our available-for-sale debt securities as of December 31, 2018 and December 31, 2017 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2007. San Francisco, California January 31, 2019 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Francisco, California January 31, 2019 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 10,019 $ 8,079 Marketable securities 31,095 33,632 Accounts receivable, net of allowances of $229 and $189 as of December 31, 2018 and 2017, respectively 7,587 5,832 Prepaid expenses and other current assets 1,779 1,020 Total current assets 50,480 48,563 Property and equipment, net 24,683 13,721 Intangible assets, net 1,294 1,884 Goodwill 18,301 18,221 Other assets 2,576 2,135 Total assets $ 97,334 $ 84,524 Liabilities and stockholders' equity Current liabilities: Accounts payable $ $ Partners payable Accrued expenses and other current liabilities 5,509 2,892 Deferred revenue and deposits Total current liabilities 7,017 3,760 Other liabilities 6,190 6,417 Total liabilities 13,207 10,177 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,385 million and 2,397 million shares issued and outstanding, as of December 31, 2018 and December 31, 2017, respectively; 4,141 million Class B shares authorized, 469 million and 509 million shares issued and outstanding, as of December 31, 2018 and December 31, 2017, respectively. Additional paid-in capital 42,906 40,584 Accumulated other comprehensive loss (760 ) (227 ) Retained earnings 41,981 33,990 Total stockholders' equity 84,127 74,347 Total liabilities and stockholders' equity $ 97,334 $ 84,524 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 55,838 $ 40,653 $ 27,638 Costs and expenses: Cost of revenue 9,355 5,454 3,789 Research and development 10,273 7,754 5,919 Marketing and sales 7,846 4,725 3,772 General and administrative 3,451 2,517 1,731 Total costs and expenses 30,925 20,450 15,211 Income from operations 24,913 20,203 12,427 Interest and other income (expense), net Income before provision for income taxes 25,361 20,594 12,518 Provision for income taxes 3,249 4,660 2,301 Net income $ 22,112 $ 15,934 $ 10,217 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 22,111 $ 15,920 $ 10,188 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 7.65 $ 5.49 $ 3.56 Diluted $ 7.57 $ 5.39 $ 3.49 Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,890 2,901 2,863 Diluted 2,921 2,956 2,925 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 3,022 2,820 2,494 Marketing and sales General and administrative Total share-based compensation expense $ 4,152 $ 3,723 $ 3,218 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 22,112 $ 15,934 $ 10,217 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax (450 ) (152 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax (52 ) (90 ) (96 ) Comprehensive income $ 21,610 $ 16,410 $ 9,969 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2015 2,845 $ $ 34,886 $ (455 ) $ 9,787 $ 44,218 Impact of the adoption of new accounting pronouncement 1,666 1,705 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (6 ) (6 ) Share-based compensation, related to employee share-based awards 3,218 3,218 Other comprehensive loss (248 ) (248 ) Net income 10,217 10,217 Balances at December 31, 2016 2,892 38,227 (703 ) 21,670 59,194 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (21 ) (1,702 ) (1,544 ) (3,246 ) Share-based compensation, related to employee share-based awards 3,723 3,723 Share repurchases (13 ) (2,070 ) (2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 40,584 (227 ) 33,990 74,347 Impact of the adoption of new accounting pronouncements (31 ) Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (19 ) (1,845 ) (1,363 ) (3,208 ) Share-based compensation, related to employee share-based awards 4,152 4,152 Share repurchases (79 ) (12,930 ) (12,930 ) Other comprehensive loss (502 ) (502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 $ $ 42,906 $ (760 ) $ 41,981 $ 84,127 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 22,112 $ 15,934 $ 10,217 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,315 3,025 2,342 Share-based compensation 4,152 3,723 3,218 Deferred income taxes (377 ) (457 ) Other (64 ) Changes in assets and liabilities: Accounts receivable (1,892 ) (1,609 ) (1,489 ) Prepaid expenses and other current assets (690 ) (192 ) (159 ) Other assets (159 ) Accounts payable Partners payable Accrued expenses and other current liabilities 1,417 1,014 Deferred revenue and deposits Other liabilities (634 ) 3,083 1,262 Net cash provided by operating activities 29,274 24,216 16,108 Cash flows from investing activities Purchases of property and equipment, net (13,915 ) (6,733 ) (4,491 ) Purchases of marketable securities (14,656 ) (25,682 ) (22,341 ) Sales of marketable securities 12,358 9,444 13,894 Maturities of marketable securities 4,772 2,988 1,261 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets (137 ) (122 ) (123 ) Other investing activities, net (25 ) (13 ) Net cash used in investing activities (11,603 ) (20,118 ) (11,792 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards (3,208 ) (3,246 ) (6 ) Principal payments on capital lease and other financing obligations (312 ) Repurchases of Class A common stock (12,879 ) (1,976 ) Net change in overdraft in cash pooling entities Other financing activities, net (13 ) Net cash used in financing activities (15,572 ) (5,235 ) (310 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash (179 ) (63 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 1,920 (905 ) 3,943 Cash, cash equivalents, and restricted cash at beginning of the period 8,204 9,109 5,166 Cash, cash equivalents, and restricted cash at end of the period $ 10,124 $ 8,204 $ 9,109 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 10,019 $ 8,079 $ 8,903 Restricted cash, included in prepaid expenses and other current assets Restricted cash, included in other assets Total cash, cash equivalents, and restricted cash $ 10,124 $ 8,204 $ 9,109 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid during the period for: Interest $ $ $ Income taxes, net $ 3,762 $ 2,117 $ 1,210 Non-cash investing and financing activities: Net change in prepaids and liabilities related to property and equipment additions $ $ $ Settlement of acquisition-related contingent consideration liability $ $ $ Change in unsettled repurchases of Class A common stock $ $ $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to income taxes, loss contingencies, fair value of acquired intangible assets and goodwill, collectability of accounts receivable, fair value of financial instruments, leases, useful lives of intangible assets and property and equipment, and revenue recognition. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition On January 1, 2018, we adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) , which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) Topic 605, Revenue Recognition (Topic 605) , using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting under Topic 605. The impact of adopting the new revenue standard was not material to our condensed consolidated financial statements and there was no adjustment to beginning retained earnings on January 1, 2018. Under Topic 606, revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition through the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usage-based taxes where it has been determined that we are acting as a pass-through agent. Revenue disaggregated by revenue source for the years ended December 31, 2018, 2017 and 2016 consists of the following (in millions): Year Ended December 31, 2017 (1) 2016 (1) Advertising $ 55,013 $ 39,942 $ 26,885 Payments and other fees Total revenue $ 55,838 $ 40,653 $ 27,638 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. Revenue disaggregated by geography, based on the billing address of our customer, consists of the following (in millions): Year Ended December 31, 2017 (1) 2016 (1) Revenue: US Canada (2) $ 25,727 $ 19,065 $ 13,432 Europe (3) 13,631 10,126 6,792 Asia-Pacific 11,733 7,921 5,037 Rest of World (3) 4,747 3,541 2,377 Total revenue $ 55,838 $ 40,653 $ 27,638 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. (2) United States revenue was $24.10 billion , $17.73 billion , and $12.58 billion for the years ended December 31, 2018 , 2017 , and 2016 . (3) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. We may accept a lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We believe that there will not be significant changes to our estimates of variable consideration. Payments and Other Fees Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Other fees revenue consists primarily of revenue from the delivery of consumer hardware devices, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue consists of billings and payments from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, approximately 70% of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2018 was driven by prepayments from marketers, partially offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ 65 Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware device inventory sold. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for viewing. The amounts capitalized are limited to estimated net realizable value or fair value on a per title basis. The portion available for viewing within one year is recognized as prepaid expenses and other current assets and the remaining portion as other assets on the consolidated balance sheets. For original content, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable. Capitalized original content costs are included in other assets on the consolidated balance sheets. Capitalized costs are amortized in cost of revenue on the consolidated statements of income based on historical and estimated viewing patterns. Capitalized content costs are reviewed when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than amortized cost. If such changes are identified, capitalized content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. Capitalized content acquisition costs have not been material to date. Income Taxes We record provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial position, results of operations, and cash flows. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. See Note 12 in these notes to the consolidated financial statements for additional information. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $1.10 billion , $324 million , and $310 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents primarily consist of cash on deposit with banks and investments in money market funds with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses are charged against interest and other income (expense), net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income (expense), net. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. We classify these overdraft balances within accrued expenses and other current liabilities on the accompanying consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of money market funds and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing market observable inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under capital leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 25 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Leased equipment and leasehold improvements Lesser of estimated useful life or remaining lease term Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We enter into lease arrangements for office space, land, facilities, data centers, and equipment under non-cancelable capital and operating leases. Certain of the operating lease agreements contain rent holidays, rent escalation provisions, and purchase options. Rent holidays and rent escalation provisions are considered in determining the straight-line rent expense to be recorded over the lease term. The lease term begins on the date of initial possession of the leased property for purposes of recognizing lease expense on a straight-line basis over the term of the lease. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease inception. We record assets and liabilities for the estimated construction costs incurred by third parties under build-to-suit lease arrangements to the extent that we are involved in the construction of structural improvements or bear construction risk prior to commencement of a lease. As of December 31, 2018, we completed our build-to-suit lease arrangements and properly derecognized the associated assets on our consolidated balance sheet. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-Lived Assets, Including Goodwill and Other Acquired Intangible Assets We evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2018 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive (loss) income as a component of stockholders' equity. As of December 31, 2018 and 2017 , we had a cumulative translation loss, net of tax of $466 million and $16 million , respectively. Net losses resulting from foreign exchange transactions were $213 million , $6 million , and $76 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. These losses were recorded as interest and other income (expense), net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of short-term money market funds, which are managed by reputable financial institutions. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy limits investment instruments to U.S. government securities, U.S. government agency securities, and corporate debt securities with the main objective of preserving capital and maintaining liquidity. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 43% , 44% , and 46% of our revenue for the years ended December 31, 2018 , 2017 , and 2016 , respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, and Brazil. We perform ongoing credit evaluations of our customers, and generally do not require collateral. We maintain an allowance for estimated credit losses. During the years ended December 31, 2018 , 2017 , and 2016 , our bad debt expenses were $77 million , $48 million , and $66 million , respectively. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2018 , 2017 , and 2016 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Topic 606, which supersedes the revenue recognition requirements in Topic 605. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. See Revenue Recognition above for further details. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes ( Topic 740 ): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date, which was not material to our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows ( Topic 230 ): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statements of cash flows. We adopted the new standard effective January 1, 2018, using the retrospective transition approach. The reclassified restricted cash balances from investing activities to changes in cash, cash equivalents and restricted cash on the consolidated statements of cash flows were not material for all periods presented. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805) : Clarifying the Definition of a Business (ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We adopted the new standard effective January 1, 2018 on a prospective basis. The new standard did not have a material impact on our consolidated financial statements. In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income StatementReporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which allows companies to reclassify stranded tax effects resulting from the Tax Act, from accumulated other comprehensive income to retained earnings. The new standard is effective for us beginning January 1, 2019, with early adoption permitted. We elected to early adopt the new standard at the beginning of the third quarter of 2018 using the aggregate portfolio approach. The amount of stranded tax effects that were reclassified from accumulated other comprehensive loss to retained earnings was not material. Recent Accounting Pronouncements Not Yet Adopted In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We will adopt the new standard effective January 1, 2019 on a modified retrospective basis and will not restate comparative periods. We will elect the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification, our assessment on whether a contract is or contains a lease, and our initial direct costs for any leases that exist prior to adoption of the new standard. We will also elect to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. We estimate approximately $6 billion would be recognized as total right-of-use assets and total lease liabilities on our consolidated balance sheet as of January 1, 2019. Other than disclosed, we do not expect the new standard to have a material impact on our remaining consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. Note 2. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, such as awards under our equity compensation plans and inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 18,411 $ 3,701 $ 13,034 $ 2,900 $ 8,270 $ 1,947 Less: Net income attributable to participating securities Net income attributable to common stockholders $ 18,410 $ 3,701 $ 13,022 $ 2,898 $ 8,246 $ 1,942 Denominator Weighted average shares outstanding 2,406 2,375 2,323 Less: Shares subject to repurchase Number of shares used for basic EPS computation 2,406 2,373 2,317 Basic EPS $ 7.65 $ 7.65 $ 5.49 $ 5.49 $ 3.56 $ 3.56 Diluted EPS: Numerator Net income attributable to common stockholders $ 18,410 $ 3,701 $ 13,022 $ 2,898 $ 8,246 $ 1,942 Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 3,701 2,898 1,942 Reallocation of net income to Class B common stock (16 ) (13 ) Net income attributable to common stockholders for diluted EPS $ 22,112 $ 3,685 $ 15,934 $ 2,885 $ 10,217 $ 1,956 Denominator Number of shares used for basic EPS computation 2,406 2,373 2,317 Conversion of Class B to Class A common stock Weighted average effect of dilutive securities: Employee stock options RSUs Shares subject to repurchase and other Number of shares used for diluted EPS computation 2,921 2,956 2,925 Diluted EPS $ 7.57 $ 7.57 $ 5.39 $ 5.39 $ 3.49 $ 3.49 Note 3. Cash and Cash Equivalents, and Marketable Securities The following table sets forth the cash and cash equivalents, and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 2,713 $ 2,212 Money market funds 6,792 5,268 U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 10,019 8,079 Marketable securities: U.S. government securities 13,836 12,766 U.S. government agency securities 8,333 10,944 Corporate debt securities 8,926 9,922 Total marketable securities 31,095 33,632 Total cash and cash equivalents, and marketable securities $ 41,114 $ 41,711 The gross unrealized losses on our marketable securities were $357 million and $289 million as of December 31, 2018 and 2017 , respectively. The gross unrealized gains for both periods were not significant. In addition, gross unrealized losses that had been in a continuous loss position for 12 months or longer were $332 million and $169 million as of December 31, 2018 and 2017 , respectively. As of December 31, 2018 , we considered the decreases in market value on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 9,746 $ 7,976 Due after one year to five years 21,349 25,656 Total $ 31,095 $ 33,632 Note 4. Fair Value Measurement The following table summarizes, for assets or liabilities measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 6,792 $ 6,792 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 13,836 13,836 U.S. government agency securities 8,333 8,333 Corporate debt securities 8,926 8,926 Total cash equivalents and marketable securities $ 38,401 $ 29,105 $ 9,296 $ Fair Value Measurement at Reporting Date Using Description December 31, 2017 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3 Cash equivalents: Money market funds $ 5,268 $ 5,268 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 12,766 12,766 U.S. government agency securities 10,944 10,944 Corporate debt securities 9,922 9,922 Total cash equivalents and marketable securities $ 39,499 $ 29,069 $ 10,430 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Note 5. Property and Equipment Property and equipment consists of the following (in millions): December 31, Land $ $ Buildings 7,401 4,909 Leasehold improvements 1,841 Network equipment 13,017 7,998 Computer software, office equipment and other 1,187 Construction in progress 7,228 2,992 Total 31,573 18,337 Less: Accumulated depreciation (6,890 ) (4,616 ) Property and equipment, net $ 24,683 $ 13,721 Depreciation expense on property and equipment was $3.68 billion , $2.33 billion , and $1.59 billion during 2018 , 2017 , and 2016 , respectively. Property and equipment as of December 31, 2018 and 2017 includes $1.06 billion and $533 million , respectively, acquired under capital lease agreements, of which a substantial majority, is included in network equipment. Accumulated depreciation of property and equipment acquired under these capital leases was $217 million and $101 million at December 31, 2018 and 2017 , respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. The construction of office buildings as of December 31, 2017 included our build-to-suit lease arrangements which were completed and derecognized during 2018. No interest was capitalized during the years ended December 31, 2018 , 2017 and 2016 . Note 6. Goodwill and Intangible Assets During the year ended December 31, 2018 , we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2018 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed during the year ended December 31, 2018 was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated during this period that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017 are as follows (in millions): Balance as of December 31, 2016 $ 18,122 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2017 $ 18,221 Goodwill acquired Effect of currency translation adjustment (8 ) Balance as of December 31, 2018 $ 18,301 Intangible assets consist of the following (in millions): December 31, 2018 December 31, 2017 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 2.8 $ 2,056 $ (1,260 ) $ $ 2,056 $ (971 ) $ 1,085 Acquired technology 1.2 1,002 (871 ) (711 ) Acquired patents 5.2 (565 ) (499 ) Trade names 1.4 (517 ) (406 ) Other 2.4 (147 ) (133 ) Total intangible assets 2.9 $ 4,654 $ (3,360 ) $ 1,294 $ 4,604 $ (2,720 ) $ 1,884 Amortization expense of intangible assets for the years ended December 31, 2018 , 2017 , and 2016 was $640 million , $692 million , and $751 million , respectively. As of December 31, 2018 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2020 2021 2022 2023 Thereafter Total $ 1,294 Note 7. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued compensation and benefits $ 1,203 $ Accrued property and equipment 1,531 Overdraft in cash pooling entities Accrued taxes Other current liabilities 1,784 1,077 Accrued expenses and other current liabilities $ 5,509 $ 2,892 The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 4,655 $ 5,372 Deferred tax liabilities Other liabilities Other liabilities $ 6,190 $ 6,417 Note 8. Long-term Debt In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2018 , no amounts had been drawn down and we were in compliance with the covenants under this facility. Note 9. Commitments and Contingencies Commitments Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data centers, land, and colocations with original lease periods expiring between 2019 and 2093 . We are committed to pay a portion of the related actual operating expenses under certain of these lease agreements. Certain of these arrangements have free rent periods or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis. The following is a schedule, by years, of the future minimum lease payments required under non-cancelable operating leases as of December 31, 2018 (in millions): Operating Leases $ 2020 2021 1,055 1,048 1,054 Thereafter 9,850 Total minimum lease payments $ 14,651 Operating lease expense was $629 million , $363 million , and $269 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. We fully repaid all our capital lease obligations during 2016. Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other contractual commitments We also have $6.17 billion of non-cancelable contractual commitments as of December 31, 2018 , primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Contingencies Legal Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018, and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. Although we believe that it is reasonably possible that we may incur a substantial loss in some of the cases, actions, or inquiries described above, we are currently unable to estimate the amount of such losses or a range of possible losses. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these matters, we evaluate the developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. We believe that the amount or any estimable range of reasonably possible or probable loss will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 12Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2018 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2018 . Note 10. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2018 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2018 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2018 , there were 2,385 million shares and 469 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date. During the second quarter of 2018, we completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion , and we completed repurchases under this authorization during the fourth quarter of 2018. During the year ended December 31, 2018 , we repurchased and subsequently retired 79 million shares of our Class A common stock for $12.93 billion . In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program. The timing and actual number of shares repurchased under this program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. As of December 31, 2018 , $9.0 billion remained available and authorized for repurchases. Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our Amended 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our Stock Plans are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. As of December 31, 2018 , there were 83 million shares reserved for future issuance under our Amended 2012 Plan. The number of shares reserved for issuance under our Amended 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 unless terminated earlier by our board of directors or a committee thereof, by a number of shares of Class A common stock equal to the lesser of (i) 2.5% of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 60 million shares reserved for issuance effective January 1, 2019. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2018 : Shares Subject to Options Outstanding Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value ( 1) (in thousands) (in years) (in millions) Balance as of December 31, 2017 3,078 $ 10.06 Stock options exercised (1,941 ) $ 7.90 Balances at December 31, 2018 1,137 $ 13.74 1.7 $ Stock options exercisable as of December 31, 2018 1,137 $ 13.74 1.7 $ (1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the official closing price of our Class A common stock of $131.09 , as reported on the Nasdaq Global Select Market on December 31, 2018 . There were no options granted, forfeited, or canceled for the year ended December 31, 2018 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2018 , 2017 , and 2016 was $315 million , $359 million , and $309 million , respectively. The total grant date fair value of stock options vested during the years ended December 31, 2018 , 2017 , and 2016 was not material. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2018 : Unvested RSUs (1) Number of Shares Weighted Average Grant Date Fair Value (in thousands) Unvested at December 31, 2017 81,214 $ 110.49 Granted 38,283 $ 168.38 Vested (43,396 ) $ 106.59 Forfeited (8,803 ) $ 119.25 Unvested at December 31, 2018 67,298 $ 144.77 (1) Unvested shares at December 31, 2017 included an inducement award issued in connection with the WhatsApp acquisition in 2014, which was subject to the terms, restrictions, and conditions of a separate non-plan RSU award agreement. This inducement award was no longer outstanding as of December 31, 2018. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2018 , 2017 , and 2016 was $7.57 billion , $6.76 billion , and $4.92 billion , respectively. As of December 31, 2018 , there was $8.96 billion of unrecognized share-based compensation expense, which was related to RSUs. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 11. Interest and other income (expense), net The following table presents the detail of interest and other income (expense), net, for the periods presented (in millions): Year Ended December 31, Interest income $ $ $ Interest expense (9 ) (6 ) (10 ) Foreign currency exchange losses, net (213 ) (6 ) (76 ) Other Interest and other income (expense), net $ $ $ 80 Note 12. Income Taxes The components of income before provision for income taxes for the years ended December 31, 2018 , 2017 , and 2016 are as follows (in millions): Year Ended December 31, Domestic $ 8,800 $ 7,079 $ 6,368 Foreign 16,561 13,515 6,150 Income before provision for income taxes $ 25,361 $ 20,594 $ 12,518 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 1,747 $ 4,455 $ 2,384 State Foreign 1,031 Total current tax expense 2,954 5,034 2,758 Deferred: Federal (296 ) (414 ) State (33 ) (18 ) Foreign (55 ) (45 ) (25 ) Total deferred tax expense/(benefits) (374 ) (457 ) Provision for income taxes $ 3,249 $ 4,660 $ 2,301 A reconciliation of the U.S. federal statutory income tax rate of 21.0% to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 21.0 % 35.0 % 35.0 % State income taxes, net of federal benefit 0.7 0.6 1.0 Research tax credits (1.0 ) (0.9 ) (0.7 ) Share-based compensation 0.3 0.4 1.0 Excess tax benefits related to share-based compensation (2.6 ) (5.8 ) (7.0 ) Effect of non-U.S. operations (5.9 ) (18.6 ) (12.8 ) Effect of U.S. tax law change (1) 11.0 Other 0.3 0.9 1.9 Effective tax rate 12.8 % 22.6 % 18.4 % (1) Due to the Tax Act which was enacted in December 2017, provisional one-time mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 1,825 $ 1,300 Tax credit carryforward Share-based compensation Accrued expenses and other liabilities Other Total deferred tax assets 3,403 2,706 Less: valuation allowance (600 ) (438 ) Deferred tax assets, net of valuation allowance 2,803 2,268 Deferred tax liabilities: Depreciation and amortization (1,401 ) (622 ) Purchased intangible assets (195 ) (309 ) Deferred taxes on foreign income (88 ) Total deferred tax liabilities (1,596 ) (1,019 ) Net deferred tax assets $ 1,207 $ 1,249 The Tax Act reduces the U.S. statutory corporate tax rate from 35% to 21% for our tax years beginning in 2018, which resulted in the re-measurement of the federal portion of our deferred tax assets as of December 31, 2017 from the 35% to 21% tax rate. The valuation allowance was approximately $600 million and $438 million as of December 31, 2018 and 2017 , respectively, mostly related to state tax credits that we do not believe will ultimately be realized. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. As of December 31, 2018 , the U.S. federal and state net operating loss carryforwards were $7.88 billion and $2.22 billion , which will begin to expire in 2033 and 2032 , respectively, if not utilized. We have federal tax credit carryforwards of $290 million , which will begin to expire in 2033 , if not utilized, and state tax credit carryforwards of $1.91 billion , most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three -year period. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and generally eliminates US taxes on foreign subsidiary distribution. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits-beginning of period $ 3,870 $ 3,309 $ 3,017 Increases related to prior year tax positions Decreases related to prior year tax positions (396 ) (34 ) (36 ) Increases related to current year tax positions Decreases related to settlements of prior year tax positions (84 ) (13 ) (11 ) Gross unrecognized tax benefits-end of period $ 4,678 $ 3,870 $ 3,309 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2018 and 2017 was $340 million and $154 million , respectively. If the balance of gross unrecognized tax benefits of $4.68 billion as of December 31, 2018 were realized in a future period, this would result in a tax benefit of $2.94 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion in Altera Corp. v. Commissioner (Tax Court Opinion), which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Opinion was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On July 24, 2018, the Ninth Circuit issued an opinion (Ninth Circuit Opinion) that reversed the Tax Court Opinion. The Ninth Circuit Opinion was subsequently withdrawn and the case is being reheard. Since the Ninth Circuit Opinion was withdrawn, we continue to treat our share-based compensation expense in accordance with the Tax Court Opinion. We also continue to monitor developments in this case and any impact the final opinion could have on our consolidated financial statements. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 tax years and by the Ireland tax authorities for our 2012 through 2015 tax years. Our 2017 tax year remains open to examination by the IRS. Our 2016 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated, aggregate amount of approximately up to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. As of December 31, 2018, we have not resolved this matter, and proceedings continue in the Tax Court. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 13. Geographical Information The following table sets forth property and equipment, net by geographic area (in millions): December 31, Property and equipment, net: United States $ 18,950 $ 10,406 Rest of the world (1) 5,733 3,315 Total property and equipment, net $ 24,683 $ 13,721 (1) No individual country, other than disclosed above, exceeded 10% of our total property and equipment, net for any period presented. For information regarding revenue disaggregated by geography, see Note 1Summary of Significant Accounting Policies, Revenue Recognition. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2018 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2018 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2018 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +4,Meta,2017," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, the most important of which is News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram is a community for sharing visual stories through photos, videos, and direct messages. Instagram is also a place for people to stay connected with the interests and communities that they care about. Messenger. Messenger is a messaging application that makes it easy for people to connect with other people, groups and businesses across a variety of platforms and devices. WhatsApp. WhatsApp is a fast, simple, and reliable messaging application that is used by people around the world to connect securely and privately. Oculus. Our Oculus virtual reality technology and content platform power products that allow people to enter a completely immersive and interactive environment to train, learn, play games, consume content, and connect with others. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in a number of longer-term initiatives, such as connectivity efforts, artificial intelligence research, and augmented and virtual reality, to develop technologies that we believe will help us better serve our communities and pursue our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. Companies that develop applications, particularly mobile applications, that provide social or other communications functionality, such as messaging, photo- and video-sharing, and micro-blogging. Companies that provide regional social networks that have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, and the level of engagement from the people who use our products continues to increase, including with video, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Our technology investments included research and development expenses of $7.75 billion , $5.92 billion and $4.82 billion in 2017, 2016 and 2015, respectively. For information about our research and development expenses, see Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of OperationsResearch and development"" of this Annual Report on Form 10-K. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, through traditional advertising agencies, and with an ecosystem of specialized agencies and partners. We currently operate six support offices and more than 40 sales offices around the globe. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing To date, our communities have grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to build our brand, grow our user base, and increase engagement around the world. We leverage the utility of our products and our social distribution channels as our most effective marketing tools. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a number of U.S. federal and state and foreign laws and regulations that affect companies conducting business on the Internet. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve user privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. There currently are a number of proposals pending before federal, state, and foreign legislative and regulatory bodies. In addition, the new European General Data Protection Regulation (GDPR) will take effect in May 2018 and will apply to all of our products and services that provide service in Europe. The GDPR will include operational requirements for companies that receive or process personal data of residents of the European Union that are different than those currently in place in the European Union, and will include significant penalties for non- compliance. Similarly, there are a number of legislative proposals in the United States, at both the federal and state level, that could impose new obligations in areas affecting our business, such as liability for copyright infringement by third parties. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are currently, and may in the future be, subject to regulatory orders or consent decrees. Violation of existing or future regulatory orders or consent decrees could subject us to substantial monetary fines and other penalties that could negatively affect our financial condition and results of operations. Various laws and regulations in the United States and abroad, such as the U.S. Bank Secrecy Act, the Dodd-Frank Act, the USA PATRIOT Act, and the Credit CARD Act, impose certain anti-money laundering requirements on companies that are financial institutions or that provide financial products and services. Under these laws and regulations, financial institutions are broadly defined to include money services businesses such as money transmitters, check cashers, and sellers or issuers of stored value or prepaid access products. Requirements imposed on financial institutions under these laws include customer identification and verification programs, record retention policies and procedures, and transaction reporting. To increase flexibility in how our online payments infrastructure (Payments) may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws relating to money transmission, gift cards and other prepaid access instruments, electronic funds transfers, anti-money laundering, charitable fundraising, counter-terrorist financing, gambling, banking and lending, financial privacy and data security, and import and export restrictions. Employees As of December 31, 2017 , we had 25,105 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. Information about Segment and Geographic Revenue Information about segment and geographic revenue is set forth in Notes 1 and 13 of our Notes to Consolidated Financial Statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Available Information Our website address is www.facebook.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The public may read and copy any materials filed by Facebook with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will continue to decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment about the quality or usefulness of our products or concerns related to privacy and sharing, safety, security, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are adverse changes in our products that are mandated by legislation, regulatory authorities, or litigation; there is decreased engagement or acceptance of product features on our service, or decreased acceptance of our terms of service, as part of changes that may be implemented in connection with the General Data Protection Regulation (GDPR) in Europe; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement, or if initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. For 2017, 2016, and 2015, advertising accounted for 98% , 97% and 95% , respectively, of our revenue. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. In addition, our advertising revenue growth has become increasingly dependent upon increased pricing of our ads. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue could also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our mobile products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver or target advertising on mobile devices; the availability, accuracy, and utility of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices for purchasing ads increase or if competitors offer lower priced or more integrated products; adverse government actions or legal developments relating to advertising, including legislative and regulatory developments and developments in litigation; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that may be implemented in connection with the GDPR or other regulation or regulatory action; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. The occurrence of any of these or other factors could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, and standards that we do not control, such as the Android and iOS operating systems. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers and mobile carriers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. We also compete with companies that develop applications, particularly mobile applications, that provide social or other communications functionality, such as messaging, photo- and video-sharing, and micro-blogging, as well as companies that provide regional social networks that have strong positions in particular countries. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver virtual reality products and services. Some of our current and potential competitors may have significantly greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, Facebook products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, or web browsers; by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult; or by making it more difficult to communicate with our users. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Action by governments to restrict access to Facebook or our other products in their countries could substantially harm our business and financial results. It is possible that governments of one or more countries may seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is also possible that government authorities could take action to restrict our ability to sell advertising. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, in March 2016, we shipped our first virtual reality hardware product, the Oculus Rift. In addition, we have announced plans to develop augmented reality technology and products. We do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies, and we will incur increased costs in connection with the development and marketing of such products and technologies. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products. We have historically monetized messaging in only a very limited fashion, and we may not be successful in our efforts to generate meaningful revenue from messaging over the long term. If these or other new or enhanced products fail to engage users, marketers, or developers, or if we are unsuccessful in our monetization efforts, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, from time to time we may change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. Similarly, we recently announced changes to our News Feed ranking algorithm to help our users have more meaningful social interactions, and we expect that these changes will have the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we have also made, and expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, the Stories format is becoming increasingly popular for sharing content across our products, and we do not currently monetize Stories at the same rate as News Feed. In addition, we plan to continue focusing on growing users and engagement on Instagram, Messenger, and WhatsApp, and we may also introduce other stand-alone applications in the future. These efforts may reduce engagement with the core Facebook application, where we have the most proven means of monetization and which serves as the platform for many of our new user experiences. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, or if events occur that damage our reputation and brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our decisions regarding user privacy, content, advertising, and other issues, which may adversely affect our reputation and brands. For example, we previously announced our discovery of certain ads and other content previously displayed on our products that may be relevant to government investigations relating to Russian interference in the 2016 U.S. presidential election. We also may fail to respond expeditiously to the sharing of objectionable content on our services or objectionable practices by advertisers, or to otherwise address user concerns, which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit, objectionable, or illegal ends. Maintaining and enhancing our brands may require us to make substantial investments and these investments may not be successful. Certain of our past actions have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches and improper access to or disclosure of our data or user data, or other hacking and phishing attacks on our systems, could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users data or to disrupt our ability to provide service. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content or payment information from users, could result in the loss or misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, and the types and volume of personal data on our systems, we believe that we are a particularly attractive target for such breaches and attacks. Such attacks may cause interruptions to the services we provide, degrade the user experience, cause users to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance; government surveillance; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, and we may incur significant costs in protecting against or remediating cyber-attacks. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. Affected users or government authorities could initiate legal or regulatory actions against us in connection with any security breaches or improper disclosure of data, which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit, objectionable, or illegal ends, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to us, has in the past, and could in the future, adversely affect our reputation. Such negative publicity also could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of Oculus products and services or other products we may introduce in the future; the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive; costs and expenses related to the development and delivery of Oculus products and services; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or enforcement by government regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax law, which are recorded in the period enacted and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth and revenue growth rates will decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will generally decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, which could reduce our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees to support our expanding operations. We will continue to invest in our messaging, security, video content, and global connectivity efforts, as well as other initiatives that may not have clear paths to monetization. In addition, we will incur increased costs in connection with the development and marketing of our Oculus products and services. Any such investments may not be successful, and any such increases in our costs may reduce our operating margin and profitability. In addition, if our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2017, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.25 billion and our effective tax rate by six percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to an alternative transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this new framework is subject to an annual review that could result in changes to our obligations and also may be challenged by national regulators or private parties. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as standard Model Contractual Clauses (MCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has agreed to refer this challenge to the Court of Justice of the European Union for decision. We also face multiple inquiries, investigations, and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApps terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated, if we are unable to transfer data between and among countries and regions in which we operate, or if we are prohibited from sharing data among our products and services, it could affect the manner in which we provide our services or adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. There currently are a number of proposals pending before federal, state, and foreign legislative and regulatory bodies. In addition, the new European General Data Protection Regulation (GDPR) will take effect in May 2018 and will apply to all of our products and services that provide service in Europe. The GDPR will include operational requirements for companies that receive or process personal data of residents of the European Union that are different than those currently in place in the European Union. For example, we may be required to implement measures to change our service or limit access to our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We may also be required to obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR will include significant penalties for non-compliance. Similarly, there are a number of legislative proposals in the United States, at both the federal and state level, that could impose new obligations in areas affecting our business, such as liability for copyright infringement by third parties. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with and may delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquires in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. For example, several data protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to assert jurisdiction over Facebook, Inc. and our subsidiaries and to restrict the ways in which we collect and use information, and other data protection authorities may do the same. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense or may not be feasible. Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we may be subject to additional class action lawsuits based on employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. Any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. Although the results of such lawsuits and claims cannot be predicted with certainty, we do not believe that the final outcome of those matters relating to our products that we currently face will have a material adverse effect on our business, financial condition, or results of operations. In addition, we are currently the subject of stockholder class action suits in connection with our initial public offering (IPO). We believe these lawsuits are without merit and are vigorously defending these lawsuits. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, recently enacted legislation in Germany may impose significant fines for failure to comply with certain content removal and disclosure obligations. If any of these events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial. For example, in 2014 we paid approximately $4.6 billion in cash and issued 178 million shares of our Class A common stock in connection with our acquisition of WhatsApp, and we paid approximately $400 million in cash and issued 23 million shares of our Class B common stock in connection with our acquisition of Oculus. We also issued a substantial number of RSUs to help retain the employees of these companies. There is no assurance that we will receive a favorable return on investment for these or other acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, Oculus and WhatsApp are larger and more complex than companies we have historically acquired. In particular, Oculus builds technology and products that are relatively new to Facebook and with which we did not have significant experience or structure in place to support prior to the acquisition. We continue to make substantial investments of resources to support these acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed with the necessary reliability and redundancy to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted. As our user base and engagement continue to grow, and the amount and types of information shared on Facebook and our other products continue to grow and evolve, such as increased engagement with video, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy the needs of our users and advertisers. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations, and unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Our products and internal systems rely on software that is highly technical, and if it contains undetected errors or vulnerabilities, our business could be adversely affected. Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immense amounts of data. The software on which we rely has contained, and will in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only be discovered after the code has been released for external or internal use. Errors, vulnerabilities, or other design defects within the software on which we rely have in the past, and may in the future, result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in targeting, measurement, or billing errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or all of our services. In addition, any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our user and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our DAUs, MAUs, and average revenue per user (ARPU), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly evaluate these metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as similar IP addresses or user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Our estimates may change as our methodologies evolve, including through the application of new data signals or technologies, which may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. As such, our estimation of duplicate or false accounts may not accurately represent the actual number of such accounts. In particular, duplicate accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate accounts may vary significantly from our estimates. In the fourth quarter of 2017, we estimate that duplicate accounts may have represented approximately 10% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as India, Indonesia, and the Philippines, as compared to more developed markets. In the fourth quarter of 2017, we estimate that false accounts may have represented approximately 3-4% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia, Turkey, and Vietnam. From time to time, we may make product changes or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. Our data limitations may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. Our estimates for revenue by user location and revenue by user device are also affected by these factors. We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. In addition, our DAU and MAU estimates will differ from estimates published by third parties due to differences in methodology. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 25,105 as of December 31, 2017 from 17,048 as of December 31, 2016, and we expect such headcount growth to continue for the foreseeable future. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our employee base. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant competition from other companies in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located and where the cost of living is high. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. Additionally, we have a number of current employees whose equity ownership in our company has provided them a substantial amount of personal wealth, which could affect their decisions about whether or not to continue to work for us. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected our relationships with such developers. If we are not successful in our efforts to continue to grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. We currently generate substantially all of our Payments revenue from developers that use Facebook on personal computers, and we expect that our Payments revenue will continue to decline as usage of Facebook on personal computers continues to decline. We currently generate substantially all of our Payments revenue from developers that use Facebook on personal computers. Specifically, applications built by developers of social games are currently responsible for substantially all of our revenue derived from Payments, and the majority of the revenue from these applications has historically been generated by a limited number of the most popular games. We have experienced and expect to see the continued decline in usage of Facebook on personal computers, which we expect will result in a continuing decline in Payments revenue. In addition, only a relatively small percentage of our users have transacted with Facebook Payments. If the Facebook-integrated applications fail to grow or maintain their users and engagement, whether as a result of the continued decline in the usage of Facebook on personal computers or otherwise, if developers do not continue to introduce new applications that attract users and create engagement on Facebook, or if Facebook-integrated applications outside of social games do not gain popularity and generate significant revenue for us, our financial performance could be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally through the web and on mobile, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; and compliance with statutory equity requirements and management of tax consequences. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our Oculus products. For example, the Oculus products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our Oculus products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture our Oculus products. We may experience supply shortages or other supply chain disruptions in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. We also require the suppliers and business partners of our Oculus products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, canceled orders, or damage to our reputation. In addition, the SECs conflict minerals rule requires disclosure by public companies of information relating to the origin, source and chain of custody of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured. We may incur significant costs associated with complying with the rule, such as costs related to the determination of the origin, source and chain of custody of the minerals used in Oculus products, the adoption of conflict minerals-related governance policies, processes and controls, and possible changes to products or sources of supply as a result of such activities. We may face inventory risk with respect to our Oculus products. We may be exposed to inventory risks with respect to our Oculus products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to Oculus products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking products Oculus may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new Oculus product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our income tax obligations are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property and the valuations of our intercompany transactions. We may also be subject to additional indirect or non-income taxes. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. The taxing authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could increase our worldwide effective tax rate and harm our financial position, results of operations, and cash flows. For example, in 2016, the IRS issued us a formal assessment relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year, and although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. We are subject to regular review and audit by U.S. federal and state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken and any adverse outcome of such a review or audit could have a negative effect on our financial position, results of operations, and cash flows. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is also determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Changes in accounting for intercompany transactions may also affect our effective tax rate. For example, with the adoption of Accounting Standards Update No. 2016-16, effective January 1, 2018, the income tax effects of an intercompany transfer will be recognized in the period in which the transfer occurs, rather than amortized over time, which may increase the impact of such transfers on our effective tax rate in a particular period. Although we believe that our provision for income taxes is reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. In addition, our future income tax rates could be adversely affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. For example, we have previously incurred losses in certain international subsidiaries that resulted in an effective tax rate that is significantly higher than the statutory tax rate in the United States and this could continue to happen in the future. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The income and non-income tax regimes we are subject to or operate under are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, changes to U.S. tax laws enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued in 2015, and is expected to continue to issue, guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities could increase our worldwide effective tax rate and harm our financial position, results of operations, and cash flows. Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax rate. The 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted on December 22, 2017, and significantly affected U.S. tax law by changing how the U.S. imposes income tax on multinational corporations. The U.S. Department of Treasury has broad authority to issue regulations and interpretative guidance that may significantly impact how we will apply the law and impact our results of operations in the period issued. The Tax Act requires complex computations not previously provided in U.S. tax law. As such, the application of accounting guidance for such items is currently uncertain. Further, compliance with the Tax Act and the accounting for such provisions require accumulation of information not previously required or regularly produced. As a result, we have provided a provisional estimate on the effect of the Tax Act in our financial statements. As additional regulatory guidance is issued by the applicable taxing authorities, as accounting treatment is clarified, as we perform additional analysis on the application of the law, and as we refine estimates in calculating the effect, our final analysis, which will be recorded in the period completed, may be different from our current provisional amounts, which could materially affect our tax obligations and effective tax rate. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and could diminish our cash reserves. In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion of our Class A common stock that commenced in 2017 and does not have an expiration date. Although our board of directors has authorized this share repurchase program, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program could diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our IPO in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $184.25 through December 31, 2017. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us; developments in anticipated or new legislation and pending lawsuits or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our IPO. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors determined not to have a separate and independent nominating function and chose to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2017 , we owned and leased approximately three million square feet of office buildings for our corporate headquarters, and 130 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately five million square feet. We also own and lease data centers throughout the United States and in various locations internationally. Further, we entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. As such, we have excluded the square footage from the total leased space and owned properties, disclosed above. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on May 22, 2012, multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the United States and in other jurisdictions against us, our directors, and/or certain of our officers alleging violation of securities laws or breach of fiduciary duties in connection with our initial public offering (IPO) and seeking unspecified damages. We believe these lawsuits are without merit, and we intend to continue to vigorously defend them. The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO, were ordered centralized for coordinated or consolidated pre-trial proceedings in the U.S. District Court for the Southern District of New York. In a series of rulings in 2013 and 2014, the court denied our motion to dismiss the consolidated securities class action and granted our motions to dismiss the derivative actions against our directors and certain of our officers. On July 24, 2015, the court of appeals affirmed the dismissal of the derivative actions. On December 11, 2015, the court granted plaintiffs' motion for class certification in the consolidated securities action. On April 14, 2017, we filed a motion for summary judgment. Trial is scheduled to begin on February 26, 2018. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also involved in other legal proceedings, claims, and regulatory, tax or government inquiries and investigations arising from the ordinary course of our business, and we may in the future be subject to additional lawsuits and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. The following table sets forth for the indicated periods the high and low intra-day sales prices per share for our Class A common stock on the Nasdaq Global Select Market. High Low High Low First Quarter $ 142.95 $ 115.51 $ 117.59 $ 89.37 Second Quarter $ 156.50 $ 138.81 $ 121.08 $ 106.31 Third Quarter $ 175.49 $ 147.80 $ 131.98 $ 112.97 Fourth Quarter $ 184.25 $ 168.29 $ 133.50 $ 113.55 Our Class B common stock is not listed nor traded on any stock exchange. Holders of Record As of December 31, 2017 , there were 3,967 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $176.46 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2017 , there were 52 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2017 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands) (in thousands) (in millions) October 1 31, 2017 1,008 $ 172.19 1,008 $ 4,788 November 1 30, 2017 $ $ 4,788 December 1 31, 2017 4,832 $ 177.64 4,832 $ 3,930 5,840 5,840 (1) In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison from May 18, 2012 (the date our Class A common stock commenced trading on the Nasdaq Global Select Market) through December 31, 2017 of the cumulative total return for our Class A common stock, the Standard Poor's 500 Stock Index (SP 500 Index) and the Nasdaq Composite Index (Nasdaq Composite). The graph assumes that $100 was invested at the market close on May 18, 2012 in the Class A common stock of Facebook, Inc., the SP 500 Index and the Nasdaq Composite and data for the SP 500 Index and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2017 using 2016 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2017 Results Our key user metrics and financial results for 2017 are as follows: User growth: Daily active users (DAUs) were 1.40 billion on average for December 2017 , an increase of 14% year-over-year. Monthly active users (MAUs) were 2.13 billion as of December 31, 2017 , an increase of 14% year-over-year. Financial results: Revenue was $40.65 billion , up 47% year-over-year, and ad revenue was $39.94 billion , up 49% year-over-year. Total costs and expenses were $20.45 billion . Income from operations was $20.20 billion . Net income was $15.93 billion with diluted earnings per share of $5.39 . Capital expenditures were $6.73 billion . Effective tax rate was 23% . Cash and cash equivalents, and marketable securities were $41.71 billion as of December 31, 2017 . Headcount was 25,105 as of December 31, 2017 . In 2017 , we continued to focus on our three main revenue growth priorities: (i) helping businesses expand their use of our mobile products, (ii) developing innovative ad products that help businesses get the most of their ad campaigns, and (iii) making our ads more relevant and effective through our targeting capabilities and outcome-based measurement. We continued to invest, based on our roadmap, in: (i) our most developed ecosystem, the Facebook app and platform as well as video, (ii) driving growth and building ecosystems around our products and features that already have significant user bases, such as Instagram, Messenger, and WhatsApp, and (iii) long-term technology initiatives, such as connectivity, artificial intelligence, and augmented and virtual reality, that we believe will further our mission to give people the power to build community and bring the world closer together. We intend to continue to invest based on this roadmap and we anticipate that additional investments in the following areas will drive significant year-over-year expense growth in 2018: (i) increased investments in security, video content, and our long-term technology initiatives, and (ii) scaling our headcount and expanding our data center capacity and office facilities to support our growth. Trends in Our User Metrics The numbers for our key metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 14% to 1.40 billion on average during December 2017 from 1.23 billion during December 2016 . Users in India, Indonesia, and Brazil represented key sources of growth in DAUs during December 2017, relative to the same period in 2016. Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community. As of December 31, 2017 , we had 2.13 billion MAUs, an increase of 14% from December 31, 2016 . Users in India, Indonesia, and Vietnam represented key sources of growth in 2017 , relative to the same period in 2016. Trends in Our Monetization by User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or virtual reality platform devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. Revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2017 in the United States Canada region was more than nine times higher than in the Asia-Pacific region. Note: Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the location of the marketer or developer. For 2017 , worldwide ARPU was $20.21 , an increase of 26% from 2016 . Over this period, ARPU increased by 41% in Europe, 36% in United States Canada, 33% in Rest of World, and 22% in Asia-Pacific. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as Asia-Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and business combinations and valuation of goodwill and other acquired intangible assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, we consider the accounting of the transition tax, deferred tax re-measurements, and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SAB 118. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount of loss. The outcome of litigation is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 9 Commitments and Contingencies and Note 12 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Business Combinations and Valuation of Goodwill and Other Acquired Intangible Assets We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2017 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized over their estimated useful lives. We evaluate the recoverability of our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of our finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the primary obligor, we recognize revenue on a net basis. Payments and other fees. Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Our other fees revenue, which has not been significant in recent periods, consists primarily of revenue from the delivery of virtual reality platform devices, and various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including content acquisition costs, credit card and other transaction fees related to processing customer transactions, cost of virtual reality platform device inventory sold, and amortization of intangible assets. Research and development. Research and development expenses consist primarily of share-based compensation, salaries, and benefits for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We expense all of our research and development costs as they are incurred. Marketing and sales. Our marketing and sales expenses consist of salaries, share-based compensation, and benefits for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures, professional services such as content reviewers, as well as amortization of intangible assets. General and administrative. The majority of our general and administrative expenses consist of salaries, benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees. In addition, general and administrative expenses include legal-related costs and professional services. Results of Operations The following tables set forth our consolidated statements of income data: Year Ended December 31, (in millions) Consolidated Statements of Income Data: Revenue $ 40,653 $ 27,638 $ 17,928 Costs and expenses: Cost of revenue 5,454 3,789 2,867 Research and development 7,754 5,919 4,816 Marketing and sales 4,725 3,772 2,725 General and administrative 2,517 1,731 1,295 Total costs and expenses 20,450 15,211 11,703 Income from operations 20,203 12,427 6,225 Interest and other income (expense), net (31 ) Income before provision for income taxes 20,594 12,518 6,194 Provision for income taxes 4,660 2,301 2,506 Net income $ 15,934 $ 10,217 $ 3,688 Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 2,820 2,494 2,350 Marketing and sales General and administrative Total share-based compensation expense $ 3,723 $ 3,218 $ 2,969 The following tables set forth our consolidated statements of income data (as a percentage of revenue): Year Ended December 31, Consolidated Statements of Income Data: Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % Share-based compensation expense included in costs and expenses (as a percentage of revenue): Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % Revenue Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (in millions) Advertising $ 39,942 $ 26,885 $ 17,079 % % Payments and other fees (6 )% (11 )% Total revenue $ 40,653 $ 27,638 $ 17,928 % % 2017 Compared to 2016 . Revenue in 2017 increased $13.02 billion , or 47% , compared to 2016 . The increase was mostly due to an increase in advertising revenue, partially offset by the continuing decline in Payments revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2017 , we estimate that mobile advertising revenue represented approximately 88% of total advertising revenue, as compared with approximately 83% in 2016 . Factors that influenced our advertising revenue growth in 2017 included (i) an increase in average price per ad, (ii) an increase in users and their engagement, and (iii) an increase in the number and frequency of ads displayed on mobile devices. We anticipate that advertising revenue growth will continue to be driven primarily by price rather than increases in the number and frequency of ads displayed. In 2017 compared to 2016 , the average price per ad increased by 29%, as compared with approximately 5% in 2016, and the number of ads delivered increased by 15%, as compared with approximately 50% in 2016. The increase in average price per ad was driven by an increase in demand for our ad inventory; factors contributing to this include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. The increase in the ads delivered was driven by an increase in users and their engagement and an increase in the number and frequency of ads displayed on News Feed, partially offset by increasing user engagement with video content and other product changes. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 26%, 27%, and 31% between the third and fourth quarters of 2017 , 2016 , and 2015 , respectively, while advertising revenue for both the first quarters of 2017 and 2016 declined 9% and 8% compared to the fourth quarters of 2016 and 2015 , respectively. Payments and other fees revenue in 2017 decreased $42 million , or 6% , compared to 2016 . The decline in Payments and other fees revenue was primarily due to decreased Payments revenue from games played on personal computers, partially offset by the revenue from the delivery of virtual reality platform devices. We anticipate Payments revenue will continue to decline, and such decline will be offset by increases in revenue from various other sources. 2016 Compared to 2015 . Revenue in 2016 increased $9.71 billion, or 54%, compared to 2015. The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads in News Feed. For 2016, we estimate that mobile advertising revenue represented approximately 83% of total advertising revenue, as compared with approximately 77% in 2015. Factors that influenced our advertising revenue growth in 2016 included (i) an increase in demand for our ad inventory, in part driven by an increase in the number of marketers actively advertising on Facebook, (ii) an increase in user growth and engagement, and (iii) an increase in the number and frequency of ads displayed in News Feed, as well as the quality, relevance, and performance of those ads. In 2016 compared to 2015, the average price per ad increased by 5% and the number of ads delivered increased by 50%. The increase in average price per ad was driven by a continued mix shift towards a greater percentage of our ads being shown in News Feed while the increase in the ads delivered was driven by the same factors that influenced our advertising growth. Payments and other fees revenue in 2016 decreased $96 million, or 11%, compared to 2015. The majority of the decrease in Payments and other fees revenue was due to decreased Payments revenue from games played on personal computers. No customer represented 10% or more of total revenue during the years ended December 31, 2017 , 2016 , and 2015 . Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2017 compared to the same period in 2016 had a favorable impact on our revenue. If we had translated revenue for the full year 2017 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $40.36 billion and $39.65 billion , respectively. Using these constant rates, revenue and advertising revenue would have been $293 million and $292 million lower than actual revenue and advertising revenue, respectively, for the full year 2017 . The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2016 compared to the same period in 2015 had an unfavorable impact on our revenue. If we had translated revenue for the full year 2016 using 2015 monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $27.91 billion and $27.15 billion, respectively. Using these constant rates, revenue and advertising revenue would have been $270 million and $269 million higher than actual revenue and advertising revenue, respectively, for the full year 2016. Cost of revenue Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Cost of revenue $ 5,454 $ 3,789 $ 2,867 % % Percentage of revenue % % % 2017 Compared to 2016 . Cost of revenue in 2017 increased $1.67 billion , or 44% , compared to 2016 . The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with partnership agreements, including content acquisition costs, and ads payment processing. 2016 Compared to 2015 . Cost of revenue in 2016 increased $922 million, or 32%, compared to 2015. The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with ads payment processing and various partnership agreements. In 2018 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with ads payment processing and various partnership agreements. Research and development Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Research and development $ 7,754 $ 5,919 $ 4,816 % % Percentage of revenue % % % 2017 Compared to 2016 . Research and development expenses in 2017 increased $1.84 billion , or 31% , compared to 2016 . The majority of the increase was due to an increase in payroll and benefits as a result of a 49% growth in employee headcount from December 31, 2016 to December 31, 2017 in engineering and other technical functions, partially offset by a $262 million decrease in share-based compensation related to the acquisitions completed in 2014. 2016 Compared to 2015 . Research and development expenses in 2016 increased $1.10 billion, or 23%, compared to 2015. The majority of the increase was due to an increase in payroll and benefits as a result of a 34% growth in employee headcount from December 31, 2015 to December 31, 2016 in engineering and other technical functions. Additionally, our equipment and related expenses in 2016 to support our research and development efforts increased $170 million compared to 2015. In 2018 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Marketing and sales $ 4,725 $ 3,772 $ 2,725 % % Percentage of revenue % % % 2017 Compared to 2016 . Marketing and sales expenses in 2017 increased $953 million , or 25% , compared to 2016 . The majority of the increase was due to increases in payroll and benefits expenses as a result of a 35% increase in employee headcount from December 31, 2016 to December 31, 2017 in our marketing and sales functions, and increases in our consulting and other professional service fees. Additionally, our marketing expenses increased $196 million in 2017, compared to 2016. 2016 Compared to 2015 . Marketing and sales expenses in 2016 increased $1.05 billion, or 38%, compared to 2015. The majority of the increase was due to payroll and benefits expenses as a result of a 28% increase in employee headcount from December 31, 2015 to December 31, 2016 in our marketing and sales functions, and increases in our consulting and other professional service fees. Additionally, our marketing expenses increased $344 million in 2016, compared to 2015. In 2018 , we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in security efforts through the hiring of employees and content reviewers. General and administrative Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) General and administrative $ 2,517 $ 1,731 $ 1,295 % % Percentage of revenue % % % 2017 Compared to 2016 . General and administrative expenses in 2017 increased $786 million , or 45% , compared to 2016 . The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 58% increase in employee headcount from December 31, 2016 to December 31, 2017 in general and administrative functions, and to a lesser extent, higher legal-related costs. 2016 Compared to 2015 . General and administrative expenses in 2016 increased $436 million, or 34%, compared to 2015. The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 43% increase in employee headcount from December 31, 2015 to December 31, 2016 in general and administrative functions, and to a lesser extent, higher professional services and legal fees. In 2018 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income (expense), net Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (in millions) Interest income, net $ $ $ 136% NM Other expense, net (1 ) (75 ) (60 ) 99% (25)% Interest and other income (expense), net $ $ $ (31 ) NM NM 2017 Compared to 2016 . Interest and other income, net in 2017 increased $300 million compared to 2016 . The majority of the increase in 2017 was due to an increase in interest income driven by higher invested cash balances and interest rates. In addition, foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities also contributed to the increase in 2017. 2016 Compared to 2015 . Interest and other income (expense), net in 2016 increased $122 million compared to 2015. Interest income, net increased mostly due to increases in interest income driven by higher invested cash balances and interest rates. In addition, the majority of the increase in other expense, net was due to foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities. Provision for income taxes Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Provision for income taxes $ 4,660 $ 2,301 $ 2,506 % (8 )% Effective tax rate % % % 2017 Compared to 2016 . Our provision for income taxes in 2017 increased $2.36 billion , or 103% , compared to 2016 , mostly due to the effects of the Tax Act that was enacted on December 22, 2017 and an increase in income before provision for income taxes, partially offset by an increase in excess tax benefits recognized from share-based compensation. As a result of the Tax Act, we recognized a one-time mandatory transition tax on accumulated foreign subsidiary earnings, remeasured our U.S. deferred tax assets and liabilities, and reassessed the net realizability of our deferred tax assets and liabilities, which increased our provision for income taxes in 2017 by $2.27 billion. Our effective tax rate in 2017 increased compared to 2016, mostly due to the Tax Act and a decrease in the tax rate benefit from share-based compensation compared to 2016. These effects were partially offset by an increase in income before provision for income taxes being earned in jurisdictions with tax rates lower than the U.S. statutory tax rate. In 2017, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.25 billion and our effective tax rate by six percentage points as compared to the tax rate without such benefits. For comparison, in 2016, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $934 million and our effective tax rate by seven percentage points, as compared to the tax rate without such benefits. 2016 Compared to 2015 . Our provision for income taxes in 2016 decreased $205 million , or 8% , compared to 2015 , primarily due to recognition of excess tax benefits from share-based compensation in our provision for income taxes resulting from the adoption of ASU 2016-09, partially offset by an increase in income before provision for income taxes. Our effective tax rate in 2016 decreased compared to 2015 due to more of our income before provision for income taxes being earned in jurisdictions with a tax rate lower than the U.S. statutory rate where we had asserted our intention to indefinitely reinvest certain of those earnings, as well as due to a lower increase in our unrecognized tax benefit in 2016 compared to 2015 and the adoption of ASU 2016-09 in 2016. Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, changes to our provisional accounting for the effects of the Tax Act during the measurement period, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of new legislation. The portion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. The accounting for share-based compensation will increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. Absent unanticipated events and unexpected effects of the Tax Act, we anticipate our effective tax rate in 2018 will be lower than it was in 2017. Our 2017 effective tax rate was significantly affected by the Tax Act. In addition, since we recognize excess tax benefits on a discrete basis, we anticipate that our effective tax rate will vary from quarter to quarter depending on our stock price in each period. If our stock price remains constant to the January 31, 2018 price, we anticipate that our effective tax rate will be lower in the first quarter of 2018 and increase in the remaining quarters throughout the year. Unrecognized Tax Benefits. As of December 31, 2017, we had net unrecognized tax benefits of $2.75 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a significant impact to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated aggregate amount of approximately $3.0 billion to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability of $3.0 billion to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and penalties. If the IRS prevails in the assessment of additional tax due based on its position, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. As of December 31, 2017, we have not resolved this matter and proceedings continue in the United States Tax Court. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. We expect to continue to accrue unrecognized tax benefits for certain recurring tax positions and anticipate that the amount for future quarters accrued will be similar to amounts accrued in 2017. Absent unanticipated events, we do not expect our unrecognized tax benefits will have a significant impact on our effective tax rate in 2018. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2017 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2017 Sep 30, Jun 30, Mar 31, Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (in millions) Consolidated Statements of Income Data: Revenue: Advertising $ 12,779 $ 10,142 $ 9,164 $ 7,857 $ 8,629 $ 6,816 $ 6,239 $ 5,201 Payments and other fees Total revenue 12,972 10,328 9,321 8,032 8,809 7,011 6,436 5,382 Costs and expenses: Cost of revenue 1,611 1,448 1,237 1,159 1,047 Research and development 1,949 2,052 1,919 1,834 1,563 1,542 1,471 1,343 Marketing and sales 1,374 1,170 1,124 1,057 1,118 General and administrative Total costs and expenses 5,620 5,206 4,920 4,705 4,243 3,894 3,702 3,372 Income from operations 7,352 5,122 4,401 3,327 4,566 3,117 2,734 2,010 Interest and other income (expense), net (33 ) Income before provision for income taxes 7,462 5,236 4,488 3,408 4,533 3,164 2,754 2,066 Provision for income taxes 3,194 Net income $ 4,268 $ 4,707 $ 3,894 $ 3,064 $ 3,568 $ 2,627 $ 2,283 $ 1,738 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 4,266 $ 4,704 $ 3,890 $ 3,059 $ 3,561 $ 2,620 $ 2,276 $ 1,732 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 1.47 $ 1.62 $ 1.34 $ 1.06 $ 1.24 $ 0.91 $ 0.80 $ 0.61 Diluted $ 1.44 $ 1.59 $ 1.32 $ 1.04 $ 1.21 $ 0.90 $ 0.78 $ 0.60 Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ $ 1,010 $ 1,032 $ $ $ $ $ 48 Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (as a percentage of total revenue) Consolidated Statements of Income Data: Revenue: Advertising % % % % % % % % Payments and other fees Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (as a percentage of total revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 24,216 $ 16,108 $ 10,320 Net cash used in investing activities (20,038 ) (11,739 ) (9,434 ) Net cash used in financing activities (5,235 ) (310 ) (139 ) Purchases of property and equipment (6,733 ) (4,491 ) (2,523 ) Depreciation and amortization 3,025 2,342 1,945 Share-based compensation 3,723 3,218 2,960 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents, and marketable securities consist primarily of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents, and marketable securities were $41.71 billion as of December 31, 2017 , an increase of $12.26 billion from December 31, 2016 , mostly due to $24.22 billion of cash generated from operations, partially offset by $6.73 billion for purchases of property and equipment, $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion for repurchases of our Class A common stock. Cash paid for income taxes (net of refunds) was $2.12 billion for the year ended December 31, 2017 . We recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings which we intend to pay over an eight-year payment schedule as prescribed by the Tax Act. In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2017 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. In November 2016, our board of directors authorized a $6.0 billion share repurchase program of our Class A common stock that commenced in 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During 2017, we repurchased and subsequently retired approximately 13 million shares of our Class A common stock for an aggregate amount of approximately $2.07 billion . In January 2017, we began funding withholding taxes due on employee equity awards by net share settlement, rather than our previous approach of requiring employees to sell shares of our common stock to cover taxes upon vesting of such awards. In 2017, we paid $3.25 billion of taxes related to the net share settlement of equity awards. As of December 31, 2017 , $15.89 billion of the $41.71 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2017 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.72 billion and total depreciation and amortization of $3.03 billion . The increase in cash flow from operating activities during 2017 compared to 2016 , was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings,which also contributed to the increase in 2017 compared to 2016. Cash flow from operating activities during 2016 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.22 billion and total depreciation and amortization of $2.34 billion. The increase in cash flow from operating activities during 2016 compared to 2015, was mostly due to an increase in net income, including the impact of ASU 2016-09 adoption, as adjusted for depreciation and amortization, deferred income taxes, and share-based compensation expense. Cash flow from operating activities during 2015 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $2.96 billion, total depreciation and amortization of $1.95 billion, and tax benefit from share-based award activity of $1.72 billion , which had been reclassified from financing activity as a result of ASU 2016-09 adoption. The increase in cash flow from operating activities during 2015 compared to 2014, was primarily due to an increase in net income, as adjusted for share-based compensation expense, and higher income tax payable as of December 31, 2015 compared to 2014. Cash Used in Investing Activities Cash used in investing activities during 2017 mostly resulted from $13.25 billion for net purchases of marketable securities and $6.73 billion for capital expenditures as we continued to invest in servers, data centers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2017 compared to 2016 was due to increases in net purchases of marketable securities and capital expenditures. Cash used in investing activities during 2016 mostly resulted from $7.19 billion for net purchases of marketable securities and $4.49 billion for capital expenditures as we continued to invest in data centers, servers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2016 compared to 2015 was mostly due to increases in capital expenditures and net purchases of marketable securities. Cash used in investing activities during 2015 primarily resulted from $6.70 billion for net purchases of marketable securities and $2.52 billion for capital expenditures as we continued to invest in servers, data centers, network infrastructure, and office buildings. The increase in cash used in investing activities during 2015 compared to 2014 was mainly due to increases in net purchases of marketable securities, partially offset by a decrease in acquisitions of businesses and purchases of intangible assets. We anticipate making capital expenditures in 2018 of approximately $14.0 billion to $15.0 billion. Cash Used in Financing Activities Cash used in financing activities during 2017 mostly consisted of $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion paid for repurchases of our Class A common stock. The increase in cash used in financing activities during 2017 compared to 2016 was mostly due to taxes paid related to net share settlement of equity awards and repurchases of our Class A common stock that commenced in 2017 . Cash used in financing activities during 2016 mostly consisted of principal payments on capital lease and other financing obligations. The increase in cash used in financing activities was due to full repayment of our capital lease and other financing obligations in 2016. Cash used in financing activities during 2015 primarily consisted of principal payments on capital lease obligations. The decrease in cash used in financing activities was primarily due to lower principal payments related to our capital lease transactions. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2017 . Contractual Obligations Our principal commitments consist of obligations under operating leases for offices, land, facilities, colocations, and data centers, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2017 (in millions): Payment Due by Period Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Operating lease obligations $ 4,644 $ $ $ $ 2,423 Financing obligation - building in progress - leased facility (1) Other contractual commitments (2) 2,953 1,830 Total contractual obligations $ 7,792 $ 2,239 $ 1,296 $ 1,008 $ 3,249 (1) Financing obligation - building in progress - leased facility represents our commitments to lease certain office buildings that are currently under construction. As of December 31, 2017 , $72 million of the total obligation was recorded as a liability and is included in other liabilities on our consolidated balance sheets. See Note 9 of the accompanying notes to our consolidated financial statements for additional information related to this financing obligation. (2) Other contractual commitments primarily relate to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.0 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities include $2.75 billion related to uncertain tax positions as of December 31, 2017 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 9 Commitments and Contingencies and Note 12 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date , which delays the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08) which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition method. We finalized our analysis and the adoption of this guidance will not have a material impact on our consolidated financial statements and our internal controls over financial reporting. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for us in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. We will adopt the new standard effective January 1, 2019. We have selected a lease accounting system and we are in the process of implementing such system as well as evaluating the use of the optional practical expedients. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, we expect our operating leases, as disclosed in Note 9 Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K, will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date. A cumulative-effect adjustment will capture the write-off of income tax consequences deferred from past intra-entity transfers involving assets other than inventory, new deferred tax assets, and other liabilities for amounts not currently recognized under U.S. GAAP. Based on transactions up to December 31, 2017, we do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We will adopt the new standard effective January 1, 2018, using the retrospective transition approach for all periods presented. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ( ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We will adopt the new standard effective January 1, 2018, on a prospective basis and do not expect the standard to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $6 million , $76 million , and $66 million in 2017 , 2016 , and 2015 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $611 million and $403 million in the market value of our available-for-sale debt securities as of December 31, 2017 and December 31, 2016 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2017 and 2016 , and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 1, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2007. San Francisco, California February 1, 2018 Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Facebook, Inc. as of December 31, 2017 and 2016 , and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017 of the Company and our report dated February 1, 2018 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Francisco, California February 1, 2018 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 8,079 $ 8,903 Marketable securities 33,632 20,546 Accounts receivable, net of allowances of $189 and $94 as of December 31, 2017 and 2016, respectively 5,832 3,993 Prepaid expenses and other current assets 1,020 Total current assets 48,563 34,401 Property and equipment, net 13,721 8,591 Intangible assets, net 1,884 2,535 Goodwill 18,221 18,122 Other assets 2,135 1,312 Total assets $ 84,524 $ 64,961 Liabilities and stockholders' equity Current liabilities: Accounts payable $ $ Partners payable Accrued expenses and other current liabilities 2,892 2,203 Deferred revenue and deposits Total current liabilities 3,760 2,875 Other liabilities 6,417 2,892 Total liabilities 10,177 5,767 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,397 million and 2,354 million shares issued and outstanding, as of December 31, 2017 and December 31, 2016, respectively; 4,141 million Class B shares authorized, 509 million and 538 million shares issued and outstanding, as of December 31, 2017 and December 31, 2016, respectively. Additional paid-in capital 40,584 38,227 Accumulated other comprehensive loss (227 ) (703 ) Retained earnings 33,990 21,670 Total stockholders' equity 74,347 59,194 Total liabilities and stockholders' equity $ 84,524 $ 64,961 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 40,653 $ 27,638 $ 17,928 Costs and expenses: Cost of revenue 5,454 3,789 2,867 Research and development 7,754 5,919 4,816 Marketing and sales 4,725 3,772 2,725 General and administrative 2,517 1,731 1,295 Total costs and expenses 20,450 15,211 11,703 Income from operations 20,203 12,427 6,225 Interest and other income (expense), net (31 ) Income before provision for income taxes 20,594 12,518 6,194 Provision for income taxes 4,660 2,301 2,506 Net income $ 15,934 $ 10,217 $ 3,688 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 15,920 $ 10,188 $ 3,669 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 5.49 $ 3.56 $ 1.31 Diluted $ 5.39 $ 3.49 $ 1.29 Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,901 2,863 2,803 Diluted 2,956 2,925 2,853 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 2,820 2,494 2,350 Marketing and sales General and administrative Total share-based compensation expense $ 3,723 $ 3,218 $ 2,969 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 15,934 $ 10,217 $ 3,688 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax (152 ) (202 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax (90 ) (96 ) (25 ) Comprehensive income $ 16,410 $ 9,969 $ 3,461 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2014 2,797 $ $ 30,225 $ (228 ) $ 6,099 $ 36,096 Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (20 ) (20 ) Share-based compensation, related to employee share-based awards 2,960 2,960 Tax benefit from share-based award activity 1,721 1,721 Other comprehensive loss (227 ) (227 ) Net income 3,688 3,688 Balances at December 31, 2015 2,845 34,886 (455 ) 9,787 44,218 Cumulative-effect adjustment from adoption of ASU 2016-09 1,666 1,705 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (6 ) (6 ) Share-based compensation, related to employee share-based awards 3,218 3,218 Other comprehensive loss (248 ) (248 ) Net income 10,217 10,217 Balances at December 31, 2016 2,892 38,227 (703 ) 21,670 59,194 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (21 ) (1,702 ) (1,544 ) (3,246 ) Share-based compensation, related to employee share-based awards 3,723 3,723 Share repurchases (13 ) (2,070 ) (2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 $ $ 40,584 $ (227 ) $ 33,990 $ 74,347 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 15,934 $ 10,217 $ 3,688 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,025 2,342 1,945 Share-based compensation 3,723 3,218 2,960 Deferred income taxes (377 ) (457 ) (795 ) Tax benefit from share-based award activity 1,721 Other Changes in assets and liabilities: Accounts receivable (1,609 ) (1,489 ) (973 ) Prepaid expenses and other current assets (192 ) (159 ) (144 ) Other assets (3 ) Accounts payable Partners payable Accrued expenses and other current liabilities 1,014 Deferred revenue and deposits (9 ) Other liabilities 3,083 1,262 1,365 Net cash provided by operating activities 24,216 16,108 10,320 Cash flows from investing activities Purchases of property and equipment (6,733 ) (4,491 ) (2,523 ) Purchases of marketable securities (25,682 ) (22,341 ) (15,938 ) Sales of marketable securities 9,444 13,894 6,928 Maturities of marketable securities 2,988 1,261 2,310 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets (122 ) (123 ) (313 ) Change in restricted cash and deposits Net cash used in investing activities (20,038 ) (11,739 ) (9,434 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards (3,246 ) (6 ) (20 ) Principal payments on capital lease and other financing obligations (312 ) (119 ) Repurchases of Class A common stock (1,976 ) Other financing activities, net (13 ) Net cash used in financing activities (5,235 ) (310 ) (139 ) Effect of exchange rate changes on cash and cash equivalents (63 ) (155 ) Net (decrease) increase in cash and cash equivalents (824 ) 3,996 Cash and cash equivalents at beginning of period 8,903 4,907 4,315 Cash and cash equivalents at end of period $ 8,079 $ 8,903 $ 4,907 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid during the period for: Interest $ $ $ Income taxes, net $ 2,117 $ 1,210 $ Non-cash investing and financing activities: Net change in accounts payable, accrued expenses and other current liabilities, and other liabilities related to property and equipment additions $ $ $ Promissory note payable issued in connection with an acquisition $ $ $ Settlement of acquisition-related contingent consideration liability $ $ $ Change in unsettled repurchases of Class A common stock $ $ $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, collectability of accounts receivable, commitments and contingencies, fair value of financial instruments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, leases, and income taxes. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition We recognize revenue once all of the following criteria have been met: persuasive evidence of an arrangement exists; delivery of our obligations to our customer has occurred; the price is fixed or determinable; and collectability of the related receivable is reasonably assured. Revenue for the years ended December 31, 2017 , 2016 , and 2015 consists of the following (in millions): Year Ended December 31, Advertising $ 39,942 $ 26,885 $ 17,079 Payments and other fees Total revenue $ 40,653 $ 27,638 $ 17,928 Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. The arrangements are evidenced by either online acceptance of terms and conditions or contracts that stipulate the types of advertising to be delivered, the timing and the pricing. Marketers pay for ad products either directly or through their relationships with advertising agencies, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the primary obligor, we recognize revenue on a net basis. Payments and Other Fees Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Other fees revenue, which was not material for all periods presented in our financial statements, consists primarily of revenue from the delivery of virtual reality platform devices and various other sources. Revenue is recognized net of applicable sales and other taxes. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including content acquisition costs, credit card and other transaction fees related to processing customer transactions, cost of virtual reality platform device inventory sold, and amortization of intangible assets. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for viewing. The amounts capitalized are limited to estimated net realizable value or fair value on a per title basis. The portion available for viewing within one year is recognized as prepaid expenses and other current assets and the remaining portion as other assets on the consolidated balance sheets. For original programming, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable. Capitalized original programming costs are included in other assets on the consolidated balance sheets. Capitalized costs are amortized in cost of revenue on the consolidated statements of income based on historical and estimated viewing patterns. Capitalized content costs are reviewed when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than amortized cost. If such changes are identified, capitalized content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. Capitalized content acquisition costs have not been material to date. Income Taxes We record provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial position, results of operations, and cash flows. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation is expected over the next 12 months, we consider the accounting of the transition tax, deferred tax re-measurements, and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SAB 118. See Note 12 in these notes to the consolidated financial statements for additional information. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $324 million , $310 million , and $281 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Cash and Cash Equivalents, and Marketable Securities Cash and cash equivalents primarily consist of cash on deposit with banks and investments in money market funds with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive (loss) income in stockholders' equity. Unrealized losses are charged against interest and other income (expense), net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income (expense), net. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of money market funds and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing market observable inputs. Our valuation technique used to measure the fair value of our contingent consideration liability as of December 31, 2016 was derived from the fair value of our common stock on such date. We settled this contingent consideration liability in July 2017. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under capital leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Leased equipment and leasehold improvements Lesser of estimated useful life or remaining lease term Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We enter into lease arrangements for office space, land, facilities, data centers, and equipment under non-cancelable capital and operating leases. Certain of the operating lease agreements contain rent holidays, rent escalation provisions, and purchase options. Rent holidays and rent escalation provisions are considered in determining the straight-line rent expense to be recorded over the lease term. The lease term begins on the date of initial possession of the leased property for purposes of recognizing lease expense on a straight-line basis over the term of the lease. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease inception. We record assets and liabilities for the estimated construction costs incurred by third parties under build-to-suit lease arrangements to the extent that we are involved in the construction of structural improvements or bear construction risk prior to commencement of a lease. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-Lived Assets, Including Goodwill and Other Acquired Intangible Assets We evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2017 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Deferred Revenue and Deposits Deferred revenue consists of billings and payments from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users. Once this balance is utilized by a user, approximately 70% of this amount would then be payable to the developer and the balance would be recognized as revenue. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ Foreign Currency Generally the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive (loss) income as a component of stockholders' equity. As of December 31, 2017 and 2016 , we had a cumulative translation loss, net of tax of $16 million and $582 million , respectively. Net losses resulting from foreign exchange transactions were $6 million , $76 million , and $66 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. These losses were recorded as interest and other income (expense), net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of short-term money market funds, which are managed by reputable financial institutions. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy limits investment instruments to U.S. government securities, U.S. government agency securities, and corporate debt securities with the main objective of preserving capital and maintaining liquidity. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 44% , 46% , and 47% of our revenue for the years ended December 31, 2017 , 2016 , and 2015 , respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, and Brazil. We perform ongoing credit evaluations of our customers, and generally do not require collateral. We maintain an allowance for estimated credit losses. During the years ended December 31, 2017 , 2016 , and 2015 , our bad debt expenses were $48 million , $66 million , and $44 million , respectively. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2017 , 2016 , and 2015 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date , which delays the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08) which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition method. We finalized our analysis and the adoption of this guidance will not have a material impact on our consolidated financial statements and our internal controls over financial reporting. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for us in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. We will adopt the new standard effective January 1, 2019. We have selected a lease accounting system and we are in the process of implementing such system as well as evaluating the use of the optional practical expedients. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, we expect our operating leases, as disclosed in Note 9 Commitments and Contingencies, will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date. A cumulative-effect adjustment will capture the write-off of income tax consequences deferred from past intra-entity transfers involving assets other than inventory, new deferred tax assets, and other liabilities for amounts not currently recognized under U.S. GAAP. Based on transactions up to December 31, 2017, we do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We will adopt the new standard effective January 1, 2018, using the retrospective transition approach for all periods presented. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ( ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We will adopt the new standard effective January 1, 2018, on a prospective basis and do not expect the standard to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. Note 2. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, such as awards under our equity compensation plans and inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 13,034 $ 2,900 $ 8,270 $ 1,947 $ 2,959 $ Less: Net income attributable to participating securities Net income attributable to common stockholders $ 13,022 $ 2,898 $ 8,246 $ 1,942 $ 2,944 $ Denominator Weighted average shares outstanding 2,375 2,323 2,259 Less: Shares subject to repurchase Number of shares used for basic EPS computation 2,373 2,317 2,249 Basic EPS $ 5.49 $ 5.49 $ 3.56 $ 3.56 $ 1.31 $ 1.31 Diluted EPS: Numerator Net income attributable to common stockholders $ 13,022 $ 2,898 $ 8,246 $ 1,942 $ 2,944 $ Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 2,898 1,942 Reallocation of net income to Class B common stock (13 ) Net income attributable to common stockholders for diluted EPS $ 15,934 $ 2,885 $ 10,217 $ 1,956 $ 3,688 $ Denominator Number of shares used for basic EPS computation 2,373 2,317 2,249 Conversion of Class B to Class A common stock Weighted average effect of dilutive securities: Employee stock options RSUs Shares subject to repurchase and other Number of shares used for diluted EPS computation 2,956 2,925 2,853 Diluted EPS $ 5.39 $ 5.39 $ 3.49 $ 3.49 $ 1.29 $ 1.29 Note 3. Cash and Cash Equivalents, and Marketable Securities The following table sets forth the cash and cash equivalents, and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 2,212 $ 1,364 Money market funds 5,268 5,409 U.S. government securities 1,463 U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 8,079 8,903 Marketable securities: U.S. government securities 12,766 7,130 U.S. government agency securities 10,944 7,411 Corporate debt securities 9,922 6,005 Total marketable securities 33,632 20,546 Total cash and cash equivalents, and marketable securities $ 41,711 $ 29,449 The gross unrealized gains or losses on our marketable securities as of December 31, 2017 and 2016 were not significant. In addition, the gross unrealized loss that had been in a continuous loss position for 12 months or longer was not significant as of December 31, 2017 and 2016 . As of December 31, 2017 , we considered the decreases in market value on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 7,976 $ 4,966 Due in one to five years 25,656 15,580 Total $ 33,632 $ 20,546 Note 4. Fair Value Measurement The following table summarizes, for assets or liabilities measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2017 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 5,268 $ 5,268 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 12,766 12,766 U.S. government agency securities 10,944 10,944 Corporate debt securities 9,922 9,922 Total cash equivalents and marketable securities $ 39,499 $ 29,069 $ 10,430 $ Fair Value Measurement at Reporting Date Using Description December 31, 2016 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3 Cash equivalents: Money market funds $ 5,409 $ 5,409 $ $ U.S. government securities 1,463 1,463 U.S. government agency securities Marketable securities: U.S. government securities 7,130 7,130 U.S. government agency securities 7,411 7,411 Corporate debt securities 6,005 6,005 Total cash equivalents and marketable securities $ 28,085 $ 22,080 $ 6,005 $ Accrued expenses and other current liabilities: Contingent consideration liability $ $ $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. In July 2017, we settled our Level 2 contingent consideration liability that was outstanding as of December 31, 2016. Note 5. Property and Equipment Property and equipment consists of the following (in millions): December 31, Land $ $ Buildings 4,909 3,109 Leasehold improvements Network equipment 7,998 5,179 Computer software, office equipment and other Construction in progress 2,992 1,890 Total 18,337 11,803 Less: Accumulated depreciation (4,616 ) (3,212 ) Property and equipment, net $ 13,721 $ 8,591 Depreciation expense on property and equipment was $2.33 billion , $1.59 billion , and $1.22 billion during 2017 , 2016 , and 2015 , respectively. Property and equipment as of December 31, 2017 and 2016 includes $533 million and $283 million , respectively, acquired under capital lease agreements, of which a substantial majority, is included in network equipment. Accumulated depreciation of property and equipment acquired under these capital leases was $101 million and $30 million at December 31, 2017 and 2016 , respectively. Construction in progress includes costs mostly related to construction of data centers, office buildings, and network equipment infrastructure to support our data centers around the world. The construction of office buildings includes leased office spaces for which we are considered to be the owner for accounting purposes. See Note 9 in these notes to the consolidated financial statements for additional information. No interest was capitalized during the years ended December 31, 2017 , 2016 and 2015 . Note 6. Goodwill and Intangible Assets During the year ended December 31, 2017 , we completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2017 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed during the year ended December 31, 2017 was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated during this period that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2016 are as follows (in millions): Balance as of December 31, 2015 $ 18,026 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2016 $ 18,122 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2017 $ 18,221 Intangible assets consist of the following (in millions): December 31, 2017 December 31, 2016 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 3.8 $ 2,056 $ (971 ) $ 1,085 $ 2,056 $ (678 ) $ 1,378 Acquired technology 1.8 (711 ) (518 ) Acquired patents 5.7 (499 ) (420 ) Trade names 2.2 (406 ) (293 ) Other 2.7 (133 ) (119 ) Total intangible assets 3.6 $ 4,604 $ (2,720 ) $ 1,884 $ 4,563 $ (2,028 ) $ 2,535 Amortization expense of intangible assets for the years ended December 31, 2017 , 2016 , and 2015 was $692 million , $751 million , and $730 million , respectively. As of December 31, 2017 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2019 2020 2021 2022 Thereafter Total $ 1,884 Note 7. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued compensation and benefits $ $ Accrued property and equipment Accrued taxes payable Contingent consideration liability Other current liabilities 1,201 Accrued expenses and other current liabilities $ 2,892 $ 2,203 The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 5,372 $ 2,431 Other liabilities 1,045 Other liabilities $ 6,417 $ 2,892 Note 8. Long-term Debt In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2017 , no amounts had been drawn down and we were in compliance with the covenants under the facility. Note 9. Commitments and Contingencies Commitments Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, land, facilities, colocations, and data centers with original lease periods expiring between 2018 and 2038 . We are committed to pay a portion of the related actual operating expenses under certain of these lease agreements. Certain of these arrangements have free rent periods or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis. The following is a schedule, by years, of the future minimum lease payments required under non-cancelable operating leases as of December 31, 2017 (in millions): Operating Leases Financing obligation, building in progress - leased facilities (1) $ $ 464 2020 2021 2022 Thereafter 2,423 Total minimum lease payments $ 4,644 $ (1) We entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. Financing obligation, building in progress - leased facilities represent the total expected financing and lease obligations associated with these leases and will be settled through monthly lease payments to the landlords when we occupy the office spaces upon completion. This amount includes $72 million that is included in property and equipment, net and other liabilities on our consolidated balance sheets as of December 31, 2017 . Operating lease expense was $363 million , $269 million , and $196 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. We fully repaid all our capital lease obligations during 2016. Other contractual commitments We also have $2.95 billion of non-cancelable contractual commitments as of December 31, 2017 , primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Contingencies Legal Matters Beginning on May 22, 2012, multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the United States and in other jurisdictions against us, our directors, and/or certain of our officers alleging violation of securities laws or breach of fiduciary duties in connection with our initial public offering (IPO) and seeking unspecified damages. We believe these lawsuits are without merit, and we intend to continue to vigorously defend them. The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO, were ordered centralized for coordinated or consolidated pre-trial proceedings in the U.S. District Court for the Southern District of New York. In a series of rulings in 2013 and 2014, the court denied our motion to dismiss the consolidated securities class action and granted our motions to dismiss the derivative actions against our directors and certain of our officers. On July 24, 2015, the court of appeals affirmed the dismissal of the derivative actions. On December 11, 2015, the court granted plaintiffs' motion for class certification in the consolidated securities action. On April 14, 2017, we filed a motion for summary judgment. Trial is scheduled to begin on February 26, 2018. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. Although we believe that it is reasonably possible that we may incur a loss in some of these cases, we are currently unable to estimate the amount of such losses. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these matters, we evaluate the developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. We believe that the amount or any estimable range of reasonably possible or probable loss will not, either individually or in the aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 12 Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial position, results of operations or cash flows. In our opinion, as of December 31, 2017 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2017 . Note 10. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2017 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2017 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2017 , there were 2,397 million shares and 509 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Abandonment of the Reclassification In September 2017, our board of directors decided to abandon the proposal to create a new class of non-voting capital stock (Class C capital stock) and the intention to issue a dividend of two shares of Class C capital stock for each outstanding share of Class A and Class B common stock (the Reclassification). As a result, we will not proceed with the filing of our amended and restated certificate of incorporation which was approved by our stockholders on June 20, 2016. Share Repurchase Program In November 2016, our board of directors authorized a $6.0 billion share repurchase program of our Class A common stock, which commenced in 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2017 , we repurchased and subsequently retired approximately 13 million shares of our Class A common stock for an aggregate amount of approximately $2.07 billion . Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in June 2016 (2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. We initially reserved 25 million shares of our Class A common stock for issuance under our 2012 Plan. The number of shares reserved for issuance under our 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the 2012 Plan, which will continue through and including April 2026 unless terminated earlier by our board of directors or a committee thereof, by a number of shares of Class A common stock equal to the lesser of (i) 2.5% of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors elected not to increase the number of shares reserved for issuance in 2017 and 2016, and approved an increase of 42 million shares reserved for issuance effective as of January 1, 2018. In addition, shares available for grant under the 2005 Stock Plan, which were reserved but not issued, forfeited or repurchased at their original issue price, or subject to outstanding awards under the 2005 Stock Plan as of the effective date of our IPO, were added to the reserves of the 2012 Plan and shares that are withheld in connection with the net settlement of RSUs are also added to the reserves of the 2012 Plan. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2017 : Shares Subject to Options Outstanding Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value ( 1) (in thousands) (in years) (in millions) Balance as of December 31, 2016 5,687 $ 7.78 Stock options exercised (2,609 ) 5.10 Balance as of December 31, 2017 3,078 $ 10.06 2.4 $ Stock options exercisable as of December 31, 2017 2,765 $ 9.50 2.3 $ (1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the official closing price of our Class A common stock of $176.46 , as reported on the Nasdaq Global Select Market on December 31, 2017 . There were no options granted, forfeited, or canceled for the year ended December 31, 2017 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2017 , 2016 , and 2015 was $359 million , $309 million , and $403 million , respectively. The total grant date fair value of stock options vested during the years ended December 31, 2017 , 2016 , and 2015 was not material. The following table summarizes additional information regarding outstanding and exercisable options under the Stock Plans at December 31, 2017 : Options Outstanding Options Exercisable Exercise Price Number of Shares Weighted Average Remaining Contractual Term Weighted Average Exercise Price Number of Shares Weighted Average Exercise Price (in thousands) (in years) (in thousands) $1.85 1.0 $ 1.85 $ 1.85 $2.95 1.6 2.95 2.95 $10.39 1,000 2.6 10.39 1,000 10.39 $15.00 1,200 2.8 15.00 15.00 3,078 2.4 $ 10.06 2,765 $ 9.50 The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2017 : Unvested RSUs (1) Number of Shares Weighted Average Grant Date Fair Value (in thousands) Unvested at December 31, 2016 98,586 $ 82.99 Granted 36,741 147.28 Vested (43,176 ) 83.74 Forfeited (10,937 ) 91.76 Unvested at December 31, 2017 81,214 $ 110.49 (1) Unvested shares include inducement awards issued in connection with the WhatsApp acquisition in 2014 and are subject to the terms, restrictions, and conditions of separate non-plan RSU award agreements. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2017 , 2016 , and 2015 was $6.76 billion , $4.92 billion , and $4.23 billion , respectively. Starting in 2016, upon adoption of ASU 2016-09, we account for forfeitures as they occur. As of December 31, 2017 , there was $7.72 billion of unrecognized share-based compensation expense, substantially all of which was related to RSUs. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years . Included in this unrecognized share-based compensation expense are 9.5 million unvested shares as of December 31, 2017 , related to RSU inducement award granted to an employee in connection with the WhatsApp acquisition in 2014. This award is subject to acceleration if the recipient's employment is terminated without ""cause"" or if the recipient resigns for ""good reason"". Note 11. Interest and other income (expense), net The following table presents the detail of interest and other income (expense), net, for the periods presented (in millions): Year Ended December 31, Interest income $ $ $ Interest expense (6 ) (10 ) (23 ) Foreign currency exchange losses, net (6 ) (76 ) (66 ) Other Interest and other income (expense), net $ $ $ (31 ) Note 12. Income Taxes The components of income before provision for income taxes for the years ended December 31, 2017 , 2016 , and 2015 are as follows (in millions): Year Ended December 31, Domestic $ 7,079 $ 6,368 $ 2,802 Foreign 13,515 6,150 3,392 Income before provision for income taxes $ 20,594 $ 12,518 $ 6,194 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 4,455 $ 2,384 $ 3,012 State Foreign Total current tax expense 5,034 2,758 3,318 Deferred: Federal (296 ) (414 ) (800 ) State (33 ) (18 ) (17 ) Foreign (45 ) (25 ) Total deferred tax benefit (374 ) (457 ) (812 ) Provision for income taxes $ 4,660 $ 2,301 $ 2,506 A reconciliation of the U.S. federal statutory income tax rate of 35.0% to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 35.0 % 35.0 % 35.0 % State income taxes, net of federal benefit 0.6 1.0 2.0 Research tax credits (0.9 ) (0.7 ) (1.4 ) Share-based compensation 0.4 1.0 2.2 Excess tax benefits related to share-based compensation (1) (5.8 ) (7.0 ) Effect of non-U.S. operations (18.6 ) (12.8 ) (0.9 ) Effect of U.S. tax law change (2) 11.0 Other 0.9 1.9 3.5 Effective tax rate 22.6 % 18.4 % 40.4 % (1) Starting in 2016, excess tax benefits from share-based award activity are reflected as a reduction of the provision for income taxes, whereas they were previously recognized in equity. (2) Due to the Tax Act which was enacted in December 2017, provisional mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our U.S. deferred tax assets and liabilities as of December 31, 2017 were re-measured from 35% to 21% .The provisional effects of the Tax Act are $2.53 billion of current income tax expense and $257 million of deferred income tax benefit for the year ended December 31, 2017. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 1,300 $ 1,252 Tax credit carryforward Share-based compensation Accrued expenses and other liabilities Other Total deferred tax assets 2,706 2,692 Less: valuation allowance (438 ) (240 ) Deferred tax assets, net of valuation allowance 2,268 2,452 Deferred tax liabilities: Depreciation and amortization (622 ) (535 ) Purchased intangible assets (309 ) (706 ) Deferred taxes on foreign income (88 ) (357 ) Total deferred tax liabilities (1,019 ) (1,598 ) Net deferred tax assets $ 1,249 $ The Tax Act reduces the U.S. statutory corporate tax rate from 35% to 21% for our tax years beginning in 2018, which resulted in the re-measurement of the federal portion of our deferred tax assets as of December 31, 2017 from 35% to the new 21% tax rate. The valuation allowance was approximately $438 million and $240 million as of December 31, 2017 and 2016 , respectively, mostly related to state tax credits that we do not believe will ultimately be realized. As of December 31, 2017 , the U.S. federal and state net operating loss carryforwards were $5.36 billion and $2.50 billion , which will begin to expire in 2033 and 2032 , respectively, if not utilized. We have federal and state tax credit carryforwards of $142 million and $1.38 billion , respectively, which will begin to expire in 2033 and 2032 , respectively, if not utilized. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three -year period. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates US taxes on foreign subsidiary distribution. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits-beginning of period $ 3,309 $ 3,017 $ 1,682 Increases related to prior year tax positions Decreases related to prior year tax positions (34 ) (36 ) (52 ) Increases related to current year tax positions 1,066 Decreases related to settlements of prior year tax positions (13 ) (11 ) (1 ) Gross unrecognized tax benefits-end of period $ 3,870 $ 3,309 $ 3,017 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2017 and 2016 was $154 million and $80 million , respectively. If the balance of gross unrecognized tax benefits of $3.87 billion as of December 31, 2017 were realized in a future period, this would result in a tax benefit of $2.67 billion within our provision of income taxes at such time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2011 through 2013 tax years and Ireland for our 2012 through 2015 tax years. Our 2014 and subsequent years remain open to examination by the IRS. Our 2016 and subsequent years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated aggregate amount of approximately $3.0 billion to $5.0 billion in excess of originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability of $3.0 billion to $5.0 billion in excess of the originally filed U.S. return, plus interest and penalties. If the IRS prevails in the assessment of additional tax due based on its position, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. As of December 31, 2017 , we have not resolved this matter and proceedings continue in the United States Tax Court. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. We believe that adequate amounts have been reserved for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. Although the timing of the resolution, settlement, and closure of any audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. However, we do not anticipate a significant impact to such amounts within the next 12 months. Note 13. Geographical Information Revenue by geography is based on the billing address of the marketer or developer. The following tables set forth revenue and property and equipment, net by geographic area (in millions): Year Ended December 31, Revenue: United States $ 17,734 $ 12,579 $ 8,513 Rest of the world (1) 22,919 15,059 9,415 Total revenue $ 40,653 $ 27,638 $ 17,928 (1) No individual country, other than disclosed above, exceeded 10% of our total revenue for any period presented. December 31, Property and equipment, net: United States $ 10,406 $ 6,793 Rest of the world (1) 3,315 1,798 Total property and equipment, net $ 13,721 $ 8,591 (1) No individual country, other than disclosed above, exceeded 10% of our total property and equipment, net for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2017 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2017 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2017 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +5,Merck & Co.,2021," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off (the Spin-Off) of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. Table o f Contents Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) 2021 2020 2019 Total Sales $ 48,704 $ 41,518 $ 39,121 Pharmaceutical 42,754 36,610 34,100 Keytruda 17,186 14,380 11,084 Gardasil/Gardasil 9 5,673 3,938 3,737 Januvia/Janumet 5,288 5,276 5,524 ProQuad/M-M-R II /Varivax 2,135 1,878 2,275 Bridion 1,532 1,198 1,131 Alliance revenue - Lynparza (1) 989 725 444 Molnupiravir 952 Pneumovax 23 893 1,087 926 Simponi 825 838 830 RotaTeq 807 797 791 Isentress/Isentress HD 769 857 975 Alliance revenue - Lenvima (1) 704 580 404 Animal Health 5,568 4,703 4,393 Livestock 3,295 2,939 2,784 Companion Animals 2,273 1,764 1,609 Other Revenues (2) 382 205 628 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs. (2) Other revenues are primarily comprised of third-party manufacturing sales and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin Lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal or gastroesophageal junction (GEJ) carcinoma, head and neck squamous cell carcinoma (HNSCC), hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer (solid tumors), including MSI-H/dMMR colorectal cancer (CRC), primary mediastinal large B-cell lymphoma (PMBCL), tumor mutational burden-high (TMB-H) cancer (solid tumors), and urothelial carcinoma, including non-muscle invasive bladder cancer. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy for human epidermal growth factor 2 (HER2)-positive gastric or GEJ adenocarcinoma, in combination with platinum-and fluoropyrimidine-based chemotherapy for esophageal or GEJ carcinoma, in combination with chemotherapy, with or without bevacizumab, for cervical cancer, in combination with chemotherapy for triple-negative breast cancer (TNBC), in combination with axitinib for advanced renal cell carcinoma (RCC), and in combination with lenvatinib for endometrial carcinoma or RCC. Keytruda is also approved for certain patients with high-risk early-stage TNBC in combination with chemotherapy as neoadjuvant treatment, and then continued as a single agent as adjuvant treatment after surgery. Keytruda is also approved as a monotherapy for the adjuvant treatment of certain patients with RCC. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast, pancreatic, and prostate cancers; and Lenvima (lenvatinib) for certain types of Table o f Contents thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with RCC, and in combination with Keytruda for certain patients with endometrial carcinoma or RCC. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; MMR II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant; Primaxin (imipenem and cilastatin) for injection, an antibiotic for the treatment of certain bacterial infections; Noxafil (posaconazole), an antifungal agent for the prevention of certain invasive fungal infections; Cancidas (caspofungin acetate) for injection, an anti-fungal agent for the treatment of certain fungal infections; Invanz (ertapenem) for injection, an antibiotic for the treatment of certain bacterial infections; and Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, both of which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Molnupiravir, an investigational oral antiviral COVID-19 medicine; Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection. Cardiovascular Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension; Verquvo (vericiguat), a medicine to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in certain adults with symptomatic chronic heart failure and reduced ejection fraction. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory Table o f Contents drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto , a line of oral and topical parasitic control products, including the original Bravecto (fluralaner) products for dogs and cats that last up to 12 weeks; Bravecto (fluralaner) One-Month , a monthly product for dogs, and Bravecto Plus (fluralaner/moxidectin), a two-month product for cats; Sentinel, a line of oral parasitic products for dogs including Sentinel Spectrum (milbemycin oxime, lufenuron, and praziquantel) and Sentinel Flavor Tabs (milbemycin oxime, lufenuron); Optimmune (cyclosporine), an ophthalmic ointment; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies; and Sure Petcare products for companion animal identification and well-being, including the microchip and pet recovery system Home Again . For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2021 Product Approvals and Authorizations Set forth below is a summary of significant product approvals and authorizations received by the Company in 2021. Product Date Approval Keytruda January 2021 European Commission (EC) approved Keytruda as monotherapy for the first-line treatment of adult patients with MSI-H or dMMR CRC. March 2021 EC approved Keytruda as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed autologous stem cell transplant (ASCT) or following at least two prior therapies when ASCT is not a treatment option. March 2021 U.S. Food and Drug Administration (FDA) approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for the treatment of patients with locally advanced or metastatic esophageal or GEJ (tumors with epicenter 1 to 5 centimeters above the GEJ) carcinoma that is not amenable to surgical resection or definitive chemoradiation. May 2021 FDA approved Keytruda , in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy, for the first-line treatment of patients with locally advanced unresectable or metastatic HER2-positive gastric or GEJ adenocarcinoma. June 2021 Chinas National Medical Products Administration (NMPA) approved Keytruda as a monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR CRC that is KRAS, NRAS and BRAF all wild-type. Table o f Contents Keytruda June 2021 EC approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus or HER2-negative GEJ adenocarcinoma in adults whose tumors express PD-L1 (Combined Positive Score [CPS] 10). July 2021 FDA approved Keytruda as monotherapy for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation. July 2021 FDA approved Keytruda plus Lenvima for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR, who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation. July 2021 FDA approved Keytruda for the treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant treatment, then continued as single agent as adjuvant treatment after surgery. August 2021 FDA approved Keytruda for the treatment of patients with locally advanced or metastatic urothelial carcinoma who are not eligible for any platinum-containing chemotherapy. August 2021 Japan Pharmaceuticals and Medical Devices Agency (PMDA) approved Keytruda for the treatment of patients with PD-L1-positive, hormone receptor-negative and HER2-negative, inoperable or recurrent breast cancer. August 2021 PMDA approved Keytruda for the treatment of patients with unresectable, advanced or recurrent MSI-H CRC. August 2021 FDA approved Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC. September 2021 NMPA approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for first-line treatment of patients with locally advanced, unresectable or metastatic carcinoma of the esophageal or GEJ. October 2021 FDA approved Keytruda in combination with chemotherapy, with or without bevacizumab, for the treatment of patients with persistent, recurrent or metastatic cervical cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. October 2021 EC approved Keytruda in combination with chemotherapy for the first-line treatment of locally recurrent unresectable or metastatic TNBC in adults whose tumors express PD-L1 (CPS 1) and who have not received prior chemotherapy for metastatic disease. November 2021 FDA approved Keytruda for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy, or following nephrectomy and resection of metastatic lesions. November 2021 EC approved Keytruda plus Lenvima as a first-line treatment for adult patients with advanced RCC. Table o f Contents Keytruda November 2021 EC approved Keytruda plus Lenvima for the treatment of advanced or recurrent endometrial carcinoma in adults who have disease progression on or following prior treatment with a platinumcontaining therapy in any setting and who are not candidates for curative surgery or radiation. November 2021 PMDA approved Keytruda in combination with chemotherapy (5-fluorouracil plus cisplatin) for the first-line treatment of patients with radically unresectable, advanced or recurrent esophageal carcinoma. December 2021 FDA approved Keytruda as a monotherapy for the adjuvant treatment of adult and pediatric (12 years and older) patients with stage IIB or IIC melanoma following complete resection. The FDA also expanded the indication for Keytruda as adjuvant treatment for stage III melanoma following complete resection to include pediatric patients (12 years and older). December 2021 Japans Ministry of Health, Labor and Welfare (MHLW) approved Keytruda in combination with Lenvima for the treatment of patients with unresectable, advanced or recurrent endometrial carcinoma that progressed after cancer chemotherapy. Lynparza (1) June 2021 NMPA approved Lynparza as monotherapy for the treatment of adult patients with germline or somatic BRCA -mutated metastatic castration-resistant prostate cancer who have progressed following prior treatment that included a new hormonal agent (abiraterone, enzalutamide). molnupiravir (2) December 2021 FDA granted Emergency Use Authorization (EUA) for molnupiravir to treat mild to moderate COVID-19 in adults with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death, and for whom alternative COVID-19 treatment options authorized by the FDA are not accessible or clinically appropriate. December 2021 MHLW granted molnupiravir Special Approval for Emergency for the treatment of infectious disease caused by SARS-CoV-2. Vaxneuvance July 2021 FDA approved Vaxneuvance for active immunization for the prevention of invasive disease caused by Streptococcus pneumoniae serotypes 1, 3, 4, 5, 6A, 6B, 7F, 9V, 14, 18C, 19A, 19F, 22F, 23F and 33F in adults 18 years of age and older. December 2021 EC approved Vaxneuvance for active immunization for the prevention of invasive disease and pneumonia caused by Streptococcus pneumoniae in individuals 18 years of age and older. Verquvo (3) January 2021 FDA approved Verquvo to reduce the risk of cardiovascular death and heart failure (HF) hospitalization following a hospitalization for heart failure or need for outpatient intravenous (IV) diuretics in adults with symptomatic chronic HF and ejection fraction less than 45%. July 2021 EC approved Verquvo for the treatment of symptomatic chronic heart failure in adult patients with reduced ejection fraction who are stabilized after a recent decompensation event requiring IV therapy. Welireg August 2021 FDA approved Welireg for adult patients with von Hippel-Lindau (VHL) disease who require therapy for associated RCC, central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. (1) Being jointly developed and commercialized in a worldwide collaboration with AstraZeneca . (2) Being jointly developed and commercialized in a worldwide collaboration with Ridgeback Biopharmaceuticals LP. Molnupiravir has not been approved by the FDA but has been authorized for emergency use. (3) Being jointly developed and commercialized in a worldwide collaboration with Bayer AG. Table o f Contents Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers, and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products as well as competitors products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. Changes to the U.S. health care system as part of health care reform enacted in prior years, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. United States The Company faces increasing pricing pressure from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins, including, through (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the Patient Protection and Affordable Care Act (ACA). In the U.S., federal and state governments for many years have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal and state laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for medicines purchased by certain state and federal entities such as the Department of Defense, Veterans Affairs, Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Table o f Contents Additionally in the U.S., consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers (PBMs) have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely affect revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been increasing the cost-sharing required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payor has taken the position that multiple branded products are therapeutically comparable. As the U.S. payor market concentrates further, pharmaceutical companies may face greater pricing pressure from private third-party payors. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the U.S. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2021, the Companys gross U.S. sales were reduced by 43.5% as a result of rebates, discounts and returns. Legislative Changes In 2021, Congress actively considered multiple versions of drug pricing legislation that could significantly impact branded pharmaceutical manufacturers. This legislation would implement a government negotiation plan for certain products covered by Medicare Parts B and D, institute financial penalties for price increases above inflation, and redesign the Medicare Part D program to include a cap on patients out of pocket costs and realign the liability for costs of the benefit among manufacturers, health plans, and the government. It is unclear when or if this legislation will be passed by Congress, and it remains very uncertain as to what other proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. Also in 2021, Congress passed the American Rescue Plan Act of 2021, which included a provision that eliminates the statutory cap on rebates drug manufacturers pay to Medicaid beginning in January 2024. These rebates act as a discount off the list price and eliminating the cap means that manufacturer discounts paid to Medicaid can increase. Prior to this change, manufacturers have not been required to pay more than 100% of the Average Manufacturer Price (AMP) in rebates to state Medicaid programs for Medicaid-covered drugs. As a result of this provision, beginning in 2024, it is possible that manufacturers may have to pay state Medicaid programs more in rebates than they received on sales of particular products. This change could present a risk to Merck in the future for drugs that have high Medicaid utilization and rebate exposure that is more than 100% of the AMP. The Company also faces increasing pricing pressure in the states, which are looking to exert greater influence over the price of prescription drugs. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical pricing and will increasingly shift to more aggressive price control tools such as Prescription Drug Affordability Boards that have the authority to conduct affordability reviews and establish upper payment limits. Regulatory Changes In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of AMP and Best Price, two metrics used to determine the rebates drug manufacturers are required to pay to state Medicaid programs. On December 21, 2020, CMS issued a final rule making significant changes to these requirements. Effective January 1, 2023, this final rule changes the way that manufacturers must calculate Best Price in relation to certain patient support programs, including coupons. PhRMA, a pharmaceutical industry trade group of which the Company is a member, filed a complaint challenging this rule as invalid asserting that it conflicts Table o f Contents with the plain language of the Medicaid drug rebate statute. Should this legal challenge fail, the impact of this and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. In November 2020, the Department of Health and Human Services Office of Inspector General issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to PBMs on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. This rulemaking also established, effective January 1, 2021, a new safe harbor for point of sale discounts at the pharmacy counter and a new safe harbor for certain service arrangements between pharmaceutical manufacturers and PBMs. Congress has delayed implementation of this Final Rule until January 1, 2026 and pending federal legislation would repeal it entirely. The pharmaceutical industry also could be considered a potential source of savings via other legislative and administrative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. European Union Efforts toward health care cost containment remain intense in the European Union (EU). The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in the EU attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs. Reference pricing may either compare a products prices in other markets (external reference pricing), or compare a products price with those of other products in a national class (internal reference pricing). The authorities then use the price data to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. Some EU Member States have established free-pricing systems, but regulate the pricing for drugs through profit control plans. Others seek to negotiate or set prices based on the cost-effectiveness of a product or an assessment of whether it offers a therapeutic benefit over other products in the relevant class. The downward pressure on health care costs in general, particularly prescription drugs, has become intense. As a result, increasingly high barriers are being erected to the entry of new products. In some EU Member States, cross-border imports from low-priced markets also exert competitive pressure that may reduce pricing within an EU Member State. Additionally, EU Member States have the power to restrict the range of pharmaceutical products for which their national health insurance systems provide reimbursement. In the EU, pricing and reimbursement plans vary widely from Member State to Member State. Some EU Member States provide that drug products may be marketed only after a reimbursement price has been agreed. Some EU Member States may require the completion of additional studies that compare the cost-effectiveness of a particular product candidate to already available therapies or so-called health technology assessments (HTA), in order to obtain reimbursement or pricing approval. The HTA of pharmaceutical products is becoming an increasingly common part of the pricing and reimbursement procedures in most EU Member States. The HTA process, which is governed by the national laws of these countries, involves the assessment of the cost-effectiveness, public health impact, therapeutic impact and/or the economic and social impact of use of a given pharmaceutical product in the national health care system of the individual country in which it is conducted. Ultimately, HTA measures the added value of a new health technology compared to existing ones. The outcome of HTAs regarding specific pharmaceutical products will often influence the pricing and reimbursement status granted to these pharmaceutical products by the regulatory authorities of individual EU Member States. A negative HTA of one of the Companys products may mean that the product is not reimbursable or may force the Company to reduce its reimbursement price or offer discounts or rebates. A negative HTA by a leading and recognized HTA body could also undermine the Companys ability to obtain reimbursement for the relevant product outside a jurisdiction. For example, EU Member States that have not yet developed HTA mechanisms may rely to some extent on the HTA performed in other countries with a developed HTA framework, to inform their pricing and reimbursement decisions. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. Table o f Contents To obtain reimbursement or pricing approval in some EU Member States, the Company may be required to conduct studies that compare the cost-effectiveness of the Companys product candidates to other therapies that are considered the local standard of care. There can be no assurance that any EU Member State will allow favorable pricing, reimbursement and market access conditions for any of the Companys products, or that it will be feasible to conduct additional cost-effectiveness studies, if required. Brexit In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period applied from January 31, 2020 until December 31, 2020, and during this period the EU and UK operated as if the UK was an EU Member State, and the UK continued to participate in the EU Customs Union allowing for the freedom of movement for people and goods. It was announced on December 24, 2020, that the EU and the UK agreed to a Trade and Cooperation Agreement (TCA). The TCA sets out the new arrangements for trade of goods, including medicines and vaccines, which allows goods to continue to flow between the EU and the UK. The TCA was signed on December 30, 2020, was applied provisionally as of January 1, 2021, and entered into force on May 1, 2021. As a result of the TCA, the Company believes that its operations will not be materially adversely affected by Brexit. Japan In Japan, the pharmaceutical industry is subject to government-mandated annual price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2022. China The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. While the mechanism for drugs being added to the governments National Reimbursement Drug List (NRDL) evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2021, drugs were added to the NRDL with an average of more than 60% price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the last five rounds of VBP had, on average, a price reduction of more than 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. Emerging Markets The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and measures impacting intellectual property, including in exceptional cases, threats of compulsory licenses (especially for COVID-19 vaccines and drugs), that aim to put pressure on the price of innovative pharmaceuticals or result in constrained market access to innovative medicine. The Company anticipates that pricing pressures and market access challenges will continue in the future to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing Table o f Contents availability of funding for health care, credit worthiness of health care partners, such as hospitals, due to COVID-19, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing global cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. Regulation The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the U.S., which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the U.S. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, approval for marketing, labeling, advertising, manufacturing, wholesale distribution, integrity of the supply chain, pharmacovigilance and safety monitoring of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU Member States. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that, in collaboration with key stakeholders, it has a role to play in helping to ensure that its science advances health care, and its products are accessible and affordable. The Company is committed to ensuring a reliable, safe global supply of its quality medicines and vaccines, and to developing, testing and implementing innovative solutions that address barriers to access and affordability of its medicines and vaccines. The Companys approach is designed to enable it to serve the greatest number of patients today, while Table o f Contents meeting the needs of patients in the future. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the U.S. who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. Merck has funded Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the EU General Data Protection Regulation (GDPR), which went into effect in May 2018 and imposes penalties of up to 4% of global revenue. The GDPR and related implementing laws in individual EU Member States govern the collection and use of personal health data and other personal data in the EU. The GDPR increased responsibility and liability in relation to personal data that the Company processes. It also imposes a number of strict obligations and restrictions on the ability to process (which includes collection, analysis and transfer of) personal data, including health data from clinical trials and adverse event reporting. The GDPR also includes requirements relating to the consent of the individuals to whom the personal data relates, the information provided to the individuals prior to processing their personal data or personal health data, notification of data processing obligations to the national data protection authorities, and the security and confidentiality of the personal data. Further, the GDPR prohibits the transfer of personal data to countries outside of the EU that are not considered by the EC to provide an adequate level of data protection, including to the U.S., except if the data controller meets very specific requirements. Following the Schrems II decision of the Court of Justice of the EU on July 16, 2020, there is considerable uncertainty as to the permissibility of international data transfers under the GDPR. In light of the implications of this decision, the Company may face difficulties regarding the transfer of personal data from the EU to third countries. Failure to comply with the requirements of the GDPR and the related national data protection laws of the EU Member States may result in significant monetary fines and other administrative penalties as well as civil liability claims from individuals whose personal data was processed. Data protection authorities from the different EU Member States may still implement certain variations, enforce the GDPR and national data protection laws differently, and introduce additional national regulations and guidelines, which adds to the complexity of processing personal data in the EU. Guidance developed at both the EU level and at the national level in individual EU Member States concerning implementation and compliance practices is often updated or otherwise revised. There is, moreover, a growing trend towards required public disclosure of clinical trial data in the EU which adds to the complexity of obligations relating to processing health data from clinical trials. Failing to comply with these obligations could lead to government enforcement actions and significant penalties against the Company, harm to its reputation, and adversely impact its business and operating results. The uncertainty regarding the interplay between different regulatory frameworks further adds to the complexity that the Company faces with regard to data protection regulation. On August 20, 2021, Chinas 13th National Peoples Congress passed the Personal Information Protection Law (PIPL) that aims to standardize the handling of personal information in China which became effective on November 1, 2021. The PIPL currently applies to the processing of personal information of natural persons in China, the processing of personal information outside China where the purpose is to provide products and services in China, and to analyze the activities of individuals in China. While similar to the GDPR, the PIPL contains unique requirements not found in the GDPR. Table o f Contents The Company has developed and implemented comprehensive plans to ensure compliance with the PIPL, with those relating to data localization and cross-border transfers yet to be completed pending forthcoming guidance from the Cyberspace Administration of China. Additional laws and regulations enacted in the U.S. (such as the California Consumer Privacy Act), Europe, Asia, and Latin America, have increased enforcement and litigation activity in the U.S. and other developed markets, as well as increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving requirements and risks and to facilitate the transfer of personal information across international borders. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, PBMs and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the U.S. and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the U.S. for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the U.S., the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Table o f Contents Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Januvia 2023 2022 2025-2026 2022 Janumet 2023 2022 N/A 2022 Janumet XR 2023 N/A N/A 2022 Isentress 2024 2023 (3) 2022-2026 (4) 2022 Simponi N/A (5) 2024 (6) N/A (5) N/A (5) Lenvima (7) 2025 (3) 2026 (3) (SPCs) 2026 Expired Bridion 2026 (3) 2023 2024 Expired Bravecto 2026 (with pending PTE) 2025 (patents), 2029 (SPCs) 2029 2025 Gardasil 2028 Expired Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A 2025 Keytruda 2028 2030 (3) 2032-2033 2028 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 2024 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Adempas (9) N/A (10) 2028 (3) 2027-2028 2023 Belsomra 2029 (3) N/A 2031 N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2029 N/A Segluromet (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (12) Steglatro (11) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A (12) Steglujan (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (12) Verquvo (8) 2035 (with pending PTE) N/A (13) N/A (13) N/A (13) Vaxneuvance 2031 (with pending PTE) No Patent N/A N/A Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A 2031 Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) 2036 2031 Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Welireg 2035 (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. (1) The EU date represents the expiration date for the following four countries: France, Germany, Italy, and Spain (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) Expiry date reflects the approved product and includes granted PTE for the 600 mg tablet in Japan. (5) The Company has no marketing rights in the U.S., Japan or China. (6) The distribution agreement with Janssen Pharmaceuticals, Inc. expires on October 1, 2024. (7) Part of a global strategic oncology collaboration with Eisai Co., Ltd. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized in a worldwide collaboration with Bayer AG. (10) The Company has no marketing rights in the U.S. (11) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. (12) The Company has no marketing rights in Japan. (13) The Company has no marketing rights in the EU, Japan or China. Table o f Contents The Company has the following key U.S. patent protection for drug candidates under review in the U.S. by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review in the U.S. Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-8591 (islatravir) MK-7962 (sotatercept) 2027 MK-8591A (doravirine + islatravir) 2032 (pending PTE for doravirine) MK-1308A (quavonlimab + pembrolizumab) MK-7684A (vibostolimab + pembrolizumab) MK-4280A (favezelimab + pembrolizumab) MK-1654 (clesrovimab) MK-4482 (molnupiravir) (1) (1) Received Emergency Use Authorization from the FDA for the treatment of high-risk adults with mild to moderate COVID-19. Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the U.S., the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a compound patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-expiring patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the U.S. and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the U.S. and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the U.S. and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Table o f Contents Royalty income in 2021 on patent and know-how licenses and other rights amounted to $286 million. Merck also incurred royalty expenses amounting to $2.4 billion in 2021 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2021, approximately 17,500 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, metabolic diseases, infectious diseases, neurosciences, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the U.S. and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the U.S., recorded data on pre-clinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Table o f Contents Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the U.S., the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. More than one of these special designations can be granted for a given application (i.e., a product designated as a Breakthrough Therapy may also be eligible for Priority Review). Due to the COVID-19 public health crisis, the U.S. Secretary of Health and Human Services has exercised statutory authority to determine that a public health emergency exists, and declared these circumstances justify the emergency use of drugs and biological products as authorized by the FDA. While in effect, this declaration enables the FDA to issue Emergency Use Authorizations (EUAs) permitting distribution and use of specific medical products absent NDA/BLA submission or approval, including products to treat or prevent diseases or conditions caused by the SARS-CoV-2 virus, subject to the terms of any such EUAs. The FDA must make certain findings to grant an EUA, including that it is reasonable to believe based on the totality of evidence that the drug or biologic may be effective, and that known or potential benefits when used under the terms of the EUA outweigh known or potential risks. Additionally, the FDA must find that there is no adequate, approved and available alternative to the emergency use. The FDA may revise or revoke an EUA if the circumstances justifying its issuance no longer exist, the criteria for its issuance are no longer met, or other circumstances make a revision or revocation appropriate to protect the public health or safety. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure Table o f Contents must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other EU Member States. Outside of the U.S. and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, the National Medical Products Administration in China, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, and the Therapeutic Goods Administration in Australia. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the U.S. or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the U.S. and internationally or in late-stage clinical development. MK-4482, molnupiravir, is an investigational oral antiviral medicine for the treatment of mild to moderate COVID-19 in adults who are at risk for progressing to severe disease. Merck is developing molnupiravir in collaboration with Ridgeback Biotherapeutics LP. The FDA granted Emergency Use Authorization (EUA) for molnupiravir in December 2021; as updated in February 2022, to authorize molnupiravir for the treatment of mild to moderate COVID-19 in adults with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death, and for whom alternative COVID-19 treatment options approved or authorized by the FDA are not accessible or clinically appropriate. The authorization is based on the Phase 3 MOVe-OUT trial. Molnupiravir is not approved for any use in the U.S. and is authorized only for the duration of the declaration that circumstances exist justifying the authorization of its emergency use under the Food, Drug and Cosmetic Act, unless the authorization is terminated or revoked sooner. Molnupiravir has also received conditional marketing authorization in the UK and Special Approval for Emergency in Japan. In November 2021, the EMA issued a positive scientific opinion for molnupiravir, which is intended to support national decision-making on the possible use of molnupiravir prior to marketing authorization. In October 2021, the EMA initiated a rolling review for molnupiravir for the treatment of COVID-19 in adults. Merck plans to work with the Committee for Medicinal Products for Human Use of the EMA to complete the rolling review process to facilitate initiating the formal review of the MAA. Applications to other regulatory bodies worldwide are underway. Molnupiravir is also being evaluated for post-exposure prophylaxis in the Phase 3 MOVe-AHEAD trial, which is evaluating the efficacy and safety of molnupiravir for the prevention of COVID-19 in adults who reside with a person with COVID-19. As previously announced, data from the MOVe-IN clinical trial indicated that molnupiravir is unlikely to demonstrate a clinical benefit in hospitalized patients, who generally had a longer duration of symptoms prior to study entry; therefore, the decision was made not to proceed to Phase 3. MK-7264, gefapixant, is an investigational, orally administered, selective P2X3 receptor antagonist, for the treatment of refractory chronic cough or unexplained chronic cough in adults under review by the FDA. The NDA for gefapixant is based on results from the COUGH-1 and COUGH-2 clinical trials. In January 2022, the FDA issued a Complete Response Letter (CRL) regarding Mercks NDA for gefapixant. In the CRL, the FDA requested additional information related to measurement of efficacy. The CRL was not related to the safety of gefapixant. Merck is reviewing the letter and considering next steps. Gefapixant is also under review in the EU, although the review period has been extended pending the receipt of additional information from the Company. V114 is an investigational 15-valent pneumococcal conjugate vaccine under review in Japan for use in adults. V114 was approved in the U.S. in 2021 for use in adults where it is marketed as Vaxneuvance . Vaxneuvance is also under priority review by the FDA for the prevention of invasive pneumococcal disease in children 6 weeks through 17 years of age. The FDA grants priority review to medicines and vaccines that, if approved, would provide a significant improvement in the safety or effectiveness of the treatment or prevention of a serious condition. The FDA set a PDUFA date of April 1, 2022. The supplemental BLA is supported by results from Phase 2 and Phase 3 clinical studies in pediatric populations including infants, children, and adolescents. Table o f Contents MK-3475, Keytruda , is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,650 clinical trials, including more than 1,250 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary, estrogen receptor positive breast cancer, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, gastric, glioblastoma, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, non-small-cell lung, small-cell lung, melanoma, mesothelioma, ovarian, prostate, renal, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU for the adjuvant treatment of adult and pediatric (12 years and older) patients with Stage IIB or IIC melanoma following complete resection based on data from the Phase 3 KEYNOTE-716 trial. Keytruda is under review in Japan for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy (surgical removal of a kidney) based on data from the Phase 3 KEYNOTE-564 trial. Keytruda is under review by the FDA for the treatment of patients with advanced endometrial cancer that is MSI-H or dMMR, who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation. This submission is based on data from the KEYNOTE-158 trial. The FDA set a PDUFA date of March 28, 2022. Keytruda is under review in the EU for the treatment of unresectable or metastatic MSI-H or dMMR colorectal, endometrial, gastric, small intestine, biliary, or pancreatic cancer in adults who have received prior therapy. The proposed indication is based on the results from the KEYNOTE-164 and KEYNOTE-158 trials. Keytruda in combination with chemotherapy is under review in the EU and Japan for the treatment of patients with high-risk, early-stage TNBC as neoadjuvant treatment, and then as a single agent as adjuvant treatment after surgery based on data from the KEYNOTE-522 trial. Keytruda is under review in Japan for treatment of adult patients with advanced or recurrent TMB-H solid tumors that have progressed after chemotherapy (limited to use when difficult to treat with standard of care) based on the KEYNOTE-158 trial. Keytruda in combination with chemotherapy with or without bevacizumab is also under review in the EU and Japan for the first-line treatment of patients with persistent, recurrent or metastatic cervical cancer based on the KEYNOTE-826 trial. In January 2021, Merck, the European Organisation for Research and Treatment of Cancer and the European Thoracic Oncology Platform announced that the Phase 3 KEYNOTE-091 trial investigating Keytruda met one of its dual primary endpoints of disease-free survival (DFS) for the adjuvant treatment of patients with stage IB-IIIA NSCLC following surgical resection regardless of PD-L1 expression. Based on an interim analysis review conducted by an independent Data Monitoring Committee, adjuvant treatment with Keytruda resulted in a statistically significant and clinically meaningful improvement in DFS compared with placebo in the all-comer population of patients with stage IB-IIIA NSCLC. At the interim analysis, there was also an improvement in DFS for patients whose tumors express PD-L1 (tumor proportion score [TPS] 50%) treated with Keytruda compared to placebo; however, this dual primary endpoint did not meet statistical significance per the pre-specified statistical plan. The trial will continue to analyze DFS in patients whose tumors express high levels of PD-L1 (TPS 50%) and evaluate overall survival, a key secondary endpoint. Results will be presented at an upcoming medical meeting and will be submitted to regulatory authorities. MK-7339, Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast, pancreatic and prostate cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca PLC. In November 2021, the FDA accepted for priority review a supplemental NDA for Lynparza for the adjuvant treatment of patients with BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative high-risk, early-stage breast cancer who have already been treated with chemotherapy either before or after surgery based on the results from the Phase 3 OlympiA trial. The FDA set a PDUFA date during the first quarter of 2022. Table o f Contents This indication is also under review in the EU. Lynparza is also under review in the EU for the treatment of certain patients with metastatic castration-resistant prostate cancer based on the PROpel clinical trial. MK-7902, Lenvima, is an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai Co., Ltd. (Eisai). Merck and Eisai are studying the Keytruda plus Lenvima combination through the LEAP (LEnvatinib And Pembrolizumab) clinical program that includes 17 Phase 3 studies across 14 different tumor types (biliary cancer, CRC, endometrial carcinoma, esophageal cancer, gastric cancer, glioblastoma, HCC, HNSCC, melanoma, pancreatic cancer, prostate cancer, NSCLC, SCLC and RCC). In July 2020, Merck and Eisai announced that the FDA issued a CRL regarding Mercks and Eisais applications seeking accelerated approval for the first-line treatment of patients with unresectable HCC based on the KEYNOTE-524/Study 116 trial. Ahead of the PDUFA action dates of Mercks and Eisais applications, another combination therapy was approved based on a randomized, controlled trial that demonstrated improvement in overall survival versus standard-of-care treatment. Consequently, the CRL stated that Mercks and Eisais applications do not provide evidence that Keytruda in combination with Lenvima represents a meaningful advantage over available therapies for the treatment of unresectable or metastatic HCC with no prior systemic therapy for advanced disease. Since the applications for KEYNOTE-524/Study 116 no longer meet the criteria for accelerated approval, both companies plan to work with the FDA to take appropriate next steps, which include conducting a well-controlled clinical trial that demonstrates substantial evidence of effectiveness and the clinical benefit of the combination. As such, LEAP-002, the Phase 3 trial evaluating the Keytruda plus Lenvima combination as a first-line treatment for advanced HCC, is currently underway and fully enrolled. The CRL does not impact the current approved indications for Keytruda or for Lenvima. Merck and Eisai have stopped LEAP-007, the Phase 3 study evaluating the first-line treatment of Lenvima in combination with Keytruda in participants with metastatic squamous or non-squamous NSCLC, whose tumors are PD-L1 positive with no EGFR or ALK genomic tumor aberrations. The trial has been discontinued following the recommendation of the external Data Monitoring Committee (eDMC) which met, as scheduled, to assess safety and futility. The eDMC determined that the study had met the criteria for declaring futility and the benefit/risk profile of the combination did not support continuing the trial. Merck and Eisai have closed LEAP-011 for further enrollment. LEAP-011 is a Phase 3 study evaluating Lenvima in combination with Keytruda for the first-line treatments of patients with platinum-ineligible urothelial carcinoma. Enrollment was closed following the recommendation of the eDMC, which met, as scheduled, to assess safety and futility. The eDMC determined that the benefit/risk profile of the combination did not support continuing the trial and improvements in outcomes in favor of the combination were unlikely to be as high as initially hypothesized. The Company also has several other programs in Phase 3 clinical development. MK-1308A is the coformulation of quavonlimab, Mercks novel investigational anti-CTLA-4 antibody, with pembrolizumab being evaluated for the treatment of RCC. Subcutaneous MK-3475, pembrolizumab, is being evaluated for comparability with the intravenous formulation in NSCLC. MK-4280A is the coformulation of favezelimab, Mercks novel investigational anti-LAG3 therapy, with pembrolizumab, being evaluated for the treatment of CRC. MK-6482, Welireg (belzutifan), is a hypoxia-inducible factor-2 (HIF-2) inhibitor being evaluated for a supplemental indication for the treatment of patients with RCC. MK-7119, Tukysa, is a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers in development for the treatment of breast cancer. In September 2020, Seagen granted Merck an exclusive license and entered into a co-development agreement with Merck to accelerate the global reach of Tukysa. MK-7684A is the coformulation of vibostolimab, an anti-TIGIT therapy, with pembrolizumab being evaluated for the treatment of NSCLC. In December 2021, Merck announced that the FDA had placed clinical holds on the investigational new drug applications for the oral and implant formulations of islatravir (MK-8591) for HIV-1 pre-exposure prophylaxis Table o f Contents (PrEP); the injectable formulation of islatravir for HIV-1 treatment and prophylaxis; and the oral doravirine/islatravir (MK-8591A) HIV-1 once-daily treatment regimen. The FDAs clinical hold is based on observations of decreases in total lymphocyte and CD4+ T-cell counts in some participants receiving islatravir in clinical studies. Merck previously announced it had stopped dosing in the Phase 2 IMAGINE-DR clinical trial of islatravir in combination with MK-8507 (MK-8591-013) and paused enrollment in the once-monthly Phase 3 PrEP studies, (MK-8591-022 and MK-8591-024). With the FDAs clinical hold, no new studies may be initiated. Additionally, Merck and Gilead have made the decision to stop all dosing of participants in the Phase 2 clinical study evaluating an oral-weekly combination treatment regimen of islatravir and Gileads investigational lenacapavir in people living with HIV who are virologically suppressed on antiretroviral therapy. This decision follows the joint announcement on November 23, 2021 of a temporary hold on further enrollment and screening in the study, which commenced in October 2021. The two companies will assess whether a different dosing of islatravir in combination with lenacapavir may provide a once-weekly oral therapy option for people living with HIV. Merck and Gilead remain committed to their collaboration, which aims to develop long-acting new treatment options to address the unmet needs for people living with HIV. MK-7962, sotatercept, is a potentially first-in-class therapy for the treatment of pulmonary arterial hypertension (PAH). Sotatercept is in clinical trials as an add-on to current standard of care for the treatment of PAH. Sotatercept was obtained in connection with Mercks acquisition of Acceleron Pharma Inc. in 2021. MK-1654, clesrovimab, is a respiratory syncytial virus (RSV) monoclonal antibody that is being evaluated for the prevention of RSV medically attended lower respiratory tract infection in infants and certain children over 2 years of age. In April 2021, Merck announced the discontinuation of development of MK-7110 which was being evaluated for the treatment of hospitalized patients with COVID-19. Merck obtained MK-7110 in December 2020 through its acquisition of OncoImmune, a privately held clinical-stage biopharmaceutical company. In 2021, Merck received feedback from the FDA that additional data would be needed to support a potential EUA application and therefore the Company did not expect MK-7110 would become available until the first half of 2022. Given this timeline and the technical, clinical and regulatory uncertainties, the availability of a number of medicines for patients hospitalized with COVID-19, and the need to concentrate Mercks resources on accelerating the development and manufacture of the most viable therapeutics and vaccines, Merck decided to discontinue development of MK-7110 for the treatment of COVID-19. In September 2021, the FDA approved updated labeling for Steglatro, Steglujan and Segluromet, medicines for adults with type 2 diabetes, to include the primary efficacy and safety results from the VERTIS CV trial, which assessed the effect of Steglatro compared with placebo on cardiovascular outcomes in adult patients with type 2 diabetes and established atherosclerotic cardiovascular disease. The FDA issued a CRL concerning the Companys application for a new indication, based on additional results from the VERTIS CV trial, to reduce the risk of hospitalization for heart failure. The Company has determined not to pursue the indication. The chart below reflects the Companys research pipeline as of February 22, 2022. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. Table o f Contents Phase 2 Phase 3 (Phase 3 entry date) Under Review Cancer MK-0482 (2) Non-Small-Cell Lung MK-1026 (nemtabrutinib) Hematological Malignancies MK-1308 (quavonlimab) (2) Non-Small-Cell Lung MK-1308A (quavonlimab+pembrolizumab) Advanced Solid Tumors Colorectal Hepatocellular Melanoma Small-Cell-Lung MK-2140 (zilovertamab vedotin) Breast Hematological Malignancies Non-Small-Cell Lung MK-3475 Keytruda Advanced Solid Tumors MK-4280 (favezelimab) (2) Hematological Malignancies Non-Small-Cell Lung MK-4280A (favezelimab+pembrolizumab) Renal Cell Small-Cell Lung MK-4830 (2) Non-Small-Cell Lung Renal Cell Small-Cell Lung MK-5890 (2) Non-Small-Cell Lung Small-Cell Lung MK-6440 (ladiratuzumab vedotin) (1)(3) Breast Esophageal Gastric Head and Neck Melanoma Non-Small-Cell Lung Prostate Small-Cell Lung MK-6482 Welireg (3) Biliary Colorectal Hepatocellular Pancreatic Rare cancers Von Hippel-Lindau Disease-Associated Tumors (EU) MK-7119 Tukysa (1) Advanced Solid Tumors Biliary Bladder Cervical Colorectal Endometrial Gastric Non-Small-Cell Lung MK-7339 Lynparza (1)(3) Advanced Solid Tumors MK-7684 (vibostolimab) (2) Melanoma MK-7684A (vibostolimab+pembrolizumab) Biliary Breast Cervical Endometrial Esophageal Head and Neck Hematological Malignancies Hepatocellular Prostate MK-7902 Lenvima (1)(2) Biliary Glioblastoma Pancreatic Prostate Small-Cell Lung V937 Breast Cutaneous Squamous Cell Head and Neck Melanoma Solid Tumors Cardiovascular MK-2060 Chikungunya Virus Vaccine V184 HIV-1 Infection MK-8591B (islatravir+MK-8507) (4) MK-8591D (islatravir+lenacapavir) (1)(4) Nonalcoholic Steatohepatitis (NASH) MK-3655 MK-6024 Overgrowth Syndrome MK-7075 (miransertib) Pneumococcal Vaccine Adult V116 Pulmonary Arterial Hypertension MK-5475 Schizophrenia MK-8189 Treatment Resistant Depression MK-1942 Antiviral COVID-19 MK-4482 (molnupiravir) (May 2021) (1)(5) (U.S) Cancer MK-1308A (quavonlimab+pembrolizumab) Renal Cell (April 2021) MK-3475 Keytruda Biliary (September 2019) Cutaneous Squamous Cell (August 2019) (EU) Gastric (May 2015) (EU) Hepatocellular (May 2016) (EU) Mesothelioma (May 2018) Ovarian (December 2018) Prostate (May 2019) Small-Cell Lung (May 2017) MK-3475 (pembrolizumab subcutaneous) Non-Small-Cell Lung (August 2021) MK-4280A (favezelimab+pembrolizumab) Colorectal (November 2021) MK-6482 Welireg (3) Renal Cell (February 2020) MK-7119 Tukysa (1) Breast (October 2019) MK-7339 Lynparza (1)(3) Colorectal (August 2020) Non-Small-Cell Lung (June 2019) Small-Cell Lung (December 2020) MK-7684A (vibostolimab+pembrolizumab) Non-Small-Cell Lung (April 2021) MK-7902 Lenvima (1)(2) Colorectal (April 2021) Esophageal (July 2021) Gastric (December 2020) Head and Neck (February 2020) Melanoma (March 2019) Non-Small-Cell Lung (March 2019) HIV-1 Infection MK-8591A (doravirine+islatravir) (February 2020) (4) HIV-1 Prevention MK-8591 (islatravir) (February 2021) (4) Pulmonary Arterial Hypertension MK-7962 (sotatercept) (January 2021) Respiratory Syncytial Virus MK-1654 (clesrovimab) (November 2021) New Molecular Entities/Vaccines Antiviral COVID-19 MK-4482 (molnupiravir) (1) (EU) Cough MK-7264 (gefapixant) (U.S.) (6) (EU) Pneumococcal Vaccine Adult V114 (JPN) Certain Supplemental Filings Cancer MK-3475 Keytruda Adjuvant Treatment of Stage IIB or IIC Melanoma (KEYNOTE-716) (EU) Adjuvent Renal Cell Cancer (KEYNOTE-564) (JPN) MSI-H or dMMR Endometrial Cancer (KEYNOTE-158) (U.S.) MSI-H or dMMR Six Tumor Basket (KEYNOTE-158) (EU) High-Risk Early-Stage Triple-Negative Breast Cancer (KEYNOTE-522) (EU) (JPN) Tumor Mutational Burden-High (KEYNOTE-158) (JPN) Cervical Cancer (KEYNOTE-826) (EU) (JPN) MK-7339 Lynparza (1) BRCA -Mutated HER2-Negative Adjuvant Breast Cancer (OlympiA) (U.S.) (EU) First-Line Metastatic Prostate Cancer (PROpel) (EU) MK-7902 Lenvima (1)(2) First-Line Metastatic Hepatocellular Carcinoma (KEYNOTE-524) (U.S.) (7) Advanced Unresectable Renal Cell Carcinoma (KEYNOTE-581) (JPN) (8) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda . (3) Being developed as monotherapy and/or in combination with Keytruda. (4) On FDA clinical hold. (5) Available in the U.S. under Emergency Use Authorization. (6) In January 2022, the FDA issued a CRL. Merck is reviewing the CRL and considering next steps. (7) In July 2020, the FDA issued a CRL for Mercks and Eisais applications. Merck and Eisai intend to submit additional data when available to the FDA. (8) Approved on February 25, 2022. Table o f Contents Human Capital As of December 31, 2021, the Company had approximately 68,000 employees worldwide, with approximately 27,000 employed in the U.S., including Puerto Rico, and, additionally, approximately 14,000 third-party contractors globally. (1) Approximately 67,000 of the Companys employees are full-time employees. Women and individuals from underrepresented ethnic groups comprise approximately 50% and 32% of its workforce (the Company defines workforce as its employees) in the U.S., respectively. Women comprise 46% of the members of the Board of Directors. Additionally, the Companys executive team is made up of 33% women. Approximately 23% of the Companys employees are represented by various collective bargaining groups. The Companys voluntary turnover rate was approximately 8.8% and 6.0%, respectively, in 2021 and 2020. The Company recognizes that its employees are critical to meet the needs of its patients and customers and that its ability to excel depends on the integrity, skill, and diversity of its employees. (1) Third party contractors include the Companys temporary workers, independent contractors, and freelancers who are viewed as full-time equivalent employees. They exclude outsourced service providers. Talent Acquisition The Company uses a comprehensive approach to ensure recruiting, retention and leadership development goals are systematically executed throughout the Company and that it hires talented leaders to achieve improved gender parity and representation across all dimensions of diversity. The Company provides training to its managers and external recruiting organizations on strategies to mitigate unconscious bias in the candidate selection and hiring process. In addition, the Company utilizes a comprehensive communications strategy, employee branding and marketing outreach, social media and strategic alliance partnerships to reach a broad pool of talent in its critical business areas. In 2021, the Company hired approximately 8,700 employees across the globe through various channels including the Companys external career site, direct passive candidate sourcing, diversity partnerships, employee referrals, universities and other external sources. Global Diversity and Inclusion Diversity and inclusion are fundamental to the Companys success and core to future innovation. The Company fosters a globally diverse and inclusive workforce for its employees by creating an environment of belonging, engagement, equity, and empowerment. The Company is proactive and intentional about diversity hiring and development programs to advance talent. The Company creates competitive advantages by leveraging diversity and inclusion to accelerate business performance. This includes fostering global supplier diversity, integrating diversity and inclusion into the Companys commercialization strategies and leveraging employee insights to improve performance. In addition to these efforts, the Company has ten Employee Business Resource Groups that provide opportunities for employees to take an active part in contributing to the Companys inclusive culture through their work in talent acquisition and development, business and customer insights and social and community outreach. The Companys diversity goals include increasing representation in senior management roles (1) by 2024 of (i) women globally to 40%, up from 31% in 2020, (ii) Black/African Americans in the U.S. to 10%, up from 3% in 2020, and (iii) Hispanics/Latinos in the U.S. to 10%, up from 5% in 2020. At December 31, 2021, representation in senior management roles at the Company for (i) women globally was 36%, (ii) Black/African Americans in the U.S. was 7%, and (iii) Hispanics/Latinos in the U.S. was 6%. In addition, by 2025, the Company seeks to maintain or exceed both its current inclusion index score and its current employee engagement index score. (2) (1) Senior management role is defined as an individual holding either a Vice President or Senior Vice President title. (2) The Inclusion Index is the average favorability score for employees responses to three items in the employee pulse survey (manager supports inclusion, sense of belonging, leaders value perspective). The Employee Engagement Index is the average favorability score for employees responses to items in the employee survey. Table o f Contents Gender and Ethnicity Performance Data (1)(2) 2021 2020 2019 Women in the workforce 50% 50% 49% Women in the workforce in the U.S. 50% 50% 50% Women on the Board of Directors 46% 46% 33% Women in executive roles (3) 33% 33% 20% Women in management roles (4) 44% 42% 42% Members of underrepresented ethnic groups on the Board of Directors 23% 23% 17% Members of underrepresented ethnic groups in executive roles (U.S.) 42% 25% 40% Members of underrepresented ethnic groups in the workforce (U.S.) 32% 30% 29% Members of underrepresented ethnic groups in management roles (U.S.) 26% 25% 23% New hires that were female 53% 50% 51% New hires that were members of underrepresented ethnic groups (U.S.) 46% 40% 35% (1) As of 12/31. As self-identified to the Company. (2) Prior period data has not been restated to adjust for the Organon Spin-Off. (3) Executive role is defined as an individual holding an Executive Vice President title. (4) Management role is defined as all managers with direct reports other than executives as defined in note 3. Compensation and Benefits The Company provides a valuable total rewards package reflecting its commitment to attract, retain and motivate its talent, and support its employees and their families in every stage of life. The Company continuously monitors and adjusts its compensation and benefit programs to ensure they are competitive, contemporary, helpful and engaging, and that they support strategic imperatives such as diversity and inclusion, equity, flexibility, quality, security and affordability. For example, the Company added a personal health care concierge service to assist U.S. employees participating in the Company medical plan with their health care needs. Aligned with its business and in support of its cancer care strategy, the Company also improved cancer screening benefits, added resources and provided immediate access to a leading cancer center of excellence for U.S. employees. Globally, the Company implemented a minimum standard of 12 weeks of paid parental leave, which inclusively applies to all parents. In the U.S., the Companys benefits rank in the top quartile of Fortune 100 companies under the Aon 2021 Benefits Index. The Company has been included in Seramount (previously the Working Mother) 100 Best Companies ranking for 35 consecutive years and was named a Seramount top ten Best Company for Dads in 2021. Employee Wellbeing The Company is committed to helping its employees and their families improve their own health and wellbeing. The Companys culture of wellbeing is referred to as Live it , which includes programs to support preventive health, emotional and financial wellbeing, physical fitness and nutrition. It is designed to inspire all employees to pursue, enjoy, and share healthy lifestyles. Live it was launched in the U.S. in 2011 and today is available in every country in which the Company has employees. In addition, many of the Companys larger sites offer onsite health clinics that provide an array of services to help its employees stay or get well, including vaccinations, cancer and biometric screenings, travel medicine and advice, diagnosis and treatment of non-occupational illnesses or injuries, health counseling and referrals. The Companys overall employee wellbeing program was recognized for excellence in health and wellbeing by receiving the most recent highest-level awards from the Business Group on Health and the American Heart Association. COVID-19 Response The Company recognizes that it has a unique responsibility to help in response to the COVID-19 pandemic and is committed to supporting and protecting its employees and their families, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches and supporting its health care providers and the communities in which they serve. The Company continues to provide employees with easy and regular access to information, including details regarding the Companys tracking process, guidance around hygiene measures and travel and best practices for working from home. Examples of pandemic support resources and programs available to the Companys employees include pay continuation for workers who have been sick or exposed, volunteer policy adjustment to enable employees with Table o f Contents medical backgrounds to volunteer in SARS-CoV-2-related activities, resources to prioritize physical and mental wellness, adjustments to medical plans to cover 100% of a COVID-19-related diagnosis, testing and treatment, backup childcare and more. Engaging Employees The Company strives to foster employee engagement by promoting a safe, positive, diverse and inclusive work environment that provides numerous opportunities for two-way communication with employees. Some of the Companys key programs and initiatives include promoting global employee engagement surveys, ongoing pulse checks to the organization for interim feedback on specific topics, fostering professional networking and collaboration, identifying and providing opportunities for volunteering and establishing positive, cooperative business relations with designated employee representatives. Talent Management and Development As the Company pursues its goal of becoming the worlds premier research-based biopharmaceutical company, there is a consistent focus on the importance of continuously developing its diverse and talented people. The Companys current talent management system supports company-wide performance management, leadership development, talent reviews and succession planning. Annual performance reviews help further the professional development of the Companys employees and ensure that the Companys workforce is aligned with the Companys objectives. The Company seeks to continuously build the skills and capabilities of its workforce to accelerate talent, improve performance and mitigate risk through relevant continuous learning experiences. This includes, but is not limited to, building leadership and management skills, as well as providing technical and functional training to all employees. Environmental Matters Environmental Sustainability The Company strives to be a strong environmental steward, and realizes that its strategy and efforts need to continuously improve for the Company to excel in an increasingly resource-constrained world. The Companys environmental sustainability strategy has three areas of focus: Driving efficiency in operations; Designing new products to minimize environmental impact; and Reducing any impacts in the Companys upstream and downstream value chain. The Company has recently adopted a set of new climate goals to address the rising expectations of its customers, investors, external stakeholders and employees regarding the environmental impact of its operations and supply chain. These goals include achieving carbon neutrality for greenhouse gas emissions across operations (Scopes 1 and 2) by 2025, reducing Scope 1 and 2 greenhouse gas emissions 46% by 2030 (from a 2019 baseline), reducing value chain (Scope 3) greenhouse gas emissions by 30% by 2030 (from a 2019 baseline), and sourcing 100% renewable energy for purchased electricity by 2025. The Companys absolute greenhouse gas reduction targets have been verified by the Science Based Target initiative. Other environmental sustainability initiatives of the Company include: Global water use and stewardship. The Companys global water strategy aims to achieve sustainable water management within its operations and its supply chain, as well as address water-related risk. Access to clean water is critical for human health, and water is a key input to the Companys manufacturing operations. The Companys sites employ a variety of technologies and techniques, such as closed-loop cooling systems and reused reverse osmosis reject water, to reduce the Companys water footprint and improve operational performance. Waste management and diversion. The Company continuously strives to reduce the amount of operational waste it generates and to maximize the use of environmentally beneficial disposal methods such as recycling, composting and waste-to-energy. Product stewardship and green and sustainable science. The Companys product stewardship program focuses on identifying and either preventing or minimizing potential safety and environmental hazards throughout a products life cycle. The Company is also committed to Table o f Contents understanding, managing and reducing the environmental impacts of its products and the materials associated with discovering and producing them. The Companys green and sustainable science program uses a green-by-design approach. By using more efficient and innovative processing methods and technologies, the Company is reducing the amount of energy, water and raw materials the Company uses to make the Companys products, thereby reducing the amount of waste the Company generates and lowering the Companys production costs. Animal conservation. The Company is a leading worldwide supplier of individual identification, real-time data access and advanced analytics for the animal conservation community. This enables the Company to produce actionable insights that inform recovery actions on a global scale, for species ranging from wild fish to penguins. The Company also provides wild fish conservation monitoring equipment and real-time video monitoring technology to advance fish health and welfare. Together, these technologies help to promote biodiversity and support the global need for reliable and safe sources of protein. Management does not believe that expenditures related to these initiatives should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. In December 2021, the Company completed its inaugural issuance of a $1.0 billion sustainability bond, which was part of an $8.0 billion underwritten bond offering. The Company intends to use the net proceeds from the sustainability bond offering to support projects and partnerships in the Companys priority environmental, social and governance (ESG) areas and contribute to the advancement of the United Nations Sustainable Development Goals. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy usage, water use and greenhouse gas emissions. Environmental Regulation and Remediation The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $12 million in 2021 and are estimated to be $24 million in the aggregate for the years 2022 through 2026. These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $40 million and $43 million at December 31, 2021 and 2020, respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $40 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Geographic Area Information The Companys operations outside the U.S. are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the U.S. as a percentage of total Company sales were 54% in 2021 and were 53% in both 2020 and 2019. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Table o f Contents Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is sec.gov . In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at merck.com/company-overview/leadership and all such information is available in print to any shareholder who requests it from the Company. The Companys 2020/2021 Environmental, Social Governance (ESG) Progress Report, which provides enhanced ESG disclosures, is available on the Companys website at merck.com/company-overview/responsibility/ . Information in the Companys ESG Progress Report is not incorporated by reference into this Form 10-K. "," Item 1A. Risk Factors. Summary Risk Factors The Company is subject to a number of risks that if realized could materially adversely affect its business, results of operations, cash flow, financial condition or prospects. The following is a summary of the principal risk factors facing the Company: The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. The Company faces continued pricing pressure with respect to its products. Unfavorable or uncertain economic conditions, together with cost-reduction measures being taken by certain governments, could negatively affect the Companys operating results. The Company faces intense competition from lower cost generic products. The Company faces intense competition from competitors products. In 2021 and 2020, COVID-19-related disruptions had an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the Table o f Contents COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. Climate change or legal, regulatory or market measures to address climate change may negatively affect the Companys business, results of operations, cash flows and prospects. Environmental, social and governance (ESG) matters may impact the Companys business and reputation. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Company may experience difficulties and delays in manufacturing certain of its products, including vaccines. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. Pharmaceutical products can develop unexpected safety or efficacy concerns. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The health care industry in the U.S. has been, and will continue to be, subject to increasing regulation and political action. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. Developments following regulatory approval may adversely affect sales of the Companys products. The Company is subject to a variety of U.S. and international laws and regulations. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. Adverse outcomes in current or future legal matters could negatively affect Mercks business. Product liability insurance for products may be limited, cost prohibitive or unavailable. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. Social media and mobile messaging platforms present risks and challenges. The above list is not exhaustive, and the Company faces additional challenges and risks. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. Table o f Contents Risk Factors The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations, cash flow or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. Risks Related to the Companys Business The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the U.S. and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to successfully assert and defend the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company asserts and defends its patents both within and outside the U.S., including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by asserting its patent with a lawsuit alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the U.S. and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and Table o f Contents rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Januvia and Janumet will lose market exclusivity in the U.S. in January 2023. Januvia and Janumet will lose market exclusivity in the EU in September 2022 and in China in July 2022. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of exclusivity. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Lynparza, Bravecto , and Bridion . In particular, in 2021, the Companys oncology portfolio, led by Keytruda, represented a substantial portion of the Companys revenue growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and financial condition. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. In order to remain competitive, the Company, like other major pharmaceutical companies, must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs and vaccines. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short Table o f Contents term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the U.S., these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment. Changes to the health care system enacted as part of health care reform in the U.S., as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the U.S. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2021, the Companys gross U.S. sales were reduced by 43.5% as a result of rebates, discounts and returns. Outside the U.S., numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated annual price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. Table o f Contents The Company expects pricing pressures to continue in the future. Unfavorable or uncertain economic conditions, together with cost-reduction measures being taken by certain governments, could negatively affect the Companys operating results. The Companys business may be adversely affected by local and global economic conditions, including with respect to inflation, interest rates, and costs of raw materials and packaging. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. In addition, the COVID-19 pandemic has caused some disruption and volatility in the Companys global supply chain network, and the Company may experience disruptions in availability and delays in shipments of raw materials and packaging, as well as related cost inflation. Any such disruptions, delays or costs may result in the Companys inability to meet demand for the Companys products. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the U.S. or in the EU. In the U.S. and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the U.S. and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in Table o f Contents connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. In 2021 and 2020, COVID-19-related disruptions had an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Companys business and financial results were negatively impacted by COVID-19-related disruptions in 2021 and 2020. The continued duration and severity of the COVID-19 pandemic is uncertain, rapidly changing and difficult to predict. The degree to which COVID-19-related disruptions impact the Companys results in 2022 will depend on future developments, beyond the Companys knowledge or control, including, but not limited to, the duration of the pandemic, its severity, the success of actions taken to contain or prevent the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In 2021, the COVID-19 pandemic impacted the Companys business in numerous ways. As expected, within the Companys human health business, which is comprised largely of physician-administered products, revenue was negatively impacted by social distancing measures and fewer well visits, which negatively affected vaccine and oncology sales in particular. The estimated negative impact of COVID-19-related disruptions to Mercks revenue for the full year 2021 was approximately $1.3 billion, attributable to the Pharmaceutical segment. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, however, roughly 75% of Mercks Pharmaceutical segment revenue is comprised of physician-administered products which could be adversely affected by the pandemic if its effects worsen. Despite the Companys efforts to manage the impacts of the COVID-19 pandemic, their ultimate effect will also depend on factors beyond the Companys knowledge or control, including the duration of the COVID-19 pandemic as well as governmental and third-party actions taken to contain or prevent the spread and treatment of the virus and mitigate its public health and economic effects. In addition, any future pandemic, epidemic or similar public health threat could present similar risks to the Companys business, cash flow, results of operations, financial condition and prospects. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the U.S. is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the U.S. or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. In particular, in February 2022, armed conflict escalated between Russia and Ukraine. It is not possible to predict the broader consequences of this conflict, which could include sanctions, embargoes, regional instability, geopolitical shifts and adverse effects on macroeconomic conditions, currency exchange rates and financial markets. Table o f Contents Climate change or legal, regulatory or market measures to address climate change may negatively affect the Companys business, results of operations, cash flows and prospects. The Company believes that climate change has the potential to negatively affect its business and results of operations, cash flows and prospects. The Company is exposed to physical risks (such as extreme weather conditions or rising sea levels), risks in transitioning to a low-carbon economy (such as additional legal or regulatory requirements, changes in technology, market risk and reputational risk) and social and human effects (such as population dislocations and harm to health and well-being) associated with climate change. These risks can be either acute (short-term) or chronic (long-term). The adverse impacts of climate change include increased frequency and severity of natural disasters and extreme weather events such as hurricanes, tornados, wildfires (exacerbated by drought), flooding, and extreme heat. Extreme weather and sea-level rise pose physical risks to the Companys facilities as well as those of its suppliers. Such risks include losses incurred as a result of physical damage to facilities, loss or spoilage of inventory, and business interruption caused by such natural disasters and extreme weather events. Other potential physical impacts due to climate change include reduced access to high-quality water in certain regions and the loss of biodiversity, which could impact future product development. These risks could disrupt the Companys operations and its supply chain, which may result in increased costs. New legal or regulatory requirements may be enacted to prevent, mitigate, or adapt to the implications of a changing climate and its effects on the environment. These regulations, which may differ across jurisdictions, could result in the Company being subject to new or expanded carbon pricing or taxes, increased compliance costs, restrictions on greenhouse gas emissions, investment in new technologies, increased carbon disclosure and transparency, upgrade of facilities to meet new building codes, and the redesign of utility systems, which could increase the Companys operating costs, including the cost of electricity and energy used by the Company. The Companys supply chain would likely be subject to these same transitional risks and would likely pass along any increased costs to the Company. Environmental, social and governance (ESG) matters may impact the Companys business and reputation. Governmental authorities, non-governmental organizations, customers, investors, external stakeholders and employees are increasingly sensitive to ESG concerns, such as diversity and inclusion, climate change, water use, recyclability or recoverability of packaging, and plastic waste. This focus on ESG concerns may lead to new requirements that could result in increased costs associated with developing, manufacturing and distributing the Companys products. The Companys ability to compete could also be affected by changing customer preferences and requirements, such as growing demand for more environmentally friendly products, packaging or supplier practices, or by failure to meet such customer expectations or demand. While the Company strives to improve its ESG performance, the Company risks negative stockholder reaction, including from proxy advisory services, as well as damage to its brand and reputation, if the Company does not act responsibly, or if the Company is perceived to not be acting responsibly in key ESG areas, including equitable access to medicines and vaccines, product quality and safety, diversity and inclusion, environmental stewardship, support for local communities, corporate governance and transparency, and addressing human capital factors in the Companys operations. If the Company does not meet the ESG expectations of its investors, customers and other stakeholders, the Company could experience reduced demand for its products, loss of customers, and other negative impacts on the Companys business and results of operations. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry, both in the U.S. and internationally, is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Table o f Contents The Company may experience difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. For example, in 2020 the Company issued a product recall for Zerbaxa following the identification of product sterility issues. The Company may, in the future, experience other difficulties and delays in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including supply chain delays, shortages in raw materials, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the U.S. has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Competition and the Health Care Environment, pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing health care reform that has led to the acceleration of generic substitution, where available. While the mechanism for drugs being added to the NRDL evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2021, drugs were added to the NRDL with an average of more than 60% price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the last five rounds of VBP had, on average, a price reduction of more than 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, at the same time macro-economic growth of selected emerging markets is expected to outpace Europe and even the U.S., leading to significant increased health care spending in those countries and access to innovative medicines for patients. A failure to maintain the Companys presence in emerging markets could therefore have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Table o f Contents The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which will cause LIBOR to cease to exist entirely in the future. While the Company has begun to implement alternative reference rates as alternatives to LIBOR, the Company cannot predict the consequences and timing of any additional or unexpected developments, which could include an increase in interest expense and will also require the amendment of contracts that reference LIBOR. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology (IT) systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt the manufacture of its animal health products at such sites or force the Company to incur substantial expenses in procuring raw materials or products elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. In addition, sales of Bravecto represent a significant portion of the Companys Animal Health segment sales. Any negative event with respect to Bravecto could have a material adverse effect on the Companys Animal Health sales. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Table o f Contents Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the U.S. and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the U.S., a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial human vaccine lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Risks Relating to Government Regulation and Legal Proceedings The health care industry in the U.S. has been, and will continue to be, subject to increasing regulation and political action. As discussed above in Competition and the Health Care Environment, the Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. On December 21, 2020, the CMS issued a final rule making significant changes to these requirements. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons. PhRMA, a pharmaceutical industry trade group, of which the Company is a member, filed a complaint challenging this rule as invalid asserting that it conflicts with the plain language of the Medicaid drug rebate statute. Should this legal Table o f Contents challenge fail, the impact of this and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. In 2021, Congress passed the American Rescue Plan Act of 2021, which included a provision that eliminates the statutory cap on rebates drug manufacturers pay to Medicaid beginning in January 2024. These rebates act as a discount off the list price and eliminating the cap means that manufacturer discounts paid to Medicaid can increase. Prior to this change, manufacturers have not been required to pay more than 100% of the Average Manufacturer Price (AMP) in rebates to state Medicaid programs for Medicaid-covered drugs. As a result of this provision, beginning in 2024, it is possible that manufacturers may have to pay state Medicaid programs more in rebates than they received on sales of particular products. This change could present a risk to Merck in the future for drugs that have high Medicaid utilization and rebate exposure that is more than 100% of the AMP. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company cannot predict what additional future changes in the health care industry in general, or the pharmaceutical industry in particular, will occur; however, any changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the U.S., including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the U.S., the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In some cases, the FDA requirements have increased the amount of time and resources necessary to develop new products and bring them to market in the U.S. Regulation outside the U.S. also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in the EU, Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; scrutiny of advertising and promotion; and the withdrawal of indications granted pursuant to accelerated approvals. In the past, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of Table o f Contents marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional health care reform initiatives in the U.S. or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU, the U.S., and China; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to health care professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are routinely examined by various tax authorities. In connection with the 2015 Organization for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in other countries. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions, including, among others, any potential changes to the existing U.S. tax law by the current U.S. Presidential administration and Congress, as well as any changes in tax law resulting from the implementation of the OECDs two-pillar solution to reform the international tax landscape . The Company has taken the position, based on the opinions of tax counsel, that its distribution of Organon common stock in connection with the 2021 Spin-Off of Organon qualifies as a transaction that is tax-free for U.S. federal income tax purposes. If any facts, assumptions, representations, and undertakings from the Company and Organon regarding the past and future conduct of their respective businesses and other matters are Table o f Contents incorrect or not otherwise satisfied, the Spin-Off may not qualify for tax-free treatment, which could result in significant U.S. federal income tax liabilities for the Company and its shareholders. Adverse outcomes in current or future legal matters could negatively affect Mercks business. Current or future litigation, claims, proceedings and government investigations could preclude or delay the commercialization of Mercks products or could adversely affect Mercks business, results of operations, cash flow, prospects and financial condition. Such legal matters may include, but are not limited to: (i) intellectual property disputes; (ii) adverse decisions in litigation, including product safety and liability, consumer protection and commercial cases; (iii) anti-bribery regulations, such as the U.S. Foreign Corrupt Practices Act, including compliance with ongoing reporting obligations to the government resulting from any settlements; (iv) recalls or withdrawals of pharmaceutical products or forced closings of manufacturing plants; (v) product pricing and promotional matters; (vi) lawsuits, claims and administrative proceedings asserting, or investigations into, violations of securities, antitrust, Federal and state pricing, consumer protection, data privacy and other laws and regulations; (vii) environmental, health, safety and sustainability matters, including regulatory actions in response to climate change; and (viii) tax liabilities resulting from assessments from tax authorities. See Item 8. Financial Statements and Supplementary Data, Note 11, Contingencies and Environmental Liabilities for more information on the Companys legal matters. In 2021, Merck informed the U.S. Department of Health and Human Services, Health Resources and Services Administration (HHS) that Merck was implementing an update to its Section 340b program integrity initiative, pursuant to which Merck required all hospital covered entities to provide 340b claims data for all claims originating from contract pharmacies. For those entities that declined to submit such claims data, Mercks new initiative provided that it would no longer voluntarily honor 340b discounts or chargebacks for contract pharmacy transactions, except for a single contract pharmacy of the hospital covered entitys choice. Also in 2021, HHS sent letters to numerous drug manufacturers stating that it had determined that those manufacturers actions restricting contract pharmacy transactions were in violation of the 340b statute and further stating that if those manufacturers did not cease their restrictions, HHS might seek both repayment of overcharges as well as civil monetary penalties. Those manufacturers are now in litigation with the U.S. government seeking to confirm the legality of the restrictions. Merck did not receive a similar letter from HHS. However, HHS could seek to implement administrative proceedings to recover overcharges and/or impose civil monetary penalties against Merck. If such proceedings were implemented against Merck a negative outcome could have a material adverse effect on Mercks business, results of operations, cash flow, prospects and financial condition. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Risks Related to Technology The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications, complex information technology systems, computing infrastructure, and cloud service providers (collectively, IT systems) to conduct Table o f Contents critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes, including data acquisition; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. Social media and mobile messaging platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media and mobile messaging channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there are internal Company Social Media and Mobile Messaging Policies that guide employees on appropriate personal and professional use of these platforms for communication about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as new communication tools expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs, environmental or other sustainability initiatives, and include Table o f Contents statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the U.S. and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. The impact of the global COVID-19 pandemic and any future pandemic, epidemic, or similar public health threat, on the Companys business, operations and financial performance. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the U.S., the EU, and China. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the U.S. requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Table o f Contents Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is currently located in Kenilworth, New Jersey. The Company has previously announced that it intends to consolidate its New Jersey campuses into a single corporate headquarters location in Rahway, New Jersey by the end of 2023. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey; Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey; West Point, Pennsylvania; Boston and Cambridge, Massachusetts; South San Francisco, California; and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the U.S. are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at seven locations in the U.S. and Puerto Rico. Outside the U.S., through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. A number of properties were transferred to Organon in the Spin-Off. Capital expenditures were $4.4 billion in 2021, $4.4 billion in 2020 and $3.4 billion in 2019. In the U.S., these amounted to $2.8 billion in 2021, $2.6 billion in 2020 and $1.9 billion in 2019. Abroad, such expenditures amounted to $1.6 billion in 2021, $1.8 billion in 2020, and $1.5 billion in 2019. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2022, there were approximately 99,932 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2021 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 246,194 $74.92 246,194 $5,047 November 1 November 30 $5,047 December 1 December 31 $5,047 Total 246,194 $74.92 246,194 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. Table o f Contents Performance Graph The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2021/2016 CAGR* MERCK $159 10% PEER GROUP** 201 15% SP 500 233 18% 2016 2017 2018 2019 2020 2021 MERCK 100.0 98.5 137.9 168.6 156.5 159.3 PEER GROUP 100.0 120.0 128.4 152.6 163.6 200.6 SP 500 100.0 121.8 116.5 153.1 181.3 233.3 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis as of December 31, 2016. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. Table o f Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify and has been treated as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off (see Note 3 to the consolidated financial statements). Table o f Contents Overview Financial Highlights ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Sales $ 48,704 17 % 16 % $ 41,518 6 % 8 % $ 39,121 Net Income from Continuing Operations Attributable to Merck Co., Inc.: GAAP $ 12,345 * * $ 4,519 (21) % (16) % $ 5,690 Non-GAAP (1) $ 15,282 33 % 31 % $ 11,506 20 % 23 % $ 9,617 Earnings per Common Share Assuming Dilution from Continuing Operations Attributable to Merck Co., Inc. Common Shareholders: GAAP $ 4.86 * * $ 1.78 (19) % (15) % $ 2.21 Non-GAAP (1) $ 6.02 33 % 32 % $ 4.53 21 % 25 % $ 3.73 * Calculation not meaningful. (1) Non-GAAP net income and non-GAAP earnings per share (EPS) exclude acquisition and divestiture-related costs, restructuring costs and certain other items. For further discussion and a reconciliation of GAAP to non-GAAP net income and EPS (see Non-GAAP Income and Non-GAAP EPS below) . Executive Summary During 2021, Merck delivered on its strategic priorities by executing commercially to drive strong revenue and earnings growth in the year, completing key business development transactions, accelerating its broad pipeline, and achieving notable regulatory milestones. Also, on June 2, 2021, Merck completed the spin-off of Organon. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off. Worldwide sales were $48.7 billion in 2021, an increase of 17% compared with 2020, or 16% excluding the favorable effect of foreign exchange. The sales increase was driven primarily by growth in oncology, vaccines, hospital acute care and animal health. Additionally, revenue in 2021 reflects the benefit of sales of molnupiravir, an investigational oral antiviral COVID-19 treatment. As discussed below, COVID-19-related disruptions negatively affected sales in 2021, but to a lesser extent than in 2020, which benefited year-over-year sales growth. Merck continues to execute scientifically compelling business development opportunities to augment its pipeline. In November 2021, Merck acquired Acceleron Pharma Inc. (Acceleron), a publicly traded biopharmaceutical company evaluating the transforming growth factor (TGF)-beta superfamily of proteins through the development of pulmonary and hematologic therapies. In April 2021, Merck acquired Pandion Therapeutics, Inc. (Pandion), a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases. Additionally, Merck entered into a collaboration with Gilead Sciences, Inc. (Gilead) to jointly develop and commercialize long-acting treatments in HIV. In 2021, Merck received over 30 approvals and filed over 20 New Drug Applications (NDAs) and supplemental Biologics License Applications (BLAs) across the U.S., the EU, Japan and China. During 2021, the Company received numerous regulatory approvals within oncology. Keytruda received approval for additional indications in the U.S. and/or internationally as monotherapy in the therapeutic areas of breast, colorectal, cutaneous squamous cell, esophageal, melanoma and renal cell cancers, as well as in combination with chemotherapy in the therapeutic areas of breast, cervical, gastric or gastroesophageal junction cancers. Keytruda was also approved in combination with Lenvima both for the treatment of certain adult patients with endometrial cancer and for the treatment of renal cell cancer. Lenvima is being developed in collaboration with Eisai Co., Ltd. (Eisai). Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received approval in China as monotherapy for the treatment of certain adult patients with metastatic castration resistant prostate cancer. Additionally, the U.S. Food and Drug Administration (FDA) approved Welireg (belzutifan), an oral hypoxia-inducible factor-2 alpha (HIF-2) inhibitor, for the treatment of adult patients with von Hippel-Lindau (VHL) Table o f Contents disease who require therapy for associated renal cell carcinoma (RCC), central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. Also in 2021, as updated in February 2022, the FDA granted Emergency Use Authorization (EUA) for molnupiravir, an investigational oral antiviral COVID-19 treatment being developed in a collaboration with Ridgeback Biotherapuetics LP (Ridgeback). Molnupiravir also received conditional marketing authorization in the United Kingdom (UK) and Special Approval for Emergency in Japan. Also in 2021, the FDA and the European Commission (EC) approved Vaxneuvance (Pneumococcal 15-valent Conjugate Vaccine), a pneumococcal conjugate vaccine for use in adults. Additionally, Verquvo, a medicine to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults was approved in the U.S., the EU and Japan. Verquvo is being jointly developed with Bayer AG (Bayer). In January 2022, the Japan Ministry of Health, Labor and Welfare (MHLW) approved Lyfnua (gefapixant) for adults with refractory or unexplained chronic cough. In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline with several regulatory submissions. Keytruda is under review in the U.S. and/or internationally for supplemental indications for the treatment of certain patients with triple negative breast, cervical, endometrial, melanoma, renal cell and tumor mutation burden-high (TMBH) cancers. Lynparza is under review for supplemental indications for the treatment of certain patients with breast and prostate cancers. Lenvima is under review in combination with Keytruda for a supplemental indication for the treatment of certain patients with hepatocellular carcinoma (HCC). MK-4482, molnupiravir, is under a rolling review by the European Medicines Agency (EMA); MK-7264, gefapixant, a selective, non-narcotic, orally-administered, investigational P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough is under review in the U.S. and the EU; and Vaxneuvance (V114), a 15-valent pneumococcal conjugate vaccine, is under priority review by the FDA for the prevention of invasive pneumococcal disease in pediatric patients. V114 is also under review in Japan for use in adults. The Companys Phase 3 oncology programs include: Keytruda in the therapeutic areas of biliary, cutaneous squamous cell, gastric, hepatocellular, mesothelioma, ovarian, prostate and small-cell lung cancers; Lynparza as monotherapy for colorectal cancer and in combination with Keytruda for non-small-cell lung and small-cell lung cancers; Lenvima in combination with Keytruda for colorectal, esophageal, gastric, head and neck, melanoma and non-small-cell lung cancers; Welireg for RCC; MK-1308A, the coformulation of quavonlimab, Mercks novel investigational anti-CTLA-4 antibody, and pembrolizumab for RCC; MK-3475, pembrolizumab subcutaneous for non-small-cell lung cancer (NSCLC); MK-7119, Tukysa (tucatinib), which is being developed in collaboration with Seagen Inc. (Seagen), for breast cancer; MK-4280A, the coformulation of favezelimab, Mercks novel investigational anti-LAG3 therapy, and pembrolizumab for colorectal cancer; and MK-7684A, the coformulation of vibostolimab, an anti-TIGIT therapy, and pembrolizumab for NSCLC. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas including: MK-7962, sotatercept, for the treatment of pulmonary arterial hypertension (PAH), which was obtained in the Acceleron acquisition; MK-1654, clesrovimab, for the prevention of respiratory syncytial virus; MK-8591, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) for the prevention of HIV-1 infection (which is on clinical hold); Table o f Contents MK-8591A, islatravir in combination with doravirine for the treatment of HIV-1 infection (which is on clinical hold); and MK-4482, molnupiravir, which is reflected in Phase 3 development in the U.S. as it remains investigational following EUA. The Company is allocating resources to support its commercial opportunities in the near term while investing heavily in research to support future innovations and long-term growth. Research and development expenses in 2021 reflect higher clinical development spending and increased investment in discovery research and early drug development. In November 2021, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.69 per share from $0.65 per share on the Companys outstanding common stock. During 2021, the Company returned $7.5 billion to shareholders through dividends and share repurchases. In December 2021, the Company completed its inaugural issuance of a $1.0 billion sustainability bond, which was part of an $8.0 billion underwritten bond offering. The Company intends to use the net proceeds from the sustainability bond offering to support projects and partnerships in the Companys priority environmental, social and governance (ESG) areas and contribute to the advancement of the United Nations Sustainable Development Goals. COVID-19 Update During the COVID-19 pandemic Merck has remained focused on protecting the safety of its employees, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of an antiviral therapy, supporting efforts to expand manufacturing capacity and supply of SARS-CoV-2/COVID-19 medicines and vaccines (see below), and supporting health care providers and Mercks communities. Although COVID-19-related disruptions negatively affected results in 2021 and 2020, Merck continues to experience strong global underlying demand across its business. In 2021, Mercks sales were unfavorably affected by COVID-19-related disruptions, which resulted in an estimated negative impact to Mercks Pharmaceutical segment sales of approximately $1.3 billion. Roughly 75% of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures and fewer well visits. Mercks sales were favorably affected by the authorization of molnupiravir in several markets as discussed further below, which resulted in sales of $952 million in 2021. In 2020, the estimated negative impact of COVID-19-related disruptions to Mercks sales was approximately $2.1 billion, of which approximately $2.0 billion was attributable to the Pharmaceutical segment and approximately $50 million was attributable to the Animal Health segment. In April 2021, Merck announced it was discontinuing the development of MK-7110 (formerly known as CD24Fc) for the treatment of hospitalized patients with COVID-19, which was obtained as part of Mercks acquisition of OncoImmune (see Note 4 to the consolidated financial statements). This decision resulted in charges of $207 million to Cost of sales in 2021. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $305 million in 2020, of which $260 million was reflected in Cost of sales and the remaining $45 million of costs were reflected in Research and development expenses. Operating expenses reflect a minor positive effect in 2021 as investments in COVID-19-related research largely offset the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Operating expenses were positively affected in 2020 by approximately $500 million primarily due to lower promotional and selling costs, as well as lower research and development expenses, net of investments in COVID-19-related antiviral and vaccine research programs. In addition, the COVID-19 pandemic has caused some disruption and volatility in the Companys global supply chain network, and the Company may in the future experience disruptions in availability and delays in shipments of raw materials and packaging, as well as related cost inflation. In December 2021, the FDA granted EUA for molnupiravir based on positive results from the Phase 3 MOVe-OUT clinical trial. Additionally, in December 2021, Japans MHLW granted Special Approval for Table o f Contents Emergency for molnupiravir. In November 2021, the UK Medicines and Healthcare products Regulatory Agency granted conditional marketing authorization for molnupiravir. In addition, in October 2021, the EMA initiated a rolling review for molnupiravir. Merck plans to work with the Committee for Medicinal Products for Human Use of the EMA to complete the rolling review process to facilitate initiating the formal review of the Marketing Authorization Application. Merck is developing molnupiravir in collaboration with Ridgeback. The companies are actively working with other regulatory agencies worldwide to submit applications for emergency use or marketing authorization. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets. See Note 5 to the consolidated financial statements for additional information related to the collaboration with Ridgeback. In March 2021, Merck announced it had entered into multiple agreements to support efforts to expand manufacturing capacity and supply of SARS-CoV-2/COVID-19 medicines and vaccines. The Biomedical Advanced Research and Development Authority (BARDA), a division of the Office of the Assistant Secretary for Preparedness and Response within the U.S. Department of Health and Human Services, is providing Merck with funding to adapt and make available a number of existing manufacturing facilities for the production of SARS-CoV-2/COVID-19 vaccines and medicines. Merck has also entered into agreements to support the manufacturing and supply of Johnson Johnsons SARS-CoV-2/COVID-19 vaccine. Merck is using certain of its facilities in the U.S. to produce drug substance, formulate and fill vials of Johnson Johnsons vaccine. Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform enacted in prior years, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 United States $ 22,425 14 % 14 % $ 19,588 6 % 6 % $ 18,420 International 26,279 20 % 17 % 21,930 6 % 9 % 20,701 Total $ 48,704 17 % 16 % $ 41,518 6 % 8 % $ 39,121 Worldwide sales grew 17% in 2021 primarily due to higher sales in the oncology franchise largely driven by strong growth of Keytruda and increased alliance revenue from Lynparza and Lenvima, as well as higher sales in the vaccines franchise, primarily attributable to growth in Gardasil/Gardasil 9, Varivax and ProQuad . Also contributing to revenue growth in 2021 were higher sales in the virology franchise attributable to molnupiravir, higher sales in the hospital acute care franchise, reflecting growth in Bridion and Prevymis , as well as higher sales of animal health products. Additionally, sales in 2021 benefited from higher third-party manufacturing sales and the achievement of milestones for an out-licensed product that triggered contingent payments to Merck. As discussed above, COVID-19-related disruptions unfavorably affected sales in 2021, but to a lesser extent than in 2020, which benefited year-over-year sales growth. Sales growth in 2021 was partially offset by lower sales of Pneumovax 23, the suspension of sales in 2020 of hospital acute care product Zerbaxa , and lower sales of virology products Isentress/Isentress HD . Sales in the U.S. grew 14% in 2021 primarily driven by higher sales of Keytruda , sales of molnupiravir, higher sales of Bridion , Gardasil 9 , Varivax and ProQuad , increased alliance revenue from Lynparza and Lenvima, Table o f Contents as well as higher sales of animal health products. Lower sales of Pneumovax 23, Januvia/Janumet and Zerbaxa partially offset revenue growth in the U.S. in 2021. International sales increased 20% in 2021 primarily due to growth in Gardasil/Gardasil 9, Keytruda , sales of molnupiravir, increased alliance revenue from Lynparza and Lenvima, as well as higher sales of Januvia/Janumet , Bridion , Prevymis and animal health products. International sales growth in 2021 was partially offset by lower sales of Noxafil , Zerbaxa and Isentress/Isentress HD . International sales represented 54% and 53% of total sales in 2021 and 2020, respectively. Worldwide sales increased 6% in 2020 primarily due to higher sales in the oncology franchise, as well as growth in certain hospital acute care products and animal health. Growth in these areas was largely offset by the negative effects of the COVID-19 pandemic as discussed above, competitive pressure in the virology franchise and pricing pressure in the diabetes franchise. See Note 19 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Keytruda $ 17,186 20 % 18 % $ 14,380 30 % 30 % $ 11,084 Alliance Revenue - Lynparza (1) 989 36 % 35 % 725 63 % 62 % 444 Alliance Revenue - Lenvima (1) 704 21 % 20 % 580 44 % 43 % 404 Emend 127 (13) % (15) % 145 (63) % (62) % 388 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Keytruda is an anti-PD-1 (programmed death receptor-1) therapy that has been approved as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal or gastroesophageal junction (GEJ) carcinoma, head and neck squamous cell carcinoma (HNSCC), HCC, NSCLC, melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer (solid tumors) including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma, TMB-H cancer (solid tumors), and urothelial carcinoma including non-muscle invasive bladder cancer. Additionally, Keytruda is approved as monotherapy for the adjuvant treatment of certain patients with RCC. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and nonsquamous NSCLC, in combination with chemotherapy, with or without bevacizumab for cervical cancer, in combination with chemotherapy for esophageal cancer, in combination with chemotherapy for gastric cancer, in combination with chemotherapy for HNSCC, in combination with chemotherapy for triple-negative-breast cancer (TNBC), in combination with axitinib for advanced RCC, and in combination with Lenvima for both endometrial carcinoma and RCC. The Keytruda clinical development program includes studies across a broad range of cancer types. Global sales of Keytruda grew 20% in 2021 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally, although the COVID-19 pandemic had a dampening effect on growing demand by negatively affecting the number of new patients starting treatment. Sales in the U.S. continue to build across the multiple approved indications, in particular for the treatment of advanced NSCLC as monotherapy, and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with continued uptake in the TNBC, RCC, HNSCC, MSI-H cancer, and esophageal cancer indications. Keytruda sales growth in international markets reflects continued uptake predominately for the NSCLC, HNSCC and RCC indications, particularly in Europe. Sales growth in 2021 was partially offset by lower pricing in Europe, China and Japan. Global sales of Keytruda grew 30% in 2020 driven by higher demand globally, particularly in the U.S. and Europe, although the COVID-19 pandemic had an unfavorable effect on growing demand. Sales growth in 2020 was partially offset by lower pricing in Japan and Europe. Table o f Contents Keytruda received numerous regulatory approvals in 2021 summarized below. Date Approval January 2021 EC approval as a first-line treatment in adult patients with MSI-H or dMMR colorectal cancer based on the KEYNOTE-177 study. March 2021 EC approval of an expanded label as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed autologous stem cell transplant (ASCT) or following at least two prior therapies when ASCT is not a treatment option based on the KEYNOTE-204 and KEYNOTE-087 trials. March 2021 FDA approval in combination with platinum- and fluoropyrimidine-based chemotherapy for the treatment of certain patients with locally advanced or metastatic esophageal or GEJ carcinoma that is not amenable to surgical resection or definitive chemoradiation based on the KEYNOTE-590 trial. May 2021 FDA approval in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic human epidermal growth factor receptor 2 (HER2)-positive gastric or GEJ adenocarcinoma based on the KEYNOTE-811 trial. May 2021 EC approval of the 400 mg every six weeks (Q6W) dosing regimen to indications where Keytruda is administered in combination with other anticancer agents. June 2021 Chinas National Medical Products Administration (NMPA) approval as a first-line treatment of adult patients with MSI-H or dMMR colorectal cancer that is KRAS, NRAS and BRAF all wild-type based on the KEYNOTE-177 study. June 2021 EC approval in combination with chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus or HER2-negative GEJ adenocarcinoma in adults whose tumors express PD-L1 based on the KEYNOTE-590 trial. July 2021 FDA approval as monotherapy for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation based on the KEYNOTE-629 trial. July 2021 FDA approval of Keytruda plus Lenvima for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation based on the KEYNOTE-775/Study 309 trial. July 2021 FDA approval of Keytruda for treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant treatment and then continued as single agent as adjuvant treatment after surgery based on the KEYNOTE-522 trial. August 2021 FDA approval of Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC based on the KEYNOTE-581 trial/Study 307 trial. August 2021 Japans Pharmaceuticals and Medical Devices Agency (PMDA) approval for the treatment of patients with unresectable, advanced or recurrent MSI-H colorectal cancer based on the KEYNOTE-177 trial. August 2021 Japans PMDA approval for the treatment of patients with PD-L1-positive, hormone receptor-negative and HER2-negative, inoperable or recurrent breast cancer based on the KEYNOTE-355 trial. September 2021 Chinas NMPA approval in combination with chemotherapy for the first-line treatment of patients with locally advanced, unresectable or metastatic carcinoma of the esophagus or GEJ based on the KEYNOTE-590 trial. October 2021 FDA approval in combination with chemotherapy, with or without bevacizumab, for the treatment of patients with persistent, recurrent or metastatic cervical cancer based on the KEYNOTE-826 trial. October 2021 EC approval in combination with chemotherapy for the first-line treatment of locally recurrent unresectable or metastatic TNBC in adults whose tumors express PD-L1 and who have not received prior chemotherapy for metastatic disease based on the KEYNOTE-355 trial. November 2021 FDA approval for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy, or following nephrectomy and resection of metastatic lesions based on the KEYNOTE-564 trial. Table o f Contents November 2021 EC approval of Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC based on the CLEAR (Study 307)/KEYNOTE-581 trial. November 2021 EC approval of Keytruda plus Lenvima for the treatment of advanced or recurrent endometrial carcinoma in adults who have disease progression on or following prior treatment with a platinumcontaining therapy in any setting and who are not candidates for curative surgery or radiation based on the KEYNOTE-775/Study 309 trial. November 2021 Japans PMDA approval in combination with chemotherapy (5-fluorouracil plus cisplatin) for the first-line treatment of patients with radically unresectable, advanced or recurrent esophageal carcinoma in combination with chemotherapy based on the KEYNOTE-590 trial. December 2021 FDA approval for the adjuvant treatment of adult and pediatric (12 years and older) patients with stage IIB or IIC melanoma following complete resection based on the KEYNOTE-716 trial; FDA expanded the indication for the adjuvant treatment of stage III melanoma following complete resection to include pediatric patients (12 years and older). December 2021 Japans MHLW approval of Keytruda in combination with Lenvima for the treatment of patients with unresectable, advanced or recurrent endometrial carcinoma that progressed after cancer chemotherapy based on the KEYNOTE-775/Study 309 trial. In March 2021, Merck announced it was voluntarily withdrawing the U.S. indication for Keytruda for the treatment of patients with metastatic small-cell lung cancer with disease progression on or after platinum-based chemotherapy and at least one other prior line of therapy. The withdrawal of this indication was done in consultation with the FDA and does not affect other indications for Keytruda . As announced in January 2020, KEYNOTE-604, the confirmatory Phase 3 trial for this indication, met one of its dual primary endpoints of progression-free survival but did not reach statistical significance for the other primary endpoint of overall survival. In 2022, Merck initiated the withdrawal of the U.S. accelerated approval indication for Keytruda for the treatment of patients with recurrent locally advanced or metastatic gastric or GEJ adenocarcinoma whose tumors express PD-L1, with disease progression on or after two or more prior lines of therapy. The decision was made in consultation with the FDA following the Oncologic Drugs Advisory Committee evaluation of this third-line gastric cancer indication for Keytruda as a monotherapy because it failed to meet its post-marketing requirement of demonstrating an overall survival benefit in a Phase 3 study. The withdrawal of this indication does not affect other indications for Keytruda . The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the U.S. in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca (see Note 5 to the consolidated financial statements). Lynparza is approved for the treatment of certain types of advanced ovarian, breast, pancreatic and prostate cancers. Alliance revenue related to Lynparza grew 36% in 2021 and 63% in 2020 due to continued uptake across the multiple approved indications in the U.S., Europe, Japan and China. In June 2021, Lynparza was granted conditional approval in China as monotherapy for the treatment of certain previously treated adult patients with germline or somatic BRCA -mutated metastatic castration-resistant prostate cancer based on the results of the PROfound trial. Lenvima is an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai (see Note 5 to the consolidated financial statements). Lenvima is approved for the treatment of certain types of thyroid cancer, HCC, in combination with everolimus for certain patients with RCC, and in combination with Keytruda both for the treatment of certain patients with endometrial carcinoma and for the treatment of certain patients with RCC. Alliance revenue related to Lenvima grew 21% in 2021 and 44% in 2020 primarily due to higher demand in the U.S. and China. Global sales of Emend (aprepitant), for the prevention of certain chemotherapy-induced nausea and vomiting, declined 13% in 2021 reflecting lower volumes in Europe and China. Worldwide sales of Emend Table o f Contents decreased 63% in 2020 primarily due to lower demand and pricing in the U.S. due to generic competition for Emend for Injection following U.S. patent expiry in September 2019. Also contributing to the Emend sales decline in 2020 was lower demand in Europe and Japan as a result of generic competition for the oral formulation of Emend following loss of market exclusivity in May 2019 and December 2019, respectively. In June 2021, Koselugo (selumetinib) was granted conditional approval in the EU for the treatment of pediatric patients three years of age and older with neurofibromatosis type 1 who have symptomatic, inoperable plexiform neurofibromas based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Stratum 1 trial. Koselugo was approved by the FDA in April 2020. Koselugo is part of the same collaboration with AstraZeneca referenced above that includes Lynparza. In August 2021, the FDA approved Welireg , an oral HIF-2 inhibitor, for the treatment of adult patients with VHL disease who require therapy for associated RCC, central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. The approval was based on results from the open-label Study 004 trial. Welireg was obtained as part of Mercks 2019 acquisition of Peloton Therapeutics, Inc. (Peloton). See Note 4 to the consolidated financial statements. Vaccines ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Gardasil/Gardasil 9 $ 5,673 44 % 39 % $ 3,938 5 % 6 % $ 3,737 ProQuad 773 14 % 13 % 678 (10) % (10) % 756 M-M-R II 391 3 % 3 % 378 (31) % (31) % 549 Varivax 971 18 % 18 % 823 (15) % (15) % 970 Pneumovax 23 893 (18) % (19) % 1,087 17 % 18 % 926 Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of human papillomavirus (HPV), grew 44% in 2021 driven primarily by strong global demand, particularly in China, as well as increased supply. Higher pricing in China and the U.S. also contributed to sales growth in 2021. Sales growth in 2021 was unfavorably affected by the replenishment in 2020 of doses borrowed from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile, which favorably affected sales by $120 million in 2020. The timing of public sector purchases in the U.S. also partially offset sales growth in 2021. Global sales of Gardasil/Gardasil 9 grew 5% in 2020 primarily due to higher volumes in China and the replenishment in 2020 of doses borrowed from the CDC Pediatric Vaccine Stockpile in 2019. The replenishment resulted in the recognition of sales of $120 million in 2020, which, when combined with the reduction of sales of $120 million in 2019 due to the borrowing, resulted in a favorable impact to sales of $240 million in 2020 compared with 2019. Lower demand in the U.S. and Hong Kong, SAR, PRC attributable to the COVID-19 pandemic partially offset the increase in sales of Gardasil/Gardasil 9 in 2020. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (royalty obligations under this agreement expire in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the U.S. to another third party (these royalty obligations expire in December 2028). The royalties are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, grew 14% in 2021 due to higher sales in the U.S. reflecting higher demand driven by the ongoing COVID-19 pandemic recovery, as well as higher pricing. Worldwide sales of ProQuad declined 10% in 2020 driven primarily by lower demand in the U.S. resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic, partially offset by higher pricing. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, grew 3% in 2021 primarily due to higher sales in the U.S. reflecting the ongoing COVID-19 pandemic recovery inclusive of higher public sector mix of business. Lower demand in Europe partially offset MMR II sales growth in 2021. Global sales of M-M-R II declined 31% in 2020 driven primarily by lower demand in the U.S. resulting from fewer Table o f Contents measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic. Lower demand in Brazil also contributed to the M-M-R II sales decline in 2020. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), grew 18% in 2021 primarily reflecting the ongoing COVID-19 pandemic recovery and higher pricing in the U.S. Higher government tenders in Brazil also contributed to Varivax sales growth in 2021. Worldwide sales of Varivax declined 15% in 2020 driven primarily by lower demand in the U.S. resulting from the COVID-19 pandemic, partially offset by higher pricing. The Varivax sales decline in 2020 was also attributable to lower government tenders in Brazil. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, declined 18% in 2021 primarily due to lower sales in the U.S. attributable to lower demand reflecting prioritization of COVID-19 vaccination, partially offset by higher pricing. Global sales of Pneumovax 23 grew 17% in 2020 primarily due to higher volumes in Europe and the U.S. attributable in part to heightened awareness of pneumococcal vaccination. Higher pricing in the U.S. also contributed to Pneumovax 23 sales growth in 2020. In July 2021, the FDA approved Vaxneuvance for active immunization for the prevention of invasive disease caused by 15 Streptococcus pneumoniae serotypes in adults 18 years of age and older. In December 2021, Vaxneuvance was approved by the EC. These approvals were based on data from seven clinical studies assessing safety, tolerability, and immunogenicity in adults. In October 2021, the CDCs Advisory Committee on Immunization Practices (ACIP) voted to recommend vaccination either with a sequential regimen of Vaxneuvance followed by Pneumovax 23, or with a single dose of 20-valent pneumococcal conjugate vaccine both for adults 65 years and older and for adults ages 19 to 64 with certain underlying medical conditions. These recommendations subsequently were adopted by the director of the CDC and the U.S. Department of Health and Human Services and published in the CDCs Morbidity and Mortality Weekly Report . In September 2021, Merck announced a settlement and license agreement with Pfizer Inc. (Pfizer), resolving all worldwide patent infringement litigation related to the use of Mercks investigational and licensed pneumococcal conjugate vaccine (PCV) products, including Vaxneuvance . Under the terms of the agreement, Merck will make certain regulatory milestone payments to Pfizer, as well as royalty payments on the worldwide sales of its PCV products. The Company will pay royalties of 7.25% of net sales of all Merck PCV products through 2026; and 2.5% of net sales of all Merck PCV products from 2027 through 2035. Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis, Inactivated Poliovirus, Haemophilus b Conjugate and Hepatitis B Vaccine), developed as part of a U.S.-based partnership between Merck and Sanofi Pasteur, is now available in the U.S. for active immunization of children six weeks through four years of age to help prevent diphtheria, tetanus, pertussis, poliomyelitis, hepatitis B, and invasive disease due to Haemophilus influenzae type b. In February 2021, the CDCs ACIP included Vaxelis as a combination vaccine option in the CDCs Recommended Child and Adolescent Immunization Schedule. Sales of Vaxelis in the U.S. are made through the U.S.-based Merck/Sanofi Pasteur partnership, the results of which are reflected in equity income from affiliates included in Other (income) expense, net. Supply sales to the partnership are recorded within Sales . Vaxelis is also approved in the EU where it is marketed directly by Merck and Sanofi Pasteur. Hospital Acute Care ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Bridion $ 1,532 28 % 27 % $ 1,198 6 % 7 % $ 1,131 Prevymis 370 32 % 30 % 281 70 % 69 % 165 Noxafil 259 (21) % (23) % 329 (50) % (50) % 662 Zerbaxa (1) * * 130 8 % 10 % 121 * Calculation not meaningful. Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 28% in 2021 due to higher demand globally, particularly in the U.S. and Europe, attributable to the COVID-19 pandemic recovery, as well as increased usage of neuromuscular blockade reversal agents and Bridion s growing share within the class. Bridion was also approved by the FDA in June 2021 for pediatric patients aged 2 years and older undergoing surgery. Worldwide sales of Bridion grew 6% in 2020 due to higher demand globally, Table o f Contents particularly in the U.S. However, fewer elective surgeries as a result of the COVID-19 pandemic unfavorably affected demand in 2020. Worldwide sales of Prevymis , a medicine for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients of an allogenic hematopoietic stem cell transplant, grew 32% in 2021 and increased 70% in 2020 due to continued uptake since launch in several markets, particularly in Europe and the U.S. Worldwide sales of Noxafil , an antifungal agent for the prevention of certain invasive fungal infections, declined 21% in 2021 primarily due to generic competition in Europe, partially offset by higher demand in China. The patent that provided market exclusivity for Noxafil in a number of major European markets expired in December 2019. As a result, the Company is experiencing lower demand for Noxafil in these markets due to generic competition and expects the decline to continue. Global sales of Noxafil declined 50% in 2020 due to generic competition in the U.S. and in Europe. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. In December 2020, the Company temporarily suspended sales of Zerbaxa , a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections, and subsequently issued a product recall, following the identification of product sterility issues. As a result, the Company recorded an intangible asset impairment charge in 2020 related to Zerbaxa (see Note 9 to the consolidated financial statements). A phased resupply of Zerbaxa was initiated in the fourth quarter of 2021, which the Company expects to continue during 2022. Immunology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Simponi $ 825 (2) % (6) % $ 838 1 % 1 % $ 830 Remicade 299 (9) % (12) % 330 (20) % (20) % 411 Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 2% in 2021 and were nearly flat in 2020. Sales of Simponi are being unfavorably affected by biosimilar competition for competing products. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade , a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 9% in 2021 and decreased 20% in 2020 driven by ongoing biosimilar competition in the Companys marketing territories in Europe. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. on October 1, 2024. Virology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Molnupiravir $ 952 $ $ Isentress/Isentress HD 769 (10) % (11) % 857 (12) % (11) % 975 Zepatier 128 (23) % (25) % 167 (55) % (54) % 370 Molnupiravir is an investigational oral antiviral COVID-19 medicine being developed in a collaboration with Ridgeback (see Note 5 to the consolidated financial statements). The FDA granted an EUA for molnupiravir in December 2021; as updated in February 2022, to authorize molnupiravir for the treatment of mild to moderate COVID-19 in high-risk adults for whom alternative FDA-approved or authorized treatment options are not Table o f Contents accessible or clinically appropriate. Also in December 2021, Japans MHLW granted Special Approval for Emergency for molnupiravir to treat infectious disease caused by SARS-CoV-2. In November 2021, the UKs MHRA granted conditional marketing authorization for molnupiravir to treat mild to moderate COVID-19 in adults at risk of developing severe illness. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets and Merck began shipping molnupiravir in the fourth quarter of 2021 to countries where it is approved or authorized. Sales of molnupiravir were $952 million in 2021 primarily consisting of sales in the U.S., the UK and Japan. Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 10% in 2021 and decreased 12% in 2020 primarily due to competitive pressure particularly in Europe and the U.S. The Company expects competitive pressure for Isentress/Isentress HD to continue. Global sales of Zepatier , a treatment for adult patients with chronic hepatitis C virus genotype (GT) 1 or GT4 infection, declined 23% in 2021 primarily due to lower demand from competitive pressure in the U.S. and Europe. Worldwide sales of Zepatier declined 55% in 2020 driven by lower demand globally due to competition and declining patient volumes, coupled with the impact of the COVID-19 pandemic. Cardiovascular ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Alliance revenue - Adempas/Verquvo (1) $ 342 22 % 22 % $ 281 38 % 38 % $ 204 Adempas 252 14 % 11 % 220 3 % 2 % 215 (1) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 5 to the consolidated financial statements). Adempas and Verquvo are part of a worldwide collaboration with Bayer to market and develop soluble guanylate cyclase (sGC) modulators (see Note 5 to the consolidated financial statements). Adempas is approved for the treatment of certain types of PAH. Verquvo was approved in the U.S. in January 2021 to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults with symptomatic chronic heart failure and reduced ejection fraction. Verquvo was also approved in Japan in June 2021 and in the EU in July 2021. These approvals were based on the results of the VICTORIA trial. Alliance revenue from the collaboration grew 22% in 2021 and rose 38% in 2020. Revenue from the collaboration also includes sales of Adempas and Verquvo in Mercks marketing territories. Sales of Adempas in Mercks marketing territories grew 14% in 2021 primarily reflecting higher demand in Europe. Diabetes ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Januvia/Janumet $ 5,288 % (2) % $ 5,276 (4) % (4) % $ 5,524 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were nearly flat in 2021 and declined 4% in 2020. Sales performance in both periods reflects continued pricing pressure and lower demand in the U.S., largely offset by higher demand in certain international markets, particularly in China. The Company expects U.S. pricing pressure to continue. Januvia and Janumet will lose market exclusivity in the U.S. in January 2023, in the EU in September 2022, and in China in July 2022. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of exclusivity. Combined sales of Januvia and Janumet in the U.S., Europe and China represented 33%, 24% and 9%, respectively, of total combined Januvia and Janumet sales in 2021. Table o f Contents Animal Health Segment ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Livestock $ 3,295 12 % 10 % $ 2,939 6 % 9 % $ 2,784 Companion Animal 2,273 29 % 26 % 1,764 10 % 11 % 1,609 Sales of livestock products grew 12% in 2021 primarily due to higher demand for ruminant products, including animal health intelligence solutions for animal identification, monitoring and traceability, as well as higher demand for poultry and swine products. Sales of livestock products increased 6% in 2020 predominantly due to an additional five months of sales in 2020 related to the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 4 to the consolidated financial statements). Sales of companion animal products grew 29% in 2021 and rose 10% in 2020 primarily due to higher demand for parasiticides, including the Bravecto line of products, as well as higher demand for companion animal vaccines. Costs, Expenses and Other ($ in millions) 2021 % Change 2020 % Change 2019 Cost of sales $ 13,626 % $ 13,618 13 % $ 12,016 Selling, general and administrative 9,634 8 % 8,955 (5) % 9,455 Research and development 12,245 (9) % 13,397 38 % 9,724 Restructuring costs 661 15 % 575 (8) % 626 Other (income) expense, net (1,341) 51 % (890) * 129 $ 34,825 (2) % $ 35,655 12 % $ 31,950 * Calculation not meaningful. Cost of Sales Cost of sales was $13.6 billion in both 2021 and 2020 and was $12.0 billion in 2019. Cost of sales includes the amortization of intangible assets recorded in connection with acquisitions, collaborations, and licensing arrangements, which totaled $1.6 billion in 2021, $1.8 billion in 2020 and $1.7 billion in 2019. Costs in 2021 and 2020 also include charges of $225 million and $260 million, respectively, related to the discontinuation of COVID-19 development programs (see Note 4 to the consolidated financial statements). Additionally, costs in 2020 and 2019 include intangible asset impairment charges of $1.6 billion and $705 million related to marketed products and other intangibles (see Note 9 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business combinations and such charges could be material. Costs in 2020 also include inventory write-offs of $120 million related to a recall for Zerbaxa (see Note 9 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities, which amounted to $160 million in 2021, $175 million in 2020 and $251 million in 2019, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 72.0% in 2021 compared with 67.2% in 2020. The gross margin improvement in 2021 reflects lower impairments and amortization of intangible assets (noted above), as well as the favorable effects of product mix and lower inventory write-offs. Partially offsetting the gross margin improvement in 2021 were higher manufacturing costs, the impact of molnupiravir (which has a lower gross margin due to profit sharing with Ridgeback as discussed in Note 5 to the consolidated financial statements), and higher compensation and benefit costs. Gross margin was 67.2% in 2020 compared with 69.3% in 2019. The gross margin decline in 2020 reflects the unfavorable effects of higher impairments and amortization of intangible assets, pricing pressure, a charge related to the discontinuation of COVID-19 vaccine development programs, and higher inventory write-offs related to the recall of Zerbaxa (noted above), partially offset by the favorable effects of product mix and lower restructuring costs. Table o f Contents Selling, General and Administrative Selling, general and administrative (SGA) expenses were $9.6 billion in 2021, an increase of 8% compared with 2020. The increase was primarily due to higher administrative costs, including compensation and benefits, higher promotional expenses in support of the Companys key growth pillars, and higher acquisition-related costs, including costs related to the acquisition of Acceleron. The COVID-19 pandemic drove lower spending in 2020 which contributed to the increase in SGA expenses in 2021. These increases were partially offset by the favorable effects of foreign exchange and a contribution in 2020 to the Merck Foundation. SGA expenses were $9.0 billion in 2020, a decline of 5% compared with 2019. The decline was driven primarily by lower administrative, selling and promotional costs, including lower travel and meeting expenses, due in part to the COVID-19 pandemic, and the favorable effect of foreign exchange, partially offset by a contribution to the Merck Foundation. Research and Development Research and development (RD) expenses were $12.2 billion in 2021, a decline of 9% compared with 2020 primarily due to lower upfront payments related to acquisitions and collaborations. The decline was partially offset by higher clinical development spending and increased investment in discovery research and early drug development, net of the reimbursement of a portion of molnupiravir development costs through the partnership with Ridgeback. Higher compensation and benefit costs, higher in-process research and development (IPRD) impairment charges, as well as costs related to the acquisition of Acceleron also partially offset the decline in RD expenses in 2021. RD expenses were $13.4 billion in 2020, an increase of 38% compared with 2019. The increase was driven largely by higher upfront payments related to acquisitions and collaborations, higher clinical development spending and increased investment in discovery research and early drug development. Higher restructuring costs also contributed to the increase in RD expenses in 2020. The increase in RD expenses in 2020 was partially offset by lower IPRD impairment charges and lower costs resulting from the COVID-19 pandemic, net of spending on COVID-19-related vaccine and antiviral research programs. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $7.1 billion in 2021, $6.5 billion in 2020 and $6.0 billion in 2019. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $3.0 billion in 2021, $2.6 billion in 2020 and $2.6 billion in 2019. Additionally, RD expenses in 2021 include a $1.7 billion charge for the acquisition of Pandion. RD expenses in 2020 include a $2.7 billion charge for the acquisition of VelosBio Inc., a $462 million charge for the acquisition of OncoImmune and charges of $826 million related to transactions with Seagen. RD expenses in 2019 include a $993 million charge for the acquisition of Peloton. See Note 4 to the consolidated financial statements for more information on these transactions. RD expenses also include IPRD impairment charges of $275 million, $90 million and $172 million in 2021, 2020 and 2019, respectively (see Note 9 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business combinations and such charges could be material. In addition, RD expenses in 2021 and 2020 include $28 million and $83 million, respectively, of costs associated with restructuring activities, primarily relating to accelerated depreciation. RD expenses also include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business combinations. The Company recorded $35 million of expenses in 2021 compared with a net reduction in expenses of $95 million and $39 million in 2020 and 2019, respectively, related to changes in these estimates. Restructuring Costs In 2019, Merck approved a global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization and builds on prior restructuring programs. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program estimated to be approximately $3.5 billion. The Company expects to record charges of Table o f Contents approximately $400 million in 2022 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program will result in annual net cost savings of approximately $900 million by the end of 2023. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $661 million in 2021, $575 million in 2020 and $626 million in 2019. Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative expenses and Research and development costs. The Company recorded aggregate pretax costs of $868 million in 2021, $880 million in 2020 and $915 million in 2019 related to restructuring program activities (see Note 6 to the consolidated financial statements). Other (Income) Expense, Net Other (income) expense, net, was $1.3 billion of income in 2021 compared with $890 million of income in 2020 primarily due to higher income from investments in equity securities, net, largely related to higher realized and unrealized gains on certain investments including the disposition in 2021 of the Companys ownership interest in Preventice Solutions Inc. (Preventice) as a result of the acquisition of Preventice by Boston Scientific, partially offset by higher foreign exchange losses and pension settlement costs. Other (income) and expense, net, was $890 million of income in 2020 compared with $129 million of expense in 2019, primarily due to higher income from investments in equity securities, net, largely related to Moderna, Inc. For details on the components of Other (income) expense, net, see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) 2021 2020 2019 Pharmaceutical segment profits $ 30,977 $ 26,106 $ 23,448 Animal Health segment profits 1,950 1,669 1,612 Other non-reportable segment profits 1 (7) Other (19,048) (21,913) (17,882) Income from Continuing Operations Before Taxes $ 13,879 $ 5,863 $ 7,171 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, RD expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including the amortization of intangible assets and amortization of purchase accounting adjustments, intangible asset impairment charges, and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Beginning in 2021, the amortization of intangible assets previously included as part of the calculation of Table o f Contents segment profits is now included in unallocated non-segment corporate expenses. Prior period Pharmaceutical and Animal Health segment profits have been recast to reflect this change on a comparable basis. Pharmaceutical segment profits grew 19% in 2021 primarily due to higher sales and the favorable effect of foreign exchange, partially offset by higher administrative and promotional costs. Pharmaceutical segment profits increased 11% in 2020 driven primarily by higher sales, as well as lower selling and promotional costs. Animal Health segment profits grew 17% in 2021 reflecting higher sales, partially offset by higher promotional, selling and administrative costs. Animal Health segment profits increased 4% in 2020 driven primarily by higher sales and lower promotional and selling costs, partially offset by higher RD costs and the unfavorable effect of foreign exchange. Taxes on Income The effective income tax rates from continuing operations were 11.0% in 2021, 22.9% in 2020 and 21.8% in 2019. The full year effective income tax rate reflects a favorable mix of income and expense, as well as higher foreign tax credits from ordinary business operations that the Company was able to credit in 2021. The effective income tax rate from continuing operations in 2021 also reflects the beneficial impact of the settlement of a foreign tax matter, as well as a net tax benefit of $207 million related to the settlement of certain federal income tax matters (see Note 16 to the consolidated financial statements). The effective income tax rate from continuing operations in 2021 also reflects the unfavorable effect of a charge for the acquisition of Pandion for which no tax benefit was recognized. The effective income tax rate in 2020 reflects the unfavorable impact of a charge for the acquisition of VelosBio for which no tax benefit was recognized. The effective income tax rate in 2019 reflects the favorable impact of a $106 million net tax benefit related to the settlement of certain federal income tax matters (see Note 16 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impact of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 16 to the consolidated financial statements). Net Income (Loss) Attributable to Noncontrolling Interests Net income (loss) attributable to noncontrolling interests was $13 million in 2021, $4 million in 2020 and $(84) million in 2019. The loss in 2019 was driven primarily by the portion of goodwill impairment charges related to certain businesses in the Healthcare Services segment that were attributable to noncontrolling interests. Non-GAAP Income and Non-GAAP EPS from Continuing Operations Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs, income and losses from investments in equity securities and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the U.S. (GAAP). Table o f Contents A reconciliation between GAAP financial measures and non-GAAP financial measures (from continuing operations) is as follows: ($ in millions except per share amounts) 2021 2020 2019 Income from continuing operations before taxes as reported under GAAP $ 13,879 $ 5,863 $ 7,171 Increase (decrease) for excluded items: Acquisition and divestiture-related costs (1) 2,484 3,642 2,970 Restructuring costs 868 880 915 Income from investments in equity securities, net (1,884) (1,292) (132) Other items: Charge for the acquisition of Pandion 1,704 Charges for the discontinuation of COVID-19 development programs 225 305 Charge for the acquisition of VelosBio (43) 2,660 Charges for the formation of collaborations (2) 1,076 Charge for the acquisition of OncoImmune 462 Charge for the acquisition of Peloton 993 Other (4) (20) 55 Non-GAAP income from continuing operations before taxes 17,229 13,576 11,972 Taxes on income as reported under GAAP 1,521 1,340 1,565 Estimated tax benefit on excluded items (3) 206 793 710 Net tax benefit from the settlement of certain federal income tax matters 207 106 Adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition (67) Tax benefit from the reversal of tax reserves related to the divestiture of MCC 86 Net tax charge related to the finalization of treasury regulations related to the enactment of the TCJA (117) Non-GAAP taxes on income from continuing operations 1,934 2,066 2,350 Non-GAAP net income from continuing operations 15,295 11,510 9,622 Less: Net income (loss) attributable to noncontrolling interests as reported under GAAP 13 4 (84) Acquisition and divestiture-related costs attributable to noncontrolling interests (89) Non-GAAP net income from continuing operations attributable to noncontrolling interests 13 4 5 Non-GAAP net income attributable to Merck Co., Inc. $ 15,282 $ 11,506 $ 9,617 EPS assuming dilution from continuing operations as reported under GAAP $ 4.86 $ 1.78 $ 2.21 EPS difference 1.16 2.75 1.52 Non-GAAP EPS assuming dilution from continuing operations $ 6.02 $ 4.53 $ 3.73 (1) Amount in 2020 includes a $1.6 billion intangible asset impairment charge related to Zerbaxa . Amount in 2019 includes a $612 million intangible asset impairment charge related to Sivextro . See Note 9 to the consolidated financial statements. (2) Includes $826 million related to transactions with Seagen. See Note 4 to the consolidated financial statements. (3) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges, and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with acquisitions and divestitures. Non-GAAP income and non-GAAP EPS also exclude amortization of intangible assets related to collaborations and licensing arrangements. Table o f Contents Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 6 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Income and Losses from Investments in Equity Securities Non-GAAP income and non-GAAP EPS exclude realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS are charges for the acquisitions of Pandion, VelosBio, OncoImmune and Peloton, as well as charges related to collaborations, including transactions with Seagen (see Note 4 to the consolidated financial statements). Also excluded from non-GAAP income and non-GAAP EPS are charges related to the discontinuation of COVID-19 development programs (see Note 4 to the consolidated financial statements). Additionally, excluded from non-GAAP income and non-GAAP EPS are certain tax items, including net tax benefits related to the settlement of certain federal income tax matters, an adjustment to tax benefits recorded in conjunction with the 2015 acquisition of Cubist Pharmaceuticals, Inc., a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC, and a net tax charge related to the finalization of U.S. treasury regulations related to the TCJA (see Note 16 to the consolidated financial statements). Research and Development Research Pipeline The Company currently has several candidates under regulatory review in the U.S. and internationally, as well as in late-stage clinical development. A chart reflecting the Companys current research pipeline as of February 22, 2022 and related discussion is set forth in Item 1. Business Research and Development above. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are summarized below; additional details are included in Note 4 to the consolidated financial statements. Merck actively monitors the landscape for growth opportunities that meet the Companys strategic criteria. In March 2021, Merck and Gilead entered into an agreement to jointly develop and commercialize long-acting treatments in HIV that combine Mercks investigational NRTTI, islatravir, and Gileads investigational capsid inhibitor, lenacapavir. The collaboration will initially focus on long-acting oral formulations and long-acting injectable formulations of these combination products, with other formulations potentially added to the collaboration as mutually agreed. There was no upfront payment made by either party upon entering into the agreement. In April 2021, Merck acquired Pandion, a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases, for total consideration of $1.9 billion. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. In November 2021, Merck acquired Acceleron, a publicly traded biopharmaceutical company, for total consideration of $11.5 billion. Acceleron is evaluating the TGF-beta superfamily of proteins that is known to play a central role in the regulation of cell growth, differentiation and repair. Accelerons lead therapeutic candidate, Table o f Contents sotatercept (MK-7962), has a novel mechanism of action with the potential to improve short-term and/or long-term clinical outcomes in patients with PAH. Sotatercept is in Phase 3 trials as an add-on to current standard of care for the treatment of PAH. In addition to sotatercept, Accelerons portfolio includes Reblozyl (luspatercept), a first-in-class erythroid maturation recombinant fusion protein that is approved in the U.S., Europe, Canada and Australia for the treatment of anemia in certain rare blood disorders and is being evaluated in clinical trials for additional indications for hematology therapies. Reblozyl is being developed and commercialized through a global collaboration with Bristol Myers Squibb. Acquired In-Process Research and Development In connection with business combinations, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2021, the balance of IPRD was $9.3 billion (see Note 9 to the consolidated financial statements). The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if the IPRD programs require additional clinical trial data than previously anticipated, or if the programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges, which could be material. In 2021, 2020, and 2019 the Company recorded IPRD impairment charges within Research and development expenses of $275 million, $90 million and $172 million, respectively (see Note 9 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Capital Expenditures Capital expenditures were $4.4 billion in 2021, $4.4 billion in 2020 and $3.4 billion in 2019. Expenditures in the U.S. were $2.8 billion in 2021, $2.6 billion in 2020 and $1.9 billion in 2019. The Company plans to invest approximately $20 billion in capital projects from 2021-2025 including expanding manufacturing capacity for oncology, vaccine and animal health products. Depreciation expense was $1.6 billion in 2021, $1.7 billion in 2020 and $1.6 billion in 2019, of which $1.1 billion in 2021, $1.2 billion in 2020 and $1.2 billion in 2019, related to locations in the U.S. Total depreciation expense in 2021, 2020 and 2019 included accelerated depreciation of $91 million, $268 million and $233 million, respectively, associated with restructuring activities (see Note 6 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) 2021 2020 2019 Working capital $ 6,394 $ 437 $ 5,263 Total debt to total liabilities and equity 31.3 % 34.7 % 31.2 % Cash provided by operating activities of continuing operations to total debt 0.4:1 0.2:1 0.3:1 Table o f Contents The increase in working capital in 2021 compared with 2020 is primarily related to decreased short-term debt. Cash provided by operating activities of continuing operations was $13.1 billion in 2021 compared with $7.6 billion in 2020 and $8.9 billion in 2019. The higher cash provided by operating activities of continuing operations in 2021 reflects stronger operating performance. Cash provided by operating activities of continuing operations includes upfront and milestone payments related to collaborations of $435 million in 2021, $2.9 billion in 2020 and $805 million in 2019. Cash provided by operating activities of continuing operations continues to be the Companys source of funds to finance operating needs, with excess cash serving as the primary source of funds to finance capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities of continuing operations was $16.4 billion in 2021 compared with $9.2 billion in 2020. The higher use of cash in investing activities of continuing operations was primarily due to higher cash used for acquisitions, including for the acquisition of Acceleron, and lower proceeds from sales of securities and other investments, partially offset by the 2020 purchase of Seagen common stock. Cash used in investing activities of continuing operations was $9.2 billion in 2020 compared with $2.5 billion in 2019. The increase was driven primarily by lower proceeds from the sales of securities and other investments, higher use of cash for acquisitions, higher capital expenditures and the purchase of Seagen common stock, partially offset by lower purchases of securities and other investments. Cash provided by financing activities of continuing operations was $3.1 billion in 2021 compared with a use of cash in financing activities of continuing operations of $2.8 billion in 2020. The change was primarily driven by the cash distribution received from Organon in connection with the spin-off (see Note 3 to the consolidated financial statements), higher proceeds from the issuance of debt (see below) and lower purchases of treasury stock, partially offset by a net decrease in short-term borrowings in 2021 compared with a net increase in short-term borrowings in 2020, higher payments on debt (see below) and higher dividends paid to shareholders. Cash used in financing activities of continuing operations was $2.8 billion in 2020 compared with $8.9 billion in 2019. The lower use of cash in financing activities of continuing operations was driven primarily by a net increase in short-term borrowings in 2020 compared with a net decrease in short-term borrowing in 2019, as well as lower purchases of treasury stock, partially offset by higher payments on debt (see below), lower proceeds from the issuance of debt (see below), higher dividends paid to shareholders and lower proceeds from the exercise of stock options. In December 2021, the Company issued $8.0 billion principal amount of senior unsecured notes consisting of $1.5 billion of 1.70% notes due 2027, $1.0 billion of 1.90% notes due 2028, $2.0 billion of 2.15% notes due 2031, $2.0 billion of 2.75% notes due 2051 and $1.5 billion of 2.90% notes due 2061. Merck used the net proceeds from the offering of the 2027 notes, the 2031 notes, the 2051 notes and the 2061 notes for general corporate purposes, including the repayment of outstanding commercial paper borrowings (including commercial paper borrowings in connection with Mercks acquisition of Acceleron), and other indebtedness. Merck allocated an amount equal to the net proceeds of the offering of the notes due in 2028 to finance or refinance, in whole or in part, projects and partnerships in the Companys priority ESG areas. In June 2020, the Company issued $4.5 billion principal amount of senior unsecured notes consisting of $1.0 billion of 0.75% notes due 2026, $1.25 billion of 1.45% notes due 2030, $1.0 billion of 2.35% notes due 2040 and $1.25 billion of 2.45% notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings and other indebtedness. In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings. In February 2022, the Companys $1.25 billion, 2.35% notes matured in accordance with their terms and were repaid. In 2021, the Companys $1.15 billion, 3.875% notes and the Companys 1.0 billion, 1.125% notes matured in accordance with their terms and were repaid. In 2020, the Companys $1.25 billion, 1.85% notes and $700 million floating-rate notes matured in accordance with their terms and were repaid. Table o f Contents The Company has a $6.0 billion credit facility that matures in June 2026. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. The Company expects foreseeable liquidity and capital resource requirements to be met through existing cash and cash equivalents and anticipated cash flows from operations, as well as commercial paper borrowings and long-term borrowings if needed. Merck believes that its sources of financing will be adequate to meet its future requirements. The Companys material cash requirements arising in the normal course of business primarily include: Debt Obligations and Interest Payments See Note 10 to the consolidated financial statements for further detail of the Companys debt obligations and the timing of expected future principal and interest payments. Tax Liabilities In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA. Additionally, the Company has liabilities for unrecognized tax benefits, including interest and penalties. See Note 16 to the consolidated financial statements for further information pertaining to the transition tax and liabilities for unrecognized tax benefits. Operating Leases See Note 10 to consolidated financial statements for further details of the Companys lease obligations and the timing of expected future lease payments. Contingent Milestone Payments The Company has accrued liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca, Eisai, and Bayer where payment has been deemed probable, but remains subject to the achievement of the related sales milestone. See Note 5 to the consolidated financial statements for additional information related to these sales-based milestones. Purchase Obligations Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Purchase obligations also include future inventory purchases the Company has committed to in connection with certain divestitures. As of December 31, 2021, the Company had total purchase obligations of $5.3 billion, of which $1.6 billion is estimated to be payable in 2022. In March 2021, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company believes it maintains a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2021, Mercks Board of Directors increased the quarterly dividend, declaring a quarterly dividend of $0.69 per share on the Companys outstanding common stock that was paid in January 2022. In January 2022, the Board of Directors declared a quarterly dividend of $0.69 per share on the Companys common stock for the second quarter of 2022 payable in April 2022. In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. In May 2021, Merck restarted its share repurchase program, which the Company had temporarily suspended in March 2020. The Company spent $840 million to purchase 11 million shares of its common stock for its treasury during 2021 under this program. As of December 31, 2021, the Companys remaining share repurchase Table o f Contents authorization was $5.0 billion. The Company purchased $1.3 billion and $4.8 billion of its common stock during 2020 and 2019, respectively, under authorized share repurchase programs. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other Comprehensive Income (Loss) ( OCI) , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated Other Comprehensive Loss ( AOCL) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $648 million and $593 million at December 31, 2021 and 2020, respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro, Japanese yen, British pound, Canadian dollar and Swiss franc. For exposures in developing country currencies, including the Chinese renminbi, the Company will enter into forward contracts to offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the Table o f Contents hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2021 and 2020, Income from Continuing Operations Before Taxes would have declined by approximately $125 million and $99 million in 2021 and 2020, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCL until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2021, the Company was a party to nine pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) 2021 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 2.40% notes due 2022 $ 1,000 4 $ 1,000 2.35% notes due 2022 (1) 1,250 5 1,250 (1) These interest rate swaps matured in February 2022. Table o f Contents The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. See Note 2 to the consolidated financial statements for a discussion of the pending discontinuation of LIBOR as part of reference rate reform. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2021 and 2020 would have positively affected the net aggregate market value of these instruments by $3.2 billion and $2.6 billion, respectively. A one percentage point decrease at December 31, 2021 and 2020 would have negatively affected the net aggregate market value by $3.9 billion and $3.1 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Estimates The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. The fair values of intangible assets are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) Table o f Contents over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent and any related patent term extension, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each IPRD project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of Table o f Contents ownership transfer to the customer and the Company is entitled to payment. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the U.S., sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, if collection of accounts receivable is expected to be in excess of one year, sales are recorded net of time value of money discounts, which have not been material. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2021, 2020 or 2019. Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) 2021 2020 Balance January 1 $ 2,776 $ 2,078 Current provision 12,412 11,423 Adjustments to prior years (110) (24) Payments (12,234) (10,701) Balance December 31 $ 2,844 $ 2,776 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $207 million and $2.6 billion, respectively, at December 31, 2021 and were $208 million and $2.6 billion, respectively, at December 31, 2020. Outside of the U.S., variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 Table o f Contents months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic or other competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 0.9% in 2021, 0.5% in 2020 and 1.0% in 2019. Outside of the U.S., returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the U.S., payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2021 and 2020 were $256 million and $279 million, respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense Table o f Contents reserves as of December 31, 2021 and 2020 of approximately $230 million and $235 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $12 million in 2021 and are estimated to be $24 million in the aggregate for the years 2022 through 2026. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $40 million and $43 million at December 31, 2021 and 2020, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $40 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense from continuing operations was $479 million in 2021, $441 million in 2020 and $388 million in 2019. At December 31, 2021, there was $699 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted-average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $748 million in 2021, $450 million in 2020 and $134 million in 2019. Net periodic benefit credit for other postretirement benefit plans was $83 million in 2021, $59 million in 2020 and $49 million in 2019. Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations Table o f Contents and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are attributable to settlement charges incurred by certain plans, as well as changes in the discount rate. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 2.60% to 3.10% at December 31, 2021, compared with a range of 2.10% to 2.80% at December 31, 2020. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2022, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will be 6.70%, compared to a range of 6.50% to 6.70% in 2021. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $85 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2021. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $58 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2021. Required funding obligations for 2022 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which primarily reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCL . Expected returns for pension plans are based on a calculated market-related value of assets. Net loss amounts in AOCL in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Table o f Contents Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax Table o f Contents position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs, environmental or other sustainability initiatives, and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Table o f Contents ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2021 and 2020, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2021, the notes to consolidated financial statements, and the report dated February 25, 2022 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) 2021 2020 2019 Sales $ 48,704 $ 41,518 $ 39,121 Costs, Expenses and Other Cost of sales 13,626 13,618 12,016 Selling, general and administrative 9,634 8,955 9,455 Research and development 12,245 13,397 9,724 Restructuring costs 661 575 626 Other (income) expense, net ( 1,341 ) ( 890 ) 129 34,825 35,655 31,950 Income from Continuing Operations Before Taxes 13,879 5,863 7,171 Taxes on Income from Continuing Operations 1,521 1,340 1,565 Net Income from Continuing Operations 12,358 4,523 5,606 Less: Net Income (Loss) Attributable to Noncontrolling Interests 13 4 ( 84 ) Net Income from Continuing Operations Attributable to Merck Co., Inc. 12,345 4,519 5,690 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 704 2,548 4,153 Net Income Attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 4.88 $ 1.79 $ 2.22 Income from Discontinued Operations 0.28 1.01 1.62 Net Income $ 5.16 $ 2.79 $ 3.84 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 4.86 $ 1.78 $ 2.21 Income from Discontinued Operations 0.28 1.00 1.61 Net Income $ 5.14 $ 2.78 $ 3.81 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2021 2020 2019 Net Income Attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Other Comprehensive Income (Loss) Net of Taxes: Net unrealized gain (loss) on derivatives, net of reclassifications 410 ( 297 ) ( 135 ) Net unrealized (loss) gain on investments, net of reclassifications ( 18 ) 96 Benefit plan net gain (loss) and prior service credit (cost), net of amortization 1,769 ( 279 ) ( 705 ) Cumulative translation adjustment ( 423 ) 153 96 1,756 ( 441 ) ( 648 ) Comprehensive Income Attributable to Merck Co., Inc. $ 14,805 $ 6,626 $ 9,195 The accompanying notes are an integral part of these consolidated financial statements. Table o f Contents Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) 2021 2020 Assets Current Assets Cash and cash equivalents $ 8,096 $ 8,050 Accounts receivable (net of allowance for doubtful accounts of $ 62 in 2021 and $ 67 in 2020) 9,230 6,803 Inventories (excludes inventories of $ 2,194 in 2021 and $ 2,070 in 2020 classified in Other assets - see Note 8) 5,953 5,554 Other current assets 6,987 4,674 Current assets of discontinued operations 2,683 Total current assets 30,266 27,764 Investments 370 785 Property, Plant and Equipment (at cost) Land 326 336 Buildings 12,529 11,998 Machinery, equipment and office furnishings 16,303 15,860 Construction in progress 8,313 6,968 37,471 35,162 Less: accumulated depreciation 18,192 18,162 19,279 17,000 Goodwill 21,264 18,882 Other Intangibles, Net 22,933 14,101 Other Assets 11,582 9,881 Noncurrent Assets of Discontinued Operations 3,175 $ 105,694 $ 91,588 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 2,412 $ 6,431 Trade accounts payable 4,609 4,327 Accrued and other current liabilities 13,859 12,212 Income taxes payable 1,224 1,597 Dividends payable 1,768 1,674 Current liabilities of discontinued operations 1,086 Total current liabilities 23,872 27,327 Long-Term Debt 30,690 25,360 Deferred Income Taxes 3,441 1,005 Other Noncurrent Liabilities 9,434 12,306 Noncurrent Liabilities of Discontinued Operations 186 Merck Co., Inc. Stockholders Equity Common stock, $ 0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2021 and 2020 1,788 1,788 Other paid-in capital 44,238 39,588 Retained earnings 53,696 47,362 Accumulated other comprehensive loss ( 4,429 ) ( 6,634 ) 95,293 82,104 Less treasury stock, at cost: 1,049,499,023 shares in 2021 and 1,046,877,695 shares in 2020 57,109 56,787 Total Merck Co., Inc. stockholders equity 38,184 25,317 Noncontrolling Interests 73 87 Total equity 38,257 25,404 $ 105,694 $ 91,588 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2019 $ 1,788 $ 38,808 $ 42,579 $ ( 5,545 ) $ ( 50,929 ) $ 181 $ 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($ 2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) 759 611 Balance December 31, 2019 1,788 39,660 46,602 ( 6,193 ) ( 55,950 ) 94 26,001 Net income attributable to Merck Co., Inc. 7,067 7,067 Other comprehensive loss, net of taxes ( 441 ) ( 441 ) Cash dividends declared on common stock ($ 2.48 per share) ( 6,307 ) ( 6,307 ) Treasury stock shares purchased ( 1,281 ) ( 1,281 ) Net income attributable to noncontrolling interests 15 15 Distributions attributable to noncontrolling interests ( 22 ) ( 22 ) Share-based compensation plans and other ( 72 ) 444 372 Balance December 31, 2020 1,788 39,588 47,362 ( 6,634 ) ( 56,787 ) 87 25,404 Net income attributable to Merck Co., Inc. 13,049 13,049 Other comprehensive income, net of taxes 1,756 1,756 Cash dividends declared on common stock ($ 2.64 per share) ( 6,715 ) ( 6,715 ) Treasury stock shares purchased ( 840 ) ( 840 ) Spin-off of Organon Co. 4,643 449 ( 1 ) 5,091 Net income attributable to noncontrolling interests 16 16 Distributions attributable to noncontrolling interests ( 29 ) ( 29 ) Share-based compensation plans and other 7 518 525 Balance December 31, 2021 $ 1,788 $ 44,238 $ 53,696 $ ( 4,429 ) $ ( 57,109 ) $ 73 $ 38,257 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2021 2020 2019 Cash Flows from Operating Activities of Continuing Operations Net income from continuing operations $ 12,358 $ 4,523 $ 5,606 Adjustments to reconcile net income from continuing operations to net cash provided by operating activities of continuing operations: Amortization 1,636 1,817 1,695 Depreciation 1,578 1,669 1,615 Intangible asset impairment charges 302 1,718 1,040 Income from investments in equity securities, net ( 1,940 ) ( 1,338 ) ( 170 ) Charge for the acquisition of Pandion Therapeutics, Inc. 1,556 Charge for the acquisition of VelosBio Inc. 2,660 Charge for the acquisition of Peloton Therapeutics, Inc. 993 Deferred income taxes 187 ( 566 ) ( 560 ) Share-based compensation 479 441 388 Other 805 1,294 354 Net changes in assets and liabilities: Accounts receivable ( 2,033 ) ( 1,002 ) 92 Inventories ( 674 ) ( 895 ) ( 473 ) Trade accounts payable 405 684 443 Accrued and other current liabilities 277 ( 1,152 ) 413 Income taxes payable ( 540 ) 814 ( 1,889 ) Noncurrent liabilities 484 ( 617 ) ( 733 ) Other ( 1,758 ) ( 2,433 ) 70 Net Cash Provided by Operating Activities of Continuing Operations 13,122 7,617 8,884 Cash Flows from Investing Activities of Continuing Operations Capital expenditures ( 4,448 ) ( 4,429 ) ( 3,369 ) Purchase of Seagen Inc. common stock ( 1,000 ) Purchases of securities and other investments ( 1 ) ( 95 ) ( 3,202 ) Proceeds from sales of securities and other investments 1,026 2,812 8,622 Acquisition of Acceleron Pharma Inc., net of cash acquired ( 11,174 ) Acquisition of Pandion Therapeutics, Inc., net of cash acquired ( 1,554 ) Acquisition of VelosBio Inc., net of cash acquired ( 2,696 ) Acquisition of ArQule, Inc., net of cash acquired ( 2,545 ) Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 179 ) ( 1,365 ) ( 294 ) Other ( 91 ) 125 374 Net Cash Used in Investing Activities of Continuing Operations ( 16,421 ) ( 9,193 ) ( 2,529 ) Cash Flows from Financing Activities of Continuing Operations Net change in short-term borrowings ( 3,986 ) 2,549 ( 3,710 ) Payments on debt ( 2,319 ) ( 1,957 ) Proceeds from issuance of debt 7,936 4,419 4,958 Distribution from Organon Co. 9,000 Purchases of treasury stock ( 840 ) ( 1,281 ) ( 4,780 ) Dividends paid to stockholders ( 6,610 ) ( 6,215 ) ( 5,695 ) Proceeds from exercise of stock options 202 89 361 Other ( 286 ) ( 436 ) 5 Net Cash Provided by (Used in) Financing Activities of Continuing Operations 3,097 ( 2,832 ) ( 8,861 ) Discontinued Operations Net cash provided by operating activities 987 2,636 4,556 Net cash used in investing activities ( 134 ) ( 250 ) ( 100 ) Net cash used in financing activities ( 504 ) Net Cash Flows Provided by Discontinued Operations 349 2,386 4,456 Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash ( 133 ) 253 17 Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 14 ( 1,769 ) 1,967 Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $ 103 of restricted cash at January 1, 2021 included in Other Assets - see Note 7) 8,153 9,934 7,967 Less: Cash and cash equivalents related to discontinued operations 12 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $ 71 of restricted cash at December 31, 2021 included in Other Assets - see Note 7) $ 8,167 $ 8,153 $ 9,934 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify and has been treated as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off (see Note 3). 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is Table o f Contents defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive loss ( AOCL ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are not impairment related are reported net of taxes in Other Comprehensive Income (OCI) . The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the extent to which fair value is less than cost, whether an allowance for credit loss is required, as well as adverse factors that could affect the value of the securities. An impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the impairment recognized in earnings, recorded in Other (income) expense, net is limited to the portion attributed to credit loss. The remaining portion of the impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period. Gains and losses from ownership interests in investment funds, which are accounted for as equity method investments, are reported on a one quarter lag. Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical Table o f Contents or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. Some customers have bill-and-hold arrangements with the Company. Revenue for bill-and-hold arrangements is recognized when control transfers to the customer even though the customer does not yet have physical possession of the goods. Control transfers when the bill-and-hold arrangement has been requested by the customer, the product is identified as belonging to the customer and is ready for physical transfer, the product cannot be directed for use by anyone but the customer and, in certain circumstances, the customer has inspected and accepted the product at the Companys facility. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the U.S., sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, if collection of accounts receivable is expected to be in excess of one year, sales are recorded net of time value of money discounts, which have not been material. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 12.3 billion in 2021, $ 11.4 billion in 2020 and $ 9.9 billion in 2019. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 207 Table o f Contents million and $ 2.6 billion, respectively, at December 31, 2021 and were $ 208 million and $ 2.6 billion, respectively, at December 31, 2020. Outside of the U.S., variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic or other competition, changes in formularies or launch of over-the-counter products, among others. Outside of the U.S., returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the U.S., payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. See Note 19 for disaggregated revenue disclosures. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.6 billion in 2021, $ 1.7 billion in 2020 and $ 1.6 billion in 2019. Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.0 billion in 2021, $ 1.8 billion in 2020 and $ 1.9 billion in 2019. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are being amortized over periods ranging from 3 to 10 years, with the longer lives generally associated with enterprise-wide projects implemented over multiple years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, trade names and patents, licenses and other, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted Table o f Contents future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each IPRD project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as a business combination, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration associated with IPRD assets. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. Table o f Contents In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on Income from Continuing Operations . The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S. (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Table o f Contents Recently Adopted Accounting Standards In December 2019, the Financial Accounting Standards Board (FASB) issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In August 2020, the FASB issued amended guidance on the accounting for convertible instruments and contracts in an entitys own equity. The guidance removes the separation model for convertible debt instruments and preferred stock, amends requirements for conversion options to be classified in equity as well as amends diluted earnings per share (EPS) calculations for certain convertible debt instruments. The amended guidance is effective for interim and annual periods in 2022. The application of the amendments in the new guidance are to be applied either on a modified retrospective or a retrospective basis. There was no impact to the Companys consolidated financial statements upon adoption on January 1, 2022. Recently Issued Accounting Standards Not Yet Adopted In March 2020, the FASB issued optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting and subsequently issued clarifying amendments. The guidance provides optional expedients and exceptions for accounting for contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The optional guidance is effective upon issuance and can be applied on a prospective basis at any time between January 1, 2020 through December 31, 2022. The Company is currently evaluating the impact of adoption on its consolidated financial statements. The Company is progressing in its evaluation of LIBOR cessation exposures, including the review of debt-related contracts, leases, business development and licensing arrangements, royalty and other agreements. The Company has amended certain agreements and continues to review other agreements for potential impacts. With regard to debt-related exposures in particular, all existing interest rate swaps linked to LIBOR will mature in 2022. The Company is still evaluating the impact to its LIBOR-based debt. Based on its evaluation thus far, the Company does not anticipate a material impact to its consolidated financial statements as a result of reference rate reform. In October 2021, the FASB issued amended guidance that requires acquiring entities to recognize and measure contract assets and liabilities in a business combination in accordance with existing revenue recognition guidance. The amended guidance is effective for interim and annual periods in 2023 and is to be applied prospectively. Early adoption is permitted on a retrospective basis to the beginning of the fiscal year of adoption. The adoption of this guidance will not have a material impact on the Companys consolidated financial statements for prior acquisitions; however, the impact in future periods will be dependent upon the contract assets and contract liabilities acquired in future business combinations. In November 2021, the FASB issued new guidance to increase the transparency of transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy. The guidance requires annual disclosures of such transactions to include the nature of the transactions and the significant terms and conditions, the accounting treatment and the impact to the companys financial statements. The guidance is effective for annual periods beginning in 2022 and is to be applied on either a prospective or retrospective basis. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of Organon through a distribution of Organons publicly traded stock to Company shareholders. In connection with the spin-off, each Merck shareholder received one-tenth of a share of Organons common stock for each share of Merck common stock held by such shareholder. The Table o f Contents distribution is expected to qualify and has been treated as tax free to Merck and its shareholders for U.S. federal income tax purposes. Indebtedness of $ 9.5 billion principal amount, consisting of term loans and senior notes, was issued in 2021 in connection with the spin-off and assumed by Organon. Merck is no longer the obligor of any Organon debt or financing arrangements. Cash proceeds of $ 9.0 billion were distributed by Organon to Merck in connection with the spin-off. Also in connection with the spin-off, Merck and Organon entered into a separation and distribution agreement and also entered into various other agreements to effect the spin-off and provide a framework for the relationship between Merck and Organon after the spin-off, including a transition services agreement (TSA), manufacturing and supply agreements (MSAs), trademark license agreements, intellectual property license agreements, an employee matters agreement, a tax matters agreement and certain other commercial agreements. Under the TSA, Merck will provide Organon various services and, similarly, Organon will provide Merck various services. The provision of services under the TSA generally will terminate within 25 months following the spin-off. Merck and Organon also entered into a series of interim operating agreements pursuant to which in various jurisdictions where Merck held licenses, permits and other rights in connection with marketing, import and/or distribution of Organon products prior to the separation, Merck will continue to market, import and distribute such products until such time as the relevant licenses and permits are transferred to Organon. Under such interim operating agreements and in accordance with the separation and distribution agreement, Merck will continue operations in the affected markets on behalf of Organon, with Organon receiving all of the economic benefits and burdens of such activities. Additionally, Merck and Organon entered into a number of MSAs pursuant to which Merck will (a) manufacture and supply certain active pharmaceutical ingredients for Organon, (b) toll manufacture and supply certain formulated pharmaceutical products for Organon, and (c) package and label certain finished pharmaceutical products for Organon. Similarly, Organon and Merck entered into a number of MSAs pursuant to which Organon will (a) manufacture and supply certain formulated pharmaceutical products for Merck, and (b) package and label certain finished pharmaceutical products for Merck. The terms of the MSAs range in initial duration from four years to ten years . Amounts included in the consolidated statement of income for the above MSAs include sales of $ 219 million and related cost of sales of $ 195 million in 2021. Amounts included in the consolidated statement of income for the TSAs was immaterial in 2021. The amount due from Organon under the above agreements was $ 964 million at December 31, 2021 and is reflected in Other current assets . The amount due to Organon under these agreements was $ 400 million at December 31, 2021 and is included in A ccrued and other current liabilities . The results of the womens health, biosimilars and established brands businesses (previously included in the Pharmaceutical segment) that were contributed to Organon in the spin-off, as well as interest expense related to the debt issuance in 2021, have been reflected as discontinued operations in the Companys consolidated statement of income as Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests through June 2, 2021, the date of the spin-off. Prior periods have been recast to reflect this presentation. As a result of the spin-off of Organon, Merck incurred separation costs of $ 556 million in 2021 and $ 743 million in 2020, which are also included in Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests . These costs primarily relate to professional fees for separation activities within finance, tax, legal and information technology functions, as well as investment banking fees. As of December 31, 2020, the assets and liabilities associated with these businesses are classified as assets and liabilities of discontinued operations in the consolidated balance sheet. Table o f Contents Details of Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests are as follows: Years Ended December 31 2021 (1) 2020 2019 Sales $ 2,512 $ 6,476 $ 7,719 Costs, Expenses and Other Cost of sales 789 1,867 2,096 Selling, general and administrative 877 1,513 1,160 Research and development 103 161 148 Restructuring costs 1 3 12 Other (income) expense, net ( 15 ) 4 10 1,755 3,548 3,426 Income from discontinued operations before taxes 757 2,928 4,293 Tax provision 50 369 122 Income from discontinued operations, net of taxes 707 2,559 4,171 Less: Income of discontinued operations attributable to noncontrolling interests 3 11 18 Income from discontinued operations, net of taxes and amounts attributable to noncontrolling interests $ 704 $ 2,548 $ 4,153 (1) Reflects amounts through the June 2, 2021 spin-off date. Details of assets and liabilities of discontinued operations are as follows: December 31 2020 Cash and cash equivalents $ 12 Accounts receivable, less allowance for doubtful accounts 1,048 Inventories 756 Other current assets 867 Current assets of discontinued operations $ 2,683 Property, plant and equipment, net $ 986 Goodwill 1,356 Other intangibles, net 503 Other assets 330 Noncurrent Assets of Discontinued Operations $ 3,175 Trade accounts payable $ 267 Accrued and other current liabilities 841 Income taxes payable ( 22 ) Total current liabilities of discontinued operations $ 1,086 Deferred income taxes $ 10 Other noncurrent liabilities 176 Noncurrent Liabilities of Discontinued Operations $ 186 As a result of the spin-off of Organon, Merck distributed net liabilities of $ 5.1 billion as of June 2, 2021 consisting of debt of $ 9.4 billion (described above), goodwill of $ 1.4 billion, property, plant and equipment of $ 981 million, cash of $ 929 million, inventory of $ 815 million, other intangibles, net, of $ 519 million and other net liabilities of $ 328 million. The spin-off also resulted in a net decrease to AOCL of $ 449 million consisting of $ 421 million for the derecognition of net losses on foreign currency translation adjustments and $ 28 million associated with employee benefit plans. The distribution of the net liabilities and reduction to AOCL resulted in a net $ 4.6 billion increase to Other paid-in capital . Table o f Contents Expenses for curtailments, settlements and termination benefits provided to certain employees were incurred in connection with the spin-off (see Note 14). Additionally, all outstanding Merck stock options, restricted stock units (RSUs) and performance share units (PSUs) (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees (see Note 13). 4. Acquisitions, Research Collaborations and License Agreements The Company continues to pursue acquisitions and the establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. 2021 Transactions In November 2021, Merck acquired Acceleron Pharma Inc. (Acceleron), a publicly traded biopharmaceutical company, for total consideration of $ 11.5 billion. Acceleron is evaluating the transforming growth factor (TGF)-beta superfamily of proteins that is known to play a central role in the regulation of cell growth, differentiation and repair. Accelerons lead therapeutic candidate, sotatercept (MK-7962), has a novel mechanism of action with the potential to improve short-term and/or long-term clinical outcomes in patients with pulmonary arterial hypertension (PAH). Sotatercept is in Phase 3 trials as an add-on to current standard of care for the treatment of PAH. Under a previous agreement assumed by Merck, Bristol Myers Squibb (BMS) was granted an exclusive license to develop and commercialize sotatercept outside of the pulmonary hypertension (PH) field (for which Merck would be eligible to receive contingent milestones and royalty payments), however, Merck retains the worldwide exclusive rights to develop and commercialize sotatercept in the PH field. The agreement provides for Merck to pay 22 % royalties on future sales of sotatercept in the PH field to BMS. In addition to sotatercept, Accelerons portfolio includes Reblozyl (luspatercept), a first-in-class erythroid maturation recombinant fusion protein that is approved in the U.S., Europe, Canada and Australia for the treatment of anemia in certain rare blood disorders and is also being evaluated in Phase 2 and Phase 3 trials for additional indications for hematology therapies. Reblozyl is being developed and commercialized through a global collaboration with BMS. In connection with this ongoing collaboration, Merck receives a 20 % sales royalty from BMS which could increase to a maximum of 24 % based on sales levels. This royalty will be reduced by 50 % upon the earlier of patent expiry or generic entry on an indication-by-indication basis in each market. Merck is eligible to receive future contingent milestone payments including up to $ 20 million in regulatory milestones and up to $ 80 million in sales-based milestones. The transaction was accounted for as a business combination. The Company incurred $ 280 million of costs directly related to the acquisition of Acceleron, consisting primarily of share-based compensation payments to settle non-vested equity awards attributable to postcombination service, severance, as well as investment banking and legal fees. These costs were included in Selling, general and administrative expenses and Research and development costs in 2021. Table o f Contents The estimated fair value of assets acquired and liabilities assumed from Acceleron is as follows: November 19, 2021 Cash and cash equivalents $ 340 Investments 285 Identifiable intangible assets: (1) IPRD - sotatercept 6,380 Products and product rights - Reblozyl ( 12 year useful life) 3,830 Deferred income tax liabilities, net ( 1,832 ) Other assets and liabilities, net 89 Total identifiable net assets 9,092 Goodwill (2) 2,422 Consideration transferred $ 11,514 (1) The estimated fair value of the identifiable intangible assets related to sotatercept and Reblozyl were determined using an income approach, specifically the multi-period excess earnings method. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 7.5 % for sotatercept and 6.0 % for Reblozyl . Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes. In April 2021, Merck acquired Pandion Therapeutics, Inc. (Pandion), a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. Total consideration paid of $ 1.9 billion included $ 147 million of costs primarily comprised of share-based compensation payments to settle equity awards. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 156 million (primarily cash) and Research and development expenses of $ 1.7 billion in 2021 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2021, Merck and Gilead Sciences, Inc. (Gilead) entered into an agreement to jointly develop and commercialize long-acting treatments in HIV that combine Mercks investigational nucleoside reverse transcriptase translocation inhibitor, islatravir, and Gileads investigational capsid inhibitor, lenacapavir. The collaboration will initially focus on long-acting oral formulations and long-acting injectable formulations of these combination products, with other formulations potentially added to the collaboration as mutually agreed. There was no upfront payment made by either party upon entering into the agreement. Under the terms of the agreement, Merck and Gilead will share operational responsibilities, as well as development, commercialization and marketing costs, and any future revenues. Global development and commercialization costs will be shared 60 % Gilead and 40 % Merck across the oral and injectable formulation programs. For long-acting oral products, Gilead will lead commercialization in the U.S. and Merck will lead commercialization in the EU and the rest of the world. For long-acting injectable products, Merck will lead commercialization in the U.S. and Gilead will lead commercialization in the EU and the rest of the world. Gilead and Merck will co-promote in the U.S. and certain other major markets. Merck and Gilead will share global product revenues equally until product revenues surpass certain pre-agreed per formulation revenue tiers. Upon passing $ 2.0 billion a year in net product sales for the oral combination, the revenue split will adjust to 65 % Gilead and 35 % Merck for any revenues above the threshold. Upon passing $ 3.5 billion a year in net product sales for the injectable combination, the revenue split will adjust to 65 % Gilead and 35 % Merck for any revenues above the threshold. Beyond the potential combinations of investigational lenacapavir and investigational islatravir, Gilead will have the option to license certain of Mercks investigational oral integrase inhibitors to develop in combination with lenacapavir. Reciprocally, Merck will have the option to license certain of Gileads investigational oral integrase inhibitors to develop in combination with islatravir. Each company may exercise its option for an investigational oral integrase inhibitor of the other company following completion of the first Phase 1 clinical trial of that integrase inhibitor. Upon exercise of an option, the companies will split development costs and revenues, unless the non-exercising company decides to opt-out. In December 2021, the U.S. Food and Drug Administration (FDA) placed full or partial clinical holds on investigational new drug applications for certain oral, implant and injectable formulations of islatravir based on Table o f Contents observations of decreases in total lymphocyte and CD4+ T-cell counts in some participants receiving islatravir in clinical studies. As a result of these holds, Merck and Gilead made the decision to stop all dosing of participants in a Phase 2 clinical study evaluating islatravir and lenacapavir in people living with HIV who are virologically suppressed on antiretroviral therapy. The two companies are assessing whether a different dosing of islatravir in combination with lenacapavir may provide a once-weekly oral therapy option for people living with HIV. Merck and Gilead remain committed to their collaboration. In January 2021, Merck entered into an exclusive license and research collaboration agreement with Artiva Biotherapeutics, Inc. (Artiva) to discover, develop and manufacture CAR-NK cells that target certain solid tumors using Artivas proprietary platform. Merck and Artiva agreed to engage in up to three different research programs, each covering a collaboration target. Merck has sole responsibility for all development and commercialization activities (including regulatory filing and approval). Under the terms of the agreement, Merck made an upfront payment of $ 30 million, which was included in Research and development expenses in 2021, for license and other rights for the first two collaboration targets and agreed to make another upfront payment of $ 15 million for license and other rights for the third collaboration target when it is selected by Merck and accepted by Artiva. In addition, Artiva is eligible to receive future contingent milestone payments (which span all three collaboration targets), aggregating up to $ 217.5 million in developmental milestones, $ 570 million in regulatory milestones, and $ 1.05 billion in sales-based milestones. The agreement also provides for Merck to pay tiered royalties ranging from 7 % to 14 % on future sales. 2020 Transactions In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $ 423 million. OncoImmunes lead therapeutic candidate (MK-7110) was being evaluated for the treatment of patients hospitalized with COVID-19. The transaction was accounted for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $ 50 million for a 20 % ownership interest in the new entity, which was valued at $ 33 million resulting in a $ 17 million premium. Merck also recognized other net liabilities of $ 22 million. The Company recorded Research and development expenses of $ 462 million in 2020 related to this transaction. In 2021, Merck received feedback from the FDA that additional data would be needed to support a potential Emergency Use Authorization (EUA) application and therefore the Company did not expect MK-7110 would become available until the first half of 2022. Given this timeline and the technical, clinical and regulatory uncertainties, the availability of a number of medicines for patients hospitalized with COVID-19, and the need to concentrate Mercks resources on accelerating the development and manufacture of the most viable therapeutics and vaccines, Merck decided to discontinue development of MK-7110 for the treatment of COVID-19. Due to the discontinuation, the Company recorded charges of $ 207 million in 2021, which are reflected in Cost of sales and relate to fixed assets and materials written off, as well as the recognition of liabilities for purchase commitments. Also in December 2020, Merck acquired VelosBio Inc. (VelosBio), a privately held, clinical-stage biopharmaceutical company, for $ 2.8 billion. VelosBios lead investigational candidate is zilovertamab vedotin (MK-2140), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 180 million (primarily cash) and Research and development expenses of $ 2.7 billion in 2020 related to the transaction. During 2021, the Company recorded adjustments to these amounts which resulted in a reduction of Research and development expenses of $ 43 million, an increase to total consideration paid of $ 47 million, and an increase to net assets recorded of $ 90 million. In September 2020, Merck and Seagen Inc. (Seagen) announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda (pembrolizumab) in triple-negative breast cancer, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. The companies will equally share profits worldwide. Under the terms of the agreement, Table o f Contents Merck made an upfront payment of $ 600 million and a $ 1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $ 200 per share. Merck recorded $ 616 million in Research and development expenses in 2020 related to this transaction reflecting the upfront payment as well as a $ 16 million premium relating to the equity shares based on the price of Seagen common stock on the closing date. Seagen is also eligible to receive future contingent milestone payments of up to $ 2.6 billion, including $ 850 million in development milestones and $ 1.75 billion in sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of human epidermal growth factor receptor 2 (HER2)-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the U.S., Canada and Europe. Merck will be responsible for marketing applications seeking approval in its territories, supported by the positive results from the HER2CLIMB clinical trial. Merck will also co-fund a portion of the Tukysa global development plan, which encompasses several ongoing and planned trials across HER2-positive cancers, including breast, colorectal, gastric and other cancers set forth in a global product development plan. Merck will solely fund and conduct country-specific clinical trials necessary to support anticipated regulatory applications in its territories. Under the terms of the agreement, Merck made upfront payments aggregating $ 210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones of up to $ 65 million and will receive tiered royalties ranging from 20 % to 33 % based on annual sales levels of Tukysa in Mercks territories. Additionally in September 2020, Merck acquired a biologics manufacturing facility located in Dunboyne, Ireland from Takeda Pharmaceutical Company Limited for 256 million ($ 302 million). The transaction was accounted for as an acquisition of an asset. Merck recorded property, plant and equipment of $ 289 million and other net assets of $ 13 million. There are no future contingent payments associated with the acquisition. In July 2020, Merck acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews from Virbac Corporation for $ 410 million. Sentinel products provide protection against common parasites in dogs. The transaction was accounted for as an acquisition of an asset. Merck recognized intangible assets of $ 401 million related to currently marketed products and inventory of $ 9 million at the acquisition date. The estimated fair values of the identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products will be amortized over their estimated useful lives of 15 years. There are no future contingent payments associated with the acquisition. Also in July 2020, Merck and Ridgeback Biotherapeutics LP (Ridgeback), a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. See Note 5 for additional information related to this collaboration. In June 2020, Merck acquired privately held Themis Bioscience GmbH (Themis), a company focused on vaccines (including a COVID-19 vaccine candidate, V591) and immune-modulation therapies for infectious diseases and cancer for $ 366 million. The acquisition originally provided for Merck to make additional contingent payments of up to $ 740 million. The transaction was accounted for as a business combination. The Company determined the fair value of the contingent consideration was $ 85 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payments. Merck recognized intangible assets for IPRD of $ 113 million, cash of $ 59 million, deferred tax assets of $ 72 million and other net liabilities of $ 32 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 239 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In January 2021, the Company announced it was discontinuing development of V591 as discussed below. As a result, in 2020, the Company recorded an IPRD impairment charge of $ 90 million within Research and development expenses. The Company also recorded a reduction in Research and development expenses resulting from a decrease in the related liability for contingent consideration of $ 45 million since future contingent milestone payments have been reduced to $ 450 million in the aggregate, including up to $ 60 million for development milestones, up to $ 196 million for regulatory approval milestones, and up to $ 194 million for commercial milestones. Table o f Contents In May 2020, Merck and the International AIDS Vaccine Initiative, Inc. (IAVI), a nonprofit scientific research organization dedicated to addressing urgent, unmet global health challenges, announced a collaboration to develop V590, an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. The agreement provided for an upfront payment by Merck of $ 6.5 million and also provided for future contingent payments based on sales. Merck also signed an agreement with the Biomedical Advanced Research and Development Authority (BARDA), part of the office of the Assistant Secretary for Preparedness and Response within an agency of the U.S. Department of Health and Human Services, to provide initial funding support to Merck for this effort. In January 2021, the Company announced it was discontinuing development of V590 as discussed below. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $ 305 million in 2020, of which $ 260 million was reflected in Cost of sales and related to fixed assets and materials written off, as well as the recognition of liabilities for purchase commitments . The remaining $ 45 million of costs were reflected in Research and development expenses and represent amounts related to the Themis acquisition noted above (an IPRD impairment charge, partially offset by a reduction in the related liability for contingent consideration). In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases. Total consideration paid of $ 2.7 billion included $ 138 million of share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of ArQule. The Company incurred $ 95 million of costs directly related to the acquisition of ArQule, consisting almost entirely of share-based compensation payments to settle non-vested equity awards attributable to postcombination service. These costs were included in Selling, general and administrative expenses in 2020. ArQules lead investigational candidate, nemtabrutinib (MK-1026), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as a business combination. The estimated fair value of assets acquired and liabilities assumed from ArQule is as follows: January 16, 2020 Cash and cash equivalents $ 145 IPRD - nemtabrutinib (1) 2,280 Licensing arrangement for ARQ 087 80 Deferred income tax liabilities ( 361 ) Other assets and liabilities, net 34 Total identifiable net assets 2,178 Goodwill (2) 512 Consideration transferred $ 2,690 (1) The estimated fair value of nemtabrutinib was determined using an income approach. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 12.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill was allocated to the Pharmaceutical segment and is not deductible for tax purposes. In 2021, Merck recorded a $ 275 million intangible asset impairment charge related to nemtabrutinib (see Note 9). 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Merck made an upfront payment of $ 1.2 billion. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million, deferred tax liabilities of $ 52 million, and other net liabilities of $ 4 million at the acquisition Table o f Contents date, as well as Research and development expenses of $ 993 million in 2019 related to the transaction. Former Peloton shareholders received a $ 50 million milestone payment from Merck in 2021 upon first commercial sale of Pelotons lead candidate, Welireg (belzutifan), which was approved as monotherapy in the U.S. in August 2021. Former Peloton shareholders are also eligible to receive $ 50 million upon U.S. regulatory approval as a combination therapy, as well as up to $ 1.05 billion of sales-based milestones. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as a business combination. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: April 1, 2019 Cash and cash equivalents $ 31 Accounts receivable 73 Inventories 93 Property, plant and equipment 60 Identifiable intangible assets (useful lives ranging from 18 - 24 years) (1) 2,689 Deferred income tax liabilities ( 589 ) Other assets and liabilities, net ( 82 ) Total identifiable net assets 2,275 Goodwill (2) 1,376 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 11.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as a business combination. Merck recognized intangible assets of $ 156 million, cash of $ 83 million and other net assets of $ 42 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 5. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies are also jointly developing and Table o f Contents commercializing AstraZenecas Koselugo (selumetinib) for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and Koselugo monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Profits from Lynparza and Koselugo product sales generated through monotherapies or combination therapies are shared equally. AstraZeneca is the principal on Lynparza and Koselugo sales transactions. Merck records its share of Lynparza and Koselugo product sales, net of cost of sales and commercialization costs, as alliance revenue, and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca and also made payments over a multi-year period for certain license options. In addition, the agreement provides for contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. Merck made sales-based milestone payments to AstraZeneca aggregating $ 550 million and $ 200 million in 2020 and 2019, respectively. As of December 31, 2021, sales-based milestone payments accrued but not yet paid totaled $ 400 million. Potential future sales-based milestone payments of $ 2.7 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020 and 2019, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 160 million and $ 60 million, respectively, in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.4 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 1.1 billion at December 31, 2021 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Lynparza $ 989 $ 725 $ 444 Alliance revenue - Koselugo 29 8 Total alliance revenue $ 1,018 $ 733 $ 444 Cost of sales (1) 167 247 148 Selling, general and administrative 178 160 138 Research and development 120 133 168 December 31 2021 2020 Receivables from AstraZeneca included in Other current assets $ 271 $ 215 Payables to AstraZeneca included in Trade a ccounts payable and Accrued and other current liabilities (2) 415 423 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone payments. Eisai In 2018, Merck and Eisai Co., Ltd. (Eisai) announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (lenvatinib), an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions) and Merck and Eisai share applicable profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development are shared by the two companies in accordance with the collaboration agreement and reflected in Research and development expenses. Certain expenses incurred solely by Merck or Eisai are not Table o f Contents shareable under the collaboration agreement, including costs incurred in excess of agreed upon caps and costs related to certain combination studies of Keytruda and Lenvima. Under the agreement, Merck made an upfront payment to Eisai and also made payments over a multi-year period for certain option rights (of which the final $ 125 million option payment was made in March 2021). In addition, the agreement provides for contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. Merck made sales-based milestone payments to Eisai aggregating $ 200 million, $ 500 million and $ 50 million in 2021, 2020 and 2019, respectively. As of December 31, 2021, sales-based milestone payments accrued but not yet paid totaled $ 600 million. Potential future sales-based milestone payments of $ 2.6 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2021 and 2020, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 75 million and $ 10 million, respectively, from Merck to Eisai. As of December 31, 2021, a regulatory approval milestone payment of $ 25 million was accrued but not yet paid. Potential future regulatory milestone payments of $ 25 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 1.0 billion at December 31, 2021 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Lenvima $ 704 $ 580 $ 404 Cost of sales (1) 195 271 206 Selling, general and administrative 127 73 80 Research and development 173 185 189 December 31 2021 2020 Receivables from Eisai included in Other current assets $ 200 $ 157 Payables to Eisai included in Accrued and other current liabilities (2) 625 335 Payables to Eisai included in Other Noncurrent Liabilities (3) 600 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone and future option payments. (3) Includes accrued milestone payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat). The two companies have implemented a joint development and commercialization strategy. The collaboration also includes development of Bayers Verquvo (vericiguat), which was approved in the U.S. in January 2021, in Japan in June 2021 and in the EU in July 2021. Under the agreement, Bayer commercializes Adempas in the Americas, while Merck commercializes in the rest of the world. For Verquvo, Merck commercializes in the U.S. and Bayer commercializes in the rest of the world. Both companies share in development costs and profits on sales. Merck records sales of Adempas and Verquvo in its marketing territories, as well as alliance revenue. Alliance revenue represents Mercks share of profits from sales of Adempas and Verquvo in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs. Cost of sales includes Bayers share of profits from sales in Mercks marketing territories. In addition, the agreement provided for contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. Merck made a sales-based milestone payment to Bayer of $ 375 million in 2020. In 2021, following the approval of Verquvo noted above, Merck determined it was probable that sales of Adempas and Verquvo in the future would trigger the remaining $ 400 million sales-based milestone Table o f Contents payment that was outstanding under this agreement. Accordingly, Merck recorded a liability of $ 400 million and a corresponding increase to the intangible assets related to this collaboration. Merck also recognized $ 153 million of cumulative amortization catch-up expense related to the recognition of this milestone in 2021. In January 2022, Merck made this final milestone payment to Bayer. The intangible asset balances related to Adempas (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments attributed to Adempas) and Verquvo (which reflects the portion of the final sales-based milestone payment that was attributed to Verquvo) were $ 806 million and $ 68 million, respectively, at December 31, 2021 and are included in Other Intangibles, Net . The assets are being amortized over their estimated useful lives (through 2027 for Adempas and through 2031 for Verquvo) as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Adempas/Verquvo $ 342 $ 281 $ 204 Net sales of Adempas recorded by Merck 252 220 215 Net sales of Verquvo recorded by Merck 7 Total sales $ 601 $ 501 $ 419 Cost of sales (1) 424 196 188 Selling, general and administrative 126 47 34 Research and development 53 63 126 December 31 2021 2020 Receivables from Bayer included in Other current assets $ 114 $ 65 Payables to Bayer included in Accrued and other current Liabilities (2) 472 (1) Includes amortization of intangible assets. Amount in 2021 includes $ 153 million of cumulative amortization catch-up expense as noted above. In addition, cost of sales in all periods now includes Bayers share of profits from sales in Mercks marketing territories. (2) Includes accrued milestone payment. Ridgeback Biotherapeutics LP In July 2020, Merck and Ridgeback, a closely held biotechnology company, entered into a collaboration agreement to develop molnupiravir (MK-4482), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback received an upfront payment and is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones. The agreement also provides for Merck to reimburse Ridgeback for a portion of certain third-party contingent milestone payments and royalties on net sales, which is part of the profit share calculation. Merck is the principal on sales transactions, recognizing sales and related costs, with profit sharing amounts recorded within Cost of sales . Profits from the collaboration are split equally between the partners. Reimbursements from Ridgeback for its share of research and development costs (deducted from Ridgebacks share of profits) are reflected as decreases to Research and development expenses. In December 2021, the FDA granted EUA for molnupiravir. Under a previously announced procurement agreement with the U.S. government, Merck agreed to supply 3.1 million courses of molnupiravir to the U.S. government upon EUA or approval from the FDA, of which approximately 888,000 courses were delivered in 2021. This procurement of molnupiravir is being supported in whole or in part with federal funds. Additionally, in December 2021, Japans Ministry of Health, Labor and Welfare granted Special Approval for Emergency in Japan for molnupiravir. Under a supply agreement, the Japanese government will purchase 1.6 million courses of molnupiravir, of which approximately 200,000 courses were delivered in 2021. Also, in November 2021, the Medicines and Healthcare products Regulatory Agency in the United Kingdom (UK) granted conditional marketing authorization for molnupiravir. The UK government has committed to purchase a total of 2.23 million courses of molnupiravir, of which approximately 152,000 courses were delivered in 2021. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets. Table o f Contents Merck and Ridgeback are committed to providing timely access to molnupiravir globally through a comprehensive supply and access approach, which includes investing at risk to produce millions of courses of therapy; tiered pricing based on the ability of governments to finance health care; entering into supply agreements with governments as noted above; allocating up to 3 million courses of therapy to the United Nations Childrens Fund (UNICEF) for use in adults; and granting voluntary licenses to generic manufacturers and to the Medicines Patent Pool (MPP) to make generic molnupiravir available in more than 100 low- and middle-income countries following local regulatory authorizations or approvals. Merck, Ridgeback and Emory University will not receive royalties for sales of molnupiravir under the MPP agreement (molnupiravir was invented at Emory University and licensed to Ridgeback) for as long as COVID-19 remains classified as a Public Health Emergency of International Concern by the World Health Organization. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 Molnupiravir sales $ 952 $ Cost of sales (1) 494 13 Selling, general and administrative 33 6 Research and development (2) 60 323 December 31 2021 2020 Payables to Ridgeback included in Accrued and other current liabilities (3) $ 283 $ 3 (1) Includes royalty expense and amortization of capitalized milestone payments. (2) Amount in 2020 includes upfront payment. (3) Includes accrued royalty and milestone payments. 6. Restructuring In 2019, Merck approved a global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization and builds on prior restructuring programs. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program estimated to be approximately $ 3.5 billion. The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 30 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company recorded total pretax costs of $ 868 million in 2021, $ 880 million in 2020 and $ 915 million in 2019 related to restructuring program activities. Since inception of the Restructuring Program through December 31, 2021, Merck has recorded total pretax accumulated costs of approximately $ 2.7 billion. The Company expects to record charges of approximately $ 400 million in 2022 related to the Restructuring Program. For segment reporting, restructuring charges are unallocated expenses. Table o f Contents The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2021 Cost of sales $ $ 52 $ 108 $ 160 Selling, general and administrative 12 7 19 Research and development 27 1 28 Restructuring costs 451 210 661 $ 451 $ 91 $ 326 $ 868 Year Ended December 31, 2020 Cost of sales $ $ 143 $ 32 $ 175 Selling, general and administrative 44 3 47 Research and development 81 2 83 Restructuring costs 385 190 575 $ 385 $ 268 $ 227 $ 880 Year Ended December 31, 2019 Cost of sales $ $ 198 $ 53 $ 251 Selling, general and administrative 33 1 34 Research and development 2 2 4 Restructuring costs 572 54 626 $ 572 $ 233 $ 110 $ 915 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2021, 2020 and 2019 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2020 $ 690 $ $ 25 $ 715 Expenses 385 268 227 880 (Payments) receipts, net ( 508 ) ( 271 ) ( 779 ) Non-cash activity ( 268 ) 38 ( 230 ) Restructuring reserves December 31, 2020 567 19 586 Expenses 451 91 326 868 (Payments) receipts, net ( 422 ) ( 186 ) ( 608 ) Non-cash activity ( 91 ) ( 118 ) ( 209 ) Restructuring reserves December 31, 2021 (1) $ 596 $ $ 41 $ 637 (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. Table o f Contents 7. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in AOCL and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro, Japanese yen, British pound, Canadian dollar and Swiss franc. For exposures in developing country currencies, including the Chinese renminbi, the Company will enter into forward contracts to offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . Table o f Contents The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCL until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 2021 2020 2019 2021 2020 2019 Net Investment Hedging Relationships Foreign exchange contracts $ ( 49 ) $ 26 $ ( 10 ) $ ( 13 ) $ ( 19 ) $ ( 31 ) Euro-denominated notes ( 296 ) 385 ( 75 ) (1) No amounts were reclassified from AOCL into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In January 2021, five interest rate swaps with a total notional amount of $ 1.15 billion matured. These swaps effectively converted the Companys $ 1.15 billion, 3.875 % fixed-rate notes due 2021 to variable rate debt. At December 31, 2021, the Company was a party to nine pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below: 2021 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 2.40 % notes due 2022 $ 1,000 4 $ 1,000 2.35 % notes due 2022 (1) 1,250 5 1,250 (1) These interest rate swaps matured in February 2022. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark LIBOR swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. See Note 2 for a discussion of the pending discontinuation of LIBOR as part of reference rate reform. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Table o f Contents The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount 2021 2020 2021 2020 Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 2,263 $ 1,150 $ 13 $ Long-Term Debt 2,301 53 Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: 2021 2020 Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other current assets $ 14 $ $ 2,250 $ 1 $ $ 1,150 Interest rate swap contracts Other Assets 54 2,250 Foreign exchange contracts Other current assets 271 6,778 12 3,183 Foreign exchange contracts Other Assets 43 1,551 45 2,030 Foreign exchange contracts Accrued and other current liabilities 24 1,623 217 5,049 Foreign exchange contracts Other Noncurrent Liabilities 1 43 1 52 $ 328 $ 25 $ 12,245 $ 112 $ 218 $ 13,714 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ 221 $ $ 10,073 $ 70 $ $ 7,260 Foreign exchange contracts Accrued and other current liabilities 96 10,640 307 11,810 $ 221 $ 96 $ 20,713 $ 70 $ 307 $ 19,070 $ 549 $ 121 $ 32,958 $ 182 $ 525 $ 32,784 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: 2021 2020 Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ 549 $ 121 $ 182 $ 525 Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 110 ) ( 110 ) ( 156 ) ( 156 ) Cash collateral posted/received ( 164 ) ( 36 ) Net amounts $ 275 $ 11 $ 26 $ 333 Table o f Contents The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 48,704 $ 41,518 $ 39,121 $ ( 1,341 ) ( 890 ) 129 $ 1,756 $ ( 441 ) $ ( 648 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items ( 40 ) 40 95 Derivatives designated as hedging instruments 1 ( 76 ) ( 65 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives 333 ( 383 ) 87 (Decrease) increase in Sales as a result of AOCL reclassifications ( 194 ) ( 6 ) 255 194 6 ( 255 ) Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 2 ) ( 4 ) ( 4 ) Amount of loss recognized in OCI on derivatives ( 2 ) ( 4 ) ( 6 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 2021 2020 2019 Derivatives Not Designated as Hedging Instruments Income Statement Caption Foreign exchange contracts (1) Other (income) expense, net $ 313 $ ( 12 ) $ 174 Foreign exchange contracts (2) Sales 9 13 1 Interest rate contracts (3) Other (income) expense, net 9 Forward contract related to Seagen common stock Research and development expenses 15 (1) These derivative contracts primarily mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. Amount in 2021 includes a loss on forward exchange contracts entered into in conjunction with the spin-off of Organon. (2) These derivatives serve as economic hedges of forecasted transactions. (3) These derivatives serve as economic hedges against rising treasury rates. At December 31, 2021, the Company estimates $ 170 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCL to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Table o f Contents Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: 2021 2020 Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses U.S. government and agency securities $ 80 $ $ $ 80 $ 84 $ $ $ 84 Foreign government bonds 2 2 5 5 Corporate notes and bonds 4 4 Total debt securities 86 86 89 89 Publicly traded equity securities (1) 1,647 1,787 Total debt and publicly traded equity securities $ 1,733 $ 1,876 (1) Unrealized net losses recorded in Other (income) expense, net on equity securities still held at December 31, 2021 were $ 232 million during 2021. Unrealized net gains recorded in Other (income) expense, net on equity securities still held at December 31, 2020 were $ 163 million during 2020. At December 31, 2021 and 2020, the Company also had $ 596 million and $ 586 million, respectively, of equity investments without readily determinable fair values included in Other Assets . The Company records unrealized gains on these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee and records unrealized losses based on unfavorable observable price changes, which are included in Other (income) expense, net . During 2021, the Company recorded unrealized gains of $ 110 million and unrealized losses of $ 1 million related to certain of these equity investments still held at December 31, 2021. During 2020, the Company recorded unrealized gains of $ 62 million and unrealized losses of $ 3 million related to certain of these investments still held at December 31, 2020. Cumulative unrealized gains and cumulative unrealized losses based on observable price changes for investments in equity investments without readily determinable fair values still held at December 31, 2021 were $ 234 million and $ 7 million, respectively. At December 31, 2021 and 2020, the Company also had $ 1.7 billion and $ 800 million, respectively, recorded in Other Assets for equity securities held through ownership interests in investment funds. (Gains) losses recorded in Other (income) expense, net relating to these investment funds were $( 1.4 ) billion, $( 583 ) million and $ 113 million for the years ended December 31, 2021, 2020 and 2019, respectively. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Table o f Contents Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total 2021 2020 Assets Investments Foreign government bonds $ $ 2 $ $ 2 $ $ 5 $ $ 5 Publicly traded equity securities 368 368 780 780 368 2 370 780 5 785 Other assets (1) U.S. government and agency securities 80 80 84 84 Corporate notes and bonds 4 4 Publicly traded equity securities 1,279 1,279 1,007 1,007 1,363 1,363 1,091 1,091 Derivative assets (2) Forward exchange contracts 351 351 90 90 Purchased currency options 184 184 37 37 Interest rate swaps 14 14 55 55 549 549 182 182 Total assets $ 1,731 $ 551 $ $ 2,282 $ 1,871 $ 187 $ $ 2,058 Liabilities Other liabilities Contingent consideration $ $ $ 777 $ 777 $ $ $ 841 $ 841 Derivative liabilities (2) Forward exchange contracts 120 120 505 505 Written currency options 1 1 20 20 121 121 525 525 Total liabilities $ $ 121 $ 777 $ 898 $ $ 525 $ 841 $ 1,366 (1) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (2) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2021 and 2020, Cash and cash equivalents include cash equivalents of $ 6.8 billion (which would be considered Level 2 in the fair value hierarchy). Table o f Contents Contingent Consideration Summarized information about the changes in the fair value of liabilities for contingent consideration associated with business combinations is as follows: 2021 2020 Fair value January 1 $ 841 $ 767 Additions 97 Changes in estimated fair value (1) 57 83 Payments ( 109 ) ( 106 ) Other ( 12 ) Fair value December 31 (2)(3) $ 777 $ 841 (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2021 includes $ 151 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2021 and 2020, $ 620 million and $ 711 million, respectively, of the liabilities relate to the termination of the Sanofi Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows using a risk-adjusted discount rate of 8 % to present value the cash flows. The additions to contingent consideration in 2020 relate to the acquisition of Themis (see Note 4). The payments of contingent consideration in both years relate to the Sanofi Pasteur MSD liabilities described above. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2021, was $ 35.7 billion compared with a carrying value of $ 33.1 billion and at December 31, 2020, was $ 36.0 billion compared with a carrying value of $ 31.8 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the U.S., Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented approximately 20 %, 15 % and 10 %, respectively, of total accounts receivable at December 31, 2021. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $ 2.8 billion and $ 2.1 billion of accounts receivable as of December 31, 2021 and 2020, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2021 and 2020, the Company had collected $ 62 million and $ 102 million, Table o f Contents respectively, on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2022 and 2021, respectively. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $ 164 million at December 31, 2021. The obligation to return such collateral is recorded in Accrued and other current liabilities . Cash collateral advanced by the Company to counterparties was $ 36 million at December 31, 2020. 8. Inventories Inventories at December 31 consisted of: 2021 2020 Finished goods $ 1,747 $ 1,610 Raw materials and work in process 6,220 5,949 Supplies 196 146 Total (approximates current cost) 8,163 7,705 Decrease to LIFO cost ( 16 ) ( 81 ) $ 8,147 $ 7,624 Recognized as: Inventories $ 5,953 $ 5,554 Other assets 2,194 2,070 Inventories valued under the LIFO method comprised approximately $ 3.3 billion and $ 2.8 billion at December 31, 2021 and 2020, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2021 and 2020, these amounts included $ 1.9 billion and $ 1.8 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 256 million and $ 279 million at December 31, 2021 and 2020, respectively, of inventories produced in preparation for product launches. 9. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2020 $ 14,825 $ 3,192 $ 52 $ 18,069 Acquisitions 742 105 847 Divestitures ( 54 ) ( 54 ) Other (1) 47 ( 29 ) 2 20 Balance December 31, 2020 (2) 15,614 3,268 18,882 Acquisitions 2,431 5 2,436 Other (1) ( 48 ) ( 6 ) ( 54 ) Balance December 31, 2021 (2) $ 17,997 $ 3,267 $ $ 21,264 (1) Includes cumulative translation adjustments on goodwill balances. (2) Accumulated goodwill impairment losses were $ 531 million at both December 31, 2021 and 2020. The additions to goodwill in the Pharmaceutical segment in 2021 were primarily related to the acquisition of Acceleron. The additions to goodwill in the Pharmaceutical segment in 2020 were primarily related to the acquisitions of ArQule and Themis. See Note 4 for more information on these acquisitions. Table o f Contents Other acquired intangibles at December 31 consisted of: 2021 2020 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 23,671 $ 15,776 $ 7,895 $ 20,928 $ 16,138 $ 4,790 IPRD 9,281 9,281 3,228 3,228 Trade names 2,882 493 2,389 2,882 352 2,530 Licenses and other 6,604 3,236 3,368 6,199 2,646 3,553 $ 42,438 $ 19,505 $ 22,933 $ 33,237 $ 19,136 $ 14,101 Acquired intangibles include products and product rights, IPRD, trade names and patents, licenses and other, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2021 include Reblozyl , $ 3.8 billion; Zerbaxa , $ 478 million; Gardasil/Gardasil 9, $ 191 million; Bridion , $ 145 million; Dificid , $ 145 million; Sivextro , $ 138 million; and Simponi , $ 101 million. Additionally, the Company had $ 5.0 billion of net acquired intangibles related to animal health marketed products at December 31, 2021, of which $ 2.3 billion relate primarily to trade names obtained through the 2019 acquisition of Antelliq (see Note 4). At December 31, 2021, IPRD primarily relates to MK-7962 (sotatercept), $ 6.4 billion, obtained through the acquisition of Acceleron in 2021 (see Note 4); MK-1026 (nemtabrutinib), $ 2.0 billion, obtained through the acquisition of ArQule in 2020 (see below and Note 4); and MK-7264 (gefapixant) $ 832 million, obtained through the acquisition of Afferent Pharmaceuticals in 2016. Some of the more significant net intangible assets included in licenses and other above at December 31, 2021 include Lynparza, $ 1.1 billion, related to a collaboration with AstraZeneca; Lenvima, $ 1.0 billion, related to a collaboration with Eisai; Adempas, $ 806 million related to a collaboration with Bayer; and Verquvo, $ 68 million, also related to a collaboration with Bayer. See Note 5 for additional information related to the intangible assets associated with these collaborations. In 2020, the Company recorded an impairment charge of $ 1.6 billion within Cost of sales related to Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. In December 2020, the Company temporarily suspended sales of Zerbaxa , and subsequently issued a product recall, following the identification of product sterility issues. The recall constituted a triggering event requiring the evaluation of the Zerbaxa intangible asset for impairment. The Company revised its cash flow forecasts for Zerbaxa utilizing certain assumptions around the return to market timeline and anticipated uptake in sales thereafter. These revised cash flow forecasts indicated that the Zerbaxa intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Zerbaxa that, when compared with its related carrying value, resulted in the impairment charge noted above. The Company also wrote-off inventory of $ 120 million to Cost of sales in 2020 related to the Zerbaxa recall. A phased resupply of Zerbaxa was initiated in the fourth quarter of 2021. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million. Of this amount, $ 612 million related to Sivextro (tedizolid phosphate), a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced cash flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until Table o f Contents completion or abandonment of the projects. Upon successful completion of each IPRD project, the Company will make a separate determination as to the then-useful life of the asset and begin amortization. In 2021, the Company recorded a $ 275 million IPRD impairment charge within Research and development expenses related to nemtabrutinib (MK-1026), a novel, oral BTK inhibitor currently being evaluated for the treatment of B-cell malignancies, obtained in connection with the acquisition of ArQule (see Note 4). As part of Mercks annual impairment assessment of IPRD intangible assets, the Company estimated the current fair value of nemtabrutinib utilizing projected future cash flows. The market participant assumptions used to derive the forecasted cash flows were updated to reflect the current competitive landscape for nemtabrutinib, including increased expected development costs for additional clinical trial data needed to develop nemtabrutinib, as well as a delay in the anticipated launch date for nemtabrutinib, which collectively reduced the projected future cash flows and estimated fair value. Additionally, the discount rate utilized to determine the current fair value of the asset was reduced to 8.5 % to reflect the current risk profile of the asset. The revised estimated fair value of nemtabrutinib when compared with its related carrying value resulted in the IPRD impairment charge noted above. The remaining IPRD intangible asset related to nemtabrutinib is $ 2.0 billion. If the assumptions used to estimate the fair value of nemtabrutinib prove to be incorrect and the development of nemtabrutinib does not progress as anticipated thereby adversely affecting projected future cash flows, the Company may record an additional impairment charge in the future and such charge could be material. In 2020, the Company recorded a $ 90 million IPRD impairment charge related to a decision to discontinue the development program for COVID-19 vaccine candidate V591 following Mercks review of findings from a Phase 1 clinical study for the vaccine. In the study, V591 was generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The discontinuation of this development program also resulted in a reversal of the related liability for contingent consideration of $ 45 million. In 2019, the Company recorded $ 172 million of IPRD impairment charges. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 11 million. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $ 1.6 billion in 2021, $ 1.8 billion in 2020 and $ 1.7 billion in 2019. The estimated aggregate amortization expense for each of the next five years is as follows: 2022, $ 1.7 billion; 2023, $ 1.6 billion; 2024, $ 1.6 billion; 2025, $ 1.4 billion; 2026, $ 1.4 billion. 10. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2021 included $ 2.3 billion of notes due in 2022 and $ 149 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2020 included $ 2.3 billion of notes due in 2021, $ 4.0 billion of commercial paper borrowings and $ 73 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.08 % and 0.79 % for the years ended December 31, 2021 and 2020, respectively. Table o f Contents Long-Term Debt Long-term debt at December 31 consisted of: 2021 2020 2.75 % notes due 2025 $ 2,495 $ 2,493 2.15 % notes due 2031 1,986 2.75 % notes due 2051 1,979 3.70 % notes due 2045 1,977 1,976 2.80 % notes due 2023 1,749 1,748 3.40 % notes due 2029 1,736 1,734 1.70 % notes due 2027 1,493 2.90 % notes due 2061 1,484 4.00 % notes due 2049 1,470 1,469 4.15 % notes due 2043 1,239 1,238 1.45 % notes due 2030 1,235 1,233 2.45 % notes due 2050 1,212 1,211 1.875 % euro-denominated notes due 2026 1,123 1,218 1.90 % notes due 2028 994 0.75 % notes due 2026 993 991 3.90 % notes due 2039 984 983 2.35 % notes due 2040 983 982 2.90 % notes due 2024 748 746 6.50 % notes due 2033 715 719 0.50 % euro-denominated notes due 2024 563 611 1.375 % euro-denominated notes due 2036 559 606 2.50 % euro-denominated notes due 2034 558 605 3.60 % notes due 2042 491 491 6.55 % notes due 2037 409 411 5.75 % notes due 2036 338 338 5.95 % debentures due 2028 306 306 5.85 % notes due 2039 271 271 6.40 % debentures due 2028 250 250 6.30 % debentures due 2026 135 135 2.35 % notes due 2022 1,269 2.40 % notes due 2022 1,032 Other 215 294 $ 30,690 $ 25,360 Other (as presented in the table above) includes borrowings at variable rates that resulted in effective interest rates of zero and 0.45 % for 2021 and 2020, respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In December 2021, the Company issued $ 8.0 billion principal amount of senior unsecured notes consisting of $ 1.5 billion of 1.70 % notes due 2027, $ 1.0 billion of 1.90 % notes due 2028, $ 2.0 billion of 2.15 % notes due 2031, $ 2.0 billion of 2.75 % notes due 2051 and $ 1.5 billion of 2.90 % notes due 2061. Merck used the net proceeds from the offering of the 2027 notes, the 2031 notes, the 2051 notes and the 2061 notes for general corporate purposes, including the repayment of outstanding commercial paper borrowings (including commercial paper borrowings in connection with Mercks acquisition of Acceleron), and other indebtedness. Merck allocated an amount equal to the net proceeds of the offering of the notes due in 2028 to finance or refinance, in whole or in part, projects and partnerships in the Companys priority environmental, social and governance (ESG) areas. Table o f Contents Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2021, the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2022, $ 2.3 billion; 2023, $ 1.7 billion; 2024, $ 1.3 billion; 2025, $ 2.5 billion; 2026, $ 2.3 billion. Interest payments related to these debt obligations are as follows: 2022, $ 910 million; 2023, $ 875 million; 2024, $ 838 million; 2025, $ 771 million; 2026, $ 743 million. The Company has a $ 6.0 billion credit facility that matures in June 2026. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of seven years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company does not record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. The Company does not separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 343 million in 2021, $ 340 million in 2020 and $ 333 million in 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $ 340 million in 2021, $ 334 million in 2020 and $ 275 million in 2019. Operating lease assets obtained in exchange for lease obligations were $ 117 million in 2021, $ 473 million in 2020 and $ 125 million in 2019. Table o f Contents Supplemental balance sheet information related to operating leases is as follows: December 31 2021 2020 Assets Other Assets (1) $ 1,586 $ 1,688 Liabilities Accrued and other current liabilities 304 291 Other Noncurrent Liabilities 1,225 1,335 $ 1,529 $ 1,626 Weighted-average remaining lease term (years) 7.0 8.0 Weighted-average discount rate 2.6 % 2.8 % (1) Includes prepaid leases that have no related lease liability. Maturities of operating leases liabilities are as follows: 2022 $ 336 2023 292 2024 242 2025 178 2026 146 Thereafter 511 Total lease payments 1,705 Less: Imputed interest 176 $ 1,529 At December 31, 2021, the Company had entered into additional real estate operating leases that had not yet commenced; the obligations associated with these leases total $ 86 million. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Table o f Contents Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the U.S. involving Fosamax (Fosamax Litigation). As of December 31, 2021, approximately 3,470 cases are pending against Merck in either a federal multidistrict litigation (Femur Fracture MDL) or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax. In March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. In May 2019, the U.S. Supreme Court decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. In November 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. Briefing on the issue is closed, and the parties await the decision of the District Court. Discovery is presently stayed in the Femur Fracture MDL. As part of the spin-off of Organon, Organon is required to indemnify Merck for all liabilities relating to, arising from, or resulting from the Fosamax Litigation. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the U.S. involving Januvia and/or Janumet . As of December 31, 2021, Merck is aware of approximately 675 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). On March 9, 2021, the MDL Court issued an omnibus order granting defendants summary judgment motions based on preemption and failure to establish general causation, as well as granting defendants motions to exclude plaintiffs expert witnesses. The plaintiffs appealed that order. Since that time, more than half of these claims have been dismissed with prejudice as to Merck, and on October 5, 2021, the U.S. Court of Appeals for the Ninth Circuit dismissed the appeal as to Merck and two of its codefendants. Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). On April 6, 2021, the court in California issued an omnibus order granting defendants summary judgment motions and also granting defendants motions to exclude plaintiffs expert witnesses. As of December 31, 2021, six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided in September 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In May 2020, the Illinois Appellate Court issued a mandate to the state trial court, which, as of December 31, 2021, had not scheduled a case management conference or otherwise taken action. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against any remaining lawsuits. Table o f Contents Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, in May 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal health care programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, in April 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, in June 2020, Merck received a CID from the U.S. Department of Justice. The CID requests answers to interrogatories, as well as various documents, regarding temperature excursions at a third-party storage facility containing certain Merck products. Merck is cooperating with the governments investigation and intends to produce information and/or documents as necessary in response to the CID. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the U.S. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation, Schering-Plough Corporation, and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. In August 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, in June 2019, the representatives of the putative direct purchaser class filed an amended complaint, and in August 2019, retailer opt-out plaintiffs filed an amended complaint. In December 2019, the district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities Table o f Contents that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. In November 2019, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed motions for class certification. In August 2020, the district court granted in part the direct purchasers motion for class certification and certified a class of 35 direct purchasers. In August 2020, the Fourth Circuit vacated the district courts class certification order and remanded for further proceedings consistent with the courts ruling. In September 2021, the direct purchaser plaintiffs filed a renewed motion for class certification. On January 25, 2022, the magistrate judge recommended that the district court deny the motion for class certification. On February 8, 2022, the direct purchaser plaintiffs filed objections to the recommendation. Briefing on these objections is ongoing. In August 2020, the Merck Defendants filed a motion for summary judgment and other motions, and plaintiffs filed a motion for partial summary judgment, and other motions. Those motions are now fully briefed, and the court has heard argument on certain of the motions. The court may hold additional hearings on the other motions. Trial in this matter has been adjourned. Also, in August 2020, the magistrate judge recommended that the court grant the motion for class certification filed by the putative indirect purchaser class. In August 2021, the district court granted certification of a class of indirect purchasers. In September 2021, the Merck Defendants petitioned to appeal the class certification decision to the Fourth Circuit. The Fourth Circuit denied that petition on September 30, 2021. In September 2020, United Healthcare Services, Inc. filed a lawsuit in the U.S. District Court for the District of Minnesota against the Merck Defendants and others (the UHC Action). The UHC Action makes similar allegations as those made in the Zetia class action, as well as allegations about Vytorin. In September 2020, the U.S. Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. In December 2020, Humana Inc. filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against Merck and others, alleging defendants violated state antitrust laws in multiple states. Also, in December 2020, Centene Corporation and others filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana. Both lawsuits allege similar anticompetitive acts to those alleged in the Zetia class action. In July 2021, the California Court ruled on defendants Motion to Quash for lack of personal jurisdiction, granting the motion as to the out-of-state claims against defendants, and ordering limited jurisdictional discovery with regard to the California claims. Also, on July 16, 2021, Humana and Centene filed actions against the Merck Defendants in New Jersey in the Bergen County Superior Court, re-asserting the claims that were dismissed in their California action. In September 2021, the parties reached an agreement that Humana and Centene would file their claims in New Jersey federal court, seek a transfer of those claims to the multidistrict Zetia litigation already in progress, and subsequently dismiss the actions previously filed in California and New Jersey state courts. In June 2021, Kaiser Foundation Health Plan, Inc. similarly filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana and Centene. The Kaiser lawsuit alleges similar anticompetitive acts to those alleged in the Zetia class action. The Kaiser action was removed to the U.S. District Court for the Northern District of California on July 16, 2021. In September 2021, the U.S. Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. As of December 2021, all of the insurer plaintiffs (Kaiser, Humana, and Centene) are part of the multidistrict Zetia litigation, and are proceeding with discovery in that action. On February 9, 2022, United Healthcare, Kaiser, and Humana each filed an amended complaint. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. In January 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. In February 2019, MSD appealed the courts order on arbitration to the Third Circuit. In October 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of Table o f Contents arbitrability. On July 6, 2020, MSD filed a renewed motion to compel arbitration, and plaintiffs filed a cross motion for summary judgment as to arbitrability. On November 20, 2020, the district court denied MSDs motion and granted plaintiffs motion. On December 4, 2020, MSD filed a notice of appeal to the Third Circuit. MSDs appeal is fully briefed, and the Third Circuit heard argument on September 24, 2021. Bravecto Litigation As previously disclosed, in January 2020, the Company was served with a complaint in the U.S. District Court for the District of New Jersey. Following motion practice, the plaintiffs filed a second amended complaint on July 1, 2021, seeking to certify a nationwide class action of purchasers or users of Bravecto (fluralaner) products in the U.S. or its territories between May 1, 2014 and July 1, 2021. Plaintiffs contend Bravecto causes neurological events in dogs and cats and alleges violations of the New Jersey Consumer Fraud Act, Breach of Warranty, Product Liability, and related theories. The Company moved to dismiss or, alternatively, to strike the class allegations from the second amended complaint, and that motion is pending. A similar case was filed in Quebec, Canada in May 2019. The Superior Court certified a class of dog owners in Quebec who gave Bravecto Chew to their dogs between February 16, 2017 and November 2, 2018 whose dogs experienced one of the conditions in the post-marketing adverse reactions section of the labeling approved on November 2, 2018. The Company and plaintiffs each appealed the class certification decision. The Court of Appeal of Quebec heard the appeal on February 7, 2022 and took the matter under advisement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that had been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the court. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the U.S., the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the U.S., alleging it improperly uses the name Merck in the U.S. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, SAR, PRC, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, SAR, PRC, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the U.S. with no trial date set, and also ongoing in numerous jurisdictions outside of the U.S. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened Table o f Contents periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Bridion As previously disclosed, between January and November 2020, the Company received multiple Paragraph IV Certification Letters under the Hatch-Waxman Act notifying the Company that generic drug companies have filed applications to the FDA seeking pre-patent expiry approval to sell generic versions of Bridion (sugammadex) Injection. In March, April and December 2020, the Company filed patent infringement lawsuits in the U.S. District Courts for the District of New Jersey and the Northern District of West Virginia against those generic companies. All actions in the District of New Jersey have been consolidated. These lawsuits, which assert one or more patents covering sugammadex and methods of using sugammadex, automatically stay FDA approval of the generic applications until June 2023 or until adverse court decisions, if any, whichever may occur earlier. Mylan Pharmaceuticals Inc., Mylan API US LLC, and Mylan Inc. (Mylan) have filed motions to dismiss in the District of New Jersey for lack of venue and failure to state a claim against certain defendants, and in the Northern District of West Virginia for failure to state a claim against certain defendants. The New Jersey motion has not yet been decided, and the West Virginia action is stayed pending resolution of the New Jersey motion. The Company has settled with four generic companies providing that these generic companies can bring their generic versions of Bridion to the market in January 2026 (which may be delayed by any applicable pediatric exclusivity) or earlier under certain circumstances. The Company has agreed to stay the lawsuit filed against one generic company, which in exchange agreed to be bound by a judgment on the merits of the consolidated action in the District of New Jersey. One of the generic companies in the consolidated action requested dismissal of the action against it and the Company did not oppose this request, which was subsequently granted by the court. The Company does not expect this company to bring its generic version of Bridion to the market before January 2026 or later, depending on any applicable pediatric exclusivity, unless the Company receives an adverse court decision. Januvia, Janumet, Janumet XR As previously disclosed, the FDA has granted pediatric exclusivity with respect to Januvia , Janumet , and Janumet XR , which provides a further six months of exclusivity in the U.S. beyond the expiration of all patents listed in the FDAs Orange Book. Adding this exclusivity to the term of the key patent protection extends exclusivity on these products to January 2023. The Company currently anticipates that sales of Januvia and Janumet in the U.S. will decline significantly after this date. However, Januvia , Janumet , and Janumet XR contain sitagliptin phosphate monohydrate and the Company has another patent covering certain phosphate salt and polymorphic forms of sitagliptin (2027 salt/polymorph patent), which, if determined to be valid, would preclude generic manufacturers from making sitagliptin phosphate salt and polymorphic forms until 2027 with the expiration of that patent, plus pediatric exclusivity. In 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of the 2027 salt/polymorph patent. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection, but prior to the expiration of the 2027 salt/polymorph patent, and a later granted patent owned by the Company covering the Janumet formulation where its term plus the pediatric exclusivity, ends in 2029. The Company also filed a patent infringement lawsuit against Mylan in the Northern District of West Virginia. The Judicial Panel on Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. Prior to the beginning of the scheduled October 2021 trial in the U.S. District Court for the District of Delaware on invalidity issues, the Company settled with all defendants scheduled to participate in that trial. In the Companys case against Mylan, a bench trial was held in December 2021 in the U.S. District Court for the Northern District of West Virginia, with closing arguments scheduled for April 13, 2022. In total, the Company has settled with 21 generic companies providing that these generic companies can bring their generic versions of Januvia and Janumet to the market in May 2026 or earlier under certain circumstances, and their generic versions of Janumet XR to the market in July 2026 or earlier under certain circumstances. Table o f Contents Additionally, in 2019, Mylan filed a petition for Inter Partes Review (IPR) at the U.S. Patent and Trademark Office (USPTO) seeking invalidity of some, but not all, of the claims of the 2027 salt/polymorph patent. The USPTO instituted IPR proceedings in May 2020, finding a reasonable likelihood that the challenged claims are not valid. A trial was held in February 2021 and a final decision was rendered in May 2021, holding that all of the challenged claims were not invalid. Mylan has appealed the USPTOs decision to the U.S. Court of Appeals for the Federal Circuit. In March 2021, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Zydus Worldwide DMCC, Zydus Pharmaceuticals (USA) Inc., and Cadila Healthcare Ltd. (collectively, Zydus). In that lawsuit, the Company alleged infringement of the 2027 salt/polymorph patent based on the filing of Zyduss application seeking approval of its sitagliptin tablets. The U.S. District Court for the District of Delaware has set a three-day bench trial in this matter beginning on October 31, 2022. In Germany, generic companies have sought the revocation of the Supplementary Protection Certificate (SPC) for Janumet . If the generic companies are successful, Janumet could lose market exclusivity in Germany at the same time as the expiry of Januvia pediatric market exclusivity in September 2022. A hearing was held in June 2021 and the court decided that the SPC for Janumet is invalid, which decision the Company has appealed. Challenges to the Janumet SPC have also occurred in the following European countries: Austria, Czech Republic, Finland, France, Hungary, Italy, Portugal, Romania, Slovakia, and Sweden. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2021 and 2020 of approximately $ 230 million and $ 235 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which Table o f Contents would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 40 million and $ 43 million at December 31, 2021 and 2020, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $ 40 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: 2021 2020 2019 Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 1,047 3,577 1,038 3,577 985 Purchases of treasury stock 11 16 66 Issuances (1) ( 9 ) ( 7 ) ( 13 ) Balance December 31 3,577 1,049 3,577 1,047 3,577 1,038 (1) Issuances primarily reflect activity under share-based compensation plans. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2021, 93 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years . RSU awards generally vest one-third each year over a three-year period. Table o f Contents Total pretax share-based compensation cost recorded in 2021, 2020 and 2019 was $ 498 million, $ 475 million and $ 417 million, respectively, including $ 479 million, $ 441 million and $ 388 million, respectively, related to continuing operations. Income tax benefits for share-based compensation expense recognized in 2021, 2020 and 2019 were $ 69 million, $ 65 million and $ 57 million, respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2021, 2020 and 2019 was $ 75.99 , $ 77.67 and $ 80.05 per option, respectively. The weighted average fair value of options granted in 2021, 2020 and 2019 was $ 9.80 , $ 9.93 and $ 10.63 per option, respectively, and were determined using the following assumptions: Years Ended December 31 2021 2020 2019 Expected dividend yield 3.1 % 3.1 % 3.2 % Risk-free interest rate 1.0 % 0.4 % 2.4 % Expected volatility 20.9 % 22.1 % 18.7 % Expected life (years) 5.9 5.8 5.9 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2021 (1) 19,446 $ 63.64 Granted (1) 4,781 75.99 Exercised (1) ( 3,728 ) 54.14 Forfeited (1) ( 626 ) 73.97 Awards transferred to Organon in the spin-off ( 1,947 ) 72.15 Adjustment to Merck awards related to the spin-off of Organon (2) 646 Outstanding December 31, 2021 18,572 $ 65.27 6.3 $ 213 Vested and expected to vest December 31, 2021 17,829 $ 64.90 6.2 $ 212 Exercisable December 31, 2021 12,136 $ 60.41 5.0 $ 198 (1) Activity prior to the Organon spin-off has not been restated. (2) In connection with the spin-off of Organon, all outstanding Merck stock options (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees. Such adjusted awards preserved the same intrinsic value and general terms and conditions (including vesting) as were in place immediately prior to the adjustments. Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 2021 2020 2019 Total intrinsic value of stock options exercised $ 106 $ 51 $ 295 Fair value of stock options vested 27 25 27 Cash received from the exercise of stock options 202 89 361 Table o f Contents A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2021 (1) 11,915 $ 74.17 2,100 $ 75.08 Granted (1) 7,897 76.16 1,487 69.33 Vested (1) ( 6,066 ) 70.25 ( 1,284 ) 57.14 Forfeited (1) ( 1,015 ) 76.62 ( 149 ) 79.33 Awards transferred to Organon in the spin-off ( 1,309 ) 76.99 ( 248 ) 77.39 Adjustment to Merck awards related to the spin-off of Organon (2) 368 60 Nonvested December 31, 2021 11,790 $ 74.88 1,966 $ 77.13 Expected to vest December 31, 2021 10,499 $ 74.93 1,832 $ 77.40 (1) Activity prior to the Organon spin-off has not been restated. (2) In connection with the spin-off of Organon, all outstanding Merck RSUs and PSUs (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees. Such adjusted awards preserved the same intrinsic value and general terms and conditions (including vesting) as were in place immediately prior to the adjustments. At December 31, 2021, there was $ 699 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the U.S. and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans (including certain costs reported as part of discontinued operations) consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ 403 $ 360 $ 293 $ 328 $ 297 $ 235 $ 48 $ 52 $ 48 Interest cost 404 431 458 123 136 176 45 57 69 Expected return on plan assets ( 755 ) ( 774 ) ( 817 ) ( 416 ) ( 414 ) ( 425 ) ( 79 ) ( 75 ) ( 72 ) Amortization of unrecognized prior service cost ( 38 ) ( 49 ) ( 49 ) ( 16 ) ( 18 ) ( 12 ) ( 63 ) ( 73 ) ( 78 ) Net loss (gain) amortization 298 303 151 142 127 64 ( 42 ) ( 18 ) ( 10 ) Termination benefits 56 10 31 5 3 8 37 2 5 Curtailments 16 10 14 ( 26 ) 6 ( 29 ) ( 4 ) ( 11 ) Settlements 216 13 8 15 1 Net periodic benefit cost (credit) $ 600 $ 304 $ 81 $ 148 $ 146 $ 53 $ ( 83 ) $ ( 59 ) $ ( 49 ) Net periodic benefit cost (credit) for pension and other postretirement benefit plans in 2021 includes expenses for curtailments, settlements and termination benefits provided to certain employees in connection with the spin-off of Organon. In connection with restructuring actions (see Note 6), termination charges were recorded in 2021, 2020 and 2019 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments and settlements were recorded on Table o f Contents certain pension plans. An increase in lump sum payments to U.S. pension plan participants also contributed to the settlements recorded during 2021. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 15), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions or in Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests if related to the spin-off of Organon (each as noted above). Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International 2021 2020 2021 2020 2021 2020 Fair value of plan assets January 1 $ 12,672 $ 11,361 $ 12,009 $ 10,135 $ 1,221 $ 1,102 Actual return on plan assets 1,250 1,908 891 1,026 118 175 Company contributions 305 199 189 383 33 19 Effects of exchange rate changes ( 671 ) 743 Benefits paid ( 219 ) ( 751 ) ( 233 ) ( 214 ) ( 86 ) ( 93 ) Settlements ( 941 ) ( 45 ) ( 55 ) ( 117 ) Spin-off of Organon ( 55 ) Other 120 53 6 18 Fair value of plan assets December 31 $ 13,067 $ 12,672 $ 12,195 $ 12,009 $ 1,292 $ 1,221 Benefit obligation January 1 $ 14,613 $ 13,003 $ 12,458 $ 10,558 $ 1,607 $ 1,673 Service cost 403 360 328 297 48 52 Interest cost 404 431 123 136 45 57 Actuarial (gains) losses (1) ( 332 ) 1,594 ( 240 ) 1,032 ( 103 ) ( 98 ) Benefits paid ( 219 ) ( 751 ) ( 233 ) ( 214 ) ( 86 ) ( 93 ) Effects of exchange rate changes ( 678 ) 788 ( 1 ) ( 3 ) Plan amendments 4 ( 64 ) Curtailments 15 11 ( 38 ) ( 8 ) ( 12 ) ( 1 ) Termination benefits 56 10 5 3 37 2 Settlements ( 941 ) ( 45 ) ( 55 ) ( 117 ) Spin-off of Organon ( 118 ) Other 19 47 6 18 Benefit obligation December 31 $ 13,999 $ 14,613 $ 11,575 $ 12,458 $ 1,541 $ 1,607 Funded status December 31 $ ( 932 ) $ ( 1,941 ) $ 620 $ ( 449 ) $ ( 249 ) $ ( 386 ) Recognized as: Other Assets $ 9 $ $ 1,395 $ 941 $ $ Accrued and other current liabilities ( 64 ) ( 82 ) ( 22 ) ( 13 ) ( 8 ) ( 9 ) Other Noncurrent Liabilities ( 877 ) ( 1,859 ) ( 753 ) ( 1,377 ) ( 241 ) ( 377 ) (1) Actuarial (gains) losses primarily reflect changes in discount rates. At December 31, 2021 and 2020, the accumulated benefit obligation was $ 24.9 billion and $ 26.3 billion, respectively, for all pension plans, of which $ 13.8 billion and $ 14.4 billion, respectively, related to U.S. pension plans. Table o f Contents Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International 2021 2020 2021 2020 Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 13,013 $ 14,613 $ 2,507 $ 8,875 Fair value of plan assets 12,072 12,672 1,731 7,488 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 12,916 $ 13,489 $ 2,462 $ 4,234 Fair value of plan assets 12,072 11,685 1,723 2,995 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2021 and 2020, $ 943 million and $ 942 million, respectively, or approximately 4 % of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Table o f Contents The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2021 2020 U.S. Pension Plans Cash and cash equivalents $ 3 $ $ $ 289 $ 292 $ 5 $ $ $ 303 $ 308 Investment funds Developed markets equities 236 3,799 4,035 206 3,884 4,090 Emerging markets equities 919 919 169 927 1,096 Mortgage and asset-backed securities 89 89 Equity securities Developed markets 2,915 2,915 2,819 2,819 Fixed income securities Government and agency obligations 2,870 2,870 2,236 2,236 Corporate obligations 2,005 2,005 1,994 1,994 Mortgage and asset-backed securities 23 23 33 33 Other investments 2 6 8 7 7 Plan assets at fair value $ 3,156 $ 4,898 $ 6 $ 5,007 $ 13,067 $ 3,199 $ 4,352 $ 7 $ 5,114 $ 12,672 International Pension Plans Cash and cash equivalents $ 82 $ 10 $ $ 18 $ 110 $ 110 $ 1 $ $ 20 $ 131 Investment funds Developed markets equities 531 4,292 121 4,944 475 4,286 118 4,879 Government and agency obligations 240 4,025 171 4,436 1,516 2,614 172 4,302 Emerging markets equities 137 72 209 154 92 246 Corporate obligations 9 8 171 188 5 12 172 189 Other fixed income obligations 15 8 3 26 9 11 4 24 Real estate 1 16 17 1 15 16 Equity securities Developed markets 369 369 505 505 Fixed income securities Government and agency obligations 3 591 3 597 3 481 3 487 Corporate obligations 223 2 225 1 174 2 177 Mortgage and asset-backed securities 90 90 70 70 Other investments Insurance contracts (2) 44 937 1 982 42 935 1 978 Other 1 1 2 1 4 5 Plan assets at fair value $ 1,387 $ 9,293 $ 937 $ 578 $ 12,195 $ 2,779 $ 7,696 $ 935 $ 599 $ 12,009 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2021 and 2020. (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. Table o f Contents The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: 2021 2020 Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ 7 $ 7 $ $ $ 9 $ 9 Actual return on plan assets: Relating to assets still held at December 31 ( 5 ) ( 5 ) ( 5 ) ( 5 ) Relating to assets sold during the year 7 7 5 5 Purchases and sales, net ( 3 ) ( 3 ) ( 2 ) ( 2 ) Balance December 31 $ $ $ 6 $ 6 $ $ $ 7 $ 7 International Pension Plans Balance January 1 $ 935 $ $ $ 935 $ 851 $ $ $ 851 Actual return on plan assets: Relating to assets still held at December 31 ( 34 ) ( 34 ) 103 103 Purchases and sales, net ( 42 ) ( 42 ) ( 17 ) ( 17 ) Transfers in (out) of Level 3 78 78 ( 2 ) ( 2 ) Balance December 31 $ 937 $ $ $ 937 $ 935 $ $ $ 935 The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2021 2020 Cash and cash equivalents $ 11 $ $ $ 28 $ 39 $ 31 $ $ $ 28 $ 59 Investment funds Developed markets equities 24 378 402 19 355 374 Emerging markets equities 92 92 16 85 101 Government and agency obligations 1 1 1 1 Mortgage and asset-backed securities 8 8 Equity securities Developed markets 290 290 258 258 Fixed income securities Government and agency obligations 275 275 221 221 Corporate obligations 191 191 196 196 Mortgage and asset-backed securities 2 2 3 3 Plan assets at fair value $ 326 $ 468 $ $ 498 $ 1,292 $ 325 $ 428 $ $ 468 $ 1,221 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2021 and 2020. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11 %, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the Table o f Contents targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Contributions during 2022 are expected to be approximately $ 280 million for U.S. pension plans, approximately $ 150 million for international pension plans and approximately $ 50 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits 2022 $ 724 $ 289 $ 84 2023 745 275 85 2024 731 278 87 2025 748 280 89 2026 770 308 90 2027 2031 4,230 1,715 469 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Net gain (loss) arising during the period $ 1,048 $ ( 448 ) $ ( 816 ) $ 815 $ ( 407 ) $ ( 227 ) $ 144 $ 198 $ 112 Prior service (cost) credit arising during the period ( 3 ) ( 1 ) ( 4 ) ( 29 ) 62 ( 1 ) ( 17 ) ( 3 ) ( 11 ) $ 1,045 $ ( 449 ) $ ( 820 ) $ 786 $ ( 345 ) $ ( 228 ) $ 127 $ 195 $ 101 Net loss (gain) amortization included in benefit cost $ 298 $ 303 $ 151 $ 142 $ 127 $ 64 $ ( 42 ) $ ( 18 ) $ ( 10 ) Prior service credit amortization included in benefit cost ( 38 ) ( 49 ) ( 49 ) ( 16 ) ( 18 ) ( 12 ) ( 63 ) ( 73 ) ( 78 ) $ 260 $ 254 $ 102 $ 126 $ 109 $ 52 $ ( 105 ) $ ( 91 ) $ ( 88 ) Table o f Contents Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 2021 2020 2019 2021 2020 2019 Net periodic benefit cost Discount rate 2.70 % 3.40 % 4.40 % 1.10 % 1.50 % 2.20 % Expected rate of return on plan assets 6.70 % 7.30 % 8.10 % 3.80 % 4.40 % 4.90 % Salary growth rate 4.60 % 4.20 % 4.30 % 2.80 % 2.80 % 2.80 % Interest crediting rate 4.70 % 4.90 % 3.40 % 3.00 % 2.80 % 2.90 % Benefit obligation Discount rate 3.00 % 2.70 % 3.40 % 1.50 % 1.10 % 1.50 % Salary growth rate 4.60 % 4.60 % 4.20 % 2.90 % 2.80 % 2.80 % Interest crediting rate 5.00 % 4.70 % 4.90 % 3.00 % 3.00 % 2.80 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2022, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will be 6.70 %, as compared to a range of 6.50 % to 6.70 % in 2021. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 2021 2020 Health care cost trend rate assumed for next year 6.4 % 6.6 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate 2032 2032 Savings Plans The Company also maintains defined contribution savings plans in the U.S. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2021, 2020 and 2019 were $ 158 million, $ 158 million and $ 143 million, respectively. Table o f Contents 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 2021 2020 2019 Interest income $ ( 36 ) $ ( 59 ) $ ( 274 ) Interest expense 806 831 893 Exchange losses 297 145 187 Income from investments in equity securities, net (1) ( 1,940 ) ( 1,338 ) ( 170 ) Net periodic defined benefit plan (credit) cost other than service cost ( 212 ) ( 339 ) ( 545 ) Other, net ( 256 ) ( 130 ) 38 $ ( 1,341 ) $ ( 890 ) $ 129 (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period, while gains and losses from ownership interests in investment funds are accounted for on a one quarter lag. The Company estimates losses of approximately $ 500 million will be recorded in the first quarter of 2022 from ownership interests in investment funds. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment, which were fully divested by the first quarter of 2020. Interest paid was $ 779 million in 2021, $ 822 million in 2020 and $ 841 million in 2019. 16. Taxes on Income A reconciliation between the effective tax rate for income from continuing operations and the U.S. statutory rate is as follows: 2021 2020 2019 Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income from continuing operations before taxes $ 2,915 21.0 % $ 1,231 21.0 % $ 1,506 21.0 % Differential arising from: Foreign earnings ( 1,446 ) ( 10.4 ) ( 965 ) ( 16.5 ) ( 461 ) ( 6.4 ) GILTI and the foreign-derived intangible income deduction ( 75 ) ( 0.5 ) 349 6.0 323 4.5 Tax settlements ( 275 ) ( 2.0 ) ( 13 ) ( 0.2 ) ( 139 ) ( 1.9 ) RD tax credit ( 81 ) ( 0.6 ) ( 108 ) ( 1.8 ) ( 116 ) ( 1.6 ) Acquisition of VelosBio ( 9 ) ( 0.1 ) 559 9.5 Acquisition of Pandion 356 2.6 Valuation allowances 102 0.7 37 0.6 115 1.6 Restructuring 61 0.4 105 1.8 39 0.5 Acquisition-related costs, including amortization 8 0.1 38 0.6 70 1.0 State taxes 2 57 1.0 ( 12 ) ( 0.2 ) Acquisition of OncoImmune 97 1.7 Acquisition of Peloton 209 2.9 Tax Cuts and Jobs Act of 2017 117 1.6 Other ( 37 ) ( 0.2 ) ( 47 ) ( 0.8 ) ( 86 ) ( 1.2 ) $ 1,521 11.0 % $ 1,340 22.9 % $ 1,565 21.8 % The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017 and the Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA Table o f Contents remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized and resulted in additional income tax expense in 2018 and 2019. The Companys remaining transition tax liability under the TCJA, which has been reduced by payments and the utilization of foreign tax credits, was $ 2.6 billion at December 31, 2021, of which $ 390 million is included in Income taxes payable and the remainder of $ 2.2 billion is included in Other Noncurrent Liabilities . As a result of the transition tax under the TCJA, the Company is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for foreign withholding taxes that would apply. The Company remains indefinitely reinvested with respect to its financial statement basis in excess of tax basis of its foreign subsidiaries. A determination of the deferred tax liability with respect to this basis difference is not practicable. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the U.S., particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21%. Beginning in 2021, the Company has an additional tax incentive in the form of a tax holiday in Switzerland for a newly active legal entity which is effective through 2030. Income from continuing operations before taxes consisted of: Years Ended December 31 2021 2020 2019 Domestic $ 1,854 $ ( 3,814 ) $ ( 66 ) Foreign 12,025 9,677 7,237 $ 13,879 $ 5,863 $ 7,171 Taxes on income from continuing operations consisted of: Years Ended December 31 2021 2020 2019 Current provision Federal $ 74 $ 893 $ 642 Foreign 1,273 969 1,523 State ( 13 ) 44 ( 40 ) 1,334 1,906 2,125 Deferred provision Federal 240 ( 605 ) ( 328 ) Foreign ( 77 ) 64 ( 228 ) State 24 ( 25 ) ( 4 ) 187 ( 566 ) ( 560 ) $ 1,521 $ 1,340 $ 1,565 Table o f Contents Deferred income taxes at December 31 consisted of: 2021 2020 Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 2,933 $ 109 $ 1,250 Inventory related 119 370 43 315 Accelerated depreciation 589 587 Equity investments 335 175 Pensions and other postretirement benefits 487 338 826 248 Compensation related 301 235 Unrecognized tax benefits 75 117 Net operating losses and other tax credit carryforwards 867 764 Other 434 180 743 81 Subtotal 2,283 4,745 2,837 2,656 Valuation allowance ( 287 ) ( 404 ) Total deferred taxes $ 1,996 $ 4,745 $ 2,433 $ 2,656 Net deferred income taxes $ 2,749 $ 223 Recognized as: Other Assets $ 692 $ 782 Deferred Income Taxes $ 3,441 $ 1,005 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2021, $ 181 million of deferred tax assets on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 164 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 686 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards. Valuation allowances of $ 123 million have been established on these U.S. tax credit carryforwards and NOL carryforwards. Income taxes paid in 2021, 2020 and 2019 (including amounts attributable to discontinued operations) were $ 2.4 billion, $ 2.7 billion and $ 4.5 billion, respectively. Tax benefits relating to stock option exercises were $ 21 million in 2021, $ 12 million in 2020 and $ 65 million in 2019. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: 2021 2020 2019 Balance January 1 $ 1,537 $ 1,225 $ 1,893 Additions related to current year positions 306 298 199 Additions related to prior year positions 63 110 46 Reductions for tax positions of prior years (1) ( 230 ) ( 4 ) ( 454 ) Settlements (1) ( 46 ) ( 70 ) ( 356 ) Lapse of statute of limitations (2) ( 58 ) ( 22 ) ( 103 ) Spin-off of Organon ( 43 ) Balance December 31 $ 1,529 $ 1,537 $ 1,225 (1) Amounts in 2021 and 2019 reflect settlements with the IRS discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.5 billion at December 31, 2021, the income tax provision would reflect a favorable net impact of $ 1.5 billion. The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2021 could decrease by up to approximately $ 11 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys Table o f Contents examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to a (benefit) expense of $( 37 ) million in 2021, $ 16 million in 2020 and $( 53 ) million in 2019. These amounts reflect the beneficial impacts of various tax settlements, including the settlements discussed below. Liabilities for accrued interest and penalties were $ 192 million and $ 205 million as of December 31, 2021 and 2020, respectively. In 2021, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2015-2016 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 190 million (of which $ 172 million related to continuing operations and $ 18 million related to discontinued operations). The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 236 million net tax benefit in 2021 (of which $ 207 million related to continuing operations and $ 29 million related to discontinued operations). This net benefit reflects reductions in reserves for unrecognized tax benefits and other related liabilities for tax positions relating to the years that were under examination. In 2019, the IRS concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million (of which $ 142 million related to discontinued operations with an offsetting credit of $ 35 million related to continuing operations). The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019 (of which $ 106 million related to continuing operations and $ 258 million related to discontinued operations). This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. The IRS is currently conducting examinations of the Companys tax returns for the years 2017 and 2018. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2021. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 2021 2020 2019 Net Income from Continuing Operations Attributable to Merck Co., Inc. $ 12,345 $ 4,519 $ 5,690 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 704 2,548 4,153 Net income attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Average common shares outstanding 2,530 2,530 2,565 Common shares issuable (1) 8 11 15 Average common shares outstanding assuming dilution 2,538 2,541 2,580 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders: Income from Continuing Operations $ 4.88 $ 1.79 $ 2.22 Income from Discontinued Operations 0.28 1.01 1.62 Net Income $ 5.16 $ 2.79 $ 3.84 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders: Income from Continuing Operations $ 4.86 $ 1.78 $ 2.21 Income from Discontinued Operations 0.28 1.00 1.61 Net Income $ 5.14 $ 2.78 $ 3.81 (1) Issuable primarily under share-based compensation plans. Table o f Contents In 2021, 2020 and 2019, 9 million, 5 million and 2 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in each component of other comprehensive income (loss) are as follows: Derivatives Investments Employee Benefit Plans Foreign Currency Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2019, net of taxes $ 166 $ ( 78 ) $ ( 3,556 ) $ ( 2,077 ) $ ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax 86 140 ( 948 ) 112 ( 610 ) Tax ( 15 ) 192 ( 16 ) 161 Other comprehensive income (loss) before reclassification adjustments, net of taxes 71 140 ( 756 ) 96 ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) 66 (3) ( 239 ) Tax 55 ( 15 ) 40 Reclassification adjustments, net of taxes ( 206 ) ( 44 ) 51 ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) 96 ( 705 ) 96 ( 648 ) Balance at December 31, 2019, net of taxes 31 18 ( 4,261 ) ( 1,981 ) ( 6,193 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 383 ) 3 ( 599 ) 64 ( 915 ) Tax 84 111 89 284 Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 299 ) 3 ( 488 ) 153 ( 631 ) Reclassification adjustments, pretax 2 (1) ( 21 ) (2) 272 (3) 253 Tax ( 63 ) ( 63 ) Reclassification adjustments, net of taxes 2 ( 21 ) 209 190 Other comprehensive income (loss), net of taxes ( 297 ) ( 18 ) ( 279 ) 153 ( 441 ) Balance at December 31, 2020, net of taxes ( 266 ) ( 4,540 ) (4) ( 1,828 ) ( 6,634 ) Other comprehensive income (loss) before reclassification adjustments, pretax 333 1,922 ( 304 ) 1,951 Tax ( 75 ) ( 374 ) ( 119 ) ( 568 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes 258 1,548 ( 423 ) 1,383 Reclassification adjustments, pretax 192 (1) 281 (3) 473 Tax ( 40 ) ( 60 ) ( 100 ) Reclassification adjustments, net of taxes 152 221 373 Other comprehensive income (loss), net of taxes 410 1,769 ( 423 ) 1,756 Spin-off of Organon (see Note 3) 28 421 449 Balance at December 31, 2021, net of taxes $ 144 $ $ ( 2,743 ) (4) $ ( 1,830 ) $ ( 4,429 ) (1) Primarily relates to foreign currency cash flow hedges that were reclassified from AOCL to Sales . (2) Represents net realized gains on the sales of available-for-sale debt securities that were reclassified from AOCL to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 3.6 billion and $ 5.4 billion at December 31, 2021 and 2020, respectively, and other postretirement benefit plan net gain of $ 473 million and $ 391 million at December 31, 2021 and 2020, respectively, as well as pension plan prior service credit of $ 190 million and $ 255 million at December 31, 2021 and 2020, respectively, and other postretirement benefit plan prior service credit of $ 181 million and $ 244 million at December 31, 2021 and 2020, respectively. Table o f Contents 19. Segment Reporting The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. Beginning in 2021, the amortization of intangible assets previously included as part of the calculation of segment profits is now included in unallocated non-segment corporate expenses. Prior period Pharmaceutical and Animal Health segment profits have been recast to reflect this change on a comparable basis. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Table o f Contents Sales of the Companys products were as follows: Years Ended December 31 2021 2020 2019 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 9,765 $ 7,421 $ 17,186 $ 8,352 $ 6,028 $ 14,380 $ 6,305 $ 4,779 $ 11,084 Alliance revenue - Lynparza (1) 515 473 989 417 308 725 269 176 444 Alliance revenue - Lenvima (1) 417 287 704 359 220 580 239 165 404 Vaccines Gardasil/Gardasil 9 1,881 3,792 5,673 1,755 2,184 3,938 1,831 1,905 3,737 ProQuad/M-M-R II/Varivax 1,629 506 2,135 1,378 500 1,878 1,683 592 2,275 Pneumovax 23 547 346 893 727 359 1,087 679 247 926 RotaTeq 473 334 807 486 311 797 506 284 791 Vaqta 100 79 179 103 67 170 130 108 238 Hospital Acute Care Bridion 762 770 1,532 583 615 1,198 533 598 1,131 Prevymis 153 218 370 119 162 281 84 81 165 Primaxin 2 258 259 2 248 251 2 271 273 Noxafil 60 199 259 42 287 329 282 380 662 Cancidas 4 208 212 7 207 213 6 242 249 Invanz ( 5 ) 207 202 9 202 211 30 233 263 Zerbaxa 4 ( 5 ) ( 1 ) 74 56 130 63 58 121 Immunology Simponi 825 825 838 838 830 830 Remicade 299 299 330 330 411 411 Neuroscience Belsomra 78 241 318 81 247 327 92 214 306 Virology Molnupiravir 632 320 952 Isentress/Isentress HD 294 474 769 326 531 857 398 576 975 Cardiovascular Alliance revenue - Adempas/Verquvo (2) 312 30 342 259 22 281 194 10 204 Adempas 252 252 220 220 215 215 Diabetes Januvia 1,404 1,920 3,324 1,470 1,836 3,306 1,724 1,758 3,482 Janumet 367 1,597 1,964 477 1,494 1,971 589 1,452 2,041 Other pharmaceutical (3) 1,007 1,302 2,310 984 1,328 2,312 1,215 1,661 2,873 Total Pharmaceutical segment sales 20,401 22,353 42,754 18,010 18,600 36,610 16,854 17,246 34,100 Animal Health: Livestock 667 2,628 3,295 612 2,327 2,939 582 2,201 2,784 Companion Animals 1,091 1,182 2,273 872 892 1,764 724 885 1,609 Total Animal Health segment sales 1,758 3,810 5,568 1,484 3,219 4,703 1,306 3,086 4,393 Other segment sales (4) 23 23 174 1 175 Total segment sales 22,159 26,163 48,322 19,517 21,819 41,336 18,334 20,333 38,668 Other (5) 266 116 382 71 111 182 86 368 453 $ 22,425 $ 26,279 $ 48,704 $ 19,588 $ 21,930 $ 41,518 $ 18,420 $ 20,701 $ 39,121 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 5). (2) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 5). (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents sales for the Healthcare Services segment. All the businesses in the Healthcare Services segment were fully divested by the first quarter of 2020. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales (including sales to Organon). Other for 2021 also includes $ 185 million related to the achievement of milestones for an out-licensed product that triggered contingent payments to Merck. Table o f Contents Consolidated sales by geographic area where derived are as follows: Years Ended December 31 2021 2020 2019 United States $ 22,425 $ 19,588 $ 18,420 Europe, Middle East and Africa 13,341 11,547 10,496 China 4,378 2,751 2,180 Japan 2,726 2,602 2,609 Asia Pacific (other than China and Japan) 2,407 2,113 2,126 Latin America 2,206 1,890 2,015 Other 1,221 1,027 1,275 $ 48,704 $ 41,518 $ 39,121 A reconciliation of segment profits to Income from Continuing Operations Before Taxes is as follows: Years Ended December 31 2021 2020 2019 Segment profits: Pharmaceutical segment $ 30,977 $ 26,106 $ 23,448 Animal Health segment 1,950 1,669 1,612 Other segments 1 ( 7 ) Total segment profits 32,927 27,776 25,053 Other profits 156 75 295 Unallocated: Interest income 36 59 274 Interest expense ( 806 ) ( 831 ) ( 893 ) Amortization ( 1,636 ) ( 1,817 ) ( 1,695 ) Depreciation ( 1,414 ) ( 1,519 ) ( 1,491 ) Research and development ( 11,692 ) ( 12,911 ) ( 9,351 ) Restructuring costs ( 661 ) ( 575 ) ( 626 ) Other unallocated, net ( 3,031 ) ( 4,394 ) ( 4,395 ) $ 13,879 $ 5,863 $ 7,171 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of intangible assets and purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net, includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration, and other miscellaneous income or expense items. Table o f Contents Equity loss from affiliates and depreciation included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2021 Included in segment profits: Equity loss from affiliates $ 11 $ $ $ 11 Depreciation 6 158 164 Year Ended December 31, 2020 Included in segment profits: Equity loss from affiliates $ 6 $ $ $ 6 Depreciation 6 143 1 150 Year Ended December 31, 2019 Included in segment profits: Equity loss from affiliates $ $ $ $ Depreciation 9 105 10 124 Property, plant and equipment, net, by geographic area where located is as follows: December 31 2021 2020 2019 United States $ 11,759 $ 10,394 $ 8,963 Europe, Middle East and Africa 6,081 5,314 4,129 Asia Pacific (other than China and Japan) 857 737 692 China 220 216 174 Latin America 199 169 180 Japan 159 166 152 Other 4 4 7 $ 19,279 $ 17,000 $ 14,297 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Table o f Contents Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Table o f Contents Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. U.S. Rebate Accruals - Medicaid, Managed Care and Medicare Part D As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts representing a portion of the accrual take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The accrued balance relative to the provision for rebates included in accrued and other current liabilities was $2.6 billion as of December 31, 2021, of which the majority relates to U.S. rebate accruals Medicaid, Managed Care and Medicare Part D. The principal considerations for our determination that performing procedures relating to U.S. rebate accruals - Medicaid, Managed Care, and Medicare Part D is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the rebate accruals, as the accruals are based on assumptions developed using pricing information and historical customer segment utilization mix, and a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating evidence related to these assumptions. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to U.S. rebate accruals - Medicaid, Managed Care, and Medicare Part D, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others (i) developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., pricing information, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid, (ii) comparing the independent estimate to the rebate accruals recorded by management, and (iii) testing rebate claims paid, including evaluating those claims for consistency with the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 25, 2022 We have served as the Companys auditor since 2002. Table o f Contents (b) Supplementary Data Selected Quarterly Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q (3) 1st Q 2021 (4) Sales $ 13,521 $ 13,154 $ 11,402 $ 10,627 Gross Profit 9,648 9,704 8,298 7,428 Net Income from Continuing Operations Attributable to Merck Co., Inc. 3,820 4,567 1,213 2,745 (Loss) Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests (62) 332 434 Net Income Attributable to Merck Co., Inc. 3,758 4,567 1,545 3,179 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 1.51 $ 1.81 $ 0.48 $ 1.08 (Loss) Income from Discontinued Operations (0.02) 0.13 0.17 Net Income $ 1.49 $ 1.81 $ 0.61 $ 1.26 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 1.51 $ 1.80 $ 0.48 $ 1.08 (Loss) Income from Discontinued Operations (0.02) 0.13 0.17 Net Income $ 1.48 $ 1.80 $ 0.61 $ 1.25 2020 (4) Sales $ 10,948 $ 10,929 $ 9,353 $ 10,288 Gross Profit 5,919 7,916 6,606 7,459 Net (Loss) Income from Continuing Operations Attributable to Merck Co., Inc. (2,617) 2,324 2,341 2,471 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 523 617 661 748 Net (Loss) Income Attributable to Merck Co., Inc. (2,094) 2,941 3,002 3,219 Basic (Loss) Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders (Loss) Income from Continuing Operations $ (1.03) $ 0.92 $ 0.93 $ 0.98 Income from Discontinued Operations 0.21 0.24 0.26 0.30 Net (Loss) Income $ (0.83) $ 1.16 $ 1.19 $ 1.27 (Loss) Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders (Loss) Income from Continuing Operations $ (1.03) $ 0.92 $ 0.92 $ 0.97 Income from Discontinued Operations 0.21 0.24 0.26 0.29 Net (Loss) Income $ (0.83) $ 1.16 $ 1.18 $ 1.26 (1) Amounts in the fourth quarter of 2020 include charges related to the acquisitions of VelosBio Inc. and OncoImmune (see Note 4) and an intangible asset impairment charge related to Zerbaxa (see Note 9). (2) Amounts in the third quarter of 2020 include charges related to transactions with Seagen Inc (see Note 4). (3) Amounts in the second quarter of 2021 include a charge related to the acquisition of Pandion Therapeutics, Inc. (see Note 4). (4) Reflects the results of the businesses that were spun-off to Organon on June 2, 2021 as discontinued operations for all periods presented (see Note 3). Table o f Contents "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2021, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2021. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Table o f Contents Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2021. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2021, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Robert M. Davis Caroline Litchfield Chief Executive Officer and President Executive Vice President and Chief Financial Officer " +6,Merck & Co.,2020," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off (the Spin-Off) products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia (ezetimibe) and Vytorin (ezetimibe/simvastatin), as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The Spin-Off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. See Risk Factors - Risks Related to the Proposed Spin-Off of Organon. s Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) 2020 2019 2018 Total Sales $ 47,994 $ 46,840 $ 42,294 Pharmaceutical 43,021 41,751 37,689 Keytruda 14,380 11,084 7,171 Januvia/Janumet 5,276 5,524 5,914 Gardasil/Gardasil 9 3,938 3,737 3,151 ProQuad/M-M-R II /Varivax 1,878 2,275 1,798 Bridion 1,198 1,131 917 Pneumovax 23 1,087 926 907 Isentress/Isentress HD 857 975 1,140 Simponi 838 830 893 RotaTeq 797 791 728 Alliance revenue - Lynparza (1) 725 444 187 Implanon/Nexplanon 680 787 703 Zetia/Vytorin 664 874 1,355 Alliance revenue - Lenvima (1) 580 404 149 Animal Health 4,703 4,393 4,212 Livestock 2,939 2,784 2,630 Companion Animals 1,764 1,609 1,582 Other Revenues (2) 270 696 393 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs. (2) Other revenues are primarily comprised of third-party manufacturing sales and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin Lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal cancer, gastric or gastroesophageal junction adenocarcinoma, head and neck squamous cell carcinoma (HNSCC), hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer, including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma (PMBCL), tumor mutational burden-high (TMB-H) cancer, and urothelial carcinoma, including non-muscle invasive bladder cancer. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with chemotherapy for triple-negative breast cancer, in combination with axitinib for renal cell carcinoma, and in combination with lenvatinib for endometrial carcinoma; and Emend (aprepitant) for the prevention of certain chemotherapy-induced nausea and vomiting. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast, pancreatic, and prostate cancers; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for certain patients with endometrial carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases s caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; MMR II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole), an antifungal agent for the prevention of certain invasive fungal infections; Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant; Primaxin (imipenem and cilastatin) for injection, an antibiotic for the treatment of certain bacterial infections; Cancidas (caspofungin acetate) for injection, an anti-fungal agent for the treatment of certain fungal infections; Invanz (ertapenem) for injection, an antibiotic for the treatment of certain bacterial infections; Cubicin (daptomycin for injection), an antibiotic for the treatment of certain bacterial infections; and Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, both of which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant; and NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory s drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto , a line of oral and topical parasitic control products, including the original Bravecto (fluralaner) products for dogs and cats that last up to 12 weeks; Bravecto (fluralaner) One-Month , a monthly product for dogs, and Bravecto Plus (fluralaner/moxidectin), a two-month product for cats; Sentinel, a line of oral parasitic products for dogs including Sentinel Spectrum (milbemycin oxime, lufenuron, and praziquantel) and Sentinel Flavor Tabs (milbemycin oxime, lufenuron); Optimmune (cyclosporine), an ophthalmic ointment; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies; and Sure Petcare products for companion animal identification and well-being, including the microchip and pet recovery system Home Again . For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2020 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2020. Product Date Approval Dificid (1) January 2020 U.S. Food and Drug Administration (FDA) approved Dificid as an oral suspension, and Dificid tablets for the treatment of Clostridioides (formerly Clostridium) difficile-associated diarrhea in children aged six months and older. Gardasil November 2020 Chinas National Medical Products Administration (NMPA) granted expanded approval for Gardasil for use in girls and women from 9 to 45 years of age. Gardasil 9 December 2020 Japans Ministry of Health, Labour and Welfare (MHLW) approved additional indication, dosage and administrations of Gardasil 9 (marketed as Silgard 9) for the prevention of anal cancer (squamous cell cancer) and precursor lesions (anal intraepithelial neoplasia (AIN) grade 1/2/3) caused by HPV types 6, 11, 16 and 18 for individuals 9 years and older and for Genital Warts (condyloma acuminate) for men 9 years and older. July 2020 Japans Pharmaceuticals and Medical Devices Agency (PMDA) approved Gardasil 9 for use in girls and women 9 years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine. June 2020 FDA granted accelerated approval for an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by HPV Types 16, 18, 31, 33, 45, 52, and 58. s Keytruda December 2020 NMPA approved Keytruda as monotherapy for the first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC whose tumors express PD-L1 (Combined Positive Score CPS 20) as determined by a fully validated test. November 2020 FDA granted accelerated approval for Keytruda in combination with chemotherapy for patients with locally recurrent unresectable or metastatic triplenegative breast cancer whose tumors express PD-L1 (CPS 10). October 2020 FDA approved an expanded label for Keytruda , as monotherapy for the treatment of adult patients with relapsed or refractory cHL. August 2020 PMDA approved Keytruda for use at an additional recommended dosage of 400 mg every six weeks (Q6W) administered as an intravenous infusion over 30 minutes across all adult indications, including Keytruda monotherapy and combination therapy. August 2020 PMDA approved Keytruda for the treatment of patients whose tumors are PD-L1-positive, and have radically unresectable, advanced or recurrent esophageal squamous cell carcinoma (ESCC) who have progressed after chemotherapy. June 2020 FDA approved Keytruda as monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR colorectal cancer. June 2020 FDA approved Keytruda as monotherapy for the treatment of patients with recurrent or metastatic cSCC that is not curable by surgery or radiation. June 2020 NMPA approved Keytruda as monotherapy for the treatment of patients with locally advanced or metastatic ESCC whose tumors express PD-L1 (CPS 10) as determined by a fully validated test, following failure of one prior line of systemic therapy. June 2020 FDA granted accelerated approval for Keytruda as monotherapy for the treatment of adult and pediatric patients with unresectable or metastatic TMB-H [10 mutations/megabase (mut/Mb)] solid tumors, as determined by an FDA-approved test, that have progressed following prior treatment and who have no satisfactory alternative treatment options. April 2020 FDA granted accelerated approval for Keytruda for use at an additional recommended dose of 400 mg every six weeks (Q6W) for all approved adult indications. January 2020 FDA approved Keytruda for patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, non-muscle invasive bladder cancer with carcinoma in situ with or without papillary tumors who are ineligible for or have elected not to undergo cystectomy. Koselugo (2) April 2020 FDA approved the kinase inhibitor Koselugo for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN). Lenvima November 2020 NMPA approved Lenvima as a monotherapy for the treatment of differentiated thyroid cancer. s Lynparza (2) December 2020 PMDA approved Lynparza for the treatment of patients with BRCA gene-mutated ( BRCA m) castration-resistant prostate cancer with distant metastasis. December 2020 PMDA approved Lynparza as maintenance treatment after platinum-based chemotherapy for patients with BRCA m curatively unresectable pancreas cancer. December 2020 PMDA approved Lynparza as maintenance treatment after first-line chemotherapy containing bevacizumab (genetical recombination) in patients with homologous recombination repair deficient (HRD) ovarian cancer. November 2020 The European Commission (EC) approved Lynparza for the maintenance treatment of adult patients with advanced (FIGO stages III and IV) high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer who are in response (complete or partial) following completion of first-line platinum-based chemotherapy in combination with bevacizumab and whose cancer is associated with HRD-positive status defined by either a breast cancer susceptibility gene 1/2 ( BRCA 1/2) mutation and/or genomic instability. November 2020 EC approved Lynparza as monotherapy for the treatment of adult patients with metastatic castration-resistant prostate cancer (mCRPC) and BRCA1/2 mutations (germline and/or somatic) who have progressed following a prior therapy that included a new hormonal agent. July 2020 EC approved Lynparza as a monotherapy for the maintenance treatment of adult patients with germline BRCA 1/2 mutations who have metastatic adenocarcinoma of the pancreas and have not progressed after a minimum of 16 weeks of platinum treatment within a first-line chemotherapy regimen. May 2020 FDA approved Lynparza for the treatment of adult patients with deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene-mutated mCRPC, as determined by an FDA-approved test, who have progressed following prior treatment with enzalutamide or abiraterone. May 2020 FDA approved Lynparza in combination with bevacizumab as a first-line maintenance treatment of adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy and whose cancer is associated with HRD positive status defined by either a deleterious or suspected deleterious BRCA mutation, and/or genomic instability, as determined by an FDA-approved test. Recarbrio June 2020 FDA approved Recarbrio for the treatment of patients 18 years of age and older with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP). Steglatro (3) July 2020 NMPA approved Steglatro 5 mg tablets for the treatment of type 2 diabetes. (1) Dificid in the U.S. and Canada is a trademark of Cubist Pharmaceuticals LLC, an indirect wholly-owned subsidiary of Merck Sharp Dohme Corp. (2) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza and Koselugo . (3) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. s Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers, and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products as well as competitors products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. United States In the United States, federal and state governments for many years have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal and state laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for medicines purchased by certain state and federal entities such as the Department of Defense, Veterans Affairs, Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Health Care Programs The United States enacted major health care reform legislation in 2010 (the ACA). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay 70% of the cost of the medicine, including biosimilar products, when Medicare Part D beneficiaries are in the Medicare Part D coverage gap (i.e., the so-called donut hole), which increased from 50% beginning in 2019 as a result of the Balanced Budget Act of 2018. Merck recorded approximately $700 million, $615 million and $365 million as a reduction to revenue in 2020, 2019, and 2018, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. The total annual industry fee has been set at $2.8 billion. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded approximately $85 million, $112 million, and $124 million of costs within Selling, general and administrative s expenses in 2020, 2019 and 2018, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. More recently, although CMS previously declined to define what constitutes a product line extension (beyond the statutory definition), CMS issued a new rule on December 21, 2020 that will significantly expand the definition of the term line extension as of January 1, 2022 to include a broad range of products, including products reflecting new strengths, dosage forms, release mechanisms, and routes of administration. This expanded definition will increase the number of drugs subject to a higher Medicaid rebate. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons, which also may result in an increase in the Companys Medicaid rebates. The impact of these and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. The Patient Protection and Affordable Care Act There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. In December 2018, a Texas federal district court struck down the ACA on the grounds that the individual health insurance mandate is unconstitutional. The United States Supreme Court heard arguments in this case on November 10, 2020. The Company is participating in the health care debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any changes to the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Other Legislative Changes In addition, other legislative changes have been proposed and adopted in the United States since the ACA was enacted. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. Drug Pricing The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins, including, in the United States (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. In November 2020, the Department of Health and Human Services Office of Inspector General (OIG) issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to pharmacy benefit managers (PBMs) on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. This rulemaking also established, effective January 1, 2021, a new safe harbor for point of sale discounts at the pharmacy counter and a new safe harbor for certain services arrangements between pharmaceutical manufacturers and PBMs. CMS also recently issued an Interim Final Rule (the MFN Rule) that alters how physicians will be reimbursed under the Medicare program for physician administered drugs. Pursuant to the MFN Rule, which was intended to be effective January 1, 2021, rather than use the current Average Sales Price (ASP)-based payment framework for certain physician-administered drugs, the MFN Rule would institute a new pricing system for certain prescription drugs and biologic products covered by Medicare Part B in which Medicare would reimburse no more than the most favored nation price, meaning the lowest price after adjusting for volume and differences in gross domestic product, for the top 50 Part B reimbursed products, which includes Keytruda , sold in 22 member countries of the Organisation for Economic Co-operation and Development (OECD). Several organizations, including two s trade groups of which Merck is a member, have filed suit challenging this regulation. Those lawsuits remain pending with a preliminary injunction having been entered in one of the cases. At this time, the Company cannot predict with any certainty if or when the MFN Rule will go into effect. Implementation of the MFN Rule could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The FDA also recently issued rulemaking allowing the commercial importation of certain prescription drugs from Canada through FDA-authorized, time-limited programs sponsored by states or Native American tribes recognized under the rule, and, in certain future circumstances, pharmacists and wholesalers. The FDA also recently released final guidance for industry detailing procedures for drug manufacturers to import FDA-approved prescription drug, biological, and combination products that were manufactured abroad and authorized and intended for sale in a foreign country. A trade organization, in which Merck is a member, brought suit, which remains pending in federal district court, challenging the commercial importation rule. These proposed changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform has contributed to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. The pharmaceutical industry also could be considered a potential source of savings via other legislative and administrative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. There was active consideration of drug-pricing related legislation in the last Congress, and it remains very uncertain as to what proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and PBMs have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely affect revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payor has taken the position that multiple branded products are therapeutically comparable. As the U.S. payor market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payors. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2020, the Companys gross U.S. sales were reduced by 45.5% as a result of rebates, discounts and returns. European Union Efforts toward health care cost containment remain intense in the European Union (EU). The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in the EU attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs. Reference pricing may either compare a products prices in other markets (external reference pricing), or compare a products price with those of other products in a national class (internal reference pricing). The authorities then use the price data to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed s pursuant to local regulations. Some EU Member States have established free-pricing systems, but regulate the pricing for drugs through profit control plans. Others seek to negotiate or set prices based on the cost-effectiveness of a product or an assessment of whether it offers a therapeutic benefit over other products in the relevant class. The downward pressure on health care costs in general, particularly prescription drugs, has become intense. As a result, increasingly high barriers are being erected to the entry of new products. In some EU Member States, cross-border imports from low-priced markets also exert competitive pressure that may reduce pricing within an EU Member State. Additionally, EU Member States have the power to restrict the range of pharmaceutical products for which their national health insurance systems provide reimbursement. In the EU, pricing and reimbursement plans vary widely from Member State to Member State. Some EU Member States provide that drug products may be marketed only after a reimbursement price has been agreed. Some EU Member States may require the completion of additional studies that compare the cost-effectiveness of a particular product candidate to already available therapies or so-called health technology assessments (HTA), in order to obtain reimbursement or pricing approval. The HTA of pharmaceutical products is becoming an increasingly common part of the pricing and reimbursement procedures in most EU Member States. The HTA process, which is governed by the national laws of these countries, involves the assessment of the cost-effectiveness, public health impact, therapeutic impact and/or the economic and social impact of use of a given pharmaceutical product in the national health care system of the individual country is conducted. Ultimately, HTA measures the added value of a new health technology compared to existing ones. The outcome of HTAs regarding specific pharmaceutical products will often influence the pricing and reimbursement status granted to these pharmaceutical products by the regulatory authorities of individual EU Member States. A negative HTA of one of the Companys products may mean that the product is not reimbursable or may force the Company to reduce its reimbursement price or offer discounts or rebates. A negative HTA by a leading and recognized HTA body could also undermine the Companys ability to obtain reimbursement for the relevant product outside a jurisdiction. For example, EU Member States that have not yet developed HTA mechanisms may rely to some extent on the HTA performed in other countries with a developed HTA framework, to inform their pricing and reimbursement decisions. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. To obtain reimbursement or pricing approval in some EU Member States, the Company may be required to conduct studies that compare the cost-effectiveness of the Companys product candidates to other therapies that are considered the local standard of care. There can be no assurance that any EU Member State will allow favorable pricing, reimbursement and market access conditions for any of the Companys products, or that it will be feasible to conduct additional cost-effectiveness studies, if required. Brexit In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period applied from January 31, 2020 until December 31, 2020, and during this period the EU and UK operated as if the UK was an EU Member State, and the UK continued to participate in the EU Customs Union allowing for the freedom of movement for people and goods. It was announced on December 24, 2020, that the EU and the UK agreed to a Trade and Cooperation Agreement (TCA). The TCA sets out the new arrangements for trade of goods, including medicines and vaccines, which allows goods to continue to flow between the EU and the UK. On December 29, 2020, the Council of the EU adopted the decision to sign the TCA and for the TCA to be provisionally applied from January 1, 2021. The UK and EU signed the TCA on December 30, 2020. In order for the TCA to be ratified and formally come into effect, the Council of the EU must unanimously approve the TCA and the European Parliament must consent to it, which the Company believes will occur. As a result of the TCA, the Company believes that its operations will not be materially adversely affected by Brexit. s Japan In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2021 and is expected to impact many Company products. China The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. Additionally, in 2017, the Chinese government updated the National Reimbursement Drug List (NRDL) for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2020, drugs were added to the NRDL through double-digit price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first three rounds of VBP have had, on average, a price reduction of 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. Emerging Markets The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and measures impacting intellectual property, including in exceptional cases, threats of compulsory licenses, that aim to put pressure on the price of innovative pharmaceuticals or result in constrained market access to innovative medicine. The Company anticipates that pricing pressures and market access challenges will continue in the future to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, credit worthiness of health care partners, such as hospitals, due to COVID-19, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and s its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. Regulation The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, approval for marketing, labeling, advertising, manufacturing, wholesale distribution, integrity of the supply chain, pharmacovigilance and safety monitoring of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its medicines, vaccines, and to quality health care around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. Merck has funded Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the EU General Data Protection Regulation, (GDPR) which went into effect in May 2018 and imposes penalties of up to 4% of global revenue. s The GDPR and related implementing laws in individual EU Member States govern the collection and use of personal health data and other personal data in the EU. The GDPR increased responsibility and liability in relation to personal data that the Company processes. It also imposes a number of strict obligations and restrictions on the ability to process (which includes collection, analysis and transfer of) personal data, including health data from clinical trials and adverse event reporting. The GDPR also includes requirements relating to the consent of the individuals to whom the personal data relates, the information provided to the individuals prior to processing their personal data or personal health data, notification of data processing obligations to the national data protection authorities, and the security and confidentiality of the personal data. Further, the GDPR prohibits the transfer of personal data to countries outside of the EU that are not considered by the EC to provide an adequate level of data protection, including to the United States, except if the data controller meets very specific requirements. Following the Schrems II decision of the Court of Justice of the European Union on July 16, 2020, there is considerable uncertainty as to the permissibility of international data transfers under the GDPR. In light of the implications of this decision, the Company may face difficulties regarding the transfer of personal data from the EU to third countries. Failure to comply with the requirements of the GDPR and the related national data protection laws of the EU Member States may result in significant monetary fines and other administrative penalties as well as civil liability claims from individuals whose personal data was processed. Data protection authorities from the different EU Member States may still implement certain variations, enforce the GDPR and national data protection laws differently, and introduce additional national regulations and guidelines, which adds to the complexity of processing personal data in the EU. Guidance developed at both EU level and at the national level in individual EU Member States concerning implementation and compliance practices is often updated or otherwise revised. There is, moreover, a growing trend towards required public disclosure of clinical trial data in the EU which adds to the complexity of obligations relating to processing health data from clinical trials. Failing to comply with these obligations could lead to government enforcement actions and significant penalties against the Company, harm to its reputation, and adversely impact its business and operating results. The uncertainty regarding the interplay between different regulatory frameworks further adds to the complexity that the Company faces with regard to data protection regulation. Additional laws and regulations enacted in the United States (such as the California Consumer Privacy Act), Europe, Asia and Latin America, have increased enforcement and litigation activity in the United States and other developed markets, as well as increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks and facilitate the transfer of personal information across international borders. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, PBMs and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law s provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Januvia 2023 2022 2025-2026 2022 Janumet 2023 2023 N/A 2022 Janumet XR 2023 N/A N/A 2022 Isentress 2024 2023 (3) 2022-2026 2022 Simponi N/A (4) 2024 (5) N/A (4) N/A (4) Lenvima (6) 2025 (3) (with pending PTE) 2021 (patents), 2026 (3) (SPCs) 2026 2021 Adempas (7) 2026 (3) 2028 (3) 2027-2028 2023 Bridion 2026 (3) (with pending PTE) 2023 2024 Expired Nexplanon 2027 (device) 2025 (device) N/A 2025 Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) 2029 2033 Gardasil 2028 2021 (3) Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A 2025 Keytruda 2028 2028 (patents), 2030 (3) (SPCs) 2032-2033 2028 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 2024 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Sivextro 2028 2024 (patents), 2029 (SPCs) 2029 2024 Belsomra 2029 (3) N/A 2031 N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2029 N/A Segluromet (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (10) N/A Steglatro (9) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A (10) Steglujan (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (10) N/A Verquvo (7) 2031 (with pending PTE) N/A (11) N/A (11) N/A (11) Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) 2036 2031 Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. s (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) The Company has no marketing rights in the U.S., Japan or China. (5) Expiration of the distribution agreement with Janssen Pharmaceuticals, Inc. (6) Part of a global strategic oncology collaboration with Eisai. (7) Being commercialized in a worldwide collaboration with Bayer AG. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. (10) The Company has no marketing rights in Japan. (11) The Company has no marketing rights in the EU, Japan or China. The Company also has the following key U.S. patent protection for drug candidates under review or in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) 2027 V114 (pneumoconjugate vaccine) 2031 (vaccine composition) MK-7110 (CD24Fc) 2031 MK-8591A (islatravir/doravirine) 2032 MK-6482 (belzutifan) Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. s Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2020 on patent and know-how licenses and other rights amounted to $185 million. Merck also incurred royalty expenses amounting to $2.0 billion in 2020 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2020, approximately 16,750 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, metabolic diseases, infectious diseases, neurosciences, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on pre-clinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can s be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. More than one of these special designations can be granted for a given application (i.e., a product designated as a Breakthrough Therapy may also be eligible for Priority Review). Due to the COVID-19 public health crisis, the United States Secretary of Health and Human Services has exercised statutory authority to determine that a public health emergency exists, and declare these circumstances justify the emergency use of drugs and biological products as authorized by the FDA. While in effect, this declaration enables the FDA to issue Emergency Use Authorizations (EUAs) permitting distribution and use of specific medical products absent NDA/BLA submission or approval, including products to treat or prevent diseases or conditions caused by the SARS-CoV-2 virus, subject to the terms of any such EUAs. The FDA must make certain findings to grant an EUA, including that it is reasonable to believe based on the totality of evidence that the drug or biologic may be effective, and that known or potential benefits when used under the terms of the EUA outweigh known or potential risks. Additionally, the FDA must find that there is no adequate, approved and available alternative to the emergency use. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in s particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other EU member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, the National Medical Products Administration in China, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, and the Therapeutic Goods Administration in Australia. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally or in late-stage clinical development. MK-7655A is combination of relebactum, a beta-lactamase inhibitor, and imipenem/cilastatin (a carbapenem antibiotic) under review in Japan for the treatment of bacterial infection. MK-7655A was approved by the FDA in 2019 and is marketed in the United States as Recarbrio . MK-1242, vericiguat, is an orally administered soluble guanylate cyclase (sGC) stimulator under review in the EU and in Japan to reduce the risk of cardiovascular death and heart failure hospitalization following a worsening heart failure event in patients with symptomatic chronic heart failure with reduced ejection fraction, in combination with other heart failure therapies. The applications are based on results from the Phase 3 VICTORIA trial. Vericiguat was approved by the FDA in January 2021 and will be marketed in the United States as Verquvo. Vericiguat is being jointly developed with Bayer. Bayer will commercialize vericiguat in territories outside the United States, if approved. MK-5618, selumetinib, is under review in the EU for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN) based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored Phase 2 SPRINT Stratum 1 trial. Selumetinib was approved by the FDA in April 2020 and is marketed in the United States as Koselugo. Selumetinib is being jointly developed and commercialized with AstraZeneca globally. V114 is an investigational 15-valent pneumococcal conjugate vaccine under priority review by the FDA for the prevention of invasive pneumococcal disease in adults 18 years of age and older. The FDA set a PDUFA date of July 18, 2021. The EMA is also reviewing an application for licensure of V114 in adults. Additionally, the Company has several ongoing Phase 3 trials evaluating V114 in pediatric patients. V114 previously received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease in pediatric patients 6 weeks to 18 years of age and adults 18 years of age and older. The Company is involved in litigation challenging the validity of several Pfizer Inc. patents that relate to pneumococcal vaccine technology in the United States and several foreign jurisdictions. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,400 clinical trials, including more than 1,000 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, estrogen receptor positive breast cancer, gastric, glioblastoma, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, non-small-cell lung, small-cell lung, melanoma, mesothelioma, ovarian, prostate, renal, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. s Keytruda in combination with chemotherapy is under review in the EU for the treatment of locally recurrent unresectable or metastatic triple negative breast cancer (TNBC) in adults whose tumors express PD-L1 with a CPS 10 and who have not received prior chemotherapy for metastatic disease based on the results of the KEYNOTE-355 trial. Keytruda was approved for this indication under accelerated approval based on progression-free survival (PFS) by the FDA in November 2020. Keytruda in combination with chemotherapy is also under review in Japan for the treatment of patients with locally recurrent unresectable or metastatic TNBC based on data from the KEYNOTE-355 trial. In July 2020, the FDA accepted for standard review a supplemental BLA for Keytruda for the treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant (pre-operative) treatment, and then as a single agent as adjuvant (post-operative) treatment after surgery. The application was based on data from the first and second interim analyses of the KEYNOTE-522 trial. In February 2021, the FDAs Oncologic Drugs Advisory Committee (ODAC), which discussed the Companys supplemental BLA for Keytruda , voted that a regulatory decision should be deferred until further data are available from the Phase 3 KEYNOTE-522 trial. The study met one of the dual primary endpoints of pathological complete response and is continuing to evaluate event-free survival. The ODAC provides the FDA with independent, expert advice and recommendations on marketed and investigational medicines for use in the treatment of cancer. The FDA is not bound by the committees guidance but takes its advice into consideration. The PDUFA date for this application is March 29, 2021. The next interim analysis is calendar-driven, and data is expected in the third quarter of 2021. In February 2021, Merck announced that the Committee for Medicinal Products for Human Use (CHMP) of the EMA adopted a positive opinion recommending approval of an expanded label for Keytruda as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed an earlier line of therapy. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-204 trial, in which Keytruda monotherapy demonstrated a significant improvement in PFS compared with brentuximab vedotin, a commonly used treatment. The recommendation is also based on supportive data from an updated analysis of the KEYNOTE-087 trial, which supported EC approval of Keytruda for the treatment of adult patients with relapsed or refractory cHL. The CHMPs recommendation will now be reviewed by the EC for marketing authorization in the EU. Keytruda was approved for this indication by the FDA in October 2020. Keytruda is also under review as monotherapy for the first-line treatment of adult patients with metastatic MSI-H or dMMR colorectal cancer in Japan based on the result of the KEYNOTE-177 trial. Keytruda was approved for this indication by the FDA in June 2020 and by the EU in January 2021. In January 2021, the FDA accepted a supplemental BLA seeking use of Keytruda for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a PDUFA date of September 9, 2021. In December 2020, the FDA accepted and granted priority review for a supplemental BLA for Keytruda in combination with chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus and gastroesophageal junction. This supplemental BLA is based on data from the pivotal Phase 3 KEYNOTE-590 trial, in which Keytruda plus chemotherapy demonstrated significant improvements in the primary endpoints of overall survival (OS) and PFS versus chemotherapy in these patients regardless of PD-L1 expression status and tumor histology. These data were presented at the European Society of Medical Oncology (ESMO) Virtual Congress 2020. The FDA set a PDUFA date of April 13, 2021. In December 2020, the CHMP of the EMA announced the start of a procedure to extend the indication to include in combination with chemotherapy, first-line treatment of locally advanced unresectable or metastatic carcinoma of the esophagus or HER-2 negative gastroesophageal junction adenocarcinoma in adults for Keytruda , based on the results from KEYNOTE-590. Keytruda is also under review for this indication in Japan. Keytruda also received Breakthrough Therapy designation from the FDA in February 2020 for the combination of Keytruda with Padcev (enfortumab vedotin-ejfv), in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. s In January 2021, Merck announced first-time data from the Phase 3 KEYNOTE-598 study evaluating Keytruda in combination with ipilimumab (Yervoy) compared with Keytruda monotherapy as first-line treatment for patients with metastatic NSCLC without EGFR or ALK genomic tumor aberrations and whose tumors express PD-L1 (tumor proportion score 50%). Results of the study showed that the addition of ipilimumab to Keytruda did not improve OS or PFS but added toxicity compared with Keytruda monotherapy in these patients. These results were presented in the Presidential Symposium at the IASLC 2020 World Conference on Lung Cancer hosted by the International Association for the Study of Lung Cancer in January 2021 and published in the Journal of Clinical Oncology. As previously announced in November 2020, the study was discontinued due to futility based on the recommendation of an independent Data Monitoring Committee (DMC), which determined the benefit/risk profile of Keytruda in combination with ipilimumab did not support continuing the trial. The DMC also advised that patients in the study discontinue treatment with ipilimumab/placebo. In February 2021, Mercks announced that the Phase 3 KEYNOTE-122 trial evaluating Keytruda versus standard of care treatment (capecitabine, gemcitabine, or docetaxel) for the treatment of recurrent or metastatic nasopharyngeal cancer did not meet its primary endpoint of OS. Full results will be presented at a future medical meeting. In May 2020, Merck and Eisai presented data from analyses of two Phase 2 trials evaluating Keytruda plus Lenvima at the 2020 American Society of Clinical Oncology (ASCO) Annual Meeting in which the Keytruda plus Lenvima combination demonstrated clinically meaningful objective response rates (ORR): the KEYNOTE-524/Study 116 trial in patients with unresectable HCC with no prior systemic therapy; and the KEYNOTE-146/Study 111 trial in patients with metastatic clear cell renal cell carcinoma (ccRCC) who progressed following immune checkpoint inhibitor therapy. In July 2020, Merck and Eisai announced that the FDA issued a CRL regarding Mercks and Eisais applications seeking accelerated approval for the first-line treatment of patients with unresectable HCC based on this trial, which showed clinically meaningful efficacy in the single-arm setting. These data supported a Breakthrough Therapy designation granted by the FDA in July 2019. Ahead of the PDUFA action dates of Mercks and Eisais applications, another combination therapy was approved based on a randomized, controlled trial that demonstrated improvement in OS versus standard-of-care treatment. Consequently, the CRL stated that Mercks and Eisais applications do not provide evidence that Keytruda in combination with Lenvima represents a meaningful advantage over available therapies for the treatment of unresectable or metastatic HCC with no prior systemic therapy for advanced disease. Since the applications for KEYNOTE-524/Study 116 no longer meet the criteria for accelerated approval, both companies plan to work with the FDA to take appropriate next steps, which include conducting a well-controlled clinical trial that demonstrates substantial evidence of effectiveness and the clinical benefit of the combination. As such, LEAP-002, the Phase 3 trial evaluating the Keytruda plus Lenvima combination as a first-line treatment for advanced HCC, is currently underway and fully enrolled. The CRL does not impact the current approved indications for Keytruda or for Lenvima. In February 2021, Merck and Eisai announced the first presentation of new investigational data from the pivotal Phase 3 CLEAR study (KEYNOTE-581/Study 307) at the 2021 Genitourinary Cancers Symposium (ASCO GU) and published simultaneously in the New England Journal of Medicine . The trial evaluated the combinations of Keytruda plus Lenvima, and Lenvima plus everolimus versus sunitinib for the first-line treatment of patients with advanced RCC. Keytruda plus Lenvima demonstrated statistically significant and clinically meaningful improvements in PFS, OS and ORR versus sunitinib. Lenvima plus everolimus also showed significant improvements in PFS and ORR versus sunitinib. Merck and Eisai will discuss these data with regulatory authorities worldwide, with the intent to submit marketing authorization applications based on these results. In December 2020, Merck and Eisai announced that the pivotal Phase 3 KEYNOTE-775/Study 309 trial evaluating the investigational use of Keytruda plus Lenvima met its dual primary endpoints of OS and PFS and its secondary efficacy endpoint of ORR in patients with advanced endometrial cancer following at least one prior platinum-based regimen. These positive results were observed in the mismatch repair proficient (pMMR) subgroup and the ITT study population, which includes both patients with endometrial carcinoma that is pMMR as well as patients whose disease is MSI-H/dMMR. Based on an analysis conducted by an independent DMC, Keytruda plus Lenvima demonstrated a statistically significant and clinically meaningful improvement in OS, PFS and ORR versus chemotherapy. Merck and Eisai will discuss these data with regulatory authorities worldwide, with the intent to s submit marketing authorization applications based on these results, and plan to present these results at an upcoming medical meeting. KEYNOTE-775/Study 309 is the confirmatory trial for KEYNOTE-146/Study 111, which supported accelerated approval by the FDA in 2019 of the Keytruda plus Lenvima combination for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR, who have disease progression following prior systemic therapy and are not candidates for curative surgery or radiation. Merck and Eisai are continuing to study the Keytruda plus Lenvima combination through the LEAP (LEnvatinib And Pembrolizumab) clinical program across 19 trials in 13 different tumor types (endometrial carcinoma, HCC, melanoma, NSCLC, RCC, squamous cell carcinoma of the head and neck, urothelial cancer, biliary tract cancer, colorectal cancer, gastric cancer, glioblastoma, ovarian cancer, and TNBC). MK-6482, belzutifan, is an investigational hypoxia-inducible factor-2 (HIF-2) inhibitor being evaluated for the treatment of patients with von Hippel-Lindau (V HL) disease-associated RCC with nonmetastatic RCC tumors less than three centimeters in size, unless immediate surgery is required. In July 2020, the FDA granted Breakthrough Therapy designation to belzutifan and has also granted orphan drug designation to belzutifan for VHL disease. These designations are based on data from a Phase 2 trial evaluating belzutifan in patients with VHL-associated ccRCC, which were presented at the 2020 ASCO Annual Meeting. Additionally, Phase 2 data showing anti-tumor responses in VHL disease patients with ccRCC and other tumors were presented at the ESMO Virtual Congress 2020 . In February 2021, Merck and Eisai began a Phase 3 trial examining Lenvima in combination with belzutifan in previously treated patients with metastatic RCC. MK-7119, Tukysa, is a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers. In September 2020, Seagen granted Merck an exclusive license and entered into a co-development agreement with Merck to accelerate the global reach of Tukysa. Merck and Seagen also announced a collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda in TNBC, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. MK-7339, Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast, pancreatic and prostate cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca. MK-7264, gefapixant, is an investigational, orally administered, selective P2X3 receptor antagonist, for the treatment of refractory or unexplained chronic cough. In September 2020, Merck announced the results from two ongoing pivotal Phase 3 trials (COUGH-1 and COUGH-2) evaluating the efficacy and safety of gefapixant. In these studies, adult patients treated with gefapixant 45 mg twice daily demonstrated a statistically significant reduction in 24-hour cough frequency versus placebo at 12 weeks (COUGH-1) and 24 weeks (COUGH-2). The gefapixant 15 mg twice daily treatment arms did not meet the primary efficacy endpoint in either Phase 3 study. These results were presented at the Virtual European Respiratory Society International Congress 2020. Merck plans to share data from COUGH-1 and COUGH-2 with regulatory authorities worldwide. MK-7110 (also known as CD24Fc) is an investigational treatment for patients hospitalized with COVID-19. Merck obtained MK-7110 through the acquisition of OncoImmune. In September 2020, OncoImmune reported topline findings from an interim efficacy analysis of a Phase 3 study evaluating MK-7110. An interim analysis of data from 203 participants (75% of the planned enrollment) indicated that selected hospitalized patients with COVID-19 treated with a single dose of MK-7110 showed a 60% higher probability of improvement in clinical status compared to placebo, as defined by the protocol. The risk of death or respiratory failure was reduced by more than 50%. Full results from this Phase 3 study, which were consistent with the topline results, were received in February 2021 and will be submitted for publication in the future. MK-7110 is also being studied in a Phase 3 trial for the treatment of graft versus host disease. Molnupiravir (also known as MK-4482) is an orally available antiviral candidate for the treatment of COVID-19 being developed in collaboration with Ridgeback Biotherapeutics LP. It is currently being evaluated in s Phase 2/3 clinical trials in both the hospital and outpatient settings. The primary completion date for the Phase 2/3 studies is June 2021. The Company anticipates interim efficacy data in the first quarter of 2021. MK-8591A is a combination of islatravir, the companys investigational oral nucleoside reverse transcriptase translocation inhibitor (NRTTI), and doravirine ( Pifeltro ) being evaluated for the treatment of HIV-1 infection. In October 2020, Merck announced Week 96 data from the Phase 2b trial (NCT03272347) evaluating the efficacy and safety of MK-8591A in treatment-nave adults with HIV-1 infection. Week 96 findings demonstrated that the combination of islatravir and doravirine maintained virologic suppression similar to Delstrigo (doravirine/lamivudine/tenofovir disoproxil fumarate), and the findings were consistent with Week 48 results. Additional Week 96 data from the study show low rates of participants meeting the definition of protocol-defined virologic failure in both the islatravir plus doravirine and the Delstrigo treatment arms, and no participants in either arm met the criteria for resistance testing. These data were presented at the virtual 2020 International Congress on Drug Therapy in HIV Infection (HIV Glasgow). In November 2020, Merck announced a collaboration with the Bill Melinda Gates Foundation (the foundation) where the foundation is committing to provide funding to support a pivotal Phase 3 study investigating a once-monthly oral pre-exposure prophylaxis (PrEP) option in women and adolescent girls at high risk for acquiring HIV-1 infection in sub-Saharan Africa. The study, IMPOWER 22, will evaluate the efficacy and safety of once-monthly islatravir and is anticipated to begin in early 2021. Merck will be funding the IMPOWER 22 clinical trial in the United States. Merck also plans to conduct additional studies in HIV prevention with islatravir in once-monthly oral PrEP. These studies will include IMPOWER 24, a global Phase 3 clinical trial to evaluate islatravir as a once-monthly oral agent for PrEP at sites across the world and among other key populations impacted by the epidemic, including men who have sex with men and transgender women. In January 2021, the FDA accepted for standard review a supplemental NDA for Steglatro (ertugliflozin) to incorporate the results of the Phase 3 VERTIS cardiovascular (CV) outcomes trial in the product labeling. The VERTIS CV trial evaluated Steglatro, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, versus placebo, added to background standard of care treatment, in patients with type 2 diabetes and atherosclerotic CV disease. The study met the primary endpoint of non-inferiority on major adverse CV events (MACE), which is a composite of CV death, nonfatal myocardial infarction or nonfatal stroke, compared to placebo. The key secondary endpoints of superiority for Steglatro versus placebo for time to the first occurrence of the composite of CV death or hospitalization for heart failure, time to CV death alone and time to the first occurrence of the composite of renal death, dialysis/transplant or doubling of serum creatinine from baseline were not met. While not a pre-specified hypothesis for statistical testing, a reduction in hospitalization for heart failure was observed with Steglatro. A supplemental application was also submitted to the EMA and is currently under review. In January 2021, the Company announced the discontinuation of the clinical development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The chart below reflects the Companys research pipeline as of February 22, 2021. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. s Phase 2 Phase 3 (Phase 3 entry date) Under Review Antiviral COVID-19 MK-4482 (molnupiravir) (1) Cancer MK-1026 Hematological Malignancies MK-1308 (quavonlimab) (2) Melanoma Non-Small-Cell Lung Solid Tumors MK-1454 (2) Head and Neck MK-2140 Advanced Solid Tumors MK-3475 Keytruda Advanced Solid Tumors MK-4280 (2) Hematological Malignancies Non-Small-Cell Lung MK-4830 Non-Small-Cell Lung MK-5890 (2) Non-Small-Cell Lung MK-6440 (ladiratuzumab vedotin) (1)(3) Advanced Solid Tumors Breast MK-7119 Tukysa (1) Advanced Solid Tumors Colorectal Gastric MK-7339 Lynparza (1)(3) Advanced Solid Tumors MK-7684 (vibostolimab) (2) Melanoma Non-Small-Cell Lung MK-7902 Lenvima (1)(2) Advanced Solid Tumors Biliary Tract Colorectal Glioblastoma V937 Breast Cutaneous Squamous Cell Head and Neck Melanoma Solid Tumors Chikungunya virus V184 Cytomegalovirus V160 HIV-1 Prevention MK-8591 (islatravir) Nonalcoholic Steatohepatitis NASH MK-3655 Overgrowth Syndrome MK-7075 (miransertib) Pneumococcal Vaccine Adult V116 Respiratory Syncytial Virus MK-1654 Schizophrenia MK-8189 Cancer MK-3475 Keytruda Biliary Tract (September 2019) Cervical (October 2018) (EU) Cutaneous Squamous Cell (August 2019) (EU) Endometrial (August 2019) (EU) Gastric (May 2015) (EU) Hepatocellular (May 2016) (EU) Mesothelioma (May 2018) Ovarian (December 2018) Prostate (May 2019) Small-Cell Lung (May 2017) (EU) MK-6482 (belzutifan) Renal Cell (February 2020) MK-7119 Tukysa (1) Breast (October 2019) MK-7339 Lynparza (1)(2) Colorectal (1) (August 2020) Non-Small-Cell Lung (2) (June 2019) Small-Cell Lung (2) (December 2020) MK-7902 Lenvima (1)(2) Bladder (May 2019) Endometrial (June 2018) (EU) Gastric (December 2020) Head and Neck (February 2020) Melanoma (March 2019) Non-Small-Cell Lung (March 2019) Cough MK-7264 (gefapixant) (March 2018) COVID-19 MK-7110 (December 2020) HIV-1 Infection MK-8591A (doravirine/islatravir) (February 2020) New Molecular Entities/Vaccines Bacterial Infection MK-7655A (relebactam+imipenem/cilastatin) (JPN) Heart Failure MK-1242 (vericiguat) (1) (EU) (JPN) Pediatric Neurofibromatosis Type 1 MK-5618 (selumetinib) (1) (EU) Pneumococcal Infection Adult V-114 (U.S.) (EU) Certain Supplemental Filings Cancer MK-3475 Keytruda Metastatic Triple-Negative Breast Cancer (KEYNOTE-355) (EU) (JPN) Early-Stage Triple-Negative Breast Cancer (KEYNOTE-522) (U.S.) Refractory Classical Hodgkin Lymphoma (KEYNOTE-204) (EU) Unresectable or Metastatic MSI-H or dMMR Colorectal Cancer (KEYNOTE-177) (JPN) Cutaneous Squamous Cell Cancer (KEYNOTE-629) (U.S.) Advanced Unresectable Metastatic Esophageal Cancer (KEYNOTE-590) (U.S.) (EU) (JPN) First-Line Metastatic HER2+ Gastric Cancer (KEYNOTE-811) (U.S.) MK-7902 Lenvima (1) First-Line Metastatic Hepatocellular Carcinoma (KEYNOTE-524) (U.S.) (2)(4) Thymic Carcinoma (NCCH1508/REMORA) (JPN) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda . (3) Being developed as monotherapy and in combination with Keytruda. (4) In July 2020, the FDA issued a CRL for Mercks and Eisais applications. Merck and Eisai intend to submit additional data when available to the FDA. Human Capital As of December 31, 2020, the Company had approximately 74,000 employees worldwide, with approximately 27,000 employed in the United States, including Puerto Rico, and approximately 26,000 third-party contractors globally. Approximately 73,000 of the Companys employees are full time-employees. Women and individuals with ethnically diverse backgrounds comprise approximately 50% and 31% of its workforce in the United States, respectively. Women comprise 46% of the members of the Board of Directors. Additionally, the Companys executive team, which includes individuals up to two structural levels below the Chief Executive s Officer, is made up of 34% women. Approximately 30% of the Companys employees are represented by various collective bargaining groups. The Company recognizes that its employees are critical to meet the needs of its patients and customers and that its ability to excel depends on the integrity, skill, and diversity of its employees. Talent Acquisition The Company uses a comprehensive approach to ensure recruiting, retention and leadership development goals are systematically executed throughout the Company and that it hires talented leaders to achieve improved gender parity and representation across all dimensions of diversity. The Company provides training to its managers and external recruiting organizations on strategies to mitigate unconscious bias in the candidate selection and hiring process. In addition, the Company utilizes a comprehensive communications strategy, marketing outreach, social media and strategic alliance partnerships to reach a broad pool of talent in its critical business areas. In 2020, the Company hired approximately 10,000 employees across the globe through various channels including the Companys external career site, diversity partnerships, employee referrals, universities and other external sources. Global Diversity and Inclusion Diversity and inclusion are fundamental to the Companys success and core to future innovation. The Company fosters a globally diverse and inclusive workforce for its employees by creating an environment of belonging, engagement, equity, and empowerment. The Company is proactive and intentional about diversity hiring and development programs to advance talent. The Company creates competitive advantages by leveraging diversity and inclusion to accelerate business performance. This includes fostering global supplier diversity, integrating diversity and inclusion into the Companys commercialization strategies and leveraging employee insights to improve performance. In addition to these efforts, the Company has ten Employee Business Resource Groups, that provide opportunities for employees to take an active part in contributing to the Companys inclusive culture through their work in talent acquisition and development, business and customer insights and social and community outreach. Gender and Ethnicity Performance Data (1) 2020 2019 2018 Women in the workforce 49% 49% 49% Women in the workforce in the U.S. 50% 50% NR Women on the Board of Directors 46% 33% 23% Women in executive roles (2) 34% 36% 32% Women in management roles (3) 43% 43% 41% Members of underrepresented ethnic groups on the Board of Directors 23% 17% 15% Members of underrepresented ethnic groups in executive roles (U.S.) 22% 26% 21% Members of underrepresented ethnic groups in the workforce (U.S.) 31% 29% 27% Members of underrepresented ethnic groups in management roles (U.S.) 29% 27% 25% New hires that were female 50% 50% 51% New hires that were members of underrepresented ethnic groups (U.S.) 42% 33% 36% NR: Not reported. (1) As of 12/31. (2) Executive is defined as the chief executive officer and two structur al levels below. (3) Management role is defined as all managers with direct reports other than executives defined in note 2. Compensation and Benefits The Company provides a valuable total rewards package reflecting its commitment to attract, retain and motivate its talent, and to supporting its employees and their families in every stage of life. The Company continuously monitors and adjusts its compensation and benefit programs to ensure they are competitive, contemporary, helpful and engaging, and that they support strategic imperatives such as diversity and inclusion, equity, flexibility, quality, security and affordability. For example, in 2020, the Company added a personal health care concierge service to assist U.S. employees participating in the Company medical plan with their health care s needs. Aligned with its business and in support of its cancer care strategy, the Company also improved cancer screening benefits, added resources and provided immediate access to a leading cancer center of excellence for U.S. employees. Globally, the Company implemented a minimum standard of 12 weeks of paid parental leave, which inclusively applies to all parents. In the United States, the Companys benefits rank in the top quartile of Fortune 100 companies under the Aon Hewitt 2019 Benefits Index. The Company has been included in the Working Mother 100 Best Companies ranking for 34 consecutive years and was named a Working Mother Best Company for Dads in 2020. Employee Wellbeing The Company is committed to helping its employees and their families improve their own health and wellbeing. The Companys culture of wellbeing is referred to as Live it , which includes programs to support preventive health, emotional and financial wellbeing, physical fitness and nutrition. It is designed to inspire all employees to pursue, enjoy, and share healthy lifestyles. Live it was launched in the United States in 2011 and today is available in every country in which the Company has employees. In addition, many of the Companys larger sites offer onsite health clinics that provide an array of services to help its employees stay or get well, including vaccinations, cancer and biometric screenings, travel medicine and advice, diagnosis and treatment of non-occupational illnesses or injuries, health counseling and referrals. The Companys overall employee wellbeing program was recognized for excellence in health and wellbeing by receiving the highest-level awards from the Business Group on Health (2019 and 2020), and the American Heart Association (2018-2020). COVID-19 Response The Company recognizes that it has a unique responsibility to help in response to the COVID-19 pandemic and is committed to supporting and protecting its employees and their families, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches and supporting its health care providers and the communities in which they serve. The Company continues to provide employees with easy and regular access to information, including details regarding the Companys tracking process, guidance around hygiene measures and travel and best practices for working from home. Examples of pandemic support resources and programs available to the Companys employees include pay continuation for workers who have been sick or exposed, volunteer policy adjustment to enable employees with medical backgrounds to volunteer in SARS-CoV-2-related activities, resources to prioritize physical and mental wellness, adjustments to medical plans to cover 100% of a COVID-19-related diagnosis, testing and treatment, backup childcare and more. Engaging Employees The Company strives to foster employee engagement by promoting a safe, positive, diverse and inclusive work environment that provides numerous opportunities for two-way communication with employees. Some of the Companys key programs and initiatives include promoting global employee engagement surveys, ongoing pulse checks to the organization for interim feedback on specific topics, fostering professional networking and collaboration, identifying and providing opportunities for volunteering and establishing positive, cooperative business relations with designated employee representatives. Talent Management and Development As the Company pursues its goal of becoming the worlds premier research-based biopharmaceutical company, it needs to continuously develop its diverse and talented people. The Companys current talent management system supports company-wide performance management, development, talent reviews and succession planning. Annual performance reviews help further the professional development of the Companys employees and ensure that the Companys workforce is aligned with the Companys objectives. The Company seeks to continuously build the skills and capabilities of its workforce to accelerate talent, improve performance and mitigate risk through relevant continuous learning experiences. This includes, but is not limited to, building leadership and management skills, as well as providing technical and functional training to all employees. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for s remediation and environmental liabilities were $11 million in 2020 and are estimated at $46 million in the aggregate for the years 2021 through 2025. These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million at both December 31, 2020 and 2019. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $65 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy usage, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 56% in both 2020 and 2019 and were 57% in 2018. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/company-overview/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Summary Risk Factors The Company is subject to a number of risks that if realized could materially adversely affect its business, results of operations, cash flow, financial condition or prospects. The following is a summary of the principal risk factors facing the Company: The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. s Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. The Company faces continued pricing pressure with respect to its products. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. The Company faces intense competition from lower cost generic products. The Company faces intense competition from competitors products. The global COVID-19 pandemic is having an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. Pharmaceutical products can develop unexpected safety or efficacy concerns. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. Developments following regulatory approval may adversely affect sales of the Companys products. The Company is subject to a variety of U.S. and international laws and regulations. s The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. Product liability insurance for products may be limited, cost prohibitive or unavailable. The Company is increasingly dependent on sophisticated software applications, computing infrastructure and cloud service providers. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. Social media platforms present risks and challenges. The proposed Spin-Off of Organon may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of Organon. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The above list is not exhaustive, and the Company faces additional challenges and risks. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. Risk Factors The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations, cash flow or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. Risks Related to the Companys Business The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent s infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the United States and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. For example, the patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company experienced a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. In addition, Januvia and Janumet will lose market exclusivity in the United States in January 2023. Januvia will lose market exclusivity in the EU in September 2022. Finally, the SPC that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of market exclusivity. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Januvia , Janumet , and Bridion . In particular, in 2020, the Companys oncology portfolio, led by Keytruda, represented the vast majority of the Companys revenue growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. s The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. In order to remain competitive, the Company, like other major pharmaceutical companies, must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs and vaccines. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. s In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the United States, larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2020, the Companys gross U.S. sales were reduced by 45.5% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2021 and is expected to impact many Company products. The Company expects pricing pressures to continue in the future. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2020 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. s If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The global COVID-19 pandemic is having an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Companys business and financial results were negatively impacted by the outbreak of COVID-19 in 2020. The continued duration and severity of the COVID-19 pandemic is uncertain, rapidly changing and difficult to predict. The degree to which COVID-19 impacts the Companys results in 2021 will depend on future developments, beyond the Companys knowledge or control, including, but not limited to, the duration of the outbreak, its severity, the success of actions taken to contain or prevent the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In 2020, the COVID-19 pandemic impacted the Companys business in numerous ways. As expected, within the Companys human health business, revenue was negatively impacted by reduced access to health care providers given social distancing measures, which negatively affected vaccine and oncology sales in particular. The estimated overall negative impact of the COVID-19 pandemic to Mercks revenue for the full year 2020 was approximately $2.5 billion, largely attributable to the Pharmaceutical segment, with approximately $50 million attributable to the Animal Health segment. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures, fewer well visits and delays in elective surgeries due to the COVID-19 pandemic. These impacts, as well as the prioritization of COVID-19 patients at health care providers, have resulted in reduced administration of many of the Companys human health products, in particular for its vaccines, including Gardasil 9, as well as for Keytruda and Implanon/ s Nexplanon . In addition, declines in elective surgeries negatively affected the demand for Bridion . However, sales of Pneumovax 23 have increased due to heightened awareness of pneumococcal vaccination. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, but the Companys assumption is that ongoing residual negative impacts will persist, particularly during the first half of 2021 and most notably with respect to vaccine sales, with the impact expected to be more acute in the United States. For the full year of 2021, Merck assumes an unfavorable impact to revenue of approximately 2% due to the COVID-19 pandemic, all of which relates to Pharmaceutical segment sales. In addition, for the full year of 2021, with respect to the COVID-19 pandemic, Merck expects a net negative impact to operating expenses, as spending on the development of its COVID-19 antiviral programs is expected to exceed the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Despite the Companys efforts to manage these impacts, their ultimate impact will also depend on factors beyond the Companys knowledge or control, including the duration of the COVID-19 virus as well as governmental and third-party actions taken to contain or prevent its spread, treat the virus and mitigate its public health and economic effects. In addition, any future pandemic, epidemic or similar public health threat could present similar risks to the Companys business, cash flow, results of operations, financial condition and prospects. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. For example, in 2020 the Company issued a product recall for Zerbaxa following the identification of product sterility issues. The Company may, in the future, experience other difficulties and delays in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to s manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Competition and the Health Care Environment, pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing health care reform that has led to the acceleration of generic substitution, where available. In 2017, the Chinese government updated the NRDL for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2020, drugs were added to the NRDL through double-digit price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first three rounds of VBP had, on average, a price reduction of 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, at the same time macro-economic growth of selected emerging markets is expected to outpace Europe and even the United States, leading to significant increased headcount spending in those countries and access to innovative medicines for patients. A failure to maintain the Companys presence in emerging markets could therefore have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. s In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which will cause LIBOR to cease to exist entirely in the future. While the Company expects that reasonable alternatives to LIBOR will be implemented prior to its termination, the Company cannot predict the consequences and timing of these developments, which could include an increase in interest expense and may also require the amendment of contracts that reference LIBOR. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology (IT) systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt the manufacture of its animal health products at such sites or force the Company to incur substantial expenses in procuring raw materials or products elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. s The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Risks Relating to Government Regulation and Legal Proceedings The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. As discussed above Competition and the Health Care Environment, the Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. The ACA increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The ACA also requires pharmaceutical manufacturers to pay 70% of the cost of medicine, including biosimilar products, when Medicare Part D beneficiaries are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2020, the Companys revenue was reduced by approximately $700 million due to this requirement. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. In 2020, the Company recorded $85 million of costs for this annual fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. More recently, although CMS previously declined to define what constitutes a product line extension (beyond the statutory definition), CMS issued a new rule on December 21, 2020 that will significantly expand the definition of the term line extension as of January 1, 2022 to include a broad range of products, including products reflecting new strengths, dosage forms, release mechanisms, and routes of administration. This expanded definition will increase the number of drugs subject to a higher Medicaid rebate. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons, which also may result in an increase in s the Companys Medicaid rebates. The impact of these and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, in November 2020, the Department of Health and Human Services Office of Inspector General (OIG) issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to PBMs on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. On November 20, 2020, CMS also issued the MFN Rule, which was intended to be effective January 1, 2021, to institute a new pricing system for certain prescription drugs and biologic products covered by Medicare Part B in which Medicare would reimburse no more than the most favored nation price, meaning the lowest price after adjusting for volume and differences in gross domestic product, for the top fifty Part B reimbursed products, which includes Keytruda , sold in 22 member countries of the OECD, rather than use the current Average Sales Price (ASP)-based payment framework for certain physician-administered drugs. Implementation of the MFN Rule could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The FDA also recently issued rulemaking allowing the commercial importation of certain prescription drugs from Canada through FDA-authorized, time-limited programs sponsored by states or Native American tribes recognized under the rule, and, in certain future circumstances, pharmacists and wholesalers. The FDA also recently released a final guidance for industry detailing procedures for drug manufacturers to import FDA-approved prescription drug, biological, and combination products that were manufactured abroad and authorized and intended for sale in a foreign country. These changes, if they become effective, could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Several organizations, including two trade groups of which Merck is a member, have filed suit challenging the MFN Rule. Those lawsuits remain pending with a preliminary injunction having been entered in one of the cases. A trade organization in which Merck is a member brought suit, which is pending, in federal district court challenging the commercial importation rule. The Company cannot predict the likelihood of these regulations becoming effective or what additional future changes in the health care industry in general, or the pharmaceutical industry in particular, will occur, however, these changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. s Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; and scrutiny of advertising and promotion. In the past, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional health care reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to health care professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. s The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Risks Related to Technology The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications, complex information technology systems, computing infrastructure, and cloud service providers (collectively, IT systems) to conduct critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing s basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Risks Related to the Proposed Spin-Off of Organon The proposed Spin-Off of Organon may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. In February 2020, the Company announced its intention to Spin-Off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company, which has been named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The transaction is expected to be completed late in the second quarter of 2021. Completion of the Spin-Off will be subject to a number of factors and conditions, and there can be no assurances that the Company will be able to complete the Spin-Off on the terms or on the timeline that was announced, if at all. Unanticipated developments could delay, prevent or otherwise adversely affect the proposed Spin-Off, including but not limited to disruptions in general or financial market conditions or potential problems or delays in obtaining various regulatory and tax approvals or clearances. In addition, consummation of the proposed Spin-Off will require final approval from the Companys Board of Directors. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of Organon. The Company will incur significant expenses in connection with the Spin-Off. In addition, the Company may not be able to achieve the full strategic and financial benefits that are expected to result from the Spin-Off. The anticipated benefits of the Spin-Off are based on a number of assumptions, some of which may prove incorrect. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. The Company cannot predict the effect of the Spin-Off on the trading price of shares of its common stock, and the market value of shares of its common stock may be less than, equal to or greater than the market value of shares of its common stock prior to the Spin-Off. In addition, the price of Mercks common stock may be more volatile around the time of the Spin-Off. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The Company expects that prior to completion of the Spin-Off it will receive an opinion from its U.S. tax counsel that concludes, among other things, that the Spin-Off of all of the outstanding Organon shares to Merck s shareholders and certain related transactions will qualify as tax-free to Merck and its shareholders under Sections 355 and 368 of the U.S. Internal Revenue Code, except to the extent of any cash received in lieu of fractional shares of Organon common stock. Any such opinion is not binding on the Internal Revenue Service (IRS). Accordingly, while the Company believes the risk is low, the IRS may reach conclusions with respect to the Spin-Off that are different from the conclusions reached in the opinion. The opinion will rely on certain facts, assumptions, representations and undertakings from Merck and Organon regarding the past and future conduct of the companies respective businesses and other matters, which, if incomplete, incorrect or not satisfied, could alter the conclusions of the party giving such opinion. If the proposed Spin-Off ultimately is determined to be taxable, which the Company believes is unlikely, the Spin-Off could be treated as a taxable dividend to Mercks shareholders for U.S. federal income tax purposes, and Mercks shareholders could incur significant U.S. federal income tax liabilities. In addition, Merck would recognize a taxable gain to the extent that the fair market value of Organon common stock exceeds Mercks tax basis in such stock on the date of the Spin-Off. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. The impact of the global COVID-19 pandemic and any future pandemic, epidemic, or similar public health threat, on the Companys business, operations and financial performance. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. s Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. The proposed Spin-Off might be delayed or the costs to complete the Spin-Off might be more significant than expected. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is currently located in Kenilworth, New Jersey. The Company has previously announced that it intends to consolidate its New Jersey campuses into a single corporate headquarters location in Rahway, New Jersey by the end of 2023. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey; Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey; West Point, Pennsylvania; Boston, Massachusetts; South San Francisco, California; and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. A number of properties will be transferred to Organon in the Spin-Off. Capital expenditures were $4.7 billion in 2020, $3.5 billion in 2019 and $2.6 billion in 2018. In the United States, these amounted to $2.7 billion in 2020, $1.9 billion in 2019 and $1.5 billion in 2018. Abroad, such expenditures amounted to $2.0 billion in 2020, $1.6 billion in 2019, and $1.1 billion in 2018. s The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2021, there were approximately 104,900 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2020 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 $0.00 $5,888 November 1 November 30 $0.00 $5,888 December 1 December 31 $0.00 $5,888 Total $0.00 $5,888 (1) The Company did not purchase any shares during the three months ended December 31, 2020 under the plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. s Performance Graph The following graph assumes a $100 investment on December 31, 2015, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2020/2015 CAGR* MERCK $180 12% PEER GRP.** 157 9% SP 500 203 15% 2015 2016 2017 2018 2019 2020 MERCK 100.0 115.1 113.4 158.9 194.3 180.1 PEER GRP. 100.0 96.9 116.1 124.1 147.2 157.2 SP 500 100.0 112.0 136.4 130.4 171.4 203.0 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. s "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. The following section of this Form 10-K generally discusses 2020 and 2019 results and year-to-year comparisons between 2020 and 2019. Discussion of 2018 results and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed on February 26, 2020. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. s Overview Financial Highlights ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 Sales $ 47,994 2 % 4 % $ 46,840 Net Income Attributable to Merck Co., Inc. 7,067 (28) % (25) % 9,843 Non-GAAP Net Income Attributable to Merck Co., Inc. (1) 15,082 13 % 16 % 13,382 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $2.78 (27) % (24) % $3.81 Non-GAAP Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders (1) $5.94 14 % 17 % $5.19 (1) Non-GAAP net income and non-GAAP earnings per share (EPS) exclude acquisition and divestiture-related costs, restructuring costs and certain other items. For further discussion and a reconciliation of GAAP to non-GAAP net income and EPS (see Non-GAAP Income and Non-GAAP EPS below) . Executive Summary Worldwide sales were $48.0 billion in 2020, an increase of 2% compared with 2019, or 4% excluding the unfavorable effect from foreign exchange. The sales increase was driven primarily by oncology, certain hospital acute care products and animal health. Growth in these areas was largely offset by the negative effects of the coronavirus disease 2019 (COVID-19) pandemic as discussed below, the effects of generic competition, particularly in the diversified brands and womens health franchises, competitive pressure in the virology franchise and pricing pressure in the diabetes franchise. During 2020, Merck continued executing on its strategic priorities reporting year-over-year sales growth despite the business challenges posed by the COVID-19 pandemic. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, sales of which were negatively affected in 2020 by patients inability to access health care providers, fewer well visits, and social distancing measures. However, in the latter part of the year, the Company experienced a partial recovery in the underlying demand for products across its key growth pillars. Despite the pandemic, Merck employees across the organization continued their important work, enrolling and maintaining clinical studies, progressing the pipeline and ensuring the supply of and patient access to the Companys portfolio of medically important medicines and vaccines. The Company also executed on Mercks capital allocation priorities by completing business development transactions and investing in its pipeline. Additionally, the Company remains on track to complete the spin-off of Organon late in the second quarter of 2021 thereby creating two companies, each focused on their strengths and portfolios allowing them to pursue their respective market opportunities and business strategies. In 2020, the products that will comprise Organon had total sales of $6.5 billion. Merck actively monitors the business development landscape for growth opportunities that meet the Companys strategic criteria. To expand its oncology presence, Merck completed the acquisitions of ArQule, Inc. (ArQule), a biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of cancer and other diseases; and VelosBio Inc. (VelosBio), a clinical-stage biopharmaceutical company committed to developing first-in-class cancer therapies targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. Additionally, Merck entered into strategic collaboration agreements with Seagen to gain access to ladiratuzumab vedotin, an investigational antibody-drug conjugate targeting LIV-1, and Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor for the treatment of human epidermal growth factor receptor 2 (HER2)-positive cancers. To augment Mercks animal health business, the Company acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews. As part of industry-wide efforts to develop solutions to the pandemic, the Company acquired OncoImmune, a company developing a therapeutic candidate for the treatment of patients hospitalized with COVID-19; and Themis Bioscience GmbH (Themis), a company focused on vaccines and immune-modulation therapies for infectious diseases, including a COVID-19 vaccine candidate. Additionally, Merck entered into s strategic collaborations with Ridgeback Biotherapeutics LP (Ridgeback Bio) to develop an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19; and with the International AIDS Vaccine Initiative, Inc. (IAVI) to develop an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. In January 2021, the Company announced it was discontinuing development of the COVID-19 vaccine candidates (see Note 3 to the consolidated financial statements). During 2020, the Company received numerous regulatory approvals within oncology. Keytruda received approval in the United States as monotherapy in the therapeutic areas of cutaneous squamous cell carcinoma (cSCC), metastatic microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) colorectal cancer, non-muscle invasive bladder cancer (NMIBC) and tumor mutational burden-high (TMB-H) solid tumors, as well as in combination with chemotherapy for the treatment of triple-negative breast cancer (TNBC). Merck also received approval in the United States for an every six weeks (Q6W) dosing regimen across all adult indications. Additionally, Keytruda received approval in China for the treatment of certain patients with head and neck squamous cell carcinoma (HNSCC) and in both China and Japan for the treatment of certain patients with esophageal squamous cell carcinoma (ESCC). Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received approval in the United States: in combination with bevacizumab as a first-line maintenance treatment of certain adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy; and for the treatment of certain adult patients with metastatic castration-resistant prostate cancer (mCRPC) following progression on prior treatment. Additionally, Lynparza was approved in the European Union (EU): as monotherapy for the treatment of adult patients with mCRPC and BRCA 1/2 mutations who have progressed following a prior therapy; and for the maintenance treatment of certain adult patients with metastatic adenocarcinoma of the pancreas. Lynparza was also approved in Japan for the treatment of three types of advanced cancer: ovarian, prostate and pancreatic cancer. Lenvima, which is being developed in collaboration with Eisai Co., Ltd. (Eisai), received approval in China as monotherapy for the treatment of differentiated thyroid cancer. Also in 2020, Gardasil 9 was approved for use in women and girls in Japan where it is marketed as Silgard 9. Additionally, in 2020, the U.S. Food and Drug and Administration (FDA) granted accelerated approval for an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by certain HPV types. In January 2021, the Company received FDA approval for Verquvo (vericiguat), to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults. Verquvo is being jointly developed with Bayer AG (Bayer). In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline with several regulatory submissions. Keytruda is under review in United States and/or internationally for the treatment of certain patients with TNBC, classical Hodgkin Lymphoma (cHL), colorectal cancer, cSCC, esophageal and gastric cancer. Lenvima is under review in Japan as monotherapy for the treatment of thymic cancer. V114, an investigational 15-valent pneumococcal conjugate vaccine, is under priority review by the FDA for the prevention of invasive pneumococcal disease in adults 18 years of age and older. The European Medicines Agency (EMA) is also reviewing an application for licensure of V114 in adults. The Company is involved in litigation challenging the validity of several Pfizer Inc. patents that relate to pneumococcal vaccine technology in the United States and several foreign jurisdictions. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of biliary tract, cervical, cutaneous squamous cell, endometrial, gastric, hepatocellular, mesothelioma, ovarian, prostate and small-cell lung cancers; Lynparza as monotherapy for colorectal cancer and in combination with Keytruda for non-small-cell lung and small-cell lung cancers; and Lenvima in combination with Keytruda for bladder, endometrial, gastric, head and neck, melanoma and non-small-cell lung cancers. Also within oncology, MK-6482, belzutifan, an investigational hypoxia-inducible factor-2 alpha (HIF-2) inhibitor being evaluated for the treatment of patients with von Hippel-Lindau disease-associated renal cell carcinoma (RCC), received Breakthrough Therapy designation from the FDA . Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including MK-7264, gefapixant, a selective, non-narcotic, orally-administered, investigational P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough; MK-7110, an investigational treatment for patients hospitalized with COVID-19; MK-8591A, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) in combination with doravirine for the treatment of HIV-1 infection; and V114, which is being evaluated for the prevention of pneumococcal disease in pediatric patients. s The Company is allocating resources to support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2020 reflect higher costs related to business development activity, higher clinical development spending and increased investment in discovery research and early drug development. In November 2020, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.65 per share from $0.61 per share on the Companys outstanding common stock. During 2020, the Company returned $7.5 billion to shareholders through dividends and share repurchases. Management In February 2021, Merck announced that Kenneth C. Frazier, chairman and chief executive officer, will retire as chief executive officer, effective June 30, 2021. Mr. Frazier will continue to serve on Mercks Board of Directors as executive chairman, for a transition period to be determined by the board. The Merck Board of Directors has unanimously elected Robert M. Davis, Mercks current executive vice president, global services and chief financial officer, as chief executive officer, as well as a member of the board, effective July 1, 2021. Mr. Davis will become president of Merck, effective April 1, 2021, at which time the Companys operating divisionsHuman Health, Animal Health, Manufacturing, and Merck Research Laboratories (MRL)will begin reporting to Mr. Davis. COVID-19 Overall, in response to the COVID-19 pandemic, Merck remains focused on protecting the safety of its employees, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches, and supporting health care providers and Mercks communities. Although COVID-19-related disruptions to patients ability to access health care providers negatively affected results in 2020, Merck remains confident in the fundamental underlying demand for its products and its prospects for long-term growth. In 2020, the estimated negative impact of the COVID-19 pandemic to Mercks sales was approximately $2.5 billion, largely attributable to the Pharmaceutical segment, with approximately $50 million attributable to the Animal Health segment. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures, fewer well visits and delays in elective surgeries due to the COVID-19 pandemic. These impacts, as well as the prioritization of COVID-19 patients at health care providers, have resulted in reduced administration of many of the Companys human health products, in particular for its vaccines, including Gardasil 9, as well as for Keytruda and Implanon/Nexplanon . In addition, declines in elective surgeries negatively affected the demand for Bridion . However, sales of Pneumovax 23 increased due to heightened awareness of pneumococcal vaccination. Operating expenses were positively affected in 2020 by approximately $600 million primarily due to lower promotional and selling costs, as well as lower research and development expenses, net of investments in COVID-19-related antiviral and vaccine research programs. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, but the Companys assumption is that ongoing residual negative impacts will persist, particularly during the first half of 2021 and most notably with respect to vaccine sales, with the impact expected to be more acute in the United States. For the full year of 2021, Merck assumes an unfavorable impact to revenue of approximately 2% due to the COVID-19 pandemic, all of which relates to Pharmaceutical segment sales. In addition, for the full year of 2021, with respect to the COVID-19 pandemic, Merck expects a net negative impact to operating expenses, as spending on the development of its COVID-19 antiviral programs is expected to exceed the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2020 was negatively s affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 United States $ 21,027 2 % 2 % $ 20,519 12 % 12 % $ 18,346 International 26,967 2 % 5 % 26,321 10 % 13 % 23,949 Total $ 47,994 2 % 4 % $ 46,840 11 % 13 % $ 42,294 U.S. plus international may not equal total due to rounding. Worldwide sales grew 2% in 2020 due to higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as increased alliance revenue from Lynparza and Lenvima. Also contributing to revenue growth were higher sales of certain vaccines, including Gardasil/Gardasil 9 and Pneumovax 23, as well as increased sales of certain hospital acute care products, including Prevymis and Bridion. Higher sales of animal health products also drove revenue growth in 2020. Sales growth in 2020 was partially offset by the effects of generic competition for certain products including womens health product NuvaRing , hospital acute care products Noxafil and Cubicin , oncology products Emend / Emend for Injection, cardiovascular products Zetia and Vytorin , and products within the diversified brands franchise, particularly Singulair. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Lower sales of pediatric vaccines, including ProQuad , M-M-R II, and Varivax , as well as lower sales of diabetes products Januvia and Janumet , and virology products Zepatier and Isentress/Isentress HD also partially offset revenue growth in 2020. As discussed above, the COVID-19 pandemic negatively affected sales in 2020. Sales in the United States grew 2% in 2020 primarily driven by higher sales of Keytruda , increased alliance revenue from Lynparza and Lenvima, and higher sales of animal health products. Revenue growth was largely offset by lower sales of NuvaRing , Januvia , Noxafil , Emend/Emend for Injection, M-M-R II, Janumet , Varivax and Implanon/Nexplanon . International sales grew 2% in 2020. The increase in international sales primarily reflects growth in Keytruda , Gardasil/Gardasil 9, increased alliance revenue from Lynparza, as well as higher sales of Pneumovax 23, Prevymis , Januvia and animal health products. Sales growth was partially offset by lower sales of Zepatier , Vytorin , Noxafil , Zetia , Remicade , Emend/Emend for Injection and products within the diversified brands franchise, particularly Singulair and Nasonex . International sales represented 56% of total sales in both 2020 and 2019. See Note 18 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Keytruda $ 14,380 30 % 30 % $ 11,084 55 % 58 % $ 7,171 Alliance Revenue - Lynparza (1) 725 63 % 62 % 444 137 % 141 % 187 Alliance Revenue - Lenvima (1) 580 44 % 43 % 404 171 % 173 % 149 Emend 145 (63) % (62) % 388 (26) % (24) % 522 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). s Keytruda is an anti-PD-1 (programmed death receptor-1) therapy that has been approved as monotherapy for the treatment of certain patients with cervical cancer, cHL, cSCC, ESCC, gastric or gastroesophageal junction adenocarcinoma, HNSCC, hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), melanoma, Merkel cell carcinoma, MSI-H or dMMR cancer including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma (PMBCL), TMB-H cancer, and urothelial carcinoma including NMIBC. Keytruda is also approved for the treatment of certain patients: in combination with chemotherapy for metastatic squamous and nonsquamous NSCLC, in combination with chemotherapy for HNSCC, in combination with chemotherapy for TNBC, in combination with axitinib for RCC, and in combination with Lenvima for endometrial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types. Global sales of Keytruda grew 30% in 2020 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally, although the COVID-19 pandemic had a dampening effect on growing demand. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of advanced NSCLC as monotherapy, and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with uptake in the RCC, adjuvant melanoma, HNSCC, bladder cancer and endometrial carcinoma indications. Uptake of the every six weeks (Q6W) adult dosing regimen in the United States benefited sales in 2020. Keytruda sales growth in international markets was driven by continued uptake in approved indications, particularly in the EU. Sales growth was partially offset by declines in Japan due to pricing. Pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda was subject to another price reduction of 20.9% in April 2020 under a provision of the Japanese pricing rules. In January 2020, the FDA approved Keytruda as monotherapy for the treatment of certain patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, NMIBC based on the results of the KEYNOTE-057 trial. In April 2020, the FDA granted accelerated approval for an additional recommended dosage of 400 mg every six weeks (Q6W) for Keytruda across all adult indications, including monotherapy and combination therapy. This new dosage option is available in addition to the current dose of 200 mg every three weeks (Q3W). In June 2020, the FDA granted accelerated approval for Keytruda as monotherapy for the treatment of adult and pediatric patients with unresectable or metastatic TMB-H solid tumors, as determined by an FDA-approved test, that have progressed following prior treatment and who have no satisfactory alternative treatment options based in part on the results of the KEYNOTE-158 trial. Also in June 2020, the FDA approved Keytruda as monotherapy for the treatment of patients with recurrent or metastatic cSCC that is not curable by surgery or radiation based on data from the KEYNOTE-629 trial. Additionally in June 2020, the FDA approved Keytruda as monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR colorectal cancer based on results from the KEYNOTE-177 trial. In October 2020, the FDA approved an expanded label for Keytruda as monotherapy for the treatment of adult patients with relapsed or refractory cHL based on results from the KEYNOTE-204 trial. The FDA also approved an updated pediatric indication for Keytruda for the treatment of pediatric patients with refractory cHL or cHL that has relapsed after two or more lines of therapy. Keytruda was previously approved under the FDAs accelerated approval process for the treatment of adult and pediatric patients with refractory cHL, or who have relapsed after three or more prior lines of therapy based on data from the KEYNOTE-087 trial. In accordance with accelerated approval regulations, continued approval was contingent upon verification and description of clinical benefit; these accelerated approval requirements have been fulfilled with the data from KEYNOTE-204. In November 2020, the FDA granted accelerated approval for Keytruda in combination with chemotherapy for the treatment of patients with locally recurrent unresectable or metastatic TNBC whose tumors express PD-L1 (Combined Positive Score [CPS] 10) as determined by an FDA-approved test. The approval is based on results from the KEYNOTE-355 trial. In June 2020, Keytruda was approved by the National Medical Products Administration (NMPA) in China as monotherapy for the second-line treatment of patients with locally advanced or metastatic ESCC whose s tumors express PD-L1 (CPS 10). This indication was granted based on the KEYNOTE-181 trial, including data from an extension of the global study in Chinese patients. In December 2020, Chinas NMPA approved Keytruda as monotherapy for the first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC whose tumors express PD-L1 (CPS 20) as determined by a fully validated test. In August 2020, Keytruda was approved by Japans Pharmaceuticals and Medical Devices Agency (PMDA) as monotherapy for the treatment of patients whose tumors are PD-L1-positive, and have radically unresectable, advanced or recurrent ESCC who have progressed after chemotherapy. The approval was based on results from the KEYNOTE-181 trial. Additionally, Keytruda was approved by Japans PMDA for use at an additional recommended dosage of 400 mg Q6W, including monotherapy and combination therapy. This new dosage option is available in addition to the current dose of 200 mg Q3W. In January 2021, Keytruda was approved by the European Commission (EC) as a first-line treatment in adult patients with MSI-H or dMMR colorectal cancer based on the results of the KEYNOTE-177 study. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the United States in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of advanced ovarian, breast, pancreatic and prostate cancers. Alliance revenue related to Lynparza grew 63% in 2020 due to continued uptake across the multiple approved indications in the United States, the EU, China and Japan. In May 2020, the FDA approved Lynparza in combination with bevacizumab as a first-line maintenance treatment of certain adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy. In November 2020, Lynparza was approved in the EU for the maintenance treatment of adult patients with advanced high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response following completion of first-line platinum-based chemotherapy in combination with bevacizumab and whose cancer is associated with homologous recombination deficiency (HRD)-positive status. These approvals were based on the results from the PAOLA-1 trial. Also in May 2020, the FDA approved Lynparza for the treatment of adult patients with deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene-mutated mCRPC who have progressed following prior treatment. In November 2020, Lynparza was approved in the EU as monotherapy for the treatment of adult patients with mCRPC and BRCA 1/2 mutations (germline and/or somatic) who have progressed following a prior therapy. These approvals were based on the results from the PROfound trial. In July 2020, Lynparza was approved in the EU as a monotherapy for the maintenance treatment of adult patients with germline BRCA 1/2 mutations who have metastatic adenocarcinoma of the pancreas and have not progressed after a first-line chemotherapy regimen. This approval was based on the results from the POLO trial. In December 2020, Lynparza was approved in Japan for the treatment of three types of advanced cancer: ovarian, prostate and pancreatic cancer. The three approvals authorize Lynparza for use as maintenance treatment after first-line chemotherapy containing bevacizumab (genetical recombination) in patients with HRD ovarian cancer; the treatment of patients with BRCA gene-mutated ( BRCA m) mCRPC; and maintenance treatment after platinum-based chemotherapy for patients with BRCA m curatively unresectable pancreas cancer. The concurrent approvals by the Japanese Ministry of Health, Labor, and Welfare are based on results from the PAOLA-1, PROfound and POLO trials. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of thyroid cancer, HCC, in combination with everolimus for certain patients with RCC, and in combination with Keytruda for the s treatment of certain patients with endometrial carcinoma. Alliance revenue related to Lenvima grew 44% in 2020 due to higher demand in the United States, China and the EU. In November 2020, Chinas NMPA approved Lenvima as a monotherapy for the treatment of differentiated thyroid cancer. Global sales of Emend , for the prevention of certain chemotherapy-induced nausea and vomiting, declined 63% in 2020 primarily due to lower demand and pricing in the United States due to generic competition for Emend for Injection following U.S. patent expiry in September 2019. Also contributing to the Emend sales decline was lower demand in the EU and Japan as a result of generic competition for the oral formulation of Emend following loss of market exclusivity in May 2019 and December 2019, respectively. U.S. market exclusivity for the oral formulation of Emend previously expired in 2015. In April 2020, the FDA approved Koselugo (selumetinib) for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN). The FDA approval is based on positive results from the National Cancer Institute (NCI) Cancer Therapy Evaluation Program (CTEP)-sponsored Phase 2 SPRINT Stratum 1 trial coordinated by the NCIs Center for Cancer Research, Pediatric Oncology Branch. This is the first regulatory approval of a medicine for the treatment of NF1 PN, a rare and debilitating genetic condition. Koselugo is being jointly developed and commercialized with AstraZeneca globally (see Note 4 to the consolidated financial statements). Vaccines ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Gardasil/Gardasil 9 $ 3,938 5 % 6 % $ 3,737 19 % 21 % $ 3,151 ProQuad 678 (10) % (10) % 756 27 % 29 % 593 M-M-R II 378 (31) % (31) % 549 28 % 29 % 430 Varivax 823 (15) % (15) % 970 25 % 28 % 774 Pneumovax 23 1,087 17 % 18 % 926 2 % 3 % 907 Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 5% in 2020 primarily due to higher volumes in China and the replenishment in 2020 of doses borrowed from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile in 2019. The replenishment resulted in the recognition of sales of $120 million in 2020, which, when combined with the reduction of sales of $120 million in 2019 due to the borrowing, resulted in a favorable impact to sales of $240 million in 2020. Lower demand in the United States and Hong Kong, SAR, PRC attributable to the COVID-19 pandemic partially offset the increase in sales of Gardasil/Gardasil 9. In June 2020, the FDA approved an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by HPV Types 16, 18, 31, 33, 45, 52, and 58. The oropharyngeal and head and neck cancer indication was approved under accelerated approval based on effectiveness in preventing HPV-related anogenital disease. In July 2020, Gardasil 9 was approved by the PMDA in Japan for use in women and girls nine years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine. In December 2020, Silgard 9 was also approved in Japan for the prevention of anal cancer and precursor lesions caused by HPV types 6, 11, 16 and 18 for individuals nine years and older and for genital warts for men nine years and older. Gardasil 9 is marketed in Japan as Silgard 9. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (royalty obligations under this agreement expire in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the United States to another third party (these royalty obligations expire in December 2028). The royalties are included in Cost of sales . s Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, declined 10% in 2020 driven primarily by lower demand in the United States resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic, partially offset by higher pricing. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, declined 31% in 2020 driven primarily by lower demand in the United States resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic. Lower demand in Brazil also contributed to the M-M-R II sales decline in 2020. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), declined 15% in 2020 driven primarily by lower demand in the United States resulting from the COVID-19 pandemic, partially offset by higher pricing. The Varivax sales decline was also attributable to lower government tenders in Brazil. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, grew 17% in 2020 primarily due to higher volumes in the EU and in the United States attributable in part to heightened awareness of pneumococcal vaccination. Higher pricing in the United States also contributed to Pneumovax 23 sales growth in 2020. Hospital Acute Care ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Bridion $ 1,198 6 % 7 % $ 1,131 23 % 26 % $ 917 Noxafil 329 (50) % (50) % 662 (11) % (7) % 742 Prevymis 281 70 % 69 % 165 128 % 131 % 72 Cubicin 152 (41) % (40) % 257 (30) % (28) % 367 Zerbaxa 130 8 % 10 % 121 39 % 42 % 87 Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 6% in 2020 due to higher demand globally, particularly in the United States. However, fewer elective surgeries as a result of the COVID-19 pandemic unfavorably affected demand in 2020. Worldwide sales of Noxafil , an antifungal agent for the prevention of certain invasive fungal infections, declined 50% in 2020 due to generic competition in the United States and in the EU. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. Additionally, the patent for Noxafil expired in a number of major European markets in December 2019. As a result, the Company is experiencing volume and pricing declines in Noxafil sales in these markets as a result of generic competition and expects the declines to continue. Worldwide sales of Prevymis , a medicine for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients of an allogenic hematopoietic stem cell transplant, grew 70% in 2020 due to continued uptake since launch in the EU and in the United States. Prevymis was approved by the EC in January 2018 and by the FDA in November 2017. Global sales of Cubicin for injection, an antibiotic for the treatment of certain bacterial infections, declined 41% in 2020 primarily due to ongoing generic competition in the EU and in the United States. In December 2020, the Company temporarily suspended sales of Zerbaxa , a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections, and subsequently issued a product recall, following the identification of product sterility issues. As a result, the Company recorded an intangible asset impairment charge related to Zerbaxa (see Note 8 to the consolidated financial statements). The Company does not anticipate that Zerbaxa will return to the market before 2022. In June 2020, the FDA approved a supplemental New Drug Application (NDA) for Recarbrio (imipenem, cilastatin, and relebactam) for the treatment of patients 18 years of age and older with hospital-acquired s bacterial pneumonia and ventilator-associated bacterial pneumonia caused by certain susceptible Gram-negative microorganisms. Immunology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Simponi $ 838 1 % 1 % $ 830 (7) % (2) % $ 893 Remicade 330 (20) % (20) % 411 (29) % (25) % 582 Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were nearly flat in 2020. Sales of Simponi are being unfavorably affected by the launch of biosimilars for a competing product. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 20% in 2020 driven by ongoing biosimilar competition in the Companys marketing territories in Europe. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. in the second half of 2024. Virology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Isentress/Isentress HD $ 857 (12) % (11) % $ 975 (15) % (10) % $ 1,140 Zepatier 167 (55) % (54) % 370 (19) % (16) % 455 Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 12% in 2020 primarily due to competitive pressure in the United States and in the EU. The Company expects competitive pressures for Isentress/Isentress HD to continue. Global sales of Zepatier , a treatment for adult patients with chronic hepatitis C virus genotype (GT) 1 or GT4 infection, declined 55% in 2020 driven by lower demand globally due to competition and declining patient volumes, coupled with the impact of the COVID-19 pandemic. Cardiovascular ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Zetia/Vytorin $ 664 (24) % (24) % $ 874 (35) % (34) % $ 1,355 Atozet 453 16 % 16 % 391 13 % 18 % 347 Rosuzet 130 8 % 9 % 120 107 % 115 % 58 Alliance revenue - Adempas (1) 281 38 % 38 % 204 47 % 47 % 139 Adempas 220 3 % 2 % 215 13 % 17 % 190 (1) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin (marketed outside the United States as Inegy ), medicines for lowering LDL cholesterol, declined 24% in 2020 driven primarily by lower sales of Ezetrol in Japan and Ezetrol and Inegy in the EU. The patent that provided market exclusivity for Ezetrol in Japan expired in September 2019 and generic competition began in June 2020. The s EU patents for Ezetrol and Inegy expired in April 2018 and April 2019, respectively. Accordingly, the Company is experiencing sales declines in these markets as a result of generic competition and expects the declines to continue. The sales decline in 2020 was also attributable to lower pricing following loss of exclusivity in Australia. Higher demand for Ezetrol in China partially offset the sales decline in 2020. Merck lost market exclusivity in the United States for Zetia in 2016 and Vytorin in 2017 and subsequently lost nearly all U.S. sales of these products as a result of generic competition. Sales of Atozet (marketed outside of the United States), a medicine for lowering LDL cholesterol, grew 16% in 2020, primarily driven by higher demand in most markets, particularly in the EU, Japan and other countries in the Asia Pacific region. Zetia , Vytorin , Atozet and Rosuze t will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide collaboration with Bayer to market and develop soluble guanylate cyclase (sGC) modulators including Adempas (see Note 4 to the consolidated financial statements). Revenue from Adempas includes Mercks share of profits from the sale of Adempas in Bayers marketing territories, which grew 38% in 2020, as well as sales in Mercks marketing territories, which grew 3% in 2020. In January 2021, the FDA approved Verquvo (vericiguat), an sGC stimulator, to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults with symptomatic chronic heart failure and reduced ejection fraction. The approval was based on the results of the pivotal Phase 3 VICTORIA trial and follows a priority regulatory review. Verquvo is part of the same worldwide clinical development collaboration with Bayer that includes Adempas referenced above. Diabetes ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Januvia/Janumet $ 5,276 (4) % (4) % $ 5,524 (7) % (4) % $ 5,914 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, declined 4% in 2020 as a result of continued pricing pressure in the United States, partially offset by higher demand in certain international markets, particularly in China. The Company expects U.S. pricing pressure to continue. Januvia and Janumet will lose market exclusivity in the United States in January 2023. The supplementary patent certificates that provide market exclusivity for Januvia and Janumet in the EU expire in September 2022 and April 2023, respectively. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after loss of market exclusivity. Womens Health ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Implanon/Nexplanon 680 (14) % (13) % 787 12 % 14 % 703 NuvaRing 236 (73) % (73) % 879 (3) % (2) % 902 Worldwide sales of Implanon/Nexplanon , a single-rod subdermal contraceptive implant, declined 14% in 2020, primarily driven by lower demand in the United States and in the EU resulting from the COVID-19 pandemic. Worldwide sales of NuvaRing , a vaginal contraceptive product, declined 73% in 2020 due to generic competition in the United States. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. Accordingly, the Company is experiencing a rapid and substantial decline in U.S. NuvaRing sales and expects the decline to continue. s Implanon/Nexplanon and NuvaRing will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Biosimilars ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Biosimilars $ 330 31 % 31 % $ 252 * * $ 64 * Calculation not meaningful. Biosimilar products are marketed by the Company pursuant to an agreement with Samsung Bioepis Co., Ltd. (Samsung) to develop and commercialize multiple pre-specified biosimilar candidates. Currently, the Company markets Renflexis (infliximab-abda), a biosimilar to Remicade (infliximab) for the treatment of certain inflammatory diseases; Ontruzant (trastuzumab-dttb), a biosimilar to Herceptin (trastuzumab) for the treatment of HER2-positive breast cancer and HER2 overexpressing gastric cancer; Brenzys (etanercept biosimilar), a biosimilar to Enbrel for the treatment of certain inflammatory diseases; and Aybintio (bevacizumab) for the treatment of certain types of cancer. Mercks commercialization territories under the agreement vary by product. Sales growth of biosimilars in 2020 was primarily due to continued post-launch uptake of Renflexis in the United States and Canada and the launch of Ontruzant in Brazil in 2020. In August 2020, the EC granted marketing authorization for Aybintio for the treatment of metastatic carcinoma of the colon or rectum, metastatic breast cancer, NSCLC, advanced and/or metastatic RCC, epithelial ovarian, fallopian tube and primary peritoneal cancer and cervical cancer. An application seeking approval of Aybintio in the United States was filed in September 2019. The above biosimilar products will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Animal Health Segment ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Livestock $ 2,939 6 % 9 % $ 2,784 6 % 11 % $ 2,630 Companion Animal 1,764 10 % 11 % 1,609 2 % 5 % 1,582 Sales of livestock products grew 6% in 2020 predominantly due to an additional five months of sales in 2020 related to the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Sales of companion animal products grew 10% in 2020 driven primarily by higher demand for the Bravecto line of products for parasitic control, as well as higher demand for companion animal vaccines. Costs, Expenses and Other ($ in millions) 2020 % Change 2019 % Change 2018 Cost of sales $ 15,485 10 % $ 14,112 4 % $ 13,509 Selling, general and administrative 10,468 (1) % 10,615 5 % 10,102 Research and development 13,558 37 % 9,872 1 % 9,752 Restructuring costs 578 (9) % 638 1 % 632 Other (income) expense, net (886) * 139 * (402) $ 39,203 11 % $ 35,376 5 % $ 33,593 * Calculation not meaningful. s Cost of Sales Cost of sales was $15.5 billion in 2020 compared with $14.1 billion in 2019. Cost of sales includes the amortization of intangible assets recorded in connection with acquisitions, collaborations, and licensing arrangements, which totaled $1.8 billion in 2020 compared with $2.0 billion in 2019, respectively. Additionally, costs in 2020 and 2019 include intangible asset impairment charges of $1.6 billion and $705 million related to marketed products and other intangibles (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Costs in 2020 also include a charge of $260 million in connection with the discontinuation of COVID-19 vaccine development programs (see Note 3 to the consolidated financial statements) and inventory write-offs of $120 million related to a recall for Zerbaxa (see Note 8 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities which amounted to $175 million in 2020 compared with $251 million in 2019, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 67.7% in 2020 compared with 69.9% in 2019. The gross margin decline in 2020 reflects the unfavorable effects of higher impairment charges (noted above), pricing pressure, a charge related to the discontinuation of COVID-19 vaccine development programs, and higher inventory write-offs related to the recall of Zerbaxa (noted above), partially offset by the favorable effects of product mix, lower amortization of intangible assets and lower restructuring costs. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.5 billion in 2020, a decline of 1% compared with 2019. The decline was driven primarily by lower administrative, selling and promotional costs, including lower travel and meeting expenses, due in part to the COVID-19 pandemic, and the favorable effect of foreign exchange, partially offset by higher costs related to the spin-off of Organon and a contribution to the Merck Foundation. SGA expenses in 2020 include $710 million of costs related to the spin-off of Organon. SGA expenses in 2020 and 2019 include restructuring costs of $47 million and $34 million, respectively, related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. Research and Development Research and development (RD) expenses were $13.6 billion in 2020, an increase of 37% compared with 2019. The increase was driven primarily by higher upfront payments related to acquisitions and collaborations, including a $2.7 billion charge in 2020 related to the acquisition of VelosBio (see Note 3 to the consolidated financial statements), as well as higher expenses related to clinical development and increased investment in discovery research and early drug development. Higher restructuring costs also contributed to the increase in RD expenses in 2020. The increase in RD expenses in 2020 was partially offset by lower in-process research and development (IPRD) impairment charges and lower costs resulting from the COVID-19 pandemic, net of spending on COVID-19-related vaccine and antiviral research programs. RD expenses are comprised of the costs directly incurred by MRL, the Companys research and development division that focuses on human health-related activities, which were $6.6 billion in 2020 compared with $6.1 billion in 2019. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $2.7 billion in 2020 and $2.6 billion in 2019. Additionally, RD expenses in 2020 include a $2.7 billion charge for the acquisition of VelosBio (noted above), a $462 million charge for the acquisition of OncoImmune and charges of $826 million related to transactions with Seagen. RD expenses in 2019 include a $993 million charge for the acquisition of Peloton. See Note 3 to the consolidated financial statements for more information on these transactions. RD expenses also include IPRD impairment charges of $90 million and $172 million in 2020 and 2019, respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such s charges could be material. In addition, RD expenses in 2020 include $83 million of costs associated with restructuring activities, primarily relating to accelerated depreciation. RD expenses also include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business acquisitions. During 2020 and 2019, the Company recorded a net reduction in expenses of $95 million and $39 million, respectively, related to changes in these estimates. Restructuring Costs In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $3.0 billion. The Company expects to record charges of approximately $700 million in 2021 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program to result in annual net cost savings of approximately $900 million by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $578 million in 2020 and $638 million in 2019. Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative expenses and Research and development costs. The Company recorded aggregate pretax costs of $883 million in 2020 and $927 million in 2019 related to restructuring program activities (see Note 5 to the consolidated financial statements). Other (Income) Expense, Net Other (income) expense, net, was $886 million of income in 2020 compared with $139 million of expense in 2019, primarily due to higher income from investments in equity securities, net, largely related to Moderna, Inc. For details on the components of Other (income) expense, net, see Note 14 to the consolidated financial statements. Segment Profits ($ in millions) 2020 2019 2018 Pharmaceutical segment profits $ 29,722 $ 28,324 $ 24,871 Animal Health segment profits 1,650 1,609 1,659 Other non-reportable segment profits 1 (7) 103 Other (22,582) (18,462) (17,932) Income Before Taxes $ 8,791 $ 11,464 $ 8,701 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for s monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including the amortization of purchase accounting adjustments, intangible asset impairment charges, and changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Pharmaceutical segment profits grew 5% in 2020 compared with 2019 driven primarily by higher sales, as well as lower selling and promotional costs. Animal Health segment profits grew 3% in 2020 driven primarily by higher sales and lower promotional and selling costs, partially offset by higher RD costs and the unfavorable effect of foreign exchange. Taxes on Income The effective income tax rates of 19.4% in 2020 and 14.7% in 2019 reflect the impacts of acquisition and divestiture-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings, including product mix. The effective income tax rate in 2020 reflects the unfavorable impact of a charge for the acquisition of VelosBio for which no tax benefit was recognized. The effective income tax rate in 2019 reflects the favorable impact of a $364 million net tax benefit related to the settlement of certain federal income tax matters (see Note 15 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impacts of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 15 to the consolidated financial statements). Net Income (Loss) Attributable to Noncontrolling Interests Net income (loss) attributable to noncontrolling interests was $15 million in 2020 compared with $(66) million in 2019. The loss in 2019 was driven primarily by the portion of goodwill impairment charges related to certain businesses in the Healthcare Services segment that were attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $7.1 billion in 2020 and $9.8 billion in 2019. EPS was $2.78 in 2020 and $3.81 in 2019. Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). s A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) 2020 2019 2018 Income before taxes as reported under GAAP $ 8,791 $ 11,464 $ 8,701 Increase (decrease) for excluded items: Acquisition and divestiture-related costs (1) 3,704 2,681 3,066 Restructuring costs 883 927 658 Other items: Charge for the acquisition of VelosBio 2,660 Charges for the formation of collaborations (2) 1,076 1,400 Charge for the acquisition of OncoImmune 462 Charge for the discontinuation of COVID-19 vaccine development programs 305 Charge for the acquisition of Peloton 993 Charge related to the termination of a collaboration with Samsung 423 Charge for the acquisition of Viralytics Limited 344 Other (20) 55 (57) Non-GAAP income before taxes 17,861 16,120 14,535 Taxes on income as reported under GAAP 1,709 1,687 2,508 Estimated tax benefit on excluded items (3) 1,122 695 535 Adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition (67) Net tax benefit from the settlement of certain federal income tax matters 364 Tax benefit from the reversal of tax reserves related to the divestiture of MCC 86 Net tax charge related to the finalization of treasury regulations related to the enactment of the TCJA (117) (160) Non-GAAP taxes on income 2,764 2,715 2,883 Non-GAAP net income 15,097 13,405 11,652 Less: Net income (loss) attributable to noncontrolling interests as reported under GAAP 15 (66) (27) Acquisition and divestiture-related costs attributable to noncontrolling interests (89) (58) Non-GAAP net income attributable to noncontrolling interests 15 23 31 Non-GAAP net income attributable to Merck Co., Inc. $ 15,082 $ 13,382 $ 11,621 EPS assuming dilution as reported under GAAP $ 2.78 $ 3.81 $ 2.32 EPS difference 3.16 1.38 2.02 Non-GAAP EPS assuming dilution $ 5.94 $ 5.19 $ 4.34 (1) Amount in 2020 includes a $1.6 billion intangible asset impairment charge related to Zerbaxa . Amount in 2019 includes a $612 million intangible asset impairment charge related to Sivextro . See Note 8 to the consolidated financial statements. (2) Amount in 2020 includes $826 million related to transactions with Seagen (see Note 3 to the consolidated financial statements). Amount in 2018 represents charge for the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements). (3) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation s associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items These items are adjusted for after evaluating them on an individual basis considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2020 are charges for the acquisitions of VelosBio and OncoImmune, charges related to collaborations, including transactions with Seagen (see Note 3 to the consolidated financial statements), a charge for the discontinuation of COVID-19 vaccine development programs, and an adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition. Excluded from non-GAAP income and non-GAAP EPS in 2019 is a charge for the acquisition of Peloton (see Note 3 to the consolidated financial statements), tax charges related to the finalization of U.S. treasury regulations related to the TCJA, a net tax benefit related to the settlement of certain federal income tax matters, and a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 15 to the consolidated financial statements). Beginning in 2021, the Company will be changing the treatment of certain items for the purposes of its non-GAAP reporting. Historically, Mercks non-GAAP results excluded the amortization of intangible assets recognized in connection with business acquisitions (reflected as part of acquisition and divestiture-related costs) but did not exclude the amortization of intangibles originating from collaborations, asset acquisitions or licensing arrangements. Beginning in 2021, Mercks non-GAAP results will no longer differentiate between the nature of the intangible assets being amortized and will exclude all amortization of intangible assets. Also, beginning in 2021, Mercks non-GAAP results will exclude gains and losses on investments in equity securities. Prior period amounts will be recast to conform to the new presentation. Research and Development Research Pipeline The Company currently has several candidates under regulatory review in the United States and internationally, as well as in late-stage clinical development. A chart reflecting the Companys current research pipeline as of February 22, 2021 and related discussion is set forth in Item 1. Business Research and Development above. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2020, the balance of IPRD was $3.2 billion (see Note 8 to the consolidated financial statements). The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of s the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2020, 2019, and 2018 the Company recorded IPRD impairment charges within Research and development expenses of $90 million, $172 million and $152 million, respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are summarized below; additional details are included in Note 3 to the consolidated financial statements. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In January 2020, Merck acquired ArQule, a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $2.7 billion. ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business. The Company recorded IPRD of $2.3 billion (related to MK-1026), goodwill of $512 million and other net liabilities of $102 million. In July 2020, Merck and Ridgeback Bio, a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Molnupiravir is currently being evaluated in Phase 2/3 clinical trials in both the hospital and outpatient settings. The primary completion date for the Phase 2/3 studies is June 2021. The Company anticipates interim efficacy data in the first quarter of 2021. In September 2020, Merck and Seagen announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. Under the terms of the agreement, Merck made an upfront payment of $600 million and a $1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $200 per share. Merck recorded $616 million in Research and development expenses in 2020 related to this transaction. Seagen is also eligible to receive future contingent milestone payments dependent upon the achievement of certain developmental and sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the United States, Canada and Europe. Under the terms of the agreement, Merck made upfront payments aggregating $210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones and tiered royalties based on annual sales levels of Tukysa in Mercks territories. In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $423 million. In addition, OncoImmune shareholders will be eligible to receive future contingent regulatory approval milestone payments and tiered royalties. OncoImmunes lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with COVID-19. Topline results from a pre-planned interim efficacy analysis from a Phase 3 study of MK-7110 were released in September 2020. Full results from this Phase 3 study, which were consistent with the topline results, were received in February 2021 and will be submitted for publication in the future. The transaction was accounted s for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $50 million for a 20% ownership interest in the new entity, which was valued at $33 million resulting in a $17 million premium. Merck also recognized other net liabilities of $22 million. The Company recorded Research and development expenses of $462 million in 2020 related to this transaction. In December 2020, Merck announced it had entered into an agreement with the U.S. Government to support the development, manufacture and initial distribution of MK-7110 upon approval or Emergency Use Authorization (EUA) from the FDA by June 30, 2021. Under the agreement, Merck was to receive up to approximately $356 million for manufacturing and supply of approximately 60,000-100,000 doses of MK-7110 to the U.S. government by June 30, 2021 to help meet the governments pandemic response goals. Following the execution of this agreement, Merck received feedback from the FDA that additional data, beyond the study conducted by OncoImmune, would be needed to support a potential EUA application. Based on this FDA feedback, Merck no longer expects to supply the U.S. government with MK-7110 in the first half of 2021. Merck is actively working with FDA to address the agencys comments. In December 2020, Merck acquired VelosBio, a privately held clinical-stage biopharmaceutical company, for $2.8 billion. VelosBios lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $180 million (primarily cash) and Research and development expenses of $2.7 billion in 2020 related to the transaction. In February 2021, Merck and Pandion Therapeutics, Inc. (Pandion) entered into a definitive agreement under which Merck will acquire Pandion, a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases, for $60 per share in cash representing an approximate total equity value of $1.85 billion. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. Under the terms of the acquisition agreement, Merck, through a subsidiary, will initiate a tender offer to acquire all outstanding shares of Pandion. The closing of the tender offer is subject to certain conditions, including the tender of shares representing at least a majority of the total number of Pandions shares of fully-diluted common stock, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and other customary conditions. The transaction is expected to close in the first half of 2021. Capital Expenditures Capital expenditures were $4.7 billion in 2020, $3.5 billion in 2019 and $2.6 billion in 2018. Expenditures in the United States were $2.7 billion in 2020, $1.9 billion in 2019 and $1.5 billion in 2018. The increased capital expenditures in 2020 and 2019 reflect investment in new capital projects focused primarily on increasing manufacturing capacity for Mercks key products. The increased capital expenditures in 2020 also reflect the purchase of a manufacturing facility in Dunboyne, Ireland to support upcoming product launches (see Note 3 to the consolidated financial statements). The Company plans to invest more than $20 billion in new capital projects from 2020-2024. Depreciation expense was $1.7 billion in 2020, $1.7 billion in 2019 and $1.4 billion in 2018, of which $1.2 billion in 2020, $1.2 billion in 2019 and $1.0 billion in 2018, related to locations in the United States. Total depreciation expense in 2020 and 2019 included accelerated depreciation of $268 million and $233 million, respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). s Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) 2020 2019 2018 Working capital $ 437 $ 5,263 $ 3,669 Total debt to total liabilities and equity 34.7 % 31.2 % 30.4 % Cash provided by operations to total debt 0.3:1 0.5:1 0.4:1 The decline in working capital in 2020 compared with 2019 is primarily related to increased short-term debt supporting the funding of business development activities and capital expenditures. Cash provided by operating activities was $10.3 billion in 2020 compared with $13.4 billion in 2019, reflecting higher payments related to collaborations which were $2.9 billion in 2020 compared with $805 million in 2019. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities was $9.4 billion in 2020 compared with $2.6 billion in 2019. The increase was driven primarily by lower proceeds from the sales of securities and other investments, higher use of cash for acquisitions and higher capital expenditures, partially offset by lower purchases of securities and other investments. Cash used in financing activities was $2.8 billion in 2020 compared with $8.9 billion in 2019. The lower use of cash in financing activities was driven primarily by a net increase in short-term borrowings in 2020 compared with a net decrease in short-term borrowing in 2019, as well as lower purchases of treasury stock, partially offset by higher payments on debt (see below), lower proceeds from the issuance of debt (see below), higher dividends paid to shareholders and lower proceeds from the exercise of stock options. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable (see Note 6 to the consolidated financial statements). The Company factored $2.3 billion and $2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2020 and 2019 the Company had collected $102 million and $256 million, respectively, on behalf of the financial institutions, which was remitted to them in January 2021 and 2020, respectively. The net cash flows from these collections are reported as financing activities in the Consolidated Statement of Cash Flows. s The Companys contractual obligations as of December 31, 2020 are as follows: Payments Due by Period ($ in millions) Total 2021 20222023 20242025 Thereafter Purchase obligations (1) $ 3,458 $ 977 $ 1,232 $ 668 $ 581 Loans payable and current portion of long-term debt 6,432 6,432 Long-term debt 25,437 4,000 3,863 17,574 Interest related to debt obligations 10,779 759 1,431 1,254 7,335 Unrecognized tax benefits (2) 305 305 Transition tax related to the enactment of the TCJA (3) 3,006 390 736 1,880 Milestone payments related to collaborations (4) 200 200 Leases (5) 1,778 335 521 342 580 $ 51,395 $ 9,398 $ 7,920 $ 8,007 $ 26,070 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2020, the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, including interest and penalties, of $1.8 billion, including $305 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2021 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA (see Note 15 to the consolidated financial statements). (4) Reflects payments under collaborative agreements for sales-based milestones that were achieved in 2020 (and therefore deemed to be contractual obligations) but not paid until 2021 (see Note 4 to the consolidated financial statements). (5) Amounts exclude reasonably certain lease renewals that have not yet been executed (see Note 9 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts do not include contingent milestone payments related to collaborative arrangements or acquisitions as they are not considered contractual obligations until the successful achievement of developmental, regulatory approval or commercial milestones. At December 31, 2020, the Company has recognized liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca and Eisai where payment remains subject to the achievement of the related sales milestone aggregating $1.0 billion (see Note 4 to the consolidated financial statements). Excluded from research and development obligations are potential future funding commitments of up to approximately $52 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $73 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2021 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $300 million to its U.S. pension plans, $170 million to its international pension plans and $35 million to its other postretirement benefit plans during 2021. In June 2020, the Company issued $4.5 billion principal amount of senior unsecured notes consisting of $1.0 billion of 0.75% notes due 2026, $1.25 billion of 1.45% notes due 2030, $1.0 billion of 2.35% notes due 2040 and $1.25 billion of 2.45% notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities. In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings. The Company has a $6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. s In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2020, Mercks Board of Directors declared a quarterly dividend of $0.65 per share on the Companys outstanding common stock that was paid in January 2021. In January 2021, the Board of Directors declared a quarterly dividend of $0.65 per share on the Companys common stock for the second quarter of 2021 payable in April 2021. In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company spent $1.3 billion to purchase 16 million shares of its common stock for its treasury during 2020 under this program. In March 2020, the Company temporarily suspended its share repurchase program. As of December 31, 2020, the Companys remaining share repurchase authorization was $5.9 billion. The Company purchased $4.8 billion and $9.1 billion of its common stock during 2019 and 2018, respectively, under authorized share repurchase programs. In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers in 2018, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the s future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other Comprehensive Income (Loss) ( OCI) , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated Other Comprehensive Income (Loss) ( AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $593 million and $456 million at December 31, 2020 and 2019, respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2020 and 2019, Income before taxes would have declined by approximately $99 million and $110 million in 2020 and 2019, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative s instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2020, the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) 2020 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 3.875% notes due 2021 (1) $ 1,150 5 $ 1,150 2.40% notes due 2022 1,000 4 1,000 2.35% notes due 2022 1,250 5 1,250 (1) These interest rate swaps matured in January 2021. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2020 and 2019 would have positively affected the net aggregate market value of these instruments by $2.6 billion and $2.0 billion, respectively. A one percentage point decrease at December 31, 2020 and 2019 would have negatively affected the net aggregate market value by $3.1 billion and $2.2 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Estimates The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including s those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize s the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly s basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2020, 2019 or 2018. Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) 2020 2019 Balance January 1 $ 2,436 $ 2,630 Current provision 13,144 11,999 Adjustments to prior years (16) (230) Payments (12,454) (11,963) Balance December 31 $ 3,110 $ 2,436 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $249 million and $2.9 billion, respectively, at December 31, 2020 and were $233 million and $2.2 billion, respectively, at December 31, 2019. Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 0.6% in 2020, 1.1% in 2019 and 1.6% in 2018. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. s Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2020 and 2019 were $279 million and $168 million, respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 10 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2020 and 2019 of approximately $250 million and $240 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. s The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $11 million in 2020 and are estimated at $46 million in the aggregate for the years 2021 through 2025. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million at both December 31, 2020 and 2019. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $475 million in 2020, $417 million in 2019 and $348 million in 2018. At December 31, 2020, there was $678 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted-average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $454 million in 2020, $137 million in 2019 and $195 million in 2018. Net periodic benefit (credit) for other postretirement benefit plans was $(59) million in 2020, $(49) million in 2019 and $(45) million in 2018. Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 2.10% to 2.80% at December 31, 2020, compared with a range of 3.20% to 3.50% at December 31, 2019. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2021, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 6.50% to 6.70%, compared to a range of 7.00% to 7.30% in 2020. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard s deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $80 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2020. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $40 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2020. Required funding obligations for 2021 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which primarily reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). s Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the s financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 15 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. s ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2020 and 2019, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2020, the notes to consolidated financial statements, and the report dated February 25, 2021 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) 2020 2019 2018 Sales $ 47,994 $ 46,840 $ 42,294 Costs, Expenses and Other Cost of sales 15,485 14,112 13,509 Selling, general and administrative 10,468 10,615 10,102 Research and development 13,558 9,872 9,752 Restructuring costs 578 638 632 Other (income) expense, net ( 886 ) 139 ( 402 ) 39,203 35,376 33,593 Income Before Taxes 8,791 11,464 8,701 Taxes on Income 1,709 1,687 2,508 Net Income 7,082 9,777 6,193 Less: Net Income (Loss) Attributable to Noncontrolling Interests 15 ( 66 ) ( 27 ) Net Income Attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 2.79 $ 3.84 $ 2.34 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 2.78 $ 3.81 $ 2.32 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2020 2019 2018 Net Income Attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Other Comprehensive Loss Net of Taxes: Net unrealized (loss) gain on derivatives, net of reclassifications ( 297 ) ( 135 ) 297 Net unrealized (loss) gain on investments, net of reclassifications ( 18 ) 96 ( 10 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization ( 279 ) ( 705 ) ( 425 ) Cumulative translation adjustment 153 96 ( 223 ) ( 441 ) ( 648 ) ( 361 ) Comprehensive Income Attributable to Merck Co., Inc. $ 6,626 $ 9,195 $ 5,859 The accompanying notes are an integral part of these consolidated financial statements. s Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) 2020 2019 Assets Current Assets Cash and cash equivalents $ 8,062 $ 9,676 Short-term investments 774 Accounts receivable (net of allowance for doubtful accounts of $ 85 in 2020 and $ 86 in 2019) 7,851 6,778 Inventories (excludes inventories of $ 2,197 in 2020 and $ 1,480 in 2019 classified in Other assets - see Note 7) 6,310 5,978 Other current assets 5,541 4,277 Total current assets 27,764 27,483 Investments 785 1,469 Property, Plant and Equipment (at cost) Land 350 343 Buildings 12,645 11,989 Machinery, equipment and office furnishings 16,649 15,394 Construction in progress 7,324 5,013 36,968 32,739 Less: accumulated depreciation 18,982 17,686 17,986 15,053 Goodwill 20,238 19,425 Other Intangibles, Net 14,604 14,196 Other Assets 10,211 6,771 $ 91,588 $ 84,397 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 6,431 $ 3,610 Trade accounts payable 4,594 3,738 Accrued and other current liabilities 13,053 12,549 Income taxes payable 1,575 736 Dividends payable 1,674 1,587 Total current liabilities 27,327 22,220 Long-Term Debt 25,360 22,736 Deferred Income Taxes 1,015 1,470 Other Noncurrent Liabilities 12,482 11,970 Merck Co., Inc. Stockholders Equity Common stock, $ 0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2020 and 2019 1,788 1,788 Other paid-in capital 39,588 39,660 Retained earnings 47,362 46,602 Accumulated other comprehensive loss ( 6,634 ) ( 6,193 ) 82,104 81,857 Less treasury stock, at cost: 1,046,877,695 shares in 2020 and 1,038,087,496 shares in 2019 56,787 55,950 Total Merck Co., Inc. stockholders equity 25,317 25,907 Noncontrolling Interests 87 94 Total equity 25,404 26,001 $ 91,588 $ 84,397 The accompanying notes are an integral part of this consolidated financial statement. s Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2018 $ 1,788 $ 39,902 $ 41,350 $ ( 4,910 ) $ ( 43,794 ) $ 233 $ 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards 322 ( 274 ) 48 Other comprehensive loss, net of taxes ( 361 ) ( 361 ) Cash dividends declared on common stock ($ 1.99 per share) ( 5,313 ) ( 5,313 ) Treasury stock shares purchased ( 1,000 ) ( 8,091 ) ( 9,091 ) Net loss attributable to noncontrolling interests ( 27 ) ( 27 ) Distributions attributable to noncontrolling interests ( 25 ) ( 25 ) Share-based compensation plans and other ( 94 ) 956 862 Balance December 31, 2018 1,788 38,808 42,579 ( 5,545 ) ( 50,929 ) 181 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($ 2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) 759 611 Balance December 31, 2019 1,788 39,660 46,602 ( 6,193 ) ( 55,950 ) 94 26,001 Net income attributable to Merck Co., Inc. 7,067 7,067 Other comprehensive loss, net of taxes ( 441 ) ( 441 ) Cash dividends declared on common stock ($ 2.48 per share) ( 6,307 ) ( 6,307 ) Treasury stock shares purchased ( 1,281 ) ( 1,281 ) Net income attributable to noncontrolling interests 15 15 Distributions attributable to noncontrolling interests ( 22 ) ( 22 ) Share-based compensation plans and other ( 72 ) 444 372 Balance December 31, 2020 $ 1,788 $ 39,588 $ 47,362 $ ( 6,634 ) $ ( 56,787 ) $ 87 $ 25,404 The accompanying notes are an integral part of this consolidated financial statement. s Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2020 2019 2018 Cash Flows from Operating Activities Net income $ 7,082 $ 9,777 $ 6,193 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 1,899 1,973 3,103 Depreciation 1,726 1,679 1,416 Intangible asset impairment charges 1,718 1,040 296 Charge for the acquisition of VelosBio Inc. 2,660 Charge for the acquisition of Peloton Therapeutics, Inc. 993 Charge for future payments related to collaboration license options 650 Deferred income taxes ( 668 ) ( 556 ) ( 509 ) Share-based compensation 475 417 348 Other ( 49 ) 184 978 Net changes in assets and liabilities: Accounts receivable ( 1,002 ) 294 ( 418 ) Inventories ( 855 ) ( 508 ) ( 911 ) Trade accounts payable 724 399 230 Accrued and other current liabilities ( 1,138 ) 376 ( 341 ) Income taxes payable 560 ( 2,359 ) 827 Noncurrent liabilities ( 453 ) ( 237 ) ( 266 ) Other ( 2,426 ) ( 32 ) ( 674 ) Net Cash Provided by Operating Activities 10,253 13,440 10,922 Cash Flows from Investing Activities Capital expenditures ( 4,684 ) ( 3,473 ) ( 2,615 ) Purchase of Seagen Inc. common stock ( 1,000 ) Purchases of securities and other investments ( 95 ) ( 3,202 ) ( 7,994 ) Proceeds from sales of securities and other investments 2,812 8,622 15,252 Acquisition of VelosBio Inc., net of cash acquired ( 2,696 ) Acquisition of ArQule, Inc., net of cash acquired ( 2,545 ) Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 1,365 ) ( 294 ) ( 431 ) Other 130 378 102 Net Cash (Used in) Provided by Investing Activities ( 9,443 ) ( 2,629 ) 4,314 Cash Flows from Financing Activities Net change in short-term borrowings 2,549 ( 3,710 ) 5,124 Payments on debt ( 1,957 ) ( 4,287 ) Proceeds from issuance of debt 4,419 4,958 Purchases of treasury stock ( 1,281 ) ( 4,780 ) ( 9,091 ) Dividends paid to stockholders ( 6,215 ) ( 5,695 ) ( 5,172 ) Proceeds from exercise of stock options 89 361 591 Other ( 436 ) 5 ( 325 ) Net Cash Used in Financing Activities ( 2,832 ) ( 8,861 ) ( 13,160 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash 253 17 ( 205 ) Net (Decrease) Increase in Cash, Cash Equivalents and Restricted Cash ( 1,769 ) 1,967 1,871 Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $ 258 of restricted cash at January 1, 2020 included in Other Assets - see Note 6) 9,934 7,967 6,096 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $ 103 of restricted cash at December 31, 2020 included in Other Assets - see Note 6) $ 8,165 $ 9,934 $ 7,967 The accompanying notes are an integral part of this consolidated financial statement. s Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. Subsequent to the spin-off, the historical results of the womens health, biosimilars and established brands businesses will be reflected as discontinued operations in the Companys consolidated financial statements. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates s over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related s to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 13.1 billion in 2020, $ 11.8 billion in 2019 and $ 10.7 billion in 2018. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 249 s million and $ 2.9 billion, respectively, at December 31, 2020 and were $ 233 million and $ 2.2 billion, respectively, at December 31, 2019. Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. See Note 18 for disaggregated revenue disclosures. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.7 billion in 2020, $ 1.7 billion in 2019 and $ 1.4 billion in 2018. Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.0 billion in 2020, $ 2.1 billion in 2019 and $ 2.1 billion in 2018. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are being amortized over periods ranging from 3 to 10 years, with the longer lives generally associated with enterprise-wide projects implemented over multiple years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted s future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as an acquisition of a business, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. s In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income . The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. s Recently Adopted Accounting Standards In June 2016, the Financial Accounting Standards Board (FASB) issued new guidance on the accounting for credit losses on financial instruments. The new guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The Company adopted the new guidance effective January 1, 2020. There was no impact to the Companys consolidated financial statements upon adoption. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under revenue recognition guidance (ASC 606). The Company retrospectively adopted the new guidance effective January 1, 2020, which resulted in minor changes to the presentation of information related to the Companys collaborative arrangements (see Note 4 and Note 18). In December 2019, the FASB issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. Recently Issued Accounting Standard Not Yet Adopted In March 2020, the FASB issued optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting and subsequently issued clarifying amendments. The guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The optional guidance is effective upon issuance and can be applied on a prospective basis at any time between January 1, 2020 through December 31, 2022. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue acquisitions and the establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. 2020 Transactions In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $ 423 million. In addition, OncoImmune shareholders will be eligible to receive up to $ 255 million of future contingent regulatory approval milestone payments and tiered royalties ranging from 10 % to 20 %. OncoImmunes lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with coronavirus disease 2019 (COVID-19). The transaction was accounted for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $ 50 million for a 20 % ownership interest in the new entity, which was valued at $ 33 million resulting in a $ 17 million premium. Merck also s recognized other net liabilities of $ 22 million. The Company recorded Research and development expenses of $ 462 million in 2020 related to this transaction. Also in December 2020, Merck acquired VelosBio Inc. (VelosBio), a privately held, clinical-stage biopharmaceutical company, for $ 2.8 billion. VelosBios lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 180 million (primarily cash) and Research and development expenses of $ 2.7 billion in 2020 related to the transaction. In September 2020, Merck and Seagen Inc. (Seagen, formerly known as Seattle Genetics, Inc.) announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda (pembrolizumab) in triple-negative breast cancer, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. The companies will equally share profits worldwide. Under the terms of the agreement, Merck made an upfront payment of $ 600 million and a $ 1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $ 200 per share. Merck recorded $ 616 million in Research and development expenses in 2020 related to this transaction reflecting the upfront payment as well as a $ 16 million premium relating to the equity shares based on the price of Seagen common stock on the closing date. Seagen is also eligible to receive future contingent milestone payments of up to $ 2.6 billion, including $ 850 million in development milestones and $ 1.75 billion in sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the United States, Canada and Europe. Merck will be responsible for marketing applications seeking approval in its territories, supported by the positive results from the HER2CLIMB clinical trial. Merck will also co-fund a portion of the Tukysa global development plan, which encompasses several ongoing and planned trials across HER2-positive cancers, including breast, colorectal, gastric and other cancers set forth in a global product development plan. Merck will solely fund and conduct country-specific clinical trials necessary to support anticipated regulatory applications in its territories. Under the terms of the agreement, Merck made upfront payments aggregating $ 210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones of up to $ 65 million and will receive tiered royalties ranging from 20 % to 33 % based on annual sales levels of Tukysa in Mercks territories. Additionally in September 2020, Merck acquired a biologics manufacturing facility located in Dunboyne, Ireland from Takeda Pharmaceutical Company Limited for 256 million ($ 302 million). The transaction was accounted for as an acquisition of an asset. Merck recorded property, plant and equipment of $ 289 million and other net assets of $ 13 million. There are no future contingent payments associated with the acquisition. In July 2020, Merck acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews from Virbac Corporation for $ 410 million. Sentinel products provide protection against common parasites in dogs. The transaction was accounted for as an acquisition of an asset. Merck recognized intangible assets of $ 401 million related to currently marketed products and inventory of $ 9 million at the acquisition date. The estimated fair values of the identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products will be amortized over their estimated useful lives of 15 years. There are no future contingent payments associated with the acquisition. Also in July 2020, Merck and Ridgeback Biotherapeutics LP (Ridgeback Bio), a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Merck s and Ridgeback are committed to ensure that any medicines developed for SARS-CoV-2 (the causative agent of COVID-19) will be accessible and affordable globally. In June 2020, Merck acquired privately held Themis Bioscience GmbH (Themis), a company focused on vaccines (including a COVID-19 vaccine candidate, V591) and immune-modulation therapies for infectious diseases and cancer for $ 366 million. The acquisition originally provided for Merck to make additional contingent payments of up to $ 740 million. The transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $ 97 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payments. Merck recognized intangible assets for IPRD of $ 136 million, cash of $ 59 million, deferred tax assets of $ 70 million and other net liabilities of $ 32 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 230 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In January 2021, the Company announced it was discontinuing development of V591 as discussed below. As a result, in 2020, the Company recorded an IPRD impairment charge of $ 90 million within Research and development expenses. The Company also recorded a reduction in Research and development expenses resulting from a decrease in the related liability for contingent consideration of $ 45 million since future contingent milestone payments have been reduced to $ 450 million in the aggregate, including up to $ 60 million for development milestones, up to $ 196 million for regulatory approval milestones, and up to $ 194 million for commercial milestones. In May 2020, Merck and the International AIDS Vaccine Initiative, Inc. (IAVI), a nonprofit scientific research organization dedicated to addressing urgent, unmet global health challenges, announced a collaboration to develop V590, an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. The agreement provided for an upfront payment by Merck of $ 6.5 million and also provided for future contingent payments based on sales. Merck also signed an agreement with the Biomedical Advanced Research and Development Authority (BARDA), part of the office of the Assistant Secretary for Preparedness and Response within an agency of the United States Department of Health and Human Services, to provide initial funding support to Merck for this effort. In January 2021, the Company announced it was discontinuing development of V590 as discussed below. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $ 305 million in 2020, of which $ 260 million was reflected in Cost of sales and related to fixed-asset and materials write-offs, as well as the recognition of liabilities for purchase commitments . The remaining $ 45 million of costs were reflected in Research and development expenses and represent amounts related to the Themis acquisition noted above (an IPRD impairment charge, partially offset by a reduction in the related liability for contingent consideration). In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases. Total consideration paid of $ 2.7 billion included $ 138 million of share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of ArQule. The Company incurred $ 95 million of transaction costs directly related to the acquisition of ArQule, consisting almost entirely of share-based compensation payments to settle non-vested equity awards attributable to postcombination service. These costs were included in Selling, general and administrative expenses in 2020. ArQules lead investigational candidate, MK-1026 (formerly known as ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business. s The estimated fair value of assets acquired and liabilities assumed from ArQule is as follows: ($ in millions) January 16, 2020 Cash and cash equivalents $ 145 IPRD MK-1026 (formerly ARQ 531) (1) 2,280 Licensing arrangement for ARQ 087 80 Deferred income tax liabilities ( 361 ) Other assets and liabilities, net 34 Total identifiable net assets 2,178 Goodwill (2) 512 Consideration transferred $ 2,690 (1) The estimated fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 12.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill was allocated to the Pharmaceutical segment and is not deductible for tax purposes. 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly known as PT2977), is a novel investigational oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $ 1.2 billion; additionally, former Peloton shareholders will be eligible to receive $ 50 million upon U.S. regulatory approval, $ 50 million upon first commercial sale in the United States, and up to $ 1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million, deferred tax liabilities of $ 52 million, and other net liabilities of $ 4 million at the acquisition date, as well as Research and development expenses of $ 993 million in 2019 related to the transaction. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: ($ in millions) April 1, 2019 Cash and cash equivalents $ 31 Accounts receivable 73 Inventories 93 Property, plant and equipment 60 Identifiable intangible assets (useful lives ranging from 18 - 24 years) (1) 2,689 Deferred income tax liabilities ( 589 ) Other assets and liabilities, net ( 82 ) Total identifiable net assets 2,275 Goodwill (2) 1,376 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 11.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. s The Companys results for 2019 include eight months of activity for Antelliq, while the Companys results in 2020 include 13 months of activity. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $ 156 million, cash of $ 83 million and other net assets of $ 42 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 2018 Transactions In 2018, the Company recorded an aggregate charge of $ 423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $ 155 million, which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $ 137 million, inventory write-offs of $ 122 million, as well as other related costs of $ 9 million. The termination of this agreement had no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ($ 378 million). The transaction provided Merck with full rights to V937 (formerly known as CVA21), an investigational oncolytic immunotherapy. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 34 million (primarily cash) at the acquisition date and Research and development expenses of $ 344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. in the second half of 2024. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of s advanced ovarian, breast, pancreatic and prostate cancers. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies are also jointly developing and commercializing AstraZenecas Koselugo (selumetinib), an oral, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, for multiple indications. In April 2020, Koselugo was approved by the U.S. Food and Drug Administration (FDA) for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 who have symptomatic, inoperable plexiform neurofibromas. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and Koselugo monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Profits from Lynparza and Koselugo product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or Koselugo. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or Koselugo. AstraZeneca is the principal on Lynparza and Koselugo sales transactions. Merck records its share of Lynparza and Koselugo product sales, net of cost of sales and commercialization costs, as alliance revenue and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.6 billion in 2017 and made payments of $ 750 million over a multi-year period for certain license options (of which $ 250 million was paid in December 2017, $ 400 million was paid in December 2018 and $ 100 million was paid in December 2019). The upfront payment and license option payments were reflected in Research and development expenses in 2017. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. In 2020, Merck determined it was probable that sales of Lynparza in the future would trigger $ 400 million of sales-based milestone payments from Merck to AstraZeneca. Accordingly, Merck recorded $ 400 million of liabilities and corresponding increases to the intangible asset related to Lynparza. Prior to 2020, Merck accrued sales-based milestone payments aggregating $ 1.0 billion related to Lynparza, of which $ 550 million, $ 200 million and $ 250 million was paid to AstraZeneca in 2020, 2019 and 2018, respectively. Potential future sales-based milestone payments of $ 2.7 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020, 2019 and 2018, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 160 million, $ 60 million and $ 140 million, respectively, in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.4 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 1.3 billion at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Lynparza $ 725 $ 444 $ 187 Alliance revenue - Koselugo 8 Total alliance revenue $ 733 $ 444 $ 187 Cost of sales (1) 247 148 93 Selling, general and administrative 160 138 48 Research and development 133 168 152 December 31 2020 2019 Receivables from AstraZeneca included in Other current assets $ 215 $ 128 Payables to AstraZeneca included in Accrued and other current liabilities (2) 423 577 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone payments. Eisai In March 2018, Merck and Eisai Co., Ltd. (Eisai) announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (lenvatinib), an orally available tyrosine kinase inhibitor discovered by Eisai. Lenvima is currently approved for the treatment of certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for the treatment of certain patients with endometrial carcinoma. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share applicable profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development are shared by the two companies in accordance with the collaboration agreement and reflected in Research and development expenses. Certain expenses incurred solely by Merck or Eisai are not shareable under the collaboration agreement, including costs incurred in excess of agreed upon caps and costs related to certain combination studies of Keytruda and Lenvima. Under the agreement, Merck made an upfront payment to Eisai of $ 750 million in 2018 and agreed to make payments of up to $ 650 million for certain option rights through 2021 (of which $ 325 million was paid in March 2019, $ 200 million was paid in March 2020 and $ 125 million is expected to be paid in March 2021). The Company recorded an aggregate charge of $ 1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for additional contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. In 2020, Merck determined it was probable that sales of Lenvima in the future would trigger sales-based milestone payments aggregating $ 400 million from Merck to Eisai. Accordingly, Merck recorded liabilities of $ 400 million and corresponding increases to the intangible asset related to Lenvima. Prior to 2020, Merck accrued sales-based milestone payments aggregating $ 950 million related to Lenvima, of which $ 500 million and $ 50 million was paid to Eisai in 2020 and 2019, respectively. Potential future sales-based milestone payments of $ 2.6 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020 and 2018, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 10 million and $ 250 million, respectively, from Merck to Eisai. Potential future regulatory milestone payments of $ 125 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 1.1 billion at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Lenvima $ 580 $ 404 $ 149 Cost of sales (1) 271 206 39 Selling, general and administrative 73 80 13 Research and development (2) 185 189 1,489 December 31 2020 2019 Receivables from Eisai included in Other current assets $ 157 $ 150 Payables to Eisai included in Accrued and other current liabilities (3) 335 700 Payables to Eisai included in Other Noncurrent Liabilities (4) 600 525 (1) Represents amortization of capitalized milestone payments. (2) Amount for 2018 includes $ 1.4 billion related to the upfront payment and option payments. (3) Includes accrued milestone and future option payments. (4) Includes accrued milestone payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat), which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers Verquvo (vericiguat), which was approved by the FDA in January 2021 to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults. Verquvo is under review by regulatory authorities in other territories including the EU and Japan. Under the agreement, Bayer commercializes Adempas in the Americas, while Merck commercializes in the rest of the world. For Verquvo, Merck will commercialize in the United States and Bayer will commercialize in the rest of the world. Both companies share in development costs and profits on sales. Merck records sales of Adempas (and will record sales of Verquvo) in its marketing territories, as well as alliance revenue. Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs. In addition, the agreement provides for contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. Prior to 2020, Merck accrued $ 725 million of sales-based milestone payments for this collaboration, of which $ 375 million and $ 350 million was paid to Bayer in 2020 and 2018, respectively. Following the 2021 FDA approval of Verquvo noted above, Merck determined it was probable that sales of Adempas and Verquvo in the future would trigger the remaining $ 400 million sales-based milestone payment. Accordingly, Merck will record a liability of $ 400 million and a corresponding increase in intangible assets related to this collaboration in the first quarter of 2021. The intangible asset balance related to this collaboration (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $ 849 million at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Adempas $ 281 $ 204 $ 139 Net sales of Adempas recorded by Merck 220 215 190 Total sales $ 501 $ 419 $ 329 Cost of sales (1) 115 113 216 Selling, general and administrative 61 41 35 Research and development 63 126 127 December 31 2020 2019 Receivables from Bayer included in Other current assets $ 65 $ 49 Payables to Bayer included in Other Noncurrent Liabilities (2) 375 (1) Includes amortization of intangible assets. (2) Represents accrued milestone payment. 5. Restructuring In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $ 3.0 billion. The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 30 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects to record charges of approximately $ 700 million in 2021 related to the Restructuring Program. Actions under previous global restructuring programs have been substantially completed. The Company recorded total pretax costs of $ 883 million in 2020, $ 927 million in 2019 and $ 658 million in 2018 related to restructuring program activities. Since inception of the Restructuring Program through December 31, 2020, Merck has recorded total pretax accumulated costs of approximately $ 1.8 billion. For segment reporting, restructuring charges are unallocated expenses. s The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2020 Cost of sales $ $ 143 $ 32 $ 175 Selling, general and administrative 44 3 47 Research and development 81 2 83 Restructuring costs 385 193 578 $ 385 $ 268 $ 230 $ 883 Year Ended December 31, 2019 Cost of sales $ $ 198 $ 53 $ 251 Selling, general and administrative 33 1 34 Research and development 2 2 4 Restructuring costs 572 66 638 $ 572 $ 233 $ 122 $ 927 Year Ended December 31, 2018 Cost of sales $ $ 10 $ 11 $ 21 Selling, general and administrative 2 1 3 Research and development ( 13 ) 15 2 Restructuring costs 473 159 632 $ 473 $ ( 1 ) $ 186 $ 658 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2020, 2019 and 2018 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 13) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2019 $ 443 $ $ 91 $ 534 Expenses 572 233 122 927 (Payments) receipts, net ( 325 ) ( 136 ) ( 461 ) Non-cash activity ( 233 ) ( 8 ) ( 241 ) Restructuring reserves December 31, 2019 690 69 759 Expenses 385 268 230 883 (Payments) receipts, net ( 508 ) ( 301 ) ( 809 ) Non-cash activity ( 268 ) 38 ( 230 ) Restructuring reserves December 31, 2020 (1) $ 567 $ $ 36 $ 603 (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. s 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . s The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 2020 2019 2018 2020 2019 2018 Net Investment Hedging Relationships Foreign exchange contracts $ 26 $ ( 10 ) $ ( 18 ) $ ( 19 ) $ ( 31 ) $ ( 11 ) Euro-denominated notes 385 ( 75 ) ( 183 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In February 2020, five interest rate swaps with notional amounts of $ 250 million each matured. These swaps effectively converted the Companys $ 1.25 billion, 1.85 % fixed-rate notes due 2020 to variable rate debt. At December 31, 2020, the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below: 2020 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 3.875 % notes due 2021 (1) $ 1,150 5 $ 1,150 2.40 % notes due 2022 1,000 4 1,000 2.35 % notes due 2022 1,250 5 1,250 (1) These interest rate swaps matured in January 2021. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark LIBOR swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. s The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount 2020 2019 2020 2019 Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 1,150 $ 1,249 $ $ ( 1 ) Long-Term Debt 2,301 3,409 53 14 Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: 2020 2019 Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other current assets $ 1 $ $ 1,150 $ $ $ Interest rate swap contracts Other Assets 54 2,250 15 3,400 Interest rate swap contracts Accrued and other current liabilities 1 1,250 Foreign exchange contracts Other current assets 12 3,183 152 6,117 Foreign exchange contracts Other Assets 45 2,030 55 2,160 Foreign exchange contracts Accrued and other current liabilities 217 5,049 22 1,748 Foreign exchange contracts Other Noncurrent Liabilities 1 52 1 53 $ 112 $ 218 $ 13,714 $ 222 $ 24 $ 14,728 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ 70 $ $ 7,260 $ 66 $ $ 7,245 Foreign exchange contracts Accrued and other current liabilities 307 11,810 73 8,693 $ 70 $ 307 $ 19,070 $ 66 $ 73 $ 15,938 $ 182 $ 525 $ 32,784 $ 288 $ 97 $ 30,666 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: 2020 2019 Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ 182 $ 525 $ 288 $ 97 Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 156 ) ( 156 ) ( 84 ) ( 84 ) Cash collateral posted/received ( 36 ) ( 34 ) Net amounts $ 26 $ 333 $ 170 $ 13 s The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 47,994 $ 46,840 $ 42,294 $ ( 886 ) 139 ( 402 ) $ ( 441 ) $ ( 648 ) $ ( 361 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items 40 95 ( 27 ) Derivatives designated as hedging instruments ( 76 ) ( 65 ) 50 Impact of cash flow hedging relationships Foreign exchange contracts Amount of (loss) gain recognized in OCI on derivatives ( 383 ) 87 228 (Decrease) increase in Sales as a result of AOCI reclassifications ( 6 ) 255 ( 160 ) 6 ( 255 ) 160 Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 4 ) ( 4 ) ( 4 ) Amount of loss recognized in OCI on derivatives ( 4 ) ( 6 ) ( 4 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 2020 2019 2018 Derivatives Not Designated as Hedging Instruments Income Statement Caption Foreign exchange contracts (1) Other (income) expense, net $ ( 12 ) $ 174 $ ( 260 ) Foreign exchange contracts (2) Sales 13 1 ( 8 ) Interest rate contracts (3) Other (income) expense, net 9 Forward contract related to Seagen common stock Research and development expenses 15 (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. (3) These derivatives serve as economic hedges against rising treasury rates. At December 31, 2020, the Company estimates $ 331 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. s Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: 2020 2019 Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses U.S. government and agency securities $ 84 $ $ $ 84 $ 266 $ 3 $ $ 269 Foreign government bonds 5 5 Commercial paper 668 668 Corporate notes and bonds 608 13 621 Asset-backed securities 226 1 227 Total debt securities 89 89 1,768 17 1,785 Publicly traded equity securities (1) 1,787 838 Total debt and publicly traded equity securities $ 1,876 $ 2,623 (1) Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2020 were $ 163 million during 2020. Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2019 were $ 160 million during 2019. At December 31, 2020 and 2019, the Company also had $ 586 million and $ 420 million, respectively, of equity investments without readily determinable fair values included in Other Assets . During 2020 and 2019, the Company recognized unrealized gains of $ 62 million and $ 20 million, respectively, in Other (income) expense, net , on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2020 and 2019, the Company recognized unrealized losses of $ 3 million and $ 13 million, respectively, in Other (income) expense, net , related to certain of these investments based on unfavorable observable price changes. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values were $ 169 million and $ 24 million, respectively. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. s Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total 2020 2019 Assets Investments Foreign government bonds $ $ 5 $ $ 5 $ $ $ $ Commercial paper 668 668 Corporate notes and bonds 621 621 Asset-backed securities 227 227 U.S. government and agency securities 209 209 Publicly traded equity securities 780 780 518 518 780 5 785 518 1,725 2,243 Other assets (1) U.S. government and agency securities 84 84 60 60 Publicly traded equity securities 1,007 1,007 320 320 1,091 1,091 380 380 Derivative assets (2) Forward exchange contracts 90 90 169 169 Interest rate swaps 55 55 15 15 Purchased currency options 37 37 104 104 182 182 288 288 Total assets $ 1,871 $ 187 $ $ 2,058 $ 898 $ 2,013 $ $ 2,911 Liabilities Other liabilities Contingent consideration $ $ $ 841 $ 841 $ $ $ 767 $ 767 Derivative liabilities (2) Forward exchange contracts 505 505 95 95 Written currency options 20 20 1 1 Interest rate swaps 1 1 525 525 97 97 Total liabilities $ $ 525 $ 841 $ 1,366 $ $ 97 $ 767 $ 864 (1) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (2) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2020 and 2019, Cash and cash equivalents include $ 6.8 billion and $ 8.9 billion, respectively, of cash equivalents (which would be considered Level 2 in the fair value hierarchy). s Contingent Consideration Summarized information about the changes in liabilities for contingent consideration associated with business acquisitions is as follows: 2020 2019 Fair value January 1 $ 767 $ 788 Additions 97 Changes in estimated fair value (1) 83 64 Payments ( 106 ) ( 85 ) Fair value December 31 (2)(3) $ 841 $ 767 (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2020 includes $ 148 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2020 and 2019, $ 711 million and $ 625 million, respectively, of the liabilities relate to the termination of the Sanofi Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8 % to present value the cash flows. The additions to contingent consideration in 2020 relate to the acquisition of Themis. The changes in the estimated fair value of liabilities for contingent consideration in 2020 and 2019 were largely attributable to increases in the liabilities recorded in connection with the termination of the Sanofi Pasteur MSD (SPMSD) joint venture in 2016. In 2020, the increase was partially offset by a decline related to the discontinuation of a COVID-19 vaccine program obtained through the acquisition of Themis. The payments of contingent consideration in both years relate to the SPMSD liabilities described above. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2020, was $ 36.0 billion compared with a carrying value of $ 31.8 billion and at December 31, 2019, was $ 28.8 billion compared with a carrying value of $ 26.3 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States, Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 45 % of total accounts receivable at December 31, 2020. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $ 2.3 billion and $ 2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the s Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2020 and 2019, the Company had collected $ 102 million and $ 256 million, respectively, on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2021 and 2020, respectively. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral advanced by the Company to counterparties was $ 36 million at December 31, 2020. Cash collateral received by the Company from various counterparties was $ 34 million at December 31, 2019. The obligation to return such collateral is recorded in Accrued and other current liabilities . 7. Inventories Inventories at December 31 consisted of: 2020 2019 Finished goods $ 1,963 $ 1,772 Raw materials and work in process 6,420 5,650 Supplies 206 207 Total (approximates current cost) 8,589 7,629 Decrease to LIFO cost ( 82 ) ( 171 ) $ 8,507 $ 7,458 Recognized as: Inventories $ 6,310 $ 5,978 Other assets 2,197 1,480 Inventories valued under the LIFO method comprised approximately $ 2.9 billion and $ 2.6 billion at December 31, 2020 and 2019, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2020 and 2019, these amounts included $ 1.9 billion and $ 1.3 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 279 million and $ 168 million at December 31, 2020 and 2019, respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2019 $ 16,162 $ 1,870 $ 221 $ 18,253 Acquisitions 19 1,322 1,341 Impairments ( 162 ) ( 162 ) Other (1) ( 7 ) ( 7 ) Balance December 31, 2019 (2) 16,181 3,192 52 19,425 Acquisitions 742 105 847 Divestitures ( 54 ) ( 54 ) Other (1) 47 ( 29 ) 2 20 Balance December 31, 2020 (2) $ 16,970 $ 3,268 $ $ 20,238 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses were $ 531 million at both December 31, 2020 and 2019. s The additions to goodwill in the Pharmaceutical segment in 2020 were primarily related to the acquisitions of ArQule and Themis (see Note 3). The additions to goodwill within the Animal Health segment in 2019 primarily relate to the acquisition of Antelliq (see Note 3). The impairments of goodwill within other non-reportable segments in 2019 relate to certain businesses within the Healthcare Services segment. The Healthcare Services segment was fully divested in the first quarter of 2020. Other intangibles at December 31 consisted of: 2020 2019 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 45,087 $ 39,925 $ 5,162 $ 45,947 $ 38,852 $ 7,095 Licenses 4,177 1,387 2,790 3,185 824 2,361 IPRD 3,228 3,228 1,032 1,032 Trade names 2,882 352 2,530 2,899 217 2,682 Other 2,223 1,329 894 2,261 1,235 1,026 $ 57,597 $ 42,993 $ 14,604 $ 55,324 $ 41,128 $ 14,196 Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2020 include Zerbaxa , $ 551 million; Implanon/Nexplanon, $ 354 million; Gardasil/Gardasil 9, $ 276 million; Dificid , $ 228 million; Bridion , $ 185 million; Sivextro , $ 154 million; and Simponi , $ 132 million. Additionally, the Company had $ 5.4 billion of net acquired intangibles related to animal health marketed products at December 31, 2020, of which $ 2.5 billion relate primarily to trade names obtained through the 2019 acquisition of Antelliq (see Note 3). Some of the Companys more significant net intangible assets included in licenses above at December 31, 2020 include Lynparza, $ 1.3 billion and Lenvima, $ 1.1 billion as a result of collaborations with AstraZeneca and Eisai (see Note 4). At December 31, 2020, IPRD primarily relates to MK-1026 obtained through the acquisition of ArQule in 2020 (see Note 3) and MK-7264 (gefapixant) obtained through the acquisition of Afferent Pharmaceuticals in 2016. The Company has an intangible asset related to a collaboration with Bayer (see Note 4) that had a carrying value of $ 849 million at December 31, 2020 reflected in Other in the table above. In 2020, the Company recorded an impairment charge of $ 1.6 billion within Cost of sales related to Zerbaxa for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. In December 2020, the Company temporarily suspended sales of Zerbaxa , and subsequently issued a product recall, following the identification of product sterility issues. The recall constituted a triggering event requiring the evaluation of the Zerbaxa intangible asset for impairment. The Company revised its cash flow forecasts for Zerbaxa utilizing certain assumptions around the return to market timeline and anticipated uptake in sales thereafter. These revised cash flow forecasts indicated that the Zerbaxa intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Zerbaxa that, when compared with its related carrying value, resulted in the impairment charge noted above. The Company also wrote-off inventory of $ 120 million to Cost of sales in 2020 related to the Zerbaxa recall. The remaining intangible asset balance related to Zerbaxa was $ 551 million at December 31, 2020. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million. Of this amount, $ 612 million related to Sivextro , a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced cash flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. s IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2020, the Company recorded a $ 90 million IPRD impairment charge within Research and development expenses related to a decision to discontinue the development program for COVID-19 vaccine candidate V591 following Mercks review of findings from a Phase 1 clinical study for the vaccine. In the study, V591 was generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The discontinuation of this development program also resulted in a reversal of the related liability for contingent consideration of $ 45 million (see Note 6). In 2019, the Company recorded $ 172 million of IPRD impairment charges. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 11 million. In 2018, the Company recorded $ 152 million of IPRD impairment charges. Of this amount, $ 139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 60 million. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $ 1.9 billion in 2020, $ 2.0 billion in 2019 and $ 3.1 billion in 2018. The estimated aggregate amortization expense for each of the next five years is as follows: 2021, $ 1.5 billion; 2022, $ 1.5 billion; 2023, $ 1.4 billion; 2024, $ 1.3 billion; 2025, $ 1.2 billion. 9. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2020 included $ 2.3 billion of notes due in 2021, $ 4.0 billion of commercial paper and $ 73 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2019 included $ 1.9 billion of notes due in 2020, $ 1.4 billion of commercial paper and $ 226 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.79 % and 2.23 % for the years ended December 31, 2020 and 2019, respectively. s Long-Term Debt Long-term debt at December 31 consisted of: 2020 2019 2.75 % notes due 2025 $ 2,493 $ 2,492 3.70 % notes due 2045 1,976 1,975 2.80 % notes due 2023 1,748 1,747 3.40 % notes due 2029 1,734 1,732 4.00 % notes due 2049 1,469 1,468 2.35 % notes due 2022 1,269 1,248 4.15 % notes due 2043 1,238 1,238 1.45 % notes due 2030 1,233 1.875 % euro-denominated notes due 2026 1,218 1,107 2.45 % notes due 2050 1,211 2.40 % notes due 2022 1,032 1,010 0.75 % notes due 2026 991 3.90 % notes due 2039 983 982 2.35 % notes due 2040 982 2.90 % notes due 2024 746 745 6.50 % notes due 2033 719 722 0.50 % euro-denominated notes due 2024 611 555 1.375 % euro-denominated notes due 2036 606 551 2.50 % euro-denominated notes due 2034 605 550 3.60 % notes due 2042 491 490 6.55 % notes due 2037 411 412 5.75 % notes due 2036 338 338 5.95 % debentures due 2028 306 306 5.85 % notes due 2039 271 271 6.40 % debentures due 2028 250 250 6.30 % debentures due 2026 135 135 3.875 % notes due 2021 1,151 1.125 % euro-denominated notes due 2021 1,113 Other 294 148 $ 25,360 $ 22,736 Other (as presented in the table above) includes $ 294 million and $ 147 million at December 31, 2020 and 2019, respectively, of borrowings at variable rates that resulted in effective interest rates of 0.45 % and 2.54 % for 2020 and 2019, respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In June 2020, the Company issued $ 4.5 billion principal amount of senior unsecured notes consisting of $ 1.0 billion of 0.75 % notes due 2026, $ 1.25 billion of 1.45 % notes due 2030, $ 1.0 billion of 2.35 % notes due 2040 and $ 1.25 billion of 2.45 % notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2020, the Company was in compliance with these covenants. s The aggregate maturities of long-term debt for each of the next five years are as follows: 2021, $ 2.3 billion; 2022, $ 2.3 billion; 2023, $ 1.7 billion; 2024, $ 1.4 billion; 2025, $ 2.5 billion. The Company has a $ 6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of eight years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company does not record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. The Company does not separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to effectively account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 346 million in 2020 and $ 339 million in 2019. Rental expense under operating leases, net of sublease income, was $ 322 million in 2018. Cash paid for amounts included in the measurement of operating lease liabilities was $ 340 million in 2020 and $ 281 million in 2019. Operating lease assets obtained in exchange for lease obligations was $ 495 million in 2020 and $ 129 million in 2019. Supplemental balance sheet information related to operating leases is as follows: December 31 2020 2019 Assets Other Assets (1) $ 1,725 $ 1,073 Liabilities Accrued and other current liabilities 300 236 Other Noncurrent Liabilities 1,362 768 $ 1,662 $ 1,004 Weighted-average remaining lease term (years) 8.0 7.4 Weighted-average discount rate 2.8 % 3.2 % (1) Includes prepaid leases that have no related lease liability. s Maturities of operating leases liabilities are as follows: 2021 $ 336 2022 277 2023 252 2024 187 2025 162 Thereafter 665 Total lease payments 1,879 Less: Imputed interest 217 $ 1,662 At December 31, 2020, the Company had entered into additional real estate operating leases that had not yet commenced; the obligations associated with these leases total $ 475 million. 10. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2020, approximately 3,520 cases are pending against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . All federal cases involving allegations of Femur Fractures have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. s In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. In May 2019, the U.S. Supreme Court decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. In November 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. Briefing on the issue is closed, and the parties await the decision of the District Court. Accordingly, as of December 31, 2020, approximately 970 cases were actively pending in the Femur Fracture MDL. As of December 31, 2020, approximately 2,270 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of cases to be reviewed through fact discovery, and Merck has continued to select additional cases to be reviewed. As of December 31, 2020, approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is presently stayed in the Femur Fracture MDL and in the state court in California. Merck intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2020, Merck is aware of approximately 1,480 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court, in separate opinions, granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery. In November 2018, the California state appellate court reversed and remanded on similar grounds. In March 2019, the parties in the MDL and the California coordinated proceedings agreed to coordinate and adopt a schedule for completing discovery on general causation and preemption issues and for renewing summary judgment and expert motions. Briefing of those motions is complete and hearings before both the MDL and California State Court judges took place on October 20 and December 8, 2020, respectively. As of December 31, 2020, six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed s the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided in September 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In May 2020, the Illinois Appellate Court issued a mandate to the state trial court, which, as of December 31, 2020, had not scheduled a case management conference. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx Merck reached a settlement with the Attorney General of Utah to fully resolve the states previously disclosed civil lawsuit alleging that Merck misrepresented the safety of Vioxx . As part of the resolution, Merck paid the state $ 25 million. The settlement does not constitute an admission by Merck of any liability or wrongdoing. This agreement marks the final resolution of litigation involving Vioxx in the United States. There is ongoing Vioxx litigation in certain countries outside the United States. Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, in May 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal health care programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, in April 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, in June 2020, Merck received a CID from the U.S. Department of Justice. The CID requests answers to interrogatories, as well as various documents, regarding temperature excursions at a third-party storage facility containing certain Merck products. Merck is cooperating with the governments investigation and intends to produce information and/or documents as necessary in response to the CID. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. s Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. In August 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, in June 2019, the representatives of the putative direct purchaser class filed an amended complaint and, in August 2019, retailer opt-out plaintiffs filed an amended complaint. In December 2019, the district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. In November 2019, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed motions for class certification. On August 21, 2020, the district court granted in part the direct purchasers motion for class certification and certified a class of 35 direct purchasers, and on November 2, 2020, the U.S. Court of Appeals for the Fourth Circuit granted the Merck Defendants motion for permission to appeal the district courts order. Also, on August 14, 2020, the magistrate judge recommended that the court grant the motion for class certification filed by the putative indirect purchaser class. The Merck Defendants objected to this report and recommendation and are awaiting a decision from the district court. On August 10, 2020, the Merck Defendants filed a motion for summary judgment and other motions, and plaintiffs filed a motion for partial summary judgment, and other motions. Those motions are now fully briefed, and the court will likely hold a hearing on the competing motions. Trial in this matter has been adjourned. On September 4, 2020, United Healthcare Services, Inc. filed a lawsuit in the United States District Court for the District of Minnesota against Merck and others (the UHC Action). The UHC Action makes similar allegations as those made in the Zetia class action. On September 23, 2020, the United States Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. On December 11, 2020, Humana Inc. filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against Merck and others, alleging defendants violated state antitrust laws in multiple states. Also, on December 11, 2020, Centene Corporation and others filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana. Both lawsuits allege similar anticompetitive acts to those alleged in the Zetia class action. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. In January 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. In February 2019, MSD appealed the courts order on arbitration to the Third Circuit. In October 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of arbitrability. On July 6, 2020, MSD filed a renewed motion to compel arbitration, and plaintiffs filed a cross motion for summary judgment as to arbitrability. On November 20, 2020, the district court denied MSDs motion and granted plaintiffs motion. On December 4, 2020, MSD filed a notice of appeal to the Third Circuit. Bravecto Litigation As previously disclosed, in January 2020, the Company was served with a complaint in the United States District Court for the District of New Jersey, seeking to certify a nationwide class action of purchasers or users of Bravecto (fluralaner) products in the United States or its territories between May 1, 2014 and December 27, 2019. The complaint contends Bravecto causes neurological events and alleges violations of the New Jersey Consumer s Fraud Act, Breach of Warranty, Product Liability, and related theories. A similar case was filed in Quebec, Canada in May 2019. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that had been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the Court. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the United States with no trial date set, and also ongoing in numerous jurisdictions outside of the United States; the Company is defending those suits in each jurisdiction. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Bridion Between January and November 2020, the Company received multiple Paragraph IV Certification Letters under the Hatch-Waxman Act notifying the Company that generic drug companies have filed applications to the FDA seeking pre-patent expiry approval to sell generic versions of Bridion (sugammadex) Injection. In March, April and December 2020, the Company filed patent infringement lawsuits in the U.S. District Courts for the District of New Jersey and the Northern District of West Virginia against those generic companies. All actions in the District of New Jersey have been consolidated. These lawsuits, which assert one or more patents covering sugammadex and methods of using sugammadex, automatically stay FDA approval of the generic applications until June 2023 or until adverse court decisions, if any, whichever may occur earlier. Mylan Pharmaceuticals Inc., Mylan API US LLC, and Mylan Inc. (Mylan) have filed motions to dismiss in the District of New Jersey for lack of venue and failure to state a claim against certain defendants, and in the Northern District of West Virginia for failure to state a claim against certain defendants. The New Jersey motion has not yet been decided, and the West Virginia action is stayed pending resolution of the New Jersey motion. s Januvia, Janumet, Janumet XR The FDA has granted pediatric exclusivity with respect to Januvia , Janumet , and Janumet XR , which provides a further six months of exclusivity in the United States beyond the expiration of all patents listed in the FDAs Orange Book. Including this exclusivity, key patent protection extends to January 2023. The Company anticipates that sales of Januvia and Janumet in the United States will decline significantly after this loss of market exclusivity. However, Januvia , Janumet , and Janumet XR contain sitagliptin phosphate monohydrate and the Company has another patent covering certain phosphate salt and polymorphic forms of sitagliptin, which, if determined to be valid, would preclude generic manufacturers from making sitagliptin phosphate salt and polymorphic forms before that patent, inclusive of pediatric exclusivity, expires in 2027 (2027 salt/polymorph patent). In 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of the 2027 salt/polymorph patent. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection, but prior to the expiration of the 2027 salt/polymorph patent, and a later granted patent owned by the Company covering the Janumet formulation which, inclusive of pediatric exclusivity, expires in 2029. The Company also filed a patent infringement lawsuit against Mylan in the Northern District of West Virginia. The Judicial Panel of Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. The U.S. District Court for the District of Delaware has scheduled the lawsuits for a single three-day trial on invalidity issues in October 2021. The Court has scheduled separate one-day trials on infringement issues in November 2021 through January 2022, to the extent such trials are necessary. In the Companys case against Mylan, the U.S. District Court for the Northern District of West Virginia has conditionally scheduled a three-day trial in December 2021 on all issues. The Company has settled with nine generic companies providing that these generic companies can bring their products to the market in May 2027 or earlier under certain circumstances. Additionally, in 2019, Mylan filed a petition for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking invalidity of some, but not all, of the claims of the 2027 salt/polymorph patent, which other manufacturers joined. The USPTO instituted IPR proceedings in May 2020, finding a reasonable likelihood that the challenged claims are not valid. A trial was held in February 2021 and a final decision is expected in May 2021. If the challenges are successful, the unchallenged claims of the 2027 salt/polymorph patent will remain valid, subject to the court proceedings described above. In Germany, two generic companies have sought the revocation of the Supplementary Protection Certificate (SPC) for Janumet . If the generic companies are successful, Janumet could lose market exclusivity in Germany as early as July 2022. Challenges to the Janumet SPC have also occurred in Portugal and Finland, and could occur in other European countries. Nexplanon In June 2017, Microspherix LLC (Microspherix) sued the Company in the U.S District Court for the District of New Jersey asserting that the manufacturing, use, sale and importation of Nexplanon infringed several of Microspherixs patents that claim radio-opaque, implantable drug delivery devices. Microspherix is claiming damages from September 2014 until those patents expire in May 2021. The Company brought IPR proceedings in the USPTO and successfully stayed the district court action. The USPTO invalidated some, but not all, of the claims asserted against the Company. The Company appealed the decisions finding claims valid, and the Court of Appeals for the Federal Circuit affirmed the USPTOs decisions. The matter is no longer stayed in the district court, and the Company is currently litigating the invalidity and non-infringement of the remaining asserted claims. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. s Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2020 and 2019 of approximately $ 250 million and $ 240 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 67 million at both December 31, 2020 and 2019. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $ 65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. s 11. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: 2020 2019 2018 Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 1,038 3,577 985 3,577 880 Purchases of treasury stock 16 66 122 Issuances (1) ( 7 ) ( 13 ) ( 17 ) Balance December 31 3,577 1,047 3,577 1,038 3,577 985 (1) Issuances primarily reflect activity under share-based compensation plans. In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the Dealers). Under the ASR agreements, Merck agreed to purchase $ 5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $ 5 billion made by Merck to the Dealers, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million. 12. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2020, 100 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years . RSU awards generally vest one-third each year over a three-year period. Total pretax share-based compensation cost recorded in 2020, 2019 and 2018 was $ 475 million, $ 417 million and $ 348 million, respectively, with related income tax benefits of $ 65 million, $ 57 million and $ 55 million, respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk- s free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2020, 2019 and 2018 was $ 77.67 , $ 80.05 and $ 58.15 per option, respectively. The weighted average fair value of options granted in 2020, 2019 and 2018 was $ 9.93 , $ 10.63 and $ 8.26 per option, respectively, and were determined using the following assumptions: Years Ended December 31 2020 2019 2018 Expected dividend yield 3.1 % 3.2 % 3.4 % Risk-free interest rate 0.4 % 2.4 % 2.9 % Expected volatility 22.1 % 18.7 % 19.1 % Expected life (years) 5.8 5.9 6.1 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2020 17,868 $ 59.88 Granted 3,564 77.67 Exercised ( 1,685 ) 52.73 Forfeited ( 301 ) 67.73 Outstanding December 31, 2020 19,446 $ 63.64 6.27 $ 353 Exercisable December 31, 2020 13,141 $ 58.30 5.13 $ 309 Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 2020 2019 2018 Total intrinsic value of stock options exercised $ 51 $ 295 $ 348 Fair value of stock options vested 25 27 29 Cash received from the exercise of stock options 89 361 591 A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2020 13,527 $ 67.58 1,972 $ 69.18 Granted 6,627 77.79 996 77.82 Vested ( 7,511 ) 65.70 ( 824 ) 64.01 Forfeited ( 728 ) 72.06 ( 44 ) 80.06 Nonvested December 31, 2020 11,915 $ 74.17 2,100 $ 75.08 At December 31, 2020, there was $ 678 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. s 13. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ 360 $ 293 $ 326 $ 301 $ 238 $ 238 $ 52 $ 48 $ 57 Interest cost 431 458 432 137 177 178 57 69 69 Expected return on plan assets ( 774 ) ( 817 ) ( 851 ) ( 415 ) ( 426 ) ( 431 ) ( 75 ) ( 72 ) ( 83 ) Amortization of unrecognized prior service cost ( 49 ) ( 49 ) ( 50 ) ( 18 ) ( 12 ) ( 13 ) ( 73 ) ( 78 ) ( 84 ) Net loss (gain) amortization 303 151 232 127 64 84 ( 18 ) ( 10 ) 1 Termination benefits 10 31 19 3 8 2 2 5 3 Curtailments 10 14 10 6 1 ( 4 ) ( 11 ) ( 8 ) Settlements 13 5 15 1 13 Net periodic benefit cost (credit) $ 304 $ 81 $ 123 $ 150 $ 56 $ 72 $ ( 59 ) $ ( 49 ) $ ( 45 ) The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2020, 2019 and 2018 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 14), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. s Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International 2020 2019 2020 2019 2020 2019 Fair value of plan assets January 1 $ 11,361 $ 9,648 $ 10,163 $ 8,580 $ 1,102 $ 968 Actual return on plan assets 1,908 2,165 1,026 1,505 175 203 Company contributions 199 130 387 262 19 14 Effects of exchange rate changes 746 31 Benefits paid ( 751 ) ( 582 ) ( 215 ) ( 230 ) ( 93 ) ( 104 ) Settlements ( 45 ) ( 117 ) ( 12 ) Other 59 27 18 21 Fair value of plan assets December 31 $ 12,672 $ 11,361 $ 12,049 $ 10,163 $ 1,221 $ 1,102 Benefit obligation January 1 $ 13,003 $ 10,620 $ 10,612 $ 9,083 $ 1,673 $ 1,615 Service cost 360 293 301 238 52 48 Interest cost 431 458 137 177 57 69 Actuarial losses (gains) (1) 1,594 2,165 1,036 1,313 ( 98 ) 21 Benefits paid ( 751 ) ( 582 ) ( 215 ) ( 230 ) ( 93 ) ( 104 ) Effects of exchange rate changes 794 4 ( 3 ) 1 Plan amendments ( 64 ) 1 Curtailments 11 18 ( 8 ) 3 ( 1 ) Termination benefits 10 31 3 8 2 5 Settlements ( 45 ) ( 117 ) ( 12 ) Other 55 27 18 18 Benefit obligation December 31 $ 14,613 $ 13,003 $ 12,534 $ 10,612 $ 1,607 $ 1,673 Funded status December 31 $ ( 1,941 ) $ ( 1,642 ) $ ( 485 ) $ ( 449 ) $ ( 386 ) $ ( 571 ) Recognized as: Other Assets $ $ $ 941 $ 837 $ $ Accrued and other current liabilities ( 82 ) ( 92 ) ( 13 ) ( 18 ) ( 9 ) ( 10 ) Other Noncurrent Liabilities ( 1,859 ) ( 1,550 ) ( 1,413 ) ( 1,268 ) ( 377 ) ( 561 ) (1) Actuarial losses (gains) primarily reflect changes in discount rates. At December 31, 2020 and 2019, the accumulated benefit obligation was $ 26.4 billion and $ 22.8 billion, respectively, for all pension plans, of which $ 14.4 billion and $ 12.8 billion, respectively, related to U.S. pension plans. s Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International 2020 2019 2020 2019 Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 14,613 $ 13,003 $ 8,951 $ 7,421 Fair value of plan assets 12,672 11,361 7,526 6,135 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 13,489 $ 12,009 $ 4,288 $ 2,476 Fair value of plan assets 11,685 10,484 3,033 1,501 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2020 and 2019, $ 942 million and $ 860 million, respectively, or approximately 4 % of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. s The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2020 2019 U.S. Pension Plans Cash and cash equivalents $ 5 $ $ $ 303 $ 308 $ 3 $ $ $ 236 $ 239 Investment funds Developed markets equities 206 3,884 4,090 205 3,542 3,747 Emerging markets equities 169 927 1,096 165 723 888 Mortgage and asset-backed securities 89 89 Government and agency obligations 173 173 Equity securities Developed markets 2,819 2,819 2,451 2,451 Fixed income securities Government and agency obligations 2,236 2,236 2,094 2,094 Corporate obligations 1,994 1,994 1,582 1,582 Mortgage and asset-backed securities 33 33 178 178 Other investments 7 7 9 9 Plan assets at fair value $ 3,199 $ 4,352 $ 7 $ 5,114 $ 12,672 $ 2,824 $ 3,854 $ 9 $ 4,674 $ 11,361 International Pension Plans Cash and cash equivalents $ 110 $ 1 $ $ 20 $ 131 $ 70 $ 1 $ $ 15 $ 86 Investment funds Developed markets equities 475 4,286 118 4,879 546 3,761 96 4,403 Government and agency obligations 1,516 2,614 172 4,302 462 2,534 207 3,203 Emerging markets equities 154 92 246 66 96 90 252 Corporate obligations 5 12 172 189 5 11 109 125 Other fixed income obligations 9 11 4 24 9 6 15 Real estate 1 15 16 1 1 Equity securities Developed markets 505 505 565 565 Fixed income securities Government and agency obligations 3 486 3 492 3 376 379 Corporate obligations 1 174 2 177 1 135 136 Mortgage and asset-backed securities 70 70 61 61 Other investments Insurance contracts (2) 76 935 1 1,012 65 851 916 Other 1 5 6 5 16 21 Plan assets at fair value $ 2,779 $ 7,736 $ 935 $ 599 $ 12,049 $ 1,727 $ 7,052 $ 851 $ 533 $ 10,163 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2020 and 2019. (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. s The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: 2020 2019 Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ 9 $ 9 $ $ $ 13 $ 13 Actual return on plan assets: Relating to assets still held at December 31 ( 5 ) ( 5 ) ( 8 ) ( 8 ) Relating to assets sold during the year 5 5 8 8 Purchases and sales, net ( 2 ) ( 2 ) ( 4 ) ( 4 ) Balance December 31 $ $ $ 7 $ 7 $ $ $ 9 $ 9 International Pension Plans Balance January 1 $ 851 $ $ $ 851 $ 811 $ 1 $ 1 $ 813 Actual return on plan assets: Relating to assets still held at December 31 103 103 54 54 Purchases and sales, net ( 17 ) ( 17 ) ( 14 ) ( 1 ) ( 1 ) ( 16 ) Transfers out of Level 3 ( 2 ) ( 2 ) Balance December 31 $ 935 $ $ $ 935 $ 851 $ $ $ 851 The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2020 2019 Cash and cash equivalents $ 31 $ $ $ 28 $ 59 $ 52 $ $ $ 22 $ 74 Investment funds Developed markets equities 19 355 374 19 324 343 Emerging markets equities 16 85 101 15 66 81 Government and agency obligations 1 1 1 16 17 Mortgage and asset-backed securities 8 8 Equity securities Developed markets 258 258 225 225 Fixed income securities Government and agency obligations 221 221 196 196 Corporate obligations 196 196 149 149 Mortgage and asset-backed securities 3 3 17 17 Plan assets at fair value $ 325 $ 428 $ $ 468 $ 1,221 $ 312 $ 362 $ $ 428 $ 1,102 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2020 and 2019. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11 %, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the s targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2021 are approximately $ 300 million for U.S. pension plans, approximately $ 170 million for international pension plans and approximately $ 35 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits 2021 $ 816 $ 274 $ 85 2022 786 277 86 2023 781 284 87 2024 772 285 89 2025 782 287 91 2026 2030 4,271 1,688 474 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Net (loss) gain arising during the period $ ( 448 ) $ ( 816 ) $ ( 397 ) $ ( 407 ) $ ( 227 ) $ ( 505 ) $ 198 $ 112 $ 186 Prior service (cost) credit arising during the period ( 1 ) ( 4 ) ( 4 ) 62 ( 1 ) ( 10 ) ( 3 ) ( 11 ) 2 $ ( 449 ) $ ( 820 ) $ ( 401 ) $ ( 345 ) $ ( 228 ) $ ( 515 ) $ 195 $ 101 $ 188 Net loss (gain) amortization included in benefit cost $ 303 $ 151 $ 232 $ 127 $ 64 $ 84 $ ( 18 ) $ ( 10 ) $ 1 Prior service credit amortization included in benefit cost ( 49 ) ( 49 ) ( 50 ) ( 18 ) ( 12 ) ( 13 ) ( 73 ) ( 78 ) ( 84 ) $ 254 $ 102 $ 182 $ 109 $ 52 $ 71 $ ( 91 ) $ ( 88 ) $ ( 83 ) s Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 2020 2019 2018 2020 2019 2018 Net periodic benefit cost Discount rate 3.40 % 4.40 % 3.70 % 1.50 % 2.20 % 2.10 % Expected rate of return on plan assets 7.30 % 8.10 % 8.20 % 4.40 % 4.90 % 5.10 % Salary growth rate 4.20 % 4.30 % 4.30 % 2.80 % 2.80 % 2.90 % Interest crediting rate 4.90 % 3.40 % 3.30 % 2.80 % 2.90 % 2.80 % Benefit obligation Discount rate 2.70 % 3.40 % 4.40 % 1.10 % 1.50 % 2.20 % Salary growth rate 4.60 % 4.20 % 4.30 % 2.80 % 2.80 % 2.80 % Interest crediting rate 4.70 % 4.90 % 3.40 % 3.00 % 2.80 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2021, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 6.50 % to 6.70 %, as compared to a range of 7.00 % to 7.30 % in 2020. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 2020 2019 Health care cost trend rate assumed for next year 6.6 % 6.8 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate 2032 2032 Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2020, 2019 and 2018 were $ 166 million, $ 149 million and $ 136 million, respectively. s 14. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 2020 2019 2018 Interest income $ ( 59 ) $ ( 274 ) $ ( 343 ) Interest expense 831 893 772 Exchange losses 145 187 145 Income from investments in equity securities, net (1) ( 1,338 ) ( 170 ) ( 324 ) Net periodic defined benefit plan (credit) cost other than service cost ( 339 ) ( 545 ) ( 512 ) Other, net ( 126 ) 48 ( 140 ) $ ( 886 ) $ 139 $ ( 402 ) (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period, while ownership interests in investment funds are accounted for on a one quarter lag. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8). Other, net in 2018 includes a gain of $ 115 million related to the settlement of certain patent litigation, income of $ 99 million related to AstraZenecas option exercise in 2014 in connection with the termination of the Companys relationship with AstraZeneca LP (AZLP), and a gain of $ 85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $ 144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $ 41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Interest paid was $ 822 million in 2020, $ 841 million in 2019 and $ 777 million in 2018. 15. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: 2020 2019 2018 Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 1,846 21.0 % $ 2,408 21.0 % $ 1,827 21.0 % Differential arising from: Foreign earnings ( 1,242 ) ( 14.1 ) ( 1,020 ) ( 8.9 ) ( 245 ) ( 2.8 ) GILTI and the foreign-derived intangible income deduction 364 4.1 336 2.9 ( 25 ) ( 0.3 ) RD tax credit ( 110 ) ( 1.3 ) ( 118 ) ( 1.0 ) ( 96 ) ( 1.1 ) Tax settlements ( 13 ) ( 0.2 ) ( 403 ) ( 3.5 ) ( 22 ) ( 0.3 ) Acquisition of VelosBio 559 6.3 Restructuring 105 1.2 39 0.3 56 0.6 Acquisition of OncoImmune 97 1.1 State taxes 67 0.8 ( 2 ) 201 2.3 Acquisition-related costs, including amortization 46 0.5 95 0.8 267 3.1 Valuation allowances 42 0.5 113 1.0 269 3.1 Acquisition of Peloton 209 1.8 Tax Cuts and Jobs Act of 2017 117 1.0 289 3.3 Other ( 52 ) ( 0.5 ) ( 87 ) ( 0.7 ) ( 13 ) ( 0.1 ) $ 1,709 19.4 % $ 1,687 14.7 % $ 2,508 28.8 % s The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017 and the Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized and resulted in additional income tax expense in 2018 and 2019. The Companys remaining transition tax liability under the TCJA, which has been reduced by payments and the utilization of foreign tax credits, was $ 3.0 billion at December 31, 2020, of which $ 390 million is included in Income taxes payable and the remainder of $ 2.6 billion is included in Other Noncurrent Liabilities . As a result of the transition tax under the TCJA, the Company is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for foreign withholding taxes that would apply. The Company remains indefinitely reinvested with respect to its financial statement basis in excess of tax basis of its foreign subsidiaries. A determination of the deferred tax liability with respect to this basis difference is not practicable. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21%. Towards the end of 2020, a new reduced tax rate arrangement was agreed to in Switzerland for certain newly active legal entities. Income before taxes consisted of: Years Ended December 31 2020 2019 2018 Domestic $ ( 3,492 ) $ 439 $ 3,717 Foreign 12,283 11,025 4,984 $ 8,791 $ 11,464 $ 8,701 Taxes on income consisted of: Years Ended December 31 2020 2019 2018 Current provision Federal $ 962 $ 514 $ 536 Foreign 1,362 1,806 2,281 State 53 ( 77 ) 200 2,377 2,243 3,017 Deferred provision Federal ( 605 ) ( 330 ) ( 402 ) Foreign ( 40 ) ( 240 ) ( 64 ) State ( 23 ) 14 ( 43 ) ( 668 ) ( 556 ) ( 509 ) $ 1,709 $ 1,687 $ 2,508 s Deferred income taxes at December 31 consisted of: 2020 2019 Assets Liabilities Assets Liabilities Product intangibles and licenses $ 141 $ 1,250 $ 442 $ 1,778 Inventory related 43 335 32 354 Accelerated depreciation 588 594 Equity investments 175 Pensions and other postretirement benefits 834 248 785 191 Compensation related 252 322 Unrecognized tax benefits 117 109 Net operating losses and other tax credit carryforwards 794 897 Other 808 81 764 84 Subtotal 2,989 2,677 3,351 3,001 Valuation allowance ( 433 ) ( 1,100 ) Total deferred taxes $ 2,556 $ 2,677 $ 2,251 $ 3,001 Net deferred income taxes $ 121 $ 750 Recognized as: Other Assets $ 894 $ 719 Deferred Income Taxes $ 1,015 $ 1,470 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2020, $ 464 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 433 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 330 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2020, 2019 and 2018 were $ 2.7 billion, $ 4.5 billion and $ 1.5 billion, respectively. Tax benefits relating to stock option exercises were $ 55 million in 2020, $ 65 million in 2019 and $ 77 million in 2018. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: 2020 2019 2018 Balance January 1 $ 1,225 $ 1,893 $ 1,723 Additions related to current year positions 298 199 221 Additions related to prior year positions 110 46 142 Reductions for tax positions of prior years (1) ( 4 ) ( 454 ) ( 73 ) Settlements (1) ( 70 ) ( 356 ) ( 91 ) Lapse of statute of limitations (2) ( 22 ) ( 103 ) ( 29 ) Balance December 31 $ 1,537 $ 1,225 $ 1,893 (1) Amounts in 2019 reflects the settlement with the IRS discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.5 billion at December 31, 2020, the income tax provision would reflect a favorable net impact of $ 1.5 billion. s The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2020 could decrease by up to approximately $ 160 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to an expense (benefit) of $ 27 million in 2020, $( 101 ) million in 2019 and $ 51 million in 2018. These amounts reflect the beneficial impacts of various tax settlements, including the settlement discussed below. Liabilities for accrued interest and penalties were $ 268 million and $ 243 million as of December 31, 2020 and 2019, respectively. In 2019, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million. The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. The IRS is currently conducting examinations of the Companys tax returns for the years 2015 and 2016. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2020. 16. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 2020 2019 2018 Net income attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Average common shares outstanding 2,530 2,565 2,664 Common shares issuable (1) 11 15 15 Average common shares outstanding assuming dilution 2,541 2,580 2,679 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 2.79 $ 3.84 $ 2.34 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 2.78 $ 3.81 $ 2.32 (1) Issuable primarily under share-based compensation plans. In 2020, 2019 and 2018, 5 million, 2 million and 6 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. s 17. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2018, net of taxes $ ( 108 ) $ ( 61 ) $ ( 2,787 ) $ ( 1,954 ) $ ( 4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax 228 ( 108 ) ( 728 ) ( 84 ) ( 692 ) Tax ( 55 ) 1 169 ( 139 ) ( 24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes 173 ( 107 ) ( 559 ) ( 223 ) ( 716 ) Reclassification adjustments, pretax 157 (1) 97 (2) 170 (3) 424 Tax ( 33 ) ( 36 ) ( 69 ) Reclassification adjustments, net of taxes 124 97 134 355 Other comprehensive income (loss), net of taxes 297 ( 10 ) ( 425 ) ( 223 ) ( 361 ) Adoption of ASU 2018-02 ( 23 ) 1 ( 344 ) 100 ( 266 ) Adoption of ASU 2016-01 ( 8 ) ( 8 ) Balance at December 31, 2018, net of taxes 166 ( 78 ) ( 3,556 ) ( 2,077 ) ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax 86 140 ( 948 ) 112 ( 610 ) Tax ( 15 ) 192 ( 16 ) 161 Other comprehensive income (loss) before reclassification adjustments, net of taxes 71 140 ( 756 ) 96 ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) 66 (3) ( 239 ) Tax 55 ( 15 ) 40 Reclassification adjustments, net of taxes ( 206 ) ( 44 ) 51 ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) 96 ( 705 ) 96 ( 648 ) Balance at December 31, 2019, net of taxes 31 18 ( 4,261 ) (4) ( 1,981 ) ( 6,193 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 383 ) 3 ( 599 ) 64 ( 915 ) Tax 84 111 89 284 Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 299 ) 3 ( 488 ) 153 ( 631 ) Reclassification adjustments, pretax 2 (1) ( 21 ) (2) 272 (3) 253 Tax ( 63 ) ( 63 ) Reclassification adjustments, net of taxes 2 ( 21 ) 209 190 Other comprehensive income (loss), net of taxes ( 297 ) ( 18 ) ( 279 ) 153 ( 441 ) Balance at December 31, 2020, net of taxes $ ( 266 ) $ $ ( 4,540 ) (4) $ ( 1,828 ) $ ( 6,634 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 13). (4) Includes pension plan net loss of $ 5.4 billion and $ 5.1 billion at December 31, 2020 and 2019, respectively, and other postretirement benefit plan net gain of $ 391 million and $ 247 million at December 31, 2020 and 2019, respectively, as well as pension plan prior service credit of $ 255 million and $ 263 million at December 31, 2020 and 2019, respectively, and other postretirement benefit plan prior service credit of $ 244 million and $ 305 million at December 31, 2020 and 2019, respectively. s 18. Segment Reporting The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. s Sales of the Companys products were as follows: Years Ended December 31 2020 2019 2018 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 8,352 $ 6,028 $ 14,380 $ 6,305 $ 4,779 $ 11,084 $ 4,150 $ 3,021 $ 7,171 Alliance revenue - Lynparza (1) 417 308 725 269 176 444 127 61 187 Alliance revenue - Lenvima (1) 359 220 580 239 165 404 95 54 149 Emend 18 127 145 183 205 388 312 210 522 Vaccines Gardasil/Gardasil 9 1,755 2,184 3,938 1,831 1,905 3,737 1,873 1,279 3,151 ProQuad/M-M-R II/Varivax 1,378 500 1,878 1,683 592 2,275 1,430 368 1,798 Pneumovax 23 727 359 1,087 679 247 926 627 281 907 RotaTeq 486 311 797 506 284 791 496 232 728 Vaqta 103 67 170 130 108 238 127 112 239 Hospital Acute Care Bridion 583 615 1,198 533 598 1,131 386 531 917 Noxafil 42 287 329 282 380 662 353 389 742 Prevymis 119 162 281 84 81 165 46 27 72 Primaxin 2 248 251 2 271 273 7 258 265 Cancidas 7 207 213 6 242 249 12 314 326 Invanz 9 202 211 30 233 263 253 243 496 Cubicin 46 106 152 92 165 257 191 176 367 Zerbaxa 74 56 130 63 58 121 42 45 87 Immunology Simponi 838 838 830 830 893 893 Remicade 330 330 411 411 582 582 Neuroscience Belsomra 81 247 327 92 214 306 96 164 260 Virology Isentress/Isentress HD 326 531 857 398 576 975 513 627 1,140 Zepatier 60 107 167 118 252 370 8 447 455 Cardiovascular Zetia ( 1 ) 483 482 14 575 590 45 813 857 Vytorin 12 171 182 16 269 285 10 487 497 Atozet 453 453 391 391 347 347 Alliance revenue - Adempas (2) 259 22 281 194 10 204 134 5 139 Adempas 220 220 215 215 190 190 Diabetes Januvia 1,470 1,836 3,306 1,724 1,758 3,482 1,969 1,718 3,686 Janumet 477 1,494 1,971 589 1,452 2,041 811 1,417 2,228 Womens Health Implanon/Nexplanon 488 192 680 568 219 787 495 208 703 NuvaRing 110 127 236 742 136 879 722 180 902 Diversified Brands Singulair 18 444 462 29 669 698 20 688 708 Cozaar/Hyzaar 21 365 386 24 418 442 23 431 453 Arcoxia 258 258 288 288 335 335 Nasonex 12 206 218 9 284 293 23 353 376 Follistim AQ 84 109 193 103 138 241 115 153 268 Other pharmaceutical (3) 1,555 3,152 4,709 1,416 3,204 4,615 1,231 3,308 4,546 Total Pharmaceutical segment sales 19,449 23,572 43,021 18,953 22,798 41,751 16,742 20,947 37,689 Animal Health: Livestock 612 2,327 2,939 582 2,201 2,784 528 2,102 2,630 Companion Animals 872 892 1,764 724 885 1,609 710 872 1,582 Total Animal Health segment sales 1,484 3,219 4,703 1,306 3,086 4,393 1,238 2,974 4,212 Other segment sales (4) 23 23 174 1 175 248 2 250 Total segment sales 20,956 26,791 47,747 20,433 25,885 46,319 18,228 23,923 42,151 Other (5) 71 176 247 86 436 521 118 26 143 $ 21,027 $ 26,967 $ 47,994 $ 20,519 $ 26,321 $ 46,840 $ 18,346 $ 23,949 $ 42,294 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4). (2) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 4). (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents sales for the non-reportable segments of Healthcare Services (fully divested in the first quarter of 2020) and Alliances (which concluded in 2018). (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. s Consolidated sales by geographic area where derived are as follows: Years Ended December 31 2020 2019 2018 United States $ 21,027 $ 20,519 $ 18,346 Europe, Middle East and Africa 13,600 12,707 12,213 China 3,624 3,207 2,184 Japan 3,376 3,583 3,212 Asia Pacific (other than China and Japan) 2,864 2,943 2,909 Latin America 2,274 2,469 2,415 Other 1,229 1,412 1,015 $ 47,994 $ 46,840 $ 42,294 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 2020 2019 2018 Segment profits: Pharmaceutical segment $ 29,722 $ 28,324 $ 24,871 Animal Health segment 1,650 1,609 1,659 Other segments 1 ( 7 ) 103 Total segment profits 31,373 29,926 26,633 Other profits 140 363 6 Unallocated: Interest income 59 274 343 Interest expense ( 831 ) ( 893 ) ( 772 ) Depreciation and amortization ( 1,602 ) ( 1,593 ) ( 1,352 ) Research and development ( 13,072 ) ( 9,499 ) ( 9,432 ) Amortization of purchase accounting adjustments ( 1,168 ) ( 1,406 ) ( 2,664 ) Restructuring costs ( 578 ) ( 638 ) ( 632 ) Charge related to the termination of a collaboration with Samsung ( 423 ) Other unallocated, net ( 5,530 ) ( 5,070 ) ( 3,006 ) Income Before Taxes $ 8,791 $ 11,464 $ 8,701 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. s Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2020 Included in segment profits: Equity (income) loss from affiliates $ 6 $ $ $ 6 Depreciation and amortization 690 164 1 855 Year Ended December 31, 2019 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization 534 109 10 653 Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ 4 $ $ $ 4 Depreciation and amortization 411 82 10 503 Property, plant and equipment, net, by geographic area where located is as follows: December 31 2020 2019 2018 United States $ 10,526 $ 8,974 $ 8,306 Europe, Middle East and Africa 6,059 4,767 3,706 Asia Pacific (other than China and Japan) 761 714 684 Latin America 252 266 264 China 217 174 167 Japan 166 152 159 Other 5 6 5 $ 17,986 $ 15,053 $ 13,291 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. s Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2020, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. s Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Customer Discount Accruals in the U.S. - Medicaid, Managed Care and Medicare Part D Rebates As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts as of December 31, 2020 in the U.S. are $3.1 billion and are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The principal considerations for our determination that performing procedures relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the provisions, as the provisions include assumptions related to changes to price and historical customer segment utilization mix, pertaining to forecasted customer claims that may not be fully paid until a subsequent period. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions and in evaluating the evidence obtained from these procedures. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others, (i) developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., changes to price, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid, (ii) comparing the independent estimate to the rebate accruals recorded by management and (iii) testing actual rebate claims paid, including evaluating those claims for consistency with the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 25, 2021 We have served as the Companys auditor since 2002. s "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2020, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2020. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated s Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2020. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2020, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +7,Merck & Co.,2019," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. While the Company continues to look for investment opportunities in this area of health care, the approach to these investments has shifted toward venture capital investments in third parties as opposed to wholly-owned businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. The Company was incorporated in New Jersey in 1970. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into a New Company In February 2020, Merck announced its intention to spin-off (the Spin-Off) products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The Spin-Off is expected to be completed in the first half of 2021, subject to market and certain other conditions. See Risk Factors - Risks Related to the Proposed Spin-Off of NewCo. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) Total Sales $ 46,840 $ 42,294 $ 40,122 Pharmaceutical 41,751 37,689 35,390 Keytruda 11,084 7,171 3,809 Januvia/Janumet 5,524 5,914 5,896 Gardasil/Gardasil 9 3,737 3,151 2,308 ProQuad/M-M-R II /Varivax 2,275 1,798 1,676 Bridion 1,131 Isentress/Isentress HD 1,140 1,204 Pneumovax 23 NuvaRing Zetia/Vytorin 1,355 2,095 Simponi Animal Health 4,393 4,212 3,875 Livestock 2,784 2,630 2,484 Companion Animals 1,609 1,582 1,391 Other Revenues (1) (1) Other revenues are primarily comprised of Healthcare Services segment revenue, third-party manufacturing sales, and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with melanoma, non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), head and neck squamous cell carcinoma (HNSCC), classical Hodgkin Lymphoma (cHL), primary mediastinal large B-cell lymphoma (PMBCL), urothelial carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, gastric or gastroesophageal junction adenocarcinoma, esophageal cancer, cervical cancer, hepatocellular carcinoma, and merkel cell carcinoma. Keytruda is also used for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with axitinib for renal cell carcinoma, and in combination with lenvatinib for endometrial carcinoma; and Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast and pancreatic cancers; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for certain patients with endometrial carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Primaxin (imipenem and cilastatin sodium) an anti-bacterial product; Invanz (ertapenem sodium) for the treatment of certain infections; Cubicin (daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; Cancidas (caspofungin acetate), an anti-fungal product; and Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product; and Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto (fluralaner), a line of oral and topical parasitic control products for dogs and cats that last up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2019 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2019. Product Date Approval Ervebo December 2019 The U.S. Food and Drug Administration (FDA) approved Ervebo for the prevention of disease caused by Zaire ebolavirus in individuals 18 years of age and older. November 2019 The European Commission (EC) granted a conditional marketing authorization for Ervebo for active immunization of individuals 18 years of age or older to protect against Ebola Virus Disease caused by Zaire Ebola virus. Keytruda December 2019 The Japanese Ministry of Health, Labour and Welfare (MHLW) approved Keytruda for three new first-line indications across advanced renal cell carcinoma (RCC) and recurrent or distant metastatic head and neck cancer. November 2019 EC approved two new regimens of Keytruda as first-line treatment for metastatic or unresectable recurrent head and neck squamous cell carcinoma (HNSCC). November 2019 The China National Medical Products Administration (NMPA) approved Keytruda for first-line treatment of metastatic squamous non-small cell lung cancer (NSCLC) in combination with chemotherapy. October 2019 NMPA approved Keytruda as monotherapy for first-line treatment of certain patients with advanced NSCLC whose tumors express PD-L1. September 2019 FDA approved Keytruda plus Lenvima combination treatment for patients with certain types of endometrial carcinoma. September 2019 EC approved Keytruda in combination with axitinib as first-line treatment for patients with advanced RCC. July 2019 FDA approved Keytruda for recurrent locally advanced or metastatic squamous cell carcinoma of the esophagus in patients whose tumors express PD-L1 combined positive score [CPS] (CPS 10) with disease progression after one of more prior lines of systemic therapy. Keytruda June 2019 FDA approved Keytruda as monotherapy for patients with metastatic small-cell lung cancer (SCLC) with disease progression on or after platinum-based chemotherapy and at least one other prior line of therapy. June 2019 FDA approved two indications for Keytruda for first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC as monotherapy for patients whose tumors express PD-L1 CPS 1 or in combination with platinum and fluorouracil regardless of PD-L1 expression. April 2019 FDA approved Keytruda in combination with axitinib for first-line treatment of patients with advanced RCC. April 2019 FDA approved an expanded label for Keytruda as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (tumor proportion score [TPS] 1%) as determined by an FDA-approved test, with no epidermal growth factor receptor (EGFR) or anaplastic lymphoma kinase positive (ALK) genomic tumor aberrations. April 2019 EC approved new extended dosing schedule for Keytruda for all approved monotherapy indications. April 2019 NMPA approved Keytruda for first-line treatment of metastatic nonsquamous NSCLC in combination with chemotherapy. March 2019 EC approved Keytruda in combination with chemotherapy for first-line treatment of adults with metastatic squamous NSCLC. February 2019 FDA approved Keytruda for the adjuvant treatment of patients with melanoma with involvement of lymph node(s) following complete resection. January 2019 MHLW approved Keytruda for five indications, including three expanded uses in advanced NSCLC, one in melanoma, as well as a new indication in advanced microsatellite instability-high tumors. Lynparza (1) December 2019 FDA approved Lynparza for first-line maintenance therapy for patients with germline BRCA -mutated (g BRCA -m) metastatic pancreatic cancer whose disease has not progressed for at least 16 weeks of a first-line, platinum-based chemotherapy regimen. December 2019 NMPA approved Lynparza as a first-line maintenance therapy in BRCA -m advanced ovarian cancer. July 2019 EC approved Lynparza as monotherapy for the maintenance treatment of adult patients with advanced BRCA -m, high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer. June 2019 MHLW approved Lynparza as first-line maintenance therapy in patients with BRCA -m advanced ovarian cancer. June 2019 EC approved Lynparza for use as first-line maintenance therapy in patients with BRCA -m advanced ovarian cancer. April 2019 EC approved Lynparza for the treatment of g BRCA -m HER2-negative advanced breast cancer. Pifeltro and Delstrigo September 2019 FDA approved supplemental New Drug Applications (sNDAs) for Pifeltro (doravirine) in combination with other antiretroviral agents, and Delstrigo (doravirine, lamivudine, and tenofovir disoproxil fumarate) as a complete regimen, for use in appropriate adults with HIV-1 infection who are virologically suppressed on a stable antiretroviral regimen. Recarbrio July 2019 FDA approved Recarbrio (imipenem, cilastatin, and relebactam) for the treatment of adults with complicated urinary tract and complicated intra-abdominal bacterial infections where limited or no alternative treatment options are available. Zerbaxa August 2019 EC approved Zerbaxa for the treatment of adults with hospital-acquired pneumonia, including ventilator-associated pneumonia (to be used in combination with an antibacterial agent active against Gram-positive pathogens when these are known or suspected to be contributing to the infectious process.) June 2019 FDA approved Zerbaxa 3g dose for the treatment of patients 18 years and older with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP). Bravecto November 2019 FDA approved Bravecto Plus topical solution for cats indicated for both external and internal parasite infestations. (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also required pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). As a result of the Balanced Budget Act of 2018 and effective at the beginning of 2019, the 50% point of service discount increased to a 70% point of service discount in the coverage gap. In addition, this point of service discount was extended to biosimilar products. Merck recorded a reduction to revenue of approximately $615 million, $365 million and $385 million in 2019, 2018 and 2017, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and decreased to $2.8 billion in 2019 and is expected to remain at that amount for 2020. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $112 million, $124 million and $210 million of costs within Selling, general and administrative expenses in 2019, 2018 and 2017, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2022. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate, and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. The pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. In addition, Congress and/or the administration may again consider proposals to allow international reference pricing or, under certain conditions, the importation of medicines from other countries. The administration has recently proposed a draft rule that would allow importation of certain lower-cost prescription drugs from Canada. If the rule is finalized as proposed, states or certain other non-federal governmental entities would be able to submit importation program proposals to the FDA for review and authorization of two-year programs (with the opportunity to extend for two more years). There will be a public comment period on the proposed rule which will expire on March 9, 2020. Following the comment period, the FDA will have to review and finalize its proposal before any states or other parties can submit their plans to comply with the federal rule. If the proposed rule is adopted, it likely will be some time before states or other parties can actually implement importation plans. In October 2018, the administration also issued an advance notice of proposed rulemaking to implement an International Pricing Index (IPI) model in the United States for products covered under Medicare Part B. The proposal would: (1) reduce Medicare Part B payments for drugs based on a market basket of international prices; (2) allow private sector vendors to negotiate prices for drugs, take title to drugs, and compete for physician and hospital business; and (3) change the physician reimbursement under Medicare Part B from the current model to eliminate the buy and bill system and instead pay physicians based on a flat fee that approximates the revenue they currently receive from drugs. Public comments on the IPI proposal were accepted through late 2018 and it is unclear when the agency may issue a proposed rule on the IPI model. Adoption of one or both of the proposed rules could have a material adverse effect on the Companys business, results of operations and financial condition. It remains uncertain as to what proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2019, the Companys gross U.S. sales were reduced by approximately 44% as a result of rebates, discounts and returns. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which occurred in 2018 and will occur again in 2020. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. Pursuant to those rules, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. Additionally, in 2017, the Chinese government updated the National Reimbursement Drug List for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2019, drugs were added through two pathways, direct inclusion and price negotiations. For price negotiations, price reductions of approximately 60% on average were required for inclusion. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first two rounds of VBP have had, on average, a price reduction of 50%. The expansion of the VBP program remains to be seen. The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2020 to varying degrees in the emerging markets, including China. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA). Examples include the UK, France, Germany, Ireland, Italy and Sweden. The HTA process is the procedure according to which the assessment of the public health impact, therapeutic impact, and the economic and social impact of use of a given medicinal product in the national health care system of the individual country is conducted. HTAs generally focus on the clinical efficacy and effectiveness, safety, cost, and cost-effectiveness of individual medicinal products as well as their potential implications for the health care system. Those elements of medicinal products are compared with other treatment options available on the market. The outcome of HTAs will often influence the pricing and reimbursement status granted to medicinal products by the regulatory authorities of individual European Union (EU) Member States. A negative HTA of one of the Companys products by a leading and recognized HTA body could undermine the Companys ability to obtain reimbursement for such product in the EU Member State in which such negative assessment was issued, and also in other EU Member States. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its medicines, vaccines, and to quality health care around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including both the EU General Data Protection Regulation, which went into effect on May 25, 2018 and imposes penalties of up to 4% of global revenue, and the California Consumer Privacy Act, which became effective January 1, 2020. Additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increased enforcement and litigation activity in the United States and other developed markets, and increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. and Swiss-U.S. Privacy Shield Programs, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Emend for Injection Expired 2020 (3) N/A Januvia 2022 (3) 2022 (3) 2025-2026 Janumet 2022 (3) N/A Janumet XR 2022 (3) N/A N/A Isentress 2023 (3) 2022-2026 Simponi N/A (4) 2024 (5) N/A (4) N/A (4) Lenvima (6) 2025 (3) (with pending PTE) 2021 (patents), 2026 (3) (SPCs) 2021 Adempas (7) 2026 (3) 2028 (3) 2027-2028 Bridion 2026 (3) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) 2033 Gardasil 2021 (3) Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A Keytruda 2028 (patents), 2030 (3) (SPCs) 2032-2033 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Belsomra 2029 (3) N/A N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) N/A Steglatro (9) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A Steglujan (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Segluromet (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) The Company has no marketing rights in the U.S., Japan or China. (5) Expiration of the distribution agreement with Janssen Pharmaceuticals, Inc. (6) Part of a global strategic oncology collaboration with Eisai. (7) Being commercialized in a worldwide collaboration with Bayer AG. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) MK-1242 (vericiguat) (1) V114 (pneumoconjugate vaccine) MK-8591A (islatravir/doravirine) (1) Being developed in a worldwide collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2019 on patent and know-how licenses and other rights amounted to $135 million. Merck also incurred royalty expenses amounting to $1.7 billion in 2019 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2019, approximately 15,600 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes and other metabolic diseases, infectious diseases, neurosciences, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on pre-clinical and clinical experience are included in the NDA for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and the National Medical Products Administration in China. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,000 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, non-small-cell lung, ovarian, PMBCL, prostate, renal, small-cell lung, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (TPS 1%) with no EGFR or ALK genomic tumor aberrations based on results from the Phase 3 KEYNOTE-042 trial. Keytruda is under review in Japan as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma based on results from the pivotal Phase 3 KEYNOTE-062 trial. Keytruda is also under review in Japan as monotherapy for the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma based on the results of the Phase 3 KEYNOTE-181 trial. Merck has made the decision to withdraw its Type II variation application for Keytruda for this indication in the EU. In October 2019, the FDA accepted a supplemental BLA seeking use of Keytruda for the treatment of patients with recurrent and/or metastatic cutaneous squamous cell carcinoma (cSCC) that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a PDUFA date of June 29, 2020. In February 2020, Merck announced the FDA issued a Complete Response Letter (CRL) regarding Mercks supplemental BLAs seeking to update the dosing frequency for Keytruda to include a 400 mg dose infused over 30 minutes every-six-weeks (Q6W) option in multiple indications. The submitted applications are based on pharmacokinetic modeling and simulation data presented at the 2018 American Society of Clinical Oncology (ASCO) Annual Meeting. These data supported the EC approval of 400 mg Q6W dosing for Keytruda monotherapy indications in March 2019. Merck is reviewing the letter and will discuss next steps with the FDA. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with neoadjuvant chemotherapy for the treatment of high-risk early-stage triple-negative breast cancer (TNBC) and in combination with enfortumab vedotin, in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In September 2019, Merck announced results from the pivotal neoadjuvant/adjuvant Phase 3 KEYNOTE-522 trial in patients with early-stage TNBC. The trial investigated a regimen of neoadjuvant Keytruda plus chemotherapy, followed by adjuvant Keytruda as monotherapy (the Keytruda regimen) compared with a regimen of neoadjuvant chemotherapy followed by adjuvant placebo (the chemotherapy-placebo regimen). Interim findings were presented at the European Society for Medical Oncology (ESMO) 2019 Congress. In the neoadjuvant phase, Keytruda plus chemotherapy resulted in a statistically significant increase in pathological complete response (pCR) versus chemotherapy in patients with early-stage TNBC. The improvement seen when adding Keytruda to neoadjuvant chemotherapy was observed regardless of PD-L1 expression. In the other dual primary endpoint of event-free-survival (EFS), with a median follow-up of 15.5 months, the Keytruda regimen reduced the risk of progression in the neoadjuvant phase and recurrence in the adjuvant phase compared with the chemotherapy-placebo regimen. Merck continues to discuss interim analysis data from KEYNOTE-522 with regulatory authorities. The Keytruda breast cancer clinical development program encompasses several internal and external collaborative studies. In February 2020, Merck announced that the pivotal Phase 3 KEYNOTE-355 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of progression-free survival (PFS) in patients with metastatic triple-negative breast cancer (mTNBC) whose tumors expressed PD-L1 (CPS 10). Based on an interim analysis conducted by an independent Data Monitoring Committee (DMC), first-line treatment with Keytruda in combination with chemotherapy (nab-paclitaxel, paclitaxel or gemcitabine/carboplatin) demonstrated a statistically significant and clinically meaningful improvement in PFS compared to chemotherapy alone in these patients. Based on the recommendation of the DMC, the trial will continue without changes to evaluate the other dual primary endpoint of overall survival (OS). In May 2019, Merck announced that the Phase 3 KEYNOTE-119 trial evaluating Keytruda as monotherapy for the second- or third-line treatment of patients with metastatic TNBC did not meet its pre-specified primary endpoint of superior OS compared to chemotherapy. Other endpoints were not formally tested per the study protocol because the primary endpoint of OS was not met. In June 2019, Merck announced full results from the pivotal Phase 3 KEYNOTE-062 trial evaluating Keytruda as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma. In the monotherapy arm of the study, Keytruda met a primary endpoint by demonstrating noninferiority to chemotherapy, the current standard of care, for OS in patients whose tumors expressed PD-L1 (CPS 1). In the combination arm of KEYNOTE-062, Keytruda plus chemotherapy was not found to be statistically superior for OS (CPS 1 or CPS 10) or PFS (CPS 1) compared with chemotherapy alone. Results were presented at the 2019 American Society of Clinical Oncology (ASCO) Annual Meeting. In September 2017, the FDA approved Keytruda as a third-line treatment for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. KEYNOTE-062 was a potential confirmatory trial for this accelerated, third-line approval. In addition to KEYNOTE-062, additional first-line, Phase 3 studies in Mercks gastric clinical program include KEYNOTE-811 and KEYNOTE-859, as well as KEYNOTE-585 in the neoadjuvant and adjuvant treatment setting. In January 2020, Merck announced that the Phase 3 KEYNOTE-604 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of PFS in the first-line treatment of patients with extensive stage SCLC. At the final analysis of the study, there was also an improvement in OS for patients treated with Keytruda in combination with chemotherapy compared to chemotherapy alone; however, these OS results did not meet statistical significance per the pre-specified statistical plan. Results will be presented at an upcoming medical meeting and discussed with regulatory authorities. Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast and pancreatic cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca. Lynparza is under review in the EU as a first-line maintenance monotherapy for patients with g BRCA m metastatic pancreatic cancer whose disease has not progressed following first-line platinum-based chemotherapy. Lynparza was approved for this indication by the FDA in December 2019 based on results from the Phase 3 POLO trial. A decision from the EMA is expected in the second half of 2020. In January 2020, the FDA accepted a supplemental NDA for Lynparza in combination with bevacizumab for the maintenance treatment of women with advanced ovarian cancer whose disease showed a complete or partial response to first-line treatment with platinum-based chemotherapy and bevacizumab based on the results from the pivotal Phase 3 PAOLA-1 trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In January 2020, the FDA accepted for Priority Review a supplemental NDA for Lynparza for the treatment of patients with metastatic castration-resistant prostate cancer (mCRPC) and deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene mutations, who have progressed following prior treatment with a new hormonal agent based on positive results from the Phase 3 PROfound trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In June 2019, Merck and AstraZeneca presented full results from the Phase 3 SOLO-3 trial which evaluated Lynparza, compared to chemotherapy, for the treatment of platinum-sensitive relapsed patients with g BRCA m advanced ovarian cancer, who have received two or more prior lines of chemotherapy. The results from the trial showed a statistically-significant and clinically-meaningful improvement in objective response rate (ORR) in the Lynparza arm compared to the chemotherapy arm. The key secondary endpoint of PFS was also significantly increased in the Lynparza arm compared to the chemotherapy arm. The results were presented at the 2019 ASCO Annual Meeting. MK-5618, selumetinib, is a MEK 1/2 inhibitor being co-developed as part of a strategic collaboration with AstraZeneca. Selumetinib is under Priority Review with the FDA as a potential new medicine for pediatric patients aged three years and older with neurofibromatosis type 1 (NF1) and symptomatic, inoperable plexiform neurofibromas. This regulatory submission was based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Phase 2 Stratum 1 trial. A PDUFA date is set for the second quarter of 2020. V503 is under review in Japan for an initial indication in females for the prevention of certain HPV-related diseases and precursors. In February 2020, the FDA accepted for Priority Review a supplemental BLA for Gardasil 9 for the prevention of certain head and neck cancers caused by vaccine-type HPV in females and males 9 through 45 years of age. The FDA set a PDUFA date of June 2020. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. Lynparza, in addition to the indications under review discussed above, is in Phase 3 development in combination with Keytruda for the treatment of NSCLC. Lenvima is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, HCC, and in combination for certain patients with RCC being co-developed as part of a strategic collaboration with Eisai. Pursuant to the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination in six types of cancer (endometrial cancer, NSCLC, HCC, HNSCC, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima both for the potential treatment of patients with advanced and/or metastatic RCC and for the potential treatment of patients with unresectable HCC not amenable to locoregional treatment. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor antagonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. MK-1242, vericiguat, is a sGC stimulator for the potential treatment of patients with worsening chronic heart failure being developed as part of a worldwide strategic collaboration between Merck and Bayer. Vericiguat is being studied in patients suffering from chronic heart failure with reduced ejection fraction (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fraction (Phase 2 clinical trial). In November 2019, Merck announced that the Phase 3 VICTORIA study evaluating the efficacy and safety of vericiguat met the primary efficacy endpoint. Vericiguat reduced the risk of the composite endpoint of heart failure hospitalization or cardiovascular death in patients with worsening chronic heart failure with reduced ejection fraction compared to placebo when given in combination with available heart failure therapies. The results of the VICTORIA study will be presented at an upcoming medical meeting in 2020. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently six Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, eight studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. V114 has received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults. The chart below reflects the Companys research pipeline as of February 21, 2020. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 Entry Date) Under Review Cancer Cancer New Molecular Entities/Vaccines MK-3475 Keytruda MK-3475 Keytruda Pediatric Neurofibromatosis Type-1 Advanced Solid Tumors Biliary Tract (September 2019) MK-5618 (selumetinib) (1) (U.S.) MK-6482 Breast (October 2015) HPV Vaccine Renal Cell Carcinoma Cervical (October 2018) (EU) V503 Human Papillomavirus 9-valent Vaccine, MK-7123 (2) Colorectal (November 2015) Recombinant (JPN) Solid Tumors Cutaneous Squamous Cell Carcinoma Certain Supplemental Filings MK-7339 Lynparza (1) (August 2019) (EU) Cancer Advanced Solid Tumors Endometrial (August 2019) (EU) MK-3475 Keytruda MK-7690 (vicriviroc) (2) Esophageal (December 2015) (EU) First-Line Metastatic Non-Small-Cell Lung Colorectal Gastric (May 2015) (EU) Cancer (KEYNOTE-042) (EU) MK-7902 Lenvima (1) Hepatocellular (May 2016) (EU) First-Line Metastatic Gastric Cancer Biliary Tract Mesothelioma (May 2018) (KEYNOTE-062) (JPN) V937 Nasopharyngeal (April 2016) Recurrent Locally Advanced or Metastatic Melanoma Ovarian (December 2018) Esophageal Cancer (KEYNOTE-180/181) MK-7684 (2) Prostate (May 2019) (JPN) Non-Small-Cell Lung Small-Cell Lung (May 2017) (EU) Recurrent and/or Metastatic Cutaneous MK-1026 MK-7339 Lynparza (1,2) Squamous Cell Carcinoma Hematological Malignancies Non-Small-Cell Lung (June 2019) (KEYNOTE-629) (U.S.) MK-4280 (2) MK-7902 Lenvima (1,2) Alternative Dosing Regimen (3) Hematological Malignancies Bladder (May 2019) (Q6W) (U.S.) Non-Small-Cell Lung Endometrial (June 2018) (EU) MK-7339 Lynparza (1) MK-1308 (2) Head and Neck Squamous Cell Carcinoma First-Line g BRCA m Pancreatic Cancer Non-Small-Cell Lung (February 2020) (POLO) (EU) MK-5890 (2) Melanoma (March 2019) First-Line Maintenance Newly Diagnosed Non-Small-Cell Lung Non-Small-Cell Lung (March 2019) Advanced Ovarian Cancer (PAOLA) Cytomegalovirus Cough (U.S.) (EU) V160 MK-7264 (gefapixant) (March 2018) Metastatic Prostate Cancer (PROfound) HIV-1 Infection Heart Failure (U.S.) (EU) MK-8591 (islatravir) MK-1242 (vericiguat) (September 2016) (1) Footnotes: Overgrowth Syndrome HIV-1 Infection (1) Being developed in a collaboration. MK-7075 MK-8591A (islatravir/doravirine) (February 2020) (2) Being developed in combination with Pediatric Neurofibromatosis Type-1 Pneumoconjugate Vaccine Keytruda. MK-5618 (selumetinib) (1) (EU) V114 (June 2018) (3) The Company received a CRL in February Respiratory Syncytial Virus 2020. Merck is reviewing the letter and will MK-1654 discuss next steps with the FDA. Schizophrenia MK-8189 Employees As of December 31, 2019, the Company had approximately 71,000 employees worldwide, with approximately 26,000 employed in the United States, including Puerto Rico. Approximately 30% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $19 million in 2019 and are estimated at $47 million in the aggregate for the years 2020 through 2024 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million and $71 million at December 31, 2019 and 2018 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $58 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in each of 2019 , 2018 and 2017 . The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the U.S. and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. For example, the patents that provided U.S. and EU market exclusivity for certain forms of Noxafil expired in July 2019 and December 2019, respectively, and the Company anticipates a significant decline in U.S. and EU Noxafil sales. Also, the patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company anticipates a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. In addition, the patents that provide market exclusivity for Januvia and Janumet in the U.S. expire in July 2022 (although six-month pediatric exclusivity may extend this date). The patent that provides market exclusivity for Januvia in the EU expires in July 2022 (although pediatric exclusivity may extend this date to September 2022). Finally, the SPC that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Januvia , Janumet , and Bridion . In particular, in 2019, the Companys oncology portfolio, led by Keytruda, represented the majority of the Companys revenue and earnings growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; and scrutiny of advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment Health Care Environment and Government Regulations. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the United States, larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2019, the Companys gross U.S. sales were reduced by approximately 44% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which will occur again in 2020. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. For example, pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5%, effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. The Company expects pricing pressures to continue in the future. The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. The ACA increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The ACA also requires pharmaceutical manufacturers to pay a point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole) which increased to 70% in 2019 and was extended to biosimilar products. In 2019, the Companys revenue was reduced by approximately $615 million due to this requirement. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. In 2019, the Company recorded $112 million of costs for this annual fee. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2022. The Company will evaluate the financial impact of these two elements when they become effective. In addition, as discussed above in Competition and the Health Care Environment, the administration has recently proposed a draft rule that would allow importation of certain lower-cost prescription drugs from Canada. If the rule is finalized as proposed, states or certain other non-federal governmental entities would be able to submit importation program proposals to the FDA for review and authorization of two-year programs (with the opportunity to extend for two more years). There will be a public comment period on the proposed rule which will expire on March 9, 2020. Following the comment period, the FDA will have to review and finalize its proposal before any states or other parties can submit their plans to comply with the federal rule. If the proposed rule is adopted, it likely will be some time before states or other parties can actually implement importation plans. Also, in October 2018, the administration issued an advance notice of proposed rulemaking to implement an International Pricing Index (IPI) model in the United States for products covered under Medicare Part B. The proposal would: (1) reduce Medicare Part B payments for drugs based on a market basket of international prices; (2) allow private sector vendors to negotiate prices for drugs, take title to drugs, and compete for physician and hospital business; and (3) change the physician reimbursement under Medicare Part B from the current model to eliminate the buy and bill system and instead pay physicians based on a flat fee that approximates the revenue they currently receive from drugs. Public comments on the IPI proposal were accepted through late 2018 and it is unclear when the agency may issue a proposed rule on the IPI model. Adoption of one or both of the proposed rules could have a material adverse effect on the Companys business, results of operations and financial condition. The Company cannot predict the likelihood of additional future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has insurance coverage insuring against losses resulting from cyber-attacks and has received proceeds in connection with the 2017 cyber-attack. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to the 2017 cyber-attack. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional healthcare reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to healthcare professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2019 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period will apply from January 31, 2020 until December 31, 2020, and during this period the EU will treat the UK as if it were an EU Member State, and the UK will continue to participate in the EU Customs Union allowing for the freedom of movement for people and goods. During the transitional period the EU and the UK will continue to negotiate a trade agreement to formalize the terms of the UKs future relationship with the EU. The Company has taken actions and made certain contingency plans for scenarios in which the UK and the EU do not reach a mutually satisfactory understanding as to a future trade agreement. It is not possible at this time to predict whether there will be any such understanding before the end of 2020, or if such an understanding is reached, whether its terms will vary in ways that result in greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and/or cross border labor issues that could materially adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Health Care Environment and Government Regulation , pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing healthcare reform that has led to the acceleration of generic substitution, where available. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first two rounds of VBP had, on average, a price reduction of 50%. The expansion of the VBP program remains to be seen. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. Also, in December 2019, a new Coronavirus, now known as COVID-19, which has proved to be highly contagious, emerged in Wuhan, China. The outbreak of the virus has caused material disruptions to the Chinese economy, including its health care system, which will have a negative effect on the Companys first quarter 2020 results which, at this time, is not expected to be material. Since the future course and duration of the COVID-19 outbreak are unknown, the Company is currently unable to determine whether the outbreak will have a further negative effect on the Companys results in 2020. The outbreak of COVID-19 currently has also had a limited effect on the Companys supply chain of drugs into and raw materials out of China. The outbreak has also negatively affected certain of the Companys clinical trials. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which may cause LIBOR to cease to exist entirely after 2021. While the Company expects that reasonable alternatives to LIBOR will be implemented prior to the 2021 target date, the Company cannot predict the consequences and timing of these developments, which could include an increase in interest expense and may also require the amendment of contracts that reference LIBOR. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its IT systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Risks Related to the Proposed Spin-Off of NewCo. The proposed Spin-Off of NewCo may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. In February 2020, the Company announced its intention to Spin-Off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The transaction is expected to be completed in the first half of 2021. Completion of the Spin-Off will be subject to a number of factors and conditions, and there can be no assurances that the Company will be able to complete the Spin-Off on the terms or on the timeline that was announced, if at all. Unanticipated developments could delay, prevent or otherwise adversely affect the proposed Spin-Off, including but not limited to disruptions in general or financial market conditions or potential problems or delays in obtaining various regulatory and tax approvals or clearances. In addition, consummation of the proposed Spin-Off will require final approval from the Companys Board of Directors. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of NewCo. The Company will incur significant expenses in connection with the Spin-Off. In addition, the Company may not be able to achieve the full strategic and financial benefits that are expected to result from the Spin-Off. The anticipated benefits of the Spin-Off are based on a number of assumptions, some of which may prove incorrect. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. The Company cannot predict the effect of the Spin-Off on the trading price of shares of its common stock, and the market value of shares of its common stock may be less than, equal to or greater than the market value of shares of its common stock prior to the Spin-Off. In addition, the price of Mercks common stock may be more volatile around the time of the Spin-Off. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The Company expects that prior to completion of the Spin-Off it will receive an opinion from its U.S. tax counsel that concludes, among other things, that the Spin-Off of all of the outstanding NewCo shares to Merck shareholders and certain related transactions will qualify as tax-free to Merck and its shareholders under Sections 355, 361 and 368 of the U.S. Internal Revenue Code, except to the extent of any cash received in lieu of fractional shares of NewCo common stock. Any such opinion is not binding on the Internal Revenue Service (IRS). Accordingly, while the Company believes the risk is low, the IRS may reach conclusions with respect to the Spin-Off that are different from the conclusions reached in the opinion. The opinion will rely on certain facts, assumptions, representations and undertakings from Merck and NewCo regarding the past and future conduct of the companies respective businesses and other matters, which, if incomplete, incorrect or not satisfied, could alter the conclusions of the party giving such opinion. If the proposed Spin-Off ultimately is determined to be taxable, which the Company believes is unlikely, the Spin-Off could be treated as a taxable dividend to Mercks shareholders for U.S. federal income tax purposes, and Mercks shareholders could incur significant U.S. federal income tax liabilities. In addition, Merck would recognize a taxable gain to the extent that the fair market value of NewCo common stock exceeds Mercks tax basis in such stock on the date of the Spin-Off. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. The proposed Spin-Off might be delayed or the costs to complete the Spin-Off might be more significant than expected. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey, Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, South San Francisco, California and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $3.5 billion in 2019 , $2.6 billion in 2018 and $1.9 billion in 2017 . In the United States, these amounted to $1.9 billion in 2019 , $1.5 billion in 2018 and $1.2 billion in 2017 . Abroad, such expenditures amounted to $1.6 billion in 2019, $1.1 billion in 2018 and $728 million in 2017. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2020, there were approximately 109,500 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2019 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 5,064,526 $83.63 $7,796 November 1 November 30 4,182,277 $84.72 $7,441 December 1 December 31 3,053,800 $89.16 $7,169 Total 12,300,603 $85.37 $7,169 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. Performance Graph The following graph assumes a $100 investment on December 31, 2014, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2019/2014 CAGR* MERCK $187 13% PEER GRP.** 9% SP 500 12% 2015 2017 2019 MERCK 100.0 96.0 110.5 108.8 152.5 186.5 PEER GRP. 100.0 103.0 99.9 119.6 127.8 151.6 SP 500 100.0 101.4 113.5 138.3 132.2 173.8 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. The following section of this Form 10-K generally discusses 2019 and 2018 results and year-to-year comparisons between 2019 and 2018 . Discussion of 2017 results and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed on February 27, 2019. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. While the Company continues to look for investment opportunities in this area of health care, the approach to these investments has shifted toward venture capital investments in third parties as opposed to wholly-owned businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into New Company In February 2020, Merck announced its intention to spin-off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed in the first half of 2021, subject to market and certain other conditions. Overview Mercks performance during 2019 demonstrates execution in both commercial and research operations driven by a focus on key growth drivers and innovative pipeline investment reinforcing the Companys science-led strategy. In 2019, Merck enhanced its portfolio and pipeline with external innovation, increased investment in new capital projects focused primarily on expanding manufacturing capacity across Mercks key businesses, and returned capital to shareholders. Worldwide sales were $46.8 billion in 2019 , an increase of 11% compared with 2018 , including a 2% unfavorable effect from foreign exchange. The sales increase was driven primarily by Mercks growth pillars of oncology, human health vaccines, certain hospital acute care products, and animal health. Growth in these areas was partially offset by the ongoing effects of generic competition, particularly in the diversified brands and cardiovascular franchises, as well as by competitive pressure, particularly in the diabetes and virology franchises. Merck continued to prioritize business development aimed at enhancing its portfolio and strengthening its pipeline by executing several business development transactions in 2019. To expand its oncology presence, Merck completed the acquisitions of Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates for the treatment of cancer and other diseases, and Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease. Merck also announced an agreement to acquire ArQule, Inc. (ArQule), a biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of cancer and other diseases; the acquisition closed in January 2020. To augment Mercks animal health business, the Company acquired Antelliq Group (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. During 2019, the Company received numerous regulatory approvals and progressed many important pipeline candidates through clinical development. Within oncology, Keytruda received multiple additional approvals in the United States, European Union (EU), China and Japan as monotherapy in the therapeutic areas of non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), esophageal cancer and in combination with axitinib for the treatment of renal cell carcinoma (RCC), in combination with chemotherapy for head and neck squamous cell carcinoma (HNSCC), and in combination with Lenvima for endometrial carcinoma. Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received U.S. Food and Drug Administration (FDA) approval for the treatment of appropriate patients with germline BRCA -mutated (g BRCA m) pancreatic cancer and European Commission (EC) approval for use in certain patients with advanced ovarian cancer and advanced or metastatic breast cancer. In addition to oncology, the Company received regulatory approvals in the hospital acute care and vaccines therapeutic areas. The FDA approved Recarbrio (imipenem, cilastatin, and relebactam) for injection, a new combination antibacterial for the treatment of certain patients with complicated urinary tract infections caused by certain Gram-negative microorganisms. Recarbrio was approved by the EC in February 2020. The FDA and EC also approved expanded indications for Zerbaxa for the treatment of patients with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP) caused by certain susceptible Gram-negative microorganisms. Additionally, Ervebo (Ebola Zaire Vaccine, Live), a vaccine for the prevention of disease caused by Zaire ebolavirus in adults, was approved in the United States and received conditional approval in the EU . In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline, particularly in oncology, with several regulatory submissions for Keytruda , Lynparza and Lenvima in the United States and internationally. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of biliary tract, breast, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, gastric, hepatocellular, mesothelioma, nasopharyngeal, ovarian, prostate and small-cell lung cancers; Lynparza in combination with Keytruda for non-small cell lung cancer; and Lenvima in combination with Keytruda for bladder, endometrial, head and neck, melanoma and non-small-cell lung cancers. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including V114, an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease that received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults; MK-7264, gefapixant, a selective, non-narcotic, orally-administered P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough; MK-8591A, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) in combination with doravirine for the treatment of HIV-1 infection; and MK-1242, vericiguat, an investigational treatment for heart failure being developed in a collaboration (see Research and Development below). The Company is allocating resources to effectively support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2019 reflect higher clinical development spending and increased investment in discovery research and early drug development. In November 2019, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.61 per share from $0.55 per share on the Companys outstanding common stock. During 2019 , the Company returned $10.5 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2019 were $3.81 compared with $2.32 in 2018 . EPS in both years reflects the impact of acquisition and divestiture-related costs, as well as restructuring costs and certain other items. Certain other items in 2019 include a charge related to the acquisition of Peloton and in 2018 include a charge related to the formation of a collaboration with Eisai Co., Ltd. (Eisai). Non-GAAP EPS, which excludes these items, was $5.19 in 2019 and $4.34 in 2018 (see Non-GAAP Income and Non-GAAP EPS below). Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2019 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange United States $ 20,325 % % $ 18,212 % % $ 17,424 International 26,515 % % 24,083 % % 22,698 Total $ 46,840 % % $ 42,294 % % $ 40,122 U.S. plus international may not equal total due to rounding. Worldwide sales grew 11% in 2019 driven primarily by higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as increased alliance revenue related to Lynparza and Lenvima. Also contributing to revenue growth were higher sales of vaccines, including Gardasil/Gardasil 9, Varivax , ProQuad and MMR II, as well as increased sales of certain hospital acute care products, including Bridion. Higher sales of animal health products also drove revenue growth in 2019 . Sales growth in 2019 was partially offset by the effects of generic competition for cardiovascular products Zetia and Vytorin , hospital acute care products Invanz , Cubicin and Noxafil , oncology product Emend , and products within the diversified brands franchise, as well as biosimilar competition for immunology product Remicade. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Lower sales of diabetes products Januvia and Janumet and HIV products Isentress/Isentress HD also partially offset revenue growth in 2019 . Sales in the United States grew 12% in 2019 driven primarily by higher sales of Keytruda , combined sales of ProQuad , M-M-R II and Varivax , and Bridion , as well as higher alliance revenue from Lenvima and Lynparza. Revenue growth was partially offset by lower sales of Januvia, Janumet , Invanz , Emend , Isentress/Isentress HD , Cubicin and Noxafil . International sales grew 10% in 2019 . Performance in international markets was led by China, which had total sales of $3.2 billion in 2019 , representing growth of 47% compared with 2018 , including a 7% unfavorable effect from foreign exchange. The increase in international sales primarily reflects growth in Keytruda , Gardasil/Gardasil 9, combined sales of ProQuad , M-M-R II and Varivax , as well as higher alliance revenue from Lynparza and Lenvima. Sales growth was partially offset by lower sales of Zetia , Vytorin , Zepatier, Remicade , and products within the diversified brands franchise. International sales represented 57% of total sales in both 2019 and 2018 . See Note 18 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Keytruda $ 11,084 % % $ 7,171 % % $ 3,809 Alliance Revenue - Lynparza (1) % % * * Alliance Revenue - Lenvima (1) % % N/A N/A Emend (26 )% (24 )% (6 )% (7 )% * Calculation not meaningful. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Keytruda is an anti-PD-1 therapy that has been approved for the treatment of multiple malignancies including cervical cancer, classical Hodgkin lymphoma (cHL), esophageal cancer, gastric or gastroesophageal junction adenocarcinoma, HNSCC, hepatocellular carcinoma (HCC), NSCLC, SCLC, melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, primary mediastinal large B-cell lymphoma (PMBCL), RCC and urothelial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In January 2020, the FDA approved Keytruda as monotherapy for the treatment of certain patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, non-muscle invasive bladder cancer (NMIBC) based on the results of the KEYNOTE-057 trial. In July 2019, the FDA approved Keytruda as monotherapy for the treatment of certain patients with recurrent locally advanced or metastatic squamous cell carcinoma of the esophagus whose tumors express PD-L1 (Combined Positive Score [CPS] 10) as determined by an FDA-approved test, based on the results of the KEYNOTE-181 and KEYNOTE-180 trials. In June 2019, the FDA approved Keytruda as monotherapy or in combination with chemotherapy for the first-line treatment of patients with metastatic or unresectable, recurrent HNSCC based on results from the pivotal Phase 3 KEYNOTE-048 trial. Keytruda was initially approved for HNSCC under the FDAs accelerated approval process based on data from the Phase 1b KEYNOTE-012 trial. In accordance with the accelerated approval process, continued approval was contingent upon verification and description of clinical benefit, which has now been demonstrated in KEYNOTE-048 and has resulted in the FDA converting the accelerated approval to a full (regular) approval. Keytruda was approved for these indications by the EC in November 2019 and by Japans Ministry of Health, Labour and Welfare (MHLW) in December 2019. Also in June 2019, the FDA approved Keytruda as monotherapy for the treatment of certain patients with metastatic SCLC based on pooled data from the KEYNOTE-158 (cohort G) and KEYNOTE-028 (cohort C1) clinical trials. In April 2019, the FDA approved Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced RCC, the most common type of kidney cancer, based on findings from the pivotal Phase 3 KEYNOTE-426 trial. Keytruda was approved for this indication by the EC in September 2019 and by Japans MHLW in December 2019. Also in April 2019, the FDA approved an expanded label for Keytruda as monotherapy for the first-line treatment of patients with NSCLC expressing PD-L1 (Tumor Proportion Score [TPS] 1%) as determined by an FDA-approved test, with no EGFR or ALK genomic tumor aberrations, in stage III disease where patients are not candidates for surgical resection or definitive chemoradiation, and in metastatic disease. The approval was based on results from the Phase 3 KEYNOTE-042 trial. In September 2019, the FDA approved the combination of Keytruda plus Lenvima for the treatment of certain patients with advanced endometrial carcinoma that is not MSI-H or mismatch repair deficient. In March 2019, the EC approved Keytruda in combination with carboplatin and either paclitaxel or nab-paclitaxel for the first-line treatment of adults with metastatic squamous NSCLC based on data from the Phase 3 KEYNOTE-407 trial. Keytruda was approved for this indication by the FDA in October 2018. In April 2019, the EC approved a new extended dosing schedule of 400 mg every six weeks (Q6W) delivered as an intravenous infusion over 30 minutes for all approved monotherapy indications in the EU. The Q6W dose is available in addition to the formerly approved dose of Keytruda 200 mg every three weeks (Q3W) infused over 30 minutes. Additionally, in 2019, Keytruda received the following approvals from Chinas National Medical Products Administration (NMPA): in combination with pemetrexed and platinum chemotherapy for the first-line treatment of patients with metastatic nonsquamous NSCLC, with no EGFR or ALK genomic tumor aberrations, based on data from the pivotal Phase 3 KEYNOTE-189 trial; as monotherapy for the first-line treatment of patients with locally advanced or metastatic NSCLC whose tumors express PD-L1 as determined by a NMPA-approved test, with no EGFR or ALK genomic tumor aberrations, based on the results from the Phase 3 KEYNOTE-042 trial; and in combination with carboplatin and paclitaxel for the first-line treatment of patients with metastatic squamous NSCLC based on findings from the pivotal Phase 3 KEYNOTE-407 trial. Global sales of Keytruda grew 55% in 2019 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC as monotherapy and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with uptake in the recently launched RCC and adjuvant melanoma indications. Other indications contributing to U.S. sales growth include HNSCC, urothelial carcinoma, melanoma, and MSI-H cancer. Keytruda sales growth in international markets was driven primarily by performance in Europe, Japan and China reflecting increased use in the treatment of NSCLC, as well as for the more recently approved indications as described above. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the United States in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca entered into in July 2017 (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of advanced ovarian, breast and pancreatic cancers. The increase in alliance revenue related to Lynparza in 2019 was driven primarily by expanded use in the United States, the EU, Japan and China reflecting in part the ongoing launch of new indications. Lynparza received approval for the treatment of certain types of advanced ovarian cancer in the United States in December 2018, in the EU and in Japan in June 2019, and in China in December 2019 based on the results of the Phase 3 SOLO-1 trial. Also, in April 2019, the EC approved Lynparza for the treatment of certain adult patients with advanced breast cancer based on the results of the Phase 3 OlympiAD trial. Additionally, in December 2019, the FDA approved Lynparza for the maintenance treatment of certain adult patients with advanced pancreatic cancer based on the results of the Phase 3 POLO trial. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai entered into in March 2018 (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of thyroid cancer, HCC, and in combination with evorolimus for certain patients with RCC. Additionally, in September 2019, the FDA approved the combination of Keytruda plus Lenvima for the treatment of certain patients with advanced endometrial carcinoma that is not MSI-H or mismatch repair deficient. This marks the first U.S. approval for the combination of Keytruda plus Lenvima. The increase in alliance revenue related to Lenvima in 2019 reflects strong performance in the treatment of HCC following recent worldwide launches, as well as a full year of collaboration activity in 2019. Global sales of Emend , for the prevention of chemotherapy-induced and post-operative nausea and vomiting, declined 26% in 2019 driven primarily by lower demand and pricing in the United States due to competition, including recent generic competition for Emend for Injection following U.S. patent expiry in September 2019. The patent that provided U.S. market exclusivity for Emend expired in 2015 and the patent that provided market exclusivity in most major European markets expired in May 2019. Additionally, Emend for Injection will lose market exclusivity in major European markets in August 2020. The Company anticipates that sales of Emend for Injection in these markets will decline significantly thereafter. Vaccines ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Gardasil/Gardasil 9 $ 3,737 % % $ 3,151 % % $ 2,308 ProQuad % % % % M-M-R II % % % % Varivax % % % % RotaTeq % % % % Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 19% in 2019 driven primarily by higher demand in the Asia Pacific region, particularly in China, and higher demand in certain European markets reflecting increased vaccination rates for both boys and girls. Growth was partially offset by lower sales in the United States. The U.S. sales decline was driven by the borrowing of Gardasil 9 doses from the U.S. Centers for Disease and Control Prevention (CDC) Pediatric Vaccine Stockpile, offset in part by higher demand and pricing. In 2019, the Company borrowed doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile. The borrowing reduced sales in 2019 by approximately $120 million and the Company recognized a corresponding liability. During 2018, the Company replenished doses borrowed from the CDC Pediatric Vaccine Stockpile in 2017 resulting in the recognition of sales of $125 million in 2018 and a reversal of the liability related to that borrowing. The decision of Japans MHLW to suspend the active recommendation for HPV vaccination is still under review. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (this agreement expires in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the United States to another third party (this agreement expires in December 2028). The royalties are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, grew 27% in 2019 driven primarily by higher volumes and pricing in the United States, as well as volume growth in the EU largely reflecting a competitor supply issue. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, grew 28% in 2019 driven primarily by higher sales in the United Sates reflecting increased demand due to measles outbreaks, as well as higher pricing. The Company anticipates that U.S. sales of M-M-R II will decline in 2020 driven by lower expected demand related to fewer measles outbreaks. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), grew 25% in 2019 driven primarily by government tenders in Latin America, as well as higher pricing and volume growth in the United States. Varivax sales are expected to decline in 2020 due in part to the timing of government tenders and competition in select Latin American markets. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, grew 9% in 2019 driven primarily by continued uptake from the launch in China and higher volumes in the United States, partially offset by lower volumes in Latin America. In December 2019, the FDA approved Ervebo for the prevention of disease caused by Zaire ebolavirus in individuals 18 years of age and older. As previously announced, Merck is working to initiate manufacturing of licensed doses and expects these doses to start becoming available in approximately the third quarter of 2020. Merck is working closely with the U.S. government, the World Health Organization (WHO), UNICEF, and Gavi (the Vaccine Alliance) to plan for how eventual, licensed doses will support future public health preparedness and response efforts against Zaire ebolavirus disease. Merck is not seeking to profit from sales of this vaccine; rather, to ensure the vaccine is sustainable by recovering manufacturing and operational costs associated with the program. Ervebo was also granted a conditional marking authorization by the EC. Additionally, Merck has made submissions to African country national regulatory authorities in collaboration with the African Vaccine Regulatory Forum that will allow the vaccine to be registered in African countries considered to be at-risk for Ebola outbreaks by the WHO. In February 2020, Merck confirmed that four African countries have approved Ervebo . Approvals in additional countries in Africa are anticipated in the near future. Hospital Acute Care ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Bridion $ 1,131 % % $ % % $ Noxafil (11 )% (7 )% % % Invanz (47 )% (44 )% (18 )% (17 )% Cubicin (30 )% (28 )% (4 )% (5 )% Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 23% in 2019 driven by higher demand globally, particularly in the United States. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, declined 11% in 2019 driven primarily by generic competition in the United States. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. Accordingly, the Company is experiencing a decline in U.S. Noxafil sales as a result of generic competition and expects the decline to continue. Additionally, the patent for Noxafil expired in a number of major European markets in December 2019. As a result, the Company anticipates sales of Noxafil in these markets will decline significantly in future periods. Global sales of Invanz , for the treatment of certain infections, declined 47% in 2019 driven by generic competition in the United States. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and generic competition began in the second half of 2018. The Company subsequently experienced a significant decline in Invanz sales in the United States as a result of this generic competition and has since lost most of its U.S. Invanz sales. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, declined 30% in 2019 resulting primarily from ongoing generic competition in the United States following expiration of the U.S. composition patent for Cubicin in 2016. In 2019, the FDA and EC approved expanded indications for Zerbaxa for the treatment of HABP/VABP caused by certain susceptible Gram-negative microorganisms based on the results of the pivotal Phase 3 ASPECT-NP trial. Zerbaxa was previously approved in the United States and EU for the treatment of adults with certain complicated urinary tract and intra-abdominal infections. In July 2019, the FDA approved Recarbrio for injection, a new combination antibacterial for the treatment of adults who have limited or no alternative treatment options with complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative microorganisms. Recarbrio was approved by the EC in February 2020. Merck anticipates making Recarbrio available in the first half of 2020. In January 2020, the FDA approved Dificid (fidaxomicin) for oral suspension and Dificid tablets for the treatment of Clostridioides (formerly Clostridium ) difficile -associated diarrhea in children aged six months and older. Immunology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Simponi $ (7 )% (2 )% $ % % $ Remicade (29 )% (25 )% (31 )% (33 )% Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 7% in 2019 driven by the unfavorable effect of foreign exchange and lower pricing in Europe. Sales of Simponi are being unfavorably affected by the launch of biosimilars for a competing product. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 29% in 2019 driven by ongoing biosimilar competition in the Companys marketing territories. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Virology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Isentress/Isentress HD $ (15 )% (10 )% $ 1,140 (5 )% (5 )% $ 1,204 Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 15% in 2019 primarily reflecting lower demand in the United States and in the EU due to competitive pressure. In September 2019, the FDA approved supplemental New Drug Applications (NDA) for Pifeltro (doravirine) in combination with other antiretroviral agents, and for Delstrigo (doravirine/lamivudine/tenofovir disoproxil fumarate) as a complete regimen, that expand their indications to include adult patients with HIV-1 infection who are virologically suppressed on a stable antiretroviral regimen. Cardiovascular ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Zetia/Vytorin $ (35 )% (34 )% $ 1,355 (35 )% (38 )% $ 2,095 Atozet % % % % Rosuzet % % % % Adempas % % % % Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin (marketed outside the United States as Inegy ), medicines for lowering LDL cholesterol, declined 35% in 2019 driven primarily by lower sales in the EU. The EU patents for Ezetrol and Inegy expired in April 2018 and April 2019, respectively. Accordingly, the Company is experiencing sales declines in these markets as a result of generic competition and expects the declines to continue. The sales decline was also attributable to loss of exclusivity in Australia. Merck lost market exclusivity in the United States for Zetia in 2016 and Vytorin in 2017 and subsequently lost nearly all U.S. sales of these products as a result of generic competition. Sales of Atozet (marketed outside of the United States), a medicine for lowering LDL cholesterol, grew 13% in 2019 , primarily driven by higher demand in the EU and in Korea. Sales of Rosuzet (marketed outside of the United States), a medicine for lowering LDL cholesterol, more than doubled in 2019 , primarily driven by the launch in Japan, as well as higher demand in Korea. Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Adempas (see Note 4 to the consolidated financial statements). The increase in alliance revenue of 27% in 2019 was driven both by higher profits from Bayer and higher sales of Adempas in Mercks marketing territories. Diabetes ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Januvia/Janumet $ 5,524 (7 )% (4 )% $ 5,914 % (1 )% $ 5,896 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, declined 7% in 2019 as a result of continued pricing pressure in the United States, partially offset by higher demand in most international markets. The Company expects U.S. pricing pressure to continue. The patents that provide market exclusivity for Januvia and Janumet in the United States expire in July 2022 (although six-month pediatric exclusivity may extend this date). The patent that provides market exclusivity for Januvia in the EU expires in July 2022 (although pediatric exclusivity may extend this date to September 2022). The supplementary patent certificate that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries. Womens Health ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange NuvaRing $ (3 )% (2 )% $ % % $ Implanon/Nexplanon % % % % Worldwide sales of NuvaRing , a vaginal contraceptive product, declined 3% in 2019 driven primarily by lower demand in the EU due to generic competition, largely offset by higher sales in the United States reflecting higher pricing that was partially offset by lower demand. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company anticipates a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. Worldwide sales of Implanon/Nexplanon , a single-rod subdermal contraceptive implant, grew 12% in 2019 , primarily driven by higher demand and pricing in the United States. Biosimilars ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Biosimilars $ * * $ * * $ * Calculation not meaningful. Biosimilar products are marketed by the Company pursuant to an agreement with Samsung Bioepis Co., Ltd. (Samsung) to develop and commercialize multiple pre-specified biosimilar candidates. Currently, the Company markets Renflexis (infliximab-abda), a tumor necrosis factor (TNF) antagonist biosimilar to Remicade (infliximab) for the treatment of certain inflammatory diseases; Ontruzant (trastuzumab-dttb), a human epidermal growth factor receptor 2 (HER2)/ neu receptor antagonist biosimilar to Herceptin (trastuzumab) for the treatment of HER2-positive breast cancer and HER2 overexpressing gastric cancer; and Brenzys (etanercept biosimilar), a TNF antagonist biosimilar to Enbrel for the treatment of certain inflammatory diseases. Mercks commercialization territories under the agreement vary by product. Sale growth of biosimilars in 2019 was driven by continued uptake of Renflexis in United States since launch in 2017, continued uptake of Ontruzant in the EU since launch in 2018, and the launch of Brenzys in Brazil in 2019. Animal Health Segment ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Livestock $ 2,784 % % $ 2,630 % % $ 2,484 Companion Animal 1,609 % % 1,582 % % 1,391 Sales of livestock products grew 6% in 2019 predominantly due to products obtained in the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Growth in sales of livestock products was also driven by higher demand for aqua and swine products. Sales of companion animal products grew 2% in 2019 driven primarily by higher demand for the Bravecto line of products for parasitic control. Costs, Expenses and Other ($ in millions) Change Change Cost of sales $ 14,112 % $ 13,509 % $ 12,912 Selling, general and administrative 10,615 % 10,102 % 10,074 Research and development 9,872 % 9,752 % 10,339 Restructuring costs % % Other (income) expense, net * (402 ) % (500 ) $ 35,376 % $ 33,593 % $ 33,601 * Greater than 100%. Cost of Sales Cost of sales was $14.1 billion in 2019 compared with $13.5 billion in 2018 . Cost of sales includes the amortization of intangible assets recorded in connection with business acquisitions, which totaled $1.4 billion in 2019 compared with $2.7 billion in 2018. Cost of sales also includes the amortization of amounts capitalized in connection with collaborations of $464 million in 2019 compared with $347 million in 2018 (see Note 8 to the consolidated financial statements). Additionally, costs in 2019 include intangible asset impairment charges of $705 million related to marketed products recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Costs in 2018 include a $423 million charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities which amounted to $251 million in 2019 compared with $21 million in 2018 , primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 69.9% in 2019 compared with 68.1% in 2018 . The gross margin improvement in 2019 reflects the charge recorded in 2018 in connection with the termination of the collaboration agreement with Samsung (noted above), favorable product mix, and lower amortization of intangible assets (noted above). These improvements in gross margin were partially offset by unfavorable manufacturing variances, inventory write-offs, pricing pressure, and higher restructuring costs. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.6 billion in 2019 , an increase of 5% compared with 2018 , driven primarily by higher administrative costs, acquisition and divestiture-related costs (largely related to the acquisition of Antelliq), promotional expenses primarily in support of strategic brands, and restructuring costs, partially offset by the favorable effect of foreign exchange and lower selling costs. SGA expenses in 2019 include restructuring costs of $34 million related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. SGA expenses include acquisition and divestiture-related costs of $126 million in 2019 compared with $32 million in 2018, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Research and Development Research and development (RD) expenses were $9.9 billion in 2019 , an increase of 1% compared with 2018 . The increase was driven primarily by a $993 million charge in 2019 for the acquisition of Peloton (see Note 3 to the consolidated financial statements), as well as higher expenses related to clinical development and increased investment in discovery research and early drug development. The increase in RD expenses in 2019 was partially offset by a $1.4 billion charge in 2018 related to the formation of an oncology collaboration with Eisai (see Note 4 to the consolidated financial statements), a $344 million charge in 2018 related to the acquisition of Viralytics Limited (Viralytics) (see Note 3 to the consolidated financial statements), and the favorable effect of foreign exchange. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $6.1 billion in 2019 compared with $5.6 billion in 2018. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $2.6 billion in 2019 and $2.3 billion in 2018. RD expenses also include in-process research and development (IPRD) impairment charges of $172 million and $152 million in 2019 and 2018 , respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business acquisitions. During 2019 and 2018, the Company recorded a net reduction in expenses of $39 million and $54 million, respectively, related to changes in these estimates. Restructuring Costs In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $2.5 billion . The Company expects to record charges of approximately $800 million in 2020 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program to result in annual net cost savings of approximately $900 million by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $638 million in 2019 and $632 million in 2018 . Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative and Research and development . The Company recorded aggregate pretax costs of $927 million in 2019 and $658 million in 2018 related to restructuring program activities (see Note 5 to the consolidated financial statements). Other (Income) Expense, Net For details on the components of Other (income) expense, net, see Note 14 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 28,324 $ 24,871 $ 23,018 Animal Health segment profits 1,609 1,659 1,552 Other non-reportable segment profits (7 ) Other (18,462 ) (17,932 ) (18,324 ) Income Before Taxes $ 11,464 $ 8,701 $ 6,521 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including amortization of purchase accounting adjustments, intangible asset impairment charges and changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. During 2019, as a result of changes to the Companys internal reporting structure, certain costs that were previously included in the Pharmaceutical segment are now being included as part of non-segment expenses within MRL. Prior period Pharmaceutical segment profits have been recast to reflect these changes on a comparable basis. Pharmaceutical segment profits grew 14% in 2019 compared with 2018 driven primarily by higher sales, as well as lower selling costs. Animal Health segment profits declined 3% in 2019 driven primarily by unfavorable product mix, higher investments in selling and product development, and the unfavorable effect of foreign exchange, partially offset by higher sales. Taxes on Income The effective income tax rates of 14.7% in 2019 and 28.8% in 2018 reflect the impacts of acquisition and divestiture-related costs, restructuring costs and the beneficial impact of foreign earnings, including product mix. The effective income tax rate in 2019 also reflects the favorable impact of a $364 million net tax benefit related to the settlement of certain federal income tax matters (see Note 15 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impacts of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 15 to the consolidated financial statements). The effective income tax rate in 2018 includes measurement-period adjustments to the provisional amounts recorded in 2017 associated with the enactment of the TCJA, including $124 million related to the transition tax. In addition, the effective income tax rate for 2018 reflects the unfavorable impacts of a charge recorded in connection with the formation of a collaboration with Eisai and a charge related to the termination of a collaboration agreement with Samsung for which no tax benefit was recognized. Net (Loss) Income Attributable to Noncontrolling Interests Net (loss) income attributable to noncontrolling interests was $(66) million in 2019 compared with $(27) million in 2018. The losses in 2019 and 2018 were driven primarily by the portion of goodwill impairment charges related to certain business in the Healthcare Services segment that are attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $9.8 billion in 2019 and $6.2 billion in 2018 . EPS was $3.81 in 2019 and $2.32 in 2018 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 11,464 $ 8,701 $ 6,521 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 2,681 3,066 3,760 Restructuring costs Other items: Charge for the acquisition of Peloton Charge related to the formation of an oncology collaboration with Eisai 1,400 Charge related to the termination of a collaboration with Samsung Charge for the acquisition of Viralytics Charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Other (57 ) (16 ) Non-GAAP income before taxes 16,120 14,535 13,542 Taxes on income as reported under GAAP 1,687 2,508 4,103 Estimated tax benefit on excluded items (1) Net tax charge related to the enactment of the TCJA and subsequent finalization of related treasury regulations (2) (117 ) (160 ) (2,625 ) Net tax benefit from the settlement of certain federal income tax matters Tax benefit from the reversal of tax reserves related to the divestiture of MCC Tax benefit related to the settlement of a state income tax matter Non-GAAP taxes on income 2,715 2,883 2,585 Non-GAAP net income 13,405 11,652 10,957 Less: Net (loss) income attributable to noncontrolling interests as reported under GAAP (66 ) (27 ) Acquisition and divestiture-related costs attributable to noncontrolling interests (89 ) (58 ) Non-GAAP net income attributable to noncontrolling interests 31 Non-GAAP net income attributable to Merck Co., Inc. $ 13,382 $ 11,621 $ 10,933 EPS assuming dilution as reported under GAAP $ 3.81 $ 2.32 $ 0.87 EPS difference 1.38 2.02 3.11 Non-GAAP EPS assuming dilution $ 5.19 $ 4.34 $ 3.98 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Amount in 2017 was provisional (see Note 15 to the consolidated financial statements). Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items These items are adjusted for after they are evaluated on an individual basis considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2019 is a charge for the acquisition of Peloton (see Note 3 to the consolidated financial statements), tax charges related to the finalization of U.S. treasury regulations related to the TCJA, a net tax benefit related to the settlement of certain federal income tax matters, and a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2017 is a charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), as well as a provisional net tax charge related to the enactment of the TCJA, a net tax benefit related to the settlement of certain federal income tax matters and a tax benefit related to the settlement of a state income tax matter (see Note 15 to the consolidated financial statements). Research and Development A chart reflecting the Companys current research pipeline as of February 21, 2020 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,000 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, non-small-cell lung, ovarian, PMBCL, prostate, renal, small-cell lung, triple-negative breast and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (TPS 1%) with no EGFR or ALK genomic tumor aberrations based on results from the Phase 3 KEYNOTE-042 trial. Keytruda is under review in Japan as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma based on results from the pivotal Phase 3 KEYNOTE-062 trial. Keytruda is also under review in Japan as monotherapy for the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma based on the results of the Phase 3 KEYNOTE-181 trial. Merck has made the decision to withdraw its Type II variation application for Keytruda for this indication in the EU. In October 2019, the FDA accepted a supplemental Biologics License Application (BLA) seeking use of Keytruda for the treatment of patients with recurrent and/or metastatic cutaneous squamous cell carcinoma (cSCC) that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a Prescription Drug User Fee Act (PDUFA) date of June 29, 2020. In February 2020, Merck announced the FDA issued a Complete Response Letter regarding Mercks supplemental BLAs seeking to update the dosing frequency for Keytruda to include a 400 mg dose infused over 30 minutes every-six-weeks (Q6W) option in multiple indications. The submitted applications are based on pharmacokinetic modeling and simulation data presented at the 2018 American Society of Clinical Oncology (ASCO) Annual Meeting. These data supported the EC approval of 400 mg Q6W dosing for Keytruda monotherapy indications in March 2019. Merck is reviewing the letter and will discuss next steps with the FDA. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with neoadjuvant chemotherapy for the treatment of high-risk, early-stage triple-negative breast cancer (TNBC) and in combination with enfortumab vedotin, in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In September 2019, Merck announced results from the pivotal neoadjuvant/adjuvant Phase 3 KEYNOTE-522 trial in patients with early-stage TNBC. The trial investigated a regimen of neoadjuvant Keytruda plus chemotherapy, followed by adjuvant Keytruda as monotherapy (the Keytruda regimen) compared with a regimen of neoadjuvant chemotherapy followed by adjuvant placebo (the chemotherapy-placebo regimen). Interim findings were presented at the European Society for Medical Oncology (ESMO) 2019 Congress. In the neoadjuvant phase, Keytruda plus chemotherapy resulted in a statistically significant increase in pathological complete response (pCR) versus chemotherapy in patients with early-stage TNBC. The improvement seen when adding Keytruda to neoadjuvant chemotherapy was observed regardless of PD-L1 expression. In the other dual primary endpoint of event-free-survival (EFS), with a median follow-up of 15.5 months, the Keytruda regimen reduced the risk of progression in the neoadjuvant phase and recurrence in the adjuvant phase compared with the chemotherapy-placebo regimen. Merck continues to discuss interim analysis data from KEYNOTE-522 with regulatory authorities. The Keytruda breast cancer clinical development program encompasses several internal and external collaborative studies. In February 2020, Merck announced that the pivotal Phase 3 KEYNOTE-355 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of progression-free survival (PFS) in patients with metastatic triple-negative breast cancer (mTNBC) whose tumors expressed PD-L1 (CPS 10). Based on an interim analysis conducted by an independent Data Monitoring Committee (DMC), first-line treatment with Keytruda in combination with chemotherapy (nab-paclitaxel, paclitaxel or gemcitabine/carboplatin) demonstrated a statistically significant and clinically meaningful improvement in PFS compared to chemotherapy alone in these patients. Based on the recommendation of the DMC, the trial will continue without changes to evaluate the other dual primary endpoint of overall survival (OS). In May 2019, Merck announced that the Phase 3 KEYNOTE-119 trial evaluating Keytruda as monotherapy for the second- or third-line treatment of patients with metastatic TNBC did not meet its pre-specified primary endpoint of superior OS compared to chemotherapy. Other endpoints were not formally tested per the study protocol because the primary endpoint of OS was not met. In June 2019, Merck announced full results from the pivotal Phase 3 KEYNOTE-062 trial evaluating Keytruda as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma. In the monotherapy arm of the study, Keytruda met a primary endpoint by demonstrating noninferiority to chemotherapy, the current standard of care, for OS in patients whose tumors expressed PD-L1 (CPS 1). In the combination arm of KEYNOTE-062, Keytruda plus chemotherapy was not found to be statistically superior for OS (CPS 1 or CPS 10) or PFS (CPS 1) compared with chemotherapy alone. Results were presented at the 2019 ASCO Annual Meeting. In September 2017, the FDA approved Keytruda as a third-line treatment for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. KEYNOTE-062 was a potential confirmatory trial for this accelerated, third-line approval. In addition to KEYNOTE-062, additional first-line, Phase 3 studies in Mercks gastric clinical program include KEYNOTE-811 and KEYNOTE-859, as well as KEYNOTE-585 in the neoadjuvant and adjuvant treatment setting. In January 2020, Merck announced that the Phase 3 KEYNOTE-604 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of PFS in the first-line treatment of patients with extensive stage SCLC. At the final analysis of the study, there was also an improvement in OS for patients treated with Keytruda in combination with chemotherapy compared to chemotherapy alone; however, these OS results did not meet statistical significance per the pre-specified statistical plan. Results will be presented at an upcoming medical meeting and discussed with regulatory authorities. Lynparza is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast and pancreatic cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). Lynparza is under review in the EU as a first-line maintenance monotherapy for patients with g BRCA m metastatic pancreatic cancer whose disease has not progressed following first-line platinum-based chemotherapy. Lynparza was approved for this indication by the FDA in December 2019 based on results from the Phase 3 POLO trial. A decision from the European Medicines Agency (EMA) is expected in the second half of 2020. In January 2020, the FDA accepted a supplemental NDA for Lynparza in combination with bevacizumab for the maintenance treatment of women with advanced ovarian cancer whose disease showed a complete or partial response to first-line treatment with platinum-based chemotherapy and bevacizumab based on the results from the pivotal Phase 3 PAOLA-1 trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In January 2020, the FDA accepted for Priority Review a supplemental NDA for Lynparza for the treatment of patients with metastatic castration-resistant prostate cancer (mCRPC) and deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene mutations, who have progressed following prior treatment with a new hormonal agent based on positive results from the Phase 3 PROfound trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In June 2019, Merck and AstraZeneca presented full results from the Phase 3 SOLO-3 trial which evaluated Lynparza, compared to chemotherapy, for the treatment of platinum-sensitive relapsed patients with g BRCA m advanced ovarian cancer, who have received two or more prior lines of chemotherapy. The results from the trial showed a statistically-significant and clinically-meaningful improvement in objective response rate (ORR) in the Lynparza arm compared to the chemotherapy arm. The key secondary endpoint of PFS was also significantly increased in the Lynparza arm compared to the chemotherapy arm. The results were presented at the 2019 ASCO Annual Meeting. MK-5618, selumetinib, is a MEK 1/2 inhibitor being co-developed as part of a strategic collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). Selumetinib is under Priority Review with the FDA as a potential new medicine for pediatric patients aged three years and older with neurofibromatosis type 1 (NF1) and symptomatic, inoperable plexiform neurofibromas. This regulatory submission was based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Phase 2 Stratum 1 trial. A PDUFA date is set for the second quarter of 2020. V503 is under review in Japan for an initial indication in females for the prevention of certain HPV-related diseases and precursors. In February 2020, the FDA accepted for Priority Review a supplemental BLA for Gardasil 9 for the prevention of certain head and neck cancers caused by vaccine-type HPV in females and males 9 through 45 years of age. The FDA set a PDUFA date of June 2020. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. Lynparza, in addition to the indications under review discussed above, is in Phase 3 development in combination with Keytruda for the treatment of NSCLC. Lenvima is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, HCC, and in combination for certain patients with RCC being co-developed as part of a strategic collaboration with Eisai (see Note 4 to the consolidated financial statements). Pursuant to the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination in six types of cancer (endometrial cancer, NSCLC, HCC, HNSCC, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima both for the potential treatment of patients with advanced and/or metastatic RCC and for the potential treatment of patients with unresectable HCC not amenable to locoregional treatment. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor antagonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. MK-1242, vericiguat, is a sGC stimulator for the potential treatment of patients with worsening chronic heart failure being developed as part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). Vericiguat is being studied in patients suffering from chronic heart failure with reduced ejection fraction (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fraction (Phase 2 clinical trial). In November 2019, Merck announced that the Phase 3 VICTORIA study evaluating the efficacy and safety of vericiguat met the primary efficacy endpoint. Vericiguat reduced the risk of the composite endpoint of heart failure hospitalization or cardiovascular death in patients with worsening chronic heart failure with reduced ejection fraction compared to placebo when given in combination with available heart failure therapies. The results of the VICTORIA study will be presented at an upcoming medical meeting in 2020. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently six Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, eight studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. V114 has received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes and other metabolic diseases, infectious diseases, neurosciences, pain, respiratory diseases, and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2019 , the balance of IPRD was $1.0 billion . The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2019 , 2018 , and 2017 the Company recorded IPRD impairment charges within Research and development expenses of $172 million , $152 million and $483 million , respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets for IPRD of $156 million , cash of $83 million and other net assets of $42 million . The excess of the consideration transferred over the fair value of net assets acquired of $20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In July 2019, Merck acquired Peloton, a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly PT2977), is a novel oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $1.2 billion in cash; additionally, former Peloton shareholders will be eligible to receive $50 million upon U.S. regulatory approval, $50 million upon first commercial sale in the United States, and up to $1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $157 million , deferred tax liabilities of $52 million , and other net liabilities of $4 million at the acquisition date and Research and development expenses of $993 million in 2019 related to the transaction. In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $2.7 billion . ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently in a Phase 2 dose expansion study for the treatment of B-cell malignancies. The Company is in the process of determining the preliminary fair value of assets acquired, liabilities assumed and total consideration transferred in this transaction, which will be accounted for as an acquisition of a business. Capital Expenditures Capital expenditures were $3.5 billion in 2019 , $2.6 billion in 2018 and $1.9 billion in 2017 . Expenditures in the United States were $1.9 billion in 2019 , $1.5 billion in 2018 and $1.2 billion in 2017 . The increased capital expenditures in 2019 reflect investment in new capital projects focused primarily on increasing manufacturing capacity for Mercks key products. As previously announced, the Company plans to invest more than $19 billion in new capital projects from 2019-2023. Depreciation expense was $1.7 billion in 2019 , $1.4 billion in 2018 and $1.5 billion in 2017 , of which $1.2 billion in 2019 , $1.0 billion in 2018 and $1.0 billion in 2017 , related to locations in the United States. Total depreciation expense in 2019 and 2017 included accelerated depreciation of $233 million and $60 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 5,263 $ 3,669 $ 6,152 Total debt to total liabilities and equity 31.2 % 30.4 % 27.8 % Cash provided by operations to total debt 0.5:1 0.4:1 0.3:1 Cash provided by operating activities was $13.4 billion in 2019 compared with $10.9 billion in 2018 , reflecting stronger operating performance and increased accounts receivable factoring as discussed below. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities was $2.6 billion in 2019 compared with cash provided by investing activities of $4.3 billion in 2018 . The change was driven primarily by lower proceeds from the sales of securities and other investments, the acquisitions of Antelliq and Peloton in 2019, and higher capital expenditures, partially offset by lower purchases of securities and other investments. Cash used in financing activities was $8.9 billion in 2019 compared with $13.2 billion in 2018 . The lower use of cash in financing activities was driven primarily by proceeds from the issuance of debt and lower purchases of treasury stock reflecting the accelerated share repurchase (ASR) program in 2018 as discussed below, as well as lower payments on debt, partially offset by the repayment of short-term borrowings, higher dividends paid to shareholders and lower proceeds from the exercise of stock options. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable (see Note 6 to the consolidated financial statements). The Company factored $2.7 billion and $1.1 billion of accounts receivable in the fourth quarter of 2019 and 2018 , respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2019 , the Company had collected $256 million on behalf of the financial institutions, which was remitted to them in January 2020. The net cash flows from these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The Companys contractual obligations as of December 31, 2019 are as follows: Payments Due by Period ($ in millions) Total 20212022 20232024 Thereafter Purchase obligations (1) $ 3,167 $ 1,097 $ 1,108 $ $ Loans payable and current portion of long-term debt 3,612 3,612 Long-term debt 22,779 4,515 3,058 15,206 Interest related to debt obligations 10,021 1,372 1,189 6,700 Unrecognized tax benefits (2) Transition tax related to the enactment of the TCJA (3) 3,397 1,181 1,045 Milestone payments related to collaborations (4) Leases (5) 1,012 $ 44,437 $ 6,562 $ 8,130 $ 6,051 $ 23,694 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2019 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $1.5 billion , including $49 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2020 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA (see Note 15 to the consolidated financial statements). (4) Reflects payments under collaborative agreements for sales-based milestones that were achieved in 2019 (and therefore deemed to be contractual obligations) but not paid until January 2020 (see Note 4 to the consolidated financial statements). (5) Amounts exclude reasonably certain lease renewals that have not yet been executed (see Note 9 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts do not include contingent milestone payments related to collaborative arrangements or acquisitions as they are not considered contractual obligations until the successful achievement of developmental, regulatory approval or commercial milestones. At December 31, 2019 , the Company has recognized liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca, Eisai and Bayer where payment remains subject to the achievement of the related sales milestone aggregating $1.4 billion (see Note 4 to the consolidated financial statements). Excluded from research and development obligations are potential future funding commitments of up to approximately $60 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $226 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2020 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $100 million to its U.S. pension plans, $150 million to its international pension plans and $15 million to its other postretirement benefit plans during 2020 . In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering of $5.0 billion for general corporate purposes, including the repayment of outstanding commercial paper borrowings. In December 2018, the Company exercised a make-whole provision on its $1.25 billion, 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. The Company has a $6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2019, Mercks Board of Directors declared a quarterly dividend of $0.61 per share on the Companys outstanding common stock that was paid in January 2020. In January 2020 , the Board of Directors declared a quarterly dividend of $0.61 per share on the Companys common stock for the second quarter of 2020 payable in April 2020 . In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company spent $4.8 billion to purchase 59 million shares of its common stock for its treasury during 2019 . In addition, the Company received 7.7 million shares in settlement of ASR agreements as discussed below. As of December 31, 2019 , the Companys remaining share repurchase authorization was $7.2 billion . The Company purchased $9.1 billion and $4.0 billion of its common stock during 2018 and 2017 , respectively, under authorized share repurchase programs. On October 25, 2018, the Company entered into ASR agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in April 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million . Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $456 million and $441 million at December 31, 2019 and 2018 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2019 and 2018 , Income before taxes would have declined by approximately $110 million and $134 million in 2019 and 2018 , respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within Other Comprehensive Income (Loss) ( OCI ), and remain in Accumulated Other Comprehensive Income (Loss) ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2019 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2019 and 2018 would have positively affected the net aggregate market value of these instruments by $2.0 billion and $1.2 billion, respectively. A one percentage point decrease at December 31, 2019 and 2018 would have negatively affected the net aggregate market value by $2.2 billion and $1.4 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2019 , 2018 or 2017 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,630 $ 2,551 Current provision 11,999 10,837 Adjustments to prior years (230 ) (117 ) Payments (11,963 ) (10,641 ) Balance December 31 $ 2,436 $ 2,630 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $233 million and $2.2 billion , respectively, at December 31, 2019 and were $245 million and $2.4 billion , respectively, at December 31, 2018 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 1.1% in 2019, 1.6% in 2018 and 2.1% in 2017. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2019 and 2018 were $168 million and $7 million , respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 10 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2019 and 2018 of approximately $240 million and $245 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $19 million in 2019 and are estimated at $47 million in the aggregate for the years 2020 through 2024 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million and $71 million at December 31, 2019 and 2018 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $58 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $417 million in 2019 , $348 million in 2018 and $312 million in 2017 . At December 31, 2019 , there was $603 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $137 million in 2019 , $195 million in 2018 and $201 million in 2017 . Net periodic benefit (credit) for other postretirement benefit plans was $(49) million in 2019 , $(45) million in 2018 and $(60) million in 2017 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 3.20% to 3.50% at December 31, 2019 , compared with a range of 4.00% to 4.40% at December 31, 2018 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2020 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.00% to 7.30% , compared to a range of 7.70% to 8.10% in 2019 . The decrease reflects lower expected asset returns and a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 10% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $70 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2019 . A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $50 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2019 . Required funding obligations for 2020 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 15 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2019 and 2018 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2019 , the notes to consolidated financial statements, and the report dated February 26, 2020 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 46,840 $ 42,294 $ 40,122 Costs, Expenses and Other Cost of sales 14,112 13,509 12,912 Selling, general and administrative 10,615 10,102 10,074 Research and development 9,872 9,752 10,339 Restructuring costs Other (income) expense, net ( 402 ) ( 500 ) 35,376 33,593 33,601 Income Before Taxes 11,464 8,701 6,521 Taxes on Income 1,687 2,508 4,103 Net Income 9,777 6,193 2,418 Less: Net (Loss) Income Attributable to Noncontrolling Interests ( 66 ) ( 27 ) Net Income Attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 3.84 $ 2.34 $ 0.88 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 3.81 $ 2.32 $ 0.87 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Other Comprehensive (Loss) Income Net of Taxes: Net unrealized (loss) gain on derivatives, net of reclassifications ( 135 ) ( 446 ) Net unrealized gain (loss) on investments, net of reclassifications ( 10 ) ( 58 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization ( 705 ) ( 425 ) Cumulative translation adjustment ( 223 ) ( 648 ) ( 361 ) Comprehensive Income Attributable to Merck Co., Inc. $ 9,195 $ 5,859 $ 2,710 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 9,676 $ 7,965 Short-term investments Accounts receivable (net of allowance for doubtful accounts of $86 in 2019 and $119 in 2018) 6,778 7,071 Inventories (excludes inventories of $1,480 in 2019 and $1,417 in 2018 classified in Other assets - see Note 7) 5,978 5,440 Other current assets 4,277 4,500 Total current assets 27,483 25,875 Investments 1,469 6,233 Property, Plant and Equipment (at cost) Land Buildings 11,989 11,486 Machinery, equipment and office furnishings 15,394 14,441 Construction in progress 5,013 3,355 32,739 29,615 Less: accumulated depreciation 17,686 16,324 15,053 13,291 Goodwill 19,425 18,253 Other Intangibles, Net 14,196 13,104 Other Assets 6,771 5,881 $ 84,397 $ 82,637 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 3,610 $ 5,308 Trade accounts payable 3,738 3,318 Accrued and other current liabilities 12,549 10,151 Income taxes payable 1,971 Dividends payable 1,587 1,458 Total current liabilities 22,220 22,206 Long-Term Debt 22,736 19,806 Deferred Income Taxes 1,470 1,702 Other Noncurrent Liabilities 11,970 12,041 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2019 and 2018 1,788 1,788 Other paid-in capital 39,660 38,808 Retained earnings 46,602 42,579 Accumulated other comprehensive loss ( 6,193 ) ( 5,545 ) 81,857 77,630 Less treasury stock, at cost: 1,038,087,496 shares in 2019 and 984,543,979 shares in 2018 55,950 50,929 Total Merck Co., Inc. stockholders equity 25,907 26,701 Noncontrolling Interests Total equity 26,001 26,882 $ 84,397 $ 82,637 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2017 $ 1,788 $ 39,939 $ 44,133 $ ( 5,226 ) $ ( 40,546 ) $ $ 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) ( 5,177 ) ( 5,177 ) Treasury stock shares purchased ( 4,014 ) ( 4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests ( 18 ) ( 18 ) Share-based compensation plans and other ( 37 ) Balance December 31, 2017 1,788 39,902 41,350 ( 4,910 ) ( 43,794 ) 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards ( 274 ) Other comprehensive loss, net of taxes ( 361 ) ( 361 ) Cash dividends declared on common stock ($1.99 per share) ( 5,313 ) ( 5,313 ) Treasury stock shares purchased ( 1,000 ) ( 8,091 ) ( 9,091 ) Net loss attributable to noncontrolling interests ( 27 ) ( 27 ) Distributions attributable to noncontrolling interests ( 25 ) ( 25 ) Share-based compensation plans and other ( 94 ) Balance December 31, 2018 1,788 38,808 42,579 ( 5,545 ) ( 50,929 ) 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) Balance December 31, 2019 $ 1,788 $ 39,660 $ 46,602 $ ( 6,193 ) $ ( 55,950 ) $ $ 26,001 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 9,777 $ 6,193 $ 2,418 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,652 4,519 4,676 Intangible asset impairment charges 1,040 Charge for the acquisition of Peloton Therapeutics, Inc. Charge for future payments related to collaboration license options Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Deferred income taxes ( 556 ) ( 509 ) ( 2,621 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable ( 418 ) Inventories ( 508 ) ( 911 ) ( 145 ) Trade accounts payable Accrued and other current liabilities ( 341 ) ( 922 ) Income taxes payable ( 2,359 ) ( 3,291 ) Noncurrent liabilities ( 237 ) ( 266 ) ( 123 ) Other ( 32 ) ( 674 ) ( 1,087 ) Net Cash Provided by Operating Activities 13,440 10,922 6,451 Cash Flows from Investing Activities Capital expenditures ( 3,473 ) ( 2,615 ) ( 1,888 ) Purchases of securities and other investments ( 3,202 ) ( 7,994 ) ( 10,739 ) Proceeds from sales of securities and other investments 8,622 15,252 15,664 Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 294 ) ( 431 ) ( 396 ) Other Net Cash (Used in) Provided by Investing Activities ( 2,629 ) 4,314 2,679 Cash Flows from Financing Activities Net change in short-term borrowings ( 3,710 ) 5,124 ( 26 ) Payments on debt ( 4,287 ) ( 1,103 ) Proceeds from issuance of debt 4,958 Purchases of treasury stock ( 4,780 ) ( 9,091 ) ( 4,014 ) Dividends paid to stockholders ( 5,695 ) ( 5,172 ) ( 5,167 ) Proceeds from exercise of stock options Other ( 325 ) ( 195 ) Net Cash Used in Financing Activities ( 8,861 ) ( 13,160 ) ( 10,006 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash ( 205 ) Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 1,967 1,871 ( 419 ) Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $2 million of restricted cash at January 1, 2019 included in Other Assets) 7,967 6,096 6,515 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $258 million of restricted cash at December 31, 2019 included in Other Assets - see Note 6) $ 9,934 $ 7,967 $ 6,096 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into New Company In February 2020, Merck announced its intention to spin-off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed in the first half of 2021, subject to market and certain other conditions. Subsequent to the spin-off, the historical results of the womans health, legacy brands and biosimilars businesses will be reflected as discontinued operations in the Companys consolidated financial statements. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers , and subsequent amendments (ASC 606 or new guidance), using the modified retrospective method. Comparative information for prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 11.8 billion in 2019 , $ 10.7 billion in 2018 and $ 10.7 billion in 2017 . Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 233 million and $ 2.2 billion , respectively, at December 31, 2019 and were $ 245 million and $ 2.4 billion , respectively, at December 31, 2018 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.7 billion in 2019 , $ 1.4 billion in 2018 and $ 1.5 billion in 2017 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.1 billion , $ 2.1 billion and $ 2.2 billion in 2019 , 2018 and 2017 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $ 548 million and $ 439 million , net of accumulated amortization at December 31, 2019 and 2018 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as an acquisition of a business, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Adopted Accounting Standards In February 2016, the Financial Accounting Standards Board (FASB) issued new accounting guidance for the accounting and reporting of leases (ASU 2016-02) and subsequently issued several updates to the new guidance (ASC 842 or new leasing guidance). The new leasing guidance requires that lessees recognize a right-of-use asset and a lease liability for each of its leases (other than leases that meet the definition of a short-term lease). Leases are classified as either operating or finance. Operating leases result in straight-line expense in the income statement (similar to previous operating leases), while finance leases result in more expense being recognized in the earlier years of the lease term (similar to previous capital leases). The Company adopted the new standard on January 1, 2019 using a modified retrospective approach. Merck elected the transition method that allows for application of the standard at the adoption date rather than at the beginning of the earliest comparative period presented in the financial statements. The Company also elected available practical expedients. Upon adoption, the Company recognized $ 1.1 billion of additional assets and related liabilities on its consolidated balance sheet (see Note 9). The adoption of the new leasing guidance did not impact the Companys consolidated statements of income or of cash flows. In April 2018, the FASB issued new guidance on the accounting for costs incurred to implement a cloud computing arrangement that is considered a service arrangement. The new guidance requires the capitalization of such costs, aligning it with the accounting for costs associated with developing or obtaining internal-use software. The Company adopted the new standard in the third quarter of 2019 using prospective application for eligible costs, which were immaterial. In August 2018, the FASB issued new guidance modifying the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The new guidance removes disclosures that no longer are considered cost beneficial, clarifies the specific requirements of certain disclosures, and adds disclosure requirements identified as relevant. The Company elected to early adopt the new guidance in 2019 on a retrospective basis resulting in minor changes to its employee benefit plan disclosures (see Note 13). Also, in August 2018, the FASB issued new guidance on fair value measurements that adds, removes, and modifies certain disclosure requirements. The Company elected to early adopt the new guidance in 2019 resulting in minor changes to its fair value disclosures (see Note 6). Recently Issued Accounting Standards Not Yet Adopted In June 2016, the FASB issued new guidance on the accounting for credit losses on financial instruments. The new guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The Company adopted the new guidance effective January 1, 2020. There was no impact to the Companys consolidated financial statements upon adoption. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under revenue recognition guidance (ASC 606). The Company adopted the new guidance effective January 1, 2020, which will result in minor changes to the footnote presentation of information related to the Companys collaborative arrangements. In December 2019, the FASB issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The amended guidance is effective for interim and annual periods in 2021. Early adoption is permitted. The application of the amendments in the new guidance are to be applied on a retrospective basis, on a modified retrospective basis through a cumulative-effect adjustment to retained earnings or prospectively, depending on the amendment. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The new guidance is effective for interim and annual periods in 2021 and is to be applied prospectively. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Completed Transaction In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $ 2.7 billion . ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently in a Phase 2 dose expansion study for the treatment of B-cell malignancies. The Company is in the process of determining the preliminary fair value of assets acquired, liabilities assumed and total consideration transferred in this transaction, which will be accounted for as an acquisition of a business. 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly PT2977), is a novel oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $ 1.2 billion in cash; additionally, former Peloton shareholders will be eligible to receive $ 50 million upon U.S. regulatory approval, $ 50 million upon first commercial sale in the United States, and up to $ 1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million , deferred tax liabilities of $ 52 million , and other net liabilities of $ 4 million at the acquisition date and Research and development expenses of $ 993 million in 2019 related to the transaction. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: ($ in millions) April 1, 2019 Cash and cash equivalents $ Accounts receivable Inventories Property, plant and equipment Identifiable intangible assets (useful lives ranging from 18-24 years) (1) 2,689 Deferred income tax liabilities ( 520 ) Other assets and liabilities, net ( 81 ) Total identifiable net assets 2,349 Goodwill (2) 1,302 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 11.5 % . Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. The Companys results for 2019 include eight months of activity for Antelliq. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets for IPRD of $ 156 million , cash of $ 83 million and other net assets of $ 42 million . The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 2018 Transactions In 2018, the Company recorded an aggregate charge of $ 423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $ 155 million , which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $ 137 million , inventory write-offs of $ 122 million , as well as other related costs of $ 9 million . The termination of this agreement has no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $ 378 million ). The transaction provided Merck with full rights to V937 (formerly CVA21), Viralyticss investigational oncolytic immunotherapy. V937 is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. V937 is currently being evaluated in multiple clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and V937 combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 34 million (primarily cash) at the acquisition date and Research and development expenses of $ 344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec), a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, MK-4621 (formerly RGT100), is in development for the treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $ 140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5 % of the shares of Valle for $ 358 million . Of the total purchase price, $ 176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $ 297 million related to currently marketed products, net deferred tax liabilities of $ 102 million , other net assets of $ 32 million and noncontrolling interest of $ 25 million . In addition, the Company recorded liabilities of $ 37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $ 37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $ 156 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5 % interest in Valle for $ 18 million , which reduced the noncontrolling interest related to Valle. Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZeneca is the principal on Lynparza sales transactions. Merck records its share of Lynparza product sales, net of cost of sales and commercialization costs, as alliance revenue and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.6 billion in 2017 and made payments of $ 750 million over a multi-year period for certain license options (of which $ 250 million was paid in December 2017, $ 400 million was paid in December 2018 and $ 100 million was paid in December 2019). The Company recorded an aggregate charge of $ 2.35 billion in Research and development expenses in 2017 related to the upfront payment and license option payments. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. In 2019, Merck determined it was probable that annual sales of Lynparza in the future would trigger a $ 300 million sales-based milestone payment from Merck to AstraZeneca. Accordingly, in 2019, Merck recorded a $300 million liability and a corresponding increase to the intangible asset related to Lynparza. Prior to 2019, Merck accrued sales-based milestone payments aggregating $ 700 million , of which $ 200 million and $ 250 million was paid to AstraZeneca in 2019 and 2018, respectively, and the remainder of $ 250 million was paid in January 2020. Potential future sales-based milestone payments of $ 3.1 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2019, Lynparza received regulatory approval in the European Union (EU) both as a monotherapy for the treatment of certain adult patients with advanced breast cancer and as a monotherapy for the maintenance treatment of certain adult patients with BRCA -mutated advanced ovarian cancer. Each of these approvals triggered a $ 30 million capitalized milestone payment from Merck to AstraZeneca. In 2018, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 140 million in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.7 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 955 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 2,419 December 31 Receivables from AstraZeneca included in Other current assets $ $ Payables to AstraZeneca included in Accrued and other current liabilities (3) Payables to AstraZeneca included Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2017 includes $ 2.35 billion related to the upfront payment and license option payments. (3) Includes accrued milestone payments. Eisai In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share gross profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development, including for studies evaluating Lenvima as monotherapy, are shared equally by the two companies and reflected in Research and development expenses. Under the agreement, Merck made an upfront payment to Eisai of $ 750 million and will make payments of up to $ 650 million for certain option rights through 2021 (of which $ 325 million was paid in March 2019, $ 200 million is expected to be paid in March 2020 and $ 125 million is expected to be paid in March 2021). The Company recorded an aggregate charge of $ 1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for additional contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. In 2019, Merck determined it was probable that annual sales of Lenvima in the future would trigger sales-based milestone payments from Merck to Eisai aggregating $ 682 million . Accordingly, in 2019, Merck recorded $ 682 million of liabilities and corresponding increases to the intangible asset related to Lenvima. In 2018, Merck accrued sales-based milestone payments aggregating $ 268 million related to Lenvima. Of these amounts, $ 50 million was paid to Eisai in 2019 and an additional $ 150 million was paid in January 2020. Potential future sales-based milestone payments of $ 3.0 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 250 million in the aggregate from Merck to Eisai. Potential future regulatory milestone payments of $ 135 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 956 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 1,489 December 31 Receivables from Eisai included in Other current assets $ $ Payables to Eisai included in Accrued and other current liabilities (3) Payables to Eisai included in Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2018 includes $ 1.4 billion related to the upfront payment and option payments. (3) Includes accrued milestone and future option payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas, which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. In addition, the agreement provides for additional contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. In 2018, Merck determined it was probable that annual worldwide sales of Adempas in the future would trigger a $ 375 million sales-based milestone payment from Merck to Bayer. Accordingly, Merck recorded a $ 375 million liability and a corresponding increase to the intangible asset related to Adempas. In 2018, the Company made a $ 350 million milestone payment to Bayer, which was accrued for in 2016 when Merck deemed the payment to be probable. There is an additional $ 400 million potential future sales-based milestone payment that has not yet been accrued as it is not deemed by the Company to be probable at this time. The intangible asset balance related to Adempas (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $ 883 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share from sales in Bayers marketing territories Total sales Cost of sales (1) Selling, general and administrative Research and development December 31 Receivables from Bayer included in Other current assets $ $ Payables to Bayer included in Other Noncurrent Liabilities (2) (1) Includes amortization of intangible assets. (2) Represents accrued milestone payment. 5. Restructuring In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $ 2.5 billion . The Company estimates that approximately 60 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 40 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects to record charges of approximately $ 800 million in 2020 related to the Restructuring Program. Actions under previous global restructuring programs have been substantially completed. The Company recorded total pretax costs of $ 927 million in 2019 , $ 658 million in 2018 and $ 927 million in 2017 related to restructuring program activities. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2019 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2018 Cost of sales $ $ $ $ Selling, general and administrative Research and development ( 13 ) Restructuring costs $ $ ( 1 ) $ $ Year Ended December 31, 2017 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2019 , 2018 and 2017 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 13) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2018 $ $ $ $ Expenses ( 1 ) (Payments) receipts, net ( 649 ) ( 238 ) ( 887 ) Non-cash activity Restructuring reserves December 31, 2018 Expenses (Payments) receipts, net ( 325 ) ( 136 ) ( 461 ) Non-cash activity ( 233 ) ( 8 ) ( 241 ) Restructuring reserves December 31, 2019 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 Net Investment Hedging Relationships Foreign exchange contracts $ ( 10 ) $ ( 18 ) $ $ ( 31 ) $ ( 11 ) $ Euro-denominated notes ( 75 ) ( 183 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2019 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 1,249 $ $ ( 1 ) $ Long-Term Debt 3,409 4,560 ( 82 ) Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other Assets $ $ $ 3,400 $ $ $ Interest rate swap contracts Accrued and other current liabilities 1,250 Interest rate swap contracts Other Noncurrent Liabilities 4,650 Foreign exchange contracts Other current assets 6,117 6,222 Foreign exchange contracts Other Assets 2,160 2,655 Foreign exchange contracts Accrued and other current liabilities 1,748 Foreign exchange contracts Other Noncurrent Liabilities $ $ $ 14,728 $ $ $ 14,390 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 7,245 $ $ $ 5,430 Foreign exchange contracts Accrued and other current liabilities 8,693 9,922 $ $ $ 15,938 $ $ $ 15,352 $ $ $ 30,666 $ $ $ 29,742 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 84 ) ( 84 ) ( 121 ) ( 121 ) Cash collateral received ( 34 ) ( 107 ) Net amounts $ $ $ $ 90 The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 46,840 $ 42,294 $ 40,122 $ ( 402 ) ( 500 ) $ ( 648 ) $ ( 361 ) $ (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items ( 27 ) ( 48 ) Derivatives designated as hedging instruments ( 65 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives ( 562 ) (Decrease) increase in Sales as a result of AOCI reclassifications ( 160 ) ( 255 ) ( 138 ) Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 4 ) ( 4 ) ( 3 ) Amount of loss recognized in OCI on derivatives ( 6 ) ( 4 ) ( 3 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 Income Statement Caption Derivatives Not Designated as Hedging Instruments Foreign exchange contracts (1) Other (income) expense, net $ $ ( 260 ) $ Foreign exchange contracts (2) Sales ( 8 ) ( 3 ) (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. At December 31, 2019 , the Company estimates $ 31 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses Commercial paper $ $ $ $ $ $ $ $ Corporate notes and bonds 4,985 ( 68 ) 4,920 U.S. government and agency securities ( 5 ) Asset-backed securities 1,285 ( 11 ) 1,275 Foreign government bonds ( 1 ) Mortgage-backed securities Total debt securities 1,768 1,785 7,340 ( 85 ) 7,261 Publicly traded equity securities (1) Total debt and publicly traded equity securities $ 2,623 $ 7,717 (1) Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2019 were $ 160 million during 2019. Unrealized net losses recognized in Other (income) expense, net on equity securities still held at December 31, 2018 were $ 35 million during 2018. At December 31, 2019 and 2018 , the Company also had $ 420 million and $ 568 million , respectively, of equity investments without readily determinable fair values included in Other Assets . During 2019 and 2018 , the Company recognized unrealized gains of $ 20 million and $ 167 million , respectively, in Other (income) expense, net , on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2019 and 2018 , the Company recognized unrealized losses of $ 13 million and $ 26 million , respectively, in Other (income) expense, net , related to certain of these investments based on unfavorable observable price changes. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values were $ 109 million and $ 21 million , respectively. Available-for-sale debt securities included in Short-term investments totaled $ 749 million at December 31, 2019 . Of the remaining debt securities, $ 933 million mature within five years. At December 31, 2019 and 2018 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Assets Investments Commercial paper $ $ $ $ $ $ $ $ Corporate notes and bonds 4,835 4,835 Asset-backed securities (1) 1,253 1,253 U.S. government and agency securities Foreign government bonds Publicly traded equity securities 1,725 2,243 6,985 7,132 Other assets (2) U.S. government and agency securities Corporate notes and bonds Asset-backed securities (1) Mortgage-backed securities Publicly traded equity securities 364 Derivative assets (3) Forward exchange contracts Purchased currency options Interest rate swaps Total assets $ $ 2,013 $ $ 2,911 $ $ 7,660 $ $ 8,171 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (3) Forward exchange contracts Interest rate swaps Written currency options Total liabilities $ $ $ $ $ $ $ $ (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. (2) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2019 , Cash and cash equivalents of $ 9.7 billion include $ 8.9 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration associated with business acquisitions is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) Additions Payments ( 85 ) ( 244 ) Fair value December 31 (2)(3) $ $ (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2019 includes $ 114 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2019 and 2018 , $ 625 million and $ 614 million , respectively, of the liabilities relate to the termination of the SPMSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8 % is used to present value the cash flows. The changes in the estimated fair value of liabilities for contingent consideration in 2019 and 2018 were largely attributable to increases in the liabilities recorded in connection with the termination of the Sanofi Pasteur MSD (SPMSD) joint venture in 2016. In 2018, these increases were partially offset by the reversal of a liability related to the discontinuation of a program obtained in connection with the acquisition of SmartCells (see Note 8). The payments of contingent consideration in both years relate to the SPMSD termination liabilities described above. The payments of contingent consideration in 2018 also include $ 175 million related to the achievement of a clinical development milestone for MK-7264 (gefapixant), a program obtained in connection with the acquisition of Afferent Pharmaceuticals. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2019 , was $ 28.8 billion compared with a carrying value of $ 26.3 billion and at December 31, 2018 , was $ 25.6 billion compared with a carrying value of $ 25.1 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States, Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 35 % of total accounts receivable at December 31, 2019 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. In 2019, the Company expanded its factoring arrangements in China and entered into factoring agreements to sell accounts receivable from the Companys major U.S. distributors. The Company factored $ 2.7 billion and $ 1.1 billion of accounts receivable in the fourth quarter of 2019 and 2018 , respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2019 , the Company had collected $ 256 million on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2020. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The costs of factoring such accounts receivable were de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $ 34 million and $ 107 million at December 31, 2019 and 2018 , respectively. The obligation to return such collateral is recorded in Accrued and other current liabilities . No cash collateral was advanced by the Company to counterparties as of December 31, 2019 or 2018 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,772 $ 1,658 Raw materials and work in process 5,650 5,004 Supplies Total (approximates current cost) 7,629 6,856 (Decrease) increase to LIFO cost ( 171 ) $ 7,458 $ 6,857 Recognized as: Inventories $ 5,978 $ 5,440 Other assets 1,480 1,417 Inventories valued under the LIFO method comprised approximately $ 2.6 billion and $ 2.5 billion at December 31, 2019 and 2018 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2019 and 2018 , these amounts included $ 1.3 billion and $ 1.4 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 168 million and $ 7 million at December 31, 2019 and 2018 , respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2018 $ 16,066 $ 1,877 $ $ 18,284 Acquisitions Impairments ( 144 ) ( 144 ) Other (1) ( 24 ) Balance December 31, 2018 (2) 16,162 1,870 18,253 Acquisitions 1,322 1,341 Impairments ( 162 ) ( 162 ) Other (1) ( 7 ) ( 7 ) Balance December 31, 2019 (2) $ 16,181 $ 3,192 $ $ 19,425 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2019 and 2018 were $ 531 million and $ 369 million , respectively. The additions to goodwill within the Animal Health segment in 2019 primarily relate to the acquisition of Antelliq (see Note 3). The impairments of goodwill within other non-reportable segments in 2019 and 2018 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 45,947 $ 38,852 $ 7,095 $ 46,615 $ 37,585 $ 9,030 Licenses 3,185 2,361 2,081 1,673 IPRD 1,032 1,032 1,064 1,064 Trade names 2,899 2,682 Other 2,261 1,235 1,026 2,403 1,168 1,235 $ 55,324 $ 41,128 $ 14,196 $ 52,372 $ 39,268 $ 13,104 Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2019 include Zerbaxa , $ 2.4 billion ; Implanon/Nexplanon, $ 412 million ; Gardasil/Gardasil 9, $ 314 million ; Dificid , $ 312 million ; Bridion , $ 230 million ; Sivextro , $ 171 million ; and Simponi , $ 163 million . Additionally, the Company had $ 2.4 billion of acquired intangibles related to animal health marketed products at December 31, 2019 . Some of the Companys more significant intangible assets included in licenses above at December 31, 2019 include Lenvima, $ 956 million and Lynparza, $ 955 million as a result of collaborations with Eisai and AstraZeneca (see Note 4). The increase in trade names in 2019 reflects $ 2.7 billion of intangibles acquired in the Antelliq acquisition in 2019 (see Note 3). The Company has an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $ 883 million at December 31, 2019 reflected in Other in the table above. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million within Cost of sales . Of this amount, $ 612 million related to Sivextro , a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced ca sh flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. In 2017, the Company recorded impairment charges related to marketed products and other intangibles of $ 58 million . Of this amount, $ 47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A were being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2019, the Company recorded $ 172 million of IPRD impairment charges within Research and development expenses. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $ 11 million . In 2018, the Company recorded $ 152 million of IPRD impairment charges. Of this amount, $ 139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $ 60 million (see Note 6). In 2017, the Company recorded $ 483 million of IPRD impairment charges. Of this amount, $ 240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The IPRD impairment charges in 2017 also include a charge of $ 226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense recorded within Cost of sales was $ 2.0 billion in 2019 , $ 3.1 billion in 2018 and $ 3.2 billion in 2017 . The estimated aggregate amortization expense for each of the next five years is as follows: 2020 , $ 1.6 billion ; 2021 , $ 1.5 billion ; 2022 , $ 1.5 billion ; 2023 , $ 1.5 billion ; 2024 , $ 1.4 billion . 9. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2019 included $ 1.9 billion of notes due in 2020, $ 1.4 billion of commercial paper and $ 226 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2018 included $ 5.1 billion of commercial paper and $ 149 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 2.23 % and 2.09 % for the years ended December 31, 2019 and 2018 , respectively. Long-Term Debt Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,492 $ 2,490 3.70% notes due 2045 1,975 1,974 2.80% notes due 2023 1,747 1,745 3.40% notes due 2029 1,732 4.00% notes due 2049 1,468 2.35% notes due 2022 1,248 1,214 4.15% notes due 2043 1,238 1,237 3.875% notes due 2021 1,151 1,132 1.125% euro-denominated notes due 2021 1,113 1,134 1.875% euro-denominated notes due 2026 1,107 1,127 2.40% notes due 2022 1,010 3.90% notes due 2039 2.90% notes due 2024 6.50% notes due 2033 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 1.85% notes due 2020 1,231 Floating-rate notes due 2020 Other $ 22,736 $ 19,806 Other (as presented in the table above) includes $ 147 million and $ 223 million at December 31, 2019 and 2018 , respectively, of borrowings at variable rates that resulted in effective interest rates of 2.54 % and 2.27 % for 2019 and 2018 , respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In March 2019, the Company issued $ 5.0 billion principal amount of senior unsecured notes consisting of $ 750 million of 2.90 % notes due 2024, $ 1.75 billion of 3.40 % notes due 2029, $ 1.0 billion of 3.90 % notes due 2039, and $ 1.5 billion of 4.00 % notes due 2049. The Company used the net proceeds from the offering of $ 5.0 billion for general corporate purposes, including the repayment of outstanding commercial paper borrowings. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2019 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2020 , $ 1.9 billion ; 2021 , $ 2.3 billion ; 2022 , $ 2.3 billion ; 2023 , $ 1.7 billion ; 2024 , $ 1.3 billion . The Company has a $ 6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases As discussed in Note 1, on January 1, 2019, Merck adopted new guidance for the accounting and reporting of leases. The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. As permitted under the transition guidance in ASC 842, the Company elected a package of practical expedients which, among other provisions, allowed the Company to carry forward historical lease classifications. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. Under ASC 842 transition guidance, Merck elected the hindsight practical expedient to determine the lease term for existing leases, which permits companies to consider available information prior to the effective date of the new guidance as to the actual or likely exercise of options to extend or terminate the lease. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of eight years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company has made an accounting policy election not to record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. As a practical expedient, the Company has made an accounting policy election for all asset classes not to separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to effectively account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 339 million in 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $ 281 million in 2019. Operating lease assets obtained in exchange for lease obligations was $ 129 million in 2019. Supplemental balance sheet information related to operating leases is as follows: December 31 Assets Other Assets (1) $ 1,073 Liabilities Accrued and other current liabilities Other Noncurrent Liabilities $ 1,004 Weighted-average remaining lease term (years) 7.4 Weighted-average discount rate 3.2 % (1) Includes prepaid leases that have no related lease liability. Maturities of operating leases liabilities are as follows: $ 2021 2022 2023 2024 Thereafter Total lease payments 1,131 Less: Imputed interest $ 1,004 At December 31, 2019 , the Company had entered into additional real estate operating leases that had not yet commenced. The obligations associated with these leases total $ 538 million , of which $ 221 million relates to a lease that will commence in April 2020 and has a lease term of 10 years . As of December 31, 2018, prior to the adoption of ASC 842, the minimum aggregate rental commitments under noncancellable leases were as follows: 2019, $ 188 million ; 2020, $ 198 million ; 2021, $ 150 million ; 2022, $ 134 million ; 2023, $ 84 million and thereafter, $ 243 million . 10. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2019 , approximately 3,750 cases are pending against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . All federal cases involving allegations of Femur Fractures have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court in August 2017, seeking review of the Third Circuits decision. The Supreme Court granted Mercks petition in June 2018, and in May 2019, the Supreme Court issued its opinion and decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. On November 15, 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. On December 13, 2019, the District Court ordered Merck to serve its opening brief on or before February 21, 2020, and plaintiffs to file their responsive brief on or before April 22, 2020. Merck may then file a reply on or before May 22, 2020. Accordingly, as of December 31, 2019 , approximately 970 cases were actively pending in the Femur Fracture MDL. As of December 31, 2019 , approximately 2,510 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of cases to be reviewed through fact discovery, and Merck has continued to select additional cases to be reviewed. As of December 31, 2019 , approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is presently stayed in the Femur Fracture MDL and in the state court in California. Merck intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2019 , Merck is aware of approximately 1,380 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court-in separate opinions-granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery. In November 2018, the California state appellate court reversed and remanded on similar grounds. In March 2019, the parties in the MDL and the California coordinated proceeding agreed to coordinate and adopt a schedule for completing discovery on general causation and preemption issues and for renewing summary judgment and Daubert motions. Under the stipulated case management schedule, the hearings for Daubert and summary judgment motions are expected to take place in June 2020. As of December 31, 2019 , six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided on September 25, 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx As previously disclosed, Merck is a defendant in a lawsuit brought by the Attorney General of Utah alleging that Merck misrepresented the safety of Vioxx . The lawsuit is pending in Utah state court. Utah seeks damages and penalties under the Utah False Claims Act. A bench trial in this matter is currently scheduled for April 20, 2020. Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, on May 21, 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal healthcare programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, on April 15, 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. On August 9, 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, on June 27, 2019, the representatives of the putative direct purchaser class filed an amended complaint and, on August 1, 2019, retailer opt-out plaintiffs filed an amended complaint. The Merck Defendants moved to dismiss the new allegations in both complaints. On October 15, 2019, the magistrate judge issued a report and recommendation recommending that the district judge grant the motions in their entirety. On December 20, 2019, the district court adopted this report and recommendation in part. The district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. Trial is currently scheduled to begin on October 28, 2020. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. On January 23, 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. On February 19, 2019, MSD appealed the courts order on arbitration to the Third Circuit. On October 28, 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of arbitrability, after which MSD may file a renewed motion to compel arbitration. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In April 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals opted-in to this action; the opt-in period has closed. In August 2017, plaintiffs filed their motion to certify a Title VII pay discrimination class and also sought final collective action certification of plaintiffs Equal Pay Act claim. On October 1, 2018, the parties entered into an agreement to fully resolve the Smith sales force litigation. As part of the settlement and in exchange for a full and general release of all individual and class claims, the Company agreed to pay $ 8.5 million . On December 3, 2019, the court approved the settlement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the Court. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the United States with no trial date set, and also ongoing in numerous jurisdictions outside of the United States; the Company is defending those suits in each jurisdiction. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the U.S. Food and Drug Administration (FDA) seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Januvia, Janumet, Janumet XR In February 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of a patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026, and a later granted patent owned by the Company covering the Janumet formulation which expires in 2028. Par Pharmaceutical dismissed its case in the U.S. District Court for the District of New Jersey against the Company and will litigate the action in the U.S. District Court for the District of Delaware. The Company filed a patent infringement lawsuit against Mylan Pharmaceuticals Inc. and Mylan Inc. (Mylan) in the Northern District of West Virginia. The Judicial Panel of Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. The U.S. District Court for the District of Delaware has scheduled the lawsuits for a single 3-day trial on invalidity issues in October 2021. The Court will schedule separate 1-day trials on infringement issues if necessary. In October 2019, Mylan filed a petition for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking invalidity of the 2026 patent. The USPTO has six months from filing to determine whether it will institute the requested IPR proceeding. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2019 and 2018 of approximately $ 240 million and $ 245 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 67 million and $ 71 million at December 31, 2019 and 2018 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $ 58 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. 11. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) ( 13 ) ( 17 ) ( 15 ) Balance December 31 3,577 1,038 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. On October 25, 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $ 5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $ 5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The payments to the Dealers were recorded as reductions to shareholders equity, consisting of a $ 4 billion increase in treasury stock, which reflected the value of the initial 56.7 million shares received on October 29, 2018, and a $ 1 billion decrease in other-paid-in capital, which reflected the value of the stock held back by the Dealers pending final settlement. Upon settlement of the ASR agreements in April 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million . 12. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2019 , 111 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards generally vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2019 , 2018 and 2017 was $ 417 million , $ 348 million and $ 312 million , respectively, with related income tax benefits of $ 57 million , $ 55 million and $ 57 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2019 , 2018 and 2017 was $ 80.05 , $ 58.15 and $ 63.88 per option, respectively. The weighted average fair value of options granted in 2019 , 2018 and 2017 was $ 10.63 , $ 8.26 and $ 7.04 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.2 % 3.4 % 3.6 % Risk-free interest rate 2.4 % 2.9 % 2.0 % Expected volatility 18.7 % 19.1 % 17.8 % Expected life (years) 5.9 6.1 6.1 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2019 23,807 $ 51.89 Granted 2,796 80.05 Exercised ( 8,119 ) 44.48 Forfeited ( 616 ) 45.48 Outstanding December 31, 2019 17,868 $ 59.88 6.48 $ Exercisable December 31, 2019 11,837 $ 55.40 5.45 $ Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2019 16,128 $ 58.85 2,039 $ 59.42 Granted 4,811 80.08 83.90 Vested ( 6,594 ) 55.70 ( 748 ) 57.87 Forfeited ( 818 ) 64.75 ( 82 ) 66.68 Nonvested December 31, 2019 13,527 $ 67.58 1,972 $ 69.18 At December 31, 2019 , there was $ 603 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 13. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets ( 817 ) ( 851 ) ( 862 ) ( 426 ) ( 431 ) ( 393 ) ( 72 ) ( 83 ) ( 78 ) Amortization of unrecognized prior service cost ( 49 ) ( 50 ) ( 53 ) ( 12 ) ( 13 ) ( 11 ) ( 78 ) ( 84 ) ( 98 ) Net loss amortization ( 10 ) Termination benefits Curtailments ( 4 ) ( 11 ) ( 8 ) ( 31 ) Settlements Net periodic benefit cost (credit) $ $ $ $ $ $ $ ( 49 ) $ ( 45 ) $ ( 60 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2019 , 2018 and 2017 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 14), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 9,648 $ 10,896 $ 8,580 $ 9,339 $ $ 1,114 Actual return on plan assets 2,165 ( 810 ) 1,505 ( 289 ) ( 72 ) Company contributions Effects of exchange rate changes ( 352 ) Benefits paid ( 582 ) ( 772 ) ( 230 ) ( 202 ) ( 104 ) ( 80 ) Settlements ( 44 ) ( 12 ) ( 106 ) Other Fair value of plan assets December 31 $ 11,361 $ 9,648 $ 10,163 $ 8,580 $ 1,102 $ Benefit obligation January 1 $ 10,620 $ 11,904 $ 9,083 $ 9,483 $ 1,615 $ 1,922 Service cost Interest cost Actuarial losses (gains) (1) 2,165 ( 1,258 ) 1,313 ( 154 ) ( 341 ) Benefits paid ( 582 ) ( 772 ) ( 230 ) ( 202 ) ( 104 ) ( 80 ) Effects of exchange rate changes ( 387 ) ( 6 ) Plan amendments ( 9 ) Curtailments ( 2 ) Termination benefits Settlements ( 44 ) ( 12 ) ( 106 ) Other Benefit obligation December 31 $ 13,003 $ 10,620 $ 10,612 $ 9,083 $ 1,673 $ 1,615 Funded status December 31 $ ( 1,642 ) $ ( 972 ) $ ( 449 ) $ ( 503 ) $ ( 571 ) $ ( 647 ) Recognized as: Other Assets $ $ $ $ $ $ Accrued and other current liabilities ( 92 ) ( 47 ) ( 18 ) ( 14 ) ( 10 ) ( 10 ) Other Noncurrent Liabilities ( 1,550 ) ( 925 ) ( 1,268 ) ( 1,148 ) ( 561 ) ( 637 ) (1) Actuarial losses (gains) primarily reflect changes in discount rates. At December 31, 2019 and 2018 , the accumulated benefit obligation was $ 22.8 billion and $ 19.0 billion , respectively, for all pension plans, of which $ 12.8 billion and $ 10.4 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 13,003 $ 10,620 $ 7,421 $ 6,251 Fair value of plan assets 11,361 9,648 6,135 5,089 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 12,009 $ 9,702 $ 2,476 $ 5,936 Fair value of plan assets 10,484 8,966 1,501 5,071 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2019 and 2018 , $ 860 million and $ 826 million , respectively, or approximately 4 % and 5 % , respectively, of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,542 3,747 3,021 3,190 Emerging markets equities Government and agency obligations Corporate obligations Equity securities Developed markets 2,451 2,451 2,172 2,172 Fixed income securities Government and agency obligations 2,094 2,094 1,509 1,509 Corporate obligations 1,582 1,582 1,246 1,246 Mortgage and asset-backed securities Other investments Plan assets at fair value $ 2,824 $ 3,854 $ $ 4,674 $ 11,361 $ 2,502 $ 3,017 $ $ 4,116 $ 9,648 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,761 4,403 3,071 3,607 Government and agency obligations 2,534 3,203 2,082 2,634 Emerging markets equities Corporate obligations Fixed income obligations Real estate Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (2) Other Plan assets at fair value $ 1,727 $ 7,052 $ $ $ 10,163 $ 1,497 $ 5,809 $ $ $ 8,580 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2019 and 2018 . (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 ( 8 ) ( 8 ) ( 3 ) ( 3 ) Relating to assets sold during the year Purchases and sales, net ( 4 ) ( 4 ) ( 3 ) ( 3 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 ( 32 ) ( 32 ) Purchases and sales, net ( 14 ) ( 1 ) ( 1 ) ( 16 ) ( 1 ) Transfers out of Level 3 ( 7 ) ( 7 ) Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Corporate obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Plan assets at fair value $ $ $ $ $ 1,102 $ $ $ $ $ (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2019 and 2018 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 10 % , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2020 are approximately $ 100 million for U.S. pension plans, approximately $ 150 million for international pension plans and approximately $ 15 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2021 2022 2023 2024 2025 2029 3,943 1,417 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ ( 816 ) $ ( 397 ) $ ( 19 ) $ ( 227 ) $ ( 505 ) $ $ $ $ Prior service (cost) credit arising during the period ( 4 ) ( 4 ) ( 13 ) ( 1 ) ( 10 ) ( 11 ) ( 31 ) $ ( 820 ) $ ( 401 ) $ ( 32 ) $ ( 228 ) $ ( 515 ) $ $ $ $ Net loss amortization included in benefit cost $ $ $ $ $ $ $ ( 10 ) $ $ Prior service credit amortization included in benefit cost ( 49 ) ( 50 ) ( 53 ) ( 12 ) ( 13 ) ( 11 ) ( 78 ) ( 84 ) ( 98 ) $ $ $ $ $ $ $ ( 88 ) $ ( 83 ) $ ( 97 ) Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 4.40 % 3.70 % 4.30 % 2.20 % 2.10 % 2.20 % Expected rate of return on plan assets 8.10 % 8.20 % 8.70 % 4.90 % 5.10 % 5.10 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.80 % 2.90 % 2.90 % Interest crediting rate 3.40 % 3.30 % 3.30 % 2.90 % 2.80 % 3.00 % Benefit obligation Discount rate 3.40 % 4.40 % 3.70 % 1.50 % 2.20 % 2.10 % Salary growth rate 4.20 % 4.30 % 4.30 % 2.80 % 2.80 % 2.90 % Interest crediting rate 4.90 % 3.40 % 3.30 % 2.80 % 2.90 % 2.80 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2020 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.00 % to 7.30 % , as compared to a range of 7.70 % to 8.10 % in 2019 . The decrease reflects lower expected asset returns and a modest shift in asset allocation. The change in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2017 to 2019 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 6.8 % 7.0 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2019 , 2018 and 2017 were $ 149 million , $ 136 million and $ 131 million , respectively. 14. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ ( 274 ) $ ( 343 ) $ ( 385 ) Interest expense Exchange losses (gains) ( 11 ) Income from investments in equity securities, net (1) ( 170 ) ( 324 ) ( 352 ) Net periodic defined benefit plan (credit) cost other than service cost ( 545 ) ( 512 ) ( 512 ) Other, net ( 140 ) $ $ ( 402 ) $ ( 500 ) (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8). Other, net in 2018 includes a gain of $ 115 million related to the settlement of certain patent litigation, income of $ 99 million related to AstraZenecas option exercise in 2014 in connection with the termination of the Companys relationship with AstraZeneca LP (AZLP), and a gain of $ 85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $ 144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $ 41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Other, net in 2017 includes income of $ 232 million related to AstraZenecas option exercise and a $ 191 million loss on extinguishment of debt. Interest paid was $ 841 million in 2019 , $ 777 million in 2018 and $ 723 million in 2017 . 15. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 2,408 21.0 % $ 1,827 21.0 % $ 2,282 35.0 % Differential arising from: Foreign earnings ( 1,020 ) ( 8.9 ) ( 245 ) ( 2.8 ) ( 1,654 ) ( 25.4 ) GILTI and the foreign-derived intangible income deduction 2.9 ( 25 ) ( 0.3 ) Tax settlements ( 403 ) ( 3.5 ) ( 22 ) ( 0.3 ) ( 356 ) ( 5.5 ) RD tax credit ( 118 ) ( 1.0 ) ( 96 ) ( 1.1 ) ( 71 ) ( 1.1 ) State taxes ( 2 ) 2.3 1.2 Acquisition of Peloton 1.8 TCJA 1.0 3.3 2,625 40.3 Valuation allowances 1.0 3.1 9.7 Acquisition-related costs, including amortization 0.8 3.1 10.9 Restructuring 0.3 0.6 2.2 Other (1) ( 87 ) ( 0.7 ) ( 13 ) ( 0.1 ) ( 287 ) ( 4.4 ) $ 1,687 14.7 % $ 2,508 28.8 % $ 4,103 62.9 % (1) Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items. The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017. Among other provisions, the TCJA reduced the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, required companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and created new taxes on certain foreign sourced earnings. The Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized as described below. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount in 2017 for its one-time transition tax liability of $ 5.3 billion . This provisional amount was reduced by the reversal of $ 2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. On the basis of revised calculations of post-1986 undistributed foreign EP and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $ 124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $ 5.5 billion . In 2019, the Company recorded additional charges of $ 117 million related to the finalization of treasury regulations associated with the TCJA. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years through 2025. The Companys remaining transition tax liability, which has been reduced by payments and the utilization of foreign tax credits, was $ 3.4 billion at December 31, 2019 , of which $ 390 million is included in Income taxes payable and the remainder of $ 3.0 billion is included in Other Noncurrent Liabilities . In 2017, the Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $ 779 million . On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $ 32 million related to deferred income taxes. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21% in 2019 and 2018 and 35% in 2017. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate compared to the U.S. statutory rate. Income before taxes consisted of: Years Ended December 31 Domestic $ $ 3,717 $ 3,483 Foreign 11,025 4,984 3,038 $ 11,464 $ 8,701 $ 6,521 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ $ $ 5,585 Foreign 1,806 2,281 1,229 State ( 77 ) ( 90 ) 2,243 3,017 6,724 Deferred provision Federal ( 330 ) ( 402 ) ( 2,958 ) Foreign ( 240 ) ( 64 ) State ( 43 ) ( 556 ) ( 509 ) ( 2,621 ) $ 1,687 $ 2,508 $ 4,103 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 1,778 $ $ 1,640 Inventory related Accelerated depreciation Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other Subtotal 3,351 3,001 3,118 2,816 Valuation allowance ( 1,100 ) ( 1,348 ) Total deferred taxes $ 2,251 $ 3,001 $ 1,770 $ 2,816 Net deferred income taxes $ $ 1,046 Recognized as: Other Assets $ $ Deferred Income Taxes $ 1,470 $ 1,702 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2019 , $ 762 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 1.1 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 135 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2019 , 2018 and 2017 were $ 4.5 billion , $ 1.5 billion and $ 4.9 billion , respectively. Tax benefits relating to stock option exercises were $ 65 million in 2019 , $ 77 million in 2018 and $ 73 million in 2017 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 1,893 $ 1,723 $ 3,494 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) ( 454 ) ( 73 ) ( 1,038 ) Settlements (1) ( 356 ) ( 91 ) ( 1,388 ) Lapse of statute of limitations (2) ( 103 ) ( 29 ) ( 11 ) Balance December 31 $ 1,225 $ 1,893 $ 1,723 (1) Amounts reflect the settlements with the IRS as discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.2 billion at December 31, 2019 , the income tax provision would reflect a favorable net impact of $ 1.1 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2019 could decrease by up to approximately $ 40 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to a (benefit) expense of $( 101 ) million in 2019 , $ 51 million in 2018 and $ 183 million in 2017 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $ 243 million and $ 372 million as of December 31, 2019 and 2018 , respectively. In 2019, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. In 2017, the IRS concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $ 2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $ 234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. The IRS is currently conducting examinations of the Companys tax returns for the years 2015 and 2016. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2019. 16. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Average common shares outstanding 2,565 2,664 2,730 Common shares issuable (1) Average common shares outstanding assuming dilution 2,580 2,679 2,748 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 3.84 $ 2.34 $ 0.88 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 3.81 $ 2.32 $ 0.87 (1) Issuable primarily under share-based compensation plans. In 2019 , 2018 and 2017 , 2 million , 6 million and 5 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 17. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2017, net of taxes $ $ ( 3 ) $ ( 3,206 ) $ ( 2,355 ) $ ( 5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 561 ) Tax ( 35 ) ( 106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 354 ) Reclassification adjustments, pretax ( 141 ) (1) ( 291 ) (2) (3) ( 315 ) Tax ( 30 ) Reclassification adjustments, net of taxes ( 92 ) ( 235 ) ( 240 ) Other comprehensive income (loss), net of taxes ( 446 ) ( 58 ) Balance at December 31, 2017, net of taxes ( 108 ) ( 61 ) ( 2,787 ) ( 1,954 ) ( 4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 108 ) ( 728 ) ( 84 ) ( 692 ) Tax ( 55 ) ( 139 ) ( 24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 107 ) ( 559 ) ( 223 ) ( 716 ) Reclassification adjustments, pretax (1) (2) (3) Tax ( 33 ) ( 36 ) ( 69 ) Reclassification adjustments, net of taxes Other comprehensive income (loss), net of taxes ( 10 ) ( 425 ) ( 223 ) ( 361 ) Adoption of ASU 2018-02 ( 23 ) ( 344 ) ( 266 ) Adoption of ASU 2016-01 ( 8 ) ( 8 ) Balance at December 31, 2018, net of taxes ( 78 ) ( 3,556 ) (4) ( 2,077 ) ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 948 ) ( 610 ) Tax ( 15 ) ( 16 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 756 ) ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) (3) ( 239 ) Tax ( 15 ) Reclassification adjustments, net of taxes ( 206 ) ( 44 ) ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) ( 705 ) ( 648 ) Balance at December 31, 2019, net of taxes $ $ $ ( 4,261 ) (4) $ ( 1,981 ) $ ( 6,193 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . In 2017, these amounts included both investments in debt and equity securities; however, as a result of the adoption of ASU 2016-01 in 2018, these amounts relate only to investments in available-for-sale debt securities. (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 13). (4) Includes pension plan net loss of $ 5.1 billion and $ 4.4 billion at December 31, 2019 and 2018 , respectively, and other postretirement benefit plan net gain of $ 247 million and $ 170 million at December 31, 2019 and 2018 , respectively, as well as pension plan prior service credit of $ 263 million and $ 314 million at December 31, 2019 and 2018 , respectively, and other postretirement benefit plan prior service credit of $ 305 million and $ 375 million at December 31, 2019 and 2018 , respectively. 18. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. During 2019, as a result of changes to the Companys internal reporting structure, certain costs that were previously included in the Pharmaceutical segment are now being included as part of non-segment expenses within Merck Research Laboratories. Prior period Pharmaceutical segment profits have been recast to reflect these changes on a comparable basis. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 6,305 $ 4,779 $ 11,084 $ 4,150 $ 3,021 $ 7,171 $ 2,309 $ 1,500 $ 3,809 Alliance revenue - Lynparza (1) Alliance revenue - Lenvima (1) Emend Vaccines Gardasil/Gardasil 9 1,831 1,905 3,737 1,873 1,279 3,151 1,565 2,308 ProQuad/M-M-R II/Varivax 1,683 2,275 1,430 1,798 1,374 1,676 Pneumovax 23 RotaTeq Vaqta Hospital Acute Care Bridion 1,131 Noxafil Primaxin Invanz Cubicin Cancidas Immunology Simponi Remicade Neuroscience Belsomra Virology Isentress/Isentress HD 1,140 1,204 Zepatier 1,660 Cardiovascular Zetia 1,344 Vytorin Atozet Adempas Diabetes Januvia 1,724 1,758 3,482 1,969 1,718 3,686 2,153 1,584 3,737 Janumet 1,452 2,041 1,417 2,228 1,296 2,158 Womens Health NuvaRing Implanon/Nexplanon Diversified Brands Singulair Cozaar/Hyzaar Nasonex Arcoxia Follistim AQ Other pharmaceutical (2) 1,563 3,343 4,901 1,319 3,380 4,705 1,759 3,556 5,314 Total Pharmaceutical segment sales 18,759 22,992 41,751 16,608 21,081 37,689 15,854 19,536 35,390 Animal Health: Livestock 2,201 2,784 2,102 2,630 2,013 2,484 Companion Animals 1,609 1,582 1,391 Total Animal Health segment sales 1,306 3,086 4,393 1,238 2,974 4,212 1,090 2,785 3,875 Other segment sales (3) Total segment sales 20,239 26,079 46,319 18,094 24,057 42,151 17,340 22,322 39,662 Other (4) $ 20,325 $ 26,515 $ 46,840 $ 18,212 $ 24,083 $ 42,294 $ 17,424 $ 22,698 $ 40,122 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4). (2) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (3) Represents the non-reportable segments of Healthcare Services and Alliances. (4) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2019 , 2018 and 2017 also includes approximately $ 80 million , $ 95 million and $ 85 million , respectively, related to the sale of the marketing rights to certain products. Consolidated sales by geographic area where derived are as follows: Years Ended December 31 United States $ 20,325 $ 18,212 $ 17,424 Europe, Middle East and Africa 12,707 12,213 11,478 Japan 3,583 3,212 3,122 China 3,207 2,184 1,586 Asia Pacific (other than Japan and China) 2,943 2,909 2,751 Latin America 2,469 2,415 2,339 Other 1,606 1,149 1,422 $ 46,840 $ 42,294 $ 40,122 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 28,324 $ 24,871 $ 23,018 Animal Health segment 1,609 1,659 1,552 Other segments ( 7 ) Total segment profits 29,926 26,633 24,845 Other profits Unallocated: Interest income Interest expense ( 893 ) ( 772 ) ( 754 ) Depreciation and amortization ( 1,573 ) ( 1,334 ) ( 1,378 ) Research and development ( 9,499 ) ( 9,432 ) ( 10,004 ) Amortization of purchase accounting adjustments ( 1,419 ) ( 2,664 ) ( 3,056 ) Restructuring costs ( 638 ) ( 632 ) ( 776 ) Charge related to the termination of a collaboration with Samsung ( 423 ) Loss on extinguishment of debt ( 191 ) Other unallocated, net ( 5,077 ) ( 3,024 ) ( 2,576 ) Income Before Taxes $ 11,464 $ 8,701 $ 6,521 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2019 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2017 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Property, plant and equipment, net, by geographic area where located is as follows: December 31 United States $ 8,974 $ 8,306 $ 8,070 Europe, Middle East and Africa 4,767 3,706 3,151 Asia Pacific (other than Japan and China) Latin America China Japan Other $ 15,053 $ 13,291 $ 12,439 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Customer Discount Accruals in the U.S. - Medicaid, Managed Care and Medicare Part D Rebates As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts as of December 31, 2019 in the U.S. are $2.4 billion and are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The principal considerations for our determination that performing procedures relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates is a critical audit matter are that there was significant judgment required by management with significant measurement uncertainty, as the calculation of the rebate accruals includes assumptions related to price and customer segment utilization, pertaining to forecasted customer claims that may not be fully paid until a subsequent period. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others, developing an independent estimate of the rebate accruals by utilizing third party data on customer segment utilization, changes to price, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid. The independent estimate was compared to the rebate accruals recorded by management to evaluate the reasonableness of the estimate. Additionally, these procedures included testing actual rebate claims paid and evaluating the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 26, 2020 We have served as the Companys auditor since 2002. (b) Supplementary Data Selected quarterly financial data for 2019 and 2018 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q 3rd Q (1) 2nd Q 1st Q (2) 2019 (3) Sales $ 11,868 $ 12,397 $ 11,760 $ 10,816 Cost of sales 3,669 3,990 3,401 3,052 Selling, general and administrative 2,888 2,589 2,712 2,425 Research and development 2,548 3,204 2,189 1,931 Restructuring costs Other (income) expense, net (223 ) Income before taxes 2,792 2,347 3,259 3,067 Net income attributable to Merck Co., Inc. 2,357 1,901 2,670 2,915 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.93 $ 0.74 $ 1.04 $ 1.13 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.92 $ 0.74 $ 1.03 $ 1.12 2018 (3) Sales $ 10,998 $ 10,794 $ 10,465 $ 10,037 Cost of sales 3,289 3,619 3,417 3,184 Selling, general and administrative 2,643 2,443 2,508 2,508 Research and development 2,214 2,068 2,274 3,196 Restructuring costs Other (income) expense, net (172 ) (48 ) (291 ) Income before taxes 2,604 2,665 2,086 1,345 Net income attributable to Merck Co., Inc. 1,827 1,950 1,707 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.70 $ 0.73 $ 0.64 $ 0.27 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.69 $ 0.73 $ 0.63 $ 0.27 (1) Amounts for 2019 include a charge related to the acquisition of Peloton Therapeutics, Inc. (see Note 3). (2) Amounts for 2018 include a charge related to the formation of a collaboration with Eisai (see Note 4). (3) Amounts for 2019 and 2018 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2019 , there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2019 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2019 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2019 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +8,Merck & Co.,2018," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes results from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. The Company was incorporated in New Jersey in 1970. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) Total Sales $ 42,294 $ 40,122 $ 39,807 Pharmaceutical 37,689 35,390 35,151 Keytruda 7,171 3,809 1,402 Januvia/Janumet 5,914 5,896 6,109 Gardasil/Gardasil 9 3,151 2,308 2,173 ProQuad/M-M-R II /Varivax 1,798 1,676 1,640 Zetia/Vytorin 1,355 2,095 3,701 Isentress/Isentress HD 1,140 1,204 1,387 Bridion Pneumovax 23 NuvaRing Simponi Animal Health 4,212 3,875 3,478 Livestock 2,630 2,484 2,287 Companion Animals 1,582 1,391 1,191 Other Revenues (1) 1,178 (1) Other revenues are primarily comprised of Healthcare Services segment revenue, third-party manufacturing sales, and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with non-small-cell lung cancer (NSCLC), melanoma, classical Hodgkin Lymphoma (cHL), urothelial carcinoma, head and neck squamous cell carcinoma (HNSCC), gastric or gastroesophageal junction adenocarcinoma, and microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, and in combination with chemotherapy in certain patients with NSCLC. Keytruda is also used in the United States for monotherapy treatment of certain patients with cervical cancer, primary mediastinal large B-cell lymphoma (PMBCL), hepatocellular carcinoma, and Merkel cell carcinoma, and in combination with chemotherapy for patients with squamous NSCLC; Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting; and Temodar (temozolomide) (marketed as Temodal outside the United States), a treatment for certain types of brain tumors. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of ovarian and breast cancer; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV) ; ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Zostavax (Zoster Vaccine Live), a vaccine to help prevent shingles (herpes zoster). Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Invanz (ertapenem sodium) for the treatment of certain infections; Cubicin ( daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; Cancidas (caspofungin acetate), an anti-fungal product; Primaxin (imipenem and cilastatin sodium), an anti-bacterial product; and Zerbaxa ( ceftolozane and tazobactam ) is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed in certain countries outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed in certain countries outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product; and Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant. Animal Health The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; and Aquaflor (Florfenicol) antibiotic for farm-raised fish. Companion Animal Products Bravecto (fluralaner), a line of oral and topical products that kills fleas and ticks in dogs and cats for up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2018 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2018. Product Date Approval Keytruda December 2018 The Japanese Ministry of Health, Labor and Welfare (JMHLW) approved Keytruda for three expanded uses in unresectable, advanced or recurrent NSCLC, one in malignant melanoma, as well as a new indication in high microsatellite instability solid tumors. December 2018 The U.S. Food and Drug Administration (FDA) approved Keytruda for the treatment of adult and pediatric patients with recurrent locally advanced or metastatic Merkel cell carcinoma. December 2018 The European Commission (EC) approved Keytruda for the adjuvant treatment of adults with stage III melanoma and lymph node involvement who have undergone complete resection. November 2018 FDA approved Keytruda for the treatment of patients with hepatocellular carcinoma who have been previously treated with sorafenib. October 2018 FDA approved Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of patients with metastatic squamous non-small cell lung cancer (NSCLC). September 2018 EC approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC in adults whose tumors have no EGFR or ALK positive mutations. September 2018 EC approved Keytruda for the treatment of recurrent or metastatic head and neck squamous cell carcinoma (HNSCC) in adults whose tumors express PD-L1 with a 50% TPS and progressing on or after platinum-containing chemotherapy. August 2018 FDA approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC patients with no EGFR or ALK genomic tumor aberrations. July 2018 The China National Drug Administration (CNDA) approved Keytruda for the treatment of adult patients with unresectable or metastatic melanoma following failure of one prior line of therapy. June 2018 FDA approved Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal large B-cell lymphoma (PMBCL), or who have relapsed after two or more prior lines of therapy. June 2018 FDA approved Keytruda for the treatment of patients with recurrent or metastatic cervical cancer with disease progression on or after chemotherapy whose tumors express PD-L1 as determined by an FDA-approved test. Lynparza (1) December 2018 FDA approved Lynparza for use as maintenance treatment of certain patients with advanced ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy. July 2018 JMHLW approved Lynparza for use in patients with unresectable or recurrent BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative breast cancer who have received prior chemotherapy. May 2018 EC approved Lynparza for use as a maintenance therapy in patients with platinum-sensitive relapsed high grade epithelial ovarian, fallopian tube, or primary peritoneal cancer, who are in response (complete or partial) to platinum based chemotherapy regardless of BRCA mutation status. January 2018 FDA approved Lynparza for use in patients with BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy. January 2018 JMHLW approved Lynparza for use as a maintenance therapy in patients with platinum-sensitive relapsed ovarian cancer, regardless of BRCA mutation status. Lenvima (2) September 2018 CNDA approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. August 2018 FDA approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. August 2018 EC approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. March 2018 JMHLW approved Lenvima for the treatment of certain patients with unresectable hepatocellular carcinoma. Gardasil 9 October 2018 FDA approved Gardasil 9 for an expanded age indication for use in women and men ages 27 to 45 for the prevention of certain cancers and diseases caused by the nine HPV types covered by the vaccine. April 2018 CNDA approved Gardasil 9 for use in girls and women ages 16 to 26. Delstrigo November 2018 EC approved Delstrigo (doravirine, lamivudine, and tenofovir disoproxil fumarate) for the treatment of adults infected with human immunodeficiency virus (HIV-1) without past or present evidence of resistance to the non-nucleoside reverse transcriptase inhibitor (NNRTI) class, lamivudine, or tenofovir. August 2018 FDA approved Delstrigo for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Pifeltro November 2018 EC approved Pifeltro (doravirine), in combination with other antiretroviral medicinal products, for the treatment of adults infected with HIV-1 without past or present evidence of resistance to the NNRTI class. August 2018 FDA approved Pifeltro for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Isentress March 2018 EC approved Isentress for an extension to the existing indication to cover treatment of neonates. Isentress is now indicated in combination with other anti-retroviral medicinal products for the treatment of HIV-1 infection. Prevymis January 2018 EC approved Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. Steglatro, Steglujan and Segluromet (3) March 2018 EC approved Steglatro (ertugliflozin), Steglujan (ertugliflozin and sitagliptin) and Segluromet (ertugliflozin and metformin hydrochloride) for the treatment of adults aged 18 years and older with type 2 diabetes mellitus as an adjunct to diet and exercise to improve glycaemic control (as monotherapy in patients for whom the use of metformin is considered inappropriate due to intolerance or contraindications, and in addition to other medicinal products for the treatment of diabetes). Vaxelis December 2018 FDA approved Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis Adsorbed, Inactivated Poliovirus, Haemophilus b Conjugate [Meningococcal Protein Conjugate] and Hepatitis B [Recombinant] Vaccine) for use in children from 6 weeks through 4 years of age (prior to the 5th birthday) (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza. (2) In March 2018, Merck and Eisai Co., Ltd. announced a strategic collaboration for the worldwide co-development and co-commercialization of Eisais Lenvima. (3) In 2013, Merck and Pfizer Inc. announced that they entered into a worldwide collaboration, except Japan, for the co-development and co-promotion of ertugliflozin. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). Approximately $365 million, $385 million and $415 million was recorded by Merck as a reduction to revenue in 2018, 2017 and 2016, respectively, related to the donut hole provision. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and will decrease to $2.8 billion in 2019 and is currently planned to remain at that amount thereafter. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $124 million, $210 million and $193 million of costs within Selling, general and administrative expenses in 2018, 2017 and 2016, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate, and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. In the case of a California law, manufacturers also are required to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which occurred in 2018. Furthermore, the government can order repricings for classes of drugs if it determines that it is appropriate under applicable rules. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA), which require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. The Companys focus on emerging markets has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2019 to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The European Union (EU) has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant expansion of the new products being approved each year. Additionally, in 2017, the government updated the National Reimbursement Drug List for the first time in eight years. While the mechanism for drugs being added to the list evolves, it is likely that in the future, inclusion will require a price negotiation which could impact the outlook in the market for selected brands. While pricing pressure has always existed in China, health care reform has led to the acceleration of generic substitution, through a pilot tendering process for mature products that have generic substitutes with a Generic Quality Consistency Evaluation approval. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, the Company has many far-reaching philanthropic programs. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicine and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the new EU General Data Protection Regulation, which went into effect on May 25, 2018 and imposes penalties up to 4% of global revenue. Additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increases enforcement and litigation activity in the United States and other developed markets, and increases regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. Privacy Shield Program, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent rights. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU and Japan (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (3) Emend Expired 2019 Emend for Injection 2020 (2) Noxafil 2019 N/A Vaxelis (4) 2020 (method of making) 2021 (5) (SPCs) Not Marketed Januvia 2022 (2) 2022 (2) 2025-2026 Janumet 2022 (2) N/A Janumet XR 2022 (2) N/A N/A Isentress 2022 (2) Simponi N/A (6) 2025 (7) N/A (6) Lenvima (8) 2025 (2) (with pending PTE) 2021 (patents), 2026 (2) (SPCs) Adempas (9) 2026 (2) 2028 (2) 2027-2028 Bridion 2026 (2) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) Gardasil 2021 (2) Expired Gardasil 9 2025 (patents) , 2030 (2) (SPCs) N/A Keytruda 2028 (patents), 2030 (2) (SPCs) Lynparza (10) 2028 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2028-2029 (with pending PTE) Zerbaxa 2028 (2) (with pending PTE) 2023 (patents), 2028 (2) (SPCs) N/A Sivextro 2028 (2) 2024 (patents), 2029 (2) (SPCs) 2029 (with pending PTE) Belsomra 2029 (2) N/A Prevymis 2029 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2029 (with pending PTE) Steglatro (11) 2031 (2) (with pending PTE) 2029 (patents), 2034 (2) (SPCs) N/A Steglujan (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Segluromet (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Delstrigo 2032 (with pending PTE) 2031 (12) N/A Pifeltro 2032 (with pending PTE) 2031 (12) N/A N/A: Currently no marketing approval. Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) Eligible for 6 months Pediatric Exclusivity. (3) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (4) Being commercialized in a U.S.-based joint partnership with Sanofi Pasteur. (5) SPCs are granted in four Major EU Markets and pending in one, based on a patent that expired in 2016. (6) The Company has no marketing rights in the U.S. and Japan. (7) Includes Pediatric Exclusivity, which is granted in four Major EU Markets and pending in one. (8) Being developed and commercialized in a global strategic oncology collaboration with Eisai. (9) Being commercialized in a worldwide collaboration with Bayer AG. (10) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (11) Being developed and promoted in a worldwide, except Japan, collaboration with Pfizer. (12) SPC applications to be filed by May 2019. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. The Company has the following key U.S. patent protection for drug candidates under review in the United States by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review (in the U.S.) Currently Anticipated Year of Expiration (in the U.S.) V920 (ebola vaccine) MK-7655A (relebactam + imipenem/cilastatin) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-1242 (vericiguat) (1) MK-7264 (gefapixant) V114 (pneumoconjugate vaccine) (1) Being developed in a worldwide clinical development collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent is subject to any future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2018 on patent and know-how licenses and other rights amounted to $135 million. Merck also incurred royalty expenses amounting to $1.3 billion in 2018 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2018, approximately 14,500 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on preclinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Preclinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Pharmaceuticals and Medical Devices Agency in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and China Food and Drug Administration. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma. This supplemental BLA is based on findings from the Phase 3 KEYNOTE-426 trial, which demonstrated that Keytruda in combination with axitinib, as compared to sunitinib, significantly improved overall survival (OS) and progression-free survival (PFS) in the first-line treatment of advanced renal cell carcinoma. These data were presented at the American Society for Clinical Oncology (ASCO) Genitourinary Cancers Symposium in February 2019. The supplemental BLA also included supporting data from the Phase 1b KEYNOTE-035 trial. The FDA set a PDUFA date of June 20, 2019. Merck has filed data from KEYNOTE-426 with regulatory authorities worldwide. In February 2019, the Committee for Medicinal Products for Human Use of the EMA adopted a positive opinion recommending Keytruda, in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of metastatic squamous NSCLC in adults. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-407 trial, which enrolled patients regardless of PD-L1 tumor expression status. The trial showed a significant improvement in OS and PFS for patients taking Keytruda in combination with chemotherapy (carboplatin and either paclitaxel or nab-paclitaxel) compared with chemotherapy alone. If approved, this would mark the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy for adults with metastatic squamous NSCLC. In October 2018, the FDA approved Keytruda in combination with carboplatin-paclitaxel or nab-paclitaxel as a first-line treatment for metastatic squamous NSCLC, regardless of PD-L1 expression. In December 2018, the FDA extended the action date for the supplemental BLA seeking approval for Keytruda as monotherapy for the first-line treatment of locally advanced or metastatic NSCLC in patients whose tumors express PD-L1 (TPS 1%) without EGFR or ALK genomic tumor aberrations. The supplemental BLA is based on results of the Phase 3 KEYNOTE-042 trial where Keytruda monotherapy demonstrated a significant improvement in OS compared with chemotherapy in this patient population. The Company submitted additional data and analyses to the FDA, which constituted a major amendment and extended the PDUFA date by three months to April 11, 2019. Merck continues to work closely with the FDA during the review of this supplemental BLA. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda as monotherapy for the treatment of patients with advanced small-cell lung cancer (SCLC) whose disease has progressed after two or more lines of prior therapy. This supplemental BLA, which is seeking accelerated approval for this new indication, is based on data from the SCLC cohorts of the Phase 2 KEYNOTE-158 and Phase 1b KEYNOTE-028 trials. The FDA set a PDUFA date of June 17, 2019. Keytruda is also being studied in combination with chemotherapy in the ongoing Phase 3 KEYNOTE-604 study in patients with newly diagnosed extensive stage SCLC. In February 2019, the FDA accepted a supplemental BLA for Keytruda as monotherapy or in combination with platinum and 5-fluorouracil chemotherapy for the first-line treatment of patients with recurrent or metastatic HNSCC. This supplemental BLA is based in part on data from the pivotal Phase 3 KEYNOTE-048 trial where Keytruda demonstrated a significant improvement in OS compared with the standard of care, as monotherapy in patients whose tumors expressed PD-L1 with Combined Positive Score (CPS)20 and CPS1 and in combination with chemotherapy in the total patient population. These data were presented at the European Society for Medical Oncology (ESMO) 2018 Congress. The FDA granted Priority Review to the supplemental BLA and set a PDUFA date of June 10, 2019. KEYNOTE-048 also serves as the confirmatory trial for KEYNOTE-012, a Phase 1b study which supported the previous accelerated approval for Keytruda as monotherapy for the treatment of patients with recurrent or metastatic HNSCC with disease progression on or after platinum-containing chemotherapy. In November 2018, Merck announced that the Phase 3 KEYNOTE-181 trial investigating Keytruda as monotherapy in the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma met a primary endpoint of OS in patients whose tumors expressed PD-L1 (CPS 10). In this pivotal study, treatment with Keytruda resulted in a statistically significant improvement in OS compared to chemotherapy (paclitaxel, docetaxel or irinotecan) in patients with CPS 10, regardless of histology. The primary endpoint of OS was also evaluated in patients with squamous cell histology and in the entire intention-to-treat study population. While directionally favorable, statistical significance for OS was not met in these two patient groups. Per the statistical analysis plan, the key secondary endpoints of PFS and objective response rate (ORR) were not formally tested, as OS was not reached in the full intention-to-treat study population. These results were presented in January 2019 at the ASCO Gastrointestinal Cancers Symposium and have been submitted for regulatory review. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In October 2018, Merck announced the first presentation of results from an interim analysis of KEYNOTE-057, a Phase 2 trial evaluating Keytruda for previously treated patients with high-risk non-muscle invasive bladder cancer. An interim analysis of the studys primary endpoint showed a complete response rate of nearly 40% at three months with Keytruda in patients whose disease was unresponsive to Bacillus Calmette-Gurin therapy, the current standard of care for this disease, and who were ineligible for or who refused to undergo radical cystectomy. These results, as well as other study findings, were presented at the ESMO 2018 Congress. In February 2019, Merck announced that the pivotal Phase 3 KEYNOTE-240 trial evaluating Keytruda , plus best supportive care, for the treatment of patients with advanced hepatocellular carcinoma who were previously treated with systemic therapy, did not meet its co-primary endpoints of OS and PFS compared with placebo plus best supportive care. In the final analysis of the study, there was an improvement in OS for patients treated with Keytruda compared to placebo, however these OS results did not meet statistical significance per the pre-specified statistical plan. Results for PFS were also directionally favorable in the Keytruda arm compared with placebo but did not reach statistical significance. The key secondary endpoint of ORR was not formally tested, since superiority was not reached for OS or PFS. Results will be presented at an upcoming medical meeting and have been shared with the FDA for discussion. The Keytruda clinical development program consists of more than 900 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, cervical, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Lynparza, is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. In April 2018, Merck and AstraZeneca announced that the EMA validated for review the MAA for Lynparza for use in patients with deleterious or suspected deleterious BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. This was the first regulatory submission for a PARP inhibitor in breast cancer in Europe. Lynparza tablets are also under review in the EU as a maintenance treatment in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response following first-line standard platinum-based chemotherapy. This submission was based on positive results from the pivotal Phase 3 SOLO-1 trial. The trial showed a statistically-significant and clinically-meaningful improvement in PFS for Lynparza compared to placebo, reducing the risk of disease progression or death by 70% in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response to platinum-based chemotherapy. In December 2018, Merck and AstraZeneca announced positive results from the randomized, open-label, controlled, Phase 3 SOLO-3 trial of Lynparza tablets in patients with relapsed ovarian cancer after two or more lines of treatment. The trial was conducted as a post-approval commitment in agreement with the FDA. Results from the trial showed BRCA -mutated advanced ovarian cancer patients treated with Lynparza following two or more prior lines of chemotherapy demonstrated a statistically significant and clinically meaningful improvement in the primary endpoint of ORR and the key secondary endpoint of PFS compared to chemotherapy. Merck and AstraZeneca plan to discuss these results with the FDA. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). In February 2019, Merck announced that the FDA accepted for Priority Review an NDA for MK-7655A for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. The PDUFA date is July 16, 2019. In April 2018, Merck announced that a pivotal Phase 3 study of MK-7655A demonstrated a favorable overall response in the treatment of certain imipenem-non-susceptible bacterial infections, the primary endpoint, with lower treatment-emergent nephrotoxicity (kidney toxicity), a secondary endpoint, compared to a colistin (colistimethate sodium) plus imipenem/cilastatin regimen. The FDA had previously designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital- acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. V920 (rVSVG-ZEBOV-GP, live attenuated), is an investigational Ebola Zaire disease vaccine candidate being studied in large scale Phase 2/3 clinical trials. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The WHO decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In November 2018, Merck announced that it has started the submission of a rolling BLA to the FDA for V920. This rolling submission was made pursuant to the FDAs Breakthrough Therapy designation. Merck expects the rolling submission of the BLA to be completed in 2019. The Company also intends to file V920 with the EMA in 2019. In February 2019, Merck announced that the FDA accepted for Priority Review a supplemental NDA for Zerbaxa to treat adult patients with nosocomial pneumonia, including ventilator-associated pneumonia, caused by certain susceptible Gram-negative microorganisms. The PDUFA date is June 3, 2019. Zerbaxa is also under review for this indication by the EMA. Zerbaxa is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor agonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. Lenvima, is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. In March 2018, Merck and Eisai entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Per the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination to support 11 potential indications in six types of cancer (endometrial cancer, NSCLC, hepatocellular carcinoma, head and neck cancer, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma and for the potential treatment of certain patients with advanced and/or metastatic non-microsatellite instability high/proficient mismatch repair endometrial carcinoma. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure with reduced ejection fracture (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fracture (Phase 2 clinical trial). The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently five Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, three studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. In January 2019, Merck announced that V114 received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age. As a result of changes in the herpes zoster vaccine environment, Merck is ending development of V212, its investigational vaccine for the prevention of shingles in immunocompromised patients. The chart below reflects the Companys research pipeline as of February 22, 2019. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer and certain other indications) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 Entry Date) Under Review Cancer Cancer New Molecular Entities/Vaccines MK-3475 Keytruda MK-3475 Keytruda Bacterial Infection Advanced Solid Tumors Breast (October 2015) MK-7655A relebactam+imipenem/cilastatin Cutaneous Squamous Cell Carcinoma Cervical (October 2018) (EU) (U.S.) Prostate Colorectal (November 2015) Ebola Vaccine MK-7902 Lenvima (1) Esophageal (December 2015) V920 (4) (U.S.) Biliary Tract Gastric (May 2015) (EU) Non-Small-Cell Lung Hepatocellular (May 2016) (EU) Certain Supplemental Filings V937 Cavatak Mesothelioma (May 2018) Cancer Melanoma Nasopharyngeal (April 2016) MK-3475 Keytruda MK-7690 Ovarian (December 2018) First-Line Advanced Renal Cell Carcinoma Colorectal (2) Renal (October 2016) (EU) (KEYNOTE-426) (U.S.) MK-7339 Lynparza (1) Small-Cell Lung (May 2017) (EU) First-Line Metastatic Squamous Non-Small- Advanced Solid Tumors MK-7902 Lenvima (1,2) Cell Lung Cancer (KEYNOTE-407) (EU) Cytomegalovirus Vaccine Endometrial (June 2018) First-Line Metastatic Non-Small-Cell Lung V160 MK-7339 Lynparza (1) Cancer (KEYNOTE-042) (U.S.) (EU) Diabetes Mellitus Pancreatic (December 2014) Third-Line Advanced Small-Cell Lung MK-8521 (3) Prostate (April 2017) Cancer (KEYNOTE-158) (U.S.) HIV-1 Infection Cough First-Line Head and Neck Cancer MK-8591 MK-7264 (gefapixant) (March 2018) (KEYNOTE-048) (U.S.) Pediatric Neurofibromatosis Type-1 Heart Failure Alternative Dosing Regimen MK-5618 (selumetinib) (1) MK-1242 (vericiguat) (September 2016) (1) (Q6W) (EU) Respiratory Syncytial Virus Pneumoconjugate Vaccine MK-7339 Lynparza (1) MK-1654 V114 (June 2018) Second-Line Metastatic Breast Cancer (EU) Schizophrenia First-Line Advanced Ovarian Cancer (EU) MK-8189 HABP/VABP (5) MK-7625A Zerbaxa (U.S.) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda. (3) Development is currently on hold. (4) Rolling submission. (5) HABP - Hospital-Acquired Bacterial Pneumonia / VABP - Ventilator-Associated Bacterial Pneumonia Employees As of December 31, 2018, the Company had approximately 69,000 employees worldwide, with approximately 25,400 employed in the United States, including Puerto Rico. Approximately 30% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Since inception of the programs through December 31, 2018, Merck has eliminated approximately 45,510 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company has substantially completed the actions under these programs. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $16 million in 2018 , and are estimated at $57 million in the aggregate for the years 2019 through 2023 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in 2018 , 57% of sales in 2017 and 54% of sales in 2016 . The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is http://www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates under review and in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. For example, pursuant to an agreement with a generic manufacturer, that manufacturer launched in the United States a generic version of Zetia in December 2016. In addition, the Company lost U.S. patent protection for Vytorin in April 2017. As a result, the Company experienced a significant and rapid loss of sales of Zetia and Vytorin in the United States in 2017, which continued in 2018. Furthermore, the patents that provide U.S. and EU market exclusivity for Noxafil will expire in July 2019 and December 2019, respectively, and the Company anticipates a significant decline in U.S. and EU Noxafil sales thereafter. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material and negative impact on results of operations and cash flows. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Januvia , Janumet , Gardasil/Gardasil 9 and Bridion . As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. For example, in 2018, sales of Zepatier were materially unfavorably affected by increasing competition and declining patient volumes. Sales of Zostavax were also materially unfavorably affected due to competition. The Company expects that competition will continue to adversely affect the sales of these products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, preclinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy or labeling changes; and greater scrutiny in advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA and Japans Pharmaceutical and Medical Device Agency have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products that are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and, in particular, direct-to-consumer advertising. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial position and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment Health Care Environment and Government Regulations. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers may, in the future, ask for and receive higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. The Company expects pricing pressures to continue in the future. The health care industry in the United States will continue to be subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2018, the Companys revenue was reduced by $365 million due to this requirement. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and will be $2.8 billion in 2019. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. In 2018, the Company recorded $124 million of costs for this annual fee. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck, at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. The Company cannot predict the likelihood of future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys business, cash flow, results of operations, financial position and prospects. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means could impact key business processes. Cyber-attacks against the Companys IT systems could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. Due to the cyber-attack, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Cost of sales , as well as expenses related to remediation efforts in Selling, general and administrative expenses and Research and development expenses, which aggregated $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders, 2018 sales were unfavorably affected in certain markets by approximately $150 million from the cyber-attack. The Company has insurance coverage insuring against costs resulting from cyber-attacks and has received proceeds. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to the 2017 cyber-attack. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems will be successful in preventing disruptions to its operations, including its manufacturing, research and sales operations. Any such disruption could result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third party providers databases or IT systems and could also result in financial, legal, business or reputational harm to the Company and potentially substantial remediation costs. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial position and prospects of the Company; these laws and regulations include (i) additional healthcare reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to healthcare professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. The Company anticipates these pricing actions will continue to negatively affect revenue performance in 2019. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material negative impact on the Companys results of operations. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum, the British government has been in the process of negotiating the terms of the UKs future relationship with the EU. While the Company has taken actions and made certain contingency plans for scenarios in which the UK and the EU do not reach a mutually satisfactory understanding as to that relationship, it is not possible at this time to predict whether there will be any such understanding, or if such an understanding is reached, whether its terms will vary in ways that result in greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and/or cross border labor issues that could materially adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Healthcare Environment , pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing healthcare reform that has led to the acceleration of generic substitution, where available. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial position and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a negative impact on future results of operations. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as Bovine Spongiform Encephalopathy or mad cow disease, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely impact the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both preclinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004, including liability for legacy Merck products first sold after that date. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain media vehicles could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Companys U.S. commercial operations are headquartered in Upper Gwynedd, Pennsylvania. The Companys U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania and Kenilworth, New Jersey. The Companys vaccines business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania. Mercks Animal Health headquarters is located in Madison, New Jersey. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, South San Francisco, California and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $2.6 billion in 2018 , $1.9 billion in 2017 and $1.6 billion in 2016 . In the United States, these amounted to $1.5 billion in 2018 , $1.2 billion in 2017 and $1.0 billion in 2016 . Abroad, such expenditures amounted to $1.1 billion in 2018, $728 million in 2017 and $594 million in 2016. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. In addition, in October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022. The focus of this investment will primarily be on increasing manufacturing capacity across Mercks key businesses. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2019, there were approximately 115,320 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2018 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 59,154,075 $70.56 $12,709 (2) November 1 November 30 5,279,715 $74.64 $12,315 December 1 December 31 4,788,526 $76.30 $11,949 Total 69,222,316 $71.27 $11,949 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in November 2017 to purchase up to $10 billion in Merck shares. In October 2018, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. Shares are approximated. (2) Amount includes $1.0 billion being held back pending final settlement under the accelerated share repurchase agreements discussed below. Performance Graph The following graph assumes a $100 investment on December 31, 2013, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2018/2013 CAGR** MERCK $179 12% PEER GRP.** 7% SP 500 8% 2014 2016 2018 MERCK 100.00 117.10 112.40 129.40 127.40 178.70 PEER GRP. 100.00 111.40 114.80 111.20 133.00 142.20 SP 500 100.00 113.70 115.20 129.00 157.20 150.30 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. In 2017, Merck began recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9 to the consolidated financial statements). Overview The Companys performance during 2018 demonstrates execution of its innovation strategy, with revenue growth in oncology, vaccines, hospital acute care and animal health, focused investment in the research and development pipeline, and disciplined allocation of resources. Additionally, Merck completed several business development transactions, expanded its capital expenditures program primarily to increase future manufacturing capacity, and returned capital to shareholders. Worldwide sales were $42.3 billion in 2018 , an increase of 5% compared with 2017 . Strong growth in the oncology franchise reflects the performance of Keytruda , as well as alliance revenue related to Lynparza and Lenvima resulting from Mercks business development activities. Also contributing to revenue growth were higher sales of vaccines, driven primarily by Gardasil/Gardasil 9, and growth in the hospital acute care franchise, largely attributable to Bridion and Noxafil . Higher sales of animal health products, reflecting increases in companion animal and livestock products both from in-line and recently launched products, also contributed to revenue growth. Growth in these areas was partially offset by competitive pressures on Zepatier and Zostavax , as well as the ongoing effects of generic and biosimilar competition that resulted in sales declines for products including Zetia , Vytorin , and Remicade . Augmenting Mercks portfolio and pipeline with external innovation remains an important component of the Companys overall strategy. In 2018, Merck continued executing on this strategy by entering into a strategic collaboration with Eisai Co., Ltd. (Eisai) for the worldwide co-development and co-commercialization of Lenvima. Lenvima is an orally available tyrosine kinase inhibitor discovered by Eisai, which is approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . In addition, Merck acquired Viralytics Limited (Viralytics), a company focused on oncolytic immunotherapy treatments for a range of cancers. Also, the Company announced an agreement to acquire Antelliq Group (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. During 2018, the Company advanced its leadership in oncology through focused commercial execution, the achievement of important regulatory milestones and the presentation of clinical data. Keytruda continues its global launch with multiple new indications across several tumor types, including approval from the U.S. Food and Drug Administration (FDA) for the treatment of certain patients with cervical cancer, primary mediastinal large B-cell lymphoma (PMBCL), a type of non-Hodgkin lymphoma, hepatocellular carcinoma, Merkel cell carcinoma, and in combination with chemotherapy for the treatment of certain patients with squamous non-small-cell lung cancer (NSCLC). Also during 2018, the European Commission (EC) approved Keytruda for the treatment of certain patients with head and neck squamous cell carcinoma (HNSCC), for the adjuvant treatment of melanoma, and in combination with chemotherapy for the first-line treatment of certain patients with nonsquamous NSCLC. This was the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy. Also in 2018, Keytruda was approved in China for the treatment of certain patients with melanoma. Additionally, Merck recently announced the receipt of five new approvals for Keytruda in Japan, including three expanded uses in advanced NSCLC, one in adjuvant melanoma, as well as a new indication in advanced microsatellite instability-high (MSI-H) tumors. Keytruda also continues to launch in many other international markets. In 2018, Lynparza, which is being developed in a collaboration with AstraZeneca PLC (AstraZeneca), received FDA approval for use in certain patients with metastatic breast cancer who have been previously treated with chemotherapy, and for use as maintenance treatment of adult patients with certain types of advanced ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to chemotherapy. Additionally, Lenvima was approved in the United States, European Union (EU), Japan and China for the treatment of certain patients with hepatocellular carcinoma. The FDA and EC also approved two new HIV-1 medicines: Delstrigo , a once-daily fixed-dose combination tablet of doravirine, lamivudine and tenofovir disoproxil fumarate; and Pifeltro (doravirine), a new non-nucleoside reverse transcriptase inhibitor to be administered in combination with other antiretroviral medicines. Merck continues to invest in its pipeline, with an emphasis on being a leader in immuno-oncology and expanding in other areas such as vaccines and hospital acute care. In addition to the recent regulatory approvals discussed above, the Company has continued to advance its late-stage pipeline with several regulatory submissions. Keytruda is under review in the United States in combination with axitinib, a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma for which it has been granted Priority Review by the FDA; in the EU for the first-line treatment of certain patients with metastatic squamous NSCLC; in the United States and in the EU as monotherapy for the first-line treatment of certain patients with locally advanced or metastatic NSCLC; in the United States as monotherapy for the treatment of certain patients with advanced small-cell lung cancer (SCLC); and in the United States as monotherapy or in combination with chemotherapy for the first-line treatment of certain patients with recurrent or metastatic HNSCC for which it has been granted Priority Review by the FDA. Additionally, MK-7655A, the combination of relebactam and imipenem/cilastatin, has been accepted for Priority Review by the FDA for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. Merck has also started the submission of a rolling Biologics License Application (BLA) to the FDA for V920, an investigational Ebola Zaire disease vaccine candidate. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of breast, cervical, colorectal, esophageal, gastric, hepatocellular, mesothelioma, nasopharyngeal, ovarian, renal and small-cell lung cancers; Lynparza for pancreatic and prostate cancer; and Lenvima in combination with Keytruda for endometrial cancer. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including V114, an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease that received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age; MK-7264, gefapixant, a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough; and MK-1242, vericiguat, an investigational treatment for heart failure being developed in a collaboration (see Research and Development below). The Company is allocating resources to effectively support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2018 reflect higher clinical development spending and investment in discovery and early drug development. In October 2018, Mercks Board of Directors approved a 15% increase to the Companys quarterly dividend, raising it to $0.55 per share from $0.48 per share on the Companys outstanding common stock. Also in October 2018, Mercks Board of Directors approved a $10 billion share repurchase program and the Company entered into $5 billion of accelerated share repurchase (ASR) agreements. During 2018 , the Company returned $14.3 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2018 were $2.32 compared with $0.87 in 2017 . EPS in both years reflect the impact of acquisition and divestiture-related costs, as well as restructuring costs and certain other items. Certain other items in 2018 include a charge related to the formation of the collaboration with Eisai and in 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation and a charge related to the formation of a collaboration with AstraZeneca. Non-GAAP EPS, which exclude these items, were $4.34 in 2018 and $3.98 in 2017 (see Non-GAAP Income and Non-GAAP EPS below). Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In the United States, pricing pressure continues on many of the Companys products. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2018 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions will continue to negatively affect revenue performance in 2019 . Cyber-attack On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. Due to a backlog of orders for certain products as a result of the cyber-attack, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2018 and 2017 of approximately $150 million and $260 million, respectively. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Cost of sales , as well as expenses related to remediation efforts in Selling, general and administrative expenses and Research and development expenses, which aggregated approximately $285 million in 2017, net of insurance recoveries of approximately $45 million. Costs in 2018 were immaterial. As referenced above, the Company has insurance coverage insuring against costs resulting from cyber-attacks and has received insurance proceeds. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to this incident. Operating Results Sales Worldwide sales were $42.3 billion in 2018, an increase of 5% compared with 2017. Sales growth was driven primarily by higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as alliance revenue related to Lynparza and Lenvima. Also contributing to revenue growth were higher sales of vaccines, driven primarily by human papillomavirus (HPV) vaccine Gardasil/Gardasil 9, as well as higher sales in the hospital acute care franchise, largely attributable to Bridion and Noxafil . Higher sales of animal health products also drove revenue growth in 2018. Sales growth in 2018 was partially offset by declines in the virology franchise driven primarily by lower sales of hepatitis C virus (HCV) treatment Zepatier , as well as lower sales of shingles (herpes zoster) vaccine Zostavax . The ongoing effects of generic and biosimilar competition for cardiovascular products Zetia and Vytorin , and immunology product Remicade , as well as lower sales of products within the diversified brands franchise also partially offset revenue growth in 2018. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Sales in the United States were $18.2 billion in 2018 , growth of 5% compared with 2017 . The increase was driven primarily by higher sales of Keytruda , Gardasil/Gardasil 9, NuvaRing , and Bridion , as well as alliance revenue from Lynparza and Lenvima, and higher sales of animal health products. Growth was partially offset by lower sales of Zepatier , Zetia , Vytorin , Zostavax , Januvia , Janumet , Invanz , and products within the diversified brands franchise. International sales were $24.1 billion in 2018 , an increase of 6% compared with 2017 . The increase primarily reflects growth in Keytruda , Gardasil/Gardasil 9, Januvia, Janumet and Atozet , as well as higher sales of animal health products. Sales growth was partially offset by lower sales of Zepatier , Remicade , Zetia , Vytorin , and products within the diversified brands franchise. International sales represented 57% of total sales in both 2018 and 2017 . Worldwide sales were $40.1 billion in 2017, an increase of 1% compared with 2016. Sales growth in 2017 was driven primarily by higher sales of Keytruda , Zepatier and Bridion . Additionally, sales in 2017 benefited from the December 31, 2016 termination of SPMSD, which marketed vaccines in most major European markets. In 2017, Merck began recording vaccine sales in the markets that were previously part of the SPMSD joint venture resulting in incremental vaccine sales of approximately $400 million during 2017. Higher sales of Pneumovax 23, Adempas, and animal health products also contributed to revenue growth in 2017. These increases were largely offset by the effects of generic competition for certain products including Zetia , which lost U.S. market exclusivity in December 2016, Vytorin , which lost U.S. market exclusivity in April 2017, Cubicin due to U.S. patent expiration in June 2016, and Cancidas , which lost EU patent protection in April 2017. Revenue growth was also offset by continued biosimilar competition for Remicade and ongoing generic erosion for products including Singulair and Nasonex . Collectively, the sales decline attributable to the above products affected by generic and biosimilar competition was $3.3 billion in 2017. Lower sales of other products within the diversified brands franchise, as well as lower combined sales of the diabetes franchise of Januvia and Janumet , and declines in sales of Isentress/Isentress HD also partially offset revenue growth. Additionally, sales in 2017 were reduced by $125 million due to a borrowing the Company made from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile of doses of Gardasil 9 as discussed below. Also, the Company was unable to fulfill orders for certain products in certain markets due to the cyber-attack, which had an unfavorable effect on sales in 2017 of approximately $260 million. See Note 19 to the consolidated financial statements for details on sales of the Companys products. Pharmaceutical Segment Oncology Keytruda is approved in the United States and in the EU as monotherapy for the treatment of certain patients with NSCLC, melanoma, classical Hodgkin lymphoma (cHL), HNSCC and urothelial carcinoma, a type of bladder cancer, and in combination with chemotherapy for certain patients with nonsquamous NSCLC. Keytruda is also approved in the United States as monotherapy for the treatment of certain patients with gastric or gastroesophageal junction adenocarcinoma and MSI-H or mismatch repair deficient cancer. In addition, the FDA recently approved Keytruda for the treatment of certain patients with cervical cancer, PMBCL, hepatocellular carcinoma, Merkel cell carcinoma, and in combination with chemotherapy for patients with squamous NSCLC (see below). Keytruda is approved in Japan for the treatment of certain patients with NSCLC, both as monotherapy and in combination with chemotherapy, melanoma, cHL, MSI-H tumors, and urothelial carcinoma. Additionally, Keytruda has been approved in China for the treatment of certain patients with melanoma. Keytruda is also approved in many other international markets. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In August 2018, the FDA approved an expanded label for Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of patients with metastatic nonsquamous NSCLC, with no EGFR or ALK genomic tumor aberrations, based on results of the KEYNOTE-189 trial. Keytruda in combination with pemetrexed and carboplatin was first approved in 2017 under the FDAs accelerated approval process for the first-line treatment of patients with metastatic nonsquamous NSCLC, based on tumor response rates and progression-free survival (PFS) data from a Phase 2 study (KEYNOTE-021, Cohort G1). In accordance with the accelerated approval process, continued approval was contingent upon verification and description of clinical benefit, which was demonstrated in KEYNOTE-189 and resulted in the FDA converting the accelerated approval to full (regular) approval. Also, in September 2018, the EC approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC in adults whose tumors have no EGFR or ALK positive mutations. In June 2018, the FDA approved Keytruda for the treatment of patients with recurrent or metastatic cervical cancer with disease progression on or after chemotherapy whose tumors express PD-L1 as determined by an FDA- approved test. Also in June 2018, the FDA approved Keytruda for the treatment of adult and pediatric patients with refractory PMBCL, or who have relapsed after two or more prior lines of therapy. In September 2018, the EC approved Keytruda as monotherapy for the treatment of recurrent or metastatic HNSCC in adults whose tumors express PD-L1 with a tumor proportion score (TPS) of 50%, and who progressed on or after platinum-containing chemotherapy, based on data from the Phase 3 KEYNOTE-040 trial. In October 2018, the FDA approved Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of patients with metastatic squamous NSCLC based on results from the KEYNOTE-407 trial. This approval marks the first time an anti-PD-1 regimen has been approved for the first-line treatment of squamous NSCLC regardless of tumor PD-L1 expression status. In November 2018, the FDA approved Keytruda for the treatment of patients with hepatocellular carcinoma who have been previously treated with sorafenib based on data from the KEYNOTE-224 trial. In December 2018, the FDA approved Keytruda for the treatment of adult and pediatric patients with recurrent locally advanced or metastatic Merkel cell carcinoma, based on the results of the Cancer Immunotherapy Trials Networks CITN-09/KEYNOTE-017 trial. Also in December 2018, the EC approved Keytruda for the adjuvant treatment of adults with stage III melanoma and lymph node involvement who have undergone complete resection. Keytruda was approved for this indication by the FDA in February 2019. These approvals were based on data from the pivotal Phase 3 EORTC1325/KEYNOTE-054 trial, conducted in collaboration with the European Organisation for Research and Treatment of Cancer. Global sales of Keytruda were $7.2 billion in 2018 , $3.8 billion in 2017 and $1.4 billion in 2016 . The year-over-year increases were driven by volume growth as the Company continues to launch Keytruda with multiple new indications globally. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC reflecting both the continued adoption of Keytruda in the first-line setting as monotherapy for patients with metastatic NSCLC whose tumors have high PD-L1 expression, as well as the uptake of Keytruda in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous NSCLC with or without PD-L1 expression. Other indications contributing to sales growth include HNSCC, bladder, and melanoma. Recently approved indications, including squamous NSCLC and MSI-H cancer, also contributed to growth in 2018. Sales growth in international markets reflects continued uptake for the treatment of NSCLC as the Company has secured reimbursement in most major markets. Sales growth in international markets in 2018 also includes contributions from the more recently approved indications as described above, including for the treatment of HNSCC, bladder cancer and in combination with chemotherapy for the treatment of NSCLC in the EU, multiple new indications in Japan, and for the treatment of melanoma in China. In January 2017, Merck entered into a settlement and license agreement to resolve worldwide patent infringement litigation related to Keytruda . Pursuant to the settlement, the Company will pay royalties of 6.5% on net sales of Keytruda in 2017 through 2023; and 2.5% on net sales of Keytruda in 2024 through 2026. Global sales of Emend , for the prevention of chemotherapy-induced and post-operative nausea and vomiting, were $522 million in 2018, a decline of 6% compared with 2017 including a 1% favorable effect from foreign exchange. The decline primarily reflects lower demand in the United States due to competition. Worldwide sales of Emend were $556 million in 2017, an increase of 1% compared with 2016. The patent that provided U.S. market exclusivity for Emend expired in 2015 and the patent that provides market exclusivity in most major European markets will expire in May 2019. The patent that provides U.S. market exclusivity for Emend for Injection expires in September 2019 and the patent that provides market exclusivity in major European markets expires in February 2020 (although six-month pediatric exclusivity may extend this date). The Company anticipates that sales of Emend in these markets will decline significantly after these patent expiries. Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca entered into in July 2017 (see Note 4 to the consolidated financial statements), is currently approved for certain types of ovarian and breast cancer. Merck recorded alliance revenue of $187 million in 2018 and $20 million in 2017 related to Lynparza. The revenue increase reflects the approval of new indications, as well as a full year of activity in 2018. In January 2018, the FDA approved Lynparza for use in patients with BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative metastatic breast cancer who have been previously treated with chemotherapy, triggering a $70 million capitalized milestone payment from Merck to AstraZeneca. Lynparza was also approved in Japan in July 2018 for use in patients with unresectable or recurrent BRCA -mutated, HER2-negative breast cancer who have received prior chemotherapy. Additionally, Lynparza was approved for use as a maintenance therapy in patients with platinum-sensitive relapsed ovarian cancer, regardless of BRCA mutation status in Japan in January 2018 and in the EU in May 2018. In December 2018, the FDA approved Lynparza for use as maintenance treatment of adult patients with deleterious or suspected deleterious germline or somatic BRCA -mutated advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy based on the results of the SOLO-1 clinical trial, triggering a $70 million capitalized milestone payment from Merck to AstraZeneca. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai entered into in March 2018 (see Note 4 to the consolidated financial statements), is approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Merck recorded alliance revenue of $149 million in 2018 related to Lenvima. In 2018, Lenvima was approved for the treatment of certain patients with hepatocellular carcinoma in the United States, the EU, Japan and China, triggering capitalized milestone payments of $250 million in the aggregate from Merck to Eisai. Vaccines On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which developed and marketed vaccines in Europe. Accordingly, vaccine sales in 2018 and 2017 include sales of Merck vaccines in the European markets that were previously part of the SPMSD joint venture, whereas sales in periods prior to 2017 do not. Prior to 2017, vaccine sales in these European markets were sold through the SPMSD joint venture, the results of which were reflected in equity income from affiliates included in Other (income) expense, net . Supply sales to SPMSD, however, are included in vaccine sales in periods prior to 2017. Incremental vaccine sales resulting from the termination of the SPMSD joint venture were approximately $400 million in 2017, of which approximately $215 million relate to Gardasil/Gardasil 9. Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, were $3.2 billion in 2018, growth of 37% compared with 2017 including a 1% favorable effect from foreign exchange. Sales growth was driven primarily by higher sales in the Asia Pacific region, particularly in China reflecting continued uptake since launch, as well as higher demand in certain European markets. The sales increase was also attributable to the replenishment in 2018 of doses borrowed from the CDC Pediatric Vaccine Stockpile in 2017 as discussed below. In April 2018, Chinas Food and Drug Administration approved Gardasil 9 for use in girls and women ages 16 to 26. In October 2018, the FDA approved an expanded age indication for use in women and men ages 27 to 45 for the prevention of certain cancers and diseases caused by the nine HPV types covered by the vaccine. During 2017, the Company made a request to borrow doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile, which the CDC granted. The Companys decision to borrow the doses from the CDC was driven in part by the temporary shutdown resulting from the cyber-attack that occurred in June 2017, as well as by overall higher demand than expected. As a result of the borrowing, the Company reversed the sales related to the borrowed doses and recognized a corresponding liability. The Company subsequently replenished a portion of the doses borrowed from the stockpile. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company replenished the remaining borrowed doses in 2018 resulting in the recognition of sales of $125 million in 2018 and a reversal of the related liability. Global sales of Gardasil/Gardasil 9 were $2.3 billion in 2017, growth of 6% compared with 2016. Sales growth was driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture noted above, as well as higher demand in the Asia Pacific region due in part to the launch in China, partially offset by lower sales in the United States. Lower sales in the United States reflect the timing of public sector purchases and the CDC stockpile borrowing as described above. The Company is a party to certain third-party license agreements with respect to Gardasil/Gardasil 9 pursuant to which the Company pays royalties on worldwide Gardasil/Gardasil 9 sales. The royalties, which vary by country and range from 7% to 13%, are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, were $593 million in 2018, an increase of 12% compared with 2017, driven primarily by higher volumes and pricing in the United States and volume growth in certain European markets. Worldwide sales of ProQuad were $528 million in 2017, an increase of 7% compared with $495 million in 2016. Sales growth in 2017 was driven primarily by higher pricing and volumes in the United States, as well as volume growth in international markets, particularly in Europe. Foreign exchange favorably affected global sales performance by 1% in 2017. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, were $430 million in 2018, an increase of 13% compared with 2017, driven primarily by volume growth in Latin America. Global sales of M-M-R II were $382 million in 2017, an increase of 8% compared with $353 million in 2016. Sales growth in 2017 was largely attributable to higher sales in Europe resulting from the termination of the SPMSD joint venture. Foreign exchange favorably affected global sales performance by 1% in 2018 and unfavorably affected global sales performance by 1% in 2017. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), were $774 million in 2018, an increase of 1% compared with 2017, reflecting volume growth in Latin America and the Asia Pacific region, along with higher pricing in the United States, largely offset by volume declines in Turkey from the loss of a government tender due to competition. Worldwide sales of Varivax were $767 million in 2017, a decline of 3% compared with $792 million in 2016. The sales decline in 2017 was driven primarily by lower volumes in Brazil due to the loss of a government tender, as well as lower sales in the United States reflecting lower demand that was partially offset by higher pricing. Higher sales in Europe resulting from the termination of the SPMSD joint venture partially offset the sales decline in 2017. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, were $907 million in 2018, an increase of 10% compared with 2017. Sales growth was driven primarily by higher pricing in the United States and volume growth in Europe. Global sales of Pneumovax 23 were $821 million in 2017, an increase of 28% compared with 2016, driven primarily by higher demand and pricing in the United States, as well as higher sales in Europe resulting from the termination of the SPMSD joint venture. Foreign exchange unfavorably affected sales performance by 1% in 2017. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, were $728 million in 2018, an increase of 6% compared with 2017, driven primarily by the launch in China. Worldwide sales of RotaTeq were $686 million in 2017, an increase of 5% compared with 2016, driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture. Worldwide sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $217 million in 2018, a decline of 68% compared with 2017, driven by lower volumes in most markets, particularly in the United States. Lower demand in the United States reflects the launch of a competing vaccine that received a preferential recommendation from the CDCs Advisory Committee on Immunization Practices in October 2017 for the prevention of shingles over Zostavax . The declines were partially offset by higher demand in certain European markets. The Company anticipates competition will continue to have an adverse effect on sales of Zostavax in future periods. Global sales of Zostavax were $668 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States reflecting the approval of a competing vaccine as noted above, partially offset by growth in Europe resulting from the termination of the SPMSD joint venture and volume growth in the Asia Pacific region. In 2018, the FDA approved Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis Adsorbed, Inactivated Poliovirus, Haemophilus b Conjugate [Meningococcal Protein Conjugate] and Hepatitis B [Recombinant] Vaccine) for use in children from 6 weeks through 4 years of age (prior to the 5th birthday). Vaxelis , which is currently being marketed in Europe, was developed as part of a joint-partnership between Merck and Sanofi. Merck and Sanofi are working to maximize production of Vaxelis to allow for a sustainable supply to meet anticipated U.S. demand. Commercial supply will not be available prior to 2020. Hospital Acute Care Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, were $917 million in 2018, growth of 30% compared with 2017, driven primarily by volume growth in the United States and certain European markets. Worldwide sales of Bridion were $704 million in 2017, growth of 46% compared with 2016, driven by strong global demand, particularly in the United States. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, were $742 million in 2018, an increase of 17% compared with 2017 including a 2% favorable effect from foreign exchange. Sales growth primarily reflects higher demand in the United States, certain European markets and China. Global sales of Noxafil were $636 million in 2017, an increase of 7% compared with 2016, primarily reflecting higher demand and pricing in the United States, as well as volume growth in Europe. The patent that provides U.S. market exclusivity for Noxafil expires in July 2019. Additionally, the patent for Noxafil will expire in a number of major European markets in December 2019. The Company anticipates sales of Noxafil in these markets will decline significantly thereafter. Global sales of Invanz , for the treatment of certain infections, were $496 million in 2018, a decline of 18% compared with 2017 including a 1% unfavorable effect from foreign exchange. The sales decline was driven by lower volumes in the United States. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and generic competition began in the second half of 2018. The Company is experiencing a significant decline in U.S. Invanz sales as a result of this generic competition and expects the decline to continue. Worldwide sales of Invanz were $602 million in 2017, an increase of 7% compared with 2016, driven primarily by higher sales in the United States, reflecting higher pricing that was partially offset by lower demand, as well as higher demand in Brazil. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, were $367 million in 2018, a decline of 4% compared with 2017 including a 1% favorable effect from foreign exchange. Worldwide sales of Cubicin were $382 million in 2017, a decline of 65% compared with 2016, resulting from generic competition in the United States following expiration of the U.S. composition patent for Cubicin in June 2016. Global sales of Cancidas , an anti-fungal product sold primarily outside of the United States, were $326 million in 2018, a decline of 23% compared with 2017, and were $422 million in 2017, a decline of 24% compared with 2016. Foreign exchange favorably affected global sales performance by 2% in 2018. The sales declines were driven primarily by generic competition in certain European markets. The EU compound patent for Cancidas expired in April 2017. Accordingly, the Company is experiencing a significant decline in Cancidas sales in these European markets and expects the decline to continue. Immunology Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $893 million in 2018, growth of 9% compared with 2017 including a 4% favorable effect from foreign exchange. Sales of Simponi were $819 million in 2017, growth of 7% compared with 2016 including a 1% favorable effect from foreign exchange. Sales growth in both years was driven by higher demand in Europe. The Company anticipates sales of Simponi will be unfavorably affected in future periods by the recent launch of biosimilars for a competing product. Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $582 million in 2018, a decline of 31% compared with 2017, and were $837 million in 2017, a decline of 34% compared with 2016. Foreign exchange favorably affected sales performance by 2% in 2018. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Virology Worldwide sales of Isentress/Isentress HD, an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, were $1.1 billion in 2018, a decline of 5% compared with 2017, and were $1.2 billion in 2017, a decline of 13% compared with 2016. Foreign exchange favorably affected global sales performance by 1% in 2017. The sales declines primarily reflect competitive pressure in the United States and Europe. In August 2018, the FDA approved two new HIV-1 medicines: Delstrigo , a once-daily fixed-dose combination tablet of doravirine, lamivudine and tenofovir disoproxil fumarate; and Pifeltro (doravirine), a new non-nucleoside reverse transcriptase inhibitor to be administered in combination with other antiretroviral medicines. Both Delstrigo and Pifeltro are indicated for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Delstrigo and Pifeltro were also approved by the EC in November 2018 . In January 2019, the FDA accepted for review supplemental New Drug Applications (NDA) for Pifeltro and Delstrigo seeking approval for use in patients living with HIV-1 who are switching from a stable antiretroviral regimen and whose virus is suppressed. The Prescription Drug User Fee Act (PDUFA) date for the supplemental NDAs is September 20, 2019. Global sales of Zepatier , a treatment for adult patients with certain types of chronic hepatitis C virus (HCV) infection, were $455 million in 2018, a decline of 73% compared with 2017. The sales decline was driven primarily by the unfavorable effects of increasing competition and declining patient volumes, particularly in the United States, Europe and Japan. The Company anticipates that sales of Zepatier in the future will continue to be adversely affected by competition and lower patient volumes. Worldwide sales of Zepatier were $1.7 billion in 2017 compared with $555 million in 2016. Sales growth in 2017 was driven primarily by higher sales in Europe, the United States and Japan following product launch in 2016. Cardiovascular Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ), Vytorin (marketed outside the United States as Inegy ), as well as Atozet and Rosuzet (both marketed in certain countries outside of the United States), medicines for lowering LDL cholesterol, were $1.8 billion in 2018, a decline of 26% compared with 2017 including a 3% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States and Europe. Zetia and Vytorin lost market exclusivity in the United States in December 2016 and April 2017, respectively. Accordingly, the Company experienced a rapid and substantial decline in U.S. Zetia and Vytorin sales as a result of generic competition and has lost nearly all U.S. sales of these products. In addition, the Company lost market exclusivity in major European markets for Ezetrol in April 2018 and has also lost market exclusivity in certain European markets for Inegy (see Note 11 to the consolidated financial statements). Accordingly, the Company is experiencing significant sales declines in these markets as a result of generic competition and expects the declines to continue. These declines were partially offset by higher sales in Japan due in part to the launch of Atozet . Combined worldwide sales of the ezetimibe family were $2.4 billion in 2017, a decline of 39% compared with 2016. The sales decline was driven by lower volumes and pricing of Zetia and Vytorin in the United States as a result of generic competition due to the loss of U.S. market exclusivity as described above. Pursuant to a collaboration with Bayer AG (Bayer) (see Note 4 to the consolidated financial statements), Merck has lead commercial rights for Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, in countries outside the Americas while Bayer has lead rights in the Americas, including the United States. The companies share profits equally under the collaboration. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. Merck recorded revenue related to Adempas of $329 million in 2018, an increase of 10% compared with 2017, reflecting higher sales in Mercks marketing territories, partially offset by lower profit sharing from Bayer due in part to lower pricing in the United States. Revenue related to Adempas was $300 million in 2017, an increase of 78% compared with 2016, reflecting both higher sales in Mercks marketing territories, as well as the recognition of higher profit sharing from Bayer. Foreign exchange favorably affected global sales performance by 3% in 2018 and by 1% in 2017. Diabetes Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were $5.9 billion in 2018, essentially flat compared with 2017. Global combined sales of Januvia and Janumet were $5.9 billion in 2017, a decline of 3% compared with 2016. Foreign exchange favorably affected sales performance by 1% in both 2018 and 2017. Sales performance in both periods was driven primarily by ongoing pricing pressure, particularly in the United States, partially offset by higher demand in most international markets. The Company expects pricing pressure to continue. Womens Health Worldwide sales of NuvaRing , a vaginal contraceptive product, were $902 million in 2018, an increase of 19% compared with 2017 including a 1% favorable effect from foreign exchange. Sales growth was driven primarily by higher pricing in the United States. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales in future periods as a result of generic competition. Global sales of NuvaRing were $761 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower sales in the United States reflecting lower volumes that were partially offset by higher pricing, and lower demand in Europe. Animal Health Segment Global sales of Animal Health products were $4.2 billion in 2018, an increase of 9% compared with 2017, reflecting growth from both in-line and recently launched companion animal and livestock products. Higher sales of companion animal products reflect growth in the Bravecto line of products that kill fleas and ticks in dogs and cats for up to 12 weeks, as well as higher sales of companion animal vaccines. Growth in livestock products reflects higher sales of ruminant, poultry and swine products. Worldwide sales of Animal Health products were $3.9 billion in 2017, an increase of 11% compared with 2016, primarily reflecting higher sales of companion animal products, largely driven by growth in Bravecto , reflecting both growth in the oral formulation and continued uptake in the topical formulation, which was launched in 2016. Animal Health sales growth in 2017 was also driven by higher sales of ruminant, poultry and swine products. In December 2018, the Company signed an agreement to acquire Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Costs, Expenses and Other ($ in millions) Change Change Cost of sales $ 13,509 % $ 12,912 % $ 14,030 Selling, general and administrative 10,102 % 10,074 % 10,017 Research and development 9,752 % 10,339 % 10,261 Restructuring costs % % Other (income) expense, net (402 ) % (500 ) * $ 33,593 % $ 33,601 % $ 35,148 * Greater than 100%. Cost of Sales Cost of sales was $13.5 billion in 2018 , $12.9 billion in 2017 and $14.0 billion in 2016 . Costs in 2018 include a $423 million charge related to the termination of a collaboration agreement with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine (see Note 3 to the consolidated financial statements). Also in 2018, the Company recorded $188 million of cumulative amortization expense for amounts capitalized in connection with the recognition of liabilities for potential future milestone payments related to collaborations (see Note 4 to the consolidated financial statements). Cost of sales includes expenses for the amortization of intangible assets recorded in connection with business acquisitions which totaled $2.7 billion in 2018, $3.1 billion in 2017 and $3.7 billion in 2016. Costs in 2017 and 2016 also include intangible asset impairment charges of $58 million and $347 million , respectively, related to marketed products and other intangibles recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). Costs in 2017 also include a $76 million intangible asset impairment charge related to a licensing agreement. The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Also included in cost of sales are expenses associated with restructuring activities which amounted to $21 million , $138 million and $181 million in 2018 , 2017 and 2016 , respectively, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 68.1% in 2018 compared with 67.8% in 2017 and 64.5% in 2016 . The year-over-year improvements in gross margin reflect a lower net impact from the amortization of intangible assets and intangible asset impairment charges related to business acquisitions, as well as restructuring costs as noted above, which reduced gross margin by 6.3 percentage points in 2018, 8.3 percentage points in 2017 and 10.6 percentage points in 2016. The gross margin improvement in 2018 compared with 2017 also reflects the favorable effects of product mix and amortization of unfavorable manufacturing variances recorded in 2017, resulting in part from the June 2017 cyber-attack. The gross margin improvement in 2018 was partially offset by a charge associated with the termination of a collaboration agreement with Samsung, as well as the unfavorable effects of pricing pressure and cumulative amortization expense for potential future milestone payments related to collaborations as noted above. The gross margin improvement in 2017 compared with 2016 also reflects the favorable effects of product mix. Manufacturing-related costs associated with the cyber-attack partially offset the gross margin improvement in 2017. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.1 billion in 2018, essentially flat compared with 2017, reflecting higher administrative costs and the unfavorable effect of foreign exchange, offset by lower selling and promotional expenses. SGA expenses were $10.1 billion in 2017, an increase of 1% compared with 2016. Higher administrative costs, including costs associated with the Company operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, remediation costs related to the cyber-attack, and higher promotional expenses related to product launches, were partially offset by lower restructuring and acquisition and divestiture-related costs, lower selling expenses and the favorable effect of foreign exchange. SGA expenses in 2016 include restructuring costs of $95 million related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. SGA expenses also include acquisition and divestiture-related costs of $32 million, $44 million and $78 million in 2018, 2017 and 2016, respectively, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Research and Development Research and development (RD) expenses were $9.8 billion in 2018, a decline of 6% compared with 2017. The decrease primarily reflects lower expenses in 2018 for upfront and license option payments related to the formation of oncology collaborations, lower in-process research and development (IPRD) impairment charges, and a reduction in expenses associated with a decrease in the estimated fair value measurement of liabilities for contingent consideration, partially offset by higher clinical development spending and investment in discovery and early drug development, as well as higher expenses related to other business development activities, including a charge in 2018 for the acquisition of Viralytics. RD expenses were $10.3 billion in 2017, an increase of 1% compared with 2016. The increase was driven primarily by a charge in 2017 related to the formation of a collaboration with AstraZeneca, an unfavorable effect from changes in the estimated fair value measurement of liabilities for contingent consideration, and higher clinical development spending, largely offset by lower IPRD impairment charges and lower restructuring costs. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $5.1 billion in 2018, $4.6 billion in 2017 and $4.4 billion in 2016. Also included in RD expenses are costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, as well as licensing activity, and certain costs from operating segments, including the Pharmaceutical and Animal Health segments, which in the aggregate were $2.8 billion, $2.9 billion and $2.6 billion for 2018, 2017 and 2016, respectively. Additionally, RD expenses in 2018 include a $1.4 billion charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), as well as a $344 million charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements). RD expenses in 2017 include a $2.35 billion charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). RD expenses also include IPRD impairment charges of $152 million , $483 million and $3.6 billion in 2018 , 2017 and 2016 , respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with acquisitions. During 2018 and 2016, the Company recorded a net reduction in expenses of $54 million and $402 million, respectively, to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs (see Note 6 to the consolidated financial statements). During 2017, the Company recorded charges of $27 million to increase the estimated fair value of liabilities for contingent consideration. RD expenses in 2016 also reflect $142 million of accelerated depreciation and asset abandonment costs associated with restructuring activities. Restructuring Costs In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $632 million , $776 million and $651 million in 2018 , 2017 and 2016 , respectively. In 2018 , 2017 and 2016 , separation costs of $473 million , $552 million and $216 million , respectively, were incurred associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Merck eliminated approximately 2,160 positions in 2018 , 2,450 positions in 2017 and 2,625 positions in 2016 related to these restructuring activities. Also included in restructuring costs are asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative and Research and development as discussed above. The Company recorded aggregate pretax costs of $658 million in 2018 , $927 million in 2017 and $1.1 billion in 2016 related to restructuring program activities (see Note 5 to the consolidated financial statements). The Company has substantially completed the actions under these programs. Other (Income) Expense, Net Other (income) expense, net, was $402 million of income in 2018 , $500 million of income in 2017 and $189 million of expense in 2016 . For details on the components of Other (income) expense, net, see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 24,292 $ 22,495 $ 22,141 Animal Health segment profits 1,659 1,552 1,357 Other non-reportable segment profits Other (17,353 ) (17,801 ) (18,985 ) Income before taxes $ 8,701 $ 6,521 $ 4,659 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA and RD expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are acquisition and divestiture-related costs (amortization of purchase accounting adjustments, intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration), restructuring costs, and a portion of equity income. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items, including a charge related to the termination of a collaboration agreement with Samsung for insulin glargine in 2018, a loss on the extinguishment of debt in 2017, and a charge related to the settlement of worldwide Keytruda patent litigation and gains on divestitures in 2016, are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. In the first quarter of 2018, the Company adopted a new accounting standard related to the classification of certain defined benefit plan costs, which resulted in a change to the measurement of segment profits (see Note 19 to the consolidated financial statements). Prior period amounts have been recast to conform to the new presentation. Pharmaceutical segment profits grew 8% in 2018 compared with 2017 primarily reflecting higher sales and lower selling and promotional costs. Pharmaceutical segment profits grew 2% in 2017 compared with 2016 primarily reflecting higher sales and the favorable effects of product mix. Animal Health segment profits grew 7% in 2018 and 14% in 2017 driven primarily by higher sales, partially offset by increased selling and promotional costs. Taxes on Income The effective income tax rates of 28.8% in 2018 , 62.9% in 2017 and 15.4% in 2016 reflect the impacts of acquisition and divestiture-related costs, restructuring costs and the beneficial impact of foreign earnings. The effective income tax rate in 2018 includes measurement-period adjustments to the provisional amounts recorded in 2017 associated with the enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA), including $124 million related to the transition tax (see Note 16 to the consolidated financial statements). In addition, the effective income tax rate for 2018 reflects the unfavorable impacts of a $1.4 billion pretax charge recorded in connection with the formation of a collaboration with Eisai and a $423 million pretax charge related to the termination of a collaboration agreement with Samsung for which no tax benefits were recognized. The effective income tax rate for 2017 includes a provisional net charge of $2.6 billion related to the enactment of the TCJA. The effective income tax rate for 2017 also reflects the unfavorable impact of a $2.35 billion pretax charge recorded in connection with the formation of a collaboration with AstraZeneca for which no tax benefit was recognized, partially offset by the favorable impact of a net tax benefit of $234 million related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), and a benefit of $88 million related to the settlement of a state income tax issue. Net (Loss) Income Attributable to Noncontrolling Interests Net (loss) income attributable to noncontrolling interests was $(27) million in 2018 compared with $24 million in 2017 and $21 million in 2016. The loss in 2018 primarily reflects the portion of goodwill impairment charges related to certain business in the Healthcare Services segment that are attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $6.2 billion in 2018 , $2.4 billion in 2017 and $3.9 billion in 2016 . EPS was $2.32 in 2018 , $0.87 in 2017 and $1.41 in 2016 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. Senior managements annual compensation is derived in part using non-GAAP income and non-GAAP EPS. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 8,701 $ 6,521 $ 4,659 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 3,066 3,760 7,312 Restructuring costs 1,069 Other items: Charge related to the formation of an oncology collaboration with Eisai 1,400 Charge related to the termination of a collaboration with Samsung Charge for the acquisition of Viralytics Charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Charge related to the settlement of worldwide Keytruda patent litigation Other (57 ) (16 ) (67 ) Non-GAAP income before taxes 14,535 13,542 13,598 Taxes on income as reported under GAAP 2,508 4,103 Estimated tax benefit on excluded items (1) 2,321 Net tax charge related to the enactment of the TCJA (2) (160 ) (2,625 ) Net tax benefit from the settlement of certain federal income tax issues Tax benefit related to the settlement of a state income tax issue Non-GAAP taxes on income 2,883 2,585 3,039 Non-GAAP net income 11,652 10,957 10,559 Less: Net (loss) income attributable to noncontrolling interests as reported under GAAP (27 ) Acquisition and divestiture-related costs attributable to noncontrolling interests (58 ) Non-GAAP net income attributable to noncontrolling interests 24 Non-GAAP net income attributable to Merck Co., Inc. $ 11,621 $ 10,933 $ 10,538 EPS assuming dilution as reported under GAAP $ 2.32 $ 0.87 $ 1.41 EPS difference (3) 2.02 3.11 2.37 Non-GAAP EPS assuming dilution $ 4.34 $ 3.98 $ 3.78 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Amount in 2017 was provisional (see Note 16 to the consolidated financial statements). (3) Represents the difference between calculated GAAP EPS and calculated non-GAAP EPS, which may be different than the amount calculated by dividing the impact of the excluded items by the weighted-average shares for the applicable year . Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects, and typically consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2017 is a charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), as well as a provisional net tax charge related to the enactment of the TCJA, a net tax benefit related to the settlement of certain federal income tax issues and a tax benefit related to the settlement of a state income tax issue (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2016 is a charge to settle worldwide patent litigation related to Keytruda . Research and Development A chart reflecting the Companys current research pipeline as of February 22, 2019 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma. This supplemental BLA is based on findings from the Phase 3 KEYNOTE-426 trial, which demonstrated that Keytruda in combination with axitinib, as compared to sunitinib, significantly improved overall survival (OS) and PFS in the first-line treatment of advanced renal cell carcinoma. These data were presented at the American Society for Clinical Oncology (ASCO) Genitourinary Cancers Symposium in February 2019. The supplemental BLA also included supporting data from the Phase 1b KEYNOTE-035 trial. The FDA set a PDUFA date of June 20, 2019. Merck has filed data from KEYNOTE-426 with regulatory authorities worldwide. In February 2019, the Committee for Medicinal Products for Human Use of the European Medicines Agency (EMA) adopted a positive opinion recommending Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of metastatic squamous NSCLC in adults. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-407 trial, which enrolled patients regardless of PD-L1 tumor expression status. The trial showed a significant improvement in OS and PFS for patients taking Keytruda in combination with chemotherapy (carboplatin and either paclitaxel or nab-paclitaxel) compared with chemotherapy alone. If approved, this would mark the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy for adults with metastatic squamous NSCLC. In October 2018, the FDA approved Keytruda in combination with carboplatin-paclitaxel or nab-paclitaxel as a first-line treatment for metastatic squamous NSCLC, regardless of PD-L1 expression. In December 2018, the FDA extended the action date for the supplemental BLA seeking approval for Keytruda as monotherapy for the first-line treatment of locally advanced or metastatic NSCLC in patients whose tumors express PD-L1 (TPS 1%) without EGFR or ALK genomic tumor aberrations. The supplemental BLA is based on results of the Phase 3 KEYNOTE-042 trial where Keytruda monotherapy demonstrated a significant improvement in OS compared with chemotherapy in this patient population. The Company submitted additional data and analyses to the FDA, which constituted a major amendment and extended the PDUFA date by three months to April 11, 2019. Merck continues to work closely with the FDA during the review of this supplemental BLA. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda as monotherapy for the treatment of patients with advanced SCLC whose disease has progressed after two or more lines of prior therapy. This supplemental BLA, which is seeking accelerated approval for this new indication, is based on data from the SCLC cohorts of the Phase 2 KEYNOTE-158 and Phase 1b KEYNOTE-028 trials. The FDA set a PDUFA date of June 17, 2019. Keytruda is also being studied in combination with chemotherapy in the ongoing Phase 3 KEYNOTE-604 study in patients with newly diagnosed extensive stage SCLC. In February 2019, the FDA accepted a supplemental BLA for Keytruda as monotherapy or in combination with platinum and 5-fluorouracil chemotherapy for the first-line treatment of patients with recurrent or metastatic HNSCC. This supplemental BLA is based in part on data from the pivotal Phase 3 KEYNOTE-048 trial where Keytruda demonstrated a significant improvement in OS compared with the standard of care, as monotherapy in patients whose tumors expressed PD-L1 with Combined Positive Score (CPS)20 and CPS1 and in combination with chemotherapy in the total patient population. These data were presented at the European Society for Medical Oncology (ESMO) 2018 Congress. The FDA granted Priority Review to the supplemental BLA and set a PDUFA date of June 10, 2019. KEYNOTE-048 also serves as the confirmatory trial for KEYNOTE-012, a Phase 1b study which supported the previous accelerated approval for Keytruda as monotherapy for the treatment of patients with recurrent or metastatic HNSCC with disease progression on or after platinum-containing chemotherapy. In November 2018, Merck announced that the Phase 3 KEYNOTE-181 trial investigating Keytruda as monotherapy in the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma met a primary endpoint of OS in patients whose tumors expressed PD-L1 (CPS 10). In this pivotal study, treatment with Keytruda resulted in a statistically significant improvement in OS compared to chemotherapy (paclitaxel, docetaxel or irinotecan) in patients with CPS 10, regardless of histology. The primary endpoint of OS was also evaluated in patients with squamous cell histology and in the entire intention-to-treat study population. While directionally favorable, statistical significance for OS was not met in these two patient groups. Per the statistical analysis plan, the key secondary endpoints of PFS and objective response rate (ORR) were not formally tested, as OS was not reached in the full intention-to-treat study population. These results were presented in January 2019 at the ASCO Gastrointestinal Cancers Symposium and have been submitted for regulatory review. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In October 2018, Merck announced the first presentation of results from an interim analysis of KEYNOTE-057, a Phase 2 trial evaluating Keytruda for previously treated patients with high-risk non-muscle invasive bladder cancer. An interim analysis of the studys primary endpoint showed a complete response rate of nearly 40% at three months with Keytruda in patients whose disease was unresponsive to Bacillus Calmette-Gurin therapy, the current standard of care for this disease, and who were ineligible for or who refused to undergo radical cystectomy. These results, as well as other study findings, were presented at the ESMO 2018 Congress. In February 2019, Merck announced that the pivotal Phase 3 KEYNOTE-240 trial evaluating Keytruda , plus best supportive care, for the treatment of patients with advanced hepatocellular carcinoma who were previously treated with systemic therapy, did not meet its co-primary endpoints of OS and PFS compared with placebo plus best supportive care. In the final analysis of the study, there was an improvement in OS for patients treated with Keytruda compared to placebo, however these OS results did not meet statistical significance per the pre-specified statistical plan. Results for PFS were also directionally favorable in the Keytruda arm compared with placebo but did not reach statistical significance. The key secondary endpoint of ORR was not formally tested, since superiority was not reached for OS or PFS. Results will be presented at an upcoming medical meeting and have been shared with the FDA for discussion. The Keytruda clinical development program consists of more than 900 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, cervical, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Lynparza, is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4 to the consolidated financial statements). In April 2018, Merck and AstraZeneca announced that the EMA validated for review the Marketing Authorization Application for Lynparza for use in patients with deleterious or suspected deleterious BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. This was the first regulatory submission for a PARP inhibitor in breast cancer in Europe. Lynparza tablets are also under review in the EU as a maintenance treatment in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response following first-line standard platinum-based chemotherapy. This submission was based on positive results from the pivotal Phase 3 SOLO-1 trial. The trial showed a statistically-significant and clinically-meaningful improvement in PFS for Lynparza compared to placebo, reducing the risk of disease progression or death by 70% in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response to platinum-based chemotherapy. In December 2018, Merck and AstraZeneca announced positive results from the randomized, open-label, controlled, Phase 3 SOLO-3 trial of Lynparza tablets in patients with relapsed ovarian cancer after two or more lines of treatment. The trial was conducted as a post-approval commitment in agreement with the FDA. Results from the trial showed BRCA -mutated advanced ovarian cancer patients treated with Lynparza following two or more prior lines of chemotherapy demonstrated a statistically significant and clinically meaningful improvement in the primary endpoint of ORR and the key secondary endpoint of PFS compared to chemotherapy. Merck and AstraZeneca plan to discuss these results with the FDA. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). In February 2019, Merck announced that the FDA accepted for Priority Review an NDA for MK-7655A for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. The PDUFA date is July 16, 2019. In April 2018, Merck announced that a pivotal Phase 3 study of MK-7655A demonstrated a favorable overall response in the treatment of certain imipenem-non-susceptible bacterial infections, the primary endpoint, with lower treatment-emergent nephrotoxicity (kidney toxicity), a secondary endpoint, compared to a colistin (colistimethate sodium) plus imipenem/cilastatin regimen. The FDA had previously designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. V920 (rVSVG-ZEBOV-GP, live attenuated), is an investigational Ebola Zaire disease vaccine candidate being studied in large scale Phase 2/3 clinical trials. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The WHO decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In November 2018, Merck announced that it has started the submission of a rolling BLA to the FDA for V920. This rolling submission was made pursuant to the FDAs Breakthrough Therapy designation. Merck expects the rolling submission of the BLA to be completed in 2019. The Company also intends to file V920 with the EMA in 2019. In February 2019, Merck announced that the FDA accepted for Priority Review a supplemental NDA for Zerbaxa to treat adult patients with nosocomial pneumonia, including ventilator-associated pneumonia, caused by certain susceptible Gram-negative microorganisms. The PDUFA date is June 3, 2019. Zerbaxa is also under review for this indication by the EMA. Zerbaxa is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor agonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. Lenvima, is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. In March 2018, Merck and Eisai entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (see Note 4 to the consolidated financial statements). Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Per the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination to support 11 potential indications in six types of cancer (endometrial cancer, NSCLC, hepatocellular carcinoma, head and neck cancer, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma and for the potential treatment of certain patients with advanced and/or metastatic non-microsatellite instability high/proficient mismatch repair endometrial carcinoma. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure with reduced ejection fracture (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fracture (Phase 2 clinical trial). The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently five Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, three studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. In January 2019, Merck announced that V114 received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age. As a result of changes in the herpes zoster vaccine environment, Merck is ending development of V212, its investigational vaccine for the prevention of shingles in immunocompromised patients. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2018 , the balance of IPRD was $1.1 billion . The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date, and the Company may also not recover the research and development expenditures made since the acquisition to further develop such programs. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2018, 2017, and 2016 the Company recorded IPRD impairment charges within Research and development expenses of $152 million , $483 million and $3.6 billion , respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain of the more recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks anti-PD-1 therapy, Keytruda . Under the agreement, Merck made an upfront payment to Eisai of $750 million and will make payments of up to $650 million for certain option rights through 2021 (of which $325 million will be paid in March 2019, $200 million is expected to be paid in 2020 and $125 million is expected to be paid in 2021). The Company recorded a charge of $1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for Eisai to receive up to $385 million associated with the achievement of certain clinical and regulatory milestones and up to $3.97 billion for the achievement of milestones associated with sales of Lenvima (see Note 4 to the consolidated financial statements). In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $378 million ). The transaction provided Merck with full rights to Cavatak (V937, formerly CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatak is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatak is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatak combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $34 million (primarily cash) at the acquisition date and Research and development expenses of $344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In February 2019, Merck and Immune Design entered into a definitive agreement under which Merck will acquire Immune Design for $5.85 per share in cash for an approximate value of $300 million. Immune Design is a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease. Immune Designs proprietary technologies, GLAAS and ZVex, are engineered to activate the immune systems natural ability to generate and/or expand antigen-specific cytotoxic immune cells to fight cancer and other chronic diseases. Under the terms of the acquisition agreement, Merck, through a subsidiary, will initiate a tender offer to acquire all outstanding shares of Immune Design. The closing of the tender offer will be subject to certain conditions, including the tender of shares representing at least a majority of the total number of Immune Designs outstanding shares, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and other customary conditions. The transaction is expected to close early in the second quarter of 2019. Capital Expenditures Capital expenditures were $2.6 billion in 2018 , $1.9 billion in 2017 and $1.6 billion in 2016 . Expenditures in the United States were $1.5 billion in 2018 , $1.2 billion in 2017 and $1.0 billion in 2016 . In October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022. The focus of this investment will primarily be on increasing manufacturing capacity across Mercks key businesses. Depreciation expense was $1.4 billion in 2018 , $1.5 billion in 2017 and $1.6 billion in 2016 . In each of these years, $1.0 billion of the depreciation expense applied to locations in the United States. Total depreciation expense in 2017 and 2016 included accelerated depreciation of $60 million and $227 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 3,669 $ 6,152 $ 13,410 Total debt to total liabilities and equity 30.4 % 27.8 % 26.0 % Cash provided by operations to total debt 0.4:1 0.3:1 0.4:1 The decline in working capital in 2018 compared with 2017 reflects the utilization of cash and short-term borrowings to fund $5.0 billion of ASR agreements, a $1.25 billion payment to redeem debt in connection with the exercise of a make-whole provision as discussed below, as well as a $750 million upfront payment related to the formation of a collaboration with Eisai discussed above. The decline in working capital in 2017 compared with 2016 primarily reflects the reclassification of $3.0 billion of notes due in the first half of 2018 from long-term debt to short-term debt, $1.85 billion of upfront and option payments related to the formation of the AstraZeneca collaboration discussed above, as well as $810 million paid to redeem debt in connection with tender offers discussed below. Cash provided by operating activities was $10.9 billion in 2018 , $6.5 billion in 2017 and $10.4 billion in 2016 . The lower cash provided by operating activities in 2017 reflects a $2.8 billion payment related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), payments of $1.85 billion related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), and a $625 million payment made by the Company related to the previously disclosed settlement of worldwide Keytruda patent litigation. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash provided by investing activities was $4.3 billion in 2018 compared with $2.7 billion in 2017. The increase in cash provided by investing activities was driven primarily by lower purchases of securities and other investments, partially offset by higher capital expenditures, lower proceeds from the sales of securities and other investments, and a $350 million milestone payment in 2018 related to a collaboration with Bayer (see Note 4 to the consolidated financial statements). Cash provided by investing activities was $2.7 billion in 2017 compared with a use of cash in investing activities of $3.2 billion in 2016. The change was driven primarily by lower purchases of securities and other investments, higher proceeds from the sales of securities and other investments and a lower use of cash for the acquisitions of businesses. Cash used in financing activities was $13.2 billion in 2018 compared with $10.0 billion in 2017. The increase in cash used in financing activities was driven primarily by higher purchases of treasury stock (largely under ASR agreements as discussed below), higher payments on debt and payment of contingent consideration related to a prior year business acquisition, partially offset by an increase in short-term borrowings. Cash used in financing activities was $10.0 billion in 2017 compared with $9.0 billion in 2016. The increase in cash used in financing activities was driven primarily by proceeds from the issuance of debt in 2016, as well as higher purchases of treasury stock and lower proceeds from the exercise of stock options in 2017, partially offset by lower payments on debt in 2017. The Companys contractual obligations as of December 31, 2018 are as follows: Payments Due by Period ($ in millions) Total 20202021 20222023 Thereafter Purchase obligations (1) $ 2,349 $ $ 1,011 $ $ Loans payable and current portion of long-term debt 5,309 5,309 Long-term debt 19,882 4,237 4,000 11,645 Interest related to debt obligations 7,680 1,163 4,923 Unrecognized tax benefits (2) Transition tax related to the enactment of the TCJA (3) 4,899 1,217 2,534 Leases $ 41,160 $ 7,364 $ 7,632 $ 6,774 $ 19,390 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2018 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $2.3 billion , including $44 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2019 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years as permitted under the TCJA (see Note 16 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts reflected for research and development obligations do not include contingent milestone payments related to collaborative arrangements and acquisitions. Contingent milestone payments are not considered contractual obligations as they are contingent upon the successful achievement of developmental, regulatory approval and commercial milestones. At December 31, 2018 , the Company has liabilities for milestone payments related to collaborations with AstraZeneca, Eisai and Bayer (see Note 4 to the consolidated financial statements). Also excluded from research and development obligations are potential future funding commitments of up to approximately $40 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $149 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2019 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $50 million to its U.S. pension plans, $150 million to its international pension plans and $15 million to its other postretirement benefit plans during 2019 . In December 2018, the Company exercised a make-whole provision on its $1.25 billion , 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. In November 2016, the Company issued 1.0 billion principal amount of senior unsecured notes consisting of 500 million principal amount of 0.50% notes due 2024 and 500 million principal amount of 1.375% notes due 2036. The Company used the net proceeds of the offering of $1.1 billion for general corporate purposes. The Company has a $6.0 billion credit facility that matures in June 2023. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In October 2018, Merck announced that its Board of Directors approved a 15% increase to the Companys quarterly dividend, raising it to $0.55 per share from $0.48 per share on the Companys outstanding common stock. Payment was made in January 2019. In January 2019 , the Board of Directors declared a quarterly dividend of $0.55 per share on the Companys common stock for the second quarter of 2019 payable in April 2019 . In November 2017, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. In October 2018, Mercks Board of Directors authorized an additional $10 billion of treasury stock purchases with no time limit for completion and the Company entered into ASR agreements of $5 billion as discussed below. The Company spent $9.1 billion to purchase shares of its common stock for its treasury during 2018 . As of December 31, 2018 , the Companys remaining share repurchase authorization was $11.9 billion. The Company purchased $4.0 billion and $3.4 billion of its common stock during 2017 and 2016 , respectively, under authorized share repurchase programs. On October 25, 2018, the Company entered into ASR agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The number of shares of Mercks common stock that Merck may receive, or may be required to remit, upon final settlement under the ASR agreements will be based upon the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount. Final settlement of the transaction under the ASR agreements is expected to occur in the first half of 2019, but may occur earlier at the option of the Dealers, or later under certain circumstances. If Merck is obligated to make adjustment payments to the Dealers under the ASR agreements, Merck may elect to satisfy such obligations in cash or in shares of Mercks common stock. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $441 million and $400 million at December 31, 2018 and 2017 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2018 and 2017 , Income before taxes would have declined by approximately $134 million and $92 million in 2018 and 2017 , respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within Other Comprehensive Income (Loss) ( OCI ), and remain in Accumulated Other Comprehensive Income (Loss) ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . In accordance with the new guidance adopted on January 1, 2018 (see Note 2 to the consolidated financial statements), the Company has elected to recognize in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In May 2018, four interest rate swaps with notional amounts aggregating $1.0 billion matured. These swaps effectively converted the Companys $1.0 billion , 1.30% fixed-rate notes due 2018 to variable rate debt. In December 2018, in connection with the early repayment of debt, the Company settled three interest rate swaps with notional amounts aggregating $550 million . These swaps effectively converted a portion of the Companys $1.25 billion , 5.00% notes due 2019 to variable rate debt. At December 31, 2018 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2018 and 2017 would have positively affected the net aggregate market value of these instruments by $1.2 billion and $1.3 billion, respectively. A one percentage point decrease at December 31, 2018 and 2017 would have negatively affected the net aggregate market value by $1.4 billion and $1.5 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a separate determination as to the then-useful life of the asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Revenue Recognition On January 1, 2018, the Company adopted a new standard on revenue recognition (see Note 2 to the consolidated financial statements). Changes to the Companys revenue recognition policy as a result of adopting the new guidance are described below. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. Certain Merck entities, including U.S. entities, have contract terms under which control of the goods passes to the customer upon shipment; however, either pursuant to the terms of the contract or as a business practice, Merck retains responsibility for goods lost or damaged in transit. Prior to the adoption of the new standard, Merck would recognize revenue for these entities upon delivery of the goods. Under the new guidance, the Company is now recognizing revenue at time of shipment for these entities. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2018 , 2017 or 2016 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,551 $ 2,945 Current provision 10,837 11,001 Adjustments to prior years (117 ) (286 ) Payments (10,641 ) (11,109 ) Balance December 31 $ 2,630 $ 2,551 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $245 million and $2.4 billion , respectively, at December 31, 2018 and were $198 million and $2.4 billion , respectively, at December 31, 2017 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 1.6% in 2018, 2.1% in 2017 and 1.4% in 2016. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically net 36 days from receipt of invoice and for U.S. animal health customers are typically net 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2018 and 2017 were $7 million and $80 million , respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2018 and 2017 of approximately $245 million and $160 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $16 million in 2018 , and are estimated at $57 million in the aggregate for the years 2019 through 2023 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $348 million in 2018 , $312 million in 2017 and $300 million in 2016 . At December 31, 2018 , there was $560 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $195 million in 2018 , $201 million in 2017 and $144 million in 2016 . Net periodic benefit (credit) for other postretirement benefit plans was $(45) million in 2018 , $(60) million in 2017 and $(88) million in 2016 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 4.00% to 4.40% at December 31, 2018 , compared with a range of 3.20% to 3.80% at December 31, 2017 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2019 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.10% , compared to a range of 7.70% to 8.30% in 2018 . The decrease is primarily due to a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 50% in U.S. equities, 15% to 30% in international equities, 30% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $80 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2018 . A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $50 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2018 . Required funding obligations for 2019 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the project. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized within the Companys operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2018 and 2017 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2018 , the notes to consolidated financial statements, and the report dated February 27, 2019 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 42,294 $ 40,122 $ 39,807 Costs, Expenses and Other Cost of sales 13,509 12,912 14,030 Selling, general and administrative 10,102 10,074 10,017 Research and development 9,752 10,339 10,261 Restructuring costs Other (income) expense, net (402 ) (500 ) 33,593 33,601 35,148 Income Before Taxes 8,701 6,521 4,659 Taxes on Income 2,508 4,103 Net Income 6,193 2,418 3,941 Less: Net (Loss) Income Attributable to Noncontrolling Interests (27 ) Net Income Attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 2.34 $ 0.88 $ 1.42 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 2.32 $ 0.87 $ 1.41 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Other Comprehensive (Loss) Income Net of Taxes: Net unrealized gain (loss) on derivatives, net of reclassifications (446 ) (66 ) Net unrealized loss on investments, net of reclassifications (10 ) (58 ) (44 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization (425 ) (799 ) Cumulative translation adjustment (223 ) (169 ) (361 ) (1,078 ) Comprehensive Income Attributable to Merck Co., Inc. $ 5,859 $ 2,710 $ 2,842 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 7,965 $ 6,092 Short-term investments 2,406 Accounts receivable (net of allowance for doubtful accounts of $119 in 2018 and $159 in 2017) 7,071 6,873 Inventories (excludes inventories of $1,417 in 2018 and $1,187 in 2017 classified in Other assets - see Note 7) 5,440 5,096 Other current assets 4,500 4,299 Total current assets 25,875 24,766 Investments 6,233 12,125 Property, Plant and Equipment (at cost) Land Buildings 11,486 11,726 Machinery, equipment and office furnishings 14,441 14,649 Construction in progress 3,355 2,301 29,615 29,041 Less: accumulated depreciation 16,324 16,602 13,291 12,439 Goodwill 18,253 18,284 Other Intangibles, Net 11,431 14,183 Other Assets 7,554 6,075 $ 82,637 $ 87,872 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 5,308 $ 3,057 Trade accounts payable 3,318 3,102 Accrued and other current liabilities 10,151 10,427 Income taxes payable 1,971 Dividends payable 1,458 1,320 Total current liabilities 22,206 18,614 Long-Term Debt 19,806 21,353 Deferred Income Taxes 1,702 2,219 Other Noncurrent Liabilities 12,041 11,117 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2018 and 2017 1,788 1,788 Other paid-in capital 38,808 39,902 Retained earnings 42,579 41,350 Accumulated other comprehensive loss (5,545 ) (4,910 ) 77,630 78,130 Less treasury stock, at cost: 984,543,979 shares in 2018 and 880,491,914 shares in 2017 50,929 43,794 Total Merck Co., Inc. stockholders equity 26,701 34,336 Noncontrolling Interests Total equity 26,882 34,569 $ 82,637 $ 87,872 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2016 $1,788 $ 40,222 $ 45,348 $ (4,148 ) $ (38,534 ) $ $ 44,767 Net income attributable to Merck Co., Inc. 3,920 3,920 Other comprehensive loss, net of taxes (1,078 ) (1,078 ) Cash dividends declared on common stock ($1.85 per share) (5,135 ) (5,135 ) Treasury stock shares purchased (3,434 ) (3,434 ) Acquisition of The StayWell Company LLC Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (16 ) (16 ) Share-based compensation plans and other (283 ) 1,422 1,139 Balance December 31, 2016 1,788 39,939 44,133 (5,226 ) (40,546 ) 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) (5,177 ) (5,177 ) Treasury stock shares purchased (4,014 ) (4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (18 ) (18 ) Share-based compensation plans and other (37 ) Balance December 31, 2017 1,788 39,902 41,350 (4,910 ) (43,794 ) 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards (see Note 2) (274 ) Other comprehensive loss, net of taxes (361 ) (361 ) Cash dividends declared on common stock ($1.99 per share) (5,313 ) (5,313 ) Treasury stock shares purchased (1,000 ) (8,091 ) (9,091 ) Net loss attributable to noncontrolling interests (27 ) (27 ) Distributions attributable to noncontrolling interests (25 ) (25 ) Share-based compensation plans and other (94 ) Balance December 31, 2018 $ 1,788 $ 38,808 $ 42,579 $ (5,545 ) $ (50,929 ) $ $ 26,882 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 6,193 $ 2,418 $ 3,941 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,519 4,676 5,471 Intangible asset impairment charges 3,948 Charge for future payments related to collaboration license options Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Charge related to the settlement of worldwide Keytruda patent litigation Deferred income taxes (509 ) (2,621 ) (1,521 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable (418 ) (619 ) Inventories (911 ) (145 ) Trade accounts payable Accrued and other current liabilities (341 ) (922 ) (2,018 ) Income taxes payable (3,291 ) Noncurrent liabilities (266 ) (123 ) (809 ) Other (674 ) (1,087 ) Net Cash Provided by Operating Activities 10,922 6,451 10,376 Cash Flows from Investing Activities Capital expenditures (2,615 ) (1,888 ) (1,614 ) Purchases of securities and other investments (7,994 ) (10,739 ) (15,651 ) Proceeds from sales of securities and other investments 15,252 15,664 14,353 Acquisitions, net of cash acquired (431 ) (396 ) (780 ) Other Net Cash Provided by (Used in) Investing Activities 4,314 2,679 (3,210 ) Cash Flows from Financing Activities Net change in short-term borrowings 5,124 (26 ) Payments on debt (4,287 ) (1,103 ) (2,386 ) Proceeds from issuance of debt 1,079 Purchases of treasury stock (9,091 ) (4,014 ) (3,434 ) Dividends paid to stockholders (5,172 ) (5,167 ) (5,124 ) Proceeds from exercise of stock options Other (325 ) (195 ) (118 ) Net Cash Used in Financing Activities (13,160 ) (10,006 ) (9,044 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash (205 ) (131 ) Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 1,871 (419 ) (2,009 ) Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $4 million of restricted cash at January 1, 2018 included in Other Assets) 6,096 6,515 8,524 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $2 million of restricted cash at December 31, 2018 included in Other Assets) $ 7,967 $ 6,096 $ 6,515 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. In 2017, Merck began recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9). 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers , and subsequent amendments (ASC 606 or new guidance), using the modified retrospective method. Merck applied the new guidance to all contracts with customers within the scope of the standard that were in effect on January 1, 2018 and recognized the cumulative effect of initially applying the new guidance as an adjustment to the opening balance of retained earnings (see Recently Adopted Accounting Standards below). Comparative information for prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods. The new guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The new guidance introduces a 5-step model to recognize revenue when or as control is transferred: identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when or as the performance obligations are satisfied. Changes to the Companys revenue recognition policy as a result of adopting ASC 606 are described below. See Note 19 for disaggregated revenue disclosures. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. Certain Merck entities, including U.S. entities, have contract terms under which control of the goods passes to the customer upon shipment; however, either pursuant to the terms of the contract or as a business practice, Merck retains responsibility for goods lost or damaged in transit. Prior to the adoption of the new standard, Merck would recognize revenue for these entities upon delivery of the goods. Under the new guidance, the Company is now recognizing revenue at time of shipment for these entities. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $10.7 billion in 2018, $10.7 billion in 2017 and $9.7 billion in 2016. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $245 million and $2.4 billion , respectively, at December 31, 2018 and were $198 million and $2.4 billion , respectively, at December 31, 2017 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically net 36 days from receipt of invoice and for U.S. animal health customers are typically net 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. The following table provides the effects of adopting ASC 606 on the Consolidated Statement of Income: Year Ended December 31, 2018 As Reported Effects of Adopting ASC 606 Amounts Without Adoption of ASC 606 Sales $ 42,294 $ (2 ) $ 42,292 Cost of sales 13,509 (6 ) 13,503 Income before taxes 8,701 8,705 Taxes on income 2,508 2,509 Net income attributable to Merck Co., Inc. 6,220 6,223 The following table provides the effects of adopting ASC 606 on the Consolidated Balance Sheet: December 31, 2018 As Reported Effects of Adopting ASC 606 Amounts Without Adoption of ASC 606 Assets Accounts receivable $ 7,071 $ (13 ) $ 7,058 Inventories 5,440 5,447 Liabilities Accrued and other current liabilities 10,151 (3 ) 10,148 Income taxes payable 1,971 (1 ) 1,970 Equity Retained earnings 42,579 (2 ) 42,577 Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $1.4 billion in 2018 , $1.5 billion in 2017 and $1.6 billion in 2016 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.1 billion , $2.2 billion and $2.1 billion in 2018 , 2017 and 2016 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $439 million and $449 million , net of accumulated amortization at December 31, 2018 and 2017 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development Acquired IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Adopted Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition (ASU 2014-09) that applies to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard was effective as of January 1, 2018 and was adopted using the modified retrospective method. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million . In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments (ASU 2016-01) and in 2018 issued related technical corrections (ASU 2018-03). The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The Company has elected to measure equity investments without readily determinable fair values at cost, adjusted for subsequent observable price changes and less impairments, which will be recognized in net income. The new guidance also changed certain disclosure requirements. ASU 2016-01 was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million . ASU 2018-03 was also adopted as of January 1, 2018 on a prospective basis and did not result in any additional impacts upon adoption. In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory (ASU 2016-16). The new guidance requires the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs, replacing the prohibition against doing so. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The new standard was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $54 million with a corresponding decrease to Deferred Income Taxes . In August 2017, the FASB issued new guidance on hedge accounting (ASU 2017-12) that is intended to more closely align hedge accounting with companies risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The Company elected to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The new guidance was applied to all existing hedges as of the adoption date. For fair value hedges of interest rate risk outstanding as of the date of adoption, the Company recorded a cumulative-effect adjustment upon adoption to the basis adjustment on the hedged item resulting from applying the benchmark component of the coupon guidance. This adjustment decreased Retained earnings by $11 million . Also, in accordance with the transition provisions of ASU 2017-12, the Company was required to eliminate the separate measurement of ineffectiveness for its cash flow hedging instruments existing as of the adoption date through a cumulative-effect adjustment to retained earnings; however, all such amounts were de minimis . In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the Tax Cuts and Jobs Act of 2017 (TCJA) (ASU 2018-02). Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of the stranded tax effects resulting from the TCJA from accumulated other comprehensive income to retained earnings thereby eliminating these stranded tax effects. The Company elected to early adopt the new guidance in the first quarter of 2018 and reclassified the stranded income tax effects of the TCJA, increasing Accumulated other comprehensive loss in the amount of $266 million with a corresponding increase to Retained earnings (see Note 18). The Companys policy for releasing disproportionate income tax effects from Accumulated other comprehensive loss is to utilize the item-by-item approach. The impact of adopting the above standards is as follows: ($ in millions) ASU 2014-09 (Revenue) ASU 2016-01 (Financial Instruments) ASU 2016-16 (Intra-Entity Transfers of Assets Other than Inventory) ASU 2017-12 (Derivatives and Hedging) ASU 2018-02 (Reclassification of Certain Tax Effects) Total Assets - Increase (Decrease) Accounts receivable $ $ Liabilities - Increase (Decrease) Income Taxes Payable (3 ) (3 ) Debt Deferred Income Taxes (54 ) (54 ) Equity - Increase (Decrease) Retained earnings (11 ) Accumulated other comprehensive loss (8 ) (266 ) (274 ) In March 2017, the FASB issued amended guidance on retirement benefits (ASU 2017-07) related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. The Company adopted the new standard as of January 1, 2018 using a retrospective transition method as to the requirement for separate presentation in the income statement of service costs and other components, and a prospective transition method as to the requirement to limit the capitalization of benefit costs to the service cost component. The Company utilized a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. Upon adoption, net periodic benefit cost (credit) other than service cost of $(512) million and $(531) million for the years ended December 31, 2017 and 2016, respectively, was reclassified to Other (income) expense, net from the previous classification within Cost of sales , Selling, general and administrative expenses and Research and development expenses (see Note 15). In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The Company adopted the new standard effective as of January 1, 2018 using a retrospective application. There were no changes to the presentation of the Consolidated Statement of Cash Flows in the previous years presented as a result of adopting the new standard. In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard was effective as of January 1, 2018 and was adopted using a retrospective application. The adoption of the new guidance did not have a material effect on the Companys Consolidated Statement of Cash Flows. In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted the new standard effective as of January 1, 2018 and will apply the new guidance to future share-based payment award modifications should they occur. In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The Company adopted the new standard in the fourth quarter of 2018 and applied the new guidance for purposes of its fourth quarter goodwill impairment assessment. The adoption of the new guidance had an immaterial effect on its consolidated financial statements. Recently Issued Accounting Standards Not Yet Adopted In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases and subsequently issued several updates to the new guidance. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new standard is effective as of January 1, 2019 and will be adopted using a modified retrospective approach. Merck will elect the transition method that allows for application of the standard at the adoption date rather than at the beginning of the earliest comparative period presented in the financial statements. The Company intends to elect available practical expedients. Merck has implemented a lease accounting software application and has completed data validation of the Companys portfolio of leases, including its assessment of potential embedded leases. Upon adoption, the Company anticipates it will recognize approximately $1 billion of additional assets and corresponding liabilities on its consolidated balance sheet, subject to finalization. In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In April 2018, the FASB issued new guidance on the accounting for costs incurred to implement a cloud computing arrangement that is considered a service arrangement. The new guidance requires the capitalization of such costs, aligning it with the accounting for costs associated with developing or obtaining internal-use software. The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. Prospective adoption for eligible costs incurred on or after the date of adoption or retrospective adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements and may elect to early adopt this guidance. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under the recently issued guidance on revenue recognition (ASC 606). The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Announced Transaction In December 2018, Merck and privately held Antelliq Group (Antelliq) signed a definitive agreement under which Merck will acquire Antelliq from funds advised by BC Partners. Antelliq is a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck will make a cash payment of approximately 2.1 billion (approximately $2.4 billion based on exchange rates at the time of the announcement) to acquire all outstanding shares of Antelliq and will assume Antelliqs debt of 1.1 billion (approximately $1.3 billion ), which it intends to repay shortly after the closing of the acquisition. The transaction is subject to clearance by antitrust and competition law authorities and other customary closing conditions, and is expected to close in the second quarter of 2019. 2018 Transactions In 2018, the Company recorded an aggregate charge of $423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $155 million , which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $137 million , inventory write-offs of $122 million , as well as other related costs of $9 million . The termination of this agreement has no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $378 million ). The transaction provided Merck with full rights to Cavatak (V937, formerly CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatak is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatak is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatak combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $34 million (primarily cash) at the acquisition date and Research and development expenses of $344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, MK-4621 (formerly RGT100), is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Valle for $358 million . Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $297 million related to currently marketed products, net deferred tax liabilities of $102 million , other net assets of $32 million and noncontrolling interest of $25 million . In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $156 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5% . Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Valle for $18 million , which reduced the noncontrolling interest related to Valle. 2016 Transactions In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferents lead investigational candidate, MK-7264 (formerly AF-219), gefapixant, is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough and for the treatment of endometriosis-related pain. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPRD of $832 million , net deferred tax liabilities of $258 million , and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. In 2018, as a result of the achievement of a clinical development milestone, Merck made a $175 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6). In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Mercks Keytruda . Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million , which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda . Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents. In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provided Merck with IOmets preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5% . Merck recognized intangible assets for IPRD of $155 million and net deferred tax assets of $32 million . The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5% . Actual cash flows are likely to be different than those assumed. In 2017, as a result of the achievement of a clinical development milestone, Merck made a $100 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6). Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZeneca is currently the principal on Lynparza sales transactions. Merck records its share of Lynparza product sales, net of cost of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and will make payments of up to $750 million over a multi-year period for certain license options (of which $250 million was paid in December 2017, $400 million was paid in December 2018 and $100 million is expected be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license option payments. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of regulatory and sales-based milestones. In 2018, Merck determined it was probable that annual sales of Lynparza in the future would trigger three sales-based milestone payments from Merck to AstraZeneca aggregating $600 million . Accordingly, in 2018, Merck recorded $600 million of liabilities and a corresponding increase to the intangible asset related to Lynparza, and recognized $58 million of cumulative amortization expense within Cost of sales . During 2018, one of the sales-based milestones was triggered, resulting in a $150 million payment to AstraZeneca. In 2018, Merck made an additional $100 million sales-based milestone payment, which was accrued for in 2017 when the Company deemed to the payment to be probable. The remaining $3.4 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer and for use in the first-line maintenance setting for advanced ovarian cancer, triggering capitalized milestone payments of $140 million in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $1.76 billion remain under the agreement. The asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $743 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 2,419 December 31 Receivables from AstraZeneca included in Other current assets $ $ Payables to AstraZeneca included in Accrued and other current liabilities (3) Payables to AstraZeneca included Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2017 includes $2.35 billion related to the upfront payment and future license option payments. (3) Includes accrued milestone and license option payments. Eisai In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks anti-PD-1 therapy, Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share gross profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development, including for studies evaluating Lenvima as monotherapy, are shared equally by the two companies and reflected in Research and development expenses. Under the agreement, Merck made an upfront payment to Eisai of $750 million and will make payments of up to $650 million for certain option rights through 2021 (of which $325 million will be paid in March 2019, $200 million is expected to be paid in 2020 and $125 million is expected to be paid in 2021). The Company recorded an aggregate charge of $1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for Eisai to receive up to $385 million associated with the achievement of certain clinical and regulatory milestones and up to $3.97 billion for the achievement of milestones associated with sales of Lenvima. In 2018, Merck determined it was probable that annual sales of Lenvima in the future would trigger three sales-based milestone payments from Merck to Eisai aggregating $268 million . Accordingly, in 2018, Merck recorded $268 million of liabilities and a corresponding increase to the intangible asset related to Lenvima, and recognized $24 million of cumulative amortization expense within Cost of sales . The remaining $3.71 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lenvima was approved for the treatment of patients with unresectable hepatocellular carcinoma in the United States, the European Union, Japan and China, triggering capitalized milestone payments to Eisai of $250 million in the aggregate. Potential future regulatory milestone payments of $135 million remain under the agreement. The asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $479 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Year Ended December 31 Alliance revenue $ Cost of sales (1) Selling, general and administrative Research and development (2) 1,489 December 31 Receivables from Eisai included in Other current assets $ Payables to Eisai included in Accrued and other current liabilities (3) Payables to Eisai included in Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Includes $1.4 billion related to the upfront payment and future option payments. (3) Includes accrued milestone and option payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas, which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. In 2018, Merck determined it was probable that annual worldwide sales of Adempas in the future would trigger a $375 million sales-based milestone payment from Merck to Bayer. Accordingly, Merck recorded a $375 million noncurrent liability and a corresponding increase to the intangible asset related to Adempas, and recognized $106 million of cumulative amortization expense within Cost of sales . In 2018, the Company made a $350 million milestone payment to Bayer, which was accrued for in 2016 when Merck deemed the payment to be probable. There is an additional $400 million potential future sales-based milestone payment that has not yet been accrued as it is not deemed by the Company to be probable at this time. The intangible asset balance related to Adempas (which includes the remaining acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $1.0 billion at December 31, 2018 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share from sales in Bayers marketing territories Total sales Cost of sales (1) Selling, general and administrative Research and development December 31 Receivables from Bayer included in Other current assets $ $ Payables to Bayer included in Accrued and other current liabilities (2) Payables to Bayer included in Other Noncurrent Liabilities (2) (1) Includes amortization of intangible assets. (2) Includes accrued milestone payments. Aggregate amortization expense related to capitalized license costs recorded within Cost of sales was $186 million in 2018 , $39 million in 2017 and $30 million in 2016 . The estimated aggregate amortization expense for each of the next five years is as follows: 2019 , $196 million ; 2020 , $193 million ; 2021 , $191 million ; 2022 , $187 million ; 2023 , $181 million . 5. Restructuring In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. The Company recorded total pretax costs of $658 million in 2018 , $927 million in 2017 and $1.1 billion in 2016 related to restructuring program activities. Since inception of the programs through December 31, 2018 , Merck has recorded total pretax accumulated costs of approximately $14.1 billion and eliminated approximately 45,510 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company has substantially completed the actions under these programs. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2018 Cost of sales $ $ $ $ Selling, general and administrative Research and development (13 ) Restructuring costs $ $ (1 ) $ $ Year Ended December 31, 2017 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2016 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ 1,069 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,160 in 2018 , 2,450 in 2017 and 2,625 in 2016 . Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2018 , 2017 and 2016 includes $141 million , $267 million and $409 million , respectively, of asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $151 million in 2016 . The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2017 $ $ $ $ Expenses (Payments) receipts, net (328 ) (394 ) (722 ) Non-cash activity (60 ) Restructuring reserves December 31, 2017 Expenses (1 ) (Payments) receipts, net (649 ) (238 ) (887 ) Non-cash activity Restructuring reserves December 31, 2018 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2020. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . In accordance with the new guidance adopted on January 1, 2018 (see Note 2), the Company has elected to recognize in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 Net Investment Hedging Relationships Foreign exchange contracts $ (18 ) $ $ $ (11 ) $ $ (1 ) Euro-denominated notes (183 ) (193 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In May 2018, four interest rate swaps with notional amounts aggregating $1.0 billion matured. These swaps effectively converted the Companys $1.0 billion , 1.30% fixed-rate notes due 2018 to variable rate debt. In December 2018, in connection with the early repayment of debt, the Company settled three interest rate swaps with notional amounts aggregating $550 million . These swaps effectively converted a portion of the Companys $1.25 billion , 5.00% notes due 2019 to variable rate debt. At December 31, 2018 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ $ $ $ (17 ) Long-Term Debt (1) 4,560 5,146 (82 ) (41 ) (1) Amounts include hedging adjustment gains related to discontinued hedging relationships of $11 million at December 31, 2017. Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other assets $ $ $ $ $ $ Interest rate swap contracts Accrued and other current liabilities 1,000 Interest rate swap contracts Other noncurrent liabilities 4,650 4,650 Foreign exchange contracts Other current assets 6,222 4,216 Foreign exchange contracts Other assets 2,655 1,936 Foreign exchange contracts Accrued and other current liabilities 2,014 Foreign exchange contracts Other noncurrent liabilities $ $ $ 14,390 $ $ $ 14,386 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 5,430 $ $ $ 3,778 Foreign exchange contracts Accrued and other current liabilities 9,922 7,431 $ $ $ 15,352 $ $ $ 11,209 $ $ $ 29,742 $ $ $ 25,595 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet (121 ) (121 ) (94 ) (94 ) Cash collateral received (107 ) (3 ) Net amounts $ $ $ $ 90 The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 42,294 $ 40,122 $ 39,807 $ (402 ) (500 ) $ (361 ) $ $ (1,078 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items (27 ) (48 ) (29 ) Derivatives designated as hedging instruments (35 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives (562 ) (Decrease) increase in Sales as a result of AOCI reclassifications (160 ) (138 ) (311 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 Income Statement Caption Derivatives Not Designated as Hedging Instruments Foreign exchange contracts (1) Other (income) expense, net $ (260 ) $ $ Foreign exchange contracts (2) Sales (8 ) (3 ) (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. At December 31, 2018 , the Company estimates $186 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Fair Value Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Gains Losses Gains Losses Corporate notes and bonds $ 4,920 $ 4,985 $ $ (68 ) $ 9,806 $ 9,837 $ $ (40 ) Asset-backed securities 1,275 1,285 (11 ) 1,542 1,548 (7 ) U.S. government and agency securities (5 ) 2,042 2,059 (17 ) Foreign government bonds (1 ) (6 ) Mortgage-backed securities (9 ) Commercial paper Total debt securities 7,261 7,340 (85 ) 14,908 14,976 (79 ) Publicly traded equity securities (1) (6 ) Total debt and publicly traded equity securities $ 7,717 $ 15,183 $ 15,241 $ $ (85 ) (1) Pursuant to the adoption of ASU 2016-01 (see Note 2), beginning on January 1, 2018, changes in the fair value of publicly traded equity securities are recognized in net income. Unrealized net losses of $35 million were recognized in Other (income) expense, net during 2018 on equity securities still held at December 31, 2018 . At December 31, 2018 , the Company also had $568 million of equity investments without readily determinable fair values included in Other Assets . During 2018 , the Company recognized unrealized gains of $167 million in Other (income) expense, net on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2018 , the Company recognized unrealized losses of $26 million in Other (income) expense, net related to certain of these investments based on unfavorable observable price changes. Available-for-sale debt securities included in Short-term investments totaled $894 million at December 31, 2018 . Of the remaining debt securities, $5.8 billion mature within five years. At December 31, 2018 and 2017 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Investments Corporate notes and bonds $ $ 4,835 $ $ 4,835 $ $ 9,678 $ $ 9,678 Asset-backed securities (1) 1,253 1,253 1,476 1,476 U.S. government and agency securities 1,767 1,835 Foreign government bonds Mortgage-backed securities Commercial paper Publicly traded equity securities 6,985 7,132 14,359 14,531 Other assets (2) U.S. government and agency securities Corporate notes and bonds Asset-backed securities (1) Mortgage-backed securities Foreign government bonds Publicly traded equity securities 221 171 Derivative assets (3) Forward exchange contracts Purchased currency options Interest rate swaps Total assets $ $ 7,660 $ $ 8,171 $ $ 14,970 $ $ 15,313 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (3) Interest rate swaps Forward exchange contracts Written currency options Total liabilities $ $ $ $ $ $ $ $ 1,152 (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. (2) Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. There were no transfers between Level 1 and Level 2 during 2018 . As of December 31, 2018 , Cash and cash equivalents of $8.0 billion include $7.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) Additions Payments (244 ) (100 ) Fair value December 31 (2) $ $ (1) Recorded in Research and development expenses, Cost of sales and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2018 includes $89 million recorded as a current liability for amounts expected to be paid within the next 12 months. The changes in the estimated fair value of liabilities for contingent consideration in 2018 were largely attributable to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture in 2016 (see Note 9), partially offset by the reversal of a liability related to the discontinuation of a program obtained in connection with the acquisition of SmartCells (see Note 8). The changes in the estimated fair value of liabilities for contingent consideration in 2017 primarily relate to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The payments of contingent consideration in 2018 include $175 million related to the achievement of a clinical milestone in connection with the acquisition of Afferent (see Note 3). The remaining payments in 2018 relate to liabilities recorded in connection with the termination of the SPMSD joint venture. The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3). Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2018 , was $25.6 billion compared with a carrying value of $25.1 billion and at December 31, 2017 , was $25.6 billion compared with a carrying value of $24.4 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2018 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $107 million and $3 million at December 31, 2018 and 2017 , respectively. The obligation to return such collateral is recorded in Accrued and other current liabilities . No cash collateral was advanced by the Company to counterparties as of December 31, 2018 or 2017 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,658 $ 1,334 Raw materials and work in process 5,004 4,703 Supplies Total (approximates current cost) 6,856 6,238 Increase to LIFO costs $ 6,857 $ 6,283 Recognized as: Inventories $ 5,440 $ 5,096 Other assets 1,417 1,187 Inventories valued under the LIFO method comprised approximately $2.5 billion and $2.2 billion at December 31, 2018 and 2017 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2018 and 2017 , these amounts included $1.4 billion and $1.1 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $7 million and $80 million at December 31, 2018 and 2017 , respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2017 $ 16,075 $ 1,708 $ $ 18,162 Acquisitions Impairments (38 ) (38 ) Other (1) (9 ) (8 ) (17 ) Balance December 31, 2017 (2) 16,066 1,877 18,284 Acquisitions Impairments (144 ) (144 ) Other (1) (24 ) Balance December 31, 2018 (2) $ 16,162 $ 1,870 $ $ 18,253 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2018 and 2017 were $369 million and $225 million , respectively. The additions to goodwill within the Animal Health segment in 2017 primarily relate to the acquisition of Valle (see Note 3). The impairments of goodwill within other non-reportable segments in 2018 and 2017 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 46,615 $ 37,585 $ 9,030 $ 46,693 $ 34,950 $ 11,743 IPRD 1,064 1,064 1,194 1,194 Tradenames Other 2,403 1,168 1,235 2,035 1,134 $ 50,291 $ 38,860 $ 11,431 $ 50,131 $ 35,948 $ 14,183 Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles related to marketed products (included in products and product rights above) at December 31, 2018 include Zerbaxa , $2.7 billion ; Sivextro , $833 million ; Implanon/Nexplanon $470 million ; Dificid , $395 million ; Gardasil/Gardasil 9, $384 million ; Bridion , $275 million ; and Simponi , $194 million . The Company has an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $1.0 billion at December 31, 2018 reflected in Other in the table above. During 2017 and 2016 , the Company recorded impairment charges related to marketed products and other intangibles of $58 million and $347 million , respectively, within Cost of sales . During 2017, the Company recorded an intangible asset impairment charge of $47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A are being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. In 2016, the Company lowered its cash flow projections for Zontivity, a product for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in an impairment charge of $252 million . Also during 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek, allergy immunotherapy tablets that, for business reasons, the Company returned to the licensor. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2018, the Company recorded $152 million of IPRD impairment charges within Research and development expenses. Of this amount, $139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The Company previously recorded an impairment charge in 2016 for the other programs obtained in connection with the acquisition of SmartCells as described below. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $60 million (see Note 6). In 2017, the Company recorded $483 million of IPRD impairment charges. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion related to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million , resulting in the recognition of the impairment charge noted above. The IPRD impairment charges in 2016 also included charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM Biotherapeutics Ltd. and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million related to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also included $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily related to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $2.9 billion in 2018 , $3.2 billion in 2017 and $3.8 billion in 2016 . The estimated aggregate amortization expense for each of the next five years is as follows: 2019 , $1.5 billion ; 2020 , $1.2 billion ; 2021 , $1.1 billion ; 2022 , $1.1 billion ; 2023 , $1.1 billion . 9. Joint Ventures and Other Equity Method Affiliates Sanofi Pasteur MSD In 1994, Merck and Pasteur Mrieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture (SPMSD) to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.0 billion for 2016. On December 31, 2016, Merck and Sanofi Pasteur (Sanofi) terminated SPMSD and ended their joint vaccines operations in Europe. Under the terms of the termination, Merck acquired Sanofis 50% interest in SPMSD in exchange for consideration of $657 million comprised of cash, as well as future royalties of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $416 million on the date of termination. The Company accounted for this transaction as a step acquisition, which required that Merck remeasure its ownership interest (previously accounted for as an equity method investment) to fair value at the acquisition date. Merck in turn sold to Sanofi its intellectual property rights held by SPMSD in exchange for consideration of $596 million comprised of cash and future royalties of 11.5% on net sales of all Sanofi products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $302 million on the date of termination. Excluded from this arrangement are sales of Vaxelis (a jointly developed pediatric hexavalent combination vaccine that was approved by the European Commission in 2016 and by the U.S. Food and Drug Administration in 2018). The European marketing rights for Vaxelis were transferred to a separate equally-owned joint venture between Sanofi and Merck. The net impact of the termination of the SPMSD joint venture is as follows: Products and product rights (8-year useful life) $ Accounts receivable Income taxes payable (221 ) Deferred income tax liabilities (147 ) Other, net Net assets acquired Consideration payable to Sanofi, net (392 ) Derecognition of Mercks previously held equity investment in SPMSD (183 ) Increase in net assets Mercks share of restructuring costs related to the termination (77 ) Net gain on termination of SPMSD joint venture (1) $ (1) Recorded in Other (income) expense, net . The estimated fair values of identifiable intangible assets related to products and product rights were determined using an income approach through which fair value is estimated based on market participant expectations of each assets projected net cash flows. The projected net cash flows were then discounted to present value utilizing a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Of the amount recorded for products and product rights, $468 million related to Gardasil/Gardasil 9. The fair value of liabilities for contingent consideration related to Mercks future royalty payments to Sanofi of $416 million (reflected in the consideration payable to Sanofi, net, in the table above) was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% used to present value the cash flows. Changes in the inputs could result in a different fair value measurement. Based on an existing accounting policy election, Merck did not record the $302 million estimated fair value of contingent future royalties to be received from Sanofi on the sale of Sanofi products, but rather is recognizing such amounts as sales occur and the royalties are earned. The Company incurred $24 million of transaction costs related to the termination of SPMSD included in Selling, general and administrative expenses in 2016. Pro forma financial information for this transaction has not been presented as the results are not significant when compared with the Companys financial results. AstraZeneca LP In 1982, Merck entered into an agreement with Astra AB (Astra) to develop and market Astra products under a royalty-bearing license. In 1993, Mercks total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (AMI), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astras new prescription medicines in the United States. In 1998, Merck and Astra completed a restructuring of the ownership and operations of the joint venture whereby Merck acquired Astras interest in AMI, renamed KBI Inc. (KBI), and contributed KBIs operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (AZLP) upon Astras 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. Merck earned revenue based on sales of KBI products and earned certain Partnership returns from AZLP. On June 30, 2014, AstraZeneca exercised its option to purchase Mercks interest in KBI (and redeem Mercks remaining interest in AZLP). A portion of the exercise price, which remained subject to a true-up in 2018 based on actual sales of Nexium and Prilosec from closing in 2014 to June 2018, was deferred and recognized as income as the contingency was eliminated as sales occurred. Once the deferred income amount was fully recognized, in 2016, the Company began recognizing income and a corresponding receivable for amounts that would be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized income of $99 million in 2018, $232 million in 2017, and $98 million in 2016 (including $5 million of remaining deferred income) in Other (income) expense, net related to these amounts. In January 2019, the Company received $424 million from AstraZeneca in settlement of these amounts, which concludes the transactions related to the 2014 termination of Companys relationship with AZLP. 10. Loans Payable, Long-Term Debt and Other Commitments Loans payable at December 31, 2018 included $5.1 billion of commercial paper and $149 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2017 included $3.0 billion of notes due in 2018 and $73 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 2.09% and 0.85% for the years ended December 31, 2018 and 2017 , respectively. Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,490 $ 2,488 3.70% notes due 2045 1,974 1,973 2.80% notes due 2023 1,745 1,744 4.15% notes due 2043 1,237 1,237 1.85% notes due 2020 1,231 1,232 2.35% notes due 2022 1,214 1,220 1.125% euro-denominated notes due 2021 1,134 1,185 3.875% notes due 2021 1,132 1,140 1.875% euro-denominated notes due 2026 1,127 1,178 2.40% notes due 2022 6.50% notes due 2033 Floating-rate notes due 2020 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 5.00% notes due 2019 1,260 Other $ 19,806 $ 21,353 Other (as presented in the table above) includes $223 million and $300 million at December 31, 2018 and 2017 , respectively, of borrowings at variable rates that resulted in effective interest rates of 2.27% and 1.42% for 2018 and 2017 , respectively. With the exception of the 6.30% debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In December 2018, the Company exercised a make-whole provision on its $1.25 billion , 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers and recognized a loss on extinguishment of debt of $191 million in 2017. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2018 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2019 , no maturities; 2020 , $1.9 billion ; 2021 , $2.3 billion ; 2022 , $2.2 billion ; 2023 , $1.7 billion . The Company has a $6.0 billion credit facility that matures in June 2023. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Rental expense under operating leases, net of sublease income, was $322 million in 2018 , $327 million in 2017 and $292 million in 2016 . The minimum aggregate rental commitments under noncancellable leases are as follows: 2019 , $188 million ; 2020 , $198 million ; 2021 , $150 million ; 2022 , $134 million ; 2023 , $84 million and thereafter, $243 million . The Company has no significant capital leases. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial position, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2018 , approximately 3,900 cases have been filed and either are pending or conditionally dismissed (as noted below) against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . In March 2011, Merck submitted a Motion to Transfer to the Judicial Panel on Multidistrict Litigation (JPML) seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. All federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court in August 2017, seeking review of the Third Circuits decision. In December 2017, the Supreme Court invited the Solicitor General to file a brief in the case expressing the views of the United States, and in May 2018, the Solicitor General submitted a brief stating that the Third Circuits decision was wrongly decided and recommended that the Supreme Court grant Mercks cert petition. The Supreme Court granted Mercks petition in June 2018, and an oral argument before the Supreme Court was held on January 7, 2019. The final decision on the Femur Fracture MDL courts preemption ruling is now pending before the Supreme Court. Accordingly, as of December 31, 2018 , nine cases were actively pending in the Femur Fracture MDL, and approximately 1,055 cases have either been dismissed without prejudice or administratively closed pending final resolution by the Supreme Court of the appeal of the Femur Fracture MDL courts preemption order. As of December 31, 2018 , approximately 2,555 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015, and Merck has continued to select additional cases to be reviewed through fact discovery from 2016 to the present. As of December 31, 2018 , approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs selected, as the first trial. The Galper trial began in February 2015 and the jury returned a verdict in Mercks favor in April 2015, and plaintiff appealed that verdict to the California appellate court. In April 2017, the California appellate court issued a decision affirming the lower courts judgment in favor of Merck. The next Femur Fracture trial in California that was scheduled to begin in April 2016 was stayed at plaintiffs request and a new trial date has not been set. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2018 , Merck is aware of approximately 1,290 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court-in separate opinions-granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery, which is ongoing. In November 2018, the California state appellate court reversed and remanded on similar grounds. As of December 31, 2018 , eight product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck intends to appeal that ruling. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx As previously disclosed, Merck is a defendant in a lawsuit brought by the Attorney General of Utah alleging that Merck misrepresented the safety of Vioxx . The lawsuit is pending in Utah state court. Utah seeks damages and penalties under the Utah False Claims Act. A bench trial in this matter is currently scheduled for July 2019. Propecia/Proscar As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar . The lawsuits were filed in various federal courts and in state court in New Jersey. The federal lawsuits were then consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey were consolidated before Judge Hyland in Middlesex County (NJ Coordinated Proceedings). As previously disclosed, on April 9, 2018, Merck and the Plaintiffs Executive Committee in the Propecia MDL and the Plaintiffs Liaison Counsel in the NJ Coordinated Proceedings entered into an agreement to resolve the above mentioned Propecia/Proscar lawsuits for an aggregate amount of $4.3 million . The settlement was subject to certain contingencies, including 95% plaintiff participation and a per plaintiff clawback if the participation rate was less than 100%. The contingencies were satisfied and the settlement agreement was finalized. After the settlement, fewer than 25 cases remain pending in the United States. The Company intends to defend against any remaining unsettled lawsuits. Governmental Proceedings As previously disclosed, the Company has learned that the Prosecution Office of Milan, Italy is investigating interactions between the Companys Italian subsidiary, certain employees of the subsidiary and certain Italian health care providers. The Company understands that this is part of a larger investigation involving engagements between various health care companies and those health care providers. The Company is cooperating with the investigation. As previously disclosed, the United Kingdom (UK) Competition and Markets Authority (CMA) issued a Statement of Objections against the Company and MSD Sharp Dohme Limited (MSD UK) in May 2017. In the Statement of Objections, the CMA alleges that MSD UK abused a dominant position through a discount program for Remicade over the period from March 2015 to February 2016. The Company and MSD UK are contesting the CMAs allegations. As previously disclosed, the Company has received an investigative subpoena from the California Insurance Commissioners Fraud Bureau (Bureau) seeking information from January 1, 2007 to the present related to the pricing and promotion of Cubicin . The Bureau is investigating whether Cubist Pharmaceuticals, Inc., which the Company acquired in 2015, unlawfully induced the presentation of false claims for Cubicin to private insurers under the California Insurance Code False Claims Act. The Company is cooperating with the investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. On December 6, 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. On February 6, 2019, the magistrate judge issued a report and recommendation recommending that the district judge grant in part and deny in part defendants motions to dismiss on non-arbitration issues. On February 20, 2019, defendants and retailer opt-out plaintiffs filed objections to the report and recommendation. After responses are filed, the parties will await a decision from the district judge. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. On January 23, 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. On February 19, 2019, MSD appealed the courts order on arbitration to the Third Circuit, and on February 22, 2019, the court granted MSDs motion to vacate existing deadlines in the district court in light of the appeal. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. In October 2014, the court denied the Companys motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. In April 2016, the court granted plaintiffs motion for conditional certification but denied plaintiffs motions to extend the liability period for their Equal Pay Act claims back to June 2009. In April 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals opted-in to this action; the opt-in period has closed. In August 2017, plaintiffs filed their motion for class certification. This motion sought to certify a Title VII pay discrimination class and also sought final collective action certification of plaintiffs Equal Pay Act claim. On October 1, 2018, the parties entered into an agreement to fully resolve the Smith sales force litigation. As part of the settlement and in exchange for a full and general release of all individual and class claims, the Company agreed to pay $8.5 million . The settlement agreement, which contains an opt-out clause allowing Merck to pull out of the agreement if 30 or more individuals opt out, will be subject to court approval. On December 18, 2018, plaintiffs filed a motion with the court seeking preliminary approval of the settlement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is ongoing. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe and constitute unfair competition. The Company and KGaA appealed the decision, and the appeal was heard in May 2017. In June 2017, the French appeals court held that certain of the activities by the Company directed to France constituted unfair competition or trademark infringement and, in December 2017, the Company decided not to pursue any further appeal. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaAs trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Companys use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal was heard in June 2017. In November 2017, the UK Court of Appeals affirmed the decision on the co-existence agreement and remitted for re-hearing issues of trademark infringement, the scope of KGaAs UK trademarks for pharmaceutical products, and the relief to which KGaA would be entitled. The re-hearing was held, and no decision has been handed down. In November 2018, the District Court in Hamburg, Germany dismissed all of KGaAs claims concerning KGaAs EU trademark with respect to the territory of the EU. In accordance with the Judgment of the Court of Justice of the EU delivered in October 2017, the District Court in Hamburg further held that it had no jurisdiction over the claim by KGaA insofar as the claim related to the territory of the UK. KGaA has appealed this decision. Further decisions from the District Court in Hamburg, Germany, in connection with claims concerning KGaAs EU trademark, German trademark and trade name rights as well as unfair competition law with respect to the territory of Germany are expected on February 28, 2019. In January 2019, the Mexican Trademark Office issued a decision on KGaAs action. The court found no trademark infringement by the Company and dismissed all of KGaAs claims for trademark infringement. The court ruled against the Company on KGaAs unfair competition claim. Both KGaA and the Company have appealed this decision. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Inegy The patents protecting Inegy in Europe have expired but supplemental protection certificates (SPCs) have been granted to the Company in many European countries that will expire in April 2019. There are multiple challenges to the SPCs related to Inegy throughout Europe and generic products have been launched in Austria, France, Italy, Ireland, Spain, Portugal, Germany, and the Netherlands. The Company has filed for preliminary injunctions in many countries that are still pending decision. Preliminary injunctions are presently in force in Austria, Czech Republic, Greece, Norway, Portugal, and Slovakia. Preliminary injunctions have been denied or revoked in Germany, Ireland, the Netherlands and Spain. The Company is appealing those decisions. In France and Belgium, preliminary injunctions were granted against some companies and denied against others, and appeals are pending. The SPC was held valid in merits proceedings in Portugal and France. The Company has filed and will continue to file actions for patent infringement seeking damages against those companies that launch generic products before April 2019. Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the district court held the patent valid and infringed. Actavis appealed this decision. While the appeal was pending, the parties reached a settlement, subject to certain terms of the agreement being met, whereby Actavis can launch its generic version prior to expiry of the patent and pediatric exclusivity under certain conditions. In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In November 2017, the parties reached a settlement whereby Roxane can launch its generic version prior to expiry of the patent under certain conditions. In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil injection. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions. In February 2018, the Company filed a lawsuit against Fresenius Kabi USA, LLC (Fresenius) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In November 2018, the Company reached a settlement with Fresenius, whereby Fresenius can launch its generic version of the intravenous product prior to expiry of the patent under certain conditions. In March 2018, the Company filed a lawsuit against Mylan Laboratories Limited in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . Nasonex Nasonex lost market exclusivity in the United States in 2016. Prior to that, in April 2015, the Company filed a patent infringement lawsuit against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotexs marketed product that the Company believed was infringing. In January 2018, the Company and Apotex settled this matter with Apotex agreeing to pay the Company $115 million plus certain other consideration. Januvia, Janumet, Janumet XR In February 2019, Par Pharmaceutical, Inc. (Par Pharmaceutical) filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of a patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026. A judgment in its favor may allow Par Pharmaceutical to bring to market a generic version of Janumet XR following the expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent it is challenging. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026, and a later granted patent owned by the Company covering the Janumet formulation which expires in 2028. No schedule for the cases has been set by the court. Gilead Patent Litigation and Opposition The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation against Gilead in the United States, Germany, and France based on different patent estates that would be infringed by Gileads sales of their two products, Sovaldi and Harvoni. Gilead opposed the European patent at the European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion . The Company submitted post-trial motions, including on the issues of enhanced damages and future royalties. Gilead submitted post-trial motions for judgment as a matter of law. A hearing on the motions was held in September 2017. Also, in September 2017, the court denied the Companys motion on enhanced damages, granted its motion on prejudgment interest and deferred its motion on future royalties. In February 2018, the court granted Gileads motion for judgment as a matter of law and found the patent was invalid for a lack of enablement. The Company appealed this decision. The appellate briefing is completed and the Company is waiting for the oral argument to be scheduled. The EPO opposition division revoked the European patent, and the Company appealed this decision. The cases in France and Germany have been stayed pending the final decision of the EPO. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial position, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2018 and 2017 of approximately $245 million and $160 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters As previously disclosed, Mercks facilities in Oss, the Netherlands, were inspected in 2012 by the Province of Brabant (Province) pursuant to the Dutch Hazards of Major Accidents Decree and the sites environmental permits. The Province issued penalties for alleged violations of regulations governing preventing and managing accidents with hazardous substances, and the government also issued a fine for alleged environmental violations at one of the Oss facilities, which together totaled $235 thousand . The Company was subsequently advised that a criminal investigation had been initiated based upon certain of the issues that formed the basis of the administrative enforcement action by the Province. As previously disclosed, the matter was settled, without any admission of liability, for an aggregate payment of 400 thousand . The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) (17 ) (15 ) (28 ) Balance December 31 3,577 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. On October 25, 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The payments to the Dealers were recorded as reductions to shareholders equity, consisting of a $4 billion increase in treasury stock, which reflects the value of the initial 56.7 million shares received on October 29, 2018, and a $1 billion decrease in other-paid-in capital, which reflects the value of the stock held back by the Dealers pending final settlement. The number of shares of Mercks common stock that Merck may receive, or may be required to remit, upon final settlement under the ASR agreements will be based upon the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount. Final settlement of the transaction under the ASR agreements is expected to occur in the first half of 2019, but may occur earlier at the option of the Dealers, or later under certain circumstances. If Merck is obligated to make adjustment payments to the Dealers under the ASR agreements, Merck may elect to satisfy such obligations in cash or in shares of Mercks common stock. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2018 , 111 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled primarily with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards generally vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2018 , 2017 and 2016 was $348 million , $312 million and $300 million , respectively, with related income tax benefits of $55 million , $57 million and $92 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2018 , 2017 and 2016 was $58.15 , $63.88 and $54.63 per option, respectively. The weighted average fair value of options granted in 2018 , 2017 and 2016 was $8.26 , $7.04 and $5.89 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.4 % 3.6 % 3.8 % Risk-free interest rate 2.9 % 2.0 % 1.4 % Expected volatility 19.1 % 17.8 % 19.6 % Expected life (years) 6.1 6.1 6.2 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2018 36,274 $ 46.77 Granted 3,520 58.15 Exercised (14,598 ) 40.51 Forfeited (1,389 ) 53.80 Outstanding December 31, 2018 23,807 $ 51.89 5.95 $ Exercisable December 31, 2018 16,184 $ 48.85 4.82 $ Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options 109 A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2018 13,609 $ 59.32 1,868 $ 60.03 Granted 7,270 58.46 1,081 57.17 Vested (3,766 ) 59.66 (758 ) 57.59 Forfeited (985 ) 59.30 (152 ) 60.06 Nonvested December 31, 2018 16,128 $ 58.85 2,039 $ 59.42 At December 31, 2018 , there was $560 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (851 ) (862 ) (831 ) (431 ) (393 ) (382 ) (83 ) (78 ) (107 ) Amortization of unrecognized prior service cost (50 ) (53 ) (55 ) (13 ) (11 ) (11 ) (84 ) (98 ) (106 ) Net loss amortization Termination benefits Curtailments (4 ) (1 ) (8 ) (31 ) (18 ) Settlements Net periodic benefit cost (credit) $ $ $ (1 ) $ $ $ $ (45 ) $ (60 ) $ (88 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2018 , 2017 and 2016 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 15), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 10,896 $ 9,766 $ 9,339 $ 7,794 $ 1,114 $ 1,019 Actual return on plan assets (810 ) 1,723 (289 ) (72 ) Company contributions, net (4 ) Effects of exchange rate changes (352 ) Benefits paid (772 ) (651 ) (202 ) (198 ) (80 ) (62 ) Settlements (44 ) (106 ) (17 ) Other Fair value of plan assets December 31 $ 9,648 $ 10,896 $ 8,580 $ 9,339 $ $ 1,114 Benefit obligation January 1 $ 11,904 $ 10,849 $ 9,483 $ 8,372 $ 1,922 $ 1,922 Service cost Interest cost Actuarial (gains) losses (1) (1,258 ) (154 ) (7 ) (341 ) (87 ) Benefits paid (772 ) (651 ) (202 ) (198 ) (80 ) (62 ) Effects of exchange rate changes (387 ) (6 ) Plan amendments (22 ) (9 ) Curtailments (2 ) (3 ) Termination benefits Settlements (44 ) (106 ) (17 ) Other Benefit obligation December 31 $ 10,620 $ 11,904 $ 9,083 $ 9,483 $ 1,615 $ 1,922 Funded status December 31 $ (972 ) $ (1,008 ) $ (503 ) $ (144 ) $ (647 ) $ (808 ) Recognized as: Other assets $ $ $ $ $ $ Accrued and other current liabilities (47 ) (59 ) (14 ) (17 ) (10 ) (11 ) Other noncurrent liabilities (925 ) (949 ) (1,148 ) (955 ) (637 ) (797 ) (1) Actuarial (gains) losses in 2018 and 2017 primarily reflect changes in discount rates. At December 31, 2018 and 2017 , the accumulated benefit obligation was $19.0 billion and $20.5 billion , respectively, for all pension plans, of which $10.4 billion and $11.5 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 10,620 $ 11,904 $ 6,251 $ 3,323 Fair value of plan assets 9,648 10,896 5,089 2,352 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 9,702 $ $ 5,936 $ 2,120 Fair value of plan assets 8,966 5,071 1,346 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2018 and 2017 , $826 million and $488 million , respectively, or approximately 5% and 2% , respectively, of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Equity securities Developed markets 2,172 2,172 2,743 2,743 Fixed income securities Government and agency obligations 1,509 1,509 Corporate obligations 1,246 1,246 Mortgage and asset-backed securities Other investments Net assets in fair value hierarchy $ 2,502 $ 3,017 $ $ 5,532 $ 3,277 $ 1,897 $ $ 5,189 Investments measured at NAV (1) 4,116 5,707 Plan assets at fair value $ 9,648 $ 10,896 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,071 3,532 3,326 3,888 Emerging markets equities Government and agency obligations 2,082 2,454 2,095 2,344 Corporate obligations Fixed income obligations Real estate (2) Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (3) Other Net assets in fair value hierarchy $ 1,497 $ 5,809 $ $ 8,119 $ 1,602 $ 6,462 $ $ 8,537 Investments measured at NAV (1) Plan assets at fair value $ 8,580 $ 9,339 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017 . (2) The plans Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds. (3) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (3 ) (3 ) (2 ) (2 ) Relating to assets sold during the year Purchases and sales, net (3 ) (3 ) (5 ) (5 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (32 ) (32 ) Purchases and sales, net (1 ) (2 ) Transfers into Level 3 (7 ) (7 ) Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Net assets in fair value hierarchy $ $ $ $ $ $ $ $ Investments measured at NAV (1) Plan assets at fair value $ $ 1,114 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 50% in U.S. equities, 15% to 30% in international equities, 30% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2019 are approximately $50 million for U.S. pension plans, approximately $150 million for international pension plans and approximately $15 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2020 2021 2022 2023 2024 2028 3,805 1,349 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ (397 ) $ (19 ) $ (743 ) $ (505 ) $ $ (380 ) $ $ $ (45 ) Prior service (cost) credit arising during the period (4 ) (13 ) (10 ) (10 ) (2 ) (31 ) (19 ) $ (401 ) $ (32 ) $ (753 ) $ (515 ) $ $ (382 ) $ $ $ (64 ) Net loss amortization included in benefit cost $ $ $ $ $ $ $ $ $ Prior service (credit) cost amortization included in benefit cost (50 ) (53 ) (55 ) (13 ) (11 ) (11 ) (84 ) (98 ) (106 ) $ $ $ $ $ $ $ (83 ) $ (97 ) $ (103 ) The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net periodic benefit cost during 2019 are $204 million and $(62) million , respectively, for pension plans (of which $141 million and $(50) million , respectively, relates to U.S. pension plans) and $(7) million and $(78) million , respectively, for other postretirement benefit plans. Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 3.70 % 4.30 % 4.70 % 2.10 % 2.20 % 2.80 % Expected rate of return on plan assets 8.20 % 8.70 % 8.60 % 5.10 % 5.10 % 5.60 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.90 % 2.90 % 2.90 % Benefit obligation Discount rate 4.40 % 3.70 % 4.30 % 2.20 % 2.10 % 2.20 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.80 % 2.90 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return within each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2019 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.10% , as compared to a range of 7.70% to 8.30% in 2018 . The decrease is primarily due to a modest shift in asset allocation. The change in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2016 to 2018 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 7.0 % 7.2 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate A one percentage point change in the health care cost trend rate would have had the following effects: One Percentage Point Increase Decrease Effect on total service and interest cost components $ $ (9 ) Effect on benefit obligation (74 ) Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2018 , 2017 and 2016 were $136 million , $131 million and $126 million , respectively. 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ (343 ) $ (385 ) $ (328 ) Interest expense Exchange losses (gains) (11 ) Income on investments in equity securities, net (1) (324 ) (352 ) (43 ) Net periodic defined benefit plan (credit) cost other than service cost (512 ) (512 ) (531 ) Other, net (140 ) $ (402 ) $ (500 ) $ (1) Includes net realized and unrealized gains and losses on investments in equity securities either owned directly or through ownership interests in investment funds. Income on investments in equity securities, net, in 2018 reflects the recognition of unrealized net gains pursuant to the prospective adoption of ASU 2016-01 on January 1, 2018 (see Note 2). The increase in income on investments in equity securities, net, in 2017 was driven primarily by higher realized gains on sales. Other, net (as presented in the table above) in 2018 includes a gain of $115 million related to the settlement of certain patent litigation (see Note 11), income of $99 million related to AstraZenecas option exercise (see Note 9), and a gain of $85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Other, net in 2017 includes income of $232 million related to AstraZenecas option exercise and a $191 million loss on extinguishment of debt (see Note 10). Other, net in 2016 includes a charge of $625 million related to the previously disclosed settlement of worldwide patent litigation related to Keytruda , a gain of $117 million related to the settlement of other patent litigation, gains of $100 million resulting from the receipt of milestone payments for out-licensed migraine clinical development programs, and $98 million of income related to AstraZenecas option exercise. Interest paid was $777 million in 2018 , $723 million in 2017 and $686 million in 2016 . 16. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 1,827 21.0 % $ 2,282 35.0 % $ 1,631 35.0 % Differential arising from: Impact of the TCJA 3.3 2,625 40.3 Valuation allowances 3.1 9.7 (5 ) (0.1 ) Impact of purchase accounting adjustments, including amortization 3.1 10.9 13.4 State taxes 2.3 1.2 3.7 Restructuring 0.6 2.2 3.1 Foreign earnings (245 ) (2.8 ) (1,654 ) (25.4 ) (1,546 ) (33.2 ) RD tax credit (96 ) (1.1 ) (71 ) (1.1 ) (58 ) (1.3 ) Tax settlements (22 ) (0.3 ) (356 ) (5.5 ) Other (1) (38 ) (0.4 ) (287 ) (4.4 ) (245 ) (5.2 ) $ 2,508 28.8 % $ 4,103 62.9 % $ 15.4 % (1) Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items. The Companys 2017 effective tax rate reflected a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduced the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. The Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA. In 2018, these amounts were finalized as described below. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount in 2017 for its one-time transition tax liability of $5.3 billion . This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. On the basis of revised calculations of post-1986 undistributed foreign EP and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $5.5 billion . The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. After payment of the amount due in 2018, the remaining transition tax liability at December 31, 2018, is $4.9 billion , of which $275 million is included in Income Taxes Payable and the remainder of $4.6 billion is included in Other Noncurrent Liabilities . As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply. In 2017, the Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million . On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $32 million related to deferred income taxes. Beginning in 2018, the TCJA includes a tax on global intangible low-taxed income (GILTI) as defined in the TCJA. The Company has made an accounting policy election to account for the tax effects of the GILTI tax in the income tax provision in future periods as the tax arises. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate compared to the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. Income before taxes consisted of: Years Ended December 31 Domestic $ 3,717 $ 3,483 $ Foreign 4,984 3,038 4,141 $ 8,701 $ 6,521 $ 4,659 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ $ 5,585 $ 1,166 Foreign 2,281 1,229 State (90 ) 3,017 6,724 2,239 Deferred provision Federal (402 ) (2,958 ) (1,255 ) Foreign (64 ) (225 ) State (43 ) (41 ) (509 ) (2,621 ) (1,521 ) $ 2,508 $ 4,103 $ 119 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 1,640 $ $ 2,256 Inventory related Accelerated depreciation Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other Subtotal 3,118 2,816 2,895 3,641 Valuation allowance (1,348 ) (900 ) Total deferred taxes $ 1,770 $ 2,816 $ 1,995 $ 3,641 Net deferred income taxes $ 1,046 $ 1,646 Recognized as: Other assets $ $ Deferred income taxes $ 1,702 $ 2,219 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2018 , $715 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $1.3 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. The Company has no NOL carryforwards relating to U.S. jurisdictions. Income taxes paid in 2018 , 2017 and 2016 were $1.5 billion , $4.9 billion and $1.8 billion , respectively. Tax benefits relating to stock option exercises were $77 million in 2018 , $73 million in 2017 and $147 million in 2016 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 1,723 $ 3,494 $ 3,448 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) (73 ) (1,038 ) (90 ) Settlements (1) (91 ) (1,388 ) (92 ) Lapse of statute of limitations (29 ) (11 ) (43 ) Balance December 31 $ 1,893 $ 1,723 $ 3,494 (1) Amounts reflect the settlements with the IRS as discussed below. If the Company were to recognize the unrecognized tax benefits of $1.9 billion at December 31, 2018 , the income tax provision would reflect a favorable net impact of $1.8 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2018 could decrease by up to approximately $750 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Expenses for interest and penalties associated with uncertain tax positions amounted to $51 million in 2018 , $183 million in 2017 and $134 million in 2016 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $372 million and $341 million as of December 31, 2018 and 2017 , respectively. In 2017, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. The IRS is currently conducting examinations of the Companys tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2018. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Average common shares outstanding 2,664 2,730 2,766 Common shares issuable (1) Average common shares outstanding assuming dilution 2,679 2,748 2,787 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 2.34 $ 0.88 $ 1.42 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 2.32 $ 0.87 $ 1.41 (1) Issuable primarily under share-based compensation plans. In 2018 , 2017 and 2016 , 6 million , 5 million and 13 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2016, net of taxes $ $ $ (2,407 ) $ (2,186 ) $ (4,148 ) Other comprehensive income (loss) before reclassification adjustments, pretax (38 ) (1,199 ) (150 ) (1,177 ) Tax (72 ) (19 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (836 ) (169 ) (889 ) Reclassification adjustments, pretax (314 ) (1) (31 ) (2) (3) (308 ) Tax Reclassification adjustments, net of taxes (204 ) (22 ) (189 ) Other comprehensive income (loss), net of taxes (66 ) (44 ) (799 ) (169 ) (1,078 ) Balance December 31, 2016, net of taxes (3 ) (3,206 ) (2,355 ) (5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax (561 ) Tax (35 ) (106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (354 ) Reclassification adjustments, pretax (141 ) (1) (291 ) (2) (3) (315 ) Tax (30 ) Reclassification adjustments, net of taxes (92 ) (235 ) (240 ) Other comprehensive income (loss), net of taxes (446 ) (58 ) Balance December 31, 2017, net of taxes (108 ) (61 ) (2,787 ) (4) (1,954 ) (4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax (108 ) (728 ) (84 ) (692 ) Tax (55 ) (139 ) (24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (107 ) (559 ) (223 ) (716 ) Reclassification adjustments, pretax (1) (2) (3) Tax (33 ) (36 ) (69 ) Reclassification adjustments, net of taxes Other comprehensive income (loss), net of taxes (10 ) (425 ) (223 ) (361 ) Adoption of ASU 2018-02 (see Note 2) (23 ) (344 ) (266 ) Adoption of ASU 2016-01 (see Note 2) (8 ) (8 ) Balance December 31, 2018, net of taxes $ $ (78 ) $ (3,556 ) (4) $ (2,077 ) $ (5,545 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . In 2017 and 2016, these amounts included both investments in debt and equity securities; however, as a result of the adoption of ASU 2016-01 (see Note 2), in 2018, these amounts relate only to investments in available-for-sale debt securities. (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 4.4 billion and $3.5 billion at December 31, 2018 and 2017 , respectively, and other postretirement benefit plan net (gain) loss of $(170) million and $(16) million at December 31, 2018 and 2017 , respectively, as well as pension plan prior service credit of $314 million and $326 million at December 31, 2018 and 2017 , respectively, and other postretirement benefit plan prior service credit of $375 million and $383 million at December 31, 2018 and 2017 , respectively. 19. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Animal Health segment met the criteria for separate reporting and became a reportable segment in 2018. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Companys SPMSD joint venture until its termination on December 31, 2016 (see Note 9). The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9). Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 4,150 $ 3,021 $ 7,171 $ 2,309 $ 1,500 $ 3,809 $ $ $ 1,402 Emend Temodar Alliance revenue - Lynparza Alliance revenue - Lenvima Vaccines (1) Gardasil/Gardasil 9 1,873 1,279 3,151 1,565 2,308 1,780 2,173 ProQuad/M-M-R II/Varivax 1,430 1,798 1,374 1,676 1,362 1,640 Pneumovax 23 RotaTeq Zostavax Hospital Acute Care Bridion Noxafil Invanz Cubicin 1,087 Cancidas Primaxin Immunology Simponi Remicade 1,268 1,268 Neuroscience Belsomra Virology Isentress/Isentress HD 1,140 1,204 1,387 Zepatier 1,660 Cardiovascular Zetia 1,344 1,588 2,560 Vytorin 1,141 Atozet Adempas Diabetes Januvia 1,969 1,718 3,686 2,153 1,584 3,737 2,286 1,622 3,908 Janumet 1,417 2,228 1,296 2,158 1,217 2,201 Womens Health NuvaRing Implanon/Nexplanon Diversified Brands Singulair Cozaar/Hyzaar Nasonex Arcoxia Follistim AQ Dulera Fosamax Other pharmaceutical (2) 1,228 2,855 4,090 1,148 2,917 4,065 1,261 3,158 4,420 Total Pharmaceutical segment sales 16,608 21,081 37,689 15,854 19,536 35,390 17,073 18,077 35,151 Animal Health: Livestock 2,102 2,630 2,013 2,484 1,841 2,287 Companion Animals 1,582 1,391 1,191 Total Animal Health segment sales 1,238 2,974 4,212 1,090 2,785 3,875 2,489 3,478 Other segment sales (3) Total segment sales 18,094 24,057 42,151 17,340 22,322 39,662 18,447 20,566 39,014 Other (4) $ 18,212 $ 24,083 $ 42,294 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 U.S. plus international may not equal total due to rounding. (1) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2018 and 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 do, however, include supply sales to SPMSD. (2) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (3) Represents the non-reportable segments of Healthcare Services and Alliances. (4) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2018, 2017 and 2016 also includes approximately $95 million , $85 million and $170 million , respectively, related to the sale of the marketing rights to certain products. Consolidated revenues by geographic area where derived are as follows: Years Ended December 31 United States $ 18,212 $ 17,424 $ 18,478 Europe, Middle East and Africa 12,213 11,478 10,953 Japan 3,212 3,122 2,846 Asia Pacific (other than Japan and China) 2,909 2,751 2,483 Latin America 2,415 2,339 2,155 China 2,184 1,586 1,435 Other 1,149 1,422 1,457 $ 42,294 $ 40,122 $ 39,807 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 24,292 $ 22,495 $ 22,141 Animal Health segment 1,659 1,552 1,357 Other segments Total segment profits 26,054 24,322 23,644 Other profits Unallocated: Interest income Interest expense (772 ) (754 ) (693 ) Depreciation and amortization (1,334 ) (1,378 ) (1,585 ) Research and development (8,853 ) (9,481 ) (9,218 ) Amortization of purchase accounting adjustments (2,664 ) (3,056 ) (3,692 ) Restructuring costs (632 ) (776 ) (651 ) Charge related to termination of collaboration agreement with Samsung (423 ) Loss on extinguishment of debt (191 ) Gain on sale of certain migraine clinical development programs Charge related to the settlement of worldwide Keytruda patent litigation (625 ) Other unallocated, net (3,024 ) (2,576 ) (3,430 ) $ 8,701 $ 6,521 $ 4,659 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. In 2018, the Company adopted a new accounting standard related to the classification of certain defined benefit plan costs (see Note 2), which resulted in a change to the measurement of segment profits. Net periodic benefit cost (credit) other than service cost is no longer included as a component of segment profits. Prior period amounts have been recast to conform to the new presentation. Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2017 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2016 Included in segment profits: Equity (income) loss from affiliates $ (105 ) $ $ $ (105 ) Depreciation and amortization Property, plant and equipment, net, by geographic area where located is as follows: December 31 United States $ 8,306 $ 8,070 $ 8,114 Europe, Middle East and Africa 3,706 3,151 2,732 Asia Pacific (other than Japan and China) Latin America China Japan Other $ 13,291 $ 12,439 $ 12,026 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Merck Co., Inc and its subsidiaries (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Change in Accounting Principle As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for retirement benefits in 2018. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Florham Park, New Jersey February 27, 2019 We have served as the Companys auditor since 2002. (b) Supplementary Data Selected quarterly financial data for 2018 and 2017 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q 1st Q (3) 2018 (4) Sales $ 10,998 $ 10,794 $ 10,465 $ 10,037 Cost of sales 3,289 3,619 3,417 3,184 Selling, general and administrative 2,643 2,443 2,508 2,508 Research and development 2,214 2,068 2,274 3,196 Restructuring costs Other (income) expense, net (172 ) (48 ) (291 ) Income before taxes 2,604 2,665 2,086 1,345 Net income attributable to Merck Co., Inc. 1,827 1,950 1,707 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.70 $ 0.73 $ 0.64 $ 0.27 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.69 $ 0.73 $ 0.63 $ 0.27 2017 (4) (5) Sales $ 10,433 $ 10,325 $ 9,930 $ 9,434 Cost of sales 3,440 3,307 3,116 3,049 Selling, general and administrative 2,643 2,459 2,500 2,472 Research and development 2,314 4,413 1,782 1,830 Restructuring costs Other (income) expense, net (149 ) (207 ) (73 ) (71 ) Income before taxes 1,879 2,439 2,003 Net (loss) income attributable to Merck Co., Inc. (1,046 ) (56 ) 1,946 1,551 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (1) Amounts for 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation (see Note 16). (2) Amounts for 2017 include a charge related to the formation of a collaboration with AstraZeneca (see Note 4). (3) Amounts for 2018 include a charge related to the formation of a collaboration with Eisai (see Note 4). (4) Amounts for 2018 and 2017 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). (5) Amounts have been recast as a result of the adoption, on January 1, 2018, of a new accounting standard related to the classification of certain defined benefit plan costs. There was no impact to net income as a result of adopting the new accounting standard (see Note 2). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2018, there have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2018 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2018 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2018 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +9,Merck & Co.,2017," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company was incorporated in New Jersey in 1970. For financial information and other information about the Companys segments, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data below. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as total sales of animal health products, were as follows: ($ in millions) Total Sales $ 40,122 $ 39,807 $ 39,498 Pharmaceutical 35,390 35,151 34,782 Januvia/Janumet 5,896 6,109 6,014 Keytruda 3,809 1,402 Gardasil/Gardasil 9 2,308 2,173 1,908 Zetia/Vytorin 2,095 3,701 3,777 ProQuad/M-M-R II /Varivax 1,676 1,640 1,505 Zepatier 1,660 Isentress/Isentress HD 1,204 1,387 1,511 Remicade 1,268 1,794 Pneumovax 23 Simponi Animal Health 3,875 3,478 3,331 Other Revenues (1) 1,178 1,385 (1) Other revenues are primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, and third-party manufacturing sales. Pharmaceutical The Companys pharmaceutical products include therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Certain of the products within the Companys franchises are as follows: Primary Care and Womens Health Cardiovascular: Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); and Atozet (ezetimibe and atorvastatin) (marketed in certain countries outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes: Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. General Medicine and Womens Health: NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product ; Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant; and Follistim AQ (follitropin beta injection) (marketed as Puregon in most countries outside the United States), a fertility treatment. Hospital and Specialty Hepatitis: Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. HIV: Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection. Hospital Acute Care: Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Invanz (ertapenem sodium) for the treatment of certain infections; Cancidas (caspofungin acetate), an anti-fungal product; Cubicin ( daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; and Primaxin (imipenem and cilastatin sodium), an anti-bacterial product. Immunology: Remicade (infliximab), a treatment for inflammatory diseases; and Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with non-small-cell lunch cancer (NSCLC), melanoma, classical Hodgkin Lymphoma (cHL), urothelial carcinoma, head and neck squamous cell carcinoma (HNSCC), gastric or gastroesophageal junction adenocarcinoma, and microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, and in combination with pemetrexed and carboplatin in certain patients with NSCLC; Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting; and Temodar (temozolomide) (marketed as Temodal outside the United States), a treatment for certain types of brain tumors. Diversified Brands Respiratory: Singulair (montelukast), a medicine indicated for the chronic treatment of asthma and the relief of symptoms of allergic rhinitis; Nasonex (mometasone furoate monohydrate), an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms; and Dulera Inhalation Aerosol (mometasone furoate/formoterol fumarate dihydrate), a combination medicine for the treatment of asthma . Other: Cozaar (losartan potassium) and Hyzaar (losartan potassium and hydrochlorothiazide), treatments for hypertension; Arcoxia (etoricoxib) for the treatment of arthritis and pain, which the Company markets outside the United States; and Fosamax (alendronate sodium) (marketed as Fosamac in Japan) for the treatment and prevention of osteoporosis. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV) ; ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Zostavax (Zoster Vaccine Live), a vaccine to help prevent shingles (herpes zoster). Animal Health The Animal Health segment discovers, develops, manufactures and markets animal health products, including vaccines. Principal products in this segment include: Livestock Products: Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; and Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine. Poultry Products: Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines and Exzolt , a systemic treatment for poultry red mite infestations. Companion Animal Products: Bravecto (fluralaner), a line of oral and topical products that kills fleas and ticks in dogs and cats for up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Activyl (Indoxacrb) /Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. Aquaculture Products: Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; and Aquaflor (Florfenicol) antibiotic for farm-raised fish. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2017 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2017. Product Date Approval Keytruda December 2017 Japanese Ministry of Health, Labour and Welfare approved Keytruda for the treatment of patients with radically unresectable urothelial carcinoma who progressed after cancer chemotherapy. September 2017 The U.S. Food and Drug Administration (FDA) approved Keytruda for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1. September 2017 The European Commission (EC) approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. May 2017 FDA approved Keytruda for the treatment of adult and pediatric patients with previously treated unresectable or metastatic, microsatellite instability-high (MSI-H) or mismatch repair deficient, solid tumors. May 2017 FDA approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. May 2017 FDA approved Keytruda in combination with pemetrexed and carboplatin for the first-line treatment of patients with metastatic nonsquamous NSCLC. May 2017 EC approved Keytruda for the treatment of adult patients with relapsed or refractory classical Hodgkin Lymphoma (cHL) who have failed autologous stem cell transplant (ASCT) and brentuximab vedotin (BV), or who are transplant-eligible and have failed BV. March 2017 FDA approved Keytruda for the treatment of adult and pediatric patients with refractory cHL, or who have relapsed after three or more prior lines of therapy. January 2017 EC approved Keytruda for the first-line treatment of metastatic NSCLC in adults whose tumors have high PD-L1 expression with no EGFR or ALK positive tumor mutations. Lynparza (1) August 2017 FDA approved the oral poly (ADP-ribose) polymerase (PARP) inhibitor, Lynparza (olaparib), as follows: New use of Lynparza as a maintenance treatment for recurrent, epithelial ovarian, fallopian tube or primary peritoneal adult cancer who are in response to platinum-based chemotherapy, regardless of BRCA status; New use of Lynparza tablets (2 tablets twice daily) as opposed to capsules (8 capsules twice daily); Lynparza tablets also now indicated for the use in patients with deleterious or suspected deleterious germline BRCA-mutated advanced ovarian cancer, who have been treated with three or more prior lines of chemotherapy. Isentress November 2017 FDA approved Isentress for use in combination with other antiretroviral agents for the treatment of HIV-1 in neonates - newborn patients from birth to four weeks of age - weighing at least 2 kg. Isentress HD July 2017 EC approved Isentress 600 mg film-coated tablets, in combination with other anti-retroviral medicinal products, as a once-daily treatment of HIV-1 infection in patients who are treatment-nave or who are virologically suppressed on an initial regimen of Isentress 400 mg twice daily. May 2017 FDA approved Isentress HD , a once-daily dose of Isentress , in combination with other antiretroviral agents, for the treatment of HIV-1 infection patients who are treatment-nave or whose virus has been suppressed on an initial regimen of Isentress 400 mg given twice daily. Prevymis November 2017 FDA approved Prevymis (letermovir) for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant (HSCT). Steglatro/ Steglujan/ Segluromet (2) December 2017 FDA approved Steglatro (ertugliflozin) tablets, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, the fixed-dose combination Steglujan (ertugliflozin and sitagliptin) tablets, and the fixed-dose combination Segluromet (ertugliflozin and metformin hydrochloride) for the treatment of type 2 diabetes. (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. (2) In 2013, Merck and Pfizer Inc. announced that they entered into a worldwide collaboration, except Japan, for the co-development and co-promotion of ertugliflozin. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to further address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). Approximately $385 million, $415 million and $550 million was recorded by Merck as a reduction to revenue in 2017, 2016 and 2015, respectively, related to the donut hole provision. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.0 billion in 2017 and will increase to $4.1 billion in 2018. The annual fee will decline to $2.8 billion in 2019 and is currently planned to remain at that amount thereafter. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $210 million, $193 million and $173 million of costs within Marketing and administrative expenses in 2017, 2016 and 2015, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys results of operations, financial condition or business. Also, during 2016, the Vermont legislature passed a pharmaceutical cost transparency law. The law requires manufacturers identified by the Vermont Green Mountain Care Board to report certain product price information to the Vermont Attorney General. The Attorney General is then required to submit a report to the legislature. During 2017, Nevada and California passed similar price transparency bills requiring manufacturers to disclose certain pricing information and to provide advance notification of price increases. A number of other states have introduced legislation of this kind and the Company expects that states will continue their focus on pharmaceutical price transparency. The extent to which these proposals will pass into law is unknown at this time. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same utilization management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company recently posted on its website its Pricing Action Transparency Report for the United States for the years 2010 - 2017. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. The report shows that the Companys average annual net price increases (after taking sales deductions such as rebates, discounts and returns into account) across the U.S. human health portfolio have been in the low to mid-single digits from 2010 - 2016. In 2017, the average net price across the Companys portfolio declined by 1.9%, reflecting specific in-year dynamics, including the impact of loss of patent protection for three major Merck medicines. Additionally, the weighted average annual discount rate has been steadily increasing over time, reflecting the competitive market for branded medicines and the impact of the ACA. In 2017, the Companys gross U.S. sales were reduced by 45.1% as a result of rebates, discounts and returns. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which will occur again in 2018. Furthermore, the government can order repricings for classes of drugs if it determines that it is appropriate under applicable rules. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA), which require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. The Companys focus on emerging markets has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2018 to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The European Union (EU) has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, the Company has many far-reaching philanthropic programs. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicine and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including a new EU General Data Protection Regulation, which will become effective in 2018 and impose penalties up to 4% of global revenue, additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increased enforcement and litigation activity in the United States and other developed markets, and increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. Privacy Shield Program, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent rights. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU and Japan (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) Cancidas Expired Expired Zostavax Expired 2018 (use) N/A Zetia Expired 2019 Vytorin Expired 2019 Asmanex 2018 (formulation) 2018 (formulation) 2020 (formulation) NuvaRing 2018 (delivery system) 2018 (delivery system) N/A Emend for Injection 2019 (2) 2020 (2) Follistim AQ 2019 (formulation) 2019 (formulation) 2019 (formulation) Noxafil 2019 N/A RotaTeq Expired Expired Recombivax 2020 (method of making) Expired Expired Dulera 2020 (combination) N/A N/A Januvia 2022 (2) 2022 (2) 2025-2026 (3) Janumet 2022 (2) N/A Janumet XR 2022 (2) N/A N/A Isentress 2022 (2) Simponi N/A (4) N/A (4) Adempas (5) 2026 (2) 2023 (patents), 2028 (2) (SPCs) 2027-2028 (3) Bridion 2026 (2) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) Gardasil 2021 (2) Gardasil 9 2025 (patents) , 2030 (2) (SPCs) N/A Keytruda 2028 (patents), 2030 (2) (SPCs) Lynparza (6) 2028 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2024 (7) Zerbaxa 2028 (2) (with pending PTE) 2023 (patents), 2028 (2) (SPCs) N/A Sivextro 2028 (2) 2024 (patents), 2029 (2) (SPCs) N/A Belsomra 2029 (2) N/A Prevymis 2029 (2) (with pending PTE) 2024 (8) N/A Steglatro (9) 2031 (2) (with pending PTE) N/A N/A Steglujan (9) 2031 (with pending PTE) N/A N/A Segluromet (9) 2031 (with pending PTE) N/A N/A Zepatier 2031 (2) 2030 (patents), 2031 (2) (SPCs) 2034 (with pending PTE) N/A: Currently no marketing approval. Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If an SPC has been granted in some but not all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) Eligible for 6 months Pediatric Exclusivity. (3) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (4) The Company has no marketing rights in the U.S. and Japan. (5) Being commercialized in a worldwide collaboration with Bayer AG. (6) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (7) PTE application to be filed by April 2018. Expected expiry 2029. (8) SPC applications to be filed by July 2018. Expected expiry 2029. Eligible for Pediatric Exclusivity. (9) Being developed and promoted in a worldwide, except Japan, collaboration with Pfizer. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. The Company has the following key U.S. patent protection for drug candidates under review in the United States by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review (in the U.S.) Currently Anticipated Year of Expiration (in the U.S.) V419 (pediatric hexavalent combination vaccine) 2020 (method of making) MK-1439 (doravirine) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) V920 (ebola vaccine) MK-5618 (selumetinib) (1) MK-7655A (relebactam + imipenem/cilastatin) MK-1242 (vericiguat) (2) (1) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (2) Being developed in a worldwide clinical development collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent is subject to any future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2017 on patent and know-how licenses and other rights amounted to $158 million. Merck also incurred royalty expenses amounting to $944 million in 2017 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2017, approximately 12,650 people were employed in the Companys research activities. Research and development expenses were $10.2 billion in 2017 , $10.1 billion in 2016 and $6.7 billion in 2015 (which included restructuring costs and acquisition and divestiture-related costs in all years). The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on preclinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Preclinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Pharmaceuticals and Medical Devices Agency in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and China Food and Drug Administration. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In December 2017, the FDA accepted for review a supplemental BLA for Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal B-cell lymphoma (PMBCL), or who have relapsed after two or more prior lines of therapy. The FDA granted Priority Review status with a PDUFA, or target action, date of April 3, 2018. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with axitnib as a first-line treatment for patients with advanced or metastatic renal cell carcinoma; for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy; and for the treatment of Merkel cell carcinoma. Also, in January 2018, Merck and Eisai Co., Ltd. (Eisai) announced receipt of Breakthrough Therapy designation from the FDA for Eisais multiple receptor tyrosine kinase inhibitor Lenvima (lenvatinib) in combination with Keytruda for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma. The Lenvima and Keytruda combination therapy is being jointly developed by Eisai and Merck. This marks the 12 th Breakthrough Therapy designation granted to Keytruda . The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In January 2018, Merck announced that the pivotal Phase 3 KEYNOTE-189 trial investigating Keytruda in combination with pemetrexed (Alimta) and cisplatin or carboplatin, for the first-line treatment of patients with metastatic non-squamous NSCLC, met its dual primary endpoints of overall survival (OS) and progression-free survival (PFS). Based on an interim analysis conducted by the independent Data Monitoring Committee, treatment with Keytruda in combination with pemetrexed plus platinum chemotherapy resulted in significantly longer OS and PFS than pemetrexed plus platinum chemotherapy alone. Results from KEYNOTE-189 will be presented at an upcoming medical meeting and submitted to regulatory authorities. In 2017, the FDA placed a full clinical hold on KEYNOTE-183 and KEYNOTE-185 and a partial clinical hold on Cohort 1 of KEYNOTE-023, three combination studies of Keytruda with lenalidomide or pomalidomide versus lenalidomide or pomalidomide alone in the blood cancer multiple myeloma. This decision followed a review of data by the Data Monitoring Committee in which more deaths were observed in the Keytruda arms of KEYNOTE-183 and KEYNOTE-185. The FDA determined that the data available at the time indicated that the risks of Keytruda plus pomalidomide or lenalidomide outweighed any potential benefit for patients with multiple myeloma. All patients enrolled in KEYNOTE-183 and KEYNOTE-185 and those in the Keytruda /lenalidomide/dexamethasone cohort in KEYNOTE-023 have discontinued investigational treatment with Keytruda . This clinical hold does not apply to other studies with Keytruda . The Keytruda clinical development program consists of more than 700 clinical trials, including more than 400 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. MK-8835, ertugliflozin, an investigational oral SGLT-2 inhibitor in development to help improve glycemic control in adults with type 2 diabetes, and two fixed-dose combination products (MK-8835A, ertugliflozin and Januvia , and MK-8835B, ertugliflozin and metformin) are under review in the EU. In January 2018, the Committee for Medicinal Products for Human Use (CHMP) of the EMA adopted a positive opinion recommending approval of these medicines. The CHMP positive opinion will be considered by the EC. Ertugliflozin and the two fixed-dose combination products were approved by the FDA in December 2017. MK-0431J is an investigational fixed-dose combination of sitagliptin and ipragliflozin under review with the Japan Pharmaceuticals and Medical Devices Agency. MK-0431 is being developed for commercialization in Japan in collaboration with Astellas Pharma Inc. (Astellas). Ipragliflozin, an SGLT2 inhibitor, co-developed by Astellas and Kotobuki Pharmaceutical Co., Ltd. (Kotobuki), is approved for use in Japan and is being co-promoted with Merck and Kotobuki. MK-1439, doravirine, is an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection. In January 2018, Merck announced that the FDA accepted for review two NDAs for doravirine. The NDAs include data for doravirine as a once-daily tablet for use in combination with other antiretroviral agents, and for use of doravirine with lamivudine and tenofovir disoproxil fumarate in a once-daily fixed-dose combination single tablet as a complete regimen (MK-1439A). The PDUFA action date for both applications is October 23, 2018. V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, under review with the FDA that is being developed and, if approved, will be commercialized through a joint venture between Merck and Sanofi. This vaccine is designed to help protect against six important diseases - diphtheria, tetanus, pertussis (whooping cough), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b (Hib), and hepatitis B. In November 2015, the FDA issued a CRL with respect to the BLA for V419. Both companies are working to provide additional data requested by the FDA. V419 is being marketed as Vaxelis in the EU. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). The FDA has designated this combination a QIDP with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. MK-7339, Lynparza (olaparib), is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. MK-5618, selumetinib, is an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple cancer types. Additionally, in February 2018, the FDA granted Orphan Drug designation for selumetinib for the treatment of neurofibromatosis type 1. The development of selumetinib is part of the global strategic oncology collaboration between Merck and AstraZeneca reference above. V920 is an investigational rVSV-ZEBOV (Ebola) vaccine candidate being studied in large scale Phase 2/3 clinical trials. In November 2014, Merck and NewLink Genetics announced an exclusive licensing and collaboration agreement for the investigational Ebola vaccine. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In December 2016, end of study results from the WHO ring vaccination trial were reported in Lancet supporting the July 2015 interim assessment that V920 offers substantial protection against Ebola virus disease, with no reported cases among vaccinated individuals from 10 days after vaccination in both randomized and non-randomized clusters. Results from other ongoing studies to be included in the first regulatory filing are anticipated in the first half of 2018. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure. The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer. V212 is an inactivated varicella zoster virus (VZV) vaccine in development for the prevention of herpes zoster. The Company completed a Phase 3 trial in autologous hematopoietic cell transplant patients and another Phase 3 trial in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The study in autologous hematopoietic cell transplant patients met its primary endpoints and Merck presented the results from this study at the American Society for Blood and Marrow Transplantation Meetings in February 2017. The study in patients with solid tumor malignancies undergoing chemotherapy met its primary endpoints, but the primary efficacy endpoint was not met in patients with hematologic malignancies. Merck will present the results from this study at an upcoming scientific meeting. Due to the competitive environment, the development of V212 is currently on hold. MK-7264 is a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough. Merck plans to initiate a Phase 3 clinical trial in the first half of 2018. MK-7264 was originally developed by Afferent Pharmaceuticals, which was acquired by the Company in 2016. The Company also discontinued certain drug candidates. In February 2018, Merck announced that it will be stopping protocol 019, also known as the APECS study, a Phase 3 study evaluating verubecestat, MK-8931, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), in people with prodromal Alzheimers disease. The decision to stop the study follows a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during a recent interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. In 2017, Merck announced that it will not submit applications for regulatory approval for MK-0859, anacetrapib, the Companys investigational cholesteryl ester transfer protein (CETP) inhibitor. The decision followed a thorough review of the clinical profile of anacetrapib, including discussions with external experts. Also in 2017, Merck made a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. The chart below reflects the Companys research pipeline as of February 23, 2018. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to Keytruda ) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 entry date) Under Review Cancer MK-3475 Keytruda Advanced Solid Tumors Ovarian Prostate Chronic Cough MK-7264 Diabetes Mellitus MK-8521 (2) HIV Infection MK-8591 Pneumoconjugate Vaccine V114 Schizophrenia MK-8189 Bacterial Infection MK-7655A (relebactam+imipenem/cilastatin) (October 2015) Cancer MK-3475 Keytruda Breast (October 2015) Colorectal (November 2015) Esophageal (December 2015) Gastric (May 2015) (EU) Head and Neck (November 2014) (EU) Hepatocellular (May 2016) Nasopharyngeal (April 2016) Renal (October 2016) Small-Cell Lung (May 2017) MK-7339 Lynparza (1) Pancreatic (December 2014) Prostate (April 2017) MK-5618 (selumetinib) (1) Thyroid (June 2013) Ebola Vaccine V920 (March 2015) Heart Failure MK-1242 (vericiguat) (September 2016) (1) Herpes Zoster V212 (inactivated VZV vaccine) (December 2010) (2) HIV MK-1439 (doravirine) (December 2014) (EU) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) (June 2015) (EU) New Molecular Entities/Vaccines Diabetes Mellitus MK-0431J (sitagliptin+ipragliflozin) (Japan) (1) MK-8835 (ertugliflozin) (EU) (1) MK-8835A (ertugliflozin+sitagliptin) (EU) (1) MK-8835B (ertugliflozin+metformin) (EU) (1) HIV MK-1439 (doravirine) (U.S.) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) (U.S.) Pediatric Hexavalent Combination Vaccine V419 (U.S.) (3) Certain Supplemental Filings MK-3475 Keytruda Relapsed or Refractory Primary Mediastinal BCell Lymphoma (PMBCL) (U.S.) MK-7339 Lynparza (1) Broader Approval for Ovarian Cancer (EU) Footnotes: (1) Being developed in a collaboration. (2) Development is currently on hold. (3) V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, that is being developed and, if approved, will be commercialized through a partnership of Merck and Sanofi. In November 2015, the FDA issued a CRL with respect to V419. Both companies are working to provide additional data requested by the FDA. Employees As of December 31, 2017, the Company had approximately 69,000 employees worldwide, with approximately 26,700 employed in the United States, including Puerto Rico. Approximately 29% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Since inception of the programs through December 31, 2017, Merck has eliminated approximately 43,350 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company has substantially completed the actions under these programs. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $11 million in 2017 , and are estimated at $56 million in the aggregate for the years 2018 through 2022 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in 2017, 54% of sales in 2016 and 56% of sales in 2015. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Financial information about geographic areas of the Companys business is provided in Item 8. Financial Statements and Supplementary Data below. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to Merck Shareholder Services, Merck Co., Inc., 2000 Galloping Hill Road, K1-3049, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any stockholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates under review and Phase 3 candidates is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product, as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. For example, pursuant to an agreement with a generic manufacturer, that manufacturer launched in the United States a generic version of Zetia in December 2016. In addition, the Company lost U.S. patent protection for Vytorin in April 2017. As a result, the Company experienced a significant and rapid loss of sales of Zetia and Vytorin in the United States in 2017, which the Company expects will continue in 2018. In addition, the patent that provides U.S. market exclusivity for NuvaRing will expire in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales thereafter. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material and negative impact on results of operations and cash flows. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Januvia , Janumet , Keytruda , Gardasil/Gardasil 9 and Isentress . As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. For example, in 2018, the Company anticipates that sales of Zepatier will be materially unfavorably affected by increasing competition and declining patient volumes. The Company also anticipates that sales of Zostavax will be materially unfavorably affected due to competition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products each year. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, preclinical testing, clinical trials and manufacturing and marketing its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU and Japan. In the United States, the FDA is of particular importance to the Company, as it administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, cost reduction. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the new products in that jurisdiction until approval is obtained, if ever. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches market, certain developments following regulatory approval, including results in post-approval Phase 4 trials or other studies, may decrease demand for the Companys products, including the following: the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy or labeling changes; and greater scrutiny in advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA and Japans Pharmaceutical and Medical Device Agency have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products that are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and, in particular, direct-to-consumer advertising. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial position and prospects. The Company faces intense competition from competitors products which, in addition to other factors, could in certain circumstances lead to non-cash impairment charges. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use or more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers may, in the future, ask for and receive higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company recently posted on its website its Pricing Action Transparency Report for the United States for the years 2010 - 2017. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. The report shows that the Companys average annual net price increases (after taking sales deductions such as rebates, discounts and returns into account) across the U.S. human health portfolio have been in the low to mid-single digits from 2010 - 2016. In 2017, the average net price across the Companys portfolio declined by 1.9%, reflecting specific in-year dynamics, including the impact of loss of patent protection for three major Merck medicines. Additionally, the weighted average annual discount rate has been steadily increasing over time, reflecting the competitive market for branded medicines and the impact of the ACA. In 2017, the Companys gross U.S. sales were reduced by 45.1% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU and Japan, have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. The Company expects pricing pressures to continue in the future. The health care industry in the United States will continue to be subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2017, the Companys revenue was reduced by $385 million due to this requirement. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.0 billion in 2017 and will be $4.1 billion in 2018. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. In 2017, the Company recorded $210 million of costs for this annual fee. On January 21, 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck, at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. The Company cannot predict the likelihood of future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys results of operations, financial condition or business. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means could impact key business processes. Cyber-attacks against the Companys IT systems could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. All of the Companys manufacturing sites are now operational, manufacturing active pharmaceutical ingredient (API), formulating, packaging and shipping product. The Companys external manufacturing was not impacted. Throughout this time, Merck continued to fulfill orders and ship product. Due to the cyber-attack, as anticipated, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Materials and Production costs, as well as expenses related to remediation efforts in Marketing and Administrative expenses and Research and Development expenses, which aggregated $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders, the Company anticipates that in 2018 sales will be unfavorably affected in certain markets by approximately $200 million from the cyber-attack. Merck does not expect a significant impairment to the value of intangible assets related to marketed products or inventories as a result of the cyber-attack. The Company has insurance coverage insuring against costs resulting from cyber-attacks and has received proceeds. However, there may be disputes with the insurers about the availability of the insurance coverage for claims related to this incident. Additionally, the temporary production shut-down from the cyber-attack contributed to the Companys inability to meet higher than expected demand for Gardasil 9, which resulted in Mercks decision to borrow doses of Gardasil 9 from the U.S. Centers for Disease Control and Prevention Pediatric Vaccine Stockpile. The Company subsequently replenished a portion of the borrowed doses in 2017. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018. The Company has implemented a variety of measures to further enhance its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the June 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the June 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems will be successful in preventing disruptions to its operations, including its manufacturing, research and sales operations. Any such disruption could result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third party providers databases or IT systems and could also result in financial, legal, business or reputational harm to the Company and potentially substantial remediation costs. Changes in laws and regulations could materially adversely affect the Companys business. All aspects of the Companys business, including research and development, manufacturing, marketing, pricing, sales, litigation and intellectual property rights, are subject to extensive legislation and regulation. Changes in applicable federal and state laws and agency regulations could have a material adverse effect on the Companys business. In particular, there is significant uncertainty about the future of the ACA and health care laws in general in the United States. The Company is participating in the debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys results of operations, financial condition or business. The uncertainty in global economic conditions together with austerity measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Companys revenue performance in 2017. The Company anticipates these pricing actions, including the biennial price reductions in Japan that will occur again in 2018, and other austerity measures will continue to negatively affect revenue performance in 2018. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material negative impact on the Companys results of operations. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. On June 23, 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of the referendum, the British government has begun negotiating the terms of the UKs future relationship with the EU. Although it is unknown what those terms will be, it is possible that there will be greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and cross boarder labor issues that could adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect its ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. In addition, in China, commercial and economic conditions may adversely affect the Companys growth prospects in that market. While the Company continues to believe that China represents an important growth opportunity, these events, coupled with heightened scrutiny of the health care industry, may continue to have an impact on product pricing and market access generally. The Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the business, financial condition or results of the Companys operations. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into acquisition, licensing, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates and interest rates could negatively affect the Companys results of operations, financial position and cash flows as occurred with respect to Venezuela in 2015 and 2016. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be affected by changes in tax laws, such as tax rate changes, new tax laws, and revised tax law interpretations in domestic and foreign jurisdictions. Further, on December 22, 2017, the U.S. Tax Cuts and Jobs Act of 2017 (TCJA) became law. The final impact of the TCJA on the Company may differ from the estimates reported, possibly materially, due to such factors as changes in interpretations and assumptions made, additional guidance that may be issued, and actions taken by the Company as a result of the TCJA, among others. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third party relationships and outsourcing arrangements could adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a negative impact on future results of operations. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as Bovine Spongiform Encephalopathy or mad cow disease, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely impact the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both preclinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004, including liability for legacy Merck products first sold after that date. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain media vehicles could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking web site could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Companys U.S. commercial operations are headquartered in Upper Gwynedd, Pennsylvania. The Companys U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania and Kenilworth, New Jersey. The Companys vaccines business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania. Mercks Animal Health global headquarters is located in Madison, New Jersey. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $1.9 billion in 2017 , $1.6 billion in 2016 and $1.3 billion in 2015 . In the United States, these amounted to $1.2 billion in 2017 , $1.0 billion in 2016 and $879 million in 2015 . Abroad, such expenditures amounted to $728 million in 2017, $594 million in 2016 and $404 million in 2015. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. The Common Stock market price information set forth in the table below is based on historical NYSE market prices. The following table also sets forth, for the calendar periods indicated, the cash dividends paid per common share and the high and low sales prices of the Companys Common Stock as reported by the NYSE. Cash Dividends Paid per Common Share Year 4th Q 3rd Q 2nd Q 1st Q 2017 $ 1.88 $ 0.47 $ 0.47 $ 0.47 $ 0.47 2016 $ 1.84 $ 0.46 $ 0.46 $ 0.46 $ 0.46 Common Stock Market Prices 2017 4th Q 3rd Q 2nd Q 1st Q High 64.90 66.41 66.40 66.80 Low 53.63 61.16 61.87 59.05 2016 High $ 65.46 $ 64.00 $ 57.87 $ 53.60 Low $ 58.29 $ 57.18 $ 52.44 $ 47.97 As of January 31, 2018, there were approximately 121,125 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2017 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 2,172,335 $63.38 $2,605 November 1 November 30 11,850,338 $55.03 $1,953 December 1 December 31 16,285,000 $56.05 $11,040 Total 30,307,673 $56.17 $11,040 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in March 2015 to purchase up to $10 billion in Merck shares. In November 2017, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. Shares are approximated. Performance Graph The following graph assumes a $100 investment on December 31, 2012, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2017/2012 CAGR** MERCK $162 10% PEER GRP.** 13% SP 500 16% 2013 2015 2017 MERCK 100.00 126.90 148.70 142.70 164.30 161.80 PEER GRP. 100.00 134.60 150.20 154.70 151.60 184.70 SP 500 100.00 132.40 150.50 152.50 170.80 208.10 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. Overview During 2017, Merck continued to bring innovation to patients and physicians, expanding its focus in oncology and advancing other programs in its late-stage pipeline. Throughout 2017, Keytruda , the Companys anti-PD-1 (programmed death receptor-1) therapy, received approval for several additional indications globally, including U.S. Food and Drug Administration (FDA) approval in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous non-small-cell lung cancer (NSCLC), irrespective of PD-L1 expression. Keytruda is the only anti-PD-1 treatment approved in the first-line setting as both monotherapy and combination therapy for appropriate patients with metastatic NSCLC. In addition, Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor, which is being developed in a collaboration, received FDA approval for the treatment of patients with germline BRCA-mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy. Additionally, in November 2017, the FDA approved Prevymis for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease, and in December 2017, the FDA approved Steglatro, Steglujan and Segluromet for the treatment of type 2 diabetes. In January 2018, Prevymis was also approved in the European Union (EU). Worldwide sales were $40.1 billion in 2017 , an increase of 1% compared with 2016 . Sales growth was driven primarily by the launches of Keytruda , Zepatier and Bridion , as well as positive performance from Mercks Animal Health business. In addition, revenue in 2017 benefited from the sale of vaccines in the markets that were previously part of the now-terminated SPMSD vaccines joint venture. Growth in these areas was largely offset by the effects of generic and biosimilar competition that resulted in sales declines for products including Zetia , Vytorin , Cubicin and Remicade . Augmenting Mercks portfolio and pipeline with external innovation remains an important component of the Companys overall strategy. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. The companies will develop and commercialize Lynparza both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PDL1 medicines. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. In addition, in October 2017, Merck acquired Rigontec GmbH (Rigontec), a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Also, in March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Merck continues to prioritize resources to maximize opportunities for ongoing and upcoming product launches. Keytruda is launching around the world in multiple indications. In 2017, Merck achieved multiple additional regulatory milestones for Keytruda , including approval from the FDA as combination therapy for appropriate patients with metastatic NSCLC as noted above, as well as monotherapy approval for the treatment of certain patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction adenocarcinoma; for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer; for the treatment of adult and pediatric patients with classical Hodgkin lymphoma (cHL); and for the treatment of adult and pediatric patients with unresectable or metastatic, microsatellite instability-high (MSI-H) or mismatch repair deficient solid tumors. During 2017, Keytruda also received approval in the EU for the treatment of certain patients with cHL and urothelial carcinoma. Merck continues to evaluate its pipeline, focusing its research efforts on the opportunities it believes have the greatest potential to address unmet medical needs. In addition to the recent regulatory approvals discussed above, the Company has continued to advance other programs in its late-stage pipeline with several regulatory submissions. MK-1439, doravirine, an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection, and MK-1439A, doravirine with lamivudine and tenofovir disoproxil fumarate, are currently under review with the FDA. In addition, the FDA accepted for review a supplemental Biologics License Application (BLA) for Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal B-cell lymphoma (PMBCL) that is refractory to or has relapsed after two prior lines of therapy. Additionally, Steglatro, Steglujan and Segluromet are under review in the EU. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of breast, colorectal, esophageal, gastric, head and neck, hepatocellular, nasopharyngeal, renal and small-cell lung cancers; Lynparza for pancreatic and prostate cancer; and selumetinib for thyroid cancer. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas (see Research and Development below). The Company continues to support its innovation strategy by remaining disciplined and prioritizing resources wherever possible to not only fund investment in the many opportunities in Mercks pipeline that it believes can help drive long-term growth, but also fund near-term opportunities to grow revenue. Research and development expenses in 2017 reflect increased clinical development spending as the Company continues to invest in the pipeline. In November 2017, Mercks Board of Directors raised the Companys quarterly dividend to $0.48 per share from $0.47 per share. During 2017 , the Company returned $9.2 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2017 were $0.87 compared with $1.41 in 2016 . EPS in both years reflect the impact of acquisition and divestiture-related costs, which in 2016 includes a charge related to the uprifosbuvir clinical development program, as well as restructuring costs and certain other items, which in 2017 include a provisional net tax charge related to the recent enactment of U.S. tax legislation and an aggregate charge related to the formation of a collaboration with AstraZeneca. Non-GAAP EPS, which exclude these items, were $3.98 in 2017 and $3.78 in 2016 (see Non-GAAP Income and Non-GAAP EPS below). Cyber-attack On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. All of the Companys manufacturing sites are now operational, manufacturing active pharmaceutical ingredient (API), formulating, packaging and shipping product. The Companys external manufacturing was not impacted. Throughout this time, Merck continued to fulfill orders and ship product. Due to the cyber-attack, as anticipated, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Materials and production costs, as well as expenses related to remediation efforts in Marketing and administrative expenses and Research and development expenses, which aggregated approximately $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders for certain products, the Company anticipates that in 2018 sales will be unfavorably affected in certain markets by approximately $200 million from the cyber-attack. Merck does not expect a significant impairment to the value of intangible assets related to marketed products or inventories as a result of the cyber-attack. As referenced above, the Company has insurance coverage insuring against costs resulting from cyber-attacks and has received insurance proceeds. However, there may be disputes with the insurers about the availability of the insurance coverage for claims related to this incident. Additionally, the temporary production shut-down from the cyber-attack contributed to the Companys inability to meet higher than expected demand for Gardasil 9, which resulted in Mercks decision to borrow doses of Gardasil 9 from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile. The Company subsequently replenished a portion of the borrowed doses in 2017. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018. Hurricane Maria In September 2017, Hurricane Maria made direct landfall on Puerto Rico. The Company has one plant in Puerto Rico that makes a limited number of its pharmaceutical products, and the Company also works with contract manufacturers on the island. Mercks plant did not sustain substantial damage, and production activities at the plant have resumed. While power has been restored to the facility, it is not yet fully reliable and the plant continues to be prepared to use alternative sources of power and water. The Company is making progress to fully restore normal operations despite the significant damage to the islands infrastructure. Supply chains within Puerto Rico are improving, but are not yet fully restored. There was an immaterial impact to sales in 2017 and the Company expects an immaterial impact to sales in 2018. Operating Results Sales Worldwide sales were $40.1 billion in 2017, an increase of 1% compared with 2016. Sales growth in 2017 was driven primarily by higher sales of recently launched products including Keytruda, Zepatier and Bridion . Additionally, sales in 2017 benefited from the December 31, 2016 termination of SPMSD, which marketed vaccines in most major European markets. In 2017, Merck began recording vaccine sales in the markets that were previously part of the SPMSD joint venture resulting in incremental vaccine sales of approximately $400 million during 2017. Higher sales of Pneumovax 23 and Adempas, as well as animal health products also contributed to revenue growth in 2017. These increases were largely offset by the effects of generic competition for certain products including Zetia , which lost U.S. market exclusivity in December 2016, Vytorin , which lost U.S. market exclusivity in April 2017, Cubicin due to U.S. patent expiration in June 2016, and Cancidas , which lost EU patent protection in April 2017. Revenue growth was also offset by continued biosimilar competition for Remicade and ongoing generic erosion for products including Singulair and Nasonex . Collectively, the sales decline attributable to the above products affected by generic and biosimilar competition was $3.3 billion in 2017. Lower sales of other products within the Diversified Brands franchise that includes certain products approaching the expiration of their marketing exclusivity or are no longer protected by patents in developed markets, including Dulera Inhalation Aerosol, as well as lower combined sales of the diabetes franchise of Januvia and Janumet , and declines in sales of Isentress/Isentress HD also partially offset revenue growth. Additionally, sales in 2017 were reduced by $125 million due to a borrowing the Company made from the CDC Pediatric Vaccine Stockpile of doses of Gardasil 9 as discussed below. Also, as anticipated, the Company was unable to fulfill orders for certain products in certain markets due to the cyber-attack, which had an unfavorable effect on sales in 2017 of approximately $260 million. Sales in the United States were $17.4 billion in 2017 , a decline of 6% compared with $18.5 billion in 2016 . The decrease was driven primarily by the effects of generic competition for Zetia and Vytorin , Cubicin , and declines of products within Diversified Brands including Nasonex and Dulera Inhalation Aerosol. Lower sales of Januvia/Janumet , Gardasil/Gardasil 9, Isentress/Isentress HD and Zostavax , also contributed to the U.S. sales decline in 2017. These declines were partially offset by higher sales of Keytruda , Zepatier , Bridion , and Pneumovax 23, along with higher sales of animal health products. International sales were $22.7 billion in 2017 , an increase of 6% compared with $21.3 billion in 2016 , primarily reflecting growth in Keytruda and Zepatier , and higher sales of vaccines due to the termination of the SPMSD joint venture, as well as higher sales of animal health products. Sales growth was partially offset by ongoing biosimilar competition for Remicade , as well as generic erosion for Cancidas and products within Diversified Brands. International sales represented 57% and 54% of total sales in 2017 and 2016 , respectively. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Companys revenue performance in 2017 . The Company anticipates these pricing actions, including the biennial price reductions in Japan that will occur again in 2018, and other austerity measures will continue to negatively affect revenue performance in 2018 . Worldwide sales were $39.8 billion in 2016, an increase of 1% compared with 2015. Foreign exchange unfavorably affected global sales performance by 2% in 2016, which includes a lower benefit from revenue hedging activities as compared with 2015. Revenue growth primarily reflects higher sales of Keytruda , the launch of the HCV treatment Zepatier, and growth in vaccine products, including Gardasil/Gardasil 9, Varivax and Pneumovax 23. Also contributing to sales growth in 2016 were higher sales of hospital acute care products including Bridion and Noxafil , growth within the diabetes franchise of Januvia and Janumet , as well as higher sales of animal health products, particularly Bravecto . These increases were largely offset by sales declines attributable to the ongoing effects of generic and biosimilar competition for certain products, including Remicade and Nasonex , along with other products within Diversified Brands. Declines in Isentress and Dulera Inhalation Aerosol also partially offset revenue growth in 2016. Sales performance in 2016 reflects a decline of approximately $625 million due to reduced operations by the Company in Venezuela as a result of the economic conditions and volatility in that country. Sales of the Companys products were as follows: ($ in millions) U.S. Intl Total U.S. Intl Total U.S. Intl Total Primary Care and Womens Health Cardiovascular Zetia $ $ $ 1,344 $ 1,588 $ $ 2,560 $ 1,612 $ $ 2,526 Vytorin 1,141 1,251 Atozet Adempas Diabetes Januvia 2,153 1,584 3,737 2,286 1,622 3,908 2,263 1,601 3,863 Janumet 1,296 2,158 1,217 2,201 1,175 2,151 General Medicine and Womens Health NuvaRing Implanon/Nexplanon Follistim AQ Hospital and Specialty Hepatitis Zepatier 1,660 HIV Isentress/Isentress HD 1,204 1,387 1,511 Hospital Acute Care Bridion Noxafil Invanz Cancidas Cubicin (1) 1,087 1,030 1,127 Primaxin Immunology Remicade 1,268 1,268 1,794 1,794 Simponi Oncology Keytruda 2,309 1,500 3,809 1,402 Emend Temodar Diversified Brands Respiratory Singulair Nasonex Dulera Other Cozaar/Hyzaar Arcoxia Fosamax Vaccines (2) Gardasil/Gardasil 9 1,565 2,308 1,780 2,173 1,520 1,908 ProQuad/M-M-R II /Varivax 1,374 1,676 1,362 1,640 1,290 1,505 Pneumovax 23 RotaTeq Zostavax Other pharmaceutical (3) 1,246 3,049 4,295 1,345 3,228 4,574 1,473 3,785 5,256 Total Pharmaceutical segment sales 15,854 19,536 35,390 17,073 18,077 35,151 16,238 18,544 34,782 Other segment sales (4) 1,486 2,785 4,272 1,374 2,489 3,862 1,213 2,454 3,667 Total segment sales 17,340 22,321 39,662 18,447 20,566 39,013 17,451 20,998 38,449 Other (5) 1,049 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 $ 17,519 $ 21,979 $ 39,498 U.S. plus international may not equal total due to rounding. (1) Sales of Cubicin in 2015 represent sales subsequent to the Cubist acquisition date. (2) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 and 2015 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 and 2015 do, however, include supply sales to SPMSD. (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents the non-reportable segments of Animal Health, Healthcare Services and Alliances. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2017 and 2016 also includes $85 million and $170 million, respectively, related to the sale of the marketing rights to certain products . Pharmaceutical Segment Primary Care and Womens Health Cardiovascular Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ), Vytorin (marketed outside the United States as Inegy ), and Atozet (marketed in certain countries outside of the United States), medicines for lowering LDL cholesterol, were $2.3 billion in 2017, a decline of 40% compared with 2016. The sales decline was driven by lower volumes and pricing of Zetia and Vytorin in the United States as a result of generic competition. By agreement, a generic manufacturer launched a generic version of Zetia in the United States in December 2016. The U.S. patent and exclusivity periods for Zetia and Vytorin otherwise expired in April 2017. Accordingly, the Company is experiencing rapid and substantial declines in U.S. Zetia and Vytorin sales and expects the declines to continue. The Company will lose market exclusivity in major European markets for Ezetrol in April 2018 and for Inegy in April 2019 and anticipates sales declines in these markets thereafter. Sales of Ezetrol and Inegy in these markets were $552 million and $457 million, respectively, in 2017. Combined worldwide sales of Zetia , Vytorin and Atozet were $3.8 billion in 2016, growth of 1% compared with 2015, reflecting volume growth in Europe and higher pricing in the United States, largely offset by lower sales in Venezuela due to reduced operations by the Company in that country and lower volumes in the United States reflecting in part generic competition for Zetia . Pursuant to a collaboration with Bayer AG (Bayer) (see Note 4 to the consolidated financial statements), Merck has lead commercial rights for Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, in countries outside the Americas while Bayer has lead rights in the Americas, including the United States. The companies share profits equally under the collaboration. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Merck recorded sales for Adempas of $300 million in 2017, $169 million in 2016 and $30 million in 2015, which includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. Diabetes Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were $5.9 billion in 2017, a decline of 3% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by ongoing pricing pressure partially offset by continued volume growth globally. Combined global sales of Januvia and Janumet were $6.1 billion in 2016, an increase of 2% compared with 2015. Sales growth was driven primarily by higher volumes in the United States, Europe and Canada, partially offset by pricing pressures in the United States and Europe, and lower sales in Venezuela due to the Companys reduced operations in that country. In April 2017, Merck announced that the FDA issued a Complete Response Letter (CRL) regarding Mercks supplemental New Drug Applications (NDA) for Januvia , Janumet and Janumet XR (sitagliptin and metformin HCl extended-release). With these applications, Merck is seeking to include data from TECOS (Trial Evaluating Cardiovascular Outcomes with Sitagliptin) in the prescribing information of sitagliptin-containing medicines. Merck is taking actions to respond to the CRL. In December 2017, the FDA approved Steglatro (ertugliflozin) tablets, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, and the fixed-dose combination Steglujan (ertugliflozin and sitagliptin) tablets, the only fixed-dose combination of an SGLT2 inhibitor and dipeptidyl peptidase-4 inhibitor Januvia (sitagliptin). The FDA also approved the fixed-dose combination Segluromet (ertugliflozin and metformin hydrochloride). Steglatro , Steglujan and Segluromet are indicated to improve glycemic control in adults with type 2 diabetes mellitus. These products are part of a worldwide (except Japan) collaboration between Merck and Pfizer Inc. (Pfizer) for the co-development and co-promotion of ertugliflozin. As a result of FDA approval, Merck will make a $60 million payment to Pfizer, which was accrued for in the fourth quarter of 2017. The amount was capitalized and will be amortized over its estimated useful life, subject to impairment testing. Merck will exclusively promote Steglatro and the two fixed-dose combination products in the United States. Merck and Pfizer will share revenues and certain costs on a 60%/40% basis, with Merck having the 60% share, and Pfizer may be entitled to additional milestone payments. In January 2018, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) adopted a positive opinion recommending approval of ertugliflozin and the two fixed-dose combination products. The CHMP positive opinion will be considered by the European Commission (EC). If approval of any of the products in the EU is received, Merck will make an additional $40 million milestone payment to Pfizer. General Medicine and Womens Health Worldwide sales of NuvaRing , a vaginal contraceptive product, were $761 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower sales in the United States reflecting lower volumes that were partially offset by higher pricing, and lower demand in Europe. Global sales of NuvaRing were $777 million in 2016, an increase of 6% compared with 2015 including a 1% unfavorable effect from foreign exchange. Sales growth largely reflects higher pricing in the United States, partially offset by volume declines in Europe. The patent that provides U.S. market exclusivity for NuvaRing will expire in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales thereafter. Worldwide sales of Implanon/Nexplanon , single-rod subdermal contraceptive implants, grew to $686 million in 2017, an increase of 13% compared with 2016, primarily reflecting higher pricing and volume growth in the United States. Global sales of Implanon/Nexplanon were $606 million in 2016, an increase of 3% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales growth reflects higher demand in the United States, partially offset by declines in international markets, particularly in Venezuela. Hospital and Specialty Hepatitis Global sales of Zepatier , a treatment for chronic hepatitis C (HCV) infection, were $1.7 billion in 2017 and $555 million in 2016. Sales growth was driven primarily by higher sales in Europe, the United States and Japan following product launch in 2016. Merck has also launched Zepatier in other international markets. The Company is beginning to experience the unfavorable effects of increasing competition and declining patient volumes and anticipates that sales of Zepatier in the future will be materially adversely affected by these factors. HIV Worldwide sales of Isentress/Isentress HD, an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, were $1.2 billion in 2017, a decline of 13% compared with 2016. The sales decline primarily reflects lower demand in the United States and Europe due to competitive pressures. In May 2017, the FDA approved Isentress HD , a once-daily dose of Isentress. In July 2017, the EC granted marketing authorization for the once-daily dose of Isentress (where it will be marketed as Isentress 600 mg). Global sales of Isentress were $1.4 billion in 2016, a decline of 8% compared with 2015 including a 2% unfavorable effect from foreign exchange. The sales decline was driven primarily by lower volumes in the United States, as well as lower demand and pricing in Europe due to competitive pressures, partially offset by a favorable adjustment to discount reserves in the United States. Hospital Acute Care Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, were $704 million in 2017, growth of 46% compared with 2016, driven by strong global demand, particularly in the United States. Worldwide sales were $482 million in 2016, growth of 37% compared with 2015 including a 2% favorable effect from foreign exchange. Sales growth reflects volume growth in most markets, including in the United States where it was approved by the FDA in December 2015, partially offset by a decline in Venezuela due to reduced operations by the Company in this country. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, were $636 million in 2017, an increase of 7% compared with 2016, primarily reflecting higher demand and pricing in the United States, as well as volume growth in Europe. Global sales of Noxafil grew 22% in 2016 to $595 million driven primarily by higher pricing in the United States, volume growth in Europe reflecting an ongoing positive impact from the approval of new formulations, and higher demand in the Asia Pacific region. Foreign exchange unfavorably affected global sales performance by 3% in 2016. Global sales of Invanz , for the treatment of certain infections, were $602 million in 2017, an increase of 7% compared with 2016, driven primarily by higher sales in the United States, reflecting higher pricing that was partially offset by lower demand, as well as higher demand in Brazil. Worldwide sales of Invanz were $561 million in 2016, a decline of 1% compared with 2015 including a 2% unfavorable effect from foreign exchange. Sales performance in 2016 reflects higher pricing in the United States, largely offset by a decline in Venezuela. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and the Company anticipates a significant decline in U.S. Invanz sales in future periods. Global sales of Cancidas , an anti-fungal product sold primarily outside of the United States, were $422 million in 2017, a decline of 24% compared with 2016, driven primarily by generic competition in certain European markets. The EU compound patent for Cancidas expired in April 2017. Accordingly, the Company is experiencing a significant decline in Cancidas sales in these European markets and expects the decline to continue. Worldwide sales of Cancidas were $558 million in 2016, a decline of 3% compared with 2015, reflecting a 4% unfavorable effect from foreign exchange and pricing declines in Europe that were offset by higher volumes in China. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, were $382 million in 2017, a decline of 65% compared with 2016, and were $1.1 billion in 2016, a decline of 4% compared with 2015. The U.S. composition patent for Cubicin expired in June 2016. Accordingly, the Company is experiencing a rapid and substantial decline in U.S. Cubicin sales as a result of generic competition and expects the decline to continue. The Company anticipates it will lose market exclusivity for Cubicin in some European markets in early 2018. In November 2017, Merck announced that the FDA approved Prevymis (letermovir) for prophylaxis (prevention) of CMV infection and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. As a result of FDA approval, Merck made a 105 million ($125 million) milestone payment to AiCuris in 2017. This amount was capitalized and will be amortized over its estimated useful life, subject to impairment testing. In January 2018, Prevymis was approved by the EC and, as a result, Merck will make an additional 30 million milestone payment to AiCuris. Merck also has filed Prevymis for regulatory approval in other markets including Japan. Immunology Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $837 million in 2017, a decline of 34% compared with 2016, and were $1.3 billion in 2016, a decline of 29% compared with 2015. Foreign exchange unfavorably affected sales performance by 1% in 2016. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $819 million in 2017, growth of 7% compared with 2016 including a 1% favorable effect from foreign exchange. Sales growth primarily reflects higher demand in Europe. Sales of Simponi were $766 million in 2016, an increase of 11% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales growth was driven primarily by higher volumes in Europe reflecting in part an ongoing positive impact from the ulcerative colitis indication. Oncology Sales of Keytruda , an anti-PD-1 therapy, were $3.8 billion in 2017 , $1.4 billion in 2016 and $566 million in 2015 . The year-over-year increases were driven by volume growth in all markets, particularly in the United States, Europe and Japan as the Company continues to launch Keytruda with multiple new indications globally. U.S. sales of Keytruda were $2.3 billion in 2017 , $792 million in 2016 and $393 million in 2015 . Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC reflecting both the continued adoption of Keytruda in the first-line setting as monotherapy for patients with metastatic NSCLC whose tumors have high PD-L1 expression, as well as the uptake of Keytruda in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous NSCLC with or without PD-L1 expression. Other indications, including melanoma, head and neck cancer, and bladder cancer, also contributed to growth in 2017. Sales growth in international markets reflects positive performance in the melanoma indications, as well as a greater contribution from the treatment of patients with NSCLC as reimbursement is established in additional markets in the first- and second-line settings. In March 2017, the FDA approved Keytruda for the treatment of adult and pediatric patients with cHL refractory to treatment, or who have relapsed after three or more prior lines of therapy. In May 2017, the EC approved Keytruda for the treatment of adult patients with relapsed or refractory cHL who have failed autologous stem cell transplant and brentuximab vedotin, or who are transplant-ineligible and have failed brentuximab vedotin. In May 2017, the FDA approved Keytruda in combination with pemetrexed and carboplatin for the first-line treatment of metastatic nonsquamous NSCLC, irrespective of PD-L1 expression. Keytruda is the only anti-PD-1 treatment approved in the first-line setting as both monotherapy and combination therapy for appropriate patients with metastatic NSCLC. In October 2016, Keytruda was approved by the FDA as monotherapy in the first-line setting for patients with metastatic NSCLC whose tumors have high PD-L1 expression, with no EGFR or ALK genomic tumor aberrations. Keytruda as monotherapy is also indicated for the second-line or greater treatment setting for patients with metastatic NSCLC whose tumors express PD-L1, with disease progression on or after platinum-containing chemotherapy. Patients with EGFR or ALK genomic tumor aberrations should have disease progression on FDA-approved therapy for these aberrations prior to receiving Keytruda . Additionally, in January 2017, the EC approved Keytruda for the first-line treatment of metastatic NSCLC in adults whose tumors have high PD-L1 expression with no EGFR or ALK positive tumor mutations. Also in May 2017, the FDA approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. In the first-line setting, Keytruda is approved for the treatment of patients with locally advanced or metastatic urothelial carcinoma who are ineligible for cisplatin-containing chemotherapy. In the second-line setting, Keytruda is approved for the treatment of patients with locally advanced or metastatic urothelial carcinoma who have disease progression during or following platinum-containing chemotherapy or within 12 months of neoadjuvant or adjuvant treatment with platinum-containing chemotherapy. In September 2017, the EC approved Keytruda for use as monotherapy for the treatment of locally advanced or metastatic urothelial carcinoma in adults who have received prior platinum-containing chemotherapy, as well as adults who are not eligible for cisplatin-containing chemotherapy. Additionally in May 2017, the FDA approved Keytruda for a first-of-its-kind indication: the treatment of adult and pediatric patients with previously treated unresectable or metastatic MSI-H or mismatch repair deficient solid tumors. With this unique indication, Keytruda is the first cancer therapy approved for use based on a biomarker, regardless of tumor type. In September 2017, the FDA approved Keytruda for the treatment of patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction adenocarcinoma whose tumors express PD-L1. In December 2017, Merck announced that the pivotal Phase 3 KEYNOTE-061 trial investigating Keytruda , as a second-line treatment for patients with advanced gastric or gastroesophageal junction adenocarcinoma, did not meet its primary endpoint of overall survival (OS) in patients whose tumors expressed PD-L1. Additionally, progression free survival (PFS) in the PD-L1 positive population did not show statistical significance. The safety profile observed in KEYNOTE-061 was consistent with that observed in previously reported studies of Keytruda ; no new safety signals were identified. The current indication remains unchanged and the Company continues to evaluate Keytruda for gastric or gastroesophageal junction adenocarcinoma through KEYNOTE-062, a Phase 3 clinical trial studying Keytruda as a monotherapy or in combination with chemotherapy as first-line treatment for patients with PD-L1 positive advanced gastric or gastroesophageal junction cancer, and with KEYNOTE-585, a Phase 3 trial studying Keytruda in combination with chemotherapy in a neoadjuvant/adjuvant setting. In August 2016, Merck announced that the FDA approved Keytruda for the treatment of patients with recurrent or metastatic head and neck squamous cell carcinoma (HNSCC) with disease progression on or after platinum-containing chemotherapy. In July 2017, Merck announced that the pivotal Phase 3 KEYNOTE-040 trial investigating Keytruda in previously treated patients with recurrent or metastatic HNSCC did not meet its pre-specified primary endpoint of OS. The safety profile observed in KEYNOTE-040 was consistent with that observed in previously reported studies of Keytruda ; no new safety signals were identified. The current indication remains unchanged and clinical trials continue, including KEYNOTE-048, a Phase 3 clinical trial of Keytruda in the first-line treatment of recurrent or metastatic HNSCC. As a result of the additional approvals received in 2017 as noted above, Keytruda is now approved in the United States and in the EU as monotherapy for the treatment of certain patients with NSCLC, melanoma, cHL and urothelial carcinoma. Keytruda is also approved in the United States as monotherapy for the treatment of certain patients with HNSCC, gastric or gastroesophageal junction adenocarcinoma and MSI-H or mismatch repair deficient cancer, and in combination with pemetrexed and carboplatin in certain patients with NSCLC. Keytruda is also approved in Japan for the treatment of radically unresectable melanoma, PD-L1-positive unresectable advanced or recurrent NSCLC, relapsed or refractory cHL, and radically unresectable urothelial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In January 2017, Merck entered into a settlement and license agreement to resolve worldwide patent infringement litigation related to Keytruda (see Note 11 to the consolidated financial statements). Pursuant to the settlement, the Company will pay royalties of 6.5% on net sales of Keytruda in 2017 through 2023; and 2.5% on net sales of Keytruda in 2024 through 2026. Lynparza, an oral PARP inhibitor being developed as part of a collaboration formed in July 2017 with AstraZeneca (see Note 4 to the consolidated financial statements), is currently approved for certain types of ovarian and breast cancer. In January 2018, the FDA approved Lynparza for use in patients with BRCA-mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. As a result of this approval, Merck will make a $70 million milestone payment to AstraZeneca (see Note 4 to the consolidated financial statements). Also in January 2018, the Japanese Ministry of Health, Labour and Welfare approved Lynparza for use as a maintenance therapy in patients for platinum-sensitive relapsed ovarian cancer, regardless of their BRCA mutation status, who responded to their last platinum-based chemotherapy. Lynparza is the first PARP inhibitor to be approved in Japan. Diversified Brands Mercks diversified brands include human health pharmaceutical products that are approaching the expiration of their marketing exclusivity or are no longer protected by patents in developed markets, but continue to be a core part of the Companys offering in other markets around the world. Respiratory Worldwide sales of Singulair, a once-a-day oral medicine for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis, were $732 million in 2017, a decline of 20% compared with 2016, and were $915 million in 2016, a decrease of 2% compared with 2015. Foreign exchange unfavorably affected global sales performance by 1% in 2017 and favorably affected global sales performance by 2% in 2016. The sales declines were driven by lower volumes in Japan as a result of generic competition. The patents that provided market exclusivity for Singulair in Japan expired in 2016. As a result, the Company is experiencing a significant decline in Singulair sales in Japan and expects the decline to continue. The Company no longer has market exclusivity for Singulair in any major market. Global sales of Nasonex , an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, were $387 million in 2017, a decline of 28% compared with 2016, and were $537 million in 2016, a decline of 37% compared with 2015. Foreign exchange favorably affected global sales performance by 1% in 2017. The Company is experiencing a substantial decline in U.S. Nasonex sales as a result of generic competition and expects the decline to continue. The decline in global Nasonex sales in 2016 was also driven by lower volumes and pricing in Europe from ongoing generic erosion and lower sales in Venezuela due to reduced operations by the Company in this country. Global sales of Dulera Inhalation Aerosol, a combination medicine for the treatment of asthma, were $287 million in 2017, a decline of 34% compared with 2016, driven by lower sales in the United States reflecting ongoing competitive pricing pressure, as well as lower demand. Worldwide sales of Dulera Inhalation Aerosol were $436 million in 2016, a decline of 19% compared with 2015 including a 1% unfavorable effect from foreign exchange. The decline was driven by lower sales in the United Sales reflecting competitive pricing pressure that was partially offset by higher demand. Vaccines On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which developed and marketed vaccines in Europe. Accordingly, vaccine sales in 2017 include sales of Merck vaccines in the European markets that were previously part of the SPMSD joint venture, whereas sales in periods prior to 2017 do not. Prior to 2017, vaccine sales in these European markets were sold through the SPMSD joint venture, the results of which are reflected in equity income from affiliates included in Other (income) expense, net (see Note 15 to the consolidated financial statements). Supply sales to SPMSD, however, are included in vaccine sales in periods prior to 2017. Incremental vaccine sales resulting from the termination of the SPMSD joint venture in 2017 were approximately $400 million, of which approximately $215 million relate to Gardasil/Gardasil 9 . Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and diseases caused by certain types of human papillomavirus (HPV), were $2.3 billion in 2017, growth of 6% compared with 2016. Sales growth was driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture noted above, as well as higher demand in Asia Pacific due in part to the launch in China, partially offset by lower sales in the United States. Lower sales in the United States reflect the timing of public sector purchases. In addition, during 2017, the Company made a request to borrow doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile, which the CDC granted. The Companys decision to borrow the doses from the CDC was driven in part by the temporary shutdown resulting from the cyber-attack that occurred in June, as well as by overall higher demand than expected. As a result of the borrowing, the Company reversed the sales related to the borrowed doses and recognized a corresponding liability. The Company subsequently replenished nearly half of the doses borrowed from the stockpile. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018, which will result in the recognition of sales and a reversal of the remaining liability. Additionally, in October 2016, the FDA approved a 2-dose vaccination regimen for Gardasil 9, for use in girls and boys 9 through 14 years of age, and the CDCs Advisory Committee on Immunization Practices (ACIP) voted to recommend the 2-dose vaccination regimen for certain 9 through 14 year olds. The Company is experiencing an impact from the transition from a 3-dose vaccine regimen to a 2-dose vaccination regimen; however, increased patient starts are helping to offset the negative effects of the transition. Mercks sales of Gardasil/Gardasil 9 were $2.2 billion in 2016, growth of 14% compared with 2015. Sales growth was driven primarily by higher volumes and pricing in the United States, as well as higher demand in the Asia Pacific region, partially offset by a decline in government tenders in Brazil. The Company is a party to certain third-party license agreements with respect to Gardasil/Gardasil 9 (including a cross-license and settlement agreement with GlaxoSmithKline). As a result of these agreements, the Company pays royalties on worldwide Gardasil/Gardasil 9 sales of 10% to 18% which vary by country and are included in Materials and production costs. Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, were $528 million in 2017, $495 million in 2016 and $454 million in 2015. The increase in 2017 as compared with 2016 was driven primarily by higher pricing and volumes in the United States, as well as volume growth in international markets, particularly in Europe. Sales growth in 2016 as compared with 2015 was driven primarily by higher demand and pricing in the United States. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, were $382 million in 2017, $353 million in 2016 and $365 million in 2015. Sales growth in 2017 as compared with 2016 was largely attributable to higher sales in Europe resulting from the termination of the SPMSD joint venture. Sales performance in 2016 as compared with 2015 was driven by higher demand in 2015 resulting from measles outbreaks in the United States. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), were $767 million in 2017, $792 million in 2016 and $686 million in 2015. The sales decline in 2017 as compared with 2016 was driven primarily by lower volumes in Brazil due to the loss of a government tender, as well as lower sales in the United States reflecting lower demand partially offset by higher pricing. Higher sales in Europe resulting from the termination of the SPMSD joint venture partially offset the decline. Sales growth in 2016 as compared with 2015 was driven primarily by higher sales in the United States reflecting the effects of public sector purchasing and higher pricing that were partially offset by lower demand. Volume growth in Brazil reflecting the timing of government tenders also contributed to the sales increase in 2016 as compared with 2015. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, were $821 million in 2017, an increase of 28% compared with 2016, driven primarily by higher demand and pricing in the United States, as well as higher sales in Europe resulting from the termination of the SPMSD joint venture. Mercks sales of Pneumovax 23 were $641 million in 2016, an increase of 18% compared with 2015, driven primarily by higher volumes and pricing in the United States and higher demand in the Asia Pacific region. Foreign exchange unfavorably affected sales performance by 1% in 2017 and favorably affected sales performance by 1% in 2016. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, were $686 million in 2017, an increase of 5% compared with 2016, driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture. Mercks sales of RotaTeq were $652 million in 2016, an increase of 7% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales performance was driven primarily by the effects of public sector purchasing in the United States, as well as volume growth in several international markets. Worldwide sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $668 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States reflecting the approval of a competitors vaccine that received a preferential recommendation from the ACIP in October 2017 for the prevention of shingles over Zostavax . The Company anticipates this competition will have a material adverse effect on sales of Zostavax in future periods. The U.S. sales decline was largely offset by growth in Europe resulting from the termination of the SPMSD joint venture and volume growth in the Asia Pacific region. Mercks sales of Zostavax were $685 million in 2016, a decline of 9% compared with 2015 including a 1% unfavorable effect from foreign exchange. The decline was driven primarily by lower volumes in the United States, partially offset by higher pricing in the United States and higher demand in the Asia Pacific region. Other Segments The Companys other segments are the Animal Health, Healthcare Services and Alliances segments, which are not material for separate reporting. Animal Health Animal Health includes pharmaceutical and vaccine products for the prevention, treatment and control of disease in all major farm and companion animal species. Animal Health sales are affected by competition and the frequent introduction of generic products. Worldwide sales of Animal Health products were $3.9 billion in 2017, $3.5 billion in 2016 and $3.3 billion in 2015. Global sales of Animal Health products grew 11% in 2017 compared with 2016 primarily reflecting higher sales of companion animal products, largely driven by growth in Bravecto , a line of products that kill fleas and ticks in dogs and cats for up to 12 weeks, reflecting both growth in the oral formulation and continued uptake in the topical formulation, which was launched in 2016. Animal Health sales growth was also driven by higher sales of ruminant, poultry and swine products. Worldwide sales of Animal Health products increased 4% in 2016 compared with 2015 including a 4% unfavorable effect from foreign exchange. Sales growth reflects volume growth across most species areas, particularly in products for companion animals, driven primarily by higher sales of Bravecto, as well as in poultry and swine products. In March 2017, Merck acquired a controlling interest in Valle, a leading privately held producer of animal health products in Brazil (see Note 3 to the consolidated financial statements). Costs, Expenses and Other ($ in millions) Change Change Materials and production $ 12,775 % $ 13,891 % $ 14,934 Marketing and administrative 9,830 % 9,762 % 10,313 Research and development 10,208 % 10,124 % 6,704 Restructuring costs % % Other (income) expense, net % % 1,527 $ 33,601 % $ 35,148 % $ 34,097 Materials and Production Materials and production costs were $12.8 billion in 2017 , $13.9 billion in 2016 and $14.9 billion in 2015 . Costs include expenses for the amortization of intangible assets recorded in connection with business acquisitions which totaled $3.1 billion in 2017, $3.7 billion in 2016 and $4.7 billion in 2015. Costs in 2017 , 2016 and 2015 also include intangible asset impairment charges of $58 million , $347 million and $45 million , respectively, related to marketed products and other intangibles recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). Costs in 2017 also include a $76 million intangible asset impairment charge related to a licensing agreement. The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, expenses for 2015 include $105 million of amortization of purchase accounting adjustments to Cubists inventories. Also included in materials and production costs are expenses associated with restructuring activities which amounted to $138 million , $181 million and $361 million in 2017 , 2016 and 2015 , respectively, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 68.2% in 2017 compared with 65.1% in 2016 and 62.2% in 2015 . The improvements in gross margin reflect a lower net impact from the amortization of intangible assets, intangible asset impairment charges and restructuring costs as noted above, which reduced gross margin by 8.2 percentage points in 2017, 10.6 percentage points in 2016 and 13.2 percentage points in 2015. The gross margin improvement in 2017 compared with 2016 also reflects the favorable effects of product mix. Manufacturing-related costs associated with the cyber-attack partially offset the gross margin improvement in 2017. The improvement in gross margin in 2016 as compared with 2015 was also driven by lower inventory write-offs and the favorable effects of foreign exchange. Marketing and Administrative Marketing and administrative (MA) expenses were $9.8 billion in 2017, an increase of 1% compared with 2016. Higher administrative costs, including costs associated with the Company operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, remediation costs related to the cyber-attack, and higher promotional expenses related to product launches were partially offset by lower restructuring and acquisition and divestiture-related costs, lower selling expenses and the favorable effect of foreign exchange. MA expenses were $9.8 billion in 2016, a decline of 5% compared with 2015, driven largely by lower acquisition and divestiture-related costs, the favorable effects of foreign exchange, lower administrative expenses, such as legal defense costs, as well as lower selling costs. Higher promotional spending largely related to product launches and higher restructuring costs partially offset the decline. MA expenses for 2017 , 2016 and 2015 include restructuring costs of $2 million , $95 million and $78 million , respectively, related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. MA expenses also include acquisition and divestiture-related costs of $44 million, $78 million and $436 million in 2017, 2016 and 2015, respectively, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Acquisition and divestiture-related costs in 2015 include costs related to the acquisition of Cubist (see Note 3 to the consolidated financial statements). Research and Development Research and development (RD) expenses were $10.2 billion in 2017, an increase of 1% compared with 2016. The increase was driven primarily by a charge in 2017 related to the formation of a collaboration with AstraZeneca, an unfavorable effect from changes in the estimated fair value measurement of liabilities for contingent consideration and higher clinical development spending, largely offset by lower in-process research and development (IPRD) impairment charges and lower restructuring costs. RD expenses were $10.1 billion in 2016 compared with $6.7 billion in 2015. The increase was driven primarily by higher IPRD impairment charges, increased clinical development spending, higher restructuring and licensing costs, partially offset by a reduction in expenses associated with a decrease in the estimated fair value measurement of liabilities for contingent consideration, as well as by the favorable effects of foreign exchange. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $4.6 billion in 2017, $4.3 billion in 2016 and $4.0 billion in 2015. Also included in RD expenses are costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, as well as licensing activity, and certain costs from operating segments, including the Pharmaceutical and Animal Health segments, which in the aggregate were $2.7 billion, $2.5 billion and $2.6 billion for 2017, 2016 and 2015, respectively. Additionally, RD expenses in 2017 include a $2.35 billion aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). RD expenses also include IPRD impairment charges of $483 million , $3.6 billion and $63 million in 2017 , 2016 and 2015 , respectively (see Research and Development below). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with acquisitions. During 2017, the Company recorded charges of $27 million to increase the estimated fair value of liabilities for contingent consideration. During 2016 and 2015, the Company recorded a reduction in expenses of $402 million and $24 million, respectively, to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs (see Note 6 to the consolidated financial statements). RD expenses in 2017 , 2016 and 2015 also reflect $11 million , $142 million and $52 million , respectively, of accelerated depreciation and asset abandonment costs associated with restructuring activities. Restructuring Costs The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $776 million , $651 million and $619 million in 2017 , 2016 and 2015 , respectively. In 2017 , 2016 and 2015 , separation costs of $552 million , $216 million and $208 million , respectively, were incurred associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Merck eliminated approximately 2,450 positions in 2017 , 2,625 positions in 2016 and 3,770 positions in 2015 related to these restructuring activities. Also included in restructuring costs are asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Materials and production , Marketing and administrative and Research and development as discussed above. The Company recorded aggregate pretax costs of $927 million in 2017 , $1.1 billion in 2016 and $1.1 billion in 2015 related to restructuring program activities (see Note 5 to the consolidated financial statements). While the Company has substantially completed the actions under the programs, approximately $500 million of additional pretax costs are expected to be incurred in 2018 relating to anticipated employee separations and remaining asset-related costs. Other (Income) Expense, Net Other (income) expense, net was $12 million of expense in 2017 , $720 million of expense in 2016 and $1.5 billion of expense in 2015 . For details on the components of Other (income) expense, net , see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 22,586 $ 22,180 $ 21,658 Other non-reportable segment profits 1,834 1,507 1,573 Other (17,899 ) (19,028 ) (17,830 ) Income before taxes $ 6,521 $ 4,659 $ 5,401 Segment profits are comprised of segment sales less standard costs, certain operating expenses directly incurred by the segment, components of equity income or loss from affiliates and certain depreciation and amortization expenses. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are acquisition and divestiture-related costs, including the amortization of purchase accounting adjustments, intangible asset impairment charges and changes in the estimated fair value measurement of liabilities for contingent consideration, restructuring costs, and a portion of equity income. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items, including a loss on the extinguishment of debt in 2017, a charge related to the settlement of worldwide Keytruda patent litigation in 2016, gains on divestitures in 2016 and 2015, as well as a net charge related to the settlement of Vioxx shareholder class action litigation and foreign exchange losses related to the devaluation of the Companys net monetary assets in Venezuela in 2015, are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Pharmaceutical segment profits grew 2% in 2017 compared with 2016 primarily reflecting higher sales and the favorable effects of product mix. Pharmaceutical segment profits grew 2% in 2016 compared with 2015 primarily reflecting higher sales. Taxes on Income The effective income tax rates of 62.9% in 2017 , 15.4% in 2016 and 17.4% in 2015 reflect the impacts of acquisition and divestiture-related costs, which in 2016 include $3.6 billion of IPRD impairment charges, as well as restructuring costs and the beneficial impact of foreign earnings. In addition, the effective income tax rate for 2017 includes a provisional net charge of $2.6 billion related to the enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 16 to the consolidated financial statements). The effective income tax rate for 2017 also reflects the unfavorable impact of a $2.35 billion aggregate pretax charge recorded in connection with the formation of a collaboration with AstraZeneca for which no tax benefit was recognized, partially offset by the favorable impact of a net benefit of $234 million related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements) and a benefit of $88 million related to the settlement of a state income tax issue. The effective income tax rate for 2015 reflects the favorable impact of a net benefit of $410 million related to the settlement of certain federal income tax issues, the impact of a net charge related to the settlement of Vioxx shareholder class action litigation being fully deductible at combined U.S. federal and state tax rates and the favorable impact of tax legislation enacted in the fourth quarter of 2015, as well as the unfavorable effect of non-tax deductible foreign exchange losses related to Venezuela (see Note 15 to the consolidated financial statements). Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $2.4 billion in 2017 , $3.9 billion in 2016 and $4.4 billion in 2015 . EPS was $0.87 in 2017 , $1.41 in 2016 and $1.56 in 2015 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. Senior managements annual compensation is derived in part using non-GAAP income and non-GAAP EPS. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 6,521 $ 4,659 $ 5,401 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 3,760 7,312 5,398 Restructuring costs 1,069 1,110 Other items: Aggregate charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Charge related to the settlement of worldwide Keytruda patent litigation Foreign currency devaluation related to Venezuela Net charge related to the settlement of Vioxx shareholder class action litigation Gain on sale of certain migraine clinical development programs (250 ) Gain on divestiture of certain ophthalmic products (147 ) Other (16 ) (67 ) (34 ) Non-GAAP income before taxes 13,542 13,598 13,034 Taxes on income as reported under GAAP 4,103 Estimated tax benefit on excluded items (1) 2,321 1,470 Provisional net tax charge related to the enactment of the TCJA (2,625 ) Net tax benefits from the settlements of certain federal income tax issues Tax benefit related to the settlement of a state income tax issue Non-GAAP taxes on income 2,585 3,039 2,822 Non-GAAP net income 10,957 10,559 10,212 Less: Net income attributable to noncontrolling interests Non-GAAP net income attributable to Merck Co., Inc. $ 10,933 $ 10,538 $ 10,195 EPS assuming dilution as reported under GAAP $ 0.87 $ 1.41 $ 1.56 EPS difference (2) 3.11 2.37 2.03 Non-GAAP EPS assuming dilution $ 3.98 $ 3.78 $ 3.59 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Represents the difference between calculated GAAP EPS and calculated non-GAAP EPS, which may be different than the amount calculated by dividing the impact of the excluded items by the weighted-average shares for the applicable year . Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects, and typically consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2017 is an aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), a provisional net tax charge related to the enactment of the TCJA, a net benefit related to the settlement of certain federal income tax issues and a benefit related to the settlement of a state income tax issue (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2016 is a charge to settle worldwide patent litigation related to Keytruda (see Note 11 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2015 are foreign exchange losses related to the devaluation of the Companys net monetary assets in Venezuela (see Note 15 to the consolidated financial statements), a net charge related to the previously disclosed settlement of Vioxx shareholder class action litigation, a gain on the sale of certain migraine clinical development programs (see Note 3 to the consolidated financial statements), a gain on the divestiture of the Companys remaining ophthalmics business in international markets (see Note 3 to the consolidated financial statements), as well as a net tax benefit related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements). Research and Development A chart reflecting the Companys current research pipeline as of February 23, 2018 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In December 2017, the FDA accepted for review a supplemental BLA for Keytruda for the treatment of adult and pediatric patients with refractory PMBCL, or who have relapsed after two or more prior lines of therapy. The FDA granted Priority Review status with a Prescription Drug User Fee Action (PDUFA), or target action, date of April 3, 2018. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with axitnib as a first-line treatment for patients with advanced or metastatic renal cell carcinoma; for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy; and for the treatment of Merkel cell carcinoma. Also, in January 2018, Merck and Eisai Co., Ltd. (Eisai) announced receipt of Breakthrough Therapy designation from the FDA for Eisais multiple receptor tyrosine kinase inhibitor Lenvima (lenvatinib) in combination with Keytruda for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma. The Lenvima and Keytruda combination therapy is being jointly developed by Eisai and Merck. This marks the 12 th Breakthrough Therapy designation granted to Keytruda . The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In January 2018, Merck announced that the pivotal Phase 3 KEYNOTE-189 trial investigating Keytruda in combination with pemetrexed (Alimta) and cisplatin or carboplatin, for the first-line treatment of patients with metastatic non-squamous NSCLC, met its dual primary endpoints of OS and PFS. Based on an interim analysis conducted by the independent Data Monitoring Committee, treatment with Keytruda in combination with pemetrexed plus platinum chemotherapy resulted in significantly longer OS and PFS than pemetrexed plus platinum chemotherapy alone. Results from KEYNOTE-189 will be presented at an upcoming medical meeting and submitted to regulatory authorities. In 2017, the FDA placed a full clinical hold on KEYNOTE-183 and KEYNOTE-185 and a partial clinical hold on Cohort 1 of KEYNOTE-023, three combination studies of Keytruda with lenalidomide or pomalidomide versus lenalidomide or pomalidomide alone in the blood cancer multiple myeloma. This decision followed a review of data by the Data Monitoring Committee in which more deaths were observed in the Keytruda arms of KEYNOTE-183 and KEYNOTE-185. The FDA determined that the data available at the time indicated that the risks of Keytruda plus pomalidomide or lenalidomide outweighed any potential benefit for patients with multiple myeloma. All patients enrolled in KEYNOTE-183 and KEYNOTE-185 and those in the Keytruda /lenalidomide/dexamethasone cohort in KEYNOTE-023 have discontinued investigational treatment with Keytruda . This clinical hold does not apply to other studies with Keytruda . The Keytruda clinical development program consists of more than 700 clinical trials, including more than 400 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. MK-8835, ertugliflozin, an investigational oral SGLT-2 inhibitor in development to help improve glycemic control in adults with type 2 diabetes, and two fixed-dose combination products (MK-8835A, ertugliflozin and Januvia , and MK-8835B, ertugliflozin and metformin) are under review in the EU. In January 2018, the CHMP of the EMA adopted a positive opinion recommending approval of these medicines. The CHMP positive opinion will be considered by the EC. Ertugliflozin and the two fixed-dose combination products were approved by the FDA in December 2017. MK-0431J is an investigational fixed-dose combination of sitagliptin and ipragliflozin under review with the Japan Pharmaceuticals and Medical Devices Agency. MK-0431 is being developed for commercialization in Japan in collaboration with Astellas Pharma Inc. (Astellas). Ipragliflozin, an SGLT2 inhibitor, co-developed by Astellas and Kotobuki Pharmaceutical Co., Ltd. (Kotobuki), is approved for use in Japan and is being co-promoted with Merck and Kotobuki. MK-1439, doravirine, is an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection. In January 2018, Merck announced that the FDA accepted for review two NDAs for doravirine. The NDAs include data for doravirine as a once-daily tablet for use in combination with other antiretroviral agents, and for use of doravirine with lamivudine and tenofovir disoproxil fumarate in a once-daily fixed-dose combination single tablet as a complete regimen (MK-1439A). The PDUFA action date for both applications is October 23, 2018. V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, under review with the FDA that is being developed and, if approved, will be commercialized through a joint venture between Merck and Sanofi. This vaccine is designed to help protect against six important diseases - diphtheria, tetanus, pertussis (whooping cough), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b (Hib), and hepatitis B. In 2015, the FDA issued a CRL with respect to the BLA for V419. Both companies are working to provide additional data requested by the FDA. V419 is being marketed as Vaxelis in the EU. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). The FDA has designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. MK-7339, Lynparza (olaparib), is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4 to the consolidated financial statements). MK-5618, selumetinib, is an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple cancer types. Additionally, in February 2018, the FDA granted Orphan Drug designation for selumetinib for the treatment of neurofibromatosis type 1. The development of selumetinib is part of the global strategic oncology collaboration between Merck and AstraZeneca reference above. V920 is an investigational rVSV-ZEBOV (Ebola) vaccine candidate being studied in large scale Phase 2/3 clinical trials. In November 2014, Merck and NewLink Genetics announced an exclusive licensing and collaboration agreement for the investigational Ebola vaccine. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In December 2016, end of study results from the WHO ring vaccination trial were reported in Lancet supporting the July 2015 interim assessment that V920 offers substantial protection against Ebola virus disease, with no reported cases among vaccinated individuals from 10 days after vaccination in both randomized and non-randomized clusters. Results from other ongoing studies to be included in the first regulatory filing are anticipated in the first half of 2018. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure. The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). V212 is an inactivated varicella zoster virus vaccine in development for the prevention of herpes zoster. The Company completed a Phase 3 trial in autologous hematopoietic cell transplant patients and another Phase 3 trial in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The study in autologous hematopoietic cell transplant patients met its primary endpoints and Merck presented the results from this study at the American Society for Blood and Marrow Transplantation Meetings in February 2017. The study in patients with solid tumor malignancies undergoing chemotherapy met its primary endpoints, but the primary efficacy endpoint was not met in patients with hematologic malignancies. Merck will present the results from this study at an upcoming scientific meeting. Due to the competitive environment, development of V212 is currently on hold. MK-7264 is a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough. Merck plans to initiate a Phase 3 clinical trial in the first half of 2018. MK-7264 was originally developed by Afferent Pharmaceuticals (Afferent), which was acquired by the Company in 2016 (see Note 3 to the consolidated financial statements). Upon initiation of the Phase 3 clinical trial, Merck will make a $175 million milestone payment, which was accrued for at estimated fair value at the time of acquisition. The Company also discontinued certain drug candidates. In February 2018, Merck announced that it will be stopping protocol 019, also known as the APECS study, a Phase 3 study evaluating verubecestat, MK-8931, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), in people with prodromal Alzheimers disease. The decision to stop the study follows a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during a recent interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. As a result, the Company recorded an IPRD impairment charge as discussed below. In 2017, Merck announced that it will not submit applications for regulatory approval for MK-0859, anacetrapib, the Companys investigational cholesteryl ester transfer protein (CETP) inhibitor. The decision followed a thorough review of the clinical profile of anacetrapib, including discussions with external experts. Also in 2017, Merck made a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge as discussed below. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2017 , the balance of IPRD was $1.2 billion . During 2017 , 2016 and 2015 , $14 million , $8 million and $280 million , respectively, of IPRD projects received marketing approval in a major market and the Company began amortizing these assets based on their estimated useful lives. All of the IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date, and the Company may also not recover the research and development expenditures made since the acquisition to further develop such programs. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2017, the Company recorded $483 million of IPRD impairment charges within Research and development expenses. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the eDMC, which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion relates to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million, resulting in the recognition of the pretax impairment charge noted above. The IPRD impairment charges in 2016 also include charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM Biotherapeutics Ltd. and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million relates to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also include $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily relate to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration (see Note 6 to the consolidated financial statements). During 2015, the Company recorded $63 million of IPRD impairment charges, of which $50 million related to the surotomycin clinical development program. In 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and the IPRD impairment charge noted above. Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain of the more recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In February 2018, Merck and Viralytics Limited (Viralytics) announced a definitive agreement pursuant to which Merck will acquire Viralytics, an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 1.75 per share. The proposed acquisition values the total issued shares in Viralytics at approximately AUD 502 million ($394 million). Upon completion of the transaction, Merck will gain full rights to Cavatax (CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatax is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatax is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatax combination in melanoma, prostate, lung and bladder cancers. The transaction remains subject to a Viralyticss shareholder vote and customary regulatory approvals. Merck anticipates the transaction will close in the second quarter of 2018. In October 2017, Merck acquired Rigontec. Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, RGT100, is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda (pembrolizumab) and Imfinzi (durvalumab). The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies will be shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and is making payments of $750 million over a multi-year period for certain license options ( $250 million was paid in December 2017, $400 million will be paid in 2018 and $100 million will be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license options payments. In addition, Merck will pay AstraZeneca up to an additional $6.15 billion contingent upon successful achievement of future regulatory and sales-based milestones for total aggregate consideration of up to $8.5 billion . Capital Expenditures Capital expenditures were $1.9 billion in 2017 , $1.6 billion in 2016 and $1.3 billion in 2015 . Expenditures in the United States were $1.2 billion in 2017 , $1.0 billion in 2016 and $879 million in 2015 . Merck plans to invest approximately $12.0 billion over five years in capital projects including approximately $8.0 billion in the United States. Depreciation expense was $1.5 billion in 2017 , $1.6 billion in 2016 and $1.6 billion in 2015 of which $1.0 billion, $1.0 billion and $1.1 billion, respectively, applied to locations in the United States. Total depreciation expense in 2017 , 2016 and 2015 included accelerated depreciation of $60 million , $227 million and $174 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 6,152 $ 13,410 $ 10,550 Total debt to total liabilities and equity 27.8 % 26.0 % 26.0 % Cash provided by operations to total debt 0.3:1 0.4:1 0.5:1 The decline in working capital in 2017 as compared with 2016 primarily reflects the reclassification of $3.0 billion of notes due in the first half of 2018 from long-term debt to short-term debt, $1.85 billion of upfront and option payments related to the formation of the AstraZeneca collaboration discussed above, as well as $810 million paid to redeem debt in connection with tender offers discussed below. Cash provided by operating activities was $6.4 billion in 2017 , $10.4 billion in 2016 and $12.5 billion in 2015 . The decline in cash provided by operating activities in 2017 reflects a $2.8 billion payment related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), payments of $1.85 billion related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), and a $625 million payment made by the Company related to the settlement of worldwide Keytruda patent litigation (see Note 11 to the consolidated financial statements). Cash provided by operating activities in 2016 reflects a net payment of approximately $680 million to fund the Vioxx shareholder class action litigation settlement not covered by insurance proceeds. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash provided by investing activities was $2.7 billion in 2017 compared with a use of cash in investing activities of $3.2 billion in 2016. The change was driven primarily by lower purchases of securities and other investments, higher proceeds from the sales of securities and other investments and a lower use of cash for the acquisitions of businesses. Cash used in investing activities was $3.2 billion in 2016 compared with $4.8 billion in 2015. The lower use of cash in 2016 was driven primarily by cash used in 2015 for the acquisition of Cubist, as well as lower purchases of securities and other investments in 2016, partially offset by lower proceeds from the sales of securities and other investments in 2016 and the use of cash in 2016 for the acquisitions of Afferent and The StayWell Company LLC. Cash used in financing activities was $10.0 billion in 2017 compared with $9.0 billion in 2016. The increase in cash used in financing activities was driven primarily by proceeds from the issuance of debt in 2016, as well as higher purchases of treasury stock and lower proceeds from the exercise of stock options in 2017, partially offset by lower payments on debt in 2017. Cash used in financing activities was $9.0 billion in 2016 compared with $5.4 billion in 2015 driven primarily by lower proceeds from the issuance of debt, partially offset by a decrease in short-term borrowings in 2015, lower payments on debt, lower purchases of treasury stock and higher proceeds from the exercise of stock options. During 2015, the Company recorded charges of $876 million related to the devaluation of its net monetary assets in Venezuela, the large majority of which was cash (see Note 15 to the consolidated financial statements). At December 31, 2017 , the total of worldwide cash and investments was $20.6 billion , including $8.5 billion of cash, cash equivalents and short-term investments, and $12.1 billion of long-term investments. A substantial majority of cash and investments are held by foreign subsidiaries that, prior to the enactment of the TCJA, would have been subject to significant tax payments if such cash and investments were repatriated in the form of dividends. In accordance with the TCJA, the Company has recorded a provisional amount for taxes on unremitted earnings through December 31, 2017 that were previously deemed to be indefinitely reinvested outside of the United States (see Note 16 to the consolidated financial statements). As a result of the TCJA, repatriation of foreign earnings in the future will have little to no incremental U.S. tax consequences. The Companys contractual obligations as of December 31, 2017 are as follows: Payments Due by Period ($ in millions) Total 20192020 20212022 Thereafter Purchase obligations (1) $ 2,226 $ $ $ $ Loans payable and current portion of long-term debt (2) 3,074 3,074 Long-term debt 21,400 3,200 4,589 13,611 Interest related to debt obligations 8,206 1,200 1,011 5,320 Unrecognized tax benefits (3) Transition tax related to the enactment of the TCJA (4) 5,057 1,194 2,465 Operating leases $ 40,882 $ 5,331 $ 6,446 $ 7,430 $ 21,675 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) In January 2018, $1.0 billion of notes matured and were repaid. (3) As of December 31, 2017 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $2.1 billion , including $67 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2018 cannot be made. (4) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years as permitted under the TCJA (see Note 16 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts reflected for research and development obligations do not include contingent milestone payments related to collaborative arrangements and acquisitions. Contingent milestone payments are not considered contractual obligations as they are contingent upon the successful achievement of developmental, regulatory approval and commercial milestones. At December 31, 2017, the Company has $635 million of accrued milestone payments related to collaborations with Pfizer, Bayer and AstraZeneca (see Note 4 to the consolidated financial statements), as well as in connection with certain licensing arrangements, that are payable in 2018. In addition, at December 31, 2017, the Company has $315 million of current liabilities for contingent consideration related to business acquisitions expected to be paid in 2018 (see Note 6 to the consolidated financial statements). Also excluded from research and development obligations are potential future funding commitments of up to approximately $60 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $73 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2018 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $60 million to its U.S. pension plans, $150 million to its international pension plans and $25 million to its other postretirement benefit plans during 2018 . In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. In November 2016, the Company issued 1.0 billion principal amount of senior unsecured notes consisting of 500 million principal amount of 0.50% notes due 2024 and 500 million principal amount of 1.375% notes due 2036. The Company used the net proceeds of the offering of $1.1 billion for general corporate purposes. The Company has a $6.0 billion, five-year credit facility that matures in June 2022. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In December 2015, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. In February 2015, Merck issued $8.0 billion aggregate principal amount of senior unsecured notes. The Company used a portion of the net proceeds of the offering of $7.9 billion to repay commercial paper issued to substantially finance the Companys acquisition of Cubist. The remaining net proceeds were used for general corporate purposes, including for repurchases of the Companys common stock, and the repayment of outstanding commercial paper borrowings and debt maturities. Also in February 2015, the Company redeemed $1.9 billion of legacy Cubist debt acquired in the acquisition (see Note 3 to the consolidated financial statements). Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2017, the Board of Directors declared a quarterly dividend of $0.48 per share on the Companys common stock that was paid in January 2018. In January 2018, the Board of Directors declared a quarterly dividend of $0.48 per share on the Companys common stock for the second quarter of 2018 payable in April 2018. In November 2017, Mercks board of directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company purchased $4.0 billion of its common stock ( 67 million shares) for its treasury during 2017 . As of December 31, 2017 , the Companys share repurchase authorization was $11.0 billion, which includes $1.0 billion in authorized repurchases remaining under a program announced in March 2015. The Company purchased $3.4 billion and $4.2 billion of its common stock during 2016 and 2015 , respectively, under authorized share repurchase programs. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $400 million and $538 million at December 31, 2017 and 2016 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statements of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2017 and 2016, Income before taxes would have declined by approximately $92 million and $26 million in 2017 and 2016, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. During 2015, upon evaluation of evolving economic conditions in Venezuela and volatility in the country, combined with a decline in transactions that were settled at the then official (CENCOEX) rate, the Company determined it was unlikely that all outstanding net monetary assets would be settled at the CENCOEX rate. Accordingly, during 2015, the Company recorded charges of $876 million within Other (income) expense, net to devalue its net monetary assets in Venezuela to an amount that represented the Companys estimate of the U.S. dollar amount that would ultimately be collected and recorded additional exchange losses of $138 million in the aggregate reflecting the ongoing effect of translating transactions and net monetary assets consistent with these rates. The Company may also use forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates that are recorded in Other (income) expense, net . The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within Other Comprehensive Income ( OCI ), and remains in Accumulated Other Comprehensive Income ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2017 , the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.30% notes due 2018 $ 1,000 $ 1,000 5.00% notes due 2019 1,250 1.85% notes due 2020 1,250 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at both December 31, 2017 and 2016 would have positively affected the net aggregate market value of these instruments by $1.3 billion. A one percentage point decrease at December 31, 2017 and 2016 would have negatively affected the net aggregate market value by $1.5 billion and $1.6 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a separate determination as to the then useful life of the asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Revenue Recognition Revenues from sales of products are recognized when title and risk of loss passes to the customer, typically at time of delivery. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts for customers for which collection of accounts receivable is expected to be in excess of one year. The provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases directly through an intermediary wholesaler. The contracted customer generally purchases product at its contracted price plus a mark-up from the wholesaler. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision is based on expected payments, which are driven by patient usage and contract performance by the benefit provider customers. The Company uses historical customer segment mix, adjusted for other known events, in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers and other customers to the amounts accrued. Adjustments are recorded when trends or significant events indicate that a change in the estimated provision is appropriate. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2017 , 2016 or 2015 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,945 $ 2,798 Current provision 10,938 9,831 Adjustments to prior years (223 ) (169 ) Payments (11,109 ) (9,515 ) Balance December 31 $ 2,551 $ 2,945 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $198 million and $2.4 billion , respectively, at December 31, 2017 and were $196 million and $2.7 billion , respectively, at December 31, 2016 . The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of additional generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 2.1% in 2017 , 1.4% in 2016 and 1.5% in 2015 . Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at both December 31, 2017 and 2016 were $80 million . Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2017 and 2016 of approximately $160 million and $185 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $11 million in 2017 , and are estimated at $56 million in the aggregate for the years 2018 through 2022 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $312 million in 2017 , $300 million in 2016 and $299 million in 2015 . At December 31, 2017 , there was $469 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $201 million in 2017 , $144 million in 2016 and $277 million in 2015 . Net periodic benefit (credit) for other postretirement benefit plans was $(60) million in 2017 , $(88) million in 2016 and $(24) million in 2015 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The increase in net periodic benefit (credit) for other postretirement benefit plans in 2017 and 2016 as compared with 2015 is largely attributable to changes in retiree medical benefits approved by the Company in December 2015, partially offset by lower returns on plan assets. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 3.20% to 3.80% at December 31, 2017 , compared with a range of 3.40% to 4.30% at December 31, 2016 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2018 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.30% , compared to a range of 8.00% to 8.75% in 2017 . The decrease is primarily due to a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 35% to 55% in U.S. equities, 20% to 35% in international equities, 20% to 35% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 13% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $77 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2017. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $44 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2017. Required funding obligations for 2018 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of Accumulated Other Comprehensive Income (AOCI) . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Materials and production costs, Marketing and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired and is assigned to reporting units. The Company tests its goodwill for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. Additionally, the Company evaluates the extent to which the fair value exceeded the carrying value of the reporting unit at the last date a valuation was performed. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the project. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized within the Companys operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Companys ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2017 and 2016 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2017 , the notes to consolidated financial statements, and the report dated February 27, 2018 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 40,122 $ 39,807 $ 39,498 Costs, Expenses and Other Materials and production 12,775 13,891 14,934 Marketing and administrative 9,830 9,762 10,313 Research and development 10,208 10,124 6,704 Restructuring costs Other (income) expense, net 1,527 33,601 35,148 34,097 Income Before Taxes 6,521 4,659 5,401 Taxes on Income 4,103 Net Income 2,418 3,941 4,459 Less: Net Income Attributable to Noncontrolling Interests Net Income Attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 0.88 $ 1.42 $ 1.58 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 0.87 $ 1.41 $ 1.56 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Other Comprehensive Income (Loss) Net of Taxes: Net unrealized loss on derivatives, net of reclassifications (446 ) (66 ) (126 ) Net unrealized loss on investments, net of reclassifications (58 ) (44 ) (70 ) Benefit plan net gain (loss) and prior service credit (cost), net of amortization (799 ) Cumulative translation adjustment (169 ) (208 ) (1,078 ) Comprehensive Income Attributable to Merck Co., Inc. $ 2,710 $ 2,842 $ 4,617 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 6,092 $ 6,515 Short-term investments 2,406 7,826 Accounts receivable (net of allowance for doubtful accounts of $210 in 2017 and $195 in 2016) 6,873 7,018 Inventories (excludes inventories of $1,187 in 2017 and $1,117 in 2016 classified in Other assets - see Note 7) 5,096 4,866 Other current assets 4,299 4,389 Total current assets 24,766 30,614 Investments 12,125 11,416 Property, Plant and Equipment (at cost) Land Buildings 11,726 11,439 Machinery, equipment and office furnishings 14,649 14,053 Construction in progress 2,301 1,871 29,041 27,775 Less: accumulated depreciation 16,602 15,749 12,439 12,026 Goodwill 18,284 18,162 Other Intangibles, Net 14,183 17,305 Other Assets 6,075 5,854 $ 87,872 $ 95,377 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 3,057 $ Trade accounts payable 3,102 2,807 Accrued and other current liabilities 10,427 10,274 Income taxes payable 2,239 Dividends payable 1,320 1,316 Total current liabilities 18,614 17,204 Long-Term Debt 21,353 24,274 Deferred Income Taxes 2,219 5,077 Other Noncurrent Liabilities 11,117 8,514 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2017 and 2016 1,788 1,788 Other paid-in capital 39,902 39,939 Retained earnings 41,350 44,133 Accumulated other comprehensive loss (4,910 ) (5,226 ) 78,130 80,634 Less treasury stock, at cost: 880,491,914 shares in 2017 and 828,372,200 shares in 2016 43,794 40,546 Total Merck Co., Inc. stockholders equity 34,336 40,088 Noncontrolling Interests Total equity 34,569 40,308 $ 87,872 $ 95,377 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2015 $1,788 $ 40,423 $ 46,021 $ (4,323 ) $ (35,262 ) $ $ 48,791 Net income attributable to Merck Co., Inc. 4,442 4,442 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.81 per share) (5,115 ) (5,115 ) Treasury stock shares purchased (4,186 ) (4,186 ) Changes in noncontrolling ownership interests (20 ) (55 ) (75 ) Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (15 ) (15 ) Share-based compensation plans and other (181 ) Balance December 31, 2015 1,788 40,222 45,348 (4,148 ) (38,534 ) 44,767 Net income attributable to Merck Co., Inc. 3,920 3,920 Other comprehensive loss, net of taxes (1,078 ) (1,078 ) Cash dividends declared on common stock ($1.85 per share) (5,135 ) (5,135 ) Treasury stock shares purchased (3,434 ) (3,434 ) Changes in noncontrolling ownership interests Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (16 ) (16 ) Share-based compensation plans and other (283 ) 1,422 1,139 Balance December 31, 2016 1,788 39,939 44,133 (5,226 ) (40,546 ) 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) (5,177 ) (5,177 ) Treasury stock shares purchased (4,014 ) (4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (18 ) (18 ) Share-based compensation plans and other (37 ) Balance December 31, 2017 $ 1,788 $ 39,902 $ 41,350 $ (4,910 ) $ (43,794 ) $ $ 34,569 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 2,418 $ 3,941 $ 4,459 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,637 5,441 6,375 Intangible asset impairment charges 3,948 Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Charge for future payments related to AstraZeneca collaboration license options Charge related to the settlement of worldwide Keytruda patent litigation Foreign currency devaluation related to Venezuela Net charge related to the settlement of Vioxx shareholder class action litigation Equity income from affiliates (42 ) (86 ) (205 ) Dividends and distributions from equity method affiliates Deferred income taxes (2,621 ) (1,521 ) (764 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable (619 ) (480 ) Inventories (145 ) Trade accounts payable (37 ) Accrued and other current liabilities (922 ) (2,018 ) (8 ) Income taxes payable (3,291 ) (266 ) Noncurrent liabilities (123 ) (809 ) (277 ) Other (1,091 ) (5 ) Net Cash Provided by Operating Activities 6,447 10,376 12,538 Cash Flows from Investing Activities Capital expenditures (1,888 ) (1,614 ) (1,283 ) Purchases of securities and other investments (10,739 ) (15,651 ) (16,681 ) Proceeds from sales of securities and other investments 15,664 14,353 20,413 Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired (7,598 ) Acquisitions of other businesses, net of cash acquired (396 ) (780 ) (146 ) Dispositions of businesses, net of cash divested Other Net Cash Provided by (Used in) Investing Activities 2,679 (3,210 ) (4,758 ) Cash Flows from Financing Activities Net change in short-term borrowings (26 ) (1,540 ) Payments on debt (1,103 ) (2,386 ) (2,906 ) Proceeds from issuance of debt 1,079 7,938 Purchases of treasury stock (4,014 ) (3,434 ) (4,186 ) Dividends paid to stockholders (5,167 ) (5,124 ) (5,117 ) Proceeds from exercise of stock options Other (195 ) (118 ) (61 ) Net Cash Used in Financing Activities (10,006 ) (9,044 ) (5,387 ) Effect of Exchange Rate Changes on Cash and Cash Equivalents (131 ) (1,310 ) Net (Decrease) Increase in Cash and Cash Equivalents (423 ) (2,009 ) 1,083 Cash and Cash Equivalents at Beginning of Year 6,515 8,524 7,441 Cash and Cash Equivalents at End of Year $ 6,092 $ 6,515 $ 8,524 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or market. The cost of a substantial majority of domestic pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt and equity securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). For declines in the fair value of equity securities that are considered other-than-temporary, impairment losses are charged to Other (income) expense, net . The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Companys ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for both debt and equity securities are included in Other (income) expense, net . Revenue Recognition Revenues from sales of products are recognized when title and risk of loss passes to the customer, typically upon delivery. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates are recorded as current liabilities. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $198 million and $2.4 billion , respectively, at December 31, 2017 and $196 million and $2.7 billion , respectively, at December 31, 2016 . The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $1.5 billion in 2017 , $1.6 billion in 2016 and $1.6 billion in 2015 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.2 billion , $2.1 billion and $2.1 billion in 2017 , 2016 and 2015 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $449 million and $452 million , net of accumulated amortization at December 31, 2017 and 2016 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. Acquired Intangibles Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development Acquired in-process research and development (IPRD) that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges in all periods. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Cost reimbursements between the collaborative partners are recognized as incurred and included in Materials and production costs, Marketing and administrative expenses and Research and development expenses based on the underlying nature of the related activities subject to reimbursement. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, materials and production costs and marketing and administrative expenses on a gross basis. The Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ) and profit sharing amounts it pays to its collaborative partners within Materials and production costs. Terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Materials and production costs provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Materials and production costs over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Issued Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard will be effective as of January 1, 2018 and will be adopted using the modified retrospective method. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million in 2018. The adoption of the new guidance will also result in some additional disclosures. In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments. The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The new guidance also simplifies the impairment testing of equity investments without readily determinable fair values and changes certain disclosure requirements. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million in 2018. In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The Company does not anticipate any changes to the presentation of its Consolidated Statement of Cash Flows as a result of adopting the new standard. In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under existing guidance, the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to a third party. The new guidance will require the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by approximately $60 million in 2018 with a corresponding increase to deferred tax assets, subject to finalization. In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The adoption of the new guidance will not have a material effect on the Companys Consolidated Statement of Cash Flows. In March 2017, the FASB amended the guidance related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. Entities must use a retrospective transition method to adopt the requirement for separate presentation in the income statement of service costs and other components and a prospective transition method to adopt the requirement to limit the capitalization of benefit costs to the service cost component. The Company will utilize a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. The new standard is effective as of January 1, 2018. Net periodic benefit cost (credit) other than service cost was approximately $(510) million and $(530) million for the years ended December 31, 2017 and 2016 , respectively, (see Note 14). Upon adoption, these amounts will be reclassified to Other (income) expense, net from their current classification within Materials and production costs, Marketing and administrative expenses and Research and development costs. In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The new standard is effective as of January 1, 2018 and will be applied to future share-based payment award modifications should they occur. In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new guidance will be effective for interim and annual periods beginning in 2019 and will be adopted using a modified retrospective approach which will require application of the new guidance at the beginning of the earliest comparative period presented. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In August 2017, the FASB issued new guidance on hedge accounting that is intended to more closely align hedge accounting with companies risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The new guidance is effective for interim and annual periods beginning in 2019 on a modified retrospective basis. Early application is permitted in any interim period. The Company intends to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The Company anticipates recording a cumulative-effect adjustment upon adoption decreasing Retained earnings by $11 million in 2018.The adoption of the new guidance will result in some additional disclosures. In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the TCJA. Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of these amounts to retained earnings thereby eliminating these stranded tax effects. The new guidance is effective for interim and annual periods in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The new guidance is effective for interim and annual periods in 2020. Early adoption is permitted. The Company does not anticipate that the adoption of the new guidance will have a material effect on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Announced Transaction In February 2018, Merck and Viralytics Limited (Viralytics) announced a definitive agreement pursuant to which Merck will acquire Viralytics, an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 1.75 per share. The proposed acquisition values the total issued shares in Viralytics at approximately AUD 502 million ( $394 million ). Upon completion of the transaction, Merck will gain full rights to Cavatax (CVA21), Viralyticss investigational oncolytic immunotherapy. The transaction remains subject to a Viralyticss shareholder vote and customary regulatory approvals. Merck anticipates the transaction will close in the second quarter of 2018. 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, RGT100, is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Valle for $358 million . Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $291 million related to currently marketed products, net deferred tax liabilities of $93 million , other net assets of $14 million and noncontrolling interest of $25 million . In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $171 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5% . Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Valle for $18 million , which reduced noncontrolling interest related to Valle. 2016 Transactions In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferents lead investigational candidate, MK-7264 (formerly AF-219), is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPRD of $832 million , net deferred tax liabilities of $258 million , and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Also in July 2016, Merck, through its wholly owned subsidiary Healthcare Services Solutions, LLC, acquired a majority ownership interest in The StayWell Company LLC (StayWell), a portfolio company of Vestar Capital Partners (Vestar). StayWell is a health engagement company that helps its clients engage and educate people to improve health and business results. Under the terms of the transaction, Merck paid $150 million for a majority ownership interest. Additionally, Merck provided StayWell with a $150 million intercompany loan to pay down preexisting third-party debt. Merck has an option to buy, and Vestar has an option to require Merck to buy, some or all of Vestars remaining ownership interest at fair value beginning three years from the acquisition date. This transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $238 million , deferred tax liabilities of $84 million , other net liabilities of $5 million and noncontrolling interest of $124 million . The excess of the consideration transferred over the fair value of net assets acquired of $275 million was recorded as goodwill and is largely attributable to anticipated synergies expected to arise after the acquisition. The goodwill was allocated to the Healthcare Services segment and is not deductible for tax purposes. The intangible assets recognized primarily relate to customer relationships, which are being amortized over a 10 -year useful life, and medical information and solutions content, which are being amortized over a five -year useful life. In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Mercks Keytruda . Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million , which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda . Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents. In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provides Merck with IOmets preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5% . Merck recognized intangible assets for IPRD of $155 million and net deferred tax assets of $32 million . The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5% . Actual cash flows are likely to be different than those assumed. In July 2017, Merck made a $100 million payment as a result of the achievement of a clinical development milestone, which was accrued for at estimated fair value at the time of acquisition as noted above. 2015 Transactions In December 2015, the Company divested its remaining ophthalmics portfolio in international markets to Mundipharma Ophthalmology Products Limited. Merck received consideration of approximately $170 million and recognized a gain of $147 million recorded in Other (income) expense, net in 2015. In July 2015, Merck acquired cCAM Biotherapeutics Ltd. (cCAM), a privately held biopharmaceutical company focused on the discovery and development of novel cancer immunotherapies. Total purchase consideration in the transaction included an upfront payment of $96 million in cash and potential future additional payments associated with the attainment of certain clinical development, regulatory and commercial milestones. The transaction was accounted for as an acquisition of a business. Merck recognized an intangible asset for IPRD of $180 million related to CM-24, a monoclonal antibody, as well as a liability for contingent consideration of $105 million , goodwill of $14 million and other net assets of $7 million . During 2016, as a result of unfavorable efficacy data, the Company determined that it would discontinue development of the pipeline program. Accordingly, the Company recorded an IPRD impairment charge of $180 million related to CM-24 and reversed the related liability for contingent consideration, which had a fair value of $116 million at the time of program discontinuation. Both the IPRD impairment charge and the income related to the reduction in the liability for contingent consideration were recorded in Research and development expenses in 2016. Also in July 2015, Merck and Allergan plc (Allergan) entered into an agreement pursuant to which Allergan acquired the exclusive worldwide rights to MK-1602 and MK-8031, Mercks investigational small molecule oral calcitonin gene-related peptide (CGRP) receptor antagonists, which are being developed for the treatment and prevention of migraine. Under the terms of the agreement, Allergan acquired these rights for upfront payments of $250 million , of which $125 million was paid in August 2015 upon closing of the transaction and the remaining $125 million was paid in April of 2016. The Company recorded a gain of $250 million within Other (income) expense, net in 2015 related to the transaction. Allergan is fully responsible for development of the CGRP programs, as well as manufacturing and commercialization upon approval and launch of the products. Under the agreement, Merck is entitled to receive potential development and commercial milestone payments and royalties at tiered double-digit rates based on commercialization of the programs. During 2016, Merck recognized gains of $100 million within Other (income) expense, net resulting from payments by Allergan for the achievement of research and development milestones. In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million , which was included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million . Merck committed up to $250 million to fund all of NGMs efforts under the initial five -year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50% . The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck has the option to extend the research agreement for two additional two -year terms. In January 2015, Merck acquired Cubist Pharmaceuticals, Inc. (Cubist), a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. Total consideration transferred of $8.3 billion included cash paid for outstanding Cubist shares of $7.8 billion , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Cubist. Share-based compensation payments to settle non-vested equity awards attributable to postcombination service were recognized as transaction expense in 2015. In addition, the Company assumed all of the outstanding convertible debt of Cubist, which had a fair value of approximately $1.9 billion at the acquisition date. Merck redeemed this debt in February 2015. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Cubist is as follows: Estimated fair value at January 21, 2015 Cash and cash equivalents $ Accounts receivable Inventories Other current assets Property, plant and equipment Identifiable intangible assets: Products and product rights (11 year weighted-average useful life) 6,923 IPRD Other noncurrent assets Current liabilities (1) (233 ) Deferred income tax liabilities (2,519 ) Long-term debt (1,900 ) Other noncurrent liabilities (1) (122 ) Total identifiable net assets 3,661 Goodwill (2) 4,670 Consideration transferred $ 8,331 (1) Included in current liabilities and other noncurrent liabilities is contingent consideration of $73 million and $50 million , respectively. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The Companys estimates of projected net cash flows considered historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent. The net cash flows were probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 8% . Actual cash flows are likely to be different than those assumed. The Company recorded the fair value of incomplete research project surotomycin (MK-4261) which, at the time of acquisition, had not reached technological feasibility and had no alternative future use. During the second quarter of 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and an IPRD impairment charge (see Note 8). In connection with the Cubist acquisition, liabilities were recorded for potential future consideration that is contingent upon the achievement of future sales-based milestones. The fair value of contingent consideration liabilities was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and a risk-adjusted discount rate of 8% used to present value the probability-weighted cash flows. Changes in the inputs could result in a different fair value measurement. This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Companys results of operations beginning after that date. During 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs, and legal and advisory fees which are reflected in Marketing and administrative expenses. The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014: Years Ended December 31 Sales $ 39,584 Net income attributable to Merck Co., Inc. 4,640 Basic earnings per common share attributable to Merck Co., Inc. common shareholders 1.65 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders 1.63 The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results. Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in February 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda (pembrolizumab) and Imfinzi (durvalumab). The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies will be shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZenca is currently the principal on Lynparza sales transactions. Merck is recording its share of product sales of Lynparza, net of costs of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and is making payments of $750 million over a multi-year period for certain license options ( $250 million was paid in December 2017, $400 million will be paid in 2018 and $100 million will be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license options payments. In addition, Merck will pay AstraZeneca up to an additional $6.15 billion contingent upon successful achievement of future regulatory milestones of $2.05 billion and sales-based milestones of $4.1 billion for total aggregate consideration of up to $8.5 billion . During the fourth quarter of 2017, based on the performance of Lynparza since the formation of the collaboration, Merck determined it was probable that annual sales of Lynparza in the future would exceed $250 million , which would trigger a $100 million sales-based milestone payment from Merck to AstraZeneca upon achievement of the sales milestone. Accordingly, in the fourth quarter of 2017, Merck recorded a $100 million liability and a corresponding intangible asset and also recognized $4 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset will be amortized over its remaining estimated useful life of 11 years , subject to impairment testing. The remaining $4.0 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. Also, in January 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer, triggering a $70 million milestone payment from Merck to AstraZeneca. This milestone payment will be capitalized and amortized over the remaining useful life of Lynparza. Summarized information related to this collaboration is as follows: Year Ended December 31 Alliance revenues (net of commercialization costs) $ Materials and production costs Marketing and administrative expenses Research and development expenses 2,419 Receivables from AstraZeneca Payables to AstraZeneca Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat), which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies equally share costs and profits from the collaboration and implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. In 2016, the Company determined it was probable that annual sales of Adempas would exceed $500 million triggering a $350 million payment from Merck to Bayer. Accordingly, in 2016, the Company recorded a $350 million liability and a corresponding intangible asset and also recognized $50 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset is being amortized over its then- remaining estimated useful life, subject to impairment testing. In 2017, annual sales of Adempas exceeded $500 million triggering the $350 million milestone payment from Merck to Bayer, which will be paid in the first quarter of 2018. There are $775 million of additional potential future sales-based milestone payments that have not yet been accrued as they are not deemed by the Company to be probable at this time. Summarized information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share of sales in Bayer's marketing territories Total sales Materials and production costs Marketing and administrative expenses Research and development expenses Receivables from Bayer Payables to Bayer Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets. 5. Restructuring The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. The Company recorded total pretax costs of $927 million in 2017 , $1.1 billion in 2016 and $1.1 billion in 2015 related to restructuring program activities. Since inception of the programs through December 31, 2017 , Merck has recorded total pretax accumulated costs of approximately $13.5 billion and eliminated approximately 43,350 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. While the Company has substantially completed the actions under these programs, approximately $500 million of additional pretax costs are expected to be incurred in 2018 relating to anticipated employee separations and remaining asset-related costs. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2017 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2016 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ 1,069 Year Ended December 31, 2015 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ 1,110 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,450 in 2017 , 2,625 in 2016 and 3,770 in 2015 . Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2017 , 2016 and 2015 includes $267 million , $409 million and $550 million , respectively, of asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $6 million in 2017 , $151 million in 2016 and $117 million in 2015 . The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2016 $ $ $ $ Expenses 1,069 (Payments) receipts, net (413 ) (347 ) (760 ) Non-cash activity (227 ) (186 ) (413 ) Restructuring reserves December 31, 2016 Expenses (Payments) receipts, net (328 ) (394 ) (722 ) Non-cash activity (60 ) Restructuring reserves December 31, 2017 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2020. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis . For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company may also use forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates that are recorded in Other (income) expense, net . The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI , and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Included in the cumulative translation adjustment are pretax losses of $520 million in 2017 , and pretax gains of $193 million in 2016 and $304 million in 2015 from the euro-denominated notes. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2017 , the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.30% notes due 2018 $ 1,000 $ 1,000 5.00% notes due 2019 1,250 1.85% notes due 2020 1,250 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other assets $ $ $ $ $ $ 2,700 Interest rate swap contracts Accrued and other current liabilities 1,000 Interest rate swap contracts Other noncurrent liabilities 4,650 3,500 Foreign exchange contracts Other current assets 4,216 6,063 Foreign exchange contracts Other assets 1,936 2,075 Foreign exchange contracts Accrued and other current liabilities 2,014 Foreign exchange contracts Other noncurrent liabilities $ $ $ 14,386 $ $ $ 14,398 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 3,778 $ $ $ 8,210 Foreign exchange contracts Accrued and other current liabilities 7,431 2,931 $ $ $ 11,209 $ $ $ 11,141 $ $ $ 25,595 $ $ $ 25,539 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet (94 ) (94 ) (131 ) (131 ) Cash collateral (received) posted (3 ) (529 ) Net amounts $ $ $ $ 90 The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship: Years Ended December 31 Derivatives designated in a fair value hedging relationship Interest rate swap contracts Amount of loss (gain) recognized in Other (income) expense, net on derivatives (1) $ $ $ (14 ) Amount of (gain) loss recognized in Other (income) expense, net on hedged item (1) (48 ) (29 ) Derivatives designated in foreign currency cash flow hedging relationships Foreign exchange contracts Amount of gain reclassified from AOCI to Sales (138 ) (311 ) (724 ) Amount of loss (gain) recognized in OCI on derivatives (210 ) (526 ) Derivatives designated in foreign currency net investment hedging relationships Foreign exchange contracts Amount of gain recognized in Other (income) expense, net on derivatives (2) (1 ) (4 ) Amount of loss (gain) recognized in OCI on derivatives (10 ) Derivatives not designated in a hedging relationship Foreign exchange contracts Amount of loss (gain) recognized in Other (income) expense, net on derivatives (3) (461 ) Amount of gain recognized in Sales (3 ) (1 ) (1) There was $5 million , $1 million and $7 million of ineffectiveness on the hedge during 2017 , 2016 and 2015 , respectively. (2) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing. (3) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. At December 31, 2017 , the Company estimates $184 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Fair Value Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Gains Losses Gains Losses Corporate notes and bonds $ 9,806 $ 9,837 $ $ (40 ) $ 10,577 $ 10,601 $ $ (39 ) U.S. government and agency securities 2,042 2,059 (17 ) 2,232 2,244 (13 ) Asset-backed securities 1,542 1,548 (7 ) 1,376 1,380 (5 ) Foreign government bonds (6 ) (2 ) Mortgage-backed securities (9 ) (6 ) Commercial paper 4,330 4,330 Equity securities (6 ) (3 ) $ 15,183 $ 15,241 $ $ (85 ) $ 20,179 $ 20,158 $ $ (68 ) Available-for-sale debt securities included in Short-term investments totaled $2.4 billion at December 31, 2017 . Of the remaining debt securities, $11.1 billion mature within five years. At December 31, 2017 and 2016 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Investments Corporate notes and bonds $ $ 9,678 $ $ 9,678 $ $ 10,389 $ $ 10,389 U.S. government and agency securities 1,767 1,835 1,890 1,919 Asset-backed securities (1) 1,476 1,476 1,257 1,257 Foreign government bonds Mortgage-backed securities (1) Commercial paper 4,330 4,330 Equity securities 14,359 14,531 19,012 19,242 Other assets (2) U.S. government and agency securities Corporate notes and bonds Mortgage-backed securities (1) Asset-backed securities (1) Foreign government bonds Equity securities 481 148 Derivative assets (3) Purchased currency options Forward exchange contracts Interest rate swaps Total assets $ $ 14,970 $ $ 15,313 $ $ 20,796 $ $ 21,174 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (2) Forward exchange contracts Interest rate swaps Written currency options Total liabilities $ $ $ $ 1,152 $ $ $ $ 1,025 (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies. (2) Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. There were no transfers between Level 1 and Level 2 during 2017 . As of December 31, 2017 , Cash and cash equivalents of $6.1 billion include $5.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) (407 ) Additions Payments (100 ) (25 ) Fair value December 31 (2) $ $ (1) Recorded in Research and development expenses, Materials and production costs and Other (income) expense, net . Includes cumulative translation adjustments. (2) Includes $315 million recorded as a current liability for amounts expected to be paid within the next 12 months. The changes in the estimated fair value of contingent consideration in 2017 primarily relate to changes in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The changes in the estimated fair value of contingent consideration in 2016 were largely attributable to the reversal of liabilities related to programs obtained in connection with the acquisitions of cCAM, OncoEthix and SmartCells (see Note 8). The additions to contingent consideration reflected in the table above in 2016 relate to the termination of the SPMSD joint venture (see Note 9) and the acquisitions of IOmet and Afferent (see Note 3). The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3) and in 2016 relate to the first commercial sale of Zerbaxa in the European Union. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2017 , was $25.6 billion compared with a carrying value of $24.4 billion and at December 31, 2016 , was $25.7 billion compared with a carrying value of $24.8 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. As of December 31, 2017 , the Companys total net accounts receivable outstanding for more than one year were approximately $130 million . The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation, Cardinal Health, Inc. and Zuellig Pharma Ltd. (Asia Pacific), which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2017 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. As of December 31, 2017 and 2016 , the Company had received cash collateral of $3 million and $529 million , respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities . The Company had not advanced any cash collateral to counterparties as of December 31, 2017 or 2016 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,334 $ 1,304 Raw materials and work in process 4,703 4,222 Supplies Total (approximates current cost) 6,238 5,681 Increase to LIFO costs $ 6,283 $ 5,983 Recognized as: Inventories $ 5,096 $ 4,866 Other assets 1,187 1,117 Inventories valued under the LIFO method comprised approximately $2.2 billion and $2.3 billion of inventories at December 31, 2017 and 2016 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2017 and 2016 , these amounts included $1.1 billion and $1.0 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $80 million at both December 31, 2017 and 2016 , of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical All Other Total Balance January 1, 2016 $ 15,862 $ 1,861 $ 17,723 Acquisitions Impairments (47 ) (47 ) Other (1) (2 ) Balance December 31, 2016 (2) 16,075 2,087 18,162 Acquisitions Impairments (38 ) (38 ) Other (1) (9 ) (8 ) (17 ) Balance December 31, 2017 (2) $ 16,066 $ 2,218 $ 18,284 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2017 and 2016 were $225 million and $187 million , respectively. In 2016, the additions to goodwill in the Pharmaceutical segment resulted primarily from the acquisitions of Afferent and IOmet (see Note 3). The additions to goodwill within other non-reportable segments in 2017 primarily relate to the acquisition of Valle, which is part of the Animal Health segment (see Note 3), and in 2016 relate to the acquisition of StayWell, which is part of the Healthcare Services segment (see Note 3). The impairments of goodwill within other non-reportable segments in 2017 and 2016 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 46,693 $ 34,950 $ 11,743 $ 46,269 $ 31,919 $ 14,350 IPRD 1,194 1,194 1,653 1,653 Tradenames Other 2,035 1,134 1,947 1,176 $ 50,131 $ 35,948 $ 14,183 $ 50,084 $ 32,779 $ 17,305 Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles related to marketed products (included in product and product rights above) at December 31, 2017 include Zerbaxa , $3.0 billion ; Sivextro , $879 million ; Zetia , $756 million ; Implanon/Nexplanon $529 million ; Dificid , $478 million ; Gardasil/Gardasil 9, $468 million ; Vytorin , $375 million ; Bridion , $320 million ; and Simponi , $226 million . The Company recognized an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $894 million at December 31, 2017 reflected in Other in the table above. During 2017 , 2016 and 2015 , the Company recorded impairment charges related to marketed products and other intangibles of $58 million , $347 million and $45 million , respectively, within Material and production costs. During 2017, the Company recorded an intangible asset impairment charge of $47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A are being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The intangible asset value for Intron A at December 31, 2017 was $13 million . The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. In 2016, the Company lowered its cash flow projections for Zontivity, a product for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in an impairment charge of $252 million . Also during 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek , allergy immunotherapy tablets that, for business reasons, the Company returned to the licensor. The charges in 2015 primarily relate to the impairment of customer relationship and tradename intangibles for certain businesses within in the Healthcare Services segment. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. During 2017 , 2016 and 2015 , $14 million , $8 million and $280 million , respectively, of IPRD was reclassified to products and product rights upon receipt of marketing approval in a major market. In 2017, the Company recorded $483 million of IPRD impairment charges within Research and development expenses. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion relates to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million , resulting in the recognition of the pretax impairment charge noted above. The IPRD impairment charges in 2016 also include charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million relates to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also include $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily relate to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration (see Note 6). During 2015, the Company recorded $63 million of IPRD impairment charges, of which $50 million related to the surotomycin clinical development program. In 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and the IPRD impairment charge noted above. All of the IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Materials and production costs was $3.2 billion in 2017 , $3.8 billion in 2016 and $4.8 billion in 2015 . The estimated aggregate amortization expense for each of the next five years is as follows: 2018 , $2.8 billion ; 2019 , $1.5 billion ; 2020 , $1.2 billion ; 2021 , $1.1 billion ; 2022 , $1.1 billion . 9. Joint Ventures and Other Equity Method Affiliates Equity income from affiliates reflects the performance of the Companys joint ventures and other equity method affiliates including SPMSD (until termination on December 31, 2016) and certain investment funds. Equity income from affiliates was $42 million in 2017 , $86 million in 2016 and $205 million in 2015 and is included in Other (income) expense, net (see Note 15). Investments in affiliates accounted for using the equity method totaled $767 million at December 31, 2017 and $715 million at December 31, 2016 . Sanofi Pasteur MSD In 1994, Merck and Pasteur Mrieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture (SPMSD) to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.0 billion for 2016 and $923 million for 2015 . On December 31, 2016, Merck and Sanofi Pasteur (Sanofi) terminated SPMSD and ended their joint vaccines operations in Europe. Under the terms of the termination, Merck acquired Sanofis 50% interest in SPMSD in exchange for consideration of $657 million comprised of cash, as well as future royalties of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $416 million on the date of termination. The Company accounted for this transaction as a step acquisition, which required that Merck remeasure its ownership interest (previously accounted for as an equity method investment) to fair value at the acquisition date. Merck in turn sold to Sanofi its intellectual property rights held by SPMSD in exchange for consideration of $596 million comprised of cash and future royalties of 11.5% on net sales of all Sanofi products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $302 million on the date of termination. Excluded from this arrangement are potential future sales of Vaxelis (a jointly developed investigational pediatric hexavalent combination vaccine that was approved by the European Commission in February 2016). The European marketing rights for Vaxelis were transferred to a separate equally-owned joint venture between Sanofi and Merck. The net impact of the termination of the SPMSD joint venture is as follows: Products and product rights (8 year useful life) $ Accounts receivable Income taxes payable (221 ) Deferred income tax liabilities (147 ) Other, net Net assets acquired Consideration payable to Sanofi, net (392 ) Derecognition of Mercks previously held equity investment in SPMSD (183 ) Increase in net assets Mercks share of restructuring costs related to the termination (77 ) Net gain on termination of SPMSD joint venture (1) $ (1) Recorded in Other (income) expense, net . The estimated fair values of identifiable intangible assets related to products and product rights were determined using an income approach through which fair value is estimated based on market participant expectations of each assets projected net cash flows. The projected net cash flows were then discounted to present value utilizing a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Of the amount recorded for products and product rights, $468 million related to Gardasil/Gardasil 9. The fair value of liabilities for contingent consideration related to Mercks future royalty payments to Sanofi of $416 million (reflected in the consideration payable to Sanofi, net, in the table above) was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% used to present value the cash flows. Changes in the inputs could result in a different fair value measurement. Based on an existing accounting policy election, Merck did not record the $302 million estimated fair value of contingent future royalties to be received from Sanofi on the sale of Sanofi products, but rather is recognizing such amounts as sales occur and the royalties are earned. The Company incurred $24 million of transaction costs related to the termination of SPMSD included in Marketing and administrative expenses in 2016. Pro forma financial information for this transaction has not been presented as the results are not significant when compared with the Companys financial results. AstraZeneca LP In 1982, Merck entered into an agreement with Astra AB (Astra) to develop and market Astra products under a royalty-bearing license. In 1993, Mercks total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (AMI), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astras new prescription medicines in the United States. In 1998, Merck and Astra completed a restructuring of the ownership and operations of the joint venture whereby Merck acquired Astras interest in AMI, renamed KBI Inc. (KBI), and contributed KBIs operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (AZLP) upon Astras 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. Merck earned revenue based on sales of KBI products and earned certain Partnership returns from AZLP. On June 30, 2014, AstraZeneca exercised its option to purchase Mercks interest in KBI (and redeem Mercks remaining interest in AZLP). A portion of the exercise price, which is subject to a true-up in 2018 based on actual sales of Nexium and Prilosec from closing in 2014 to June 2018, was deferred and recognized as income as the contingency was eliminated as sales occurred. Once the deferred income amount was fully recognized, in 2016, the Company began recognizing income and a corresponding receivable for amounts that will be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized income of $232 million , $98 million and $182 million in 2017, 2016 and 2015, respectively, in Other (income) expense, net related to these amounts. The receivable from AstraZeneca was $325 million at December 31, 2017. 10. Loans Payable, Long-Term Debt and Other Commitments Loans payable at December 31, 2017 included $3.0 billion of notes due in 2018 and $73 million of long-dated notes that are subject to repayment at the option of the holder. Loans payable at December 31, 2016 included $300 million of notes due in 2017 , $267 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.85% and 0.40% for the years ended December 31, 2017 and 2016 , respectively. Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,488 $ 2,487 3.70% notes due 2045 1,973 1,972 2.80% notes due 2023 1,744 1,743 5.00% notes due 2019 1,260 1,273 4.15% notes due 2043 1,237 1,236 1.85% notes due 2020 1,232 1,238 2.35% notes due 2022 1,220 1,228 1.125% euro-denominated notes due 2021 1,185 1,035 1.875% euro-denominated notes due 2026 1,178 1,028 3.875% notes due 2021 1,140 1,152 2.40% notes due 2022 1,003 6.50% notes due 2033 Floating-rate notes due 2020 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 Floating-rate borrowing due 2018 1.10% notes due 2018 1.30% notes due 2018 Other $ 21,353 $ 24,274 Other (as presented in the table above) includes $300 million and $147 million at December 31, 2017 and 2016 , respectively, of borrowings at variable rates that resulted in effective interest rates of 1.42% and 0.89% for 2017 and 2016 , respectively. With the exception of the 6.30% debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers and recognized a loss on extinguishment of debt of $191 million in 2017. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with financial covenants including a requirement that the Total Debt to Capitalization Ratio (as defined in the applicable agreements) not exceed 60% . At December 31, 2017 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2018 , $3.0 billion ; 2019 , $1.3 billion ; 2020 , $1.9 billion ; 2021 , $2.3 billion ; 2022 , $2.2 billion . The Company has a $6.0 billion , five -year credit facility that matures in June 2022. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Rental expense under operating leases, net of sublease income, was $327 million in 2017 , $292 million in 2016 and $303 million in 2015 . The minimum aggregate rental commitments under noncancellable leases are as follows: 2018 , $255 million ; 2019 , $175 million ; 2020 , $126 million ; 2021 , $90 million ; 2022 , $68 million and thereafter, $138 million . The Company has no significant capital leases. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial position, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2017 , approximately 4,085 cases are filed and pending against Merck in either federal or state court. In approximately 15 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (ONJ), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax . In addition, plaintiffs in approximately 4,070 of these actions generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . Cases Alleging ONJ and/or Other Jaw Related Injuries In August 2006, the Judicial Panel on Multidistrict Litigation (JPML) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation ( Fosamax ONJ MDL) for coordinated pre-trial proceedings. In December 2013, Merck reached an agreement in principle with the Plaintiffs Steering Committee (PSC) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million . Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (ONJ Master Settlement Agreement) that was executed in April 2014 and included over 1,200 plaintiffs. In July 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level of $27.3 million since the participation level was approximately 95% . Merck has fully funded the ONJ Master Settlement Agreement and the escrow agent under the agreement has been making settlement payments to qualifying plaintiffs. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below. Discovery is currently ongoing in some of the approximately 15 remaining ONJ cases that are pending in various federal and state courts and the Company intends to defend against these lawsuits. Cases Alleging Femur Fractures In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. The Glynn decision was not appealed by plaintiff. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). The Femur Fracture MDL court also dismissed without prejudice another approximately 510 cases pending plaintiffs appeal of the preemption ruling to the Third Circuit. On March 22, 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. On April 5, 2017, Merck filed a petition seeking a rehearing on the Third Circuits March 22, 2017 decision, which was denied on April 24, 2017. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court on August 22, 2017, seeking review of the Third Circuits decision. On December 4, 2017, the Supreme Court invited the Solicitor General to file a brief in the case expressing the views of the United States. In addition, in June 2014, the Femur Fracture MDL court granted Merck summary judgment in the Gaynor v. Merck case and found that Mercks updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes. The plaintiffs in Gaynor did not appeal the Femur Fracture MDL courts findings with respect to the adequacy of the 2011 label change but did appeal the dismissal of their case based on preemption grounds, and the Third Circuit subsequently reversed that dismissal in its March 22, 2017 decision. In August 2014, Merck filed a motion requesting that the Femur Fracture MDL court enter a further order requiring all plaintiffs in the Femur Fracture MDL who claim that the 2011 Fosamax label is inadequate and the proximate cause of their alleged injuries to show cause why their cases should not be dismissed based on the courts preemption decision and its ruling in the Gaynor case. In November 2014, the court granted Mercks motion and entered the requested show cause order. No plaintiffs responded to or appealed the November 2014 show cause order. As of December 31, 2017 , approximately 530 cases were pending in the Femur Fracture MDL following the reinstatement of the cases that had been on appeal to the Third Circuit. The 510 cases dismissed without prejudice that were also pending the final resolution of the aforementioned appeal have not yet been reinstated. As of December 31, 2017 , approximately 2,750 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015, and Merck has continued to select additional cases to be reviewed through fact discovery during 2016 and 2017. As of December 31, 2017 , approximately 280 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs selected, as the first trial. The Galper trial began in February 2015 and the jury returned a verdict in Mercks favor in April 2015, and plaintiff appealed that verdict to the California appellate court. Oral argument on plaintiffs appeal in Galper was held in November 2016 and, on April 24, 2017, the California appellate court issued a decision affirming the lower courts judgment in favor of Merck. The next Femur Fracture trial in California that was scheduled to begin in April 2016 was stayed at plaintiffs request and a new trial date has not been set. Additionally, there are five Femur Fracture cases pending in other state courts. Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2017 , Merck is aware of approximately 1,235 product user claims alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. These complaints were filed in several different state and federal courts. Most of the claims were filed in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called In re Incretin-Based Therapies Products Liability Litigation (MDL). The MDL includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet , Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. The majority of claims not filed in the MDL were filed in the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court - in separate opinions - granted summary judgment to defendants on grounds of preemption. Of the approximately 1,235 product user claims, these rulings resulted in the dismissal of approximately 1,100 product user claims. Plaintiffs appealed the MDL and California State Court preemption rulings. On November 28, 2017, the U.S. Court of Appeals for the Ninth Circuit (Ninth Circuit) reversed the trial courts ruling in the MDL and remanded for further proceedings. The Ninth Circuit did not address the substance of defendants preemption argument but instead ruled that the district court made various errors during discovery. Jurisdiction returned to U.S. District Court for the Southern District of California on January 2, 2018. The preemption appeal in the California state court litigation has been fully briefed, but the court has not yet scheduled oral argument. As of December 31, 2017 , seven product users have claims pending against Merck in state courts other than California state court, including four active product user claims pending in Illinois state court. On June 30, 2017, the Illinois trial court denied Mercks motion for summary judgment on grounds of preemption. Merck sought permission to appeal that order on an interlocutory basis and was granted a stay of proceedings in the trial court. On September 19, 2017, an intermediate appellate court in Illinois denied Mercks petition for interlocutory review. On October 20, 2017, Merck filed a petition with the Illinois Supreme Court, seeking leave to appeal the appellate courts denial. The Illinois Supreme Court denied Mercks petition for certiorari review and, instead, directed the appellate court to answer the certified question. As a result, proceedings in the trial court remain stayed and trials for certain of the product users in Illinois have been delayed. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Propecia/Proscar As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar . As of December 31, 2017 , approximately 775 lawsuits have been filed by plaintiffs who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar . Approximately 20 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer, testicular cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Hyland in Middlesex County. In addition, there is one matter pending in state court in California, one matter pending in state court in Ohio, and one matter on appeal in the Massachusetts Supreme Judicial Court. The Company intends to defend against these lawsuits. Governmental Proceedings As previously disclosed, the Company has learned that the Prosecution Office of Milan, Italy is investigating interactions between the Companys Italian subsidiary, certain employees of the subsidiary and certain Italian health care providers. The Company understands that this is part of a larger investigation involving engagements between various health care companies and those health care providers. The Company is cooperating with the investigation. As previously disclosed, the United Kingdom (UK) Competition and Markets Authority (CMA) issued a Statement of Objections against the Company and MSD Sharp Dohme Limited (MSD UK) on May 23, 2017. In the Statement of Objections, the CMA alleges that MSD UK abused a dominant position through a discount program for Remicade over the period from March 2015 to February 2016. The Company and MSD UK are contesting the CMAs allegations. As previously disclosed, the Company has received an investigative subpoena from the California Insurance Commissioners Fraud Bureau (Bureau) seeking information from January 1, 2007 to the present related to the pricing and promotion of Cubicin . The Bureau is investigating whether Cubist Pharmaceuticals, Inc., which the Company acquired in 2015, unlawfully induced the presentation of false claims for Cubicin to private insurers under the California Insurance Code False Claims Act. The Company is cooperating with the investigation. As previously disclosed, the Company has received a civil investigative demand from the U.S. Attorneys Office for the Southern District of New York that requests information relating to the Companys contracts with, services from and payments to pharmacy benefit managers with respect to Maxalt and Levitra from January 1, 2006 to the present. The Company is cooperating with the investigation. As previously disclosed, the Company has received a subpoena from the Office of Inspector General of the U.S. Department of Health and Human Services on behalf of the U.S. Attorneys Office for the District of Maryland and the Civil Division of the U.S. Department of Justice that requests information relating to the Companys marketing of Singulair and Dulera Inhalation Aerosol and certain of its other marketing activities from January 1, 2006 to the present. The Company is cooperating with the investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation K-DUR Antitrust Litigation In June 1997 and January 1998, Schering-Plough Corporation (Schering-Plough) settled patent litigation with Upsher-Smith, Inc. (Upsher-Smith) and ESI Lederle, Inc. (Lederle), respectively, relating to generic versions of Schering-Ploughs long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher-Smith had filed abbreviated New DrugApplications (NDA). Putative class and non-class action suits were then filed on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle and were consolidated in a multidistrict litigation in the U.S. District Court for the District of New Jersey. In February 2016, the court denied the Companys motion for summary judgment relating to all of the direct purchasers claims concerning the settlement with Upsher-Smith and granted the Companys motion for summary judgment relating to all of the direct purchasers claims concerning the settlement with Lederle. As previously disclosed, in February 2017, Merck and Upsher-Smith reached a settlement in principle with the class of direct purchasers and the opt-outs to the class. Merck will contribute approximately $80 million in the aggregate towards the overall settlement. On April 5, 2017, the claims of the opt-outs were dismissed with prejudice pursuant to a written settlement agreement with those parties. On May 15, 2017, Merck and the class executed a settlement agreement, which received preliminary approval from the court on May 23, 2017. On October 5, 2017, the court entered a Final Judgment and Order of Dismissal approving the settlement agreement with the direct purchaser class and dismissing the claims of the class with prejudice. Zetia Antitrust Litigation In May 2010, Schering Corporation (Schering) and MSP Singapore Company LLC (MSP) settled patent litigation with Glenmark Pharmaceuticals Inc., USA, and Glenmark Pharmaceuticals Ltd. (together, Glenmark) relating to a generic version of Zetia , a pharmaceutical product containing ezetimibe used by patients with high cholesterol, for which Glenmark had filed an abbreviated NDA. In January and February 2018, putative class action suits were filed on behalf of direct and indirect purchasers of Zetia against Merck, MSD, Schering-Plough, Schering, MSP, and Glenmark in the U.S. District Courts for the Eastern District of Virginia and the Eastern District of New York. These suits claim violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. These suits seek unspecified damages. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. Plaintiffs sought and were granted leave to file an amended complaint. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. In October 2014, the court denied the Companys motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. On April 27, 2016, the court granted plaintiffs motion for conditional certification but denied plaintiffs motions to extend the liability period for their Equal Pay Act claims back to June 2009. As a result, the liability period will date back to April 2012, at the earliest. On April 29, 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals have opted-in to this action; the opt-in period has closed. On August 1, 2017, plaintiffs filed their motion for class certification. This motion seeks to certify a Title VII pay discrimination class and also seeks final collective action certification of plaintiffs Equal Pay Act claim. The parties are currently engaged in motion practice before the court. Qui Tam Litigation As previously disclosed, on June 21, 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery. The Company intends to defend against these lawsuits. Merck KGaA Litigation In January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, and India alleging breach of the parties co-existence agreement, unfair competition and/or trademark infringement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe. The Company and KGaA appealed the decision, and the appeal was heard in May 2017. In June 2017, the French appeals court held that certain of the activities by the Company directed to France constituted unfair competition or trademark infringement and no further appeal was pursued. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaAs trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Companys use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal was heard in June 2017. In November 2017, the UK Court of Appeals affirmed the decision on the co-existence agreement and remitted for re-hearing issues of trade mark infringement, validity and the relief to which KGaA would be entitled. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company currently involved in such patent infringement litigation in the United States include Noxafil and NuvaRing . Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the district court held the patent valid and infringed. Actavis has appealed this decision. In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the parties reached a settlement whereby Roxane can launch its generic version upon expiry of the patent, or earlier under certain conditions. In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil injection. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions. Nasonex Nasonex lost market exclusivity in the United States in 2016. Prior to that, in April 2015, the Company filed a patent infringement lawsuit against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotexs marketed product that the Company believed was infringing. In January 2018, the Company and Apotex settled this matter with Apotex agreeing to pay the Company $115 million plus certain other consideration. NuvaRing In December 2013, the Company filed a lawsuit against a subsidiary of Allergan plc in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing . The trial in this matter was held in January 2016. In August 2016, the district court ruled that the patent was invalid and the Company appealed this decision. In October 2017, the appellate court reversed the district court decision and found the patent to be valid. The case was remanded and the district court enjoined the defendant from marketing its generic version of NuvaRing until the patent expires. In September 2015, the Company filed a lawsuit against Teva Pharma in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing . Based on its ruling in the Allergan plc matter, the district court dismissed the Companys lawsuit in December 2016. Following the appellate reversal in the Allergan plc matter, the defendant has agreed to be enjoined from marketing its generic version of NuvaRing until the patent expires. Anti-PD-1 Antibody Patent Oppositions and Litigation As previously disclosed, Ono Pharmaceutical Co. (Ono) has a European patent (EP 1 537 878) (878) that broadly claims the use of an anti-PD-1 antibody, such as the Companys immunotherapy, Keytruda , for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (BMS) in certain markets. BMS and Ono also own European Patent EP 2 161 336 (336) that, as granted, broadly claimed anti-PD-1 antibodies that could include Keytruda . As previously disclosed, the Company and BMS and Ono were engaged in worldwide litigation, including in the United States, over the validity and infringement of the 878 patent, the 336 patent and their equivalents. In January 2017, the Company announced that it had entered into a settlement and license agreement with BMS and Ono resolving the worldwide patent infringement litigation related to the use of an anti-PD-1 antibody for the treatment of cancer, such as Keytruda . Under the settlement and license agreement, the Company made a one-time payment of $625 million (which was recorded as an expense in the Companys 2016 financial results) to BMS and will pay royalties on the worldwide sales of Keytruda for a non-exclusive license to market Keytruda in any market in which it is approved. For global net sales of Keytruda , the Company will pay royalties of 6.5% of net sales occurring from January 1, 2017 through and including December 31, 2023; and 2.5% of net sales occurring from January 1, 2024 through and including December 31, 2026. The parties also agreed to dismiss all claims worldwide in the relevant legal proceedings. In October 2015, PDL Biopharma (PDL) filed a lawsuit in the United States against the Company alleging that the manufacture of Keytruda infringed US Patent No. 5,693,761 (761 patent), which expired in December 2014. This patent claims platform technology used in the creation and manufacture of recombinant antibodies and PDL is seeking damages for pre-expiry infringement of the 761 patent. In April 2017, the parties reached a settlement pursuant to which, in exchange for a lump sum, PDL dismissed its lawsuit with prejudice and granted the Company a fully paid-up non-exclusive license to the 761 patent. In July 2016, the Company filed a declaratory judgment action in the United States against Genentech and City of Hope seeking a ruling that US Patent No. 7,923,221 (Cabilly III patent), which claims platform technology used in the creation and manufacture of recombinant antibodies, is invalid and that Keytruda and bezlotoxumab do not infringe the Cabilly III patent. In July 2016, the Company also filed a petition in the USPTO for Inter Partes Review (IPR) of certain claims of US Patent No. 6,331,415 (Cabilly II patent), which claims platform technology used in the creation and manufacture of recombinant antibodies and is also owned by Genentech and City of Hope, as being invalid. In December 2016, the USPTO denied the petition but allowed the Company to join an IPR filed previously by another party. In May 2017, the parties reached a settlement pursuant to which the Company dismissed its lawsuit with prejudice and moved to terminate the IPR and Genentech and City of Hope granted the Company a fully paid-up non-exclusive license to the Cabilly II and Cabilly III patent. Gilead Patent Litigation and Opposition In August 2013, Gilead Sciences, Inc. (Gilead) filed a lawsuit in the U.S. District Court for the Northern District of California seeking a declaration that two Company patents were invalid and not infringed by the sale of their two sofosbuvir containing products, Solvadi and Harvoni. The Company filed a counterclaim that the sale of these products did infringe these two patents and sought a reasonable royalty for the past, present and future sales of these products. In March 2016, at the conclusion of a jury trial, the patents were found to be not invalid and infringed. The jury awarded the Company $200 million as a royalty for sales of these products up to December 2015. After the conclusion of the jury trial, the court held a bench trial on the equitable defenses raised by Gilead. In June 2016, the court found for Gilead and determined that Merck could not collect the jury award and that the patents were unenforceable with respect to Gilead. The Company appealed the courts decision. Gilead also asked the court to overturn the jurys decision on validity. The court held a hearing on Gileads motion in August 2016, and the court subsequently rejected Gileads request, which Gilead appealed. A hearing on the combined appeals for this case was held on February 4, 2018. The Company will pay 20% , net of legal fees, of damages or royalties, if any, that it receives to Ionis Pharmaceuticals, Inc. The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation against Gilead in the United States, the UK, Norway, Canada, Germany, France, and Australia based on different patent estates that would also be infringed by Gileads sales of these two products. Gilead opposed the European patent at the European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion . The Company submitted post-trial motions, including on the issues of enhanced damages and future royalties. Gilead submitted post-trial motions for judgment as a matter of law. A hearing on the motions was held in September 2017. Also, in September 2017, the court denied the Companys motion on enhanced damages, granted its motion on prejudgment interest and deferred its motion on future royalties. In February 2018, the court granted Gileads motion for judgment as a matter of law and found the patent was invalid for a lack of enablement. The Company will appeal this decision. In Australia, the Company was initially unsuccessful and the Full Federal Court affirmed the lower court decision. The Company has sought leave to appeal to the High Court of Australia for further review. In Canada, the Company was initially unsuccessful and the Federal Court of Appeals affirmed the lower court decision The Company sought leave to the Supreme Court of Canada for further review. In the UK and Norway, the patent was held invalid and no further appeal was filed. The EPO opposition division revoked the European patent, and the Company appealed this decision. The cases in France and Germany have been stayed pending the final decision of the EPO. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial position, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2017 and December 31, 2016 of approximately $160 million and $185 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters As previously disclosed, Mercks facilities in Oss, the Netherlands, were inspected by the Province of Brabant (Province) pursuant to the Dutch Hazards of Major Accidents Decree and the sites environmental permits. The Province issued penalties for alleged violations of regulations governing preventing and managing accidents with hazardous substances, and the government also issued a fine for alleged environmental violations at one of the Oss facilities, which together totaled $235 thousand . The Company was subsequently advised that a criminal investigation had been initiated based upon certain of the issues that formed the basis of the administrative enforcement action by the Province. The Company intends to defend itself against any enforcement action that may result from this investigation. In May 2015, the Environmental Protection Agency (EPA) conducted an air compliance evaluation of the Companys pharmaceutical manufacturing facility in Elkton, Virginia. As a result of the investigation, the Company was issued a Notice of Noncompliance and Show Cause Notification relating to certain federally enforceable requirements applicable to the Elkton facility. The Company has been advised by the EPA that enforcement action is no longer being pursued. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) (15 ) (28 ) (18 ) Balance December 31 3,577 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2017 , 118 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled primarily with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards will vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2017 , 2016 and 2015 was $312 million , $300 million and $299 million , respectively, with related income tax benefits of $57 million , $92 million and $93 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2017 , 2016 and 2015 was $63.88 , $54.63 and $59.73 per option, respectively. The weighted average fair value of options granted in 2017 , 2016 and 2015 was $7.04 , $5.89 and $6.46 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.6 % 3.8 % 4.1 % Risk-free interest rate 2.0 % 1.4 % 1.7 % Expected volatility 17.8 % 19.6 % 19.9 % Expected life (years) 6.1 6.2 6.2 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2017 45,091 $ 44.47 Granted 4,232 63.88 Exercised (11,512 ) 43.38 Forfeited (1,537 ) 51.78 Outstanding December 31, 2017 36,274 $ 46.77 4.89 $ Exercisable December 31, 2017 26,778 $ 42.54 3.64 $ 110 Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2017 13,266 $ 57.19 1,744 $ 59.24 Granted 5,014 63.85 1,008 63.62 Vested (3,795 ) 58.13 (833 ) 62.71 Forfeited (876 ) 58.22 (51 ) 60.24 Nonvested December 31, 2017 13,609 $ 59.32 1,868 $ 60.03 At December 31, 2017 , there was $469 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (862 ) (831 ) (819 ) (393 ) (382 ) (379 ) (78 ) (107 ) (143 ) Amortization of unrecognized prior service cost (53 ) (55 ) (56 ) (11 ) (11 ) (14 ) (98 ) (106 ) (64 ) Net loss amortization Termination benefits Curtailments (12 ) (4 ) (1 ) (9 ) (31 ) (18 ) (19 ) Settlements Net periodic benefit cost (credit) $ $ (1 ) $ $ $ $ $ (60 ) $ (88 ) $ (24 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The increase in net periodic benefit credit for other postretirement benefit plans in 2017 and 2016 as compared with 2015 is largely attributable to changes in retiree medical benefits approved by the Company in December 2015, partially offset by lower returns on plan assets. In connection with restructuring actions (see Note 5), termination charges were recorded in 2017 , 2016 and 2015 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 9,766 $ 9,266 $ 7,794 $ 7,204 $ 1,019 $ 1,913 Actual return on plan assets 1,723 Company contributions, net (4 ) Effects of exchange rate changes (546 ) Benefits paid (651 ) (504 ) (198 ) (193 ) (62 ) (108 ) Settlements (17 ) (21 ) Assets no longer restricted to the payment of postretirement benefits (1) (992 ) Other Fair value of plan assets December 31 $ 10,896 $ 9,766 $ 9,339 $ 7,794 $ 1,114 $ 1,019 Benefit obligation January 1 $ 10,849 $ 9,723 $ 8,372 $ 7,733 $ 1,922 $ 1,810 Service cost Interest cost Actuarial losses (gains) (2) (7 ) (87 ) Benefits paid (651 ) (504 ) (198 ) (193 ) (62 ) (108 ) Effects of exchange rate changes (576 ) Plan amendments (22 ) Curtailments (3 ) (15 ) Termination benefits Settlements (17 ) (21 ) Other Benefit obligation December 31 $ 11,904 $ 10,849 $ 9,483 $ 8,372 $ 1,922 $ 1,922 Funded status December 31 $ (1,008 ) $ (1,083 ) $ (144 ) $ (578 ) $ (808 ) $ (903 ) Recognized as: Other assets $ $ $ $ $ $ Accrued and other current liabilities (59 ) (50 ) (17 ) (7 ) (11 ) (11 ) Other noncurrent liabilities (949 ) (1,033 ) (955 ) (1,022 ) (797 ) (892 ) (1) As a result of certain allowable administrative actions that occurred in June 2016, $992 million of plan assets previously restricted for the payment of other postretirement benefits became available to fund certain other health and welfare benefits. (2) Actuarial losses in 2017 and 2016 primarily reflect changes in discount rates. At December 31, 2017 and 2016 , the accumulated benefit obligation was $20.5 billion and $18.4 billion , respectively, for all pension plans, of which $11.5 billion and $10.5 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 11,904 $ 10,849 $ 3,323 $ 5,486 Fair value of plan assets 10,896 9,766 2,352 4,457 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ $ 9,807 $ 2,120 $ 2,692 Fair value of plan assets 9,057 1,346 1,898 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2017 and 2016 , $488 million and $435 million , respectively, or approximately 2% of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Equity securities Developed markets 2,743 2,743 2,521 2,521 Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Net assets in fair value hierarchy $ 3,277 $ 1,897 $ $ 5,189 $ 3,148 $ 1,376 $ $ 4,542 Investments measured at NAV (1) 5,707 5,224 Plan assets at fair value $ 10,896 $ 9,766 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,326 3,888 2,846 3,033 Emerging markets equities Government and agency obligations 2,095 2,344 1,904 2,027 Corporate obligations Fixed income obligations Real estate (2) Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (3) Other Net assets in fair value hierarchy $ 1,602 $ 6,462 $ $ 8,537 $ $ 5,637 $ $ 7,006 Investments measured at NAV (1) Plan assets at fair value $ 9,339 $ 7,794 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2017 and 2016 . (2) The plans Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds. (3) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (2 ) (2 ) (3 ) (3 ) Relating to assets sold during the year Purchases and sales, net (5 ) (5 ) (6 ) (6 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (9 ) (8 ) Purchases and sales, net (2 ) (2 ) (1 ) (1 ) Transfers into Level 3 Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Net assets in fair value hierarchy $ $ $ $ $ $ $ $ Investments measured at NAV (1) Plan assets at fair value $ 1,114 $ 1,019 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2017 and 2016 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 35% to 55% in U.S. equities, 20% to 35% in international equities, 20% to 35% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 13% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2018 are approximately $60 million for U.S. pension plans, approximately $150 million for international pension plans and approximately $25 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2019 2020 2021 2022 2023 2027 3,760 1,326 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ (19 ) $ (743 ) $ $ $ (380 ) $ (66 ) $ $ (45 ) $ Prior service (cost) credit arising during the period (13 ) (10 ) (13 ) (2 ) (4 ) (31 ) (19 ) $ (32 ) $ (753 ) $ $ $ (382 ) $ (70 ) $ $ (64 ) $ Net loss amortization included in benefit cost $ $ $ $ $ $ $ $ $ Prior service (credit) cost amortization included in benefit cost (53 ) (55 ) (56 ) (11 ) (11 ) (14 ) (98 ) (106 ) (64 ) $ $ $ $ $ $ $ (97 ) $ (103 ) $ (59 ) The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net periodic benefit cost during 2018 are $314 million and $(64) million , respectively, for pension plans (of which $230 million and $(51) million , respectively, relates to U.S. pension plans) and $1 million and $(84) million , respectively, for other postretirement benefit plans. Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 4.30 % 4.70 % 4.20 % 2.20 % 2.80 % 2.70 % Expected rate of return on plan assets 8.70 % 8.60 % 8.50 % 5.10 % 5.60 % 5.70 % Salary growth rate 4.30 % 4.30 % 4.40 % 2.90 % 2.90 % 2.90 % Benefit obligation Discount rate 3.70 % 4.30 % 4.80 % 2.10 % 2.20 % 2.80 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.90 % 2.90 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return within each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2018 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.30% , as compared to a range of 8.00% to 8.75% in 2017 . The decrease is primarily due to a modest shift in asset allocation. The increase in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2015 to 2017 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 7.2 % 7.4 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate A one percentage point change in the health care cost trend rate would have had the following effects: One Percentage Point Increase Decrease Effect on total service and interest cost components $ $ (11 ) Effect on benefit obligation (104 ) Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2017 , 2016 and 2015 were $131 million , $126 million and $125 million , respectively. 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ (385 ) $ (328 ) $ (289 ) Interest expense Exchange (gains) losses (11 ) 1,277 Equity income from affiliates (42 ) (86 ) (205 ) Other, net (304 ) $ $ $ 1,527 The exchange losses in 2015 were related primarily to the Venezuelan Bolvar. During 2015, upon evaluation of evolving economic conditions in Venezuela and volatility in the country, combined with a decline in transactions that were settled at the then official (CENCOEX) rate, the Company determined it was unlikely that all outstanding net monetary assets would be settled at the CENCOEX rate. Accordingly, during 2015, the Company recorded charges of $876 million to devalue its net monetary assets in Venezuela to amounts that represented the Companys estimate of the U.S. dollar amount that would ultimately be collected and recorded additional exchange losses of $138 million in the aggregate during 2015 reflecting the ongoing effect of translating transactions and net monetary assets consistent with these rates. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. The decline in equity income from affiliates in 2017 as compared with 2016 was driven primarily by the termination of the SPMSD joint venture on December 31, 2016, partially offset by higher equity income from certain research investment funds. The decline in equity income from affiliates in 2016 as compared with 2015 was driven primarily by lower equity income from certain research investment funds. Other, net (as presented in the table above) in 2017 includes gains of $291 million on the sale of equity investments, income of $232 million related to AstraZenecas option exercise (see Note 9), and a $191 million loss on extinguishment of debt (see Note 10). Other, net in 2016 includes a charge of $625 million to settle worldwide patent litigation related to Keytruda (see Note 11), a gain of $117 million related to the settlement of other patent litigation, gains of $100 million resulting from the receipt of milestone payments for out-licensed migraine clinical development programs (see Note 3) and $98 million of income related to AstraZenecas option exercise. Other, net in 2015 includes a $680 million net charge related to the settlement of Vioxx shareholder class action litigation (which was paid in 2016) and an expense of $78 million for a contribution of investments in equity securities to the Merck Foundation, partially offset by a $250 million gain on the sale of certain migraine clinical development programs (see Note 3), a $147 million gain on the divestiture of Mercks remaining ophthalmics business in international markets (see Note 3), and the recognition of $182 million of income related to AstraZenecas option exercise. Interest paid was $723 million in 2017 , $686 million in 2016 and $653 million in 2015 . 16. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 2,282 35.0 % $ 1,631 35.0 % $ 1,890 35.0 % Differential arising from: Provisional impact of the TCJA 2,625 40.3 Impact of purchase accounting adjustments, including amortization 10.9 13.4 14.8 Valuation allowances 9.7 (5 ) (0.1 ) 0.7 Restructuring 2.2 3.1 3.1 State taxes 1.2 3.7 2.9 U.S. health care reform legislation 1.1 1.4 1.2 Foreign currency devaluation related to Venezuela 5.9 Foreign earnings (1,725 ) (26.5 ) (1,646 ) (35.3 ) (2,144 ) (39.7 ) Tax settlements (356 ) (5.5 ) (417 ) (7.7 ) Unremitted foreign earnings (30 ) (0.6 ) 4.8 Other (1) (361 ) (5.5 ) (241 ) (5.2 ) (196 ) (3.6 ) $ 4,103 62.9 % $ 15.4 % $ 17.4 % (1) Other includes the tax effect of contingency reserves, research credits, losses on foreign subsidiaries and miscellaneous items. The Companys 2017 effective tax rate reflects a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduces the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. The Company has reflected the impact of the TCJA in its financial statements as described below. However, application of certain provisions of the TCJA remains subject to further interpretation and in these instances the Company has made a reasonable estimate of the effects of the TCJA. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount for its one-time transition tax liability of $5.3 billion . Merck has not yet finalized its calculation of the total post-1986 undistributed EP for these foreign subsidiaries. The transition tax is based in part on the amount of undistributed EP held in cash and other specified assets; therefore, this amount may change when the Company finalizes its calculation of post-1986 undistributed foreign EP and finalizes the amounts held in cash or other specified assets. This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment, resulting in a net transition tax payment of $5.1 billion . As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. The current portion of the transition tax liability of $545 million is included as reduction to prepaid income taxes included in Other Current Assets and the remainder of $4.5 billion is included in Other Noncurrent Liabilities . As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply. The Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million . The deferred tax benefit calculation remains subject to certain clarifications, particularly related to executive compensation and benefits. Beginning in 2018, the TCJA includes a tax on global intangible low-taxed income (GILTI) as defined in the TCJA. The Company is allowed to make an accounting policy election to account for the tax effects of the GILTI tax either in the income tax provision in future periods as the tax arises, or as a component of deferred taxes on the related investments in foreign subsidiaries. The Company is currently evaluating the GILTI provisions of the TCJA and the implications on its tax provision and has not finalized the accounting policy election; therefore, the Company has not recorded deferred taxes for GILTI as of December 31, 2017. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35% U.S. statutory rate. The Companys 2015 effective tax rate reflects the impact of the Protecting Americans From Tax Hikes Act, which was signed into law on December 18, 2015, extending the research credit permanently and the controlled foreign corporation look-through provisions for five years. Income before taxes consisted of: Years Ended December 31 Domestic $ 3,483 $ $ 2,247 Foreign 3,038 4,141 3,154 $ 6,521 $ 4,659 $ 5,401 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ 5,585 $ 1,166 $ Foreign 1,229 State (90 ) 6,724 2,239 1,706 Deferred provision Federal (2,958 ) (1,255 ) (552 ) Foreign (225 ) (163 ) State (41 ) (49 ) (2,621 ) (1,521 ) (764 ) $ 4,103 $ $ 120 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Intangibles $ $ 2,435 $ $ 3,854 Inventory related Accelerated depreciation Unremitted foreign earnings 2,044 Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other 1,088 1,248 Subtotal 3,074 3,820 3,377 7,640 Valuation allowance (900 ) (268 ) Total deferred taxes $ 2,174 $ 3,820 $ 3,109 $ 7,640 Net deferred income taxes $ 1,646 $ 4,531 Recognized as: Other assets $ $ Deferred income taxes $ 2,219 $ 5,077 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2017 , $630 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $900 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $24 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2017 , 2016 and 2015 were $4.9 billion , $1.8 billion and $1.8 billion , respectively. Tax benefits relating to stock option exercises were $73 million in 2017 , $147 million in 2016 and $109 million in 2015 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 3,494 $ 3,448 $ 3,534 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) (1,038 ) (90 ) (59 ) Settlements (1) (1,388 ) (92 ) (184 ) Lapse of statute of limitations (11 ) (43 ) (94 ) Balance December 31 $ 1,723 $ 3,494 $ 3,448 (1) Amounts reflect the settlements with the IRS as discussed below. If the Company were to recognize the unrecognized tax benefits of $1.7 billion at December 31, 2017 , the income tax provision would reflect a favorable net impact of $1.6 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2017 could decrease by up to approximately $165 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Expenses for interest and penalties associated with uncertain tax positions amounted to $183 million in 2017 , $134 million in 2016 and $102 million in 2015 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $341 million and $886 million as of December 31, 2017 and 2016 , respectively. In 2017, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. Although the IRSs examination of the Companys 2002-2005 federal tax returns was concluded prior to 2015, one issue relating to a refund claim remained open. During 2015, this issue was resolved and the Company received a refund of approximately $715 million , which exceeded the receivable previously recorded by the Company, resulting in a tax benefit of $410 million . The IRS is currently conducting examinations of the Companys tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Companys income tax returns are open for examination for the period 2003 through 2017. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Average common shares outstanding 2,730 2,766 2,816 Common shares issuable (1) Average common shares outstanding assuming dilution 2,748 2,787 2,841 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.88 $ 1.42 $ 1.58 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.87 $ 1.41 $ 1.56 (1) Issuable primarily under share-based compensation plans. In 2017 , 2016 and 2015 , 5 million , 13 million and 9 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2015, net of taxes $ $ $ (2,986 ) $ (1,978 ) $ (4,323 ) Other comprehensive income (loss) before reclassification adjustments, pretax (9 ) (158 ) 1,069 Tax (177 ) (13 ) (272 ) (28 ) (490 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (186 ) Reclassification adjustments, pretax (731 ) (1) (73 ) (2) (3) (22 ) (623 ) Tax (62 ) Reclassification adjustments, net of taxes (475 ) (48 ) (22 ) (404 ) Other comprehensive income (loss), net of taxes (126 ) (70 ) (208 ) Balance December 31, 2015, net of taxes (2,407 ) (2,186 ) (4,148 ) Other comprehensive income (loss) before reclassification adjustments, pretax (38 ) (1,199 ) (150 ) (1,177 ) Tax (72 ) (19 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (836 ) (169 ) (889 ) Reclassification adjustments, pretax (314 ) (1) (31 ) (2) (3) (308 ) Tax Reclassification adjustments, net of taxes (204 ) (22 ) (189 ) Other comprehensive income (loss), net of taxes (66 ) (44 ) (799 ) (169 ) (1,078 ) Balance December 31, 2016, net of taxes (3 ) (3,206 ) (4) (2,355 ) (5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax (561 ) Tax (35 ) (106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (354 ) Reclassification adjustments, pretax (141 ) (1) (291 ) (2) (3) (315 ) Tax (30 ) Reclassification adjustments, net of taxes (92 ) (235 ) (240 ) Other comprehensive income (loss), net of taxes (446 ) (58 ) Balance December 31, 2017, net of taxes $ (108 ) $ (61 ) $ (2,787 ) (4) $ (1,954 ) $ (4,910 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 3.5 billion and $3.9 billion at December 31, 2017 and 2016 , respectively, and other postretirement benefit plan net (gain) loss of $(16) million and $115 million at December 31, 2017 and 2016 , respectively, as well as pension plan prior service credit of $326 million and $361 million at December 31, 2017 and 2016 , respectively, and other postretirement benefit plan prior service credit of $383 million and $466 million at December 31, 2017 and 2016 , respectively. 19. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Companys SPMSD joint venture until its termination on December 31, 2016 (see Note 9). The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Primary Care and Womens Health Cardiovascular Zetia $ $ $ 1,344 $ 1,588 $ $ 2,560 $ 1,612 $ $ 2,526 Vytorin 1,141 1,251 Atozet Adempas Diabetes Januvia 2,153 1,584 3,737 2,286 1,622 3,908 2,263 1,601 3,863 Janumet 1,296 2,158 1,217 2,201 1,175 2,151 General Medicine and Womens Health NuvaRing Implanon/Nexplanon Follistim AQ Hospital and Specialty Hepatitis Zepatier 1,660 HIV Isentress/Isentress HD 1,204 1,387 1,511 Hospital Acute Care Bridion Noxafil Invanz Cancidas Cubicin (1) 1,087 1,030 1,127 Primaxin Immunology Remicade 1,268 1,268 1,794 1,794 Simponi Oncology Keytruda 2,309 1,500 3,809 1,402 Emend Temodar Diversified Brands Respiratory Singulair Nasonex Dulera Other Cozaar/Hyzaar Arcoxia Fosamax Vaccines (2) Gardasil/Gardasil 9 1,565 2,308 1,780 2,173 1,520 1,908 ProQuad/M-M-R II/Varivax 1,374 1,676 1,362 1,640 1,290 1,505 Pneumovax 23 RotaTeq Zostavax Other pharmaceutical (3) 1,246 3,049 4,295 1,345 3,228 4,574 1,473 3,785 5,256 Total Pharmaceutical segment sales 15,854 19,536 35,390 17,073 18,077 35,151 16,238 18,544 34,782 Other segment sales (4) 1,486 2,785 4,272 1,374 2,489 3,862 1,213 2,454 3,667 Total segment sales 17,340 22,321 39,662 18,447 20,566 39,013 17,451 20,998 38,449 Other (5) 1,049 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 $ 17,519 $ 21,979 $ 39,498 U.S. plus international may not equal total due to rounding. (1) Sales of Cubicin in 2015 represent sales subsequent to the Cubist acquisition date. (2) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 and 2015 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 and 2015 do, however, include supply sales to SPMSD. (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents the non-reportable segments of Animal Health, Healthcare Services and Alliances. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2017 and 2016 also includes $85 million and $170 million , respectively, related to the sale of the marketing rights to certain products. Consolidated revenues by geographic area where derived are as follows: Years Ended December 31 United States $ 17,424 $ 18,478 $ 17,519 Europe, Middle East and Africa 11,478 10,953 10,677 Asia Pacific 4,337 3,918 3,825 Japan 3,122 2,846 2,673 Latin America 2,339 2,155 2,825 Other 1,422 1,457 1,979 $ 40,122 $ 39,807 $ 39,498 A reconciliation of total segment profits to consolidated Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 22,586 $ 22,180 $ 21,658 Other segments 1,834 1,507 1,573 Total segment profits 24,420 23,687 23,231 Other profits Unallocated: Interest income Interest expense (754 ) (693 ) (672 ) Equity income from affiliates (19 ) Depreciation and amortization (1,378 ) (1,585 ) (1,573 ) Research and development (9,355 ) (9,084 ) (5,871 ) Amortization of purchase accounting adjustments (3,056 ) (3,692 ) (4,816 ) Restructuring costs (776 ) (651 ) (619 ) Loss on extinguishment of debt (191 ) Gain on sale of certain migraine clinical development programs Charge related to the settlement of worldwide Keytruda patent litigation (625 ) Gain on divestiture of certain ophthalmic products Foreign currency devaluation related to Venezuela (876 ) Net charge related to the settlement of Vioxx shareholder class action litigation (680 ) Other unallocated, net (2,849 ) (3,588 ) (4,354 ) $ 6,521 $ 4,659 $ 5,401 Segment profits are comprised of segment sales less standard costs and certain operating expenses directly incurred by the segments. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of contingent consideration, and other miscellaneous income or expense items. Equity income from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical All Other Total Year Ended December 31, 2017 Included in segment profits: Equity income from affiliates $ (7 ) $ $ (7 ) Depreciation and amortization (125 ) (87 ) (212 ) Year Ended December 31, 2016 Included in segment profits: Equity income from affiliates $ $ $ Depreciation and amortization (160 ) (23 ) (183 ) Year Ended December 31, 2015 Included in segment profits: Equity income from affiliates $ $ $ Depreciation and amortization (82 ) (18 ) (100 ) Property, plant and equipment, net by geographic area where located is as follows: December 31 United States $ 8,070 $ 8,114 $ 8,467 Europe, Middle East and Africa 3,151 2,732 2,844 Asia Pacific Latin America Japan Other $ 12,439 $ 12,026 $ 12,507 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Merck Co., Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Florham Park, New Jersey February 27, 2018 We have served as the Companys auditor since 2002 (b) Supplementary Data Selected quarterly financial data for 2017 and 2016 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q 1st Q 2017 (3) Sales $ 10,433 $ 10,325 $ 9,930 $ 9,434 Materials and production 3,406 3,274 3,080 3,015 Marketing and administrative 2,580 2,401 2,438 2,411 Research and development 2,281 4,383 1,749 1,796 Restructuring costs Other (income) expense, net (19 ) (86 ) Income before taxes 1,879 2,439 2,003 Net (loss) income attributable to Merck Co., Inc. (1,046 ) (56 ) 1,946 1,551 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 2016 (3) Sales $ 10,115 $ 10,536 $ 9,844 $ 9,312 Materials and production 3,332 3,409 3,578 3,572 Marketing and administrative 2,593 2,393 2,458 2,318 Research and development 4,650 1,664 2,151 1,659 Restructuring costs Other (income) expense, net (Loss) income before taxes (1,356 ) 2,887 1,504 1,624 Net (loss) income attributable to Merck Co., Inc. (594 ) 2,184 1,205 1,125 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.22 ) $ 0.79 $ 0.44 $ 0.41 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.22 ) $ 0.78 $ 0.43 $ 0.40 (1) Amounts for 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation (see Note 16). Amounts for 2016 include a charge to settle worldwide patent litigation related to Keytruda (see Note 11). (2) Amounts for 2017 include an aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4). (3) Amounts for 2017 and 2016 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the period covered by this report, there have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2017 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training, which includes financial stewardship. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2017 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2017 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Chief Financial Officer Global Services " +10,Alphabet Inc.,2021," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history, inspiring us to tackle big problems and invest in moonshots like artificial intelligence (AI) research and quantum computing. We continue this work under the leadership of Sundar Pichai, who has served as CEO of Google since 2015 and as CEO of Alphabet since 2019. Alphabet is a collection of businesses the largest of which is Google. We report Google in two segments, Google Services and Google Cloud; we also report all non-Google businesses collectively as Other Bets. Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long-term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Alphabet's structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers; it propels ideas, people and businesses large and small. Our mission to organize the worlds information and make it universally accessible and useful is as relevant today as it was when we were founded in 1998. Since then, we have evolved from a company that helps people find answers to a company that also helps people get things done. We are focused on building an even more helpful Google for everyone, and we aspire to give everyone the tools they need to increase their knowledge, health, happiness, and success. Every year, there are trillions of searches on Google, and 15% of the searches we see every day are new. We continue to invest deeply in AI and other technologies to ensure the most helpful search experience possible. YouTube provides people with entertainment, information, and opportunities to learn something new. And Google Assistant offers the best way to get things done seamlessly across different devices, providing intelligent help throughout a person's day, no matter where they are. We are continually innovating and building new product features that will help our users, partners, customers, and communities. We have invested more than $100 billion in RD over the last five years. In addition, with the onset of Alphabet Inc. the pandemic, we have focused in particular on features that help people in their daily lives and that support businesses working to serve their customers. For example, we have added live busyness trends in Google Maps that help users instantly spot when a neighborhood or part of town is near or at its busiest. We have also helped businesses navigate uncertainty during an uneven economic recovery, and we have worked to address the complex challenge of distributing critical information about COVID-19 vaccines to billions of people around the world. Importantly, we have made authoritative content a key focus area across both Google Search and YouTube to help users find trusted public health information. Other Bets also remain focused on innovation through technology that can positively affect people's lives. For instance, Waymo is working toward our goal of making transportation safer and easier for everyone and Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and to invest for the long term within each of our segments. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in, as they are the key to our long-term success. The power of AI Across the company, investments in AI and machine learning are increasingly driving many of our latest innovations and have enabled us to build products that are smarter and more helpful. For example, in May of 2021, we introduced Multitask Unified Model or MUM which has the potential to transform how Google helps with complex tasks. MUM is trained across 75 different languages, which means that it can learn from sources written in one language and help bring that information to people in another. It is also multimodal, so it understands information across text and images and, in the future, can expand to more modalities like video and audio. We are currently experimenting with MUMs capabilities to make searching more natural and intuitive and even enable entirely new ways to search. DeepMind also made a significant AI-powered breakthrough, solving a 50-year-old protein folding challenge, which will help the world better understand one of lifes fundamental building blocks, and will enable researchers to tackle new and difficult problems, from fighting diseases to environmental sustainability. DeepMind has since shared its new AlphaFold protein structure database, which doubled the number of high-accuracy human protein structures available to researchers. Google For reporting purposes, Google comprises two segments: Google Services and Google Cloud. Google Services Serving our users We have always been a company committed to building helpful products that can improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google Services' core products and platforms include ads, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube, each with broad and growing adoption by users around the world. Our products and services have come a long way since the company was founded more than two decades ago. Rather than the ten blue links in our early search results, users can now get direct answers to their questions using their computer, mobile device, or their own voice, making it quicker, easier and more natural to find what they are looking for. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content both on the web and through platforms like Google Play and YouTube. With the continued adoption of mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are extraordinary platforms and hardware. That is why we continue to invest in platforms like our Android mobile operating system, Chrome browser, and Chrome operating system, as Alphabet Inc. well as growing our family of hardware devices. We see tremendous potential for devices to be helpful and make people's lives easier by combining the best of our AI, software and hardware. This potential is reflected in our latest generation of hardware products such as Pixel 5a 5G and Pixel 6 phones, the Fitbit Charge 5, Chromecast with Google TV, and the new Google Nest Cams and Nest Doorbell. Creating products that people rely on every day is a journey that we are investing in for the long run. The key to building helpful products for users is our commitment to privacy, security, and user choice. We protect user privacy and security with products that are secure by default and private by design, and that keep users in control of their data. Our privacy-preserving technologies safeguard individual privacy and enhance data protection. As the Internet evolves, so does our approach to privacy and security. We continue to enhance our anti-malware features in Chrome and drive improvements such as auto-delete controls that automatically delete web and app searches after 18 months. And we continue to keep users and their passwords safe through advances like our built-in password manager. How we make money We have built world-class advertising technologies for advertisers, agencies, and publishers to power their digital marketing businesses. Our advertising solutions help millions of companies grow their businesses through our wide range of products across devices and formats, and we aim to ensure positive user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. Google Services generates revenues primarily by delivering both performance and brand advertising that appears on Google Search other properties, YouTube and Google Network partners' properties (""Google Network properties""). We continue to invest in both performance and brand advertising and seek to improve the measurability of advertising so advertisers understand the effectiveness of their campaigns. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads. Brand advertising helps enhance users' awareness of and affinity for advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, including filtering out invalid traffic, removing billions of bad ads from our systems every year, and closely monitoring the sites, apps, and videos where ads appear and blocklisting them when necessary to ensure that ads do not fund bad content. We continue to look to the future and are making long-term investments that we expect to grow revenues beyond advertising, including revenues from Google Play, hardware, and YouTube non-advertising. Google Play generates revenues from sales of apps and in-app purchases and digital content sold in the Google Play store. Hardware generates revenues from sales of Fitbit wearable devices, Google Nest home products, Pixel phones, and other devices. YouTube non-advertising generates revenues from YouTube Premium and YouTube TV subscriptions and other services. Google Cloud Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics, and AI. We see significant opportunity in helping businesses utilize these strengths with features like data migration, modern development environments, and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. Google Cloud Platform enables developers to build, test, and deploy applications on its highly scalable and reliable infrastructure. Google Workspace collaboration tools which include apps like Gmail, Docs, Drive, Calendar, Meet and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays digital experiences are being built in the cloud, Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Google Cloud Platform generates revenues from infrastructure, platform and other services. Alphabet Inc. Google Workspace generates revenues from cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar and Meet. Our cloud services are generally provided on either a consumption or subscription basis and may have contract terms longer than a year. Other Bets Across Alphabet, we are also using technology to try to solve big problems that affect a wide variety of industries. Alphabets investment in the portfolio of Other Bets includes emerging businesses at various stages of development, ranging from those in the RD phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in the portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, including from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Yahoo, and Yandex. Vertical search engines and e-commerce providers, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks offered by ByteDance, Meta, Snap, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other online advertising platforms and networks, such as Amazon, AppNexus, Criteo, and Meta, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms, such as Amazon, Apple, and Microsoft. Digital assistant providers, such as Amazon and Apple. Providers of enterprise cloud services, such as Alibaba, Amazon, Microsoft, and Salesforce. Providers of digital video services, such as Amazon, Apple, ATT, ByteDance, Disney, Hulu, Meta, and Netflix. Other digital content and application platform providers, such as Amazon and Apple. Providers of workspace connectivity and productivity products, such as Meta, Microsoft, Salesforce, and Zoom. Competing successfully depends heavily on our ability to develop and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security, and availability of our products and services; advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels; and content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. For additional information about competition, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Alphabet Inc. Ongoing Commitment to Sustainability We believe that every business has the opportunity and obligation to protect our planet. Sustainability is one of our core values at Google, and we strive to build sustainability into everything we do. We have been a leader on sustainability and climate change since Googles founding over 20 years ago. These are some of our key achievements over the past two decades: In 2007, we became the first major company to be carbon neutral for our operations. In 2017, we became the first major company to match 100% of our annual electricity use with renewable energy, which we have achieved for four consecutive years. In 2020, we issued $5.75 billion in sustainability bondsthe largest sustainability or green bond issuance by any company in history at the time. The net proceeds from the issuance are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. As of December 31, 2020, we have allocated $3.47 billion of the net proceeds, as outlined in our Sustainability Bond Impact Report published in 2021. Also in 2020, we compensated for our legacy carbon footprint, making Google the first major company to be carbon neutral for its entire operating history. Our sustainability strategy is focused on three key pillars: accelerating the transition to carbon-free energy and a circular economy, empowering everyone with technology, and benefiting the people and places where we operate. To accelerate the transition to a carbon-free economy, in 2020, we launched our third decade of climate action, and we are now working toward a new set of ambitious goals. By 2030, we aim to: achieve net-zero emissions across all of our operations and value chain; become the first major company to run on carbon-free energy 24 hours a day, seven days a week, 365 days a year; enable 5 gigawatts of new carbon-free energy through investments in our key manufacturing regions; and help more than 500 cities and local governments reduce an aggregate of 1 gigaton of carbon emissions annually. To accelerate the transition to a circular economy, we are working to maximize the reuse of finite resources across our operations, products, and supply chains and to enable others to do the same. We are also working to empower everyone with technology by committing to help 1 billion people make more sustainable choices by the end of 2022 through our core products. To benefit the people and places where we operate, we have set goals to replenish more water than we consume by 2030 and to support water security in communities where we operate. We will focus on three areas: enhancing our stewardship of water resources across Google office campuses and data centers; replenishing our water use and improving watershed health and ecosystems in water-stressed communities; and sharing technology and tools that help everyone predict, prevent, and recover from water stress. We remain steadfast in our commitment to sustainability, and we will continue to lead and encourage others to join us in improving the health of our planet. We are proud of what we have achieved so far, and we are energized to help move the world closer to a more sustainable and carbon-free future for all. More information on our approach to sustainability can be found in our annual sustainability reports, including Googles Environmental Report and Alphabets 2021 Sustainability Bond Impact Report, which outlines the allocation of our net proceeds from our sustainability bonds. The contents of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. For additional information about risks and uncertainties applicable to our commitments to attain certain sustainability goals, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Culture and Workforce We are a company of curious, talented, and passionate people. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex challenges in technology and society. Our people are critical for our continued success, so we work hard to create an environment where employees can have fulfilling careers, and be happy, healthy, and productive. We offer industry-leading benefits and programs to take care of the diverse needs of our employees and their families, including opportunities for career growth and Alphabet Inc. development, resources to support their financial health, and access to excellent healthcare choices. Our competitive compensation programs help us to attract and retain top candidates, and we will continue to invest in recruiting talented people to technical and non-technical roles, and rewarding them well. We provide a variety of high quality training and support to our managers to build and strengthen their capabilities-ranging from courses for new managers, to learning resources that help them provide feedback and manage performance, to coaching and individual support. At Alphabet, we are committed to making diversity, equity, and inclusion part of everything we do and to growing a workforce that is representative of the users we serve. More information on Googles approach to diversity can be found in our annual diversity reports, available publicly at diversity.google. The contents of our diversity reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. As of December 31, 2021, Alphabet had 156,500 employees. We have work councils and statutory employee representation obligations in certain countries, and we are committed to supporting protected labor rights, maintaining an open culture and listening to all employees. Supporting healthy and open dialogue is central to how we work, and we communicate information about the company through multiple internal channels to our employees. When necessary, we contract with businesses around the world to provide specialized services where we do not have appropriate in-house expertise or resources, often in fields that require specialized training like cafe operations, content moderation, customer support, and physical security. We also contract with temporary staffing agencies when we need to cover short-term leaves, when we have spikes in business needs, or when we need to quickly incubate special projects. We choose our partners and staffing agencies carefully, and review their compliance with Googles Supplier Code of Conduct. We continually make improvements to promote a respectful and positive working environment for everyone employees, vendors, and temporary staff alike. Government Regulation We are subject to numerous United States (U.S.) federal, state, and foreign laws and regulations covering a wide variety of subject matters. Like other companies in the technology industry, we face heightened scrutiny from both U.S. and foreign governments with respect to our compliance with laws and regulations. Many of these laws and regulations are evolving and their applicability and scope, as interpreted by the courts, remain uncertain. Our compliance with these laws and regulations may be onerous and could, individually or in the aggregate, increase our cost of doing business, make our products and services less useful, limit our ability to pursue certain business models, cause us to change our business practices, affect our competitive position relative to our peers, and/or otherwise have an adverse effect on our business, reputation, financial condition, and operating results. For additional information about government regulation applicable to our business, see Risk Factors in Item 1A, Trends in Our Business and Financial Effect in Part II, Item 7, and Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. For additional information, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items that may be material or of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, that may be material or of interest to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance Alphabet Inc. guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The contents of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results, and affect the trading price of our Class A and Class C stock. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generated more than 80% of total revenues from the display of ads online in 2021. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising and/or data privacy practices have in the past, and may in the future, affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions have affected, and may in the future affect, the demand for advertising, resulting in fluctuations in the amounts our advertisers spend on advertising, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, customers, and other partners, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in RD, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories and well established relationships in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in RD and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Further, discrepancies in enforcement of existing laws may enable our lesser known competitors to aggressively interpret those laws without commensurate scrutiny, thereby affording them competitive advantages. Our competitors may also be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in providing compelling products and services or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could divert management attention and harm our financial condition and operating results. Alphabet Inc. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google Services, Google Cloud, and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google Services, Google Cloud, and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of resources and management attention from current operations and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google Services, we continue to invest heavily in hardware, including our smartphones, home devices, and wearables, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. Within Google Cloud, we devote significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale our salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large, experienced, and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use AI and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition, and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing regulations, increasing competition, and increased costs for many aspects of our business. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. For additional information, see Trends in Our Business and Financial Effect in Part II, Item 7 of this Annual Report on Form 10-K. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services, and brands as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. There is always the possibility that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. Alphabet Inc. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the U.S., may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google Services, Google Cloud, and Other Bets increases our ability to enter new categories and launch new and innovative products and services that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands have been, and may in the future be, negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to respond appropriately to the sharing of misinformation or objectionable content on our services and/or products or objectionable practices by advertisers, or otherwise to adequately address user concerns, our users may lose confidence in our brands. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, trustworthy, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our finished products; to design certain of our components and parts; to participate in the distribution of our products and services; and to design, manufacture, or assemble certain components and parts in our technical infrastructure. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We have experienced and/or may in the future experience supply shortages and/or price increases that could negatively affect our operations, driven by raw material, component or part availability, manufacturing capacity, labor shortages, industry allocations, logistics capacity, tariffs, trade disputes and barriers, natural disasters or pandemics, the effects of climate change (such as sea level rise, drought, flooding, heat waves, wildfires and resultant air quality effects and power shutoffs associated with wildfire prevention, and increased storm severity), and significant changes in the financial or business condition of our suppliers. In addition, some of the components we use in our technical infrastructure and products are available from only one or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant supply interruption that affects us or our vendors could delay critical data center upgrades or expansions and delay product availability. We may enter into long-term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because certain of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Alphabet Inc. Our products and services have had, and in the future may have, quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance, and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption to, interference with, or failure of our complex information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, problems with the design or implementation of our new global enterprise resource planning system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from modifications or upgrades, terrorist attacks, natural disasters or pandemics, the effects of climate change (such as sea level rise, drought, flooding, heat waves, wildfires and resultant air quality effects and power shutoffs associated with wildfire prevention, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster or pandemic, closure of a facility, or other unanticipated problems affecting our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and have contained in the past, and may contain in the future, errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. As the phased implementation continues, we may experience delays, increased costs, and other difficulties. Failure to successfully design and implement the ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2021. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.; import and export requirements, tariffs and other market access barriers that may prevent or impede us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs; longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud; an evolving foreign policy landscape that may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom and new customer requirements), in addition to other adverse effects that we are unable to effectively anticipate; Alphabet Inc. anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties; uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent; and different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we have faced, and will continue to face, exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on some interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available or may only be available with limited functionality for our users or our advertisers on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Concerns about, including the adequacy of, our practices with regard to the collection, use, governance, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations and regulations regarding privacy and data change. Our products and services involve the storage, handling, and transmission of proprietary and other sensitive information. Software bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss or improper use and disclosure of such information, which could result in litigation and other potential liability, including regulatory fines and penalties, as well as reputational harm. Additionally, our products incorporate highly technical and complex technologies, and thus our technologies and software have contained, and are likely in the future to contain, undetected errors, bugs, or vulnerabilities. We have in the past discovered, and may in the future discover, some errors in our software code only after we have released the code. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation, brand, and business, and impair our ability to attract and retain users or customers. Such incidents have occurred in the past and may continue to occur due to the scale and nature of our products and services. While there is no guarantee that such incidents will not cause significant damage, we expect to continue to expend significant resources to maintain security protections that limit the effect of bugs, theft, misuse, and security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. Cyber attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. We have seen, and will continue to see, industry-wide vulnerabilities, such as the Log4j vulnerability reported in December 2021, which could affect our or other parties systems. We expect to continue to experience such Alphabet Inc. incidents or vulnerabilities in the future. Our efforts to address undesirable activity on our platform may also increase the risk of retaliatory attack. We may experience future security issues, whether due to employee error or malfeasance or system errors or vulnerabilities in our or other parties systems. While we may not determine some of these issues to be material at the time they occur and may remedy them quickly, there is no guarantee that these issues will not ultimately result in significant legal, financial, and reputational harm, including government inquiries and enforcement actions, litigation, and negative publicity. Because the techniques used to obtain unauthorized access to, disable or degrade service provided by or otherwise sabotage systems change frequently and often are recognized only after being launched against a target, even taking all reasonable precautions, including those required by law, we have been unable in the past and may continue to be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Further, if any partners with whom we share user or other customer information fail to implement adequate data-security practices or fail to comply with our terms and policies or otherwise suffer a network or other security breach, our users information may be improperly accessed, used, or disclosed. If an actual or perceived breach of our or our business partners or service providers security occurs, the market perception of the effectiveness of our security measures would be harmed, we could lose users and customers, our trade secrets or those of our business partners may be compromised, and we may be exposed to significant legal and financial risks, including legal claims (which may include class-action litigation) and regulatory action, fines, and penalties. Any of the foregoing consequences could have a material and adverse effect on our business, reputation, and results of operations. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process, particularly during times of a natural disaster or pandemic, may not be adequate, may fail to accurately assess the severity of an incident, may not be fast enough to prevent or limit harm, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. For additional information, see also our risk factor on privacy and data protection regulations under Risks Related to Laws and Regulations below. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to prevent and mitigate cyber attacks, we are making significant investments in safety, security, and review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigation and review of platform applications that could access the information of users of our services. As a result of these efforts, we have in the past discovered, and may in the future discover, incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. However, we may not have discovered, and may in the future not discover, all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, including factors outside of our control such as a natural disaster or pandemic, and we may learn of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or off-line, or instances of spamming, scraping, or spreading disinformation. While we may not determine some of these incidents to be material at the time they occurred and we may remedy them quickly, there is no guarantee that these issues will not ultimately result in significant legal, financial, and reputational harm, including government inquiries and enforcement actions, litigation, and negative publicity. We may also be unsuccessful in our efforts to enforce our policies or otherwise prevent or remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in ways that harm our business operations and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content on our platforms, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines across our platforms, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and Alphabet Inc. invalid traffic, we have been unable and may continue to be unable to adequately detect and prevent all such abuses or promote uniformly high-quality content. Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts have affected, and may continue to affect, the quality of content on our platforms and lead them to display false, misleading, or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam on our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes designed to detect and prevent abuse from low-quality websites. We also face other challenges on our platforms, including violations of our content guidelines involving incidents such as attempted election interference, activities that threaten the safety and/or well-being of our users on- or off-line, and the spreading of misinformation or disinformation. If we fail to either detect and prevent an increase in problematic content or effectively promote high-quality content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory action, which could result in monetary penalties and damages and divert managements time and attention. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, by charging increased fees to us or our users to provide our offerings, or by providing our competitors preferential access. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the U.S. and elsewhere regarding such protections. For example, in 2018 the U.S. Federal Communications Commission repealed net neutrality rules, which could permit internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. These could harm existing key relationships, including with our users, customers, advertisers, and/or content providers, and impair our ability to attract new ones; damage our reputation; and increase costs, thereby negatively affecting our business. Risks Related to Laws, Regulations, and Policies We face increased regulatory scrutiny as well as changes in regulatory conditions, laws, and policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry face increased regulatory scrutiny, enforcement action, and other proceedings. For instance, the U.S. Department of Justice, joined by a number of state Attorneys General, filed an antitrust complaint against Google on October 20, 2020, alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Similarly, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the U.S. District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. Various other regulatory agencies in the U.S. and around the world, including competition enforcers, consumer protection agencies, data protection authorities, grand juries, inter-agency consultative groups, and a range of other governmental bodies have and continue to review and in some cases challenge our products and services and their compliance with laws and regulations around the world. We continue to cooperate with these investigations and defend litigation where appropriate. Various laws, regulations, investigations, enforcement lawsuits, and regulatory actions have in the past, and may in the future, result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral litigation, all of which could harm our business, reputation, financial condition, and operating results. Alphabet Inc. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies have in the past, and may in the future, increase our cost of doing business and limit our ability to pursue certain business models, offer products or services in certain jurisdictions, or cause us to change our business practices. We have in the past had to alter or stop offering certain products and services as a result of laws or regulations that made them unfeasible, and new laws or regulations could result in our having to terminate, alter, or withdraw products and services in the future. Additional costs of doing business, new limitations, or changes to our business model or practices could harm our business, reputation, financial condition, and operating results. We are subject to regulations, laws, and policies that govern a wide range of topics, including those related to matters beyond our core products and services. For instance, new regulations, laws, policies, and international accords relating to environmental and social matters, including sustainability, climate change, human capital, and diversity, are being developed and formalized in Europe, the U.S., and elsewhere, which may entail specific, target-driven frameworks and/or disclosure requirements. We have implemented robust environmental and social programs, adopted reporting frameworks and principles, and announced a number of goals and initiatives, including those related to environmental sustainability and diversity. The implementation of these goals and initiatives may require considerable investments, and our goals, with all of their contingencies, dependencies, and in certain cases, reliance on third-party verification and/or performance, are complex and ambitious, and we cannot guarantee that we will achieve them. Additionally, there can be no assurance that our current programs, reporting frameworks, and principles will be in compliance with any new environmental and social laws and regulations that may be promulgated in the U.S. and elsewhere, and the costs of changing any of our current practices to comply with any new legal and regulatory requirements in the U.S. and elsewhere may be substantial. Furthermore, industry and market practices may further develop to become even more robust than what is required under any new laws and regulations, and we may have to expend significant efforts and resources to keep up with market trends and stay competitive among our peers. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations, or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices, have made, and may continue to make, our products and services less useful, limit our ability to pursue certain business models or offer certain products and services in certain jurisdictions, require us to incur substantial costs, expose us to civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: Laws and regulations around the world focused on large technology platforms, including the Digital Markets Act in the European Union and proposed antitrust legislation on self-preferencing and mergers and acquisitions in the U.S., which may limit certain business practices, and in some cases, create the risk of significant penalties. Privacy laws, such as the GDPR, CCPA, CPRA, Virginia CDPA, and ColoPA (as defined and discussed further below). Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. Consumer protection laws, including EUs New Deal for Consumers, which could result in monetary penalties and create a range of new compliance obligations. New laws further restricting the collection, processing and/or sharing of advertising-related data. Copyright or similar laws around the world, including the EU Directive on Copyright in the Digital Single Market (EUCD) and EU member state transpositions. These and similar laws that have been adopted or proposed introduce new licensing regimes that could affect our ability to operate. The EUCD and similar laws could also increase the liability of some content-sharing services with respect to content uploaded by their users. Some of these laws, as well as follow-on administrative or judicial actions, have also created or may create a new property right in news publications that limits the ability of some online services to link to, interact with, or present such content. They may also require individual or collective compensation negotiations with news agencies and publishers for the use of such content, which may result in payment obligations that significantly exceed the value that such content provides to Google and its users, potentially harming our services, commercial operations, and business results. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Alphabet Inc. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors, including the Childrens Online Privacy Protection Act of 1998 and the United Kingdoms Age-Appropriate Design Code. Various laws with regard to content moderation and removal, and related disclosure obligations, such as the Network Enforcement Act in Germany and the European Union's pending Digital Services Act, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. Various legislative, litigation, and regulatory activity regarding our Google Play billing policies and business model, which could result in monetary penalties, damages and/or prohibition. Various legislative and regulatory activity requiring disclosure of information about the operation of our services and algorithms, which may make it easier for websites to artificially promote low-quality, deceptive, or harmful content on services like Google Search and YouTube, potentially harming the quality of our services. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act and Section 230 of the Communications Decency Act in the U.S. and the E-Commerce Directive in Europe, against liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. There are legislative proposals in both the U.S. and EU that could reduce our safe harbor protection. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take have subjected us, and will likely continue to subject us, to additional laws and regulations. Our investment in a variety of new fields, such as healthcare and payment services, has expanded, and will continue to expand, the scope of regulations that apply to our business. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, other proceedings, and consent decrees that may harm our business, financial condition, and operating results. We are subject to claims, suits, government investigations, other proceedings, and consent decrees involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products and services, including hardware as well as Google Cloud offerings, we also are subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental effects, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled around the world. Claims have been brought against us, and we Alphabet Inc. expect will continue to be brought against us, for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Any failure or alleged failure to comply with these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation have resulted in, and may continue to result in, fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business, and may be particularly challenging during certain times, such as a natural disaster or pandemic. Amongst others, we are and will be subject to the following laws and regulations: The General Data Protection Regulation (GDPR), which applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. Ensuring compliance with the range of obligations created by the GDPR is an ongoing commitment that involves substantial costs. Despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate the GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have an adverse effect on our business. Serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. Various state privacy laws, such as the California Consumer Privacy Act of 2018 (CCPA), which came into effect in January of 2020; the California Privacy Rights Act (CPRA), which will go into effect in 2023; the Virginia Consumer Data Protection Act (Virginia CDPA), which will go into effect in 2023; and the Colorado Privacy Act (ColoPA), which will go into effect in 2023; all of which give new data privacy rights to their respective residents (including, in California, a private right of action in the event of a data breach resulting from our failure to implement and maintain reasonable security procedures and practices) and impose significant obligations on controllers and processors of consumer data. SB-327 in California, which regulates the security of data in connection with internet connected devices. Further, we are subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive personal data. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks that previously allowed U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland have been invalidated by the CJEU. The CJEU upheld Standard Contractual Clauses (SCCs) as a valid transfer mechanism, provided they meet certain requirements. On June 4, 2021, the European Commission published new SCCs for this purpose, and we may have to adapt our existing contractual arrangements to meet these new requirements. The validity of data transfer mechanisms remains subject to legal, regulatory, and political developments in both Europe and the U.S., such as recent recommendations from the European Data Protection Board, decisions from supervisory authorities, recent proposals for reform of the data transfer mechanisms for transfers of personal data outside the United Kingdom, and potential invalidation of other data transfer mechanisms, which, together with increased enforcement action from supervisory authorities in relation to cross-border transfers of personal data, could have a significant adverse effect on our ability to process and transfer personal data outside of the European Economic Area and/or the United Kingdom. These laws and regulations are evolving and subject to interpretation, including developments which create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. For example, in the EU, several supervisory authorities have issued new guidance concerning the ePrivacy Directives requirements regarding the use of cookies and similar technologies, including limitations on the use of data across messaging products and specific requirements for enabling users to accept or reject cookies, and have in some cases brought (and may seek to bring in the future) enforcement action in relation to those requirements. In the U.S., certain types of cookies may be deemed sales of personal information Alphabet Inc. within the CCPA and other state laws, such that certain disclosure requirements and limitations apply to the use of such cookies. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data that could increase the cost and complexity of delivering our services and carries the potential of service interruptions in those countries. We face, and may continue to face, intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or will enhance long-term stockholder value, and share repurchases could increase the volatility of our stock prices and could diminish our cash reserves. We engage in share repurchases of our Class A and Class C stock from time to time in accordance with authorizations from the Board of Directors of Alphabet. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Further, our share repurchases could affect our share trading prices, increase their volatility, reduce our cash reserves and may be suspended or terminated at any time, which may result in a decrease in the trading prices of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B stock has 10 votes per share, our Class A stock has one vote per share, and our Class C stock has no voting rights. As of December 31, 2021, Larry Page and Sergey Brin beneficially owned approximately 85.9% of our outstanding Class B stock, which represented approximately 51.4% of the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C stock carries no voting rights (except as required by applicable law), the issuance of the Class C stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. The share repurchases made pursuant to our repurchase program may also Alphabet Inc. affect Larry and Sergeys relative voting power. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A stock and our Class C stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. Our Board of Directors has the right to elect directors to fill a vacancy created by the expansion of the Board of Directors or the resignation, death, or removal of a director. Our stockholders may not act by written consent, which makes it difficult to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the Board of Directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our Board of Directors may issue, without stockholder approval, shares of undesignated preferred stock, which makes it possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the Board of Directors has approved the transaction. Our Board of Directors could rely on Delaware law to prevent or delay an acquisition of us. General Risks The continuing effects of COVID-19 are highly unpredictable and could be significant, and may have an adverse effect on our business, operations and our future financial performance. Since COVID-19 was declared a global pandemic by the World Health Organization, our business, operations and financial performance have been, and may continue to be, affected by the macroeconomic impacts resulting from the efforts to control the spread of COVID-19. As a result of the scale of the ongoing pandemic, including the introduction of new variants of COVID-19 and vaccination and other efforts to control the spread, our revenue growth rate and expenses as a percentage of our revenues in future periods may differ significantly from our historical rates, and our future operating results may fall below expectations. Additionally, we may experience a significant and prolonged shift in user behavior such as a shift in interests to less commercial topics. As a result of the pandemic, our workforce shifted to operating in a primarily remote working environment, which continues to create inherent productivity, connectivity, and oversight challenges. The effects of the ongoing pandemic are dynamic and uneven. As we prepare to return our workforce in more locations back to the office, we may experience increased costs and/or disruption as we experiment with hybrid work models, in addition to potential effects on our ability to operate effectively and maintain our corporate culture. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results have fluctuated, and may in the future fluctuate, as a result of a number of factors, many outside of our control, including the cyclicality and seasonality in our business and geopolitical events. As a result, comparing our operating results (including our expenses as a percentage of our revenues) on a period-to-period basis may not be meaningful, and our past results should not be relied on as an indication of our future performance. Consequently, our operating results in future quarters may fall below expectations. Alphabet Inc. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of such potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions; failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction; failure to successfully integrate and further develop the acquired business or technology; implementation or remediation of controls, procedures, and policies at the acquired company; integration of the acquired companys accounting, human resource (including cultural integration and retention of employees), and other administrative systems, and coordination of product, engineering, and sales and marketing functions; transition of operations, users, and customers onto our existing platforms; in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries; liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, warranty claims, product liabilities, and other known and unknown liabilities; and litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology, maintaining our culture, and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our ability to compete effectively and our future success depends on our continuing to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Restrictive immigration policy and regulatory changes may also affect our ability to hire, mobilize, or retain some of our global talent. Alphabet Inc. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows and evolves, we may need to implement more complex organizational management structures or adapt our corporate culture and work environments to ever-changing circumstances, such as during times of a natural disaster or pandemic, and these changes could affect our ability to compete effectively or have an adverse effect on our corporate culture. We are exposed to fluctuations in the fair values of our investments and, in some instances, our financial statements incorporate valuation methodologies that are subjective in nature resulting in fluctuations over time. The fair value of our investments may in the future be, and certain investments have been in the past, negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying entities, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates, the effect of new or changing regulations, the stock market in general, or other factors. We measure certain of our non-marketable equity and debt securities, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, requires management judgment and estimation, and may change over time. We adjust the carrying value of our non-marketable equity securities to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, are recognized in other income (expense), which increases the volatility of our other income (expense). The unrealized gains and losses we record from fair value remeasurements of our non-marketable equity securities in any particular period may differ significantly from the gains or losses we ultimately experience on such investments. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, decreases in our stock price for shares paid as employee compensation, changes in the valuation of our deferred tax assets or liabilities, the application of different provisions of tax laws or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. Various jurisdictions around the world have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapping international tax regimes. The Organization for Economic Cooperation and Development (OECD) continues to advance proposals relating to its initiative for modernizing international tax rules, with the goal of having different countries implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. In addition, in response to significant market volatility and disruptions to business operations resulting from the global spread of COVID-19, legislatures and taxing authorities in many jurisdictions in which we operate may propose changes to their tax rules. These changes could include modifications that have temporary effect, and more permanent Alphabet Inc. changes. The effect of these potential new rules on us, our long-term tax planning, and our effective tax rate could be material. The trading price for our Class A stock and non-voting Class C stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. In addition to the factors discussed in this report, the trading price of our Class A stock and Class C stock have fluctuated, and may continue to fluctuate widely, in response to various factors, many of which are beyond our control, including, among others, the activities of our peers and changes in broader economic and political conditions around the world. These broad market and industry factors may harm the market price of our Class A stock and our Class C stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters. In addition, we own and lease office/building space and RD sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2021, there were approximately 4,907 and 1,733 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2021, there were approximately 64 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long-term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace, and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class A common stock and Class C capital stock during the quarter ended December 31, 2021: Period Total Number of Class A Shares Purchased (in thousands) (1) Total Number of Class C Shares Purchased (in thousands) (1) Average Price Paid per Class A Share (2) Average Price Paid per Class C Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 126 1,445 $ 2,812.76 $ 2,794.72 1,571 $ 26,450 November 1 - 30 289 1,393 $ 2,943.97 $ 2,956.73 1,682 $ 21,479 December 1 - 31 250 1,169 $ 2,880.79 $ 2,898.56 1,419 $ 17,371 Total 665 4,007 4,672 (1) The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-year total stockholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2016 to December 31, 2021. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE 5-YEAR TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2016 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2022 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-year total stockholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2016 to December 31, 2021. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE 5-YEAR TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2016 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2022 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with Note about Forward-Looking Statements, Part I, Item 1 ""Business,"" Part I, Item 1A ""Risk Factors,"" and our consolidated financial statements and related notes included under Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2019 results where it would be redundant to the discussion previously included in Item 7 of our 2020 Annual Report on Form 10-K. Understanding Alphabets Financial Results Alphabet is a collection of businesses the largest of which is Google. We report Google in two segments, Google Services and Google Cloud; we also report all non-Google businesses collectively as Other Bets. Other Bets include earlier stage technologies that are further afield from our core Google business. For further details on our segments, see Part I, Item 1 Business and Note 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Trends in Our Business and Financial Effect The following long-term trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to be able to be connected no matter where they are or what they are doing. We are focused on expanding our products and services to stay in front of these trends in order to maintain and grow our business. We are increasingly generating advertising revenues from different channels, including mobile, and newer advertising formats. The margins on advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures, our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners and Google Network partners to increase as our revenues grow and TAC as a percentage of our advertising revenues (""TAC rate"") to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; the percentage of queries channeled through paid access points; product mix; the relative revenue growth rates of advertising revenues from different channels; and revenue share terms. We expect these trends to continue to affect our revenue growth rates and put pressure on our margins. As online advertising evolves, we continue to expand our product offerings, which may affect our monetization. As interactions between users and advertisers change, and as online user behavior evolves, we continue to expand and evolve our product offerings to serve these changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in revenues from ads on YouTube and Google Play, which monetize at a lower rate than our traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, such as India. We continue to invest heavily and develop localized versions of our products and advertising programs relevant to our users in these markets. This has led to a trend of increased revenues from emerging markets. We expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could affect our revenues as developing markets initially monetize at a lower rate than more mature markets. Alphabet Inc. International revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. The portion of revenues that we derive from non-advertising revenues is increasing and may adversely affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. We currently derive non-advertising revenues primarily from sales of apps and in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud services and subscription and other services. A number of Other Bets initiatives are in their initial development stages, and as such, revenues from these businesses could be volatile. In addition, the margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus across Google Services, Google Cloud and Other Bets. We also expect to continue to invest in land and buildings for data centers and offices, and information technology assets, which includes servers and network equipment, to support the long-term growth of our business. In addition, acquisitions and strategic investments contribute to the breadth and depth of our offerings, expand our expertise in engineering and other functional areas, and build strong partnerships around strategic initiatives. For example, in January 2021 we closed the acquisition of Fitbit, Inc. for $2.1 billion, which is expected to help spur innovation in wearable devices. We face continuing changes in regulatory conditions, laws, and public policies, which could affect our business practices and financial results. Changes in social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics and related legal matters have resulted in fines and caused us to change our business practices. As these global trends continue, our cost of doing business may increase, and our ability to pursue certain business models or offer certain products or services may be limited. Examples include the antitrust complaints filed by the U.S. Department of Justice and a number of state Attorneys General, the Digital Markets Act in Europe, and various legislative proposals in the U.S. focused on large technology platforms. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs. For additional information see Culture and Workforce in Part I, Item 1 Business. Seasonality and other Our advertising revenues are affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends, such as traditional retail seasonality. Additionally, our non-advertising revenues, including those generated from Google Cloud, Google Play, hardware, and YouTube, may be affected by fluctuations driven by changes in pricing, digital content releases, fee structures, new product and service launches, other market dynamics, as well as seasonality. Revenues and Monetization Metrics Google Services Google Services revenues consist of revenues generated from advertising (Google advertising) as well as revenues from other sources (Google other revenues). Google Advertising Google advertising revenues are comprised of the following: Google Search other, which includes revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.), and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads, which includes revenues generated on YouTube properties; and Alphabet Inc. Google Network, which includes revenues generated on Google Network properties participating in AdMob, AdSense, and Google Ad Manager. We use certain metrics to track how well traffic across various properties is monetized as it relates to our advertising revenues: paid clicks and cost-per-click pertain to traffic on Google Search other properties, while impressions and cost-per-impressions pertain to traffic on our Network partners properties. Paid clicks represent engagement by users and include clicks on advertisements by end-users on Google search properties and other Google owned and operated properties including Gmail, Google Maps, and Google Play. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Impressions include impressions displayed to users on Google Network properties participating primarily in AdMob, AdSense, and Google Ad Manager. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions, and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine, and update our methodologies for monitoring, gathering, and counting the number of paid clicks and the number of impressions, and for identifying the revenues generated by the corresponding click and impression activity. Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google Search other properties and the change in impressions and cost-per-impression on Google Network properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions, including the effect of COVID-19; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Google Other Google other revenues are comprised of the following: Google Play, which includes sales of apps and in-app purchases and digital content sold in the Google Play store; Devices and Services, which includes sales of hardware, including Fitbit wearable devices, Google Nest home products, and Pixel phones; YouTube non-advertising, which includes YouTube Premium and YouTube TV subscriptions; and other products and services. Google Cloud Google Cloud revenues are comprised of the following: Google Cloud Platform, which includes fees for infrastructure, platform, and other services; Google Workspace, which includes fees for cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar and Meet; and other enterprise services. Other Bets Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Alphabet Inc. For further details on how we recognize revenue, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Costs and Expenses Our cost structure has two components: cost of revenues and operating expenses. Our operating expenses include costs related to RD, sales and marketing, and general and administrative functions. Certain of these expenses, including those associated with the operation of our technical infrastructure as well as components of our operating expenses, are generally less variable in nature and may not correlate to the changes in revenue. Cost of Revenues Cost of revenues is comprised of TAC and other costs of revenues. TAC includes: Amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Amounts paid to Google Network partners primarily for ads displayed on their properties. Other cost of revenues includes: Content acquisition costs, which are payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee). Expenses associated with our data centers (including bandwidth, compensation expenses, depreciation, energy, and other equipment costs) as well as other operations costs (such as content review as well as customer and product support costs). Inventory and other costs related to the hardware we sell. The cost of revenues as a percentage of revenues generated from ads placed on Google Network properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google Search other properties, because most of the advertiser revenues from ads served on Google Network properties are paid as TAC to our Google Network partners. Operating Expenses Operating expenses are generally incurred during our normal course of business, which we categorize as either RD, sales and marketing, or general and administrative. The main components of our RD expenses are: compensation expenses for engineering and technical employees responsible for RD related to our existing and new products and services; depreciation; and professional services fees primarily related to consulting and outsourcing services. The main components of our sales and marketing expenses are: compensation expenses for employees engaged in sales and marketing, sales support, and certain customer service functions; and spending relating to our advertising and promotional activities in support of our products and services. The main components of our general and administrative expenses are: compensation expenses for employees in finance, human resources, information technology, legal, and other administrative support functions; expenses related to legal matters, including fines and settlements; and professional services fees, including audit, consulting, outside legal, and outsourcing services. Alphabet Inc. Other Income (Expense), Net Other income (expense), net primarily consists of interest income (expense), the effect of foreign currency exchange gains (losses), net gains (losses) and impairment on our marketable and non-marketable securities, performance fees, and income (loss) and impairment from our equity method investments. For additional details, including how we account for our investments and factors that can drive fluctuations in the value of our investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K as well as Item 7A, Quantitative and Qualitative Disclosures About Market Risk. Provision for Income Taxes Provision for income taxes represents the estimated amount of federal, state, and foreign income taxes incurred in the U.S. and the many jurisdictions in which we operate. The provision includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. For additional details, including a reconciliation of the U.S. federal statutory rate to our effective tax rate, see Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Executive Overview The following table summarizes consolidated financial results for the years ended December 31, 2020 and 2021 unless otherwise specified (in millions, except for per share information and percentages): Year Ended December 31, 2020 2021 $ Change % Change Consolidated revenues $ 182,527 $ 257,637 $ 75,110 41 % Change in consolidated constant currency revenues 39 % Cost of revenues $ 84,732 $ 110,939 $ 26,207 31 % Operating expenses $ 56,571 $ 67,984 $ 11,413 20 % Operating income $ 41,224 $ 78,714 $ 37,490 91 % Operating margin 23 % 31 % 8 % Other income (expense), net $ 6,858 $ 12,020 $ 5,162 75 % Net Income $ 40,269 $ 76,033 $ 35,764 89 % Diluted EPS $ 58.61 $ 112.20 $ 53.59 91 % Number of Employees 135,301 156,500 21,199 16 % Revenues were $257.6 billion, an increase of 41%. The increase in revenues was primarily driven by Google Services and Google Cloud. The adverse effect of COVID-19 on 2020 advertising revenues also contributed to the year-over-year growth. Cost of revenues was $110.9 billion, an increase of 31%, primarily driven by increases in TAC and content acquisition costs. An overall increase in data centers and other operations costs was partially offset by a reduction in depreciation expense due to the change in the estimated useful life of our servers and certain network equipment. Operating expenses were $68.0 billion, an increase of 20%, primarily driven by headcount growth, increases in advertising and promotional expenses and charges related to legal matters. Other information: Operating cash flow was $91.7 billion, primarily driven by revenues generated from our advertising products. Share repurchases were $50.3 billion, an increase of 62%. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Alphabet Inc. Capital expenditures, which primarily reflected investments in technical infrastructure, were $24.6 billion. In January 2021, we updated the useful lives of certain of our servers and network equipment, resulting in a reduction in depreciation expense of $2.6 billion recorded primarily in cost of revenues and RD. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Our acquisition of Fitbit closed in early January 2021, and the related revenues are included in Google other. See Note 8 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. On February 1, 2022, the Company announced that the Board of Directors had approved and declared a 20-for-one stock split in the form of a one-time special stock dividend on each share of the Companys Class A, Class B, and Class C stock. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information. The Effect of COVID-19 on our Financial Results We began to observe the effect of COVID-19 on our financial results in March 2020 when, despite an increase in users' search activity, our advertising revenues declined compared to the prior year. This was due to a shift of user search activity to less commercial topics and reduced spending by our advertisers. For the quarter ended June 30, 2020 our advertising revenues declined due to the continued effects of COVID-19 and the related reductions in global economic activity, but we observed a gradual return in user search activity to more commercial topics. This was followed by increased spending by our advertisers, which continued throughout the second half of 2020. Additionally, over the course of 2020, we experienced variability in our margins as many of our expenses are less variable in nature and/or may not correlate to changes in revenues. Market volatility contributed to fluctuations in the valuation of our equity investments. Further, our assessment of the credit deterioration of our customers due to changes in the macroeconomic environment during the period was reflected in our allowance for credit losses for accounts receivable. Throughout 2021 we remained focused on innovating and investing in the services we offer to consumers and businesses to support our long-term growth. The impact of COVID-19 on 2020 financial results affected year-over-year growth trends. The COVID-19 pandemic continues to evolve, be unpredictable and affect our business and financial results. Our past results may not be indicative of our future performance, and historical trends in our financial results may differ materially. Financial Results Revenues The following table presents revenues by type (in millions): Year Ended December 31, 2020 2021 Google Search other $ 104,062 $ 148,951 YouTube ads 19,772 28,845 Google Network 23,090 31,701 Google advertising 146,924 209,497 Google other 21,711 28,032 Google Services total 168,635 237,529 Google Cloud 13,059 19,206 Other Bets 657 753 Hedging gains (losses) 176 149 Total revenues $ 182,527 $ 257,637 Google Services Google advertising revenues Google Search other Google Search other revenues increased $44.9 billion from 2020 to 2021. The overall growth was driven by interrelated factors including increases in search queries resulting from growth in user adoption and usage, primarily Alphabet Inc. on mobile devices, growth in advertiser spending, and improvements we have made in ad formats and delivery. The adverse effect of COVID-19 on 2020 revenues also contributed to the year-over-year increase. YouTube ads YouTube ads revenues increased $9.1 billion from 2020 to 2021. Growth was driven by our direct response and brand advertising products. Growth for our direct response advertising products was primarily driven by increased advertiser spending as well as improvements to ad formats and delivery. Growth for our brand advertising products was primarily driven by increased spending by our advertisers and the adverse effect of COVID-19 on 2020 revenues. Google Network Google Network revenues increased $8.6 billion from 2020 to 2021. The growth was primarily driven by strength in AdMob, Google Ad Manager, and AdSense. The adverse effect of COVID-19 on 2020 revenues also contributed to the year-over-year increase. Monetization Metrics Paid clicks and cost-per-click The following table presents changes in paid clicks and cost-per-click (expressed as a percentage) from 2020 to 2021: Year Ended December 31, 2021 Paid clicks change 23 % Cost-per-click change 15 % Paid clicks increased from 2020 to 2021 driven by a number of interrelated factors, including an increase in search queries resulting from growth in user adoption and usage, primarily on mobile devices; an increase in clicks relating to ads on Google Play; growth in advertiser spending; and improvements we have made in ad formats and delivery. The adverse effect of COVID-19 on 2020 paid clicks also contributed to the increase. The increase in cost-per-click from 2020 to 2021 was driven by a number of interrelated factors including changes in device mix, geographic mix, growth in advertiser spending, ongoing product changes, and property mix, as well as the adverse effect of COVID-19 in 2020. Impressions and cost-per-impression The following table presents changes in impressions and cost-per-impression (expressed as a percentage) from 2020 to 2021: Year Ended December 31, 2021 Impressions change 2 % Cost-per-impression change 35 % Impressions increased from 2020 to 2021 primarily driven by growth in AdMob, partially offset by a decline in impressions related to AdSense. The increase in cost-per-impression was primarily driven by the adverse effect of COVID-19 in 2020 as well as the effect of interrelated factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, and property mix. Google other revenues Google other revenues increased $6.3 billion from 2020 to 2021. The growth was primarily driven by YouTube non-advertising and hardware, followed by Google Play. Growth for YouTube non-advertising was primarily due to an increase in paid subscribers. Growth in hardware reflects the inclusion of Fitbit revenues, as the acquisition closed in January 2021, and an increase in phone sales. Growth for Google Play was primarily driven by sales of apps and in-app purchases. Alphabet Inc. Google Cloud Google Cloud revenues increased $6.1 billion from 2020 to 2021. The growth was primarily driven by GCP followed by Google Workspace offerings. Google Cloud's infrastructure and platform services were the largest drivers of growth in GCP. Revenues by Geography The following table presents revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, 2020 2021 United States 47 % 46 % EMEA 30 % 31 % APAC 18 % 18 % Other Americas 5 % 5 % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Percentage Change The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. We use non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (GAAP) results helps improve the ability to understand our performance because it excludes the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue percentage change on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior year comparable period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue percentage change is calculated by determining the change in current period revenues over prior year comparable period revenues where current period foreign currency revenues are translated using prior year comparable period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on international revenues and total revenues (in millions, except percentages): Year Ended December 31, 2020 2021 % Change from Prior Year EMEA revenues $ 55,370 $ 79,107 43 % EMEA constant currency revenues 76,321 38 % APAC revenues 32,550 46,123 42 % APAC constant currency revenues 45,666 40 % Other Americas revenues 9,417 14,404 53 % Other Americas constant currency revenues 14,317 52 % United States revenues 85,014 117,854 39 % Hedging gains (losses) 176 149 Total revenues $ 182,527 $ 257,637 41 % Revenues, excluding hedging effect $ 182,351 $ 257,488 Exchange rate effect (3,330) Total constant currency revenues $ 254,158 39 % EMEA revenue growth from 2020 to 2021 was favorably affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro and British pound. APAC revenue growth from 2020 to 2021 was favorably affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Australian dollar, partially offset by the U.S. dollar strengthening relative to the Japanese yen. Other Americas growth change from 2020 to 2021 was favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Canadian dollar, partially offset by the U.S. dollar strengthening relative to the Argentine peso and the Brazilian real. Costs and Expenses Cost of Revenues The following tables present cost of revenues, including TAC (in millions, except percentages): Year Ended December 31, 2020 2021 TAC $ 32,778 $ 45,566 Other cost of revenues 51,954 65,373 Total cost of revenues $ 84,732 $ 110,939 Total cost of revenues as a percentage of revenues 46.4 % 43.1 % Cost of revenues increased $26.2 billion from 2020 to 2021. The increase was due to an increase in other cost of revenues and TAC of $13.4 billion and $12.8 billion, respectively. The increase in TAC from 2020 to 2021 was due to an increase in TAC paid to distribution partners and to Google Network partners, primarily driven by growth in revenues subject to TAC. The TAC rate decreased from 22.3% to 21.8% from 2020 to 2021 primarily due to a revenue mix shift from Google Network properties to Google Search other properties. The TAC rate on Google Search other properties revenues and the TAC rate on Google Network revenues were both substantially consistent from 2020 to 2021. The increase in other cost of revenues from 2020 to 2021 was driven by increases in content acquisition costs primarily for YouTube, data center and other operations costs, and hardware costs. The increase in data center and Alphabet Inc. other operations costs was partially offset by a reduction in depreciation expense due to the change in the estimated useful life of our servers and certain network equipment beginning in the first quarter of 2021. Research and Development The following table presents RD expenses (in millions, except percentages): Year Ended December 31, 2020 2021 Research and development expenses $ 27,573 $ 31,562 Research and development expenses as a percentage of revenues 15.1 % 12.3 % RD expenses increased $4.0 billion from 2020 to 2021. The increase was primarily due to an increase in compensation expenses of $3.5 billion, largely resulting from an 11% increase in headcount, and an increase in professional service fees of $516 million. This increase was partially offset by a reduction in depreciation expense of $450 million including the effect of our change in the estimated useful life of our servers and certain network equipment. Sales and Marketing The following table presents sales and marketing expenses (in millions, except percentages): Year Ended December 31, 2020 2021 Sales and marketing expenses $ 17,946 $ 22,912 Sales and marketing expenses as a percentage of revenues 9.8 % 8.9 % Sales and marketing expenses increased $5.0 billion from 2020 to 2021, primarily driven by an increase in advertising and promotional activities of $2.5 billion and an increase in compensation expenses of $2.2 billion. The increase in advertising and promotional activities was driven by both increased spending in the current period and a reduction in spending in 2020 due to COVID-19. The increase in compensation expenses was largely due to a 14% increase in headcount. General and Administrative The following table presents general and administrative expenses (in millions, except percentages): Year Ended December 31, 2020 2021 General and administrative expenses $ 11,052 $ 13,510 General and administrative expenses as a percentage of revenues 6.1 % 5.2 % General and administrative expenses increased $2.5 billion from 2020 to 2021. The increase was primarily driven by a $1.7 billion increase in charges relating to legal matters and a $664 million increase in compensation expenses, largely resulting from a 14% increase in headcount. These increases were partially offset by a reduction in expense of $808 million related to a decline in allowance for credit losses for accounts receivable, as 2020 reflected a higher allowance related to the economic effect of COVID-19. Alphabet Inc. Segment Profitability The following table presents segment operating income (loss) (in millions). Year Ended December 31, 2020 2021 Operating income (loss): Google Services $ 54,606 $ 91,855 Google Cloud (5,607) (3,099) Other Bets (4,476) (5,281) Corporate costs, unallocated (1) (3,299) (4,761) Total income from operations $ 41,224 $ 78,714 (1) Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including certain fines and settlements, as well as costs associated with certain shared RD activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Google Services Google services operating income increased $37.2 billion from 2020 to 2021. The increase was due to growth in revenues partially offset by increases in TAC, content acquisition costs, compensation expenses, advertising and promotional expenses, and charges related to certain legal matters. The increase in expenses was partially offset by a reduction in costs driven by the change in the estimated useful life of our servers and certain network equipment. The effect of COVID-19 on 2020 results affected the year-over-year increase in operating income. Google Cloud Google Cloud operating loss decreased $2.5 billion from 2020 to 2021. The decrease in operating loss was primarily driven by growth in revenues, partially offset by an increase in expenses, primarily driven by compensation expenses. The increase in expenses was partially offset by a reduction in costs driven by the change in the estimated useful life of our servers and certain network equipment. Other Bets Other Bets operating loss increased $805 million from 2020 to 2021. The increase in operating loss was primarily driven by increases in compensation expenses, including an increase in valuation-based compensation charges during the second quarter of 2021. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, 2020 2021 Other income (expense), net $ 6,858 $ 12,020 Other income (expense), net, increased $5.2 billion from 2020 to 2021. The increase was primarily driven by increases in net unrealized gains recognized for our marketable and non-marketable equity securities of $6.9 billion, partially offset by an increase in accrued performance fees related to certain investments of $1.3 billion. See Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Provision for Income Taxes The following table presents provision for income taxes (in millions, except for effective tax rate): Year Ended December 31, 2020 2021 Provision for income taxes $ 7,813 $ 14,701 Effective tax rate 16.2 % 16.2 % The provision for income taxes increased from 2020 to 2021, primarily due to an increase in pre-tax earnings, including in countries that have higher statutory rates, partially offset by an increase in the stock-based compensation related tax benefit, and the U.S. federal Foreign-Derived Intangible Income tax deduction benefit. Our effective tax rate Alphabet Inc. was substantially consistent from 2020 to 2021. See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Financial Condition Cash, Cash Equivalents, and Marketable Securities As of December 31, 2021, we had $139.6 billion in cash, cash equivalents, and short-term marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities, and marketable equity securities. Sources, Uses of Cash and Related Trends Our principal sources of liquidity are cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from operations. The primary use of capital continues to be to invest for the long-term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. The following table presents our cash flows (in millions): Year Ended December 31, 2020 2021 Net cash provided by operating activities $ 65,124 $ 91,652 Net cash used in investing activities $ (32,773) $ (35,523) Net cash used in financing activities $ (24,408) $ (61,362) Cash Provided by Operating Activities Our largest source of cash provided by operations are advertising revenues generated by Google Search other properties, Google Network properties, and YouTube ads. Additionally, we generate cash through sales of apps and in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from operating activities include payments to distribution and Google Network partners, for compensation and related costs, and for content acquisition costs. In addition, uses of cash from operating activities include hardware inventory costs, income taxes, and other general corporate expenditures. Net cash provided by operating activities increased from 2020 to 2021 primarily due to the net effect of an increase in cash received from revenues and cash paid for cost of revenues and operating expenses, and changes in operating assets and liabilities. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of marketable and non-marketable securities, purchases of property and equipment, and payments for acquisitions. Net cash used in investing activities increased from 2020 to 2021 primarily due to a decrease in maturities and sales of marketable securities, an increase in purchases of property and equipment, offset by a decrease in purchases of non-marketable securities. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Cash used in financing activities consists primarily of repurchases of common and capital stock, net payments related to stock-based award activities, and repayments of debt. Net cash used in financing activities increased from 2020 to 2021 primarily due to repayment of debt and an increase in cash payments for repurchases of common and capital stock. Liquidity and Material Cash Requirements We expect existing cash, cash equivalents, short-term marketable securities, cash flows from operations and financing activities to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for at least the next 12 months and thereafter for the foreseeable future. Alphabet Inc. Capital Expenditures and Leases We make investments in land and buildings for data centers and offices and information technology assets through purchases of property and equipment and lease arrangements to provide capacity for the growth of our services and products. Capital Expenditures Our capital investments in property and equipment consist primarily of the following major categories: technical infrastructure, which consists of our investments in servers and network equipment for computing, storage and networking requirements for ongoing business activities, including machine learning (collectively referred to as our information technology assets) and data center land and building construction; and office facilities, ground up development projects and related building improvements. Construction in progress consists primarily of technical infrastructure and office facilities which have not yet been placed in service for our intended use. The time frame from date of purchase to placement in service of these assets may extend from months to years. For example, our data center construction projects are generally multi-year projects with multiple phases, where we acquire qualified land and buildings, construct buildings, and secure and install information technology assets. During the years ended December 31, 2020 and 2021, we spent $22.3 billion and $24.6 billion on capital expenditures, respectively. Depreciation of our property and equipment commences when the deployment of such assets are completed and are ready for our intended use. Land is not depreciated. For the years ended December 31, 2020 and 2021, our depreciation and impairment expenses on property and equipment were $12.9 billion and $11.6 billion, respectively. Leases For the years ended December 31, 2020 and 2021, we recognized total operating lease assets of $2.8 billion and $3.0 billion, respectively. As of December 31, 2021, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 8 years, was $15.5 billion, of which $2.5 billion is short-term. As of December 31, 2021, we have entered into leases that have not yet commenced with future short-term and long-term lease payments of $606 million and $5.2 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2022 and 2026 with non-cancelable lease terms of 1 to 25 years. For the years ended December 31, 2020 and 2021, our operating lease expenses (including variable lease costs) were $2.9 billion and $3.4 billion, respectively. Finance lease costs were not material for the years ended December 31, 2020 and 2021. See Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information on leases. Financing We have a short-term debt financing program of up to $ 10.0 billion through the issuance of commercial paper, which increased from $5.0 billion in September 2021. Net proceeds from this program are used for general corporate purposes. As of December 31, 2021, we had no commercial paper outstanding. As of December 31, 2021, we had $ 10.0 billion of revolving credit facilities with no amounts outstanding. In April 2021, we terminated the existing revolving credit facilities, which were scheduled to expire in July 2023, and entered into two new revolving credit facilities in the amounts of $ 4.0 billion and $ 6.0 billion, which will expire in April 2022 and April 2026, respectively. The interest rates for the new credit facilities are determined based on a formula using certain market rates, as well as our progress toward the achievement of certain sustainability goals . No amounts have been borrowed under the new credit facilities. As of December 31, 2021, we have senior unsecured notes outstanding with a total carrying value of $12.8 billion with short-term and long-term future interest payments of $231 million and $4.0 billion, respectively. See Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information on our debt. Share Repurchase Program In April 2021, the Board of Directors of Alphabet authorized the company to repurchase up to $ 50.0 billion of its Class C stock. In July 2021, the Alphabet board approved an amendment to the April 2021 authorization, permitting the company to repurchase both Class A and Class C shares in a manner deemed in the best interest of the company and its stockholders, taking into account the economic cost and prevailing market conditions, including the relative trading Alphabet Inc. prices and volumes of the Class A and Class C shares. In accordance with the authorizations of the Board of Directors of Alphabet, during 2021 we repurchased and subsequently retired 20.3 million aggregate shares for $ 50.3 billion. Of the aggregate amount repurchased and subsequently retired, 1.2 million shares were Class A stock repurchased for $ 3.4 billion. As of December 31, 2021, $ 17.4 billion remains available for Class A and Class C share repurchases under the amended authorization. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. European Commission Fines In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($ 2.7 billion as of June 27, 2017), 4.3 billion ($ 5.1 billion as of June 30, 2018), and 1.5 billion ($ 1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Taxes As of December 31, 2021, we had short-term and long-term income taxes payable of $784 million and $5.7 billion related to a one-time transition tax payable incurred as a result of the U.S. Tax Cuts and Jobs Act (""Tax Act""). As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. We also have taxes payable of $3.5 billion primarily related to uncertain tax positions as of December 31, 2021. Purchase Commitments We regularly enter into significant non-cancelable contractual obligations primarily related to data center operations and build-outs, information technology assets, office buildings, purchases of inventory, and network capacity arrangements. As of December 31, 2021, such purchase commitments, which do not qualify for recognition on our Consolidated Balance Sheets, amount to $13.7 billion, of which $11.9 billion is short-term. These amounts represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2021. Critical Accounting Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in them have had or are reasonably likely to have a material effect on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit and compliance committee of our Board of Directors. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Fair Value Measurements of Non-Marketable Equity Securities We measure certain financial instruments at fair value on a nonrecurring basis, consisting primarily of our non-marketable equity securities. These investments are accounted for under the measurement alternative and are measured at cost, less impairment, subject to upward and downward adjustments resulting from observable price changes for identical or similar investments of the same issuer. These adjustments require quantitative assessments of the fair value of our securities, which may require the use of unobservable inputs. Pricing adjustments are determined by using various valuation methodologies and involve the use of estimates using the best information available, which may include cash flow projections or other available market data. Non-marketable equity securities are also evaluated for impairment, based on qualitative factors including the companies' financial and liquidity position and access to capital resources, among others. When indicators of impairment exist, we prepare quantitative measurements of the fair value of our equity investments using a market approach or an income approach, which requires judgment and the use of unobservable inputs, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we write down the investment to its fair value. Alphabet Inc. We also have compensation arrangements with payouts based on realized returns from certain investments, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Property and Equipment We assess the reasonableness of the useful lives of our property and equipment periodically as well as when other changes occur, such as when there are changes to ongoing business operations, changes in the planned use and utilization of assets, or technological advancements, that could indicate a change in the period over which we expect to benefit from the assets. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Recording an uncertain tax position involves various qualitative considerations, including evaluation of comparable and resolved tax exposures, applicability of tax laws, and likelihood of settlement. We evaluate uncertain tax positions periodically, considering changes in facts and circumstances, such as new regulations or recent judicial opinions, as well as the status of audit activities by taxing authorities. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury consumer protection, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood and the estimated amount of a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Change in Accounting Estimate In January 2021, we completed an assessment of the useful lives of our servers and certain network equipment. In doing so, we determined we should adjust the estimated useful life. This change in accounting estimate was effective beginning fiscal year 2021 and is detailed further in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. International revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro, and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in Alphabet Inc. foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on assets and liabilities denominated in currencies other than the functional currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on these assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approxima tely $497 million and $285 million as of December 31, 2020 and 2021, respectively, after consideration of the effect of foreign exchange contracts in place for the years ended December 31, 2020 and 2021. We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. I f the U.S. dollar weakened by 10% as of December 31, 2020 and 2021, the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $912 million and $1.3 billion lower as of December 31, 2020 and 2021, respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $1.0 billion lower as of both December 31, 2020 and 2021. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that w ill allow us to preserve capital and maintain liquidity. We invest primarily in debt securities, including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as compared to interest rates at the time of purchase. For certain fixed and variable rate debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. We measure securities for which we have not elected the fair value option at fair value with gains and losses recorded in AOCI until the securities are sold, less any expected credit losses. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of marketable debt securities as of December 31, 2020 and 2021 are shown below (in millions): As of December 31, 12-Month Average As of December 31, 2020 2021 2020 2021 Risk Category - Interest Rate $ 144 $ 139 $ 145 $ 148 Alphabet Inc. Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2020 and 2021 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $5.9 billion and $7.8 billion of our investments as of December 31, 2020 and 2021, respectively. A hypothetical adverse price change of 10% on our December 31, 2021 balance, which could be experienced in the near term, would decrease the fair value of marketable equity securities by $780 million. From time to time, we may enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value measured at the time of the observable transaction is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize, and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of investments through liquidity events such as public offerings, acquisitions, private sales or other market events. As of December 31, 2020 and 2021, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $18.9 billion and $27.6 billion, respectively. Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge relating to our non-marketable equity securities. Changes in valuation of non-marketable equity securities may not directly correlate with changes in valuation of marketable equity securities. Additionally, observable transactions at lower valuations could result in significant losses on our non-marketable equity securities. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the effect. The carrying values of our equity method investments, which totaled approximately $1.4 billion and $1.5 billion as of December 31, 2020 and 2021, respectively, generally do not fluctuate based on market price changes. However, these investments could be impaired if the carrying value exceeds the fair value and is not expected to recover. For further information about our equity investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm (PCAOB ID: 42 ) Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 45 Alphabet Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2020 and 2021, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 1, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, personal injury, consumer protection, and other matters. As described in Note 10 to the consolidated financial statements Contingencies such claims, suits, regulatory and government investigations, and other proceedings could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgment in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 1, 2022 Alphabet Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2021 consolidated financial statements of the Company and our report dated February 1, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 1, 2022 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2020 2021 Assets Current assets: Cash and cash equivalents $ 26,465 $ 20,945 Marketable securities 110,229 118,704 Total cash, cash equivalents, and marketable securities 136,694 139,649 Accounts receivable, net 30,930 39,304 Income taxes receivable, net 454 966 Inventory 728 1,170 Other current assets 5,490 7,054 Total current assets 174,296 188,143 Non-marketable securities 20,703 29,549 Deferred income taxes 1,084 1,284 Property and equipment, net 84,749 97,599 Operating lease assets 12,211 12,959 Intangible assets, net 1,445 1,417 Goodwill 21,175 22,956 Other non-current assets 3,953 5,361 Total assets $ 319,616 $ 359,268 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 5,589 $ 6,037 Accrued compensation and benefits 11,086 13,889 Accrued expenses and other current liabilities 28,631 31,236 Accrued revenue share 7,500 8,996 Deferred revenue 2,543 3,288 Income taxes payable, net 1,485 808 Total current liabilities 56,834 64,254 Long-term debt 13,932 14,817 Deferred revenue, non-current 481 535 Income taxes payable, non-current 8,849 9,176 Deferred income taxes 3,561 5,257 Operating lease liabilities 11,146 11,389 Other long-term liabilities 2,269 2,205 Total liabilities 97,072 107,633 Contingencies (Note 10) Stockholders equity: Preferred stock, $ 0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding 0 0 Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $ 0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000 , Class B 3,000,000 , Class C 3,000,000 ); 675,222 (Class A 300,730 , Class B 45,843 , Class C 328,649 ) and 662,121 (Class A 300,737 , Class B 44,665 , Class C 316,719 ) shares issued and outstanding 58,510 61,774 Accumulated other comprehensive income (loss) 633 ( 1,623 ) Retained earnings 163,401 191,484 Total stockholders equity 222,544 251,635 Total liabilities and stockholders equity $ 319,616 $ 359,268 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2019 2020 2021 Revenues $ 161,857 $ 182,527 $ 257,637 Costs and expenses: Cost of revenues 71,896 84,732 110,939 Research and development 26,018 27,573 31,562 Sales and marketing 18,464 17,946 22,912 General and administrative 9,551 11,052 13,510 European Commission fines 1,697 0 0 Total costs and expenses 127,626 141,303 178,923 Income from operations 34,231 41,224 78,714 Other income (expense), net 5,394 6,858 12,020 Income before income taxes 39,625 48,082 90,734 Provision for income taxes 5,282 7,813 14,701 Net income $ 34,343 $ 40,269 $ 76,033 Basic net income per share of Class A and B common stock and Class C capital stock $ 49.59 $ 59.15 $ 113.88 Diluted net income per share of Class A and B common stock and Class C capital stock $ 49.16 $ 58.61 $ 112.20 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2019 2020 2021 Net income $ 34,343 $ 40,269 $ 76,033 Other comprehensive income (loss): Change in foreign currency translation adjustment ( 119 ) 1,139 ( 1,442 ) Available-for-sale investments: Change in net unrealized gains (losses) 1,611 1,313 ( 1,312 ) Less: reclassification adjustment for net (gains) losses included in net income ( 111 ) ( 513 ) ( 64 ) Net change, net of income tax benefit (expense) of $( 221 ), $( 230 ), and $ 394 1,500 800 ( 1,376 ) Cash flow hedges: Change in net unrealized gains (losses) 22 42 716 Less: reclassification adjustment for net (gains) losses included in net income ( 299 ) ( 116 ) ( 154 ) Net change, net of income tax benefit (expense) of $ 42 , $ 11 , and $( 122 ) ( 277 ) ( 74 ) 562 Other comprehensive income (loss) 1,104 1,865 ( 2,256 ) Comprehensive income $ 35,447 $ 42,134 $ 73,777 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2018 695,556 $ 45,049 $ ( 2,306 ) $ 134,885 $ 177,628 Cumulative effect of accounting change 0 0 ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 202 0 0 202 Stock-based compensation expense 0 10,890 0 0 10,890 Income tax withholding related to vesting of restricted stock units and other 0 ( 4,455 ) 0 0 ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) 0 ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities 0 160 0 0 160 Net income 0 0 0 34,343 34,343 Other comprehensive income (loss) 0 0 1,104 0 1,104 Balance as of December 31, 2019 688,335 50,552 ( 1,232 ) 152,122 201,442 Common and capital stock issued 8,398 168 0 0 168 Stock-based compensation expense 0 13,123 0 0 13,123 Income tax withholding related to vesting of restricted stock units and other 0 ( 5,969 ) 0 0 ( 5,969 ) Repurchases of capital stock ( 21,511 ) ( 2,159 ) 0 ( 28,990 ) ( 31,149 ) Sale of interest in consolidated entities 0 2,795 0 0 2,795 Net income 0 0 0 40,269 40,269 Other comprehensive income (loss) 0 0 1,865 0 1,865 Balance as of December 31, 2020 675,222 58,510 633 163,401 222,544 Common and capital stock issued 7,225 12 0 0 12 Stock-based compensation expense 0 15,539 0 0 15,539 Income tax withholding related to vesting of restricted stock units and other 0 ( 10,273 ) 0 0 ( 10,273 ) Repurchases of common and capital stock ( 20,326 ) ( 2,324 ) 0 ( 47,950 ) ( 50,274 ) Sale of interest in consolidated entities 0 310 0 0 310 Net income 0 0 0 76,033 76,033 Other comprehensive income (loss) 0 0 ( 2,256 ) 0 ( 2,256 ) Balance as of December 31, 2021 662,121 $ 61,774 $ ( 1,623 ) $ 191,484 $ 251,635 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2019 2020 2021 Operating activities Net income $ 34,343 $ 40,269 $ 76,033 Adjustments: Depreciation and impairment of property and equipment 10,856 12,905 11,555 Amortization and impairment of intangible assets 925 792 886 Stock-based compensation expense 10,794 12,991 15,376 Deferred income taxes 173 1,390 1,808 Gain on debt and equity securities, net ( 2,798 ) ( 6,317 ) ( 12,270 ) Other ( 592 ) 1,267 ( 213 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 4,340 ) ( 6,524 ) ( 9,095 ) Income taxes, net ( 3,128 ) 1,209 ( 625 ) Other assets ( 621 ) ( 1,330 ) ( 1,846 ) Accounts payable 428 694 283 Accrued expenses and other liabilities 7,170 5,504 7,304 Accrued revenue share 1,273 1,639 1,682 Deferred revenue 37 635 774 Net cash provided by operating activities 54,520 65,124 91,652 Investing activities Purchases of property and equipment ( 23,548 ) ( 22,281 ) ( 24,640 ) Purchases of marketable securities ( 100,315 ) ( 136,576 ) ( 135,196 ) Maturities and sales of marketable securities 97,825 132,906 128,294 Purchases of non-marketable securities ( 1,932 ) ( 7,175 ) ( 2,838 ) Maturities and sales of non-marketable securities 405 1,023 934 Acquisitions, net of cash acquired, and purchases of intangible assets ( 2,515 ) ( 738 ) ( 2,618 ) Other investing activities 589 68 541 Net cash used in investing activities ( 29,491 ) ( 32,773 ) ( 35,523 ) Financing activities Net payments related to stock-based award activities ( 4,765 ) ( 5,720 ) ( 10,162 ) Repurchases of common and capital stock ( 18,396 ) ( 31,149 ) ( 50,274 ) Proceeds from issuance of debt, net of costs 317 11,761 20,199 Repayments of debt ( 585 ) ( 2,100 ) ( 21,435 ) Proceeds from sale of interest in consolidated entities, net 220 2,800 310 Net cash used in financing activities ( 23,209 ) ( 24,408 ) ( 61,362 ) Effect of exchange rate changes on cash and cash equivalents ( 23 ) 24 ( 287 ) Net increase (decrease) in cash and cash equivalents 1,797 7,967 ( 5,520 ) Cash and cash equivalents at beginning of period 16,701 18,498 26,465 Cash and cash equivalents at end of period $ 18,498 $ 26,465 $ 20,945 Supplemental disclosures of cash flow information Cash paid for income taxes, net of refunds $ 8,203 $ 4,990 $ 13,412 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (""Alphabet"") became the successor issuer to Google. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates due to uncertainties, including the effects of COVID-19. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses; fair values of financial instruments, intangible assets, and goodwill; useful lives of intangible assets and property and equipment; income taxes; and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, and the results of which form the basis for making judgments about the carrying values of assets and liabilities. In January 2021, we completed an assessment of the useful lives of our servers and network equipment and adjusted the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years . This change in accounting estimate was effective beginning in fiscal year 2021. Based on the carrying value of servers and certain network equipment as of December 31, 2020 and those acquired during the year ended December 31, 2021, the effect of this change in estimate was a reduction in depreciation expense of $ 2.6 billion and an increase in net income of $ 2.0 billion, or $ 3.02 per basic share and $ 2.98 per diluted share, for the year ended December 31, 2021. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, and the collectibility of an amount that we expect in exchange for those goods or services is probable. Sales and other similar taxes are excluded from revenues. Advertising Revenues We generate advertising revenues primarily by delivering advertising on: Google Search and other properties, including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc. and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube properties; and Google Network properties, including revenues from Google Network properties participating in AdMob, AdSense, and Google Ad Manager. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager, and Google Marketing Platform, among others. We offer advertising by delivering both performance and brand advertising. We recognize revenues for performance advertising when a user engages with the advertisement, such as a click, a view, or a purchase. For brand advertising, we recognize revenues when the ad is displayed, or a user views the ad. For ads placed on Google Network properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network partners are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Alphabet Inc. Google Cloud Revenues Google Cloud revenues consist of revenues from: Google Cloud Platform, which includes fees for infrastructure, platform, and other services; Google Workspace, which includes fees for cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar, and Meet; and other enterprise services. Our cloud services are generally provided on either a consumption or subscription basis and may have contract terms longer than a year. Revenues related to cloud services provided on a consumption basis are recognized when the customer utilizes the services, based on the quantity of services consumed. Revenues related to cloud services provided on a subscription basis are recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Google Other Revenues Google other revenues consist of revenues from: Google Play, which includes sales of apps and in-app purchases and digital content sold in the Google Play store; hardware, which includes sales of Fitbit wearable devices, Google Nest home products, and Pixel phones; YouTube non-advertising, which includes YouTube Premium and YouTube TV subscriptions; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a service fee. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Sales Commissions We expense sales commissions when incurred and when the amortization period (the period of the expected benefit) is one year or less. We recognize an asset for certain sales commissions if we expect the period of benefit of these costs to exceed one year and recognize the expense over the amortization period. These costs are recorded within sales and marketing expenses. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC includes: Amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Amounts paid to Google Network partners primarily for ads displayed on their properties. Other cost of revenues includes: Content acquisition costs, which are payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee). Alphabet Inc. Expenses associated with our data centers (including bandwidth, compensation expenses, depreciation, energy, and other equipment costs) as well as other operations costs (such as content review as well as customer and product support costs). Inventory and other costs related to the hardware we sell. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products. As a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory income tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding, and the income tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation also includes other stock-based awards, such as performance stock units (PSUs) that include market conditions and awards that may be settled in cash or the stock of certain Other Bets. PSUs and certain Other Bet awards are equity classified and expense is recognized over the requisite service period. Certain Other Bet awards are liability classified and remeasured at fair value through settlement. The fair value of Other Bet awards is based on the equity valuation of the respective Other Bet. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2019, 2020 and 2021, advertising and promotional expenses totaled approximately $ 6.8 billion, $ 5.4 billion, and $ 7.9 billion, respectively. Performance Fees Performance fees refer to compensation arrangements with payouts based on realized returns from certain investments. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Performance fees are recorded as a component of other income (expense), net. Fair Value Measurements Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. Alphabet Inc. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative financial instruments, and certain non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities. Other financial assets and liabilities are carried at cost with fair value disclosed, if required. We measure certain other instruments, including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, also at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. Financial Instruments Our financial instruments include cash, cash equivalents, marketable and non-marketable securities, derivative financial instruments and accounts receivable. Credit Risks We are subject to credit risk from cash equivalents, marketable securities, derivative financial instruments, including foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We manage our credit risk exposure by performing ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. Cash Equivalents We invest excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. Marketable Securities We classify all marketable debt securities that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities on our Consolidated Balance Sheets. We determine the appropriate classification of our investments in marketable debt securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for the changes in allowance for expected credit losses, which are recorded in other income (expense), net. For certain marketable debt securities we have elected the fair value option, for which changes in fair value are recorded in other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Our investments in marketable equity securities are measured at fair value with the related gains and losses, including unrealized, recognized in other income (expense), net. We classify our marketable equity securities subject to long-term lock-up restrictions beyond twelve months as other non-current assets on the Consolidated Balance Sheets. Non-Marketable Securities We account for non-marketable equity securities through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Adjustments are determined primarily based on a market approach as of the transaction date and are recorded as a component of other income (expense), net. Non-marketable debt securities are classified as available-for-sale securities. Alphabet Inc. Non-marketable securities that do not have stated contractual maturity dates are classified as other non-current assets on the Consolidated Balance Sheets. Derivative Financial Instruments See Note 3 for the accounting policy pertaining to derivative financial instruments. Accounts Receivable Our payment terms for accounts receivable vary by the types and locations of our customers and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customers, we require payment before the products or services are delivered to the customer. We maintain an allowance for credit losses for accounts receivable, which is recorded as an offset to accounts receivable, and changes in such are classified as general and administrative expense in the Consolidated Statements of Income. We assess collectibility by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with known disputes or collectibility issues. In determining the amount of the allowance for credit losses, we consider historical collectibility based on past due status and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information, current market conditions (such as the effects caused by COVID-19), and reasonable and supportable forecasts of future economic conditions. The allowance for credit losses on accounts receivable was $ 789 million and $ 550 million as of December 31, 2020 and 2021, respectively. Other Our financial instruments also include debt and equity investments in companies with which we also have commercial arrangements. For these transactions, judgment is required to assess the substance of the arrangements, such as the market value of similar transactions or the fair value of the investment based on stand-alone transactions, and whether the agreements should be accounted for as separate transactions under the applicable GAAP. Impairment of Investments We periodically review our debt and non-marketable equity securities for impairment. For debt securities in an unrealized loss position, we determine whether a credit loss exists. The credit loss is estimated by considering available information relevant to the collectibility of the security and information about past events, current conditions, and reasonable and supportable forecasts. Any credit loss is recorded as a charge to other income (expense), net, not to exceed the amount of the unrealized loss. Unrealized losses other than the credit loss are recognized in accumulated other comprehensive income (AOCI). If we have an intent to sell, or if it is more likely than not that we will be required to sell a debt security in an unrealized loss position before recovery of its amortized cost basis, we will write down the security to its fair value and record the corresponding charge as a component of other income (expense), net. For non-marketable equity securities, including equity method investments, we consider whether impairment indicators exist by evaluating the companies' financial and liquidity position and access to capital resources, among other indicators. If the assessment indicates that the investment is impaired, we write down the investment to its fair value by recording the corresponding charge as a component of other income (expense), net. We prepare quantitative measurements of the fair value of our equity investments using a market approach or an income approach. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. We are the primary beneficiary of a VIE when we have the power to direct activities that most significantly affect the economic performance of the VIE and have the obligation to absorb the majority of their losses or benefits. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is a VIE and, if so, whether we are the primary beneficiary. Alphabet Inc. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers, and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets, which we regularly evaluate. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of four to five years (generally, four years for servers and five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities, and the long-term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense (excluding variable lease costs) is recognized on a straight-line basis over the lease term. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets or asset group is not recoverable, the impairment recognized is measured as the amount by which the carrying value exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units periodically, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were no t material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives on a straight-line basis generally over periods ranging from one to twelve years . Alphabet Inc. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Foreign Currency We translate the financial statements of our international subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in AOCI as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Note 2. Revenues Revenue Recognition The following table presents revenues disaggregated by type (in millions): Year Ended December 31, 2019 2020 2021 Google Search other $ 98,115 $ 104,062 $ 148,951 YouTube ads 15,149 19,772 28,845 Google Network 21,547 23,090 31,701 Google advertising 134,811 146,924 209,497 Google other 17,014 21,711 28,032 Google Services total 151,825 168,635 237,529 Google Cloud 8,918 13,059 19,206 Other Bets 659 657 753 Hedging gains (losses) 455 176 149 Total revenues $ 161,857 $ 182,527 $ 257,637 No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2019, 2020, or 2021. Alphabet Inc. The following table presents revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, 2019 2020 2021 United States $ 74,843 46 % $ 85,014 47 % $ 117,854 46 % EMEA (1) 50,645 31 55,370 30 79,107 31 APAC (1) 26,928 17 32,550 18 46,123 18 Other Americas (1) 8,986 6 9,417 5 14,404 5 Hedging gains (losses) 455 0 176 0 149 0 Total revenues $ 161,857 100 % $ 182,527 100 % $ 257,637 100 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (""Other Americas""). Revenue Backlog and Deferred Revenues As of December 31, 2021 we had $ 51.0 billion of remaining performance obligations (revenue backlog), primarily related to Google Cloud, a nd expect to recognize approximately half of this amount as revenues over the next 24 months with the remaining thereafter. Our revenue backlog represents commitments in customer contracts for future services that have not yet been recog nized as revenues. The amount and timing of revenue recognition for these commitments is largely driven by when our customers utilize services and our ability to deliver in accordance with relevant contract terms, which could affect our estimate of revenue backlog and when we expect to recognize such as revenues. Revenue backlog includes related deferred revenue currently recorded as well as amounts that will be invoiced in future periods, and excludes contracts with an original expected term of one year or less and cancellable contracts. We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. Deferred revenues primarily relate to Google Cloud and Google other. Total deferred revenue as of December 31, 2020 was $ 3.0 billion, of which $ 2.3 billion was recognized as revenues for the year ending December 31, 2021. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities, which are accounted for as available-for-sale within Level 2 in the fair value hierarchy, because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. For certain marketable debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. The fair value option was elected for these securities to align with the unrealized gains and losses from related derivative contracts. Unrealized net gains (losses) related to debt securities still held where we have elected the fair value option were $ 87 million and $( 35 ) million as of December 31, 2020 and December 31, 2021, respectively. As of December 31, 2020 and December 31, 2021, the fair value of these debt securities was $ 2.0 billion and $ 4.7 billion, respectively. Alphabet Inc. The following tables summarize debt securities, for which we did not elect the fair value option, by significant investment categories as of December 31, 2020 and 2021 (in millions): As of December 31, 2020 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 3,564 $ 0 $ 0 $ 3,564 $ 3,564 $ 0 Government bonds 55,156 793 ( 9 ) 55,940 2,527 53,413 Corporate debt securities 31,521 704 ( 2 ) 32,223 8 32,215 Mortgage-backed and asset-backed securities 16,767 364 ( 7 ) 17,124 0 17,124 Total $ 107,008 $ 1,861 $ ( 18 ) $ 108,851 $ 6,099 $ 102,752 As of December 31, 2021 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 5,133 $ 0 $ 0 $ 5,133 $ 5,133 $ 0 Government bonds 53,288 258 ( 238 ) 53,308 5 53,303 Corporate debt securities 35,605 194 ( 223 ) 35,576 12 35,564 Mortgage-backed and asset-backed securities 18,829 96 ( 112 ) 18,813 0 18,813 Total $ 112,855 $ 548 $ ( 573 ) $ 112,830 $ 5,150 $ 107,680 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 292 million, $ 899 million, and $ 432 million for the years ended December 31, 2019, 2020, and 2021, respectively. We recognized gross realized losses of $ 143 million, $ 184 million, and $ 329 million for the years ended December 31, 2019, 2020, and 2021, respectively. We reflect these gains and losses as a component of other income (expense), net. The following table summarizes the estimated fair value of investments in marketable debt securities by stated contractual maturity dates (in millions): As of December 31, 2021 Due in 1 year or less $ 16,192 Due in 1 year through 5 years 78,625 Due in 5 years through 10 years 4,675 Due after 10 years 12,864 Total $ 112,356 The following tables present fair values and gross unrealized losses recorded to AOCI as of December 31, 2020 and 2021, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2020 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 5,516 $ ( 9 ) $ 3 $ 0 $ 5,519 $ ( 9 ) Corporate debt securities 1,999 ( 1 ) 0 0 1,999 ( 1 ) Mortgage-backed and asset-backed securities 929 ( 5 ) 242 ( 2 ) 1,171 ( 7 ) Total $ 8,444 $ ( 15 ) $ 245 $ ( 2 ) $ 8,689 $ ( 17 ) Alphabet Inc. As of December 31, 2021 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 32,843 $ ( 236 ) $ 71 $ ( 2 ) $ 32,914 $ ( 238 ) Corporate debt securities 22,737 ( 152 ) 303 ( 5 ) 23,040 ( 157 ) Mortgage-backed and asset-backed securities 11,502 ( 106 ) 248 ( 6 ) 11,750 ( 112 ) Total $ 67,082 $ ( 494 ) $ 622 $ ( 13 ) $ 67,704 $ ( 507 ) During the years ended December 31, 2020 and 2021, we did not recognize significant credit losses and the ending allowance for credit losses was immaterial. See Note 7 for further details on other income (expense), net. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value upon observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). Non-marketable equity securities that have been remeasured during the period based on observable transactions are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods which may include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The fair value of non-marketable equity securities that have been remeasured due to impairment are classified within Level 3. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, 2020 2021 Net gain (loss) on equity securities sold during the period $ 1,339 $ 1,196 Unrealized gain (loss) on equity securities held as of the end of the period 4,253 11,184 Total gain (loss) recognized in other income (expense), net $ 5,592 $ 12,380 In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains (losses) on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic net gains recognized on the securities sold during the period. Cumulative net gains are calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Alphabet Inc. Equity Securities Sold During the Year Ended December 31, 2020 2021 Total sale price $ 4,767 $ 5,604 Total initial cost 2,674 1,206 Cumulative net gains (1) $ 2,093 $ 4,398 (1) Cumulative net gains excludes cumulative losses of $ 738 million resulting from our equity derivatives, which hedged the changes in fair value of certain marketable equity securities sold during the year ended December 31, 2021. The associated derivative liabilities arising from these losses were settled against our holdings of the underlying equity securities. Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2020 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 2,227 $ 14,616 $ 16,843 Cumulative net gain (loss) (1) 3,631 4,277 7,908 Carrying value (2) $ 5,858 $ 18,893 $ 24,751 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 6.1 billion gains and $ 1.9 billion losses (including impairment). (2) The long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 429 million is included within other non-current assets. As of December 31, 2021 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 4,211 $ 15,135 $ 19,346 Cumulative net gain (loss) (1) 3,587 12,436 16,023 Carrying value (2) $ 7,798 $ 27,571 $ 35,369 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 14.1 billion gains and $ 1.7 billion losses (including impairment). (2) The long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 1.4 billion is included within other non-current assets. Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2020 and 2021 (in millions): As of December 31, 2020 As of December 31, 2021 Cash and Cash Equivalents Marketable Equity Securities Cash and Cash Equivalents Marketable Equity Securities Level 1: Money market funds $ 12,210 $ 0 $ 7,499 $ 0 Marketable equity securities (1)(2) 0 5,470 0 7,447 12,210 5,470 7,499 7,447 Level 2: Mutual funds 0 388 0 351 Total $ 12,210 $ 5,858 $ 7,499 $ 7,798 (1) The balance as of December 31, 2020 and 2021 includes investments that were reclassified from non-marketable equity securities following the commencement of public market trading of the issuers or acquisition by public entities (certain investments are subject to short-term lock-up restrictions). (2) As of December 31, 2020 and 2021, the long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 429 million and $ 1.4 billion, respectively, is included within other non-current assets. Alphabet Inc. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, which are included as adjustments to the carrying value of non-marketable equity securities held as of the end of the period (in millions): Year Ended December 31, 2020 2021 Unrealized gains on non-marketable equity securities $ 3,020 $ 9,971 Unrealized losses on non-marketable equity securities (including impairment) ( 1,489 ) ( 122 ) Total unrealized gain (loss) recognized on non-marketable equity securities $ 1,531 $ 9,849 During the year ended December 31, 2021, included in the $ 27.6 billion of non-marketable equity securities held as of the end of the period, $ 18.6 billion were measured at fair value resulting in a net unrealized gain of $ 9.8 billion. Equity securities accounted for under the Equity Method As of December 31, 2020 and 2021, equity securities accounted for under the equity method had a carrying value of approximately $ 1.4 billion and $ 1.5 billion, respectively. Our share of gains and losses, including impairments, are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We enter into derivative instruments to manage risks relating to our ongoing business operations. The primary risk managed with derivative instruments is foreign exchange risk. We use foreign currency contracts to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also enter into derivative instruments to partially offset our exposure to other risks and enhance investment returns. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value and classify the derivatives primarily within Level 2 in the fair value hierarchy. We present our collar contracts (an option strategy comprised of a combination of purchased and written options) at net fair values where both the purchased and written options are with the same counterparty. For other derivative contracts, we present at gross fair values. We primarily record changes in the fair value in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. Further, we enter into collateral security arrangements that provide for collateral to be received or pledged when the net fair value of certain financial instruments fluctuates from contractually established thresholds. Cash collateral received related to derivative instruments under our collateral security arrangements are included in other current assets with a corresponding liability. Cash and non-cash collateral pledged related to derivative instruments under our collateral security arrangements are included in other current assets. Cash Flow Hedges We designate foreign currency forward and option contracts (including collars) as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. These contracts have maturities of 24 months or less. Cash flow hedge amounts included in the assessment of hedge effectiveness are deferred in AOCI and subsequently reclassified to revenue when the hedged item is recognized in earnings. We exclude the change in forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are reclassified to other income (expense), net in the period of de-designation. As of December 31, 2021, the net accumulated gain on our foreign currency cash flow hedges before tax effect was $ 518 million, which is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We designate foreign currency forward contracts as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Fair value hedge amounts included in the Alphabet Inc. assessment of hedge effectiveness are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Net Investment Hedges We designate foreign currency forward contracts as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. Net investment hedge amounts included in the assessment of hedge effectiveness are recognized in AOCI along with the foreign currency translation adjustment. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Other Derivatives Other derivatives not designated as hedging instruments consist primarily of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the functional currency of a subsidiary. Gains and losses on these contracts, as well as the related costs, are recognized in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. We also use derivatives not designated as hedging instruments to manage risks relating to interest rates, commodity prices, credit exposures and to enhance investment returns. Additionally, from time to time, we enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Gains (losses) arising from these derivatives are reflected within the ""other"" component of other income (expense), net and the offsetting recognized gains (losses) on the marketable equity securities are reflected within the gain (loss) on equity securities, net component of other income (expense), net. See Note 7 for further details on other income (expense), net. The gross notional amounts of outstanding derivative instruments were as follows (in millions): As of December 31, 2020 2021 Derivatives Designated as Hedging Instruments: Foreign exchange contracts Cash flow hedges $ 10,187 $ 16,362 Fair value hedges $ 1,569 $ 2,556 Net investment hedges $ 9,965 $ 10,159 Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts $ 39,861 $ 41,031 Other contracts $ 2,399 $ 4,275 Alphabet Inc. The fair values of outstanding derivative instruments were as follows (in millions): As of December 31, 2020 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 33 $ 316 $ 349 Other contracts Other current and non-current assets 0 16 16 Total $ 33 $ 332 $ 365 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 395 $ 185 $ 580 Other contracts Accrued expenses and other liabilities, current and non-current 0 942 942 Total $ 395 $ 1,127 $ 1,522 As of December 31, 2021 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 867 $ 42 $ 909 Other contracts Other current and non-current assets 0 52 52 Total $ 867 $ 94 $ 961 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 8 $ 452 $ 460 Other contracts Accrued expenses and other liabilities, current and non-current 0 121 121 Total $ 8 $ 573 $ 581 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) were summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, 2019 2020 2021 Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ 38 $ 102 $ 806 Amount excluded from the assessment of effectiveness ( 14 ) ( 37 ) 48 Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness 131 ( 851 ) 754 Total $ 155 $ ( 786 ) $ 1,608 The effect of derivative instruments on income was summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, 2019 2020 2021 Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 161,857 $ 5,394 $ 182,527 $ 6,858 $ 257,637 $ 12,020 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ 367 $ 0 $ 144 $ 0 $ 165 $ 0 Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach 88 0 33 0 ( 16 ) 0 Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items 0 ( 19 ) 0 18 0 ( 95 ) Derivatives designated as hedging instruments 0 19 0 ( 18 ) 0 95 Amount excluded from the assessment of effectiveness 0 25 0 4 0 8 Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness 0 243 0 151 0 82 Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts 0 ( 413 ) 0 718 0 ( 860 ) Other Contracts 0 0 0 ( 906 ) 0 101 Total gains (losses) $ 455 $ ( 145 ) $ 177 $ ( 33 ) $ 149 $ ( 669 ) Alphabet Inc. Offsetting of Derivatives The gross amounts of derivative instruments subject to master netting arrangements with various counterparties, and cash and non-cash collateral received and pledged under such agreements were as follows (in millions): Offsetting of Assets As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 397 $ ( 32 ) $ 365 $ ( 295 ) (1) $ ( 16 ) $ 0 $ 54 As of December 31, 2021 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 999 $ ( 38 ) $ 961 $ ( 434 ) (1) $ ( 394 ) $ ( 12 ) $ 121 (1) The balances as of December 31, 2020 and 2021 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 1,554 $ ( 32 ) $ 1,522 $ ( 295 ) (2) $ ( 1 ) $ ( 943 ) $ 283 As of December 31, 2021 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 619 $ ( 38 ) $ 581 $ ( 434 ) (2) $ ( 4 ) $ ( 110 ) $ 33 (2) The balances as of December 31, 2020 and 2021 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2022 and 2063. Components of operating lease expense were as follows (in millions): Year Ended December 31, 2020 2021 Operating lease cost $ 2,267 $ 2,699 Variable lease cost 619 726 Total operating lease cost $ 2,886 $ 3,425 Alphabet Inc. Supplemental information related to operating leases was as follows (in millions): Year Ended December 31, 2020 2021 Cash payments for operating leases $ 2,004 $ 2,489 New operating lease assets obtained in exchange for operating lease liabilities $ 2,765 $ 2,951 As of December 31, 2021, our operating leases had a weighted average remaining lease term of 8 years and a weighted average discount rate of 2.3 %. Future lease payments under operating leases as of December 31, 2021 were as follows (in millions): 2022 $ 2,539 2023 2,527 2024 2,226 2025 1,815 2026 1,401 Thereafter 4,948 Total future lease payments 15,456 Less imputed interest ( 1,878 ) Total lease liability balance $ 13,578 As of December 31, 2021, we have entered into leases that have not yet commenced with short-term and long-term future lease payments of $ 606 million and $ 5.2 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2022 and 2026 with non-cancelable lease terms of 1 to 25 years. Note 5. Variable Interest Entities Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2020 and 2021, assets that can only be used to settle obligations of these VIEs were $ 5.7 billion and $ 6.0 billion, respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 2.3 billion and $ 2.5 billion, respectively. Total noncontrolling interests (NCI), including redeemable noncontrolling interests (RNCI), in our consolidated subsidiaries was $ 3.9 billion and $ 4.3 billion as of December 31, 2020 and 2021, respectively. NCI and RNCI are included within additional paid-in capital. Net loss attributable to noncontrolling interests was not material for any period presented and is included within the ""other"" component of other income (expense), net. See Note 7 for further details on other income (expense), net. Waymo In June 2021, Waymo, a self-driving technology development company and a consolidated VIE, completed an investment round of $ 2.5 billion, the majority of which represented investment from Alphabet. The investments from external parties were accounted for as equity transactions and resulted in recognition of noncontrolling interests. Unconsolidated VIEs We have investments in VIEs in which we are not the primary beneficiary. These VIEs include private companies that are primarily early stage companies and certain renewable energy entities in which activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we are not the primary beneficiary, and the results of operations and financial position of these VIEs are not included in our consolidated financial statements. We account for these investments as non-marketable equity securities or equity method investments. The maximum exposure of these unconsolidated VIEs is generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these Alphabet Inc. VIEs is our capital investments in them. The carrying value, and maximum exposure of these unconsolidated VIEs were $ 1.7 billion and $ 1.9 billion, respectively, as of December 31, 2020 and $ 2.7 billion and $ 2.9 billion, respectively, as of December 31, 2021 . Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 10.0 billion through the issuance of commercial paper, which increased from $ 5.0 billion in September 2021. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2020 and 2021. Our short-term debt balance also includes the current portion of certain long-term debt. Long-Term Debt Total outstanding debt is summarized below (in millions, except percentages): Effective Interest Rate As of December 31, Maturity Coupon Rate 2020 2021 Debt 2011-2020 Notes Issuances 2024 - 2060 0.45 % - 3.38 % 0.57 % - 3.38 % $ 14,000 $ 13,000 Future finance lease payments, net (1) 1,201 2,086 Total debt 15,201 15,086 Unamortized discount and debt issuance costs ( 169 ) ( 156 ) Less: Current portion of Notes (2) ( 999 ) Less: Current portion future finance lease payments, net (1)(2) ( 101 ) ( 113 ) Total long-term debt $ 13,932 $ 14,817 (1) Net of imputed interest. (2) Total current portion of long-term debt is included within other accrued expenses and current liabilities. See Note 7. The notes in the table above are comprised of fixed-rate senior unsecured obligations and generally rank equally with each other. We may redeem the notes at any time in whole or in part at specified redemption prices. The effective interest rates are based on proceeds received with interest payable semi-annually. The total estimated fair value of the outstanding notes, including the current portion, was approximately $ 14.0 billion and $ 12.4 billion as of December 31, 2020 and December 31, 2021, respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2021, the aggregate future principal payments for long-term debt, including finance lease liabilities, for each of the next five years and thereafter were as follows (in millions): 2022 $ 187 2023 146 2024 1,159 2025 1,162 2026 2,165 Thereafter 10,621 Total $ 15,440 Credit Facility As of December 31, 2021, we have $ 10.0 billion of revolving credit facilities. No amounts were outstanding under the credit facilities as of December 31, 2020 and 2021. Alphabet Inc. In April 2021, we terminated the existin g $ 4.0 billion revolving credit facilities, which were scheduled to expire in July 2023, and entered into two new revolving credit facilities in the amounts of $ 4.0 billion and $ 6.0 billion , which will expire in April 2022 and April 2026, respectively. The interest rates for the new credit facilities are determined based on a formula using certain market rates, as well as our progress toward the achievement of certain sustainability goals. No amounts have been borrowed under the new credit facilities. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2020 2021 Land and buildings $ 49,732 $ 58,881 Information technology assets 45,906 55,606 Construction in progress 23,111 23,171 Leasehold improvements 7,516 9,146 Furniture and fixtures 197 208 Property and equipment, gross 126,462 147,012 Less: accumulated depreciation ( 41,713 ) ( 49,414 ) Property and equipment, net $ 84,749 $ 97,599 Accrued expenses and other current liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2020 2021 European Commission fines (1) $ 10,409 $ 9,799 Payables to brokers for unsettled investment trades 754 397 Accrued customer liabilities 3,118 3,505 Accrued purchases of property and equipment 2,197 2,415 Current operating lease liabilities 1,694 2,189 Other accrued expenses and current liabilities 10,459 12,931 Accrued expenses and other current liabilities $ 28,631 $ 31,236 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) Components of AOCI, net of income tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2018 $ ( 1,884 ) $ ( 688 ) $ 266 $ ( 2,306 ) Cumulative effect of accounting change 0 0 ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 36 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 14 ) ( 14 ) Amounts reclassified from AOCI 0 ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 ( 2,003 ) 812 ( 41 ) ( 1,232 ) Other comprehensive income (loss) before reclassifications 1,139 1,313 79 2,531 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 37 ) ( 37 ) Amounts reclassified from AOCI 0 ( 513 ) ( 116 ) ( 629 ) Other comprehensive income (loss) 1,139 800 ( 74 ) 1,865 Balance as of December 31, 2020 ( 864 ) 1,612 ( 115 ) 633 Other comprehensive income (loss) before reclassifications ( 1,442 ) ( 1,312 ) 668 ( 2,086 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 48 48 Amounts reclassified from AOCI 0 ( 64 ) ( 154 ) ( 218 ) Other comprehensive income (loss) ( 1,442 ) ( 1,376 ) 562 ( 2,256 ) Balance as of December 31, 2021 $ ( 2,306 ) $ 236 $ 447 $ ( 1,623 ) The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location 2019 2020 2021 Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ 149 $ 650 $ 82 Benefit (provision) for income taxes ( 38 ) ( 137 ) ( 18 ) Net of income tax 111 513 64 Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue 367 144 165 Interest rate contracts Other income (expense), net 6 6 6 Benefit (provision) for income taxes ( 74 ) ( 34 ) ( 17 ) Net of income tax 299 116 154 Total amount reclassified, net of income tax $ 410 $ 629 $ 218 Alphabet Inc. Other Income (Expense), Net Components of other income (expense), net, were as follows (in millions): Year Ended December 31, 2019 2020 2021 Interest income $ 2,427 $ 1,865 $ 1,499 Interest expense (1) ( 100 ) ( 135 ) ( 346 ) Foreign currency exchange gain (loss), net (2) 103 ( 344 ) ( 240 ) Gain (loss) on debt securities, net 149 725 ( 110 ) Gain (loss) on equity securities, net 2,649 5,592 12,380 Performance fees ( 326 ) ( 609 ) ( 1,908 ) Income (loss) and impairment from equity method investments, net 390 401 334 Other (3) 102 ( 637 ) 411 Other income (expense), net $ 5,394 $ 6,858 $ 12,020 (1) Interest expense is net of interest capitalized of $ 167 million, $ 218 million, and $ 163 million for the years ended December 31, 2019, 2020, and 2021, respectively. (2) Our foreign currency exchange gain (loss), net, is primarily related to the forward points for our foreign currency hedging contracts and foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contracts' losses and gains. (3) During the year ended December 31, 2020, we entered into derivatives that hedged the changes in fair value of certain marketable equity securities, which resulted in losses of $ 902 million and gains of $ 92 million for the years ended December 31, 2020 and 2021, respectively. The offsetting recognized gains and losses on the marketable equity securities are reflected in Gain (loss) on equity securities, net. Note 8. Acquisitions Fitbit In January 2021, we closed the acquisition of Fitbit, a leading wearables brand for $ 2.1 billion. The addition of Fitbit to Google Services is expected to help spur innovation in wearable devices. The assets acquired and liabilities assumed were recorded at fair value. The purchase price excludes post acquisition compensation arrangements. The purchase price was attributed to $ 440 million cash acquired, $ 590 million of intangible assets, $ 1.2 billion of goodwill and $ 92 million of net liabilities assumed. Goodwill was recorded in the Google Services segment and primarily attributable to synergies expected to arise after the acquisition. Goodwill is not expected to be deductible for tax purposes. Other Acquisitions During the year ended December 31, 2021, we completed other acquisitions and purchases of intangible assets for total consideration of approximately $ 885 million, net of cash acquired, of which the total amount of goodwill expected to be deductible for tax purposes is approximately $ 118 million. Pro forma results of operations for these acquisitions have not been presented because they are not material to our consolidated results of operations, either individually or in the aggregate. Alphabet Inc. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2020 and 2021 were as follows (in millions): Google Google Services Google Cloud Other Bets Total Balance as of December 31, 2019 $ 19,921 $ 0 $ 0 $ 703 $ 20,624 Acquisitions 204 53 189 0 446 Foreign currency translation and other adjustments 46 56 5 ( 2 ) 105 Allocation in the fourth quarter of 2020 (1) ( 20,171 ) 18,408 1,763 0 0 Balance as of December 31, 2020 0 18,517 1,957 701 21,175 Acquisitions 0 1,325 382 103 1,810 Foreign currency translation and other adjustments 0 ( 16 ) ( 2 ) ( 11 ) ( 29 ) Balance as of December 31, 2021 $ 0 $ 19,826 $ 2,337 $ 793 $ 22,956 (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2020. See Note 15 for further details. Other Intangible Assets Information regarding purchased intangible assets was as follows (in millions): As of December 31, 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 4,639 $ 3,649 $ 990 Customer relationships 266 49 217 Trade names and other 624 461 163 Total definite-lived intangible assets 5,529 4,159 1,370 Indefinite-lived intangible assets 75 0 75 Total intangible assets $ 5,604 $ 4,159 $ 1,445 As of December 31, 2021 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,786 $ 4,112 $ 674 Customer relationships 506 140 366 Trade names and other 534 295 239 Total definite-lived intangible assets 5,826 4,547 1,279 Indefinite-lived intangible assets 138 0 138 Total intangible assets $ 5,964 $ 4,547 $ 1,417 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 0.7 years, 3.5 years, and 4.5 years, respectively. For all intangible assets acquired and purchased during the year ended December 31, 2021, patents and developed technology have a weighted-average useful life of 4.1 years, customer relationships have a weighted-average useful life of 4.3 years, and trade names and other have a weighted-average useful life of 9.9 years. Amortization expense relating to purchased intangible assets was $ 795 million, $ 774 million, and $ 875 million for the years ended December 31, 2019, 2020, and 2021, respectively. Alphabet Inc. As of December 31, 2021, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter was as follows (in millions): 2022 $ 537 2023 255 2024 226 2025 98 2026 61 Thereafter 102 $ 1,279 Note 10. Contingencies Indemnifications In the normal course of business, including to facilitate transactions in our services and products and corporate activities, we indemnify certain parties, including advertisers, Google Network partners, customers of Google Cloud offerings, lessors and service providers with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims, and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2021, we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision to the General Court, and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On November 10, 2021, the General Court rejected our appeal, and we subsequently filed an appeal with the European Court of Justice on January 20, 2022. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ($ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search partners' agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Alphabet Inc. From time to time we are subject to formal and informal inquiries and investigations on competition matters by regulatory authorities in the U.S., Europe, and other jurisdictions. In August 2019, we began receiving civil investigative demands from the U.S. Department of Justice (DOJ) requesting information and documents relating to our prior antitrust investigations and certain aspects of our business. The DOJ and a number of state Attorneys General filed a lawsuit on October 20, 2020 alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the U.S. District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. On June 22, 2021, the EC opened a formal investigation into Google's advertising technology business practices. On July 7, 2021, a number of state Attorneys General filed an antitrust complaint against us in the U.S. District Court for the Northern District of California, alleging that Googles operation of Android and Google Play violated U.S. antitrust laws and state antitrust and consumer protection laws. We believe these complaints are without merit and will defend ourselves vigorously. The DOJ and state Attorneys General continue their investigations into certain aspects of our business. We continue to cooperate with federal and state regulators in the U.S., the EC and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces (Java APIs). After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the Federal Circuit Court of Appeals reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the U.S. Supreme Court to review the case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. The Supreme Court heard oral arguments in our case on October 7, 2020. On April 5, 2021, the Supreme Court reversed the Federal Circuit's ruling and found that Googles use of the Java APIs was a fair use as a matter of law. The Supreme Court remanded the case to the Federal Circuit for further proceedings in conformity with the Supreme Court opinion. On May 14, 2021, the Federal Circuit entered an order affirming the district courts final judgment in favor of Google. On June 21, 2021, the Federal Circuit issued a mandate returning the case to the district court, and the case is now concluded. Other We are also regularly subject to claims, suits, regulatory and government investigations, other proceedings, and consent decrees involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. For example, we have a number of privacy investigations and suits ongoing in multiple jurisdictions. Such claims, suits, regulatory and government investigations, other proceedings, and consent decrees could result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral related civil litigation or other adverse consequences, all of which could harm our business, reputation, financial condition, and operating results. Alphabet Inc. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred, and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both the likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14. Note 11. Stockholders' Equity Preferred Stock Our Board of Directors has authorized 100 million shares of preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2020 and 2021, no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our Board of Directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In April 2021, the Board of Directors of Alphabet authorized the company to repurchase up to $ 50.0 billion of its Class C stock. In July 2021, the Alphabet board approved an amendment to the April 2021 authorization, permitting the company to repurchase both Class A and Class C shares in a manner deemed in the best interest of the company and its stockholders, taking into account the economic cost and prevailing market conditions, including the relative trading prices and volumes of the Class A and Class C shares. As of December 31, 2021, $ 17.4 billion remains available for Class A and Class C share repurchases under the amended authorization. In accordance with the authorizations of the Board of Directors of Alphabet, during the years ended December 31, 2020 and 2021, we repurchased and subsequently retired 21.5 million and 20.3 million aggregate shares for $ 31.1 billion and $ 50.3 billion, respectively. Of the aggregate amount repurchased and subsequently retired during 2021, 1.2 million shares were Class A stock for $ 3.4 billion. Stock Split Effected in Form of Stock Dividend (Stock Split) On February 1, 2022, the Company announced that the Board of Directors had approved and declared a 20-for-one stock split in the form of a one-time special stock dividend on each share of the Companys Class A, Class B, and Class C stock. The Stock Split is subject to stockholder approval of an amendment to the Companys Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Class A, Class B, and Class C stock to accommodate the Stock Split. Alphabet Inc. If approval is obtained, each of the Companys stockholders of record at the close of business on July 1, 2022 (the Record Date), will receive, after the close of business on July 15, 2022, a dividend of 19 additional shares of the same class of stock for every share held by such stockholder as of the Record Date. Note 12. Net Income Per Share We compute net income per share of Class A, Class B, and Class C stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A stock assumes the conversion of Class B stock, while the diluted net income per share of Class B stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A, Class B, and Class C stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our Board of Directors from declaring or paying unequal per share dividends on our Class A, Class B, and Class C stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our Board of Directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A, Class B, and Class C stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2019, 2020 and 2021, the net income per share amounts are the same for Class A, Class B, and Class C stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A, Class B, and Class C stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, 2019 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 0 0 Reallocation of undistributed earnings ( 126 ) ( 20 ) 126 Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 46,527 0 0 Restricted stock units and other contingently issuable shares 413 0 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Alphabet Inc. Year Ended December 31, 2020 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 17,733 $ 2,732 $ 19,804 Denominator Number of shares used in per share computation 299,815 46,182 334,819 Basic net income per share $ 59.15 $ 59.15 $ 59.15 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 17,733 $ 2,732 $ 19,804 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,732 0 0 Reallocation of undistributed earnings ( 180 ) ( 25 ) 180 Allocation of undistributed earnings $ 20,285 $ 2,707 $ 19,984 Denominator Number of shares used in basic computation 299,815 46,182 334,819 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 46,182 0 0 Restricted stock units and other contingently issuable shares 87 0 6,125 Number of shares used in per share computation 346,084 46,182 340,944 Diluted net income per share $ 58.61 $ 58.61 $ 58.61 Year Ended December 31, 2021 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 34,200 $ 5,174 $ 36,659 Denominator Number of shares used in per share computation 300,310 45,430 321,910 Basic net income per share $ 113.88 $ 113.88 $ 113.88 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 34,200 $ 5,174 $ 36,659 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 5,174 0 0 Reallocation of undistributed earnings ( 581 ) ( 77 ) 581 Allocation of undistributed earnings $ 38,793 $ 5,097 $ 37,240 Denominator Number of shares used in basic computation 300,310 45,430 321,910 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 45,430 0 0 Restricted stock units and other contingently issuable shares 15 0 10,009 Number of shares used in per share computation 345,755 45,430 331,919 Diluted net income per share $ 112.20 $ 112.20 $ 112.20 Alphabet Inc. Note 13. Compensation Plans Stock Plans Our stock plans include the Alphabet Amended and Restated 2012 Stock Plan, the Alphabet 2021 Stock Plan and Other Bet stock-based plans. Under our stock plans, RSUs and other types of awards may be granted. An RSU award is an agreement to issue shares of our Class C stock at the time the award vests. RSUs generally vest over four years contingent upon employment on the vesting date. As of December 31, 2021, there were 37,479,707 shares of Class C stock reserved for future issuance under the Alphabet 2021 Stock Plan. Stock-Based Compensation For the years ended December 31, 2019, 2020, and 2021, total stock-based compensation expense was $ 11.7 billion, $ 13.4 billion, and $ 15.7 billion, including amounts associated with awards we expect to settle in Alphabet stock of $ 10.8 billion, $ 12.8 billion, and $ 15.0 billion, respectively. For the years ended December 31, 2019, 2020, and 2021, we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.8 billion, $ 2.7 billion, and $ 3.1 billion, respectively. For the years ended December 31, 2019, 2020, and 2021, tax benefit realized related to awards vested or exercised during the period was $ 2.2 billion, $ 3.6 billion, and $ 5.9 billion, respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the RD tax credit. Stock-Based Award Activities The following table summarizes the activities for unvested Alphabet RSUs for the year ended December 31, 2021: Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2020 19,288,793 $ 1,262.13 Granted 10,582,700 $ 1,949.16 Vested ( 11,209,486 ) $ 1,345.98 Forfeited/canceled ( 1,767,294 ) $ 1,425.48 Unvested as of December 31, 2021 16,894,713 $ 1,626.13 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2019 and 2020 was $ 1,092.36 and $ 1,407.97 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2019, 2020, and 2021 were $ 15.2 billion, $ 17.8 billion, and $ 28.8 billion, respectively. As of December 31, 2021, there was $ 25.8 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.5 years. 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 724 million, $ 855 million, and $ 916 million for the years ended December 31, 2019, 2020, and 2021, respectively. Note 14. Income Taxes Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, 2019 2020 2021 Domestic operations $ 16,426 $ 37,576 $ 77,016 Foreign operations 23,199 10,506 13,718 Total $ 39,625 $ 48,082 $ 90,734 Alphabet Inc. Provision for income taxes consisted of the following (in millions): Year Ended December 31, 2019 2020 2021 Current: Federal and state $ 2,424 $ 4,789 $ 10,126 Foreign 2,713 1,687 2,692 Total 5,137 6,476 12,818 Deferred: Federal and state 286 1,552 2,018 Foreign ( 141 ) ( 215 ) ( 135 ) Total 145 1,337 1,883 Provision for income taxes $ 5,282 $ 7,813 $ 14,701 The reconciliation of federal statutory income tax rate to our effective income tax rate was as follows: Year Ended December 31, 2019 2020 2021 U.S. federal statutory tax rate 21.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 4.9 ) ( 0.3 ) 0.2 Foreign-derived intangible income deduction ( 0.7 ) ( 3.0 ) ( 2.5 ) Stock-based compensation expense ( 0.7 ) ( 1.7 ) ( 2.5 ) Federal research credit ( 2.5 ) ( 2.3 ) ( 1.6 ) Deferred tax asset valuation allowance 0.0 1.4 0.6 State and local income taxes 1.1 1.1 1.0 Effective tax rate 13.3 % 16.2 % 16.2 % Our effective tax rate for 2019 was affected significantly by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate because substantially all of the income from foreign operations was earned by an Irish subsidiary. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S. On July 27, 2015, the U.S. Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the U.S. Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. In 2020, there was an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities were as follows (in millions): As of December 31, 2020 2021 Deferred tax assets: Accrued employee benefits $ 580 $ 549 Accruals and reserves not currently deductible 1,049 1,816 Tax credits 3,723 5,179 Net operating losses 1,085 1,790 Operating leases 2,620 2,503 Intangible assets 1,525 2,034 Other 981 925 Total deferred tax assets 11,563 14,796 Valuation allowance ( 4,823 ) ( 7,129 ) Total deferred tax assets net of valuation allowance 6,740 7,667 Deferred tax liabilities: Property and equipment, net ( 3,382 ) ( 5,237 ) Net investment gains ( 1,901 ) ( 3,229 ) Operating leases ( 2,354 ) ( 2,228 ) Other ( 1,580 ) ( 946 ) Total deferred tax liabilities ( 9,217 ) ( 11,640 ) Net deferred tax assets (liabilities) $ ( 2,477 ) $ ( 3,973 ) As of December 31, 2021, our federal, state, and foreign net operating loss carryforwards for income tax purposes were approximately $ 5.6 billion, $ 4.6 billion, and $ 1.7 billion respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2023, foreign net operating loss carryforwards will begin to expire in 2025 and the state net operating loss carryforwards will begin to expire in 2028. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2021, our California RD carryforwards for income tax purposes were approximately $ 5.0 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2021, our investment tax credit carryforwards for state income tax purposes were approximately $ 700 million and will begin to expire in 2025. We use the flow-through method of accounting for investment tax credits. We believe this tax credit is not likely to be realized. As of December 31, 2021, we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits, net deferred tax assets relating to certain Other Bets, and certain foreign net operating losses that we believe are not likely to be realized. We continue to reassess the remaining valuation allowance quarterly, and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, 2019 2020 2021 Beginning gross unrecognized tax benefits $ 4,652 $ 3,377 $ 3,837 Increases related to prior year tax positions 938 372 529 Decreases related to prior year tax positions ( 143 ) ( 557 ) ( 263 ) Decreases related to settlement with tax authorities ( 2,886 ) ( 45 ) ( 329 ) Increases related to current year tax positions 816 690 1,384 Ending gross unrecognized tax benefits $ 3,377 $ 3,837 $ 5,158 The total amount of gross unrecognized tax benefits was $ 3.4 billion, $ 3.8 billion, and $ 5.2 billion as of December 31, 2019, 2020, and 2021, respectively, of which $ 2.3 billion, $ 2.6 billion, and $ 3.7 billion, if recognized, would affect our effective tax rate, respectively. As of December 31, 2020 and 2021, we accrued $ 222 million and $ 270 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. Our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2014 through 2020 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, it is reasonably possible that our unrecognized tax benefits from certain U.S. federal, state and non U.S. tax positions could decrease by approximately $ 2.0 billion in the next 12 months. Positions that may be resolved include various U.S. and non-U.S. matters. Note 15. Information about Segments and Geographic Areas We report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps and in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and platform services, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues from fees received for Google Cloud Platform services, Google Workspace collaboration tools and other enterprise services. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Revenues, certain costs, such as costs associated with content and traffic acquisition, certain engineering activities, and hardware, as well as certain operating expenses are directly attributable to our segments. Due to the integrated nature of Alphabet, other costs and expenses, such as technical infrastructure and office facilities, are managed centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Alphabet Inc. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including certain fines and settlements, as well as costs associated with certain shared RD activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Our operating segments are not evaluated using asset information. Information about segments during the periods presented were as follows (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2019 2020 2021 Revenues: Google Services $ 151,825 $ 168,635 $ 237,529 Google Cloud 8,918 13,059 19,206 Other Bets 659 657 753 Hedging gains (losses) 455 176 149 Total revenues $ 161,857 $ 182,527 $ 257,637 Operating income (loss): Google Services $ 48,999 $ 54,606 $ 91,855 Google Cloud ( 4,645 ) ( 5,607 ) ( 3,099 ) Other Bets ( 4,824 ) ( 4,476 ) ( 5,281 ) Corporate costs, unallocated (1) ( 5,299 ) ( 3,299 ) ( 4,761 ) Total income from operations $ 34,231 $ 41,224 $ 78,714 (1) Corporate costs, unallocated includes a fine and legal settlement totaling $ 2.3 billion for the year ended December 31, 2019. For revenues by geography, see Note 2. The following table presents long-lived assets by geographic area, which includes property and equipment, net and operating lease assets (in millions): As of December 31, 2020 2021 Long-lived assets: United States $ 69,315 $ 80,207 International 27,645 30,351 Total long-lived assets $ 96,960 $ 110,558 Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2021, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management and provide timely information to our management team. The implementation is expected to continue in phases over the next few years. We completed the implementation of certain of our subledgers, which included changes to our processes, procedures and internal controls over financial reporting during the second quarter of 2021. There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures, which in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2021. While we continue to evolve our work model in response to the uneven effects of the ongoing pandemic around the world, we believe that our internal controls over financial reporting continue to be eff ective. We have continued to re-evaluate and refine our financial reporting process to provide reasonable assurance that we could report our financial results accurately and in a timely manner. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2021. Management reviewed the results of its assessment with our Audit and Compliance Committee. The effectiveness of our internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP , an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +11,Alphabet Inc.,2020," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history, inspiring us to tackle big problems, and invest in moonshots like artificial intelligence (""AI"") research and quantum computing. We continue this work under the leadership of Sundar Pichai, who has served as CEO of Google since 2015 and as CEO of Alphabet since 2019. Alphabet is a collection of businesses the largest of which is Google which we report as two segments: Google Services and Google Cloud. We report all non-Google businesses collectively as Other Bets. Our Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Our Alphabet structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. Our mission to organize the worlds information and make it universally accessible and useful is as relevant today as it was when we were founded in 1998. Since then, weve evolved from a company that helps people find answers to a company that helps you get things done. Were focused on building an even more helpful Google for everyone, and we aspire to give everyone the tools they need to increase their knowledge, health, happiness and success. Across Alphabet, we're focused on continually innovating in areas where technology can have an impact on peoples lives. Every year, there are trillions of searches on Google, and we continue to invest deeply in AI and other technologies to ensure the most helpful Search experience possible. People come to YouTube for entertainment, information and opportunities to learn something new. And Google Assistant offers the best way to get things done seamlessly across different devices, providing intelligent help throughout your day, no matter where you are. Since the pandemic began, our teams have built new features to help users go about their daily lives, and to support businesses working to serve their customers during an uncertain time. In conjunction with Apple, we launched Exposure Notification apps that are being used by local governments globally. Our COVID-19 Community Mobility Reports are used by public health agencies and researchers around the globe, and weve committed hundreds of millions of dollars to help small businesses through a combination of small business loans, grants and ad credits. Importantly, we've made authoritative content a key focus area across both Google Search and YouTube to help users search for trusted public health information. Our Other Bets are also pursuing initiatives with similar goals. For instance, as a part of our efforts in the Metro Phoenix area, Waymo is working toward our goal of making transportation safer and easier for everyone while Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and AI are increasingly driving many of our latest innovations. Our investments in machine learning over the past decade have enabled us to build products that are smarter and more helpful. For example, a huge breakthrough in natural language understanding, called BERT, now improves results for almost every English language search query. DeepMind made a significant AI-powered breakthrough, solving a 50-year-old protein folding challenge, which will help us better understand one of lifes fundamental building blocks, and will enable researchers to tackle new and difficult problems, from fighting diseases to environmental sustainability. Alphabet Inc. Google For reporting purposes, Google comprises two segments: Google Services and Google Cloud. Google Services Serving our users We have always been a company committed to building helpful products that can improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google Services' core products and platforms include Android, Chrome, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube, each with broad and growing adoption by users around the world. Our products and services have come a long way since the company was founded more than two decades ago. Rather than the ten blue links in our early search results, users can now get direct answers to their questions using their computer, mobile device, or their own voice, making it quicker, easier and more natural to find what you're looking for. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. With the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of our AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 4a, Pixel 4a 5G and Pixel 5 phones, Chromecast with Google TV and the Google Nest Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Key to building helpful products for users is our commitment to privacy, security and user choice. As the Internet evolves, we continue to invest in keeping data safe, including enhanced malware features in Chrome and improvements to auto-delete controls that will automatically delete web and app searches after 18 months. How we make money Our advertising products deliver relevant ads at just the right time, to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across devices and formats. Google Services generates revenues primarily by delivering both performance advertising and brand advertising. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google Search other properties, YouTube and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have built a world-class ad technology platform for advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging Alphabet Inc. from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blocklisting them when necessary to ensure that ads do not fund bad content. We continue to look to the future and are making long-term investments that will grow revenues beyond advertising, including Google Play, hardware, and YouTube. We are also investing in research efforts in AI and quantum computing to foster innovation across our businesses and create new opportunities. Google Cloud Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics and AI. We see significant opportunity in helping businesses utilize these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and Google Workspace (formerly known as G Suite). Google Cloud Platform enables developers to build, test, and deploy applications on its highly scalable and reliable infrastructure. Our Google Workspace collaboration tools which include apps like Gmail, Docs, Drive, Calendar, Meet and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Google Cloud generates revenues primarily from fees received for Google Cloud Platform services and Google Workspace collaboration tools. Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets investment in our portfolio of Other Bets include emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues are primarily generated from internet and TV services, as well as licensing and RD services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in our portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Apple, ATT, Disney, Facebook, Hulu, Netflix and TikTok. In businesses that are further afield from our advertising business, we compete with companies that have longer operating histories and more established relationships with customers and users. We face competition from: Other digital content and application platform providers, such as Amazon and Apple. Alphabet Inc. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Ongoing Commitment to Sustainability At Google, we build technology that helps people do more for the planet. We strive to build sustainability into everything we do, including designing and operating efficient data centers, advancing carbon-free energy, creating sustainable workplaces, building better devices and services, empowering users with technology, and enabling a responsible supply chain. Google has been carbon neutral since 2007, and in 2019, for the third consecutive year, we matched 100% of our electricity consumption with renewable energy purchases. We are the largest annual corporate purchaser of renewable energy in the world, based on renewable electricity purchased in megawatt-hour (MWh). In 2020, we neutralized our entire legacy carbon footprint since our founding (covering all our operational emissions before we became carbon neutral in 2007), making Google the first major company to achieve carbon neutrality for its entire operating history. In our third decade of climate action, weve set our most ambitious goal yet: to run our business on carbon-free energy everywhere, at all times, by 2030. We're also investing in technologies to help our partners and people all over the world make sustainable choices. For example, we intend to enable 5 GW of new carbon-free energy across our key manufacturing regions by 2030 through investment. We anticipate this will spur more than $5 billion in clean energy investments, avoid the amount of emissions equal to taking more than 1 million cars off the road each year, and create more than 8,000 clean energy jobs. With the Environmental Insights Explorer, we're also working to help more than 500 cities and local governments globally reduce a total of 1 gigaton of carbon emissions annually by 2030 thats the equivalent of the annual carbon emissions of a country the size of Japan. Googles products are already helping people make more sustainable choices in their daily lives, whether its using Google Maps to find bike-shares and electric vehicle charging stations, or in many European countries, using Google Flights to sort the least carbon-intensive option flights. There are more tools and information we can provide, and our goal is to find new ways that our products can help 1 billion people make more sustainable choices by 2022. Climate change is one of the most significant global challenges of our time. In 2017, we developed a climate resilience strategy, which included conducting a climate scenario analysis. We've earned a spot on the CDP (formerly the Carbon Disclosure Project) Climate Change A List for seven consecutive years. We believe our CDP climate change response reflects the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). In 2020, we issued $5.75 billion in sustainability bonds, the largest sustainability or green bond issuance by any company in history. The net proceeds from the issuance are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. More information on our approach to sustainability can be found in our annual sustainability reports, including Googles environmental report. The content of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. Alphabet Inc. Culture and Workforce Were a company of curious, talented and passionate people. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex challenges in technology and society. Our people are critical for our continued success. We work hard to provide an environment where Googlers can have fulfilling careers, and be happy, healthy and productive. We offer industry-leading benefits and programs to take care of the diverse needs of our employees and their families, including access to excellent healthcare choices, opportunities for career growth and development, and resources to support their financial health. Our competitive compensation programs help us to attract and retain top candidates, and we will continue to invest in recruiting talented people to technical and non-technical roles and rewarding them well. Alphabet is committed to making diversity, equity, and inclusion part of everything we do and were committed to growing a workforce thats representative of the users we serve. More information on Googles approach to diversity can be found in our annual diversity reports, available publicly at diversity.google. The content of our diversity reports is not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. We have work councils and statutory employee representation obligations in certain countries and we are committed to supporting protected labor rights, maintaining an open culture and listening to all Googlers. Supporting healthy and open dialogue is central to how we work, and we communicate information about the company through multiple internal channels to our employees. As of December 31, 2020, Alphabet had 135,301 employees. When necessary, we contract with businesses around the world to provide specialized services where we dont have appropriate in-house expertise or resources, often in fields that require specialized training like cafe operations, customer support, content moderation and physical security. We also contract with temporary staffing agencies when we need to cover short-term leaves, when we have spikes in business needs, or when we need to quickly incubate special projects. We choose our partners and staffing agencies carefully, and review their compliance with Googles Supplier Code of Conduct. We continually make improvements to promote a respectful and positive working environment for everyone employees, vendors and temporary staff alike. Government Regulation We are subject to numerous U.S. federal, state, and foreign laws and regulations covering a wide variety of subject matters. Like other companies in the technology industry, we face heightened scrutiny from both U.S. and foreign governments with respect to our compliance with laws and regulations. Our compliance with these laws and regulations may be onerous and could, individually or in the aggregate, increase our cost of doing business, impact our competitive position relative to our peers, and/or otherwise have an adverse impact on our business, reputation, financial condition, and operating results. For additional information about government regulation applicable to our business, see Risk Factors in Part I, Item 1A, Trends in Our Business in Part II, Item 7, and Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality (including developments and volatility arising from COVID-19). Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or Alphabet Inc. announcements regarding our financial performance and other items that may be material or of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, that may be material or of interest to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generate d over 80% o f total revenues from the display of ads online in 2020. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising and/or data privacy practices may affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions, including COVID-19 and its effects on the global economy (as discussed in greater detail in our COVID-19 risk factor under General Risks below), have impacted the demand for advertising and resulted in fluctuations in the amounts our advertisers spend on advertising, and could have an adverse impact on such demand and spend, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories and well established relationships in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Further, discrepancies in enforcement of existing laws may enable our lesser known competitors to aggressively interpret those laws without commensurate scrutiny, thereby affording them competitive advantages. Our competitors may also be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This Alphabet Inc. may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could disrupt our current operations and harm our financial condition and operating results. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google Services, Google Cloud and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google Services, Google Cloud and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of management resources and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google Services, we continue to invest heavily in hardware, including our smartphones and home devices, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. Within Google Cloud, we devote significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale our salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large experienced and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use artificial intelligence and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition, and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition, COVID-19 and its effects on the global economy has impacted and may continue to adversely impact our revenue growth rate (as discussed in greater detail in our COVID-19 risk factor under General Risks below). In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing regulations, increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix, property mix, and partner agreements can affect margin. The margin we earn on revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners as well as increased content acquisition Alphabet Inc. costs to content providers. We may also face an increase in infrastructure costs, supporting businesses such as Search, Google Cloud, and YouTube. Many of our expenses are less variable in nature and may not correlate to changes in revenues. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brands as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google Services, Google Cloud and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of misinformation or objectionable content on our services and/or products or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that, if not properly managed, could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our finished products, to design certain of our components and parts, and to participate in the distribution of our products and services. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We have experienced and/or may experience supply shortages and price increases driven by raw material, component or part availability, manufacturing capacity, labor shortages, industry allocations, tariffs, trade disputes Alphabet Inc. and barriers, natural disasters or pandemics (including COVID-19), the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We have experienced and/or may in the future, experience shortages or other supply chain disruptions that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available from only one or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant supply interruption could delay critical data center upgrades or expansions and delay product availability. We may enter into long term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because certain of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Our products and services may have quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property, could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption, interference with, or failure of our complex information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, complications with the design or implementation of our new global enterprise resource planning system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from modifications or upgrades, terrorist attacks, natural disasters or pandemics (including COVID-19), the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster or pandemic (including COVID-19), closure of a facility, or other unanticipated problems at, or impacting, our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. We may not be able to successfully implement the ERP system without experiencing delays, increased costs, and other difficulties. Failure to successfully design and implement the new ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Alphabet Inc. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 53% of our consolidated revenues in 2020. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Import and export requirements, tariffs and other market access barriers that may prevent or impede us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign events, including the effect of the United Kingdom's withdrawal from the European Union, may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom and new customer requirements), in addition to other adverse effects that we are unable to effectively anticipate. Anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings, particularly in light of market volatilities due to COVID-19. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on some interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available or may only be available with limited functionality for our users or our advertisers on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Alphabet Inc. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations regarding privacy and data change. Our products and services involve the storage and transmission of proprietary and other sensitive information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users or customers. We expect to continue to expend significant resources to maintain security protections that shield against bugs, theft, misuse, or security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. We may experience future security issues, whether due to employee error or malfeasance or system errors or vulnerabilities in our or other parties systems, which could result in significant legal and financial exposure. Government inquiries and enforcement actions, litigation, and adverse press coverage could harm our business. We may be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Attacks and security issues could also compromise trade secrets and other sensitive information, harming our business. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process, particularly during times of a natural disaster or pandemic (including COVID-19), may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to mitigate cyber attacks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigations and review of platform applications that could access the information of users of our services. As a result of these efforts, we could discover incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, including factors outside of our control such as a natural disaster or pandemic (including COVID-19), and we may be notified of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading disinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content on our platforms, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines across our platforms, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and invalid traffic, we may be unable to adequately detect and prevent such abuses or promote high-quality content, particularly during times of a natural disaster or pandemic (including COVID-19). Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts Alphabet Inc. (known as web spam) may affect the quality of content on our platforms and lead them to display false, misleading or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on detecting and preventing abuse from low-quality websites. We also face other challenges on our platforms, including violations of our content guidelines involving incidents such as attempted election interference, activities that threaten the safety and/or well-being of our users on- or offline, and the spreading of disinformation, among other challenges. If we fail to either detect and prevent an increase in problematic content or effectively promote high-quality content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, by charging increased fees to us or our users to provide our offerings, or by providing our competitors preferential access. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in 2018 the United States Federal Communications Commission repealed net neutrality rules, which could permit internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. COVID-19 has also resulted in quarantines, shelter in place orders, and work from home directives, all of which have increased demands for internet access and may create access challenges. These could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our business. Risks Related to Laws and Regulations We face increased regulatory scrutiny as well as changes in regulatory conditions, laws and policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry face increased regulatory scrutiny, enforcement action, and other proceedings. For instance, the U.S. Department of Justice, joined by a number of state Attorneys General, filed an antitrust complaint against Google on October 20, 2020, alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the United States District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. Various other regulatory agencies in the United States and around the world, including competition enforcers, consumer protection agencies, data protection authorities, grand juries, inter-agency consultative groups, and a range of other governmental bodies have and continue to review our products and services and their compliance with laws and regulations around the world. We continue to cooperate with these investigations. Various laws, regulations, investigations, enforcement lawsuits, and regulatory actions have in the past and may in the future result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring Alphabet Inc. obligations, changes to our products and services, alterations to our business models and operations, and collateral litigation, all of which could harm our business, reputation, financial condition, and operating results. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics may increase our cost of doing business, limit our ability to pursue certain business models, offer products or services in certain jurisdictions, or cause us to change our business practices. We have in the past had to alter or withdraw certain products and services as a result of laws or regulations that made them unfeasible, and new laws or regulations, such as the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission currently tabled in parliament, could result in our having to alter or withdraw products and services in the future. These additional costs of doing business, new limitations or changes to our business model or practices could harm our business, reputation, financial condition, and operating results. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices) may make our products and services less useful, limit our ability to pursue certain business models or offer certain products and services, require us to incur substantial costs, expose us to civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: New competition laws and related regulations around the world, that can limit certain business practices, and in some cases, create the risk of significant penalties. Privacy laws, such as the California Consumer Privacy Act of 2018 that came into effect in January of 2020 and the California Privacy Rights Act which will go into effect in 2023, both of which give new data privacy rights to California residents, and SB-327 in California, which regulates the security of data in connection with internet connected devices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. New laws further restricting the collection, processing and/or sharing of advertising-related data. Copyright or similar laws around the world, including the EU Directive on Copyright in the Digital Single Market (EUCD) of April 17, 2019, which EU Member States must implement by June 7, 2021; and the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission. These and similar laws that have been adopted or proposed introduce new constraining licensing regimes that could affect our ability to operate. The EUCD and similar laws could increase the liability of some content-sharing services with respect to content uploaded by their users. Some of these laws, as well as follow-on administrative or judicial actions, have also created or may create a new property right in news publications that limits the ability of some online services to interact with or present such content. They may also impose compensation negotiations with news agencies and publishers for the use of such content, which may result in payment obligations that significantly exceed the value that such content provides to Google and its users. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. Various legislative, litigation, and regulatory activity regarding our Google Play billing policies and business model, which could result in monetary penalties, damages and/or prohibition. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: Alphabet Inc. We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act and Section 230 of the Communications Decency Act in the United States and the E-Commerce Directive in Europe, against liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. There are legislative proposals in both the US and EU that could reduce our safe harbor protection. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take may subject us to additional laws and regulations. Our investment in a variety of new fields, such as healthcare and payment services, may expand the scope of regulations that apply to our business. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, and other proceedings that may harm our business, financial condition, and operating results. We are subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as Google Cloud offerings, we also are subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental impacts, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled around the world. Claims have been brought against us for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Adverse interpretations of these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation could result in fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business, and may be particularly challenging during certain times, such as a natural disaster or pandemic (including COVID-19). Recent legal developments in Europe have created compliance uncertainty regarding transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU Alphabet Inc. users or customers, or the monitoring of their behavior in the EU. The GDPR creates a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment that involves substantial costs, and despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have an adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland. Recently, the CJEU ruled that the EU-U.S. Privacy Shield is an invalid transfer mechanism, but upheld Standard Contractual Clauses as a valid transfer mechanism, provided they meet certain requirements. The validity of data transfer mechanisms remains subject to legal, regulatory, and political developments in both Europe and the U.S., such as recent recommendations from the European Data Protection Board, the invalidation of the EU-U.S. Privacy Shield and potential invalidation of other data transfer mechanisms, which could have a significant adverse impact on our ability to process and transfer personal data outside of the EEA. These developments create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. We face, and may continue to face intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or will enhance long-term stockholder value, and share repurchases could increase the volatility of our stock prices and could diminish our cash reserves . Alphabet Inc. We engage in share repurchases of our Class C capital stock from time to time in accordance with authorizations from the Board of Directors of Alphabet. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Further, our share repurchases could affect our share trading prices, increase their volatility, reduce our cash reserves and may be suspended or terminated at any time, which may result in a decrease in the trading prices of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2020, Larry Page and Sergey Brin beneficially owned approximate ly 85.3% of our outstanding Class B common stock, which represented approximate ly 51.5% o f the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A common stock and our Class C capital stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of continuing the influence of Larry and Sergey. Our Board of Directors has the right to elect directors to fill a vacancy created by the expansion of the Board of Directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our Board of Directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the Board of Directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our Board of Directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the Board of Directors has approved the transaction. Our Board of Directors could rely on Delaware law to prevent or delay an acquisition of us. Alphabet Inc. General Risks The continuing impacts of COVID-19 are highly unpredictable and could be significant, and may have an adverse effect on our business, operations and our future financial performance. Since COVID-19 was declared a global pandemic by the World Health Organization, governments and municipalities around the world have instituted measures in an effort to control the spread of COVID-19, including quarantines, shelter-in-place orders, school closings, travel restrictions, and closure of non-essential businesses. The macroeconomic impacts on our business continue to evolve and be unpredictable and may continue to adversely affect our business, operations and financial performance. As a result of the scale of the ongoing pandemic and the speed at which the global community has been impacted, our revenue growth rate and expense as a percentage of our revenues in future periods may differ significantly from our historical rate, and our future operating results may fall below expectations. The future impacts of the ongoing pandemic on our business, operations and future financial performance could include, but are not limited to: Significant decline in advertising revenues as advertiser spending slows due to an economic downturn. This decline in advertising revenues could persist through and beyond a recessionary period. In addition, we may experience a significant and prolonged shift in user behavior such as a shift in interests to less commercial topics. Significant decline in other revenues due to a decline or shifts in customer demand. For example, if consumer demand for electronics significantly declines, our hardware revenues could be significantly impacted. Adverse impacts to our operating income, operating margin, net income, EPS and respective growth rates - particularly if expenses do not decrease across Alphabet at the same pace as revenue declines. Many of our expenses are less variable in nature and/or may not correlate to changes in revenues, including costs associated with our data centers and facilities as well as employee compensation. As such, we may not be able to decrease them significantly in the short-term, or we may choose not to significantly reduce them in an effort to remain focused on long-term outlook and investment opportunities. Significant decline in our operating cash flows as a result of decreased advertiser spending and deterioration in the credit quality and liquidity of our customers, which could adversely affect our accounts receivable. Investing cash flows could decrease due to slowing spend on data center and facilities construction projects due to a slowing or stopping of construction or significant restrictions placed on construction. The prolonged and broad-based shift to a remote working environment continues to create inherent productivity, connectivity, and oversight challenges and could affect our ability to enhance, develop and support existing products and services, detect and prevent spam and problematic content, hold product sales and marketing events, and generate new sales leads, among others. In addition, the changed environment under which we are operating could have an effect on our internal controls over financial reporting as well as our ability to meet a number of our compliance requirements in a timely or quality manner. Additional and/or extended, governmental lockdowns, restrictions or new regulations could significantly impact the ability of our employees and vendors to work productively. Governmental restrictions have been globally inconsistent and it remains unclear when a return to worksite locations or travel will be permitted or what restrictions will be in place in those environments. As we prepare to return our workforce in more locations back to the office in 2021, we may experience increased costs as we prepare our facilities for a safe return to work environment and experiment with hybrid work models, in addition to potential effects on our ability to compete effectively and maintain our corporate culture. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results (including our expenses as a percentage of our revenues) on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed under this Item 1A in addition to the following factors may affect our operating results: Our ability to attract user and/or customer adoption of, and generate significant revenues from, new products, services, and technologies in which we have invested considerable time and resources. Alphabet Inc. Our ability to monetize traffic on Google Search other properties, YouTube and our Google Network Members' properties across various devices. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Geopolitical events, including trade disputes. Changes in global business or macroeconomic conditions. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of such potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully integrate and further develop the acquired business or technology. Implementation or remediation of controls, procedures, and policies at the acquired company. Integration of the acquired companys accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Alphabet Inc. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology, maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our ability to compete effectively and our future success depends on our continuing to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Restrictive immigration policy and regulatory changes may also impact our ability to hire, mobilize or retain some of our global talent. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows and evolves, we may need to implement more complex organizational management structures or adapt our corporate culture and work environments to ever-changing circumstances, such as during times of a natural disaster or pandemic (including COVID-19), and these changes could impact our ability to compete effectively or have an adverse impact on our corporate culture. We are exposed to fluctuations in the market values of our investments and, in some instances, our financial statements incorporate valuation methodologies that are subjective in nature resulting in fluctuations over time. The market value of our investments can be negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying entities, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates, the effect of new or changing regulations, the stock market in general, or other factors. The effect of COVID-19 on our impairment assessment for non-marketable investments requires significant judgment due to the uncertainty around the duration and severity of the impact. We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, require management judgment and estimation, and may change over time. We adjust the carrying value of our non-marketable equity investments to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). The unrealized gains and losses we record on our non-marketable equity securities in any particular period may differ significantly from the realized gains or losses we ultimately experience on such investments. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax Alphabet Inc. assets or liabilities, the application of different provisions of tax laws or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. Various jurisdictions around the world have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapp ing international tax regimes. The Organization for Economic Cooperation and Development (OECD) recently released proposals relating to its initiative for modernizing international tax rules, with the goal of having different countries implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. In addition, in response to significant market volatility and disruptions to business operations resulting from the global spread of COVID-19, legislatures and taxing authorities in many jurisdictions in which we operate may propose changes to their tax rules. These changes could include modifications that have temporary effect, and more permanent changes. The impact of these potential new rules on us, our long-term tax planning, and our effective tax rate could be material. The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments; recommendations by securities analysts or changes in their earnings estimates; announcements about our or our competitors' earnings that are not in line with analyst expectations, the risk of which is enhanced, in our case, because it is our policy not to give guidance on earnings; commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy; the volume of shares of Class A common stock and Class C capital stock available for public sale; sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees); short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock; the size, timing and share class of any share repurchase program; and the perceived values of Class A common stock and Class C capital stock relative to one another. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. Alphabet Inc. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which we believe is sufficient to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2020, there were approximately 4,337 and 1,942 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2020, there were approximately 64 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2020: Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 1,869 $ 1,540.84 1,869 $ 22,667 November 1 - 30 1,640 $ 1,748.65 1,640 $ 19,799 December 1 - 31 1,205 $ 1,787.62 1,205 $ 17,645 Total 4,714 4,714 (1) The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2015 to December 31, 2020. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2015 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-Year total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2015 to December 31, 2020. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2015 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2018 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2019 Annual Report on Form 10-K. Trends in Our Business The following long-term trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of these trends in order to maintain and grow our business. We generate our advertising revenues increasingly from different channels, including mobile, and newer advertising formats, and the margins from the advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures, our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners and Google Network Members to increase as our revenues grow and to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; the percentage of queries channeled through paid access points; product mix; the relative revenue growth rates of advertising revenues from different channels; and revenue share terms. We expect these trends to continue to affect our revenue growth rates and put pressure on our overall margins. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube ads and Google Play ads, which monetize at a lower rate than our traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, such as India, where we continue to invest heavily and develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time, as regions with emerging markets, such as APAC, have demonstrated higher revenue growth rates. We expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could impact our margins as developing markets initially monetize at a lower rate than more mature markets. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. Alphabet Inc. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud services and subscription and other services. The margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. In addition, we expect to continue to invest in land and buildings for data centers and offices, and information technology assets, which includes servers and network equipment, to support the long-term growth of our business. In addition, acquisitions and strategic investments are an important part of our strategy and use of capital, contributing to the breadth and depth of our offerings, expanding our expertise in engineering and other functional areas, and building strong partnerships around strategic initiatives. For example, in 2020 we announced our Google for India Digitization Fund to invest approximately $10 billion into India over the next 5-7 years through a mix of equity investments, partnerships, and operational, infrastructure and ecosystem investments. We face continuing changes in regulatory conditions, laws and public policies, which could impact our business practices and financial results. Changes in social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics and related legal matters have resulted in fines and caused us to change our business practices. As these global trends continue, for example the recent antitrust complaints filed by the U.S. Department of Justice and a number of state Attorneys General as well as the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission, our cost of doing business may increase and our ability to pursue certain business models or offer certain products or services may be limited. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. The Impact of COVID-19 on our Results and Operations In late 2019, an outbreak of COVID-19 emerged and by March 11, 2020 was declared a global pandemic by the World Health Organization. Across the United States and the world, governments and municipalities instituted measures in an effort to control the spread of COVID-19, including quarantines, shelter-in-place orders, school closings, travel restrictions and the closure of non-essential businesses. The macroeconomic impacts of COVID-19 are significant and continue to evolve, as exhibited by, among other things, a rise in unemployment, changes in consumer behavior, and market volatility. We began to observe the impact of COVID-19 and the related reductions in global economic activity on our financial results in March 2020 when, despite an increase in users' search activity, our advertising revenues declined compared to the prior year due to a shift of user search activity to less commercial topics and reduced spending by our advertisers. During the course of the quarter ended June 30, 2020, we observed a gradual return in user search activity to more commercial topics, followed by increased spending by our advertisers that continued throughout the second half of 2020. We continue to assess the realized and potential credit deterioration of our customers due to changes in the macroeconomic environment, which has been reflected in our allowance for credit losses for accounts receivable. Additionally, over the course of the year we experienced variability in our margins as many of our expenses are less variable in nature and/or may not correlate to changes in revenues, including costs associated with our data centers and facilities as well as employee compensation. Also, market volatility has contributed to fluctuations in the valuation of our equity investments. Alphabet Inc. While we continued to make investments in land and buildings for data centers, offices and information technology, in 2020 we slowed the pace of our investments, primarily as it relates to office facilities, as a result of COVID-19. The ongoing impact of COVID-19 on our business continues to evolve and be unpredictable. For example, to the extent the pandemic disrupts economic activity globally we, like other businesses, are not immune to continued adverse impacts to our business, operations and financial results from volatility in advertising spending, changes in user behavior and preferences, credit deterioration and liquidity of our customers, depressed economic activity, or volatility in capital markets. The ongoing impact will depend on a number of factors, including the duration and severity of the pandemic; the uneven impact to certain industries; advances in testing, treatment and prevention including vaccines; and the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. To address the potential impact to our business, over the near-term, we continue to evaluate the pace of our investment plans, including, but not limited to, our hiring, investments in data centers, servers, network equipment, real estate and facilities, marketing and travel spending, as well as taking certain measures to support our customers, our overall workforce, and communities we operate in. As we look to return our workforce in more locations back to the office in 2021, we may experience increased costs as we prepare our facilities for a safe return to work environment and experiment with hybrid work models. At the same time, we believe the current environment is accelerating digital transformation and we remain focused on innovating and investing in the services we offer to consumers and businesses. For example, as it relates to Google Cloud, we continue to invest aggressively around the globe in our go-to-market capabilities, product development and technical infrastructure to support long term growth. The ongoing impact of COVID-19 and the extent of these measures we have taken and the additional measures that we may implement could have a material impact on our financial results. Our past results may not be indicative of our future performance, and historical trends in our financial results may differ materially. Executive Overview The following table summarizes our consolidated financial results for the years ended December 31, 2019 and 2020 (in millions, except for per share information and percentages). Year Ended December 31, 2019 2020 Revenues $161,857 $182,527 Increase in revenues year over year 18 % 13 % Increase in constant currency revenues year over year 20 % 14 % Operating income (1) $ 34,231 $ 41,224 Operating margin (1) 21 % 23 % Other income (expense), net $ 5,394 $ 6,858 Net Income (1) $ 34,343 $ 40,269 Diluted EPS (1) $ 49.16 $ 58.61 (1) Results for 2019 include the effect of the $1.7 billion EC fine. See Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Total revenues were $182.5 billion, an increase of 13% year over year, primarily driven by an increase in Google Services segment revenues of $16.8 billion or 11% and an increase in Google Cloud segment revenues of $4.1 billion or 46%. Revenues from the United States, EMEA, APAC, and Other Americas were $85.0 billion, $55.4 billion, $32.6 billion, and $9.4 billion, respectively. Total cost of revenues was $84.7 billion, an increase of 18% year over year. TAC was $32.8 billion, an increase of 9% year over year, primarily driven by an increase in revenues subject to TAC. Other cost of revenues were $51.9 billion, an increase of 24% year over year, primarily driven by an increase in data centers and other operations costs and content acquisition costs. Alphabet Inc. Operating expenses were $56.6 billion, an increase of 5% year over year primarily driven by headcount growth and partially offset by declines in advertising and promotional expenses and travel and entertainment expenses. Other information: Operating cash flow was $65.1 billion. Capital expenditures, which primarily included investments in technical infrastructure, were $22.3 billion. Number of employees was 135,301 as of December 31, 2020. The majority of new hires during the year were engineers and product managers. Our Segments Beginning in the fourth quarter of 2020, we report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues primarily from fees received for Google Cloud Platform (""GCP"") services and Google Workspace (formerly known as G Suite) collaboration tools. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from the Other Bets are derived primarily through the sale of internet services as well as licensing and RD services. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including fines and settlements, as well as costs associated with certain shared research and development activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Financial Results Revenues The following table presents our revenues by type (in millions). Year Ended December 31, 2019 2020 Google Search other $ 98,115 $ 104,062 YouTube ads 15,149 19,772 Google Network Members' properties 21,547 23,090 Google advertising 134,811 146,924 Google other 17,014 21,711 Google Services total 151,825 168,635 Google Cloud 8,918 13,059 Other Bets 659 657 Hedging gains (losses) 455 176 Total revenues $ 161,857 $ 182,527 Google Services Google advertising revenues Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google Search other properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; Alphabet Inc. changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions including the impact of COVID-19; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has been affected over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels; changes in our product mix; changes in advertising quality or formats and delivery; the evolution of the online advertising market; increasing competition; our investments in new business strategies; query growth rates; and shifts in the geographic mix of our revenues. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Google advertising revenues consist primarily of the following: Google Search other consists of revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.) and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads consists of revenues generated on YouTube properties; and Google Network Members' properties consist of revenues generated on Google Network Members' properties participating in AdMob, AdSense, and Google Ad Manager. Google Search other Google Search other revenues increased $5,947 million from 2019 to 2020. The overall growth was primarily driven by interrelated factors including increases in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices, growth in advertiser spending primarily in the second half of the year, and improvements we have made in ad formats and delivery. This increase was partially offset by a decline in advertiser spending primarily in the first half of the year driven by the impact of COVID-19. YouTube ads YouTube ads revenues increased $4,623 million from 2019 to 2020. Growth was primarily driven by our direct response advertising products, which benefited from improvements to ad formats and delivery and increased advertiser spending. Brand advertising products also contributed to growth despite revenues being adversely impacted by a decline in advertiser spending primarily in the first half of the year driven by the impact of COVID-19. Google Network Members' properties Google Network Members' properties revenues increased $1,543 million from 2019 to 2020. The growth was primarily driven by strength in AdMob and Google Ad Manager. Use of Monetization Metrics Paid clicks for our Google Search other properties represent engagement by users and include clicks on advertisements by end-users on Google search properties and other owned and operated properties including Gmail, Google Maps, and Google Play. Historically, we included certain viewed YouTube engagement ads and the related revenues in our paid clicks and cost-per-click monetization metrics. Over time, advertising on YouTube has expanded to multiple advertising formats and the type of viewed engagement ads historically included in paid clicks and cost-per-click metrics have increasingly covered a smaller portion of YouTube advertising revenues. As a result, we removed these ads and the related revenues from the paid clicks and cost-per-click metrics for the current and historical periods presented. The revised metrics provide a better understanding of monetization trends on the properties included within Google Search other, as they now more closely correlate with the related changes in revenues. Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense and Google Ad Manager. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Alphabet Inc. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google Search other properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google Search other properties and the revenues generated by impression activity on Google Network Members properties. Paid clicks and cost-per-click The following table presents changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, 2019 2020 Paid clicks change 23 % 19 % Cost-per-click change (6) % (10) % Paid clicks increased from 2019 to 2020 primarily due to an increase in clicks due to interrelated factors, resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. Growth was also driven by an increase in clicks relating to ads on Google Play. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was primarily driven by reduced advertiser spending in response to COVID-19 primarily during the first half of the year. The decrease in cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Paid clicks increased from 2018 to 2019 primarily due to an increase in clicks due to interrelated factors, including an increase in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. Growth was also driven by an increase in clicks relating to ads on Google Play. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was driven by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Impressions and cost-per-impression The following table presents changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, 2020 Impressions change 15 % Cost-per-impression change (8) % Impressions increased from 2019 to 2020 primarily due to growth in Google Ad Manager. The positive effect on our revenues from an increase in impressions was partially offset by a decrease in the cost-per-impression paid by our advertisers which was driven by a reduction in advertiser spending in response to COVID-19, primarily during the first half of the year, as well as the effect of a combination of factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google other revenues Google other revenues consist primarily of revenues from: Google Play, which includes revenues from sales of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising, including YouTube Premium and YouTube TV subscriptions and other services; and other products and services. Alphabet Inc. Google other revenues increased $4,697 million from 2019 to 2020. The growth was primarily driven by Google Play and YouTube non-advertising. Growth for Google Play was primarily driven by sales of apps and in-app purchases, which benefited from elevated user engagement partially due to the impact of COVID-19. Growth for YouTube non-advertising was primarily driven by an increase in paid subscribers. Over time, our growth rate for Google other revenues may be affected by the seasonality associated with new product and service launches as well as market dynamics. Google Cloud Our Google Cloud revenues increased $4,141 million from 2019 to 2020. The growth was primarily driven by GCP followed by our Google Workspace offerings. Our infrastructure and our data and analytics platform products were the largest drivers of growth in GCP. Over time, our growth rate for Google Cloud revenues may be affected by customer usage, market dynamics, as well as new product and service launches. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, 2019 2020 United States 46 % 47 % EMEA 31 % 30 % APAC 17 % 18 % Other Americas 6 % 5 % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Percentage Change The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (""GAAP"") results helps improve the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue percentage change on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue percentage change is calculated by determining the change in period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions, except percentages): Year Ended December 31, 2019 2020 EMEA revenues $ 50,645 $ 55,370 Exclude foreign exchange effect on current period revenues using prior year rates 2,397 (111) EMEA constant currency revenues $ 53,042 $ 55,259 Prior period EMEA revenues $ 44,739 $ 50,645 EMEA revenue percentage change 13 % 9 % EMEA constant currency revenue percentage change 19 % 9 % APAC revenues $ 26,928 $ 32,550 Exclude foreign exchange effect on current period revenues using prior year rates 388 11 APAC constant currency revenues $ 27,316 $ 32,561 Prior period APAC revenues $ 21,341 $ 26,928 APAC revenue percentage change 26 % 21 % APAC constant currency revenue percentage change 28 % 21 % Other Americas revenues $ 8,986 $ 9,417 Exclude foreign exchange effect on current period revenues using prior year rates 541 964 Other Americas constant currency revenues $ 9,527 $ 10,381 Prior period Other Americas revenues $ 7,608 $ 8,986 Other Americas revenue percentage change 18 % 5 % Other Americas constant currency revenue percentage change 25 % 16 % United States revenues $ 74,843 $ 85,014 United States revenue percentage change 18 % 14 % Hedging gains (losses) 455 176 Total revenues $ 161,857 $ 182,527 Total constant currency revenues $ 164,728 $ 183,215 Prior period revenues, excluding hedging effect (1) $ 136,957 $ 161,402 Total revenue percentage change 18 % 13 % Total constant currency revenue percentage change 20 % 14 % (1) Total revenues and hedging gains (losses) for the year ended December 31, 2018 were $136,819 million and $(138) million, respectively. EMEA revenue percentage change from 2019 to 2020 was not significantly affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro offset by the U.S. dollar strengthening relative to the Turkish lira and Russian ruble. APAC revenue percentage change from 2019 to 2020 was not significantly affected by foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Indian rupee, partially offset by the U.S. dollar weakening relative to the Japanese yen. Other Americas revenue percentage change from 2019 to 2020 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Alphabet Inc. Costs and Operating Expenses Cost of Revenues Cost of revenues includes TAC which are paid to our distribution partners who make available our search access points and services, and amounts paid to Google Network Members primarily for ads displayed on their properties. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues as a percentage of revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google properties (which includes Google Search other and YouTube ads), because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers (including bandwidth, compensation expenses including stock-based compensation (""SBC""), depreciation, energy, and other equipment costs) as well as other operations costs (such as content review and customer support costs). These costs are generally less variable in nature and may not correlate with related changes in revenues; and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions, except percentages): Year Ended December 31, 2019 2020 TAC $ 30,089 $ 32,778 Other cost of revenues 41,807 51,954 Total cost of revenues $ 71,896 $ 84,732 Total cost of revenues as a percentage of revenues 44.4 % 46.4 % Cost of revenues increased $12,836 million from 2019 to 2020. The increase was due to increases in other cost of revenues and TAC of $10,147 million and $2,689 million, respectively. The increase in other cost of revenues from 2019 to 2020 was due to an increase in data center and other operations costs and an increase in content acquisition costs primarily for YouTube. This increase was partially offset by a decline in hardware costs. The increase in TAC from 2019 to 2020 was due to increases in TAC paid to distribution partners and to Google Network Members, driven by growth in revenues subject to TAC. The TAC rate was 22.3% in both 2019 and 2020. The TAC rate on Google properties revenues and the TAC rate on Google Network revenues were both substantially consistent from 2019 to 2020. Over time, cost of revenues as a percentage of total revenues may be affected by a number of factors, including the following: The amount of TAC paid to distribution partners, which is affected by changes in device mix, geographic mix, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; The amount of TAC paid to Google Network Members, which is affected by a combination of factors such as geographic mix, product mix, and revenue share terms; Relative revenue growth rates of Google properties and Google Network Members' properties; Certain costs that are less variable in nature and may not correlate with the related revenues; Costs associated with our data centers and other operations to support ads, Google Cloud, Search, YouTube and other products; Content acquisition costs, which are primarily affected by the relative growth rates in our YouTube advertising and subscription revenues; Costs related to hardware sales; and Increased proportion of non-advertising revenues, which generally have higher costs of revenues, relative to our advertising revenues. Alphabet Inc. Research and Development The following table presents our RD expenses (in millions, except percentages): Year Ended December 31, 2019 2020 Research and development expenses $ 26,018 $ 27,573 Research and development expenses as a percentage of revenues 16.1 % 15.1 % RD expenses consist primarily of: Compensation expenses (including SBC) for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $1,555 million from 2019 to 2020. The increase was primarily due to an increase in compensation expenses of $1,619 million, largely resulting from a 11% increase in headcount and partially offset by higher compensation charges in certain Other Bets in 2019. Additionally, the increase in RD expenses was partially offset by a decrease in travel and entertainment expenses of $383 million. Over time, RD expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues. In addition, RD expenses may be affected by a number of factors including continued investment in ads, Android, Chrome, Google Cloud, Google Play, hardware, machine learning, Other Bets, Search and YouTube. Sales and Marketing The following table presents our sales and marketing expenses (in millions, except percentages): Year Ended December 31, 2019 2020 Sales and marketing expenses $ 18,464 $ 17,946 Sales and marketing expenses as a percentage of revenues 11.4 % 9.8 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses decreased $518 million from 2019 to 2020. The decrease was primarily due to a decrease in advertising and promotional expenses of $1,395 million, as we reduced spending and paused or rescheduled campaigns and changed some events to digital-only formats as a result of COVID-19, and a decrease in travel and entertainment expenses of $371 million. The decrease was partially offset by an increase in compensation expenses of $1,347 million, largely resulting from an 8% increase in headcount. Over time, sales and marketing expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues. In addition, sales and marketing expenses may be affected by a number of factors including the seasonality associated with new product and service launches and strategic decisions regarding the timing and extent of our spending. General and Administrative The following table presents our general and administrative expenses (in millions, except percentages): Year Ended December 31, 2019 2020 General and administrative expenses $ 9,551 $ 11,052 General and administrative expenses as a percentage of revenues 5.9 % 6.1 % General and administrative expenses consist primarily of: Compensation expenses (including SBC) for employees in our finance, human resources, information technology, and legal organizations; Depreciation; Alphabet Inc. Equipment-related expenses; Legal-related expenses; and Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $1,501 million from 2019 to 2020. The increase was primarily due to an increase in compensation expenses of $887 million, largely resulting from a 16% increase in headcount. In addition, there was an increase of $440 million related to allowance for credit losses for accounts receivable. The increase was partially offset by a $554 million charge recognized in 2019 relating to a legal settlement. Over time, general and administrative expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues, the effect of discrete items such as legal settlements, or allowances for credit losses for accounts receivable. European Commission Fines In March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a 1.5 billion ( $1.7 billion as of March 20, 2019) fine, which was accrued in the first quarter of 2019. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Segment Profitability The following table presents our segment operating income (loss) (in millions). For comparative purposes, amounts in prior periods have been recast. Year Ended December 31, 2018 2019 2020 Operating income (loss): Google Services $ 43,137 $ 48,999 $ 54,606 Google Cloud (4,348) (4,645) (5,607) Other Bets (3,358) (4,824) (4,476) Corporate costs, unallocated (1) (7,907) (5,299) (3,299) Total income from operations $ 27,524 $ 34,231 $ 41,224 (1) Corporate costs, unallocated includes a fine of $5.1 billion for the year ended December 31, 2018 and a fine and legal settlement totaling $2.3 billion for the year ended December 31, 2019. Google Services Google services operating income increased $5,607 million from 2019 to 2020. The increase was primarily driven by an increase in revenues partially offset by increases in content acquisition costs primarily for YouTube, data center and other operations costs, and TAC. Additionally, there was an increase in operating expenses primarily driven by an increase in compensation expenses (including SBC) largely due to increases in headcount. Operating income benefited from a decline in hardware costs. Google services operating income increased $5,862 million from 2018 to 2019. The increase was primarily driven by an increase in revenues partially offset by increases in TAC, data center and other operations costs, and content acquisition costs primarily for YouTube. Additionally, there was an increase in operating expenses primarily driven by an increase in compensation expenses (including SBC) largely due to an increase in headcount. Google Cloud Google Cloud operating loss increased $962 million from 2019 to 2020 and increased $297 million from 2018 to 2019. The increase in operating loss in both periods was driven by an increase in total expenses of $5,103 million from 2019 to 2020 and $3,377 million from 2018 to 2019. Operating expenses increased primarily due to compensation expenses (including SBC), largely driven by an increase in headcount. Additionally, data center and other operating costs increased in both periods. Other Bets Other Bets operating loss decreased $348 million from 2019 to 2020 and increased $1,466 million from 2018 to 2019. The fluctuations were primarily driven by compensation expenses (including SBC). Alphabet Inc. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, 2019 2020 Other income (expense), net $ 5,394 $ 6,858 Other income (expense), net, increased $1,464 million from 2019 to 2020. The change was primarily driven by an increase in net gains on equity and debt securities of $3,519 million, partially offset by a $902 million loss resulting from our equity derivatives, which hedged the changes in fair value of certain marketable equity securities, and a decrease in interest income of $562 million. Over time, other income (expense), net, may be affected by market dynamics and other factors. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets, including the effects of COVID-19, could result in a significant change in the value of our investments. Fluctuations in the value of these investments has, and we expect will continue to, contribute to volatility of OIE in future periods. For additional information about our investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Provision for Income Taxes The following table presents our provision for income taxes (in millions, except for effective tax rate): Year Ended December 31, 2019 2020 Provision for income taxes $ 5,282 $ 7,813 Effective tax rate 13.3 % 16.2 % Our provision for income taxes and our effective tax rate increased from 2019 to 2020. The increase in the provision for income taxes and our effective tax rate is primarily due to benefits related to the resolution of multi-year audits in 2019 that did not recur in 2020, higher earnings in countries that have higher statutory rates resulting from the change in our corporate legal entity structure implemented as of December 31, 2019, and an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets, partially offset by an increase in the U.S. federal Foreign-Derived Intangible Income tax deduction benefits. See Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. We expect our future effective tax rate to be affected by the geographic mix of earnings in countries with different statutory rates. Additionally, our future effective tax rate may be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Alphabet Inc. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2020. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Seasonal fluctuations in internet usage and advertiser expenditures, underlying business trends such as traditional retail seasonality and macroeconomic conditions have affected, and are likely to continue to affect, our business (including developments and volatility arising from COVID-19). Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2019 Jun 30, 2019 Sept 30, 2019 Dec 31, 2019 Mar 31, 2020 Jun 30, 2020 Sept 30, 2020 Dec 31, 2020 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 36,339 $ 38,944 $ 40,499 $ 46,075 $ 41,159 $ 38,297 $ 46,173 56,898 Costs and expenses: Cost of revenues 16,012 17,296 17,568 21,020 18,982 18,553 21,117 26,080 Research and development 6,029 6,213 6,554 7,222 6,820 6,875 6,856 7,022 Sales and marketing 3,905 4,212 4,609 5,738 4,500 3,901 4,231 5,314 General and administrative 2,088 2,043 2,591 2,829 2,880 2,585 2,756 2,831 European Commission fines 1,697 0 0 0 0 0 0 0 Total costs and expenses 29,731 29,764 31,322 36,809 33,182 31,914 34,960 41,247 Income from operations 6,608 9,180 9,177 9,266 7,977 6,383 11,213 15,651 Other income (expense), net 1,538 2,967 (549) 1,438 (220) 1,894 2,146 3,038 Income before income taxes 8,146 12,147 8,628 10,704 7,757 8,277 13,359 18,689 Provision for income taxes 1,489 2,200 1,560 33 921 1,318 2,112 3,462 Net income $ 6,657 $ 9,947 $ 7,068 $ 10,671 $ 6,836 $ 6,959 $ 11,247 15,227 Basic net income per share of Class A and B common stock and Class C capital stock $ 9.58 $ 14.33 $ 10.20 $ 15.49 $ 9.96 $ 10.21 $ 16.55 $ 22.54 Diluted net income per share of Class A and B common stock and Class C capital stock $ 9.50 $ 14.21 $ 10.12 $ 15.35 $ 9.87 $ 10.13 $ 16.40 $ 22.30 Financial Condition Cash, Cash Equivalents, and Marketable Securities As of December 31, 2020, we had $136.7 billion in cash, cash equivalents, and short-term marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities and marketable equity securities. Sources, Uses of Cash and Related Trends Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Alphabet Inc. The following table presents our cash flows (in millions): Year Ended December 31, 2019 2020 Net cash provided by operating activities $ 54,520 $ 65,124 Net cash used in investing activities $ (29,491) $ (32,773) Net cash used in financing activities $ (23,209) $ (24,408) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google Search other properties, Google Network Members' properties and YouTube ads. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from our operating activities include compensation and related costs, payments to our distribution partners and Google Network Members, and payments for content acquisition costs. In addition, uses of cash from operating activities include hardware inventory costs, income taxes, and other general corporate expenditures. Net cash provided by operating activities increased from 2019 to 2020 primarily due to the net effect of increases in cash received from revenues and cash paid for cost of revenues and operating expenses, and changes in operating assets and liabilities. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of marketable and non-marketable securities, purchases of property and equipment, and payments for acquisitions. Net cash used in investing activities increased from 2019 to 2020 primarily due to a net increase in purchases of securities, partially offset by decreases in payments for acquisitions and purchases of property and equipment. The net decrease in purchases of property and equipment was driven by decreases in purchases of land and buildings for offices as well as data center construction, partially offset by increases in purchases of servers. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Cash used in financing activities consists primarily of repurchases of capital stock, net payments related to stock-based award activities, and repayments of debt. Net cash used in financing activities increased from 2019 to 2020 primarily due to an increase in cash payments for repurchases of capital stock, partially offset by increases in net proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Liquidity and Material Cash Requirements We expect existing cash, cash equivalents, short-term marketable securities, cash flows from operations and financing activities to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for at least the next 12 months and thereafter for the foreseeable future. As of December 31, 2020, we had long-term taxes payable of $6.5 billion related to a one-time transition tax payable incurred as a result of the U.S. Tax Cuts and Jobs Act (""Tax Act""). As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($2.7 billion as of June 27, 2017), 4.3 billion ($5.1 billion as of June 30, 2018), and 1.5 billion ($1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. In January 2021, we closed the acquisition of Fitbit, a leading wearables brand, for $2.1 billion. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. As of December 31, 2020, we had no commercial paper outstanding. As of December 31, 2020, we have $4.0 billion of revolving credit facilities expiring Alphabet Inc. in July 2023 with no amounts outstanding. The interest rate for the credit facilities is determined based on a formula using certain market rates. In August 2020, we issued $10.0 billion of fixed-rate senior unsecured notes in six tranches: $1.0 billion due in 2025, $1.0 billion due in 2027, $2.25 billion due in 2030, $1.25 billion due in 2040, $2.5 billion due in 2050 and $2.0 billion due in 2060. The 2020 Notes had a weighted average duration of 21.5 years and weighted average coupon rate of 1.57%. Of the total issuance, $5.75 billion was designated as Sustainability Bonds, the net proceeds of which are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. The remaining net proceeds are used for general corporate purposes. As of December 31, 2020, we have senior unsecured notes outstanding with a total carrying value of $13.8 billion. Refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the debts. In accordance with the authorizations of the Board of Directors of Alphabet, in 2020 we repurchased and subsequently retired 21.5 million shares of Alphabet Class C capital stock for an aggregate amount of $31.1 billion. As of December 31, 2020, $17.6 billion remains authorized and available for repurchase. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Capital Expenditures and Leases We make investments in land and buildings for data centers and offices and information technology assets through purchases of property and equipment and lease arrangements to provide capacity for the growth of our services and products. Our capital investments in property and equipment consist primarily of the following major categories: Technical infrastructure, which consists of our investments in servers and network equipment for compute, storage and networking requirements for ongoing business activities, including machine learning, (collectively referred to as our information technology assets) and data center land and building construction; and Office facilities, ground up development projects and related building improvements. Due to the integrated nature of Alphabet, our technical infrastructure and office facilities are managed centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Our technical infrastructure investments are designed to support all of Alphabet, including primarily ads, Google Cloud, Search, and YouTube. Construction in progress consists primarily of technical infrastructure and office facilities which have not yet been placed in service for our intended use. The time frame from date of purchase to placement in service of these assets may extend to multiple periods. For example, our data center construction projects are generally multi-year projects with multiple phases, where we acquire qualified land and buildings, construct buildings, and secure and install information technology assets. During the years ended December 31, 2019 and 2020, we spent $23.5 billion and $22.3 billion on capital expenditures and recognized total operating lease assets of $4.4 billion and $2.8 billion, respectively. As of December 31, 2020, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 9 years, was $15.1 billion. As of December 31, 2020, we have entered into leases that have not yet commenced with future lease payments of $8.0 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2021 and 2026 with non-cancelable lease terms of 1 to 25 years. Depreciation of our property and equipment commences when the deployment of such assets are completed and are ready for our intended use. Land is not depreciated. For the years ended December 31, 2019 and 2020, our depreciation and impairment expenses on property and equipment were $10.9 billion and $12.9 billion, respectively. For the years ended December 31, 2019 and 2020, our operating lease expenses (including variable lease costs), were $2.4 billion and $2.9 billion, respectively. Finance leases were not material for the years ended December 31, 2019 and 2020. Please refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the leases. Alphabet Inc. Contractual Obligations as of December 31, 2020 The following summarizes our contractual obligations as of December 31, 2020 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations (1) $ 15,091 $ 2,198 $ 4,165 $ 3,127 $ 5,601 Obligations for leases that have not yet commenced (1) 8,049 370 1,198 1,469 5,012 Purchase obligations (2) 10,656 7,368 1,968 354 966 Long-term debt obligations (3) 19,840 1,357 634 2,587 15,262 Tax payable (4) 7,359 834 1,916 4,609 0 Other long-term liabilities reflected on our balance sheet (5) 1,421 532 616 185 88 Total contractual obligations $ 62,416 $ 12,659 $ 10,497 $ 12,331 $ 26,929 (1) For further information, refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to data center operations and build-outs; information technology assets; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2020. Excluded from the table above are open orders for purchases that support normal operations, which are generally cancelable. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $2.3 billion as of December 31, 2020 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing and outcomes of tax audits. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the EC fines, refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. See Note 10 included in Part II, Item 8 of this annual report on Form 10-K for more information on our commitments and contingencies. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit and compliance committee of our Board of Directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Alphabet Inc. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (""IRS"") and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury consumer protection, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair Value Measurements We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. The fair value hierarchy prioritizes the inputs used to measure fair value whereby it gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. We maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Our use of unobservable inputs reflects the assumptions that market participants would use and may include our own data adjusted based on reasonably available information. We apply judgment in assessing the relevance of observable market data to determine the priority of inputs under the fair value hierarchy, particularly in situations where there is very little or no market activity. Alphabet Inc. In determining the fair values of our non-marketable equity and debt investments, as well as assets acquired (especially with respect to intangible assets) and liabilities assumed in business combinations, we make significant estimates and assumptions, some of which include the use of unobservable inputs. Certain stock-based compensation awards may be settled in the stock of certain of our Other Bets or in cash. These awards are based on the equity values of the respective Other Bet, which requires use of unobservable inputs. We also have compensation arrangements with payouts based on realized investment returns, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Non-marketable Equity Securities Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include the companies' financial and liquidity position, access to capital resources and the time since the last adjustment to fair value, among others. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we write down the investment to its fair value. Change in Accounting Estimate In January 2021, we completed an assessment of the useful lives of our servers and network equipment and determined we should adjust the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years. This change in accounting estimate will be effective beginning fiscal year 2021. For assets that are in-service as of December 31, 2020, we expect operating results to be favorably impacted by approximately $2.1 billion for the full fiscal year 2021. The effect of the change may be different due to our capital investments during the fiscal year 2021. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the functional currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approximately $8 million and $497 million as of Alphabet Inc. December 31, 2019 and 2020, respectively, after consideration of the effect of foreign exchange contracts in place for the years ended December 31, 2019 and 2020. We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2019 and 2020, the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $1.1 billion and $912 million lower as of December 31, 2019 and 2020, respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (""CTA"") within AOCI related to our net investment hedge would have been approximately $936 million and $1 billion lower as of December 31, 2019 and 2020, respectively. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as compared to interest rates at the time of purchase. For certain fixed and variable rate debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. We measure securities for which we have not elected the fair value option at fair value with gains and losses recorded in AOCI until the securities are sold, less any expected credit losses. We use value-at-risk (""VaR"") analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2019 and 2020 are shown below (in millions): As of December 31, 12-Month Average As of December 31, 2019 2020 2019 2020 Risk Category - Interest Rate $ 104 $ 144 $ 90 $ 145 Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2019 and 2020 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. Alphabet Inc. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $3.3 billion and $5.9 billion of our investments as of December 31, 2019 and 2020, respectively. A hypothetical adverse price change of 30% on our December 31, 2020 balance, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $1.8 billion. From time to time, we may enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value measured at the time of the observable transaction is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of our investments through liquidity events such as public offerings, acquisitions, private sales or other market events. As of December 31, 2019 and 2020, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $11.4 billion and $18.9 billion, respectively. Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge relating to our non-marketable equity securities. Changes in valuation of non-marketable equity securities may not directly correlate with changes in valuation of marketable equity securities. Additionally, observable transactions at lower valuations could result in significant losses on our non-marketable equity securities. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the impact. The carrying values of our equity method investments, which totaled approximately $1.3 billion and $1.4 billion as of December 31, 2019 and 2020, respectively, generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value and is not expected to recover. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2019 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 2, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, and government investigations involving competition, intellectual property, privacy, consumer protection, tax, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, and other matters. As described in Note 10 to the consolidated financial statements Commitments and Contingencies such claims could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgment in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 2, 2021 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2020 consolidated financial statements of the Company and our report dated February 2, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 2, 2021 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2019 As of December 31, 2020 Assets Current assets: Cash and cash equivalents $ 18,498 $ 26,465 Marketable securities 101,177 110,229 Total cash, cash equivalents, and marketable securities 119,675 136,694 Accounts receivable, net 25,326 30,930 Income taxes receivable, net 2,166 454 Inventory 999 728 Other current assets 4,412 5,490 Total current assets 152,578 174,296 Non-marketable investments 13,078 20,703 Deferred income taxes 721 1,084 Property and equipment, net 73,646 84,749 Operating lease assets 10,941 12,211 Intangible assets, net 1,979 1,445 Goodwill 20,624 21,175 Other non-current assets 2,342 3,953 Total assets $ 275,909 $ 319,616 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 5,561 $ 5,589 Accrued compensation and benefits 8,495 11,086 Accrued expenses and other current liabilities 23,067 28,631 Accrued revenue share 5,916 7,500 Deferred revenue 1,908 2,543 Income taxes payable, net 274 1,485 Total current liabilities 45,221 56,834 Long-term debt 4,554 13,932 Deferred revenue, non-current 358 481 Income taxes payable, non-current 9,885 8,849 Deferred income taxes 1,701 3,561 Operating lease liabilities 10,214 11,146 Other long-term liabilities 2,534 2,269 Total liabilities 74,467 97,072 Commitments and Contingencies (Note 10) Stockholders equity: Convertible preferred stock, $ 0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding 0 0 Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $ 0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000 , Class B 3,000,000 , Class C 3,000,000 ); 688,335 (Class A 299,828 , Class B 46,441 , Class C 342,066 ) and 675,222 (Class A 300,730 , Class B 45,843 , Class C 328,649 ) shares issued and outstanding 50,552 58,510 Accumulated other comprehensive income (loss) ( 1,232 ) 633 Retained earnings 152,122 163,401 Total stockholders equity 201,442 222,544 Total liabilities and stockholders equity $ 275,909 $ 319,616 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2018 2019 2020 Revenues $ 136,819 $ 161,857 $ 182,527 Costs and expenses: Cost of revenues 59,549 71,896 84,732 Research and development 21,419 26,018 27,573 Sales and marketing 16,333 18,464 17,946 General and administrative 6,923 9,551 11,052 European Commission fines 5,071 1,697 0 Total costs and expenses 109,295 127,626 141,303 Income from operations 27,524 34,231 41,224 Other income (expense), net 7,389 5,394 6,858 Income before income taxes 34,913 39,625 48,082 Provision for income taxes 4,177 5,282 7,813 Net income $ 30,736 $ 34,343 $ 40,269 Basic net income per share of Class A and B common stock and Class C capital stock $ 44.22 $ 49.59 $ 59.15 Diluted net income per share of Class A and B common stock and Class C capital stock $ 43.70 $ 49.16 $ 58.61 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2018 2019 2020 Net income $ 30,736 $ 34,343 $ 40,269 Other comprehensive income (loss): Change in foreign currency translation adjustment ( 781 ) ( 119 ) 1,139 Available-for-sale investments: Change in net unrealized gains (losses) 88 1,611 1,313 Less: reclassification adjustment for net (gains) losses included in net income ( 911 ) ( 111 ) ( 513 ) Net change, net of tax benefit (expense) of $ 156 , $( 221 ), and $( 230 ) ( 823 ) 1,500 800 Cash flow hedges: Change in net unrealized gains (losses) 290 22 42 Less: reclassification adjustment for net (gains) losses included in net income 98 ( 299 ) ( 116 ) Net change, net of tax benefit (expense) of $( 103 ), $ 42 , and $ 11 388 ( 277 ) ( 74 ) Other comprehensive income (loss) ( 1,216 ) 1,104 1,865 Comprehensive income $ 29,520 $ 35,447 $ 42,134 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2017 694,783 $ 40,247 $ ( 992 ) $ 113,247 $ 152,502 Cumulative effect of accounting change 0 0 ( 98 ) ( 599 ) ( 697 ) Common and capital stock issued 8,975 148 0 0 148 Stock-based compensation expense 0 9,353 0 0 9,353 Tax withholding related to vesting of restricted stock units 0 ( 4,782 ) 0 0 ( 4,782 ) Repurchases of capital stock ( 8,202 ) ( 576 ) 0 ( 8,499 ) ( 9,075 ) Sale of interest in consolidated entities 0 659 0 0 659 Net income 0 0 0 30,736 30,736 Other comprehensive income (loss) 0 0 ( 1,216 ) 0 ( 1,216 ) Balance as of December 31, 2018 695,556 45,049 ( 2,306 ) 134,885 177,628 Cumulative effect of accounting change 0 0 ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 202 0 0 202 Stock-based compensation expense 0 10,890 0 0 10,890 Tax withholding related to vesting of restricted stock units and other 0 ( 4,455 ) 0 0 ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) 0 ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities 0 160 0 0 160 Net income 0 0 0 34,343 34,343 Other comprehensive income (loss) 0 0 1,104 0 1,104 Balance as of December 31, 2019 688,335 50,552 ( 1,232 ) 152,122 201,442 Common and capital stock issued 8,398 168 0 0 168 Stock-based compensation expense 0 13,123 0 0 13,123 Tax withholding related to vesting of restricted stock units and other 0 ( 5,969 ) 0 0 ( 5,969 ) Repurchases of capital stock ( 21,511 ) ( 2,159 ) 0 ( 28,990 ) ( 31,149 ) Sale of interest in consolidated entities 0 2,795 0 0 2,795 Net income 0 0 0 40,269 40,269 Other comprehensive income (loss) 0 0 1,865 0 1,865 Balance as of December 31, 2020 675,222 $ 58,510 $ 633 $ 163,401 $ 222,544 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2018 2019 2020 Operating activities Net income $ 30,736 $ 34,343 $ 40,269 Adjustments: Depreciation and impairment of property and equipment 8,164 10,856 12,905 Amortization and impairment of intangible assets 871 925 792 Stock-based compensation expense 9,353 10,794 12,991 Deferred income taxes 778 173 1,390 Gain on debt and equity securities, net ( 6,650 ) ( 2,798 ) ( 6,317 ) Other ( 189 ) ( 592 ) 1,267 Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 2,169 ) ( 4,340 ) ( 6,524 ) Income taxes, net ( 2,251 ) ( 3,128 ) 1,209 Other assets ( 1,207 ) ( 621 ) ( 1,330 ) Accounts payable 1,067 428 694 Accrued expenses and other liabilities 8,614 7,170 5,504 Accrued revenue share 483 1,273 1,639 Deferred revenue 371 37 635 Net cash provided by operating activities 47,971 54,520 65,124 Investing activities Purchases of property and equipment ( 25,139 ) ( 23,548 ) ( 22,281 ) Purchases of marketable securities ( 50,158 ) ( 100,315 ) ( 136,576 ) Maturities and sales of marketable securities 48,507 97,825 132,906 Purchases of non-marketable investments ( 2,073 ) ( 1,932 ) ( 7,175 ) Maturities and sales of non-marketable investments 1,752 405 1,023 Acquisitions, net of cash acquired, and purchases of intangible assets ( 1,491 ) ( 2,515 ) ( 738 ) Other investing activities 98 589 68 Net cash used in investing activities ( 28,504 ) ( 29,491 ) ( 32,773 ) Financing activities Net payments related to stock-based award activities ( 4,993 ) ( 4,765 ) ( 5,720 ) Repurchases of capital stock ( 9,075 ) ( 18,396 ) ( 31,149 ) Proceeds from issuance of debt, net of costs 6,766 317 11,761 Repayments of debt ( 6,827 ) ( 585 ) ( 2,100 ) Proceeds from sale of interest in consolidated entities, net 950 220 2,800 Net cash used in financing activities ( 13,179 ) ( 23,209 ) ( 24,408 ) Effect of exchange rate changes on cash and cash equivalents ( 302 ) ( 23 ) 24 Net increase in cash and cash equivalents 5,986 1,797 7,967 Cash and cash equivalents at beginning of period 10,715 16,701 18,498 Cash and cash equivalents at end of period $ 16,701 $ 18,498 $ 26,465 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 5,671 $ 8,203 $ 4,990 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (""Alphabet"") became the successor issuer to Google. We generate revenues by delivering relevant, cost-effective online advertising, cloud-based solutions that provide customers with platforms, collaboration tools and services, and sales of other products and services, such as apps and in-app purchases, digital content and subscriptions for digital content, and hardware. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (""GAAP"") requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses, fair values of financial instruments (including non-marketable equity securities), intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. As of December 31, 2020 the impact of COVID-19 continues to unfold and the extent of the impact will depend on a number of factors, including the duration and severity of the pandemic; the uneven impact to certain industries; advances in testing, treatment and prevention; and the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. As a result, certain of our estimates and assumptions, including the allowance for credit losses for accounts receivable, the credit worthiness of customers entering into revenue arrangements, the valuation of non-marketable equity securities, including our impairment assessment, and the fair values of our financial instruments require increased judgment and carry a higher degree of variability and volatility that could result in material changes to our estimates in future periods. In January 2021, we completed an assessment of the useful lives of our servers and network equipment and determined we should adjust the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years . This change in accounting estimate will be effective beginning fiscal year 2021. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers and the collectibility of an amount that we expect in exchange for those goods or services is probable. Sales and other similar taxes are excluded from revenues. Advertising Revenues We generate advertising revenues primarily by delivering advertising on Google Search other properties, including Google.com, the Google Search app, Google Play, Gmail and Google Maps; YouTube, and Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager and Google Marketing Platform, among others. We offer advertising by delivering both performance and brand advertising. We recognize revenues for performance advertising when a user engages with the advertisement, such as a click, a view, or a purchase. For brand advertising, we recognize revenues when the ad is displayed or a user views the ad. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues Alphabet Inc. for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Google Cloud Revenues Google Cloud revenues consist primarily of fees received for Google Cloud Platform services (which includes infrastructure and data analytics platform products and other services) and Google Workspace (formerly G Suite) collaboration tools and other enterprise services. Our cloud services are generally provided on either a consumption or subscription basis. Revenues related to cloud services provided on a consumption basis are recognized when the customer utilizes the services, based on the quantity of services consumed. Revenues related to cloud services provided on a subscription basis are recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Google Play, which includes revenues from sale of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising services including, YouTube premium and YouTube TV subscriptions and other services; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Sales Commissions We expense sales commissions when incurred when the amortization period is one year or less. We recognize an asset for certain sales commissions if we expect the period of benefit of these costs to exceed one year and amortize it over the period of expected benefit. These costs are recorded within sales and marketing expenses. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to our distribution partners who make available our search access points and services and amounts paid to Google Network Members primarily for ads displayed on their properties. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play. We pay fees to these content providers based on revenues generated or a flat fee; Alphabet Inc. Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (""RSUs""). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding and the tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation also includes other stock-based awards, such as performance stock units (""PSUs"") and awards that may be settled in cash or the stock of certain Other Bets. PSUs and certain Other Bet awards are equity classified and expense is recognized over the requisite service period. Certain Other Bet awards are liability classified and remeasured at fair value through settlement. The fair value of Other Bet awards is based on the equity valuation of the respective Other Bet. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2018, 2019 and 2020, advertising and promotional expenses totaled approximately $ 6.4 billion, $ 6.8 billion, and $ 5.4 billion, respectively. Performance Fees Performance fees refer to compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. Performance fees, which are primarily related to gains on equity securities, are recorded as a component of other income (expense), net. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of markets in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2018, 2019, or 2020. In 2018, 2019, and 2020, we generated approximately 46 %, 46 %, and 47 % of our revenues, respectively, from customers based in the U.S. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from Alphabet Inc. customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities, which are adjusted to fair value when observable price changes are identified or when the non-marketable equity securities are impaired (referred to as the measurement alternative) . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. We classify all marketable debt securities that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities on our Consolidated Balance Sheets. We determine the appropriate classification of our investments in marketable debt securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for the changes in allowance for expected credit losses, which are recorded in other income (expense), net. For certain marketable debt securities we have elected the fair value option, for which changes in fair value are recorded in other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Our investments in marketable equity securities are measured at fair value with the related gains and losses, realized and unrealized, recognized in other income (expense), net. Accounts Receivable Our payment terms for accounts receivable vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customers, we require payment before the products or services are delivered to the customer. Alphabet Inc. We maintain an allowance for credit losses for accounts receivable, which is recorded as an offset to accounts receivable and changes in such are classified as general and administrative expense in the Consolidated Statements of Income. We assess collectibility by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with known disputes or collectibility issues. In determining the amount of the allowance for credit losses, we consider historical collectibility based on past due status and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information, current market conditions and reasonable and supportable forecasts of future economic conditions to inform adjustments to historical loss data. For the year ended December 31, 2020, our assessment considered the impact of COVID-19 and estimates of expected credit and collectibility trends. Volatility in market conditions and evolving credit trends are difficult to predict and may cause variability and volatility that may have a material impact on our allowance for credit losses in future periods. The allowance for credit losses on accounts receivable was $ 275 million and $ 789 million as of December 31, 2019 and 2020, respectively. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative. Under the measurement alternative, the carrying value of our non-marketable equity investments is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment. Adjustments are determined primarily based on a market approach as of the transaction date and are recorded as a component of other income (expense), net. Non-marketable debt investments are classified as available-for-sale securities. Non-marketable investments that do not have stated contractual maturity dates are classified as non-current assets on the Consolidated Balance Sheets. Impairment of Investments We periodically review our debt and non-marketable equity investments for impairment. For debt securities in an unrealized loss position, we determine whether a credit loss exists. The credit loss is estimated by considering available information relevant to the collectibility of the security and information about past events, current conditions, and reasonable and supportable forecasts. Any credit loss is recorded as a charge to other income (expense), net, not to exceed the amount of the unrealized loss. Unrealized losses other than the credit loss are recognized in accumulated other comprehensive income (""AOCI""). If we have an intent to sell, or if it is more likely than not that we will be required to sell a debt security in an unrealized loss position before recovery of its amortized cost basis, we will write down the security to its fair value and record the corresponding charge as a component of other income (expense), net. For non-marketable equity securities we consider whether impairment indicators exist by evaluating the companies' financial and liquidity position, access to capital resources and the time since the last adjustment to fair value, among others. If the assessment indicates that the investment is impaired, we write down the investment to its fair value by recording the corresponding charge as a component of other income (expense), net. Fair value is estimated using the best information available, which may include cash flow projections or other available market data. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests is considered a variable interest entity (""VIE""). We consolidate VIEs when we are the primary beneficiary. We are the primary beneficiary of a VIE when we have the power to direct activities that most significantly affect the economic performance of the VIE and have the obligation to absorb the majority of their losses or benefits. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is a VIE and, if so, whether we are the primary beneficiary. Alphabet Inc. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets, which we regularly evaluate. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet beginning January 1, 2019. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities and the long term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense (excluding variable lease costs) is recognized on a straight-line basis over the lease term. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets or asset group are not recoverable, the impairment recognized is measured as the amount by which the carrying value exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units periodically, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were no t material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives generally over periods ranging from one to twelve years . Alphabet Inc. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Recently Adopted Accounting Pronouncements In June 2016, the Financial Accounting Standards Board (""FASB"") issued Accounting Standards Update No. 2016-13 (""ASU 2016-13"") ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"", which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to certain available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes result in earlier recognition of credit losses. We adopted ASU 2016-13 using the modified retrospective approach as of January 1, 2020. The cumulative effect upon adoption was not material to our consolidated financial statements. See Impairment of Investments and ""Accounts Receivable"" above as well as Note 3 for the effect on our consolidated financial statements. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. See Note 15 for further details. Alphabet Inc. Note 2. Revenues Revenue Recognition The following table presents our revenues disaggregated by type (in millions). Year Ended December 31, 2018 2019 2020 Google Search other $ 85,296 $ 98,115 $ 104,062 YouTube ads 11,155 15,149 19,772 Google Network Members' properties 20,010 21,547 23,090 Google advertising 116,461 134,811 146,924 Google other 14,063 17,014 21,711 Google Services total 130,524 151,825 168,635 Google Cloud 5,838 8,918 13,059 Other Bets 595 659 657 Hedging gains (losses) ( 138 ) 455 176 Total revenues $ 136,819 $ 161,857 $ 182,527 The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, 2018 2019 2020 United States $ 63,269 46 % $ 74,843 46 % $ 85,014 47 % EMEA (1) 44,739 33 50,645 31 55,370 30 APAC (1) 21,341 15 26,928 17 32,550 18 Other Americas (1) 7,608 6 8,986 6 9,417 5 Hedging gains (losses) ( 138 ) 0 455 0 176 0 Total revenues $ 136,819 100 % $ 161,857 100 % $ 182,527 100 % (1) Regions represent Europe, the Middle East, and Africa (""EMEA""); Asia-Pacific (""APAC""); and Canada and Latin America (""Other Americas""). Deferred Revenues and Remaining Performance Obligations We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. Deferred revenues primarily relate to Google Cloud and Google other. Our total deferred revenue as of December 31, 2019 was $ 2.3 billion, of which $ 1.8 billion was recognized as revenues for the year ending December 31, 2020. Additionally, we have performance obligations associated with commitments in customer contracts, primarily related to Google Cloud, for future services that have not yet been recognized as revenues, also referred to as remaining performance obligations. Remaining performance obligations include related deferred revenue currently recorded as well as amounts that will be invoiced in future periods, and excludes (i) contracts with an original expected term of one year or less, (ii) cancellable contracts, and (iii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. As of December 31, 2020, the amount not yet recognized as revenues from these commitments is $ 29.8 billion. We expect to recognize approximately half over the next 24 months with the remaining thereafter. However, the amount and timing of revenue recognition is largely driven by when the customer utilizes the services and our ability to deliver in accordance with relevant contract terms, which could impact our estimate of the remaining performance obligations and when we expect to recognize such as revenues. Alphabet Inc. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities, which are accounted for as available-for-sale, within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. For certain marketable debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. The fair value option was elected for these securities to align with the unrealized gains and losses from related derivative contracts. Unrealized net gains related to debt securities still held where we have elected the fair value option were $ 87 million as of December 31, 2020. As of December 31, 2020, the fair value of these debt securities was $ 2 billion. Balances as of December 31, 2019 were not material. The following tables summarize our debt securities, for which we did not elect the fair value option, by significant investment categories as of December 31, 2019 and 2020 (in millions): As of December 31, 2019 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,294 $ 0 $ 0 $ 2,294 $ 2,294 $ 0 Government bonds 55,033 434 ( 30 ) 55,437 4,518 50,919 Corporate debt securities 27,164 337 ( 3 ) 27,498 44 27,454 Mortgage-backed and asset-backed securities 19,453 96 ( 41 ) 19,508 0 19,508 Total $ 103,944 $ 867 $ ( 74 ) $ 104,737 $ 6,856 $ 97,881 As of December 31, 2020 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 3,564 $ 0 $ 0 $ 3,564 $ 3,564 $ 0 Government bonds 55,156 793 ( 9 ) 55,940 2,527 53,413 Corporate debt securities 31,521 704 ( 2 ) 32,223 8 32,215 Mortgage-backed and asset-backed securities 16,767 364 ( 7 ) 17,124 0 17,124 Total $ 107,008 $ 1,861 $ ( 18 ) $ 108,851 $ 6,099 $ 102,752 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 1.3 billion, $ 292 million, and $ 899 million for the years ended December 31, 2018, 2019, and 2020, respectively. We recognized gross realized losses of $ 143 million, $ 143 million, and $ 184 million for the years ended December 31, 2018, 2019, and 2020, respectively. We reflect these gains and losses as a component of other income (expense), net. The following table summarizes the estimated fair value of our investments in marketable debt securities by stated contractual maturity dates (in millions): As of December 31, 2020 Due in 1 year or less $ 19,795 Due in 1 year through 5 years 69,228 Due in 5 years through 10 years 2,739 Due after 10 years 13,038 Total $ 104,800 Alphabet Inc. The following tables present fair values and gross unrealized losses recorded to AOCI as of December 31, 2019 and 2020, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2019 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 6,752 $ ( 20 ) $ 4,590 $ ( 10 ) $ 11,342 $ ( 30 ) Corporate debt securities 1,665 ( 2 ) 978 ( 1 ) 2,643 ( 3 ) Mortgage-backed and asset-backed securities 4,536 ( 13 ) 2,835 ( 28 ) 7,371 ( 41 ) Total $ 12,953 $ ( 35 ) $ 8,403 $ ( 39 ) $ 21,356 $ ( 74 ) As of December 31, 2020 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 5,516 $ ( 9 ) $ 3 $ 0 $ 5,519 $ ( 9 ) Corporate debt securities 1,999 ( 1 ) 0 0 1,999 ( 1 ) Mortgage-backed and asset-backed securities 929 ( 5 ) 242 ( 2 ) 1,171 ( 7 ) Total $ 8,444 $ ( 15 ) $ 245 $ ( 2 ) $ 8,689 $ ( 17 ) During the years ended December 31, 2018, and 2019 we did no t recognize any significant other-than-temporary impairment losses. During the year ended December 31, 2020, with the adoption of ASU 2016-13, we did not recognize significant credit losses and the ending allowance for credit losses was immaterial. See Note 7 for further details on other income (expense), net. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). Non-marketable equity securities that have been remeasured during the period based on observable transactions are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods which may include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The fair value of non-marketable equity securities that have been remeasured due to impairment are classified within Level 3. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for our marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, 2019 2020 Net gain (loss) on equity securities sold during the period $ ( 301 ) $ 1,339 Net unrealized gain (loss) on equity securities held as of the end of the period 2,950 4,253 Total gain (loss) recognized in other income (expense), net $ 2,649 $ 5,592 Alphabet Inc. In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains (losses) on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic realized net gains on the securities sold during the period. Cumulative net gains are calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Equity Securities Sold During the Year Ended December 31, 2019 2020 Total sale price $ 3,134 $ 4,767 Total initial cost 858 2,674 Cumulative net gains (losses) $ 2,276 $ 2,093 Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for our marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2019 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 1,935 $ 8,297 $ 10,232 Cumulative net gain (loss) (1) 1,361 3,056 4,417 Carrying value $ 3,296 $ 11,353 $ 14,649 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 3.5 billion unrealized gains and $ 445 million unrealized losses (including impairment). As of December 31, 2020 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 2,227 $ 14,616 $ 16,843 Cumulative net gain (loss) (1) 3,631 4,277 7,908 Carrying value (2) $ 5,858 $ 18,893 $ 24,751 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 6.1 billion unrealized gains and $ 1.9 billion unrealized losses (including impairment). (2) The long-term portion of marketable equity securities of $ 429 million is included in other non-current assets. Alphabet Inc. Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2019 and 2020 (in millions): As of December 31, 2019 As of December 31, 2020 Cash and Cash Equivalents Marketable Equity Securities Cash and Cash Equivalents Marketable Equity Securities Level 1: Money market funds $ 4,604 $ 0 $ 12,210 $ 0 Marketable equity securities (1)(2) 0 3,046 0 5,470 4,604 3,046 12,210 5,470 Level 2: Mutual funds 0 250 0 388 Total $ 4,604 $ 3,296 $ 12,210 $ 5,858 (1) The balance as of December 31, 2019 and 2020 includes investments that were reclassified from non-marketable equity securities following the commencement of public market trading of the issuers or acquisition by public entities. As of December 31, 2020 certain investments are subject to short-term lock-up restrictions. (2) As of December 31, 2020 the long-term portion of marketable equity securities of $ 429 million is included within other non-current assets. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities (in millions): Year Ended December 31, 2019 2020 Unrealized gains $ 2,163 $ 3,020 Unrealized losses (including impairment) ( 372 ) ( 1,489 ) Total unrealized gain (loss) for non-marketable equity securities $ 1,791 $ 1,531 During the year ended December 31, 2020, included in the $ 18.9 billion of non-marketable equity securities, $ 9.7 billion were measured at fair value resulting in a net unrealized gain of $ 1.5 billion. Equity securities accounted for under the Equity Method As of December 31, 2019 and 2020, equity securities accounted for under the equity method had a carrying value of approximately $ 1.3 billion and $ 1.4 billion, respectively. Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We enter into derivative instruments to manage risks relating to our ongoing business operations. The primary risk managed with derivative instruments is foreign exchange risk. We use foreign currency contracts to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also enter into derivative instruments to partially offset our exposure to other risks and enhance investment returns. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value and classify the derivatives primarily within Level 2 in the fair value hierarchy. We present our collar contracts (an option strategy comprised of a combination of purchased and written options) at net fair values where both the purchased and written options are with the same counterparty. For other derivative contracts, we present at gross fair values. We primarily record changes in the fair value in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. Further, we enter into collateral security arrangements that provide for collateral to be received or pledged when the net fair value of certain financial instruments fluctuates from contractually established thresholds. Cash collateral received related to derivative instruments under our collateral security arrangements are included in other current assets with a corresponding liability. Cash and non-cash Alphabet Inc. collateral pledged related to derivative instruments under our collateral security arrangements are included in other current assets. Cash Flow Hedges We designate foreign currency forward and option contracts (including collars) as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. These contracts have maturities of 24 months or less. Cash flow hedge amounts included in the assessment of hedge effectiveness are deferred in AOCI and subsequently reclassified to revenue when the hedged item is recognized in earnings. We exclude the change in forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are reclassified to other income (expense), net in the period of de-designation. As of December 31, 2020, the net accumulated loss on our foreign currency cash flow hedges before tax effect was $ 124 million, which is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We designate foreign currency forward contracts as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Fair value hedge amounts included in the assessment of hedge effectiveness are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Net Investment Hedges We designate foreign currency forward contracts as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. Net investment hedge amounts included in the assessment of hedge effectiveness are recognized in AOCI along with the foreign currency translation adjustment. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Other Derivatives Other derivatives not designated as hedging instruments consist primarily of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the functional currency of a subsidiary. Gains and losses on these contracts, as well as the related costs, are recognized in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. We also use derivatives not designated as hedging instruments to manage risks relating to interest rates, equity and commodity prices, credit exposures and to enhance investment returns. The gross notional amounts of our outstanding derivative instruments were as follows (in millions): As of December 31, 2019 As of December 31, 2020 Derivatives Designated as Hedging Instruments: Foreign exchange contracts Cash flow hedges $ 13,207 $ 10,187 Fair value hedges $ 455 $ 1,569 Net investment hedges $ 9,318 $ 9,965 Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts $ 43,497 $ 39,861 Other contracts $ 117 $ 2,399 Alphabet Inc. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2019 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 91 $ 253 $ 344 Other contracts Other current and non-current assets 0 1 1 Total $ 91 $ 254 $ 345 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 173 $ 196 $ 369 Other contracts Accrued expenses and other liabilities, current and non-current 0 13 13 Total $ 173 $ 209 $ 382 As of December 31, 2020 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 33 $ 316 $ 349 Other contracts Other current and non-current assets 0 16 16 Total $ 33 $ 332 $ 365 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 395 $ 185 $ 580 Other contracts Accrued expenses and other liabilities, current and non-current 0 942 942 Total $ 395 $ 1,127 $ 1,522 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (""OCI"") are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, 2018 2019 2020 Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ 332 $ 38 $ 102 Amount excluded from the assessment of effectiveness 26 ( 14 ) ( 37 ) Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness 136 131 ( 851 ) Total $ 494 $ 155 $ ( 786 ) Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, 2018 2019 2020 Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 136,819 $ 7,389 $ 161,857 $ 5,394 $ 182,527 $ 6,858 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ ( 139 ) $ 0 $ 367 $ 0 $ 144 $ 0 Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach 1 0 88 0 33 0 Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items 0 ( 96 ) 0 ( 19 ) 0 18 Derivatives designated as hedging instruments 0 96 0 19 0 ( 18 ) Amount excluded from the assessment of effectiveness 0 37 0 25 0 4 Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness 0 78 0 243 0 151 Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts 0 54 0 ( 413 ) 0 718 Other Contracts 0 0 0 0 0 ( 906 ) Total gains (losses) $ ( 138 ) $ 169 $ 455 $ ( 145 ) $ 177 $ ( 33 ) Offsetting of Derivatives The gross amounts of our derivative instruments subject to master netting arrangements with various counterparties, and cash and non-cash collateral received and pledged under such agreements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 366 $ ( 21 ) $ 345 $ ( 88 ) (1) $ ( 234 ) $ 0 $ 23 As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 397 $ ( 32 ) $ 365 $ ( 295 ) (1) $ ( 16 ) $ 0 $ 54 (1) The balances as of December 31, 2019 and 2020 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 403 $ ( 21 ) $ 382 $ ( 88 ) (2) $ 0 $ 0 $ 294 As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 1,554 $ ( 32 ) $ 1,522 $ ( 295 ) (2) $ ( 1 ) $ ( 943 ) $ 283 (2) The balances as of December 31, 2019 and 2020 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating and finance lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2021 and 2063. Components of operating lease expense were as follows (in millions): Year Ended December 31, 2019 2020 Operating lease cost $ 1,820 $ 2,267 Variable lease cost 541 619 Total operating lease cost $ 2,361 $ 2,886 Alphabet Inc. Supplemental information related to operating leases is as follows (in millions): Year Ended December 31, 2019 2020 Cash payments for operating leases $ 1,661 $ 2,004 New operating lease assets obtained in exchange for operating lease liabilities $ 4,391 $ 2,765 As of December 31, 2020, our operating leases had a weighted average remaining lease term of 9 years and a weighted average discount rate of 2.6 %. Future lease payments under operating leases as of December 31, 2020 were as follows (in millions): 2021 $ 2,198 2022 2,170 2023 1,995 2024 1,738 2025 1,389 Thereafter 5,601 Total future lease payments 15,091 Less imputed interest ( 2,251 ) Total lease liability balance $ 12,840 As of December 31, 2020, we have entered into leases that have not yet commenced with future lease payments of $ 8.0 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2021 and 2026 with non-cancelable lease terms of 1 to 25 years. Note 5. Variable Interest Entities Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2019 and 2020, assets that can only be used to settle obligations of these VIEs were $ 3.1 billion and $ 5.7 billion, respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 1.2 billion and $ 2.3 billion, respectively. Total noncontrolling interests (""NCI""), including redeemable noncontrolling interests (""RNCI""), in our consolidated subsidiaries increased from $ 1.2 billion to $ 3.9 billion f rom December 31, 2019 to December 31, 2020, primarily due to external investments in Waymo. NCI and RNCI are included within additional paid-in capital. Net loss attributable to noncontrolling interests was not material for any period presented and is included within other income (expense), net. Waymo Waymo is an autonomous driving technology development company with a mission to make it safe and easy for people and things to get where they're going. In the first half of 2020, Waymo completed an externally led investment round raising in total $ 3.2 billion, which includes investment from Alphabet. No gain or loss was recognized. The investments related to external parties were accounted for as equity transactions and resulted in recognition of noncontrolling interests. Unconsolidated VIEs We have investments in some VIEs in which we are not the primary beneficiary. These VIEs include private companies that are primarily early stage companies and certain renewable energy entities in which activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we are not the primary beneficiary, and the results of operations and financial position of these VIEs are not included in our consolidated financial statements. We account for these investments as non-marketable equity investments or equity method investments. Alphabet Inc. VIEs are generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these VIEs is our capital investments in them. The carrying value and maximum exposure of these unconsolidated VIEs were not material as of December 31, 2019 and 2020. Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2019 and 2020. Our short-term debt balance also includes the current portion of certain long-term debt. Long-Term Debt In August 2020, Alphabet issued $ 10.0 billion of fixed-rate senior unsecured notes in six tranches (collectively, 2020 Notes): $ 1.0 billion due in 2025, $ 1.0 billion due in 2027, $ 2.25 billion due in 2030, $ 1.25 billion due in 2040, $ 2.5 billion due in 2050 and $ 2.0 billion due in 2060. The 2020 Notes had a weighted average duration of 21.5 years and weighted average coupon rate of 1.57 %. Of the total issuance, $ 5.75 billion was designated as Sustainability Bonds, the net proceeds of which are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. The remaining net proceeds are used for general corporate purposes. The total outstanding debt is summarized below (in millions, except percentages): Maturity Coupon Rate Effective Interest Rate As of December 31, 2019 As of December 31, 2020 Debt 2011-2016 Notes Issuances 2021 - 2026 2.00 % - 3.63 % 2.23 % - 3.73 % $ 4,000 $ 4,000 2020 Notes Issuance 2025 - 2060 0.45 % - 2.25 % 0.57 % - 2.33 % 0 10,000 Future finance lease payments, net (1) 711 1,201 Total debt 4,711 15,201 Unamortized discount and debt issuance costs ( 42 ) ( 169 ) Less: Current portion of Notes (2) 0 ( 999 ) Less: Current portion future finance lease payments, net (1)(2) ( 115 ) ( 101 ) Total long-term debt $ 4,554 $ 13,932 (1) Net of imputed interest. (2) Total current portion of long-term debt is included within other accrued expenses and current liabilities. See Note 7. The notes in the table above are comprised of fixed-rate senior unsecured obligations and generally rank equally with each other. We may redeem the notes at any time in whole or in part at specified redemption prices. The effective interest rates are based on proceeds received with interest payable semi-annually. The total estimated fair value of the outstanding notes, including the current portion, was approximately $ 4.1 billion and $ 14.0 billion as of December 31, 2019 and December 31, 2020, respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. Alphabet Inc. As of December 31, 2020, the aggregate future principal payments for long-term debt, including finance lease liabilities, for each of the next five years and thereafter are as follows (in millions): 2021 $ 1,104 2022 86 2023 86 2024 1,087 2025 1,088 Thereafter 11,868 Total $ 15,319 Credit Facility As of December 31, 2020, we have $ 4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2019 and 2020. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2019 As of December 31, 2020 Land and buildings $ 39,865 $ 49,732 Information technology assets 36,840 45,906 Construction in progress 21,036 23,111 Leasehold improvements 6,310 7,516 Furniture and fixtures 156 197 Property and equipment, gross 104,207 126,462 Less: accumulated depreciation ( 30,561 ) ( 41,713 ) Property and equipment, net $ 73,646 $ 84,749 Accrued expenses and other current liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2019 As of December 31, 2020 European Commission fines (1) $ 9,405 $ 10,409 Accrued customer liabilities 2,245 3,118 Accrued purchases of property and equipment 2,411 2,197 Current operating lease liabilities 1,199 1,694 Other accrued expenses and current liabilities 7,807 11,213 Accrued expenses and other current liabilities $ 23,067 $ 28,631 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2017 $ ( 1,103 ) $ 233 $ ( 122 ) $ ( 992 ) Cumulative effect of accounting change 0 ( 98 ) 0 ( 98 ) Other comprehensive income (loss) before reclassifications ( 781 ) 88 264 ( 429 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 26 26 Amounts reclassified from AOCI 0 ( 911 ) 98 ( 813 ) Other comprehensive income (loss) ( 781 ) ( 823 ) 388 ( 1,216 ) Balance as of December 31, 2018 ( 1,884 ) ( 688 ) 266 ( 2,306 ) Cumulative effect of accounting change 0 0 ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 36 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 14 ) ( 14 ) Amounts reclassified from AOCI 0 ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 ( 2,003 ) 812 ( 41 ) ( 1,232 ) Other comprehensive income (loss) before reclassifications 1,139 1,313 79 2,531 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 37 ) ( 37 ) Amounts reclassified from AOCI 0 ( 513 ) ( 116 ) ( 629 ) Other comprehensive income (loss) 1,139 800 ( 74 ) 1,865 Balance as of December 31, 2020 $ ( 864 ) $ 1,612 $ ( 115 ) $ 633 The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location 2018 2019 2020 Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ 1,190 $ 149 $ 650 Benefit (provision) for income taxes ( 279 ) ( 38 ) ( 137 ) Net of tax 911 111 513 Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue ( 139 ) 367 144 Interest rate contracts Other income (expense), net 6 6 6 Benefit (provision) for income taxes 35 ( 74 ) ( 34 ) Net of tax ( 98 ) 299 116 Total amount reclassified, net of tax $ 813 $ 410 $ 629 Alphabet Inc. Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, 2018 2019 2020 Interest income $ 1,878 $ 2,427 $ 1,865 Interest expense (1) ( 114 ) ( 100 ) ( 135 ) Foreign currency exchange gain (loss), net (2) ( 80 ) 103 ( 344 ) Gain (loss) on debt securities, net (3) 1,190 149 725 Gain (loss) on equity securities, net 5,460 2,649 5,592 Performance fees ( 1,203 ) ( 326 ) ( 609 ) Income (loss) and impairment from equity method investments, net ( 120 ) 390 401 Other (4) 378 102 ( 637 ) Other income (expense), net $ 7,389 $ 5,394 $ 6,858 (1) Interest expense is net of interest capitalized of $ 92 million, $ 167 million, and $ 218 million for the years ended December 31, 2018, 2019, and 2020, respectively. (2) Our foreign currency exchange gain (loss), net, is primarily related to the forward points for our foreign currency hedging contracts and foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contracts' losses and gains. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $ 1.3 billion gain. (4) During the year ended December 31, 2020, we entered into derivatives that hedged the changes in fair value of certain marketable equity securities, which resulted in a $ 902 million loss. The offsetting recognized gains on the marketable equity securities are reflected in Gain (loss) on equity securities, net. Note 8. Acquisitions 2020 Acquisitions During the year ended December 31, 2020, we completed acquisitions and purchases of intangible assets for total consideration of approximately $ 744 million, net of cash acquired. In aggregate, $ 248 million was attributed to intangible assets, $ 446 million to goodwill and $ 50 million to net assets acquired. These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. Pro forma results of operations for these acquisitions have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2020, patents and developed technology have a weighted-average useful life of 4.1 years, customer relationships have a weighted-average useful life of 4.7 years, and trade names and other have a weighted-average useful life of 4.6 years. Acquisition of Fitbit In January 2021, we closed the acquisition of Fitbit, a leading wearables brand for $ 2.1 billion. Alphabet Inc. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2020 were as follows (in millions): Google Google Services Google Cloud Other Bets Total Balance as of December 31, 2018 $ 17,521 $ 0 $ 0 $ 367 $ 17,888 Acquisitions 2,353 0 0 475 2,828 Transfers 9 0 0 ( 9 ) 0 Foreign currency translation and other adjustments 38 0 0 ( 130 ) ( 92 ) Balance as of December 31, 2019 19,921 0 0 703 20,624 Acquisitions 204 0 0 0 204 Foreign currency translation and other adjustments 46 0 0 ( 4 ) 42 Allocation in the fourth quarter of 2020 (1) ( 20,171 ) 18,408 1,763 0 0 Acquisitions 0 53 189 0 242 Foreign currency translation and other adjustments 0 56 5 2 63 Balance as of December 31, 2020 $ 0 $ 18,517 $ 1,957 $ 701 $ 21,175 (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2020. See Note 15 for further details Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 4,972 $ 3,570 $ 1,402 Customer relationships 254 30 224 Trade names and other 703 350 353 Total $ 5,929 $ 3,950 $ 1,979 As of December 31, 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,639 $ 3,649 $ 990 Customer relationships 266 49 217 Trade names and other 699 461 238 Total $ 5,604 $ 4,159 $ 1,445 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 1.6 years, 4.9 years, and 2.1 years, respectively. Amortization expense relating to purchased intangible assets was $ 865 million, $ 795 million, and $ 774 million for the years ended December 31, 2018, 2019, and 2020, respectively. Alphabet Inc. As of December 31, 2020, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): 2021 $ 719 2022 375 2023 104 2024 78 2025 53 Thereafter 116 $ 1,445 Note 10. Commitments and Contingencies Purchase Obligations As of December 31, 2020, we had $ 10.7 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, information technology assets and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, customers of Google Cloud offerings, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2020, we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ($ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search partners' agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. Alphabet Inc. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. From time to time we are subject to formal and informal inquiries and investigations on competition matters by regulatory authorities in the United States, Europe, and other jurisdictions. For example, in August 2019, we began receiving civil investigative demands from the U.S. Department of Justice (""DOJ"") requesting information and documents relating to our prior antitrust investigations and certain aspects of our business. The DOJ and a number of state Attorneys General filed a lawsuit on October 20, 2020 alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the United States District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. We believe these complaints are without merit and will defend ourselves vigorously. The DOJ and state Attorneys General continue their investigations into certain aspects of our business. We continue to cooperate with federal and state regulators in the United States, and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices, and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (""ITC"") has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (""Oracle"") brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. The Supreme Court heard oral arguments in our case on October 7, 2020. If the Supreme Court does not rule in our favor, the case will be remanded to the district court for further determination of the remaining issues in the case, including damages, if any. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral related civil litigation or other adverse consequences, all of which could harm our business, reputation, financial condition, and operating results. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we Alphabet Inc. disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14. Note 11. Stockholders' Equity Convertible Preferred Stock Our Board of Directors has authorized 100 million shares of convertible preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2019 and 2020, no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our Board of Directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In July 2020, the Board of Directors of Alphabet authorized the company to repurchase up to an additional $ 28.0 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2019 and 2020, we repurchased and subsequently retired 15.3 million and 21.5 million shares of Alphabet Class C capital stock for an aggregate amount of $ 18.4 billion and $ 31.1 billion, respectively. Note 12. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of Alphabet Inc. safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our Board of Directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our Board of Directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2018, 2019 and 2020, the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, 2018 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 0 0 Reallocation of undistributed earnings ( 146 ) ( 24 ) 146 Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 0 0 Restricted stock units and other contingently issuable shares 689 0 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Alphabet Inc. Year Ended December 31, 2019 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 0 0 Reallocation of undistributed earnings ( 126 ) ( 20 ) 126 Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,527 0 0 Restricted stock units and other contingently issuable shares 413 0 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Year Ended December 31, 2020 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 17,733 $ 2,732 $ 19,804 Denominator Number of shares used in per share computation 299,815 46,182 334,819 Basic net income per share $ 59.15 $ 59.15 $ 59.15 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 17,733 $ 2,732 $ 19,804 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,732 0 0 Reallocation of undistributed earnings ( 180 ) ( 25 ) 180 Allocation of undistributed earnings $ 20,285 $ 2,707 $ 19,984 Denominator Number of shares used in basic computation 299,815 46,182 334,819 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,182 0 0 Restricted stock units and other contingently issuable shares 87 0 6,125 Number of shares used in per share computation 346,084 46,182 340,944 Diluted net income per share $ 58.61 $ 58.61 $ 58.61 Alphabet Inc. Note 13. Compensation Plans Stock Plans Our stock plans include the Alphabet 2012 Stock Plan and Other Bet stock-based plans. Under our stock plans, RSUs and other types of awards may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. RSUs granted to participants under the Alphabet 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2020, there were 38,777,813 shares of stock reserved for future issuance under our Alphabet 2012 Stock Plan. Stock-Based Compensation For the years ended December 31, 2018, 2019 and 2020, total stock-based compensation expense was $ 10.0 billion, $ 11.7 billion and $ 13.4 billion, including amounts associated with awards we expect to settle in Alphabet stock of $ 9.4 billion, $ 10.8 billion, and $ 12.8 billion, respectively. For the years ended December 31, 2018, 2019 and 2020, we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.5 billion, $ 1.8 billion, and $ 2.7 billion, respectively. For the years ended December 31, 2018, 2019 and 2020, tax benefit realized related to awards vested or exercised during the period was $ 2.1 billion, $ 2.2 billion and $ 3.6 billion, respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Stock-Based Award Activities The following table summarizes the activities for our unvested Alphabet RSUs for the year ended December 31, 2020: Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2019 19,394,236 $ 1,055.22 Granted 12,647,562 1,407.97 Vested ( 11,643,670 ) 1,089.31 Forfeited/canceled ( 1,109,335 ) 1,160.01 Unvested as of December 31, 2020 19,288,793 $ 1,262.13 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2018 and 2019, was $ 1,095.89 and $ 1,092.36 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2018, 2019, and 2020 were $ 14.1 billion, $ 15.2 billion, and $ 17.8 billion, respectively. As of December 31, 2020, there was $ 22.8 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.6 years. 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 691 million, $ 724 million, and $ 855 million for the years ended December 31, 2018, 2019, and 2020, respectively. Note 14. Income Taxes Income from continuing operations before income taxes consists of the following (in millions): Year Ended December 31, 2018 2019 2020 Domestic operations $ 15,779 $ 16,426 $ 37,576 Foreign operations 19,134 23,199 10,506 Total $ 34,913 $ 39,625 $ 48,082 Alphabet Inc. The provision for income taxes consists of the following (in millions): Year Ended December 31, 2018 2019 2020 Current: Federal and state $ 2,153 $ 2,424 $ 4,789 Foreign 1,251 2,713 1,687 Total 3,404 5,137 6,476 Deferred: Federal and state 907 286 1,552 Foreign ( 134 ) ( 141 ) ( 215 ) Total 773 145 1,337 Provision for income taxes $ 4,177 $ 5,282 $ 7,813 The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, 2018 2019 2020 U.S. federal statutory tax rate 21.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 4.4 ) ( 4.9 ) ( 0.3 ) Foreign-derived intangible income deduction ( 0.5 ) ( 0.7 ) ( 3.0 ) Stock-based compensation expense ( 2.2 ) ( 0.7 ) ( 1.7 ) Federal research credit ( 2.4 ) ( 2.5 ) ( 2.3 ) Impact of the Tax Cuts and Jobs Act ( 1.3 ) ( 0.6 ) 0.0 European Commission fines 3.1 1.0 0.0 Deferred tax asset valuation allowance ( 2.0 ) 0.0 1.4 State and local income taxes ( 0.4 ) 1.1 1.1 Other adjustments 1.1 ( 0.4 ) 0.0 Effective tax rate 12.0 % 13.3 % 16.2 % Our effective tax rate for 2018 and 2019 was affected significantly by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate because substantially all of the income from foreign operations was earned by an Irish subsidiary. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the United States Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. In 2020, there was an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, 2019 2020 Deferred tax assets: Stock-based compensation expense $ 421 $ 518 Accrued employee benefits 463 580 Accruals and reserves not currently deductible 1,047 1,049 Tax credits 3,264 3,723 Net operating losses 771 1,085 Operating leases 1,876 2,620 Intangible assets 164 1,525 Other 226 463 Total deferred tax assets 8,232 11,563 Valuation allowance ( 3,502 ) ( 4,823 ) Total deferred tax assets net of valuation allowance 4,730 6,740 Deferred tax liabilities: Property and equipment, net ( 1,798 ) ( 3,382 ) Renewable energy investments ( 466 ) ( 415 ) Foreign Earnings ( 373 ) ( 383 ) Net investment gains ( 1,074 ) ( 1,901 ) Operating leases ( 1,619 ) ( 2,354 ) Other ( 380 ) ( 782 ) Total deferred tax liabilities ( 5,710 ) ( 9,217 ) Net deferred tax assets (liabilities) $ ( 980 ) $ ( 2,477 ) As of December 31, 2020, our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $ 3.1 billion, $ 3.1 billion, and $ 1.4 billion respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2023, foreign net operating loss carryforwards will begin to expire in 2024 and the state net operating loss carryforwards will begin to expire in 2028. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2020, our California research and development credit carryforwards for income tax purposes were approximately $ 3.7 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2020, we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits, net deferred tax assets relating to certain of our Other Bets, and certain foreign net operating losses that we believe are not likely to be realized. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, 2018 2019 2020 Beginning gross unrecognized tax benefits $ 4,696 $ 4,652 $ 3,377 Increases related to prior year tax positions 321 938 372 Decreases related to prior year tax positions ( 623 ) ( 143 ) ( 557 ) Decreases related to settlement with tax authorities ( 191 ) ( 2,886 ) ( 45 ) Increases related to current year tax positions 449 816 690 Ending gross unrecognized tax benefits $ 4,652 $ 3,377 $ 3,837 The total amount of gross unrecognized tax benefits was $ 4.7 billion, $ 3.4 billion, and $ 3.8 billion as of December 31, 2018, 2019, and 2020, respectively, of which, $ 2.9 billion, $ 2.3 billion, and $ 2.6 billion, if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2019 was primarily as a result of the resolution of multi-year audits. As of December 31, 2019 and 2020, we accrued $ 130 million and $ 222 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2011 through 2019 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, we do not believe it is reasonably possible that our unrecognized tax benefits will materially change in the next 12 months. Note 15. Information about Segments and Geographic Areas Beginning in the fourth quarter of 2020, we report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues primarily from fees received for Google Cloud Platform services and Google Workspace (formerly known as G Suite) collaboration tools. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from the Other Bets are derived primarily through the sale of internet services as well as licensing and RD services. Revenues and certain costs, such as costs associated with content and traffic acquisition, certain engineering, and hardware costs and other operating expenses, are directly attributable to our segments. Due to the integrated nature of Alphabet, other costs and expenses, such as technical infrastructure and office facilities, are managed Alphabet Inc. centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including fines and settlements, as well as costs associated with certain shared research and development activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. Information about segments during the periods presented were as follows (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2018 2019 2020 Revenues: Google Services $ 130,524 $ 151,825 $ 168,635 Google Cloud 5,838 8,918 13,059 Other Bets 595 659 657 Hedging gains (losses) ( 138 ) 455 176 Total revenues $ 136,819 $ 161,857 $ 182,527 Operating income (loss): Google Services $ 43,137 $ 48,999 $ 54,606 Google Cloud ( 4,348 ) ( 4,645 ) ( 5,607 ) Other Bets ( 3,358 ) ( 4,824 ) ( 4,476 ) Corporate costs, unallocated (1) ( 7,907 ) ( 5,299 ) ( 3,299 ) Total income from operations $ 27,524 $ 34,231 $ 41,224 (1) Corporate costs, unallocated includes a fine of $ 5.1 billion for the year ended December 31, 2018 and a fine and legal settlement totaling $ 2.3 billion for the year ended December 31, 2019. For revenues by geography, see Note 2. The following table presents certain of our long-lived assets by geographic area, which includes property and equipment, net and operating lease assets (in millions). As of December 31, 2019 As of December 31, 2020 Long-lived assets: United States $ 63,102 $ 69,315 International 21,485 27,645 Total long-lived assets $ 84,587 $ 96,960 Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2020, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management and provide timely information to our management team. The implementation is expected to occur in phases over the next several years. The initial phase, which included changes to our general ledger and consolidated financial reporting systems, was completed during the third quarter of 2020. There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures, which in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2020 . While pre-existing controls were not specifically designed to operate in our current work from home operating environment, we believe that our internal controls over financial reporting continue to be effective. We have continued to re-evaluate and refine our financial reporting process to provide reasonable assurance that we could report our financial results accurately and timely. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2020. Management reviewed the results of its assessment with our Audit and Compliance Committee. The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +12,Alphabet Inc.,2019," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history inspiring us to do things like tackling deep computer science problems, such as our investments in artificial intelligence (AI) and quantum computing. Alphabet is a collection of businesses the largest of which is Google. We report all non-Google businesses collectively as Other Bets. Our Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Each of our businesses are designed to prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. Today, our mission to organize the worlds information and make it universally accessible and useful is as relevant as it was when we were founded in 1998. Since then, weve evolved from a company that helps people find answers to a company that helps you get things done. Were focused on building an even more helpful Google for everyone. We aspire to give everyone the tools they need to increase their knowledge, health, happiness, and success. Across Google, we're focused on continually innovating in areas where technology can have an impact on peoples lives. Our work in AI is helping to produce earlier and more precise flood warnings. Were also working hard to make sure that our products are accessible to the more than one billion individuals around the world with a disability. For example, Android 10 has automatic Live Captions for videos, podcasts and voicemails to make it easier to consume information on the phone. Our Other Bets are also pursuing initiatives with similar goals. For instance, as a part of our efforts in the Metro Phoenix area, Waymo is working toward our goal of making transportation safer and easier for everyone while Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and AI are increasingly driving many of our latest innovations. Within Google, our investments in machine learning over a decade have enabled us to build products that are smarter and more helpful. For example, our investments in AI are enabling doctors to detect cancer earlier. Machine learning powers the Google Assistant and many of our newer technologies. Google Serving our users We have always been a company committed to building products that have the potential to improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google's core products and platforms, such as Android, Chrome, Gmail, Google Drive, Google Maps, Google Play, Search, and YouTube each have over one billion monthly active users. As the majority of Alphabets big bets continue to reside within Google, an important benefit of the shift to Alphabet has been the tremendous focus that were able to have on Googles many extraordinary opportunities. Our products have come a long way since the company was founded more than two decades ago. Instead of just showing ten blue links in our search results, we are increasingly able to provide direct answers even if you're speaking your question using Voice Search which makes it quicker, easier and more natural to find what you're looking for. With Google Lens, you can use your phones camera to identify an unfamiliar landmark or find a trailer Alphabet Inc. from a movie poster. Over time, we have also added other services that let you access information quickly and easily like Google Maps, which helps you navigate to a store while showing you current traffic conditions, or Google Photos, which helps you store and organize your photos. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. And with the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, and Daydream virtual reality platform, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of Google's AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 4 phones and the Google Nest Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Key to building helpful products for users is our commitment to keeping their data safe online. As the Internet evolves, we continue to invest in our industry-leading security technologies and privacy tools, such as the addition of auto-delete controls to enable users to automatically delete activity after 3 or 18 months and incognito mode in YouTube and Maps. Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics and AI. We see significant opportunity in helping businesses enhance these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and G Suite. Google Cloud Platform enables developers to build, test, and deploy applications on Googles highly scalable and reliable infrastructure. Our G Suite productivity tools which include apps like Gmail, Docs, Drive, Calendar, and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. How we make money The goal of our advertising products is to deliver relevant ads at just the right time and to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across devices and formats. We generate revenues primarily by delivering both performance advertising and brand advertising. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google properties and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have built a world-class ad technology platform for advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blacklisting them when necessary to ensure that ads do not fund bad content. Alphabet Inc. We continue to look to the future and are making long-term investments that will grow revenues beyond advertising, including Google Cloud, Google Play, hardware, and YouTube. We are also investing in research efforts in AI and quantum computing to foster innovation across our businesses and create new opportunities . Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets investment in our portfolio of Other Bets include emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues are primarily generated from internet and TV services, as well as licensing and RD services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in our portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Apple, ATT, Disney, Facebook, Hulu, Netflix and TikTok. In businesses that are further afield from our advertising business, we compete with companies that have longer operating histories and more established relationships with customers and users. We face competition from: Other digital content and application platform providers, such as Amazon and Apple. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Intellectual Property Alphabet Inc. We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Culture and Employees We take great pride in our culture. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex technical challenges. Transparency and open dialogue are central to how we work, and we aim to ensure that company news reaches our employees first through internal channels. Despite our rapid growth, we still cherish our roots as a startup and wherever possible empower employees to act on great ideas regardless of their role or function within the company. We strive to hire great employees, with backgrounds and perspectives as diverse as those of our global users. We work to provide an environment where these talented people can have fulfilling careers addressing some of the biggest challenges in technology and society. Our employees are among our best assets and are critical for our continued success. We expect to continue investing in hiring talented employees and to provide competitive compensation programs to our employees. As of December 31, 2019 , we had 118,899 full-time employees. Although we have work councils and statutory employee representation obligations in certain countries, our U.S. employees are not represented by a labor union. Competition for qualified personnel in our industry is intense, particularly for software engineers, computer scientists, and other technical staff. Ongoing Commitment to Sustainability We strive to build sustainability into everything we do from designing and operating efficient data centers, advancing carbon-free energy, creating sustainable workplaces, building better devices and services, empowering users with technology, and enabling a responsible supply chain. Google has been carbon neutral since 2007 and we are the largest corporate purchaser of renewable energy in the world. In 2018, for the second consecutive year, we matched 100% of our electricity consumption with renewable energy purchases, as reported in our 2019 Environmental Report. Some other 2019 highlights and achievements include: We made our largest corporate purchase of renewable energy: 18 new energy deals totaling 1,600 megawatts, which is anticipated to spur the construction of more than $2 billion in new energy infrastructure. 100% of Nest products launched in 2019 include recycled plastic content and we launched carbon neutral shipping for Googles direct customers who buy a product on Google Shopping or purchase Made by Google hardware. The Environmental Insights Explorer is enabling municipalities which represent more than 70% of global greenhouse gas emissions according to the 2016 United Nations Habitat World Cities Report to estimate emissions and develop climate action plans. In 2019, we expanded this tool to more than 100 cities worldwide. We believe that climate change is one of the most significant global challenges of our time. In 2017, we developed a climate resilience strategy, which included conducting a climate scenario analysis. We have been on CDPs (formerly the Carbon Disclosure Project) Climate Change A list for five consecutive years. We believe our CDP report reflects the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). More information on Google's approach to sustainability can be found in our annual sustainability reports. The content of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. Alphabet Inc. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, which may be of interest or material to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generated over 83% of total revenues from the display of ads online in 2019. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising policies or practices may affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions can also have a material negative effect on the demand for advertising and cause our advertisers to reduce the amounts they spend on advertising, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Our competitors may be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. For example, we are investing significantly in subscription-based products and services such as YouTube, which face intense competition from large experienced companies with well established relationships with users. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors Alphabet Inc. are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could disrupt our current operations and harm our financial condition and operating results. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of management resources and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google, we continue to invest heavily in hardware, including our smartphones and home devices, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. We are also devoting significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and G Suite. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale the Cloud salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large experienced and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use artificial intelligence and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition , and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, Google Play, gaming, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix, property mix, and partner agreements can affect margin. The margin we earn on revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners as well as increased content acquisition costs to content providers. We may also face an increase in infrastructure costs, supporting businesses such as Search, Google Cloud, and YouTube. Additionally, our spend to promote new products and services or distribute certain products and services or increased investment in our innovation efforts across Google and our Other Bets businesses may affect our operating margins. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Alphabet Inc. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of misinformation or objectionable content on our services or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Our brands may also be negatively affected by the use of our products or services to disseminate information that is deemed to be false or misleading. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that, if not properly managed, could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our assemblies and finished products, to design certain of our components and parts, and to participate in the distribution of our products and services. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We may experience supply shortages and price increases driven by raw material availability, manufacturing capacity, labor shortages, industry allocations, tariffs, trade disputes and barriers, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We may experience shortages or other supply chain disruptions that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available only from a single source or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant hardware supply interruption could delay critical data center upgrades or expansions. Alphabet Inc. We may enter into long term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because many of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Our products and services may have quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property, could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption, interference with, or failure of our information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, complications with the design or implementation of our new global enterprise resource planning (ERP) system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from terrorist attacks, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, closure of a facility, or other unanticipated problems at our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. We may not be able to successfully implement the ERP system without experiencing delays, increased costs, and other difficulties. Failure to successfully design and implement the new ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2019. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Alphabet Inc. Import and export requirements, tariffs, trade disputes and barriers, and customs classifications that may prevent us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign events, including Brexit, the United Kingdom's withdrawal from the European Union (EU). Brexit may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom), in addition to other adverse effects that we are unable to effectively anticipate. Anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these new interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on these new interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations regarding privacy and data change. Our products and services involve the storage and transmission of proprietary information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users or customers. We expect to continue to expend significant resources to maintain security protections that shield against bugs, theft, misuse, or security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. We may experience future security issues, whether due to employee error or malfeasance or system errors or Alphabet Inc. vulnerabilities in our or other parties systems, which could result in significant legal and financial exposure. Government inquiries and enforcement actions, litigation, and adverse press coverage could harm our business. We may be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Attacks and security issues could also compromise trade secrets and other sensitive information, harming our business. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to mitigate cyber attacks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigations and review of platform applications that could access the information of users of our services. As a result of these efforts, we could discover incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, and we may be notified of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading disinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and invalid traffic, we may be unable to adequately detect and prevent such abuses. Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts (known as web spam) may affect the quality of content on our platforms and lead them to display false, misleading or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on low-quality websites. If we fail to detect and prevent an increase in problematic content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Alphabet Inc. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in 2018 the United States Federal Communications Commission repealed net neutrality rules, which could lead internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. Such interference could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our business. Risks Related to Laws and Regulations We are subject to increasing regulatory scrutiny as well as changes in public policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry are experiencing increased regulatory scrutiny. For instance, various regulatory agencies, including competition, consumer protection, and privacy authorities, are reviewing aspects of our products and services. We continue to cooperate with these investigations. Prior, existing, and new investigations have in the past and may in the future result in substantial fines and penalties, changes to our products and services, alterations to our business operations, and civil litigation, all of which could harm our business, reputation, financial condition, and operating results. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics may increase our cost of doing business, limit our ability to pursue certain business models or offer certain products or services, and cause us to change our business practices. Further, our investment in a variety of new fields, including the health industry and payment services, also raises a number of new regulatory issues. These factors could harm our business and operating results in material ways. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices) may make our products and services less useful, limit our ability to pursue certain business models or offer certain products and services, require us to incur substantial costs, expose us to unanticipated civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: Competition laws and regulations around the world. Privacy laws, such as the California Consumer Privacy Act of 2018 that came into effect in January of 2020, which gives new data privacy rights to California residents, and SB-327 in California, which regulates the security of data in connection with internet connected devices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. Copyright laws, such as the EU Directive on Copyright in the Digital Single Market (EUCD) of April 17, 2019, which increases the liability of content-sharing services with respect to content uploaded by their users. It has also created a new property right in news publications that will limit the ability of some online services to interact with or present such content. Each EU Member State must implement the EUCD by June 7, 2021. In addition, there are new constraining licensing regimes that limit our ability to operate with respect to copyright protected works. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Alphabet Inc. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. Court decisions that require Google to remove links not just in the jurisdiction of the issuing court, but for all versions of the search engine worldwide, including in locations where the content at issue is lawful, may limit the content we can show to our users and impose significant operational burdens. The Supreme Court of Canada issued such a decision against Google in June 2017, and others could treat its decision as persuasive. With respect to the right to be forgotten, a follow-up case of the CJEU on September 24, 2019 ruled that a search engine operator is not required to remove links from all versions of the search engine worldwide, but the court also noted in some cases, removal of links from all versions of the search engine available from the EU (including non-EU specific versions) may be required. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take may subject us to additional laws and regulations. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, and other proceedings that may harm our business, financial condition, and operating results. We are subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as Google Cloud offerings, we may also be subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental impacts, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled both within the U.S. and internationally. Claims have been brought against us for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. Alphabet Inc. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Adverse interpretations of these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation could result in fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business. Recent legal developments in Europe have created compliance uncertainty regarding transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. The GDPR creates a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment that involves substantial costs, and despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have a material adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland. However, these frameworks face a number of legal challenges and their validity remains subject to legal, regulatory, and political developments in both Europe and the U.S. The potential invalidation of data transfer mechanisms could have a significant adverse impact on our ability to process and transfer personal data outside of the EEA. These developments create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. We face, and may continue to face intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, hold large numbers of patents, copyrights, trademarks, and trade secrets and are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property Alphabet Inc. infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or that any share repurchase program will enhance long-term stockholder value, and share repurchases could increase the volatility of the price of our stock and could diminish our cash reserves. In January 2018, January 2019, and July 2019, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion , $12.5 billion , and $25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2018 and January 2019 authorizations were completed in 2019. As of December 31, 2019, $20.8 billion remains available for repurchase. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Our share repurchase program could affect the price of our stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2019, Larry Page and Sergey Brin beneficially owned approximately 84.3% of our outstanding Class B common stock, which represented approximately 51.2% of the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A common stock and our Class C capital stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of continuing the influence of Larry and Sergey. Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Alphabet Inc. Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us. General Risks Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly, year-to-date, and annual expenses as a percentage of our revenues may differ significantly from our historical rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this section in addition to the following factors may affect our operating results: Our ability to continue to attract and retain users and customers to our products and services. Our ability to attract user and/or customer adoption of, and generate significant revenues from, new products, services, and technologies in which we have invested considerable time and resources. Our ability to monetize traffic on Google properties and our Google Network Members' properties across various devices. Revenue fluctuations caused by changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix. The amount of revenues and expenses generated and incurred in currencies other than U.S. dollars, and our ability to manage the resulting risk through our foreign exchange risk management program. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Geopolitical events, including trade disputes. Changes in global business or macroeconomic conditions. Because our businesses are changing and evolving, our historical operating results may not be useful to you in predicting our future operating results. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully integrate and further develop the acquired business or technology. Alphabet Inc. Implementation or remediation of controls, procedures, and policies at the acquired company. Integration of the acquired companys accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology. He also plays a key role in maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, particularly in light of our holding company structure, adverse changes to our corporate culture could harm our business operations. In preparing our financial statements, we incorporate valuation methodologies that are subjective in nature and valuations may fluctuate over time. We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, require management judgment and estimation, and may change over time. Alphabet Inc. As it relates to our non-marketable investments, the market values can be negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying companies, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates that replace LIBOR, the effect of new or changing regulations, the stock market in general, or other factors. Since January 2018, we adjust the carrying value of our non-marketable equity investments to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could materially adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. In particular, France, Italy, and other countries have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapping international tax regimes. The Organization for Economic Cooperation and Development recently released a proposal relating to its initiative for modernizing international tax rules, with the goal of having different countries enact legislation to implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. For example, from January 1, 2019 through December 31, 2019, the closing price of our Class A common stock ranged from $1,025.47 per share to $1,362.47 per share, and the closing price of our Class C capital stock ranged from $1,016.06 to $1,361.17 per share. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others: Quarterly variations in our operating results or those of our competitors. Announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments. Recommendations by securities analysts or changes in earnings estimates. Announcements about our earnings that are not in line with analyst expectations, the risk of which is enhanced because it is our policy not to give guidance on earnings. Announcements by our competitors of their earnings that are not in line with analyst expectations. Alphabet Inc. Commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy. The volume of shares of Class A common stock and Class C capital stock available for public sale. Sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees). Short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock. The perceived values of Class A common stock and Class C capital stock relative to one another. Any share repurchase program. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which we believe is sufficient to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Note 10 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2019 , there were approximately 2,455 and 2,030 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2019 , there were approximately 66 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2019 : Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 1,970 $ 1,229.02 1,970 $ 24,470 November 1 - 30 1,626 $ 1,304.00 1,626 $ 22,350 December 1 - 31 1,164 $ 1,337.16 1,164 $ 20,793 Total 4,760 4,760 (1) In January and July 2019, the board of directors of Alphabet authorized the company to repurchase up to an additional $12.5 billion and $25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2019 authorization were completed during the fourth quarter of 2019. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2014 to December 31, 2019 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2014 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-Year total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2014 to December 31, 2019 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2014 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2017 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2018 Annual Report on Form 10-K, as amended. Trends in Our Business The following trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of these trends in order to maintain and grow our business. We generate our advertising revenues increasingly from different channels, including mobile, and newer advertising formats, and the margins from the advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners to increase as our revenues grow and to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; and the percentage of queries channeled through paid access points. We expect these trends to continue to put pressure on our overall margins and affect our revenue growth rates. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube engagement ads, which monetize at a lower rate than traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, and we continue to develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time and we expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could impact our margins as developing markets initially monetize at a lower rate than more mature markets. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. Alphabet Inc. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription and other services. The margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. In addition, our capital expenditures have grown over the last several years. We expect this trend to continue in the long term as we invest heavily in land and buildings for data centers and offices, and information technology infrastructure, which includes servers and network equipment . In addition, acquisitions remain an important part of our strategy and use of capital, and we expect to continue to spend cash on acquisitions and other investments. These acquisitions generally enhance the breadth and depth of our offerings, as well as expand our expertise in engineering and other functional areas. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. Executive Overview of Results Below are our key financial results for the fiscal year ended December 31, 2019 (consolidated unless otherwise noted): Revenues of $161.9 billion and revenue growth of 18% year over year, constant currency revenue growth of 20% year over year. Google segment revenues of $160.7 billion with revenue growth of 18% year over year and Other Bets revenues of $659 million with revenue growth of 11% year over year. Revenues from the United States , EMEA , APAC , and Other Americas were $74.8 billion , $50.6 billion , $26.9 billion , and $9.0 billion , respectively. Cost of revenues was $71.9 billion , consisting of TAC of $30.1 billion and other cost of revenues of $41.8 billion . Our TAC as a percentage of advertising revenues (TAC rate) was 22.3% . Operating expenses (excluding cost of revenues) were $55.7 billion . Income from operations was $34.2 billion . Other income (expense), net, was $5.4 billion . Effective tax rate was 13% . Net income was $34.3 billion with diluted net income per share of $49.16 . Operating cash flow was $54.5 billion . Capital expenditures were $23.5 billion . Number of employees was 118,899 as of December 31, 2019 . The majority of new hires during the year were engineers and product managers. By product area, the largest headcount additions were in Google Cloud and Search. Information about Segments We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Alphabet Inc. Our reported segments are: Google Google includes our main products such as ads, Android, Chrome, hardware, Google Cloud, Google Maps, Google Play, Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes Access, Calico, CapitalG, GV, Verily, Waymo, and X, among others. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Revenues The following table presents our revenues by segment and revenue source (in millions). Certain amounts in prior periods have been reclassified to conform with current period presentation. Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google properties 77,961 96,451 113,264 Google Network Members' properties 17,616 20,010 21,547 Google advertising 95,577 116,461 134,811 Google Cloud 4,056 5,838 8,918 Google other (1) 10,914 14,063 17,014 Google revenues 110,547 136,362 160,743 Other Bets revenues Hedging gains (losses) (169 ) (138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 (1) YouTube non-advertising revenues are included in Google other revenues. Google advertising revenues Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has been affected over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels; changes in our product mix; changes in advertising quality or formats and delivery; the evolution of the online advertising market; increasing competition; our investments in new business strategies; query growth rates; and shifts in the geographic mix of our revenues. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Alphabet Inc. The following table presents our Google advertising revenues (in millions): Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google Network Members' properties 17,616 20,010 21,547 Google advertising $ 95,577 $ 116,461 $ 134,811 Google advertising revenues as a percentage of Google segment revenues 86.5 % 85.4 % 83.9 % (1) YouTube non-advertising revenues are included in Google other revenues. Google advertising revenues are generated on our Google properties (including Google Search other properties and YouTube) and Google Network Members properties. Google advertising revenues consist primarily of the following: Google Search other consists of revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.) and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads consists of revenues generated primarily on YouTube properties; and Google Network Members' properties consist of revenues generated primarily on Google Network Members' properties participating in AdMob, AdSense, and Google Ad Manager. Google Search other Our Google Search other revenues increased $12,819 million from 2018 to 2019. The growth was primarily driven by interrelated factors including increases in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices, continued growth in advertiser activity, and improvements we have made in ad formats and delivery. Revenue growth was partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. Our Google Search other revenues increased $15,485 million from 2017 to 2018. The growth was primarily driven by increases in mobile search resulting from ongoing growth in user adoption and usage, as well as continued growth in advertiser activity. Growth was also driven by improvements in ad formats and delivery, primarily on desktop. Additionally, revenue growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. YouTube ads YouTube ads revenues increased $3,994 million from 2018 to 2019 and increased $3,005 million from 2017 to 2018. The largest contributors to the growth during both periods were our direct response and brand advertising products, both of which benefited from improvements to ad formats and delivery and increased advertiser spending. Google Network Members' properties Our Google Network Members' properties revenues increased $1,537 million from 2018 to 2019. The growth was primarily driven by strength in both AdManager (included in what was previously referred to as programmatic advertising buying) and AdMob, partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. Our Google Network Members' properties revenues increased $2,394 million from 2017 to 2018, primarily driven by strength in both AdMob and AdManager, offset by a decline in our traditional AdSense businesses. Additionally, the growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. Use of Monetization Metrics Paid clicks for our Google properties represent engagement by users and include clicks on advertisements by end-users related to searches on Google.com and other owned and operated properties including Gmail, Google Maps, and Google Play; and viewed YouTube engagement ads (certain YouTube ad formats are not included in our click or impression based metrics). Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense and Google Ad Manager. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Alphabet Inc. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google properties and the revenues generated by impression activity on Google Network Members properties. Google properties The following table presents changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, Paid clicks change % % Cost-per-click change (25 )% (7 )% The number of paid clicks through our advertising programs on Google properties increased from 2018 to 2019 due to growth in views of YouTube engagement ads; increase in clicks due to interrelated factors, including an increase in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was primarily driven by continued growth in YouTube engagement ads where cost-per-click remains lower than on our other advertising platforms. Cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google Network Members' properties The following table presents changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, Impressions change % % Cost-per-impression change % % Impressions increased from 2018 to 2019 primarily due to growth in AdManager. The cost-per-impression was relatively unchanged due to a combination of factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google Cloud The following table presents our Google Cloud revenues (in millions): Year Ended December 31, Google Cloud $ 4,056 $ 5,838 $ 8,918 Google Cloud revenues as a percentage of Google segment revenues 3.7 % 4.3 % 5.5 % Google Cloud revenues consist primarily of revenues from Cloud offerings, including Google Cloud Platform (GCP), which includes infrastructure, data and analytics, and other services G Suite productivity tools; and other enterprise cloud services. Our Google Cloud revenues increased $3,080 million from 2018 to 2019 and increased $1,782 million from 2017 to 2018. The growth during both periods was primarily driven by continued strength in our GCP and G Suite offerings. Our infrastructure and our data and analytics platform products have been the largest drivers of growth in GCP. Alphabet Inc. Google other revenues The following table presents our Google other revenues (in millions): Year Ended December 31, Google other 10,914 14,063 17,014 Google other revenues as a percentage of Google segment revenues 9.9 % 10.3 % 10.6 % Google other revenues consist primarily of revenues from: Google Play, which includes revenues from sales of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising, including YouTube Premium and YouTube TV subscriptions and other services; and other products and services. Our Google other revenues increased $2,951 million from 2018 to 2019. The growth was primarily driven by Google Play and YouTube subscriptions. Our Google other revenues increased $3,149 million from 2017 to 2018. The growth was primarily driven by Google Play and hardware. Over time, our growth rate for Google Cloud and Google other revenues may be affected by the seasonality associated with new product and service launches and market dynamics. Other Bets The following table presents our Other Bets revenues (in millions): Year Ended December 31, Other Bets revenues $ $ $ Other Bets revenues as a percentage of total revenues 0.4 % 0.4 % 0.4 % Other Bets revenues consist primarily of revenues from sales of Access internet and TV services and Verily licensing and RD services. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, United States % % EMEA % % APAC % % Other Americas % % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Growth The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and constant currency revenue growth for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (GAAP) results helps improve Alphabet Inc. the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue growth on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue growth (expressed as a percentage) is calculated by determining the increase in current period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions): Year Ended December 31, EMEA revenues $ 44,739 $ 50,645 Exclude foreign exchange effect on current period revenues using prior year rates (1,325 ) 2,397 EMEA constant currency revenues $ 43,414 $ 53,042 Prior period EMEA revenues $ 36,236 $ 44,739 EMEA revenue growth % % EMEA constant currency revenue growth % % APAC revenues $ 21,341 $ 26,928 Exclude foreign exchange effect on current period revenues using prior year rates (49 ) APAC constant currency revenues $ 21,292 $ 27,316 Prior period APAC revenues $ 16,192 $ 21,341 APAC revenue growth % % APAC constant currency revenue growth % % Other Americas revenues $ 7,608 $ 8,986 Exclude foreign exchange effect on current period revenues using prior year rates Other Americas constant currency revenues $ 8,012 $ 9,527 Prior period Other Americas revenues $ 6,147 $ 7,608 Other Americas revenue growth % % Other Americas constant currency revenue growth % % United States revenues $ 63,269 $ 74,843 United States revenue growth % % Hedging gains (losses) (138 ) Total revenues $ 136,819 $ 161,857 Total constant currency revenues $ 135,987 $ 164,728 Prior period revenues, excluding hedging effect (1) $ 111,024 $ 136,957 Total revenue growth % % Total constant currency revenue growth % % (1) Total revenues and hedging gains (losses) for the year ended December 31, 2017 were $110,855 million and $(169) million, respectively. Our EMEA revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Euro and British pound. Our APAC revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates primarily due to the U.S. dollar strengthening relative to the Australian dollar and South Korean won, partially offset by the U.S. dollar weakening relative to the Japanese yen. Our Other Americas revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Alphabet Inc. Costs and Expenses Cost of Revenues Cost of revenues consists of TAC which are paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues as a percentage of revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google properties because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expenses (including stock-based compensation (SBC)), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions): Year Ended December 31, TAC $ 26,726 $ 30,089 Other cost of revenues 32,823 41,807 Total cost of revenues $ 59,549 $ 71,896 Total cost of revenues as a percentage of revenues 43.5 % 44.4 % Cost of revenues increased $12,347 million from 2018 to 2019 . The increase was due to increases in other cost of revenues and TAC of $8,984 million and $3,363 million , respectively. The increase in other cost of revenues from 2018 to 2019 was due to an increase in data center and other operations costs. Additionally, there was an increase in content acquisition costs for YouTube consistent with the growth in YouTube revenues. The increase in TAC from 2018 to 2019 was due to increases in TAC paid to distribution partners and to Google Network Members, primarily driven by growth in revenues subject to TAC. The TAC rate decreased from 22.9% to 22.3% , primarily due to the favorable revenue mix shift from Google Network Members' properties to Google properties. The TAC rate on Google properties revenues increased primarily due to the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. The TAC rate on Google Network revenues decreased primarily due to changes in product mix to products that carry a lower TAC rate. Over time, cost of revenues as a percentage of total revenues may be affected by a number of factors, including the following: The amount of TAC paid to Google Network Members, which is affected by a combination of factors such as geographic mix, product mix, revenue share terms, and fluctuations of the U.S. dollar compared to certain foreign currencies ; The amount of TAC paid to distribution partners, which is affected by changes in device mix, geographic mix, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; Relative revenue growth rates of Google properties and Google Network Members' properties; Costs associated with our data centers and other operations to support ads, Google Cloud, Search, YouTube and other products ; Content acquisition costs, which are primarily affected by the relative growth rates in our YouTube advertising and subscription revenues; Costs related to hardware sales; and Increased proportion of non-advertising revenues, which generally have higher costs of revenues, relative to our advertising revenues. Alphabet Inc. Research and Development The following table presents our RD expenses (in millions): Year Ended December 31, Research and development expenses $ 21,419 $ 26,018 Research and development expenses as a percentage of revenues 15.7 % 16.1 % RD expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $4,599 million from 2018 to 2019 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $3,519 million, largely resulting from a 23% increase in headcount. Over time, RD expenses as a percentage of revenues may be affected by a number of factors including continued investment in ads, Android, Chrome, Google Cloud, Google Play, hardware, machine learning, Other Bets, and Search. Sales and Marketing The following table presents our sales and marketing expenses (in millions): Year Ended December 31, Sales and marketing expenses $ 16,333 $ 18,464 Sales and marketing expenses as a percentage of revenues 11.9 % 11.4 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) and facilities-related costs for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses increased $2,131 million from 2018 to 2019 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,371 million , largely resulting from a 15% increase in headcount. In addition, there was an increase in advertising and promotional expenses of $402 million . Over time, sales and marketing expenses as a percentage of revenues may be affected by a number of factors including the seasonality associated with new product and service launches. General and Administrative The following table presents our general and administrative expenses (in millions): Year Ended December 31, General and administrative expenses $ 6,923 $ 9,551 General and administrative expenses as a percentage of revenues 5.1 % 5.9 % General and administrative expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for employees in our finance, human resources, information technology, and legal organizations; Depreciation expenses; Equipment-related expenses; Legal-related expenses; and Alphabet Inc. Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $2,628 million from 2018 to 2019 . The increase was primarily due to an increase in legal-related expenses of $1,157 million , including a charge of $554 million from a legal settlement in 2019 and the effect of a legal settlement gain recorded in 2018. Additionally, there was an increase in compensation expenses (including SBC) and facilities-related costs of $687 million , largely resulting from a 19% increase in headcount. Performance fees of $1,203 million have been reclassified from general and administrative expenses to other income (expense), net, for 2018 to conform with current period presentation. See Note 7 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further details. Over time, general and administrative expenses as a percentage of revenues may be affected by discrete items such as legal settlements. European Commission Fines In July 2018, the EC announced its decision that certain provisions in Google's Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $5.1 billion as of June 30, 2018) fine, which was accrued in the second quarter of 2018. In March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a 1.5 billion ( $1.7 billion as of March 20, 2019) fine, which was accrued in the first quarter of 2019. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, Other income (expense), net $ 7,389 $ 5,394 Other income (expense), net, as a percentage of revenues 5.4 % 3.3 % Other income (expense), net, decreased $1,995 million from 2018 to 2019 . This decrease was primarily driven by a decrease in gains on equity securities, which were $2,649 million in 2019 as compared to $5,460 million in 2018. The majority of the gains in both periods were unrealized. The effect of the decrease in gains on equity securities was partially offset by a decrease in performance fees. The decrease in other income (expense) was also driven by a decrease in gains on debt securities primarily due to an unrealized gain recognized in 2018 resulting from the modification of the terms of a non-marketable debt security. Performance fees of $1,203 million have been reclassified from general and administrative expenses to other income (expense), net, for 2018 to conform with current period presentation. See Note 7 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further details. Over time, other income (expense), net, as a percentage of revenues may be affected by market dynamics and other factors. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets could result in a significant change in the value of our equity securities. Fluctuations in the value of these investments has, and we expect will continue to, contribute to volatility of OIE in future periods. For additional information about equity investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Alphabet Inc. Provision for Income Taxes The following table presents our provision for income taxes (in millions) and effective tax rate: Year Ended December 31, Provision for income taxes $ 4,177 $ 5,282 Effective tax rate 12.0 % 13.3 % Our provision for income taxes and our effective tax rate increased from 2018 to 2019 , due to discrete events in 2018 and 2019. In 2018, we released our deferred tax asset valuation allowance related to gains on equity securities and recognized the benefits of the U.S. Tax Cuts and Jobs Act (""Tax Act""). In 2019, we recognized an increase in discrete benefits related to the resolution of multi-year audits, partially offset by the reversal of Altera tax benefit as a result of the U.S. Court of Appeals decision. See Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda. This will affect our geographic mix of earnings . We expect our future effective tax rate to be affected by the geographic mix of earnings in countries with different statutory rates. Additionally, our future effective tax rate may be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Alphabet Inc. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2019 . This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Seasonal fluctuations in internet usage and advertiser expenditures, underlying business trends such as traditional retail seasonality and macroeconomic conditions have affected, and are likely to continue to affect, our business. Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2018 Jun 30, 2018 Sept 30, 2018 Dec 31, 2018 Mar 31, 2019 Jun 30, 2019 Sept 30, 2019 Dec 31, 2019 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 31,146 $ 32,657 $ 33,740 $ 39,276 $ 36,339 $ 38,944 $ 40,499 $ 46,075 Costs and expenses: Cost of revenues 13,467 13,883 14,281 17,918 16,012 17,296 17,568 21,020 Research and development 5,039 5,114 5,232 6,034 6,029 6,213 6,554 7,222 Sales and marketing 3,604 3,780 3,849 5,100 3,905 4,212 4,609 5,738 General and administrative 1,403 1,764 1,753 2,003 2,088 2,043 2,591 2,829 European Commission fines 5,071 1,697 Total costs and expenses 23,513 29,612 25,115 31,055 29,731 29,764 31,322 36,809 Income from operations 7,633 3,045 8,625 8,221 6,608 9,180 9,177 9,266 Other income (expense), net 2,910 1,170 1,458 1,851 1,538 2,967 (549 ) 1,438 Income from continuing operations before income taxes 10,543 4,215 10,083 10,072 8,146 12,147 8,628 10,704 Provision for income taxes 1,142 1,020 1,124 1,489 2,200 1,560 Net income $ 9,401 $ 3,195 $ 9,192 $ 8,948 $ 6,657 $ 9,947 $ 7,068 $ 10,671 Basic net income per share of Class A and B common stock and Class C capital stock $ 13.53 $ 4.60 $ 13.21 $ 12.87 $ 9.58 $ 14.33 $ 10.20 $ 15.49 Diluted net income per share of Class A and B common stock and Class C capital stock $ 13.33 $ 4.54 $ 13.06 $ 12.77 $ 9.50 $ 14.21 $ 10.12 $ 15.35 Capital Resources and Liquidity As of December 31, 2019 , we had $119.7 billion in cash, cash equivalents, and marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities and marketable equity securities. As of December 31, 2019 , we had long-term taxes payable of $7.3 billion related to a one-time transition tax payable incurred as a result of the Tax Act. As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ( $2.7 billion as of June 27, 2017), 4.3 billion ( $5.1 billion as of June 30, 2018), and 1.5 billion ( $1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Alphabet Inc. In November 2019, we entered into an agreement to acquire Fitbit, a leading wearables brand, for $7.35 per share, representing a total purchase price of approximately $2.1 billion as of the date of the agreement. The acquisition of Fitbit is expected to be completed in 2020, subject to customary closing conditions, including the receipt of regulatory approvals. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2019 . We have $4.0 billion of revolving credit facilities expiring in July 2023 with no amounts outstanding as of December 31, 2019 . The interest rate for the credit facilities is determined based on a formula using certain market rates. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. As of December 31, 2019 , we have senior unsecured notes outstanding due in 2021, 2024, and 2026 with a total carrying value of $4.0 billion . As of December 31, 2019 , we had remaining authorization of $20.8 billion for repurchase of Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. We continue to make significant investments in land and buildings for data centers and offices and information technology infrastructure through purchases of property and equipment and lease arrangements to provide capacity for the growth of our business. During the year ended December 31, 2019, we spent $23.5 billion on capital expenditures and recognized total operating lease assets of $4.4 billion . As of December 31, 2019, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 10 years , was $13.9 billion . Finance leases were not material for the year ended December 31, 2019. Please refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the leases. The following table presents our cash flows (in millions): Year Ended December 31, Net cash provided by operating activities $ 47,971 $ 54,520 Net cash used in investing activities $ (28,504 ) $ (29,491 ) Net cash used in financing activities $ (13,179 ) $ (23,209 ) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google properties and Google Network Members' properties. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from our operating activities include payments to our Google Network Members and distribution partners, and payments for content acquisition costs. In addition, uses of cash from operating activities include compensation and related costs, hardware inventory costs, other general corporate expenditures, and income taxes. Net cash provided by operating activities increased from 2018 to 2019 primarily due to increases in cash received from revenues, offset by increases in cash paid for cost of revenues and operating expenses. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of property and Alphabet Inc. equipment, which primarily includes our investments in land and buildings for data centers and offices and information technology infrastructure to provide capacity for the growth of our businesses; purchases of marketable and non-marketable securities; and payments for acquisitions. Net cash used in investing activities increased from 2018 to 2019 primarily due to a net increase in purchases of securities and an increase in payments for acquisitions, partially offset by a decrease in payments for purchases of property and equipment. The decrease in purchases of property and equipment was driven by decreases in purchases of servers as well as land and buildings for offices, partially offset by an increase in data center construction. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from sale of interest in consolidated entities. Cash used in financing activities consists primarily of net payments related to stock-based award activities, repurchases of capital stock, and repayments of debt. Net cash used in financing activities increased from 2018 to 2019 primarily due to an increase in cash payments for repurchases of capital stock and a decrease in proceeds from sale of interest in consolidated entities. Contractual Obligations as of December 31, 2019 The following summarizes our contractual obligations as of December 31, 2019 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations (1) $ 13,854 $ 1,757 $ 3,525 $ 2,809 $ 5,763 Obligations for leases that have not yet commenced (1) 7,418 1,314 5,005 Purchase obligations (2) 5,660 4,212 Long-term debt obligations (3) 5,288 1,258 1,224 2,579 Tax payable (4) 7,315 1,166 3,661 2,488 Other long-term liabilities reflected on our balance sheet (5) 1,484 Total contractual obligations $ 41,019 $ 6,690 $ 8,375 $ 9,577 $ 16,377 (1) For further information, refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to information technology assets and data center operation costs; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2019 . Excluded from the table above are open orders for purchases that support normal operations. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $2.6 billion as of December 31, 2019 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for the construction of offices and certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the EC fines, refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2019 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Alphabet Inc. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, consumer protection, non-income taxes, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated Alphabet Inc. from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair Value Measurements We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. The fair value hierarchy prioritizes the inputs used to measure fair value whereby it gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. We maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Our use of unobservable inputs reflects the assumptions that market participants would use and may include our own data adjusted based on reasonably available information. We apply judgment in assessing the relevance of observable market data to determine the priority of inputs under the fair value hierarchy, particularly in situations where there is very little or no market activity. In determining the fair values of our non-marketable equity and debt investments, as well as assets acquired (especially with respect to intangible assets) and liabilities assumed in business combinations, we make significant estimates and assumptions, some of which include the use of unobservable inputs. Certain stock-based compensation awards may be settled in the stock of certain of our Other Bets or in cash. These awards are based on the equity values of the respective Other Bet, which requires use of unobservable inputs. We also have compensation arrangements with payouts based on realized investment returns, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Non-marketable Equity Securities Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include industry and market conditions, financial performance, business prospects, and other relevant events and factors. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we measure our non-marketable securities at fair value. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the local currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign Alphabet Inc. currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets and liabilities denominated in currencies other than the local currencies at the balance sheet dates, it would have resulted in an adverse effect on income before income taxes of approximately $1 million and $8 million as of December 31, 2018 and 2019 , respectively. The adverse effect as of December 31, 2018 and 2019 is after consideration of the offsetting effect of approximately $374 million and $662 million , respectively, from foreign exchange contracts in place for the years ended December 31, 2018 and 2019 . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2018 and 2019 , the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $772 million and $1.1 billion lower as of December 31, 2018 and 2019 , respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $635 million and $936 million lower as of December 31, 2018 and 2019 , respectively. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as a result of higher market interest rates compared to interest rates at the time of purchase. We account for both fixed and variable rate securities at fair value with gains and losses recorded in AOCI until the securities are sold. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2018 and 2019 are shown below (in millions): As of December 31, 12-Month Average As of December 31, Risk Category - Interest Rate $ $ $ $ Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2018 and 2019 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Alphabet Inc. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $3.3 billion of our investments as of December 31, 2019 . A hypothetical adverse price change of 10%, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $330 million . Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value is measured at the time of the observable transaction, which is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of our investments through liquidity events such as public offerings, acquisitions, private sales or other favorable market events. As of December 31, 2019 , the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $11.4 billion . Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge on our non-marketable equity securities. The carrying values of our equity method investments generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2018 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 3, 2020 expressed an unqualified opinion thereon. Adoption of New Accounting Standard As discussed in Note 1 to the financial statements, the Company changed its method for accounting for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, and government investigations involving competition, intellectual property, privacy, consumer protection, tax, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, and other matters. As described in Note 10 to the financial statements Commitments and Contingencies such claims could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgement in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 3, 2020 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2019 consolidated financial statements of the Company and our report dated February 3, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 3, 2020 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2018 As of December 31, 2019 Assets Current assets: Cash and cash equivalents $ 16,701 $ 18,498 Marketable securities 92,439 101,177 Total cash, cash equivalents, and marketable securities 109,140 119,675 Accounts receivable, net of allowance of $729 and $753 20,838 25,326 Income taxes receivable, net 2,166 Inventory 1,107 Other current assets 4,236 4,412 Total current assets 135,676 152,578 Non-marketable investments 13,859 13,078 Deferred income taxes Property and equipment, net 59,719 73,646 Operating lease assets 10,941 Intangible assets, net 2,220 1,979 Goodwill 17,888 20,624 Other non-current assets 2,693 2,342 Total assets $ 232,792 $ 275,909 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 4,378 $ 5,561 Accrued compensation and benefits 6,839 8,495 Accrued expenses and other current liabilities 16,958 23,067 Accrued revenue share 4,592 5,916 Deferred revenue 1,784 1,908 Income taxes payable, net Total current liabilities 34,620 45,221 Long-term debt 4,012 4,554 Deferred revenue, non-current Income taxes payable, non-current 11,327 9,885 Deferred income taxes 1,264 1,701 Operating lease liabilities 10,214 Other long-term liabilities 3,545 2,534 Total liabilities 55,164 74,467 Commitments and Contingencies (Note 10) Stockholders equity: Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000, Class C 3,000,000); 695,556 (Class A 299,242, Class B 46,636, Class C 349,678) and 688,335 (Class A 299,828, Class B 46,441, Class C 342,066) shares issued and outstanding 45,049 50,552 Accumulated other comprehensive loss ( 2,306 ) ( 1,232 ) Retained earnings 134,885 152,122 Total stockholders equity 177,628 201,442 Total liabilities and stockholders equity $ 232,792 $ 275,909 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenues $ 110,855 $ 136,819 $ 161,857 Costs and expenses: Cost of revenues 45,583 59,549 71,896 Research and development 16,625 21,419 26,018 Sales and marketing 12,893 16,333 18,464 General and administrative 6,840 6,923 9,551 European Commission fines 2,736 5,071 1,697 Total costs and expenses 84,677 109,295 127,626 Income from operations 26,178 27,524 34,231 Other income (expense), net 1,015 7,389 5,394 Income before income taxes 27,193 34,913 39,625 Provision for income taxes 14,531 4,177 5,282 Net income $ 12,662 $ 30,736 $ 34,343 Basic net income per share of Class A and B common stock and Class C capital stock $ 18.27 $ 44.22 $ 49.59 Diluted net income per share of Class A and B common stock and Class C capital stock $ 18.00 $ 43.70 $ 49.16 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 12,662 $ 30,736 $ 34,343 Other comprehensive income (loss): Change in foreign currency translation adjustment 1,543 ( 781 ) ( 119 ) Available-for-sale investments: Change in net unrealized gains (losses) 1,611 Less: reclassification adjustment for net (gains) losses included in net income ( 911 ) ( 111 ) Net change (net of tax effect of $0, $156, and $221) ( 823 ) 1,500 Cash flow hedges: Change in net unrealized gains (losses) ( 638 ) Less: reclassification adjustment for net (gains) losses included in net income ( 299 ) Net change (net of tax effect of $247, $103, and $42) ( 545 ) ( 277 ) Other comprehensive income (loss) 1,410 ( 1,216 ) 1,104 Comprehensive income $ 14,072 $ 29,520 $ 35,447 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2016 691,293 $ 36,307 $ ( 2,402 ) $ 105,131 $ 139,036 Cumulative effect of accounting change ( 15 ) ( 15 ) Common and capital stock issued 8,652 Stock-based compensation expense 7,694 7,694 Tax withholding related to vesting of restricted stock units ( 4,373 ) ( 4,373 ) Repurchases of capital stock ( 5,162 ) ( 315 ) ( 4,531 ) ( 4,846 ) Sale of interest in consolidated entities Net income 12,662 12,662 Other comprehensive income (loss) 1,410 1,410 Balance as of December 31, 2017 694,783 40,247 ( 992 ) 113,247 152,502 Cumulative effect of accounting change ( 98 ) ( 599 ) ( 697 ) Common and capital stock issued 8,975 Stock-based compensation expense 9,353 9,353 Tax withholding related to vesting of restricted stock units and other ( 4,782 ) ( 4,782 ) Repurchases of capital stock ( 8,202 ) ( 576 ) ( 8,499 ) ( 9,075 ) Sale of interest in consolidated entities Net income 30,736 30,736 Other comprehensive income (loss) ( 1,216 ) ( 1,216 ) Balance as of December 31, 2018 695,556 45,049 ( 2,306 ) 134,885 177,628 Cumulative effect of accounting change ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 Stock-based compensation expense 10,890 10,890 Tax withholding related to vesting of restricted stock units and other ( 4,455 ) ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities Net income 34,343 34,343 Other comprehensive income (loss) 1,104 1,104 Balance as of December 31, 2019 688,335 $ 50,552 $ ( 1,232 ) $ 152,122 $ 201,442 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Operating activities Net income $ 12,662 $ 30,736 $ 34,343 Adjustments: Depreciation and impairment of property and equipment 6,103 8,164 10,856 Amortization and impairment of intangible assets Stock-based compensation expense 7,679 9,353 10,794 Deferred income taxes (Gain) loss on debt and equity securities, net ( 6,650 ) ( 2,798 ) Other ( 189 ) ( 592 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 3,768 ) ( 2,169 ) ( 4,340 ) Income taxes, net 8,211 ( 2,251 ) ( 3,128 ) Other assets ( 2,164 ) ( 1,207 ) ( 621 ) Accounts payable 1,067 Accrued expenses and other liabilities 4,891 8,614 7,170 Accrued revenue share 1,273 Deferred revenue Net cash provided by operating activities 37,091 47,971 54,520 Investing activities Purchases of property and equipment ( 13,184 ) ( 25,139 ) ( 23,548 ) Purchases of marketable securities ( 92,195 ) ( 50,158 ) ( 100,315 ) Maturities and sales of marketable securities 73,959 48,507 97,825 Purchases of non-marketable investments ( 1,745 ) ( 2,073 ) ( 1,932 ) Maturities and sales of non-marketable investments 1,752 Acquisitions, net of cash acquired, and purchases of intangible assets ( 287 ) ( 1,491 ) ( 2,515 ) Proceeds from collection of notes receivable 1,419 Other investing activities Net cash used in investing activities ( 31,401 ) ( 28,504 ) ( 29,491 ) Financing activities Net payments related to stock-based award activities ( 4,166 ) ( 4,993 ) ( 4,765 ) Repurchases of capital stock ( 4,846 ) ( 9,075 ) ( 18,396 ) Proceeds from issuance of debt, net of costs 4,291 6,766 Repayments of debt ( 4,377 ) ( 6,827 ) ( 585 ) Proceeds from sale of interest in consolidated entities Net cash used in financing activities ( 8,298 ) ( 13,179 ) ( 23,209 ) Effect of exchange rate changes on cash and cash equivalents ( 302 ) ( 23 ) Net increase (decrease) in cash and cash equivalents ( 2,203 ) 5,986 1,797 Cash and cash equivalents at beginning of period 12,918 10,715 16,701 Cash and cash equivalents at end of period $ 10,715 $ 16,701 $ 18,498 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 6,191 $ 5,671 $ 8,203 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (Alphabet) became the successor issuer to Google. We generate revenues primarily by delivering relevant, cost-effective online advertising. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. Noncontrolling interests are not presented separately as the amounts are not material. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the bad debt allowance, sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Revenue Recognition We recognize revenues when we transfer control of promised goods or services to our customers in an amount that reflects the consideration to which we expect to be entitled to in exchange for those goods or services. See Note 2 for further discussion on Revenues. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding and the tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation includes stock-based awards, such as performance stock units (PSUs) and awards that may be settled in cash or the stock of certain of our Other Bets. PSUs are equity classified and expense is recognized over the requisite service period. Awards that are liability classified are remeasured at fair value through Alphabet Inc. settlement or maturity (six months and one day after vesting). The fair value of such awards is based on the equity valuation of the respective Other Bet. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. Performance fees, which are primarily related to gains on equity securities, are recorded as a component of other income (expense), net. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of markets in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2017 , 2018 , or 2019 . In 2017 , 2018 , and 2019 , we generated approximately 47 % , 46 % , and 46 % of our revenues, respectively, from customers based in the U.S. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. We maintain reserves for estimated credit losses and these losses have generally been within our expectations. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities, which are adjusted to fair value when observable price changes are identified or when the non-marketable equity securities are impaired (referred to as the measurement alternative) . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. Alphabet Inc. We classify all marketable investments that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities. We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for unrealized losses determined to be other-than-temporary, which we record within other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative in accordance with Accounting Standards Update No. 2016-01, which we adopted on January 1, 2018. Under the measurement alternative, the carrying value of our non-marketable equity investments is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment. Adjustments are determined primarily based on a market approach as of the transaction date. We account for our non-marketable investments that meet the definition of a debt security as available-for-sale securities. We classify our non-marketable investments that do not have stated contractual maturity dates, as non-current assets on the Consolidated Balance Sheets. Impairment of Investments We periodically review our debt and equity investments for impairment. For debt securities we consider the duration, severity and the reason for the decline in security value; whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or if the amortized cost basis cannot be recovered as a result of credit losses. If any impairment is considered other-than-temporary, we will write down the security to its fair value and record the corresponding charge as other income (expense), net. For equity securities we consider impairment indicators such as negative changes in industry and market conditions, financial performance, business prospects, and other relevant events and factors. If indicators exist and the fair value of the security is below the carrying amount, we write down the security to fair value. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests in is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE; and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Accounts Receivable We record accounts receivable at the invoiced amount. We maintain an allowance for doubtful accounts to reserve for potentially uncollectible receivables. We review the accounts receivable by amounts due from customers that are past due to identify specific customers with known disputes or collectability issues. In determining the amount of the reserve, we make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Alphabet Inc. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet beginning January 1, 2019. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities and the long term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense is recognized on a straight-line basis over the lease term. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair Alphabet Inc. values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets are not recoverable, the impairment recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were not material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives generally over periods ranging from one to twelve years . Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2017 , 2018 and 2019 , advertising and promotional expenses totaled approximately $ 5.1 billion , $ 6.4 billion , and $ 6.8 billion , respectively. Recent Accounting Pronouncements Recently issued accounting pronouncements not yet adopted In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-13 (ASU 2016-13) ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"", which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We will adopt ASU 2016-13 effective January 1, 2020 with the cumulative effect of adoption recorded as an adjustment to retained earnings. The effect on our consolidated financial statements and related disclosures is not expected to be material. Alphabet Inc. Recently adopted accounting pronouncements In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (Topic 842) ""Leases."" Topic 842 supersedes the lease requirements in Accounting Standards Codification Topic 840, ""Leases."" Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases continue to be classified as either finance or operating. We adopted Topic 842 effective January 1, 2019. The most significant effects of Topic 842 were the recognition of $ 8.0 billion of operating lease assets and $ 8.4 billion of operating lease liabilities and the de-recognition of $ 1.5 billion of build-to-suit assets and liabilities upon adoption. We applied Topic 842 to all leases as of January 1, 2019 with comparative periods continuing to be reported under Topic 840. In the adoption of Topic 842, we carried forward the assessment from Topic 840 of whether our contracts contain or are leases, the classification of our leases, and remaining lease terms. Our accounting for finance leases remains substantially unchanged. The standard did not have a significant effect on our consolidated results of operations or cash flows. See Note 4 for further details. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Hedging gains (losses), which were previously included in Google revenues, are now reported separately as a component of total revenues for all periods presented. See Note 2 for further details. Additionally, performance fees have been reclassified for all periods from general and administrative expenses to other income (expense), net to align with the presentation of the investment gains and losses on which the performance fees are based. See Note 7 for further details. Note 2. Revenues Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that we expect in exchange for those goods or services. Sales and other similar taxes are excluded from revenues. The following table presents our revenues disaggregated by type (in millions). Certain amounts in prior periods have been reclassified to conform with current period presentation. Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google properties 77,961 96,451 113,264 Google Network Members' properties 17,616 20,010 21,547 Google advertising 95,577 116,461 134,811 Google Cloud 4,056 5,838 8,918 Google other (1) 10,914 14,063 17,014 Google revenues 110,547 136,362 160,743 Other Bets revenues Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 (1) YouTube non-advertising revenues are included in Google other revenues. Alphabet Inc. The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, United States $ 52,449 % $ 63,269 % $ 74,843 % EMEA (1) 36,236 44,739 50,645 APAC (1) 16,192 21,341 26,928 Other Americas (1) 6,147 7,608 8,986 Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 % $ 136,819 % $ 161,857 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (Other Americas). Advertising Revenues We generate advertising revenues primarily by delivering advertising on Google properties, including Google.com, the Google Search app, YouTube, Google Play, Gmail and Google Maps; and Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager as part of the Authorized Buyers marketplace, and Google Marketing Platform, among others. We offer advertising on a click, impression or view basis. We recognize revenue each time a user clicks on the ad, when the ad is displayed or a user views the ad. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Google Cloud Revenues Google Cloud revenues consist primarily of revenues from Google Cloud Platform (which includes infrastructure and data and analytics platform products, and other services), G Suite productivity tools and other enterprise cloud services. Our cloud revenues are provided on either a consumption or subscription basis. Revenue related to cloud services provided on a consumption basis is recognized when the customer utilizes the services, based on the quantity of services consumed. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Google Play, which includes revenues from sale of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising including, YouTube premium and YouTube TV subscriptions and other services; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Alphabet Inc. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Deferred Revenues We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. The increase in the deferred revenue balance for the year ended December 31, 2019 was primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $ 1.7 billion of revenues recognized that were included in the deferred revenue balance as of December 31, 2018 . Additionally, we have performance obligations associated with commitments in customer contracts, primarily related to Google Cloud, for future services that have not yet been recognized in revenue. This includes related deferred revenue currently recorded and amounts that will be invoiced in future periods. As of December 31, 2019 , the amount not yet recognized in revenue from these commitments is $ 11.4 billion , which reflects our assessment of relevant contract terms. This amount excludes contracts (i) with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. We expect to recognize approximately two thirds over the next 24 months with the remaining thereafter. However, the amount and timing of revenue recognition is largely driven by customer utilization, which could impact our estimate of the remaining amount of commitments and when we expect to recognize such revenues. Sales Commissions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. The following tables summarize our debt securities by significant investment categories as of December 31, 2018 and 2019 (in millions): As of December 31, 2018 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,202 $ $ $ 2,202 $ 2,202 $ Government bonds 53,634 ( 414 ) 53,291 3,717 49,574 Corporate debt securities 25,383 ( 316 ) 25,082 25,038 Mortgage-backed and asset-backed securities 16,918 ( 324 ) 16,605 16,605 Total $ 98,137 $ $ ( 1,054 ) $ 97,180 $ 5,963 $ 91,217 Alphabet Inc. As of December 31, 2019 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,294 $ $ $ 2,294 $ 2,294 $ Government bonds 55,033 ( 30 ) 55,437 4,518 50,919 Corporate debt securities 27,164 ( 3 ) 27,498 27,454 Mortgage-backed and asset-backed securities 19,453 ( 41 ) 19,508 19,508 Total $ 103,944 $ $ ( 74 ) $ 104,737 $ 6,856 $ 97,881 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 185 million , $ 1.3 billion , and $ 292 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. We recognized gross realized losses of $ 295 million , $ 143 million , and $ 143 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. We reflect these gains and losses as a component of other income (expense), net, in the Consolidated Statements of Income. The following table summarizes the estimated fair value of our investments in marketable debt securities with stated contractual maturity dates, accounted for as available-for-sale securities and classified by the contractual maturity date of the securities (in millions): As of December 31, 2019 Due in 1 year $ 20,392 Due in 1 year through 5 years 63,151 Due in 5 years through 10 years 2,671 Due after 10 years 11,667 Total $ 97,881 The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2018 and 2019 , aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2018 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 12,019 $ ( 85 ) $ 23,877 $ ( 329 ) $ 35,896 $ ( 414 ) Corporate debt securities 10,171 ( 107 ) 11,545 ( 209 ) 21,716 ( 316 ) Mortgage-backed and asset-backed securities 5,534 ( 75 ) 8,519 ( 249 ) 14,053 ( 324 ) Total $ 27,724 $ ( 267 ) $ 43,941 $ ( 787 ) $ 71,665 $ ( 1,054 ) As of December 31, 2019 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 6,752 $ ( 20 ) $ 4,590 $ ( 10 ) $ 11,342 $ ( 30 ) Corporate debt securities 1,665 ( 2 ) ( 1 ) 2,643 ( 3 ) Mortgage-backed and asset-backed securities 4,536 ( 13 ) 2,835 ( 28 ) 7,371 ( 41 ) Total $ 12,953 $ ( 35 ) $ 8,403 $ ( 39 ) $ 21,356 $ ( 74 ) Alphabet Inc. During the years ended December 31, 2017 , 2018 and 2019 , we did not recognize any significant other-than-temporary impairment losses. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. All gains and losses on marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Non-marketable equity securities that have been remeasured during the period are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods using the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for our marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, Net gain (loss) on equity securities sold during the period $ 1,458 $ ( 301 ) Net unrealized gain (loss) on equity securities held as of the end of the period (1) 4,002 2,950 Total gain (loss) recognized in other income (expense), net $ 5,460 $ 2,649 (1) Includes net gains of $ 4.1 billion and $ 1.8 billion related to non-marketable equity securities for the years ended December 31, 2018 and 2019 , respectively. In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic realized gain on the securities sold during the period. Cumulative net gains is calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Equity Securities Sold During the Year Ended December 31, Total sale price $ 1,965 $ 3,134 Total initial cost Cumulative net gains $ 1,450 $ 2,276 Alphabet Inc. Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for our marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2018 Marketable Securities Non-Marketable Securities Total Total initial cost $ 1,168 $ 8,168 $ 9,336 Cumulative net gain (1) 4,107 4,161 Carrying value $ 1,222 $ 12,275 $ 13,497 (1) Non-marketable securities cumulative net gain is comprised of $ 4.3 billion unrealized gains and $ 178 million unrealized losses (including impairment). As of December 31, 2019 Marketable Securities Non-Marketable Securities Total Total initial cost $ 1,935 $ 8,297 $ 10,232 Cumulative net gain (1) 1,361 3,056 4,417 Carrying value $ 3,296 $ 11,353 $ 14,649 (1) Non-marketable securities cumulative net gain is comprised of $ 3.5 billion unrealized gains and $ 445 million unrealized losses (including impairment). Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2018 and 2019 (in millions): As of December 31, 2018 As of December 31, 2019 Cash and Cash Equivalents Marketable Securities Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 3,493 $ $ 4,604 $ Marketable equity securities (1) 3,046 3,493 4,604 3,046 Level 2: Mutual funds Total $ 3,493 $ 1,222 $ 4,604 $ 3,296 (1) The balance a s of December 31, 2019 includes investments that were reclassified from non-marketable equity securities following the initial public offering of the issuers. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities (in millions): Year Ended December 31, Unrealized gains $ 4,285 $ 2,163 Unrealized losses (including impairment) ( 178 ) ( 372 ) Total unrealized gain (loss) for non-marketable equity securities $ 4,107 $ 1,791 During the year ended December 31, 2019 , included in the $ 11.4 billion of non-marketable equity securities, $ 7.6 billion were measured at fair value primarily based on observable market transactions, resulting in a net unrealized gain of $ 1.8 billion . Alphabet Inc. Equity securities accounted for under the Equity Method Equity securities accounted for under the equity method had a carrying value of approximately $ 1.3 billion as of December 31, 2018 and 2019 . Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We classify our foreign currency and interest rate derivative contracts primarily within Level 2 in the fair value hierarchy as the valuation inputs are based on quoted prices and market observable data of similar instruments. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. Any components excluded from the assessment of hedge effectiveness are recognized in the same income statement line as the hedged item. We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also use interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and debt issuances. Our program is not used for trading or speculative purposes. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. As of December 31, 2018 and 2019 , we received cash collateral related to the derivative instruments under our collateral security arrangements of $ 327 million and $ 252 million , respectively, which was included in other current assets. Cash Flow Hedges We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options), designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $ 11.8 billion and $ 13.2 billion as of December 31, 2018 and 2019 , respectively. These contracts have maturities of 24 months or less. For forwards and option contracts, we exclude the change in the forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI and subsequently reclassify these gains and losses to revenues when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are immediately reclassified to other income (expense), net. As of December 31, 2019 , the net accumulated loss on our foreign currency cash flow hedges before tax effect was $ 82 million , of which $ 82 million is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $ 2.0 billion and $ 455 million as of December 31, 2018 and 2019 , respectively. Gains and losses on these forward contracts are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. Net Investment Hedges We use forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), Alphabet Inc. net. The notional principal of these contracts was $ 6.7 billion and $ 9.3 billion as of December 31, 2018 and 2019 , respectively. Gains and losses on these forward contracts are recognized in AOCI as part of the foreign currency translation adjustment. Other Derivatives Other derivatives not designated as hedging instruments consist of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of the outstanding foreign exchange contracts was $ 20.1 billion and $ 43.5 billion as of December 31, 2018 and 2019 , respectively. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2018 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ As of December 31, 2019 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ 67 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ ( 955 ) $ $ Amount excluded from the assessment of effectiveness ( 14 ) Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness Total $ ( 955 ) $ $ Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 110,855 $ 1,015 $ 136,819 $ 7,389 $ 161,857 $ 5,394 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ ( 169 ) $ $ ( 139 ) $ $ $ Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items ( 96 ) ( 19 ) Derivatives designated as hedging instruments ( 197 ) Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts Derivatives not designated as hedging instruments ( 230 ) ( 413 ) Total gains (losses) $ ( 169 ) $ ( 124 ) $ ( 138 ) $ $ $ ( 145 ) Offsetting of Derivatives We present our forwards and purchased options at gross fair values in the Consolidated Balance Sheets. For foreign currency collars, we present at net fair values where both purchased and written options are with the same counterparty. Our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2018 and 2019 , information related to these offsetting arrangements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ ( 56 ) $ $ ( 90 ) (1) $ ( 307 ) $ ( 14 ) $ As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ ( 21 ) $ $ ( 88 ) (1) $ ( 234 ) $ $ (1) The balances as of December 31, 2018 and 2019 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ ( 56 ) $ $ ( 90 ) (2) $ $ $ As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ ( 21 ) $ $ ( 88 ) (2) $ $ $ (2) The balances as of December 31, 2018 and 2019 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating and finance lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2020 and 2063 . Components of operating lease expense were as follows (in millions): Year Ended December 31, 2019 Operating lease cost $ 1,820 Variable lease cost Total operating lease cost $ 2,361 Alphabet Inc. Supplemental information related to operating leases was as follows (in millions): Year Ended December 31, 2019 Cash payments for operating leases $ 1,661 New operating lease assets obtained in exchange for operating lease liabilities $ 4,391 As of December 31, 2019 , our operating leases had a weighted average remaining lease term of 10 years and a weighted average discount rate of 2.8 % . Future lease payments under operating leases as of December 31, 2019 were as follows (in millions): $ 1,757 1,845 1,680 1,508 1,301 Thereafter 5,763 Total future lease payments 13,854 Less imputed interest ( 2,441 ) Total lease liability balance $ 11,413 As of December 31, 2019 , we have entered into leases that have not yet commenced with future lease payments of $ 7.4 billion , excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2020 and 2026 with non-cancelable lease terms of 1 to 25 years. Supplemental Information for Comparative Periods As of December 31, 2018, prior to the adoption of Topic 842, future minimum payments under operating leases having initial or remaining non-cancelable lease terms in excess of one year, net of sublease income amounts, were as follows (in millions): Operating Leases (1) Sub-lease Income Net Operating Leases $ 1,319 $ $ 1,303 1,397 1,384 1,337 1,327 1,153 1,145 980 Thereafter 3,916 3,911 Total minimum payments $ 10,102 $ $ 10,047 (1) Includes future minimum payments for leases which have not yet commenced. Rent expense under operating leases was $ 1.1 billion and $ 1.3 billion for the years ended December 31, 2017, and 2018, respectively. Note 5. Variable Interest Entities (VIEs) Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. We are the primary beneficiary because we have the power to direct activities that most significantly affect their economic performance and have the obligation to absorb the majority of their losses or benefits. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2018 and 2019 , assets that can only be used to settle obligations of these VIEs were $ 2.4 billion and $ 3.1 billion , respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 909 million and $ 1.2 billion , respectively. Alphabet Inc. Calico Calico is a life science company with a mission to harness advanced technologies to increase our understanding of the biology that controls lifespan. In September 2014, AbbVie Inc. (AbbVie) and Calico entered into a research and development collaboration agreement intended to help both companies discover, develop, and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. In the second quarter of 2018, AbbVie and Calico amended the collaboration agreement resulting in an increase in total commitments. As of December 31, 2019 , AbbVie has contributed $ 1,250 million to fund the collaboration pursuant to the agreement. As of December 31, 2019 , Calico has contributed $ 500 million and has committed up to an additional $ 750 million . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market. Both companies share costs and profits for projects covered under this agreement equally. AbbVie's contribution has been recorded as a liability on Calico's financial statements, which is reduced and reflected as a reduction to research and development expense as eligible research and development costs are incurred by Calico. As of December 31, 2019 , we have contributed $ 480 million to Calico in exchange for Calico convertible preferred units and are committed to fund up to an additional $ 750 million on an as-needed basis and subject to certain conditions. Verily Verily is a life science and healthcare company with a mission to make the world's health data useful so that people enjoy healthier lives. In December 2018, Verily received $ 900 million in cash from a $ 1.0 billion investment round. The remaining $ 100 million was received in the first quarter of 2019. As of December 31, 2019 , Verily has received an aggregate amount of $ 1.8 billion from sales of equity securities to external investors. These transactions were accounted for as equity transactions and no gain or loss was recognized. In the fourth quarter of 2019, Verily obtained a controlling financial interest in Onduo, an existing equity method investment. The transaction resulted in a $ 357 million gain from the revaluation of the previously held economic interest, which was recognized in other income (expense), net. Unconsolidated VIEs Certain of our non-marketable investments, including certain renewable energy investments accounted for under the equity method and certain other investments in private companies, are VIEs. The renewable energy entities' activities involve power generation using renewable sources. Private companies that we invest in are primarily early stage companies. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we do not consolidate these VIEs in our consolidated financial statements. The maximum exposure of these unconsolidated VIEs is generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these VIEs is our capital investments in them. The carrying value and maximum exposure of these unconsolidated VIEs were not material as of December 31, 2018 and 2019 . Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2018 and 2019 . Long-Term Debt Google issued $ 3.0 billion of senior unsecured notes in three tranches (collectively, 2011 Notes) in May 2011, due in 2014, 2016, and 2021, as well as $ 1.0 billion of senior unsecured notes (2014 Notes) in February 2014 due in 2024. In April 2016, we completed an exchange offer with eligible holders of Googles 2011 Notes due 2021 and 2014 Notes due 2024 (collectively, the Google Notes). An aggregate principal amount of approximately $ 1.7 billion of the Google Notes was exchanged for approximately $ 1.7 billion of Alphabet notes with identical interest rate and maturity. Alphabet Inc. Because the exchange was between a parent and the subsidiary company and for substantially identical notes, the change was treated as a debt modification for accounting purposes with no gain or loss recognized. In August 2016, Alphabet issued $ 2.0 billion of senior unsecured notes (2016 Notes) due 2026. The net proceeds from the issuance of the 2016 Notes were used for general corporate purposes, including the repayment of outstanding commercial paper. The Alphabet notes due in 2021, 2024, and 2026 rank equally with each other and are structurally subordinate to the outstanding Google Notes. The total outstanding long-term debt is summarized below (in millions): As of December 31, 2018 As of December 31, 2019 3.625% Notes due on May 19, 2021 $ 1,000 $ 1,000 3.375% Notes due on February 25, 2024 1,000 1,000 1.998% Notes due on August 15, 2026 2,000 2,000 Unamortized discount for the Notes above ( 50 ) ( 42 ) Subtotal (1) 3,950 3,958 Total future finance lease payments Less: imputed interest for finance leases ( 89 ) Total long-term debt $ 4,012 $ 4,554 (1) Includes the outstanding (and unexchanged) Google Notes issued in 2011 and 2014 and the Alphabet notes exchanged in 2016. The effective interest yields based on proceeds received from the outstanding notes due in 2021, 2024, and 2026 were 3.734 % , 3.377 % , and 2.231 % , respectively, with interest payable semi-annually. We may redeem these notes at any time in whole or in part at specified redemption prices. The total estimated fair value of all outstanding notes was approximately $ 3.9 billion and $ 4.1 billion as of December 31, 2018 and 2019 , respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2019 , the aggregate future principal payments for long-term debt including long-term finance leases for each of the next five years and thereafter are as follows (in millions): $ 2021 1,046 2023 2024 1,047 Thereafter 2,500 Total $ 4,685 Credit Facility As of December 31, 2019 , we have $ 4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2018 and 2019 . Alphabet Inc. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2018 As of December 31, 2019 Land and buildings $ 30,179 $ 39,865 Information technology assets 30,119 36,840 Construction in progress 16,838 21,036 Leasehold improvements 5,310 6,310 Furniture and fixtures Property and equipment, gross 82,507 104,207 Less: accumulated depreciation ( 22,788 ) ( 30,561 ) Property and equipment, net $ 59,719 $ 73,646 As of December 31, 2018 and 2019, information technology assets and land and buildings under finance leases with a cost basis of $ 648 million and $ 1.6 billion , respectively, were included in property and equipment. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2018 As of December 31, 2019 European Commission fines (1) $ 7,754 $ 9,405 Accrued customer liabilities 1,810 2,245 Accrued purchases of property and equipment 1,603 2,411 Current operating lease liabilities 1,199 Other accrued expenses and current liabilities 5,791 7,807 Accrued expenses and other current liabilities $ 16,958 $ 23,067 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2016 $ ( 2,646 ) $ ( 179 ) $ $ ( 2,402 ) Other comprehensive income (loss) before reclassifications 1,543 ( 638 ) 1,212 Amounts reclassified from AOCI Other comprehensive income (loss) 1,543 ( 545 ) 1,410 Balance as of December 31, 2017 ( 1,103 ) ( 122 ) ( 992 ) Cumulative effect of accounting change ( 98 ) ( 98 ) Other comprehensive income (loss) before reclassifications ( 781 ) ( 429 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI Amounts reclassified from AOCI ( 911 ) ( 813 ) Other comprehensive income (loss) ( 781 ) ( 823 ) ( 1,216 ) Balance as of December 31, 2018 ( 1,884 ) ( 688 ) ( 2,306 ) Cumulative effect of accounting change ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI ( 14 ) ( 14 ) Amounts reclassified from AOCI ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 $ ( 2,003 ) $ $ ( 41 ) $ ( 1,232 ) The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ ( 105 ) $ 1,190 $ Benefit (provision) for income taxes ( 279 ) ( 38 ) Net of tax ( 105 ) Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue ( 169 ) ( 139 ) Interest rate contracts Other income (expense), net Benefit (provision) for income taxes ( 74 ) Net of tax ( 93 ) ( 98 ) Total amount reclassified, net of tax $ ( 198 ) $ $ 75 Alphabet Inc. Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, Interest income $ 1,312 $ 1,878 $ 2,427 Interest expense (1) ( 109 ) ( 114 ) ( 100 ) Foreign currency exchange gain (loss), net (2) ( 121 ) ( 80 ) Gain (loss) on debt securities, net (3) ( 110 ) 1,190 Gain (loss) on equity securities, net 5,460 2,649 Performance fees (4) ( 32 ) ( 1,203 ) ( 326 ) Gain (loss) and impairment from equity method investments, net ( 156 ) ( 120 ) Other Other income (expense), net $ 1,015 $ 7,389 $ 5,394 (1) Interest expense is net of interest capitalized of $ 48 million , $ 92 million , and $ 167 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. (2) Our foreign currency exchange gain (loss), net, are related to the option premium costs and forwards points for our foreign currency hedging contracts, our foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contract losses and gains. The net foreign currency transaction losses were $ 226 million , $ 195 million , and $ 166 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $ 1.3 billion gain. (4) Performance fees were reclassified for prior periods from general and administrative expenses to other income (expense), net to conform with current period presentation. Note 8. Acquisitions 2019 Acquisitions Looker In December 2019, we obtained all regulatory clearances necessary to close the acquisition of Looker, a unified platform for business intelligence, data applications and embedded analytics for $ 2.4 billion , with integration pending approval from a UK regulatory review. The addition of Looker to Google Cloud is expected to help customers accelerate how they analyze data, deliver business intelligence, and build data-driven applications. The fair value of assets acquired and liabilities assumed was recorded based on a preliminary valuation and our estimates and assumptions are subject to change within the measurement period. The $ 2.4 billion purchase price includes our previously held equity interest and excludes post acquisition compensation arrangements. In aggregate, $ 91 million was cash acquired, $ 290 million was attributed to intangible assets, $ 1.9 billion to goodwill and $ 48 million to net assets acquired . Goodwill was recorded in the Google segment and primarily attributable to synergies expected to arise after the acquisition. Goodwill is not expected to be deductible for tax purposes. Other Acquisitions During the year ended December 31, 2019 , we completed other acquisitions and purchases of intangible assets for total consideration of approximately $ 1.0 billion . In aggregate, $ 28 million was cash acquired, $ 282 million was attributed to intangible assets, $ 904 million to goodwill and $ 185 million to net liabilities assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. Pro forma results of operations for these acquisitions, including Looker, have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2019 , patents and developed technology have a weighted-average useful life of 3.5 years, customer relationships have a weighted-average useful life of 6.3 years, and trade names and other have a weighted-average useful life of 4.5 years. Pending Acquisition of Fitbit In November 2019, we entered into an agreement to acquire Fitbit, a leading wearables brand, for $ 7.35 per share, representing a total purchase price of approximately $ 2.1 billion as of the date of the agreement. The acquisition Alphabet Inc. of Fitbit is expected to be completed in 2020, subject to customary closing conditions, including the receipt of regulatory approvals. Upon the close of the acquisition, Fitbit will be part of Google segment. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2019 were as follows (in millions): Google Other Bets Total Consolidated Balance as of December 31, 2017 $ 16,295 $ $ 16,747 Acquisitions 1,227 1,227 Transfers ( 80 ) Foreign currency translation and other adjustments ( 81 ) ( 5 ) ( 86 ) Balance as of December 31, 2018 17,521 17,888 Acquisitions 2,353 2,828 Transfers ( 9 ) Foreign currency translation and other adjustments ( 130 ) ( 92 ) Balance as of December 31, 2019 $ 19,921 $ $ 20,624 Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2018 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 5,125 $ 3,394 $ 1,731 Customer relationships Trade names and other Total $ 6,177 $ 3,957 $ 2,220 As of December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,972 $ 3,570 $ 1,402 Customer relationships Trade names and other Total $ 5,929 $ 3,950 $ 1,979 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 2.3 years, 5.6 years, and 3.0 years, respectively. Amortization expense relating to purchased intangible assets was $ 796 million , $ 865 million , and $ 795 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. Alphabet Inc. As of December 31, 2019 , expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): $ 2021 2022 2023 2024 Thereafter $ 1,979 Note 10. Commitments and Contingencies Purchase Obligations As of December 31, 2019 , we had $ 5.7 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, customers of Google Cloud offerings, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2019 , we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ( $ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ( $ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. Alphabet Inc. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. From time to time we are subject to formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions. For example, in August 2019, we began receiving civil investigative demands from the U.S. Department of Justice requesting information and documents relating to our prior antitrust investigations and certain of our business practices. Attorneys general from 51 U.S. states and territories have also opened antitrust investigations into certain of our business practices. We continue to cooperate with federal and state regulators in the United States, and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices, and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. If the Supreme Court does not rule in our favor, the case will be remanded to the district court for further determination of the remaining issues in the case, including damages, if any. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil or criminal penalties, or other adverse consequences. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, Alphabet Inc. consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We believe these matters are without merit and we are defending ourselves vigorously. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14 . Note 11. Stockholders' Equity Convertible Preferred Stock Our board of directors has authorized 100 million shares of convertible preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2018 and 2019 , no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our board of directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $ 8.6 billion of its Class C capital stock. In January and July 2019, the board of directors of Alphabet authorized the company to repurchase up to an additional $ 12.5 billion and $ 25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2018 and January 2019 authorizations were completed in 2019. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2018 and 2019 , we repurchased and subsequently retired 8.2 million shares of Alphabet Class C capital stock for an aggregate amount of $ 9.1 billion and 15.3 million shares of Alphabet Class C capital stock for an aggregate amount of $ 18.4 billion , respectively. Note 12. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our board of directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely Alphabet Inc. affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our board of directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2017 , 2018 and 2019 , the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 5,438 $ $ 6,362 Denominator Number of shares used in per share computation 297,604 47,146 348,151 Basic net income per share $ 18.27 $ 18.27 $ 18.27 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 5,438 $ $ 6,362 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares Reallocation of undistributed earnings ( 74 ) ( 14 ) Allocation of undistributed earnings $ 6,226 $ $ 6,436 Denominator Number of shares used in basic computation 297,604 47,146 348,151 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 47,146 Restricted stock units and other contingently issuable shares 1,192 9,491 Number of shares used in per share computation 345,942 47,146 357,642 Diluted net income per share $ 18.00 $ 18.00 $ 18.00 Alphabet Inc. Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 Reallocation of undistributed earnings ( 146 ) ( 24 ) Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 Restricted stock units and other contingently issuable shares 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 Reallocation of undistributed earnings ( 126 ) ( 20 ) Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,527 Restricted stock units and other contingently issuable shares 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Alphabet Inc. Note 13. Compensation Plans Stock Plans Under our 2012 Stock Plan, RSUs or stock options may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. Incentive and non-qualified stock options, or rights to purchase common stock, are generally granted for a term of 10 years. RSUs granted to participants under the 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2019 , there were 37,982,435 shares of stock reserved for future issuance under our Stock Plan. Additionally, we have stock-based awards that may be settled in the stock of certain of our Other Bets. Stock-Based Compensation For the years ended December 31, 2017 , 2018 and 2019 , total stock-based compensation expense was $ 7.9 billion , $ 10.0 billion and $ 11.7 billion , including amounts associated with awards we expect to settle in Alphabet stock of $ 7.7 billion , $ 9.4 billion , and $ 10.8 billion , respectively. For the years ended December 31, 2017 , 2018 and 2019 , we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.6 billion , $ 1.5 billion , and $ 1.8 billion , respectively. For the years ended December 31, 2017 , 2018 and 2019 , tax benefit realized related to awards vested or exercised during the period was $ 2.7 billion , $ 2.1 billion and $ 2.2 billion , respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Stock-Based Award Activities The following table summarizes the activities for our unvested RSUs in Alphabet stock for the year ended December 31, 2019 : Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2018 18,467,678 $ 936.96 Granted 13,934,041 $ 1,092.36 Vested ( 11,576,766 ) $ 919.28 Forfeited/canceled ( 1,430,717 ) $ 990.56 Unvested as of December 31, 2019 19,394,236 $ 1,055.22 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2017 and 2018 , was $ 845.06 and $ 1,095.89 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2017 , 2018 , and 2019 were $ 11.3 billion , $ 14.1 billion , and $ 15.2 billion , respectively. As of December 31, 2019 , there was $ 19.1 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.6 years . 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 448 million , $ 691 million , and $ 724 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. Alphabet Inc. Note 14. Income Taxes Income from continuing operations before income taxes consists of the following (in millions): Year Ended December 31, Domestic operations $ 10,680 $ 15,779 $ 16,426 Foreign operations 16,513 19,134 23,199 Total $ 27,193 $ 34,913 $ 39,625 The provision for income taxes consists of the following (in millions): Year Ended December 31, 2018 Current: Federal and state $ 12,608 $ 2,153 $ 2,424 Foreign 1,746 1,251 2,713 Total 14,354 3,404 5,137 Deferred: Federal and state Foreign ( 43 ) ( 134 ) ( 141 ) Total Provision for income taxes $ 14,531 $ 4,177 $ 5,282 The Tax Act enacted on December 22, 2017 introduced significant changes to U.S. income tax law. Effective 2018, the Tax Act reduced the U.S. statutory tax rate from 35% to 21% and created new taxes on certain foreign-sourced earnings and certain related-party payments. Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our consolidated financial statements as of December 31, 2017. As we collected and prepared necessary data, and interpreted the additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we made adjustments, over the course of 2018, to the provisional amounts including refinements to deferred taxes. The accounting for the tax effects of the Tax Act was completed as of December 31, 2018. Transition tax The Tax Act required us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our transitional tax liability and income tax expense of $ 10.2 billion as of December 31, 2017. Subsequent adjustments in 2018 and 2019 were not material. Deferred tax effects Due to the change in the statutory tax rate from the Tax Act, we remeasured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. We recognized a deferred tax benefit of $ 376 million to reflect the reduced U.S. tax rate and other effects of the Tax Act as of December 31, 2017. Alphabet Inc. The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, U.S. federal statutory tax rate 35.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 14.2 ) ( 4.9 ) ( 5.6 ) Effect of the Tax Act Transition tax 37.6 ( 0.1 ) ( 0.6 ) Deferred tax effects ( 1.4 ) ( 1.2 ) 0.0 Federal research credit ( 1.8 ) ( 2.4 ) ( 2.5 ) Stock-based compensation expense ( 4.5 ) ( 2.2 ) ( 0.7 ) European Commission fines 3.5 3.1 1.0 Deferred tax asset valuation allowance 0.9 ( 2.0 ) 0.0 State and local income taxes 0.1 ( 0.4 ) 1.1 Other adjustments ( 1.8 ) 1.1 ( 0.4 ) Effective tax rate 53.4 % 12.0 % 13.3 % Our effective tax rate for each of the years presented was affected by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. Substantially all of the income from foreign operations was earned by an Irish subsidiary. Beginning in 2018, earnings realized in foreign jurisdictions are subject to U.S. tax in accordance with the Tax Act. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the United States Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, Deferred tax assets: Stock-based compensation expense $ $ Accrued employee benefits Accruals and reserves not currently deductible 1,047 Tax credits 1,979 3,264 Basis difference in investment in Arris Prepaid cost sharing Net operating losses Operating leases 1,876 Other Total deferred tax assets 5,551 8,232 Valuation allowance ( 2,817 ) ( 3,502 ) Total deferred tax assets net of valuation allowance 2,734 4,730 Deferred tax liabilities: Property and equipment, net ( 1,382 ) ( 1,798 ) Renewable energy investments ( 500 ) ( 466 ) Foreign Earnings ( 111 ) ( 373 ) Net investment gains ( 1,143 ) ( 1,074 ) Operating leases ( 1,619 ) Other ( 125 ) ( 380 ) Total deferred tax liabilities ( 3,261 ) ( 5,710 ) Net deferred tax assets (liabilities) $ ( 527 ) $ ( 980 ) As of December 31, 2019 , our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $ 1.8 billion , $ 3.1 billion , and $ 1.9 billion respectively. If not utilized, the federal and foreign net operating loss carryforwards will begin to expire in 2021 and the state net operating loss carryforwards will begin to expire in 2020. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2019 , our California research and development credit carryforwards for income tax purposes were approximately $ 3.0 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2019 , we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits and certain foreign net operating losses that we believe are not likely to be realized. Due to gains from equity securities recognized, we released the valuation allowance in 2018 against the deferred tax asset for the book-to-tax basis difference in our investments in Arris shares received from the sale of the Motorola Home business to Arris in 2013. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, Beginning gross unrecognized tax benefits $ 5,393 $ 4,696 $ 4,652 Increases related to prior year tax positions Decreases related to prior year tax positions ( 257 ) ( 623 ) ( 143 ) Decreases related to settlement with tax authorities ( 1,875 ) ( 191 ) ( 2,886 ) Increases related to current year tax positions Ending gross unrecognized tax benefits $ 4,696 $ 4,652 $ 3,377 The total amount of gross unrecognized tax benefits was $ 4.7 billion , $ 4.7 billion , and $ 3.4 billion as of December 31, 2017 , 2018 , and 2019 , respectively, of which, $ 3.0 billion , $ 2.9 billion , and $ 2.3 billion , if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2017 and 2019 was primarily as a result of the resolution of multi-year audits. As of December 31, 2018 and 2019 , we had accrued $ 490 million and $ 130 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS completed its examination through our 2015 tax years; all issues have been concluded and the IRS will commence its examination of our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2011 through 2018 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, we do not believe it is reasonably possible that our unrecognized tax benefits will materially change in the next 12 months. Note 15. Information about Segments and Geographic Areas We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as ads, Android, Chrome, hardware, Google Cloud, Google Maps, Google Play, Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes Access, Calico, CapitalG, GV, Verily, Waymo, and X, among others. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Alphabet Inc. Revenues, cost of revenues, and operating expenses are generally directly attributed to our segments. Inter-segment revenues are not presented separately, as these amounts are immaterial. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. Information about segments during the periods presented were as follows (in millions): Year Ended December 31, Revenues: Google $ 110,547 $ 136,362 $ 160,743 Other Bets Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 Year Ended December 31, Operating income (loss): Google $ 32,456 $ 36,655 $ 41,673 Other Bets ( 2,734 ) ( 3,358 ) ( 4,824 ) Reconciling items (1) ( 3,544 ) ( 5,773 ) ( 2,618 ) Total income from operations $ 26,178 $ 27,524 $ 34,231 (1) Reconciling items are generally comprised of corporate administrative costs, hedging gains (losses) and other miscellaneous items that are not allocated to individual segments. Reconciling items include t he European Commission fines for the years ended December 31, 2017, 2018 and 2019, and a charge from a legal settlement for the year ended December 31, 2019. Performance fees previously included in reconciling items were reclassified for the years ended December 31, 2017 and 2018 from general and administrative expenses to other income (expense), net to conform with current period presentation. For further information on the reclassification, see Note 1. Year Ended December 31, Capital expenditures: Google $ 12,619 $ 25,460 $ 25,251 Other Bets Reconciling items (2) ( 502 ) ( 1,984 ) Total capital expenditures as presented on the Consolidated Statements of Cash Flows $ 13,184 $ 25,139 $ 23,548 (2) Reconciling items are related to timing differences of payments as segment capital expenditures are on accrual basis while total capital expenditures shown on the Consolidated Statements of Cash Flow are on cash basis and other miscellaneous differences. Alphabet Inc. Stock-based compensation (SBC) and depreciation, amortization, and impairment are included in segment operating income (loss) as shown below (in millions): Year Ended December 31, Stock-based compensation: Google $ 7,168 $ 8,755 $ 10,185 Other Bets Reconciling items (3) Total stock-based compensation (4) $ 7,679 $ 9,353 $ 10,794 Depreciation, amortization, and impairment: Google $ 6,608 $ 8,708 $ 11,158 Other Bets Reconciling items (3) Total depreciation, amortization, and impairment $ 6,915 $ 9,035 $ 11,781 (3) Reconciling items relate to corporate administrative and other costs that are not allocated to individual segments. (4) For purposes of segment reporting, SBC represents awards that we expect to settle in Alphabet stock. The following table presents our long-lived assets by geographic area (in millions): As of December 31, 2018 As of December 31, 2019 Long-lived assets: United States $ 74,882 $ 94,907 International 22,234 28,424 Total long-lived assets $ 97,116 $ 123,331 For revenues by geography, see Note 2 . Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2019 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global enterprise resource planning (ERP) system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain the Companys financial records, enhance the flow of financial information, improve data management and provide timely information to the Companys management team. The implementation is expected to occur in phases over the next several years, with initial changes to our general ledger and consolidated financial reporting to take place in 2020. There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures which, in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2019 . Management reviewed the results of its assessment with our Audit Committee. The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +13,Alphabet Inc.,2018," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history -- inspiring us to do things like rethink the mobile device ecosystem with Android and map the world with Google Maps. As part of that, our founders also explained that you could expect us to make ""smaller bets in areas that might seem very speculative or even strange when compared to our current businesses."" From the start, the company has always strived to do more, and to do important and meaningful things with the resources we have. Alphabet is a collection of businesses -- the largest of which is Google. It also includes businesses that are generally pretty far afield of our main internet products in areas such as self-driving cars, life sciences, internet access and TV services. We report all non-Google businesses collectively as Other Bets. Our Alphabet structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. At Google, our mission is to make sure that information serves everyone, not just a few. So whether you're a child in a rural village or a professor at an elite university, you can access the same information. We are helping people get online by tailoring digital experiences to the needs of emerging markets. For instance, our digital payments app in India, now called Google Pay, helps tens of millions of people and businesses easily pay with just a few taps. We're also making sure our core Google products are fast and useful, especially for users in areas where speed and connectivity are central concerns. Other Alphabet companies are also pursuing initiatives with similar goals. For instance, Loon announced that it will bring its balloon-powered internet to regions of central Kenya, starting in 2019. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and artificial intelligence (AI) are increasingly driving many of our latest innovations. Within Google, our investments in machine learning over a decade have enabled us to build products that are smarter and more useful -- it's what allows you to use your voice to ask the Google Assistant for information, to translate the web from one language to another, to see better YouTube recommendations, and to search for people and events in Google Photos. Our advertising tools also use machine learning to help marketers find the right audience, deliver the right creative, and optimize their campaigns through better auto-bidding and measurement tools. Machine learning is also showing great promise in helping us tackle big issues, like dramatically improving the energy efficiency of our data centers. Across Other Bets, machine learning helps self-driving cars better detect and respond to others on the road, assists delivery drones in determining whether a location is safe for drop off, and can also help clinicians more accurately detect sight-threatening eye diseases. Google Serving our users We have always been a company committed to building products that have the potential to improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google's core products and platforms such as Android, Chrome, Gmail, Google Drive, Google Maps, Google Play, Search, and YouTube each have over one billion monthly active users. But most important, we believe we are just beginning to scratch the surface. Our vision is to remain a place of incredible creativity and innovation Alphabet Inc. that uses our technical expertise to tackle big problems. As the majority of Alphabets big bets continue to reside within Google, an important benefit of the shift to Alphabet has been the tremendous focus that were able to have on Googles many extraordinary opportunities. Googles mission to organize the worlds information and make it universally accessible and useful has always been our North Star, and our products have come a long way since the company was founded two decades ago. Instead of just showing ten blue links in our search results, we are increasingly able to provide direct answers -- even if you're speaking your question using Voice Search -- which makes it quicker, easier and more natural to find what you're looking for. You can also type or talk with the Google Assistant in a conversational way across multiple devices like phones, speakers, headphones, televisions and more. And with Google Lens, you can use your phones camera to identify an unfamiliar landmark or find a trailer from a movie poster. Over time, we have also added other services that let you access information quickly and easily -- like Google Maps, which helps you navigate to a store while showing you current traffic conditions, or Google Photos, which helps you store and organize your photos. This drive to make information more accessible has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. And with the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, and Daydream virtual reality platform, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of Google's AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 3 phones and the Google Home Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Google was a company built in the cloud and has been investing in infrastructure, security, data management, analytics, and AI from the very beginning. We have continued to enhance these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and G Suite, to our customers. Google Cloud Platform enables developers to build, test, and deploy applications on Googles highly scalable and reliable infrastructure. Our G Suite productivity tools -- which include apps like Gmail, Docs, Drive, Calendar, Hangouts, and more -- are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Key to building helpful products for users is our commitment to keeping their data safe online. As the Internet evolves, we continue to invest in our industry-leading security technologies and privacy tools. How we make money The goal of our advertising business is to deliver relevant ads at just the right time and to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns across screens. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across screens and formats. We generate revenues primarily by delivering both performance advertising and brand advertising. Perf ormance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google properties and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through v ideos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. Alphabet Inc. We have built a world-class ad technology platform for brand advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of brand advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blacklisting them when necessary to ensure that ads do not fund bad content. Beyond our advertising business, we also generate revenues in other areas. For instance, we generate revenue when users purchase digital content like apps, movies and music through Google Play or when they purchase our Made by Google hardware devices. Businesses also pay for the use of our cloud services like Google Cloud Platform and G Suite. Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets Other Bets are emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. To do this, we make sure we have a strong CEO to run each company while also rigorously handling capital allocation and working to make sure each business is executing well. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. We continue to build these businesses thoughtfully and systematically to capitalize on the opportunities ahead. We are investing for the long term while being very deliberate about the focus, scale and pace of investments. Other Bets primarily generate revenues from internet and TV services and licensing and RD services. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Facebook, Hulu, and Netflix. We compete with companies that have longer operating histories and more established relationships with customers and users in businesses that are further afield from our advertising business. We face competition from: Other digital content and application platform providers, such as Apple. Companies that design, manufacture, and market consumer electronics products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for our advertising-related businesses, competing successfully depends on attracting and retaining: Alphabet Inc. Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Culture and Employees We take great pride in our culture. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex technical challenges. Transparency and open dialogue are central to how we work, and we aim to ensure that company news reaches our employees first through internal channels. Despite our rapid growth, we still cherish our roots as a startup and wherever possible empower employees to act on great ideas regardless of their role or function within the company. We strive to hire great employees, with backgrounds and perspectives as diverse as those of our global users. We work to provide an environment where these talented people can have fulfilling careers addressing some of the biggest challenges in technology and society. Our employees are among our best assets and are critical for our continued success. We expect to continue investing in hiring talented employees and to provide competitive compensation programs to our employees. As of December 31, 2018 , we had 98,771 full-time employees. Although we have work councils and statutory employee representation obligations in certain countries, our U.S. employees are not represented by a labor union. Competition for qualified personnel in our industry is intense, particularly for software engineers, computer scientists, and other technical staff. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality. Other Items We believe that climate change is one of the most significant global challenges of our time. We have established a climate change strategy based on four dimensions: matching 100% of the electricity consumption of our operations with purchases of renewable energy; understanding the effect of climate change on the resiliency of our core business operations; being a vocal advocate for greening electrical grids worldwide; and empowering everyonebusinesses, governments, nonprofit organizations, communities, and individualsto use Google technology to help create a more sustainable and resource-efficient world. Google's approach to climate change and our broader sustainability efforts are provided in our annual sustainability reports. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and our Proxy Statements are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, which may be of interest or material to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. Alphabet Inc. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common and capital stock. Risks Related to Our Businesses and Industries We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, and our revenues and operating results could be adversely affected. Our businesses are rapidly evolving, intensely competitive, and subject to changing technologies, shifting user needs, and frequent introductions of new products and services. Competing successfully depends heavily on our ability to accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies to the marketplace in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. As a result, we must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and our existing products and services, and introduce new products and services that people can easily and effectively use. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some companies have longer operating histories and more established relationships with customers and users. They can use their experiences and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in hiring talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Our competitors may be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. In addition, new products and services, including those that incorporate or utilize artificial intelligence and machine learning, can raise new or exacerbate existing ethical, technological, legal, and other challenges, which may negatively affect our brands and demand for our products and services and adversely affect our revenues and operating results. Our operating results may also suffer if our innovations are not responsive to the needs of our users, advertisers, customers, and content providers; are not appropriately timed with market opportunities; or are not effectively brought to market. As technologies continue to develop, our competitors may be able to offer our users and/or customers experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, customers, and content providers, our revenues and operating results could be adversely affected. We generate a significant portion of our revenues from advertising, and reduced spending by advertisers or a loss of partners could harm our advertising business. We generated over 85% of total revenues from advertising in 2018 . Many of our advertisers, companies that distribute our products and services, digital publishers, and content partners can terminate their contracts with us at any time. Those partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. For example, changes to our data privacy practices, as well as changes to third-party advertising policies or practices may affect the type of ads and/or manner of advertising that we are able to provide which could have an adverse effect on our business. If we do not provide superior value or deliver advertisements efficiently and competitively, our reputation could be affected, we could see a decrease in revenue from advertisers and/or experience other adverse effects to our business. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions can also have a material negative effect on user activity and the demand for advertising and cause our advertisers to reduce the amounts they spend on advertising, which could adversely affect our revenues and advertising business. We are subject to increasing regulatory scrutiny as well as changes in public policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry have experienced increased regulatory scrutiny recently. For instance, various regulatory agencies are reviewing aspects of our search and other businesses. This can lead to increased scrutiny from other regulators and legislators, that may affect our reputation, brand and third-party Alphabet Inc. relationships. Such reviews have and may in the future also result in substantial regulatory fines, changes to our business practices and other penalties, which could negatively affect our business and results of operations. We continue to cooperate with regulatory authorities around the world in investigations they are conducting with respect to our business. Changes in social, political, and regulatory conditions or in laws and policies governing a wide range of topics may cause us to change our business practices. Further, our expansion into a variety of new fields also raises a number of new regulatory issues. These factors could negatively affect our business and results of operations in material ways. Our ongoing investment in new businesses and new products, services, and technologies is inherently risky, and could disrupt our current operations. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The creation of Alphabet as a holding company in 2015 and the investments that we are making across various areas in Google and Other Bets are a reflection of our ongoing efforts to innovate and provide products and services that are useful to users. Our investments in Google and Other Bets span a wide range of industries. Such endeavors may involve significant risks and uncertainties, including distraction of management from our advertising and related business, use of alternative investment, governance or compensation structures, the fact that such offerings or strategies may not be commercially viable for an indefinite amount of time or at all, or may not result in adequate return of capital on our investments; and unidentified issues may not be discovered in our due diligence of such strategies and offerings which could cause us to fail to realize the anticipated benefits of such investments and incur unanticipated liabilities. Because these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not adversely affect our reputation, financial condition, and operating results. The Internet is accessed through a variety of platforms and form factors that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our search technology, products, or operating systems developed for these devices and modalities, our business could be adversely affected. The number of people who access the Internet through devices other than desktop computers, including mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television set-top devices, is increasing dramatically. The functionality and user experience associated with some alternative devices and modalities may make the use of our products and services or the generation of advertising revenue through such devices more difficult (or just different), and the versions of our products and services developed for these devices may not be compatible or compelling to users, manufacturers, or distributors of alternative devices. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could affect our search and advertising business over time. As new devices and platforms are continually being released, it is difficult to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to the creation, support, and maintenance of products and services across multiple platforms and devices. If we are unable to attract and retain a substantial number of alternative device manufacturers, suppliers, distributors, developers, and users to our products and services, or if we are slow to develop products and technologies that are more compatible with alternative devices and platforms, we may fail to capture the opportunities available as consumers and advertisers continue to exist in a dynamic, multi-platform environment. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline and/or vary over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Within our advertising business, changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels or if there is a decrease in the rate of adoption of our products, services, and technologies, among other factors. In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into a variety of new fields, including through products and services such as Google Cloud, Google Play, and hardware products where margins have generally been lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix and property mix can affect margin. The margin we earn on Alphabet Inc. revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners due to a number of factors. Additionally, our spend to promote new products and services or distribute certain products or an increased investment in our innovation efforts across the Company (within Google as well as our Other Bets businesses) may affect our operating margins. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly, year-to-date, and annual expenses as a percentage of our revenues may differ significantly from our historical rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this section in addition to the following factors may affect our operating results: Our ability to continue to attract and retain users and customers to our products and services. Our ability to attract user and/or customer adoption of and generate significant revenues from new products, services, and technologies in which we have invested considerable time and resources. Our ability to monetize (or generate revenues from) traffic on Google properties and our Google Network Members' properties across various devices. Revenue fluctuations in our advertising business caused by changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix. The amount of revenues and expenses generated and incurred in currencies other than U.S. dollars, and our ability to manage the resulting risk through our foreign exchange risk management program. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Because our businesses are changing and evolving, our historical operating results may not be useful to you in predicting our future operating results. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations of existing laws and regulations) may make our products and services less useful, require us to incur substantial costs, expose us to unanticipated civil or criminal liability, or cause us to change our business practices. For example, our products and services are closely scrutinized by competition authorities around the world, which may limit our ability to pursue certain business models or offer certain products or services. Current and new patent laws may also affect the ability of companies, including us, to protect their innovations and defend against claims of patent infringement. Similarly, the Directive on Copyright in the Digital Single Market (DSM) in Europe, if passed in its proposed form, will increase the liability of large hosted platforms with respect to content uploaded by their users. It will also create a new property right in news publications that will limit the ability of online services to interact with or present such content. In addition to the DSM, other changes to copyright laws being considered elsewhere, will, if passed, increase costs and require companies, including us, to change or cease offering certain existing services. Additionally, as the focus on data privacy and security increases globally, we are and will Alphabet Inc. continue to be subject to various and evolving laws. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Furthermore, many of these laws do not contemplate or address the unique issues raised by a number of our new businesses, products, services and technologies. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain. Other recently passed laws and/or certain court decisions that could harm our business include, among others: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. Court decisions such as the judgment of the Court of Justice of the European Union on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. Court decisions that require Google to suppress content not just in the jurisdiction of the issuing court, but for all of our users worldwide, including locations where the content at issue is lawful. The Supreme Court of Canada issued such a decision against Google in June 2017, and others could treat its decision as persuasive. For instance, with respect to the right to be forgotten, a follow-up case is pending before the Court of Justice of the European Union, which could result in an order to apply delisting actions under the right to be forgotten worldwide. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. The California Consumer Privacy Act of 2018 that comes into effect in January of 2020, and gives new data privacy rights to California residents and regulates the security of data in connection with internet connected devices. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Privacy laws, which could be interpreted broadly thereby limiting product offerings and/or increasing costs. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are regularly subject to claims, suits, government investigations, and other proceedings that may adversely affect our business and results of operations. We are regularly subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as our Google Cloud offerings, we may also be subject to a variety of claims including product warranty, product liability and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental concerns or if users or customers experience service disruptions, failures, or other issues. In addition, our businesses face intellectual property litigation, as discussed later, that exposes us to the risk of exclusion and cease and desist orders, which could limit our ability to sell products and services. Such claims, suits, and government investigations are inherently uncertain. Regardless of the outcome, any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted and may in the future result in additional substantial fines and penalties that could adversely affect our business, consolidated financial position, results of operations, or cash flows in a particular period. These proceedings could also result in Alphabet Inc. reputational harm, criminal sanctions, consent decrees, or orders preventing us from offering certain features, functionalities, products, or services, requiring a change in our business practices or product recalls or corrections, or requiring development of non-infringing or otherwise altered products or technologies. Any of these consequences could adversely affect our business and results of operations. We may be subject to legal liability associated with providing online services or content. We host and provide a wide variety of services and products that enable users to exchange information, advertise products and services, conduct business, and engage in various online activities both domestically and internationally. The law relating to the liability of providers of these online services and products for activities of their users is still somewhat unsettled both within the U.S. and internationally. Claims have been threatened and have been brought against us for defamation, negligence, breaches of contract, copyright or trademark infringement, unfair competition, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information that we publish or to which we provide links or that may be posted online or generated by us or by third parties, including our users. In addition, we are and have been and may again in the future be subject to domestic or international actions alleging that certain content we have generated or third-party content that we have made available within our products and services violates U.S. and international law. We also place advertisements which are displayed on third-party publishers and advertising networks properties, and we offer third-party products, services, or content. We may be subject to claims concerning these products, services, or content by virtue of our involvement in marketing, branding, broadcasting, or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services, or content. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, which may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Data privacy and security concerns relating to our technology and our practices could damage our reputation and deter current and potential users or customers from using our products and services. Bugs or defects in our products and services have occurred and may occur in the future, or our security measures could be breached, resulting in the improper use and/or disclosure of user data, and our services and systems are subject to attacks that could degrade or deny the ability of users and customers to access, or rely on information received about, our products and services. As a consequence, our products and services may be perceived as being insecure, users and customers may curtail or stop using our products and services, and we may incur significant legal, reputational, and financial exposure. From time to time, concerns are expressed about whether our products, services, or processes compromise the privacy of users, customers, and others. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data privacy related matters, even if unfounded, could damage our reputation and adversely affect our operating results. Our policies and practices may change over time as users and customers expectations regarding privacy and their data changes. Our products and services involve the storage and transmission of users and customers proprietary information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems failures, compromises of our security, failure to abide by our privacy policies, inadvertent disclosure that results in the release of our users data, or in our or our users inability to access such data, could result in government investigations and other liability, legislation or regulation, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users. We expect to continue to expend significant resources to maintain state-of-the-art security protections that shield against bugs, theft, misuse or security vulnerabilities or breaches. We experience cyber attacks of varying degrees and other attempts to gain unauthorized access to our systems on a regular basis. Our security measures may in the future be breached due to employee error, malfeasance, system errors or vulnerabilities, including vulnerabilities of our vendors, suppliers, their products, or otherwise. Such breach or other unauthorized access, increased government surveillance, or attempts by outside parties to fraudulently induce employees, users, or customers to disclose sensitive information in order to gain access to our data or our users or customers data could result in significant legal and financial exposure, damage to our reputation, and a loss of confidence in the security of our products and services that could potentially have an adverse effect on our business. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, become more sophisticated, and often are not recognized until launched against a target, we may be unable to anticipate or detect these techniques or to implement adequate preventative measures. Cyber attacks could also compromise trade secrets and other sensitive information and result in such information being disclosed to others and becoming less valuable, which could negatively affect our business. If an actual or perceived breach of our security Alphabet Inc. occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose users and customers. While we have dedicated significant resources to privacy and security incident response, including dedicated worldwide incident response teams, our response process may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident, among other issues. As a result, we may suffer significant legal, reputational, or financial exposure, which could adversely affect our business and results of operations. Our business is subject to complex and rapidly evolving U.S. and international laws and regulations regarding privacy and data protection. Many of these laws and regulations are subject to change and uncertain interpretation and could result in claims, changes to our business practices, penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. Companies are under increased regulatory scrutiny relating to data privacy and security. Authorities around the world are considering a number of legislative and regulatory proposals concerning data protection, including measures to ensure that encryption of users data does not hinder law enforcement agencies access to that data. In addition, the interpretation and application of consumer and data protection laws in the U.S., Europe and elsewhere are often uncertain and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices. These legislative and regulatory proposals, if adopted, and such interpretations could, in addition to the possibility of fines, result in an order requiring that we change our data practices, which could have an adverse effect on our business and results of operations. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. Recent legal developments in Europe have created compliance uncertainty regarding certain transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR), became effective in the European Union (EU) beginning on May 25, 2018, and applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. The GDPR subjects us to a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment which involves substantial costs, and it is possible that despite our efforts, governmental authorities or third parties will assert that our business practices fail to comply. We have been and may in the future be, subject to lawsuits alleging violations of the GDPR. If our operations are found to be in violation of the GDPRs requirements, we may be required to change our business practices and/or be subject to significant civil penalties, business disruption, and reputational harm, any of which could have a material adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to the higher of 4% of annual worldwide revenues or 20 million. Fines of up to the higher of 2% of annual worldwide revenues or 10 million can be levied for other specified violations. In addition, the European Commission in July 2016 and the Swiss Government in January 2017 approved the EU-U.S. and the Swiss-U.S. Privacy Shield frameworks, respectively, which are designed to allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with the Privacy Shield requirements to freely import personal data from the EU and Switzerland. However, these frameworks face a number of legal challenges and their validity remains subject to legal, regulatory and political developments in both Europe and the U.S. This has resulted in some uncertainty, and compliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business. We are, and may in the future be, subject to intellectual property or other claims, which are costly to defend, could result in significant damage awards, and could limit our ability to use certain technologies in the future. Many companies, in particular those in internet, technology and media own large numbers of patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent holding companies may continue to seek to monetize patents they have purchased or otherwise obtained by bringing claims against us, whether such claims are meritorious or not. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Third parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease and desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to Alphabet Inc. infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services, and may also cause us to change our business practices and require development of non-infringing products, services or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and/or indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims brought against us. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming, expensive to litigate or settle, and cause significant diversion of management attention. To the extent such claims are successful, they may have an adverse effect on our business, including our product and service offerings, consolidated financial position, results of operations, or cash flows. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised by outside parties, or by our employees, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, however it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and results of operations. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions. Effecting these strategic transactions could create unforeseen operating difficulties and expenditures. The areas where we face risks include, among others: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully further develop the acquired business or technology. Implementation or remediation of controls, procedures, and policies at the acquired company. Alphabet Inc. Integration of the acquired company's accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of an acquisition or other strategic transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, privacy issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may adversely affect our financial condition or results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of objectionable content on our services or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Our brands may also be negatively affected by the use of our products or services to disseminate information that is deemed to be false or misleading. Furthermore, if we fail to maintain and enhance equity in our brands, our business, operating results, and financial condition may be materially and adversely affected. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a meaningful role in peoples everyday lives. We face a number of manufacturing and supply chain risks that, if not properly managed, could adversely affect our financial results and prospects. We face a number of risks related to manufacturing and supply chain management. These manufacturing and supply chain risks could affect our ability to supply both our products and our internet-based services. We rely on third parties to manufacture many of our assemblies and finished products, third-party arrangements for the design of some components and parts, and third party distributors, including cellular network carriers. Our business could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. Alphabet Inc. We may experience supply shortages and price increases driven by raw material availability, manufacturing capacity, labor shortages, industry allocations, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We may experience shortages or other supply chain disruptions in the future that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available only from a single source or limited sources, and we may not be able to find replacement vendors on favorable terms or at all in the event of a supply chain disruption. In addition, a significant hardware supply interruption could delay critical data center upgrades or expansions. We may enter into long term contracts that commit us to significant terms and conditions of supply. We may be liable for material and product that is not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because many of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and therefore less competitive and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. The products and services we sell or offer may have quality issues resulting from the design or manufacture of the product, or from the software used. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet our users and/or customers expectations or our products or services are found to be defective, then our sales and operating earnings, and ultimately our reputation, could be negatively affected. We also require our suppliers and business partners to comply with law and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. If any of them violates laws or implements practices regarded as unethical, we could experience supply chain disruptions, canceled orders, terminations of or damage to key relationships, and damage to our reputation. If any of them fails to procure necessary license rights to third-party intellectual property, legal action could ensue that could affect the saleability of our products and expose us to financial obligations to third parties. Web spam, including content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. Web spam refers to websites that violate or attempt to violate our guidelines or that otherwise seek to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Web spam may also affect the quality of content posted on our platforms and may manipulate them to display false, misleading or undesirable content. Although English-language web spam in our search results has been significantly reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek ways to improve their rankings inappropriately. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from web spam such as low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on low-quality websites. We, like others in the industry, face other violations of our guidelines, including sophisticated attempts by bad actors to manipulate our advertising systems to fraudulently generate revenues for themselves or others, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to detect and prevent invalid traffic, including attempts by bad actors to generate income fraudulently, we may be unable to adequately detect and prevent such abuses in the future. If we are subject to an increasing number of web spam, including content farms or other violations of our guidelines, this could hurt our reputation for delivering relevant information or reduce user traffic to our websites or their use of our platforms, which may adversely affect our financial condition or results. Interruption, interference with or failure of our information technology and communications systems could hurt our ability to effectively provide our products and services, which could damage our reputation and harm our operating results. Alphabet Inc. The availability of our products and services depends on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference or interruption from terrorist attacks, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, computer denial of service attacks, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and to potential disruptions if the operators of certain of these facilities have financial difficulties. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using, or other unanticipated problems at our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in our services or the failure of our systems. Our international operations expose us to additional risks that could harm our business, operating results, and financial condition. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2018 . In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Import and export requirements, tariffs, trade disputes and barriers, and customs classifications that may prevent us from offering products or providing services to a particular market and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign laws and legal systems, including those that may occur as a result of the United Kingdom's potential withdrawal from the European Union (""Brexit""). Brexit may adversely affect global economic and market conditions and could contribute to volatility in the foreign exchange markets, which we may be unable to effectively manage through our foreign exchange risk management program. Brexit may also adversely affect our revenues and could subject us to new regulatory costs and challenges, in addition to other adverse effects that we are unable to effectively anticipate. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of workers' councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Changes in international local political, economic, regulatory, tax, social, and labor conditions may also harm our business, and compliance with complex international and U.S. laws and regulations that apply to our international operations increases our cost of doing business. These numerous and sometimes conflicting laws and regulations include, among others, internal control and disclosure rules, privacy and data protection requirements, anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to governmental officials, and competition regulations, among others. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries, and could also materially affect our brand, our international growth efforts, our ability to attract and retain employees, our business, and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these laws and regulations, there can be no assurance that our employees, contractors, or agents will not violate our policies. Since we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could adversely affect our financial condition and results of operations. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Alphabet Inc. Our future success depends in a large part upon the continued service of key members of our senior management team. In particular, Larry Page and Sergey Brin are critical to the overall management of Alphabet and its subsidiaries, and they, along with Sundar Pichai, the Chief Executive Officer of Google, play an important role in the development of our technology. They also play a key role in maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, particularly in light of our holding company structure, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively affect our future success. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures, including legal actions, that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by Internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in the United States the Federal Communications Commission repealed net neutrality rules effective June 11, 2018, which could lead internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. Such interference could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our revenues and growth. New and existing technologies could affect our ability to customize ads and/or could block ads online, which would harm our business. Technologies have been developed to make customizable ads more difficult or to block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the core functionality of third-party digital advertising. Most of our Google revenues are derived from fees paid to us in connection with the display of ads online. As a result, such technologies and tools could adversely affect our operating results. We are exposed to fluctuations in the market values of our investments. Given the global nature of our business, we have investments both domestically and internationally. Market values of these investments can be negatively affected by liquidity, credit deterioration or losses, financial results, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates that replace LIBOR, the effect of new or changing regulations, or other factors. Due to the adoption of ASU 2016-01 Financial Instruments; Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities in January 2018, we adjust the carrying value of our non-marketable equity securities to fair value for observable transactions of identical or similar investments of the same issuer and impairment. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). Alphabet Inc. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could materially adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be adversely affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions on various tax-related assertions, examples include transfer pricing adjustments or permanent establishment. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws or rates in various jurisdictions may be subject to significant change, which could materially affect our financial position and results of operations. Risks Related to Ownership of Our Stock The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. For example, from January 1, 2018 through December 31, 2018, the closing price of our Class A common stock ranged from $984.66 per share to $1,285.50 per share, and the closing price of our Class C capital stock ranged from $976.21 to $1,268.32 per share. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others: Quarterly variations in our results of operations or those of our competitors. Announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments. Recommendations by securities analysts or changes in earnings estimates. Announcements about our earnings that are not in line with analyst expectations, the risk of which is enhanced because it is our policy not to give guidance on earnings. Announcements by our competitors of their earnings that are not in line with analyst expectations. Commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy. The volume of shares of Class A common stock and Class C capital stock available for public sale. Sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees). Short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock. The perceived values of Class A common stock and Class C capital stock relative to one another. Any share repurchase program. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Alphabet Inc. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock regardless of our actual operating performance. We cannot guarantee that any share repurchase program will be fully consummated or that any share repurchase program will enhance long-term stockholder value, and share repurchases could increase the volatility of the price of our stock and could diminish our cash reserves. In 2016 and 2018, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion and $8.6 billion of its Class C capital stock, respectively. The 2016 authorization was completed in 2018. As of December 31, 2018 , $1.7 billion remains available for repurchase. In January 2019, our board of directors authorized the repurchase of up to an additional $12.5 billion of our Class C capital stock. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Our share repurchase program could affect the price of our stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2018, Larry Page, Sergey Brin, and Eric E. Schmidt beneficially owned approximately 92.8% of our outstanding Class B common stock, which represented approximately 56.5% of the voting power of our outstanding common stock. Larry, Sergey, and Eric therefore have significant influence over management and affairs and over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could prolong the duration of Larry, Sergey and Erics current relative ownership of our voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts our stockholders ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. As a result, the market price of our Class A common stock and our Class C capital stock could be adversely affected. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry, Sergey, and Eric have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of prolonging the influence of Larry, Sergey, and Eric. Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. Alphabet Inc. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us. Risk Related to Our Holding Company Reorganization As a holding company, Alphabet is dependent on the operations and funds of its subsidiaries. Alphabet is a holding company with no business operations of its own. Alphabets most significant assets are the outstanding equity interests in its subsidiaries, including Google, that are each separate and distinct legal entities. As a result of our holding company structure, we rely on cash flows from subsidiaries to meet our obligations, including to service any debt obligations of Alphabet. Our subsidiaries may be restricted in their ability to pay cash dividends or to make other distributions to Alphabet and therefore, our ability to meet our obligations may be adversely affected by such restrictions. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which in the aggregate (including our headquarters) represent approximately 11.2 million square feet of office/building space and approximately fifty-nine acres of developable land to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Note 9 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2018 , there were approximately 2,026 and 2,195 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018 , there were approximately 65 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. We do not expect to pay any cash dividends in the foreseeable future. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2018 : Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 $ 1,115.81 $ 3,412 November 1 - 30 $ 1,054.22 $ 2,506 December 1 - 31 $ 1,048.23 $ 1,688 Total 2,470 $ 1,073.02 2,470 (1) In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 10 in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2013 to December 31, 2018 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2013 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2015 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 57-Month total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from April 3, 2014 to December 31, 2018 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on April 3, 2014 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2015 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. Trends in Our Business The following trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube engagement ads, which monetize at a lower rate than traditional desktop search ads. Additionally, we continue to see a shift to programmatic buying which presents opportunities for advertisers to connect with the right user, in the right moment, in the right context. Programmatic buying has a different monetization profile than traditional advertising buying on Google properties. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from mobile and other new formats. Our users are accessing the Internet via diverse devices and modalities and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of this shift in order to maintain and grow our business. We generate our advertising revenues increasingly from mobile and newer advertising formats, and the margins from the advertising revenues from these sources have generally been lower than those from traditional desktop search. Accordingly, we expect TAC paid to our distribution partners to increase due to changes in device mix between mobile, desktop, and tablet, partner mix, partner agreement terms, and the percentage of queries channeled through paid access points. We expect these trends to continue to put pressure on our overall margins. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, and we continue to develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time and we expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings. The margins on these non-advertising businesses vary significantly and may be lower than the margins on our advertising business. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. Alphabet Inc. As we continue to look for new ways to serve our users and expand our businesses, we will invest heavily in RD and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. Our capital expenditures have grown over time. We expect this trend to continue in the long term as we invest heavily in data centers, real estate and facilities, and information technology infrastructure. In addition, acquisitions remain an important part of our strategy and use of capital, and we expect to continue to spend cash on acquisitions and other investments. These acquisitions generally enhance the breadth and depth of our offerings, as well as expand our expertise in engineering and other functional areas. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. Executive Overview of Results Below are our key financial results for the fiscal year ended December 31, 2018 (consolidated unless otherwise noted): Revenues of $136.8 billion and revenue growth of 23% year over year, constant currency revenue growth of 22% year over year. Google segment revenues of $136.2 billion with revenue growth of 23% year over year and Other Bets revenues of $595 million with revenue growth of 25% year over year. Revenues from the United States , EMEA , APAC , and Other Americas were $63.3 billion , $44.6 billion , $21.4 billion , and $7.6 billion , respectively. Cost of revenues was $59.5 billion , consisting of TAC of $26.7 billion and other cost of revenues of $32.8 billion . Our TAC as a percentage of advertising revenues was 23% . Operating expenses (excluding cost of revenues) were $50.9 billion . Income from operations was $26.3 billion . Other income (expense), net, was $8.6 billion . Effective tax rate was 12% . Net income was $30.7 billion with diluted net income per share of $43.70 . Operating cash flow was $48.0 billion . Capital expenditures were $25.1 billion . Number of employees was 98,771 as of December 31, 2018 . Information about Segments We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as Ads, Android, Chrome, Google Cloud, Google Maps, Google Play, Hardware (including Nest), Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes businesses such as Access, Calico, CapitalG, GV, Verily, Waymo, and X. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. In Q1 2018, Nest joined Googles hardware team. Consequently, the financial results of Nest are reported in the Google segment, with Nest revenues reflected in Google other revenues. Prior period segment information has been recast to conform to the current period segment presentation. Consolidated financial results are not affected. Alphabet Inc. Please refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Revenues The following table presents our revenues, by segment and revenue source (in millions): Year Ended December 31, Google segment Google properties revenues $ 63,785 $ 77,788 $ 96,336 Google Network Members' properties revenues 15,598 17,587 19,982 Google advertising revenues 79,383 95,375 116,318 Google other revenues 10,601 15,003 19,906 Google segment revenues $ 89,984 $ 110,378 $ 136,224 Other Bets Other Bets revenues $ $ $ Revenues $ 90,272 $ 110,855 $ 136,819 Google segment The following table presents our Google segment revenues (in millions): Year Ended December 31, Google segment revenues $ 89,984 $ 110,378 $ 136,224 Google segment revenues as a percentage of total revenues 99.7 % 99.6 % 99.6 % Use of Monetization Metrics When assessing our advertising revenues performance, historically we presented the percentage change in the number of paid clicks and cost-per-click for both our Google properties and our Google Network Members properties (Network) revenues. As our impression-based revenues have become a more significant driver of Network revenues growth, the percentage change in paid clicks and cost-per-click cover less of our total Network revenues. As a result, in Q1 2018, we transitioned our Network revenue metrics from the percentage change in paid clicks and cost-per-click to the percentage change in impressions and cost-per-impression. Click-based revenues generated by our Network business are included in impression-based metrics, so that these metrics cover nearly all of our Network business. The monetization metrics for Google properties revenues remain unchanged. Paid clicks for our Google properties represent engagement by users and include clicks on advertisements by end-users related to searches on Google.com, clicks related to advertisements on other owned and operated properties including Gmail, Google Maps, and Google Play; and viewed YouTube engagement ads. Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense for Content, AdSense for Search, and Google Ad Manager (includes what was formerly DoubleClick AdExchange). Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google properties and the revenues generated by impression activity on Google Network Members properties. Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have fluctuated and may continue to fluctuate because of various factors, including: Alphabet Inc. advertiser competition for keywords; changes in advertising quality or formats; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions; growth rates of revenues within Google properties; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has fluctuated over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels, changes in our product mix, increasing competition, query growth rates, our investments in new business strategies, shifts in the geographic mix of our revenues, and the evolution of the online advertising market. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Google properties The following table presents our Google properties revenues (in millions), and changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, Google properties revenues $ 63,785 $ 77,788 $ 96,336 Google properties revenues as a percentage of Google segment revenues 70.9 % 70.5 % 70.7 % Paid clicks change % % Cost-per-click change (21 )% (25 )% Google properties revenues consist primarily of advertising revenues that are generated on: Google search properties which includes revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.; and Other Google owned and operated properties like Gmail, Google Maps, Google Play, and YouTube. Our Google properties revenues increased $18,548 million from 2017 to 2018 and increased $14,003 million from 2016 to 2017 . The growth during both periods was primarily driven by increases in mobile search resulting from ongoing growth in user adoption and usage, as well as continued growth in advertiser activity. We also experienced growth in YouTube driven primarily by video advertising, as well as growth in desktop search due to improvements in ad formats and delivery. Additionally, revenue growth from 2017 to 2018 was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. The growth from 2016 to 2017 was partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. The number of paid clicks through our advertising programs on Google properties increased from 2017 to 2018 and from 2016 to 2017 due to growth in YouTube engagement ads, increases in mobile search queries, improvements we have made in ad formats and delivery, and continued global expansion of our products, advertisers and user base. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers from 2017 to 2018 and from 2016 to 2017 . The decreases in cost-per-click were primarily driven by continued growth in YouTube engagement ads where cost-per-click remains lower than on our other advertising platforms. Cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Alphabet Inc. Google Network Members' properties The following table presents our Google Network Members' properties revenues (in millions) and changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, Google Network Members' properties revenues $ 15,598 $ 17,587 $ 19,982 Google Network Members' properties revenues as a percentage of Google segment revenues 17.3 % 15.9 % 14.7 % Impressions change % % Cost-per-impression change % % Google Network Members' properties revenues consist primarily of advertising revenues generated from advertisements served on Google Network Members' properties participating in: AdMob; AdSense (such as AdSense for Content, AdSense for Search, etc.); and Google Ad Manager . Our Google Network Members' properties revenues increased $2,395 million from 2017 to 2018 . The growth was primarily driven by strength in both AdMob and programmatic advertising buying, offset by a decline in our traditional AdSense businesses. Additionally, the growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. The increase in impressions from 2017 to 2018 resulted primarily from growth in AdMob offset by a decrease from AdSense for Content due to ongoing product changes. The increase in cost-per-impression was primarily due to ongoing product and policy changes and improvements we have made in ad formats and delivery and was also affected by changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Our Google Network Members' properties revenues increased $1,989 million from 2016 to 2017 . The growth was primarily driven by strength in both programmatic advertising buying and AdMob, offset by a decline in our traditional AdSense businesses and the general strengthening of the U.S. dollar compared to certain foreign currencies. The increase in impressions from 2016 to 2017 resulted primarily from growth in programmatic advertising and AdMob, partially offset by a decrease from AdSense for Search. The increase in cost-per-impression from 2016 to 2017 was primarily due to ongoing product and policy changes and improvements we have made in ad formats and delivery and was also affected by changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google other revenues The following table presents our Google other revenues (in millions): Year Ended December 31, Google other revenues $ 10,601 $ 15,003 $ 19,906 Google other revenues as a percentage of Google segment revenues 11.8 % 13.6 % 14.6 % Google other revenues consist primarily of revenues from: Apps, in-app purchases, and digital content in the Google Play store; Google Cloud offerings; and Hardware. Our Google other revenues increased $4,903 million from 2017 to 2018 . The increase was primarily driven by revenues from Google Cloud offerings, revenues from Google Play, largely relating to in-app purchases (revenues which we recognize net of payout to developers), and hardware sales. Our Google other revenues increased $4,402 million from 2016 to 2017 . The increase was primarily driven by revenues from Google Cloud offerings, hardware sales, and revenues from Google Play, largely relating to in-app purchases (revenues which we recognize net of payout to developers). Alphabet Inc. Other Bets The following table presents our Other Bets revenues (in millions): Year Ended December 31, Other Bets revenues $ $ $ Other Bets revenues as a percentage of total revenues 0.3 % 0.4 % 0.4 % Other Bets revenues consist primarily of revenues and sales from internet and TV services as well as licensing and RD services. Our Other Bets revenues increased $118 million from 2017 to 2018 and increased $189 million from 2016 to 2017 . These increases were primarily driven by revenues from sales of Access internet and TV services and revenues from Verily licensing and RD services. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, United States % % % EMEA % % % APAC % % % Other Americas % % % For the amounts of revenues by geography, please refer to Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Growth The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our international revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and constant currency revenue growth for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to GAAP results helps improve the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue growth on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue growth (expressed as a percentage) is calculated by determining the increase in current period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions): Year Ended December 31, EMEA revenues $ 30,304 $ 36,046 $ 44,567 Exclude foreign exchange effect on current period revenues using prior year rates 1,291 (5 ) (1,325 ) Exclude hedging effect recognized in current period (479 ) EMEA constant currency revenues $ 31,116 $ 36,231 $ 43,414 Prior period EMEA revenues, excluding hedging effect $ 25,379 $ 29,825 $ 36,236 EMEA revenue growth % % EMEA constant currency revenue growth % % APAC revenues $ 12,559 $ 16,235 $ 21,374 Exclude foreign exchange effect on current period revenues using prior year rates (362 ) (49 ) Exclude hedging effect recognized in current period (31 ) (43 ) (33 ) APAC constant currency revenues $ 12,166 $ 16,218 $ 21,292 Prior period APAC revenues, excluding hedging effect $ 9,564 $ 12,528 $ 16,192 APAC revenue growth % % APAC constant currency revenue growth % % Other Americas revenues $ 4,628 $ 6,125 $ 7,609 Exclude foreign exchange effect on current period revenues using prior year rates (148 ) Exclude hedging effect recognized in current period (29 ) (1 ) Other Americas constant currency revenues $ 4,943 $ 5,999 $ 8,012 Prior period Other Americas revenues, excluding hedging effect $ 3,836 $ 4,599 $ 6,147 Other Americas revenue growth % % Other Americas constant currency revenue growth % % United States revenues $ 42,781 $ 52,449 $ 63,269 United States revenue growth % % Total revenues $ 90,272 $ 110,855 $ 136,819 Total constant currency revenues $ 91,006 $ 110,897 $ 135,987 Total revenue growth % % Total constant currency revenue growth % % Our EMEA revenues and revenue growth from 2017 to 2018 were favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro and British pound. Our EMEA revenues and revenue growth from 2016 to 2017 were unfavorably affected by hedging losses. Our APAC revenues and revenue growth from 2017 to 2018 were favorably affected by changes in foreign currency exchange rates, as well as hedging benefits, primarily due to the U.S. dollar weakening relative to the Japanese yen, offset by the U.S. dollar strengthening relative to the Australian dollar. Our APAC revenues and revenue growth from 2016 to 2017 were slightly affected by hedging benefits and changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Japanese yen, offset by the U.S. dollar weakening relative to the Australian dollar, Indian rupee, South Korean won, and Taiwanese dollar. Alphabet Inc. Our Other Americas revenues and revenue growth from 2017 to 2018 were unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Our Other Americas revenues and revenue growth from 2016 to 2017 were favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Brazilian real and Canadian dollar, offset by the U.S. dollar strengthening relative to the Argentine peso. Costs and Expenses Cost of Revenues Cost of revenues consists of TAC which are paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues related to revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues related to revenues generated from ads placed on Google properties because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expenses (including stock-based compensation (SBC)), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions): Year Ended December 31, TAC $ 16,793 $ 21,672 $ 26,726 Other cost of revenues 18,345 23,911 32,823 Total cost of revenues $ 35,138 $ 45,583 $ 59,549 Total cost of revenues as a percentage of revenues 38.9 % 41.1 % 43.5 % Year Ended December 31, TAC to distribution partners $ 5,894 $ 9,031 $ 12,572 TAC to distribution partners as a percentage of Google properties revenues (1) (Google properties TAC rate) 9.2 % 11.6 % 13.1 % TAC to Google Network Members $ 10,899 $ 12,641 $ 14,154 TAC to Google Network Members as a percentage of Google Network Members' properties revenues (1) (Network Members TAC rate) 69.9 % 71.9 % 70.8 % TAC $ 16,793 $ 21,672 $ 26,726 TAC as a percentage of advertising revenues (1) (Aggregate TAC rate) 21.2 % 22.7 % 23.0 % (1) Revenues include hedging gains (losses) which affect TAC rates. Cost of revenues increased $13,966 million from 2017 to 2018 . The increase was due to increases in TAC and other cost of revenues of $5,054 million and $8,912 million , respectively. The increase in TAC to distribution partners from 2017 to 2018 was a result of an increase in Google properties revenues and the associated TAC rate. The increase in the Google properties TAC rate was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are Alphabet Inc. channeled through paid access points. The increase in TAC to Google Network Members from 2017 to 2018 was a result of an increase in Google Network Members' properties revenues offset by a decrease in the associated TAC rate. The decrease in the Network Members TAC rate was primarily due to a shift to lower TAC products within programmatic advertising buying. The increase in the aggregate TAC rate from 2017 to 2018 was a result of an increase in Google properties TAC rate, partially offset by a favorable revenue mix shift from Google Network Members' properties to Google properties. Other cost of revenues increased $8,912 million from 2017 to 2018 . The increase was due to an increase in data center and other operations costs, which was affected by increased allocations primarily from general and administrative expenses; content acquisition costs as a result of increased activities related to YouTube; and hardware costs associated with new hardware launches. Cost of revenues increased $10,445 million from 2016 to 2017 . The increase was due to an increase in TAC of $4,879 million . The increase in TAC to distribution partners was a result of an increase in Google properties revenues and the associated TAC rate. The increase in TAC to Google Network Members was a result of an increase in Google Network Members' properties revenues and the associated TAC rate. The increase in the Google properties TAC rate was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. The increase in the Network Members TAC rate was driven by the continued underlying shift in advertising buying from our traditional network business to programmatic advertising buying. The increase in the aggregate TAC rate was also partially offset by a favorable revenue mix shift from Google Network Members' properties to Google properties. Other cost of revenues increased $5,566 million from 2016 to 2017. The increase was due to various factors, including an increase in data center and other operations costs, which include depreciation, compensation expenses (including SBC), energy, bandwidth, and other equipment costs as a result of business growth; hardware costs associated with new hardware launches; and content acquisition costs as a result of increased activities related to YouTube. We expect cost of revenues to increase in dollar amount and as a percentage of total revenues in future periods based on a number of factors, including the following: Google Network Members TAC rates, which are affected by a combination of factors such as geographic mix, product mix, revenue share terms, and fluctuations of the U.S. dollar compared to certain foreign currencies ; Google properties TAC rates, which are affected by changes in device mix between mobile, desktop, and tablet, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; Growth rates of expenses associated with our data centers and other operations, content acquisition costs, as well as our hardware inventory and related costs; Higher cost of revenues associated with the increased proportion of non-advertising revenues relative to our advertising revenues; and Relative revenue growth rates of Google properties and our Google Network Members' properties. Research and Development The following table presents our RD expenses (in millions): Year Ended December 31, Research and development expenses $ 13,948 $ 16,625 $ 21,419 Research and development expenses as a percentage of revenues 15.5 % 15.0 % 15.7 % RD expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $4,794 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $3,518 million, largely resulting from a 24% increase in headcount. In addition, there was an increase in depreciation and equipment-related expenses of $499 Alphabet Inc. million and $318 million, respectively, as well as an increase in professional services fees of $305 million due to additional expenses incurred for outsourced services and consulting. RD expenses increased $2,677 million from 2016 to 2017 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,886 million, largely resulting from a 16% increase in headcount. In addition, there was an increase in depreciation expenses of $323 million and equipment-related expenses of $246 million. We expect that RD expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. Sales and Marketing The following table presents our sales and marketing expenses (in millions): Year Ended December 31, Sales and marketing expenses $ 10,485 $ 12,893 $ 16,333 Sales and marketing expenses as a percentage of revenues 11.6 % 11.6 % 11.9 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) and facilities-related costs for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses increased $3,440 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,418 million, largely resulting from a 12% increase in headcount. In addition, there was an increase in advertising and promotional expenses of $1,233 million, largely resulting from increases in marketing and promotion-related expenses for our Cloud offerings and the Google Assistant. Sales and marketing expenses increased $2,408 million from 2016 to 2017 . The increase was primarily due to an increase in advertising and promotional expenses of $1,266 million, largely resulting from increases in marketing and promotion-related expenses for our hardware products, Cloud offerings, and YouTube. In addition, there was an increase in compensation expenses (including SBC) and facilities-related costs of $853 million, largely resulting from a 6% increase in headcount. We expect that sales and marketing expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. General and Administrative The following table presents our general and administrative expenses (in millions): Year Ended December 31, General and administrative expenses $ 6,985 $ 6,872 $ 8,126 General and administrative expenses as a percentage of revenues 7.7 % 6.2 % 5.9 % General and administrative expenses consist primarily of: Compensation expenses (including SBC and accrued performance fees related to gains on securities) and facilities-related costs for employees in our facilities, finance, human resources, information technology, and legal organizations; Depreciation; Equipment-related expenses; and Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $1,254 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,660 million, largely resulting from accrued performance fees primarily related to gains on equity securities. The increase was offset by reduced allocations (with a corresponding net increase primarily in cost of revenues). Alphabet Inc. General and administrative expenses decreased $113 million from 2016 to 2017 . The decrease was primarily from reduced allocations to general and administrative expenses with an offsetting increase to cost of revenues and other operating expenses. The decrease was partially offset by an increase in compensation expenses (including SBC) and facilities-related costs of $271 million, largely resulting from a 9% increase in headcount. Additionally, there was an increase in professional service fees of $253 million due to additional expenses incurred for outsourced services and consulting services. We expect general and administrative expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. European Commission Fines In June 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($2.7 billion as of June 27, 2017) fine, which was accrued in the second quarter of 2017. In July 2018, the EC announced its decision that certain provisions in Google's Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($5.1 billion as of June 30, 2018) fine, which was accrued in the second quarter of 2018. Please refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, Other income (expense), net $ $ 1,047 $ 8,592 Other income (expense), net, as a percentage of revenues 0.5 % 0.9 % 6.3 % Other income (expense), net, increased $7,545 million from 2017 to 2018 . This increase was primarily driven by unrealized gains on equity securities resulting from the adoption of a new accounting standard and the modification of the terms of a non-marketable debt security resulting in a recognized unrealized gain. Other income (expense), net, increased $613 million from 2016 to 2017 . This increase was primarily driven by reduced costs of our foreign currency hedging activities, decreased losses on marketable securities and an increase in interest income. We expect other income (expense), net, will fluctuate in dollar amount and percentage of revenues in future periods as it is largely driven by market dynamics. Beginning in 2018, changes in the value of marketable and non-marketable equity security investments are reflected in OIE. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets could result in a significant change in the value of our equity securities. Fluctuations in the value of these investments could contribute to the volatility of OIE in future periods. For additional information about equity investments, please see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Provision for Income Taxes The following table presents our provision for income taxes (in millions) and effective tax rate: Year Ended December 31, Provision for income taxes $ 4,672 $ 14,531 $ 4,177 Effective tax rate 19.3 % 53.4 % 12.0 % Our provision for income taxes and our effective tax rate decreased from 2017 to 2018 , due to the U.S. Tax Cuts and Jobs Act (Tax Act) which was enacted in December 2017. Please refer to Note 13 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Alphabet Inc. Our provision for income taxes and our effective tax rate increased from 2016 to 2017 , due to the effects of the Tax Act related to the one time-transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax and the base erosion tax, respectively. Our future effective tax rate could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2018 . This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Both seasonal fluctuations in internet usage, advertising expenditures and underlying business trends such as traditional retail seasonality have affected, and are likely to continue to affect, our business. Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2017 Jun 30, 2017 Sept 30, 2017 Dec 31, 2017 Mar 31, 2018 Jun 30, 2018 Sept 30, 2018 Dec 31, 2018 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 24,750 $ 26,010 $ 27,772 $ 32,323 $ 31,146 $ 32,657 $ 33,740 $ 39,276 Costs and expenses: Cost of revenues 9,795 10,373 11,148 14,267 13,467 13,883 14,281 17,918 Research and development 3,942 4,172 4,205 4,306 5,039 5,114 5,232 6,034 Sales and marketing 2,644 2,897 3,042 4,310 3,604 3,780 3,849 5,100 General and administrative 1,801 1,700 1,595 1,776 2,035 2,002 2,068 2,021 European Commission fines 2,736 5,071 Total costs and expenses 18,182 21,878 19,990 24,659 24,145 29,850 25,430 31,073 Income from operations 6,568 4,132 7,782 7,664 7,001 2,807 8,310 8,203 Other income (expense), net 3,542 1,408 1,773 1,869 Income from continuing operations before income taxes 6,819 4,377 7,979 8,018 10,543 4,215 10,083 10,072 Provision for income taxes 1,393 1,247 11,038 1,142 1,020 1,124 Net income (loss) $ 5,426 $ 3,524 $ 6,732 $ (3,020 ) $ 9,401 $ 3,195 $ 9,192 $ 8,948 Basic net income (loss) per share of Class A and B common stock and Class C capital stock $ 7.85 $ 5.09 $ 9.71 $ (4.35 ) $ 13.53 $ 4.60 $ 13.21 $ 12.87 Diluted net income (loss) per share of Class A and B common stock and Class C capital stock $ 7.73 $ 5.01 $ 9.57 $ (4.35 ) $ 13.33 $ 4.54 $ 13.06 $ 12.77 Capital Resources and Liquidity As of December 31, 2018 , we had $109.1 billion in cash, cash equivalents, and marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities. From time to time, we may hold Alphabet Inc. marketable equity securities obtained through acquisitions or strategic investments in private companies that subsequently go public. In December 2017, the Tax Act was enacted and resulted in a one-time transition tax on accumulated foreign subsidiary earnings. After 2017, our foreign earnings held by foreign subsidiaries are no longer subject to U.S. tax upon repatriation to the U.S. As of December 31, 2018 , the remaining long-term tax payable related to the Tax Act of $7.4 billion is presented within income tax payable, non-current on our Consolidated Balance Sheets. As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. During the years ended December 31, 2017 and 2018, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($2.7 billion as of June 27, 2017) and 4.3 billion ($5.1 billion as of June 30, 2018), respectively. While under appeal, EC fines are included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the respective fines. Please refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2018 . We have $4.0 billion of revolving credit facilities expiring in July 2023 with no amounts outstanding. The interest rate for the credit facilities is determined based on a formula using certain market rates. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. As of December 31, 2018 , we have senior unsecured notes outstanding due in 2021, 2024, and 2026 with a total carrying value of $4.0 billion . In 2016 and 2018, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion and $8.6 billion of its Class C capital stock, respectively. The 2016 authorization was completed in 2018. As of December 31, 2018 , $1.7 billion remains available for repurchase. In January 2019, our board of directors authorized the repurchase of up to an additional $12.5 billion of our Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to stock repurchases. The following table presents our cash flows (in millions): Year Ended December 31, Net cash provided by operating activities $ 36,036 $ 37,091 $ 47,971 Net cash used in investing activities $ (31,165 ) $ (31,401 ) $ (28,504 ) Net cash used in financing activities $ (8,332 ) $ (8,298 ) $ (13,179 ) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google properties and Google Network Members' properties. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings . Our primary uses of cash from our operating activities include payments to our Google Network Members and distribution partners, and payments for content acquisition costs. In addition, uses of cash from operating activities include compensation and related costs, hardware inventory costs, other general corporate expenditures, and income taxes. Net cash provided by operating activities increased from 2017 to 2018 primarily due to increases in cash received from advertising revenues and Google other revenues (net of payouts to app developers), offset by increases in cash paid for cost of revenues and operating expenses. Alphabet Inc. Net cash provided by operating activities increased from 2016 to 2017 primarily due to increases in cash received from advertising revenues and Google other revenues (net of payouts to app developers), offset by increases in cash paid for cost of revenues, operating expenses, and income taxes. Cash Used in Investing Activities Cash provided by or used in investing activities primarily consists of purchases of property and equipment; purchases, maturities, and sales of marketable and non-marketable securities; and payments for acquisitions. Net cash used in investing activities decreased from 2017 to 2018 primarily due to a decrease in purchases of marketable securities. The decrease was partially offset by higher investments in land and buildings for offices and data centers, as well as, servers to provide capacity for the growth of our businesses. Generally, our investment in office facilities is driven by workforce needs; and our investment in data centers is driven by our compute and storage requirements and has a lead time of up to three years. Further, the decrease was partially offset by an increase in payments for acquisitions and a decrease in maturities and sales of marketable securities. Net cash used in investing activities increased slightly from 2016 to 2017 primarily due to an increase in purchases of marketable securities and an increase in purchases of property and equipment, partially offset by an increase in the maturities and sales of marketable securities, a decrease in cash collateral paid related to securities lending, and an increase in proceeds received from collections of notes receivables. Cash Used in Financing Activities Cash provided by or used in financing activities consists primarily of net proceeds or payments from stock-based award activities, repurchases of capital stock, and net proceeds or payments from issuance or repayments of debt. Net cash used in financing activities increased from 2017 to 2018 primarily due to higher cash payments for repurchases of capital stock and stock-based award activities. Net cash used in financing activities decreased slightly from 2016 to 2017 primarily due to lower net cash payments from repayments and issuance of debt, partially offset by higher cash payments for repurchases of capital stock. Contractual Obligations as of December 31, 2018 The following summarizes our contractual obligations as of December 31, 2018 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations, net of sublease income amounts (1) $ 10,047 $ 1,303 $ 2,711 $ 2,122 $ 3,911 Purchase obligations (2) 7,433 5,132 1,407 Long-term debt obligations (3) 4,689 1,220 3,181 Tax payable (4) 7,440 2,029 5,411 Other long-term liabilities reflected on our balance sheet (5) 2,443 1,048 Total contractual obligations $ 32,052 $ 6,910 $ 8,005 $ 8,473 $ 8,664 (1) For further information, refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to information technology assets and data center operation costs; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2018 . Excluded from the table above are open orders for purchases that support normal operations. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 5 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 13 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $3.9 billion as of December 31, 2018 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for the construction of offices and certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the Alphabet Inc. EC fines, refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2018 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, non-income taxes, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any Alphabet Inc. of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Valuation of Non-marketable Equity Securities Beginning on January 1, 2018, our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative upon the adoption of ASU 2016-01. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include industry and market conditions, financial performance, business prospects, and other relevant events and factors. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we measure our non-marketable securities at fair value. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the local currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets and liabilities denominated in currencies other than the local currencies at the balance sheet dates, it would have resulted in an adverse effect on income before income taxes of approximately $52 million and $1 million as of December 31, 2017 and 2018 , respectively. The adverse effect as of December 31, 2017 and 2018 is after consideration of the offsetting effect of approximately $374 million for both periods from foreign exchange contracts in place for the months ended December 31, 2017 and December 31, 2018 . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do Alphabet Inc. not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2017 and December 31, 2018 , the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $950 million and $772 million lower as of December 31, 2017 and December 31, 2018 , respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. During 2018, we entered into foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $635 million lower as of December 31, 2018. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity requirements. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as a result of higher market interest rates compared to interest rates at the time of purchase. We account for both fixed and variable rate securities at fair value with gains and losses recorded in AOCI until the securities are sold. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2017 and 2018 are shown below (in millions): As of December 31, 12-Month Average As of December 31, Risk Category - Interest Rate $ $ $ $ Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2017 and 2018 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of marketrelated risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $1.2 billion of our investments as of December 31, 2018. A hypothetical adverse price change of 10%, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $120 million . Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the Alphabet Inc. measurement alternative). The fair value is measured at the time of the observable transaction, which is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize value in our investments through liquidity events such as public offerings, acquisitions, private sales or other favorable market events reflecting appreciation to the cost of our initial investment. As of December 31, 2018, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $12.3 billion . Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge on our non-marketable equity securities. The carrying values of our equity method investments generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2017 and 2018, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedule listed in the Index at Item 15(a)2 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 4, 2019 expressed an unqualified opinion thereon. Adoption of New Accounting Standard As discussed in Note 1 to the consolidated financial statements, the Company changed its method for accounting for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 4, 2019 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2018 consolidated financial statements of the Company and our report dated February 4, 2019 expressed an unqualified opinion thereon that included an explanatory paragraph regarding the Companys adoption of a new accounting standard for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitation of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 4, 2019 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2017 As of December 31, 2018 Assets Current assets: Cash and cash equivalents $ 10,715 $ 16,701 Marketable securities 91,156 92,439 Total cash, cash equivalents, and marketable securities 101,871 109,140 Accounts receivable, net of allowance of $674 and $729 18,336 20,838 Income taxes receivable, net Inventory 1,107 Other current assets 2,983 4,236 Total current assets 124,308 135,676 Non-marketable investments 7,813 13,859 Deferred income taxes Property and equipment, net 42,383 59,719 Intangible assets, net 2,692 2,220 Goodwill 16,747 17,888 Other non-current assets 2,672 2,693 Total assets $ 197,295 $ 232,792 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 3,137 $ 4,378 Accrued compensation and benefits 4,581 6,839 Accrued expenses and other current liabilities 10,177 16,958 Accrued revenue share 3,975 4,592 Deferred revenue 1,432 1,784 Income taxes payable, net Total current liabilities 24,183 34,620 Long-term debt 3,969 4,012 Deferred revenue, non-current Income taxes payable, non-current 12,812 11,327 Deferred income taxes 1,264 Other long-term liabilities 3,059 3,545 Total liabilities 44,793 55,164 Commitments and Contingencies (Note 9) Stockholders equity: Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000, Class C 3,000,000); 694,783 (Class A 298,470, Class B 46,972, Class C 349,341) and 695,556 (Class A 299,242, Class B 46,636, Class C 349,678) shares issued and outstanding 40,247 45,049 Accumulated other comprehensive loss (992 ) (2,306 ) Retained earnings 113,247 134,885 Total stockholders equity 152,502 177,628 Total liabilities and stockholders equity $ 197,295 $ 232,792 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenues $ 90,272 $ 110,855 $ 136,819 Costs and expenses: Cost of revenues 35,138 45,583 59,549 Research and development 13,948 16,625 21,419 Sales and marketing 10,485 12,893 16,333 General and administrative 6,985 6,872 8,126 European Commission fines 2,736 5,071 Total costs and expenses 66,556 84,709 110,498 Income from operations 23,716 26,146 26,321 Other income (expense), net 1,047 8,592 Income before income taxes 24,150 27,193 34,913 Provision for income taxes 4,672 14,531 4,177 Net income $ 19,478 $ 12,662 $ 30,736 Basic net income per share of Class A and B common stock and Class C capital stock $ 28.32 $ 18.27 $ 44.22 Diluted net income per share of Class A and B common stock and Class C capital stock $ 27.85 $ 18.00 $ 43.70 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 19,478 $ 12,662 $ 30,736 Other comprehensive income (loss): Change in foreign currency translation adjustment (599 ) 1,543 (781 ) Available-for-sale investments: Change in net unrealized gains (losses) (314 ) Less: reclassification adjustment for net (gains) losses included in net income (911 ) Net change (net of tax effect of $0, $0, and $156) (93 ) (823 ) Cash flow hedges: Change in net unrealized gains (losses) (638 ) Less: reclassification adjustment for net (gains) losses included in net income (351 ) Net change (net of tax effect of $64, $247, and $103) (545 ) Other comprehensive income (loss) (528 ) 1,410 (1,216 ) Comprehensive income $ 18,950 $ 14,072 $ 29,520 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2015 687,348 $ 32,982 $ (1,874 ) $ 89,223 $ 120,331 Cumulative effect of accounting change (133 ) Common and capital stock issued 9,106 Stock-based compensation expense 6,700 6,700 Tax withholding related to vesting of restricted stock units (3,597 ) (3,597 ) Repurchases of capital stock (5,161 ) (256 ) (3,437 ) (3,693 ) Net income 19,478 19,478 Other comprehensive loss (528 ) (528 ) Balance as of December 31, 2016 691,293 36,307 (2,402 ) 105,131 139,036 Cumulative effect of accounting change (15 ) (15 ) Common and capital stock issued 8,652 Stock-based compensation expense 7,694 7,694 Tax withholding related to vesting of restricted stock units (4,373 ) (4,373 ) Repurchases of capital stock (5,162 ) (315 ) (4,531 ) (4,846 ) Sale of subsidiary shares Net income 12,662 12,662 Other comprehensive income 1,410 1,410 Balance as of December 31, 2017 694,783 40,247 (992 ) 113,247 152,502 Cumulative effect of accounting change (98 ) (599 ) (697 ) Common and capital stock issued 8,975 Stock-based compensation expense 9,353 9,353 Tax withholding related to vesting of restricted stock units and other (4,782 ) (4,782 ) Repurchases of capital stock (8,202 ) (576 ) (8,499 ) (9,075 ) Sale of subsidiary shares Net income 30,736 30,736 Other comprehensive loss (1,216 ) (1,216 ) Balance as of December 31, 2018 695,556 $ 45,049 $ (2,306 ) $ 134,885 $ 177,628 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Operating activities Net income $ 19,478 $ 12,662 $ 30,736 Adjustments: Depreciation and impairment of property and equipment 5,267 6,103 8,164 Amortization and impairment of intangible assets Stock-based compensation expense 6,703 7,679 9,353 Deferred income taxes (38 ) (Gain) loss on debt and equity securities, net (6,650 ) Other (189 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable (2,578 ) (3,768 ) (2,169 ) Income taxes, net 3,125 8,211 (2,251 ) Other assets (2,164 ) (1,207 ) Accounts payable 1,067 Accrued expenses and other liabilities 1,515 4,891 8,614 Accrued revenue share Deferred revenue Net cash provided by operating activities 36,036 37,091 47,971 Investing activities Purchases of property and equipment (10,212 ) (13,184 ) (25,139 ) Proceeds from disposals of property and equipment Purchases of marketable securities (84,509 ) (92,195 ) (50,158 ) Maturities and sales of marketable securities 66,895 73,959 48,507 Purchases of non-marketable investments (1,109 ) (1,745 ) (2,073 ) Maturities and sales of non-marketable investments 1,752 Cash collateral related to securities lending (2,428 ) Investments in reverse repurchase agreements Acquisitions, net of cash acquired, and purchases of intangible assets (986 ) (287 ) (1,491 ) Proceeds from collection of notes receivable 1,419 Net cash used in investing activities (31,165 ) (31,401 ) (28,504 ) Financing activities Net payments related to stock-based award activities (3,304 ) (4,166 ) (4,993 ) Repurchases of capital stock (3,693 ) (4,846 ) (9,075 ) Proceeds from issuance of debt, net of costs 8,729 4,291 6,766 Repayments of debt (10,064 ) (4,377 ) (6,827 ) Proceeds from sale of subsidiary shares Net cash used in financing activities (8,332 ) (8,298 ) (13,179 ) Effect of exchange rate changes on cash and cash equivalents (170 ) (302 ) Net increase (decrease) in cash and cash equivalents (3,631 ) (2,203 ) 5,986 Cash and cash equivalents at beginning of period 16,549 12,918 10,715 Cash and cash equivalents at end of period $ 12,918 $ 10,715 $ 16,701 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 1,643 $ 6,191 $ 5,671 Cash paid for interest, net of amounts capitalized $ $ $ See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (Alphabet) became the successor issuer to Google. We generate revenues primarily by delivering relevant, cost-effective online advertising. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. Noncontrolling interests are not presented separately as the amounts are not material. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the bad debt allowance, sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Revenue Recognition We recognize revenues when we transfer control of promised goods or services to our customers in an amount that reflects the consideration to which we expect to be entitled to in exchange for those goods or services. See Note 2 for further discussion on Revenues. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other costs of revenues (which is the cost of revenues excluding TAC) include the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital. Additionally, stock-based compensation includes other types of stock-based awards that may be settled in the stock of certain of our Other Bets or in cash. Awards that are liability classified are remeasured at fair value through settlement or maturity. The fair value of such awards is based on the valuation of equity of the respective Other Bet. Alphabet Inc. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of vertical market segments in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. We maintain reserves for estimated credit losses and these losses have generally been within our expectations. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2016 , 2017 , or 2018 . In 2016 , 2017 , and 2018 , we generated approximately 47% , 47% , and 46% of our revenues, respectively, from customers based in the U.S. See Note 2 for further details. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets that are measured at fair value on a nonrecurring basis include non-marketable equity securities measured at fair value when observable price changes are identified or when non-marketable equity securities are impaired . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. We classify all investments that are readily convertible to known amounts of cash and have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities. We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available Alphabet Inc. to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for unrealized losses determined to be other-than-temporary, which we record within other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Beginning on January 1, 2018, our non-marketable equity securities not accounted for under the equity method are either carried at fair value or under the measurement alternative upon the adoption of ASU 2016-01. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Adjustments are determined primarily based on a market approach as of the transaction date. We classify our non-marketable investments as non-current assets on the Consolidated Balance Sheets as those investments do not have stated contractual maturity dates. We account for our non-marketable investments that meet the definition of a debt security as available-for-sale securities. Impairment of Investments We periodically review our debt and equity investments for impairment. For debt securities we consider the duration, severity and the reason for the decline in security value; whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or if the amortized cost basis cannot be recovered as a result of credit losses. If any impairment is considered other-than-temporary, we will write down the security to its fair value and record the corresponding charge as other income (expense), net. For equity securities we consider impairment indicators such as negative changes in industry and market conditions, financial performance, business prospects, and other relevant events and factors. If indicators exist and the fair value of the security is below the carrying amount, we write down the security to fair value. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests in is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE; and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Accounts Receivable We record accounts receivable at the invoiced amount. We maintain an allowance for doubtful accounts to reserve for potentially uncollectible receivables. We review the accounts receivable by amounts due from customers that are past due to identify specific customers with known disputes or collectability issues. In determining the amount of the reserve, we make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets. We depreciate buildings over periods of seven to 25 years. We generally depreciate information technology assets over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Alphabet Inc. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets are not recoverable, the impairment recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were not material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives over periods ranging from one to twelve years. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange losses in other income (expense), net. Alphabet Inc. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2016 , 2017 and 2018 , advertising and promotional expenses totaled approximately $3.9 billion , $5.1 billion , and $6.4 billion , respectively. Recent Accounting Pronouncements Recently issued accounting pronouncements not yet adopted In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02 (Topic 842) ""Leases."" Topic 842 supersedes the lease requirements in Accounting Standards Codification (ASC) Topic 840, ""Leases."" Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases will continue to be classified as either finance or operating. We will adopt Topic 842 effective January 1, 2019 using a modified retrospective method and will not restate comparative periods. As permitted under the transition guidance, we will carry forward the assessment of whether our contracts contain or are leases, classification of our leases and remaining lease terms. Based on our portfolio of leases as of December 31, 2018, approximately $9 billion of lease assets and liabilities will be recognized on our balance sheet upon adoption, primarily relating to real estate. We are substantially complete with our implementation efforts. In June 2016, the FASB issued Accounting Standards Update No. 2016-13 (ASU 2016-13) ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"" which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We will adopt ASU 2016-13 effective January 1, 2020. We are currently evaluating the effect of the adoption of ASU 2016-13 on our consolidated financial statements. The effect will largely depend on the composition and credit quality of our investment portfolio and the economic conditions at the time of adoption. Recently adopted accounting pronouncements In January 2016, the FASB issued Accounting Standards Update No. 2016-01 (ASU 2016-01) ""Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,"" which amends various aspects of the recognition, measurement, presentation, and disclosure of financial instruments. We adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective method for our marketable equity securities and the prospective method for our non-marketable equity securities. This resulted in a $98 million reclassification of net unrealized gains from AOCI to opening retained earnings. We have elected to use the measurement alternative for our non-marketable equity securities, defined as cost adjusted for changes from observable transactions for identical or similar investments of the same issuer, less impairment. The adoption of ASU 2016-01 increases the volatility of our other income (expense), net, as a result of the unrealized gain or loss from the remeasurement of our equity securities. For further information on unrealized gains from equity securities, see Note 3 . In October 2016, the FASB issued Accounting Standards Update No. 2016-16 (ASU 2016-16) ""Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory."" ASU 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. We adopted ASU 2016-16 as of January 1, 2018 using a modified retrospective transition method, resulting in a $701 million reclassification of prepaid income taxes related to asset transfers that occurred prior to adoption from other current and non-current assets to opening retained earnings. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Note 2. Revenues Adoption of ASC Topic 606, ""Revenue from Contracts with Customers"" On January 1, 2017 , we adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2017 . Results for reporting periods beginning after January 1, 2017 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605. The effect from the adoption of ASC 606 was not material to our financial statements. Alphabet Inc. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. The following table presents our revenues disaggregated by revenue source (in millions). Sales and usage-based taxes are excluded from revenues. Year Ended December 31, 2016 (1) Google properties $ 63,785 $ 77,788 $ 96,336 Google Network Members' properties 15,598 17,587 19,982 Google advertising revenues 79,383 95,375 116,318 Google other revenues 10,601 15,003 19,906 Other Bets revenues Total revenues (2) $ 90,272 $ 110,855 $ 136,819 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. (2) Revenues include hedging gains (losses) of $539 million , $(169) million , and $(138) million for the years ended December 31, 2016 , 2017 , and 2018 , respectively, which do not represent revenues recognized from contracts with customers. The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, United States $ 42,781 % $ 52,449 % $ 63,269 % EMEA (1) 30,304 36,046 44,567 APAC (1) 12,559 16,235 21,374 Other Americas (1) 4,628 6,125 7,609 Total revenues (2) $ 90,272 % $ 110,855 % $ 136,819 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (Other Americas). (2) Revenues include hedging gains (losses) for the years ended December 31, 2016 , 2017 , and 2018 . Advertising Revenues We generate revenues primarily by delivering advertising on Google properties and Google Network Members properties. Google properties revenues consist primarily of advertising revenues generated on Google.com, the Google Search app, and other Google owned and operated properties like Gmail, Google Maps, Google Play, and YouTube. Google Network Members properties revenues consist primarily of advertising revenues generated on Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads (formerly AdWords), Google Ad Manager as part of the Authorized Buyers marketplace (formerly DoubleClick AdExchange), and Google Marketing Platform (includes what was formerly DoubleClick Bid Manager), among others. We offer advertising on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on an ad on Google properties or Google Network Members' properties or when a user views certain YouTube engagement ads. For these customers, we recognize revenue each time a user clicks on the ad or when a user views the ad for a specified period of time. We also offer advertising on other bases such as cost-per-impression, which means an advertiser pays us based on the number of times their ads are displayed on Google properties or Google Network Members properties. For these customers, we recognize revenue each time an ad is displayed. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers Alphabet Inc. are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Apps, in-app purchases, and digital content in the Google Play store; Google Cloud offerings; Hardware; and Other miscellaneous products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues recognized. We believe that there will not be significant changes to our estimates of variable consideration. Deferred Revenues We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. The increase in the deferred revenue balance for the twelve months ended December 31, 2018 is primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $1.5 billion of revenues recognized that were included in the deferred revenue balance as of December 31, 2017 . Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. In January 2018, we reclassified our U.S. government notes included in marketable debt securities from Level 1 to Level 2 within the fair value hierarchy as these securities are priced based on a combination of quoted prices for identical or similar instruments in active markets and models with significant observable market inputs. Prior period amounts have been reclassified to conform with current period presentation. The vast majority of our government bond holdings are highly liquid U.S. government notes. We classify our non-marketable debt securities within Level 3 in the fair value hierarchy because they are preferred stock and convertible notes issued by private companies without quoted market prices. To estimate the fair value of Alphabet Inc. our non-marketable debt securities, we use a combination of valuation methodologies, including market and income approaches based on prior transaction prices; estimated timing, probability, and amount of cash flows; and illiquidity considerations. Financial information of private companies may not be available and consequently we estimate the fair value based on the best available information at the measurement date. The following tables summarize our debt securities by significant investment categories as of December 31, 2017 and 2018 (in millions): As of December 31, 2017 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Non-Marketable Securities Level 2: Time deposits (1) $ $ $ $ $ $ $ Government bonds (2) 51,548 (406 ) 51,152 1,241 49,911 Corporate debt securities 24,269 (135 ) 24,155 24,029 Mortgage-backed and asset-backed securities 16,789 (180 ) 16,622 16,622 92,965 (721 ) 92,288 1,724 90,564 Level 3: Non-marketable debt securities 1,083 1,894 1,894 Total $ 94,048 $ $ (721 ) $ 94,182 $ 1,724 $ 90,564 $ 1,894 As of December 31, 2018 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Non-Marketable Securities Level 2: Time deposits (1) $ 2,202 $ $ $ 2,202 $ 2,202 $ $ Government bonds (2) 53,634 (414 ) 53,291 3,717 49,574 Corporate debt securities 25,383 (316 ) 25,082 25,038 Mortgage-backed and asset-backed securities 16,918 (324 ) 16,605 16,605 98,137 (1,054 ) 97,180 5,963 91,217 Level 3: Non-marketable debt securities Total $ 98,284 $ $ (1,054 ) $ 97,443 $ 5,963 $ 91,217 $ (1) As of December 31, 2017, the majority of our time deposits were foreign deposits. As of December 31, 2018, the majority of our time deposits are domestic deposits. (2) Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds, and municipal securities. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $251 million , $185 million , and $1.3 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. We recognized gross realized losses of $304 million , $295 million , and $143 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. We reflect these gains and losses as a component of other income (expense), net, in the Consolidated Statements of Income. The following table summarizes the estimated fair value of our investments in marketable debt securities with stated contractual maturity dates, accounted for as available-for-sale securities and classified by the contractual maturity date of the securities (in millions): Alphabet Inc. As of December 31, 2018 Due in 1 year $ 23,669 Due in 1 year through 5 years 54,504 Due in 5 years through 10 years 2,236 Due after 10 years 10,808 Total $ 91,217 The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2017 and 2018 , aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2017 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds (1) $ 28,836 $ (211 ) $ 17,660 $ (195 ) $ 46,496 $ (406 ) Corporate debt securities 18,300 (114 ) 1,710 (21 ) 20,010 (135 ) Mortgage-backed and asset-backed securities 11,061 (105 ) 3,449 (75 ) 14,510 (180 ) Total $ 58,197 $ (430 ) $ 22,819 $ (291 ) $ 81,016 $ (721 ) As of December 31, 2018 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds (1) $ 12,019 $ (85 ) $ 23,877 $ (329 ) $ 35,896 $ (414 ) Corporate debt securities 10,171 (107 ) 11,545 (209 ) 21,716 (316 ) Mortgage-backed and asset-backed securities 5,534 (75 ) 8,519 (249 ) 14,053 (324 ) Total $ 27,724 $ (267 ) $ 43,941 $ (787 ) $ 71,665 $ (1,054 ) (1) Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds, and municipal securities. During the years ended December 31, 2016 , 2017 and 2018 , we did not recognize any significant other-than-temporary impairment losses. Losses on impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net. The following table presents a reconciliation for our non-marketable debt securities measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) (in millions): Year Ended December 31, Beginning balance $ 1,165 $ 1,894 Total net gains (losses) Included in earnings (10 ) Included in other comprehensive income (1 ) Purchases Sales (2 ) (52 ) Settlements (1) (54 ) (2,228 ) Ending balance $ 1,894 $ (1) During the year ended December 31, 2018 the terms of a non-marketable debt security were modified resulting in an unrealized $1.3 billion gain recognized in other income (expense), net and a reclassification of the security to non-marketable equity securities. Alphabet Inc. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, realized and unrealized gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Marketable equity securities Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Prior to January 1, 2018, we accounted for the majority of our marketable equity securities at fair value with unrealized gains and losses recognized in accumulated other comprehensive income on the balance sheet. Realized gains and losses on marketable equity securities sold or impaired were recognized in other income (expense), net. Starting January 1, 2018, upon our adoption of ASU 2016-01, unrealized gains and losses during the year are recognized in other income (expense), net. Upon adoption, we reclassified $98 million net unrealized gains related to marketable equity securities from accumulated other comprehensive income to opening retained earnings. The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2017 and 2018 (in millions): As of December 31, 2017 Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 1,833 $ Marketable equity securities 1,833 Level 2: Mutual funds (1) Total $ 1,833 $ (1) The fair value option was elected for mutual funds with gains (losses) recognized in other income (expense), net. As of December 31, 2018 Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 3,493 $ Marketable equity securities 3,493 Level 2: Mutual funds Total $ 3,493 $ 1,222 Non-marketable equity securities Our non-marketable equity securities are investments in privately held companies without readily determinable market values. Prior to January 1, 2018, we accounted for our non-marketable equity securities at cost less impairment. Realized gains and losses on non-marketable securities sold or impaired were recognized in other income (expense), net. As of December 31, 2017, non-marketable equity securities accounted for under the cost method had a carrying value of $ 4.5 billion and a fair value of approximately $ 8.8 billion . On January 1, 2018, we adopted ASU 2016-01 which changed the way we account for non-marketable securities. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Because we adopted ASU 2016-01 prospectively, we recognize unrealized gains that occurred in prior Alphabet Inc. periods in the first period after January 1, 2018 when there is an observable transaction for our securities. Non-marketable equity securities remeasured during the year ended December 31, 2018 are classified within Level 3 in the fair value hierarchy because we estimate the value based on valuation methods using the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities held as of December 31, 2018 (in millions): Twelve Months Ended December 31, 2018 Upward adjustments $ 4,285 Downward adjustments (including impairment) (178 ) Total unrealized gain (loss) for non-marketable equity securities $ 4,107 The following table summarizes the total carrying value of our non-marketable equity securities held as of December 31, 2018 including cumulative unrealized upward and downward adjustments made to the initial cost basis of the securities (in millions): Initial cost basis (1) $ 8,168 Upward adjustments 4,285 Downward adjustments (including impairment) (178 ) Total carrying value at the end of the period $ 12,275 (1) Includes $2.2 billion for a non-marketable equity security reclassified from a non-marketable debt security during 2018. During the year ended December 31, 2018 , included in the $12.3 billion of non-marketable equity securities, $6.9 billion were measured at fair value based on observable market transactions, resulting in a net unrealized gain of $4.1 billion . Gains and losses on marketable and non-marketable equity securities Realized and unrealized gains and losses for our marketable and non-marketable equity securities for the year ended December 31, 2018 are summarized below (in millions): Twelve Months Ended December 31, 2018 Realized gain (loss) for equity securities sold during the period $ 1,458 Unrealized gain (loss) on equity securities held as of the end of the period (1) 4,002 Total gain (loss) recognized in other income (expense), net $ 5,460 (1) Includes $4,107 million related to non-marketable equity securities for the year ended December 31, 2018 . Equity securities accounted for under the Equity Method As of December 31, 2017 and 2018 , equity securities accounted for under the equity method had a carrying value of approximately $1.4 billion and $1.3 billion , respectively. Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net. Derivative Financial Instruments We classify our foreign currency and interest rate derivative contracts primarily within Level 2 in the fair value hierarchy as the valuation inputs are based on quoted prices and market observable data of similar instruments. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. As a result of our adoption of Accounting Standard Update No. 2017-12 (ASU 2017-12) ""Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,"" the components excluded from the assessment of hedge effectiveness are recognized in the same income statement line as the hedged item beginning January 1, 2018. Alphabet Inc. We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also use interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and debt issuances. Our program is not used for trading or speculative purposes. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. As of December 31, 2017 and 2018 , we received cash collateral related to the derivative instruments under our collateral security arrangements of $15 million and $327 million , respectively, which was included in other current assets. Cash Flow Hedges We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options), designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $11.7 billion and $11.8 billion as of December 31, 2017 and 2018 , respectively. These contracts have maturities of 24 months or less. For forwards and option contracts, we exclude the change in the forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI and subsequently reclassify these gains and losses to revenues when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are immediately reclassified to other income (expense), net. As of December 31, 2018 , the net gain or loss of our foreign currency cash flow hedges before tax effect was a net accumulated gain of $247 million , of which a net gain of $247 million is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $2.9 billion and $2.0 billion as of December 31, 2017 and 2018 , respectively. Gains and losses on these forward contracts are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. Net Investment Hedges During the year ended December 31, 2018 , we entered into forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $6.7 billion as of December 31, 2018 . Gains and losses on these forward contracts are recognized in AOCI as part of the foreign currency translation adjustment. Other Derivatives Other derivatives not designated as hedging instruments consist of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of the outstanding foreign exchange contracts was $15.2 billion and $20.1 billion as of December 31, 2017 and 2018 , respectively. Alphabet Inc. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2017 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ As of December 31, 2018 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ $ (955 ) $ Amount excluded from the assessment of effectiveness Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness Total $ $ (955 ) $ Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 90,272 $ $ 110,855 $ 1,047 $ 136,819 $ 8,592 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ $ $ (169 ) $ $ (139 ) $ Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach Amount excluded from the assessment of effectiveness (381 ) Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items (139 ) (96 ) Derivatives designated as hedging instruments (197 ) Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts Derivatives not designated as hedging instruments (230 ) Total gains (losses) $ $ (245 ) $ (169 ) $ (124 ) $ (138 ) $ Offsetting of Derivatives We present our forwards and purchased options at gross fair values in the Consolidated Balance Sheets. For foreign currency collars, we present at net fair values where both purchased and written options are with the same counterparty. Our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2017 and 2018 , information related to these offsetting arrangements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2017 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ (22 ) $ $ (64 ) (1) $ (4 ) $ (2 ) $ As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ (56 ) $ $ (90 ) (1) $ (307 ) $ (14 ) $ (1) The balances as of December 31, 2017 and 2018 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2017 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ (22 ) $ $ (64 ) (2) $ $ $ As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ (56 ) $ $ (90 ) (2) $ $ $ (2) The balances as of December 31, 2017 and 2018 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Variable Interest Entities (VIEs) Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. We are the primary beneficiary because we have the power to direct activities that most significantly affect their economic performance and have the obligation to absorb the majority of their losses or benefits. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2017 and 2018 , assets that can only be used to settle obligations of these VIEs were $1.7 billion and $2.4 billion , respectively, and the liabilities for which creditors only have recourse to the VIEs were $997 million and $909 million , respectively. Calico Calico is a life science company with a mission to harness advanced technologies to increase our understanding of the biology that controls lifespan. Alphabet Inc. In September 2014, AbbVie Inc. (AbbVie) and Calico entered into a research and development collaboration agreement intended to help both companies discover, develop, and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. In the second quarter of 2018, AbbVie and Calico amended the collaboration agreement resulting in an increase in total commitments. As of December 31, 2018 , AbbVie has contributed $750 million to fund the collaboration pursuant to the agreement and is committed to an additional $500 million which will be paid by the fourth quarter of 2019. As of December 31, 2018 , Calico has contributed $500 million and has committed up to an additional $750 million . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market. Both companies share costs and profits for projects covered under this agreement equally. AbbVie's contribution has been recorded as a liability on Calico's financial statements, which is reduced and reflected as a reduction to research and development expense as eligible research and development costs are incurred by Calico. As of December 31, 2018 , we have contributed $480 million to Calico in exchange for Calico convertible preferred units and are committed to fund up to an additional $750 million on an as-needed basis and subject to certain conditions. Verily Verily is a life science company with a mission to make the world's health data useful so that people enjoy healthier lives. In 2017, Temasek, a Singapore-based investment company, purchased a noncontrolling interest in Verily for an aggregate of $800 million in cash. In December 2018, Verily received $900 million in cash from a $1.0 billion investment round. The remaining $100 million is expected to be received in the first quarter of 2019. These transactions were accounted for as equity transactions and no gain or loss was recognized. Unconsolidated VIEs Certain renewable energy investments included in our non-marketable equity investments accounted for under the equity method are VIEs. These entities' activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance such as setting operating budgets. Therefore, we do not consolidate these VIEs in our consolidated financial statements. The carrying value and maximum exposure of these VIEs were $896 million and $705 million as of December 31, 2017 and 2018 , respectively. The maximum exposure is based on current investments to date. We have determined the single source of our exposure to these VIEs is our capital investment in them. Other unconsolidated VIEs were not material as of December 31, 2017 and 2018 . Note 5. Debt Short-Term Debt We have a debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2017 and 2018 . Long-Term Debt Google issued $3.0 billion of senior unsecured notes in three tranches (collectively, 2011 Notes) in May 2011, due in 2014, 2016, and 2021, as well as $1.0 billion of senior unsecured notes (2014 Notes) in February 2014 due in 2024. In April 2016, we completed an exchange offer with eligible holders of Googles 2011 Notes due 2021 and 2014 Notes due 2024 (collectively, the Google Notes). An aggregate principal amount of approximately $1.7 billion of the Google Notes was exchanged for approximately $1.7 billion of Alphabet notes with identical interest rate and maturity. Because the exchange was between a parent and the subsidiary company and for substantially identical notes, the change was treated as a debt modification for accounting purposes with no gain or loss recognized. In August 2016, Alphabet issued $2.0 billion of senior unsecured notes (2016 Notes) due 2026. The net proceeds from the issuance of the 2016 Notes were used for general corporate purposes, including the repayment of outstanding Alphabet Inc. commercial paper. The Alphabet notes due in 2021, 2024, and 2026 rank equally with each other and are structurally subordinate to the outstanding Google Notes. The total outstanding long-term debt is summarized below (in millions): As of December 31, 2017 As of December 31, 2018 3.625% Notes due on May 19, 2021 $ 1,000 $ 1,000 3.375% Notes due on February 25, 2024 1,000 1,000 1.998% Notes due on August 15, 2026 2,000 2,000 Unamortized discount for the Notes above (57 ) (50 ) Subtotal (1) 3,943 3,950 Capital lease obligation Total long-term debt $ 3,969 $ 4,012 (1) Includes the outstanding (and unexchanged) Google Notes issued in 2011 and 2014 and the Alphabet notes exchanged in 2016. The effective interest yields based on proceeds received from the outstanding notes due in 2021, 2024, and 2026 were 3.734% , 3.377% , and 2.231% , respectively, with interest payable semi-annually. We may redeem these notes at any time in whole or in part at specified redemption prices. The total estimated fair value of all outstanding notes was approximately $4.0 billion and $3.9 billion as of December 31, 2017 and 2018 , respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2018 , the aggregate future principal payments for long-term debt including long-term capital leases for each of the next five years and thereafter are as follows (in millions): $ 2020 2021 1,003 2023 Thereafter 3,039 Total $ 4,062 Credit Facility As of December 31, 2018 , we have $4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2017 and 2018 . Note 6. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2017 As of December 31, 2018 Land and buildings $ 23,183 $ 30,179 Information technology assets 21,429 30,119 Construction in progress 10,491 16,838 Leasehold improvements 4,496 5,310 Furniture and fixtures Property and equipment, gross 59,647 82,507 Less: accumulated depreciation (17,264 ) (22,788 ) Property and equipment, net $ 42,383 $ 59,719 Alphabet Inc. As of December 31, 2017 and 2018 , assets under capital lease with a cost basis of $390 million and $648 million , respectively, were included in property and equipment. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2017 As of December 31, 2018 European Commission fines (1) $ 2,874 $ 7,754 Accrued customer liabilities 1,489 1,810 Other accrued expenses and current liabilities 5,814 7,394 Accrued expenses and other current liabilities $ 10,177 $ 16,958 (1) Includes the effects of foreign exchange and interest. See Note 9 for further details Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2015 $ (2,047 ) $ (86 ) $ $ (1,874 ) Other comprehensive income (loss) before reclassifications (599 ) (314 ) (398 ) Amounts reclassified from AOCI (351 ) (130 ) Other comprehensive income (loss) (599 ) (93 ) (528 ) Balance as of December 31, 2016 $ (2,646 ) $ (179 ) $ $ (2,402 ) Other comprehensive income (loss) before reclassifications 1,543 (638 ) 1,212 Amounts reclassified from AOCI Other comprehensive income (loss) 1,543 (545 ) 1,410 Balance as of December 31, 2017 $ (1,103 ) $ $ (122 ) $ (992 ) Other comprehensive income (loss) before reclassifications (1) (781 ) (10 ) (527 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI Amounts reclassified from AOCI (911 ) (813 ) Other comprehensive income (loss) (781 ) (921 ) (1,314 ) Balance as of December 31, 2018 $ (1,884 ) $ (688 ) $ $ (2,306 ) (1) The change in unrealized gains (losses) on available-for-sale investments included a $98 million adjustment of net unrealized gains related to marketable equity securities from AOCI to opening retained earnings as a result of the adoption of ASU 2016-01 on January 1, 2018. Alphabet Inc. The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ (221 ) $ (105 ) $ 1,190 Provision for income taxes (279 ) Net of tax $ (221 ) $ (105 ) $ Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue $ $ (169 ) $ (139 ) Interest rate contracts Other income (expense), net Benefit (provision) for income taxes (193 ) Net of tax $ $ (93 ) $ (98 ) Total amount reclassified, net of tax $ $ (198 ) $ Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, Interest income $ 1,220 $ 1,312 $ 1,878 Interest expense (1) (124 ) (109 ) (114 ) Foreign currency exchange losses, net (2) (475 ) (121 ) (80 ) Gain (loss) on debt securities, net (3) (53 ) (110 ) 1,190 Gain (loss) on equity securities, net (20 ) 5,460 Loss and impairment from equity method investments, net (202 ) (156 ) (120 ) Other Other income (expense), net $ $ 1,047 $ 8,592 (1) Interest expense is net of interest capitalized of $0 million , $48 million , and $92 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. (2) Our foreign currency exchange losses, net, are related to the option premium costs and forwards points for our foreign currency hedging contracts, our foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contract losses and gains. The net foreign currency transaction losses were $112 million , $226 million , and $195 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $1.3 billion gain. Note 7. Acquisitions 2018 Acquisitions HTC Corporation (HTC) In January 2018, we completed the acquisition of a team of engineers and a non-exclusive license of intellectual property from HTC for $1.1 billion in cash. In aggregate, $10 million was cash acquired, $165 million was attributed to intangible assets, $934 million was attributed to goodwill, and $9 million was attributed to net liabilities assumed. Goodwill, which was included in the Google segment, is not deductible for tax purposes. We expect this transaction to accelerate Googles ongoing hardware efforts. The transaction was accounted for as a business combination. Other Acquisitions During the year ended December 31, 2018 , we completed other acquisitions and purchases of intangible assets for total consideration of approximately $573 million . In aggregate, $10 million was cash acquired, $295 million was attributed to intangible assets, $293 million was attributed to goodwill, and $25 million was attributed to net liabilities Alphabet Inc. assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. The amount of goodwill expected to be deductible for tax purposes is approximately $81 million . Pro forma results of operations for these acquisitions, including HTC, have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2018 , patents and developed technology have a weighted-average useful life of 3.7 years, customer relationships have a weighted-average useful life of 2.3 years, and trade names and other have a weighted-average useful life of 3.7 years. 2017 Acquisitions During the year ended December 31, 2017 , we completed various acquisitions and purchases of intangible assets for total consideration of approximately $322 million . In aggregate, $12 million was cash acquired, $117 million was attributed to intangible assets, $221 million was attributed to goodwill, and $28 million was attributed to net liabilities assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. The amount of goodwill expected to be deductible for tax purposes is approximately $60 million . Pro forma results of operations for these acquisitions have not been presented because they are not material to the consolidated results of operations, either individually or in aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2017 , patents and developed technology have a weighted-average useful life of 3.7 years, customer relationships have a weighted-average useful life of 2.0 years, and trade names and other have a weighted-average useful life of 8.8 years. Note 8. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2018 were as follows (in millions): Google Other Bets Total Consolidated Balance as of December 31, 2016 $ 16,027 $ $ 16,468 Acquisitions Foreign currency translation and other adjustments Balance as of December 31, 2017 16,295 16,747 Acquisitions 1,227 1,227 Transfers (80 ) Foreign currency translation and other adjustments (81 ) (5 ) (86 ) Balance as of December 31, 2018 $ 17,521 $ $ 17,888 Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2017 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 5,260 $ 3,040 $ 2,220 Customer relationships Trade names and other Total $ 6,163 $ 3,471 $ 2,692 Alphabet Inc. As of December 31, 2018 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 5,125 $ 3,394 $ 1,731 Customer relationships Trade names and other Total $ 6,177 $ 3,957 $ 2,220 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 3.0 years, 0.5 years, and 3.8 years, respectively. Amortization expense relating to purchased intangible assets was $833 million , $796 million , and $865 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. As of December 31, 2018 , expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): $ 2020 2021 2022 2023 Thereafter $ 2,220 Note 9. Commitments and Contingencies Operating Leases We have entered into various non-cancelable operating lease agreements for data centers and land and offices throughout the world with lease periods expiring between 2019 and 2063 . We are committed to pay a portion of the actual operating expenses under certain of these lease agreements. These operating expenses are not included in the table below. Certain of these arrangements have free or escalating rent payment provisions. We recognize rent expense on a straight-line basis. As of December 31, 2018 , future minimum payments under operating leases having initial or remaining non-cancelable lease terms in excess of one year, net of sublease income amounts, were as follows (in millions): Operating Leases (1) Sub-lease Income Net Operating Leases $ 1,319 $ $ 1,303 1,397 1,384 1,337 1,327 1,153 1,145 980 Thereafter 3,916 3,911 Total minimum payments $ 10,102 $ $ 10,047 (1) Includes future minimum payments for leases which have not yet commenced. We have entered into certain non-cancelable lease agreements with lease periods expiring between 2021 and 2044 where we are the deemed owner for accounting purposes of new construction projects. Excluded from the table above are future minimum lease payments under such leases totaling approximately $3.5 billion , for which a $1.5 billion liability is included on the Consolidated Balance Sheets as of December 31, 2018 . Rent expense under operating leases was $897 million , $1.1 billion , and $1.3 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. Alphabet Inc. Purchase Obligations As of December 31, 2018 , we had $7.4 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2018 , we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On April 15, 2015, the EC issued a Statement of Objections (SO) regarding the display and ranking of shopping search results and ads, to which we responded on August 27, 2015. On July 14, 2016, the EC issued a Supplementary SO regarding shopping search results and ads. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ( $2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $2.7 billion for the fine in the second quarter of 2017. While under appeal, the fine is included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the fine. On April 20, 2016, the EC issued an SO regarding certain Android distribution practices. We responded to the SO and the EC's informational requests. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision and implemented changes to certain of our Android distribution practices. We recognized a charge of $5.1 billion for the fine in the second quarter of 2018. While under appeal, the fine is included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the fine. On July 14, 2016, the EC issued an SO regarding the syndication of AdSense for Search. We responded to the SO and continue to respond to the EC's informational requests. There is significant uncertainty as to the outcome of this investigation; however, an adverse decision could result in fines and directives to alter or terminate certain conduct. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any. We remain committed to working with the EC to resolve these matters. The Comision Nacional de Defensa de la Competencia in Argentina, the Competition Commission of India (CCI), Brazil's Administrative Council for Economic Defense (CADE), and the Korean Fair Trade Commission have also opened investigations into certain of our business practices. In November 2016, we responded to the CCI Director General's report with interim findings of competition law infringements regarding search and ads. On February 8, 2018, the CCI issued its final decision, including a fine of approximately $21 million , finding no violation of competition law infringement on most of the issues it investigated, but finding violations, including in the display of the flights unit in search results, and a contractual provision in certain direct search intermediation agreements. We have appealed the CCI decision. The fine was accrued for in 2018. Alphabet Inc. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services, and may also cause us to change our business practices, and require development of non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss for a company or its suppliers in an ITC action could result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them for certain intellectual property infringement claims against them, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. Our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for an en banc rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition (such as the pending EC investigations described above), intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil or criminal penalties, or other adverse consequences. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We believe these matters are without merit and we are defending ourselves vigorously. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. Alphabet Inc. For information regarding income tax contingencies, see Note 13 . Note 10. Stockholders Equity Convertible Preferred Stock Our board of directors has authorized 100 million shares of convertible preferred stock, $0.001 par value, issuable in series. As of December 31, 2017 and 2018 , no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our board of directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In October 2016, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion of its Class C capital stock, which was completed during 2018. In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2017 and 2018 , we repurchased and subsequently retired 5.2 million shares of Alphabet Class C capital stock for an aggregate amount of $4.8 billion and 8.2 million shares of Alphabet Class C capital stock for an aggregate amount of $9.1 billion , respectively. Note 11. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our board of directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our board of directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2016 , 2017 and 2018 , the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 8,332 $ 1,384 $ 9,762 Denominator Number of shares used in per share computation 294,217 48,859 344,702 Basic net income per share $ 28.32 $ 28.32 $ 28.32 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 8,332 $ 1,384 $ 9,762 Effect of dilutive securities in equity method investments and subsidiaries (9 ) (2 ) (10 ) Allocation of undistributed earnings for diluted computation 8,323 1,382 9,752 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 1,382 Reallocation of undistributed earnings (94 ) (21 ) Allocation of undistributed earnings $ 9,611 $ 1,361 $ 9,846 Denominator Number of shares used in basic computation 294,217 48,859 344,702 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 48,859 Restricted stock units and other contingently issuable shares 2,055 8,873 Number of shares used in per share computation 345,131 48,859 353,575 Diluted net income per share $ 27.85 $ 27.85 $ 27.85 Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 5,438 $ $ 6,362 Denominator Number of shares used in per share computation 297,604 47,146 348,151 Basic net income per share $ 18.27 $ 18.27 $ 18.27 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 5,438 $ $ 6,362 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares Reallocation of undistributed earnings (74 ) (14 ) Allocation of undistributed earnings $ 6,226 $ $ 6,436 Denominator Number of shares used in basic computation 297,604 47,146 348,151 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 47,146 Restricted stock units and other contingently issuable shares 1,192 9,491 Number of shares used in per share computation 345,942 47,146 357,642 Diluted net income per share $ 18.00 $ 18.00 $ 18.00 Alphabet Inc. Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 Reallocation of undistributed earnings (146 ) (24 ) Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 Restricted stock units and other contingently issuable shares 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Note 12. Compensation Plans Stock Plans Under our 2012 Stock Plan, RSUs or stock options may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. Incentive and non-qualified stock options, or rights to purchase common stock, are generally granted for a term of 10 years. RSUs granted to participants under the 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2018 , there were 31,848,134 shares of stock reserved for future issuance under our Stock Plan. Stock-Based Compensation For the years ended December 31, 2016 , 2017 and 2018 , total stock-based compensation expense was $6.9 billion , $7.9 billion and $10.0 billion , including amounts associated with awards we expect to settle in Alphabet stock of $6.7 billion , $7.7 billion , and $9.4 billion , respectively. For the years ended December 31, 2016 , 2017 and 2018 , we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $1.5 billion , $1.6 billion , and $1.5 billion , respectively. For the years ended December 31, 2016 , 2017 and 2018 , tax benefit realized related to awards vested or exercised during the period was $2.1 billion , $2.7 billion and $2.1 billion , respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Alphabet Inc. Stock-Based Award Activities The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2018 : Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2017 20,077,346 $ 712.45 Granted 12,669,251 $ 1,095.89 Vested (12,847,910 ) $ 756.45 Forfeited/canceled (1,431,009 ) $ 814.19 Unvested as of December 31, 2018 18,467,678 $ 936.96 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2016 and 2017 , was $713.89 and $845.06 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2016 , 2017 , and 2018 were $9.0 billion , $11.3 billion , and $14.1 billion , respectively. As of December 31, 2018 , there was $16.2 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.5 years . 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $385 million , $448 million , and $691 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. For the year ended December 31, 2018 , performance fees of $1.2 billion primarily related to gains on equity securities (for further information on gains on equity securities, see Note 3 ) were accrued and recorded as a component of general and administrative expenses. Note 13. Income Taxes Income from continuing operations before income taxes included income from domestic operations of $12.0 billion , $10.7 billion , and $15.8 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively, and income from foreign operations of $12.1 billion , $16.5 billion , and $19.1 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. The provision for income taxes consists of the following (in millions): Year Ended December 31, 2017 Current: Federal and state $ 3,826 $ 12,608 $ 2,153 Foreign 1,746 1,251 Total 4,792 14,354 3,404 Deferred: Federal and state (70 ) Foreign (50 ) (43 ) (134 ) Total (120 ) Provision for income taxes $ 4,672 $ 14,531 $ 4,177 The Tax Act enacted on December 22, 2017 introduced significant changes to U.S. income tax law. Effective 2018, the Tax Act reduced the U.S. statutory tax rate from 35% to 21% and created new taxes on certain foreign-sourced earnings and certain related-party payments. Alphabet Inc. Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our consolidated financial statements as of December 31, 2017. As we collected and prepared necessary data, and interpreted the additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we made adjustments, over the course of the year, to the provisional amounts including refinements to deferred taxes. The accounting for the tax effects of the Tax Act has been completed as of December 31, 2018. One-time transition tax The Tax Act required us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion as of December 31, 2017. Deferred tax effects Due to the change in the statutory tax rate from the Tax Act, we remeasured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. We recognized a deferred tax benefit of $376 million to reflect the reduced U.S. tax rate and other effects of the Tax Act as of December 31, 2017. The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, U.S. federal statutory tax rate 35.0 % 35.0 % 21.0 % Foreign income taxed at different rates (11.0 ) (14.2 ) (4.9 ) Effect of the Tax Act One-time transition tax 0.0 37.6 (0.1 ) Deferred tax effects 0.0 (1.4 ) (1.2 ) Federal research credit (2.0 ) (1.8 ) (2.4 ) Stock-based compensation expense (3.4 ) (4.5 ) (2.2 ) European Commission fine 0.0 3.5 3.1 Deferred tax asset valuation allowance 0.1 0.9 (2.0 ) Other adjustments 0.6 (1.7 ) 0.7 Effective tax rate 19.3 % 53.4 % 12.0 % Our effective tax rate for each of the years presented was affected by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. Substantially all of the income from foreign operations was earned by an Irish subsidiary. Beginning in 2018, earnings realized in foreign jurisdictions are subject to U.S. tax in accordance with the Tax Act. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. The IRS served a Notice of Appeal on February 22, 2016 and the case is being heard by the Ninth Circuit Court of Appeals. The Ninth Circuit Court of Appeals overturned the Tax Courts decision in an opinion issued on July 24, 2018, but withdrew that opinion in an order issued on August 7, 2018 to allow time for a reconstituted panel to confer on the appeal. At this time, the Ninth Circuit Court of Appeals has not issued a final decision, and the U.S. Treasury has not withdrawn the requirement to include stock-based compensation from its regulations. We have evaluated the opinion and continue to record a tax benefit related to reimbursement of cost share payments for the previously shared stock-based compensation costs. In accordance with the Tax Act, the Altera tax benefit was remeasured from 35% to 21%. We also remeasured the tax benefit expected to be realized upon settlement including the expected future new taxes enacted by the Tax Act due upon resolution of the matter. The tax liability recorded as of December 31, 2016 for the U.S. tax cost of the potential repatriation associated with the contingent foreign earnings was reversed due to the Tax Act introducing a territorial tax system and providing a 100% dividend received deduction on certain qualified dividends from foreign subsidiaries. We will continue to monitor developments related to the case and the potential effect on our consolidated financial statements. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We recorded a provisional adjustment to our U.S. deferred income taxes as of December 31, 2017 to reflect the reduction in the U.S. statutory tax rate from 35% to 21% resulting from the Tax Act. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, Deferred tax assets: Stock-based compensation expense $ $ Accrued employee benefits Accruals and reserves not currently deductible 1,062 Tax credits 1,187 1,979 Basis difference in investment in Arris Prepaid cost sharing Net operating losses Other Total deferred tax assets 4,351 5,781 Valuation allowance (2,531 ) (2,817 ) Total deferred tax assets net of valuation allowance 1,820 2,964 Deferred tax liabilities: Property and equipment (551 ) (1,382 ) Identified intangibles (419 ) (229 ) Renewable energy investments (531 ) (500 ) Investment gains/losses (22 ) (1,143 ) Other (47 ) (237 ) Total deferred tax liabilities (1,570 ) (3,491 ) Net deferred tax assets (liabilities) $ $ (527 ) As of December 31, 2018 , our federal and state net operating loss carryforwards for income tax purposes were approximately $1.2 billion and $1.4 billion , respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2021 and the state net operating loss carryforwards will begin to expire in 2019. It is more likely than not that certain federal net operating loss carryforwards and our state net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. Our foreign net operating loss carryforwards for income tax purposes were $950 million that will begin to expire in 2021. As of December 31, 2018 , our California research and development credit carryforwards for income tax purposes were approximately $2.4 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2018 , we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, and certain foreign net operating losses that we believe are not likely to be realized. Due to gains from equity securities recognized in 2018, we released the valuation allowance against the deferred tax asset for the book-to-tax basis difference in our investments in Arris shares received from the sale of the Motorola Home business to Arris in 2013. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. For further information on the unrealized gains related to marketable equity securities recognized in other income (expenses), see Note 1. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits from January 1, 2016 to December 31, 2018 (in millions): Beginning gross unrecognized tax benefits $ 4,167 $ 5,393 $ 4,696 Increases related to prior year tax positions Decreases related to prior year tax positions (157 ) (257 ) (623 ) Decreases related to settlement with tax authorities (196 ) (1,875 ) (191 ) Increases related to current year tax positions Ending gross unrecognized tax benefits $ 5,393 $ 4,696 $ 4,652 The total amount of gross unrecognized tax benefits was $5.4 billion , $4.7 billion , and $4.7 billion as of December 31, 2016 , 2017 , and 2018 , respectively, of which, $4.3 billion , $3.0 billion , and $2.9 billion , if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2017 was primarily as a result of the resolution of a multi-year U.S. audit. As of December 31, 2017 and 2018 , we had accrued $362 million and $490 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2013 through 2015 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. Our 2016 and 2017 tax years remain subject to examination by the IRS for U.S. federal tax purposes, and our 2011 through 2017 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, it is reasonably possible that certain U.S. federal and non-U.S. tax audits may be concluded within the next 12 months, which could significantly increase or decrease the balance of our gross unrecognized tax benefits. We estimate that our unrecognized tax benefits as of December 31, 2018 could possibly decrease by approximately $600 million in the next 12 months. Positions that may be resolved include various U.S. and non-U.S. matters. Note 14. Information about Segments and Geographic Areas We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as Ads, Android, Chrome, Google Cloud, Google Maps, Google Play, Hardware (including Nest), Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes businesses such as Access, Calico, CapitalG, GV, Verily, Waymo, and X. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Alphabet Inc. Revenues, cost of revenues, and operating expenses are generally directly attributed to our segments. Inter-segment revenues are not presented separately, as these amounts are immaterial. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. In Q1 2018, Nest joined Googles hardware team. Consequently, the financial results of Nest are reported in the Google segment, with Nest revenues reflected in Google other revenues. Prior period segment information has been recast to conform to the current period segment presentation. Consolidated financial results are not affected. Information about segments during the periods presented were as follows (in millions): Year Ended December 31, Revenues: Google $ 89,984 $ 110,378 $ 136,224 Other Bets Total revenues $ 90,272 $ 110,855 $ 136,819 Year Ended December 31, Operating income (loss): Google $ 27,055 $ 32,287 $ 36,517 Other Bets (2,741 ) (2,734 ) (3,358 ) Reconciling items (1) (598 ) (3,407 ) (6,838 ) Total income from operations $ 23,716 $ 26,146 $ 26,321 (1) Reconciling items are primarily comprised of the European Commission fines for the years ended December 31, 2017 and 2018, and performance fees for the year ended December 31, 2018, as well as corporate administrative costs and other miscellaneous items that are not allocated to individual segments for all periods presented. Year Ended December 31, Capital expenditures: Google $ 9,437 $ 12,619 $ 25,460 Other Bets 1,365 Reconciling items (2) (590 ) (502 ) Total capital expenditures as presented on the Consolidated Statements of Cash Flows $ 10,212 $ 13,184 $ 25,139 (2) Reconciling items are related to timing differences of payments as segment capital expenditures are on accrual basis while total capital expenditures shown on the Consolidated Statements of Cash Flow are on cash basis and other miscellaneous differences. Alphabet Inc. Stock-based compensation (SBC) and depreciation, amortization, and impairment are included in segment operating income (loss) as shown below (in millions): Year Ended December 31, Stock-based compensation: Google $ 6,201 $ 7,168 $ 8,755 Other Bets Reconciling items (3) Total stock-based compensation (4) $ 6,703 $ 7,679 $ 9,353 Depreciation, amortization, and impairment: Google $ 5,882 $ 6,608 $ 8,708 Other Bets Reconciling items (5) Total depreciation, amortization, and impairment as presented on the Consolidated Statements of Cash Flows $ 6,144 $ 6,915 $ 9,035 (3) Reconciling items represent corporate administrative costs that are not allocated to individual segments. (4) For purposes of segment reporting, SBC represents awards that we expect to settle in Alphabet stock. (5) Reconciling items are primarily related to corporate administrative costs and other miscellaneous items that are not allocated to individual segments. The following table presents our long-lived assets by geographic area (in millions): As of December 31, 2017 As of December 31, 2018 Long-lived assets: United States $ 55,113 $ 74,882 International 17,874 22,234 Total long-lived assets $ 72,987 $ 97,116 For revenues by geography, see Note 2 . "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2018 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Alphabet Inc. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2018 . Management reviewed the results of its assessment with our Audit Committee. The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +14,Microsoft Corporation,2021," ITEM 1. BUSINESSGENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. We are creating the tools and platforms that deliver better, faster, and more effective solutions to support new startups, improve educational and health outcomes, and empower human ingenuity. Microsoft is innovating and expanding our entire portfolio to help people and organizations overcome todays challenges and emerge stronger. We bring technology and products together into experiences and solutions that unlock value for our customers.In a dynamic environment, digital technology is the key input that powers the worlds economic output. Our ecosystem of customers and partners have learned that while hybrid work is complex, embracing flexibility, different work styles, and a culture of trust can help navigate the challenges the world faces today. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. Customers are looking to unlock value while simplifying security and management. From infrastructure and data, to business applications and collaboration, we provide unique, differentiated value to customers. We are building a distributed computing fabric across cloud and the edge to help every organization build, run, and manage mission-critical workloads anywhere. In the next phase of innovation, artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. We are enabling metaverse experiences at all layers of our stack, so customers can more effectively model, automate, simulate, and predict changes within their industrial environments, feel a greater sense of presence in the new world of hybrid work, and create custom immersive worlds to enable new opportunities for connection and experimentation. What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.PART I Item 1Our products include operating systems , cross-device productivity and collaboration applications , server applications , business solution applications , desktop and server management tools , software development tools , and video games. We also design and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. The Ambitions That Drive UsTo achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing. Reinvent Productivity and Business ProcessesAt Microsoft, we provide technology and resources to help our customers create a secure hybrid work environment. Our family of products plays a key role in the ways the world works, learns, and connects. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office 365, Dynamics 365, and LinkedIn. Microsoft 365 brings together Office 365, Windows, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase collaboration, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is a comprehensive platform for work, with meetings, calls, chat, collaboration, and business process automation. Microsoft Viva is an employee experience platform that brings together communications, knowledge, learning, resources, and insights powered by Microsoft 365. Together with the Microsoft Cloud, Dynamics 365, Microsoft Teams, and Azure Synapse bring a new era of collaborative applications that transform every business function and process. Microsoft Power Platform is helping domain experts drive productivity gains with low-code/no-code tools, robotic process automation, virtual agents, and business intelligence. In a dynamic labor market, LinkedIn is helping professionals use the platform to connect, learn, grow, and get hired. Build the Intelligent Cloud and Intelligent Edge PlatformAs digital transformation accelerates, organizations in every sector across the globe can address challenges that will have a fundamental impact on their success. For enterprises, digital technology empowers employees, optimizes operations, engages customers, and in some cases, changes the very core of products and services. Microsoft has a proven track record of delivering high value to our customers across many diverse and durable growth markets.We continue to invest in high performance and sustainable computing to meet the growing demand for fast access to Microsoft services provided by our network of cloud computing infrastructure and datacenters. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.The Microsoft Cloud is the most comprehensive and trusted cloud, providing the best integration across the technology stack while offering openness, improving time to value, reducing costs, and increasing agility. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from Internet of Things (IoT) sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. PART I Item 1Our hybrid infrastructure consistency spans security, compliance, identity, and management, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. Our industry clouds bring together capabilities across the entire Microsoft Cloud, along with industry-specific customizations, to improve time to value, increase agility, and lower costs. Azure Arc simplifies governance and management by delivering a consistent multi-cloud and on-premises management platform. Security, compliance, identity, and management underlie our entire tech stack. We offer integrated, end-to-end capabilities to protect people and organizations. In March 2022, we completed our acquisition of Nuance Communications, Inc. (Nuance). Together, Microsoft and Nuance will enable organizations across industries to accelerate their business goals with security-focused, cloud-based solutions infused with powerful, vertically optimized AI. We are accelerating our development of mixed reality solutions with new Azure services and devices. Microsoft Mesh enables presence and shared experiences from anywhere through mixed reality applications. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks new workloads and experiences to create common understanding and drive more informed decisions. The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. Azure Synapse brings together data integration, enterprise data warehousing, and big data analytics in a comprehensive solution. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. From GitHub to Visual Studio, we provide a developer tool chain for everyone, no matter the technical experience, across all platforms, whether Azure, Windows, or any other cloud or client platform.Additionally, we are extending our infrastructure beyond the planet, bringing cloud computing to space. Azure Orbital is a fully managed ground station as a service for fast downlinking of data.Create More Personal ComputingWe strive to make computing more personal by putting people at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working, learning, and playing. Windows also plays a critical role in fueling our cloud business with Windows 365, a desktop operating system thats also a cloud service. From another internet-connected device, including Android or macOS devices, you can run Windows 365, just like a virtual machine.With Windows 11, we have simplified the design and experience to empower productivity and inspire creativity. Windows 11 offers innovations focused on enhancing productivity and is designed to support hybrid work. It adds new experiences that include powerful task switching tools like new snap layouts, snap groups, and desktops new ways to stay connected through Microsoft Teams chat the information you want at your fingertips and more. Windows 11 security and privacy features include operating system security, application security, and user and identity security. Tools like search, news, and maps have given us immediate access to the worlds information. Today, through our Search, News, Mapping, and Browse services, Microsoft delivers unique trust, privacy, and safety features. Microsoft Edge is our fast and secure browser that helps protect your data, with built-in shopping tools designed to save you time and money. Organizational tools such as Collections, Vertical Tabs, and Immersive Reader help make the most of your time while browsing, streaming, searching, and sharing.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. The Surface family includes Surface Laptop Studio, Surface Laptop 4, Surface Laptop Go 2, Surface Laptop Pro 8, Surface Pro X, Surface Go 3, Surface Studio 2, and Surface Duo 2. PART I Item 1With three billion people actively playing games today, and a new generation steeped in interactive entertainment, Microsoft continues to invest in content, community, and cloud services . We have broadened our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played , including cloud gaming so players can stream across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers , including the acquisition of ZeniMax Media Inc., the parent company of Bethesda Softworks LLC . In January 2022, we announced plans to acquire Activision Blizzard , Inc., a leader in game development and an interactive entertainment content publisher . Xbox Game Pass is a community with access to a curated library of over 100 first- and third-party console and PC titles . Xbox Cloud Gaming is Microsofts game streaming technology that is complementary to our console hardware and gives fans the ultimate choice to play the games they want, with the people they want, on the devices they want. Our Future OpportunityThe case for digital transformation has never been more urgent. Customers are looking to us to help improve productivity and the affordability of their products and services. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications, drive deeper insights, and improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Tackling security from all angles with our integrated, end-to-end solutions spanning security, compliance, identity, and management, across all clouds and platforms. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment. Using Windows to fuel our cloud business, grow our share of the PC market, and drive increased engagement with our services like Microsoft 365 Consumer, Teams, Edge, Bing, Xbox Game Pass, and more. Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.Corporate Social ResponsibilityCommitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. We are accelerating progress toward a more sustainable future by reducing our environmental footprint, advancing research, helping our customers build sustainable solutions, and advocating for policies that benefit the environment. In January 2020, we announced a bold commitment and detailed plan to be carbon negative by 2030, and to remove from the environment by 2050 all the carbon we have emitted since our founding in 1975. This included a commitment to invest $1 billion over four years in new technologies and innovative climate solutions. We built on this pledge by adding commitments to be water positive by 2030, zero waste by 2030, and to protect ecosystems by developing a Planetary Computer. We also help our suppliers and customers around the world use Microsoft technology to reduce their own carbon footprint.Fiscal year 2021 was a year of both successes and challenges. While we continued to make progress on several of our goals, with an overall reduction in our combined Scope 1 and Scope 2 emissions, our Scope 3 emissions increased, due in substantial part to significant global datacenter expansions and growth in Xbox sales and usage as a result of the COVID-19 pandemic. Despite these Scope 3 increases, we will continue to build the foundations and do the work to deliver on our commitments, and help our customers and partners achieve theirs. We have learned the impact of our work will not all be felt immediately, and our experience highlights how progress wont always be linear.PART I Item 1While fiscal year 2021 presented us with some new learnings, we also made some great progress. A few examples that illuminate the diversity of our work include: We purchased the removal of 1.4 million metrics tons of carbon. Four of our datacenters received new or renewed Zero Waste certifications. We granted $100 million to Breakthrough Energy Catalyst to accelerate the development of climate solutions the world needs to reach net-zero across four key areas: direct air capture, green hydrogen, long duration energy storage, and sustainable aviation fuel. We joined the First Movers Coalition as an early leader and expert partner in the carbon dioxide removal sector, with a commitment of $200 million toward carbon removal by 2030. Sustainability is an existential priority for our society and businesses today. This led us to create our Microsoft Cloud for Sustainability, an entirely new business process category to help organizations monitor their carbon footprint across their operations. We also joined with leading organizations to launch the Carbon Call an initiative to mobilize collective action to solve carbon emissions and removal accounting challenges for a net zero future.The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment. Our cloud and AI services and datacenters help businesses cut energy consumption, reduce physical footprints, and design sustainable products.Addressing Racial Injustice and InequityWe are committed to addressing racial injustice and inequity in the United States for Black and African American communities and helping improve lived experiences at Microsoft, in employees communities, and beyond. Our Racial Equity Initiative focuses on three multi-year pillars, each containing actions and progress we expect to make or exceed by 2025. Strengthening our communities: using data, technology, and partnerships to help improve the lives of Black and African American people in the United States, including our employees and their communities. Evolving our ecosystem: using our balance sheet and relationships with suppliers and partners to foster societal change and create new opportunities. Increasing representation and strengthening inclusion: build on our momentum, adding a $150 million investment to strengthen inclusion and double the number of Black, African American, Hispanic, and Latinx leaders in the United States by 2025. Over the last year, we collaborated with partners and worked within neighborhoods and communities to launch and scale a number of projects and programs, including: working with 70 organizations in 145 communities on the Justice Reform Initiative, expanding access to affordable broadband and devices for Black and African American communities and key institutions that support them in major urban centers, expanding access to skills and education to support Black and African American students and adults to succeed in the digital economy, and increasing technology support for nonprofits that provide critical services to Black and African American communities.We have made meaningful progress on representation and inclusion at Microsoft. We are 90 percent of the way to our 2025 commitment to double the number of Black and African American people managers, senior individual contributors, and senior leaders in the U.S., and 50 percent of the way for Hispanic and Latinx people managers, senior individual contributors, and senior leaders in the U.S.We exceeded our goal on increasing the percentage of transaction volumes with Black- and African American-owned financial institutions and increased our deposits with Black- and African American-owned minority depository institutions, enabling increased funds into local communities. Additionally, we enriched our supplier pipeline, reaching more than 90 percent of our goal to spend $500 million with double the number of Black and African American-owned suppliers. We also increased the number of identified partners in the Black Partner Growth Initiative and continue to invest in the partner community through the Black Channel Partner Alliance by supporting events focused on business growth, accelerators, and mentorship.Progress does not undo the egregious injustices of the past or diminish those who continue to live with inequity. We are committed to leveraging our resources to help accelerate diversity and inclusion across our ecosystem and to hold ourselves accountable to accelerate change for Microsoft, and beyond.PART I Item 1Investing in Digital Skills The COVID-19 pandemic led to record unemployment, disrupting livelihoods of people around the world. After helping over 30 million people in 249 countries and territories with our global skills initiative, we introduced a new initiative to support a more skills-based labor market, with greater flexibility and accessible learning paths to develop the right skills needed for the most in-demand jobs. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. We previously invested $20 million in key non-profit partnerships through Microsoft Philanthropies to help people from underserved communities that are often excluded by the digital economy. We also launched a national campaign with U.S. community colleges to help skill and recruit into the cybersecurity workforce 250,000 people by 2025, representing half of the countrys workforce shortage. To that end, we are making curriculum available free of charge to all of the nations public community colleges, providing training for new and existing faculty at 150 community colleges, and providing scholarships and supplemental resources to 25,000 students. HUMAN CAPITAL RESOURCES OverviewMicrosoft aims to recruit, develop, and retain world-changing talent from a diversity of backgrounds. To foster their and our success, we seek to create an environment where people can thrive, where they can do their best work, where they can proudly be their authentic selves, guided by our values, and where they know their needs can be met. We strive to maximize the potential of our human capital resources by creating a respectful, rewarding, and inclusive work environment that enables our global employees to create products and services that further our mission to empower every person and every organization on the planet to achieve more.As of June 30, 2022, we employed approximately 221,000 people on a full-time basis, 122,000 in the U.S. and 99,000 internationally. Of the total employed people, 85,000 were in operations, including manufacturing, distribution, product support, and consulting services 73,000 were in product research and development 47,000 were in sales and marketing and 16,000 were in general and administration. Certain employees are subject to collective bargaining agreements.Our CultureMicrosofts culture is grounded in the growth mindset. This means everyone is on a continuous journey to learn and grow. We believe potential can be nurtured and is not pre-determined, and we should always be learning and curious trying new things without fear of failure. We identified four attributes that allow growth mindset to flourish: Obsessing over what matters to our customers. Becoming more diverse and inclusive in everything we do. Operating as one company, One Microsoft, instead of multiple siloed businesses. Making a difference in the lives of each other, our customers, and the world around us.Our employee listening systems enable us to gather feedback directly from our workforce to inform our programs and employee needs globally. Seventy percent of employees globally participated in our fiscal year 2022 Employee Signals survey, which covers a variety of topics such as thriving, inclusion, team culture, wellbeing, and learning and development. Throughout the fiscal year, we collect over 75,000 Daily Pulse employee survey responses. During fiscal year 2022, our Daily Pulse surveys gave us invaluable insights into ways we could support employees through the COVID-19 pandemic, addressing racial injustice, the war in Ukraine, and their general wellbeing. In addition to Employee Signals and Daily Pulse surveys, we gain insights through onboarding, internal mobility, leadership, performance and development, exit surveys, internal Yammer channels, employee QA sessions, and AskHR Service support.PART I Item 1Diversity and Inclusion At Microsoft we have an inherently inclusive mission: to empower every person and every organization on the planet to achieve more. We think of diversity and inclusion as core to our business model, informing our actions to impact economies and people around the world. There are billions of people who want to achieve more, but have a different set of circumstances, abilities, and backgrounds that often limit access to opportunity and achievement. The better we represent that diversity inside Microsoft, the more effectively we can innovate for those we seek to empower.We strive to include others by holding ourselves accountable for diversity, driving global systemic change in our workplace and workforce, and creating an inclusive work environment. Through this commitment we can allow everyone the chance to be their authentic selves and do their best work every day. We support multiple highly active Employee Resource Groups for women, families, racial and ethnic minorities, military, people with disabilities, and employees who identify as LGBTQIA+, where employees can go for support, networking, and community-building. As described in our 2021 Proxy Statement , annual performance and compensation reviews of our senior leadership team include an evaluation of their contributions to employee culture and diversity. To ensure accountability over time, we publicly disclose our progress on a multitude of workforce metrics including: Detailed breakdowns of gender, racial, and ethnic minority representation in our employee population, with data by job types, levels, and segments of our business. Our EEO-1 report (equal employment opportunity). Disability representation. Pay equity (see details below). Total Rewards We develop dynamic, sustainable, market-driven, and strategic programs with the goal of providing a highly differentiated portfolio to attract, reward, and retain top talent and enable our employees to thrive. These programs reinforce our culture and values such as collaboration and growth mindset. Managers evaluate and recommend rewards based on, for example, how well we leverage the work of others and contribute to the success of our colleagues. We monitor pay equity and career progress across multiple dimensions.As part of our effort to promote a One Microsoft and inclusive culture, in fiscal year 2021 we expanded stock eligibility to all Microsoft employees as part of our annual rewards process. This includes all non-exempt and exempt employees and equivalents across the globe including business support professionals and datacenter and retail employees. In response to the Great Reshuffle, in fiscal year 2022 we announced a sizable investment in annual merit and annual stock award opportunity for all employees below senior executive levels. We also invested in base salary adjustments for our datacenter and retail hourly employees and hourly equivalents outside the U.S. These investments have supported retention and help to ensure that Microsoft remains an employer of choice.Pay EquityIn our 2021 Diversity and Inclusion Report, we reported that all racial and ethnic minority employees in the U.S. combined earn $1.006 for every $1.000 earned by their white counterparts, that women in the U.S. earn $1.002 for every $1.000 earned by their counterparts in the U.S. who are men, and women in the U.S. plus our twelve other largest employee geographies representing 86.6% of our global population (Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, Romania, Singapore, and the United Kingdom) combined earn $1.001 for every $1.000 by men in these countries. Our intended result is a global performance and development approach that fosters our culture, and competitive compensation that ensures equitable pay by role while supporting pay for performance.Wellness and SafetyMicrosoft is committed to supporting our employees well-being and safety while they are at work and in their personal lives. We took a wide variety of measures to protect the health and well-being of our employees, suppliers, and customers during the COVID-19 pandemic and are now supporting employees in shifting to return to office and/or hybrid arrangements. We developed hybrid guidelines for managers and employees to support the transition and continue to identify ways we can support hybrid work scenarios through our employee listening systems.PART I Item 1We have invested significantly in holistic wellbeing, and offer a differentiated benefits package which includes many physical, emotional, and financial wellness programs including counseling through the Microsoft CARES Employee Assistance Program, mental wellbeing support, flexible fitness benefits, savings and investment tools, adoption assistance, and back-up care for children and elders. Finally, our Occupational Health and Safety program helps ensure employees can stay safe while they are working. We continue to strive to support our Ukrainian employees and their dependents during the Ukraine crisis with emergency relocation assistance, emergency leave, and other benefits.Learning and DevelopmentOur growth mindset culture begins with valuing learning over knowing seeking out new ideas, driving innovation, embracing challenges, learning from failure, and improving over time. To support this culture, we offer a wide range of learning and development opportunities. We believe learning can be more than formal instruction, and our learning philosophy focuses on providing the right learning, at the right time, in the right way. Opportunities include: Personalized, integrated, and relevant views of all learning opportunities on both our internal learning portal Learning (Viva Learning + LinkedIn Learning) and our external learning portal MS Learn are available to all employees worldwide. In-the-classroom learning, learning cohorts, our early-in-career Aspire program, and manager excellence communities. Required learning for all employees and managers on topics such as compliance, regulation, company culture, leadership, and management. This includes the annual Standards of Business Conduct training. On-the-job stretch and advancement opportunities. Managers holding conversations about employees career and development plans, coaching on career opportunities, and programs like mentoring and sponsorship. Customized manager learning to build people manager capabilities and similar learning solutions to build leadership skills for all employees including differentiated leadership development programs. New employee orientation covering a range of topics including company values, and culture, as well as ongoing onboarding programs. New tools to assist managers and employees in learning how to operate, be productive, and connect in the new flexible hybrid world of work. These include quick guides for teams to use, such as Creating Team Agreements, Reconnecting as a Team, and Running Effective Hybrid Meetings.Our employees embrace the growth mindset and take advantage of the formal learning opportunities as well as thousands of informal and on-the-job learning opportunities. In terms of formal on-line learning solutions, in fiscal year 2022 our employees completed over 4.7 million courses, averaging over 14 hours per employee. Given our focus on understanding core company beliefs and compliance topics, all employees complete required learning programs like Standards of Business Conduct, Privacy, Unconscious Bias, and preventing harassment courses. Our corporate learning portal has over 100,000 average monthly active users. We have over 27,000 people managers, all of whom must complete between 20-33 hours of required manager capability and excellence training and are assigned ongoing required training each year. In addition, all employees complete skills training based on the profession they are in each year.New Ways of Working The COVID-19 pandemic accelerated our capabilities and culture with respect to flexible work. We introduced a Hybrid Workplace Flexibility Guide to better support managers and employees as they adapt to new ways of working that shift paradigms, embrace flexibility, promote inclusion, and drive innovation. Our ongoing survey data shows employees value the flexibility related to work location, work site, and work hours, and while many have begun returning to worksites as conditions have permitted, they also continue to adjust hours and/or spend some of workweeks working at home, another site, or remotely. We are focused on building capabilities to support a variety of workstyles where individuals, teams, and our business can deliver success.PART I Item 1OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva. Office Consumer, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as frontline workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Talent Solutions also includes Learning Solutions, which help businesses close critical skills gaps in times where companies are having to do more with existing talent. Marketing Solutions help companies reach, engage, and convert their audiences at scale. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. LinkedIn has over 850 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed and applications consumed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications, including Power Apps and Power Automate.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Meta, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.Dynamics competes with cloud-based and on-premises business solution providers such as Oracle, Salesforce, and SAP.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHub. Enterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance professional services. Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product.Nuance and GitHub include both cloud and on-premises offerings. Nuance provides healthcare and enterprise AI solutions. GitHub provides a collaboration platform and code hosting service for developers. Enterprise ServicesEnterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance Professional Services, assist customers in developing, deploying, and managing Microsoft server solutions, Microsoft desktop solutions, and Nuance conversational AI and ambient intelligent solutions, along with providing training and certification to developers and IT professionals on various Microsoft products.CompetitionAzure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.PART I Item 1We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, Snowflake, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing and Windows Internet of Things. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services. Search and news advertising. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.PART I Item 1Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender for Endpoint, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year.Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. DevicesWe design and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Xbox Cloud Gaming, our game streaming service, and continued investment in gaming hardware. Xbox Cloud Gaming utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorite games with them and play on the device most convenient to them. Xbox enables people to connect and share online gaming experiences that are accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators. Search and News AdvertisingOur Search and news advertising business is designed to deliver relevant search, native, and display advertising to a global audience. We have several partnerships with other companies, including Yahoo, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings.On June 6, 2022, we acquired Xandr, Inc., a technology platform with tools to accelerate the delivery of our digital advertising solutions.Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. PART I Item 1Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs. Xbox and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Meta, Google, and Tencent. We also compete with other providers of entertainment services such as video streaming platforms. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our Search and news advertising business competes with Google and a wide array of websites, social platforms like Meta, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. For the majority of our products, we have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. However, some of our products contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers and/or manufacturers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, software development tools and services (including GitHub), AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Teams, con sumer web experiences (including search and news advertising), and the Surface line of devices. Security, Compliance, Identity, and Management , focuses on cloud platform and application security, identity and network access, enterprise mobility, information protection, and managed services. Technology and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, and applications. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction. PART I Item 1Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 69,000 U.S. and international patents issued and over 19,000 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We may also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, supporting societal and/or environmental efforts, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We plan to continue to make significant investments in a broad range of product research and development activities, and as appropriate we will coordinate our research and development across operating segments and leverage the results across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.PART I Item 1OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Dell, Hewlett-Packard, Lenovo, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In fiscal year 2021, we closed our Microsoft Store physical locations and opened our Microsoft Experience Centers. Microsoft Experience Centers are designed to facilitate deeper engagement with our partners and customers across industries. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and SA. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.PART I Item 1Volume Licensing Programs Enterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Customer AgreementA Microsoft Customer Agreement is a simplified purchase agreement presented, accepted, and stored through a digital experience. A Microsoft Customer Agreement is a non-expiring agreement that is designed to support all customers over time, whether purchasing through a partner or directly from Microsoft.Microsoft Online Subscription AgreementA Microsoft Online Subscription Agreement is designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Microsoft Products and Services Agreement Microsoft Products and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. Open ValueOpen Value agreements are a simple, cost-effective way to acquire the latest Microsoft technology. These agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a three-year period. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus A Select Plus agreement is designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.PART I Item 1CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1INFORMATION ABOUT OUR EXECUTIV E OFFICERS Our executive officers as of July 28, 2022 were as follows:NameAgePosition with the CompanySatya NadellaChairman of the Board and Chief Executive OfficerJudson AlthoffExecutive Vice President and Chief Commercial OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Vice ChairChristopher D. YoungExecutive Vice President, Business Development, Strategy, and VenturesMr. Nadella was appointed Chairman of the Board in June 2021 and Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Althoff was appointed Executive Vice President and Chief Commercial Officer in July 2021. He served as Executive Vice President, Worldwide Commercial Business from July 2017 until that time. Prior to that, Mr. Althoff served as the President of Microsoft North America. Mr. Althoff joined Microsoft in March 2013 as President of Microsoft North America.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Vice Chair in September 2021. Prior to that, he served as President and Chief Legal Officer since September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.Mr. Young has served as Executive Vice President, Business Development, Strategy, and Ventures since joining Microsoft in November 2020. Prior to Microsoft, he served as the Chief Executive Officer of McAfee, LLC from 2017 to 2020, and served as a Senior Vice President and General Manager of Intel Security Group from 2014 until 2017, when he led the initiative to spin out McAfee into a standalone company. Mr. Young also serves on the Board of Directors of American Express Company.PART I Item 1AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time. We publish a variety of reports and resources related to our Corporate Social Responsibility programs and progress on our Reports Hub website, www.microsoft.com/corporate-responsibility/reports-hub, including reports on sustainability, responsible sourcing, accessibility, digital trust, and public policy engagement. The information found on these websites is not part of, or incorporated by reference into, this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORSOur operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.STRATEGIC AND COMPETITIVE RISKS We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We embrace cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to meet our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other IoT endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1ARISKS RELATING TO THE EVOLUTION OF OUR BUSINESS We make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in March 2021 we completed our acquisition of ZeniMax Media Inc. for $8.1 billion, and in March 2022 we completed our acquisition of Nuance Communications, Inc. for $18.8 billion. In January 2022 we announced a definitive agreement to acquire Activision Blizzard , Inc. for $68.7 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that they raise new compliance-related obligations and challenges, that we have difficulty integrating and retaining new employees, business systems, and technology, that they distract management from our other businesses, or that announced transactions may not be completed. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones, as well as acquired companies ability to meet our policies and processes in areas such as data governance, privacy, and cybersecurity. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record, a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACYBERSECURITY, DATA PRIVACY, AND PLATFORM ABUSE RISKS Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technologyThreats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Nation-state and state-sponsored actors can deploy significant resources to plan and carry out exploits. Nation-state attacks against us or our customers may intensify during periods of intense diplomatic or armed conflict, such as the ongoing conflict in Ukraine. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems or reveal confidential information. Malicious actors may employ the IT supply chain to introduce malware through software updates or compromised supplier accounts or hardware.Cyberthreats are constantly evolving and becoming increasingly sophisticated and complex, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, subject us to ransomware attacks, require us to allocate more resources to improve technologies or remediate the impacts of attacks, or otherwise adversely affect our business.The cyberattacks uncovered in late 2020 known as Solorigate or Nobelium are an example of a supply chain attack where malware was introduced to a software providers customers, including us, through software updates. The attackers were later able to create false credentials that appeared legitimate to certain customers systems. We may be targets of further attacks similar to Solorigate/Nobelium as both a supplier and consumer of IT.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge, or emerging cybersecurity regulations in jurisdictions worldwide.PART I Item 1ASecurity of our products, services, devices, and customers data The security of our products and services is important in our customers decisions to purchase or use our products or services across cloud and on-premises environments. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. In addition, adversaries can attack our customers on-premises or cloud environments, sometimes exploiting previously unknown (zero day) vulnerabilities, such as occurred in early calendar year 2021 with several of our Exchange Server on-premises products. Vulnerabilities in these or any product can persist even after we have issued security patches if customers have not installed the most recent updates, or if the attackers exploited the vulnerabilities before patching to install additional malware to further compromise customers systems. Adversaries will continue to attack customers using our cloud services as customers embrace digital transformation. Adversaries that acquire user account information can use that information to compromise our users accounts, including where accounts share the same attributes such as passwords. Inadequate account security practices may also result in unauthorized access, and user activity may result in ransomware or other malicious software impacting a customers use of our products or services. We are increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.Our customers operate complex IT systems with third-party hardware and software from multiple vendors that may include systems acquired over many years. They expect our products and services to support all these systems and products, including those that no longer incorporate the strongest current security advances or standards. As a result, we may not be able to discontinue support in our services for a product, service, standard, or feature solely because a more secure alternative is available. Failure to utilize the most current security advances and standards can increase our customers vulnerability to attack. Further, customers of widely varied size and technical sophistication use our technology, and consequently may have limited capabilities and resources to help them adopt and implement state of the art cybersecurity practices and technologies. In addition, we must account for this wide variation of technical sophistication when defining default settings for our products and services, including security default settings, as these settings may limit or otherwise impact other aspects of IT operations and some customers may have limited capability to review and reset these defaults.Cyberattacks such as Solorigate/Nobelium may adversely impact our customers even if our production services are not directly compromised. We are committed to notifying our customers whose systems have been impacted as we become aware and have available information and actions for customers to help protect themselves. We are also committed to providing guidance and support on detection, tracking, and remediation. We may not be able to detect the existence or extent of these attacks for all of our customers or have information on how to detect or track an attack, especially where an attack involves on-premises software such as Exchange Server where we may have no or limited visibility into our customers computing environments.Development and deployment of defensive measuresTo defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls, anti-virus software, and advanced security and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our products and services.PART I Item 1AThe cost of measures to protect products and customer-facing services could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number, breadth, and scale of our cloud-based offerings, we store and process increasingly large amounts of personal data of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, marketplace, and gaming platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, Microsoft News, Microsoft Store, Bing, and Xbox, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, dissemination of information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AOther digital safety abuses Our hosted consumer services as well as our enterprise services may be used to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale, the limitations of existing technologies, and conflicting legal frameworks. When discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online have been enacted, and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the development and use of AI may result in reputational harm or liability . We are building AI into many of our offerings, including our productivity services, and we are also making first- and third-party AI available for our customers to use in solutions that they build. We expect these elements of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Ineffective or inadequate AI development or deployment practices by Microsoft or others could result in incidents that impair the acceptance of AI solutions or cause harm to individuals or society. These deficiencies and other failures of AI systems could subject us to competitive harm, regulatory action, legal liability, including under new proposed legislation regulating AI in jurisdictions such as the European Union (EU), and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social, economic, or political issues, we may experience brand or reputational harm. OPERATIONAL RISKS We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. Our datacenters depend on predictable energy and networking supplies, the cost or availability of which could be adversely affected by a variety of factors, including the transition to a clean energy economy and geopolitical disruptions. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Microsoft 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. PART I Item 1AWe may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. Our software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical business functions and multiple workloads. Many of our products and services are interdependent with one another. Each of these circumstances potentially magnifies the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge.There are limited suppliers for certain device and datacenter components. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If components are delayed or become unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes that restrict supply sources, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. LEGAL, REGULATORY, AND LITIGATION RISKS Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the EU, the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. PART I Item 1AGovernment regulatory actions and court decisions such as these may result in fines or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come s from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows post-sale monetization opportunities may be limited. Regulatory scrutiny may inhibit our ability to consummate acquisitions or impose conditions that reduce the ultimate value of such transactions. Our global operations subject us to potential consequences under anti-corruption, trade, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them, and also cooperate with investigations by U.S. and foreign law enforcement authorities. An example of increasing international regulatory complexity is the EU Whistleblower Directive, initiated in 2021, which may present compliance challenges to the extent it is implemented in different forms by EU member states. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Increasing trade laws, policies, sanctions, and other regulatory requirements also affect our operations in and outside the U.S. relating to trade and investment. Economic sanctions in the U.S., the EU, and other countries prohibit most business with restricted entities or countries such as Crimea, Cuba, Iran, North Korea, and Syria. U.S. export controls restrict Microsoft from offering many of its products and services to, or making investments in, certain entities in specified countries. U.S. import controls restrict us from integrating certain information and communication technologies into our supply chain and allow for government review of transactions involving information and communications technology from countries determined to be foreign adversaries. Periods of intense diplomatic or armed conflict, such as the ongoing conflict in Ukraine, may result in (1) new and rapidly evolving sanctions and trade restrictions, which may impair trade with sanctioned individuals and countries, and (2) negative impacts to regional trade ecosystems among our customers, partners, and us. Non-compliance with sanctions as well as general ecosystem disruptions could result in reputational harm, operational delays, monetary fines, loss of revenues, increased costs, loss of export privileges, or criminal sanctions.PART I Item 1AOther regulatory areas that may apply to our products and online services offerings include requirements related to user privacy, telecommunications, data storage and protection, advertising, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws , including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Regulators may assert that our collection, use, and management of customer data and other information is inconsistent with their laws and regulations , including laws that apply to the tracking of users via technology such as cookies . Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative and regulatory action is emerging in the area s of AI and content moderation, which could increase costs or restrict opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or global accessibility requirements, we could lose sales opportunities or face regulatory or legal actions.Laws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage. The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling continues to generate uncertainty about the legal requirements for data transfers from the EU under other legal mechanisms and has resulted in some EU data protection authorities blocking the use of U.S.-based services that involve the transfer of data to the U.S. The U.S. and the EU in March 2022 agreed in principle on a replacement framework for the Privacy Shield, called the Trans-Atlantic Data Privacy Framework. A failure of the U.S. and EU to finalize the Trans-Atlantic Data Privacy Framework could compound that uncertainty and result in additional blockages of data transfers. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. For example, the EU General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. More recently, the EU has been developing new requirements related to the use of data, including in the Digital Markets Act, the Digital Services Act, and the Data Act, that will add additional rules and restriction on the use of data in our products and services. Engineering efforts to build and maintain capabilities to facilitate compliance with these laws involve substantial expense and the diversion of engineering resources from other projects. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR and other data regulations, or if our implementation to comply with the GDPR makes our offerings less attractive. Compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply, or if regulators assert we have failed to comply (including in response to complaints made by customers), it may lead to regulatory enforcement actions, which can result in monetary penalties (of up to 4% of worldwide revenue in the case of GDPR), private lawsuits, reputational damage, blockage of international data transfers, and loss of customers. The highest fines assessed under GDPR have recently been increasing, especially against large technology companies. Jurisdictions around the world, such as China, India, and states in the U.S. have adopted, or are considering adopting or expanding, laws and regulations imposing obligations regarding the handling or transfer of personal data. PART I Item 1AThe Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) and possible future legislative changes may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA or possible future legislative changes, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. We earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. PART I Item 1AINTELLECTUAL PROPERTY RISKS We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing or cross-licensing our patents to others in return for a royalty and/or increased freedom to operate. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, price changes in products using licensed patents, greater value from cross-licensing, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.Third parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. GENERAL RISKS If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. PART I Item 1A Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced a decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict, such as the ongoing conflict in Ukraine, pose a risk of general economic disruption in affected countries, which may increase our operating costs and negatively impact our ability to sell to and collect from customers in affected markets. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory systems and requirements and market interventions that could impact our operating strategies, access to national, regional, and global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic such as COVID-19 may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic has had widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. The extent to which global pandemics impact our business going forward will depend on factors such as the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. PART I Item 1AMeasures to contain a global pandemic may intensify other risks described in these Risk Factors. Any of these measures may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions. We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.The long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational, economic, and geopolitical risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist and protectionist trends and concerns about human rights and political expression in specific countries may significantly alter the trade and commercial environments. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, and non-local sourcing restrictions, export controls, investment restrictions, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations. Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. Our global workforce is primarily non-unionized, but we have several unions and works councils outside of the United States. In the U.S., there has been a general increase in workers exercising their right to form or join a union. While Microsoft has not received such petitions in the U.S., the unionization of significant employee populations could result in higher costs and other operational changes necessary to respond to changing conditions and to establish new relationships with worker representatives. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2022 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately 5 million square feet of space we lease. In addition, we own and lease space domestically that includes office and datacenter space.We also own and lease facilities internationally for datacenters, research and development, and other operations. The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, and Singapore. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, the Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2022:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESMARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 25, 2022, there were 86,465 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2022:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet BePurchased Under the Plans or Programs(In millions)April 1, 2022 April 30, 20229,124,963$289.349,124,963$45,869May 1, 2022 May 31, 20229,809,727265.959,809,72743,260June 1, 2022 June 30, 20229,832,841259.429,832,84140,70928,767,53128,767,531All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards. Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2022: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 14, 2022August 18, 2022September 8, 2022$0.62$4,627We returned $12.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2022. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of our operations for the year ended June 30, 2022 compared to the year ended June 30, 2021. For a discussion of the year ended June 30, 2021 compared to the year ended June 30, 2020, please refer to Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended June 30, 2021.OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.Highlights from fiscal year 2022 compared with fiscal year 2021 included: Microsoft Cloud (formerly commercial cloud) revenue increased 32% to $91.2 billion. Office Commercial products and cloud services revenue increased 13% driven by Office 365 Commercial growth of 18%. Office Consumer products and cloud services revenue increased 11% and Microsoft 365 Consumer subscribers grew to 59.7 million. LinkedIn revenue increased 34%. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 39%. Server products and cloud services revenue increased 28% driven by Azure and other cloud services growth of 45%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 11%. Windows Commercial products and cloud services revenue increased 11%. Xbox content and services revenue increased 3%. Search and news advertising revenue excluding traffic acquisition costs increased 27%. Surface revenue increased 3%.On March 4, 2022, we completed our acquisition of Nuance Communications, Inc. (Nuance) for a total purchase price of $18.8 billion, consisting primarily of cash. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The financial results of Nuance have been included in our consolidated financial statements since the date of the acquisition. Nuance is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements ( Part II, Item 8 of this Form 10-K ) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.PART II Item 7Economic Conditions, Challenges, and Risks The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers and/or manufacturers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Fluctuations in the U.S. dollar relative to certain foreign currencies did not have a material impact on reported revenue or expenses from our international operations in fiscal year 2022.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on financial results prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), and growth comparisons relate to the corresponding period of last fiscal year.In the first quarter of fiscal year 2022, we made updates to the presentation and method of calculation for certain metrics, most notably changes to incorporate all current and anticipated revenue streams within our Office Consumer and Server products and cloud services metrics and changes to align with how we manage our Windows OEM and Search and news advertising businesses. None of these changes had a material impact on previously reported amounts in our MDA.PART II Item 7In the third quarter of fiscal year 2022, we completed our acquisition of Nuance. Nuance is included in all commercial metrics and our Server products and cloud services revenue growth metric. Azure and other cloud services revenue includes Nuance cloud services, and Server products revenue includes Nuance on-premises offerings. CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Microsoft Cloud revenue Revenue from Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Microsoft Cloud gross margin percentageGross margin percentage for our Microsoft Cloud business Productivity and Business Processes and Intelligent CloudMetrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft VivaOffice Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office servicesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionMicrosoft 365 Consumer subscribersThe number of Microsoft 365 Consumer subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applicationsLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales SolutionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHubPART II Item 7More Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM revenue growthRevenue from sales of Windows Pro and non-Pro licenses sold through the OEM channelWindows Commercial products and cloud services revenue growthRevenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenue growthRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud servicesSearch and news advertising revenue, excluding TAC, growthRevenue from search and news advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers and news partnersSUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change Revenue$198,270$168,08818%Gross margin135,620115,85617%Operating income83,38369,91619% Net income72,73861,27119%Diluted earnings per share9.658.0520%Adjusted net income (non-GAAP)69,44760,65115% Adjusted diluted earnings per share (non-GAAP)9.217.9716%Adjusted net income and adjusted diluted earnings per share (EPS) are non-GAAP financial measures which exclude the net income tax benefit related to transfer of intangible properties in the first quarter of fiscal year 2022 and the net income tax benefit related to an India Supreme Court decision on withholding taxes in the third quarter of fiscal year 2021 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results. See Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Fiscal Year 2022 Compared with Fiscal Year 2021Revenue increased $30.2 billion or 18% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Search and news advertising and Windows. Cost of revenue increased $10.4 billion or 20% driven by growth in Microsoft Cloud.Gross margin increased $19.8 billion or 17% driven by growth across each of our segments. Gross margin percentage decreased slightly. Excluding the impact of the fiscal year 2021 change in accounting estimate for the useful lives of our server and network equipment, gross margin percentage increased 1 point driven by improvement in Productivity and Business Processes. Microsoft Cloud gross margin percentage decreased slightly to 70%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage increased 3 points driven by improvement across our cloud services, offset in part by sales mix shift to Azure and other cloud services.PART II Item 7Operating expenses increased $ 6 .3 billion or 14 % driven by investments in cloud engineering , LinkedIn, Gaming, and commercial sales . Key changes in operating expenses were: Research and development expenses increased $3.8 billion or 18% driven by investments in cloud engineering, Gaming, and LinkedIn. Sales and marketing expenses increased $1.7 billion or 8% driven by investments in commercial sales and LinkedIn. Sales and marketing included a favorable foreign currency impact of 2%. General and administrative expenses increased $793 million or 16% driven by investments in corporate functions.Operating income increased $13.5 billion or 19% driven by growth across each of our segments.Current year net income and diluted EPS were positively impacted by the net tax benefit related to the transfer of intangible properties, which resulted in an increase to net income and diluted EPS of $3.3 billion and $0.44, respectively. Prior year net income and diluted EPS were positively impacted by the net tax benefit related to the India Supreme Court decision on withholding taxes, which resulted in an increase to net income and diluted EPS of $620 million and $0.08, respectively. Gross margin and operating income both included an unfavorable foreign currency impact of 2%. SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change RevenueProductivity and Business Processes$63,364$53,91518%Intelligent Cloud75,25160,08025%More Personal Computing59,65554,09310%Total $198,270$168,08818%Operating Income Productivity and Business Processes$29,687$24,35122%Intelligent Cloud32,72126,12625%More Personal Computing20,97519,4398%Total $83,383$69,91619%Reportable SegmentsFiscal Year 2022 Compared with Fiscal Year 2021 Productivity and Business Processes Revenue increased $9.4 billion or 18%. Office Commercial products and cloud services revenue increased $4.4 billion or 13%. Office 365 Commercial revenue grew 18% driven by seat growth of 14%, with continued momentum in small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Commercial products revenue declined 22% driven by continued customer shift to cloud offerings. Office Consumer products and cloud services revenue increased $641 million or 11% driven by Microsoft 365 Consumer subscription revenue. Microsoft 365 Consumer subscribers grew 15% to 59.7 million. LinkedIn revenue increased $3.5 billion or 34% driven by a strong job market in our Talent Solutions business and advertising demand in our Marketing Solutions business. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 39%. PART II Item 7Operating income increased $5.3 billion or 22%. Gross margin increased $7.3 billion or 17% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate, gross margin percentage increased 2 points driven by improvement across all cloud services. Operating expenses increased $2.0 billion or 11% driven by investments in LinkedIn and cloud engineering. Gross margin and operating income both included an unfavorable foreign currency impact of 2%.Intelligent Cloud Revenue increased $15.2 billion or 25%. Server products and cloud services revenue increased $14.7 billion or 28% driven by Azure and other cloud services. Azure and other cloud services revenue grew 45% driven by growth in our consumption-based services. Server products revenue increased 5% driven by hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments. Enterprise Services revenue increased $464 million or 7% driven by growth in Enterprise Support Services.Operating income increased $6.6 billion or 25%. Gross margin increased $9.4 billion or 22% driven by growth in Azure and other cloud services. Gross margin percentage decreased. Excluding the impact of the change in accounting estimate, gross margin percentage was relatively unchanged driven by improvement in Azure and other cloud services, offset in part by sales mix shift to Azure and other cloud services. Operating expenses increased $2.8 billion or 16% driven by investments in Azure and other cloud services. Revenue and operating income included an unfavorable foreign currency impact of 2% and 3%, respectively.More Personal Computing Revenue increased $5.6 billion or 10%. Windows revenue increased $2.3 billion or 10% driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 11% driven by continued strength in the commercial PC market, which has higher revenue per license. Windows Commercial products and cloud services revenue increased 11% driven by demand for Microsoft 365. Search and news advertising revenue increased $2.3 billion or 25%. Search and news advertising revenue excluding traffic acquisition costs increased 27% driven by higher revenue per search and search volume. Gaming revenue increased $860 million or 6% on a strong prior year comparable that benefited from Xbox Series X|S launches and stay-at-home scenarios, driven by growth in Xbox hardware and Xbox content and services. Xbox hardware revenue increased 16% due to continued demand for Xbox Series X|S. Xbox content and services revenue increased 3% driven by growth in Xbox Game Pass subscriptions and first-party content, offset in part by a decline in third-party content. Surface revenue increased $226 million or 3%.Operating income increased $1.5 billion or 8%. Gross margin increased $3.1 billion or 10% driven by growth in Windows and Search and news advertising. Gross margin percentage was relatively unchanged. Operating expenses increased $1.5 billion or 14% driven by investments in Gaming, Search and news advertising, and Windows marketing.PART II Item 7OPERATING EXPENSES Research and Development(In millions, except percentages)Percentage ChangeResearch and development$24,512$20,71618%As a percent of revenue12%12%0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Research and development expenses increased $3.8 billion or 18% driven by investments in cloud engineering, Gaming, and LinkedIn.Sales and Marketing(In millions, except percentages)Percentage ChangeSales and marketing$21,825$20,1178%As a percent of revenue11%12%(1)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses increased $1.7 billion or 8% driven by investments in commercial sales and LinkedIn. Sales and marketing included a favorable foreign currency impact of 2%.General and Administrative(In millions, except percentages)Percentage Change General and administrative$5,900$5,10716%As a percent of revenue3%3%0pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.General and administrative expenses increased $793 million or 16% driven by investments in corporate functions.PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,094$2,131Interest expense(2,063)(2,346)Net recognized gains on investments1,232Net gains (losses) on derivatives(52)Net gains (losses) on foreign currency remeasurements(75)Other, net(32)Total$$1,186We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Interest and dividends income decreased due to lower portfolio balances. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments decreased primarily due to lower gains on equity securities. INCOME TAXES Effective Tax RateOur effective tax rate for fiscal years 2022 and 2021 was 13% and 14%, respectively. The decrease in our effective tax rate was primarily due to a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties, offset in part by changes in the mix of our income before income taxes between the U.S. and foreign countries, as well as tax benefits in the prior year from the India Supreme Court decision on withholding taxes in the case of Engineering Analysis Centre of Excellent Private Limited vs The Commissioner of Income Tax, an agreement between the U.S. and India tax authorities related to transfer pricing, and final Tax Cuts and Jobs Act (TCJA) regulations.In the first quarter of fiscal year 2022, we transferred certain intangible properties from our Puerto Rico subsidiary to the U.S. The transfer of intangible properties resulted in a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022, as the value of future U.S. tax deductions exceeds the current tax liability from the U.S. global intangible low-taxed income tax.We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016.Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the net income tax benefit related to the transfer of intangible properties, earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland, and tax benefits relating to stock-based compensation. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2022, our U.S. income before income taxes was $47.8 billion and our foreign income before income taxes was $35.9 billion. In fiscal year 2021, our U.S. income before income taxes was $35.0 billion and our foreign income before income taxes was $36.1 billion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017. As of June 30, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2021, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the net tax benefit related to the transfer of intangible properties in the first quarter of fiscal year 2022 and the net income tax benefit related to an India Supreme Court decision on withholding taxes in the third quarter of fiscal year 2021. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change Net income$72,738$61,27119%Net income tax benefit related to transfer of intangible properties(3,291)*Net income tax benefit related to India Supreme Court decision on withholding taxes(620)*Adjusted net income (non-GAAP)$69,447$60,65115%Diluted earnings per share$9.65$8.0520% Net income tax benefit related to transfer of intangible properties(0.44)*Net income tax benefit related to India Supreme Court decision on withholding taxes(0.08)*Adjusted diluted earnings per share (non-GAAP)$9.21$7.9716% * Not meaningful. PART II Item 7LIQUIDITY AND CAPITAL RESOURCES We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $104.8 billion and $130.3 billion as of June 30, 2022 and 2021, respectively. Equity investments were $6.9 billion and $6.0 billion as of June 30, 2022 and 2021, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Cash from operations increased $12.3 billion to $89.0 billion for fiscal year 2022, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees. Cash used in financing increased $10.4 billion to $58.9 billion for fiscal year 2022, mainly due to a $5.3 billion increase in common stock repurchases and a $5.3 billion increase in repayments of debt. Cash used in investing increased $2.7 billion to $30.3 billion for fiscal year 2022, mainly due to a $13.1 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $3.3 billion increase in additions to property and equipment, offset in part by a $15.6 billion increase in cash from net investment purchases, sales, and maturities.PART II Item 7Debt ProceedsWe issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2022:(In millions)Three Months EndingSeptember 30, 2022$17,691December 31, 202213,923March 31, 20239,491June 30, 20234,433Thereafter2,870Total$48,408If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. PART II Item 7Material Cash Requirements and Other Obligations Contractual ObligationsThe following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2022:(In millions)ThereafterTotalLong-term debt: (a) Principal payments$2,750$52,761$55,511Interest payments1,46821,13922,607Construction commitments (b) 7,9428,518Operating and finance leases, including imputed interest (c) 4,60944,04548,654Purchase commitments ( d ) 42,6692,98545,654Total$59,438$121,506$180,944( a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( d ) Purchase commitments primarily relate to datacenters and include open purchase orders and take-or-pay contracts that are not presented as construction commitments above. Income TaxesAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $6.2 billion, which included $1.5 billion for fiscal year 2022. The remaining transition tax of $12.0 billion is payable over the next four years, with $1.3 billion payable within 12 months. Provisions enacted in the TCJA related to the capitalization for tax purposes of research and experimental expenditures became effective on July 1, 2022. These provisions require us to capitalize research and experimental expenditures and amortize them on the U.S. tax return over five or fifteen years, depending on where research is conducted. The final foreign tax credit regulations, also effective on July 1, 2022, introduced significant changes to foreign tax credit calculations in the U.S. tax return. While these provisions are not expected to have a material impact on our fiscal year 2023 effective tax rate on a net basis, our cash paid for taxes would increase unless these provisions are postponed or modified through legislative processes.Share Repurchases During fiscal years 2022 and 2021, we repurchased 95 million shares and 101 million shares of our common stock for $28.0 billion and $23.0 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. As of June 30, 2022, $40.7 billion remained of our $60 billion share repurchase program. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends During fiscal year 2022, our Board of Directors declared quarterly dividends of $0.62 per share. We intend to continue returning capital to shareholders in the form of dividends, subject to declaration by our Board of Directors. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Other Planned Uses of Capital On January 18, 2022 , we entered into a definitive agreement to acquire Activision Blizzard , Inc. (Activision Blizzard ) for $ 95 .00 per share in an all-cash transaction valued at $ 68 .7 billion, inclusive of Activision Blizzards net cash. The acquisition has been approved by Activision Blizzards shareholders, and we expect it to close in fiscal year 2023, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.CRITICAL ACCOUNTING ESTIMATES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Critical accounting estimates are those estimates that involve a significant level of estimation uncertainty and could have a material impact on our financial condition or results of operations. We have critical accounting estimates in the areas of revenue recognition, impairment of investment securities, goodwill, research and development costs, legal and other contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. PART II Item 7Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. Impairment of Investment Securities We review debt investments quarterly for credit losses and impairment. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. This determination requires significant judgment. In making this judgment, we employ a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery, then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a periodic basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. PART II Item 7Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.CHANGE IN ACCOUNTING ESTIMATE In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years. This change in accounting estimate will be effective beginning fiscal year 2023. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2022, it is estimated this change will increase our fiscal year 2023 operating income by $3.7 billion. We had previously increased the estimated useful lives of both server and network equipment in July 2020.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerAlice L. JollaCorporate Vice President and Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKRISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency Revenue10% decrease in foreign exchange rates$(6,822)EarningsForeign currency Investments10% decrease in foreign exchange rates(94)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,536)Fair ValueCredit 100 basis point increase in credit spreads(350)Fair ValueEquity10% decrease in equity market prices(637)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS(In millions, except per share amounts)Year Ended June 30,Revenue:Product$72,732 $71,074 $68,041 Service and other125,538 97,014 74,974 Total revenue198,270 168,088 143,015 Cost of revenue:Product19,064 18,219 16,017 Service and other43,586 34,013 30,061 Total cost of revenue62,650 52,232 46,078 Gross margin135,620 115,856 96,937 Research and development24,512 20,716 19,269 Sales and marketing21,825 20,117 19,598 General and administrative5,900 5,107 5,111 Operating income83,383 69,916 52,959 Other income, net 1,186 Income before income taxes83,716 71,102 53,036 Provision for income taxes10,978 9,831 8,755 Net income$72,738 $61,271 $44,281 Earnings per share:Basic$9.70 $8.12 $5.82 Diluted$9.65 $8.05 $5.76 Weighted average shares outstanding:Basic7,496 7,547 7,610 Diluted7,540 7,608 7,683 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS(In millions)Year Ended June 30,Net income$72,738 $61,271 $44,281 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )Net change related to investments( 5,360 )( 2,266 )3,990 Translation adjustments and other( 1,146 )( 426 )Other comprehensive income (loss)( 6,500 )( 1,374 )3,526 Comprehensive income$66,238 $59,897 $47,807 Refer to accompanying notes. PART II Item 8BALANCE SHEETS (In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$13,931 $14,224 Short-term investments90,826 116,110 Total cash, cash equivalents, and short-term investments104,757 130,334 Accounts receivable, net of allowance for doubtful accounts of $ 633 and $ 751 44,261 38,043 Inventories3,742 2,636 Other current assets16,924 13,393 Total current assets169,684 184,406 Property and equipment, net of accumulated depreciation of $ 59,660 and $ 51,351 74,398 59,715 Operating lease right-of-use assets13,148 11,088 Equity investments6,891 5,984 Goodwill67,524 49,711 Intangible assets, net11,298 7,800 Other long-term assets21,897 15,075 Total assets$364,840 $333,779 Liabilities and stockholders equityCurrent liabilities:Accounts payable$19,000 $15,163 Current portion of long-term debt2,749 8,072 Accrued compensation10,661 10,057 Short-term income taxes4,067 2,174 Short-term unearned revenue45,538 41,525 Other current liabilities13,067 11,666 Total current liabilities95,082 88,657 Long-term debt47,032 50,074 Long-term income taxes26,069 27,190 Long-term unearned revenue2,870 2,616 Deferred income taxesOperating lease liabilities11,489 9,629 Other long-term liabilities15,526 13,427 Total liabilities198,298 191,791 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,464 and 7,519 86,939 83,111 Retained earnings84,281 57,055 Accumulated other comprehensive income (loss)( 4,678 )1,822 Total stockholders equity166,542 141,988 Total liabilities and stockholders equity$364,840 $333,779 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS(In millions)Year Ended June 30,OperationsNet income$72,738 $61,271 $44,281 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other14,460 11,686 12,796 Stock-based compensation expense7,502 6,118 5,289 Net recognized gains on investments and derivatives( 409 )( 1,249 )( 219 )Deferred income taxes( 5,702 )( 150 )Changes in operating assets and liabilities:Accounts receivable( 6,834 )( 6,481 )( 2,577 )Inventories( 1,123 )( 737 )Other current assets( 709 )( 932 )( 2,330 )Other long-term assets( 2,805 )( 3,459 )( 1,037 )Accounts payable2,943 2,798 3,018 Unearned revenue5,109 4,633 2,212 Income taxes( 2,309 )( 3,631 )Other current liabilities2,344 4,149 1,346 Other long-term liabilities1,402 1,348 Net cash from operations89,035 76,740 60,675 FinancingCash premium on debt exchange( 1,754 )( 3,417 )Repayments of debt( 9,023 )( 3,750 )( 5,518 )Common stock issued1,841 1,693 1,343 Common stock repurchased( 32,696 )( 27,385 )( 22,968 )Common stock cash dividends paid( 18,135 )( 16,521 )( 15,137 )Other, net( 863 )( 769 )( 334 )Net cash used in financing( 58,876 )( 48,486 )( 46,031 )InvestingAdditions to property and equipment( 23,886 )( 20,622 )( 15,441 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 22,038 )( 8,909 )( 2,521 )Purchases of investments( 26,456 )( 62,924 )( 77,190 )Maturities of investments16,451 51,792 66,449 Sales of investments28,443 14,008 17,721 Other, net( 2,825 )( 922 )( 1,241 )Net cash used in investing( 30,311 )( 27,577 )( 12,223 )Effect of foreign exchange rates on cash and cash equivalents( 141 )( 29 )( 201 )Net change in cash and cash equivalents( 293 )2,220 Cash and cash equivalents, beginning of period14,224 13,576 11,356 Cash and cash equivalents, end of period$13,931 $14,224 $13,576 Refer to accompanying notes.PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions, except per share amounts)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$83,111 $80,552 $78,520 Common stock issued1,841 1,963 1,343 Common stock repurchased( 5,688 )( 5,539 )( 4,599 )Stock-based compensation expense7,502 6,118 5,289 Other, net( 1 )Balance, end of period86,939 83,111 80,552 Retained earningsBalance, beginning of period57,055 34,566 24,150 Net income72,738 61,271 44,281 Common stock cash dividends( 18,552 )( 16,871 )( 15,483 )Common stock repurchased( 26,960 )( 21,879 )( 18,382 )Cumulative effect of accounting changes( 32 )Balance, end of period84,281 57,055 34,566 Accumulated other comprehensive income (loss)Balance, beginning of period1,822 3,186 ( 340 )Other comprehensive income (loss)( 6,500 )( 1,374 )3,526 Cumulative effect of accounting changesBalance, end of period( 4,678 )1,822 3,186 Total stockholders equity$166,542 $141,988 $118,304 Cash dividends declared per common share$2.48 $2.24 $2.04 Refer to accompanying notes. PART II Item 8NOTES TO FINANCIAL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties.In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years . This change in accounting estimate will be effective beginning fiscal year 2023. We had previously increased the estimated useful lives of both server and network equipment in July 2020.Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, video games, and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances and Other Receivables Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future, LinkedIn subscriptions, Office 365 subscriptions, Xbox subscriptions, Windows post-delivery support, Dynamics business solutions, and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.As of June 30, 2022 and 2021, other receivables due from suppliers were $ 1.0 billion and $ 965 million, respectively, and are included in accounts receivable, net in our consolidated balance sheets.As of June 30, 2022 and 2021, long-term accounts receivable, net of allowance for doubtful accounts, was $ 3.8 billion and $ 3.4 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. PART II Item 8Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 245 )( 252 )( 178 )Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$ 816 We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2022 and 2021, our financing receivables, net were $ 4.1 billion and $ 4.4 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.5 billion, $ 1.5 billion, and $ 1.6 billion in fiscal years 2022, 2021, and 2020, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding credit losses and impairments, are recorded in other comprehensive income . Fair value is calculated based on publicly available market information or other estimates determined by management. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. To determine credit losses, we employ a systematic methodology that considers available quantitative and qualitative evidence. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery , then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a periodic basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in other income (expense), net with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities include certain over-the-counter forward, option, and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to four years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Accounting for Income TaxesIn December 2019, the Financial Accounting Standards Board issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. We adopted the standard effective July 1, 2021. Adoption of the standard did not have a material impact on our consolidated financial statements.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. The components of basic and diluted EPS were as follows: (In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$72,738 $61,271 $ 44,281 Weighted average outstanding shares of common stock (B)7,496 7,547 7,610 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,540 7,608 7,683 Earnings Per ShareBasic (A/B)$9.70 $8.12 $5.82 Diluted (A/C)$9.65 $8.05 $5.76 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,094 $2,131 $2,680 Interest expense( 2,063 )( 2,346 )( 2,591 )Net recognized gains on investments1,232 Net gains (losses) on derivatives( 52 )Net gains (losses) on foreign currency remeasurements( 75 )( 191 )Other, net( 32 )( 40 )Total$$1,186 $PART II Item 8Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 138 )( 40 )( 37 ) Impairments and allowance for credit losses( 81 )( 2 )( 17 ) Total$( 57 )$$( 4 ) Net recognized gains (losses) on equity investments were as follows:(In millions) Year Ended June 30,Net realized gains on investments sold$$$Net unrealized gains on investments still held1,057 69 Impairments of investments( 20 )( 11 )( 116 ) Total$$1,169 $ 36 PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2022Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$2,500 $$$2,500 $2,498 $$Certificates of depositLevel 22,071 2,071 2,032 U.S. government securitiesLevel 179,696 ( 2,178 )77,547 77,538 U.S. agency securitiesLevel 2( 9 )Foreign government bondsLevel 2( 24 )Mortgage- and asset-backed securitiesLevel 2( 30 )Corporate notes and bondsLevel 211,661 ( 554 )11,111 11,111 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 13 )Municipal securitiesLevel 3( 6 )Total debt investments$98,118 $$( 2,814 )$95,357 $4,539 $90,818 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,590 $1,134 $$Equity investmentsOther6,435 6,435 Total equity investments$8,025 $1,134 $$6,891 Cash$8,258 $8,258 $$Derivatives, net (a) Total$111,648 $13,931 $90,826 $6,891 PART II Item 8(In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2021Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,316 $$$4,316 $1,331 $2,985 $Certificates of depositLevel 23,615 3,615 2,920 U.S. government securitiesLevel 190,664 3,832 ( 111 )94,385 1,500 92,885 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,213 ( 2 )6,220 5,995 Mortgage- and asset-backed securitiesLevel 23,442 ( 6 )3,458 3,458 Corporate notes and bondsLevel 28,443 ( 9 )8,683 8,683 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3( 7 )Total debt investments$117,966 $4,177 $( 135 )$122,008 $5,976 $116,032 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,582 $$$Equity investmentsOther5,378 5,378 Total equity investments$6,960 $$$5,984 Cash$7,272 $7,272 $$Derivatives, net (a) Total$136,318 $14,224 $116,110 $5,984 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2022 and 2021, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 3.8 billion and $ 3.3 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2022U.S. government and agency securities$59,092 $( 1,835 )$2,210 $( 352 )$61,302 $( 2,187 )Foreign government bonds( 18 )( 6 )( 24 )Mortgage- and asset-backed securities( 26 )( 4 )( 30 )Corporate notes and bonds9,443 ( 477 )( 77 )10,229 ( 554 )Municipal securities( 12 )( 7 )( 19 )Total$69,641 $( 2,368 )$3,138 $( 446 )$72,779 $( 2,814 )PART II Item 8Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2021U.S. government and agency securities$5,294 $( 111 )$$$5,294 $( 111 )Foreign government bonds3,148 ( 1 )( 1 )3,153 ( 2 )Mortgage- and asset-backed securities1,211 ( 5 )( 1 )1,298 ( 6 )Corporate notes and bonds1,678 ( 8 )( 1 )1,712 ( 9 )Municipal securities( 7 )( 7 )Total$11,389 $( 132 )$$( 3 )$11,516 $( 135 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)AdjustedCost BasisEstimatedFair ValueJune 30, 2022Due in one year or less$26,480 $26,470 Due after one year through five years52,006 50,748 Due after five years through 10 years18,274 16,880 Due after 10 years1,358 1,259 Total$98,118 $95,357 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.PART II Item 8Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts . These contracts are not designated as hedging instruments and are included in Other contracts in the tables below. Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2022, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,081 Interest rate contracts purchased1,139 1,247 Not Designated as Hedging InstrumentsForeign exchange contracts purchased10,322 14,223 Foreign exchange contracts sold21,606 23,391 Other contracts purchased2,773 2,456 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 77 )$$( 8 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 362 )( 291 )Other contracts( 112 )( 36 )Gross amounts of derivatives( 551 )( 335 )Gross amounts of derivatives offset in the balance sheet( 130 )( 141 )Cash collateral received 0 ( 75 ) 0 ( 42 )Net amounts of derivatives$$( 493 )$$( 235 )Reported asShort-term investments$$$$Other current assetsOther long-term assetsOther current liabilities( 298 )( 182 )Other long-term liabilities( 195 )( 53 )Total$$( 493 )$$( 235 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 343 million and $ 550 million, respectively, as of June 30, 2022, and $ 395 million and $ 335 million, respectively, as of June 30, 2021. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2022Derivative assets$$$$Derivative liabilities( 551 )( 551 )June 30, 2021Derivative assetsDerivative liabilities( 335 )( 335 )PART II Item 8Gains (losses) on derivative instruments recognized in other income (expense), net were as follows:(In millions)Year Ended June 30,Designated as Fair Value Hedging InstrumentsForeign exchange contractsDerivatives$$$Hedged items( 50 )( 188 )Excluded from effectiveness assessmentInterest rate contractsDerivatives( 92 )( 37 )Hedged items( 93 )Designated as Cash Flow Hedging InstrumentsForeign exchange contractsAmount reclassified from accumulated other comprehensive income( 79 )Not Designated as Hedging InstrumentsForeign exchange contracts( 123 )Other contracts( 72 )Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$( 57 )$$( 38 )NOTE 6 INVENTORIES The components of inventories were as follows:(In millions)June 30,Raw materials$1,144 $1,190 Work in processFinished goods2,516 1,367 Total$3,742 $2,636 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$4,734 $3,660 Buildings and improvements55,014 43,928 Leasehold improvements7,819 6,884 Computer equipment and software60,631 51,250 Furniture and equipment5,860 5,344 Total, at cost134,058 111,066 Accumulated depreciation( 59,660 )( 51,351 )Total, net$ 74,398 $ 59,715 During fiscal years 2022, 2021, and 2020, depreciation expense was $ 12.6 billion, $ 9.3 billion, and $ 10.7 billion, respectively. We have committed $ 8.5 billion, primarily related to datacenters, for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2022. NOTE 8 BUSINESS COMBINATIONS Nuance Communications, Inc. On March 4, 2022 , we completed our acquisition of Nuance Communications, Inc. (Nuance) for a total purchase price of $ 18.8 billion, consisting primarily of cash. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The financial results of Nuance have been included in our consolidated financial statements since the date of the acquisition. Nuance is reported as part of our Intelligent Cloud segment.The purchase price allocation as of the date of acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:(In millions) Goodwill (a) $ 16,308 Intangible assets4,365 Other assetsOther liabilities (b) ( 1,971 )Total $18,761 (a) Goodwill was assigned to our Intelligent Cloud segment and was primarily attributed to increased synergies that are expected to be achieved from the integration of Nuance. None of the goodwill is expected to be deductible for income tax purposes. (b) Includes $ 986 million of convertible senior notes issued by Nuance in 2015 and 2017, of which $ 985 million was redeemed prior to June 30, 2022. The remaining $ 1 million of notes are redeemable through their respective maturity dates and are included in other current liabilities on our consolidated balance sheets as of June 30, 2022. PART II Item 8Following are the details of the purchase price allocated to the intangible assets acquired:(In millions, except average life)AmountWeightedAverage LifeCustomer-related$2,610 9 yearsTechnology-based1,540 5 yearsMarketing-related4 yearsTotal$4,365 7 yearsZeniMax Media Inc.On March 9, 2021 , we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC (Bethesda), for a total purchase price of $ 8.1 billion, consisting primarily of cash. The purchase price included $ 766 million of cash and cash equivalents acquired. Bethesda is one of the largest, privately held game developers and publishers in the world, and brings a broad portfolio of games, technology, and talent to Xbox. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment.The allocation of the purchase price to goodwill was completed as of December 31, 2021. The major classes of assets and liabilities to which we have allocated the purchase price were as follows:(In millions) Cash and cash equivalents$Goodwill 5,510 Intangible assets1,968 Other assetsOther liabilities( 244 ) Total $8,121 Goodwill was assigned to our More Personal Computing segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of ZeniMax. None of the goodwill is expected to be deductible for income tax purposes.Following are details of the purchase price allocated to the intangible assets acquired:(In millions, except average life)AmountWeightedAverage LifeTechnology-based$1,341 4 yearsMarketing-related11 yearsTotal$1,968 6 yearsActivision Blizzard, Inc.On January 18, 2022 , we entered into a definitive agreement to acquire Activision Blizzard , Inc. (Activision Blizzard ) for $ 95.00 per share in an all-cash transaction valued at $ 68.7 billion, inclusive of Activision Blizzards net cash. Activision Blizzard is a leader in game development and an interactive entertainment content publisher. The acquisition will accelerate the growth in our gaming business across mobile, PC, console, and cloud and will provide building blocks for the metaverse. The acquisition has been approved by Activision Blizzards shareholders, and we expect it to close in fiscal year 202 3 , subject to the satisfaction of certain regulatory approvals and other customary closing conditions.PART II Item 8NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows:(In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2022Productivity and Business Processes$24,190 $$$24,317 $$( 105 )$24,811 Intelligent Cloud12,697 13,256 16,879 (b) (b) 30,182 More Personal Computing6,464 5,556 (a) (a) 12,138 ( 255 )12,531 Total$43,351 $6,061 $299 $49,711 $18,126 $( 313 )$67,524 (a) Includes goodwill of $ 5.5 billion related to ZeniMax. See Note 8 Business Combinations for further information . (b) Includes goodwill of $ 16.3 billion related to Nuance. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill ImpairmentWe test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2022, May 1, 2021, or May 1, 2020 tests. As of June 30, 2022 and 2021, accumulated goodwill impairment was $ 11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$11,277 $( 6,958 )$4,319 $9,779 $( 7,007 )$2,772 Customer-related7,342 ( 3,171 )4,171 4,958 ( 2,859 )2,099 Marketing-related4,942 ( 2,143 )2,799 4,792 ( 1,878 )2,914 Contract-based( 7 )( 431 )Total$23,577 (a) $( 12,279 )$11,298 $19,975 (b) $( 12,175 )$7,800 (a) Includes intangible assets of $ 4.4 billion related to Nuance. See Note 8 Business Combinations for further information. (b) Includes intangible assets of $ 2.0 billion related to ZeniMax. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2022, 2021, or 2020. We estimate that we have no significant residual value related to our intangible assets.PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$2,611 4 years$1,628 4 yearsCustomer-related2,837 9 years4 yearsMarketing-related4 years6 yearsContract-based0 years3 yearsTotal$5,681 7 years$ 2,359 5 yearsIntangible assets amortization expense was $ 2.0 billion, $ 1.6 billion, and $ 1.6 billion for fiscal years 2022, 2021, and 2020, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2022:(In millions)Year Ending June 30,$2,654 2,385 1,631 1,227 Thereafter2,592 Total$11,298 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 4.50 %4.57 %2011 issuance of $ 2.3 billion (a) 5.30 %5.36 %2012 issuance of $ 2.3 billion (a) 2.13 %3.50 %2.24 %3.57 %1,204 1,204 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,814 2,814 2013 issuance of 4.1 billion2.63 %3.13 %2.69 %3.22 %2,404 4,803 2015 issuance of $ 23.8 billion (a) 2.65 %4.75 %2.72 %4.78 %10,805 12,305 2016 issuance of $ 19.8 billion (a) 2.00 %3.95 %2.10 %4.03 %9,430 12,180 2017 issuance of $ 17.0 billion (a) 2.88 %4.50 %3.04 %4.53 %8,945 10,695 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 10,000 2021 issuance of $ 8.2 billion (a) 2.92 %3.04 %2.92 %3.04 %8,185 8,185 Total face value55,511 63,910 Unamortized discount and issuance costs( 471 )( 511 )Hedge fair value adjustments ( b ) ( 68 )Premium on debt exchange (a) ( 5,191 )( 5,293 )Total debt49,781 58,146 Current portion of long-term debt( 2,749 )( 8,072 )Long-term debt$47,032 $50,074 (a) In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities. The premiums are amortized over the terms of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2022 and 2021, the estimated fair value of long-term debt, including the current portion, was $ 50.9 billion and $ 70.0 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. Cash paid for interest on our debt for fiscal years 2022, 2021, and 2020 was $ 1.9 billion, $ 2.0 billion, and $ 2.4 billion, respectively . The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2022: (In millions)Year Ending June 30,$2,750 5,250 2,250 3,000 8,000 Thereafter34,261 Total$55,511 PART II Item 8NOTE 12 INCOME TAXES Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$8,329 $3,285 $3,537 U.S. state and local1,679 1,229 Foreign6,672 5,467 4,444 Current taxes$16,680 $9,981 $8,744 Deferred TaxesU.S. federal$( 4,815 )$$U.S. state and local( 1,062 )( 204 )( 6 )Foreign( 41 )Deferred taxes$( 5,702 )$( 150 )$Provision for income taxes$10,978 $9,831 $8,755 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$47,837 $34,972 $24,116 Foreign 35,879 36,130 28,920 Income before income taxes$83,716 $71,102 $53,036 Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %21.0 %Effect of:Foreign earnings taxed at lower rates( 1.3 )%( 2.7 )%( 3.7 )%Impact of intangible property transfers( 3.9 )%%%Foreign-derived intangible income deduction( 1.1 )%( 1.3 )%( 1.1 )%State income taxes, net of federal benefit1.4 %1.4 %1.3 %Research and development credit( 0.9 )%( 0.9 )%( 1.1 )%Excess tax benefits relating to stock-based compensation( 1.9 )%( 2.4 )%( 2.2 )%Interest, net0.5 %0.5 %1.0 %Other reconciling items, net( 0.7 )%( 1.8 )%1.3 %Effective rate13.1 %13.8 %16.5 %In the first quarter of fiscal year 2022, we transferred certain intangible properties from our Puerto Rico subsidiary to the U.S. The transfer of intangible properties resulted in a $ 3.3 billion net income tax benefit in the first quarter of fiscal year 2022, as the value of future U.S. tax deductions exceeds the current tax liability from the U.S. global intangible low-taxed income (GILTI) tax.PART II Item 8We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $ 620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016 . The decrease from the federal statutory rate in fiscal year 2022 is primarily due to the net income tax benefit related to the transfer of intangible properties, earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2021 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. In fiscal years 2022, 2021, and 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 71 %, 82 %, and 86 % of our foreign income before tax. Other reconciling items, net consists primarily of tax credits and GILTI tax, and in fiscal year 2021, includes tax benefits from the India Supreme Court decision on withholding taxes. In fiscal years 2022, 2021, and 2020, there were no individually significant other reconciling items.The decrease in our effective tax rate for fiscal year 2022 compared to fiscal year 2021 was primarily due to a $ 3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties, offset in part by changes in the mix of our income before income taxes between the U.S. and foreign countries, as well as tax benefits in the prior year from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing, and final Tax Cuts and Jobs Act (TCJA) regulations. The decrease in our effective tax rate for fiscal year 2021 compared to fiscal year 2020 was primarily due to tax benefits from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing, final TCJA regulations, and an increase in tax benefits relating to stock-based compensation.PART II Item 8The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,874 2,960 Loss and credit carryforwards1,546 1,090 Amortization10,656 6,346 Leasing liabilities4,557 4,060 Unearned revenue2,876 2,659 OtherDeferred income tax assets23,571 17,936 Less valuation allowance( 1,012 )( 769 )Deferred income tax assets, net of valuation allowance$22,559 $17,167 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 174 )$( 2,381 )Leasing assets( 4,291 )( 3,834 )Depreciation( 1,602 )( 1,010 )Deferred tax on foreign earnings( 3,104 )( 2,815 )Other( 103 )( 144 )Deferred income tax liabilities$( 9,274 )$( 10,184 )Net deferred income tax assets$13,285 $6,983 Reported AsOther long-term assets$13,515 $7,181 Long-term deferred income tax liabilities( 230 )( 198 )Net deferred income tax assets$13,285 $6,983 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2022, we had federal, state, and foreign net operating loss carryforwards of $ 318 million, $ 1.3 billion, and $ 2.1 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2023 through 2042 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation but are expected to be realized with the exception of those which have a valuation allowance. As of June 30, 2022, we had $ 1.3 billion federal capital loss carryforwards for U.S. tax purposes from our acquisition of Nuance. The federal capital loss carryforwards are subject to an annual limitation and will expire in various years from fiscal 2023 through 2025 .The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards, federal capital loss carryforwards, and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $ 16.0 billion, $ 13.4 billion, and $ 12.5 billion in fiscal years 2022, 2021, and 2020, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2022, 2021, and 2020, were $ 15.6 billion, $ 14.6 billion, and $ 13.8 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2022, 2021, and 2020 by $ 13.3 billion, $ 12.5 billion, and $ 12.1 billion, respectively.PART II Item 8As of June 30, 2022, 2021, and 2020, we had accrued interest expense related to uncertain tax positions of $ 4.3 billion, $ 4.3 billion, and $ 4.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2022, 2021, and 2020 included interest expense related to uncertain tax positions of $ 36 million, $ 274 million, and $ 579 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows: (In millions)Year Ended June 30,Beginning unrecognized tax benefits$14,550 $13,792 $13,146 Decreases related to settlements( 317 )( 195 )( 31 )Increases for tax positions related to the current year1,145 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 246 )( 297 )( 331 )Decreases due to lapsed statutes of limitations( 1 )( 5 )Ending unrecognized tax benefits$15,593 $14,550 $13,792 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $ 1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017 .As of June 30, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2021 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements. NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$24,558 $22,120 Intelligent Cloud19,371 17,710 More Personal Computing4,479 4,311 Total$48,408 $44,141 Changes in unearned revenue were as follows: (In millions)Year Ended June 30, 2022Balance, beginning of period$44,141 Deferral of revenue110,455 Recognition of unearned revenue( 106,188 )Balance, end of period$48,408 PART II Item 8Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 193 billion as of June 30, 2022, of which $ 189 billion is related to the commercial portion of revenue. We expect to recognize approximately 45 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. Our leases have remaining lease terms of 1 year to 19 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows: (In millions)Year Ended June 30,Operating lease cost$2,461 $2,127 $2,043 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$1,409 $1,307 $Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$2,368 $2,052 $1,829 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases5,268 4,380 3,677 Finance leases4,234 3,290 3,467 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$13,148 $11,088 Other current liabilities$2,228 $1,962 Operating lease liabilities11,489 9,629 Total operating lease liabilities$13,717 $11,591 Finance LeasesProperty and equipment, at cost$17,388 $14,107 Accumulated depreciation( 3,285 )( 2,306 )Property and equipment, net$14,103 $11,801 Other current liabilities$1,060 $Other long-term liabilities13,842 11,750 Total finance lease liabilities$14,902 $12,541 Weighted Average Remaining Lease TermOperating leases8 years8 yearsFinance leases12 years12 yearsWeighted Average Discount RateOperating leases2.1 %2.2 %Finance leases3.1 %3.4 %The following table outlines maturities of our lease liabilities as of June 30, 2022:(In millions)Year Ending June 30,OperatingLeasesFinanceLeases$2,456 $1,477 2,278 1,487 1,985 1,801 1,625 1,483 1,328 1,489 Thereafter5,332 9,931 Total lease payments15,004 17,668 Less imputed interest( 1,287 )( 2,766 )Total$13,717 $14,902 As of June 30, 2022, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 7.2 billion and $ 8.8 billion, respectively. These operating and finance leases will commence between fiscal year 2023 and fiscal year 2028 with lease terms of 1 year to 18 years .PART II Item 8NOTE 15 CONTINGENCIES Antitrust Litigation and Claims China State Administration for Market Regulation Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. In 2019, the SAMR presented preliminary views as to certain possible violations of Chinas Anti-Monopoly Law.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 46 lawsuits, including 45 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing on general causation is scheduled for September of 2022 . Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2022, we accrued aggregate legal liabilities of $ 364 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 600 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. PART II Item 8NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,519 7,571 7,643 IssuedRepurchased( 95 )( 101 )( 126 )Balance, end of year7,464 7,519 7,571 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020 and was completed in November 2021.On September 14, 2021, our Board of Directors approved a share repurchase program authorizing up to $ 60.0 billion in share repurchases. This share repurchase program commenced in November 2021, following completion of the program approved on September 18, 2019, has no expiration date, and may be terminated at any time. As of June 30, 2022, $ 40.7 billion remained of this $ 60.0 billion share repurchase program.We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$6,200 $5,270 $4,000 Second Quarter6,233 5,750 4,600 Third Quarter7,800 5,750 6,000 Fourth Quarter7,800 6,200 5,088 Total$28,033 $22,970 $19,688 All repurchases were made using cash resources. Shares repurchased during the fourth and third quarters of fiscal year 2022 were under the share repurchase program approved on September 14, 2021. Shares repurchased during the second quarter of fiscal year 2022 were under the share repurchase programs approved on both September 14, 2021 and September 18, 2019. Shares repurchased during the first quarter of fiscal year 2022, fiscal year 2021, and the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 4.7 billion, $ 4.4 billion, and $ 3.3 billion for fiscal years 2022, 2021, and 2020, respectively.PART II Item 8Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2022(In millions)September 14, 2021 November 18, 2021 December 9, 2021 $0.62 $4,652 December 7, 2021 February 17, 2022 March 10, 2022 0.62 4,645 March 14, 2022 May 19, 2022 June 9, 2022 0.62 4,632 June 14, 2022 August 18, 2022 September 8, 2022 0.62 4,627 Total$2.48 $18,556 Fiscal Year 2021September 15, 2020 November 19, 2020 December 10, 2020 $0.56 $4,230 December 2, 2020 February 18, 2021 March 11, 2021 0.56 4,221 March 16, 2021 May 20, 2021 June 10, 2021 0.56 4,214 June 16, 2021 August 19, 2021 September 9, 2021 0.56 4,206 Total$2.24 $16,871 The dividend declared on June 14, 2022 was included in other current liabilities as of June 30, 2022. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component :(In millions)Year Ended June 30,DerivativesBalance, beginning of period$( 19 )$( 38 )$Unrealized gains (losses), net of tax of $( 15 ) , $ 9 , and $( 10 )( 57 )( 38 )Reclassification adjustments for (gains) losses included in other income (expense), net( 17 )Tax expense (benefit) included in provision for income taxes( 16 )Amounts reclassified from accumulated other comprehensive income (loss)( 15 )Net change related to derivatives, net of tax of $ 1 , $ 7 , and $( 10 )( 38 )Balance, end of period$( 13 )$( 19 )$( 38 )InvestmentsBalance, beginning of period$3,222 $5,478 $1,488 Unrealized gains (losses), net of tax of $( 1,440 ) , $( 589 ), and $ 1,057 ( 5,405 )( 2,216 )3,987 Reclassification adjustments for (gains) losses included in other income (expense), net( 63 )Tax expense (benefit) included in provision for income taxes( 12 )( 1 )Amounts reclassified from accumulated other comprehensive income (loss)( 50 )Net change related to investments, net of tax of $( 1,428 ) , $( 602 ), and $ 1,058 ( 5,360 )( 2,266 )3,990 Cumulative effect of accounting changesBalance, end of period$( 2,138 )$3,222 $5,478 Translation Adjustments and OtherBalance, beginning of period$( 1,381 )$( 2,254 )$( 1,828 )Translation adjustments and other, net of tax of $ 0 , $( 9 ), and $ 1 ( 1,146 )( 426 )Balance, end of period$( 2,527 )$( 1,381 )$( 2,254 )Accumulated other comprehensive income (loss), end of period$( 4,678 )$1,822 $3,186 NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$7,502 $6,118 $5,289 Income tax benefits related to stock-based compensation1,293 1,065 Stock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.56 0.62 $0.51 0.56 $0.46 0.51 Interest rates0.03 %3.6 %0.01 %1.5 %0.1 %2.2 %During fiscal year 2022, the following activity occurred under our stock plans: SharesWeighted AverageGrant-Date FairValue(In millions)Stock AwardsNonvested balance, beginning of year$152.51 Granted (a) 291.22 Vested( 47 ) 143.10 Forfeited( 10 ) 189.88 Nonvested balance, end of year$227.59 (a) Includes 1 million, 2 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2022, 2021, and 2020, respectively. As of June 30, 2022, there was approximately $ 16.7 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 291.22 , $ 221.13 , and $ 140.49 for fiscal years 2022, 2021, and 2020, respectively. The fair value of stock awards vested was $ 14.1 billion, $ 13.4 billion, and $ 10.1 billion, for fiscal years 2022, 2021, and 2020, respectively. As of June 30, 2022, an aggregate of 211 million shares were authorized for future grant under our stock plans.Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Under the terms of the ESPP that were approved in 2012, the plan was set to terminate on December 31, 2022. At our 2021 Annual Shareholders Meeting, our shareholders approved a successor ESPP with a January 1, 2022 effective date and ten-year expiration of December 31, 2031. No additional shares were requested at this meeting.Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$259.55 $207.88 $142.22 As of June 30, 2022, 81 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plans We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We match a portion of each dollar a participant contributes into the plans. Employer-funded retirement benefits for all plans were $ 1.4 billion, $ 1.2 billion, and $ 1.0 billion in fiscal years 2022, 2021, and 2020, respectively, and were expensed as contributed.NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva. Office Consumer, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHub. Enterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance professional services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing and Windows Internet of Things. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services. Search and news advertising. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include legal, including settlements and fines, information technology, human resources, finance, excise taxes, field selling, shared facilities services, and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$63,364 $53,915 $46,398 Intelligent Cloud75,251 60,080 48,366 More Personal Computing59,655 54,093 48,251 Total$198,270 $168,088 $143,015 Operating Income Productivity and Business Processes$29,687 $24,351 $18,724 Intelligent Cloud32,721 26,126 18,324 More Personal Computing20,975 19,439 15,911 Total$83,383 $69,916 $52,959 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2022, 2021, or 2020. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $100,218 $83,953 $73,160 Other countries98,052 84,135 69,855 Total$198,270 $168,088 $143,015 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$67,321 $52,589 $41,379 Office products and cloud services44,862 39,872 35,316 Windows24,761 22,488 21,510 Gaming16,230 15,370 11,575 LinkedIn13,816 10,289 8,077 Search and news advertising11,591 9,267 8,524 Enterprise Services7,407 6,943 6,409 Devices6,991 6,791 6,457 Other 5,291 4,479 3,768 Total$198,270 $168,088 $143,015 We have recast certain previously reported amounts in the table above to conform to the way we internally manage and monitor our business.Our Microsoft Cloud (formerly commercial cloud) revenue, which includes Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 91.2 billion, $ 69.1 billion and $ 51.7 billion in fiscal years 2022, 2021, and 2020, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$106,430 $76,153 $60,789 Ireland15,505 13,303 12,734 Other countries44,433 38,858 29,770 Total$166,368 $ 128,314 $ 103,293 PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2022 and 2021, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2022, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2022, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 28, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statementsCritical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: - Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.- Tested management's identification and treatment of contract terms. - Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statementsCritical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington July 28, 2022We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2022. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2022 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended June 30, 2022, of the Company and our report dated July 28, 2022, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, WashingtonJuly 28, 2022PART II, III Item 9B, 9C, 10, 11, 12, 13, 14" +15,Microsoft Corporation,2020," ITEM 1. BUSINESSGENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We bring technology and products together into experiences and solutions that unlock value for our customers. Our ecosystem of customers and partners has stepped up to help people and organizations in every country use technology to be resilient and transform during the most trying of circumstances. Amid rapid change weve witnessed technology empower telehealth, remote manufacturing, and new ways of working from home and serving customers. These capabilities have relied on the public cloud, which is built on the investments we have made over time. We are living in the new era of the intelligent cloud and intelligent edge, which is being sharpened by rapid advances in distributed computing, ambient intelligence, and multidevice experiences. This means the places we go and the things we interact with will increasingly become digitized, creating new opportunities and new breakthroughs. In the next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, and video games. We also design and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The Ambitions That Drive Us To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesAt Microsoft, were providing technology and resources to help our customers navigate a remote environment. Were seeing our family of products play key roles in the ways the world is continuing to work, learn, and connect. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is enabling rapid digital transformation by giving people a single tool to chat, call, meet, and collaborate. Microsoft Viva is an employee experience platform that brings together communications, knowledge, learning, resources, and insights powered by Microsoft 365. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and discover new habits, while simplifying security and management. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. This creates an opportunity to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformIn the new remote world, companies have accelerated their own digital transformation to empower their employees, optimize their operations, engage customers, and in some cases, change the very core of their products and services. Partnering with organizations on their digital transformation during this period is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice their success is our success.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.The Microsoft Cloud is the most comprehensive and trusted cloud, providing the best integration across the technology stack while offering openness, improving time to value, reducing costs, and increasing agility. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans security, compliance, identity, and management, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. Azure Arc simplifies governance and management by delivering a consistent multi-cloud and on-premises management platform. Security, compliance, identity, and management underlie our entire tech stack. We offer integrated, end-to-end capabilities to protect people and organizations. In April 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc., a cloud and AI software provider with healthcare and enterprise AI experience. The acquisition will build on our industry-specific cloud offerings. PART I Item 1We are accelerating our development of mixed reality solutions with new Azure services and devices. Microsoft Mesh enables presence and shared experiences from anywhere through mixed reality applications. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads and experiences which we believe will shape the next era of computing. The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. Azure Synapse Analytics, a limitless analytics service, brings together data integration, enterprise data warehousing, and big data analytics for immediate business intelligence and machine learning needs. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. From GitHub to Visual Studio, we provide a developer tool chain for everyone, no matter the technical experience, across all platforms, whether Azure, Windows, or any other cloud or client platform.Create More Personal ComputingWe strive to make computing more personal by putting people at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working and learning. The PC has been mission-critical across work, school, and life to sustain productivity in a remote everything world. Windows 10 serves the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising. In June 2021, Microsoft announced the next generation of Windows Windows 11. Windows 11 builds on the strengths of productivity, versatility, and security on Windows 10 today and adds in new experiences that include powerful task switching tools like new snap layouts, snap groups, and desktops new ways to stay connected through chat the information you want at your fingertips and more. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge.Microsoft Edge is our fast and secure browser that helps protect your data, with built-in shopping tools designed to save you time and money. Organizational tools such as Collections, Vertical Tabs, and Immersive Reader help you make the most of your time while browsing, streaming, searching, sharing, and more.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. The Surface family includes Surface Book 3, Surface Laptop Go, Surface Go 2, Surface Pro 7, Surface Laptop 4, Surface Pro X, Surface Studio 2, and Surface Duo. To expand usage and deepen engagement, we continue to invest in content, community, and cloud services as we pursue the expansive opportunity in the gaming industry. We have broadened our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played, including cloud gaming so players can stream across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers, including the March 2021 acquisition of ZeniMax Media Inc., the parent company of Bethesda Softworks LLC, one of the largest, privately held game developers and publishers in the world. Xbox Game Pass is a community with access to a curated library of over 100 first- and third-party console and PC titles. Xbox Cloud Gaming is Microsofts game streaming technology that is complementary to our console hardware and gives fans the ultimate choice to play the games they want, with the people they want, on the devices they want. PART I Item 1Our Future Opportunity In a time of great disruption and uncertainty, customers are looking to us to accelerate their own digital transformations as software and cloud computing play a huge role across every industry and around the world. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business, grow our share of the PC market, and drive increased engagement with our services like Microsoft 365 Consumer, Teams, Edge, Bing, Xbox Game Pass , and more. Tackling security from all angles with our integrated, end-to-end solutions spanning security, compliance, identity, and management, across all clouds and platforms. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.COVID-19In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic. The COVID-19 pandemic continues to have widespread and unpredictable impacts on global society, economies, financial markets, and business practices, and continues to impact our business operations, including our employees, customers, partners, and communities. Refer to Managements Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7 of this Form 10-K) for further discussion regarding the impact of COVID-19 on our fiscal year 2021 financial results. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.Corporate Social ResponsibilityCommitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. We are accelerating progress toward a more sustainable future by reducing our environmental footprint, advancing research, helping our customers build sustainable solutions, and advocating for policies that benefit the environment. In January 2020, we announced a bold commitment and detailed plan to be carbon negative by 2030, and to remove from the environment by 2050 all the carbon we have emitted since our founding in 1975. This included a commitment to invest $1 billion over four years in new technologies and innovative climate solutions. We built on this pledge by adding commitments to be water positive by 2030, zero waste by 2030, and to protect ecosystems by developing a Planetary Computer. We also help our suppliers and customers around the world use Microsoft technology to reduce their own carbon footprint. In January 2021, we announced that in fiscal year 2020 we reduced Microsofts carbon emissions by 586,683 metric tons. We purchased the removal of 1.3 million metric tons of carbon from 26 projects around the world. Furthermore, we shared a commitment to transparency by subjecting the data in our annual sustainability report to third-party review and to accountability by including progress on sustainability goals as a factor in determining executive pay.PART I Item 1The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment . Our cloud and AI services and datacenters help businesses cut energy consumption, reduce physical footprints, and design sustainable products. We also pledged a $50 million investment in AI for Earth to accelerate innovation by putting AI in the hands of those working to directly address sustainability challenges. We are committed to playing our part to help accelerate the worlds transition to a more economically and environmentally sustainable future for us all . Addressing Racial Injustice and InequityOur future opportunity depends on reaching and empowering all communities, and we are committed to taking action to help address racial injustice and inequity. With significant input from employees and leaders who are members of the Black and African American community, our senior leadership team and board of directors announced in June 2020 that we had developed a set of actions to help improve the lived experience at Microsoft and drive change in the communities in which we live and work. These efforts include increasing our representation and strengthening our culture of inclusion by doubling the number of Black and African American people managers, senior individual contributors, and senior leaders in the United States by 2025 evolving our ecosystem with our supply chain, banking partners, and partner ecosystem and strengthening our communities by using data, technology, and partnerships to help address racial injustice and inequities of the Black and African American communities in the U.S. and improve the safety and wellbeing of our employees and their communities.Over the last year, we have collaborated with partners and worked within neighborhoods and communities to launch and scale a number of projects and programs including: expanding our existing justice reform work with a five-year, $50 million sustained effort, expanding access to affordable broadband and devices for Black and African American communities and key institutions that support them in major urban centers, expanding access to skills and education to support Black and African American students and adults to succeed in the digital economy, and increasing technology support for nonprofits that provide critical services to Black and African American communities.We have more than doubled our percentage share of transaction volume with Black- and African American-owned financial institutions and increased our deposits with Black- and African American-owned minority depository institutions, enabling increased funds into local communities. Additionally, we have seen growth in our Black- and African American-owned supplier base and in Black- and African American-owned technology partners in the Microsoft Partner Network, and we launched the Black Channel Partner Alliance community to support partners onboarding to the Microsoft Cloud and to unlock partner benefits for co-selling with Microsoft.We acknowledge we have more work ahead of us to address racial injustice and inequity, and are applying many of the programs above to help other underrepresented communities.Investing in Digital SkillsWith a continued focus on digital transformation, Microsoft is helping to ensure that no one is left behind, particularly as economies recover from the COVID-19 pandemic. We announced in June 2020 that we are expanding access to the digital skills that have become increasingly vital to many of the worlds jobs, and especially to individuals hardest hit by recent job losses. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. We also invested $20 million in key non-profit partnerships through Microsoft Philanthropies to help people from underserved communities that are often excluded by the digital economy. Over 42 million people across every continent have accessed free training through our skills initiative. The effort surpassed its initial goals and has been expanded with a new emphasis on connecting learners with jobs that help put their new training to use and connecting employers with skilled job seekers they might not find in traditional networks. PART I Item 1HUMAN CAPITAL RESOURCES OverviewMicrosoft aims to recruit, develop, and retain diverse, world-changing talent. To foster their and our success, we seek to create an environment where people can do their best work a place where they can proudly be their authentic selves, guided by our values, and where they know their needs can be met. We strive to maximize the potential of our human capital resources by creating a respectful, rewarding, and inclusive work environment that enables our global employees to create products and services that further our mission to empower every person and every organization on the planet to achieve more.As of June 30, 2021, we employed approximately 181,000 people on a full-time basis, 103,000 in the U.S. and 78,000 internationally. Of the total employed people, 67,000 were in operations, including manufacturing, distribution, product support, and consulting services 60,000 were in product research and development 40,000 were in sales and marketing and 14,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.Our CultureMicrosofts culture is grounded in the growth mindset. This means everyone is on a continuous journey to learn and grow. We believe potential can be nurtured and is not pre-determined, and we should always be learning and curious - trying new things without fear of failure. We identified four attributes that allow growth mindset to flourish: Obsessing over what matters to our customers. Becoming more diverse and inclusive in everything we do. Operating as one company, One Microsoft, instead of multiple siloed businesses. Making a difference in the lives of each other, our customers, and the world around us. Our employee listening systems enable us to gather feedback directly from our workforce to inform our programs and employee needs globally. 88% of employees globally participated in our fiscal year 2021 MS Poll engagement survey, which covers a variety of topics such as inclusion, pay and benefits, and learning and development. Throughout the fiscal year, we also collect nearly 75,000 Daily Pulse employee survey responses. During fiscal year 2021, our Daily Pulse surveys gave us invaluable insights into ways we could support employees through the COVID-19 pandemic and addressing racial injustice. In addition to poll and pulse surveys, we gain insights through onboarding and exit surveys, internal Yammer channels, employee QA sessions, and AskHR Service support.Diversity and InclusionAt Microsoft we have an inherently inclusive mission: to empower every person and every organization on the planet to achieve more. We think of diversity and inclusion as core to our business model, informing our actions to impact economies and people around the world. There are billions of people who want to achieve more, but have a different set of circumstances, abilities, and backgrounds that often limit access to opportunity and achievement. The better we represent that diversity inside Microsoft, the more effectively we can innovate for those we seek to empower.We strive to include others by holding ourselves accountable for diversity, driving global systemic change in our workplace and workforce, and creating an inclusive work environment. Through this commitment we can allow everyone the chance to be their authentic selves and do their best work every day. We support multiple highly active Employee Resource Groups for women, families, racial and ethnic minorities, military, people with disabilities, or who identify as LGBTQI+, where employees can go for support, networking, and community-building. As described in our 2020 Proxy Statement , annual performance and compensation reviews of our senior leadership team include an evaluation of their contributions to employee culture and diversity. To ensure accountability over time, we publicly disclose our progress on a multitude of workforce metrics including: Detailed breakdowns of gender, racial, and ethnic minority representation in our employee population, with data by job types, levels, and segments of our business. Our EEO-1 report (equal employment opportunity). Disability representation.PART I Item 1Total Rewards We develop dynamic, sustainable, and strategic programs with the goal of providing a highly differentiated portfolio to attract, reward, and retain top talent and enable our employees to do their best work. These programs reinforce our culture and values such as collaboration and growth mindset. Managers evaluate and recommend rewards based on, for example, how well we leverage the work of others and contribute to the success of our colleagues. We monitor pay equity and career progress across multiple dimensions.As part of our effort to promote a One Microsoft and inclusive culture, we expanded stock eligibility to all Microsoft employees as part of our annual rewards process. This includes all non-exempt and exempt employees and equivalents across the globe including business support professionals and datacenter and retail employees.Pay EquityIn our 2020 Diversity and Inclusion Report, we reported that all racial and ethnic minority employees in the U.S. combined earn $1.006 for every $1.000 earned by their white counterparts, that women in the U.S. earn $1.001 for every $1.000 earned by their counterparts in the U.S. who are men, and women in the U.S. plus our ten other largest employee geographies (Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, and United Kingdom) combined earn $1.000 for every $1.000 by men in these countries. Our intended result is a global performance and development approach that fosters our culture, and competitive compensation that ensures equitable pay by role while supporting pay for performance.Wellness and SafetyMicrosoft is committed to supporting our employees well-being and safety while they are at work and in their personal lives. We took a wide variety of measures to protect the health and well-being of our employees, suppliers, and customers during the COVID-19 pandemic. We made substantial modifications to employee travel policies and implemented office closures so non-essential employees could work remotely. We continued to pay hourly service providers such as cleaning and reception staff who may have otherwise been furloughed. We implemented a global Paid Pandemic School and Childcare Closure Leave to support working parents, added wellbeing days for those who needed to take time off for mental health and wellness, implemented on-demand COVID-19 testing and vaccinations on our Redmond, Washington campus, and extended full medical plan coverage for coronavirus testing, treatment, and telehealth services. We also expanded existing programs such as our Microsoft CARES Employee Assistance Program and family backup care.In addition to the extraordinary steps and programs relating to COVID-19, our comprehensive benefits package includes many physical, emotional, and financial wellness programs including counseling through the Microsoft CARES Employee Assistance Program, flexible fitness benefits, savings and investment tools, adoption assistance, and back-up care for children and elders. Finally, our Occupational Health and Safety program helps ensure employees can stay safe while they are working.Learning and DevelopmentOur growth mindset culture begins with valuing learning over knowing seeking out new ideas, driving innovation, embracing challenges, learning from failure, and improving over time. To support this culture, we offer a wide range of learning and development opportunities. We believe learning can be more than formal instruction, and our learning philosophy focuses on providing the right learning, at the right time, in the right way. Opportunities include: Personalized, integrated, and relevant views of all learning opportunities on our internal learning portal, our external learning portal MS Learn, and LinkedIn Learning that is available to all employees worldwide. In-the-classroom learning, learning pods, our early-in-career Aspire program, and manager excellence communities. On-the-job stretch and advancement opportunities. Managers holding conversations about employees career and development plans, coaching on career opportunities, and programs like mentoring and sponsorship. Customized manager learning to build people manager capabilities and similar learning solutions to build leadership skills for all employees including differentiated leadership development programs.PART I Item 1 New employee orientation covering a range of topics including company values, culture, and Standards of Business Conduct , as well as ongoing onboarding program . Our employees embrace the growth mindset and take advantage of the formal learning opportunities as well as thousands of informal and on-the-job learning opportunities. In terms of formal on-line learning solutions, in fiscal year 2021 our employees completed over 5 million courses, averaging over 18 hours per employee. Given our focus on understanding core company beliefs and compliance topics, all employees complete required learning programs like Standards of Business Conduct, Privacy, Unconscious Bias, and preventing harassment courses. Our corporate learning portal has over 100,000 average monthly active users. All of our approximately 23,000 people managers must complete between 25-30 hours of required manager capability and excellence training and are assigned ongoing required training each year. In addition, all employees complete skills training based on the profession they are in each year.New Ways of Working The global pandemic has accelerated our capabilities and culture with respect to flexible work. Microsoft has introduced a Hybrid Workplace Flexibility Guide to better support managers and employees as they adapt to new ways of working that shift paradigms, embrace flexibility, promote inclusion, and drive innovation. Our ongoing survey data shows employees value the flexibility related to work location, work site, and work hours, and while many indicate they intend to return to a worksite once conditions permit, they also intend to adjust hours or spend some portions of workweeks working remotely. We are focused on building capabilities to support a variety of workstyles where individuals, teams, and our business can be successful.OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business. Office Consumer, including Microsoft 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.PART I Item 1Office Commercial Office Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as frontline workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.LinkedInLinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Marketing Solutions help companies reach, engage, and convert their audiences at scale. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. Finally, Learning Solutions, including Glint, help businesses close critical skills gaps in times where companies are having to do more with existing talent. LinkedIn has over 750 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions , Learning Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed and applications consumed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications, including Power Apps and Power Automate.PART I Item 1Competition Competitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.Dynamics competes with cloud-based and on-premises business solution providers such as Oracle, Salesforce.com, and SAP.Intelligent CloudOur Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.PART I Item 1Competition Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows IoT and MSN advertising. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising. Search advertising. PART I Item 1Windows The Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Xbox Cloud Gaming, our game streaming service, and continued investment in gaming hardware. Xbox Cloud Gaming utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorites games with them and play on the device most convenient to them. PART I Item 1Xbox enables people to connect and share online gaming experiences that are accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators. Search AdvertisingOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.Xbox and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Facebook, Google, and Tencent. We also compete with other providers of entertainment services such as video streaming platforms. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. For the majority of our products, we have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. However, some of our products contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.PART I Item 1RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility + Security, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 65,000 U.S. and international patents issued and over 21,000 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We may also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, supporting societal and/or environmental efforts, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. PART I Item 1In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Dell, Hewlett-Packard, Lenovo, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In fiscal year 2021, we closed our Microsoft Store physical locations and opened our Microsoft Experience Centers. Microsoft Experience Centers are designed to facilitate deeper engagement with our partners and customers across industries. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. PART I Item 1We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and SA. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. PART I Item 1Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1INFORMATION ABOUT OUR EXECUTIV E OFFICERS Our executive officers as of July 29, 2021 were as follows:NameAgePosition with the CompanySatya NadellaChairman of the Board and Chief Executive OfficerJudson AlthoffExecutive Vice President and Chief Commercial OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Chief Legal OfficerChristopher D. YoungExecutive Vice President, Business Development, Strategy, and VenturesMr. Nadella was appointed Chairman of the Board in June 2021 and Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Althoff was appointed Executive Vice President and Chief Commercial Officer in July 2021. He served as Executive Vice President, Worldwide Commercial Business from July 2017 until that time. Prior to that, Mr. Althoff served as the President of Microsoft North America. Mr. Althoff joined Microsoft in March 2013 as President of Microsoft North America.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 28 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.Mr. Young joined Microsoft in November 2020 as Executive Vice President, Business Development, Strategy, and Ventures. Prior to Microsoft, he served as the Chief Executive Officer of McAfee, LLC from 2017 to 2020, and served as a Senior Vice President and General Manager of Intel Security Group from 2014 until 2017, when he led the initiative to spin out McAfee into a standalone company. Mr. Young also serves on the Board of Directors of American Express Company.PART I Item 1AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.We publish a variety of reports and resources related to our Corporate Social Responsibility programs and progress on our Reports hub website, www.microsoft.com/corporate-responsibility/reports-hub, including reports on sustainability, responsible sourcing, accessibility, digital trust, and public policy engagement. The information found on these websites is not part of, or incorporated by reference into, this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.STRATEGIC AND COMPETITIVE RISKS We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives.PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We embrace cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other IoT endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1ARISKS RELATING TO THE EVOLUTION OF OUR BUSINESS We make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, which could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in October 2018 we completed our acquisition of GitHub, Inc. (GitHub) for $7.5 billion, in March 2021 we completed our acquisition of ZeniMax Media Inc. for $8.1 billion, and in April 2021 we announced a definitive agreement to acquire Nuance Communications, Inc. for $19.7 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, that they distract management from our other businesses, or that announced transactions may not be completed. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record, a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACYBERSECURITY, DATA PRIVACY, AND PLATFORM ABUSE RISKS Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technologyThreats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Nation state and state sponsored actors can deploy significant resources to plan and carry out exploits. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems or reveal confidential information. Malicious actors may employ the IT supply chain to introduce malware through software updates or compromised supplier accounts or hardware.Cyberthreats are constantly evolving and becoming increasingly sophisticated and complex, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improve technologies or remediate the impacts of attacks, or otherwise adversely affect our business.The cyberattacks uncovered in late 2020 known as Solorigate or Nobelium are an example of a supply chain attack where malware was introduced to a software providers customers, including us, through software updates. The attackers were later able to create false credentials that appeared legitimate to certain customers systems. We may be targets of further attacks similar to Solorigate/Nobelium as both a supplier and consumer of IT.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.PART I Item 1ASecurity of our products, services, devices, and customers data The security of our products and services is important in our customers decisions to purchase or use our products or services across cloud and on-premises environments. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. In addition, adversaries can attack our customers on-premises or cloud environments, sometimes exploiting previously unknown (zero day) vulnerabilities, such as occurred in early calendar year 2021 with several of our Exchange Server on-premises products. Vulnerabilities in these or any product can persist even after we have issued security patches if customers have not installed the most recent updates, or if the attackers exploited the vulnerabilities before patching to install additional malware to further compromise customers systems. Adversaries will continue to attack customers using our cloud services as customers embrace digital transformation. Adversaries that acquire user account information can use that information to compromise our users accounts, including where accounts share the same attributes as passwords. Inadequate account security practices may also result in unauthorized access, and user activity may result in ransomware or other malicious software impacting a customers use of our products or services. We are increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.Our customers operate complex IT systems with third-party hardware and software from multiple vendors that may include systems acquired over many years. They expect our products and services to support all these systems and products, including those that no longer incorporate the strongest current security advances or standards. As a result, we may not be able to discontinue support in our services for a product, service, standard, or feature solely because a more secure alternative is available. Failure to utilize the most current security advances and standards can increase our customers vulnerability to attack. Further, customers of widely varied size and technical sophistication use our technology, and consequently may have limited capabilities and resources to help them adopt and implement state of the art cybersecurity practices and technologies. In addition, we must account for this wide variation of technical sophistication when defining default settings for our products and services, including security default settings, as these settings may limit or otherwise impact other aspects of IT operations and some customers may have limited capability to review and reset these defaults.The Solorigate/Nobelium or similar cyberattacks may adversely impact our customers even if our production services are not directly compromised. We are committed to notifying our customers whose systems have been impacted as we become aware and have available information and actions for customers to help protect themselves. We are also committed to providing guidance and support on detection, tracking, and remediation. We may not be able to detect the existence or extent of these attacks for all of our customers or have information on how to detect or track an attack, especially where an attack involves on-premises software such as Exchange Server where we may have no or limited visibility into our customers computing environments.Development and deployment of defensive measuresTo defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls, anti-virus software, and advanced security and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our product and services.PART I Item 1AThe cost of measures to protect products and customer-facing services could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, MSN, and Xbox, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1ADigital safety and service misuse Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. OPERATIONAL RISKS We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Microsoft 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical business functions and multiple workloads. Many of our products and services are interdependent with one another. Each of these circumstances potentially magnifies the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes that restrict supply sources, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. LEGAL, REGULATORY, AND LITIGATION RISKS Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows post-sale monetization opportunities may be limited. Our global operations subject us to potential consequences under anti-corruption, trade, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Increasing trade laws, policies, sanctions, and other regulatory requirements also affect our operations in and outside the U.S. relating to trade and investment. Economic sanctions in the U.S., the EU, and other countries prohibit most business with restricted entities or countries such as Crimea, Cuba, Iran, North Korea, and Syria. U.S. export controls restrict Microsoft from offering many of its products and services to, or making investments in, certain entities in specified countries. U.S. import controls restrict us from integrating certain information and communication technologies into our supply chain and allow for government review of transactions involving information and communications technology from countries determined to be foreign adversaries. Non-compliance could result in reputational harm, operational delays, monetary fines, loss of export privileges, or criminal sanctions.Other regulatory areas that may apply to our products and online services offerings include requirements related to user privacy, telecommunications, data storage and protection, advertising, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws, including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Regulators may assert that our collection, use, and management of customer and other data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative and regulatory action is emerging in the areas of AI and content moderation, which could increase costs or restrict opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or global accessibility requirements, we could lose sales opportunities or face regulatory or legal actions.PART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling has led to uncertainty about the legal requirements for data transfers from the EU under other l egal mechanisms. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, the EU General Data Protection Regulation (GDPR), became effective. The law, which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. Engineering efforts to build and maintain capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if our implementation to comply with the GDPR make s our offerings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to comply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits, reputational damage , and loss of customers . Countries around the world, and states in the U.S . such as California , Colorado, and Virginia , ha ve adopted, or are considering adopting or expanding , laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation. PART I Item 1AWe may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) and possible future legislative changes may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA or possible future legislative changes , and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. We earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. INTELLECTUAL PROPERTY RISKS We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing or cross-licensing our patents to others in return for a royalty and/or increased freedom to operate. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, price changes in products using licensed patents, greater value from cross-licensing, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. GENERAL RISKS If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced a decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.PART I Item 1ACatastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory systems and requirements and market interventions that could impact our operating strategies, access to national, regional, and global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic continues to have widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures to contain the virus, including social distancing, travel restrictions, and vaccination programs. Even as efforts to contain the pandemic have made progress and some restrictions have relaxed, new variants of the virus are causing additional outbreaks. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance.Measures to contain the virus that impact us, our partners, distributors, and suppliers may further intensify these impacts and other risks described in these Risk Factors. Any of these may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions.We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.PART I Item 1AThe long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services. Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational, economic, and geopolitical risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist and protectionist trends and concerns about human rights and political expression in specific countries may significantly alter the trade and commercial environments. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, and non-local sourcing restrictions, export controls, investment restrictions, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations. Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2021 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately 5 million square feet of space we lease. In addition, we own and lease space domestically that includes office and datacenter space.We also own and lease facilities internationally for datacenters, research and development, and other operations. The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, Singapore, and South Korea. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Israel, Japan, Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2021:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company was required to make annual reports of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015 . The Final Order expired in April of 2021. During fiscal year 2021, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking) (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, prior to expiration of the Final Order, the Antitrust Compliance Officer reported to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings.Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESMARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 26, 2021, there were 89,291 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2021:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet bePurchased Under the Plans or Programs(In millions)April 1, 2021 April 30, 20217,493,732$255.237,493,732$13,030May 1, 2021 May 31, 20218,823,524247.368,823,52410,847June 1, 2021 June 30, 20218,155,857258.078,155,8578,74224,473,11324,473,113All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2021: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 16, 2021August 19, 2021September 9, 2021$0.56$4,211We returned $10.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2021. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of our operations for the year ended June 30, 2021 compared to the year ended June 30, 2020. For a discussion of the year ended June 30, 2020 compared to the year ended June 30, 2019, please refer to Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended June 30, 2020.OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.As the world continues to respond to COVID-19, we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.Highlights from fiscal year 2021 compared with fiscal year 2020 included: Commercial cloud revenue increased 34% to $69.1 billion. Office Commercial products and cloud services revenue increased 13% driven by Office 365 Commercial growth of 22%. Office Consumer products and cloud services revenue increased 10% and Microsoft 365 Consumer subscribers increased to 51.9 million. LinkedIn revenue increased 27%. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 43%. Server products and cloud services revenue increased 27% driven by Azure growth of 50%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased slightly. Windows Commercial products and cloud services revenue increased 14%. Xbox content and services revenue increased 23%. Search advertising revenue, excluding traffic acquisition costs, increased 13%. Surface revenue increased 5%.On March 9, 2021, we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC, for a total purchase price of $8.1 billion, consisting primarily of cash. The purchase price included $768 million of cash and cash equivalents acquired. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements ( Part II, Item 8 of this Form 10-K ) for further discussion. PART II Item 7Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Weakening of the U.S. dollar relative to certain foreign currencies increased reported revenue and did not have a material impact on reported expenses from our international operations in fiscal year 2021.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.COVID-19In fiscal year 2021, the COVID-19 pandemic continued to impact our business operations and financial results. Cloud usage and demand benefited as customers accelerate their digital transformation priorities. Our consumer businesses also benefited from the remote environment, with continued demand for PCs and productivity tools, as well as strong engagement across our Gaming platform. We saw improvement in customer advertising spend and savings in operating expenses related to COVID-19, but experienced weakness in transactional licensing. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is uncertainty in the nature and degree of its continued effects over time. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.PART II Item 7Change in Accounting Estimate In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years. This change in accounting estimate was effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2020, the effect of this change in estimate for fiscal year 2021 was an increase in operating income of $2.7 billion and net income of $2.3 billion, or $0.30 per both basic and diluted share. Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last fiscal year.CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Commercial cloud revenue Revenue from our commercial cloud business, which includes Azure, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Commercial cloud gross margin percentageGross margin percentage for our commercial cloud business PART II Item 7Productivity and Business Processes and Intelligent Cloud Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for BusinessOffice Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions and Office licensed on-premisesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionMicrosoft 365 Consumer subscribersThe number of Microsoft 365 Consumer (formerly Office 365 Consumer) subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applicationsLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning SolutionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHubMore Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM Pro revenue growthRevenue from sales of Windows Pro licenses sold through the OEM channel, which primarily addresses demand in the commercial marketWindows OEM non-Pro revenue growthRevenue from sales of Windows non-Pro licenses sold through the OEM channel, which primarily addresses demand in the consumer marketPART II Item 7Windows Commercial products and cloud services revenue growth Revenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenueRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising Search advertising revenue, excluding TAC, growthRevenue from search advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change Revenue$168,088$143,01518%Gross margin115,85696,93720%Operating income69,91652,95932%Net income61,27144,28138%Diluted earnings per share8.055.7640%Adjusted net income (non-GAAP)60,65144,28137%Adjusted diluted earnings per share (non-GAAP)7.975.7638%Adjusted net income and adjusted diluted earnings per share (EPS) are non-GAAP financial measures which exclude tax benefits related to an India Supreme Court decision on withholding taxes in fiscal year 2021 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results. See Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Revenue increased $25.1 billion or 18% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Gaming. Cost of revenue increased $6.2 billion or 13% driven by growth in commercial cloud and Gaming, offset in part by a reduction in depreciation expense due to the change in estimated useful lives of our server and network equipment.Gross margin increased $18.9 billion or 20% driven by growth across each of our segments and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage decreased slightly driven by gross margin percentage reduction in More Personal Computing. Commercial cloud gross margin percentage increased 4 points to 71% driven by gross margin percentage improvement in Azure and the change in estimated useful lives of our server and network equipment, offset in part by sales mix shift to Azure.Operating expenses increased $2.0 billion or 4% driven by investments in cloud engineering and commercial sales, offset in part by savings related to COVID-19 across each of our segments, prior year charges associated with the closing of our Microsoft Store physical locations, and a reduction in bad debt expense.Key changes in operating expenses were: Research and development expenses increased $1.4 billion or 8% driven by investments in cloud engineering. Sales and marketing expenses increased $519 million or 3% driven by investments in commercial sales, offset in part by a reduction in bad debt expense. Sales and marketing included an unfavorable foreign currency impact of 2%. General and administrative expenses were relatively unchanged, driven by prior year charges associated with the closing of our Microsoft Store physical locations, offset in part by an increase in certain employee-related expenses and business taxes.PART II Item 7Operating income increased $17.0 billion or 32% driven by growth across each of our segments and the change in estimated useful lives of our server and network equipment. Current year net income and diluted EPS were positively impacted by the tax benefit related to the India Supreme Court decision on withholding taxes, which resulted in an increase to net income and diluted EPS of $620 million and $0.08, respectively. Revenue, gross margin, and operating income included a favorable foreign currency impact of 3%, 3%, and 4%, respectively. SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change RevenueProductivity and Business Processes$53,915$46,39816%Intelligent Cloud60,08048,36624%More Personal Computing54,09348,25112%Total $168,088$143,01518%Operating Income Productivity and Business Processes$24,351$18,72430%Intelligent Cloud26,12618,32443%More Personal Computing19,43915,91122%Total $69,916$52,95932%Reportable Segments Productivity and Business Processes Revenue increased $7.5 billion or 16%. Office Commercial products and cloud services revenue increased $4.0 billion or 13%. Office 365 Commercial revenue grew 22% driven by seat growth of 17% and higher revenue per user. Office Commercial products revenue declined 23% driven by continued customer shift to cloud offerings and transactional weakness. Office Consumer products and cloud services revenue increased $474 million or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong prior year comparable that benefited from transactional strength in Japan. Microsoft 365 Consumer subscribers increased 22% to 51.9 million. LinkedIn revenue increased $2.2 billion or 27% driven by advertising demand in our Marketing Solutions business. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 43%. Operating income increased $5.6 billion or 30%. Gross margin increased $6.5 billion or 18% driven by growth in Office 365 Commercial and LinkedIn, and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage decreased slightly driven by a sales mix shift to cloud offerings, on a low prior year comparable impacted by increased usage. Operating expenses increased $839 million or 5% driven by investments in commercial sales, cloud engineering, and LinkedIn.Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively. PART II Item 7Intelligent Cloud Revenue increased $11.7 billion or 24%. Server products and cloud services revenue increased $11.2 billion or 27% driven by Azure. Azure revenue grew 50% due to growth in our consumption-based services. Server products revenue increased 6% driven by hybrid and premium solutions, on a strong prior year comparable that benefited from demand related to SQL Server 2008 and Windows Server 2008 end of support. Enterprise Services revenue increased $534 million or 8% driven by growth in Premier Support Services.Operating income increased $7.8 billion or 43%. Gross margin increased $9.7 billion or 29% driven by growth in Azure and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage was relatively unchanged driven by gross margin percentage improvement in Azure, offset in part by sales mix shift to Azure. Operating expenses increased $1.9 billion or 12% driven by investments in Azure. Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively.More Personal Computing Revenue increased $5.8 billion or 12%. Windows revenue increased $933 million or 4% driven by growth in Windows Commercial. Windows Commercial products and cloud services revenue increased 14% driven by demand for Microsoft 365. Windows OEM revenue increased slightly driven by consumer PC demand, on a strong prior year OEM Pro comparable that benefited from Windows 7 end of support. Windows OEM Pro revenue decreased 9% and Windows OEM non-Pro revenue grew 21%. Gaming revenue increased $3.8 billion or 33% driven by growth in Xbox content and services and Xbox hardware. Xbox content and services revenue increased $2.3 billion or 23% driven by growth in third-party titles, Xbox Game Pass subscriptions, and first-party titles. Xbox hardware revenue increased 92% driven by higher price of consoles sold due to the Xbox Series X|S launches. Search advertising revenue increased $788 million or 10%. Search advertising revenue excluding traffic acquisition costs increased 13% driven by higher revenue per search and search volume. Surface revenue increased $302 million or 5%.Operating income increased $3.5 billion or 22%. Gross margin increased $2.8 billion or 10% driven by growth in Windows, Gaming, and Search advertising. Gross margin percentage decreased driven by sales mix shift to Gaming hardware. Operating expenses decreased $752 million or 6% driven by prior year charges associated with the closing of our Microsoft Store physical locations and reductions in retail store expenses and marketing, offset in part by investments in Gaming.Gross margin and operating income included a favorable foreign currency impact of 2% and 3%, respectively.PART II Item 7OPERATING EXPENSES Research and Development(In millions, except percentages)Percentage ChangeResearch and development$20,716$19,2698%As a percent of revenue12%13%(1)pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Research and development expenses increased $1.4 billion or 8% driven by investments in cloud engineering.Sales and Marketing(In millions, except percentages)Percentage ChangeSales and marketing$20,117$19,5983%As a percent of revenue12%14%(2)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses increased $519 million or 3% driven by investments in commercial sales, offset in part by a reduction in bad debt expense. Sales and marketing included an unfavorable foreign currency impact of 2%.General and Administrative(In millions, except percentages)Percentage Change General and administrative$5,107$5,1110%As a percent of revenue3%4%(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.General and administrative expenses were relatively unchanged, driven by prior year charges associated with the closing of our Microsoft Store physical locations, offset in part by an increase in certain employee-related expenses and business taxes.PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,131$2,680Interest expense(2,346)(2,591)Net recognized gains on investments1,232Net gains on derivativesNet gains (losses) on foreign currency remeasurements(191)Other, net(40)Total$1,186$We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Interest and dividends income decreased due to lower yields on fixed-income securities. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments increased due to higher gains on equity securities. Net gains on derivatives decreased due to lower gains on foreign currency contracts.INCOME TAXES Effective Tax RateOur effective tax rate for fiscal years 2021 and 2020 was 14% and 17%, respectively. The decrease in our effective tax rate was primarily due to tax benefits from a decision by the India Supreme Court on withholding taxes in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax, an agreement between the U.S. and India tax authorities related to transfer pricing, final Tax Cuts and Jobs Act (TCJA) regulations, and an increase in tax benefits relating to stock-based compensation.We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016.Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2021, our U.S. income before income taxes was $35.0 billion and our foreign income before income taxes was $36.1 billion. In fiscal year 2020, our U.S. income before income taxes was $24.1 billion and our foreign income before income taxes was $28.9 billion.Uncertain Tax PositionsWe settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017. PART II Item 7As of June 30, 202 1 , the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2020, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the tax benefits related to the India Supreme Court decision on withholding taxes in fiscal year 2021. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change Net income$61,271$44,28138%Net income tax benefit related to India Supreme Court decision on withholding taxes(620)*Adjusted net income (non-GAAP)$60,651$44,28137%Diluted earnings per share$8.05$5.7640%Net income tax benefit related to India Supreme Court decision on withholding taxes(0.08)*Adjusted diluted earnings per share (non-GAAP)$7.97$5.7638%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $130.3 billion and $136.5 billion as of June 30, 2021 and 2020. Equity investments were $6.0 billion and $3.0 billion as of June 30, 2021 and 2020, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Cash from operations increased $16.1 billion to $76.7 billion for fiscal year 2021, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees. Cash used in financing increased $2.5 billion to $48.5 billion for fiscal year 2021, mainly due to a $4.4 billion increase in common stock repurchases and a $1.4 billion increase in dividends paid, offset in part by a $1.8 billion decrease in repayments of debt and a $1.7 billion decrease in cash premium paid on debt exchange. Cash used in investing increased $15.4 billion to $27.6 billion for fiscal year 2021, mainly due to a $6.4 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, a $5.2 billion increase in additions to property and equipment, and a $4.1 billion decrease in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2021:(In millions)Three Months EndingSeptember 30, 2021$15,922December 31, 202112,646March 31, 20228,786June 30, 20224,171Thereafter2,616Total$44,141If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases During fiscal years 2021 and 2020, we repurchased 101 million shares and 126 million shares of our common stock for $23.0 billion and $19.7 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated financial statements during the periods presented. PART II Item 7Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2021: (In millions)2023-20242025-2026ThereafterTotalLong-term debt: (a) Principal payments$8,075$8,000$5,250$42,585$63,910Interest payments1,6282,8472,43817,32024,233Construction commitments (b) 8,9279,456Operating leases, including imputed interest (c) 2,8014,9563,4696,74717,973Finance leases, including imputed interest (c) 1,3413,2563,77414,09622,467Transition tax (d) 1,4274,1058,03013,562Purchase commitments (e) 29,1291,70831,553Other long-term liabilities (f) Total$53,328$25,766$23,475$81,281$183,850(a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (e) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. (f) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.6 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. (Nuance) for $56.00 per share in an all-cash transaction valued at $19.7 billion, inclusive of Nuances net debt. The acquisition has been approved by Nuances shareholders, and we expect it to close by the end of calendar year 2021, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. LiquidityAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $4.7 billion, which included $1.5 billion for fiscal year 2021. The remaining transition tax of $13.6 billion is payable over the next five years with a final payment in fiscal year 2026. We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. PART II Item 7RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies, as well as uncertainty in the current economic environment due to COVID-19. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. Impairment of Investment Securities We review debt investments quarterly for credit losses and impairment. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. This determination requires significant judgment. In making this judgment, we employ a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery, then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. PART II Item 7Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a periodic basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. PART II Item 7The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part I I , Item 8 of this Form 10-K) for further discussion. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerAlice L. JollaCorporate Vice President and Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currencyRevenue10% decrease in foreign exchange rates$(6,756)EarningsForeign currencyInvestments10% decrease in foreign exchange rates(136)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(3,511)Fair ValueCredit100 basis point increase in credit spreads(309)Fair ValueEquity10% decrease in equity market prices(602)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$71,074 $68,041 $66,069 Service and other97,014 74,974 59,774 Total revenue168,088 143,015 125,843 Cost of revenue:Product18,219 16,017 16,273 Service and other34,013 30,061 26,637 Total cost of revenue52,232 46,078 42,910 Gross margin115,856 96,937 82,933 Research and development20,716 19,269 16,876 Sales and marketing20,117 19,598 18,213 General and administrative5,107 5,111 4,885 Operating income69,916 52,959 42,959 Other income, net 1,186 Income before income taxes71,102 53,036 43,688 Provision for income taxes9,831 8,755 4,448 Net income$61,271 $44,281 $39,240 Earnings per share:Basic$8.12 $5.82 $5.11 Diluted$8.05 $5.76 $5.06 Weighted average shares outstanding:Basic7,547 7,610 7,673 Diluted7,608 7,683 7,753 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS (In millions)Year Ended June 30,Net income$61,271 $44,281 $39,240 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )( 173 )Net change related to investments( 2,266 )3,990 2,405 Translation adjustments and other( 426 )( 318 )Other comprehensive income (loss)( 1,374 )3,526 1,914 Comprehensive income$59,897 $47,807 $41,154 Refer to accompanying notes. PART II Item 8BALANCE SHEETS (In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$14,224 $13,576 Short-term investments116,110 122,951 Total cash, cash equivalents, and short-term investments130,334 136,527 Accounts receivable, net of allowance for doubtful accounts of $ 751 and $ 788 38,043 32,011 Inventories2,636 1,895 Other current assets13,393 11,482 Total current assets184,406 181,915 Property and equipment, net of accumulated depreciation of $ 51,351 and $ 43,197 59,715 44,151 Operating lease right-of-use assets11,088 8,753 Equity investments5,984 2,965 Goodwill49,711 43,351 Intangible assets, net7,800 7,038 Other long-term assets15,075 13,138 Total assets$333,779 $301,311 Liabilities and stockholders equityCurrent liabilities:Accounts payable$15,163 $12,530 Current portion of long-term debt8,072 3,749 Accrued compensation10,057 7,874 Short-term income taxes2,174 2,130 Short-term unearned revenue41,525 36,000 Other current liabilities11,666 10,027 Total current liabilities88,657 72,310 Long-term debt50,074 59,578 Long-term income taxes27,190 29,432 Long-term unearned revenue2,616 3,180 Deferred income taxesOperating lease liabilities9,629 7,671 Other long-term liabilities13,427 10,632 Total liabilities191,791 183,007 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,519 and 7,571 83,111 80,552 Retained earnings57,055 34,566 Accumulated other comprehensive income1,822 3,186 Total stockholders equity141,988 118,304 Total liabilities and stockholders equity$333,779 $301,311 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS (In millions)Year Ended June 30,OperationsNet income$61,271 $44,281 $39,240 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,686 12,796 11,682 Stock-based compensation expense6,118 5,289 4,652 Net recognized gains on investments and derivatives( 1,249 )( 219 )( 792 )Deferred income taxes( 150 )( 6,463 )Changes in operating assets and liabilities:Accounts receivable( 6,481 )( 2,577 )( 2,812 )Inventories( 737 )Other current assets( 932 )( 2,330 )( 1,718 )Other long-term assets( 3,459 )( 1,037 )( 1,834 )Accounts payable2,798 3,018 Unearned revenue4,633 2,212 4,462 Income taxes( 2,309 )( 3,631 )2,929 Other current liabilities4,149 1,346 1,419 Other long-term liabilities1,402 1,348 Net cash from operations76,740 60,675 52,185 FinancingCash premium on debt exchange( 1,754 )( 3,417 )Repayments of debt( 3,750 )( 5,518 )( 4,000 )Common stock issued1,693 1,343 1,142 Common stock repurchased( 27,385 )( 22,968 )( 19,543 )Common stock cash dividends paid( 16,521 )( 15,137 )( 13,811 )Other, net( 769 )( 334 )( 675 )Net cash used in financing( 48,486 )( 46,031 )( 36,887 )InvestingAdditions to property and equipment( 20,622 )( 15,441 )( 13,925 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 8,909 )( 2,521 )( 2,388 )Purchases of investments( 62,924 )( 77,190 )( 57,697 )Maturities of investments51,792 66,449 20,043 Sales of investments14,008 17,721 38,194 Other, net( 922 )( 1,241 )Net cash used in investing( 27,577 )( 12,223 )( 15,773 )Effect of foreign exchange rates on cash and cash equivalents( 29 )( 201 )( 115 )Net change in cash and cash equivalents2,220 ( 590 )Cash and cash equivalents, beginning of period13,576 11,356 11,946 Cash and cash equivalents, end of period$14,224 $13,576 $11,356 Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions, except per share amounts)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$80,552 $78,520 $71,223 Common stock issued1,963 1,343 6,829 Common stock repurchased( 5,539 )( 4,599 )( 4,195 )Stock-based compensation expense6,118 5,289 4,652 Other, net( 1 )Balance, end of period83,111 80,552 78,520 Retained earnings Balance, beginning of period34,566 24,150 13,682 Net income61,271 44,281 39,240 Common stock cash dividends( 16,871 )( 15,483 )( 14,103 )Common stock repurchased( 21,879 )( 18,382 )( 15,346 )Cumulative effect of accounting changes( 32 )Balance, end of period57,055 34,566 24,150 Accumulated other comprehensive income (loss)Balance, beginning of period3,186 ( 340 ) ( 2,187 )Other comprehensive income (loss)( 1,374 )3,526 1,914 Cumulative effect of accounting changes( 67 )Balance, end of period1,822 3,186 ( 340 )Total stockholders equity$141,988 $118,304 $102,330 Cash dividends declared per common share$2.24 $2.04 $1.84 Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to COVID-19.In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years . This change in accounting estimate was effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2020, the effect of this change in estimate for fiscal year 2021 was an increase in operating income of $ 2.7 billion and net income of $ 2.3 billion, or $ 0.30 per both basic and diluted share. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, video games, and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances and Other Receivables Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future, LinkedIn subscriptions, Office 365 subscriptions, Xbox subscriptions, Windows 10 post-delivery support, Dynamics business solutions, and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.As of June 30, 2021 and 2020, other receivables due from suppliers were $ 965 million and $ 442 million, respectively, and are included in accounts receivable, net in our consolidated balance sheets.As of June 30, 2021 and 2020, long-term accounts receivable, net of allowance for doubtful accounts, was $ 3.4 billion and $ 2.7 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. PART II Item 8Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 252 )( 178 )( 116 )Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$ 816 $ 434 We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2021 and 2020, our financing receivables, net were $ 4.4 billion and $ 5.2 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.5 billion, $ 1.6 billion, and $ 1.6 billion in fiscal years 2021, 2020, and 2019, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding credit losses and impairments, are recorded in other comprehensive income . Fair value is calculated based on publicly available market information or other estimates determined by management. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. To determine credit losses, we employ a systematic methodology that considers available quantitative and qualitative evidence. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery , then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a periodic basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to four years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceFinancial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We adopted the standard effective July 1, 2020. We use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities are recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. We applied a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. The adoption of the standard did not have a material impact on our consolidated financial statements.Recent Accounting Guidance Not Yet AdoptedAccounting for Income TaxesIn December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021. We have completed our assessment and concluded that adoption of the new standard will not have a material impact on our consolidated financial statements.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. The components of basic and diluted EPS were as follows: (In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$61,271 $44,281 $39,240 Weighted average outstanding shares of common stock (B)7,547 7,610 7,673 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,608 7,683 7,753 Earnings Per ShareBasic (A/B)$8.12 $5.82 $5.11 Diluted (A/C)$8.05 $5.76 $5.06 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,131 $2,680 $2,762 Interest expense( 2,346 )( 2,591 )( 2,686 )Net recognized gains on investments1,232 Net gains on derivativesNet gains (losses) on foreign currency remeasurements( 191 )( 82 )Other, net( 40 )( 57 )Total$1,186 $$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 40 )( 37 ) ( 93 ) Impairments and allowance for credit losses( 2 )( 17 ) ( 16 ) Total$$( 4 ) $( 97 ) Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$$Net unrealized gains on investments still held1,057 Impairments of investments( 11 )( 116 ) ( 10 )Total$1,169 $$PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2021Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,316 $$$4,316 $1,331 $2,985 $Certificates of depositLevel 23,615 3,615 2,920 U.S. government securitiesLevel 190,664 3,832 ( 111 )94,385 1,500 92,885 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,213 ( 2 )6,220 5,995 Mortgage- and asset-backed securitiesLevel 23,442 ( 6 )3,458 3,458 Corporate notes and bondsLevel 28,443 ( 9 )8,683 8,683 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3( 7 )Total debt investments$117,966 $4,177 $( 135 )$122,008 $5,976 $116,032 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,582 $$$Equity investmentsOther5,378 5,378 Total equity investments$6,960 $$$5,984 Cash$7,272 $7,272 $$Derivatives, net (a) Total$136,318 $14,224 $116,110 $5,984 PART II Item 8(In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2020Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,687 $$$4,688 $1,618 $3,070 $Certificates of depositLevel 22,898 2,898 1,646 1,252 U.S. government securitiesLevel 192,067 6,495 ( 1 )98,561 3,168 95,393 U.S. agency securitiesLevel 22,439 2,441 1,992 Foreign government bondsLevel 26,982 ( 3 )6,985 6,984 Mortgage- and asset-backed securitiesLevel 24,865 ( 6 )4,900 4,900 Corporate notes and bondsLevel 28,500 ( 17 )8,810 8,810 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 4 )Municipal securitiesLevel 3Total debt investments$122,900 $6,929 $( 31 )$129,798 $6,882 $122,916 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,198 $$$Equity investmentsOther2,551 2,551 Total equity investments$3,749 $$$2,965 Cash$5,910 $5,910 $$Derivatives, net (a) Total$139,492 $13,576 $122,951 $2,965 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2021 and 2020, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 3.3 billion and $ 1.4 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2021U.S. government and agency securities$5,294 $( 111 )$$$5,294 $( 111 )Foreign government bonds3,148 ( 1 )( 1 )3,153 ( 2 )Mortgage- and asset-backed securities1,211 ( 5 )( 1 )1,298 ( 6 )Corporate notes and bonds1,678 ( 8 )( 1 )1,712 ( 9 )Municipal securities( 7 )( 7 )Total$11,389 $( 132 )$$( 3 )$11,516 $( 135 )PART II Item 8Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2020U.S. government and agency securities$2,323 $( 1 )$$$2,323 $( 1 )Foreign government bonds( 3 )( 3 )Mortgage- and asset-backed securities1,014 ( 6 )1,014 ( 6 )Corporate notes and bonds( 17 )( 17 )Municipal securities( 4 )( 4 )Total$4,552 $( 31 )$$$4,552 $( 31 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)AdjustedCost BasisEstimatedFair ValueJune 30, 2021Due in one year or less$22,612 $22,676 Due after one year through five years67,541 70,315 Due after five years through 10 years25,212 26,327 Due after 10 years2,601 2,690 Total$117,966 $122,008 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.PART II Item 8Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts . These contracts are not designated as hedging instruments and are included in Other contracts in the tables below. Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2021, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,081 6,754 Interest rate contracts purchased1,247 1,295 Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,223 11,896 Foreign exchange contracts sold23,391 15,595 Other contracts purchased2,456 1,844 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 8 )$$( 54 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 291 )( 334 )Other contracts( 36 )( 11 )Gross amounts of derivatives( 335 )( 399 )Gross amounts of derivatives offset in the balance sheet( 141 )( 154 )Cash collateral received 0 ( 42 )( 154 )Net amounts of derivatives$$( 235 )$$( 395 )Reported asShort-term investments$$$$Other current assetsOther long-term assetsOther current liabilities( 182 )( 334 )Other long-term liabilities( 53 )( 61 )Total$$( 235 )$$( 395 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 395 million and $ 335 million, respectively, as of June 30, 2021, and $ 399 million and $ 399 million, respectively, as of June 30, 2020. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2021Derivative assets$$$$Derivative liabilities( 335 )( 335 )June 30, 2020Derivative assetsDerivative liabilities( 399 )( 399 )PART II Item 8Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows: (In millions)Year Ended June 30,2019RevenueOther Income(Expense), NetRevenueOther Income(Expense), NetRevenueOtherIncome(Expense),NetDesignated as Fair Value Hedging Instruments Foreign exchange contractsDerivatives$$$$$$( 130 )Hedged items( 188 )Excluded from effectiveness assessmentInterest rate contractsDerivatives( 37 )Hedged items( 93 )Designated as Cash Flow Hedging Instruments Foreign exchange contractsAmount reclassified from accumulated other comprehensive incomeExcluded from effectiveness assessment( 64 )Not Designated as Hedging Instruments Foreign exchange contracts( 123 )( 97 )Other contractsGains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$$( 38 )$NOTE 6 INVENTORIES The components of inventories were as follows:(In millions)June 30,Raw materials$1,190 $Work in processFinished goods1,367 1,112 Total$2,636 $1,895 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$3,660 $1,823 Buildings and improvements43,928 33,995 Leasehold improvements6,884 5,487 Computer equipment and software51,250 41,261 Furniture and equipment5,344 4,782 Total, at cost111,066 87,348 Accumulated depreciation( 51,351 )( 43,197 )Total, net$ 59,715 $44,151 During fiscal years 2021, 2020, and 2019, depreciation expense was $ 9.3 billion, $ 10.7 billion, and $ 9.7 billion, respectively. Depreciation expense declined in fiscal year 2021 due to the change in estimated useful lives of our server and network equipment. We have committed $ 9.5 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2021. During fiscal year 2020, we recorded an impairment charge of $ 186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.NOTE 8 BUSINESS COMBINATIONS ZeniMax Media Inc.On March 9, 2021 , we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC (Bethesda), for a total purchase price of $ 8.1 billion, consisting primarily of cash. The purchase price included $ 768 million of cash and cash equivalents acquired. Bethesda is one of the largest, privately held game developers and publishers in the world, and brings a broad portfolio of games, technology, and talent to Xbox. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment.The purchase price allocation as of the date of acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:(In millions) Cash and cash equivalents$Goodwill 5,469 Intangible assets1,968 Other assetsOther liabilities( 223 ) Total $8,121 Goodwill was assigned to our More Personal Computing segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of ZeniMax. None of the goodwill is expected to be deductible for income tax purposes.PART II Item 8Following are details of the purchase price allocated to the intangible assets acquired:(In millions)AmountWeightedAverage LifeTechnology-based$1,341 4 yearsMarketing-related11 yearsTotal$1,968 6 yearsGitHub, Inc.On October 25, 2018 , we acquired GitHub, Inc. (GitHub), a software development platform, in a $ 7.5 billion stock transaction (inclusive of total cash payments of $ 1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497 Intangible assets1,267 Other assetsOther liabilities( 217 )Total$ 6,924 The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$ 648 8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,267 7 yearsTransactions recognized separately from the purchase price allocation were approximately $ 600 million, primarily related to equity awards recognized as expense over the related service period. Nuance Communications, Inc.On April 11, 2021 , we entered into a definitive agreement to acquire Nuance Communications, Inc. (Nuance) for $ 56.00 per share in an all-cash transaction valued at $ 19.7 billion, inclusive of Nuances net debt. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The acquisition has been approved by Nuances shareholders, and we expect it to close by the end of calendar year 2021, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.PART II Item 8NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows:(In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2021Productivity and Business Processes$24,277 $$( 94 )$24,190 $$$24,317 Intelligent Cloud11,351 1,351 ( 5 )12,697 13,256 More Personal Computing6,398 ( 30 )6,464 5,556 (a) (a ) 12,138 Total$ 42,026 $1,454 $( 129 )$43,351 $6,061 $299 $49,711 (a) Includes goodwill of $ 5.5 billion related to ZeniMax. See Note 8 Business Combinations for further information . The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2021, May 1, 2020, or May 1, 2019 tests. As of June 30, 2021 and 2020, accumulated goodwill impairment was $ 11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$9,779 $( 7,007 )$2,772 $8,160 $( 6,381 )$1,779 Customer-related4,958 ( 2,859 )2,099 4,967 ( 2,320 )2,647 Marketing-related4,792 ( 1,878 )2,914 4,158 ( 1,588 )2,570 Contract-based( 431 )( 432 )Total$19,975 (a) $( 12,175 )$7,800 $17,759 $( 10,721 )$7,038 (a) Includes intangible assets of $ 2.0 billion related to ZeniMax. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2021, 2020, or 2019. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$1,628 4 years$6 yearsCustomer-related4 years5 yearsMarketing-related6 years2 yearsContract-based3 years0 yearsTotal$2,359 5 years$5 yearsIntangible assets amortization expense was $ 1.6 billion, $ 1.6 billion, and $ 1.9 billion for fiscal years 2021, 2020, and 2019, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2021:(In millions)Year Ending June 30,$1,683 1,722 1,415 Thereafter1,727 Total$7,800 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 4.50 %4.57 %1,571 2011 issuance of $ 2.3 billion (a) 5.30 %5.36 %1,270 2012 issuance of $ 2.3 billion (a) 2.13 %3.50 %2.24 %3.57 %1,204 1,650 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,814 2,919 2013 issuance of 4.1 billion2.13 %3.13 %2.23 %3.22 %4,803 4,549 2015 issuance of $ 23.8 billion (a) 2.38 %4.75 %2.47 %4.78 %12,305 15,549 2016 issuance of $ 19.8 billion (a) 1.55 %3.95 %1.64 %4.03 %12,180 16,955 2017 issuance of $ 17.0 billion (a) 2.40 %4.50 %2.52 %4.53 %10,695 12,385 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 10,000 2021 issuance of $ 8.2 billion (a) 2.92 %3.04 %2.92 %3.04 %8,185 Total face value63,910 67,407 Unamortized discount and issuance costs( 511 )( 554 )Hedge fair value adjustments ( b ) Premium on debt exchange (a) ( 5,293 )( 3,619 )Total debt58,146 63,327 Current portion of long-term debt( 8,072 )( 3,749 )Long-term debt$50,074 $59,578 (a) In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities. The premiums are amortized over the terms of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2021 and 2020, the estimated fair value of long-term debt, including the current portion, was $ 70.0 billion and $ 77.1 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. Cash paid for interest on our debt for fiscal years 2021, 2020, and 2019 was $ 2.0 billion, $ 2.4 billion, and $ 2.4 billion, respectively . The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2021: (In millions)Year Ending June 30,$8,075 2,750 5,250 2,250 3,000 Thereafter42,585 Total$63,910 PART II Item 8NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $ 13.7 billion related to the enactment of the TCJA in fiscal year 2018 and adjusted the provisional net charge by recording additional tax expense of $ 157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $ 2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (GILTI) tax. Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$3,285 $3,537 $4,718 U.S. state and local1,229 Foreign5,467 4,444 5,531 Current taxes$9,981 $8,744 $10,911 Deferred TaxesU.S. federal$$$( 5,647 )U.S. state and local( 204 )( 6 )( 1,010 )Foreign( 41 )Deferred taxes$( 150 )$$( 6,463 )Provision for income taxes$9,831 $8,755 $4,448 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$34,972 $24,116 $15,799 Foreign 36,130 28,920 27,889 Income before income taxes$71,102 $53,036 $43,688 PART II Item 8Effective Tax Rate The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %21.0 %Effect of:Foreign earnings taxed at lower rates( 2.7 )%( 3.7 )%( 4.1 )%Impact of the enactment of the TCJA0 %0 %0.4 %Impact of intangible property transfers0 %0 %( 5.9 )%Foreign-derived intangible income deduction( 1.3 )%( 1.1 )%( 1.4 )%State income taxes, net of federal benefit1.4 %1.3 %0.7 %Research and development credit( 0.9 )%( 1.1 )%( 1.1 )%Excess tax benefits relating to stock-based compensation( 2.4 )%( 2.2 )%( 2.2 )%Interest, net0.5 %1.0 %1.0 %Other reconciling items, net( 1.8 )%1.3 %1.8 %Effective rate13.8 %16.5 %10.2 %We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $ 620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016 . The decrease from the federal statutory rate in fiscal year 2021 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $ 2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. In fiscal year 2021 and 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % and 86 % of our foreign income before tax. In fiscal years 2019, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax, and in fiscal year 2021, includes tax benefits from the India Supreme Court decision on withholding taxes. In fiscal years 2021, 2020, and 2019, there were no individually significant other reconciling items.PART II Item 8The decrease in our effective tax rate for fiscal year 2021 compared to fiscal year 2020 was primarily due to tax benefits from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing , final TCJA regulations, and an increase in tax benefits relating to stock-based compensation. The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $ 2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,960 2,721 Loss and credit carryforwards1,090 Amortization6,346 6,737 Leasing liabilities4,060 3,025 Unearned revenue2,659 1,553 OtherDeferred income tax assets18,160 15,716 Less valuation allowance( 769 )( 755 )Deferred income tax assets, net of valuation allowance$17,391 $14,961 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 2,605 )$( 2,642 )Leasing assets( 3,834 )( 2,817 )Depreciation( 1,010 )( 376 )Deferred GILTI tax liabilities( 2,815 )( 2,581 )Other( 144 )( 344 )Deferred income tax liabilities$( 10,408 )$( 8,760 )Net deferred income tax assets$6,983 $6,201 Reported AsOther long-term assets$7,181 $6,405 Long-term deferred income tax liabilities( 198 )( 204 )Net deferred income tax assets$6,983 $6,201 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2021, we had federal, state, and foreign net operating loss carryforwards of $ 304 million, $ 1.3 billion, and $ 2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2022 through 2041 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation but are expected to be realized with the exception of those which have a valuation allowance.The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $ 2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements.Income taxes paid, net of refunds, were $ 13.4 billion, $ 12.5 billion, and $ 8.4 billion in fiscal years 2021, 2020, and 2019, respectively. PART II Item 8Uncertain Tax Positions Gross unrecognized tax benefits related to uncertain tax positions as of June 30, 2021, 2020, and 2019, were $ 14.6 billion, $ 13.8 billion, and $ 13.1 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2021, 2020, and 2019 by $ 12.5 billion, $ 12.1 billion, and $ 12.0 billion, respectively.As of June 30, 2021, 2020, and 2019, we had accrued interest expense related to uncertain tax positions of $ 4.3 billion, $ 4.0 billion, and $ 3.4 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2021, 2020, and 2019 included interest expense related to uncertain tax positions of $ 274 million, $ 579 million, and $ 515 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$13,792 $13,146 $11,961 Decreases related to settlements( 195 )( 31 )( 316 )Increases for tax positions related to the current year2,106 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 297 )( 331 )( 1,113 )Decreases due to lapsed statutes of limitations( 1 )( 5 )Ending unrecognized tax benefits$14,550 $13,792 $13,146 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $ 1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017 .As of June 30, 2021, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2020 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$22,120 $18,643 Intelligent Cloud17,710 16,620 More Personal Computing4,311 3,917 Total$44,141 $39,180 PART II Item 8Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2021Balance, beginning of period$39,180 Deferral of revenue94,565 Recognition of unearned revenue( 89,604 )Balance, end of period$44,141 Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 146 billion as of June 30, 2021, of which $ 141 billion is related to the commercial portion of revenue. We expect to recognize approximately 50 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. Our leases have remaining lease terms of 1 year to 15 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$2,127 $2,043 $1,707 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$1,307 $$Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$2,052 $1,829 $1,670 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases4,380 3,677 2,303 Finance leases3,290 3,467 2,532 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$11,088 $8,753 Other current liabilities$1,962 $1,616 Operating lease liabilities9,629 7,671 Total operating lease liabilities$11,591 $9,287 Finance LeasesProperty and equipment, at cost$14,107 $10,371 Accumulated depreciation( 2,306 )( 1,385 )Property and equipment, net$11,801 $8,986 Other current liabilities$$Other long-term liabilities11,750 8,956 Total finance lease liabilities$12,541 $9,496 Weighted Average Remaining Lease TermOperating leases8 years8 yearsFinance leases12 years13 yearsWeighted Average Discount RateOperating leases2.2 %2.7 %Finance leases3.4 %3.9 %The following table outlines maturities of our lease liabilities as of June 30, 2021:(In millions)Year Ending June 30,OperatingLeasesFinanceLeases$2,125 $1,179 1,954 1,198 1,751 1,211 1,463 1,537 1,133 1,220 Thereafter4,111 8,856 Total lease payments12,537 15,201 Less imputed interest( 946 )( 2,660 )Total$11,591 $12,541 As of June 30, 2021, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 5.4 billion and $ 7.3 billion, respectively. These operating and finance leases will commence between fiscal year 2022 and fiscal year 2026 with lease terms of 1 year to 15 years .During fiscal year 2020, we recorded an impairment charge of $ 161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.PART II Item 8NOTE 15 CONTINGENCIES Patent and Intellectual Property Claims There were 63 patent infringement cases pending against Microsoft as of June 30, 2021, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement and form of notice have been approved by the courts in British Columbia, Ontario, and Quebec. The ten-month claims period commenced on November 23, 2020 and will close on September 23, 2021.Other Antitrust Litigation and Claims China State Administration for Market Regulation Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. In 2019, the SAMR presented preliminary views as to certain possible violations of Chinas Anti-Monopoly Law.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 46 lawsuits, including 45 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing on general causation is scheduled for January and February of 2022 . PART II Item 8Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2021, we accrued aggregate legal liabilities of $ 339 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,571 7,643 7,677 IssuedRepurchased( 101 )( 126 )( 150 )Balance, end of year7,519 7,571 7,643 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2021, $ 8.7 billion remained of this $ 40.0 billion share repurchase program.PART II Item 8We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$5,270 $4,000 $2,600 Second Quarter5,750 4,600 6,100 Third Quarter5,750 6,000 3,899 Fourth Quarter6,200 5,088 4,200 Total$22,970 $19,688 $16,799 Shares repurchased during fiscal year 2021 and the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 4.4 billion, $ 3.3 billion, and $ 2.7 billion for fiscal years 2021, 2020, and 2019, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2021(In millions)September 15, 2020 November 19, 2020 December 10, 2020 $0.56 $4,230 December 2, 2020 February 18, 2021 March 11, 2021 0.56 4,221 March 16, 2021 May 20, 2021 June 10, 2021 0.56 4,214 June 16, 2021 August 19, 2021 September 9, 2021 0.56 4,211 Total$2.24 $16,876 Fiscal Year 2020September 18, 2019 November 21, 2019 December 12, 2019 $0.51 $3,886 December 4, 2019 February 20, 2020 March 12, 2020 0.51 3,876 March 9, 2020 May 21, 2020 June 11, 2020 0.51 3,865 June 17, 2020 August 20, 2020 September 10, 2020 0.51 3,856 Total$2.04 $15,483 The dividend declared on June 16, 2021 was included in other current liabilities as of June 30, 2021. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component :(In millions)Year Ended June 30,DerivativesBalance, beginning of period$( 38 )$$Unrealized gains (losses), net of tax of $ 9 , $( 10 ), and $ 2 ( 38 )Reclassification adjustments for gains included in earnings( 17 )( 341 )Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)( 15 )( 333 )Net change related to derivatives, net of tax of $ 7 , $( 10 ), and $( 6 )( 38 )( 173 )Balance, end of period$( 19 )$( 38 )$InvestmentsBalance, beginning of period$5,478 $1,488 $( 850 )Unrealized gains (losses), net of tax of $( 589 ) , $ 1,057 , and $ 616 ( 2,216 )3,987 2,331 Reclassification adjustments for (gains) losses included in other income (expense), net( 63 )Tax expense (benefit) included in provision for income taxes( 1 )( 19 )Amounts reclassified from accumulated other comprehensive income (loss)( 50 )Net change related to investments, net of tax of $( 602 ) , $ 1,058 , and $ 635 ( 2,266 )3,990 2,405 Cumulative effect of accounting changes( 67 )Balance, end of period$3,222 $5,478 $1,488 Translation Adjustments and OtherBalance, beginning of period$( 2,254 )$( 1,828 )$( 1,510 )Translation adjustments and other, net of tax effects of $( 9 ) , $ 1 , and $( 1 )( 426 )( 318 )Balance, end of period$( 1,381 )$( 2,254 )$( 1,828 )Accumulated other comprehensive income (loss), end of period$1,822 $3,186 $( 340 )NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2021, an aggregate of 251 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$6,118 $5,289 $4,652 Income tax benefits related to stock-based compensation1,065 Stock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.51 0.56 $0.46 0.51 $0.42 0.46 Interest rates0.01 %1.5 %0.1 %2.2 %1.8 %3.1 %During fiscal year 2021, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$ 105.23 Granted (a) 221.13 Vested( 58 ) 99.41 Forfeited( 8 ) 129.92 Nonvested balance, end of year$152.51 (a) Includes 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2021, 2020, and 2019. As of June 30, 2021, there was approximately $ 12.0 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 221.13 , $ 140.49 , and $ 107.02 for fiscal years 2021, 2020, and 2019, respectively. The fair value of stock awards vested was $ 13.4 billion, $ 10.1 billion, and $ 8.7 billion, for fiscal years 2021, 2020, and 2019, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Under the terms of the ESPP that were approved in 2012, the plan will terminate on December 31, 2022. We intend to request shareholder approval for a successor ESPP with a January 1, 2022 effective date and ten-year expiration of December 31, 2031 at our 2021 Annual Shareholders Meeting. No additional shares will be requested at this meeting. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$207.88 $142.22 $104.85 As of June 30, 2021, 88 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50 % of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $ 1.2 billion, $ 1.0 billion, and $ 877 million in fiscal years 2021, 2020, and 2019, respectively, and were expensed as contributed. NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business. Office Consumer, including Microsoft 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows Internet of Things and MSN advertising. Devices, including Surface and PC accessories. PART II Item 8 Gaming, including Xbox hardware and Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties , cloud services, and advertising . Search advertising. Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include legal, including settlements and fines, information technology, human resources, finance, excise taxes, field selling, shared facilities services, and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$53,915 $46,398 $41,160 Intelligent Cloud60,080 48,366 38,985 More Personal Computing54,093 48,251 45,698 Total$168,088 $143,015 $125,843 Operating Income Productivity and Business Processes$24,351 $18,724 $16,219 Intelligent Cloud26,126 18,324 13,920 More Personal Computing19,439 15,911 12,820 Total$69,916 $52,959 $42,959 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2021, 2020, or 2019. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $83,953 $73,160 $64,199 Other countries84,135 69,855 61,644 Total$168,088 $143,015 $ 125,843 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows:(In millions)Year Ended June 30,Server products and cloud services$52,589 $41,379 $32,622 Office products and cloud services39,872 35,316 31,769 Windows23,227 22,294 20,395 Gaming15,370 11,575 11,386 LinkedIn10,289 8,077 6,754 Search advertising8,528 7,740 7,628 Enterprise Services6,943 6,409 6,124 Devices6,791 6,457 6,095 Other4,479 3,768 3,070 Total$168,088 $143,015 $125,843 Our commercial cloud revenue, which includes Azure, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 69.1 billion, $ 51.7 billion and $ 38.1 billion in fiscal years 2021, 2020, and 2019, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$76,153 $60,789 $55,252 Ireland13,303 12,734 12,958 Other countries38,858 29,770 25,422 Total$ 128,314 $ 103,293 $ 93,632 PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2021 and 2020, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2021, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2021, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 29, 2021, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: - Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.- Tested management's identification and treatment of contract terms. - Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statements Critical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLPSeattle, Washington July 29, 2021 We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2021. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2021 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2021, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the ""financial statements"") as of and for the year ended June 30, 2021, of the Company and our report dated July 29, 2021, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, Washington July 29, 2021PART II, III Item 9B, 10, 11, 12, 13, 14" +16,Microsoft Corporation,2019," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. As the world responds to the outbreak of a novel strain of the coronavirus (COVID-19), we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. Our unique role as a platform and tools provider allows us to connect the dots, bring together an ecosystem of partners, and enable organizations of all sizes to build the digital capability required to address these challenges.In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems cross-device productivity applications server applications business solution applications desktop and server management tools software development tools and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The Ambitions That Drive Us To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesAt Microsoft, were providing technology and resources to help our customers navigate a remote environment. Were seeing our family of products play key roles in the ways the world is continuing to work, learn, and connect. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is enabling rapid digital transformation by giving people a single tool to chat, call, meet, and collaborate. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and discover new habits, while simplifying security and management. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. This creates an opportunity to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformIn the new remote world, companies have accelerated their own digital transformation to empower their employees, optimize their operations, engage customers, and in some cases, change the very core of their products and services. Partnering with organizations on their digital transformation during this period is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice their success is our success.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions with new Azure services and devices. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 serves the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently added several new products and accessories into the Surface family, including Surface Book 3 and Surface Go 2. These new Surface products join Surface Pro 7, Surface Laptop 3, and Surface Pro X. To expand usage and deepen engagement, we continue to invest in content, community, and cloud services as we pursue the expansive opportunity in the gaming industry. We are broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers. Xbox Game Pass, with over 10 million members from 41 countries, is a community with access to a curated library of over 100 first- and third-party console and PC titles. Project xCloud is Microsofts game streaming technology that is complementary to our console hardware and will give fans the ultimate choice to play the games they want, with the people they want, on the devices they want. Our Future OpportunityIn a time of great disruption and uncertainty, customers are looking to us to accelerate their own digital transformations as software and cloud computing play a huge role across every industry and around the world. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.PART I Item 1COVID-19 In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic. The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes, and closure of non-essential businesses. To protect the health and well-being of our employees, suppliers, and customers, we have made substantial modifications to employee travel policies, implemented office closures as employees are advised to work from home, and cancelled or shifted our conferences and other marketing events to virtual-only through fiscal year 2021. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time. Refer to Managements Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7 of this Form 10-K) for further discussion regarding the impact of COVID-19 on our fiscal year 2020 financial results.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.Commitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. Were empowering our customers and partners with new technology to help them drive efficiencies, transform their businesses, and create their own solutions for sustainability. In January 2020, we announced a bold new environmental sustainability strategy focused on carbon, water, waste, and ecosystems. As part of our commitment, we are investing $1 billion over the next four years in new technologies and innovative climate solutions. We set an ambitious goal to reduce and ultimately remove Microsofts carbon footprint. By 2030 Microsoft will be carbon negative, and by 2050 Microsoft will remove from the environment all the carbon the company has emitted directly or by electrical consumption since it was founded in 1975. We also launched a new initiative to use Microsoft technology to help our suppliers and customers around the world reduce their own carbon footprint. The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment. Our cloud and AI services help businesses cut energy consumption, reduce physical footprints, and design sustainable products. We also pledged a $50 million investment in AI for Earth to accelerate innovation by putting AI in the hands of those working to directly address sustainability challenges. Lastly, this work is supported by using our voice to support policies we think can advance sustainability efforts.Addressing Racial InjusticeOur future opportunity depends on reaching and empowering all communities, and we are committed to taking action to help address racial injustice and inequity. With significant input from employees and leaders who are members of the Black and African American community, our senior leadership team and board of directors has developed a set of actions to help improve the lived experience at Microsoft and drive change in the communities in which we live and work. These efforts include increasing our representation and culture of inclusion by doubling the number of Black and African American people managers, senior individual contributors, and senior leaders in the United States by 2025 engaging our ecosystem by using our balance sheet and engagement with suppliers and partners to extend the vision for societal change and strengthening our communities by using the power of data, technology, and partnership to help improve the lives of Black and African American citizens across the United States.PART I Item 1Investing in Digital Skills With a continued focus on digital transformation, Microsoft is making efforts to help ensure that no one is left behind, particularly as economies start to recover from the COVID-19 pandemic. We are expanding access to the digital skills that have become increasingly vital to many of the worlds jobs, and especially to individuals hardest hit by recent job losses, including those with lower incomes, women, and underrepresented minorities. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. This is combined with $20 million we are investing in key non-profit partnerships through Microsoft Philanthropies. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.PART I Item 1Office Consumer Office Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.LinkedInLinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Learning Solutions, including Glint, help businesses close critical skills gaps in times where companies are having to do more with existing talent. Marketing Solutions help companies grow relationships between businesses. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. Finally, Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. LinkedIn has over 700 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions , Learning Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.PART I Item 1Dynamics competes with vendors such as Oracle, Salesforce.com, and SAP to provide cloud-based and on-premise s business solutions for small, medium, and large organizations. Intelligent CloudOur Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionAzure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.PART I Item 1We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows IoT and MSN advertising. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.PART I Item 1Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Project xCloud, our game streaming service, and continued investment in gaming hardware. Project xCloud utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorites games with them and play on the device most convenient to them. Project xCloud will provide players with more choice over how and where they play.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators.SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. PART I Item 1Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs. Xbox Live and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Facebook, Google, and Tencent. We also compete with other providers of entertainment services such as Netflix and Hulu. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. The majority of our hardware products contain components for which there is only one qualified supplier. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices.RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility + Security, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction.PART I Item 1Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 63,000 U.S. and international patents issued and over 24,500 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. We plan to continue to make significant investments in a broad range of research and development efforts. PART I Item 1DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In June 2020, we announced a strategic change in our retail operations, including closing our Microsoft Store physical locations. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. PART I Item 1LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.PART I Item 1The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users. CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 30, 2020 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 26 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2020, we employed approximately 163,000 people on a full-time basis, 96,000 in the U.S. and 67,000 internationally. Of the total employed people, 56,000 were in operations, including manufacturing, distribution, product support, and consulting services 55,000 were in product research and development 40,000 were in sales and marketing and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives.PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox Live, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, which could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in October 2018, we completed our acquisition of GitHub, Inc. (GitHub) for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improve technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes as passwords. Inadequate account security practices may also result in unauthorized access. User activity may also result in ransomware or other malicious software impacting a customers use of our products or services. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our product and services.PART I Item 1AThe cost of these steps could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, MSN, and Xbox Live, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1ADigital safety and service misuse Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Crimea, Cuba, Iran, North Korea, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws, including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling has led to uncertainty about the legal requirements for data transfers from the EU under other l egal mechanisms. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, the EU General Data Protection Regulation (GDPR), became effective. The law, which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. Engineering efforts to build and maintain capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if our implementation to comply with the GDPR make s our offerings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to comply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits, reputational damage , and loss of customers . Countries around the world, and states in the U.S . such as California , ha ve adopted, or are considering adopting or expanding , laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. PART I Item 1AChallenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes, and closure of non-essential businesses. To protect the health and well-being of our employees, suppliers, and customers, we have made substantial modifications to employee travel policies, implemented office closures as employees are advised to work from home, and cancelled or shifted our conferences and other marketing events to virtual-only through fiscal year 2021. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time.In the third and fourth quarters of fiscal year 2020, we have experienced adverse impacts to our supply chain, a slowdown in transactional licensing, and lower demand for our advertising services. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance.PART I Item 1AMeasures to contain the virus that impact us, our partners, distributors, and suppliers may further intensify these impacts and other risks described in these Risk Factors. Any of these may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions.We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.The long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2020 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India our datacenters in Ireland, the Netherlands, and Singapore and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Israel, Japan, Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2020:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. This will be the last annual report under the Final Order. During fiscal year 2020, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking) (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 27, 2020, there were 91,674 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2020:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet bePurchased Under the Plans or Programs(In millions)April 1, 2020 April 30, 20208,906,563$165.908,906,563$35,323May 1, 2020 May 31, 20209,655,700182.319,655,70033,563June 1, 2020 June 30, 20209,648,400191.809,648,40031,71228,210,66328,210,663All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2020: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 17, 2020August 20, 2020September 10, 2020$0.51$3,861We returned $8.9 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2020. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.As the world responds to the outbreak of a novel strain of the coronavirus (COVID-19), we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.Highlights from fiscal year 2020 compared with fiscal year 2019 included: Commercial cloud revenue increased 36% to $51.7 billion. Office Commercial products and cloud services revenue increased 12%, driven by Office 365 Commercial growth of 24%. Office Consumer products and cloud services revenue increased 11%, with continued growth in Office 365 Consumer subscribers to 42.7 million. LinkedIn revenue increased 20%. Dynamics products and cloud services revenue increased 14%, driven by Dynamics 365 growth of 42%. Server products and cloud services revenue increased 27%, driven by Azure growth of 56%. Enterprise Services revenue increased 5%. Windows Commercial products and cloud services revenue increased 18%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 9%. Surface revenue increased 8%. Xbox content and services revenue increased 11%. Search advertising revenue, excluding traffic acquisition costs, was relatively unchanged.Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.PART II Item 7Economic Conditions, Challenges, and Risks The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019. Strengthening of the U.S. dollar relative to certain foreign currencies reduced reported revenue and expenses from our international operations in fiscal year 2020.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.COVID-19In fiscal year 2020, the COVID-19 pandemic impacted our business operations, including our employees, customers, partners, and communities, and we saw the following trends in our financial operating results. In the Productivity and Business Processes and Intelligent Cloud segments, cloud usage and demand increased as customers shifted to work and learn from home. We also experienced a slowdown in transactional licensing, particularly in small and medium businesses, and LinkedIn was negatively impacted by the weak job market and reductions in advertising spend. In the More Personal Computing segment, Windows OEM, Surface, and Gaming benefited from increased demand to support remote work-, play-, and learn-from-home scenarios, while Search was negatively impacted by reductions in advertising spend. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is substantial uncertainty in the nature and degree of its continued effects over time.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.PART II Item 7Reportable Segments We report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last fiscal year.CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Commercial cloud revenue Revenue from our commercial cloud business, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Commercial cloud gross margin percentageGross margin percentage for our commercial cloud business PART II Item 7Productivity and Business Processes and Intelligent Cloud Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends. Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services, including Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs)Office Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premisesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionOffice 365 Consumer subscribersThe number of Office 365 Consumer subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premisesLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium SubscriptionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHubEnterprise Services revenue growthRevenue from Enterprise Services, including Premier Support Services and Microsoft Consulting ServicesMore Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM Pro revenue growthRevenue from sales of Windows Pro licenses sold through the OEM channel, which primarily addresses demand in the commercial marketWindows OEM non-Pro revenue growthRevenue from sales of Windows non-Pro licenses sold through the OEM channel, which primarily addresses demand in the consumer marketWindows Commercial products and cloud services revenue growthRevenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenueRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties Search advertising revenue, excluding TAC, growthRevenue from search advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2020Versus 2019Percentage Change 2019Versus 2018Revenue$143,015$125,843$110,36014%14%Gross margin96,93782,93372,00717%15%Operating income52,95942,95935,05823%23%Net income44,28139,24016,57113%137%Diluted earnings per share5.765.062.1314%138%Non-GAAP net income44,28136,83030,26720%22%Non-GAAP diluted earnings per share5.764.753.8821%22%Non-GAAP net income and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties in fiscal year 2019 and the net tax impact of the Tax Cuts and Jobs Act (TCJA) in fiscal years 2019 and 2018 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2020 Compared with Fiscal Year 2019Revenue increased $17.2 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office Commercial and LinkedIn. More Personal Computing revenue increased, driven by Windows and Surface.Gross margin increased $14.0 billion or 17%, driven by growth across each of our segments. Gross margin percentage increased, driven by sales mix shift to higher margin businesses. Commercial cloud gross margin percentage increased 4 points to 67%, primarily driven by improvement in Azure.Operating income increased $10.0 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $3.2 billion or 7%, driven by growth in commercial cloud. Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsoft Store physical locations, offset in part by a reduction in business taxes and legal expenses.Gross margin and operating income included an unfavorable foreign currency impact of 2% and 4%, respectively.Prior year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.PART II Item 7Operating income increased $7.9 billion or 23%, driven by growth across each of our segments. Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Fiscal year 2019 net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2020Versus 2019Percentage Change 2019Versus 2018RevenueProductivity and Business Processes$46,398$41,160$35,86513%15%Intelligent Cloud48,36638,98532,21924%21%More Personal Computing48,25145,69842,2766%8%Total $143,015$125,843$110,36014%14%Operating Income Productivity and Business Processes$18,724$16,219$12,92415%25%Intelligent Cloud18,32413,92011,52432%21%More Personal Computing15,91112,82010,61024%21%Total $52,959$42,959$35,05823%23%Reportable Segments Fiscal Year 2020 Compared with Fiscal Year 2019Productivity and Business Processes Revenue increased $5.2 billion or 13%. Office Commercial products and cloud services revenue increased $3.1 billion or 12%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial revenue grew 24%, due to seat growth and higher revenue per user. Office Consumer products and cloud services revenue increased $458 million or 11%, driven by Microsoft 365 Consumer subscription revenue and transactional strength in Japan. Office 365 Consumer subscribers increased 23% to 42.7 million with increased demand from remote work and learn scenarios. LinkedIn revenue increased $1.3 billion or 20%, driven by growth across all businesses. Dynamics products and cloud services revenue increased 14%, driven by Dynamics 365 growth of 42%. PART II Item 7Operating income increased $2 .5 billion or 15 %. Gross margin increased $4.1 billion or 13%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage was relatively unchanged, due to gross margin percentage improvement in LinkedIn, offset in part by an increased mix of cloud offerings. Operating expenses increased $1.6 billion or 11%, driven by investments in LinkedIn and cloud engineering. Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.Intelligent Cloud Revenue increased $9.4 billion or 24%. Server products and cloud services revenue increased $8.8 billion or 27%, driven by Azure. Azure revenue grew 56%, due to growth in our consumption-based services. Server products revenue increased 8% , due to hybrid and premium solutions, as well as demand related to SQL Server 2008 and Windows Server 2008 end of support. Enterprise Services revenue increased $285 million or 5% , driven by growth in Premier Support Services.Operating income increased $4.4 billion or 32%. Gross margin increased $6.9 billion or 26%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.5 billion or 19%, driven by investments in Azure. Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.More Personal Computing Revenue increased $2.6 billion or 6%. Windows revenue increased $1.9 billion or 9%, driven by growth in Windows Commercial and Windows OEM. Windows Commercial products and cloud services revenue increased 18%, driven by increased demand for Microsoft 365. Windows OEM revenue increased 9%, ahead of PC market growth. Windows OEM Pro revenue grew 11%, driven by Windows 7 end of support and healthy Windows 10 demand, offset in part by weakness in small and medium businesses. Windows OEM non-Pro revenue grew 5%, driven by consumer demand from remote work and learn scenarios. Surface revenue increased $457 million or 8%, driven by increased demand from remote work and learn scenarios. Gaming revenue increased $189 million or 2%, driven by an increase in Xbox content and services, offset in part by a decrease in Xbox hardware. Xbox content and services revenue increased $943 million or 11% on a strong prior year comparable, driven by growth in Minecraft, third-party titles, and subscriptions, accelerated by higher engagement during stay-at-home guidelines. Xbox hardware revenue declined 31%, primarily due to a decrease in volume and price of consoles sold. Search advertising revenue increased $112 million or 1%. Search advertising revenue, excluding traffic acquisition costs, was relatively unchanged.Operating income increased $3.1 billion or 24%. Gross margin increased $3.0 billion or 12%, driven by growth in Windows, Gaming, and Surface. Gross margin percentage increased, due to sales mix shift to higher margin businesses and gross margin percentage improvement in Gaming. Operating expenses decreased $119 million or 1%, driven by the redeployment of engineering resources, offset in part by charges associated with the closing of our Microsoft Store physical locations and investments in Gaming.PART II Item 7Gross margin and operating income included an unfavorable foreign currency impact of 2% and 3%, respectively. Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial products and cloud services revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. Office Consumer products and cloud services revenue increased $286 million or 7%, driven by Microsoft 365 Consumer, due to recurring subscription revenue and transactional strength in Japan. LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics products and cloud services revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial products and cloud services revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer.PART II Item 7 Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018Research and development$19,269$16,876$14,72614%15%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2020 Compared with Fiscal Year 2019Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Sales and Marketing (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018Sales and marketing$19,598$18,213$17,4698%4%As a percent of revenue14%14%16%0ppt(2)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2020 Compared with Fiscal Year 2019Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. General and Administrative (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018General and administrative$5,111$4,885$4,7545%3%As a percent of revenue4%4%4%0ppt0pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2020 Compared with Fiscal Year 2019General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsoft Store physical locations, offset in part by a reduction in business taxes and legal expenses.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,680$2,762$2,214Interest expense(2,591)(2,686)(2,733)Net recognized gains on investments2,399Net gains (losses) on derivatives(187)Net losses on foreign currency remeasurements(191)(82)(218)Other, net(40)(57)(59)Total$$$1,416We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2020 Compared with Fiscal Year 2019Interest and dividends income decreased due to lower yields, offset in part by higher average portfolio balances on fixed-income securities. Interest expense decreased due to capitalization of interest expense and a decrease in outstanding long-term debt due to debt maturities, offset in part by debt exchange transaction fees and higher finance lease expense. Net recognized gains on investments decreased due to lower gains and higher other-than-temporary impairments on equity investments, offset in part by gains on fixed income securities in the current period compared to losses in the prior period. Net gains on derivatives increased due to higher gains on foreign exchange and equity derivatives.PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . INCOME TAXES Effective Tax RateFiscal Year 2020 Compared with Fiscal Year 2019Our effective tax rate for fiscal years 2020 and 2019 was 17% and 10%, respectively. The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2020, our U.S. income before income taxes was $24.1 billion and our foreign income before income taxes was $28.9 billion. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion.Fiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. In April 2020, the IRS commenced the audit for tax years 2014 to 2017. As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP net income and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties in fiscal year 2019 and the net tax impact of the TCJA in fiscal years 2019 and 2018. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2020 Versus 2019Percentage Change 2019 Versus 2018Net income$44,281$39,240$16,57113%137%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Non-GAAP net income$44,281$36,830$30,26720%22%Diluted earnings per share$5.76$5.06$2.1314%138%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Non-GAAP diluted earnings per share$5.76$4.75$3.8821%22%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $136.5 billion and $133.8 billion as of June 30, 2020 and 2019. Equity investments were $3.0 billion and $2.6 billion as of June 30, 2020 and 2019, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2020 Compared with Fiscal Year 2019Cash from operations increased $8.5 billion to $60.7 billion for fiscal year 2020, mainly due to an increase in cash from customers, offset in part by an increase in cash used to pay income taxes, suppliers, and employees. Cash used in financing increased $9.1 billion to $46.0 billion for fiscal year 2020, mainly due to a $3.4 billion cash premium on our debt exchange, a $3.4 billion increase in common stock repurchases, a $1.5 billion increase in repayments of debt, and a $1.3 billion increase in dividends paid. Cash used in investing decreased $3.6 billion to $12.2 billion for fiscal year 2020, mainly due to a $6.4 billion increase in cash from net investment purchases, sales, and maturities, offset in part by a $1.5 billion increase in additions to property and equipment and $1.2 billion in other investing to facilitate the purchase of components. PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2020:(In millions)Three Months EndingSeptember 30, 2020$13,884December 31, 202010,950March 31, 20217,476June 30, 20213,690Thereafter3,180Total$39,180If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2020, 2019, and 2018, we repurchased 126 million shares, 150 million shares, and 99 million shares of our common stock for $19.7 billion, $16.8 billion, and $8.6 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2020: (In millions)2022-20232024-2025ThereafterTotalLong-term debt: (a) Principal payments$3,750$10,716$7,500$45,441$67,407Interest payments2,0283,7363,29325,26534,322Construction commitments (b) 4,7615,041Operating leases, including imputed interest (c) 2,4203,9862,9294,40913,744Finance leases, including imputed interest (c) 2,2432,6769,61115,522Transition tax (d) 1,4502,8996,3434,53115,223Purchase commitments (e) 25,0591,32427,024Other long-term liabilities (f) Total$40,460 $25,478 $23,142$89,885 $178,965 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (e) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. (f) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $15.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. LiquidityAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $3.2 billion, which included $1.2 billion for fiscal year 2020. The remaining transition tax of $15.2 billion is payable over the next six years with a final payment in fiscal year 2026. During fiscal year 2020, we also paid $3.7 billion related to the transfer of intangible properties that occurred in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies, as well as uncertainty in the current economic environment due to the recent outbreak of COVID-19. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. PART II Item 7Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.CHANGE IN ACCOUNTING ESTIMATE In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years. This change in accounting estimate will be effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in Property and equipment, net as of June 30, 2020, it is estimated this change will increase our fiscal year 2021 operating income by $2.7 billion.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currencyRevenue10% decrease in foreign exchange rates$(4,142)EarningsForeign currencyInvestments10% decrease in foreign exchange rates(119)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(3,951)Fair ValueCredit100 basis point increase in credit spreads(301)Fair ValueEquity10% decrease in equity market prices(239)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$68,041 $66,069 $ 64,497 Service and other74,974 59,774 45,863 Total revenue143,015 125,843 110,360 Cost of revenue:Product16,017 16,273 15,420 Service and other30,061 26,637 22,933 Total cost of revenue46,078 42,910 38,353 Gross margin96,937 82,933 72,007 Research and development19,269 16,876 14,726 Sales and marketing19,598 18,213 17,469 General and administrative5,111 4,885 4,754 Operating income52,959 42,959 35,058 Other income, net 1,416 Income before income taxes53,036 43,688 36,474 Provision for income taxes8,755 4,448 19,903 Net income$44,281 $39,240 $16,571 Earnings per share:Basic$5.82 $5.11 $2.15 Diluted$5.76 $5.06 $2.13 Weighted average shares outstanding:Basic7,610 7,673 7,700 Diluted7,683 7,753 7,794 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS (In millions)Year Ended June 30,Net income$44,281 $39,240 $16,571 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )( 173 )Net change related to investments3,990 2,405 ( 2,717 )Translation adjustments and other( 426 )( 318 )( 178 )Other comprehensive income (loss)3,526 1,914 ( 2,856 ) Comprehensive income$47,807 $41,154 $13,715 Refer to accompanying notes. PART II Item 8BALANCE SHEETS(In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$13,576 $11,356 Short-term investments122,951 122,463 Total cash, cash equivalents, and short-term investments136,527 133,819 Accounts receivable, net of allowance for doubtful accounts of $ 788 and $ 411 32,011 29,524 Inventories1,895 2,063 Other current assets11,482 10,146 Total current assets181,915 175,552 Property and equipment, net of accumulated depreciation of $ 43,197 and $ 35,330 44,151 36,477 Operating lease right-of-use assets8,753 7,379 Equity investments2,965 2,649 Goodwill43,351 42,026 Intangible assets, net7,038 7,750 Other long-term assets13,138 14,723 Total assets$301,311 $286,556 Liabilities and stockholders equityCurrent liabilities:Accounts payable$12,530 $9,382 Current portion of long-term debt3,749 5,516 Accrued compensation7,874 6,830 Short-term income taxes2,130 5,665 Short-term unearned revenue36,000 32,676 Other current liabilities10,027 9,351 Total current liabilities72,310 69,420 Long-term debt59,578 66,662 Long-term income taxes29,432 29,612 Long-term unearned revenue3,180 4,530 Deferred income taxesOperating lease liabilities7,671 6,188 Other long-term liabilities10,632 7,581 Total liabilities183,007 184,226 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,571 and 7,643 80,552 78,520 Retained earnings34,566 24,150 Accumulated other comprehensive income (loss)3,186 ( 340 ) Total stockholders equity118,304 102,330 Total liabilities and stockholders equity$301,311 $286,556 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS (In millions)Year Ended June 30,OperationsNet income$44,281 $39,240 $16,571 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other12,796 11,682 10,261 Stock-based compensation expense5,289 4,652 3,940 Net recognized gains on investments and derivatives( 219 )( 792 )( 2,212 )Deferred income taxes( 6,463 )( 5,143 )Changes in operating assets and liabilities:Accounts receivable( 2,577 )( 2,812 )( 3,862 )Inventories( 465 )Other current assets( 2,330 )( 1,718 )( 952 )Other long-term assets( 1,037 )( 1,834 )( 285 )Accounts payable3,018 1,148 Unearned revenue2,212 4,462 5,922 Income taxes( 3,631 )2,929 18,183 Other current liabilities1,346 1,419 Other long-term liabilities1,348 ( 20 )Net cash from operations60,675 52,185 43,884 FinancingRepayments of short-term debt, maturities of 90 days or less, net( 7,324 )Proceeds from issuance of debt7,183 Cash premium on debt exchange( 3,417 )Repayments of debt( 5,518 )( 4,000 )( 10,060 )Common stock issued1,343 1,142 1,002 Common stock repurchased( 22,968 )( 19,543 )( 10,721 )Common stock cash dividends paid( 15,137 )( 13,811 )( 12,699 )Other, net( 334 )( 675 )( 971 )Net cash used in financing( 46,031 )( 36,887 )( 33,590 )InvestingAdditions to property and equipment( 15,441 )( 13,925 )( 11,632 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 2,521 )( 2,388 )( 888 )Purchases of investments( 77,190 )( 57,697 )( 137,380 )Maturities of investments66,449 20,043 26,360 Sales of investments17,721 38,194 117,577 Other, net( 1,241 )( 98 )Net cash used in investing( 12,223 )( 15,773 )( 6,061 )Effect of foreign exchange rates on cash and cash equivalents( 201 )( 115 )Net change in cash and cash equivalents2,220 ( 590 )4,283 Cash and cash equivalents, beginning of period11,356 11,946 7,663 Cash and cash equivalents, end of period$13,576 $11,356 $11,946 Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$78,520 $71,223 $69,315 Common stock issued1,343 6,829 1,002 Common stock repurchased( 4,599 )( 4,195 )( 3,033 )Stock-based compensation expense5,289 4,652 3,940 Other, net( 1 )( 1 )Balance, end of period80,552 78,520 71,223 Retained earnings Balance, beginning of period24,150 13,682 17,769 Net income44,281 39,240 16,571 Common stock cash dividends( 15,483 )( 14,103 )( 12,917 )Common stock repurchased( 18,382 )( 15,346 )( 7,699 )Cumulative effect of accounting changes( 42 )Balance, end of period34,566 24,150 13,682 Accumulated other comprehensive income (loss)Balance, beginning of period( 340 )( 2,187 ) Other comprehensive income (loss)3,526 1,914 ( 2,856 )Cumulative effect of accounting changes( 67 )Balance, end of period3,186 ( 340 )( 2,187 )Total stockholders equity$ 118,304 $ 102,330 $ 82,718 Cash dividends declared per common share$2.04 $1.84 $1.68 Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to the recent outbreak of a novel strain of the coronavirus (COVID-19).In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years . This change in accounting estimate will be effective beginning fiscal year 2021.Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems cross-device productivity applications server applications business solution applications desktop and server management tools software development tools video games and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox Live solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2020 and 2019, long-term accounts receivable, net of allowance for doubtful accounts, was $ 2.7 billion and $ 2.2 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 178 )( 116 )( 98 )Balance, end of period$$$ 397 Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$ 816 $ 434 $ 397 PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future LinkedIn subscriptions Office 365 subscriptions Xbox Live subscriptions Windows 10 post-delivery support Dynamics business solutions Skype prepaid credits and subscriptions and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront. We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2020 and 2019, our financing receivables, net were $ 5.2 billion and $ 4.3 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.6 billion in fiscal years 2020, 2019, and 2018. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other comprehensive income . Debt investments are impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of , and business outlook , for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to three years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceFinancial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the Financial Accounting Standards Board (FASB) issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. We adopted the standard effective July 1, 2019. As we did not hold derivative instruments requiring an adjustment upon adoption, there was no impact in our consolidated financial statements. Adoption of the standard enhanced the presentation of the effects of our hedging instruments and the hedged items in our consolidated financial statements to increase the understandability of the results of our hedging strategies.Recent Accounting Guidance Not Yet AdoptedFinancial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We have evaluated the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems. We continue to monitor economic implications of the COVID-19 pandemic. Based on current market conditions, adoption of the standard will not have a material impact on our consolidated financial statements. Accounting for Income TaxesIn December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021, with early adoption permitted. We are currently evaluating the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.PART II Item 8The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$ 44,281 $ 39,240 $ 16,571 Weighted average outstanding shares of common stock (B)7,610 7,673 7,700 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,683 7,753 7,794 Earnings Per ShareBasic (A/B)$5.82 $5.11 $2.15 Diluted (A/C)$5.76 $5.06 $2.13 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,680 $2,762 $2,214 Interest expense( 2,591 )( 2,686 )( 2,733 )Net recognized gains on investments2,399 Net gains (losses) on derivatives( 187 )Net losses on foreign currency remeasurements( 191 )( 82 )( 218 )Other, net( 40 )( 57 )( 59 )Total$$$1,416 Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 37 )( 93 )( 987 )Other-than-temporary impairments of investments( 17 )( 16 )( 6 )Total$( 4 )$( 97 )$( 966 )Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$$3,406 Net unrealized gains on investments still held 69 479 Impairments of investments( 116 ) ( 10 ) ( 41 ) Total$ 36 $ 745 $ 3,365 PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2020Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,687 $$$4,688 $1,618 $3,070 $Certificates of depositLevel 22,898 2,898 1,646 1,252 U.S. government securitiesLevel 192,067 6,495 ( 1 )98,561 3,168 95,393 U.S. agency securitiesLevel 22,439 2,441 1,992 Foreign government bondsLevel 26,982 ( 3 )6,985 6,984 Mortgage- and asset-backed securitiesLevel 24,865 ( 6 )4,900 4,900 Corporate notes and bondsLevel 28,500 ( 17 )8,810 8,810 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 4 )Municipal securitiesLevel 3Total debt investments$122,900 $6,929 $( 31 )$129,798 $6,882 $122,916 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,198 $$$Equity investmentsOther2,551 2,551 Total equity investments$3,749 $$$2,965 Cash$5,910 $5,910 $$Derivatives, net (a) Total$139,492 $13,576 $122,951 $2,965 PART II Item 8(In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$2,211 $$$2,211 $1,773 $$Certificates of depositLevel 22,018 2,018 1,430 U.S. government securitiesLevel 1104,925 1,854 ( 104 )106,675 105,906 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350 ( 8 )6,346 2,506 3,840 Mortgage- and asset-backed securitiesLevel 23,554 ( 3 )3,561 3,561 Corporate notes and bondsLevel 27,437 ( 7 )7,541 7,541 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747 $2,027 $( 122 )$129,652 $7,176 $122,476 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,085 2,085 Total equity investments$3,058 $$$2,649 Cash$3,771 $3,771 $$Derivatives, net (a) ( 13 )( 13 )Total$136,468 $11,356 $122,463 $2,649 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2020 and 2019, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 1.4 billion and $ 1.2 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2020U.S. government and agency securities$2,323 $( 1 )$$$2,323 $( 1 )Foreign government bonds( 3 )( 3 )Mortgage- and asset-backed securities1,014 ( 6 )1,014 ( 6 )Corporate notes and bonds( 17 )( 17 )Municipal securities( 4 )( 4 )Total$4,552 $( 31 )$$$4,552 $( 31 )PART II Item 8Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2019U.S. government and agency securities$1,491 $( 1 )$39,158 $( 103 )$40,649 $( 104 )Foreign government bonds( 8 )( 8 )Mortgage- and asset-backed securities( 1 )( 2 )1,042 ( 3 )Corporate notes and bonds( 3 )( 4 )( 7 )Total$2,678 $( 5 )$39,989 $( 117 )$42,667 $( 122 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2020Due in one year or less$36,169 $36,276 Due after one year through five years51,465 54,700 Due after five years through 10 years32,299 35,674 Due after 10 years2,967 3,148 Total$122,900 $129,798 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions.Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. PART II Item 8Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2020, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,754 6,034 Interest rate contracts purchased1,295 Not Designated as Hedging InstrumentsForeign exchange contracts purchased11,896 14,889 Foreign exchange contracts sold15,595 15,614 Other contracts purchased1,844 2,007 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 54 )$$( 93 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 334 )( 172 )Other contracts( 11 )( 7 )Gross amounts of derivatives( 399 )( 272 )Gross amounts of derivatives offset in the balance sheet( 154 )( 113 )Cash collateral received( 154 )( 78 )Net amounts of derivatives$$( 395 )$$( 236 )Reported asShort-term investments$$$( 13 )$Other current assetsOther long-term assetsOther current liabilities( 334 )( 221 )Other long-term liabilities( 61 )( 15 )Total$$( 395 )$$( 236 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 399 million and $ 399 million, respectively, as of June 30, 2020, and $ 247 million and $ 272 million, respectively, as of June 30, 2019. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2020Derivative assets$$$$Derivative liabilities( 399 )( 399 )June 30, 2019Derivative assetsDerivative liabilities( 272 )( 272 )PART II Item 8Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows:(In millions)Year Ended June 30,2018RevenueOther Income(Expense), NetRevenueOther Income(Expense), NetRevenueOtherIncome(Expense),NetDesignated as Fair Value Hedging Instruments Foreign exchange contractsDerivatives$$$$( 130 )$$( 78 )Hedged itemsExcluded from effectiveness assessmentInterest rate contractsDerivativesHedged items( 93 )Equity contractsDerivatives( 324 )Hedged itemsExcluded from effectiveness assessmentDesignated as Cash Flow Hedging Instruments Foreign exchange contractsAmount reclassified from accumulated other comprehensive incomeExcluded from effectiveness assessment( 64 )( 255 )Not Designated as Hedging Instruments Foreign exchange contracts( 123 )( 97 )( 33 )Other contracts( 104 )Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$( 38 )$$NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,112 1,611 Total$1,895 $2,063 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,823 $1,540 Buildings and improvements33,995 26,288 Leasehold improvements5,487 5,316 Computer equipment and software41,261 33,823 Furniture and equipment4,782 4,840 Total, at cost87,348 71,807 Accumulated depreciation( 43,197 )( 35,330 )Total, net$ 44,151 $ 36,477 During fiscal years 2020, 2019, and 2018, depreciation expense was $ 10.7 billion, $ 9.7 billion, and $ 7.7 billion, respectively. We have committed $ 5.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2020. During fiscal year 2020, we recorded an impairment charge of $ 186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018 , we acquired GitHub, Inc. (GitHub), a software development platform, in a $ 7.5 billion stock transaction (inclusive of total cash payments of $ 1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497 Intangible assets1,267 Other assetsOther liabilities( 217 )Total$ 6,924 The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. PART II Item 8Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,267 7 yearsTransactions recognized separately from the purchase price allocation were approximately $ 600 million, primarily related to equity awards recognized as expense over the related service period. OtherDuring fiscal year 2020, we completed 15 acquisitions for $ 2.4 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. The effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2020Productivity and Business Processes$23,823 $$( 60 ) $24,277 $$( 94 )$24,190 Intelligent Cloud5,703 5,605 (a) (a) 11,351 1,351 ( 5 )12,697 More Personal Computing6,157 ( 48 ) 6,398 ( 30 )6,464 Total $ 35,683 $ 6,408 $( 65 )$ 42,026 $1,454 $( 129 )$ 43,351 (a) Includes goodwill of $ 5.5 billion related to GitHub. See Note 8 Business Combinations for further information . The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2020, May 1, 2019, or May 1, 2018 tests. As of June 30, 2020 and 2019, accumulated goodwill impairment was $ 11.3 billion.PART II Item 8NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$8,160 $( 6,381 )$1,779 $7,691 $( 5,771 )$1,920 Customer-related4,967 ( 2,320 )2,647 4,709 ( 1,785 )2,924 Marketing-related4,158 ( 1,588 )2,570 4,165 ( 1,327 )2,838 Contract-based( 432 )( 506 )Total$ 17,759 $( 10,721 )$7,038 $ 17,139 (a) $( 9,389 )$7,750 (a) Includes intangible assets of $ 1.3 billion related to GitHub. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2020, 2019, or 2018. We estimate that we have no significant residual value related to our intangible assets. The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$6 years$5 yearsCustomer-related5 years8 yearsMarketing-related2 years10 yearsContract-based0 years3 yearsTotal$ 836 5 years$1,708 7 yearsIntangible assets amortization expense was $ 1.6 billion, $ 1.9 billion, and $ 2.2 billion for fiscal years 2020, 2019, and 2018, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2020: (In millions)Year Ending June 30,$1,483 1,399 1,219 Thereafter1,639 Total$7,038 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 3.00 %4.50 %3.14 %4.57 %1,571 2,000 2011 issuance of $ 2.3 billion (a) 4.00 %5.30 %4.08 %5.36 %1,270 1,500 2012 issuance of $ 2.3 billion 2.13 %3.50 %2.24 %3.57 %1,650 1,650 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,919 3,500 2013 issuance of 4.1 billion2.13 %3.13 %2.23 %3.22 %4,549 4,613 2014 issuance 2015 issuance of $ 23.8 billion (a) 2.00 %4.75 %2.09 %4.78 %15,549 22,000 2016 issuance of $ 19.8 billion (a) 1.55 %3.95 %1.64 %4.03 %16,955 19,750 2017 issuance of $ 17.0 billion (a) 2.40 %4.50 %2.52 %4.53 %12,385 17,000 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 Total face value67,407 72,781 Unamortized discount and issuance costs( 554 )( 603 )Hedge fair value adjustments ( b ) Premium on debt exchange (a) ( 3,619 )Total debt63,327 72,178 Current portion of long-term debt( 3,749 )( 5,516 )Long-term debt$59,578 $66,662 (a) In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities. The premium will be amortized over the term of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2020 and 2019, the estimated fair value of long-term debt, including the current portion, was $ 77.1 billion and $ 78.9 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2020: (In millions)Year Ending June 30,$3,750 7,966 2,750 5,250 2,250 Thereafter45,441 Total$67,407 PART II Item 8NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $ 13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $ 157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $ 2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (GILTI) tax. Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$3,537 $4,718 $19,764 U.S. state and localForeign4,444 5,531 4,348 Current taxes$8,744 $10,911 $25,046 Deferred TaxesU.S. federal$$( 5,647 )$( 4,292 )U.S. state and local( 6 )( 1,010 )( 458 )Foreign( 41 )( 393 )Deferred taxes$$( 6,463 )$( 5,143 )Provision for income taxes$ 8,755 $ 4,448 $ 19,903 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$24,116 $15,799 $11,527 Foreign 28,920 27,889 24,947 Income before income taxes$ 53,036 $ 43,688 $36,474 PART II Item 8Effective Tax Rate The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %28.1 %Effect of:Foreign earnings taxed at lower rates( 3.7 )%( 4.1 )%( 7.8 )%Impact of the enactment of the TCJA0 %0.4 %37.7 %Impact of intangible property transfers0 %( 5.9 )%0 %Foreign-derived intangible income deduction( 1.1 )%( 1.4 )%0 %State income taxes, net of federal benefit1.3 %0.7 %1.3 %Research and development credit( 1.1 )%( 1.1 )%( 1.3 )%Excess tax benefits relating to stock-based compensation( 2.2 )%( 2.2 )%( 2.5 )%Interest, net1.0 %1.0 %1.2 %Other reconciling items, net1.3 %1.8 %( 2.1 )%Effective rate16.5 %10.2 %54.6 %The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $ 2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, offset in part by earnings taxed at lower rates in foreign jurisdictions. In fiscal year 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 86 % of our foreign income before tax. In fiscal years 2019 and 2018, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % and 87 % of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax. In fiscal years 2020, 2019, and 2018, there were no individually significant other reconciling items.The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $ 2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. PART II Item 8The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,721 2,287 Loss and credit carryforwards3,518 Depreciation and amortization6,361 7,046 Leasing liabilities3,025 1,594 Unearned revenue1,553 OtherDeferred income tax assets15,340 15,693 Less valuation allowance( 755 )( 3,214 )Deferred income tax assets, net of valuation allowance$14,585 $12,479 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 2,642 )$( 738 )Unearned revenue( 30 )Leasing assets( 2,817 )( 1,510 )Deferred GILTI tax liabilities( 2,581 )( 2,607 )Other( 344 )( 291 )Deferred income tax liabilities$( 8,384 )$( 5,176 )Net deferred income tax assets$6,201 $7,303 Reported AsOther long-term assets$6,405 $7,536 Long-term deferred income tax liabilities( 204 )( 233 )Net deferred income tax assets$6,201 $7,303 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2020, we had federal, state, and foreign net operating loss carryforwards of $ 547 million, $ 975 million, and $ 2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2021 through 2040 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance.The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $ 2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements. Income taxes paid, net of refunds, were $ 12.5 billion, $ 8.4 billion, and $ 5.5 billion in fiscal years 2020, 2019, and 2018, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2020, 2019, and 2018, were $ 13.8 billion, $ 13.1 billion, and $ 12.0 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2020, 2019, and 2018 by $ 12.1 billion, $ 12.0 billion, and $ 11.3 billion, respectively.PART II Item 8As of June 30, 2020, 2019, and 2018, we had accrued interest expense related to uncertain tax positions of $ 4.0 billion, $ 3.4 billion, and $ 3.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2020, 2019, and 2018 included interest expense related to uncertain tax positions of $ 579 million, $ 515 million, and $ 688 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$13,146 $11,961 $11,737 Decreases related to settlements( 31 )( 316 )( 193 )Increases for tax positions related to the current year2,106 1,445 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 331 )( 1,113 )( 1,176 )Decreases due to lapsed statutes of limitations( 5 )( 3 )Ending unrecognized tax benefits$ 13,792 $ 13,146 $ 11,961 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013 . In April 2020, the IRS commenced the audit for tax years 2014 to 2017 .As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$18,643 $16,831 Intelligent Cloud16,620 16,988 More Personal Computing3,917 3,387 Total$39,180 $37,206 Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2020Balance, beginning of period$37,206 Deferral of revenue78,922 Recognition of unearned revenue( 76,948 )Balance, end of period$39,180 PART II Item 8Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 111 billion as of June 30, 2020, of which $ 107 billion is related to the commercial portion of revenue. We expect to recognize approximately 50 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$2,043 $1,707 $1,585 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,829 $1,670 $1,522 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases3,677 2,303 1,571 Finance leases3,467 2,532 1,933 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$8,753 $7,379 Other current liabilities$1,616 $1,515 Operating lease liabilities7,671 6,188 Total operating lease liabilities$9,287 $7,703 Finance LeasesProperty and equipment, at cost$10,371 $7,041 Accumulated depreciation( 1,385 )( 774 )Property and equipment, net$8,986 $6,267 Other current liabilities$$Other long-term liabilities8,956 6,257 Total finance lease liabilities$9,496 $6,574 Weighted Average Remaining Lease TermOperating leases8 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases2.7 %3.0 %Finance leases3.9 %4.6 %Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,807 $1,652 1,474 1,262 1,000 1,236 Thereafter3,122 7,194 Total lease payments10,317 12,023 Less imputed interest( 1,030 )( 2,527 )Total$9,287 $9,496 As of June 30, 2020, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 3.4 billion and $ 3.5 billion, respectively. These operating and finance leases will commence between fiscal year 2021 and fiscal year 2023 with lease terms of 1 year to 16 years .During fiscal year 2020, we recorded an impairment charge of $ 161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.PART II Item 8NOTE 15 CONTINGENCIES Patent and Intellectual Property Claims There were 64 patent infringement cases pending against Microsoft as of June 30, 2020, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence once each court approves the form of notice to the class . Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to occur in the second quarter of fiscal year 2021 . PART II Item 8Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2020, we accrued aggregate legal liabilities of $ 306 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,643 7,677 7,708 IssuedRepurchased( 126 )( 150 )( 99 )Balance, end of year7,571 7,643 7,677 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $ 31.7 billion remained of this $ 40.0 billion share repurchase program.PART II Item 8We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$4,000 $2,600 $1,600 Second Quarter4,600 6,100 1,800 Third Quarter6,000 3,899 3,100 Fourth Quarter5,088 4,200 2,100 Total$19,688 $16,799 $ 8,600 Shares repurchased during the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 3.3 billion, $ 2.7 billion, and $ 2.1 billion for fiscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2020 (In millions) September 18, 2019 November 21, 2019 December 12, 2019 $0.51 $3,886 December 4, 2019 February 20, 2020 March 12, 2020 0.51 3,876 March 9, 2020 May 21, 2020 June 11, 2020 0.51 3,865 June 17, 2020 August 20, 2020 September 10, 2020 0.51 3,861 Total$2.04 $15,488 Fiscal Year 2019September 18, 2018 November 15, 2018 December 13, 2018 $0.46 $3,544 November 28, 2018 February 21, 2019 March 14, 2019 0.46 3,526 March 11, 2019 May 16, 2019 June 13, 2019 0.46 3,521 June 12, 2019 August 15, 2019 September 12, 2019 0.46 3,510 Total$1.84 $14,101 The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component : (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains (losses), net of tax of $( 10 ) , $ 2 , and $ 11 ( 38 )Reclassification adjustments for gains included in revenue( 341 )( 185 )Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)( 333 )( 179 )Net change related to derivatives, net of tax of $( 10 ) , $( 6 ), and $ 5 ( 38 )( 173 )Balance, end of period$( 38 )$$InvestmentsBalance, beginning of period$1,488 $( 850 )$1,825 Unrealized gains (losses), net of tax of $ 1,057 , $ 616 , and $( 427 )3,987 2,331 ( 1,146 )Reclassification adjustments for (gains) losses included in other income (expense), net( 2,309 )Tax expense (benefit) included in provision for income taxes( 1 )( 19 )Amounts reclassified from accumulated other comprehensive income (loss)( 1,571 )Net change related to investments, net of tax of $ 1,058 , $ 635 , and $( 1,165 )3,990 2,405 ( 2,717 )Cumulative effect of accounting changes( 67 )Balance, end of period$5,478 $1,488 $( 850 )Translation Adjustments and OtherBalance, beginning of period$( 1,828 )$( 1,510 )$( 1,332 )Translation adjustments and other, net of tax effects of $ 1 , $( 1 ), and $ 0 ( 426 )( 318 )( 178 )Balance, end of period$( 2,254 )$( 1,828 )$( 1,510 )Accumulated other comprehensive income (loss), end of period$3,186 $( 340 )$( 2,187 )NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2020, an aggregate of 283 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$5,289 $4,652 $ 3,940 Income tax benefits related to stock-based compensationStock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.46 0.51 $0.42 0.46 $0.39 0.42 Interest rates0.1 %2.2 %1.8 %3.1 %1.7 %2.9 %During fiscal year 2020, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$78.49 Granted (a) 140.49 Vested( 65 ) 75.35 Forfeited( 9 ) 90.30 Nonvested balance, end of year$105.23 (a) Includes 2 million, 2 million, and 3 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2020, 2019, and 2018, respectively. As of June 30, 2020, there was approximately $ 10.2 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 140.49 , $ 107.02 , and $ 75.88 for fiscal years 2020, 2019, and 2018, respectively. The fair value of stock awards vested was $ 10.1 billion, $ 8.7 billion, and $ 6.6 billion, for fiscal years 2020, 2019, and 2018, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$142.22 $104.85 $ 76.40 As of June 30, 2020, 96 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50 % of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $ 1.0 billion, $ 877 million, and $ 807 million in fiscal years 2020, 2019, and 2018, respectively, and were expensed as contributed. NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows Internet of Things and MSN advertising. Devices, including Surface and PC accessories. PART II Item 8 Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live ( transactions, subscriptions, cloud services, and advertising ), video games, and third-party video game royalties. Search. Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines information technology human resources finance excise taxes field selling shared facilities services and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$46,398 $41,160 $35,865 Intelligent Cloud48,366 38,985 32,219 More Personal Computing48,251 45,698 42,276 Total$143,015 $125,843 $110,360 Operating Income Productivity and Business Processes$18,724 $16,219 $12,924 Intelligent Cloud18,324 13,920 11,524 More Personal Computing15,911 12,820 10,610 Total$52,959 $42,959 $35,058 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2020, 2019, or 2018. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $73,160 $64,199 $55,926 Other countries69,855 61,644 54,434 Total$143,015 $ 125,843 $ 110,360 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows:(In millions)Year Ended June 30,Server products and cloud services$41,379 $32,622 $26,129 Office products and cloud services35,316 31,769 28,316 Windows22,294 20,395 19,518 Gaming11,575 11,386 10,353 LinkedIn8,077 6,754 5,259 Search advertising7,740 7,628 7,012 Devices6,457 6,095 5,134 Enterprise Services6,409 6,124 5,846 Other3,768 3,070 2,793 Total$143,015 $125,843 $ 110,360 Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 51.7 billion, $ 38.1 billion and $ 26.6 billion in fiscal years 2020, 2019, and 2018, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$60,789 $55,252 $44,501 Ireland12,734 12,958 12,843 Other countries29,770 25,422 22,538 Total$ 103,293 $ 93,632 $ 79,882 PART II Item 8NOTE 20 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2020Revenue$ 33,055 $36,906 $35,021 $38,033 $143,015 Gross margin22,649 24,548 24,046 25,694 96,937 Operating income 12,686 13,891 12,975 13,407 52,959 Net income10,678 11,649 10,752 11,202 44,281 Basic earnings per share1.40 1.53 1.41 1.48 5.82 Diluted earnings per share1.38 1.51 1.40 1.46 5.76 Fiscal Year 2019Revenue 29,084 32,471 30,571 33,717 125,843 Gross margin19,179 20,048 20,401 23,305 82,933 Operating income9,955 10,258 10,341 12,405 42,959 Net income (a) 8,824 8,420 8,809 13,187 39,240 Basic earnings per share1.15 1.09 1.15 1.72 5.11 Diluted earnings per share (b) 1.14 1.08 1.14 1.71 5.06 (a) Reflects the $ 157 million net charge related to the enactment of the TCJA for the second quarter and the $ 2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $ 2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $ 0.02 for the second quarter, $( 0.34 ) for the fourth quarter, and $( 0.31 ) for fiscal year 2019 . PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2020, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested management's identification and treatment of contract terms. Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statements Critical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLPSeattle, Washington July 30, 2020 We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2020. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2020 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2020, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the ""financial statements"") as of and for the year ended June 30, 2020, of the Company and our report dated July 30, 2020, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, Washington July 30, 2020 PART II, III Item 9B, 10, 11, 12, 13, 14" +17,Microsoft Corporation,2018," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The A mbitions T hat D rive U s To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesWe are in a unique position to empower people and organizations to succeed in a rapidly evolving workplace. Computing experiences are evolving, no longer bound to one device at a time. Instead, experiences are expanding to many devices as people move from home to work to on the go. These modern needs, habits, and expectations of our customers are motivating us to bring Microsoft Office 365, Windows platform, devices, including Microsoft Surface, and third-party applications into a more cohesive Microsoft 365 experience.Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Microsoft Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is core to our vision for the modern workplace as the digital hub that creates a single canvas for teamwork, conversations, meetings, and content. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and inspire teamwork, while simplifying security and management. Organizations of all sizes can now digitize business-critical functions, redefining what customers can expect from their business applications. This creates an opportunity for us to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformCompanies are looking to use digital technology to fundamentally reimagine how they empower their employees, engage customers, optimize their operations, and change the very core of their products and services. Partnering with organizations on their digital transformation is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Microsoft Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions, with new Azure services and devices such as HoloLens 2. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for cus tomers to take Microsoft SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation help s every developer be an AI d eveloper, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. On October 25, 2018, we completed our acquisition of GitHub, Inc. (GitHub), a service that millions of developers around the world rely on to write code together. The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences.Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently expanded our Surface family of devices with the Surface Hub 2S, which brings together Microsoft Teams, Windows, and Surface hardware to power teamwork for organizations. We are mobilizing to pursue our expansive opportunity in the gaming industry, broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed. We have a strong position with our Xbox One console, our large and growing highly engaged community of gamers on Xbox Live, and with Windows 10, the most popular operating system for PC gamers. We will continue to connect our gaming assets across PC, console, and mobile, and work to grow and engage the Xbox Live member network more deeply and frequently with services like Mixer and Xbox Game Pass. Our approach is to enable gamers to play the games they want, with the people they want, on the devices they want.Our Future OpportunityCustomers are looking to us to accelerate their own digital transformations and to unlock new opportunity in this era of intelligent cloud and intelligent edge. We continue to develop complete, intelligent solutions for our customers that empower users to be creative and work together while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.PART I Item 1Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Office 365. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the world's professionals to make them more productive and successful, and is the world's largest professional network on the Internet. LinkedIn offers services that can be used by customers to transform the way they hire, market, sell, and learn. In addition to LinkedIns free services, LinkedIn offers three categories of monetized solutions: Talent Solutions, Marketing Solutions, and Premium Subscriptions, which includes Sales Solutions. Talent Solutions is comprised of two elements: Hiring, and Learning and Development. Hiring provides services to recruiters that enable them to attract, recruit, and hire talent. Learning and Development provides subscriptions to enterprises and individuals to access online learning content. Marketing Solutions enables companies to advertise to LinkedIns member base. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Premium Subscriptions also includes Sales Solutions, which helps sales professionals find, qualify, and create sales opportunities and accelerate social selling capabilities. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions.On November 16, 2018, LinkedIn acquired Glint, an employee engagement platform, to expand its Talent Solutions offerings. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and analytics applications for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services; job boards; traditional recruiting firms; and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers.Dynamics competes with vendors such as Infor, NetSuite, Oracle, Salesforce.com, SAP, and The Sage Group to provide cloud-based and on-premise business solutions for small, medium, and large organizations.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesOur server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Azure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionOur server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. PART I Item 1We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware a nd software applications, security, and manageability. Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, Salesforce.com, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows IoT; and MSN advertising. Devices, including Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. PART I Item 1Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings. Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface, PC accessories, and other intelligent devices. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. GamingOur gaming platform is designed to provide a unique variety of entertainment using our devices, peripherals, applications, online services, and content. We released Xbox One S and Xbox One X in August 2016 and November 2017, respectively. With the launch of the Mixer service in May 2017, offering interactive live streaming, and Xbox Game Pass in June 2017, providing unlimited access to over 100 Xbox titles, we continue to open new opportunities for customers to engage both on- and off-console. With our acquisition of PlayFab in January 2018, we enable worldwide game developers to utilize game services, LiveOps, and analytics for player acquisition, engagement, and retention. We have also made these services available for developers outside of the gaming industry.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox Live revenue is mainly affected by subscriptions and sales of Xbox Live enabled content, as well as advertising. We also continue to design and sell gaming content to showcase our unique platform capabilities for Xbox consoles, Windows-enabled devices, and other devices. Growth of our Gaming business is determined by the overall active user base through Xbox Live enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences via online services including game streaming, downloadable content, and peripherals. SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.PART I Item 1Our gaming platform competes with console platforms from Nintendo and Sony , both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years. Nintendo released its latest generation console in March 2017 and Sony released its latest generation console in November 2013. We also compete with other providers of entertainment services through online marketplaces. We believe our gaming pla tform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our o wn game franchises as well as other digital content offerings. Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live and our cloud gaming services face competition from various online marketplaces, including those operated by Amazon, Apple, and Google. Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region; the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region; and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility and Management, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on connecting gaming assets across the range of devices to grow and engage the Xbox Live member network through game experiences, streaming content, and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. PART I Item 1We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internatio nally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and curren tly have a portfolio of over 61,000 U.S. and international patents issued and over 26,000 pending. While we employ much of our internally- developed intellectual property exclusively in our products and services, we also engage in outbound licensing of spec ific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we i ncorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with enterprises and public-sector organizations worldwide to identify and meet their technology requirements; managing OEM relationships; and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. PART I Item 1There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a di rect agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with ma ny regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces, online stores, and retail stores. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, and training to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. PART I Item 1Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, hosting partner, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 31, 2019 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerMargaret L. JohnsonExecutive Vice President, Business DevelopmentBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Ms. Johnson was appointed Executive Vice President, Business Development in September 2014. Prior to that Ms. Johnson spent 24 years at Qualcomm in various leadership positions across engineering, sales, marketing and business development. She most recently served as Executive Vice President of Qualcomm Technologies, Inc. Ms. Johnson also serves on the Board of Directors of BlackRock, Inc.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2019, we employed approximately 144,000 people on a full-time basis, 85,000 in the U.S. and 59,000 internationally. Of the total employed people, 47,000 were in operations, including manufacturing, distribution, product support, and consulting services; 47,000 were in product research and development; 38,000 were in sales and marketing; and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RIS K FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on personal computers. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end-users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Microsoft Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, Microsoft SQL Server, Windows Server, Azure, Office 365, Xbox Live, Mixer, LinkedIn, and other p roducts and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commerc ial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their p urchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may no t be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Microsoft Edge and Bing, that drive post- sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or prod uct experiences, which could negatively impact product and feature adoption, product design , and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. In December 2016, we completed our acquisition of LinkedIn Corporation (LinkedIn) for $27.0 billion, and in October 2018, we completed our acquisition of GitHub, Inc. for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge on our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. Our acquisition of LinkedIn resulted in a significant increase in our goodwill and intangible asset balances. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improved technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes like passwords. Inadequate account security practices may also result in unauthorized access. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. PART I Item 1AThe cost of these steps could reduc e our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future pu rchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers ma y fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilitie s may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. As illustrated by the Spectre and Meltdown threats, our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For LinkedIn, Microsoft Advertising, MSN, Xbox Live, and other products and services that provide content or host ads that come from or can be influenced by third parties, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AHarmful content online Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, substantial liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an Internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or insufficient Internet connectivity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophis ticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contai n provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described in the next paragraph. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow bec ause of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Microsoft Surface. To resolve thes e claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In s ome countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact on our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow; at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Iran, North Korea, Cuba, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Skype are covered by existing laws regulating telecommunications services, and some new laws are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us , or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve . For example, the EU and the U.S. formally entered into a new framework in July 2016 that provides a mechanism for companies to transfer data from EU member states to the U.S. This framework, called the Privacy Shield, is intended to address shortcomings identified by the European Court of Justice in a predecessor mechanism. The Privacy Shield and other mechanisms are currently subject to challenges in European courts, which may lead to uncertainty about the legal basis for data transfers across the Atlant ic. The Privacy Shield and other potential rules on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, a new EU law governing data practices and privacy , the General Data Protection Regulation (GDPR), bec a me effective. The law , which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of new compliance obligations regarding the handling of personal data. Engineering efforts to build new capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experien ce reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if the changes we implement to comply with the GDPR make our offe rings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to c omply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits , or reputational damage . In the U.S., California has adopted and several states are considering ad opting laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal reviews by regulators may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location and movement of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S . A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing juris dictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements . If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Substantial revenue comes from our U.S. government contracts. An extended federal government shutdown resulting from failing to pass budget appropriations, adopt continuing funding resolutions or raise the debt ceiling, and other budgetary decisions limiting or delaying federal government spending, could reduce government IT spending on our products and services and adversely affect our revenue. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. PART I Item 1AWe maintain an investment portfolio of various holdings, t ypes, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio c omprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements . Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages on our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The long-term effects of climate change on the global economy or the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other natural resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in weather where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVE D STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2019 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India; our datacenters in Ireland, the Netherlands, and Singapore; and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, Germany, India, Japan, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. These annual reports will continue through 2020. During fiscal year 2019, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking); (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts; and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 16 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 29, 2019, there were 94,069 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2019:PeriodTotal Number of SharesPurchasedAveragePrice Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares that May Yet bePurchased under the Plans or Programs(In millions)April 1, 2019 April 30, 20198,547,612$122.858,547,612$14,551May 1, 2019 May 31, 201914,029,339126.3214,029,33912,778June 1, 2019 June 30, 201910,469,682131.5910,469,68211,40133,046,63333,046,633All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2019: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 12, 2019August 15, 2019September 12, 2019$0.46$3,516We returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.Highlights from fiscal year 2019 compared with fiscal year 2018 included: Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties, increased 43% to $38.1 billion. Office Commercial revenue increased 13%, driven by Office 365 Commercial growth of 33%. Office Consumer revenue increased 7%, and Office 365 Consumer subscribers increased to 34.8 million. LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. Dynamics revenue increased 15%, driven by Dynamics 365 growth of 47%. Server products and cloud services revenue, including GitHub, increased 25%, driven by Azure growth of 72%. Enterprise Services revenue increased 5%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 4%. Windows Commercial revenue increased 14%. Microsoft Surface revenue increased 23%. Gaming revenue increased 10%, driven by Xbox software and services growth of 19%. Search advertising revenue, excluding traffic acquisition costs, increased 13%.We have recast certain prior period commercial cloud metrics to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations.On October 25, 2018, we acquired GitHub, Inc. (GitHub) in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional ne t charge related to the enactment of the TCJA of $13. 7 billion in fiscal year 2018 , and adjusted our provisional net charge by recording additional tax expense of $ 157 million in the second quarter of fiscal year 2019. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland, which resulted in a $2.6 billion net income tax benef it . Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of foreign currencies relative to the U.S. dollar throughout fiscal year 2018 positively impacted reported revenue and increased reported expenses from our international operations. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017Revenue$125,843$110,360$96,57114%14%Gross margin82,93372,00762,31015%16%Operating income42,95935,05829,02523%21%Net income39,24016,57125,489137%(35)%Diluted earnings per share5.062.133.25138%(34)%Non-GAAP operating income42,959 35,05829,33123% 20%Non-GAAP net income36,83030,26725,73222%18%Non-GAAP diluted earnings per share4.753.883.2922%18%Non-GAAP operating income, net income, and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.Operating income increased $7.9 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Current year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Prior year net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively. Fiscal Year 2018 Compared with Fiscal Year 2017Revenue increased $13.8 billion or 14%, driven by growth across each of our segments. Productivity and Business Processes revenue increased, driven by LinkedIn and higher revenue from Office. Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services. More Personal Computing revenue increased, driven by higher revenue from Gaming, Windows, Search advertising, and Surface, offset in part by lower revenue from Phone.PART II Item 7Gross margin increased $9.7 billion or 16%, due to growth across each of our segments. Gross margin percentage increased slightly, driven by favo rable segment sales mix and gross margin percentage improvement in More Personal Computing. Gross margin included a 7 percentage point improvement in commercial cloud, primarily from Azure. Operating income increased $6.0 billion or 21%, driven by growth across each of our segments. LinkedIn operating loss increased $63 million to $987 million, including $1.5 billion of amortization of intangible assets. Operating income included a favorable foreign currency impact of 2%.Key changes in expenses were: Cost of revenue increased $4.1 billion or 12%, mainly due to growth in our commercial cloud, Gaming, LinkedIn, and Search advertising, offset in part by a reduction in Phone cost of revenue. Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses.Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted earnings per share of $13.7 billion and $1.75, respectively. Fiscal year 2017 operating income, net income, and diluted EPS were negatively impacted by restructuring expenses, which resulted in a decrease to operating income, net income, and diluted EPS of $306 million, $243 million, and $0.04, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017RevenueProductivity and Business Processes$41,160$35,865$29,87015%20%Intelligent Cloud38,98532,21927,40721%18%More Personal Computing45,69842,27639,2948%8%Total $125,843$110,360$96,57114%14%Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,38925%13%Intelligent Cloud13,92011,5249,12721%26%More Personal Computing12,82010,6108,81521%20%Corporate and Other(306)**Total $42,959$35,058$29,02523%21%* Not meaningful. Reportable Segments Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. PART II Item 7 Office Consumer revenue increased $286 million or 7 %, driven by Office 365 Consumer, due to recurring subscription revenue and transactional strength in Japan . LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer. Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to a sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Productivity and Business Processes Revenue increased $6.0 billion or 20%. LinkedIn revenue increased $3.0 billion to $5.3 billion. Fiscal year 2018 included a full period of results, whereas fiscal year 2017 only included results from the date of acquisition on December 8, 2016. LinkedIn revenue primarily consisted of revenue from Talent Solutions. Office Commercial revenue increased $2.4 billion or 11%, driven by Office 365 Commercial revenue growth, mainly due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial. Office Consumer revenue increased $382 million or 11%, driven by Office 365 Consumer revenue growth, mainly due to growth in subscribers. Dynamics revenue increased 13%, driven by Dynamics 365 revenue growth. Operating income increased $1.5 billion or 13%, including a favorable foreign currency impact of 2%. Gross margin increased $4.4 billion or 19%, driven by LinkedIn and growth in Office Commercial. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Office 365 Commercial and LinkedIn. LinkedIn cost of revenue increased $818 million to $1.7 billion, including $888 million of amortization for acquired intangible assets. Operating expenses increased $2.9 billion or 25%, driven by LinkedIn expenses and investments in commercial sales capacity and cloud engineering. LinkedIn operating expenses increased $2.2 billion to $4.5 billion, including $617 million of amortization of acquired intangible assets. Intelligent CloudRevenue increased $4.8 billion or 18%. Server products and cloud services revenue increased $4.5 billion or 21%, driven by Azure and server products licensed on-premises revenue growth. Azure revenue grew 91%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products licensed on-premises revenue increased 5% , mainly due to a higher mix of premium licenses for Windows Server and Microsoft SQL Server. Enterprise Services revenue increased $304 million or 5% , driven by higher revenue from Premier Support Services and Microsoft Consulting Services, offset in part by a decline in revenue from custom support agreements.Operating income increased $2.4 billion or 26%. Gross margin increased $3.1 billion or 16%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage decreased, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Azure. Operating expenses increased $683 million or 7%, driven by investments in commercial sales capacity and cloud engineering.More Personal Computing Revenue increased $3.0 billion or 8%. Windows revenue increased $925 million or 5%, driven by growth in Windows Commercial and Windows OEM, offset by a decline in patent licensing revenue. Windows Commercial revenue increased 12%, driven by multi-year agreement revenue growth. Windows OEM revenue increased 5%. Windows OEM Pro revenue grew 11%, ahead of a strengthening commercial PC market. Windows OEM non-Pro revenue declined 4%, below the consumer PC market, driven by continued pressure in the entry-level price category. Gaming revenue increased $1.3 billion or 14%, driven by Xbox software and services revenue growth of 20%, mainly from third-party title strength. PART II Item 7 Search advertising revenue increased $793 million or 13%. Search advertising revenue, excluding traffic acquisition costs, increased 16%, driven by growth in Bing, due to higher revenue per search and search volume. Surface revenue increased $625 million or 16%, driven by a higher mix of premium devices and an increase in volumes sold, due to the latest editions of Surface. Phone revenue decreased $525 million.Operating income increased $1.8 billion or 20%, including a favorable foreign currency impact of 2%. Gross margin increased $2.2 billion or 11%, driven by growth in Windows, Surface, Search, and Gaming. Gross margin percentage increased, primarily due to gross margin percentage improvement in Surface. Operating expenses increased $391 million or 3%, driven by investments in Search, AI, and Gaming engineering and commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Corporate and Other Corporate and Other includes corporate-level activity not specifically allocated to a segment, including restructuring expenses.Fiscal Year 2019 Compared with Fiscal Year 2018 We did not incur Corporate and Other activity in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 Corporate and Other operating loss decreased $306 million, due to a reduction in restructuring expenses, driven by employee severance expenses primarily related to our sales and marketing restructuring plan in fiscal year 2017.OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Research and development$16,876$14,726$13,03715%13%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Fiscal Year 2018 Compared with Fiscal Year 2017Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. LinkedIn expenses increased $762 million to $1.5 billion.PART II Item 7Sales and Marketing (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Sales and marketing$18,213$17,469$15,4614%13%As a percent of revenue14%16%16%(2)ppt0pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2019 Compared with Fiscal Year 2018Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. Fiscal Year 2018 Compared with Fiscal Year 2017Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. LinkedIn expenses increased $1.2 billion to $2.5 billion, including $617 million of amortization of acquired intangible assets.General and Administrative (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017General and administrative$4,885$4,754$4,4813%6%As a percent of revenue4%4%5%0ppt(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.Fiscal Year 2018 Compared with Fiscal Year 2017General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses. LinkedIn expenses increased $234 million to $528 million.RESTRUCTURING EXPENSES Restructuring expenses include employee severance expenses and other costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities.Fiscal Year 2019 Compared with Fiscal Year 2018We did not incur restructuring expenses in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 During fiscal year 2017, we recorded $306 million of employee severance expenses, primarily related to our sales and marketing restructuring plan. PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2019 Compared with Fiscal Year 2018Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . Fiscal Year 2018 Compared with Fiscal Year 2017Dividends and interest income increased primarily due to higher average portfolio balances and yields on fixed-income securities. Interest expense increased primarily due to higher average outstanding long-term debt and higher finance lease expense. Net recognized gains on investments decreased primarily due to higher losses on sales of fixed-income securities, offset in part by higher gains on sales of equity securities. Net losses on derivatives decreased primarily due to lower losses on equity, foreign exchange, and commodity derivatives, offset in part by losses on interest rate derivatives in the current period as compared to gains in the prior period. INCOME TAXES Effective Tax RateFiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Our effective tax rate for fiscal years 2018 and 2017 was 55% and 15%, respectively. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA in fiscal year 2018 and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. Our effective tax rate was higher than the U.S. federal statutory rate primarily due to the net charge related to the enactment of the TCJA, offset in part by earnings taxed at lower rates in foreign jurisdictions resulting from our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion. In fiscal year 2017, our U.S. income before income taxes was $6.8 billion and our foreign income before income taxes was $23.1 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our global intangible low-taxed income (GILTI) effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months. As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP operating income, net income, and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2019 Versus 2018Percentage Change 2018 Versus 2017Operating income$42,959 $35,058$29,02523%21%Net tax impact of transfer of intangible properties **Net tax impact of the TCJA**Restructuring expenses**Non-GAAP operating income$42,959 $35,058$29,33123%20%Net income$39,240$16,571$25,489137%(35)%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Restructuring expenses**Non-GAAP net income$36,830$30,267$25,73222%18%Diluted earnings per share$5.06$2.13$3.25138%(34)%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Restructuring expenses0.04**Non-GAAP diluted earnings per share$4.75$3.88$3.2922%18%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $133.8 billion as of both June 30, 2019 and 2018. Equity investments were $2.6 billion and $1.9 billion as of June 30, 2019 and 2018, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Cash from operations increased $4.4 billion to $43.9 billion for fiscal year 2018, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees, net cash paid for income taxes, cash paid for interest on debt, and cash paid to suppliers. Cash used in financing was $33.6 billion for fiscal year 2018, compared to cash from financing of $8.4 billion for fiscal year 2017. The change was mainly due to a $41.7 billion decrease in proceeds from issuance of debt, net of repayments of debt, offset in part by a $1.1 billion decrease in cash used for common stock repurchases. Cash used in investing decreased $40.7 billion to $6.1 billion for fiscal year 2018, mainly due to a $25.1 billion decrease in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $19.1 billion increase in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2019:(In millions)Three Months Ending,September 30, 2019$12,353December 31, 20199,807March 31, 20206,887June 30, 20203,629Thereafter4,530Total$37,206If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2019, 2018, and 2017, we repurchased 150 million shares, 99 million shares, and 170 million shares of our common stock for $16.8 billion, $8.6 billion, and $10.3 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2019: (In millions)2021-20222023-2024ThereafterTotalLong-term debt: (a) Principal payments$5,518$11,744$8,000$47,519$72,781Interest payments2,2994,3093,81829,38339,809Construction commitments (b) 3,4433,958Operating leases, including imputed interest (c) 1,7903,1442,4133,64510,992Finance leases, including imputed interest (c) 2,0082,1659,87214,842Transition tax (d) 1,1802,9004,1688,15516,403Purchase commitments (e) 17,4781,18519,161Other long-term liabilities (f) Total$32,505 $25,877 $20,752 $99,237 $178,371 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( c ) Refer to Note 15 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( e ) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. ( f ) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. Liquidity As a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable interest free over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of approximately $2.0 billion, which included $1.5 billion for fiscal year 2019. The first installment of the transition tax was paid in fiscal year 2019, and the remaining transition tax of $16.4 billion is payable over the next seven years with a final payment in fiscal year 2026. During the first quarter of fiscal year 2020, we expect to pay $1.2 billion related to the second installment of the transition tax, and $3.5 billion related to the transfer of intangible properties in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be s ufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.PART II Item 7Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration; Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency - Revenue10% decrease in foreign exchange rates$(3,402)EarningsForeign currency - Investments10% decrease in foreign exchange rates(120)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,909)Fair ValueCredit100 basis point increase in credit spreads(224)Fair ValueEquity10% decrease in equity market prices(244)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATE MENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$66,069$64,497$63,811Service and other59,77445,86332,760Total revenue125,843110,36096,571Cost of revenue:Product16,27315,42015,175Service and other26,63722,93319,086Total cost of revenue42,91038,35334,261Gross margin82,93372,00762,310Research and development16,87614,72613,037Sales and marketing18,21317,46915,461General and administrative4,8854,7544,481RestructuringOperating income42,95935,05829,025Other income, net 1,416Income before income taxes43,68836,47429,901Provision for income taxes4,44819,9034,412Net income$39,240$16,571$25,489Earnings per share:Basic$5.11$2.15$3.29Diluted$5.06$2.13$3.25Weighted average shares outstanding:Basic7,6737,7007,746Diluted7,7537,7947,832Refer to accompanying notes. PART II Item 8COMPREHENSIVE IN COME STATEMENTS (In millions)Year Ended June 30,Net income$39,240$16,571$25,489Other comprehensive income (loss), net of tax:Net change related to derivatives(173)(218)Net change related to investments2,405(2,717)(1,116)Translation adjustments and other(318)(178)Other comprehensive income (loss)1,914(2,856) (1,167) Comprehensive income$41,154$13,715$24,322Refer to accompanying notes. Refer to Note 18 Accumulated Other Comprehensive Income (Loss) for further information.PART II Item 8BALANCE SHEETS (In millions)June 30, AssetsCurrent assets:Cash and cash equivalents$11,356$11,946Short-term investments122,463121,822Total cash, cash equivalents, and short-term investments133,819133,768Accounts receivable, net of allowance for doubtful accounts of $411 and $37729,52426,481Inventories2,0632,662Other10,1466,751Total current assets175,552169,662Property and equipment, net of accumulated depreciation of $35,330 and $29,22336,47729,460Operating lease right-of-use assets7,3796,686Equity investments2,6491,862Goodwill42,02635,683Intangible assets, net7,7508,053Other long-term assets14,7237,442Total assets$286,556$258,848Liabilities and stockholders equityCurrent liabilities:Accounts payable$9,382$8,617Current portion of long-term debt5,5163,998Accrued compensation6,8306,103Short-term income taxes5,6652,121Short-term unearned revenue32,67628,905Other9,3518,744Total current liabilities69,42058,488Long-term debt66,66272,242Long-term income taxes29,61230,265Long-term unearned revenue4,5303,815Deferred income taxesOperating lease liabilities6,1885,568Other long-term liabilities7,5815,211Total liabilities184,226176,130Commitments and contingenciesStockholders equity:Common stock and paid-in capital shares authorized 24,000; outstanding 7,643 and 7,67778,52071,223Retained earnings24,15013,682Accumulated other comprehensive loss(340)(2,187) Total stockholders equity102,33082,718Total liabilities and stockholders equity$286,556$258,848Refer to accompanying notes. PART II Item 8CASH FLOWS S TATEMENTS (In millions) Year Ended June 30,OperationsNet income$39,240$16,571$25,489Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,68210,2618,778Stock-based compensation expense4,6523,9403,266Net recognized gains on investments and derivatives(792)(2,212)(2,073)Deferred income taxes(6,463)(5,143)(829)Changes in operating assets and liabilities:Accounts receivable(2,812)(3,862)(1,216)Inventories(465)Other current assets(1,718)(952)1,028Other long-term assets(1,834)(285)(917)Accounts payable1,148Unearned revenue4,4625,9223,820Income taxes2,92918,1831,792Other current liabilities1,419Other long-term liabilities(20)(118)Net cash from operations52,18543,88439,507FinancingRepayments of short-term debt, maturities of 90 days or less, net(7,324)(4,963)Proceeds from issuance of debt7,18344,344Repayments of debt(4,000)(10,060)(7,922)Common stock issued1,1421,002Common stock repurchased(19,543)(10,721)(11,788)Common stock cash dividends paid(13,811)(12,699)(11,845)Other, net(675)(971)(190)Net cash from (used in) financing(36,887)(33,590)8,408InvestingAdditions to property and equipment(13,925)(11,632)(8,129)Acquisition of companies, net of cash acquired, and purchases of intangible and other assets(2,388)(888)(25,944)Purchases of investments(57,697)(137,380)(176,905)Maturities of investments20,04326,36028,044Sales of investments38,194117,577136,350Securities lending payable(98)(197)Net cash used in investing(15,773)(6,061)(46,781)Effect of foreign exchange rates on cash and cash equivalents(115)Net change in cash and cash equivalents(590)4,2831,153Cash and cash equivalents, beginning of period11,9467,6636,510Cash and cash equivalents, end of period$11,356$11,946$7,663Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQ UITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$71,223$69,315$68,178Common stock issued6,8291,002Common stock repurchased(4,195)(3,033)(2,987)Stock-based compensation expense4,6523,9403,266Other, net(1) Balance, end of period78,52071,22369,315Retained earnings Balance, beginning of period13,68217,76913,118Net income39,24016,57125,489Common stock cash dividends(14,103)(12,917)(12,040)Common stock repurchased(15,346)(7,699)(8,798)Cumulative effect of accounting changes(42)Balance, end of period24,15013,68217,769Accumulated other comprehensive income (loss)Balance, beginning of period(2,187) 1,794Other comprehensive income (loss)1,914(2,856) (1,167)Cumulative effect of accounting changes(67)Balance, end of period(340) (2,187)Total stockholders equity$102,330$82,718$87,711Cash dividends declared per common share$1.84$1.68$1.56Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts related to investments, derivatives, and fair value measurements to conform to the current period presentation based on our adoption of the new accounting standard for financial instruments. We have recast prior period commercial cloud revenue to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations. We have also recast components of the prior period deferred income tax assets and liabilities to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized on our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income (OCI). Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Microsoft Office 365, Microsoft Azure, Microsoft Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 20 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct pe rformance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell ea ch of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2019 and 2018, long-term accounts receivable, net of allowance for doubtful accounts, was $2.2 billion and $1.8 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs(116) (98)(106)Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recogni zed ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics busin ess solutions; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 14 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain online products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6 billion, $1.6 billion, and $1.5 billion in fiscal years 2019, 2018, and 2017, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in OCI. Debt investments are impaired whe n a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers avai lable quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specifi c adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method, or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. For derivative instruments designated as cash flow hedges, the effective portion of the gains and losses are initially reported as a component of OCI and subsequently recognized in revenue when the hedged exposure is recognized in revenue. Gains and losses on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. PART II Item 8 Level 2 inputs are based upon quoted prices for similar instr uments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corrobo rated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interes t rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed secur ities, corporate notes and bonds, and municipal securities . Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. PART II Item 8We have lease agreem ents with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment lease s, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceIncome Taxes Intra-Entity Asset TransfersIn October 2016, the Financial Accounting Standards Board (FASB) issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the guidance effective July 1, 2018. Adoption of the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We recorded a net cumulative-effect adjustment that resulted in an increase in retained earnings of $557 million, which reversed the previous deferral of income tax consequences and recorded new deferred tax assets from intra-entity transfers involving assets other than inventory, partially offset by a U.S. deferred tax liability related to global intangible low-taxed income (GILTI). Adoption of the standard resulted in an increase in long-term deferred tax assets of $2.8 billion, an increase in long-term deferred tax liabilities of $2.1 billion, and a reduction in other current assets of $152 million. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.Financial Instruments Recognition, Measurement, Presentation, and Disclosure In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than OCI. We adopted the standard effective July 1, 2018. Adoption of the standard was applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (AOCI) to retained earnings as of the effective date, and we elected to measure equity investments without readily determinable fair values at cost with adjustments for observable changes in price or impairments. The cumulative-effect adjustment included any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The impact on our consolidated balance sheets upon adoption was not material. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.PART II Item 8Recent Accounting Guid ance Not Yet Adopted Financial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We evaluated the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems, and do not expect the impact to be material upon adoption.Financial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems. NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$39,240$16,571$25,489Weighted average outstanding shares of common stock (B)7,6737,7007,746Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,7537,7947,832Earnings Per ShareBasic (A/B)$5.11$2.15$3.29Diluted (A/C)$5.06$2.13$3.25Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities(93)(987)(162)Other-than-temporary impairments of investments(16)(6)(14)Total$(97)$(966)$(68)Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$3,406$2,692Net unrealized gains on investments still heldImpairments of investments(10) (41) (41) Total$$3,365$2,651PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand Cash EquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,211$$$2,211$1,773$$Certificates of depositLevel 22,0182,0181,430U.S. government securitiesLevel 1104,9251,854(104)106,675105,906U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350(8)6,3462,5063,840Mortgage- and asset-backed securitiesLevel 23,554(3)3,5613,561Corporate notes and bondsLevel 27,437(7)7,5417,541Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747$2,027$(122)$129,652$7,176$122,476$Changes in Fair Value Recorded inNet IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,0852,085Total equity investments$3,058$$$2,649Cash$3,771$3,771$$Derivatives, net (a) (13)(13)Total$136,468$11,356$122,463$2,649PART II Item 8(In millions) Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2018Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,513$$$2,513$2,215$$Certificates of depositLevel 22,0582,0581,865U.S. government securitiesLevel 1108,120(1,167)107,0152,280104,735U.S. agency securitiesLevel 21,7421,7421,398Foreign government bondsLevel 1Foreign government bondsLevel 25,063(10)5,0545,054Mortgage- and asset-backed securitiesLevel 23,864(13)3,8553,855Corporate notes and bondsLevel 26,929(56)6,8946,894Corporate notes and bondsLevel 3Municipal securitiesLevel 2(1)Total debt investments$130,597$$(1,247)$129,475$7,758$121,717$Equity investmentsLevel 1$$$$Equity investmentsLevel 3Equity investmentsOther1,5581,557Total equity investments$2,109$$$1,862Cash$3,942$3,942$$Derivatives, net (a) Total$135,630$11,946$121,822$1,862(a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2019 and 2018, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.2 billion and $697 million, respectively. As of June 30, 2019, we had no collateral received under agreements for loaned securities. As of June 30, 2018, collateral received under agreements for loaned securities was $1.8 billion and primarily comprised U.S. government and agency securities. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2019U.S. government and agency securities$1,491$(1)$39,158$(103)$40,649$(104)Foreign government bonds(8)(8)Mortgage- and asset-backed securities(1)(2)1,042(3)Corporate notes and bonds(3)(4)(7)Total$2,678$(5)$39,989$(117)$42,667$(122)PART II Item 8 Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2018U.S. government and agency securities$82,352$(1,064)$4,459$(103)$86,811$(1,167)Foreign government bonds3,457(7)(3)3,470(10)Mortgage- and asset-backed securities2,072(9)(4)2,168(13)Corporate notes and bonds3,111(43)(13)3,412(56)Municipal securities(1)(1)Total$91,037$(1,124)$4,869$(123)$95,906$(1,247)Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2019Due in one year or less$53,200$53,124Due after one year through five years47,01647,783Due after five years through 10 years26,65827,824Due after 10 yearsTotal$127,747$129,652NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Equity Securities held in our equity investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. In the past, to hedge our price risk, we also used and designated equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. PART II Item 8Other Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2019, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts sold$6,034$11,101Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,8899,425Foreign exchange contracts sold15,61413,374Equity contracts purchasedEquity contracts soldOther contracts purchased1,327Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Changes in Fair Value Recorded in Other Comprehensive IncomeDesignated as Hedging InstrumentsForeign exchange contracts$$$$Changes in Fair Value Recorded in Net IncomeDesignated as Hedging InstrumentsForeign exchange contracts(93)Not Designated as Hedging InstrumentsForeign exchange contracts(172)(197)Equity contracts(7)Other contracts(7)(3)Gross amounts of derivatives(272)(207)Gross amounts of derivatives offset in the balance sheet(113)(152)Cash collateral received(78) (235)Net amounts of derivatives$$(236) $$(289)Reported asShort-term investments$(13)$$$Other current assetsOther long-term assetsOther current liabilities(221)(288)Other long-term liabilities(15)(1)Total$$(236)$$(289)Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $247 million and $272 million, respectively, as of June 30, 2019, and $533 million and $207 million, respectively, as of June 30, 2018. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1Level 2Level 3TotalJune 30, 2019Derivative assets$$$$Derivative liabilities(272)(272)June 30, 2018Derivative assetsDerivative liabilities(1)(206)(207)PART II Item 8Fair Value Hedge Gains (Losses) We recognized in other income (expense), net the following gains (losses) on contracts designated as fair value hedges and their related hedged items: (In millions)Year Ended June 30,Foreign Exchange ContractsDerivatives$$$Hedged items(386)Total amount of ineffectiveness$$$Equity ContractsDerivatives$$(324)$(74)Hedged itemsTotal amount of ineffectiveness$$$Amount of equity contracts excluded from effectiveness assessment$$$(80)Cash Flow Hedge Gains (Losses) We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges: (In millions)Year Ended June 30,Effective PortionGains recognized in other comprehensive income (loss), net of tax of $1 , $11, and $4$$$Gains reclassified from accumulated other comprehensive income (loss) into revenueAmount Excluded from Effectiveness Assessment and Ineffective PortionLosses recognized in other income (expense), net(64)(255)(389)We do not have any net derivative gains included in AOCI as of June 30, 2019 that will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during fiscal year 2019. Non-designated Derivative Gains (Losses) We recognized in other income (expense), net the following gains (losses) on derivatives not designated as hedging instruments: (In millions)Year Ended June 30,Foreign exchange contracts$(97)$(33)$(117)Equity contracts(87)(114)Other contracts(17)(3)Total$(59)$(137)$(234)PART II Item 8NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,6111,953Total$2,063$2,662NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,540$1,254Buildings and improvements26,28820,604Leasehold improvements5,3164,735Computer equipment and software33,82327,633Furniture and equipment4,8404,457Total, at cost71,80758,683Accumulated depreciation(35,330)(29,223)Total, net$36,477$29,460During fiscal years 2019, 2018, and 2017, depreciation expense was $9.7 billion, $7.7 billion, and $6.1 billion, respectively. We have committed $4.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2019. NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018, we acquired GitHub, Inc. (GitHub), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497Intangible assets1,267Other assetsOther liabilities(217)Total$6,924The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,2677 yearsTransactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period. LinkedIn CorporationOn December 8, 2016, we completed our acquisition of all issued and outstanding shares of LinkedIn Corporation (LinkedIn), the worlds largest professional network on the Internet, for a total purchase price of $27.0 billion. The purchase price consisted primarily of cash of $26.9 billion. The acquisition is expected to accelerate the growth of LinkedIn, Office 365, and Dynamics 365. The financial results of LinkedIn have been included in our consolidated financial statements since the date of the acquisition. PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2017. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash and cash equivalents$1,328Short-term investments2,110Other current assetsProperty and equipment1,529Intangible assets7,887Goodwill ( a ) 16,803Short-term debt (b) (1,323)Other current liabilities(1,117)Deferred income taxes(774)Other(131)Total purchase price$27,009(a) Goodwill was assigned to our Productivity and Business Processes segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of LinkedIn. None of the goodwill is expected to be deductible for income tax purposes. (b) Convertible senior notes issued by LinkedIn on November 12, 2014, substantially all of which were redeemed after our acquisition of LinkedIn. The remaining $18 million of notes are not redeemable and are included in long-term debt in our consolidated balance sheets. Refer to Note 11 Debt for further information. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$3,6077 yearsMarketing-related (trade names)2,14820 yearsTechnology-based2,1093 yearsContract-based5 yearsFair value of intangible assets acquired$7,8879 yearsOur consolidated income statements include the following revenue and operating loss attributable to LinkedIn since the date of acquisition:(In millions)Year Ended June 30,Revenue$2,271Operating loss(924)Following are the supplemental consolidated financial results of Microsoft Corporation on an unaudited pro forma basis, as if the acquisition had been consummated on July 1, 2015: (In millions, except per share amounts)Year Ended June 30,Revenue$98,291$94,490Net income25,17919,128Diluted earnings per share3.212.38These pro forma results were based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily amortization of intangible assets. Acquisition costs and other nonrecurring charges were immaterial and are included in the earliest period presented.PART II Item 8Other During fiscal year 2019, we completed 19 additional acquisitions for $1.6 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2019Productivity and Business Processes$23,739$$$23,823$$(60)$24,277Intelligent Cloud5,555(16)5,7035,605(a) (a) 11,351More Personal Computing5,828(65)6,157(48)6,398Total $35,122$$(69)$35,683$6,408$(65)$42,026(a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2019, May 1, 2018, or May 1, 2017 tests. As of June 30, 2019 and 2018, accumulated goodwill impairment was $11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$7,691$(5,771)$1,920$7,220$(5,018)$2,202Customer-related4,709(1,785)2,9244,031(1,205)2,826Marketing-related4,165(1,327)2,8384,006(1,071)2,935Contract-based(506)(589)Total$17,139(a) $(9,389)$7,750$15,936$(7,883)$8,053(a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 Business Combinations for further information. No material impairments of intangible assets were identified during fiscal years 2019, 2018, or 2017. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$5 years$4 yearsMarketing-related10 years5 yearsContract-based3 years4 yearsCustomer-related8 years5 yearsTotal$1,7087 years$5 yearsIntangible assets amortization expense was $1.9 billion, $2.2 billion, and $1.7 billion for fiscal years 2019, 2018, and 2017, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2019: (In millions)Year Ending June 30,$1,4881,2821,1871,053Thereafter2,003Total$7,750NOTE 11 DEBT Short-term DebtAs of June 30, 2019 and 2018, we had no commercial paper issued or outstanding. Effective August 31, 2018, we terminated our credit facilities, which served as back-up for our commercial paper program. Long-term DebtAs of June 30, 2019, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $72.2 billion and $78.9 billion, respectively. As of June 30, 2018, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $76.2 billion and $77.5 billion, respectively. These estimated fair values are based on Level 2 inputs. PART II Item 8The components of our long-term debt, including the current portion, and the associated interest rates were as follows: (In millions, except interest rates)Face Value June 30,Face Value June 30,StatedInterestRateEffectiveInterestRateNotesNovember 3, 2018$$1,7501.300%1.396%December 6, 20181,2501.625%1.824%June 1, 20191,0004.200%4.379%August 8, 2019 2,5002,5001.100%1.203%November 1, 2019 0.500%0.500%February 6, 2020 1,5001,5001.850%1.952%February 12, 20201,5001,5001.850%1.935%October 1, 20201,0001,0003.000%3.137%November 3, 20202,2502,2502.000%2.093%February 8, 20214.000%4.082%August 8, 2021 2,7502,7501.550%1.642%December 6, 2021 (a) 1,9942,0442.125%2.233%February 6, 2022 1,7501,7502.400%2.520%February 12, 20221,5001,5002.375%2.466%November 3, 20221,0001,0002.650%2.717%November 15, 20222.125%2.239%May 1, 20231,0001,0002.375%2.465%August 8, 2023 1,5001,5002.000%2.101%December 15, 20231,5001,5003.625%3.726%February 6, 2024 2,2502,2502.875%3.041%February 12, 20252,2502,2502.700%2.772%November 3, 20253,0003,0003.125%3.176%August 8, 2026 4,0004,0002.400%2.464%February 6, 2027 4,0004,0003.300%3.383%December 6, 2028 (a) 1,9932,0443.125%3.218%May 2, 2033 (a) 2.625%2.690%February 12, 20351,5001,5003.500%3.604%November 3, 20351,0001,0004.200%4.260%August 8, 2036 2,2502,2503.450%3.510%February 6, 2037 2,5002,5004.100%4.152%June 1, 20395.200%5.240%October 1, 20401,0001,0004.500%4.567%February 8, 20411,0001,0005.300%5.361%November 15, 20423.500%3.571%May 1, 20433.750%3.829%December 15, 20434.875%4.918%February 12, 20451,7501,7503.750%3.800%November 3, 20453,0003,0004.450%4.492%August 8, 2046 4,5004,5003.700%3.743%February 6, 20473,0003,0004.250%4.287%February 12, 20552,2502,2504.000%4.063%November 3, 20551,0001,0004.750%4.782%August 8, 20562,2502,2503.950%4.033%February 6, 2057 2,0002,0004.500%4.528%Total$72,781$76,898(a) Euro-denominated debt securities. The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. Cash paid for interest on our debt for fiscal years 2019, 2018, and 2017 was $2.4 billion, $2.4 billion, and $1.6 billion, respectively. As of June 30, 2019 and 2018, the aggregate debt issuance costs and unamortized discount associated with our long-term debt, including the current portion, were $603 million and $658 million, respectively. PART II Item 8Maturities of our long-term debt for each of the next five years and thereafter are as follows: (In millions)Year Ending June 30,$5,5183,7507,9942,7505,250Thereafter47,519Total$72,781NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our GILTI effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax. PART II Item 8Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$4,718$19,764$2,739U.S. state and localForeign5,5314,3482,472Current taxes$10,911$25,046$5,241Deferred TaxesU.S. federal$(5,647)$(4,292)$(554)U.S. state and local(1,010)(458)Foreign(393)(544)Deferred taxes$(6,463)$(5,143)$(829)Provision for income taxes$4,448$19,903$4,412U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$15,799$11,527$6,843Foreign 27,88924,94723,058Income before income taxes$43,688$36,474$29,901Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0%28.1%35.0%Effect of:Foreign earnings taxed at lower rates(4.1)%(7.8)%(11.6)%Impact of the enactment of the TCJA0.4%37.7%0%Phone business losses0%0%(5.7)%Impact of intangible property transfers(5.9)%0%0%Foreign-derived intangible income deduction(1.4)%0%0%Research and development credit(1.1)%(1.3)%(0.9)%Excess tax benefits relating to stock-based compensation(2.2)%(2.5)%(2.1)%Interest, net1.0%1.2%1.4%Other reconciling items, net2.5%(0.8)%(1.3)%Effective rate10.2%54.6%14.8%PART II Item 8The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers , and earnings taxed at lower rates in foreign jurisdictions resulting from producing and dis tributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico . The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 , offset in part by earnings taxed at lower rates in foreign jurisdictions. The decrease from the federal statutory rate in fiscal year 2017 is primarily due to earnings taxed at lower rates in foreign jurisdictions. Our foreign regional operating centers in Ireland, Singapore and Puerto Rico , which are taxed at rates lower than the U.S. rate, generated 82 %, 8 7 %, and 76 % of our foreign income b efore tax in fiscal years 2019, 2018, and 2017, respectively. Other reconciling items, net consists primarily of tax credits, GILTI, and U.S. state income taxes. In fiscal years 2019, 2018, and 2017, there were no individually significant other reconciling items. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,2871,832Loss and credit carryforwards3,5183,369Depreciation and amortization7,046Leasing liabilities1,5941,427Unearned revenueOtherDeferred income tax assets15,6937,495Less valuation allowance(3,214)(3,186)Deferred income tax assets, net of valuation allowance$12,479$4,309Deferred Income Tax LiabilitiesUnrealized gain on investments and debt$(738)$Unearned revenue(30)(639)Depreciation and amortization(1,164)Leasing assets(1,510)(1,366)Deferred GILTI tax liabilities(2,607)(61)Other(291)(251)Deferred income tax liabilities$(5,176)$(3,481)Net deferred income tax assets (liabilities)$7,303$Reported AsOther long-term assets$7,536$1,369Long-term deferred income tax liabilities(233)(541)Net deferred income tax assets (liabilities)$7,303$Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. PART II Item 8As of J une 30, 2019, we had federal, state and foreign net operating loss carryforwards of $ 978 million, $ 770 million, and $11. 6 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 20 20 through 203 9 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $8.4 billion, $5.5 billion, and $2.4 billion in fiscal years 2019, 2018, and 2017, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2019, 2018, and 2017, were $13.1 billion, $12.0 billion, and $11.7 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2019, 2018, and 2017 by $12.0 billion, $11.3 billion, and $10.2 billion, respectively.As of June 30, 2019, 2018, and 2017, we had accrued interest expense related to uncertain tax positions of $3.4 billion, $3.0 billion, and $2.3 billion, respectively, net of income tax benefits. The provision for (benefit from) income taxes for fiscal years 2019, 2018, and 2017 included interest expense related to uncertain tax positions of $515 million, $688 million, and $399 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$11,961$11,737$10,164Decreases related to settlements(316)(193)(4)Increases for tax positions related to the current year2,1061,4451,277Increases for tax positions related to prior yearsDecreases for tax positions related to prior years(1,113)(1,176)(49)Decreases due to lapsed statutes of limitations(3)(48)Ending unrecognized tax benefits$13,146$11,961$11,737We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 RESTRUCTURING CHARGES In June 2017, management approved a sales and marketing restructuring plan. In fiscal year 2017, we recorded employee severance expenses of $306 million primarily related to this sales and marketing restructuring plan. The actions associated with this restructuring plan were completed as of June 30, 2018.PART II Item 8NOTE 14 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$16,831$14,864Intelligent Cloud16,98814,706More Personal Computing3,3873,150Total$37,206$32,720Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2019Balance, beginning of period$32,720Deferral of revenue69,493Recognition of unearned revenue(65,007)Balance, end of period$37,206Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (contracted not recognized revenue), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $91 billion as of June 30, 2019, of which we expect to recognize approximately 50% of the revenue over the next 12 months and the remainder thereafter. Many customers are committing to our products and services for longer contract terms, which is increasing the percentage of contracted revenue that will be recognized beyond the next 12 months.NOTE 15 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$1,707$1,585$1,412Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$PART II Item 8Supplemental cash flow information related to leases was as follows: (In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,670$1,522$1,157Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases2,3031,5711,270Finance leases2,5321,9331,773Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate) June 30, Operating LeasesOperating lease right-of-use assets$7,379$6,686Other current liabilities$1,515$1,399Operating lease liabilities6,1885,568Total operating lease liabilities$7,703$6,967Finance LeasesProperty and equipment, at cost$7,041$4,543Accumulated depreciation(774)(404)Property and equipment, net$6,267$4,139Other current liabilities$$Other long-term liabilities6,2574,125Total finance lease liabilities$6,574$4,301Weighted Average Remaining Lease TermOperating leases7 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases3.0%2.7%Finance leases4.6%5.2%Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,678$1,4381,2351,036Thereafter2,4385,671Total lease payments8,6648,776Less imputed interest(961)(2,202)Total$7,703$6,574PART II Item 8As of June 30 , 201 9 , we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 2.3 billion and $ 6.1 billion, respectively. These operating and finance leases will commence between fiscal year 20 20 and fiscal year 202 2 with lease terms of 1 year to 15 years. NOTE 16 CONTINGENCIES Patent and Intellectual Property Claims There were 44 patent infringement cases pending against Microsoft as of June 30, 2019, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence. Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to be scheduled in the second half of calendar year 2019. PART II Item 8Employment-Related Lit igation Moussouris v. MicrosoftCurrent and former female Microsoft employees in certain engineering and information technology roles brought this class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an expert report showing no statistically significant disparity in pay and promotions between similarly situated men and women. In June 2018, the court denied the plaintiffs motion for class certification. Plaintiffs sought an interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit, which was granted in September 2018. Oral argument is scheduled for October 2019. Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2019, we accrued aggregate legal liabilities of $386 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.0 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 17 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,6777,7087,808IssuedRepurchased(150)(99)(170)Balance, end of year7,6437,6777,708Share Repurchases On September 16, 2013, our Board of Directors approved a share repurchase program (2013 Share Repurchase Program) authorizing up to $40.0 billion in share repurchases. The 2013 Share Repurchase Program became effective on October 1, 2013, and was completed on December 22, 2016. On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to an additional $40.0 billion in share repurchases (2016 Share Repurchase Program). This share repurchase program commenced on December 22, 2016 following completion of the 2013 Share Repurchase Program, has no expiration date, and may be suspended or discontinued at any time without notice. As of June 30, 2019, $11.4 billion remained of the 2016 Share Repurchase Program.PART II Item 8We repurchased the following shares of common stock under the share repurchase prog rams: (In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$2,600$1,600$3,550Second Quarter6,1001,8003,533Third Quarter3,8993,1001,600Fourth Quarter4,2002,1001,600Total$16,799$8,600$10,283Shares repurchased in the first and second quarter of fiscal year 2017 were under the 2013 Share Repurchase Program. All other shares repurchased were under the 2016 Share Repurchase Program. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $2.7 billion, $2.1 billion, and $1.5 billion for fiscal years 2019, 2018, and 2017, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2019 (In millions) September 18, 2018November 15, 2018December 13, 2018$0.46$3,544November 28, 2018February 21, 2019March 14, 20190.463,526March 11, 2019May 16, 2019June 13, 20190.463,521June 12, 2019August 15, 2019September 12, 20190.463,516Total$1.84$14,107Fiscal Year 2018September 19, 2017November 16, 2017December 14, 2017$0.42$3,238November 29, 2017February 15, 2018March 8, 20180.423,232March 12, 2018May 17, 2018June 14, 20180.423,226June 13, 2018August 16, 2018September 13, 20180.423,220Total$1.68$12,916The dividend declared on June 12, 2019 was included in other current liabilities as of June 30, 2019. PART II Item 8NOTE 1 8 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component: (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains, net of tax of $2 , $11, and $4Reclassification adjustments for gains included in revenue(341)(185)(555)Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)(333)(179)(546)Net change related to derivatives, net of tax of $(6), $5, and $(5)(173)(218)Balance, end of period$$$InvestmentsBalance, beginning of period$(850)$1,825$2,941Unrealized gains (losses), net of tax of $616 , $(427), and $2672,331(1,146)Reclassification adjustments for (gains) losses included in other income (expense), net(2,309)(2,513)Tax expense (benefit) included in provision for income taxes(19)Amounts reclassified from accumulated other comprehensive income (loss)(1,571)(1,633)Net change related to investments, net of tax of $635 , $(1,165), and $(613)2,405(2,717)(1,116)Cumulative effect of accounting changes(67)Balance, end of period$1,488$(850)$1,825Translation Adjustments and OtherBalance, beginning of period$(1,510)$(1,332)$(1,499)Translation adjustments and other, net of tax effects of $(1) , $0, and $9(318)(178)Balance, end of period$(1,828)$(1,510)$(1,332)Accumulated other comprehensive income (loss), end of period$(340)$(2,187)$NOTE 19 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2019, an aggregate of 327 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$4,652$3,940$3,266Income tax benefits related to stock-based compensation1,066PART II Item 8Stock Plans Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a four or five-year service period. Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a four-year service period. PSUs generally vest over a three-year performance period. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions: Year Ended June 30,Dividends per share (quarterly amounts)$0.42 - $0.46$0.39 - $0.42$0.36 - $0.39Interest rates1.8% - 3.1%1.7% - 2.9%1.2% - 2.2%During fiscal year 2019, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$57.85Granted (a) 107.02Vested(77) 57.08Forfeited(13) 69.35Nonvested balance, end of year$78.49(a) Includes 2 million, 3 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2019, 2018, and 2017, respectively. As of June 30, 2019, there was approximately $8.6 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of 3 years. The weighted average grant-date fair value of stock awards granted was $107.02, $75.88, and $55.64 for fiscal years 2019, 2018, and 2017, respectively. The fair value of stock awards vested was $8.7 billion, $6.6 billion, and $4.8 billion, for fiscal years 2019, 2018, and 2017, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$104.85$76.40$56.36As of June 30, 2019, 105 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $877 million, $807 million, and $734 million in fiscal years 2019, 2018, and 2017, respectively, and were expensed as contributed. NOTE 20 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things (IoT); and MSN advertising. Devices, including Microsoft Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including restructuring expenses. Segment revenue and operating income were as follows during the periods presented: (In millions)Year Ended June 30,RevenueProductivity and Business Processes$41,160$35,865$29,870Intelligent Cloud38,98532,21927,407More Personal Computing45,69842,27639,294Total$125,843$110,360$96,571Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,389Intelligent Cloud13,92011,5249,127More Personal Computing12,82010,6108,815Corporate and Other(306)Total$42,959$35,058$29,025Corporate and Other operating loss comprised restructuring expenses. No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2019, 2018, or 2017. Revenue, classified by the major geographic areas in which our customers were located, was as follows:(In millions)Year Ended June 30,United States (a) $64,199$55,926$51,078Other countries61,64454,43445,493Total$125,843$110,360$96,571(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$32,622$26,129$21,649Office products and cloud services31,76928,31625,573Windows20,39519,51818,593Gaming11,38610,3539,051Search advertising7,6287,0126,219LinkedIn6,7545,2592,271Enterprise Services6,1245,8465,542Devices6,0955,1345,062Other3,0702,7932,611Total$125,843$110,360$96,571Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $38.1 billion, $26.6 billion and $16.2 billion in fiscal years 2019, 2018, and 2017, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment; it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$55,252$44,501$42,730Ireland12,95812,84312,889Other countries25,42222,53819,898Total$93,632$79,882$75,517PART II Item 8NOTE 2 1 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2019Revenue$29,084$32,471$30,571$33,717$125,843Gross margin19,17920,04820,40123,30582,933Operating income 9,95510,25810,34112,40542,959Net income (a) 8,8248,4208,80913,18739,240Basic earnings per share1.151.091.151.725.11Diluted earnings per share (b) 1.141.081.141.715.06Fiscal Year 2018Revenue $24,538$28,918$26,819$30,085$110,360Gross margin16,26017,85417,55020,34372,007Operating income 7,7088,6798,29210,37935,058Net income (loss) ( c ) 6,576(6,302) 7,4248,87316,571Basic earnings (loss) per share0.85(0.82) 0.961.152.15Diluted earnings (loss) per share ( d ) 0.84(0.82)0.951.142.13(a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019. ( c ) Reflects the net charge (benefit) related to the enactment of the TCJA of $13.8 billion for the second quarter, $(104) million for the fourth quarter, and $13.7 billion for fiscal year 2018. ( d ) Reflects the net charge (benefit) related to the enactment of the TCJA, wh ich decreased (increased) diluted EPS $1.78 for the second quarter, $(0.01) for the fourth quarter, and $1.75 for fiscal year 2018. PART II Item 8REPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the Company) as of June 30, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows, for each of the three years in the period ended June 30, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 1, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the Companys Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. PART II Item 8Revenue Recognition Refer to Note 1 to the F inancial S tatements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Estimation of variable consideration when determining the amount of revenue to recognize (e.g., customer credits, incentives, and in certain instances, estimation of customer usage of products and services). Given these factors, the related audit effort in evaluating managements judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Companys revenue recognition for these customer agreements included the following: We tested the effectiveness of internal controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated managements significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested managements identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration. Assessed the terms in the customer agreement and evaluated the appropriateness of managements application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of managements estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of managements calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 1 2 to the F inancial S tatements Critical Audit Matter Description The Companys long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (IRS). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Companys financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating managements estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate managements estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of managements methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated managements documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of managements judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of managements estimates by considering how tax law, including statutes, regulations and case law, impacted managements judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019We have served as the Companys auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2019. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019; their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2019, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the financial statements) as of and for the year ended June 30, 2019, of the Company and our report dated August 1, 2019, expressed an unqualified opinion on those financial statements.Basis for OpinionThe Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019 PART II, III Item 9B, 10, 11, 12, 13, 14" +18,Microsoft Corporation,2017," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The A mbitions T hat D rive U s To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesWe are in a unique position to empower people and organizations to succeed in a rapidly evolving workplace. Computing experiences are evolving, no longer bound to one device at a time. Instead, experiences are expanding to many devices as people move from home to work to on the go. These modern needs, habits, and expectations of our customers are motivating us to bring Microsoft Office 365, Windows platform, devices, including Microsoft Surface, and third-party applications into a more cohesive Microsoft 365 experience.Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Microsoft Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is core to our vision for the modern workplace as the digital hub that creates a single canvas for teamwork, conversations, meetings, and content. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and inspire teamwork, while simplifying security and management. Organizations of all sizes can now digitize business-critical functions, redefining what customers can expect from their business applications. This creates an opportunity for us to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformCompanies are looking to use digital technology to fundamentally reimagine how they empower their employees, engage customers, optimize their operations, and change the very core of their products and services. Partnering with organizations on their digital transformation is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Microsoft Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions, with new Azure services and devices such as HoloLens 2. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for cus tomers to take Microsoft SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation help s every developer be an AI d eveloper, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. On October 25, 2018, we completed our acquisition of GitHub, Inc. (GitHub), a service that millions of developers around the world rely on to write code together. The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences.Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently expanded our Surface family of devices with the Surface Hub 2S, which brings together Microsoft Teams, Windows, and Surface hardware to power teamwork for organizations. We are mobilizing to pursue our expansive opportunity in the gaming industry, broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed. We have a strong position with our Xbox One console, our large and growing highly engaged community of gamers on Xbox Live, and with Windows 10, the most popular operating system for PC gamers. We will continue to connect our gaming assets across PC, console, and mobile, and work to grow and engage the Xbox Live member network more deeply and frequently with services like Mixer and Xbox Game Pass. Our approach is to enable gamers to play the games they want, with the people they want, on the devices they want.Our Future OpportunityCustomers are looking to us to accelerate their own digital transformations and to unlock new opportunity in this era of intelligent cloud and intelligent edge. We continue to develop complete, intelligent solutions for our customers that empower users to be creative and work together while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.PART I Item 1Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Office 365. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the world's professionals to make them more productive and successful, and is the world's largest professional network on the Internet. LinkedIn offers services that can be used by customers to transform the way they hire, market, sell, and learn. In addition to LinkedIns free services, LinkedIn offers three categories of monetized solutions: Talent Solutions, Marketing Solutions, and Premium Subscriptions, which includes Sales Solutions. Talent Solutions is comprised of two elements: Hiring, and Learning and Development. Hiring provides services to recruiters that enable them to attract, recruit, and hire talent. Learning and Development provides subscriptions to enterprises and individuals to access online learning content. Marketing Solutions enables companies to advertise to LinkedIns member base. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Premium Subscriptions also includes Sales Solutions, which helps sales professionals find, qualify, and create sales opportunities and accelerate social selling capabilities. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions.On November 16, 2018, LinkedIn acquired Glint, an employee engagement platform, to expand its Talent Solutions offerings. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and analytics applications for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services; job boards; traditional recruiting firms; and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers.Dynamics competes with vendors such as Infor, NetSuite, Oracle, Salesforce.com, SAP, and The Sage Group to provide cloud-based and on-premise business solutions for small, medium, and large organizations.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesOur server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Azure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionOur server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. PART I Item 1We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware a nd software applications, security, and manageability. Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, Salesforce.com, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows IoT; and MSN advertising. Devices, including Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. PART I Item 1Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings. Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface, PC accessories, and other intelligent devices. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. GamingOur gaming platform is designed to provide a unique variety of entertainment using our devices, peripherals, applications, online services, and content. We released Xbox One S and Xbox One X in August 2016 and November 2017, respectively. With the launch of the Mixer service in May 2017, offering interactive live streaming, and Xbox Game Pass in June 2017, providing unlimited access to over 100 Xbox titles, we continue to open new opportunities for customers to engage both on- and off-console. With our acquisition of PlayFab in January 2018, we enable worldwide game developers to utilize game services, LiveOps, and analytics for player acquisition, engagement, and retention. We have also made these services available for developers outside of the gaming industry.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox Live revenue is mainly affected by subscriptions and sales of Xbox Live enabled content, as well as advertising. We also continue to design and sell gaming content to showcase our unique platform capabilities for Xbox consoles, Windows-enabled devices, and other devices. Growth of our Gaming business is determined by the overall active user base through Xbox Live enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences via online services including game streaming, downloadable content, and peripherals. SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.PART I Item 1Our gaming platform competes with console platforms from Nintendo and Sony , both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years. Nintendo released its latest generation console in March 2017 and Sony released its latest generation console in November 2013. We also compete with other providers of entertainment services through online marketplaces. We believe our gaming pla tform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our o wn game franchises as well as other digital content offerings. Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live and our cloud gaming services face competition from various online marketplaces, including those operated by Amazon, Apple, and Google. Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region; the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region; and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility and Management, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on connecting gaming assets across the range of devices to grow and engage the Xbox Live member network through game experiences, streaming content, and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. PART I Item 1We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internatio nally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and curren tly have a portfolio of over 61,000 U.S. and international patents issued and over 26,000 pending. While we employ much of our internally- developed intellectual property exclusively in our products and services, we also engage in outbound licensing of spec ific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we i ncorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with enterprises and public-sector organizations worldwide to identify and meet their technology requirements; managing OEM relationships; and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. PART I Item 1There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a di rect agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with ma ny regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces, online stores, and retail stores. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, and training to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. PART I Item 1Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, hosting partner, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 31, 2019 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerMargaret L. JohnsonExecutive Vice President, Business DevelopmentBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Ms. Johnson was appointed Executive Vice President, Business Development in September 2014. Prior to that Ms. Johnson spent 24 years at Qualcomm in various leadership positions across engineering, sales, marketing and business development. She most recently served as Executive Vice President of Qualcomm Technologies, Inc. Ms. Johnson also serves on the Board of Directors of BlackRock, Inc.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2019, we employed approximately 144,000 people on a full-time basis, 85,000 in the U.S. and 59,000 internationally. Of the total employed people, 47,000 were in operations, including manufacturing, distribution, product support, and consulting services; 47,000 were in product research and development; 38,000 were in sales and marketing; and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RIS K FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on personal computers. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end-users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Microsoft Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, Microsoft SQL Server, Windows Server, Azure, Office 365, Xbox Live, Mixer, LinkedIn, and other p roducts and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commerc ial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their p urchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may no t be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Microsoft Edge and Bing, that drive post- sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or prod uct experiences, which could negatively impact product and feature adoption, product design , and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. In December 2016, we completed our acquisition of LinkedIn Corporation (LinkedIn) for $27.0 billion, and in October 2018, we completed our acquisition of GitHub, Inc. for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge on our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. Our acquisition of LinkedIn resulted in a significant increase in our goodwill and intangible asset balances. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improved technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes like passwords. Inadequate account security practices may also result in unauthorized access. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. PART I Item 1AThe cost of these steps could reduc e our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future pu rchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers ma y fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilitie s may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. As illustrated by the Spectre and Meltdown threats, our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For LinkedIn, Microsoft Advertising, MSN, Xbox Live, and other products and services that provide content or host ads that come from or can be influenced by third parties, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AHarmful content online Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, substantial liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an Internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or insufficient Internet connectivity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophis ticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contai n provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described in the next paragraph. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow bec ause of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Microsoft Surface. To resolve thes e claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In s ome countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact on our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow; at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Iran, North Korea, Cuba, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Skype are covered by existing laws regulating telecommunications services, and some new laws are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us , or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve . For example, the EU and the U.S. formally entered into a new framework in July 2016 that provides a mechanism for companies to transfer data from EU member states to the U.S. This framework, called the Privacy Shield, is intended to address shortcomings identified by the European Court of Justice in a predecessor mechanism. The Privacy Shield and other mechanisms are currently subject to challenges in European courts, which may lead to uncertainty about the legal basis for data transfers across the Atlant ic. The Privacy Shield and other potential rules on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, a new EU law governing data practices and privacy , the General Data Protection Regulation (GDPR), bec a me effective. The law , which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of new compliance obligations regarding the handling of personal data. Engineering efforts to build new capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experien ce reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if the changes we implement to comply with the GDPR make our offe rings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to c omply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits , or reputational damage . In the U.S., California has adopted and several states are considering ad opting laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal reviews by regulators may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location and movement of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S . A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing juris dictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements . If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Substantial revenue comes from our U.S. government contracts. An extended federal government shutdown resulting from failing to pass budget appropriations, adopt continuing funding resolutions or raise the debt ceiling, and other budgetary decisions limiting or delaying federal government spending, could reduce government IT spending on our products and services and adversely affect our revenue. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. PART I Item 1AWe maintain an investment portfolio of various holdings, t ypes, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio c omprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements . Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages on our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The long-term effects of climate change on the global economy or the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other natural resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in weather where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVE D STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2019 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India; our datacenters in Ireland, the Netherlands, and Singapore; and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, Germany, India, Japan, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. These annual reports will continue through 2020. During fiscal year 2019, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking); (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts; and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 16 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 29, 2019, there were 94,069 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2019:PeriodTotal Number of SharesPurchasedAveragePrice Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares that May Yet bePurchased under the Plans or Programs(In millions)April 1, 2019 April 30, 20198,547,612$122.858,547,612$14,551May 1, 2019 May 31, 201914,029,339126.3214,029,33912,778June 1, 2019 June 30, 201910,469,682131.5910,469,68211,40133,046,63333,046,633All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2019: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 12, 2019August 15, 2019September 12, 2019$0.46$3,516We returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.Highlights from fiscal year 2019 compared with fiscal year 2018 included: Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties, increased 43% to $38.1 billion. Office Commercial revenue increased 13%, driven by Office 365 Commercial growth of 33%. Office Consumer revenue increased 7%, and Office 365 Consumer subscribers increased to 34.8 million. LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. Dynamics revenue increased 15%, driven by Dynamics 365 growth of 47%. Server products and cloud services revenue, including GitHub, increased 25%, driven by Azure growth of 72%. Enterprise Services revenue increased 5%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 4%. Windows Commercial revenue increased 14%. Microsoft Surface revenue increased 23%. Gaming revenue increased 10%, driven by Xbox software and services growth of 19%. Search advertising revenue, excluding traffic acquisition costs, increased 13%.We have recast certain prior period commercial cloud metrics to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations.On October 25, 2018, we acquired GitHub, Inc. (GitHub) in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional ne t charge related to the enactment of the TCJA of $13. 7 billion in fiscal year 2018 , and adjusted our provisional net charge by recording additional tax expense of $ 157 million in the second quarter of fiscal year 2019. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland, which resulted in a $2.6 billion net income tax benef it . Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of foreign currencies relative to the U.S. dollar throughout fiscal year 2018 positively impacted reported revenue and increased reported expenses from our international operations. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017Revenue$125,843$110,360$96,57114%14%Gross margin82,93372,00762,31015%16%Operating income42,95935,05829,02523%21%Net income39,24016,57125,489137%(35)%Diluted earnings per share5.062.133.25138%(34)%Non-GAAP operating income42,959 35,05829,33123% 20%Non-GAAP net income36,83030,26725,73222%18%Non-GAAP diluted earnings per share4.753.883.2922%18%Non-GAAP operating income, net income, and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.Operating income increased $7.9 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Current year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Prior year net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively. Fiscal Year 2018 Compared with Fiscal Year 2017Revenue increased $13.8 billion or 14%, driven by growth across each of our segments. Productivity and Business Processes revenue increased, driven by LinkedIn and higher revenue from Office. Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services. More Personal Computing revenue increased, driven by higher revenue from Gaming, Windows, Search advertising, and Surface, offset in part by lower revenue from Phone.PART II Item 7Gross margin increased $9.7 billion or 16%, due to growth across each of our segments. Gross margin percentage increased slightly, driven by favo rable segment sales mix and gross margin percentage improvement in More Personal Computing. Gross margin included a 7 percentage point improvement in commercial cloud, primarily from Azure. Operating income increased $6.0 billion or 21%, driven by growth across each of our segments. LinkedIn operating loss increased $63 million to $987 million, including $1.5 billion of amortization of intangible assets. Operating income included a favorable foreign currency impact of 2%.Key changes in expenses were: Cost of revenue increased $4.1 billion or 12%, mainly due to growth in our commercial cloud, Gaming, LinkedIn, and Search advertising, offset in part by a reduction in Phone cost of revenue. Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses.Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted earnings per share of $13.7 billion and $1.75, respectively. Fiscal year 2017 operating income, net income, and diluted EPS were negatively impacted by restructuring expenses, which resulted in a decrease to operating income, net income, and diluted EPS of $306 million, $243 million, and $0.04, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017RevenueProductivity and Business Processes$41,160$35,865$29,87015%20%Intelligent Cloud38,98532,21927,40721%18%More Personal Computing45,69842,27639,2948%8%Total $125,843$110,360$96,57114%14%Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,38925%13%Intelligent Cloud13,92011,5249,12721%26%More Personal Computing12,82010,6108,81521%20%Corporate and Other(306)**Total $42,959$35,058$29,02523%21%* Not meaningful. Reportable Segments Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. PART II Item 7 Office Consumer revenue increased $286 million or 7 %, driven by Office 365 Consumer, due to recurring subscription revenue and transactional strength in Japan . LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer. Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to a sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Productivity and Business Processes Revenue increased $6.0 billion or 20%. LinkedIn revenue increased $3.0 billion to $5.3 billion. Fiscal year 2018 included a full period of results, whereas fiscal year 2017 only included results from the date of acquisition on December 8, 2016. LinkedIn revenue primarily consisted of revenue from Talent Solutions. Office Commercial revenue increased $2.4 billion or 11%, driven by Office 365 Commercial revenue growth, mainly due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial. Office Consumer revenue increased $382 million or 11%, driven by Office 365 Consumer revenue growth, mainly due to growth in subscribers. Dynamics revenue increased 13%, driven by Dynamics 365 revenue growth. Operating income increased $1.5 billion or 13%, including a favorable foreign currency impact of 2%. Gross margin increased $4.4 billion or 19%, driven by LinkedIn and growth in Office Commercial. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Office 365 Commercial and LinkedIn. LinkedIn cost of revenue increased $818 million to $1.7 billion, including $888 million of amortization for acquired intangible assets. Operating expenses increased $2.9 billion or 25%, driven by LinkedIn expenses and investments in commercial sales capacity and cloud engineering. LinkedIn operating expenses increased $2.2 billion to $4.5 billion, including $617 million of amortization of acquired intangible assets. Intelligent CloudRevenue increased $4.8 billion or 18%. Server products and cloud services revenue increased $4.5 billion or 21%, driven by Azure and server products licensed on-premises revenue growth. Azure revenue grew 91%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products licensed on-premises revenue increased 5% , mainly due to a higher mix of premium licenses for Windows Server and Microsoft SQL Server. Enterprise Services revenue increased $304 million or 5% , driven by higher revenue from Premier Support Services and Microsoft Consulting Services, offset in part by a decline in revenue from custom support agreements.Operating income increased $2.4 billion or 26%. Gross margin increased $3.1 billion or 16%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage decreased, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Azure. Operating expenses increased $683 million or 7%, driven by investments in commercial sales capacity and cloud engineering.More Personal Computing Revenue increased $3.0 billion or 8%. Windows revenue increased $925 million or 5%, driven by growth in Windows Commercial and Windows OEM, offset by a decline in patent licensing revenue. Windows Commercial revenue increased 12%, driven by multi-year agreement revenue growth. Windows OEM revenue increased 5%. Windows OEM Pro revenue grew 11%, ahead of a strengthening commercial PC market. Windows OEM non-Pro revenue declined 4%, below the consumer PC market, driven by continued pressure in the entry-level price category. Gaming revenue increased $1.3 billion or 14%, driven by Xbox software and services revenue growth of 20%, mainly from third-party title strength. PART II Item 7 Search advertising revenue increased $793 million or 13%. Search advertising revenue, excluding traffic acquisition costs, increased 16%, driven by growth in Bing, due to higher revenue per search and search volume. Surface revenue increased $625 million or 16%, driven by a higher mix of premium devices and an increase in volumes sold, due to the latest editions of Surface. Phone revenue decreased $525 million.Operating income increased $1.8 billion or 20%, including a favorable foreign currency impact of 2%. Gross margin increased $2.2 billion or 11%, driven by growth in Windows, Surface, Search, and Gaming. Gross margin percentage increased, primarily due to gross margin percentage improvement in Surface. Operating expenses increased $391 million or 3%, driven by investments in Search, AI, and Gaming engineering and commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Corporate and Other Corporate and Other includes corporate-level activity not specifically allocated to a segment, including restructuring expenses.Fiscal Year 2019 Compared with Fiscal Year 2018 We did not incur Corporate and Other activity in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 Corporate and Other operating loss decreased $306 million, due to a reduction in restructuring expenses, driven by employee severance expenses primarily related to our sales and marketing restructuring plan in fiscal year 2017.OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Research and development$16,876$14,726$13,03715%13%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Fiscal Year 2018 Compared with Fiscal Year 2017Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. LinkedIn expenses increased $762 million to $1.5 billion.PART II Item 7Sales and Marketing (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Sales and marketing$18,213$17,469$15,4614%13%As a percent of revenue14%16%16%(2)ppt0pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2019 Compared with Fiscal Year 2018Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. Fiscal Year 2018 Compared with Fiscal Year 2017Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. LinkedIn expenses increased $1.2 billion to $2.5 billion, including $617 million of amortization of acquired intangible assets.General and Administrative (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017General and administrative$4,885$4,754$4,4813%6%As a percent of revenue4%4%5%0ppt(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.Fiscal Year 2018 Compared with Fiscal Year 2017General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses. LinkedIn expenses increased $234 million to $528 million.RESTRUCTURING EXPENSES Restructuring expenses include employee severance expenses and other costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities.Fiscal Year 2019 Compared with Fiscal Year 2018We did not incur restructuring expenses in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 During fiscal year 2017, we recorded $306 million of employee severance expenses, primarily related to our sales and marketing restructuring plan. PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2019 Compared with Fiscal Year 2018Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . Fiscal Year 2018 Compared with Fiscal Year 2017Dividends and interest income increased primarily due to higher average portfolio balances and yields on fixed-income securities. Interest expense increased primarily due to higher average outstanding long-term debt and higher finance lease expense. Net recognized gains on investments decreased primarily due to higher losses on sales of fixed-income securities, offset in part by higher gains on sales of equity securities. Net losses on derivatives decreased primarily due to lower losses on equity, foreign exchange, and commodity derivatives, offset in part by losses on interest rate derivatives in the current period as compared to gains in the prior period. INCOME TAXES Effective Tax RateFiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Our effective tax rate for fiscal years 2018 and 2017 was 55% and 15%, respectively. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA in fiscal year 2018 and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. Our effective tax rate was higher than the U.S. federal statutory rate primarily due to the net charge related to the enactment of the TCJA, offset in part by earnings taxed at lower rates in foreign jurisdictions resulting from our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion. In fiscal year 2017, our U.S. income before income taxes was $6.8 billion and our foreign income before income taxes was $23.1 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our global intangible low-taxed income (GILTI) effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months. As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP operating income, net income, and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2019 Versus 2018Percentage Change 2018 Versus 2017Operating income$42,959 $35,058$29,02523%21%Net tax impact of transfer of intangible properties **Net tax impact of the TCJA**Restructuring expenses**Non-GAAP operating income$42,959 $35,058$29,33123%20%Net income$39,240$16,571$25,489137%(35)%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Restructuring expenses**Non-GAAP net income$36,830$30,267$25,73222%18%Diluted earnings per share$5.06$2.13$3.25138%(34)%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Restructuring expenses0.04**Non-GAAP diluted earnings per share$4.75$3.88$3.2922%18%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $133.8 billion as of both June 30, 2019 and 2018. Equity investments were $2.6 billion and $1.9 billion as of June 30, 2019 and 2018, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Cash from operations increased $4.4 billion to $43.9 billion for fiscal year 2018, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees, net cash paid for income taxes, cash paid for interest on debt, and cash paid to suppliers. Cash used in financing was $33.6 billion for fiscal year 2018, compared to cash from financing of $8.4 billion for fiscal year 2017. The change was mainly due to a $41.7 billion decrease in proceeds from issuance of debt, net of repayments of debt, offset in part by a $1.1 billion decrease in cash used for common stock repurchases. Cash used in investing decreased $40.7 billion to $6.1 billion for fiscal year 2018, mainly due to a $25.1 billion decrease in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $19.1 billion increase in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2019:(In millions)Three Months Ending,September 30, 2019$12,353December 31, 20199,807March 31, 20206,887June 30, 20203,629Thereafter4,530Total$37,206If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2019, 2018, and 2017, we repurchased 150 million shares, 99 million shares, and 170 million shares of our common stock for $16.8 billion, $8.6 billion, and $10.3 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2019: (In millions)2021-20222023-2024ThereafterTotalLong-term debt: (a) Principal payments$5,518$11,744$8,000$47,519$72,781Interest payments2,2994,3093,81829,38339,809Construction commitments (b) 3,4433,958Operating leases, including imputed interest (c) 1,7903,1442,4133,64510,992Finance leases, including imputed interest (c) 2,0082,1659,87214,842Transition tax (d) 1,1802,9004,1688,15516,403Purchase commitments (e) 17,4781,18519,161Other long-term liabilities (f) Total$32,505 $25,877 $20,752 $99,237 $178,371 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( c ) Refer to Note 15 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( e ) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. ( f ) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. Liquidity As a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable interest free over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of approximately $2.0 billion, which included $1.5 billion for fiscal year 2019. The first installment of the transition tax was paid in fiscal year 2019, and the remaining transition tax of $16.4 billion is payable over the next seven years with a final payment in fiscal year 2026. During the first quarter of fiscal year 2020, we expect to pay $1.2 billion related to the second installment of the transition tax, and $3.5 billion related to the transfer of intangible properties in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be s ufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.PART II Item 7Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration; Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency - Revenue10% decrease in foreign exchange rates$(3,402)EarningsForeign currency - Investments10% decrease in foreign exchange rates(120)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,909)Fair ValueCredit100 basis point increase in credit spreads(224)Fair ValueEquity10% decrease in equity market prices(244)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATE MENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$66,069$64,497$63,811Service and other59,77445,86332,760Total revenue125,843110,36096,571Cost of revenue:Product16,27315,42015,175Service and other26,63722,93319,086Total cost of revenue42,91038,35334,261Gross margin82,93372,00762,310Research and development16,87614,72613,037Sales and marketing18,21317,46915,461General and administrative4,8854,7544,481RestructuringOperating income42,95935,05829,025Other income, net 1,416Income before income taxes43,68836,47429,901Provision for income taxes4,44819,9034,412Net income$39,240$16,571$25,489Earnings per share:Basic$5.11$2.15$3.29Diluted$5.06$2.13$3.25Weighted average shares outstanding:Basic7,6737,7007,746Diluted7,7537,7947,832Refer to accompanying notes. PART II Item 8COMPREHENSIVE IN COME STATEMENTS (In millions)Year Ended June 30,Net income$39,240$16,571$25,489Other comprehensive income (loss), net of tax:Net change related to derivatives(173)(218)Net change related to investments2,405(2,717)(1,116)Translation adjustments and other(318)(178)Other comprehensive income (loss)1,914(2,856) (1,167) Comprehensive income$41,154$13,715$24,322Refer to accompanying notes. Refer to Note 18 Accumulated Other Comprehensive Income (Loss) for further information.PART II Item 8BALANCE SHEETS (In millions)June 30, AssetsCurrent assets:Cash and cash equivalents$11,356$11,946Short-term investments122,463121,822Total cash, cash equivalents, and short-term investments133,819133,768Accounts receivable, net of allowance for doubtful accounts of $411 and $37729,52426,481Inventories2,0632,662Other10,1466,751Total current assets175,552169,662Property and equipment, net of accumulated depreciation of $35,330 and $29,22336,47729,460Operating lease right-of-use assets7,3796,686Equity investments2,6491,862Goodwill42,02635,683Intangible assets, net7,7508,053Other long-term assets14,7237,442Total assets$286,556$258,848Liabilities and stockholders equityCurrent liabilities:Accounts payable$9,382$8,617Current portion of long-term debt5,5163,998Accrued compensation6,8306,103Short-term income taxes5,6652,121Short-term unearned revenue32,67628,905Other9,3518,744Total current liabilities69,42058,488Long-term debt66,66272,242Long-term income taxes29,61230,265Long-term unearned revenue4,5303,815Deferred income taxesOperating lease liabilities6,1885,568Other long-term liabilities7,5815,211Total liabilities184,226176,130Commitments and contingenciesStockholders equity:Common stock and paid-in capital shares authorized 24,000; outstanding 7,643 and 7,67778,52071,223Retained earnings24,15013,682Accumulated other comprehensive loss(340)(2,187) Total stockholders equity102,33082,718Total liabilities and stockholders equity$286,556$258,848Refer to accompanying notes. PART II Item 8CASH FLOWS S TATEMENTS (In millions) Year Ended June 30,OperationsNet income$39,240$16,571$25,489Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,68210,2618,778Stock-based compensation expense4,6523,9403,266Net recognized gains on investments and derivatives(792)(2,212)(2,073)Deferred income taxes(6,463)(5,143)(829)Changes in operating assets and liabilities:Accounts receivable(2,812)(3,862)(1,216)Inventories(465)Other current assets(1,718)(952)1,028Other long-term assets(1,834)(285)(917)Accounts payable1,148Unearned revenue4,4625,9223,820Income taxes2,92918,1831,792Other current liabilities1,419Other long-term liabilities(20)(118)Net cash from operations52,18543,88439,507FinancingRepayments of short-term debt, maturities of 90 days or less, net(7,324)(4,963)Proceeds from issuance of debt7,18344,344Repayments of debt(4,000)(10,060)(7,922)Common stock issued1,1421,002Common stock repurchased(19,543)(10,721)(11,788)Common stock cash dividends paid(13,811)(12,699)(11,845)Other, net(675)(971)(190)Net cash from (used in) financing(36,887)(33,590)8,408InvestingAdditions to property and equipment(13,925)(11,632)(8,129)Acquisition of companies, net of cash acquired, and purchases of intangible and other assets(2,388)(888)(25,944)Purchases of investments(57,697)(137,380)(176,905)Maturities of investments20,04326,36028,044Sales of investments38,194117,577136,350Securities lending payable(98)(197)Net cash used in investing(15,773)(6,061)(46,781)Effect of foreign exchange rates on cash and cash equivalents(115)Net change in cash and cash equivalents(590)4,2831,153Cash and cash equivalents, beginning of period11,9467,6636,510Cash and cash equivalents, end of period$11,356$11,946$7,663Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQ UITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$71,223$69,315$68,178Common stock issued6,8291,002Common stock repurchased(4,195)(3,033)(2,987)Stock-based compensation expense4,6523,9403,266Other, net(1) Balance, end of period78,52071,22369,315Retained earnings Balance, beginning of period13,68217,76913,118Net income39,24016,57125,489Common stock cash dividends(14,103)(12,917)(12,040)Common stock repurchased(15,346)(7,699)(8,798)Cumulative effect of accounting changes(42)Balance, end of period24,15013,68217,769Accumulated other comprehensive income (loss)Balance, beginning of period(2,187) 1,794Other comprehensive income (loss)1,914(2,856) (1,167)Cumulative effect of accounting changes(67)Balance, end of period(340) (2,187)Total stockholders equity$102,330$82,718$87,711Cash dividends declared per common share$1.84$1.68$1.56Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts related to investments, derivatives, and fair value measurements to conform to the current period presentation based on our adoption of the new accounting standard for financial instruments. We have recast prior period commercial cloud revenue to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations. We have also recast components of the prior period deferred income tax assets and liabilities to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized on our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income (OCI). Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Microsoft Office 365, Microsoft Azure, Microsoft Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 20 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct pe rformance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell ea ch of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2019 and 2018, long-term accounts receivable, net of allowance for doubtful accounts, was $2.2 billion and $1.8 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs(116) (98)(106)Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recogni zed ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics busin ess solutions; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 14 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain online products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6 billion, $1.6 billion, and $1.5 billion in fiscal years 2019, 2018, and 2017, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in OCI. Debt investments are impaired whe n a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers avai lable quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specifi c adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method, or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. For derivative instruments designated as cash flow hedges, the effective portion of the gains and losses are initially reported as a component of OCI and subsequently recognized in revenue when the hedged exposure is recognized in revenue. Gains and losses on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. PART II Item 8 Level 2 inputs are based upon quoted prices for similar instr uments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corrobo rated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interes t rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed secur ities, corporate notes and bonds, and municipal securities . Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. PART II Item 8We have lease agreem ents with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment lease s, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceIncome Taxes Intra-Entity Asset TransfersIn October 2016, the Financial Accounting Standards Board (FASB) issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the guidance effective July 1, 2018. Adoption of the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We recorded a net cumulative-effect adjustment that resulted in an increase in retained earnings of $557 million, which reversed the previous deferral of income tax consequences and recorded new deferred tax assets from intra-entity transfers involving assets other than inventory, partially offset by a U.S. deferred tax liability related to global intangible low-taxed income (GILTI). Adoption of the standard resulted in an increase in long-term deferred tax assets of $2.8 billion, an increase in long-term deferred tax liabilities of $2.1 billion, and a reduction in other current assets of $152 million. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.Financial Instruments Recognition, Measurement, Presentation, and Disclosure In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than OCI. We adopted the standard effective July 1, 2018. Adoption of the standard was applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (AOCI) to retained earnings as of the effective date, and we elected to measure equity investments without readily determinable fair values at cost with adjustments for observable changes in price or impairments. The cumulative-effect adjustment included any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The impact on our consolidated balance sheets upon adoption was not material. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.PART II Item 8Recent Accounting Guid ance Not Yet Adopted Financial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We evaluated the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems, and do not expect the impact to be material upon adoption.Financial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems. NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$39,240$16,571$25,489Weighted average outstanding shares of common stock (B)7,6737,7007,746Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,7537,7947,832Earnings Per ShareBasic (A/B)$5.11$2.15$3.29Diluted (A/C)$5.06$2.13$3.25Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities(93)(987)(162)Other-than-temporary impairments of investments(16)(6)(14)Total$(97)$(966)$(68)Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$3,406$2,692Net unrealized gains on investments still heldImpairments of investments(10) (41) (41) Total$$3,365$2,651PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand Cash EquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,211$$$2,211$1,773$$Certificates of depositLevel 22,0182,0181,430U.S. government securitiesLevel 1104,9251,854(104)106,675105,906U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350(8)6,3462,5063,840Mortgage- and asset-backed securitiesLevel 23,554(3)3,5613,561Corporate notes and bondsLevel 27,437(7)7,5417,541Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747$2,027$(122)$129,652$7,176$122,476$Changes in Fair Value Recorded inNet IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,0852,085Total equity investments$3,058$$$2,649Cash$3,771$3,771$$Derivatives, net (a) (13)(13)Total$136,468$11,356$122,463$2,649PART II Item 8(In millions) Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2018Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,513$$$2,513$2,215$$Certificates of depositLevel 22,0582,0581,865U.S. government securitiesLevel 1108,120(1,167)107,0152,280104,735U.S. agency securitiesLevel 21,7421,7421,398Foreign government bondsLevel 1Foreign government bondsLevel 25,063(10)5,0545,054Mortgage- and asset-backed securitiesLevel 23,864(13)3,8553,855Corporate notes and bondsLevel 26,929(56)6,8946,894Corporate notes and bondsLevel 3Municipal securitiesLevel 2(1)Total debt investments$130,597$$(1,247)$129,475$7,758$121,717$Equity investmentsLevel 1$$$$Equity investmentsLevel 3Equity investmentsOther1,5581,557Total equity investments$2,109$$$1,862Cash$3,942$3,942$$Derivatives, net (a) Total$135,630$11,946$121,822$1,862(a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2019 and 2018, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.2 billion and $697 million, respectively. As of June 30, 2019, we had no collateral received under agreements for loaned securities. As of June 30, 2018, collateral received under agreements for loaned securities was $1.8 billion and primarily comprised U.S. government and agency securities. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2019U.S. government and agency securities$1,491$(1)$39,158$(103)$40,649$(104)Foreign government bonds(8)(8)Mortgage- and asset-backed securities(1)(2)1,042(3)Corporate notes and bonds(3)(4)(7)Total$2,678$(5)$39,989$(117)$42,667$(122)PART II Item 8 Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2018U.S. government and agency securities$82,352$(1,064)$4,459$(103)$86,811$(1,167)Foreign government bonds3,457(7)(3)3,470(10)Mortgage- and asset-backed securities2,072(9)(4)2,168(13)Corporate notes and bonds3,111(43)(13)3,412(56)Municipal securities(1)(1)Total$91,037$(1,124)$4,869$(123)$95,906$(1,247)Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2019Due in one year or less$53,200$53,124Due after one year through five years47,01647,783Due after five years through 10 years26,65827,824Due after 10 yearsTotal$127,747$129,652NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Equity Securities held in our equity investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. In the past, to hedge our price risk, we also used and designated equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. PART II Item 8Other Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2019, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts sold$6,034$11,101Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,8899,425Foreign exchange contracts sold15,61413,374Equity contracts purchasedEquity contracts soldOther contracts purchased1,327Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Changes in Fair Value Recorded in Other Comprehensive IncomeDesignated as Hedging InstrumentsForeign exchange contracts$$$$Changes in Fair Value Recorded in Net IncomeDesignated as Hedging InstrumentsForeign exchange contracts(93)Not Designated as Hedging InstrumentsForeign exchange contracts(172)(197)Equity contracts(7)Other contracts(7)(3)Gross amounts of derivatives(272)(207)Gross amounts of derivatives offset in the balance sheet(113)(152)Cash collateral received(78) (235)Net amounts of derivatives$$(236) $$(289)Reported asShort-term investments$(13)$$$Other current assetsOther long-term assetsOther current liabilities(221)(288)Other long-term liabilities(15)(1)Total$$(236)$$(289)Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $247 million and $272 million, respectively, as of June 30, 2019, and $533 million and $207 million, respectively, as of June 30, 2018. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1Level 2Level 3TotalJune 30, 2019Derivative assets$$$$Derivative liabilities(272)(272)June 30, 2018Derivative assetsDerivative liabilities(1)(206)(207)PART II Item 8Fair Value Hedge Gains (Losses) We recognized in other income (expense), net the following gains (losses) on contracts designated as fair value hedges and their related hedged items: (In millions)Year Ended June 30,Foreign Exchange ContractsDerivatives$$$Hedged items(386)Total amount of ineffectiveness$$$Equity ContractsDerivatives$$(324)$(74)Hedged itemsTotal amount of ineffectiveness$$$Amount of equity contracts excluded from effectiveness assessment$$$(80)Cash Flow Hedge Gains (Losses) We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges: (In millions)Year Ended June 30,Effective PortionGains recognized in other comprehensive income (loss), net of tax of $1 , $11, and $4$$$Gains reclassified from accumulated other comprehensive income (loss) into revenueAmount Excluded from Effectiveness Assessment and Ineffective PortionLosses recognized in other income (expense), net(64)(255)(389)We do not have any net derivative gains included in AOCI as of June 30, 2019 that will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during fiscal year 2019. Non-designated Derivative Gains (Losses) We recognized in other income (expense), net the following gains (losses) on derivatives not designated as hedging instruments: (In millions)Year Ended June 30,Foreign exchange contracts$(97)$(33)$(117)Equity contracts(87)(114)Other contracts(17)(3)Total$(59)$(137)$(234)PART II Item 8NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,6111,953Total$2,063$2,662NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,540$1,254Buildings and improvements26,28820,604Leasehold improvements5,3164,735Computer equipment and software33,82327,633Furniture and equipment4,8404,457Total, at cost71,80758,683Accumulated depreciation(35,330)(29,223)Total, net$36,477$29,460During fiscal years 2019, 2018, and 2017, depreciation expense was $9.7 billion, $7.7 billion, and $6.1 billion, respectively. We have committed $4.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2019. NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018, we acquired GitHub, Inc. (GitHub), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497Intangible assets1,267Other assetsOther liabilities(217)Total$6,924The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,2677 yearsTransactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period. LinkedIn CorporationOn December 8, 2016, we completed our acquisition of all issued and outstanding shares of LinkedIn Corporation (LinkedIn), the worlds largest professional network on the Internet, for a total purchase price of $27.0 billion. The purchase price consisted primarily of cash of $26.9 billion. The acquisition is expected to accelerate the growth of LinkedIn, Office 365, and Dynamics 365. The financial results of LinkedIn have been included in our consolidated financial statements since the date of the acquisition. PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2017. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash and cash equivalents$1,328Short-term investments2,110Other current assetsProperty and equipment1,529Intangible assets7,887Goodwill ( a ) 16,803Short-term debt (b) (1,323)Other current liabilities(1,117)Deferred income taxes(774)Other(131)Total purchase price$27,009(a) Goodwill was assigned to our Productivity and Business Processes segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of LinkedIn. None of the goodwill is expected to be deductible for income tax purposes. (b) Convertible senior notes issued by LinkedIn on November 12, 2014, substantially all of which were redeemed after our acquisition of LinkedIn. The remaining $18 million of notes are not redeemable and are included in long-term debt in our consolidated balance sheets. Refer to Note 11 Debt for further information. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$3,6077 yearsMarketing-related (trade names)2,14820 yearsTechnology-based2,1093 yearsContract-based5 yearsFair value of intangible assets acquired$7,8879 yearsOur consolidated income statements include the following revenue and operating loss attributable to LinkedIn since the date of acquisition:(In millions)Year Ended June 30,Revenue$2,271Operating loss(924)Following are the supplemental consolidated financial results of Microsoft Corporation on an unaudited pro forma basis, as if the acquisition had been consummated on July 1, 2015: (In millions, except per share amounts)Year Ended June 30,Revenue$98,291$94,490Net income25,17919,128Diluted earnings per share3.212.38These pro forma results were based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily amortization of intangible assets. Acquisition costs and other nonrecurring charges were immaterial and are included in the earliest period presented.PART II Item 8Other During fiscal year 2019, we completed 19 additional acquisitions for $1.6 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2019Productivity and Business Processes$23,739$$$23,823$$(60)$24,277Intelligent Cloud5,555(16)5,7035,605(a) (a) 11,351More Personal Computing5,828(65)6,157(48)6,398Total $35,122$$(69)$35,683$6,408$(65)$42,026(a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2019, May 1, 2018, or May 1, 2017 tests. As of June 30, 2019 and 2018, accumulated goodwill impairment was $11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$7,691$(5,771)$1,920$7,220$(5,018)$2,202Customer-related4,709(1,785)2,9244,031(1,205)2,826Marketing-related4,165(1,327)2,8384,006(1,071)2,935Contract-based(506)(589)Total$17,139(a) $(9,389)$7,750$15,936$(7,883)$8,053(a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 Business Combinations for further information. No material impairments of intangible assets were identified during fiscal years 2019, 2018, or 2017. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$5 years$4 yearsMarketing-related10 years5 yearsContract-based3 years4 yearsCustomer-related8 years5 yearsTotal$1,7087 years$5 yearsIntangible assets amortization expense was $1.9 billion, $2.2 billion, and $1.7 billion for fiscal years 2019, 2018, and 2017, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2019: (In millions)Year Ending June 30,$1,4881,2821,1871,053Thereafter2,003Total$7,750NOTE 11 DEBT Short-term DebtAs of June 30, 2019 and 2018, we had no commercial paper issued or outstanding. Effective August 31, 2018, we terminated our credit facilities, which served as back-up for our commercial paper program. Long-term DebtAs of June 30, 2019, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $72.2 billion and $78.9 billion, respectively. As of June 30, 2018, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $76.2 billion and $77.5 billion, respectively. These estimated fair values are based on Level 2 inputs. PART II Item 8The components of our long-term debt, including the current portion, and the associated interest rates were as follows: (In millions, except interest rates)Face Value June 30,Face Value June 30,StatedInterestRateEffectiveInterestRateNotesNovember 3, 2018$$1,7501.300%1.396%December 6, 20181,2501.625%1.824%June 1, 20191,0004.200%4.379%August 8, 2019 2,5002,5001.100%1.203%November 1, 2019 0.500%0.500%February 6, 2020 1,5001,5001.850%1.952%February 12, 20201,5001,5001.850%1.935%October 1, 20201,0001,0003.000%3.137%November 3, 20202,2502,2502.000%2.093%February 8, 20214.000%4.082%August 8, 2021 2,7502,7501.550%1.642%December 6, 2021 (a) 1,9942,0442.125%2.233%February 6, 2022 1,7501,7502.400%2.520%February 12, 20221,5001,5002.375%2.466%November 3, 20221,0001,0002.650%2.717%November 15, 20222.125%2.239%May 1, 20231,0001,0002.375%2.465%August 8, 2023 1,5001,5002.000%2.101%December 15, 20231,5001,5003.625%3.726%February 6, 2024 2,2502,2502.875%3.041%February 12, 20252,2502,2502.700%2.772%November 3, 20253,0003,0003.125%3.176%August 8, 2026 4,0004,0002.400%2.464%February 6, 2027 4,0004,0003.300%3.383%December 6, 2028 (a) 1,9932,0443.125%3.218%May 2, 2033 (a) 2.625%2.690%February 12, 20351,5001,5003.500%3.604%November 3, 20351,0001,0004.200%4.260%August 8, 2036 2,2502,2503.450%3.510%February 6, 2037 2,5002,5004.100%4.152%June 1, 20395.200%5.240%October 1, 20401,0001,0004.500%4.567%February 8, 20411,0001,0005.300%5.361%November 15, 20423.500%3.571%May 1, 20433.750%3.829%December 15, 20434.875%4.918%February 12, 20451,7501,7503.750%3.800%November 3, 20453,0003,0004.450%4.492%August 8, 2046 4,5004,5003.700%3.743%February 6, 20473,0003,0004.250%4.287%February 12, 20552,2502,2504.000%4.063%November 3, 20551,0001,0004.750%4.782%August 8, 20562,2502,2503.950%4.033%February 6, 2057 2,0002,0004.500%4.528%Total$72,781$76,898(a) Euro-denominated debt securities. The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. Cash paid for interest on our debt for fiscal years 2019, 2018, and 2017 was $2.4 billion, $2.4 billion, and $1.6 billion, respectively. As of June 30, 2019 and 2018, the aggregate debt issuance costs and unamortized discount associated with our long-term debt, including the current portion, were $603 million and $658 million, respectively. PART II Item 8Maturities of our long-term debt for each of the next five years and thereafter are as follows: (In millions)Year Ending June 30,$5,5183,7507,9942,7505,250Thereafter47,519Total$72,781NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our GILTI effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax. PART II Item 8Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$4,718$19,764$2,739U.S. state and localForeign5,5314,3482,472Current taxes$10,911$25,046$5,241Deferred TaxesU.S. federal$(5,647)$(4,292)$(554)U.S. state and local(1,010)(458)Foreign(393)(544)Deferred taxes$(6,463)$(5,143)$(829)Provision for income taxes$4,448$19,903$4,412U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$15,799$11,527$6,843Foreign 27,88924,94723,058Income before income taxes$43,688$36,474$29,901Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0%28.1%35.0%Effect of:Foreign earnings taxed at lower rates(4.1)%(7.8)%(11.6)%Impact of the enactment of the TCJA0.4%37.7%0%Phone business losses0%0%(5.7)%Impact of intangible property transfers(5.9)%0%0%Foreign-derived intangible income deduction(1.4)%0%0%Research and development credit(1.1)%(1.3)%(0.9)%Excess tax benefits relating to stock-based compensation(2.2)%(2.5)%(2.1)%Interest, net1.0%1.2%1.4%Other reconciling items, net2.5%(0.8)%(1.3)%Effective rate10.2%54.6%14.8%PART II Item 8The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers , and earnings taxed at lower rates in foreign jurisdictions resulting from producing and dis tributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico . The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 , offset in part by earnings taxed at lower rates in foreign jurisdictions. The decrease from the federal statutory rate in fiscal year 2017 is primarily due to earnings taxed at lower rates in foreign jurisdictions. Our foreign regional operating centers in Ireland, Singapore and Puerto Rico , which are taxed at rates lower than the U.S. rate, generated 82 %, 8 7 %, and 76 % of our foreign income b efore tax in fiscal years 2019, 2018, and 2017, respectively. Other reconciling items, net consists primarily of tax credits, GILTI, and U.S. state income taxes. In fiscal years 2019, 2018, and 2017, there were no individually significant other reconciling items. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,2871,832Loss and credit carryforwards3,5183,369Depreciation and amortization7,046Leasing liabilities1,5941,427Unearned revenueOtherDeferred income tax assets15,6937,495Less valuation allowance(3,214)(3,186)Deferred income tax assets, net of valuation allowance$12,479$4,309Deferred Income Tax LiabilitiesUnrealized gain on investments and debt$(738)$Unearned revenue(30)(639)Depreciation and amortization(1,164)Leasing assets(1,510)(1,366)Deferred GILTI tax liabilities(2,607)(61)Other(291)(251)Deferred income tax liabilities$(5,176)$(3,481)Net deferred income tax assets (liabilities)$7,303$Reported AsOther long-term assets$7,536$1,369Long-term deferred income tax liabilities(233)(541)Net deferred income tax assets (liabilities)$7,303$Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. PART II Item 8As of J une 30, 2019, we had federal, state and foreign net operating loss carryforwards of $ 978 million, $ 770 million, and $11. 6 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 20 20 through 203 9 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $8.4 billion, $5.5 billion, and $2.4 billion in fiscal years 2019, 2018, and 2017, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2019, 2018, and 2017, were $13.1 billion, $12.0 billion, and $11.7 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2019, 2018, and 2017 by $12.0 billion, $11.3 billion, and $10.2 billion, respectively.As of June 30, 2019, 2018, and 2017, we had accrued interest expense related to uncertain tax positions of $3.4 billion, $3.0 billion, and $2.3 billion, respectively, net of income tax benefits. The provision for (benefit from) income taxes for fiscal years 2019, 2018, and 2017 included interest expense related to uncertain tax positions of $515 million, $688 million, and $399 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$11,961$11,737$10,164Decreases related to settlements(316)(193)(4)Increases for tax positions related to the current year2,1061,4451,277Increases for tax positions related to prior yearsDecreases for tax positions related to prior years(1,113)(1,176)(49)Decreases due to lapsed statutes of limitations(3)(48)Ending unrecognized tax benefits$13,146$11,961$11,737We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 RESTRUCTURING CHARGES In June 2017, management approved a sales and marketing restructuring plan. In fiscal year 2017, we recorded employee severance expenses of $306 million primarily related to this sales and marketing restructuring plan. The actions associated with this restructuring plan were completed as of June 30, 2018.PART II Item 8NOTE 14 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$16,831$14,864Intelligent Cloud16,98814,706More Personal Computing3,3873,150Total$37,206$32,720Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2019Balance, beginning of period$32,720Deferral of revenue69,493Recognition of unearned revenue(65,007)Balance, end of period$37,206Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (contracted not recognized revenue), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $91 billion as of June 30, 2019, of which we expect to recognize approximately 50% of the revenue over the next 12 months and the remainder thereafter. Many customers are committing to our products and services for longer contract terms, which is increasing the percentage of contracted revenue that will be recognized beyond the next 12 months.NOTE 15 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$1,707$1,585$1,412Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$PART II Item 8Supplemental cash flow information related to leases was as follows: (In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,670$1,522$1,157Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases2,3031,5711,270Finance leases2,5321,9331,773Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate) June 30, Operating LeasesOperating lease right-of-use assets$7,379$6,686Other current liabilities$1,515$1,399Operating lease liabilities6,1885,568Total operating lease liabilities$7,703$6,967Finance LeasesProperty and equipment, at cost$7,041$4,543Accumulated depreciation(774)(404)Property and equipment, net$6,267$4,139Other current liabilities$$Other long-term liabilities6,2574,125Total finance lease liabilities$6,574$4,301Weighted Average Remaining Lease TermOperating leases7 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases3.0%2.7%Finance leases4.6%5.2%Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,678$1,4381,2351,036Thereafter2,4385,671Total lease payments8,6648,776Less imputed interest(961)(2,202)Total$7,703$6,574PART II Item 8As of June 30 , 201 9 , we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 2.3 billion and $ 6.1 billion, respectively. These operating and finance leases will commence between fiscal year 20 20 and fiscal year 202 2 with lease terms of 1 year to 15 years. NOTE 16 CONTINGENCIES Patent and Intellectual Property Claims There were 44 patent infringement cases pending against Microsoft as of June 30, 2019, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence. Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to be scheduled in the second half of calendar year 2019. PART II Item 8Employment-Related Lit igation Moussouris v. MicrosoftCurrent and former female Microsoft employees in certain engineering and information technology roles brought this class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an expert report showing no statistically significant disparity in pay and promotions between similarly situated men and women. In June 2018, the court denied the plaintiffs motion for class certification. Plaintiffs sought an interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit, which was granted in September 2018. Oral argument is scheduled for October 2019. Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2019, we accrued aggregate legal liabilities of $386 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.0 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 17 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,6777,7087,808IssuedRepurchased(150)(99)(170)Balance, end of year7,6437,6777,708Share Repurchases On September 16, 2013, our Board of Directors approved a share repurchase program (2013 Share Repurchase Program) authorizing up to $40.0 billion in share repurchases. The 2013 Share Repurchase Program became effective on October 1, 2013, and was completed on December 22, 2016. On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to an additional $40.0 billion in share repurchases (2016 Share Repurchase Program). This share repurchase program commenced on December 22, 2016 following completion of the 2013 Share Repurchase Program, has no expiration date, and may be suspended or discontinued at any time without notice. As of June 30, 2019, $11.4 billion remained of the 2016 Share Repurchase Program.PART II Item 8We repurchased the following shares of common stock under the share repurchase prog rams: (In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$2,600$1,600$3,550Second Quarter6,1001,8003,533Third Quarter3,8993,1001,600Fourth Quarter4,2002,1001,600Total$16,799$8,600$10,283Shares repurchased in the first and second quarter of fiscal year 2017 were under the 2013 Share Repurchase Program. All other shares repurchased were under the 2016 Share Repurchase Program. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $2.7 billion, $2.1 billion, and $1.5 billion for fiscal years 2019, 2018, and 2017, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2019 (In millions) September 18, 2018November 15, 2018December 13, 2018$0.46$3,544November 28, 2018February 21, 2019March 14, 20190.463,526March 11, 2019May 16, 2019June 13, 20190.463,521June 12, 2019August 15, 2019September 12, 20190.463,516Total$1.84$14,107Fiscal Year 2018September 19, 2017November 16, 2017December 14, 2017$0.42$3,238November 29, 2017February 15, 2018March 8, 20180.423,232March 12, 2018May 17, 2018June 14, 20180.423,226June 13, 2018August 16, 2018September 13, 20180.423,220Total$1.68$12,916The dividend declared on June 12, 2019 was included in other current liabilities as of June 30, 2019. PART II Item 8NOTE 1 8 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component: (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains, net of tax of $2 , $11, and $4Reclassification adjustments for gains included in revenue(341)(185)(555)Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)(333)(179)(546)Net change related to derivatives, net of tax of $(6), $5, and $(5)(173)(218)Balance, end of period$$$InvestmentsBalance, beginning of period$(850)$1,825$2,941Unrealized gains (losses), net of tax of $616 , $(427), and $2672,331(1,146)Reclassification adjustments for (gains) losses included in other income (expense), net(2,309)(2,513)Tax expense (benefit) included in provision for income taxes(19)Amounts reclassified from accumulated other comprehensive income (loss)(1,571)(1,633)Net change related to investments, net of tax of $635 , $(1,165), and $(613)2,405(2,717)(1,116)Cumulative effect of accounting changes(67)Balance, end of period$1,488$(850)$1,825Translation Adjustments and OtherBalance, beginning of period$(1,510)$(1,332)$(1,499)Translation adjustments and other, net of tax effects of $(1) , $0, and $9(318)(178)Balance, end of period$(1,828)$(1,510)$(1,332)Accumulated other comprehensive income (loss), end of period$(340)$(2,187)$NOTE 19 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2019, an aggregate of 327 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$4,652$3,940$3,266Income tax benefits related to stock-based compensation1,066PART II Item 8Stock Plans Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a four or five-year service period. Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a four-year service period. PSUs generally vest over a three-year performance period. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions: Year Ended June 30,Dividends per share (quarterly amounts)$0.42 - $0.46$0.39 - $0.42$0.36 - $0.39Interest rates1.8% - 3.1%1.7% - 2.9%1.2% - 2.2%During fiscal year 2019, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$57.85Granted (a) 107.02Vested(77) 57.08Forfeited(13) 69.35Nonvested balance, end of year$78.49(a) Includes 2 million, 3 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2019, 2018, and 2017, respectively. As of June 30, 2019, there was approximately $8.6 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of 3 years. The weighted average grant-date fair value of stock awards granted was $107.02, $75.88, and $55.64 for fiscal years 2019, 2018, and 2017, respectively. The fair value of stock awards vested was $8.7 billion, $6.6 billion, and $4.8 billion, for fiscal years 2019, 2018, and 2017, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$104.85$76.40$56.36As of June 30, 2019, 105 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $877 million, $807 million, and $734 million in fiscal years 2019, 2018, and 2017, respectively, and were expensed as contributed. NOTE 20 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things (IoT); and MSN advertising. Devices, including Microsoft Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including restructuring expenses. Segment revenue and operating income were as follows during the periods presented: (In millions)Year Ended June 30,RevenueProductivity and Business Processes$41,160$35,865$29,870Intelligent Cloud38,98532,21927,407More Personal Computing45,69842,27639,294Total$125,843$110,360$96,571Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,389Intelligent Cloud13,92011,5249,127More Personal Computing12,82010,6108,815Corporate and Other(306)Total$42,959$35,058$29,025Corporate and Other operating loss comprised restructuring expenses. No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2019, 2018, or 2017. Revenue, classified by the major geographic areas in which our customers were located, was as follows:(In millions)Year Ended June 30,United States (a) $64,199$55,926$51,078Other countries61,64454,43445,493Total$125,843$110,360$96,571(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$32,622$26,129$21,649Office products and cloud services31,76928,31625,573Windows20,39519,51818,593Gaming11,38610,3539,051Search advertising7,6287,0126,219LinkedIn6,7545,2592,271Enterprise Services6,1245,8465,542Devices6,0955,1345,062Other3,0702,7932,611Total$125,843$110,360$96,571Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $38.1 billion, $26.6 billion and $16.2 billion in fiscal years 2019, 2018, and 2017, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment; it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$55,252$44,501$42,730Ireland12,95812,84312,889Other countries25,42222,53819,898Total$93,632$79,882$75,517PART II Item 8NOTE 2 1 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2019Revenue$29,084$32,471$30,571$33,717$125,843Gross margin19,17920,04820,40123,30582,933Operating income 9,95510,25810,34112,40542,959Net income (a) 8,8248,4208,80913,18739,240Basic earnings per share1.151.091.151.725.11Diluted earnings per share (b) 1.141.081.141.715.06Fiscal Year 2018Revenue $24,538$28,918$26,819$30,085$110,360Gross margin16,26017,85417,55020,34372,007Operating income 7,7088,6798,29210,37935,058Net income (loss) ( c ) 6,576(6,302) 7,4248,87316,571Basic earnings (loss) per share0.85(0.82) 0.961.152.15Diluted earnings (loss) per share ( d ) 0.84(0.82)0.951.142.13(a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019. ( c ) Reflects the net charge (benefit) related to the enactment of the TCJA of $13.8 billion for the second quarter, $(104) million for the fourth quarter, and $13.7 billion for fiscal year 2018. ( d ) Reflects the net charge (benefit) related to the enactment of the TCJA, wh ich decreased (increased) diluted EPS $1.78 for the second quarter, $(0.01) for the fourth quarter, and $1.75 for fiscal year 2018. PART II Item 8REPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the Company) as of June 30, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows, for each of the three years in the period ended June 30, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 1, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the Companys Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. PART II Item 8Revenue Recognition Refer to Note 1 to the F inancial S tatements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Estimation of variable consideration when determining the amount of revenue to recognize (e.g., customer credits, incentives, and in certain instances, estimation of customer usage of products and services). Given these factors, the related audit effort in evaluating managements judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Companys revenue recognition for these customer agreements included the following: We tested the effectiveness of internal controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated managements significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested managements identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration. Assessed the terms in the customer agreement and evaluated the appropriateness of managements application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of managements estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of managements calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 1 2 to the F inancial S tatements Critical Audit Matter Description The Companys long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (IRS). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Companys financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating managements estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate managements estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of managements methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated managements documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of managements judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of managements estimates by considering how tax law, including statutes, regulations and case law, impacted managements judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019We have served as the Companys auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2019. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019; their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2019, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the financial statements) as of and for the year ended June 30, 2019, of the Company and our report dated August 1, 2019, expressed an unqualified opinion on those financial statements.Basis for OpinionThe Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019 PART II, III Item 9B, 10, 11, 12, 13, 14" +19,Costco,2021," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. General We operate membership warehouses and e-commerce websites based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. For our e- commerce operations we ship merchandise through our depots, our logistics operations for big and bulky items, as well as through drop-ship and other delivery arrangements with our suppliers. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, Executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit most items to fast-selling models, sizes, and colors. We carry less than 4,000 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. We average anywhere from 9,000 to 11,000 SKUs online, some of which are also available in our warehouses. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise and services in the following categories: Core Merchandise Categories (or core business): Foods and Sundries (including sundries, dry grocery, candy, cooler, freezer, deli, liquor, and tobacco) Non-Foods (previously Hardlines and Softlines; including major appliances, electronics, health and beauty aids, hardware, garden and patio, sporting goods, tires, toys and seasonal, office supplies, automotive care, postage, tickets, apparel, small appliances, furniture, domestics, housewares, special order kiosk, and jewelry) Fresh Foods (including meat, produce, service deli, and bakery) Warehouse Ancillary (includes gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and Other Businesses (includes e-commerce, business centers, travel, and other) Warehouse ancillary businesses operate primarily within or next to our warehouses, encouraging members to shop more frequently. The number of warehouses with gas stations varies significantly by country, and we have no gasoline business in Korea or China. We operated 636 gas stations at the end of 2021. Net sales for our gasoline business represented approximately 9% of total net sales in 2021. Our other businesses sell products and services that complement our warehouse operations (core and warehouse ancillary businesses). Our e-commerce operations give members convenience and a broader selection of goods and services. Net sales for e-commerce represented approximately 7% of total net sales in 2021. This figure does not consider other services we offer online in certain countries such as business delivery, travel, same-day grocery, and various other services. Our business centers carry items tailored specifically for food services, convenience stores and offices, and offer walk-in shopping and deliveries. Business centers are included in our total warehouse count. Costco Travel offers vacation packages, hotels, cruises, and other travel products exclusively for Costco members (offered in the U.S., Canada, and the U.K.). We have direct buying relationships with many producers of brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. The COVID-19 pandemic created unprecedented supply constraints, including disruptions and delays that have impacted and could continue to impact the flow and availability of certain products. When sources of supply become unavailable, we seek alternative sources. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 12 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at all of our warehouses and websites. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 89% worldwide at the end of 2021. The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. At the end of 2020, we standardized our membership count methodology globally to be consistent with the U.S. and Canada, which resulted in the addition to the count of approximately 2.0 million total cardholders for 2020, of which 1.3 million were paid members. The change did not impact 2019. Membership fee income and the renewal rate calculations were not affected. Our membership was made up of the following (in thousands): 2021 2020 2019 Gold Star 50,200 46,800 42,900 Business, including affiliates 11,500 11,300 11,000 Total paid members 61,700 58,100 53,900 Household cards 49,900 47,400 44,600 Total cardholders 111,600 105,500 98,500 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., Japan, Korea, and Taiwan, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (generally up to a maximum reward of $1,000 per year), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members totaled 25.6 million and represented 55% of paid members (excluding affiliates) in the U.S. and Canada and 17% of paid members (excluding affiliates) in our Other International operations at the end of 2021. They generally shop more frequently and spend more than other members. Human Capital Our Code of Ethics requires that we Take Care of Our Employees, which is fundamental to the obligation to Take Care of Our Members. We must also carefully control our selling, general and administrative (SGA) expenses, so that we can sell high quality goods and services at low prices. Compensation and benefits for employees is our largest expense after the cost of merchandise and is carefully monitored. At the end of 2021, we employed 288,000 employees worldwide. The large majority (approximately 95%) is employed in our membership warehouses and distribution channels and approximately 17,000 employees are represented by unions. We also utilize seasonal employees during peak periods. The total number of employees by segment is: Number of Employees 2021 2020 2019 United States 192,000 181,000 167,000 Canada 47,000 46,000 42,000 Other International 49,000 46,000 45,000 Total employees 288,000 273,000 254,000 We believe that our warehouses are among the most productive in the retail industry, owing in substantial part to the commitment and efficiency of our employees. We seek to provide them not merely with employment but careers. Many attributes of our business contribute to the objective; the more significant include: competitive compensation and benefits for those working in our membership warehouses and distributions channels; a commitment to promoting from within; and maintaining a ratio of at least 50% of our employee base being full-time employees. These attributes contribute to what we consider, especially for the industry, a high retention rate. In 2021, in the U.S. that rate was above 90% for employees who have been with us for at least one year. The commitment to Take Care of Our Employees is also the foundation of our approach to diversity, equity and inclusion and creating an inclusive and respectful workplace. In 2021, we added training and communication for managers on topics of race, bias and equity, and greater visibility of our employee demographics. Embracing differences is important to the growth of our Company. It leads to more opportunities, innovation, and employee satisfaction and connects us to the communities where we do business. Costco is firmly committed to helping protect the health and safety of our members and employees and to serving our communities. In response to the COVID-19 pandemic and its associated challenges, we began providing premium pay to the majority of our hourly employees in March 2020 and continued for a full year through February 2021, at which time a portion of the premium was built permanently into our hourly wage scales in the U.S. In fall 2020, we also began offering employees additional paid time off to attend to child care and schooling needs through the 2021 school year. As the global effect of coronavirus (COVID-19) continues to evolve, we are closely monitoring the changing situation and complying with public health guidance. For more detailed information regarding our programs and initiatives, see Employees within our Sustainability Commitment (located on our website). This report and other information on our website are not incorporated by reference into and do not form any part of this Annual Report. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon are among our significant general merchandise retail competitors in the U.S. We also compete with other warehouse clubs including Walmarts Sams Club and BJs Wholesale Club, and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple clubs. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature. We believe that Kirkland Signature products are high quality, offered at prices that are generally lower than national brands, and help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers, pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 1995 69 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 1993 65 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non-Foods and E-commerce Merchandise, from 2013 to January 2018. 2018 59 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 2019 59 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 2018 64 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 2011 68 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 1994 69 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Foods and Sundries and Private Label, from 1995 to December 2012. 2013 69 Yoram Rubanenko Executive Vice President, Northeast and Southeast Regions. Mr. Rubanenko was Senior Vice President and General Manager, Southeast Region, from 2013 to September 2021, and Vice President, Regional Operations Manager for the Northeast Region, from 1998 to 2013. 2021 57 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 2016 56 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and future profitability could be delayed or otherwise materially adversely affected. We have made and may continue to make investments and acquisitions to improve the speed, accuracy and efficiency of our supply chains and delivery channels. The effectiveness of these investments can be less predictable than opening new locations and might not provide the anticipated benefits or desired rates of return. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive membership, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes, pandemics or other extreme weather conditions or catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. Our e-commerce business depends heavily on third-party and in-house logistics providers and that business is negatively affected when these providers are unable to provide services in a timely fashion. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to environmental, social and governance practices) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns, or we may experience out-of-stock positions and delivery delays, which could result in higher costs, both of which would reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. Availability and performance of our information technology (IT) systems are vital to our business. Failure to successfully execute IT projects and have IT systems available to our business would adversely impact our operations. IT systems play a crucial role in conducting our business. These systems are utilized to process a very high volume of transactions, conduct payment transactions, track and value our inventory and produce reports critical for making business decisions. Failure or disruption of these systems could have an adverse impact on our ability to buy products and services from our suppliers, produce goods in our manufacturing plants, move the products in an efficient manner to our warehouses and sell products to our members. We are undertaking large technology and IT transformation projects. The failure of these projects could adversely impact our business plans and potentially impair our day to day business operations. Given the high volume of transactions we process, it is important that we build strong digital resiliency to prevent disruption from events such as power outages, computer and telecommunications failures, viruses, internal or external security breaches, errors by employees, and catastrophic events such as fires, earthquakes, tornadoes and hurricanes. Any debilitating failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services and may cause serious impairment in our business operations including loss of business services, increased cost of moving merchandise and failure to provide service to our members. We are currently making substantial investments in maintaining and enhancing our digital resiliency and failure or delay in these projects could be costly and harmful to our business. Failure to deliver IT transformation efforts efficiently and effectively could result in the loss of our competitive position and adversely impact our financial condition and results of operations. We are required to maintain the privacy and security of personal and business information amidst multiplying threat landscapes and in compliance with privacy and data protection regulations globally. Failure to do so could damage our business, including our reputation with members, suppliers and employees, cause us to incur substantial additional costs, and become subject to litigation and regulatory action. Increased security threats and more sophisticated cyber misconduct pose a risk to our systems, networks, products and services. We rely upon IT systems and networks, some of which are managed by third parties, in connection with virtually all of our business activities. Additionally, we collect, store and process sensitive information relating to our business, members, suppliers and employees. Operating these IT systems and networks, and processing and maintaining this data, in a secure manner, is critical to our business operations and strategy. Increased remote work due to the COVID-19 pandemic has also increased the possible attack surfaces. Threats designed to gain unauthorized access to systems, networks and data, both ours and third parties with whom we work, are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crimes and advanced persistent threats. Phishing attacks have emerged as particularly prominent, including as vectors for ransomware attacks, which have increased in breadth and frequency. While we train our employees as part of our security efforts, that training cannot be completely effective. These threats pose a risk to the security of our systems and networks and the confidentiality, integrity, and availability of our data. It is possible that our IT systems and networks, or those managed by third parties such as cloud providers or suppliers that otherwise host confidential information, could have vulnerabilities, which could go unnoticed for a period of time. While our cybersecurity and compliance efforts seek to mitigate such risks, there can be no guarantee that the actions and controls we and our third-party service providers have implemented and are implementing, will be sufficient to protect our systems, information or other property. The potential impacts of a material cybersecurity attack include reputational damage, litigation, government enforcement actions, penalties, disruption to systems, unauthorized release of confidential or otherwise protected information, corruption of data, diminution in the value of our investment in IT systems and increased cybersecurity protection and remediation costs. This could adversely affect our competitiveness, results of operations and financial condition and, critically in light of our business model, loss of member confidence. Further, the insurance coverage we maintain and indemnification arrangements with third-parties may be inadequate to cover claims, costs, and liabilities relating to cybersecurity incidents. In addition, data we collect, store and process is subject to a variety of U.S. and international laws and regulations, such as the European Union's General Data Protection Regulation, California Consumer Privacy Act, Health Insurance Portability and Accountability Act, and other emerging privacy and cybersecurity laws across the various states and around the globe, which may carry significant potential penalties for noncompliance. We are subject to payment-related risks. We accept payments using a variety of methods, including select credit and debit cards, cash and checks, co-brand cardholder rebates, Executive member 2% reward certificates, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these parties become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, including food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety or labeling standards or our members ' expectations, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long-term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media, particularly in the wake of COVID-19. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of our employees, including members of our senior management and other key operations, IT, merchandising and administrative personnel. Failure to identify and implement a succession plan for senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including the continuing impacts of the pandemic, regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear a significant portion of the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets or customer expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, pandemics and other health crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China, the United States and the United Kingdom, have raised the cost of many items and created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin is influenced in part by our merchandising and pricing strategies in response to potential cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, inflationary pressures, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Inflationary factors such as increases in merchandise costs may adversely affect our business, financial condition and results of operations. If inflation on merchandise increases beyond our ability to control we may not be able to adjust prices to sufficiently offset the effect of the various cost increases without negatively impacting consumer demand. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years due to, among other things, the continuing impacts of the pandemic and uncertain economic environment. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions causing a loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, natural disasters, extreme weather conditions, public health emergencies, supply constraints and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, packaging, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our merchandise costs and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters, extreme weather conditions, public health emergencies or other catastrophic events could negatively affect our business, financial condition, and results of operations. Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes, wildfires, droughts; acts of terrorism or violence, including active shooter situations; energy shortages; public health issues, including pandemics and quarantines, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, limitations on store operating hours, less frequent visits by members to physical locations, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, disruptions to our IT systems, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. The COVID-19 pandemic continues to affect our business, financial condition and results of operations in many respects. The continuing impacts of the COVID-19 pandemic are highly unpredictable and volatile and are affecting certain business operations, demand for our products and services, in-stock positions, costs of doing business, availability of labor, access to inventory, supply chain operations, our ability to predict future performance, exposure to litigation, and our financial performance, among other things. The pandemic has resulted in widespread and continuing impacts on the global economy and on our employees, members, suppliers and other people and entities with which we do business. There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders, and business and government shutdowns. The pandemic and any preventative or protective actions that governments or we may take may result in business disruption, reduced member traffic and reduced sales in certain merchandise categories, and increased operating expenses. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products. Member demand for certain products has and may continue to fluctuate as the pandemic progresses and member behaviors change, which may challenge our ability to anticipate and/or adjust inventory levels to meet that demand. Similarly, increased demand for online purchases of products has impacted our fulfillment operations, resulting in delays in deliveries and lost sales from being out of stock for certain SKUs. Failure to appropriately respond, or the perception of an inadequate response to evolving events around the pandemic, could cause reputational harm to our brand and subject us to lost sales, as well as claims from employees, members, suppliers, regulators or other parties. Additionally, a future outbreak of confirmed cases of COVID-19 in our facilities could result in temporary or sustained workforce shortages or facility closures, which would negatively impact our business and results of operations. Some jurisdictions have taken measures intended to expand the availability of workers compensation or to change the presumptions applicable to workers compensation measures. These actions may increase our exposure to claims and increase our costs. Other factors and uncertainties include, but are not limited to: The severity and duration of the pandemic, including future mutations or related variants of the virus in areas in which we operate; Evolving macroeconomic factors, including general economic uncertainty, unemployment rates, and recessionary pressures; Changes in labor markets affecting us and our suppliers; Unknown consequences on our business performance and initiatives stemming from the substantial investment of time and other resources to the pandemic response; The pace of recovery when the pandemic subsides. The long-term impact of the pandemic on our business, including consumer behaviors; and Disruption and volatility within the financial and credit markets. To the extent that COVID-19 continues to adversely affect the U.S. and global economy, our business, results of operations, cash flows, or financial condition, it may also heighten other risks described in this section, including but not limited to those related to consumer behavior and expectations, competition, brand reputation, implementation of strategic initiatives, cybersecurity threats, payment-related risks, technology systems disruption, supply chain disruptions, labor availability and cost, litigation, operational risk as a result of remote work arrangements and regulatory requirements. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. Government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change, extreme weather conditions, wildfires, droughts and rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the price of our stock to decline. Legal and Regulatory Risks We are subject to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the withdrawal of the U.K. from the European Union, and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act of 2002 requires management assessments of the effectiveness of internal control over financial reporting and disclosure controls and procedures. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. Changes in tax rates, new U.S. or foreign tax legislation, and exposure to additional tax liabilities could adversely affect our financial condition and results of operations. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide and increasingly broad array of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. Operations at our facilities require the treatment and disposal of wastewater, stormwater and agricultural and food processing wastes, the use and maintenance of refrigeration systems, including ammonia-based chillers, noise, odor and dust management, the operation of mechanized processing equipment, and other operations that potentially could affect the environment and public health and safety. Failure to comply with current and future environmental, health and safety standards could result in the imposition of fines and penalties, illness or injury of our employees, and claims or lawsuits related to such illnesses or injuries, and temporary closures or limits on the operations of facilities. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At August 29, 2021, we operated 815 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 454 110 564 Canada 89 16 105 Other International 101 45 146 Total 644 171 815 _______________ (1) 121 of the 171 leases are land-only leases, where Costco owns the building. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2021 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 10June 6, 2021 102,000 $ 381.50 102,000 $ 3,338 June 7July 4, 2021 108,000 387.32 108,000 3,296 July 5August 1, 2021 63,000 412.73 63,000 3,270 August 2August 29, 2021 45,000 446.15 45,000 3,250 Total fourth quarter 318,000 $ 398.76 318,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 28, 2016, through August 29, 2021. The following graph provides information concerning average sales per warehouse over a 10 year period. Average Sales Per Warehouse* (Sales In Millions) Year Opened # of Whses 2021 20 $ 140 2020 13 $ 132 152 2019 20 $ 129 138 172 2018 21 $ 116 119 141 172 2017 26 $ 121 142 158 176 206 2016 29 $ 87 97 118 131 145 173 2015 23 $ 83 85 94 112 122 136 163 2014 30 $ 108 109 115 125 140 144 155 182 2013 26 $ 99 109 113 116 124 137 144 158 186 2012 Before 607 $ 155 163 169 170 169 175 188 195 205 232 Totals 815 155 160 164 162 159 163 176 182 192 217 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Fiscal Year *First year sales annualized. 2017 was a 53-week fiscal year "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to promote understanding of the results of operations and financial condition. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of operations for 2021 compared to 2020. For discussion related to the results of operations and changes in financial condition for 2020 compared to 2019 refer to Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2020 Form 10-K, which was filed with the United States Securities and Exchange Commission (SEC) on October 7, 2020. In 2021, we combined the hardlines and softlines merchandise categories into non-foods. This change did not have a material impact on the discussion of our results of operations. Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (foods and sundries, non-foods, and fresh foods), warehouse ancillary (includes gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and other businesses (includes e-commerce, business centers, travel and other). We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales-related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business draws members, but it generally has a lower gross margin percentage relative to our non-gasoline business. It also has lower SGA expenses as a percent of net sales compared to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China, the United States and the United Kingdom, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years. The impact to our net sales and gross margin is influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve net sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of operating floor space square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse operations. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business operates on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canadian, and Other International operating segments (see Note 12 to the consolidated financial statements included in Item 8 of this Report). Certain operations in the Other International segment have relatively higher rates of square footage growth, lower wage and benefit costs as a percentage of sales, less or no direct membership warehouse competition, or lack an e-commerce business. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for 2021 included: We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020; Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021; Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership; Gross margin percentage decreased seven basis points, driven primarily by a shift in sales penetration from our core merchandise categories to our warehouse ancillary and other businesses; SGA expenses as a percentage of net sales decreased 40 basis points, primarily due to leveraging increased sales and decreased incremental wages related to COVID-19; The effective tax rate in 2021 was 24.0% compared to 24.4% in 2020; Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020; We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels. This included sales increases in non-foods and in many of our warehouse ancillary and other businesses, certain of which experienced closures or restrictions in 2020. COVID-related supply and logistics constraints have adversely affected some merchandise categories and are expected to do so for the foreseeable future. We paid $515 in incremental wages during 2021 related to COVID-19. The incremental wage and benefit costs associated with COVID-19, which began on March 1, 2020 and ended on February 28, 2021, totaled approximately $825. Effective March 1, 2021, we permanently increased wages for hourly and most salaried warehouse employees. The estimated annualized pre-tax cost is approximately $400. Additionally, in certain areas in the United States governments have mandated or are considering mandating extra pay for classes of employees that include our employees, which has and will result in higher costs. RESULTS OF OPERATIONS Net Sales 2021 2020 2019 Net Sales $ 192,052 $ 163,220 $ 149,351 Increases in net sales: U.S. 16 % 9 % 9 % Canada 22 % 5 % 3 % Other International 23 % 13 % 5 % Total Company 18 % 9 % 8 % Increases in comparable sales: U.S. 15 % 8 % 8 % Canada 20 % 5 % 2 % Other International 19 % 9 % 2 % Total Company 16 % 8 % 6 % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. 14 % 9 % 6 % Canada 12 % 7 % 5 % Other International 13 % 11 % 6 % Total Company 13 % 9 % 6 % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019. Net Sales Net sales increased $28,832 or 18% during 2021. The improvement was attributable to an increase in comparable sales of 16%, and sales at new warehouses opened in 2020 and 2021. While sales in all core merchandise categories increased, sales were particularly strong in non-foods. Sales increases were also strong in our warehouse ancillary and other businesses, predominantly e-commerce and gasoline. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years. Changes in foreign currencies relative to the U.S. dollar positively impacted net sales by approximately $2,759, or 169 basis points, compared to 2020, attributable to our Canadian and Other International operations. Changes in gasoline prices positively impacted net sales by $1,636, or 100 basis points, compared to 2020, due to a 12% increase in the average price per gallon. The volume of gasoline sold increased approximately 10%, positively impacting net sales by $1,469, or 90 basis points. Comparable Sales Comparable sales increased 16% during 2021 and were positively impacted by increases in shopping frequency and average ticket. There was an increase of 44% in e-commerce comparable sales in 2021, driven by an increase of 80% in the first half of the year. Membership Fees 2021 2020 2019 Membership fees $ 3,877 $ 3,541 $ 3,352 Membership fees increase 9 % 6 % 7 % Membership fees increased 9% in 2021, driven by sign-ups and upgrades to Executive membership. Excluding the positive impact of changes in foreign currencies relative to the U.S. dollar, membership fees increased 8%. At the end of 2021, our member renewal rates were 91% in the U.S. and Canada and 89% worldwide. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. Gross Margin 2021 2020 2019 Net sales $ 192,052 $ 163,220 $ 149,351 Less merchandise costs 170,684 144,939 132,886 Gross margin $ 21,368 $ 18,281 $ 16,465 Gross margin percentage 11.13 % 11.20 % 11.02 % The gross margin of our core merchandise categories (foods and sundries, non-foods and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased 23 basis points. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. The increase was across all categories, most significantly in non-foods. Total gross margin percentage decreased seven basis points compared to 2020. Excluding the impact of gasoline price inflation on net sales in 2021, gross margin percentage was 11.22%, an increase of two basis points. This increase was due to a two basis point improvement in our core merchandise categories, predominantly non-foods, and in our warehouse ancillary and other businesses, largely e-commerce. The comparison was also positively impacted by a three basis point reserve on inventory recorded in 2020 with no such reserve this year. Gross margin percentage was negatively impacted three basis points due to increased 2% rewards and two basis points due to a LIFO charge for higher merchandise costs. Changes in foreign currencies relative to the U.S. dollar positively impacted gross margin by approximately $301 in 2021. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), decreased in our U.S. segment, due to our warehouse ancillary and other businesses, our core merchandise categories, and the LIFO charge, partially offset by the reserve for certain inventory in 2020. Our Canadian and Other International segments increased, primarily due to our warehouse ancillary and other businesses and certain of our core merchandise categories. These increases were partially offset by increased 2% rewards. Selling, General and Administrative Expenses 2021 2020 2019 SGA expenses $ 18,461 $ 16,332 $ 14,994 SGA expenses as a percentage of net sales 9.61 % 10.01 % 10.04 % SGA expenses as a percentage of net sales decreased 40 basis points compared to 2020. SGA expenses as a percentage of net sales excluding the impact of gasoline price inflation was 9.69%, a decrease of 32 basis points. Warehouse operations and other businesses were lower by 24 basis points, largely attributable to payroll leveraging increased sales. Incremental wages as a result of COVID-19, which ended on February 28, 2021, were lower by eight basis points. Central operating costs were lower by five basis points. Stock compensation expense was lower by three basis points, and costs associated with the acquisition of Innovel were lower by one basis point. These decreases were offset by an increase of five basis points related to a partial reversal of a product tax assessment in 2020, as well as an increase of four basis points related to a write-off of certain information technology assets in the fourth quarter of 2021 that are no longer expected to be utilized as part of the modernization of our information systems. Changes in foreign currencies relative to the U.S. dollar increased our SGA expenses by approximately $228 in 2021. Preopening 2021 2020 2019 Preopening expenses $ 76 $ 55 $ 86 Warehouse openings, including relocations United States 13 9 18 Canada 5 4 3 Other International 4 3 4 Total warehouse openings, including relocations 22 16 25 Preopening expenses include startup costs for new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and corporate facilities. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new or international market. Interest Expense 2021 2020 2019 Interest expense $ 171 $ 160 $ 150 Interest expense primarily relates to Senior Notes. For more information on our debt arrangements, refer to the consolidated financial statements included in Item 8 of this Report. Interest Income and Other, Net 2021 2020 2019 Interest income $ 41 $ 89 $ 126 Foreign-currency transaction gains, net 56 7 27 Other, net 46 (4) 25 Interest income and other, net $ 143 $ 92 $ 178 The decrease in interest income in 2021 was primarily due to lower interest rates in the U.S. and Canada, partially offset by higher average cash and investment balances. Foreign-currency transaction gains, net include mark-to-market adjustments for forward foreign-exchange contracts and revaluation or settlement of monetary assets and liabilities by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Note 1 to the consolidated financial statements included in Item 8 of this Report. During 2020, other, net was impacted by a $36 charge related to the repayment of certain Senior Notes. Provision for Income Taxes 2021 2020 2019 Provision for income taxes $ 1,601 $ 1,308 $ 1,061 Effective tax rate 24.0 % 24.4 % 22.3 % The effective tax rate for 2021 included discrete net tax benefits of $163, including a benefit of $75 due to excess benefits from stock compensation, $70 related to the special dividend payable through our 401(k) plan, and $19 related to a reduction in the valuation allowance against certain deferred tax assets. Excluding these benefits, the tax rate was 26.4% for 2021. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: 2021 2020 2019 Net cash provided by operating activities $ 8,958 $ 8,861 $ 6,356 Net cash used in investing activities (3,535) (3,891) (2,865) Net cash used in financing activities (6,488) (1,147) (1,147) Our primary sources of liquidity are cash flows generated from our operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $12,175 and $13,305 at the end of 2021 and 2020, respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,816 and $1,636 at the end of 2021 and 2020, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by a change in exchange rates of $46 and $70 in 2021 and 2020, respectively, and negatively impacted by $15 in 2019. Material contractual obligations arising in the normal course of business primarily consist of purchase obligations, long-term debt and related interest payments, leases, and construction and land purchase obligations. See Notes 5 and 6 to the consolidated financial statements included in Item 8 of this Report for amounts outstanding on August 29, 2021, related to debt and leases. Purchase obligations consist of contracts primarily related to merchandise, equipment, and third-party services, the majority of which are due in the next 12 months. Construction and land purchase obligations consist of contracts primarily related to the development and opening of new and relocated warehouses, the majority of which (other than leases) are due in the next 12 months. Management believes that our cash and investment position and operating cash flows as well as capacity under existing and available credit agreements will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. Cash Flows from Operating Activities Net cash provided by operating activities totaled $8,958 in 2021, compared to $8,861 in 2020. Our cash flow provided by operations is primarily from net sales and membership fees. Cash flow used in operations generally consists of payments to merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, the forward deployment of inventory to accelerate delivery times, payment terms with our suppliers, and early payments to obtain discounts from suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $3,535 in 2021, compared to $3,891 in 2020, and is primarily related to capital expenditures. In 2020, we acquired Innovel (Costco Wholesale Logistics) and a minority interest in Navitus. Net cash flows from investing activities also includes purchases and maturities of short-term investments. Capital Expenditures Our primary requirements for capital are acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations, and working capital. In 2021, we spent $3,588 on capital expenditures, and it is our current intention to spend approximat ely $3,800 to $4,200 d uring fiscal 2022. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 22 new warehous es, including two relocations, in 2021, and plan to open approximately up to 35 additional new warehouses, including five relocations, in 2022. We have experienced delays in real estate and construction activities due to COVID-19. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs or based on the current economic environment. Cash Flows from Financing Activities Net cash used in financing activities totaled $6,488 in 2021, compared to $1,147 in 2020. Cash flows used in financing activities primarily related to the payment of dividends, repurchases of common stock, and withholding taxes on stock-based awards. In 2020, we issued $4,000 in aggregate principal amount of Senior Notes and repaid $3,200 of Senior Notes. Stock Repurchase Programs During 2021 and 2020, we repurchased 1,358,000 and 643,000 shares of common stock, at average prices of $364.39 and $308.45, respectively, totaling approximately $495 and $198, respectively. These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. The remaining amount available to be purchased under our approved plan was $3,250 at the end of 2021. Dividends Cash dividends declared in 2021 totaled $12.98 per share, as compared to $2.70 per share in 2020. Dividends in 2021 included a special dividend of $10.00 per share, resulting in an aggregate payment of approximately $4,430. In April 2021, the Board of Directors increased our quarterly cash dividend from $0.70 to $0.79 per share. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At August 29, 2021, we had borrowing capacity under these facilities of $1,050. Our international operations maintain $574 of the total borrowing capacity under bank credit facilities, of which $201 is guaranteed by the Company. Short-term borrowings outstanding under the bank credit facilities at the end of 2021 were immaterial, and there were none outstanding at the end of 2020. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $235. The outstanding commitments under these facilities at the end of 2021 totaled $197, most of which were standby letters of credit which do not expire or have expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities Claims for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Recent Accounting Pronouncements We do not expect that any recently issued accounting pronouncements will have a material effect on our financial statements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2021 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2021, long-term debt with fixed interest rates was $7,531. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 29, 2021, would have decreased the fair value of the contracts by $149 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to some of the fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 29, 2021 and August 30, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 29, 2021 and August 30, 2020, and the results of its operations and its cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 5, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle The Company changed its method of accounting for leases as of September 2, 2019, due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of workers' compensation self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. We identified the evaluation of the Companys workers compensation self-insurance liabilities for the United States operations as a critical audit matter because of the extent of specialized skill and knowledge needed to evaluate the underlying assumptions and judgments made by the Company in the actuarial models. Specifically, subjective auditor judgment was required to evaluate the Company's selected loss rates and initial expected losses used in the actuarial models. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys self-insurance workers' compensation process. This included controls related to the development and selection of the assumptions listed above used in the actuarial calculation and review of the actuarial report. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards Evaluating the Companys ability to estimate self-insurance workers' compensation liabilities by comparing its historical estimates with actual incurred losses and paid losses Evaluating the above listed assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance workers' compensation liabilities and comparing them to the amounts recorded by the Company /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 5, 2021 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of August 29, 2021 and August 30, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019 , and the related notes (collectively, the consolidated financial statements), and our report dated October 5, 2021 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 5, 2021 COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 REVENUE Net sales $ 192,052 $ 163,220 $ 149,351 Membership fees 3,877 3,541 3,352 Total revenue 195,929 166,761 152,703 OPERATING EXPENSES Merchandise costs 170,684 144,939 132,886 Selling, general and administrative 18,461 16,332 14,994 Preopening expenses 76 55 86 Operating income 6,708 5,435 4,737 OTHER INCOME (EXPENSE) Interest expense ( 171 ) ( 160 ) ( 150 ) Interest income and other, net 143 92 178 INCOME BEFORE INCOME TAXES 6,680 5,367 4,765 Provision for income taxes 1,601 1,308 1,061 Net income including noncontrolling interests 5,079 4,059 3,704 Net income attributable to noncontrolling interests ( 72 ) ( 57 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 5,007 $ 4,002 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 11.30 $ 9.05 $ 8.32 Diluted $ 11.27 $ 9.02 $ 8.26 Shares used in calculation (000s) Basic 443,089 442,297 439,755 Diluted 444,346 443,901 442,923 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 5,079 $ 4,059 $ 3,704 Foreign-currency translation adjustment and other, net 181 162 ( 245 ) Comprehensive income 5,260 4,221 3,459 Less: Comprehensive income attributable to noncontrolling interests 93 80 37 COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 5,167 $ 4,141 $ 3,422 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) August 29, 2021 August 30, 2020 ASSETS CURRENT ASSETS Cash and cash equivalents $ 11,258 $ 12,277 Short-term investments 917 1,028 Receivables, net 1,803 1,550 Merchandise inventories 14,215 12,242 Other current assets 1,312 1,023 Total current assets 29,505 28,120 OTHER ASSETS Property and equipment, net 23,492 21,807 Operating lease right-of-use assets 2,890 2,788 Other long-term assets 3,381 2,841 TOTAL ASSETS $ 59,268 $ 55,556 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 16,278 $ 14,172 Accrued salaries and benefits 4,090 3,605 Accrued member rewards 1,671 1,393 Deferred membership fees 2,042 1,851 Current portion of long-term debt 799 95 Other current liabilities 4,561 3,728 Total current liabilities 29,441 24,844 OTHER LIABILITIES Long-term debt, excluding current portion 6,692 7,514 Long-term operating lease liabilities 2,642 2,558 Other long-term liabilities 2,415 1,935 TOTAL LIABILITIES 41,190 36,851 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $ 0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $ 0.01 par value; 900,000,000 shares authorized; 441,825,000 and 441,255,000 shares issued and outstanding 4 4 Additional paid-in capital 7,031 6,698 Accumulated other comprehensive loss ( 1,137 ) ( 1,297 ) Retained earnings 11,666 12,879 Total Costco stockholders equity 17,564 18,284 Noncontrolling interests 514 421 TOTAL EQUITY 18,078 18,705 TOTAL LIABILITIES AND EQUITY $ 59,268 $ 55,556 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT SEPTEMBER 2, 2018 438,189 $ 4 $ 6,107 $ ( 1,199 ) $ 7,887 $ 12,799 $ 304 $ 13,103 Net income 3,659 3,659 45 3,704 Foreign-currency translation adjustment and other, net ( 237 ) ( 237 ) ( 8 ) ( 245 ) Stock-based compensation 598 598 598 Release of vested restricted stock units (RSUs), including tax effects 2,533 ( 272 ) ( 272 ) ( 272 ) Repurchases of common stock ( 1,097 ) ( 16 ) ( 231 ) ( 247 ) ( 247 ) Cash dividends declared and other ( 1,057 ) ( 1,057 ) ( 1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 4 6,417 ( 1,436 ) 10,258 15,243 341 15,584 Net income 4,002 4,002 57 4,059 Foreign-currency translation adjustment and other, net 139 139 23 162 Stock-based compensation 621 621 621 Release of vested RSUs, including tax effects 2,273 ( 330 ) ( 330 ) ( 330 ) Repurchases of common stock ( 643 ) ( 10 ) ( 188 ) ( 198 ) ( 198 ) Cash dividends declared ( 1,193 ) ( 1,193 ) ( 1,193 ) BALANCE AT AUGUST 30, 2020 441,255 4 6,698 ( 1,297 ) 12,879 18,284 421 18,705 Net income 5,007 5,007 72 5,079 Foreign-currency translation adjustment and other, net 160 160 21 181 Stock-based compensation 668 668 668 Release of vested RSUs, including tax effects 1,928 ( 312 ) ( 312 ) ( 312 ) Repurchases of common stock ( 1,358 ) ( 23 ) ( 472 ) ( 495 ) ( 495 ) Cash dividends declared ( 5,748 ) ( 5,748 ) ( 5,748 ) BALANCE AT AUGUST 29, 2021 441,825 $ 4 $ 7,031 $ ( 1,137 ) $ 11,666 $ 17,564 $ 514 $ 18,078 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 5,079 $ 4,059 $ 3,704 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,781 1,645 1,492 Non-cash lease expense 286 194 Stock-based compensation 665 619 595 Other non-cash operating activities, net 85 42 9 Deferred income taxes 59 104 147 Changes in operating assets and liabilities: Merchandise inventories ( 1,892 ) ( 791 ) ( 536 ) Accounts payable 1,838 2,261 322 Other operating assets and liabilities, net 1,057 728 623 Net cash provided by operating activities 8,958 8,861 6,356 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments ( 1,331 ) ( 1,626 ) ( 1,094 ) Maturities and sales of short-term investments 1,446 1,678 1,231 Additions to property and equipment ( 3,588 ) ( 2,810 ) ( 2,998 ) Acquisitions ( 1,163 ) Other investing activities, net ( 62 ) 30 ( 4 ) Net cash used in investing activities ( 3,535 ) ( 3,891 ) ( 2,865 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding 188 137 210 Proceeds from short-term borrowings 41 Proceeds from issuance of long-term debt 3,992 298 Repayments of long-term debt ( 94 ) ( 3,200 ) ( 89 ) Tax withholdings on stock-based awards ( 312 ) ( 330 ) ( 272 ) Repurchases of common stock ( 496 ) ( 196 ) ( 247 ) Cash dividend payments ( 5,748 ) ( 1,479 ) ( 1,038 ) Other financing activities, net ( 67 ) ( 71 ) ( 9 ) Net cash used in financing activities ( 6,488 ) ( 1,147 ) ( 1,147 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 46 70 ( 15 ) Net change in cash and cash equivalents ( 1,019 ) 3,893 2,329 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 12,277 8,384 6,055 CASH AND CASH EQUIVALENTS END OF YEAR $ 11,258 $ 12,277 $ 8,384 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 149 $ 124 $ 141 Income taxes, net $ 1,527 $ 1,052 $ 1,187 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ $ 286 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53-week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions take into account historical and forward-looking factors that the Company believes are reasonable, including but not limited to the potential impacts arising from the novel coronavirus (COVID-19) and related public and private sector policies and initiatives. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2021 and 2020, are $ 999 and $ 810 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. Short-Term Investments Short-term investments generally consist of debt securities (U.S. Government and Agency Notes), with maturities at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. These available-for-sale investments have a low level of inherent credit risk given they are issued by the U.S. Government and Agencies. Changes in their fair value are primarily attributable to changes in interest rates and market liquidity. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for credit impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be impaired as the result of a credit loss, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 3 , 4 , and 5 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and LIBOR or Secured Overnight Financing Rate and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include discounts and volume rebates. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for credit losses which considers creditworthiness of vendors and third parties, historical experience and current economic trends. Write-offs of receivables were immaterial in 2021, 2020, and 2019. Merchandise Inventories Merchandise inventories consist of the following: 2021 2020 United States $ 10,248 $ 8,871 Canada 1,456 1,310 Other International 2,511 2,061 Merchandise inventories $ 14,215 $ 12,242 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. An immaterial charge was recorded to merchandise costs to increase the cumulative LIFO valuation on merchandise inventories at August 29, 2021. As of August 30, 2020, U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts using estimates based on experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment, Net Property and equipment are stated at cost. Depreciation and amortization expense is computed primarily using the straight-line method over estimated useful lives. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably certain at the date the leasehold improvements are made. The Company capitalizes certain computer software and costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. To the extent that the assets become ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over their estimated useful lives. In the fourth quarter of 2021, the Company recognized an $ 84 write-off of certain information technology assets, which was recorded in selling, general and administrative expenses, in the consolidated statements of income. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2021 and 2020 were immaterial. The following table summarizes the Company's property and equipment balances at the end of 2021 and 2020: Estimated Useful Lives 2021 2020 Land N/A $ 7,507 $ 6,696 Buildings and improvements 5-50 years 19,139 17,982 Equipment and fixtures 3-20 years 9,505 8,749 Construction in progress N/A 1,507 1,276 37,658 34,703 Accumulated depreciation and amortization ( 14,166 ) ( 12,896 ) Property and equipment, net $ 23,492 $ 21,807 The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. Impairment charges recognized in 2021 were immaterial. There were no impairment charges recognized in 2020 or 2019. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities. Leases generally contain one or more of the following options, which the Company can exercise at the end of the initial term: (a) renew the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase the property at the then-fair market value; or (c) a right of first refusal in the event of a third-party offer. Some leases include free-rent periods and step-rent provisions, which are recognized on a straight-line basis over the original term of the lease and any extension options that the Company is reasonably certain to exercise from the date the Company has control of the property. Certain leases provide for periodic rent increases based on price indices or the greater of minimum guaranteed amounts or sales volume. Our leases do not contain any material residual value guarantees or material restrictive covenants. The Company determines at inception whether a contract is or contains a lease. The Company initially records right-of-use (ROU) assets and lease obligations for its finance and operating leases based on the discounted future minimum lease payments over the term. The lease term is defined as the noncancelable period of the lease plus any options to extend when it is reasonably certain that the Company will exercise the option. As the rate implicit in the Company's leases is not easily determinable, the present value of the sum of the lease payments is calculated using the Company's incremental borrowing rate. The rate is determined using a portfolio approach based on the rate of interest the Company would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. The Company uses quoted interest rates from financial institutions to derive the incremental borrowing rate. Impairment of ROU assets is evaluated in a similar manner as described in Property and Equipment, net above. The Company's asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability, with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases are included in other liabilities in the accompanying consolidated balance sheet. Goodwill and Acquired Intangible Assets Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired and is not subject to amortization. The Company reviews goodwill annually in the fourth quarter for impairment or when circumstances indicate carrying value may exceed the fair value. This evaluation is performed at the reporting unit level. If a qualitative assessment indicates that it is more likely than not that the fair value is less than carrying value, a quantitative analysis is completed using either the income or market approach, or a combination of both. The income approach estimates fair value based on expected discounted future cash flows, while the market approach uses comparable public companies and transactions to develop metrics to be applied to historical and expected future operating results. Goodwill is included in other long-term assets in the consolidated balance sheets. The following table summarizes goodwill by reportable segment: United States Operations Canadian Operations Other International Operations Total Balance at September 1, 2019 $ 13 $ 27 $ 13 $ 53 Changes in currency translation 1 1 Acquisition 934 934 Balance at August 30, 2020 $ 947 $ 27 $ 14 $ 988 Changes in currency translation and other (1) 6 1 1 8 Balance at August 29, 2021 $ 953 $ 28 $ 15 $ 996 ____________ (1) Other consists of changes to the purchase price allocation. See Note 2 . Definite-lived intangible assets, which are not material, are included in other long-term assets on the consolidated balance sheets and are amortized on a straight-line basis over their estimated lives, which approximates the pattern of expected economic benefit. Insurance/Self-insurance Liabilities Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to limit exposures arising from very large losses. The Company uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2021 and 2020, these insurance liabilities were $ 1,257 and $ 1,188 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. There were no derivative instruments in a net liability position at the end of 2021 and for those in a net liability position at the end of 2020, the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered was immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 1,331 and $ 1,036 at the end of 2021 and 2020, respectively. See Note 4 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2021 and 2020. The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2021, 2020 and 2019. The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial in 2021, 2020, and 2019. Revenue Recognition The Company adopted Accounting Standards Update (ASU) 2014-09 in 2019, which provided for changes in the recognition of revenue from contracts with customers. The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and member returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. The Company offers merchandise in the following core merchandise categories: foods and sundries, non-foods (previously hardlines and softlines), and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is generally recognized upon shipment to the member. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively. In most countries, the Company's Executive members qualify for a 2% reward on qualified purchases, subject to an annual maximum value, which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2021, 2020, and 2019, the net reduction in sales was $ 2,047 , $ 1,707 , and $ 1,537 respectively. The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Shop card liabilities are included in other current liabilities in the consolidated balance sheets. Citibank, N.A. became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot, fulfillment and manufacturing operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans, which are not material. Amounts expensed under all plans were $ 748 , $ 676 , and $ 614 for 2021, 2020, and 2019, respectively, and are predominantly included in selling, general and administrative expenses in the consolidated statements of income. Stock-Based Compensation RSUs granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 8 for additional information on the Companys stock-based compensation plans. Preopening Expenses Preopening expenses include startup costs for new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and corporate facilities and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 7 for additional information. Note 2Acquisition of Innovel On March 17, 2020, the Company acquired Innovel Solutions for $ 999 , using existing cash and cash equivalents. Innovel (now known as Costco Wholesale Logistics or CWL) provides final-mile delivery, installation and white-glove capabilities for big and bulky products in the United States and Puerto Rico. Its financial results have been included in the Company's consolidated financial statements from the date of acquisition. The net purchase price of $ 999 has been allocated to the tangible and intangible assets of $ 294 and liabilities assumed of $ 235 , based on fair values on the acquisition date. The remaining unallocated net purchase price of $ 940 was recorded as goodwill. Goodwill represents the acquisition's benefits to the Company, which include the ability to serve more members and improve delivery times, enabling growth in certain segments of our U.S. e-commerce operations. The Company assigned this goodwill, which is deductible for tax purposes, to reporting units within the U.S. segment. Changes to the purchase price allocation originally recorded in 2020 were not material. Note 3Investments The Companys investments were as follows: 2021: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 375 $ 6 $ 381 Held-to-maturity: Certificates of deposit 536 536 Total short-term investments $ 911 $ 6 $ 917 2020: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 436 $ 12 $ 448 Held-to-maturity: Certificates of deposit 580 580 Total short-term investments $ 1,016 $ 12 $ 1,028 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended August 29, 2021, and August 30, 2020. At the end of 2021 and 2020, there were no available-for-sale securities in a continuous unrealized-loss position. There were no sales of available-for-sale securities during 2021 or 2020. The maturities of available-for-sale and held-to-maturity securities at the end of 2021 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ 190 $ 191 $ 536 Due after one year through five years 185 190 Total $ 375 $ 381 $ 536 Note 4Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The table below presents information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. Level 2 2021 2020 Investment in government and agency securities (1) $ 393 $ 508 Forward foreign-exchange contracts, in asset position (2) 17 1 Forward foreign-exchange contracts, in (liability) position (2) ( 2 ) ( 21 ) Total $ 408 $ 488 ____________ (1) At August 29, 2021, $ 12 cash and cash equivalents and $ 381 short-term investments are included in the accompanying consolidated balance sheets. At August 30, 2020, $ 60 cash and cash equivalents and $ 448 short-term investments are included in the consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the consolidated balance sheets. At August 29, 2021, and August 30, 2020, the Company did not hold any Level 1 or 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers between levels during 2021 or 2020. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. Fair value adjustments to nonfinancial assets during 2021 were immaterial and there were no fair value adjustments to these items during 2020. Note 5Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $ 1,050 and $ 967 , in 2021 and 2020, respectively. Borrowings on these short-term facilities were immaterial during 2021 and 2020. Short-term borrowings outstanding were $ 41 at the end of 2021. There were no outstanding balances at the end of 2020. Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100 % of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, the holder has the right to require the Company to purchase this security at a price of 101 % of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary, valued using Level 3 inputs. In June 2021, the Japanese subsidiary repaid approximately $ 94 of its Guaranteed Senior Notes. In April 2020, the Company issued $ 4,000 in aggregate principal amount of Senior Notes as follows: $ 1,250 of 1.375 % due June 2027; $ 1,750 of 1.600 % due April 2030; and $ 1,000 of 1.750 % due April 2032. In May 2020, a portion of the proceeds from the issuance were used to repay, prior to maturity, the outstanding $ 1,000 and $ 500 principal balances and interest on the 2.150 % and 2.250 % Senior Notes, respectively. The early redemption resulted in a $ 36 charge which was recorded in interest income and other, net in 2020. At the end of 2021 and 2020, the fair value of the Company's long-term debt, including the current portion, was approximately $ 7,692 and $ 7,987 , respectively. The carrying value of long-term debt consisted of the following: 2021 2020 2.300% Senior Notes due May 2022 $ 800 $ 800 2.750% Senior Notes due May 2024 1,000 1,000 3.000% Senior Notes due May 2027 1,000 1,000 1.375% Senior Notes due June 2027 1,250 1,250 1.600% Senior Notes due April 2030 1,750 1,750 1.750% Senior Notes due April 2032 1,000 1,000 Other long-term debt 731 857 Total long-term debt 7,531 7,657 Less unamortized debt discounts and issuance costs 40 48 Less current portion (1) 799 95 Long-term debt, excluding current portion $ 6,692 $ 7,514 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: 2022 $ 800 2023 91 2024 1,109 2025 136 2026 100 Thereafter 5,295 Total $ 7,531 Note 6Leases The tables below present information regarding the Company's lease assets and liabilities. 2021 2020 Assets Operating lease right-of-use assets $ 2,890 $ 2,788 Finance lease assets (1) 1,000 592 Total lease assets $ 3,890 $ 3,380 Liabilities Current Operating lease liabilities (2) $ 222 $ 231 Finance lease liabilities (2) 72 31 Long-term Operating lease liabilities 2,642 2,558 Finance lease liabilities (3) 980 657 Total lease liabilities $ 3,916 $ 3,477 _______________ (1) Included in other long-term assets in the consolidated balance sheets. (2) Included in other current liabilities in the consolidated balance sheets. (3) Included in other long-term liabilities in the consolidated balance sheets. 2021 2020 Weighted-average remaining lease term (years) Operating leases 21 21 Finance leases 22 20 Weighted-average discount rate Operating leases 2.16 % 2.23 % Finance leases 4.91 % 6.34 % The components of lease expense, excluding short-term lease costs and sublease income (which were not material), were as follows: 2021 2020 Operating lease costs (1) $ 296 $ 252 Finance lease costs: Amortization of lease assets (1) 50 31 Interest on lease liabilities (2) 37 33 Variable lease costs (3) 151 87 Total lease costs $ 534 $ 403 _______________ (1) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. (2) Included in interest expense in the consolidated statements of income. (3) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. Supplemental cash flow information related to leases was as follows: 2021 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows operating leases $ 282 $ 258 Operating cash flows finance leases 37 33 Financing cash flows finance leases 67 49 Leased assets obtained in exchange for operating lease liabilities 350 354 Leased assets obtained in exchange for finance lease liabilities 399 317 As of August 29, 2021, future minimum payments during the next five fiscal years and thereafter are as follows: Operating Leases (1) Finance Leases 2022 $ 260 $ 107 2023 273 92 2024 232 87 2025 191 159 2026 192 74 Thereafter 2,507 1,070 Total (2) 3,655 1,589 Less amount representing interest 791 537 Present value of lease liabilities $ 2,864 $ 1,052 _______________ (1) Operating lease payments have not been reduced by future sublease income of $ 99 . (2) Excludes $ 665 of lease payments for leases that have been signed but not commenced. Note 7Equity Dividends Cash dividends declared in 2021 totaled $ 12.98 per share, as compared to $ 2.70 per share in 2020. Dividends in 2021 included a special dividend of $ 10.00 per share, resulting in an aggregate payment of approximately $ 4,430 . The Company's current quarterly dividend rate is $ 0.79 per share. Stock Repurchase Programs The Company's stock repurchase program is conducted under a $ 4,000 authorization by the Board of Directors, which expires in April 2023. As of the end of 2021, the remaining amount available under the approved plan was $ 3,250 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 2021 1,358 $ 364.39 $ 495 2020 643 308.45 198 2019 1,097 225.16 247 These amounts may differ from repurchases of common stock in the consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time to time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Note 8Stock-Based Compensation The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are generally performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant and the future forfeited shares from grants under the previous plan, up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. In conjunction with a special cash dividend paid in the second quarter of 2021, and in accordance with the plans, the number of shares subject to outstanding RSUs was increased on the dividend record date to preserve their value. They were adjusted by multiplying the number of outstanding shares by a factor of 1.019 (rounded up to a whole share), representing the ratio of the Nasdaq closing price of $ 391.77 on November 30, 2020, which was the last trading day immediately prior to the ex-dividend date, to the Nasdaq opening price of $ 384.50 on the ex-dividend date, December 1, 2020. The outstanding RSUs increased by approximately 94,000 . The adjustment did not result in additional stock-based compensation expense, as the fair value of the awards did not change. As further required by the plans, the maximum number of shares issuable was proportionally adjusted, which resulted in an additional 220,000 RSU shares available to be granted. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on unvested and undelivered shares. At the end of 2021, 12,001,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2021: 4,218,000 time-based RSUs, which vest upon continued employment or service over specified periods of time; and 131,000 performance-based RSUs, of which 104,000 were granted to executive officers subject to the determination of the attainment of performance targets for 2021. This determination occurred in September 2021, at which time at least 33% of the units vested, as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2021: Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2020 5,174 $ 207.55 Granted 1,982 369.15 Vested and delivered ( 2,764 ) 235.64 Forfeited ( 137 ) 253.53 Special cash dividend 94 N/A Outstanding at the end of 2021 4,349 $ 257.88 The weighted-average grant date fair value of RSUs granted was $ 369.15 , $ 294.08 , and $ 224.00 in 2021, 2020, and 2019, respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2021 was $ 728 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2021 were approximately 1,516,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits: 2021 2020 2019 Stock-based compensation expense $ 665 $ 619 $ 595 Less recognized income tax benefit 140 128 128 Stock-based compensation expense, net $ 525 $ 491 $ 467 Note 9 Taxes Income Taxes Income before income taxes is comprised of the following: 2021 2020 2019 Domestic $ 4,931 $ 4,204 $ 3,591 Foreign 1,749 1,163 1,174 Total $ 6,680 $ 5,367 $ 4,765 The provisions for income taxes are as follows: 2021 2020 2019 Federal: Current $ 718 $ 616 $ 328 Deferred 84 77 222 Total federal 802 693 550 State: Current 265 230 178 Deferred 11 8 26 Total state 276 238 204 Foreign: Current 557 372 405 Deferred ( 34 ) 5 ( 98 ) Total foreign 523 377 307 Total provision for income taxes $ 1,601 $ 1,308 $ 1,061 Except for certain provisions, the Tax Cuts and Jobs Act (2017 Tax Act) was effective for tax years beginning on or after January 1, 2018. Most provisions became effective for the Company for 2019, including limitations on the ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of 2018 and throughout 2019 included: a lower U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The lower U.S. tax rate of 21.0 % was effective for all of 2021, 2020, and 2019. The reconciliation between the statutory tax rate and the effective rate for 2021, 2020, and 2019 is as follows: 2021 2020 2019 Federal taxes at statutory rate $ 1,403 21.0 % $ 1,127 21.0 % $ 1,001 21.0 % State taxes, net 243 3.6 190 3.6 171 3.6 Foreign taxes, net 92 1.4 92 1.7 ( 1 ) Employee stock ownership plan (ESOP) ( 91 ) ( 1.3 ) ( 24 ) ( 0.5 ) ( 18 ) ( 0.4 ) 2017 Tax Act ( 123 ) ( 2.6 ) Other ( 46 ) ( 0.7 ) ( 77 ) ( 1.4 ) 31 0.7 Total $ 1,601 24.0 % $ 1,308 24.4 % $ 1,061 22.3 % During 2019, the Company recognized net tax benefits of $ 123 related to the 2017 Tax Act. This benefit included $ 105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. The Company recognized total net tax benefits of $ 163 , $ 81 and $ 221 in 2021, 2020 and 2019, respectively. These include benefits of $ 75 , $ 77 and $ 59 , respectively, related to the stock-based compensation accounting standard adopted in 2018, in addition to the impacts of the 2017 Tax Act noted above. During 2021, there was a net tax benefit of $ 70 related to the portion of the special dividend paid through our 401(k) plan. The components of the deferred tax assets (liabilities) are as follows: 2021 2020 Deferred tax assets: Equity compensation $ 72 $ 80 Deferred income/membership fees 161 144 Foreign tax credit carry forward 146 101 Operating lease liabilities 769 832 Accrued liabilities and reserves 681 639 Other 62 Total deferred tax assets 1,891 1,796 Valuation allowance ( 214 ) ( 105 ) Total net deferred tax assets 1,677 1,691 Deferred tax liabilities: Property and equipment ( 935 ) ( 800 ) Merchandise inventories ( 216 ) ( 228 ) Operating lease right-of-use assets ( 744 ) ( 801 ) Foreign branch deferreds ( 92 ) ( 81 ) Other ( 40 ) Total deferred tax liabilities ( 1,987 ) ( 1,950 ) Net deferred tax liabilities $ ( 310 ) $ ( 259 ) The deferred tax accounts at the end of 2021 and 2020 include deferred income tax assets of $ 444 and $ 406 , respectively, included in other long-term assets; and deferred income tax liabilities of $ 754 and $ 665 , respectively, included in other long-term liabilities. In 2021 and 2020, the Company had valuation allowances of $ 214 and $ 105 , respectively, primarily related to foreign tax credits that the Company believes will not be realized due to carry forward limitations. The foreign tax credit carry forwards are set to expire beginning in fiscal 2030. The Company no longer considers fiscal year earnings of non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested (other than China) and has recorded the estimated incremental foreign withholding taxes (net of available foreign tax credits) and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries, which totaled $ 3,070 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2021 and 2020 is as follows: 2021 2020 Gross unrecognized tax benefit at beginning of year $ 30 $ 27 Gross increasescurrent year tax positions 2 1 Gross increasestax positions in prior years 2 8 Gross decreasestax positions in prior years ( 3 ) Lapse of statute of limitations ( 1 ) ( 3 ) Gross unrecognized tax benefit at end of year $ 33 $ 30 The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2021 and 2020, these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that if recognized would favorably affect the effective income tax rate in future periods is $ 30 and $ 28 at the end of 2021 and 2020, respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Accrued interest and penalties recognized during 2021 and 2020, and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and abroad. Some audits may conclude in the next 12 months, and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2017. The Company is currently subject to examination in California for fiscal years 2013 to present. Other Taxes The Company is subject to multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. In the fourth quarter of 2020, the Company reached an agreement on a product tax audit resulting in a benefit of $ 84 . The Company recorded a charge of $ 123 in 2019 regarding this matter. Other possible losses or range of possible losses associated with these examinations are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 10Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): 2021 2020 2019 Net income attributable to Costco $ 5,007 $ 4,002 $ 3,659 Weighted average basic shares 443,089 442,297 439,755 RSUs 1,257 1,604 3,168 Weighted average diluted shares 444,346 443,901 442,923 Note 11Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigations arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in an action commenced in August 2013 under the California Labor Code Private Attorneys General Act (PAGA) alleging violation of California Wage Order 7-2001 for failing to provide seating to employees who work at entrance and exit doors in California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 2013-1-CV-248813; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or reasonably comfortable workplace temperature conditions. Lane v. Costco Wholesale Corp. (Case No. CIVDS 1908816; San Bernardino Superior Court). The Company filed an answer denying the material allegations of the complaint. In October 2019, the parties reached an agreement to settle for an immaterial amount the seating claims on a representative basis, which received court approval in February 2020. The workplace temperature claims continue in litigation. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In October 2019, the parties reached an agreement on a class settlement for an immaterial amount, which received court approval in January 2021. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez v. Costco Wholesale Corp. (Case No. 2:19-cv-03454; C.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In December 2019, the court issued an order denying class certification. In January 2020, the plaintiffs dismissed their Labor Code claims without prejudice, and the court remanded the action to state court. The remand was appealed; the appeal is in abeyance due to a pending settlement for an immaterial amount that was agreed upon in February 2021. The preliminary approval hearing of the settlement is scheduled for October 2021. In May 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340; E.D. Cal.). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The Company has moved for partial summary judgement, and the parties have filed competing motions regarding class certification. In August 2019, the plaintiff filed a companion case in state court seeking penalties under PAGA. Rough v. Costco Wholesale Corp. (Case No. FCS053454; Sonoma County Superior Court). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The state court action has been stayed pending resolution of the federal action. In June 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp . (Case No. 3:19-cv-05624-EMC; N.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In June 2021, the plaintiff agreed to dismiss his claims for failure to provide meal and rest breaks and to pay minimum wages. In July 2021, the parties reached an agreement settling for an immaterial amount the remaining claim and related derivative claims. In April 2020, an employee, alleging underpayment of sick pay, filed a class and representative action against the Company, alleging claims under California law for failure to pay all wages at termination and for Labor Code penalties under PAGA. Kristy v. Costco Wholesale Corp. (Case No. 5:20-cv-04119; N.D. Cal.). The case was stayed due to the plaintiff's bankruptcy, and his individual claim was settled for an immaterial amount. A request for dismissal of the class and representative action is pending. In July 2020, an employee filed an action under PAGA on behalf of all California non-exempt employees alleging violations of California Labor Code provisions regarding meal and rest periods, minimum wage, overtime, wage statements, reimbursement of expenses, and payment of wages at termination. Schwab v. Costco Wholesale Corporation (Case No. 37-2020-00023551-CU-OE-CTL; San Diego County Superior Court). In August 2020, the Company filed a motion to strike portions of the complaint, which was denied, and an answer has been filed denying the material allegations of the complaint. In December 2020, a former employee filed suit against the Company asserting collective and class claims on behalf of non-exempt employees under the Fair Labor Standards Act and New York Labor Law for failure to pay for all hours worked on a weekly basis and failure to provide proper wage statements and notices. The plaintiff also asserts individual retaliation claims. Cappadora v. Costco Wholesale Corp. (Case No. 1:20-cv-06067; E.D.N.Y.). An amended complaint was filed, and the Company has denied the material allegations of the amended complaint. In August 2021, a former employee filed a similar suit, asserting collective and class claims on behalf of non-exempt employees under the FLSA and New York law. Umadat v. Costco Wholesale Corp. (Case No. 2:21-cv-4814; E.D.N.Y.). The Company has not yet responded to the complaint. In February 2021, a former employee filed a class action against the Company alleging violations of California Labor Code regarding payment of wages, meal and rest periods, wage statements, reimbursement of expenses, payment of final wages to terminated employees, and for unfair business practices. Edwards v. Costco Wholesale Corp. (Case No. 5:21-cv-00716: C.D. Cal.). In May 2021, the Company filed a motion to dismiss the complaint, which was granted with leave to amend. In June 2021, the plaintiff filed an amended complaint, which the Company moved to dismiss later that month. The court granted the motion in part in July 2021 with leave to amend. In August 2021, the plaintiff filed a second amended complaint and filed a separate representative action under PAGA asserting the same Labor Code claims and seeking civil penalties and attorneys' fees. The Company has filed an answer to the second amended class action complaint denying the material allegations. In July 2021, a former temporary staffing employee filed a class action against the Company and a staffing company alleging violations of the California Labor Code regarding payment of wages, meal and rest periods, wage statements, the timeliness of wages and final wages, and for unfair business practices. Dimas v. Costco Wholesale Corp. (Case No. STK-CV-UOE-2021-0006024; San Joaquin Superior Court). The Company has not yet responded to the complaint. Beginning in December 2017, the United States Judicial Panel on Multidistrict Litigation has consolidated numerous cases concerning the impacts of opioid abuses filed against various defendants by counties, cities, hospitals, Native American tribes, third-party payors, and others. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and a hospital in Texas, class actions filed on behalf of infants born with opioid-related medical conditions in 40 states, and class actions and individual actions filed on behalf of individuals seeking to recover alleged increased insurance costs associated with opioid abuse in 43 states and American Samoa. Claims against the Company in state courts in New Jersey, Oklahoma, Utah, and Arizona have been dismissed. The Company is defending all of the pending matters. The Company and its CEO and CFO were defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Dec. 11, 2018). The complaints alleged violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. A consolidated amended complaint was filed on April 16, 2019. On November 26, 2019, the court entered an order dismissing the consolidated amended complaint and granting the plaintiffs leave to file a further amended complaint. A further amended complaint was filed on March 9, which the court dismissed with prejudice on August 19, 2020. On July 20, 2021, the Ninth Circuit affirmed the dismissal. Members of the Board of Directors, one other individual, and the Company were defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash.; filed Dec. 11, 2018). Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1), and June 12, 2019, Rahul Modi v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-15514-1). In light of the dismissal in Johnson noted above, the plaintiffs in the derivative actions agreed voluntarily to dismiss their complaints. On June 23, 2020, a putative class action was filed against the Company, the Board of Directors, the Costco Benefits Committee and others under the Employee Retirement Income Security Act, in the United States District Court for the Eastern District of Wisconsin. Dustin S. Soulek v. Costco Wholesale, et al. , Case No. 1:20-cv-937. The class is alleged to be beneficiaries of the Costco 401(k) plan from June 23, 2014, and the claims are that the defendants breached their fiduciary duties in the operation and oversight of the plan. The complaint seeks injunctive relief, damages, interest, costs, and attorneys' fees. On September 11, 2020, the defendants filed a motion to dismiss the complaint, and on September 21 the plaintiffs filed an amended complaint, which the defendants have also moved to dismiss. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 12Segment Reporting The Company is principally engaged in the operation of membership warehouses through wholly owned subsidiaries in the U.S., Canada, Mexico, Japan, U.K., Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. The following table provides information for the Company's reportable segments: United States Operations Canadian Operations Other International Operations Total 2021 Total revenue $ 141,398 $ 27,298 $ 27,233 $ 195,929 Operating income 4,262 1,176 1,270 6,708 Depreciation and amortization 1,339 177 265 1,781 Additions to property and equipment 2,612 272 704 3,588 Property and equipment, net 15,993 2,317 5,182 23,492 Total assets 39,589 5,962 13,717 59,268 2020 Total revenue $ 122,142 $ 22,434 $ 22,185 $ 166,761 Operating income 3,633 860 942 5,435 Depreciation and amortization 1,248 155 242 1,645 Additions to property and equipment 2,060 258 492 2,810 Property and equipment, net 14,916 2,172 4,719 21,807 Total assets 38,366 5,270 11,920 55,556 2019 Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 924 750 4,737 Depreciation and amortization 1,126 143 223 1,492 Additions to property and equipment 2,186 303 509 2,998 Property and equipment, net 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 Disaggregated Revenue The following table summarizes net sales by merchandise category; sales from e-commerce websites and business centers have been allocated to their respective merchandise categories: 2021 2020 2019 Foods and Sundries $ 77,277 $ 68,659 $ 59,672 Non-Foods 55,966 44,807 41,160 Fresh Foods 27,183 23,204 19,948 Warehouse Ancillary and Other Businesses 31,626 26,550 28,571 Total net sales $ 192,052 $ 163,220 $ 149,351 "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of August 29, 2021 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of August 29, 2021, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control Integrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of August 29, 2021. The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2021 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. " +20,Costco,2020," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit most items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. We average anywhere from 8,000 to 10,000 SKUs online, some of which are also available in our warehouses. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations varies significantly by country, and we do not currently operate our gasoline business in Korea or China. We operated 615 gas stations at the end of 2020. Net sales for our gasoline business represented approximately 9% of total net sales in 2020. Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. Net sales for e-commerce represented approximately 6% of total net sales in 2020. This figure does not consider other services we offer online in certain countries such as business delivery, travel, same-day grocery, and various other services. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. The COVID-19 pandemic created unprecedented supply constraints including disruptions and delays that have impacted and could continue to impact the flow and availability of certain products. When sources of supply become unavailable, we seek alternative sources. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 12 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 88% on a worldwide basis at the end of 2020. The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. At the end of 2020, we standardized our membership count methodology globally to be consistent with the U.S. and Canada, which resulted in the addition to the count of approximately 2.0 million total cardholders for 2020, of which 1.3 million were paid members. The change did not impact 2019 or 2018. Membership fee income and the renewal rate calculations were not affected. Our membership was made up of the following (in thousands): 2020 2019 2018 Gold Star 46,800 42,900 40,700 Business, including affiliates 11,300 11,000 10,900 Total paid members 58,100 53,900 51,600 Household cards 47,400 44,600 42,700 Total cardholders 105,500 98,500 94,300 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., Japan, Korea, and Taiwan, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (generally up to a maximum reward of $1,000 per year), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico, Japan, and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members, who totaled 22.6 million and represented 39% of paid members at the end of 2020, generally shop more frequently and spend more than other members. Labor Our employee count was as follows: 2020 2019 2018 Full-time employees 156,000 149,000 143,000 Part-time employees 117,000 105,000 102,000 Total employees 273,000 254,000 245,000 Approximately 17,100 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon are among our significant general merchandise retail competitors. We also compete with other warehouse clubs (primarily Walmarts Sams Club and BJs Wholesale Club), and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple clubs. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered at prices that are generally lower than national brands, and help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 1995 68 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 1993 64 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce Merchandise, from 2013 to January 2018. 2018 58 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 2019 58 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 2018 63 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 2001 69 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 2011 67 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 1994 68 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 2013 68 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 2016 55 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. We have made and may continue to make investments and acquisitions to improve the speed, accuracy and efficiency of our supply chains. The effectiveness of these investments can be less predictable than opening new locations and might not provide the anticipated benefits or desired rates of return. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes, pandemics or other extreme weather conditions or catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. Our e-commerce business depends heavily on third-party logistics providers and that business is negatively affected when these providers are unable to provide services in a timely fashion. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns, or we may experience out-of-stock positions and delivery delays, which could result in higher costs, both of which would reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. Availability and performance of our information technology (IT) systems are vital for our business to operate efficiently. Failure to execute complex IT projects, and have these IT systems available to our business will adversely impact our operations. IT systems play a crucial role in conducting our business on a daily basis. These systems are utilized to process a very high volume of transactions, conduct payment transactions, track and value our inventory and produce reports which are critical for making business decisions on a daily, weekly and periodic basis. Failure or disruption of these IT systems could have an adverse impact on our ability to buy products from our suppliers, produce goods in our manufacturing plants, move the products in an efficient manner to our warehouses and sell products to our members. We are undertaking large technology and IT transformation projects. The failure of these projects could adversely impact our business plans and potentially impair our day to day business operations. Given the high volume of transactions we process, it is important that we build strong digital resiliency for our business-critical systems to prevent disruption from events such as power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, errors by employees, and catastrophic events such as fires, earthquakes tornadoes and hurricanes. Any debilitating failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services and may cause serious impairment in our business operations including loss of business services, increased cost of moving merchandise and failure to provide service to our members. We are currently making significant investments in enhancing our digital resiliency and failure or delay in execution of these projects could delay our ability to be resilient to disruptive events. Failure to deliver our IT transformation efforts efficiently and effectively could result in the loss of our competitive position and adversely impact our financial condition and results of operations. We are required to maintain the privacy and security of personal and business information amidst evolving threat landscapes and in compliance with emerging privacy and data protection regulations globally. Failure to meet the requirements could damage our reputation with members, suppliers and employees, cause us to incur substantial additional costs, and become subject to litigation. Increased IT security threats and more sophisticated computer crime pose a risk to our systems, networks, products and services. We rely upon IT systems and networks, some of which are managed by third parties, in connection with a variety of business activities. Additionally, we collect, store and process sensitive information relating to our business, members, suppliers and employees. Operating these IT systems and networks, and processing and maintaining this data, in a secure manner, is critical to our business operations and strategy. The increased use of remote work infrastructure due to the COVID-19 pandemic has also increased the possible attack surfaces. Security threats designed to gain unauthorized access to our systems, networks and data, are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crimes and advanced persistent threats. These threats pose a risk to the security of our systems and networks and the confidentiality, integrity, and availability of our data. It is possible that our IT systems and networks, or those managed by third parties such as cloud providers, could have vulnerabilities, which could go unnoticed for a period of time. While our cybersecurity and compliance posture seeks to mitigate such risks, there can be no guarantee that the actions and controls we and our third-party service providers have implemented and are implementing, will be sufficient to protect our systems, information or other property. The potential impacts of a future material cybersecurity attack includes reputational damage, litigation, government enforcement actions, penalties, disruption to systems, unauthorized release of confidential or otherwise protected information, corruption of data, diminution in the value of our investment in IT systems and increased cybersecurity protection and remediation costs. This could adversely affect our competitiveness, results of operations and financial condition and loss of member confidence. Further, the amount of insurance coverage we maintain may be inadequate to cover claims or liabilities relating to a cybersecurity attack. In addition, data we collect, store and process is subject to a variety of U.S. and international laws and regulations, such as the European Union's General Data Protection Regulation, California Consumer Privacy Act, Health Insurance Portability and Accountability Act, China cybersecurity law and other emerging privacy and cybersecurity laws across the various states and around the globe, which may carry significant potential penalties for noncompliance. We are subject to payment-related risks. We accept payments using a variety of methods, including select credit and debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these parties become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, including food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long-term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media, particularly in the wake of COVID-19. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of our employees, including members of our senior management and other key operations, IT, merchandising and administrative personnel. Failure to identify and implement a succession plan for senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear a significant portion of the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and customer expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, pandemics and other health crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China and the United States, have raised the cost of many items and created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our business, including net sales and gross margin, will be influenced in part by merchandising and pricing strategies in response to potential cost increases by us and our competitors. While these potential impacts are uncertain, they could have an adverse impact on our financial results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions causing a loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, natural disasters, extreme weather conditions, public health emergencies, supply constraints and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters, extreme weather conditions, public health emergencies or other catastrophic events could negatively affect our business, financial condition, and results of operations. Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes; acts of terrorism or violence, including active shooter situations; public health issues, including pandemics and quarantines, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, limitations on store operating hours, less frequent visits by members to physical locations, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, disruptions to our IT systems, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. The COVID-19 pandemic is affecting our business, financial condition and results of operations in many respects. The continuing impacts of the COVID-19 pandemic are highly unpredictable and volatile, and are affecting certain business operations, demand for our products and services, in-stock positions, costs of doing business, availability of labor, access to inventory, supply chain operations, our ability to predict future performance, exposure to litigation, and our financial performance, among other things. The COVID-19 pandemic has resulted in widespread and continuing impacts on the global economy and on our employees, members, suppliers and other people and entities with which we do business. There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders and business and government shutdowns. We are taking precautionary measures intended to help minimize the risk of the virus to our employees, including temporarily requiring some employees to work remotely. To reward our employees for exemplary service in difficult times we temporarily increased compensation levels and otherwise incurred increased spending for wages and benefits, including overtime pay. The pandemic and any preventative or protective actions that governments or we may take are likely to result in a period of business disruption, reduced member traffic and reduced sales in certain merchandise categories, and increased operating expenses. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. These disruptions and delays have strained certain domestic and international supply chains, which have affected and could continue to negatively affect the flow or availability of certain products. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand. These factors have resulted in higher out-of-stock positions in certain products, as well as delays in delivering those products. Even if we are able to find alternate sources for certain products, they may cost more or require us to incur higher transportation costs, adversely impacting our profitability and financial condition. Similarly, increased demand for online purchases of products has impacted our fulfillment operations, resulting in delays in delivering products to members. If we do not respond appropriately to the pandemic, or if our members do not participate in social distancing and other safety measures, the well-being of our employees and members could be at risk, and a failure to appropriately respond, or the perception of an inadequate response, could cause reputational harm to our brand and subject us to lost sales and claims from employees, members, suppliers, regulators or other parties. Additionally, a future outbreak of confirmed cases of COVID-19 in our facilities could result in temporary or sustained workforce shortages or facility closures, which would negatively impact our business and results of operations. Some jurisdictions have taken measures intended to expand the availability of workers compensation or to change the presumptions applicable to workers compensation measures. These actions may increase our exposure to claims and increase our costs. In an effort to strengthen our liquidity position, during the year we issued $4,000 million Senior Notes, a portion of which was used to repay, prior to maturity, $1,500 million of our 2.150% and 2.250% Senior Notes. Financial and credit markets have experienced and may continue to experience significant volatility and turmoil. Our continued access to external sources of liquidity depends on multiple factors, including the condition of debt capital markets, our operating performance, and maintaining strong credit ratings. If the impacts of the pandemic continue to disrupt the financial markets, or if rating agencies lower our credit ratings, it could adversely affect our ability to access the debt markets, our cost of funds, and other terms for new debt or other sources of external liquidity, if needed. Other factors and uncertainties include, but are not limited to: The severity and duration of the pandemic, including whether there is a second wave caused by additional periods of increases or spikes in the number of COVID-19 cases, future mutations or related strains of the virus in areas in which we operate; Evolving macroeconomic factors, including general economic uncertainty, unemployment rates, and recessionary pressures; Unknown consequences on our business performance and initiatives stemming from the substantial investment of time and other resources to the pandemic response; The pace of recovery when the pandemic subsides; and The long-term impact of the pandemic on our business, including consumer behaviors. To the extent that COVID-19 continues to adversely affect the U.S. and global economy, our business, results of operations, cash flows, or financial condition, it may also heighten other risks described in this section, including but not limited to those related to consumer behavior and expectations, competition, brand reputation, implementation of strategic initiatives, cybersecurity threats, payment-related risks, technology systems disruption, supply chain disruptions, labor availability and cost, litigation, operational risk as a result of remote work arrangements and regulatory requirements. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. Government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change, extreme weather conditions, and rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks We are subject to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the withdrawal of the U.K. from the European Union, and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act of 2002 requires management assessments of the effectiveness of internal control over financial reporting and disclosure controls and procedures. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional tax liabilities. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide and increasingly broad array of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. Operations at our facilities require the treatment and disposal of wastewater, stormwater and agricultural and food processing wastes, the use and maintenance of refrigeration systems, including ammonia-based chillers, noise, odor and dust management, the operation of mechanized processing equipment, and other operations that potentially could affect the environment and public health and safety. Failure to comply with current and future environmental, health and safety standards could result in the imposition of fines and penalties, illness or injury of our employees, and claims or lawsuits related to such illnesses or injuries, and temporary closures or limits on the operations of facilities. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At August 30, 2020, we operated 795 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 443 109 552 Canada 87 14 101 Other International 99 43 142 Total 629 166 795 _______________ (1) 119 of the 166 leases are land-only leases, where Costco owns the building. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2020 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 11June 7, 2020 $ $ 3,833 June 8July 5, 2020 94,000 301.79 94,000 3,805 July 6August 2, 2020 93,000 324.51 93,000 3,775 August 3August 30, 2020 88,000 340.17 88,000 3,745 Total fourth quarter 275,000 $ 321.73 275,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 30, 2015, through August 30, 2020. "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (food and sundries, hardlines, softlines, and fresh foods), warehouse ancillary and other businesses. We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business draws members, but it generally has a lower gross margin percentage relative to our non-gasoline business. It also has lower SGA expenses as a percent of net sales compared to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin will be influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve net sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of operating floor space square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse business. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business operates on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 12 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wage and benefit costs as a percentage of country sales, less or no direct membership warehouse competition, and may lack an e-commerce business. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. For discussion related to the results of operations and changes in financial condition for 2019 compared to 2018 refer to Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2019 Form 10-K, which was filed with the United States Securities and Exchange Commission on October 11, 2019. Highlights for 2020 included: We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019; Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020; Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses; Gross margin percentage increased 18 basis points, driven primarily by certain core merchandise categories, partially offset by certain ancillary and other businesses, which were negatively impacted by COVID-19 related closures or restrictions; SGA expenses as a percentage of net sales decreased three basis points primarily due to leveraging increased sales and partial reversal of a previous year tax assessment. These benefits were partially offset by incremental wage and sanitation costs as a result of COVID-19; The effective tax rate in 2020 was 24.4% compared to 22.3% in 2019; Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019; In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico; In April 2020, we issued $4,000 in aggregate principal amount of Senior Notes, some proceeds of which were used to repay $1,500 of Senior Notes; and In April 2020, the Board of Directors approved an increase in the quarterly cash dividend from $0.65 to $0.70 per share. COVID-19 On March 11, 2020, the World Health Organization announced that COVID-19 infections had become a pandemic, and shortly afterward the U.S. declared a National Emergency. The outbreak has led to widespread and continuing impacts on the global economy and is affecting many aspects of our business and the operations of others with which we do business. In our response to the pandemic and in an effort to protect our members and employees, we have taken several measures, as described in Item 1A Risk Factors, and their implications on our results of operations have impacted us across all our reportable segments to varying degrees. Throughout the pandemic our warehouses have largely remained open as a result of being deemed an essential business in most markets and resulted in strong sales increases in our food and sundries and fresh foods merchandise categories compared to pre-pandemic time periods. This growth in certain of our core business categories has led to improved gross margin and SGA percentages as we leveraged these sales to achieve greater efficiency. Our e-commerce business has also benefited, as more members have shopped online during the pandemic. Conversely, we have experienced decreases in both the sales and profitability of many of our ancillary and other businesses due to temporary closures or limited demand. Additionally, we paid $564 in incremental wage and sanitation costs during 2020 related to COVID-19. RESULTS OF OPERATIONS Net Sales 2020 2019 2018 Net Sales $ 163,220 $ 149,351 $ 138,434 Changes in net sales: U.S. 9 % 9 % 9 % Canada 5 % 3 % 10 % Other International 13 % 5 % 14 % Total Company 9 % 8 % 10 % Changes in comparable sales: U.S. 8 % 8 % 9 % Canada 5 % 2 % 9 % Other International 9 % 2 % 11 % Total Company 8 % 6 % 9 % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. 9 % 6 % 7 % Canada 7 % 5 % 4 % Other International 11 % 6 % 7 % Total Company 9 % 6 % 7 % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019. Net Sales Net sales increased $13,869 or 9% during 2020, primarily due to an 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. During the second half of 2020, we experienced a significant sales shift from certain of our ancillary and other businesses to our core merchandise categories, primarily food and sundries and fresh foods, as a result of COVID-19. This shift was largely driven by price deflation and lower volume in our gasoline business; temporary closures of most of our optical, hearing aid and photo departments; limited service in our food courts; and minimal demand in our travel business. Changes in gasoline prices negatively impacted net sales by $1,504, or 101 basis points, compared to 2019, due to a 10% decrease in the average price per gallon. The volume of gasoline sold decreased approximately 4%, negatively impacting net sales by $699, or 47 basis points. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $663, or 44 basis points, compared to 2019, attributable to our Canadian and Other International Operations. Comparable Sales Comparable sales increased 8% during 2020 and were positively impacted by increases in average ticket. While traffic increased slightly in 2020, it decreased in the second half of the year due to capacity restrictions and regulations related to COVID-19. There was an increase of 50% in e-commerce comparable sales in 2020, with an increase of 80% in the second half of the year. Membership Fees 2020 2019 2018 Membership fees $ 3,541 $ 3,352 $ 3,142 Membership fees increase 6 % 7 % 10 % Membership fees as a percentage of net sales 2.17 % 2.24 % 2.27 % The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses. At the end of 2020, our member renewal rates were 91% in the U.S. and Canada and 88% worldwide. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. Gross Margin 2020 2019 2018 Net sales $ 163,220 $ 149,351 $ 138,434 Less merchandise costs 144,939 132,886 123,152 Gross margin $ 18,281 $ 16,465 $ 15,282 Gross margin percentage 11.20 % 11.02 % 11.04 % The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased 16 basis points, primarily due to increases in fresh foods and softlines, partially offset by a decrease in hardlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Fresh foods gross margin increased as a result of efficiencies from increased sales, partially offset by operating losses from our poultry complex. Total gross margin percentage increased 18 basis points compared to 2019. Excluding the impact of gasoline price deflation on net sales, gross margin percentage was 11.10%, an increase of eight basis points. This increase was primarily due to a 32 basis point increase in our core merchandise categories, predominantly fresh foods and food and sundries, partially offset by a decrease in softlines and hardlines. This increase was also positively impacted by our co-branded credit card program, which included an adjustment in 2019 to our estimate of breakage on rewards earned. These increases were partially offset by a decrease of 14 basis points in our warehouse ancillary and other businesses, predominantly certain ancillary businesses that were negatively impacted by COVID-19 related closures or restrictions. However, certain of our ancillary and other businesses, such as tire shop, gasoline and e-commerce businesses, did improve. Gross margin was also negatively impacted by incremental wage and sanitation costs related to COVID-19 of six basis points, a reserve for certain inventory of three basis points, and increased spending by members under the Executive Membership 2% reward program of one basis point. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $68 in 2020. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), was impacted by increases in fresh foods and food and sundries and decreases in softlines and hardlines in each of our U.S., Canadian, and Other International segments. Each of our segments were also negatively impacted by the incremental wage and sanitation costs as a result of COVID-19. The segment gross margin percentage increased in our U.S. operations, predominantly in our core merchandise categories which includes the impact from our co-branded credit card program, as discussed above, partially offset by certain ancillary businesses that were negatively impacted by COVID-19 related closures or restrictions. Our Canadian segment gross margin percentage decreased primarily due to certain of our warehouse ancillary and other businesses that were negatively impacted by COVID-19 related closures or restrictions. The segment gross margin percentage increased in our Other International operations primarily due to core merchandise categories, as discussed above, and was also positively impacted by certain warehouse ancillary and other businesses, predominantly e-commerce. These increases were partially offset by increased spending by members under the Executive Membership 2% reward program. Selling, General and Administrative Expenses 2020 2019 2018 SGA expenses $ 16,332 $ 14,994 $ 13,876 SGA expenses as a percentage of net sales 10.01 % 10.04 % 10.02 % SGA expenses as a percentage of net sales decreased three basis points compared to 2019. SGA expenses as a percentage of net sales, excluding the impact of gasoline price deflation, was 9.91%, a decrease of 13 basis points. SGA expenses were negatively impacted by approximately $456, or 28 basis points, due to incremental wage and sanitation costs as a result of COVID-19, and approximately $24 or one basis point due to costs associated with the acquisition of Innovel (see Note 2 to the consolidated financial statements). Operating costs related to warehouse operations and other businesses, which include e-commerce and travel, were lower by 26 basis points, primarily due to leveraging increased sales. SGA expenses were also benefited by 13 basis points related to a product tax assessment charge in 2019 which was partially reversed in 2020. Stock compensation was lower by two basis points, and central operating costs were lower by one basis point. Our Canadian segment SGA percentage was higher compared to 2019 due primarily to the incremental wage and sanitation costs related to COVID as outlined above. Changes in foreign currencies relative to the U.S. dollar positively impacted SGA expenses by approximately $58. Preopening 2020 2019 2018 Preopening expenses $ 55 $ 86 $ 68 Warehouse openings, including relocations United States 9 18 17 Canada 4 3 3 Other International 3 4 5 Total warehouse openings, including relocations 16 25 25 Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether a warehouse is owned or leased, and whether openings are in an existing, new, or international market. In 2020, operations commenced at our new poultry processing plant, and in 2019, we opened our first warehouse in China. Interest Expense 2020 2019 2018 Interest expense $ 160 $ 150 $ 159 Interest expense primarily relates to Senior Notes. In December 2019 and February 2020, we repaid $1,200 and $500 in total outstanding principal of the 1.700% and 1.750% Senior Notes, respectively. In April 2020, we issued $4,000 in aggregate principal amount of long-term debt consisting of $ 1,250 of 1.375 % Senior Notes due June 2027; $ 1,750 of 1.600 % Senior Notes due April 2030; and $ 1,000 of 1.750 % Senior Notes due April 2032. A portion of the proceeds was used to repay, prior to maturity, $1,000 and $500 of the 2.150% and 2.250% Senior Notes. For more information on our debt arrangements refer to Note 5 to the consolidated financial statements. Interest Income and Other, Net 2020 2019 2018 Interest income $ 89 $ 126 $ 75 Foreign-currency transaction gains, net 7 27 23 Other, net (4) 25 23 Interest income and other, net $ 92 $ 178 $ 121 The decrease in interest income in 2020 was primarily due to lower interest rates in the U.S. and Canada, partially offset by higher average cash and investment balances. Foreign-currency transaction gains, net include the revaluation and settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Note 1 to the consolidated financial statements. Other, net was impacted by a $36 charge related to the repayment of certain Senior Notes, as discussed above and in Note 5 . Provision for Income Taxes 2020 2019 2018 Provision for income taxes $ 1,308 $ 1,061 $ 1,263 Effective tax rate 24.4 % 22.3 % 28.4 % The effective tax rate for 2020 included discrete net tax benefits of $81, including a benefit of $77 due to excess tax benefits from stock compensation. Excluding these benefits, the tax rate was 25.9% for 2020. The effective tax rate for 2019 included discrete net tax benefits of $221, including a benefit of $59 due to excess tax benefits from stock compensation. This also included a tax benefit of $105 related to U.S. taxation of deemed foreign dividends, offset by losses of foreign tax credits, which impacted the effective tax rate. Excluding these benefits, the tax rate was 26.9% for 2019. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: 2020 2019 2018 Net cash provided by operating activities $ 8,861 $ 6,356 $ 5,774 Net cash used in investing activities (3,891) (2,865) (2,947) Net cash used in financing activities (1,147) (1,147) (1,281) Our primary sources of liquidity are cash flows generated from our operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $13,305 and $9,444 at the end of 2020 and 2019, respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,636 and $1,434 at the end of 2020 and 2019, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by a change in exchange rates of $70 in 2020, and negatively impacted by $15 and $37 in 2019 and 2018, respectively. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. We no longer consider earnings after 2017 of our non-U.S. consolidated subsidiaries to be indefinitely reinvested. Cash Flows from Operating Activities Net cash provided by operating activities totaled $8,861 in 2020, compared to $6,356 in 2019. Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, payment terms with our suppliers, and the amount of payables paid early to obtain discounts from our suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $3,891 in 2020, compared to $2,865 in 2019, and primarily related to capital expenditures. In 2020, we acquired Innovel and a minority interest in Navitus. For more information see Notes 1 and 2 to the consolidated financial statements. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations, and working capital. In 2020, we spent $2,810 on capital expenditures, and it is our current intention to spend approximat ely $3,000 to $3,200 d uring fiscal 2021. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 16 new warehous es, including three relocations, in 2020, and plan to open approximately 23 additional new warehouses, including three relocations, in 2021. We have experienced delays in real estate and construction activities due to COVID-19. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs or based on the current economic environment. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,147 in both 2020 and 2019. In April 2020, we issued $4,000 in aggregate principal amount of Senior Notes as follows: $1,250 of 1.375% due June 2027; $1,750 of 1.600% due April 2030; and $1,000 of 1.750% due April 2032. A portion of the proceeds was used to repay, prior to maturity, the outstanding $1,000 and $500 principal balances on the 2.150% and 2.250% Senior Notes, respectively, at a redemption price plus accrued interest as specified in the Notes' agreements. The remaining funds are intended for general corporate purposes. Financing activities also included $1,200 and $500 repayment of our 1.700% and 1.750% Senior Notes, respectively, payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. Stock Repurchase Programs During 2020 and 2019, we repurchased 643,000 and 1,097,000 shares of common stock, at average prices of $308.45 and $225.16, respectively, totaling approximately $198 and $247, respectively. These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. The remaining amount available to be purchased under our approved plan was $3,745 at the end of 2020. Dividends Cash dividends declared in 2020 totaled $2.70 per share, as compared to $2.44 per share in 2019. Dividends totaling $1,479 were paid during 2020, of which $286 related to the dividend declared in August 2019. In April 2020, the Board of Directors increased our quarterly cash dividend from $0.65 to $0.70 per share. In July 2020, the Board of Directors declared a quarterly cash dividend in the amount of $0.70 per share, which was paid on August 14, 2020. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At August 30, 2020, we had borrowing capacity under these facilities of $967. Our international operations maintain $500 of the total borrowing capacity under bank credit facilities, of which $204 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2020 and 2019. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $183. The outstanding commitments under these facilities at the end of 2020 totaled $166, most of which were standby letters of credit which do not expire or have expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Contractual Obligations At August 30, 2020, our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 2022 to 2023 2024 to 2025 2026 and thereafter Total Purchase obligations (1) $ 12,575 $ 9 $ $ $ 12,584 Long-term debt (2) 241 1,163 1,475 5,776 8,655 Operating leases (3) (4) 273 499 388 2,410 3,570 Construction and land obligations 979 35 1,014 Finance lease obligations (4) 61 128 197 742 1,128 Purchase obligations (equipment, services and other) (5) 674 205 72 187 1,138 Other (6) 60 36 28 108 232 Total $ 14,863 $ 2,075 $ 2,160 $ 9,223 $ 28,321 _______________ (1) Includes open purchase orders primarily related to merchandise and supplies. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Operating lease payments have not been reduced by future sublease income of $101. (4) Includes amounts representing interest. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations and deferred compensation obligations. The amount excludes $25 of non-current unrecognized tax contingencies and $48 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities Claims for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2020 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2020, long-term debt with fixed interest rates was $7,657. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 30, 2020, would have decreased the fair value of the contracts by $111 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to some of the fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 30, 2020 and September 1, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 30, 2020 and September 1, 2019, and the results of its operations and its cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 6, 2020 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases as of September 2, 2019 due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated insurance/self-insurance liabilities as of August 30, 2020 were $1,188 million, a portion of which related to workers compensation and general liability self-insurance liabilities for the United States and Canadian operations. We identified the evaluation of the Companys workers compensation and general liability self-insurance liabilities for the United States and Canadian operations as a critical audit matter because of the extent of specialized skill and knowledge needed to evaluate the Companys actuarial models and the judgments required to assess the underlying assumptions made by the Company. Specifically, subjective auditor judgment was required to evaluate certain assumptions underlying the Companys actuarial estimates, including reporting and payment patterns used in the projections of the ultimate loss; loss and exposure trends; the selected loss rates and initial expected losses used in the Paid and Incurred Bornhuetter-Ferguson methods; and the selection of the ultimate loss derived from the various methods. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested operating effectiveness of certain internal controls over the Companys self-insurance process. This included controls related to the development and selection of the assumptions listed above used in the actuarial calculation and review of the actuarial report. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards Evaluating the Companys ability to estimate self-insurance liabilities by comparing its historical estimate with actual incurred losses and paid losses Evaluating the above listed assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance liabilities and comparing them to the amounts recorded by the Company /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 6, 2020 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of August 30, 2020 and September 1, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated October 6, 2020 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 6, 2020 COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 REVENUE Net sales $ 163,220 $ 149,351 $ 138,434 Membership fees 3,541 3,352 3,142 Total revenue 166,761 152,703 141,576 OPERATING EXPENSES Merchandise costs 144,939 132,886 123,152 Selling, general and administrative 16,332 14,994 13,876 Preopening expenses 55 86 68 Operating income 5,435 4,737 4,480 OTHER INCOME (EXPENSE) Interest expense ( 160 ) ( 150 ) ( 159 ) Interest income and other, net 92 178 121 INCOME BEFORE INCOME TAXES 5,367 4,765 4,442 Provision for income taxes 1,308 1,061 1,263 Net income including noncontrolling interests 4,059 3,704 3,179 Net income attributable to noncontrolling interests ( 57 ) ( 45 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 4,002 $ 3,659 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 9.05 $ 8.32 $ 7.15 Diluted $ 9.02 $ 8.26 $ 7.09 Shares used in calculation (000s) Basic 442,297 439,755 438,515 Diluted 443,901 442,923 441,834 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 4,059 $ 3,704 $ 3,179 Foreign-currency translation adjustment and other, net 162 ( 245 ) ( 192 ) Comprehensive income 4,221 3,459 2,987 Less: Comprehensive income attributable to noncontrolling interests 80 37 38 COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 4,141 $ 3,422 $ 2,949 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) August 30, 2020 September 1, 2019 ASSETS CURRENT ASSETS Cash and cash equivalents $ 12,277 $ 8,384 Short-term investments 1,028 1,060 Receivables, net 1,550 1,535 Merchandise inventories 12,242 11,395 Other current assets 1,023 1,111 Total current assets 28,120 23,485 OTHER ASSETS Property and equipment, net 21,807 20,890 Operating lease right-of-use assets 2,788 Other long-term assets 2,841 1,025 TOTAL ASSETS $ 55,556 $ 45,400 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 14,172 $ 11,679 Accrued salaries and benefits 3,605 3,176 Accrued member rewards 1,393 1,180 Deferred membership fees 1,851 1,711 Current portion of long-term debt 95 1,699 Other current liabilities 3,728 3,792 Total current liabilities 24,844 23,237 OTHER LIABILITIES Long-term debt, excluding current portion 7,514 5,124 Long-term operating lease liabilities 2,558 Other long-term liabilities 1,935 1,455 TOTAL LIABILITIES 36,851 29,816 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 441,255,000 and 439,625,000 shares issued and outstanding 4 4 Additional paid-in capital 6,698 6,417 Accumulated other comprehensive loss ( 1,297 ) ( 1,436 ) Retained earnings 12,879 10,258 Total Costco stockholders equity 18,284 15,243 Noncontrolling interests 421 341 Total equity 18,705 15,584 TOTAL LIABILITIES AND EQUITY $ 55,556 $ 45,400 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT SEPTEMBER 3, 2017 437,204 $ 4 $ 5,800 $ ( 1,014 ) $ 5,988 $ 10,778 $ 301 $ 11,079 Net income 3,134 3,134 45 3,179 Foreign-currency translation adjustment and other, net ( 185 ) ( 185 ) ( 7 ) ( 192 ) Stock-based compensation 547 547 547 Release of vested restricted stock units (RSUs), including tax effects 2,741 ( 217 ) ( 217 ) ( 217 ) Repurchases of common stock ( 1,756 ) ( 26 ) ( 296 ) ( 322 ) ( 322 ) Cash dividends declared and other 3 ( 939 ) ( 936 ) ( 35 ) ( 971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 4 6,107 ( 1,199 ) 7,887 12,799 304 13,103 Net income 3,659 3,659 45 3,704 Foreign-currency translation adjustment and other, net ( 237 ) ( 237 ) ( 8 ) ( 245 ) Stock-based compensation 598 598 598 Release of vested RSUs, including tax effects 2,533 ( 272 ) ( 272 ) ( 272 ) Repurchases of common stock ( 1,097 ) ( 16 ) ( 231 ) ( 247 ) ( 247 ) Cash dividends declared and other ( 1,057 ) ( 1,057 ) ( 1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 4 6,417 ( 1,436 ) 10,258 15,243 341 15,584 Net income 4,002 4,002 57 4,059 Foreign-currency translation adjustment and other, net 139 139 23 162 Stock-based compensation 621 621 621 Release of vested RSUs, including tax effects 2,273 ( 330 ) ( 330 ) ( 330 ) Repurchases of common stock ( 643 ) ( 10 ) ( 188 ) ( 198 ) ( 198 ) Cash dividends declared ( 1,193 ) ( 1,193 ) ( 1,193 ) BALANCE AT AUGUST 30, 2020 441,255 $ 4 $ 6,698 $ ( 1,297 ) $ 12,879 $ 18,284 $ 421 $ 18,705 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 4,059 $ 3,704 $ 3,179 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,645 1,492 1,437 Non-cash lease expense 194 Stock-based compensation 619 595 544 Other non-cash operating activities, net 42 9 ( 6 ) Deferred income taxes 104 147 ( 49 ) Changes in operating assets and liabilities: Merchandise inventories ( 791 ) ( 536 ) ( 1,313 ) Accounts payable 2,261 322 1,561 Other operating assets and liabilities, net 728 623 421 Net cash provided by operating activities 8,861 6,356 5,774 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments ( 1,626 ) ( 1,094 ) ( 1,060 ) Maturities and sales of short-term investments 1,678 1,231 1,078 Additions to property and equipment ( 2,810 ) ( 2,998 ) ( 2,969 ) Acquisitions ( 1,163 ) Other investing activities, net 30 ( 4 ) 4 Net cash used in investing activities ( 3,891 ) ( 2,865 ) ( 2,947 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding 137 210 80 Proceeds from issuance of long-term debt 3,992 298 Repayments of long-term debt ( 3,200 ) ( 89 ) ( 86 ) Tax withholdings on stock-based awards ( 330 ) ( 272 ) ( 217 ) Repurchases of common stock ( 196 ) ( 247 ) ( 328 ) Cash dividend payments ( 1,479 ) ( 1,038 ) ( 689 ) Other financing activities, net ( 71 ) ( 9 ) ( 41 ) Net cash used in financing activities ( 1,147 ) ( 1,147 ) ( 1,281 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 70 ( 15 ) ( 37 ) Net change in cash and cash equivalents 3,893 2,329 1,509 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 8,384 6,055 4,546 CASH AND CASH EQUIVALENTS END OF YEAR $ 12,277 $ 8,384 $ 6,055 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 124 $ 141 $ 143 Income taxes, net $ 1,052 $ 1,187 $ 1,204 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ 286 $ 250 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. In February 2020, the Company acquired a 35 % interest in Navitus Health Solutions, a pharmacy benefit manager. This investment is included in other long-term assets and is accounted for using the equity-method with earnings/losses recorded in other income in the consolidated statement of income. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions take into account historical and forward looking factors that the Company believes are reasonable, including but not limited to the potential impacts arising from the novel coronavirus (COVID-19) and related public and private sector policies and initiatives. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2020 and 2019 are $ 810 and $ 673 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. Short-Term Investments Short-term investments generally consist of debt securities (U.S. Government and Agency Notes), with maturities at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 3 , 4 , and 5 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include discounts and volume rebates. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial in 2020, 2019, and 2018. Merchandise Inventories Merchandise inventories consist of the following: 2020 2019 United States $ 8,871 $ 8,415 Canada 1,310 1,123 Other International 2,061 1,857 Merchandise inventories $ 12,242 $ 11,395 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. As of August 30, 2020, and September 1, 2019, U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts using estimates based on experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment, Net Property and equipment are stated at cost. Depreciation and amortization expense is computed primarily using the straight-line method over estimated useful lives. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably certain at the date the leasehold improvements are made. The Company capitalizes certain computer software and costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. When the assets are ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over their estimated useful lives. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2020 and 2019 were immaterial. The following table summarizes the Company's property and equipment balances at the end of 2020 and 2019: Estimated Useful Lives 2020 2019 Land N/A $ 6,696 $ 6,417 Buildings and improvements 5-50 years 17,982 17,136 Equipment and fixtures 3-20 years 8,749 7,801 Construction in progress N/A 1,276 1,272 34,703 32,626 Accumulated depreciation and amortization ( 12,896 ) ( 11,736 ) Property and equipment, net $ 21,807 $ 20,890 The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2020, 2019 or 2018. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities. Leases generally contain one or more of the following options, which the Company can exercise at the end of the initial term: (a) renew the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase the property at the then-fair market value; or (c) a right of first refusal in the event of a third-party offer. Some leases include free-rent periods and step-rent provisions, which are recognized on a straight-line basis over the original term of the lease and any extension options that the Company is reasonably certain to exercise from the date the Company has control of the property. Certain leases provide for periodic rent increases based on price indices or the greater of minimum guaranteed amounts or sales volume. Our leases do not contain any material residual value guarantees or material restrictive covenants. The Company determines at inception whether a contract is or contains a lease. The Company initially records right-of-use (ROU) assets and lease obligations for its finance and operating leases based on the discounted future minimum lease payments over the term. As the rate implicit in the Company's leases is not easily determinable, the present value of the sum of the lease payments is calculated using the Company's incremental borrowing rate. The rate is determined using a portfolio approach based on the rate of interest the Company would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. The Company uses quoted interest rates from financial institutions to derive the incremental borrowing rate. The lease term is defined as the noncancelable period of the lease plus any options to extend when it is reasonably certain that the Company will exercise the option. Impairment of ROU assets is evaluated in a similar manner as described in Property and Equipment, Net above. The Company's asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability, with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases are included in other liabilities in the accompanying consolidated balance sheet. Goodwill and Acquired Intangible Assets Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired and is not subject to amortization. The Company reviews goodwill annually in the fourth quarter for impairment or when circumstances indicate carrying value may exceed the fair value. This evaluation is performed at the reporting unit level. If a qualitative assessment indicates that it is more likely than not that the fair value is less than carrying value, a quantitative analysis is completed using either the income or market approach, or a combination of both. The income approach estimates fair value based on expected discounted future cash flows, while the market approach uses comparable public companies and transactions to develop metrics to be applied to historical and expected future operating results. Goodwill is included in other long-term assets in the consolidated balance sheets. The following table summarizes goodwill by reportable segment: United States Operations Canadian Operations Other International Operations Total Balance at September 1, 2019 $ 13 $ 27 $ 13 $ 53 Changes in currency translation 1 1 Acquisition 934 934 Balance at August 30, 2020 $ 947 $ 27 $ 14 $ 988 Definite-lived intangible assets, which are not material, are included in other long-term assets on the consolidated balance sheets and are amortized on a straight-line basis over their estimated lives, which approximates the pattern of expected economic benefit. Insurance/Self-insurance Liabilities Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. It uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2020 and 2019, these insurance liabilities were $ 1,188 and $ 1,222 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. The aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial at the end of 2020 and 2019. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 1,036 and $ 704 at the end of 2020 and 2019, respectively. See Note 4 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2020 and 2019. The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2020, 2019 and 2018. The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial in 2020, 2019, and 2018. Revenue Recognition The Company adopted Accounting Standards Update (ASU) 2014-09 in 2019, which provided for changes in the recognition of revenue from contracts with customers. The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and member returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. The Company offers merchandise in the following core merchandise categories: food and sundries, hardlines, softlines, and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is generally recognized upon shipment to the member. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively. In most countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum of approximately $1,000 per year), which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2020, 2019 and 2018, the net reduction in sales was $ 1,707 , $ 1,537 , and $ 1,394 respectively. The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Citibank, N.A. (Citi) became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot, fulfillment and manufacturing operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $ 676 , $ 614 , and $ 578 for 2020, 2019, and 2018, respectively, and are predominantly included in selling, general and administrative expenses in the consolidated statements of income. Stock-Based Compensation RSUs granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 8 for additional information on the Companys stock-based compensation plans. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 7 for additional information. Recent Accounting Pronouncements Adopted In February 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02 - Leases (ASC 842), which required recognition on the balance sheet for the rights and obligations created by leases with terms greater than 12 months. The Company adopted ASC 842, using the modified retrospective transition method and used September 2, 2019, as the date of initial application. Consequently, the comparative periods presented continue to be in accordance with ASC 840, Leases, previously in effect. The Company elected the package of practical expedients permitted under the transition guidance, allowing the Company to carry forward conclusions related to: (a) whether expired or existing contracts contain leases; (b) lease classification; and (c) initial direct costs for existing leases. The Company has elected not to record operating lease right-of-use assets or lease liabilities associated with leases with durations of 12 months or less. The Company elected the practical expedient allowing aggregation of non-lease components with related lease components when evaluating the accounting treatment for all classes of underlying assets. Adoption of the new standard resulted in an initial increase to assets and liabilities of $ 2,632 , related to recognition of operating lease right-of-use assets and operating lease obligations as of September 2, 2019. Other impacts in the Company's consolidated balance sheet were not material. The standard did not materially impact the consolidated statements of income and cash flows. For more information on the Company's lease arrangements refer to Note 6 . Note 2Acquisition of Innovel On March 17, 2020, the Company acquired Innovel Solutions for $ 998 , using existing cash and cash equivalents. Cash paid excludes the final settlement of certain holdbacks and provisional amounts, discussed below. As part of the acquisition, in the fourth quarter of 2020, a payment of $ 25 was made relating to certain holdbacks. Innovel provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico. Its financial results have been included in the Company's consolidated financial statements from the date of acquisition. Innovel's results of operations were not material to the Company's consolidated results during 2020. Pro forma results are thus not considered meaningful. As of August 30, 2020, the initial accounting for the acquisition was incomplete, pending determination of the final purchase price, working capital adjustments, the fair value of operating lease right-of-use assets, operating lease liabilities, and other assumed obligations. The net purchase price of $ 998 was allocated to tangible and intangible assets of $ 283 and liabilities assumed of $ 219 , based on their preliminary fair values on the acquisition date. The remaining unallocated net purchase price of $ 934 was recorded as goodwill. Goodwill represents the acquisition's benefits to the Company, which include the ability to serve more members and improve delivery times, enabling growth in certain segments of our U.S. e-commerce operations. The Company assigned this goodwill, which is deductible for tax purposes, to reporting units within the U.S. segment. The changes to the purchase price allocation originally recorded in the third quarter of 2020 were not material. As additional information becomes available, the provisional fair value estimates will be refined. Note 3Investments The Companys investments were as follows: 2020: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 436 $ 12 $ 448 Held-to-maturity: Certificates of deposit 580 580 Total short-term investments $ 1,016 $ 12 $ 1,028 2019: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 716 $ 6 $ 722 Held-to-maturity: Certificates of deposit 338 338 Total short-term investments $ 1,054 $ 6 $ 1,060 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended August 30, 2020, and September 1, 2019. At the end of 2020, there were no available-for-sale securities in a continuous unrealized-loss position. At the end of 2019, available-for-sale securities that were in a continuous unrealized-loss position were not material. There were no sales of available-for-sale securities during 2020 or 2019. The maturities of available-for-sale and held-to-maturity securities at the end of 2020 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ 172 $ 173 $ 580 Due after one year through five years 264 275 Total $ 436 $ 448 $ 580 Note 4Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The table below presents information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. Level 2 2020 2019 Investment in government and agency securities (1) $ 508 $ 766 Forward foreign-exchange contracts, in asset position (2) 1 15 Forward foreign-exchange contracts, in (liability) position (2) ( 21 ) ( 4 ) Total $ 488 $ 777 ____________ (1) At August 30, 2020, $ 60 cash and cash equivalents and $ 448 short-term investments are included in the accompanying consolidated balance sheets. At September 1, 2019, $ 44 cash and cash equivalents and $ 722 short-term investments are included in the consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the consolidated balance sheets. At August 30, 2020, and September 1, 2019, the Company did not hold any Level 1 or 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers between levels during 2020 or 2019. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2020 or 2019. Note 5Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $ 967 and $ 865 , in 2020 and 2019, respectively. Borrowings on these short-term facilities were immaterial during 2020 and 2019, and there were no outstanding borrowings at the end of 2020 and 2019. Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100 % of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, the holder has the right to require the Company to purchase this security at a price of 101 % of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. In April 2020, the Company issued $4,000 in aggregate principal amount of Senior Notes as follows: $ 1,250 of 1.375 % due June 2027; $ 1,750 of 1.600 % due April 2030; and $ 1,000 of 1.750 % due April 2032. In May 2020, a portion of the proceeds from the issuance were used to repay, prior to maturity, the outstanding $ 1,000 and $ 500 principal balances and interest on the 2.150 % and 2.250 % Senior Notes, respectively. The early redemption resulted in a $36 charge which was recorded in interest income and other, net in 2020. The remaining funds are intended for general corporate purposes. In December 2019, the Company paid the outstanding $ 1,200 principal balance and interest on the 1.700 % Senior Notes, with existing sources of cash and cash equivalents and short-term investments. In February 2020, the Company paid the outstanding $ 500 principal balance and interest on the 1.750 % Senior Notes, with existing sources of cash and cash equivalents and short-term investments. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary, valued using Level 3 inputs. In August 2019, the Company's Japanese subsidiary issued approximately $ 200 and $ 100 of Guaranteed Senior Notes at fixed interest rates of 0.28 % and 0.42 %, respectively. Interest is payable semi-annually, and principal is due in August 2029 and August 2034, respectively. At the end of 2020 and 2019, the fair value of the Company's long-term debt, including the current portion, was approximately $ 7,987 and $ 6,997 , respectively. The carrying value of long-term debt consisted of the following: 2020 2019 1.700% Senior Notes due December 2019 $ $ 1,200 1.750% Senior Notes due February 2020 500 2.150% Senior Notes due May 2021 1,000 2.250% Senior Notes due February 2022 500 2.300% Senior Notes due May 2022 800 800 2.750% Senior Notes due May 2024 1,000 1,000 3.000% Senior Notes due May 2027 1,000 1,000 1.375% Senior Notes due June 2027 1,250 1.600% Senior Notes due April 2030 1,750 1.750% Senior Notes due April 2032 1,000 Other long-term debt 857 852 Total long-term debt 7,657 6,852 Less unamortized debt discounts and issuance costs 48 29 Less current portion (1) 95 1,699 Long-term debt, excluding current portion $ 7,514 $ 5,124 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: 2021 $ 95 2022 800 2023 95 2024 1,114 2025 142 Thereafter 5,411 Total $ 7,657 Note 6Leases The tables below present information regarding the Company's lease assets and liabilities. 2020 Assets Operating lease right-of-use assets $ 2,788 Finance lease assets (1) 592 Total lease assets $ 3,380 Liabilities Current Operating lease liabilities (2) $ 231 Finance lease liabilities (2) 31 Long-term Operating lease liabilities 2,558 Finance lease liabilities (3) 657 Total lease liabilities $ 3,477 _______________ (1) Included in other long-term assets in the consolidated balance sheets. (2) Included in other current liabilities in the consolidated balance sheets. (3) Included in other long-term liabilities in the consolidated balance sheets. 2020 Weighted-average remaining lease term (years) Operating leases 21 Finance leases 20 Weighted-average discount rate Operating leases 2.23 % Finance leases 6.34 % The components of lease expense, excluding short-term lease costs and sublease income (which were not material), were as follows: Operating lease costs (1) $ 252 Finance lease costs: Amortization of lease assets (1) 31 Interest on lease liabilities (2) 33 Variable lease costs (3) 87 Total lease costs $ 403 _______________ (1) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. (2) Included in interest expense in the consolidated statements of income. (3) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. Amount excludes property taxes, which were immaterial. Supplemental cash flow information related to leases was as follows: 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows operating leases $ 258 Operating cash flows finance leases 33 Financing cash flows finance leases 49 Leased assets obtained in exchange for operating lease liabilities 354 Leased assets obtained in exchange for finance lease liabilities 317 As of August 30, 2020, future minimum payments during the next five fiscal years and thereafter are as follows: Operating Leases (1) Finance Leases 2021 $ 273 $ 61 2022 253 62 2023 246 66 2024 212 63 2025 176 134 Thereafter 2,410 742 Total (2) 3,570 1,128 Less amount representing interest 781 440 Present value of lease liabilities $ 2,789 $ 688 _______________ (1) Operating lease payments have not been reduced by future sublease income of $ 101 . (2) Excludes $ 280 of lease payments for leases that have been signed but not commenced. As of September 1, 2019, future minimum payments, net of sub-lease income of $ 105 , under noncancelable operating leases with terms of at least one year and capital leases reported under ASC 840 were as follows: Operating Leases Capital Leases 2020 $ 239 $ 51 2021 229 53 2022 202 38 2023 193 39 2024 181 39 Thereafter 2,206 544 Total $ 3,250 764 Less amount representing interest 343 Net present value of minimum lease payments $ 421 Note 7Stockholders Equity Dividends Cash dividends declared in 2020 totaled $ 2.70 per share, as compared to $ 2.44 per share in 2019. The Company's current quarterly dividend rate is $ 0.70 per share. Stock Repurchase Programs The Company's stock repurchase program is conducted under a $ 4,000 authorization by the Board of Directors, which expires in April 2023. As of the end of 2020, the remaining amount available under the approved plan was $ 3,745 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 2020 643 $ 308.45 $ 198 2019 1,097 225.16 247 2018 1,756 183.13 322 These amounts may differ from repurchases of common stock in the consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time to time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Note 8Stock-Based Compensation Plans The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant and the future forfeited shares from grants under the previous plan, up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on unvested and undelivered shares. At the end of 2020, 13,624,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2020: 5,021,000 time-based RSUs that vest upon continued employment over specified periods of time; 153,000 performance-based RSUs, of which 123,000 were granted to executive officers subject to the determination of the attainment of performance targets for 2020. This determination occurred in September 2020, at which time at least 33% of the units vested, as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2020: Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2019 6,496 $ 167.55 Granted 2,252 294.08 Vested and delivered ( 3,374 ) 188.92 Forfeited ( 200 ) 197.45 Outstanding at the end of 2020 5,174 $ 207.55 The weighted-average grant date fair value of RSUs granted was $ 294.08 , $ 224.00 , and $ 156.19 in 2020, 2019, and 2018, respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2020 was $ 697 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2020 were approximately 1,733,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: 2020 2019 2018 Stock-based compensation expense $ 619 $ 595 $ 544 Less recognized income tax benefit 128 128 116 Stock-based compensation expense, net $ 491 $ 467 $ 428 Note 9 Taxes Income Taxes Income before income taxes is comprised of the following: 2020 2019 2018 Domestic $ 4,204 $ 3,591 $ 3,182 Foreign 1,163 1,174 1,260 Total $ 5,367 $ 4,765 $ 4,442 The provisions for income taxes are as follows: 2020 2019 2018 Federal: Current $ 616 $ 328 $ 636 Deferred 77 222 ( 35 ) Total federal 693 550 601 State: Current 230 178 190 Deferred 8 26 22 Total state 238 204 212 Foreign: Current 372 405 487 Deferred 5 ( 98 ) ( 37 ) Total foreign 377 307 450 Total provision for income taxes $ 1,308 $ 1,061 $ 1,263 Except for certain provisions, the Tax Cuts and Jobs Act (2017 Tax Act) is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions became effective for fiscal 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of fiscal 2018 and throughout fiscal 2019 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0 % was effective for all of 2020 and 2019 and resulted in a blended rate for the Company of 25.6 % for 2018. The reconciliation between the statutory tax rate and the effective rate for 2020, 2019, and 2018 is as follows: 2020 2019 2018 Federal taxes at statutory rate $ 1,127 21.0 % $ 1,001 21.0 % $ 1,136 25.6 % State taxes, net 190 3.6 171 3.6 154 3.4 Foreign taxes, net 92 1.7 ( 1 ) 32 0.7 Employee stock ownership plan (ESOP) ( 24 ) ( 0.5 ) ( 18 ) ( 0.4 ) ( 14 ) ( 0.3 ) 2017 Tax Act ( 123 ) ( 2.6 ) 19 0.4 Other ( 77 ) ( 1.4 ) 31 0.7 ( 64 ) ( 1.4 ) Total $ 1,308 24.4 % $ 1,061 22.3 % $ 1,263 28.4 % During 2019, the Company recognized net tax benefits of $ 123 related to the 2017 Tax Act. This benefit primarily included $ 105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. During 2018, the Company recognized a net tax expense of $ 19 related to the 2017 Tax Act. This expense included $ 142 for the estimated tax on deemed repatriation of foreign earnings, and $ 43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $ 166 for the remeasurement of certain deferred tax liabilities. The Company recognized total net tax benefits of $ 81 , $ 221 and $ 57 in 2020, 2019 and 2018, respectively. These amounts include a benefit of $ 77 , $ 59 and $ 33 , respectively, related to the stock-based compensation accounting standard adopted in 2018 in addition to the impacts of the 2017 Tax Act noted above. The components of the deferred tax assets (liabilities) are as follows: 2020 2019 Deferred tax assets: Equity compensation $ 80 $ 74 Deferred income/membership fees 144 180 Foreign tax credit carry forward 101 65 Operating lease liabilities 832 Accrued liabilities and reserves 639 566 Total deferred tax assets 1,796 885 Valuation allowance ( 105 ) ( 76 ) Total net deferred tax assets 1,691 809 Deferred tax liabilities: Property and equipment ( 800 ) ( 677 ) Merchandise inventories ( 228 ) ( 187 ) Operating lease right-of-use assets ( 801 ) Foreign branch deferreds ( 81 ) ( 69 ) Other ( 40 ) ( 21 ) Total deferred tax liabilities $ ( 1,950 ) $ ( 954 ) Net deferred tax liabilities $ ( 259 ) $ ( 145 ) The deferred tax accounts at the end of 2020 and 2019 include deferred income tax assets of $ 406 and $ 398 , respectively, included in other long-term assets; and deferred income tax liabilities of $ 665 and $ 543 , respectively, included in other long-term liabilities. In 2020 and 2019, the Company recorded valuation allowances of $ 105 and $ 76 , respectively, primarily related to foreign tax credits that the Company believes will not be realized due to limitations on the ability to claim the credits during the carry forward period. The foreign tax credit carry forwards are set to expire beginning in fiscal 2030. The Company no longer considers fiscal year earnings of non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to 2018, which totaled $ 2,955 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2020 and 2019 is as follows: 2020 2019 Gross unrecognized tax benefit at beginning of year $ 27 $ 36 Gross increasescurrent year tax positions 1 5 Gross increasestax positions in prior years 8 2 Gross decreasestax positions in prior years ( 3 ) Settlements ( 4 ) Lapse of statute of limitations ( 3 ) ( 12 ) Gross unrecognized tax benefit at end of year $ 30 $ 27 The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2020 and 2019, these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $ 28 and $ 24 at the end of 2020 and 2019, respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Accrued interest and penalties recognized during 2020 and 2019 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2017. The Company is currently subject to examination in California for fiscal years 2013 to present. Other Taxes The Company is subject to multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. Subsequent to the end of 2019, the Company received an assessment related to a product tax audit covering multiple years. The Company recorded a charge of $ 123 in 2019. In the fourth quarter of 2020, the Company reached an agreement with the tax authority on this matter, resulting in a benefit of $84. Other possible losses or range of possible losses associated with these matters are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 10Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): 2020 2019 2018 Net income attributable to Costco $ 4,002 $ 3,659 $ 3,134 Weighted average basic shares 442,297 439,755 438,515 RSUs 1,604 3,168 3,319 Weighted average diluted shares 443,901 442,923 441,834 Note 11Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in an action under the California Labor Code Private Attorneys General Act (PAGA) alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 5:13-CV-03598; N.D. Cal.; filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The action has been remanded to state court. In January 2019, an employee brought similar claims for relief concerning Costco employees engaged at member services counters in California. Rodriguez v. Costco Wholesale Corp. (Case No. RG19001310; Alameda Superior Court). The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or appropriate workplace temperature conditions. Lane v. Costco Wholesale Corp. (Dec. 6, 2018 Notice to California Labor and Workforce Development Agency). The Company filed an answer denying the material allegations of the complaint. In October 2019, the parties reached an agreement to settle the seating claims on a representative basis, which received court approval in February 2020. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In October 2019, the parties reached an agreement on a class settlement, which received preliminary court approval in July 2020. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez v. Costco Wholesale Corp. (Case No. 2:19-cv-03454; C.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In December 2019, the court issued an order denying class certification. In January 2020, the plaintiffs dismissed their Labor Code claims without prejudice, and the court remanded the action to state court. The remand is being appealed. In May 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340; E.D. Cal.). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In August 2019, Rough filed a companion case in state court seeking penalties under PAGA. Rough v. Costco Wholesale Corp. (Case No. FCS053454; Sonoma County Superior Court). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The state court action has been stayed pending resolution of the federal action. In June 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp . (Case No. 3:19-cv-05624; N.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In April 2020, an employee, alleging underpayment of sick pay, filed a class and representative action against the Company, alleging claims under California law for failure to pay all wages at termination and for Labor Code penalties under PAGA. Kristy v. Costco Wholesale Corp. (Case No. 20CV366341; Santa Clara County Superior Court). A motion to dismiss was filed as to plaintiff's amended complaint, the case has been stayed due to the plaintiff's bankruptcy. In July 2020, an employee filed an action under PAGA on behalf of all California non-exempt employees alleging violations of California Labor Code provisions regarding meal and rest periods, minimum wage, overtime, wage statements, reimbursement of expenses, and payment of wages at termination. Schwab v. Costco Wholesale Corporation (Case No. 37-2020-00023551-CU-OE-CTL; San Diego County Superior Court). In August 2020, the Company filed a motion to strike portions of the complaint. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases concerning the impacts of opioid abuses filed against various defendants by counties, cities, hospitals, Native American tribes, third-party payors, and others. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and class actions filed on behalf of infants born with opioid-related medical conditions in 40 states, and class actions and individual actions filed on behalf of individuals seeking to recover alleged increased insurance costs associated with opioid abuse in 43 states and American Samoa. In 2019, similar actions were commenced against the Company in state court in Utah. Claims against the Company in state courts in New Jersey, Oklahoma, and Arizona have been dismissed. The Company is defending all of these matters. The Company and its CEO and CFO are defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Dec. 11, 2018). The complaints allege violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. They seek unspecified damages, equitable relief, interest, and costs and attorneys fees. On January 30, 2019, an order was entered consolidating the actions, and a consolidated amended complaint was filed on April 16, 2019. On November 26, 2019, the court entered an order dismissing the consolidated amended complaint and granting the plaintiffs leave to file a further amended complaint. A further amended complaint was filed on March 9, which the court dismissed with prejudice on August 19, 2020. Plaintiffs filed a notice of appeal in September 2020. Members of the Board of Directors, one other individual, and the Company are defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash.; filed Dec. 11, 2018). The complaint seeks unspecified damages, disgorgement of compensation, corporate governance changes, and costs and attorneys' fees. Because the complaint is derivative in nature, it does not seek monetary damages from the Company, which is a nominal defendant. By agreement among the parties the action has been stayed pending further proceedings in the class action. Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1), and June 12, 2019, Rahul Modi v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-15514-1). These actions have also been stayed. On June 23, 2020, a putative class action was filed against the Company, the ""Board of Directors,"" the ""Costco Benefits Committee"" and others under the Employee Retirement Income Security Act, in the United States District Court for the Eastern District of Wisconsin. Dustin S. Soulek v. Costco Wholesale, et al. , Case No. 20-cv-937. The class is alleged to be beneficiaries of the Costco 401(k) plan from June 23, 2014, and the claims are that the defendants breached their fiduciary duties in the operation and oversight of the plan. The complaint seeks injunctive relief, damages, interest, costs, and attorneys' fees. On September 11, the defendants filed a motion to dismiss the complaint, and on September 21 the plaintiffs filed an amended complaint. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 12Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. The following table provides information for the Company's reportable segments: United States Operations Canadian Operations Other International Operations Total 2020 Total revenue $ 122,142 $ 22,434 $ 22,185 $ 166,761 Operating income 3,633 860 942 5,435 Depreciation and amortization 1,248 155 242 1,645 Additions to property and equipment 2,060 258 492 2,810 Property and equipment, net 14,916 2,172 4,719 21,807 Total assets 38,366 5,270 11,920 55,556 2019 Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 924 750 4,737 Depreciation and amortization 1,126 143 223 1,492 Additions to property and equipment 2,186 303 509 2,998 Property and equipment, net 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 2018 Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 939 754 4,480 Depreciation and amortization 1,078 135 224 1,437 Additions to property and equipment 2,046 268 655 2,969 Property and equipment, net 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Disaggregated Revenue The following table summarizes net sales by merchandise category; sales from business centers and e-commerce websites have been allocated to their respective categories: 2020 2019 2018 Food and sundries $ 68,659 $ 59,672 $ 56,073 Hardlines 27,729 24,570 22,620 Fresh foods 23,204 19,948 18,879 Softlines 17,078 16,590 15,387 Ancillary and other 26,550 28,571 25,475 Total net sales $ 163,220 $ 149,351 $ 138,434 Note 13Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2020 and 2019. 52 Weeks Ended August 30, 2020 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 36,236 $ 38,256 $ 36,451 $ 52,277 $ 163,220 Membership fees 804 816 815 1,106 3,541 Total revenue 37,040 39,072 37,266 53,383 166,761 OPERATING EXPENSES Merchandise costs (1) 32,233 34,056 32,249 46,401 144,939 Selling, general and administrative (2) 3,732 3,743 3,830 5,027 (3) 16,332 Preopening expenses 14 7 8 26 55 Operating income 1,061 1,266 1,179 1,929 5,435 OTHER INCOME (EXPENSE) Interest expense ( 38 ) ( 34 ) ( 37 ) ( 51 ) ( 160 ) Interest income and other, net 35 45 21 ( 9 ) 92 INCOME BEFORE INCOME TAXES 1,058 1,277 1,163 1,869 5,367 Provision for income taxes 202 330 311 465 1,308 Net income including noncontrolling interests 856 947 852 1,404 4,059 Net income attributable to noncontrolling interests ( 12 ) ( 16 ) ( 14 ) ( 15 ) ( 57 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 844 $ 931 $ 838 $ 1,389 $ 4,002 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.91 $ 2.10 $ 1.90 $ 3.14 $ 9.05 Diluted $ 1.90 $ 2.10 $ 1.89 $ 3.13 $ 9.02 Shares used in calculation (000s) Basic 441,818 442,021 442,322 442,843 442,297 Diluted 443,680 443,727 443,855 444,231 443,901 _______________ (1) Includes $ 108 of incremental wage and sanitation costs as a result of COVID-19 of which $ 44 and $ 64 were recorded in the third and fourth quarters, respectively. (2) Includes $ 456 of incremental wage and sanitation costs as a result of COVID-19 of which $ 239 and $ 217 were recorded in the third and fourth quarters, respectively. (3) Includes a $ 84 benefit due to a partial reversal of an accrual for a product tax assessment in 2019. 52 Weeks Ended September 1, 2019 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 34,311 $ 34,628 $ 33,964 $ 46,448 $ 149,351 Membership fees 758 768 776 1,050 3,352 Total revenue 35,069 35,396 34,740 47,498 152,703 OPERATING EXPENSES Merchandise costs 30,623 30,720 30,233 41,310 132,886 Selling, general and administrative 3,475 3,464 3,371 4,684 (1) 14,994 Preopening expenses 22 9 14 41 86 Operating income 949 1,203 1,122 1,463 4,737 OTHER INCOME (EXPENSE) Interest expense ( 36 ) ( 34 ) ( 35 ) ( 45 ) ( 150 ) Interest income and other, net 22 46 36 74 178 INCOME BEFORE INCOME TAXES 935 1,215 1,123 1,492 4,765 Provision for income taxes 158 314 207 382 1,061 Net income including noncontrolling interests 777 901 916 1,110 3,704 Net income attributable to noncontrolling interests ( 10 ) ( 12 ) ( 10 ) ( 13 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 767 $ 889 $ 906 $ 1,097 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.75 $ 2.02 $ 2.06 $ 2.49 $ 8.32 Diluted $ 1.73 $ 2.01 $ 2.05 $ 2.47 $ 8.26 Shares used in calculation (000s) Basic 439,157 440,284 439,859 439,727 439,755 Diluted 442,749 442,337 442,642 443,400 442,923 _______________ (1) Includes a $ 123 charge for a product tax assessment. "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of August 30, 2020 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of August 30, 2020, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control Integrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of August 30, 2020. The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +21,Costco,2019," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash, checks, and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations varies significantly by country, and we do not currently operate our gasoline business in Korea, France or China. We operated 593 gas stations at the end of 2019 . Net sales for our gasoline business represented approximately 11% of total net sales in 2019. Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. At the end of 2019, we operated e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Net sales for e-commerce represented approximately 4% of total net sales in 2019 . Additionally, we offer business delivery, travel and various other services online in certain countries. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 88% on a worldwide basis at the end of 2019 . The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 42,900 40,700 38,600 Business, including affiliates 11,000 10,900 10,800 Total paid members 53,900 51,600 49,400 Household cards 44,600 42,700 40,900 Total cardholders 98,500 94,300 90,300 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., and Korea, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (up to a maximum reward of $1,000 per year in the U.S. and Canada and varies in Mexico, the U.K. and Korea), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members, who represented 39% of paid members at the end of 2019 , generally shop more frequently and spend more than other members. Labor Our employee count was as follows: Full-time employees 149,000 143,000 133,000 Part-time employees 105,000 102,000 98,000 Total employees 254,000 245,000 231,000 Approximately 16,000 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with other warehouse clubs (primarily Walmarts Sams Club and BJs Wholesale Club), and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered to our members at prices that are generally lower than national brands, and that they help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 67 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 63 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce merchandise, from 2013 to January 2018. 57 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 57 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 62 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 68 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 66 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 67 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 67 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 54 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets, including China. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. We rely extensively on information technology to process transactions, compile results, and manage our business. Failure or disruption of our primary and back-up systems could adversely affect our business. A failure to adequately update our existing systems and implement new systems could harm our business and adversely affect our results of operations. Given the very high volume of transactions we process it is important that we maintain uninterrupted operation of our business-critical systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors or misfeasance by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making and will continue to make investments to improve or advance critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace could be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process should mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. The potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. We previously identified a material weakness in our internal control related to ineffective information technology general controls and if we fail to maintain an effective system of internal control in the future, this could result in loss of investor confidence and adversely impact our stock price. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. We reported in our Annual Report on Form 10-K as of September 2, 2018, a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology systems that support the Companys financial reporting processes. During 2019, we completed the remediation measures related to the material weakness and concluded that our internal control over financial reporting was effective as of September 1, 2019 . Completion of remediation does not provide assurance that our remediation or other controls will continue to operate properly. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. If we do not maintain the privacy and security of personal and business information, we could damage our reputation with members and employees, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and employees and entrust that information to third-party business associates, including cloud service-providers that perform activities for us. Our warehouse and online businesses depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or defects within our hardware or software, or those of our business associates, that results in our members' or employees' information being obtained by unauthorized persons could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation, government actions, or the imposition of penalties. In addition, a breach could require expending significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is highly regulated in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to, among other things, systems changes and the development of new processes. If we or those with whom we share information fail to comply with laws and regulations, such as the General Data Protection Regulation (GDPR) and California Consumer Privacy Act (CCPA), our reputation could be damaged, possibly resulting in lost business, and we could be subjected to additional legal risk or financial losses as a result of non-compliance. We have security measures and controls to protect personal and business information and continue to make investments to secure access to our information technology network. These measures may be undermined, however, due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business and results of operations. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, select credit and debit cards, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, such as food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our business, including net sales and gross margin, will be influenced in part by merchandising and pricing strategies in response to potential cost increases by us and our competitors. While these potential impacts are uncertain, they could have an adverse impact on our financial results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions leading to loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change and extreme weather conditions, such as hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities and income taxes, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional tax liabilities. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 1, 2019 , we operated 782 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France China Total _______________ (1) 114 of the 162 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2019 : United States Canada Other International Total Total Warehouses in Operation 2015 and prior 2016 2017 2018 2019 2020 (expected through 12/31/2019) Total At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Additionally, we operate various fulfillment, processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2019 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 13June 9, 2019 39,000 $ 246.12 39,000 $ 3,985 June 10July 7, 2019 36,000 263.30 36,000 3,976 July 8August 4, 2019 54,000 278.15 54,000 3,961 August 5September 1, 2019 65,000 275.37 65,000 3,943 Total fourth quarter 194,000 $ 268.08 194,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. This authorization revoked previously authorized but unused amounts, totaling $2,237 . Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 31, 2014 , through September 1, 2019 . "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); changes in the cost of gasoline and associated competitive conditions; and changes from the revenue recognition standard. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private-label items, and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin will be influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefits costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for 2019 included: We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018 ; Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019; Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. Gross margin percentage decreased two basis points. Excluding the impact of the new revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales increased eight basis points; Selling, general administrative (SGA) expenses as a percentage of net sales increased two basis points. Excluding the impact of the new revenue recognition standard on net sales, SGA as a percentage of adjusted net sales increased 11 basis points, primarily related to a $123 charge for a product tax assessment; Effective March 2019, starting and supervisor wages were increased and paid bonding leave was made available for hourly employees in the U.S. and Canada. The estimated annualized pre-tax cost of these increases is approximately $50-$60; The effective tax rate in 2019 was 22.3% compared to 28.4% in 2018. Both years were favorably impacted by the Tax Cuts and Jobs Act (2017 Tax Act) and other net tax benefits; Net income increased 17% to $3,659 , or $8.26 per diluted share compared to $3,134 , or $7.09 per diluted share in 2018 ; and In April 2019 , the Board of Directors approved an increase in the quarterly cash dividend from $0.57 to $0.65 per share and authorized a new share repurchase program in the amount of $4,000. Results of operations Net Sales Net Sales $ 149,351 $ 138,434 $ 126,172 Changes in net sales: U.S. % % % Canada % % % Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % % % Other International % % % Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. % % % Canada % % % Other International % % % Total Company % % % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019 . See Note 1 in Item 8. Net Sales Net sales increased $10,917 or 8% during 2019 , primarily due to a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $1,463, or 106 basis points, compared to 2018, attributable to our Canadian and Other International Operations. The revenue recognition standard positively impacted net sales by $1,332, or 96 basis points. Changes in gasoline prices did not have a material impact on net sales. Comparable Sales Comparable sales increased 6% during 2019 and were positively impacted by increases in both shopping frequency and average ticket. Comparable sales were negatively impacted by cannibalization (established warehouses losing sales to our newly opened locations). Membership Fees Membership fees $ 3,352 $ 3,142 $ 2,853 Membership fees increase % % % Membership fees as a percentage of net sales 2.24 % 2.27 % 2.26 % The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses and the annual fee increase. Changes in foreign currencies relative to the U.S. dollar negatively impacted membership fees by approximately $30 in 2019. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide. As reported in 2017, we increased our annual membership fees in the U.S. and Canada and in certain of our Other International operations. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact of approximately $178 in 2018 and positively impacted 2019, primarily the first two quarters, by approximately $73. Gross Margin Net sales $ 149,351 $ 138,434 $ 126,172 Less merchandise costs 132,886 123,152 111,882 Gross margin $ 16,465 $ 15,282 $ 14,290 Gross margin percentage 11.02 % 11.04 % 11.33 % The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased seven basis points primarily due to increases in food and sundries and fresh foods partially offset by decreases in softlines and hardlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased two basis points compared to 2018. Excluding the impact of the revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales was 11.12%, an increase of eight basis points. This increase was primarily due to a 19 basis point increase in our warehouse ancillary and other businesses, predominantly our gasoline business. This increase was partially offset by decreases of four basis points in our core merchandise categories, four basis points due to an adjustment to our estimate of breakage on rewards earned under our co-branded credit card program and three basis points due to increased spending by members under the Executive Membership 2% reward program. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $155 in 2019. The segment gross margin percentage, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), increased in our U.S. operations, predominantly in our warehouse ancillary and other businesses, primarily our gasoline business. This increase was partially offset by decreases in our core merchandise categories and the breakage adjustment noted above. The segment gross margin percentage in our Canadian operations decreased predominantly in hardlines and softlines and certain of our warehouse ancillary and other businesses, partially offset by an increase in fresh foods. The segment gross margin percentage in our Other International operations decreased primarily in our core merchandise categories and due to the introduction of the Executive Membership 2% reward program in Korea. This decrease was partially offset by an increase in our gasoline business. Selling, General and Administrative Expenses SGA expenses $ 14,994 $ 13,876 $ 12,950 SGA expenses as a percentage of net sales 10.04 % 10.02 % 10.26 % SGA expenses as a percentage of net sales increased two basis points compared to 2018 . Excluding the impact of the revenue recognition standard on net sales, SGA expenses as a percentage of adjusted net sales were 10.13%, an increase of 11 basis points. This increase is largely due to a $123 charge, or eight basis points, recorded in the U.S. related to a product tax assessment. Central operating costs were higher by two basis points and stock compensation expense was higher by one basis point. Operating costs as a percent of adjusted net sales related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were flat despite the wage increases and bonding leave benefits for U.S. and Canadian hourly employees effective in March 2019. Changes in foreign currencies relative to the U.S. dollar positively impacted SGA expenses by approximately $124 in 2019. Preopening Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether a warehouse is owned or leased, and whether openings are in an existing, new, or international market. In 2019, we opened our first warehouse in China. Subsequent to year end, operations commenced at our new poultry processing plant. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company. Interest expense decreased in 2019 largely due to an increase in capitalized interest associated with our new poultry processing plant. Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ The increase in interest income in 2019 was primarily due to higher interest rates earned on higher average cash and investment balances. Foreign-currency transaction gains (losses), net include the revaluation and settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. Provision for Income Taxes Provision for income taxes $ 1,061 $ 1,263 $ 1,325 Effective tax rate 22.3 % 28.4 % 32.8 % Our effective tax rate for 2019 was favorably impacted by the reduction in the U.S. federal corporate tax rate in December 2017 from 35% to 21%, which was in effect for all of 2019, and compared to a higher blended rate effective for 2018. Net discrete tax benefits of $221 in 2019 included a benefit of $59 related to the stock-based compensation accounting standard adopted in the first quarter of 2018. This also included a tax benefit of $105 related to U.S. taxation of deemed foreign dividends, offset by losses of foreign tax credits, which impacted the effective tax rate. The tax rate for 2019 was 26.9%, excluding the net discrete tax benefits. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 6,356 $ 5,774 $ 6,726 Net cash used in investing activities (2,865 ) (2,947 ) (2,366 ) Net cash used in financing activities (1,147 ) (1,281 ) (3,218 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $9,444 and $7,259 at the end of 2019 and 2018 , respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,434 and $1,348 at the end of 2019 and 2018, respectively. These receivables generally settle within four days. Cash and cash equivalents were negatively impacted by a change in exchange rates of $15 and $37 in 2019 and 2018 , respectively, and positively impacted by $25 in 2017. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. We no longer consider earnings after 2017 of our non-U.S. consolidated subsidiaries to be indefinitely reinvested. Cash Flows from Operating Activities Net cash provided by operating activities totaled $6,356 in 2019 , compared to $5,774 in 2018 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, payment terms with our suppliers, and the amount of payables paid early to obtain discounts from our suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,865 in 2019 , compared to $2,947 in 2018 , and primarily related to capital expenditures. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations and working capital. In 2019 , we spent $2,998 on capital expenditures, and it is our current intention to spend approximat ely $3,000 to $3,200 d uring fiscal 2020. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 25 new warehous es, including five relocations, in 2019 , and plan to open approximately 22 additional new warehouses, including three relocations, in 2020. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,147 in 2019 , compared to $1,281 in 2018 . Cash flows used in financing activities primarily related to the payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. Dividends totaling $ 1,038 were paid during 2019, of which $250 related to the dividend declared in August 2018. In August 2019, approximately $200 and $100 of Guaranteed Senior Notes were issued by our Japanese subsidiary at fixed interest rates of 0.28% and 0.42%, respectively. Stock Repurchase Programs In April 2019, the Board of Directors authorized a new share repurchase program in the amount of $4,000, which expires in April 2023. This authorization revoked previously authorized but unused amounts, totaling $2,237 . During 2019 and 2018 , we repurchased 1,097,000 and 1,756,000 shares of common stock, at average prices of $225.16 and $183.13 , respectively, totaling approximately $247 and $322 , respectively. The remaining amount available to be purchased under our approved plan was $3,943 at the end of 2019 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends declared in 2019 totaled $2.44 per share, as compared to $2.14 per share in 2018 . In April 2019 , the Board of Directors increased our quarterly cash dividend from $0.57 to $0.65 per share. In August 2019 , the Board of Directors declared a quarterly cash dividend in the amount of $0.65 per share, which was paid subsequent to the end of 2019. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 1, 2019 , we had borrowing capacity under these facilities of $865, including a $400 revolving line of credit, which expires in June 2020. The Company currently has no plans to draw upon this facility. Our international operations maintain $355 of the total borrowing capacity under bank credit facilities, of which $150 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2019 and 2018 . The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $219. The outstanding commitments under these facilities at the end of 2019 totaled $145, most of which were standby letters of credit with expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Contractual Obligations At September 1, 2019 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 to 2022 2023 to 2024 2025 and thereafter Total Purchase obligations (merchandise) (1) $ 8,752 $ $ $ $ 8,756 Long-term debt (2) 1,828 2,594 1,330 1,651 7,403 Operating leases (3) 2,206 3,250 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 12,032 $ 3,332 $ 1,838 $ 4,562 $ 21,764 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Excludes common area maintenance, taxes, and insurance and have been reduced by $105 related to sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations and deferred compensation obligations. The amount excludes $27 of non-current unrecognized tax contingencies and $36 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements, other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. The 2017 Tax Act includes various provisions that significantly altered U.S. tax law, many of which impact our business (see Note 8 to the consolidated financial statements for further discussion). Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2019 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 1, 2019 , would have decreased the fair value of the contracts by $79 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 1, 2019 and September 2, 2018 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 1, 2019 and September 2, 2018 , and the results of its operations and its cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 10, 2019 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. We identified the evaluation of the Companys self-insurance liabilities as a critical audit matter because of the specialized skills necessary to evaluate the Companys actuarial models and the judgments required to assess the underlying assumptions made by the Company. Key assumptions underlying the Companys actuarial estimates include: reporting and payment patterns used in the projections of the ultimate loss; loss and exposure trends; the selected loss rates and initial expected losses used in the Paid and Incurred Bornhuetter-Ferguson methods; and the selection of the ultimate loss derived from the various methods. The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys self-insurance process. Such controls included controls over the (a) evaluation of claims information sent to the actuary, (b) development and selection of the key assumptions used in the actuarial calculation, and (c) review of the actuarial report and evaluation of the external actuarial experts qualifications, competency, and objectivity. We tested the claims data used in the actuarial calculation by selecting a sample and checking key attributes such as date of loss. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards; Evaluating the Companys ability to estimate self-insurance liabilities by comparing its historical estimates with actual loss payments; Evaluating the key assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance liabilities and comparing them to the amounts recorded by the Company; and Evaluating the qualifications of the Companys actuaries by assessing their certifications, and determining whether they met the Qualification Standards of the American Academy of Actuaries to render the statements of actuarial opinion implicit in their analyses. Performance of incremental audit procedures over IT financial reporting processes As of September 2, 2018, the Company identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. Automated and manual business process controls that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. While our report dated October 10, 2019 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting as of September 1, 2019, during a portion of the 52-week period ended September 1, 2019, the ITGCs were ineffective and the information or system generated reports produced by the affected financial reporting systems could not be relied upon without further testing. We identified the performance of the necessary incremental audit procedures over the financial information reliant on the impacted IT systems as a critical audit matter. Significant auditor judgment was required to design and execute the incremental audit procedures and to assess the sufficiency of the procedures performed and evidence obtained due to ineffective controls and the complexity of the Companys IT environment. The primary procedures we performed to address this critical audit matter included the following. We involved IT professionals with specialized skills and knowledge to assist in the identification and design of the incremental procedures. We modified the types of procedures that were performed, which included: Testing the underlying records of selected transaction data obtained from the impacted IT systems to support the use of the information in the conduct of the audit; and Involving forensic professionals with specialized skills and knowledge in data analysis to perform an evaluation of the journal entry data, including assessing that the entire population of automated and manual transactions has been identified. Forensic professionals also assisted with the identification of certain entries that required additional testing and for all such entries, we agreed the journal entry data to source documents. We evaluated the collective results of the incremental audit procedures performed to assess the sufficiency of audit evidence obtained related to the information produced by the impacted IT systems. Evaluation of the impact of the 2017 Tax Act As discussed in Note 8 to the consolidated financial statements, H.R. 1, the ""Tax Cuts and Jobs Act"" (2017 Tax Act) contains numerous provisions impacting the computation of the Companys U.S. federal and state corporate income tax provision, including the Global Intangible Low Tax Income (GILTI), Foreign Derived Intangibles Income (FDII) and Foreign Tax Credit (FTC) provisions. For the year ended September 1, 2019, the Company recognized net tax benefits of $123 million related to the 2017 Tax Act. We identified the evaluation of the Companys implementation of the provisions of the 2017 Tax Act as a critical audit matter. A high degree of judgment was required to interpret the impact of the new tax law on the Company, especially given the complexity of the 2017 Tax Act and related Treasury Regulations. Further, evaluating the Companys application of the GILTI, FDII and FTC provisions of the 2017 Tax Act required complex auditor judgment. The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys income tax process, including controls over the (a) identification and interpretation of the relevant provisions of the 2017 Tax Act and related Treasury Regulations and (b) calculation of the impact of the GILTI, FDII and FTC provisions. We involved tax professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation and application of the 2017 Tax Act. They developed an independent assessment of the impact of the GILTI, FDII and FTC provisions based on our understanding and interpretation, and compared it to the net tax benefits the Company recognized related to the 2017 Tax Act. /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 10, 2019 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 1, 2019 and September 2, 2018, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 1, 2019, the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated October 10, 2019 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting ( Item 9A ). Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 10, 2019 COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) September 1, 2019 September 2, 2018 ASSETS CURRENT ASSETS Cash and cash equivalents $ 8,384 $ 6,055 Short-term investments 1,060 1,204 Receivables, net 1,535 1,669 Merchandise inventories 11,395 11,040 Other current assets 1,111 Total current assets 23,485 20,289 PROPERTY AND EQUIPMENT Land 6,417 6,193 Buildings and improvements 17,136 16,107 Equipment and fixtures 7,801 7,274 Construction in progress 1,272 1,140 32,626 30,714 Less accumulated depreciation and amortization (11,736 ) (11,033 ) Net property and equipment 20,890 19,681 OTHER ASSETS 1,025 TOTAL ASSETS $ 45,400 $ 40,830 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 11,679 $ 11,237 Accrued salaries and benefits 3,176 2,994 Accrued member rewards 1,180 1,057 Deferred membership fees 1,711 1,624 Current portion of long-term debt 1,699 Other current liabilities 3,792 2,924 Total current liabilities 23,237 19,926 LONG-TERM DEBT, excluding current portion 5,124 6,487 OTHER LIABILITIES 1,455 1,314 Total liabilities 29,816 27,727 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 439,625,000 and 438,189,000 shares issued and outstanding Additional paid-in capital 6,417 6,107 Accumulated other comprehensive loss (1,436 ) (1,199 ) Retained earnings 10,258 7,887 Total Costco stockholders equity 15,243 12,799 Noncontrolling interests Total equity 15,584 13,103 TOTAL LIABILITIES AND EQUITY $ 45,400 $ 40,830 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 REVENUE Net sales $ 149,351 $ 138,434 $ 126,172 Membership fees 3,352 3,142 2,853 Total revenue 152,703 141,576 129,025 OPERATING EXPENSES Merchandise costs 132,886 123,152 111,882 Selling, general and administrative 14,994 13,876 12,950 Preopening expenses Operating income 4,737 4,480 4,111 OTHER INCOME (EXPENSE) Interest expense (150 ) (159 ) (134 ) Interest income and other, net INCOME BEFORE INCOME TAXES 4,765 4,442 4,039 Provision for income taxes 1,061 1,263 1,325 Net income including noncontrolling interests 3,704 3,179 2,714 Net income attributable to noncontrolling interests (45 ) (45 ) (35 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 3,659 $ 3,134 $ 2,679 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 8.32 $ 7.15 $ 6.11 Diluted $ 8.26 $ 7.09 $ 6.08 Shares used in calculation (000s) Basic 439,755 438,515 438,437 Diluted 442,923 441,834 440,937 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 3,704 $ 3,179 $ 2,714 Foreign-currency translation adjustment and other, net (245 ) (192 ) Comprehensive income 3,459 2,987 2,812 Less: Comprehensive income attributable to noncontrolling interests COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 3,422 $ 2,949 $ 2,764 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT AUGUST 28, 2016 437,524 $ $ 5,490 $ (1,099 ) $ 7,686 $ 12,079 $ $ 12,332 Net income 2,679 2,679 2,714 Foreign-currency translation adjustment and other, net Stock-based compensation Release of vested restricted stock units (RSUs), including tax effects 2,673 (165 ) (165 ) (165 ) Conversion of convertible notes Repurchases of common stock (2,998 ) (41 ) (432 ) (473 ) (473 ) Cash dividends declared and other (2 ) (3,945 ) (3,945 ) (3,945 ) BALANCE AT SEPTEMBER 3, 2017 437,204 5,800 (1,014 ) 5,988 10,778 11,079 Net income 3,134 3,134 3,179 Foreign-currency translation adjustment and other, net (185 ) (185 ) (7 ) (192 ) Stock-based compensation Release of vested RSUs, including tax effects 2,741 (217 ) (217 ) (217 ) Repurchases of common stock (1,756 ) (26 ) (296 ) (322 ) (322 ) Cash dividends declared and other (939 ) (936 ) (35 ) (971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 6,107 (1,199 ) 7,887 12,799 13,103 Net income 3,659 3,659 3,704 Foreign-currency translation adjustment and other, net (237 ) (237 ) (8 ) (245 ) Stock-based compensation Release of vested RSUs, including tax effects 2,533 (272 ) (272 ) (272 ) Repurchases of common stock (1,097 ) (16 ) (231 ) (247 ) (247 ) Cash dividends declared and other (1,057 ) (1,057 ) (1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 $ $ 6,417 $ (1,436 ) $ 10,258 $ 15,243 $ $ 15,584 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 3,704 $ 3,179 $ 2,714 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,492 1,437 1,370 Stock-based compensation Other non-cash operating activities, net (6 ) (14 ) Deferred income taxes (49 ) (29 ) Changes in operating assets and liabilities: Merchandise inventories (536 ) (1,313 ) (894 ) Accounts payable 1,561 2,258 Other operating assets and liabilities, net Net cash provided by operating activities 6,356 5,774 6,726 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments (1,094 ) (1,060 ) (1,279 ) Maturities and sales of short-term investments 1,231 1,078 1,385 Additions to property and equipment (2,998 ) (2,969 ) (2,502 ) Other investing activities, net (4 ) Net cash used in investing activities (2,865 ) (2,947 ) (2,366 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding (236 ) Proceeds from issuance of long-term debt 3,782 Repayments of long-term debt (89 ) (86 ) (2,200 ) Tax withholdings on stock-based awards (272 ) (217 ) (202 ) Repurchases of common stock (247 ) (328 ) (469 ) Cash dividend payments (1,038 ) (689 ) (3,904 ) Other financing activities, net (9 ) (41 ) Net cash used in financing activities (1,147 ) (1,281 ) (3,218 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (15 ) (37 ) Net change in cash and cash equivalents 2,329 1,509 1,167 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 6,055 4,546 3,379 CASH AND CASH EQUIVALENTS END OF YEAR $ 8,384 $ 6,055 $ 4,546 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ $ $ Income taxes, net $ 1,187 $ 1,204 $ 1,185 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ $ COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018, the Company purchased its former joint-venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2019 and 2018 are $ 673 and $ 463 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. The accompanying notes are an integral part of these consolidated financial statements. Short-Term Investments In general, short-term investments have a maturity at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 2 , 3 , and 4 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include volume rebates or other discounts. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial in 2019 , 2018 , and 2017 . Merchandise Inventories Merchandise inventories consist of the following: United States $ 8,415 $ 8,081 Canada 1,123 1,189 Other International 1,857 1,770 Merchandise inventories $ 11,395 $ 11,040 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. As of September 1, 2019 and September 2, 2018 , U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on the Companys experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment Property and equipment are stated at cost. In general, new building additions are classified into components, each with an estimated useful life, generally five to fifty years for buildings and improvements and three to twenty years for equipment and fixtures. Depreciation and amortization expense is computed using the straight-line method over estimated useful lives or the lease term, if shorter. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably assured at the date the leasehold improvements are made. The Company capitalizes certain computer software and software development costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. When the assets are ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over the estimated useful lives of the software, generally three to seven years. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2019 and 2018 were immaterial. The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2019 , 2018 or 2017 . Insurance/Self-insurance Liabilities The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. It uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2019 and 2018 , these insurance liabilities were $ 1,222 and $ 1,148 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. At the end of 2019 and 2018 , the aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 704 and $ 717 at the end of 2019 and 2018 , respectively. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2019 and 2018 . The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2019 , 2018 , and 2017 . The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial for 2019 , 2018 , and 2017 . Revenue Recognition The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. Merchandise Sales - The Company offers merchandise in the following core merchandise categories: food and sundries, hardlines, softlines, and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is recognized upon shipment to the member to the extent there is no installation provided as a part of the contract. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. Principal Versus Agent - The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. Membership Fees - The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2019 and 2018 were $1,711 and $1,624 , respectively. In certain countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum of approximately $1,000 per year), which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2019 , 2018 and 2017, the net reduction in sales was $1,537 , $1,394 , and $1,281 respectively. Shop Cards - The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Previously, the shop cards were branded as cash cards. Co-Branded Credit Card Program - Citibank, N.A. (Citi) became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot and fulfillment operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $614 , $578 , and $543 for 2019 , 2018 , and 2017 , respectively, and are predominantly included in selling, general and administrative expenses in the accompanying consolidated statements of income. Stock-Based Compensation Restricted stock units (RSUs) granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting of a portion of outstanding shares based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 7 for additional information on the Companys stock-based compensation plans. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2068 , with the exception of one lease in the U.K., which expires in 2151 . These leases generally contain one or more of the following options, which the Company can exercise at the end of the initial lease term: (a) renewal for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume. The Company has capital leases for certain warehouse locations, expiring at various dates through 2059 . Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income. The Company records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent the Company is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, the Company assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, it accounts for the arrangement as a financing lease. The Companys asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2019 and 2018 , respectively, and are included in other liabilities in the accompanying consolidated balance sheets. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 6 for additional information. Recent Accounting Pronouncements Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, providing for changes in the recognition of revenue from contracts with customers. The guidance requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows. The Company adopted the standard in the first quarter of 2019, using the modified retrospective approach, and recorded a cumulative effect adjustment of $16 as an increase to retained earnings, which is included in cash dividend declared and other in the consolidated statements of equity. The standard impacted the presentation and timing of certain revenue transactions. Specifically, the changes included gross presentation of the Companys estimate of merchandise returns reserve and the related recoverable assets, recognizing shop card breakage over the period of redemption, and accelerating the recognition of certain e-commerce and special-order sales. Additionally, the Companys evaluation under the standard of its status as a principal in certain revenue arrangements resulted in the recognition of additional sales on a gross basis. The effect of the standard on the Company's consolidated balance sheet was an increase to other current liabilities and other current assets of $649 and $698 at adoption and at the end of 2019 , respectively, related to the estimate of merchandise returns reserve and the related recoverable assets. The effect of the adoption of this standard on the Company's consolidated statement of income is as follows: As Reported ASU 2014-09 Effect Excluding ASU 2014-09 Effect 52 Weeks Ended September 1, 2019 Net Sales $ 149,351 $ 1,332 $ 148,019 Merchandise Costs 132,886 1,324 131,562 Gross Margin (1) 16,465 16,457 ______________ (1) Net sales less merchandise costs. For related disaggregated revenue disclosures, see Note 11 . Recent Accounting Pronouncements Not Yet Adopted In February 2016, the FASB issued ASU 2016-02, which requires recognition on the balance sheet of rights and obligations created by leases with terms greater than twelve months. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and utilize the transition option, which allows for a cumulative-effect adjustment in the period of adoption and does not require application of the guidance to comparative periods. The primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. The Company has substantially completed its assessment of the new standard and estimates total assets and liabilities will increase by approximately $2,400 upon adoption. The adoption is not expected to have a material impact to the Company's consolidated statements of income or cash flows. The Company continues to evaluate the related disclosure requirements. Note 2Investments The Companys investments were as follows: 2019: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ $ $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,054 $ $ 1,060 2018: Cost Basis Unrealized Losses, Net Recorded Basis Available-for-sale: Government and agency securities $ $ (14 ) $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,218 $ (14 ) $ 1,204 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended September 1, 2019 , and September 2, 2018 . At the end of 2019 and 2018 , the Company's available-for-sale securities that were in a continuous unrealized-loss position were not material. There were no sales of available-for-sale securities in 2019. Proceeds from sales of available-for-sale securities were $39 and $202 during 2018 , and 2017 , respectively. Gross realized gains or losses from sales of available-for-sale securities were not material in 2018 and 2017 . The maturities of available-for-sale and held-to-maturity securities at the end of 2019 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ $ $ Due after one year through five years Due after five years Total $ $ $ 48 Note 3Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The tables below present information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. 2019: Level 1 Level 2 Investment in government and agency securities (1) $ $ Forward foreign-exchange contracts, in asset position (2) Forward foreign-exchange contracts, in (liability) position (2) (4 ) Total $ $ 2018: Level 1 Level 2 Money market mutual funds (3) $ $ Investment in government and agency securities (1) Forward foreign-exchange contracts, in asset position (2) Forward foreign-exchange contracts, in (liability) position (2) (2 ) Total $ $ ______________ (1) At September 1, 2019 , $44 cash and cash equivalents and $722 short-term investments are included in the accompanying consolidated balance sheets. At September 2, 2018 , immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying consolidated balance sheets. (3) Included in cash and cash equivalents in the accompanying balance sheet. During and at the end of both 2019 and 2018 , the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during 2019 and 2018 . Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2019 and 2018 . Note 4Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $865 and $857 , in 2019 and 2018 , respectively. Borrowings on these short-term facilities were immaterial during 2019 and 2018 , and there were no outstanding borrowings at the end of 2019 and 2018 . Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, which have various principal balances, interest rates, and maturity dates as described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100% of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, as defined by the terms of the Senior Notes, the holder has the right to require the Company to purchase this security at a price of 101% of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary and are valued using Level 3 inputs. In October 2018, the Company's Japanese subsidiary repaid a Guaranteed Senior Note and in August 2019, issued approximately $200 and $100 of Guaranteed Senior Notes at fixed interest rates of 0.28% and 0.42% , respectively. Interest is payable semi-annually, and principal is due in August 2029 and August 2034 , respectively. At the end of 2019 and 2018 , the fair value of the Company's long-term debt, including the current portion, was approximately $6,997 and $6,492 , respectively. The carrying value of long-term debt consisted of the following: 1.70% Senior Notes due December 2019 $ 1,200 $ 1,200 1.75% Senior Notes due February 2020 2.15% Senior Notes due May 2021 1,000 1,000 2.25% Senior Notes due February 2022 2.30% Senior Notes due May 2022 2.75% Senior Notes due May 2024 1,000 1,000 3.00% Senior Notes due May 2027 1,000 1,000 Other long-term debt Total long-term debt 6,852 6,613 Less unamortized debt discounts and issuance costs Less current portion (1) 1,699 Long-term debt, excluding current portion $ 5,124 $ 6,487 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: $ 1,700 1,094 1,300 94 1,113 Thereafter 1,551 Total $ 6,852 Note 5Leases Operating Leases The aggregate rental expense for 2019 , 2018 , and 2017 was $268 , $265 , and $258 , respectively. Sub-lease income and contingent rent were not material in 2019 , 2018 , or 2017 . Capital and Build-to-Suit Leases Gross assets recorded under capital and build-to-suit leases were $457 and $427 at the end of 2019 and 2018 , respectively. These assets are recorded net of accumulated amortization of $106 and $94 at the end of 2019 and 2018 , respectively. At the end of 2019 , future minimum payments, net of sub-lease income of $105 for all years combined, under non-cancelable operating leases with terms of at least one year and capital leases were as follows: Operating Leases Capital Leases (1) $ $ 2021 2022 2023 2024 Thereafter 2,206 Total $ 3,250 Less amount representing interest (343 ) Net present value of minimum lease payments Less current installments (2) (26 ) Long-term capital lease obligations less current installments (3) $ _______________ (1) Includes build-to-suit lease obligations. (2) Included in other current liabilities in the accompanying consolidated balance sheets. (3) Included in other liabilities in the accompanying consolidated balance sheets. Note 6Stockholders Equity Dividends The Companys current quarterly dividend rate is $0.65 per share. In August 2019, the Board of Directors declared a quarterly cash dividend in the amount of $0.65 per share, which was paid subsequent to the end of 2019. Stock Repurchase Programs In April 2019 , the Board of Directors authorized a new share repurchase program in the amount of $4,000 , which expires in April 2023 . This authorization revoked previously authorized but unused amounts, totaling $2,237 . As of the end of 2019 , the remaining amount available for stock repurchases under the approved plan was $3,943 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 1,097 $ 225.16 $ 2018 1,756 183.13 2017 2,998 157.87 These amounts may differ from repurchases of common stock in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Note 7Stock-Based Compensation Plans The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. On January 24, 2019, shareholders approved the adoption of the 2019 Incentive Plan, which replaced the Seventh Restated 2002 Stock Incentive Plan (Seventh Plan). The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant under the Seventh Plan on January 24, 2019 and future forfeited shares from grants under the Seventh Plan up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on non-vested and undelivered shares. At the end of 2019 , 15,676,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2019 : 6,268,000 time-based RSUs that vest upon continued employment over specified periods of time; 228,000 performance-based RSUs, of which 150,000 were granted to executive officers subject to the certification of the attainment of specified performance targets for 2019. This certification occurred in September 2019, at which time a portion vested as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2019 : Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2018 7,578 $ 140.85 Granted 2,792 224.00 Vested and delivered (3,719 ) 155.65 Forfeited (155 ) 164.75 Outstanding at the end of 2019 6,496 $ 167.55 The weighted-average grant date fair value of RSUs granted was $224.00 , $156.19 , and $144.12 in 2019 , 2018 , and 2017 , respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2019 was $ 694 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2019 were approximately 2,194,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: Stock-based compensation expense before income taxes $ $ $ Less income tax benefit (1) (128 ) (116 ) (167 ) Stock-based compensation expense, net of income taxes $ $ $ _______________ (1) In 2019 and 2018, the income tax benefit reflects the reduction in the U.S. federal statutory income tax rate from 35% to 21% . Note 8 Taxes Income Taxes Income before income taxes is comprised of the following: Domestic $ 3,591 $ 3,182 $ 2,988 Foreign 1,174 1,260 1,051 Total $ 4,765 $ 4,442 $ 4,039 The provisions for income taxes are as follows: Federal: Current $ $ $ Deferred (35 ) Total federal State: Current Deferred Total state Foreign: Current Deferred (98 ) (37 ) (42 ) Total foreign Total provision for income taxes $ 1,061 $ 1,263 $ 1,325 In December 2017, the 2017 Tax Act was signed into law. Except for certain provisions, the 2017 Tax Act is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions became effective for 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of 2018 and throughout 2019 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0% was effective for all of 2019 and resulted in a blended rate for the Company of 25.6% for 2018. The reconciliation between the statutory tax rate and the effective rate is as follows: Federal taxes at statutory rate $ 1,001 21.0 % $ 1,136 25.6 % $ 1,414 35.0 % State taxes, net 3.6 3.4 2.9 Foreign taxes, net (1 ) 0.0 0.7 (64 ) (1.6 ) Employee stock ownership plan (ESOP) (18 ) (0.4 ) (14 ) (0.3 ) (104 ) (2.6 ) 2017 Tax Act (123 ) (2.6 ) 0.4 Other 0.7 (64 ) (1.4 ) (37 ) (0.9 ) Total $ 1,061 22.3 % $ 1,263 28.4 % $ 1,325 32.8 % During 2019, the Company recognized net tax benefits of $123 related to the 2017 Tax Act. This benefit primarily included $105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. During 2018, the Company recognized a net tax expense of $19 related to the 2017 Tax Act. This expense included $142 for the estimated tax on deemed repatriation of foreign earnings, and $43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $166 for the remeasurement of certain deferred tax liabilities. In 2019 and 2018, the Company recognized total net tax benefits of $221 and $57 , which included a benefit of $59 and $33 , respectively, related to the stock-based compensation accounting standard adopted in 2018 in addition to the impacts of the 2017 Tax Act noted above. In 2017, the Company s provision for income taxes was favorably impacted by a net tax benefit of $104 , primarily due to the $82 tax benefit recorded in connection with the May 2017 special cash dividends paid by the Company to employees through the Company's 401(k) retirement plan. Dividends on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2019 or 2018. The components of the deferred tax assets (liabilities) are as follows: Deferred tax assets: Equity compensation $ $ Deferred income/membership fees Foreign tax credit carry forward Accrued liabilities and reserves Total deferred tax assets Valuation allowance (76 ) Total net deferred tax assets Deferred tax liabilities: Property and equipment (677 ) (478 ) Merchandise inventories (187 ) (175 ) Foreign branch deferreds (69 ) Other (21 ) (40 ) Total deferred tax liabilities $ (954 ) $ (693 ) Net deferred tax (liabilities)/assets $ (145 ) $ (1 ) The deferred tax accounts at the end of 2019 and 2018 include deferred income tax assets of $398 and $316 , respectively, included in other assets; and deferred income tax liabilities of $543 and $317 , respectively, included in other liabilities. In 2019, the Company recorded a valuation allowance of $76 primarily related to foreign tax credits that we believe will not be realized due to limitations on the Company's ability to claim the credits during the carry forward period. The foreign tax credit carry forwards are set to expire beginning in fiscal 2027. The Company no longer considers fiscal year earnings of our non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to 2018, which totaled $2,924 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2019 and 2018 is as follows: Gross unrecognized tax benefit at beginning of year $ $ Gross increasescurrent year tax positions Gross increasestax positions in prior years Gross decreasestax positions in prior years (17 ) Settlements (4 ) (1 ) Lapse of statute of limitations (12 ) (10 ) Gross unrecognized tax benefit at end of year $ $ The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2019 and 2018 , these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $24 and $32 at the end of 2019 and 2018 , respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized during 2019 and 2018 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2014. Other Taxes The Company is undergoing multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. Subsequent to the end of 2019, the Company received an assessment related to a product tax audit covering multiple years. The Company recorded a charge of $123 in 2019, but plans to protest the assessment. Other possible losses or range of possible losses associated with these matters are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 9Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): Net income attributable to Costco $ 3,659 $ 3,134 $ 2,679 Weighted average basic shares 439,755 438,515 438,437 RSUs and other 3,168 3,319 2,500 Weighted average diluted shares 442,923 441,834 440,937 Note 10Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 5:13-CV-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The action has been stayed pending review by the Ninth Circuit of the order certifying a class. In January 2019, an employee brought similar claims for relief concerning Costco employees engaged at member services counters in California. Rodriguez v. Costco Wholesale Corp. (Case No. RG19001310, Alameda Superior Court filed Jan. 4, 2019). The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or appropriate workplace temperature conditions. Lane v. Costco Wholesale Corp. (Dec. 6, 2018 Notice to California Labor and Workforce Development Agency). The Company filed an answer denying the material allegations of the complaint. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438 Santa Clara Superior Court filed Jan. 3, 2019). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez, et ano., v. Costco Wholesale Corp., et al. (Case No. 2:19-cv-03454 C.D. Cal. Filed Mar. 25, 2019). The Company filed an answer denying the material allegations of the complaint. In May 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340 E.D. Cal. filed May 28, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In June 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp ., (Case No. 3:19-cv-05624 (N.D. Cal. filed June 11, 2019). The Company filed an answer denying the material allegations of the complaint. In August 2019, Rough filed a companion case in state court seeking penalties under the California Labor Code Private Attorneys General Act. Rough v. Costco (Case No. FCS053454, Sonoma County Superior Court, filed August 23, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In September 2019, an employee re-filed a class action against the Company alleging claims under California law for failure to pay wages, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Mosley v. Costco Wholesale Corp. (Case No. 2:19-cv-07935, C.D. Cal. filed Sept. 12, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes, and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and class actions filed in thirty-eight states on behalf of infants born with opioid-related medical conditions. In 2019 similar actions were commenced against the Company in state courts in Utah. Claims against the Company in state courts in New Jersey and Oklahoma have been dismissed. The Company is defending all of these matters. The Company and its CEO and CFO are defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash. filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash. filed Dec. 11, 2018). The complaints allege violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. They seek unspecified damages, equitable relief, interest, and costs and attorneys fees. On January 30, 2019, an order was entered consolidating the actions and a consolidated amended complaint was filed on April 16, 2019. A motion to dismiss the complaint was filed on June 7. Members of the Board of Directors, one other individual, and the Company are defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash. filed Dec. 11, 2018). The complaint seeks unspecified damages, disgorgement of compensation, corporate governance changes, and costs and attorneys' fees. Because the complaint is derivative in nature, it does not seek monetary damages from the Company, which is a nominal defendant. By agreement among the parties the action has been stayed pending further proceedings in the class actions. Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), and April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1). These actions have also been stayed. In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. The relief to be sought is not known at this time. The Company is seeking to cooperate concerning the resolution of these notices. On February 13, 2019, the Company's affiliate in Spain received notice from the General Directorate on Environment and Sustainability of the Regional Government of Madrid that the Directorate was investigating issues concerning rain, sewage and hydrocarbon drainage related to the Company's warehouse in Getafe. In August the Company was advised that no fines would be sought in this matter. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 11Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. United States Operations Canadian Operations Other International Operations Total Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 4,737 Depreciation and amortization 1,126 1,492 Additions to property and equipment 2,186 2,998 Net property and equipment 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 4,480 Depreciation and amortization 1,078 1,437 Additions to property and equipment 2,046 2,969 Net property and equipment 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Total revenue $ 93,889 $ 18,775 $ 16,361 $ 129,025 Operating income 2,644 4,111 Depreciation and amortization 1,044 1,370 Additions to property and equipment 1,714 2,502 Net property and equipment 12,339 1,820 4,002 18,161 Total assets 24,068 4,471 7,808 36,347 Disaggregated Revenue The following table summarizes net sales by merchandise category: Food and Sundries $ 59,672 $ 56,073 $ 52,362 Hardlines 24,570 22,620 20,583 Fresh Foods 19,948 18,879 17,849 Softlines 16,590 15,387 14,537 Ancillary 28,571 25,475 20,841 Total Net Sales $ 149,351 $ 138,434 $ 126,172 Note 12Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2019 and 2018 . 52 Weeks Ended September 1, 2019 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 34,311 $ 34,628 $ 33,964 $ 46,448 $ 149,351 Membership fees 1,050 3,352 Total revenue 35,069 35,396 34,740 47,498 152,703 OPERATING EXPENSES Merchandise costs 30,623 30,720 30,233 41,310 132,886 Selling, general and administrative 3,475 3,464 3,371 4,684 (1 ) 14,994 Preopening expenses Operating income 1,203 1,122 1,463 4,737 OTHER INCOME (EXPENSE) Interest expense (36 ) (34 ) (35 ) (45 ) (150 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,215 1,123 1,492 4,765 Provision for income taxes 1,061 Net income including noncontrolling interests 1,110 3,704 Net income attributable to noncontrolling interests (10 ) (12 ) (10 ) (13 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,097 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.75 $ 2.02 $ 2.06 $ 2.49 $ 8.32 Diluted $ 1.73 $ 2.01 $ 2.05 $ 2.47 $ 8.26 Shares used in calculation (000s) Basic 439,157 440,284 439,859 439,727 439,755 Diluted 442,749 442,337 442,642 443,400 442,923 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.57 $ 0.57 $ 0.65 $ 0.65 $ 2.44 _______________ (1) Includes a $123 charge for a product tax assessment. 52 Weeks Ended September 2, 2018 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 31,117 $ 32,279 $ 31,624 $ 43,414 $ 138,434 Membership fees 3,142 Total revenue 31,809 32,995 32,361 44,411 141,576 OPERATING EXPENSES Merchandise costs 27,617 28,733 28,131 38,671 123,152 Selling, general and administrative 3,224 3,234 3,155 4,263 13,876 Preopening expenses Operating income 1,016 1,067 1,446 4,480 OTHER INCOME (EXPENSE) Interest expense (37 ) (37 ) (37 ) (48 ) (159 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,071 1,449 4,442 Provision for income taxes 1,263 Net income including noncontrolling interests 1,053 3,179 Net income attributable to noncontrolling interests (11 ) (12 ) (12 ) (10 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,043 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.46 $ 1.60 $ 1.71 $ 2.38 $ 7.15 Diluted $ 1.45 $ 1.59 $ 1.70 $ 2.36 $ 7.09 Shares used in calculation (000s) Basic 437,965 439,022 438,740 438,379 438,515 Diluted 440,851 441,568 441,715 442,427 441,834 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.50 $ 0.50 $ 0.57 $ 0.57 $ 2.14 "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of September 1, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 1, 2019 , using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework (2013). As disclosed in Part II Item 9A Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended September 2, 2018 , during the fourth quarter of fiscal 2018 we identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. During 2019 , management implemented our previously disclosed remediation plan that included: (i) creating and filling an IT Compliance Oversight function; (ii) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over IT systems impacting financial reporting; (iii) developing and maintaining documentation underlying ITGCs to promote knowledge transfer upon personnel and function changes; (iv) developing enhanced risk assessment procedures and controls related to changes in IT systems; (v) implementing an IT management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board of Directors. During the fourth quarter of 2019 , we completed our testing of the operating effectiveness of the implemented controls and found them to be effective. As a result we have concluded the material weakness has been remediated as of September 1, 2019 . Changes in Internal Control Over Financial Reporting Except for the changes in connection with our implementation of the remediation plan discussed above, there have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +22,Costco,2018," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018 , and August 28, 2016 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 145,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations vary significantly by country, and we do not operate our gasoline business in Korea or France. We operated 567 gas stations at the end of 2018 . Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. We operate e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Net sales for e-commerce represented approximately 4% of total net sales in 2018 . Additionally, we offer business delivery, travel and various other services online in certain countries. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase and manufacture private-label merchandise, as long as quality and member demand are comparable and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable evidence. Business members have the ability to add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 90% in the U.S. and Canada and 88% on a worldwide basis at the end of 2018 . The majority of members renew within six months following their renewal date. Therefore, our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 40,700 38,600 36,800 Business, including affiliates 10,900 10,800 10,800 Total paid members 51,600 49,400 47,600 Household cards 42,700 40,900 39,100 Total cardholders 94,300 90,300 86,700 Paid cardholders (except Business affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada for an additional annual fee of $60. Executive memberships are also available in Mexico and the U.K., for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (up to a maximum reward of $1,000 per year in U.S. and Canada and varies in Mexico and the U.K.), and can be redeemed only at Costco warehouses. This program also offers (except in Mexico), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing services. These services are generally provided by third parties and vary by state and country. Executive members, who represented 37% of paid members at the end of 2018 , generally shop more frequently and spend more than other members. Labor Our employee count was as follows: Full-time employees 143,000 133,000 126,000 Part-time employees 102,000 98,000 92,000 Total employees 245,000 231,000 218,000 Approximately 15,900 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with warehouse club operations (primarily Walmarts Sams Club and BJs Wholesale Club), and nearly every major U.S. and Mexico metropolitan area has multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, patents, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered to our members at prices that are generally lower than national brands, and that they help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are properly maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, from this code to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Executive Officers of the Registrant The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 66 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 62 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce merchandise, from 2013 to January 2018. 56 Franz E. Lazarus Executive Vice President, Administration. Mr. Lazarus was Senior Vice President, Administration-Global Operations, from 2006 to September 2012. 71 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 61 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 67 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 65 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 66 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 66 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 53 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lack of familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce member renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. We rely extensively on information technology to process transactions, compile results, and manage our businesses. Failure or disruption of our primary and back-up systems could adversely affect our businesses. A failure to adequately update our existing systems and implement new systems could harm our businesses and adversely affect our results of operations. Given the very high volume of transactions we process each year it is important that we maintain uninterrupted operation of our business-critical computer systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making, and will continue to make, investments to improve or advance critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace would be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process will mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. The potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. We identified a material weakness in our internal control related to ineffective information technology general controls which, if not remediated appropriately or timely, could result in loss of investor confidence and adversely impact our stock price. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. As disclosed in Part II, Item 9A, during the fourth quarter of fiscal 2018, management identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. As a result, management concluded that our internal control over financial reporting was not effective as of September 2, 2018. We are implementing remedial measures and, while there can be no assurance that our efforts will be successful, we plan to remediate the material weakness prior to the end of fiscal 2019. These measures will result in additional technology and other expenses. If we are unable to remediate the material weakness, or are otherwise unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods, could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. If we do not maintain the privacy and security of personal and business information, we could damage our reputation with members and employees, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and employees and entrust that information to third-party business associates, including cloud service-providers that perform activities for us. Our warehouse and online businesses depend upon the secure transmission of encrypted confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or defects within our hardware or software, or those of our business associates, that results in our members' or employees' information being obtained by unauthorized persons, could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation, government actions, or the imposition of penalties. In addition, a breach could require that we expend significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is regulated at the national and state or local level in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to, among other things, systems changes and the development of new processes. If we or those with whom we share information fail to comply with these laws and regulations, our reputation could be damaged, possibly resulting in lost future business, and we could be subjected to additional legal risk as a result of non-compliance, including fines of up to 4% of our global revenue in the case of the General Data Protection Regulation (GDPR). We do not maintain cyber-insurance for these risks. We have security measures and controls to protect personal and business information and continue to make investments to secure access to our information technology network. These measures may be undermined, however, due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business and results of operations. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, a select variety of credit and debit cards, and our proprietary cash card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related card acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services, including the processing of credit and debit cards, and our proprietary cash card, and it could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. In addition, if our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, such as food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our vendors are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with all safety standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury in the future or that we will not be subject to claims, lawsuits, or government investigations relating to such matters resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making technology investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact the business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance, or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. We are primarily self-insured as it relates to property damage. Although we maintain specific coverages for catastrophic losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flow and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including merchandise pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop with digital devices, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Prices of certain commodity products, including gasoline and other food products, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by significant events like the outbreak of war or acts of terrorism. Vendors may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any vendor has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions of our merchandise leading to loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key vendors could negatively affect us. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality or more expensive than those from existing vendors. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volume we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. For these or other reasons, one or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase our costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase for sale in our warehouses around the world is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to one or more of our properties, the temporary closure of one or more warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots within the countries in which we operate, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may result in increased compliance and merchandise costs, and legislation or regulation affecting energy inputs that could materially affect our profitability. Climate change and extreme weather conditions, such as intense hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels could affect our ability to procure needed commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. During 2018 , we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities and income taxes, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional income tax liabilities. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates, adverse outcomes in tax audits, including transfer pricing disputes, or any change in the pronouncements relating to accounting for income taxes could have a material adverse effect on our financial condition and results of operations. Significant changes in, or failure to comply with, federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 2, 2018 , we operated 762 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea (2) Taiwan Australia Spain Iceland France Total _______________ (1) 106 of the 157 leases are land-only leases, where Costco owns the building. (2) In fiscal 2018, Costco purchased the remaining equity interest and three formerly leased locations from its former joint-venture partner in Korea. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2018 : United States Canada Other International Total Total Warehouses in Operation 2014 and prior 2015 2016 2017 2018 2019 (expected through 12/31/2018) Total At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2018: Fourth Quarter $ 233.13 $ 195.48 $ 0.570 Third Quarter 197.16 180.84 0.570 Second Quarter 198.91 172.61 0.500 First Quarter 173.42 154.61 0.500 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2018 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 14June 10, 2018 96,000 $ 198.61 96,000 $ 2,497 June 11July 8, 2018 134,000 208.49 134,000 2,469 July 9August 5, 2018 111,000 216.06 111,000 2,445 August 6September 2, 2018 78,000 225.20 78,000 2,427 Total fourth quarter 419,000 $ 211.35 419,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation plus dividends) on our common stock for the last five years with the cumulative total return of the SP 500 Index, the SP 500 Retail Index, and a peer group previously selected by the Company. The SP 500 Retail Index is intended to replace the previously selected peer group to allow for a more broad representation of industry performance. The transition to a larger retail index provides a better representation of total retail market performance. For the year ended September 2, 2018 , the cumulative total return of the previous peer group is provided pursuant to SEC rules requiring presentation in the year of change, and consists of: Amazon.com Inc.; The Home Depot Inc.; Lowe's Companies; Best Buy Co., Inc.; Staples Inc.; Target Corporation; Kroger Company; and Walmart Stores, Inc. This group will not be presented in future periods. The information provided is from September 1, 2013 , through September 2, 2018 . The graph assumes the investment of $100 in Costco common stock, the SP 500 Index, the SP 500 Retail Index, and the previously selected peer group on September 1, 2013, and reinvestment of all dividends. "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable warehouse sales (comparable sales) growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items, and through our online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales. Our membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates, materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets. Our financial performance depends heavily on our ability to control costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low margins, modest changes in various items in the income statement, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefits costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. Fiscal year 2018 and 2016 were 52-week fiscal years ending on September 2, 2018 and August 28, 2016 , respectively, and 2017 was a 53-week fiscal year ending on September 3, 2017 . Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for fiscal year 2018 included: We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017 ; Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017 ; Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses; Gross margin percentage decreased 29 basis points due to the impact of gasoline price inflation on net sales and a shift in sales penetration to certain lower margin warehouse ancillary businesses from our core merchandise categories; Selling, general administrative (SGA) expenses as a percentage of net sales decreased 24 basis points, due to the impact of gasoline price inflation and leveraging increased sales; The effective tax rate in 2018 was 28.4% and was favorably impacted by the 2017 Tax Act and net tax benefits of $57. The effective tax rate in 2017 was 32.8% and was favorably impacted by net tax benefits of $104; Net income increased 17% to $3,134 , or $7.09 per diluted share compared to $2,679 , or $6.08 per diluted share in 2017 ; and In April 2018, the Board of Directors approved an increase in the quarterly cash dividend from $0.50 to $0.57 per share. Results of operations Net Sales Net Sales $ 138,434 $ 126,172 $ 116,073 Changes in net sales: U.S. % % % Canada % % (2 )% Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % % (3 )% Other International % % (3 )% Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices: U.S. % % % Canada % % % Other International % % % Total Company % % % 2018 vs. 2017 Net Sales Net sales increased $12,262 or 10% during 2018 , primarily due to a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by the impact of one additional week of sales in 2017. Changes in gasoline prices positively impacted net sales by approximately $2,267, or 180 basis points, due to a 19% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar positively impacted net sales by approximately $1,156, or 92 basis points, compared to 2017 . The positive impact was driven by both our Canadian and Other International operations. Comparable Sales Comparable sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices and exchange rates in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). 2017 vs. 2016 Net Sales Net sales increased $10,099 or 9% during 2017, primarily due to a 4% increase in comparable sales, new warehouses opened in 2016 and 2017, and the benefit of one additional week of sales in 2017. Changes in gasoline prices positively impacted net sales by approximately $785, or 68 basis points, due to an 8% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $295, or 25 basis points, compared to 2016. The negative impact was driven by Other International operations, partially offset by positive impacts attributable to our Canadian operations. Comparable Sales Comparable sales increased 4% during 2017 and were positively impacted by an increase in shopping frequency and, to a lesser extent, an increased average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices, offset by decreases in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization. Membership Fees Membership fees $ 3,142 $ 2,853 $ 2,646 Membership fees increase % % % Membership fees as a percentage of net sales 2.27 % 2.26 % 2.28 % 2018 vs. 2017 The increase in membership fees was primarily due to the annual fee increase and membership sign-ups at existing and new warehouses. These increases were partially offset by the impact of one additional week of membership fees in 2017. At the end of 2018 , our member renewal rates were 90% in the U.S. and Canada and 88% worldwide. As reported in fiscal 2017, we increased our annual membership fees in the U.S. and Canada and in certain of our Other International operations. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact of approximately $178 in fiscal 2018 and will positively impact fiscal 2019, primarily the first two quarters, by approximately $70. 2017 vs. 2016 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fee revenue, the annual fee increase, and an increased number of upgrades to our higher-fee Executive Membership program. Fee increases had a positive impact on membership fee revenues during 2017 of approximately $23. Gross Margin Net sales $ 138,434 $ 126,172 $ 116,073 Less merchandise costs 123,152 111,882 102,901 Gross margin $ 15,282 $ 14,290 $ 13,172 Gross margin percentage 11.04 % 11.33 % 11.35 % 2018 vs. 2017 The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased one basis point primarily due to increases in food and sundries and hardlines partially offset by decreases in fresh foods and softlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased 29 basis points compared to 2017. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.22%, a decrease of 11 basis points. This decrease was primarily due to a shift in sales penetration to certain lower margin warehouse ancillary and other businesses, which contributed to a 13 basis point decrease in our core merchandise categories, except hardlines which was flat. Gross margin percentage was also negatively impacted by 10 basis points due to a non-recurring legal settlement benefiting 2017 and costs related to our centralized return centers in the U.S. These decreases were partially offset by a 13 basis point increase in our warehouse ancillary and other businesses, predominantly our gasoline business. Changes in foreign currencies relative to the U.S. dollar positively impacted gross margin by approximately $124 in 2018. The segment gross margin percentage, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), decreased in our U.S. operations, predominantly in our core merchandise categories, and as a result of the non-recurring legal settlement in 2017, and the costs related to our centralized return centers mentioned above. The segment gross margin percentage in our Canadian operations increased, due to warehouse ancillary and other businesses, primarily our gasoline business. The segment gross margin percentage in our Other International operations decreased, predominantly in food and sundries and softlines, partially offset by an increase in our gasoline business. 2017 vs. 2016 The gross margin of our core merchandise categories, when expressed as a percentage of core merchandise sales, increased eight basis points due to increases in these categories other than fresh foods. Total gross margin percentage decreased two basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.40%, an increase of five basis points. This increase was primarily due to amounts earned under the co-branded credit card arrangement in the U.S. of 15 basis points and a benefit of three basis points from non-recurring legal settlements and other matters. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. These increases were partially offset by a six basis point decrease in our core merchandise categories, primarily due to food and sundries as a result of a decrease in sales penetration. The gross margin percentage was also negatively impacted by five basis points due to a LIFO benefit in 2016 and one basis point in warehouse ancillary and other businesses. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact on gross margin in 2017. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales, increased in our U.S. operations, due to amounts earned under the co-branded credit card arrangement and non-recurring legal settlements and other matters as discussed above. These increases were partially offset by a decrease in core merchandise categories, predominantly food and sundries as a result of a decrease in sales penetration, and a LIFO benefit in 2016. The segment gross margin percentage in our Canadian operations increased, primarily due to increases in warehouse ancillary and other businesses, primarily our pharmacy business, partially offset by a decrease in our core merchandise categories, largely fresh foods. The segment gross margin percentage increased in our Other International operations due to increases across all core merchandise categories, except fresh foods. Selling, General and Administrative Expenses SGA expenses $ 13,876 $ 12,950 $ 12,068 SGA expenses as a percentage of net sales 10.02 % 10.26 % 10.40 % 2018 vs. 2017 SGA expenses as a percentage of net sales decreased 24 basis points compared to 2017. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.19%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were lower by six basis points, predominantly in our U.S. and Other International operations, due to leveraging increased sales. Charges related to certain non-recurring legal and other matters in 2017 positively impacted SGA expense by two basis points. Stock compensation expense was also lower by one basis point. Central operating costs were higher by two basis points. Changes in foreign currencies relative to the U.S. dollar increased our SGA expenses by approximately $98 in 2018. Effective in June 2018, a portion of the savings generated from the Tax Cuts and Jobs Act (the 2017 Tax Act) were used to increase wages for the majority of our U.S. hourly employees. The impact in fiscal 2018 was two basis points and the estimated annualized pre-tax cost of these increases is approximately $120. 2017 vs. 2016 SGA expenses as a percentage of net sales decreased 14 basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.33%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, were lower by nine basis points, primarily due to lower costs associated with the co-branded credit card arrangement in the U.S. of 18 basis points. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. This was partially offset by higher payroll and employee benefit expenses of 11 basis points, primarily in our U.S. operations. Central operating costs were higher by one basis point, primarily due to increased costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations. Stock compensation expense was also higher by one basis point. Preopening Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new, or international market. In 2017, we entered into two new international markets, Iceland and France. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. In March and June 2017, we repaid $2,200 in total outstanding principal of the 5.5% and 1.125% Senior Notes, respectively. Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ 2018 vs. 2017 The increase in interest income in 2018 as compared to 2017 was primarily due to higher interest rates earned on higher average cash and investment balances. Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. In 2018, the increase was primarily due to a strengthening U.S. dollar relative to certain foreign currencies on forward foreign-exchange contracts. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. 2017 vs. 2016 Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. Provision for Income Taxes Provision for income taxes $ 1,263 $ 1,325 $ 1,243 Effective tax rate 28.4 % 32.8 % 34.3 % Our effective tax rate for 2018 was favorably impacted by the 2017 Tax Act, which included a reduction in the U.S. federal corporate rate from 35% to 21%. Due to the timing of our fiscal year relative to the effective date of the rate change, our U.S. corporate rate for 2018 resulted in a blended rate of 25.6%. Other impacts from the 2017 Tax Act consisted of tax expense of $142 for the estimated tax on deemed repatriation of unremitted earnings and $43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $166 for the provisional remeasurement of certain deferred tax liabilities. In 2018, we also recognized net tax benefits of $76, which was largely driven by the adoption of an accounting standard related to stock-based compensation and other immaterial net benefits. In 2017, our provision was favorably impacted by net tax benefits of $104, primarily due to a tax benefit recorded in connection with the May 2017 special dividend paid to employees through our 401(k) retirement plan of $82. This dividend was deductible for U.S. income tax purposes. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 5,774 $ 6,726 $ 3,292 Net cash used in investing activities (2,947 ) (2,366 ) (2,345 ) Net cash used in financing activities (1,281 ) (3,218 ) (2,419 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $7,259 and $5,779 at the end of 2018 and 2017 , respectively. Of these balances, approximately $ 1,348 and $ 1,255 represented unsettled credit and debit card receivables, respectively. These receivables generally settle within four days. Cash and cash equivalents were negatively impacted by a change in exchange rates of $ 37 in 2018 and positively impacted by $ 25 and $ 50 in 2017 and 2016 , respectively. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. While we believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements, beginning in the second quarter of fiscal 2018, we no longer consider current fiscal year and future earnings of our non-U.S. consolidated subsidiaries to be permanently reinvested. We recorded the estimated incremental foreign withholding (net of available foreign tax credits) and state income taxes payable on current fiscal year earnings assuming a hypothetical repatriation to the U.S. We continue to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to fiscal 2018 to be indefinitely reinvested and have not provided for withholding or state taxes. In fiscal 2018, we recorded a one-time charge of $142 for the estimated tax on deemed repatriation of unremitted earnings under the 2017 Tax Act. The 2017 Tax Act provides for the payment of the federal tax over an eight-year period. Because of the availability of foreign tax credits, the amount payable is $97, of which $89 is classified as long-term and included in other liabilities on our consolidated balance sheet. Cash Flows from Operating Activities Net cash provided by operating activities totaled $ 5,774 in 2018 , compared to $ 6,726 in 2017 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise vendors, warehouse operating costs including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. The decrease in net cash provided by operating activities for 2018 when compared to 2017 was primarily due to accelerated vendor payments of approximately $1,700 made in the last week of fiscal 2016, which positively impacted cash flows in 2017. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,947 in 2018 , compared to $2,366 in 2017 , and primarily related to capital expenditures. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures We opened 21 net new warehous es and relocated 4 warehouses in 2018 and plan to open approximately 20 net new warehouses and relocate up to 4 warehouses in 2019 . Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations and working capital. In 2018 , we spent $2,969 on capital expenditures, and it is our current intention to spend approximately $2,800 to $3,100 during fiscal 2019 . These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,281 in 2018 , compared to $3,218 in 2017 . The primary uses of cash in 2018 were related to dividend payments and repurchases of common stock. Net cash used in financing activities in 2017 primarily related to dividend payments, predominantly the special dividend paid in May 2017, and the repayments of debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. The proceeds received were net of a discount and used to pay the special dividend and a portion of the redemption of the 1.125% Senior Notes. Stock Repurchase Programs During 2018 and 2017 , we repurchased 1,756,000 and 2,998,000 shares of common stock, at average prices of $183.13 and $157.87 , totaling approximately $322 and $473 , respectively. The remaining amount available to be purchased under our approved plan was $2,427 at the end of 2018 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends declared in 2018 totaled $ 2.14 per share, as compared to $ 8.90 per share in 2017 , which included a special cash dividend of $7.00 per share. In April 2018 , our Board of Directors increased our quarterly cash dividend from $0.50 to $0.57 per share. Subsequent to the end of 2018, our Board of Directors declared a quarterly cash dividend in the amount of $0.57 per share, which is payable on November 23, 2018. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 2, 2018 , we had borrowing capacity under these facilities of $857, including a $400 revolving line of credit renewed by the U.S., which expires in June 2019. The Company currently has no plans to draw upon this facility. Our international operations maintain $344 of the total borrowing capacity under bank credit facilities, of which $163 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2018 and 2017. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $220. The outstanding standby letters of credit under these facilities at the end of 2018 totaled $149 and expire within one year. The bank credit facilities and commercial paper programs have various expiration dates, all within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit then outstanding. Contractual Obligations At September 2, 2018 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2020 to 2021 2022 to 2023 2024 and thereafter Total Purchase obligations (merchandise) (1) $ 9,029 $ $ $ $ 9,031 Long-term debt (2) 3,029 1,537 2,496 7,294 Operating leases (3) 2,215 3,207 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 10,862 $ 3,745 $ 2,070 $ 5,502 $ 22,179 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Excludes common area maintenance, taxes, and insurance and have been reduced by $105 related to sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations, deferred compensation obligations and current liabilities for unrecognized tax contingencies. The total amount excludes $36 of non-current unrecognized tax contingencies and $30 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had, or are reasonably likely to have, a material current or future effect on our financial condition or financial statements other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-Insurance Liabilities The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. We use different mechanisms, including a wholly-owned captive insurance subsidiary and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims of an extended nature. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. In December 2017, the 2017 Tax Act was signed into law and our effective tax rate for fiscal 2018 reflects the provisional impact (see Note 8 to our Consolidated Financial Statements). Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2018 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2018 , long-term debt with fixed interest rates was $6,577 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 2, 2018 , would have decreased the fair value of the contracts by $80 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 2, 2018 and September 3, 2017 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 2, 2018 and September 3, 2017 , and the results of its operations and its cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 25, 2018 expressed an adverse opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 25, 2018 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of September 2, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described below, on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 2, 2018 and September 3, 2017, and the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018, the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016, and the related notes (collectively, the consolidated financial statements), and our report dated October 25, 2018 expressed an unqualified opinion on those consolidated financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the companys annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in managements assessment: There were ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. As a result, business process automated and manual controls that were dependent on the affected ITGCs were ineffective because they could have been adversely impacted. These control deficiencies were a result of: IT control processes lacked sufficient documentation; insufficient knowledge and training of certain individuals with IT expertise; and risk-assessment processes inadequate to identify and assess changes in IT environments and personnel that could impact internal control over financial reporting. The material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the fiscal year 2018 consolidated financial statements, and this report does not affect our report on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting (Item 9A). Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 25, 2018 COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) September 2, 2018 September 3, 2017 ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,055 $ 4,546 Short-term investments 1,204 1,233 Receivables, net 1,669 1,432 Merchandise inventories 11,040 9,834 Other current assets Total current assets 20,289 17,317 PROPERTY AND EQUIPMENT Land 6,193 5,690 Buildings and improvements 16,107 15,127 Equipment and fixtures 7,274 6,681 Construction in progress 1,140 30,714 28,341 Less accumulated depreciation and amortization (11,033 ) (10,180 ) Net property and equipment 19,681 18,161 OTHER ASSETS TOTAL ASSETS $ 40,830 $ 36,347 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 11,237 $ 9,608 Accrued salaries and benefits 2,994 2,703 Accrued member rewards 1,057 Deferred membership fees 1,624 1,498 Other current liabilities 3,014 2,725 Total current liabilities 19,926 17,495 LONG-TERM DEBT, excluding current portion 6,487 6,573 OTHER LIABILITIES 1,314 1,200 Total liabilities 27,727 25,268 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 438,189,000 and 437,204,000 shares issued and outstanding Additional paid-in capital 6,107 5,800 Accumulated other comprehensive loss (1,199 ) (1,014 ) Retained earnings 7,887 5,988 Total Costco stockholders equity 12,799 10,778 Noncontrolling interests Total equity 13,103 11,079 TOTAL LIABILITIES AND EQUITY $ 40,830 $ 36,347 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 REVENUE Net sales $ 138,434 $ 126,172 $ 116,073 Membership fees 3,142 2,853 2,646 Total revenue 141,576 129,025 118,719 OPERATING EXPENSES Merchandise costs 123,152 111,882 102,901 Selling, general and administrative 13,876 12,950 12,068 Preopening expenses Operating income 4,480 4,111 3,672 OTHER INCOME (EXPENSE) Interest expense (159 ) (134 ) (133 ) Interest income and other, net INCOME BEFORE INCOME TAXES 4,442 4,039 3,619 Provision for income taxes 1,263 1,325 1,243 Net income including noncontrolling interests 3,179 2,714 2,376 Net income attributable to noncontrolling interests (45 ) (35 ) (26 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 3,134 $ 2,679 $ 2,350 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 7.15 $ 6.11 $ 5.36 Diluted $ 7.09 $ 6.08 $ 5.33 Shares used in calculation (000s) Basic 438,515 438,437 438,585 Diluted 441,834 440,937 441,263 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 2.14 $ 8.90 $ 1.70 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 3,179 $ 2,714 $ 2,376 Foreign-currency translation adjustment and other, net (192 ) Comprehensive income 2,987 2,812 2,402 Less: Comprehensive income attributable to noncontrolling interests COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 2,949 $ 2,764 $ 2,372 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT AUGUST 30, 2015 437,952 $ $ 5,218 $ (1,121 ) $ 6,518 $ 10,617 $ $ 10,843 Net income 2,350 2,350 2,376 Foreign-currency translation adjustment and other, net Stock-based compensation Stock options exercised, including tax effects Release of vested restricted stock units (RSUs), including tax effects 2,749 (146 ) (146 ) (146 ) Conversion of convertible notes Repurchases of common stock (3,184 ) (41 ) (436 ) (477 ) (477 ) Cash dividends declared and other (746 ) (746 ) (3 ) (749 ) BALANCE AT AUGUST 28, 2016 437,524 5,490 (1,099 ) 7,686 12,079 12,332 Net income 2,679 2,679 2,714 Foreign-currency translation adjustment and other, net Stock-based compensation Release of vested RSUs, including tax effects 2,673 (165 ) (165 ) (165 ) Conversion of convertible notes Repurchases of common stock (2,998 ) (41 ) (432 ) (473 ) (473 ) Cash dividends declared and other (2 ) (3,945 ) (3,945 ) (3,945 ) BALANCE AT SEPTEMBER 3, 2017 437,204 5,800 (1,014 ) 5,988 10,778 11,079 Net income 3,134 3,134 3,179 Foreign-currency translation adjustment and other, net (185 ) (185 ) (7 ) (192 ) Stock-based compensation Release of vested RSUs, including tax effects 2,741 (217 ) (217 ) (217 ) Repurchases of common stock (1,756 ) (26 ) (296 ) (322 ) (322 ) Cash dividends declared and other (939 ) (936 ) (35 ) (971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 $ $ 6,107 $ (1,199 ) $ 7,887 $ 12,799 $ $ 13,103 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 3,179 $ 2,714 $ 2,376 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,437 1,370 1,255 Stock-based compensation Other non-cash operating activities, net (6 ) (14 ) (57 ) Deferred income taxes (49 ) (29 ) Changes in operating assets and liabilities: Merchandise inventories (1,313 ) (894 ) (25 ) Accounts payable 1,561 2,258 (1,532 ) Other operating assets and liabilities, net Net cash provided by operating activities 5,774 6,726 3,292 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments (1,060 ) (1,279 ) (1,432 ) Maturities and sales of short-term investments 1,078 1,385 1,709 Additions to property and equipment (2,969 ) (2,502 ) (2,649 ) Other investing activities, net Net cash used in investing activities (2,947 ) (2,366 ) (2,345 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank checks outstanding (236 ) Repayments of short-term borrowings (106 ) Proceeds from short-term borrowings Proceeds from issuance of long-term debt 3,782 Repayments of long-term debt (86 ) (2,200 ) (1,288 ) Tax withholdings on stock-based awards (217 ) (202 ) (220 ) Repurchases of common stock (328 ) (469 ) (486 ) Cash dividend payments (689 ) (3,904 ) (746 ) Other financing activities, net (41 ) Net cash used in financing activities (1,281 ) (3,218 ) (2,419 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (37 ) Net change in cash and cash equivalents 1,509 1,167 (1,422 ) CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 4,546 3,379 4,801 CASH AND CASH EQUIVALENTS END OF YEAR $ 6,055 $ 4,546 $ 3,379 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest (reduced by $19, $16, and $19, interest capitalized in 2018, 2017, and 2016, respectively) $ $ $ Income taxes, net $ 1,204 $ 1,185 $ SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Property and equipment acquired, but not yet paid $ $ $ Cash dividend declared, but not yet paid $ $ $ The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Basis of Presentation The consolidated financial statements include the accounts of Costco Wholesale Corporation, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018 , Costco purchased its former joint-venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the fiscal year ending on the Sunday closest to August 31. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018 , and August 28, 2016 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively. The Company provides for the daily replenishment of major bank accounts as checks are presented. Included in accounts payable at the end of 2018 and 2017 are $ 463 and $ 383 , respectively, representing the excess of outstanding checks over cash on deposit at the banks on which the checks were drawn. Short-Term Investments In general, short-term investments have a maturity at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 2, 3, and 4 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include coupons, volume rebates or other purchase discounts. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial for fiscal years 2018 , 2017 , and 2016 . Merchandise Inventories Merchandise inventories consist of the following: United States $ 8,081 $ 7,091 Canada 1,189 1,040 Other International 1,770 1,703 Merchandise inventories $ 11,040 $ 9,834 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis. As of September 2, 2018 and September 3, 2017 , U.S. merchandise inventories valued at LIFO approximated FIFO after considering the lower of cost or market principle. Due to net deflation, a benefit of $64 was recorded to merchandise costs in 2016 . The Company provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on the Companys experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment Property and equipment are stated at cost. In general, new building additions are classified into components, each with an estimated useful life, generally five to fifty years for buildings and improvements and three to twenty years for equipment and fixtures. Depreciation and amortization expense is computed using the straight-line method over estimated useful lives or the lease term, if shorter. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably assured at the date the leasehold improvements are made. The Company capitalizes certain computer software and software development costs incurred in developing or obtaining computer software for internal use. These costs are included in equipment and fixtures and amortized on a straight-line basis over the estimated useful lives of the software, generally three to seven years. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets that were removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2018 and 2017 were immaterial. The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2018 , 2017 or 2016 . Insurance/Self-Insurance Liabilities The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. It uses different mechanisms including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2018 and 2017 , these insurance liabilities were $ 1,148 and $ 1,059 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. At the end of 2018 and 2017 , the aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 717 and $ 637 at the end of 2018 and 2017 , respectively. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2018 and 2017 . The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2018 , 2017 , and 2016 . The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial for 2018 and 2017 and resulted in net gains of $38 for 2016 . Revenue Recognition The Company generally recognizes sales, which include gross shipping fees where applicable, net of returns, at the time the member takes possession of merchandise or receives services. When the Company collects payments from members prior to the transfer of ownership of merchandise or the performance of services, the amounts received are generally recorded as deferred sales, included in other current liabilities in the consolidated balance sheets, until the sale or service is completed. The Company reserves for estimated sales returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The sales returns reserve is based on an estimate of the net realizable value of merchandise inventories expected to be returned. Amounts collected from members for sales or value added taxes are recorded on a net basis. Generally, when Costco is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, can influence product or service specifications, or has several but not all of these indicators, revenue is recorded on a gross basis. It otherwise records the net amounts earned, which is reflected in net sales. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership. The Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $ 1,000 per year), which can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales. The sales reduction and corresponding liability (classified as accrued member rewards in the consolidated balance sheets) are computed after giving effect to the estimated impact of non-redemptions, based on historical data. The net reduction in sales was $ 1,394 , $ 1,281 , and $ 1,172 in 2018 , 2017 , and 2016 , respectively. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for coupons and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, utilities, credit and debit card processing fees, as well as other operating costs incurred to support warehouse operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $578 , $543 , and $489 for 2018 , 2017 , and 2016 , respectively, and are predominantly included in selling, general and administrative expenses in the accompanying consolidated statements of income. Stock-Based Compensation Restricted stock units (RSUs) granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting of a portion of outstanding shares based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 7 for additional information on the Companys stock-based compensation plans. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2064 , with the exception of one lease in the U.K., which expires in 2151 . These leases generally contain one or more of the following options, which the Company can exercise at the end of the initial lease term: (a) renewal of the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume. The Company has capital leases for certain warehouse locations, expiring at various dates through 2059 . Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income. The Company records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent the Company is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, the Company assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, it accounts for the arrangement as a financing lease. The Companys asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are recorded as a liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the leasehold improvements. These liabilities are accreted over time to the projected future value of the obligation using the Companys incremental borrowing rate. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2018 and 2017 , respectively, and are included in other liabilities in the accompanying consolidated balance sheets. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 6 for additional information. Recent Accounting Pronouncements Adopted In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09 related to the accounting for share-based payment transactions. The guidance relates to income taxes, forfeitures, and minimum statutory tax withholding requirements. The new standard was effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance at the beginning of its first quarter of fiscal year 2018. As a result, the Company recognized a net tax benefit in fiscal 2018 of $ 33 as part of its income tax provision in the accompanying consolidated statements of income, which includes the impact of the lower tax rate from the 2017 Tax Act. Previously, tax benefits associated with the release of employee RSUs were reflected in equity. These amounts are now reflected as cash flows from operations instead of cash flows from financing activities in the consolidated statements of cash flows on a prospective basis. Adoption of this guidance did not have a material impact on the consolidated balance sheets, consolidated statements of cash flows, or related disclosures. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the FASB issued ASU 2014-09 providing for changes in the recognition of revenue from contracts with customers. The guidance converges the requirements for reporting revenue and requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows arising from these contracts. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2019, using the modified retrospective approach through a cumulative effect adjustment to retained earnings. The Company has substantially completed its assessment of the new standard and it does not believe the impacts to be material to the Company's consolidated financial statements. The Company continues to evaluate the disclosure requirements related to the new standard. In February 2016, the FASB issued ASU 2016-02 which will require recognition on the balance sheet for the rights and obligations created by leases with terms greater than twelve months. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and plans to utilize the transition option which does not require application of the guidance to comparative periods in the year of adoption. While the Company continues to evaluate this standard and the effect on related disclosures, the primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. The adoption is expected to have a material impact on the Company's consolidated balance sheets, but not on the consolidated statements of income or cash flows. Additionally, the Company is in the process of reviewing current accounting policies, changes to business processes, systems and controls to support adoption of the new standard, which includes implementing a new lease accounting system. Note 2Investments The Companys investments were as follows: 2018: Cost Basis Unrealized Losses, Net Recorded Basis Available-for-sale: Government and agency securities $ $ (14 ) $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,218 $ (14 ) $ 1,204 2017: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ $ $ Mortgage-backed securities Total available-for-sale Held-to-maturity: Certificates of deposit Total short-term investments $ 1,233 $ $ 1,233 Gross unrealized gains and losses on available-for-sale securities were not material in 2018 , 2017 , and 2016 . At the end of 2018 and 2017 , the Company's available-for-sale securities that were in a continuous unrealized-loss position were not material. The Company had no available-for-sale securities in a continuous unrealized-loss position in 2016. Gross unrealized gains and losses on cash equivalents were not material at the end of 2018 , and there were no gross unrealized gains and losses on cash equivalents at the end of 2017 or 2016 . The proceeds from sales of available-for-sale securities were $39 , $202 , and $291 during 2018 , 2017 , and 2016 , respectively. Gross realized gains or losses from sales of available-for-sale securities were not material in 2018 , 2017 , and 2016 . The maturities of available-for-sale and held-to-maturity securities at the end of 2018 were as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ $ $ Due after one year through five years Due after five years Total $ $ $ Note 3Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The tables below present information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. 2018: Level 1 Level 2 Money market mutual funds (1) $ $ Investment in government and agency securities (2) Forward foreign-exchange contracts, in asset position (3) Forward foreign-exchange contracts, in (liability) position (3) (2 ) Total $ $ 2017: Level 1 Level 2 Money market mutual funds (1) $ $ Investment in government and agency securities (2) Investment in mortgage-backed securities Forward foreign-exchange contracts, in asset position (3) Forward foreign-exchange contracts, in (liability) position (3) (8 ) Total $ $ ______________ (1) Included in cash and cash equivalents in the accompanying consolidated balance sheets. (2) At September 2, 2018, immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying condensed consolidated balance sheets. At September 3, 2017, there were no securities included in cash and cash equivalents and $947 included in short-term investments in the accompanying condensed consolidated balance sheets. (3) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying consolidated balance sheets. See Note 1 for additional information on derivative instruments. During and at the end of both 2018 and 2017 , the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during 2018 and 2017 . Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2018 and 2017 . Note 4Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities with a borrowing capacity of $857 and $833 , in 2018 and 2017 , respectively. Borrowings on these short-term facilities were immaterial during 2018 and 2017, and there were no outstanding borrowings at the end of 2018 and 2017 . Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, which have various principal balances, interest rates, and maturity dates as described below. In May 2017, the Company issued $3,800 in aggregate principal amount of Senior Notes, with maturity dates between May 2021 and May 2027. Additionally, in 2017 the Company repaid long-term debt totaling $2,200 . The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100% of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, as defined by the terms of the Senior Notes, the holder has the right to require the Company to purchase this security at a price of 101% of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary and are valued using Level 3 inputs. At the end of 2018 and 2017 , the fair value of the Company's long-term debt, including the current portion, was approximately $6,492 and $6,753 , respectively. The carrying value of long-term debt consisted of the following: 1.70% Senior Notes due December 2019 $ 1,199 $ 1,198 1.75% Senior Notes due February 2020 2.15% Senior Notes due May 2021 2.25% Senior Notes due February 2022 2.30% Senior Notes due May 2022 2.75% Senior Notes due May 2024 3.00% Senior Notes due May 2027 Other long-term debt Total long-term debt 6,577 6,659 Less current portion (1) Long-term debt, excluding current portion $ 6,487 $ 6,573 _______________ (1) Included in other current liabilities in the consolidated balance sheets. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: $ 2020 1,700 1,091 1,300 90 Thereafter 2,343 Total $ 6,614 Note 5Leases Operating Leases The aggregate rental expense for 2018 , 2017 , and 2016 was $ 265 , $ 258 , and $ 250 , respectively. Sub-lease income and contingent rent were not material in 2018 , 2017 , or 2016 . Capital and Build-to-Suit Leases Gross assets recorded under capital and build-to-suit leases were $ 427 and $ 404 at the end of 2018 and 2017 , respectively. These assets are recorded net of accumulated amortization of $ 94 and $ 78 at the end of 2018 and 2017 , respectively. At the end of 2018 , future minimum payments, net of sub-lease income of $ 105 for all years combined, under non-cancelable operating leases with terms of at least one year and capital leases were as follows: Operating Leases Capital Leases (1) $ $ 2020 2021 2022 2023 Thereafter 2,215 Total $ 3,207 Less amount representing interest (427 ) Net present value of minimum lease payments Less current installments (2) (7 ) Long-term capital lease obligations less current installments (3) $ _______________ (1) Includes build-to-suit lease obligations. (2) Included in other current liabilities in the accompanying consolidated balance sheets. (3) Included in other liabilities in the accompanying consolidated balance sheets. Note 6Stockholders Equity Dividends The Companys current quarterly dividend rate is $0.57 per share. In May 2017, the Company paid a special cash dividend of $7.00 per share. The aggregate payment was approximately $3,100 . Subsequent to the end of 2018, the Board of Directors declared a quarterly cash dividend in the amount of $0.57 per share, which is payable on November 23, 2018. Stock Repurchase Programs The Companys stock repurchase program is conducted under a $4,000 authorization by the Board of Directors, which expires April 17, 2019 . As of the end of 2018 , the remaining amount available for stock repurchases under the approved plan was $2,427 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 1,756 $ 183.13 $ 2017 2,998 157.87 2016 3,184 149.90 These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Note 7Stock-Based Compensation Plans The Company grants stock-based compensation primarily to employees and non-employee directors. RSU grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain certain years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date rather than upon retirement. The Seventh Restated 2002 Stock Incentive Plan (Seventh Plan) is the Companys only stock-based compensation plan with shares available for grant at the end of 2018 . Each share issued in respect of stock awards is counted as 1.75 shares toward the limit of shares made available under the Seventh Plan. The Seventh Plan authorized the issuance of 23,500,000 shares ( 13,429,000 RSUs) of common stock for future grants in addition to the shares authorized under the previous plan. The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of statutory withholding taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on non-vested and undelivered shares. At the end of 2018 , 8,313,000 shares were available to be granted as RSUs under the Seventh Plan. The following awards were outstanding at the end of 2018: 7,246,000 time-based RSUs that vest upon continued employment over specified periods of time; 332,000 performance-based RSUs, of which 205,000 were granted to executive officers subject to the certification of the attainment of specified performance targets for 2018 . This certification occurred in October 2018 , at which time a portion vested as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2018 : Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2017 8,199 $ 128.15 Granted 3,722 156.19 Vested and delivered (4,088 ) 129.49 Forfeited (255 ) 138.57 Outstanding at the end of 2018 7,578 $ 140.85 The weighted-average grant date fair value of RSUs granted was $156.19 , $144.12 , and $153.46 in 2018 , 2017 , and 2016 , respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2018 was $ 693 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2018 were approximately 2,658,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: Stock-based compensation expense before income taxes $ $ $ Less income tax benefit (1) (116 ) (167 ) (150 ) Stock-based compensation expense, net of income taxes $ $ $ _______________ (1) In 2018, the income tax benefit reflects the reduction in the U.S. federal statutory income tax rate from 35% to 21% . Note 8Income Taxes Income before income taxes is comprised of the following: Domestic $ 3,182 $ 2,988 $ 2,622 Foreign 1,260 1,051 Total $ 4,442 $ 4,039 $ 3,619 The provisions for income taxes are as follows: Federal: Current $ $ $ Deferred (35 ) Total federal State: Current Deferred Total state Foreign: Current Deferred (37 ) (42 ) Total foreign Total provision for income taxes $ 1,263 $ 1,325 $ 1,243 In December 2017, the 2017 Tax Act was signed into law. Except for certain provisions, the 2017 Tax Act is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions will become effective for fiscal 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of fiscal 2018 and throughout the remainder of fiscal 2018 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0% resulted in a blended rate for the Company of 25.6% for fiscal 2018. The reconciliation between the statutory tax rate and the effective rate is as follows: Federal taxes at statutory rate $ 1,136 25.6 % $ 1,414 35.0 % $ 1,267 35.0 % State taxes, net 3.4 2.9 2.5 Foreign taxes, net 0.7 (64 ) (1.6 ) (21 ) (0.6 ) Employee stock ownership plan (ESOP) (14 ) (0.3 ) (104 ) (2.6 ) (17 ) (0.5 ) 2017 Tax Act 0.4 Other (64 ) (1.4 ) (37 ) (0.9 ) (77 ) (2.1 ) Total $ 1,263 28.4 % $ 1,325 32.8 % $ 1,243 34.3 % During fiscal 2018, the Company recognized a net tax expense of $19 related to the 2017 Tax Act. This expense included $ 142 for the estimated tax on deemed repatriation of foreign earnings, and $ 43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $ 166 for the provisional remeasurement of certain deferred tax liabilities. These items were predominantly recorded in the second quarter as provisional amounts and reflect the Company's current interpretations and estimates that it believes are reasonable. As the Company continues to evaluate the 2017 Tax Act and available data, it anticipates that adjustments may be made in future periods up to and including the second quarter of fiscal 2019 in accordance with Staff Accounting Bulletin 118. In fiscal 2018, we also recognized net tax benefits of $ 76 , which was largely driven by the adoption of an accounting standard related to stock-based compensation and other immaterial net benefits. In fiscal 2017, the Company s provision for income taxes was favorably impacted by a net tax benefit of $ 104 , primarily due to tax benefits recorded in connection with the May 2017 special cash dividends paid by the Company to employees through the Company's 401(k) retirement plan of $ 82 . Dividends on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2018 or 2016. The components of the deferred tax assets (liabilities) are as follows: Equity compensation $ $ Deferred income/membership fees Accrued liabilities and reserves Property and equipment (478 ) (747 ) Merchandise inventories (175 ) (252 ) Other (1) (40 ) Net deferred tax (liabilities)/assets $ (1 ) $ (58 ) _______________ (1) Includes foreign tax credits of $36 for 2017. There were no foreign tax credits in 2018. The deferred tax accounts at the end of fiscal 2018 and 2017 include deferred income tax assets of $316 and $254 , respectively, included in other assets; and deferred income tax liabilities of $317 and $312 , respectively, included in other liabilities. The Company no longer considers current fiscal 2018 and future earnings of our non-U.S. consolidated subsidiaries to be permanently reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on current fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to fiscal 2018, which totaled $ 3,071 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2018 and 2017 is as follows: Gross unrecognized tax benefit at beginning of year $ $ Gross increasescurrent year tax positions Gross increasestax positions in prior years Gross decreasestax positions in prior years (17 ) Settlements (1 ) (11 ) Lapse of statute of limitations (10 ) (9 ) Gross unrecognized tax benefit at end of year $ $ The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2018 and 2017 , these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $32 and $29 at the end of 2018 and 2017 , respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized during 2018 and 2017 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2014. The Company is currently subject to examination in California for fiscal years 2007 to present. No other examinations are believed to be material. Note 9Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of potentially dilutive common shares outstanding (shares in 000s): Net income attributable to Costco $ 3,134 $ 2,679 $ 2,350 Weighted average number of common shares used in basic net income per common share 438,515 438,437 438,585 RSUs and other 3,319 2,500 2,678 Weighted average number of common shares and dilutive potential of common stock used in diluted net income per share 441,834 440,937 441,263 Note 10Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded an immaterial accrual with respect to one matter described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters and exit attendants in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. (Case No. 5:13-cv-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The plaintiff has since indicated that exit attendants are no longer a subject of the litigation. The action in the district court has been stayed pending review by the Ninth Circuit of the order certifying a class. On September 6, 2018, counsel claiming to represent an employee notified the California Labor and Workforce Development agency of an intention to bring similar claims concerning Costco employees engaged at member services counters. On November 23, 2016, the Companys Canadian subsidiary received from the Ontario Ministry of Health and Long Term Care a request for an inspection and information concerning compliance with the anti-rebate provisions in the Ontario Drug Benefit Act and the Drug Interchangeability and Dispensing Fee Act. The Company is seeking to cooperate with the request. The Ministry has indicated it has reason to believe the Company received payments in violation of these laws and is seeking disgorgement of these sums. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal court cases that name the Company, including actions filed by a number of counties and cities in Michigan, New Jersey and Ohio, and a third-party payor in Ohio. Similar cases that name the Company have been filed in state courts in New Jersey and Oklahoma. The Company is defending these matters. In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. The Company is seeking to cooperate concerning the resolution of these notices. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter. Note 11Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, and France and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1. Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. United States Operations Canadian Operations Other International Operations Total Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 4,480 Depreciation and amortization 1,078 1,437 Additions to property and equipment 2,046 2,969 Net property and equipment 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Total revenue $ 93,889 $ 18,775 $ 16,361 $ 129,025 Operating income 2,644 4,111 Depreciation and amortization 1,044 1,370 Additions to property and equipment 1,714 2,502 Net property and equipment 12,339 1,820 4,002 18,161 Total assets 24,068 4,471 7,808 36,347 Total revenue $ 86,579 $ 17,028 $ 15,112 $ 118,719 Operating income 2,326 3,672 Depreciation and amortization 1,255 Additions to property and equipment 1,823 2,649 Net property and equipment 11,745 1,628 3,670 17,043 Total assets 22,511 3,480 7,172 33,163 The following table summarizes the percentage of net sales by merchandise category: Food and Sundries % % % Hardlines % % % Fresh Foods % % % Softlines % % % Ancillary % % % Note 12Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2018 and 2017 . 52 Weeks Ended September 2, 2018 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 31,117 $ 32,279 $ 31,624 $ 43,414 $ 138,434 Membership fees 3,142 Total revenue 31,809 32,995 32,361 44,411 141,576 OPERATING EXPENSES Merchandise costs 27,617 28,733 28,131 38,671 123,152 Selling, general and administrative 3,224 3,234 3,155 4,263 13,876 Preopening expenses Operating income 1,016 1,067 1,446 4,480 OTHER INCOME (EXPENSE) Interest expense (37 ) (37 ) (37 ) (48 ) (159 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,071 1,449 4,442 Provision for income taxes 1,263 Net income including noncontrolling interests 1,053 3,179 Net income attributable to noncontrolling interests (11 ) (12 ) (12 ) (10 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,043 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.46 $ 1.60 $ 1.71 $ 2.38 $ 7.15 Diluted $ 1.45 $ 1.59 $ 1.70 $ 2.36 $ 7.09 Shares used in calculation (000s) Basic 437,965 439,022 438,740 438,379 438,515 Diluted 440,851 441,568 441,715 442,427 441,834 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.50 $ 0.50 $ 0.57 $ 0.57 $ 2.14 53 Weeks Ended September 3, 2017 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (17 Weeks) Total (53 Weeks) REVENUE Net sales $ 27,469 $ 29,130 $ 28,216 $ 41,357 $ 126,172 Membership fees 2,853 Total revenue 28,099 29,766 28,860 42,300 129,025 OPERATING EXPENSES Merchandise costs 24,288 25,927 24,970 36,697 111,882 Selling, general and administrative 2,940 2,980 2,907 4,123 12,950 Preopening expenses Operating income 1,450 4,111 OTHER INCOME (EXPENSE) Interest expense (29 ) (31 ) (21 ) (53 ) (134 ) Interest income and other, net (4 ) INCOME BEFORE INCOME TAXES 1,419 4,039 Provision for income taxes (1) 1,325 Net income including noncontrolling interests 2,714 Net income attributable to noncontrolling interests (10 ) (6 ) (6 ) (13 ) (35 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ $ 2,679 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.24 $ 1.17 $ 1.59 $ 2.10 $ 6.11 Diluted $ 1.24 $ 1.17 $ 1.59 $ 2.08 $ 6.08 Shares used in calculation (000s) Basic 438,007 439,127 438,817 437,987 438,437 Diluted 440,525 440,657 441,056 441,036 440,937 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.45 $ 0.45 $ 7.50 (2) $ 0.50 $ 8.90 _______________ (1) Includes an $82 tax benefit recorded in the third quarter in connection with the special cash dividend paid to employees through the Company's 401(k) Retirement Plan. (2) Includes the special cash dividend of $7.00 per share paid in May 2017. "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of September 2, 2018 and, based on their evaluation, have concluded that the disclosure controls and procedures were not effective as of such date due to a material weakness in internal control over financial reporting, described below. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 2, 2018, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework (2013). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. Our business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. We believe that these control deficiencies were a result of: IT control processes lacking sufficient documentation such that the successful operation of ITGCs was overly dependent upon knowledge and actions of certain individuals with IT expertise, which led to failures resulting from changes in IT personnel; insufficient training of IT personnel on the importance of ITGCs; and risk-assessment processes inadequate to identify and assess changes in IT environments that could impact internal control over financial reporting. The material weakness did not result in any identified misstatements to the financial statements, and there were no changes to previously released financial results. Based on this material weakness, the Companys management concluded that at September 2, 2018, the Companys internal control over financial reporting was not effective. The Companys independent registered public accounting firm, KPMG LLP has issued an adverse audit report on the effectiveness of the Companys internal control over financial reporting as of September 2, 2018, which appears in Item 8 of this Form 10-K. Following identification of the material weakness and prior to filing this Annual Report on Form 10-K, we completed substantive procedures for the year ended September 2, 2018. Based on these procedures, management believes that our consolidated financial statements included in this Form 10-K have been prepared in accordance with U.S. GAAP. Our CEO and CFO have certified that, based on their knowledge, the financial statements, and other financial information included in this Form 10-K, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this Form 10-K. KPMG LLP has issued an unqualified opinion on our financial statements, which is included in Item 8 of this Form 10-K. Remediation Management has been implementing and continues to implement measures designed to ensure that control deficiencies contributing to the material weakness are remediated, such that these controls are designed, implemented, and operating effectively. The remediation actions include: (i) creating and filling an IT Compliance Oversight function; (ii) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over IT systems impacting financial reporting; (iii) developing and maintaining documentation underlying ITGCs to promote knowledge transfer upon personnel and function changes; (iv) developing enhanced risk assessment procedures and controls related to changes in IT systems; (v) implementing an IT management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board of Directors. We believe that these actions will remediate the material weakness. The weakness will not be considered remediated, however, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2019. Changes in Internal Control Over Financial Reporting Except for the material weakness identified during the quarter, as of September 2, 2018, there have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of fiscal 2018 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +23,Costco,2017," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen, four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . References to 2016 and 2015 relate to the 52-week fiscal years ended August 28, 2016 , and August 30, 2015 , respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts when available. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to individual warehouses. This process creates freight volume and handling efficiencies, eliminating many costs associated with traditional multiple-step distribution channels. Item 1Business (Continued) Our average warehouse space is approximately 145,000 square feet, with newer units slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits of our warehouses and using a membership format, we have inventory losses (shrinkage) well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,800 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Foods (including dry foods, packaged foods, and groceries) Sundries (including snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gas stations and pharmacy) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include our gas stations, pharmacy, optical dispensing centers, food courts, and hearing-aid centers. We sell gasoline in all countries except Korea and France, with the number of warehouses with gas stations varying significantly by country. We operated 536, 508, and 472 gas stations at the end of 2017 , 2016 , and 2015 , respectively. Our online businesses, which include e-commerce, business delivery, and travel, vary by country. In the U.S. and Canada, we offer all of our online businesses. We operate e-commerce websites in all countries except Japan, Australia, Spain, Iceland, and France. Online businesses provide our members additional products and services, many not found in our warehouses. Net sales for our online business were approximately 4% of our total net sales in 2017 and 2016 , respectively, and 3% in 2015 . We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if one or more of our current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase private-label merchandise, as long as quality and member demand are comparable and the value to our members is significant. Item 1Business (Continued) Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at any of our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable evidence. Business members have the ability to add additional cardholders (add-ons). Add-ons are not available for Gold Star members. Effective June 1, 2017, we increased our annual membership fees in the U.S. and Canada for Gold Star (individual), Business and Business add-on by $5 to $60 per year. The Executive membership fee increased from $110 to $120 (annual membership fee of $60, plus Executive upgrade of $60), and the maximum annual 2% reward, which is earned on qualified purchases and can be redeemed only at Costco warehouses, increased from $750 to $1,000. Our annual membership fees in our Other International operations vary by country. All paid memberships include a free household card. Our member renewal rate was 90% in the U.S. and Canada and 87% on a worldwide basis in 2017 . The majority of members renew within six months following their renewal date. Therefore, our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 38,600 36,800 34,000 Business, including add-ons 10,800 10,800 10,600 Total paid members 49,400 47,600 44,600 Household cards 40,900 39,100 36,700 Total cardholders 90,300 86,700 81,300 Paid cardholders (except Business add-ons) are eligible to upgrade to an Executive membership in the U.S., Canada, Mexico and the U.K. for an additional annual fee, which varies by country. Executive members have access to additional savings and benefits on various business and consumer services (except in Mexico), such as auto and home insurance, the Costco auto purchase program and check printing services. The services are generally provided by third-parties and vary by state and country. Executive members represented 38% of paid members at the end of 2017 . Executive members generally spend more than other members, and the percentage of our net sales attributable to these members continues to increase. Labor Our employee count was as follows: Full-time employees 133,000 126,000 117,000 Part-time employees 98,000 92,000 88,000 Total employees 231,000 218,000 205,000 Approximately 15,600 employees are union employees. We consider our employee relations to be very good. Item 1Business (Continued) Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Wal-Mart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with warehouse club operations (primarily Wal-Marts, Sams Club and BJs Wholesale Club), and nearly every major U.S. and Mexico metropolitan area has multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, patents, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality products, offered to our members at prices that are generally lower than those for similar national brand products and that they help lower costs, differentiate our merchandise offerings from other retailers, and generally earn higher margins. We expect to continue to increase the sales penetration of our private label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property rights. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and their registrations are properly maintained. Available Information Our U.S. internet website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with, or furnishing such documents to, the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. In addition, the public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, from this code to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Item 1Business (Continued) Executive Officers of the Registrant The executive officers of Costco, their position, and ages are listed below. All executive officers have 25 or more years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 65 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 61 Franz E. Lazarus Executive Vice President, Administration. Mr. Lazarus was Senior Vice President, Administration-Global Operations from 2006 to September 2012. 70 John D. McKay Executive Vice President, Chief Operating Officer, Northern Division. Mr. McKay was Senior Vice President, General Manager, Northwest Region from 2000 to March 2010. 60 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development from 2001 until March 2010. 66 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 64 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994, and has been the Chief Diversity Officer since 2010. 65 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label from 1995 to December 2012. 65 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region from 2010 to July 2015. 52 Dennis R. Zook Executive Vice President, Chief Operating Officer, Southwest Division and Mexico. 68 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products to retain our existing member base and attract new members. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and regional depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations, and increase the cost of sites and of constructing, leasing and operating our warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us, within their jurisdictions. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance and member traffic. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lack of familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new websites will be profitably deployed and, as a result, future profitability could be delayed or otherwise materially adversely affected. Item 1ARisk Factors (Continued) Our failure to maintain membership loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business model. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce member renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. Although we believe that our receiving and distribution process is efficient, unforeseen disruptions in operations due to fires, tornadoes and hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We rely extensively on information technology to process transactions, compile results, and manage our businesses. Failure or disruption of our primary and back-up systems could adversely affect our businesses. A failure to adequately update our existing systems and implement new systems could harm our businesses and adversely affect our results of operations. Given the very high volume of transactions we process each year it is important that we maintain uninterrupted operation of our business-critical computer systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making, and will continue to make, significant technology investments to improve or replace critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace would be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process will mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. Additionally, the potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. If we do not maintain the privacy and security of member-related and other business information, we could damage our reputation with members, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and entrust that information to third-party business associates, including cloud service providers that perform activities for us. Our Item 1ARisk Factors (Continued) warehouse and online businesses depend upon the secure transmission of encrypted confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or those of our business associates, that results in our members ' information being obtained by unauthorized persons, could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of penalties. In addition, a breach could require that we expend significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is regulated at the national and state or local level in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to necessary systems changes and the development of new processes. If we or those with whom we share information fail to comply with these laws and regulations, our reputation could be damaged, possibly resulting in lost future business, and we could be subjected to additional legal risk as a result of non-compliance. Our security measures may be undermined due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, a select variety of credit and debit cards, and our proprietary cash card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related card acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services, including the processing of credit and debit cards, and our proprietary cash card, and it could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. In addition, if our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause unexpected illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise offerings, such as food and prepared food products for human consumption, drugs, children ' s products, pet products, and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our vendors are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with all safety standards. While we are subject to governmental inspection and regulations and work to comply in all material respects Item 1ARisk Factors (Continued) with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause a health-related illness or injury in the future or that we will not be subject to claims, lawsuits, or government investigations relating to such matters resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. If we do not successfully develop and maintain a relevant multichannel experience for our members, our results of operations could be adversely impacted. Multichannel retailing is rapidly evolving and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making technology investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact the business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. We are predominantly self-insured, with insurance coverage for certain catastrophic risks, for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability and inventory loss. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. The occurrence of significant claims, a substantial rise in costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Item 1ARisk Factors (Continued) We are primarily self-insured as it relates to property damage, due to the substantial premiums required for insurance coverage over physical losses caused by certain natural disasters, as well as the limitations on available coverage for such losses. Although we maintain specific coverages for losses from physical damages in excess of certain amounts to guard against catastrophic losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flow and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, and department and specialty stores. Such retailers and warehouse club operators compete in a variety of ways, including merchandise pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop with digital devices, which has enhanced competition. Some competitors may have greater financial resources, better access to merchandise and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including increased duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Prices of certain commodity products, including gasoline and other food products, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by significant events like the outbreak of war or acts of terrorism. Vendors may be unable to supply us with quality merchandise at competitive prices in a timely manner or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any vendor has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions of our merchandise leading to loss of sales and profits. Item 1ARisk Factors (Continued) We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key vendors could negatively affect us. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality or more expensive than those from existing vendors. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volume we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. For these or other reasons, one or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation, and otherwise damage our reputation and our brands, increase our costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we must translate the financial statements of our international operations from local currencies into U.S. dollars using exchange rates for the current period. Future fluctuations in currency exchange rates over time that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. We may pay for products we purchase for sale in our warehouses around the world with a currency other than the local currency of the country in which the goods will be sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to one or more of our properties, the temporary closure of one or more warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots within the countries in which we operate, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may result in increased compliance costs and legislation or regulation affecting energy inputs that could materially affect Item 1ARisk Factors (Continued) our profitability. Climate change could affect our ability to procure needed commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Climate change may be associated with extreme weather conditions, such as more intense hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels. Failure to meet market expectations for our financial performance could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate which could adversely affect our business, financial condition and results of operations. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade, monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities located in countries which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and greater difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including, but not limited to, revenue recognition, merchandise inventories, vendor rebates and other vendor consideration, impairment of long-lived assets, self-insurance liabilities, and income taxes are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance. Provisions for losses related to self-insured risks are generally based upon independent actuarially determined estimates. The assumptions underlying the ultimate costs of existing claim losses can be highly unpredictable, which can affect the liability recorded for such claims. For example, variability in health care cost inflation rates inherent in these claims can affect the amounts recognized. Similarly, changes in legal trends and interpretations, as well as changes in the nature and method of how claims are settled can impact ultimate costs. Although our estimates of liabilities incurred do not anticipate significant changes in historical trends for these variables, any changes could have a considerable effect upon future claim costs and currently recorded liabilities and could materially impact our consolidated financial statements. Item 1ARisk Factors (Continued) We could be subject to additional income tax liabilities. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates, adverse outcomes in tax audits, including transfer pricing disputes, or any change in the pronouncements relating to accounting for income taxes could have a material adverse effect on our financial condition and results of operations. Significant changes in, or failure to comply with, federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 3, 2017 we operated 741 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France Total _______________ (1) 102 of the 154 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2017 : United States Canada Other International Total Total Warehouses in Operation 2013 and prior 2014 2015 2016 2017 2018 (expected through 12/31/2017) Total At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate depots for the consolidation and distribution of most merchandise shipments to the warehouses, and various processing, packaging, and other facilities to support ancillary and other businesses, including our online business. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 2016: Fourth Quarter 169.04 141.29 0.450 Third Quarter 158.25 146.44 0.450 Second Quarter 168.87 143.28 0.400 First Quarter 163.10 138.30 0.400 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2017 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 8June 4, 2017 92,000 $171.87 92,000 $2,973 June 5July 2, 2017 573,000 162.00 573,000 $2,881 July 3July 30, 2017 451,000 155.06 451,000 $2,811 July 31September 3, 2017 396,000 156.95 396,000 $2,749 Total fourth quarter 1,512,000 $159.21 1,512,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019. "," Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) OVERVIEW We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items. Our philosophy is to provide our members with quality goods and services at the most competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We operate our lower-margin gasoline business in all countries except Korea and France. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are increasingly less significant relative to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth both domestically and internationally has also increased our sales. Our membership format is an integral part of our business model and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase penetration of our Executive members, and sustain high renewal rates, materially influences our profitability. Our financial performance depends heavily on our ability to control costs. While we believe that we have achieved successes in this area historically, some significant costs are partially outside our control, most Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) particularly health care and utility expenses. With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low gross margins, modest changes in various items in the income statement, particularly merchandise costs and SGA expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefit costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. Fiscal year 2017 was a 53-week fiscal year ending on September 3, 2017 , while 2016 and 2015 were 52-week fiscal years ending on August 28, 2016 , and August 30, 2015 , respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for fiscal year 2017 included: We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016 ; Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017; Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017 , the annual fee increase, and executive membership upgrades; Gross margin percentage decreased two basis points; SGA expenses as a percentage of net sales decreased 14 basis points, driven by lower costs associated with the co-branded credit card arrangement in the U.S.; Net income increased 14% to $2,679 , or $6.08 per diluted share compared to $2,350 , or $5.33 per diluted share in 2016 . The 2017 results were positively impacted by a $82 tax benefit, or $0.19 per diluted share, in connection with the special cash dividend paid to the Company's 401(k) Plan participants and other net benefits of approximately $51, or $0.07 per diluted share, for non-recurring net legal and other matters; In 2017, we re-paid long-term debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes; we issued $3,800 in aggregate principal amount of Senior Notes which funded a special cash dividend of $7.00 per share paid in May 2017 (approximately $3,100); and In April 2017, the Board of Directors approved an increase in the quarterly cash dividend from $0.45 to $0.50 per share. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) RESULTS OF OPERATIONS Net Sales Net Sales $ 126,172 $ 116,073 $ 113,666 Changes in net sales: U.S. % % % Canada % (2 )% (3 )% Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % (3 )% (5 )% Other International % (3 )% (3 )% Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices: U.S. % % % Canada % % % Other International % % % Total Company % % % 2017 vs. 2016 Net Sales Net sales increased $10,099 or 9% during 2017 , primarily due to a 4% increase in comparable sales, new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017 . Changes in gasoline prices positively impacted net sales by approximately $785, or 68 basis points, due to an 8% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $295, or 25 basis points, compared to 2016 . The negative impact was driven by Other International operations, partially offset by positive impacts attributable to our Canadian operations. Comparable Sales Comparable sales increased 4% during 2017 and were positively impacted by an increase in shopping frequency and, to a lesser extent, an increased average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices, offset by decreases in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). 2016 vs. 2015 Net Sales Net sales increased $2,407 or 2% during 2016. This was attributable to sales at new warehouses opened in 2015 and 2016. Comparable sales were flat. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $2,690, or 237 basis points, compared to 2015. The negative impact was primarily attributable to our Canadian operations and within certain of our Other International Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) operations. Changes in gasoline prices negatively impacted net sales by approximately $2,194, or 193 basis points, due to a 19% decrease in the average sales price per gallon. Comparable Sales Comparable sales were flat during 2016, with an increase in shopping frequency offset by a decrease in the average ticket. The average ticket and comparable sales results were negatively impacted by changes in foreign currencies relative to the U.S. dollar and a decrease in gasoline prices. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). Membership Fees Membership fees $ 2,853 $ 2,646 $ 2,533 Membership fees increase % % % Membership fees as a percentage of net sales 2.26 % 2.28 % 2.23 % 2017 vs. 2016 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fee revenue, the annual fee increase (discussed below), and an increased number of upgrades to our higher-fee Executive Membership program. At the end of 2017 , our member renewal rates were 90% in the U.S. and Canada and 87% worldwide. In the first fiscal quarter of 2017, we increased our annual membership fees in certain of our Other International operations. Effective June 1, 2017, we also increased our annual membership fees in the U.S. and Canada for Gold Star (individual), Business and Business add-on by $5 to $60 and for Executive Membership from$110 to $120 (annual membership fee of $60, plus the Executive upgrade of $60); and the maximum 2% reward associated with Executive Membership increased from $750 to $1,000 annually. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact on membership fee revenues during 2017 of approximately $23 and will positively impact the next several quarters. We expect these increases to positively impact membership fee revenue by approximately $175 in fiscal 2018. 2016 vs. 2015 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses and increased upgrades to our higher-fee Executive Membership program. These increases were partially offset by changes in foreign currencies relative to the U.S. dollar, which negatively impacted fees by approximately $52 in 2016. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Gross Margin Net sales $ 126,172 $ 116,073 $ 113,666 Less merchandise costs 111,882 102,901 101,065 Gross margin $ 14,290 $ 13,172 $ 12,601 Gross margin percentage 11.33 % 11.35 % 11.09 % 2017 vs. 2016 The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased eight basis points due to increases in these categories other than fresh foods. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased two basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.40%, an increase of five basis points. This increase was primarily due to amounts earned under the co-branded credit card arrangement in the U.S. of 15 basis points and a benefit of three basis points from non-recurring legal settlements and other matters. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. Changes of comparable magnitude will not occur in subsequent years. These increases were partially offset by a six basis point decrease in our core merchandise categories, primarily due to food and sundries as a result of a decrease in sales penetration. The gross margin percentage was also negatively impacted by five basis points due to a LIFO benefit in 2016 and one basis point in warehouse ancillary and other businesses. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact on gross margin in 2017. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), increased in our U.S. operations, due to amounts earned under the co-branded credit card arrangement and non-recurring legal settlements and other matters as discussed above. These increases were partially offset by a decrease in core merchandise categories, predominantly food and sundries as a result of a decrease in sales penetration, and a LIFO benefit in 2016. The segment gross margin percentage in our Canadian operations increased, primarily due to increases in warehouse ancillary and other businesses, primarily our pharmacy business, partially offset by a decrease in our core merchandise categories, largely fresh foods. The segment gross margin percentage increased in our Other International operations due to increases across all core merchandise categories, except fresh foods. 2016 vs. 2015 The gross margin of our core merchandise categories, when expressed as a percentage of core merchandise sales, increased 13 basis points, primarily due to increases in these categories other than fresh foods. Total gross margin percentage increased 26 basis points compared to 2015. Excluding the impact of gasoline price deflation on net sales, gross margin as a percentage of adjusted net sales was 11.14%, an increase of five basis points. A larger LIFO benefit in 2016 compared to 2015 positively contributed three basis points. The LIFO benefit resulted largely from lower costs for merchandise inventories, primarily in food and sundries and gasoline. Our core merchandise categories positively contributed one basis point, primarily due to an increase in hardlines, partially offset by food and sundries due to a decrease in sales penetration. Warehouse ancillary and other business gross margin positively contributed one basis point, primarily due to hearing aids and e-commerce businesses, partially offset by our gasoline business. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $286 in 2016. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Segment gross margin percentage increased in our U.S. operations predominantly due to a positive contribution from our core merchandise categories, primarily hardlines and softlines, and the LIFO benefit discussed above. The segment gross margin percentage in our Canadian operations decreased, primarily due to a decrease in all core merchandise categories, except hardlines, partially offset by increases in warehouse ancillary and other businesses, primarily pharmacy and e-commerce businesses. The segment gross margin percentage in Other International operations decreased in all merchandise categories, except fresh foods, which was higher. Selling, General and Administrative Expenses SGA expenses $ 12,950 $ 12,068 $ 11,445 SGA expenses as a percentage of net sales 10.26 % 10.40 % 10.07 % 2017 vs. 2016 SGA expenses as a percentage of net sales decreased 14 basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.33%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were lower by nine basis points, primarily due to lower costs associated with the co-branded credit card arrangement in the U.S. of 18 basis points. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. Changes of comparable magnitude will not occur in subsequent years. This was partially offset by higher payroll and employee benefit expenses of 11 basis points, primarily in our U.S. operations. Central operating costs were higher by one basis point, primarily due to increased costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations. Stock compensation expense was also higher by one basis point. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact in 2017. 2016 vs. 2015 SGA expenses as a percentage of net sales increased 33 basis points compared to 2015. Excluding the negative impact of gasoline price deflation on net sales, SGA expenses as a percentage of adjusted net sales were 10.20%, an increase of 13 basis points. This was largely due to: higher central operating costs of six basis points, predominantly due to costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations; and higher stock compensation expense of four basis points, due to appreciation in the trading price of our stock at the time of grant. Charges for non-recurring legal and regulatory matters during 2016 negatively impacted SGA expenses by two basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were higher by one basis point due to higher payroll and employee benefit costs, primarily health care, i n our U.S. operations. This increase was partially offset by lower payroll expense as a percentage of net sales in our Canadian operations. Changes in foreign currencies relative to the U.S. dollar decreased our SGA expenses by approximately $211 in 2016. Preopening Expenses Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations 24 Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Preopening expenses include costs for startup operations related to new warehouses, including relocations, development in new international markets, and expansions at existing warehouses. In 2017, we entered into two new international markets, Iceland and France. Preopening expenses vary due to the number of warehouse openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new, or international market. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company (described in further detail under the heading Cash Flows from Financing Activities and in Note 4 to the consolidated financial statements included in Item 8 of this Report). Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ 2017 vs. 2016 Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. 2016 vs. 2015 The decrease in interest income in 2016 is attributable to lower average cash and investment balances, due in part to the payment of the outstanding principal balance and interest on the 0.65% Senior Notes in the second quarter of 2016. Provision for Income Taxes Provision for income taxes $ 1,325 $ 1,243 $ 1,195 Effective tax rate 32.8 % 34.3 % 33.2 % In 2017 and 2015, our provision was favorably impacted by net tax benefits of $104 and $68, respectively, primarily due to tax benefits recorded in connection with the May 2017 and February 2015 special cash dividends paid to employees through our 401(K) Retirement Plan of $82 and $57, respectively. These dividends are deductible for U.S. income tax purposes. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 6,726 $ 3,292 $ 4,285 Net cash used in investing activities (2,366 ) (2,345 ) (2,480 ) Net cash used in financing activities (3,218 ) (2,419 ) (2,324 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents and short-term investments. Cash and cash equivalents and short-term investments were $5,779 and $4,729 at the end of 2017 and 2016 , respectively. Of these balances, approximately $1,255 and $1,071 represented unsettled credit and debit card receivables, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by changes in exchange rates of $25 and $50 in 2017 and 2016, respectfully, and negatively impacted by $418 in 2015. We have not provided for U.S. deferred taxes on cumulative undistributed earnings of certain non-U.S. consolidated subsidiaries, including the remaining undistributed earnings of our Canadian operations, because our subsidiaries have invested or will invest the undistributed earnings indefinitely, or the earnings if repatriated would not result in an adverse tax consequence. Although we have historically asserted that certain non-U.S. undistributed earnings will be permanently reinvested, we may repatriate such earnings to the extent we can do so without an adverse tax consequence. If we determine that such earnings are no longer indefinitely reinvested, deferred taxes, to the extent required and applicable, are recorded at that time. During 2017, we changed our position regarding an additional portion of the undistributed earnings of our Canadian operations, as we determined such earnings could be repatriated without adverse tax consequences. Subsequent to the end of 2017, we repatriated a portion of our undistributed earnings in our Canadian operations without adverse tax consequences. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements and have no current plans to repatriate for use in the U.S. cash and cash equivalents and short-term investments held by non-U.S. consolidated subsidiaries whose earnings are considered indefinitely reinvested. Cash and cash equivalents and short-term investments held at these subsidiaries with earnings considered to be indefinitely reinvested totaled $1,463 at September 3, 2017. Cash Flows from Operating Activities Net cash provided by operating activities totaled $6,726 in 2017 , compared to $3,292 in 2016 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise vendors, warehouse operating costs including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. The increase in net cash provided by operating activities for 2017 when compared to 2016 was primarily due to accelerated vendor payments of approximately $1,700 made in the last week of fiscal 2016, in advance of implementing our modernized accounting system. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,366 in 2017 , compared to $2,345 in 2016 . Cash flow used in investing activities is primarily related to funding warehouse expansion and remodeling. Net cash flows from investing activities also includes purchases and maturities of short-term investments. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Capital Expenditure Plans Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. To a lesser extent, capital is required for initial warehouse operations, our information systems, and working capital. We opened 26 new warehous es and relocated 2 warehouses in 2017 and plan to open up to 24 new warehouses and relocate up to six warehouses in 2018 . In 2017 we spent $2,502 on capital expenditures, and it is our current intention to spend approximately $2,500 to $2,700 during fiscal 2018 . These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $3,218 in 2017 , compared to $2,419 in 2016 . The primary uses of cash in 2017 were related to dividend payments, predominantly the special dividend paid in May 2017, and the repayments of debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes. Net cash used in financing activities in 2016 includes a $1,200 repayment of our 0.65% Senior Notes in December 2015. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. The proceeds received were net of a discount and used to pay the special cash dividend and a portion of the redemption of the 1.125% Senior Notes. Stock Repurchase Programs During 2017 and 2016 , we repurchased 2,998,000 and 3,184,000 shares of common stock, at average prices of $157.87 and $149.90 , totaling approximately $473 and $477 , respectively. The remaining amount available to be purchased under our approved plan was $2,749 at the end of 2017 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends paid in 2017 totaled $8.90 per share, which included a special cash dividend of $7.00 per share, as compared to $1.70 per share in 2016 . In April 2017 , our Board of Directors increased our quarterly cash dividend from $0.45 to $0.50 per share. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 3, 2017, we had borrowing capacity under these facilities of $833, including a $400 revolving line of credit entered into by our U.S. operations in June 2017 with an expiration date of one year. The Company currently has no plans to draw upon the new revolving line of credit. Our international operations maintain $349 of the total borrowing capacity under bank credit facilities, of which $166 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2017 and 2016. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $181. The outstanding standby letters of credit under these facilities at the end of 2017 totaled $103 and expire within one year. The bank credit facilities have various expiration dates, all within one year, and we generally intend to renew these facilities prior to their expiration. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit then outstanding. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Contractual Obligations At September 3, 2017 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2019 to 2020 2021 to 2022 2023 and thereafter Total Purchase obligations (merchandise) (1) $ 8,029 $ $ $ $ 8,035 Long-term debt (2) 2,060 2,588 2,650 7,528 Operating leases (3) 2,123 3,113 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 9,670 $ 2,774 $ 3,058 $ 5,427 $ 20,929 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Operating lease obligations exclude amounts for common area maintenance, taxes, and insurance and have been reduced by $112 to reflect sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) The amounts exclude certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations, deferred compensation obligations and current liabilities for unrecognized tax contingencies. The total amount excludes $35 of non-current unrecognized tax contingencies and $29 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had, or are reasonably likely to have, a material current or future effect on our financial condition or financial statements other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and judgments, including those related to revenue recognition, merchandise inventory valuation, impairment of long-lived assets, insurance/self-insurance liabilities, and income taxes. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Revenue Recognition We generally recognize sales, which includes gross shipping fees where applicable, net of returns, at the time the member takes possession of merchandise or receives services. When we collect payment from members prior to the transfer of ownership of merchandise or the performance of services, the amount is generally recorded as deferred sales in the consolidated balance sheets until the sale or service is completed. We provide for estimated sales returns based on historical trends and reduce sales and merchandise costs accordingly. Our sales returns reserve is based on an estimate of the net realizable value of merchandise inventories to be returned. Amounts collected from members for sales and value added taxes are recorded on a net basis. We evaluate whether it is appropriate to record the gross amount of merchandise sales and related costs or a net amount. Generally, when we are the primary obligor, subject to inventory risk, have latitude in establishing prices and selecting suppliers, influence product or service specifications, or have several but not all of these indicators, revenue is recorded on a gross basis. If we are not the primary obligor and do not possess other indicators of gross reporting as noted above, we record a net amount, which is reflected in net sales. We account for membership fee revenue, net of refunds, on a deferred basis, whereby revenue is recognized ratably over one year. Our Executive members qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $1,000 per year in the U.S. and Canada and varies in our Other International operations), which can be redeemed only at Costco warehouses. We account for this reward as a reduction in sales. The sales reduction and corresponding liability are computed after giving effect to the estimated impact of non-redemptions, based on historical data. Merchandise Inventories Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis. We provide for estimated inventory shrinkage between physical inventory counts as a percentage of net sales. The provision is adjusted to reflect results of the actual physical inventory counts, which generally occur in the second and fourth quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as we progress toward earning those rebates, provided they are probable and reasonably estimable. Other consideration received from vendors is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of agreement, or using other systematic approaches. Impairment of Long-Lived Assets We evaluate our long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances occur that may indicate the carrying amount may not be fully recoverable. Our judgments are based on existing market and operational conditions. Future events could cause us to conclude that impairment factors exist, requiring a downward adjustment of these assets to their then-current fair value. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Insurance/Self-Insurance Liabilities We are predominantly self-insured, with insurance coverage for certain catastrophic risks, for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. We use different mechanisms including a wholly-owned captive insurance subsidiary and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. Our cumulative foreign undistributed earnings, except the additional portion of earnings in Canada, were considered indefinitely reinvested as of September 3, 2017 . These earnings would be subject to U.S. income tax if we changed our position and could result in a U.S. deferred tax liability. Although we have historically asserted that certain non-U.S. undistributed earnings will be permanently reinvested, we may repatriate such earnings to the extent we can do so without an adverse tax consequence. Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities, and asset and mortgage-backed securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2017 would have an incremental change in fair market value of $20. For those investments that are classified as available-for-sale, the unrealized gains or Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) (Continued) losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features. We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships. There can be no assurance that this practice is effective. These contracts are limited to less than one year. See Note 1 and Note 3 to the consolidated financial statements included in Item 8 of this Report for additional information on the fair value of unsettled forward foreign-exchange contracts at the end of 2017 and 2016 . A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 3, 2017 would have decreased the fair value of the contracts by $69 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy that we consume, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data The following documents are filed as part of Item 8 of this Report on the pages listed below: Page Reports of Independent Registered Public Accounting Firm Consolidated Balance Sheets, as of September 3, 2017 and August 28, 2016 Consolidated Statements of Income, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Comprehensive Income, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Equity, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Cash Flows, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Notes to Consolidated Financial Statements Managements Report on the Consolidated Financial Statements Costcos management is responsible for the preparation, integrity and objectivity of the accompanying consolidated financial statements and the related financial information. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) and necessarily include certain amounts that are based on estimates and informed judgments. The Companys management is also responsible for the preparation of the related financial information included in this Annual Report on Form 10-K and its accuracy and consistency with the consolidated financial statements. The consolidated financial statements have been audited by KPMG LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). The independent registered public accounting firms responsibility is to express an opinion as to the fairness with which such consolidated financial statements present our financial position, results of operations and cash flows in accordance with U.S. GAAP. "," Item 9AControls and Procedures Disclosure Controls and Procedures As of the end of the period covered by this Annual Report on Form 10-K, we performed an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities and Exchange Act of 1934 (the Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Annual Report, our disclosure controls and procedures are effective. There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) during our fiscal quarter ended September 3, 2017 , that has materially affected or is reasonably likely to materially affect our internal control over financial reporting. Managements Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting Item 9AControls and Procedures (Continued) is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Under the supervision and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 3, 2017 , using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of September 3, 2017 . The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +24,Pfizer,2021," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of biopharmaceutical products. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . Our purpose fuels everything we do and reflects both our passion for science and our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the digital race in pharma ; and 5. Lead the conversation . In addition, Pfizer continues to enhance its ESG strategy, which is focused on six areas where we see opportunities to create a meaningful impact over the next decade: product innovation; equitable access and pricing; product quality and safety; diversity, equity and inclusion; climate change; and business ethics. We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities in 2021 include, among others: (i) the July 2021 global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader (the estrogen receptor is a well-known disease driver in most breast cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the treatment of cancer; and (iv) the December 2021 research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. In addition, in December 2021, we entered into a definitive agreement to acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020 and 2021, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, the development of a vaccine to help prevent Pfizer Inc. 2021 Form 10-K COVID-19 and an oral COVID-19 treatment. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. COMMERCIAL OPERATIONS Following (i) the spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan in 2020, which created a new global pharmaceutical company, Viatris, and (ii) the formation of the Consumer Healthcare JV with GSK in 2019, we saw the culmination of Pfizers transformation into a more focused, global leader in science-based innovative medicines and vaccines, and beginning in the fourth quarter of 2020, we operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business, and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Our Biopharma business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Comirnaty/BNT162b2*, the Prevnar family*, Nimenrix, FSME/IMMUN-TicoVac and Trumenba Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Inlyta*, Sutent, Retacrit, Lorbrena and Braftovi Internal Medicine Includes innovative brands in cardiovascular metabolic and womens health, as well as regional brands. Eliquis* and the Premarin family Hospital** Includes our global portfolio of sterile injectable and anti-infective medicines, as well as an oral COVID-19 treatment. Sulperazon, Medrol, Zavicefta, Zithromax, Vfend, Panzyga and Paxlovid Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra, Eucrisa/Staquis and Cibinqo Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2021, 2020 and 2019. Each of Comirnaty/BNT162b2 and Inlyta recorded direct product and/or Alliance revenues of more than $1 billion in 2021. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2021 and 2020. Comirnaty/BNT162b2, Eliquis and Xtandi include Alliance revenues and direct sales. Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). ** Prior to the fourth quarter of 2021, PC1 had been managed within the Hospital therapeutic area. Also, on December 31, 2021, we completed the sale of our Meridian subsidiary, which was part of the Hospital therapeutic area prior to its sale. See Note 1A for additional information. For additional information on our operating segments and products, see Note 17 and for additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Comirnaty/BNT162b2 is an mRNA-based coronavirus vaccine to help prevent COVID-19, which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech equally share the costs of development for the Comirnaty program. Comirnaty/BNT162b2 has been granted an approval or an authorization in many countries around the world in populations varying by country. We also share gross profits equally from commercialization of Comirnaty/BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on Comirnaty/BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on Myfembree (relugolix 40 Pfizer Inc. 2021 Form 10-K mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) for heavy menstrual bleeding associated with uterine fibroids in premenopausal women and the management of moderate to severe pain associated with endometriosis. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and Myfembree, with Myovant bearing our share of allowable expenses up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for Comirnaty/BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, (i) with BioNTech to develop a modified mRNA-based vaccine for the prevention of varicella zoster (Shingles), and (ii) with Valneva to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. These collaboration, alliance and license agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances and license arrangements and investments, see Note 2 . Our RD Operations. In 2021, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units within WRDM are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. Our GPD organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for late-stage clinical assets in Pfizers pipeline. Science-based platform-services organizations within WRDM. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Examples of these platform organizations include Pharmaceutical Sciences and Medicine Design, and Worldwide Medical and Safety. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, composed of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA and Note 17 . Pfizer Inc. 2021 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 8, 2022, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Product Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $51.5 billion accounted for 63% of our total revenues in 2021. Revenues exceeded $500 million in each of 21, 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively, with the increase in the number of countries in 2021 primarily driven by Comirnaty/BNT162b2. By total revenues, Japan was our largest national market outside the U.S. in 2021. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17B . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery systems. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Certain of these government contracts may be renegotiated or terminated at the discretion of a government entity. In addition, our contracts with government and supranational organizations for the sales of Comirnaty/BNT162b2 and Paxlovid, which are on a committed basis, represented a significant amount of revenues in 2021. We also seek to gain access for our products on formularies, which are lists of approved medicines available to members of healthcare programs or PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our significant customers, see Note 17C . We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers and patients; MCOs that provide insurance coverage, such as hospitals, integrated delivery systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. In the U.S., we market directly to consumers through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. Pfizer Inc. 2021 Form 10-K PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs or vaccines upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Product U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 (2) 2022 Sutent 2021 (3) 2022 (3) 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (4) 2025 Prevnar 13/Prevenar 13 2026 (5) 2029 Eliquis (6) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (7) 2027 (7) (7) Vyndaqel/Vyndamax/Vynmac 2024 (2028 pending PTE) 2026 2026/2029 (8) Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (4) Braftovi (9) 2031 (2031 pending PTE) (9) (9) Mektovi (9) 2031 (10) (9) (9) Bavencio (11) 2033 2032 2033 Lorbrena 2033 2034 2036 Prevnar 20/Apexxnar 2033 (2035 pending PTE) 2033 2033 (12) Cibinqo 2034 2034 (13) 2034 (2038 pending PTE) Comirnaty (14) (14), (15) (14) Paxlovid (16) (16) (16) (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our product from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix expired in the U.S. in November 2020 and in Europe in September 2021. (3) The basic product patent for Sutent expired in the U.S. in August 2021 and in Europe in January 2022. (4) Expiry is provided by regulatory exclusivity in this market. (5) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and were the subject of patent infringement litigation. Prior to the resolution of the litigation in our favor on both challenged patents, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). As a result of the litigation, the remaining generic companies are not permitted to launch their products until the 2031 expiration date of the formulation patent. Under the terms of the settlement agreements, the permitted date of launch for the settled generic companies under these patents is April 1, 2028. Both patents may be subject to subsequent challenges. While we cannot predict the outcome of any potential future litigation, these are the alternatives that might occur: (a) if both patents are upheld in future litigation, through appeal, the permitted date of launch for the settled generic companies under these patents would remain April 1, 2028; (b) if the formulation patent is held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant could launch products immediately upon such an adverse decision. Refer to Note 16A1 for more information. Pfizer Inc. 2021 Form 10-K (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Vyndaqel (tafamidis meglumine) basic patent expiry in Japan is August 2026 for treatment of polyneuropathy. Vynmac (tafamidis) was approved in Japan for treatment of cardiomyopathy with regulatory exclusivity expiring March 2029. (9) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) Mektovi U.S. expiry is provided by a method of use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. (12) Product not yet approved or authorized in this market. (13) An SPC has been filed for Cibinqo in the U.K. with expected expiry in 2036 based on the September 2021 approval. Cibinqo was approved in other major European markets in December 2021. (14) The basic product patent application for Comirnaty has been filed in these markets. If granted, a full term is expected in these markets. Comirnaty is being developed and commercialized in collaboration with BioNTech . (15) Pfizer does not have co-promotion rights for Comirnaty in Germany. (16) The basic product patent application for Paxlovid has been filed in these markets. If granted, a full term is expected in these markets. Loss of Intellectual Property Rights. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Competitive Products, Intellectual Property Protection and Third-Party Intellectual Property Claims sections in this Form 10-K and Note 16A1 . Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat or prevent diseases or indications similar to those treated or prevented by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic drug and biosimilar manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug or vaccine approval as we seek to further demonstrate the value of our products for the conditions they treat or prevent, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines and vaccines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition, including from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars, which include biosimilars of certain inflammation immunology and oncology biologic medicines, compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We seek to maximize the opportunity to establish a first-to- Pfizer Inc. 2021 Form 10-K market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we expect to continue to face intensified competition by certain generic manufacturers in 2022 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Commercial Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. In light of the COVID-19 pandemic and related large-scale healthcare disruptions, we expect value-based payment models may have reduced participation if the incentives to participate are reduced or eliminated. Financially weakened hospitals may weigh their ability to take on the financial risk of downside models. In contrast, providers in more advanced value-based models, such as full capitation, a fixed amount paid in advance per patient per unit of time-period, generally found their revenues remained steady during the pandemic, which may ultimately encourage the growth of such models. We believe medicines and vaccines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines and vaccines within an efficient and affordable healthcare system. This includes assessing our go-to market model to address patient affordability challenges. We have engaged with major payors and the U.S. government to explore opportunities to improve access and reimbursement in an effort to drive pro-patient policies. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we are developing stronger internal capabilities focused on demonstrating the value of the medicines and vaccines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and vaccines and competitor medicines and vaccines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 302 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs and vaccines to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger MCOs, which enhances those MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates Pfizer Inc. 2021 Form 10-K pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2022. However, we are seeing an increase in overall demand in the industry for certain components and raw materials with the potential to constrain available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact, including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing the operations of biopharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and/or administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines and vaccines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. For a biopharmaceutical company to market a drug or a biologic product, including vaccines, in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or BLA (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals) and the Drug Supply Chain Security Act (the law that, among other things, sets forth requirements related to product tracing, product identifiers and verification for manufacturers, wholesale distributors, repackagers and dispensers to facilitate the tracing of product through the pharmaceutical distribution supply chain), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Authorization/Approval Data sections in this Form 10-K. In the context of public health emergencies, like the COVID-19 pandemic, we may apply to the FDA for an EUA, which if granted, allows for the distribution and use of our products during the declared emergency, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated by the government. Although the criteria for an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing obligations. The FDA generally expects EUA holders to work toward submission of full applications, such as a BLA or an NDA, as soon as possible. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws, as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits corruptly soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services, including to government payers, such as Medicare and Medicaid, that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State Pfizer Inc. 2021 Form 10-K attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Pricing, Reimbursement and Access Regulations. Pricing and reimbursement for our products depend in part on government regulation. Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded or more directly impose controls on drug pricing, government reimbursement, and access to medicines and vaccines on public and private insurance plans could have a material impact on us. In addition, in order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1H. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. We expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. In addition, changes to the Medicaid program or the federal 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could have a material impact on our business. For example, certain changes issued in a final rule by the Centers for Medicare Medicaid Services (CMS) in December 2020 to the Medicaid Drug Rebate Program could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities. Additional changes to the 340B program are undergoing review and their status is unclear. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid managed care programs typically is determined by the health plans with which state Medicaid agencies contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. States budgets were impacted less by the COVID-19 pandemic than expected and are generally growing. We expect states to seek cost cutting within Medicaid, which may focus on managed care capitation payments and/or formulary management. States may also advance drug-pricing initiatives with a focus on affordability review boards, financial penalties related to pricing practices, manufacturer pricing and reporting requirements, as well as regulation of prescription drug assistance or copay accumulator programs in the commercial market. Payers may promote generic drugs and biosimilars more aggressively to generate savings and attempt to stimulate additional price competition. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us is increasingly important to our business and is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory and other governmental bodies. Such laws and regulations continue to evolve and are increasingly being enforced vigorously. Outside the United States New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. In the U.K., the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. Health authorities in many middle- and lower-income countries require marketing approval by a recognized regulatory authority (e.g., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU, the EMAs PRAC is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., Japan, China, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments globally may use a variety of measures to control costs, including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations such as the WHO are increasing scrutiny of international pharmaceutical pricing through policy recommendations and sponsorship of programs, such as The Oslo Medicines Initiative which is planning a high-level meeting in 2022 to agree on WHO Europe Member States commitments to ensure affordability for high-priced medicines. In November 2020, the EC published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. Pfizer Inc. 2021 Form 10-K In China, pricing pressures have increased in recent years because of an overall focus on healthcare cost containment with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. For patented products, drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program, a tender process where a certain portion of included molecule volumes are guaranteed to tender winners and is intended to contain healthcare costs by driving utilization of generics that have passed QCE, has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to VBP qualification in future rounds. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or industry trade associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers and/or healthcare organizations, such as academic teaching hospitals. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The WTO Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent and other intellectual property-related protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property policy environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, pursuant to the ongoing review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Discussions are ongoing at the WTO that seek to limit intellectual property protections within the context of the COVID-19 pandemic response. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines and vaccines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including but not limited to, the EUs General Data Protection Regulations and Chinas Personal Information Protection Law. The legislative and regulatory framework for privacy and data protection issues worldwide is also rapidly evolving as countries continue to adopt new and updated privacy and data security laws. The interpretation and application of such laws and regulations remain uncertain and continue to evolve. In addition, enforcement of such laws and regulations is increasing. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2021 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $55 million in environment-related capital expenditures and $152 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, the potential for more frequent and severe weather events, and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2021, we employed approximately 79,000 people worldwide, with approximately 29,000 based in the U.S. Women compose approximately 49% of our global workforce, and approximately 34% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent, but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, Pfizer Inc. 2021 Form 10-K fostering career growth and internal mobility and offering competitive compensation and benefits programs that encourage mental and physical well being. Core Values. To fully realize Pfizers purpose we have established a clear set of goals regarding what we need to achieve for patients and how we will go about achieving them. The how is represented by four simple, powerful company values Courage , Excellence , Equity and Joy . Each value defines our company and our culture: Courage : Breakthroughs start by challenging convention especially in the face of uncertainty or adversity. This happens when we think big, speak up and are decisive. Excellence : We can only change patients lives when we perform at our best together. This happens when we focus on what matters, agree who does what and measure outcomes. Equity : Every person deserves to be seen, heard and cared for. This happens when we are inclusive, act with integrity and reduce health care disparities. Joy : We give ourselves to our work, and it also gives to us. We find joy when we take pride, recognize one another and have fun. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our commitments to equity consist of specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) building a more inclusive colleague experience through representation and meaningful connections; (ii) advancing equitable health outcomes by evaluating our work through the lens of the communities we serve, (iii) providing resources on allyship and the science behind inclusion to support all colleagues in having courageous conversations about equity, race and the avoidance of bias; (iv) working to help transform society with external diversity, equity and inclusion partnerships, including deploying capital, engaging diverse suppliers and amplifying equity initiatives; and (v) working to help ensure demographics of clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . To attract, develop and inspire the brightest talent, we aim to support our colleagues by engaging and partnering with them to help ensure they feel they are part of a community. We understand the importance of continuously listening and responding to colleague feedback and our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their colleague experience. Through this survey, we measure and track key areas of the overall colleague experience and equip leaders with actionable insights for discussion and follow up. Regular topics in the survey include: (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer; (ii) purpose, including how colleagues work connects with our purpose; (iii) inclusion, such as having a climate in which diverse perspectives are valued; and (iv) growth, including the ability for colleagues to gain new experiences that align with their individual career goals. In 2021, we continued to maintain low turnover rates relative to the pharmaceutical industry and in our 2021 Pfizer Pulse survey, on average , 90% of colleagues reported feeling engaged, as measured by pride in working at Pfizer, willingness to recommend Pfizer as a great place to work and intent to stay. In addition, 92% of the colleagues agreed that their daily work contributes to our purpose. While we are slightly behind in our Bold Moves goal to create room for meaningful work, we continue to make progress on simplifying processes and removing needless complexity. We have committed to tangible actions and principles that incorporate the similar behaviors and mindset we used to develop a COVID-19 vaccine in an accelerated timeline. These behaviors include working with urgency and overcoming bureaucracy, as well as believing in our purpose, trusting in one another and being transparent. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insightsis based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. Our commitments to colleague development consist of specific actions to encourage non-linear career growth paths for all colleagues, including (i) a common language around growthalong with a guiding frameworkto help colleagues identify their next best growth experience, (ii) tools and resources to encourage growth conversations and offer transparency on the sources of growth available, and (iii) a variety of programs including mentoring, job rotations, experiential project roles, skill-based volunteering and learning resources focused on various topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being . Protecting the health, safety and well-being of colleagues and contingent workers, all of whom are essential to delivering our business objectives, is an integral part of how we operate. Our Global Environment, Health Safety (EHS) Policy and supporting standards outline our approach to assessment, evaluation, elimination, and mitigation of EHS risks across our operations. COVID-19 pandemic preparedness and response continues to be a key focus to help ensure on-site workers at our commercial, manufacturing and research sites remain safe and healthy while continuing to support work from home arrangements for colleagues who can work remotely. As part of these efforts, we (i) implemented a vaccination program for colleagues and their families in the U.S. and 23 other countries where employer vaccination programs were possible, (ii) partnered with and launched Thrive Global, a wellness and organizational change initiative with a primary focus on colleague mental health and wellness, and (iii) hosted educational webinars and information sessions on mental health and well-being, nutrition and work life balance through our employee assistance program provider. Pay Equity. Our commitment to pay equity for all colleagues is based in our value of Equity and our intention to continue to build a diverse and inclusive workforce. We are committed to equitable pay practices at Pfizer for employees based on role, education, experience, performance, and location and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the About Careers section of Pfizers website and our ESG Report. "," ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is Pfizer Inc. 2021 Form 10-K not meant to be a complete discussion of all potential risks or uncertainties. Additionally, our business is subject to general risks applicable to any company, such as economic conditions, geopolitical events, extreme weather and natural disasters. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. The negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and value-based pricing/contracting to improve their cost containment efforts. Such payers are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Also, business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches continue to occur, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line products and product candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. The entry to the market of competing biosimilars is expected to increase pricing pressures on our biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or Alliance revenues of more than $1 billion for each of nine products that collectively accounted for 75% of our total revenues in 2021. In particular, Comirnaty/BNT162b2 accounted for 45% of our total revenues in 2021. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription or vaccination growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective product should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K. For Comirnaty/BNT162b2 and Pfizer Inc. 2021 Form 10-K Paxlovid, while we believe that these products have the potential to provide ongoing revenue streams for Pfizer for the foreseeable future, revenues of these products following the COVID-19 pandemic may not be at the similar levels as those being generated during the pandemic. For information on additional risks associated with Comirnaty/BNT162b2 and Paxlovid, see the COVID-19 Pandemic section below. In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17C . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, primarily through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. For example, our gene therapy product candidates are based on a novel technology with only a few gene therapies approved to date, which makes it difficult to predict the time and cost of development and the ability to obtain regulatory approval. Further, gene therapy may face difficulties in gaining the acceptance of patients or the medical community. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions including inflation, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 63% of our total 2021 revenues were derived from international operations, including 29% from Europe and 19% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA and Note 7E . For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Note 11 . From time to time, we issued variable rate debt based on LIBOR, or undertook interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month Pfizer Inc. 2021 Form 10-K LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend any contracts to accommodate the SOFR rate where required. We do not expect the transition to have significant impact on our business or financial condition. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in our supply chain, product manufacturing and distribution networks, as well as sales or marketing, due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on, reputational harm, the impact to our facilities due to health pandemics or natural or man-made disasters, including as a result of climate change, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain supply and/or appropriate quality standards throughout our supply network and/or comply with applicable regulations; inability to supply certain products due to voluntary product recalls (as is the case with Chantix); and supply chain disruptions at our facilities or at a supplier or vendor. In addition, we engage contract manufacturers, and, from time to time, our contract manufacturers may face difficulties or are unable to manufacture our products at the necessary quantity or quality levels. Regulatory agencies periodically inspect our manufacturing facilities, as well as third-party facilities that we rely on, to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. In July and August 2021, Pfizer recalled 16 lots of Chantix in the U.S. due to the presence of a nitrosamine, N-nitroso-varenicline, at or above the FDA interim acceptable intake limit. In September 2021, Pfizer expanded its voluntary recall in the U.S. to include all lots of Chantix. We currently also have a voluntary recall across multiple markets and a global pause in shipments of Chantix. Technical solutions are being pursued to reduce nitrosamine levels in Chantix to enable return to market. Nitrosamines are impurities common in water and foods and everyone is exposed to some level of nitrosamines. In response to requests from various regulatory authorities, manufacturers across the pharmaceutical industry, including Pfizer, are evaluating their product portfolios for the potential for the presence or formation of nitrosamines. This may lead to additional recalls or other market actions for Pfizer products. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For information on additional risks specific to our Consumer Healthcare JV, see the Consumer Healthcare JV with GSK section below. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines and vaccines prime targets for counterfeiters. Counterfeit medicines and vaccines pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact Pfizers patients, potentially causing them harm. This, in turn, may result in the loss of patient confidence in the Pfizer name and in the integrity of our medicines and vaccines, and potentially impact our business through lost sales, product recalls, and possible litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the internet in lieu of traditional brick and mortar pharmacies or authorized full-service internet pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of consumers misplaced trust with certain e-commerce retailers coupled with the anonymity the internet affords counterfeiters. While counterfeiters generally target any medicine or vaccine boasting strong demand, we have observed heightened counterfeit and fraud attempts to our COVID-19 vaccine, as well as other products potentially utilized in the treatment of COVID-19. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, investing in innovative technologies to detect and disrupt sophisticated internet offers and scams, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2021 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. We expect to see continued focus by the Federal government on regulating pricing which could result in legislative and regulatory changes designed to control costs. Some states have implemented, and others are considering, patient access constraints or cost cutting under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have continued to focus on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for COVID-19 treatments and vaccines. U.S. HEALTHCARE REGULATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare regulation, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. Any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may need to amend our clinical trial protocols or conduct additional clinical trials under certain circumstances, for example, to further assess appropriate dosage or collect additional safety data. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval for new products and indications from regulators. Regulatory approvals of our products depend on myriad factors, including regulatory determinations as to the products safety and efficacy. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency or conditional basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP or any FDA Advisory Committee that may be convened to review our applications such as EUAs, NDAs or BLAs, which may impact the potential marketing and use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, including regulator-directed risk evaluations and Pfizer Inc. 2021 Form 10-K assessments, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-AUTHORIZATION/APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies and clinical trials, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as other products in the class. The potential regulatory and commercial implications of post-marketing study results typically cannot immediately be determined. For example, in December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. Updates include a new boxed warning for major adverse cardiovascular events (MACE) and updated boxed warnings regarding mortality, malignancies and thrombosis (with corresponding updates to applicable warnings and precautions). In addition, indications for the treatment of adults with moderately to severely active RA or active PsA, and patients who are two years of age and older with active polyarticular course juvenile idiopathic arthritis have been revised; Xeljanz is now indicated in patients who have had inadequate response or intolerance to one or more tumor necrosis factor blockers. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. We continue to work with regulatory agencies to review the full results and analyses of ORAL Surveillance and their impact on product labeling. The terms of our EUA for Comirnaty require that we conduct post-authorization observational studies in patients at least 5 years of age or older who received a booster dose, or other populations of interest including healthcare workers, pregnant women, immunocompromised individuals, and subpopulations with specific comorbidities. Additionally, in relation to the FDA approval for Comirnaty, we are required to complete certain postmarketing study requirements and commitments by 2024 as identified in the August 2021 approval letter. The terms of our EUA for Paxlovid require monitoring for convergence of global viral variants of SARS-CoV-2 and potential assessment of Paxlovid activity against identified global variants of interest. Additionally, in relation to the potential FDA approval for Paxlovid, we are required to complete certain other analyses and studies as identified in the December 2021 authorization letter. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial and other asserted and unasserted matters, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. Pfizer Inc. 2021 Form 10-K We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, no guarantee exists that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. For example, in May 2021, the Brazilian Supreme Court voted to invalidate Article 40 of Brazils Patent Law, which guaranteed a minimum 10-year patent term from patent grant, and to give retroactive effect to such decision. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. Further, legal or regulatory action by various stakeholders or governments could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products. Discussions are ongoing at the WTO regarding the role of intellectual property in the context of the COVID-19 pandemic response. This includes a proposal that would release WTO members from their obligation under WTO-TRIPS to grant and enforce various types of intellectual property protection on health products and technology in relation to the prevention, containment or treatment of COVID-19. In May 2021 and again in November 2021, the Biden Administration called on countries to waive intellectual property protections on COVID-19 vaccines. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third-party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD-PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant royalty payments or damages. Pfizer Inc. 2021 Form 10-K For example, our RD in a therapeutic area may not be first and another company or entity may have obtained relevant patents before us. We are involved in patent-related disputes with third parties over our attempts to market pharmaceutical products. Once we have final regulatory approval of the related products, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems (including cloud services) to operate our business. We produce, collect, process, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality, integrity and availability of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party providers who may or could have access to our confidential information. We rely on technology developed, supplied and/or maintained by third-parties that may make us vulnerable to supply chain style cyber-attacks. Further, technology and security vulnerabilities of acquisitions, business partners or third-party providers may not be identified during due diligence or soon enough to mitigate exploitation. The size and complexity of our information technology and information security systems, and those of our third-party providers (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or contingent workers, providers, or malicious attackers. As a global pharmaceutical company, our systems and assets are the target of frequent cyber-attacks. Such cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions, extortion, theft of confidential or proprietary information, compromise of data integrity or unauthorized information disclosure. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris in November 2020, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. Pfizer Inc. 2021 Form 10-K In June 2021, GSK announced that it intends to demerge at least 80% of its 68% ownership interest in the JV in mid-2022, subject to GSK shareholder approval. Following the demerger, the JV is expected to be an independent, listed company on the London Stock Exchange with American Depositary Receipts to be listed in the U.S., in which Pfizer would initially hold a 32% ownership interest and GSK may hold up to a 13.6% ownership interest. Notwithstanding GSKs announcement, the demerger may not be completed within expected time periods or at all, and both the timing and success of the demerger (or any other separation and public listing transaction), will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to any separation and public listing transactions (including the announced demerger), their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others: impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain disruptions and shortages, including challenges related to reliance on third-party suppliers resulting in reduced availability of materials or components used in the development, manufacturing, distribution or administration of our products; disruptions to pipeline development and clinical trials, including difficulties or delays in enrolling certain clinical trials, retaining clinical trial participants, accessing needed supplies, and accruing a sufficient number of cases in certain clinical trials; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; reduced product demand as a result of unemployment or increased focus on COVID-19 vaccination; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce or being restricted from enforcing, intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; challenges related to our human capital and talent development, including challenges in attracting, hiring and retaining highly skilled and diverse workforce; challenges related to vaccine mandates; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines and vaccines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution, including, among others: uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical and clinical data (including the Phase 1/2/3 or Phase 4 data for BNT162b2 or any other vaccine candidate in the BNT162 program or Paxlovid or any other future COVID-19 treatment) in any of our studies in pediatrics, adolescents or adults or real world evidence, including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data or further information regarding the quality of pre-clinical, clinical or safety data, including by audit or inspection; the ability to produce comparable clinical or other results for BNT162b2 or Paxlovid, including the rate of effectiveness and/or efficacy, safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial for BNT162b2 or Paxlovid and additional studies, in real-world data studies or in larger, more diverse populations following commercialization; the ability of BNT162b2 or any future vaccine to prevent, or Paxlovid or any other future COVID-19 treatment to be effective against, COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine or Paxlovid will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program, Paxlovid or other programs will be published in scientific journal publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; whether and when submissions to request emergency use or conditional marketing authorizations for BNT162b2 or any potential future vaccines in additional populations, for a booster dose for BNT162b2 or any potential future vaccines (including potential future annual boosters or re-vaccinations), and/or biologics license and/or EUA applications or amendments to any such applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when submissions to request emergency use or conditional marketing authorizations for Paxlovid or any other future COVID-19 treatment and/or any drug applications for any indication for Paxlovid or any other future COVID-19 treatment may be filed in any jurisdiction, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any application that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program, Paxlovid or any other future COVID-19 treatment or any other COVID-19 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines or drugs benefits outweigh its known risks and determination of the vaccines or drugs efficacy and, if approved, whether it will be commercially successful; Pfizer Inc. 2021 Form 10-K decisions by regulatory authorities impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine or drug, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; the possibility that COVID-19 will diminish in severity or prevalence, or disappear entirely; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines formulation, dosing schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations, booster doses or potential future annual boosters or re-vaccinations or new variant-specific vaccines; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program, Paxlovid or any other COVID-19 program; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any treatment for COVID-19, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine or treatment courses of Paxlovid within the projected time periods; whether and when additional supply or purchase agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine or treatment advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public confidence or awareness of our COVID-19 vaccine or Paxlovid, including challenges driven by misinformation, access, concerns about clinical data integrity and prescriber and pharmacy education; trade restrictions; potential third-party royalties or other claims related to our COVID-19 vaccine or Paxlovid; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines and vaccines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the Pfizer Inc. 2021 Form 10-K business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, tax laws and regulations internationally and in the U.S. (including, among other things, any potential adoption of global minimum taxation requirements and any potential changes to existing tax law and regulations by the Biden Administration and Congress), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 1B. UNRESOLVED STAFF COMMENTS N/A ITEM 2. PROPERTIES ITEM 3. LEGAL PROCEEDINGS ITEM 4. MINE SAFETY DISCLOSURES N/A INFORMATION ABOUT OUR EXECUTIVE OFFICERS PART II ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ITEM 6. [RESERVED] ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ITEM 9A. CONTROLS AND PROCEDURES ITEM 9B. OTHER INFORMATION N/A ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS N/A PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 15(a)(1) Financial Statements 15(a)(2) Financial Statement Schedules 15(a)(3) Exhibits ITEM 16. FORM 10-K SUMMARY N/A = Not Applicable DEFINED TERMS Unless the context requires otherwise, references to Pfizer, the Company, we, us or our in this Form 10-K (defined below) refer to Pfizer Inc. and its subsidiaries. Pfizers fiscal year-end for subsidiaries operating outside the U.S. is as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. References to Notes in this Form 10-K are to the Notes to the consolidated financial statements in Item 8. Financial Statements and Supplementary Data in this Form 10-K. We also have used several other terms in this Form 10-K, most of which are explained or defined below. Form 10-K This Annual Report on Form 10-K for the fiscal year ended December 31, 2021 Proxy Statement Proxy Statement for the 2022 Annual Meeting of Shareholders, which will be filed no later than 120 days after December 31, 2021 AbbVie AbbVie Inc. ABO Accumulated benefit obligation represents the present value of the benefit obligation earned through the end of the year but does not factor in future compensation increases ACA (also referred to as U.S. Healthcare Legislation) U.S. Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act ACIP Advisory Committee on Immunization Practices Akcea Akcea Therapeutics, Inc. ALK anaplastic lymphoma kinase Alliance revenues Revenues from alliance agreements under which we co-promote products discovered or developed by other companies or us Anacor Anacor Pharmaceuticals, Inc. ASR accelerated share repurchase agreement Arena Arena Pharmaceuticals, Inc. Array Array BioPharma Inc. Arvinas Arvinas, Inc. Astellas Astellas Pharma Inc., Astellas US LLC and Astellas Pharma US, Inc. ATTR-CM transthyretin amyloid cardiomyopathy Beam Beam Therapeutics Inc. Biogen Biogen Inc. Biohaven Biohaven Pharmaceutical Holding Company Ltd., Biohaven Pharmaceutical Ireland DAC and BioShin Limited. (collectively, Biohaven) BioNTech BioNTech SE Biopharma Pfizer Biopharmaceuticals Group BLA Biologics License Application BMS Bristol-Myers Squibb Company BNT162b2* Pfizer-BioNTech COVID-19 Vaccine, also known as Comirnaty BOD Board of Directors BRCA BReast CAncer susceptibility gene CDC U.S. Centers for Disease Control and Prevention cGMPs current Good Manufacturing Practices Comirnaty* Pfizer-BioNTech COVID-19 Vaccine, also known as BNT162b2 Consumer Healthcare JV GSK Consumer Healthcare JV COVID-19 novel coronavirus disease of 2019 CMA conditional marketing authorisation CStone CStone Pharmaceuticals DEA U.S. Drug Enforcement Agency Developed Europe Includes the following markets: Western Europe, Scandinavian countries and Finland Developed Markets Includes the following markets: U.S., Developed Europe, Japan, Canada, South Korea, Australia and New Zealand Developed Rest of World Includes the following markets: Japan, Canada, South Korea, Australia and New Zealand EC European Commission EMA European Medicines Agency Emerging Markets Includes, but is not limited to, the following markets: Asia (excluding Japan and South Korea), Latin America, Central Europe, Eastern Europe, the Middle East, Africa and Turkey EPS earnings per share ESOP employee stock ownership plan EU European Union EUA emergency use authorization Exchange Act Securities Exchange Act of 1934, as amended FASB Financial Accounting Standards Board FCPA U.S. Foreign Corrupt Practices Act FDA U.S. Food and Drug Administration FFDCA U.S. Federal Food, Drug and Cosmetic Act Pfizer Inc. 2021 Form 10-K i GAAP Generally Accepted Accounting Principles GDFV grant-date fair value GIST gastrointestinal stromal tumors GPD Global Product Development organization GSK GlaxoSmithKline plc Hospira Hospira, Inc. Ionis Ionis Pharmaceuticals, Inc. IPRD in-process research and development IRC Internal Revenue Code IRS U.S. Internal Revenue Service JAK Janus kinase JV joint venture King King Pharmaceuticals LLC (formerly King Pharmaceuticals, Inc.) LIBOR London Interbank Offered Rate Lilly Eli Lilly and Company LOE loss of exclusivity MCO managed care organization mCRC metastatic colorectal cancer mCRPC metastatic castration-resistant prostate cancer mCSPC metastatic castration-sensitive prostate cancer mRNA messenger ribonucleic acid MDA Managements Discussion and Analysis of Financial Condition and Results of Operations Medivation Medivation LLC (formerly Medivation, Inc.) Meridian Meridian Medical Technologies, Inc. Moodys Moodys Investors Service MTM mark-to-market Mylan Mylan N.V. Mylan-Japan collaboration a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan that terminated on December 21, 2020 Myovant Myovant Sciences Ltd. NAV net asset value NDA new drug application nmCRPC non-metastatic castration-resistant prostate cancer NMPA National Medical Product Administration in China NSCLC non-small cell lung cancer NYSE New York Stock Exchange OPKO OPKO Health, Inc. OTC over-the-counter Paxlovid* an oral COVID-19 treatment (nirmatrelvir [PF-07321332] tablets and ritonavir tablets) PBM pharmacy benefit manager PBO Projected benefit obligation; represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases PC1 Pfizer CentreOne PGS Pfizer Global Supply Pharmacia Pharmacia Corporation PMDA Pharmaceuticals and Medical Device Agency in Japan PRAC Pharmacovigilance Risk Assessment Committee PsA psoriatic arthritis QCE quality consistency evaluation RA rheumatoid arthritis RCC renal cell carcinoma RD research and development ROU right of use Sandoz Sandoz, Inc., a division of Novartis AG SP Standard Poors SEC U.S. Securities and Exchange Commission Tax Cuts and Jobs Act or TCJA Legislation commonly referred to as the U.S. Tax Cuts and Jobs Act of 2017 Therachon Therachon Holding AG Trillium Trillium Therapeutics Inc. TSAs transition service arrangements UC ulcerative colitis Pfizer Inc. 2021 Form 10-K ii U.K. United Kingdom Upjohn Business Pfizers former global, primarily off-patent branded and generics business, which included a portfolio of 20 globally recognized solid oral dose brands, including Lipitor, Lyrica, Norvasc, Celebrex and Viagra, as well as a U.S.-based generics platform, Greenstone, that was spun-off on November 16, 2020 and combined with Mylan to create Viatris U.S. United States Valneva Valneva SE VBP volume-based procurement Viatris Viatris Inc. ViiV ViiV Healthcare Limited WHO World Health Organization WRDM Worldwide Research, Development and Medical WTO World Trade Organization * This Form 10-K includes discussion of the COVID-19 vaccine that Pfizer has co-developed with BioNTech (BNT162b2) and our oral COVID-19 treatment (Paxlovid). This Form 10-K may refer to the vaccine by its brand name, Comirnaty (approved under a BLA), or as BNT162b2 (authorized under EUA). The vaccine is FDA-approved to prevent COVID-19 in individuals 16 years of age and older. The vaccine is authorized by the FDA to prevent COVID-19 in individuals 5 years of age and older. In addition, Comirnaty/BNT162b2 is authorized by the FDA for a third dose in certain immunocompromised individuals 5 years of age and older and as a booster dose in individuals 12 years of age and older. Paxlovid has been authorized for emergency use by the FDA under an EUA, for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS CoV-2 viral testing, and who are at high-risk for progression to severe COVID-19, including hospitalization or death. The emergency uses are only authorized for the duration of the declaration that circumstances exist justifying the authorization of emergency use of the medical product under Section 564(b)(1) of the FFDCA unless the declaration is terminated or authorization revoked sooner. The FDA has issued EUAs to certain other companies for products intended for the prevention or treatment of COVID-19 and may continue to do so during the duration of the Declaration. Please see the EUA Fact Sheets at www.cvdvaccine-us.com and www.covid19oralrx.com . This Form 10-K includes discussion of certain clinical studies relating to various in-line products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. Some amounts in this Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks mentioned are the property of their owners. AVAILABLE INFORMATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 24, 2022. Our Proxy Statement will be available on our website on or about March 17, 2022. Our 2021 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 17, 2022. We also have a Pfizer Investor Insights website, which includes articles on the company, its products and its pipeline, located at insights.pfizer.com . Information in our ESG Report and on the Pfizer Investor Insights website are not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the About Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; information concerning our Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. Pfizer Inc. 2021 Form 10-K iii FORWARD-LOOKING INFORMATION AND FACTORS THAT MAY AFFECT FUTURE RESULTS This Form 10-K contains forward-looking statements. We also provide forward-looking statements in other materials we release to the public, as well as public oral statements. Given their forward-looking nature, these statements involve substantial risks, uncertainties and potentially inaccurate assumptions. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek, potential and other words and terms of similar meaning or by using future dates. We include forward-looking information in our discussion of the following, among other topics: our anticipated operating and financial performance, reorganizations, business plans, strategy and prospects; expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, clinical trial results and other developing data, revenue contribution, growth, performance, timing of exclusivity and potential benefits; strategic reviews, capital allocation objectives, dividends and share repurchases; plans for and prospects of our acquisitions, dispositions and other business development activities, and our ability to successfully capitalize on these opportunities; sales, expenses, interest rates, foreign exchange rates and the outcome of contingencies, such as legal proceedings; expectations for impact of or changes to existing or new government regulations or laws; our ability to anticipate and respond to macroeconomic, geopolitical, health and industry trends, pandemics, acts of war and other large-scale crises; and manufacturing and product supply. In particular, forward-looking information in this Form 10-K includes statements relating to specific future actions and effects, including, among others, our efforts to respond to COVID-19, including our development of a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, the forecasted revenue contribution of Comirnaty and the potential number of doses that we and BioNTech believe can be manufactured and/or delivered; the forecasted revenue contribution of Paxlovid and the potential number of treatment courses that we believe can be manufactured; our expectations regarding the impact of COVID-19 on our business; the expected patent term for Comirnaty and Paxlovid; the expectations for ongoing revenue streams from Comirnaty and Paxlovid; the expected impact of patent expiries and competition from generic manufacturers; the expected pricing pressures on our products and the anticipated impact to our business; the availability of raw materials for 2022; the expected charges and/or costs in connection with the spin-off of the Upjohn Business and its combination with Mylan; the benefits expected from our business development transactions; our anticipated liquidity position; the anticipated costs and savings from certain of our initiatives, including our Transforming to a More Focused Company program; our planned capital spending; and the expected benefit payments and employer contributions for our benefit plans. Given their nature, we cannot assure that any outcome expressed in these forward-looking statements will be realized in whole or in part. Actual outcomes may vary materially from past results and those anticipated, estimated, implied or projected. These forward-looking statements may be affected by underlying assumptions that may prove inaccurate or incomplete, or by known or unknown risks and uncertainties, including those described in this section and in the Item 1A. Risk Factors section in this Form 10-K. Therefore, you are cautioned not to unduly rely on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities law. You are advised, however, to consult any further disclosures we make on related subjects. Some of the factors that could cause actual results to differ are identified below, as well as those discussed in the Item 1A. Risk Factors section in this Form 10-K and within MDA. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. The occurrence of any of the risks identified below or in the Item 1A. Risk Factors section in this Form 10-K, or other risks currently unknown, could have a material adverse effect on our business, financial condition or results of operations, or we may be required to increase our accruals for contingencies. It is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties: Risks Related to Our Business, Industry and Operations, and Business Development: the outcome of RD activities, including, the ability to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, and/or regulatory approval and/or launch dates; the possibility of unfavorable pre-clinical and clinical trial results, including the possibility of unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; and whether and when additional data from our pipeline programs will be published in scientific journal publications, and if so, when and with what modifications and interpretations; our ability to successfully address comments received from regulatory authorities such as the FDA or the EMA, or obtain approval for new products and indications from regulators on a timely basis or at all; regulatory decisions impacting labeling, including the scope of indicated patient populations, product dosage, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities; the impact of recommendations by technical or advisory committees; and the timing of pricing approvals and product launches; claims and concerns that may arise regarding the safety or efficacy of in-line products and product candidates, including claims and concerns that may arise from the outcome of post-approval clinical trials, which could impact marketing approval, product labeling, and/or availability or commercial potential, including uncertainties regarding the commercial or other impact of the results of the Xeljanz ORAL Surveillance (A3921133) study or actions by regulatory authorities based on analysis of ORAL Surveillance or other data, including on other JAK inhibitors in our portfolio; the success and impact of external business development activities, including the ability to identify and execute on potential business development opportunities; the ability to satisfy the conditions to closing of announced transactions in the anticipated time frame or at all; the ability to realize the anticipated benefits of any such transactions in the anticipated time frame or at all; the Pfizer Inc. 2021 Form 10-K potential need for and impact of additional equity or debt financing to pursue these opportunities, which could result in increased leverage and/or a downgrade of our credit ratings; challenges integrating the businesses and operations; disruption to business and operations relationships; risks related to growing revenues for certain acquired products; significant transaction costs; and unknown liabilities; competition, including from new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat or prevent diseases and conditions similar to those treated or intended to be prevented by our in-line products and product candidates; the ability to successfully market both new and existing products, including biosimilars; difficulties or delays in manufacturing, sales or marketing; supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on; and legal or regulatory actions; the impact of public health outbreaks, epidemics or pandemics (such as the COVID-19 pandemic), including the impact of vaccine mandates where applicable, on our business, operations and financial condition and results, including impacts on our employees, manufacturing, supply chain, sales and marketing, RD and clinical trials; risks and uncertainties related to our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution; trends toward managed care and healthcare cost containment, and our ability to obtain or maintain timely or adequate pricing or favorable formulary placement for our products; interest rate and foreign currency exchange rate fluctuations, including the impact of possible currency devaluations in countries experiencing high inflation rates; any significant issues involving our largest wholesale distributors or government customers, which account for a substantial portion of our revenues; the impact of the increased presence of counterfeit medicines or vaccines in the pharmaceutical supply chain; any significant issues related to the outsourcing of certain operational and staff functions to third parties; and any significant issues related to our JVs and other third-party business arrangements; uncertainties related to general economic, political, business, industry, regulatory and market conditions including, without limitation, uncertainties related to the impact on us, our customers, suppliers and lenders and counterparties to our foreign-exchange and interest-rate agreements of challenging global economic conditions and recent and possible future changes in global financial markets; any changes in business, political and economic conditions due to actual or threatened terrorist activity, civil unrest or military action; the impact of product recalls, withdrawals and other unusual items, including uncertainties related to regulator-directed risk evaluations and assessments; trade buying patterns; the risk of an impairment charge related to our intangible assets, goodwill or equity-method investments; the impact of, and risks and uncertainties related to, restructurings and internal reorganizations, as well as any other corporate strategic initiatives, and cost-reduction and productivity initiatives, each of which requires upfront costs but may fail to yield anticipated benefits and may result in unexpected costs or organizational disruption; Risks Related to Government Regulation and Legal Proceedings : the impact of any U.S. healthcare reform or legislation or any significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs or changes in the tax treatment of employer-sponsored health insurance that may be implemented; U.S. federal or state legislation or regulatory action and/or policy efforts affecting, among other things, pharmaceutical product pricing, intellectual property, reimbursement or access or restrictions on U.S. direct-to-consumer advertising; limitations on interactions with healthcare professionals and other industry stakeholders; as well as pricing pressures for our products as a result of highly competitive insurance markets; legislation or regulatory action in markets outside of the U.S., including China, affecting pharmaceutical product pricing, intellectual property, reimbursement or access, including, in particular, continued government-mandated reductions in prices and access restrictions for certain biopharmaceutical products to control costs in those markets; the exposure of our operations globally to possible capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, as well as political unrest, unstable governments and legal systems and inter-governmental disputes; legal defense costs, insurance expenses, settlement costs and contingencies, including those related to actual or alleged environmental contamination; the risk and impact of an adverse decision or settlement and the adequacy of reserves related to legal proceedings; the risk and impact of tax related litigation; governmental laws and regulations affecting our operations, including, without limitation, changes in laws and regulations or their interpretation, including, among others, changes in tax laws and regulations internationally and in the U.S., including, among others, potential adoption of global minimum taxation requirements and potential changes to existing tax law by the current U.S. Presidential administration and Congress; Pfizer Inc. 2021 Form 10-K Risks Related to Intellectual Property, Technology and Security: any significant breakdown or interruption of our information technology systems and infrastructure (including cloud services); any business disruption, theft of confidential or proprietary information, extortion or integrity compromise resulting from a cyber-attack; the risk that our currently pending or future patent applications may not be granted on a timely basis or at all, or any patent-term extensions that we seek may not be granted on a timely basis, if at all; and our ability to protect our patents and other intellectual property, including against claims of invalidity that could result in LOE, unasserted intellectual property claims and in response to any pressure, or legal or regulatory action by, various stakeholders or governments that could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products, including our vaccine to help prevent COVID-19 and our oral COVID-19 treatment. PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of biopharmaceutical products. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . Our purpose fuels everything we do and reflects both our passion for science and our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the digital race in pharma ; and 5. Lead the conversation . In addition, Pfizer continues to enhance its ESG strategy, which is focused on six areas where we see opportunities to create a meaningful impact over the next decade: product innovation; equitable access and pricing; product quality and safety; diversity, equity and inclusion; climate change; and business ethics. We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities in 2021 include, among others: (i) the July 2021 global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader (the estrogen receptor is a well-known disease driver in most breast cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the treatment of cancer; and (iv) the December 2021 research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. In addition, in December 2021, we entered into a definitive agreement to acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020 and 2021, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, the development of a vaccine to help prevent Pfizer Inc. 2021 Form 10-K COVID-19 and an oral COVID-19 treatment. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. COMMERCIAL OPERATIONS Following (i) the spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan in 2020, which created a new global pharmaceutical company, Viatris, and (ii) the formation of the Consumer Healthcare JV with GSK in 2019, we saw the culmination of Pfizers transformation into a more focused, global leader in science-based innovative medicines and vaccines, and beginning in the fourth quarter of 2020, we operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business, and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Our Biopharma business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Comirnaty/BNT162b2*, the Prevnar family*, Nimenrix, FSME/IMMUN-TicoVac and Trumenba Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Inlyta*, Sutent, Retacrit, Lorbrena and Braftovi Internal Medicine Includes innovative brands in cardiovascular metabolic and womens health, as well as regional brands. Eliquis* and the Premarin family Hospital** Includes our global portfolio of sterile injectable and anti-infective medicines, as well as an oral COVID-19 treatment. Sulperazon, Medrol, Zavicefta, Zithromax, Vfend, Panzyga and Paxlovid Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra, Eucrisa/Staquis and Cibinqo Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2021, 2020 and 2019. Each of Comirnaty/BNT162b2 and Inlyta recorded direct product and/or Alliance revenues of more than $1 billion in 2021. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2021 and 2020. Comirnaty/BNT162b2, Eliquis and Xtandi include Alliance revenues and direct sales. Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). ** Prior to the fourth quarter of 2021, PC1 had been managed within the Hospital therapeutic area. Also, on December 31, 2021, we completed the sale of our Meridian subsidiary, which was part of the Hospital therapeutic area prior to its sale. See Note 1A for additional information. For additional information on our operating segments and products, see Note 17 and for additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Comirnaty/BNT162b2 is an mRNA-based coronavirus vaccine to help prevent COVID-19, which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech equally share the costs of development for the Comirnaty program. Comirnaty/BNT162b2 has been granted an approval or an authorization in many countries around the world in populations varying by country. We also share gross profits equally from commercialization of Comirnaty/BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on Comirnaty/BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on Myfembree (relugolix 40 Pfizer Inc. 2021 Form 10-K mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) for heavy menstrual bleeding associated with uterine fibroids in premenopausal women and the management of moderate to severe pain associated with endometriosis. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and Myfembree, with Myovant bearing our share of allowable expenses up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for Comirnaty/BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, (i) with BioNTech to develop a modified mRNA-based vaccine for the prevention of varicella zoster (Shingles), and (ii) with Valneva to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. These collaboration, alliance and license agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances and license arrangements and investments, see Note 2 . Our RD Operations. In 2021, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units within WRDM are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. Our GPD organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for late-stage clinical assets in Pfizers pipeline. Science-based platform-services organizations within WRDM. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Examples of these platform organizations include Pharmaceutical Sciences and Medicine Design, and Worldwide Medical and Safety. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, composed of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA and Note 17 . Pfizer Inc. 2021 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 8, 2022, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Product Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $51.5 billion accounted for 63% of our total revenues in 2021. Revenues exceeded $500 million in each of 21, 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively, with the increase in the number of countries in 2021 primarily driven by Comirnaty/BNT162b2. By total revenues, Japan was our largest national market outside the U.S. in 2021. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17B . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery systems. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Certain of these government contracts may be renegotiated or terminated at the discretion of a government entity. In addition, our contracts with government and supranational organizations for the sales of Comirnaty/BNT162b2 and Paxlovid, which are on a committed basis, represented a significant amount of revenues in 2021. We also seek to gain access for our products on formularies, which are lists of approved medicines available to members of healthcare programs or PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our significant customers, see Note 17C . We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers and patients; MCOs that provide insurance coverage, such as hospitals, integrated delivery systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. In the U.S., we market directly to consumers through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. Pfizer Inc. 2021 Form 10-K PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs or vaccines upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Product U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 (2) 2022 Sutent 2021 (3) 2022 (3) 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (4) 2025 Prevnar 13/Prevenar 13 2026 (5) 2029 Eliquis (6) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (7) 2027 (7) (7) Vyndaqel/Vyndamax/Vynmac 2024 (2028 pending PTE) 2026 2026/2029 (8) Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (4) Braftovi (9) 2031 (2031 pending PTE) (9) (9) Mektovi (9) 2031 (10) (9) (9) Bavencio (11) 2033 2032 2033 Lorbrena 2033 2034 2036 Prevnar 20/Apexxnar 2033 (2035 pending PTE) 2033 2033 (12) Cibinqo 2034 2034 (13) 2034 (2038 pending PTE) Comirnaty (14) (14), (15) (14) Paxlovid (16) (16) (16) (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our product from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix expired in the U.S. in November 2020 and in Europe in September 2021. (3) The basic product patent for Sutent expired in the U.S. in August 2021 and in Europe in January 2022. (4) Expiry is provided by regulatory exclusivity in this market. (5) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and were the subject of patent infringement litigation. Prior to the resolution of the litigation in our favor on both challenged patents, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). As a result of the litigation, the remaining generic companies are not permitted to launch their products until the 2031 expiration date of the formulation patent. Under the terms of the settlement agreements, the permitted date of launch for the settled generic companies under these patents is April 1, 2028. Both patents may be subject to subsequent challenges. While we cannot predict the outcome of any potential future litigation, these are the alternatives that might occur: (a) if both patents are upheld in future litigation, through appeal, the permitted date of launch for the settled generic companies under these patents would remain April 1, 2028; (b) if the formulation patent is held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant could launch products immediately upon such an adverse decision. Refer to Note 16A1 for more information. Pfizer Inc. 2021 Form 10-K (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Vyndaqel (tafamidis meglumine) basic patent expiry in Japan is August 2026 for treatment of polyneuropathy. Vynmac (tafamidis) was approved in Japan for treatment of cardiomyopathy with regulatory exclusivity expiring March 2029. (9) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) Mektovi U.S. expiry is provided by a method of use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. (12) Product not yet approved or authorized in this market. (13) An SPC has been filed for Cibinqo in the U.K. with expected expiry in 2036 based on the September 2021 approval. Cibinqo was approved in other major European markets in December 2021. (14) The basic product patent application for Comirnaty has been filed in these markets. If granted, a full term is expected in these markets. Comirnaty is being developed and commercialized in collaboration with BioNTech . (15) Pfizer does not have co-promotion rights for Comirnaty in Germany. (16) The basic product patent application for Paxlovid has been filed in these markets. If granted, a full term is expected in these markets. Loss of Intellectual Property Rights. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Competitive Products, Intellectual Property Protection and Third-Party Intellectual Property Claims sections in this Form 10-K and Note 16A1 . Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat or prevent diseases or indications similar to those treated or prevented by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic drug and biosimilar manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug or vaccine approval as we seek to further demonstrate the value of our products for the conditions they treat or prevent, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines and vaccines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition, including from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars, which include biosimilars of certain inflammation immunology and oncology biologic medicines, compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We seek to maximize the opportunity to establish a first-to- Pfizer Inc. 2021 Form 10-K market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we expect to continue to face intensified competition by certain generic manufacturers in 2022 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Commercial Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. In light of the COVID-19 pandemic and related large-scale healthcare disruptions, we expect value-based payment models may have reduced participation if the incentives to participate are reduced or eliminated. Financially weakened hospitals may weigh their ability to take on the financial risk of downside models. In contrast, providers in more advanced value-based models, such as full capitation, a fixed amount paid in advance per patient per unit of time-period, generally found their revenues remained steady during the pandemic, which may ultimately encourage the growth of such models. We believe medicines and vaccines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines and vaccines within an efficient and affordable healthcare system. This includes assessing our go-to market model to address patient affordability challenges. We have engaged with major payors and the U.S. government to explore opportunities to improve access and reimbursement in an effort to drive pro-patient policies. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we are developing stronger internal capabilities focused on demonstrating the value of the medicines and vaccines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and vaccines and competitor medicines and vaccines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 302 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs and vaccines to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger MCOs, which enhances those MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates Pfizer Inc. 2021 Form 10-K pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2022. However, we are seeing an increase in overall demand in the industry for certain components and raw materials with the potential to constrain available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact, including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing the operations of biopharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and/or administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines and vaccines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. For a biopharmaceutical company to market a drug or a biologic product, including vaccines, in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or BLA (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals) and the Drug Supply Chain Security Act (the law that, among other things, sets forth requirements related to product tracing, product identifiers and verification for manufacturers, wholesale distributors, repackagers and dispensers to facilitate the tracing of product through the pharmaceutical distribution supply chain), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Authorization/Approval Data sections in this Form 10-K. In the context of public health emergencies, like the COVID-19 pandemic, we may apply to the FDA for an EUA, which if granted, allows for the distribution and use of our products during the declared emergency, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated by the government. Although the criteria for an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing obligations. The FDA generally expects EUA holders to work toward submission of full applications, such as a BLA or an NDA, as soon as possible. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws, as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits corruptly soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services, including to government payers, such as Medicare and Medicaid, that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State Pfizer Inc. 2021 Form 10-K attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Pricing, Reimbursement and Access Regulations. Pricing and reimbursement for our products depend in part on government regulation. Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded or more directly impose controls on drug pricing, government reimbursement, and access to medicines and vaccines on public and private insurance plans could have a material impact on us. In addition, in order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1H. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. We expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. In addition, changes to the Medicaid program or the federal 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could have a material impact on our business. For example, certain changes issued in a final rule by the Centers for Medicare Medicaid Services (CMS) in December 2020 to the Medicaid Drug Rebate Program could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities. Additional changes to the 340B program are undergoing review and their status is unclear. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid managed care programs typically is determined by the health plans with which state Medicaid agencies contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. States budgets were impacted less by the COVID-19 pandemic than expected and are generally growing. We expect states to seek cost cutting within Medicaid, which may focus on managed care capitation payments and/or formulary management. States may also advance drug-pricing initiatives with a focus on affordability review boards, financial penalties related to pricing practices, manufacturer pricing and reporting requirements, as well as regulation of prescription drug assistance or copay accumulator programs in the commercial market. Payers may promote generic drugs and biosimilars more aggressively to generate savings and attempt to stimulate additional price competition. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us is increasingly important to our business and is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory and other governmental bodies. Such laws and regulations continue to evolve and are increasingly being enforced vigorously. Outside the United States New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. In the U.K., the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. Health authorities in many middle- and lower-income countries require marketing approval by a recognized regulatory authority (e.g., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU, the EMAs PRAC is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., Japan, China, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments globally may use a variety of measures to control costs, including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations such as the WHO are increasing scrutiny of international pharmaceutical pricing through policy recommendations and sponsorship of programs, such as The Oslo Medicines Initiative which is planning a high-level meeting in 2022 to agree on WHO Europe Member States commitments to ensure affordability for high-priced medicines. In November 2020, the EC published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. Pfizer Inc. 2021 Form 10-K In China, pricing pressures have increased in recent years because of an overall focus on healthcare cost containment with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. For patented products, drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program, a tender process where a certain portion of included molecule volumes are guaranteed to tender winners and is intended to contain healthcare costs by driving utilization of generics that have passed QCE, has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to VBP qualification in future rounds. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or industry trade associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers and/or healthcare organizations, such as academic teaching hospitals. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The WTO Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent and other intellectual property-related protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property policy environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, pursuant to the ongoing review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Discussions are ongoing at the WTO that seek to limit intellectual property protections within the context of the COVID-19 pandemic response. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines and vaccines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including but not limited to, the EUs General Data Protection Regulations and Chinas Personal Information Protection Law. The legislative and regulatory framework for privacy and data protection issues worldwide is also rapidly evolving as countries continue to adopt new and updated privacy and data security laws. The interpretation and application of such laws and regulations remain uncertain and continue to evolve. In addition, enforcement of such laws and regulations is increasing. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2021 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $55 million in environment-related capital expenditures and $152 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, the potential for more frequent and severe weather events, and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2021, we employed approximately 79,000 people worldwide, with approximately 29,000 based in the U.S. Women compose approximately 49% of our global workforce, and approximately 34% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent, but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, Pfizer Inc. 2021 Form 10-K fostering career growth and internal mobility and offering competitive compensation and benefits programs that encourage mental and physical well being. Core Values. To fully realize Pfizers purpose we have established a clear set of goals regarding what we need to achieve for patients and how we will go about achieving them. The how is represented by four simple, powerful company values Courage , Excellence , Equity and Joy . Each value defines our company and our culture: Courage : Breakthroughs start by challenging convention especially in the face of uncertainty or adversity. This happens when we think big, speak up and are decisive. Excellence : We can only change patients lives when we perform at our best together. This happens when we focus on what matters, agree who does what and measure outcomes. Equity : Every person deserves to be seen, heard and cared for. This happens when we are inclusive, act with integrity and reduce health care disparities. Joy : We give ourselves to our work, and it also gives to us. We find joy when we take pride, recognize one another and have fun. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our commitments to equity consist of specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) building a more inclusive colleague experience through representation and meaningful connections; (ii) advancing equitable health outcomes by evaluating our work through the lens of the communities we serve, (iii) providing resources on allyship and the science behind inclusion to support all colleagues in having courageous conversations about equity, race and the avoidance of bias; (iv) working to help transform society with external diversity, equity and inclusion partnerships, including deploying capital, engaging diverse suppliers and amplifying equity initiatives; and (v) working to help ensure demographics of clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . To attract, develop and inspire the brightest talent, we aim to support our colleagues by engaging and partnering with them to help ensure they feel they are part of a community. We understand the importance of continuously listening and responding to colleague feedback and our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their colleague experience. Through this survey, we measure and track key areas of the overall colleague experience and equip leaders with actionable insights for discussion and follow up. Regular topics in the survey include: (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer; (ii) purpose, including how colleagues work connects with our purpose; (iii) inclusion, such as having a climate in which diverse perspectives are valued; and (iv) growth, including the ability for colleagues to gain new experiences that align with their individual career goals. In 2021, we continued to maintain low turnover rates relative to the pharmaceutical industry and in our 2021 Pfizer Pulse survey, on average , 90% of colleagues reported feeling engaged, as measured by pride in working at Pfizer, willingness to recommend Pfizer as a great place to work and intent to stay. In addition, 92% of the colleagues agreed that their daily work contributes to our purpose. While we are slightly behind in our Bold Moves goal to create room for meaningful work, we continue to make progress on simplifying processes and removing needless complexity. We have committed to tangible actions and principles that incorporate the similar behaviors and mindset we used to develop a COVID-19 vaccine in an accelerated timeline. These behaviors include working with urgency and overcoming bureaucracy, as well as believing in our purpose, trusting in one another and being transparent. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insightsis based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. Our commitments to colleague development consist of specific actions to encourage non-linear career growth paths for all colleagues, including (i) a common language around growthalong with a guiding frameworkto help colleagues identify their next best growth experience, (ii) tools and resources to encourage growth conversations and offer transparency on the sources of growth available, and (iii) a variety of programs including mentoring, job rotations, experiential project roles, skill-based volunteering and learning resources focused on various topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being . Protecting the health, safety and well-being of colleagues and contingent workers, all of whom are essential to delivering our business objectives, is an integral part of how we operate. Our Global Environment, Health Safety (EHS) Policy and supporting standards outline our approach to assessment, evaluation, elimination, and mitigation of EHS risks across our operations. COVID-19 pandemic preparedness and response continues to be a key focus to help ensure on-site workers at our commercial, manufacturing and research sites remain safe and healthy while continuing to support work from home arrangements for colleagues who can work remotely. As part of these efforts, we (i) implemented a vaccination program for colleagues and their families in the U.S. and 23 other countries where employer vaccination programs were possible, (ii) partnered with and launched Thrive Global, a wellness and organizational change initiative with a primary focus on colleague mental health and wellness, and (iii) hosted educational webinars and information sessions on mental health and well-being, nutrition and work life balance through our employee assistance program provider. Pay Equity. Our commitment to pay equity for all colleagues is based in our value of Equity and our intention to continue to build a diverse and inclusive workforce. We are committed to equitable pay practices at Pfizer for employees based on role, education, experience, performance, and location and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the About Careers section of Pfizers website and our ESG Report. ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is Pfizer Inc. 2021 Form 10-K not meant to be a complete discussion of all potential risks or uncertainties. Additionally, our business is subject to general risks applicable to any company, such as economic conditions, geopolitical events, extreme weather and natural disasters. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. The negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and value-based pricing/contracting to improve their cost containment efforts. Such payers are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Also, business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches continue to occur, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line products and product candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. The entry to the market of competing biosimilars is expected to increase pricing pressures on our biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or Alliance revenues of more than $1 billion for each of nine products that collectively accounted for 75% of our total revenues in 2021. In particular, Comirnaty/BNT162b2 accounted for 45% of our total revenues in 2021. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription or vaccination growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective product should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K. For Comirnaty/BNT162b2 and Pfizer Inc. 2021 Form 10-K Paxlovid, while we believe that these products have the potential to provide ongoing revenue streams for Pfizer for the foreseeable future, revenues of these products following the COVID-19 pandemic may not be at the similar levels as those being generated during the pandemic. For information on additional risks associated with Comirnaty/BNT162b2 and Paxlovid, see the COVID-19 Pandemic section below. In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17C . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, primarily through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. For example, our gene therapy product candidates are based on a novel technology with only a few gene therapies approved to date, which makes it difficult to predict the time and cost of development and the ability to obtain regulatory approval. Further, gene therapy may face difficulties in gaining the acceptance of patients or the medical community. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions including inflation, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 63% of our total 2021 revenues were derived from international operations, including 29% from Europe and 19% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA and Note 7E . For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Note 11 . From time to time, we issued variable rate debt based on LIBOR, or undertook interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month Pfizer Inc. 2021 Form 10-K LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend any contracts to accommodate the SOFR rate where required. We do not expect the transition to have significant impact on our business or financial condition. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in our supply chain, product manufacturing and distribution networks, as well as sales or marketing, due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on, reputational harm, the impact to our facilities due to health pandemics or natural or man-made disasters, including as a result of climate change, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain supply and/or appropriate quality standards throughout our supply network and/or comply with applicable regulations; inability to supply certain products due to voluntary product recalls (as is the case with Chantix); and supply chain disruptions at our facilities or at a supplier or vendor. In addition, we engage contract manufacturers, and, from time to time, our contract manufacturers may face difficulties or are unable to manufacture our products at the necessary quantity or quality levels. Regulatory agencies periodically inspect our manufacturing facilities, as well as third-party facilities that we rely on, to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. In July and August 2021, Pfizer recalled 16 lots of Chantix in the U.S. due to the presence of a nitrosamine, N-nitroso-varenicline, at or above the FDA interim acceptable intake limit. In September 2021, Pfizer expanded its voluntary recall in the U.S. to include all lots of Chantix. We currently also have a voluntary recall across multiple markets and a global pause in shipments of Chantix. Technical solutions are being pursued to reduce nitrosamine levels in Chantix to enable return to market. Nitrosamines are impurities common in water and foods and everyone is exposed to some level of nitrosamines. In response to requests from various regulatory authorities, manufacturers across the pharmaceutical industry, including Pfizer, are evaluating their product portfolios for the potential for the presence or formation of nitrosamines. This may lead to additional recalls or other market actions for Pfizer products. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For information on additional risks specific to our Consumer Healthcare JV, see the Consumer Healthcare JV with GSK section below. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines and vaccines prime targets for counterfeiters. Counterfeit medicines and vaccines pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact Pfizers patients, potentially causing them harm. This, in turn, may result in the loss of patient confidence in the Pfizer name and in the integrity of our medicines and vaccines, and potentially impact our business through lost sales, product recalls, and possible litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the internet in lieu of traditional brick and mortar pharmacies or authorized full-service internet pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of consumers misplaced trust with certain e-commerce retailers coupled with the anonymity the internet affords counterfeiters. While counterfeiters generally target any medicine or vaccine boasting strong demand, we have observed heightened counterfeit and fraud attempts to our COVID-19 vaccine, as well as other products potentially utilized in the treatment of COVID-19. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, investing in innovative technologies to detect and disrupt sophisticated internet offers and scams, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2021 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. We expect to see continued focus by the Federal government on regulating pricing which could result in legislative and regulatory changes designed to control costs. Some states have implemented, and others are considering, patient access constraints or cost cutting under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have continued to focus on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for COVID-19 treatments and vaccines. U.S. HEALTHCARE REGULATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare regulation, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. Any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may need to amend our clinical trial protocols or conduct additional clinical trials under certain circumstances, for example, to further assess appropriate dosage or collect additional safety data. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval for new products and indications from regulators. Regulatory approvals of our products depend on myriad factors, including regulatory determinations as to the products safety and efficacy. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency or conditional basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP or any FDA Advisory Committee that may be convened to review our applications such as EUAs, NDAs or BLAs, which may impact the potential marketing and use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, including regulator-directed risk evaluations and Pfizer Inc. 2021 Form 10-K assessments, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-AUTHORIZATION/APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies and clinical trials, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as other products in the class. The potential regulatory and commercial implications of post-marketing study results typically cannot immediately be determined. For example, in December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. Updates include a new boxed warning for major adverse cardiovascular events (MACE) and updated boxed warnings regarding mortality, malignancies and thrombosis (with corresponding updates to applicable warnings and precautions). In addition, indications for the treatment of adults with moderately to severely active RA or active PsA, and patients who are two years of age and older with active polyarticular course juvenile idiopathic arthritis have been revised; Xeljanz is now indicated in patients who have had inadequate response or intolerance to one or more tumor necrosis factor blockers. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. We continue to work with regulatory agencies to review the full results and analyses of ORAL Surveillance and their impact on product labeling. The terms of our EUA for Comirnaty require that we conduct post-authorization observational studies in patients at least 5 years of age or older who received a booster dose, or other populations of interest including healthcare workers, pregnant women, immunocompromised individuals, and subpopulations with specific comorbidities. Additionally, in relation to the FDA approval for Comirnaty, we are required to complete certain postmarketing study requirements and commitments by 2024 as identified in the August 2021 approval letter. The terms of our EUA for Paxlovid require monitoring for convergence of global viral variants of SARS-CoV-2 and potential assessment of Paxlovid activity against identified global variants of interest. Additionally, in relation to the potential FDA approval for Paxlovid, we are required to complete certain other analyses and studies as identified in the December 2021 authorization letter. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial and other asserted and unasserted matters, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. Pfizer Inc. 2021 Form 10-K We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, no guarantee exists that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. For example, in May 2021, the Brazilian Supreme Court voted to invalidate Article 40 of Brazils Patent Law, which guaranteed a minimum 10-year patent term from patent grant, and to give retroactive effect to such decision. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. Further, legal or regulatory action by various stakeholders or governments could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products. Discussions are ongoing at the WTO regarding the role of intellectual property in the context of the COVID-19 pandemic response. This includes a proposal that would release WTO members from their obligation under WTO-TRIPS to grant and enforce various types of intellectual property protection on health products and technology in relation to the prevention, containment or treatment of COVID-19. In May 2021 and again in November 2021, the Biden Administration called on countries to waive intellectual property protections on COVID-19 vaccines. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third-party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD-PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant royalty payments or damages. Pfizer Inc. 2021 Form 10-K For example, our RD in a therapeutic area may not be first and another company or entity may have obtained relevant patents before us. We are involved in patent-related disputes with third parties over our attempts to market pharmaceutical products. Once we have final regulatory approval of the related products, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems (including cloud services) to operate our business. We produce, collect, process, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality, integrity and availability of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party providers who may or could have access to our confidential information. We rely on technology developed, supplied and/or maintained by third-parties that may make us vulnerable to supply chain style cyber-attacks. Further, technology and security vulnerabilities of acquisitions, business partners or third-party providers may not be identified during due diligence or soon enough to mitigate exploitation. The size and complexity of our information technology and information security systems, and those of our third-party providers (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or contingent workers, providers, or malicious attackers. As a global pharmaceutical company, our systems and assets are the target of frequent cyber-attacks. Such cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions, extortion, theft of confidential or proprietary information, compromise of data integrity or unauthorized information disclosure. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris in November 2020, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. Pfizer Inc. 2021 Form 10-K In June 2021, GSK announced that it intends to demerge at least 80% of its 68% ownership interest in the JV in mid-2022, subject to GSK shareholder approval. Following the demerger, the JV is expected to be an independent, listed company on the London Stock Exchange with American Depositary Receipts to be listed in the U.S., in which Pfizer would initially hold a 32% ownership interest and GSK may hold up to a 13.6% ownership interest. Notwithstanding GSKs announcement, the demerger may not be completed within expected time periods or at all, and both the timing and success of the demerger (or any other separation and public listing transaction), will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to any separation and public listing transactions (including the announced demerger), their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others: impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain disruptions and shortages, including challenges related to reliance on third-party suppliers resulting in reduced availability of materials or components used in the development, manufacturing, distribution or administration of our products; disruptions to pipeline development and clinical trials, including difficulties or delays in enrolling certain clinical trials, retaining clinical trial participants, accessing needed supplies, and accruing a sufficient number of cases in certain clinical trials; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; reduced product demand as a result of unemployment or increased focus on COVID-19 vaccination; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce or being restricted from enforcing, intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; challenges related to our human capital and talent development, including challenges in attracting, hiring and retaining highly skilled and diverse workforce; challenges related to vaccine mandates; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines and vaccines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution, including, among others: uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical and clinical data (including the Phase 1/2/3 or Phase 4 data for BNT162b2 or any other vaccine candidate in the BNT162 program or Paxlovid or any other future COVID-19 treatment) in any of our studies in pediatrics, adolescents or adults or real world evidence, including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data or further information regarding the quality of pre-clinical, clinical or safety data, including by audit or inspection; the ability to produce comparable clinical or other results for BNT162b2 or Paxlovid, including the rate of effectiveness and/or efficacy, safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial for BNT162b2 or Paxlovid and additional studies, in real-world data studies or in larger, more diverse populations following commercialization; the ability of BNT162b2 or any future vaccine to prevent, or Paxlovid or any other future COVID-19 treatment to be effective against, COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine or Paxlovid will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program, Paxlovid or other programs will be published in scientific journal publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; whether and when submissions to request emergency use or conditional marketing authorizations for BNT162b2 or any potential future vaccines in additional populations, for a booster dose for BNT162b2 or any potential future vaccines (including potential future annual boosters or re-vaccinations), and/or biologics license and/or EUA applications or amendments to any such applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when submissions to request emergency use or conditional marketing authorizations for Paxlovid or any other future COVID-19 treatment and/or any drug applications for any indication for Paxlovid or any other future COVID-19 treatment may be filed in any jurisdiction, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any application that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program, Paxlovid or any other future COVID-19 treatment or any other COVID-19 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines or drugs benefits outweigh its known risks and determination of the vaccines or drugs efficacy and, if approved, whether it will be commercially successful; Pfizer Inc. 2021 Form 10-K decisions by regulatory authorities impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine or drug, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; the possibility that COVID-19 will diminish in severity or prevalence, or disappear entirely; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines formulation, dosing schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations, booster doses or potential future annual boosters or re-vaccinations or new variant-specific vaccines; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program, Paxlovid or any other COVID-19 program; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any treatment for COVID-19, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine or treatment courses of Paxlovid within the projected time periods; whether and when additional supply or purchase agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine or treatment advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public confidence or awareness of our COVID-19 vaccine or Paxlovid, including challenges driven by misinformation, access, concerns about clinical data integrity and prescriber and pharmacy education; trade restrictions; potential third-party royalties or other claims related to our COVID-19 vaccine or Paxlovid; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines and vaccines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the Pfizer Inc. 2021 Form 10-K business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, tax laws and regulations internationally and in the U.S. (including, among other things, any potential adoption of global minimum taxation requirements and any potential changes to existing tax law and regulations by the Biden Administration and Congress), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 2. PROPERTIES We own and lease space globally for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2021, we had 327 owned and leased properties, amounting to approximately 41 million square feet. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in the second half of 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2021, PGS had responsibility for 39 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in Note 16A . INFORMATION ABOUT OUR EXECUTIVE OFFICERS The executive officers of the Company are set forth in this table. Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2022 Annual Meeting of Shareholders, or until his or her earlier death, resignation or removal. Each of the executive officers is a member of the Pfizer Executive Leadership Team. Name Age Position Albert Bourla 60 Chairman of the Board since January 2020 and Chief Executive Officer since January 2019. Chief Operating Officer from January 2018 until December 2018. Group President, Pfizer Innovative Health from June 2016 until December 2017. Group President, Global Innovative Pharma Business (responsible for Vaccines, Oncology and Consumer Healthcare since 2014) from February 2016 until June 2016. President and General Manager of Established Products Business Unit from December 2010 until December 2013. Our Director since February 2018. William Carapezzi 64 Executive Vice President, Global Business Services and Transformation since June 2020. Senior Vice President of Global Business Operations from June 2013 until June 2020. Senior Vice President of Global Tax from 2008 until June 2013. Frank A. DAmelio 64 Chief Financial Officer, Executive Vice President since January 2022. Chief Financial Officer and Executive Vice President, Global Supply from June 2020 until December 2021. Chief Financial Officer, Executive Vice President, Business Operations and Global Supply from November 2018 until June 2020. Executive Vice President, Business Operations and Chief Financial Officer from December 2010 until October 2018. Senior Vice President and Chief Financial Officer from September 2007 until December 2010. Director of Zoetis Inc. and Humana Inc. and Chair of the Humana Inc. Board of Directors Audit Committee. Mikael Dolsten 63 Chief Scientific Officer, President, Worldwide Research, Development and Medical since January 2019. President of Worldwide Research and Development from December 2010 until December 2018. Senior Vice President; President of Worldwide Research and Development from May 2010 until December 2010. Senior Vice President; President of Pfizer BioTherapeutics Research Development Group from October 2009 until May 2010. Director of Agilent Technologies, Inc, and Vimian Group AB. Pfizer Inc. 2021 Form 10-K Name Age Position Lidia Fonseca 53 Chief Digital and Technology Officer, Executive Vice President since January 2019. Chief Information Officer and Senior Vice President of Quest Diagnostics Incorporated from 2014 to 2018. Senior Vice President of Laboratory Corporation of America Holdings from 2008 until March 2013. Director of Tegna, Inc. Angela Hwang 56 Group President, Pfizer Biopharmaceuticals Group since January 2019. Group President, Pfizer Essential Health from January 2018 until December 2018. Global President, Pfizer Inflammation and Immunology from January 2016 until December 2017. Regional Head, U.S. Vaccines from January 2014 until December 2015. Vice President, Emerging Markets for the Primary Care therapeutic area from September 2011 until December 2013. Director of United Parcel Service, Inc. Rady A. Johnson 60 Chief Compliance, Quality and Risk Officer, Executive Vice President since January 2019. Executive Vice President, Chief Compliance and Risk Officer from December 2013 until December 2018. Senior Vice President and Associate General Counsel from October 2006 until December 2013. Douglas M. Lankler 56 General Counsel, Executive Vice President since December 2013. Corporate Secretary from January 2014 until February 2014. Executive Vice President, Chief Compliance and Risk Officer from February 2011 until December 2013. Executive Vice President, Chief Compliance Officer from December 2010 until February 2011. Aamir Malik 46 Chief Business Innovation Officer, Executive Vice President since August 2021. Various U.S. geographic leadership roles with McKinsey Company from 2019 to 2021; previously co-led McKinsey Companys Global Pharmaceuticals Medical Products practice from 2015 to 2018. Michael McDermott 56 Chief Global Supply Officer, Executive Vice President since January 2022. President of Pfizer Global Supply from 2018 until 2021. Vice President of Pfizer Global Supply from 2014 until 2018. Vice President of the Biotechnology Unit from 2012 until 2014. Payal Sahni 47 Chief People Experience Officer, Executive Vice President since January 2022. Chief Human Resources Officer, Executive Vice President from June 2020 to December 2021. From May 2016 until June 2020 served as Senior Vice President of Human Resources for multiple operating units. Vice President of Human Resources, Vaccines, Oncology Consumer from 2015 until 2016. Ms. Sahni has served in a number of positions in the Human Resources organization with increasing responsibility since joining Pfizer in 1997. Sally Susman 60 Chief Corporate Affairs Officer, Executive Vice President since January 2019. Executive Vice President, Corporate Affairs (formerly Policy, External Affairs and Communications) from December 2010 until December 2018. Senior Vice President, Policy, External Affairs and Communications from December 2009 until December 2010. Director of WPP plc. PART II "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 22, 2022, there were 133,758 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2021 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) October 4 through October 31, 2021 8,817 $ 44.74 $ 5,292,881,709 November 1 through November 30, 2021 4,687 $ 44.71 $ 5,292,881,709 December 1 through December 31, 2021 33,186 $ 55.35 $ 5,292,881,709 Total 46,690 $ 52.27 (a) See Note 12 . (b) Represents (i) 44,604 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 2,086 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. Pfizer Inc. 2021 Form 10-K PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche Holding AG and Sanofi SA. Five Year Performance 2016 2017 2018 2019 2020 2021 PFIZER $100.0 $115.8 $144.5 $134.5 $139.1 $232.0 PEER GROUP $100.0 $117.3 $126.7 $154.0 $160.4 $186.9 SP 500 $100.0 $121.8 $116.5 $153.1 $181.3 $233.3 "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2021 Total Revenues$81.3 billion 2021 Net Cash Flow from Operations$32.6 billion An increase of 95% compared to 2020 An increase of 126% compared to 2020 2021 Reported Diluted EPS$3.85 2021 Adjusted Diluted EPS (Non-GAAP)$4.42* An increase of 137% compared to 2020 An increase of 96% compared to 2020 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our former Upjohn Business in the fourth quarter of 2020, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines and beginning in the fourth quarter of 2020 operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments: Biopharma and PC1. Biopharma is the only reportable segment. On December 31, 2021, we completed the sale of our Meridian subsidiary, and beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 75% has been incurred since inception and through December 31, 2021. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base and support model align appropriately with our new operating structure. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. We are taking steps to restructure our corporate enabling functions to appropriately support our business, RD and PGS platform functions. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA . RD: We believe we have a strong pipeline and are well-positioned for future growth. RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new Pfizer Inc. 2021 Form 10-K products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. See the Item 1. Business Research and Development section of this Form 10-K for our RD priorities and strategy. We seek to leverage a strong pipeline, organize around expected operational growth drivers and capitalize on trends creating long-term growth opportunities, including: an aging global population that is generating increased demand for innovative medicines and vaccines that address patients unmet needs; advances in both biological science and digital technology that are enhancing the delivery of breakthrough new medicines and vaccines; and the increasingly significant role of hospitals in healthcare systems. Our Business Development Initiatives We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities that closed or are targeted to close in 2022 include: Acquisition of Arena In December 2021, we and Arena announced that the companies entered into a definitive agreement under which we will acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. Under the terms of the agreement, we will acquire all outstanding shares of Arena for $100 per share in an all-cash transaction for a total equity value of approximately $6.7 billion. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. Collaboration with Biohaven In November 2021, we entered into a collaboration and license agreement and related sublicense agreement with Biohaven Pharmaceutical Holding Company Ltd., Biohaven Pharmaceutical Ireland DAC and BioShin Limited (collectively, Biohaven) pursuant to which we acquired rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S., subject to regulatory approval. Rimegepant is currently commercialized in the U.S., Israel, and the U.A.E. under the brand name Nurtec ODT, with certain additional applications pending outside of the U.S. Biohaven will continue to lead RD globally and we have the exclusive right to commercialization globally, outside of the U.S. Upon the closing of the transaction, which occurred on January 4, 2022, we paid Biohaven $500 million, including an upfront payment of $150 million and an equity investment of $350 million. Biohaven is also eligible to receive up to $740 million in non-U.S. commercialization milestone payments, in addition to tiered double-digit royalties on net sales outside of the U.S. In addition to the milestone payments and royalties above, we will also reimburse Biohaven for the portion of certain additional milestone payments and royalties due to third parties in accordance with preexisting Biohaven agreements, which are attributed to ex-U.S. sales. For additional information, including discussion of recent significant business development activities, see Note 2 . Our 2021 Performance Revenues Revenues increased $39.6 billion, or 95%, to $81.3 billion in 2021 from $41.7 billion in 2020, reflecting an operational increase of $38.4 billion, or 92%, as well as a favorable impact of foreign exchange of $1.2 billion, or 3%. Excluding direct sales and alliance revenues of Comirnaty and sales of Paxlovid, revenues increased 6% operationally, reflecting strong growth in Eliquis, Biosimilars, PC1, Vyndaqel/Vyndamax, the Hospital therapeutic area, Inlyta and Xtandi, partially offset by declines in the Prevnar family, Chantix/Champix, Enbrel and Sutent. The following outlines the components of the net change in revenues: See the Analysis of the Consolidated Statements of IncomeRevenues by Geography and RevenuesSelected Product Discussion sections within MDA for more information, including a discussion of key drivers of our revenue performance. For information regarding the primary indications or class of certain products, see Note 17C. Pfizer Inc. 2021 Form 10-K Income from Continuing Operations Before Provision/(Benefit) for Taxes on Income The increase in Income from continuing operations before provision/(benefit) for taxes on income of $17.3 billion in 2021, compared to 2020, was primarily attributable to: (i) higher revenues, (ii) net periodic benefit credits in 2021 versus net periodic benefit costs in 2020, (iii) lower asset impairment charges, and (iv) higher net gains on equity securities, partially offset by (v) increases in: Cost of sales, Research and development expenses and Selling, informational and administrative expenses. See the Analysis of the Consolidated Statements of Income within MDA and Note 4 for additional information. For information on our tax provision and effective tax rate, see the Provision/(Benefit) for Taxes on Income section within MDA and Note 5 . Our Operating Environment We, like other businesses in our industry, are subject to certain industry-specific challenges. These include, among others, the topics listed below. See also the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors sections of this Form 10-K. Regulatory EnvironmentPipeline Productivity Our product lines must be replenished to offset revenue losses when products lose exclusivity or market share or to respond to healthcare and innovation trends, as well as to provide for earnings growth. As a result, we devote considerable resources to our RD activities which, while essential to our growth, incorporate a high degree of risk and cost, including whether a particular product candidate or new indication for an in-line product will achieve the desired clinical endpoint or safety profile, will be approved by regulators or will be successful commercially. We conduct clinical trials to provide data on safety and efficacy to support the evaluation of a products overall benefit-risk profile for a particular patient population. In addition, after a product has been approved or authorized and launched, we continue to monitor its safety as long as it is available to patients. This includes postmarketing trials that may be conducted voluntarily or pursuant to a regulatory request to gain additional medical knowledge. For the entire life of the product, we collect safety data and report safety information to the FDA and other regulatory authorities. Regulatory authorities may evaluate potential safety concerns and take regulatory actions in response, such as updating a products labeling, restricting its use, communicating new safety information to the public, or, in rare cases, requiring us to suspend or remove a product from the market. The commercial potential of in-line products may be negatively impacted by post-marketing developments. Intellectual Property Rights and Collaboration/Licensing Rights The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. While additional patent expiries will continue, we expect a moderate impact of reduced revenues due to patent expiries from 2022 through 2025. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information on patent rights we consider most significant to our business as a whole, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. For a discussion of recent developments with respect to patent litigation, see Note 16A1. Regulatory Environment/Pricing and AccessGovernment and Other Payer Group Pressures The pricing of medicines by pharmaceutical manufacturers and the cost of healthcare, which includes medicines, medical services and hospital services, continues to be important to payers, governments, patients, and other stakeholders. Federal and state governments and private third-party payers in the U.S. continue to take action to manage the utilization of drugs and cost of drugs, including increasingly employing formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. We consider a number of factors impacting the pricing of our medicines and vaccines. Within the U.S., we often engage with patients, doctors and healthcare plans. We also often provide significant discounts from the list price to insurers, including PBMs and MCOs. The price that patients pay in the U.S. for prescribed medicines and vaccines is ultimately set by healthcare providers and insurers. Governments globally may use a variety of measures to control costs, including proposing pricing reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In the U.S., we expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. Also, certain changes proposed by the CMS in December 2020 to the Medicaid program and 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities if they go into effect. Additional changes to the 340B program are undergoing review and their status is unclear. We anticipate that these and similar initiatives will continue to increase pricing pressures globally. For additional information, see the Item 1. Business Pricing Pressures and Managed Care Organizations and Government Regulation and Price Constraints sections in this Form 10-K. Product Supply We periodically encounter supply delays, disruptions or shortages, including due to voluntary product recalls such as our recent Chantix recall. For information on our recent Chantix recall and risks related to product manufacturing, see the Item 1A. Risk FactorsProduct Manufacturing, Sales and Marketing Risks section in this Form 10-K. The Global Economic Environment In addition to the industry-specific factors discussed above, we, like other businesses of our size and global extent of activities, are exposed to economic cycles. Certain factors in the global economic environment that may impact our global operations include, among other things, currency fluctuations, capital and exchange controls, global economic conditions including inflation, restrictive government actions, changes in intellectual property, legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, Pfizer Inc. 2021 Form 10-K production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Government pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria or other means of cost control. COVID-19 Pandemic The COVID-19 pandemic has impacted our business, operations and financial condition and results. Our Response to COVID-19 Pfizer has helped lead the global effort to confront the COVID-19 pandemic by advancing a vision for industry-wide collaboration while making significant investments in breakthrough science and global manufacturing. Comirnaty/BNT162b2 : We have collaborated with BioNTech to jointly develop Comirnaty/BNT162b2, a mRNA-based coronavirus vaccine to help prevent COVID-19. The FDA has approved Comirnaty in the U.S. to prevent COVID-19 in individuals 16 years of age and older as a two-dose primary series (30 g per dose). Comirnaty is the first COVID-19 vaccine to be granted approval by the FDA and had previously been available to this patient population in the U.S. under an EUA since December 2020. The vaccine is also available to individuals 5 to 15 years old under an EUA granted by the FDA in 2021 (10 g per dose for children 5 through 11 years of age (October 2021) and 30 g per dose for individuals 12 years of age and older (May 2021)). The FDA has also authorized for emergency use: (i) a third dose of Comirnaty/BNT162b2 in certain immunocompromised individuals 5 years of age and older and (ii) Comirnaty/BNT162b2 as a booster dose in individuals 12 years of age and older. Comirnaty/BNT162b2 has also been granted an approval or an authorization in many other countries around the world in populations varying by country. We continue to evaluate our vaccine, including for additional pediatric indications, and the short- and long-term efficacy of Comirnaty. We are also studying vaccine candidates to potentially prevent COVID-19 caused by new and emerging variants, such as the Omicron variant, or an updated vaccine as needed. In 2021, we manufactured more than three billion doses and, in fiscal 2021, delivered 2.2 billion doses around the world. Pfizer and BioNTech expect we can manufacture up to four billion doses in total by the end of 2022. The companies have entered into agreements to supply pre-specified doses of Comirnaty in 2022 with multiple developed and emerging countries around the world and are continuing to deliver doses of Comirnaty to governments under such agreements. We also signed agreements with multiple countries to supply Comirnaty doses in 2023 and are currently negotiating similar potential agreements with multiple other countries. We anticipate delivering at least two billion doses to low- and middle-income countries by the end of 2022one billion that was delivered in 2021 and one billion expected to be delivered in 2022, with the possibility to increase those deliveries if more orders are placed by these countries for 2022. One billion of the aforementioned doses to low- and middle-income countries are being supplied to the U.S. government at a not-for-profit price to be donated to the worlds poorest nations at no charge to those countries. As of February 8, 2022, we forecasted approximately $32 billion in revenues for Comirnaty in 2022, with gross profit to be split evenly with BioNTech, which includes doses expected to be delivered in fiscal 2022 under contracts signed as of late-January 2022. Paxlovid : In December 2021, the FDA authorized the emergency use of Paxlovid, a novel oral COVID-19 treatment, which is a SARS-CoV2-3CL protease inhibitor and is co-administered with a low dose of ritonavir, for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death. The FDA based its decision on clinical data from the Phase 2/3 EPIC-HR (Evaluation of Protease Inhibition for COVID-19 in High-Risk Patients), which enrolled non-hospitalized adults aged 18 and older with confirmed COVID-19 who are at increased risk of progressing to severe illness. Paxlovid has been granted an authorization or approval in many other countries. We continue to evaluate Paxlovid in other populations, including in patients with a confirmed diagnosis of SARS-CoV-2 infection who are at standard risk (i.e., low risk of hospitalization or death) (Phase 2/3 EPIC-SR (Evaluation of Protease Inhibition for COVID-19 in Standard Risk Patients)) and in adults living in the same household as someone with a confirmed COVID-19 infection (Phase 2/3 EPIC-PEP (Evaluation of Protease Inhibition for COVID-19 in Post-Exposure Prophylaxis)). We have entered into agreements with multiple countries to supply pre-specified courses of Paxlovid, such as the U.S. and U.K., and have initiated bilateral outreach to approximately 100 countries around the world. Additionally, we have signed a voluntary non-exclusive license agreement with the Medicines Patent Pool (MPP) for Paxlovid. Under the terms of the agreement, MPP can grant sublicenses to qualified generic medicine manufacturers worldwide to manufacture and supply Paxlovid to 95 low- and middle-income countries, covering up to approximately 53% of the worlds population. Pfizer plans to manufacture up to 120 million treatment courses by the end of 2022, depending on the global need, which will be driven by advance purchase agreements, with 30 million courses expected to be produced in the first half of 2022 and the remaining 90 million courses expected to be produced in the second half of 2022. As of February 8, 2022, we forecasted approximately $22 billion of revenues for Paxlovid in 2022, which includes treatment courses expected to be delivered in fiscal 2022, primarily relating to supply contracts signed or committed as of late-January 2022. IV Protease Inhibitor: In February 2022, we discontinued the global clinical development program for PF-07304814, an intravenously administered SARS-CoV-2 main protease inhibitor being evaluated in adults hospitalized with severe COVID-19. This decision was made based on a totality of information, including a careful review of early data and a thorough assessment of the candidates potential to successfully fulfill patient needs. Dosing of PF-07304814 in the National Institutes of Healths ongoing Accelerating COVID-19 Therapeutic Interventions and Vaccines (ACTIV)-3 study has ceased. Impact of COVID-19 on Our Business and Operations As part of our on-going monitoring and assessment, we have made certain assumptions regarding the pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, Pfizer Inc. 2021 Form 10-K as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. We are focused on all aspects of our business and are implementing measures aimed at mitigating issues where possible, including by using digital technology to assist in operations for our commercial, manufacturing, RD and corporate enabling functions globally. Apart from our introduction of Comirnaty/BNT162b2 and Paxlovid, our business and operations have been impacted by the pandemic in various ways. Our portfolio of products experienced varying impacts from the pandemic in 2021. For example, certain of our vaccines such as the Prevnar family were impacted by disruptions to healthcare activity related to COVID-19, including the prioritization of primary and booster vaccination campaigns for COVID-19. For some products such as Vyndaqel/Vyndamax, we continued to see postponement of elective and diagnostic procedures in 2021 due to COVID-19, which may subside in 2022 as COVID-19 vaccination and booster rates continue to increase and/or if COVID-19 cases subside. On the other hand, some products such as Ibrance saw accelerating demand in 2021 as the delays in diagnosis and treatment initiations caused by the COVID-19 pandemic show signs of recovery across several international markets. For detail on the impact of the COVID-19 pandemic on certain of our products, see the Analysis of the Consolidated Statements of IncomeRevenues by Geography and RevenuesSelected Product Discussion sections within this MDA. In 2021, engagement with healthcare professionals started to return to pre-pandemic levels and we continue to review and assess epidemiological data to inform in-person engagements with healthcare professionals and to help ensure the safety of our colleagues, customers and communities. As part of our commitment to engaging our customers in the manner they prefer, we are also taking a hybrid approach of virtual and in person engagements and saw customer response to both approaches. During the pandemic, we adapted our promotional platform by amplifying our digital capabilities to reach healthcare professionals and customers to provide critical education and information, including increasing the scale of our remote engagement. Most of our colleagues who are able to perform their job functions outside of our facilities continue to temporarily work remotely, while certain colleagues in the PGS and WRDM organizations continue to work onsite and are subject to strict protocols intended to reduce the risk of transmission. As of December 31, 2021, more than 96% of our U.S. employee population had been fully vaccinated or received an approved exception. Also, in 2021 and to date, we have not seen a significant disruption to our supply chain, and all of our manufacturing sites globally have continued to operate at or near normal levels. However, we are seeing an increase in overall demand in the industry for certain components and raw materials potentially constraining available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. Certain of our clinical trials were impacted by the COVID-19 pandemic in 2021, which included, in some cases, challenges related to recruiting clinical trial participants and accruing cases in certain studies. Our clinical trials also progressed in this challenging environment through innovation, such as decentralized visits (e.g., telemedicine and home visits) to accommodate participants ability to maintain scheduled visits, as well as working with suppliers to manage the shortage of certain clinical supplies. We will continue to pursue efforts to maintain the continuity of our operations while monitoring for new developments related to the pandemic. Future developments could result in additional favorable or unfavorable impacts on our business, operations or financial condition and results. If we experience significant disruption in our manufacturing or supply chains or significant disruptions in clinical trials or other operations, or if demand for our products is significantly reduced as a result of the COVID-19 pandemic, we could experience a material adverse impact on our business, operations and financial condition and results. For additional information, please see the Item 1A. Risk FactorsCOVID-19 Pandemic section of this Form 10-K. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS Following is a discussion about the critical accounting estimates and assumptions impacting our consolidated financial statements. Also, see Note 1D . For a description of our significant accounting policies, see Note 1 . Of these policies, the following are considered critical to an understanding of our consolidated financial statements as they require the application of the most subjective and the most complex judgments: Acquisitions ( Note 1E ); Fair Value ( Note 1F ); Revenues ( Note 1H ); Asset Impairments ( Note 1M ); Tax Assets and Liabilities and Income Tax Contingencies ( Note 1Q ); Pension and Postretirement Benefit Plans ( Note 1R ); and Legal and Environmental Contingencies ( Note 1S ). For a discussion of a recently adopted accounting standard and a change in accounting principle related to our pension and postretirement plans, see Notes 1B and 1C. Acquisitions We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair value as of the acquisition date. For further detail on acquisition accounting, see Note 1E . Historically, intangible assets have been the most significant fair values within our business combinations. For further information on our process to estimate the fair value of intangible assets, see Asset Impairments below. Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. If any of our ratios, factors, assessments, experiences or judgments are not indicative or accurate estimates of our future experience, our results could be materially affected. The potential of our estimates to vary (sensitivity) differs by program, product, type of customer and geographic location. However, estimates associated with U.S. Medicare, Medicaid and performance-based contract rebates are most at risk for material adjustment because of the extensive time delay Pfizer Inc. 2021 Form 10-K between the recording of the accrual and its ultimate settlement, an interval that can generally range up to one year. Because of this lag, our recording of adjustments to reflect actual amounts can incorporate revisions of several prior quarters. Rebate accruals are product specific and, therefore for any period, are impacted by the mix of products sold as well as the forecasted channel mix for each individual product. For further information, see the Analysis of the Consolidated Statements of IncomeRevenue Deductions section within MDA and Note 1H . Asset Impairments We review all of our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Our impairment review processes are described in Note 1M. Examples of events or circumstances that may be indicative of impairment include: A significant adverse change in legal factors or in the business climate that could affect the value of the asset. For example, a successful challenge of our patent rights would likely result in generic competition earlier than expected. A significant adverse change in the extent or manner in which an asset is used such as a restriction imposed by the FDA or other regulatory authorities that could affect our ability to manufacture or sell a product. An expectation of losses or reduced profits associated with an asset. This could result, for example, from a change in a government reimbursement program that results in an inability to sustain projected product revenues and profitability. This also could result from the introduction of a competitors product that impacts projected revenue growth, as well as the lack of acceptance of a product by patients, physicians and payers. For IPRD projects, this could result from, among other things, a change in outlook based on clinical trial data, a delay in the projected launch date or additional expenditures to commercialize the product. Identifiable Intangible Assets We use an income approach, specifically the discounted cash flow method to determine the fair value of intangible assets, other than goodwill. We start with a forecast of all the expected net cash flows associated with the asset, which incorporates the consideration of a terminal value for indefinite-lived assets, and then we apply an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions that impact our fair value estimates include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the projections and the impact of technological advancements and risk associated with IPRD assets, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic origin of the projected cash flows. While all intangible assets other than goodwill can face events and circumstances that can lead to impairment, those that are most at risk of impairment include IPRD assets (approximately $3.1 billion as of December 31, 2021) and newly acquired or recently impaired indefinite-lived brand assets. IPRD assets are high-risk assets, given the uncertain nature of RD. Newly acquired and recently impaired indefinite-lived assets are more vulnerable to impairment as the assets are recorded at fair value and are then subsequently measured at the lower of fair value or carrying value at the end of each reporting period. As such, immediately after acquisition or impairment, even small declines in the outlook for these assets can negatively impact our ability to recover the carrying value and can result in an impairment charge. Goodwill Our goodwill impairment review work as of December 31, 2021 concluded that none of our goodwill was impaired and we do not believe the risk of impairment is significant at this time. In our review, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors that we consider include, for example, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we then perform a quantitative fair value test. When we are required to determine the fair value of a reporting unit, we typically use the income approach. The income approach is a forward-looking approach to estimating fair value and relies primarily on internal forecasts. Within the income approach, we use the discounted cash flow method. We start with a forecast of all the expected net cash flows for the reporting unit, which includes the application of a terminal value, and then we apply a reporting unit-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of technological risk and competitive, legal and/or regulatory forces on the projections, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. For all of our reporting units, there are a number of future events and factors that may impact future results and that could potentially have an impact on the outcome of subsequent goodwill impairment testing. For a list of these factors, see the Forward-Looking Information and Factors That May Affect Future Result s and the Item 1A. Risk Factors sections in this Form 10-K. Benefit Plans For a description of our different benefit plans, see Note 11 . Our assumptions reflect our historical experiences and our judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our benefit plans can materially impact our results of operations. Pfizer Inc. 2021 Form 10-K The following provides (i) at the end of each year, the expected annual rate of return on plan assets for the following year, (ii) the actual annual rate of return on plan assets achieved in each year, and (iii) the weighted-average discount rate used to measure the benefit obligations at the end of each year for our U.S. pension plans and our international pension plans (a) : 2021 2020 2019 U.S. Pension Plans Expected annual rate of return on plan assets 6.3 % 6.8 % 7.0 % Actual annual rate of return on plan assets 9.2 14.1 22.6 Discount rate used to measure the plan obligations 2.9 2.6 3.3 International Pension Plans Expected annual rate of return on plan assets 3.1 3.4 3.6 Actual annual rate of return on plan assets 11.4 9.7 10.7 Discount rate used to measure the plan obligations 1.6 1.5 1.7 (a) For detailed assumptions associated with our benefit plans, see Note 11B . Expected Annual Rate of Return on Plan Assets The assumptions for the expected annual rate of return on all of our plan assets reflect our actual historical return experience and our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The expected annual rate of return on plan assets for our U.S. plans and the majority of our international plans is applied to the fair value of plan assets at each year-end and the resulting amount is reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs to a 50 basis point decline in our assumption for the expected annual rate of return on plan assets, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2022 Net Periodic Benefit Costs Expected annual rate of return on plan assets 50 basis point decline $133 The actual return on plan assets was approximately $2.6 billion during 2021 . Discount Rate Used to Measure Plan Obligations The weighted-average discount rate used to measure the plan obligations for our U.S. defined benefit plans is determined at least annually and evaluated and modified, as required, to reflect the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better, that reflect the rates at which the pension benefits could be effectively settled. The discount rate used to measure the plan obligations for our international plans is determined at least annually by reference to investment grade corporate bonds, rated AA/Aa or better, including, when there is sufficient data, a yield-curve approach. These discount rate determinations are made in consideration of local requirements. The measurement of the plan obligations at the end of the year will affect the amount of service cost, interest cost and amortization expense reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs and benefit obligations to a 10 basis point decline in our assumption for the discount rate, holding all other assumptions constant (in millions, pre-tax): Assumption Change Decrease in 2022 Net Periodic Benefit Costs Increase to 2021 Benefit Obligations Discount rate 10 basis point decline $16 $442 The change in the discount rates used in measuring our plan obligations as of December 31, 2021 resulted in a decrease in the measurement of our aggregate plan obligations by approximately $786 million. Income Tax Assets and Liabilities Income tax assets and liabilities include income tax valuation allowances and accruals for uncertain tax positions. For additional information, see Notes 1Q and 5, as well as the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA . Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax, legal contingencies and guarantees and indemnifications. For additional information, see Notes 1Q , 1S , 5D and 16 . Pfizer Inc. 2021 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF INCOME Revenues by Geography The following presents worldwide revenues by geography: Year Ended December 31, % Change Worldwide U.S. International Worldwide U.S. International (MILLIONS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 21/20 20/19 21/20 20/19 21/20 20/19 Operating segments: Biopharma $ 79,557 $ 40,724 $ 38,013 $ 29,221 $ 21,055 $ 18,901 $ 50,336 $ 19,670 $ 19,112 95 7 39 11 156 3 Pfizer CentreOne 1,731 926 810 524 400 437 1,206 526 374 87 14 31 (8) 129 41 Consumer Healthcare 2,082 988 1,094 (100) (100) (100) Total revenues $ 81,288 $ 41,651 $ 40,905 $ 29,746 $ 21,455 $ 20,326 $ 51,542 $ 20,196 $ 20,579 95 2 39 6 155 (2) 2021 v. 2020 The following provides an analysis of the change in worldwide revenues by geographic areas in 2021: (MILLIONS) Worldwide U.S. International Operational growth/(decline): Growth from Comirnaty, Eliquis, Biosimilars, Vyndaqel/Vyndamax, the Hospital therapeutic area, Inlyta and Xtandi, partially offset by a decline from the Prevnar family, while Xeljanz and Ibrance were flat. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis $ 38,546 $ 8,802 $ 29,744 Growth from PC1 primarily reflecting manufacturing of legacy Upjohn products for Viatris under manufacturing and supply agreements and certain Comirnaty-related manufacturing activities performed on behalf of BioNTech. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis 780 124 656 Lower revenues for Chantix/Champix, Enbrel and Sutent: The decrease for Chantix/Champix was driven by the voluntary recall across multiple markets in the second half of 2021 and the ongoing global pause in shipments of Chantix due to the presence of N-nitroso-varenicline above an acceptable level of intake set by various global regulators, the ultimate timing for resolution of which may vary by country, and the negative impact of the COVID-19 pandemic resulting in a decline in patient visits to doctors for preventive health purposes The decrease for Enbrel internationally primarily reflects continued biosimilar competition, which is expected to continue The decrease for Sutent primarily reflects lower volume demand in the U.S. resulting from its loss of exclusivity in August 2021, as well as continued erosion as a result of increased competition in certain international developed markets (869) (501) (368) Other operational factors, net (27) (134) 106 Operational growth, net 38,429 8,291 30,137 Favorable impact of foreign exchange 1,208 1,208 Revenues increase/(decrease) $ 39,637 $ 8,291 $ 31,346 Emerging markets revenues increased $12.3 billion, or 147%, in 2021 to $20.7 billion from $8.4 billion in 2020, reflecting an operational increase of $12.2 billion, or 145%, and a favorable impact from foreign exchange of approximately 2%. The operational increase in emerging markets was primarily driven by revenues from Comirnaty and growth from certain products in the Hospital therapeutic area, Eliquis and PC1, partially offset by a decline from the Prevnar family. Pfizer Inc. 2021 Form 10-K 2020 v. 2019 The following provides an analysis of the change in worldwide revenues by geographic areas in 2020: (MILLIONS) Worldwide U.S. International Operational growth/(decline): Growth from Vyndaqel/Vyndamax, Eliquis, Biosimilars, Ibrance, Inlyta, Xeljanz, Xtandi, the Hospital therapeutic area and the Prevnar family $ 3,560 $ 2,132 $ 1,428 Growth from PC1 in international markets driven by growth of certain key accounts as well new contract manufacturing activities 114 (36) 151 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations, and none in 2020 (2,082) (988) (1,094) Lower revenues for Enbrel internationally, primarily reflecting continued biosimilar competition in most developed Europe markets, as well as in Japan and Brazil, all of which is expected to continue (320) (320) Decline from Chantix/Champix reflecting the negative impact of the COVID-19 pandemic resulting in a decline in patient visits to doctors for preventive health purposes as well as the loss of patent protection in the U.S. in November 2020 (185) (183) (2) Other operational factors, net (9) 205 (214) Operational growth/(decline), net 1,078 1,129 (50) Unfavorable impact of foreign exchange (331) (331) Revenues increase/(decrease) $ 746 $ 1,129 $ (383) Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for the Prevnar family in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for Comirnaty. Emerging markets revenues decreased $456 million, or 5%, in 2020 to $8.4 billion, from $8.8 billion in 2019, and were relatively flat operationally, reflecting an unfavorable impact of foreign exchange of 5% on emerging markets revenues. The relatively flat operational performance was primarily driven by growth from Eliquis, the Prevnar family, Ibrance and Zavicefta, offset by lower revenues for Consumer Healthcare, reflecting the July 31, 2019 completion of the Consumer Healthcare JV transaction. Revenue Deductions Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. These deductions represent estimates of related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. The following presents information about revenue deductions: Year Ended December 31, (MILLIONS) 2021 2020 2019 Medicare rebates $ 726 $ 647 $ 628 Medicaid and related state program rebates 1,214 1,136 1,259 Performance-based contract rebates 3,253 2,660 2,332 Chargebacks 6,122 4,531 3,411 Sales allowances 4,809 3,835 3,776 Sales returns and cash discounts 1,054 924 878 Total $ 17,178 $ 13,733 $ 12,284 Revenue deductions are primarily a function of product sales volume, mix of products sold, contractual or legislative discounts and rebates. For information on our accruals for revenue deductions, including the balance sheet classification of these accruals, see Note 1H . Pfizer Inc. 2021 Form 10-K RevenuesSelected Product Discussion Biopharma Revenue (MILLIONS) Year Ended Dec. 31, % Change Product Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary Comirnaty (a) $36,781 * U.S. $ 7,809 $ 154 * Driven by global uptake, following a growing number of regulatory approvals and temporary authorizations. Intl. 28,972 * * Worldwide $ 36,781 $ 154 * * Eliquis $5,970 Up 19% (operationally) U.S. $ 3,160 $ 2,688 18 Global growth driven primarily by continued increased adoption in non-valvular atrial fibrillation and oral anti-coagulant market share gains, as well as a favorable adjustment related to the Medicare coverage gap provision resulting from lower than previously expected discounts in prior periods. Intl. 2,810 2,260 24 21 Worldwide $ 5,970 $ 4,949 21 19 Ibrance $5,437 Flat (operationally) U.S. $ 3,418 $ 3,634 (6) Flat performance driven primarily by accelerating demand internationally as the delays in diagnosis and treatment initiations caused by the COVID-19 pandemic show signs of recovery across several international markets, offset by a decline in the U.S., primarily driven by an increase in the proportion of patients accessing Ibrance through our Patient Assistance Program. Intl. 2,019 1,758 15 12 Worldwide $ 5,437 $ 5,392 1 Prevnar family $5,272 Down 11% (operationally) U.S. $ 2,701 $ 2,930 (8) Decline primarily resulting from: the normalization of demand in Germany and certain other developed markets following significantly increased adult demand in 2020 resulting from greater vaccine awareness for respiratory illnesses due to the COVID-19 pandemic; the adult indication due to disruptions to healthcare activity related to COVID-19, including the prioritization of primary and booster vaccination campaigns for COVID-19 in the U.S.; the continued impact of the lower remaining unvaccinated eligible adult population in the U.S. and the June 2019 change to the ACIP recommendation for the Prevnar 13 adult indication to shared clinical decision-making; and a decline in the pediatric indication internationally due to disruptions to healthcare activity related to COVID-19. This decline was partially offset by: U.S. growth in the pediatric indication, driven by government purchasing patterns, which was partially offset by disruptions to healthcare activity related to COVID-19. Intl. 2,571 2,920 (12) (13) Worldwide $ 5,272 $ 5,850 (10) (11) Xeljanz $2,455 Flat (operationally) U.S. $ 1,647 $ 1,706 (3) Flat performance as a decline in the U.S. was offset by operational growth internationally. The decline in the U.S. was primarily driven by: the negative impact of data from a long-term safety study, which resulted in JAK class labeling issued by the FDA in December 2021; an unfavorable change in channel mix toward lower-priced channels, despite a 2% increase in underlying demand, driven by growth in our UC and PsA indications; and continued investments to improve formulary positioning and unlock access to additional patient lives. The decline in the U.S. was offset by: operational growth internationally mainly driven by continued uptake in the UC indication in certain developed markets. Intl. 808 731 11 8 Worldwide $ 2,455 $ 2,437 1 Vyndaqel/ Vyndamax $2,015 Up 55% (operationally) U.S. $ 909 $ 613 48 Growth primarily driven by continued strong uptake of the ATTR-CM indication in the U.S., developed Europe and Japan. Intl. 1,106 675 64 61 Worldwide $ 2,015 $ 1,288 56 55 Xtandi $1,185 Up 16% (operationally) U.S. $ 1,185 $ 1,024 16 Growth primarily driven by strong demand across the mCRPC, nmCRPC and mCSPC indications. Intl. Worldwide $ 1,185 $ 1,024 16 16 Inlyta $1,002 Up 26% (operationally) U.S. $ 599 $ 523 15 Growth primarily reflects continued adoption in developed Europe and the U.S. of combinations of certain immune checkpoint inhibitors and Inlyta for the first-line treatment of patients with advanced RCC. Intl. 403 264 53 49 Worldwide $ 1,002 $ 787 27 26 Pfizer Inc. 2021 Form 10-K Revenue (MILLIONS) Year Ended Dec. 31, % Change Product Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary Biosimilars $2,343 Up 51% (operationally) U.S. $ 1,561 $ 899 74 Growth primarily driven by recent oncology monoclonal antibody biosimilar launches and growth from Retacrit in the U.S. Intl. 782 628 25 19 Worldwide $ 2,343 $ 1,527 53 51 Hospital $7,301 Up 5% (operationally) U.S. $ 2,688 $ 2,705 (1) Growth primarily driven by the anti-infectives portfolio in international markets, primarily as a result of recent launches of Zavicefta and Cresemba. Intl. 4,613 4,073 13 9 Worldwide $ 7,301 $ 6,777 8 5 Pfizer CentreOne Revenue (MILLIONS) Year Ended Dec. 31, % Change Operating Segment Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary PC1 $1,731 Up 84% (operationally) U.S. $ 524 $ 400 31 Growth primarily reflects manufacturing of legacy Upjohn products for Viatris under manufacturing and supply agreements and certain Comirnaty-related manufacturing activities performed on behalf of BioNTech. Intl. 1,206 526 129 125 Worldwide $ 1,731 $ 926 87 84 (a) Comirnaty includes direct sales and alliance revenues related to sales of the Pfizer-BioNTech COVID-19 vaccine, which are recorded within our Vaccines therapeutic area. It does not include revenues for certain Comirnaty-related manufacturing activities performed on behalf of BioNTech, which are included in the PC1 contract development and manufacturing organization. Revenues related to these manufacturing activities totaled $320 million for 2021 and $0 million in 2020. * Calculation is not meaningful or results are equal to or greater than 100%. See the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K for information regarding the expiration of various patent rights, Note 16 for a discussion of recent developments concerning patent and product litigation relating to certain of the products discussed above and Note 17C for additional information regarding the primary indications or class of the selected products discussed above. Costs and Expenses Costs and expenses follow: Year Ended December 31, % Change (MILLIONS) 2021 2020 2019 21/20 20/19 Cost of sales $ 30,821 $ 8,484 $ 8,054 * 5 Percentage of Revenues 37.9 % 20.4 % 19.7 % Selling, informational and administrative expenses 12,703 11,597 12,726 10 (9) Research and development expenses 13,829 9,393 8,385 47 12 Amortization of intangible assets 3,700 3,348 4,429 11 (24) Restructuring charges and certain acquisition-related costs 802 579 601 38 (4) Other (income)/deductionsnet (4,878) 1,219 3,497 * (65) * Calculation is not meaningful or results are equal to or greater than 100%. Cost of Sales 2021 v. 2020 Cost of sales increased $22.3 billion, primarily due to: the impact of Comirnaty, which includes a charge for the 50% gross profit split with BioNTech and applicable royalty expenses; increased sales volumes of other products, driven mostly by PC1; and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory. The increase in Cost of sales as a percentage of revenues was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. 2020 v. 2019 Cost of sales increased $431 million, primarily due to: increased sales volumes; an increase in royalty expenses, due to an increase in sales of related products; an unfavorable impact of incremental costs incurred in response to the COVID-19 pandemic; and Pfizer Inc. 2021 Form 10-K an unfavorable impact of foreign exchange and hedging activity on intercompany inventory, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction. The increase in Cost of sales as a percentage of revenues was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. Selling, Informational and Administrative (SIA) Expenses 2021 v. 2020 SIA expenses increased $1.1 billion, mostly due to: increased product-related spending across multiple therapeutic areas; costs related to Comirnaty, driven by a higher provision for healthcare reform fees based on sales; and an increase in costs related to implementing our cost-reduction/productivity initiatives, partially offset by: lower spending on Chantix following the loss of patent protection in the U.S. in November 2020. 2020 v. 2019 SIA expenses decreased $1.1 billion, mostly due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; lower spending for corporate enabling functions; lower spending on sales and marketing activities due to the impact of the COVID-19 pandemic; and lower investments across the Internal Medicine and Inflammation Immunology portfolios, partially offset by: an increase in costs related to implementing our cost-reduction/productivity initiatives; and an increase in business and legal entity alignment costs. Research and Development (RD) Expenses 2021 v. 2020 RD expenses increased $4.4 billion, primarily due to: a charge for acquired IPRD related to our acquisition of Trillium; a net increase in charges for upfront and milestone payments on collaboration and licensing arrangements, driven by payments to Arvinas and Beam; and increased investments across multiple therapeutic areas, including additional spending related to the development of the oral COVID-19 treatment program. 2020 v. 2019 RD expenses increased $1.0 billion, mainly due to: costs related to our collaboration agreement with BioNTech to co-develop a COVID-19 vaccine, including an upfront payment to BioNTech and a premium paid on our equity investment in BioNTech; a net increase in upfront payments, mainly related to Myovant and Valneva; and increased investments towards building new capabilities and driving automation, partially offset by: a net reduction of upfront and milestone payments associated with the acquisition of Therachon and Akcea in 2019. Amortization of Intangible Assets 2021 v. 2020 Amortization of intangible assets increased $353 million, primarily due to amortization of capitalized Comirnaty sales milestones to BioNTech. 2020 v. 2019 Amortization of intangible assets decreased $1.1 billion, mainly due the non-recurrence of amortization of fully amortized assets and the impairment of Eucrisa in the fourth quarter of 2019, partially offset by the increase in amortization of intangible assets from our acquisition of Array. For additional information, see Notes 2A and 10A . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives Transforming to a More Focused Company Program For a description of our program, as well as the anticipated and actual costs, see Note 3. The program savings discussed below may be rounded and represent approximations. In connection with restructuring our corporate enabling functions, we expect gross cost savings of $1.0 billion, or net cost savings, excluding merit and inflation growth and certain real estate cost increases, of $700 million, to be achieved primarily from 2021 through 2022. In connection with transforming our marketing strategy, we expect net cost savings of $1.3 billion, to be achieved primarily from Pfizer Inc. 2021 Form 10-K 2022 through 2024. In connection with manufacturing network optimization, we expect net cost savings of $550 million to be achieved primarily from 2020 through 2023. Certain qualifying costs for this program were recorded in 2021 and 2020, and in the fourth quarter of 2019, and are reflected as Certain Significant Items and excluded from our non-GAAP measure of Adjusted Income. See the Non-GAAP Financial Measure: Adjusted Income section of this MDA. In addition to this program, we continuously monitor our operations for cost reduction and/or productivity opportunities, especially in light of the losses of exclusivity and the expiration of collaborative arrangements for various products. Other (Income)/DeductionsNet 2021 v. 2020 Other incomenet increased $6.1 billion, mainly due to: net periodic benefit credits recorded in 2021 versus net periodic benefit costs recorded in 2020; lower asset impairment charges; higher net gains on equity securities; and net gains on asset disposals in 2021 versus net losses in 2020. 2020 v. 2019 Other deductionsnet decreased $2.3 billion, mainly due to: lower asset impairment charges; lower business and legal entity alignment costs; higher Consumer Healthcare JV equity method income; lower charges for certain legal matters; and higher income from collaborations, out-licensing arrangements and sales of compound/product rights, partially offset by: higher net losses on asset disposals. See Note 4 for additional information . Provision/(Benefit) for Taxes on Income Year Ended December 31, % Change (MILLIONS) 2021 2020 2019 21/20 20/19 Provision/(benefit) for taxes on income $ 1,852 $ 370 $ 583 * (36) Effective tax rate on continuing operations 7.6 % 5.3 % 5.2 % * Indicates calculation not meaningful or result is equal to or greater than 100%. For information about our effective tax rate and the events and circumstances contributing to the changes between periods, as well as details about discrete elements that impacted our tax provisions, see Note 5 . Discontinued Operations For information about our discontinued operations, see Note 2B . PRODUCT DEVELOPMENTS A comprehensive update of Pfizers development pipeline was published as of February 8, 2022 and is available at www.pfizer.com/science/drug-product-pipeline. It includes an overview of our research and a list of compounds in development with targeted indication and phase of development, as well as mechanism of action for some candidates in Phase 1 and all candidates from Phase 2 through registration. The following provides information about significant marketing application-related regulatory actions by, and filings pending with, the FDA and regulatory authorities in the EU and Japan. The table below includes only approvals for products that have occurred in the last twelve months and does not include approvals that may have occurred prior to that time. The table includes filings with regulatory decisions pending (even if the filing occurred outside of the last twelve-month period). Pfizer Inc. 2021 Form 10-K PRODUCT DISEASE AREA APPROVED/FILED* U.S. EU JAPAN Comirnaty/BNT162b2 (PF-07302048) (a) Immunization to prevent COVID-19 (16 years of age and older) BLA Aug. CMA Dec. Approved Feb. Immunization to prevent COVID-19 (12-15 years of age) EUA May CMA May Approved May Immunization to prevent COVID-19 (booster) EUA Sep. CMA Oct. Approved Nov. Immunization to prevent COVID-19 (5-11 years of age) EUA Oct. CMA Nov. Approved Jan. Bavencio (avelumab) (b) First-line maintenance urothelial cancer Approved Jan. Approved Feb. Xtandi (enzalutamide) (c) mCSPC Approved April Cibinqo (abrocitinib) Atopic dermatitis Approved Jan. Approved Dec. Approved Sep. Xeljanz (tofacitinib) Ankylosing spondylitis Approved Dec. Approved Nov. Myfembree (relugolix fixed dose combination) (d) Uterine fibroids (combination with estradiol and norethindrone acetate) Approved May Endometriosis (combination with estradiol and norethindrone acetate) Filed Sep. Lorbrena/Lorviqua (lorlatinib) First-line ALK-positive NSCLC Approved Mar. Approved Jan. Approved Nov. Ngenla (somatrogon) (e) Pediatric growth hormone deficiency Filed Jan. Approved Feb. Approved Jan. Prevnar 20/Apexxnar (Vaccine) (f) Immunization to prevent invasive and non-invasive pneumococcal infections (adults) Approved June Approved Feb. TicoVac (Vaccine) Immunization to prevent tick-borne encephalitis Approved Aug. Paxlovid (g) (nirmatrelvir [PF-07321332]; ritonavir) COVID-19 infection (high risk population) EUA Dec. CMA Jan. Approved Feb. Rimegepant (h) Acute migraine Filed Feb. Migraine prevention Filed Feb. * For the U.S., the filing date is the date on which the FDA accepted our submission. For the EU, the filing date is the date on which the EMA validated our submission. (a) Being developed in collaboration with BioNTech. Prior to BLA, Comirnaty/BNT162b2 for ages 16 and up was available in the U.S. pursuant to an EUA from the FDA on December 11, 2020. In December 2021, a supplemental BLA was submitted to the FDA requesting to expand the approval of Comirnaty to include individuals ages 12 through 15 years. In February 2022, following a request from the FDA, a rolling submission seeking to amend the EUA to include children 6 months through 4 years of age (6 months to 5 years of age) was initiated as we wait for data evaluating a third 3 g dose given at least two months after the second dose of the two-dose series in this age group. A booster dose received EUA from the FDA on September 22, 2021 for individuals 65 years of age and older, individuals 18 through 64 years of age at high risk of severe COVID-19, and individuals 18 through 64 years of age with frequent institutional or occupational exposure to SARS-CoV-2. In addition, in October 2021, the FDA authorized for emergency use a booster dose to eligible individuals who have completed primary vaccination with a different authorized COVID-19 vaccine. Subsequently, the FDA expanded the booster EUA: (i) in November 2021 to include individuals 18 years of age and older, (ii) in December 2021 to include individuals 16 years of age and older and (iii) in January 2022 to include individuals 12 years of age and older as well as individuals 5 through 11 years of age who have been determined to have certain kinds of immunocompromise. A booster dose received conditional marketing authorization from the EMA in October 2021 for individuals 18 years of age and older and may be given to individuals 5 years and older with a severely weakened immune system, at least 28 days after their second dose. A booster dose received approval in Japan in November 2021 for 18 years of age and older. (b) Being developed in collaboration with Merck KGaA, Germany. (c) Being developed in collaboration with Astellas. (d) Being developed in collaboration with Myovant. (e) Being developed in collaboration with OPKO. In January 2022, Pfizer and OPKO received a Complete Response Letter (CRL) from the FDA for the BLA for somatrogon. Pfizer is evaluating the CRL and will work with the FDA to determine an appropriate path forward in the U.S. (f) In October 2021, the CDCs ACIP voted to recommend Prevnar 20 for routine use in adults. Specifically, the ACIP voted to recommend the following: (i) adults 65 years of age or older who have not previously received a pneumococcal conjugate vaccine or whose previous vaccination history is unknown should receive a pneumococcal conjugate vaccine (either pneumococcal 20-valent conjugate vaccine (PCV20) or pneumococcal 15-valent conjugate vaccine (PCV15)). If PCV15 is used, this should be followed by a dose of pneumococcal polysaccharide vaccine (PPSV23); and (ii) adults aged 19 years of age or older with certain underlying medical conditions or other risk factors who have not previously received a pneumococcal conjugate vaccine or whose previous vaccination history is unknown should receive a pneumococcal conjugate vaccine (either PCV20 or PCV15). If PCV15 is used, this should be followed by a dose of PPSV23. The Pfizer Inc. 2021 Form 10-K recommendations were published in the Morbidity and Mortality Weekly Report on January 28, 2022. The publication also notes for adults who have received pneumococcal conjugate vaccine (PCV13) but have not completed their recommended pneumococcal vaccine series with PPSV23, one dose of Prevnar 20 may be used if PPSV23 is not available. (g) In December 2021, the FDA authorized the emergency use of Paxlovid for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death. In January 2022, the EMA approved the CMA of Paxlovid for treating COVID-19 in adults who do not require supplemental oxygen and who are at increased risk of the disease becoming severe. (h) Under a commercialization arrangement with Biohaven. In September 2021, the FDA issued a Drug Safety Communication (DSC) related to Xeljanz/Xeljanz XR and two competitors arthritis medicines in the same drug class, based on its completed review of the ORAL Surveillance trial. The DSC stated that the FDA will require revisions to the Boxed Warnings for each of these medicines to include information about the risks of serious heart-related events, cancer, blood clots, and death. In addition, the DSC indicated the FDAs intention to limit approved uses of these products to certain patients who have not responded or cannot tolerate one or more tumor necrosis factor (TNF) blockers. In December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. For additional information, see Item 1A. Risk FactorsPost-Authorization/Approval Data . In China, the following products received regulatory approvals in the last twelve months: Cresemba for fungal infection and Besponsa for second line acute lymphoblastic leukemia, both in December 2021. The following provides information about additional indications and new drug candidates in late-stage development: PRODUCT/CANDIDATE PROPOSED DISEASE AREA LATE-STAGE CLINICAL PROGRAMS FOR ADDITIONAL USES AND DOSAGE FORMS FOR IN-LINE AND IN-REGISTRATION PRODUCTS Ibrance (palbociclib) (a) ER+/HER2+ metastatic breast cancer Xtandi (enzalutamide) (b) Non-metastatic high-risk castration sensitive prostate cancer Talzenna (talazoparib) Combination with Xtandi (enzalutamide) for first-line mCRPC Combination with Xtandi (enzalutamide) for DNA Damage Repair (DDR)-deficient mCSPC PF-06482077 (Vaccine) Immunization to prevent invasive and non-invasive pneumococcal infections (pediatric) somatrogon (PF-06836922) (c) Adult growth hormone deficiency Braftovi (encorafenib) and Erbitux (cetuximab) (d) First-line BRAF v600E -mutant mCRC Myfembree (relugolix fixed dose combination) (e) Combination with estradiol and norethindrone acetate for contraceptive efficacy Braftovi (encorafenib) and Mektovi (binimetinib) and Keytruda (pembrolizumab) (f) BRAF v600E -mutant metastatic or unresectable locally advanced melanoma Comirnaty / BNT162b2 (PF-07302048) (g) Immunization to prevent COVID-19 (children 2 to 5years of age) Immunization to prevent COVID-19 (infants 6 months to 24 months) Paxlovid (nirmatrelvir [PF-07321332]; ritonavir) COVID-19 Infection (standard risk population) COVID-19 Infection ( post exposure prophylaxis) NEW DRUG CANDIDATES IN LATE-STAGE DEVELOPMENT aztreonam-avibactam (PF-06947387) Treatment of infections caused by Gram-negative bacteria fidanacogene elaparvovec (PF-06838435) (h) Hemophilia B giroctocogene fitelparvovec (PF-07055480) (i) Hemophilia A PF-06425090 (Vaccine) Immunization to prevent primary clostridioides difficile infection PF-06886992 (Vaccine) Immunization to prevent serogroups meningococcal infection (adolescent and young adults) PF-06928316 (Vaccine) Immunization to prevent respiratory syncytial virus infection (maternal) Immunization to prevent respiratory syncytial virus infection (older adults) PF-07265803 Dilated cardiomyopathy due to Lamin A/C gene mutation ritlecitinib (PF-06651600) Alopecia areata sasanlimab (PF-06801591) Combination with Bacillus Calmette-Guerin for non-muscle-invasive bladder cancer fordadistrogene movaparvovec (PF-06939926) Duchenne muscular dystrophy marstacimab (PF-06741086) Hemophilia elranatamab (PF-06863135) Multiple myeloma, double-class exposed Omicron-based mRNA vaccine (g) Immunization to prevent COVID-19 (adults) (a) Being developed in collaboration with The Alliance Foundation Trials, LLC. (b) Being developed in collaboration with Astellas. (c) Being developed in collaboration with OPKO. (d) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (e) Being developed in collaboration with Myovant. (f) Keytruda is a registered trademark of Merck Sharp Dohme Corp. (g) Being developed in collaboration with BioNTech. Pfizer Inc. 2021 Form 10-K (h) Being developed in collaboration with Spark Therapeutics, Inc. (i) Being developed in collaboration with Sangamo Therapeutics, Inc. In February 2022, Pfizer and Merck KGaA, Darmstadt, Germany (Merck KGaA) provided an update on the Phase 3 JAVELIN Lung 100 trial, which assessed the safety and efficacy of two dosing regimens of avelumab monotherapy compared with platinum-based doublet chemotherapy as first-line treatment in patients with metastatic NSCLC whose tumors express PD-L1. While avelumab showed clinical activity in this population, the study did not meet the primary endpoints of overall survival and progression-free survival in the high PD-L1+population for either of the avelumab dosing regimens evaluated. The safety profile for avelumab in this trial was consistent with that observed in the overall JAVELIN clinical development program. Avelumab is not approved for the treatment of any patients with NSCLC. The outcome of the JAVELIN Lung 100 trial has no bearing on any of avelumabs currently-approved indications. Full results of the study will be shared at a future date. In the fourth quarter of 2021, enrollment was stopped in C4591015 Study (a Phase 2/3 placebo controlled randomized observer-blind study to evaluate the safety, tolerability, and immunogenicity of BNT162b2 against COVID-19 in healthy pregnant women 18 years of age and older). This study was developed prior to availability or recommendation for COVID-19 vaccination in pregnant women. The environment changed during 2021 and by September 2021, COVID-19 vaccines were recommended by applicable recommending bodies (e.g., ACIP in the U.S.) for pregnant women in all participating/planned countries, and as a result the enrollment rate declined significantly. With the declining enrollment, the study had insufficient sample size to assess the primary immunogenicity objective and continuation of this placebo controlled study could no longer be justified due to global recommendations. This proposal was shared with and agreed to by FDA and EMA. For additional information about our RD organization, see the Item 1. Business Research and Development section of this Form 10-K. NON-GAAP FINANCIAL MEASURE: ADJUSTED INCOME Adjusted income is an alternative measure of performance used by management to evaluate our overall performance in conjunction with other performance measures. As such, we believe that investors understanding of our performance is enhanced by disclosing this measure. We use Adjusted income, certain components of Adjusted income and Adjusted diluted EPS to present the results of our major operationsthe discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwideprior to considering certain income statement elements as follows: Measure Definition Relevance of Metrics to Our Business Performance Adjusted income Net income attributable to Pfizer Inc. common shareholders (a) before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items Provides investors useful information to: evaluate the normal recurring operational activities, and their components, on a comparable year-over-year basis assist in modeling expected future performance on a normalized basis Provides investors insight into the way we manage our budgeting and forecasting, how we evaluate and manage our recurring operations and how we reward and compensate our senior management (b) Adjusted cost of sales, Adjusted selling, informational and administrative expenses, Adjusted research and development expenses, Adjusted amortization of intangible assets and Adjusted other (income)/deductions net Cost of sales, Selling, informational and administrative expenses, Research and development expenses, Amortization of intangible assets an d Other (income)/deductionsnet (a) , each before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items, which are components of the Adjusted income measure Adjusted diluted EPS EPS attributable to Pfizer Inc. common shareholdersdiluted (a) before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items (a) Most directly comparable GAAP measure. (b) The short-term incentive plans for substantially all non-sales-force employees worldwide are funded from a pool based on our performance, measured in significant part by three metrics, one of which is Adjusted diluted EPS, which is derived from Adjusted income and accounts for 40% of the bonus pool funding tied to financial performance. Additionally, the payout for performance share awards is determined in part by Adjusted net income, which is derived from Adjusted income. The bonus pool funding, which is largely based on financial performance, may be modified by our RD performance as measured by four metrics relating to our pipeline and may be further modified by our Compensation Committees assessment of other factors. Adjusted income and its components and Adjusted diluted EPS are non-GAAP financial measures that have no standardized meaning prescribed by GAAP and, therefore, are limited in their usefulness to investors. Because of their non-standardized definitions, they may not be comparable to the calculation of similar measures of other companies and are presented to permit investors to more fully understand how management assesses performance. A limitation of these measures is that they provide a view of our operations without including all events during a period, and do not provide a comparable view of our performance to peers. These measures are not, and should not be viewed as, substitutes for their directly comparable GAAP measures of Net income attributable to Pfizer Inc. common shareholders , components of Net income attributable to Pfizer Inc. common shareholders and EPS attributable to Pfizer Inc. common shareholdersdiluted , respectively. See the accompanying reconciliations of certain GAAP reported to non-GAAP adjusted informationcertain line items for 2021, 2020 and 2019 below. We also recognize that, as internal measures of performance, these measures have limitations, and we do not restrict our performance-management process solely to these measures. We also use other tools designed to achieve the highest levels of performance. For example, our RD organization has productivity targets, upon which its effectiveness is measured. In addition, total shareholder return, both on an absolute basis and relative to a publicly traded pharmaceutical index, plays a significant role in determining payouts under certain of our incentive compensation plans. Pfizer Inc. 2021 Form 10-K Purchase Accounting Adjustments Adjusted income excludes certain significant purchase accounting impacts resulting from business combinations and net asset acquisitions. These impacts can include the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, and to a much lesser extent, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. Therefore, the Adjusted income measure includes the revenues earned upon the sale of the acquired products without considering the acquisition cost of those products. The exclusion of amortization attributable to acquired intangible assets provides management and investors an alternative view of our results by providing a degree of parity to internally developed intangible assets for which RD costs have been expensed. However, we have not factored in the impacts of any other differences that might have occurred if we had discovered and developed those intangible assets on our own, such as different RD costs, timelines or resulting sales; accordingly, this approach does not intend to be representative of the results that would have occurred if we had discovered and developed the acquired intangible assets internally. Acquisition-Related Items Adjusted income excludes acquisition-related items, which are comprised of transaction, integration, restructuring charges and additional depreciation costs for business combinations because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate businesses as a result of an acquisition. We have made no adjustments for resulting synergies. The significant costs incurred in connection with a business combination result primarily from the need to eliminate duplicate assets, activities or employeesa natural result of acquiring a fully integrated set of activities. For this reason, we believe that such costs incurred can be viewed differently in the context of an acquisition from those costs incurred in other, more normal, business contexts. The integration and restructuring costs for a business combination may occur over several years, with the more significant impacts typically ending within three years of the relevant transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. Discontinued Operations Adjusted income excludes the results of discontinued operations, as well as any related gains or losses on the disposal of such operations. We believe that this presentation is meaningful to investors because, while we review our therapeutic areas and product lines for strategic fit with our operations, we do not build or run our business with the intent to discontinue parts of our business. Restatements due to discontinued operations do not impact compensation or change the Adjusted income measure for the compensation in respect of the restated periods, but are presented for consistency across all periods. Certain Significant Items Adjusted income excludes certain significant items representing substantive and/or unusual items that are evaluated individually on a quantitative and qualitative basis. Certain significant items may be highly variable and difficult to predict. Furthermore, in some cases it is reasonably possible that they could reoccur in future periods. For example, although major non-acquisition-related cost-reduction programs are specific to an event or goal with a defined term, we may have subsequent programs based on reorganizations of the business, cost productivity or in response to LOE or economic conditions. Legal charges to resolve litigation are also related to specific cases, which are facts and circumstances specific and, in some cases, may also be the result of litigation matters at acquired companies that were inestimable, not probable or unresolved at the date of acquisition. Gains and losses on equity securities have a very high degree of inherent market volatility, which we do not control and cannot predict with any level of certainty and because we do not believe including these gains and losses assists investors in understanding our business or is reflective of our core operations and business. Unusual items represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis; items that would be non-recurring; or items that relate to products we no longer sell. See the Reconciliations of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items below for a non-inclusive list of certain significant items. Beginning in 2021, we exclude pension and postretirement actuarial remeasurement gains and losses from our measure of Adjusted income because of their inherent market volatility, which we do not control and cannot predict with any level of certainty and because we do not believe including these gains and losses assists investors in understanding our business or is reflective of our core operations and business. Pfizer Inc. 2021 Form 10-K Reconciliations of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items 2021 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 30,821 $ 12,703 $ 13,829 $ 3,700 $ (4,878) $ 21,979 $ 3.85 Purchase accounting adjustments (b) 25 (3) 6 (3,088) (114) 3,175 Acquisition-related items 52 Discontinued operations (c) 585 Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (108) (450) (1) 1,309 Certain asset impairments (e) (86) 86 Upfront and milestone payments on collaborative and licensing arrangements (f) (1,056) 1,056 (Gains)/losses on equity securities (g) 1,338 (1,338) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) 1,601 (1,601) Asset acquisitions of IPRD (h) (2,240) 2,240 Other (52) (141) (15) (334) (i) 542 Income tax provisionNon-GAAP items (2,848) Non-GAAP adjusted $ 30,685 $ 12,110 $ 10,523 $ 613 $ (2,473) $ 25,236 $ 4.42 2020 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 8,484 $ 11,597 $ 9,393 $ 3,348 $ 1,219 $ 9,159 $ 1.63 Purchase accounting adjustments (b) 18 (2) 5 (3,064) (75) 3,117 Acquisition-related items 44 Discontinued operations (c) (2,879) Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (61) (197) 2 791 Certain asset impairments (e) (1,691) 1,691 Upfront and milestone payments on collaborative and licensing arrangements (f) (454) 454 (Gains)/losses on equity securities (g) 557 (557) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) (1,092) 1,092 Asset acquisitions of IPRD (h) (50) 50 Other (56) (292) (j) (24) (697) (i) 1,063 Income tax provisionNon-GAAP items (1,299) Non-GAAP adjusted $ 8,386 $ 11,106 $ 8,872 $ 284 $ (1,779) $ 12,727 $ 2.26 Pfizer Inc. 2021 Form 10-K 2019 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 8,054 $ 12,726 $ 8,385 $ 4,429 $ 3,497 $ 16,026 $ 2.82 Purchase accounting adjustments (b) 19 2 4 (4,158) (21) 4,153 Acquisition-related items (2) 185 Discontinued operations (c) (6,056) Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (89) (73) (30) 611 Certain asset impairments (e) (2,757) 2,757 Upfront and milestone payments on collaborative and licensing arrangements (f) (279) 279 (Gains)/losses on equity securities (g) 415 (415) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) (750) 750 (Gain) on completion of Consumer Healthcare JV transaction (8,107) Asset acquisitions of IPRD (h) (337) 337 Other (118) (190) (18) (1,007) (i) 1,333 Income tax provisionNon-GAAP items (797) Non-GAAP adjusted $ 7,865 $ 12,463 $ 7,726 $ 271 $ (623) $ 11,056 $ 1.95 (a) Items that reconcile GAAP Reported to Non-GAAP Adjusted balances are shown pre-tax and include discontinued operations. Our effective tax rates for GAAP reported income from continuing operations were: 7.6% in 2021, 5.3% in 2020 and 5.2% in 2019. See Note 5 . Our effective tax rates on Non-GAAP adjusted income were: 15.3% in 2021, 13.7% in 2020 and 16.0% in 2019. (b) Purchase accounting adjustments include items such as the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. For all years presented, primarily consists of amortization of intangible assets. (c) Relates primarily to the spin-off of our Upjohn Business, and our sale of Meridian. See Note 2B. (d) Includes employee termination costs, asset impairments and other exit costs related to our cost-reduction and productivity initiatives not associated with acquisitions. See Note 3. (e) Primarily includes intangible asset impairment charges. For 2020, $900 million is related to IPRD assets acquired from Array and $528 million is related to Eucrisa. For 2019, $2.6 billion is related to Eucrisa. See Note 4 . (f) Primarily includes the following charges: (i) for 2021, an upfront payment to Arvinas and a premium paid on our equity investment in Arvinas totaling $706 million, a $300 million upfront payment to Beam and a $50 million net upfront payment to BioNTech; (ii) for 2020, a payment of $151 million representing the expense portion of an upfront payment to Myovant, an upfront payment to Valneva of $130 million, an upfront payment to BioNTech and a premium paid on our equity investment in BioNTech totaling $98 million, as well as a $75 million milestone payment to Akcea; and (iii) for 2019, an upfront license fee payment of $250 million to Akcea. (g) (Gains)/losses on equity securities, and actuarial valuation and other pension and postretirement plan (gains)/losses are removed from adjusted earnings due to their inherent market volatility. (h) Primarily includes payments for acquired IPRD. For 2021, includes a $2.1 billion charge related to our acquisition of Trillium, which was accounted for as an asset acquisition, and a $177 million charge related to an asset acquisition completed in the second quarter of 2021. For 2019, included a $337 million charge related to our acquisition of Therachon, which was accounted for as an asset acquisition. (i) For 2021, the total of $334 million primarily includes: (i) charges representing our equity-method accounting pro rata share of restructuring charges and costs of preparing for separation from GSK of $185 million recorded by the Consumer Healthcare JV and (ii) charges for certain legal matters of $162 million. For 2020, the total of $697 million primarily included: (i) charges of $367 million, which represent our equity-method accounting pro rata share of transaction-specific restructuring and business combination accounting charges recorded by the Consumer Healthcare JV, and (ii) losses on asset disposals of $238 million. For 2019, the total of $1.0 billion primarily included: (i) $300 million of business and legal entity alignment costs for consulting, legal, tax and advisory services associated with the design, planning and implementation of our then new business structure, effective in the beginning of 2019, (ii) charges for certain legal matters of $291 million, (iii) charges of $152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity associated with the formation of the Consumer Healthcare JV, (iv) net losses on early retirement of debt of $138 million and (v) charges of $112 million representing our equity-method accounting pro rata share of restructuring and business combination accounting charges recorded by the Consumer Healthcare JV. (j) For 2020, amounts in Selling, informational and administrative expenses of $292 million primarily include costs for consulting, legal, tax and advisory services associated with a non-recurring internal reorganization of legal entities. Pfizer Inc. 2021 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF CASH FLOWS Cash Flows from Continuing Operations Year Ended December 31, (MILLIONS) 2021 2020 2019 Drivers of change Cash provided by/(used in): Operating activities from continuing operations $ 32,922 $ 10,540 $ 7,015 2021 v. 2020 The change was driven primarily by higher net income adjusted for non-cash items, the payment for the acquisition of Trillium, a decrease in contributions to pension plans, and the impact of timing of receipts and payments in the ordinary course of business, mostly from an increase in cash flows from Other current liabilities driven by: (i) a $9.7 billion accrual for the gross profit split due to BioNTech, (ii) an increase in royalties payable, as well as (iii) an increase in deferred revenues for advance payments in 2021 for Comirnaty. The change in Other Adjustments, net , is mostly due to an increase in unrealized gains on equity securities. 2020 v. 2019 The change was driven mainly by higher net income adjusted for non-cash items, advanced payments in 2020 for Comirnaty recorded in deferred revenue, the upfront cash payment associated with our acquisition of Therachon in 2019, and the upfront cash payment associated with our licensing agreement with Akcea in 2019, partially offset by an increase in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net was driven primarily by an increase in equity method dividends received, partially offset by an increase in equity income and increases in net unrealized gains on equity securities. Investing activities from continuing operations $ (22,534) $ (4,162) $ (3,825) 2021 v. 2020 The change was driven mainly by a $24.7 billion increase in purchases of short-term investments with original maturities of greater than three months and a $9.0 billion increase in net purchases of short-term investments with original maturities of three months or less, partially offset by a $16.4 billion increase in redemptions of short-term investments with original maturities of greater than three months. 2020 v. 2019 The change was driven mostly by a $6.0 billion decrease in net proceeds from short-term investments with original maturities of three months or less and $2.7 billion in net purchases of short-term investments with original maturities of greater than three months in 2020 (compared to $2.3 billion net proceeds from short-term investments with original maturities of greater than three months in 2019), partially offset by the cash used to acquire Array, net of cash acquired, of $10.9 billion in 2019. Financing activities from continuing operations $ (9,816) $ (21,640) $ (8,485) 2021 v. 2020 The change was driven mostly by a $9.8 billion net reduction in repayments of short-term borrowings with maturities of greater than three months, a $4.0 billion decrease in net payments on short-term borrowings with maturities of three months or less and a $2.0 billion reduction in repayments of long-term debt, partially offset by a $4.2 billion decrease in proceeds from issuances of long-term debt. 2020 v. 2019 The change was driven mostly by $14.0 billion net payments of short-term borrowings in 2020 (compared to $10.6 billion net proceeds raised from short-term borrowings in 2019) and an increase in cash dividends paid of $397 million, partially offset by a decrease in purchases of common stock of $8.9 billion, lower repayments on long-term debt of $2.8 billion, and an increase in issuances of long-term debt of $280 million. Cash Flows from Discontinued Operations Cash flows from discontinued operations primarily relate to our former Meridian subsidiary, Upjohn Business and the Mylan-Japan collaboration (see Note 2B ). In 2020, net cash provided by financing activities from discontinued operations primarily reflects issuances of long-term debt . ANALYSIS OF FINANCIAL CONDITION, LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK Due to our significant operating cash flows, which is a key strength of our liquidity and capital resources and our primary funding source, as well as our financial assets, access to capital markets, revolving credit agreements, and available lines of credit, we believe that we have, and will maintain, the ability to meet our liquidity needs to support ongoing operations, our capital allocation objectives, and our contractual and other obligations for the foreseeable future. Pfizer Inc. 2021 Form 10-K We focus efforts to optimize operating cash flows through achieving working capital efficiencies that target accounts receivable, inventories, accounts payable, and other working capital. Excess cash from operating cash flows is invested in money market funds and available-for-sale debt securities which consist of primarily high-quality, highly liquid, well-diversified debt securities. We have taken, and will continue to take, a conservative approach to our financial investments and monitoring of our liquidity position in response to market changes. We typically maintain cash and cash equivalent balances and short-term investments which, together with our available revolving credit facilities, are in excess of our commercial paper and other short-term borrowings. Additionally, we may obtain funding through short-term or long-term sources from our access to the capital markets, banking relationships and relationships with other financial intermediaries to meet our liquidity needs. Diverse sources of funds: Related disclosure presented in this Form 10-K Internal sources: Operating cash flows Consolidated Statements of Cash Flows Operating Activities and the Analysis of the Consolidated Statements of Cash Flows within MDA Cash and cash equivalents Consolidated Balance Sheets Money market funds Note 7A Available-for-sale debt securities Note 7A, 7B External sources: Short-term funding: Commercial paper Note 7C Revolving credit facilities Note 7C Lines of credit Note 7C Long-term funding: Long-term debt Note 7D Equity Consolidated Statements of Equity and Note 12 For additional information about the sources and uses of our funds and capital resources for the years ended December 31, 2021 and 2020, see the Analysis of the Consolidated Statements of Cash Flows in this MDA. In August 2021, we completed a public offering of $1 billion aggregate principal amount of senior unsecured sustainability notes. We are using the net proceeds to finance or refinance, in whole or in part as follows: RD expenses related to our COVID-19 vaccines, capital expenditures in connection with the manufacture and distribution of COVID-19 vaccines and our other projects that have environmental and/or social benefits. For additional information, see Note 7D . Credit Ratings The cost and availability of financing are influenced by credit ratings, and increases or decreases in our credit rating could have a beneficial or adverse effect on financing. Our long-term debt is rated high-quality by both SP and Moodys. In November 2020, upon the completion of the Upjohn separation, both Moodys and SP lowered our long-term debt rating one notch to A2 and A+, respectively, and our short-term rating remained unchanged. SP continues to rate our long-term debt rating outlook as Stable since November 2020, while Moodys recently upgraded our long-term debt rating outlook to Positive in December 2021. The current ratings assigned to our commercial paper and senior unsecured long-term debt: NAME OF RATING AGENCY Pfizer Short-Term Rating Pfizer Long-Term Rating Outlook/Watch Moodys P-1 A2 Positive SP A-1+ A+ Stable A security rating is not a recommendation to buy, sell or hold securities and the rating is subject to revision or withdrawal at any time by the rating organization. Each rating should be evaluated independently of any other rating. Capital Allocation Framework Our capital allocation framework is devised to facilitate (i) the achievement of medical breakthroughs through RD investments and business development activities and (ii) returning capital to shareholders through dividends and share repurchases. See the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business and Strategy section of this MDA. Our current and projected dividends provide a return to shareholders while maintaining sufficient capital to invest in growing our business. Our dividends are not restricted by debt covenants. While the dividend level remains a decision of Pfizers BOD and will continue to be evaluated in the context of future business performance, we currently believe that we can support future annual dividend increases, barring significant unforeseen events. In December 2021, our BOD declared a first-quarter dividend of $0.40 per share, payable on March 4, 2022, to shareholders of record at the close of business on January 28, 2022. The first-quarter 2022 cash dividend will be our 333rd consecutive quarterly dividend. See Note 12 for information on the shares of our common stock purchased and the cost of purchases under our publicly announced share-purchase plans, including our accelerated share repurchase agreements. At December 31, 2021, our remaining share-purchase authorization was approximately $5.3 billion. Off-Balance Sheet Arrangements, Contractual, and Other Obligations In the ordinary course of business, (i) we enter into off-balance sheet arrangements that may result in contractual and other obligations and (ii) in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that Pfizer Inc. 2021 Form 10-K may arise in connection with the transaction or that are related to events and activities. For more information on guarantees and indemnifications, see Note 16B . Additionally, certain of our co-promotion or license agreements give our licensors or partners the rights to negotiate for, or in some cases to obtain under certain financial conditions, co-promotion or other rights in specified countries with respect to certain of our products. Furthermore, collaboration, licensing or other RD arrangements may give rise to potential milestone payments. Payments under these agreements generally become due and payable only upon the achievement of certain development, regulatory and/or commercialization milestones, which may span several years and which may never occur. Our significant contractual and other obligations as of December 31, 2021 consisted of: Long-term debt, including current portion (see Note 7 ) and related interest payments; Estimated cash payments related to the TCJA repatriation estimated tax liability (see Note 5 ). Estimated future payments related to the TCJA repatriation tax liability that will occur after December 31, 2021 total $8.3 billion, of which an estimated $750 million is to be paid in the next twelve months and an estimated $7.6 billion is to be paid in periods thereafter; Certain commitments totaling $5.2 billion, of which an estimated $1.5 billion is to be paid in the next twelve months, and $3.7 billion in periods thereafter ( see Note 16C ); Purchases of property plant and equipment ( see Note 9 ). In 2022, we expect to spend approximately $3.3 billion on property, plant and equipment; and Future minimum rental commitments under non-cancelable operating leases (see Note 15 ). Gl o bal Economic Conditions Our Venezuela and Argentina operations function in hyperinflationary economies. The impact to Pfizer is not considered material. For additional information on the global economic environment, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. Market Risk We are subject to foreign exchange risk, interest rate risk, and equity price risk. The objective of our financial risk management program is to minimize the impact of foreign exchange rate and interest rate movements on our earnings. We address such exposures through a combination of operational means and financial instruments. For more information on how we manage our foreign exchange and interest rate risks, see Notes 1G and 7E , as well as the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K for key currencies in which we operate. Our sensitivity analyses of such risks are discussed below. Foreign Exchange Risk The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2021, the expected adverse impact on our net income would not be significant. Interest Rate Risk The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point decrease in interest rates as of December 31, 2021, the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. LIBOR For information on interest rate risk and LIBOR, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. We do not expect the transition to an alternative rate to have a material impact on our liquidity or financial resources. Pfizer Inc. 2021 Form 10-K NEW ACCOUNTING STANDARDS Recently Adopted Accounting Standard See Note 1B. Recently Issued Accounting Standards, Not Adopted as of December 31, 2021 Standard/Description Effective Date Effect on the Financial Statements Reference rate reform provides temporary optional expedients and exceptions to the guidance for contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued after 2021 because of reference rate reform. The new guidance provides the following optional expedients: 1. Simplify accounting analyses under current U.S. GAAP for contract modifications. 2. Simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. 3. Allow a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform. Elections can be adopted prospectively at any time through December 31, 2022. We are assessing the impact, but currently, we do not expect this new guidance to have a material impact on our consolidated financial statements. Accounting for contract assets and contract liabilities from contracts with customers requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606. This new guidance will generally result in the acquirer recognizing contract assets and contract liabilities at the same amounts that were recorded by the acquiree. Previously, these amounts were recognized by the acquirer at fair value as of the acquisition date. January 1, 2023. Early adoption is permitted. We do not expect this new guidance to have a material impact on our consolidated financial statements. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Pfizer Inc. 2021 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2022 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1C to the consolidated financial statements, the Company has elected to change its method of accounting for pension and postretirement plans in 2021 to immediately recognize actuarial gains and losses in the consolidated statements of income. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed in Note 1H to the consolidated financial statements, the Company records estimated deductions for Medicare, Medicaid, and performance-based contract rebates (collectively, U.S. rebates) as a reduction to gross product revenues. The accrual for U.S. rebates is recorded in the same period that the corresponding revenues are recognized. The length of time between when a sale is made and when the U.S. rebate is paid by the Company can be as long as one year, which increases the need for significant management judgment and knowledge of market conditions and practices in estimating the accrual. We identified the evaluation of the U.S. rebates accrual as a critical audit matter because the evaluation of the product-specific experience ratio assumption involved especially challenging auditor judgment. The product-specific experience ratio assumption relates to estimating which of the Companys revenue transactions will ultimately be subject to a related rebate. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys U.S. rebates accrual process related to the development of the product-specific experience ratio assumptions. We estimated the U.S. rebates accrual using internal information and historical data and compared the result to the Companys estimated U.S. rebates accrual. We evaluated the Companys ability to accurately estimate the accrual for U.S. rebates by comparing historically recorded accruals to the actual amount that was ultimately paid by the Company. Evaluation of gross unrecognized tax benefits As discussed in Notes 5D and 1 Q , the Companys tax positions are subject to audit by local taxing authorities in each respective tax jurisdiction, and the resolution of such audits may span multiple years. Since tax law is complex and often subject to varied interpretations and judgments, it is uncertain whether some of the Companys tax positions will be sustained upon audit. As of December 31, 2021, the Company has recorded gross unrecognized tax benefits, excluding associated interest, of $6.1 billion. Pfizer Inc. 2021 Form 10-K Report of Independent Registered Public Accounting Firm We identified the evaluation of the Companys gross unrecognized tax benefits as a critical audit matter because a high degree of audit effort, including specialized skills and knowledge, and complex auditor judgment was required in evaluating the Companys interpretation of tax law and its estimate of the ultimate resolution of its tax positions. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Companys liability for unrecognized tax position process related to (1) interpretation of tax law, (2) evaluation of which of the Companys tax positions may not be sustained upon audit, and (3) estimation and recording of the gross unrecognized tax benefits. We involved tax and valuation professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation of tax laws, including the assessment of transfer pricing practices in accordance with applicable tax laws and regulations. We inspected settlements with applicable taxing authorities, including assessing the expiration of statutes of limitations. We tested the calculation of the liability for uncertain tax positions, including an evaluation of the Companys assessment of the technical merits of tax positions and estimates of the amount of tax benefits expected to be sustained. Evaluation of product and other product-related litigation As discussed in Notes 1S and 16 to the consolidated financial statements, the Company is involved in product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others. Certain of these pending product and other product-related legal proceedings could result in losses that could be substantial. The accrued liability and/or disclosure for the pending product and other product-related legal proceedings requires a complex series of judgments by the Company about future events, which involves a number of uncertainties. We identified the evaluation of product and other product-related litigation as a critical audit matter. Challenging auditor judgment was required to evaluate the Companys judgments about future events and uncertainties. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys product liability and other product-related litigation processes, including controls related to (1) the evaluation of information from external and internal legal counsel, (2) forward-looking expectations, and (3) new legal proceedings, or other legal proceedings not currently reserved or disclosed. We read letters received directly from the Companys external and internal legal counsel that described the Companys probable or reasonably possible legal contingency to pending product and other product-related legal proceedings. We inspected the Companys minutes from meetings of the Audit Committee, which included the status of key litigation matters. We evaluated the Companys ability to estimate its monetary exposure to pending product and other product-related legal proceedings by comparing historically recorded liabilities to actual monetary amounts incurred upon resolution of prior legal matters. We analyzed relevant publicly available information about the Company, its competitors, and the industry. We have not been able to determine the specific year that we or our predecessor firms began serving as the Companys auditor, however, we are aware that we or our predecessor firms have served as the Companys auditor since at least 1942. New York, New York February 24, 2022 Pfizer Inc. 2021 Form 10-K Consolidated Statements of Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2021 2020 2019 Revenues $ 81,288 $ 41,651 $ 40,905 Costs and expenses: Cost of sales (a) 30,821 8,484 8,054 Selling, informational and administrative expenses (a) 12,703 11,597 12,726 Research and development expenses (a) 13,829 9,393 8,385 Amortization of intangible assets 3,700 3,348 4,429 Restructuring charges and certain acquisition-related costs 802 579 601 (Gain) on completion of Consumer Healthcare JV transaction ( 6 ) ( 8,107 ) Other (income)/deductionsnet ( 4,878 ) 1,219 3,497 Income from continuing operations before provision/(benefit) for taxes on income 24,311 7,036 11,321 Provision/(benefit) for taxes on income 1,852 370 583 Income from continuing operations 22,459 6,666 10,738 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income before allocation to noncontrolling interests 22,025 9,195 16,056 Less: Net income attributable to noncontrolling interests 45 36 29 Net income attributable to Pfizer Inc. common shareholders $ 21,979 $ 9,159 $ 16,026 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 4.00 $ 1.19 $ 1.92 Discontinued operationsnet of tax ( 0.08 ) 0.46 0.95 Net income attributable to Pfizer Inc. common shareholders $ 3.92 $ 1.65 $ 2.88 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.93 $ 1.18 $ 1.89 Discontinued operationsnet of tax ( 0.08 ) 0.45 0.94 Net income attributable to Pfizer Inc. common shareholders $ 3.85 $ 1.63 $ 2.82 Weighted-average sharesbasic 5,601 5,555 5,569 Weighted-average sharesdiluted 5,708 5,632 5,675 (a) Exclusive of amortization of intangible assets, except as disclosed in Note 1M. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Comprehensive Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2021 2020 2019 Net income before allocation to noncontrolling interests $ 22,025 $ 9,195 $ 16,056 Foreign currency translation adjustments, net ( 682 ) 772 675 Reclassification adjustments ( 17 ) ( 288 ) ( 682 ) 755 387 Unrealized holding gains/(losses) on derivative financial instruments, net 526 ( 582 ) 476 Reclassification adjustments for (gains)/losses included in net income (a) 134 21 ( 664 ) 660 ( 561 ) ( 188 ) Unrealized holding gains/(losses) on available-for-sale securities, net ( 355 ) 361 ( 1 ) Reclassification adjustments for (gains)/losses included in net income (b) ( 30 ) ( 188 ) 39 ( 384 ) 173 38 Benefit plans: prior service (costs)/credits and other, net 116 52 ( 7 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 154 ) ( 176 ) ( 181 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 74 ) ( 2 ) Other ( 2 ) 1 ( 113 ) ( 124 ) ( 189 ) Other comprehensive income/(loss), before tax ( 519 ) 243 48 Tax provision/(benefit) on other comprehensive income/(loss) 71 ( 227 ) 178 Other comprehensive income/(loss) before allocation to noncontrolling interests $ ( 589 ) $ 471 $ ( 130 ) Comprehensive income/(loss) before allocation to noncontrolling interests $ 21,435 $ 9,666 $ 15,926 Less: Comprehensive income/(loss) attributable to noncontrolling interests 43 27 18 Comprehensive income/(loss) attributable to Pfizer Inc. $ 21,393 $ 9,639 $ 15,908 (a) Reclassified into Other (income)/deductionsnet and Cost of sales . See Note 7E. (b) Reclassified into Other (income)/deductionsnet . See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Balance Sheets Pfizer Inc. and Subsidiary Companies As of December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2021 2020 Assets Cash and cash equivalents $ 1,944 $ 1,786 Short-term investments 29,125 10,437 Trade accounts receivable, less allowance for doubtful accounts: 2021$ 492 ; 2020$ 508 11,479 7,913 Inventories 9,059 8,020 Current tax assets 4,266 3,264 Other current assets 3,820 3,646 Total current assets 59,693 35,067 Equity-method investments 16,472 16,856 Long-term investments 5,054 3,406 Property, plant and equipment 14,882 13,745 Identifiable intangible assets 25,146 28,337 Goodwill 49,208 49,556 Noncurrent deferred tax assets and other noncurrent tax assets 3,341 2,383 Other noncurrent assets 7,679 4,879 Total assets $ 181,476 $ 154,229 Liabilities and Equity Short-term borrowings, including current portion of long-term debt: 2021$ 1,636 ; 2020$ 2,002 $ 2,241 $ 2,703 Trade accounts payable 5,578 4,283 Dividends payable 2,249 2,162 Income taxes payable 1,266 1,049 Accrued compensation and related items 3,332 3,049 Deferred revenues 3,067 1,113 Other current liabilities 24,939 11,561 Total current liabilities 42,671 25,920 Long-term debt 36,195 37,133 Pension benefit obligations 3,489 4,766 Postretirement benefit obligations 235 645 Noncurrent deferred tax liabilities 349 4,063 Other taxes payable 11,331 11,560 Other noncurrent liabilities 9,743 6,669 Total liabilities 104,013 90,756 Commitments and Contingencies Preferred stock, no par value, at stated value; 27 shares authorized; no shares issued or outstanding at December 31, 2021 and December 31, 2020 Common stock, $ 0.05 par value; 12,000 shares authorized; issued: 2021 9,471 ; 2020 9,407 473 470 Additional paid-in capital 90,591 88,674 Treasury stock, shares at cost: 2021 3,851 ; 2020 3,840 ( 111,361 ) ( 110,988 ) Retained earnings 103,394 90,392 Accumulated other comprehensive loss ( 5,897 ) ( 5,310 ) Total Pfizer Inc. shareholders equity 77,201 63,238 Equity attributable to noncontrolling interests 262 235 Total equity 77,462 63,473 Total liabilities and equity $ 181,476 $ 154,229 See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Equity Pfizer Inc. and Subsidiary Companies PFIZER INC. SHAREHOLDERS Preferred Stock Common Stock Treasury Stock (MILLIONS, EXCEPT PREFERRED SHARES) Shares Stated Value Shares Par Value Addl Paid-In Capital Shares Cost Retained Earnings Accum. Other Comp. Loss Share - holders Equity Non-controlling Interests Total Equity Balance, January 1, 2019 478 $ 19 9,332 $ 467 $ 86,253 ( 3,615 ) $ ( 101,610 ) $ 83,527 $ ( 5,249 ) $ 63,407 $ 351 $ 63,758 Net income 16,026 16,026 29 16,056 Other comprehensive income/(loss), net of tax ( 118 ) ( 118 ) ( 11 ) ( 130 ) Cash dividends declared, per share: $ 1.46 Common stock ( 8,174 ) ( 8,174 ) ( 8,174 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 6 ) ( 6 ) Share-based payment transactions 37 2 1,219 ( 8 ) ( 326 ) 894 894 Purchases of common stock ( 213 ) ( 8,865 ) ( 8,865 ) ( 8,865 ) Preferred stock conversions and redemptions ( 47 ) ( 2 ) ( 3 ) 1 ( 4 ) ( 4 ) Other ( 40 ) 19 ( 21 ) ( 60 ) ( 81 ) Balance, December 31, 2019 431 17 9,369 468 87,428 ( 3,835 ) ( 110,801 ) 91,397 ( 5,367 ) 63,143 303 63,447 Net income 9,159 9,159 36 9,195 Other comprehensive income/(loss), net of tax 480 480 ( 9 ) 471 Cash dividends declared, per share: $ 1.53 Common stock ( 8,571 ) ( 8,571 ) ( 8,571 ) Preferred stock Noncontrolling interests ( 91 ) ( 91 ) Share-based payment transactions 37 2 1,261 ( 6 ) ( 218 ) 1,044 1,044 Preferred stock conversions and redemptions (a) ( 431 ) ( 17 ) ( 15 ) 1 31 ( 1 ) ( 1 ) Distribution of Upjohn Business (b) ( 1,592 ) ( 423 ) ( 2,015 ) ( 3 ) ( 2,018 ) Other ( 1 ) ( 1 ) Balance, December 31, 2020 9,407 470 88,674 ( 3,840 ) ( 110,988 ) 90,392 ( 5,310 ) 63,238 235 63,473 Net income 21,979 21,979 45 22,025 Other comprehensive income/(loss), net of tax ( 587 ) ( 587 ) ( 3 ) ( 589 ) Cash dividends declared, per share: $ 1.57 Common stock ( 8,816 ) ( 8,816 ) ( 8,816 ) Preferred stock Noncontrolling interests ( 8 ) ( 8 ) Share-based payment transactions 64 3 1,917 ( 11 ) ( 373 ) ( 77 ) 1,470 1,470 Other ( 85 ) ( 85 ) ( 7 ) ( 92 ) Balance, December 31, 2021 $ 9,471 $ 473 $ 90,591 ( 3,851 ) $ ( 111,361 ) $ 103,394 $ ( 5,897 ) $ 77,201 $ 262 $ 77,462 (a) See Note 12 . (b) See Note 2B. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2021 2020 2019 Operating Activities Net income before allocation to noncontrolling interests $ 22,025 $ 9,195 $ 16,056 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income from continuing operations before allocation to noncontrolling interests 22,459 6,666 10,738 Adjustments to reconcile net income before allocation to noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 5,191 4,681 5,755 Asset write-offs and impairments 276 2,049 2,889 TCJA impact ( 323 ) Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed (a) ( 6 ) ( 8,254 ) Deferred taxes from continuing operations ( 4,293 ) ( 1,575 ) 561 Share-based compensation expense 1,182 755 687 Benefit plan contributions in excess of expense/income ( 3,123 ) ( 1,242 ) ( 55 ) Other adjustments, net ( 1,573 ) ( 479 ) ( 1,080 ) Other changes in assets and liabilities, net of acquisitions and divestitures: Trade accounts receivable ( 3,811 ) ( 1,275 ) ( 1,124 ) Inventories ( 1,125 ) ( 778 ) ( 1,071 ) Other assets ( 1,057 ) ( 137 ) 847 Trade accounts payable 1,242 355 ( 341 ) Other liabilities 18,721 2,768 861 Other tax accounts, net ( 1,166 ) ( 1,240 ) ( 3,074 ) Net cash provided by operating activities from continuing operations 32,922 10,540 7,015 Net cash provided by/(used in) operating activities from discontinued operations ( 343 ) 3,863 5,572 Net cash provided by operating activities 32,580 14,403 12,588 Investing Activities Purchases of property, plant and equipment ( 2,711 ) ( 2,226 ) ( 2,046 ) Purchases of short-term investments ( 38,457 ) ( 13,805 ) ( 6,835 ) Proceeds from redemptions/sales of short-term investments 27,447 11,087 9,183 Net (purchases of)/proceeds from redemptions/sales of short-term investments with original maturities of three months or less ( 8,088 ) 920 6,925 Purchases of long-term investments ( 1,068 ) ( 597 ) ( 201 ) Proceeds from redemptions/sales of long-term investments 649 723 232 Acquisitions of businesses, net of cash acquired ( 10,861 ) Other investing activities, net (a) ( 305 ) ( 265 ) ( 223 ) Net cash provided by/(used in) investing activities from continuing operations ( 22,534 ) ( 4,162 ) ( 3,825 ) Net cash provided by/(used in) investing activities from discontinued operations ( 12 ) ( 109 ) ( 120 ) Net cash provided by/(used in) investing activities ( 22,546 ) ( 4,271 ) ( 3,945 ) Financing Activities Proceeds from short-term borrowings 12,352 16,455 Principal payments on short-term borrowings ( 22,197 ) ( 8,378 ) Net (payments on)/proceeds from short-term borrowings with original maturities of three months or less ( 96 ) ( 4,129 ) 2,551 Proceeds from issuance of long-term debt 997 5,222 4,942 Principal payments on long-term debt ( 2,004 ) ( 4,003 ) ( 6,806 ) Purchases of common stock ( 8,865 ) Cash dividends paid ( 8,729 ) ( 8,440 ) ( 8,043 ) Other financing activities, net 16 ( 444 ) ( 342 ) Net cash provided by/(used in) financing activities from continuing operations ( 9,816 ) ( 21,640 ) ( 8,485 ) Net cash provided by/(used in) financing activities from discontinued operations 11,991 Net cash provided by/(used in) financing activities ( 9,816 ) ( 9,649 ) ( 8,485 ) Effect of exchange-rate changes on cash and cash equivalents and restricted cash and cash equivalents ( 59 ) ( 8 ) ( 32 ) Net increase/(decrease) in cash and cash equivalents and restricted cash and cash equivalents 159 475 125 Cash and cash equivalents and restricted cash and cash equivalents, at beginning of period 1,825 1,350 1,225 Cash and cash equivalents and restricted cash and cash equivalents, at end of period $ 1,983 $ 1,825 $ 1,350 - Continued - Pfizer Inc. 2021 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, 2021 2020 2019 Supplemental Cash Flow Information Cash paid/(received) during the period for: Income taxes $ 7,427 $ 3,153 $ 3,664 Interest paid 1,467 1,641 1,587 Interest rate hedges ( 2 ) ( 20 ) ( 42 ) Non-cash transactions: Right-of-use assets obtained in exchange for lease liabilities $ 1,943 $ 410 $ 314 32 % equity-method investment in the Consumer Healthcare JV received in exchange for contributing Pfizers Consumer Healthcare business (a) 15,711 (a) The $ 8.3 billion Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed reflects the receipt of a 32 % equity-method investment in the new company initially valued at $ 15.7 billion in exchange for net assets contributed of $ 7.6 billion and is presented in operating activities net of $ 146 million cash conveyed that is reflected in Other investing activities, net . See Note 2C. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 1. Basis of Presentation and Significant Accounting Policies A. Basis of Presentation The consolidated financial statements include the accounts of our parent company and all subsidiaries and are prepared in accordance with U.S. GAAP. The decision of whether or not to consolidate an entity for financial reporting purposes requires consideration of majority voting interests, as well as effective economic or other control over the entity. Typically, we do not seek control by means other than voting interests. For subsidiaries operating outside the U.S., the financial information is included as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. Substantially all unremitted earnings of international subsidiaries are free of legal and contractual restrictions. All significant transactions among our subsidiaries have been eliminated. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. See Note 17 . On December 31, 2021, we completed the sale of our Meridian subsidiary, the manufacturer of EpiPen and other auto-injector products. Prior to its sale, Meridian was managed within the Hospital therapeutic area. Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. On December 21, 2020, Pfizer and Viatris completed the termination of a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (the Mylan-Japan collaboration) pursuant to an agreement dated November 13, 2020, and we transferred related inventories and operations that were part of the Mylan-Japan collaboration to Viatris. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. The assets and liabilities associated with Meridian and the Mylan-Japan collaboration are classified as assets and liabilities of discontinued operations as of December 31, 2020. Upon completion of the spin-off of the Upjohn Business on November 16, 2020, the Upjohn assets and liabilities were derecognized from our consolidated balance sheet and are reflected in Retained Earnings Distribution of Upjohn Business in the consolidated statement of equity. Prior to the spin-off of the Upjohn Business in November 2020, the Upjohn Business, the Mylan-Japan collaboration and Meridian were managed as part of our former Upjohn operating segment. With the separation of the Upjohn Business, the Mylan-Japan collaboration and Meridian, as well as the formation of the Consumer Healthcare JV in 2019, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines. Certain prior year amounts have been reclassified to conform with the current year presentation. In addition, other acquisitions and business development activities completed in 2021, 2020 and 2019 impacted financial results in the periods presented. See Note 2. Certain amounts in the consolidated financial statements and associated notes may not add due to rounding. All percentages have been calculated using unrounded amounts. B . New Accounting Standard Adopted in 2021 On January 1, 2021, we adopted a new accounting standard for income tax that eliminates certain exceptions to the guidance related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The adoption of this guidance did not have a material impact on our consolidated financial statements. C. Change in Accounting Principle In the first quarter of 2021, we adopted a change in accounting principle to a more preferable policy under U.S. GAAP to immediately recognize actuarial gains and losses arising from the remeasurement of our pension and postretirement plans (MTM Accounting). Under the prior policy, we deferred recognition of these gains and losses in Accumulated other comprehensive loss . The accumulated actuarial gains/losses outside of a corridor were then amortized into net periodic benefit costs over the average remaining service period or the average life expectancy of participants. This change has been applied to all pension and postretirement plans on a retrospective basis for all prior periods presented, and as of January 1, 2019, resulted in a cumulative effect decrease to Retained earnings of $ 6.0 billion, with a corresponding offset to Accumulated other comprehensive loss . Each time a pension or postretirement plan is remeasured, the actuarial gain or loss is recognized immediately and classified as Other (income)/deductionsnet . We believe that MTM Accounting is a more preferable policy as it provides improved transparency of results and performance, better alignment with fair value accounting principles and a better reflection of current economic and interest rate trends on plan investments and assumptions and the actuarial impact of plan remeasurements. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The impacts of the adjustments on our consolidated financial statements are summarized as follows: Year Ended December 31, 2021 2020 2019 (MILLIONS, EXCEPT PER COMMON SHARE DATA) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Previous Accounting Principle Impact of Change As Adjusted Consolidated Statements of Income: (Gain) on completion of Consumer Healthcare JV transaction $ $ $ $ ( 6 ) $ $ ( 6 ) $ ( 8,086 ) $ ( 21 ) $ ( 8,107 ) Other (income)/deductionsnet ( 2,820 ) ( 2,058 ) ( 4,878 ) 672 547 1,219 3,264 233 3,497 Income from continuing operations before provision/(benefit) for taxes on income 22,253 2,058 24,311 7,584 ( 547 ) 7,036 11,533 ( 212 ) 11,321 Provision/(benefit) for taxes on income 1,399 453 1,852 496 ( 125 ) 370 631 ( 48 ) 583 Discontinued operationsnet of tax ( 434 ) ( 434 ) 2,564 ( 35 ) 2,529 5,400 ( 82 ) 5,318 Net income before allocation to noncontrolling interests 20,420 1,605 22,025 9,652 ( 457 ) 9,195 16,302 ( 246 ) 16,056 Net income attributable to Pfizer Inc. common shareholders 20,374 1,605 21,979 9,616 ( 457 ) 9,159 16,273 ( 246 ) 16,026 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.71 $ 0.29 $ 4.00 $ 1.27 $ ( 0.08 ) $ 1.19 $ 1.95 $ ( 0.03 ) $ 1.92 Discontinued operationsnet of tax ( 0.08 ) ( 0.08 ) 0.46 ( 0.01 ) 0.46 0.97 ( 0.01 ) 0.95 Net income attributable to Pfizer Inc. common shareholders 3.63 0.29 3.92 1.73 ( 0.08 ) 1.65 2.92 ( 0.04 ) 2.88 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.65 $ 0.28 $ 3.93 $ 1.25 $ ( 0.07 ) $ 1.18 $ 1.92 $ ( 0.03 ) $ 1.89 Discontinued operationsnet of tax ( 0.08 ) ( 0.08 ) 0.46 ( 0.01 ) 0.45 0.95 ( 0.01 ) 0.94 Net income attributable to Pfizer Inc. common shareholders 3.57 0.28 3.85 1.71 ( 0.08 ) 1.63 2.87 ( 0.04 ) 2.82 Year Ended December 31, 2021 2020 2019 (MILLIONS) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Previous Accounting Principle Impact of Change As Adjusted Consolidated Statements of Comprehensive Income: Foreign currency translation adjustments, net $ ( 731 ) $ 49 $ ( 682 ) $ 957 $ ( 185 ) $ 772 $ 654 $ 21 $ 675 Benefit plans: actuarial gains/(losses), net 1,565 ( 1,565 ) ( 1,128 ) 1,128 ( 826 ) 826 Reclassification adjustments related to amortization 285 ( 285 ) 276 ( 276 ) 241 ( 241 ) Reclassification adjustments related to settlements, net 209 ( 209 ) 278 ( 278 ) 274 ( 274 ) Other 49 ( 49 ) ( 189 ) 189 22 ( 22 ) Tax provision/(benefit) on other comprehensive income/(loss) 545 ( 475 ) 71 ( 349 ) 122 ( 227 ) 115 63 178 Consolidated Statements of Cash Flows: Deferred taxes from continuing operations $ ( 4,746 ) $ 453 $ ( 4,293 ) $ ( 1,449 ) $ ( 125 ) $ ( 1,575 ) $ 609 $ ( 48 ) $ 561 Benefit plan contributions in excess of expense/income ( 1,065 ) ( 2,058 ) ( 3,123 ) ( 1,790 ) 547 ( 1,242 ) ( 288 ) 233 ( 55 ) Year Ended December 31, 2021 2020 (MILLIONS) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Consolidated Balance Sheets: Noncurrent deferred tax assets and other noncurrent tax assets $ 3,320 $ 22 $ 3,341 $ 2,383 $ $ 2,383 Other noncurrent assets 7,679 7,679 4,879 4,879 Pension benefit obligations 3,489 3,489 4,766 4,766 Retained earnings 101,789 1,605 103,394 96,770 ( 6,378 ) 90,392 Accumulated other comprehensive loss ( 4,313 ) ( 1,583 ) ( 5,897 ) ( 11,688 ) 6,378 ( 5,310 ) Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Estimates and Assumptions In preparing these financial statements, we use certain estimates and assumptions that affect reported amounts and disclosures. These estimates and assumptions can impact all elements of our financial statements. For example, in the consolidated statements of income, estimates are used when accounting for deductions from revenues, determining the cost of inventory that is sold, allocating cost in the form of depreciation and amortization, and estimating restructuring charges and the impact of contingencies, as well as determining provisions for taxes on income. On the consolidated balance sheets, estimates are used in determining the valuation and recoverability of assets, and in determining the reported amounts of liabilities, all of which also impact the consolidated statements of income. Certain estimates of fair value and amounts recorded in connection with acquisitions, revenue deductions, impairment reviews, restructuring-associated charges, investments and financial instruments, valuation allowances, pension and postretirement benefit plans, contingencies, share-based compensation, and other calculations can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. Our estimates are often based on complex judgments and assumptions that we believe to be reasonable, but that can be inherently uncertain and unpredictable. If our estimates and assumptions are not representative of actual outcomes, our results could be materially impacted. As future events and their effects cannot be determined with precision, our estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. We are subject to risks and uncertainties that may cause actual results to differ from estimated amounts, such as changes in the healthcare environment, competition, litigation, legislation and regulations. We regularly evaluate our estimates and assumptions using historical experience and expectations about the future. We adjust our estimates and assumptions when facts and circumstances indicate the need for change. E. Acquisitions Our consolidated financial statements include the operations of acquired businesses after the completion of the acquisitions. We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date and that the fair value of acquired IPRD be recorded on the balance sheet. Transaction costs are expensed as incurred. Any excess of the consideration transferred over the assigned values of the net assets acquired is recorded as goodwill. When we acquire net assets that do not constitute a business, as defined in U.S. GAAP, no goodwill is recognized and acquired IPRD is expensed in Research and development expenses . Contingent consideration in a business combination is included as part of the acquisition cost and is recognized at fair value as of the acquisition date. Fair value is generally estimated by using a probability-weighted discounted cash flow approach. See Note 16D . Any liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. These changes in fair value are recognized in earnings in Other (income)/deductionsnet . F. Fair Value We measure certain assets and liabilities at fair value, either upon initial recognition or for subsequent accounting or reporting. We estimate fair value using an exit price approach, which requires, among other things, that we determine the price that would be received to sell an asset or paid to transfer a liability in an orderly market. The determination of an exit price is considered from the perspective of market participants, considering the highest and best use of non-financial assets and, for liabilities, assuming that the risk of non-performance will be the same before and after the transfer. When estimating fair value, depending on the nature and complexity of the asset or liability, we may use one or all of the following techniques: Income approach, which is based on the present value of a future stream of net cash flows. Market approach, which is based on market prices and other information from market transactions involving identical or comparable assets or liabilities. Cost approach, which is based on the cost to acquire or construct comparable assets, less an allowance for functional and/or economic obsolescence. Our fair value methodologies depend on the following types of inputs: Quoted prices for identical assets or liabilities in active markets (Level 1 inputs). Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are directly or indirectly observable, or inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (Level 2 inputs). Unobservable inputs that reflect estimates and assumptions (Level 3 inputs). The following inputs and valuation techniques are used to estimate the fair value of our financial assets and liabilities: Available-for-sale debt securitiesthird-party matrix-pricing model that uses significant inputs derived from or corroborated by observable market data and credit-adjusted yield curves. Equity securities with readily determinable fair valuesquoted market prices and observable NAV prices. Derivative assets and liabilitiesthird-party matrix-pricing model that uses inputs derived from or corroborated by observable market data. Where applicable, these models use market-based observable inputs, including interest rate yield curves to discount future cash flow amounts, and forward and spot prices for currencies. The credit risk impact to our derivative financial instruments was not significant. Money market fundsobservable NAV prices. We periodically review the methodologies, inputs and outputs of third-party pricing services for reasonableness. Our procedures can include, for example, referencing other third-party pricing models, monitoring key observable inputs (like benchmark interest rates) and selectively performing test-comparisons of values with actual sales of financial instruments. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies G. Foreign Currency Translation For most of our international operations, local currencies have been determined to be the functional currencies. We translate functional currency assets and liabilities to their U.S. dollar equivalents at exchange rates in effect as of the balance sheet date and income and expense amounts at average exchange rates for the period. The U.S. dollar effects that arise from changing translation rates are recorded in Other comprehensive income/(loss) . The effects of converting non-functional currency monetary assets and liabilities into the functional currency are recorded in Other (income)/deductionsnet . For operations in highly inflationary economies, we translate monetary items at rates in effect as of the balance sheet date, with translation adjustments recorded in Other (income)/deductionsnet , and we translate non-monetary items at historical rates. H. Revenues and Trade Accounts Receivable Revenue Recognition We record revenues from product sales when there is a transfer of control of the product from us to the customer. We typically determine transfer of control based on when the product is shipped or delivered and title passes to the customer. Our Sales Contracts Sales on credit are typically under short-term contracts. Collections are based on market payment cycles common in various markets, with shorter cycles in the U.S. Sales are adjusted for sales allowances, chargebacks, rebates and sales returns and cash discounts. Sales returns occur due to LOE, product recalls or a changing competitive environment. Deductions from Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment is required when estimating the impact of these revenue deductions on gross sales for a reporting period. Provisions for pharmaceutical sales returns Provisions are based on a calculation for each market that incorporates the following, as appropriate: local returns policies and practices; historical returns as a percentage of sales; an understanding of the reasons for past returns; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, such as LOE, product recalls or a changing competitive environment. Generally, returned products are destroyed, and customers are refunded the sales price in the form of a credit. We record sales incentives as a reduction of revenues at the time the related revenues are recorded or when the incentive is offered, whichever is later. We estimate the cost of our sales incentives based on our historical experience with similar incentives programs to predict customer behavior. The following outlines our common sales arrangements: Customers Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Prescription pharmaceutical products that ultimately are used by patients are generally covered under governmental programs, managed care programs and insurance programs, including those managed through PBMs, and are subject to sales allowances and/or rebates payable directly to those programs. Those sales allowances and rebates are generally negotiated, but government programs may have legislated amounts by type of product (e.g., patented or unpatented). Specifically: In the U.S., we sell our products principally to distributors and hospitals. We also have contracts with managed care programs or PBMs and legislatively mandated contracts with the federal and state governments under which we provide rebates based on medicines utilized by the lives they cover. We record provisions for Medicare, Medicaid, and performance-based contract pharmaceutical rebates based upon our experience ratio of rebates paid and actual prescriptions written during prior periods. We apply the experience ratio to the respective periods sales to determine the rebate accrual and related expense. This experience ratio is evaluated regularly to ensure that the historical trends are as current as practicable. We estimate discounts on branded prescription drug sales to Medicare Part D participants in the Medicare coverage gap, also known as the doughnut hole, based on the historical experience of beneficiary prescriptions and consideration of the utilization that is expected to result from the discount in the coverage gap. We evaluate this estimate regularly to ensure that the historical trends and future expectations are as current as practicable. For performance-based contract rebates, we also consider current contract terms, such as changes in formulary status and rebate rates. Outside the U.S., the majority of our pharmaceutical sales allowances are contractual or legislatively mandated and our estimates are based on actual invoiced sales within each period, which reduces the risk of variations in the estimation process. In certain European countries, rebates are calculated on the governments total unbudgeted pharmaceutical spending or on specific product sales thresholds and we apply an estimated allocation factor against our actual invoiced sales to project the expected level of reimbursement. We obtain third-party information that helps us to monitor the adequacy of these accruals. Provisions for pharmaceutical chargebacks (primarily reimbursements to U.S. wholesalers for honoring contracted prices and legislated discounts to third parties) closely approximate actual amounts incurred, as we settle these deductions generally within two to five weeks of incurring the liability. We recorded direct product sales and/or Alliance revenues of more than $ 1 billion for each of nine products in 2021, for each of seven products in 2020 and for each of six products in 2019. In the aggregate, these direct products sales and/or alliance product revenues represented 75 % of our revenues in 2021, 54 % of our revenues in 2020 and 49 % of our revenues in 2019. See Note 17B for additional information. The loss or expiration of intellectual property rights can have a significant adverse effect on our revenues as our contracts with customers will generally be at lower selling prices and lower volumes due to added generic competition. We generally provide for higher sales returns during the period in which individual markets begin to near the loss or expiration of intellectual property rights. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Our accruals for Medicare, Medicaid and related state program and performance-based contract rebates, chargebacks, sales allowances and sales returns and cash discounts are as follows: As of December 31, (MILLIONS) 2021 2020 Reserve against Trade accounts receivable, less allowance for doubtful accounts $ 1,077 $ 861 Other current liabilities : Accrued rebates 3,811 3,017 Other accruals 528 432 Other noncurrent liabilities 433 399 Total accrued rebates and other sales-related accruals $ 5,850 $ 4,708 Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenues . Trade Accounts Receivable Trade accounts receivable are stated at their net realizable value. The allowance for credit losses reflects our best estimate of expected credit losses of the receivables portfolio determined on the basis of historical experience, current information, and forecasts of future economic conditions. In developing the estimate for expected credit losses, trade accounts receivables are segmented into pools of assets depending on market (U.S. versus international), delinquency status, and customer type (high risk versus low risk and government versus non-government), and fixed reserve percentages are established for each pool of trade accounts receivables. In determining the reserve percentages for each pool of trade accounts receivables, we considered our historical experience with certain customers and customer types, regulatory and legal environments, country and political risk, and other relevant current and future forecasted macroeconomic factors. These credit risk indicators are monitored on a quarterly basis to determine whether there have been any changes in the economic environment that would indicate the established reserve percentages should be adjusted, and are considered on a regional basis to reflect more geographic-specific metrics. Additionally, write-offs and recoveries of customer receivables are tracked against collections on a quarterly basis to determine whether the reserve percentages remain appropriate. When management becomes aware of certain customer-specific factors that impact credit risk, specific allowances for these known troubled accounts are recorded. Trade accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. During 2021 and 2020, additions to the allowance for credit losses, write-offs and recoveries of customer receivables were not material to our consolidated financial statements. I. Collaborative Arrangements Payments to and from our collaboration partners are presented in our consolidated statements of income based on the nature of the arrangement (including its contractual terms), the nature of the payments and applicable accounting guidance. Under co-promotion agreements, we record the amounts received for our share of gross profits from our collaboration partners as alliance revenues, a component of Revenues, when our collaboration partners are the principal in the transaction and we receive a share of their net sales or profits. Alliance revenues are recorded as we perform co-promotion activities for the collaboration and the collaboration partners sell the products to their customers. The related expenses for selling and marketing these products including reimbursements to or from our collaboration partners for these costs are included in Selling, informational and administrative expenses. In collaborative arrangements where we manufacture a product for our collaboration partners, we record revenues when we transfer control of the product to our collaboration partners. In collaboration arrangements where we are the principal in the transaction, we record amounts paid to collaboration partners for their share of net sales or profits earned, and all royalty payments to collaboration partners as Cost of sales . Royalty payments received from collaboration partners are included in Other (income)/deductionsnet. Reimbursements to or from our collaboration partners for development costs are typically recorded in Research and development expenses . Upfront payments and pre-approval milestone payments due from us to our collaboration partners in development stage collaborations are recorded as Research and development expenses . Milestone payments due from us to our collaboration partners after regulatory approval has been attained for a medicine are recorded in Identifiable intangible assetsDeveloped technology rights . Upfront and pre-approval milestone payments earned from our collaboration partners by us are recognized in Other (income)/deductionsnet over the development period for the products, when our performance obligations include providing RD services to our collaboration partners. Upfront, pre-approval and post-approval milestone payments earned by us may be recognized in Other (income)/deductionsnet immediately when earned or over other periods depending upon the nature of our performance obligations in the applicable collaboration. Where the milestone event is regulatory approval for a medicine, we generally recognize milestone payments due to us in the transaction price when regulatory approval in the applicable jurisdiction has been attained. We may recognize milestone payments due to us in the transaction price earlier than the milestone event in certain circumstances when recognition of the income would not be probable of a significant reversal. J. Cost of Sales and Inventories Inventories are recorded at the lower of cost or net realizable value. The cost of finished goods, work in process and raw materials is determined using average actual cost. We regularly review our inventories for impairment and reserves are established when necessary. K. Selling, Informational and Administrative Expenses Selling, informational and administrative costs are expensed as incurred. Among other things, these expenses include the internal and external costs of marketing, advertising, shipping and handling, information technology and legal defense. Advertising expenses totaled approximately $ 2.0 billion in 2021, $ 1.8 billion in 2020 and $ 2.3 billion in 2019. Production costs are expensed as incurred and the costs of TV, radio, and other electronic media and publications are expensed when the related advertising occurs. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies L. Research and Development Expenses RD costs are expensed as incurred. These expenses include the costs of our proprietary RD efforts, as well as costs incurred in connection with certain licensing arrangements. Before a compound receives regulatory approval, we record upfront and milestone payments we make to third parties under licensing arrangements as expense. Upfront payments are recorded when incurred, and milestone payments are recorded when the specific milestone has been achieved. Once a compound receives regulatory approval, we record any milestone payments in Identifiable intangible assets, less accumulated amortization and, unless the asset is determined to have an indefinite life, we typically amortize the payments on a straight-line basis over the remaining agreement term or the expected product life cycle, whichever is shorter. M. Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets Long-lived assets include: Property, plant and equipment , less accumulated depreciationThese assets are recorded at cost, including any significant improvements after purchase, less accumulated depreciation. Property, plant and equipment assets, other than land and construction in progress, are depreciated on a straight-line basis over the estimated useful life of the individual assets. Depreciation begins when the asset is ready for its intended use. For tax purposes, accelerated depreciation methods are used as allowed by tax laws. Identifiable intangible assets, less accumulated amortization These assets are recorded at fair value at acquisition. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite lives are not amortized until a useful life can be determined. Goodwill Goodwill represents the excess of the consideration transferred for an acquired business over the assigned values of its net assets. Goodwill is not amortized. Amortization of finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as these intangible assets benefit multiple business functions. Amortization of intangible assets that are for a single function and depreciation of property, plant and equipment are included in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses, as appropriate. We review our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Specifically: For finite-lived intangible assets, such as developed technology rights, and for other long-lived assets, such as property, plant and equipment, whenever impairment indicators are present, we calculate the undiscounted value of the projected cash flows for the asset, or asset group, and compare this estimated amount to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. In addition, in all cases of an impairment review, we reevaluate the remaining useful lives of the assets and modify them, as appropriate. For indefinite-lived intangible assets, such as brands and IPRD assets, when necessary, we determine the fair value of the asset and record an impairment loss, if any, for the excess of book value over fair value. In addition, in all cases of an impairment review other than for IPRD assets, we re-evaluate whether continuing to characterize the asset as indefinite-lived is appropriate. For goodwill, when necessary, we determine the fair value of each reporting unit and record an impairment loss, if any, for the excess of the book value of the reporting unit over the implied fair value. N. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives We may incur restructuring charges in connection with acquisitions when we implement plans to restructure and integrate the acquired operations or in connection with our cost-reduction and productivity initiatives. In connection with acquisition activity, we typically incur costs associated with executing the transactions, integrating the acquired operations (which may include expenditures for consulting and the integration of systems and processes), and restructuring the combined company (which may include charges related to employees, assets and activities that will not continue in the combined company); and In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges for site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. Included in Restructuring charges and certain acquisition-related costs are all restructuring charges, as well as certain other costs associated with acquiring and integrating an acquired business. If the restructuring action results in a change in the estimated useful life of an asset, that incremental impact is classified in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Employee termination costs are generally recorded when the actions are probable and estimable and include accrued severance benefits, pension and postretirement benefits, many of which may be paid out during periods after termination. Transaction costs, such as banking, legal, accounting and other similar costs incurred in connection with a business acquisition are expensed as incurred . Our business and platform functions may be impacted by these actions, including sales and marketing, manufacturing and RD, as well as our corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement). O. Cash Equivalents and Statement of Cash Flows Cash equivalents include items almost as liquid as cash, such as certificates of deposit and time deposits with maturity periods of three months or less when purchased. If items meeting this definition are part of a larger investment pool, we classify them as Short-term investments . Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Cash flows for financial instruments designated as fair value or cash flow hedges may be included in operating, investing or financing activities, depending on the classification of the items being hedged. Cash flows for financial instruments designated as net investment hedges are classified according to the nature of the hedging instrument. Cash flows for financial instruments that do not qualify for hedge accounting treatment are classified according to their purpose and accounting nature. P. Investments and Derivative Financial Instruments The classification of an investment depends on the nature of the investment, our intent and ability to hold the investment, and the degree to which we may exercise influence. Our investments are primarily comprised of the following: Public equity securities with readily determinable fair values, which are carried at fair value, with changes in fair value reported in Other (income)/deductionsnet. Available-for-sale debt securities, which are carried at fair value, with changes in fair value reported in Other comprehensive income/(loss) until realized. Held-to-maturity debt securities, which are carried at amortized cost. Private equity securities without readily determinable fair values and where we have no significant influence are measured at cost minus any impairment and plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. For equity investments in common stock or in-substance common stock where we have significant influence over the financial and operating policies of the investee, we use the equity-method of accounting. Under the equity-method, we record our share of the investees income and expenses in Other (income)/deductionsnet . The excess of the cost of the investment over our share of the underlying equity in the net assets of the investee as of the acquisition date is allocated to the identifiable assets and liabilities of the investee, with any remaining excess amount allocated to goodwill. Such investments are initially recorded at cost, which is the fair value of consideration paid and typically does not include contingent consideration. Realized gains or losses on sales of investments are determined by using the specific identification cost method. We regularly evaluate all of our financial assets for impairment. For investments in debt and equity, when a decline in fair value, if any, is determined, an impairment charge is recorded and a new cost basis in the investment is established. Derivative financial instruments are carried at fair value in various balance sheet categories (see Note 7A ), with changes in fair value reported in Net income or, for derivative financial instruments in certain qualifying hedging relationships, in Other comprehensive income/(loss) (see Note 7E ). Q. Tax Assets and Liabilities and Income Tax Contingencies Tax Assets and Liabilities Current tax assets primarily include (i) tax effects for intercompany transfers of inventory within our combined group, which are recognized in the consolidated statements of income when the inventory is sold to a third party and (ii) income tax receivables that are expected to be recovered either via refunds from taxing authorities or reductions to future tax obligations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws. We provide a valuation allowance when we believe that our deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax-planning strategies, that would be implemented, if necessary, to realize the deferred tax assets. Amounts recorded for valuation allowances requires judgments about future income which can depend heavily on estimates and assumptions. All deferred tax assets and liabilities within the same tax jurisdiction are presented as a net amount in the noncurrent section of our consolidated balance sheet. The TCJA subjects a U.S. shareholder to current tax on global intangible low-taxed income earned by certain foreign subsidiaries. The FASB Staff QA, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income , states that we are permitted to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as global intangible low-taxed income in future years or provide for the tax expense related to such income in the year the tax is incurred. We elected to recognize deferred taxes for temporary differences expected to reverse as global intangible low-taxed income in future years. Other non-current tax assets primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. Other taxes payable as of December 31, 2021 and 2020 include liabilities for uncertain tax positions and the noncurrent portion of the repatriation tax liability for which we elected payment over eight years through 2026. For additional information, see Note 5D for uncertain tax positions and Note 5A for the repatriation tax liability and other estimates and assumptions in connection with the TCJA. Income Tax Contingencies We account for income tax contingencies using a benefit recognition model. If we consider that a tax position is more likely than not to be sustained upon audit, based solely on the technical merits of the position, we recognize all or a portion of the benefit. We measure the benefit by determining the amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the taxing authority with full knowledge of all relevant information. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies We regularly monitor our position and subsequently recognize the unrecognized tax benefit: (i) if there are changes in tax law, analogous case law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) if the statute of limitations expires; or (iii) if there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. Liabilities for uncertain tax positions are classified as current only when we expect to pay cash within the next 12 months. Interest and penalties, if any, are recorded in Provision/(benefit) for taxes on income and are classified on our consolidated balance sheet with the related tax liability. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. R. Pension and Postretirement Benefit Plans The majority of our employees worldwide are covered by defined benefit pension plans, defined contribution plans or both. In the U.S., we have both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans, as well as other postretirement benefit plans consisting primarily of medical insurance for retirees and their eligible dependents. We recognize the overfunded or underfunded status of each of our defined benefit plans as an asset or liability. The obligations are generally measured at the actuarial present value of all benefits attributable to employee service rendered, as provided by the applicable benefit formula. Our pension and other postretirement obligations may be determined using assumptions such as discount rate, expected annual rate of return on plan assets, expected employee turnover and participant mortality. For our pension plans, the obligation may also include assumptions as to future compensation levels. For our other postretirement benefit plans, the obligation may include assumptions as to the expected cost of providing medical insurance benefits, as well as the extent to which those costs are shared with the employee or others (such as governmental programs). Plan assets are measured at fair value. Net periodic pension and postretirement benefit costs other than the service costs are recognized in Other (income)/deductionsnet . S. Legal and Environmental Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, such as patent litigation, product liability and other product-related litigation, commercial litigation, environmental claims and proceedings, government investigations and guarantees and indemnifications. In assessing contingencies related to legal and environmental proceedings that are pending against the Company, or unasserted claims that are probable of being asserted, we record accruals for these contingencies to the extent that we conclude that a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, we accrue that amount. Alternatively, when no amount within a range of loss appears to be a better estimate than any other amount, we accrue the lowest amount in the range. We record anticipated recoveries under existing insurance contracts when recovery is assured. T. Share-Based Payments Our compensation programs can include share-based payments. Generally, grants under share-based payment programs are accounted for at fair value and these fair values are generally amortized on a straight-line basis over the vesting terms with the related costs recorded in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Note 2. Acquisitions, Divestitures, Equity-Method Investments, Licensing Arrangements and Collaborative Arrangements A. Acquisitions Trillium On November 17, 2021, we acquired all of the issued and outstanding common stock not already owned by Pfizer of Trillium, a clinical stage immuno-oncology company developing therapies targeting cancer immune evasion pathways and specific cell targeting approaches, for a price of $ 18.50 per share in cash, for total consideration of $ 2.0 billion, net of cash acquired. As a result, Trillium became our wholly owned subsidiary. We previously held a 2 % ownership investment in Trillium. Trilliums lead program, TTI-622, is an investigational fusion protein that is designed to block the inhibitory activity of CD47, a molecule that is overexpressed by a wide variety of tumors. We accounted for the transaction as an asset acquisition since the lead asset, TTI-622, represented substantially all of the fair value of the gross assets acquired, which exclude cash acquired. At the acquisition date, we recorded a $ 2.1 billion charge representing an acquired IPRD asset with no alternative future use in Research and development expenses , of which the $ 2.0 billion net cash consideration is presented as a cash outflow from operating activities. In connection with this acquisition, we recorded $ 256 million of assets acquired primarily consisting of cash and investments. Liabilities assumed were approximately $ 81 million. Array On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $ 48 per share in cash. The total fair value of the consideration transferred was $ 11.2 billion ($ 10.9 billion, net of cash acquired). In addition, $ 157 million in payments to Array employees for the fair value of previously unvested stock options was recognized as post-closing compensation expense and recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). We financed the majority of the transaction with debt and the balance with existing cash. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Arrays portfolio includes Braftovi (encorafenib) and Mektovi (binimetinib), a broad pipeline of targeted cancer medicines in different stages of RD, as well as a portfolio of out-licensed medicines, which may generate milestones and royalties over time. The final allocation of the consideration transferred to the assets acquired and the liabilities assumed was completed in 2020. In connection with this acquisition, we recorded: (i) $ 6.3 billion in Identifiable intangible assets , consisting of $ 2.0 billion of Developed technology rights with a useful life of 16 years , $ 2.8 billion of IPRD and $ 1.5 billion of Licensing agreements and other ($ 1.2 billion for technology in development indefinite-lived licensing agreements and $ 360 million for developed technology finite-lived licensing agreements with a useful life of 10 years), (ii) $ 6.1 billion of Goodwill , (iii) $ 1.1 billion of net deferred tax liabilities and (iv) $ 451 million of assumed long-term debt, which was paid in full in 2019. In 2020, we recorded measurement period adjustments to the estimated fair values initially recorded in 2019, which resulted in a reduction in Identifiable intangible assets of approximately $ 900 million with a corresponding change to Goodwill and net deferred tax liabilities. The measurement period adjustments were recorded to better reflect market participant assumptions about facts and circumstances existing as of the acquisition date and did not have a material impact on our consolidated statement of income for the year ended December 31, 2020. Therachon On July 1, 2019, we acquired all the remaining shares of Therachon, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $ 340 million upfront, plus potential milestone payments of up to $ 470 million contingent on the achievement of key milestones in the development and commercialization of the lead asset. We accounted for the transaction as an asset acquisition since the lead asset represented substantially all the fair value of the gross assets acquired. The total fair value of the consideration transferred for Therachon was $ 322 million, which consisted of $ 317 million of cash and our previous $ 5 million investment in Therachon. In connection with this asset acquisition, we recorded a charge of $ 337 million in Research and development expenses. B. Divestitures Meridian On December 31, 2021, we completed the sale of our Meridian subsidiary for approximately $ 51 million in cash and recognized a loss of approximately $ 167 million, net of tax, in Discontinued operationsnet of tax . In connection with the sale, Pfizer and the purchaser of Meridian entered into various agreements to provide a framework for our relationship after the sale, including interim TSAs and a manufacturing supply agreement (MSA). The TSAs primarily involve Pfizer providing services related to information technology, among other activities, and are generally expected to be for terms of no more than 12 to 18 months post sale. The MSA is for a term of three years post sale with a two year extension period. No amounts were recorded under the above arrangements in 2021. Upjohn Separation and Combination with Mylan On November 16, 2020, we completed the spin-off and the combination of the Upjohn Business with Mylan (the Transactions) to form Viatris. The Transactions were structured as an all-stock, Reverse Morris Trust transaction. Specifically, (i) we contributed the Upjohn Business to a wholly owned subsidiary, which was renamed Viatris, so that the Upjohn Business was separated from the remainder of our business (the Separation), (ii) following the Separation, we distributed, on a pro rata basis, all of the shares of Viatris common stock held by Pfizer to Pfizer stockholders as of the November 13, 2020 record date, such that each Pfizer stockholder as of the record date received approximately 0.124079 shares of Viatris common stock per share of Pfizer common stock (the Distribution); and (iii) immediately after the Distribution, the Upjohn Business combined with Mylan in a series of transactions in which Mylan shareholders received one share of Viatris common stock for each Mylan ordinary share held by such shareholder, subject to any applicable withholding taxes (the Combination). Prior to the Distribution, Viatris made a cash payment to Pfizer equal to $ 12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris. As of the closing of the Combination, Pfizer stockholders owned approximately 57 % of the outstanding shares of Viatris common stock, and Mylan shareholders owned approximately 43 % of the outstanding shares of Viatris common stock, in each case on a fully diluted, as-converted and as-exercised basis. The Transactions are generally expected to be tax free to Pfizer and Pfizer stockholders for U.S. tax purposes. Beginning November 16, 2020, Viatris operates both the Upjohn Business and Mylan as an independent publicly traded company, which is traded under the symbol VTRS on the NASDAQ. In connection with the Transactions, in June 2020, Upjohn Inc. and Upjohn Finance B.V. completed privately placed debt offerings of $ 7.45 billion and 3.60 billion aggregate principal amounts, respectively, (approximately $ 11.4 billion) of senior unsecured notes and entered into other financing arrangements, including a $ 600 million delayed draw term loan agreement and a revolving credit facility agreement for up to $ 4.0 billion. Proceeds from the debt offerings and other financing arrangements were used to fund the $ 12.0 billion cash distribution Viatris made to Pfizer prior to the Distribution. We used the cash distribution proceeds to pay down commercial paper borrowings and redeem the $ 1.15 billion aggregate principal amount outstanding of our 1.95 % senior unsecured notes that were due in June 2021 and $ 342 million aggregate principal amount outstanding of our 5.80 % senior unsecured notes that were due in August 2023, before the maturity date. Interest expense for the $ 11.4 billion in debt securities incurred during 2020 is included in Discontinued operationsnet of tax . Following the Separation and Combination of the Upjohn Business with Mylan, we are no longer the obligor or guarantor of any Upjohn debt or Upjohn financing arrangements. As a result of the spin-off of the Upjohn Business, we distributed net assets of $ 1.6 billion as of November 16, 2020, which was reflected as a reduction to Retained earnings and reflects the change in accounting principle in the first quarter of 2021 to MTM Accounting. See Note 1C. Of this amount, $ 412 million represents cash transferred to the Upjohn Business, with the remainder considered a non-cash activity in the consolidated statement of cash flows for the year ended December 31, 2020. The spin-off also resulted in a net increase to Accumulated other comprehensive loss of $ 423 million for the derecognition of net gains on foreign currency translation adjustments of $ 397 million and prior service net credits associated with benefit plans of $ 26 million, which were reclassified to Retained earnings . As a result of the separation of Upjohn, we incurred separation-related costs of $ 434 million in 2020 and $ 83 million in 2019, which are included in Discontinued operationsnet of tax . These costs primarily relate to professional fees for regulatory filings and separation activities within finance, tax, legal and information system functions as well as investment banking fees. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In connection with the Transactions, Pfizer and Viatris entered into various agreements to effect the Separation and Combination to provide a framework for our relationship after the Combination, including a separation and distribution agreement, interim operating models, including agency arrangements, MSAs, TSAs, a tax matters agreement, and an employee matters agreement, among others. The interim agency operating model arrangements primarily include billings, collections and remittance of rebates that we are performing on a transitional basis on behalf of Viatris. Under the MSAs, Pfizer or Viatris, as the case may be, manufactures, labels and packages products for the other party. The terms of the MSAs range in initial duration from four to seven years post-Separation. The TSAs primarily involve Pfizer providing services to Viatris related to finance, information technology and human resource infrastructure and are generally expected to be for terms of no more than three years post-Separation. The amounts recorded under the above agreements were not material to our consolidated results of operations in 2021 and 2020. In addition, Pfizer and Mylan had a pre-existing arms-length commercial agreement, which is continuing with Viatris and is not material to Pfizers consolidated financial statements. Net amounts due from Viatris under the above agreements were $ 53 million as of December 31, 2021 and $ 401 million as of December 31, 2020. The cash flows associated with the above agreements are included in Net cash provided by operating activities from continuing operations, except for a $ 277 million payment to Viatris made in 2021 pursuant to terms of the separation agreement, which is reported in Other financing activities, net, and was recorded as a payable to Viatris in Other current liabilities as of December 31, 2020. Components of Discontinued operationsnet of tax: Year Ended December 31, (a) (MILLIONS) 2021 2020 2019 Revenues $ 277 $ 7,572 $ 10,845 Costs and expenses: Cost of sales 204 2,106 2,173 Selling, informational and administrative expenses 26 1,682 1,624 Research and development expenses 9 224 265 Amortization of intangible assets 45 224 181 Restructuring charges and certain acquisition-related costs 2 29 146 Other (income)/deductionsnet 365 428 401 Pre-tax income/(loss) from discontinued operations ( 375 ) 2,879 6,056 Provision/(benefit) for taxes on income ( 107 ) 349 738 Income/(loss) from discontinued operationsnet of tax ( 268 ) 2,529 5,318 Pre-tax loss on sale of discontinued operations ( 211 ) Benefit for taxes on income ( 44 ) Loss on sale of discontinued operationsnet of tax ( 167 ) Discontinued operationsnet of tax $ ( 434 ) $ 2,529 $ 5,318 (a) In 2021, Discontinued operationsnet of tax primarily includes (i) the operations of Meridian prior to its sale on December 31, 2021 recognized in Income/(loss) from discontinued operationsnet of tax, which includes a pre-tax amount for a Multi-District Litigation relating to EpiPen against the Company in the U.S. District Court for the District of Kansas for $ 345 million; and (ii) the after tax loss of $ 167 million related to the sale of Meridian recognized in Loss on sale of discontinued operationsnet of tax. To a much lesser extent, Discontinued operationsnet of tax in 2021 also includes the operations of the Mylan-Japan collaboration prior to its termination on December 21, 2020 and post-closing adjustments directly related to our former Upjohn and Nutrition discontinued businesses, including adjustments for tax, benefits and legal-related matters recognized in Income/(loss) from discontinued operationsnet of tax. In 2020 and 2019, Discontinued operationsnet of tax relates to the operations of the Upjohn Business, Meridian and the Mylan-Japan collaboration and includes the change in accounting principle in the first quarter of 2021 to MTM Accounting. See Note 1C . In 2020, Discontinued operationsnet of tax includes pre-tax interest expense of $ 116 million associated with the U.S. dollar and Euro denominated senior unsecured notes issued by Upjohn Inc. and Upjohn Finance B.V. in the second quarter of 2020 and pre-tax charges of $ 223 million related to the remeasurement of Euro debt issued by Upjohn Finance B.V. in the second quarter of 2020. Components of assets and liabilities of discontinued operations and other assets held for sale: As of December 31, (a) (MILLIONS) 2021 2020 Current assets of discontinued operations and other assets held for sale Other current assets $ 25 $ 215 Property, plant and equipment $ $ 155 Identifiable intangible assets 134 Other noncurrent assets 29 Noncurrent assets of discontinued operations Other noncurrent assets $ $ 319 Current liabilities of discontinued operations Other current liabilities $ $ 74 Noncurrent liabilities of discontinued operations Other noncurrent liabilities $ $ 16 (a) Amounts as of December 31, 2021 represent property, plant and equipment held for sale. Amounts as of December 31, 2020 primarily relate to discontinued operations of our former Meridian subsidiary and the Mylan-Japan collaboration. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Equity-Method Investments Formation of Consumer Healthcare JV On July 31, 2019, we completed a transaction in which we and GSK combined our respective consumer healthcare businesses into a new JV that operates globally under the GSK Consumer Healthcare name. In exchange, we received a 32 % equity stake in the new company and GSK owns the remaining 68 %. Upon closing, we deconsolidated our Consumer Healthcare business and recognized a pre-tax gain of $ 8.1 billion ($ 5.4 billion, net of tax) in the third quarter of 2019 in (Gain) on completion of Consumer Healthcare JV transaction for the difference in the fair value of our 32 % equity stake and the carrying value of our Consumer Healthcare business. Our financial results and our Consumer Healthcare segments operating results for 2019 reflect seven months of Consumer Healthcare segment domestic operations and eight months of Consumer Healthcare segment international operations. The financial results for 2021 and 2020 do not reflect any contribution from the Consumer Healthcare business. In valuing our investment in the Consumer Healthcare JV, we used discounted cash flow techniques. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which include the expected impact of competitive, legal or regulatory forces on the products; the long-term growth rate, which seeks to project the sustainable growth rate over the long term; the discount rate, which seeks to reflect our best estimate of the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. We are accounting for our interest in the Consumer Healthcare JV as an equity-method investment. The carrying value of our investment in the Consumer Healthcare JV is $ 16.3 billion as of December 31, 2021 and $ 16.7 billion as of December 31, 2020 and is reported as a private equity investment in Equity-method investments as of December 31, 2021 and 2020. The Consumer Healthcare JV is a foreign investee whose reporting currency is the U.K. pound, and therefore we translate its financial statements into U.S. dollars and recognize the impact of foreign currency translation adjustments in the carrying value of our investment and in other comprehensive income. The decrease in the value of our investment from December 31, 2020 to December 31, 2021 is primarily due to dividends totaling $ 499 million, as well as $ 384 million in pre-tax foreign currency translation adjustments (see Note 6 ), partially offset by our share of the JVs earnings. We record our share of earnings from the Consumer Healthcare JV on a quarterly basis on a one-quarter lag in Other (income)/deductionsnet commencing from August 1, 2019. Our total share of the JVs earnings generated in the fourth quarter of 2020 and the first nine months of 2021, which we recorded in our operating results in 2021, was $ 495 million. Our total share of the JVs earnings generated in the fourth quarter of 2019 and the first nine months of 2020, which we recorded in our operating results in 2020, was $ 417 million. Our total share of two months of the JVs earnings generated in the third quarter of 2019, which we recorded in our operating results in the fourth quarter of 2019, was $ 47 million. As of the July 31, 2019 closing date, we estimated that the fair value of our investment in the Consumer Healthcare JV was $ 15.7 billion and that 32 % of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was $ 11.2 billion, resulting in an initial basis difference of approximately $ 4.5 billion. In the fourth quarter of 2019, we preliminarily completed the allocation of the basis difference, which resulted from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV, primarily to inventory, definite-lived intangible assets, indefinite-lived intangible assets, related deferred tax liabilities and equity method goodwill within the investment account. During the fourth quarter of 2019, the Consumer Healthcare JV revised the initial carrying value of the net assets of the JV and our 32 % share of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was reduced to $ 11.0 billion and our initial basis difference was increased to $ 4.8 billion. The adjustment was allocated to equity method goodwill within the investment account. We began recording the amortization of basis differences allocated to inventory, definite-lived intangible assets and related deferred tax liabilities in Other (income)/deductionsnet commencing August 1, 2019. The total amortization and adjustment of basis differences resulting from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV is included in Other (income)/deductionsnet and was not material to our results of operations in the periods presented. See Note 4. Amortization of basis differences on inventory and related deferred tax liabilities was completely recognized by the second quarter of 2020. Basis differences on definite-lived intangible assets and related deferred tax liabilities are being amortized over the lives of the underlying assets, which range from 8 to 20 years. As a part of Pfizer in 2019, pre-tax income on a management basis for the Consumer Healthcare business was $ 654 million through July 31, 2019. Summarized financial information for our equity method investee, the Consumer Healthcare JV, as of September 30, 2021, the most recent period available, and as of September 30, 2020 and for the periods ending September 30, 2021, 2020, and 2019 is as follows: (MILLIONS) September 30, 2021 September 30, 2020 Current assets $ 6,890 $ 6,614 Noncurrent assets 39,445 38,361 Total assets $ 46,335 $ 44,975 Current liabilities $ 5,133 $ 5,246 Noncurrent liabilities 5,218 5,330 Total liabilities $ 10,351 $ 10,576 Equity attributable to shareholders $ 35,705 $ 34,154 Equity attributable to noncontrolling interests 279 245 Total net equity $ 35,984 $ 34,400 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies For the Twelve Months Ending For the Two Months Ending (MILLIONS) September 30, 2021 September 30, 2020 September 30, 2019 Net sales $ 12,836 $ 12,720 $ 2,161 Cost of sales ( 4,755 ) ( 5,439 ) ( 803 ) Gross profit $ 8,081 $ 7,281 $ 1,358 Income from continuing operations 1,614 1,350 152 Net income 1,614 1,350 152 Income attributable to shareholders 1,547 1,307 148 Investment in ViiV In 2009, we and GSK created ViiV, which is focused on research, development and commercialization of human immunodeficiency virus (HIV) medicines. We own approximately 11.7 % of ViiV, and prior to 2016 we accounted for our investment under the equity method due to the significant influence that we have over the operations of ViiV through our board representation and minority veto rights. We suspended application of the equity method to our investment in ViiV in 2016 when the carrying value of our investment was reduced to zero due to the recognition of cumulative equity method losses and dividends. Since 2016, we have recognized dividends from ViiV as income in Other (income)/deductionsnet when earned, including dividends of $ 166 million in 2021, $ 278 million in 2020 and $ 220 million in 2019 (see Note 4 ). Summarized financial information for our equity method investee, ViiV, as of December 31, 2021 and 2020 and for the years ending December 31, 2021, 2020, and 2019 is as follows: As of December 31, (MILLIONS) 2021 2020 Current assets $ 3,608 $ 3,283 Noncurrent assets 3,563 3,381 Total assets $ 7,171 $ 6,664 Current liabilities $ 3,497 $ 3,028 Noncurrent liabilities 6,536 6,370 Total liabilities $ 10,033 $ 9,398 Total net equity/(deficit) attributable to shareholders $ ( 2,862 ) $ ( 2,734 ) Year Ended December 31, (MILLIONS) 2021 2020 2019 Net sales $ 6,380 $ 6,224 $ 6,139 Cost of sales ( 682 ) ( 574 ) ( 516 ) Gross profit $ 5,698 $ 5,650 $ 5,623 Income from continuing operations 2,040 2,012 3,398 Net income 2,040 2,012 3,398 Income attributable to shareholders 2,040 2,012 3,398 D. Licensing Arrangements Agreement with Valneva On April 30, 2020, we signed an agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, which covers six serotypes that are prevalent in North America and Europe. Valneva and Pfizer will work closely together throughout the development of VLA15. Valneva is eligible to receive a total of up to $ 308 million in cash payments from us consisting of a $ 130 million upfront payment, which was paid and recorded in Research and development expenses in our second quarter of 2020, as well as $ 35 million in development milestones and $ 143 million in early commercialization milestones. Under the terms of the agreement, Valneva will fund 30 % of all development costs through completion of the development program, and in return we will pay Valneva tiered royalties. We will lead late-stage development and have sole control over commercialization. Agreement with Akcea On October 4, 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a wholly-owned subsidiary of Ionis. The transaction closed in November 2019 and we made an upfront payment of $ 250 million to Akcea, which was recorded in Research and development expenses in our fourth quarter of 2019. On January 31, 2022, we and Ionis announced the discontinuation of the Pfizer-led clinical development program for the licensed product and that we would be returning the rights to the licensed product to Ionis. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies E. Collaborative Arrangements We enter into collaborative arrangements with respect to in-line medicines, as well as medicines in development that require completion of research and regulatory approval. Collaborative arrangements are contractual agreements with third parties that involve a joint operating activity, typically a research and/or commercialization effort, where both we and our partner are active participants in the activity and are exposed to the significant risks and rewards of the activity. Our rights and obligations under our collaborative arrangements vary. For example, we have agreements to co-promote pharmaceutical products discovered by us or other companies, and we have agreements where we partner to co-develop and/or participate together in commercializing, marketing, promoting, manufacturing and/or distributing a drug product. Collaboration with Beam On December 24, 2021, we entered into a multi-year research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. Under the terms of the agreement, Beam conducts all research activities through development candidate selection for three undisclosed targets, which are not included in Beams existing programs, and we may opt in to obtain exclusive licenses to each development candidate. Beam has a right to opt in, at the end of phase 1/2 studies, upon the payment by Beam of an option exercise fee, to a global co-development and co-commercialization agreement with respect to one program licensed under the collaboration pursuant to which we and Beam would share net profits as well as development and commercialization costs in a 65 %/ 35 % ratio (Pfizer/Beam). Upon entering into the agreement, we recorded $ 300 million in Research and development expenses in the fourth quarter of 2021 for an upfront payment due to Beam, and if we exercise our opt in to licenses for all three targets, Beam would be eligible for up to an additional $ 1.05 billion in development, regulatory and commercial milestone payments for a potential total deal consideration of up to $ 1.35 billion. Beam is also eligible to receive royalties on global net sales for each licensed program. Collaboration with Arvinas On July 21, 2021, we entered into a global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader. The estrogen receptor is a well-known disease driver in most breast cancers. In connection with the agreement, we made an upfront cash payment of $ 650 million to Arvinas and we made a $ 350 million equity investment in the common stock of Arvinas. We recognized $ 706 million for the upfront payment and a premium paid on our equity investment in Research and development expenses in our third quarter of 2021. Arvinas is also eligible to receive up to $ 400 million in approval milestones and up to $ 1 billion in commercial milestones. The companies will equally share worldwide development costs, commercialization expenses and profits. As of December 31, 2021, we held a 6.5 % equity stake of Arvinas. Collaboration with Myovant On December 26, 2020, we entered into a collaboration with Myovant to jointly develop and commercialize Orgovyx (relugolix) in advanced prostate cancer and Myfembree (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health in the U.S. and Canada. We also received an exclusive option to commercialize relugolix in oncology outside the U.S. and Canada, excluding certain Asian countries, which we declined to exercise. Under the terms of the agreement, the companies will equally share profits and allowable expenses for Orgovyx and Myfembree in the U.S. and Canada, with Myovant bearing our share of allowable expenses up to a maximum of $ 100 million in 2021 and up to a maximum of $ 50 million in 2022. We record our share of gross profits as Alliance revenue. Myovant remains responsible for regulatory interactions and drug supply and continues to lead clinical development for Myfembree. Myovant is entitled to receive up to $ 4.35 billion, including an upfront payment of $ 650 million, which was made in December 2020, $ 200 million in potential regulatory milestones for FDA approvals for Myfembree in womens health, of which $ 100 million was paid to Myovant in July 2021 and recognized as Identifiable intangible assetsDeveloped technology rights , and tiered sales milestones of up to $ 3.5 billion in total for prostate cancer and for the combined womens health indications. In connection with this transaction, in 2020 we recognized $ 499 million in Identifiable intangible assetsDeveloped technology rights and $ 151 million in Research and development expenses representing the relative fair value of the portion of the upfront payment allocated to the approved indication and unapproved indications of the product, respectively. Collaboration with CStone On September 29, 2020, we entered into a strategic collaboration with CStone to address oncological needs in China. The collaboration encompasses our $ 200 million upfront equity investment in CStone, the development and commercialization of CStones sugemalimab (CS1001, PD-L1 antibody) in mainland China, and a framework between the companies to bring additional oncology assets to the Greater China market. The transaction closed on October 9, 2020. As of December 31, 2021, we held a 9.8 % equity stake of CStone. Collaborations with BioNTech On December 30, 2021, we entered into a new research, development and commercialization agreement to develop a potential first mRNA-based vaccine for the prevention of shingles (herpes zoster virus) based on BioNTechs proprietary mRNA technology and our antigen technology. Under the terms of the agreement, we agreed to pay BioNTech $ 225 million, including an upfront cash payment of $ 75 million and an equity investment of $ 150 million. BioNTech is eligible to receive future regulatory and sales milestone payments of up to $ 200 million. In return, BioNTech agreed to pay us $ 25 million for our proprietary antigen technology. The net upfront payment to BioNTech was recorded to Research and development expenses in our fourth quarter of 2021. We and BioNTech will share development costs. We will have commercialization rights to the potential vaccine worldwide, excluding Germany, Turkey and certain developing countries where BioNTech will have commercialization rights. We and BioNTech will share gross profits from commercialization of any product. On April 9, 2020, we signed a global agreement with BioNTech to co-develop a mRNA-based coronavirus vaccine program, BNT162b2, aimed at preventing COVID-19 infection. In connection with the April 2020 agreement, we made an upfront cash payment of $ 72 million and an equity investment in the common stock of BioNTech of $ 113 million. We recognized $ 98 million for the upfront payment and a premium paid on the equity investment in Research and development expenses in our second quarter of 2020. BioNTech became eligible to receive potential milestone payments of up to $ 563 million for a total consideration of $ 748 million. Under the terms of this agreement, we and BioNTech share gross profits and development costs equally after approval and successful commercialization of the vaccine, and we were responsible for all of Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies the development costs until commercialization of the vaccine. Thereafter, BioNTech was to repay us its 50 percent share of these development costs through reductions in gross profit sharing and milestone payments to BioNTech over time. On January 29, 2021, we and BioNTech signed an amended version of the April 2020 agreement. Under the January 2021 agreement, BioNTech paid us their 50 percent share of prior development costs in a lump sum payment during the first quarter of 2021. Further RD costs are being shared equally. We have commercialization rights to the vaccine worldwide, excluding Germany and Turkey where BioNTech markets and distributes the vaccine under the agreement with us, and excluding China, Hong Kong, Macau and Taiwan, which are subject to a separate collaboration between BioNTech and Shanghai Fosun Pharmaceutical (Group) Co., Ltd. We recognize Revenues and Cost of sales on a gross basis in markets where we are commercializing the vaccine and we record our share of gross profits related to sales of the vaccine by BioNTech in Germany and Turkey in Alliance revenues. We made an additional investment of $ 50 million in common stock of BioNTech as part of an underwritten equity offering by BioNTech, which closed in July 2020. As of December 31, 2021, we held an equity stake of 2.5 % of BioNTech. Summarized Financial Information for Collaborative Arrangements The following provides the amounts and classification of payments (income/(expense)) between us and our collaboration partners: Year Ended December 31, (MILLIONS) 2021 2020 2019 Revenues Revenues (a) $ 590 $ 284 $ 305 Revenue sAlliance revenues (b) 7,652 5,418 4,648 Total revenues from collaborative arrangements $ 8,241 $ 5,703 $ 4,953 Cost of sales (c) $ ( 16,169 ) $ ( 61 ) $ ( 52 ) Selling, informational and administrative expenses (d) ( 175 ) ( 194 ) ( 176 ) Research and development expenses (e) ( 742 ) ( 192 ) 104 Other income/(deductions)net (f) 820 567 362 (a) Represents sales to our partners of products manufactured by us. (b) Substantially all relates to amounts earned from our partners under co-promotion agreements. The increase in 2021 reflects increases in alliance revenues from Comirnaty, Eliquis and Xtandi, while the increase in 2020 reflects increases in alliance revenues from Eliquis and Xtandi. (c) Primarily relates to amounts paid to collaboration partners for their share of net sales or profits earned in collaboration arrangements where we are the principal in the transaction, and cost of sales for inventory purchased from our partners. The increase in 2021 is primarily related to Comirnaty. (d) Represents net reimbursements to our partners for selling, informational and administrative expenses incurred. (e) Primarily relates to upfront payments and pre-approval milestone payments earned by our partners as well as net reimbursements. (f) Primarily relates to royalties from our collaboration partners. The amounts outlined in the above table do not include transactions with third parties other than our collaboration partners, or other costs for the products under the collaborative arrangements. Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives In 2019, we substantially completed several multi-year initiatives focused on positioning us for future growth and creating a simpler, more efficient operating structure within each business. A. Transforming to a More Focused Company Program With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We have undertaken efforts to ensure our cost base and support model align appropriately with our new operating structure. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. This program is primarily composed of the following three initiatives: We are taking steps to restructure our corporate enabling functions to appropriately support our business, RD and PGS platform functions. We expect costs, primarily related to restructuring our corporate enabling functions, to total $ 1.6 billion, with substantially all costs to be cash expenditures. Actions include, among others, changes in location of certain activities, expanded use and co-location of centers of excellence and shared services, and increased use of digital technologies. The associated actions and the specific costs will primarily include severance and benefit plan impacts, exit costs as well as associated implementation costs. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. We expect costs of $ 1.1 billion, with substantially all costs to be cash expenditures. Actions include, among others, centralization of certain activities and enhanced use of digital technologies. The costs for this effort primarily include severance and associated implementation costs. We are also optimizing our manufacturing network under this program and incurring one-time costs for cost-reduction initiatives related to our manufacturing operations. We expect to incur costs of $ 800 million, with approximately 25 % of the costs to be non-cash. The costs for this effort include, among other things, severance costs, implementation costs, product transfer costs, site exit costs, as well as accelerated depreciation. The program costs discussed above are expected to be incurred primarily from 2020 through 2022, and may be rounded and represent approximations. From the start of this program in the fourth quarter of 2019 through December 31, 2021, we incurred costs of $ 2.2 billion, of which $ 856 million is associated with Biopharma ($ 712 million in 2021, $ 79 million in 2020 and $ 64 million in 2019). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Key Activities In 2021 and 2020, we incurred costs of $ 1.3 billion and $ 838 million, respectively, composed primarily of the Transforming to a More Focused Company program. In 2019, we incurred costs of $ 820 million composed of $ 548 million for the 2017-2019 and Organizing for Growth initiatives, $ 288 million for the integration of Array, $ 94 million for the integration of Hospira, and $ 87 million for the Transforming to a More Focused Company program, partially offset by income of $ 197 million, primarily due to the reversal of certain accruals upon the effective favorable settlement of an IRS audit for multiple tax years and other acquisition-related initiatives. The following summarizes acquisitions and cost-reduction/productivity initiatives costs and credits: Year Ended December 31, (MILLIONS) 2021 2020 2019 Restructuring charges/(credits): Employee terminations $ 680 $ 474 $ 108 Asset impairments 53 66 69 Exit costs/(credits) 8 ( 6 ) 50 Restructuring charges/(credits) (a) 741 535 227 Transaction costs (b) 20 10 63 Integration costs and other (c) 41 34 311 Restructuring charges and certain acquisition-related costs 802 579 601 Net periodic benefit costs/(credits) recorded in Other (income)/deductionsnet (d) ( 63 ) 3 23 Additional depreciationasset restructuring recorded in our consolidated statements of income as follows (e) : Cost of sales 63 21 29 Selling, informational and administrative expenses 23 3 Research and development expenses ( 3 ) 8 Total additional depreciationasset restructuring 87 17 40 Implementation costs recorded in our consolidated statements of income as follows (f) : Cost of sales 45 40 61 Selling, informational and administrative expenses 426 197 73 Research and development expenses 1 1 22 Total implementation costs 472 238 156 Total costs associated with acquisitions and cost-reduction/productivity initiatives $ 1,298 $ 838 $ 820 (a) Represents acquisition-related costs ($ 9 million credit in 2021 and $ 192 million credit in 2019) and cost reduction initiatives ($ 750 million charge in 2021, $ 535 million charge in 2020, and $ 418 million charge in 2019). 2021 and 2020 charges mainly represent employee termination costs for our Transforming to a More Focused Company cost-reduction program. 2019 restructuring charges mainly represent employee termination costs for cost-reduction and productivity initiatives, partially offset by the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit for multiple tax years (see Note 5B ). The employee termination costs for 2019 were primarily for our improvements to operational effectiveness as part of the realignment of our business structure, and also included employee termination costs for the Transforming to a More Focused Company cost-reduction program. (b) Represents external costs for banking, legal, accounting and other similar services. (c) Represents external, incremental costs directly related to integrating acquired businesses, such as expenditures for consulting and the integration of systems and processes, and certain other qualifying costs. 2021 costs primarily related to our acquisition of Trillium. 2020 costs primarily related to our acquisition of Array. 2019 costs mainly related to our acquisitions of Array, including $ 157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense (see Note 2A ), and Hospira. (d) Amounts include the impact of a change in accounting principle. See Note 1C. (e) Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions. (f) Represents external, incremental costs directly related to implementing our non-acquisition-related cost-reduction/productivity initiatives. The following summarizes the components and changes in restructuring accruals: (MILLIONS) Employee Termination Costs Asset Impairment Charges Exit Costs Accrual Balance, January 1, 2020 $ 770 $ $ 46 $ 816 Provision 474 66 ( 6 ) 535 Utilization and other (a) ( 462 ) ( 66 ) ( 25 ) ( 554 ) Balance, December 31, 2020 (b) 782 15 798 Provision 680 53 8 741 Utilization and other (a) ( 449 ) ( 53 ) 34 ( 468 ) Balance, December 31, 2021 (c) $ 1,014 $ $ 57 $ 1,071 (a) Includes adjustments for foreign currency translation. (b) Included in Other current liabilities ($ 628 million) and Other noncurrent liabilities ($ 169 million). (c) Included in Other current liabilities ($ 816 million) and Other noncurrent liabilities ($ 255 million). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 4. Other (Income)/DeductionsNet Components of Other (income)/deductionsnet include: Year Ended December 31, (MILLIONS) 2021 2020 2019 Interest income $ ( 36 ) $ ( 73 ) $ ( 225 ) Interest expense (a) 1,291 1,449 1,573 Net interest expense 1,255 1,376 1,348 Royalty-related income ( 857 ) ( 770 ) ( 646 ) Net (gains)/losses on asset disposals ( 99 ) 237 ( 32 ) Net (gains)/losses recognized during the period on equity securities (b) ( 1,344 ) ( 540 ) ( 454 ) Income from collaborations, out-licensing arrangements and sales of compound/product rights (c) ( 396 ) ( 326 ) ( 168 ) Net periodic benefit costs/(credits) other than service costs (d) ( 2,547 ) 311 305 Certain legal matters, net (e) 182 28 292 Certain asset impairments (f) 86 1,691 2,792 Business and legal entity alignment costs (g) 300 Consumer Healthcare JV equity method (income)/loss (h) ( 471 ) ( 298 ) ( 17 ) Other, net (i) ( 687 ) ( 491 ) ( 224 ) Other (income)/deductionsnet $ ( 4,878 ) $ 1,219 $ 3,497 (a) Capitalized interest totaled $ 108 million in 2021, $ 96 million in 2020 and $ 88 million in 2019. (b) 2021 gains include, among other things, unrealized gains of $ 1.6 billion related to investments in BioNTech and Cerevel. 2020 gains included, among other things, unrealized gains of $ 405 million related to investments in BioNTech and SpringWorks Therapeutics, Inc. (SpringWorks). 2019 gains included, among other things, unrealized gains of $ 295 million related to investments in Cortexyme, Inc. and SpringWorks. (c) 2021 includes, among other things, $ 188 million of net collaboration income from BioNTech related to the COVID-19 vaccine and $ 97 million of milestone income from multiple licensees. 2020 included, among other things, (i) a $ 75 million upfront payment received from our sale of our CK1 assets to Biogen, (ii) $ 40 million of milestone income from Puma Biotechnology, Inc. related to Neratinib regulatory approvals in the EU, (iii) $ 30 million of milestone income from Lilly related to the first commercial sale in the U.S. of LOXO-292 for the treatment of RET fusion-positive NSCLC and (iv) $ 108 million in milestone income from multiple licensees. 2019 included, among other things, $ 78 million in milestone income from Mylan Pharmaceuticals Inc. related to the FDAs approval and launch of Wixela Inhub , a generic of Advair Diskus (fluticasone propionate and salmeterol inhalation powder) and $ 52 million in milestone income from multiple licensees. (d) Amounts include the impact of a change in accounting principle. See Notes 1C and 11 . In 2019, other non-service cost components activity related to the Consumer Healthcare JV transaction, such as gain on settlements, were recorded in (Gain) on completion of Consumer Healthcare JV transaction. (e) Includes legal reserves for certain pending legal matters. (f) 2020 represents intangible asset impairment charges associated with our Biopharma segment: (i) $ 900 million related to IPRD assets for unapproved indications of certain cancer medicines, acquired in our Array acquisition, and reflected, among other things, updated commercial forecasts; (ii) $ 528 million related to Eucrisa, a finite-lived developed technology right acquired in our Anacor acquisition, and reflected updated commercial forecasts mainly reflecting competitive pressures; and (iii) $ 263 million related to finite-lived developed technology rights for certain generic sterile injectables acquired in our Hospira acquisition, and reflected updated commercial forecasts mainly reflecting competitive pressures. 2019 primarily included intangible asset impairment charges of $ 2.8 billion, mainly composed of $ 2.6 billion, related to Eucrisa, and reflected updated commercial forecasts mainly reflecting competitive pressures. (g) Mainly represents incremental costs for the design, planning and implementation of our then new business structure, effective in the beginning of 2019, and primarily includes consulting, legal, tax and other advisory services. (h) See Note 2C . (i) 2021 includes, among other things, (i) income net of costs associated with TSAs of $ 288 million; (ii) dividend income of $ 166 million from our investment in ViiV and (iii) charges of $ 142 million, reflecting the change in the fair value of contingent consideration. 2020 included, among other things, (i) dividend income of $ 278 million from our investment in ViiV; (ii) income net of costs associated with TSAs of $ 114 million and (iii) charges of $ 105 million, reflecting the change in the fair value of contingent consideration. 2019 included, among other things, (i) dividend income of $ 220 million from our investment in ViiV; (ii) charges of $ 152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV; and (iii) net losses on early retirement of debt of $ 138 million. The asset impairment charges included in Other (income)/deductionsnet are based on estimates of fair value. Note 5. Tax Matters A. Taxes on Income from Continuing Operations Components of Income from continuing operations before provision/(benefit) for taxes on income include: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States $ 6,064 $ ( 2,887 ) $ 7,332 International 18,247 9,924 3,988 Income from continuing operations before provision/(benefit) for taxes on income ( a), (b) $ 24,311 $ 7,036 $ 11,321 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (a) 2021 v. 2020 The domestic income in 2021 versus domestic loss in 2020 was mainly related to Comirnaty income, lower asset impairment charges, net periodic benefit credits in 2021 versus net periodic benefit costs in 2020 and higher net gains from equity securities, partially offset by higher RD expenses. The increase in the international income was primarily related to Comirnaty income, net periodic benefit credits in 2021 versus net periodic benefit costs in 2020 and lower asset impairment charges. (b) 2020 v. 2019 The domestic loss in 2020 versus domestic income in 2019 was mainly related to the non-recurrence of the gain on the completion of the Consumer Healthcare JV transaction as well as higher asset impairment charges and higher RD expenses. The increase in the international income was primarily related to the non-recurrence of the write off of assets contributed to the Consumer Healthcare JV as well as lower asset impairment charges and lower amortization of intangible assets. Components of Provision/(benefit) for taxes on income based on the location of the taxing authorities include: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States Current income taxes: Federal $ 3,342 $ 372 $ ( 1,887 ) State and local 34 56 ( 186 ) Deferred income taxes: Federal ( 3,850 ) ( 1,164 ) 1,254 State and local ( 491 ) ( 131 ) 276 Total U.S. tax benefit ( 964 ) ( 867 ) ( 543 ) TCJA Current income taxes ( 135 ) Deferred Income taxes ( 187 ) Total TCJA tax benefit ( 323 ) International Current income taxes 2,769 1,517 2,418 Deferred income taxes 48 ( 279 ) ( 969 ) Total international tax provision 2,816 1,237 1,449 Provision/(benefit) for taxes on income $ 1,852 $ 370 $ 583 Amounts discussed below are rounded to the nearest hundred million and represent approximations. We elected, with the filing of our 2018 U.S. Federal Consolidated Income Tax Return, to pay our initial estimated $ 15 billion repatriation tax liability on accumulated post-1986 foreign earnings over eight years through 2026. The third annual installment of this liability was paid by its April 15, 2021 due date. The fourth annual installment is due April 18, 2022 and is reported in current Income taxes payable as of December 31, 2021. The remaining liability is reported in noncurrent Other taxes payable. Our obligations may vary as a result of changes in our uncertain tax positions and/or availability of attributes such as foreign tax and other credit carryforwards. The changes in Provision/(benefit) for taxes on income impacting the effective tax rate year-over-year are summarized below: 2021 v. 2020 The higher effective tax rate in 2021 was mainly the result of: the change in the jurisdictional mix of earnings primarily related to Comirnaty; and lower tax benefits related to the impairment of intangible assets, partially offset by: certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV with GSK based on estimates and assumptions that we believe to be reasonable. 2020 v. 2019 The higher effective tax rate in 2020 was mainly the result of: the non-recurrence of the $ 1.4 billion tax benefits, representing taxes and interest, recorded in 2019 due to the favorable settlement of an IRS audit for multiple tax years; the non-recurrence of the tax benefits related to certain tax initiatives associated with the implementation of our then new business structure; and the non-recurrence of the tax benefits recorded in 2019 as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA, as well as: lower tax benefits related to the impairment of intangible assets, partially offset by: the non-recurrence of the tax expense of $ 2.7 billion recorded in the third quarter of 2019 associated with the gain on the completion of the Consumer Healthcare JV transaction; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. In all years, federal, state and international net tax liabilities assumed or established as part of a business acquisition are not included in Provision/(benefit) for taxes on income (see Note 2A ). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Tax Rate Reconciliation The reconciliation of the U.S. statutory income tax rate to our effective tax rate for Income from continuing operations follows: Year Ended December 31, 2021 2020 2019 U.S. statutory income tax rate 21.0 % 21.0 % 21.0 % TCJA impact (a) ( 2.9 ) Taxation of non-U.S. operations (b), (c) ( 4.3 ) ( 9.9 ) ( 4.7 ) Tax settlements and resolution of certain tax positions (a) ( 0.4 ) ( 2.7 ) ( 14.0 ) Completion of Consumer Healthcare JV transaction (a) 8.3 Certain Consumer Healthcare JV initiatives (a) ( 6.0 ) U.S. RD tax credit ( 0.5 ) ( 1.4 ) ( 0.8 ) Interest (d) 0.4 1.1 0.6 All other, net (e) ( 2.6 ) ( 2.8 ) ( 2.3 ) Effective tax rate for income from continuing operations 7.6 % 5.3 % 5.2 % (a) See Note 5A. (b) For taxation of non-U.S. operations, this rate impact reflects the income tax rates and relative earnings in the locations where we do business outside the U.S., together with the U.S. tax cost on our international operations, changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions, as well as changes in valuation allowances. Specifically: (i) the jurisdictional location of earnings is a significant component of our effective tax rate each year, and the rate impact of this component is influenced by the specific location of non-U.S. earnings and the level of such earnings as compared to our total earnings; (ii) the U.S. tax implications of our foreign operations is a significant component of our effective tax rate each year and generally offsets some of the reduction to our effective tax rate each year resulting from the jurisdictional location of earnings; (iii) the impact of certain tax initiatives; and (iv) the impact of changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions is a component of our effective tax rate each year that can result in either an increase or decrease to our effective tax rate. The jurisdictional mix of earnings, which includes the impact of the location of earnings as well as the U.S. tax cost on our international operations, can vary as a result of operating fluctuations in the normal course of business and as a result of the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on strategic business decisions. See also Note 5A for the components of pre-tax income and Provision/(benefit) for taxes on income, which is based on the location of the taxing authorities, and for information about settlements and other items impacting Provision/(benefit) for taxes on income . (c) In all years, the reduction in our effective tax rate is a result of the jurisdictional location of earnings and is largely due to lower tax rates in certain jurisdictions, as well as manufacturing and other incentives for our subsidiaries in Singapore and, to a lesser extent, in Puerto Rico. We benefit from Puerto Rican tax incentives pursuant to a grant that expires during 2029. Under such grant, we are partially exempt from income, property and municipal taxes. In Singapore, we benefit from incentive tax rates effective through 2047 on income from manufacturing and other operations. (d) Includes changes in interest related to our uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions. (e) All other, net is primarily due to routine business operations. C. Deferred Taxes Components of our deferred tax assets and liabilities, shown before jurisdictional netting, follow: 2021 Deferred Tax* 2020 Deferred Tax* (MILLIONS) Assets (Liabilities) Assets (Liabilities) Prepaid/deferred items (a) $ 4,086 $ ( 456 ) $ 3,114 $ ( 336 ) Inventories 408 ( 56 ) 276 ( 25 ) Intangible assets (b) 1,778 ( 4,577 ) 793 ( 5,355 ) Property, plant and equipment (c) 117 ( 1,647 ) 211 ( 1,220 ) Employee benefits (d) 1,594 ( 178 ) 1,981 ( 124 ) Restructurings and other charges 303 291 Legal and product liability reserves 373 382 Net operating loss/tax credit carryforwards (e) 1,431 1,761 Unremitted earnings ( 45 ) ( 46 ) State and local tax adjustments 197 171 Investments (f) 70 ( 689 ) 130 ( 3,545 ) All other 89 ( 68 ) 80 ( 76 ) 10,446 ( 7,714 ) 9,190 ( 10,726 ) Valuation allowances ( 1,462 ) ( 1,586 ) Total deferred taxes $ 8,983 $ ( 7,714 ) $ 7,604 $ ( 10,726 ) Net deferred tax asset/(liability) (g) $ 1,269 $ ( 3,123 ) * The deferred tax assets and liabilities associated with global intangible low-taxed income are included in the relevant categories. See Note 1Q . (a) The increase in net deferred tax assets in 2021 is primarily related to temporary differences associated with Comirnaty royalty accruals and the result of operating lease ROU liabilities recognized during the period. (b) The increase in the deferred tax assets is primarily due to the acquisition of intangible assets relating to Trillium and the decrease in the 2021 deferred tax liabilities is primarily the result of amortization of intangible assets. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (c) The increase in net deferred tax liabilities in 2021 is primarily the result of operating lease ROU assets recognized during the period. See Note 15 . (d) The decrease in net deferred tax assets in 2021 is primarily the result of favorable pension plan asset performance reported in the period. See Note 11A . (e) The amounts in 2021 and 2020 are reduced for unrecognized tax benefits of $ 3.0 billion and $ 3.0 billion, respectively, where we have net operating loss carryforwards, similar tax losses, and/or tax credit carryforwards that are available, under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position. (f) The decrease in net deferred tax liabilities in 2021 is primarily due to certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV. (g) In 2021, Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.6 billion), and Noncurrent deferred tax liabilities ($ 0.3 billion). In 2020, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.9 billion), and Noncurrent deferred tax liabilities ($ 4.1 billion). We have carryforwards, primarily related to net operating and capital losses, general business credits, foreign tax credits and charitable contributions, which are available to reduce future U.S. federal and/or state, as well as international, income taxes payable with either an indefinite life or expiring at various times from 2022 to 2041. Certain of our U.S. net operating losses and general business credits are subject to limitations under IRC Section 382. As of December 31, 2021, we have not made a U.S. tax provision on $ 55.0 billion of unremitted earnings of our international subsidiaries. As these earnings are intended to be indefinitely reinvested overseas, the determination of a hypothetical unrecognized deferred tax liability as of December 31, 2021 is not practicable. The amount of indefinitely reinvested earnings is based on estimates and assumptions and subject to management evaluation, and is subject to change in the normal course of business based on operational cash flow, completion of local statutory financial statements and the finalization of tax returns and audits, among other things. Accordingly, we regularly update our earnings and profits analysis for such events. D. Tax Contingencies For a description of our accounting policies associated with accounting for income tax contingencies, see Note 1Q. Uncertain Tax Positions As tax law is complex and often subject to varied interpretations, it is uncertain whether some of our tax positions will be sustained upon audit. As of December 31, 2021, we had $ 4.5 billion and as of December 31, 2020, we had $ 4.3 billion in net unrecognized tax benefits, excluding associated interest. Tax assets for uncertain tax positions primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. As of December 31, 2021, we had $ 1.5 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.4 billion) and Other taxes payable ($ 105 million). As of December 31, 2020, we had $ 1.3 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.1 billion), Noncurrent deferred tax liabilities ($ 122 million) and Other taxes payable ($ 46 million). Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. The reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows: (MILLIONS) 2021 2020 2019 Balance, beginning $ ( 5,595 ) $ ( 5,381 ) $ ( 6,259 ) Acquisitions 37 ( 44 ) Divestitures (a) 265 Increases based on tax positions taken during a prior period (b) ( 111 ) ( 232 ) ( 36 ) Decreases based on tax positions taken during a prior period (b), (c) 103 64 1,109 Decreases based on settlements for a prior period (d) 24 15 100 Increases based on tax positions taken during the current period (b) ( 550 ) ( 411 ) ( 383 ) Impact of foreign exchange 22 ( 72 ) 25 Other, net (b), (e) 40 120 107 Balance, ending (f) $ ( 6,068 ) $ ( 5,595 ) $ ( 5,381 ) (a) For 2020, related to the separation of Upjohn. See Note 2B . (b) Primarily included in Provision/(benefit) for taxes on income. (c) Primarily related to effectively settling certain issues with the U.S. and foreign tax authorities. See Note 5A. (d) Primarily related to cash payments and reductions of tax attributes. (e) Primarily related to decreases as a result of a lapse of applicable statutes of limitations. (f) In 2021, included in Income taxes payable ($ 19 million), Other current assets ($ 42 million) Noncurrent deferred tax assets and other noncurrent tax assets ($ 3.0 billion), Noncurrent deferred tax liabilities ($ 5 million) and Other taxes payable ($ 3.0 billion). In 2020, included in Income taxes payable ($ 34 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 18 million), Noncurrent deferred tax liabilities ($ 3.0 billion) and Other taxes payable ($ 2.5 billion). Interest related to our unrecognized tax benefits is recorded in accordance with the laws of each jurisdiction and is recorded primarily in Provision/(benefit) for taxes on income . In 2021 and 2020, we recorded net increases in interest of $ 108 million and $ 89 million, respectively. In 2019, we recorded a net decrease in interest of $ 564 million, resulting primarily from a settlement with the IRS. Gross accrued interest totaled $ 601 million as of December 31, 2021 (reflecting a decrease of $ 1 million as a result of cash payments) and gross Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies accrued interest totaled $ 493 million as of December 31, 2020 (reflecting a decrease of $ 5 million as a result of cash payments and a decrease of $ 75 million relating to the separation of Upjohn). In 2021 and 2020, these amounts were substantially all included in Other taxes payable. Accrued penalties are not significant. See also Note 5A. Status of Tax Audits and Potential Impact on Accruals for Uncertain Tax Positions The U.S. is one of our major tax jurisdictions, and we are regularly audited by the IRS. With respect to Pfizer, the IRS has issued Revenue Agents Reports (RARs) for tax years 2011-2013 and 2014-2015. We are not in agreement with the RARs and are currently appealing certain disputed issues. Tax years 2016-2018 are currently under audit. Tax years 2019-2021 are open, but not under audit. All other tax years are closed. In addition to the open audit years in the U.S., we have open audit years in certain major international tax jurisdictions such as Canada (2013-2021), Europe (2011-2021, primarily reflecting Ireland, the U.K., France, Italy, Spain and Germany), Asia Pacific (2011-2021, primarily reflecting China, Japan and Singapore) and Latin America (1998-2021, primarily reflecting Brazil). Any settlements or statutes of limitations expirations could result in a significant decrease in our uncertain tax positions. We estimate that it is reasonably possible that within the next 12 months, our gross unrecognized tax benefits, exclusive of interest, could decrease by as much as $ 75 million, as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant. E. Tax Provision/(Benefit) on Other Comprehensive Income/(Loss) Components of the Tax provision/(benefit) on other comprehensive income/(loss) include: Year Ended December 31, (MILLIONS) 2021 2020 2019 Foreign currency translation adjustments, net (a) $ 43 $ ( 119 ) $ 260 Unrealized holding gains/(losses) on derivative financial instruments, net 84 ( 88 ) 83 Reclassification adjustments for (gains)/losses included in net income 29 ( 25 ) ( 125 ) 114 ( 113 ) ( 42 ) Unrealized holding gains/(losses) on available-for-sale securities, net ( 44 ) 45 Reclassification adjustments for (gains)/losses included in net income ( 4 ) ( 24 ) 5 ( 48 ) 22 5 Benefit plans: prior service (costs)/credits and other, net 27 12 ( 1 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 47 ) ( 31 ) ( 43 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 17 ) ( 1 ) Other ( 1 ) 1 ( 38 ) ( 17 ) ( 45 ) Tax provision/(benefit) on other comprehensive income/(loss) $ 71 $ ( 227 ) $ 178 (a) Taxes are not provided for foreign currency translation adjustments relating to investments in international subsidiaries that are expected to be held indefinitely. Note 6. Accumulated Other Comprehensive Loss, Excluding Noncontrolling Interests The following summarizes the changes, net of tax, in Accumulated other comprehensive loss (a) : Net Unrealized Gains/(Losses) Benefit Plans (MILLIONS) Foreign Currency Translation Adjustments Derivative Financial Instruments Available-For-Sale Securities Prior Service (Costs)/ Credits and Other Accumulated Other Comprehensive Income/(Loss) Balance, January 1, 2019 $ ( 6,075 ) $ 167 $ ( 68 ) $ 728 $ ( 5,249 ) Other comprehensive income/(loss) (b) 139 ( 146 ) 33 ( 144 ) ( 118 ) Balance, December 31, 2019 ( 5,936 ) 20 ( 35 ) 584 ( 5,367 ) Other comprehensive income/(loss) (b) 883 ( 448 ) 151 ( 106 ) 480 Distribution of Upjohn Business (c) ( 397 ) ( 26 ) ( 423 ) Balance, December 31, 2020 ( 5,450 ) ( 428 ) 116 452 ( 5,310 ) Other comprehensive income/(loss) (b) ( 722 ) 547 ( 336 ) ( 75 ) ( 587 ) Balance, December 31, 2021 $ ( 6,172 ) $ 119 $ ( 220 ) $ 377 $ ( 5,897 ) (a) Amounts include the impact of a change in accounting principle. See Note 1C. (b) Amounts do not include foreign currency translation adjustments attributable to noncontrolling interests. Foreign currency translation adjustments include net losses in 2021 and net gains in 2020 and 2019 related to our equity-method investment in the Consumer Healthcare JV (see Note 2C ) , and the impact of our net investment hedging program. (c) For more information, see Note 2B. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 7. Financial Instruments A. Fair Value Measurements Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis and Fair Value Hierarchy, using a Market Approach: As of December 31, 2021 As of December 31, 2020 (MILLIONS) Total Level 1 Level 2 Total Level 1 Level 2 Financial assets: Short-term investments Classified as equity securities with readily determinable fair values: Money market funds $ 5,365 $ $ 5,365 $ 567 $ $ 567 Classified as available-for-sale debt securities: Government and agencynon-U.S. 17,318 17,318 7,719 7,719 Government and agencyU.S. 4,050 4,050 982 982 Corporate and other 647 647 1,008 1,008 22,014 22,014 9,709 9,709 Total short-term investments 27,379 27,379 10,276 10,276 Other current assets Derivative assets: Interest rate contracts 4 4 18 18 Foreign exchange contracts 704 704 234 234 Total other current assets 709 709 251 251 Long-term investments Classified as equity securities with readily determinable fair values (a) 3,876 3,849 27 2,809 2,776 32 Classified as available-for-sale debt securities: Government and agencynon-U.S. 465 465 6 6 Government and agencyU.S. 6 6 121 121 Corporate and other 50 50 521 521 128 128 Total long-term investments 4,397 3,849 548 2,936 2,776 160 Other noncurrent assets Derivative assets: Interest rate contracts 16 16 117 117 Foreign exchange contracts 242 242 5 5 Total derivative assets 259 259 122 122 Insurance contracts (b) 808 808 693 693 Total other noncurrent assets 1,067 1,067 814 814 Total assets $ 33,552 $ 3,849 $ 29,703 $ 14,278 $ 2,776 $ 11,501 Financial liabilities: Other current liabilities Derivative liabilities: Foreign exchange contracts $ 476 $ $ 476 $ 501 $ $ 501 Total other current liabilities 476 476 501 501 Other noncurrent liabilities Derivative liabilities: Foreign exchange contracts 405 405 599 599 Total other noncurrent liabilities 405 405 599 599 Total liabilities $ 881 $ $ 881 $ 1,100 $ $ 1,100 (a) Long-term equity securities of $ 194 million as of December 31, 2021 and $ 190 million as of December 31, 2020 were held in restricted trusts for U.S. non-qualified employee benefit plans. (b) Includes life insurance policies held in restricted trusts for U.S. non-qualified employee benefit plans. The underlying invested assets in these contracts are marketable securities, which are carried at fair value, with changes in fair value recognized in Other (income)/deductionsnet (see Note 4 ) . Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis The carrying value of Long-term debt, excluding the current portion was $ 36 billion as of December 31, 2021 and $ 37 billion as of December 31, 2020. The estimated fair value of such debt, using a market approach and Level 2 inputs, was $ 42 billion as of December 31, 2021 and $ 46 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The differences between the estimated fair values and carrying values of held-to-maturity debt securities, private equity securities, long-term receivables and short-term borrowings not measured at fair value on a recurring basis were not significant as of December 31, 2021 and 2020. The fair value measurements of our held-to-maturity debt securities and short-term borrowings are based on Level 2 inputs. The fair value measurements of our long-term receivables and private equity securities are based on Level 3 inputs. B. Investments Total Short-Term, Long-Term and Equity-Method Investments The following summarizes our investments by classification type: As of December 31, (MILLIONS) 2021 2020 Short-term investments Equity securities with readily determinable fair values (a) $ 5,365 $ 567 Available-for-sale debt securities 22,014 9,709 Held-to-maturity debt securities 1,746 161 Total Short-term investments $ 29,125 $ 10,437 Long-term investments Equity securities with readily determinable fair values $ 3,876 $ 2,809 Available-for-sale debt securities 521 128 Held-to-maturity debt securities 34 37 Private equity securities at cost (b) 623 432 Total Long-term investments $ 5,054 $ 3,406 Equity-method investments 16,472 16,856 Total long-term investments and equity-method investments $ 21,526 $ 20,262 Held-to-maturity cash equivalents $ 268 $ 89 (a) As of December 31, 2021 and 2020, includes money market funds primarily invested in U.S. Treasury and government debt. (b) Represent investments in the life sciences sector. Debt Securities At December 31, 2021, our investment portfolio consisted of debt securities issued across diverse governments, corporate and financial institutions, which are investment-grade. The contractual or estimated maturities, are as follows: As of December 31, 2021 As of December 31, 2020 Gross Unrealized Maturities (in Years) Gross Unrealized (MILLIONS) Amortized Cost Gains Losses Fair Value Within 1 Over 1 to 5 Over 5 Amortized Cost Gains Losses Fair Value Available-for-sale debt securities Government and agency non-U.S. $ 18,032 $ 13 $ ( 263 ) $ 17,783 $ 17,318 $ 465 $ $ 7,593 $ 136 $ ( 4 ) $ 7,725 Government and agency U.S. 4,056 ( 1 ) 4,055 4,050 6 1,104 ( 1 ) 1,103 Corporate and other 698 ( 1 ) 697 647 50 1,006 2 1,008 Held-to-maturity debt securities Time deposits and other 947 947 917 18 11 283 283 Government and agency non-U.S. 1,102 1,102 1,097 4 1 5 5 Total debt securities $ 24,835 $ 14 $ ( 265 ) $ 24,584 $ 24,029 $ 543 $ 13 $ 9,991 $ 138 $ ( 5 ) $ 10,124 Any expected credit losses to these portfolios would be immaterial to our financial statements. Equity Securities The following presents the calculation of the portion of unrealized (gains)/losses that relates to equity securities, excluding equity method investments, held at the reporting date: Year Ended December 31, (MILLIONS) 2021 2020 2019 Net (gains)/losses recognized during the period on equity securities (a) $ ( 1,344 ) $ ( 540 ) $ ( 454 ) Less: Net (gains)/losses recognized during the period on equity securities sold during the period ( 80 ) ( 24 ) ( 25 ) Net unrealized (gains)/losses during the reporting period on equity securities still held at the reporting date (b) $ ( 1,264 ) $ ( 515 ) $ ( 429 ) (a) Reported in Other (income)/deductions net. See Note 4 . (b) Included in net unrealized gains are observable price changes on equity securities without readily determinable fair values. As of December 31, 2021, there were cumulative impairments and downward adjustments of $ 97 million and upward adjustments of $ 156 million. Impairments, downward and upward adjustments were not significant in 2021, 2020 and 2019 . Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Short-Term Borrowings Short-term borrowings include: As of December 31, (MILLIONS) 2021 2020 Commercial paper $ $ 556 Current portion of long-term debt, principal amount 1,636 2,004 Other short-term borrowings, principal amount (a) 605 145 Total short-term borrowings, principal amount 2,241 2,705 Net unamortized discounts, premiums and debt issuance costs ( 2 ) Total Short-term borrowings, including current portion of long-term debt , carried at historical proceeds, as adjusted $ 2,241 $ 2,703 (a) Primarily includes cash collateral. See Note 7F . The weighted-average effective interest rate on commercial paper outstanding was approximately 0.13 % as of December 31, 2020. As of December 31, 2021, we had access to a $ 7 billion committed U.S. revolving credit facility expiring in 2026, which may be used for general corporate purposes including to support our commercial paper borrowings. In addition to the U.S. revolving credit facility, our lenders have provided us an additional $ 360 million in lines of credit, of which $ 322 million expire within one year. Essentially all lines of credit were unused as of December 31, 2021. D. Long-Term Debt The following outlines our senior unsecured long-term debt and the weighted-average stated interest rate by maturity: As of December 31, (MILLIONS) 2021 2020 Notes due 2022 ( 1.0 % for 2020) (a) $ $ 1,728 Notes due 2023 ( 3.2 % for 2021 and 2020) 2,550 2,550 Notes due 2024 ( 3.9 % for 2021 and 2020) 2,250 2,250 Notes due 2025 ( 0.8 % for 2021 and 2020) 750 750 Notes due 2026 ( 2.9 % for 2021 and 2020) 3,000 3,000 Notes due 2027 ( 2.1 % for 2021 and 2.0 % for 2020) 1,051 1,121 Notes due 2028-2032 ( 3.1 % for 2021 and 3.4 % for 2020) 6,660 5,660 Notes due 2033-2037 ( 5.6 % for 2021 and 2020) 4,250 4,250 Notes due 2038-2042 ( 5.5 % for 2021 and 2020) 6,079 6,086 Notes due 2043-2047 ( 3.7 % for 2021 and 2020) 4,858 4,878 Notes due 2048-2050 ( 3.6 % for 2021 and 2020) 3,500 3,500 Total long-term debt, principal amount 34,948 35,774 Net fair value adjustments related to hedging and purchase accounting 1,438 1,562 Net unamortized discounts, premiums and debt issuance costs ( 195 ) ( 207 ) Other long-term debt 4 4 Total long-term debt, carried at historical proceeds, as adjusted $ 36,195 $ 37,133 Current portion of long-term debt, carried at historical proceeds, as adjusted (not included above ( 1.0 % for 2021 and 2.6 % for 2020)) $ 1,636 $ 2,002 (a) Reclassified to the current portion of long-term debt. Our long-term debt outlined in the above table is generally redeemable by us at any time at varying redemption prices plus accrued and unpaid interest. Issuances In August 2021, we issued the following senior unsecured notes at an effective interest rate of 1.79 %: (MILLIONS) Principal Interest Rate Maturity Date As of December 31, 2021 1.750 % (a) August 18, 2031 $ 1,000 (a) The notes may be redeemed by us at any time, in whole, or in part, at a redemption price plus accrued and unpaid interest. In May 2020, we completed a public offering of $ 4.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 2.11 % and in March 2020, we completed a public offering of $ 1.25 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 2.67 %. In March 2019, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.57 %. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Retirements In November 2020, we repurchased all $ 1.15 billion and $ 342 million principal amount outstanding of the 1.95 % senior unsecured notes due June 2021 and 5.80 % senior unsecured notes due August 2023 and recorded a total net loss of $ 36 million, in Other (income)/deductionsnet. See Note 2B . In March 2020, we repurchased at par all $ 1.065 billion principal amount outstanding of our senior unsecured notes due in 2047. In January 2019, we repurchased all 1.1 billion ($ 1.3 billion) principal amount outstanding of the 5.75 % euro-denominated debt due June 2021 at a redemption value of 1.3 billion ($ 1.5 billion). We recorded a net loss of $ 138 million in Other (income)/deductionsnet , which included the related termination of cross currency swaps . E. Derivative Financial Instruments and Hedging Activities Foreign Exchange Risk A significant portion of our revenues, earnings and net investments in foreign affiliates is exposed to changes in foreign exchange rates. Where foreign exchange risk is not offset by other exposures, we manage our foreign exchange risk principally through the use of derivative financial instruments and foreign currency debt. These financial instruments serve to mitigate the impact on net income as a result of remeasurement into another currency, or against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions. The derivative financial instruments primarily hedge or offset exposures in the euro, U.K. pound, Japanese yen and Canadian dollar. We hedge a portion of our forecasted intercompany inventory sales denominated in euro, Japanese yen, Canadian dollar, Chinese renminbi, U.K. pound and Australian dollar for up to two years . Under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. Changes in fair value are reported in earnings or in Other comprehensive income/(loss) , depending on the nature and purpose of the financial instrument (hedge or offset relationship). For certain foreign exchange contracts, we exclude an amount from the assessment of hedge effectiveness and recognize the excluded amount through an amortization approach in earnings. The hedge relationships are as follows: Generally, we recognize the gains and losses on foreign exchange contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged item. We also recognize the offsetting foreign exchange impact attributable to the hedged item in earnings. Generally, we record in Other comprehensive income/(loss) gains or losses on foreign exchange contracts that are designated as cash flow hedges and reclassify those amounts into earnings in the same period or periods during which the hedged transaction affects earnings. We record in Other comprehensive income/(loss) Foreign currency translation adjustments, net the foreign exchange gains and losses related to foreign exchange-denominated debt and foreign exchange contracts designated as a hedge of our net investments in foreign subsidiaries and reclassify those amounts into earnings upon the sale or substantial liquidation of our net investments. For foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses immediately into earnings along with the earnings impact of the items they generally offset. These contracts take the opposite currency position of that reflected on the balance sheet to counterbalance the effect of any currency movement. Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt or investments to fixed rates. The derivative financial instruments primarily hedge U.S. dollar fixed-rate debt. We recognize the change in fair value on interest rate contracts that are designated as fair value hedges in earnings, as well as the offsetting earnings impact of the hedged risk attributable to the hedged item. The following summarizes the fair value of the derivative financial instruments and notional amounts (including those reported as part of discontinued operations): (MILLIONS) As of December 31, 2021 As of December 31, 2020 Fair Value Fair Value Notional Asset Liability Notional Asset Liability Derivatives designated as hedging instruments: Foreign exchange contracts (a) $ 29,576 $ 787 $ 717 $ 24,369 $ 145 $ 1,005 Interest rate contracts 2,250 21 1,950 135 808 717 280 1,005 Derivatives not designated as hedging instruments: Foreign exchange contracts $ 21,419 160 164 $ 15,063 94 95 Total $ 968 $ 881 $ 373 $ 1,100 (a) The notional amount of outstanding foreign exchange contracts hedging our intercompany forecasted inventory sales was $ 4.8 billion as of December 31, 2021 and $ 5.0 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes information about the gains/(losses) incurred to hedge or offset operational foreign exchange or interest rate risk exposures (including those reported as part of discontinued operations): Gains/(Losses) Recognized in OID (a) Gains/(Losses) Recognized in OCI (a) Gains/(Losses) Reclassified from OCI into OID and COS (a) Year Ended December 31, (MILLIONS) 2021 2020 2021 2020 2021 2020 Derivative Financial Instruments in Cash Flow Hedge Relationships: Foreign exchange contracts (b) $ $ $ 488 $ ( 649 ) $ ( 173 ) $ ( 77 ) Amount excluded from effectiveness testing and amortized into earnings (c) 38 55 38 57 Derivative Financial Instruments in Fair Value Hedge Relationships: Interest rate contracts ( 7 ) 369 Hedged item 7 ( 369 ) Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign exchange contracts 468 ( 501 ) Amount excluded from effectiveness testing and amortized into earnings (c) 52 181 109 154 Non-Derivative Financial Instruments in Net Investment Hedge Relationships: (d) Foreign currency short-term borrowings 78 8 Foreign currency long-term debt 86 ( 183 ) Derivative Financial Instruments Not Designated as Hedges: Foreign exchange contracts ( 192 ) 178 All other net (c) 1 12 1 ( 1 ) $ ( 192 ) $ 178 $ 1,210 $ ( 1,077 ) $ ( 25 ) $ 133 (a) OID = Other (income)/deductionsnet, included in Other (income)/deductionsnet in the consolidated statements of income . COS = Cost of Sales, included in Cost of sales in the consolidated statements of income. OCI = Other comprehensive income/(loss), included in the consolidated statements of comprehensive income . (b) The amounts reclassified from OCI into COS were: a net loss of $ 89 million in 2021; and a net gain of $ 172 million in 2020 (including a gain of $ 22 million reported in Discontinued operationsnet of tax ). The remaining amounts were reclassified from OCI into OID. Based on year-end foreign exchange rates that are subject to change, we expect to reclassify a pre-tax gain of $ 362 million within the next 12 months into income . The maximum length of time over which we are hedging our exposure to the variability in future foreign exchange cash flows is approximately 21 years and relates to foreign currency debt. (c) The amounts reclassified from OCI were reclassified into OID. (d) Short-term borrowings and long-term debt include foreign currency borrowings which are used as net investment hedges. The short-term borrowings carrying value as of December 31, 2021 was $ 1.1 billion. The long-term debt carrying values as of December 31, 2021 and December 31, 2020 were $ 844 million and $ 2.1 billion, respectively. The following summarizes cumulative basis adjustments to our long-term debt in fair value hedges: As of December 31, 2021 As of December 31, 2020 Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount (MILLIONS) Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Long-term debt $ 2,233 $ 16 $ 1,154 $ 2,016 $ 117 $ 1,149 (a) Carrying amounts exclude the cumulative amount of fair value hedging adjustments. F . Credit Risk On an ongoing basis, we monitor and review the credit risk of our customers, financial institutions and exposures in our investment portfolio. With respect to our trade accounts receivable, we monitor the creditworthiness of our customers to which we grant credit in the normal course of business. In general, there is no requirement for collateral from customers. For additional information on our trade accounts receivable and Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies allowance for credit losses, see Note 1H . A significant portion of our trade accounts receivable balances are due from wholesalers and governments. For additional information on our trade accounts receivables with significant customers, see Note 17C . With respect to our investments, we monitor concentrations of credit risk associated with government, government agency, and corporate issuers of securities. Investments are placed in instruments that are investment grade and are primarily short in duration. Exposure limits are established to limit a concentration with any single credit counterparty. As of December 31, 2021, the largest investment exposures in our portfolio represent primarily sovereign debt instruments issued by the U.S., Canada, Japan, U.K., Germany, France, Australia, and Switzerland. With respect to our derivative financial instrument agreements with financial institutions, we do not expect to incur a significant loss from failure of any counterparty. Derivative financial instruments are executed under International Swaps and Derivatives Association (ISDA) master agreements with credit-support annexes that contain zero threshold provisions requiring collateral to be exchanged daily depending on levels of exposure. As a result, there are no significant concentrations of credit risk with any individual financial institution. As of December 31, 2021, the aggregate fair value of these derivative financial instruments that are in a net payable position was $ 372 million, for which we have posted collateral of $ 382 million with a corresponding amount reported in Short-term investments . As of December 31, 2021, the aggregate fair value of our derivative financial instruments that are in a net receivable position was $ 477 million, for which we have received collateral of $ 581 million with a corresponding amount reported in Short-term borrowings, including current portion of long-term debt. Note 8. Other Financial Information A. Inventories The following summarizes the components of Inventories : As of December 31, (MILLIONS) 2021 2020 Finished goods $ 3,641 $ 2,867 Work in process 4,424 4,436 Raw materials and supplies 994 716 Inventories (a) $ 9,059 $ 8,020 Noncurrent inventories not included above (b) $ 939 $ 890 (a) The change from December 31, 2020 reflects increases for certain products, including inventory build for new product launches (primarily Comirnaty), network strategy and supply recovery, partially offset by decreases due to market demand. (b) Included in Other noncurrent assets . There are no recoverability issues for these amounts. B. Other Current Liabilities Other current liabilities includes, among other things, amounts payable to BioNTech for the gross profit split for Comirnaty, which totaled $ 9.7 billion as of December 31, 2021 and $ 25 million as of December 31, 2020. Note 9. Property, Plant and Equipment (PPE) The following summarizes the components of Property, plant and equipment : Useful Lives As of December 31, (MILLIONS) (Years) 2021 2020 Land - $ 423 $ 443 Buildings 33 - 50 9,001 8,998 Machinery and equipment 8 - 20 12,252 11,000 Furniture, fixtures and other 3 - 12.5 4,457 4,484 Construction in progress - 3,822 3,481 29,955 28,406 Less: Accumulated depreciation 15,074 14,661 Property, plant and equipment $ 14,882 $ 13,745 The following provides long-lived assets by geographic area: As of December 31, (MILLIONS) 2021 2020 Property, plant and equipment United States $ 8,385 $ 7,666 Developed Europe 5,094 4,775 Developed Rest of World 347 413 Emerging Markets 1,056 890 Property, plant and equipment $ 14,882 $ 13,745 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 10. Identifiable Intangible Assets and Goodwill A. Identifiable Intangible Assets The following summarizes the components of Identifiable intangible assets : As of December 31, 2021 As of December 31, 2020 (MILLIONS) Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Finite-lived intangible assets Developed technology rights (a) $ 73,346 $ ( 53,732 ) $ 19,614 $ 73,040 $ ( 50,532 ) $ 22,508 Brands 922 ( 807 ) 115 922 ( 774 ) 148 Licensing agreements and other 2,284 ( 1,299 ) 985 2,292 ( 1,187 ) 1,106 76,552 ( 55,838 ) 20,714 76,255 ( 52,493 ) 23,762 Indefinite-lived intangible assets Brands 827 827 827 827 IPRD 3,092 3,092 3,175 3,175 Licensing agreements and other 513 513 573 573 4,432 4,432 4,575 4,575 Identifiable intangible assets (b) $ 80,984 $ ( 55,838 ) $ 25,146 $ 80,830 $ ( 52,493 ) $ 28,337 (a) The increase in the gross carrying amount primarily reflects $ 500 million of capitalized Comirnaty sales milestones to BioNTech, partially offset by net losses from foreign currency translation adjustments. (b) The decrease is primarily due to amortization, partially offset by the capitalization of the Comirnaty milestones described above. Developed Technology Rights Developed technology rights represent the cost for developed technology acquired from third parties and can include the right to develop, use, market, sell and/or offer for sale the product, compounds and intellectual property that we have acquired with respect to products, compounds and/or processes that have been completed. We possess a well-diversified portfolio of hundreds of developed technology rights across therapeutic categories, representing our commercialized products. The significant components of developed technology rights are the following: Xtandi, Prevnar 13/Prevenar 13 Infant, Braftovi/Mektovi, Premarin, Prevnar 13/Prevenar 13 Adult, Eucrisa, Orgovyx, Zavicefta, Tygacil, Bavencio, Merrem/Meronem and Comirnaty. Also included in this category are the post-approval milestone payments made under our alliance agreements for certain prescription pharmaceutical products. Brands Brands represent the cost for tradenames and know-how, as the products themselves do not receive patent protection. Indefinite-lived brands include Medrol and Depo-Medrol, while finite-lived brands include Zavedos and Depo-Provera. IPRD IPRD assets represent RD assets that have not yet received regulatory approval in a major market. The significant components of IPRD are the following: the program for the oral poly adenosine diphosphate (ADP) ribose polymerase inhibitor for the treatment of patients with germline BRCA-mutated advanced breast cancer acquired as part of the Medivation acquisition and assets acquired in connection with the Array acquisition. IPRD assets are required to be classified as indefinite-lived assets until the successful completion or the abandonment of the associated RD effort. Accordingly, during the development period after the date of acquisition, these assets are not amortized until approval is obtained in a major market, typically either the U.S. or the EU, or in a series of other countries, subject to certain specified conditions and management judgment. At that time, we will determine the useful life of the asset, reclassify it out of IPRD and begin amortization. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. IPRD assets are high-risk assets, given the uncertain nature of RD. Accordingly, we expect that many of these IPRD assets will become impaired and be written-off at some time in the future. Licensing Agreements Licensing agreements for developed technology and for technology in development primarily relate to out-licensing arrangements acquired from third parties, including the Array acquisition. These assets represent the cost for the license, where we acquired the right to future royalties and/or milestones upon development or commercialization by the licensing partner. A significant component of the licensing arrangements are for out-licensing arrangements with a number of partners for oncology technology in varying stages of development that have not yet received regulatory approval in a major market. Accordingly, during the development period after the date of acquisition, each of these assets is classified as indefinite-lived intangible assets and will not be amortized until approval is obtained in a major market. At that time we will determine the useful life of the asset, reclassify the respective licensing arrangement asset to finite-lived intangible asset and begin amortization. If the development effort is abandoned, the related licensing asset will likely be written-off, and we will record an impairment charge. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Amortization The weighted-average life for each of our total finite-lived intangible assets is approximately 8 years, and for the largest component, developed technology rights, is approximately 7 years. Total amortization expense for finite-lived intangible assets was $ 3.7 billion in 2021, $ 3.4 billion in 2020 and $ 4.5 billion in 2019. The following provides the expected annual amortization expense: (MILLIONS) 2022 2023 2024 2025 2026 Amortization expense $ 3,279 $ 2,936 $ 2,686 $ 2,500 $ 2,449 B. Goodwill The following summarizes the components and changes in the carrying amount of Goodwill : (MILLIONS) Total (a) Balance, January 1, 2020 $ 48,181 Additions (b) 727 Other (c) 648 Balance, December 31, 2020 49,556 Additions Other (c) ( 348 ) Balance, December 31, 2021 $ 49,208 (a) As a result of the reorganization of our commercial operations during the fourth quarter of 2021 (see Note 17 ), we were required to estimate the relative fair values of our PC1 and Hospital organizations to determine any reallocation of goodwill. We completed this analysis and determined that no goodwill was required to be reallocated. As a result, our entire goodwill balance continues to be assigned within the Biopharma reportable segment. (b) Additions primarily represent the impact of measurement period adjustments related to our Array acquisition (see Note 2A ). (c) Other represents the impact of foreign exchange . Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans The majority of our employees worldwide are eligible for retirement benefits provided through defined benefit pension plans, defined contribution plans or both. In the U.S., we sponsor both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans. A qualified plan meets the requirements of certain sections of the IRC, and, generally, contributions to qualified plans are tax deductible. A qualified plan typically provides benefits to a broad group of employees with restrictions on discriminating in favor of highly compensated employees with regard to coverage, benefits and contributions. A supplemental (non-qualified) plan provides additional benefits to certain employees. In addition, we provide medical insurance benefits to certain retirees and their eligible dependents through our postretirement plans. As discussed in Note 1C , we adopted a change in accounting principle to a more preferable policy under U.S. GAAP to immediately recognize actuarial gains and losses arising from the remeasurement of pension and postretirement plans. This change has been applied to all pension and postretirement plans on a retrospective basis for all prior periods presented. A. Components of Net Periodic Benefit Costs and Changes in Other Comprehensive Income/(Loss) The following summarizes the components of net periodic benefit cost/(credit), including those reported as part of discontinued operations for 2020 and 2019, and the changes in Other comprehensive income/(loss) for our benefit plans: Pension Plans Postretirement Plans U.S. International Year Ended December 31, (MILLIONS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ $ $ $ 130 $ 146 $ 125 $ 36 $ 38 $ 37 Interest cost 455 533 676 146 164 215 29 49 75 Expected return on plan assets ( 1,052 ) ( 1,015 ) ( 890 ) ( 327 ) ( 314 ) ( 318 ) ( 39 ) ( 36 ) ( 33 ) Amortization of prior service cost/(credit) ( 2 ) ( 3 ) ( 4 ) ( 1 ) ( 3 ) ( 4 ) ( 151 ) ( 170 ) ( 173 ) Actuarial (gains)/losses (a) ( 684 ) 1,152 284 ( 690 ) 148 669 ( 167 ) ( 165 ) ( 118 ) Curtailments ( 4 ) ( 4 ) ( 1 ) ( 82 ) ( 62 ) Special termination benefits 17 1 20 2 2 Net periodic benefit cost/(credit) reported in income ( 1,265 ) 668 82 ( 746 ) 141 686 ( 372 ) ( 282 ) ( 271 ) Cost/(credit) reported in Other comprehensive income/(loss) 2 5 4 4 5 21 107 114 164 Cost/(credit) recognized in Comprehensive income $ ( 1,264 ) $ 674 $ 86 $ ( 742 ) $ 145 $ 707 $ ( 265 ) $ ( 168 ) $ ( 107 ) (a) Reflects actuarial remeasurement gains in 2021, primarily due to favorable plan asset performance and increases in discount rates, and actuarial remeasurement losses in 2020 and 2019, primarily due to decreases in discount rates partially offset by favorable plan asset performance. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The components of net periodic benefit cost/(credit) other than the service cost component are included in Other (income)/deductionsnet (see Note 4 ). B. Actuarial Assumptions Pension Plans Postretirement Plans U.S. International Year Ended December 31, (PERCENTAGES) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Weighted-average assumptions used to determine net periodic benefit cost: Discount rate: Pension plans/postretirement plans 2.6 % 3.3 % 4.4 % 2.5 % 3.2 % 4.3 % Interest cost 1.2 % 1.5 % 2.2 % Service cost 1.4 % 1.6 % 2.4 % Expected return on plan assets 6.8 % 7.0 % 7.2 % 3.4 % 3.6 % 3.9 % 6.8 % 7.0 % 7.3 % Rate of compensation increase (a) 2.9 % 2.9 % 1.4 % Weighted-average assumptions used to determine benefit obligations at fiscal year-end: Discount rate 2.9 % 2.6 % 3.3 % 1.6 % 1.5 % 1.7 % 2.9 % 2.5 % 3.2 % Rate of compensation increase (a) 2.8 % 2.9 % 1.4 % (a) The rate of compensation increase is not used to determine the net periodic benefit cost and benefit obligation for the U.S. pension plans as these plans are frozen. All of the assumptions are reviewed on at least an annual basis. We revise these assumptions based on an annual evaluation of long-term trends as well as market conditions that may have an impact on the cost of providing retirement benefits. The weighted-average discount rate for our U.S. defined benefit plans is determined annually and evaluated and modified to reflect at year-end the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better that reflect the rates at which the pension benefits could be effectively settled. For our international plans, the discount rates are set by benchmarking against investment grade corporate bonds rated AA/Aa or better, including, when there is sufficient data, a yield curve approach. These rate determinations are made consistent with local requirements. Overall, the yield curves used to measure the benefit obligations at year-end 2021 resulted in higher discount rates as compared to the prior year. The following provides the healthcare cost trend rate assumptions for our U.S. postretirement benefit plans: As of December 31, 2021 2020 Healthcare cost trend rate assumed for next year 6.0 % 5.6 % Rate to which the cost trend rate is assumed to decline 4.0 % 4.5 % Year that the rate reaches the ultimate trend rate 2045 2037 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Obligations and Funded Status The following provides: (i) an analysis of the changes in our benefit obligations, plan assets and funded status of our benefit plans, including those reported as part of discontinued operations for 2020, (ii) the funded status recognized in our consolidated balance sheets and (iii) the pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Pension Plans Postretirement Plans U.S. International Year Ended December 31, (MILLIONS) 2021 2020 2021 2020 2021 2020 Change in benefit obligation (a) Benefit obligation, beginning $ 18,306 $ 17,886 $ 12,001 $ 11,059 $ 1,238 $ 1,667 Service cost 130 146 36 38 Interest cost 455 533 146 164 29 49 Employee contributions 10 8 78 88 Plan amendments 2 2 ( 116 ) ( 56 ) Changes in actuarial assumptions and other (b) ( 331 ) 2,112 89 702 ( 117 ) ( 132 ) Foreign exchange impact ( 298 ) 646 1 2 Upjohn spin-off (c) ( 1,016 ) 3 ( 320 ) ( 218 ) Acquisitions/divestitures/other, net Curtailments and special termination benefits 17 1 ( 2 ) ( 8 ) Settlements ( 785 ) ( 767 ) ( 47 ) ( 34 ) Benefits paid ( 512 ) ( 445 ) ( 374 ) ( 372 ) ( 147 ) ( 201 ) Benefit obligation, ending (a) 17,150 18,306 11,657 12,001 995 1,238 Change in plan assets Fair value of plan assets, beginning 16,094 14,586 9,811 8,956 588 519 Actual return on plan assets 1,405 1,974 1,106 868 89 69 Company contributions 143 1,433 451 197 145 113 Employee contributions 10 8 78 88 Foreign exchange impact ( 229 ) 462 Upjohn spin-off (c) ( 687 ) 2 ( 270 ) Acquisitions/divestitures, net ( 6 ) Settlements ( 785 ) ( 767 ) ( 47 ) ( 34 ) Benefits paid ( 512 ) ( 445 ) ( 374 ) ( 372 ) ( 147 ) ( 201 ) Fair value of plan assets, ending 16,346 16,094 10,729 9,811 753 588 Funded statusPlan assets less than benefit obligation $ ( 805 ) $ ( 2,211 ) $ ( 928 ) $ ( 2,191 ) $ ( 241 ) $ ( 651 ) Amounts recorded in our consolidated balance sheet: Noncurrent assets $ 447 $ $ 1,480 $ 522 $ $ Current liabilities ( 138 ) ( 127 ) ( 33 ) ( 31 ) ( 6 ) ( 6 ) Noncurrent liabilities ( 1,113 ) ( 2,084 ) ( 2,376 ) ( 2,681 ) ( 235 ) ( 645 ) Funded status $ ( 805 ) $ ( 2,211 ) $ ( 928 ) $ ( 2,191 ) $ ( 241 ) $ ( 651 ) Pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Prior service (costs)/credits $ ( 6 ) $ ( 4 ) $ ( 35 ) $ ( 31 ) $ 581 $ 688 Information related to the funded status of pension plans with an ABO in excess of plan assets (d) : Fair value of plan assets $ 120 $ 16,094 $ 1,304 $ 6,674 ABO 1,371 18,306 3,344 8,961 Information related to the funded status of pension plans with a PBO in excess of plan assets (d) : Fair value of plan assets $ 120 $ 16,094 $ 1,381 $ 6,735 PBO 1,371 18,306 3,789 9,447 (a) For the U.S. pension plans, the benefit obligation is both the PBO and ABO as these plans are frozen and future benefit accruals no longer increase with future compensation increases. For the international pension plans, the benefit obligation is the PBO. The ABO for our international pension plans was $ 11.2 billion in 2021 and $ 11.5 billion in 2020. For the postretirement plans, the benefit obligation is the ABO. (b) Primarily includes actuarial gains resulting from increases i n discount rates in 2021, offset by increases in inflation assumptions in 2021 for the international plans, and actuarial losses resulting from decreases in discount rates in 2020 . (c) For more information, see Note 2B . (d) Our main U.S. qualified plan and many of our international plans were overfunded as of December 31, 2021. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Plan Assets The following provides the components of plan assets, including those reported as part of discontinued operations for 2020: As of December 31, 2021 As of December 31, 2020 Fair Value Fair Value (MILLIONS EXCEPT TARGET ALLOCATION PERCENTAGE) Target Allocation Percentage Total Level 1 Level 2 Level 3 Assets Measured at NAV (a) Total Level 1 Level 2 Level 3 Assets Measured at NAV (a) U.S. pension plans Cash and cash equivalents 0-10% $ 1,326 $ 78 $ 1,248 $ $ $ 781 $ 70 $ 711 $ $ Equity securities: 20-40% Global equity securities 2,273 2,233 38 2 3,241 3,213 27 1 Equity commingled funds 1,352 1,152 200 1,325 1,110 215 Fixed income securities: 45-75% Corporate debt securities 5,566 18 5,548 6,499 23 6,476 Government and agency obligations (b) 2,533 2,533 1,555 1,555 Fixed income commingled funds 38 38 23 23 Other investments: 5-20% Partnership investments (c) 2,079 3 2,076 1,431 1,431 Insurance contracts 158 158 190 190 Other commingled funds (d) 1,019 10 1,009 1,049 11 1,038 Total 100 % $ 16,346 $ 2,332 $ 10,726 $ 2 $ 3,286 $ 16,094 $ 3,306 $ 10,103 $ 1 $ 2,684 International pension plans Cash and cash equivalents 0-10% $ 541 $ 191 $ 346 $ $ 3 $ 407 $ 61 $ 346 $ $ Equity securities: 10-20% Equity commingled funds 1,453 1,386 67 2,051 1,681 370 Fixed income securities: 45-70% Corporate debt securities 1,187 1,187 925 925 Government and agency obligations (b) 2,415 2,415 1,334 1,334 Fixed income commingled funds 2,266 1,138 1,128 2,484 1,217 1,267 Other investments: 15-35% Partnership investments (c) 107 2 106 69 3 66 Insurance contracts 1,329 56 1,273 1,027 57 969 1 Other (d) 1,431 141 404 886 1,514 117 393 1,003 Total 100 % $ 10,729 $ 191 $ 6,672 $ 1,677 $ 2,189 $ 9,811 $ 61 $ 5,681 $ 1,362 $ 2,707 U.S. postretirement plans (e) Cash and cash equivalents 0-5% $ 85 $ 3 $ 82 $ $ $ $ $ $ $ Insurance contracts 95-100% 669 669 588 588 Total 100 % $ 753 $ 3 $ 750 $ $ $ 588 $ $ 588 $ $ (a) Certain investments that are measured at NAV per share (or its equivalent) have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented for the total pension benefits plan assets. (b) Government and agency obligations are inclusive of repurchase agreements . (c) Mainly includes investments in private equity, private debt, public equity limited partnerships, and, to a lesser extent, real estate and venture capital. (d) Mostly includes investments in hedge funds and real estate. (e) Reflects postretirement plan assets, which support a portion of our U.S. retiree medical plans. The following provides an analysis of the changes in our more significant investments valued using significant unobservable inputs, including those reported as part of discontinued operations for 2020: International Pension Plans Year Ended December 31, (MILLIONS) 2021 2020 Fair value, beginning $ 1,362 $ 1,342 Actual return on plan assets: Assets held, ending 23 22 Purchases, sales, and settlements, net 52 ( 47 ) Transfer into/(out of) Level 3 265 ( 13 ) Exchange rate changes ( 24 ) 58 Fair value, ending $ 1,677 $ 1,362 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following methods and assumptions were used to estimate the fair value of our pension and postretirement plans assets: Cash and cash equivalents: Level 1 investments may include cash, cash equivalents and foreign currency valued using exchange rates. Level 2 investments may include short-term investment funds which are commingled funds priced at a stable NAV by the administrator of the funds. Equity securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 1 and Level 2 investments may include commingled funds that have a readily determinable fair value based on quoted prices on an exchange or a published NAV derived from the quoted prices in active markets of the underlying securities. Level 3 investments may include individual securities that are unlisted, delisted, suspended, or illiquid and are typically valued using their last available price. Fixed income securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include commingled funds that have a readily determinable fair value based on observable prices of the underlying securities. Level 2 investments may include corporate bonds, government and government agency obligations and other fixed income securities valued using bid evaluation pricing models or quoted prices of securities with similar characteristics. Level 3 investments may include securities that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Other investments: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include Insurance contracts which invest in interest bearing cash, U.S. government securities and corporate debt instruments. Level 3 investments may include securities or insurance contracts that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Equity securities, Fixed income securities and Other investments may each be combined into commingled funds. Most commingled funds are valued to reflect the interest in the fund based on the reported year-end NAV. Partnership and Other investments are valued based on year-end reported NAV (or its equivalent), with adjustments as appropriate for lagged reporting of up to three months. Certain investments are authorized to include derivatives, such as equity or bond futures, swaps, options and currency futures or forwards for managing risks and exposures. Global plan assets are managed with the objective of generating returns that will enable the plans to meet their future obligations, while seeking to manage net periodic benefit costs and cash contributions over the long-term. We utilize long-term asset allocation ranges in the management of our plans invested assets. Our long-term return expectations are developed based on a diversified, global investment strategy that takes into account historical experience, as well as the impact of portfolio diversification, active portfolio management, and our view of current and future economic and financial market conditions. As market conditions and other factors change, we may adjust our targets accordingly and our asset allocations may vary from the target allocations. E. Cash Flows It is our practice to fund amounts for our qualified pension plans that are at least sufficient to meet the minimum requirements set forth in applicable employee benefit laws and local tax laws. The following provides the expected future cash flow information related to our benefit plans: Pension Plans Postretirement Plans (MILLIONS) U.S. International Expected employer contributions: 2022 $ 138 $ 177 $ 74 Expected benefit payments: 2022 $ 1,296 $ 384 $ 78 2023 1,155 372 73 2024 1,140 383 69 2025 1,089 392 66 2026 1,058 397 68 20272031 4,908 2,124 359 The above table reflects the total U.S. and international plan benefits projected to be paid from the plans or from our general assets under the current actuarial assumptions used for the calculation of the benefit obligation. F. Defined Contribution Plans We have defined contribution plans in the U.S. and other countries. For the majority of the U.S. defined contribution plans, employees may contribute a portion of their salaries and bonuses to the plans, and we match, in cash, a portion of the employee contributions. We also offer a Retirement Savings Contribution (RSC) which is an annual non-contributory employer contribution in the U.S. and Puerto Rico. We recorded charges related to the employer contributions to global defined contribution plans of $ 732 million in 2021, $ 685 million in 2020 and $ 659 million in 2019. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 12. Equity A. Common Stock Purchases We purchase our common stock through privately negotiated transactions or in the open market as circumstances and prices warrant. Purchased shares under each of the share-purchase plans, which are authorized by our BOD, are available for general corporate purposes. In December 2017, the BOD authorized a $ 10 billion share repurchase program, which was exhausted in the first quarter of 2019. In December 2018, the BOD authorized another $ 10 billion share repurchase program to be utilized over time and share repurchases commenced thereunder in the first quarter of 2019. In February 2019, we entered into an ASR with Goldman Sachs Co. LLC to repurchase $ 6.8 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 6.8 billion and received an initial delivery of 130 million shares of common stock, which represented approximately 80 % of the notional amount of the ASR. In August 2019, the ASR with Goldman Sachs Co. LLC was completed resulting in Goldman Sachs Co. LLC owing us an additional 33.5 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 41.42 per share. The common stock received is included in Treasury stock . The following provides the number of shares of our common stock purchased and the cost of purchases under our publicly announced share purchase plans, including our ASR: Year Ended December 31, (SHARES IN MILLIONS, DOLLARS IN BILLIONS) 2021 2019 (a) Shares of common stock purchased 213 Cost of purchase $ $ $ 8.9 (a) Represents shares purchased pursuant to the ASR with Goldman Sachs Co. LLC entered into in February 2019, as well as open market share repurchases of $ 2.1 billion . Our remaining share-purchase authorization was approximately $ 5.3 billion at December 31, 2021. B. Preferred Stock and Employee Stock Ownership Plans Prior to May 4, 2020, we had outstanding Series A convertible perpetual preferred stock (the Series A Preferred Stock) that was held by an ESOP trust (the Trust). All outstanding shares of Series A Preferred Stock were converted, at the direction of the independent fiduciary under the Trust and in accordance with the certificate of designations for the Series A Preferred Stock, into shares of our common stock on May 4, 2020. The Trust received an aggregate of 1,070,369 shares of our common stock upon conversion, with zero shares of Series A Preferred Stock remaining outstanding as a result of the conversion. In December 2020, we filed a certificate of elimination and a restated certificate of incorporation with the Delaware Secretary of State, which eliminated the Series A Preferred Stock. Since May 4, 2020, we have one ESOP that holds common stock of the Company (Common ESOP). As of December 31, 2021, all shares of common stock held by the Common ESOP have been allocated to the Pfizer U.S. defined contribution plan participants. The compensation cost related to the Common ESOP was $ 19 million in 2021, $ 19 million in 2020 and $ 20 million in 2019. Note 13. Share-Based Payments Our compensation programs can include share-based payment awards with value that is determined by reference to the fair value of our shares and that provide for the grant of shares or options to acquire shares or similar arrangements. Our share-based awards are designed based on competitive survey data or industry peer groups used for compensation purposes, and are allocated between different long-term incentive awards, generally in the form of Total Shareholder Return Units (TSRUs), Restricted Stock Units (RSUs), Portfolio Performance Shares (PPSs), Performance Share Awards (PSAs), Breakthrough Performance Awards (BPAs) and Stock Options, as determined by the Compensation Committee. The 2019 Stock Plan (2019 Plan) replaced and superseded the 2014 Plan. It provides for 400 million shares, in addition to shares remaining under the 2014 Plan, to be authorized for grants. The 2019 Plan provides that the number of stock options, TSRUs, RSUs, or performance-based awards that may be granted to any one individual during any 36-month period is limited to 20 million shares, and that RSUs count as three shares, PPSs, PSAs and BPAs count as three shares times the maximum potential payout, while TSRUs and stock options count as one share, toward the maximum shares available under the 2019 Plan. As of December 31, 2021, 315 million shares were available for award. Although not required to do so, we have used authorized and unissued shares and, to a lesser extent, treasury stock to satisfy our obligations under these programs. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies A summary of the awards and valuation details: Awarded to Terms Valuation Recognition and Presentation Total Shareholder Return Units (TSRUs) (a), (b) Senior and other key management and select employees Entitle the holder to receive shares of our common stock with a value equal to the difference between the defined settlement price and the grant price, plus the dividend equivalents accumulated during the five or seven -year term, if and to the extent the total value is positive. Settlement price is the average closing price of our common stock during the 20 trading days ending on the fifth or seventh anniversary of the grant, as applicable; the grant price is the closing price of our common stock on the date of the grant. Automatically settle on the fifth or seventh anniversary of the grant but vest on the third anniversary of the grant. As of the grant date using a Monte Carlo simulation model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Restricted Stock Units (RSUs) Select employees Entitle the holder to receive a specified number of shares of our common stock, including dividend equivalents that are reinvested into additional RSUs. For RSUs granted, in virtually all instances, the units vest on the third anniversary of the grant date assuming continuous service from the grant date. As of the grant date using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Portfolio Performance Shares (PPSs) Select employees Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents earned on such shares. For PPSs granted, the awards vest on the third anniversary of the grant assuming continuous service from the grant date and the number of shares paid, if any, depends on the achievement of predetermined goals related to Pfizers long-term product portfolio during a three or five -year performance period from the year of the grant date, as applicable. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned, and managements assessment of the probability that the specified performance criteria will be achieved. Performance Share Awards (PSAs) Senior and other key management Entitle the holder to receive, at the end of the performance period, shares of our common stock (retirees) earned, if any, or an equal value in cash (active colleagues), including dividend equivalents on shares earned, dependent upon the achievement of predetermined goals related to two measures: a. Adjusted net income over three one -year periods; and b. TSR as compared to the NYSE ARCA Pharmaceutical Index (DRG Index) over the three -year performance period. PSAs vest on the third anniversary of the grant assuming continuous service from the grant date. The award that may be earned ranges from 0 % to 200 % of the target award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned and managements assessment of the probability that the specified performance criteria will be achieved. Breakthrough Performance Awards (BPAs) Select employees identified as instrumental in delivering medicines to patients (excluding executive officers) Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents earned on such shares. For BPAs granted, the awards, if earned/vested, are settled at the end of the performance period, but no earlier than the one -year anniversary of the date of grant and dependent upon the achievement of the respective predetermined performance goals related to advancing Pfizers product pipeline during the performance period. The number of shares that may be earned ranges from 0 % to 600 % of the target award depending on the level and timing of goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned and managements assessment of the probability that the specified performance criteria will be achieved and/or managements assessment of the probable vesting term. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Awarded to Terms Valuation Recognition and Presentation Stock Options Select employees Entitle the holder to purchase a specified number of shares of our common stock at a price per share equal to the closing market price of our common stock on the date of grant, for a period of time when vested. Since 2016, only a limited set of non-U.S. employees received stock option grants. No stock options were awarded to senior and other key management in any period presented. Stock options vest on the third anniversary of the grant assuming continuous service from the grant date and have a contractual term of 10 years. As of the grant date using the Black-Scholes-Merton option-pricing model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. (a) Retirement-eligible holders, as defined in the grant terms, can convert their TSRUs, when vested, into Profit Units (PTUs) with a conversion ratio based on a calculation used to determine the shares at TSRU settlement. The PTUs are entitled to earn Dividend Equivalent Units (DEUs), and the PTUs and DEUs will be settled in our common stock on the TSRUs original settlement date and will be subject to the terms and conditions of the original grant including forfeiture provisions. (b) In 2017, Performance Total Shareholder Return Units (PTSRUs) were awarded to the Former Chairman and Chief Executive Officer ( 1,444,395 PTSRUs) and 361,099 PTSRUs were awarded to the Group President, Chief Business Officer (former role Group President Pfizer Innovative Health) at a grant price of $ 30.31 and at a GDFV of $ 5.54 per PTSRU. In addition to having the same characteristics and valuation methodology of TSRUs, PTSRU grants require special service and performance conditions . The following provides data related to all TSRU, RSU, PPS, PSA and stock option activity: (MILLIONS, EXCEPT FAIR VALUE OF SHARES VESTED PER TSRU AND STOCK OPTION) TSRUs RSUs PPSs PSAs Stock Options Year Ended December 31, 2021 2020 2019 2021 2020 2019 2021 2020 2019 2021 2020 2019 2021 2020 2019 Total fair value of shares vested (a) $ 7.26 $ 6.22 $ 8.52 $ 304 $ 334 $ 454 $ 181 $ 119 $ 136 $ 33 $ 25 $ 64 $ 4.86 $ 3.56 $ 5.98 Total intrinsic value of options exercised or share units converted $ 594 $ 84 $ 175 $ 228 $ 224 $ 245 $ 584 $ 293 $ 261 Cash received upon exercise $ 795 $ 425 $ 394 Tax benefits realized from exercise $ 106 $ 55 $ 47 Compensation cost recognized, pre-tax (b) $ 259 $ 287 $ 294 $ 281 $ 272 $ 275 $ 535 $ 180 $ 114 $ 76 $ 31 $ 28 $ 5 $ 6 $ 7 Total compensation cost related to nonvested awards not yet recognized, pre-tax $ 187 $ 224 $ 229 $ 271 $ 228 $ 241 $ 175 $ 104 $ 87 $ 54 $ 32 $ 34 $ 3 $ 4 $ 5 Weighted-average period over which cost is expected to be recognized (years) 1.6 1.6 1.6 1.8 1.7 1.7 1.8 1.8 1.8 1.8 1.9 1.8 1.6 1.7 1.6 (a) Weighted-average GDFV per TSRUs and stock options. (b) TSRU includes expense for PTSRUs, which is not significant for all years presented . Total share-based payment expense was $ 1.2 billion, $ 780 million and $ 718 million in 2021, 2020 and 2019, respectively, which includes pre-tax share-based payment expense included in Discontinued operations net of tax of $ 2 million, $ 25 million and $ 32 million in 2021, 2020 and 2019, respectively. Tax benefit for share-based compensation expense was $ 227 million, $ 141 million and $ 137 million in 2021, 2020 and 2019, respectively. The table above excludes total expense due to the modification for share-based awards in connection with our cost reduction/productivity initiatives, which was not significant for all years presented and is recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). Amounts capitalized as part of inventory cost were not significant for any period presented. Summary of the weighted-average assumptions used in the valuation of TSRUs and stock options: TSRUs Stock Options Year Ended December 31, 2021 2020 2019 2021 2020 2019 Expected dividend yield (based on a constant dividend yield during the expected term) 4.51 % 4.36 % 3.27 % 4.51 % 4.36 % 3.27 % Risk-free interest rate (based on interpolated yield on U.S. Treasury zero-coupon issues) 0.93 % 1.15 % 2.55 % 1.27 % 1.25 % 2.66 % Expected stock price volatility (based on implied volatility, after consideration of historical volatility) 26.53 % 20.99 % 18.34 % 26.54 % 20.97 % 18.34 % TSRUs contractual/stock options expected term, years (based on historical exercise and post-vesting termination patterns for stock options) 5.15 5.12 5.13 6.75 6.75 6.75 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summary of all TSRU, RSU, PPS, PSA and BPA activity during 2021 (with the shares granted representing the maximum award that could be achieved for PPSs, PSAs and BPAs): TSRUs RSUs PPSs (a) PSAs BPAs TSRUs Per TSRU, Weighted Average Shares Weighted Avg. GDFV per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share (Thousands) GDFV Grant Price (Thousands) (Thousands) (Thousands) (Thousands) Nonvested, December 31, 2020 129,844 $ 6.90 $ 32.94 23,692 $ 35.50 20,077 $ 36.81 5,264 $ 36.81 $ Granted 34,522 7.26 33.83 10,893 34.31 8,632 33.82 1,798 33.82 1,165 38.73 Vested ( 44,888 ) 7.21 30.54 ( 8,747 ) 34.66 ( 6,095 ) 33.88 ( 984 ) 33.85 Reinvested dividend equivalents 956 41.33 Forfeited ( 4,879 ) 6.77 33.78 ( 1,255 ) 35.17 ( 1,133 ) 41.45 ( 924 ) 34.43 ( 306 ) 47.47 Nonvested, December 31, 2021 114,599 $ 6.90 $ 34.12 25,540 $ 35.52 21,480 $ 59.05 5,154 $ 59.05 859 $ 59.05 (a) Vested and non-vested shares outstanding, but not paid as of December 31, 2021 were 34.1 million. Summary of TSRU and PTU information as of December 31, 2021 (a), (b) : TSRUs (Thousands) PTUs (Thousands) Weighted-Average Grant Price Per TSRU Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (Millions) TSRUs Outstanding 206,996 $ 31.71 2.2 $ 5,969 TSRUs Vested 92,398 28.72 0.8 2,946 TSRUs Expected to vest (c) 110,476 34.16 3.3 2,910 TSRUs exercised and converted to PTUs 3,074 $ 0.8 $ 182 (a) In 2021, we settled 46,060,346 TSRUs with a weighted-average grant price of $ 23.04 per unit. (b) In 2021, 7,093,787 TSRUs with a weighted-average grant price of $ 27.41 per unit were converted into 2,943,737 PTUs. (c) The number of TSRUs expected to vest takes into account an estimate of expected forfeitures. Summary of all stock option activity during 2021: Shares (Thousands) Weighted-Average Exercise Price Per Share Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (a) (Millions) Outstanding, December 31, 2020 75,402 $ 28.31 Granted 779 33.82 Exercised ( 31,036 ) 25.75 Forfeited ( 89 ) 34.39 Expired ( 181 ) 20.27 Outstanding, December 31, 2021 44,874 30.20 2.7 $ 1,295 Vested and expected to vest, December 31, 2021 (b) 44,747 30.19 2.7 1,291 Exercisable, December 31, 2021 41,583 $ 29.81 2.3 $ 1,216 (a) Market price of our underlying common stock less exercise price. (b) The number of options expected to vest takes into account an estimate of expected forfeitures. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 14. Earnings Per Common Share Attributable to Pfizer Inc. Common Shareholders The following presents the detailed calculation of EPS: Year Ended December 31, (IN MILLIONS) 2021 2020 2019 EPS NumeratorBasic Income from continuing operations attributable to Pfizer Inc. $ 22,414 $ 6,630 $ 10,708 Less: Preferred stock dividendsnet of tax 1 Income from continuing operations attributable to Pfizer Inc. common shareholders 22,414 6,630 10,708 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income attributable to Pfizer Inc. common shareholders $ 21,979 $ 9,159 $ 16,025 EPS NumeratorDiluted Income from continuing operations attributable to Pfizer Inc. common shareholders and assumed conversions $ 22,414 $ 6,630 $ 10,708 Discontinued operationsnet of tax, attributable to Pfizer Inc. common shareholders and assumed conversions ( 434 ) 2,529 5,318 Net income attributable to Pfizer Inc. common shareholders and assumed conversions $ 21,979 $ 9,159 $ 16,026 EPS Denominator Weighted-average number of common shares outstandingBasic 5,601 5,555 5,569 Common-share equivalents: stock options, stock issuable under employee compensation plans convertible preferred stock and accelerated share repurchase agreements 107 77 106 Weighted-average number of common shares outstandingDiluted 5,708 5,632 5,675 Anti-dilutive common stock equivalents (a) 2 4 2 (a) These common stock equivalents were outstanding for the periods presented, but were not included in the computation of diluted EPS for those periods because their inclusion would have had an anti-dilutive effect. Allocated shares held by the Common ESOP, including reinvested dividends, are considered outstanding for EPS calculations and the eventual conversion of allocated preferred shares held by the Preferred ESOP was assumed in the diluted EPS calculation until the conversion date, which occurred in May 2020. See Note 12 . Note 15. Leases We lease real estate, fleet, and equipment for use in our operations. Our leases generally have lease terms of 1 to 30 years, some of which include options to terminate or extend leases for up to 5 to 10 years or on a month-to-month basis. We include options that are reasonably certain to be exercised as part of the determination of lease terms. We may negotiate termination clauses in anticipation of any changes in market conditions, but generally these termination options have not been exercised. Residual value guarantees are generally not included within our operating leases with the exception of some fleet leases. In addition to base rent payments, the leases may require us to pay directly for taxes and other non-lease components, such as insurance, maintenance and other operating expenses, which may be dependent on usage or vary month-to-month. Variable lease payments amounted to $ 381 million in 2021, $ 380 million in 2020 and $ 326 million in 2019. We elected the practical expedient to not separate non-lease components from lease components in calculating the amounts of ROU assets and lease liabilities for all underlying asset classes. We determine if an arrangement is a lease at inception of the contract and we perform the lease classification test as of the lease commencement date. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. For operating leases, the ROU assets and liabilities in our consolidated balance sheets follows: As of December 31, (MILLIONS) Balance Sheet Classification 2021 2020 ROU assets Other noncurrent assets $ 2,839 $ 1,386 Lease liabilities (short-term) Other current liabilities 449 320 Lease liabilities (long-term) Other noncurrent liabilities 2,510 1,108 Components of total lease cost includes: Year Ended December 31, (MILLIONS) 2021 2020 2019 Operating lease cost $ 548 $ 432 $ 421 Variable lease cost 381 380 326 Sublease income ( 41 ) ( 40 ) ( 45 ) Total lease cost $ 888 $ 772 $ 702 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Other supplemental information follows: As of December 31, (MILLIONS) 2021 2020 Operating leases Weighted-Average Remaining Contractual Lease Term (Years) 12 6.9 Weighted-Average Discount Rate 2.8 % 2.9 % Year Ended December 31, (MILLIONS) 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 387 $ 333 $ 338 (Gains)/losses on sale and leaseback transactions, net 1 ( 3 ) ( 29 ) The following reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the consolidated balance sheet as of December 31, 2021: (MILLIONS) Period Operating Lease Liabilities Next one year (a) $ 520 1-2 years 417 2-3 years 322 3-4 years 279 4-5 years 217 Thereafter 1,865 Total undiscounted lease payments 3,621 Less: Imputed interest 661 Present value of minimum lease payments 2,960 Less: Current portion 449 Noncurrent portion $ 2,510 (a) Reflects lease payments due within 12 months subsequent to the balance sheet date. Note 16. Contingencies and Certain Commitments We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax and legal contingencies. The following outlines our legal contingencies. For a discussion of our tax contingencies, see Note 5B. A. Legal Proceedings Our legal contingencies include, but are not limited to, the following: Patent litigation, which typically involves challenges to the coverage and/or validity of patents on various products, processes or dosage forms. An adverse outcome could result in loss of patent protection for a product, a significant loss of revenues from that product or impairment of the value of associated assets. We are the plaintiff in the majority of these actions. Product liability and other product-related litigation related to current or former products, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others, and often involves highly complex issues relating to medical causation, label warnings and reliance on those warnings, scientific evidence and findings, actual, provable injury and other matters. Commercial and other asserted or unasserted matters, which can include acquisition-, licensing-, intellectual property-, collaboration- or co-promotion-related and product-pricing claims and environmental claims and proceedings, can involve complexities that will vary from matter to matter. Government investigations, which often are related to the extensive regulation of pharmaceutical companies by national, state and local government agencies in the U.S. and in other jurisdictions. Certain of these contingencies could result in increased expenses and/or losses, including damages, royalty payments, fines and/or civil penalties, which could be substantial, and/or criminal charges. We believe that our claims and defenses in matters in which we are a defendant are substantial, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of matters, which could have a material adverse effect on our results of operations and/or our cash flows in the period in which the amounts are accrued or paid. We have accrued for losses that are both probable and reasonably estimable. Substantially all of our contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments, which result from a complex series of judgments about future events and uncertainties, are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. For proceedings under environmental laws to which a governmental authority is a party, we have adopted a disclosure threshold of $ 1 million in potential or actual governmental monetary sanctions. The principal pending matters to which we are a party are discussed below. In determining whether a pending matter is a principal matter, we consider both quantitative and qualitative factors to assess materiality, such as, among others, the amount of damages and the nature of other relief sought, if specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be, or is, a class action and, if not certified, our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; whether related actions have been transferred to multidistrict litigation; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a readers judgment about our financial statements in light of all of the information that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters in which we are the plaintiff, we consider, among other things, the financial significance of the product protected by the patent(s) at issue. Some of the matters discussed below include those which management believes that the likelihood of possible loss in excess of amounts accrued is remote. A1. Legal ProceedingsPatent Litigation We are involved in suits relating to our patents, including but not limited to, those discussed below. Most involve claims by generic drug manufacturers that patents covering our products (or those of our collaboration/licensing partners to which we have licenses or co-promotion rights and to which we may or may not be a party), processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. In addition to the challenges to the U.S. patents that are discussed below, patent rights to certain of our products or those of our collaboration/licensing partners are being challenged in various other jurisdictions. For example, some of our collaboration or licensing partners face challenges to the validity of their patent rights in non-U.S. jurisdictions. We are also party to patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for allegedly causing delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In 2017, the Patent Trial and Appeal Board (PTAB) initiated proceedings with respect to two of our pneumococcal vaccine patents. However, the PTAB declined to initiate proceedings as to two other pneumococcal vaccine patents; those two patents, and one other patent, were challenged in federal court in Delaware. In September 2021, Pfizer and a challenger entered into a settlement and license agreement, resolving all worldwide legal proceedings involving that challenger, related to our pneumococcal vaccine patents. Other challenges to pneumococcal vaccine patents remain pending at the PTAB and outside the U.S. The invalidation of any of the patents in our pneumococcal portfolio could potentially allow additional competitor vaccines into the marketplace. In the event that any of the patents are found valid and infringed, a competitors vaccine might be prohibited from entering the market or a competitor might be required to pay us a royalty. We are also subject to patent litigation pursuant to which one or more third parties seek damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities. For example, our Hospira subsidiaries are involved in patent and patent-related disputes over their attempts to bring generic pharmaceutical and biosimilar products to market. If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. Actions In Which We Are The Plaintiff EpiPen In 2010, King, which we acquired in 2011 and is a wholly-owned subsidiary, brought a patent-infringement action against Sandoz in the U.S. District Court for the District of New Jersey in connection with Sandozs abbreviated new drug application (ANDA) filed with the FDA seeking approval to market an epinephrine injectable product. Sandoz is challenging patents, which expire in 2025, covering the next-generation autoinjector for use with epinephrine that is sold under the EpiPen brand name. Xeljanz (tofacitinib) Beginning in 2017, we brought patent-infringement actions against several generic manufacturers that filed separate ANDAs with the FDA seeking approval to market their generic versions of tofacitinib tablets in one or both of 5 mg and 10 mg dosage strengths, and in both immediate and extended release forms. To date, we have settled actions with several manufacturers on terms not material to us. The remaining actions continue in the U.S. District Court for the District of Delaware as described below. In January 2021, we brought a separate patent-infringement action against Aurobindo Pharma Limited (Aurobindo) asserting the infringement and validity of the patent covering the active ingredient expiring in December 2025 and the patent covering a polymorphic form of tofacitinib expiring in 2023, which Aurobindo challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg and 10 mg tablets. In October 2021, we brought a separate patent-infringement action against Sinotherapeutics Inc. (Sinotherapeutics) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Sinotherapeutics in its ANDA seeking approval to market a generic version of tofacitinib 11 mg extended release tablets. In February 2022, we brought a separate patent-infringement action against Teva Pharmaceuticals USA, Inc. (Teva) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Teva in its ANDA seeking approval to market a generic version of tofacitinib 22 mg extended release tablets. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In February 2022, we brought a separate patent-infringement action against Slayback Pharma LLC (Slayback) asserting the infringement and validity of our compound patent covering the active ingredient that was challenged by Slayback in its ANDA seeking approval to market a generic version of tofacitinib oral solution 1 mg/mL. Inlyta (axitinib) In 2019, Glenmark Pharmaceuticals Ltd. (Glenmark) notified us that it had filed an ANDA with the FDA seeking approval to market a generic version of Inlyta. Glenmark asserts the invalidity and non-infringement of the crystalline form patent for Inlyta that expires in 2030. In 2019, we filed suit against Glenmark in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the crystalline form patent for Inlyta. Ibrance (palbociclib) Beginning in September 2020, we received correspondence from several generic companies notifying us that they would seek approval to market generic versions of Ibrance capsules. The generic companies assert the invalidity and non-infringement of our crystalline form patent which expires in 2034. Beginning in October 2020, we brought patent infringement actions against each of these generic companies in various federal courts, asserting the validity and infringement of the crystalline form patent. We have settled with one of these generic companies on terms not material to the company. Beginning in January 2021, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Ibrance tablets. The generic companies are challenging some or all of the following patents: (i) the composition of matter patent expiring in 2027; (ii) the composition of matter patent expiring in 2023; (iii) the method of use patent expiring in 2023; (iv) the crystalline form patent expiring in 2034; and (v) a tablet formulation patent expiring in 2036. We brought patent infringement actions against each of the generic filers in various federal courts, asserting the validity and infringement of the patents challenged by the generic companies. Eucrisa Beginning in September 2021, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Eucrisa. The companies assert the invalidity and non-infringement of a composition of matter patent expiring in 2026, two method of use patents expiring in 2027, and one other method of use patent expiring in 2030. In September 2021, we brought patent infringement actions against the generic filers in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the patents challenged by the generic companies. Matter Involving Our Collaboration/Licensing Partners Eliquis In 2017, twenty-five generic companies sent BMS Paragraph-IV certification letters informing BMS that they had filed ANDAs seeking approval of generic versions of Eliquis, challenging the validity and infringement of one or more of the three patents listed in the Orange Book for Eliquis. One of the patents expired in December 2019 and the remaining patents currently are set to expire in 2026 and 2031. Eliquis has been jointly developed and is being commercialized by BMS and Pfizer. BMS and Pfizer filed patent-infringement actions against all generic filers in the U.S. District Court for the District of Delaware and the U.S. District Court for the District of West Virginia, asserting that each of the generic companies proposed products would infringe each of the patent(s) that each generic filer challenged. Some generic filers challenged only the 2031 patent, some challenged both the 2031 and 2026 patent, and one generic company challenged all three patents. In August 2020, the U.S. District Court for the District of Delaware ruled that both the 2026 patent and the 2031 patent are valid and infringed by the proposed generic products. In August and September 2020, the generic filers appealed the District Courts decision to the U.S. Court of Appeals for the Federal Circuit. Prior to the August 2020 ruling, we and BMS settled with certain of the companies on terms not material to us, and we and BMS may settle with other generic companies in the future. In September 2021, the U.S. Court of Appeals for the Federal Circuit affirmed the District Courts decision. A2. Legal ProceedingsProduct Litigation We are defendants in numerous cases, including but not limited to those discussed below, related to our pharmaceutical and other products. Plaintiffs in these cases seek damages and other relief on various grounds for alleged personal injury and economic loss. Asbestos Between 1967 and 1982, Warner-Lambert owned American Optical Corporation (American Optical), which manufactured and sold respiratory protective devices and asbestos safety clothing. In connection with the sale of American Optical in 1982, Warner-Lambert agreed to indemnify the purchaser for certain liabilities, including certain asbestos-related and other claims. Warner-Lambert was acquired by Pfizer in 2000 and is a wholly owned subsidiary of Pfizer. Warner-Lambert is actively engaged in the defense of, and will continue to explore various means of resolving, these claims. Numerous lawsuits against American Optical, Pfizer and certain of its previously owned subsidiaries are pending in various federal and state courts seeking damages for alleged personal injury from exposure to products allegedly containing asbestos and other allegedly hazardous materials sold by Pfizer and certain of its previously owned subsidiaries. There also are a small number of lawsuits pending in various federal and state courts seeking damages for alleged exposure to asbestos in facilities owned or formerly owned by Pfizer or its subsidiaries. Effexor Beginning in 2011, actions, including purported class actions, were filed in various federal courts against Wyeth and, in certain of the actions, affiliates of Wyeth and certain other defendants relating to Effexor XR, which is the extended-release formulation of Effexor. The plaintiffs in each of the class actions seek to represent a class consisting of all persons in the U.S. and its territories who directly purchased, indirectly purchased or reimbursed patients for the purchase of Effexor XR or generic Effexor XR from any of the defendants from June 14, 2008 until the time the defendants allegedly unlawful conduct ceased. The plaintiffs in all of the actions allege delay in the launch of generic Effexor XR in the U.S. and its territories, in violation of federal antitrust laws and, in certain of the actions, the antitrust, consumer protection and various other laws of certain states, as the result of Wyeth fraudulently obtaining and improperly listing certain patents for Effexor XR in the Orange Book, enforcing certain patents for Effexor XR and entering into a litigation settlement agreement with a generic drug manufacturer with respect to Effexor XR. Each of the plaintiffs seeks treble damages (for itself in the individual actions or on behalf of the putative class in the Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies purported class actions) for alleged price overcharges for Effexor XR or generic Effexor XR in the U.S. and its territories since June 14, 2008. All of these actions have been consolidated in the U.S. District Court for the District of New Jersey. In 2014, the District Court dismissed the direct purchaser plaintiffs claims based on the litigation settlement agreement, but declined to dismiss the other direct purchaser plaintiff claims. In 2015, the District Court entered partial final judgments as to all settlement agreement claims, including those asserted by direct purchasers and end-payer plaintiffs, which plaintiffs appealed to the U.S. Court of Appeals for the Third Circuit. In 2017, the U.S. Court of Appeals for the Third Circuit reversed the District Courts decisions and remanded the claims to the District Court. Lipitor Beginning in 2011, purported class actions relating to Lipitor were filed in various federal courts against, among others, Pfizer, certain Pfizer affiliates, and, in most of the actions, Ranbaxy Laboratories Ltd. (Ranbaxy) and certain Ranbaxy affiliates. The plaintiffs in these various actions seek to represent nationwide, multi-state or statewide classes consisting of persons or entities who directly purchased, indirectly purchased or reimbursed patients for the purchase of Lipitor (or, in certain of the actions, generic Lipitor) from any of the defendants from March 2010 until the cessation of the defendants allegedly unlawful conduct (the Class Period). The plaintiffs allege delay in the launch of generic Lipitor, in violation of federal antitrust laws and/or state antitrust, consumer protection and various other laws, resulting from (i) the 2008 agreement pursuant to which Pfizer and Ranbaxy settled certain patent litigation involving Lipitor and Pfizer granted Ranbaxy a license to sell a generic version of Lipitor in various markets beginning on varying dates, and (ii) in certain of the actions, the procurement and/or enforcement of certain patents for Lipitor. Each of the actions seeks, among other things, treble damages on behalf of the putative class for alleged price overcharges for Lipitor (or, in certain of the actions, generic Lipitor) during the Class Period. In addition, individual actions have been filed against Pfizer, Ranbaxy and certain of their affiliates, among others, that assert claims and seek relief for the plaintiffs that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. These various actions have been consolidated for pre-trial proceedings in a Multi-District Litigation in the U.S. District Court for the District of New Jersey. In September 2013 and 2014, the District Court dismissed with prejudice the claims of the direct purchasers. In October and November 2014, the District Court dismissed with prejudice the claims of all other Multi-District Litigation plaintiffs. All plaintiffs have appealed the District Courts orders dismissing their claims with prejudice to the U.S. Court of Appeals for the Third Circuit. In addition, the direct purchaser class plaintiffs appealed the order denying their motion to amend the judgment and for leave to amend their complaint to the Court of Appeals. In 2017, the Court of Appeals reversed the District Courts decisions and remanded the claims to the District Court. Also, in 2013, the State of West Virginia filed an action in West Virginia state court against Pfizer and Ranbaxy, among others, that asserts claims and seeks relief on behalf of the State of West Virginia and residents of that state that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. EpiPen (Direct Purchaser) In February 2020, a lawsuit was filed in the U.S. District Court for the District of Kansas against Pfizer, its affiliates King and Meridian, and various Mylan entities, on behalf of a purported U.S. nationwide class of direct purchaser plaintiffs who purchased EpiPen devices directly from the defendants. Plaintiffs in this action generally allege that Pfizer and Mylan conspired to delay market entry of generic EpiPen through the settlement of patent litigation regarding EpiPen, and thereby delayed market entry of generic EpiPen in violation of federal antitrust law. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In July 2021, the District Court granted defendants motion to dismiss the direct purchaser complaint, without prejudice. In September 2021, plaintiffs filed an amended complaint. Nexium 24HR and Protonix A number of individual and multi-plaintiff lawsuits have been filed against Pfizer, certain of its subsidiaries and/or other pharmaceutical manufacturers in various federal and state courts alleging that the plaintiffs developed kidney-related injuries purportedly as a result of the ingestion of certain proton pump inhibitors. The cases against Pfizer involve Protonix and/or Nexium 24HR and seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In 2017, the federal actions were ordered transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the District of New Jersey. As part of our Consumer Healthcare JV transaction with GSK, the JV has agreed to assume, and to indemnify Pfizer for, liabilities arising out of such litigation to the extent related to Nexium 24HR. Docetaxel Personal Injury Actions A number of lawsuits have been filed against Hospira and Pfizer in various federal and state courts alleging that plaintiffs who were treated with Docetaxel developed permanent hair loss. The significant majority of the cases also name other defendants, including the manufacturer of the branded product, Taxotere. Plaintiffs seek compensatory and punitive damages. In 2016, the federal cases were transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the Eastern District of Louisiana. Mississippi Attorney General Government Action In 2018, the Attorney General of Mississippi filed a complaint in Mississippi state court against the manufacturer of the branded product and eight other manufacturers including Pfizer and Hospira, alleging, with respect to Pfizer and Hospira, a failure to warn about a risk of permanent hair loss in violation of the Mississippi Consumer Protection Act. The action seeks civil penalties and injunctive relief. Zantac A number of lawsuits have been filed against Pfizer in various federal and state courts alleging that plaintiffs developed various types of cancer, or face an increased risk of developing cancer, purportedly as a result of the ingestion of Zantac. The significant majority of these cases also name other defendants that have historically manufactured and/or sold Zantac. Pfizer has not sold Zantac since 2006, and only sold an OTC version of the product. Plaintiffs seek compensatory and punitive damages. In February 2020, the federal actions were transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the Southern District of Florida. Plaintiffs in the Multi-District Litigation have filed against Pfizer and many other defendants a master personal injury complaint, a consolidated consumer class action complaint alleging, among other things, claims under consumer protection Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies statutes of all 50 states, and a medical monitoring complaint seeking to certify medical monitoring classes under the laws of 13 states. Plaintiffs previously had filed a consolidated third-party payor class action complaint alleging violation of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) statute and seeking reimbursement for payments made for the prescription version of Zantac, but the Multi-District Litigation court dismissed that complaint; Plaintiffs have appealed the dismissal to the U.S. Court of Appeals for the Eleventh Circuit. In addition, (i) Pfizer has received service of Canadian class action complaints naming Pfizer and other defendants, and seeking compensatory and punitive damages for personal injury and economic loss, allegedly arising from the defendants sale of Zantac in Canada; and (ii) the State of New Mexico and the Mayor and City Council of Baltimore separately filed civil actions against Pfizer and many other defendants in state court, alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in those jurisdictions. In April 2021, a Judicial Council Coordinated Proceeding was created in the Superior Court of California in Alameda County to coordinate personal injury actions against Pfizer and other defendants filed in California state court. Chantix Beginning in August 2021, a number of putative class actions have been filed against Pfizer in various U.S. federal courts following Pfizers voluntary recall of Chantix due to the presence of a nitrosamine, N-nitroso-varenicline. Plaintiffs assert that they suffered economic harm purportedly as a result of purchasing Chantix or generic varenicline medicines sold by Pfizer. Plaintiffs seek to represent nationwide and state-specific classes and seek various remedies, including damages and medical monitoring. Similar putative class actions have been filed in Canada and Israel, where the product brand is Champix. A3. Legal ProceedingsCommercial and Other Matters Monsanto-Related Matters In 1997, Monsanto Company (Former Monsanto) contributed certain chemical manufacturing operations and facilities to a newly formed corporation, Solutia Inc. (Solutia), and spun off the shares of Solutia. In 2000, Former Monsanto merged with Pharmacia Upjohn Company to form Pharmacia. Pharmacia then transferred its agricultural operations to a newly created subsidiary, named Monsanto Company (New Monsanto), which it spun off in a two-stage process that was completed in 2002. Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. In connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities related to Pharmacias former agricultural business. New Monsanto has defended and/or is defending Pharmacia in connection with various claims and litigation arising out of, or related to, the agricultural business, and has been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. In connection with its spin-off in 1997, Solutia assumed, and agreed to indemnify Pharmacia for, liabilities related to Former Monsantos chemical businesses. As the result of its reorganization under Chapter 11 of the U.S. Bankruptcy Code, Solutias indemnification obligations relating to Former Monsantos chemical businesses are primarily limited to sites that Solutia has owned or operated. In addition, in connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities primarily related to Former Monsantos chemical businesses, including, but not limited to, any such liabilities that Solutia assumed. Solutias and New Monsantos assumption of, and agreement to indemnify Pharmacia for, these liabilities apply to pending actions and any future actions related to Former Monsantos chemical businesses in which Pharmacia is named as a defendant, including, without limitation, actions asserting environmental claims, including alleged exposure to polychlorinated biphenyls. Solutia and/or New Monsanto are defending Pharmacia in connection with various claims and litigation arising out of, or related to, Former Monsantos chemical businesses, and have been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. Environmental Matters In 2009, we submitted a revised site-wide feasibility study with regard to the Wyeth Holdings Corporation (formerly, American Cyanamid Company) discontinued industrial chemical facility in Bound Brook, New Jersey. In 2011, Wyeth Holdings Corporation executed an Administrative Settlement Agreement and Order on Consent for Removal Action (the 2011 Administrative Settlement Agreement) with the U.S. Environmental Protection Agency (EPA) with regard to the Bound Brook facility. In accordance with the 2011 Administrative Settlement Agreement, we completed construction of an interim remedy. In 2012, the EPA issued a final remediation plan for the Bound Brook facilitys main plant area. In 2013, Wyeth Holdings Corporation (now Wyeth Holdings LLC) entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the main plant area and to perform a focused feasibility study for two adjacent lagoons. In 2015, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey that allows Wyeth Holdings LLC to complete the design and to implement the remedy for the main plant area. The consent decree (which supersedes the 2011 Administrative Settlement Agreement) was entered by the District Court in 2015. In 2018, the EPA issued a final remediation plan for the two adjacent lagoons. In 2019, Wyeth Holdings LLC entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the lagoons. In September 2021, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey, which the court approved in November 2021, that will allow Wyeth Holdings LLC to complete the design and implement the remedy for the two adjacent lagoons. We have accrued for the estimated costs of the site remedies for the Bound Brook facility. We are a party to a number of other proceedings brought under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, and other state, local or foreign laws in which the primary relief sought is the cost of past and/or future remediation. Contracts with Iraqi Ministry of Health In 2017, a number of U.S. service members, civilians, and their families brought a complaint in the U.S. District Court for the District of Columbia against a number of pharmaceutical and medical devices companies, including Pfizer and certain of its subsidiaries, alleging that the defendants violated the U.S. Anti-Terrorism Act. The complaint alleges that the defendants provided funding for terrorist organizations through their sales practices pursuant to pharmaceutical and medical device contracts with the Iraqi Ministry of Health, and seeks monetary relief. In July 2020, the District Court granted defendants motions to dismiss and dismissed all of plaintiffs claims. In January 2022, the Court of Appeals reversed the District Courts decision. In February 2022, the defendants filed for en banc review of the Court of Appeals decision. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Allergan Complaint for Indemnity In 2019, Pfizer was named as a defendant in a complaint, along with King, filed by Allergan Finance LLC (Allergan) in the Supreme Court of the State of New York, asserting claims for indemnity related to Kadian, which was owned for a short period by King in 2008, prior to Pfizer's acquisition of King in 2010. This suit was voluntarily discontinued without prejudice in January 2021. Breach of ContractXalkori/Lorbrena We are a defendant in a breach of contract action brought by New York University (NYU) in the Supreme Court of the State of New York (Supreme Court). NYU alleges that it is entitled to royalties on Pfizers sales of Xalkori under the terms of a Research and License Agreement between NYU and Sugen, Inc. Sugen, Inc. was acquired by Pharmacia in August 1999, and Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. The action was originally filed in 2013. In 2015, the Supreme Court dismissed the action and, in 2017, the New York State Appellate Division reversed the decision and remanded the proceedings to the Supreme Court. In January 2020, the Supreme Court denied both parties summary judgment motions. In October 2020, NYU filed a separate breach of contract action against Pfizer alleging that it is entitled to royalties on sales of Lorbrena under the terms of the same NYU-Sugen, Inc. Research and Licensing Agreement. In February 2022, the parties reached an agreement to settle both breach of contract actions on terms not material to Pfizer. Viatris Securities Litigation In October 2021, a putative class action was filed in the Court of Common Pleas of Allegheny County, Pennsylvania on behalf of former Mylan N.V. shareholders who received Viatris common stock in exchange for Mylan shares in connection with the spin-off of the Upjohn Business and its combination with Mylan (the Transactions). Viatris, Pfizer, and certain of each companys current and former officers, directors and employees are named as defendants. The complaint alleges that the defendants violated certain provisions of the Securities Act of 1933 in connection with certain disclosures made in or omitted from the registration statement and related prospectus issued in connection with the Transactions. Plaintiff seeks damages, costs and expenses and other equitable and injunctive relief. A4. Legal ProceedingsGovernment Investigations We are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Among the investigations by government agencies are the matters discussed below. Greenstone Investigations U.S. Department of Justice Antitrust Division Investigation Since July 2017, the U.S. Department of Justice's Antitrust Division has been investigating our former Greenstone generics business. We believe this is related to an ongoing broader antitrust investigation of the generic pharmaceutical industry. We have produced records relating to this investigation. State Attorneys General and Multi-District Generics Antitrust Litigation In April 2018, Greenstone received requests for information from the Antitrust Department of the Connecticut Office of the Attorney General. In May 2019, Attorneys General of more than 40 states plus the District of Columbia and Puerto Rico filed a complaint against a number of pharmaceutical companies, including Greenstone and Pfizer. The matter has been consolidated with a Multi-District Litigation in the Eastern District of Pennsylvania. As to Greenstone and Pfizer, the complaint alleges anticompetitive conduct in violation of federal and state antitrust laws and state consumer protection laws. In June 2020, the State Attorneys General filed a new complaint against a large number of companies, including Greenstone and Pfizer, making similar allegations, but concerning a new set of drugs. This complaint was transferred to the Multi-District Litigation in July 2020. The Multi-District Litigation also includes civil complaints filed by private plaintiffs and state counties against Pfizer, Greenstone and a significant number of other defendants asserting allegations that generally overlap with those asserted by the State Attorneys General. Subpoena relating to Manufacturing of Quillivant XR In October 2018, we received a subpoena from the U.S. Attorneys Office for the Southern District of New York (SDNY) seeking records relating to our relationship with another drug manufacturer and its production and manufacturing of drugs including, but not limited to, Quillivant XR. We have produced records pursuant to the subpoena. Government Inquiries relating to Meridian Medical Technologies In February 2019, we received a civil investigative demand from the U.S. Attorneys Office for the SDNY. The civil investigative demand seeks records and information related to alleged quality issues involving the manufacture of auto-injectors at the Meridian site. In August 2019, we received a HIPAA subpoena from the U.S. Attorneys Office for the Eastern District of Missouri seeking similar records and information. We are producing records in response to these requests. U.S. Department of Justice/SEC Inquiry relating to Russian Operations In June 2019, we received an informal request from the U.S. Department of Justices FCPA Unit seeking documents relating to our operations in Russia. In September 2019, we received a similar request from the SECs FCPA Unit. We have produced records pursuant to these requests. Docetaxel Mississippi Attorney General Government Investigation See Legal Proceedings Product Litigation Docetaxel Mississippi Attorney General Government Investigation above for information regarding a government investigation related to Docetaxel marketing practices. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies U.S. Department of Justice Inquiries relating to India Operations In March 2020, we received an informal request from the U.S. Department of Justice's Consumer Protection Branch seeking documents relating to our manufacturing operations in India, including at our former facility located at Irrungattukottai in India. In April 2020, we received a similar request from the U.S. Attorneys Office for the SDNY regarding a civil investigation concerning operations at our facilities in India. We are producing records pursuant to these requests. U.S. Department of Justice/SEC Inquiry relating to China Operations In June 2020, we received an informal request from the U.S. Department of Justice's FCPA Unit seeking documents relating to our operations in China. In August 2020, we received a similar request from the SECs FCPA Unit. We are producing records pursuant to these requests. Zantac State of New Mexico and Mayor and City Council of Baltimore Civil Actions See Legal ProceedingsProduct LitigationZantac above for information regarding civil actions separately filed by the State of New Mexico and the Mayor and City Council of Baltimore alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in those jurisdictions. A5. Legal ProceedingsMatters Resolved During 2021 During 2021, certain matters, including the matter discussed below, were resolved or became the subject of definitive settlement agreements or settlement agreements-in-principle. EpiPen Beginning in 2017, purported class actions were filed in various federal courts by indirect purchasers of EpiPen against Pfizer, and/or its current and former affiliates King and Meridian, and/or various entities affiliated with Mylan, and Mylan former Chief Executive Officer, Heather Bresch. The plaintiffs in these actions represent U.S. nationwide classes comprising persons or entities who paid for any portion of the end-user purchase price of an EpiPen between 2009 until the cessation of the defendants allegedly unlawful conduct. Against Pfizer and/or its affiliates, plaintiffs in these actions generally allege that Pfizers and/or its affiliates settlement of patent litigation regarding EpiPen delayed market entry of generic EpiPen in violation of federal and various state antitrust laws. At least one lawsuit also alleges that Pfizer and/or Mylan violated RICO. Plaintiffs also filed various federal antitrust, state consumer protection and unjust enrichment claims against, and relating to conduct attributable solely to, Mylan and/or its affiliates regarding EpiPen. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In 2017, all of these indirect purchase actions were consolidated for coordinated pre-trial proceedings in a Multi-District Litigation in the U.S. District Court for the District of Kansas with other EpiPen-related actions against Mylan and/or its affiliates to which Pfizer, King and Meridian are not parties. In July 2021, Pfizer and plaintiffs filed a stipulation of settlement to resolve the Multi-District Litigation for $ 345 million. The District Court approved the settlement in November 2021, and the payment was made in accordance with the terms of the settlement agreement. B. Guarantees and Indemnifications In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities prior to or following a transaction. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we may be required to reimburse the loss. These indemnifications are generally subject to various restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of December 31, 2021, the estimated fair value of these indemnification obligations has been included in our financial statements and is not material to Pfizer. In addition, in connection with our entry into certain agreements and other transactions, our counterparties may agree to indemnify us. For example, in November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction and as previously disclosed, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of certain matters. We have also guaranteed the long-term debt of certain companies that we acquired and that now are subsidiaries of Pfizer. See Note 7D . C. Certain Commitments As of December 31, 2021, we had commitments totaling $ 5.2 billion that are legally binding and enforceable. These commitments include payments relating to potential milestone payments deemed reasonably likely to occur, and purchase obligations for goods and services. See Note 5A for information on the TCJA repatriation tax liability. D. Contingent Consideration for Acquisitions We may be required to make payments to sellers for certain prior business combinations that are contingent upon future events or outcomes. See Note 1E . The estimated fair value of contingent consideration as of December 31, 2021 is $ 697 million, of which $ 135 million is recorded in Other current liabilities and $ 563 million in Other noncurrent liabilities, and as of December 31, 2020 is $ 689 million, of which $ 123 million is recorded in Other current liabilities and $ 566 million in Other noncurrent liabilities . The increase in the contingent consideration balance from December 31, 2020 is primarily due to fair value adjustments, partially offset by payments made upon the achievement of certain sales-based milestones. E. Insurance Our insurance coverage reflects market conditions (including cost and availability) existing at the time it is written, and our decision to obtain insurance coverage or to self-insure varies accordingly. Depending upon the cost and availability of insurance and the nature of the risk involved, the amount of self-insurance may be significant. The cost and availability of coverage have resulted in self-insuring certain exposures, including product liability. If we incur substantial liabilities that are not covered by insurance or substantially exceed insurance Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies coverage and that are in excess of existing accruals, there could be a material adverse effect on our cash flows or results of operations in the period in which the amounts are paid and/or accrued. Note 17 . Segment, Geographic and Other Revenue Information A. Segment Information We regularly review our operating segments and the approach used by management to evaluate performance and allocate resources. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines and beginning in the fourth quarter of 2020 operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Biopharma is a science-based medicines business that includes six therapeutic areas Oncology, Inflammation Immunology, Rare Disease, Hospital, Vaccines and Internal Medicine. The Hospital therapeutic area commercializes our global portfolio of sterile injectable and anti-infective medicines. Each operating segment has responsibility for its commercial activities. Regional commercial organizations market, distribute and sell our products and are supported by global platform functions that are responsible for the research, development, manufacturing and supply of our products and global corporate enabling functions. Biopharma receives its RD services from GPD and WRDM. These services include IPRD projects for new investigational products and additional indications for in-line products. Each business has a geographic footprint across developed and emerging markets. Our chief operating decision maker uses the revenues and earnings of the operating segments, among other factors, for performance evaluation and resource allocation. Biopharma is the only reportable segment. We have revised prior-period information (Revenues and Earnings, as defined by management) to conform to the current management structure. Other Costs and Business Activities Certain pre-tax costs are not allocated to our operating segment results, such as costs associated with the following: WRDMthe RD and Medical expenses managed by our WRDM organization, which is generally responsible for research projects for our Biopharma portfolio until proof-of-concept is achieved and then for transitioning those projects to the GPD organization for possible clinical and commercial development. RD spending may include upfront and milestone payments for intellectual property rights. The WRDM organization also has responsibility for certain science-based and other platform-services organizations, which provide end-to-end technical expertise and other services to the various RD projects, as well as the Worldwide Medical and Safety group, which ensures that Pfizer provides all stakeholdersincluding patients, healthcare providers, pharmacists, payers and health authoritieswith complete and up-to-date information on the risks and benefits associated with Pfizer products so that they can make appropriate decisions on how and when to use Pfizers medicines. GPDthe costs associated with our GPD organization, which is generally responsible for clinical trials from WRDM in the Biopharma portfolio, including late-stage portfolio spend. GPD also provides technical support and other services to Pfizer RD projects. GPD is responsible for facilitating all regulatory submissions and interactions with regulatory agencies. Corporate and Other Unallocatedthe costs associated with (i) corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement, among others), all strategy, business development, portfolio management and valuation capabilities, patient advocacy activities and certain compensation and other corporate costs, such as interest income and expense, and gains and losses on investments; (ii) overhead expenses primarily associated with our manufacturing (which include manufacturing variances associated with production) operations that are not directly assessed to an operating segment, as business unit (segment) management does not manage these costs; and (iii) our share of earnings from the Consumer Healthcare JV. Certain transactions and events such as (i) purchase accounting adjustments, where we incur expenses associated with the amortization of fair value adjustments to inventory, intangible assets and PPE; (ii) acquisition-related items, where we incur costs for executing the transaction, integrating the acquired operations and restructuring the combined company; and (iii) certain significant items, representing substantive and/or unusual, and in some cases recurring, items (such as pension and postretirement actuarial remeasurement gains and losses, gains on the completion of joint venture transactions, restructuring charges, legal charges or net gains and losses on investments in equity securities) that are evaluated on an individual basis by management and that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis. Such items can include, but are not limited to, non-acquisition-related restructuring costs, as well as costs incurred for legal settlements, asset impairments and disposals of assets or businesses, including, as applicable, any associated transition activities. The operating results of PC1, our global contract development and manufacturing organization, and through July 31, 2019 our former Consumer Healthcare business are included in Other business activities. Segment Assets We manage our assets on a total company basis, not by operating segment, as our operating assets are shared or commingled. Therefore, our chief operating decision maker does not regularly review any asset information by operating segment and, accordingly, we do not report asset information by operating segment. Total assets were $ 181 billion as of December 31, 2021 and $ 154 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Selected Income Statement Information The following table provides selected income statement information by reportable segment: Revenues Earnings (a) Depreciation and Amortization (b) Year Ended December 31, Year Ended December 31, Year Ended December 31, (MILLIONS OF DOLLARS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Reportable Segment: Biopharma $ 79,557 $ 40,724 $ 38,013 $ 40,226 $ 27,089 $ 24,419 $ 1,439 $ 1,013 $ 978 Other business activities (c) 1,731 926 2,892 ( 10,396 ) ( 12,308 ) ( 11,216 ) 598 603 592 Reconciling Items: Purchase accounting adjustments ( 3,175 ) ( 3,117 ) ( 4,153 ) 3,067 3,047 4,145 Acquisition-related costs ( 52 ) ( 44 ) ( 185 ) 3 Certain significant items (d) ( 2,292 ) ( 4,584 ) 2,456 87 18 37 $ 81,288 $ 41,651 $ 40,905 $ 24,311 $ 7,036 $ 11,321 $ 5,191 $ 4,681 $ 5,755 (a) Income from continuing operations before provision/(benefit) for taxes on income. Biopharmas earnings include dividend income from our investment in ViiV of $ 166 million in 2021, $ 278 million in 2020 and $ 220 million in 2019. (b) Certain production facilities are shared. Depreciation is allocated based on estimates of physical production. Amounts here relate solely to the depreciation and amortization associated with continuing operations. (c) Other business activities include revenues and costs associated with PC1, as well as costs associated with global WRDM and GPD platform functions, global corporate enabling functions and other corporate items, as noted above, that we do not allocate to our operating segments. In 2019, Other business activities also include revenues and costs associated with our former Consumer Healthcare business through July 31, 2019. See Note 2C. (d) Certain significant items are substantive and/or unusual, and in some cases recurring, items (as noted above) that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis. For Earnings in 2021, includes, among other items: (i) a $ 2.1 billion charge for IPRD related to our acquisition of Trillium, which was accounted for as an asset acquisition and recorded in Research and development expenses , (ii) restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring of $ 1.3 billion ($ 450 million recorded in Selling, informational and administrative expenses and the remaining amount primarily recorded in Restructuring charges and certain acquisition-related costs ) and (iii) upfront and milestone payments on collaborative and licensing arrangements of $ 1.1 billion recorded in Research and development expenses , partially offset by (iv) actuarial valuation and other pension and postretirement plan gains of $ 1.6 billion recorded in Other (income)/deductionsnet and (v) gains on equity securities of $ 1.3 billion recorded in Other (income)/deductionsnet . For Earnings in 2020, includes, among other items; (i) charges of $ 1.7 billion related to certain asset impairments recorded in Other (income)/deductionsnet , (ii) actuarial valuation and other pension and postretirement plan losses of $ 1.1 billion recorded in Other (income)/deductionsnet and (iii) restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring of $ 791 million ($ 197 million recorded in Selling, informational and administrative expenses and the remaining amount primarily recorded in Restructuring charges and certain acquisition-related costs ). For Earnings in 2019, includes, among other items: (i) a pre-tax gain of $ 8.1 billion recorded in (Gain) on completion of Consumer Healthcare JV transaction associated with the completion of the Consumer Healthcare JV transaction, partially offset by (ii) charges of $ 2.8 billion related to certain asset impairments recorded in Other (income)/deductionsnet and (iii) actuarial valuation and other pension and postretirement plan losses of $ 750 million recorded in Other (income)/deductionsnet. For additional information, see Notes 2A, 2C, 3 and 4 . B. Geographic Information The following summarizes revenues by geographic area: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States $ 29,746 $ 21,455 $ 20,326 Developed Europe 18,336 7,788 7,729 Developed Rest of World 12,506 4,036 4,022 Emerging Markets 20,701 8,372 8,828 Revenues $ 81,288 $ 41,651 $ 40,905 Revenues exceeded $500 million in each of 21 , 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively. The U.S. is the only country to contribute more than 10 % of total revenue in 2021, 2020 and 2019. As a percentage of revenues, our largest national market outside the U.S. was Japan, which contributed 9 % of total revenue in 2021 and 6 % in each of 2020 and 2019. We and our collaboration partner, BioNTech, have entered into agreements to supply pre-specified doses of Comirnaty with multiple developed and emerging nations around the world and are continuing to deliver doses of Comirnaty under such agreements. We currently sell the Comirnaty vaccine directly to government and government sponsored customers. This includes supply agreements entered into in November 2020 and February and May 2021 with the EC on behalf of the different EU member states and certain other countries. Each EU member state submits its own Comirnaty vaccine order to us and is responsible for payment pursuant to terms of the supply agreements negotiated by the EC. C. Other Revenue Information Significant Customers Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccine products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes revenue, as a percentage of total revenues, for our three largest U.S. wholesaler customers: Year Ended December 31, 2021 2020 2019 McKesson, Inc. 9 % 16 % 15 % AmerisourceBergen Corporation 7 % 14 % 11 % Cardinal Health, Inc. 5 % 10 % 9 % Collectively, our three largest U.S. wholesaler customers represented 24 %, 30 % and 25 % of total trade accounts receivable as of December 31, 2021, 2020 and 2019. Additionally, revenues from the U.S. government represented 13 % of total revenues for 2021, and primarily represent sales of Comirnaty. Accounts receivable from the U.S. government represented 12 % of total trade accounts receivable as of December 31, 2021, and primarily relate to sales of Comirnaty. Significant Product Revenues The following provides detailed revenue information for several of our major products: (MILLIONS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2021 2020 2019 TOTAL REVENUES (a) $ 81,288 $ 41,651 $ 40,905 PFIZER BIOPHARMACEUTICALS GROUP (BIOPHARMA) (a), (b) $ 79,557 $ 40,724 $ 38,013 Vaccines $ 42,625 $ 6,575 $ 6,504 Comirnaty direct sales and alliance revenues Active immunization to prevent COVID-19 36,781 154 Prevnar family (c) Pneumococcal disease 5,272 5,850 5,847 Nimenrix Meningococcal ACWY disease 193 221 230 FSME-IMMUN/TicoVac Tick-borne encephalitis disease 185 196 220 Trumenba Meningococcal B disease 118 112 135 All other Vaccines Various 74 42 73 Oncology $ 12,333 $ 10,867 $ 9,014 Ibrance HR-positive/HER2-negative metastatic breast cancer 5,437 5,392 4,961 Xtandi alliance revenues mCRPC, nmCRPC, mCSPC 1,185 1,024 838 Inlyta Advanced RCC 1,002 787 477 Sutent Advanced and/or metastatic RCC, adjuvant RCC, refractory GIST (after disease progression on, or intolerance to, imatinib mesylate) and advanced pancreatic neuroendocrine tumor 673 819 936 Bosulif Philadelphia chromosomepositive chronic myelogenous leukemia 540 450 365 Xalkori ALK-positive and ROS1-positive advanced NSCLC 493 544 530 Ruxience (d) Non-hodgkins lymphoma, chronic lymphocytic leukemia, granulomatosis with polyangiitis (Wegeners Granulomatosis) and microscopic polyangiitis 491 170 ( 1 ) Retacrit (d) Anemia 444 386 225 Zirabev (d) Treatment of mCRC; unresectable, locally advanced, recurrent or metastatic NSCLC; recurrent glioblastoma; metastatic RCC; and persistent, recurrent or metastatic cervical cancer 444 143 1 Lorbrena ALK-positive metastatic NSCLC 266 204 115 Aromasin Post-menopausal early and advanced breast cancer 211 148 136 Trazimera (d) HER-positive breast cancer and metastatic stomach cancers 197 98 6 Besponsa Relapsed or refractory B-cell acute lymphoblastic leukemia 192 182 157 Braftovi In combination with Mektovi for metastatic melanoma in patients with a BRAF V600E/K mutation and, in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy 187 160 48 Bavencio alliance revenues Locally advanced or metastatic urothelial carcinoma; metastatic Merkel cell carcinoma; immunotherapy and tyrosine kinase inhibitor combination for patients with advanced RCC 178 80 49 Mektovi In combination with Braftovi for metastatic melanoma in patients with a BRAF V600E/K mutation 155 142 49 All other Oncology Various 238 137 122 Internal Medicine $ 9,329 $ 9,003 $ 8,790 Eliquis alliance revenues and direct sales Nonvalvular atrial fibrillation, deep vein thrombosis, pulmonary embolism 5,970 4,949 4,220 Premarin family Symptoms of menopause 563 680 734 Chantix/Champix An aid to smoking cessation treatment in adults 18 years of age or older 398 919 1,107 BMP2 Development of bone and cartilage 266 274 287 Toviaz Overactive bladder 238 252 250 Pristiq Depression 187 171 176 All other Internal Medicine Various 1,706 1,758 2,016 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (MILLIONS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2021 2020 2019 Hospital (a) $ 7,301 $ 6,777 $ 6,695 Sulperazon Bacterial infections 683 618 684 Medrol Anti-inflammatory glucocorticoid 432 402 469 Zavicefta Bacterial infections 413 212 108 Fragmin Treatment/prevention of venous thromboembolism 305 252 253 Zithromax Bacterial infections 278 276 336 Vfend Fungal infections 267 270 346 Tygacil Bacterial infections 200 160 197 Precedex Sedation agent in surgery or intensive care 177 260 155 Zyvox Bacterial infections 173 222 251 Paxlovid COVID-19 Infection ( high risk population) 76 IVIg Products (e) Various 430 376 275 All other Anti-infectives Various 1,453 1,294 1,396 All other Hospital Various 2,412 2,435 2,225 Inflammation Immunology (II) $ 4,431 $ 4,567 $ 4,733 Xeljanz RA, PsA, UC, active polyarticular course juvenile idiopathic arthritis, ankylosing spondylitis 2,455 2,437 2,242 Enbrel (Outside the U.S. and Canada) RA, juvenile idiopathic arthritis, PsA, plaque psoriasis, pediatric plaque psoriasis, ankylosing spondylitis and nonradiographic axial spondyloarthritis 1,185 1,350 1,699 Inflectra/Remsima (d) Crohns disease, pediatric Crohns disease, UC, pediatric UC, RA in combination with methotrexate, ankylosing spondylitis, PsA and plaque psoriasis 657 659 625 All other II Various 134 121 167 Rare Disease $ 3,538 $ 2,936 $ 2,278 Vyndaqel/Vyndamax ATTR-cardiomyopathy and polyneuropathy 2,015 1,288 473 BeneFIX Hemophilia B 438 454 488 Genotropin Replacement of human growth hormone 389 427 498 Refacto AF/Xyntha Hemophilia A 304 370 426 Somavert Acromegaly 277 277 264 All other Rare Disease Various 115 120 129 PFIZER CENTREONE (b) $ 1,731 $ 926 $ 810 CONSUMER HEALTHCARE BUSINESS (f) $ $ $ 2,082 Total Alliance revenues $ 7,652 $ 5,418 $ 4,648 Total Biosimilars (d) $ 2,343 $ 1,527 $ 911 Total Sterile Injectable Pharmaceuticals (g) $ 5,746 $ 5,315 $ 5,013 (a) On December 31, 2021, we completed the sale of our Meridian subsidiary. Prior to its sale, Meridian was managed as part of the Hospital therapeutic area. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. On December 21, 2020, Pfizer and Viatris completed the termination of the Mylan-Japan collaboration. Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. Prior-period financial information has been restated, as appropriate. See Note 1A . (b) At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1. PC1, which previously had been managed within the Hospital therapeutic area, includes revenues from our contract manufacturing, including certain Comirnaty-related manufacturing activities performed on behalf of BioNTech ($ 320 million for 2021 and $ 0 million for 2020 and 2019), and active pharmaceutical ingredient sales operation, as well as revenues related to our manufacturing and supply agreements with former legacy Pfizer businesses/partnerships, including but not limited to, transitional manufacturing and supply agreements with Viatris following the spin-off of the Upjohn Business. We have revised prior period information to conform to the current management structure. (c) Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). (d) Biosimilars are highly similar versions of approved and authorized biological medicines and primarily include revenues from Inflectra/Remsima, Ruxience, Retacrit, Zirabev and Trazimera. (e) Intravenous immunoglobulin (IVIg) products include the revenues from Panzyga, Octagam and Cutaquig. (f) On July 31, 2019, our Consumer Healthcare business, an OTC medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare JV. See Note 2C . (g) Total Sterile Injectable Pharmaceuticals represents the total of all branded and generic injectable products in the Hospital therapeutic area, including anti-infective sterile injectable pharmaceuticals. Remaining Performance Obligations Contracted revenue expected to be recognized from remaining performance obligations for firm orders in long-term contracts to supply Comirnaty to our customers totals $ 34.4 billion as of December 31, 2021, which includes amounts received in advance and deferred and amounts that will be invoiced as we deliver the product to our customers in future periods. Of this amount, we expect to recognize revenue of Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies $ 22.3 billion in 2022, $ 11.8 billion in 2023 and $ 265 million in 2024. Remaining performance obligations exclude arrangements with an original expected contract duration of less than one year. Deferred Revenues Our deferred revenues primarily relate to advance payments received or receivable in connection with contracts that we entered into during 2021 and 2020 with various government or government sponsored customers in international markets for supply of Comirnaty. The deferred revenues associated with the advance payments related to Comirnaty total $ 3.3 billion as of December 31, 2021 and $ 957 million as of December 31, 2020, with $ 3.0 billion and $ 249 million recorded in current liabilities and noncurrent liabilities, respectively as of December 31, 2021, and $ 957 million recorded in current liabilities as of December 31, 2020. The increase in the Comirnaty deferred revenues during 2021 was the result of additional advance payments received as we entered into new or amended contracts or as we invoiced customers in advance of vaccine deliveries less amounts recognized in Revenues as we delivered doses to our customers. During 2021, we recognized in revenue substantially all of the balance of Comirnaty deferred revenues as of December 31, 2020. The Comirnaty deferred revenues as of December 31, 2021 will be recognized in Revenues proportionately as we deliver doses of the vaccine to our customers and satisfy our performance obligation under the contracts, with the amounts included in current liabilities expected to be recognized in Revenues within the next 12 months, and the amounts included in noncurrent liabilities expected to be recognized in Revenues in 2023 and in the first quarter of 2024. Deferred revenues associated with contracts for other products were not significant as of December 31, 2021 or 2020. Pfizer Inc. 2021 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2021 (a) Revenues $ 14,516 $ 18,899 $ 24,035 $ 23,838 Costs and expenses (b) 8,802 11,951 15,546 19,876 Restructuring charges and certain acquisition-related costs (c) 22 (1) 646 135 Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 5,692 6,949 7,843 3,827 Provision/(benefit) for taxes on income/(loss) (d) 808 1,123 (328) 249 Income/(loss) from continuing operations 4,885 5,825 8,171 3,578 Discontinued operationsnet of tax (e) 1 (236) (13) (187) Net income/(loss) before allocation to noncontrolling interests 4,886 5,589 8,159 3,391 Less: Net income attributable to noncontrolling interests 9 26 12 (2) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 4,877 $ 5,563 $ 8,146 $ 3,393 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.87 $ 1.04 $ 1.45 $ 0.64 Discontinued operationsnet of tax (0.04) (0.03) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.87 $ 0.99 $ 1.45 $ 0.60 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.86 $ 1.02 $ 1.43 $ 0.62 Discontinued operationsnet of tax (0.04) (0.03) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.86 $ 0.98 $ 1.42 $ 0.59 (a) Business development activities impacted our results of operations in 2021 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Cost of sales for all quarters reflects higher costs for Comirnaty. The fourth quarter includes a $2.1 billion charge for IPRD expense associated with the acquisition of Trillium, as well as other upfront and milestone payments on collaboration and licensing arrangements. See Notes 2A, D and E. (c) The third and fourth quarters of 2021 primarily include employee termination costs associated with our Transforming to a More Focused Company program. See Note 3. (d) All periods reflect a change in the jurisdictional mix of earnings primarily related to Comirnaty. The third quarter of 2021 reflects benefits resulting from certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV with GSK. See Note 5A. (e) All periods include the operating results of Meridian prior to its sale on December 31, 2021 and to a lesser extent post-closing adjustments directly related to prior discontinued businesses. The second quarter of 2021 includes a pre-tax charge of $345 million to resolve a legal matter related to Meridian and the fourth quarter of 2021 includes an after tax loss of $167 million related to the sale of Meridian. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. Pfizer Inc. 2021 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2020 (a) Revenues $ 10,007 $ 9,795 $ 10,215 $ 11,634 Costs and expenses (b) 7,100 6,389 9,635 10,917 Restructuring charges and certain acquisition-related costs 54 360 2 163 (Gain) on completion of Consumer Healthcare JV transaction (6) Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,859 3,046 577 554 Provision/(benefit) for taxes on income/(loss) 358 425 (334) (80) Income/(loss) from continuing operations 2,501 2,621 911 634 Discontinued operationsnet of tax (c) 863 876 566 224 Net income/(loss) before allocation to noncontrolling interests 3,364 3,497 1,477 857 Less: Net income attributable to noncontrolling interests 9 8 8 11 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,355 $ 3,489 $ 1,469 $ 847 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.45 $ 0.47 $ 0.16 $ 0.11 Discontinued operationsnet of tax 0.16 0.16 0.10 0.04 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.60 $ 0.63 $ 0.26 $ 0.15 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.47 $ 0.16 $ 0.11 Discontinued operationsnet of tax 0.15 0.16 0.10 0.04 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.60 $ 0.62 $ 0.26 $ 0.15 (a) Business development activities impacted our results of operations in 2020 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Certain asset impairments totaled $900 million in the third quarter of 2020 and $791 million in the fourth quarter of 2020 recorded in Other (income)/deductionsnet . See Note 4. (c) Operating results of the Upjohn Business through November 16, 2020, the date of the spin-off and combination with Mylan, the Mylan-Japan collaboration and Meridian are presented as discontinued operations in all periods presented. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures As of the end of the period covered by this Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. Pfizer Inc. 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pfizer Inc.: Opinion on Internal Control Over Financial Reporting We have audited Pfizer Inc. and Subsidiary Companies (the Company) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements), and our report dated February 24, 2022 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. New York, New York February 24, 2022 Pfizer Inc. 2021 Form 10-K Managements Report on Internal Control Over Financial Reporting Managements Report We prepared and are responsible for the financial statements that appear in this Form 10-K. These financial statements are in conformity with accounting principles generally accepted in the United States of America and, therefore, include amounts based on informed judgments and estimates. We also accept responsibility for the preparation of other financial information that is included in this document. Report on Internal Control Over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) . Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2021. The Companys independent auditors have issued their auditors report on the Companys internal control over financial reporting. That report appears above in this Form 10-K . Albert Bourla Chairman and Chief Executive Officer Frank DAmelio Jennifer B. Damico Principal Financial Officer Principal Accounting Officer February 24, 2022 Pfizer Inc. 2021 Form 10-K PART III " +25,Pfizer,2020," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of our products, principally biopharmaceutical products, and to a lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people; 2. Deliver first-in-class science; 3. Transform our go-to-market model; 4. Win the digital race in pharma; and 5. Lead the conversation. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. Following (i) the recent spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan, which created a new global pharmaceutical company, Viatris, in November 2020 and (ii) the formation of the Consumer Healthcare JV in 2019, we saw the culmination of Pfizers transformation into a more focused, innovative science-based biopharmaceutical products business. Our significant recent business development activities in 2020 include: (i) the April 2020 agreement with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody, sugemalimab, and to bring additional oncology assets to China, (iv) the November 2020 spin-off and combination of the Upjohn Business with Mylan, and (v) the December 2020 entry into a collaboration with Myovant to jointly develop and commercialize relugolix in advanced prostate cancer and womens health in the U.S. and Canada. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, among others, the development of a vaccine to help prevent COVID-19. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsDevelopment, Regulatory Approval and Marketing of Products and COVID-19 Pandemic sections in this Form 10-K. COMMERCIAL OPERATIONS In 2020, we managed our commercial operations through a global structure consisting of two businessesBiopharma, and, through November 16, 2020, Upjohn, each led by a single manager. On November 16, 2020, we completed the spin-off and combination of the Upjohn Business with Mylan. Following the combination, we now operate as a focused innovative biopharmaceutical company engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. In 2019, Consumer Healthcare, which was our OTC medicines business, was Pfizer Inc. 2020 Form 10-K combined with GSKs consumer healthcare business to form a consumer healthcare JV in which we own a 32% equity stake. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Notes 1A and 2C. Our business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis*, Chantix/Champix* and the Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Sutent*, Inlyta, Retacrit, Lorbrena and Braftovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Zithromax, Vfend and Panzyga Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Prevnar 13/Prevenar 13 (pediatric/adult)*, Nimenrix, FSME/IMMUN-TicoVac, Trumenba and the Pfizer-BioNTech COVID-19 vaccine Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra and Eucrisa/Staquis Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2020, 2019 and 2018. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2020, Chantix/Champix recorded direct product revenues of more than $1 billion in 2019 and 2018 and Sutent recorded direct product revenues of more than $1 billion in 2018. Eliquis includes Alliance revenues and direct sales. For additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Pfizer-BioNTech COVID-19 Vaccine (BNT162b2) is an mRNA-based coronavirus vaccine to help prevent COVID-19 which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech will equally share the costs of development for the BNT162 program. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. We will also share gross profits equally from commercialization of BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist approved by the FDA for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and the relugolix combination tablet, with Myovant bearing our share of allowable expenses up to a maximum of $100 million in 2021 and up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, with Lilly to jointly develop and globally commercialize tanezumab for the treatment of osteoarthritis pain and cancer pain, under which the companies share equally the ongoing development costs and, if successful, will co-commercialize and share equally in profits and certain expenses in the U.S., while Pfizer will be responsible for commercialization activities and costs outside the U.S., with Lilly having the right to Pfizer Inc. 2020 Form 10-K receive certain tiered royalties outside the U.S. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. We also have arrangements with third parties that fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive future payments, such as milestone-based, revenue sharing, or profit-sharing payments or royalties. These collaboration, alliance, license and funding agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances, license and funding arrangements and investments, see Note 2 . Our RD Operations. In 2020, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. GPD is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in our portfolio. Science-based platform-services organizations. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions (which are part of our WRDM organization) such as Pharmaceutical Sciences and Medicine Design. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Another platform-service organization is the Worldwide Medical and Safety (WMS) group, which includes worldwide safety surveillance, medical information and the Chief Medical Office. The WMS group provides patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information about the risks and benefits associated with Pfizers RD programs and marketed products so they can make appropriate decisions on how and when to use our products. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. In 2020, the RD organization within Upjohn supported the off-patent branded and generic established medicines and managed its resources separately from the WRDM and GPD organizations. Following the spin-off and combination of the Upjohn Business with Mylan to create Viatris, we have agreed to provide certain transition services to Viatris including support for RD, pharmacovigilance and safety surveillance. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA. Pfizer Inc. 2020 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 2, 2021, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $20.2 billion accounted for 48% of our total revenues in 2020. Revenues exceeded $500 million in each of 8, 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17A . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. A portion of our government contracts are subject to renegotiation or termination of contracts or subcontracts at the discretion of a government entity. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our largest biopharmaceutical wholesalers, see Note 17B . Pfizer Inc. 2020 Form 10-K We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Drug U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 2022 Sutent 2021 2022 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (3) 2025 Prevnar 13/Prevenar 13 2026 __(4) 2029 Eliquis (5) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (6) 2027 * (6) * (6) Vyndaqel/Vyndamax 2024 (2028 pending PTE) 2026 2026 Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (7) Braftovi (8) 2031 (2031 pending PTE) * (8) * (8) Mektovi (8) 2031 (9) * (8) * (8) Bavencio (10) 2033 2032 2033 Lorbrena 2033 2034 2036 (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our drug from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix in the U.S. expired in November 2020. (3) Xeljanz Europe expiry is provided by regulatory exclusivity. (4) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (5) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and are the subject of patent infringement litigation. Prior to the August 2020 ruling referenced in the following sentence, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). In August 2020, the U.S. District Court for the District of Delaware decided that the two challenged Eliquis patents are both valid and infringed by the remaining generic companies. The remaining generic companies have appealed the Delaware court decision and the final decision in this case could determine when generic versions of Eliquis will come on the market. While we cannot predict the outcome of this pending litigation, these are the alternatives that might occur: (a) If the district courts decision is upheld in the current appeal with respect to both patents, under the terms of previously executed settlement agreements with the settled generic companies, the permitted date of launch for the settled generic companies under these patents is April 1, 2028; (b) if the formulation patent is held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies could launch products immediately upon such an adverse decision. In addition, both patents may be subject to subsequent challenges by parties other than the remaining generic companies. If this were to occur, depending on the outcome of the subsequent challenge, the potential launch by generic companies, including challengers, if successful, could occur on timelines similar to those discussed above. Pfizer Inc. 2020 Form 10-K Refer to Note 16A1 for more information. (6) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (7) Besponsa Japan expiry is provided by regulatory exclusivity. (8) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (9) Mektovi U.S. expiry is provided by a method of use patent. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Intellectual Property Protection, Third Party Intellectual Property Claims and Competitive Products sections in this Form 10-K and Note 16A1 . Losses of Product Exclusivity. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. The basic product patent for Chantix in the U.S. expired on November 10, 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug approval as we seek to further demonstrate the value of our products for the conditions they treat, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We sell biosimilars of certain inflammation immunology and oncology biologic medicines. We seek to maximize the opportunity to establish a first-to-market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Pfizer Inc. 2020 Form 10-K Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2021 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 299 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger entities, which enhances MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Pfizer Inc. 2020 Form 10-K Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. We have supplier management activities in place to monitor supply channels and to take action as needed to secure necessary volumes. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2021. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing pharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. Many of our activities are subject to the jurisdiction of the SEC. For a biopharmaceutical company to market a drug or a biologic product in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or Biologics License Application (BLA) (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. Once a drug or biologic is approved, the FDA must be notified of any product modifications and may require additional studies or clinical trials. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Approval Data section in this Form 10-K. In the context of public health emergencies like the COVID-19 pandemic, we may apply for EUA with the FDA, which when granted, allows for the distribution and use of our products during the term declared and extended by the government, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated at the governments discretion. Although the criteria of an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing compliance obligations. The FDA expects EUA holders to work toward submission of full applications, such as a BLA, as soon as possible. For BNT162b2, we are working towards submitting a BLA for possible full regulatory approval. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Healthcare Reform . Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. This includes potential replacements for the ACA, if it is ultimately invalidated by the U.S. Supreme Court in California v. Texas , as well as efforts at the state level to develop additional public insurance options or implement a single payer healthcare system. We do not expect that invalidation of the ACA itself would have a material impact on our business given the modest revenues the health insurance exchanges and Medicaid expansion generate for us. However, a future replacement of the ACA or other healthcare reform efforts may adversely affect our business and financial results, particularly if such replacement or reform reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Pfizer Inc. 2020 Form 10-K Pricing and Reimbursement . Pricing and reimbursement for our products depend in part on government regulation. In order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1G. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. In the Fall of 2020, the Trump Administration finalized an importation pathway from Canada and a payment model to tie Medicare Part B physician reimbursement to international prices, though ultimate implementation of both is uncertain due to legal challenges. We expect to see continued focus on regulating pricing resulting in additional legislation and regulation under the newly elected Congress and the Biden Administration. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid and Medicare managed care programs typically is determined by the health plans with which state Medicaid agencies and Medicare contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us as part of our business activities is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. Such laws and regulations have the potential to affect our business materially, continue to evolve and are increasingly being enforced vigorously. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. From January 1, 2021, as a consequence of the U.K. leaving the EU (Brexit), the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority for the U.K. In China, following significant regulatory reforms in recent years, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle- and lower-income require marketing approval by a recognized regulatory authority (i.e., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU/EEA, the EMAs Pharmacovigilance Risk Assessment Committee is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., China, Japan, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of measures including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations, such as the World Health Organization and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. On November 25, 2020, the European Commission published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. In China, pricing pressures have increased in recent years, with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. Drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program has also been initiated and expanded nationwide, under which a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to Pfizer Inc. 2020 Form 10-K implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, following a review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including the EUs General Data Protection Regulations. The legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2020 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $42 million in environment-related capital expenditures and $120 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is clear: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2020, we employed approximately 78,500 people worldwide, with approximately 29,400 based in the U.S. Women compose approximately 48% of our workforce, and approximately 32% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, and offering competitive compensation and benefits programs that encourage healthy work-life balance, so that all colleagues feel ready, equipped and energized to deliver innovative breakthroughs that extend and significantly improve patients lives. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our new and expanded commitments to equity include specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) increasing the representation of both women and underrepresented ethnic groups; (ii) providing resources to support managers in having courageous conversations about equity, race and the avoidance of bias within their teams; (iii) revising our Political Action Committee (PAC) bylaws to help ensure that PAC recipients consistently demonstrate conduct that align with our core values; and (iv) working to help ensure recruitment demographics of all clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . We understand the importance of continuously listening and responding to colleague feedback. Our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their Pfizer experience and equips leaders with Pfizer Inc. 2020 Form 10-K actionable insights for discussion and follow up. Regular topics in the survey include (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer, and (ii) purpose, including how colleagues work connects with our purpose. Through these surveys, we can measure and track the degree to which colleagues are proud to work at Pfizer, would recommend Pfizer as a great place to work to others and intend to stay with Pfizer. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insights is based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. We strive to ensure that all colleagues have an equal opportunity to grow and offer a variety of programs including mentoring, job rotations, experiential project roles, skill based volunteering and learning programs focused on many topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being. We are committed to the health, safety and well-being of our colleagues and continue to advance a comprehensive occupational injury and illness prevention program. During 2020, our COVID-19 pandemic preparedness and response was a primary focus. Our comprehensive pandemic response plan incorporates guidance issued by external health authorities and is designed to keep onsite workers at our manufacturing and research sites safe and healthy. A global employee assistance program provides stress management, mental health, emotional, resiliency and pandemic guidance and support to our colleagues. Pay Equity. We are committed to pay equity, based on gender or race/ethnicity, and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the Careers section of Pfizers website. AVAILABLE INFORM ATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 25, 2021. Our Proxy Statement will be available on our website on or about March 11, 2021. Our 2020 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 11, 2021. Information in our ESG Report is not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. "," ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is not meant to be a complete discussion of all potential risks or uncertainties. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. Negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line drugs and drug candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. While multi-source generic competition for Chantix has not yet begun, it could commence at anytime. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against JJ alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or alliance revenues of more than $1 billion for each of seven products that collectively accounted for 53% of our total revenues in 2020. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and other Intellectual Property Rights section in this Form 10-K. Pfizer Inc. 2020 Form 10-K In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17B . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, either through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political or civil unrest, terrorist activity, unstable governments and legal systems and inter-governmental disputes. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. In addition, since a significant portion of our business is conducted in the EU, as well as the U.K., the changes resulting from Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 48% of our total 2020 revenues were derived from international operations, including 23% from Europe and 17% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Notes 7E and 11 . From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend Pfizer Inc. 2020 Form 10-K any contracts to accommodate the SOFR rate where required. While our exposure to LIBOR is very low, market volatility related to the transition may adversely affect the trading market for securities linked to such benchmarks. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in product manufacturing, sales or marketing due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, damage to our facilities due to natural or man-made disasters, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain appropriate quality standards throughout our supply network and/or comply with applicable regulations; and supply chain disruptions at our facilities or at a supplier or vendor. Regulatory agencies periodically inspect our manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. For example, in September 2017, our subsidiary, Meridian, received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as Official Action Indicated (OAI). Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines prime targets for counterfeiters. Counterfeit medicines pose a significant risk to patient health and safety because of the conditions under which they are manufactured often in unregulated, unlicensed, uninspected and unsanitary sites as well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact our business, by, among other things, causing patient harm, the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the Internet in lieu of traditional brick and mortar pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of the anonymity it affords counterfeiters. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. Some states have implemented, and others are considering, price controls or patient access constraints under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have recently focused on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, Pfizer Inc. 2020 Form 10-K could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for new COVID-19 therapies and vaccines. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare reform, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending that could affect pharmaceutical utilization and pricing as does the Medicare Payment Advisory Commission. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval from regulators. Regulatory approvals of our products depend on myriad factors, including a regulator making a determination as to whether a product is safe and efficacious. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP, that may impact the use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as Pfizer Inc. 2020 Form 10-K other products in the class. The potential regulatory and commercial implications of post-marketing study results, for approved indications and potential new indications of an in-line product, typically cannot immediately be determined. For example, the potential impact of the co-primary endpoint results from a recently completed post-marketing required safety study of Xeljanz, ORAL Surveillance (A3921133), announced in January 2021, and related results, analyses and discussions with and reviews by regulators, remain uncertain. We are working with the FDA and other regulatory agencies to review the full results and analyses as they become available. The terms of our EUA for the BNT162b2 vaccine require that we conduct post-authorization observational studies. In addition, the FDA expects EUA holders to work towards submission of full application, such as a BLA, as soon as possible. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices Pfizer Inc. 2020 Form 10-K that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems to operate our business. We collect, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party vendors who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or malicious attackers. Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent cyber-attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may result in additional expenses and may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. GSK has indicated that it intends to separate the JV as an independent company listed on the U.K. equity market. Until July 31, 2024, GSK has the exclusive right to initiate a separation and listing transaction. We have the option to participate in a separation and listing transaction initiated by GSK. However, the separation and public listing transaction may not be initiated or completed within expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for us or our shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others, impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain interruptions, including challenges related to reliance on third-party suppliers; disruptions to pipeline development and clinical trials, including difficulties or delays in enrollment of certain clinical trials and in access to needed supplies; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; further reduced product demand as a result of increased unemployment; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; potential increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce, Pfizer Inc. 2020 Form 10-K intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution, including, among others, uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical or clinical data (including the in vitro and Phase 3 data for the Pfizer-BioNTech COVID-19 vaccine (BNT162b2)), including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data; the ability to produce comparable clinical or other results, including the rate of vaccine effectiveness and safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial and additional studies or in larger, more diverse populations upon commercialization; the ability of BNT162b2 to prevent COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program or other programs will be published in scientific publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; when other biologics license and/or EUA applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines that may arise from the BNT162 program, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any applications that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines benefits outweigh its known risks and determination of the vaccines efficacy and, if approved, whether it will be commercially successful; regulatory decisions impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines ultra-low temperature formulation, two-dose schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program or potential treatment for COVID-19; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any potential approved treatment, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine within the projected time periods as previously indicated; whether and when additional supply agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public vaccine confidence or awareness; trade restrictions; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. Pfizer Inc. 2020 Form 10-K INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, taxation requirements, competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 1B. UNRESOLVED STAFF COMMENTS N/A ITEM 2. PROPERTIES ITEM 3. LEGAL PROCEEDINGS ITEM 4. MINE SAFETY DISCLOSURES N/A INFORMATION ABOUT OUR EXECUTIVE OFFICERS PART II ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ITEM 6. SELECTED FINANCIAL DATA ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ITEM 9A. CONTROLS AND PROCEDURES ITEM 9B. OTHER INFORMATION N/A PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 15(a)(1) Financial Statements 15(a)(2) Financial Statement Schedules 15(a)(3) Exhibits ITEM 16. FORM 10-K SUMMARY N/A = Not Applicable DEFINED TERMS Unless the context requires otherwise, references to Pfizer, the Company, we, us or our in this Form 10-K (defined below) refer to Pfizer Inc. and its subsidiaries. The financial information included in our consolidated financial statements for our subsidiaries operating outside the U.S. is as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. References to Notes in this Form 10-K are to the Notes to the consolidated financial statements in Item 8. Financial Statements and Supplementary Data in this Form 10-K. We also have used several other terms in this Form 10-K, most of which are explained or defined below. 2018 Financial Report Exhibit 13 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2018 Form 10-K This Annual Report on Form 10-K for the fiscal year ended December 31, 2020 Proxy Statement Proxy Statement for the 2021 Annual Meeting of Shareholders, which will be filed no later than 120 days after December 31, 2020 AbbVie AbbVie Inc. ABO Accumulated benefit obligation represents the present value of the benefit obligation earned through the end of the year but does not factor in future compensation increases ACA (also referred to as U.S. Healthcare Legislation) U.S. Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act ACIP Advisory Committee on Immunization Practices Akcea Akcea Therapeutics, Inc. ALK anaplastic lymphoma kinase Alliance revenues Revenues from alliance agreements under which we co-promote products discovered or developed by other companies or us Allogene Allogene Therapeutics, Inc. AML Acute Myeloid Leukemia Anacor Anacor Pharmaceuticals, Inc. AOCI Accumulated Other Comprehensive Income Array Array BioPharma Inc. Astellas Astellas Pharma Inc., Astellas US LLC and Astellas Pharma US, Inc. ATTR-CM transthyretin amyloid cardiomyopathy Bain Capital Bain Capital Private Equity and Bain Capital Life Sciences Biogen Biogen Inc. BioNTech BioNTech SE Biopharma Pfizer Biopharmaceuticals Group BMS Bristol-Myers Squibb Company BNT162b2 Pfizer-BioNTech COVID-19 Vaccine BOD Board of Directors BRCA BReast CAncer susceptibility gene CAR T chimeric antigen receptor T cell CDC U.S. Centers for Disease Control and Prevention Cellectis Cellectis S.A. Cerevel Cerevel Therapeutics, LLC cGMPs current Good Manufacturing Practices CIAS cognitive impairment associated with schizophrenia Consumer Healthcare JV GSK Consumer Healthcare JV COVID-19 novel coronavirus disease of 2019 CMA conditional marketing authorization CStone CStone Pharmaceuticals DEA U.S. Drug Enforcement Agency Developed Europe Includes the following markets: Western Europe, Scandinavian countries and Finland Developed Markets Includes the following markets: U.S., Developed Europe, Japan, Canada, Australia, South Korea and New Zealand Developed Rest of World Includes the following markets: Japan, Canada, Australia, South Korea and New Zealand EMA European Medicines Agency Emerging Markets Includes, but is not limited to, the following markets: Asia (excluding Japan and South Korea), Latin America, Eastern Europe, Africa, the Middle East, Central Europe and Turkey EPS earnings per share ESOP employee stock ownership plan EU European Union EUA emergency use authorization Exchange Act Securities Exchange Act of 1934, as amended FASB Financial Accounting Standards Board FCPA U.S. Foreign Corrupt Practices Act FDA U.S. Food and Drug Administration Pfizer Inc. 2020 Form 10-K i FFDCA U.S. Federal Food, Drug and Cosmetic Act GAAP Generally Accepted Accounting Principles GDFV grant-date fair value GIST gastrointestinal stromal tumors GPD Global Product Development organization GSK GlaxoSmithKline plc Hospira Hospira, Inc. Ionis Ionis Pharmaceuticals, Inc. IPRD in-process research and development IRC Internal Revenue Code IRS U.S. Internal Revenue Service IV intravenous JJ Johnson Johnson JV joint venture King King Pharmaceuticals LLC (formerly King Pharmaceuticals, Inc.) LDL low density lipoprotein LIBOR London Interbank Offered Rate Lilly Eli Lilly Company LOE loss of exclusivity MCO managed care organization mCRC metastatic colorectal cancer mCRPC metastatic castration-resistant prostate cancer mCSPC metastatic castration-sensitive prostate cancer mRNA messenger ribonucleic acid MDA Managements Discussion and Analysis of Financial Condition and Results of Operations Medivation Medivation LLC (formerly Medivation Inc.) Meridian Meridian Medical Technologies, Inc. Moodys Moodys Investors Service Mylan Mylan N.V. Mylan-Japan collaboration a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan that terminated on December 21, 2020 Myovant Myovant Sciences Ltd. NAV net asset value NDA new drug application nmCRPC non-metastatic castration-resistant prostate cancer NMPA National Medical Product Administration in China NYSE New York Stock Exchange OTC over-the-counter PBM pharmacy benefit manager PBO Projected benefit obligation; represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases PCPP Pfizer Consolidated Pension Plan PGS Pfizer Global Supply Pharmacia Pharmacia Corporation PMDA Pharmaceuticals and Medical Device Agency in Japan PsA psoriatic arthritis QCE quality consistency evaluation RA rheumatoid arthritis RCC renal cell carcinoma RD research and development ROU right of use Sandoz Sandoz, Inc., a division of Novartis AG SP Standard Poors SEC U.S. Securities and Exchange Commission Servier Les Laboratoires Servier SAS Shire Shire International GmbH Tax Cuts and Jobs Act or TCJA Legislation commonly referred to as the U.S. Tax Cuts and Jobs Act of 2017 Teva Teva Pharmaceuticals USA, Inc. Therachon Therachon Holding AG Pfizer Inc. 2020 Form 10-K ii Upjohn Business Pfizers global, primarily off-patent branded and generics business, which includes a portfolio of 20 globally recognized solid oral dose brands, including Lipitor, Lyrica, Norvasc, Celebrex and Viagra, as well as a U.S.-based generics platform, Greenstone, that was spun-off on November 16, 2020 and combined with Mylan to create Viatris UC ulcerative colitis U.K. United Kingdom U.S. United States VAI Voluntary Action Indicated Valneva Valneva SE VBP volume-based procurement Viatris Viatris Inc. ViiV ViiV Healthcare Limited WRDM Worldwide Research, Development and Medical This Form 10-K includes discussion of certain clinical studies relating to various in-line products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. Some amounts in this Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks mentioned are the property of their owners. FORWARD-LOOKING INFORMATION AND FACTORS THAT MAY AFFECT FUTURE RESULTS This Form 10-K contains forward-looking statements. We also provide forward-looking statements in other materials we release to the public, as well as public oral statements. Given their forward-looking nature, these statements involve substantial risks, uncertainties and potentially inaccurate assumptions. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek and other words and terms of similar meaning or by using future dates. We include forward-looking information in our discussion of the following, among other topics: our anticipated operating and financial performance, reorganizations, business plans and prospects; expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, post-approval clinical trial results and other developing data that become available, revenue contribution, growth, performance, timing of exclusivity and potential benefits; strategic reviews, capital allocation objectives, dividends and share repurchases; plans for and prospects of our acquisitions, dispositions and other business development activities, and our ability to successfully capitalize on these opportunities; sales, expenses, interest rates, foreign exchange rates and the outcome of contingencies, such as legal proceedings; expectations for impact of or changes to existing or new government regulations or laws; our ability to anticipate and respond to macroeconomic, geopolitical, health and industry trends, pandemics, acts of war and other large-scale crises; and manufacturing and product supply. In particular, forward-looking information in this Form 10-K includes statements relating to specific future actions and effects, including, among others, our efforts to respond to COVID-19, including our development of a vaccine to help prevent COVID-19, the forecasted revenue contribution of BNT162b2 and the potential number of doses that we and BioNTech believe can be delivered; our expectations regarding the impact of COVID-19 on our business; the expected impact of patent expiries and competition from generic manufacturers; the expected pricing pressures on our products and the anticipated impact to our business; the availability of raw materials for 2021; the expected charges and/or costs in connection with the spin-off of the Upjohn Business and its combination with Mylan; the benefits expected from our business development transactions; our anticipated liquidity position; the anticipated costs and savings from certain of our initiatives, including our Transforming to a More Focused Company program; our planned capital spending; the expectations for our quarterly dividend payments; and the expected benefit payments and employer contributions for our benefit plans. Given their nature, we cannot assure that any outcome expressed in these forward-looking statements will be realized in whole or in part. Actual outcomes may vary materially from past results and those anticipated, estimated, implied or projected. These forward-looking statements may be affected by underlying assumptions that may prove inaccurate or incomplete, or by known or unknown risks and uncertainties, including those described in this section and in the Item 1A. Risk Factors section in this Form 10-K. Therefore, you are cautioned not to unduly rely on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities law. You are advised, however, to consult any further disclosures we make on related subjects. Some of the factors that could cause actual results to differ are identified below, as well as those discussed in the Item 1A. Risk Factors section in this Form 10-K and within MDA. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. The occurrence of any of the risks identified below or in the Item 1A. Risk Factors section in this Form 10-K, or other risks currently unknown, could have a material adverse effect on our business, financial condition or results of operations, or we may be required to increase our accruals for contingencies. It is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties: Pfizer Inc. 2020 Form 10-K iii Risks Related to Our Business, Industry and Operations, and Business Development: the outcome of RD activities, including, the ability to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, and/or regulatory approval and/or launch dates, as well as the possibility of unfavorable pre-clinical and clinical trial results, including the possibility of unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data; our ability to successfully address comments received from regulatory authorities such as the FDA or the EMA, or obtain approval from regulators on a timely basis or at all; regulatory decisions impacting labeling, manufacturing processes, safety and/or other matters; the impact of recommendations by technical or advisory committees; and the timing of pricing approvals and product launches; claims and concerns that may arise regarding the safety or efficacy of in-line products and product candidates, including claims and concerns that may arise from the outcome of post-approval clinical trials, which could impact marketing approval, product labeling, and/or availability or commercial potential, including uncertainties regarding the commercial or other impact of the results of the Xeljanz ORAL Surveillance (A3921133) study or any potential actions by regulatory authorities based on analysis of ORAL Surveillance or other data; the success and impact of external business development activities, including the ability to identify and execute on potential business development opportunities; the ability to satisfy the conditions to closing of announced transactions in the anticipated time frame or at all; the ability to realize the anticipated benefits of any such transactions in the anticipated time frame or at all; the potential need for and impact of additional equity or debt financing to pursue these opportunities, which could result in increased leverage and/or a downgrade of our credit ratings; challenges integrating the businesses and operations; disruption to business and operations relationships; risks related to growing revenues for certain acquired products; significant transaction costs; and unknown liabilities; competition, including from new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates; the ability to successfully market both new and existing products, including biosimilars; difficulties or delays in manufacturing, sales or marketing; supply disruptions, shortages or stock-outs at our facilities; and legal or regulatory actions; the impact of public health outbreaks, epidemics or pandemics (such as the COVID-19 pandemic) on our business, operations and financial condition and results; risks and uncertainties related to our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution; trends toward managed care and healthcare cost containment, and our ability to obtain or maintain timely or adequate pricing or favorable formulary placement for our products; interest rate and foreign currency exchange rate fluctuations, including the impact of possible currency devaluations in countries experiencing high inflation rates; any significant issues involving our largest wholesale distributors, which account for a substantial portion of our revenues; the impact of the increased presence of counterfeit medicines in the pharmaceutical supply chain; any significant issues related to the outsourcing of certain operational and staff functions to third parties; and any significant issues related to our JVs and other third-party business arrangements; uncertainties related to general economic, political, business, industry, regulatory and market conditions including, without limitation, uncertainties related to the impact on us, our customers, suppliers and lenders and counterparties to our foreign-exchange and interest-rate agreements of challenging global economic conditions and recent and possible future changes in global financial markets; any changes in business, political and economic conditions due to actual or threatened terrorist activity, civil unrest or military action; the impact of product recalls, withdrawals and other unusual items; trade buying patterns; the risk of an impairment charge related to our intangible assets, goodwill or equity-method investments; the impact of, and risks and uncertainties related to, restructurings and internal reorganizations, as well as any other corporate strategic initiatives, and cost-reduction and productivity initiatives, each of which requires upfront costs but may fail to yield anticipated benefits and may result in unexpected costs or organizational disruption; Risks Related to Government Regulation and Legal Proceedings : the impact of any U.S. healthcare reform or legislation or any significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs or changes in the tax treatment of employer-sponsored health insurance that may be implemented; U.S. federal or state legislation or regulatory action and/or policy efforts affecting, among other things, pharmaceutical product pricing, intellectual property, reimbursement or access or restrictions on U.S. direct-to-consumer advertising; limitations on interactions with healthcare professionals and other industry stakeholders; as well as pricing pressures for our products as a result of highly competitive insurance markets; legislation or regulatory action in markets outside of the U.S., including China, affecting pharmaceutical product pricing, intellectual property, reimbursement or access, including, in particular, continued government-mandated reductions in prices and access restrictions for certain biopharmaceutical products to control costs in those markets; the exposure of our operations outside of the U.S. to possible capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, as well as political unrest, unstable governments and legal systems and inter-governmental disputes; Pfizer Inc. 2020 Form 10-K iv legal defense costs, insurance expenses, settlement costs and contingencies, including those related to actual or alleged environmental contamination; the risk and impact of an adverse decision or settlement and the adequacy of reserves related to legal proceedings; the risk and impact of tax related litigation; governmental laws and regulations affecting our operations, including, without limitation, changes in laws and regulations or their interpretation, including, among others, changes in taxation requirements; Risks Related to Intellectual Property, Technology and Security: any significant breakdown, infiltration or interruption of our information technology systems and infrastructure; the risk that our currently pending or future patent applications may not be granted on a timely basis or at all, or any patent-term extensions that we seek may not be granted on a timely basis, if at all; and our ability to protect our patents and other intellectual property, including against claims of invalidity that could result in LOE and in response to any pressure, or legal or regulatory action by, various stakeholders or governments that could potentially result in us not seeking intellectual property protection for or agreeing not to enforce intellectual property related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19. Pfizer Inc. 2020 Form 10-K v PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of our products, principally biopharmaceutical products, and to a lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people; 2. Deliver first-in-class science; 3. Transform our go-to-market model; 4. Win the digital race in pharma; and 5. Lead the conversation. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. Following (i) the recent spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan, which created a new global pharmaceutical company, Viatris, in November 2020 and (ii) the formation of the Consumer Healthcare JV in 2019, we saw the culmination of Pfizers transformation into a more focused, innovative science-based biopharmaceutical products business. Our significant recent business development activities in 2020 include: (i) the April 2020 agreement with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody, sugemalimab, and to bring additional oncology assets to China, (iv) the November 2020 spin-off and combination of the Upjohn Business with Mylan, and (v) the December 2020 entry into a collaboration with Myovant to jointly develop and commercialize relugolix in advanced prostate cancer and womens health in the U.S. and Canada. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, among others, the development of a vaccine to help prevent COVID-19. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsDevelopment, Regulatory Approval and Marketing of Products and COVID-19 Pandemic sections in this Form 10-K. COMMERCIAL OPERATIONS In 2020, we managed our commercial operations through a global structure consisting of two businessesBiopharma, and, through November 16, 2020, Upjohn, each led by a single manager. On November 16, 2020, we completed the spin-off and combination of the Upjohn Business with Mylan. Following the combination, we now operate as a focused innovative biopharmaceutical company engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. In 2019, Consumer Healthcare, which was our OTC medicines business, was Pfizer Inc. 2020 Form 10-K combined with GSKs consumer healthcare business to form a consumer healthcare JV in which we own a 32% equity stake. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Notes 1A and 2C. Our business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis*, Chantix/Champix* and the Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Sutent*, Inlyta, Retacrit, Lorbrena and Braftovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Zithromax, Vfend and Panzyga Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Prevnar 13/Prevenar 13 (pediatric/adult)*, Nimenrix, FSME/IMMUN-TicoVac, Trumenba and the Pfizer-BioNTech COVID-19 vaccine Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra and Eucrisa/Staquis Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2020, 2019 and 2018. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2020, Chantix/Champix recorded direct product revenues of more than $1 billion in 2019 and 2018 and Sutent recorded direct product revenues of more than $1 billion in 2018. Eliquis includes Alliance revenues and direct sales. For additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Pfizer-BioNTech COVID-19 Vaccine (BNT162b2) is an mRNA-based coronavirus vaccine to help prevent COVID-19 which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech will equally share the costs of development for the BNT162 program. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. We will also share gross profits equally from commercialization of BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist approved by the FDA for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and the relugolix combination tablet, with Myovant bearing our share of allowable expenses up to a maximum of $100 million in 2021 and up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, with Lilly to jointly develop and globally commercialize tanezumab for the treatment of osteoarthritis pain and cancer pain, under which the companies share equally the ongoing development costs and, if successful, will co-commercialize and share equally in profits and certain expenses in the U.S., while Pfizer will be responsible for commercialization activities and costs outside the U.S., with Lilly having the right to Pfizer Inc. 2020 Form 10-K receive certain tiered royalties outside the U.S. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. We also have arrangements with third parties that fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive future payments, such as milestone-based, revenue sharing, or profit-sharing payments or royalties. These collaboration, alliance, license and funding agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances, license and funding arrangements and investments, see Note 2 . Our RD Operations. In 2020, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. GPD is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in our portfolio. Science-based platform-services organizations. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions (which are part of our WRDM organization) such as Pharmaceutical Sciences and Medicine Design. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Another platform-service organization is the Worldwide Medical and Safety (WMS) group, which includes worldwide safety surveillance, medical information and the Chief Medical Office. The WMS group provides patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information about the risks and benefits associated with Pfizers RD programs and marketed products so they can make appropriate decisions on how and when to use our products. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. In 2020, the RD organization within Upjohn supported the off-patent branded and generic established medicines and managed its resources separately from the WRDM and GPD organizations. Following the spin-off and combination of the Upjohn Business with Mylan to create Viatris, we have agreed to provide certain transition services to Viatris including support for RD, pharmacovigilance and safety surveillance. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA. Pfizer Inc. 2020 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 2, 2021, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $20.2 billion accounted for 48% of our total revenues in 2020. Revenues exceeded $500 million in each of 8, 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17A . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. A portion of our government contracts are subject to renegotiation or termination of contracts or subcontracts at the discretion of a government entity. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our largest biopharmaceutical wholesalers, see Note 17B . Pfizer Inc. 2020 Form 10-K We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Drug U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 2022 Sutent 2021 2022 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (3) 2025 Prevnar 13/Prevenar 13 2026 __(4) 2029 Eliquis (5) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (6) 2027 * (6) * (6) Vyndaqel/Vyndamax 2024 (2028 pending PTE) 2026 2026 Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (7) Braftovi (8) 2031 (2031 pending PTE) * (8) * (8) Mektovi (8) 2031 (9) * (8) * (8) Bavencio (10) 2033 2032 2033 Lorbrena 2033 2034 2036 (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our drug from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix in the U.S. expired in November 2020. (3) Xeljanz Europe expiry is provided by regulatory exclusivity. (4) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (5) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and are the subject of patent infringement litigation. Prior to the August 2020 ruling referenced in the following sentence, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). In August 2020, the U.S. District Court for the District of Delaware decided that the two challenged Eliquis patents are both valid and infringed by the remaining generic companies. The remaining generic companies have appealed the Delaware court decision and the final decision in this case could determine when generic versions of Eliquis will come on the market. While we cannot predict the outcome of this pending litigation, these are the alternatives that might occur: (a) If the district courts decision is upheld in the current appeal with respect to both patents, under the terms of previously executed settlement agreements with the settled generic companies, the permitted date of launch for the settled generic companies under these patents is April 1, 2028; (b) if the formulation patent is held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies could launch products immediately upon such an adverse decision. In addition, both patents may be subject to subsequent challenges by parties other than the remaining generic companies. If this were to occur, depending on the outcome of the subsequent challenge, the potential launch by generic companies, including challengers, if successful, could occur on timelines similar to those discussed above. Pfizer Inc. 2020 Form 10-K Refer to Note 16A1 for more information. (6) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (7) Besponsa Japan expiry is provided by regulatory exclusivity. (8) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (9) Mektovi U.S. expiry is provided by a method of use patent. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Intellectual Property Protection, Third Party Intellectual Property Claims and Competitive Products sections in this Form 10-K and Note 16A1 . Losses of Product Exclusivity. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. The basic product patent for Chantix in the U.S. expired on November 10, 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug approval as we seek to further demonstrate the value of our products for the conditions they treat, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We sell biosimilars of certain inflammation immunology and oncology biologic medicines. We seek to maximize the opportunity to establish a first-to-market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Pfizer Inc. 2020 Form 10-K Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2021 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 299 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger entities, which enhances MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Pfizer Inc. 2020 Form 10-K Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. We have supplier management activities in place to monitor supply channels and to take action as needed to secure necessary volumes. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2021. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing pharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. Many of our activities are subject to the jurisdiction of the SEC. For a biopharmaceutical company to market a drug or a biologic product in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or Biologics License Application (BLA) (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. Once a drug or biologic is approved, the FDA must be notified of any product modifications and may require additional studies or clinical trials. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Approval Data section in this Form 10-K. In the context of public health emergencies like the COVID-19 pandemic, we may apply for EUA with the FDA, which when granted, allows for the distribution and use of our products during the term declared and extended by the government, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated at the governments discretion. Although the criteria of an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing compliance obligations. The FDA expects EUA holders to work toward submission of full applications, such as a BLA, as soon as possible. For BNT162b2, we are working towards submitting a BLA for possible full regulatory approval. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Healthcare Reform . Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. This includes potential replacements for the ACA, if it is ultimately invalidated by the U.S. Supreme Court in California v. Texas , as well as efforts at the state level to develop additional public insurance options or implement a single payer healthcare system. We do not expect that invalidation of the ACA itself would have a material impact on our business given the modest revenues the health insurance exchanges and Medicaid expansion generate for us. However, a future replacement of the ACA or other healthcare reform efforts may adversely affect our business and financial results, particularly if such replacement or reform reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Pfizer Inc. 2020 Form 10-K Pricing and Reimbursement . Pricing and reimbursement for our products depend in part on government regulation. In order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1G. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. In the Fall of 2020, the Trump Administration finalized an importation pathway from Canada and a payment model to tie Medicare Part B physician reimbursement to international prices, though ultimate implementation of both is uncertain due to legal challenges. We expect to see continued focus on regulating pricing resulting in additional legislation and regulation under the newly elected Congress and the Biden Administration. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid and Medicare managed care programs typically is determined by the health plans with which state Medicaid agencies and Medicare contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us as part of our business activities is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. Such laws and regulations have the potential to affect our business materially, continue to evolve and are increasingly being enforced vigorously. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. From January 1, 2021, as a consequence of the U.K. leaving the EU (Brexit), the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority for the U.K. In China, following significant regulatory reforms in recent years, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle- and lower-income require marketing approval by a recognized regulatory authority (i.e., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU/EEA, the EMAs Pharmacovigilance Risk Assessment Committee is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., China, Japan, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of measures including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations, such as the World Health Organization and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. On November 25, 2020, the European Commission published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. In China, pricing pressures have increased in recent years, with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. Drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program has also been initiated and expanded nationwide, under which a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to Pfizer Inc. 2020 Form 10-K implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, following a review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including the EUs General Data Protection Regulations. The legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2020 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $42 million in environment-related capital expenditures and $120 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is clear: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2020, we employed approximately 78,500 people worldwide, with approximately 29,400 based in the U.S. Women compose approximately 48% of our workforce, and approximately 32% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, and offering competitive compensation and benefits programs that encourage healthy work-life balance, so that all colleagues feel ready, equipped and energized to deliver innovative breakthroughs that extend and significantly improve patients lives. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our new and expanded commitments to equity include specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) increasing the representation of both women and underrepresented ethnic groups; (ii) providing resources to support managers in having courageous conversations about equity, race and the avoidance of bias within their teams; (iii) revising our Political Action Committee (PAC) bylaws to help ensure that PAC recipients consistently demonstrate conduct that align with our core values; and (iv) working to help ensure recruitment demographics of all clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . We understand the importance of continuously listening and responding to colleague feedback. Our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their Pfizer experience and equips leaders with Pfizer Inc. 2020 Form 10-K actionable insights for discussion and follow up. Regular topics in the survey include (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer, and (ii) purpose, including how colleagues work connects with our purpose. Through these surveys, we can measure and track the degree to which colleagues are proud to work at Pfizer, would recommend Pfizer as a great place to work to others and intend to stay with Pfizer. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insights is based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. We strive to ensure that all colleagues have an equal opportunity to grow and offer a variety of programs including mentoring, job rotations, experiential project roles, skill based volunteering and learning programs focused on many topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being. We are committed to the health, safety and well-being of our colleagues and continue to advance a comprehensive occupational injury and illness prevention program. During 2020, our COVID-19 pandemic preparedness and response was a primary focus. Our comprehensive pandemic response plan incorporates guidance issued by external health authorities and is designed to keep onsite workers at our manufacturing and research sites safe and healthy. A global employee assistance program provides stress management, mental health, emotional, resiliency and pandemic guidance and support to our colleagues. Pay Equity. We are committed to pay equity, based on gender or race/ethnicity, and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the Careers section of Pfizers website. AVAILABLE INFORM ATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 25, 2021. Our Proxy Statement will be available on our website on or about March 11, 2021. Our 2020 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 11, 2021. Information in our ESG Report is not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is not meant to be a complete discussion of all potential risks or uncertainties. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. Negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line drugs and drug candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. While multi-source generic competition for Chantix has not yet begun, it could commence at anytime. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against JJ alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or alliance revenues of more than $1 billion for each of seven products that collectively accounted for 53% of our total revenues in 2020. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and other Intellectual Property Rights section in this Form 10-K. Pfizer Inc. 2020 Form 10-K In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17B . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, either through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political or civil unrest, terrorist activity, unstable governments and legal systems and inter-governmental disputes. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. In addition, since a significant portion of our business is conducted in the EU, as well as the U.K., the changes resulting from Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 48% of our total 2020 revenues were derived from international operations, including 23% from Europe and 17% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Notes 7E and 11 . From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend Pfizer Inc. 2020 Form 10-K any contracts to accommodate the SOFR rate where required. While our exposure to LIBOR is very low, market volatility related to the transition may adversely affect the trading market for securities linked to such benchmarks. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in product manufacturing, sales or marketing due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, damage to our facilities due to natural or man-made disasters, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain appropriate quality standards throughout our supply network and/or comply with applicable regulations; and supply chain disruptions at our facilities or at a supplier or vendor. Regulatory agencies periodically inspect our manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. For example, in September 2017, our subsidiary, Meridian, received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as Official Action Indicated (OAI). Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines prime targets for counterfeiters. Counterfeit medicines pose a significant risk to patient health and safety because of the conditions under which they are manufactured often in unregulated, unlicensed, uninspected and unsanitary sites as well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact our business, by, among other things, causing patient harm, the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the Internet in lieu of traditional brick and mortar pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of the anonymity it affords counterfeiters. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. Some states have implemented, and others are considering, price controls or patient access constraints under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have recently focused on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, Pfizer Inc. 2020 Form 10-K could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for new COVID-19 therapies and vaccines. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare reform, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending that could affect pharmaceutical utilization and pricing as does the Medicare Payment Advisory Commission. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval from regulators. Regulatory approvals of our products depend on myriad factors, including a regulator making a determination as to whether a product is safe and efficacious. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP, that may impact the use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as Pfizer Inc. 2020 Form 10-K other products in the class. The potential regulatory and commercial implications of post-marketing study results, for approved indications and potential new indications of an in-line product, typically cannot immediately be determined. For example, the potential impact of the co-primary endpoint results from a recently completed post-marketing required safety study of Xeljanz, ORAL Surveillance (A3921133), announced in January 2021, and related results, analyses and discussions with and reviews by regulators, remain uncertain. We are working with the FDA and other regulatory agencies to review the full results and analyses as they become available. The terms of our EUA for the BNT162b2 vaccine require that we conduct post-authorization observational studies. In addition, the FDA expects EUA holders to work towards submission of full application, such as a BLA, as soon as possible. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices Pfizer Inc. 2020 Form 10-K that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems to operate our business. We collect, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party vendors who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or malicious attackers. Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent cyber-attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may result in additional expenses and may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. GSK has indicated that it intends to separate the JV as an independent company listed on the U.K. equity market. Until July 31, 2024, GSK has the exclusive right to initiate a separation and listing transaction. We have the option to participate in a separation and listing transaction initiated by GSK. However, the separation and public listing transaction may not be initiated or completed within expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for us or our shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others, impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain interruptions, including challenges related to reliance on third-party suppliers; disruptions to pipeline development and clinical trials, including difficulties or delays in enrollment of certain clinical trials and in access to needed supplies; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; further reduced product demand as a result of increased unemployment; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; potential increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce, Pfizer Inc. 2020 Form 10-K intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution, including, among others, uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical or clinical data (including the in vitro and Phase 3 data for the Pfizer-BioNTech COVID-19 vaccine (BNT162b2)), including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data; the ability to produce comparable clinical or other results, including the rate of vaccine effectiveness and safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial and additional studies or in larger, more diverse populations upon commercialization; the ability of BNT162b2 to prevent COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program or other programs will be published in scientific publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; when other biologics license and/or EUA applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines that may arise from the BNT162 program, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any applications that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines benefits outweigh its known risks and determination of the vaccines efficacy and, if approved, whether it will be commercially successful; regulatory decisions impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines ultra-low temperature formulation, two-dose schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program or potential treatment for COVID-19; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any potential approved treatment, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine within the projected time periods as previously indicated; whether and when additional supply agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public vaccine confidence or awareness; trade restrictions; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. Pfizer Inc. 2020 Form 10-K INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, taxation requirements, competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 2. PROPERTIES We own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2020, we had 363 owned and leased properties, amounting to approximately 43 million square feet. In 2020, we reduced the number of properties in our portfolio by 90 sites and 4 million square feet, primarily due to the spin-off and combination of the Upjohn Business with Mylan to form Viatris. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2020, PGS had responsibility for 43 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit five of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in Note 16A . INFORMATION ABOUT OUR EXECUTIVE OFFICERS The executive officers of the Company are set forth in this table. Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2021 Annual Meeting of Shareholders, or until his or her earlier death, resignation or removal. Each of the executive officers is a member of the Pfizer Executive Leadership Team. Name Age Position Albert Bourla 59 Chairman of the Board since January 2020 and Chief Executive Officer since January 2019. Chief Operating Officer from January 2018 until December 2018. Group President, Pfizer Innovative Health from June 2016 until December 2017. Group President, Global Innovative Pharma Business (responsible for Vaccines, Oncology and Consumer Healthcare since 2014) from February 2016 until June 2016. President and General Manager of Established Products Business Unit from December 2010 until December 2013. Our Director since February 2018. Board member of Pharmaceutical Research and Manufacturers of America (PhRMA). Board member of The Pfizer Foundation, which promotes access to quality healthcare. Director of the Partnership for New York City and Catalyst, a global non-profit organization accelerating progress for the advancement of women into leadership. William Carapezzi 63 Executive Vice President, Global Business Services and Transformation since June 2020. Senior Vice President of Global Business Operations from June 2013 until June 2020. Senior Vice President of Global Tax from 2008 until June 2013. Pfizer Inc. 2020 Form 10-K Name Age Position Frank A. DAmelio 63 Chief Financial Officer and Executive Vice President, Global Supply since June 2020. Chief Financial Officer, Executive Vice President, Business Operations and Global Supply from November 2018 until June 2020. Executive Vice President, Business Operations and Chief Financial Officer from December 2010 until October 2018. Senior Vice President and Chief Financial Officer from September 2007 until December 2010. Director of Zoetis Inc. and Humana Inc. and Chair of the Humana Inc. Board of Directors Audit Committee. Director of the Independent College Fund of New Jersey. Mikael Dolsten 62 Chief Scientific Officer, President, Worldwide Research, Development and Medical since January 2019. President of Worldwide Research and Development from December 2010 until December 2018. Senior Vice President; President of Worldwide Research and Development from May 2010 until December 2010. Senior Vice President; President of Pfizer BioTherapeutics Research Development Group from October 2009 until May 2010. He was Senior Vice President of Wyeth and President, Wyeth Research from June 2008 until October 2009. Director of Karyopharm Therapeutics Inc. Director of PhRMA Foundation and Governor of New York Academy of Science (NYAS). Lidia Fonseca 52 Chief Digital and Technology Officer, Executive Vice President since January 2019. Chief Information Officer and Senior Vice President of Quest Diagnostics Incorporated from 2014 to 2018. Senior Vice President of Laboratory Corporation of America Holdings from 2008 until March 2013. Director of Tegna, Inc. Angela Hwang 55 Group President, Pfizer Biopharmaceuticals Group since January 2019. Group President, Pfizer Essential Health from January 2018 until December 2018. Global President, Pfizer Inflammation and Immunology from January 2016 until December 2017. Regional Head, U.S. Vaccines from January 2014 until December 2015. Vice President, Emerging Markets for the Primary Care therapeutic area from September 2011 until December 2013. Vice President, U.S. Brands commercial organization within Essential Health from October 2009 until August 2011. Director of United Parcel Service, Inc. Rady A. Johnson 59 Chief Compliance, Quality and Risk Officer, Executive Vice President since January 2019. Executive Vice President, Chief Compliance and Risk Officer from December 2013 until December 2018. Senior Vice President and Associate General Counsel from October 2006 until December 2013. Douglas M. Lankler 55 General Counsel, Executive Vice President since December 2013. Corporate Secretary from January 2014 until February 2014. Executive Vice President, Chief Compliance and Risk Officer from February 2011 until December 2013. Executive Vice President, Chief Compliance Officer from December 2010 until February 2011. Senior Vice President and Chief Compliance Officer from January 2010 until December 2010. Senior Vice President, Deputy General Counsel and Chief Compliance Officer from August 2009 until January 2010. A. Rod MacKenzie 61 Chief Development Officer, Executive Vice President since June 2016. Senior Vice President, Chief Development Officer from March 2016 until June 2016. Group Senior Vice President and Head, Pharma Therapeutics Research and Development from 2010 until March 2016. Dr. MacKenzie represents Pfizer as a member of the Board of Directors of ViiV Healthcare Limited, TransCelerate Biopharma Inc. and the National Health Council. Payal Sahni 46 Chief Human Resources Officer, Executive Vice President since June 2020. From May 2016 until June 2020 served as Senior Vice President of Human Resources for multiple operating units. Vice President of Human Resources, Vaccines, Oncology Consumer from 2015 until 2016. Ms. Sahni has served in a number of positions in the Human Resources organization with increasing responsibility since joining Pfizer in 1997. Sally Susman 59 Chief Corporate Affairs Officer, Executive Vice President since January 2019. Executive Vice President, Corporate Affairs (formerly Policy, External Affairs and Communications) from December 2010 until December 2018. Senior Vice President, Policy, External Affairs and Communications from December 2009 until December 2010. Director of WPP plc. John D. Young 56 Chief Business Officer, Group President since January 2019. Group President, Pfizer Innovative Health from January 2018 until December 2018. Group President, Pfizer Essential Health from June 2016 until December 2017. Group President, Global Established Pharma Business from January 2014 until June 2016. President and General Manager, Pfizer Primary Care from June 2012 until December 2013. Primary Care Business Units Regional President for Europe and Canada from 2009 until June 2012. Director of Johnson Controls International plc. Mr. Young represents Pfizer as a member of the Board of Directors of the Consumer Healthcare JV. Director of Biotechnology Innovation Organization (BIO). PART II "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 23, 2021, there were 139,582 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2020 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) September 28 through October 25, 2020 26,921 $ 36.99 $ 5,292,881,709 October 26 through November 30, 2020 84,279 $ 37.48 $ 5,292,881,709 December 1 through December 31, 2020 69,317 $ 37.39 $ 5,292,881,709 Total 180,517 $ 37.37 Pfizer Inc. 2020 Form 10-K (a) See Note 12 . (b) Represents (i) 174,555 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,962 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2015, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche and Sanofi. Five Year Performance 2015 2016 2017 2018 2019 2020 PFIZER $100.0 $104.5 $120.9 $151.0 $140.5 $145.4 PEER GROUP $100.0 $100.8 $118.1 $127.8 $155.3 $161.7 SP 500 $100.0 $112.0 $136.4 $130.4 $171.4 $203.0 Pfizer Inc. 2020 Form 10-K "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2020 Total Revenues$41.9 billion 2020 Net Cash Flow from Operations$14.4 billion An increase of 2% compared to 2019 An increase of 14% compared to 2019 2020 Reported Diluted EPS$1.71 2020 Adjusted Diluted EPS (Non-GAAP)$2.22* A decrease of 40% compared to 2019 An increase of 16% compared to 2019 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. Pfizer Inc. 2020 Form 10-K References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off and combination of our Upjohn Business with Mylan in November 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We now operate as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 70% has been incurred since inception and through December 31, 2020. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base aligns appropriately with our revenue base. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. In addition, we are taking steps to restructure our corporate enabling functions to appropriately support and drive the purpose of our focused innovative biopharmaceutical products business and RD and PGS platform functions. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA. RD: We believe we have a strong pipeline and are well-positioned for future growth. RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. See the Item 1. Business Research and Development section of this Form 10-K for our RD priorities and strategy. We seek to leverage a strong pipeline, organize around expected operational growth drivers and capitalize on trends creating long-term growth opportunities, including: an aging global population that is generating increased demand for innovative medicines and vaccines that address patients unmet needs; advances in both biological science and digital technology that are enhancing the delivery of breakthrough new medicines and vaccines; and the increasingly significant role of hospitals in healthcare systems. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. For additional information, including discussion of recent significant business development activities, see Note 2 . Our 2020 Performance Revenues Revenues increased $736 million, or 2%, to $41.9 billion in 2020 from $41.2 billion in 2019, reflecting an operational increase of $1.1 billion, or 3%, and an unfavorable impact of foreign exchange of $331 million, or 1%. Excluding the impact of the Consumer Healthcare transaction, revenues increased 8% operationally, reflecting strong growth in Vyndaqel/Vyndamax, Eliquis, Ibrance outside developed Europe, Inlyta, Xeljanz, Xtandi, Prevenar 13 outside the U.S., oncology biosimilars and certain products in the Hospital therapeutic area in the U.S., partially offset by Enbrel internationally and Prevnar 13 and Chantix in the U.S. Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for Prevenar 13 in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for BNT162b2. Pfizer Inc. 2020 Form 10-K The following outlines the components of the net change in revenues: For worldwide revenues, including a discussion of key drivers of our revenue performance and revenues by geography, see the discussion in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion and Revenues by Geography sections within MDA. For additional information regarding the primary indications or class of certain products, see Note 17B. Income from Continuing Operations Before Provision/(Benefit) for Taxes on Income The following provides an analysis of the change in Income from continuing operations before provision/(benefit) for taxes on income for 2020: (MILLIONS OF DOLLARS) Income from continuing operations before provision/(benefit) for taxes on income for the year ended December 31, 2019 $ 11,485 Favorable change in revenues 736 Favorable/(Unfavorable) changes: Non-recurrence of (Gain) on completion of Consumer Healthcare JV transaction (8,080) Higher Cost of sales (a) (441) Lower Selling, information and administrative expenses (a) 1,136 Higher Research and development expenses (a) (1,010) Lower Amortization of intangible assets (a) 1,026 Lower asset impairment charges (b) 1,152 Higher net periodic benefit credits other than service costs (b) 308 Lower business and legal entity alignment costs (b) 300 Higher Consumer Healthcare JV equity method income (b) 281 Lower charges for certain legal matters (b) 264 Higher income from collaborations, out-licensing arrangements and sales of compound/product rights (b) 158 Lower charges to separate our Consumer Healthcare business into a separate legal entity (b) 152 Lower interest expense (b) 125 Higher royalty-related income (b) 124 Lower net losses on early retirement of debt (b) 101 Higher net gains recognized during the period on equity securities (b) 86 Higher ViiV dividend income (b) 58 Higher net losses on asset disposals (b) (268) Lower interest income (b) (153) All other items, net (44) Income from continuing operations before provision/(benefit) for taxes on income for the year ended December 31, 2020 $ 7,497 (a) See the Costs and Expenses section within MDA . (b) See Note 4 . For information on our tax provision and effective tax rate, see the Provision/(Benefit) for Taxes on Income section within MDA and Note 5A . Our Operating Environment We, like other businesses in our industry, are subject to certain industry-specific challenges. These include, among others, the topics listed below. See also the Item 1. BusinessGovernment Regulation and Price Constraints section of this Form 10-K. Regulatory EnvironmentPipeline Productivity Our product lines must be replenished to offset revenue losses when products lose their market exclusivity, respond to healthcare and innovation trends and provide for earnings growth. As a result, we devote considerable resources to our RD activities which, while essential to our growth, incorporate a high degree of risk and cost, including whether a particular product candidate or new indication for an in-line product will achieve the desired clinical endpoint or safety profile, will be approved by regulators or will be successful commercially. We conduct clinical trials to Pfizer Inc. 2020 Form 10-K provide data on safety and efficacy to support the evaluation of a drugs overall benefit-risk profile for a particular patient population. In addition, after a product has been approved and launched, we continue to monitor its safety as long as it is available to patients. This includes postmarketing trials that may be conducted voluntarily or pursuant to a regulatory request to gain additional medical knowledge. For the entire life of the product, we collect safety data and report safety information to the FDA and other regulatory authorities. Regulatory authorities may evaluate potential safety concerns and take regulatory actions in response, such as updating a products labeling, restricting its use, communicating new safety information to the public, or, in rare cases, requiring us to suspend or remove a product from the market. The commercial potential of in-line products may be negatively impacted by post-marketing developments. Intellectual Property Rights and Collaboration/Licensing Rights The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. While additional patent expiries will continue, we expect a moderate impact of reduced revenues due to patent expiries from 2021 through 2025. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to ensure appropriate patient access. For additional information on patent rights we consider most significant to our business as a whole, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. For a discussion of recent developments with respect to patent litigation, see Note 16A1. Regulatory Environment/Pricing and AccessU.S. Healthcare Legislation In March 2010, the ACA was enacted in the U.S. We recorded the following amounts to reflect the impact of the ACA legislation: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Reduction to Revenues , related to the Medicare coverage gap discount provision $ 1,175 $ 761 $ 418 Selling, informational and administrative expenses , related to the fee payable to the federal government 195 210 134 Regulatory Environment/Pricing and AccessGovernment and Other Payer Group Pressures The pricing of medicines by pharmaceutical manufacturers and the cost of healthcare, which includes medicines, medical services and hospital services, continues to be important to payers, governments, patients, and other stakeholders. Federal and state governments and private third-party payers in the U.S. continue to take action to manage the utilization of drugs and cost of drugs, including increasingly employing formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. We consider a number of factors impacting the pricing of our medicines. Within the U.S., we often engage with patients, doctors and healthcare plans. We also often provide significant discounts from the list price to insurers, including PBMs and MCOs. The price that patients pay in the U.S. for prescribed medicines is ultimately set by healthcare providers and insurers. On average, insurers impose a higher out-of-pocket burden on patients for prescription medicines than for comparably priced medical services. Certain governments outside the U.S. provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to effectively regulate prices or patient reimbursement levels to control costs for the government-sponsored healthcare system. Governments may use a variety of measures, including proposing pricing reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. The Global Economic Environment In addition to the industry-specific factors discussed above, we, like other businesses of our size and global extent of activities, are exposed to the economic cycle. Certain factors in the global economic environment that may impact our global operations include, among other things, currency fluctuations, capital and exchange controls, global economic conditions, restrictive government actions, changes in intellectual property, legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest, terrorist activity, unstable governments and legal systems, inter-governmental disputes and public health outbreaks, epidemics and pandemics. Government pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria or other means of cost control. COVID-19 Pandemic The continuation of the COVID-19 pandemic has impacted our business, operations and financial condition and results. For additional information on the impact of COVID-19 on our revenues, please see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur 2020 Performance section of this MDA. Our Response to COVID-19 We are committed to confronting the public health challenge posed by the pandemic by collaborating with industry partners and academic institutions to develop potential approaches to prevent and treat COVID-19. In March 2020, we issued a five-point plan calling on the biopharmaceutical industry to join us in committing to unprecedented collaboration to combat COVID-19. Subsequently, we have made some important advances, including, among others: Entry into a global agreement (except for China, Hong Kong, Macau and Taiwan) with BioNTech for the development, manufacture and commercialization of an mRNA-based coronavirus vaccine, BNT162, to help prevent COVID-19. In November 2020, the companies announced that after conducting the final efficacy analysis in the Phase 3 study, BNT162b2 met both of the studys primary efficacy endpoints. Pfizer Inc. 2020 Form 10-K Analysis of the data indicated a vaccine efficacy rate against COVID-19 of 95% in participants without prior SARS-CoV-2 infection (first primary objective) and also in participants with and without prior SARS-CoV-2 infection (second primary objective), in each case measured from seven days after the second dose. The FDA authorized the distribution and use of BNT162b2 in the U.S. to help prevent COVID-19 for individuals 16 years of age and older under an EUA issued in December 2020. BNT162b2 has not been approved or licensed by the FDA. The EUA authorizes distribution and use of this product subject to the conditions set forth in the EUA, and only for the duration of the declaration by the Department of Health Human Services that circumstances exist justifying authorization of emergency use of drugs and biological products (such as BNT162b2) during the COVID-19 pandemic under Section 564 of the FFDCA (the Declaration), or until revocation of the EUA by the FDA. The FDA has issued EUAs to certain other companies for products intended for the prevention or treatment of COVID-19 and may continue to do so during the duration of the Declaration. The FDA expects EUA holders to work towards submission of a BLA as soon as possible. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. The companies continue to study BNT162b2, including studies evaluating it in additional populations, booster doses and emerging variants. Based on the updated 6-dose labeling and subject to continuous process improvements, expansion at current facilities and adding new suppliers and contract manufacturers, the companies believe that they can potentially manufacture at least 2 billion doses in total by the end of 2021. The companies have entered into agreements to supply pre-specified doses of BNT162b2 with multiple developed and emerging nations around the world and are continuing to deliver doses of BNT162b2 to governments under such agreements. As of February 2, 2021, based on the doses to be delivered in 2021 primarily under agreements entered into as of February 2, 2021 (including, among others, agreements with the U.S. government to supply 200 million doses, the European Commission to supply 300 million doses, the Japanese government to supply 144 million doses and COVID-19 Vaccines Global Access (COVAX) for up to 40 million doses in 2021, subject to the negotiation and execution of additional agreements under the COVAX Facility structure), we forecasted approximately $15 billion in revenues in 2021 from BNT162b2, with gross margin to be split evenly with BioNTech. This forecast was based on doses mostly covered under agreements entered into as of February 2, 2021 and did not include all of the doses we can potentially deliver by the end of 2021. The companies continue to enter into agreements with governments for additional doses, including, among others, the exercise by the U.S. government of an option for an additional 100 million doses and an agreement with the European Commission for an additional 200 million doses to be delivered in 2021. Accordingly, this forecast may change based, in part, on these and future additional agreements that may be signed and as circumstances warrant. For additional information on our COVID-19 vaccine development program, see Note 2 and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. Initiation, in September 2020, of a Phase 1b clinical trial in hospitalized participants with COVID-19 to evaluate the safety, tolerability and pharmacokinetics of a novel investigational protease inhibitor for COVID-19, PF-07304814, which is a phosphate prodrug of a 3C-like (3CL) protease inhibitor, PF-00835231. Despite our significant investments and efforts, any of our ongoing development programs related to COVID-19 may not be successful as the risk of failure is significant, and there can be no certainty these efforts will yield a successful product or that costs will ultimately be recouped. Impact of COVID-19 on Our Business and Operations The following discussion summarizes our current views of key business and operational areas impacted by the pandemic and its effects on our business, operations, and financial condition and results. As part of our on-going monitoring and assessment, we have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally; the emergence of additional virus variants; the duration of the pandemic; new information regarding the severity and incidence of COVID-19; the safety, efficacy and availability of vaccines and treatments for COVID-19; the rate at which the population becomes vaccinated against COVID-19; the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. We are focused on all aspects of our business and are implementing measures aimed at mitigating issues where possible, including by using digital technology to assist in operations for our commercial, manufacturing, RD and enabling functions globally. Our business and operations have been impacted by the pandemic in various ways. For example: At this time, most of our colleagues who are able to perform their job functions outside of our facilities continue to work remotely, while certain colleagues in the PGS and WRDM organizations continue to work onsite and are subject to strict protocols intended to reduce the risk of transmission. While engagement with healthcare professionals has started to return to pre-pandemic levels due to our virtual engagement capabilities, our sales force colleagues continue to encounter mixed access as a result of ongoing restrictions on in-person meetings. We are actively reviewing and assessing epidemiological data and our colleagues remain ready to resume in-person engagements with healthcare professionals on a location-by-location basis as soon as it is safe to do so. During the pandemic, we have adapted our promotional platform by amplifying our existing digital capabilities to reach healthcare professionals and customers to provide critical education and information, including increasing the scale of our remote engagement. We have not seen a significant disruption to our supply chain to date, and all of our manufacturing sites globally have continued to operate at or near normal levels. After a brief pause to the recruitment portion of certain ongoing clinical studies and a delay to most new study starts, we restarted recruitment across the development portfolio (including new study starts) in late-April 2020. Our portfolio of products experienced varying impacts from the pandemic. Some of our products are medically necessary but also more reliant on maintenance therapy with continuing patients in addition to new patients, some of our products are more reliant on new patient starts and typically require doctor visits, including wellness visits, and some of our products are identified as medically necessary for treatment in the pandemic. A large proportion of our portfolio comprises oral or self-injected medicines that do not require a visit to an infusion center or a physicians office for administration, but vaccines and physician-administered medicines, which do require office visits, were impacted in 2020 by COVID-19-related mobility restrictions or limitations and decline in patient visits to doctors. In addition, certain of our vaccines such as Prevnar 13/Prevenar 13 may be impacted by recommendations by certain health officials to not co-administer such vaccines alongside the COVID-19 vaccines. For additional detail on the impact of the COVID-19 pandemic on our products, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussio n section within MDA. Pfizer Inc. 2020 Form 10-K Notwithstanding the foregoing impact of the pandemic, given our significant operating cash flows, as well as our financial assets, access to capital markets and revolving credit agreements, we believe we have, and expect to maintain, the ability to meet liquidity needs for the foreseeable future. We will continue to pursue efforts to maintain the continuity of our operations while monitoring for new developments related to the pandemic. Future developments could result in additional favorable or unfavorable impacts on our business, operations or financial condition and results. If we experience significant disruption in our manufacturing or supply chains or significant disruptions in clinical trials or other operations, or if demand for our products is significantly reduced as a result of the COVID-19 pandemic, we could experience a material adverse impact on our business, operations and financial condition and results. See the Item 1A. Risk FactorsCOVID-19 Pandemic section of this Form 10-K. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS Following is a discussion about the critical accounting estimates and assumptions impacting our consolidated financial statements. Also, see Note 1C . For a description of our significant accounting policies, see Note 1 . Of these policies, the following are considered critical to an understanding of our consolidated financial statements as they require the application of the most subjective and the most complex judgments: Acquisitions ( Note 1D ); Fair Value ( Note 1E ); Revenues ( Note 1G ); Asset Impairments ( Note 1L ); Tax Assets and Liabilities and Income Tax Contingencies ( Note 1P ); Pension and Postretirement Benefit Plans ( Note 1Q ); and Legal and Environmental Contingencies ( Note 1R ). Acquisitions and Fair Value For discussions about the application of fair value, see the following: recent acquisitions ( Note 2A ); investments ( Note 7A) ; benefit plan assets ( Note 11D ); and Asset Impairments below. Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. If any of our ratios, factors, assessments, experiences or judgments are not indicative or accurate estimates of our future experience, our results could be materially affected. The potential of our estimates to vary (sensitivity) differs by program, product, type of customer and geographic location. However, estimates associated with U.S. Medicare, Medicaid and performance-based contract rebates are most at risk for material adjustment because of the extensive time delay between the recording of the accrual and its ultimate settlement, an interval that can generally range up to one year. Because of this lag, our recording of adjustments to reflect actual amounts can incorporate revisions of several prior quarters. Asset Impairments We review all of our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Our impairment review processes are described in Note 1L. Examples of events or circumstances that may be indicative of impairment include: A significant adverse change in legal factors or in the business climate that could affect the value of the asset. For example, a successful challenge of our patent rights would likely result in generic competition earlier than expected. A significant adverse change in the extent or manner in which an asset is used such as a restriction imposed by the FDA or other regulatory authorities that could affect our ability to manufacture or sell a product. An expectation of losses or reduced profits associated with an asset. This could result, for example, from a change in a government reimbursement program that results in an inability to sustain projected product revenues and profitability. This also could result from the introduction of a competitors product that impacts projected revenue growth, as well as the lack of acceptance of a product by patients, physicians and payers. For IPRD projects, this could result from, among other things, a change in outlook based on clinical trial data, a delay in the projected launch date or additional expenditures to commercialize the product. Identifiable Intangible Assets We use an income approach, specifically the discounted cash flow method to determine the fair value of intangible assets, other than goodwill. We start with a forecast of all the expected net cash flows associated with the asset, which incorporates the consideration of a terminal value for indefinite-lived assets, and then we apply an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions that impact our fair value estimates include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the projections and the impact of technological advancements and risk associated with IPRD assets, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic origin of the projected cash flows. While all intangible assets other than goodwill can face events and circumstances that can lead to impairment, those that are most at risk of impairment include IPRD assets (approximately $3.2 billion as of December 31, 2020) and newly acquired or recently impaired indefinite-lived brand assets. IPRD assets are high-risk assets, given the uncertain nature of RD. Newly acquired and recently impaired indefinite-lived assets are more vulnerable to impairment as the assets are recorded at fair value and are then subsequently measured at the lower of fair value or Pfizer Inc. 2020 Form 10-K carrying value at the end of each reporting period. As such, immediately after acquisition or impairment, even small declines in the outlook for these assets can negatively impact our ability to recover the carrying value and can result in an impairment charge. Goodwill Our goodwill impairment review work as of December 31, 2020 concluded that none of our goodwill was impaired and we do not believe the risk of impairment is significant at this time. In our review, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors that we consider include, for example, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we then perform a quantitative fair value test. When we are required to determine the fair value of a reporting unit, we mainly use the income approach but may also use the market approach, or a weighted-average combination of both approaches. The income approach is a forward-looking approach to estimating fair value and relies primarily on internal forecasts. Within the income approach, we use the discounted cash flow method. We start with a forecast of all the expected net cash flows for the reporting unit, which includes the application of a terminal value, and then we apply a reporting unit-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of technological risk and competitive, legal and/or regulatory forces on the projections, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. The market approach is a historical approach to estimating fair value and relies primarily on external information. We may use two alternative methods within the market approach: Guideline public company methodthis method employs market multiples derived from market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market and the application of the identified multiples to the corresponding measure of our reporting units financial performance. Guideline transaction methodthis method relies on pricing multiples derived from transactions of significant interests in companies engaged in the same or similar lines of business and the application of the identified multiples to the corresponding measure of our reporting units financial performance. The market approach is only appropriate when the available external information is robust and deemed to be a reliable proxy for the specific reporting unit being valued; however, these assessments may prove to be incomplete or inaccurate. Some of the more significant estimates and assumptions inherent in this approach include: the selection of appropriate guideline companies and transactions and the determination of applicable premiums and discounts based on any differences in ownership percentages, ownership rights, business ownership forms or marketability between the reporting unit and the guideline companies and transactions. For all of our reporting units, there are a number of future events and factors that may impact future results and that could potentially have an impact on the outcome of subsequent goodwill impairment testing. For a list of these factors, see the Forward-Looking Information and Factors That May Affect Future Results and the Item 1A. Risk Factors sections in this Form 10-K. Benefit Plans For a description of our different benefit plans, see Note 11 . Effective January 1, 2018, accruals for future benefits under the PCPP (our largest U.S. defined benefit plan) and the defined benefit section of the Pfizer Group Pension Scheme (our largest pension plan in the U.K.) were frozen and resulted in elimination of future service costs for the plans. The Pfizer defined contribution savings plan provides additional annual contributions to those previously accruing benefits under the PCPP and active members of the Pfizer Group Pension Scheme started accruing benefits under the defined contribution section of that plan. Our assumptions reflect our historical experiences and our judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our benefit plans can materially impact our results of operations. The following provides (i) at the end of each year, the expected annual rate of return on plan assets for the following year, (ii) the actual annual rate of return on plan assets achieved in each year, and (iii) the weighted-average discount rate used to measure the benefit obligations at the end of each year for our U.S. qualified pension plans and our international pension plans (a) : 2020 2019 2018 U.S. Qualified Pension Plans Expected annual rate of return on plan assets 6.8 % 7.0 % 7.2 % Actual annual rate of return on plan assets 14.1 22.6 (5.3) Discount rate used to measure the plan obligations 2.6 3.3 4.4 International Pension Plans Expected annual rate of return on plan assets 3.4 3.6 3.9 Actual annual rate of return on plan assets 9.7 10.7 (0.9) Discount rate used to measure the plan obligations 1.5 1.7 2.5 (a) For detailed assumptions associated with our benefit plans, see Note 11B . Pfizer Inc. 2020 Form 10-K Expected Annual Rate of Return on Plan Assets The assumptions for the expected annual rate of return on all of our plan assets reflect our actual historical return experience and our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The expected annual rate of return on plan assets for our U.S. plans and the majority of our international plans is applied to the fair value of plan assets at each year-end and the resulting amount is reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs to a 50 basis point decline in our assumption for the expected annual rate of return on plan assets, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2021 Net Periodic Benefit Costs Expected annual rate of return on plan assets 50 basis point decline $116 The actual return on plan assets was approximately $2.9 billion during 2020 . Discount Rate Used to Measure Plan Obligations The weighted-average discount rate used to measure the plan obligations for our U.S. defined benefit plans is determined at least annually and evaluated and modified, as required, to reflect the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better, that reflect the rates at which the pension benefits could be effectively settled. The discount rate used to measure the plan obligations for our international plans is determined at least annually by reference to investment grade corporate bonds, rated AA/Aa or better, including, when there is sufficient data, a yield-curve approach. These discount rate determinations are made in consideration of local requirements. The measurement of the plan obligations at the end of the year will affect the amount of service cost, interest cost and amortization expense reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs and benefit obligations to a 10 basis point decline in our assumption for the discount rate, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2021 Net Periodic Benefit Costs 2020 Benefit Obligations Increase Increase Discount rate 10 basis point decline $2 $483 The change in the discount rates used in measuring our plan obligations as of December 31, 2020 resulted in an increase in the measurement of our aggregate plan obligations by approximately $1.9 billion. Anticipated Change in Accounting Policy We anticipate making a change in our pension accounting policy under which we would begin recognizing actuarial gains and losses immediately in the income statement compared to our current accounting policy that recognizes such gains and losses in stockholders equity and amortizes them as a component of net periodic benefit cost/(credit) over future periods. This anticipated change is expected to go into effect in the first quarter of 2021 and if adopted, will require recasting prior period amounts to conform to the new accounting policy. Income Tax Assets and Liabilities Income tax assets and liabilities include income tax valuation allowances and accruals for uncertain tax positions. For additional information, see Notes 1P and 5, as well as the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk Selected Measures of Liquidity and Capital Resources section within MDA . Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax, legal contingencies and guarantees and indemnifications. For additional information, see Notes 1P , 1R , 5D and 16 . Pfizer Inc. 2020 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF INCOME Revenues by Geography The following presents worldwide revenues by geography: Year Ended December 31, % Change Worldwide U.S. International Worldwide U.S. International (MILLIONS OF DOLLARS) 2020 2019 2018 2020 2019 2018 2020 2019 2018 20/19 19/18 20/19 19/18 20/19 19/18 Total revenues $ 41,908 $ 41,172 $ 40,825 $ 21,712 $ 20,593 $ 20,119 $ 20,196 $ 20,579 $ 20,705 2 1 5 2 (2) (1) 2020 v. 2019 The following provides an analysis of the change in worldwide revenues by geographic areas in 2020: (MILLIONS OF DOLLARS) Worldwide U.S. International Operational growth/(decline): Growth from Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz, Vyndaqel/Vyndamax, Xtandi, Inlyta, Biosimilars and the Hospital therapeutic area, partially offset by Chantix/Champix. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis $ 3,479 $ 1,902 $ 1,577 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations, and none in 2020 (2,082) (988) (1,094) Lower revenues for Enbrel internationally, primarily reflecting continued biosimilar competition in most developed Europe markets, as well as in Japan and Brazil, all of which is expected to continue (320) (320) Other operational factors, net (10) 205 (214) Operational growth/(decline), net 1,068 1,119 (50) Unfavorable impact of foreign exchange (331) (331) Revenues increase/(decrease) $ 736 $ 1,119 $ (383) Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for Prevenar 13 in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for BNT162b2. Emerging markets revenues decreased $456 million, or 5%, in 2020 to $8.4 billion from $8.8 billion in 2019, and were relatively flat operationally, reflecting an unfavorable impact of foreign exchange of 5% on emerging markets revenues. The relatively flat operational performance was primarily driven by growth from Eliquis, Prevenar 13, Ibrance and Zavicefta, offset by lower revenues for Consumer Healthcare, reflecting the July 31, 2019 completion of the Consumer Healthcare JV transaction. Pfizer Inc. 2020 Form 10-K 2019 v. 2018 The following provides an analysis of the change in worldwide revenues by geographic areas in 2019: (MILLIONS OF DOLLARS) Worldwide U.S. International Operational growth/(decline): Growth from Ibrance, Eliquis, Xeljanz and Prevnar/Prevenar 13 $ 2,495 $ 914 $ 1,581 Higher revenues for certain Hospital products as a result of: continued growth of anti-infective products in China, driven by increased demand for Sulperazon and new launches; the 2018 U.S. launches of our immune globulin IV products (Panzyga and Octagam); and the launches of certain anti-infectives products (Zavicefta, Zinforo and Cresemba) in international developed and emerging markets 472 174 298 Higher revenues for Inlyta, primarily in the U.S. driven by increased demand resulting from the second quarter of 2019 U.S. FDA approvals for the combinations of certain immune checkpoint inhibitors plus Inlyta for the first-line treatment of patients with advanced RCC 190 175 14 Higher revenues for Biosimilars, primarily in the U.S. 168 185 (17) Higher revenues for rare disease products driven by: the U.S. launches in May 2019 of Vyndaqel and in September 2019 of Vyndamax for the treatment of ATTR-CM; continued uptake for the transthyretin amyloid polyneuropathy indication, primarily in developed Europe; and the March 2019 launch of the ATTR-CM indication in Japan, partially offset by: lower revenues for certain rare disease products, including the hemophilia franchises (Refacto AF/Xyntha and BeneFIX), primarily due to competitive pressures, and Genotropin in developed markets, mainly due to unfavorable channel mix in the U.S. 159 108 51 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 only reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations (1,436) (889) (547) Lower revenues from other Hospital products, primarily reflecting declines in developed markets, mostly due to the continued expected negative impact from generic competition for products that have previously lost marketing exclusivity (447) (200) (247) Lower revenues for Enbrel, primarily in most developed Europe markets due to continued biosimilar competition (292) (292) Other operational factors, net 141 6 136 Operational growth, net 1,450 473 976 Unfavorable impact of foreign exchange (1,103) (1,103) Revenues increase/(decrease) $ 347 $ 473 $ (127) Emerging markets revenues increased $210 million, or 2%, in 2019 to $8.8 billion, from $8.6 billion in 2018, reflecting an operational increase of $820 million, or 10%. Foreign exchange had an unfavorable impact of 7% on emerging markets revenues. The operational increase in emerging markets was primarily driven by Prevenar 13, Ibrance and Eliquis. Revenue Deductions Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. These deductions represent estimates of related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. The following presents information about revenue deductions: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Medicare rebates $ 647 $ 628 $ 495 Medicaid and related state program rebates 1,136 1,259 984 Performance-based contract rebates 2,660 2,332 1,758 Chargebacks 4,531 3,411 2,954 Sales allowances 3,841 3,782 3,536 Sales returns and cash discounts 924 878 1,128 Total $ 13,739 $ 12,290 $ 10,854 Revenue deductions are primarily a function of product sales volume, mix of products sold, contractual or legislative discounts and rebates. For information on our accruals for revenue deductions, including the balance sheet classification of these accruals, see Note 1G . Pfizer Inc. 2020 Form 10-K RevenuesSelected Product Discussion Revenue (MILLIONS OF DOLLARS) Year Ended Dec. 31, % Change Product Global Revenues Region 2020 2019 Total Oper. Operational Results Commentary Prevnar 13/ Prevenar 13 $5,850 Up 1% (operationally) U.S. $ 2,930 $ 3,209 (9) Operational growth internationally primarily reflects increased adult uptake in certain international markets resulting from greater vaccine awareness for respiratory illnesses, including specifically pneumococcal disease, due to the COVID-19 pandemic, as well as continued strong pediatric uptake in China, partially offset by a decline in the U.S., primarily driven by the expected unfavorable impact of disruptions to wellness visits for pediatric and adult patients due to COVID-19-related mobility restrictions or limitations as well as the continued impact of a lower remaining eligible adult population and the impact of the revised ACIP recommendation for the adult indication to shared clinical decision making, which means the decision to vaccinate should be made at the individual level between health care providers and their patients. Intl. 2,920 2,638 11 13 Worldwide $ 5,850 $ 5,847 1 Ibrance $5,392 Up 9% (operationally) U.S. $ 3,634 $ 3,250 12 Primarily driven by continued strong volume growth in most markets, partially offset by pricing pressures in certain developed Europe markets. Intl. 1,758 1,710 3 5 Worldwide $ 5,392 $ 4,961 9 9 Eliquis $4,949 Up 18% (operationally) U.S. $ 2,688 $ 2,343 15 Primarily driven by continued increased adoption in non-valvular atrial fibrillation as well as oral anti-coagulant market share gains, partially offset by a lower net price due to an increased impact from the Medicare coverage gap and unfavorable channel mix in the U.S. Intl. 2,260 1,877 20 22 Worldwide $ 4,949 $ 4,220 17 18 Xeljanz $2,437 Up 9% (operationally) U.S. $ 1,706 $ 1,636 4 Higher volumes in the U.S. within the RA, PsA and UC indications driven by reaching additional patients through improvements in formulary access, partially offset by increased discounts from recently-signed contracts which were entered into in order to unlock access to additional patient lives. Also reflects operational growth internationally mainly driven by continued uptake in the RA indication and, to a lesser extent, from the recent launch of the UC indication in certain developed markets. Intl. 731 606 21 23 Worldwide $ 2,437 $ 2,242 9 9 Vyndaqel/ Vyndamax $1,288 * U.S. $ 613 $ 191 * Driven by the U.S. launches of Vyndaqel in May 2019 and Vyndamax in September 2019 for the treatment of ATTR-CM and by the March 2019 launch of the ATTR-CM indication in Japan and the February 2020 approval of the ATTR-CM indication in the EU. Intl. 675 282 * * Worldwide $ 1,288 $ 473 * * Xtandi $1,024 Up 22% (operationally) U.S. $ 1,024 $ 838 22 Primarily driven by continued strong demand for Xtandi in the mCRPC and nmCRPC indications, as well as the mCSPC indication, which was approved in the U.S. in December 2019. Intl. Worldwide $ 1,024 $ 838 22 22 Chantix/ Champix $919 Down 17% (operationally) U.S. $ 716 $ 899 (20) Driven by the U.S. and primarily reflects expected lower demand resulting from reduced doctor visits, including wellness visits when Chantix is typically prescribed, due to COVID-19-related mobility restrictions or limitations as well as the loss of patent protection in the U.S. in November 2020, partially offset by increased demand in Spain as a result of government reimbursement starting in January 2020. Intl. 203 208 (2) (1) Worldwide $ 919 $ 1,107 (17) (17) Inlyta $787 Up 66% (operationally) U.S. $ 523 $ 295 78 Primarily due to increased demand in the U.S. and certain developed international markets, following the approvals in 2019 for combinations of certain immune checkpoint inhibitors plus Inlyta for the first-line treatment of patients with advanced RCC. Intl. 264 182 45 47 Worldwide $ 787 $ 477 65 66 Biosimilars $1,527 Up 68% (operationally) U.S. $ 899 $ 451 99 Primarily driven by recent oncology biosimilar launches in the U.S. and other global markets and continued growth from Retacrit, primarily in the U.S. Intl. 628 460 36 37 Worldwide $ 1,527 $ 911 68 68 Hospital $7,961 Up 3% (operationally) U.S. $ 3,362 $ 3,081 9 Higher revenues in the U.S., primarily driven by increased demand for certain sterile injectable products utilized in the intubation and ongoing treatment of mechanically-ventilated COVID-19 patients, continued growth from Panzyga and recent anti-infective launches, as well as Pfizer CentreOne business in international markets, partially offset by lower demand for certain anti-infective products in China due to lower infection rates driven by fewer elective surgical procedures, shorter in-patient hospital stays and improved infection control. Intl. 4,599 4,691 (2) Worldwide $ 7,961 $ 7,772 2 3 * Calculation is not meaningful or results are equal to or greater than 100%. See the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K for information regarding the expiration of various patent rights. See Note 16 for a discussion of recent developments concerning patent and product litigation relating to certain of the products discussed above. See Note 17B for additional information regarding the primary indications or class of the selected products discussed above. Pfizer Inc. 2020 Form 10-K Product Developments A comprehensive update of Pfizers development pipeline was published as of February 2, 2021 and is available at www.pfizer.com/science/drug-product-pipeline. It includes an overview of our research and a list of compounds in development with targeted indication and phase of development, as well as mechanism of action for some candidates in Phase 1 and all candidates from Phase 2 through registration. The following provides information about significant marketing application-related regulatory actions by, and filings pending with, the FDA and regulatory authorities in the EU and Japan. The table below includes only approvals for products that have occurred in the last twelve months and does not include approvals that may have occurred prior to that time. The table includes filings with regulatory decisions pending (even if the filing occurred outside of the last twelve-month period). PRODUCT DISEASE AREA APPROVED/FILED* U.S. EU JAPAN PF-07302048 (COVID-19 Vaccine) (a) Immunization to prevent COVID-19 (16 years of age and older) EUA Dec. CMA Dec. Approved Feb. Bavencio (avelumab) (b) First-line maintenance urothelial cancer Approved June Approved Jan. Filed May First-line RCC (combination with Inlyta (axitinib)) Approved Dec. Nyvepria (pegfilgrastim-apgf) Neutropenia in patients undergoing cancer chemotherapy (biosimilar) Approved June Approved Nov. Braftovi (encorafenib) (c) Second or third-line BRAF v600E -mutant mCRC (combination with Erbitux (cetuximab)) Approved April Approved June Approved Nov. Braftovi (encorafenib) and Mektovi (binimetinib) (c) Second or third-line BRAF V600E -mutant mCRC (combination with Erbitux (cetuximab)) Approved Nov. Xtandi (enzalutamide) (d) mCSPC Approved Dec. Filed July Abrilada (U.S.); Amsparity (EU) (adalimumab-afzb) (e) RA (biosimilar) Approved Nov. Approved Feb. abrocitinib (PF-04965842) Atopic dermatitis Filed Oct. Filed Oct. Filed Dec. Infliximab Pfizer (infliximab) Ankylosing spondylitis (biosimilar) Approved Oct. Bevacizumab Pfizer (bevacizumab) Non-small cell lung cancer (biosimilar) Approved Sept. Rituximab Pfizer (rituximab) Chronic idiopathic thrombocytopenic purpura (biosimilar) Approved Aug. tanezumab (f) Chronic pain due to moderate-to-severe osteoarthritis Filed March Filed March Filed Aug. Bosulif (bosutinib) First-line chronic myelogenous leukemia Approved June Daurismo (glasdegib) Combination with low-dose cytarabine for AML Approved June Ruxience (rituximab) Follicular lymphoma (biosimilar) Approved April Staquis (crisaborole) Atopic dermatitis Approved March Vyndaqel (tafamidis free acid) ATTR-CM Approved Feb. Xeljanz (tofacitinib) Modified release 11 mg tablet for RA (combination with methotrexate) Approved Dec. Ankylosing spondylitis Filed Aug. Relugolix (g) Uterine fibroids (combination with estradiol and norethindrone acetate) Filed Aug. Lorbrena (lorlatinib) First- line ALK-positive non-small cell lung cancer Filed Dec. somatrogon (PF-06836922) (h) Pediatric growth hormone deficiency Filed Jan. PF-06482077 (Vaccine) Invasive and non-invasive pneumococcal infections (adults) Filed Dec. Pfizer Inc. 2020 Form 10-K * For the U.S., the filing date is the date on which the FDA accepted our submission. For the EU, the filing date is the date on which the EMA validated our submission. (a) PF-07302048 or BNT162b2 (Pfizer/BioNTech COVID-19 vaccine) received EUA from the FDA and CMA from the EMA. (b) Being developed in collaboration with Merck KGaA, Germany. (c) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (d) Being developed in collaboration with Astellas. (e) We are working to make Abrilada available to U.S. patients as soon as feasible based on the terms of our agreement with AbbVie. Current plans are to launch Abrilada in 2023. We do not currently plan to commercialize Amsparity in the EU due to unfavorable market conditions. (f) Being developed in collaboration with Lilly. (g) Being developed in collaboration with Myovant. (h) Being developed in collaboration with OPKO Health, Inc. In China, the following products received regulatory approvals in the last twelve months: Eucrisa for atopic dermatitis in July 2020 and Vyndaqel for cardiac amyloidosis in September 2020. The following provides information about additional indications and new drug candidates in late-stage development: PRODUCT/CANDIDATE PROPOSED DISEASE AREA LATE-STAGE CLINICAL PROGRAMS FOR ADDITIONAL USES AND DOSAGE FORMS FOR IN-LINE AND IN-REGISTRATION PRODUCTS Bavencio (avelumab) (a) First-line non-small cell lung cancer Ibrance (palbociclib) (b) ER+/HER2+ metastatic breast cancer Xtandi (enzalutamide) (c) Non-metastatic high-risk castration sensitive prostate cancer Talzenna (talazoparib) Combination with Xtandi (enzalutamide) for first-line mCRPC PF-06482077 (Vaccine) Invasive and non-invasive pneumococcal infections (pediatric) somatrogon (PF-06836922) (d) Adult growth hormone deficiency tanezumab (e) Cancer pain Braftovi (encorafenib) and Erbitux (cetuximab) (f) First-line BRAF v600E -mutant mCRC Relugolix (g) Combination with estradiol and norethindrone acetate for endometriosis NEW DRUG CANDIDATES IN LATE-STAGE DEVELOPMENT aztreonam-avibactam (PF-06947387) Treatment of infections caused by Gram-negative bacteria for which there are limited or no treatment options fidanacogene elaparvovec (PF-06838435) Hemophilia B Giroctocogene fitelparvovec (SB-525 or PF-07055480) Hemophilia A PF-06425090 (Vaccine) Primary clostridioides difficile infection PF-06886992 (Vaccine) Serogroups meningococcal (adolescent and young adults) PF-06928316 (Vaccine) Respiratory syncytial virus infection (maternal) PF-07265803 Dilated cardiomyopathy due to Lamin A/C gene mutation ritlecitinib (PF-06651600) Alopecia areata sasanlimab (PF-06801591) Non-muscle-invasive bladder cancer PF-06939926 Duchenne muscular dystrophy marstacimab (PF-06741086) Hemophilia (a) Being developed in collaboration with Merck KGaA, Germany. (b) Being developed in collaboration with the Alliance Foundation Trial. (c) Being developed in collaboration with Astellas. (d) Being developed in collaboration with OPKO Health, Inc. (e) Being developed in collaboration with Lilly. (f) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (g) Being developed in collaboration with Myovant. For additional information about our RD organization, see the Item 1. Business Research and Development section of this Form 10-K. COSTS AND EXPENSES The changes in costs and expenses below reflect, among other things, a decline in expenses resulting from the July 31, 2019 completion of the Consumer Healthcare JV transaction (see Note 2C ). In addition, the COVID-19 pandemic impacted certain operating expenses in 2020. Pfizer Inc. 2020 Form 10-K Costs and expenses follow: Year Ended December 31, % Change (MILLIONS OF DOLLARS) 2020 2019 2018 20/19 19/18 Cost of sales $ 8,692 $ 8,251 $ 8,987 5 (8) Percentage of Revenues 20.7 % 20.0 % 22.0 % Selling, informational and administrative expenses 11,615 12,750 12,612 (9) 1 Percentage of Revenues 27.7 % 31.0 % 30.9 % Research and development expenses 9,405 8,394 7,760 12 8 Percentage of Revenues 22.4 % 20.4 % 19.0 % Amortization of intangible assets 3,436 4,462 4,736 (23) (6) Percentage of Revenues 8.2 % 10.8 % 11.6 % Restructuring charges and certain acquisition-related costs 600 601 1,058 (43) Percentage of Revenues 1.4 % 1.5 % 2.6 % Other (income)/deductionsnet 669 3,314 2,077 (80) 60 Cost of Sales 2020 v. 2019 Cost of sales increased $441 million, primarily due to: increased sales volumes; the increase in royalty expenses, due to an increase in sales of related products; the unfavorable impact of incremental costs incurred in response to the COVID-19 pandemic; and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction. The increase in Cost of sales as a percentage of revenues in 2020, compared to 2019, was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. 2019 v. 2018 Cost of sales decreased $736 million, primarily due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; the favorable impact of foreign exchange; and the favorable impact of hedging activity of intercompany inventory, partially offset by: the unfavorable change in product mix; and the increase in royalty expenses, due to an increase in sales of related products. The decrease in Cost of sales as a percentage of revenues in 2019, compared to 2018, was primarily due to all of the factors discussed above, as well an increase in alliance revenues, which have no associated cost of sales. Selling, Informational and Administrative (SIA) Expenses 2020 v. 2019 SIA expenses decreased $1.1 billion, mostly due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; lower spending for corporate enabling functions; lower spending on sales and marketing activities due to the impact of the COVID-19 pandemic; and lower investments across the Internal Medicine and Inflammation Immunology portfolios, partially offset by: the increase in external, incremental costs directly related to implementing our cost-reduction/productivity initiatives; and the increase in business and legal entity alignment costs. 2019 v. 2018 SIA expenses increased $138 million, primarily due to: additional investment in emerging markets; additional investment in the Oncology portfolio in developed markets; increased employee deferred compensation as a result of savings plan gains; the increase due to the timing of expenses (i.e., insurance recoveries and product donations); marketing and promotional expenses for the U.S. launches of Vyndaqel in May 2019 and Vyndamax in September 2019; Pfizer Inc. 2020 Form 10-K increased business and legal entity alignment costs; costs to separate Consumer Healthcare; and increased healthcare reform expenses, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV; and the favorable impact of foreign exchange. Research and Development (RD) Expenses 2020 v. 2019 RD expenses increased $1.0 billion, mainly due to: costs related to our collaboration agreement with BioNTech to co-develop a COVID-19 vaccine, including an upfront payment to BioNTech; a net increase in upfront payments, mainly related to Myovant and Valneva; and increased investments towards building new capabilities and driving automation, partially offset by: the net reduction of upfront and milestone payments associated with the acquisition of Therachon in July 2019 and Akcea in October 2019. 2019 v. 2018 RD expenses increased $635 million, mainly due to: upfront payments to Therachon and Akcea; increased investments towards building new capabilities and driving automation; increased spending on our Inflammation Immunology and Rare Disease portfolios due to several Phase 3 programs and investment in gene therapy; increased spending related to assets acquired from our acquisition of Array; and increased medical spend for new and growing products, partially offset by: decreased spending across the Oncology, Vaccines and Internal Medicine portfolios, as select programs have reached completion; the decrease in the value of the portfolio performance share grants reflecting changes in the price of Pfizers common stock, as well as managements assessment of the probability that the specified performance criteria will be achieved; the discontinuation of the Staphylococcus aureus vaccine trial; the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV; and the favorable impact of foreign exchange. Amortization of Intangible Assets 2020 v. 2019 Amortization of intangible assets decreased $1.0 billion, primarily due to: the non-recurrence of amortization of fully amortized assets and the impairment of Eucrisa in the fourth quarter of 2019, partially offset by: the increase in amortization of intangible assets from our acquisition of Array. 2019 v. 2018 Amortization of intangible assets decreased $274 million, mainly due to: the non-recurrence of amortization as a result of the impairment of sterile injectable products in the fourth quarter of 2018; fully amortized assets; and the contribution of our Consumer Healthcare business to the Consumer Healthcare JV, partially offset by: the increase in amortization related to assets recorded as a result of the approval of Xtandi in the U.S. for the treatment of nmCRPC in July of 2018; and amortization of intangible assets from our acquisition of Array. For additional information, see Notes 2A , 2C , and 10A . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives Transforming to a More Focused Company Program For a description of our program, as well as the anticipated and actual costs, see Note 3. The program savings discussed below may be rounded and represent approximations. In connection with the costs primarily related to the corporate enabling functions initiatives, we expect gross cost savings of $1.0 billion, or net cost savings, excluding merit and inflation growth and certain real estate cost increases, of $700 million, to be achieved primarily over the two-year period 2021-2022. In connection with manufacturing network optimization, including legacy cost reduction initiatives, we expect targeted net cost savings of $300 million to be achieved primarily from 2020 through 2022. Pfizer Inc. 2020 Form 10-K Certain qualifying costs for this program were recorded in 2020, and in the fourth quarter of 2019, and are reflected as Certain Significant Items and excluded from our non-GAAP measure of Adjusted Income. See the Non-GAAP Financial Measure: Adjusted Income section of this MDA. In addition to this program, we continuously monitor our operations for cost reduction and/or productivity opportunities, especially in light of the losses of exclusivity and the expiration of collaborative arrangements for various products. Other (Income)/DeductionsNet 2020 v. 2019 Other deductionsnet decreased $2.6 billion, mainly due to: lower asset impairment charges; higher net periodic benefit credits other than service costs; lower business and legal entity alignment costs; higher Consumer Healthcare JV equity method income; and lower charges for certain legal matters, partially offset by: higher net losses on asset disposals. 2019 v. 2018 Other deductionsnet increased $1.2 billion, mainly due to: higher net periodic benefits costs other than service costs; lower income from collaborations, out-licensing arrangements and sales of compound/product rights; higher interest expense mainly as a result of an increased commercial paper balance due to the acquisition of Array, as well as the retirement of lower-coupon debt and the issuance of new debt with a higher coupon than the debt outstanding for the comparative prior year period; and higher business and legal entity alignment costs, partially offset by: lower asset impairment charges. See Note 4 for additional information . PROVISION/(BENEFIT) FOR TAXES ON INCOME Year Ended December 31, % Change (MILLIONS OF DOLLARS) 2020 2019 2018 20/19 19/18 Provision/(benefit) for taxes on income $ 477 $ 618 $ (266) (23) * Effective tax rate on continuing operations 6.4 % 5.4 % (7.4) % * Indicates calculation not meaningful or result is equal to or greater than 100%. For information about our effective tax rate and the events and circumstances contributing to the changes between periods, as well as details about discrete elements that impacted our tax provisions, see Note 5 . DISCONTINUED OPERATIONS For information about our discontinued operations, see Note 2B . NON-GAAP FINANCIAL MEASURE: ADJUSTED INCOME Adjusted income is an alternative measure of performance used by management to evaluate our overall performance in conjunction with other performance measures. As such, we believe that investors understanding of our performance is enhanced by disclosing this measure. We use Adjusted income, certain components of Adjusted income and Adjusted diluted EPS to present the results of our major operationsthe discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwideprior to considering certain income statement elements as follows: Measure Definition Illustrative Use Adjusted income Net income attributable to Pfizer Inc. common shareholders (a) before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items Monthly managerial analysis of our operating results and our annual budgets are prepared using these non-GAAP measures Senior managements compensation is determined, in part, using these non-GAAP measures (b) Adjusted cost of sales, Adjusted selling, informational and administrative expenses, Adjusted research and development expenses, Adjusted other (income)/deductions net Cost of sales, Selling, informational and administrative expenses, Research and development expenses, Amortization of intangible assets an d Other (income)/deductionsnet (a) , each before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items, which are components of the Adjusted income measure Adjusted diluted EPS EPS attributable to Pfizer Inc. common shareholdersdiluted (a) before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items Pfizer Inc. 2020 Form 10-K (a) Most directly comparable GAAP measure. (b) The short-term incentive plans for substantially all non-sales-force employees worldwide are funded from a pool based on our performance, measured in significant part by three metrics, one of which is Adjusted diluted EPS, which is derived from Adjusted income and accounts for 40% of the bonus pool funding. Additionally, the payout for Performance Share Awards is determined in part by Adjusted net income, which is derived from Adjusted income. Effective for the 2020 performance year and consistent with shareholder feedback received in 2019, the Compensation Committee of the BOD approved adding an RD pipeline achievement factor to the existing short-term incentive financial metrics. Adjusted income, and its components and Adjusted diluted EPS, are non-GAAP financial measures that have no standardized meaning prescribed by GAAP and, therefore, are limited in their usefulness to investors. Because of their non-standardized definitions, they may not be comparable to the calculation of similar measures of other companies and are presented solely to permit investors to more fully understand how management assesses performance. A limitation of these measures is that they provide a view of our operations without including all events during a period, and do not provide a comparable view of our performance to peers. These measures are not, and should not be viewed as, substitutes for their directly comparable GAAP measures of Net income attributable to Pfizer Inc. common shareholders , components of Net income attributable to Pfizer Inc. common shareholders and EPS attributable to Pfizer Inc. common shareholdersdiluted , respectively. See the accompanying reconciliations of certain GAAP reported to non-GAAP adjusted information for 2020, 2019 and 2018 below. We also recognize that, as internal measures of performance, these measures have limitations, and we do not restrict our performance-management process solely to these measures. We also use other tools designed to achieve the highest levels of performance. For example, our RD organization has productivity targets, upon which its effectiveness is measured. In addition, total shareholder return, both on an absolute basis and relative to a publicly traded pharmaceutical index, plays a significant role in determining payouts under certain of our incentive compensation plans. Purchase Accounting Adjustments Adjusted income excludes certain significant purchase accounting impacts resulting from business combinations and net asset acquisitions. These impacts can include the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, and to a much lesser extent, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. Therefore, the Adjusted income measure includes the revenues earned upon the sale of the acquired products without considering the acquisition cost of those products. The exclusion of amortization attributable to acquired intangible assets provides management and investors an alternative view of our results by providing a degree of parity to internally developed intangible assets for which RD costs have been expensed. However, we have not factored in the impacts of any other differences that might have occurred if we had discovered and developed those intangible assets on our own, such as different RD costs, timelines or resulting sales; accordingly, this approach does not intend to be representative of the results that would have occurred if we had discovered and developed the acquired intangible assets internally. Acquisition-Related Costs Adjusted income excludes acquisition-related costs, which are comprised of transaction, integration, restructuring charges and additional depreciation costs for business combinations because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate businesses as a result of an acquisition. We have made no adjustments for resulting synergies. The significant costs incurred in connection with a business combination result primarily from the need to eliminate duplicate assets, activities or employeesa natural result of acquiring a fully integrated set of activities. For this reason, we believe that such costs incurred can be viewed differently in the context of an acquisition from those costs incurred in other, more normal, business contexts. The integration and restructuring costs for a business combination may occur over several years, with the more significant impacts typically ending within three years of the relevant transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. Discontinued Operations Adjusted income excludes the results of discontinued operations, as well as any related gains or losses on the disposal of such operations. We believe that this presentation is meaningful to investors because, while we review our therapeutic areas and product lines for strategic fit with our operations, we do not build or run our business with the intent to discontinue parts of our business. Restatements due to discontinued operations do not impact compensation or change the Adjusted income measure for the compensation in respect of the restated periods, but are presented for consistency across all periods. Certain Significant Items Adjusted income excludes certain significant items representing substantive and/or unusual items that are evaluated individually on a quantitative and qualitative basis. Certain significant items may be highly variable and difficult to predict. Furthermore, in some cases it is reasonably possible that they could reoccur in future periods. For example, although major non-acquisition-related cost-reduction programs are specific to an event or goal with a defined term, we may have subsequent programs based on reorganizations of the business, cost productivity or in response to LOE or economic conditions. Legal charges to resolve litigation are also related to specific cases, which are facts and circumstances specific and, in some cases, may also be the result of litigation matters at acquired companies that were inestimable, not probable or unresolved at the date of acquisition. Unusual items represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis; items that would be non-recurring; or items that relate to products we no longer sell. For a non-inclusive list of certain significant items see Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income below. Pfizer Inc. 2020 Form 10-K Reconciliation of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items 2020 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 41,908 $ $ $ $ $ 41,908 Cost of sales 8,692 18 (118) 8,592 Selling, informational and administrative expenses 11,615 (2) (489) 11,124 Research and development expenses 9,405 5 (526) 8,884 Amortization of intangible assets 3,436 (3,152) 284 Restructuring charges and certain acquisition-related costs 600 (44) (556) (Gain) on completion of Consumer Healthcare JV transaction (6) 6 Other (income)/deductionsnet 669 (75) (2,068) (1,474) Income from continuing operations before provision/(benefit) for taxes on income 7,497 3,206 44 3,752 14,499 Provision/(benefit) for taxes on income (b) 477 668 9 803 1,957 Income from continuing operations 7,021 2,537 35 2,948 12,541 Income from discontinued operationsnet of tax 2,631 (2,631) Net income attributable to noncontrolling interests 36 36 Net income attributable to Pfizer Inc. common shareholders 9,616 2,537 35 (2,631) 2,948 12,506 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 1.71 0.45 0.01 (0.47) 0.52 2.22 2019 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 41,172 $ $ $ $ $ 41,172 Cost of sales 8,251 19 (208) 8,062 Selling, informational and administrative expenses 12,750 2 (2) (263) 12,488 Research and development expenses 8,394 4 (663) 7,736 Amortization of intangible assets 4,462 (4,191) 271 Restructuring charges and certain acquisition-related costs 601 (183) (418) (Gain) on completion of Consumer Healthcare JV transaction (8,086) 8,086 Other (income)/deductionsnet 3,314 (21) (3,563) (270) Income from continuing operations before provision/(benefit) for taxes on income 11,485 4,186 185 (2,971) 12,885 Provision/(benefit) for taxes on income (b) 618 823 59 539 2,039 Income from continuing operations 10,867 3,363 126 (3,510) 10,846 Income from discontinued operationsnet of tax 5,435 (5,435) Net income attributable to noncontrolling interests 29 29 Net income attributable to Pfizer Inc. common shareholders 16,273 3,363 126 (5,435) (3,510) 10,817 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 2.87 0.59 0.02 (0.96) (0.62) 1.91 Pfizer Inc. 2020 Form 10-K 2018 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 40,825 $ $ $ $ $ 40,825 Cost of sales 8,987 3 (10) (105) 8,874 Selling, informational and administrative expenses 12,612 2 (2) (191) 12,420 Research and development expenses 7,760 3 (47) 7,716 Amortization of intangible assets 4,736 (4,456) 280 Restructuring charges and certain acquisition-related costs 1,058 (299) (759) (Gain) on completion of Consumer Healthcare JV transaction Other (income)/deductionsnet 2,077 (182) (7) (2,520) (631) Income from continuing operations before provision/(benefit) for taxes on income 3,594 4,630 318 3,622 12,164 Provision/(benefit) for taxes on income (b) (266) 888 54 1,509 2,185 Income from continuing operations 3,861 3,741 264 2,113 9,979 Income from discontinued operationsnet of tax 7,328 (7,328) Net income attributable to noncontrolling interests 36 36 Net income attributable to Pfizer Inc. common shareholders 11,153 3,741 264 (7,328) 2,113 9,944 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 1.87 0.63 0.04 (1.23) 0.35 1.66 (a) For details of adjustments, see Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income . (b) The effective tax rate on Non-GAAP Adjusted income was 13.5% in 2020, 15.8% in 2019 and 18.0% in 2018. The decrease in 2020, compared with 2019, was primarily due to a favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. The decrease in 2019, compared with 2018, was primarily due to a favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business, partially offset by a decrease in tax benefits for the resolution of certain tax positions, principally non-U.S., pertaining to prior years. Pfizer Inc. 2020 Form 10-K Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Purchase accounting adjustments Amortization, depreciation and other (a) $ 3,224 $ 4,205 $ 4,633 Cost of sales (18) (19) (3) Total purchase accounting adjustmentspre-tax 3,206 4,186 4,630 Income taxes (b) (668) (823) (888) Total purchase accounting adjustmentsnet of tax 2,537 3,363 3,741 Acquisition-related items Restructuring charges/(credits) (c) (192) 37 Transaction costs (c) 10 63 1 Integration costs and other (c) 34 311 260 Net periodic benefit costs/(credits) other than service costs (d) 7 Additional depreciationasset restructuring (e) 3 12 Total acquisition-related itemspre-tax 44 185 318 Income taxes (f) (9) (59) (54) Total acquisition-related itemsnet of tax 35 126 264 Discontinued operations Income from discontinued operationsnet of tax (g) (2,631) (5,435) (7,328) Certain significant items Restructuring charges/(credits) cost reduction initiatives (h) 556 418 759 Implementation costs and additional depreciationasset restructuring (i) 257 192 212 Net (gains)/losses on asset disposals (d) 238 Net (gains)/losses recognized during the period on equity securities (d) (557) (415) (586) Certain legal matters, net (d) 24 291 84 Certain asset impairments (d) 1,691 2,798 3,101 Business and legal entity alignment costs (j) 270 412 63 (Gain) on completion of Consumer Healthcare JV transaction (k) (6) (8,086) Other (l) 1,278 1,418 (10) Total certain significant itemspre-tax 3,752 (2,971) 3,622 Income taxes (m) (803) (539) (1,509) Total certain significant itemsnet of tax 2,948 (3,510) 2,113 Total purchase accounting adjustments, acquisition-related items, discontinued operations and certain significant itemsnet of tax, attributable to Pfizer Inc. $ 2,890 $ (5,455) $ (1,209) (a) Included primarily in Amortization of intangible assets . (b) Included in Provision/(benefit) for taxes on income. Includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying that applicable tax rate. (c) Included in Restructuring charges and certain acquisition-related costs . See Note 3. (d) Included in Other (income)/deductionsnet. See Note 4 . (e) In 2019, primarily included in Selling, informational and administrative expenses. In 2018, primarily included in C ost of sales. Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions related to acquisitions. (f) Included in Provision/(benefit) for taxes on income. Income taxes includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying the applicable tax rate. 2019 includes the impact of the non-taxable reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of a U.S. IRS audit for multiple tax years. (g) Included in Income from discontinued operationsnet of tax and relates to the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan . See Note 2B. (h) Amounts relate to employee termination costs, asset impairments and other exit costs not associated with acquisitions, which are included in Restructuring charges and certain acquisition-related costs (see Note 3 ) . (i) Amounts relate to our cost-reduction/productivity initiatives not related to acquisitions (see Note 3 ) . For 2020, primarily included in Cost of sales ($62 million) and Selling, informational and administrative expenses ($197 million). For 2019, included in Cost of sales ($89 million), Selling, informational and administrative expenses ($73 million) and Research and development expenses ($30 million). For 2018, included in Cost of sales ($101 million), Selling, informational and administrative expenses ($71 million) and Research and development expenses ($39 million). (j) In 2020, included in Cost of sales ($51 million), Selling, informational and administrative expenses ($206 million) and Research and development expenses ($13 million) and primarily represents costs for consulting, legal, tax and advisory services associated with internal reorganization of legal entities. In 2019, primarily included in Cost of sales ($15 million), Selling, informational and administrative expenses ($96 million) and Other (income)/deductionsnet ($300 million) and in 2018, included in Other (income)/deductionsnet and represents costs for consulting, legal, tax and other advisory services associated with the design, planning and implementation of our then new business structure, effective in the beginning of 2019. (k) Included in (Gain) on completion of Consumer Healthcare JV transaction (see Note 2C ). Pfizer Inc. 2020 Form 10-K (l) For 2020, primarily included in Selling, informational and administrative expenses ($86 million) , Research and development expenses ($515 million) and Other (income)/deductionsnet ($672 million). For 2019, included in Cost of sales ($104 million), Selling, informational and administrative expenses ($94 million), Research and development expenses ($632 million) and Other (income)/deductionsnet ($589 million). For 2018, primarily included in Selling, informational and administrative expenses ($120 million) and Other (income)/deductionsnet ($142 million income). 2020 includes the following charges recorded in Research and development expenses: (i) $151 million, representing the expense portion of our upfront payment to Myovant, (ii) an upfront payment of $130 million to Valneva, (iii) a $75 million milestone payment to Akcea, (iv) a $72 million upfront payment to BioNTech and (v) a $50 million milestone payment to Therachon. 2020 also includes, among other things, the following charges recorded in Other (income)/deductionsnet: (i) charges of $367 million, primarily representing our pro rata share of restructuring and business combination accounting charges recorded by the Consumer Healthcare JV, partially offset by gains from the divestiture of certain of the JVs brands recorded by the Consumer Healthcare JV, and our write-off and amortization of equity method basis differences primarily related to those brand divestitures and to inventory, and (ii) $198 million of settlement losses within the U.S. PCPP. 2019 included, among other things, (i) a $337 million charge in Research and development expenses related to our acquisition of Therachon, (ii) an upfront license fee payment of $250 million to Akcea, recorded in Research and development expenses, (iii) charges of $240 million, primarily in Selling, informational and administrative expenses ($87 million) and Other (income)/deductionsnet ($152 million), for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity associated with the formation of the Consumer Healthcare JV, (iv) net losses on early retirement of debt of $138 million in Other (income)/deductionsnet, (v) charges of $112 million recorded in Other (income)/deductionsnet representing our pro rata share of primarily restructuring and business combination accounting charges recorded by the Consumer Healthcare JV and (vi) a $99 million charge in Cost of sales related to rivipansel, primarily for inventory manufactured for expected future sale. For 2018, included, among other things, (i) a non-cash $343 million pre-tax gain in Other (income)/deductionsnet associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system, (ii) an $88 million charge, in the aggregate, in Selling, informational and administrative expenses for a special, one-time bonus paid to virtually all Pfizer colleagues, excluding executives, which was one of several actions taken by us after evaluating the expected positive net impact of the December 2017 enactment of the TCJA and (iii) a non-cash $50 million pre-tax gain in Other (income)/deductionsnet as a result of the contribution of our allogeneic CAR T therapy development program assets in connection with our contribution agreement entered into with Allogene (see Note 2B ) . (m) Included in Provision/(benefit) for taxes on income. Income taxes includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying the applicable tax rate. The amount in 2020 was favorably impacted by tax benefits associated with intangible asset impairment charges (see Note 4 ). The amount in 2019 was favorably impacted by a benefit of $1.4 billion, representing tax and interest, resulting from the favorable settlement of a U.S. IRS audit for multiple tax years, the benefits related to certain tax initiatives for the implementation of our then new business structure, as well as the tax benefit recorded as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA and unfavorably impacted by the tax expense of approximately $2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV transaction. The amount in 2018 was favorably impacted primarily by tax benefits related to the TCJA, including certain 2018 tax initiatives as well as adjustments to the provisional estimate of the legislation, reported and disclosed within the applicable measurement period, in accordance with guidance issued by the SEC. Pfizer Inc. 2020 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF CASH FLOWS Cash Flows from Continuing Operations Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Drivers of change Cash provided by/(used in): Operating activities from continuing operations $ 10,586 $ 7,011 $ 8,875 2020 v. 2019 The change is driven mainly by higher net income adjusted for non-cash items, advanced payments in 2020 for BNT162b2 recorded in deferred revenue, the upfront cash payment associated with our acquisition of Therachon in 2019, and the upfront cash payment associated with our licensing agreement with Akcea in 2019, partially offset by an increase in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net is driven primarily by an increase in equity method dividends received, partially offset by an increase in equity income and increases in net unrealized gains on equity securities. 2019 v. 2018 The change is driven mostly by the upfront cash payments in 2019 associated with our acquisition of Therachon and our licensing agreement with Akcea, partially offset by a decrease in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net is driven primarily by a non-cash gain in 2018 associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, and a non-cash gain in 2018 on the contribution of Pfizers allogeneic CAR T developmental program assets, partially offset by net gains on foreign exchange hedging of our intercompany inventory sales. Investing activities from continuing operations $ (4,188) $ (3,852) $ 4,584 2020 v. 2019 The change is driven mostly by a $6.0 billion decrease in net proceeds from short-term investments with original maturities of three months or less and $2.7 billion in net purchases of short-term investments with original maturities of greater than three months in 2020 (compared to $2.3 billion net proceeds from short-term investments with original maturities of greater than three months in 2019), partially offset by the cash used to acquire Array, net of cash acquired, of $10.9 billion in 2019. 2019 v. 2018 The change is driven primarily by cash used for the acquisition of Array, net of cash acquired, of $10.9 billion in 2019, partially offset by an increase in net proceeds generated from the sale of investments of $2.9 billion for cash needs, including financing the acquisition of Array. Financing activities from continuing operations $ (21,640) $ (8,485) $ (20,441) 2020 v. 2019 The change is driven primarily by $14.0 billion net payments on short-term borrowings in 2020 (compared to $10.6 billion net proceeds raised from short-term borrowings in 2019) and an increase in cash dividends paid of $397 million, partially offset by a decrease in purchases of common stock of $8.9 billion, lower repayments on long-term debt of $2.8 billion, and an increase in issuances of long-term debt of $280 million. 2019 v. 2018 The change is driven mostly by $10.6 billion of net proceeds raised from short-term borrowings in 2019, primarily in connection with the acquisition of Array (compared to net payments on short-term borrowings of $2.3 billion in 2018) and lower purchases of common stock of $3.3 billion, partially offset by higher repayments on long-term debt of $3.2 billion and lower proceeds from the exercise of stock options of $864 million. Cash Flows from Discontinued Operations Cash flows from discontinued operations relate to the Upjohn Business (see Note 2B ). In 2020, net cash provided by financing activities from discontinued operations primarily reflects issuances of long-term debt . Pfizer Inc. 2020 Form 10-K ANALYSIS OF FINANCIAL CONDITION, LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK We rely largely on operating cash flows, short-term investments or commercial paper borrowings and long-term debt to provide for our liquidity requirements. We continue our efforts to improve cash inflows through working capital efficiencies. We target specific areas of focus including accounts receivable, inventories, accounts payable, and other working capital, which allows us to optimize our operating cash flows. Due to our significant operating cash flows as well as our financial assets, access to capital markets and available lines of credit and revolving credit agreements, we believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future, which can include, among others: the working capital requirements of our operations, including our RD activities; investments in our business; dividend payments and potential increases in the dividend rate; share repurchases; the cash requirements for our cost-reduction/productivity initiatives; paying down outstanding debt; contributions to our pension and postretirement plans; and business development activities. Our long-term debt is rated high-quality by both SP and Moodys. See the Credit Ratings section below. We have taken, and will continue to take, a conservative approach to our financial investments and monitoring of our liquidity position in response to market changes. Our debt investments consist primarily of high-quality, highly liquid, well-diversified available-for-sale debt securities. Debt CapacityLines of Credit We have available lines of credit and revolving credit agreements with a group of banks and other financial intermediaries. We typically maintain cash and cash equivalent balances and short-term investments which, together with our available revolving credit facilities, are in excess of our commercial paper and other short-term borrowings. See Note 7C . Selected Measures of Liquidity and Capital Resources The following presents certain relevant measures of our liquidity and capital resources: As of December 31, (MILLIONS OF DOLLARS, EXCEPT RATIOS) 2020 2019 Selected financial assets (a) : Cash and cash equivalents $ 1,784 $ 1,121 Short-term investments 10,437 8,525 Long-term investments, excluding private equity securities at cost 2,973 2,258 15,195 11,905 Debt: Short-term borrowings, including current portion of long-term debt 2,703 16,195 Long-term debt 37,133 35,955 39,835 52,150 Selected net financial liabilities $ (24,641) $ (40,245) Working capital (b) $ 9,147 $ (4,501) Ratio of current assets to current liabilities 1.35:1 0.88:1 (a) See Note 7 for a description of certain assets held and for a description of credit risk related to our financial instruments held. (b) The increase in working capital was primarily driven by the use of Upjohn cash distribution proceeds to pay down short-term commercial paper borrowings. See Note 2B . On November 16, 2020, we received $12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris (see Note 2B ). In November 2020, we used the cash proceeds to pay down commercial paper and redeem, before the maturity date, the $1.15 billion aggregate principal amount outstanding of 1.95% senior unsecured notes that were due in June 2021 and $342 million aggregate principal amount of 5.80% senior unsecured notes that were due in August 2023. In May 2020, we completed a public offering of $4.0 billion aggregate principal amount of senior unsecured notes. In March 2020, we: completed a public offering of $1.25 billion aggregate principal amount of senior unsecured sustainability notes. The proceeds were initially used to repay outstanding commercial paper and subsequently will be used to help manage our environmental impact and support increased patient access to our medicines and vaccines, especially among underserved populations, and strengthen healthcare systems; and repurchased at par all $1.065 billion principal amount outstanding of senior unsecured notes that were due in 2047 before the maturity date. For additional information about these issuances and retirements, see Note 7D. For additional information about the sources and uses of our funds, see the Analysis of the Consolidated Statements of Cash Flows within MDA. Pfizer Inc. 2020 Form 10-K Credit Ratings Two major corporate debt-rating organizations, Moodys and SP, assign ratings to our short-term and long-term debt. A security rating is not a recommendation to buy, sell or hold securities and the rating is subject to revision or withdrawal at any time by the rating organization. Each rating should be evaluated independently of any other rating. The current ratings assigned to our commercial paper and senior unsecured long-term debt: NAME OF RATING AGENCY Pfizer Short-Term Pfizer Long-Term Outlook/Watch Date of Last Rating Change Rating Rating Moodys P-1 A2 Stable November 2020 SP A-1+ A+ Stable November 2020 Both Moodys and SP lowered Pfizers long-term debt rating one notch to A2 and A+, respectively, upon completion of the Upjohn separation in November 2020. Pfizers short-term rating remained unchanged. Additionally, both rating agencies removed Pfizers long-term debt rating from under review and assigned a stable outlook. LIBOR For information on interest rate risk and LIBOR, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. We do not expect the transition to an alternative rate to have a material impact on our liquidity or financial resources. Gl o bal Economic Conditions Our Venezuela and Argentina operations function in hyperinflationary economies. The impact to Pfizer is not considered material. For additional information on the global economic environment, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. Market Risk The objective of our financial risk management program is to minimize the impact of foreign exchange rate and interest rate movements on our earnings. We address these exposures through a combination of operational means and financial instruments. We adapt our practices periodically as economic conditions change. For more information, see Notes 1F and 7E , as well as the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K for key currencies in which we operate. Foreign Exchange Risk We are subject to foreign exchange risk in our commercial operations, assets and liabilities that are denominated in foreign currencies and our net investments in foreign subsidiaries. On the commercial side, a significant portion of our revenues and earnings is exposed to changes in exchange rates. Where foreign exchange risk is not offset by other exposures, we may use foreign currency forward-exchange contracts and/or foreign currency swaps to manage that risk. With respect to our financial assets and liabilities, our primary foreign exchange exposure arises from intercompany receivables and payables, and, to a lesser extent, from investments and debt denominated in currencies other than the functional currency of the business entity. In addition, under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. In these cases, we may use foreign exchange contracts and/or foreign currency debt. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2020, the expected adverse impact on our net income would not be significant. Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk which may have an impact on net income. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt (or investments) to fixed rates. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point decrease in interest rates as of December 31, 2020, the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. Pfizer Inc. 2020 Form 10-K Contractual Obligations Payments due under contractual obligations as of December 31, 2020, mature as follows: Years (MILLIONS OF DOLLARS) Total 2021 2023 2025 There-after Long-term debt, including current portion (a) $ 39,135 $ 2,002 $ 4,346 $ 3,068 $ 29,719 Consists of senior unsecured notes (including fixed and floating rate, foreign currency denominated, and other notes). Commitments under financing leases are not significant. Interest payments on long-term debt obligations (a) 21,122 1,390 2,746 2,455 14,530 Incorporates only current period assumptions for interest rates, foreign currency translation rates and hedging strategies, and assumes that interest is accrued through the maturity date or expiration of the related instrument. Other long-term liabilities (b) 2,070 383 451 381 855 Includes expected payments relating to our unfunded U.S. supplemental (non-qualified) pension plans, postretirement plans and deferred compensation plans. Excludes amounts relating to our U.S. qualified pension plans and international pension plans, all of which have a substantial amount of plan assets, because the required funding obligations are not expected to be material and/or because such liabilities do not necessarily reflect future cash payments, as the impact of changes in economic conditions on the fair value of the pension plan assets and/or liabilities can be significant. Also, excludes $4.2 billion of liabilities related to the fair value of derivative financial instruments, legal matters and employee terminations, among other liabilities, most of which do not represent contractual obligations. Operating leases (c) 3,312 357 638 460 1,856 Includes future minimum rental commitments under non-cancelable operating leases, including an agreement to lease space in an office building in New York City. Purchase obligations and other (d) 3,793 847 1,470 933 543 Includes agreements to purchase goods and services that are enforceable and legally binding and includes amounts relating to advertising, information technology services, employee benefit administration services, and potential milestone payments deemed reasonably likely to occur. Other taxes payabledeemed repatriated accumulated post-1986 earnings of foreign subsidiaries (e) 9,000 700 1,700 3,700 2,900 Represents estimated cash payments related to the TCJA repatriation tax liability. Uncertain tax positions (e) 42 42 Includes only income tax amounts currently payable. We are unable to predict the timing of tax settlements related to our noncurrent obligations for uncertain tax positions as tax audits can involve complex issues and the resolution of those issues may span multiple years, particularly if subject to negotiation or litigation. (a) See Note 7 . (b) See Notes 3 , 7A , 11E and 16 . (c) See Note 15 . (d) Also includes obligations to make guaranteed fixed annual payments over the next six years in connection with the U.S. and EU approvals for Besponsa ($401 million) and an obligation to make guaranteed fixed annual payments over the next seven years for Bosulif ($195 million), both associated with RD arrangements. (e) See Note 5. The above table includes amounts for potential milestone payments under collaboration, licensing or other arrangements, if the payments are deemed reasonably likely to occur. Payments under these agreements generally become due and payable only upon the achievement of certain development, regulatory and/or commercialization milestones, which may span several years and which may never occur. In 2021, we expect to spend approximately $3.0 billion on property, plant and equipment. We rely largely on operating cash flows to fund our capital investment needs. Off-Balance Sheet Arrangements In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities. For more information on guarantees and indemnifications, see Note 16B . Additionally, certain of our co-promotion or license agreements give our licensors or partners the rights to negotiate for, or in some cases to obtain under certain financial conditions, co-promotion or other rights in specified countries with respect to certain of our products. Share-Purchase Plans and Accelerated Share Repurchase Agreements See Note 12 for information on the shares of our common stock purchased and the cost of purchases under our publicly announced share-purchase plans, including our accelerated share repurchase agreements. At December 31, 2020, our remaining share-purchase authorization was approximately $5.3 billion. Pfizer Inc. 2020 Form 10-K Dividends on Common Stock In December 2020, our BOD declared a first-quarter dividend of $0.39 per share, payable on March 5, 2021, to shareholders of record at the close of business on January 29, 2021. The first-quarter 2021 cash dividend will be our 329th consecutive quarterly dividend. Our current and projected dividends provide a return to shareholders while maintaining sufficient capital to invest in growing our business. Our dividends are not restricted by debt covenants. While the dividend level remains a decision of Pfizers BOD and will continue to be evaluated in the context of future business performance, we currently believe that we can support future annual dividend increases, barring significant unforeseen events. Viatris is expected to begin paying a quarterly dividend in the second quarter of 2021, at which time Pfizers quarterly dividend is expected to be reduced such that the combined dividend dollar amount received by Pfizer shareholders, based upon the combination of continued Pfizer ownership and approximately 0.124079 shares of Viatris common stock which were granted for each Pfizer share in the spin-off, will equate to Pfizers dividend amount in effect immediately prior to the initiation of the Viatris dividend. NEW ACCOUNTING STANDARDS Recently Adopted Accounting Standards See Note 1B. Recently Issued Accounting Standards, Not Adopted as of December 31, 2020 Standard/Description Effective Date Effect on the Financial Statements Accounting for income taxes eliminates certain exceptions to the guidance, related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. January 1, 2021. We do not expect this guidance to have a material impact on our consolidated financial statements. Reference rate reform provides temporary optional expedients and exceptions to the guidance for contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued after 2021 because of reference rate reform. The new guidance provides the following optional expedients: 1. Simplify accounting analyses under current U.S. GAAP for contract modifications. 2. Simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. 3. Allow a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform. Elections can be adopted prospectively at any time in the first quarter of 2020 through December 31, 2022. We are assessing the impact of the provisions of this new guidance on our consolidated financial statements. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Pfizer Inc. 2020 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed in Note 1G to the consolidated financial statements, the Company records estimated deductions for Medicare, Medicaid, and performance-based contract rebates (collectively, U.S. rebates) as a reduction to gross product revenues. The accrual for U.S. rebates is recorded in the same period that the corresponding revenues are recognized. The length of time between when a sale is made and when the U.S. rebate is paid by the Company can be as long as one year, which increases the need for significant management judgment and knowledge of market conditions and practices in estimating the accrual. We identified the evaluation of the U.S. rebates accrual as a critical audit matter because the evaluation of the product-specific experience ratio assumption involved especially challenging auditor judgment. The product-specific experience ratio assumption relates to estimating which of the Companys revenue transactions will ultimately be subject to a related rebate. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys U.S. rebates accrual process related to the development of the product-specific experience ratio assumptions. We estimated the U.S. rebates accrual using internal information and historical data and compared the result to the Companys estimated U.S. rebates accrual. We evaluated the Companys ability to accurately estimate the accrual for U.S. rebates by comparing historically recorded accruals to the actual amount that was ultimately paid by the Company. Evaluation of gross unrecognized tax benefits As discussed in Notes 5D and 1P, the Companys tax positions are subject to audit by local taxing authorities in each respective tax jurisdiction, and the resolution of such audits may span multiple years. Since tax law is complex and often subject to varied interpretations and judgments, it is uncertain whether some of the Companys tax positions will be sustained upon audit. As of December 31, 2020, the Company has recorded gross unrecognized tax benefits, excluding associated interest, of $5.6 billion. We identified the evaluation of the Companys gross unrecognized tax benefits as a critical audit matter because a high degree of audit effort, including specialized skills and knowledge, and complex auditor judgment was required in evaluating the Companys interpretation of tax law and its estimate of the ultimate resolution of its tax positions. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Companys liability for unrecognized tax position process related to (1) interpretation Pfizer Inc. 2020 Form 10-K Report of Independent Registered Public Accounting Firm of tax law, (2) evaluation of which of the Companys tax positions may not be sustained upon audit, and (3) estimation and recording of the gross unrecognized tax benefits. We involved tax and valuation professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation of tax laws, including the assessment of transfer pricing practices in accordance with applicable tax laws and regulations. We inspected settlements with applicable taxing authorities, including assessing the expiration of statutes of limitations. We tested the calculation of the liability for uncertain tax positions, including an evaluation of the Companys assessment of the technical merits of tax positions and estimates of the amount of tax benefits expected to be sustained. Evaluation of product and other product-related litigation As discussed in Notes 1R and 16 to the consolidated financial statements, the Company is involved in product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others. Certain of these pending product and other product-related legal proceedings could result in losses that could be substantial. The accrued liability and/or disclosure for the pending product and other product-related legal proceedings requires a complex series of judgments by the Company about future events, which involves a number of uncertainties. We identified the evaluation of product and other product-related litigation as a critical audit matter. Challenging auditor judgment was required to evaluate the Companys judgments about future events and uncertainties. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys product liability and other product-related litigation processes, including controls related to (1) the evaluation of information from external and internal legal counsel, (2) forward-looking expectations, and (3) new legal proceedings, or other legal proceedings not currently reserved or disclosed. We read letters received directly from the Companys external and internal legal counsel that described the Companys probable or reasonably possible legal contingency to pending product and other product-related legal proceedings. We inspected the Companys minutes from meetings of the Audit Committee, which included the status of key litigation matters. We evaluated the Companys ability to estimate its monetary exposure to pending product and other product-related legal proceedings by comparing historically recorded liabilities to actual monetary amounts incurred upon resolution of prior legal matters. We analyzed relevant publicly available information about the Company, its competitors, and the industry. KPMG LLP We have not been able to determine the specific year that KPMG and our predecessor firms began serving as the Companys auditor, however, we are aware that KPMG and our predecessor firms have served as the Companys auditor since at least 1942. New York, New York February 25, 2021 Pfizer Inc. 2020 Form 10-K Consolidated Statements of Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2020 2019 2018 Revenues $ 41,908 $ 41,172 $ 40,825 Costs and expenses: Cost of sales (a) 8,692 8,251 8,987 Selling, informational and administrative expenses (a) 11,615 12,750 12,612 Research and development expenses (a) 9,405 8,394 7,760 Amortization of intangible assets 3,436 4,462 4,736 Restructuring charges and certain acquisition-related costs 600 601 1,058 (Gain) on completion of Consumer Healthcare JV transaction ( 6 ) ( 8,086 ) Other (income)/deductionsnet 669 3,314 2,077 Income from continuing operations before provision/(benefit) for taxes on income 7,497 11,485 3,594 Provision/(benefit) for taxes on income 477 618 ( 266 ) Income from continuing operations 7,021 10,867 3,861 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income before allocation to noncontrolling interests 9,652 16,302 11,188 Less: Net income attributable to noncontrolling interests 36 29 36 Net income attributable to Pfizer Inc. common shareholders $ 9,616 $ 16,273 $ 11,153 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 1.26 $ 1.95 $ 0.65 Income from discontinued operationsnet of tax 0.47 0.98 1.25 Net income attributable to Pfizer Inc. common shareholders $ 1.73 $ 2.92 $ 1.90 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 1.24 $ 1.91 $ 0.64 Income from discontinued operationsnet of tax 0.47 0.96 1.23 Net income attributable to Pfizer Inc. common shareholders $ 1.71 $ 2.87 $ 1.87 Weighted-average sharesbasic 5,555 5,569 5,872 Weighted-average sharesdiluted 5,632 5,675 5,977 (a) Exclusive of amortization of intangible assets, except as disclosed in Note 1L. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Comprehensive Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2020 2019 2018 Net income before allocation to noncontrolling interests $ 9,652 $ 16,302 $ 11,188 Foreign currency translation adjustments, net $ 957 $ 654 $ ( 799 ) Reclassification adjustments ( 17 ) ( 288 ) ( 22 ) 940 366 ( 821 ) Unrealized holding gains/(losses) on derivative financial instruments, net ( 582 ) 476 220 Reclassification adjustments for (gains)/losses included in net income (a) 21 ( 664 ) 27 ( 561 ) ( 188 ) 247 Unrealized holding gains/(losses) on available-for-sale securities, net 361 ( 1 ) ( 185 ) Reclassification adjustments for (gains)/losses included in net income (b) ( 188 ) 39 124 Reclassification adjustments for unrealized gains included in Retained earnings (c) ( 462 ) 173 38 ( 522 ) Benefit plans: actuarial gains/(losses), net ( 1,128 ) ( 826 ) ( 649 ) Reclassification adjustments related to amortization 276 241 242 Reclassification adjustments related to settlements, net 278 274 142 Other ( 189 ) 22 112 ( 763 ) ( 289 ) ( 153 ) Benefit plans: prior service (costs)/credits and other, net 52 ( 7 ) ( 9 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 176 ) ( 181 ) ( 181 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 2 ) ( 19 ) Other 1 2 ( 124 ) ( 189 ) ( 207 ) Other comprehensive income/(loss), before tax ( 335 ) ( 262 ) ( 1,457 ) Tax provision/(benefit) on other comprehensive income/(loss) (d) ( 349 ) 115 518 Other comprehensive income/(loss) before allocation to noncontrolling interests $ 14 $ ( 376 ) $ ( 1,975 ) Comprehensive income before allocation to noncontrolling interests $ 9,666 $ 15,926 $ 9,214 Less: Comprehensive income/(loss) attributable to noncontrolling interests 27 18 16 Comprehensive income attributable to Pfizer Inc. $ 9,639 $ 15,908 $ 9,198 (a) Reclassified into Other (income)/deductionsnet and Cost of sales . See Note 7E. (b) Reclassified into Other (income)/deductionsnet . (c) See Note 1B in our 2018 Financial Report. (d) See Note 5E. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Balance Sheets Pfizer Inc. and Subsidiary Companies As of December 31, (MILLIONS, EXCEPT PREFERRED STOCK ISSUED AND PER COMMON SHARE DATA) 2020 2019 Assets Cash and cash equivalents $ 1,784 $ 1,121 Short-term investments 10,437 8,525 Trade accounts receivable, less allowance for doubtful accounts: 2020$ 508 ; 2019$ 493 7,930 6,772 Inventories 8,046 7,068 Current tax assets 3,264 2,736 Other current assets 3,438 2,357 Current assets of discontinued operations and other assets held for sale 167 4,224 Total current assets 35,067 32,803 Equity-method investments 16,856 17,133 Long-term investments 3,406 3,014 Property, plant and equipment 13,900 12,969 Identifiable intangible assets 28,471 33,936 Goodwill 49,577 48,202 Noncurrent deferred tax assets and other noncurrent tax assets 2,383 1,911 Other noncurrent assets 4,569 4,199 Noncurrent assets of discontinued operations 13,427 Total assets $ 154,229 $ 167,594 Liabilities and Equity Short-term borrowings, including current portion of long-term debt: 2020$ 2,002 ; 2019$ 1,462 $ 2,703 $ 16,195 Trade accounts payable 4,309 3,887 Dividends payable 2,162 2,104 Income taxes payable 1,049 980 Accrued compensation and related items 3,058 2,390 Other current liabilities 12,640 9,334 Current liabilities of discontinued operations 2,413 Total current liabilities 25,920 37,304 Long-term debt 37,133 35,955 Pension benefit obligations 4,766 5,291 Postretirement benefit obligations 645 926 Noncurrent deferred tax liabilities 4,063 5,652 Other taxes payable 11,560 12,126 Other noncurrent liabilities 6,669 6,894 Total liabilities 90,756 104,148 Commitments and Contingencies Preferred stock, no par value, at stated value; 27 shares authorized; issued: 2020 0 ; 2019 431 17 Common stock, $ 0.05 par value; 12,000 shares authorized; issued: 2020 9,407 ; 2019 9,369 470 468 Additional paid-in capital 88,674 87,428 Treasury stock, shares at cost: 2020 3,840 ; 2019 3,835 ( 110,988 ) ( 110,801 ) Retained earnings 96,770 97,670 Accumulated other comprehensive loss ( 11,688 ) ( 11,640 ) Total Pfizer Inc. shareholders equity 63,238 63,143 Equity attributable to noncontrolling interests 235 303 Total equity 63,473 63,447 Total liabilities and equity $ 154,229 $ 167,594 See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Equity Pfizer Inc. and Subsidiary Companies PFIZER INC. SHAREHOLDERS Preferred Stock Common Stock Treasury Stock (MILLIONS, EXCEPT PREFERRED SHARES AND PER SHARE AMOUNTS) Shares Stated Value Shares Par Value Addl Paid-In Capital Shares Cost Retained Earnings Accum. Other Comp. Loss Share - holders Equity Non-controlling Interests Total Equity Balance, January 1, 2018 524 $ 21 9,275 $ 464 $ 84,278 ( 3,296 ) $ ( 89,425 ) $ 85,291 $ ( 9,321 ) $ 71,308 $ 348 $ 71,656 Net income 11,153 11,153 36 11,188 Other comprehensive income/(loss), net of tax ( 1,955 ) ( 1,955 ) ( 20 ) ( 1,975 ) Cash dividends declared, per share: $ 1.38 Common stock ( 8,060 ) ( 8,060 ) ( 8,060 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 12 ) ( 12 ) Share-based payment transactions 57 3 1,977 ( 12 ) 13 1,993 1,993 Purchases of common stock ( 307 ) ( 12,198 ) ( 12,198 ) ( 12,198 ) Preferred stock conversions and redemptions ( 46 ) ( 2 ) ( 3 ) ( 4 ) ( 4 ) Other (a) 1,172 1,172 1,172 Balance, December 31, 2018 478 19 9,332 467 86,253 ( 3,615 ) ( 101,610 ) 89,554 ( 11,275 ) 63,407 351 63,758 Net income 16,273 16,273 29 16,302 Other comprehensive income/(loss), net of tax ( 365 ) ( 365 ) ( 11 ) ( 376 ) Cash dividends declared, per share: $ 1.46 Common stock ( 8,174 ) ( 8,174 ) ( 8,174 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 6 ) ( 6 ) Share-based payment transactions 37 2 1,219 ( 8 ) ( 326 ) 894 894 Purchases of common stock ( 213 ) ( 8,865 ) ( 8,865 ) ( 8,865 ) Preferred stock conversions and redemptions ( 47 ) ( 2 ) ( 3 ) 1 ( 4 ) ( 4 ) Other ( 40 ) 19 ( 21 ) ( 60 ) ( 81 ) Balance, December 31, 2019 431 17 9,369 468 87,428 ( 3,835 ) ( 110,801 ) 97,670 ( 11,640 ) 63,143 303 63,447 Net income 9,616 9,616 36 9,652 Other comprehensive income/(loss), net of tax 23 23 ( 9 ) 14 Cash dividends declared, per share: $ 1.53 Common stock ( 8,571 ) ( 8,571 ) ( 8,571 ) Preferred stock Noncontrolling interests ( 91 ) ( 91 ) Share-based payment transactions 37 2 1,261 ( 6 ) ( 218 ) 1,044 1,044 Preferred stock conversions and redemptions (b) ( 431 ) ( 17 ) ( 15 ) 1 31 ( 1 ) ( 1 ) Distribution of Upjohn Business (c) ( 1,944 ) ( 71 ) ( 2,015 ) ( 3 ) ( 2,018 ) Other ( 1 ) ( 1 ) Balance, December 31, 2020 $ 9,407 $ 470 $ 88,674 ( 3,840 ) $ ( 110,988 ) $ 96,770 $ ( 11,688 ) $ 63,238 $ 235 $ 63,473 (a) Primarily represents the cumulative effect of the adoption of new accounting standards in 2018 for revenues, financial assets and liabilities, income tax accounting, and the reclassification of certain tax effects. See Note 1B in our 2018 Financial Report. (b) See Note 12 . (c) See Note 2B . See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2020 2019 2018 Operating Activities Net income before allocation to noncontrolling interests $ 9,652 $ 16,302 $ 11,188 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income from continuing operations before allocation to noncontrolling interests 7,021 10,867 3,861 Adjustments to reconcile net income before allocation to noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 4,777 5,795 6,150 Asset write-offs and impairments 2,049 2,941 3,398 TCJA impact ( 323 ) ( 596 ) Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed (a) ( 6 ) ( 8,233 ) Deferred taxes from continuing operations ( 1,468 ) 596 ( 2,204 ) Share-based compensation expense 756 688 923 Benefit plan contributions in excess of expense/income ( 1,790 ) ( 288 ) ( 1,057 ) Other adjustments, net ( 478 ) ( 1,080 ) ( 1,266 ) Other changes in assets and liabilities, net of acquisitions and divestitures: Trade accounts receivable ( 1,249 ) ( 1,140 ) ( 458 ) Inventories ( 736 ) ( 1,080 ) ( 432 ) Other assets ( 146 ) 840 ( 52 ) Trade accounts payable 353 ( 340 ) 404 Other liabilities 2,741 851 367 Other tax accounts, net ( 1,238 ) ( 3,084 ) ( 163 ) Net cash provided by operating activities from continuing operations 10,586 7,011 8,875 Net cash provided by operating activities from discontinued operations 3,817 5,576 6,952 Net cash provided by operating activities 14,403 12,588 15,827 Investing Activities Purchases of property, plant and equipment ( 2,252 ) ( 2,072 ) ( 1,984 ) Purchases of short-term investments ( 13,805 ) ( 6,835 ) ( 11,677 ) Proceeds from redemptions/sales of short-term investments 11,087 9,183 17,581 Net (purchases of)/proceeds from redemptions/sales of short-term investments with original maturities of three months or less 920 6,925 ( 3,917 ) Purchases of long-term investments ( 597 ) ( 201 ) ( 1,797 ) Proceeds from redemptions/sales of long-term investments 723 232 6,244 Acquisitions of businesses, net of cash acquired ( 10,861 ) Acquisitions of intangible assets ( 539 ) ( 418 ) ( 152 ) Other investing activities, net (a) 274 195 287 Net cash provided by/(used in) investing activities from continuing operations ( 4,188 ) ( 3,852 ) 4,584 Net cash provided by/(used in) investing activities from discontinued operations ( 82 ) ( 94 ) ( 60 ) Net cash provided by/(used in) investing activities ( 4,271 ) ( 3,945 ) 4,525 Financing Activities Proceeds from short-term borrowings 12,352 16,455 3,711 Principal payments on short-term borrowings ( 22,197 ) ( 8,378 ) ( 4,437 ) Net (payments on)/proceeds from short-term borrowings with original maturities of three months or less ( 4,129 ) 2,551 ( 1,617 ) Proceeds from issuance of long-term debt 5,222 4,942 4,974 Principal payments on long-term debt ( 4,003 ) ( 6,806 ) ( 3,566 ) Purchases of common stock ( 8,865 ) ( 12,198 ) Cash dividends paid ( 8,440 ) ( 8,043 ) ( 7,978 ) Proceeds from exercise of stock options 425 394 1,259 Other financing activities, net ( 869 ) ( 736 ) ( 588 ) Net cash provided by/(used in) financing activities from continuing operations ( 21,640 ) ( 8,485 ) ( 20,441 ) Net cash provided by/(used in) financing activities from discontinued operations 11,991 Net cash provided by/(used in) financing activities ( 9,649 ) ( 8,485 ) ( 20,441 ) Effect of exchange-rate changes on cash and cash equivalents and restricted cash and cash equivalents ( 8 ) ( 32 ) ( 116 ) Net increase/(decrease) in cash and cash equivalents and restricted cash and cash equivalents 475 125 ( 205 ) Cash and cash equivalents and restricted cash and cash equivalents, at beginning of period 1,350 1,225 1,431 Cash and cash equivalents and restricted cash and cash equivalents, at end of period $ 1,825 $ 1,350 $ 1,225 - Continued - Pfizer Inc. 2020 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, 2020 2019 2018 Supplemental Cash Flow Information Cash paid (received) during the period for: Income taxes $ 3,153 $ 3,664 $ 3,655 Interest paid 1,641 1,587 1,311 Interest rate hedges ( 20 ) ( 42 ) ( 38 ) Non-cash transactions: 32 % equity-method investment in the Consumer Healthcare JV received in exchange for contributing Pfizers Consumer Healthcare business (a) $ $ 15,711 $ Equity investment in Allogene received in exchange for Pfizer's allogeneic CAR T developmental program assets 92 Equity investment in Cerevel in exchange for Pfizers portfolio of clinical and preclinical neuroscience assets 343 (a) The $ 8.2 billion Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed reflects the receipt of a 32 % equity-method investment in the new company initially valued at $ 15.7 billion in exchange for net assets contributed of $ 7.6 billion and is presented in operating activities net of $ 146 million cash conveyed that is reflected in Other investing activities, net . See Note 2C. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 1. Basis of Presentation and Significant Accounting Policies A. Basis of Presentation The consolidated financial statements include the accounts of our parent company and all subsidiaries and are prepared in accordance with U.S. GAAP. The decision of whether or not to consolidate an entity for financial reporting purposes requires consideration of majority voting interests, as well as effective economic or other control over the entity. Typically, we do not seek control by means other than voting interests. For subsidiaries operating outside the U.S., the financial information is included as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. Substantially all unremitted earnings of international subsidiaries are free of legal and contractual restrictions. All significant transactions among our subsidiaries have been eliminated. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan. Prior to the separation of the Upjohn Business, beginning in 2020, the Upjohn Business, Meridian, which is the manufacturer of EpiPen and other auto-injector products, and a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (the Mylan-Japan collaboration) were managed as part of our former Upjohn operating segment. Revenues and expenses associated with Meridian and the Mylan-Japan collaboration were included in the Upjohn operating segment results along with the results of operations of the Upjohn Business in Pfizers historical consolidated financial statements. Meridian, which remains with Pfizer, supplies EpiPen Auto-Injectors to Viatris under a supply agreement expiring December 31, 2024, with an option for Viatris to extend for an additional one-year term. On December 21, 2020, which falls in Pfizers international 2021 fiscal year, Pfizer and Viatris completed the termination, under the previously disclosed agreement dated November 13, 2020, of the Mylan-Japan collaboration and we transferred related inventories and operations that were part of the Mylan-Japan collaboration to Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. The financial results of Meridian are now included in our Hospital therapeutic area for all periods presented. Upon completion of the spin-off of the Upjohn Business on November 16, 2020, the Upjohn assets and liabilities were derecognized from our consolidated balance sheet and are reflected in Retained Earnings Distribution of Upjohn Business in the consolidated statement of equity. The assets and liabilities associated with the Upjohn Business and the Mylan-Japan collaboration are classified as assets and liabilities of discontinued operations. Certain prior year amounts have been reclassified to conform with the current year presentation. In addition, other acquisitions and business development activities completed in 2020, 2019 and 2018, including the acquisitions of Array and Therachon, and the contribution of our Consumer Healthcare business to the Consumer Healthcare JV, impacted financial results in the periods presented. See Note 2. Prior to the separation of the Upjohn Business, we managed our commercial operations through three distinct business segments: (i) our innovative science-based biopharmaceutical products business (Biopharma); (ii) our global, primarily off-patent branded and generics business (Upjohn); and (iii) through July 31, 2019, Pfizers consumer healthcare business. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We now operate as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Regional commercial organizations market, distribute and sell our products. Our commercial organization is supported by global platform functions that are responsible for the research, development, manufacturing and supply of our products. The business is also supported by global corporate enabling functions. Our determination that we operate as a single segment is consistent with the financial information regularly reviewed by the chief operating decision maker for purposes of evaluating performance, allocating resources, setting incentive compensation targets, and planning and forecasting for future periods. Our chief operating decision maker allocates resources and assesses financial performance on a consolidated basis. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. For information about product and geographic revenues, see Note 17 . Certain amounts in the consolidated financial statements and associated notes may not add due to rounding. All percentages have been calculated using unrounded amounts. B . New Accounting Standards Adopted in 2020 On January 1, 2020, we adopted the following accounting standards: Credit Losses on Financial Instruments We adopted a new accounting standard for credit losses on financial instruments, which replaces the probable initial recognition threshold for incurred loss estimates under prior guidance with a methodology that reflects expected credit loss estimates. The standard generally impacts financial assets that have a contractual right to receive cash and are not accounted for at fair value through net income, such as accounts receivable and held-to-maturity debt securities. The new guidance requires us to identify, analyze, document and support new methodologies for quantifying expected credit loss estimates for certain financial instruments, using information such as historical experience, current economic conditions and information, and the use of reasonable and supportable forecasted information. The standard also amends existing impairment guidance for available-for-sale debt securities to incorporate a credit loss allowance and allows for reversals of credit impairments in the event the issuers credit improves. We adopted the new accounting standard utilizing the modified retrospective method and, therefore, no adjustments were made to prior period financial statements. The cumulative effect of adopting the standard as an adjustment to the opening balance of Retained earnings was not material. The adoption of this standard did not have a material impact on our consolidated statement of income or consolidated statement of cash flows for the year ended December 31, 2020, nor on our consolidated balance sheet as of December 31, 2020. For additional information, see Note 1G. Goodwill Impairment Testing We prospectively adopted the new standard, which eliminates the requirement to perform a hypothetical purchase price allocation to measure goodwill impairment. Under the new guidance, the goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and recognizing an impairment charge for the amount by which the carrying amount Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies of the reporting unit exceeds its fair value. There was no impact to our consolidated financial statements from the adoption of this new standard. Implementation Costs in a Cloud Computing Arrangement We prospectively adopted the new standard related to customers accounting for implementation costs incurred in a cloud computing arrangement that is considered a service contract. The new guidance aligns the requirements for capitalizing implementation costs in such arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The adoption of this guidance did not have a material impact on our consolidated financial statements. Collaboration Agreements We prospectively adopted the new standard, which provides guidance clarifying the interaction between the accounting for collaborative arrangements and revenue from contracts with customers. There was no impact to our consolidated financial statements from the adoption of this new standard. C. Estimates and Assumptions In preparing these financial statements, we use certain estimates and assumptions that affect reported amounts and disclosures. These estimates and assumptions can impact all elements of our financial statements. For example, in the consolidated statements of income, estimates are used when accounting for deductions from revenues, determining the cost of inventory that is sold, allocating cost in the form of depreciation and amortization, and estimating restructuring charges and the impact of contingencies, as well as determining provisions for taxes on income. On the consolidated balance sheets, estimates are used in determining the valuation and recoverability of assets, and in determining the reported amounts of liabilities, all of which also impact the consolidated statements of income. Certain estimates of fair value and amounts recorded in connection with acquisitions, revenue deductions, impairment reviews, restructuring-associated charges, investments and financial instruments, valuation allowances, pension and postretirement benefit plans, contingencies, share-based compensation, and other calculations can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. Our estimates are often based on complex judgments and assumptions that we believe to be reasonable, but that can be inherently uncertain and unpredictable. If our estimates and assumptions are not representative of actual outcomes, our results could be materially impacted. As future events and their effects cannot be determined with precision, our estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. We are subject to risks and uncertainties that may cause actual results to differ from estimated amounts, such as changes in the healthcare environment, competition, litigation, legislation and regulations. We regularly evaluate our estimates and assumptions using historical experience and expectations about the future. We adjust our estimates and assumptions when facts and circumstances indicate the need for change. D. Acquisitions Our consolidated financial statements include the operations of acquired businesses after the completion of the acquisitions. We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date and that the fair value of acquired IPRD be recorded on the balance sheet. Transaction costs are expensed as incurred. Any excess of the consideration transferred over the assigned values of the net assets acquired is recorded as goodwill. When we acquire net assets that do not constitute a business, as defined in U.S. GAAP, no goodwill is recognized and acquired IPRD is expensed. Contingent consideration in a business combination is included as part of the acquisition cost and is recognized at fair value as of the acquisition date. Fair value is generally estimated by using a probability-weighted discounted cash flow approach. See Note 16D . Any liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. These changes in fair value are recognized in earnings in Other (income)/deductionsnet . E. Fair Value We measure certain assets and liabilities at fair value, either upon initial recognition or for subsequent accounting or reporting. We estimate fair value using an exit price approach, which requires, among other things, that we determine the price that would be received to sell an asset or paid to transfer a liability in an orderly market. The determination of an exit price is considered from the perspective of market participants, considering the highest and best use of non-financial assets and, for liabilities, assuming that the risk of non-performance will be the same before and after the transfer. When estimating fair value, depending on the nature and complexity of the asset or liability, we may use one or all of the following techniques: Income approach, which is based on the present value of a future stream of net cash flows. Market approach, which is based on market prices and other information from market transactions involving identical or comparable assets or liabilities. Cost approach, which is based on the cost to acquire or construct comparable assets, less an allowance for functional and/or economic obsolescence. Our fair value methodologies depend on the following types of inputs: Quoted prices for identical assets or liabilities in active markets (Level 1 inputs). Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are directly or indirectly observable, or inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (Level 2 inputs). Unobservable inputs that reflect estimates and assumptions (Level 3 inputs). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following inputs and valuation techniques are used to estimate the fair value of our financial assets and liabilities: Available-for-sale debt securitiesthird-party matrix-pricing model that uses significant inputs derived from or corroborated by observable market data and credit-adjusted yield curves. Equity securities with readily determinable fair valuesquoted market prices and observable NAV prices. Derivative assets and liabilitiesthird-party matrix-pricing model that uses inputs derived from or corroborated by observable market data. Where applicable, these models use market-based observable inputs, including interest rate yield curves to discount future cash flow amounts, and forward and spot prices for currencies. The credit risk impact to our derivative financial instruments was not significant. Money market fundsobservable NAV prices. We periodically review the methodologies, inputs and outputs of third-party pricing services for reasonableness. Our procedures can include, for example, referencing other third-party pricing models, monitoring key observable inputs (like benchmark interest rates) and selectively performing test-comparisons of values with actual sales of financial instruments. F. Foreign Currency Translation For most of our international operations, local currencies have been determined to be the functional currencies. We translate functional currency assets and liabilities to their U.S. dollar equivalents at exchange rates in effect as of the balance sheet date and income and expense amounts at average exchange rates for the period. The U.S. dollar effects that arise from changing translation rates are recorded in Other comprehensive income/(loss) . The effects of converting non-functional currency monetary assets and liabilities into the functional currency are recorded in Other (income)/deductionsnet . For operations in highly inflationary economies, we translate monetary items at rates in effect as of the balance sheet date, with translation adjustments recorded in Other (income)/deductionsnet , and we translate non-monetary items at historical rates. G . Revenues and Trade Accounts Receivable Revenue Recognition We record revenues from product sales when there is a transfer of control of the product from us to the customer. We determine transfer of control based on when the product is shipped or delivered and title passes to the customer. Our Sales Contracts Sales on credit are typically under short-term contracts. Collections are based on market payment cycles common in various markets, with shorter cycles in the U.S. Sales are adjusted for sales allowances, chargebacks, rebates and sales returns and cash discounts. Sales returns occur due to LOE, product recalls or a changing competitive environment. Deductions from Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment is required when estimating the impact of these revenue deductions on gross sales for a reporting period. Provisions for pharmaceutical sales returns Provisions are based on a calculation for each market that incorporates the following, as appropriate: local returns policies and practices; historical returns as a percentage of sales; an understanding of the reasons for past returns; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, such as LOE, product recalls or a changing competitive environment. Generally, returned products are destroyed, and customers are refunded the sales price in the form of a credit. We record sales incentives as a reduction of revenues at the time the related revenues are recorded or when the incentive is offered, whichever is later. We estimate the cost of our sales incentives based on our historical experience with similar incentives programs to predict customer behavior. The following outlines our common sales arrangements: Customers Our biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Customers for our consumer healthcare business, which were part of the business that was combined with GSKs Consumer Healthcare business included retailers and, to a lesser extent, wholesalers and distributors. Biopharmaceutical products that ultimately are used by patients are generally covered under governmental programs, managed care programs and insurance programs, including those managed through PBMs, and are subject to sales allowances and/or rebates payable directly to those programs. Those sales allowances and rebates are generally negotiated, but government programs may have legislated amounts by type of product (e.g., patented or unpatented). Specifically: In the U.S., we sell our products principally to distributors and hospitals. We also have contracts with managed care programs or PBMs and legislatively mandated contracts with the federal and state governments under which we provide rebates based on medicines utilized by the lives they cover. We record provisions for Medicare, Medicaid, and performance-based contract pharmaceutical rebates based upon our experience ratio of rebates paid and actual prescriptions written during prior periods. We apply the experience ratio to the respective periods sales to determine the rebate accrual and related expense. This experience ratio is evaluated regularly to ensure that the historical trends are as current as practicable. We estimate discounts on branded prescription drug sales to Medicare Part D participants in the Medicare coverage gap, also known as the doughnut hole, based on the historical experience of beneficiary prescriptions and consideration of the utilization that is expected to result from the discount in the coverage gap. We evaluate this estimate regularly to ensure that the historical trends and future expectations are as current as practicable. For performance-based contract rebates, we also consider current contract terms, such as changes in formulary status and rebate rates. Outside the U.S., the majority of our pharmaceutical sales allowances are contractual or legislatively mandated and our estimates are based on actual invoiced sales within each period, which reduces the risk of variations in the estimation process. In certain European countries, Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies rebates are calculated on the governments total unbudgeted pharmaceutical spending or on specific product sales thresholds and we apply an estimated allocation factor against our actual invoiced sales to project the expected level of reimbursement. We obtain third-party information that helps us to monitor the adequacy of these accruals. Provisions for pharmaceutical chargebacks (primarily reimbursements to U.S. wholesalers for honoring contracted prices to third parties) closely approximate actual amounts incurred, as we settle these deductions generally within two to five weeks of incurring the liability. We recorded direct product sales and/or alliance revenues of more than $ 1 billion for each of seven products in 2020, for each of six products in 2019 and for each of seven products in 2018. In the aggregate, these direct products sales and/or alliance product revenues represent 53 % of our revenues in 2020, 49 % of our revenues in 2019 and 47 % of our revenues in 2018. See Note 17B for additional information. The loss or expiration of intellectual property rights can have a significant adverse effect on our revenues as our contracts with customers will generally be at lower selling prices due to added competition and we generally provide for higher sales returns during the period in which individual markets begin to near the loss or expiration of intellectual property rights. Our accruals for Medicare, Medicaid and related state program and performance-based contract rebates, chargebacks, sales allowances and sales returns and cash discounts are as follows: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Reserve against Trade accounts receivable, less allowance for doubtful accounts $ 861 $ 823 Other current liabilities : Accrued rebates 3,017 2,512 Other accruals 436 379 Other noncurrent liabilities 399 384 Total accrued rebates and other sales-related accruals $ 4,712 $ 4,098 Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenues . Trade Accounts Receivable Trade accounts receivable are stated at their net realizable value. The allowance for credit losses reflects our best estimate of expected credit losses of the receivables portfolio determined on the basis of historical experience, current information, and forecasts of future economic conditions. In developing the estimate for expected credit losses, trade accounts receivables are segmented into pools of assets depending on market (U.S. versus international), delinquency status, and customer type (high risk versus low risk and government versus non-government), and fixed reserve percentages are established for each pool of trade accounts receivables. In determining the reserve percentages for each pool of trade accounts receivables, we considered our historical experience with certain customers and customer types, regulatory and legal environments, country and political risk, and other relevant current and future forecasted macroeconomic factors. These credit risk indicators are monitored on a quarterly basis to determine whether there have been any changes in the economic environment that would indicate the established reserve percentages should be adjusted, and are considered on a regional basis to reflect more geographic-specific metrics. Additionally, write-offs and recoveries of customer receivables are tracked against collections on a quarterly basis to determine whether the reserve percentages remain appropriate. When management becomes aware of certain customer-specific factors that impact credit risk, specific allowances for these known troubled accounts are recorded. Trade accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. During 2020, additions to the allowance for credit losses, write-offs and recoveries of customer receivables were not material to our consolidated financial statements. H. Collaborative Arrangements Payments to and from our collaboration partners are presented in our consolidated statements of income based on the nature of the arrangement (including its contractual terms), the nature of the payments and applicable accounting guidance. Under co-promotion agreements, we record the amounts received for our share of gross profits from our collaboration partners as alliance revenues, a component of Revenues, when our collaboration partners are the principal in the transaction and we receive a share of their net sales or profits. Alliance revenues are recorded as we perform co-promotion activities for the collaboration and the collaboration partners sell the products to their customers. The related expenses for selling and marketing these products including reimbursements to or from our collaboration partners for these costs are included in Selling, informational and administrative expenses. In collaborative arrangements where we manufacture a product for our collaboration partners, we record revenues when we transfer control of the product to our collaboration partners. In collaboration arrangements where we are the principal in the transaction, we record amounts paid to collaboration partners for their share of net sales or profits earned, and all royalty payments to collaboration partners as Cost of sales . Royalty payments received from collaboration partners are included in Other (income)/deductionsnet. Reimbursements to or from our collaboration partners for development costs are recorded in Research and development expenses . Upfront payments and pre-approval milestone payments due from us to our collaboration partners in development stage collaborations are recorded as Research and development expenses . Milestone payments due from us to our collaboration partners after regulatory approval has been attained for a medicine are recorded in Identifiable intangible assetsDeveloped technology rights . Upfront and pre-approval milestone payments earned from our collaboration partners by us are recognized in Other (income)/deductionsnet over the development period for the products, when our performance obligations include providing RD services to our collaboration partners. Upfront, pre-approval and post-approval milestone payments earned by us may be recognized in Other (income)/deductionsnet immediately when earned or over other periods depending upon the nature of our performance obligations in the applicable collaboration. Where the milestone event is regulatory approval for a medicine, we generally recognize milestone payments due to us in the transaction price when regulatory approval in the applicable jurisdiction has been attained. We may recognize milestone payments due to us in the transaction price earlier than the milestone event in certain circumstances when recognition of the income would not be probable of a significant reversal. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies I. Cost of Sales and Inventories Inventories are recorded at the lower of cost or net realizable value. The cost of finished goods, work in process and raw materials is determined using average actual cost. We regularly review our inventories for impairment and reserves are established when necessary. J. Selling, Informational and Administrative Expenses Selling, informational and administrative costs are expensed as incurred. Among other things, these expenses include the internal and external costs of marketing, advertising, shipping and handling, information technology and legal defense. Advertising expenses totaled approximately $ 1.8 billion in 2020, $ 2.4 billion in 2019 and $ 2.7 billion in 2018. Production costs are expensed as incurred and the costs of TV, radio, and other electronic media and publications are expensed when the related advertising occurs. K. Research and Development Expenses RD costs are expensed as incurred. These expenses include the costs of our proprietary RD efforts, as well as costs incurred in connection with certain licensing arrangements. Before a compound receives regulatory approval, we record upfront and milestone payments we make to third parties under licensing arrangements as expense. Upfront payments are recorded when incurred, and milestone payments are recorded when the specific milestone has been achieved. Once a compound receives regulatory approval, we record any milestone payments in Identifiable intangible assets, less accumulated amortization and, unless the asset is determined to have an indefinite life, we amortize the payments on a straight-line basis over the remaining agreement term or the expected product life cycle, whichever is shorter. L. Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets Long-lived assets include: Property, plant and equipment, less accumulated depreciationThese assets are recorded at cost, including any significant improvements after purchase, less accumulated depreciation. Property, plant and equipment assets, other than land and construction in progress, are depreciated on a straight-line basis over the estimated useful life of the individual assets. Depreciation begins when the asset is ready for its intended use. For tax purposes, accelerated depreciation methods are used as allowed by tax laws. Identifiable intangible assets, less accumulated amortization These assets are recorded at fair value at acquisition. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite lives are not amortized until a useful life can be determined. Goodwill Goodwill represents the excess of the consideration transferred for an acquired business over the assigned values of its net assets. Goodwill is not amortized. Amortization of finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as these intangible assets benefit multiple business functions. Amortization of intangible assets that are for a single function and depreciation of property, plant and equipment are included in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses, as appropriate. We review our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Specifically: For finite-lived intangible assets, such as developed technology rights, and for other long-lived assets, such as property, plant and equipment, whenever impairment indicators are present, we calculate the undiscounted value of the projected cash flows for the asset, or asset group, and compare this estimated amount to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. In addition, in all cases of an impairment review, we reevaluate the remaining useful lives of the assets and modify them, as appropriate. For indefinite-lived intangible assets, such as Brands and IPRD assets, when necessary, we determine the fair value of the asset and record an impairment loss, if any, for the excess of book value over fair value. In addition, in all cases of an impairment review other than for IPRD assets, we re-evaluate whether continuing to characterize the asset as indefinite-lived is appropriate. For goodwill, when necessary, we determine the fair value of each reporting unit and record an impairment loss, if any, for the excess of the book value of the reporting unit over the implied fair value. M. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives We may incur restructuring charges in connection with acquisitions when we implement plans to restructure and integrate the acquired operations or in connection with our cost-reduction and productivity initiatives. In connection with acquisition activity, we typically incur costs associated with executing the transactions, integrating the acquired operations (which may include expenditures for consulting and the integration of systems and processes), and restructuring the combined company (which may include charges related to employees, assets and activities that will not continue in the combined company); and In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges for site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. Included in Restructuring charges and certain acquisition-related costs are all restructuring charges, as well as certain other costs associated with acquiring and integrating an acquired business. If the restructuring action results in a change in the estimated useful life of an asset, that incremental impact is classified in Cost of sales, Selling, informational and administrative expenses and/or Research and development Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies expenses , as appropriate. Employee termination costs are generally recorded when the actions are probable and estimable and include accrued severance benefits, pension and postretirement benefits, many of which may be paid out during periods after termination. Transaction costs, such as banking, legal, accounting and other similar costs incurred in connection with a business acquisition are expensed as incurred . Our business and platform functions may be impacted by these actions, including sales and marketing, manufacturing and RD, as well as our corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement). N. Cash Equivalents and Statement of Cash Flows Cash equivalents include items almost as liquid as cash, such as certificates of deposit and time deposits with maturity periods of three months or less when purchased. If items meeting this definition are part of a larger investment pool, we classify them as Short-term investments . Cash flows for financial instruments designated as fair value or cash flow hedges may be included in operating, investing or financing activities, depending on the classification of the items being hedged. Cash flows for financial instruments designated as net investment hedges are classified according to the nature of the hedge instrument. Cash flows for financial instruments that do not qualify for hedge accounting treatment are classified according to their purpose and accounting nature. O. Investments and Derivative Financial Instruments The classification of an investment depends on the nature of the investment, our intent and ability to hold the investment, and the degree to which we may exercise influence. Our investments are primarily comprised of the following: Public equity securities with readily determinable fair values, which are carried at fair value, with changes in fair value reported in Other (income)/deductionsnet. Available-for-sale debt securities, which are carried at fair value, with changes in fair value reported in Other comprehensive income/(loss) until realized. Held-to-maturity debt securities, which are carried at amortized cost. Private equity securities without readily determinable fair values and where we have no significant influence are measured at cost minus any impairment and plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. For equity investments in common stock or in-substance common stock where we have significant influence over the financial and operating policies of the investee, we use the equity-method of accounting. Under the equity-method, we record our share of the investees income and expenses in Other (income)/deductionsnet . The excess of the cost of the investment over our share of the underlying equity in the net assets of the investee as of the acquisition date is allocated to the identifiable assets and liabilities of the investee, with any remaining excess amount allocated to goodwill. Such investments are initially recorded at cost, which is the fair value of consideration paid and typically does not include contingent consideration. Realized gains or losses on sales of investments are determined by using the specific identification cost method. We regularly evaluate all of our financial assets for impairment. For investments in debt and equity, when a decline in fair value, if any, is determined, an impairment charge is recorded and a new cost basis in the investment is established. Derivative financial instruments are carried at fair value in various balance sheet categories (see Note 7A ), with changes in fair value reported in Net income or, for derivative financial instruments in certain qualifying hedging relationships, in Other comprehensive income/(loss) (see Note 7E ). P . Tax Assets and Liabilities and Income Tax Contingencies Tax Assets and Liabilities Current tax assets primarily includes (i) tax effects for intercompany transfers of inventory within our combined group, which are recognized in the consolidated statements of income when the inventory is sold to a third party and (ii) income tax receivables that are expected to be recovered either via refunds from taxing authorities or reductions to future tax obligations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws. We provide a valuation allowance when we believe that our deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax-planning strategies, that would be implemented, if necessary, to realize the deferred tax assets. Amounts recorded for valuation allowances requires judgments about future income which can depend heavily on estimates and assumptions. All deferred tax assets and liabilities within the same tax jurisdiction are presented as a net amount in the noncurrent section of our consolidated balance sheet. Other non-current tax assets primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Other taxes payable as of December 31, 2020 and 2019 include liabilities for uncertain tax positions and the noncurrent portion of the repatriation tax liability for which we elected payment over eight years through 2026. For additional information, see Note 5D for uncertain tax positions and Note 5A for the repatriation tax liability and other estimates and assumptions in connection with the TCJA. Income Tax Contingencies We account for income tax contingencies using a benefit recognition model. If we consider that a tax position is more likely than not to be sustained upon audit, based solely on the technical merits of the position, we recognize all or a portion of the benefit. We measure the benefit by determining the amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the taxing authority with full knowledge of all relevant information. We regularly monitor our position and subsequently recognize the unrecognized tax benefit: (i) if there are changes in tax law, analogous case law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) if the statute of limitations expires; or (iii) if there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. Liabilities for uncertain tax positions are classified as current only when we expect to pay cash within the next 12 months. Interest and penalties, if any, are recorded in Provision/(benefit) for taxes on income and are classified on our consolidated balance sheet with the related tax liability. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Q. Pension and Postretirement Benefit Plans The majority of our employees worldwide are covered by defined benefit pension plans, defined contribution plans or both. In the U.S., we have both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans, as well as other postretirement benefit plans consisting primarily of medical insurance for retirees and their eligible dependents. We recognize the overfunded or underfunded status of each of our defined benefit plans as an asset or liability. The obligations are generally measured at the actuarial present value of all benefits attributable to employee service rendered, as provided by the applicable benefit formula. Our pension and other postretirement obligations may be determined using assumptions such as discount rate, expected annual rate of return on plan assets, expected employee turnover and participant mortality. For our pension plans, the obligation may also include assumptions as to future compensation levels. For our other postretirement benefit plans, the obligation may include assumptions as to the expected cost of providing medical insurance benefits, as well as the extent to which those costs are shared with the employee or others (such as governmental programs). Plan assets are measured at fair value. Net periodic pension and postretirement benefit costs other than the service costs are recognized in Other (income)/deductionsnet . R. Legal and Environmental Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, such as patent litigation, product liability and other product-related litigation, commercial litigation, environmental claims and proceedings, government investigations and guarantees and indemnifications. We record accruals for these contingencies to the extent that we conclude that a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, we accrue that amount. Alternatively, when no amount within a range of loss appears to be a better estimate than any other amount, we accrue the lowest amount in the range. We record anticipated recoveries under existing insurance contracts when recovery is assured. S. Share-Based Payments Our compensation programs can include share-based payments. Generally, grants under share-based payment programs are accounted for at fair value and these fair values are generally amortized on a straight-line basis over the vesting terms with the related costs recorded in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Note 2. Acquisitions, Divestitures, Equity-Method Investments, Licensing Arrangements and Collaborative Arrangements A. Acquisitions Array On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $ 48 per share in cash. The total fair value of the consideration transferred was $ 11.2 billion ($ 10.9 billion, net of cash acquired). In addition, $ 157 million in payments to Array employees for the fair value of previously unvested stock options was recognized as post-closing compensation expense and recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). We financed the majority of the transaction with debt and the balance with existing cash. Arrays portfolio includes Braftovi (encorafenib) and Mektovi (binimetinib), a broad pipeline of targeted cancer medicines in different stages of RD, as well as a portfolio of out-licensed medicines, which may generate milestones and royalties over time. The final allocation of the consideration transferred to the assets acquired and the liabilities assumed was completed in 2020. In connection with this acquisition, we recorded: (i) $ 6.3 billion in Identifiable intangible assets , consisting of $ 2.0 billion of Developed technology rights with Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies a useful life of 16 years , $ 2.8 billion of IPRD and $ 1.5 billion of Licensing agreements ($ 1.2 billion for technology in development indefinite-lived licensing agreements and $ 360 million for developed technology finite-lived licensing agreements with a useful life of 10 years), (ii) $ 6.1 billion of Goodwill , (iii) $ 1.1 billion of net deferred tax liabilities and (iv) $ 451 million of assumed long-term debt, which was paid in full in 2019. In 2020, we recorded measurement period adjustments to the estimated fair values initially recorded in 2019, which resulted in a reduction in Identifiable intangible assets of approximately $ 900 million with a corresponding change to Goodwill and net deferred tax liabilities. The measurement period adjustments were recorded to better reflect market participant assumptions about facts and circumstances existing as of the acquisition date and did not have a material impact on our consolidated statement of income for the year ended December 31, 2020. Therachon On July 1, 2019, we acquired all the remaining shares of Therachon, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $ 340 million upfront, plus potential milestone payments of up to $ 470 million contingent on the achievement of key milestones in the development and commercialization of the lead asset. In 2018, we acquired approximately 3 % of Therachons outstanding shares for $ 5 million. We accounted for the transaction as an asset acquisition since the lead asset represented substantially all the fair value of the gross assets acquired. The total fair value of the consideration transferred for Therachon was $ 322 million, which consisted of $ 317 million of cash and our previous $ 5 million investment in Therachon. In connection with this asset acquisition, we recorded a charge of $ 337 million in Research and development expenses. B . Divestitures Upjohn Separation and Combination with Mylan On November 16, 2020, we completed the spin-off and the combination of the Upjohn Business with Mylan (the Transactions) to form Viatris. The Transactions were structured as an all-stock, Reverse Morris Trust transaction. Specifically, (i) we contributed the Upjohn Business to a wholly owned subsidiary, which was renamed Viatris, so that the Upjohn Business was separated from the remainder of our business (the Separation), (ii) following the Separation, we distributed, on a pro rata basis, all of the shares of Viatris common stock held by Pfizer to Pfizer stockholders as of the November 13, 2020 record date, such that each Pfizer stockholder as of the record date received approximately 0.124079 shares of Viatris common stock per share of Pfizer common stock (the Distribution); and (iii) immediately after the Distribution, the Upjohn Business combined with Mylan in a series of transactions in which Mylan shareholders received one share of Viatris common stock for each Mylan ordinary share held by such shareholder, subject to any applicable withholding taxes (the Combination). Prior to the Distribution, Viatris made a cash payment to Pfizer equal to $ 12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris. As of the closing of the Combination, Pfizer stockholders owned approximately 57 % of the outstanding shares of Viatris common stock, and Mylan shareholders owned approximately 43 % of the outstanding shares of Viatris common stock, in each case on a fully diluted, as-converted and as-exercised basis. The Transactions are generally expected to be tax free to Pfizer and Pfizer stockholders for U.S. tax purposes. Beginning November 16, 2020, Viatris operates both the Upjohn Business and Mylan as an independent publicly traded company, which is traded under the symbol VTRS on the NASDAQ. In connection with the Transactions, in June 2020, Upjohn Inc. and Upjohn Finance B.V. completed privately placed debt offerings of $ 7.45 billion and 3.60 billion aggregate principal amounts, respectively, (approximately $ 11.4 billion) of senior unsecured notes and entered into other financing arrangements, including a $ 600 million delayed draw term loan agreement and a revolving credit facility agreement for up to $ 4.0 billion. Proceeds from the debt offerings and other financing arrangements were used to fund the $ 12.0 billion cash distribution Viatris made to Pfizer prior to the Distribution. We used the cash distribution proceeds to pay down commercial paper borrowings and redeem the $ 1.15 billion aggregate principal amount outstanding of our 1.95 % senior unsecured notes that were due in June 2021 and $ 342 million aggregate principal amount outstanding of our 5.80 % senior unsecured notes that were due in August 2023, before the maturity date. Interest expense for the $ 11.4 billion in debt securities incurred during 2020 is included in Income from discontinued operationsnet of tax . Following the Separation and Combination of the Upjohn Business with Mylan, we are no longer the obligor or guarantor of any Upjohn debt or Upjohn financing arrangements. As a result of the separation of Upjohn, we incurred separation-related costs of $ 434 million in 2020 and $ 83 million in 2019, which are included in Income from discontinued operationsnet of tax . These costs primarily relate to professional fees for regulatory filings and separation activities within finance, tax, legal and information system functions as well as investment banking fees. In connection with the Transactions, Pfizer and Viatris entered into various agreements to effect the Separation and Combination to provide a framework for our relationship after the Combination, including a separation and distribution agreement, manufacturing and supply agreements (MSAs), transition service agreements (TSAs), a tax matters agreement, and an employee matters agreement, among others. Under the MSAs, Pfizer or Viatris, as the case may be, manufactures, labels, and packages products for the other party. The terms of the MSAs range in initial duration from 4 to 7 years post-Separation. The TSAs primarily involve Pfizer providing services to Viatris related to finance, information technology and human resource infrastructure and are generally expected to be for terms of no more than 3 years post-Separation. In addition, we are also party to various commercial agreements with Viatris. The amounts billed for net manufacturing supply and transition services provided under the above agreements as well as sales to and purchases from Viatris are not material to our results of continuing operations in 2020. Included in our consolidated balance sheet as of December 31, 2020 are net amounts due from Viatris primarily related to various interim agency operating models and transitional services, partially offset by net amounts due to Viatris for unsettled intercompany balances as of the closing date of the spin-off, transaction-related indemnifications and a contractual cash payment pursuant to terms of the separation and distribution agreement, totaling approximately $ 401 million. The interim agency operating model primarily includes billings, collections and remittance of rebates that we are performing on a transitional basis on behalf of Viatris. The operating results of the Upjohn Business are reported as Income from discontinued operationsnet of tax through November 16, 2020, the date of the spin-off and combination with Mylan. In addition, as of December 31, 2019, the assets and liabilities associated with this business are classified as assets and liabilities of discontinued operations. Prior-period financial information has been restated, as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Components of Income from discontinued operationsnet of tax: Year Ended December 31, (a) (MILLIONS OF DOLLARS) 2020 2019 2018 Revenues $ 7,314 $ 10,578 $ 12,822 Costs and expenses: Cost of sales 1,899 1,976 2,261 Selling, informational and administrative expenses 1,665 1,599 1,842 Research and development expenses 212 255 246 Amortization of intangible assets 136 148 157 Restructuring charges and certain acquisition-related costs 7 146 ( 14 ) Other (income)/deductionsnet 400 253 30 Pre-tax income from discontinued operations 2,995 6,201 8,300 Provision for taxes on income 364 766 973 Income from discontinued operationsnet of tax $ 2,631 $ 5,435 $ 7,328 (a) Virtually all Income from discontinued operations net of tax relates to the Upjohn Business and the Mylan-Japan collaboration in all periods presented. Components of assets and liabilities of discontinued operations and other assets held for sale: As of December 31, (a) (MILLIONS OF DOLLARS) 2020 2019 Cash and cash equivalents $ $ 184 Trade accounts receivable, less allowance for doubtful accounts 1,952 Inventories 86 1,215 Other current assets 852 Other assets held for sale 82 21 Current assets of discontinued operations and other assets held for sale $ 167 $ 4,224 Property, plant and equipment $ $ 998 Identifiable intangible assets 1,434 Goodwill 10,451 Other noncurrent assets 544 Noncurrent assets of discontinued operations $ $ 13,427 Trade accounts payable $ $ 334 Accrued compensation and related items 330 Other current liabilities 1,749 Current liabilities of discontinued operations $ $ 2,413 Pension and postretirement benefit obligations $ $ 545 Other noncurrent liabilities 403 Noncurrent liabilities of discontinued operations (b) $ $ 948 (a) Amounts relate to discontinued operations of the Upjohn Business and the Mylan-Japan collaboration, except for amounts in Other assets held for sale, which represent unrelated property, plant and equipment held for sale. (b) Included in Other noncurrent liabilities . As a result of the spin-off of the Upjohn Business, we distributed net assets of $ 1.9 billion as of November 16, 2020, which has been reflected as a reduction to Retained earnings . Of this amount, $ 412 million represents cash transferred to the Upjohn Business, with the remainder considered a non-cash activity in the consolidated statement of cash flows for the year ended December 31, 2020. The spin-off also resulted in a net increase to Accumulated other comprehensive loss of $ 71 million for the derecognition of net gains on foreign currency translation adjustments of $ 397 million and actuarial losses net of prior service credits associated with benefit plans of $ 326 million, which were reclassified to Retained earnings . Contribution Agreement Between Pfizer and Allogene In April 2018, Pfizer and Allogene announced that the two companies entered into a contribution agreement for Pfizers portfolio of assets related to allogeneic CAR T therapy, an investigational immune cell therapy approach to treating cancer. Under this agreement, we received an equity investment in Allogene and Allogene received our rights to pre-clinical and clinical CAR T assets, all of which were previously licensed to us from French cell therapy company, Cellectis, beginning in 2014 and French pharmaceutical company, Servier, beginning in 2015. Allogene assumed responsibility for all potential financial obligations to both Cellectis and Servier. In connection with the Allogene transaction, we recognized a non-cash $ 50 million pre-tax gain in Other (income)/deductionsnet in the second quarter of 2018 , representing the difference between the $ 127 million fair value of the equity investment received and the book value of assets transferred (including an allocation of goodwill) (see Note 4 ). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies As of December 31, 2020, we held a 15.7 % equity stake in Allogene, and our investment in Allogene is being measured at fair value with changes in fair value recognized in net income. Sale of Phase 2b Ready AMPA Receptor Potentiator for CIAS to Biogen In April 2018, we sold our Phase 2b ready AMPA receptor potentiator for CIAS to Biogen. We received $ 75 million upfront which was recognized in Other (income)/deductionsnet (see Note 4 ) and may receive up to $ 515 million in total development and commercialization milestones, as well as tiered royalties in the low-to-mid-teen percentages. Divestiture of Neuroscience Assets In September 2018, we and Bain Capital entered into a transaction to create a new biopharmaceutical company, Cerevel (formerly known as Cerevel Therapeutics, LLC), to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system including Parkinsons disease, epilepsy, Alzheimers disease, schizophrenia and addiction. In connection with this transaction, we out-licensed the portfolio to Cerevel in exchange for a 25 % ownership stake in Cerevels parent company, Cerevel Therapeutics, Inc., and potential future regulatory and commercial milestone payments and royalties. In connection with the transaction, we recognized a non-cash $ 343 million pre-tax gain in Other (income)/deductionsnet in the third quarter of 2018, representing the fair value of the equity investment received as the assets transferred had a book value of $ 0 (see Note 4 ). On October 27, 2020, Cerevel Therapeutics, Inc. completed a merger with ARYA Sciences Acquisition Corp II, a publicly-traded special purpose acquisition corporation, and a concurrent private investment in public equity PIPE transaction to form Cerevel Therapeutics Holdings, Inc. Our existing shares in Cerevel Therapeutics, Inc. converted into common shares of Cerevel Therapeutics Holdings, Inc. as part of the merger transaction, and we purchased an additional $ 12 million in common shares as part of the PIPE transaction. The common shares of Cerevel Therapeutics Holdings, Inc. trade publicly on the NASDAQ stock market (ticker symbol CERE). As of December 31, 2020, we continue to hold a 21.5 % equity stake in Cerevel Therapeutics Holdings, Inc. for which we have elected the fair value option and which we measure at fair value with changes in fair value recognized in net income. In the fourth quarter of 2020, we remeasured our investment based on the market price of Cerevel Therapeutics Holdings, Inc. common shares as of December 31, 2020 less a discount for lack of marketability, and we recognized a gain of $ 20 million in Other income/(deductions)net. C. Equity-Method Investments Formation of Consumer Healthcare JV On July 31, 2019, we completed a transaction in which we and GSK combined our respective consumer healthcare businesses into a new JV that operates globally under the GSK Consumer Healthcare name. In exchange, we received a 32 % equity stake in the new company and GSK owns the remaining 68 %. Upon closing, we deconsolidated our Consumer Healthcare business and recognized a pre-tax gain of $ 8.1 billion ($ 5.4 billion, net of tax) in the third quarter of 2019 in (Gain) on completion of Consumer Healthcare JV transaction for the difference in the fair value of our 32 % equity stake and the carrying value of our Consumer Healthcare business. Our financial results and our Consumer Healthcare segments operating results for 2019 reflect seven months of Consumer Healthcare segment domestic operations and eight months of Consumer Healthcare segment international operations. The financial results for 2020 do not reflect any contribution from the Consumer Healthcare business. In valuing our investment in the Consumer Healthcare JV, we used discounted cash flow techniques. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which include the expected impact of competitive, legal or regulatory forces on the products; the long-term growth rate, which seeks to project the sustainable growth rate over the long term; the discount rate, which seeks to reflect our best estimate of the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. We are accounting for our interest in the Consumer Healthcare JV as an equity-method investment. The carrying value of our investment in the Consumer Healthcare JV is $ 16.7 billion as of December 31, 2020 and $ 17.0 billion as of December 31, 2019 and is reported as a private equity investment in Equity-method investments as of December 31, 2020 and 2019. The Consumer Healthcare JV is a foreign investee whose reporting currency is the U.K. pound, and therefore we translate its financial statements into U.S. dollars and recognize the impact of foreign currency translation adjustments in the carrying value of our investment and in other comprehensive income. The decrease in the value of our investment from December 31, 2019 to December 31, 2020 is primarily due to dividends of $ 932 million, which were received from the Consumer Healthcare JV in June, September and November 2020, largely offset by our share of the JVs earnings of $ 417 million and $ 345 million in pre-tax foreign currency translation adjustments (see Note 6 ). We record our share of earnings from the Consumer Healthcare JV on a quarterly basis on a one-quarter lag in Other (income)/deductionsnet commencing from August 1, 2019. Our total share of the JVs earnings generated in the fourth quarter of 2019 and the first nine months of 2020, which we recorded in our operating results in 2020, was $ 417 million. Our total share of two months of the JVs earnings generated in the third quarter of 2019, which we recorded in our operating results in the fourth quarter of 2019, was $ 47 million. As of the July 31, 2019 closing date, we estimated that the fair value of our investment in the Consumer Healthcare JV was $ 15.7 billion and that 32 % of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was $ 11.2 billion, resulting in an initial basis difference of approximately $ 4.5 billion. In the fourth quarter of 2019, we preliminarily completed the allocation of the basis difference, which resulted from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV, primarily to inventory, definite-lived intangible assets, indefinite-lived intangible assets, related deferred tax liabilities and equity method goodwill within the investment account. During the fourth quarter of 2019, the Consumer Healthcare JV revised the initial carrying value of the net assets of the JV and our 32 % share of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was reduced to $ 11.0 billion and our initial basis difference was increased to $ 4.8 billion. The adjustment was allocated to equity method goodwill within the investment account. We began recording the amortization of basis differences allocated to inventory, definite-lived intangible assets and related deferred tax liabilities in Other (income)/deductionsnet commencing August 1, 2019. During the third and fourth quarters of 2020, we recognized write-offs of a portion of our basis differences allocated to indefinite-lived and definite-lived intangible assets and related deferred tax liabilities for the divestiture of certain brands by the Consumer Healthcare JV during its second quarter of 2020. The total amortization and write-off of these basis differences for the fourth quarter of 2019 and the first nine months of 2020, which was included in Other (income)/deductions Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies net in 2020, was $ 119 million of expense. The amortization of basis differences for two months of the third quarter of 2019 totaling approximately $ 31 million is included in our operating results in the fourth quarter of 2019. See Note 4. Amortization of basis differences on inventory and related deferred tax liabilities was completely recognized by the second quarter of 2020. Basis differences on definite-lived intangible assets and related deferred tax liabilities are being amortized over the lives of the underlying assets, which range from 8 to 20 years. While we have received our full 32 % interest in the Consumer Healthcare JV as of the July 31, 2019 closing and transferred control of our Consumer Healthcare business to the Consumer Healthcare JV, the contribution of the business was not completed in certain non-U.S. jurisdictions due to temporary regulatory or operational constraints. In these jurisdictions, we have continued to operate the business for the net economic benefit of the Consumer Healthcare JV, and we are indemnified against risks associated with such operations in the interim period, subject to our obligations under the definitive transaction agreements. We expect the contribution in these jurisdictions to be completed by the second half of 2021. As such, we have treated these jurisdictions as sold for accounting purposes. In connection with the contribution, we entered into certain transitional agreements designed to facilitate the orderly transition of the business to the Consumer Healthcare JV. These agreements primarily relate to administrative services, which are generally to be provided for a period of up to 24 months after closing. We will also manufacture and supply certain consumer products for the Consumer Healthcare JV and the Consumer Healthcare JV will manufacture and supply certain retained Pfizer products for us after closing, generally for a term of up to six years . These agreements are not material to Pfizer. As a part of Pfizer, pre-tax income on a management basis for the Consumer Healthcare business was $ 654 million through July 31, 2019 and $ 977 million in 2018. Summarized financial information for our equity method investee, the Consumer Healthcare JV, as of and for the twelve months ending September 30, 2020, the most recent period available, and as of and for the two months ending September 30, 2019 is as follows: (MILLIONS OF DOLLARS) September 30, 2020 September 30, 2019 Current assets $ 6,614 $ 7,505 Noncurrent assets 38,361 38,575 Total assets $ 44,975 $ 46,081 Current liabilities $ 5,246 $ 5,241 Noncurrent liabilities 5,330 5,536 Total liabilities $ 10,576 $ 10,776 Equity attributable to shareholders $ 34,154 $ 35,199 Equity attributable to noncontrolling interests 245 105 Total net equity $ 34,400 $ 35,304 For the Twelve Months Ending For the Two Months Ending (MILLIONS OF DOLLARS) September 30, 2020 September 30, 2019 Net sales $ 12,720 $ 2,161 Cost of sales ( 5,439 ) ( 803 ) Gross profit $ 7,281 $ 1,358 Income from continuing operations 1,350 152 Net income 1,350 152 Income attributable to shareholders 1,307 148 Investment in ViiV In 2009, we and GSK created ViiV, which is focused on research, development and commercialization of human immunodeficiency virus (HIV) medicines. We own approximately 11.7 % of ViiV, and prior to 2016 we accounted for our investment under the equity method due to the significant influence that we have over the operations of ViiV through our board representation and minority veto rights. We suspended application of the equity method to our investment in ViiV in 2016 when the carrying value of our investment was reduced to zero due to the recognition of cumulative equity method losses and dividends. Since 2016, we have recognized dividends from ViiV as income in Other (income)/deductionsnet when earned, including dividends of $ 278 million in 2020, $ 220 million in 2019 and $ 253 million in 2018 (see Note 4 ). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summarized financial information for our equity method investee, ViiV, as of December 31, 2020 and 2019 and for the years ending December 31, 2020, 2019, and 2018 is as follows: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Current assets $ 3,283 $ 3,839 Noncurrent assets 3,381 3,437 Total assets $ 6,664 $ 7,276 Current liabilities $ 3,028 $ 2,904 Noncurrent liabilities 6,370 5,860 Total liabilities $ 9,398 $ 8,765 Total net equity/(deficit) attributable to shareholders $ ( 2,734 ) $ ( 1,489 ) Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Net sales $ 6,224 $ 6,139 $ 6,219 Cost of sales ( 574 ) ( 516 ) ( 462 ) Gross profit $ 5,650 $ 5,623 $ 5,757 Income from continuing operations 2,012 3,398 2,154 Net income 2,012 3,398 2,154 Income attributable to shareholders 2,012 3,398 2,154 D. Licensing Arrangements Agreement with Valneva 2 On April 30, 2020, we signed an agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, which covers six serotypes that are prevalent in North America and Europe. Valneva and Pfizer will work closely together throughout the development of VLA15. Valneva is eligible to receive a total of up to $ 308 million in cash payments from us consisting of a $ 130 million upfront payment, which was paid and recorded in Research and development expenses in our second quarter of 2020, as well as $ 35 million in development milestones and $ 143 million in early commercialization milestones. Under the terms of the agreement, Valneva will fund 30 % of all development costs through completion of the development program, and in return we will pay Valneva tiered royalties. We will lead late-stage development and have sole control over commercialization. Agreement with BioNTech In August 2018, a multi-year RD arrangement went into effect between BioNTech and Pfizer to develop mRNA-based vaccines for prevention of influenza (flu). In relation to this RD arrangement, in September 2018, we made an upfront payment of $ 50 million to BioNTech, which was recorded in Research and development expenses, and BioNTech became eligible to receive up to $ 325 million in development and sales-based milestones and royalty payments associated with worldwide sales. As part of the transaction, we also purchased 169,670 newly-issued ordinary shares of BioNTech for $ 50 million in the third quarter of 2018. Akcea On October 4, 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a wholly-owned subsidiary of Ionis. The transaction closed in November 2019 and we made an upfront payment of $ 250 million to Akcea, which was recorded in Research and development expenses in our fourth quarter of 2019. We may be required to make development, regulatory and sales milestone payments of up to $ 1.3 billion and pay tiered, double-digit royalties on annual worldwide net sales upon marketing approval of AKCEA-ANGPTL3-LRx. E. Collaborative Arrangements In the normal course of business, we enter into collaborative arrangements with respect to in-line medicines, as well as medicines in development that require completion of research and regulatory approval. Collaborative arrangements are contractual agreements with third parties that involve a joint operating activity, typically a research and/or commercialization effort, where both we and our partner are active participants in the activity and are exposed to the significant risks and rewards of the activity. Our rights and obligations under our collaborative arrangements vary. For example, we have agreements to co-promote pharmaceutical products discovered by us or other companies, and we have agreements where we partner to co-develop and/or participate together in commercializing, marketing, promoting, manufacturing and/or distributing a drug product. Agreement with Myovant On December 26, 2020, we entered into a collaboration to jointly develop and commercialize Orgovyx (relugolix) in advanced prostate cancer and, if approved, relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health in the U.S. and Canada. We will also receive an exclusive option to commercialize relugolix in oncology outside the U.S. and Canada, excluding certain Asian countries. Under the terms of the agreement, the companies will equally share profits and allowable expenses for Orgovyx and the relugolix combination tablet in the U.S. and Canada, with Myovant bearing our share of allowable expenses up to a maximum Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies of $ 100 million in 2021 and up to a maximum of $ 50 million in 2022. We will record our share of gross profits as Alliance revenue. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Myovant will be entitled to receive up to $ 4.35 billion, including an upfront payment of $ 650 million, which was made in December 2020, $ 200 million in potential regulatory milestones for FDA approvals for relugolix combination tablet in womens health, and tiered sales milestones of up to $ 3.5 billion for prostate cancer and also for the combined womens health indications. If we exercise the option to commercialize relugolix in oncology outside of the U.S. and Canada, excluding certain Asian countries, Myovant will receive $ 50 million and be entitled to receive double-digit royalties on sales. In connection with this transaction, we recognized $ 499 million in Identifiable intangible assetsDeveloped technology rights and $ 151 million in Research and development expenses representing the relative fair value of the portion of the upfront payment allocated to the approved indication and unapproved indications of the product, respectively. Agreement with CStone On September 29, 2020, we entered into a strategic collaboration with CStone to address oncological needs in China. The collaboration encompasses our $ 200 million upfront equity investment in CStone, a collaboration between the companies for the development and commercialization of CStones sugemalimab (CS1001, PD-L1 antibody) in mainland China, and a framework between the companies to bring additional oncology assets to the Greater China market. The transaction closed on October 9, 2020. As of December 31, 2020, we held a 9.9 % stake in CStone. Agreement with BioNTech On April 9, 2020, we signed a global agreement with BioNTech to co-develop a mRNA-based coronavirus vaccine program, BNT162b2, aimed at preventing COVID-19 disease. The collaboration rapidly advanced a COVID-19 vaccine candidate into human clinical testing based on BioNTechs proprietary mRNA vaccine platforms, and the vaccine has been granted EUA in the U.S., the EU and the U.K., among other countries. We are working with BioNTech to manufacture and help ensure rapid worldwide access to the vaccine. The collaboration leverages our broad expertise in vaccine RD, regulatory capabilities, and global manufacturing and distribution network. In connection with the April 2020 agreement, we paid BioNTech an upfront cash payment of $ 72 million, which was recorded in Research and development expenses in our second quarter of 2020, and we made an additional equity investment of $ 113 million in common stock of BioNTech. BioNTech became eligible to receive potential milestone payments of up to $ 563 million for a total consideration of $ 748 million. Under the terms of this agreement, we and BioNTech will share gross profits and development costs equally after the vaccine is approved and successfully commercialized, and we were responsible for all of the development costs until commercialization of the vaccine. Thereafter, BioNTech was to repay us its 50 percent share of these development costs through reductions in gross profit sharing and milestone payments to BioNTech over time. On January 29, 2021, we and BioNTech signed an amended version of the April 2020 agreement. Under the January 2021 agreement, BioNTech will pay us their 50 percent share of prior development costs in a lump sum payment during the first quarter of 2021. Further RD costs will be shared equally. We have commercialization rights to the vaccine worldwide (excluding Germany and Turkey where BioNTech will market and distribute the vaccine under the agreement with us, and excluding China, Hong Kong, Macau and Taiwan, which are subject to a separate collaboration between BioNTech and Shanghai Fosun Pharmaceutical (Group) Co., Ltd). We recognize Revenues and Cost of sales on a gross basis in markets where we are commercializing the vaccine and we will record our share of gross profits related to sales of the vaccine by BioNTech in Germany and Turkey in Alliance revenues . We made an additional investment of $ 50 million in common stock of BioNTech as part of an underwritten equity offering by BioNTech, which closed in July 2020. As of December 31, 2020, we held an equity stake of 2.5 % in BioNTech. Summarized Financial Information for Collaborative Arrangements The following provides the amounts and classification of payments (income/(expense)) between us and our collaboration partners: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Revenues Revenues (a) $ 284 $ 305 $ 268 Revenue sAlliance revenues (b) 5,418 4,648 3,838 Total revenues from collaborative arrangements $ 5,703 $ 4,953 $ 4,107 Cost of sales (c) $ ( 61 ) $ ( 52 ) $ ( 34 ) Selling, informational and administrative expenses (d) ( 194 ) ( 176 ) ( 92 ) Research and development expenses (e) ( 192 ) 104 162 Other income/(deductions)net (f) 567 362 281 (a) Represents sales to our partners of products manufactured by us. (b) Substantially all relates to amounts earned from our partners under co-promotion agreements. The increases in each of the periods presented reflect increases in alliance revenues from Eliquis and Xtandi. (c) Primarily relates to amounts paid to collaboration partners for their share of net sales or profits earned in collaboration arrangements where we are the principal in the transaction, and cost of sales for inventory purchased from our partners. (d) Represents net reimbursements to our partners for selling, informational and administrative expenses incurred. (e) Primarily relates to upfront payments and pre-approval milestone payments earned by our partners as well as net reimbursements. (f) Primarily relates to royalties from our collaboration partners. The amounts outlined in the above table do not include transactions with third parties other than our collaboration partners, or other costs for the products under the collaborative arrangements. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives In 2019, we substantially completed several multi-year initiatives focused on positioning us for future growth and creating a simpler, more efficient operating structure within each business. Transforming to a More Focused Company Program With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We have undertaken efforts to ensure our cost base aligns appropriately with our revenue base. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. In addition, we are taking steps to restructure our corporate enabling functions to appropriately support and drive the purpose of our focused innovative biopharmaceutical products business and RD and PGS platform functions. The program costs discussed below may be rounded and represent approximations. We expect costs for this program, primarily related to corporate enabling functions, to be incurred from 2020 through 2022 and to total $ 1.6 billion on a pre-tax basis, with substantially all costs to be cash expenditures. Actions will include, among others, changes in location of certain activities, expanded use and co-location of centers of excellence and shared services, and increased use of digital technologies. The associated actions and the specific costs will primarily include severance and benefit plan impacts, exit costs as well as associated implementation costs. Also as part of this program, we expect to incur costs related to manufacturing network optimization, including certain legacy cost-reduction initiatives, of $ 500 million, with approximately 20 % of the costs to be non-cash. The costs for this effort are expected to be incurred primarily from 2020 through 2022, and will include, among other things, implementation costs, product transfer costs, site exit costs, as well as accelerated depreciation. From the start of this program in the fourth quarter of 2019 through December 31, 2020, we incurred costs of $ 900 million. Key Activities In 2020, we incurred costs of $ 896 million, composed primarily of the Transforming to a More Focused Company program. In 2019, we incurred costs of $ 820 million composed of $ 548 million for the 2017-2019 and Organizing for Growth initiatives, $ 288 million for the integration of Array, $ 94 million for the integration of Hospira, and $ 87 million for the Transforming to a More Focused Company program, partially offset by income of $ 197 million, primarily due to the reversal of certain accruals upon the effective favorable settlement of an IRS audit for multiple tax years and other acquisition-related initiatives. The following summarizes acquisitions and cost-reduction/productivity initiatives costs and credits: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Restructuring charges/(credits): Employee terminations $ 474 $ 108 $ 473 Asset impairments (a) 88 69 290 Exit costs/(credits) ( 6 ) 50 33 Restructuring charges (b) 556 227 796 Transaction costs (c) 10 63 1 Integration costs and other (d) 34 311 260 Restructuring charges and certain acquisition-related costs 600 601 1,058 Net periodic benefit costs recorded in Other (income)/deductionsnet 39 23 144 Additional depreciationasset restructuring recorded in our consolidated statements of income as follows (e) : Cost of sales 23 29 36 Selling, informational and administrative expenses 3 2 Research and development expenses ( 3 ) 8 Total additional depreciationasset restructuring 19 40 38 Implementation costs recorded in our consolidated statements of income as follows (f) : Cost of sales 40 61 75 Selling, informational and administrative expenses 197 73 71 Research and development expenses 1 22 39 Total implementation costs 238 156 186 Total costs associated with acquisitions and cost-reduction/productivity initiatives $ 896 $ 820 $ 1,426 (a) 2018 charges are largely for cost-reduction initiatives not associated with acquisitions. (b) Represents acquisition-related costs ($ 192 million credit in 2019, and $ 37 million charge in 2018) and cost reduction initiatives ($ 556 million charge in 2020, $ 418 million charge in 2019, and $ 759 million charge in 2018). 2020 charges mainly represent employee termination costs for our Transforming to a More Focused Company cost-reduction program. 2019 restructuring charges mainly represent employee termination costs for cost-reduction and productivity initiatives, partially offset by the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit for multiple tax years (see Note 5B ). 2018 charges were primarily related to employee termination costs and asset write downs. The employee termination costs for Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies 2019 and 2018 were primarily for our improvements to operational effectiveness as part of the realignment of our business structure, and for 2019, also includes employee termination costs for the Transforming to a More Focused Company cost-reduction program. (c) Represents external costs for banking, legal, accounting and other similar services. (d) Represents external, incremental costs directly related to integrating acquired businesses, such as expenditures for consulting and the integration of systems and processes, and certain other qualifying costs. 2020 costs primarily related to our acquisition of Array. 2019 costs mainly related to our acquisitions of Array, including $ 157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense (see Note 2A ), and Hospira. 2018 costs mostly related to our acquisition of Hospira. (e) Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions. (f) Represents external, incremental costs directly related to implementing our non-acquisition-related cost-reduction/productivity initiatives. The following summarizes the components and changes in restructuring accruals: (MILLIONS OF DOLLARS) Employee Termination Costs Asset Impairment Charges Exit Costs Accrual Balance, January 1, 2019 $ 1,113 $ $ 49 $ 1,161 Provision (a) 108 69 50 227 Utilization and other (b) ( 450 ) ( 69 ) ( 53 ) ( 572 ) Balance, December 31, 2019 (c) 770 46 816 Provision 474 88 ( 6 ) 556 Utilization and other (b) ( 462 ) ( 88 ) ( 25 ) ( 575 ) Balance, December 31, 2020 (d) $ 782 $ $ 15 $ 798 (a) Includes the reversal of certain accruals related to our acquisition of Wyeth upon the favorable settlement of an IRS audit for multiple tax years. See Note 5D . (b) Includes adjustments for foreign currency translation. (c) Included in Other current liabilities ($ 641 million) and Other noncurrent liabilities ($ 175 million). (d) Included in Other current liabilities ($ 628 million) and Other noncurrent liabilities ($ 169 million). Note 4. Other (Income)/DeductionsNet Components of Other (income)/deductionsnet include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Interest income $ ( 73 ) $ ( 225 ) $ ( 333 ) Interest expense (a) 1,449 1,573 1,316 Net interest expense 1,376 1,348 983 Royalty-related income ( 770 ) ( 646 ) ( 485 ) Net (gains)/losses on asset disposals 237 ( 32 ) ( 71 ) Net (gains)/losses recognized during the period on equity securities (b) ( 540 ) ( 454 ) ( 586 ) Net realized (gains)/losses on sales of investments in debt securities (c) 141 Income from collaborations, out-licensing arrangements and sales of compound/product rights (d) ( 326 ) ( 168 ) ( 476 ) Net periodic benefit costs/(credits) other than service costs (e) ( 236 ) 72 ( 270 ) Certain legal matters, net (f) 28 292 84 Certain asset impairments (g) 1,691 2,843 3,115 Business and legal entity alignment costs (h) 300 63 Consumer Healthcare JV equity method (income)/loss (i) ( 298 ) ( 17 ) Other, net (j) ( 493 ) ( 226 ) ( 421 ) Other (income)/deductionsnet $ 669 $ 3,314 $ 2,077 (a) Capitalized interest totaled $ 96 million in 2020, $ 88 million in 2019 and $ 73 million in 2018. (b) 2020 gains include, among other things, unrealized gains of $ 405 million related to investments in BioNTech and SpringWorks Therapeutics, Inc. (SpringWorks). 2019 gains included, among other things, unrealized gains of $ 295 million related to investments in Cortexyme, Inc. and SpringWorks. 2018 gains included unrealized gains on equity securities of $ 477 million, reflecting the adoption of a new accounting standard in 2018 and were primarily driven by unrealized gains of $ 466 million related to our investment in Allogene. See Notes 2B and 7B. (c) 2018 primarily included gross realized losses on sales of available-for-sale debt securities of $ 402 million and a net loss of $ 18 million from derivative financial instruments used to hedge the foreign exchange component of the matured available-for-sale debt securities, partially offset by gross realized gains on sales of available-for-sale debt securities of $ 280 million. Proceeds from the sale of available-for-sale debt securities were $ 5.7 billion in 2018. (d) 2020 includes, among other things, (i) an upfront payment to us of $ 75 million from our sale of our CK1 assets to Biogen, (ii) $ 40 million of milestone income from Puma Biotechnology, Inc. related to Neratinib regulatory approvals in the EU, (iii) $ 30 million of milestone income from Lilly related to the first commercial sale in the U.S. of LOXO-292 for the treatment of RET fusion-positive NSCLC and (iv) $ 108 million in milestone income from multiple licensees. 2019 includes, among other things, $ 78 million in milestone income from Mylan Pharmaceuticals Inc. related to the FDAs approval and launch of Wixela Inhub , a generic of Advair Diskus (fluticasone propionate and salmeterol inhalation powder) and $ 52 million in milestone income from multiple licensees. 2018 includes, among other things, (i) $ 118 million in milestone income from multiple licensees, (ii) $ 110 million in milestone payments received from Shire, of which $ 75 million related to their first dosing of a patient in a Phase 3 clinical trial for the treatment of UC and $ 35 million related to their first dosing of a patient in a Phase 3 clinical trial Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies for the treatment of Crohns disease, (iii) an upfront payment to us and a recognized milestone totaling $ 85 million for the sale of an AMPA receptor potentiator for CIAS to Biogen, (iv) $ 50 million in gains related to sales of compound/product rights and (v) a $ 40 million milestone payment from Merck Co., Inc. in conjunction with the approval of ertugliflozin in the EU. (e) See Note 11 . In 2019, other non-service cost components activity related to the Consumer Healthcare JV transaction, such as gain on settlements, were recorded in (Gain) on completion of Consumer Healthcare JV transaction. (f) 2019 mostly included legal reserves for certain pending legal matters. 2018 primarily included legal reserves for certain pending legal matters, partially offset by the reversal of a legal accrual where a loss was no longer deemed probable. (g) 2020 primarily includes intangible asset impairment charges of $ 1.7 billion, mainly composed of: (i) $ 900 million related to IPRD assets for unapproved indications of certain cancer medicines, acquired in our Array acquisition, and reflect, among other things, updated commercial forecasts; (ii) $ 528 million related to Eucrisa, a finite-lived developed technology right acquired in our Anacor acquisition, and reflects updated commercial forecasts mainly reflecting competitive pressures; and (iii) $ 263 million related to finite-lived developed technology rights for certain generic sterile injectables acquired in our Hospira acquisition, and reflects updated commercial forecasts mainly reflecting competitive pressures. 2019 primarily included intangible asset impairment charges of $ 2.8 billion, mainly composed of $ 2.6 billion, related to Eucrisa, and reflects updated commercial forecasts mainly reflecting competitive pressures. 2018 primarily included intangible asset impairment charges of $ 3.1 billion, mainly composed of (i) $ 2.6 billion related to developed technology rights, $ 242 million related to licensing agreements and $ 80 million related to IPRD, all of which were acquired in our Hospira acquisition, for generic sterile injectable products associated with various indications; and (ii) $ 117 million related to a multi-antigen vaccine IPRD program for adults undergoing elective spinal fusion surgery. The intangible asset impairment charges for the generic sterile injectable products reflect, among other things, updated commercial forecasts, reflecting an increased competitive environment as well as higher manufacturing costs, largely stemming from manufacturing and supply issues. The intangible asset impairment charge for the multi-antigen vaccine IPRD program was the result of the Phase 2b trial reaching futility at a pre-planned interim analysis. (h) Mainly represents incremental costs for the design, planning and implementation of our then new business structure, effective in the beginning of 2019, and primarily includes consulting, legal, tax and other advisory services. (i) See Note 2C . (j) 2020 includes, among other things, (i) dividend income of $ 278 million from our investment in ViiV and (ii) charges of $ 105 million, reflecting the change in the fair value of contingent consideration. 2019 included, among other things, (i) dividend income of $ 220 million from our investment in ViiV; (ii) charges of $ 152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV; and (iii) net losses on early retirement of debt of $ 138 million. 2018 included, among other things, (i) a non-cash $ 343 million pre-tax gain associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system; (ii) dividend income of $ 253 million from our investment in ViiV; (iii) a non-cash $ 50 million pre-tax gain related to our contribution agreement entered into with Allogene (see Note 2B ); (iv) charges of $ 207 million, reflecting the change in the fair value of contingent consideration, and (vi) charges of $ 112 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV. The asset impairment charges included in Other (income)/deductionsnet are based on estimates of fair value. Additional information about the intangible assets that were impaired during 2020 (impairment recorded in Other (income)/deductionsnet ) follows: Year Ended December 31, Fair Value (a) 2020 (MILLIONS OF DOLLARS) Amount Level 1 Level 2 Level 3 Impairment Intangible assets IPRD (b) $ 1,100 $ $ $ 1,100 $ 900 Intangible assetsDeveloped technology rights (b) 740 740 791 Total $ 1,840 $ $ $ 1,840 $ 1,691 (a) The fair value amount is presented as of the date of impairment, as these assets are not measured at fair value on a recurring basis. See also Note 1E. (b) Reflects intangible assets written down to fair value in 2020. Fair value was determined using the income approach, specifically the multi-period excess earnings method, also known as the discounted cash flow method. We started with a forecast of all the expected net cash flows for the asset and then applied an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the product; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. Note 5. Tax Matters A. Taxes on Income from Continuing Operations Components of Income from continuing operations before provision/(benefit) for taxes on income include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States $ ( 2,488 ) $ 7,064 $ ( 6,111 ) International 9,986 4,420 9,706 Income from continuing operations before provision/(benefit) for taxes on income ( a), (b) $ 7,497 $ 11,485 $ 3,594 (a) 2020 v. 2019 The domestic loss in 2020 versus domestic income in 2019 was mainly related to the non-recurrence of the gain on the completion of the Consumer Healthcare JV transaction as well as higher certain asset impairments and higher RD expenses. The increase in the international income was primarily related to the non-recurrence of the write off of assets contributed to the Consumer Healthcare JV as well as lower certain asset impairments and lower amortization of intangible assets. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (b) 2019 v. 2018 The domestic income in 2019 versus domestic loss in 2018 was mainly related to the completion of the Consumer Healthcare JV transaction as well as lower certain asset impairments, partially offset by higher business and legal entity alignment costs as well as increased costs related to certain legal matters. The decrease in the international income was primarily related to higher certain asset impairments as well as the write off of assets contributed to the Consumer Healthcare JV. Components of Provision/(benefit) for taxes on income based on the location of the taxing authorities include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States Current income taxes: Federal $ 371 $ ( 1,886 ) $ 388 State and local 58 ( 187 ) ( 49 ) Deferred income taxes: Federal ( 1,061 ) 1,193 ( 1,641 ) State and local ( 115 ) 266 15 Total U.S. tax benefit ( 747 ) ( 613 ) ( 1,287 ) TCJA (a) Current income taxes ( 135 ) ( 3,035 ) Deferred Income taxes ( 187 ) 2,439 Total TCJA tax benefit ( 323 ) ( 596 ) International Current income taxes 1,517 2,418 2,195 Deferred income taxes ( 292 ) ( 863 ) ( 579 ) Total international tax provision 1,224 1,555 1,617 Provision/(benefit) for taxes on income $ 477 $ 618 $ ( 266 ) (a) The 2018 current tax benefit and deferred tax expense primarily relate to the utilization of tax credit carryforwards against the repatriation tax liability associated with the enactment of the TCJA. See discussion below. Amounts discussed below are rounded to the nearest hundred million and represent approximations. In 2018, we finalized our provisional accounting for the tax effects of the TCJA, based on our best estimates of available information and data. We reported and disclosed the impacts within the applicable measurement period, in accordance with SEC guidance, and recorded a favorable adjustment of $ 100 million to Provision/(benefit) for taxes on income . We elected, with the filing of our 2018 U.S. Federal Consolidated Income Tax Return, to pay our initial estimated $ 15 billion repatriation tax liability on accumulated post-1986 foreign earnings over eight years through 2026. The third annual installment of this liability, which is due to be paid in April 2021, is reported in current Income taxes payable , and the remaining liability is reported in noncurrent Other taxes payable as of December 31, 2020. Our obligations may vary as a result of changes in our uncertain tax positions and/or availability of attributes such as foreign tax and other credit carryforwards. The TCJA subjects a U.S. shareholder to current tax on global intangible low-taxed income earned by certain foreign subsidiaries. The FASB Staff QA, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income , states that we are permitted to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as global intangible low-taxed income in future years or provide for the tax expense related to such income in the year the tax is incurred. We elected to recognize deferred taxes for temporary differences expected to reverse as global intangible low-taxed income in future years. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law in the U.S. to provide certain relief as a result of the COVID-19 pandemic. In addition, governments around the world have enacted or implemented various forms of tax relief measures in response to the economic conditions in the wake of COVID-19. As of December 31, 2020, neither the CARES Act nor changes to income tax laws or regulations in other jurisdictions had a significant impact on our effective tax rate. The changes in Provision/(benefit) for taxes on income impacting the effective tax rate year-over-year are summarized below: 2020 v. 2019 The higher effective tax rate in 2020 was mainly the result of: the non-recurrence of the $ 1.4 billion tax benefits, representing taxes and interest, recorded in 2019 due to the favorable settlement of an IRS audit for multiple tax years; the non-recurrence of the tax benefits related to certain tax initiatives associated with the implementation of our then new business structure; and the non-recurrence of the tax benefits recorded in 2019 as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA, as well as: lower tax benefits related to the impairment of intangible assets, partially offset by: the non-recurrence of the tax expense of $ 2.7 billion recorded in the third quarter of 2019 associated with the gain related to the completion of the Consumer Healthcare JV transaction; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies 2019 v. 2018 The higher effective tax rate was primarily the result of: the tax expense of $ 2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV transaction; and the non-recurrence of certain tax initiatives and favorable adjustments to the provisional estimate of the TCJA, partially offset by: an increase in tax benefits associated with the resolution of certain tax positions pertaining to prior years, primarily due to a benefit of $ 1.4 billion, representing tax and interest, resulting from the favorable settlement of an IRS audit; benefits related to certain tax initiatives associated with the implementation of our then new business structure; the tax benefits recorded as a result of additional guidance issued by the U.S. Department of Treasury related to the enactment of the TCJA; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. In all years, federal, state and international net tax liabilities assumed or established as part of a business acquisition are not included in Provision/(benefit) for taxes on income (see Note 2A ). B. Tax Rate Reconciliation The reconciliation of the U.S. statutory income tax rate to our effective tax rate for Income from continuing operations follows: Year Ended December 31, 2020 2019 2018 U.S. statutory income tax rate 21.0 % 21.0 % 21.0 % TCJA impact (a) ( 2.8 ) ( 16.6 ) Taxation of non-U.S. operations (b), (c) ( 9.6 ) ( 4.5 ) 1.2 Tax settlements and resolution of certain tax positions (d) ( 2.5 ) ( 13.8 ) ( 19.3 ) Completion of Consumer Healthcare JV transaction (d) 8.2 U.S. Healthcare Legislation (e) 0.1 ( 1.1 ) U.S. RD tax credit ( 1.3 ) ( 0.8 ) ( 2.2 ) Interest (f) 1.1 0.6 5.7 All other, net (g) ( 2.4 ) ( 2.5 ) 3.9 Effective tax rate for income from continuing operations 6.4 % 5.4 % ( 7.4 ) % (a) See Note 5A. (b) For taxation of non-U.S. operations, this rate impact reflects the income tax rates and relative earnings in the locations where we do business outside the U.S., together with the U.S. tax cost on our international operations, changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions, as well as changes in valuation allowances. Specifically: (i) the jurisdictional location of earnings is a significant component of our effective tax rate each year, and the rate impact of this component is influenced by the specific location of non-U.S. earnings and the level of such earnings as compared to our total earnings; (ii) the U.S. tax implications of our foreign operations is a significant component of our effective tax rate each year and generally offsets some of the reduction to our effective tax rate each year resulting from the jurisdictional location of earnings; (iii) the impact of certain tax initiatives; and (iv) the impact of changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions is a component of our effective tax rate each year that can result in either an increase or decrease to our effective tax rate. The jurisdictional mix of earnings, which includes the impact of the location of earnings as well as the U.S. tax cost on our international operations, can vary as a result of operating fluctuations in the normal course of business and as a result of the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on strategic business decisions. See also Note 5A for the components of pre-tax income and Provision/(benefit) for taxes on income, which is based on the location of the taxing authorities, and for information about settlements and other items impacting Provision/(benefit) for taxes on income . (c) In all years, the impact on our effective tax rate is the result of the jurisdictional location of earnings. In 2020 and 2019, the reduction in our effective tax rate resulting from the jurisdictional location of earnings is largely due to lower tax rates in certain jurisdictions, as well as manufacturing and other incentives for our subsidiaries in Singapore and to a lesser extent in Puerto Rico. We benefit from Puerto Rican tax incentives pursuant to a grant that expires during 2029. Under such grant, we are partially exempt from income, property and municipal taxes. In Singapore, we benefit from incentive tax rates effective through 2045 on income from manufacturing and other operations. (d) For a discussion about tax settlements and resolution of certain tax positions and the impact of the gain on the completion of the Consumer Healthcare JV transaction, see Note 5A. (e) The favorable rate impact in 2018 is a result of the updated 2017 invoice received from the federal government, which reflected a lower expense than what was previously estimated for invoiced periods, as well as certain tax initiatives. (f) Includes changes in interest related to our uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions. (g) All other, net is primarily due to routine business operations. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Deferred Taxes Components of our deferred tax assets and liabilities, shown before jurisdictional netting, follow: 2020 Deferred Tax* 2019 Deferred Tax* (MILLIONS OF DOLLARS) Assets (Liabilities) Assets (Liabilities) Prepaid/deferred items (a) $ 3,094 $ ( 352 ) $ 1,918 $ ( 204 ) Inventories 276 ( 25 ) 267 ( 10 ) Intangible assets (b) 793 ( 5,355 ) 718 ( 6,784 ) Property, plant and equipment 211 ( 1,219 ) 177 ( 1,204 ) Employee benefits 1,981 ( 127 ) 2,115 ( 37 ) Restructurings and other charges 291 212 Legal and product liability reserves 382 469 Net operating loss/tax credit carryforwards (c) 1,761 2,003 Unremitted earnings ( 46 ) ( 77 ) State and local tax adjustments 171 152 Investments (d) 128 ( 3,545 ) 11 ( 3,318 ) All other 102 ( 57 ) 167 ( 9 ) 9,189 ( 10,726 ) 8,208 ( 11,643 ) Valuation allowances ( 1,586 ) ( 1,526 ) Total deferred taxes $ 7,603 $ ( 10,726 ) $ 6,682 $ ( 11,643 ) Net deferred tax liability (e) $ ( 3,123 ) $ ( 4,961 ) * The deferred tax assets and liabilities associated with global intangible low-taxed income are included in the relevant categories. See Note 5A . (a) The increase in 2020 is primarily related to the capitalization of certain RD-related expenses. (b) The decrease in 2020 is primarily the result of amortization of intangible assets and certain impairment charges. (c) The amounts in 2020 and 2019 are reduced for unrecognized tax benefits of $ 3.0 billion and $ 2.9 billion, respectively, where we have net operating loss carryforwards, similar tax losses, and/or tax credit carryforwards that are available, under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position. (d) The amounts in 2020 and 2019 are primarily related to the Consumer Healthcare JV. See Note 2C. (e) In 2020, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.9 billion), and Noncurrent deferred tax liabilities ($ 4.1 billion). In 2019, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.7 billion), and Noncurrent deferred tax liabilities ($ 5.7 billion). We have carryforwards, primarily related to net operating and capital losses, general business credits, foreign tax credits and charitable contributions, which are available to reduce future U.S. federal and/or state, as well as international, income taxes payable with either an indefinite life or expiring at various times from 2021 to 2040. Certain of our U.S. net operating losses and general business credits are subject to limitations under IRC Section 382. As of December 31, 2020, we have not made a U.S. tax provision on $ 55.0 billion of unremitted earnings of our international subsidiaries. As these earnings are intended to be indefinitely reinvested overseas, the determination of a hypothetical unrecognized deferred tax liability as of December 31, 2020 is not practicable. The amount of indefinitely reinvested earnings is based on estimates and assumptions and subject to management evaluation, and is subject to change in the normal course of business based on operational cash flow, completion of local statutory financial statements and the finalization of tax returns and audits, among other things. Accordingly, we regularly update our earnings and profits analysis for such events. D. Tax Contingencies For a description of our accounting policies associated with accounting for income tax contingencies, see Note 1P. Uncertain Tax Positions As tax law is complex and often subject to varied interpretations, it is uncertain whether some of our tax positions will be sustained upon audit. As of December 31, 2020, we had $ 4.3 billion and as of December 31, 2019, we had $ 4.2 billion in net unrecognized tax benefits, excluding associated interest. Tax assets for uncertain tax positions primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. As of December 31, 2020, we had $ 1.3 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.1 billion), Noncurrent deferred tax liabilities ($ 122 million) and Other taxes payable ($ 46 million). As of December 31, 2019, we had $ 1.2 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.0 billion) and Noncurrent deferred tax liabilities ($ 109 million). Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows: (MILLIONS OF DOLLARS) 2020 2019 2018 Balance, beginning $ ( 5,381 ) $ ( 6,259 ) $ ( 6,558 ) Acquisitions (a) 37 ( 44 ) Divestitures (b) 265 Increases based on tax positions taken during a prior period (c) ( 232 ) ( 36 ) ( 192 ) Decreases based on tax positions taken during a prior period (c), (d) 64 1,109 561 Decreases based on settlements for a prior period (e) 15 100 123 Increases based on tax positions taken during the current period (c) ( 411 ) ( 383 ) ( 370 ) Impact of foreign exchange ( 72 ) 25 56 Other, net (c), (f) 120 107 121 Balance, ending (g) $ ( 5,595 ) $ ( 5,381 ) $ ( 6,259 ) (a) For 2020 and 2019, primarily related to the acquisition of Array (goodwill adjustment made within the measurement period). See Note 2A . (b) For 2020, related to the separation of Upjohn. See Note 2B . (c) Primarily included in Provision/(benefit) for taxes on income. (d) Primarily related to effectively settling certain issues with the U.S. and foreign tax authorities. See Note 5A. (e) Primarily related to cash payments and reductions of tax attributes. (f) Primarily related to decreases as a result of a lapse of applicable statutes of limitations. (g) In 2020, included in Income taxes payable ($ 34 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 18 million), Noncurrent deferred tax liabilities ($ 3.0 billion) and Other taxes payable ($ 2.5 billion). In 2019, included in Income taxes payable ($ 108 million), Current tax assets ($ 2 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 51 million), Noncurrent deferred tax liabilities ($ 2.8 billion) and Other taxes payable ($ 2.4 billion). Interest related to our unrecognized tax benefits is recorded in accordance with the laws of each jurisdiction and is recorded primarily in Provision/(benefit) for taxes on income . In 2020, we recorded a net increase in interest of $ 89 million. In 2019, we recorded a net decrease in interest of $ 564 million, resulting primarily from a settlement with the IRS; and in 2018, we recorded a net increase in interest of $ 103 million. Gross accrued interest totaled $ 493 million as of December 31, 2020 (reflecting a decrease of $ 5 million as a result of cash payments and a decrease of $ 75 million relating to the separation of Upjohn) and gross accrued interest totaled $ 485 million as of December 31, 2019 (reflecting a decrease of $ 13 million as a result of cash payments). In 2020, this amount was included in Income taxes payable ($ 7 million) and Other taxes payable ($ 486 million). In 2019, this amount was included in Income taxes payable ($ 20 million) and Other taxes payable ($ 465 million). Accrued penalties are not significant. See also Note 5A. Status of Tax Audits and Potential Impact on Accruals for Uncertain Tax Positions The U.S. is one of our major tax jurisdictions, and we are regularly audited by the IRS. With respect to Pfizer, the IRS has issued a Revenue Agents Report (RAR) for tax years 2011-2013. We are not in agreement with the RAR and are currently appealing certain disputed issues. Tax years 2014-2015 are currently under audit. Tax years 2016-2020 are open, but not under audit. All other tax years are closed. In addition to the open audit years in the U.S., we have open audit years in other major tax jurisdictions, such as Canada (2013-2020), Japan (2017-2020), Europe (2011-2020, primarily reflecting Ireland, the U.K., France, Italy, Spain and Germany), Latin America (1998-2020, primarily reflecting Brazil) and Puerto Rico (2016-2020). Any settlements or statutes of limitations expirations could result in a significant decrease in our uncertain tax positions. We estimate that it is reasonably possible that within the next 12 months, our gross unrecognized tax benefits, exclusive of interest, could decrease by as much as $ 50 million, as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies E. Tax Provision/(Benefit) on Other Comprehensive Income/(Loss) Components of the Tax provision/(benefit) on other comprehensive income/(loss) include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Foreign currency translation adjustments, net (a) $ ( 79 ) $ 254 $ 94 Unrealized holding gains/(losses) on derivative financial instruments, net ( 88 ) 83 21 Reclassification adjustments for (gains)/losses included in net income ( 25 ) ( 125 ) 27 Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) 1 ( 113 ) ( 42 ) 50 Unrealized holding gains/(losses) on available-for-sale securities, net 45 ( 23 ) Reclassification adjustments for (gains)/losses included in net income ( 24 ) 5 16 Reclassification adjustments for tax on unrealized gains from AOCI to Retained earnings (c) ( 45 ) 22 5 ( 53 ) Benefit plans: actuarial gains/(losses), net ( 281 ) ( 169 ) ( 141 ) Reclassification adjustments related to amortization 62 55 55 Reclassification adjustments related to settlements, net 65 65 33 Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) 637 Other ( 8 ) ( 10 ) 29 ( 161 ) ( 58 ) 612 Benefit plans: prior service (costs)/credits and other, net 12 ( 1 ) 2 Reclassification adjustments related to amortization of prior service costs and other, net ( 31 ) ( 43 ) ( 39 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 1 ) ( 4 ) Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) ( 144 ) Other 1 ( 17 ) ( 45 ) ( 185 ) Tax provision/(benefit) on other comprehensive income/(loss) $ ( 349 ) $ 115 $ 518 (a) Taxes are not provided for foreign currency translation adjustments relating to investments in international subsidiaries that are expected to be held indefinitely. (b) For additional information on the adoption of a new accounting standard related to reclassification of certain tax effects from AOCI, see Note 1B in our 2018 Financial Report. (c) For additional information on the adoption of a new accounting standard related to financial assets and liabilities, see Note 1B in our 2018 Financial Report. Note 6. Accumulated Other Comprehensive Loss, Excluding Noncontrolling Interests The following summarizes the changes, net of tax, in Accumulated other comprehensive loss : Net Unrealized Gains/(Losses) Benefit Plans (MILLIONS OF DOLLARS) Foreign Currency Translation Adjustments Derivative Financial Instruments Available-For-Sale Securities Actuarial Gains/(Losses) Prior Service (Costs)/ Credits and Other Accumulated Other Comprehensive Income/(Loss) Balance, January 1, 2018 $ ( 5,180 ) $ ( 30 ) $ 401 $ ( 5,262 ) $ 750 $ ( 9,321 ) Other comprehensive income/(loss) due to the adoption of new accounting standards (a) ( 2 ) ( 1 ) ( 416 ) ( 637 ) 144 ( 913 ) Other comprehensive income/(loss) (b) ( 893 ) 198 ( 53 ) ( 128 ) ( 166 ) ( 1,041 ) Balance, December 31, 2018 ( 6,075 ) 167 ( 68 ) ( 6,027 ) 728 ( 11,275 ) Other comprehensive income/(loss) (b) 123 ( 146 ) 33 ( 231 ) ( 144 ) ( 365 ) Balance, December 31, 2019 ( 5,952 ) 20 ( 35 ) ( 6,257 ) 584 ( 11,640 ) Other comprehensive income/(loss) (b) 1,028 ( 448 ) 151 ( 602 ) ( 106 ) 23 Distribution of Upjohn Business (c) ( 397 ) 352 ( 26 ) ( 71 ) Balance, December 31, 2020 $ ( 5,321 ) $ ( 428 ) $ 116 $ ( 6,507 ) $ 452 $ ( 11,688 ) (a) Represent the cumulative effect adjustments as of January 1, 2018 from the adoption of accounting standards related to (i) financial assets and liabilities and (ii) the reclassification of certain tax effects from AOCI. See Note 1B in our 2018 Financial Report. (b) Amounts do not include foreign currency translation adjustments attributable to noncontrolling interests of $ 9 million loss in 2020, $ 11 million loss in 2019 and $ 20 million loss in 2018. Foreign currency translation adjustments in 2020 primarily include gains from the strengthening of the euro, Japanese yen, Australian dollar and U.K. pound against the U.S. dollar, and net gains related to foreign currency translation adjustments related to our equity method investment in the Consumer Healthcare JV (see Note 2C ) , partially offset by the impact of our net investment hedging program. Foreign currency translation adjustments in 2019 primarily include a gain of approximately $ 1.3 billion pre-tax ($ 978 million after-tax) related to foreign currency translation adjustments attributable to our equity method investment in the Consumer Healthcare JV (see Note 2C ), partially offset by the strengthening of the U.S. dollar against the euro and the Australian dollar, and the results of our net investment hedging program. Amounts in 2018 primarily reflect the strengthening of the U.S. dollar against the euro, U.K. pound and Chinese renminbi. (c) For more information, see Note 2B. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 7. Financial Instruments A. Fair Value Measurements Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis and Fair Value Hierarchy, using a Market Approach: As of December 31, 2020 As of December 31, 2019 (MILLIONS OF DOLLARS) Total Level 1 Level 2 Total Level 1 Level 2 Financial assets: Short-term investments Classified as equity securities with readily determinable fair values: Money market funds $ 567 $ $ 567 $ 705 $ $ 705 Classified as available-for-sale debt securities: Government and agencynon-U.S. 7,719 7,719 4,863 4,863 Government and agencyU.S. 982 982 811 811 Corporate and other 1,008 1,008 1,013 1,013 9,709 9,709 6,687 6,687 Total short-term investments 10,276 10,276 7,392 7,392 Other current assets Derivative assets: Interest rate contracts 18 18 53 53 Foreign exchange contracts 234 234 413 413 Total other current assets 251 251 465 465 Long-term investments Classified as equity securities with readily determinable fair values (a) 2,809 2,776 32 1,902 1,863 39 Classified as available-for-sale debt securities: Government and agencynon-U.S. 6 6 Government and agencyU.S. 121 121 303 303 Corporate and other 11 11 128 128 315 315 Total long-term investments 2,936 2,776 160 2,216 1,863 354 Other noncurrent assets Derivative assets: Interest rate contracts 117 117 266 266 Foreign exchange contracts 5 5 261 261 Total derivative assets 122 122 526 526 Insurance contracts (b) 693 693 575 575 Total other noncurrent assets 814 814 1,102 1,102 Total assets $ 14,278 $ 2,776 $ 11,501 $ 11,176 $ 1,863 $ 9,313 Financial liabilities: Other current liabilities Derivative liabilities: Foreign exchange contracts $ 501 $ $ 501 $ 114 $ $ 114 Total other current liabilities 501 501 114 114 Other noncurrent liabilities Derivative liabilities: Foreign exchange contracts 599 599 604 604 Total other noncurrent liabilities 599 599 604 604 Total liabilities $ 1,100 $ $ 1,100 $ 718 $ $ 718 (a) Long-term equity securities of $ 190 million as of December 31, 2020 and $ 176 million as of December 31, 2019 were held in restricted trusts for employee benefit plans. (b) Includes life insurance policies held in restricted trusts for U.S. non-qualified employee benefit plans. The underlying invested assets in these contracts are marketable securities, which are carried at fair value, with changes in fair value recognized in Other (income)/deductionsnet (see Note 4 ) . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis Carrying values and estimated fair values using a market approach: As of December 31, 2020 As of December 31, 2019 Carrying Value Estimated Fair Value Carrying Value Estimated Fair Value (MILLIONS OF DOLLARS) Total Level 2 Total Level 2 Financial Liabilities Long-term debt, excluding the current portion $ 37,133 $ 45,533 $ 45,533 $ 35,955 $ 40,842 $ 40,842 The differences between the estimated fair values and carrying values for held-to-maturity debt securities, private equity securities, long-term receivables and short-term borrowings not measured at fair value on a recurring basis were not significant as of December 31, 2020 and 2019. The fair value measurements of our held-to-maturity debt securities and short-term borrowings are based on Level 2 inputs. The fair value measurements of our long-term receivables and private equity securities are based on Level 3 inputs using a market approach. B. Investments Total Short-Term and Long-Term Investments and Equity-Method Investments The following summarizes our investments by classification type: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Short-term investments Equity securities with readily determinable fair values (a) $ 567 $ 705 Available-for-sale debt securities 9,709 6,687 Held-to-maturity debt securities 161 1,133 Total Short-term investments $ 10,437 $ 8,525 Long-term investments Equity securities with readily determinable fair values $ 2,809 $ 1,902 Available-for-sale debt securities 128 315 Held-to-maturity debt securities 37 42 Private equity securities at cost (b) 432 756 Total Long-term investments $ 3,406 $ 3,014 Equity-method investments 16,856 17,133 Total long-term investments and equity-method investments $ 20,262 $ 20,147 Held-to-maturity cash equivalents $ 89 $ 163 (a) As of December 31, 2020 and 2019, includes money market funds primarily invested in U.S. Treasury and government debt. (b) Represent investments in the life sciences sector. Debt Securities At December 31, 2020, our investment securities portfolio consisted of diverse, primarily investment-grade, debt securities. The contractual maturities, or estimated maturities, of the debt securities are as follows: As of December 31, 2020 As of December 31, 2019 Gross Unrealized Maturities (in Years) Gross Unrealized (MILLIONS OF DOLLARS) Amortized Cost Gains Losses Fair Value Within 1 Over 1 to 5 Over 5 Amortized Cost Gains Losses Fair Value Available-for-sale debt securities Government and agency non-U.S. $ 7,593 $ 136 $ ( 4 ) $ 7,725 $ 7,719 $ 6 $ $ 4,895 $ 6 $ ( 38 ) $ 4,863 Government and agency U.S. 1,104 ( 1 ) 1,103 982 121 1,120 ( 6 ) 1,114 Corporate and other (a) 1,006 2 1,008 1,008 1,027 ( 2 ) 1,025 Held-to-maturity debt securities Time deposits and other 283 283 251 9 24 535 535 Government and agency non-U.S. 5 5 5 803 803 Total debt securities $ 9,991 $ 138 $ ( 5 ) $ 10,124 $ 9,959 $ 136 $ 29 $ 8,380 $ 6 $ ( 47 ) $ 8,340 (a) Primarily issued by a diverse group of corporations . For our portfolio of available-for-sale and held-to-maturity debt securities, any expected credit losses would be immaterial to the financial statements. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Equity Securities The following presents the calculation of the portion of unrealized (gains)/losses that relate to equity securities, excluding equity method investments, held at the reporting date: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Net (gains)/losses recognized during the period on equity securities (a) $ ( 540 ) $ ( 454 ) $ ( 586 ) Less: Net (gains)/losses recognized during the period on equity securities sold during the period ( 24 ) ( 25 ) ( 109 ) Net unrealized (gains)/losses during the reporting period on equity securities still held at the reporting date (b) $ ( 515 ) $ ( 429 ) $ ( 477 ) (a) Reported in Other (income)/deductions net. See Note 4 . (b) Included in net unrealized gains are observable price changes on equity securities without readily determinable fair values. Since January 1, 2018, there were cumulative impairments and downward adjustments of $ 81 million and upward adjustments of $ 61 million. Impairments, downward and upward adjustments were not significant in 2020, 2019 and 2018 . C. Short-Term Borrowings Short-term borrowings include: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Commercial paper (a) $ 556 $ 13,915 Current portion of long-term debt, principal amount (b) 2,004 1,458 Other short-term borrowings, principal amount (c) 145 860 Total short-term borrowings, principal amount 2,705 16,233 Net fair value adjustments related to hedging and purchase accounting 5 Net unamortized discounts, premiums and debt issuance costs ( 2 ) ( 43 ) Total Short-term borrowings, including current portion of long-term debt , carried at historical proceeds, as adjusted $ 2,703 $ 16,195 (a) See Note 2B . (b) See Note 7D . (c) Primarily includes cash collateral. See Note 7F . The weighted-average effective interest rate on commercial paper outstanding was approximately 0.13 % as of December 31, 2020 and 1.92 % as of December 31, 2019. As of December 31, 2020, we had access to a total of $ 11 billion in U.S. revolving credit facilities consisting of a $ 7 billion facility expiring in 2025 and a $ 4 billion facility expiring in September 2021, which may be used to support our commercial paper borrowings. In January 2021, the $ 4 billion facility was terminated at our request. In addition to the U.S. revolving credit facilities, our lenders have provided us an additional $ 332 million in lines of credit, of which $ 300 million expire within one year. Of these total lines of credit, $ 11.3 billion were unused as of December 31, 2020. D. Long-Term Debt The following outlines our senior unsecured long-term debt and the weighted-average stated interest rate by maturity: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Notes due 2021 ( 2.4 % for 2019) (a) $ $ 3,153 Notes due 2022 ( 1.0 % for 2020 and 2019) 1,728 1,624 Notes due 2023 ( 3.2 % for 2020 and 3.7 % for 2019) 2,550 2,892 Notes due 2024 ( 3.9 % for 2020 and 2019) 2,250 2,250 Notes due 2025 ( 0.8 % for 2020) 750 Notes due 2026 ( 2.9 % for 2020 and 2019) 3,000 3,000 Notes due 2027-2030 ( 3.1 % for 2020 and 3.6 % for 2019) 6,781 4,453 Notes due 2034-2036 ( 5.3 % for 2020 and 2019) 2,250 2,250 Notes due 2037-2040 ( 5.6 % for 2020 and 6.0 % for 2019) 8,086 7,066 Notes due 2043-2046 ( 3.7 % for 2020 and 2019) 4,878 4,818 Notes due 2047-2050 ( 3.6 % for 2020 and 4.1 % for 2019) 3,500 3,315 Total long-term debt, principal amount 35,774 34,820 Net fair value adjustments related to hedging and purchase accounting 1,562 1,305 Net unamortized discounts, premiums and debt issuance costs ( 207 ) ( 176 ) Other long-term debt 4 5 Total long-term debt, carried at historical proceeds, as adjusted $ 37,133 $ 35,955 Current portion of long-term debt, carried at historical proceeds, as adjusted (not included above ( 2.6 % and 1.2 %)) $ 2,002 $ 1,462 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (a) Reclassified to the current portion of long-term debt. Our long-term debt outlined in the above table is generally redeemable by us at any time at varying redemption prices plus accrued and unpaid interest. Issuances In 2020, we issued the following: (MILLIONS OF DOLLARS) Principal Interest Rate Maturity Date As of December 31, 2020 0.800 % (a) May 28, 2025 $ 750 1.700 % (a) May 28, 2030 1,000 2.550 % (a) May 28, 2040 1,000 2.700 % (a) May 28, 2050 1,250 $ 4,000 2.625 % (b) April 1, 2030 $ 1,250 (a) May be redeemed by us at any time, in whole, or in part, at varying redemption prices plus accrued and unpaid interest. The weighted-average effective interest rate for the notes at issuance was 2.11 %. (b) May be redeemed by us at any time, in whole, or in part, at a redemption price plus accrued and unpaid interest. The weighted average effective interest rate for the notes at issuance was 2.67 %. In March 2019, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.57 %. In September 2018, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.56 %. Retirements In November 2020, we repurchased all $ 1.15 billion and $ 342 million principal amount outstanding of the 1.95 % senior unsecured notes due June 2021 and 5.80 % senior unsecured notes due August 2023 and recorded a total net loss of $ 36 million, in Other (income)/deductionsnet. See Note 2B . In March 2020, we repurchased at par all $ 1.065 billion principal amount outstanding of our senior unsecured notes due in 2047. In January 2019, we repurchased all 1.1 billion ($ 1.3 billion) principal amount outstanding of the 5.75 % euro-denominated debt due June 2021 at a redemption value of 1.3 billion ($ 1.5 billion). We recorded a net loss of $ 138 million in Other (income)/deductionsnet , which included the related termination of cross currency swaps . E. Derivative Financial Instruments and Hedging Activities Foreign Exchange Risk A significant portion of our revenues, earnings and net investments in foreign affiliates is exposed to changes in foreign exchange rates. We manage our foreign exchange risk predominately through the use of derivative financial instruments and foreign currency debt. These financial instruments serve to mitigate the impact on net income as a result of remeasurement into another currency, or against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions. The derivative financial instruments primarily hedge or offset exposures in the euro, U.K. pound, Japanese yen, Swedish krona and Canadian dollar. Additionally, we hedge a portion of our forecasted intercompany inventory sales denominated in euro, Japanese yen, Chinese renminbi, Canadian dollar, U.K. pound and Australian dollar for up to two years . Changes in fair value are reported in earnings or in Other comprehensive income/(loss) , depending on the nature and purpose of the financial instrument (hedge or offset relationship). For certain foreign exchange contracts, we exclude an amount from the assessment of hedge effectiveness and recognize the excluded amount through an amortization approach in earnings. The hedge relationships are as follows: Generally, we recognize the gains and losses on foreign exchange contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged item. We also recognize the offsetting foreign exchange impact attributable to the hedged item in earnings. Generally, we record in Other comprehensive income/(loss) gains or losses on foreign exchange contracts that are designated as cash flow hedges and reclassify those amounts into earnings in the same period or periods during which the hedged transaction affects earnings. We record in Other comprehensive income/(loss) Foreign currency translation adjustments, net the foreign exchange gains and losses related to foreign exchange-denominated debt and foreign exchange contracts designated as a hedge of our net investments in foreign subsidiaries and reclassify those amounts into earnings upon the sale or substantial liquidation of our net investments. For certain foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses on contracts that are used to offset foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt or investments to fixed rates. The derivative financial instruments primarily hedge U.S. dollar fixed-rate debt. We recognize the gains and losses on interest rate contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged risk. We also recognize the offsetting earnings impact attributable to the hedged item. The following summarizes the fair value of the derivative financial instruments and the related notional amounts (including those reported as part of discontinued operations): (MILLIONS OF DOLLARS) As of December 31, 2020 As of December 31, 2019 Fair Value Fair Value Notional Asset Liability Notional Asset Liability Derivatives designated as hedging instruments: Foreign exchange contracts (a) $ 24,369 $ 145 $ 1,005 $ 25,193 $ 591 $ 662 Interest rate contracts 1,950 135 6,645 318 280 1,005 909 662 Derivatives not designated as hedging instruments: Foreign exchange contracts $ 15,063 94 95 $ 19,623 82 55 Total $ 373 $ 1,100 $ 992 $ 718 (a) The notional amount of outstanding foreign exchange contracts hedging our intercompany forecasted inventory sales was $ 5.0 billion as of December 31, 2020 and $ 5.9 billion as of December 31, 2019 . The following summarizes information about the gains/(losses) incurred to hedge or offset operational foreign exchange or interest rate risk (including gains/(losses) reported as part of discontinued operations). Amount of Gains/(Losses) Recognized in OID (a) Amount of Gains/(Losses) Recognized in OCI (a) Amount of Gains/(Losses) Reclassified from OCI into OID and COS (a) As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 Derivative Financial Instruments in Cash Flow Hedge Relationships: Foreign exchange contracts (b) $ $ $ ( 649 ) $ 339 $ ( 77 ) $ 525 Amount excluded from effectiveness testing recognized in earnings based on an amortization approach (c) 55 136 57 140 Derivative Financial Instruments in Fair Value Hedge Relationships: Interest rate contracts 369 900 Hedged item ( 369 ) ( 900 ) Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign exchange contracts ( 501 ) ( 313 ) The portion on foreign exchange contracts excluded from the assessment of hedge effectiveness (c) 181 188 154 144 Non-Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign currency short-term borrowings 8 34 Foreign currency long-term debt (d) ( 183 ) 36 Derivative Financial Instruments Not Designated as Hedges: Foreign exchange contracts 178 ( 172 ) All other net (c) 12 ( 1 ) ( 1 ) $ 178 $ ( 172 ) $ ( 1,077 ) $ 421 $ 133 $ 808 (a) OID = Other (income)/deductionsnet, included in Other (income)/deductionsnet in the consolidated statements of income . COS = Cost of Sales, included in Cost of sales in the consolidated statements of income. OCI = Other comprehensive income/(loss), included in the consolidated statements of comprehensive income . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (b) The amounts reclassified from OCI into COS were: a net gain of $ 172 million in 2020 (including a gain of $ 22 million reported in Income from discontinued operationsnet of tax ); and a net gain of $ 247 million in 2019 (including a gain of $ 46 million reported in Income from discontinued operationsnet of tax ). The remaining amounts were reclassified from OCI into OID. Based on year-end foreign exchange rates that are subject to change, we expect to reclassify a pre-tax loss of $ 341 million within the next 12 months into income . The maximum length of time over which we are hedging future foreign exchange cash flow relates to our $ 1.8 billion U.K. pound debt maturing in 2043. (c) The amounts reclassified from OCI were reclassified into OID. (d) Long-term debt includes foreign currency borrowings with carrying values of $ 2.1 billion as of December 31, 2020, which are used as hedging instruments in net investment hedge relationships. The following summarizes the amounts recorded in our consolidated balance sheet related to cumulative basis adjustments for fair value hedges: As of December 31, 2020 As of December 31, 2019 Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount (MILLIONS OF DOLLARS) Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Long-term debt $ 2,016 $ 117 $ 1,149 $ 7,092 $ 266 $ 690 (a) Carrying amounts exclude the cumulative amount of fair value hedging adjustments. F . Credit Risk On an ongoing basis, we monitor and review the credit risk of our customers, financial institutions and exposures in our investment portfolio. With respect to our trade accounts receivable, we monitor the creditworthiness of our customers to which we grant credit in the normal course of business. In general, there is no requirement for collateral from customers. For additional information on our trade accounts receivable and allowance for credit losses, see Note 1G . A significant portion of our trade accounts receivable balances are due from drug wholesalers. For additional information on our trade accounts receivables with significant customers, see Note 17B . With respect to our investments, we monitor concentrations of credit risk associated with government, government agency, and corporate issuers of securities. Investments are placed in instruments that are investment grade and are primarily short in duration. Exposure limits are established to limit a concentration with any single credit counterparty. As of December 31, 2020, the largest investment exposures in our portfolio represent primarily sovereign debt instruments issued by the U.S., France, Canada, Japan, Sweden and Germany. With respect to our derivative financial instrument agreements with financial institutions, we do not expect to incur a significant loss from failure of any counterparty. Derivative financial instruments are executed under International Swaps and Derivatives Association (ISDA) master agreements with credit-support annexes that contain zero threshold provisions requiring collateral to be exchanged daily depending on levels of exposure. As a result, there are no significant concentrations of credit risk with any individual financial institution. As of December 31, 2020, the aggregate fair value of these derivative financial instruments that are in a net payable position was $ 946 million, for which we have posted collateral of $ 821 million with a corresponding amount reported in Short-term investments . As of December 31, 2020, the aggregate fair value of our derivative financial instruments that are in a net receivable position was $ 137 million, for which we have received collateral of $ 142 million with a corresponding amount reported in Short-term borrowings, including current portion of long-term debt. Note 8. Inventories The following summarizes the components of Inventories : As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Finished goods $ 2,878 $ 2,265 Work in process 4,430 4,131 Raw materials and supplies 738 672 Inventories (a) $ 8,046 $ 7,068 Noncurrent inventories not included above (b) $ 890 $ 638 (a) The change from December 31, 2019 reflects increases for certain products, including inventory build for new product launches, supply recovery, market demand and network strategy, and an increase due to foreign exchange. (b) Included in Other noncurrent assets . There are no recoverability issues for these amounts. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 9. Property, Plant and Equipment The following summarizes the components of Property, plant and equipment : Useful Lives As of December 31, (MILLIONS OF DOLLARS) (Years) 2020 2019 Land - $ 444 $ 495 Buildings 33 - 50 9,022 9,181 Machinery and equipment 8 - 20 11,153 10,648 Furniture, fixtures and other 3 - 12.5 4,541 4,840 Construction in progress - 3,552 2,794 28,711 27,959 Less: Accumulated depreciation 14,812 14,990 Property, plant and equipment $ 13,900 $ 12,969 The following provides long-lived assets by geographic area: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Property, plant and equipment United States $ 7,821 $ 7,194 Developed Europe 4,775 4,238 Developed Rest of World 413 453 Emerging Markets 890 1,083 Property, plant and equipment $ 13,900 $ 12,969 Note 10. Identifiable Intangible Assets and Goodwill A. Identifiable Intangible Assets The following summarizes the components of Identifiable intangible assets : As of December 31, 2020 As of December 31, 2019 (MILLIONS OF DOLLARS) Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Finite-lived intangible assets Developed technology rights (a) $ 73,545 $ ( 50,902 ) $ 22,643 $ 72,449 $ ( 47,092 ) $ 25,357 Brands 922 ( 774 ) 148 922 ( 741 ) 181 Licensing agreements and other (b) 2,292 ( 1,186 ) 1,106 1,687 ( 1,108 ) 579 76,759 ( 52,862 ) 23,896 75,058 ( 48,941 ) 26,117 Indefinite-lived intangible assets Brands 827 827 827 827 IPRD (c) 3,175 3,175 5,919 5,919 Licensing agreements and other (b) 573 573 1,073 1,073 4,575 4,575 7,819 7,819 Identifiable intangible assets (d) $ 81,334 $ ( 52,862 ) $ 28,471 $ 82,877 $ ( 48,941 ) $ 33,936 (a) The increase in the gross carrying amount primarily reflects the transfer of $ 600 million from IPRD to Developed technology rights to reflect the approval of Braftovi in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy, as well as a $ 499 million capitalized portion of an upfront payment to Myovant (see Note 2E ) and an increase from a $ 200 million measurement period adjustment related to the acquisition of Array (see Note 2A ), partially offset by a $ 528 million impairment of Eucrisa (see Note 4 ) and a $ 263 million impairment of certain generic sterile injectables acquired in connection with our acquisition of Hospira (see Note 4 ). (b) The changes in the gross carrying amounts primarily reflect the transfer of $ 600 million from indefinite-lived Licensing agreements and other to finite-lived Licensing agreements and other to reflect the approval in the U.S. of several products subject to out-licensing arrangements acquired from Array, as well as measurement period adjustments related to the acquisition of Array. (c) The decrease in the gross carrying amount primarily reflects a decrease from a $ 1.2 billion measurement period adjustment related to the acquisition of Array, a $ 900 million impairment of IPRD (see Note 4 ), and the transfer of $ 600 million from IPRD to Developed technology rights to reflect the approval of Braftovi in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy. (d) The decrease is primarily due to amortization, impairments , and measurement period adjustments related to the acquisition of Array, partially offset by the capitalization of an upfront payment to Myovant (see Note 2E ). Nearly all of our identifiable intangible assets are managed by our commercial organization, with only 9 % of total cost of IPRD managed by our RD organization. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Developed Technology Rights Developed technology rights represent the cost for developed technology acquired from third parties and can include the right to develop, use, market, sell and/or offer for sale the product, compounds and intellectual property that we have acquired with respect to products, compounds and/or processes that have been completed. We possess a well-diversified portfolio of hundreds of developed technology rights across therapeutic categories, representing our commercialized products. The significant components of developed technology rights are the following: Xtandi, Prevnar 13/Prevenar 13 Infant, Braftovi/Mektovi, Premarin, Prevnar 13/Prevenar 13 Adult, Eucrisa, Orgovyx, and, to a lesser extent Zavicefta, Tygacil, Merrem/Meronem, Refacto AF/Xyntha, Pristiq and Bosulif. Also included in this category are the post-approval milestone payments made under our alliance agreements for certain biopharmaceutical products. Brands Brands represent the cost for tradenames and know-how, as the products themselves do not receive patent protection. Indefinite-lived brands include Medrol and Depo-Medrol, while finite-lived brands include Depo-Provera and Zavedos. IPRD IPRD assets represent RD assets that have not yet received regulatory approval in a major market. The significant components of IPRD are the following: the program for the oral poly ADP ribose polymerase inhibitor for the treatment of patients with germline BRCA-mutated advanced breast cancer acquired as part of the Medivation acquisition and assets acquired in connection with the Array acquisition. IPRD assets are required to be classified as indefinite-lived assets until the successful completion or the abandonment of the associated RD effort. Accordingly, during the development period after the date of acquisition, these assets are not amortized until approval is obtained in a major market, typically either the U.S. or the EU, or in a series of other countries, subject to certain specified conditions and management judgment. At that time, we will determine the useful life of the asset, reclassify it out of IPRD and begin amortization. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. IPRD assets are high-risk assets, given the uncertain nature of RD. Accordingly, we expect that many of these IPRD assets will become impaired and be written-off at some time in the future. Licensing Agreements Licensing agreements for developed technology and for technology in development primarily relate to out-licensing arrangements acquired from third parties, including the Array acquisition. These assets represent the cost for the license, where we acquired the right to future royalties and/or milestones upon development or commercialization by the licensing partner. A significant component of the licensing arrangements are for out-licensing arrangements with a number of partners for oncology technology in varying stages of development that have not yet received regulatory approval in a major market. Accordingly, during the development period after the date of acquisition, each of these assets is classified as indefinite-lived intangible assets and will not be amortized until approval is obtained in a major market. At that time we will determine the useful life of the asset, reclassify the respective licensing arrangement asset to finite-lived intangible asset and begin amortization. If the development effort is abandoned, the related licensing asset will likely be written-off, and we will record an impairment charge. Amortization The weighted-average life for each of our total finite-lived intangible assets and the largest component, developed technology rights, is approximately 9 years. Total amortization expense for finite-lived intangible assets was $ 3.5 billion in 2020, $ 4.5 billion in 2019 and $ 4.8 billion in 2018. The following provides the expected annual amortization expense: (MILLIONS OF DOLLARS) 2021 2022 2023 2024 2025 Amortization expense $ 3,372 $ 3,249 $ 2,921 $ 2,642 $ 2,492 B. Goodwill At the beginning of 2019, we reorganized our commercial operations and began to manage our businesses through three different operating segmentsBiopharma, Upjohn and Consumer Healthcare. As a result of the reorganization of our commercial operations, our remaining goodwill was required to be reallocated amongst the then new Biopharma and Upjohn operating segments by determining the fair value of each reporting unit under our old and new management structure and the portions being transferred. We completed this re-allocation based on relative fair value in the second quarter of 2019 and retrospectively presented goodwill according to the operating structure. Our Consumer Healthcare business was classified as held for sale as of December 31, 2018 and, upon closing of the transaction with GSK during the third quarter of 2019, we deconsolidated our Consumer Healthcare business and derecognized Consumer Healthcare goodwill. For additional information, see Note 2C . On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan. Upon closing, we deconsolidated the Upjohn business and derecognized $ 10.6 billion in Upjohn goodwill. In addition, at December 31, 2019, the goodwill associated with the Upjohn Business was classified as Noncurrent assets of discontinued operations . For additional information, see Note 2B . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes the components and changes in the carrying amount of Goodwill : (MILLIONS OF DOLLARS) Total Balance, January 1, 2019 $ 42,927 Additions (a) 5,411 Other (b) ( 136 ) Balance, December 31, 2019 48,202 Additions (c) 727 Other (b) 648 Balance, December 31, 2020 $ 49,577 (a) Additions relate to our acquisition of Array (see Note 2A ). (b) Other represents the impact of foreign exchange. (c) Additions primarily represent the impact of measurement period adjustments related to our Array acquisition (see Note 2A ). Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans The majority of our employees worldwide are eligible for retirement benefits provided through defined benefit pension plans, defined contribution plans or both. In the U.S., we sponsor both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans. A qualified plan meets the requirements of certain sections of the IRC, and, generally, contributions to qualified plans are tax deductible. A qualified plan typically provides benefits to a broad group of employees with restrictions on discriminating in favor of highly compensated employees with regard to coverage, benefits and contributions. A supplemental (non-qualified) plan provides additional benefits to certain employees. In addition, we provide medical insurance benefits to certain retirees and their eligible dependents through our postretirement plans. A. Components of Net Periodic Benefit Costs and Changes in Other Comprehensive Income/(Loss) The following provides the annual (credit)/cost (including costs reported as part of discontinued operations) and changes in Other comprehensive income/(loss) for our benefit plans: Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ $ $ $ $ $ $ 146 $ 125 $ 136 $ 38 $ 37 $ 39 Interest cost 499 629 598 34 47 55 164 215 212 49 75 72 Expected return on plan assets ( 1,015 ) ( 890 ) ( 1,040 ) ( 306 ) ( 317 ) ( 360 ) ( 36 ) ( 33 ) ( 37 ) Amortization of: Actuarial losses 136 147 120 15 11 13 125 80 101 3 7 Prior service cost/(credit) ( 3 ) ( 3 ) 2 ( 1 ) ( 1 ) ( 1 ) ( 3 ) ( 4 ) ( 4 ) ( 170 ) ( 173 ) ( 178 ) Curtailments 12 1 ( 1 ) ( 4 ) ( 47 ) ( 17 ) Settlements 223 230 113 49 27 26 6 16 4 ( 10 ) Special termination benefits ( 1 ) 4 6 2 17 10 2 2 Net periodic benefit cost/(credit) reported in income ( 161 ) 116 ( 189 ) 99 100 103 132 115 84 ( 118 ) ( 146 ) ( 111 ) (Credit)/cost reported in Other comprehensive income/(loss) 640 ( 246 ) 361 95 115 ( 189 ) 202 570 84 ( 50 ) 38 105 (Credit)/cost recognized in Comprehensive income $ 479 $ ( 129 ) $ 171 $ 194 $ 215 $ ( 86 ) $ 333 $ 685 $ 168 $ ( 168 ) $ ( 107 ) $ ( 6 ) Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Actuarial Assumptions The following provides the weighted-average actuarial assumptions of our benefit plans: Year Ended December 31, (PERCENTAGES) 2020 2019 2018 Weighted-average assumptions used to determine benefit obligations Discount rate: U.S. qualified pension plans 2.6 % 3.3 % 4.4 % U.S. non-qualified pension plans 2.4 % 3.2 % 4.3 % International pension plans 1.5 % 1.7 % 2.5 % Postretirement plans 2.5 % 3.2 % 4.3 % Rate of compensation increase (a) : International pension plans 2.9 % 1.4 % 1.4 % Weighted-average assumptions used to determine net periodic benefit cost Discount rate: U.S. qualified pension plans 3.3 % 4.4 % 3.8 % U.S. non-qualified pension plans 3.2 % 4.3 % 3.7 % International pension plans interest cost 1.5 % 2.2 % 2.0 % International pension plans service cost 1.6 % 2.4 % 2.3 % Postretirement plans 3.2 % 4.3 % 3.7 % Expected return on plan assets: U.S. qualified pension plans 7.0 % 7.2 % 7.5 % International pension plans 3.6 % 3.9 % 4.4 % Postretirement plans 7.0 % 7.3 % 7.5 % Rate of compensation increase: U.S. qualified pension plans (a) 2.8 % U.S. non-qualified pension plans (a) 2.8 % International pension plans 2.9 % 1.4 % 2.5 % (a) Effective January 1, 2018, we froze the defined benefit plans to future benefit accruals in the U.S. and members accrued benefits to that date no longer increase in line with future compensation increases. The rate of compensation increase is therefore no longer an assumption used to determine the benefit obligation and net periodic benefit cost for the U.S. qualified and non-qualified pension plans. The assumptions above are used to develop the benefit obligations at each fiscal year-end. All of the assumptions are reviewed on at least an annual basis. We revise these assumptions based on an annual evaluation of long-term trends as well as market conditions that may have an impact on the cost of providing retirement benefits. The weighted-average discount rate for our U.S. defined benefit plans is determined annually and evaluated and modified to reflect at year-end the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better that reflect the rates at which the pension benefits could be effectively settled. For our international plans, the discount rates are set by benchmarking against investment grade corporate bonds rated AA/Aa or better, including, when there is sufficient data, a yield curve approach. These rate determinations are made consistent with local requirements. Overall, the yield curves used to measure the benefit obligations at year-end 2020 resulted in lower discount rates as compared to the prior year. The following provides the healthcare cost trend rate assumptions for our U.S. postretirement benefit plans: As of December 31, 2020 2019 Healthcare cost trend rate assumed for next year (up to age 65) 5.4 % 5.6 % Healthcare cost trend rate assumed for next year (age 65 and older) 5.6 % 6.0 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the rate reaches the ultimate trend rate 2037 2037 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Obligations and Funded Status The following provides an analysis of the changes in our benefit obligations, plan assets and funded status of our benefit plans (including those reported as part of discontinued operations): U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Change in benefit obligation (a) Benefit obligation, beginning $ 16,535 $ 15,141 $ 1,351 $ 1,280 $ 11,059 $ 9,952 $ 1,667 $ 1,870 Service cost 146 125 38 37 Interest cost 499 629 34 47 164 215 49 75 Employee contributions 8 7 88 84 Plan amendments 2 2 18 ( 56 ) ( 56 ) Changes in actuarial assumptions and other (b) 1,953 2,001 159 152 702 1,224 ( 132 ) ( 87 ) Foreign exchange impact 646 ( 33 ) 2 ( 1 ) Upjohn spin-off (c) ( 1,016 ) ( 320 ) ( 218 ) Acquisitions/divestitures/other, net ( 4 ) ( 1 ) ( 55 ) ( 36 ) Curtailments ( 2 ) Settlements ( 650 ) ( 692 ) ( 117 ) ( 70 ) ( 34 ) ( 34 ) Special termination benefits ( 1 ) 4 2 17 2 Benefits paid ( 383 ) ( 544 ) ( 62 ) ( 74 ) ( 372 ) ( 360 ) ( 201 ) ( 221 ) Benefit obligation, ending (a) 16,940 16,535 1,366 1,351 12,001 11,059 1,238 1,667 Change in plan assets Fair value of plan assets, beginning 14,586 13,051 8,956 8,215 519 469 Actual gain/(loss) on plan assets 1,974 2,760 868 873 69 50 Company contributions 1,253 11 179 144 197 230 113 137 Employee contributions 8 7 88 84 Foreign exchange impact 462 42 Upjohn spin-off (c) ( 687 ) ( 270 ) Acquisitions/divestitures, net ( 6 ) ( 16 ) Settlements ( 650 ) ( 692 ) ( 117 ) ( 70 ) ( 34 ) ( 34 ) Benefits paid ( 383 ) ( 544 ) ( 62 ) ( 74 ) ( 372 ) ( 360 ) ( 201 ) ( 221 ) Fair value of plan assets, ending 16,094 14,586 9,811 8,956 588 519 Funded statusPlan assets less than benefit obligation $ ( 845 ) $ ( 1,949 ) $ ( 1,366 ) $ ( 1,351 ) $ ( 2,191 ) $ ( 2,103 ) $ ( 651 ) $ ( 1,148 ) (a) The PBO represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases. The ABO is similar to the PBO but does not factor in future compensation increases. For the U.S. qualified and supplemental (non-qualified) pension plans, the benefit obligation is the PBO, which is also equal to the ABO. For the international pension plans, the benefit obligation is the PBO. The ABO for our international pension plans was $ 11.5 billion in 2020 and $ 10.6 billion in 2019. For the postretirement plans, the benefit obligation is the ABO. (b) Primarily includes actuarial losses resulting from decreases in discount rates in 2020 and 2019 . (c) For more information, see Note 2B . The following provides information as to how the funded status is recognized in our consolidated balance sheets: Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Noncurrent assets (a) $ $ $ $ $ 522 $ 453 $ $ Current liabilities (b) ( 127 ) ( 189 ) ( 31 ) ( 30 ) ( 6 ) ( 24 ) Noncurrent liabilities (c) ( 845 ) ( 1,949 ) ( 1,239 ) ( 1,162 ) ( 2,681 ) ( 2,526 ) ( 645 ) ( 1,124 ) Funded status $ ( 845 ) $ ( 1,949 ) $ ( 1,366 ) $ ( 1,351 ) $ ( 2,191 ) $ ( 2,103 ) $ ( 651 ) $ ( 1,148 ) (a) Included in Other noncurrent assets . (b) Included in Accrued compensation and related items . (c) Included in Pension benefit obligations , Postretirement benefit obligations , and Other noncurrent liabilities , as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following provides the pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Actuarial losses (a) $ ( 5,062 ) $ ( 4,812 ) $ ( 579 ) $ ( 484 ) $ ( 3,056 ) $ ( 2,921 ) $ 58 $ ( 76 ) Prior service (costs)/credits ( 3 ) ( 2 ) ( 1 ) ( 31 ) ( 21 ) 688 830 Total (b) $ ( 5,065 ) $ ( 4,814 ) $ ( 580 ) $ ( 485 ) $ ( 3,087 ) $ ( 2,942 ) $ 746 $ 754 (a) Primarily represent the impact of changes in discount rates and other assumptions that result in cumulative changes in our PBO, as well as the cumulative difference between the expected return and actual return on plan assets. These accumulated actuarial losses are recognized in Accumulated other comprehensive loss and are amortized into net periodic benefit costs primarily over the average remaining service period for active participants for plans that are not frozen or the average life expectancy of plan participants for frozen plans, primarily using the corridor approach. (b) The change from December 31, 2019 includes the derecognition of $ 388 million of pre-tax actuarial losses, net of prior service credits associated with benefit plans distributed as a result of the spin-off and the combination of the Upjohn Business with Mylan on November 16, 2020. The following provides information related to the funded status of selected benefit plans (including those reported as part of liabilities of discontinued operations): U.S. Qualified U.S. Supplemental (Non-Qualified) International As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 Pension plans with an ABO in excess of plan assets: Fair value of plan assets $ 16,094 $ 14,586 $ $ $ 6,674 $ 5,843 ABO 16,940 16,535 1,366 1,351 8,961 7,960 Pension plans with a PBO in excess of plan assets: Fair value of plan assets 16,094 14,586 6,735 5,947 PBO 16,940 16,535 1,366 1,351 9,447 8,503 All of our U.S. plans and many of our international plans were underfunded as of December 31, 2020. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Plan Assets The following provides the components of plan assets (including those reported as part of discontinued operations): Fair Value Fair Value (MILLIONS OF DOLLARS) As of December 31, 2020 Level 1 Level 2 Level 3 Assets Measured at NAV (a) As of December 31, 2019 Level 1 Level 2 Level 3 Assets Measured at NAV (a) U.S. qualified pension plans Cash and cash equivalents $ 781 $ 70 $ 711 $ $ $ 363 $ 80 $ 284 $ $ Equity securities: Global equity securities 3,241 3,213 27 1 3,464 3,406 57 Equity commingled funds 1,325 1,110 215 1,179 819 360 Fixed income securities: Corporate debt securities 6,499 23 6,476 5,292 10 5,281 1 Government and agency obligations (b) 1,555 1,555 1,799 1,799 Fixed income commingled funds 23 23 6 6 Other investments: Partnership investments (c) 1,431 1,431 1,212 1,212 Insurance contracts 190 190 196 196 Other commingled funds (d) 1,049 11 1,038 1,075 9 1,066 Total $ 16,094 $ 3,306 $ 10,103 $ 1 $ 2,684 $ 14,586 $ 3,496 $ 8,451 $ 1 $ 2,638 International pension plans Cash and cash equivalents $ 407 $ 61 $ 346 $ $ $ 221 $ 33 $ 187 $ $ Equity securities: Equity commingled funds 2,051 1,681 370 1,922 1,548 374 Fixed income securities: Corporate debt securities 925 925 796 796 Government and agency obligations (b) 1,334 1,334 1,200 1,200 Fixed income commingled funds 2,484 1,217 1,267 2,201 1,031 1,171 Other investments: Partnership investments (c) 69 3 66 66 3 63 Insurance contracts 1,027 57 969 1 1,027 82 944 1 Other (d) 1,514 117 393 1,003 1,524 82 398 1,043 Total $ 9,811 $ 61 $ 5,681 $ 1,362 $ 2,707 $ 8,956 $ 33 $ 4,929 $ 1,342 $ 2,652 U.S. postretirement plans (e) Insurance contracts $ 588 $ $ 588 $ $ $ 519 $ $ 519 $ $ (a) Certain investments that are measured at NAV per share (or its equivalent) have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented for the total pension benefits plan assets. (b) Government and agency obligations are inclusive of repurchase agreements . (c) Mainly includes investments in private equity, private debt, public equity limited partnerships, and, to a lesser extent, real estate and venture capital. (d) Mostly includes investments in hedge funds and real estate. (e) Reflects postretirement plan assets, which support a portion of our U.S. retiree medical plans. The following provides an analysis of the changes in our more significant investments valued using significant unobservable inputs (including those reported as part of discontinued operations): International Pension Plans Insurance contracts Other Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 Fair value, beginning $ 944 $ 684 $ 398 $ 382 Actual return on plan assets: Assets held, ending 32 50 ( 10 ) 6 Purchases, sales, and settlements, net ( 38 ) ( 40 ) ( 10 ) 6 Transfer into/(out of) Level 3 ( 11 ) 247 ( 2 ) Exchange rate changes 42 2 16 4 Fair value, ending $ 969 $ 944 $ 393 $ 398 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Equity securities, Fixed income securities and Other investments may each be combined into commingled funds. Most commingled funds are valued to reflect the interest in the fund based on the reported year-end NAV. Partnership and Other investments are valued based on year-end reported NAV (or its equivalent), with adjustments as appropriate for lagged reporting of up to three months. The following methods and assumptions were used to estimate the fair value of our pension and postretirement plans assets: Cash and cash equivalents: Level 1 investments may include cash, cash equivalents and foreign currency valued using exchange rates. Level 2 investments may include short-term investment funds which are commingled funds priced at a stable NAV by the administrator of the funds. Equity securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 1 and Level 2 investments may include commingled funds that have a readily determinable fair value based on quoted prices on an exchange or a published NAV derived from the quoted prices in active markets of the underlying securities. Level 3 investments may include individual securities that are unlisted, delisted, suspended, or illiquid and are typically valued using their last available price. Fixed income securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include commingled funds that have a readily determinable fair value based on observable prices of the underlying securities. Level 2 investments may include corporate bonds, government and government agency obligations and other fixed income securities valued using bid evaluation pricing models or quoted prices of securities with similar characteristics. Level 3 investments may include securities that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Other investments: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include Insurance contracts which invest in interest bearing cash, U.S. government securities and corporate debt instruments. Certain investments are authorized to include derivatives, such as equity or bond futures, swaps, options and currency futures or forwards for managing risks and exposures. The following provides the long-term target asset allocations ranges and the percentage of the fair value of plan assets for benefit plans: Target Allocation Percentage Percentage of Plan Assets As of December 31, (PERCENTAGES) 2020 2020 2019 U.S. qualified pension plans Cash and cash equivalents 0 - 10 % 4.9 % 2.5 % Equity securities 35 - 55 % 28.4 % 31.8 % Fixed income securities 28 - 53 % 50.2 % 48.7 % Other investments 5 - 20 % 16.6 % 17.0 % Total 100 % 100 % 100 % International pension plans Cash and cash equivalents 0 - 10 % 4.2 % 2.5 % Equity securities 20 - 40 % 20.9 % 21.5 % Fixed income securities 35 - 60 % 48.4 % 46.9 % Other investments 10 - 35 % 26.6 % 29.2 % Total 100 % 100 % 100 % U.S. postretirement plans Cash and cash equivalents 0 - 5 % Other investments 95 - 100 % 100 % 100 % Total 100 % 100 % 100 % Global plan assets are managed with the objective of generating returns that will enable the plans to meet their future obligations, while seeking to manage net periodic benefit costs and cash contributions over the long-term. We utilize long-term asset allocation ranges in the management of our plans invested assets. Our long-term return expectations are developed based on a diversified, global investment strategy that takes into account historical experience, as well as the impact of portfolio diversification, active portfolio management, and our view of current and future economic and financial market conditions. As market conditions and other factors change, we may adjust our targets accordingly and our asset allocations may vary from the target allocations. Our long-term asset allocation ranges reflect our asset class return expectations and tolerance for investment risk within the context of the respective plans long-term benefit obligations. These ranges are supported by analysis that incorporates historical and expected returns by asset class, as well as volatilities and correlations across asset classes and our liability profile. Each pension plan is overseen by a local committee or board that is responsible for the overall investment of the pension plan assets. In determining investment policies and associated target allocations, each committee or board considers a wide variety of factors. As such, the target asset allocation for each of our international pension plans is set on a standalone basis by the relevant board or committee. The target Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies asset allocation ranges shown for the international pension plans seek to reflect the combined target allocations across all such plans, while also showing the range within which the target allocations for each plan typically falls. The investment managers of certain separately managed accounts, commingled funds and private equity funds may be permitted to use repurchase agreements and derivative securities, including U.S. Treasury and equity futures contracts as described in each respective investment management, subscription, partnership or other governing agreement. E. Cash Flows It is our practice to fund amounts for our qualified pension plans that are at least sufficient to meet the minimum requirements set forth in applicable employee benefit laws and local tax laws. The following provides the expected future cash flow information related to our benefit plans: Pension Plans (MILLIONS OF DOLLARS) U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Expected employer contributions: 2021 $ $ 127 $ 282 $ 90 Expected benefit payments: 2021 $ 1,139 $ 127 $ 371 $ 97 2022 1,036 121 375 94 2023 1,032 116 375 92 2024 1,030 106 385 89 2025 986 100 393 86 20262030 4,625 424 2,086 430 The above table reflects the total U.S. and international plan benefits projected to be paid from the plans or from our general assets under the current actuarial assumptions used for the calculation of the benefit obligation and, therefore, actual benefit payments may differ from projected benefit payments. F. Defined Contribution Plans We have defined contribution plans in the U.S. and several other countries. For the majority of the U.S. defined contribution plans, employees may contribute a portion of their salaries and bonuses to the plans, and we match, in cash, a portion of the employee contributions. Beginning on January 1, 2011, for newly hired non-union employees, rehires and transfers to the U.S. or Puerto Rico, we no longer offer a defined benefit pension plan and, instead, offer a Retirement Savings Contribution (RSC) in the defined contribution plan. The RSC is an annual non-contributory employer contribution (that is not dependent upon the participant making a contribution) determined based on each employees eligible compensation, age and years of service. Beginning on January 1, 2018, all non-union employees in the U.S. and Puerto Rico defined benefit plans transitioned to the RSC in the defined contribution plans. We recorded charges related to the employer contributions to global defined contribution plans of $ 685 million in 2020, $ 659 million in 2019 and $ 622 million in 2018. Note 12. Equity A. Common Stock Purchases We purchase our common stock through privately negotiated transactions or in the open market as circumstances and prices warrant. Purchased shares under each of the share-purchase plans, which are authorized by our BOD, are available for general corporate purposes. In December 2015, the BOD authorized an $ 11 billion share repurchase program, which was exhausted in the third quarter of 2018. In December 2017, the BOD authorized an additional $ 10 billion share repurchase program, which was exhausted in the first quarter of 2019. In December 2018, the BOD authorized another $ 10 billion share repurchase program to be utilized over time and share repurchases commenced thereunder in the first quarter of 2019. In March 2018, we entered into an accelerated share repurchase agreement (ASR) with Citibank, N.A. to repurchase $ 4 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 4 billion and received an initial delivery of 87 million shares of stock at a price of $ 36.61 per share, which represented approximately 80 % of the notional amount of the ASR. In September 2018, the ASR was completed resulting in Citibank owing us an additional 21 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 36.86 per share. The common stock received is included in Treasury stock . In February 2019, we entered into an ASR with Goldman Sachs Co. LLC to repurchase $ 6.8 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 6.8 billion and received an initial delivery of 130 million shares of common stock, which represented approximately 80 % of the notional amount of the ASR. In August 2019, the ASR with Goldman Sachs Co. LLC was completed resulting in Goldman Sachs Co. LLC owing us an additional 33.5 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 41.42 per share. The common stock received is included in Treasury stock . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following provides the number of shares of our common stock purchased and the cost of purchases under our publicly announced share purchase plans, including our ASRs: Year Ended December 31, (SHARES IN MILLIONS, DOLLARS IN BILLIONS) 2020 2019 (a) 2018 (b) Shares of common stock purchased 213 307 Cost of purchase $ $ 8.9 $ 12.2 (a) Represents shares purchased pursuant to the ASR with Goldman Sachs Co. LLC entered into in February 2019, as well as open market share repurchases of $ 2.1 billion . (b) Represents shares purchased pursuant to the ASR with Citibank entered into in March 2018, as well as open market share repurchases of $ 8.2 billion . Our remaining share-purchase authorization was approximately $ 5.3 billion at December 31, 2020. B. Preferred Stock and Employee Stock Ownership Plans Prior to May 4, 2020, our Series A convertible perpetual preferred stock (the Series A Preferred Stock) was held by an ESOP trust (the Trust). All outstanding shares of Series A Preferred Stock were converted, at the direction of the independent fiduciary under the Trust and in accordance with the certificate of designations for the Series A Preferred Stock, into shares of our common stock on May 4, 2020. The Trust received an aggregate of 1,070,369 shares of our common stock upon conversion, with zero shares of Series A Preferred Stock remaining outstanding as a result of the conversion. In December 2020, we filed a certificate of elimination and a restated certificate of incorporation with the Delaware Secretary of State, which eliminated the Series A Preferred Stock. Since May 4, 2020, we have one ESOP that holds common stock of the Company (Common ESOP). Prior to that there was also an ESOP that held the Series A Preferred Stock. As of December 31, 2020, all shares of common stock held by the Common ESOP have been allocated to the Pfizer U.S. defined contribution plan participants. The compensation cost related to the Common ESOP was $ 19 million in 2020, $ 20 million in 2019 and $ 19 million in 2018. Note 13. Share-Based Payments Our compensation programs can include share-based payment awards with value that is determined by reference to the fair value of our shares and that provide for the grant of shares or options to acquire shares or similar arrangements. Our share-based awards are designed based on competitive survey data or industry peer groups used for compensation purposes; and are allocated between different long-term incentive awards, generally in the form of Total Shareholder Return Units (TSRUs), Restricted Stock Units (RSUs), Portfolio Performance Shares (PPSs), Performance Share Awards (PSAs) and Stock Options, as determined by the Compensation Committee. The 2019 Stock Plan (2019 Plan) replaced and superseded the 2014 Plan. It provides for 400 million shares, in addition to shares remaining under the 2014 Plan, to be authorized for grants. The 2019 Plan provides that the number of stock options, TSRUs, RSUs, or performance-based awards that may be granted to any one individual during any 36-month period is limited to 20 million shares, and that RSUs, PPSs and PSAs count as three shares, while TSRUs and stock options count as one share, toward the maximum shares available under the 2019 Plan. As of December 31, 2020, 411 million shares were available for award. Although not required to do so we have used authorized and unissued shares and, to a lesser extent, treasury stock to satisfy our obligations under these programs. A summary of the awards and valuation details: Awarded to Terms Valuation Recognition and Presentation Total Shareholder Return Units (TSRUs) (a), (b) Senior and other key management and select employees Entitle the holder to receive shares of our common stock with a value equal to the difference between the defined settlement price and the grant price, plus the dividends accumulated during the five or seven -year term, if and to the extent the total value is positive. Settlement price is the average closing price of our common stock during the 20 trading days ending on the fifth or seventh anniversary of the grant, as applicable; the grant price is the closing price of our common stock on the date of the grant. Automatically settled on the fifth or seventh anniversary of the grant but vest on the third anniversary of the grant, after which time there is no longer a substantial likelihood of forfeiture. As of the grant date using a Monte Carlo simulation model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Restricted Stock Units (RSUs) Select employees Entitle the holder to receive a specified number of shares of our common stock, including shares resulting from dividend equivalents paid on such RSUs. For RSUs granted during the periods presented, in virtually all instances, the units vest after three years of continuous service from the grant date. As of the grant date using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Awarded to Terms Valuation Recognition and Presentation Portfolio Performance Shares (PPSs) Select employees Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents paid on such shares. For PPSs granted during the period presented, the awards vest after three years of continuous service from the grant date and the number of shares paid, if any, depends on the achievement of predetermined goals related to Pfizers long-term product portfolio during a five -year performance period from the year of the grant date. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, changes in the number of shares that are probable of being earned and changes in managements assessment of the probability that the specified performance criteria will be achieved and/or changes in managements assessment of the probable vesting term. Performance Share Awards (PSAs) Senior and other key management Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents, dependent upon the achievement of predetermined goals related to two measures: a. Adjusted operating income (for performance years through 2018) or adjusted net income (for 2019 and later years, except for the 2017 PSAs) over three one-year periods; and b. TSR as compared to the NYSE ARCA Pharmaceutical Index (DRG Index) over the three -year performance period. PSAs vest after three years of continuous service from the grant date. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, changes in the number of shares that are probable of being earned and changes in managements assessment of the probability that the specified performance criteria will be achieved. Stock Options Select employees Entitle the holder to purchase a specified number of our common stock at a price per share equal to the closing market price of our common stock on the date of grant, when vested. Beginning in 2016, only a limited set of non-U.S. employees received stock option grants. No stock options were awarded to senior and other key management in any period presented. Stock options vest after three years of continuous service from the grant date and have a contractual term of 10 years. As of the grant date using the Black-Scholes-Merton option-pricing model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. (a) Retirement-eligible holders, as defined in the grant terms, can convert their TSRUs, when vested, into Profit Units (PTUs) with a conversion ratio based on a calculation used to determine the shares at TSRU settlement. The PTUs are entitled to earn Dividend Equivalent Units (DEUs), and the PTUs and DEUs will be settled in our common stock on the TSRUs original settlement date and will be subject to the terms and conditions of the original grant including forfeiture provisions. (b) In 2017, Performance Total Shareholder Return Units (PTSRUs) were awarded to the Former Chairman and Chief Executive Officer ( 1,444,395 PTSRUs) and 361,099 PTSRUs were awarded to the Group President, Chief Business Officer (former role Group President Pfizer Innovative Health) at a grant price of $ 30.31 and at a GDFV of $ 5.54 per PTSRU. All these amounts have been adjusted for the Upjohn spin-off discussed in Note 2B . In addition to having the same characteristics and valuation methodology of TSRUs, PTSRU grants require special service and performance conditions . The following provides data related to all TSRU, RSU, PPS, PSA and stock option activity: (MILLIONS OF DOLLARS, EXCEPT FAIR VALUE OF SHARES VESTED PER TSRU AND STOCK OPTION) TSRUs RSUs PPSs PSAs Stock Options Year Ended December 31, 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 Total fair value of shares vested (a) $ 6.22 $ 8.52 $ 7.42 $ 334 $ 454 $ 146 $ 119 $ 136 $ 169 $ 25 $ 64 $ 4 $ 3.56 $ 5.98 $ 5.06 Total intrinsic value of options exercised or share units converted $ 84 $ 175 $ 151 $ 224 $ 245 $ 194 $ 293 $ 261 $ 625 Cash received upon exercise $ 425 $ 394 $ 1,259 Tax benefits realized from exercise $ 55 $ 47 $ 115 Compensation cost recognized, pre-tax (b) $ 287 $ 294 $ 302 $ 272 $ 275 $ 286 $ 180 $ 114 $ 276 $ 31 $ 28 $ 62 $ 6 $ 7 $ 12 Total compensation cost related to nonvested awards not yet recognized, pre-tax $ 224 $ 229 $ 246 $ 228 $ 241 $ 256 $ 104 $ 87 $ 102 $ 32 $ 34 $ 41 $ 4 $ 5 $ 5 Weighted-average period over which cost is expected to be recognized (years) 1.6 1.6 1.6 1.7 1.7 1.7 1.8 1.8 1.8 1.9 1.8 1.8 1.7 1.6 1.7 (a) Weighted-average GDFV per TSRUs and stock options. (b) TSRU includes expense for PTSRUs, which is not significant for all years presented . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Total share-based payment expense was $ 780 million, $ 718 million and $ 949 million in 2020, 2019 and 2018, respectively, which includes pre-tax share-based payment expense included in Income from discontinued operations net of tax of $ 23 million, $ 30 million and $ 27 million in 2020, 2019 and 2018, respectively. Tax benefit for share-based compensation expense was $ 141 million, $ 137 million and $ 180 million in 2020, 2019 and 2018, respectively. The table above excludes total expense due to the modification for share-based awards in connection with our cost reduction/productivity initiatives, which was not significant for all years presented and is recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). Amounts capitalized as part of inventory cost were not significant for any period presented. Summary of the weighted-average assumptions used in the valuation of TSRUs and stock options: TSRUs Stock Options Year Ended December 31, 2020 2019 2018 2020 2019 2018 Expected dividend yield (based on a constant dividend yield during the expected term) 4.36 % 3.27 % 3.73 % 4.36 % 3.27 % 3.73 % Risk-free interest rate (based on interpolated yield on U.S. Treasury zero-coupon issues) 1.15 % 2.55 % 2.60 % 1.25 % 2.66 % 2.85 % Expected stock price volatility (based on implied volatility, after consideration of historical volatility) 20.99 % 18.34 % 20.00 % 20.97 % 18.34 % 20.02 % TSRUs contractual/stock options expected term, years (based on historical exercise and post-vesting termination patterns for stock options) 5.12 5.13 5.12 6.75 6.75 6.75 Summary of all TSRU, RSU, PPS and PSA activity during 2020 (with the shares granted representing the maximum award that could be achieved for PPSs and PSAs): TSRUs RSUs PPSs (a) PSAs TSRUs Per TSRU, Weighted Average Shares Weighted Avg. GDFV per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share (Thousands) GDFV Grant Price (Thousands) (Thousands) (Thousands) Nonvested, December 31, 2019 (b) 122,654 $ 7.53 $ 38.01 23,407 $ 37.54 17,694 $ 39.18 5,061 $ 39.18 Granted (b) 51,158 6.22 34.12 8,423 34.22 8,150 34.10 1,713 34.10 Vested (b) ( 45,757 ) 6.40 34.11 ( 9,321 ) 34.70 ( 6,393 ) 34.73 ( 728 ) 34.65 Reinvested dividend equivalents (b) 955 37.32 Forfeited (b) ( 4,782 ) 7.27 37.20 ( 999 ) 37.91 ( 713 ) 36.78 ( 1,052 ) 35.00 Upjohn spin-off adjustment (c) 6,571 6.88 32.94 1,228 35.55 1,338 36.69 270 36.69 Nonvested, December 31, 2020 129,844 $ 6.90 $ 32.94 23,692 $ 35.50 20,077 $ 36.81 5,264 $ 36.81 (a) Vested and non-vested shares outstanding, but not paid as of December 31, 2020 were 33.9 million. (b) Activity prior to the Upjohn Business spin-off has not been adjusted. (c) In connection with the Upjohn Business spin-off, the Company made adjustments to preserve the intrinsic value of the awards immediately before and after the spin-off. The terms of the outstanding awards remain the same and continue to vest over the original vesting periods. Certain outstanding awards at the time of the spin-off held by employees of Upjohn were prorated for services performed and the remaining portion forfeited at the time of the separation. The share-based awards held as of November 16, 2020 were adjusted as follows: The number of outstanding TSRUs was increased and the grant price was decreased. The number of shares of common stock subject to each outstanding RSUs, PPSs, and PSAs was increased. The adjustments to the stock-based compensation awards did not result in additional compensation cost. Summary of TSRU and PTU information as of December 31, 2020 (a), (b) : TSRUs (Thousands) PTUs (Thousands) Weighted-Average Grant Price Per TSRU Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (Millions) TSRUs Outstanding 230,539 $ 29.57 2.3 $ 1,737 TSRUs Vested 100,696 25.22 0.8 1,168 TSRUs Expected to vest (c) 124,594 32.94 3.3 547 TSRUs exercised and converted to PTUs 1,467 $ 0.3 $ 54 (a) In 2020, we settled 5,478,547 TSRUs with a weighted-average grant price of $ 30.93 per unit. (b) In 2020, 2,217,044 TSRUs with a weighted-average grant price of $ 29.26 per unit were converted into 757,285 PTUs. (c) The number of TSRUs expected to vest takes into account an estimate of expected forfeitures. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summary of all stock option activity during 2020: Shares (Thousands) Weighted-Average Exercise Price Per Share Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (a) (Millions) Outstanding, December 31, 2019 (b) 88,600 $ 28.39 Granted (b) 1,755 34.10 Exercised (b) ( 18,492 ) 23.05 Forfeited (b) ( 160 ) 35.49 Expired (b) ( 326 ) 24.91 Upjohn spin-off adjustment (c) 4,024 28.08 Outstanding, December 31, 2020 75,402 28.31 3.1 $ 645 Vested and expected to vest, December 31, 2020 (d) 75,226 28.30 3.0 645 Exercisable, December 31, 2020 71,732 $ 27.97 2.8 $ 635 (a) Market price of our underlying common stock less exercise price. (b) Activity prior to the Upjohn Business spin-off has not been adjusted. (c) In connection with the Upjohn business spin-off discussed above, the number of shares of common stock subject to each outstanding stock option was increased and the exercise price was decreased. These adjustments did not result in additional compensation cost. (d) The number of options expected to vest takes into account an estimate of expected forfeitures. Note 14. Earnings Per Common Share Attributable to Pfizer Inc. Common Shareholders The following presents the detailed calculation of EPS: Year Ended December 31, (IN MILLIONS) 2020 2019 2018 EPS NumeratorBasic Income from continuing operations attributable to Pfizer Inc. $ 6,985 $ 10,838 $ 3,825 Less: Preferred stock dividendsnet of tax 1 1 Income from continuing operations attributable to Pfizer Inc. common shareholders 6,984 10,837 3,824 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income attributable to Pfizer Inc. common shareholders $ 9,616 $ 16,272 $ 11,152 EPS NumeratorDiluted Income from continuing operations attributable to Pfizer Inc. common shareholders and assumed conversions $ 6,985 $ 10,838 $ 3,825 Income from discontinued operationsnet of tax, attributable to Pfizer Inc. common shareholders and assumed conversions 2,631 5,435 7,328 Net income attributable to Pfizer Inc. common shareholders and assumed conversions $ 9,616 $ 16,273 $ 11,153 EPS Denominator Weighted-average number of common shares outstandingBasic 5,555 5,569 5,872 Common-share equivalents: stock options, stock issuable under employee compensation plans convertible preferred stock and accelerated share repurchase agreements 77 106 105 Weighted-average number of common shares outstandingDiluted 5,632 5,675 5,977 Anti-dilutive common stock equivalents (a) 4 2 2 (a) These common stock equivalents were outstanding for the periods presented, but were not included in the computation of diluted EPS for those periods because their inclusion would have had an anti-dilutive effect. Allocated shares held by the Common ESOP, including reinvested dividends, are considered outstanding for EPS calculations and the eventual conversion of allocated preferred shares held by the Preferred ESOP was assumed in the diluted EPS calculation until the conversion date, which occurred in May 2020. See Note 12 . Note 15. Leases We lease real estate, fleet, and equipment for use in our operations. Our leases generally have lease terms of 1 to 30 years, some of which include options to terminate or extend leases for up to 5 to 10 years or on a month-to-month basis. We include options that are reasonably certain to be exercised as part of the determination of lease terms. We may negotiate termination clauses in anticipation of any changes in market conditions, but generally these termination options have not been exercised. Residual value guarantees are generally not included within our operating leases with the exception of some fleet leases. In addition to base rent payments, the leases may require us to pay directly for taxes and other non-lease components, such as insurance, maintenance and other operating expenses, which may be dependent on usage or vary month-to-month. Variable lease payments amounted to $ 380 million in 2020 and $ 327 million in 2019. We elected the practical expedient in the new standard to not separate non-lease components from lease components in calculating the amounts of ROU assets and lease liabilities for all underlying asset classes. We determine if an arrangement is a lease at inception of the contract and we perform the lease classification test as of the lease commencement date. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. For operating leases, the ROU assets and liabilities in our consolidated balance sheets follows: As of December 31, (MILLIONS OF DOLLARS) Balance Sheet Classification 2020 2019 ROU assets Other noncurrent assets $ 1,393 $ 1,289 Lease liabilities (short-term) Other current liabilities 321 269 Lease liabilities (long-term) Other noncurrent liabilities 1,114 1,030 Components of total lease cost includes: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 Operating lease cost $ 433 $ 422 Variable lease cost 380 327 Sublease income ( 40 ) ( 45 ) Total lease cost $ 773 $ 704 Other supplemental information for 2020 follows: Weighted-Average Remaining Contractual Lease Term (Years) Weighted-Average Discount Rate (MILLIONS OF DOLLARS) As of December 31, 2020 Year Ended December 31, Operating leases 6.9 2.9 % Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 334 (Gains)/losses on sale and leaseback transactions, net ( 3 ) ROU assets obtained in exchange for new operating lease liabilities 413 Other supplemental information for 2019 follows: Weighted-Average Remaining Contractual Lease Term (Years) Weighted-Average Discount Rate (MILLIONS OF DOLLARS) As of December 31, 2019 Year Ended December 31, Operating leases 6.9 3.5 % Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 339 (Gains)/losses on sale and leaseback transactions, net ( 29 ) ROU assets obtained in exchange for new operating lease liabilities 318 The following reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the consolidated balance sheet as of December 31, 2020: (MILLIONS OF DOLLARS) Period Operating Lease Liabilities Next one year (a) $ 357 1-2 years 299 2-3 years 250 3-4 years 167 4-5 years 137 Thereafter 408 Total undiscounted lease payments 1,618 Less: Imputed interest 183 Present value of minimum lease payments 1,435 Less: Current portion 321 Noncurrent portion $ 1,114 (a) Reflects lease payments due within 12 months subsequent to the balance sheet date. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In April 2018, we entered an agreement to lease space in an office building in New York City. We expect to take control of the property in 2021 and relocate our global headquarters to this new office building in 2022. Our future minimum rental commitment under this 20-year lease is approximately $ 1.6 billion. Prior to our adoption of the new lease standard, rental expense, net of sublease income, was $ 301 million in 2018. Note 16. Contingencies and Certain Commitments We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax and legal contingencies. The following outlines our legal contingencies. For a discussion of our tax contingencies, see Note 5B. A. Legal Proceedings Our legal contingencies include, but are not limited to, the following: Patent litigation, which typically involves challenges to the coverage and/or validity of patents on various products, processes or dosage forms. We are the plaintiff in the majority of these actions. An adverse outcome in actions in which we are the plaintiff could result in loss of patent protection for a drug, a significant loss of revenues from that drug or impairment of the value of associated assets. Product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others, often involves highly complex issues relating to medical causation, label warnings and reliance on those warnings, scientific evidence and findings, actual, provable injury and other matters. Commercial and other matters, which can include acquisition-, licensing-, collaboration- or co-promotion-related and product-pricing claims and environmental claims and proceedings, can involve complexities that will vary from matter to matter. Government investigations, which often are related to the extensive regulation of pharmaceutical companies by national, state and local government agencies in the U.S. and in other jurisdictions. Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, which could be substantial, and/or criminal charges. We believe that our claims and defenses in matters in which we are a defendant are substantial, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of matters, which could have a material adverse effect on our results of operations and/or our cash flows in the period in which the amounts are accrued or paid. We have accrued for losses that are both probable and reasonably estimable. Substantially all of our contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments, which result from a complex series of judgments about future events and uncertainties, are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. In August 2020, the SEC amended its disclosure rules regarding the threshold for disclosure of proceedings under environmental laws to which a governmental authority is a party. In accordance with the amended rule, we have adopted a disclosure threshold for such proceedings of $ 1 million in potential or actual governmental monetary sanctions. The principal pending matters to which we are a party are discussed below. In determining whether a pending matter is a principal matter, we consider both quantitative and qualitative factors to assess materiality, such as, among others, the amount of damages and the nature of other relief sought, if specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be, or is, a class action and, if not certified, our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; whether related actions have been transferred to multidistrict litigation; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a readers judgment about our financial statements in light of all of the information that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters in which we are the plaintiff, we consider, among other things, the financial significance of the product protected by the patent(s) at issue. Some of the matters discussed below include those which management believes that the likelihood of possible loss in excess of amounts accrued is remote. A1. Legal ProceedingsPatent Litigation We are involved in suits relating to our patents, including but not limited to, those discussed below. Most involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. In addition to the challenges to the U.S. patents that are discussed below, patent rights to certain of our products are being challenged in various other jurisdictions. We are also party to patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for allegedly causing delay of generic entry. Additionally, our licensing and collaboration partners face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In 2017, the Patent Trial and Appeal Board (PTAB) initiated proceedings, which remain pending, with respect to two of our pneumococcal vaccine patents. However, the PTAB declined to initiate proceedings as to two other pneumococcal vaccine patents. Various legal challenges to other pneumococcal vaccine patents remain pending in jurisdictions outside the U.S. The invalidation of all of the patents in our pneumococcal portfolio could potentially allow a competitors pneumococcal vaccine into the marketplace. In the event that any of the patents are found valid and infringed, a competitors pneumococcal vaccine might be prohibited from entering the market or a competitor might be required to pay us a royalty. We are also subject to patent litigation pursuant to which one or more third parties seek damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities. For example, our Hospira subsidiaries are involved in patent disputes over their attempts to bring generic pharmaceutical and biosimilar products to market. If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. Actions In Which We Are The Plaintiff EpiPen In 2010, King, which we acquired in 2011 and is a wholly-owned subsidiary, brought a patent-infringement action against Sandoz in the U.S. District Court for the District of New Jersey in connection with Sandozs abbreviated new drug application (ANDA) filed with the FDA seeking approval to market an epinephrine injectable product. Sandoz is challenging patents, which expire in 2025, covering the next-generation autoinjector for use with epinephrine that is sold under the EpiPen brand name. Xeljanz (tofacitinib) Beginning in 2017, we brought patent-infringement actions against several generic manufacturers that filed separate ANDAs with the FDA seeking approval to market their generic versions of tofacitinib tablets in one or both of 5 mg and 10 mg dosage strengths, and in both immediate and extended release forms. To date, we have settled actions with several generic manufacturers on terms not material to Pfizer. The remaining actions continue in the U.S. District Court for the District of Delaware as described below. In 2017, we brought a patent-infringement action against Zydus Pharmaceuticals (USA) Inc. and Cadila Healthcare Ltd. (collectively, Zydus) asserting the infringement and validity of three patents: the patent covering the active ingredient expiring in December 2025 (the 2025 Patent), the patent covering an enantiomer of tofacitinib expiring in 2022, and the patent covering a polymorphic form of tofacitinib expiring in 2023 (the 2023 Patent), which Zydus challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg tablets. In November 2020, we settled the case against Zydus on terms not material to Pfizer. In February 2021, we brought a separate patent-infringement action against Zydus asserting the infringement and validity of our composition of matter and crystalline form patents challenged by Zydus in its ANDA seeking approval to market a generic version of tofacitinib 22 mg extended release tablets. In 2018, we brought a separate patent infringement action against Teva Pharmaceuticals USA, Inc. (Teva) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Teva in its ANDA seeking approval to market a generic version of tofacitinib 11 mg extended release tablets. In January 2021, we brought a separate patent-infringement action against Aurobindo Pharma Limited (Aurobindo) asserting the infringement and validity of the 2025 Patent and the 2023 Patent, which Aurobindo challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg and 10 mg tablets. Inlyta (axitinib) In 2019, Glenmark Pharmaceuticals Limited (Glenmark) notified us that it had filed an ANDA with the FDA seeking approval to market a generic version of Inlyta. Glenmark asserts the invalidity and non-infringement of the crystalline form patent for Inlyta that expires in 2030. In June 2019, we filed suit against Glenmark in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the crystalline form patent for Inlyta. Ibrance (palbociclib) In March 2019, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Ibrance. The generic companies assert the invalidity and non-infringement of two composition of matter patents, one of which expires in 2023 and one of which expires in 2027, as a result of a U.S. Patent Term Extension certificate issued in January 2021, and a method of use patent covering palbociclib, which expires in 2023. In April 2019, we brought patent infringement actions against each of the generic filers in various federal courts, asserting the validity and infringement of the patents challenged by the generic companies. Beginning in September 2020, we received correspondence from several generic companies notifying us that they would seek approval to market generic versions of Ibrance. The generic companies assert the invalidity and non-infringement of our crystalline form patent which expires in 2034. Beginning in October 2020, we brought patent infringement actions against each of these generic companies in various federal courts, asserting the validity and infringement of the crystalline form patent. Lyrica (pregabalin) U.K. In June 2014, Generics (U.K.) Ltd (trading as Mylan) filed an invalidity action against the Lyrica pain use patent in the High Court of Justice in London. Subsequently, Actavis Group PTC ehf filed an invalidity action in the same court, and Pfizer sued Actavis Group PTC ehf, Actavis U.K. Ltd and Caduceus Pharma Ltd (together, Actavis) for infringement and requested preliminary relief. Our request for preliminary relief was denied in a January 2015 hearing, and the denial subsequently was confirmed on appeal. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In February 2015, the National Health Service (NHS) England was ordered by the High Court, as an intermediary, to issue guidance for prescribers and pharmacists directing the prescription and dispensing of Lyrica by brand when pregabalin was prescribed for the treatment of neuropathic pain. NHS Wales and NHS Northern Ireland also issued prescribing guidance. The guidance to prescribe and dispense Lyrica for neuropathic pain was withdrawn upon patent expiration in July 2017. We also filed infringement actions against (i) Teva UK Ltd, and (ii) Dr. Reddys Laboratories (UK) Ltd and Caduceus Pharma Ltd (together, Dr. Reddys) in February 2015, seeking the same relief as in the action against Actavis. Dr. Reddys filed an invalidity counterclaim. These actions were stayed pending the outcome of the Mylan and Actavis cases. The Mylan and Actavis invalidity actions were heard in the High Court at the same time as the Actavis infringement action. The High Court ruled against us, holding that the asserted claims were either not infringed or invalid, and appeals followed. In November 2018, the U.K. Supreme Court ruled that all the relevant claims directed to neuropathic pain were invalid. In October 2015, after Sandoz GmbH and Sandoz Ltd (together, Sandoz) launched a full label generic pregabalin product, we obtained from the High Court a preliminary injunction enjoining Sandoz from further sales of the product and ordering Sandoz to identify the parties holding its product. Sandoz identified wholesaler AAH Pharmaceuticals Ltd and pharmacy chain Lloyds Pharmacy Ltd (supplied by AAH), and we requested that these parties cease further sales and withdraw the Sandoz full label product. In October 2015, Lloyds was added to the Sandoz action, and we obtained a preliminary order from the High Court requiring Lloyds to advise its pharmacists that the Sandoz full label product should not be dispensed. In November 2015, the High Court confirmed the preliminary injunction against Sandoz and Lloyds. Sandoz filed an invalidity counterclaim. Upon agreement of the parties, in December 2015, the proceedings against Lloyds were discontinued, and the proceedings against Sandoz were stayed pending outcome of the Mylan and Actavis cases. The preliminary injunction against Sandoz remained in place until patent expiration in July 2017. In May 2020, Dr. Reddys filed a claim for damages in connection with the above-referenced legal actions. In July 2020, the Scottish Ministers and fourteen Scottish Health Boards (together, NHS Scotland) filed a claim for damages in connection with the above-referenced legal action concerning Sandoz. In September 2020, Teva, Sandoz, Ranbaxy, Inc. (Ranbaxy), Actavis, and the Secretary of State for Health and Social Care, together with 32 other National Health Service entities (together, NHS England, Wales, and Northern Ireland) filed claims for damages in the above-referenced legal actions. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Japan In January 2017, Sawai Pharmaceutical Company Limited (a Japanese generic company) (Sawai) filed an invalidation action against the Lyrica pain use patent in the Japanese Patent Office (JPO). Hexal AG has filed a separate invalidation action that was stayed pending the result of the Sawai action. Multiple parties were allowed to intervene in the Sawai case. In July 2020, the JPO recognized the validity of certain amended claims of the patent covering Lyrica. We are appealing the decision. In August 2020, the Japanese regulatory authority granted regulatory approval to multiple generic companies and we filed legal actions against the generic companies seeking preliminary and permanent injunctions to prevent infringement of our patent. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Matter Involving Our Collaboration/Licensing Partners Eliquis In February, March, and April 2017, twenty-five generic companies sent BMS Paragraph-IV certification letters informing BMS that they had filed ANDAs seeking approval of generic versions of Eliquis, challenging the validity and infringement of one or more of the three patents listed in the Orange Book for Eliquis. One of the patents expired in December 2019 and the remaining patents currently are set to expire in 2026 and 2031. Eliquis has been jointly developed and is being commercialized by BMS and Pfizer. In April 2017, BMS and Pfizer filed patent-infringement actions against all generic filers in the U.S. District Court for the District of Delaware and the U.S. District Court for the District of West Virginia, asserting that each of the generic companies proposed products would infringe each of the patent(s) that each generic filer challenged. Some generic filers challenged only the 2031 patent, some challenged both the 2031 and 2026 patent, and one generic company challenged all three patents. In August 2020, the U.S. District Court for the District of Delaware ruled that both the 2026 patent and the 2031 patent are valid and infringed by the proposed generic products. In August and September 2020, the generic filers appealed the District Courts decision to the U.S. Court of Appeals for the Federal Circuit. Prior to the August 2020 ruling, we and BMS settled with certain of the generic companies on terms not material to Pfizer, and we and BMS may settle with other generic companies in the future. A2. Legal ProceedingsProduct Litigation We are defendants in numerous cases, including but not limited to those discussed below, related to our pharmaceutical and other products. Plaintiffs in these cases seek damages and other relief on various grounds for alleged personal injury and economic loss. Asbestos Between 1967 and 1982, Warner-Lambert owned American Optical Corporation (American Optical), which manufactured and sold respiratory protective devices and asbestos safety clothing. In connection with the sale of American Optical in 1982, Warner-Lambert agreed to indemnify the purchaser for certain liabilities, including certain asbestos-related and other claims. Warner-Lambert was acquired by Pfizer in 2000 and is a wholly owned subsidiary of Pfizer. Warner-Lambert is actively engaged in the defense of, and will continue to explore various means of resolving, these claims. Numerous lawsuits against American Optical, Pfizer and certain of its previously owned subsidiaries are pending in various federal and state courts seeking damages for alleged personal injury from exposure to products allegedly containing asbestos and other allegedly hazardous materials sold by Pfizer and certain of its previously owned subsidiaries. There also are a small number of lawsuits pending in various federal and state courts seeking damages for alleged exposure to asbestos in facilities owned or formerly owned by Pfizer or its subsidiaries. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Effexor Beginning in May 2011, actions, including purported class actions, were filed in various federal courts against Wyeth and, in certain of the actions, affiliates of Wyeth and certain other defendants relating to Effexor XR, which is the extended-release formulation of Effexor. The plaintiffs in each of the class actions seek to represent a class consisting of all persons in the U.S. and its territories who directly purchased, indirectly purchased or reimbursed patients for the purchase of Effexor XR or generic Effexor XR from any of the defendants from June 14, 2008 until the time the defendants allegedly unlawful conduct ceased. The plaintiffs in all of the actions allege delay in the launch of generic Effexor XR in the U.S. and its territories, in violation of federal antitrust laws and, in certain of the actions, the antitrust, consumer protection and various other laws of certain states, as the result of Wyeth fraudulently obtaining and improperly listing certain patents for Effexor XR in the Orange Book, enforcing certain patents for Effexor XR and entering into a litigation settlement agreement with a generic drug manufacturer with respect to Effexor XR. Each of the plaintiffs seeks treble damages (for itself in the individual actions or on behalf of the putative class in the purported class actions) for alleged price overcharges for Effexor XR or generic Effexor XR in the U.S. and its territories since June 14, 2008. All of these actions have been consolidated in the U.S. District Court for the District of New Jersey. In October 2014, the District Court dismissed the direct purchaser plaintiffs claims based on the litigation settlement agreement, but declined to dismiss the other direct purchaser plaintiff claims. In January 2015, the District Court entered partial final judgments as to all settlement agreement claims, including those asserted by direct purchasers and end-payer plaintiffs, which plaintiffs appealed to the U.S. Court of Appeals for the Third Circuit. In August 2017, the U.S. Court of Appeals for the Third Circuit reversed the District Courts decisions and remanded the claims to the District Court. Lipitor Antitrust Actions Beginning in November 2011, purported class actions relating to Lipitor were filed in various federal courts against, among others, Pfizer, certain Pfizer affiliates, and, in most of the actions, Ranbaxy and certain Ranbaxy affiliates. The plaintiffs in these various actions seek to represent nationwide, multi-state or statewide classes consisting of persons or entities who directly purchased, indirectly purchased or reimbursed patients for the purchase of Lipitor (or, in certain of the actions, generic Lipitor) from any of the defendants from March 2010 until the cessation of the defendants allegedly unlawful conduct (the Class Period). The plaintiffs allege delay in the launch of generic Lipitor, in violation of federal antitrust laws and/or state antitrust, consumer protection and various other laws, resulting from (i) the 2008 agreement pursuant to which Pfizer and Ranbaxy settled certain patent litigation involving Lipitor and Pfizer granted Ranbaxy a license to sell a generic version of Lipitor in various markets beginning on varying dates, and (ii) in certain of the actions, the procurement and/or enforcement of certain patents for Lipitor. Each of the actions seeks, among other things, treble damages on behalf of the putative class for alleged price overcharges for Lipitor (or, in certain of the actions, generic Lipitor) during the Class Period. In addition, individual actions have been filed against Pfizer, Ranbaxy and certain of their affiliates, among others, that assert claims and seek relief for the plaintiffs that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. These various actions have been consolidated for pre-trial proceedings in a Multi-District Litigation ( In re Lipitor Antitrust Litigation MDL-2332 ) in the U.S. District Court for the District of New Jersey. In September 2013 and 2014, the District Court dismissed with prejudice the claims of the direct purchasers. In October and November 2014, the District Court dismissed with prejudice the claims of all other Multi-District Litigation plaintiffs. All plaintiffs have appealed the District Courts orders dismissing their claims with prejudice to the U.S. Court of Appeals for the Third Circuit. In addition, the direct purchaser class plaintiffs appealed the order denying their motion to amend the judgment and for leave to amend their complaint to the Court of Appeals. In August 2017, the Court of Appeals reversed the District Courts decisions and remanded the claims to the District Court. Also, in January 2013, the State of West Virginia filed an action in West Virginia state court against Pfizer and Ranbaxy, among others, that asserts claims and seeks relief on behalf of the State of West Virginia and residents of that state that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. Personal Injury Actions A number of individual and multi-plaintiff lawsuits have been filed against Pfizer in various federal and state courts alleging that the plaintiffs developed type 2 diabetes purportedly as a result of the ingestion of Lipitor. Plaintiffs seek compensatory and punitive damages. In February 2014, the federal actions were transferred for consolidated pre-trial proceedings to a Multi-District Litigation ( In re Lipitor (Atorvastatin Calcium) Marketing, Sales Practices and Products Liability Litigation (No. II) MDL-2502 ) in the U.S. District Court for the District of South Carolina. Since 2016, certain cases in the Multi-District Litigation were remanded to certain state courts. In January 2017, the District Court granted our motion for summary judgment, dismissing substantially all of the remaining cases pending in the Multi-District Litigation. In January 2017, the plaintiffs appealed the District Courts decision to the U.S. Court of Appeals for the Fourth Circuit. In June 2018, the Court of Appeals affirmed the District Courts decision. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Viagra Since April 2016, a Multi-District Litigation has been pending in the U.S. District Court for the Northern District of California ( In Re: Viagra (Sildenafil Citrate) Products Liability Litigation, MDL-2691 ), in which plaintiffs allege that they developed melanoma and/or the exacerbation of melanoma purportedly as a result of the ingestion of Viagra. Additional cases filed against Lilly with respect to Cialis have also been consolidated in the Multi-District Litigation (In re: Viagra (Sildenafil Citrate) and Cialis (Tadalafil) Products Liability Litigation, MDL-2691 ). In January 2020, the District Court granted our and Lillys motion to exclude all of plaintiffs general causation opinions. As a result, in April 2020, the District Court entered summary judgment in favor of defendants and dismissed all of plaintiffs claims. In April 2020, plaintiffs filed a notice of appeal in the U.S. Court of Appeals for the Ninth Circuit. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies EpiPen Beginning in February 2017, purported class actions were filed in various federal courts by indirect purchasers of EpiPen against Pfizer, and/or its affiliates King and Meridian, and/or various entities affiliated with Mylan, and Mylan Chief Executive Officer, Heather Bresch. The plaintiffs in these actions seek to represent U.S. nationwide classes comprising persons or entities who paid for any portion of the end-user purchase price of an EpiPen between 2009 until the cessation of the defendants allegedly unlawful conduct. In February 2020, a similar lawsuit was filed in the U.S. District Court for the District of Kansas against Pfizer, King, Meridian and the Mylan entities on behalf of a purported U.S. nationwide class of direct purchaser plaintiffs who purchased EpiPen devices directly from the defendants (the 2020 Lawsuit). Against Pfizer and/or its affiliates, plaintiffs in these actions generally allege that Pfizers and/or its affiliates settlement of patent litigation regarding EpiPen delayed market entry of generic EpiPen in violation of federal antitrust laws and various state antitrust laws. At least one lawsuit also alleges that Pfizer and/or Mylan violated the federal Racketeer Influenced and Corrupt Organizations Act (RICO). Plaintiffs also filed various federal antitrust, state consumer protection and unjust enrichment claims against, and relating to conduct attributable solely to, Mylan and/or its affiliates regarding EpiPen. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In August 2017, all of these actions, except for the 2020 Lawsuit, were consolidated for coordinated pre-trial proceedings in a Multi-District Litigation ( In re: EpiPen (Epinephrine Injection, USP) Marketing, Sales Practices and Antitrust Litigation, MDL-2785 ) in the U.S. District Court for the District of Kansas with other EpiPen-related actions against Mylan and/or its affiliates to which Pfizer, King and Meridian are not parties. In July 2020, a new lawsuit was filed in the U.S. District Court for the District of Colorado on behalf of indirect purchasers. Plaintiff represents a putative U.S. nationwide class of persons or entities who paid for any portion of the end-user purchase price of certain refill or replacement EpiPens since 2010. Plaintiff alleges that Pfizer and Meridian misrepresented the shelf-life and expiration date of EpiPen, in violation of the federal RICO statute. Plaintiff seeks treble damages for alleged unnecessary replacement or refill purchases of EpiPens by members of the putative class. Nexium 24HR and Protonix A number of individual and multi-plaintiff lawsuits have been filed against Pfizer, certain of its subsidiaries and/or other pharmaceutical manufacturers in various federal and state courts alleging that the plaintiffs developed kidney-related injuries purportedly as a result of the ingestion of certain proton pump inhibitors. The cases against Pfizer involve Protonix and/or Nexium 24HR and seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In August 2017, the federal actions were ordered transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re: Proton-Pump Inhibitor Products Liability Litigation (No. II)) in the U.S. District Court for the District of New Jersey. In 2019, we and GSK combined our respective consumer healthcare businesses into a new Consumer Healthcare JV that operates globally under the GSK Consumer Healthcare name. As part of the JV transaction, the JV has agreed to assume, and to indemnify Pfizer for, liabilities arising out of such litigation to the extent related to Nexium 24HR. Docetaxel Personal Injury Actions A number of lawsuits have been filed against Hospira and Pfizer in various federal and state courts alleging that plaintiffs who were treated with Docetaxel developed permanent hair loss. The significant majority of the cases also name other defendants, including the manufacturer of the branded product, Taxotere. Plaintiffs seek compensatory and punitive damages. In October 2016, the federal cases were transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re Taxotere (Docetaxel) Products Liability Litigation, MDL-2740 ) in the U.S. District Court for the Eastern District of Louisiana. Mississippi Attorney General Government Action In October 2018, the Attorney General of Mississippi filed a complaint in Mississippi state court against the manufacturer of the branded product and eight other manufacturers including Pfizer and Hospira, alleging, with respect to Pfizer and Hospira, a failure to warn about a risk of permanent hair loss in violation of the Mississippi Consumer Protection Act. The action seeks civil penalties and injunctive relief. Array Securities Litigation In November 2017, two purported class actions were filed in the U.S. District Court for the District of Colorado alleging that Array, which we acquired in July 2019 and is our wholly owned subsidiary, and certain of its former officers violated federal securities laws in connection with certain disclosures made, or omitted, by Array regarding the NRAS-mutant melanoma program. In March 2018, the actions were consolidated into a single proceeding. Zantac A number of lawsuits have been filed against Pfizer in various federal and state courts alleging that plaintiffs developed various types of cancer, or face an increased risk of developing cancer, purportedly as a result of the ingestion of Zantac. The significant majority of these cases also name other defendants that have historically manufactured and/or sold Zantac. Pfizer has not sold Zantac since 2006, and only sold an OTC version of the product. Plaintiffs seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In February 2020, the federal actions were transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re Zantac/Ranitidine NDMA Litigation, MDL-2924 ) in the U.S. District Court for the Southern District of Florida. From June to December 2020: (i) plaintiffs in the Multi-District Litigation filed against Pfizer and many other defendants a consolidated consumer class action complaint alleging, among other things, violations of the RICO statute and consumer protection statutes of all 50 states, and a consolidated third-party payor class action complaint alleging violation of the RICO statute and seeking reimbursement for payments made for the prescription version of Zantac; (ii) Pfizer received service of two Canadian class action complaints naming Pfizer and other defendants, and seeking compensatory and punitive damages for personal injury and economic loss, allegedly arising from the defendants sale of Zantac in Canada; (iii) the State of New Mexico filed a civil action against Pfizer and many other defendants, alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in New Mexico; and (iv) Pfizer received service of a suit filed by the Mayor and City Council of Baltimore naming Pfizer and other defendants alleging various claims under Maryland law. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies A3. Legal ProceedingsCommercial and Other Matters Monsanto-Related Matters In 1997, Monsanto Company (Former Monsanto) contributed certain chemical manufacturing operations and facilities to a newly formed corporation, Solutia Inc. (Solutia), and spun off the shares of Solutia. In 2000, Former Monsanto merged with Pharmacia Upjohn Company to form Pharmacia. Pharmacia then transferred its agricultural operations to a newly created subsidiary, named Monsanto Company (New Monsanto), which it spun off in a two-stage process that was completed in 2002. Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. In connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities related to Pharmacias former agricultural business. New Monsanto has defended and/or is defending Pharmacia in connection with various claims and litigation arising out of, or related to, the agricultural business, and has been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. In connection with its spin-off in 1997, Solutia assumed, and agreed to indemnify Pharmacia for, liabilities related to Former Monsantos chemical businesses. As the result of its reorganization under Chapter 11 of the U.S. Bankruptcy Code, Solutias indemnification obligations relating to Former Monsantos chemical businesses are primarily limited to sites that Solutia has owned or operated. In addition, in connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities primarily related to Former Monsantos chemical businesses, including, but not limited to, any such liabilities that Solutia assumed. Solutias and New Monsantos assumption of, and agreement to indemnify Pharmacia for, these liabilities apply to pending actions and any future actions related to Former Monsantos chemical businesses in which Pharmacia is named as a defendant, including, without limitation, actions asserting environmental claims, including alleged exposure to polychlorinated biphenyls. Solutia and/or New Monsanto are defending Pharmacia in connection with various claims and litigation arising out of, or related to, Former Monsantos chemical businesses, and have been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. Environmental Matters In 2009, we submitted to the U.S. Environmental Protection Agency (EPA) a corrective measures study report with regard to Pharmacias discontinued industrial chemical facility in North Haven, Connecticut. In September 2010, our corrective measures study report was approved by the EPA, and we commenced construction of the site remedy in late 2011 under an Updated Administrative Order on Consent with the EPA. In September 2019, the EPA acknowledged that construction of the site remedy has been completed. Also in 2009, we submitted a revised site-wide feasibility study with regard to Wyeth Holdings Corporations (formerly, American Cyanamid Company) discontinued industrial chemical facility in Bound Brook, New Jersey. In July 2011, Wyeth Holdings Corporation executed an Administrative Settlement Agreement and Order on Consent for Removal Action (the 2011 Administrative Settlement Agreement) with the EPA with regard to the Bound Brook facility. In accordance with the 2011 Administrative Settlement Agreement, we completed construction of an interim remedy to address the discharge of impacted groundwater from the facility to the Raritan River. In September 2012, the EPA issued a final remediation plan for the Bound Brook facilitys main plant area, which is generally in accordance with one of the remedies evaluated in our revised site-wide feasibility study. In March 2013, Wyeth Holdings Corporation (now Wyeth Holdings LLC) entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the main plant area and to perform a focused feasibility study for two adjacent lagoons. In September 2015, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey that allows Wyeth Holdings LLC to complete the design and to implement the remedy for the main plant area. The consent decree (which supersedes the 2011 Administrative Settlement Agreement) was entered by the District Court in December 2015. In September 2018, the EPA issued a final remediation plan for the two adjacent lagoons, which is generally in accordance with one of the remedies evaluated in our focused feasibility study, and, in September 2019, Wyeth Holdings LLC entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the lagoons. We have accrued for the estimated costs of the site remedies for the North Haven and Bound Brook facilities. We are a party to a number of other proceedings brought under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, and other state, local or foreign laws in which the primary relief sought is the cost of past and/or future remediation. Contracts with Iraqi Ministry of Health In October 2017, a number of U.S. service members, civilians, and their families brought a complaint in the U.S. District Court for the District of Columbia against a number of pharmaceutical and medical devices companies, including Pfizer and certain of its subsidiaries, alleging that the defendants violated the U.S. Anti-Terrorism Act. The complaint alleges that the defendants provided funding for terrorist organizations through their sales practices pursuant to pharmaceutical and medical device contracts with the Iraqi Ministry of Health, and seeks monetary relief. In July 2020, the District Court granted defendants motions to dismiss and dismissed all of plaintiffs claims. The plaintiffs are appealing the District Courts decision. Allergan Complaint for Indemnity In August 2018, Pfizer was named as a defendant in a third-party complaint for indemnity, along with King, filed by Allergan Finance LLC (Allergan) in a Multi-District Litigation ( In re National Prescription Opiate Litigation MDL 2804 ) in the U.S. District Court for the Northern District of Ohio. The lawsuit asserted claims for indemnity related to Kadian, which was owned for a short period by King in 2008, prior to Pfizer's acquisition of King in 2010. In December 2018, the District Court dismissed the lawsuit. In February 2019, Allergan filed a similar complaint in the Supreme Court of the State of New York, asserting claims for indemnity related to Kadian. That suit was voluntarily discontinued without prejudice in January 2021. Breach of ContractXalkori/Lorbrena We are a defendant in a breach of contract action brought by New York University (NYU) in the Supreme Court of the State of New York (Supreme Court). NYU alleges that it is entitled to royalties on Pfizers sales of Xalkori under the terms of a Research and License Agreement between NYU and Sugen, Inc. Sugen, Inc. was acquired by Pharmacia in August 1999, and Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. The action was originally filed in 2013. In December 2015, the Supreme Court dismissed the action and, in Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies May 2017, the New York State Appellate Division reversed the decision and remanded the proceedings to the Supreme Court. In January 2020, the Supreme Court denied both parties summary judgment motions. In October 2020, NYU filed a separate breach of contract action against Pfizer alleging that it is entitled to royalties on sales of Lorbrena under the terms of the same NYU-Sugen, Inc. Research and Licensing Agreement. A4. Legal ProceedingsGovernment Investigations We are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Among the investigations by government agencies are the matters discussed below. Greenstone Investigations U.S. Department of Justice Antitrust Division Investigation Since July 2017, the U.S. Department of Justice's Antitrust Division has been investigating our former Greenstone generics business. We believe this is related to an ongoing broader antitrust investigation of the generic pharmaceutical industry. The government has been obtaining information from Greenstone relating to this investigation. State Attorneys General Generics Antitrust Litigation In April 2018, Greenstone received requests for information from the Antitrust Department of the Connecticut Office of the Attorney General. In May 2019, Attorneys General of more than 40 states plus the District of Columbia and Puerto Rico filed a complaint against a number of pharmaceutical companies, including Greenstone and Pfizer. The matter has been consolidated with a Multi-District Litigation ( In re: Generic Pharmaceuticals Pricing Antitrust Litigation MDL No. 2724) in the Eastern District of Pennsylvania. As to Greenstone and Pfizer, the complaint alleges anticompetitive conduct in violation of federal and state antitrust laws and state consumer protection laws. In June 2020, the State Attorneys General filed a new complaint against a large number of companies, including Greenstone and Pfizer, making similar allegations, but concerning a new set of drugs. This complaint was transferred to the Multi-District Litigation in July 2020. Subpoena relating to Manufacturing of Quillivant XR In October 2018, we received a subpoena from the U.S. Attorneys Office for the Southern District of New York (SDNY) seeking records relating to our relationship with another drug manufacturer and its production and manufacturing of drugs including, but not limited to, Quillivant XR. We have produced records pursuant to the subpoena. Government Inquiries relating to Meridian Medical Technologies In February 2019, we received a civil investigative demand from the U.S. Attorneys Office for the SDNY. The civil investigative demand seeks records and information related to alleged quality issues involving the manufacture of auto-injectors at our Meridian site. In August 2019, we received a HIPAA subpoena from the U.S. Attorneys Office for the Eastern District of Missouri seeking similar records and information. We are producing records in response to these requests. U.S. Department of Justice/SEC Inquiry relating to Russian Operations In June 2019, we received an informal request from the U.S. Department of Justices Foreign Corrupt Practices Act (FCPA) Unit seeking documents relating to our operations in Russia. In September 2019, we received a similar request from the SECs FCPA Unit. We have produced records pursuant to these requests. Docetaxel Mississippi Attorney General Government Investigation See Note 16A2. Contingencies and Certain Commitments: Legal Proceedings Product Litigation Docetaxel Mississippi Attorney General Government Investigation above for information regarding a government investigation related to Docetaxel marketing practices. U.S. Department of Justice Inquiries relating to India Operations In March 2020, we received an informal request from the U.S. Department of Justice's Consumer Protection Branch seeking documents relating to our manufacturing operations in India, including at our former facility located at Irrungattukottai in India. In April 2020, we received a similar request from the U.S. Attorneys Office for the SDNY regarding a civil investigation concerning operations at our facilities in India. We are producing records pursuant to these requests. U.S. Department of Justice/SEC Inquiry relating to China Operations In June 2020, we received an informal request from the U.S. Department of Justice's FCPA Unit seeking documents relating to our operations in China. In August 2020, we received a similar request from the SECs FCPA Unit. We are producing records pursuant to these requests. Zantac State of New Mexico Civil Action See Note 16A2. Contingencies and Certain Commitments: Legal ProceedingsProduct LitigationZantac above for information regarding a civil action filed by the State of New Mexico alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in New Mexico. A5. Legal ProceedingsMatters Resolved During 2020 During the full-year 2020, certain matters, including the matter discussed below, were resolved or became the subject of definitive settlement agreements or settlement agreements-in-principle. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Hormone Therapy Consumer Class Action A certified consumer class action was pending against Wyeth in the U.S. District Court for the Southern District of California based on the alleged off-label marketing of its hormone therapy products. The case was originally filed in December 2003. The class consisted of California consumers who purchased Wyeths hormone-replacement products between January 1995 and January 2003 and who did not seek personal injury damages therefrom. The class sought compensatory and punitive damages, including a full refund of the purchase price. In March 2020, the parties reached an agreement, and obtained preliminary court approval, to resolve this matter for $ 200 million, which was paid in full in the second quarter of 2020. B. Guarantees and Indemnifications In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities prior to or following a transaction. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we may be required to reimburse the loss. These indemnifications are generally subject to various restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of December 31, 2020, the estimated fair value of these indemnification obligations was not significant. In addition, in connection with our entry into certain agreements and other transactions, our counterparties may agree to indemnify us. For example, our collaboration agreement with EMD Serono, Inc. to co-promote Rebif in the U.S. expired at the end of 2015 and included certain indemnity provisions. Patent litigation brought by Biogen Idec MA Inc. against EMD Serono Inc. and Pfizer is pending in the U.S. District Court for the District of New Jersey and the United States Court of Appeals for the Federal Circuit. EMD Serono Inc. has acknowledged that it is obligated to satisfy any award of damages. We have also guaranteed the long-term debt of certain companies that we acquired and that now are subsidiaries of Pfizer. See Note 7D . C. Certain Commitments As of December 31, 2020, we had agreements totaling $ 3.8 billion to purchase goods and services that are enforceable and legally binding and include amounts relating to advertising, information technology services, employee benefit administration services, and potential milestone payments deemed reasonably likely to occur. See Note 5A for information on the TCJA repatriation tax liability. D. Contingent Consideration for Acquisitions We may be required to make payments to sellers for certain prior business combinations that are contingent upon future events or outcomes. See Note 1D . The estimated fair value of contingent consideration as of December 31, 2020 is $ 689 million, of which $ 123 million is recorded in Other current liabilities and $ 566 million in Other noncurrent liabilities and $ 711 million, of which $ 160 million is recorded in Other current liabilities and $ 551 million in Other noncurrent liabilities as of December 31, 2019. The decrease in the contingent consideration balance from December 31, 2019 is primarily due to payments made upon the achievement of certain sales-based milestones, partially offset by fair value adjustments. E. Insurance Our insurance coverage reflects market conditions (including cost and availability) existing at the time it is written, and our decision to obtain insurance coverage or to self-insure varies accordingly. Depending upon the cost and availability of insurance and the nature of the risk involved, the amount of self-insurance may be significant. The cost and availability of coverage have resulted in self-insuring certain exposures, including product liability. If we incur substantial liabilities that are not covered by insurance or substantially exceed insurance coverage and that are in excess of existing accruals, there could be a material adverse effect on our cash flows or results of operations in the period in which the amounts are paid and/or accrued. Note 17 . Product, Geographic and Other Revenue Information A. Geographic Information The following summarizes revenues by geographic area: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States $ 21,712 $ 20,593 $ 20,119 Developed Europe 7,788 7,729 7,997 Developed Rest of World 4,036 4,022 4,090 Emerging Markets 8,372 8,828 8,618 Revenues $ 41,908 $ 41,172 $ 40,825 Revenues exceeded $500 million in each of 8 , 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. The U.S. is the only country to contribute more than 10 % of total revenue in 2020, 2019 and 2018. As a percentage of revenues, our two largest national markets outside the U.S. were China, which contributed 6 % of total revenue in each of 2020, 2019 and 2018, and Japan, which contributed 6 % of total revenue in 2020 and 5 % in each of 2019 and 2018. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Other Revenue Information Significant Customers We sell our biopharmaceutical products primarily to customers in the wholesale sector. The following summarizes revenue, as a percentage of total revenues, for our three largest U.S. wholesaler customers: Year Ended December 31, 2020 2019 2018 McKesson, Inc. 16 % 15 % 13 % AmerisourceBergen Corporation 13 % 11 % 8 % Cardinal Health, Inc. 10 % 9 % 8 % Collectively, our three largest U.S. wholesaler customers represented 30 %, 25 % and 29 % of total trade accounts receivable as of December 31, 2020, 2019 and 2018. Significant Product Revenues The following provides detailed revenue information for several of our major products: (MILLIONS OF DOLLARS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2020 2019 2018 TOTAL REVENUES (a) $ 41,908 $ 41,172 $ 40,825 Internal Medicine (a) $ 9,003 $ 8,790 $ 8,548 Eliquis alliance revenues and direct sales Nonvalvular atrial fibrillation, deep vein thrombosis, pulmonary embolism 4,949 4,220 3,434 Chantix/Champix An aid to smoking cessation treatment in adults 18 years of age or older 919 1,107 1,085 Premarin family Symptoms of menopause 680 734 832 BMP2 Development of bone and cartilage 274 287 279 Toviaz Overactive bladder 252 250 271 All other Internal Medicine Various 1,930 2,192 2,648 Oncology $ 10,867 $ 9,014 $ 7,471 Ibrance Metastatic breast cancer 5,392 4,961 4,118 Xtandi alliance revenues mCRPC, nmCRPC, mCSPC 1,024 838 699 Sutent Advanced and/or metastatic RCC, adjuvant RCC, refractory GIST (after disease progression on, or intolerance to, imatinib mesylate) and advanced pancreatic neuroendocrine tumor 819 936 1,049 Inlyta Advanced RCC 787 477 298 Xalkori ALK-positive and ROS1-positive advanced NSCLC 544 530 524 Bosulif Philadelphia chromosomepositive chronic myelogenous leukemia 450 365 296 Retacrit (b) Anemia 386 225 82 Lorbrena ALK-positive metastatic NSCLC 204 115 11 Ruxience (b) Non-hodgkins lymphoma, chronic lymphocytic leukemia, granulomatosis with polyangiitis (Wegeners Granulomatosis) and microscopic polyangiitis 170 ( 1 ) Braftovi In combination with Mektovi for metastatic melanoma for patients who test positive for a BRAF genetic mutation and, in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy 160 48 Zirabev (b) Treatment of mCRC; unresectable, locally advanced, recurrent or metastatic NSCLC; recurrent glioblastoma; metastatic RCC; and persistent, recurrent or metastatic cervical cancer 143 1 Mektovi In combination with Braftovi for metastatic melanoma for patients who test positive for a BRAF genetic mutation 142 49 All other Oncology Various 645 470 395 Hospital (a), (c) $ 7,961 $ 7,772 $ 7,955 Sulperazon Bacterial infections 618 684 613 Medrol Anti-inflammatory glucocorticoid 402 469 493 EpiPen (a) Epinephrine injection used in treatment of life-threatening allergic reactions 297 303 303 Zithromax Bacterial infections 276 336 326 Vfend Fungal infections 270 346 392 Panzyga Primary humoral immunodeficiency 269 183 39 Precedex Sedation agent in surgery or intensive care 260 155 213 Fragmin Treatment/prevention of venous thromboembolism 252 253 293 Zyvox Bacterial infections 222 251 236 Zavicefta Bacterial infections 212 108 46 Pfizer CentreOne (d) Various 926 810 755 All other Anti-infectives Various 1,455 1,592 1,661 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (MILLIONS OF DOLLARS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2020 2019 2018 All other Hospital (c) Various 2,502 2,281 2,584 Vaccines $ 6,575 $ 6,504 $ 6,332 Prevnar 13/Prevenar 13 Pneumococcal disease 5,850 5,847 5,802 Nimenrix Meningococcal disease 221 230 140 FSME/IMMUN-TicoVac Tick-borne encephalitis disease 196 220 184 BNT162b2 Active immunization to prevent COVID-19 in individuals 16 years of age and older 154 All other Vaccines Various 154 207 206 Inflammation Immunology (II) $ 4,567 $ 4,733 $ 4,720 Xeljanz RA, PsA, UC, active polyarticular course juvenile idiopathic arthritis 2,437 2,242 1,774 Enbrel (Outside the U.S. and Canada) RA, juvenile idiopathic arthritis, PsA, plaque psoriasis, pediatric plaque psoriasis, ankylosing spondylitis and nonradiographic axial spondyloarthritis 1,350 1,699 2,112 Inflectra/Remsima (b) Crohns disease, pediatric Crohns disease, UC, pediatric UC, RA in combination with methotrexate, ankylosing spondylitis, PsA and plaque psoriasis 659 625 642 All other II Various 121 167 192 Rare Disease $ 2,936 $ 2,278 $ 2,211 Vyndaqel/Vyndamax ATTR-cardiomyopathy and polyneuropathy 1,288 473 148 BeneFIX Hemophilia B 454 488 554 Genotropin Replacement of human growth hormone 427 498 558 Refacto AF/Xyntha Hemophilia A 370 426 514 Somavert Acromegaly 277 264 267 All other Rare Disease Various 120 129 170 Consumer Healthcare Business (e) $ $ 2,082 $ 3,587 Total Alliance revenues $ 5,418 $ 4,648 $ 3,838 Total Biosimilars (b) $ 1,527 $ 911 $ 769 Total Sterile Injectable Pharmaceuticals (a). (f) $ 5,315 $ 5,013 $ 5,173 (a) On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. On December 21, 2020, Pfizer and Viatris completed the termination of a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (Mylan-Japan) and we transferred the operations that were part of the Mylan-Japan collaboration to Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reported as Income from discontinued operationsnet of tax for all periods presented. Prior-period financial information has been restated, as appropriate. Prior to the separation of the Upjohn Business, and beginning in 2020, Upjohn began managing our Meridian subsidiary, the manufacturer of EpiPen and other auto-injector products, and the Mylan-Japan collaboration. As a result, revenues associated with our Meridian subsidiary, except for product revenues for EpiPen sold in Canada, and Mylan-Japan were reported in Upjohn beginning in the first quarter of 2020. Beginning in the fourth quarter of 2020, the results of our Meridian subsidiary are reported in the Hospital therapeutic area for all periods presented in our consolidated financial statements. (b) Biosimilars are highly similar versions of approved and authorized biological medicines and primarily include revenues from Inflectra/Remsima, Retacrit, Ruxience and Zirabev. (c) Hospital is a therapeutic area that commercializes our global portfolio of sterile injectable and anti-infective medicines. Hospital also includes Pfizer CentreOne (d) . All other Hospital primarily includes revenues from legacy Sterile Injectable Pharmaceuticals (SIP) products (that are not anti-infective products) and, to a much lesser extent, solid oral dose products (that are not anti-infective products). SIP anti-infective products that are not individually listed above are recorded in All other Anti-infectives. (d) Pfizer CentreOne includes revenues from our contract manufacturing and active pharmaceutical ingredient sales operation, including sterile injectables contract manufacturing, and revenues related to our manufacturing and supply agreements. (e) On July 31, 2019, our Consumer Healthcare business, an OTC medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare JV. See Note 2C . (f) Total Sterile Injectable Pharmaceuticals represents the total of all branded and generic injectable products in the Hospital therapeutic area, including anti-infective sterile injectable pharmaceuticals . Contract Liabilities Our contract liabilities primarily relate to advance payments received or receivable in connection with contracts that we entered into during 2020 with various government or government sponsored customers in international markets for supply of BNT162b2. The deferred revenue associated with these advance payments totals approximately $ 957 million as of December 31, 2020 and are recorded in Other current liabilities . The deferred revenue will be recognized in Revenues proportionately as we deliver doses of the vaccine to our customers and satisfy our performance obligation under the contracts, which we expect to fully occur during 2021. Contract liabilities associated with other customer contracts were not significant as of December 31, 2020 or 2019. Pfizer Inc. 2020 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS OF DOLLARS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2020 (a) Revenues $ 10,083 $ 9,864 $ 10,277 $ 11,684 Costs and expenses (b) 7,219 6,559 8,716 11,323 Restructuring charges and certain acquisition-related costs 54 360 2 184 (Gain) on completion of Consumer Healthcare JV transaction (6) Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,817 2,944 1,559 178 Provision/(benefit) for taxes on income/(loss) 355 396 (104) (170) Income/(loss) from continuing operations 2,462 2,548 1,663 348 Income from discontinued operationsnet of tax (c) 948 887 539 257 Net income/(loss) before allocation to noncontrolling interests 3,410 3,434 2,202 605 Less: Net income attributable to noncontrolling interests 9 8 8 11 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,401 $ 3,426 $ 2,194 $ 594 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.46 $ 0.30 $ 0.06 Income from discontinued operationsnet of tax (c) 0.17 0.16 0.10 0.05 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.61 $ 0.62 $ 0.39 $ 0.11 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.45 $ 0.29 $ 0.06 Income from discontinued operationsnet of tax (c) 0.17 0.16 0.10 0.05 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.61 $ 0.61 $ 0.39 $ 0.10 (a) Business development activities impacted our results of operations in 2020 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Certain asset impairments totaled $900 million in the third quarter of 2020 and $791 million in the fourth quarter of 2020 recorded in Other (income)/deductionsnet . See Note 4. (c) Operating results of the Upjohn Business and the Mylan-Japan collaboration are presented as discontinued operations in all periods presented following the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan and the December 21, 2020 termination of the Mylan-Japan collaboration. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. Pfizer Inc. 2020 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS OF DOLLARS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2019 (a) Revenues $ 9,957 $ 10,363 $ 10,402 $ 10,449 Costs and expenses (b) 7,839 8,257 8,695 12,380 Restructuring charges and certain acquisition-related costs (c), (d) 39 (122) 351 333 (Gain) on completion of Consumer Healthcare JV transaction (d) (8,087) 1 Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,079 2,228 9,442 (2,264) Provision/(benefit) for taxes on income/(loss) (e) 142 (1,169) 2,866 (1,221) Income/(loss) from continuing operations 1,937 3,397 6,576 (1,043) Income from discontinued operationsnet of tax (f) 1,952 1,659 1,107 716 Net income/(loss) before allocation to noncontrolling interests 3,889 5,056 7,684 (327) Less: Net income attributable to noncontrolling interests 6 10 4 10 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,884 $ 5,046 $ 7,680 $ (337) Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.34 $ 0.61 $ 1.19 $ (0.19) Income from discontinued operationsnet of tax (f) 0.35 0.30 0.20 0.13 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.69 $ 0.91 $ 1.38 $ (0.06) Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.34 $ 0.60 $ 1.16 $ (0.19) Income from discontinued operationsnet of tax (f) 0.34 0.29 0.20 0.13 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.68 $ 0.89 $ 1.36 $ (0.06) (a) Business development activities impacted our results of operations in 2019 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. The fourth quarter of 2019 includes $2.6 billion in certain asset impairments recorded in Other (income)/deductionsnet . See Note 4. (c) The second quarter of 2019 includes the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit from multiple tax years. See Note 5B . The third quarter of 2019 includes $217 million of integration costs and other, primarily including $157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense. See Note 2A . The fourth quarter of 2019 primarily includes employee termination costs, asset impairments and other exit costs associated with cost reduction initiatives. The employee termination costs are mostly associated with our improvements to operational effectiveness as part of the realignment of our organizational structure and for the Transforming to a More Focused Company program. See Note 3. (d) See Note 2C. (e) During the second quarter of 2019, Pfizer reached settlement of disputed issues at the IRS Office of Appeals, thereby settling all issues related to U.S. tax returns of Pfizer for the years 2009-2010. As a result of settling these years, in the second quarter of 2019 we recorded a benefit of approximately $1.4 billion, representing tax and interest. The third quarter of 2019 reflects tax expense of approximately $2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV. (f) Operating results of the Upjohn Business and the Mylan-Japan collaboration are presented as discontinued operations in all periods presented following the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan and the December 21, 2020 termination of the Mylan-Japan collaboration. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures As of the end of the period covered by this Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. Pfizer Inc. 2020 Form 10-K Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and Shareholders of Pfizer Inc.: Opinion on Internal Control Over Financial Reporting We have audited Pfizer Inc. and Subsidiary Companies (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Pfizer Inc. and Subsidiary Companies as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated February 25, 2021 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. KPMG LLP New York, New York February 25, 2021 Pfizer Inc. 2020 Form 10-K Managements Report on Internal Control Over Financial Reporting Managements Report We prepared and are responsible for the financial statements that appear in this Form 10-K. These financial statements are in conformity with accounting principles generally accepted in the United States of America and, therefore, include amounts based on informed judgments and estimates. We also accept responsibility for the preparation of other financial information that is included in this document. Report on Internal Control Over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) . Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. The Companys independent auditors have issued their auditors report on the Companys internal control over financial reporting. That report appears above in this Form 10-K . Albert Bourla Chairman and Chief Executive Officer Frank DAmelio Jennifer B. Damico Principal Financial Officer Principal Accounting Officer February 25, 2021 Pfizer Inc. 2020 Form 10-K PART III " +26,Pfizer,2019," Item 1. BusinessAbout Pfizer section in this 2019 Form 10-K. ** As of January 28, 2020 Pfizer Inc. 2019 Form 10-K iv PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture and distribution of healthcare products, including innovative medicines and vaccines. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us . The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our Companys purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. With the formation of the GSK Consumer Healthcare joint venture and the pending combination of Upjohn with Mylan, which are further discussed below, Pfizer is transforming itself into a more focused, global leader in science-based innovative medicines. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: License Agreement with Akcea Therapeutics, Inc. In October 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a majority-owned affiliate of Ionis. The transaction closed in November 2019 and we made an upfront payment of $250 million to Akcea and Ionis. Formation of a New Consumer Healthcare Joint Venture On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates globally under the GSK Consumer Healthcare name. The joint venture is a category leader in pain relief, respiratory and vitamins, minerals and supplements, and therapeutic oral health and is the largest global OTC consumer healthcare business. In exchange for contributing our Consumer Healthcare business to the joint venture, we received a 32% equity stake in the new company and GSK owns the remaining 68% . Acquisition of Array BioPharma Inc. On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $48 per share in cash. The total fair value of the consideration transferred for Array was approximately $11.2 billion ($10.9 billion, net of cash acquired). Agreement to Combine Upjohn with Mylan N.V. On July 29, 2019, we announced that we entered into a definitive agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, Viatris. Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, Upjohn is expected to be spun off or split off to Pfizers shareholders and, immediately thereafter, combined with Mylan. Pfizer shareholders would own 57% of the combined new company, and former Mylan shareholders would own 43%. The transaction is expected to be tax free to Pfizer and Pfizer shareholders. The transaction is anticipated to close in mid-2020, subject to Mylan shareholder approval and satisfaction of other customary closing conditions, including receipt of regulatory approvals. Pfizer Inc. 2019 Form 10-K Acquisition of Therachon Holding AG On July 1, 2019, we acquired all the remaining shares of Therachon Holding AG, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $340 million upfront, plus potential milestone payments of up to $470 million, contingent on the achievement of key milestones in the development and commercialization of the lead asset. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Development Initiatives and Our Strategy sections and the Notes to Consolidated Financial Statements Note 2 . Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements in our 2019 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of medicines for the EU and the European Economic Area countries. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this 2019 Form 10-K. Some amounts in this 2019 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks in this 2019 Form 10-K are the property of their respective owners. AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2019 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this 2019 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2020 Proxy Statement and our 2019 Financial Report, portions of which are filed as Exhibit 13 to this 2019 Form 10-K, and which also will be contained in Appendix A to our 2020 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to this information. Our 2019 Annual Report to Shareholders consists of our 2019 Financial Report and the Corporate and Shareholder Information attached to the 2020 Proxy Statement. Our 2019 Financial Report will be available on our website on or about February 27, 2020. Our 2020 Proxy Statement will be available on our website on or about March 13, 2020. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts is not incorporated by reference into this 2019 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2019 Form 10-K COMMERCIAL OPERATIONS At the beginning of our 2019 fiscal year, we began to manage our commercial operations through a new global structure consisting of three businessesPfizer Biopharmaceuticals Group (Biopharma), Upjohn and, through July 31, 2019, Consumer Healthcare, each led by a single manager. We have revised prior-period segment information in our 2019 Form 10-K to reflect the 2019 reorganization. Biopharma and Upjohn are the only reportable segments. For additional information regarding the 2019 reorganization, as well as our Organizing for Growth initiative, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyOrganizing for Growth section and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report. On July 31, 2019, Pfizers Consumer Healthcare business, an over-the-counter medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare joint venture in which we own a 32% equity stake. For additional information, see the Notes to Consolidated Financial Statements Note 1A. Basis of Presentation and Significant Accounting Policies: Basis of Presentation and Note 2C. Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements: Equity-Method Investments and Assets and Liabilities Held for Sale in our 2019 Financial Report . Some additional information about our Biopharma and Upjohn business segments follows: Pfizer Biopharmaceuticals Group Biopharma is a science-based medicines business that includes six business units Oncology, Inflammation Immunology, Rare Disease, Hospital, Vaccines and Internal Medicine. The Hospital unit commercializes our global portfolio of sterile injectable and anti-infective medicines and includes Pfizers contract manufacturing operation, Pfizer CentreOne. At the beginning of our 2019 fiscal year, we also incorporated our biosimilar portfolio into the Oncology and Inflammation Immunology business units and certain legacy established products into the Internal Medicine business unit. Each business unit is committed to delivering breakthroughs that change patients lives. Upjohn is a global, primarily off-patent branded and generic medicines business, which includes a portfolio of 20 globally recognized solid oral dose brands, as well as a U.S.-based generics platform, Greenstone. Select products include: - Prevnar 13/Prevenar 13 - Ibrance - Eliquis - Xeljanz - Enbrel (outside the U.S. and Canada) - Chantix/Champix - Sutent - Xtandi - Vyndaqel/Vyndamax Select products include: - Lyrica - Lipitor - Norvasc - Celebrex - Viagra - Certain generic medicines On July 29, 2019, we announced that we entered into a definitive agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, Viatris. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Business Development Initiatives and Our Strategy sections in our 2019 Financial Report. For a further discussion of these operating segments, see the Pfizer Biopharmaceuticals Group (Biopharma) and Upjohn sections in this 2019 Form 10-K, the table captioned Revenues by Operating Segment and Geography in the Analysis of the Consolidated Statements of Income section and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , in our 2019 Financial Report, which are incorporated by reference. Pfizer Inc. 2019 Form 10-K PFIZER BIOPHARMACEUTICALS GROUP (BIOPHARMA) The key therapeutic areas comprising our Biopharma business segment include: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis, Chantix/Champix and Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies, and biosimilars across a wide range of cancers. Ibrance, Sutent, Xtandi, Xalkori, Inlyta and Braftovi + Mektovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Vfend and Zithromax Vaccines Includes innovative vaccines brands across all agesinfants, adolescents and adultsin pneumococcal disease, Meningococcal disease and tick-borne encephalitis, with a pipeline focus on healthcare-acquired infections and maternal health. Prevnar 13/Prevenar 13 (pediatric/adult), FSME-IMMUN, Nimenrix and Trumenba Inflammation and Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz, Enbrel (outside the U.S. and Canada), Inflectra and Eucrisa Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia, and endocrine diseases. Vyndaqel/Vyndamax, BeneFIX, Genotropin and Refacto AF/Xyntha We recorded direct product and/or alliance revenues of more than $1 billion for each of six Biopharma products in 2019 , seven Biopharma products in 2018 and six Biopharma products in 2017 : Biopharma $1 Billion+ Products 2018 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Ibrance Ibrance Ibrance Eliquis* Eliquis * Eliquis * Xeljanz Enbrel Enbrel Enbrel Xeljanz Xeljanz Chantix/Champix Chantix/Champix Sutent Sutent * Eliquis includes alliance revenues and direct sales in 2019, 2018 and 2017. For a discussion of certain Biopharma products and additional information regarding collaboration and/or co-promotion agreements involving certain of these Biopharma products, see the Item 1A. Business Collaboration and Co-Promotion Agreements and Patents and Other Intellectual Property Rights sections of this 2019 Form 10-K; for additional information regarding the revenues of our Biopharma business, including revenues by geography and of significant Biopharma products, see the Analysis of the Consolidated Statements of Income Revenues Overview, Revenues by Operating Segment and Geography and RevenuesSelected Product Discussion sections and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report; and for additional information on the key operational revenue drivers of our Biopharma business, see the Analysis of Operating Segment Information Biopharma Operating Segment section in our 2019 Financial Report. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K UPJOHN Upjohns products are used to treat non-communicable diseases across a broad range of therapeutic areas, including: Cardiovascular (Lipitor, Norvasc and Revatio); Pain and neurology (Lyrica and Celebrex); Psychiatry (Effexor, Zoloft and Xanax); Urology (Viagra); and Ophthalmology (Xalatan/Xalacom). We recorded direct product revenues of more than $1 billion for two Upjohn products in 2019 , three Upjohn products in 2018 , and three Upjohn products in 2017 : Upjohn $1 Billion+ Products Lyrica Lyrica Lyrica Lipitor Lipitor Lipitor Norvasc Viagra For a discussion of certain Upjohn products and additional information regarding the revenues of our Upjohn business, including revenues by geography and of significant Upjohn products, see the Analysis of the Consolidated Statements of Income Revenues Overview, Revenues by Operating Segment and Geography and RevenuesSelected Product Discussion sections and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report; and for additional information on the key operational revenue drivers of our Upjohn business, see the Analysis of Operating Segment Information Upjohn Operating Segment section in our 2019 Financial Report. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. COLLABORATION AND CO-PROMOTION AGREEMENTS We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including, among others, Eliquis, Xtandi and Bavencio. Revenues from Eliquis (except in certain markets where we have direct sales) , Xtandi and Bavencio are included in alliance revenues. Eliquis has been jointly developed and is commercialized by Pfizer and BMS. Pfizer funds between 50% and 60% of all development costs depending on the study. Profits and losses are shared equally on a global basis, except in certain countries where Pfizer commercializes Eliquis and pays BMS compensation based on a percentage of net sales. We have full commercialization rights in certain smaller markets. BMS supplies the product to us at cost plus a percentage of the net sales to end-customers in these markets. Eliquis is part of the Novel Oral Anticoagulant market; the agents in this class were developed as alternative treatment options to warfarin in appropriate patients. Xtandi is being developed and commercialized through a collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi. Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. In addition, Pfizer and Astellas share certain development and other collaboration expenses, and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (income)/deductionsnet ). Xtandi is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells. Bavencio (avelumab) is being developed and commercialized in collaboration with Merck KGaA. Both companies jointly fund the majority of development and commercialization costs, and split equally any profits related to net sales generated from selling any products containing avelumab from this collaboration. Bavencio is a human anti-programmed death ligand-1 (PD-L1) antibody. Pfizer Inc. 2019 Form 10-K RESEARCH AND DEVELOPMENT Innovation is critical to the success of our Company, and drug discovery and development are time-consuming, expensive and unpredictable. Pfizers purpose is to deliver breakthroughs that change patients lives. RD is at the heart of fulfilling Pfizers purpose as we work to translate advanced science and technologies into the therapies that matter most. Our RD Priorities and Strategy Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where Pfizer has a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position Pfizer for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on: Oncology; Inflammation and Immunology; Vaccines; Internal Medicine; Rare Diseases; and Hospital . While a significant portion of RD is done internally, we continue to seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. These agreements enable us to co-develop, license or acquire promising compounds, technologies and/or capabilities. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. Collaboration, alliance, license and funding agreements and equity- or debt-based investments allow us to share risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For additional information, see the Notes to Consolidated Financial Statements Note 2 . Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements in our 2019 Financial Report. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. In 2019, we continued to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time. Our RD spending is conducted through a number of matrix organizations: Research Units within our WRDM organization are generally responsible for research and early-stage development assets for our Biopharma business (assets that have not yet achieved proof-of-concept). Our Research Units are organized by therapeutic area to enhance flexibility, cohesiveness and focus. Because of our structure, we are able to rapidly redeploy resources within a Research Unit between various projects as necessary because in many instances the workforce shares similar skills, expertise and/or focus. Our science-based and other platform-services organizations provide technical expertise and other services to the various RD projects, and are organized into science-based functions (which are part of our WRDM organization), such as Pharmaceutical Sciences, Medicine Design, and non-science-based functions, such as Facilities, Digital and Finance. Within each of these functions, we are able to migrate resources among projects, candidates and/or targets in any therapeutic area and in most phases of development, allowing us to react quickly in response to evolving needs. In addition, the Worldwide Medical and Safety group, within WRDM, ensures that Pfizer provides all stakeholders including patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information on the risks and benefits associated with Pfizer products so that they can make appropriate decisions on how and when to use Pfizers medicines. Our RD organization within Upjohn supports the off-patent branded and generic established medicines and helps to develop product enhancements, new indications and new market registrations for these medicines. Pfizer Inc. 2019 Form 10-K Our Global Product Development (GPD) organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in the Biopharma portfolio. We manage RD operations on a total-company basis through our matrix organizations described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and Biopharma RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. Our Upjohn RD organization manages its resources separately from the WRDM and GPD organizations, with operational support from GPD for select clinical development regulatory activities and from WRDM for clinical supply operations and global pharmacovigilance processing. Generally, we do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information on our RD operations and expenses, see the Costs and Expenses Research and Development (RD) Expenses section in our 2019 Financial Report. Our RD Pipeline and Competition The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. The process from discovery to development to regulatory approval can take more than ten years. As of January 28, 2020 , we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of Income Product DevelopmentsBiopharmaceutical section in our 2019 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. In 2019, operations in developed and emerging markets were managed through our business segments: Biopharma, Upjohn and, through July 31, 2019, Consumer Healthcare. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets, particularly in Asia, provide growth opportunities for our medicines. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $27.9 billion accounted for 54% of our total revenues in 2019 . Revenues exceeded $500 million in each of eleven countries outside the U.S. in 2019, 2018 and 2017. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues Overview and Revenues by Operating Segment and Geography sections and the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report. Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries, including, among other things, currency fluctuations, capital and exchange control regulations and expropriation and other restrictive government actions. See the Item 1A. Risk Factors International Operations section in this 2019 Form 10-K. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See the Item 1. Business Government Regulation and Price Constraints Outside the United States section in this 2019 Form 10-K for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7 F . Financial Instruments : Derivative Financial Instruments and Hedging Activities in our 2019 Financial Report, which is incorporated by reference, as well as Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the U.S. Centers for Disease Control and Prevention, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary Pfizer Inc. 2019 Form 10-K products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. In 2019 , our top three biopharmaceutical wholesalers accounted for approximately 37% of our total revenues (and approximately 79% of our total U.S. revenues). % of 2019 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see the Item 1. Business Government Regulation and Price Constraints Outside the United States Intellectual Property section in this 2019 Form 10-K. In various markets, a period of regulatory exclusivity may be provided to certain drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period of regulatory exclusivity will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, grant of an additional six-month pediatric extension and/or the granted patent term extension in the U.S. and Japan and Supplementary Patent Certificate in Europe), are those for the medicines set forth in the table below. Unless otherwise indicated, the years set forth in the table below pertain to the basic product patent expiration for the respective products. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Pfizer Inc. 2019 Form 10-K Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Lyrica 2019 (1) 2014 (2) 2022 (3) Chantix/Champix Sutent Ibrance Vyndaqel/Vyndamax Inlyta Xeljanz 2028 (4) Prevnar 13/Prevenar 13 __(5) Eliquis (6) Xtandi (7) * (7) * (7) Xalkori Besponsa 2028 (8) Braftovi (9) * (9) * (9) Mektovi (9) 2031 (10) * (9) * (9) Bavencio (11) (1) Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. (2) Lyrica regulatory exclusivity in the EU expired in July 2014. (3) Lyrica is covered by a Japanese method-of-use patent which expires in 2022. The patent is currently subject to an invalidation action. (4) Xeljanz EU expiry is provided by regulatory exclusivity. (5) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other EU patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Besponsa Japan expiry is provided by regulatory exclusivity. (9) Pfizer has exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. Pfizer receives royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) The U.S. expiration date in the table for Mektovi is provided by a method-of-use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Many of our branded products have multiple patents that expire at varying dates, thereby strengthening our overall patent protection. However, once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Also, if one of our patents is found to be invalid by judicial, court or administrative proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. For additional information, see the Item 1A. Risk Factors Patent Protection section in this 2019 Form 10-K. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim either do not infringe our patents or our patents are invalid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. We will continue to aggressively defend our patent rights whenever we deem appropriate. For additional Pfizer Inc. 2019 Form 10-K information, see the Notes to Consolidated Financial Statements Note 16 A1 . Contingencies and Certain Commitments Legal ProceedingsPatent Litigation in our 2019 Financial Report. Recent Losses and Expected Losses of Product Exclusivity Certain of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. For example, as a result of a patent litigation settlement, Teva launched a generic version of Viagra in the U.S. in December 2017. Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. See the table above for the basic product patent expiries of our most significant products. We expect the impact of reduced revenues due to patent expiries will be significant in 2020, then moderating downward to a much lower level from 2021 through 2025. For additional information, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. The following table provides information about certain products recently experiencing, or expected to experience in 2020 , patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan. Our financial results in 2019 and our financial guidance for 2020 reflect the impact of the loss of exclusivity of various products discussed below: (MILLIONS OF DOLLARS) Product Revenues in Markets Impacted Products Key Dates (a) Markets Impacted Year Ended December 31, Viagra (b) June 2013 May 2014 December 2017 Major European markets Japan U.S. $ $ $ Lyrica (c) July 2014 June 2019 Major European markets U.S. 2,208 3,852 3,901 Pristiq (d) March 2017 U.S. Chantix (e) November 2020 U.S. (a) Unless otherwise noted, Key Dates indicate patent-based expiration dates. (b) As a result of a patent litigation settlement, Teva launched a generic version of Viagra in the U.S. in December 2017. (c) Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. (d) As a result of a patent litigation settlement with several generic manufacturers, generic versions of Pristiq launched in the U.S. in March 2017. (e) The basic product patent for Chantix in the U.S. will expire in November 2020, which includes the FDAs grant of pediatric exclusivity that extended the period of market exclusivity in the U.S. for Chantix for an additional six months from May 2020. Biologic Products Our biologic products, including BeneFIX, ReFacto, Xyntha, Bavencio, Prevnar 13/Prevenar 13 and Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference our originator biologic products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin, that was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA in 2010, a framework for such approval exists in the U.S. In Europe, the European Commission grants marketing authorizations for biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop and commercialize biosimilar medicines. Some of the biosimilars that we currently market include Inflectra, Nivestym, Retacrit, Zirabev, Ruxience and Trazimera in the U.S.; Inflectra, Retacrit, Nivestim and Trazimera in the EU; and Ixifi, Trazimera, Zirabev and Ruxience in Japan. See the Item 1A. Risk Factors Biosimilars section in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K We may face litigation with respect to the validity and/or scope of patents relating to our biologic products. Likewise, as we develop, manufacture and seek to launch biosimilars, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, we have seen some improvement in global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints Outside the United States Intellectual Property section in this 2019 Form 10-K. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further demonstrating the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians, payers and global health authorities. We also seek to continually enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our efforts to accurately and ethically launch and promote our products to our customers. Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals, and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our vaccines business may face competition from the introduction of alternative vaccines. For example, Prevnar 13 may face competition in the form of competitor vaccines, including vaccines with additional serotypes or next-generation pneumococcal conjugate vaccines prior to or after the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products. We also sell biosimilars of certain inflammation immunology and oncology biologic medicines globally. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with potentially higher levels of sales and profitability until other generic or biosimilar competitors enter the market. Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 300 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see the Item 1. Business Government Regulation and Price Constraints In the United States section in this 2019 Form 10-K), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using Pfizer Inc. 2019 Form 10-K formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and copay accumulator programs to improve their cost containment efforts. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. For additional information, see the Item 1. Business Government Regulation and Price Constraints In the United StatesHealthcare Reform section in this 2019 Form 10-K. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors can market a competing version of our product after the expiration or loss of our patent and often charge much less. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2020, which may result in price cuts and volume loss of some of our products. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Favoring generics may reduce sales of our branded products. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. In 2019 , we experienced periodic shortages of select materials due to constrained capacity or operational challenges with the associated suppliers. Supplier management activities are ongoing to work to ensure the necessary supply to meet our requirements for these materials. No significant impact to our operations is anticipated in 2020. Pfizer Inc. 2019 Form 10-K GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, delays in product approvals, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulation by the FDA, including regulations that govern, among other things, the safety and efficacy of our medicines, clinical trials, advertising and promotion, manufacturing, labeling and record keeping. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. Other U.S. federal agencies, including the DEA, also regulate certain of our products. Many of our activities also are subject to the jurisdiction of the SEC. Biopharmaceutical companies seeking to market a product in the U.S. must first test the product to demonstrate that it is safe and effective for its intended use. If, after evaluation, the FDA determines the product is safe (i.e., its benefits outweigh its known risks) and effective, then the FDA will approve the product for marketing, issuing a New Drug Application or Biologics License Application, as appropriate. Companies seeking to market a generic prescription drug must scientifically demonstrate that the generic drug is bioequivalent to the innovator drug. The Abbreviated New Drug Application, or generic drug application, must show, among other things, that the generic drug is pharmaceutically equivalent to the brand, the manufacturer is capable of making the drug correctly, and the proposed label is the same as that of the innovator/brand drugs label. Even after a drug or biologic is approved for marketing, it may still be subject to postmarketing commitments or postmarketing requirements. Postmarketing commitments are studies or clinical trials that the drug or biologic sponsor has agreed to conduct, but are not required by law and/or regulation. Postmarketing requirements include studies and clinical trials that sponsors are required to conduct, by law and/or regulation, as a condition of approval. Postmarketing studies or clinical trials can be required in order to assess a known risk or demonstrate clinical benefit for drugs or biologics approved pursuant to accelerated approval. If a company fails to meet its postmarketing requirements, the FDA may assess a civil monetary penalty, issue a warning letter or deem the drug or biologic misbranded. Once a drug or biologic is approved, the FDA must be notified of any modifications to the product and the FDA may also require a manufacturer to submit additional studies or conduct clinical trials. In addition, we are also required to report adverse events and comply with cGMPs, as well as advertising and promotion regulations. Failure to comply with the FFDCA may subject us to administrative and/or judicial sanctions, including warning letters, product recalls, seizures, delays in product approvals, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference innovator biologic. The FDA is responsible for implementation of the legislation and approval of new biosimilars. Through FDA approvals and the issuance of draft and final guidance, the FDA has addressed a number of issues related to the biosimilars approval pathway, such as the labeling expectations for biosimilars. For example, in 2019, the FDA issued final guidance regarding the standards for demonstrating interchangeability with a U.S.-licensed reference product. In addition, in 2017, the Biosimilar User Fee Act was reauthorized for a five-year period, which led to a significant increase in the FDAs biosimilar user fee revenues, thereby providing the FDA with additional resources to process biosimilar applications. For example, since the enactment of the newly authorized fee structure, the FDA estimates its revenues from biosimilar user fees generally will exceed $40 million. Sales and Marketing Laws and Regulations . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended, among other things, to prevent fraud and abuse in the healthcare industry and to protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying anything of value to generate business, including purchasing or prescribing of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs or biologics) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal healthcare programs (including Medicare and Medicaid). The federal government Pfizer Inc. 2019 Form 10-K and various states also have enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and healthcare providers, require disclosure to the federal or state government and the public of such interactions, and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing and reimbursement for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section and the Notes to Consolidated Financial Statements Note 1 G . Basis of Presentation and Significant Accounting Policies : Revenues and Trade Accounts Receivable in our 2019 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including proposed action on drug importation, could adversely affect our business if implemented. There continues to be considerable public and government scrutiny of pharmaceutical pricing, and measures to address the perceived high cost of pharmaceuticals are being considered by Congress, the Presidential Administration and select states. For example, recent legislation revised how manufacturers calculate the average manufacturer price on branded drugs with authorized generics under the Medicaid drug rebate program, which the Congressional Budget Office has estimated will reduce Medicaid costs by over $3 billion over the next decade. Proposals for even more far-reaching reform, such as immediately eliminating or phasing out private health insurance, are being proposed by some Democratic candidates for U.S. President. In particular, several states have enacted or are considering transparency laws that require prescription drug manufacturers to report to the state and make public price increases, and sometimes to provide a written justification for the increase. In addition to new state transparency laws and the introduction of several Federal pricing bills, we have also seen the Presidential Administration introduce proposals related to importation and express interest in international reference pricing in Medicare Part B. We expect to see continued focus in regulating pricing resulting in additional legislation and regulation that could adversely impact revenue. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors U.S. Entitlement Reform section in this 2019 Form 10-K. Also, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products under certain state Medicaid programs. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. States continue to explore options for controlling healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program that are tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains and wholesalers, who collectively are the primary purchasers of our pharmaceutical products in the U.S., and PBMs will increase pricing pressures on pharmaceutical manufacturers, including us. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this 2019 Form 10-K. The potential for additional pricing and access pressures in the commercial sector continues to be significant. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This is a trend that is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Longer term, we are seeing a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better Pfizer Inc. 2019 Form 10-K understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs . Healthcare Reform. There have been significant efforts at the federal and state levels to reform the healthcare system by enhancing access to healthcare, improving the delivery of healthcare and further rationalizing payment for healthcare. We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is additional uncertainty given the ruling in December 2019 by the U.S. Circuit Court of Appeals for the Fifth Circuit in Texas v. Azar that the individual mandate, which is a significant provision of the ACA, is unconstitutional. The case has been remanded to a lower court to determine whether the individual mandate is inseparable from the entire ACA, in which case the ACA as a whole would be rendered unconstitutional. In the meantime, the remaining provisions of the law remain in effect. The revenues generated for Pfizer by the health insurance exchanges and Medicaid expansion under the ACA are not material, so the impact of full invalidation of the law is expected to be limited. However, any future replacement for the ACA may adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Any future healthcare reform efforts may adversely affect our business and financial results. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. Pfizer collects personal data as part of its regular business activities. The collection and use of this data is subject to privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. For example, we are subject to the California Consumer Privacy Act (CCPA). The CCPA, which came into effect on January 1, 2020, imposes numerous obligations on us, including a duty to disclose the categories of personal data that we collect, sell, or share about California consumers, and gives those consumers rights regarding their personal data. Noncompliance with any of these laws could result in the imposition of fines, penalties, or orders to stop non-compliant activities, and could damage our reputation and harm our business. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU, which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In China, the regulatory system historically presented numerous challenges for the pharmaceutical industry, as its requirements for drug development and registration were often inconsistent with U.S. or other international standards. In recent years, however, China has introduced reforms and draft reforms, which are discussed in more detail below, that attempt to address these challenges. Furthermore, in 2017, the China regulatory authority, the National Medical Products Administration (NMPA), became a member of the International Council for Harmonization (ICH), which has resulted in greater adoption of international technical guidelines and practices by the government. 2019 was another active year in this respect, with a number of reforms coming into effect, and more proposals and drafts being issued for consultation. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, postmarketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. Pharmacovigilance. In the EU, the EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pfizer Inc. 2019 Form 10-K Pricing and Reimbursement . Certain governments, including the different EU member states, the U.K., China, Japan, Canada, South Korea and some other international markets, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), quality consistency evaluation processes and volume-based procurement. In addition, the international patchwork of price regulation and differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and hinders patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations, including the World Health Organization (WHO), and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. In 2019, the WHO continued exerting pressure on pharmaceutical pricing practices by supporting strategies to reduce medicine prices, including calling for greater transparency around the cost of research and development and production of medicines, as well as disclosure of net prices. In Japan, the pricing environment for innovative medicines further deteriorated in 2019 with the introduction of a health technology assessment (HTA) system to inform price adjustments of healthcare technologies after launch. Expansion of this system for reimbursement decisions, as seen in other HTA markets, remains a risk. While significant challenges remain, the 2020 Drug Pricing Reform Package, unlike the last reform package in 2018, is not expected to fundamentally change the access landscape. Furthermore, the eligibility criteria for the Price Maintenance Premium, a key policy that protects against price erosion for certain products, is expected to be somewhat enhanced while expedited regulatory pathways are codified in law. In Canada, the Patented Medicine Prices Review Board (PMPRB) released draft guidelines to implement new pricing regulations in November 2019, which will go into force in July 2020. These regulations drop the U.S. from the reference basket of countries used to determine price and add economic factors for setting ceiling prices for new medicines. An initial analysis of the potential impact of these proposed changes to the PMPRB regulations estimated an approximately $26 billion reduction in industry revenues over the next decade. China Pricing Pressures . In China, healthcare is largely driven by a public payer system, with public medical insurance as the largest single payer for pharmaceuticals, and pricing pressures have increased in recent years. Government officials have consistently emphasized the importance of improved health outcomes, the need for healthcare reform and decreased drug prices as key indicators of progress towards reform. While the government provides basic health insurance for the vast majority of Chinese citizens, that insurance is not adequate to cover many innovative medicines, and alternative funding sources for innovative medicines remain suboptimal. In 2019, Chinas government negotiated with companies to add approximately 90 innovative drugs (mainly oncology medicines) to the National Reimbursement Drug List. This builds on 60 drugs already added through negotiation in 2017 and 2018. Prices for drugs have been reduced dramatically through this government-led process. While these negotiations have included a path to access for companies, market access is not assured. In addition, significant questions about the processes and negotiations for provincial tendering remain, as well as the need for multi-layered negotiations across provincial, municipal and hospital levels. In the off-patent space, in 2013, China began to implement a quality consistency evaluation (QCE) process in order to improve the quality of domestically-manufactured generic drugs, primarily by requiring such drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). In 2018, numerous local generics were officially deemed bioequivalent under QCE. A pilot project for centralized volume-based procurement (VBP) was then initiated including 25 molecules of drugs covering 11 major Chinese cities. Under this procurement model, a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Upjohn and most off-patent originators were not successful in the first bidding process under this pilot, which was finalized in December 2018 and implemented in March 2019, and most contracts went to local generic companies. The first bidding process resulted in significant price cuts by the successful bidders, with some bidders reducing the price of their products by as much as 96 percent, as companies attempted to secure volumes on the Chinese pharmaceutical market. The drugs that lost the bidding were also requested to reduce their selling price up to 30 percent based on the price difference with the successful bidder. Chinas government began nationwide expansion of the VBP pilot in December 2019. The expanded model, which is being implemented nationwide, applies to certain drugs that are purchased for public hospitals as well as some military and private medical institutions. As in the first bidding process, our Upjohn business unit and most originator brands were not successful in Pfizer Inc. 2019 Form 10-K the bidding process for this nationwide expansion, and those contracts mostly went to local Chinese generic companies. The QCE-qualified generic makers of atorvastatin and amlodipine bid aggressively, lowering prices even further from the March 2019 tender. Our Upjohn business unit continues to take steps to mitigate the revenue impact of these initiatives but anticipates that they will continue to affect our Upjohn business in China in the future. We expect to utilize our presence in the retail channel, private hospitals and tendering capabilities to mitigate some of these pricing pressures. In addition, we believe that our geographic expansion to under-penetrated and lower-tiered cities and counties and additional focus on non-tendered products will increase sales volumes in greater China and partially mitigate pressures from QCE. In late 2019, China announced another round of expansion of the national VBP program, which covers 33 new molecules, including Biopharmas Zithromax tablets and Diflucan tablets and no Upjohn products. Biopharma was not successful in the bidding process for this expansion. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines. The government currently plans to implement this universal reimbursement price initiative within the next two to three years. If this policy is implemented, the new reimbursement level for Upjohns products will likely be lower than the current reimbursement level, placing additional pressures on price and/or patient copays. There remains uncertainty as to whether, when and how this policy may be officially implemented. The Chinese government could also enact other policies that may increase pricing pressures or have the effect of reducing the volume of sales available to Upjohns products. This potential policy, and any other policies like it that could increase pricing and copay pressures on Upjohns drug products in China, could have an adverse effect on our business, financial condition and results of operations. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. The scope of future QCE products and timing of any program expansion is currently unknown, making it difficult to determine the impact on Pfizers business and financial condition. We will continue to monitor the market for developments. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, but its implementation has been delayed by the need for the EU authorities to establish new technical systems. This regulation is aimed at simplifying and harmonizing the administrative processes and governance of clinical trials in the EU and will require increased public posting of clinical trial results. It is currently not anticipated to be fully implemented until the first half of 2022 at the earliest. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. The U.K. left the EU on January 31, 2020 with status quo arrangements through a transition period scheduled to end on December 31, 2020. The consequences of the U.K. leaving the EU and the terms of the future trading relationship continue to be highly uncertain, which may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. However, both the U.K. and the EU have issued detailed guidance for the industry on how medicines, medical devices and clinical trials will be separately regulated in their respective territories. Pfizer has substantially completed its preparations for Brexit, having made the changes necessary to meet relevant regulatory requirements in the EU and the U.K., through the transition period and afterwards, especially in the regulatory, research, manufacturing and supply chain areas. Between 2018 and 2021, we expect to spend up to approximately $60 million in one-time costs to make these adaptations. For additional information on Brexit, see the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce backlogs for existing applications for drug approval, in recent years, the NMPA has unveiled numerous reform initiatives for Chinas drug approval system and engaged in significant efforts to build its capabilities. The NMPA divides drugs into new drugs and generics, with the definition for new drugs changed from China New to Global New. This means that drugs previously approved in other markets (such as the U.S. or Europe) are not considered new drugs under Chinas regulatory regime. This change in definition creates more opportunities for Chinas domestic drug manufacturers than for multinational firms, because multinational firms have historically had significant competitive advantage in successfully achieving regulatory approvals for drugs first approved outside of China. Revisions in 2019 made clear, however, that regulatory approval from the FDA or the EMA would no longer be required for approval of imported drugs, though a notable exception persists for imported vaccines, which still require prior approval from a reference regulatory agency such as the FDA. In 2019, China published a revision to its Drug Administration Law and introduced a marketing authorization holder system, which grants the NMPA more authority over regulating manufacturers and provides manufacturers more flexibility in contract manufacturing arrangements and manufacturing site transfers. While challenges remain, a number of other policy changes are streamlining and accelerating approvals of domestic and imported drugs in China. These reforms, along with Chinas June 2018 elevation to the ICH Management Committee, are expected to pave the way for integration of Chinese regulations with global practices. These changes include introducing more streamlined processes for maintaining renewal of product registrations, reduction in importing testing requirements, and establishing an expedited registration pathway for drugs to treat rare diseases and serious, life-threatening illnesses with no effective treatment. Though certain details on implementation are unclear (e.g., evolving list of qualified rare diseases and no guidance on what qualifies as serious, life threatening), the NMPA aims to build expedited pathways for certain categories of products similar to the U.S. and European regulatory systems. Additionally, the NMPA published changes to Chinas registration requirements that align more with international practices, including a 60-day review timeline for clinical trial authorizations and Pfizer Inc. 2019 Form 10-K guidance for acceptance of foreign clinical data and the utilization of real world data in drug development and regulatory decision making. Although a number of regulatory changes better support Chinas inclusion in simultaneous global drug development, unique regulatory requirements continue to pose challenges for multinational companies, including Chinas Human Genetic Resources process for exporting clinical trial samples (which adds months to starting a clinical trial in China); mismatched China Pharmacopoeia and manufacturing data requirements that require standards exceeding acceptable practices in the U.S., EU, and Japan; and unpredictable and inconsistent clinical trial inspection practices. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, the European Federation of Pharmaceutical Industries and Associations disclosure code requires all members, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, some countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to protect their local pharmaceutical industries. Considerable political and economic pressure exists to weaken current intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. In developed countries as well, including the EU, we are facing an increasingly challenging intellectual property environment. As part of the Canada/EU Comprehensive Economic Trade Agreement (CETA), Canada now provides sui generis protection, commonly referred to as patent term restoration, for patent term extensions for basic patents; however, the extension is capped at two years, whereas the international norm is five years. In addition, the implementing regulations may create obstacles for patentees applying for patent term restoration via a Certificate of Supplementary Protection (CSP), and Canadas proposed drug pricing reforms may negatively impact the benefit of a CSP. Furthermore, the United States-Mexico-Canada Agreement (USMCA) will, when implemented, require Canada and Mexico to make certain improvements to their current intellectual property regimes, including the establishment of patent term adjustment for unreasonable delays in the grant of patents. In China, the intellectual property environment has improved in recent years, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, although China remained on the U.S. Trade Representatives Priority Watch List for 2019 due to ongoing enforcement challenges and Chinas failure to make certain structural reforms. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In 2019, the regulatory authority granted marketing approval to generic products while the reference product in each case are still subject to patent protection, and there is no effective legal means to resolve patent disputes prior to the marketing of those infringing drugs. The U.S. and China recently signed an initial agreement in which China has committed to address some patent-related concerns, and both governments have indicated that they will continue bilateral discussions on implementation of these commitments and other intellectual property issues in 2020. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. Additionally, an increased threat of issuance of compulsory licenses for biopharmaceutical products exists, which adds to business uncertainty. In India, we have seen some progress in terms of expediting patent approval processes to reduce pendency rates and implementing training programs to enhance enforcement. Despite these positive steps, gaps remain in terms of addressing longstanding intellectual property concerns. For example, policies favoring compulsory licensing of patents, the tendency of the Pfizer Inc. 2019 Form 10-K Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. Data Privacy. Outside of the U.S., many countries where we conduct business, including the EU, have privacy and data security laws and regulations concerning the collection and use of personal data, and we must comply with these laws and regulations as well. One applicable law is the EUs General Data Protection Regulation (GDPR). The GDPR imposes detailed obligations on companies that collect, use, or otherwise process personal data and penalties for noncompliance may include fines of up to 4 percent of the companys global annual revenue. Additionally, the legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. Any inability to comply with applicable laws, regulations, policies, industry standards or other legal obligations regarding data protection or privacy could result in additional costs and liability to Pfizer as well as reputational harm and may adversely affect our business. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 16 A3 . Contingencies and Certain Commitments Legal ProceedingsCommercial and Other Matters in our 2019 Financial Report. As a result, we incurred capital and operational expenditures in 2019 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $31 million ; and other environment-related expenses $136 million . While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. For example, in 2017, our manufacturing and commercial operations in Puerto Rico were impacted by hurricanes as our three manufacturing sites in Puerto Rico sustained damage and became inoperable due to issues impacting Puerto Rico overall. All three sites resumed operations, and remediation activities were completed in 2018. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to potential weather-related risks and other natural disasters and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5 . Tax Matters in our 2019 Financial Report is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We generally believe we have good relationships with our employees. As of December 31, 2019 , we employed approximately 88,300 people in our operations throughout the world. DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2019 , our activities included supplying medicine and medical products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2019 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2019 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2019 Form 10-K and in our 2019 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, revenue contribution, growth, performance, timing of exclusivity and potential benefits, strategic reviews, capital allocation objectives, plans for and prospects of our acquisitions and other business-development activities, benefits anticipated from the reorganization of our commercial operations in 2019, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, government regulation, our ability to successfully capitalize on growth opportunities or prospects, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, including, among others, the expected timing, benefits, charges and/or costs in connection with our agreement to combine Upjohn with Mylan to create a new global pharmaceutical company, Viatris, set forth in the Item 1. BusinessAbout Pfizer and Item 1A. Risk FactorsPending Combination of Upjohn with Mylan sections in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Business Development Initiatives and Our Strategy sections and the Notes to Consolidated Financial StatementsNote 1A. Basis of Presentation and Significant Accounting PoliciesBasis of Presentation in our 2019 Financial Report; the expected impact of patent expiries on our business set forth in the Item 1. BusinessPatents and Other Intellectual Property Rights section in this 2019 Form 10-K and in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Operating EnvironmentIndustry-Specific ChallengesIntellectual Property Rights and Collaboration/Licensing Rights section in our 2019 Financial Report; the expected competition from certain generic manufacturers in China in the Item 1. BusinessCompetitionGeneric Products and Item 1A. Risk FactorsGeneric Competition sections in this 2019 Form 10-K; the anticipated costs related to our preparations for Brexit set forth in the Item 1. BusinessGovernment Regulation and Price ConstraintsOutside the United StatesBrexit section in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment section in our 2019 Financial Report; the availability of raw materials for 2020 set forth in Item 1. Business Raw Materials in this 2019 Form 10-K; the expected pricing pressures on our products in the U.S. and internationally and the anticipated impact to our business set forth in the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this 2019 Form 10-K; the anticipated impact of climate change on Pfizer set forth in Item 1. BusinessEnvironmental Matters in this 2019 Form 10-K; the expected demerger of the GSK Consumer Healthcare joint venture set forth in the Item 1A. Risk Factors Consumer Healthcare Joint Venture with GSK section in this 2019 Form 10-K; the benefits expected from the reorganization of our commercial operations in 2019 and our expectations regarding growth set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Organizing for Growth section in our 2019 Financial Report; our anticipated liquidity position set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment and the Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2019 Financial Report; the anticipated costs and savings from certain of our initiatives, including Transforming to a More Focused Company initiative, set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Transforming to a More Focused Company and Costs and Expenses Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives sections and the Notes to Consolidated Financial Statements Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives in our 2019 Financial Report; our plans for increasing investment in the U.S. set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyCapital Allocation and Expense ManagementIncreasing Investment in the U.S. section in our 2019 Financial Report; the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Financial Guidance for 2020 section in our 2019 Financial Report; the expected impact of the Advisory Committee on Immunization Practices recommendation for Prevnar 13 for adults 65 and older on Prevnar 13s revenues set forth in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product DiscussionPrevnar 13/Prevenar 13 (Biopharma) section in our 2019 Financial Report; the expected impact of updates to the prescribing information for Xeljanz on its growth set forth in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product DiscussionXeljanz (Biopharma) section in our 2019 Financial Report; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources Contractual Obligations section in our 2019 Financial Report; the expected payments to our unfunded U.S. supplemental (non-qualified) pension plans, postretirement plans and deferred compensation plans and expected funding obligations set forth in the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources Contractual Obligations section; and the voluntary contribution we expect to make during 2020 for the U.S. qualified plans set forth in the Notes to Consolidated Financial Statements Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report. Pfizer Inc. 2019 Form 10-K We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Private third-party payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization of drugs and control the cost of drugs. Consolidation among MCOs has increased the negotiating power of MCOs and other private third-party payers. Private third-party payers, as well as governments, increasingly employ formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. Failure to obtain or maintain timely or adequate pricing or favorable formulary placement for our products, or failure to obtain such formulary placement at favorable pricing, could adversely impact revenue. Private third-party payers often implement formularies with copayment tiers to encourage utilization of certain drugs and have also been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private third-party payers are also implementing new initiatives like so-called copay accumulators (policies that provide that the value of copay assistance does not count as out-of-pocket costs that are applied toward deductibles) that can shift more of the cost burden to manufacturers and patients. This cost shifting has increased consumer interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, biopharmaceutical companies may face greater pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic competition could lead to our loss of a major portion of revenues for that product in a very short period of time. A number of our products have experienced significant generic competition over the last few years. For example, Lyrica (a product in our Upjohn business) lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. In China, we are expected to face further intensified competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents or that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. Pfizer Inc. 2019 Form 10-K COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development. Some of these have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with products from competitors, including other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before the anticipated formation of the generic or biosimilar marketplace is important to that products profitability. With increasing competition in the generic or biosimilar product markets, our success will depend on our ability to bring new products to market quickly. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which may result in delayed approvals of new generic products over the next few years. Also, we may face access challenges for our biosimilar products where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to the innovator product. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against Johnson Johnson (JJ) alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product and/or alliance revenues of more than $1 billion for each of eight biopharmaceutical products in 2019: Prevnar 13/Prevenar 13, Ibrance, Eliquis, Lyrica, Xeljanz, Lipitor, Enbrel and Chantix/Champix. Those products accounted for 49% of our total revenues in 2019 . If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures, supply shortages or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. A number of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra (a product in our Upjohn business) in the U.S. in December 2017. In addition, Lyrica (a product in our Upjohn business) lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this 2019 Form 10-K. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the scientific approach may not succeed for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that is positioned to deliver value in the near-term and over time. These strategies may not deliver the desired result, which could affect growth and profitability in the future. Pfizer Inc. 2019 Form 10-K BIOSIMILARS Abbreviated legal pathways for the approval of biosimilars exist in many international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biologic products, our biologic products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. For example, Enbrel faces ongoing biosimilar competition in most European markets. The loss of patent rights, due to patent expiration or litigation, could trigger competition. We are developing and commercializing biosimilar medicines. Risks related to our commercialization of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower uptake for biosimilars due to various factors that may vary for different biosimilars (e.g., anti-competitive practices, physician reluctance to prescribe biosimilars for existing patients taking the originator product, or misaligned financial incentives). See also the Competitive Products risk factor above. RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication and its reimbursement potential must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and manufacturing and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and adequately addressed could affect our future results. INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets. However, our strategies in emerging markets may not be successful and these countries may not continue to sustain these growth rates. For example, even though China is growing faster than most emerging markets, we face certain challenges in China due to government imposed pricing controls affecting certain Pfizer medicines. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. The impact of payers efforts to control access to and pricing of specialty pharmaceuticals is increasing. A number of factors create a more challenging paradigm for Pfizer given our growing specialty business portfolio such as formulary restrictions and increasing use of utilization management tools such as step edits, which can lead to higher negotiated rebates or discounts to health plans and PBMs in the U.S., as well as the increasing use of health technology assessments and government pressures in markets around the world. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS Difficulties or delays in product manufacturing, sales or marketing could affect future results through regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, product liability or unanticipated costs. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of component materials is delayed or unavailable and that the quality of such materials are substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout our internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); Pfizer Inc. 2019 Form 10-K risks to supply chain continuity and commercial operations as a result of natural (including hurricanes, earthquakes and floods) or man-made disasters (including arson or terrorist attacks) at our facilities or at a supplier or vendor, including those that may be related to climate change; failure to maintain the integrity of our supply chains against economic adulteration, product diversion, product theft, counterfeit goods and cyberattacks. As an example, we have been experiencing production issues with Genotropin that will decrease revenue from that product. Regulatory agencies periodically inspect our drug manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, recall of a product, delays or denials of product approvals, import bans or denials of import certifications, any of which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, for example, we received a warning letter from the FDA communicating the FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. We undertook corrective actions to address the concerns raised by the FDA. In January 2018, the FDA upgraded the status of Pfizers McPherson manufacturing facility to VAI based on an October 2017 inspection. The change to VAI status lifted the compliance hold that the FDA placed on approval of pending applications. In June 2018, the FDA informed us that it had completed an evaluation of corrective actions and closed out the February 2017 warning letter issued to our McPherson manufacturing facility after determining that we had addressed the violations contained in the warning letter. In July-August 2018, the FDA conducted a follow-up inspection of our McPherson facility and issued an inspection report noting several findings. Pfizer responded to the FDAs findings, and is in the process of implementing a corrective and preventive action plan to address the FDAs concerns. On the basis of the July-August 2018 FDA inspection, the FDA changed the inspection classification of the McPherson site to Official Action Indicated (OAI). Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. Communication with the FDA on the status of the McPherson site is ongoing. As a result of the current OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our McPherson site until the site status is upgraded, which upgrade would be based on a re-inspection by the FDA. We have been experiencing shortages of products from the legacy Hospira portfolio, among others, largely driven by capacity constraints, technical issues, supplier quality concerns or unanticipated increases in demand. We have made considerable progress in remediating issues at legacy Hospira facilities manufacturing sterile injectables and have substantially improved supply from most of these sites. Continuing product shortage interruption at these manufacturing facilities could negatively impact our financial results. In addition, in September 2017, Meridian Medical Technologies, Inc., a subsidiary of Pfizer Inc., received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as OAI. Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services to other parties, including transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of these third parties to complete activities on schedule or in accordance with our expectations; failure by one or more of these parties to meet their contractual or other obligations to Pfizer; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between Pfizer and one or more of these third parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, could expose us to suboptimal quality of service delivery or deliverables, could result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or reputational harm, all with potential negative implications for our product pipeline and business. BIOPHARMACEUTICAL WHOLESALERS In 2019 , our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 32% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 37% of our total revenues (and approximately 79% of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact Pfizer Inc. 2019 Form 10-K our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, and could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, such as in connection with our contribution agreement entered into with Allogene Therapeutics, Inc., the value of those securities will fluctuate, and may depreciate in value. We may not control the company in which we acquire securities, such as in connection with a divestiture or collaborative arrangement, and as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Legal proceedings or regulatory issues often arise as a result of activities that occurred at acquired companies, their partners and other third parties. In 2016, for example, we paid $784.6 million to resolve allegations related to Wyeths reporting of prices to the government with respect to Protonix for activities that occurred prior to our acquisition of Wyeth. For these and other reasons, we may not realize the anticipated benefits of such transactions, and expected synergies and accretion may not be realized within the expected timeframes, or at all. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; the tendency to misuse and abuse medicines; and the relatively modest risk of penalties faced by counterfeiters compared to the large profits that can be earned by them from the sale of counterfeit medicines. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines continue to pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Counterfeiters have been recently evolving to counterfeit life sustaining medications such as oncology medicines. This shift significantly increases the risk to patients who, for instance, unsuspectingly purchase counterfeit oncology medications from illicit online pharmacies operated by criminal counterfeiting organizations. Failure to mitigate this new threat posed by counterfeit biopharma medicines could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We have an enterprise-wide strategy to counteract the threats associated with counterfeit medicines, and focused on educating patients and health care providers to reduce demand through awareness; increasing engagement and education of global law enforcement, customs and regulatory agencies about the growing prevalence of counterfeit life sustaining medicines; enhancing online identification and disruption efforts in partnership with pharmaceutical associations to optimize resources and impact; educating legislators about the risk to the security of the international drug supply chain by illicit manufacturing and distribution networks operated by transnational criminal organizations; supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; and using data analytics and risk assessment tools to better target the factors that give rise to the counterfeiting problem in the first place. However, our efforts and the efforts of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2019 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. There have also been recent state legislative efforts to address drug costs, which generally have focused on increasing transparency around drug costs or limiting drug prices. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. See the discussion regarding pricing and reimbursement in the Item 1. Business Government Regulation and Price Constraints In the United States Pricing and Reimbursement section in this 2019 Form 10-K. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as the different EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. For example, China, in 2013, began to implement a QCE process, under which numerous local generics have officially been deemed bioequivalents of a qualified reference drug. Chinas government subsequently initiated a pilot project for centralized VBP in 2018, which included 25 molecules of drugs and covered 11 major Chinese cities. Under this procurement model, a tender process was established whereby a certain portion of included molecule volumes were guaranteed to tender winners. This tender process was intended to contain healthcare costs by driving utilization of generics and bioequivalents that had passed QCE, and has resulted in dramatic price cuts for off-patent medicines. Chinas government began nationwide expansion of the VBP pilot in December 2019. See the discussion regarding these government initiatives in China in the Item 1. Business Government Regulation and Price Constraints Outside the United States China Pricing Pressures section in this 2019 Form 10-K. We anticipate that these initiatives will continue to increase pricing pressures on our drug products in China in the future. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of healthcare coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion in the Item 1. Business Government Regulation and Price Constraints In the United States section in this 2019 Form 10-K. We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is additional uncertainty given the ruling in December 2019 by the U.S. Circuit Court of Appeals for the Fifth Circuit in Texas v. Azar that the individual mandate, which is a significant provision of the ACA, is unconstitutional. The case has been remanded to a lower court to determine whether the individual mandate is inseparable from the entire ACA, in which case the ACA as a whole would be rendered unconstitutional. In the meantime, the remaining provisions of the law remain in effect. The revenues generated for Pfizer by the health insurance exchanges and Medicaid expansion under the ACA are not material, so the impact of full invalidation of the law is expected to be limited. However, any future replacement of the ACA may adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Any future healthcare reform efforts may adversely affect our business and financial results. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. Presidential Administrations policy proposals), revisions to reimbursement of biopharmaceuticals under government programs (such as the implementation of international reference pricing for Medicare Part B drugs, or changes to protected class criteria for Part D drugs), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. Pfizer Inc. 2019 Form 10-K U.S. ENTITLEMENT REFORM In the U.S., government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending, and the December 2018 release includes proposals to cap federal Medicaid payments to the states, and to require manufacturers to pay a minimum rebate on drugs covered under Medicare Part D for low-income beneficiaries. Significant Medicare reductions could also result if, for example, Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or Congress chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, corporate integrity or deferred prosecution agreements or exclusion from future participation in government healthcare programs, as well as reputational harm. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our Company, and drug discovery and development are time-consuming, expensive and unpredictable. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new clinical data and further analyses of existing clinical data, including results that may not support further clinical development of the applicable product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. Similarly, we may not be able to successfully address all of the comments received from regulatory authorities such as the FDA and the EMA, or obtain approval from regulators. Regulatory approval of drug or biologic products depends on myriad factors, including a regulator making a determination as to whether a products benefits outweigh its known risks and a determination of the products efficacy. Additionally, clinical trial data are subject to differing interpretations and assessments by regulatory authorities. Even after a drug or biologic is approved, it could be adversely affected by regulatory decisions impacting labeling, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the Advisory Committee on Immunization Practices that may impact the use of our vaccines. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional or more extensive clinical trials prior to granting approval or increased post-approval requirements. For these and other reasons discussed in Item 1A. Risk Factors , we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. For example, in July and December 2019, the FDA updated the U.S. prescribing information for Xeljanz to include three additional boxed warnings as well as changes to the indication and dosing for ulcerative colitis. In January 2020, the EMA revised the summary of product characteristics (SmPC) for Xeljanz to include new warnings and recommendations for use of Xeljanz due to an increased risk of venous thromboembolism and, due to an increased risk of infections, revised warnings in patients older than 65 years of age. These updates were based on the FDAs and EMAs review of data from the ongoing post-marketing requirement rheumatoid arthritis study A3921133. Postmarketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products could implicate the entire class of products; and this, in turn, could have an adverse effect on the availability or commercial viability of our product(s) as well as other products in the class. Pfizer Inc. 2019 Form 10-K INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide, offer, or promise something of value to a healthcare professional, other healthcare provider and/or government official. Requirements or industry standards in the U.S. and certain jurisdictions abroad that require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as both U.S. and foreign enforcement agencies adopt or increase enforcement efforts in respect of existing and new laws and regulations governing product promotion, marketing, anti-bribery and kickbacks, industry regulations, and codes of conduct. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory clarifications and/or interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals, including further clarifications and/or interpretations of or changes to the U.S. Tax Cuts and Jobs Act of 2017), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision/(Benefit) for Taxes on Income Changes in Tax Laws and New Accounting Standards sections, and the Notes to Consolidated Financial Statements Note 1 B. Basis of Presentation and Significant Accounting Policies : Adoption of New Accounting Standards in 2019 in our 2019 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various legal proceedings, including patent litigation, such as claims that our patents are invalid and/or do not cover the product of the generic drug manufacturer or where one or more third parties seeks damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings, including various means for resolving asbestos litigation, that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2019 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in May 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five Pfizer Inc. 2019 Form 10-K years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. For additional information, including information regarding certain legal proceedings in which we are involved in, see the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in policies or practices that may weaken its intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid in such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In October 2017, the Patent Trial and Appeal Board (PTAB) refused to initiate proceedings as to two patents. In June 2018, the PTAB ruled on another patent, holding that one claim was valid and that all other claims were invalid. The party challenging that patent has appealed the decision. In November 2019, the Federal Circuit vacated the PTABs ruling and requested that the PTAB redecide the challenge. In March and June 2019, an additional patent was found invalid in separate proceedings by the PTAB. We have appealed. Challenges to other patents remain pending in jurisdictions outside the U.S. The invalidation of all of these patents in our pneumococcal portfolio could potentially allow a competitor pneumococcal vaccine into the marketplace. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks Pfizer Inc. 2019 Form 10-K and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not always be successful. Part of our business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others, and in some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold in the event that we or one of our subsidiaries, like Hospira, is found to have willfully infringed valid patent rights of a third party. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2019 Form 10-K RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of any of our strategic acquisitions will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions and substantial regulatory scrutiny due to quality issues. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Development Initiatives section in our 2019 Financial Report. PENDING COMBINATION OF UPJOHN WITH MYLAN Pfizer, Mylan and Upjohn may be unable to satisfy the conditions or obtain the approvals required to complete the combination of Upjohn with Mylan (the Combination), and regulatory agencies may delay or impose conditions on approval of the Combination, which may diminish the anticipated benefits of the Combination. The consummation of the Combination is subject to numerous conditions, including the receipt by Pfizer of an Internal Revenue Service ruling and an opinion of its tax counsel to the effect that, among other things, certain transactions related to the Combination and certain related transactions will constitute a tax-free reorganization within the meaning of Section 368(a)(1)(D) of the Internal Revenue Code, the approval of the Combination by Mylan shareholders, and other customary conditions, certain of which are dependent upon the actions of third parties. As a result of such conditions, Pfizer cannot make any assurances that the Combination will be consummated on the terms or timeline currently contemplated, or at all. Completion of the Combination is also conditioned upon the receipt of certain required government consents and approvals, including certain approvals required from regulatory agencies. While Pfizer, Mylan and Upjohn intend to pursue vigorously all required governmental approvals, the requirement to receive these approvals prior to the consummation of the Combination could delay the completion of the Combination, possibly for a significant period of time. Any delay in the completion of the Combination could diminish the anticipated benefits of the Combination or result in additional transaction costs, loss of revenue or other effects associated with uncertainty about the Combination, including delaying Pfizers ability to capitalize on its strategy of becoming a more focused, innovative company as well as Upjohns ability to optimize the execution of its growth strategies. Pfizer may be subject to shareholder lawsuit, or other actions filed in connection with or in opposition to the Combination or any related transactions. Such litigation could have an adverse effect on the business, financial condition and results of operations of Pfizer and could prevent or delay the consummation of the Combination. Pfizer has expended and will continue to expend significant management time and resources and has incurred and will continue to incur significant expenses due to legal, advisory, printing and financial services fees related to the Combination, including costs required to obtain the required government consents or defend or settle actions noted above. We expect to incur costs of approximately $500 million in connection with fully separating Upjohn, inclusive of $145 million incurred in 2019. Such charges will include costs and expenses related to separation of legal entities and anticipated transaction costs. Many of these expenses must be paid regardless of whether the Combination is consummated, and even if the expected benefits of the Combination are not achieved. Additionally, the completion of the Combination, including for example, obtaining regulatory approvals, will require significant time and attention from Pfizer management and may divert attention from the day-to-day operations of our business. Even if the Combination is completed as anticipated, Pfizer may not realize some or all of the expected benefits. Furthermore, Upjohn may experience operational challenges in integrating the Upjohn and Mylan businesses, which may also diminish the anticipated benefits of the Combination. Even if the Combination is completed, the anticipated operational, financial, strategic and other benefits of the Combination may not be achieved. There are many factors that could impact the anticipated benefits from the Combination, including, among others, strategic adjustments required to reflect the nature of our business following the Combination, any negative reaction to the Combination by our customers and business partners, and increased risks resulting from Pfizer becoming a company that is more focused on innovative medicines. In addition, Pfizer has agreed to provide certain transition services to the combined company, generally for an initial period of 24 months following the completion of the Combination (with certain possibilities for extension). These obligations under the transition agreements may result in additional expenses and may divert Pfizer Inc. 2019 Form 10-K Pfizers focus and resources that would otherwise be invested into maintaining or growing Pfizers business. An inability to realize the full extent of the anticipated benefits of the Combination, as well as any delays encountered in the process, could have an adverse effect on the revenues, level of expenses and operating results of our business. Furthermore, the Combination is a complex, costly and time-consuming process. Even if Upjohn and Mylan successfully integrate, Pfizer, Upjohn and Mylan cannot predict with certainty if or when the anticipated synergies, growth opportunities and benefits resulting from the Combination will occur, or the extent to which they actually will be achieved. For example, the benefits from the Combination may be offset by costs incurred in integrating the companies or by required capital expenditures related to the combined businesses. In addition, the quantification of synergies expected to result from the Combination is based on significant estimates and assumptions that are subjective in nature and inherently uncertain. Realization of any benefits and synergies could be affected by a number of factors beyond Pfizers, Mylans, Upjohns or the combined companys control, including, without limitation, general economic conditions, increased operating costs, regulatory developments and the other risks described in these risk factors. The amount of synergies actually realized in the Combination, if any, and the time periods in which any such synergies are realized, could differ materially from the synergies anticipated to be realized, regardless of whether the two business operations are combined successfully. If the integration is unsuccessful or if the combined company is unable to realize the anticipated synergies and other benefits of the Combination, there could be a material adverse effect on the combined companys share price, business, financial condition and results of operations. CONSUMER HEALTHCARE JOINT VENTURE WITH GSK On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates globally under the GSK Consumer Healthcare name. Following the integration of the combined business, GSK intends to separate the joint venture as an independent company via a demerger of its equity interest to its shareholders and a listing of the combined business on the U.K. equity market. In February 2020, GSK announced the initiation of a two-year program to prepare for the separation of GSK into two companies, including a standalone Consumer Healthcare company. Until the fifth anniversary of the closing of the transaction, GSK will have the sole right to decide whether and when to initiate a separation and listing, and may also sell all or part of its stake in the joint venture in a contemporaneous initial public offering. Should a separation and listing occur during the first five years after closing, Pfizer has the option to participate through the distribution of some or all of its equity interest in the joint venture to its shareholders. Following a separation or listing, and subject to customary lock-up or similar restrictions, Pfizer will also have the ability to sell its equity interest in the joint venture through the capital markets. After the fifth anniversary of the closing of the transaction, both GSK and Pfizer will have the right to decide whether and when to initiate a separation and public listing of the joint venture. The planned separation and public listing transactions may not be initiated or completed within the expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for Pfizer or its shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Although Pfizer is entitled to participate in any separation and listing transaction initiated by GSK prior to the fifth anniversary of the closing, it is not required to do so, and any future distribution or sale of Pfizers equity stake in the joint venture will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Pfizers ability to complete any such future distribution or sale may also be impacted by the size of Pfizers retained equity stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the joint ventures business may subject us and the joint venture to risks and uncertainties that may adversely affect our business and financial results. Moreover, although we have certain consent, board representation and other governance rights with respect to the joint venture, Pfizer is a minority owner of the joint venture. As a result, Pfizer does not have control over the joint venture, its management or its policies and we may have business interests, strategies and goals that differ in certain respects from those of GSK or the joint venture. In addition, the joint venture will be subject to the risks associated with the joint ventures consumer healthcare business, and the business, financial condition and results of operations of the joint venture may be affected by factors that are different from or in addition to those that previously affected the business, financial condition and results of operations of Pfizers historical consumer healthcare business. Many of these factors are outside of our and the joint ventures control, and could materially impact the business, financial condition and results of operations of the joint venture. The success of the transaction will also depend, in part, on the joint ventures ability to realize the anticipated benefits and cost synergies from the transaction. These anticipated benefits and cost savings may not be realized or may not be realized within the expected time period. The joint ventures integration of Pfizers and GSKs historic consumer healthcare businesses may result in material unanticipated problems, costs, expenses, liabilities, competitive responses, and loss of customer and other business relationships. Any material unanticipated issues arising from the integration process could negatively impact our stock price and our or the joint ventures future business and financial results . Pfizer Inc. 2019 Form 10-K OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses of our size, we are exposed to both global and industry-specific economic conditions. Governments, corporations, and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic or biosimilar products, delay treatments, skip doses or use less effective treatments. As discussed above, government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. Details on how Brexit will be finally executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report. Public health epidemics or outbreaks could adversely impact our business. In December 2019, a novel strain of coronavirus (COVID-19) emerged in Wuhan, Hubei Province, China . While initially the outbreak was largely concentrated in China and caused significant disruptions to its economy, it has now spread to several other countries and infections have been reported globally. The extent to which the coronavirus impacts our operations will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the outbreak, new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or treat its impact, among others. In particular, the continued spread of the coronavirus globally could adversely impact our operations, including among others, our manufacturing and supply chain, sales and marketing and clinical trial operations and could have an adverse impact on our business and our financial results. We also continue to monitor the global trade environment and potential trade conflicts and impediments. If trade restrictions or tariffs reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 54% of our total 2019 revenues were derived from international operations, including 21% from Europe and 24% from China, Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Chinese renminbi, the Japanese yen, the Canadian dollar, the U.K. pound and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations, including Venezuela and Argentina, can impact our results and financial guidance . For additional information about our exposure to foreign currency risk, see the Item 7A. Quantitative and Qualitative Disclosures About Market RiskForeign Exchange Risk section in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and Pfizer Inc. 2019 Form 10-K Outlook Our Financial Guidance for 2020 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2019 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section and the Notes to Consolidated Financial Statements Note 7 F . Financial Instruments : Derivative Financial Instruments and Hedging Activities and Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report, which are incorporated by reference. From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in July 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. Various governing parties, including government agencies, are working on a benchmark transition plan for LIBOR (and other interbank offered rates globally) . We are monitoring their progress, and we will likely amend contracts to accommodate any replacement rate where it is not already provided. As a result, our interest expense could increase and our available cash flow for general corporate requirements may be adversely affected. Additionally, uncertainty as to the nature of a potential discontinuance, modification, alternative reference rates or other reforms may materially adversely affect the trading market for securities linked to such benchmarks. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources LIBOR section in our 2019 Financial Report. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. MARKET FLUCTUATIONS IN OUR EQUITY INVESTMENTS In 2018, we adopted a new accounting standard whereby certain equity investments are measured at fair value with changes in fair value now recognized in net income. We expect the adoption of this new accounting standard may increase the volatility of our income in future periods due to changes in the fair value of certain equity investments. For additional information, see the Notes to Consolidated Financial Statements Note 4. Other (Income)/Deductions Net in our 2019 Financial Report and the Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. Our pension benefit obligations and postretirement benefit obligations, net of our plan assets, are subject to volatility from changes in fair value of equity investments and other investment risk. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section and the Notes to Consolidated Financial Statements Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report. COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) the reorganization of our commercial operations in 2019; (iii) any other corporate strategic initiatives; and (iv) any acquisitions, divestitures or other initiatives, such as our agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, which is anticipated to close in mid-2020, our acquisition of Array and the formation of the new consumer healthcare joint venture with GSK. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible Pfizer Inc. 2019 Form 10-K assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2019 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. Pfizer Inc. 2019 Form 10-K ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2019 , we had 453 owned and leased properties, amounting to approximately 47 million square feet. In 2019, we reduced the number of properties in our portfolio by 45 sites and 6 million square feet, which reflects the divestment of properties in connection with the formation of the GSK Consumer Healthcare joint venture and the addition of properties in connection with the acquisition of Array. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to approximately 90 countries. In April 2018, we entered an agreement to lease space at the Spiral, an office building in the Hudson Yards neighborhood of New York City. We will relocate our global headquarters to this property with occupancy expected beginning in 2022. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2019, we operationalized the new RD facilities in St. Louis, Missouri and Andover, Massachusetts. We also purchased an RD property in Durham, North Carolina in 2019 and expect to renovate and fit out the space over the next several years. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2019 , PGS had responsibility for 42 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of two of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In 2019, seven manufacturing plants transferred from PGSs responsibility to Upjohns responsibility, and an additional two plants are expected to be fully migrated from PGSs responsibility to Upjohns responsibility over the next several years. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9 . Property, Plant and Equipment in our 2019 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 25, 2020 , there were 142,524 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Selected Quarterly Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2019 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2019 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) September 30, 2019 through October 27, 2019 32,848 $ 36.06 $ 5,292,881,709 October 28, 2019 through November 30, 2019 13,399 $ 37.50 $ 5,292,881,709 December 1, 2019 through December 31, 2019 67,767 $ 38.86 $ 5,292,881,709 Total 114,014 $ 37.89 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12 . Equity in our 2019 Financial Report, which is incorporated by reference. (b) These columns represent (i) 108,367 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,647 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards. Pfizer Inc. 2019 Form 10-K ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2019 Financial Report. ," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial Risk Management The objective of our financial risk management program is to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings. We manage these financial exposures through operational means and through the use of third-party instruments. These practices may change as economic conditions change. Foreign Exchange Risk We operate globally and, as such, we are subject to foreign exchange risk in our commercial operations, as well as in our financial assets (investments) and liabilities (borrowings). Our net investments in foreign subsidiaries are also subject to currency risk. On the commercial side, a significant portion of our revenues and earnings is exposed to changes in foreign exchange rates. See the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report for the key currencies in which we operate. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenues in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Where foreign exchange risk cannot be mitigated via operational means, we may use foreign currency forward-exchange contracts and/or foreign currency swaps to manage that risk. With respect to our financial assets and liabilities, our primary foreign exchange exposure arises predominantly from short-term and long-term intercompany receivables and payables, and, to a lesser extent, from short-term and long-term investments and debt, where the assets and/or liabilities are denominated in currencies other than the functional currency of the business entity. We also hedge some forecasted intercompany sales denominated in euro, Japanese yen, Chinese renminbi, U.K. pound, Canadian dollar, and Australian dollar to protect against longer-term movements. In addition, under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. In these cases, we may use foreign currency swaps, foreign currency forward-exchange contracts and/or foreign currency debt. For details about these and other financial instruments, including fair valuation methodologies, see the Notes to Consolidated Financial Statements Note 7A. Financial Instruments : Fair Value Measurements in our 2019 Financial Report. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this sensitivity analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2019 , the expected adverse impact on our net income would not be significant. Interest Rate Risk We are subject to interest rate risk on our investments and on our borrowings. We manage interest rate risk in the aggregate, while focusing on Pfizers immediate and intermediate liquidity needs. With respect to our investments, we strive to maintain a predominantly floating-rate basis position, but our strategy may change based on prevailing market conditions. Our floating-rate assets are subject to the risk that short-term interest rates may fall and, as a result, the investments would generate less interest income. Fixed-rate investments provide a known amount of interest income regardless of a change in interest rates. We sometimes use interest rate swaps in our financial investment portfolio. Pfizer Inc. 2019 Form 10-K We borrow primarily on a long-term, fixed-rate basis. From time to time, depending on market conditions, we will change the profile of our outstanding debt by entering into derivative financial instruments like interest rate swaps. For details about these and other financial instruments, including fair valuation methodologies, see the Notes to Consolidated Financial Statements Note 7A. Financial Instruments : Fair Value Measurements in our 2019 Financial Report. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this sensitivity analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point increase in interest rates as of December 31, 2019 , the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm in our 2019 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2019 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2019 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2019 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. " +27,Pfizer,2018," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: On February 3, 2017, we completed the sale of our global infusion systems net assets, HIS, to ICU Medical for up to approximately $900 million , composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS, which was acquired as part of the Hospira acquisition in September 2015, includes IV pumps, solutions and devices. On December 22, 2016, for $1,045 million we acquired the development and commercialization rights to AstraZenecas small molecule anti-infectives business, primarily outside the U.S., which includes the newly approved EU drug Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ( $13.9 billion , net of cash acquired). Medivation is a biopharmaceutical company focused on developing and commercializing small molecules for oncology. On June 24, 2016, we acquired Anacor for approximately $4.9 billion in cash ( $4.5 billion net of cash acquired), plus $698 million debt assumed. Anacor is a biopharmaceutical company focused on novel small-molecule therapeutics derived from its boron chemistry platform. On September 3, 2015, we acquired Hospira, a leading provider of sterile injectable drugs and infusion technologies as well as a provider of biosimilars, for approximately $16.1 billion in cash ( $15.7 billion , net of cash acquired). For a further discussion of our strategy and our business development initiatives, see the Notes to Consolidated Financial Statements Note 2. Acquisitions, Sale of Hospira Infusion Systems Net Assets, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment and the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Our Business Development Initiatives section in our 2017 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA regulates the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of drugs for the EU and the European Economic Area countries. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Government Regulation and Price Constraints section below. Note: Some amounts in this 2017 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2017 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this 2017 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2018 Proxy Statement and the 2017 Financial Report, portions of which are filed as Exhibit 13 to this 2017 Form 10-K, and which also will be contained in Appendix A to our 2018 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to this information. Our 2017 Annual Report to Shareholders consists of the 2017 Financial Report and the Corporate and Shareholder Information attached to the 2018 Proxy Statement. Our 2017 Financial Report will be available on our website on or about February 22, 2018. Our 2018 Proxy Statement will be available on our website on or about March 15, 2018. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers; as well as Chief Executive Officer and Chief Financial Officer certifications, are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts does not, and shall not be deemed to, constitute a part of this 2017 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2017 Form 10-K COMMERCIAL OPERATIONS We manage our commercial operations through two distinct business segments: Pfizer Innovative Health (IH) and Pfizer Essential Health (EH). The IH and EH operating segments are each led by a single manager. Each operating segment has responsibility for its commercial activities and for certain IPRD projects for new investigational products and additional indications for in-line products that generally have achieved proof-of-concept. Each business has a geographic footprint across developed and emerging markets. Some additional information about our business segments as of the date of the filing of this 2017 Form 10-K follows: IH focuses on developing and commercializing novel, value-creating medicines and vaccines that significantly improve patients lives, as well as products for consumer healthcare. Key therapeutic areas include internal medicine, vaccines, oncology, inflammation immunology, rare disease and consumer healthcare. EH includes legacy brands that have lost or will soon lose market exclusivity in both developed and emerging markets, branded generics, generic sterile injectable products, biosimilars, select branded products including anti-infectives and, through February 2, 2017, HIS. EH also includes an RD organization, as well as our contract manufacturing business. We expect that the IH biopharmaceutical portfolio of innovative, largely patent-protected, in-line and newly launched products will be sustained by ongoing investments to develop promising assets and targeted business development in areas of focus to help ensure a pipeline of highly-differentiated product candidates in areas of unmet medical need. The assets managed by IH are science-driven, highly differentiated and generally require a high-level of engagement with healthcare providers and consumers. EH is expected to generate strong consistent cash flow by providing patients around the world with access to effective, lower-cost, high-value treatments. EH leverages our biologic development, regulatory and manufacturing expertise to seek to advance its biosimilar development portfolio. Additionally, EH leverages capabilities in formulation development and manufacturing expertise to help advance its generic sterile injectables portfolio. EH may also engage in targeted business development to further enable its commercial strategies. IH will have continued focus on RD productivity and pipeline strength while maximizing the value of our recently launched brands and in-line portfolio. Our acquisitions of Anacor and Medivation expanded our pipeline in the high priority therapeutic areas of inflammation and immunology and oncology. For EH, we continue to invest in growth drivers and manage the portfolio to extract additional value while seeking opportunities for operating efficiencies. This strategy includes active management of our portfolio; maximizing growth of core product segments; acquisitions to strengthen core areas of our portfolio further, such as our recent acquisition of AstraZenecas small molecule anti-infectives business; and divestitures to increase focus on our core strengths. In line with this strategy, on February 3, 2017, we completed the sale of Pfizers global infusion systems net assets, representing the infusion systems net assets that we acquired as part of the Hospira transaction, HIS, to ICU Medical. Leading brands include: - Prevnar 13/Prevenar 13 - Xeljanz - Eliquis - Lyrica (U.S., Japan and certain other markets) - Enbrel (outside the U.S. and Canada) - Ibrance - Xtandi - Several OTC consumer healthcare products (e.g., Advil and Centrum ) Leading brands include: - Lipitor - Premarin family - Norvasc - Lyrica (Europe, Russia, Turkey, Israel and Central Asia countries) - Celebrex - Viagra* - Inflectra/Remsima - Several sterile injectable products * Viagra lost exclusivity in the U.S. in December 2017. Beginning in the first quarter of 2018, revenues for Viagra in the U.S. and Canada, which were reported in IH through December 2017, will be reported in EH (which reported all other Viagra revenues excluding the U.S. and Canada through 2017). Therefore, total Viagra worldwide revenues will be reported in EH from 2018 forward. For a further discussion of these operating segments, see the Innovative Health and Essential Health sections below and the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , the table captioned Revenues by Segment and Geography in the Analysis of the Consolidated Statements of Income section, and the Analysis of Operating Segment Information section in our 2017 Financial Report, which are incorporated by reference. Pfizer Inc. 2017 Form 10-K INNOVATIVE HEALTH The key therapeutic areas comprising our IH business segment include: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Neuroscience and Pain, as well as regional brands. Lyrica (outside Europe, Russia, Turkey, Israel and Central Asia countries), Chantix/Champix and Eliquis (jointly developed and commercialized with BMS) Vaccines Includes innovative vaccines brands across all agesinfants, adolescents and adultsin pneumococcal disease, meningitis and tick borne encephalitis, with a focus on healthcare-acquired infections and maternal health. Prevnar 13/Prevenar 13 (pediatric/adult), Trumenba and FSME-IMMUN Oncology Includes innovative oncology brands of biologics, small molecules and immunotherapies across a wide range of cancers. Ibrance, Sutent, Xalkori, Inlyta and Xtandi (jointly developed and commercialized with Astellas) Inflammation and Immunology Includes innovative brands for chronic immune and inflammatory diseases. Enbrel (outside the U.S. and Canada), Xeljanz and Eucrisa Rare Disease Includes innovative brands for a number of rare diseases, including hematology, neuroscience, and inherited metabolic disorders. BeneFix , Genotropin , and Refacto AF/Xyntha Consumer Healthcare Includes over-the-counter (OTC) brands with a focus on dietary supplements, pain management, gastrointestinal and respiratory and personal care. According to Euromonitor Internationals retail sales data, in 2017, Pfizers Consumer Healthcare business was the fifth-largest branded multi-national, OTC consumer healthcare business in the world and produced two of the ten largest selling consumer healthcare brands ( Centrum and Advil ) in the world. Dietary Supplements: Centrum brands, Caltrate and Emergen-C Pain Management: Advil brands and ThermaCare Gastrointestinal: Nexium 24HR/Nexium Control and Preparation H Respiratory and Personal Care: Robitussin , Advil Cold Sinus and ChapStick In October 2017, we announced that we are reviewing strategic alternatives for our Consumer Healthcare business. A range of options will be considered, including a full or partial separation of the Consumer Healthcare business from Pfizer through a spin-off, sale or other transaction, and we may ultimately determine to retain the business. We expect that any decision regarding strategic alternatives for Consumer Healthcare would be made during 2018. We recorded direct product and/or alliance revenues of more than $1 billion for each of seven IH products in 2017 and 2016 and for each of five IH products in 2015 : Innovative Health $1B+ Products 2016 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Lyrica IH Lyrica IH Lyrica IH Ibrance Enbrel Enbrel Eliquis* Ibrance Viagra IH Enbrel Eliquis* Sutent Xeljanz Viagra IH Sutent Sutent * Eliquis includes alliance revenues and direct sales in 2017 and 2016. Geographic Revenues for Innovative Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For a discussion of certain IH products and additional information regarding the revenues of our IH business, including revenues of major IH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Discussion sections in our 2017 Financial Report; and for additional information on the key operational revenue drivers of our IH business, see the Analysis of Operating Segment Information Innovative Health Operating Segment section of our 2017 Financial Report. For a discussion on the risks associated with our dependence on certain of our major products, see Item 1A. Risk FactorsDependence on Key In-Line Products below. ESSENTIAL HEALTH The product categories in our EH business segment include: Product Category Description Key Products Global Brands Legacy Established Products Includes products that have lost patent protection (excluding Sterile Injectable Pharmaceuticals and Peri-LOE Products). Lipitor , Premarin family and Norvasc Global Brands Peri-LOE Products Includes products that have recently lost or are anticipated to soon lose patent protection. Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Viagra* , Celebrex , Pristiq , Zyvox , Vfend , Revatio and Inspra Sterile Injectable Pharmaceuticals Includes generic injectables and proprietary specialty injectables (excluding Peri-LOE Products). Medrol , Sulperazon , Fragmin and Tygacil Biosimilars Includes recombinant and monoclonal antibodies, primarily in inflammation, oncology and supportive care. Inflectra / Remsima (biosimilar infliximab) (U.S. and certain international markets), Nivestim (biosimilar filgrastim) (certain European, Asian and Africa/Middle East markets) and Retacrit (biosimilar epoetin zeta) (certain European and Africa/Middle East markets) Pfizer CentreOne Includes revenues from our contract manufacturing and active pharmaceutical ingredient sales operation, including sterile injectables contract manufacturing, and revenues related to our manufacturing and supply agreements, including with Zoetis Inc. -- * Viagra lost exclusivity in the U.S. in December 2017. Beginning in the first quarter of 2018, revenues for Viagra in the U.S. and Canada, which were reported in IH through December 2017, will be reported in EH (which reported all other Viagra revenues excluding the U.S. and Canada through 2017). Therefore, total Viagra worldwide revenues will be reported in EH from 2018 forward. Through February 2, 2017, our EH business segment also included HIS, which includes Medication Management products composed of infusion pumps and related software and services, as well as intravenous infusion products, including large volume intravenous solutions and their associated administration sets. On February 3, 2017, we completed the sale of HIS to ICU Medical. For additional information, see the Notes to Consolidated Financial Statements Note 2B. Sale of Hospira Infusion Systems Net Assets to ICU Medical, Inc. (EH). We recorded direct product revenues of more than $1 billion for one EH product in 2017 , two EH products in 2016 and three EH products in 2015 : Essential Health $1B+ Products Lipitor Lipitor Lipitor Premarin family of products Lyrica EH Premarin family of products Geographic Revenues for Essential Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For a discussion of certain EH products and additional information regarding the revenues of our EH business, including revenues of major EH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Discussion sections in our 2017 Financial Report; and for additional information on the key operational revenue drivers of our EH business, see the Analysis of Operating Segment Information Essential Health Operating Segment section of our 2017 Financial Report. For a discussion on the risks associated with our dependence on certain of our major products, see Item 1A. Risk FactorsDependence on Key In-Line Products below. COLLABORATION AND CO-PROMOTION AGREEMENTS We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including Eliquis , Xtandi and Bavencio . Eliquis has been jointly developed and is being commercialized in collaboration with BMS. Pfizer funds between 50% and 60% of all development costs depending on the study. Profits and losses are shared equally on a global basis, except in certain countries where Pfizer commercializes Eliquis and pays BMS compensation based on a percentage of net sales. We have full commercialization rights in certain smaller markets. BMS supplies the product to us at cost plus a percentage of the net sales to end-customers in these markets. Eliquis is part of the Novel Oral Anticoagulant market; the agents in this class were developed as alternative treatment options to warfarin in appropriate patients. Xtandi is being developed and commercialized through a collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi . Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. In addition, Pfizer and Astellas share certain development and other collaboration expenses, and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (Income)/Deductions Net ). Xtandi is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells. Bavencio is being developed and commercialized in collaboration with Merck KGaA. Both companies jointly fund all development and commercialization costs, and split equally any profits generated from selling any anti-PD-L1 or anti-PD-1 Pfizer Inc. 2017 Form 10-K products from this collaboration. Bavencio is currently approved in metastatic Merkel cell carcinoma in the U.S., Europe and Japan, as well as received accelerated approval for second line treatment of locally advanced or metastatic urothelial carcinoma in the U.S. Collaboration rights for Enbrel (in the U.S. and Canada), Spiriva and Rebif have expired. For additional information, including a description of certain of these expired collaboration and co-promotion agreements, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2017 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products and Collaborations and Other Relationships with Third Parties sections below. RESEARCH AND DEVELOPMENT Our goal is to discover, develop and bring to market innovative products that address major unmet medical needs. Our RD Priorities and Strategy Our RD priorities include delivering a pipeline of differentiated therapies and vaccines with the greatest medical and commercial potential, advancing our capabilities that can position Pfizer for long-term leadership and creating new models for biomedical collaboration that will expedite the pace of innovation and productivity. To that end, our research and development primarily focuses on: Biosimilars; Inflammation and Immunology; Metabolic Disease and Cardiovascular Risks; Oncology; Rare Diseases; and Vaccines. In January 2018, we announced our decision to end internal neuroscience discovery and early development efforts and re-allocate funding to other areas where we have stronger scientific leadership. We plan to create a dedicated neuroscience venture fund to support continued efforts to advance the field. The development of tanezumab and potential treatments for rare neuromuscular disorders is not impacted by this decision. While a significant portion of RD is done internally, we continue to seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines, by entering into collaborations, alliances and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. For additional information on these collaborations, agreements and investments, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Description of Research and Development Operations section in our 2017 Financial Report. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. Our RD spending is conducted through a number of matrix organizations. Research Units within our Worldwide Research and Development (WRD) organization are generally responsible for research and early-stage development assets for our IH business (assets that have not yet achieved proof-of-concept). Our science-based and other platform-services organizations, where a significant portion of our RD spending occurs, provide end-to-end scientific and technical expertise and other services to the various RD projects, and are organized into science-based functions (which are part of our WRD organization), such as Pharmaceutical Sciences, Medicinal Chemistry, Regulatory and Drug Safety, and non-science-based functions, such as Facilities, Business Technology and Finance. Our RD organization within the EH business supports the large base of EH products and is expected to develop potential new sterile injectable drugs and therapeutic solutions, as well as biosimilars. Our Global Product Development organization is a unified center for late-stage development for our innovative products and is generally responsible for the operational execution of clinical development of assets that are in clinical trials for our WRD and Innovative portfolios. For discussion regarding these RD matrix organizations and additional information on our RD operations, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Description of Research and Development Operations and Costs and Expenses Research and Development (RD) Expenses sections in our 2017 Financial Report. Our RD Pipeline and Competition Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. According to the Pharmaceutical Benchmarking Forum, out of 17 compounds entering preclinical development, on average, only one is approved by a regulatory authority in a major market (U.S., the EU or Japan). The process from early discovery or design to development to regulatory approval can take more than ten years. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. As of January 30, 2018 , we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments Biopharmaceutical section in our 2017 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections below. Pfizer Inc. 2017 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. Operations in developed and emerging markets are managed through our two business segments: IH and EH. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $26.5 billion accounted for 50% of our total revenues in 2017 . By total revenues, Japan and China are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information in our 2017 Financial Report, and the table captioned Revenues by Segment and Geography in our 2017 Financial Report. Those tables are incorporated by reference. Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries, including, among other things, currency fluctuations, capital and exchange control regulations and expropriation and other restrictive government actions. See Item 1A. Risk Factors Risks Affecting International Operations below. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See Government Regulation and Price Constraints Outside the United States below for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7F. Financial Instruments: Derivative Financial Instruments and Hedging Activities in our 2017 Financial Report, as well as the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2017 Financial Report. Those sections of our 2017 Financial Report are incorporated by reference. Pfizer Inc. 2017 Form 10-K MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; Managed Care Organizations that provide insurance coverage, such as hospitals, Integrated Delivery Systems, Pharmacy Benefit Managers and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the Centers for Disease Control and Prevention, wholesalers and individual provider offices. We seek to gain access for our products on healthcare authority and MCO formularies, which are lists of approved medicines available to members of the MCOs. MCOs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We also work with MCOs to assist them with disease management, patient education and other tools that help their medical treatment routines. In 2017 , our top three biopharmaceutical wholesalers accounted for approximately 38% of our total revenues (and approximately 79% of our total U.S. revenues). % of 2017 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers Our global Consumer Healthcare business uses its own sales and marketing organizations to promote its products, and occasionally uses distributors and agents, principally in smaller markets. The advertising and promotions for our Consumer Healthcare business are generally disseminated to consumers through television, print, digital and other media advertising, as well as through in-store promotion. Consumer Healthcare products are sold through a wide variety of channels, including distributors, pharmacies, retail chains and grocery and convenience stores. Our Consumer Healthcare business generates a significant portion of its sales from several large customers, the loss of any one of which could have a material adverse effect on the Consumer Healthcare business. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see Government Regulation and Price ConstraintsIntellectual Property below. In various markets, a period of regulatory exclusivity may be provided to certain therapeutics upon approval. The scope and term of such exclusivity will vary but, in general, the period of regulatory exclusivity will run concurrently with the term of any existing patent rights associated with the therapeutic. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, the additional six-month pediatric exclusivity period and/or the granted patent term extension), are those for the medicines set forth in the table below. Unless otherwise indicated, the years set forth in the table below pertain to the basic product patent expiration for the respective products. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Viagra 2012 (1) 2013 (1) Lyrica 2014 (2) 2022 (3) Chantix Sutent Ibrance Inlyta Xeljanz 2027 (4) Prevnar 13/Prevenar 13 2026 (5) Eucrisa N/A (6) N/A (6) Eliquis (7) Xtandi (8) * (8) * (8) Besponsa 2028 (9) Xalkori Bavencio (10) (1) In addition to the basic product patent covering Viagra , which expired in 2012, Viagra is covered by a U.S. method-of-treatment patent which, including the six-month pediatric exclusivity period associated with Revatio (which has the same active ingredient as Viagra ), expires in 2020. As a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra in the U.S. in December 2017. The corresponding method-of-treatment patent covering Viagra in Japan expired in May 2014. (2) For Lyrica , regulatory exclusivity in the EU expired in July 2014. (3) Lyrica is covered by a Japanese method-of-use patent which expires in 2022. The patent is currently subject to an invalidation action. (4) Xeljanz EU expiry is provided by regulatory exclusivity. (5) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 has been revoked following an opposition proceeding. This first instance decision has been appealed. There are other EU patents and pending applications covering the formulation and various aspects of the manufacturing process of Prevenar 13 that remain in force. (6) Eucrisa is not approved in the EU and Japan. (7) Eliquis was developed and is being commercialized in collaboration with BMS. (8) Xtandi is being developed and commercialized in collaboration with Astellas, who has exclusive commercialization rights for Xtandi outside the U.S. (9) Besponsa Japan expiry is provided by regulatory exclusivity. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. A number of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years. For additional information, including a description of certain of our expired co-promotion agreements, and a further discussion of our products experiencing, or expected to experience in 2018 , patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2017 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. For additional information, see the Notes to Consolidated Financial Statements Note 17A1. Commitments and ContingenciesLegal ProceedingsPatent Litigation in our 2017 Financial Report. The expiration of a basic product patent or loss of patent protection resulting from a legal challenge normally results in significant competition from generic products against the originally patented product and can result in a significant reduction in revenues for that product in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Biotechnology Products Our biotechnology products, including BeneFIX , ReFacto , Xyntha , Bavencio , Prevnar 13/Prevenar 13 and Enbrel (we market Enbrel outside the U.S. and Canada), may face in the future, or already face, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference biotechnology products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin , which was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be similar to the original biologic in terms of safety and efficacy and to have no clinically meaningful differences. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage in 2010 of the ACA, a framework for such approval exists in the U.S. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop biosimilar medicines. See Item 1A. Risk Factors Biotechnology Products below. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. Likewise, as we develop and manufacture biosimilars and seek to launch products, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, global protection of intellectual property rights has been improving. For additional information, see Government Regulation and Price Constraints Intellectual Property below. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus, generic and biosimilar drug manufacturers and consumer healthcare manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further understanding the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians and global health authorities. We also seek to continually Pfizer Inc. 2017 Form 10-K enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our salespersons efforts to accurately and ethically launch and promote our products to our customers. Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising; interactions with, and payments to, healthcare professionals; and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our vaccines business may face competition from the introduction of alternative or next generation vaccines. For example, Prevnar 13 may face competition in the form of alternative 13-valent or additional valent next-generation pneumococcal conjugate vaccines prior to the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products, as well as biosimilars. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with potentially higher levels of sales and profitability until other generic or biosimilar competitors enter the market. Our Consumer Healthcare business faces competition from OTC business units in other major pharmaceutical and consumer packaged goods companies, and retailers who carry their own private label brands. Our competitive position is affected by several factors, including the amount and effectiveness of our and our competitors promotional resources; customer acceptance; product quality; our and our competitors introduction of new products, ingredients, claims, dosage forms, or other forms of innovation; and pricing, regulatory and legislative matters (such as product labeling, patient access and prescription to OTC switches). Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 291 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see Government Regulation and Price Constraints In the United States below), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, copay accumulator programs and value-based pricing/contracting to improve their cost containment efforts. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs are currently evaluating the appropriate placement of biosimilars on their formularies. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. Pfizer Inc. 2017 Form 10-K MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. Under the Trump administration, there have been ongoing efforts to modify or repeal all or certain provisions of the ACA, although the current likelihood of repeal of the ACA appears low given the failure of the Senates multiple attempts to repeal various combinations of ACA provisions. We are monitoring any such actions to see if any changes to the ACA will be enacted that would impact our business. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors do not generally need to conduct clinical trials and can market a competing version of our product after the expiration or loss of our patent and often charge much less. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. In 2017 , we experienced periodic shortages of select materials due to constrained capacity or operational challenges with the associated suppliers. Supplier management activities are ongoing to work to ensure the necessary supply to meet our requirements for these materials. No significant impact to our operations is anticipated in 2018. GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2017 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, delays in product approvals, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulations by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling and storage of our products, record keeping, advertising and promotion. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. The FDA also regulates our Consumer Healthcare products. Other U.S. federal agencies, including the DEA, also regulate certain of our products. The U.S. Federal Trade Commission has the authority to regulate the advertising of consumer healthcare products, including OTC drugs and dietary supplements. Many of our activities also are subject to the jurisdiction of the SEC. Before a new biopharmaceutical product may be marketed in the U.S., the FDA must approve an NDA for a new drug or a BLA for a biologic. The steps required before the FDA will approve an NDA or BLA generally include preclinical studies followed by multiple stages of clinical trials conducted by the study sponsor; sponsor submission of the application to the FDA for review; the FDAs review of the data to assess the drugs safety and effectiveness; and the FDAs inspection of the facilities where the product will be manufactured. Before a generic drug may be marketed in the U.S., the FDA must approve an ANDA. The ANDA review process typically does not require new preclinical and clinical studies, because it relies on the studies establishing safety and efficacy conducted for the referenced drug previously approved through the NDA process. The ANDA process, however, does require the sponsor to conduct one or more bioequivalence studies to show that the ANDA drug is bioequivalent to the previously approved referenced brand drug, submission of an application to the FDA for review, and the FDAs inspection of the facilities where the product will be manufactured. As a condition of product approval, the FDA may require a sponsor to conduct post-marketing clinical studies, known as Phase 4 studies, and surveillance programs to monitor the effect of the approved product. The FDA may limit further marketing of a product based on the results of these post-market studies and programs. Any modifications to a drug or biologic, including new indications or changes to labeling or manufacturing processes or facilities, may require the submission and approval of a new or supplemental NDA or BLA before the modification can be implemented, which may require that we develop additional data or conduct additional preclinical studies and clinical trials. Our ongoing manufacture and distribution of drugs and biologics is subject to continuing regulation by the FDA, including recordkeeping requirements, reporting of adverse experiences associated with the product, and adherence to cGMPs, which regulate all aspects of the manufacturing process. We are also subject to numerous regulatory requirements relating to the advertising and promotion of drugs and biologics, including, but not limited to, standards and regulations for direct-to-consumer advertising. Failure to comply with the applicable regulatory requirements governing the manufacture and marketing of our products may subject us to administrative or judicial sanctions, including warning letters, product recalls or seizures, delays in product approvals, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference, innovator biologic. The FDA is responsible for implementation of the legislation and approval of new biosimilars. Through those approvals and the issuance of draft and final guidance, the FDA has begun to address open questions about the naming convention for biosimilars and the use of data from a non-U.S.-licensed comparator to demonstrate biosimilarity and/or interchangeability with a U.S.-licensed reference product. Over the next several years, the FDA is expected to issue additional draft and final guidance documents impacting biosimilars. In addition, in 2017, the Biosimilar User Fee Act was reauthorized for a five-year period, which should lead to a significant increase in the FDAs biosimilar user fee revenues, thereby providing the FDA with additional resources to process biosimilar applications. Also, there have been ongoing federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. While none of those efforts have focused on changes to the provisions of the ACA related to the biosimilar regulatory framework, if those efforts continue in 2018 and if the ACA is repealed, substantially modified, or invalidated, it is unclear what, if any, impact such action would have on biosimilar regulation. Sales and Marketing . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended to prevent fraud and abuse in the healthcare industry and protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying any remuneration to generate business, including the purchase or prescription of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal healthcare programs (including Medicare and Medicaid). The federal government and various states also have enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and healthcare providers; require disclosure to the federal or state government and public of such interactions; and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section in our 2017 Financial Report and in the Notes to Consolidated Financial Statements Note 1G. Basis of Presentation and Significant Accounting Policies: Revenues and Trade Accounts Receivable in our 2017 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. For example, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products in certain states. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. Given certain states current and potential ongoing fiscal crises, a growing number of states are considering a variety of cost-control strategies, including capitated managed care plans that typically contain cost by restricting access to certain treatments. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers, who are the primary purchasers of our pharmaceutical products in the U.S., will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. Recently, there has been considerable public and government scrutiny of pharmaceutical pricing and proposals to address the perceived high cost of pharmaceuticals. There have also been recent state legislative efforts to address drug costs, which generally have focused on increasing transparency around drug costs or limiting drug prices. Recent legislation enacted includes, for example, a 2017 Maryland law that prohibits a generic drug manufacturer or wholesale distributor from engaging in price gouging in the sale of certain off-patent or generic drugs, and a 2017 California law that requires manufacturers to provide advanced notification of price increases to certain purchasers and report specified drug pricing information to the state. Certain state legislation, like the Maryland law, has been subject to legal challenges . Adoption of new legislation at the federal or state level could further affect demand for, or pricing of, our products. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We will continue to work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and ensure access to medicines within an efficient and affordable healthcare system. Healthcare Reform. The U.S. and state governments continue to propose and pass legislation designed to regulate the healthcare industry. For example, in March 2010, the U.S. Congress enacted the ACA that expanded healthcare coverage through Medicaid expansion and the implementation of the individual health insurance exchanges and which included changes to the coverage and reimbursement of drug products under government healthcare programs. Under President Trumps administration, there have been ongoing efforts to modify or repeal all or certain provisions of the ACA, although the current likelihood of repeal of the ACA appears low given the failure of the Senates multiple attempts to repeal various combinations of ACA provisions. In October 2017, the President signed an Executive Order directing federal agencies to look for ways to authorize more health plans that could be less expensive because the plans would not have to meet all of the ACAs coverage requirements, and announced that his administration will withhold the cost-sharing subsidies paid to health insurance exchange plans serving low-income enrollees. In December 2017, the comprehensive tax reform package signed into law, the Tax Cuts and Jobs Act, includes a provision that effectively repealed the ACAs individual mandate by removing the penalties. These and similar actions by the administration are widely expected to lead to fewer Americans having comprehensive ACA-compliant health insurance, even in the absence of a full legislative repeal. The revenues generated for Pfizer by the health insurance exchanges under the ACA are minor, so the impact of the recent administration actions is expected to be limited. We also may face uncertainties if our industry is looked to for savings to fund certain legislation, such as lifting the debt ceiling. One recent example is the Bipartisan Budget Act of 2018, which increased the discount we pay in the Medicare Part D coverage gap from 50% to 70%, which will modestly reduce our future Medicare Part D revenues. We cannot predict the ultimate content, timing or effect of any changes to the ACA or other federal and state reform efforts. There is no assurance that federal or state healthcare reform will not adversely affect our future business and financial results. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Outside the United States We encounter similar regulatory and legislative issues in most other countries. New Drug Approvals. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Historically, Chinas regulatory system has presented numerous challenges for the pharmaceutical industry, as its requirements for drug development and registration have not always been consistent with U.S. or other international standards. The CFDA, however, has introduced reforms and draft reforms in recent years, which are discussed in more detail below, that attempt to address these challenges, with 2017 being an especially active year in this respect. In the past, it has been common to see treatments entering the Chinese market two to eight years behind first marketing in the U.S. and Europe, because historically China has only issued import drug licenses to treatments approved by mature regulatory authorities such as the FDA or the EMA. In addition, to obtain marketing approvals for new drugs in China, a clinical trial authorization issued by the CFDA has historically been required for the conduct of Phase I to III clinical trials. Applications for approval of imported drugs that included China-originated data in their Multi-Regional Clinical Trials and met the relevant technical review requirements were allowed to receive local clinical trial waivers on a case-by-case basis. Historically, oral generics only had to undergo bioequivalence studies upon a filing for record with the CFDA, while sterile injectable generics often needed local confirmatory trials for regulatory approval. A Chinese drug license would only be granted if, following review, the CFDA determines that the clinical data confirm the drugs safety and effectiveness. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. These requirements delay marketing authorization in those countries relative to the U.S. and Europe. Pharmacovigilance. In the EU, there is detailed legislation and guidance on pharmacovigilance, which has been increased and strengthened in recent years. The EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . In Europe, Japan, China, Canada, South Korea and some other international markets, governments provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global economic pressures. Governments, including the different EU Member States, may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, health technology assessments, and international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries). This international patchwork of price regulation and differing economic conditions and assessments of value across countries has led to different prices in different countries, varying health outcomes and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and can hinder patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations (UN) and the Organization for Economic Cooperation and Development (OECD), are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations (e.g., 2016 UN High Level Panel Report on Access to Medicines and 2017 OECD Report on New Health Technologies Managing Access, Value and Sustainability ). Government adoption of these recommendations may lead to additional pricing pressures. In Japan, the government recently released a basic framework for pharmaceutical pricing that will lead to the adoption of cost effectiveness assessments in some form, quarterly pricing reviews for new indications, and severe narrowing of the criteria to gain a price maintenance premium. In China, despite removal of government-set price caps the government continues to exercise indirect price control by setting reimbursement standards through a negotiation mechanism between drug manufacturers and social insurance administrations. Provincial biddings, cross-regional procurement and secondary hospital price negotiations are likely to intensify as government cost containment efforts continue. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, which is expected to come into effect some time in late 2019. This regulation is aimed at simplifying and harmonizing the governance of clinical trials in the EU and will require increased public posting of clinical trial results. Under its Publication of Clinical Data for Medicinal Products for Human Use policy, the EMA proactively publishes clinical trial data from application dossiers for new marketing authorizations, including data from trials taking place outside the EU, after the EMA has made a decision on the marketing authorization. The policy includes limited exceptions for commercially confidential information and the exclusion of any protected personal data. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. In March 2017, the U.K. government formally notified the European Council of its intention to leave the EU after it triggered Article 50 of the Lisbon Treaty to begin the two-year negotiation process establishing the terms of the exit and outlining the future relationship between the U.K. and the EU. Formal negotiations officially started in June 2017. This process continues to be highly complex and the end result of these negotiations may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. It was announced in November 2017 that the EMA will be relocating from London, U.K. to Amsterdam, Netherlands by the expected date of Brexit in March 2019. At present, it is still unclear whether and to what extent the U.K. will remain within or aligned to the EU system of medicines regulation, and/or what separate requirements will be imposed in the U.K. after it leaves the EU. For additional information on Brexit, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. in our 2017 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce backlogs for existing applications for drug approval, the CFDA has unveiled numerous reform initiatives for Chinas drug approval system, and engaged in significant efforts to build its capabilities. The CFDA now divides drugs into new drugs and generics, with the definition for new drugs changed from China New to Global New. This means that drugs previously approved in other markets (such as the U.S. or Europe) will not be considered new drugs under Chinas regulatory regime, with the exception of drugs introduced within one year of approval in mature markets. This change in definition creates more opportunities for Chinas domestic drug manufacturers than for multinational firms, because multinational firms have historically had significant competitive advantage in successfully achieving regulatory approvals for drugs first approved outside of China. The 2017 revisions made clear, however, that regulatory approval from the FDA or the EMA would no longer be required for approval of imported drugs, though a notable exception persists for imported vaccines, which still require prior approval from a relevant regulatory agency. The marketing authorization holder system, which will allow for more flexibility in contract manufacturing arrangements and asset transfers, now applies to all drugs developed and manufactured in China, but not yet to imported drugs. While challenges remain, a number of other policy changes are streamlining and accelerating approvals of domestic and imported drugs in China. These reforms, along with Chinas June 2017 entry into the International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use, are expected to pave the way for integration of CFDAs regulations with global practices. These changes include introducing an umbrella clinical trial authorization for all three phases of registration studies (instead of the original phase-by-phase approvals), a filing/recordation system for bioequivalence studies on generics (instead of the original review and approval system), admitting more categories of drugs as innovative drugs eligible for the fast track/green channel approval pathway and ongoing implementation of previously announced regulatory reforms. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, the EFPIAs disclosure code requires all members, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, some countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool for reducing the price of imported medicines, as well as to protect their local pharmaceutical industries. There is considerable political and economic pressure to weaken existing intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, issuance (and threat of issuance) of compulsory licenses, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries. In developed countries as well, including the EU, we are facing an increasingly challenging intellectual property environment. Canadas intellectual property regime for drugs provides some level of patent protection and data exclusivity (eight years plus six-month pediatric extension), but it lacks the predictability and stability that otherwise comparable countries provide. Through intense negotiations as part of the Canada/EU Comprehensive Economic Trade Agreement (CETA), Canadian authorities reluctantly agreed to introduce a right of appeal, a form of patent term restoration and to elevate the current data protection to a treaty obligation, further aligning its intellectual property regime to the EU. In particular, CETA Article 20.25 provides sui generis protection for patent term extensions of two to five years for basic patents, subject to various rules and limitations. In China, the intellectual property environment has improved, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, and several companies, including Pfizer, have established RD centers in China due to increased confidence in Chinas intellectual property environment. Despite this, China remained on the U.S. Trade Representatives Priority Watch List for 2017. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. In India, we have seen some progress in terms of expediting patent approval processes to reduce pendency rates and implementing training programs to enhance enforcement. Despite these positive steps, gaps remain in terms of addressing longstanding intellectual property concerns. For example, policies favoring compulsory licensing of patents, the tendency of the Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 17A3. Commitments and ContingenciesLegal ProceedingsCommercial and Other Matters in our 2017 Financial Report. As a result, we incurred capital and operational expenditures in 2017 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $30 million ; and other environment-related expenses $142 million . While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. For example, in 2017, our manufacturing and commercial operations in Puerto Rico were impacted by hurricanes. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Impact of Recent Hurricanes in Puerto Rico section of the 2017 Financial Report. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to potential weather-related risks and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5. Tax Matters in our 2017 Financial Report, is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We believe we have good relationships with our employees. As of December 31, 2017 , we employed approximately 90,200 people in our operations throughout the world. Pfizer Inc. 2017 Form 10-K DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224 (the Executive Orders). In some instances, ITRSHRA requires companies to disclose these types of transactions, even if they were permissible under U.S. law or were conducted by a non-U.S. affiliate in accordance with the local law under which such entity operates. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2017 , our activities included supplying life-saving medicines, medical products and consumer products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2017 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2017 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2017 Form 10-K and in our 2017 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, approvals, performance, timing of exclusivity and potential benefits of Pfizers products and product candidates, strategic reviews, capital allocation, business-development plans, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions and other business development activities, the disposition of the HIS net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the availability of raw materials for 2018 set forth in Item 1. BusinessRaw Materials in this 2017 Form 10-K; the expected impact of the recent hurricanes in Puerto Rico set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessImpact of Recent Hurricanes in Puerto Rico section in our 2017 Financial Report; the anticipated progress in remediation efforts at certain of our Hospira manufacturing facilities set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessProduct Manufacturing section in our 2017 Financial Report; the anticipated timeframe for any decision regarding strategic alternatives for Pfizer Consumer Healthcare set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyOur Business Development Initiatives section in our 2017 Financial Report; our anticipated liquidity position set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment and the Analysis of Financial Condition, Liquidity and Capital Resources sections in the 2017 Financial Report; the financial impact of the recently passed Tax Cuts and Jobs Act set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment, Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsIncome Tax Assets and Liabilities, Provision/(Benefit) for Taxes on IncomeChanges in Tax Laws and Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations sections in our 2017 Financial Report and in Notes to Consolidated Financial StatementsNote 1. Basis of Presentation and Significant Accounting Policies and Note 5. Tax Matters; plans relating to increasing investment in the U.S. following the expected positive net impact of the Tax Cuts and Jobs Act set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyCapital Allocation and Expense Management section in our 2017 Financial Report; the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2018 section in our 2017 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section in our 2017 Financial Report and in the Notes to Consolidated Financial StatementsNote 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives; the expected plan for repatriating the majority of our cash held internationally in 2018 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesDomestic and International Short-Term Funds section in our 2017 Financial Report; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section in our 2017 Financial Report; and the contributions that we expect to make from our general assets to the Companys pension and postretirement plans during 2018 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section and in the Notes to Consolidated Financial StatementsNote 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2017 Financial Report. We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors Pfizer Inc. 2017 Form 10-K for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Consolidation among MCOs has increased the negotiating power of MCOs and other private insurers. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. They are also trying newer programs like copay accumulators to shift more of the cost burden to manufacturers and patients. This cost shifting has given consumers greater control of medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. payer market concentrates further and as more drugs become available in generic form, biopharmaceutical companies may face greater pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. The date at which generic competition commences may be different from the date that the patent or regulatory exclusivity expires. However, upon the loss or expiration of patent protection for one of our products, or upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a generic manufacturer of a generic version of one of our patented products, we can lose the major portion of revenues for that product in a very short period of time, which can adversely affect our business. A number of our products are expected to face significantly increased generic competition over the next few years. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development, some of which have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with products from competitors, including other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before the anticipated formation of the generic or biosimilar marketplace is important to that products profitability. Prices for products typically decline, sometimes dramatically, following generic or biosimilar entry, and as additional companies receive approvals to market that product, competition intensifies. If a companys generic or biosimilar product can be first-to-market such that its only competition is the branded drug for a period of time, higher levels of sales and profitability can be achieved until other generic or biosimilar competitors enter the market. With increasing competition in the generic or biosimilar product market, the timeliness with which we can market new generic or biosimilar products will increase in importance. Our success will depend on our ability to bring new products to market quickly. Also, we may face access challenges for our biosimilar products where our product may not receive access at parity to the innovator product and remains in a disadvantaged position. For example, Inflectra/Remsima has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against Johnson Johnson (JJ) alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. Pfizer Inc. 2017 Form 10-K DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product and/or alliance revenues of more than $1 billion for each of nine biopharmaceutical products in 2017: Prevnar 13/Prevenar 13 , Lyrica , Ibrance , Eliquis , Enbrel , Lipitor , Xeljanz , Viagra and Sutent . Those products accounted for 46% of our total revenues in 2017 . If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, access pressures or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. Patents covering several of our best-selling medicines have recently expired or will expire in the next few years (including some of our billion-dollar and previously billion-dollar products), and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra in the U.S. in December 2017. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses and Expected Losses of Product Exclusivity section in our 2017 Financial Report. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For additional information on recent losses of collaborations rights, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses of Collaboration Rights section in our 2017 Financial Report. RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities in order to deliver a robust pipeline could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the science may not work for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. There can be no assurance that these strategies will deliver the desired result, which could affect profitability in the future. BIOTECHNOLOGY PRODUCTS Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. For example, Enbrel faces ongoing biosimilar competition in most developed Europe markets, which is expected to continue. The expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant regulatory exclusivity period has expired. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. We are developing biosimilar medicines. The evolving pathway for registration and approval of biosimilar products by the FDA and regulatory authorities in certain other countries could diminish the value of our investments in biosimilars. Other risks related to our development of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with high costs associated with clinical development or intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower prescriptions for biosimilars due to potential concerns over comparability with innovator medicines. See also the Competitive Products risk factor above. Pfizer Inc. 2017 Form 10-K RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and addressed could affect our future results. RISKS AFFECTING INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets. However, there is no assurance that our strategies in emerging markets will be successful or that these countries will continue to sustain these growth rates. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets, as discussed above, can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. The impact of payers efforts to control access to and pricing of specialty pharmaceuticals is increasing. For Pfizer to date, a number of factors create a more challenging paradigm given our growing specialty business portfolio. These include formulary restrictions and dispensation barriers, such as step edits, leading to higher negotiated rebates or discounts to health plans and PBMs in the U.S., as well as the increasing use of health technology assessments in markets around the world. CONSUMER HEALTHCARE The Consumer Healthcare business may be impacted by economic volatility, the timing and severity of the cough, cold and flu season, generic or store brand competition affecting consumer spending patterns and market share gains of competitors branded products or generic store brands. In addition, regulatory and legislative outcomes regarding the safety, efficacy or unintended uses of specific ingredients in our Consumer Healthcare products may require withdrawal, reformulation and/or relabeling of certain products (e.g., cough/cold products). See The Global Economic Environment and Strategic Alternatives for Pfizer Consumer Healthcare risk factors below. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS Difficulties or delays in product manufacturing, sales or marketing could affect future results through regulatory actions, shut-downs, approval delays, withdrawals, recalls, penalties, supply disruptions or shortages, reputational harm, product liability, unanticipated costs or otherwise. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of incoming materials may be delayed or become unavailable and that the quality of incoming materials may be substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout the internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); risks to supply chain continuity and commercial operations as a result of natural (including hurricanes, earthquakes and floods) or man-made disasters at our facilities or at a supplier or vendor, including those that may be related to climate change; or failure to maintain the integrity of our supply chains against intentional and criminal acts such as economic adulteration, product diversion, product theft, counterfeit goods and cyberattacks. Regulatory agencies periodically inspect our drug manufacturing facilities to evaluate compliance with applicable cGMP requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment or voluntary recall of a product, any of Pfizer Inc. 2017 Form 10-K which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, we received a warning letter from the FDA communicating the FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. We are undertaking corrective actions to address the concerns raised by the FDA. In January 2018, the FDA upgraded the status of Pfizers McPherson, Kansas manufacturing facility to Voluntary Action Indicated (VAI) based on an October 2017 inspection. The change to VAI status will lift the compliance hold that the FDA placed on approval of pending applications, and is an important step toward resolving the issues cited in the February 2017 FDA warning letter. In addition, in September 2017, Meridian, a subsidiary of Pfizer Inc., received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri. We are undertaking corrective actions to address the concerns raised by the FDA, and communication with the FDA is ongoing. Until the corrective actions are implemented and approved by the FDA, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis, Missouri sites. OUTSOURCING AND ENTERPRISE RESOURCE PLANNING We outsource certain services to third parties in areas including transaction processing, accounting, information technology, manufacturing, clinical trial execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. For example, in 2017, we placed the majority of our clinical trial execution services with four Clinical Research Organizations (CROs). Service performance issues with these CROs may adversely impact the progression of our clinical trial programs. Outsourcing of services to third parties could expose us to sub-optimal quality of service delivery or deliverables, which may result in repercussions such as missed deadlines or other timeliness issues, erroneous data, supply disruptions, non-compliance (including with applicable legal requirements and industry standards) or reputational harm, with potential negative implications for our results. We are migrating to a consistent enterprise resource planning system across the organization. These are enhancements of ongoing activities to standardize our financial systems. If any difficulties in the migration to or in the operation of our enterprise resource planning system were to occur, they could adversely affect our operations, including, among other ways, through a failure to meet demand for our products, or adversely affect our ability to meet our financial reporting obligations. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. Third parties may not complete activities on schedule or in accordance with our expectations. Failure by one or more of these third parties to meet their contractual or other obligations to Pfizer; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between Pfizer and one or more of these third parties, could delay or prevent the development, approval or commercialization of our products and product candidates and could also result in non-compliance or reputational harm, all with potential negative implications for our product pipeline and business. BIOPHARMACEUTICAL WHOLESALERS In 2017 , our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 33% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 38% of our total revenues (and approximately 79% of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through collaborations, alliances, license and funding agreements, joint ventures, equity- or debt-based investments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframe or at all, and integrate acquisitions. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Legal proceedings or regulatory issues often arise as a result of activities that occurred at acquired companies, their partners and other third parties. In 2016, for example, we paid $784.6 million to resolve allegations related to Wyeths reporting of prices to the government with respect to Protonix for activities that occurred prior to our Pfizer Inc. 2017 Form 10-K acquisition of Wyeth. Additionally, we may not realize the anticipated benefits of such transactions, including the possibility that expected synergies and accretion will not be realized or will not be realized within the expected time frame. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; and the relatively modest risk of penalties faced by counterfeiters compared to the large profits that can be earned by them from the sale of counterfeit medicines. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines pose a risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate the threat of counterfeit medicines, which is exacerbated by the complexity of the supply chain, could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We undertake significant efforts to counteract the threats associated with counterfeit medicines, including, among other things, working with the FDA and other regulatory authorities and multinational coalitions to combat the counterfeiting of medicines and supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; implementing business practices designed to protect patient health; promoting public policies intended to hinder counterfeiting; working diligently to raise public awareness about the dangers of counterfeit medicines; and working collaboratively with wholesalers, pharmacies, customs offices, and law enforcement agencies to increase inspection coverage, monitor distribution channels, and improve surveillance of distributors and repackagers. No assurance can be given, however, that our efforts and the efforts of others will be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. Efforts by government officials or legislators to implement measures to regulate prices or payments for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as Europe, Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions, failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many Pfizer Inc. 2017 Form 10-K countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM/HEALTHCARE LEGISLATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of healthcare coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion under the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Regulatory Environment/Pricing and Access U.S. Healthcare Legislation section in our 2017 Financial Report and in Item 1. Business under the caption Government Regulation and Price ConstraintsIn the United States . We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. The likelihood of such a repeal currently appears low given the recent failure of the Senates multiple attempts to repeal various combinations of such ACA provisions. In October 2017, the President signed an Executive Order directing federal agencies to look for ways to authorize more health plans that could be less expensive because the plans would not have to meet all of the ACAs coverage requirements, and announced that his administration will withhold the cost-sharing subsidies paid to health insurance exchange plans serving low-income enrollees. These and similar actions by the administration are widely expected to lead to fewer Americans having comprehensive ACA-compliant health insurance, even in the absence of a legislative repeal. The revenues generated for Pfizer by the health insurance exchanges under the ACA are minor, so the impact of the recent administration actions is expected to be limited. There is no assurance that any future replacement, modification or repeal of the ACA will not adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. presidential administrations policy proposals), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. U.S. ENTITLEMENT REFORM In the U.S., government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending, and the December 2016 release includes proposals to cap Medicaid grants to the states, and to require manufacturers to pay a minimum rebate on drugs covered under part D of Medicare for low-income beneficiaries. Significant Medicare reductions could also result if Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or Congress chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, or exclusion from future participation in government healthcare programs. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. The process from early discovery or design to development to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, including unfavorable new clinical data and additional analyses of existing clinical data. There can be no assurance regarding our ability to meet anticipated pre-clinical and clinical trial commencement and completion dates, regulatory submission and approval dates, and launch dates for product candidates, or as to whether or when we will receive regulatory approval for new products or for new indications or dosage forms for existing products, which will depend on the assessment by regulatory authorities of the benefit-risk profile suggested by the totality of the efficacy and safety information submitted. Decisions by regulatory authorities regarding labeling, ingredients and other matters could adversely affect the availability or commercial potential of our products. There is no assurance that we will be able to address Pfizer Inc. 2017 Form 10-K the comments received by us from regulatory authorities such as the FDA and the EMA with respect to certain of our drug applications to the satisfaction of those authorities, that any of our pipeline products will receive regulatory approval and, if approved, be commercially successful or that recently approved products will be approved in other markets and/or be commercially successful. There is also a risk that we may not adequately address existing regulatory agency findings concerning the adequacy of our regulatory compliance processes and systems or implement sustainable processes and procedures to maintain regulatory compliance and to address future regulatory agency findings, should they occur. In addition, there are risks associated with preliminary, early stage or interim data, including the risk that final results of studies for which preliminary, early stage or interim data have been provided and/or additional clinical trials may be different from (including less favorable than) the preliminary, early stage or interim data results and may not support further clinical development of the applicable product candidate or indication. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. There are many considerations that can affect the marketing of our products around the world. Regulatory delays, the inability to successfully complete or adequately design and implement clinical trials within the anticipated quality, time and cost guidelines or in compliance with applicable regulatory expectations, claims and concerns about safety and efficacy, new discoveries, patent disputes and claims about adverse side effects are a few of the factors that can adversely affect our business. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional clinical trials prior to granting approval or increased post-approval requirements, such as risk evaluation and mitigation strategies. In addition, failure to put in place adequate controls and/or resources for effective collection, reporting and management of adverse events from clinical trials and post-marketing surveillance, in compliance with current and evolving regulatory requirements could result in risks to patient safety, regulatory actions and risks to product sales. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which may result in delayed approvals of new generic products. While the FDA is taking steps to address the backlog of pending applications, continued approval delays may be experienced by generic drug applicants over the next few years. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products that implicate (or are perceived to implicate) an entire class of products could have an adverse effect on the availability or commercial potential of the affected products. Accordingly, new data about our products, or products similar to our products, could negatively impact demand for our products due to real or perceived side effects or uncertainty regarding efficacy and, in some cases, could result in updated labeling, restrictions on use, product withdrawal or recall. INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide something of value to a healthcare professional, other healthcare provider and/or government official. If the interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as non-U.S. jurisdictions adopt or increase enforcement efforts of new anti-bribery laws and regulations. Requirements or industry standards in the U.S. and certain jurisdictions abroad that require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers increase government and public scrutiny of such financial interactions. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory clarifications and/or interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals, including further clarifications and/or interpretations of the recently passed Tax Cuts and Jobs Act), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision/(Benefit) for Taxes on Income Changes in Tax Laws and New Accounting Standards sections, and Notes to Consolidated Financial Pfizer Inc. 2017 Form 10-K Statements Note 1B. Basis of Presentation and Significant Accounting Policies: Adoption of New Accounting Standards in 2017 in our 2017 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various legal proceedings, including patent, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe we have substantial defenses in these matters, we could in the future incur judgments, enter into settlements of claims or revise our expectations regarding the outcomes of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to investigations and extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. As a result, we have interactions with government agencies on an ongoing basis. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, as well as reputational harm and increased public interest in the matter could result from government investigations. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2017 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Pfizer Inc. 2017 Form 10-K Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in a policy of routine compulsory licensing of pharmaceutical intellectual property as a result of local political pressure or in the case of national emergencies. In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches to challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio have been challenged in inter partes review and post-grant review proceedings in the U.S. The invalidation of these patents could potentially allow a competitor pneumococcal vaccine into the marketplace. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not be successful. Part of our EH business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others. To achieve a first-to-market or early market position for generic pharmaceutical products and biosimilars, we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold in the event that we or one of our subsidiaries, like Hospira, is found to have willfully infringed valid patent rights of a third party. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. Pfizer Inc. 2017 Form 10-K RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with the acquisition of Hospira, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from the acquisitions of Hospira, Anacor and Medivation may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions and substantial regulatory scrutiny due to quality issues, including receiving a warning letter from the FDA in February 2017 communicating the FDA s view that certain violations of cGMP regulations exist at Hospira s manufacturing facility in McPherson, Kansas. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Product Manufacturing section in our 2017 Financial Report. Also, the success of our acquisition of Medivation depends on our ability to grow revenues for Xtandi and expand Xtandi into the non-metastatic castration-resistant prostate cancer setting. STRATEGIC ALTERNATIVES FOR PFIZER CONSUMER HEALTHCARE In October 2017, we announced plans to review a range of strategic alternatives for our Consumer Healthcare business, including a full or partial separation of the Consumer Healthcare business from Pfizer through a spin-off, sale or other transaction, as well as the possibility that we may ultimately determine to retain the business. We expect that a decision regarding strategic alternatives for the Consumer Healthcare business would be made in 2018. We will incur expenses in connection with the review of strategic alternatives and are likely to incur significant expenses if we determine to move forward with any strategic alternatives. Our future results may be affected by the impact of our review and, if applicable, consummation of strategic alternatives for our Consumer Healthcare business, which are subject to certain risks and uncertainties, including, among other things, the ability to realize the anticipated benefits of any strategic alternatives we may pursue, the potential for disruption to our business and diversion of managements attention from other aspects of our business, the possibility that such strategic alternatives will not be completed on terms that are advantageous to Pfizer and the possibility that we may be unable to realize a higher value for our Consumer Healthcare through strategic alternatives. Pfizer Inc. 2017 Form 10-K OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses, we are exposed to both global and industry-specific economic conditions. Governments, corporations and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic or biosimilar products, delay treatments, skip doses or use less effective treatments. Government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. Examples include Europe, Japan, China, Canada, South Korea and a number of other international markets. The U.S. continues to maintain competitive insurance markets, but has also seen significant increases in patient cost-sharing and growing government influence as government programs continue to grow as a source of coverage. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. Details on how Brexit will be executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. section in our 2017 Financial Report. We also continue to monitor the global trade environment and potential trade conflicts. If trade restrictions reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 50% of our total 2017 revenues were derived from international operations, including 21% from Europe and 20% from Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Japanese yen, the Chinese renminbi, the U.K. pound, the Canadian dollar and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations can impact our results and financial guidance. For additional information about our exposure to foreign currency risk, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2018 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2017 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks and the measures we have taken to help contain them are discussed in the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2017 Financial Report. For additional details, see the Notes to Consolidated Financial Statements Note 7F. Financial Instruments: Derivative Financial Instruments and Hedging Activities and Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2017 Financial Report and the Pfizer Inc. 2017 Form 10-K Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section in our 2017 Financial Report. Those sections of our 2017 Financial Report are incorporated by reference. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) our internal separation of our commercial operations into our current operating structure; (iii) any other corporate strategic initiatives, such as our evaluation of strategic alternatives for our Consumer Healthcare business; and (iv) any acquisitions, divestitures or other initiatives, such as our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2017 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. INTERNAL CONTROL OVER FINANCIAL REPORTING The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. Pfizer Inc. 2017 Form 10-K ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES In 2017 , we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2017 , we had 501 owned and leased properties, amounting to approximately 53 million square feet. In 2017 , we reduced the number of properties in our portfolio by 66 sites and 4.2 million square feet, which includes the divestment of properties in connection with the sale of the HIS net assets to ICU Medical, the disposal of surplus real property assets and the reduction of operating space in all regions. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2018 , we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2018 , we continue to advance construction of new RD facilities in St. Louis, Missouri and Andover, Massachusetts. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2017 , PGS had responsibility for 58 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2017 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2017 Financial Report, which is also incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2017 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 20, 2018 , there were 158,190 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2017 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2017 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 2, 2017 through October 29, 2017 31,838 $ 35.61 $ 6,355,862,076 October 30, 2017 through November 30, 2017 17,257 $ 35.11 $ 6,355,862,076 December 1, 2017 through December 31, 2017 15,332 $ 36.09 $ 16,355,862,076 Total 64,427 $ 35.59 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12. Equity in our 2017 Financial Report, which is incorporated by reference. (b) These columns reflect (i) 59,102 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs; and (ii) the open market purchase by the trustee of 5,325 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards. ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2017 Financial Report. , ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2017 Financial Report. ," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2017 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2017 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2017 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2017 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. " +28,Pfizer,2017," ITEM 1. BUSINESS GENERAL Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. On February 3, 2017, we completed the sale of our global infusion therapy net assets, HIS, to ICU Medical for up to approximately $900 million, composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS includes IV pumps, solutions and devices. Under the terms of the agreement, we received 3.2 million newly issued shares of ICU Medical common stock, which we valued at approximately $430 million (based upon the closing price of ICU Medical common stock on the closing date less a discount for lack of marketability), a promissory note from ICU Medical in the amount of $75 million and net cash of approximately $200 million before customary adjustments for net working capital. In addition, we are entitled to receive a contingent amount of up to an additional $225 million in cash based on ICU Medicals achievement of certain cumulative performance targets for the combined company through December 31, 2019. After receipt of the ICU Medical shares, we own approximately 16.4% of ICU Medical as of the closing date. We have agreed to certain restrictions on transfer of our ICU Medical shares for 18 months. For additional information, see Notes to Consolidated Financial Statements Note 2B. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Assets and Liabilities Held for Sale in our 2016 Financial Report. On December 22, 2016, which falls in the first fiscal quarter of 2017 for our international operations, we acquired the development and commercialization rights to AstraZenecas small molecule anti-infectives business, primarily outside the U.S., including the commercialization and development rights to the newly approved EU drug Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. Under the terms of the agreement, we made an upfront payment of approximately $550 million to AstraZeneca upon the close of the transaction and will make a deferred payment of $175 million in January 2019. In addition, AstraZeneca is eligible to receive up to $250 million in milestone payments, up to $600 million in sales-related payments, as well as tiered royalties on sales of Zavicefta and aztreonam-avibactam in certain markets. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ($13.9 billion, net of cash acquired). Medivation is now a wholly-owned subsidiary of Pfizer. Medivation is a biopharmaceutical company focused on developing and commercializing small molecules for oncology. Medivations portfolio includes Xtandi (enzalutamide), an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells, and two development-stage oncology assets. Xtandi is being developed and commercialized through a collaboration between Pfizer and Astellas. Astellas has exclusive commercialization rights for Xtandi outside the U.S. For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Acquisitions in our 2016 Financial Report. On June 24, 2016, we acquired Anacor for approximately $4.9 billion in cash ($4.5 billion net of cash acquired), plus $698 million debt assumed. Anacor is now a wholly-owned subsidiary of Pfizer. Anacor is a biopharmaceutical company focused on novel small-molecule therapeutics derived from its boron chemistry platform. Anacors crisaborole, a non-steroidal topical PDE-4 inhibitor with anti-inflammatory properties, was approved by the FDA on December 14, 2016 under the trade name, Eucrisa . For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Acquisitions in our 2016 Financial Report. On September 3, 2015, we acquired Hospira, a leading provider of sterile injectable drugs and infusion technologies as well as a provider of biosimilars, for approximately $16.1 billion in cash ( $15.7 billion , net of cash acquired). The combination of local Pfizer and Hospira entities may be pending in various jurisdictions and integration is subject to completion of various local legal and regulatory steps. For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment : Acquisitions in our 2016 Financial Report. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Our Business Development Initiatives section in our 2016 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA regulates the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of drugs for the EU and the European Economic Area countries. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority, such as the FDA or EMA, before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Government Regulation and Price Constraints section below. Note: Some amounts in this 2016 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. Pfizer Inc. 2016 Form 10-K AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2016 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Throughout this 2016 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2017 Proxy Statement and the 2016 Financial Report, portions of which are filed as Exhibit 13 to this 2016 Form 10-K, and which also will be contained in Appendix A to our 2017 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to such information. Our 2016 Annual Report to Shareholders consists of the 2016 Financial Report and the Corporate and Shareholder Information attached to the 2017 Proxy Statement. Our 2016 Financial Report will be available on our website on or about February 23, 2017. Our 2017 Proxy Statement will be available on our website on or about March 16, 2017. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers; as well as Chief Executive Officer and Chief Financial Officer certifications, are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017-5755. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts does not, and shall not be deemed to, constitute a part of this 2016 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2016 Form 10-K COMMERCIAL OPERATIONS We manage our commercial operations through two distinct business segments: Pfizer Innovative Health (IH) and Pfizer Essential Health (EH), which was previously known as Established Products. Beginning in the second quarter of 2016, we reorganized our operating segments to reflect that we now manage our innovative pharmaceutical and consumer healthcare operations as one business segment, IH . From the beginning of our fiscal year 2014 until the second quarter of 2016, these operations were managed as two business segments: the Global Innovative Products segment and the Vaccines, Oncology and Consumer Healthcare segment. We have revised prior-period information to reflect the reorganization. The IH and EH operating segments are each led by a single manager. Each operating segment has responsibility for its commercial activities and for certain IPRD projects for new investigational products and additional indications for in-line products that generally have achieved proof of concept. Each business has a geographic footprint across developed and emerging markets. Some additional information about our business segments follows: Pfizer Innovative Health Pfizer Essential Health IH focuses on developing and commercializing novel, value-creating medicines and vaccines that significantly improve patients lives, as well as products for consumer healthcare. Key therapeutic areas include internal medicine, vaccines, oncology, inflammation immunology, rare diseases and consumer healthcare. EH includes legacy brands that have lost or will soon lose market exclusivity in both developed and emerging markets, branded generics, generic sterile injectable products, biosimilars and, through February 2, 2017, infusion systems. EH also includes an RD organization, as well as our contract manufacturing business. Leading brands include: - Prevnar 13 - Xeljanz - Eliquis - Lyrica (U.S., Japan and certain other markets) - Enbrel (outside the U.S. and Canada) - Viagra (U.S. and Canada) - Ibrance - Xtandi - Several OTC consumer products (e.g., Advil and Centrum ) Leading brands include: - Lipitor - Premarin family - Norvasc - Lyrica (Europe, Russia, Turkey, Israel and Central Asia countries) - Celebrex - Pristiq - Several sterile injectable products We expect that the IH biopharmaceutical portfolio of innovative, largely patent-protected, in-line and newly launched products will be sustained by ongoing investments to develop promising assets and targeted business development in areas of focus to ensure a pipeline of highly-differentiated product candidates in areas of unmet medical need. The assets managed by IH are science-driven, highly differentiated and generally require a high level of engagement with healthcare providers and consumers. EH is expected to generate strong consistent cash flow by providing patients around the world with access to effective, lower-cost, high-value treatments. EH leverages our biologic development, regulatory and manufacturing expertise to seek to advance its biosimilar development portfolio. Additionally, EH leverages capabilities in formulation development and manufacturing expertise to help advance its generic sterile injectables portfolio. EH may also engage in targeted business development to further enable its commercial strategies. For a further discussion of these operating segments, see the Innovative Health and Essential Health sections below and the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , the table captioned Revenues by Segment and Geographic Area in the Analysis of the Consolidated Statements of Income section, and the Analysis of Operating Segment Information section in our 2016 Financial Report, which are incorporated by reference. Pfizer Inc. 2016 Form 10-K INNOVATIVE HEALTH We recorded direct product sales of more than $1 billion for each of six IH products in 2016 ( Prevnar 13/Prevenar 13 , Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Enbrel (outside the U.S. and Canada), Ibrance , Viagra (U.S. and Canada) and Sutent ), and for each of five IH products in 2015 and 2014 ( Prevnar 13/Prevenar 13, Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Enbrel (outside the U.S. and Canada), Viagra (U.S. and Canada) and Sutent ). We also recorded more than $1 billion in IH Alliance revenues in 2016 and 2015 (primarily Eliquis ). See Item 1A. Risk Factors Dependence on Key In-Line Products below. Geographic Revenues for Innovative Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For additional information regarding the revenues of our IH business, including revenues of major IH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Descriptions sections in our 2016 Financial Report; and for additional information on the key operational revenue drivers of our IH business, see the Analysis of Operating Segment Information Innovative Health Operating Segment section of our 2016 Financial Report. The key therapeutic areas comprising our IH business segment include: Internal Medicine For a discussion of certain of our key Internal Medicine products, including Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Viagra (U.S. and Canada), Chantix/Champix and Eliquis (jointly developed and commercialized with BMS), see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Vaccines For a discussion of certain of our key Vaccine products, including Prevnar 13/Prevenar 13 , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Oncology For a discussion of certain of our key Oncology products, including Ibrance, Sutent, Xalkori, Inlyta and Xtandi (jointly developed and commercialized with Astellas), see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Inflammation and Immunology For a discussion of certain of our key Inflammation and Immunology products, including Enbrel (outside the U.S. and Canada) and Xeljanz , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Rare Diseases For a discussion of certain of our key Rare Diseases products, including BeneFix , Genotropin , and Refacto AF/Xyntha , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Consumer Healthcare According to Euromonitor Internationals retail sales data, in 2016 , Pfizers Consumer Healthcare business was the fourth-largest branded multi-national, OTC consumer healthcare business in the world and produced two of the ten largest selling consumer healthcare brands ( Centrum and Advil ) in the world. Major categories and product lines in our Consumer Healthcare business include: Dietary Supplements : Centrum brands (including Centrum , Centrum Silver , Centrum Mens and Womens , Centrum MultiGummies , Centrum VitaMints , Centrum Specialist , Centrum Flavor Burst and Centrum Kids ), Caltrate and Emergen-C ; Pain Management : Advil brands (including Advil , Advil PM , Advil Liqui-Gels , Advil Film Coated , Advil Menstrual Pain , Childrens Advil , Infants Advil and Advil Migraine) and ThermaCare ; Gastrointestinal : Nexium 24HR/Nexium Control and Preparation H ; and Respiratory and Personal Care : Robitussin , Advil Cold Sinus , Advil Sinus Congestion Pain, Dimetapp and ChapStick . ESSENTIAL HEALTH We recorded direct product sales of more than $1 billion for each of two EH products in 2016 ( Lipitor and the Premarin family of products), three EH products in 2015 ( Lipitor , Lyrica (Europe, Russia, Turkey, Israel and Central Asia) and the Premarin family of products) and six EH products in 2014 ( Celebrex , Lipitor , Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Zyvox , Norvasc and the Premarin family of products). See Item 1A. Risk Factors Dependence on Key In-Line Products below. Geographic Revenues for Essential Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets Pfizer Inc. 2016 Form 10-K For additional information regarding the revenues of our EH business, including revenues of major EH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Descriptions sections in our 2016 Financial Report; and for additional information on the key operational revenue drivers of our EH business, see the Analysis of Operating Segment Information Essential Health Operating Segment section of our 2016 Financial Report. The product categories in our EH business segment include: Global Brands , which includes: Legacy Established Products : includes products that have lost patent protection (excluding Sterile Injectable Pharmaceuticals and Peri-LOE Products); and Peri-LOE Products : includes products that have recently lost or are anticipated to soon lose patent protection. These products primarily include Lyrica in certain developed Europe markets, Pristiq globally, Celebrex , Zyvox and Revatio in most developed markets, Vfend and Viagra in certain developed Europe markets and Japan, and Inspra in the EU; Sterile Injectable Pharmaceuticals : includes generic injectables and proprietary specialty injectables (excluding Peri-LOE Products); Infusion Systems (through February 2, 2017): includes Medication Management Systems products composed of infusion pumps and related software and services, as well as intravenous infusion products, including large volume intravenous solutions and their associated administration sets; Biosimilars : includes Inflectra / Remsima (biosimilar infliximab) in the U.S. and certain international markets, Nivestim (biosimilar filgrastim) in certain European, Asian and Africa/Middle East markets and Retacrit (biosimilar epoetin zeta) in certain European and Africa/Middle East markets; and Pfizer CentreOne : includes (i) revenues from legacy Pfizers contract manufacturing and active pharmaceutical ingredient sales operation (previously known as Pfizer CentreSource), including revenues related to our manufacturing and supply agreements with Zoetis Inc.; and (ii) revenues from legacy Hospiras One-2-One sterile injectables contract manufacturing operation. For a discussion of certain of our key EH products, including Lipitor , the Premarin family of products, Norvasc , Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Celebrex , Pristiq, Zyvox and Inflectra , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. ALLIANCE REVENUES We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including Eliquis and Xtandi. Eliquis has been jointly developed and is being commercialized in collaboration with BMS. The two companies share commercialization expenses and profit/losses equally on a global basis. In April 2015, we signed an agreement with BMS to transfer full commercialization rights in certain smaller markets to us, beginning in the third quarter of 2015. Xtandi is being developed and commercialized in collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi . Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. Pfizer and Astellas also share certain development and other collaboration expenses and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (Income)/Deductions Net). Collaboration rights for Enbrel (in the U.S. and Canada), Spiriva and Rebif have expired. For additional information, including a description of certain of these collaboration and co-promotion agreements and their expiration dates, see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions and the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights sections in our 2016 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Pfizer Inc. 2016 Form 10-K RESEARCH AND DEVELOPMENT Innovation by our RD organization is very important to our success. Our goal is to discover, develop and bring to market innovative products that address major unmet medical needs. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. Our RD spending is conducted through a number of matrix organizations. Our WRD organization is generally responsible for research projects for our IH business until proof-of-concept is achieved and then for transitioning those projects to the IH segment via the GPD organization, which was formed in early 2016, for possible clinical and commercial development. The GPD organization is a new, unified center for late-stage development for our innovative products. GPD is expected to enable more efficient and effective development and enhance our ability to accelerate and progress assets through our pipeline. GPD combines certain previously separate development-related functions from the IH business and the WRD organization to achieve a development capability that is expected to deliver high-quality, efficient, and well-executed clinical programs by enabling greater speed, greater cost efficiencies, and reduced complexity across our development portfolio. The WRD and GPD organizations also have responsibility for certain science-based and other end-to-end platform-services organizations, which provide technical expertise and other services to the various RD projects, including EH RD projects. These organizations include science-based functions (which are part of our WRD organization), such as Pharmaceutical Sciences, Medicinal Chemistry, Regulatory and Drug Safety. As a result, within each of these functions, we are able to migrate resources among projects, candidates and/or targets in any therapeutic area and in most phases of development, allowing us to react quickly in response to evolving needs. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. For additional information regarding our RD operations, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Research and Development Operations and Costs and Expenses Research and Development (RD) Expenses Description of Research and Development Operations sections in our 2016 Financial Report. Our RD Priorities and Strategy Our RD priorities include delivering a pipeline of differentiated therapies and vaccines with the greatest medical and commercial promise, innovating new capabilities that can position Pfizer for long-term leadership and creating new models for biomedical collaboration that will expedite the pace of innovation and productivity. To that end, our research primarily focuses on: Biosimilars; Inflammation and Immunology; Metabolic Disease and Cardiovascular Risks; Neuroscience; Oncology; Rare Diseases; and Vaccines. We also seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines, by entering into collaborations and alliance and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. These agreements enable us to co-develop, license or acquire promising compounds, technologies or capabilities. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. Collaboration, alliance, license and funding agreements and equity- or debt-based investments allow us to share risk and cost and to access external scientific and technological expertise, and enable us to advance our own products as well as in-licensed or acquired products. Our RD Pipeline and Competition Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. According to the Pharmaceutical Benchmarking Forum, out of 20 compounds entering preclinical development, only one is approved by a regulatory authority in a major market (U.S., the EU or Japan). The process from early discovery or design to development to regulatory approval can take more than ten years. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. As of January 31, 2017, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments Biopharmaceutical section in our 2016 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections below. Pfizer Inc. 2016 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. Operations in developed and emerging markets are managed through our two business segments: IH and EH. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $26.5 billion accounted for 50% of our total revenues in 2016 . Japan is our largest national market outside the U.S. For a geographic breakdown of revenues, see the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information in our 2016 Financial Report, and the table captioned Revenues by Segment and Geographic Area in our 2016 Financial Report. Those tables are incorporated by reference. Revenues by National Market Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries. These include, among other things, currency fluctuations, capital and exchange control regulations, expropriation and other restrictive government actions. See Item 1A. Risk Factors Risks Affecting International Operations below. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See Government Regulation and Price Constraints Outside the United States below for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7E. Financial Instruments: Derivative Financial Instruments and Hedging Activities in our 2016 Financial Report, as well as the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2016 Financial Report. Those sections of our 2016 Financial Report are incorporated by reference. MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Pfizer Inc. 2016 Form 10-K Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the Centers for Disease Control and Prevention, wholesalers and individual provider offices. We seek to gain access for our products on healthcare authority and MCO formularies, which are lists of approved medicines available to members of the MCOs. MCOs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We also work with MCOs to assist them with disease management, patient education and other tools that help their medical treatment routines. In 2016, our top three biopharmaceutical wholesalers accounted for approximately 39 % of our total revenues (and approximately 76 % of our total U.S. revenues). % of 2016 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers Our global Consumer Healthcare business uses its own sales and marketing organizations to promote its products, and occasionally uses distributors and agents, principally in smaller markets. The advertising and promotions for our Consumer Healthcare business are generally disseminated to consumers through television, print, digital and other media advertising, as well as through in-store promotion. Consumer Healthcare products are sold through a wide variety of channels, including distributors, pharmacies, retail chains and grocery and convenience stores. Our Consumer Healthcare business generates a significant portion of its sales from several large customers, the loss of any one of which could have a material adverse effect on the Consumer Healthcare business. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see Government Regulation and Price Constraints Intellectual Property below. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, the additional six-month pediatric exclusivity period and/or the granted patent term extension), are those for the medicines set forth in the table below. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Viagra 2012 (1) 2013 (1) Lyrica 2014 (2) Chantix 2021 Xeljanz N/A (3) Sutent 2021 Eliquis (4) 2026 Ibrance 2023 N/A (5) Inlyta 2025 Prevnar 13/Prevenar 13 2026 (6) Eucrisa N/A (7) N/A (7) Xtandi (8) * (8) * (8) Xalkori 2027 (1) In addition to the basic product patent covering Viagra , which expired in 2012, Viagra is covered by a U.S. method-of-treatment patent which, including the six-month pediatric exclusivity period associated with Revatio (which has the same active ingredient as Viagra ), expires in 2020. However, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. will be allowed to launch a generic version of Viagra in the U.S. in December 2017, or earlier under certain circumstances. The corresponding method-of-treatment patent covering Viagra in Japan expired in May 2014. (2) For Lyrica , regulatory exclusivity in the EU expired in July 2014. (3) The Xeljanz marketing authorization application has been filed and is under review in the EU. (4) Eliquis was developed and is being commercialized in collaboration with BMS. (5) The Ibrance marketing authorization application has been filed and is under review in Japan. (6) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 has been revoked following an opposition proceeding. This first instance decision has been appealed. There are other EU patents and pending applications covering the formulation and various aspects of the manufacturing process of Prevenar 13 that remain in force. (7) Eucrisa is not approved in the EU and Japan. (8) Xtandi is being developed and commercialized in collaboration with Astellas, who has exclusive commercialization rights for Xtandi outside the U.S. A number of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years. For additional information, including a description of certain of our co-promotion agreements and their expiration dates, and a further discussion of our products experiencing, or expected to experience in 2017, patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2016 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . For additional information, see the Notes to Consolidated Financial Statements Note 17A1. Commitments and ContingenciesLegal ProceedingsPatent Litigation in our 2016 Financial Report. The expiration of a basic product patent or loss of patent protection resulting from a legal challenge normally results in significant competition from generic products against the originally patented product and can result in a significant reduction in revenues for that product in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Biotechnology Products Our biotechnology products, including BeneFIX , ReFacto , Xyntha and Enbrel (we market Enbrel outside the U.S. and Canada), may face in the future, or already face, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference biotechnology products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin , which was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be similar to the original biologic in terms of safety and efficacy and to have no clinically meaningful differences. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage in 2010 of the ACA, a framework for such approval exists in the U.S. The regulatory implementation of these ACA provisions is ongoing, and, since 2015, the FDA approved a number of biosimilars, including Inflectra (infliximab-dyyb). Pfizer has exclusive commercialization rights to Inflectra from Celltrion Inc. and Celltrion Healthcare, Co., Ltd. (collectively, Celltrion) in the U.S., Canada and certain other territories. Pfizer also shares Inflectra commercialization rights with Celltrion in Europe. For additional information on Inflectra , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions Inflectra/Remsima section in our 2016 Financial Report. For additional information on the ACAs approval framework for biosimilars, see Government Regulation and Price Constraints Biosimilar Regulation below. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In 2013, the EMA approved the first biosimilar of a monoclonal antibody, and in January 2016, the European Commission approved an etanercept biosimilar referencing Pfizers Enbrel . In Japan, the regulatory authority has granted marketing authorizations for certain biosimilars pursuant to a guideline for biosimilar approvals issued in 2009. If competitors are able to obtain marketing approval for biosimilars that reference our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. Expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant exclusivity period has expired. However, biosimilar manufacturing is complex. At least initially upon approval of a biosimilar competitor, biosimilar competition with respect to biologics may not be as significant as generic competition with respect to small molecule drugs. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop biosimilar medicines. As such, a better-defined biosimilars approval pathway will assist us in pursuing approval of our own biosimilar products in the U.S. See Item 1A. Risk Factors Biotechnology Products below. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. Likewise, as we develop and manufacture biosimilars and seek to launch products, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, global protection of intellectual property rights has been improving. For additional information, see Government Regulation and Price Constraints Intellectual Property below. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus, generic and biosimilar drug manufacturers and consumer healthcare manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further understanding the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians and global health authorities. We also seek to continually enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our salespersons efforts to accurately and ethically launch and promote our products to our customers. Pfizer Inc. 2016 Form 10-K Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising; interactions with, and payments to, healthcare professionals; and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our Consumer Healthcare business faces competition from OTC business units in other major pharmaceutical and consumer packaged goods companies, and retailers who carry their own private label brands. Our competitive position is affected by several factors, including the amount and effectiveness of our and our competitors promotional resources; customer acceptance; product quality; our and our competitors introduction of new products, ingredients, claims, dosage forms, or other forms of innovation; and pricing, regulatory and legislative matters (such as product labeling, patient access and prescription to OTC switches). Our vaccines business may face competition from the introduction of alternative or next generation vaccines. For example, Prevnar 13 may face competition in the form of alternative 13-valent or additional valent next-generation pneumococcal conjugate vaccines prior to the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products, as well as biosimilars. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with a period of exclusivity as the only generic or biosimilar provider. Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 283 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see Government Regulation and Price Constraints In the United States below), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs have recently introduced additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. We are closely monitoring these new approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. In 2015, the FDA approved the first biosimilar and MCOs are evaluating the appropriate placement of these new agents on their formularies. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are Pfizer Inc. 2016 Form 10-K carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. In 2017, there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. We are monitoring any such actions to see if any changes to the ACA will be enacted that would impact our business. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors do not generally need to conduct clinical trials and can market a competing version of our product after the expiration or loss of our patent and often charge much less. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. No serious shortages or delays of raw materials were encountered in 2016 , and none are expected in 2017 . We have successfully secured the materials necessary to meet our requirements where there have been short-term imbalances between supply and demand, but generally at higher prices than those historically paid. GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2016 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulations by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling and storage of our products, record keeping, advertising and promotion. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. The FDA also regulates our Consumer Healthcare products. Other U.S. federal agencies, including the DEA, also regulate certain of our products. The U.S. Federal Trade Commission has the authority to regulate the advertising of consumer healthcare products, including OTC drugs and dietary supplements. Many of our activities also are subject to the jurisdiction of the SEC. Before a new biopharmaceutical product may be marketed in the U.S., the FDA must approve an NDA for a new drug or a BLA for a biologic. The steps required before the FDA will approve an NDA or BLA generally include preclinical studies followed by multiple stages of clinical trials conducted by the study sponsor; sponsor submission of the application to the FDA for review; the FDAs review of the data to assess the drugs safety and effectiveness; and the FDAs inspection of the facilities where the product will be manufactured. Before a generic drug may be marketed in the U.S., the FDA must approve an ANDA. The ANDA review process typically does not require new preclinical and clinical studies, because it relies on the studies establishing safety and efficacy conducted for the referenced drug previously approved through the NDA process. The ANDA process, however, does require the sponsor to conduct one or more bioequivalence studies to show that the ANDA drug is bioequivalent to the previously approved referenced brand drug, submission of an application to the FDA for review, and the FDAs inspection of the facilities where the product will be manufactured. As a condition of product approval, the FDA may require a sponsor to conduct post-marketing clinical studies, known as Phase 4 studies, and surveillance programs to monitor the effect of the approved product. The FDA may limit further marketing of a product based on the results of these post-market studies and programs. Any modifications to a drug or biologic, including new indications or changes to labeling or manufacturing processes or facilities, may require the submission and approval of a new or supplemental NDA or BLA before the modification can be implemented, which may require that we develop additional data or conduct additional preclinical studies and clinical trials. Our ongoing manufacture and distribution of drugs and biologics is subject to continuing regulation by the FDA, including recordkeeping requirements, reporting of adverse experiences associated with the product, and adherence to cGMPs, which regulate all aspects of the manufacturing process. We are also subject to numerous regulatory requirements relating to the advertising and promotion of drugs and biologics, including, but not limited to, standards and regulations for direct-to-consumer advertising. Failure to comply with the applicable regulatory requirements governing the manufacture and marketing of our products may subject us to administrative or judicial sanctions, including warning letters, product recalls or seizures, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference, innovator biologic. The FDA is responsible for implementation of the legislation and, since 2015, approved a number of biosimilars, including Inflectra . Through those approvals and the issuance of draft and final guidance, the FDA has begun to address open questions about the naming convention for biosimilars and the use of data from a non-U.S.-licensed comparator to demonstrate biosimilarity and/or interchangeability with a U.S.-licensed reference product. Over the next several years, the FDA is expected to issue additional draft and final guidance documents impacting biosimilars. In 2017, there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. If the ACA is repealed, substantially modified, or invalidated, it is unclear what, if any, impact such action would have on biosimilar regulation. Sales and Marketing . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended to prevent fraud and abuse in the healthcare industry and protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying any remuneration to generate business, including the purchase or prescription of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent. Although the specific provisions of these laws vary, their scope is generally broad and there may not be regulations, guidance or court decisions that apply the laws to any particular industry practices, including the marketing practices of pharmaceutical companies. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal health care programs (including Medicare and Medicaid). The federal government and various states have also enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and health care providers; require disclosure to the federal or state government and public of such interactions; and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section in our 2016 Financial Report and in the Notes to Consolidated Financial Statements Note 1G. Basis of Presentation and Significant Accounting Policies: Revenues and Trade Accounts Receivable in our 2016 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. For example, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products in certain states. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. Given certain states current and potential ongoing fiscal crises, a growing number of states are considering a variety of cost-control strategies, including capitated managed care plans that typically contain cost by restricting access to certain treatments. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers, who are the primary purchasers of our pharmaceutical products in the U.S., will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. Healthcare Reform. The U.S. and state governments continue to propose and pass legislation designed to regulate the healthcare industry. In March 2010, the U.S. Congress enacted the ACA, which included changes that significantly affected the pharmaceutical industries, such as: increasing drug rebates paid to state Medicaid programs under the Medicaid Drug Rebate Program for brand name and generic prescription drugs and extending those rebates to Medicaid managed care; requiring pharmaceutical manufacturers to provide discounts on brand name prescription drugs sold to Medicare beneficiaries whose prescription drug costs cause the beneficiaries to be subject to the Medicare Part D coverage gap; and imposing an annual fee on manufacturers and importers of brand name prescription drugs reimbursed under certain government programs, including Medicare and Medicaid. The ACA included provisions designed to increase the number of Americans covered by health insurance. Specifically, since 2014, the ACA has required most individuals to maintain health insurance coverage or potentially to pay a penalty for noncompliance and has offered states the option of expanding Medicaid coverage to additional individuals. The implementation of the coverage expansion had a negligible impact on Pfizers 2016 revenues. The ACA also establishes an Independent Payment Advisory Board (IPAB) to reduce the per capita rate of growth in Medicare spending by proposing changes to Medicare payments if expenditures exceed certain targets. The threshold for triggering IPAB proposals was not reached in 2016, so no adjustments will be made under the IPAB until 2019 at the earliest. If no IPAB members are nominated, the duties of the IPAB will default to the Secretary of the Department of Health and Human Services. Additionally, efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products could adversely affect our business if implemented. There has recently been considerable public and government scrutiny of pharmaceutical pricing and proposals to address the perceived high cost of pharmaceuticals. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We continue to work with stakeholders to ensure access to medicines within an efficient and affordable healthcare system. Adoption of other new legislation at the federal or state level could further affect demand for, or pricing of, our products. In 2017, we may face uncertainties because there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is no assurance that the ACA, as currently enacted or as amended in the future, will not adversely affect our business and financial results, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. We will continue to actively work with law makers and advocate for solutions that effectively improve patient health outcomes and lower costs to the healthcare system. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Outside the United States We encounter similar regulatory and legislative issues in most other countries. New Drug Approvals and Pharmacovigilance. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. These requirements delay marketing authorization in those countries relative to the U.S. and Europe. Chinas regulatory system is unique in many ways, and its drug development and registration requirements are not always consistent with U.S. or other international standards. It is common to see treatments entering the Chinese market two to eight years behind first marketing in the U.S. and Europe, because historically China has only issued import drug licenses to treatments approved by a foreign regulatory authority. In addition, to obtain marketing approvals for new drugs in China, a clinical trial authorization issued by the CFDA is required for the conduct of Phase I to III clinical trials. Foreign applicants of imported drugs, if including China-originated data in their Multi-Regional Clinical Trials and meeting the relevant technical review requirements, may receive case-by-case additional local clinical trial waivers. Oral generics, on the other hand, only need to undergo bioequivalence studies upon a filing for record with the CFDA, while sterile injectable generics may need local confirmatory trials for regulatory approval. A Chinese drug license will only be granted if, following review, the CFDA determines that the clinical data confirm the drugs safety and effectiveness. In the EU, there is detailed legislation and guidance on pharmacovigilance, which has been increased and strengthened in recent years. The EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . In Europe, Japan, China, Canada, South Korea and some other international markets, governments provide healthcare at low direct cost to consumers and regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global economic pressures. Governments, including the different EU Member States, may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, value-based pricing, and international reference pricing (i.e., the practice of many countries linking their regulated medicine prices to those of other countries). This international patchwork of price regulation and differing economic conditions and assessments of value across countries has led to different prices in different countries and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and hinders patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations (UN) and the Organization for Economic Co-operation and Development (OECD), are increasing policy pressures and scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations (e.g., 2016 UN High Level Panel Report on Access to Medicines , and 2017 OECD Report on New Health Technologies Managing Access, Value and Sustainability ). Government adoption of these recommendations may lead to additional pricing pressures. In Japan, the government recently released a basic framework for pharmaceutical pricing that may lead to the adoption of cost effectiveness assessments and pricing reviews. In China, government-set price caps were lifted for the vast majority of drug products on June 1, 2015. However, the government continues to exercise indirect price control by setting reimbursement standards through a negotiation mechanism between drug manufacturers and social insurance administrations. In addition, the CFDA is now asking some companies to enter into pricing commitments as a condition for regulatory approval. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, which is expected to come into effect by October 2018. This new regulation is aimed at simplifying and harmonizing the governance of clinical trials in the EU and will require increased public posting of clinical trial results. In another effort to increase the public availability of clinical trial results, the EMA adopted a new policy on Publication of Clinical Data for Medicinal Products for Human Use, which became effective January 1, 2015 and is now being actively implemented. Under this policy, the EMA now proactively publishes clinical trial data from application dossiers for new marketing authorizations, including data from trials taking place outside the EU, after the EMA has made a decision on the marketing authorization. The policy includes limited exceptions for commercially confidential information and the exclusion of any protected personal data. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. At present, it is unclear whether the U.K. will remain within, or affiliated to, the EU system of medicines approval and regulation, or separate itself completely. Immediately following Brexit, EU laws are expected to continue to apply until amended or repealed by the U.K. Parliament. It is however probable that the EMA, currently in London, will have to relocate to an EU member state, many of which have already bid to become the new host country. For additional information on Brexit, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. in our 2016 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce the existing drug approval backlogs, the CFDA unveiled several reform initiatives for Chinas drug approval system. The regulator now divides drugs into new drugs and generics, with the definition for new drugs changed from drugs never marketed in China to drugs that are neither marketed in or outside China. This change in definition creates more incentives for Chinas domestic drug manufacturers than for multinational firms, because imported drugs first marketed outside China are no longer considered new drugs. Furthermore, the revised rules do not clarify whether foreign regulatory approval is still required for imported drug final approval in China. Another major initiative is the piloting of the marketing authorization holder system in ten provinces in China, where the market authorization/drug license holders are no longer required to be the actual manufacturers. The marketing authorization holder system will allow for more flexibilities in contract manufacturing arrangements and asset transfers, but it is not applicable to imported drugs. A number of other policy changes are expected to be able to streamline and accelerate domestic and imported drug approvals in China. These changes include introducing an umbrella clinical trial authorization for all three phases of registration studies (instead of the original phase-by-phase approvals), implementing a filing/recordation system for bioequivalence studies on generics (instead of the original review and approval system), and admitting more types of drugs as innovative drugs eligible for the fast track/green channel approval pathway. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, in 2013, the EFPIA released its disclosure code of transfers of value to healthcare professionals and organizations. The code requires all members of EFPIA, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations beginning in 2016, covering the relevant transfers in 2015. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, a number of countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool for reducing the price of imported medicines, as well as to protect their local pharmaceutical industries. There is considerable political and economic pressure to weaken existing intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, issuance (and threat of issuance) of compulsory licenses, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries. Canadas intellectual property regime for drugs provides some level of patent protection and data exclusivity (eight years plus six-month pediatric extension), but it lacks the predictability and stability that otherwise comparable countries provide. Through intense negotiations as part of the Canada/EU Comprehensive Economic Trade Agreement, Canadian authorities reluctantly agreed to introduce a right of appeal, a form of patent term restoration and to elevate the current data protection to a treaty obligation, further aligning its intellectual property regime to the EU. In China, the intellectual property environment has improved, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, and several companies, including Pfizer, have established RD centers in China due to increased confidence in Chinas intellectual property environment. Despite this, China remained on the U.S. Trade Representatives Priority Watch List for 2016. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. In India, policies favoring compulsory licensing of patents, the increasing tendency of the Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. In South Korea, the laws and regulations for the patent-regulatory approval linkage system was implemented as part of the U.S.-Korea Free Trade Agreement in 2012. The Korean patent-regulatory approval linkage system includes biologics. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 17A3. Commitments and ContingenciesLegal ProceedingsCommercial and Other Matters in our 2016 Financial Report. As a result, we incurred capital and operational expenditures in 2016 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $27 million; and other environment-related expenses $126 million. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to these potential risks and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5. Tax Matters in our 2016 Financial Report, is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We believe we have good relationships with our employees. As of December 31, 2016 , we employed approximately 96,500 people in our operations throughout the world. DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224 (the Executive Orders). In some instances, ITRSHRA requires companies to disclose these types of transactions, even if they were permissible under U.S. law or were conducted by a non-U.S. affiliate in accordance with the local law under which such entity operates. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2016 , our activities included supplying life-saving medicines, medical products and consumer products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2016 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2016 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2016 Form 10-K and in our 2016 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, target, forecast, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated future operating and financial performance, business plans and prospects, in-line products and product candidates, strategic reviews, capital allocation, business-development plans, and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business, the disposition of the Hospira Infusion Systems net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 section in our 2016 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section in our 2016 Financial Report and in the Notes to Consolidated Financial StatementsNote 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section in our 2016 Financial Report; and the contributions that we expect to make from our general assets to the Companys pension and postretirement plans during 2017 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section and in the Notes to Consolidated Financial StatementsNote 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2016 Financial Report. We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Consolidation among MCOs has increased the negotiating power of MCOs and other private insurers. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. This cost shifting has given consumers greater control of medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. MCOs have recently introduced additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. payer market concentrates further and as more drugs become available in generic form, biopharmaceutical companies may face greater Pfizer Inc. 2016 Form 10-K pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. The date at which generic competition commences may be different from the date that the patent or regulatory exclusivity expires. However, upon the loss or expiration of patent protection for one of our products, or upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a generic manufacturer of a generic version of one of our patented products, we can lose the major portion of revenues for that product in a very short period of time, which can adversely affect our business. A number of our products are expected to face significantly increased generic competition over the next few years. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering several of their products that may impact our licenses or co-promotion rights to such products. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development, some of which have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with branded products from competitors, as well as other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before anticipated generic or biosimilar market formation is important to that products profitability. Prices for products typically decline, sometimes dramatically, following generic market formation, and as additional companies receive approvals to market that product, competition intensifies. If a companys generic or biosimilar product can be first-to-market such that its only competition is the branded drug for a period of time, higher levels of sales and profitability can be achieved until other generic or biosimilar competitors enter the market. With increasing competition in the generic or biosimilar product market, the timeliness with which we can market new generic or biosimilar products will increase in importance. Our success will depend on our ability to bring new products to market quickly. DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product revenues of more than $1 billion for each of eight biopharmaceutical products: Prevnar 13/Prevenar 13 , Lyrica , Enbrel , Ibrance , Lipitor , Viagra , Sutent and the Premarin family of products, as well as more than $1 billion in Alliance revenues (primarily Eliquis ) in 2016. Those products and Alliance revenues accounted for 43% of our total revenues in 2016. If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. Patents covering several of our best-selling medicines have recently expired or will expire in the next few years (including some of our billion-dollar and previously billion-dollar products), and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, pursuant to terms of a settlement agreement, certain formulations of Zyvox became subject to generic competition in the U.S. in January 2015. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses and Expected Losses of Product Exclusivity section in our 2016 Financial Report. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For additional information on recent losses of collaborations rights, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses of Collaboration Rights section in our 2016 Financial Report. Pfizer Inc. 2016 Form 10-K RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities in order to deliver a robust pipeline could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the science may not work for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. There can be no assurance that these strategies will deliver the desired result, which could affect profitability in the future. BIOTECHNOLOGY PRODUCTS Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. The expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant exclusivity period has expired. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. We are developing biosimilar medicines. The evolving pathway for registration and approval of biosimilar products by the FDA and regulatory authorities in certain other countries could diminish the value of our investments in biosimilars. Other risks related to our development of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with high costs associated with clinical development or intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower prescriptions of biosimilars due to potential concerns over comparability with innovator medicines. RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and addressed could affect our future results. RISKS AFFECTING INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets, including the full integration of emerging markets into each of our two distinct operating segments: IH and EH. However, there is no assurance that our strategies in emerging markets will be successful or that these countries will continue to sustain these growth rates. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly Pfizer Inc. 2016 Form 10-K monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets, as discussed above, can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. While the impact of payers efforts to control access to and pricing of specialty pharmaceuticals has had limited impact on Pfizer to date, a number of factors may lead to a more significant adverse business impact in the future given our growing specialty business portfolio. These include the increasing use of health technology assessments in markets around the world, U.S. PBMs seeking to negotiate greater discounts, deteriorating finances of certain governments, the uptake of biosimilars as they become available and efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products. CONSUMER HEALTHCARE The Consumer Healthcare business may be impacted by economic volatility, the timing and severity of the cough, cold and flu season, generic or store brand competition affecting consumer spending patterns and market share gains of competitors branded products or generic store brands. In addition, regulatory and legislative outcomes regarding the safety, efficacy or unintended uses of specific ingredients in our Consumer Healthcare products may require withdrawal, reformulation and/or relabeling of certain products (e.g., cough/cold products). See The Global Economic Environment risk factor below. PRODUCT MANUFACTURING AND MARKETING RISKS Difficulties or delays in product manufacturing or marketing could affect future results through regulatory actions, shut-downs, approval delays, withdrawals, recalls, penalties, supply disruptions or shortages, reputational harm, product liability, unanticipated costs or otherwise. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of incoming materials may be delayed or become unavailable and that the quality of incoming materials may be substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout the internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); risks to supply chain continuity as a result of natural or man-made disasters at our facilities or at a supplier or vendor, including those that may be related to climate change; or failure to maintain the integrity of our supply chains against intentional and criminal acts such as economic adulteration, product diversion, product theft, and counterfeit goods. Regulatory agencies periodically inspect our drug manufacturing facilities to ensure compliance with applicable cGMP requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions or voluntary recall of a product, any of which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, we received a warning letter from the FDA communicating FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. Hospira is undertaking corrective actions to address the concerns raised by the FDA. Communication with the FDA is ongoing. Until the violations are corrected, the FDA may refuse to grant premarket approval applications and/or the FDA may refuse to grant export certificates related to products manufactured at McPherson, Kansas. OUTSOURCING AND ENTERPRISE RESOURCE PLANNING We outsource certain services to third parties in areas including transaction processing, accounting, information technology, manufacturing, clinical trial execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. For example, in 2016, we placed the majority of our clinical trial execution services with four strategic Clinical Research Organizations (CROs). Service performance issues with these CROs may adversely impact the progression of our clinical trial programs. Outsourcing of services to third parties could expose us to sub-optimal quality of service delivery or deliverables, which may result in repercussions such as missed deadlines or other timeliness issues, erroneous data, supply disruptions, non-compliance (including with applicable legal requirements and industry standards) or reputational harm, with potential negative implications for our results. We continue to pursue a multi-year initiative to outsource some transaction-processing activities within certain accounting processes and are migrating to a consistent enterprise resource planning system across the organization. These are enhancements of ongoing activities to support the growth of our financial shared service capabilities and standardize our financial systems. If any difficulties in the migration to or in the operation of our enterprise resource planning system were to occur, they could adversely affect our operations, including, among other ways, through a failure to meet demand for our products, or adversely affect our ability to meet our financial reporting obligations. Pfizer Inc. 2016 Form 10-K COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the development and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development and commercialization activities, but we do not control many aspects of those activities. Third parties may not complete activities on schedule or in accordance with our expectations. Failure by one or more of these third parties to meet their contractual, regulatory or other obligations to Pfizer, or any disruption in the relationships between Pfizer and these third parties, could delay or prevent the development, approval or commercialization of our products and product candidates and could also result in non-compliance or reputational harm, all with potential negative implications for our product pipeline and business. DIFFICULTIES OF OUR BIOPHARMACEUTICAL WHOLESALERS In 2016, our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 31% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 39 % of our total revenues (and approximately 76 % of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact our results of operations. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through collaborations, alliances, licenses, joint ventures, equity- or debt-based investments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframe or at all, and integrate acquisitions. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Additionally, we may not realize the anticipated benefits of such transactions, including the possibility that expected synergies and accretion will not be realized or will not be realized within the expected time frame. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; and the relatively modest risk of penalties faced by counterfeiters. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines pose a risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate the threat of counterfeit medicines, which is exacerbated by the complexity of the supply chain, could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We undertake significant efforts to counteract the threats associated with counterfeit medicines, including, among other things, working with the FDA and other regulatory authorities and multinational coalitions to combat the counterfeiting of medicines and supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; implementing business practices designed to protect patient health; promoting public policies intended to hinder counterfeiting; working diligently to raise public awareness about the dangers of counterfeit medicines; and working collaboratively with wholesalers, pharmacies, customs offices, and law enforcement agencies to increase inspection coverage, monitor distribution channels, and improve surveillance of distributors and repackagers. No Pfizer Inc. 2016 Form 10-K assurance can be given, however, that our efforts and the efforts of others will be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. Additionally, efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products could adversely affect our business if implemented. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as Europe, Japan, China, Canada and South Korea, governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions, failure to obtain timely or adequate government-approved pricing or formulary placement where required for our products or obtaining such pricing or placement at unfavorable pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM/HEALTHCARE LEGISLATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of health care coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion under the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Regulatory Environment/Pricing and Access U.S. Healthcare Legislation section in our 2016 Financial Report and in Item 1. Business under the caption Government Regulation and Price ConstraintsIn the United States . In 2017, we may face uncertainties because there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. Although the revenues generated for Pfizer by the Medicaid expansion and health insurance exchanges under the ACA have been exceeded by the new rebates, discounts, and taxes, there is no assurance that repeal or replacement of the ACA will not adversely affect our business and financial results, particularly if replacement legislation reduces incentives for employer-sponsored insurance coverage, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. presidential administrations policy proposals), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. U.S. DEFICIT-REDUCTION ACTIONS In the U.S., government actions to reduce the national deficit may affect payment by government programs for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing the federal deficit, and the December 2016 release includes proposals to cap Medicaid grants to the states, and to require manufacturers to pay a minimum rebate on drugs covered under part D of Medicare for low-income beneficiaries. Significant Medicare reductions could also result if Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or it chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health Pfizer Inc. 2016 Form 10-K programs that may be implemented, and/or any significant additional taxes or fees that may be imposed on us, as part of any broad deficit-reduction effort could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, or exclusion from future participation in government healthcare programs. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our company. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. Drug discovery and development is time-consuming, expensive and unpredictable. The process from early discovery or design to development to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, including unfavorable new clinical data and additional analyses of existing clinical data. There can be no assurance regarding our ability to meet anticipated pre-clinical and clinical trial commencement and completion dates, regulatory submission and approval dates, and launch dates for product candidates, or as to whether or when we will receive regulatory approval for new products or for new indications or dosage forms for existing products, which will depend on the assessment by regulatory authorities of the benefit-risk profile suggested by the totality of the efficacy and safety information submitted. Decisions by regulatory authorities regarding labeling, ingredients and other matters could adversely affect the availability or commercial potential of our products. There is no assurance that we will be able to address the comments in complete response letters received by us with respect to certain of our drug applications to the satisfaction of the FDA, that any of our late stage pipeline products will receive regulatory approval and/or be commercially successful or that recently approved products will be approved in other markets and/or be commercially successful. There is also a risk that we may not adequately address existing regulatory agency findings concerning the adequacy of our regulatory compliance processes and systems or implement sustainable processes and procedures to maintain regulatory compliance and to address future regulatory agency findings, should they occur. In addition, there are risks associated with interim data, including the risk that final results of studies for which interim data have been provided and/or additional clinical trials may be different from (including less favorable than) the interim data results and may not support further clinical development of the applicable product candidate or indication. There are many considerations that can affect the marketing of our products around the world. Regulatory delays, the inability to successfully complete or adequately design and implement clinical trials within the anticipated quality, time and cost guidelines or in compliance with applicable regulatory expectations, claims and concerns about safety and efficacy, new discoveries, patent disputes and claims about adverse side effects are a few of the factors that can adversely affect our business. Further, claims and concerns about safety and efficacy can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional clinical trials prior to granting approval or increased post-approval requirements, such as risk evaluation and mitigation strategies. In addition, failure to put in place adequate controls and/or resources for effective collection, reporting and management of adverse events from clinical trials and post-marketing surveillance, in compliance with current and evolving regulatory requirements could result in risks to patient safety, regulatory actions and risks to product sales. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which has delayed approvals of new generic products. These delays have become longer, and while the FDA has stated that it is taking steps to address the backlog of pending applications, continued approval delays may be experienced by generic drug applicants over the next few years. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products that implicate (or are perceived to implicate) an entire class of products could have an adverse effect on the availability or commercial potential of the affected products. Accordingly, new data about our products, or products similar to our products, could negatively impact demand for our products due to real or Pfizer Inc. 2016 Form 10-K perceived side effects or uncertainty regarding efficacy and, in some cases, could result in updated labeling, restrictions on use, product withdrawal or recall. INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide something of value to a healthcare professional and/or government official. If the interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as non-U.S. jurisdictions adopt or increase enforcement efforts of new anti-bribery laws and regulations. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision for Taxes on Income Changes in Tax Law and New Accounting Standards sections, and Notes to Consolidated Financial Statements Note 1B. Basis of Presentation and Significant Accounting Policies: Adoption of New Accounting Standards in our 2016 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various patent, product liability, consumer, commercial, securities, antitrust, environmental, employment and tax litigations and claims, government investigations and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe we have substantial defenses in these matters, we could in the future incur judgments, enter into settlements of claims or revise our expectations regarding the outcomes of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to investigations and extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. As a result, we have interactions with government agencies on an ongoing basis. Criminal charges, and substantial fines and/or civil penalties, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from government investigations. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2016 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. Pfizer Inc. 2016 Form 10-K RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in a policy of routine compulsory licensing of pharmaceutical intellectual property as a result of local political pressure or in the case of national emergencies. In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches to challenge our patent rights. Most of the suits by generic drug manufacturers involve claims that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not be successful. Part of our EH business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others. To achieve a first-to-market or early market position for generic pharmaceutical products and biosimilars, we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic Pfizer Inc. 2016 Form 10-K pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If those proceedings ultimately determine that our products infringe the patent rights of third parties, we may face patent infringement damages, including the possibility of owing the third party a reasonable royalty or the lost profits from the sale of the branded product. Remedies also may include or consist of an injunction preventing us from further manufacture or sales of the affected product during the term of one or more of the valid, infringed patents. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with the acquisition of Hospira, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from the acquisitions of Hospira, Anacor and Medivation may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges regularly adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions, device remediations and substantial regulatory scrutiny due to quality issues, including receiving a warning letter from the FDA in February 2017 communicating FDA s view that certain violations of cGMP regulations exist at Hospira s manufacturing facility in McPherson, Kansas. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses, we are exposed to both global and industry-specific economic conditions. Governments, corporations and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic products, delay treatments, skip doses or use less effective treatments. Government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. Examples include Europe, Japan, China, Canada, South Korea and a number of other international markets. The U.S. continues to maintain competitive insurance markets, but has also seen significant Pfizer Inc. 2016 Form 10-K increases in patient cost-sharing and growing government influence as government programs continue to grow as a source of coverage. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications to our research, commercial and general business operations in the U.K. and the EU. Details on how Brexit will be executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be, especially in EU nations with weaker economic conditions such as Greece. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. section in our 2016 Financial Report. We also continue to monitor the global trade environment and potential trade conflicts. If trade restrictions reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues and earnings, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 50% of our total 2016 revenues were derived from international operations, including 21% from Europe and 20% from Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Japanese yen, the Chinese renminbi, the U.K. pound, the Canadian dollar and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates, including those changes resulting from the volatility following the U.K. referendum in which voters approved Brexit, can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations can impact our results and financial guidance. For additional information about our exposure to foreign currency risk, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2016 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks and the measures we have taken to help contain them are discussed in the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2016 Financial Report. For additional details, see the Notes to Consolidated Financial Statements Note 7E. Financial Instruments: Derivative Financial Instruments and Hedging Activities and Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2016 Financial Report and the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section in our 2016 Financial Report. Those sections of our 2016 Financial Report are incorporated by reference. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. Pfizer Inc. 2016 Form 10-K COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS/INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) our internal separation of our commercial operations into our current operating structure; (iii) any other corporate strategic initiatives; and (iv) any acquisitions, divestitures or other initiatives, such as our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business. In addition, our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2016 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. INTERNAL CONTROL OVER FINANCIAL REPORTING The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES In 2016, we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2016, we had 567 owned and leased properties, amounting to approximately 57 million square feet. In 2016, we reduced the number of properties in our portfolio by 28 sites and 2.3 million square feet with the disposal of surplus real property assets and with reductions of operating space in all regions. These reductions include partial offsets due to acquisitions of Anacor, Bamboo Therapeutics Inc., substantially all of the assets of BIND Therapeutics, Inc. and Medivation. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizer Inc. 2016 Form 10-K Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2017, we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. In addition, we plan continued execution on consolidating properties related to Hospira and other acquired companies. We also plan to further expand our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2017, we will continue to consolidate our RD operations in Cambridge, Massachusetts into the Kendall Square neighborhood, and continue to advance our operations in St. Louis, Missouri and Andover, Massachusetts. Our Pfizer Global Supply (PGS) division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2016, PGS operated 63 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of eight of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2016 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2016 Financial Report, which is also incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2016 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. The stock currently trades on the NYSE under the symbol PFE. As of February 21, 2017 , there were 166,694 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2016 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2016 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 3, 2016 through October 30, 2016 33,946 $ 33.64 $ 11,355,862,076 October 31, 2016 through November 30, 2016 14,578 $ 31.57 $ 11,355,862,076 December 1, 2016 through December 31, 2016 25,816 $ 32.28 $ 11,355,862,076 Total 74,340 $ 32.76 (a) On October 23, 2014, we announced that the Board of Directors had authorized an $11 billion share-purchase plan (the October 2014 Stock Purchase Plan), and share purchases commenced thereunder in January 2015. In December 2015, the Board of Directors authorized a new $11 billion share repurchase program to be utilized over time. On March 8, 2016, we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. (GSCo.) to repurchase $5 billion of our common stock. Pursuant to the terms of the agreement, on March 10, 2016, we paid $5 billion to GSCo. and received an initial delivery of approximately 136 million shares of our common stock from GSCo. based on a price of $29.36 per share, which represented, based on the closing share price of our common stock on the NYSE on March 8, 2016, approximately 80% of the notional amount of the accelerated share repurchase agreement. On June 20, 2016, the accelerated share repurchase agreement with GSCo. was completed, which, per the terms of the agreement, resulted in GSCo. owing us a certain number of shares of Pfizer common stock. Pursuant to the agreements settlement terms, we received an additional 18 million shares of our common stock from GSCo. on June 20, 2016. The average price paid for all of the shares delivered under the accelerated share repurchase agreement was $32.38 per share. The common stock received is included in Treasury stock . This agreement was entered into pursuant to our previously announced share repurchase authorization. At December 31, 2016, our remaining share-purchase authorization was approximately $11.4 billion at December 31, 2016 . (b) These columns reflect the following transactions during the fourth fiscal quarter of 2016 : (i) the surrender to Pfizer of 70,024 shares of common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock units issued to employees; (ii) the surrender to Pfizer of 2,105 shares of common stock to satisfy tax withholding obligations in connection with the vesting of performance share awards issued to employees; (iii) the surrender to Pfizer of 1,669 shares of common stock to pay the exercise price and to satisfy tax withholding obligations in connection with the exercise of employee stock options issued to employees; (iv) the open market purchase by the trustee of 532 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards; and (v) the surrender of 10 shares of common stock to satisfy withholding obligations in connection with the settlement of total shareholder return units. On February 2, 2017, we entered into an accelerated share repurchase agreement with Citibank N.A. This agreement was entered into pursuant to Pfizers previously announced share repurchase authorization. For additional information, see the Notes to Consolidated Financial Statements Note 19. Subsequent Events in our 2016 Financial Report, which is incorporated by reference. ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2016 Financial Report. Pfizer Inc. 2016 Form 10-K , ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2016 Financial Report. ," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2016 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2016 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2016 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2016 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. " +29,PepsiCo,2021," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global beverage and convenient food company with a complementary portfolio of brands, including Lays, Doritos, Cheetos, Gatorade, Pepsi-Cola, Mountain Dew, Quaker and SodaStream. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into seven reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded convenient food businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our branded convenient food businesses, such as cereal, rice, pasta and other branded food, in the United States and Canada; 3) PepsiCo Beverages North America (PBNA), which includes our beverage businesses in the United States and Canada; 4) Latin America (LatAm), which includes all of our beverage and convenient food businesses in Latin America; 5) Europe, which includes all of our beverage and convenient food businesses in Europe; Table of Contents 6) Africa, Middle East and South Asia (AMESA), which includes all of our beverage and convenient food businesses in Africa, the Middle East and South Asia; and 7) Asia Pacific, Australia and New Zealand and China Region (APAC), which includes all of our beverage and convenient food businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded convenient foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells branded convenient foods, which include cereals, rice, pasta and other branded products. QFNAs products include Capn Crunch cereal, Life cereal, Pearl Milling Company syrups and mixes, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker Simply Granola and Rice-A-Roni side dishes. QFNAs branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Gatorade Zero, Mountain Dew, Pepsi and Propel. PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. and Ocean Spray Cranberries, Inc. (Ocean Spray). In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture (Juice Transaction) that will operate across North America and Europe. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of convenient food brands including Cheetos, Doritos, Emperador, Lays, Mabel, Marias Gamesa, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded convenient foods. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Table of Contents Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of convenient food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Lubimy Sad, Mirinda, Pepsi and Pepsi Max. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, as part of its beverage business, manufactures and distributes SodaStream sparkling water makers and related products. Further, Europe makes, markets, distributes and sells a number of dairy products including Agusha, Chudo and Domik v Derevne. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. See Note 13 to our consolidated financial statements for further information. Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of convenient food brands including Chipsy, Doritos, Kurkure, Lays, Sasko, Spekko and White Star, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of convenient food brands including BaiCaoWei, Cheetos, Doritos, Lays and Smiths, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi and Sting. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Table of Contents Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages and convenient foods directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and distribution centers, both company and third-party operated, to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages and convenient foods to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage and convenient food products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for convenient foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. During 2021, we experienced higher than anticipated commodity, packaging and other input costs and, in some instances, limited shortages due to global inflation, supply chain disruptions, labor shortages, increased demand and other regulatory and macroeconomic factors associated with the novel coronavirus (COVID-19) pandemic, which has continued into fiscal 2022. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Table of Contents We also maintain voluntary supply chain finance agreements with several participating global financial institutions, pursuant to which our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to such global financial institutions. These agreements did not have a material impact on our business or financial results. See Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewtr, BaiCaoWei, Bare, Bokomo, Bolt24, bubly, Capn Crunch, Ceres, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Driftwell, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Gatorade Zero, Gatorlyte, Grandmas, H2oh!, Health Warrior, Imunele, J7, Kas, Kurkure, Lays, Life, Lifewtr, Liquifruit, Lubimy, Mabel, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Moirs, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Game Fuel, Mountain Dew Kickstart, Mountain Dew Zero Sugar, MTN Dew Energy, Mug, Munchies, Muscle Milk, Near East, Off the Eaten Path, Paso de los Toros, Pasta Roni, Pearl Milling Company, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, PopCorners, Pronutro, Propel, Quaker, Quaker Chewy, Quaker Simply Granola, Rice-A-Roni, Rockstar Energy, Rold Gold, Ruffles, Sabritas, Safari, Sakata, Saladitas, San Carlos, Sandora, Santitas, Sasko, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Spekko, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, V Water, Vesely Molochnik, Walkers, Weetbix, White Star, Ya and Yachak. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Ocean Spray. We also distribute Bang Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. In addition, in the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. In 2022, we will also begin to distribute Hard MTN Dew, an alcoholic beverage manufactured and owned by the Boston Beer Company. We have licensed the use of the Hard MTN Dew trademark to the Boston Beer Company, which has appointed us as their distributor for this product. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as convenient food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. Our beverage and convenient food sales are generally highest in the third quarter due to seasonal and holiday-related patterns and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Table of Contents Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the continued growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the international expansion of hard discounters, and the current economic environment, including in light of the COVID-19 pandemic, continue to increase the importance of major customers. In 2021, sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 13% of our consolidated net revenue, with sales reported across all of our divisions, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. The loss of this customer would have a material adverse effect on our FLNA, QFNA and PBNA divisions. Our Competition Our beverage and convenient food products are in highly competitive categories and markets and compete against products of international beverage and convenient food companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage and convenient food competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Hormel Foods Corporation, Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Utz Brands, Inc. Many of our convenient food products hold significant leadership positions in the convenient food industry in the United States and worldwide. In 2021, we and The Coca-Cola Company represented approximately 22% and 19%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Table of Contents Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage and convenient food products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and sustainability and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting the needs of our customers and consumers and accelerating growth. These activities principally involve: innovations focused on creating consumer preferred products to grow and transform our portfolio through development of new technologies, ingredients, flavors and substrates; development and improvement of our manufacturing processes including reductions in cost and environmental footprint; implementing product improvements to our global portfolio that reduce added sugars, sodium or saturated fat; offering more products with functional ingredients and positive nutrition including whole grains, fruit, vegetables, dairy, protein, fiber, micronutrients and hydration; development of packaging technology and new package designs, including reducing the amount of plastic in our packaging and developing recyclable, compostable, biodegradable or otherwise sustainable packaging; development of marketing, merchandising and dispensing equipment; further expanding our beyond the bottle portfolio including innovation for our SodaStream business; investments in technology and digitalization, including artificial intelligence and data analytics to enhance our consumer insights and research; continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and efforts focused on reducing our impact on the environment, including reducing water use in our operations and our agricultural practices and reducing our climate impact in our operations throughout our value chain. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, South Africa, the United Kingdom and the United States, and leverage consumer insights, food science and engineering to meet our strategy to continually innovate our portfolio of beverages and convenient foods. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. Table of Contents The U.S. laws and regulations that we are subject to include, but are not limited to: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act and various state laws and regulations governing workplace health and safety; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; various state and federal laws pertaining to sale and distribution of alcohol beverages; data privacy and personal data protection laws and regulations, including the California Consumer Privacy Act of 2018 (as modified by the California Privacy Rights Act); customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from Table of Contents deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some types of single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over environmental, social and governance matters, including climate change, is expected to continue to result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, to limit or impose additional costs on commercial water use due to local water scarcity concerns or to expand mandatory reporting of certain environmental, social and governance metrics. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations and to achieve our sustainability goals. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and expenditures necessary to comply with such requirements or to achieve our sustainability goals, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Human Capital PepsiCo believes that human capital management, including attracting, developing and retaining a high quality workforce, is critical to our long-term success. Our Board of Directors (Board) and its Committees provide oversight on a broad range of human capital management topics, including corporate culture, diversity, equity and inclusion, pay equity, health and safety, training and development and compensation and benefits. We employed approximately 309,000 people worldwide as of December 25, 2021, including approximately 129,000 people within the United States. We are party to numerous collective bargaining agreements and believe that relations with our employees are generally good. Protecting the safety, health, and well-being of our associates around the world is PepsiCos top priority. We strive to achieve an injury-free work environment. We also continue to invest in emerging technologies to protect our employees from injuries, including leveraging fleet telematics and distracted driving technology, resulting in reductions in road traffic accidents, and deploying wearable ergonomic risk reduction devices. In addition, throughout the COVID-19 pandemic, we have remained focused on the health and safety of our associates, especially our frontline associates who continue to make, move and sell our products during this critical time, including by continuing to implement various safety protocols in our facilities, providing personal protective equipment and enabling testing. Table of Contents We believe that our culture of diversity, equity and inclusion is a competitive advantage that fuels innovation, enhances our ability to attract and retain talent and strengthens our reputation. We continually strive to improve the attraction, retention, and advancement of diverse associates to ensure we sustain a high-caliber pipeline of talent that also represents the communities we serve. As of December 25, 2021, our global workforce was approximately 27% female, while management roles were approximately 43% female. As of December 25, 2021, approximately 45% of our U.S. workforce was comprised of racially/ethnically diverse individuals, of which approximately 31% of our U.S. associates in managerial roles were racially/ethnically diverse individuals. Direct reports of our Chief Executive Officer include 7 executives globally who are racially/ethnically diverse and/or female. We are also committed to the continued growth and development of our associates. PepsiCo supports and develops its associates through a variety of global training and development programs that build and strengthen employees' leadership and professional skills, including career development plans, mentoring programs and in-house learning opportunities, such as PEP U Degreed, our internal global online learning resource. In 2021, PepsiCo employees completed over 1,000,000 hours of training. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. The following risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business or financial performance, which in turn can affect the price of our publicly traded securities. These are not the only risks we face. There may be other risks we are not currently aware of or that we currently deem not to be material but that may become material in the future. Business Risks The impact of COVID-19 continues to create considerable uncertainty for our business. Our global operations continue to expose us to risks associated with the COVID-19 pandemic. Numerous measures have been implemented around the world to try to reduce the spread of the virus and these measures have impacted and continue to impact us, our business partners and consumers. Table of Contents We have seen and could continue to see changes in consumer demand as a result of COVID-19, including the inability of consumers to purchase our products due to illness, quarantine or other restrictions, store closures, or financial hardship. We also have seen and could continue to see shifts in product and channel prefe rences, including an increase in demand in the e-commerce channel, which has impacted and could continue to impact our sales and profitability. Reduced demand for our products or changes in consumer purchasing patterns, as well as continued economic uncertainty, can adversely affect our customers financial condition, which can result in bankruptcy filings and/or an inability to pay for our products. In addition, we may also continue to experience business disruptions as a result of COVID-19, resulting from temporary closures of our facilities or facilities of our business partners or the inability of a significant portion of our or our business partners workforce to work because of illness, absenteeism, quarantine, vaccine mandates, or travel or other governmental restrictions. In addition, we and our business partners may also continue to see adverse impacts to our supply chain as a result of COVID-19 through raw material, packaging or other supply shortages, labor shortages or reduced availability of air or other commercial transport, port congestion and closures or border restrictions, any of which can impact our business. Any sustained interruption in our or our business partners operations, distribution network or supply chain or any significant continuous shortage of raw materials, packaging or other supplies can negatively impact our business. We have also incurred, and could continue to incur, increased employee and operating costs as a result of COVID-19, such as costs related to expanded benefits and frontline incentives, the provision of personal protective equipment and increased sanitation, allowances for credit losses, upfront payment reserves and inventory write-offs, and cost inflation in commodities, packaging, transportation and other input costs, which have negatively impacted and may continue to negatively impact our profitability. In addition, the increase in certain of our employees working remotely has resulted in increased demand on our information technology infrastructure, which can be subject to failure, disruption or unavailability, and increased vulnerability to cyberattacks and other cyber incidents. Also, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. The impact of COVID-19 has heightened, or in some cases manifested, certain of the other risks discussed below. The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the emergence and spread of new variants of the virus, including the omicron and delta variants, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus and evolving strains or variants of the virus, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in the future, in response to the pandemic, and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Reduction in future demand for our products would adversely affect our business. Demand for our products depends in part on our ability to innovate and anticipate and effectively respond to shifts in consumer trends and preferences, including the types of products our consumers want and how they browse for, purchase and consume them. Consumer preferences continuously evolve due to a variety of factors, including: changes in consumer demographics, consumption patterns and channel preferences (including continued increases in the e-commerce and online-to-offline channels); pricing; product quality; concerns or perceptions regarding packaging and its environmental impact (such as single-use and other plastic packaging); and concerns or perceptions regarding the nutrition profile and health effects of, or location of origin of, ingredients or substances in our products or packaging, including due to the results of third-party studies (whether or not scientifically valid). Concerns with any of the foregoing could lead consumers to reduce or publicly boycott the purchase or consumption of our products. Consumer Table of Contents preferences are also influenced by perception of our brand image or the brand images of our products, the success of our advertising and marketing campaigns, our ability to engage with our consumers in the manner they prefer, including through the use of digital media or assets, and the perception of our use, and the use of social media. These and other factors have reduced in the past and could continue to reduce consumers willingness to purchase certain of our products. Any inability on our part to anticipate or react to changes in consumer preferences and trends, or make the right strategic investments to do so, including investments in data analytics to understand consumer trends, can lead to reduced demand for our products, lead to inventory write-offs or erode our competitive and financial position, thereby adversely affecting our business. In addition, our business operations, including our supply chain, are subject to disruption by natural disasters or other events beyond our control that could negatively impact product availability and decrease demand for our products if our crisis management plans do not effectively resolve these issues. Damage to our reputation or brand image can adversely affect our business. Maintaining a positive reputation globally is critical to selling our products. Our reputation or brand image has in the past been, and could in the future be, adversely impacted by a variety of factors, including: any failure by us or our business partners to maintain high ethical, business and environmental, social and governance practices, including with respect to human rights, child labor laws, diversity, equity and inclusion, workplace conditions and employee health and safety; any failure to achieve our environmental, social and governance goals, including with respect to the nutrition profile of our products, diversity, equity and inclusion initiatives, packaging, water use and our impact on the environment; any failure to address health concerns about our products, products we distribute, or particular ingredients in our products, including concerns regarding whether certain of our products contribute to obesity or an increase in public health costs; our research and development efforts; any product quality or safety issues, including the recall of any of our products; any failure to comply with laws and regulations; consumer perception of our advertising campaigns, sponsorship arrangements, marketing programs, use of social media and our response to political and social issues or catastrophic events; or any failure to effectively respond to negative or inaccurate comments about us on social media or otherwise regarding any of the foregoing. Damage to our reputation or brand image has in the past and could in the future decrease demand for our products, thereby adversely affecting our business. Product recalls or other issues or concerns with respect to product quality and safety can adversely affect our business. We have and could in the future recall products due to product quality or safety issues, including actual or alleged mislabeling, misbranding, spoilage, undeclared allergens, adulteration or contamination. Product recalls have in the past and could in the future adversely affect our business by resulting in losses due to their cost, the destruction of product inventory or lost sales due to any unavailability of the product for a period of time. In addition, product quality or safety issues, whether as a result of failure to comply with food safety laws or otherwise, have in the past and could in the future also reduce consumer confidence and demand for our products, cause production and delivery disruptions, and result in increased costs (including payment of fines and/or judgments) and damage our reputation, particularly as we expand into new categories, such as nuts and meat convenient foods globally and the distribution of alcoholic beverages in the United States, all of which can adversely affect our business. Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries or civil or criminal proceedings, all of which may result in fines, penalties, damages or criminal liability. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Table of Contents Any inability to compete effectively can adversely affect our business. Our products compete against products of international beverage and convenient food companies that, like us, operate in multiple geographies, as well as regional, local and private label and economy brand manufacturers and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Our products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends. Our business can be adversely affected if we are unable to effectively promote or develop our existing products or introduce and effectively market new products, if we are unable to effectively adopt new technologies, including artificial intelligence and data analytics to develop new commercial insights and improve operating efficiencies, if we are unable to continuously strengthen and evolve our capabilities in digital marketing, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to supply disruptions, pricing pressure (including as a result of commodity inflation) or otherwise compete effectively, and we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures. Failure to attract, develop and maintain a highly skilled and diverse workforce can have an adverse effect on our business. Our business requires that we attract, develop and maintain a highly skilled and diverse workforce. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to attract, retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover, sustained labor shortage or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to attract, develop and maintain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. In addition, failure to attract, retain and develop associates from underrepresented communities can damage our business results and our reputation. Any of the foregoing can adversely affect our business. Water scarcity can adversely affect our business. We and our business partners use water in the manufacturing and sourcing of our products. Water is also essential to the production of the raw materials needed in our manufacturing process. Lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress, including due to the effects of climate change, may lead to: supply chain disruption; adverse effects on our operations or the operations of our business partners; higher compliance costs; capital expenditures (including investments in the development of technologies to enhance water efficiency and reduce consumption); higher production costs, including less favorable pricing for water; the interruption or cessation of operations at, or relocation of, our facilities or the facilities of our business partners; failure to achieve our goals relating to water use; perception of our failure to act responsibly with respect to water use or to effectively respond to legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business. Table of Contents Changes in the retail landscape or in sales to any key customer can adversely affect our business. The retail landscape continues to evolve, including continued growth in e-commerce channels and hard discounters. Our business will be adversely affected if we are unable to maintain and develop successful relationships with e-commerce retailers and hard discounters, while also maintaining relationships with our key customers operating in traditional retail channels (many of whom are also focused on increasing their e-commerce sales). Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers or we fail to find ways to create increasingly better digital tools and capabilities for our retail customers to enable them to grow their businesses. In addition, our business can be adversely affected if we are unable to profitably expand our own direct-to-consumer e-commerce capabilities. The retail industry is also impacted by increased consolidation of ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, impacting our ability to compete in these areas. Consolidation also adversely impacts our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, we must maintain mutually beneficial relationships with our key customers, including Walmart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business. Disruption of our manufacturing operations or supply chain, including increased commodity, packaging, transportation, labor and other input costs, can adversely affect our business. We have experienced and could continue to experience disruption in our manufacturing operations and supply chain. Many of the raw materials and supplies used in the production of our products are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions. Some raw materials and supplies, including packaging materials, are available only from a limited number of suppliers or from a sole supplier or are in short supply when seasonal demand is at its peak. There can be no assurance that we will be able to maintain favorable arrangements and relationships with suppliers or that our contingency plans will be effective to prevent disruptions that may arise from shortages or discontinuation of any raw materials and other supplies that we use in the manufacture, production and distribution of our products. Any sustained or significant disruption to the manufacturing or sourcing of products or materials could increase our costs and interrupt product supply, which can adversely impact our business. The raw materials and other supplies, including agricultural commodities, fuel and packaging materials, such as recycled PET, transportation, labor and other supply chain inputs that we use for the manufacturing, production and distribution of our products are subject to price volatility and fluctuations in availability caused by many factors, including changes in supply and demand, supplier capacity constraints, inflation, weather conditions (including potential effects of climate change), fire, natural disasters, disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks (including COVID-19), labor shortages (including the lack of availability of truck drivers or as a result of COVID-19), strikes or work stoppages, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), port congestions or delays, transport capacity constraints, cybersecurity incidents or other disruptions, loss or impairment of key manufacturing sites, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Many of our raw materials and supplies are purchased in the open market and the prices we pay for such items are subject to fluctuation. We experienced higher than anticipated commodity, packaging and transportation costs during 2021, which may continue. When input prices increase unexpectedly or significantly, we may Table of Contents be unwilling or unable to increase our product prices or unable to effectively hedge against price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. Political and social conditions can adversely affect our business. Political and social conditions in the markets in which our products are sold have been and could continue to be difficult to predict, resulting in adverse effects on our business. The results of elections, referendums or other political conditions (including government shutdowns or hostilities between countries) in these markets have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or result in uncertainty as to how such laws, regulations, programs or policies may change, including with respect to tariffs, sanctions, environmental and climate change regulations, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products, any of which can adversely affect our business. In addition, political and social conditions in certain cities throughout the U.S. as well as globally have resulted in demonstrations and protests, including in connection with political elections and civil rights and liberties. Our operations, including the distribution of our products and the ingredients or other raw materials used in the production of our products, may be disrupted if such events persist for a prolonged period of time, including due to actions taken by governmental authorities in affected cities and regions, which can adversely affect our business. Our business can be adversely affected if we are unable to grow in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, China, South Africa, Brazil and India. There can be no assurance that our products will be accepted or be successful in any particular developing or emerging market, due to competition, price, cultural differences, consumer preferences, method of distribution or otherwise. Our business in these markets has been and could continue in the future to be impacted by economic, political and social conditions; acts of war, terrorist acts, and civil unrest, including demonstrations and protests; competition; tariffs, sanctions or other regulations restricting contact with certain countries in these markets; foreign ownership restrictions; nationalization of our assets or the assets of our business partners; government-mandated closure, or threatened closure, of our operations or the operations of our business partners; restrictions on the import or export of our products or ingredients or substances used in our products; highly inflationary economies; devaluation or fluctuation or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with laws and regulations. Our business can be adversely affected if we are unable to expand our business in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets. Changes in economic conditions can adversely impact our business. Many of the jurisdictions in which our products are sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns, Table of Contents which have and could continue to result in adverse changes in interest rates, tax laws or tax rates; inflation; volatile commodity markets; labor shortages; highly inflationary economies, devaluation, fluctuation or demonetization of currency; contraction in the availability of credit; austerity or stimulus measures; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are sold; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our business partners, including financial institutions with whom we do business, and any negative impact on any of the foregoing may also have an adverse impact on our business. Future cyber incidents and other disruptions to our information systems can adversely affect our business. We depend on information systems and technology, including public websites and cloud-based services, for many activities important to our business, including communications within our company, interfacing with customers and consumers; ordering and managing inventory; managing and operating our facilities; protecting confidential information, including personal data we collect; maintaining accurate financial records and complying with regulatory, financial reporting, legal and tax requirements. Our business has in the past and could in the future be negatively affected by system shutdowns, degraded systems performance, systems disruptions or security incidents. These disruptions or incidents may be caused by cyberattacks and other cyber incidents, network or power outages, software, equipment or telecommunications failures, the unintentional or malicious actions of employees or contractors, natural disasters, fires or other catastrophic events. Cyberattacks and other cyber incidents are occurring more frequently, the techniques used to gain access to information technology systems and data, disable or degrade service or sabotage systems are constantly evolving and becoming more sophisticated in nature and are being carried out by groups and individuals with a wide range of expertise and motives. Cyberattacks and cyber incidents may be difficult to detect for periods of time and take many forms including cyber extortion, denial of service, social engineering, introduction of viruses or malware (such as ransomware), exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromise. As with other global companies, we are regularly subject to cyberattacks and other cyber incidents, including the types of attacks and incidents described above. If we do not allocate and effectively manage the resources necessary to continue building and maintaining our information technology infrastructure, or if we fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, our business has been and can continue to be adversely affected, which has resulted in and can continue to result in some or all of the following: transaction errors, processing inefficiencies, inability to access our data or systems, lost revenues or other costs resulting from disruptions or shutdowns of offices, plants, warehouses, distribution centers or other facilities, intellectual property or other data loss, litigation, claims, legal or regulatory proceedings, inquiries or investigations, fines or penalties, remediation costs, damage to our reputation or a negative impact on employee morale and the loss of current or potential customers. Similar risks exist with respect to third-party providers, including suppliers, software and cloud-based service providers, that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and the systems managed, hosted, provided and/or used by such third parties and their vendors. For example, malicious actors have employed and could continue to employ the information technology supply chain to introduce malware through software updates or compromised supplier accounts or hardware. The need to coordinate with various third-party service providers, including with respect to timely notification and access to personnel and information concerning an incident, may complicate our efforts to resolve issues that arise. As a result, we are subject to the risk that Table of Contents the activities associated with our third-party service providers can adversely affect our business even if the attack or breach does not directly impact our systems or information. Although the cyber incidents and other systems disruptions that we have experienced to date have not had a material effect on our business, such incidents or disruptions could have a material adverse effect on us in the future. While we devote significant resources to network security, disaster recovery, employee training and other measures to secure our information technology systems and prevent unauthorized access to or loss of data, there are no guarantees that they will be adequate to safeguard against all cyber incidents, systems disruptions, system compromises or misuses of data. In addition, while we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents and information systems failures, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Failure to successfully complete or manage strategic transactions can adversely affect our business. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, distribution agreements, divestitures, refranchisings and other strategic transactions. The success of these transactions, including the recent completion of the Juice Transaction, is dependent upon, among other things, our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; and receipt of necessary consents, clearances and approvals. Risks associated with strategic transactions include integrating manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company or difficulties separating such personnel, activities and systems in connection with divestitures; operating through new business models or in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming controls (including internal control over financial reporting and disclosure controls and procedures) and policies (including with respect to environmental compliance, health and safety compliance and compliance with anti-bribery laws); retaining existing customers and consumers and attracting new customers and consumers; managing tax costs or inefficiencies; maintaining good relations with divested or refranchised businesses in our supply or sales chain; inability to offset loss of revenue associated with divested brands or businesses; managing the impact of business decisions or other actions or omissions of our joint venture partners that may have different interests than we do; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. Strategic transactions that are not successfully completed or managed effectively, or our failure to effectively manage the risks associated with such transactions, have in the past and could continue to result in adverse effects on our business. Our reliance on third-party service providers and enterprise-wide systems can have an adverse effect on our business. We rely on third-party service providers, including cloud data service providers, for certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. Failure by these third parties to meet their contractual, regulatory and other obligations to us, or our failure to adequately monitor their performance, has in the past and could continue to result in our inability to achieve the expected cost savings or efficiencies and result in additional costs to correct errors made by such service providers. Depending on the function involved, such errors can also lead to business disruption, systems performance degradation, processing inefficiencies or other systems disruptions, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation, claims, legal or regulatory proceedings, inquiries or investigations, fines or penalties, remediation costs, Table of Contents damage to our reputation or have a negative impact on employee morale, all of which can adversely affect our business. In addition, we continue on our multi-year phased business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions and have begun to roll out these systems in certain countries and divisions. We have experienced and could continue to experience systems outages and operating inefficiencies following these planned implementations. In addition, if we do not continue to allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, our business could be adversely affected. Climate change or measures to address climate change can negatively affect our business or damage our reputation. Climate change may have a negative effect on agricultural productivity which may result in decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as potatoes, sugar cane, corn, wheat, rice, oats, oranges and other fruits (and fruit-derived oils). In addition, climate change may also increase the frequency or severity of natural disasters and other extreme weather conditions (including rising temperatures and drought), which could pose physical risks to our facilities, impair our production capabilities, disrupt our supply chain or impact demand for our products. Also, there is an increased focus in many jurisdictions in which our products are made, manufactured, distributed or sold regarding environmental policies relating to climate change, regulating greenhouse gas emissions, energy policies and sustainability, including single-use plastics. This increased focus may result in new or increased legal and regulatory requirements, such as potential carbon pricing programs, which could result in significant increased costs and require additional investments in facilities and equipment. As a result, the effects of climate change can negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception of a failure to act responsibly with respect to the environment or to effectively respond to regulatory requirements concerning climate change can lead to adverse publicity, which could adversely affect demand for our products or damage our reputation. Any of the foregoing can adversely affect our business. Strikes or work stoppages can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions have occurred and may occur in the future if we are unable to renew, or enter into new, collective bargaining agreements on satisfactory terms and can impair manufacturing and distribution of our products, lead to a loss of sales, increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy, all of which can adversely affect our business. Financial Risks Failure to realize benefits from our productivity initiatives can adversely affect our financial performance. Our future growth depends, in part, on our ability to continue to reduce costs and improve efficiencies, including our multi-year phased implementation of shared business service organizational models. We continue to identify and implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently. Some of these measures result in unintended consequences, such as business disruptions, distraction of management and employees, reduced morale and productivity, unexpected Table of Contents employee attrition, an inability to attract or retain key personnel and negative publicity. If we are unable to successfully implement our productivity initiatives as planned or do not achieve expected savings as a result of these initiatives, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our financial performance. A deterioration in our estimates and underlying assumptions regarding the future performance of our business can result in an impairment charge that can adversely affect our results of operations. We conduct impairment tests on our goodwill and other indefinite-lived intangible assets annually or more frequently if circumstances indicate that impairment may have occurred. In addition, amortizable intangible assets, property, plant and equipment and other long-lived assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. A deterioration in our underlying assumptions regarding the impact of competitive operating conditions, macroeconomic conditions or other factors used to estimate the future performance of any of our reporting units or assets, including any deterioration in the weighted-average cost of capital based on market data available at the time, can result in an impairment charge, which can adversely affect our results of operations. Fluctuations in exchange rates impact our financial performance. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Given our global operations, we also pay for the ingredients, raw materials and commodities used in our business in numerous currencies. Fluctuations in exchange rates, including as a result of inflation, central bank monetary policies, currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our financial performance. Our borrowing costs and access to capital and credit markets can be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us and their ratings are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the state of the economy and our industry. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. Any downgrade or announcement that we are under review for a potential downgrade of our credit ratings, especially any downgrade to below investment grade, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, result in a reduction in our liquidity, or impair our ability to access the commercial paper market with the same flexibility that we have experienced historically (and therefore require us to rely more heavily on more expensive types of debt financing), all of which can adversely affect our financial performance. Legal, Tax and Regulatory Risks Taxes aimed at our products can adversely affect our business or financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of certain of our products, particularly our beverages, as a result of the ingredients or substances contained in our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain amount of added sugar (or other sweetener), some apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and others apply a flat tax rate on beverages containing any amount of added sugar (or other sweetener). For example, certain provinces in Canada enacted a flat tax on all sugar-sweetened beverages, effective Table of Contents September 1, 2022, at a rate of 0.20 Canadian dollars (0.16 U.S. dollars) per liter . These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain of our products, reduce overall consumption of our products or lead to negative publicity, resulting in an adverse effect on our business and financial performance. Limitations on the marketing or sale of our products can adversely affect our business and financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, limitations on the marketing or sale of our products as a result of ingredients or substances in our products. These limitations require that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. For example, Argentina and Colombia enacted warning labeling requirements in 2021 to indicate whether a particular pre-packaged food or beverage product is considered to be high in sugar, sodium or saturated fat. Certain jurisdictions have imposed or are considering imposing color-coded labeling requirements where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat, in products. The imposition or proposed imposition of additional limitations on the marketing or sale of our products has in the past and could continue to reduce overall consumption of our products, lead to negative publicity or leave consumers with the perception that our products do not meet their health and wellness needs, resulting in an adverse effect on our business and financial performance. Laws and regulations related to the use or disposal of plastics or other packaging materials can adversely affect our business and financial performance. We rely on diverse packaging solutions to safely deliver products to our customers and consumers. Certain of our products are sold in packaging designed to be recyclable or commercially compostable. However, not all packaging is recycled, whether due to lack of infrastructure or otherwise, and certain of our packaging is not currently recyclable. Packaging waste not properly disposed of that displays one or more of our brands has in the past resulted in and could continue to result in negative publicity, litigation or reduced consumer demand for our products, adversely affecting our financial performance. Many jurisdictions in which our products are sold have imposed or are considering imposing regulations or policies intended to encourage the use of sustainable packaging, waste reduction or increased recycling rates or to restrict the sale of products utilizing certain packaging. These regulations vary in form and scope and include extended producer responsibility policies, plastic or packaging taxes, restrictions on certain products and materials, requirements for bottle caps to be tethered to bottles, bans on the use of single-use plastics and requirements to charge deposit fees. For example, the European Union, Peru and certain states in the United States, among other jurisdictions, have imposed a minimum recycled content requirement for beverage bottle packaging and similar legislation is under consideration in other jurisdictions. These laws and regulations have in the past and could continue to increase the cost of our products, impact demand for our products, result in negative publicity and require us and our business partners, including our independent bottlers, to increase capital expenditures to invest in minimizing the amount of plastic or other materials used in our packaging or to develop alternative packaging, all of which can adversely affect our business and financial performance. Failure to comply with personal data protection and privacy laws can adversely affect our business. We are subject to a variety of continuously evolving and developing laws and regulations in numerous jurisdictions regarding personal data protection and privacy laws. These laws and regulations may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with these laws and Table of Contents regulations, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation or residents of the state of California who are covered by the California Consumer Privacy Act (as modified by the California Privacy Rights Act), impose significant costs and challenges that are likely to continue to increase over time, particularly as additional jurisdictions adopt similar regulations. Failure to comply with these laws and regulations or to otherwise protect personal data from unauthorized access, use or other processing, have in the past and could in the future result in litigation, claims, legal or regulatory proceedings, inquiries or investigations, damage to our reputation, fines or penalties, all of which can adversely affect our business. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our financial performance. Increases in income tax rates or other changes in tax laws, including changes in how existing tax laws are interpreted or enforced, can adversely affect our financial performance. For example, economic and political conditions in countries where we are subject to taxes, including the United States, have in the past and could continue to result in significant changes in tax legislation or regulation, including those proposed and under consideration by the United States Congress and the Organization for Economic Co-operation and Development. For example, numerous countries have recently agreed to a statement in support of a global minimum tax rate of 15% as well as global profit reallocation. There can be no assurance that these changes will be adopted by individual countries, or that once adopted by individual countries, that they will not have adverse effects on our financial performance. This increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our financial performance. We are also subject to regular reviews, examinations and audits by numerous taxing authorities with respect to income and non-income based taxes. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, has made and could continue to make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. If we are unable to adequately protect our intellectual property rights, or if we are found to infringe on the intellectual property rights of others, our business can be adversely affected. We possess intellectual property rights that are important to our business, including ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets. The laws of various jurisdictions in which we operate have differing levels of protection of intellectual property. Our competitive position and the value of our products and brands can be reduced and our business adversely affected if we fail to obtain or adequately protect our intellectual property, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections afforded our intellectual property. Also, in the course of developing new products or improving the quality of existing products, we have in the past infringed or been alleged to have infringed, and could in the future infringe or be alleged to infringe, on the intellectual property rights of others. Such infringement or allegations of infringement could result in expensive litigation and damages, damage to our reputation, disruption to our operations, injunctions against development, manufacturing, use and/or sale of certain products, inventory write-offs or other limitations on our ability to introduce new products or improve the quality of existing products, resulting in an adverse effect on our business. Failure to comply with laws and regulations applicable to our business can adversely affect our business. The conduct of our business is subject to numerous laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content (including whether a product Table of Contents contains genetically engineered ingredients), quality, safety, transportation, traceability, sourcing (including pesticide use), packaging, disposal, recycling and use of our products or raw materials, employment and occupational health and safety, environmental, social and governance matters (including climate change) and data privacy and protection. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position, as is compliance with anti-corruption laws. The imposition of new laws, changes in laws or regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products or raw materials are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business. For example, increasing governmental and societal attention to environmental, social and governance matters has resulted and could continue to result in new laws or regulatory requirements. In addition, the entry into new markets or categories, including our planned entry into the alcoholic beverage industry as a distributor in the United States and expansion into the nuts and meat convenient foods categories globally, has resulted in and could continue to result in our business being subject to additional regulations resulting in higher compliance costs. If one jurisdiction imposes or proposes to impose new laws or regulations that impact the manufacture, distribution or sale of our products, other jurisdictions may follow. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, all of which can adversely affect our business. In addition, the results of third-party studies (whether or not scientifically valid) purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials have resulted in and could continue to result in our being subject to new taxes and regulations or lawsuits that can adversely affect our business. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients, personal injury and property damage, intellectual property rights, privacy, employment, tax and insurance matters, environmental, social and governance matters and matters relating to our compliance with applicable laws and regulations. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. Responding to these matters, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image. Any of the foregoing can adversely affect our business. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2021 year and that remain unresolved. Table of Contents ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: Property Type Location Owned/ Leased FLNA Research and development facility Plano, Texas Owned QFNA Convenient food plant Cedar Rapids, Iowa Owned PBNA Research and development facility Valhalla, New York Owned PBNA Concentrate plant Arlington, Texas Owned PBNA Tropicana plant (a) Bradenton, Florida Owned LatAm Convenient food plant Celaya, Mexico Owned LatAm Two convenient food plants Vallejo, Mexico Owned Europe Convenient food plant Kashira, Russia Owned Europe Manufacturing plant Lehavim, Israel Owned Europe Dairy plant Moscow, Russia Owned (b) AMESA Convenient food plant Riyadh, Saudi Arabia Owned (b) APAC Convenient food plant Wuhan, China Owned (b) FLNA, QFNA, PBNA Shared service center Winston Salem, North Carolina Leased PBNA, LatAm Concentrate plant Colonia, Uruguay Owned (b) PBNA, Europe, AMESA Two concentrate plants Cork, Ireland Owned PBNA, AMESA, APAC Concentrate plant Singapore Owned (b) All divisions Shared service center Hyderabad, India Leased (a) As of December 25, 2021, this property was reclassified as held for sale on the consolidated balance sheet in connection with our Juice Transaction. See Note 13 to our consolidated financial statements for further information. (b) The land on which these properties are located is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. Table of Contents "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP. Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 3, 2022, there were approximately 101,778 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 2, 2022, the Board of Directors declared a quarterly dividend of $1.075 per share payable March 31, 2022, to shareholders of record on March 4, 2022. For the remainder of 2022, the record dates for these dividend payments are expected to be June 3, September 2 and December 2, 2022, subject to approval of the Board of Directors. On February 10, 2022, we announced a 7% increase in our annualized dividend to $4.60 per share from $4.30 per share, effective with the dividend expected to be paid in June 2022. Additionally, on February 10, 2022, we announced a share repurchase program providing for the repurchase of up to $10.0 billion of PepsiCo common stock commencing on February 11, 2022 and expiring on February 28, 2026 (2022 share repurchase program). Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. We expect to return a total of approximately $7.7 billion to shareholders in 2022, comprising dividends of approximately $6.2 billion and share repurchases of approximately $1.5 billion. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. Table of Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview 30 Our Operations 31 Other Relationships 31 Our Business Risks 31 OUR FINANCIAL RESULTS Results of Operations Consolidated Review 36 Results of Operations Division Review 38 FLNA 40 QFNA 40 PBNA 40 LatAm 41 Europe 41 AMESA 42 APAC 42 Results of Operations Other Consolidated Results 43 Non-GAAP Measures 43 Items Affecting Comparability 46 Our Liquidity and Capital Resources 49 Return on Invested Capital 52 OUR CRITICAL ACCOUNTING POLICIES AND ESTIMATES Revenue Recognition 53 Goodwill and Other Intangible Assets 54 Income Tax Expense and Accruals 55 Pension and Retiree Medical Plans 56 CONSOLIDATED STATEMENT OF INCOME 59 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME 60 CONSOLIDATED STATEMENT OF CASH FLOWS 61 CONSOLIDATED BALANCE SHEET 63 CONSOLIDATED STATEMENT OF EQUITY 64 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note 1 Basis of Presentation and Our Divisions 65 Note 2 Our Significant Accounting Policies 70 Note 3 Restructuring and Impairment Charges 73 Note 4 Intangible Assets 75 Note 5 Income Taxes 78 Note 6 Share-Based Compensation 81 Note 7 Pension, Retiree Medical and Savings Plans 85 Note 8 Debt Obligations 92 Note 9 Financial Instruments 94 Note 10 Net Income Attributable to PepsiCo per Common Share 99 Note 11 Accumulated Other Comprehensive Loss Attributable to PepsiCo 100 Note 12 Leases 101 Note 13 Acquisitions and Divestitures 103 Note 14 Supplemental Financial Information 106 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 108 GLOSSARY 112 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. Discussion in this Form 10-K includes results of operations and financial condition for 2021 and 2020 and year-over-year comparisons between 2021 and 2020. For discussion on results of operations and financial condition pertaining to 2019 and year-over-year comparisons between 2020 and 2019, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 26, 2020. OUR BUSINESS Executive Overview PepsiCo is a leading global beverage and convenient food company with a complementary portfolio of brands, including Lays, Doritos, Cheetos, Gatorade, Pepsi-Cola, Mountain Dew, Quaker and SodaStream. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories. As a global company with deep local ties, we faced many of the same challenges in 2021 as our consumers, customers, and competitors across the world, including the second year of the COVID-19 pandemic; a worsening climate crisis; supply chain disruptions; inflationary pressures; shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To meet the challenges of today and those of tomorrow we are driven by an approach called PepsiCo Positive (pep+). pep+ is a strategic end-to-end transformation of our business, with sustainability at the center of how the company will strive to create growth and value by operating within planetary boundaries and inspiring positive change for the planet and people. pep+ will guide how we will work to transform our business operations, from sourcing ingredients and making and selling products in a more sustainable way, to leveraging our more than one billion connections with consumers each day to take sustainability mainstream and engage people to make choices that are better for themselves and the planet. pep+ drives action and progress across three key pillars, bringing together a number of industry-leading 2030 sustainability goals under a comprehensive framework: Positive Agriculture : We are working to spread regenerative practices to restore the Earth across land equal to the company's entire agricultural footprint (approximately 7 million acres), sustainably source key crops and ingredients, and improve the livelihoods of more people in our agricultural supply chain. Positive Value Chain : We are working to build a circular and inclusive value chain through actions to: achieve net-zero emissions by 2040; become net water positive by 2030; and introduce more sustainable packaging into the value chain. Our packaging goals include cutting virgin plastic per serving, using recycled content in our plastic packaging, and scaling our SodaStream business globally, an innovative platform that almost entirely eliminates the need for beverage packaging, among other levers. Additionally, we are making progress on our diversity, equity and inclusion journey. And we have introduced a new global workforce volunteering program, One Smile at a Table of Contents Time, to encourage, support and empower each one of our approximately 309,000 employees to make positive impacts in their local communities. Positive Choices : We continue working to evolve our portfolio of beverage and convenient food products so that they are better for the planet and people, including by incorporating more diverse ingredients in both new and existing food products that are better for the planet and/or deliver nutritional benefits, prioritizing chickpeas, plant-based proteins and whole grains; expanding our position in the nuts seeds category, where PepsiCo is already the global branded leader, including leadership positions in Mexico, China and several Western European markets; and accelerating our reduction of added sugars and sodium through the use of science-based targets across our portfolio and cooking our food offerings with healthier oils. We are also continuing to scale new business models that require little or no single-use packaging, including SodaStream an icon of a Positive Choice and the largest sparkling water brand in the world by volume. SodaStream, already sold in more than 40 countries, and its new SodaStream Professional platform is expected to expand into functional beverages and reach additional markets by the end of 2022, part of the brand's effort to help consumers avoid plastic bottles. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers, competition and human capital. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks COVID-19 Our global operations continue to expose us to risks associated with the COVID-19 pandemic, which continues to result in challenging operating environments and has affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold. Numerous measures have been implemented around the world to try to reduce the spread of the virus, including travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns and closures. These measures have impacted and will continue to impact us, our customers (including foodservice customers), consumers, employees, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with whom we do business, which may continue to result in changes in demand for our products, increases in operating costs (whether as a result of changes to our supply chain or increases in employee costs, including expanded benefits and frontline incentives, costs associated with the provision of personal protective equipment and increased sanitation, or otherwise), or adverse impacts to our supply chain through labor shortages, raw Table of Contents material shortages or reduced availability of air or other commercial transport, port closures or border restrictions, any of which can impact our ability to make, manufacture, distribute and sell our products. In addition, measures that impact our ability to access our offices, plants, warehouses, distribution centers or other facilities, or that impact the ability of our business partners to do the same or the inability of a significant portion of our or our business partners workforce to work because of illness, absenteeism, quarantine, vaccine mandates, or travel or other governmental restrictions, may continue to impact the availability or productivity of our and their employees, many of whom are not able to perform their job functions remotely. Public concern regarding the risk of contracting COVID-19 has impacted and may continue to impact demand from consumers, including due to consumers not leaving their homes or leaving their homes less often than they did prior to the start of the pandemic or otherwise shopping for and consuming food and beverage products in a different manner than they historically have or because some of our consumers have lower discretionary income due to unemployment or reduced or limited work as a result of measures taken in response to the pandemic. Even as governmental restrictions are relaxed and economies gradually, partially, or fully reopen in certain of these jurisdictions and markets, the ongoing economic impacts and health concerns associated with the pandemic may continue to affect consumer behavior, spending levels and shopping and consumption preferences. Changes in consumer purchasing and consumption patterns may increase demand for our products in one quarter, resulting in decreased demand for our products in subsequent quarters, or in a lower-margin sales channel resulting in potentially reduced profit from sales of our products. We continue to see shifts in product and channel preferences as markets move through varying stages of restrictions and re-opening at different times, including changes in at-home consumption, in immediate consumption and away-from-home channels, such as convenience and gas and foodservice. In addition, we continue to see an increase in demand in the e-commerce and online-to-offline channels and any failure to capitalize on this demand could adversely affect our ability to maintain and grow sales or category share and erode our competitive position. Any reduced demand for our products or change in consumer purchasing and consumption patterns, as well as continued economic uncertainty (including supply chain disruptions and labor shortages), can adversely affect our customers and business partners financial condition, which can result in bankruptcy filings and/or an inability to pay for our products, reduced or canceled orders of our products, continued or additional closing of restaurants, stores, entertainment or sports complexes, schools or other venues in which our products are sold, or reduced capacity at any of the foregoing, or our business partners inability to supply us with ingredients or other items necessary for us to make, manufacture, distribute or sell our products. Such adverse changes in our customers or business partners financial condition have also resulted and may continue to result in our recording additional charges for our inability to recover or collect any accounts receivable, owned or leased assets, including certain foodservice and vending and other equipment, or prepaid expenses. In addition, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. While we have developed and implemented and continue to develop and implement health and safety protocols, business continuity plans and crisis management protocols in an effort to mitigate the negative impact of COVID-19 to our employees and our business, the extent of the impact of the pandemic on our business and financial results will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the emergence and spread of new variants of the virus, including the omicron and delta variants, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus and evolving strains or variants of the virus, global economic conditions during and after the pandemic, governmental actions that have been Table of Contents taken, or may be taken in the future, in response to the pandemic and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Risks Associated with Commodities and Our Supply Chain Many of the commodities used in the production and transportation of our products are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. During 2021, we experienced higher than anticipated transportation and commodity costs, which we expect to continue in 2022. A number of external factors, including the COVID-19 pandemic, adverse weather conditions, supply chain disruptions (including raw material shortages) and labor shortages, have impacted and may continue to impact transportation and commodity availability and costs. When prices increase, we may or may not pass on such increases to our customers without suffering reduced volume, revenue, margins and operating results. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Risks Associated with Climate Change Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased legal and regulatory requirements to reduce or mitigate the potential effects of climate change, including regulation of greenhouse gas emissions and potential carbon pricing programs. These new or increased legal or regulatory requirements could result in significant increased costs of compliance and additional investments in facilities and equipment. However, we are unable to predict the scope, nature and timing of any new or increased environmental laws and regulations and therefore cannot predict the ultimate impact of such laws and regulations on our business or financial results. We continue to monitor existing and proposed laws and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such laws or regulations. Risks Associated with International Operations We are subject to risks in the normal course of business that are inherent to international operations. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold, including in certain developing and emerging markets, operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. Imposition of Taxes and Regulations on our Products Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, COVID-19 has resulted in increased regulatory focus on labeling in certain jurisdictions, including in Mexico which enacted product labeling requirements and limitations on the marketing of certain of our products as a result of ingredients or substances contained in such products. Further, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, Table of Contents encourage waste reduction and increased recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages and convenient foods in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used vary by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. Retail Landscape Our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We have seen and expect to continue to see a further shift to e-commerce, online-to-offline and other online purchasing by consumers, including as a result of the COVID-19 pandemic. We continue to monitor changes in the retail landscape and seek to identify actions we may take to build our global e-commerce and digital capabilities, such as expanding our direct-to-consumer business, and distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to food safety and cybersecurity. During 2021, in addition to COVID-19 discussions as part of risk updates to the Board and the relevant Committees, the Board was provided with updates on COVID-19s impact to our business, financial condition and operations through memos, teleconferences or other appropriate means of communication. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; Table of Contents The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Sustainability, Diversity and Public Policy Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability (including climate change), diversity, equity and inclusion, and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board of Directors and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key market risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies and Estimates for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Table of Contents Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.6 billion as of December 25, 2021 and $1.1 billion as of December 26, 2020. At the end of 2021, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2021 by $177 million, which would generally be offset by a reduction in the cost of the underlying commodity purchases. Foreign Exchange Our operations outside of the United States generated 44% of our consolidated net revenue in 2021, with Mexico, Russia, Canada, China, the United Kingdom and South Africa, collectively, comprising approximately 23% of our consolidated net revenue in 2021. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business. During 2021, favorable foreign exchange contributed 1 percentage point to net revenue growth, primarily due to appreciation in the Mexican peso, Canadian dollar and South African rand. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. Our foreign currency derivatives had a total notional value of $2.8 billion as of December 25, 2021 and $1.9 billion as of December 26, 2020. At the end of 2021, we estimate that an unfavorable 10% change in the underlying exchange rates would have decreased our net unrealized gains in 2021 by $278 million, which would be significantly offset by an inverse change in the fair value of the underlying exposure. The total notional amount of our debt instruments designated as net investment hedges was $2.1 billion as of December 25, 2021 and $2.7 billion as of December 26, 2020. Interest Rates Our interest rate derivatives had a total notional value of $2.1 billion as of December 25, 2021 and $3.0 billion as of December 26, 2020. Assuming year-end 2021 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2021 by $47 million due to higher cash and cash equivalents and short-term investments levels, as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Physical or unit volume is one of the key metrics management uses internally to make operating and strategic decisions, including the preparation of our annual operating plan and the evaluation of our business performance. We believe volume provides additional information to facilitate the comparison of our historical operating performance and underlying trends, and provides additional transparency on how we evaluate our business because it measures demand for our products at the consumer level. Table of Contents Beverage volume includes volume of concentrate sold to independent bottlers and volume of finished products bearing company-owned or licensed trademarks and allied brand products and joint venture trademarks sold by company-owned bottling operations. Beverage volume also includes volume of finished products bearing company-owned or licensed trademarks sold by our noncontrolled affiliates. Concentrate volume sold to independent bottlers is reported in concentrate shipments and equivalents (CSE), whereas finished beverage product volume is reported in bottler case sales (BCS). Both CSE and BCS convert all beverage volume to an 8-ounce-case metric. Typically, CSE and BCS are not equal in any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our net revenue is not entirely based on BCS volume due to the independent bottlers in our supply chain, we believe that BCS is a better measure of the consumption of our beverage products. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Convenient food volume includes volume sold by our subsidiaries and noncontrolled affiliates of convenient food products bearing company-owned or licensed trademarks. Internationally, we measure convenient food product volume in kilograms, while in North America we measure convenient food product volume in pounds. FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Consolidated Net Revenue and Operating Profit 2021 2020 Change Net revenue $ 79,474 $ 70,372 13 % Operating profit $ 11,162 $ 10,080 11 % Operating margin 14.0 % 14.3 % (0.3) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. Operating profit grew 11% and operating margin declined 0.3 percentage points. Operating profit growth was primarily driven by net revenue growth and productivity savings, partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs, and higher advertising and marketing expenses. The operating margin decline primarily reflects higher commodity costs. Lower charges taken as a result of the COVID-19 pandemic compared to the prior year contributed 6 percentage points to operating profit growth. Additionally, lower acquisition and divestiture-related charges included in Items Affecting Comparability contributed 3 percentage points to operating profit growth. Juice Transaction In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. These juice businesses delivered approximately $3 billion in net revenue in 2021. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. Table of Contents Results of Operations Division Review See Our Business Risks, Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect mergers and acquisitions activity, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on this measure, see Non-GAAP Measures. 2021 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Organic volume (b) Effective net pricing FLNA 8 % (0.5) 7 % 2 5 QFNA % (1) % (7) 7 PBNA 12 % (0.5) (1) 10 % 5 5 LatAm 17 % (2) 15 % 4 10 Europe 9 % (0.5) 9 % 4.5 4 AMESA 33 % (4.5) (17) 12 % 7 4 APAC 34 % (6) (15) 13 % 12 1 Total 13 % (1) (2) 10 % 4 5 (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures, including the impact of an extra month of volume for our acquisitions of Pioneer Food Group Ltd. (Pioneer Foods) in our AMESA division and Hangzhou Haomusi Food Co., Ltd. (Be Cheery) in our APAC division as we aligned the reporting calendars of these acquisitions with those of our divisions. In certain instances, the impact of organic volume growth on net revenue growth differs from the unit volume growth disclosed in the following divisional discussions due to the impacts of acquisitions and divestitures, product mix, nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Table of Contents Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability 2021 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges (c) Core, Non-GAAP Measure (b) FLNA $ 5,633 $ $ 28 $ 2 $ 5,663 QFNA 578 578 PBNA 2,442 20 11 2,473 LatAm 1,369 37 1,406 Europe 1,292 81 8 1,381 AMESA 858 15 10 883 APAC 673 7 4 684 Corporate unallocated expenses (1,683) 19 49 (39) (1,654) Total $ 11,162 $ 19 $ 237 $ (4) $ 11,414 2020 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges (c) Core, Non-GAAP Measure (b) FLNA $ 5,340 $ $ 83 $ 29 $ 5,452 QFNA 669 5 674 PBNA 1,937 47 66 2,050 LatAm 1,033 31 1,064 Europe 1,353 48 1,401 AMESA 600 14 173 787 APAC 590 5 7 602 Corporate unallocated expenses (1,442) (73) 36 (20) (1,499) Total $ 10,080 $ (73) $ 269 $ 255 $ 10,531 (a) See Items Affecting Comparability. (b) Includes the charges taken as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. (c) The income amounts primarily relate to gains associated with the contingent consideration in connection with our acquisition of Rockstar Energy Beverages (Rockstar). In 2021, this impact is partially offset by divestiture-related charges associated with the Juice Transaction. See Note 13 to our consolidated financial statements for further information. Table of Contents Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis 2021 Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 5.5 % (1) (0.5) 4 % 3 % QFNA (14) % (0.5) (14) % (14) % PBNA 26 % (2) (4) 21 % (1) 20 % LatAm 33 % 32 % (4.5) 28 % Europe (4.5) % 2.5 1 (1.5) % (1.5) (3) % AMESA 43 % (31) 12 % (2) 10 % APAC 14 % 1 (1.5) 14 % (3) 10 % Corporate unallocated expenses 17 % (7) (1) 1 10 % 10 % Total 11 % 1 (3) 8 % (1) 7 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 8%, primarily driven by effective net pricing and organic volume growth. Unit volume grew 2%, primarily reflecting double-digit growth in variety packs and the impact of our BFY Brands, Inc. (BFY Brands) acquisition in the first quarter of 2020, partially offset by a low-single-digit decline in trademark Tostitos and a double-digit decline in trademark Santitas. Operating profit increased 5.5%, primarily reflecting the net revenue growth, productivity savings and a 3-percentage-point impact of lower charges taken as a result of the COVID-19 pandemic. These impacts were partially offset by certain operating cost increases, including strategic initiatives and incremental transportation costs, and a 4-percentage-point impact of higher commodity costs, primarily packaging material and cooking oil. QFNA Net revenue grew slightly and unit volume declined 7%. The net revenue growth reflects effective net pricing and a 1-percentage-point impact of favorable foreign exchange, largely offset by a decrease in organic volume. The unit volume decline was primarily driven by double-digit declines in pancake syrups and mixes and in ready-to-eat cereals and a high-single-digit decline in oatmeal, partially offset by growth in Cheetos macaroni and cheese, which was introduced in the third quarter of 2020, and double-digit growth in lite snacks. Operating profit declined 14%, primarily reflecting certain operating cost increases, including incremental transportation costs, and an 8-percentage-point impact of higher commodity costs, partially offset by productivity savings. The impact of the COVID-19 pandemic contributed to a current-year decrease in consumer demand, which had a negative impact on net revenue, unit volume and operating profit performance compared to the significant COVID-19 related surge in consumer demand in the prior year. PBNA Net revenue increased 12%, primarily driven by effective net pricing and an increase in organic volume. Unit volume increased 6%, driven by a 7% increase in non-carbonated beverage (NCB) volume and a 4% increase in CSD volume. The NCB volume increase primarily reflected double-digit increases in our Table of Contents overall water portfolio and our energy portfolio, a low-single-digit increase in Gatorade sports drinks and a mid-single-digit increase in Lipton ready-to-drink teas. Operating profit increased 26%, primarily reflecting the net revenue growth, a 15-percentage-point impact of lower charges taken as a result of the COVID-19 pandemic and productivity savings. These impacts were partially offset by certain operating cost increases, including incremental transportation costs, an 18-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Higher prior-year acquisition and divestiture-related charges contributed 4 percentage points to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. In 2020, we received a notice of termination without cause from Vital Pharmaceuticals, Inc., which would end our distribution rights of Bang Energy drinks, effective October 24, 2023. LatAm Net revenue increased 17%, primarily reflecting effective net pricing and organic volume growth. Convenient foods unit volume grew 3.5%, primarily reflecting low-single-digit growth in Brazil and Mexico. Beverage unit volume grew 8%, primarily reflecting double-digit growth in Argentina and Chile. Additionally, Brazil experienced low-single-digit growth, Mexico experienced mid-single-digit growth and Guatemala experienced high-single-digit growth. Operating profit increased 33%, primarily reflecting the net revenue growth, productivity savings and a 4.5-percentage-point impact of favorable foreign exchange. These impacts were partially offset by certain operating cost increases, a 30-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. A current-year recognition of certain indirect tax credits in Brazil and lower charges taken as a result of the COVID-19 pandemic contributed 6 percentage points and 4 percentage points, respectively, to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. Europe Net revenue increased 9%, primarily reflecting organic volume growth and effective net pricing. Convenient foods unit volume grew 4%, primarily reflecting double-digit growth in Turkey and mid-single-digit growth in Russia and Poland, partially offset by a mid-single-digit decline in the United Kingdom. Additionally, the Netherlands grew slightly and France experienced low-single-digit growth. Beverage unit volume grew 8%, primarily reflecting double-digit growth in Russia, Turkey and the United Kingdom and high-single-digit growth in France, partially offset by a low-single-digit decline in Germany. Operating profit decreased 4.5%, primarily reflecting certain operating cost increases, a 28-percentage-point impact of higher commodity costs and a 2.5-percentage-point impact each from higher restructuring and impairment charges and a gain on an asset sale in the prior year. These impacts were partially offset by the net revenue growth and productivity savings. Additionally, lower charges taken as a result of the COVID-19 pandemic and favorable settlements of promotional spending accruals compared to the prior Table of Contents year positively contributed 5 percentage points and 3 percentage points, respectively, to operating profit performance. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue and unit volume performance. During the fourth quarter of 2021, the implementation of an Enterprise Resource Planning (ERP) system in the United Kingdom caused a temporary disruption to our United Kingdom operations which had a negative impact on net revenue, unit volume and operating profit performance. These issues were largely resolved within the quarter and the business operations had resumed by year end. AMESA Net revenue increased 33%, reflecting a 14-percentage-point impact of our Pioneer Foods acquisition, which included the impact of an extra month of net revenue compared to the prior year as we aligned Pioneer Foods reporting calendar with that of our AMESA division, as well as organic volume growth and effective net pricing. Favorable foreign exchange contributed 4.5 percentage points to net revenue growth. Convenient foods unit volume grew 38%, primarily reflecting a 35-percentage-point impact of our Pioneer Foods acquisition, which included the impact of an extra month of unit volume as we aligned Pioneer Foods reporting calendar with that of our AMESA division, double-digit growth in India and Pakistan and high-single-digit growth in the Middle East, partially offset by a low-single-digit decline in South Africa (excluding our Pioneer Foods acquisition). Beverage unit volume grew 20%, primarily reflecting double-digit growth in India and Pakistan. Additionally, the Middle East experienced double-digit growth and Nigeria experienced high-single-digit growth. Operating profit increased 43%, primarily reflecting the net revenue growth, a 31-percentage-point impact of the prior-year acquisition and divestiture-related charges associated with our Pioneer Foods acquisition and productivity savings. These impacts were partially offset by certain operating cost increases, a 13-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Additionally, lower charges taken as a result of the COVID-19 pandemic and our Pioneer Foods acquisition contributed 3 percentage points and 2 percentage points, respectively, to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. APAC Net revenue increased 34%, reflecting a 15-percentage-point impact of our Be Cheery acquisition, which included the impact of an extra month of net revenue compared to the prior year as we aligned Be Cheerys reporting calendar with that of our APAC division, as well as organic volume growth, a 6- percentage-point impact of favorable foreign exchange and effective net pricing. Convenient foods unit volume grew 19%, primarily reflecting a 16-percentage-point impact of our Be Cheery acquisition, which included the impact of an extra month of unit volume as we aligned Be Cheerys reporting calendar with that of our APAC division, and double-digit growth in China (excluding our Be Cheery acquisition) and Thailand. Additionally, Australia, Indonesia and Taiwan each experienced low-single-digit growth. Table of Contents Beverage unit volume grew 13%, primarily reflecting double-digit growth in China, partially offset by a low-single-digit decline in Vietnam. Additionally, the Philippines experienced low-single-digit growth and Thailand experienced mid-single-digit growth. Operating profit increased 14%, primarily reflecting the net revenue growth, productivity savings and a 2- percentage-point contribution from our Be Cheery acquisition, partially offset by certain operating cost increases and higher advertising and marketing expenses. Additionally, impairment charges associated with an equity method investment reduced operating profit growth by 3 percentage points. Favorable foreign exchange contributed 3 percentage points to operating profit growth. Other Consolidated Results 2021 2020 Change Other pension and retiree medical benefits income $ 522 $ 117 $ 405 Net interest expense and other $ (1,863) $ (1,128) $ (735) Annual tax rate 21.8 % 20.9 % Net income attributable to PepsiCo (a) $ 7,618 $ 7,120 7 % Net income attributable to PepsiCo per common share diluted (a) $ 5.49 $ 5.12 7 % (a) In 2021, lower charges taken as a result of the COVID-19 pandemic contributed 7 percentage points to both net income attributable to PepsiCo growth and net income attributable to PepsiCo per common share growth. See Note 1 to our consolidated financial statements for further information. Other pension and retiree medical benefits income increased $405 million, primarily reflecting lower settlement charges in 2021, the recognition of fixed income gains on plan assets, the impact of plan changes approved in 2020, as discussed in Note 7 to our consolidated financial statements, and the impact of discretionary plan contributions, partially offset by a decrease in the expected rate of return on plan assets. Net interest expense and other increased $735 million, reflecting a charge of $842 million in connection with our cash tender offers. See Note 8 to our consolidated financial statements for further information. This impact was partially offset by lower interest rates on average debt balances. The reported tax rate increased 0.9 percentage points, primarily reflecting the net tax impact of adjustments to uncertain tax positions related to the final assessment from the Internal Revenue Service (IRS) audit for the tax years 2014 through 2016. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; costs associated with mergers, acquisitions, divestitures and other structural changes; gains associated with divestitures; pension and retiree medical-related amounts (including all settlement and curtailment gains and losses); charges or Table of Contents adjustments related to the enactment of new laws, rules or regulations, such as tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. Previously, certain immaterial pension and retiree medical-related settlement and curtailment gains and losses were not considered items affecting comparability. Pension and retiree medical-related service cost, interest cost, expected return on plan assets, and other net periodic pension costs will continue to be reflected in our core results. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures contained in this Form 10-K are discussed below: Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income, net interest expense and other, provision for income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 Multi-Year Productivity Plan (2019 Productivity Plan), costs associated with our acquisitions and divestitures, the impact of settlement and curtailment gains and losses related to pension and retiree medical plans, a charge related to cash tender offers and tax expense related to the Tax Cuts and Jobs Act (TCJ Act) (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance or that we believe impact comparability with the prior year. Organic revenue growth We define organic revenue growth as a measure that adjusts for the impacts of foreign exchange translation, acquisitions and divestitures, and where applicable, the impact of an additional week of results every five or six years (53 rd reporting week), including in our 2022 financial results. Adjusting for acquisitions and divestitures reflects mergers and acquisitions activity, including the impact in 2021 of an extra month of net revenue for our acquisitions of Pioneer Foods in our AMESA division and Be Cheery in our APAC division as we aligned the reporting calendars of these acquisitions with those of our divisions, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Table of Contents Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Table of Contents Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: 2021 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Net interest expense and other Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 37,075 $ 42,399 $ 31,237 $ 11,162 $ 522 $ (1,863) $ 2,142 $ 61 $ 7,618 Items Affecting Comparability Mark-to-market net impact (39) 39 20 19 5 14 Restructuring and impairment charges (29) 29 (208) 237 10 41 1 205 Acquisition and divestiture-related charges (1) 1 5 (4) 23 (27) Pension and retiree medical-related impact 12 1 11 Charge related to cash tender offers 842 165 677 Tax expense related to the TCJ Act (190) 190 Core, Non-GAAP Measure $ 37,006 $ 42,468 $ 31,054 $ 11,414 $ 544 $ (1,021) $ 2,187 $ 62 $ 8,688 2020 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 31,797 $ 38,575 $ 28,495 $ 10,080 $ 117 $ 1,894 $ 7,120 Items Affecting Comparability Mark-to-market net impact 64 (64) 9 (73) (15) (58) Restructuring and impairment charges (30) 30 (239) 269 20 58 231 Acquisition and divestiture-related charges (32) 32 (223) 255 18 237 Pension and retiree medical-related impact 205 47 158 Core, Non-GAAP Measure $ 31,799 $ 38,573 $ 28,042 $ 10,531 $ 342 $ 2,002 $ 7,688 (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. 2021 2020 Change Net income attributable to PepsiCo per common share diluted, GAAP measure $ 5.49 $ 5.12 7 % Mark-to-market net impact 0.01 (0.04) Restructuring and impairment charges 0.15 0.17 Acquisition and divestiture-related charges (0.02) 0.17 Pension and retiree medical-related impact 0.01 0.11 Charge related to cash tender offers 0.49 Tax expense related to the TCJ Act 0.14 Core net income attributable to PepsiCo per common share diluted, non-GAAP measure $ 6.26 (a) $ 5.52 (a) 13 % Impact of foreign exchange translation (1.5) Growth in core net income attributable to PepsiCo per common share diluted, on a constant currency basis, non-GAAP measure 12 % (a) (a) Does not sum due to rounding. Table of Contents Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. To build on the successful implementation of the 2019 Productivity Plan to date, we expanded and extended the program through the end of 2026 to take advantage of additional opportunities within the initiatives of the 2019 Productivity Plan. We now expect to incur pre-tax charges of approximately $3.15 billion, including cash expenditures of approximately $2.4 billion, as compared to our previous estimate of pre-tax charges of approximately $2.5 billion, which included cash expenditures of approximately $1.6 billion. Plan to date through December 25, 2021, we have incurred pre-tax charges of $1.0 billion, including cash expenditures of $776 million. In our 2022 financial results, we expect to incur pre-tax charges of approximately $350 million, including cash expenditures of approximately $300 million. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2022 and 2023 financial results, with the balance to be incurred through 2026. See Note 3 to our consolidated financial statements for further information related to our 2019 Productivity Plan. We regularly evaluate productivity initiatives beyond the productivity plan and other initiatives discussed above and in Note 3 to our consolidated financial statements. Acquisition and Divestiture-Related Charges Acquisition and divestiture-related charges primarily include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets, merger and integration charges and costs associated with divestitures. Merger and integration charges include liabilities to support socioeconomic programs in South Africa, closing costs, employee-related costs, gains associated with contingent consideration, contract termination costs and other integration costs. See Note 13 to our consolidated financial statements for further information. Pension and Retiree Medical-Related Impact Pension and retiree medical-related impact primarily includes settlement charges related to lump sum distributions exceeding the total of annual service and interest costs, as well as curtailment gains related to plan changes. See Note 7 to our consolidated financial statements for further information. Table of Contents Charge Related to Cash Tender Offers As a result of the cash tender offers for some of our long-term debt, we recorded a charge primarily representing the tender price paid over the carrying value of the tendered notes and loss on treasury rate locks used to mitigate the interest rate risk on the cash tender offers. See Note 8 to our consolidated financial statements for further information. Tax Expense Related to the TCJ Act Tax expense related to the TCJ Act reflects adjustments to the mandatory transition tax liability under the TCJ Act. See Note 5 to our consolidated financial statements for further information. Table of Contents Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs, including with respect to our net capital spending plans. Our primary sources of liquidity include cash from operations, pre-tax cash proceeds of approximately $3.5 billion from the Juice Transaction, proceeds obtained from issuances of commercial paper and long-term debt, and cash and cash equivalents. These sources of cash are available to fund cash outflows that have both a short- and long-term component, including debt repayments and related interest payments; payments for acquisitions, including support for socioeconomic programs in South Africa related to our acquisition of Pioneer Foods; operating leases; purchase, marketing, and other contractual commitments, including capital expenditures and the transition tax liability under the TCJ Act. In addition, these sources of cash fund other cash outflows including anticipated dividend payments and share repurchases. We do not have guarantees or off-balance sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our liquidity. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Our sources and uses of cash were not materially adversely impacted by COVID-19 and, to date, we have not identified any material liquidity deficiencies as a result of the COVID-19 pandemic. Based on the information currently available to us, we do not expect the impact of the COVID-19 pandemic to have a material impact on our future liquidity. We will continue to monitor and assess the impact the COVID-19 pandemic may have on our business and financial results. See Item 1A. Risk Factors, Our Business Risks and Note 1 to our consolidated financial statements for further information related to the impact of the COVID-19 pandemic on our business and financial results. As of December 25, 2021, cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a one-time mandatory transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 25, 2021, our mandatory transition tax liability was $2.9 billion, which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $309 million of this liability in 2022. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. As part of our evolving market practices, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with a majority of our suppliers generally range from 60 to 90 days, which we deem to be commercially reasonable. We will continue to monitor economic conditions and market practice working with our suppliers to adjust as necessary. We also maintain voluntary supply chain finance agreements with several participating global financial institutions. Under these agreements, our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to these participating global financial institutions. Supplier participation in these financing arrangements is voluntary. Our suppliers negotiate their financing agreements directly with the respective global financial institutions and we are not a party to these agreements. These financing arrangements allow participating suppliers to leverage PepsiCos creditworthiness in establishing credit spreads and associated costs, which generally provides our suppliers with more favorable terms than they would be able to secure on their own. Neither PepsiCo nor any of its subsidiaries provide any guarantees to any third party in connection with these financing arrangements. We have no economic interest in our suppliers decision to participate in these agreements. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. All Table of Contents outstanding amounts related to suppliers participating in such financing arrangements are recorded within accounts payable and other current liabilities in our consolidated balance sheet. We were informed by the participating financial institutions that as of December 25, 2021 and December 26, 2020, $1.5 billion and $1.2 billion, respectively, of our accounts payable to suppliers who participate in these financing arrangements are outstanding. These supply chain finance arrangements did not have a material impact on our liquidity or capital resources in the periods presented and we do not expect such arrangements to have a material impact on our liquidity or capital resources for the foreseeable future. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: 2021 2020 Net cash provided by operating activities $ 11,616 $ 10,613 Net cash used for investing activities $ (3,269) $ (11,619) Net cash (used for)/provided by financing activities $ (10,780) $ 3,819 Operating Activities In 2021, net cash provided by operating activities was $11.6 billion, compared to $10.6 billion in the prior year. The increase in operating cash flow primarily reflects favorable working capital comparisons and operating profit performance, partially offset by higher pre-tax pension and retiree medical plan contributions and higher net cash tax payments in the current year. Investing Activities In 2021, net cash used for investing activities was $3.3 billion, primarily reflecting net capital spending of $4.5 billion, partially offset by maturities of short-term investments with maturities greater than three months of $1.1 billion. In 2020, net cash used for investing activities was $11.6 billion, primarily reflecting net cash paid in connection with our acquisitions of Rockstar of $3.85 billion, Pioneer Foods of $1.2 billion and Be Cheery of $0.7 billion, net capital spending of $4.2 billion, as well as purchases of short-term investments with maturities greater than three months of $1.1 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities; and see Note 13 to our consolidated financial statements for further discussion of our acquisitions. We regularly review our plans with respect to net capital spending, including in light of the ongoing uncertainty caused by the COVID-19 pandemic on our business, and believe that we have sufficient liquidity to meet our net capital spending needs. Financing Activities In 2021, net cash used for financing activities was $10.8 billion, primarily reflecting the return of operating cash flow to our shareholders largely through dividend payments of $5.8 billion, cash tender offers/debt redemption of $4.8 billion, payments of long-term debt borrowings of $3.5 billion and Table of Contents payments of acquisition-related contingent consideration of $0.8 billion, partially offset by proceeds from issuances of long-term debt of $4.1 billion. In 2020, net cash provided by financing activities was $3.8 billion, primarily reflecting proceeds from issuances of long-term debt of $13.8 billion, partially offset by the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.5 billion, payments of long-term debt borrowings of $1.8 billion and debt redemptions of $1.1 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and expired on June 30, 2021. On February 10, 2022, we announced the 2022 share repurchase program. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities for further information. In addition, on February 10, 2022, we announced a 7% increase in our annualized dividend to $4.60 per share from $4.30 per share, effective with the dividend expected to be paid in June 2022. We expect to return a total of approximately $7.7 billion to shareholders in 2022, comprising dividends of approximately $6.2 billion and share repurchases of approximately $1.5 billion. Free Cash Flow The table below reconciles net cash provided by operating activities, as reflected on our cash flow statement, to our free cash flow. Free cash flow is a non-GAAP financial measure. For further information on free cash flow, see Non-GAAP Measures. 2021 2020 Change Net cash provided by operating activities, GAAP measure $ 11,616 $ 10,613 9 % Capital spending (4,625) (4,240) Sales of property, plant and equipment 166 55 Free cash flow, non-GAAP measure $ 7,157 $ 6,428 11 % We use free cash flow primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders primarily through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Material Changes in Line Items in Our Consolidated Financial Statements Material changes in line items in our consolidated statement of income are discussed in Results of Operations Division Review and Items Affecting Comparability. Table of Contents Material changes in line items in our consolidated statement of cash flows are discussed in Our Liquidity and Capital Resources. Material changes in line items in our consolidated balance sheet are discussed below: Total Assets In 2021, total assets were $92.4 billion, compared to $92.9 billion in the prior year. The decrease in total assets is primarily driven by the following line items: Change (a) Reference Cash and cash equivalents $ (2.6) Consolidated Statement of Cash Flows Short-term investments $ (1.0) Consolidated Statement of Cash Flows Assets held for sale $ 1.8 Note 13 Property, plant and equipment, net $ 1.0 Note 1, Note 14 Other indefinite-lived intangible assets $ (0.5) Note 4 Other assets $ 0.9 Note 14 Total Liabilities In 2021, total liabilities were $76.2 billion, compared to $79.4 billion in the prior year. The decrease in total liabilities is primarily driven by the following line items: Change (a) Reference Accounts payable and other current liabilities $ 1.6 Note 14 Liabilities held for sale $ 0.8 Note 13 Long-term debt obligations $ (4.3) Note 8 Other liabilities (b) $ (2.2) Note 7, Note 9 and Note 12 (a) In billions. (b) Reflects changes primarily related to pension and retiree medical plans, contingent consideration associated with our acquisition of Rockstar and leases. Total Equity Refer to our consolidated statement of equity for material changes in equity line items. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. 2021 2020 Net income attributable to PepsiCo $ 7,618 $ 7,120 Interest expense 1,988 1,252 Tax on interest expense (441) (278) $ 9,165 $ 8,094 Average debt obligations (a) $ 42,341 $ 41,402 Average common shareholders equity (b) 14,924 13,536 Average invested capital $ 57,265 $ 54,938 ROIC, non-GAAP measure 16.0 % 14.7 % (a) Includes a quarterly average of short-term and long-term debt obligations. (b) Includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. Table of Contents The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. 2021 2020 ROIC, non-GAAP measure 16.0 % 14.7 % Impact of: Average cash, cash equivalents and short-term investments 2.2 3.4 Interest income (0.2) (0.2) Tax on interest income 0.1 Mark-to-market net impact 0.1 (0.1) Restructuring and impairment charges 0.2 0.3 Acquisition and divestiture-related charges (0.1) 0.4 Pension and retiree medical-related impact (0.1) 0.2 Tax expense related to the TCJ Act 0.3 0.1 Other net tax benefits 1.0 Core Net ROIC, non-GAAP measure 18.4 % 19.9 % OUR CRITICAL ACCOUNTING POLICIES AND ESTIMATES An appreciation of our critical accounting policies and estimates is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, including those related to the COVID-19 pandemic, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies and estimates with our Audit Committee. Our critical accounting policies and estimates are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage and convenient food products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty Table of Contents related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions, including those related to the COVID-19 pandemic, based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre- Table of Contents existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is Table of Contents separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is not more likely than not that some portion or all of the deferred tax assets will be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. In 2021, our annual tax rate was 21.8% compared to 20.9% in 2020. See Other Consolidated Results for further information. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. See Items Affecting Comparability and Note 7 to our consolidated financial statements for information about changes and settlements within our pension plans. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected rate of return on assets in our funded plans; the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities; for pension expense, the rate of salary increases for plans where benefits are based on earnings; and for retiree medical expense, health care cost trend rates. Table of Contents Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans obligation and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: 2022 2021 2020 Pension Service cost discount rate 3.1 % 2.6 % 3.4 % Interest cost discount rate 2.4 % 1.9 % 2.8 % Expected rate of return on plan assets 6.1 % 6.2 % 6.6 % Expected rate of salary increases 3.1 % 3.1 % 3.2 % Retiree medical Service cost discount rate 2.8 % 2.3 % 3.2 % Interest cost discount rate 2.1 % 1.6 % 2.6 % Expected rate of return on plan assets 5.7 % 5.4 % 5.8 % Current health care cost trend rate 5.8 % 5.5 % 5.6 % Based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2022 primarily reflecting plan changes and related impacts, and higher discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2022 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ 37 Expected rate of return $ 49 Table of Contents Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. We made discretionary contributions to our U.S. qualified defined benefit plans of $75 million in January 2022 and expect to make an additional $75 million contribution in the third quarter of 2022. Our pension and retiree medical plan contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Table of Contents Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2021 2020 2019 Net Revenue $ 79,474 $ 70,372 $ 67,161 Cost of sales 37,075 31,797 30,132 Gross profit 42,399 38,575 37,029 Selling, general and administrative expenses 31,237 28,495 26,738 Operating Profit 11,162 10,080 10,291 Other pension and retiree medical benefits income/(expense) 522 117 ( 44 ) Net interest expense and other ( 1,863 ) ( 1,128 ) ( 935 ) Income before income taxes 9,821 9,069 9,312 Provision for income taxes 2,142 1,894 1,959 Net income 7,679 7,175 7,353 Less: Net income attributable to noncontrolling interests 61 55 39 Net Income Attributable to PepsiCo $ 7,618 $ 7,120 $ 7,314 Net Income Attributable to PepsiCo per Common Share Basic $ 5.51 $ 5.14 $ 5.23 Diluted $ 5.49 $ 5.12 $ 5.20 Weighted-average common shares outstanding Basic 1,382 1,385 1,399 Diluted 1,389 1,392 1,407 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Net income $ 7,679 $ 7,175 $ 7,353 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment ( 369 ) ( 650 ) 628 Net change on cash flow hedges 155 7 ( 90 ) Net pension and retiree medical adjustments 770 ( 532 ) 283 Other 22 ( 1 ) ( 2 ) 578 ( 1,176 ) 819 Comprehensive income 8,257 5,999 8,172 Less: Comprehensive income attributable to noncontrolling interests 61 55 39 Comprehensive Income Attributable to PepsiCo $ 8,196 $ 5,944 $ 8,133 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Operating Activities Net income $ 7,679 $ 7,175 $ 7,353 Depreciation and amortization 2,710 2,548 2,432 Operating lease right-of-use asset amortization 505 478 412 Share-based compensation expense 301 264 237 Restructuring and impairment charges 247 289 370 Cash payments for restructuring charges ( 256 ) ( 255 ) ( 350 ) Acquisition and divestiture-related charges ( 4 ) 255 55 Cash payments for acquisition and divestiture-related charges ( 176 ) ( 131 ) ( 10 ) Pension and retiree medical plan expenses 123 408 519 Pension and retiree medical plan contributions ( 785 ) ( 562 ) ( 716 ) Deferred income taxes and other tax charges and credits 298 361 453 Tax expense/(benefit) related to the TCJ Act 190 ( 8 ) Tax payments related to the TCJ Act ( 309 ) ( 78 ) ( 423 ) Change in assets and liabilities: Accounts and notes receivable ( 651 ) ( 420 ) ( 650 ) Inventories ( 582 ) ( 516 ) ( 190 ) Prepaid expenses and other current assets 159 26 ( 87 ) Accounts payable and other current liabilities 1,762 766 735 Income taxes payable 30 ( 159 ) ( 287 ) Other, net 375 164 ( 196 ) Net Cash Provided by Operating Activities 11,616 10,613 9,649 Investing Activities Capital spending ( 4,625 ) ( 4,240 ) ( 4,232 ) Sales of property, plant and equipment 166 55 170 Acquisitions, net of cash acquired, and investments in noncontrolled affiliates ( 61 ) ( 6,372 ) ( 2,717 ) Divestitures and sales of investments in noncontrolled affiliates 169 6 253 Short-term investments, by original maturity: More than three months - purchases ( 1,135 ) More than three months - maturities 1,135 16 More than three months - sales 62 Three months or less, net ( 58 ) 27 19 Other investing, net 5 40 ( 8 ) Net Cash Used for Investing Activities ( 3,269 ) ( 11,619 ) ( 6,437 ) (Continued on following page) Table of Contents Consolidated Statement of Cash Flows (continued) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Financing Activities Proceeds from issuances of long-term debt $ 4,122 $ 13,809 $ 4,621 Payments of long-term debt ( 3,455 ) ( 1,830 ) ( 3,970 ) Cash tender offers/debt redemption ( 4,844 ) ( 1,100 ) ( 1,007 ) Short-term borrowings, by original maturity: More than three months - proceeds 8 4,077 6 More than three months - payments ( 397 ) ( 3,554 ) ( 2 ) Three months or less, net 434 ( 109 ) ( 3 ) Payments of acquisition-related contingent consideration ( 773 ) Cash dividends paid ( 5,815 ) ( 5,509 ) ( 5,304 ) Share repurchases - common ( 106 ) ( 2,000 ) ( 3,000 ) Proceeds from exercises of stock options 185 179 329 Withholding tax payments on restricted stock units (RSUs) and performance stock units (PSUs) converted ( 92 ) ( 96 ) ( 114 ) Other financing ( 47 ) ( 48 ) ( 45 ) Net Cash (Used for)/Provided by Financing Activities ( 10,780 ) 3,819 ( 8,489 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 114 ) ( 129 ) 78 Net (Decrease)/Increase in Cash and Cash Equivalents and Restricted Cash ( 2,547 ) 2,684 ( 5,199 ) Cash and Cash Equivalents and Restricted Cash, Beginning of Year 8,254 5,570 10,769 Cash and Cash Equivalents and Restricted Cash, End of Year $ 5,707 $ 8,254 $ 5,570 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 25, 2021 and December 26, 2020 (in millions except per share amounts) 2021 2020 ASSETS Current Assets Cash and cash equivalents $ 5,596 $ 8,185 Short-term investments 392 1,366 Accounts and notes receivable, net 8,680 8,404 Inventories 4,347 4,172 Prepaid expenses and other current assets 980 874 Assets held for sale 1,788 Total Current Assets 21,783 23,001 Property, Plant and Equipment, net 22,407 21,369 Amortizable Intangible Assets, net 1,538 1,703 Goodwill 18,381 18,757 Other Indefinite-Lived Intangible Assets 17,127 17,612 Investments in Noncontrolled Affiliates 2,627 2,792 Deferred Income Taxes 4,310 4,372 Other Assets 4,204 3,312 Total Assets $ 92,377 $ 92,918 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 4,308 $ 3,780 Accounts payable and other current liabilities 21,159 19,592 Liabilities held for sale 753 Total Current Liabilities 26,220 23,372 Long-Term Debt Obligations 36,026 40,370 Deferred Income Taxes 4,826 4,284 Other Liabilities 9,154 11,340 Total Liabilities 76,226 79,366 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,383 and 1,380 shares, respectively) 23 23 Capital in excess of par value 4,001 3,910 Retained earnings 65,165 63,443 Accumulated other comprehensive loss ( 14,898 ) ( 15,476 ) Repurchased common stock, in excess of par value ( 484 and 487 shares, respectively) ( 38,248 ) ( 38,446 ) Total PepsiCo Common Shareholders Equity 16,043 13,454 Noncontrolling interests 108 98 Total Equity 16,151 13,552 Total Liabilities and Equity $ 92,377 $ 92,918 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2021 2020 2019 Shares Amount Shares Amount Shares Amount Common Stock Balance, beginning of year 1,380 $ 23 1,391 $ 23 1,409 $ 23 Change in repurchased common stock 3 ( 11 ) ( 18 ) Balance, end of year 1,383 23 1,380 23 1,391 23 Capital in Excess of Par Value Balance, beginning of year 3,910 3,886 3,953 Share-based compensation expense 302 263 235 Stock option exercises, RSUs and PSUs converted ( 118 ) ( 143 ) ( 188 ) Withholding tax on RSUs and PSUs converted ( 92 ) ( 96 ) ( 114 ) Other ( 1 ) Balance, end of year 4,001 3,910 3,886 Retained Earnings Balance, beginning of year 63,443 61,946 59,947 Cumulative effect of accounting changes ( 34 ) 8 Net income attributable to PepsiCo 7,618 7,120 7,314 Cash dividends declared - common (a) ( 5,896 ) ( 5,589 ) ( 5,323 ) Balance, end of year 65,165 63,443 61,946 Accumulated Other Comprehensive Loss Balance, beginning of year ( 15,476 ) ( 14,300 ) ( 15,119 ) Other comprehensive income/(loss) attributable to PepsiCo 578 ( 1,176 ) 819 Balance, end of year ( 14,898 ) ( 15,476 ) ( 14,300 ) Repurchased Common Stock Balance, beginning of year ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) Share repurchases ( 1 ) ( 106 ) ( 15 ) ( 2,000 ) ( 24 ) ( 3,000 ) Stock option exercises, RSUs and PSUs converted 4 303 4 322 6 516 Other 1 1 1 Balance, end of year ( 484 ) ( 38,248 ) ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) Total PepsiCo Common Shareholders Equity 16,043 13,454 14,786 Noncontrolling Interests Balance, beginning of year 98 82 84 Net income attributable to noncontrolling interests 61 55 39 Distributions to noncontrolling interests ( 49 ) ( 44 ) ( 42 ) Acquisitions 5 Other, net ( 2 ) 1 Balance, end of year 108 98 82 Total Equity $ 16,151 $ 13,552 $ 14,868 (a) Cash dividends declared per common share were $ 4.2475 , $ 4.0225 and $ 3.7925 for 2021, 2020 and 2019, respectively. See accompanying notes to the consolidated financial statements. Table of Contents Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived intangible assets, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. Additionally, the business and economic uncertainty resulting from the COVID-19 pandemic has made such estimates and assumptions more difficult to calculate. As future events and their effect cannot be determined with precision, actual results could differ significantly from those estimates. Our fiscal year ends on the last Saturday of each December, resulting in a 53 rd reporting week every five or six years, including in our 2022 financial results. While our North America results are reported on a weekly calendar basis, substantially all of our international operations reported on a monthly calendar basis prior to the fourth quarter of 2021, and beginning in the fourth quarter of 2021, all of our international operations report on a monthly calendar basis. This change did not have a material impact on our consolidated financial statements. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Table of Contents Our Divisions We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded convenient food businesses in the United States and Canada; 2) QFNA, which includes our branded convenient food businesses, such as cereal, rice, pasta and other branded food, in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage and convenient food businesses in Latin America; 5) Europe, which includes all of our beverage and convenient food businesses in Europe; 6) AMESA, which includes all of our beverage and convenient food businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage and convenient food businesses in Asia Pacific, Australia and New Zealand, and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, China, the United Kingdom and South Africa. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: 2021 2020 2019 FLNA 13 % 13 % 13 % QFNA 1 % 1 % 1 % PBNA 19 % 18 % 17 % LatAm 5 % 6 % 7 % Europe 13 % 16 % 17 % AMESA 6 % 6 % 3 % APAC 2 % 2 % 5 % Corporate unallocated expenses 41 % 38 % 37 % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Table of Contents Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net Revenue and Operating Profit Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2021 2020 2019 2021 2020 2019 FLNA $ 19,608 $ 18,189 $ 17,078 $ 5,633 $ 5,340 $ 5,258 QFNA 2,751 2,742 2,482 578 669 544 PBNA 25,276 22,559 21,730 2,442 1,937 2,179 LatAm 8,108 6,942 7,573 1,369 1,033 1,141 Europe 13,038 11,922 11,728 1,292 1,353 1,327 AMESA (a) 6,078 4,573 3,651 858 600 671 APAC (b) 4,615 3,445 2,919 673 590 477 Total division 79,474 70,372 67,161 12,845 11,522 11,597 Corporate unallocated expenses ( 1,683 ) ( 1,442 ) ( 1,306 ) Total $ 79,474 $ 70,372 $ 67,161 $ 11,162 $ 10,080 $ 10,291 (a) The increase in net revenue reflects our acquisition of Pioneer Foods. See Note 13 for further information. (b) The increase in net revenue reflects our acquisition of Be Cheery. See Note 13 for further information. Our primary performance obligation is the distribution and sales of beverage and convenient food products to our customers. The following table reflects the approximate percentage of net revenue generated between our beverage business and our convenient food business for each of our international divisions, as well as our consolidated net revenue: 2021 2020 2019 Beverage (a) Convenient Food Beverage (a) Convenient Food Beverage (a) Convenient Food LatAm 10 % 90 % 10 % 90 % 10 % 90 % Europe 55 % 45 % 55 % 45 % 55 % 45 % AMESA (b) 30 % 70 % 30 % 70 % 40 % 60 % APAC 20 % 80 % 25 % 75 % 25 % 75 % PepsiCo 45 % 55 % 45 % 55 % 45 % 55 % (a) Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. (b) The increase in the approximate percentage of net revenue generated by our convenient food business in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 13 for further information. Table of Contents Operating profit in 2021 and 2020 includes certain pre-tax charges/credits taken as a result of the COVID-19 pandemic. These pre-tax charges/credits by division are as follows: 2021 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ ( 8 ) $ $ $ 35 $ 27 $ 2 $ 56 QFNA ( 1 ) 2 1 2 PBNA ( 19 ) ( 21 ) 31 14 ( 16 ) ( 11 ) LatAm 1 44 15 4 64 Europe ( 3 ) ( 2 ) 13 8 5 21 AMESA ( 1 ) ( 2 ) 1 3 6 7 APAC 2 2 5 9 Total $ ( 32 ) $ ( 23 ) $ ( 1 ) $ 128 $ 70 $ 6 $ 148 2020 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ 17 $ $ 8 $ 145 $ 59 $ $ 229 QFNA 2 9 3 1 15 PBNA 29 56 28 115 50 26 304 LatAm 1 19 56 18 8 102 Europe 5 3 11 23 22 24 88 AMESA 2 3 9 7 12 33 APAC 3 ( 7 ) 2 5 3 Total $ 56 $ 59 $ 72 $ 350 $ 161 $ 76 $ 774 (a) Reflects the expected impact of the global economic uncertainty caused by COVID-19, leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers, including foodservice and vending businesses. Income amounts represent reductions in the previously recorded reserves due to improved projected default rates and lower at-risk receivable balances. (b) Relates to promotional spending for which benefit is not expected to be received. Income amounts represent reductions in previously recorded reserves due to improved projected default rates and lower overall advance balances. (c) Income amount represents a true-up of inventory write-downs. Includes a reserve for product returns of $ 20 million in 2020. (d) Includes incremental frontline incentive pay, crisis child care and other leave benefits and labor costs. Income amount includes a social welfare relief credit of $ 11 million. (e) Includes costs associated with personal protective equipment, temperature scans, cleaning and other sanitization services. (f) Includes certain reserves for property, plant and equipment, donations of cash and product, and other costs. Income amount represents adjustments for changes in estimates of previously recorded amounts. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, tax-related contingent consideration, certain acquisition and divestiture-related charges, as well as certain other items. Table of Contents Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending 2021 2020 2021 2020 2019 FLNA $ 9,763 $ 8,730 $ 1,411 $ 1,189 $ 1,227 QFNA 1,101 1,021 92 85 104 PBNA 37,801 37,079 1,275 1,245 1,053 LatAm 7,272 6,977 461 390 557 Europe 18,472 17,917 752 730 613 AMESA 6,125 5,942 325 252 267 APAC 5,654 5,770 203 230 195 Total division 86,188 83,436 4,519 4,121 4,016 Corporate (a) 6,189 9,482 106 119 216 Total $ 92,377 $ 92,918 $ 4,625 $ 4,240 $ 4,232 (a) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2021, the change in assets was primarily due to a decrease in cash and cash equivalents and short-term investments. Refer to the cash flow statement for further information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization 2021 2020 2019 2021 2020 2019 FLNA $ 11 $ 10 $ 7 $ 594 $ 550 $ 492 QFNA 46 41 44 PBNA 25 28 29 926 899 857 LatAm 4 4 5 283 251 270 Europe 37 40 37 364 350 341 AMESA 5 3 2 181 149 116 APAC 9 5 1 102 91 76 Total division 91 90 81 2,496 2,331 2,196 Corporate 123 127 155 Total $ 91 $ 90 $ 81 $ 2,619 $ 2,458 $ 2,351 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) 2021 2020 2019 2021 2020 United States $ 44,545 $ 40,800 $ 38,644 $ 36,324 $ 36,657 Mexico 4,580 3,924 4,190 1,720 1,708 Russia 3,426 3,009 3,263 3,751 3,644 Canada 3,405 2,989 2,831 2,846 2,794 China (b) 2,679 1,732 1,300 1,745 1,649 United Kingdom 2,102 1,882 1,723 906 874 South Africa (c) 2,008 1,282 405 1,389 1,484 All other countries 16,729 14,754 14,805 13,399 13,423 Total $ 79,474 $ 70,372 $ 67,161 $ 62,080 $ 62,233 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. See Note 2 and Note 14 for further information on property, plant and equipment. See Note 2 and Note 4 for further information on goodwill and other intangible assets. Investments in noncontrolled affiliates are evaluated for Table of Contents impairment upon a significant change in the operating or macroeconomic environment. These assets are reported in the country where they are primarily used. (b) The increase in net revenue reflects our acquisition of Be Cheery. See Note 13 for further information. (c) The increase in net revenue reflects our acquisition of Pioneer Foods. See Note 13 for further information. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage and convenient food products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. In addition, we exclude from net revenue all sales, use, value-added and certain excise taxes assessed by government authorities on revenue producing transactions. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers. We are exposed to concentration of credit risk from our major customers, including Walmart. We have not experienced credit issues with these customers. In 2021, sales to Walmart and its affiliates (including Sams) represented approximately 13 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance Table of Contents levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed one year and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 262 million as of December 25, 2021 and $ 299 million as of December 26, 2020 are included in prepaid expenses and other current assets and other assets on our balance sheet. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 5.1 billion in 2021, $ 4.6 billion in 2020 and $ 4.7 billion in 2019, including advertising expenses of $ 3.5 billion in 2021 and $ 3.0 billion in both 2020 and 2019. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 53 million and $ 48 million as of December 25, 2021 and December 26, 2020, respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 13.7 billion in 2021, $ 11.9 billion in 2020 and $ 10.9 billion in 2019. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 135 million in 2021, $ 152 million in 2020 and $ 166 million in 2019. Net capitalized software and development costs were $ 809 million and $ 664 million as of December 25, 2021 and December 26, 2020, respectively. Table of Contents Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 752 million, $ 719 million and $ 711 million in 2021, 2020 and 2019, respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Income Taxes Note 5. Share-Based Compensation Note 6. Table of Contents Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Inventories Note 14. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO); or, in limited instances, last-in, first-out (LIFO) methods. Property, Plant and Equipment Note 14. Property, plant and equipment is recorded at historical cost. Depreciation is recognized on a straight-line basis over an assets estimated useful life. Construction in progress is not depreciated until ready for service. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2019, the Financial Accounting Standards Board (FASB) issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a step-up in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all of the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. We adopted the guidance in the first quarter of 2021. The adoption did not have a material impact on our consolidated financial statements or related disclosures. Note 3 Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. To build on the successful implementation of the 2019 Productivity Plan to date, we expanded and extended the plan through the end of 2026 to take advantage of additional opportunities within the initiatives described above. We now expect to incur pre-tax charges of approximately $ 3.15 billion, including cash expenditures of approximately $ 2.4 billion, as compared to our previous estimate of pre-tax charges of approximately $ 2.5 billion, which included cash expenditures of approximately $ 1.6 billion. These pre-tax charges are expected to consist of approximately 55 % of severance and other employee-related costs, 10 % for asset impairments (all non-cash) resulting from plant closures and related actions and 35 % for other costs associated with the implementation of our initiatives. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges 15 % 1 % 25 % 10 % 25 % 5 % 4 % 15 % Table of Contents A summary of our 2019 Productivity Plan charges is as follows: 2021 2020 2019 Cost of sales $ 29 $ 30 $ 115 Selling, general and administrative expenses 208 239 253 Other pension and retiree medical benefits expense 10 20 2 Total restructuring and impairment charges $ 247 $ 289 $ 370 After-tax amount $ 206 $ 231 $ 303 Impact on net income attributable to PepsiCo per common share $ ( 0.15 ) $ ( 0.17 ) $ ( 0.21 ) 2021 2020 2019 Plan to Date through 12/25/2021 FLNA $ 28 $ 83 $ 22 $ 164 QFNA 5 2 12 PBNA 20 47 51 158 LatAm 37 31 62 139 Europe 81 48 99 234 AMESA 15 14 38 70 APAC 7 5 47 61 Corporate 49 36 47 139 237 269 368 977 Other pension and retiree medical benefits expense 10 20 2 67 Total $ 247 $ 289 $ 370 $ 1,044 Plan to Date through 12/25/2021 Severance and other employee costs $ 564 Asset impairments 157 Other costs 323 Total $ 1,044 Severance and other employee costs primarily include severance and other termination benefits, as well as voluntary separation arrangements. Other costs primarily include costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. Table of Contents A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 29, 2018 $ 105 $ $ 1 $ 106 2019 restructuring charges 149 92 129 370 Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation 12 ( 92 ) 10 ( 70 ) Liability as of December 28, 2019 128 21 149 2020 restructuring charges 158 33 98 289 Cash payments (a) ( 138 ) ( 117 ) ( 255 ) Non-cash charges and translation ( 26 ) ( 33 ) 3 ( 56 ) Liability as of December 26, 2020 122 5 127 2021 restructuring charges 120 32 95 247 Cash payments (a) ( 163 ) ( 93 ) ( 256 ) Non-cash charges and translation ( 15 ) ( 32 ) ( 47 ) Liability as of December 25, 2021 $ 64 $ $ 7 $ 71 (a) Excludes cash expenditures of $ 2 million in both 2021 and 2020, and $ 4 million in 2019, reported in the cash flow statement in pension and retiree medical plan contributions. Substantially all of the restructuring accrual at December 25, 2021 is expected to be paid by the end of 2022. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 Productivity Plan. We regularly evaluate different productivity initiatives beyond the productivity plan and other initiatives described above. Note 4 Intangible Assets A summary of our amortizable intangible assets is as follows: 2021 2020 2019 Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights (a) 56 60 $ 976 $ ( 187 ) $ 789 $ 976 $ ( 173 ) $ 803 Customer relationships 10 24 623 ( 227 ) 396 642 ( 204 ) 438 Brands (b) 20 40 1,151 ( 989 ) 162 1,348 ( 1,099 ) 249 Other identifiable intangibles 10 24 451 ( 260 ) 191 474 ( 261 ) 213 Total $ 3,201 $ ( 1,663 ) $ 1,538 $ 3,440 $ ( 1,737 ) $ 1,703 Amortization expense $ 91 $ 90 $ 81 (a) Acquired franchise rights includes our distribution agreement with Vital Pharmaceuticals, Inc., with an expected residual value higher than our carrying value. The distribution agreements useful life is three years, in accordance with the three-year termination notice issued, and is not reflected in the average useful life above. (b) The change primarily reflects assets reclassified as held for sale in connection with our Juice Transaction. See Note 13 for further information. Table of Contents Amortization is recognized on a straight-line basis over an intangible assets estimated useful life. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 25, 2021 and using average 2021 foreign exchange rates, is expected to be as follows: 2022 2023 2024 2025 2026 Five-year projected amortization $ 84 $ 84 $ 83 $ 81 $ 72 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 25, 2021, December 26, 2020 and December 28, 2019. We did not recognize any impairment charges for indefinite-lived intangible assets in the year ended December 25, 2021. In 2020, we recognized a pre-tax impairment charge of $ 41 million related to a coconut water brand in PBNA. We did not recognize any material impairment charges for indefinite-lived intangible assets in the year ended December 28, 2019. As of December 25, 2021, the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia on the estimated fair value of our indefinite-lived intangible assets in Russia and have concluded that there are no impairments for the year ended December 25, 2021. The estimated fair value of indefinite-lived intangible assets is dependent on macroeconomic conditions (including a resulting increase in the weighted-average cost of capital used to estimate fair value), future revenues and their contributions to operating results and expected future cash flows (including perpetuity growth assumptions), and significant changes in the decisions regarding assets that do not perform consistent with our expectations. Subsequent to December 25, 2021, we discontinued or repositioned certain juice and dairy brands in Russia in our Europe segment. As a result, we will recognize pre-tax impairment charges of approximately $ 0.2 billion in the first quarter of 2022 in selling, general and administrative expenses. For further information on our policies for indefinite-lived intangible assets, see Note 2. Table of Contents The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2020 Acquisitions Translation and Other Balance, End of 2020 Acquisitions/(Divestitures) Translation and Other Balance, End of 2021 FLNA (a) Goodwill $ 299 $ 164 $ 2 $ 465 $ ( 8 ) $ 1 $ 458 Brands 162 179 ( 1 ) 340 340 Total 461 343 1 805 ( 8 ) 1 798 QFNA Goodwill 189 189 189 Brands 11 ( 11 ) Total 200 ( 11 ) 189 189 PBNA (b) (c) Goodwill 9,898 2,280 11 12,189 ( 216 ) 1 11,974 Reacquired franchise rights 7,089 18 7,107 7,107 Acquired franchise rights 1,517 16 3 1,536 1 1 1,538 Brands (d) 763 2,400 ( 41 ) 3,122 ( 290 ) ( 324 ) 2,508 Total 19,267 4,696 ( 9 ) 23,954 ( 505 ) ( 322 ) 23,127 LatAm Goodwill 501 ( 43 ) 458 ( 25 ) 433 Brands 125 ( 17 ) 108 ( 1 ) ( 7 ) 100 Total 626 ( 60 ) 566 ( 1 ) ( 32 ) 533 Europe (b) Goodwill (e) 3,961 ( 2 ) ( 153 ) 3,806 ( 28 ) ( 78 ) 3,700 Reacquired franchise rights (e) 505 ( 9 ) 496 ( 23 ) ( 32 ) 441 Acquired franchise rights (e) 157 15 172 ( 14 ) 158 Brands (f) 4,181 ( 109 ) 4,072 182 4,254 Total 8,804 ( 2 ) ( 256 ) 8,546 ( 51 ) 58 8,553 AMESA (g) Goodwill 446 560 90 1,096 ( 2 ) ( 31 ) 1,063 Brands 183 31 214 ( 9 ) 205 Total 446 743 121 1,310 ( 2 ) ( 40 ) 1,268 APAC (h) Goodwill 207 306 41 554 3 7 564 Brands (d) 100 309 36 445 31 476 Total 307 615 77 999 3 38 1,040 Total goodwill 15,501 3,308 ( 52 ) 18,757 ( 251 ) ( 125 ) 18,381 Total reacquired franchise rights 7,594 9 7,603 ( 23 ) ( 32 ) 7,548 Total acquired franchise rights 1,674 16 18 1,708 1 ( 13 ) 1,696 Total brands 5,342 3,071 ( 112 ) 8,301 ( 291 ) ( 127 ) 7,883 Total $ 30,111 $ 6,395 $ ( 137 ) $ 36,369 $ ( 564 ) $ ( 297 ) $ 35,508 (a) Acquisitions/divestitures in 2021 and acquisitions in 2020 primarily reflect our acquisition of BFY Brands. (b) Acquisitions/divestitures in 2021 primarily reflects assets reclassified as held for sale in connection with our Juice Transaction. See Note 13 for further information. (c) Acquisitions in 2020 primarily reflects our acquisition of Rockstar. See Note 13 for further information. (d) Translation and other in 2021 primarily reflects the allocation of the Rockstar brand to the respective divisions, which was finalized in 2021 as part of purchase price allocation. (e) Translation and other primarily reflects the depreciation of the euro in 2021 and depreciation of the Russian ruble in 2020. (f) Translation and other in 2021 reflects the allocation of the Rockstar brand from PBNA, which was finalized in 2021 as part of purchase price allocation, partially offset by the depreciation of the euro. Translation and other in 2020 primarily reflects the depreciation of the Russian ruble. Table of Contents (g) Acquisitions in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 13 for further information. (h) Acquisitions in 2020 primarily reflects our acquisition of Be Cheery. See Note 13 for further information. Note 5 Income Taxes The components of income before income taxes are as follows: 2021 2020 2019 United States $ 3,740 $ 4,070 $ 4,123 Foreign 6,081 4,999 5,189 $ 9,821 $ 9,069 $ 9,312 The provision for income taxes consisted of the following: 2021 2020 2019 Current: U.S. Federal $ 702 $ 715 $ 652 Foreign 955 932 807 State 44 110 196 1,701 1,757 1,655 Deferred: U.S. Federal 375 273 325 Foreign ( 14 ) ( 167 ) ( 31 ) State 80 31 10 441 137 304 $ 2,142 $ 1,894 $ 1,959 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: 2021 2020 2019 U.S. Federal statutory tax rate 21.0 % 21.0 % 21.0 % State income tax, net of U.S. Federal tax benefit 1.0 1.2 1.6 Lower taxes on foreign results ( 1.6 ) ( 0.8 ) ( 0.9 ) One-time mandatory transition tax - TCJ Act 1.9 ( 0.1 ) Other, net ( 0.5 ) ( 0.5 ) ( 0.6 ) Annual tax rate 21.8 % 20.9 % 21.0 % Tax Cuts and Jobs Act In 2021, we recorded $ 190 million ($ 0.14 per share) of net tax expense related to the TCJ Act as a result of adjustments related to the final assessment of the 2014 through 2016 IRS audit . There were no tax amounts recognized in 2020 related to the TCJ Act. In 2019, we recognized a net tax benefit totaling $ 8 million ($ 0.01 per share) related to the TCJ Act. As of December 25, 2021, our mandatory transition tax liability was $ 2.9 billion, which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 309 million in 2021, $ 78 million in 2020 and $ 663 million in 2019. We currently expect to pay approximately $ 309 million of this liability in 2022. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary Table of Contents differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. We elected to treat the tax effect of GILTI as a current-period expense when incurred. Other Tax Matters In 2021, we received a final assessment from the IRS audit for the tax years 2014 through 2016. The assessment included both agreed and unagreed issues. On October 29, 2021, we filed a formal written protest of the assessment and requested an appeals conference. As a result of the analysis of the 2014 through 2016 final assessment, we remeasured all applicable reserves for uncertain tax positions for all years open under the statute of limitations, including any correlating adjustments impacting the mandatory transition tax liability under the TCJ Act, resulting in a net non-cash tax expense of $ 112 million in 2021. On May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2021, no income tax adjustments related to the TRAF were recorded. During 2020, we recorded a net tax benefit of $ 72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded a net tax expense of $ 24 million related to the impact of the TRAF. While the accounting for the impacts of the TRAF are deemed to be complete, further adjustments to our financial statements and related disclosures could be made in future quarters, including in connection with final tax return filings. Deferred tax liabilities and assets are comprised of the following: 2021 2020 Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ 578 $ 578 Property, plant and equipment 2,036 1,851 Recapture of net operating losses 504 504 Pension liabilities 216 Right-of-use assets 450 371 Other 254 159 Gross deferred tax liabilities 4,038 3,463 Deferred tax assets Net carryforwards 4,974 5,008 Intangible assets other than nondeductible goodwill 1,111 1,146 Share-based compensation 98 90 Retiree medical benefits 147 153 Other employee-related benefits 379 373 Pension benefits 80 Deductible state tax and interest benefits 149 150 Lease liabilities 450 371 Other 842 866 Gross deferred tax assets 8,150 8,237 Valuation allowances ( 4,628 ) ( 4,686 ) Deferred tax assets, net 3,522 3,551 Net deferred tax liabilities/(assets) $ 516 $ ( 88 ) Table of Contents A summary of our valuation allowance activity is as follows: 2021 2020 2019 Balance, beginning of year $ 4,686 $ 3,599 $ 3,753 Provision ( 9 ) 1,082 ( 124 ) Other (deductions)/additions ( 49 ) 5 ( 30 ) Balance, end of year $ 4,628 $ 4,686 $ 3,599 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2020 2014-2019 Mexico 2014-2020 2014-2016 United Kingdom 2018-2020 None Canada (Domestic) 2016-2020 2016-2017 Canada (International) 2010-2020 2010-2017 Russia 2018-2020 None Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 25, 2021, the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.9 billion. We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 326 million as of December 25, 2021, of which $ 3 million of tax benefit was recognized in 2021. The gross amount of interest accrued, reported in other liabilities, was $ 338 million as of December 26, 2020, of which $ 93 million of tax expense was recognized in 2020. Table of Contents A reconciliation of unrecognized tax benefits is as follows: 2021 2020 Balance, beginning of year $ 1,621 $ 1,395 Additions for tax positions related to the current year 222 128 Additions for tax positions from prior years 681 153 Reductions for tax positions from prior years ( 558 ) ( 22 ) Settlement payments ( 25 ) ( 13 ) Statutes of limitations expiration ( 39 ) ( 23 ) Translation and other ( 2 ) 3 Balance, end of year $ 1,900 $ 1,621 Carryforwards and Allowances Operating loss carryforwards totaling $ 30.0 billion as of December 25, 2021 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.3 billion in 2022, $ 26.8 billion between 2023 and 2041 and $ 2.9 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is not more likely than not that some portion or all of the deferred tax assets will be realized. Undistributed International Earnings As of December 25, 2021, we had approximately $ 7 billion of undistributed international earnings. We intend to continue to reinvest $ 7 billion of earnings outside the United States for the foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs and PSUs. As of December 25, 2021, 44 million shares were available for future share-based compensation grants under the LTIP. Table of Contents The following table summarizes our total share-based compensation expense, which is primarily recorded in selling, general and administrative expenses, and excess tax benefits recognized: 2021 2020 2019 Share-based compensation expense - equity awards $ 301 $ 264 $ 237 Share-based compensation expense - liability awards 20 11 8 Restructuring charges 1 ( 1 ) ( 2 ) Total $ 322 $ 274 $ 243 Income tax benefits recognized in earnings related to share-based compensation $ 57 $ 48 $ 39 Excess tax benefits related to share-based compensation $ 38 $ 35 $ 50 As of December 25, 2021, there was $ 372 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: 2021 2020 2019 Expected life 7 years 6 years 5 years Risk-free interest rate 1.1 % 0.9 % 2.4 % Expected volatility 14 % 14 % 14 % Expected dividend yield 3.1 % 3.4 % 3.1 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. Table of Contents A summary of our stock option activity for the year ended December 25, 2021 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 26, 2020 10,640 $ 99.54 Granted 2,157 $ 134.25 Exercised ( 2,321 ) $ 79.87 Forfeited/expired ( 334 ) $ 125.35 Outstanding at December 25, 2021 10,142 $ 110.54 5.79 $ 600,755 Exercisable at December 25, 2021 5,407 $ 93.49 3.47 $ 412,524 Expected to vest as of December 25, 2021 4,419 $ 129.78 8.41 $ 176,771 (a) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. A summary of our RSU and PSU activity for the year ended December 25, 2021 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 26, 2020 6,127 $ 119.92 Granted 2,636 $ 131.81 Converted ( 2,229 ) $ 112.09 Forfeited ( 557 ) $ 126.70 Outstanding at December 25, 2021 (b) 5,977 $ 127.45 1.31 $ 1,014,854 Expected to vest as of December 25, 2021 (c) 6,016 $ 127.59 1.30 $ 1,021,312 (a) In thousands. Outstanding awards are disclosed at target. (b) The outstanding PSUs for which the vesting period has not ended as of December 25, 2021, at the threshold, target and maximum award levels were zero , 1 million and 2 million, respectively. (c) Represents the number of outstanding awards expected to vest, including estimated performance adjustments on all outstanding PSUs as of December 25, 2021. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and Table of Contents achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. A summary of our long-term cash activity for the year ended December 25, 2021 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 26, 2020 $ 47,513 Granted 16,507 Vested ( 16,567 ) Forfeited ( 1,661 ) Outstanding at December 25, 2021 (b) $ 45,792 $ 50,238 1.29 Expected to vest as of December 25, 2021 (c) $ 43,480 $ 47,771 1.27 (a) In thousands. Outstanding awards are disclosed at target. (b) The outstanding awards for which the vesting period has not ended as of December 25, 2021, at the threshold, target and maximum award levels based on the achievement of its market conditions were zero , $ 46 million and $ 92 million, respectively. (c) Represents the number of outstanding awards expected to vest, based on the most recent valuation as of December 25, 2021. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: 2021 2020 2019 Stock Options Total number of options granted (a) 2,157 1,847 1,286 Weighted-average grant-date fair value of options granted $ 9.88 $ 8.31 $ 10.89 Total intrinsic value of options exercised (a) $ 153,306 $ 155,096 $ 275,745 Total grant-date fair value of options vested (a) $ 10,605 $ 8,652 $ 9,838 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,636 2,496 2,754 Weighted-average grant-date fair value of RSUs/PSUs granted $ 131.81 $ 131.21 $ 116.87 Total intrinsic value of RSUs/PSUs converted (a) $ 273,878 $ 303,165 $ 333,951 Total grant-date fair value of RSUs/PSUs vested (a) $ 198,469 $ 235,523 $ 275,234 (a) In thousands. As of December 25, 2021 and December 26, 2020, there were approximately 299,000 and 287,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Table of Contents Note 7 Pension, Retiree Medical and Savings Plans In connection with our Juice Transaction subsequent to December 25, 2021, we transferred pension and retiree medical obligations of approximately $ 150 million and related assets to the newly formed joint venture. In 2021, we adopted a change to the Canadian defined benefit plans to freeze pension accruals for salaried participants, effective January 1, 2024, and to close the hourly plan to new non-union employees hired on or after January 1, 2022. After the effective date, all salaried participants will receive an employer contribution to the defined contribution plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. We also adopted a change to the U.K. defined benefit plan to freeze pension accruals for all participants effective March 31, 2022. After the effective date, participants will have the opportunity to receive employer contributions to match employee contributions up to defined limits. Pre-tax pension benefits expense will decrease after the effective dates, partially offset by contributions to defined contribution plans. In 2021, we adopted a change to the U.S. qualified defined benefit plans to transfer certain participants from PepsiCo Employees Retirement Plan A (Plan A) to PepsiCo Employees Retirement Plan I (Plan I), effective January 1, 2022. The benefits offered to the plans participants were unchanged. There is no material impact to pre-tax pension benefits expense from this transaction. In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A of $ 205 million ($ 158 million after-tax or $ 0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pre-tax pension benefits expense decreased $ 70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to Plan I and to a newly created plan, PepsiCo Employees Retirement Hourly Plan (Plan H), effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization facilitated a more targeted investment strategy and provided additional flexibility in evaluating opportunities to reduce risk and volatility. There was no material impact to pre-tax pension benefits expense as a result of this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pre-tax pension benefits expense increased $ 45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ($ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ($ 211 million after-tax or $ 0.15 per share). Table of Contents Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10 % of the greater of the market-related value of plan assets or plan obligations, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 9 years), Plan H (approximately 11 years) and retiree medical (approximately 9 years), and the remaining life expectancy for participants in Plan I (approximately 27 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in both Plan A and Plan H, except that prior service cost/(credit) for salaried participants subject to the freeze is amortized on a straight-line basis over the period up to the effective date of the freeze, or the remaining life expectancy for participants in Plan I. Table of Contents Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International 2021 2020 2021 2020 2021 2020 Change in projected benefit obligation Obligation at beginning of year $ 16,753 $ 15,230 $ 4,430 $ 3,753 $ 1,006 $ 988 Service cost 518 434 104 86 33 25 Interest cost 324 435 74 85 15 25 Plan amendments 23 ( 221 ) 3 ( 17 ) ( 25 ) Participant contributions 3 2 Experience (gain)/loss ( 215 ) 2,042 ( 178 ) 467 ( 17 ) 81 Benefit payments ( 976 ) ( 378 ) ( 106 ) ( 92 ) ( 83 ) ( 89 ) Settlement/curtailment ( 220 ) ( 808 ) ( 99 ) ( 24 ) Special termination benefits 9 19 Other, including foreign currency adjustment ( 56 ) 170 1 Obligation at end of year $ 16,216 $ 16,753 $ 4,175 $ 4,430 $ 954 $ 1,006 Change in fair value of plan assets Fair value at beginning of year $ 15,465 $ 14,302 $ 4,303 $ 3,732 $ 315 $ 302 Actual return on plan assets 1,052 1,908 387 401 20 47 Employer contributions/funding 580 387 158 120 47 55 Participant contributions 3 2 Benefit payments ( 976 ) ( 378 ) ( 106 ) ( 92 ) ( 83 ) ( 89 ) Settlement ( 217 ) ( 754 ) ( 52 ) ( 29 ) Other, including foreign currency adjustment ( 69 ) 169 Fair value at end of year $ 15,904 $ 15,465 $ 4,624 $ 4,303 $ 299 $ 315 Funded status $ ( 312 ) $ ( 1,288 ) $ 449 $ ( 127 ) $ ( 655 ) $ ( 691 ) Amounts recognized Other assets $ 692 $ 797 $ 564 $ 110 $ $ Other current liabilities ( 48 ) ( 53 ) ( 1 ) ( 1 ) ( 57 ) ( 51 ) Other liabilities ( 956 ) ( 2,032 ) ( 114 ) ( 236 ) ( 598 ) ( 640 ) Net amount recognized $ ( 312 ) $ ( 1,288 ) $ 449 $ ( 127 ) $ ( 655 ) $ ( 691 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,550 $ 4,116 $ 696 $ 1,149 $ ( 220 ) $ ( 212 ) Prior service (credit)/cost ( 63 ) ( 119 ) ( 11 ) ( 19 ) ( 34 ) ( 45 ) Total $ 3,487 $ 3,997 $ 685 $ 1,130 $ ( 254 ) $ ( 257 ) Changes recognized in net (gain)/loss included in other comprehensive loss Net (gain)/loss arising in current year $ ( 301 ) $ 1,009 $ ( 355 ) $ 268 $ ( 22 ) $ 50 Amortization and settlement recognition ( 265 ) ( 409 ) ( 95 ) ( 75 ) 14 23 Foreign currency translation (gain)/loss ( 3 ) 42 Total $ ( 566 ) $ 600 $ ( 453 ) $ 235 $ ( 8 ) $ 73 Accumulated benefit obligation at end of year $ 15,489 $ 15,949 $ 4,021 $ 4,108 The net gain arising in the current year is primarily attributable to the increase in discount rate offset by actual experience differing from demographic assumptions. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. Table of Contents The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Lump sum payouts are generally higher when interest rates are lower. Curtailments are recognized when events such as plant closures, the sale of a business, or plan changes result in a significant reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ 518 $ 434 $ 381 $ 104 $ 86 $ 73 $ 33 $ 25 $ 23 Other pension and retiree medical benefits (income)/expense: Interest cost $ 324 $ 435 $ 543 $ 74 $ 85 $ 97 $ 15 $ 25 $ 36 Expected return on plan assets ( 970 ) ( 929 ) ( 892 ) ( 231 ) ( 202 ) ( 188 ) ( 15 ) ( 16 ) ( 18 ) Amortization of prior service (credits)/cost ( 31 ) 12 10 ( 2 ) ( 11 ) ( 12 ) ( 19 ) Amortization of net losses/(gains) 224 196 161 77 61 32 ( 14 ) ( 23 ) ( 27 ) Settlement/curtailment losses/(gains) (a) 40 213 296 ( 11 ) 19 12 Special termination benefits 9 19 1 Total other pension and retiree medical benefits (income)/expense $ ( 404 ) $ ( 54 ) $ 119 $ ( 93 ) $ ( 37 ) $ ( 47 ) $ ( 25 ) $ ( 26 ) $ ( 28 ) Total $ 114 $ 380 $ 500 $ 11 $ 49 $ 26 $ 8 $ ( 1 ) $ ( 5 ) (a) In 2020, U.S. includes a settlement charge of $ 205 million ($ 158 million after-tax or $ 0.11 per share) related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million ($ 170 million after-tax or $ 0.12 per share) and a pension lump sum settlement charge of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Table of Contents The following table provides the weighted-average assumptions used to determine net periodic benefit cost and projected benefit obligation for our pension and retiree medical plans: Pension Retiree Medical U.S. International 2021 2020 2019 2021 2020 2019 2021 2020 2019 Net Periodic Benefit Cost Service cost discount rate 2.6 % 3.4 % 4.4 % 2.7 % 3.2 % 4.2 % 2.3 % 3.2 % 4.3 % Interest cost discount rate 2.0 % 2.9 % 4.1 % 1.7 % 2.4 % 3.2 % 1.6 % 2.6 % 3.8 % Expected return on plan assets 6.4 % 6.8 % 7.1 % 5.3 % 5.6 % 5.8 % 5.4 % 5.8 % 6.6 % Rate of salary increases 3.0 % 3.1 % 3.1 % 3.3 % 3.3 % 3.7 % Projected Benefit Obligation Discount rate 2.9 % 2.5 % 3.3 % 2.4 % 2.0 % 2.5 % 2.7 % 2.3 % 3.1 % Rate of salary increases 3.0 % 3.0 % 3.1 % 3.3 % 3.3 % 3.3 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit obligation in excess of plan assets: Pension Retiree Medical U.S. International 2021 2020 2021 2020 2021 2020 Selected information for plans with accumulated benefit obligation in excess of plan assets (a) Obligation for service to date $ ( 1,499 ) $ ( 5,537 ) $ ( 127 ) $ ( 172 ) Fair value of plan assets $ 705 $ 4,156 $ 102 $ 123 Selected information for plans with projected benefit obligation in excess of plan assets (a) Benefit obligation $ ( 1,709 ) $ ( 9,172 ) $ ( 286 ) $ ( 2,933 ) $ ( 954 ) $ ( 1,006 ) Fair value of plan assets $ 705 $ 7,088 $ 171 $ 2,696 $ 299 $ 315 (a) The decrease in U.S. pension plans with obligations in excess of plan assets primarily reflects employer contributions to Plan H. Of the total projected pension benefit obligation as of December 25, 2021, approximately $ 810 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2022 2023 2024 2025 2026 2027 - 2031 Pension $ 1,110 $ 960 $ 960 $ 995 $ 1,030 $ 5,385 Retiree medical (a) $ 95 $ 90 $ 90 $ 85 $ 80 $ 355 (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 1 million for each of the years from 2022 through 2026 and approximately $ 4 million in total for 2027 through 2031. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Table of Contents Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical 2021 2020 2019 2021 2020 2019 Discretionary (a) $ 525 $ 339 $ 417 $ $ $ Non-discretionary 213 168 255 47 55 44 Total $ 738 $ 507 $ 672 $ 47 $ 55 $ 44 (a) Includes $ 500 million contribution in 2021, $ 325 million contribution in 2020 and $ 400 million contribution in 2019 to fund our qualified defined benefit plans in the United States. We made a discretionary contribution of $ 75 million to our U.S. qualified defined benefit plans in January 2022 and expect to make an additional $ 75 million contribution in the third quarter of 2022. In addition, in 2022, we expect to make non-discretionary contributions of approximately $ 135 million to our U.S. and international pension benefit plans and approximately $ 55 million for retiree medical benefits. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We also regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan obligations, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected obligations. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2022 and 2021, our expected long-term rate of return on U.S. plan assets is 6.3 % and 6.4 %, respectively. Our target investment allocations for U.S. plan assets are as follows: 2022 2021 Fixed income 56 % 51 % U.S. equity 22 % 24 % International equity 18 % 21 % Real estate 4 % 4 % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets Table of Contents for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2021 and 2020 are categorized consistently by Level 1 (quoted prices in active markets for identical assets), Level 2 (significant other observable inputs) and Level 3 (significant unobservable inputs) in both years and are as follows: Fair Value Hierarchy Level 2021 2020 U.S. plan assets (a) Equity securities, including preferred stock (b) 1 $ 6,387 $ 7,179 Government securities (c) 2 2,523 2,177 Corporate bonds (c) 2 6,210 5,437 Mortgage-backed securities (c) 2 199 119 Contracts with insurance companies (d) 3 9 9 Cash and cash equivalents (e) 1, 2 352 278 Sub-total U.S. plan assets 15,680 15,199 Real estate commingled funds measured at net asset value (f) 478 517 Dividends and interest receivable, net of payables 45 64 Total U.S. plan assets $ 16,203 $ 15,780 International plan assets Equity securities (b) 1 $ 2,232 $ 2,119 Government securities (c) 2 1,053 937 Corporate bonds (c) 2 400 445 Fixed income commingled funds (g) 1 632 509 Contracts with insurance companies (d) 3 43 50 Cash and cash equivalents 1 34 33 Sub-total international plan assets 4,394 4,093 Real estate commingled funds measured at net asset value (f) 221 202 Dividends and interest receivable 9 8 Total international plan assets $ 4,624 $ 4,303 (a) Includes $ 299 million and $ 315 million in 2021 and 2020, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) Invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio was invested in domestic and international corporate preferred stock investments. The common and preferred stock investments are based on quoted prices in active markets. The commingled funds are based on the published price of the fund and include one large-cap fund that represents 11 % and 13 % of total U.S. plan assets for 2021 and 2020, respectively. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 32 % and 30 % of total U.S. plan assets for 2021 and 2020, respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 25, 2021 and December 26, 2020. (e) Includes Level 1 assets of $ 216 million and $ 178 million for 2021 and 2020, respectively, and Level 2 assets of $ 136 million and $ 100 million for 2021 and 2020, respectively. (f) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (g) Based on the published price of the fund. Table of Contents Retiree Medical Cost Trend Rates 2022 2021 Average increase assumed 6 % 6 % Ultimate projected increase 4 % 5 % Year of ultimate projected increase 2046 2040 These assumed health care cost trend rates have an impact on the retiree medical plan expense and obligation, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement and we make Company matching contributions for certain employees on a portion of employee contributions based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution based on age and years of service regardless of employee contribution. In 2021, 2020 and 2019, our total Company contributions were $ 246 million, $ 225 million and $ 197 million, respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2021 (a) 2020 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,872 $ 3,358 Commercial paper ( 0.1 % and 0.2 %) 400 396 Other borrowings ( 2.2 % and 1.7 %) 36 26 $ 4,308 $ 3,780 Long-term debt obligations (b) Notes due 2021 ( 2.2 %) $ $ 3,356 Notes due 2022 ( 2.4 % and 2.5 %) 3,868 3,867 Notes due 2023 ( 1.5 % and 1.5 %) 3,019 3,017 Notes due 2024 ( 2.1 % and 2.1 %) 2,986 3,067 Notes due 2025 ( 2.7 % and 2.7 %) 3,230 3,227 Notes due 2026 ( 3.2 % and 3.2 %) 2,450 2,492 Notes due 2027-2060 ( 2.6 % and 2.8 %) 24,313 24,673 Other, due 2021-2027 ( 1.3 % and 1.3 %) 32 29 39,898 43,728 Less: current maturities of long-term debt obligations 3,872 3,358 Total $ 36,026 $ 40,370 (a) Amounts are shown net of unamortized net discounts of $ 233 million and $ 260 million for 2021 and 2020, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. As of December 25, 2021 and December 26, 2020, our international debt of $ 38 million and $ 29 million, respectively, was related to borrowings from external parties, including various lines of credit. These lines Table of Contents of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2021, we issued the following senior notes: Interest Rate Maturity Date Amount (a) 0.750 % October 2033 1,000 1.950 % October 2031 $ 1,250 2.625 % October 2041 $ 750 2.750 % October 2051 $ 1,000 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. The net proceeds from the issuances of the above notes will be used for general corporate purposes, including the repurchase of outstanding indebtedness and the repayment of commercial paper. In 2021, we paid $ 4.8 billion in cash in connection with the tender of certain notes redeemed in the following amounts: Interest Rate Maturity Date Principal Amount Tendered 5.500 % May 2035 $ 8 5.500 % May 2035 $ 1 (a) 5.500 % January 2040 $ 26 3.500 % March 2040 $ 443 4.875 % November 2040 $ 30 4.000 % March 2042 $ 261 3.600 % August 2042 $ 210 4.250 % October 2044 $ 190 4.600 % July 2045 $ 203 4.450 % April 2046 $ 532 3.450 % October 2046 $ 622 4.000 % May 2047 $ 212 3.375 % July 2049 $ 508 3.625 % March 2050 $ 611 3.875 % March 2060 $ 240 (a) Series A. As a result of the cash tender offers, we recorded a pre-tax charge of $ 842 million ($ 677 million after-tax or $ 0.49 per share) to net interest expense and other, primarily representing the tender price paid over the carrying value of the tendered notes and loss on treasury rate locks used to mitigate the interest rate risk on the cash tender offers. See Note 9 to our consolidated financial statements for the mark-to-market impact of treasury rate locks associated with the cash tender offers. In 2021, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement), which expires on May 28, 2026. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). Additionally, we may, once a year, Table of Contents request renewal of the agreement for an additional one-year period. The Five-Year Credit Agreement replaced our $ 3.75 billion five year credit agreement, dated as of June 3, 2019. Also in 2021, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement), which expires on May 27, 2022. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which term loan would mature no later than the anniversary of the then effective termination date. The 364-Day Credit Agreement replaced our $ 3.75 billion 364-day credit agreement, dated as of June 1, 2020. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 25, 2021, there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2020, one of our international consolidated subsidiaries borrowed 21.7 billion South African rand, or approximately $ 1.3 billion, from our two unsecured bridge loan facilities (Bridge Loan Facilities) to fund our acquisition of Pioneer Foods. These borrowings were fully repaid in April 2020 and no further borrowings under these Bridge Loan Facilities are permitted. In 2021, we paid $ 750 million to redeem all $ 750 million outstanding principal amount of our 1.70 % senior notes due 2021 and terminated the associated interest rate swap with a notional amount of $ 250 million. In 2020, we paid $ 1.1 billion to redeem all $ 1.1 billion outstanding principal amount of our 2.15 % senior notes due 2020 and terminated associated interest rate swaps with a notional amount of $ 0.8 billion. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. We do not use derivative instruments for trading or speculative purposes. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other Table of Contents comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 25, 2021 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. Credit Risk We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below either of these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position as of December 25, 2021 was $ 247 million. We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 25, 2021. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.6 billion as of December 25, 2021 and $ 1.1 billion as of December 26, 2020. Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Table of Contents Our foreign currency derivatives had a total notional value of $ 2.8 billion as of December 25, 2021 and $ 1.9 billion as of December 26, 2020. The total notional amount of our debt instruments designated as net investment hedges was $ 2.1 billion as of December 25, 2021 and $ 2.7 billion as of December 26, 2020. For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 2.1 billion as of December 25, 2021 and $ 3.0 billion as of December 26, 2020. As of December 25, 2021, approximately 2 % of total debt was subject to variable rates, compared to approximately 3 %, after the impact of the related interest rate derivative instruments, as of December 26, 2020. Held-to-Maturity Debt Securities Investments in debt securities that we have the positive intent and ability to hold until maturity are classified as held-to-maturity. Highly liquid debt securities with original maturities of three months or less are recorded as cash equivalents. Our held-to-maturity debt securities consist of U.S. Treasury securities and commercial paper. As of December 25, 2021, we had no investments in U.S. Treasury securities. As of December 26, 2020, we had $ 2.1 billion of investments in U.S. Treasury securities with $ 2.0 billion recorded in cash and cash equivalents and $ 0.1 billion in short-term investments. As of December 25, 2021, we had $ 130 million of investments in commercial paper recorded in cash and cash equivalents. As of December 26, 2020, we had $ 260 million of investments in commercial paper with $ 75 million recorded in cash and cash equivalents and $ 185 million in short-term investments. Held-to-maturity debt securities are recorded at amortized cost, which approximates fair value, and realized gains or losses are reported in earnings. Our investments mature in less than one year. As of December 25, 2021 and December 26, 2020, gross unrecognized gains and losses and the allowance for expected credit losses were not material. Table of Contents Fair Value Measurements The fair values of our financial assets and liabilities as of December 25, 2021 and December 26, 2020 are categorized as follows: 2021 2020 Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Index funds (b) 1 $ 337 $ $ 231 $ Prepaid forward contracts (c) 2 $ 21 $ $ 18 $ Deferred compensation (d) 2 $ $ 505 $ $ 477 Contingent consideration (e) 3 $ $ $ $ 861 Derivatives designated as fair value hedging instruments: Interest rate (f) 2 $ $ $ 2 $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) 2 $ 29 $ 14 $ 9 $ 71 Interest rate (g) 2 14 264 13 307 Commodity (h) 2 70 5 32 $ 113 $ 283 $ 54 $ 378 Derivatives not designated as hedging instruments: Foreign exchange (g) 2 $ 19 $ 7 $ 4 $ 8 Commodity (h) 2 35 22 19 7 $ 54 $ 29 $ 23 $ 15 Total derivatives at fair value (i) $ 167 $ 312 $ 79 $ 393 Total $ 525 $ 817 $ 328 $ 1,731 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (c) Based primarily on the price of our common stock. (d) Based on the fair value of investments corresponding to employees investment elections. (e) In connection with our acquisition of Rockstar, we recorded a liability for tax-related contingent consideration payable over up to 15 years, with an option to accelerate all remaining payments, with estimated maximum payments of approximately $ 1.1 billion, using current tax rates. The fair value of the liability is estimated using probability-weighted, discounted future cash flows at current tax rates. In the fourth quarter of 2021, we exercised our option to accelerate all remaining payments. The change in the contingent consideration in 2021 is comprised of the fourth quarter payment of $ 773 million, a recognized pre-tax gain of $ 86 million ($ 66 million after-tax or $ 0.05 per share), recorded in selling, general and administrative expenses, and a fair value decrease of $ 2 million, recorded in goodwill as a result of the finalization of purchase price allocation. (f) Based on London Interbank Offered Rate forward rates. As of December 25, 2021, we had no hedged fixed-rate debt. As of December 26, 2020, the carrying amount of hedged fixed-rate debt was $ 0.2 billion and classified on our balance sheet within short-term debt obligations. As of December 25, 2021, there were no fair value hedging adjustments to hedged fixed-rate debt. As of December 26, 2020, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was a $ 2 million gain. As of December 25, 2021, the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 2 million net loss, which is being amortized over the remaining life of the related debt obligations. (g) Based on recently reported market transactions of spot and forward rates. (h) Primarily based on recently reported market transactions of swap arrangements. (i) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 25, 2021 and December 26, 2020 were not material. Collateral received or posted against our asset or liability positions was not material. Exchange-traded commodity futures are cash-settled on a daily basis and, therefore, not included in the table as of December 25, 2021. Table of Contents The carrying amounts of our cash and cash equivalents and short-term investments recorded at amortized cost approximate fair value (classified as Level 2 in the fair value hierarchy) due to their short-term maturity. The fair value of our debt obligations as of December 25, 2021 and December 26, 2020 was $ 43 billion and $ 50 billion, respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) 2021 2020 2021 2020 2021 2020 Foreign exchange $ ( 4 ) $ $ ( 7 ) $ ( 9 ) $ 82 $ ( 43 ) Interest 56 ( 6 ) 44 ( 96 ) 64 ( 129 ) Commodity ( 218 ) 53 ( 285 ) ( 21 ) ( 194 ) 56 Net investment ( 192 ) 235 Total $ ( 166 ) $ 47 $ ( 440 ) $ 109 $ ( 48 ) $ ( 116 ) (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from treasury rate locks, with a total notional value of $ 3.2 billion, to mitigate the interest rate risk on the cash tender offers and are included in net interest expense and other. See Note 8 to our consolidated financial statements for further information. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains on cross-currency interest rate swaps are included in selling, general and administrative expenses. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net gains of $ 176 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Table of Contents Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: 2021 2020 2019 Income Shares (a) Income Shares (a) Income Shares (a) Basic net income attributable to PepsiCo per common share $ 5.51 $ 5.14 $ 5.23 Net income available for PepsiCo common shareholders $ 7,618 1,382 $ 7,120 1,385 $ 7,314 1,399 Dilutive securities: Stock options, RSUs, PSUs and other (b) 7 7 8 Diluted $ 7,618 1,389 $ 7,120 1,392 $ 7,314 1,407 Diluted net income attributable to PepsiCo per common share $ 5.49 $ 5.12 $ 5.20 (a) Weighted-average common shares outstanding (in millions). (b) The dilutive effect of these securities is calculated using the treasury stock method. The weighted-average amount of antidilutive securities excluded from the calculation of diluted earnings per common share was immaterial for the years ended December 25, 2021, December 26, 2020 and December 28, 2019. Table of Contents Note 11 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Other (a) Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 29, 2018 (b) $ ( 11,918 ) $ 87 $ ( 3,271 ) $ ( 17 ) $ ( 15,119 ) Other comprehensive income/(loss) before reclassifications (c) 636 ( 131 ) ( 89 ) ( 2 ) 414 Amounts reclassified from accumulated other comprehensive loss 14 468 482 Net other comprehensive income/(loss) 636 ( 117 ) 379 ( 2 ) 896 Tax amounts ( 8 ) 27 ( 96 ) ( 77 ) Balance as of December 28, 2019 (b) ( 11,290 ) ( 3 ) ( 2,988 ) ( 19 ) ( 14,300 ) Other comprehensive (loss)/income before reclassifications (d) ( 710 ) 126 ( 1,141 ) ( 1 ) ( 1,726 ) Amounts reclassified from accumulated other comprehensive loss ( 116 ) 465 349 Net other comprehensive (loss)/income ( 710 ) 10 ( 676 ) ( 1 ) ( 1,377 ) Tax amounts 60 ( 3 ) 144 201 Balance as of December 26, 2020 (b) ( 11,940 ) 4 ( 3,520 ) ( 20 ) ( 15,476 ) Other comprehensive (loss)/income before reclassifications (e) ( 340 ) 248 702 22 632 Amounts reclassified from accumulated other comprehensive loss 18 ( 48 ) 299 269 Net other comprehensive (loss)/income ( 322 ) 200 1,001 22 901 Tax amounts ( 47 ) ( 45 ) ( 231 ) ( 323 ) Balance as of December 25, 2021 (b) $ ( 12,309 ) $ 159 $ ( 2,750 ) $ 2 $ ( 14,898 ) (a) The change in 2021 primarily comprises fair value increases in available-for-sale securities. (b) Pension and retiree medical amounts are net of taxes of $ 1,466 million as of December 29, 2018, $ 1,370 million as of December 28, 2019, $ 1,514 million as of December 26, 2020 and $ 1,283 million as of December 25, 2021. (c) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. (d) Currency translation adjustment primarily reflects the depreciation of the Russian ruble and Mexican peso. (e) Currency translation adjustment primarily reflects the depreciation of the Turkish lira, Swiss franc and Mexican peso. Table of Contents The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement 2021 2020 2019 Currency translation: Divestitures $ 18 $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ 6 $ $ 1 Net revenue Foreign exchange contracts 76 ( 43 ) 2 Cost of sales Interest rate derivatives 64 ( 129 ) 7 Selling, general and administrative expenses Commodity contracts ( 190 ) 50 3 Cost of sales Commodity contracts ( 4 ) 6 1 Selling, general and administrative expenses Net (gains)/losses before tax ( 48 ) ( 116 ) 14 Tax amounts 11 29 ( 2 ) Net (gains)/losses after tax $ ( 37 ) $ ( 87 ) $ 12 Pension and retiree medical items: Amortization of net prior service credit $ ( 44 ) $ $ ( 9 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses 289 238 169 Other pension and retiree medical benefits income/(expense) Settlement/curtailment losses 54 227 308 Other pension and retiree medical benefits income/(expense) Net losses before tax 299 465 468 Tax amounts ( 65 ) ( 101 ) ( 102 ) Net losses after tax $ 234 $ 364 $ 366 Total net losses reclassified for the year, net of tax $ 215 $ 277 $ 378 Note 12 Leases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years, some of which include options to extend the lease term for up to five years and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Table of Contents Components of lease cost are as follows: 2021 2020 2019 Operating lease cost (a) $ 563 $ 539 $ 474 Variable lease cost (b) $ 112 $ 111 $ 101 Short-term lease cost (c) $ 469 $ 436 $ 379 (a) Includes right-of-use asset amortization of $ 505 million, $ 478 million, and $ 412 million in 2021, 2020, and 2019, respectively. (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. In 2021, 2020 and 2019, we recognized gains of $ 42 million, $ 7 million and $ 77 million, respectively, on sale-leaseback transactions with terms under five years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: 2021 2020 2019 Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ 567 $ 555 $ 478 Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ 934 $ 621 $ 479 Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification 2021 2020 Right-of-use assets Other assets $ 2,020 $ 1,670 Current lease liabilities Accounts payable and other current liabilities $ 446 $ 460 Non-current lease liabilities Other liabilities $ 1,598 $ 1,233 Weighted-average remaining lease term and discount rate for our operating leases are as follows: 2021 2020 2019 Weighted-average remaining lease term 7 years 6 years 6 years Weighted-average discount rate 3 % 4 % 4 % Maturities of lease liabilities by year for our operating leases are as follows: 2022 $ 511 2023 402 2024 314 2025 245 2026 202 2027 and beyond 677 Total lease payments 2,351 Less: Imputed interest 307 Present value of lease liabilities $ 2,044 Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Table of Contents Note 13 Acquisitions and Divestitures 2020 Acquisitions On March 23, 2020, we acquired all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe, for 110.00 South African rand per share in cash. The total consideration transferred was approximately $ 1.2 billion and was funded by two unsecured bridge loan facilities entered into by one of our international consolidated subsidiaries, which were fully repaid in April 2020. In connection with our acquisition of Pioneer Foods, we have made certain commitments to the South Africa Competition Commission, including a commitment to provide the equivalent of 8.8 billion South African rand, or approximately $ 0.5 billion as of the acquisition date, in value for the benefit of our employees, agricultural development, education, developing Pioneer Foods operations and enterprise development programs in South Africa. Included in this commitment is 2.3 billion South African rand, or approximately $ 0.1 billion, relating to the implementation of an employee ownership plan and an agricultural, entrepreneurship and educational development fund, which is an irrevocable condition of the acquisition. This commitment was recorded in selling, general and administrative expenses primarily in the year ended December 26, 2020 and was primarily settled in the fourth quarter of 2021. The remaining commitment of 6.5 billion South African rand, or approximately $ 0.4 billion as of the acquisition date, relates to capital expenditures and/or business-related costs which will be incurred and recorded over a five-year period from the acquisition date. On April 24, 2020, we acquired Rockstar, an energy drink maker with whom we had a distribution agreement prior to the acquisition, for an upfront cash payment of approximately $ 3.85 billion and contingent consideration related to estimated future tax benefits associated with the acquisition of approximately $ 0.88 billion. In the fourth quarter of 2021, we exercised our option to accelerate all remaining payments due under the contingent consideration arrangement. See Note 9 for further information about the contingent consideration. On June 1, 2020, we acquired all of the outstanding shares of Be Cheery, one of the largest online convenient food companies in China, from Haoxiangni Health Food Co., Ltd. for cash. The total consideration transferred was approximately $ 0.7 billion. Table of Contents We accounted for the 2020 transactions as business combinations. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the respective dates of acquisition. The purchase price allocations for each of the 2020 acquisitions were finalized in the second quarter of 2021. The fair value of identifiable assets acquired and liabilities assumed in the acquisitions of Pioneer Foods, Rockstar and Be Cheery and the resulting goodwill as of the respective acquisition dates is summarized as follows: Pioneer Foods Rockstar Be Cheery Acquisition date March 23, 2020 April 24, 2020 June 1, 2020 Inventories $ 229 $ 52 $ 45 Property, plant and equipment 379 8 60 Amortizable intangible assets 52 98 Nonamortizable intangible assets 183 2,400 309 Other assets and liabilities ( 53 ) ( 9 ) ( 24 ) Net deferred income taxes ( 117 ) ( 99 ) Noncontrolling interest ( 5 ) Total identifiable net assets 668 2,451 389 Goodwill 558 2,278 309 Total purchase price $ 1,226 $ 4,729 $ 698 Goodwill is calculated as the excess of the aggregate of the fair value of the consideration transferred over the fair value of the net assets recognized. The goodwill recorded as part of the acquisition of Pioneer Foods primarily reflects synergies expected to arise from our combined brand portfolios and distribution networks, and is not deductible for tax purposes. All of the goodwill is recorded in the AMESA segment. The goodwill recorded as part of the acquisition of Rockstar primarily represents the value of PepsiCos expected new innovation in the energy category and is deductible for tax purposes. All of the goodwill is recorded in the PBNA segment. The goodwill recorded as part of the acquisition of Be Cheery primarily reflects growth opportunities for PepsiCo as we leverage Be Cheerys direct-to-consumer and supply chain capabilities and is not deductible for tax purposes. All of the goodwill is recorded in the APAC segment. Juice Transaction In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners for approximately $ 3.5 billion in cash and a 39 % noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. The North America portion of the transaction was completed on January 24, 2022 and the Europe portion of the transaction was completed on February 1, 2022. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. In connection with the sale, we entered into a transition services agreement with PAI Partners, under which we will provide certain services to the joint venture to help facilitate an orderly transition of the business following the sale. In return for these services, the new joint venture is required to pay certain agreed upon fees to reimburse us for our actual costs without markup. Subsequent to the transaction close date, the purchase price will be adjusted for net working capital and net debt amounts as of the transaction close date compared to targeted amounts set forth in the purchase agreement. We expect to record a pre-tax gain of approximately $ 3 billion in our PBNA and Europe segments in the first quarter of 2022 as a result of this transaction. We have reclassified $ 1.8 billion of assets, primarily accounts receivable, net, and inventories of $ 0.5 billion, goodwill and other intangible assets of $ 0.6 billion and property, plant and equipment of Table of Contents $ 0.5 billion, and liabilities of $ 0.8 billion, primarily accounts payable and other liabilities of $ 0.6 billion and deferred income taxes of $ 0.2 billion, related to the Juice Transaction as held for sale in our consolidated balance sheet as of December 25, 2021. The Juice Transaction does not meet the criteria to be classified as discontinued operations. Acquisition and Divestiture-Related Charges A summary of our acquisition and divestiture-related charges is as follows: 2021 2020 2019 Cost of sales $ 1 $ 32 $ 34 Selling, general and administrative expenses (a) ( 5 ) 223 21 Total $ ( 4 ) $ 255 $ 55 After-tax amount (b) $ ( 27 ) $ 237 $ 47 Impact on net income attributable to PepsiCo per common share $ 0.02 $ ( 0.17 ) $ ( 0.03 ) (a) The income amount primarily relates to the acceleration payment made in the fourth quarter of 2021 under the contingent consideration arrangement associated with our acquisition of Rockstar, which is partially offset by other acquisition and divestiture-related charges. (b) In 2021, includes a tax benefit related to contributions to socioeconomic programs in South Africa. Acquisition and divestiture-related charges primarily include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets (recorded in cost of sales), merger and integration charges and costs associated with divestitures (recorded in selling, general and administrative expenses). Merger and integration charges include liabilities to support socioeconomic programs in South Africa, closing costs, employee-related costs, gains associated with contingent consideration, contract termination costs and other integration costs. Acquisition and divestiture-related charges by division are as follows: 2021 2020 2019 Transaction FLNA $ 2 $ 29 $ BFY Brands PBNA 11 66 Juice Transaction, Rockstar Europe 8 46 Juice Transaction, SodaStream International Ltd. AMESA 10 173 7 Pioneer Foods APAC 4 7 Be Cheery Corporate (a) ( 39 ) ( 20 ) 2 Rockstar, Juice Transaction Total $ ( 4 ) $ 255 $ 55 (a) In 2021, the income amount primarily relates to the acceleration payment made in the fourth quarter of 2021 under the contingent consideration arrangement associated with our acquisition of Rockstar, which is partially offset by divestiture-related charges associated with the Juice Transaction. In 2020, the income amount primarily relates to the change in the fair value of the Rockstar contingent consideration. Table of Contents Note 14 Supplemental Financial Information Balance Sheet 2021 2020 2019 Accounts and notes receivable Trade receivables $ 7,172 $ 6,892 Other receivables 1,655 1,713 Total 8,827 8,605 Allowance, beginning of year 201 105 $ 101 Cumulative effect of accounting change 44 Net amounts charged to expense (a) ( 19 ) 79 22 Deductions (b) ( 25 ) ( 32 ) ( 30 ) Other (c) ( 10 ) 5 12 Allowance, end of year 147 201 $ 105 Net receivables $ 8,680 $ 8,404 Inventories (d) Raw materials and packaging $ 1,898 $ 1,720 Work-in-process 151 205 Finished goods 2,298 2,247 Total $ 4,347 $ 4,172 Property, plant and equipment, net (e) Average Useful Life (Years) Land $ 1,123 $ 1,171 Buildings and improvements 15 - 44 10,279 10,214 Machinery and equipment, including fleet and software 5 - 15 31,486 31,276 Construction in progress 3,940 3,679 46,828 46,340 Accumulated depreciation ( 24,421 ) ( 24,971 ) Total $ 22,407 $ 21,369 Depreciation expense $ 2,484 $ 2,335 $ 2,257 Other assets Noncurrent notes and accounts receivable $ 111 $ 109 Deferred marketplace spending 119 130 Pension plans (f) 1,260 910 Right-of-use assets (g) 2,020 1,670 Other 694 493 Total $ 4,204 $ 3,312 Accounts payable and other current liabilities Accounts payable (h) $ 9,834 $ 8,853 Accrued marketplace spending 3,087 2,935 Accrued compensation and benefits 2,324 2,059 Dividends payable 1,508 1,430 Current lease liabilities (g) 446 460 Other current liabilities 3,960 3,855 Total $ 21,159 $ 19,592 (a) 2021 includes reductions in the previously recorded reserves of $ 32 million, while 2020 includes an allowance for expected credit losses of $ 56 million, related to the COVID-19 pandemic. See Note 1 for further information. (b) Includes accounts written off. (c) Includes adjustments related primarily to currency translation and other adjustments. Table of Contents (d) Approximately 7 % and 6 % of the inventory cost in 2021 and 2020, respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. See Note 2 for further information. (e) See Note 2 for further information. (f) See Note 7 for further information. (g) See Note 12 for further information. (h) Increase reflects higher production payables due to strong business performance across a number of our divisions as well as higher commodity prices, partially offset by liabilities reclassified as held for sale in connection with our Juice Transaction. Statement of Cash Flows 2021 2020 2019 Interest paid (a) $ 1,184 $ 1,156 $ 1,076 Income taxes paid, net of refunds (b) $ 1,933 $ 1,770 $ 2,226 (a) In 2021, excludes the charge related to cash tender offers. See Note 8 for further information. (b) In 2021, 2020 and 2019, includes tax payments of $ 309 million, $ 78 million and $ 423 million, respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. 2021 2020 Cash and cash equivalents $ 5,596 $ 8,185 Restricted cash included in other assets (a) 111 69 Total cash and cash equivalents and restricted cash $ 5,707 $ 8,254 (a) Primarily relates to collateral posted against certain of our derivative positions. Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 25, 2021 and December 26, 2020, the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 25, 2021, and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 25, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 25, 2021 and December 26, 2020, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 25, 2021, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 25, 2021 based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Table of Contents Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Sales incentive accruals As discussed in Note 2 to the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the sales incentive process, including controls related to (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, Table of Contents based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 25, 2021 was $35.5 billion which represents 38% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 25, 2021. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the indefinite-lived assets impairment process, including controls related to the development of forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 25, 2021, the Company recorded reserves for unrecognized tax benefits of $1.9 billion. The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, new tax law, relevant court rulings or tax authority settlements. We identified the evaluation of certain of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is Table of Contents complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, associated external counsel opinions, information from tax examinations, relevant court rulings and tax authority settlements. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 9, 2022 Table of Contents GLOSSARY Acquisitions and divestitures : mergers and acquisitions activity, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver beverages and convenient foods directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by/used for operating activities less capital spending, plus sales of property, plant and equipment. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for the impacts of foreign exchange translation, acquisitions and divestitures, and where applicable, the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Table of Contents Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. Table of Contents ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 25, 2021. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. During our fourth quarter of 2021, we continued migrating certain of our financial processing systems to an ERP solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses in phases over the next several years. In connection with these ERP implementations, we are updating and will continue to update our internal control over financial reporting, as necessary, to accommodate modifications to our business processes and accounting procedures. Beginning in the fourth quarter of 2021 and continuing into the first quarter of 2022, we began implementing these systems, resulting in changes that materially affected our internal control over financial reporting. These system implementations did not have an adverse effect, nor do we expect will have an adverse effect, on our internal control over financial reporting. In addition, in connection with our 2019 multi-year productivity plan, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with this Table of Contents multi-year productivity plan and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes, to maintain effective controls over our financial reporting. These business process changes have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. Except with respect to the continued implementation of ERP systems, there have been no changes in our internal control over financial reporting during our fourth quarter of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We will continue to assess the impact on our internal control over financial reporting as we continue to implement our ERP solution and our 2019 multi-year productivity plan. " +30,PepsiCo,2020," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into seven reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PepsiCo Beverages North America (PBNA), which includes our beverage businesses in the United States and Canada; 4) Latin America (LatAm), which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) Africa, Middle East and South Asia (AMESA), which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and Table of Contents 7) Asia Pacific, Australia and New Zealand and China Region (APAC), which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. QFNAs branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel and Tropicana. PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). In 2020, we acquired Rockstar Energy Beverages (Rockstar), an energy drink maker with whom we had a distribution agreement prior to the acquisition. See Note 14 to our consolidated financial statements for further information about our acquisition of Rockstar. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Table of Contents Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Lubimy Sad, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, as part of its beverage business, manufactures and distributes SodaStream sparkling water makers and related products. Further, Europe makes, markets, distributes and sells a number of dairy products including Agusha, Chudo and Domik v Derevne. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of snack food brands including Chipsy, Doritos, Kurkure, Lays, Sasko, Spekko and White Star, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In 2020, we acquired Pioneer Food Group Ltd. (Pioneer Foods), a food and beverage company in South Africa with exports to countries across the globe. See Note 14 to our consolidated financial statements for further information about our acquisition of Pioneer Foods. Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of snack food brands including BaiCaoWei, Cheetos, Doritos, Lays and Smiths, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). In 2020, we acquired all of the outstanding shares of Hangzhou Haomusi Food Co., Ltd. (Be Cheery), one of the largest online snacks companies in China. See Note 14 to our consolidated financial statements for further information about our acquisition of Be Cheery. COVID-19 The novel coronavirus (COVID-19) pandemic in 2020 resulted in challenging operating environments and affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold, including as a result of travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns Table of Contents and closures. We expect that the COVID-19 pandemic will continue to impact our business operations, including our employees, customers, consumers, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with which we do business. The extent to which the COVID-19 pandemic will impact our future business operations and financial results remains uncertain and will continue to depend on numerous evolving factors outside our control. See Item 1A. Risk Factors for discussion of the risks and uncertainties associated with the COVID-19 pandemic. Also, see Our Business Risks in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 1 to our consolidated financial statements for further information related to the impact of COVID-19 on our 2020 financial results. Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and distribution centers, both company and third-party operated, to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure Table of Contents adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. We also maintain voluntary supply chain finance agreements with several participating global financial institutions, pursuant to which our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to such global financial institutions. These agreements have not had a material impact on our business or financial results. See Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewtr, Aunt Jemima, BaiCaoWei, Bare, Bokomo, Bolt24, bubly, Capn Crunch, Ceres, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Driftwell, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Liquifruit, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Moirs, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Game Fuel, Mountain Dew Ice, Mountain Dew Kickstart, Mountain Dew Zero Sugar, Mug, Munchies, Muscle Milk, Naked, Near East, Off the Eaten Path, O.N.E., Paso de los Toros, Pasta Roni, Pearl Milling Company, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, PopCorners, Pronutro, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rockstar Energy, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Safari, Sakata, Saladitas, San Carlos, Sandora, Santitas, Sasko, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Spekko, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers, Weetbix, White Star, Ya and Yachak. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Bang Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Table of Contents Seasonality Our businesses are affected by seasonal variations. Our beverage, food and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the international expansion of hard discounters, and the current economic environment, including in light of the COVID-19 pandemic, continue to increase the importance of major customers. In 2020, sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 14% of our consolidated net revenue, with sales reported across all of our divisions, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. The loss of this customer would have a material adverse effect on our FLNA, QFNA and PBNA divisions. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Table of Contents Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Utz Brands, Inc. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2020, we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting the needs of our customers and consumers and accelerating growth. These activities principally involve: innovations focused on creating consumer preferred products to grow and transform our portfolio through development of new technologies, ingredients, flavors and substrates; development and improvement of our manufacturing processes including reductions in cost and environmental footprint; implementing product improvements to our global portfolio that reduce added sugars, sodium or saturated fat; offering more products with functional ingredients and positive nutrition including whole grains, fruit, vegetables, dairy, protein, fiber, micronutrients and hydration; development of packaging technology and new package designs, including reducing the amount of plastic in our packaging and developing recyclable and sustainable packaging; development of marketing, merchandising and dispensing equipment; further expanding our beyond the bottle portfolio including innovation for our SodaStream business; investments in technology and digitalization including data analytics to enhance our consumer insights and research; continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and efforts focused on reducing our impact on the environment including reducing water use in our operations and our agricultural practices. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, South Africa, the United Kingdom and the United States, and leverage consumer insights, food science and engineering to meet our strategy to continually innovate our portfolio of convenient foods and beverages. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by Table of Contents government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include, but are not limited to: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act and various state laws and regulations governing workplace health and safety; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; data privacy and personal data protection laws and regulations, including the California Consumer Privacy Act of 2018; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. Table of Contents In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some types of single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Human Capital PepsiCo believes that human capital management, including attracting, developing and retaining a high quality workforce, is critical to our long-term success. Our Board and its Committees provide oversight on a broad range of human capital management topics, including corporate culture, diversity and inclusion, pay equity, health and safety, training and development and compensation and benefits. We employed approximately 291,000 people worldwide as of December 26, 2020, including approximately 120,000 people within the United States. We are party to numerous collective bargaining agreements and believe that relations with our employees are generally good. Protecting the safety, health, and well-being of our associates around the world is PepsiCos top priority. We strive to achieve an injury-free work environment. We also continue to invest in emerging technologies to protect our employees from injuries, including leveraging fleet telematics and distracted driving technology, resulting in reductions in road traffic accidents, and deploying wearable ergonomic risk reduction devices. In addition, throughout the COVID-19 pandemic, we have remained focused on the health and safety of our associates, especially our frontline associates who continue to make, move and sell our products during this critical time, including by implementing new safety protocols in our facilities, providing personal protective equipment and enabling testing. We believe that our culture of diversity and inclusion is a competitive advantage that fuels innovation, enhances our ability to attract and retain talent and strengthens our reputation. We continually strive to Table of Contents improve the attraction, retention, and advancement of diverse associates to ensure we sustain a high-caliber pipeline of talent that also represents the communities we serve. As of December 26, 2020, our global workforce was approximately 25% female, while management roles were approximately 41% female. As of December 26, 2020, approximately 43% of our U.S. workforce was comprised of racially/ethnically diverse individuals, of which approximately 30% of our U.S. associates in managerial roles were racially/ethnically diverse individuals. Direct reports of our Chief Executive Officer include 7 executives globally who are racially/ethnically diverse and/or female. We are also committed to the continued growth and development of our associates. PepsiCo supports and develops its associates through a variety of global training and development programs that build and strengthen employees' leadership and professional skills, including career development plans, mentoring programs and in-house learning opportunities, such as PEP U Degreed, our internal global online learning resource. In 2020, PepsiCo employees completed over 875,000 hours of training. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. The following risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business or financial performance, which in turn can affect the price of our publicly traded securities. These are not the only risks we face. There may be other risks we are not currently aware of or that we currently deem not to be material but may become material in the future. COVID-19 Risks The impact of COVID-19 continues to create considerable uncertainty for our business. Our global operations continue to expose us to risks associated with the COVID-19 pandemic. Authorities around the world have implemented numerous measures to try to reduce the spread of the virus and such measures have impacted and continue to impact us, our business partners and consumers. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen a resurgence of COVID-19 cases resulting in reinstitution or expansion of such measures. Table of Contents We have seen and could continue to see changes in consumer demand as a result of COVID-19, including the inability of consumers to purchase our products due to illness, quarantine or other restrictions, store closures, or financial hardship. We also continue to see shifts in product and channel prefe rences, particularly an increase in demand in the e-commerce channel, which has impacted and could continue to impact our sales and profitability. Reduced demand for our products or changes in consumer purchasing patterns, as well as continued economic uncertainty, can adversely affect our customers financial condition, which can result in bankruptcy filings and/or an inability to pay for our products. In addition, we may also continue to experience business disruptions as a result of COVID-19, resulting from temporary closures of our facilities or facilities of our business partners or the inability of a significant portion of our or our business partners workforce to work because of illness, quarantine, or travel or other governmental restrictions. Any sustained interruption in our or our business partners operations, distribution network or supply chain or any significant continuous shortage of raw materials or other supplies, including personal protective equipment or sanitization products, can negatively impact our business. We have also incurred, and expect to continue to incur, increased employee and operating costs as a result of COVID-19, such as costs related to expanded benefits and frontline incentives, the provision of personal protective equipment and increased sanitation, allowances for credit losses, upfront payment reserves and inventory write-offs, which have negatively impacted and may continue to negatively impact our profitability. In addition, the increase in certain of our employees working remotely has resulted in increased demand on our information technology infrastructure, which can be subject to failure, disruption or unavailability, and increased vulnerability to cyberattacks and other cyber incidents. Also, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. The impact of COVID-19 has heightened, or in some cases manifested, certain of the other risks discussed herein. The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the development and availability of effective treatments and vaccines, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in the future, in response to the pandemic, and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Business Risks Reduction in future demand for our products would adversely affect our business. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including the types of products our consumers want and how they browse for, purchase and consume them. Consumer preferences continuously evolve due to a variety of factors, including: changes in consumer demographics, consumption patterns and channel preferences (including continued rapid increases in the e-commerce and online-to-offline channels); pricing; product quality; concerns or perceptions regarding packaging and its environmental impact (such as single-use and other plastic packaging); and concerns or perceptions regarding the nutrition profile and health effects of, or location of origin of, ingredients or substances in our products. Concerns with any of the foregoing could lead consumers to reduce or publicly boycott the purchase or consumption of our products. Consumer preferences are also influenced by perception of our brand image or the brand images of our products, the success of our advertising and marketing campaigns, our ability to engage with our consumers in the manner they prefer, including through the use of digital media, and the perception of our use, and the use of social media. These and other factors have reduced in the past and could continue to reduce consumers willingness to purchase certain of our products. Any inability on our part to anticipate Table of Contents or react to changes in consumer preferences and trends, or make the right strategic investments to do so, including investments in data analytics to understand consumer trends, can lead to reduced demand for our products, lead to inventory write-offs or erode our competitive and financial position, thereby adversely affecting our business. In addition, our business operations are subject to disruption by natural disasters or other events beyond our control that could negatively impact product availability and decrease demand for our products if our crisis management plans do not effectively resolve these issues. Damage to our reputation or brand image can adversely affect our business. Maintaining a positive reputation globally is critical to selling our products. Our reputation or brand image has in the past been, and could in the future be, adversely impacted by a variety of factors, including: any failure by us or our business partners to maintain high ethical, social, business and environmental practices, including with respect to human rights, child labor laws and workplace conditions and employee health and safety; any failure to achieve our sustainability goals, including with respect to the nutrition profile of our products, packaging, water use and our impact on the environment; any failure to address health concerns about our products or particular ingredients in our products, including concerns regarding whether certain of our products contribute to obesity; our research and development efforts; any product quality or safety issues, including the recall of any of our products; any failure to comply with laws and regulations; consumer perception of our advertising campaigns, sponsorship arrangements, marketing programs and use of social media; or any failure to effectively respond to negative or inaccurate comments about us on social media or otherwise regarding any of the foregoing. Damage to our reputation or brand image has in the past and could in the future decrease demand for our products, thereby adversely affecting our business. Issues or concerns with respect to product quality and safety can adversely affect our business. Product quality or safety issues, including alleged mislabeling, misbranding, spoilage, undeclared allergens, adulteration or contamination, whether as a result of failure to comply with food safety laws or otherwise, have in the past and could in the future reduce consumer confidence and demand for our products, cause production and delivery disruptions, require product recalls and result in increased costs (including payment of fines and/or judgments) and damage our reputation, all of which can adversely affect our business. Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries or civil or criminal proceedings, all of which may result in fines, penalties, damages or criminal liability. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any inability to compete effectively can adversely affect our business. Our products compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label and economy brand manufacturers and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Our products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends. Our business can be adversely affected if we are unable to effectively promote or develop our existing products or introduce new products, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively, and we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures. Table of Contents Failure to attract, develop and maintain a highly skilled and diverse workforce can have an adverse effect on our business. Our business requires that we attract, develop and maintain a highly skilled and diverse workforce. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to attract, retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to attract, develop and maintain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. In addition, failure to attract, retain and develop associates from underrepresented communities can damage our business results and our reputation. Any of the foregoing can adversely affect our business. Water scarcity can adversely affect our business. We and our business partners use water in the manufacturing and sourcing of our products. Lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations or the operations of our business partners; higher compliance costs; capital expenditures (including investments in the development of technologies to enhance water efficiency and reduce consumption); higher production costs, including less favorable pricing for water; the interruption or cessation of operations at, or relocation of, our facilities or the facilities of our business partners; failure to achieve our sustainability goals relating to water use; perception of our failure to act responsibly with respect to water use or to effectively respond to legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business. Changes in the retail landscape or in sales to any key customer can adversely affect our business. The retail landscape continues to evolve, including rapid growth in e-commerce channels and hard discounters. Our business will be adversely affected if we are unable to maintain and develop successful relationships with e-commerce retailers and hard discounters, while also maintaining relationships with our key customers operating in traditional retail channels (many of whom are also focused on increasing their e-commerce sales). Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers or we fail to find ways to create more powerful digital tools and capabilities for our retail customers to enable them to grow their businesses. In addition, our business can be adversely affected if we are unable to profitably expand our own direct-to-consumer e-commerce capabilities. The retail industry is also impacted by increased consolidation of ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, impacting our ability to compete in these areas. Consolidation also adversely impacts our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, we must maintain mutually beneficial relationships with our key customers, including Walmart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business. Table of Contents Disruption of our supply chain may adversely affect our business. Many of the raw materials and supplies used in the production of our products are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions. Some raw materials and supplies, including packaging materials such as recycled PET, are available only from a limited number of suppliers or from a sole supplier or are in short supply when seasonal demand is at its peak. There can be no assurance that we will be able to maintain favorable arrangements and relationships with suppliers or that our contingency plans will be effective to prevent disruptions that may arise from shortages or discontinuation of any raw materials and other supplies that we use in the manufacture, production and distribution of our products. The raw materials and other supplies, including agricultural commodities and fuel, that we use for the manufacturing, production and distribution of our products are subject to price volatility and fluctuations in availability caused by many factors, including changes in supply and demand, weather conditions (including potential effects of climate change), fire, natural disasters, disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Many of our raw materials and supplies are purchased in the open market. The prices we pay for such items are subject to fluctuation. If price changes result in unexpected or significant increases in the costs of any raw materials or other supplies, we may be unwilling or unable to increase our product prices or unable to effectively hedge against price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. Political and social conditions can adversely affect our business. Political and social conditions in the markets in which our products are sold have been and could continue to be difficult to predict, resulting in adverse effects on our business. The results of elections, referendums or other political conditions (including government shutdowns) in these markets, including the United Kingdoms withdrawal from the European Union, have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or result in uncertainty as to how such laws, regulations, programs or policies may change, including with respect to tariffs, sanctions, environmental and climate change regulations, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products, any of which can adversely affect our business. In addition, political and social conditions in certain cities throughout the U.S. as well as globally have resulted in demonstrations and protests, including in connection with political elections and civil rights and liberties. Our operations, including the distribution of our products and the ingredients or other raw materials used in the production of our products, may be disrupted if such events persist for a prolonged period of time, including due to actions taken by governmental authorities in affected cities and regions, which can adversely affect our business. Our business can be adversely affected if we are unable to grow in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China, South Africa and India. There can be no assurance that our products will be accepted or be successful in any particular developing or emerging market, due to competition, price, cultural differences, consumer preferences, method of distribution or otherwise. Our business in these markets has been and could continue in the future to be impacted by economic, political and social conditions; acts of war, terrorist acts, and civil unrest, including demonstrations and protests; competition; tariffs, sanctions or other regulations restricting contact with Table of Contents certain countries in these markets; foreign ownership restrictions; nationalization of our assets or the assets of our business partners; government-mandated closure, or threatened closure, of our operations or the operations of our business partners; restrictions on the import or export of our products or ingredients or substances used in our products; highly inflationary economies; devaluation or fluctuation or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with laws and regulations. Our business can be adversely affected if we are unable to expand our business in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets. Changes in economic conditions can adversely impact our business. Many of the jurisdictions in which our products are sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns, which have and could continue to result in adverse changes in interest rates, tax laws or tax rates; volatile commodity markets; highly inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit; demonetization, austerity or stimulus measures; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are sold; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our business partners, including financial institutions with whom we do business, and any negative impact on any of the foregoing may also have an adverse impact on our business. Future cyber incidents and other disruptions to our information systems can adversely affect our business. We depend on information systems and technology, including public websites and cloud-based services, for many activities important to our business, including communications within our company, interfacing with customers and consumers; ordering and managing inventory; managing and operating our facilities; protecting confidential information; maintaining accurate financial records and complying with regulatory, financial reporting, legal and tax requirements. Our business has in the past and could in the future be negatively affected by system shutdowns, degraded systems performance, systems disruptions or security incidents. These disruptions or incidents may be caused by cyberattacks and other cyber incidents, network or power outages, software, equipment or telecommunications failures, the unintentional or malicious actions of employees or contractors, natural disasters, fires or other catastrophic events. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals with a wide range of expertise and motives. Cyberattacks and cyber incidents take many forms including cyber extortion, denial of service, social engineering, introduction of viruses or malware, exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromise. As with other global companies, we are regularly subject to cyberattacks and other cyber incidents, including many of the types of attacks and incidents described above. If we do not allocate and effectively manage the resources necessary to continue to build and maintain our information technology infrastructure, or if Table of Contents we fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, our business can be adversely affected, resulting in transaction errors, processing inefficiencies, data loss, legal claims or proceedings, regulatory penalties, and the loss of sales and customers. Similar risks exist with respect to third-party providers, including cloud-based service providers, that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and the systems managed, hosted, provided and/or used by such third parties and their vendors. The need to coordinate with various third-party service providers, including with respect to timely notification and access to personnel and information concerning an incident, may complicate our efforts to resolve issues that arise. As a result, we are subject to the risk that the activities associated with our third-party service providers can adversely affect our business even if the attack or breach does not directly impact our systems or information. Although the cyber incidents and other systems disruptions that we have experienced to date have not had a material effect on our business, such incidents or disruptions could have a material adverse effect on us in the future. While we devote significant resources to network security, disaster recovery, employee training and other security measures to protect our systems and data, there are no assurances that such measures will protect us against all cyber incidents or systems disruptions. In addition, while we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents and information systems failures, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Failure to successfully complete or manage strategic transactions can adversely affect our business. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, distribution agreements, divestitures, refranchisings and other strategic transactions. The success of these transactions is dependent upon, among other things, our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals; and diversion of managements attention from day-to-day operations. Risks associated with strategic transactions include integrating manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; operating through new business models or in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming controls (including internal control over financial reporting and disclosure controls and procedures) and policies (including with respect to environmental compliance, health and safety compliance and compliance with anti-bribery laws); retaining existing customers and consumers and attracting new customers and consumers; managing tax costs or inefficiencies; maintaining good relations with divested or refranchised businesses in our supply or sales chain; managing the impact of business decisions or other actions or omissions of our joint venture partners that may have different interests than we do; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. Strategic transactions that are not successfully completed or managed effectively, or our failure to effectively manage the risks associated with such transactions, have in the past and could continue to result in adverse effects on our business. Our reliance on third-party service providers can have an adverse effect on our business. We rely on third-party service providers, including cloud data service providers, for certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. Failure by these third parties to meet their contractual, regulatory and other obligations to us, or our failure to adequately monitor their performance, has in the past and could Table of Contents continue to result in our inability to achieve the expected cost savings or efficiencies and result in additional costs to correct errors made by such service providers. Depending on the function involved, such errors can also lead to business disruption, systems performance degradation, processing inefficiencies or other systems disruptions, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, damage to our reputation or have a negative impact on employee morale, all of which can adversely affect our business. In addition, we continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, our business could be adversely affected. Climate change or measures to address climate change can negatively affect our business or damage our reputation. Climate change may have a negative effect on agricultural productivity which may result in decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as potatoes, sugar cane, corn, wheat, rice, oats, oranges and other fruits (and fruit-derived oils). In addition, climate change may also increase the frequency or severity of natural disasters and other extreme weather conditions, which could impair our production capabilities, disrupt our supply chain or impact demand for our products. Also, concern over climate change may result in new or increased legal and regulatory requirements to reduce or mitigate the effects of climate change, which could result in significant increased costs and require additional investments in facilities and equipment. As a result, the effects of climate change can negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception of a failure to act responsibly with respect to the environment or to effectively respond to regulatory requirements concerning climate change can lead to adverse publicity, resulting in an adverse effect on our business or damage to our reputation. Strikes or work stoppages can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions can occur if we are unable to renew, or enter into new, collective bargaining agreements on satisfactory terms and can impair manufacturing and distribution of our products, lead to a loss of sales, increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy, all of which can adversely affect our business. Financial Risks Failure to realize benefits from our productivity initiatives can adversely affect our financial performance. Our future growth depends, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models. We continue to identify and implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently. Some of these measures result in unintended consequences, such as business disruptions, distraction of management and employees, reduced morale and productivity, unexpected employee attrition, an inability to attract or retain key personnel and negative publicity. If we are unable to successfully implement our productivity initiatives as planned or do not achieve expected savings as a Table of Contents result of these initiatives, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our financial performance. A deterioration in our estimates and underlying assumptions regarding the future performance of our business can result in an impairment charge that can adversely affect our results of operations. We conduct impairment tests on our goodwill and other indefinite-lived intangible assets annually or more frequently if circumstances indicate that impairment may have occurred. In addition, amortizable intangible assets, property, plant and equipment and other long-lived assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. A deterioration in our underlying assumptions regarding the impact of competitive operating conditions, macroeconomic conditions or other factors used to estimate the future performance of any of our reporting units or assets, including any deterioration in the weighted-average cost of capital based on market data available at the time, can result in an impairment, which can adversely affect our results of operations. Fluctuations in exchange rates impact our financial performance. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Given our global operations, we also pay for the ingredients, raw materials and commodities used in our business in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our financial performance. Our borrowing costs and access to capital and credit markets can be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us and their ratings are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the state of the economy and our industry. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. Any downgrade or announcement that we are under review for a potential downgrade of our credit ratings, especially any downgrade to below investment grade, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, result in a reduction in our liquidity, or impair our ability to access the commercial paper market with the same flexibility that we have experienced historically (and therefore require us to rely more heavily on more expensive types of debt financing), all of which can adversely affect our financial performance. Legal, Tax and Regulatory Risks Taxes aimed at our products can adversely affect our business or financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of certain of our products, particularly our beverages, as a result of the ingredients or substances contained in our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain amount of added sugar (or other sweetener), some apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and others apply a flat tax rate on beverages containing any amount of added sugar (or other sweetener). For example, Poland enacted a graduated tax on all sweetened beverages, effective January 1, 2021, at a rate of PLN 0.5 (USD 0.12) per liter for drinks with a sugar (or other sweetener) content of up to 5g per 100ml and an additional PLN 0.05 (USD 0.01) for each gram of sugar (or other sweetener) over 5g . These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain Table of Contents of our products, reduce overall consumption of our products or lead to negative publicity, resulting in an adverse effect on our business and financial performance. Limitations on the marketing or sale of our products can adversely affect our business and financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, limitations on the marketing or sale of our products as a result of ingredients or substances in our products. These limitations require that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. For example, Mexico has imposed a stop-sign labeling scheme to signal the presence of non-caloric sweeteners and caffeine in pre-packaged foods and non-alcoholic beverages. Certain jurisdictions have imposed or are considering imposing color-coded labeling requirements where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat, in products. The imposition or proposed imposition of additional limitations on the marketing or sale of our products has in the past and could continue to reduce overall consumption of our products, lead to negative publicity or leave consumers with the perception that our products do not meet their health and wellness needs, resulting in an adverse effect on our business and financial performance. Laws and regulations related to the use or disposal of plastics or other packaging can adversely affect our business and financial performance. Certain of our products are sold in plastic or other packaging designed to be recyclable. However, not all packaging is recycled, whether due to lack of infrastructure or otherwise, and certain of our packaging is not currently recyclable. Packaging waste that displays one or more of our brands has in the past resulted in and could continue to result in negative publicity or reduced consumer demand for our products, adversely affecting our financial performance. Many jurisdictions in which our products are sold have imposed or are considering imposing regulations or policies intended to encourage the use of sustainable packaging, waste reduction or increased recycling rates or to restrict the sale of products utilizing certain packaging. These regulations vary in form and scope and include taxes to incentivize behavior, restrictions on certain products and materials, requirements for bottle caps to be tethered to bottles, bans on the use of single-use plastics, extended producer responsibility policies and requirements to charge deposit fees. For example, the European Union has imposed a minimum recycled content requirement for beverage bottles packaging and similar legislation is under consideration in several states in the United States. These laws and regulations have in the past and could continue to increase the cost of our products, impact demand for our products, result in negative publicity and require us and our business partners, including our independent bottlers, to increase our capital expenditures to invest in minimizing the amount of plastic or other materials used in our packaging or to develop alternative packaging, all of which can adversely affect our business and financial performance. Failure to comply with personal data protection and privacy laws can adversely affect our business. We are subject to a variety of continuously evolving and developing laws and regulations in numerous jurisdictions regarding personal data protection and privacy laws. These laws and regulations may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with these laws and regulations, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation or residents of the state of California who are covered by the California Consumer Privacy Act, impose significant costs and challenges that are likely to continue to increase over time. Failure to comply with these laws and regulations can result in litigation, claims, legal or regulatory proceedings, inquiries or investigations or damage to our reputation, all of which can adversely affect our business. Table of Contents Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our financial performance. Increases in income tax rates or other changes in tax laws, including changes in how existing tax laws are interpreted or enforced, can adversely affect our financial performance. For example, economic and political conditions in countries where we are subject to taxes, including the United States, have in the past and could continue to result in significant changes in tax legislation or regulation, including as a result of any changes enacted during the new U.S. presidential administration. The increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our financial performance. We are also subject to regular reviews, examinations and audits by numerous taxing authorities with respect to income and non-income based taxes. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. If we are unable to adequately protect our intellectual property rights, or if we are found to infringe on the intellectual property rights of others, our business can be adversely affected. We possess intellectual property rights that are important to our business, including ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets. The laws of various jurisdictions in which we operate have differing levels of protection of intellectual property. Our competitive position and the value of our products and brands can be reduced and our business adversely affected if we fail to obtain or adequately protect our intellectual property, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections afforded our intellectual property. Also, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed on the intellectual property rights of others, directly or indirectly, such finding can damage our reputation and limit our ability to introduce new products or improve the quality of existing products, resulting in an adverse effect on our business. Failure to comply with laws and regulations applicable to our business can adversely affect our business. The conduct of our business is subject to numerous laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content (including whether a product contains genetically engineered ingredients), quality, safety, transportation, traceability, packaging, disposal, recycling and use of our products, employment and occupational health and safety, environmental matters (including pesticide use) and data privacy and protection. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position, as is compliance with anti-corruption laws. The imposition of new laws, changes in laws or regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business. In addition, if one jurisdiction imposes or proposes to impose new laws or regulations that impact the manufacture, distribution or sale of our products, other jurisdictions can often follow. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, all of which can adversely affect our business. Table of Contents Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients, intellectual property rights, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. Responding to these matters, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image. Any of the foregoing can adversely affect our business. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2020 year and that remain unresolved. Table of Contents ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: Property Type Location Owned/ Leased FLNA Research and development facility Plano, Texas Owned QFNA Food plant Cedar Rapids, Iowa Owned PBNA Research and development facility Valhalla, New York Owned PBNA Concentrate plant Arlington, Texas Owned PBNA Tropicana plant Bradenton, Florida Owned LatAm Snack plant Celaya, Mexico Owned LatAm Two snack plants Vallejo, Mexico Owned Europe Snack plant Kashira, Russia Owned Europe Manufacturing plant Lehavim, Israel Owned Europe Dairy plant Moscow, Russia Owned (a) AMESA Snack plant Riyadh, Saudi Arabia Owned (a) APAC Snack plant Wuhan, China Owned (a) FLNA, QFNA, PBNA Shared service center Winston Salem, North Carolina Leased PBNA, LatAm Concentrate plant Colonia, Uruguay Owned (a) PBNA, Europe, AMESA Two concentrate plants Cork, Ireland Owned PBNA, AMESA, APAC Concentrate plant Singapore Owned (a) All divisions Shared service center Hyderabad, India Leased (a) The land on which these plants are located is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 4, 2021, there were approximately 105,807 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 4, 2021, the Board of Directors declared a quarterly dividend of $1.0225 payable March 31, 2021, to shareholders of record on March 5, 2021. For the remainder of 2021, the record dates for these dividend payments are expected to be June 4, September 3 and December 3, 2021, subject to approval of the Board of Directors. On February 11, 2021, we announced a 5% increase in our annualized dividend to $4.30 per share from $4.09 per share, effective with the dividend expected to be paid in June 2021. We expect to return a total of approximately $5.9 billion to shareholders in 2021, comprised of dividends of approximately $5.8 billion and share repurchases of approximately $100 million. We have recently completed our share repurchase activity and do not expect to repurchase any additional shares for the balance of 2021. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2020 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/5/2020 $ 9,525 9/6/2020 - 10/3/2020 1.0 $ 134.59 1.0 (137) 9,388 10/4/2020 - 10/31/2020 0.9 $ 138.83 0.9 (125) 9,263 11/1/2020 - 11/28/2020 0.9 $ 141.82 0.9 (120) 9,143 11/29/2020 - 12/26/2020 0.4 $ 144.83 0.4 (59) Total 3.2 $ 139.04 3.2 $ 9,084 (a) All shares were repurchased in open market transactions pursuant to the $15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. Table of Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview 29 Our Operations 30 Other Relationships 30 Our Business Risks 30 OUR FINANCIAL RESULTS Results of Operations Consolidated Review 35 Results of Operations Division Review 37 FLNA 39 QFNA 39 PBNA 39 LatAm 40 Europe 40 AMESA 41 APAC 41 Results of Operations Other Consolidated Results 42 Non-GAAP Measures 42 Items Affecting Comparability 44 Our Liquidity and Capital Resources 47 Return on Invested Capital 51 OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition 52 Goodwill and Other Intangible Assets 53 Income Tax Expense and Accruals 54 Pension and Retiree Medical Plans 55 Consolidated Statement of Income 58 Consolidated Statement of Comprehensive Income 59 Consolidated Statement of Cash Flows 60 Consolidated Balance Sheet 62 Consolidated Statement of Equity 63 Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions 64 Note 2 Our Significant Accounting Policies 68 Note 3 Restructuring and Impairment Charges 72 Note 4 Intangible Assets 76 Note 5 Income Taxes 78 Note 6 Share-Based Compensation 82 Note 7 Pension, Retiree Medical and Savings Plans 86 Note 8 Debt Obligations 92 Note 9 Financial Instruments 94 Note 10 Net Income Attributable to PepsiCo per Common Share 99 Note 11 Preferred Stock 99 Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo 100 Note 13 Leases 101 Note 14 Acquisitions and Divestitures 103 Note 15 Supplemental Financial Information 105 Report of Independent Registered Public Accounting Firm 107 GLOSSARY 111 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. Discussion in this Form 10-K includes results of operations and financial condition for 2020 and 2019 and year-over-year comparisons between 2020 and 2019. For discussion on results of operations and financial condition pertaining to 2018 and year-over-year comparisons between 2019 and 2018, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 28, 2019. OUR BUSINESS Executive Overview PepsiCo is a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories Everything we do is driven by an approach we call Winning with Purpose. Winning with Purpose is our guide for achieving accelerated, sustainable growth that includes our mission, to Create More Smiles with Every Sip and Every Bite; our vision, to Be the Global Leader in Convenient Foods and Beverages by Winning with Purpose; and The PepsiCo Way, seven behaviors that define our shared culture. This approach proved prescient and powerful in 2020 as we faced a worsening climate crisis, renewed calls for racial equality, and the first global pandemic in a century. Life in communities around the world was transformed, and our business was tested like never before. First and foremost, we had to protect the health of our associates, so that we could continue to serve our consumers, customers and communities. At the same time, we had to secure our supply chain; ensure continuity in manufacturing, distribution and sales; further strengthen our e-commerce and digital capabilities; reimagine our marketing; deliver positive outcomes for people, our shareholders and the planet; and much more. These challenges were in addition to the structural issues facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To meet this once in a generation moment and ensure our Companys long-term success, we will continue to focus on becoming Faster, Stronger, and Better: We will become Faster by sustaining or improving growth and market share in our high return foods and snacks businesses in North America; improving the profitability of our PBNA business and capturing our fair share of category growth; accelerating our growth and presence in international snacks and food while investing wisely in beverages to balance between growth and returns; and making the necessary investments in our manufacturing capacity, go-to-market systems and digital initiatives, such as improving our presence and scale in our e-commerce business. Table of Contents We will become Stronger by renewing our focus on driving holistic cost management throughout our organization to support our investments in advantaged capabilities, such as a highly agile and flexible end-to-end value chain; more precision around revenue management; and investing in data analytics that can provide more granularity around consumer insights. We also plan to continue investing to further expand global business services into new capabilities, which will enable better insight and support for our businesses at a lower cost. And we will remain focused on diversifying our workforce and reinforcing The PepsiCo Way, where we emphasize that employees act like owners to get things done quickly. We will become Better by further integrating purpose into our business strategy and brands by becoming planet positive, strengthening our roots in our communities, and advancing social justice. This includes supporting practices and technologies that improve farmer livelihoods and agricultural resiliency; using precious resources such as water more efficiently; accelerating our efforts to reduce greenhouse gas emissions throughout our value chain; driving progress toward a world where plastics need never become waste; advancing respect for human rights; and investing to promote shared prosperity in local communities where we live and work. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers, competition and human capital. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks COVID-19 Our global operations continue to expose us to risks associated with the COVID-19 pandemic, which continues to result in challenging operating environments and has affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold. Travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns and closures continue in many of these markets. These measures have impacted and will continue to impact us, our customers (including foodservice customers), consumers, employees, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with whom we do business, which may result in changes in demand for our products, increases in operating costs (whether as a result of changes to our supply chain or increases in employee costs, including expanded benefits and frontline incentives, costs associated with the provision of personal protective equipment and increased sanitation, or otherwise), or adverse impacts to our supply chain through reduced availability of air or other commercial transport, port closures or border restrictions, any Table of Contents of which can impact our ability to make, manufacture, distribute and sell our products. In addition, measures that impact our ability to access our offices (several of which remain closed), plants, warehouses, distribution centers or other facilities, or that impact the ability of our customers (including our foodservice customers), consumers, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties to do the same, may continue to impact the availability or productivity of our and their employees, many of whom are not able to perform their job functions remotely. Public concern regarding the risk of contracting COVID-19 has impacted and may continue to impact demand from consumers, including due to consumers not leaving their homes or leaving their homes less often than they did prior to the start of the pandemic or otherwise shopping for and consuming food and beverage products in a different manner than they historically have or because some of our consumers have lower discretionary income due to unemployment or reduced or limited work as a result of measures taken in response to the pandemic. Even as governmental restrictions are relaxed and economies gradually, partially, or fully reopen in certain of these jurisdictions and markets, the ongoing economic impacts and health concerns associated with the pandemic may continue to affect consumer behavior, spending levels and shopping and consumption preferences. In addition, as a result of COVID-19, certain jurisdictions, such as certain states in Mexico, have enacted or are considering enacting new or expanded product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. Changes in consumer purchasing and consumption patterns may increase demand for our products in one quarter, resulting in decreased demand for our products in subsequent quarters, or in a lower-margin sales channel resulting in potentially reduced profit from sales of our products. We continue to see shifts in product and channel preferences as markets move through varying stages of restrictions and re-opening at different times, including changes in at-home consumption, in immediate consumption and away-from-home channels, such as convenience and gas and foodservice. In addition, we continue to see a rapid increase in demand in the e-commerce and online-to-offline channels and any failure to capitalize on this demand could adversely affect our ability to maintain and grow sales or category share and erode our competitive position. Any reduced demand for our products or change in consumer purchasing and consumption patterns, as well as continued economic uncertainty, can adversely affect our customers and business partners financial condition, which can result in bankruptcy filings and/or an inability to pay for our products, reduced or canceled orders of our products, continued or additional closing of restaurants, stores, entertainment or sports complexes, schools or other venues in which our products are sold, or reduced capacity at any of the foregoing, or our business partners inability to supply us with ingredients or other items necessary for us to make, manufacture, distribute or sell our products. Such adverse changes in our customers or business partners financial condition have also resulted and may continue to result in our recording additional charges for our inability to recover or collect any accounts receivable, owned or leased assets, including certain foodservice and vending and other equipment, or prepaid expenses. In addition, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. While we have developed and implemented and continue to develop and implement health and safety protocols, business continuity plans and crisis management protocols in an effort to mitigate the negative impact of COVID-19 to our employees and our business, the extent of the impact of the pandemic on our business and financial results will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the development and availability of effective treatments and vaccines, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in Table of Contents the future, in response to the pandemic and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Coronavirus Aid, Relief, and Economic Security Act (CARES Act) The CARES Act was enacted on March 27, 2020 in the United States. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the Tax Cuts and Jobs Act (TCJ Act) and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. Refer to the COVID-19 discussion above and Note 5 to our consolidated financial statements for further information. Risks Associated with International Operations We are subject to risks in the normal course of business. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. Imposition of Taxes and Regulations on our Products Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, encourage waste reduction and increased recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used vary by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. The related provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. For further information, see Our Liquidity and Table of Contents Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded net tax expense of $24 million related to the impact of the TRAF. See Our Critical Accounting Policies and Note 5 to our consolidated financial statements for further information. Retail Landscape Our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We have seen and expect to continue to see a further shift to e-commerce, online-to-offline, and other online purchasing by consumers, including as a result of the COVID-19 pandemic. We continue to monitor changes in the retail landscape and seek to identify actions we may take to build our global e-commerce and digital capabilities, such as expanding our direct-to-consumer business, and distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. During 2020, in addition to COVID-19 discussions as part of risk updates to the Board and the relevant Committees, the Board was provided with updates on COVID-19s impact to our business, financial condition and operations through memos, teleconferences or other appropriate means of communication. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; Table of Contents The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Sustainability, Diversity and Public Policy Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability, diversity and inclusion, and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Table of Contents Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 26, 2020 and December 28, 2019. At the end of 2020, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2020 by $121 million, which would generally be offset by a reduction in the cost of the underlying commodity purchases. Foreign Exchange Our operations outside of the United States generated 42% of our consolidated net revenue in 2020, with Mexico, Russia, Canada, the United Kingdom, China and South Africa, collectively, comprising approximately 21% of our consolidated net revenue in 2020. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business. During 2020, unfavorable foreign exchange reduced net revenue growth by 2 percentage points, primarily due to declines in the Mexican peso, Russian ruble and Brazilian real. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms withdrawal from the European Union (Brexit), including the effects of the post-Brexit trade deal entered into between the United Kingdom and the European Union in December 2020, as well as the economic, operating and political environment in Russia and the potential impact for the Europe segment and our other businesses. Our foreign currency derivatives had a total notional value of $1.9 billion as of December 26, 2020 and December 28, 2019. At the end of 2020, we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2020 by $175 million, which would be significantly offset by an inverse change in the fair value of the underlying exposure. The total notional amount of our debt instruments designated as net investment hedges was $2.7 billion as of December 26, 2020 and $2.5 billion as of December 28, 2019. Interest Rates Our interest rate derivatives had a total notional value of $3.0 billion as of December 26, 2020 and $5.0 billion as of December 28, 2019. Assuming year-end 2020 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2020 by $80 million due to higher cash and cash equivalents and short-term investments levels, as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Physical or unit volume is one of the key metrics management uses internally to make operating and strategic decisions, including the preparation of our annual operating plan and the evaluation of our business performance. We believe volume provides additional information to facilitate the comparison of Table of Contents our historical operating performance and underlying trends, and provides additional transparency on how we evaluate our business because it measures demand for our products at the consumer level. Beverage volume includes volume of concentrate sold to independent bottlers and volume of finished products bearing company-owned or licensed trademarks and allied brand products and joint venture trademarks sold by company-owned bottling operations, including by our noncontrolled affiliates. Concentrate volume sold to independent bottlers is reported in concentrate shipments and equivalents (CSE), whereas finished beverage product volume is reported in bottler case sales (BCS). Both CSE and BCS convert all beverage volume to an 8-ounce-case metric. Typically, CSE and BCS are not equal in any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our net revenue is not entirely based on BCS volume due to the independent bottlers in our supply chain, we believe that BCS is a better measure of the consumption of our beverage products. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Food and snack volume includes volume sold by our subsidiaries and noncontrolled affiliates of snack products bearing company-owned or licensed trademarks. Internationally, we measure food and snack product volume in kilograms, while in North America we measure food and snack product volume in pounds. FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Consolidated Net Revenue and Operating Profit 2020 2019 Change Net revenue $ 70,372 $ 67,161 5 % Operating profit $ 10,080 $ 10,291 (2) % Operating profit margin 14.3 % 15.3 % (1.0) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. Operating profit decreased 2% and operating profit margin declined 1.0 percentage point. Operating profit performance was primarily driven by certain operating cost increases, partially offset by net revenue growth and productivity savings. The charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 7 percentage points. See Note 1 to our consolidated financial statements for further information. Additionally, higher inventory fair value adjustments and merger and integration charges included in Items Affecting Comparability and unfavorable foreign exchange each negatively impacted operating profit performance by 2 percentage points. Table of Contents Results of Operations Division Review See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on this measure, see Non-GAAP Measures. 2020 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Organic Volume (b) Effective net pricing FLNA 7 % (1) 6 % 3 3 QFNA 10 % 11 % 10 PBNA 4 % (2) 2 % (1) 3 LatAm (8) % 11 3 % 3 Europe 2 % 4 6 % 6 AMESA 25 % 1 (25) 1 % 1 APAC 18 % (10) 8 % 5 3 Total 5 % 2 (3) 4 % 2 2 (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, the impact of organic volume growth on net revenue growth differs from the unit volume growth disclosed in the following divisional discussions due to product mix, nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Table of Contents Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability 2020 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure (b) FLNA $ 5,340 $ $ 83 $ 29 $ 5,452 QFNA 669 5 674 PBNA 1,937 47 66 2,050 LatAm 1,033 31 1,064 Europe 1,353 48 1,401 AMESA 600 14 173 787 APAC 590 5 7 602 Corporate unallocated expenses (1,442) (73) 36 (20) (1,499) Total $ 10,080 $ (73) $ 269 $ 255 $ 10,531 2019 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure FLNA $ 5,258 $ $ 22 $ $ 5,280 QFNA 544 2 546 PBNA 2,179 51 2,230 LatAm 1,141 62 1,203 Europe 1,327 99 46 1,472 AMESA 671 38 7 716 APAC 477 47 524 Corporate unallocated expenses (1,306) (112) 47 2 (1,369) Total $ 10,291 $ (112) $ 368 $ 55 $ 10,602 (a) See Items Affecting Comparability. (b) Operating profit for 2020 includes the charges taken as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. Table of Contents Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis 2020 Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 2 % 1 1 3 % 3 % QFNA 23 % 24 % 24 % PBNA (11) % 3 (8) % (8) % LatAm (10) % (2) (12) % 11 % Europe 2 % (4) (3) (5) % 4 (0.5) % AMESA (11) % (3.5) 24 10 % 10 % APAC 24 % (10) 2 15 % 1 16 % Corporate unallocated expenses 10 % (6) 2 3.5 10 % 10 % Total (2) % (1) 2 (1) % 2 1 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 7% and unit volume grew 3%. The net revenue growth was driven by effective net pricing and organic volume growth. The unit volume growth primarily reflects double-digit growth in variety packs and dips, and high-single-digit growth in trademark Tostitos and Ruffles, partially offset by a double-digit decline in nuts and seeds. Operating profit increased 2%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases. Additionally, the charges taken as a result of the COVID-19 pandemic reduced operating profit growth by 4 percentage points. QFNA Net revenue and unit volume each increased 10%. The net revenue growth reflects organic volume growth and favorable pricing, partially offset by unfavorable mix. The unit volume growth was driven by double-digit growth in oatmeal and pancake syrup and mix and high-single-digit growth in ready-to-eat cereals. The COVID-19 pandemic drove an increase in consumer demand, which had a positive impact on both net revenue and unit volume growth. Operating profit grew 23%, reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases. Additionally, the charges taken as a result of the COVID-19 pandemic reduced operating profit growth by 3 percentage points. PBNA Net revenue increased 4%, primarily driven by effective net pricing, partially offset by a decrease in organic volume. Unit volume decreased 1%, driven by a 5% decrease in CSD volume, largely offset by a 4% increase in non-carbonated beverage (NCB) volume. The NCB volume increase primarily reflected a high-single-digit increase in Gatorade sports drinks, a double-digit increase in our energy portfolio, primarily due to acquisitions, and a low-single-digit increase in our overall water portfolio, partially offset by a mid-single-digit decrease in our juice and juice drinks portfolio. In addition, acquisitions contributed 2 percentage points to net revenue growth. Table of Contents Operating profit decreased 11%, reflecting certain operating cost increases, including incremental information technology costs, a 14-percentage-point impact of the charges taken as a result of the COVID-19 pandemic and the organic volume decrease. These impacts were partially offset by the effective net pricing, productivity savings, lower advertising and marketing expenses, and a 4-percentage-point impact of lower commodity costs. Prior-year gains associated with sales of assets negatively impacted operating profit performance by 2 percentage points. Additionally, impairment charges associated with a coconut water brand negatively impacted operating profit performance by 2 percentage points. Acquisitions positively contributed 4 percentage points to operating profit performance. In the fourth quarter of 2020, we received notice of termination without cause from Vital Pharmaceuticals, Inc., which would end our distribution rights of Bang Energy drinks, effective October 24, 2023. LatAm Net revenue decreased 8%, primarily reflecting an 11-percentage-point impact of unfavorable foreign exchange, partially offset by effective net pricing. Snacks unit volume grew slightly, primarily reflecting low-single-digit growth in Brazil, partially offset by a slight decline in Mexico. Beverage unit volume declined 1%, primarily reflecting a high-single-digit decline in Argentina, a mid-single-digit decline in Honduras and a low-single-digit decline in Guatemala, partially offset by double-digit growth in Brazil, low-single-digit growth in Mexico and mid-single-digit growth in Chile. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume performance. Operating profit decreased 10%, primarily reflecting certain operating cost increases and a 9-percentage-point impact of higher commodity costs due to transaction-related foreign exchange. These impacts were partially offset by productivity savings and the effective net pricing. Additionally, unfavorable foreign exchange and certain charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 11 percentage points and 8 percentage points, respectively. Europe Net revenue increased 2%, reflecting organic volume growth, partially offset by a 4-percentage-point impact of unfavorable foreign exchange. Snacks unit volume grew 4%, primarily reflecting double-digit growth in Turkey, high-single-digit growth in the United Kingdom and France and mid-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in Spain. Additionally, Russia and Poland each experienced low-single-digit growth. Beverage unit volume grew 11%, primarily reflecting double-digit growth in Germany and France, partially offset by a mid-single-digit decline in Poland and a low-single-digit decline in Turkey. Additionally, Russia experienced low-single-digit growth and the United Kingdom experienced mid-single-digit growth. Operating profit increased 2%, primarily reflecting the organic volume growth, productivity savings, a 4-percentage-point impact of lower restructuring and impairment charges, a 3-percentage-point impact of the prior-year inventory fair value adjustments and merger and integration charges primarily associated with our acquisition of SodaStream International Ltd. (SodaStream) and a 2-percentage-point impact of a gain on an asset sale. These impacts were partially offset by certain operating cost increases and a 2-percentage-point impact of higher commodity costs due to transaction-related foreign exchange. Additionally, the charges taken as a result of the COVID-19 pandemic and unfavorable foreign exchange reduced operating profit growth by 6 percentage points and 4 percentage points, respectively. Table of Contents AMESA Net revenue increased 25%, primarily reflecting a 28-percentage-point impact of the Pioneer Foods acquisition, partially offset by a 3-percentage-point impact of the prior-year refranchising of a portion of our beverage business in India. Net revenue was also negatively impacted by the COVID-19 pandemic. Snacks unit volume grew 199%, primarily reflecting a 195-percentage-point impact of the Pioneer Foods acquisition, double-digit growth in Pakistan and mid-single-digit growth in the Middle East. Additionally, India and South Africa (excluding our Pioneer Foods acquisition) each experienced low-single-digit growth. Beverage unit volume declined 5%, primarily reflecting a double-digit decline in India and a high-single-digit decline in Pakistan, partially offset by slight growth in the Middle East and low-single-digit growth in Nigeria. Our Pioneer Foods acquisition positively contributed 2 percentage points to beverage unit volume performance. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume performance. Operating profit decreased 11%, primarily reflecting certain operating cost increases, partially offset by productivity savings, lower advertising and marketing expenses and a 3-percentage-point impact of lower commodity costs. The inventory fair value adjustments and merger and integration charges associated with our Pioneer Foods acquisition negatively impacted operating profit performance by 24 percentage points and were partially offset by Pioneer Foods 9-percentage-point positive contribution to operating profit performance. Additionally, the charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 5 percentage points. APAC Net revenue increased 18%, primarily reflecting a 10-percentage-point impact of our Be Cheery acquisition, organic volume growth and effective net pricing. Snacks unit volume grew 17%, primarily reflecting a 10-percentage-point impact of our Be Cheery acquisition and double-digit growth in Indonesia, partially offset by a low-single-digit decline in Thailand. Additionally, China (excluding our Be Cheery acquisition) and Australia each experienced mid-single-digit growth and Taiwan experienced low-single-digit growth. Beverage unit volume grew 1%, primarily reflecting high-single-digit growth in China, partially offset by a double-digit decline in the Philippines, a mid-single-digit decline in Vietnam and a low-single-digit decline in Thailand. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume growth. Operating profit increased 24%, primarily reflecting the net revenue growth, productivity savings and a 10-percentage-point impact of lower restructuring and impairment charges, partially offset by certain operating cost increases and higher advertising and marketing expenses. Table of Contents Other Consolidated Results 2020 2019 Change Other pension and retiree medical benefits income/(expense) $ 117 $ (44) $ 161 Net interest expense and other $ (1,128) $ (935) $ (193) Annual tax rate 20.9 % 21.0 % Net income attributable to PepsiCo (a) $ 7,120 $ 7,314 (3) % Net income attributable to PepsiCo per common share diluted (a) $ 5.12 $ 5.20 (2) % (a) The charges taken as a result of the COVID-19 pandemic negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 8 percentage points. See Note 1 to our consolidated financial statements for further information. Other pension and retiree medical benefits income increased $161 million, primarily reflecting the recognition of fixed income gains on plan assets, the impact of discretionary plan contributions and higher prior-year settlement losses, partially offset by the decrease in discount rates. Net interest expense and other increased $193 million, primarily due to higher average debt balances, lower interest rates on cash, as well as lower gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by lower interest rates on debt and higher average cash balances. The reported tax rate decreased 0.1 percentage points, primarily reflecting the net tax benefits related to the TRAF, partially offset by an increase in reserves for uncertain tax positions in foreign jurisdictions. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; amounts associated with mergers, acquisitions, divestitures and other structural changes; pension and retiree medical related items; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. Table of Contents The following non-GAAP financial measures contained in this Form 10-K are discussed below: Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income/expense, provision for income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 Multi-Year Productivity Plan (2019 Productivity Plan) and our 2014 Multi-Year Productivity Plan (2014 Productivity Plan), inventory fair value adjustments and merger and integration charges associated with our acquisitions, pension-related settlement charges and net tax related to the TCJ Act (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, each on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic revenue growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Table of Contents Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: 2020 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 31,797 $ 38,575 $ 28,495 $ 10,080 $ 117 $ 1,894 $ 7,120 Items Affecting Comparability Mark-to-market net impact 64 (64) 9 (73) (15) (58) Restructuring and impairment charges (30) 30 (239) 269 20 58 231 Inventory fair value adjustments and merger and integration charges (32) 32 (223) 255 18 237 Pension-related settlement charge 205 47 158 Core, Non-GAAP Measure $ 31,799 $ 38,573 $ 28,042 $ 10,531 $ 342 $ 2,002 $ 7,688 2019 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 30,132 $ 37,029 $ 26,738 $ 10,291 $ (44) $ 1,959 $ 39 $ 7,314 Items Affecting Comparability Mark-to-market net impact 57 (57) 55 (112) (25) (87) Restructuring and impairment charges (115) 115 (253) 368 2 67 5 298 Inventory fair value adjustments and merger and integration charges (34) 34 (21) 55 8 47 Pension-related settlement charges 273 62 211 Net tax related to the TCJ Act 8 (8) Core, Non-GAAP Measure $ 30,040 $ 37,121 $ 26,519 $ 10,602 $ 231 $ 2,079 $ 44 $ 7,775 Table of Contents (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. 2020 2019 Change Net income attributable to PepsiCo per common share diluted, GAAP measure $ 5.12 $ 5.20 (2) % Mark-to-market net impact (0.04) (0.06) Restructuring and impairment charges 0.17 0.21 Inventory fair value adjustments and merger and integration charges 0.17 0.03 Pension-related settlement charges 0.11 0.15 Net tax related to the TCJ Act (0.01) Core net income attributable to PepsiCo per common share diluted, non-GAAP measure $ 5.52 (a) $ 5.53 (a) % Impact of foreign exchange translation 2 Growth in core net income attributable to PepsiCo per common share diluted, on a constant currency basis, non-GAAP measure 2 % (a) Does not sum due to rounding. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $2.5 billion, including cash expenditures of approximately $1.6 billion. Plan to date through December 26, 2020, we have incurred pre-tax charges of $797 million, including cash expenditures of $518 million. In our 2021 financial results, we expect to incur pre-tax charges of approximately $500 million, including cash expenditures of approximately $400 million, with the balance to be reflected in our 2022 and 2023 financial results. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2021 and 2022 results. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan was completed in 2019. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $1.3 billion and $960 million, respectively. See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Inventory Fair Value Adjustments and Merger and Integration Charges In 2020, we recorded inventory fair value adjustments and merger and integration charges related to our acquisitions of BFY Brands, Inc. (BFY Brands), Rockstar, Pioneer Foods and Be Cheery. Inventory fair value adjustments and merger and integration charges include fair value adjustments to the acquired Table of Contents inventory included in the acquisition-date balance sheets and closing costs, employee-related costs, contract termination costs, changes in the fair value of contingent consideration and other integration costs. Merger and integration charges also include liabilities to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods. In 2019, we recorded inventory fair value adjustments and merger and integration charges primarily related to SodaStreams acquired inventory included in acquisition-date balance sheet, as well as merger and integration charges, including employee-related costs. See Note 14 to our consolidated financial statements for further information. Pension-Related Settlement Charges In 2020, we recorded a pension settlement charge related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, we recorded pension settlement charges related to the purchase of a group annuity contract and one-time lump sum payments to certain former employees who had vested benefits. See Note 7 to our consolidated financial statements for further information. Net Tax Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. We recognized net tax benefits in 2019 related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. Table of Contents Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs, including with respect to our net capital spending plans. Our primary sources of cash available to fund cash outflows, such as our anticipated dividend payments, debt repayments, payments for acquisitions, including the contingent consideration related to Rockstar, and the transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper and long-term debt and cash and cash equivalents. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Our sources and uses of cash were not materially adversely impacted by COVID-19 in 2020 and, to date, we have not identified any material liquidity deficiencies as a result of the COVID-19 pandemic. Based on the information currently available to us, we do not expect the impact of COVID-19 to have a material impact on our liquidity. We will continue to monitor and assess the impact COVID-19 may have on our business and financial results. See Note 1 to our consolidated financial statements for further information. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the TCJ Act and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. See Item 1A. Risk Factors and Our Business Risks for further information related to the COVID-19 pandemic. As of December 26, 2020, cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 26, 2020, our mandatory transition tax liability was $3.2 billion, which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $309 million of this liability in 2021. See Credit Facilities and Long-Term Contractual Commitments. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. As part of our evolving market practices, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with a majority of our suppliers generally range from 60 to 90 days, which we deem to be commercially reasonable. We will continue to monitor economic conditions and market practice working with our suppliers to adjust as necessary. We also maintain voluntary supply chain finance agreements with several participating global financial institutions. Under these agreements, our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to these participating global financial institutions. Supplier participation in these financing arrangements is voluntary. Our suppliers negotiate their financing agreements directly with the respective global financial institutions and we are not a party to these agreements. These financing arrangements allow participating suppliers to leverage PepsiCos creditworthiness in establishing credit spreads and associated costs, which generally provides our suppliers with more favorable terms than they would be able to secure on their own. Neither PepsiCo nor any of its subsidiaries provide any guarantees to any third party in connection with these financing arrangements. We have no economic interest in our suppliers decision to participate in these agreements. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. All outstanding amounts related to suppliers participating in such financing arrangements are recorded within Table of Contents accounts payable and other current liabilities in our consolidated balance sheet. We have been informed by the participating financial institutions that as of December 26, 2020 and December 28, 2019, $1.2 billion and $1.1 billion, respectively, of our accounts payable to suppliers who participate in these financing arrangements are outstanding. These supply chain finance arrangements did not have a material impact on our liquidity or capital resources in the periods presented and we do not expect such arrangements to have a material impact on our liquidity or capital resources for the foreseeable future. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: 2020 2019 Net cash provided by operating activities $ 10,613 $ 9,649 Net cash used for investing activities $ (11,619) $ (6,437) Net cash provided by/(used for) financing activities $ 3,819 $ (8,489) Operating Activities In 2020, net cash provided by operating activities was $10.6 billion, compared to $9.6 billion in the prior year. The increase in operating cash flow primarily reflects lower net cash tax payments and lower pre-tax pension and retiree medical plan contributions in the current year. Investing Activities In 2020, net cash used for investing activities was $11.6 billion, primarily reflecting net cash paid in connection with our acquisitions of Rockstar of $3.85 billion, Pioneer Foods of $1.2 billion and Be Cheery of $0.7 billion, net capital spending of $4.2 billion, as well as purchases of short-term investments with maturities greater than three months of $1.1 billion. In 2019, net cash used for investing activities was $6.4 billion, primarily reflecting $4.1 billion of net capital spending, as well as $1.9 billion of the remaining cash paid in connection with our acquisition of SodaStream. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities; and see Note 14 to our consolidated financial statements for further discussion of our acquisitions. We regularly review our plans with respect to net capital spending, including in light of the ongoing uncertainty caused by the COVID-19 pandemic on our business, and believe that we have sufficient liquidity to meet our net capital spending needs. Financing Activities In 2020, net cash provided by financing activities was $3.8 billion, primarily reflecting proceeds from issuances of long-term debt of $13.8 billion, partially offset by the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.5 billion, payments of long-term debt borrowings of $1.8 billion and debt redemptions of $1.1 billion. Table of Contents In 2019, net cash used for financing activities was $8.5 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $8.3 billion, payments of long-term debt borrowings of $4.0 billion and debt redemptions of $1.0 billion, partially offset by proceeds from issuances of long-term debt of $4.6 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. In addition, on February 11, 2021, we announced a 5% increase in our annualized dividend to $4.30 per share from $4.09 per share, effective with the dividend expected to be paid in June 2021. We expect to return a total of approximately $5.9 billion to shareholders in 2021, comprised of dividends of approximately $5.8 billion and share repurchases of approximately $100 million. We have recently completed our share repurchase activity and do not expect to repurchase any additional shares for the balance of 2021. Free Cash Flow The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. 2020 2019 Change Net cash provided by operating activities, GAAP measure $ 10,613 $ 9,649 10 % Capital spending (4,240) (4,232) Sales of property, plant and equipment 55 170 Free cash flow, non-GAAP measure $ 6,428 $ 5,587 15 % We use free cash flow primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Table of Contents Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2021 2022 2023 2024 2025 2026 and beyond Recorded Liabilities: Long-term debt obligations (b) $ 40,330 $ $ 6,895 $ 6,298 $ 27,137 Operating leases (c) 1,895 486 663 333 413 One-time mandatory transition tax - TCJ Act (d) 3,239 309 617 1,351 962 Other long-term liabilities (e) 1,277 159 135 140 843 Other: Interest on debt obligations (f) 15,988 1,160 2,043 1,771 11,014 Purchasing commitments (g) 2,295 894 1,034 246 121 Marketing commitments (h) 950 355 366 161 68 Other long-term contractual commitments (i) 347 85 167 95 Total contractual commitments $ 66,321 $ 3,448 $ 11,920 $ 10,395 $ 40,558 (a) Based on year-end foreign exchange rates. (b) Excludes $3,358 million related to current maturities of debt, $40 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $260 million related to unamortized net discounts. (c) Primarily reflects building leases. See Note 13 to our consolidated financial statements for further information on operating leases. (d) Reflects our transition tax liability as of December 26, 2020, which must be paid through 2026 under the provisions of the TCJ Act. (e) Reflects contingent consideration related to estimated future tax benefits associated with our acquisition of Rockstar. Also reflects commitments to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods. See Note 9 and Note 14 to our consolidated financial statements for further information. (f) Interest payments on floating-rate debt are estimated using interest rates effective as of December 26, 2020. Includes accrued interest of $352 million as of December 26, 2020. (g) Reflects non-cancelable commitments, primarily for the purchase of commodities and outsourcing services in the normal course of business and does not include purchases that we are likely to make based on our plans but are not obligated to incur. (h) Reflects non-cancelable commitments, primarily for sports marketing in the normal course of business. (i) Reflects our commitment to incur capital expenditures and/or business-related costs associated with our acquisition of Pioneer Foods. See Note 14 to our consolidated financial statements for further information. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. Bottler funding to independent bottlers is not reflected in the table above as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in the table above. See Note 7 to our consolidated financial statements for further information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Table of Contents Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. 2020 2019 Net income attributable to PepsiCo $ 7,120 $ 7,314 Interest expense 1,252 1,135 Tax on interest expense (278) (252) $ 8,094 $ 8,197 Average debt obligations (a) $ 41,402 $ 31,975 Average common shareholders equity (b) 13,536 14,317 Average invested capital $ 54,938 $ 46,292 ROIC, non-GAAP measure 14.7 % 17.7 % (a) Includes a quarterly average of short-term and long-term debt obligations. (b) Includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. 2020 2019 ROIC 14.7 % 17.7 % Impact of: Average cash, cash equivalents and short-term investments 3.4 3.0 Interest income (0.2) (0.5) Tax on interest income 0.1 0.1 Mark-to-market net impact (0.1) (0.2) Restructuring and impairment charges 0.3 0.5 Inventory fair value adjustments and merger and integration charges 0.4 0.1 Pension-related settlement charges 0.2 0.5 Net tax related to the TCJ Act 0.1 (1.0) Other net tax benefits 1.0 2.2 Charges related to cash tender and exchange offers (0.1) Net ROIC, excluding items affecting comparability 19.9 % 22.3 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, including those related to the COVID-19 pandemic, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Table of Contents Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. We recorded $20 million of reserves for product returns in 2020 as a result of the COVID-19 pandemic . See Note 1 to our consolidated financial statements for further information. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. There were no material changes in credit terms as a result of the COVID-19 pandemic. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers (including foodservice and vending businesses). We recorded an allowance for expected credit losses of $56 million in 2020 as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Table of Contents Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions, including those related to the COVID-19 pandemic, based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. These Table of Contents assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. We recorded a net tax benefit of $28 million ($0.02 per share) in 2018 related to the TCJ Act. The related provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $8 million ($0.01 per share) related to the TCJ Act. See further information in Items Affecting Comparability. On May 19, 2019, a public referendum held in Switzerland passed the TRAF, effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $72 million related to the adoption of the TRAF in the Table of Contents Swiss Canton of Bern. During 2019, we recorded net tax expense of $24 million related to the impact of the TRAF. In 2020, our annual tax rate was 20.9% compared to 21.0% in 2019. See Other Consolidated Results for further information. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in the PepsiCo Employees Retirement Plan A (Plan A) of $205 million ($158 million after-tax or $0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pension benefits pre-tax expense is expected to decrease by approximately $70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to the PepsiCo Employees Retirement Plan I (Plan I) and to a newly created plan, the PepsiCo Employees Retirement Hourly Plan (Plan H), effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization will facilitate a more targeted investment strategy and provide additional flexibility in evaluating opportunities to reduce risk and volatility. No material impact to pension benefit pre-tax expense is expected from this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pension benefits pre-tax expense is expected to increase approximately $45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $220 million ($170 million after-tax or $0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $53 million ($41 million after-tax or $0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $273 million ($211 million after-tax or $0.15 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Table of Contents Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans obligation and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Table of Contents Weighted-average assumptions for pension and retiree medical expense are as follows: 2021 2020 2019 Pension Service cost discount rate 2.6 % 3.4 % 4.4 % Interest cost discount rate 1.9 % 2.8 % 3.9 % Expected rate of return on plan assets 6.2 % 6.6 % 6.8 % Expected rate of salary increases 3.1 % 3.2 % 3.2 % Retiree medical Service cost discount rate 2.3 % 3.2 % 4.3 % Interest cost discount rate 1.6 % 2.6 % 3.8 % Expected rate of return on plan assets 5.4 % 5.8 % 6.6 % Current health care cost trend rate 5.5 % 5.6 % 5.7 % In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A. In addition, based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2021 primarily reflecting the recognition of fixed income gains on plan assets, the impact of discretionary plan contributions and plan changes, partially offset by lower discount rates and lower rate of expected returns on U.S. plan assets. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2021 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ 55 Expected rate of return $ 50 Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. In November 2020, we received approval from our Board of Directors to make discretionary contributions of $500 million to our U.S. qualified defined benefit plans. We contributed $300 million of the approved amount in January 2021; we expect to contribute the remaining $200 million in the third quarter of 2021. We made discretionary contributions to our U.S. qualified defined benefit plans of $325 million in 2020 and $400 million in 2019. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Table of Contents Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions except per share amounts) 2020 2019 2018 Net Revenue $ 70,372 $ 67,161 $ 64,661 Cost of sales 31,797 30,132 29,381 Gross profit 38,575 37,029 35,280 Selling, general and administrative expenses 28,495 26,738 25,170 Operating Profit 10,080 10,291 10,110 Other pension and retiree medical benefits income/(expense) 117 ( 44 ) 298 Net interest expense and other ( 1,128 ) ( 935 ) ( 1,219 ) Income before income taxes 9,069 9,312 9,189 Provision for/(benefit from) income taxes (See Note 5) 1,894 1,959 ( 3,370 ) Net income 7,175 7,353 12,559 Less: Net income attributable to noncontrolling interests 55 39 44 Net Income Attributable to PepsiCo $ 7,120 $ 7,314 $ 12,515 Net Income Attributable to PepsiCo per Common Share Basic $ 5.14 $ 5.23 $ 8.84 Diluted $ 5.12 $ 5.20 $ 8.78 Weighted-average common shares outstanding Basic 1,385 1,399 1,415 Diluted 1,392 1,407 1,425 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Net income $ 7,175 $ 7,353 $ 12,559 Other comprehensive (loss)/income, net of taxes: Net currency translation adjustment ( 650 ) 628 ( 1,641 ) Net change on cash flow hedges 7 ( 90 ) 40 Net pension and retiree medical adjustments ( 532 ) 283 ( 467 ) Other ( 1 ) ( 2 ) 6 ( 1,176 ) 819 ( 2,062 ) Comprehensive income 5,999 8,172 10,497 Less: Comprehensive income attributable to noncontrolling interests 55 39 44 Comprehensive Income Attributable to PepsiCo $ 5,944 $ 8,133 $ 10,453 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Operating Activities Net income $ 7,175 $ 7,353 $ 12,559 Depreciation and amortization 2,548 2,432 2,399 Share-based compensation expense 264 237 256 Restructuring and impairment charges 289 370 308 Cash payments for restructuring charges ( 255 ) ( 350 ) ( 255 ) Inventory fair value adjustments and merger and integration charges 255 55 75 Cash payments for merger and integration charges ( 131 ) ( 10 ) ( 73 ) Pension and retiree medical plan expenses 408 519 221 Pension and retiree medical plan contributions ( 562 ) ( 716 ) ( 1,708 ) Deferred income taxes and other tax charges and credits 361 453 ( 531 ) Net tax related to the TCJ Act ( 8 ) ( 28 ) Tax payments related to the TCJ Act ( 78 ) ( 423 ) ( 115 ) Other net tax benefits related to international reorganizations ( 2 ) ( 4,347 ) Change in assets and liabilities: Accounts and notes receivable ( 420 ) ( 650 ) ( 253 ) Inventories ( 516 ) ( 190 ) ( 174 ) Prepaid expenses and other current assets 26 ( 87 ) 9 Accounts payable and other current liabilities 766 735 882 Income taxes payable ( 159 ) ( 287 ) 448 Other, net 642 218 ( 258 ) Net Cash Provided by Operating Activities 10,613 9,649 9,415 Investing Activities Capital spending ( 4,240 ) ( 4,232 ) ( 3,282 ) Sales of property, plant and equipment 55 170 134 Acquisitions, net of cash acquired, and investments in noncontrolled affiliates ( 6,372 ) ( 2,717 ) ( 1,496 ) Divestitures 4 253 505 Short-term investments, by original maturity: More than three months - purchases ( 1,135 ) ( 5,637 ) More than three months - maturities 16 12,824 More than three months - sales 62 1,498 Three months or less, net 27 19 16 Other investing, net 42 ( 8 ) 2 Net Cash (Used for)/Provided by Investing Activities ( 11,619 ) ( 6,437 ) 4,564 (Continued on following page) Table of Contents Consolidated Statement of Cash Flows (continued) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Financing Activities Proceeds from issuances of long-term debt $ 13,809 $ 4,621 $ Payments of long-term debt ( 1,830 ) ( 3,970 ) ( 4,007 ) Debt redemption/cash tender and exchange offers ( 1,100 ) ( 1,007 ) ( 1,589 ) Short-term borrowings, by original maturity: More than three months - proceeds 4,077 6 3 More than three months - payments ( 3,554 ) ( 2 ) ( 17 ) Three months or less, net ( 109 ) ( 3 ) ( 1,352 ) Cash dividends paid ( 5,509 ) ( 5,304 ) ( 4,930 ) Share repurchases - common ( 2,000 ) ( 3,000 ) ( 2,000 ) Proceeds from exercises of stock options 179 329 281 Withholding tax payments on restricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted ( 96 ) ( 114 ) ( 103 ) Other financing ( 48 ) ( 45 ) ( 55 ) Net Cash Provided by/(Used for) Financing Activities 3,819 ( 8,489 ) ( 13,769 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 129 ) 78 ( 98 ) Net Increase/(Decrease) in Cash and Cash Equivalents and Restricted Cash 2,684 ( 5,199 ) 112 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 5,570 10,769 10,657 Cash and Cash Equivalents and Restricted Cash, End of Year $ 8,254 $ 5,570 $ 10,769 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2020 2019 ASSETS Current Assets Cash and cash equivalents $ 8,185 $ 5,509 Short-term investments 1,366 229 Accounts and notes receivable, net 8,404 7,822 Inventories 4,172 3,338 Prepaid expenses and other current assets 874 747 Total Current Assets 23,001 17,645 Property, Plant and Equipment, net 21,369 19,305 Amortizable Intangible Assets, net 1,703 1,433 Goodwill 18,757 15,501 Other Indefinite-Lived Intangible Assets 17,612 14,610 Investments in Noncontrolled Affiliates 2,792 2,683 Deferred Income Taxes 4,372 4,359 Other Assets 3,312 3,011 Total Assets $ 92,918 $ 78,547 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 3,780 $ 2,920 Accounts payable and other current liabilities 19,592 17,541 Total Current Liabilities 23,372 20,461 Long-Term Debt Obligations 40,370 29,148 Deferred Income Taxes 4,284 4,091 Other Liabilities 11,340 9,979 Total Liabilities 79,366 63,679 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,380 and 1,391 shares, respectively) 23 23 Capital in excess of par value 3,910 3,886 Retained earnings 63,443 61,946 Accumulated other comprehensive loss ( 15,476 ) ( 14,300 ) Repurchased common stock, in excess of par value ( 487 and 476 shares, respectively) ( 38,446 ) ( 36,769 ) Total PepsiCo Common Shareholders Equity 13,454 14,786 Noncontrolling interests 98 82 Total Equity 13,552 14,868 Total Liabilities and Equity $ 92,918 $ 78,547 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions except per share amounts) 2020 2019 2018 Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year $ $ 0.8 $ 41 Conversion to common stock ( 0.1 ) ( 6 ) Retirement of preferred stock ( 0.7 ) ( 35 ) Balance, end of year Repurchased Preferred Stock Balance, beginning of year ( 0.7 ) ( 197 ) Redemptions ( 2 ) Retirement of preferred stock 0.7 199 Balance, end of year Common Stock Balance, beginning of year 1,391 23 1,409 23 1,420 24 Shares issued in connection with preferred stock conversion to common stock 1 Change in repurchased common stock ( 11 ) ( 18 ) ( 12 ) ( 1 ) Balance, end of year 1,380 23 1,391 23 1,409 23 Capital in Excess of Par Value Balance, beginning of year 3,886 3,953 3,996 Share-based compensation expense 263 235 250 Equity issued in connection with preferred stock conversion to common stock 6 Stock option exercises, RSUs, PSUs and PEPunits converted ( 143 ) ( 188 ) ( 193 ) Withholding tax on RSUs, PSUs and PEPunits converted ( 96 ) ( 114 ) ( 103 ) Other ( 3 ) Balance, end of year 3,910 3,886 3,953 Retained Earnings Balance, beginning of year 61,946 59,947 52,839 Cumulative effect of accounting changes ( 34 ) 8 ( 145 ) Net income attributable to PepsiCo 7,120 7,314 12,515 Cash dividends declared - common (a) ( 5,589 ) ( 5,323 ) ( 5,098 ) Retirement of preferred stock ( 164 ) Balance, end of year 63,443 61,946 59,947 Accumulated Other Comprehensive Loss Balance, beginning of year ( 14,300 ) ( 15,119 ) ( 13,057 ) Other comprehensive (loss)/income attributable to PepsiCo ( 1,176 ) 819 ( 2,062 ) Balance, end of year ( 15,476 ) ( 14,300 ) ( 15,119 ) Repurchased Common Stock Balance, beginning of year ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) Share repurchases ( 15 ) ( 2,000 ) ( 24 ) ( 3,000 ) ( 18 ) ( 2,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted 4 322 6 516 6 469 Other 1 1 2 Balance, end of year ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) Total PepsiCo Common Shareholders Equity 13,454 14,786 14,518 Noncontrolling Interests Balance, beginning of year 82 84 92 Net income attributable to noncontrolling interests 55 39 44 Distributions to noncontrolling interests ( 44 ) ( 42 ) ( 49 ) Acquisitions 5 Other, net 1 ( 3 ) Balance, end of year 98 82 84 Total Equity $ 13,552 $ 14,868 $ 14,602 (a) Cash dividends declared per common share were $ 4.0225 , $ 3.7925 and $ 3.5875 for 2020, 2019 and 2018, respectively. See accompanying notes to the consolidated financial statements. Table of Contents Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. The business and economic uncertainty resulting from the COVID-19 pandemic has made such estimates and assumptions more difficult to calculate. As future events and their effect cannot be determined with precision, actual results could differ significantly from those estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. While our North America results are reported on a weekly calendar basis, substantially all of our international operations report on a monthly calendar basis. Certain operations in our Europe segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Table of Contents Our Divisions We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, the United Kingdom, China and South Africa. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: 2020 2019 2018 FLNA 13 % 13 % 13 % QFNA 1 % 1 % 1 % PBNA 18 % 17 % 18 % LatAm 6 % 7 % 8 % Europe 16 % 17 % 9 % AMESA 6 % 3 % 4 % APAC 2 % 5 % 4 % Corporate unallocated expenses 38 % 37 % 43 % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Table of Contents Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net Revenue and Operating Profit Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2020 2019 2018 2020 2019 2018 FLNA $ 18,189 $ 17,078 $ 16,346 $ 5,340 $ 5,258 $ 5,008 QFNA 2,742 2,482 2,465 669 544 637 PBNA 22,559 21,730 21,072 1,937 2,179 2,276 LatAm 6,942 7,573 7,354 1,033 1,141 1,049 Europe 11,922 11,728 10,973 1,353 1,327 1,256 AMESA (a) 4,573 3,651 3,657 600 671 661 APAC (b) 3,445 2,919 2,794 590 477 619 Total division 70,372 67,161 64,661 11,522 11,597 11,506 Corporate unallocated expenses ( 1,442 ) ( 1,306 ) ( 1,396 ) Total $ 70,372 $ 67,161 $ 64,661 $ 10,080 $ 10,291 $ 10,110 (a) In 2020, the increase in net revenue primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. (b) In 2020, the increase in net revenue primarily reflects our acquisition of Be Cheery. See Note 14 for further information. Our primary performance obligation is the distribution and sales of beverage and food and snack products to our customers. The following tables reflect the approximate percentage of net revenue generated between our beverage business and our food and snack business for each of our international divisions, as well as our consolidated net revenue: 2020 2019 2018 Beverage (a) Food/Snack Beverage (a) Food/Snack Beverage (a) Food/Snack LatAm 10 % 90 % 10 % 90 % 10 % 90 % Europe 55 % 45 % 55 % 45 % 50 % 50 % AMESA (b) 30 % 70 % 40 % 60 % 45 % 55 % APAC 25 % 75 % 25 % 75 % 25 % 75 % PepsiCo 45 % 55 % 45 % 55 % 45 % 55 % (a) Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue in 2020, 2019 and 2018. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. (b) The increase in the approximate percentage of net revenue generated by our food and snack business primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. Table of Contents Operating profit in 2020 includes certain pre-tax charges taken as a result of the COVID-19 pandemic. These pre-tax charges by division are as follows: 2020 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ 17 $ $ 8 $ 145 $ 59 $ $ 229 QFNA 2 9 3 1 15 PBNA 29 56 28 115 50 26 304 LatAm 1 19 56 18 8 102 Europe 5 3 11 23 22 24 88 AMESA 2 3 9 7 12 33 APAC (g) 3 ( 7 ) 2 5 3 Total $ 56 $ 59 $ 72 $ 350 $ 161 $ 76 $ 774 (a) Reflects the expected impact of the global economic uncertainty caused by COVID-19, leveraging estimates of creditworthiness, projections of default and recovery rates for certain of our customers, including foodservice and vending businesses. (b) Relates to promotional spending for which benefit is not expected to be received. (c) Includes a reserve for product returns of $ 20 million. (d) Includes incremental frontline incentive pay, crisis child care and other leave benefits and labor costs. (e) Includes costs associated with personal protective equipment, temperature scans, cleaning and other sanitization services. (f) Includes reserves for property, plant and equipment, donations of cash and product and other costs. (g) Income amount includes a social welfare relief credit of $ 11 million. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, tax-related contingent consideration and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending 2020 2019 2020 2019 2018 FLNA $ 8,730 $ 7,519 $ 1,189 $ 1,227 $ 840 QFNA 1,021 941 85 104 53 PBNA (a) 37,079 31,449 1,245 1,053 945 LatAm 6,977 7,007 390 557 492 Europe 17,917 17,814 730 613 466 AMESA (b) 5,942 3,672 252 267 198 APAC (c) 5,770 4,113 230 195 138 Total division 83,436 72,515 4,121 4,016 3,132 Corporate (d) 9,482 6,032 119 216 150 Total $ 92,918 $ 78,547 $ 4,240 $ 4,232 $ 3,282 (a) In 2020, the increase in assets was primarily related to our acquisition of Rockstar. See Note 14 for further information. (b) In 2020, the increase in assets was primarily related to our acquisition of Pioneer Foods. See Note 14 for further information. (c) In 2020, the increase in assets was primarily related to our acquisition of Be Cheery. See Note 14 for further information. (d) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2020, the change in assets was primarily due to an increase in cash and cash equivalents and short-term investments. Refer to the cash flow statement for further information. Table of Contents Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization 2020 2019 2018 2020 2019 2018 FLNA $ 10 $ 7 $ 7 $ 550 $ 492 $ 457 QFNA 41 44 45 PBNA 28 29 31 899 857 821 LatAm 4 5 5 251 270 253 Europe 40 37 23 350 341 319 AMESA 3 2 2 149 116 169 APAC 5 1 1 91 76 80 Total division 90 81 69 2,331 2,196 2,144 Corporate 127 155 186 Total $ 90 $ 81 $ 69 $ 2,458 $ 2,351 $ 2,330 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) 2020 2019 2018 2020 2019 United States (b) $ 40,800 $ 38,644 $ 37,148 $ 36,657 $ 30,601 Mexico 3,924 4,190 3,878 1,708 1,666 Russia 3,009 3,263 3,191 3,644 4,314 Canada 2,989 2,831 2,736 2,794 2,695 United Kingdom 1,882 1,723 1,743 874 827 China (c) 1,732 1,300 1,164 1,649 705 South Africa (d) 1,282 405 432 1,484 137 All other countries 14,754 14,805 14,369 13,423 12,587 Total $ 70,372 $ 67,161 $ 64,661 $ 62,233 $ 53,532 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. See Note 2 and Note 15 for further information on property, plant and equipment. See Note 2 and Note 4 for further information on goodwill and other intangible assets. Investments in noncontrolled affiliates are evaluated for impairment upon a significant change in the operating or macroeconomic environment. These assets are reported in the country where they are primarily used. (b) In 2020, the increase in long-lived assets was primarily related to our acquisition of Rockstar. See Note 14 for further information. (c) In 2020, the increase in net revenue and long-lived assets was primarily related to our acquisition of Be Cheery. See Note 14 for further information. (d) In 2020, the increase in net revenue and long-lived assets was primarily related to our acquisition of Pioneer Foods. See Note 14 for further information. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. In addition, we exclude from net revenue all sales, use, value-added and certain excise taxes assessed by government authorities on revenue producing transactions. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove Table of Contents and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. We recorded $ 20 million of reserves for product returns in 2020 as a result of the COVID-19 pandemic . See Note 1 for further information. As a result of the implementation of the revenue recognition guidance adopted in the first quarter of 2018, which did not have a material impact on our accounting policies, we recorded an adjustment in the first quarter of 2018 of $ 137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expected to be entitled to in line with revenue recognition. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. There were no material changes in credit terms as a result of the COVID-19 pandemic. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers (including foodservice and vending businesses). We recorded an allowance for expected credit losses of $ 56 million in 2020 as a result of the COVID-19 pandemic. See Note 1 for further information. Expected credit loss expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2020, sales to Walmart and its affiliates (including Sams) represented approximately 14 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the Table of Contents shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 299 million as of December 26, 2020 and $ 272 million as of December 28, 2019 are included in prepaid expenses and other current assets and other assets on our balance sheet. We recorded reserves of $ 59 million for upfront payments to customers in 2020 as a result of the COVID-19 pandemic . See Note 1 for further information. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 4.6 billion in 2020, $ 4.7 billion in 2019 and $ 4.2 billion in 2018, including advertising expenses of $ 3.0 billion in both 2020 and 2019, and $ 2.6 billion in 2018. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 48 million and $ 55 million as of December 26, 2020 and December 28, 2019, respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 11.9 billion in 2020, $ 10.9 billion in 2019 and $ 10.5 billion in 2018. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 152 million in 2020, $ 166 million in 2019 and $ 204 million in 2018. Net capitalized software and development costs were $ 664 million and $ 572 million as of December 26, 2020 and December 28, 2019, respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Table of Contents Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 719 million, $ 711 million and $ 680 million in 2020, 2019 and 2018, respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Income Taxes Note 5. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Table of Contents Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO); or, in limited instances, last-in, first-out (LIFO) methods. Property, Plant and Equipment Note 15. Property, plant and equipment is recorded at historical cost. Depreciation is recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2016, the Financial Accounting Standards Board (FASB) issued guidance that changes the impairment model used to measure credit losses for most financial assets. Under the new model we are required to estimate expected credit losses over the life of our trade receivables, certain other receivables and certain other financial instruments. The new model replaced the existing incurred credit loss model and generally results in earlier recognition of allowances for credit losses. We adopted this guidance in the first quarter of 2020 and the adoption did not have a material impact on our consolidated financial statements or disclosures. On initial recognition, we recorded an after-tax cumulative effect decrease to retained earnings of $ 34 million ($ 44 million pre-tax) as of the beginning of 2020. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a step-up in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all of the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. The guidance is effective in the first quarter of 2021 with early adoption permitted. We will adopt the guidance when it becomes effective in the first quarter of 2021. The guidance is not expected to have a material impact on our consolidated financial statements or related disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2020 2019 2018 2019 Productivity Plan $ 289 $ 370 $ 138 2014 Productivity Plan 170 Total restructuring and impairment charges 289 370 308 Other productivity initiatives 3 8 Total restructuring and impairment charges and other productivity initiatives $ 289 $ 373 $ 316 Table of Contents 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $ 2.5 billion, including cash expenditures of approximately $ 1.6 billion. These pre-tax charges are expected to consist of approximately 65 % of severance and other employee-related costs, 15 % for asset impairments (all non-cash) resulting from plant closures and related actions and 20 % for other costs associated with the implementation of our initiatives. We expect to complete this plan by 2023. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges 15 % 1 % 30 % 10 % 25 % 5 % 3 % 11 % A summary of our 2019 Productivity Plan charges is as follows: 2020 2019 2018 Cost of sales $ 30 $ 115 $ 3 Selling, general and administrative expenses 239 253 100 Other pension and retiree medical benefits expense 20 2 35 Total restructuring and impairment charges $ 289 $ 370 $ 138 After-tax amount $ 231 $ 303 $ 109 Net income attributable to PepsiCo per common share $ 0.17 $ 0.21 $ 0.08 2020 2019 2018 Plan to Date through 12/26/2020 FLNA $ 83 $ 22 $ 31 $ 136 QFNA 5 2 5 12 PBNA 47 51 40 138 LatAm 31 62 9 102 Europe 48 99 6 153 AMESA 14 38 3 55 APAC 5 47 2 54 Corporate 36 47 7 90 269 368 103 740 Other pension and retiree medical benefits expense 20 2 35 57 Total $ 289 $ 370 $ 138 $ 797 Plan to Date through 12/26/2020 Severance and other employee costs $ 444 Asset impairments 125 Other costs 228 Total $ 797 Table of Contents Severance and other employee costs primarily include severance and other termination benefits, as well as voluntary separation arrangements. Other costs primarily include costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total 2018 restructuring charges $ 137 $ $ 1 $ 138 Non-cash charges and translation ( 32 ) ( 32 ) Liability as of December 29, 2018 105 1 106 2019 restructuring charges 149 92 129 370 Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation 12 ( 92 ) 10 ( 70 ) Liability as of December 28, 2019 128 21 149 2020 restructuring charges 158 33 98 289 Cash payments (a) ( 138 ) ( 117 ) ( 255 ) Non-cash charges and translation ( 26 ) ( 33 ) 3 ( 56 ) Liability as of December 26, 2020 $ 122 $ $ 5 $ 127 (a) Excludes cash expenditures of $ 2 million and $ 4 million for 2020 and 2019, respectively, reported in the cash flow statement in pension and retiree medical contributions. Substantially all of the restructuring accrual at December 26, 2020 is expected to be paid by the end of 2021. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, included the next generation of productivity initiatives that we believed would strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the plan through the end of 2019 to take advantage of additional opportunities within the initiatives described above that further strengthened our beverage, food and snack businesses. The 2014 Productivity Plan was completed in 2019. In 2019, there were no material pre-tax charges related to this plan and all cash payments were paid at year end. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $ 1.3 billion and $ 960 million, respectively. These total plan pre-tax charges consisted of 59 % of severance and other employee costs, 15 % of asset impairments and 26 % of other costs, including costs associated with the implementation of our initiatives, including certain consulting and other contract termination costs. These total plan pre-tax charges were incurred by division as follows: FLNA 14 %, QFNA 3 %, PBNA 29 %, LatAm 15 %, Europe 23 %, AMESA 3 %, APAC 3 % and Corporate 10 %. Table of Contents A summary of our 2014 Productivity Plan charges is as follows: 2018 Selling, general and administrative expenses $ 169 Other pension and retiree medical benefits expense 1 Total restructuring and impairment charges $ 170 After-tax amount $ 143 Net income attributable to PepsiCo per common share $ 0.10 2018 FLNA $ 8 QFNA 2 PBNA 51 LatAm 30 Europe 53 AMESA 15 APAC 12 Corporate (a) ( 1 ) Total $ 170 (a) Income amount primarily relates to other pension and retiree medical benefits. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 30, 2017 $ 212 $ $ 14 $ 226 2018 restructuring charges 86 28 56 170 Cash payments (a) ( 203 ) ( 52 ) ( 255 ) Non-cash charges and translation ( 4 ) ( 28 ) 5 ( 27 ) Liability as of December 29, 2018 91 23 114 Cash payments ( 77 ) ( 16 ) ( 93 ) Non-cash charges and translation ( 14 ) ( 7 ) ( 21 ) Liability as of December 28, 2019 $ $ $ $ (a) Excludes cash expenditures of $ 11 million reported in the cash flow statement in pension and retiree medical plan contributions. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. Table of Contents Note 4 Intangible Assets A summary of our amortizable intangible assets is as follows: 2020 2019 2018 Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights (a) 56 60 $ 976 $ ( 173 ) $ 803 $ 846 $ ( 158 ) $ 688 Customer relationships (b) 10 24 642 ( 204 ) 438 457 ( 177 ) 280 Brands 20 40 1,348 ( 1,099 ) 249 1,326 ( 1,066 ) 260 Other identifiable intangibles 10 24 474 ( 261 ) 213 459 ( 254 ) 205 Total $ 3,440 $ ( 1,737 ) $ 1,703 $ 3,088 $ ( 1,655 ) $ 1,433 Amortization expense $ 90 $ 81 $ 69 (a) The change in 2020 primarily reflects our distribution agreement with Vital Pharmaceuticals, Inc., with an expected residual value higher than our carrying value. The distribution agreements useful life is three years, in accordance with the three-year termination notice issued, and is not reflected in the average useful life above. (b) The change in 2020 primarily reflects our acquisitions of Pioneer Foods and Be Cheery. See Note 14 for further information. Amortization is recognized on a straight-line basis over an intangible assets estimated useful life. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 26, 2020 and using average 2020 foreign exchange rates, is expected to be as follows: 2021 2022 2023 2024 2025 Five-year projected amortization $ 92 $ 89 $ 87 $ 87 $ 84 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 26, 2020, December 28, 2019 and December 29, 2018. In 2020, we recognized a pre-tax impairment charge of $ 41 million related to a coconut water brand in PBNA. We did not recognize any material impairment charges for indefinite-lived intangible assets in each of the years ended December 28, 2019 and December 29, 2018. As of December 26, 2020, the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia on the estimated fair value of our indefinite-lived intangible assets in Russia and have concluded that there are no impairments for the year ended December 26, 2020. However, there could be an impairment of the carrying value of certain brands in Russia, including juice and dairy brands, if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows (including perpetuity growth assumptions), if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For further information on our policies for indefinite-lived intangible assets, see Note 2. Table of Contents The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2019 Acquisitions Translation and Other Balance, End of 2019 Acquisitions Translation and Other Balance, End of 2020 FLNA (a) Goodwill $ 297 $ ( 3 ) $ 5 $ 299 $ 164 $ 2 $ 465 Brands 161 1 162 179 ( 1 ) 340 Total 458 ( 3 ) 6 461 343 1 805 QFNA Goodwill 184 6 ( 1 ) 189 189 Brands 25 ( 14 ) 11 ( 11 ) Total 209 ( 8 ) ( 1 ) 200 ( 11 ) 189 PBNA (b) Goodwill 9,813 66 19 9,898 2,280 11 12,189 Reacquired franchise rights 7,058 31 7,089 18 7,107 Acquired franchise rights 1,510 7 1,517 16 3 1,536 Brands 353 418 ( 8 ) 763 2,400 ( 41 ) 3,122 Total 18,734 484 49 19,267 4,696 ( 9 ) 23,954 LatAm Goodwill 509 ( 8 ) 501 ( 43 ) 458 Brands 127 ( 2 ) 125 ( 17 ) 108 Total 636 ( 10 ) 626 ( 60 ) 566 Europe (c) (d) Goodwill 3,361 440 160 3,961 ( 2 ) ( 153 ) 3,806 Reacquired franchise rights 497 8 505 ( 9 ) 496 Acquired franchise rights 161 ( 4 ) 157 15 172 Brands 4,188 ( 139 ) 132 4,181 ( 109 ) 4,072 Total 8,207 301 296 8,804 ( 2 ) ( 256 ) 8,546 AMESA (e) Goodwill 437 11 ( 2 ) 446 560 90 1,096 Brands 183 31 214 Total 437 11 ( 2 ) 446 743 121 1,310 APAC (f) Goodwill 207 207 306 41 554 Brands 101 ( 1 ) 100 309 36 445 Total 308 ( 1 ) 307 615 77 999 Total goodwill 14,808 520 173 15,501 3,308 ( 52 ) 18,757 Total reacquired franchise rights 7,555 39 7,594 9 7,603 Total acquired franchise rights 1,671 3 1,674 16 18 1,708 Total brands 4,955 265 122 5,342 3,071 ( 112 ) 8,301 Total $ 28,989 $ 785 $ 337 $ 30,111 $ 6,395 $ ( 137 ) $ 36,369 (a) The change in acquisitions in 2020 primarily reflects our acquisition of BFY Brands. (b) The change in acquisitions in 2020 primarily reflects our acquisition of Rockstar. See Note 14 for further information. The change in acquisitions in 2019 primarily reflects our acquisition of CytoSport Inc. (c) The change in translation and other in 2020 primarily reflects the depreciation of the Russian ruble. The change in translation and other in 2019 primarily reflects the appreciation of the Russian ruble. (d) The change in acquisitions in 2019 primarily reflects our acquisition of SodaStream. See Note 14 for further information. (e) The change in acquisitions in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. (f) The change in acquisitions in 2020 primarily reflects our acquisition of Be Cheery. See Note 14 for further information. Table of Contents Note 5 Income Taxes The components of income before income taxes are as follows: 2020 2019 2018 United States $ 4,070 $ 4,123 $ 3,864 Foreign 4,999 5,189 5,325 $ 9,069 $ 9,312 $ 9,189 The provision for/(benefit from) income taxes consisted of the following: 2020 2019 2018 Current: U.S. Federal $ 715 $ 652 $ 437 Foreign 932 807 378 State 110 196 63 1,757 1,655 878 Deferred: U.S. Federal 273 325 140 Foreign ( 167 ) ( 31 ) ( 4,379 ) State 31 10 ( 9 ) 137 304 ( 4,248 ) $ 1,894 $ 1,959 $ ( 3,370 ) A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: 2020 2019 2018 U.S. Federal statutory tax rate 21.0 % 21.0 % 21.0 % State income tax, net of U.S. Federal tax benefit 1.2 1.6 0.5 Lower taxes on foreign results ( 0.8 ) ( 0.9 ) ( 2.2 ) One-time mandatory transition tax - TCJ Act ( 0.1 ) 0.1 Remeasurement of deferred taxes - TCJ Act ( 0.4 ) International reorganizations ( 47.3 ) Tax settlements ( 7.8 ) Other, net ( 0.5 ) ( 0.6 ) ( 0.6 ) Annual tax rate 20.9 % 21.0 % ( 36.7 ) % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35 % to 21 %, effective January 1, 2018. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $ 2.5 billion ($ 1.70 per share) in the fourth quarter of 2017. Table of Contents The provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. As a result, in 2018, we recognized a net tax benefit of $ 28 million ($ 0.02 per share) related to the TCJ Act. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $ 8 million ($ 0.01 per share) related to the TCJ Act. There were no tax amounts recognized in 2020 related to the TCJ Act. As of December 26, 2020, our mandatory transition tax liability was $ 3.2 billion, which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 78 million in 2020, $ 663 million in 2019 and $ 150 million in 2018. We currently expect to pay approximately $ 309 million of this liability in 2021. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. Coronavirus Aid, Relief, and Economic Security Act The CARES Act was enacted on March 27, 2020 in the United States. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the TCJ Act and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the TRAF, effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $ 72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded net tax expense of $ 24 million related to the impact of the TRAF. While the accounting for the impacts of the TRAF are deemed to be complete, further adjustments to our financial statements and related disclosures could be made in future quarters, including in connection with final tax return filings. In 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $ 4.3 billion ($ 3.05 per share) in 2018. The related deferred tax asset of $ 4.4 billion is being amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Table of Contents Deferred tax liabilities and assets are comprised of the following: 2020 2019 Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ 578 $ 578 Property, plant and equipment 1,851 1,583 Recapture of net operating losses 504 335 Right-of-use assets 371 345 Other 159 167 Gross deferred tax liabilities 3,463 3,008 Deferred tax assets Net carryforwards 5,008 4,168 Intangible assets other than nondeductible goodwill 1,146 793 Share-based compensation 90 94 Retiree medical benefits 153 154 Other employee-related benefits 373 350 Pension benefits 80 104 Deductible state tax and interest benefits 150 126 Lease liabilities 371 345 Other 866 741 Gross deferred tax assets 8,237 6,875 Valuation allowances ( 4,686 ) ( 3,599 ) Deferred tax assets, net 3,551 3,276 Net deferred tax assets $ ( 88 ) $ ( 268 ) A summary of our valuation allowance activity is as follows: 2020 2019 2018 Balance, beginning of year $ 3,599 $ 3,753 $ 1,163 Provision 1,082 ( 124 ) 2,639 Other additions/(deductions) 5 ( 30 ) ( 49 ) Balance, end of year $ 4,686 $ 3,599 $ 3,753 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2019 2014-2016 Mexico 2014-2019 2014-2016 United Kingdom 2017-2019 None Canada (Domestic) 2016-2019 2016-2017 Canada (International) 2010-2019 2010-2017 Russia 2017-2019 None Table of Contents In 2018, we recognized a non-cash tax benefit of $ 364 million ($ 0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, in 2018, we recognized non-cash tax benefits of $ 353 million ($ 0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $ 717 million ($ 0.50 per share) in 2018. Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 26, 2020, the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.6 billion. We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 338 million as of December 26, 2020, of which $ 93 million of tax expense was recognized in 2020. The gross amount of interest accrued, reported in other liabilities, was $ 250 million as of December 28, 2019, of which $ 84 million of tax expense was recognized in 2019. A reconciliation of unrecognized tax benefits is as follows: 2020 2019 Balance, beginning of year $ 1,395 $ 1,440 Additions for tax positions related to the current year 128 179 Additions for tax positions from prior years 153 93 Reductions for tax positions from prior years ( 22 ) ( 201 ) Settlement payments ( 13 ) ( 74 ) Statutes of limitations expiration ( 23 ) ( 47 ) Translation and other 3 5 Balance, end of year $ 1,621 $ 1,395 Carryforwards and Allowances Operating loss carryforwards totaling $ 28.3 billion as of December 26, 2020 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.2 billion in 2021, $ 25.2 billion between 2022 and 2040 and $ 2.9 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In 2018, we repatriated $ 20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability, related to the TCJ Act. As of December 26, 2020, we had approximately $ 6 billion of undistributed international earnings. We intend to continue to reinvest $ 6 billion of earnings outside the United States for the Table of Contents foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 26, 2020, 52 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense, which is primarily recorded in selling, general and administrative expenses, and excess tax benefits recognized: 2020 2019 2018 Share-based compensation expense - equity awards $ 264 $ 237 $ 256 Share-based compensation expense - liability awards 11 8 20 Restructuring charges ( 1 ) ( 2 ) ( 6 ) Total $ 274 $ 243 $ 270 Income tax benefits recognized in earnings related to share-based compensation $ 48 $ 39 $ 45 Excess tax benefits related to share-based compensation $ 35 $ 50 $ 48 As of December 26, 2020, there was $ 300 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Table of Contents Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: 2020 2019 2018 Expected life 6 years 5 years 5 years Risk-free interest rate 0.9 % 2.4 % 2.6 % Expected volatility 14 % 14 % 12 % Expected dividend yield 3.4 % 3.1 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 26, 2020 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 28, 2019 11,625 $ 89.03 Granted 1,847 $ 131.79 Exercised ( 2,440 ) $ 73.37 Forfeited/expired ( 392 ) $ 102.69 Outstanding at December 26, 2020 10,640 $ 99.54 5.26 $ 484,362 Exercisable at December 26, 2020 6,545 $ 85.84 3.31 $ 387,625 Expected to vest as of December 26, 2020 3,719 $ 120.67 8.31 $ 90,725 (a) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. Table of Contents A summary of our RSU and PSU activity for the year ended December 26, 2020 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 28, 2019 6,380 $ 111.53 Granted (b) 2,496 $ 131.21 Converted (c) ( 2,315 ) $ 109.61 Forfeited ( 434 ) $ 117.51 Outstanding at December 26, 2020 (d) 6,127 $ 119.92 1.27 $ 888,832 Expected to vest as of December 26, 2020 5,447 $ 119.72 1.26 $ 790,179 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Represents the number of PSUs that vested during the year, net of awards above and below target levels based on the achievement of its performance conditions. (d) The outstanding PSUs for which the vesting period has not ended as of December 26, 2020, at the threshold, target and maximum award levels were zero , 1 million and 2 million, respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three-year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model, which incorporates into the fair-value determination the possibility that the market condition may not be satisfied until actual performance is determined. PEPunits were last granted in 2015 and all outstanding PEPunits were converted to 278,000 shares in 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. Table of Contents A summary of our long-term cash activity for the year ended December 26, 2020 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 28, 2019 $ 44,224 Granted (b) 18,975 Vested (c) ( 15,686 ) Forfeited Outstanding at December 26, 2020 (d) $ 47,513 $ 45,669 1.23 Expected to vest as of December 26, 2020 $ 42,658 $ 41,318 1.14 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Represents the amount of long-term cash awards that vested during the year, net of awards above and below target levels based on the achievement of its market conditions. (d) The outstanding long-term cash awards for which the vesting period has not ended as of December 26, 2020, at the threshold, target and maximum award levels were zero , 48 million and 95 million, respectively . Other Share-Based Compensation Data The following is a summary of other share-based compensation data: 2020 2019 2018 Stock Options Total number of options granted (a) 1,847 1,286 1,429 Weighted-average grant-date fair value of options granted $ 8.31 $ 10.89 $ 9.80 Total intrinsic value of options exercised (a) $ 155,096 $ 275,745 $ 224,663 Total grant-date fair value of options vested (a) $ 8,652 $ 9,838 $ 15,506 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,496 2,754 2,634 Weighted-average grant-date fair value of RSUs/PSUs granted $ 131.21 $ 116.87 $ 108.75 Total intrinsic value of RSUs/PSUs converted (a) $ 303,165 $ 333,951 $ 260,287 Total grant-date fair value of RSUs/PSUs vested (a) $ 235,523 $ 275,234 $ 232,141 PEPunits Total intrinsic value of PEPunits converted (a) $ $ $ 30,147 Total grant-date fair value of PEPunits vested (a) $ $ $ 9,430 (a) In thousands. As of December 26, 2020 and December 28, 2019, there were approximately 287,000 and 269,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Table of Contents Note 7 Pension, Retiree Medical and Savings Plans In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A of $ 205 million ($ 158 million after-tax or $ 0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pension benefits pre-tax expense is expected to decrease by approximately $ 70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to Plan I and to a newly created plan, Plan H, effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization will facilitate a more targeted investment strategy and provide additional flexibility in evaluating opportunities to reduce risk and volatility. No material impact to pension benefit pre-tax expense is expected from this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pension benefits pre-tax expense is expected to increase approximately $ 45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ($ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ($ 211 million after-tax or $ 0.15 per share). Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10 % of the greater of the market-related value of plan assets or plan obligations, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years ) and retiree medical (approximately 8 years), or the remaining life expectancy for participants in Plan I (approximately 23 years). In 2021, we expect the average remaining service life for participants in Plan A to be approximately 9 years , the remaining life expectancy for participants in Plan I to be approximately 27 years and the average remaining service life for participants in Plan H to be approximately 11 years . The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in both Plan A and Plan H, except that prior service cost/(credit) for salaried participants subject to the freeze will be amortized on a Table of Contents straight-line basis over the period up to the effective date of the freeze, or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International 2020 2019 2020 2019 2020 2019 Change in projected benefit obligation Obligation at beginning of year $ 15,230 $ 13,807 $ 3,753 $ 3,098 $ 988 $ 996 Service cost 434 381 86 73 25 23 Interest cost 435 543 85 97 25 36 Plan amendments ( 221 ) 15 ( 17 ) 1 ( 25 ) Participant contributions 2 2 Experience loss 2,042 2,091 467 515 81 36 Benefit payments ( 378 ) ( 341 ) ( 92 ) ( 100 ) ( 89 ) ( 105 ) Settlement/curtailment ( 808 ) ( 1,268 ) ( 24 ) ( 31 ) Special termination benefits 19 2 Other, including foreign currency adjustment 170 98 1 2 Obligation at end of year $ 16,753 $ 15,230 $ 4,430 $ 3,753 $ 1,006 $ 988 Change in fair value of plan assets Fair value at beginning of year $ 14,302 $ 12,258 $ 3,732 $ 3,090 $ 302 $ 285 Actual return on plan assets 1,908 3,101 401 551 47 78 Employer contributions/funding 387 550 120 122 55 44 Participant contributions 2 2 Benefit payments ( 378 ) ( 341 ) ( 92 ) ( 100 ) ( 89 ) ( 105 ) Settlement ( 754 ) ( 1,266 ) ( 29 ) ( 31 ) Other, including foreign currency adjustment 169 98 Fair value at end of year $ 15,465 $ 14,302 $ 4,303 $ 3,732 $ 315 $ 302 Funded status $ ( 1,288 ) $ ( 928 ) $ ( 127 ) $ ( 21 ) $ ( 691 ) $ ( 686 ) Amounts recognized Other assets $ 797 $ 744 $ 110 $ 99 $ $ Other current liabilities ( 53 ) ( 52 ) ( 1 ) ( 1 ) ( 51 ) ( 58 ) Other liabilities ( 2,032 ) ( 1,620 ) ( 236 ) ( 119 ) ( 640 ) ( 628 ) Net amount recognized $ ( 1,288 ) $ ( 928 ) $ ( 127 ) $ ( 21 ) $ ( 691 ) $ ( 686 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 4,116 $ 3,516 $ 1,149 $ 914 $ ( 212 ) $ ( 285 ) Prior service (credit)/cost ( 119 ) 114 ( 19 ) ( 45 ) ( 32 ) Total $ 3,997 $ 3,630 $ 1,130 $ 914 $ ( 257 ) $ ( 317 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ 1,009 $ ( 120 ) $ 268 $ 152 $ 50 $ ( 24 ) Amortization and settlement recognition ( 409 ) ( 457 ) ( 75 ) ( 44 ) 23 27 Foreign currency translation loss/(gain) 42 26 ( 1 ) Total $ 600 $ ( 577 ) $ 235 $ 134 $ 73 $ 2 Accumulated benefit obligation at end of year $ 15,949 $ 14,255 $ 4,108 $ 3,441 The net loss/(gain) arising in the current year is primarily attributable to the decrease in discount rate, offset by actual asset returns exceeding expected returns. Table of Contents The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Lump sum payouts are generally higher when interest rates are lower. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ 434 $ 381 $ 431 $ 86 $ 73 $ 92 $ 25 $ 23 $ 32 Other pension and retiree medical benefits (income)/expense: Interest cost $ 435 $ 543 $ 482 $ 85 $ 97 $ 93 $ 25 $ 36 $ 34 Expected return on plan assets ( 929 ) ( 892 ) ( 943 ) ( 202 ) ( 188 ) ( 197 ) ( 16 ) ( 18 ) ( 19 ) Amortization of prior service cost/(credits) 12 10 3 ( 12 ) ( 19 ) ( 20 ) Amortization of net losses/(gains) 196 161 179 61 32 45 ( 23 ) ( 27 ) ( 8 ) Settlement/curtailment losses (a) 213 296 8 19 12 6 Special termination benefits 19 1 36 2 1 Total other pension and retiree medical benefits (income)/expense $ ( 54 ) $ 119 $ ( 235 ) $ ( 37 ) $ ( 47 ) $ ( 51 ) $ ( 26 ) $ ( 28 ) $ ( 12 ) Total $ 380 $ 500 $ 196 $ 49 $ 26 $ 41 $ ( 1 ) $ ( 5 ) $ 20 (a) In 2020, U.S. includes a settlement charge of $ 205 million ($ 158 million after-tax or $ 0.11 per share) related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million ($ 170 million after-tax or $ 0.12 per share) and a pension lump sum settlement charge of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Table of Contents The following table provides the weighted-average assumptions used to determine net periodic benefit cost and projected benefit obligation for our pension and retiree medical plans: Pension Retiree Medical U.S. International 2020 2019 2018 2020 2019 2018 2020 2019 2018 Net Periodic Benefit Cost Service cost discount rate 3.4 % 4.4 % 3.8 % 3.2 % 4.2 % 3.5 % 3.2 % 4.3 % 3.6 % Interest cost discount rate 2.9 % 4.1 % 3.4 % 2.4 % 3.2 % 2.8 % 2.6 % 3.8 % 3.0 % Expected return on plan assets 6.8 % 7.1 % 7.2 % 5.6 % 5.8 % 6.0 % 5.8 % 6.6 % 6.5 % Rate of salary increases 3.1 % 3.1 % 3.1 % 3.3 % 3.7 % 3.7 % Projected Benefit Obligation Discount rate 2.5 % 3.3 % 4.4 % 2.0 % 2.5 % 3.4 % 2.3 % 3.1 % 4.2 % Rate of salary increases 3.0 % 3.1 % 3.1 % 3.3 % 3.3 % 3.7 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit obligation in excess of plan assets: Pension Retiree Medical U.S. International 2020 2019 2020 2019 2020 2019 Selected information for plans with accumulated benefit obligation in excess of plan assets (a) Obligation for service to date $ ( 5,537 ) $ ( 9,194 ) $ ( 172 ) $ ( 192 ) Fair value of plan assets $ 4,156 $ 8,497 $ 123 $ 151 Selected information for plans with projected benefit obligation in excess of plan assets Benefit obligation $ ( 9,172 ) $ ( 10,169 ) $ ( 2,933 ) $ ( 632 ) $ ( 1,006 ) $ ( 988 ) Fair value of plan assets $ 7,088 $ 8,497 $ 2,696 $ 512 $ 315 $ 302 (a) The decrease in U.S. pension plans in 2020 primarily reflects the approved reorganization of the U.S. qualified defined benefit plans, resulting in the transfer of obligations and plan assets relating to certain participants from Plan A to Plan I and Plan H. Of the total projected pension benefit obligation as of December 26, 2020, approximately $ 854 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2021 2022 2023 2024 2025 2026 - 2030 Pension $ 925 $ 1,080 $ 915 $ 960 $ 990 $ 5,270 Retiree medical (a) $ 95 $ 95 $ 90 $ 85 $ 80 $ 370 (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 1 million for each of the years from 2021 through 2025 and approximately $ 4 million in total for 2026 through 2030. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Table of Contents Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical 2020 2019 2018 2020 2019 2018 Discretionary (a) $ 339 $ 417 $ 1,417 $ $ $ 37 Non-discretionary 168 255 198 55 44 56 Total $ 507 $ 672 $ 1,615 $ 55 $ 44 $ 93 (a) Includes $ 325 million contribution in 2020, $ 400 million contribution in 2019 and $ 1.4 billion contribution in 2018 to fund Plan A in the United States. In November 2020, we received approval from our Board of Directors to make discretionary contributions of $ 500 million to our U.S. qualified defined benefit plans. We contributed $ 300 million of the approved amount in January 2021; we expect to contribute the remaining $ 200 million in the third quarter of 2021. In addition, in 2021, we expect to make non-discretionary contributions of approximately $ 160 million to our U.S. and international pension benefit plans and approximately $ 50 million for retiree medical benefits. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan obligations, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected obligations. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2021 and 2020, our expected long-term rate of return on U.S. plan assets is 6.4 % and 6.8 %, respectively. Our target investment allocations for U.S. plan assets are as follows: 2021 2020 Fixed income 51 % 50 % U.S. equity 24 % 25 % International equity 21 % 21 % Real estate 4 % 4 % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the Table of Contents reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2020 and 2019 are categorized consistently by Level 1 (quoted prices in active markets for identical assets), Level 2 (significant other observable inputs) and Level 3 (significant unobservable inputs) in both years and are as follows: Fair Value Hierarchy Level 2020 2019 U.S. plan assets (a) Equity securities, including preferred stock (b) 1 $ 7,179 $ 6,605 Government securities (c) 2 2,177 2,154 Corporate bonds (c) 2 5,437 4,737 Mortgage-backed securities (c) 2 119 159 Contracts with insurance companies (d) 3 9 9 Cash and cash equivalents (e) 1, 2 278 275 Sub-total U.S. plan assets 15,199 13,939 Real estate commingled funds measured at net asset value (f) 517 605 Dividends and interest receivable, net of payables 64 60 Total U.S. plan assets $ 15,780 $ 14,604 International plan assets Equity securities (b) 1, 2 $ 2,119 $ 1,973 Government securities (c) 2 937 725 Corporate bonds (c) 2 445 331 Fixed income commingled funds (g) 1 509 437 Contracts with insurance companies (d) 3 50 42 Cash and cash equivalents 1 33 24 Sub-total international plan assets 4,093 3,532 Real estate commingled funds measured at net asset value (f) 202 193 Dividends and interest receivable 8 7 Total international plan assets $ 4,303 $ 3,732 (a) Includes $ 315 million and $ 302 million in 2020 and 2019, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) Invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The commingled funds are based on the published price of the fund and include one large-cap fund that represents 13 % and 16 % of total U.S. plan assets for 2020 and 2019, respectively. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. The international portfolio includes Level 1 assets of $ 2,119 million and $ 1,941 million for 2020 and 2019, respectively, and Level 2 assets of $ 32 million for 2019. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 30 % and 28 % of total U.S. plan assets for 2020 and 2019, respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 26, 2020 and December 28, 2019. (e) Cash and cash equivalents in the U.S. includes Level 1 assets of $ 178 million and $ 159 million for 2020 and 2019, respectively, and Level 2 assets of $ 100 million and $ 116 million for 2020 and 2019, respectively. (f) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (g) Based on the published price of the fund. Table of Contents Retiree Medical Cost Trend Rates 2021 2020 Average increase assumed 6 % 6 % Ultimate projected increase 5 % 5 % Year of ultimate projected increase 2040 2039 These assumed health care cost trend rates have an impact on the retiree medical plan expense and obligation, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement and we make Company matching contributions for certain employees on a portion of employee contributions based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution based on age and years of service regardless of employee contribution. In 2020, 2019 and 2018, our total Company contributions were $ 225 million, $ 197 million and $ 180 million, respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2020 (a) 2019 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,358 $ 2,848 Commercial paper ( 0.2 %) 396 Other borrowings ( 1.7 % and 6.4 %) 26 72 $ 3,780 $ 2,920 Long-term debt obligations (b) Notes due 2020 ( 2.7 %) 2,840 Notes due 2021 ( 2.2 % and 2.4 %) 3,356 3,276 Notes due 2022 ( 2.5 % and 2.7 %) 3,867 3,831 Notes due 2023 ( 1.5 % and 2.8 %) 3,017 1,272 Notes due 2024 ( 2.1 % and 3.4 %) 3,067 1,839 Notes due 2025 ( 2.7 % and 3.1 %) 3,227 1,691 Notes due 2026-2060 ( 2.9 % and 3.4 %) 27,165 17,219 Other, due 2020-2026 ( 1.3 % and 1.3 %) 29 28 43,728 31,996 Less: current maturities of long-term debt obligations ( 3,358 ) ( 2,848 ) Total $ 40,370 $ 29,148 (a) Amounts are shown net of unamortized net discounts of $ 260 million and $ 163 million for 2020 and 2019, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. Table of Contents As of December 26, 2020 and December 28, 2019, our international debt of $ 29 million and $ 69 million, respectively, was related to borrowings from external parties, including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2020, we issued the following senior notes: Interest Rate Maturity Date Amount (a) 2.250 % March 2025 $ 1,500 2.625 % March 2027 $ 500 2.750 % March 2030 $ 1,500 3.500 % March 2040 $ 750 3.625 % March 2050 $ 1,500 3.875 % March 2060 $ 750 0.750 % May 2023 $ 1,000 1.625 % May 2030 $ 1,000 0.250 % May 2024 1,000 0.500 % May 2028 1,000 0.400 % October 2023 $ 750 1.400 % February 2031 $ 750 0.400 % October 2032 750 1.050 % October 2050 750 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. The net proceeds from the issuances of the above notes will be used for general corporate purposes, including the repayment of commercial paper. In 2020, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on May 31, 2021. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion in U.S dollars and/or euros. We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which term loan would mature no later than the anniversary of the then effective termination date. The 364-Day Credit Agreement replaced our $ 3.75 billion 364-day credit agreement, dated as of June 3, 2019. The 364-Day Credit Agreement is in addition to the five-year unsecured revolving credit agreement (Five-Year Credit Agreement) we entered into in 2019, and which expires on June 3, 2024. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion in U.S. dollars and/or euros. Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Funds borrowed under the 364-Day Credit Agreement and Five-Year Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 26, 2020, there were no outstanding borrowings under the 364-Day Credit Agreement or the Five-Year Credit Agreement. In 2020, one of our international consolidated subsidiaries borrowed 21.7 billion South African rand, or approximately $ 1.3 billion, from our two unsecured bridge loan facilities (Bridge Loan Facilities) to fund Table of Contents our acquisition of Pioneer Foods. These borrowings were fully repaid in April 2020 and no further borrowings under these Bridge Loan Facilities are permitted. In 2020, we paid $ 1.1 billion to redeem all $ 1.1 billion outstanding principal amount of our 2.15 % senior notes due 2020 and terminated associated interest rate swaps with a notional amount of $ 0.8 billion. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. In 2018, we completed a cash tender offer to redeem $ 1.3 billion of certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $ 1.6 billion in cash. Also in 2018, we completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for newly issued PepsiCo notes. These notes were issued in an aggregate principal amount of $ 732 million, equal to the exchanged notes. As a result of the above transactions, we recorded a pre-tax charge of $ 253 million ($ 191 million after-tax or $ 0.13 per share) to interest expense in 2018, primarily representing the tender price paid over the carrying value of the tendered notes. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. We do not use derivative instruments for trading or speculative purposes. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 26, 2020 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. Credit Risk We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to Table of Contents be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position as of December 26, 2020 was $ 283 million. We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 26, 2020. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.1 billion as of December 26, 2020 and December 28, 2019. Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $ 1.9 billion as of December 26, 2020 and December 28, 2019. The total notional amount of our debt instruments designated as net investment hedges was $ 2.7 billion as of December 26, 2020 and $ 2.5 billion as of December 28, 2019. For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and Table of Contents swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 3.0 billion as of December 26, 2020 and $ 5.0 billion as of December 28, 2019. As of December 26, 2020, approximately 3 % of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 9 % as of December 28, 2019. Held-to-Maturity Debt Securities Investments in debt securities that we have the positive intent and ability to hold until maturity are classified as held-to-maturity. Highly liquid debt securities with original maturities of three months or less are recorded as cash equivalents. Our held-to-maturity debt securities consist of U.S. Treasury securities and commercial paper. As of December 26, 2020, we had $ 2.1 billion of investments in U.S. Treasury securities with $ 2.0 billion recorded in cash and cash equivalents and $ 0.1 billion in short-term investments. We had no investments in U.S. Treasury securities as of December 28, 2019. As of December 26, 2020, we had $ 260 million of investments in commercial paper with $ 75 million recorded in cash and cash equivalents and $ 185 million in short-term investments. As of December 28, 2019, we had $ 130 million of investments in commercial paper recorded in cash and cash equivalents. Held-to-maturity debt securities are recorded at amortized cost, which approximates fair value, and realized gains or losses are reported in earnings. Our investments mature in less than one year. As of December 26, 2020 and December 28, 2019, gross unrecognized gains and losses and the allowance for expected credit losses were not material. Table of Contents Fair Value Measurements The fair values of our financial assets and liabilities as of December 26, 2020 and December 28, 2019 are categorized as follows: 2020 2019 Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Index funds (b) 1 $ 231 $ $ 229 $ Prepaid forward contracts (c) 2 $ 18 $ $ 17 $ Deferred compensation (d) 2 $ $ 477 $ $ 468 Contingent consideration (e) 3 $ $ 861 $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) 2 $ 2 $ $ $ 5 Derivatives designated as cash flow hedging instruments: Foreign exchange (g) 2 $ 9 $ 71 $ 5 $ 32 Interest rate (g) 2 13 307 390 Commodity (h) 1 2 5 Commodity (i) 2 32 2 5 $ 54 $ 378 $ 9 $ 432 Derivatives not designated as hedging instruments: Foreign exchange (g) 2 $ 4 $ 8 $ 3 $ 2 Commodity (h) 1 23 7 Commodity (i) 2 19 7 6 24 $ 23 $ 15 $ 32 $ 33 Total derivatives at fair value (j) $ 79 $ 393 $ 41 $ 470 Total $ 328 $ 1,731 $ 287 $ 938 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (c) Based primarily on the price of our common stock. (d) Based on the fair value of investments corresponding to employees investment elections. (e) In connection with our acquisition of Rockstar, we recorded a liability for tax-related contingent consideration payable over up to 15 years, with an option to accelerate all remaining payments, with estimated maximum payments of approximately $ 1.1 billion, using current tax rates. The fair value of the liability is estimated using probability-weighted, discounted future cash flows at current tax rates. The significant unobservable inputs (Level 3) used to estimate the fair value include the expected future tax benefits associated with the acquisition, the probability that the option to accelerate all remaining payments will be exercised and discount rates. The expected annual future tax benefits range from approximately $ 40 million to $ 110 million, with an average of $ 70 million. The probability, in any given year, that the option to accelerate will be exercised ranges from 3 to 25 percent, with a weighted-average payment period of approximately 4 years. The discount rates range from less than 1 percent to 5 percent, with a weighted average of 3 percent. The contingent consideration measured at fair value using unobservable inputs as of December 26, 2020 is $ 861 million, comprised of an $ 882 million liability recognized at the acquisition date of Rockstar and a fair value decrease of $ 21 million in the year ended December 26, 2020, recorded in selling, general and administrative expenses. (f) Based on London Interbank Offered Rate forward rates. As of December 26, 2020 and December 28, 2019, the carrying amount of hedged fixed-rate debt was $ 0.2 billion and $ 2.2 billion, respectively, and classified on our balance sheet within short-term and long-term debt obligations. As of December 26, 2020 and December 28, 2019, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was a $ 2 million gain and $ 5 million loss, respectively. As of December 26, 2020, the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 19 million loss, which is being amortized over the remaining life of the related debt obligations. Table of Contents (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 26, 2020 and December 28, 2019 were not material. Collateral received or posted against our asset or liability positions was not material. Exchange-traded commodity futures are cash-settled on a daily basis and, therefore, not included in the table as of December 26, 2020. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. Our cash equivalents and short-term investments are classified as Level 2 in the fair value hierarchy. The fair value of our debt obligations as of December 26, 2020 and December 28, 2019 was $ 50 billion and $ 34 billion, respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) 2020 2019 2020 2019 2020 2019 Foreign exchange $ $ ( 1 ) $ ( 9 ) $ 57 $ ( 43 ) $ 3 Interest rate ( 6 ) ( 64 ) ( 96 ) 67 ( 129 ) 7 Commodity 53 ( 17 ) ( 21 ) 7 56 4 Net investment 235 ( 30 ) Total $ 47 $ ( 82 ) $ 109 $ 101 $ ( 116 ) $ 14 (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in net interest expense and other. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in net interest expense and other. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are included in cost of sales. Interest rate derivative losses/gains are included in net interest expense and other. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $ 7 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Table of Contents Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: 2020 2019 2018 Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 7,120 $ 7,314 $ 12,515 Preferred stock: Redemption premium (b) ( 2 ) Net income available for PepsiCo common shareholders $ 7,120 1,385 $ 7,314 1,399 $ 12,513 1,415 Basic net income attributable to PepsiCo per common share $ 5.14 $ 5.23 $ 8.84 Net income available for PepsiCo common shareholders $ 7,120 1,385 $ 7,314 1,399 $ 12,513 1,415 Dilutive securities: Stock options, RSUs, PSUs and other (c) 7 8 10 Employee stock ownership plan (ESOP) convertible preferred stock 2 Diluted $ 7,120 1,392 $ 7,314 1,407 $ 12,515 1,425 Diluted net income attributable to PepsiCo per common share $ 5.12 $ 5.20 $ 8.78 (a) Weighted-average common shares outstanding (in millions). (b) See Note 11 for further information. (c) The dilutive effect of these securities is calculated using the treasury stock method. The weighted-average amount of antidilutive securities excluded from the calculation of diluted earnings per common share was immaterial for the years ended December 26, 2020, December 28, 2019 and December 29, 2018. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. Activities of our preferred stock are included in the equity statement. Table of Contents Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 30, 2017 (a) $ ( 10,277 ) $ 47 $ ( 2,804 ) $ ( 23 ) $ ( 13,057 ) Other comprehensive (loss)/income before reclassifications (b) ( 1,664 ) ( 61 ) ( 813 ) 6 ( 2,532 ) Amounts reclassified from accumulated other comprehensive loss 44 111 218 373 Net other comprehensive (loss)/income ( 1,620 ) 50 ( 595 ) 6 ( 2,159 ) Tax amounts ( 21 ) ( 10 ) 128 97 Balance as of December 29, 2018 (a) ( 11,918 ) 87 ( 3,271 ) ( 17 ) ( 15,119 ) Other comprehensive (loss)/income before reclassifications (c) 636 ( 131 ) ( 89 ) ( 2 ) 414 Amounts reclassified from accumulated other comprehensive loss 14 468 482 Net other comprehensive (loss)/income 636 ( 117 ) 379 ( 2 ) 896 Tax amounts ( 8 ) 27 ( 96 ) ( 77 ) Balance as of December 28, 2019 (a) ( 11,290 ) ( 3 ) ( 2,988 ) ( 19 ) ( 14,300 ) Other comprehensive (loss)/income before reclassifications (d) ( 710 ) 126 ( 1,141 ) ( 1 ) ( 1,726 ) Amounts reclassified from accumulated other comprehensive loss ( 116 ) 465 349 Net other comprehensive (loss)/income ( 710 ) 10 ( 676 ) ( 1 ) ( 1,377 ) Tax amounts 60 ( 3 ) 144 201 Balance as of December 26, 2020 (a) $ ( 11,940 ) $ 4 $ ( 3,520 ) $ ( 20 ) $ ( 15,476 ) (a) Pension and retiree medical amounts are net of taxes of $ 1,338 million as of December 30, 2017, $ 1,466 million as of December 29, 2018, $ 1,370 million as of December 28, 2019 and $ 1,514 million as of December 26, 2020. (b) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. (c) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. (d) Currency translation adjustment primarily reflects the depreciation of the Russian ruble and Mexican peso. Table of Contents The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement 2020 2019 2018 Currency translation: Divestitures $ $ $ 44 Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ $ 1 $ ( 1 ) Net revenue Foreign exchange contracts ( 43 ) 2 ( 7 ) Cost of sales Interest rate derivatives ( 129 ) 7 119 Net interest expense and other Commodity contracts 50 3 3 Cost of sales Commodity contracts 6 1 ( 3 ) Selling, general and administrative expenses Net (gains)/losses before tax ( 116 ) 14 111 Tax amounts 29 ( 2 ) ( 27 ) Net (gains)/losses after tax $ ( 87 ) $ 12 $ 84 Pension and retiree medical items: Amortization of net prior service credit $ $ ( 9 ) $ ( 17 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses 238 169 216 Other pension and retiree medical benefits income/(expense) Settlement/curtailment losses 227 308 19 Other pension and retiree medical benefits income/(expense) Net losses before tax 465 468 218 Tax amounts ( 101 ) ( 102 ) ( 45 ) Net losses after tax $ 364 $ 366 $ 173 Total net losses reclassified for the year, net of tax $ 277 $ 378 $ 301 Note 13 Leases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years, some of which include options to extend the lease term for up to five years, and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Table of Contents Components of lease cost are as follows: 2020 2019 Operating lease cost (a) $ 539 $ 474 Variable lease cost (b) $ 111 $ 101 Short-term lease cost (c) $ 436 $ 379 (a) Includes right-of-use asset amortization of $ 478 million and $ 412 million in 2020 and 2019, respectively. (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. Rent expense for the year ended December 29, 2018 was $ 771 million. In 2020 and 2019, we recognized gains of $ 7 million and $ 77 million, respectively, on sale-leaseback transactions with terms under four years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: 2020 2019 Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ 555 $ 478 Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ 621 $ 479 Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification 2020 2019 Right-of-use assets Other assets $ 1,670 $ 1,548 Current lease liabilities Accounts payable and other current liabilities $ 460 $ 442 Non-current lease liabilities Other liabilities $ 1,233 $ 1,118 Weighted-average remaining lease term and discount rate for our operating leases are as follows: 2020 2019 Weighted-average remaining lease term 6 years 6 years Weighted-average discount rate 4 % 4 % Maturities of lease liabilities by year for our operating leases are as follows: 2021 $ 486 2022 385 2023 278 2024 194 2025 139 2026 and beyond 413 Total lease payments 1,895 Less: Imputed interest ( 202 ) Present value of lease liabilities $ 1,693 Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Table of Contents Note 14 Acquisitions and Divestitures Acquisition of Pioneer Food Group Ltd. On March 23, 2020, we acquired all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe, for 110.00 South African rand per share in cash. The total consideration transferred was approximately $ 1.2 billion and was funded by the Bridge Loan Facilities entered into by one of our international consolidated subsidiaries. See Note 8 for further information. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, in our AMESA segment. The assets acquired and liabilities assumed in Pioneer Foods as of the acquisition date, which primarily include goodwill and other intangible assets of $ 0.8 billion and property, plant and equipment of $ 0.4 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the second quarter of 2021. In connection with our acquisition of Pioneer Foods, we have made certain commitments to the South Africa Competition Commission, including a commitment to provide the equivalent of 7.7 billion South African rand, or approximately $ 0.4 billion as of the acquisition date, in value for the benefit of our employees, agricultural development, education, developing Pioneer Foods operations and enterprise development programs in South Africa. Included in this commitment is 2.2 billion South African rand, or approximately $ 0.1 billion, relating to the implementation of an employee ownership plan and an agricultural, entrepreneurship and educational development fund, which is an irrevocable condition of the acquisition and will primarily be settled within the twelve-month period from the acquisition date. This was recorded in selling, general and administrative expenses in 2020. The remaining commitment of 5.5 billion South African rand, or approximately $ 0.3 billion as of the acquisition date, relates to capital expenditures and/or business-related costs which will be incurred and recorded over a five-year period from the acquisition date. Acquisition of Rockstar Energy Beverages On April 24, 2020, we acquired Rockstar, an energy drink maker with whom we had a distribution agreement prior to the acquisition, for an upfront cash payment of approximately $ 3.85 billion and contingent consideration related to estimated future tax benefits associated with the acquisition of approximately $ 0.9 billion. See Note 9 for further information about the contingent consideration. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, primarily in our PBNA segment. The assets acquired and liabilities assumed in Rockstar as of the acquisition date, which primarily include goodwill and other intangible assets of $ 4.7 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the second quarter of 2021. Acquisition of Hangzhou Haomusi Food Co., Ltd. On June 1, 2020, we acquired all of the outstanding shares of Be Cheery, one of the largest online snacks companies in China, from Haoxiangni Health Food Co., Ltd. for cash. The total consideration transferred was approximately $ 0.7 billion. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, in our Table of Contents APAC segment. The assets acquired and liabilities assumed in Be Cheery as of the acquisition date, which primarily include goodwill and other intangible assets of $ 0.7 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the third quarter of 2021. Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $ 144.00 per share in cash, in a transaction valued at approximately $ 3.3 billion. The total consideration transferred was $ 3.3 billion (or $ 3.2 billion, net of cash and cash equivalents acquired). The purchase price allocation was finalized in the fourth quarter of 2019. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 144 million ($ 126 million after-tax or $ 0.09 per share) in selling, general and administrative expenses in our APAC segment as a result of this transaction. Refranchising in Czech Republic, Hungary and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in Czech Republic, Hungary and Slovakia. We recorded a pre-tax gain of $ 58 million ($ 46 million after-tax or $ 0.03 per share) in selling, general and administrative expenses in our Europe segment as a result of this transaction. Inventory Fair Value Adjustments and Merger and Integration Charges A summary of our inventory fair value adjustments and merger and integration charges is as follows: 2020 2019 2018 Cost of sales $ 32 $ 34 $ Selling, general and administrative expenses 223 21 75 Total $ 255 $ 55 $ 75 After-tax amount $ 237 $ 47 $ 75 Net income attributable to PepsiCo per common share $ 0.17 $ 0.03 $ 0.05 Inventory fair value adjustments and merger and integration charges include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets (recorded in cost of sales) and closing costs, employee-related costs, contract termination costs, changes in the fair value of contingent consideration and other integration costs (recorded in selling, general and administrative expenses). Merger and integration charges also include liabilities to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods (recorded in selling, general and administrative expenses). Table of Contents Inventory fair value adjustments and merger and integration charges by division are as follows: 2020 2019 2018 Acquisition FLNA $ 29 $ $ BFY Brands PBNA 66 Rockstar Europe 46 57 SodaStream AMESA 173 7 Pioneer Foods APAC 7 Be Cheery Corporate (a) ( 20 ) 2 18 Rockstar, SodaStream Total $ 255 $ 55 $ 75 (a) In 2020, the income amount primarily relates to the change in the fair value of contingent consideration associated with our acquisition of Rockstar. Note 15 Supplemental Financial Information Balance Sheet 2020 2019 2018 Accounts and notes receivable Trade receivables $ 6,892 $ 6,447 Other receivables 1,713 1,480 Total 8,605 7,927 Allowance, beginning of year 105 101 $ 129 Cumulative effect of accounting change 44 Net amounts charged to expense (a) 79 22 16 Deductions (b) ( 32 ) ( 30 ) ( 33 ) Other (c) 5 12 ( 11 ) Allowance, end of year 201 105 $ 101 Net receivables $ 8,404 $ 7,822 Inventories (d) Raw materials and packaging $ 1,720 $ 1,395 Work-in-process 205 200 Finished goods 2,247 1,743 Total $ 4,172 $ 3,338 Property, plant and equipment, net (e) Average Useful Life (Years) Land $ 1,171 $ 1,130 Buildings and improvements 15 - 44 10,214 9,314 Machinery and equipment, including fleet and software 5 - 15 31,276 29,390 Construction in progress 3,679 3,169 46,340 43,003 Accumulated depreciation ( 24,971 ) ( 23,698 ) Total $ 21,369 $ 19,305 Depreciation expense $ 2,335 $ 2,257 $ 2,241 Other assets Noncurrent notes and accounts receivable $ 109 $ 85 Deferred marketplace spending 130 147 Pension plans (f) 910 846 Right-of-use assets (g) 1,670 1,548 Other 493 385 Total $ 3,312 $ 3,011 Table of Contents Accounts payable and other current liabilities Accounts payable $ 8,853 $ 8,013 Accrued marketplace spending 2,935 2,765 Accrued compensation and benefits 2,059 1,835 Dividends payable 1,430 1,351 Current lease liabilities (g) 460 442 Other current liabilities 3,855 3,135 Total $ 19,592 $ 17,541 (a) In 2020, includes an allowance for expected credit losses of $ 56 million related to the COVID-19 pandemic. See Note 1 for further information. (b) Includes accounts written off. (c) Includes adjustments related primarily to currency translation and other adjustments. (d) Approximately 6 % and 7 % of the inventory cost in 2020 and 2019, respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. See Note 2 for further information. (e) See Note 2 for further information. (f) See Note 7 for further information. (g) See Note 13 for further information. Statement of Cash Flows 2020 2019 2018 Interest paid (a) $ 1,156 $ 1,076 $ 1,388 Income taxes paid, net of refunds (b) $ 1,770 $ 2,226 $ 1,203 (a) In 2018, excludes the premiums paid in accordance with the debt transactions. See Note 8 for further information. (b) In 2020, 2019 and 2018, includes tax payments of $ 78 million, $ 423 million and $ 115 million, respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. 2020 2019 Cash and cash equivalents $ 8,185 $ 5,509 Restricted cash included in other assets (a) 69 61 Total cash and cash equivalents and restricted cash $ 8,254 $ 5,570 (a) Primarily relates to collateral posted against certain of our derivative positions. Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 26, 2020 and December 28, 2019, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 26, 2020 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 26, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 26, 2020 and December 28, 2019, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 26, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 26, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted by SEC guidance, the scope of management's assessment of the effectiveness of internal control over financial reporting as of December 26, 2020 excluded Pioneer Food Group Ltd. and its subsidiaries (Pioneer Foods) and Hangzhou Haomusi Food Co., Ltd. and its subsidiaries (Be Cheery), both of which the Company acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of the Company as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of the Company as of and for the year ended December 26, 2020. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Pioneer Foods and Be Cheery. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and Table of Contents performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Sales incentive accruals As discussed in Note 2 to the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation Table of Contents and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys sales incentive process, including (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 26, 2020 was $36.4 billion which represents 39% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 26, 2020. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys indefinite-lived assets impairment process to develop the forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Table of Contents Unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 26, 2020, the Company recorded reserves for unrecognized tax benefits of $1.6 billion. The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, new tax law, relevant court rulings or tax authority settlements. We identified the evaluation of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, associated external counsel opinions, information from tax examinations, relevant court rulings and tax authority settlements. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 10, 2021 Table of Contents GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, and where applicable, foreign exchange translation and the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Table of Contents Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. Table of Contents ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. ," Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 26, 2020. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2020, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue Table of Contents to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. Item 9B. Other Information. Not applicable. "," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 26, 2020. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2020, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue Table of Contents to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +31,PepsiCo,2019," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations Changes to Organizational Structure During the fourth quarter of 2019, we realigned our Europe Sub-Saharan Africa (ESSA) and Asia, Middle East and North Africa (AMENA) reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. As a result, our beverage, food and snack businesses in North Africa, the Middle East and South Asia that were part of our former AMENA segment and our businesses in Sub-Saharan Africa that were part of our former ESSA segment are now reported together as our Africa, Middle East and South Asia (AMESA) segment. The remaining beverage, food and snack businesses that were part of our former AMENA segment are now reported together as our Asia Pacific, Australia and New Zealand and China region (APAC) segment and our beverage, food and snack businesses in Europe are now reported as our Europe segment. These changes did not impact our Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), PepsiCo Beverages North America (PBNA), formerly named North America Beverages, or Latin America (LatAm) reportable segments or our consolidated financial results . Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Pasta Roni, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel, Sierra Mist and Tropicana. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, Europe makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. Further, as part of its beverage business, Europe manufactures and distributes sparkling water makers through SodaStream International Ltd. (SodaStream). See Note 14 to our consolidated financial statements for further information about our acquisition of SodaStream. Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In 2019, we entered into an agreement to acquire Pioneer Food Group Ltd. (Pioneer Foods), a food and beverage company in South Africa with exports to countries across the globe . The transaction is subject to certain regulatory approvals and other customary conditions and is expected to close in the first half of 2020. See Note 14 to our consolidated financial statements for further information about our acquisition of Pioneer Foods. Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Doritos, Lays and Smiths, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including 1893, Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewater, Aunt Jemima, Bare, Bolt24, bubly, Capn Crunch, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mothers, Mountain Dew, Mountain Dew Amp Game Fuel, Mountain Dew Code Red, Mountain Dew Ice, Mountain Dew Kickstart, Mountain Dew Zero Sugar, Mug, Munchies, Muscle Milk, Naked, Near East, Off the Eaten Path, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, San Carlos, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. Our beverage, food and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2019 , sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 13% of our consolidated net revenue, with sales reported across all of our divisions. Our top five retail customers represented approximately 34% of our 2019 net revenue in North America, with Walmart and its affiliates (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2019 , we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, marketing and merchandising equipment, dispensing equipment, packaging technology (including investments in recycling-focused technologies), package design (including development of sustainable, bio-based packaging) and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of natural flavors, sweetener alternatives and flavor modifiers and innovation in existing sweeteners and flavoring, further expanding our beyond the bottle portfolio, including further growing our SodaStream business, and offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; investments in technology and digitalization, including data analytics to enhance our consumer insights; and efforts focused on reducing our impact on the environment, including improvements in energy efficiency, water use in our operations and our agricultural practices. Our research centers are located around the world, including Brazil, China, India, Ireland, Mexico, Russia, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to innovate in nutritious and convenient beverages, foods and snacks. In 2019 , we continued to make investments to further digitalize our business including: continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and leveraging technology and data analytics to capture and analyze consumer level data to increasingly structure personalized communications with consumers and satisfy demand at the store level. In addition, we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our beyond the bottle offerings by offering bubly in fountain dispensing; developing 100% recycled PET packaging for LIFEWTR and aluminum can packaging for Aquafina; expanding our state of the art food and beverage healthy vending initiative to increase the availability of nutritious and convenient beverages, foods and snacks; further expanding our portfolio, through a combination of brand extensions, product reformulations, new product innovations and acquisitions to offer products with more of the nutritious ingredients and hydration our consumers are looking for, such as Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies), KeVita (probiotics, tonics and fermented teas), Bare (baked apple chips and other baked fruits and vegetables), Health Warrior (nutrition bars), Evolve (plant-based protein products) and Muscle Milk (protein shakes); further expanding our whole grain products globally; and further expanding our portfolio in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water in our agricultural supply chain), and by incorporating improvements in the sustainability and resources of our agricultural supply chain into our operations; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers, including through the use of data and technology to optimize yields and efficiency and promote responsible use of pesticides; and efforts to create a circular future for packaging, including the increased use of recycled content and alternative packaging, support for increased packaging recovery and recycling rates globally, optimization of packaging technology and design to minimize the amount of plastic in our packaging and to make our packaging increasingly recoverable or recyclable with lower environmental impact, and our continued investments in developing compostable and biodegradable packaging. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; data privacy and personal data protection laws and regulations, including the California Privacy Act of 2018; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some plastic beverage bottles and other single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 28, 2019 , we and our consolidated subsidiaries employed approximately 267,000 people worldwide, including approximately 116,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K, including the Managements Discussion and Analysis of Financial Condition and Results of Operations section and the consolidated financial statements and related notes. These risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks described below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends are often not a reliable indicator of future operating results, financial and business performance, events or trends. Future demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics can result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers, including through e-commerce and hard discounters); or the location of origin or source of ingredients and products (including the environmental impact related to production and packaging of our products). Consumer preferences continuously evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending, consumption and purchasing habits; consumer concerns or perceptions regarding the nutrition profile of products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic, locally or sustainably sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including single-use and other plastic packaging, and their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or our respective social media posts, business practices or other information disseminated by or regarding them or us; product boycotts; or a downturn in economic conditions. These factors have in the past and could in the future reduce consumers willingness to purchase certain of our products and any inability on our part to anticipate or react to such changes can lead to reduced demand for our products or erode our competitive and financial position, resulting in adverse effects on our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories (through acquisitions and innovation, such as increasing non-carbonated beverage offerings and other alternatives to, or reformulations of, carbonated beverage offerings); respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients and packaging materials (including to respond to applicable regulations); develop sweetener alternatives and innovation; increase the recyclability or recoverability of our packaging; create more relevant and personalized experiences for consumers whether in a digital environment or through digital devices in an otherwise physical environment; improve the production and distribution of our products; enhance our data analytics capabilities to develop new commercial insights; respond to competitive product and pricing pressures and changes in distribution channels, including in the e-commerce channel; maintain our labeling certifications (e.g., non-GMO) from independent organizations and regulatory authorities for certain of our products; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including correctly anticipating or effectively reacting to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers, including through the use of digital technology. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively market or distribute our products can reduce demand for our products, result in inventory write-offs and erode our competitive and financial position and can adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to the use or disposal of plastics or other product packaging can increase our costs, reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our food and beverage products are sold in plastic or other packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to lack of infrastructure or otherwise. In addition, certain of our packaging is not currently recyclable, compostable or biodegradable. There is a growing concern with the accumulation of plastic, including microplastics, and other packaging waste in the environment, particularly in the worlds oceans and waterways. As a result, packaging waste that displays one or more of our brands has in the past and could continue to result in negative publicity (whether or not valid) or reduce consumer demand and overall consumption of our products, resulting in adverse effects on our business, financial condition or results of operations. In response to these concerns, the United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to increase the sustainability of packaging, encourage waste reduction and increase recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. These regulations vary in scope and form from taxes or fees designed to incentivize behavior to restrictions or bans on certain products and materials. For example, 24 countries in the European Union (EU) have established extended producer responsibility (EPR) policies, which make manufacturers such as us responsible for the costs of recycling beverage and food packaging after consumers have used them. EPR policies are also being contemplated in other jurisdictions around the world, including certain states in the United States. In addition, 10 states in the United States as well as a growing number of European countries have a bottle deposit return system in effect, which requires a deposit charged to consumers to incentivize the return of the beverage container. Further, certain jurisdictions have imposed or are considering imposing other types of regulations or policies, including packaging taxes, requirements for bottle caps to be tethered to the plastic bottle, minimum recycled content mandates, which would require packaging to include a certain percentage of post-consumer recycled material in a new package, and even bans on the use of some plastic beverage bottles and other single-use plastics. These laws and regulations, whatever their scope or form, have in the past and could continue to increase the cost of our products, reduce consumer demand and overall consumption of our products or result in negative publicity (whether or not valid), resulting in adverse effects on our business, financial condition or results of operations. While we continue to devote significant resources to increase the recyclability and sustainability of our packaging, the increased focus on reducing plastic waste has required and could continue to require us to increase capital expenditures, including requiring additional investments to minimize the amount of plastic across our packaging, including to increase the use of alternative packaging materials (e.g., glass and aluminum) in certain markets; increase the amount of recycled content in our packaging; and develop sustainable, bio-based packaging as a replacement for fossil fuel-based plastic packaging, including flexible film alternatives for our snacks packaging. Our failure to minimize our plastics use, increase the amount of recycled content in our packaging or develop sustainable packaging or consumers failure to accept such sustainable packaging has in the past and could continue to reduce consumer demand and overall consumption of our products and erode our competitive and financial position. Further, our reputation can be damaged for failure to achieve our sustainability goals with respect to our plastics use, including our goal to reduce 35% of virgin plastic content across our beverage portfolio by 2025, or if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations can adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to differing regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold, as is the packaging, disposal and recyclability of our products. For example, the EU has mandated tethered caps for all beverage bottles by 2024 and minimum recycled content of 25% for PET bottles by 2025 and 30% for all plastic bottles by 2030 and laws mandating various minimum recycled content thresholds for PET bottles are also in place in Turkey, Bolivia, Ecuador and Peru, while the use of recycled content in food and beverage packaging is prohibited in a range of countries, for example, in Asia. In addition, these laws and regulations and related interpretations have changed and could continue to change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes have included and could continue to include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices, including restrictions on the audience to whom products are marketed; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws related to pesticide used by farmers in our supply chain or residual amounts of pesticide that may be found in certain of our ingredients or products; laws related to traceability requirements for our supply chain; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business, reputation, financial condition or results of operations. The imposition of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product, production, recovery or recycling requirements, or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products, commodities used in the production of our products or use, disposal, recovery or recyclability of our products and their packaging, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, resulting in adverse effects on our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions often follow. For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing has in the past and could continue to result in decreased demand for certain of our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) have been and continue to be underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials, such as 4-MeI, acrylamide, caffeine, pesticides (e.g., glyphosate), furfuryl alcohol, added sugars, sodium, saturated fat and plastic. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and foods high in sugar, sodium or saturated fat. The results of these studies and documents have contributed to or resulted in and could continue to contribute to or result in an increase in consumer concerns (whether or not valid) about the health implications of consumption of certain of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, resulting in reduced demand for our products, our Company being subject to lawsuits or new regulations that can adversely affect sales of our products, and other adverse effects on our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business can take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or can fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, any of which can adversely affect our business, reputation, financial condition or results of operations. In addition, certain regulatory authorities under whose laws we operate have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, resulting in an adverse effect on the sales of products in our portfolio or damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products can adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the particular substance or ingredient levels. For example, Peru revised an existing threshold tax to become a graduated tax, effective June 2019, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per- ounce tax rate, while Saudi Arabia expanded an existing flat tax rate of 50% on the retail price of carbonated soft drinks to include all sweetened beverages, including non-caloric beverages, effective December 2019. These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain of our products, reduce consumer demand and overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs, resulting in adverse effects on our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products could reduce demand for such products and can adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements has in the past and could continue to reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs, resulting in adverse effects on our business, financial condition or results of operations. Our business, financial condition or results of operations can suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective, if we fail to invest in and incorporate technology and digital tools across all areas of our business (including the use of data analytics to enhance our ability to effectively market to consumers), if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which could adversely affect our business, financial condition or results of operations. Failure to realize anticipated benefits from our productivity or reinvestment initiatives or operating model can have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models while reinvesting back into the business. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently in the highly competitive beverage, food and snack categories and markets. Some of these measures have yielded and could continue to yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our business, financial condition or results of operations. Further, in order to continue to capitalize on our cost reduction efforts and operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. From time to time, we have in the past and could continue to implement these investment initiatives to enable us to compete more effectively, including investments to increase manufacturing capacity, improve innovation, transform our manufacturing, commercial and corporate operations through digital technologies and artificial intelligence, and enhance brand management through our use of data analytics to develop new commercial and consumer insights. If we fail to realize all or any of the anticipated benefits of these reinvestment initiatives, our business, financial condition or results of operations can be adversely affected. Our business, financial condition or results of operations can be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold have been and could continue to be difficult to predict, resulting in adverse effects on our business, financial condition and results of operations. The results of elections, referendums or other political conditions (including government shutdowns) in these markets have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or create uncertainty as to how such laws, regulations and government programs or policies may change, including with respect to tariffs, sanctions, climate change regulation, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products. For example, the United Kingdoms withdrawal from the European Union (commonly referred to as Brexit) is likely to lead to differing laws and regulations in the United Kingdom and European Union and further global economic, trade and regulatory uncertainty. Any changes in, or the imposition of, new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions can have an adverse impact on our business, financial condition or results of operations. Our business, financial condition or results of operations can be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences as to distribution or otherwise. The following factors can reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; our inability to hire or retain a highly skilled workforce; imposition of new or increased tariffs and other impositions on imported goods or sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations or tariffs on the products of such corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions, tariffs or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly inflationary economies and potential highly inflationary economies, devaluation or fluctuation, such as the devaluation of the Russian ruble, Turkish lira, Brazilian real, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses, such as occurred with respect to our Venezuelan businesses which were deconsolidated at the end of the third quarter of 2015; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our business, reputation, financial condition or results of operations can be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results have in the past and could continue to be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions, may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, can limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; can leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or can result in a decline in the market value of our investments in debt securities, resulting in an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, contract manufacturers, distributors and joint venture partners and can result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which can also have an adverse impact on our business, reputation, financial condition or results of operations. Our business and reputation can suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage and operate our facilities; to conduct research and development, including through the use of data analytics; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals (including criminal hackers, hacktivists, state-sponsored actors, criminal and terrorist organizations, individuals or groups participating in organized crime and insiders) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of computing resources, notoriety, financial fraud, operational disruption, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation and identity takeover attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware, exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromises. As with other global companies, we are regularly subject to cyberattacks, including many of the types of attacks described above. Although we incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, lapses in our controls or the malicious or negligent actions of employees (including misuse of information they are entitled to access), or from deliberate cyberattacks such as malicious or disruptive software, phishing, denial of service attacks, malicious social engineering, hackers or otherwise), our business can be disrupted and, among other things, be subject to: transaction errors or financial loss; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues or other costs resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which can cause errors or delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or business operations disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and those of our third-party providers, and the information stored therein can be compromised, including through cyberattacks or other external or internal methods, resulting in unauthorized parties accessing or extracting sensitive data or confidential information. In the ordinary course of business, we receive, process, transmit and store information relating to identifiable individuals, primarily employees and former employees. Privacy and data protection laws may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with privacy and data protection laws, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation, which went into effect in May 2018, and residents of the State of California covered by the California Consumer Privacy Act of 2018, which went into effect on January 1, 2020, impose significant costs or challenges that are likely to increase over time. Failure to comply with existing or future data privacy laws and regulations can result in litigation, claims, legal or regulatory proceedings, inquiries or investigations. We continue to devote significant resources to network security, backup and disaster recovery, enhancing our internal controls, and other security measures, including training, to protect our systems and data. In addition, our risk management program also includes periodic review and discussion by our Board of Directors of analyses of emerging cybersecurity threats and our plans and strategies to address them. However, these security measures and processes cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies has heightened these and other operational risks, as certain aspects of the security of such technologies are complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy and other supplies. We and our business partners use various raw materials, energy and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oats, oranges and other fruits, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, the use of plastics and energy, animal welfare and human rights concerns and other risks associated with the global food system is leading to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and can adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake, wildfire or flooding), disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks, such as the recent coronavirus, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), limited or sole sources of supply, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. For example, concerns regarding trade relations between the United States and China escalated during fiscal 2019, with the United States imposing tariffs on the importation of certain Chinese goods and retaliatory Chinese tariffs on U.S. goods. Higher duties on existing tariffs or additional tariffs imposed by the United States on a broader range of imports, or further retaliatory trade measures taken by China or other countries in response, could result in an increase in supply chain costs that we are not able to offset or otherwise adversely impact our results of operations. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs can adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water scarcity can have an adverse impact on our business, financial condition or results of operations. We and our suppliers, bottlers, contract manufacturers, joint venture partners and other third parties use water in the manufacturing of our products. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations or the operations of our suppliers, bottlers, contract manufacturers, distributor, joint venture partners or other third parties; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs, including less favorable pricing for water; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; failure to achieve our sustainability goals relating to water use; perception (whether or not valid) of our failure to act responsibly with respect to water use or to effectively respond to new, or changes in, legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business, financial condition or results of operations. Business disruptions can have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, distributors, joint venture partners and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations has occurred in the past and could continue to occur due to any of the following factors which can impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake, wildfire or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics or other contagious outbreaks, such as the recent coronavirus; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power, fuel or water shortages; strikes, labor disputes or lack of availability of qualified personnel, such as truck drivers; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, has in the past resulted and could continue to result in adverse effects on our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity can adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which can adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we can decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which can result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which can reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes can adversely affect our reputation or brands. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing can adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts can materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image can adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image has in the past and could continue to be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals, including with respect to plastic packaging, or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, plastics or other packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, including the recyclability or recoverability of our packaging, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees or agents engage in or are believed to have engaged in improper activities, we have in the past and could continue to be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, resulting in damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information can also hurt our reputation. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, has in the past and could continue to also generate adverse publicity (whether or not valid) that can damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons has in the past and could continue to result in decreased demand for our products, resulting in adverse effects on our business, financial condition or results of operations, as well as requiring additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, can adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Issues associated with these activities have in the past and could continue to include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, the following factors also have in the past and could continue to pose additional risk risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees (both of the acquired company and our company); conforming standards, controls (including internal control over financial reporting and disclosure controls and procedures, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners have in the past and could continue to adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we have in the past and could continue to be unable to complete or effectively manage such transactions on terms commercially favorable to us or at all, resulting in failure to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain can adversely impact our sales or business performance. Acquisitions or joint ventures that are not successfully completed, integrated into our existing operations or managed effectively, or divestitures or refranchisings that are not successfully completed or managed effectively or do not result in the benefits or cost savings we expect, have in the past and could continue to result in adverse effects on our business, financial condition or results of operations. A change in our estimates and underlying assumptions regarding the future performance of our businesses can result in an impairment charge that materially affects our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable and have recorded impairments in the past. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, can adversely affect our results of operations. Factors considered to determine if an impairment exist include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that can result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. While no material impairment charges have been recorded in the periods presented in this Form 10-K, we may in the future record impairment charges that have a material adverse effect on our results of operations in the periods recognized. See Note 4 to our consolidated financial statements for further information. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction can reduce our after-tax income from such jurisdiction and adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, existing tax laws in the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have been and could in the future be subject to significant change. For example, in December 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and additional guidance issued by the Internal Revenue Service (IRS) may continue to impact our recorded amounts in future periods. In addition, o n May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. Certain provisions of the TRAF were enacted in fiscal year 2019, resulting in adjustments to our deferred taxes. The future impact of the TRAF cannot currently be estimated and we continue to monitor and assess the impact of TRAF on our business and financial results. For further information regarding the impact and potential impact of the TCJ Act and the TRAF, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, can adversely affect our business, financial condition or results of operations. For example, the Organization for Economic Cooperation and Development (OECD) has recommended changes to numerous long-standing international tax principles through its base erosion and profit shifting (BEPS) project. These changes have been or are being adopted by many of the countries in which we do business. In connection with the OECDs BEPS project, the OECD has undertaken a new project focused on Addressing the Tax Challenges of the Digitalization of the Economy. This project may impact all multinational businesses by reallocating where some profits are taxed and implementing a global model for minimum taxation. The increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our provision for income taxes, results of operations and/or cash flow. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. In connection with the OECDs BEPS project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it can have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to hire and retain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing can adversely affect our business, reputation, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer can adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business, financial condition or results of operations. Disruption in the retail landscape, including rapid growth in the e-commerce channel and hard discounters, can adversely affect our business, financial condition or results of operations. Our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites, mobile commerce applications and subscription services as well as the integration of physical and digital operations among retailers. We continue to make significant investments in attracting talent to and building our global e-commerce and digital capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which can adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce and hard discounters may result in consumer price deflation, which may affect our relationships with key retail customers. Further, the ability of consumers to compare prices on a real-time basis using digital technology puts additional pressure on us to maintain competitive prices. If these e-commerce and hard discounter retailers were to take significant additional market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, including finding ways to create more powerful digital tools and capabilities for our retail customers to enable them to grow their businesses, our ability to maintain and grow our profitability, share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, which may impact our ability to compete in these areas. Such retailers or buying groups demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, such consolidation can continue to adversely impact our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may continue to reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, can reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets would be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings can impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market can also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity can adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize information technology support services and administrative functions in certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. We may enter into new or additional agreements for shared services in other functions in the future to achieve cost savings and efficiencies as we continue to migrate to shared business service organizational models across our business operations. In addition, we increasingly utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. Failure by these third-party service providers or vendors to perform effectively, or our failure to adequately monitor their performance (including compliance with service level agreements or regulatory or legal requirements), has in the past and could continue to result in our inability to achieve the expected cost savings, additional costs to correct errors made by such service providers, damage to our reputation or our being subject to litigation, claims, legal or regulatory proceedings, inquiries or investigations. Depending on the function involved, such errors can also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, damage to our reputation or have a negative impact on employee morale. In addition, the management of multiple third-party service providers increases operational complexity and decreases our control. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which can result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, can lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom, China and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our business, financial condition and results of operations. Climate change or legal, regulatory or market measures to address climate change may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, tornado, earthquake, wildfire or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency, we may experience disruptions in, or significant increases in our costs of, operation and delivery and be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions can substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change can negatively affect our business and operations I n addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change can lead to adverse publicity, resulting in an adverse effect on our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact and recyclability or recoverability of packaging, including plastic. Our reputation can be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions can occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which can impair manufacturing and distribution of our products or lead to a loss of sales, resulting in an adverse impact on our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements can also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, can be reduced, resulting in an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property, although the laws of various jurisdictions have differing levels of protection of intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, can be reduced, resulting in an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding can have an adverse impact on our business, reputation, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image, resulting in an adverse impact on our business, financial condition or results of operations. Many factors can adversely affect the price of our publicly traded securities. Many factors can adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, have in the past and could continue to include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, inquiries or investigations; changes in laws and regulations applicable to our products or business operations; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we have or have not taken in the past or may or may not take in the future as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, have not and may not in the future have the impact we intend, resulting in adversely effects on the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, can adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2019 year and that remain unresolved. ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. PBNAs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. LatAms three snack plants in Mexico (one in Celaya and two in Vallejo), all of which are owned. Europes snack plant in Kashira, Russia, its dairy plant in Moscow, Russia, and its fruit juice plant in Zeebrugge, Belgium, all of which are owned. AMESAs snack plant in Riyadh, Saudi Arabia, which is leased. APACs snack plant in Wuhan, China, which is owned. Our primary concentrate plants in Cork, Ireland and in Singapore, all of which are either owned or leased. Our concentrate plants in Cork, Ireland are shared by our PBNA, Europe and AMESA segments and our concentrate plant in Singapore is shared by our PBNA and APAC segments. A shared service center in Winston-Salem, North Carolina, which is primarily shared by our FLNA, QFNA and PBNA segments, which is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 6, 2020 , there were approximately 109,312 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 10, 2020 , the Board of Directors declared a quarterly dividend of $0.955 payable March 31, 2020 , to shareholders of record on March 6, 2020 . For the remainder of 2020 , the record dates for these dividend payments are expected to be June 5, September 4 and December 4, 2020 , subject to approval of the Board of Directors. On February 13, 2020 , we announced a 7% increase in our annualized dividend to $4.09 per share from $3.82 per share, effective with the dividend expected to be paid in June 2020 . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases of approximately $2 billion and dividends of approximately $5.5 billion. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2019 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/7/2019 $ 11,783 9/8/2019 - 10/5/2019 1.5 $ 135.74 1.5 (204 ) 11,579 10/6/2019 - 11/2/2019 1.3 $ 136.76 1.3 (170 ) 11,409 11/3/2019 - 11/30/2019 1.5 $ 133.90 1.5 (202 ) 11,207 12/1/2019 - 12/28/2019 0.9 $ 136.52 0.9 (123 ) Total 5.2 $ 135.58 5.2 $ 11,084 (a) All shares were repurchased in open market transactions pursuant to the $ 15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Results of Operations Division Review FLNA QFNA PBNA LatAm Europe AMESA APAC Results of Operations Other Consolidated Results Non-GAAP Measures Items Affecting Comparability Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Leases Note 14 Acquisitions and Divestitures Note 15 Supplemental Financial Information Note 16 Selected Quarterly Financial Data (unaudited) Report of Independent Registered Public Accounting Firm GLOSSARY 41 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview PepsiCo is a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories Everything we do is driven by an approach we call Winning with Purpose. Winning with Purpose is our guide for achieving accelerated, sustainable growth that includes our mission, to Create More Smiles with Every Sip and Every Bite; our vision, to Be the Global Leader in Convenient Foods and Beverages by Winning with Purpose; and The PepsiCo Way, seven behaviors that define our shared culture. Winning with Purpose is designed to help us meet the needs of our shareholders, customers, consumers, partners and communities, while caring for our planet and inspiring our associates. This strategy is also designed to address key challenges facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To adapt to these challenges, we intend to continue to focus on becoming Faster, Stronger, and Better: Faster by winning in the marketplace, being more consumer-centric and accelerating investment for topline growth. This includes broadening our portfolios to win locally in convenient foods and beverages, fortifying our North American businesses, and accelerating our international expansion, with disciplined focus on markets where we see a strong likelihood of prevailing over our competition. Stronger by continuing to transform our capabilities, cost, and culture by leveraging scale and technology in global markets across our operations and winning locally. This includes continuing to focus on driving savings through holistic cost management to reinvest to succeed in the marketplace, developing and scaling core capabilities through technology, and building differentiated talent and culture. Better by continuing to focus our sustainability agenda on helping to build a more sustainable food system and investing in six priority areas: next generation agriculture, water stewardship, plastic packaging, products, climate change, and people. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, encourage waste reduction and increased recycling rates or facilitate waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. In addition, our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce and digital capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Our provisional measurement period ended in the fourth quarter of 2018 and while our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. For further information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. See Our Critical Accounting Policies and Note 5 to our consolidated financial statements for further information. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 28, 2019 and December 29, 2018 . At the end of 2019 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2019 by $106 million . Foreign Exchange Our operations outside of the United States generated 42% of our consolidated net revenue in 2019 , with Mexico, Russia, Canada, the United Kingdom, China and Brazil , collectively, comprising approximately 22% of our consolidated net revenue in 2019 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business, as well as the proposed acquisition of Pioneer Foods. During 2019 , unfavorable foreign exchange reduced net revenue growth by 2 percentage points, reflecting declines in the euro, Turkish lira, Brazilian real, Russian ruble and Argentine peso. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, as well as the economic, operating and political environment in Russia and the potential impact for the Europe segment and our other businesses. Our foreign currency derivatives had a total notional value of $1.9 billion as of December 28, 2019 and $2.0 billion as of December 29, 2018 . At the end of 2019 , we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2019 by $135 million . The total notional amount of our debt instruments designated as net investment hedges was $2.5 billion as of December 28, 2019 and $0.9 billion as of December 29, 2018 . Interest Rates Our interest rate derivatives had a total notional value of $5.0 billion as of December 28, 2019 and $10.5 billion as of December 29, 2018 . Assuming year-end 2019 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2019 by $25 million due to higher cash and cash equivalents as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Beverage volume reflects sales of concentrate and beverage products bearing company-owned or licensed trademarks to authorized bottlers, independent distributors and retailers. Concentrate beverage volume is sold to franchised-owned bottlers and independent distributors. Finished goods beverage volume is sold to retailers and independent distributors and includes direct shipments to retailers. Beverage volume is measured in bottler case sales (BCS), which converts all beverage volume to an 8-ounce-case metric. We believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the customer level. In our franchised-owned business, beverage revenue is based on concentrate shipments and equivalents (CSE), representing physical concentrate volume shipments to such customers. As a result, for our franchise-owned businesses, BCS and CSE are not typically equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Food and snack volume is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing company-owned or licensed trademarks. In addition, FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2019 , total servings increased 4% compared to 2018 , primarily reflecting our acquisition of SodaStream. In 2018, total servings increased 1% compared to 2017. Consolidated Net Revenue and Operating Profit Change Net revenue $ 67,161 $ 64,661 $ 63,525 % % Operating profit $ 10,291 $ 10,110 $ 10,276 % (2 )% Operating profit margin 15.3 % 15.6 % 16.2 % (0.3 ) (0.5 ) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2019 Operating profit grew 2% and operating profit margin declined 0.3 percentage points. Operating profit growth was driven by productivity savings of more than $1 billion and net revenue growth, partially offset by certain operating cost increases, a 5-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. The operating profit margin decline primarily reflects higher advertising and marketing expenses. Favorable mark-to-market net impact on commodity derivatives included in corporate unallocated expenses (see Items Affecting Comparability) contributed 3 percentage points to operating profit growth. Gains on the refranchising of a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in the prior year reduced operating profit growth by 2 percentage points. Operating profit decreased 2% and operating profit margin declined 0.5 percentage points. The operating profit performance was driven by certain operating cost increases and a 6-percentage-point impact of higher commodity costs, partially offset by productivity savings of more than $1 billion and net revenue growth. The impact of refranchising a portion of our beverage business in Jordan in 2017 and a 2017 gain associated with the sale of our minority stake in Britvic negatively impacted operating profit performance by 2.5 percentage points. These impacts were offset by a 2-percentage-point positive impact of refranchising a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in 2018. Items affecting comparability (see Items Affecting Comparability) negatively impacted operating profit performance by 3 percentage points and decreased operating profit margin by 0.5 percentage points, primarily due to higher mark-to-market net impact on commodity derivatives included in corporate unallocated expenses. Results of Operations Division Review During the fourth quarter of 2019, we realigned certain of our reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. See Our Operations in Item 1. Business for further information. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees . Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on organic revenue growth, see Non-GAAP Measures. Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Volume (b) Effective net pricing FLNA 4.5 % 4.5 % QFNA % % PBNA % (1 ) % (1 ) LatAm % % Europe % (6 ) 5.5 % (1 ) AMESA % % 2.5 APAC 4.5 % % Total % (1 ) 4.5 % 0.5 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Sales and certain other taxes Organic % Change, Non-GAAP Measure (a) Volume (b) Effective net pricing FLNA 3.5 % % QFNA (1.5 )% (2 )% (0.5 ) (1 ) PBNA % 0.5 % (1 ) LatAm % % Europe % 0.5 % AMESA (0.5 )% % 1.5 APAC (3 )% (1 ) 0.5 % Total % % (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our company-owned and franchise-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure FLNA $ 5,258 $ $ $ $ 5,280 QFNA PBNA 2,179 2,230 LatAm 1,141 1,203 Europe 1,327 1,472 AMESA APAC Corporate unallocated expenses (1,306 ) (112 ) (1,369 ) Total $ 10,291 $ (112 ) $ $ $ 10,602 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Merger and integration charges Core, Non-GAAP Measure FLNA $ 5,008 $ $ $ $ 5,044 QFNA PBNA 2,276 2,364 LatAm 1,049 1,089 Europe 1,256 1,372 AMESA APAC Corporate unallocated expenses (1,396 ) (1,205 ) Total $ 10,110 $ $ $ $ 10,620 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Core, Non-GAAP Measure FLNA $ 4,793 $ $ $ 4,847 QFNA PBNA 2,700 2,743 LatAm Europe 1,199 1,252 AMESA APAC (5 ) Corporate unallocated expenses (1,170 ) (15 ) (1,168 ) Total $ 10,276 $ (15 ) $ $ 10,490 (a) See Items Affecting Comparability. Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA % % % QFNA (15 )% (0.5 ) (15 )% (15 )% PBNA (4 )% (1 ) (6 )% (6 )% LatAm % % % Europe % (1 ) % % AMESA 1.5 % 5.5 % 2.5 % APAC (23 )% (17 )% (16 )% Corporate unallocated expenses (6 )% (3 ) % % Total % (3 ) % % Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 4.5 % % % QFNA % (1 )% (1 )% PBNA (16 )% (14 )% (14 )% LatAm % (2 ) % % Europe % % % AMESA (16 )% (14 )% (14 )% APAC % % (2 ) % Corporate unallocated expenses % (15 ) (1.5 ) % % Total (2 )% % 0.5 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 4.5% and volume grew 1%. The net revenue growth was driven by effective net pricing and volume growth. The volume growth reflects mid-single-digit growth in trademark Doritos, Cheetos and Ruffles and low-single-digit growth in variety packs, partially offset by a double-digit decline in trademark Santitas. Operating profit grew 5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and higher advertising and marketing expenses. Additionally, a prior-year bonus extended to certain U.S. employees in connection with the TCJ Act contributed 1 percentage point to operating profit growth . 2018 Net revenue grew 3.5%, primarily reflecting effective net pricing and volume growth. Volume grew 1%, reflecting mid-single-digit growth in variety packs and low-single-digit growth in trademark Doritos, partially offset by a double-digit decline in trademark Santitas. Operating profit grew 4.5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and a 1-percentage-point impact of a bonus extended to certain U.S. employees related to the TCJ Act. QFNA Net revenue grew 1% and volume was flat. The net revenue growth primarily reflects favorable mix. The volume performance was driven by double-digit growth in trademark Gamesa and mid-single-digit growth in Aunt Jemima mixes and syrups, offset by a mid-single-digit decline in oatmeal and a low-single-digit decline in ready-to-eat cereals. Operating profit decreased 15%, reflecting certain operating cost increases, a 5-percentage-point impact of higher commodity costs, and higher advertising and marketing expenses. These impacts were partially offset by productivity savings. Net revenue declined 1.5% and volume declined 0.5%. The net revenue performance reflects unfavorable net pricing and mix and the volume decline. The volume decline was driven by a double-digit decline in trademark Gamesa and a mid-single-digit decline in ready-to-eat cereals, partially offset by mid-single-digit growth in oatmeal. Operating profit decreased slightly, reflecting certain operating cost increases, the net revenue performance and a 3-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1-percentage-point positive contribution from insurance settlement recoveries related to the 2017 earthquake in Mexico. PBNA Net revenue grew 3%, driven by effective net pricing, partially offset by a decline in volume. Acquisitions contributed 1 percentage point to the net revenue growth. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage (NCB) volume. The NCB volume increase primarily reflected a mid-single-digit increase in our overall water portfolio, partially offset by a low-single-digit decrease in our juice and juice drinks portfolio. Operating profit decreased 4%, reflecting certain operating cost increases, higher advertising and marketing expenses, an 8-percentage-point impact of higher commodity costs and the volume decline. These impacts were partially offset by the effective net pricing and productivity savings. Year-over-year gains on asset sales negatively contributed 1 percentage point to operating profit performance. A gain associated with an insurance recovery positively contributed 1 percentage point to current-year operating profit performance and was offset by less-favorable insurance adjustments compared to the prior year, which negatively impacted the current-year operating profit performance by 1 percentage point. Additionally, a prior-year bonus extended to certain U.S. employees in connection with the TCJ Act positively contributed 2 percentage points to operating profit performance. 2018 Net revenue grew 1%, driven by effective net pricing, partially offset by a decline in volume. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage volume. The non-carbonated beverage volume increase primarily reflected a high-single-digit increase in our overall water portfolio. Additionally, a low-single-digit increase in Gatorade sports drinks was offset by a low-single-digit decline in our juice and juice drinks portfolio. Operating profit decreased 16%, reflecting certain operating cost increases, including increased transportation costs, a 7-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. These impacts were partially offset by productivity savings and the net revenue growth. Higher gains on asset sales positively contributed 1.5 percentage points to operating profit performance. A bonus extended to certain U.S. employees related to the TCJ Act negatively impacted operating profit performance by 1.5 percentage points and was partially offset by 2017 costs related to hurricanes which positively contributed 1 percentage point to operating profit performance. LatAm Net revenue increased 3%, primarily reflecting effective net pricing, partially offset by a 4-percentage-point impact of unfavorable foreign exchange. Snacks volume experienced a slight decline, reflecting a high-single-digit decline in Brazil, partially offset by low-single-digit growth in Mexico. Beverage volume grew 4%, reflecting high-single-digit growth in Brazil and Guatemala, partially offset by a mid-single-digit decline in Argentina and a low-single-digit decline in Colombia. Additionally, Honduras experienced low-single-digit growth and Mexico and Chile each experienced mid-single-digit growth. Operating profit increased 9%, reflecting the effective net pricing and productivity savings, partially offset by certain operating cost increases and a 10-percentage-point impact of higher commodity costs largely due to transaction-related foreign exchange. Unfavorable foreign exchange and higher restructuring and impairment charges each reduced operating profit growth by 2 percentage points. Net revenue grew 2%, reflecting effective net pricing, partially offset by a 6-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, reflecting low-single-digit growth in Mexico, partially offset by a mid-single-digit decline in Brazil. Beverage volume declined 1%, reflecting a high-single-digit decline in Brazil, a low-single-digit decline in Mexico and a mid-single-digit decline in Argentina, partially offset by double-digit growth in Colombia, mid-single-digit growth in Guatemala and low-single-digit growth in Honduras. Operating profit increased 13%, reflecting the net revenue growth, productivity savings and a 4-percentage-point impact of insurance settlement recoveries related to the 2017 earthquake in Mexico. These impacts were partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Europe Net revenue increased 7%, reflecting an 8-percentage-point impact of our SodaStream acquisition and effective net pricing, partially offset by a 5-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, primarily reflecting mid-single-digit growth in Poland and France and low-single-digit growth in Spain and the Netherlands, partially offset by a mid-single-digit decline in Turkey and a slight decline in the United Kingdom. Additionally, Russia experienced slight growth. Beverage volume grew 23%, primarily reflecting a 24-percentage-point impact of our SodaStream acquisition, mid-single-digit growth in Poland and low-single-digit growth in the United Kingdom and Germany, partially offset by a mid-single-digit decline in Russia, a high-single-digit decline in Turkey and a slight decline in France. Operating profit increased 6%, reflecting the net revenue growth, productivity savings and a 10-percentage-point net impact of our SodaStream acquisition. These impacts were partially offset by certain operating cost increases, a 10-percentage-point impact of higher commodity costs largely due to transaction-related foreign exchange, higher advertising and marketing expenses, and a 4-percentage-point impact of a prior-year gain on the refranchising of our entire beverage bottling operations and snack distribution operations in CHS. Unfavorable foreign exchange reduced operating profit growth by 5 percentage points. Net revenue increased 4%, reflecting volume growth and effective net pricing, partially offset by a 2-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 4%, reflecting high-single-digit growth in Poland and France and mid-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Spain, Russia, and Turkey each experienced low-single-digit growth. Beverage volume grew 6%, reflecting double-digit growth in Germany and Poland and high-single-digit growth in France, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Russia and Turkey each experienced mid-single-digit growth. Operating profit increased 5%, reflecting the net revenue growth, productivity savings and a 4-percentage-point net impact of refranchising our entire beverage bottling operations and snack distribution operations in CHS. These impacts were partially offset by certain operating cost increases and a 9-percentage-point impact of higher commodity costs. Additionally, a 2017 gain on the sale of our minority stake in Britvic and the merger and integration charges related to our acquisition of SodaStream reduced operating profit growth by 8 percentage points and 4 percentage points, respectively. AMESA Net revenue decreased slightly, reflecting a 3-percentage-point impact of refranchising a portion of our beverage business in India, partially offset by volume growth and effective net pricing. Snacks volume grew 7%, reflecting double-digit growth in Pakistan and high-single-digit growth in the Middle East and India, partially offset by a low-single-digit decline in South Africa. Beverage volume grew 4%, reflecting high-single-digit growth in India and Nigeria, partially offset by low-single-digit declines in the Middle East and Pakistan. Operating profit increased 1.5%, reflecting productivity savings, the volume growth and the effective net pricing. These impacts were partially offset by certain operating cost increases, a 5-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Higher restructuring and impairment charges and unfavorable foreign exchange reduced operating profit growth by 3 percentage points and 2.5 percentage points, respectively. 2018 Net revenue decreased 0.5%, reflecting a 4-percentage-point impact of the 2017 refranchising of a portion of our beverage business in Jordan, partially offset by effective net pricing and volume growth. Snacks volume grew 2.5%, reflecting double-digit growth in India and Pakistan, partially offset by a mid-single-digit decline in the Middle East and a low-single-digit decline in South Africa. Beverage volume grew 1%, reflecting mid-single-digit growth in India, high-single-digit growth in Nigeria and low-single-digit growth in Pakistan, partially offset by a mid-single-digit decline in the Middle East. Operating profit decreased 16%, reflecting a 22-percentage-point impact of the 2017 refranchising of a portion of our beverage business in Jordan, certain operating cost increases and a 6-percentage-point impact of higher commodity costs. These impacts were partially offset by the effective net pricing and productivity savings. APAC Net revenue increased 4.5%, reflecting volume growth and effective net pricing, partially offset by a 3-percentage-point impact of unfavorable foreign exchange and a 2-percentage-point impact of the prior-year refranchising of a portion of our beverage business in Thailand. Snacks volume grew 6%, reflecting double-digit growth in China and mid-single-digit growth in Thailand, partially offset by a low-single-digit decline in Indonesia. Additionally, Australia and Taiwan each experienced low-single-digit growth. Beverage volume grew 4%, reflecting double-digit growth in Vietnam and Thailand and mid-single-digit growth in the Philippines. Additionally, China experienced low-single-digit growth. Operating profit decreased 23%, primarily reflecting a 23-percentage-point impact of the gain on the prior-year refranchising of a portion of our beverage business in Thailand. Additionally, certain operating cost increases and higher advertising and marketing expenses negatively impacted operating profit performance. These impacts were partially offset by the net revenue growth and productivity savings. Higher restructuring and impairment charges negatively impacted operating profit performance by 6 percentage points. Net revenue decreased 3%, reflecting an 11-percentage-point impact of refranchising a portion of our beverage business in Thailand, partially offset by net volume growth and effective net pricing. Snacks volume grew 7%, reflecting double-digit growth in China, partially offset by a slight decline in Taiwan. Additionally, Thailand experienced high-single-digit growth and Indonesia and Australia each experienced low-single-digit growth. Beverage volume declined slightly, reflecting a double-digit decline in the Philippines, partially offset by double-digit growth in Vietnam, low-single-digit growth in China and mid-single-digit growth in Thailand. Operating profit increased 54%, reflecting a 35-percentage-point net impact of refranchising a portion of our beverage business in Thailand. The net volume growth, productivity savings and the effective net pricing also contributed to operating profit growth. These impacts were partially offset by higher advertising and marketing expenses and certain operating cost increases. Higher restructuring and impairment charges reduced operating profit growth by 5 percentage points. Other Consolidated Results Change Other pension and retiree medical benefits (expense)/income $ (44 ) $ $ $ (342 ) $ Net interest expense $ (935 ) $ (1,219 ) $ (907 ) $ $ (312 ) Annual tax rate (a) 21.0 % (36.7 )% 48.9 % Net income attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 (42 )% % Net income attributable to PepsiCo per common share diluted $ 5.20 $ 8.78 $ 3.38 (41 )% % Mark-to-market net impact (0.06 ) 0.09 (0.01 ) Restructuring and impairment charges 0.21 0.18 0.16 Inventory fair value adjustments and merger and integration charges 0.03 0.05 Pension-related settlement charges 0.15 Net tax related to the TCJ Act (a) (0.01 ) (0.02 ) 1.70 Other net tax benefits (a) (3.55 ) Charges related to cash tender and exchange offers 0.13 Net income attributable to PepsiCo per common share diluted, excluding above items (b) $ 5.53 (c) $ 5.66 $ 5.23 (2 )% % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (b) (1 )% % (a) See Note 5 to our consolidated financial statements for further information. (b) See Non-GAAP Measures. (c) Does not sum due to rounding. Other pension and retiree medical benefits expense increased $342 million, primarily reflecting settlement charges of $220 million related to the purchase of a group annuity contract and settlement charges of $53 million related to one-time lump sum payments to certain former employees who had vested benefits. Net interest expense decreased $284 million reflecting the prior-year charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. This decrease also reflects lower interest expense due to lower average debt balances. These impacts were partially offset by lower interest income due to lower average cash balances. The reported tax rate increased 57.7 percentage points, primarily reflecting the prior-year other net tax benefits related to the reorganization of our international operations, which increased the current-year reported tax rate by 47 percentage points. Additionally, the prior-year favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, increased the current-year reported tax rate by 8 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo decreased 42% and net income attributable to PepsiCo per common share decreased 41%. Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 38 percentage points. Other pension and retiree medical benefits income increased $65 million, reflecting the impact of the $1.4 billion discretionary pension contribution to the PepsiCo Employees Retirement Plan A (Plan A) in the United States, as well as the recognition of net asset gains, partially offset by higher amortization of net losses. Net interest expense increased $312 million reflecting a charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. This increase also reflects higher interest rates on debt balances, as well as losses on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest income due to higher interest rates on cash balances. The reported tax rate decreased 85.6 percentage points, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the 2017 provisional net tax expense related to the TCJ Act, which reduced the 2018 reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo increased 158% and net income attributable to PepsiCo per common share increased 160%. Items affecting comparability (see Items Affecting Comparability) positively contributed 150 percentage points to net income attributable to PepsiCo growth and 152 percentage points to net income attributable to PepsiCo per common share growth. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; amounts associated with mergers, acquisitions, divestitures and other structural changes; pension and retiree medical related items; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures contained in this Form 10-K are discussed below. Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits expense/income, interest expense, provision for/benefit from income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 and 2014 Productivity Plans, inventory fair value adjustments and merger and integration charges primarily associated with our acquisition of SodaStream, pension-related settlement charges, net tax related to the TCJ Act, other net tax benefits and charges related to cash tender and exchange offers (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic revenue growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. Starting in 2018, our reported results reflected the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excluded the impact of approximately $75 million of these taxes previously recognized in net revenue. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment . Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 30,132 $ 37,029 $ 26,738 $ 10,291 $ (44 ) $ 1,959 $ $ 7,314 Items Affecting Comparability Mark-to-market net impact (57 ) (112 ) (25 ) (87 ) Restructuring and impairment charges (115 ) (253 ) Inventory fair value adjustments and merger and integration charges (34 ) (21 ) Pension-related settlement charges Net tax related to the TCJ Act (8 ) Core, Non-GAAP Measure $ 30,040 $ 37,121 $ 26,519 $ 10,602 $ $ 2,079 $ $ 7,775 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Interest expense (Benefit from)/provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 29,381 $ 35,280 $ 25,170 $ 10,110 $ $ 1,525 $ (3,370 ) $ $ 12,515 Items Affecting Comparability Mark-to-market net impact (83 ) (80 ) Restructuring and impairment charges (3 ) (269 ) Merger and integration charges (75 ) Net tax related to the TCJ Act (28 ) Other net tax benefits 5,064 (5,064 ) Charges related to cash tender and exchange offers (253 ) Core, Non-GAAP Measure $ 29,295 $ 35,366 $ 24,746 $ 10,620 $ $ 1,272 $ 1,878 $ $ 8,065 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,796 $ 34,729 $ 24,453 $ 10,276 $ $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (229 ) Provisional net tax related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,804 $ 34,721 $ 24,231 $ 10,490 $ $ 2,307 $ 7,524 (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $2.5 billion , of which we have incurred $508 million plan to date through December 28, 2019 and cash expenditures of approximately $1.6 billion , of which we have incurred approximately $261 million plan to date through December 28, 2019 . We expect to incur pre-tax charges of approximately $450 million and cash expenditures of approximately $400 million in our 2020 financial results, with the balance to be reflected in our 2021 through 2023 financial results. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2020 and 2021 results. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan was completed in 2019. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $1.3 billion and $960 million , respectively. See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Inventory Fair Value Adjustments and Merger and Integration Charges In 2019 , we recorded inventory fair value adjustments and merger and integration charges of $55 million ( $47 million after-tax or $0.03 per share), including $46 million in our Europe segment, $7 million in our AMESA segment and $2 million in corporate unallocated expenses. These charges are primarily related to fair value adjustments to the acquired inventory included in SodaStreams balance sheet at the acquisition date, as well as merger and integration charges, including employee-related costs. In 2018 , we recorded merger and integration charges of $75 million ($0.05 per share), including $57 million in our Europe segment and $18 million in corporate unallocated expenses, related to our acquisition of SodaStream. These charges include closing costs, advisory fees and employee-related costs. See Note 14 to our consolidated financial statements for further information. Pension-Related Settlement Charges In 2019 , we recorded pension settlement charges of $273 million ($211 million after-tax or $0.15 per share), reflecting settlement charges of $220 million ( $170 million after-tax or $0.12 per share) related to the purchase of a group annuity contract and settlement charges of $53 million ( $41 million after-tax or $0.03 per share) related to one-time lump sum payments to certain former employees who had vested benefits. See Note 7 to our consolidated financial statements for further information. Net Tax Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. In 2017, we recorded a provisional net tax expense of $2.5 billion ( $1.70 per share) associated with the enactment of the TCJ Act. We recognized net tax benefits of $8 million ( $0.01 per share) and $28 million ( $0.02 per share) in 2019 and 2018 , respectively, related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. Other Net Tax Benefits In 2018, we reorganized our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). Also in 2018, we recognized non-cash tax benefits associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $717 million ($0.50 per share). See Note 5 to our consolidated financial statements for further information. Charges Related to Cash Tender and Exchange Offers In 2018, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements for further information. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, bridge loan facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments, debt repayments, the proposed acquisition of Pioneer Foods and the transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper, bridge loan facilities and long-term debt and cash and cash equivalents. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our revolving credit facilities and bridge loan facilities. See also Item 1A. Risk Factors and Our Business Risks for further discussion. As of December 28, 2019 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 28, 2019 , our mandatory transition tax liability was $3.3 billion , which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $0.1 billion of this liability in 2020 . See Credit Facilities and Long-Term Contractual Commitments. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,649 $ 9,415 $ 10,030 Net cash (used for)/provided by investing activities $ (6,437 ) $ 4,564 $ (4,403 ) Net cash used for financing activities $ (8,489 ) $ (13,769 ) $ (4,186 ) Operating Activities During 2019 , net cash provided by operating activities was $9.6 billion , compared to $9.4 billion in the prior year. The operating cash flow performance primarily reflects lower pre-tax pension and retiree medical plan contributions in the current year, partially offset by higher net cash tax payments in the current year. During 2018, net cash provided by operating activities was $9.4 billion, compared to $10.0 billion in 2017. The operating cash flow performance primarily reflects discretionary contributions of $1.5 billion to our pension and retiree medical plans in 2018, partially offset by lower net cash tax payments in 2018. Investing Activities During 2019 , net cash used for investing activities was $6.4 billion , primarily reflecting $4.1 billion of net capital spending, as well as $1.9 billion of the remaining cash paid in connection with our acquisition of SodaStream. During 2018, net cash provided by investing activities was $4.6 billion, primarily reflecting net maturities and sales of debt securities with maturities greater than three months of $8.7 billion, partially offset by net capital spending of $3.1 billion and $1.2 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of SodaStream. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2020 net capital spending to be approximately $5 billion . Financing Activities During 2019 , net cash used for financing activities was $8.5 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $8.3 billion, payments of long-term debt borrowings of $4.0 billion and debt redemptions of $1.0 billion, partially offset by proceeds from issuances of long-term debt of $4.6 billion. During 2018, net cash used for financing activities was $13.8 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.9 billion, payments of long-term debt borrowings of $4.0 billion, cash tender and exchange offers of $1.6 billion and net payments of short-term borrowings of $1.4 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. On February 13, 2020 , we announced a 7% increase in our annualized dividend to $4.09 per share from $3.82 per share, effective with the dividend expected to be paid in June 2020 . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases of approximately $2 billion and dividends of approximately $5.5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,649 $ 9,415 $ 10,030 2.5 (6 ) Capital spending (4,232 ) (3,282 ) (2,969 ) Sales of property, plant and equipment Free cash flow $ 5,587 $ 6,267 $ 7,241 (11 ) (13 ) We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2021 2022 2023 2024 2025 and beyond Recorded Liabilities: Long-term debt obligations (b) $ 29,142 $ $ 7,156 $ 3,110 $ 18,876 Operating leases (c) 1,763 One-time mandatory transition tax - TCJ Act (d) 3,317 1,737 Other: Interest on debt obligations (e) 12,403 1,730 1,388 8,289 Purchasing commitments (f) 2,032 Marketing commitments (g) 1,308 Total contractual commitments $ 49,965 $ 2,849 $ 11,549 $ 6,087 $ 29,480 (a) Based on year-end foreign exchange rates. (b) Excludes $2,848 million related to current maturities of debt, $6 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $163 million related to unamortized net discounts. (c) Primarily reflects building leases. See Note 13 to our consolidated financial statements for further information on operating leases. (d) Reflects our transition tax liability as of December 28, 2019 , which must be paid through 2026 under the provisions of the TCJ Act. (e) Interest payments on floating-rate debt are estimated using interest rates effective as of December 28, 2019 . Includes accrued interest of $ 305 million as of December 28, 2019. (f) Reflects non-cancelable commitments, primarily for the purchase of commodities and outsourcing services in the normal course of business and does not include purchases that we are likely to make based on our plans, but are not obligated to incur. (g) Reflects non-cancelable commitments, primarily for sports marketing in the normal course of business. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. Bottler funding to independent bottlers is not reflected in the table above as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in the table above. See Note 7 to our consolidated financial statements for further information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo (a) $ 7,314 $ 12,515 $ 4,857 Interest expense 1,135 1,525 1,151 Tax on interest expense (252 ) (339 ) (415 ) $ 8,197 $ 13,701 $ 5,593 Average debt obligations (b) $ 31,975 $ 38,169 $ 38,707 Average common shareholders equity (c) 14,317 11,368 12,004 Average invested capital $ 46,292 $ 49,537 $ 50,711 Return on invested capital 17.7 % 27.7 % 11.0 % (a) Results include the impact of the TCJ Act. Additionally, our 2018 results included other net tax benefits related to the reorganization of our international operations. See Note 5 to our consolidated financial statements for further information. (b) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (c) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 17.7 % 27.7 % 11.0 % Impact of: Average cash, cash equivalents and short-term investments 3.0 7.8 7.6 Interest income (0.5 ) (0.6 ) (0.5 ) Tax on interest income 0.1 0.1 0.2 Mark-to-market net impact (0.2 ) 0.2 Restructuring and impairment charges 0.5 0.4 0.3 Inventory fair value adjustments and merger and integration charges 0.1 0.1 Pension-related settlement charges 0.5 Net tax related to the TCJ Act (1.0 ) (1.1 ) 4.5 Other net tax benefits 2.2 (9.7 ) 0.1 Charges related to cash tender and exchange offers (0.1 ) (0.1 ) Charges related to the transaction with Tingyi (a) (0.1 ) Venezuela impairment charges (a) (0.2 ) Net ROIC, excluding items affecting comparability 22.3 % 24.8 % 22.9 % (a) See Item 6. Selected Financial Data for further information. OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year-end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ( $1.70 per share) in the fourth quarter of 2017. We recorded a net tax benefit of $28 million ( $0.02 per share) in 2018, related to the TCJ Act. Our provisional measurement period ended in the fourth quarter of 2018 and while our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $8 million ( $0.01 per share) related to the TCJ Act, including the impact of additional guidance issued by the IRS in the first quarter of 2019 and adjustments related to the filing of our 2018 U.S. federal tax return. See further information in Items Affecting Comparability. On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. In 2019 , our annual tax rate was 21.0% compared to (36.7)% in 2018 , as discussed in Other Consolidated Results. The tax rate increased 57.7 percentage points compared to 2018 , primarily reflecting the prior-year other net tax benefits related to the reorganization of our international operations, which increased the current-year reported tax rate by 47 percentage points. Additionally, the prior-year favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, increased the current-year reported tax rate by 8 percentage points. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $220 million ( $170 million after-tax or $0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $53 million ( $41 million after-tax or $0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $273 million ($211 million after-tax or $0.15 per share). Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and the PepsiCo Employees Retirement Plan I (Plan I) to facilitate a targeted investment strategy over time and provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 3.4 % 4.4 % 3.7 % Interest cost discount rate 2.8 % 3.9 % 3.2 % Expected rate of return on plan assets 6.6 % 6.8 % 6.9 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 3.2 % 4.3 % 3.6 % Interest cost discount rate 2.6 % 3.8 % 3.0 % Expected rate of return on plan assets 5.8 % 6.6 % 6.5 % Current health care cost trend rate 5.6 % 5.7 % 5.8 % In 2019, we incurred pension settlement charges related to the purchase of a group annuity contract of $220 million and one-time lump sum settlements of $53 million to certain former employees who had vested benefits. In addition, based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2020 primarily driven by the recognition of fixed income gains on plan assets and the impact of approved plan contributions, primarily offset by the decrease in discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2020 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ Expected rate of return $ Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. We made discretionary contributions to Plan A in the United States of $150 million in January 2020, $400 million in 2019 and $1.4 billion in 2018. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions except per share amounts) Net Revenue $ 67,161 $ 64,661 $ 63,525 Cost of sales 30,132 29,381 28,796 Gross profit 37,029 35,280 34,729 Selling, general and administrative expenses 26,738 25,170 24,453 Operating Profit 10,291 10,110 10,276 Other pension and retiree medical benefits (expense)/income ( 44 ) Interest expense ( 1,135 ) ( 1,525 ) ( 1,151 ) Interest income and other Income before income taxes 9,312 9,189 9,602 Provision for/(benefit from) income taxes (See Note 5) 1,959 ( 3,370 ) 4,694 Net income 7,353 12,559 4,908 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 Net Income Attributable to PepsiCo per Common Share Basic $ 5.23 $ 8.84 $ 3.40 Diluted $ 5.20 $ 8.78 $ 3.38 Weighted-average common shares outstanding Basic 1,399 1,415 1,425 Diluted 1,407 1,425 1,438 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Net income $ 7,353 $ 12,559 $ 4,908 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment ( 1,641 ) 1,109 Net change on cash flow hedges ( 90 ) ( 36 ) Net pension and retiree medical adjustments ( 467 ) ( 159 ) Net change on available-for-sale securities ( 2 ) ( 68 ) Other ( 2,062 ) Comprehensive income 8,172 10,497 5,770 Comprehensive income attributable to noncontrolling interests ( 39 ) ( 44 ) ( 51 ) Comprehensive Income Attributable to PepsiCo $ 8,133 $ 10,453 $ 5,719 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Operating Activities Net income $ 7,353 $ 12,559 $ 4,908 Depreciation and amortization 2,432 2,399 2,369 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges ( 350 ) ( 255 ) ( 113 ) Pension and retiree medical plan expenses Pension and retiree medical plan contributions ( 716 ) ( 1,708 ) ( 220 ) Deferred income taxes and other tax charges and credits ( 531 ) Net tax related to the TCJ Act ( 8 ) ( 28 ) 2,451 Tax payments related to the TCJ Act ( 423 ) ( 115 ) Other net tax benefits related to international reorganizations ( 2 ) ( 4,347 ) Change in assets and liabilities: Accounts and notes receivable ( 650 ) ( 253 ) ( 202 ) Inventories ( 190 ) ( 174 ) ( 168 ) Prepaid expenses and other current assets ( 87 ) Accounts payable and other current liabilities Income taxes payable ( 287 ) ( 338 ) Other, net ( 256 ) ( 305 ) Net Cash Provided by Operating Activities 9,649 9,415 10,030 Investing Activities Capital spending ( 4,232 ) ( 3,282 ) ( 2,969 ) Sales of property, plant and equipment Acquisition of SodaStream, net of cash and cash equivalents acquired ( 1,939 ) ( 1,197 ) Other acquisitions and investments in noncontrolled affiliates ( 778 ) ( 299 ) ( 61 ) Divestitures Short-term investments, by original maturity: More than three months - purchases ( 5,637 ) ( 18,385 ) More than three months - maturities 12,824 15,744 More than three months - sales 1,498 Three months or less, net Other investing, net ( 8 ) Net Cash (Used for)/Provided by Investing Activities ( 6,437 ) 4,564 ( 4,403 ) Financing Activities Proceeds from issuances of long-term debt 4,621 7,509 Payments of long-term debt ( 3,970 ) ( 4,007 ) ( 4,406 ) Debt redemption/cash tender and exchange offers ( 1,007 ) ( 1,589 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments ( 2 ) ( 17 ) ( 128 ) Three months or less, net ( 3 ) ( 1,352 ) ( 1,016 ) Cash dividends paid ( 5,304 ) ( 4,930 ) ( 4,472 ) Share repurchases - common ( 3,000 ) ( 2,000 ) ( 2,000 ) Share repurchases - preferred ( 2 ) ( 5 ) Proceeds from exercises of stock options Withholding tax payments on r estricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted ( 114 ) ( 103 ) ( 145 ) Other financing ( 45 ) ( 53 ) ( 76 ) Net Cash Used for Financing Activities ( 8,489 ) ( 13,769 ) ( 4,186 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 98 ) Net (Decrease)/Increase in Cash and Cash Equivalents and Restricted Cash ( 5,199 ) 1,488 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 10,769 10,657 9,169 Cash and Cash Equivalents and Restricted Cash, End of Year $ 5,570 $ 10,769 $ 10,657 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 28, 2019 and December 29, 2018 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 5,509 $ 8,721 Short-term investments Restricted cash 1,997 Accounts and notes receivable, net 7,822 7,142 Inventories 3,338 3,128 Prepaid expenses and other current assets Total Current Assets 17,645 21,893 Property, Plant and Equipment, net 19,305 17,589 Amortizable Intangible Assets, net 1,433 1,644 Goodwill 15,501 14,808 Other indefinite-lived intangible assets 14,610 14,181 Indefinite-Lived Intangible Assets 30,111 28,989 Investments in Noncontrolled Affiliates 2,683 2,409 Deferred Income Taxes 4,359 4,364 Other Assets 3,011 Total Assets $ 78,547 $ 77,648 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 2,920 $ 4,026 Accounts payable and other current liabilities 17,541 18,112 Total Current Liabilities 20,461 22,138 Long-Term Debt Obligations 29,148 28,295 Deferred Income Taxes 4,091 3,499 Other Liabilities 9,979 9,114 Total Liabilities 63,679 63,046 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,391 and 1,409 shares, respectively) Capital in excess of par value 3,886 3,953 Retained earnings 61,946 59,947 Accumulated other comprehensive loss ( 14,300 ) ( 15,119 ) Repurchased common stock, in excess of par value (476 and 458 shares, respectively) ( 36,769 ) ( 34,286 ) Total PepsiCo Common Shareholders Equity 14,786 14,518 Noncontrolling interests Total Equity 14,868 14,602 Total Liabilities and Equity $ 78,547 $ 77,648 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year $ 0.8 $ 0.8 $ Conversion to common stock ( 0.1 ) ( 6 ) Retirement of preferred stock ( 0.7 ) ( 35 ) Balance, end of year 0.8 Repurchased Preferred Stock Balance, beginning of year ( 0.7 ) ( 197 ) ( 0.7 ) ( 192 ) Redemptions ( 2 ) ( 5 ) Retirement of preferred stock 0.7 Balance, end of year ( 0.7 ) ( 197 ) Common Stock Balance, beginning of year 1,409 1,420 1,428 Shares issued in connection with preferred stock conversion to common stock Change in repurchased common stock ( 18 ) ( 12 ) ( 1 ) ( 8 ) Balance, end of year 1,391 1,409 1,420 Capital in Excess of Par Value Balance, beginning of year 3,953 3,996 4,091 Share-based compensation expense Equity issued in connection with preferred stock conversion to common stock Stock option exercises, RSUs, PSUs and PEPunits converted ( 188 ) ( 193 ) ( 236 ) Withholding tax on RSUs, PSUs and PEPunits converted ( 114 ) ( 103 ) ( 145 ) Other ( 3 ) ( 4 ) Balance, end of year 3,886 3,953 3,996 Retained Earnings Balance, beginning of year 59,947 52,839 52,518 Cumulative effect of accounting changes ( 145 ) Net income attributable to PepsiCo 7,314 12,515 4,857 Cash dividends declared - common (a) ( 5,323 ) ( 5,098 ) ( 4,536 ) Retirement of preferred stock ( 164 ) Balance, end of year 61,946 59,947 52,839 Accumulated Other Comprehensive Loss Balance, beginning of year ( 15,119 ) ( 13,057 ) ( 13,919 ) Other comprehensive income/(loss) attributable to PepsiCo ( 2,062 ) Balance, end of year ( 14,300 ) ( 15,119 ) ( 13,057 ) Repurchased Common Stock Balance, beginning of year ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) ( 438 ) ( 31,468 ) Share repurchases ( 24 ) ( 3,000 ) ( 18 ) ( 2,000 ) ( 18 ) ( 2,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) Total PepsiCo Common Shareholders Equity 14,786 14,518 11,045 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests ( 42 ) ( 49 ) ( 62 ) Other, net ( 3 ) ( 1 ) Balance, end of year Total Equity $ 14,868 $ 14,602 $ 10,981 (a) Cash dividends declared per common share were $ 3.7925 , $ 3.5875 and $ 3.1675 for 2019 , 2018 and 2017 , respectively. See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. While our North America results are reported on a weekly calendar basis, substantially all of our international operations report on a monthly calendar basis. Certain operations in our Europe segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Our Divisions During the fourth quarter of 2019, we realigned our ESSA and AMENA reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. As a result, our beverage, food and snack businesses in North Africa, the Middle East and South Asia that were part of our former AMENA segment and our businesses in Sub-Saharan Africa that were part of our former ESSA segment are now reported together as our AMESA segment. The remaining beverage, food and snack businesses that were part of our former AMENA segment are now reported together as our APAC segment and our beverage, food and snack businesses in Europe are now reported as our Europe segment. These changes did not impact our FLNA, QFNA, PBNA or LatAm reportable segments or our consolidated financial results. Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, the United Kingdom, China and Brazil . The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: FLNA % % % QFNA % % % PBNA % % % LatAm % % % Europe % % % AMESA % % % APAC % % % Corporate unallocated expenses % % % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2019 (a) 2018 (a) FLNA $ 17,078 $ 16,346 $ 15,798 $ 5,258 $ 5,008 $ 4,793 QFNA 2,482 2,465 2,503 PBNA 21,730 21,072 20,936 2,179 2,276 2,700 LatAm 7,573 7,354 7,208 1,141 1,049 Europe 11,728 10,973 10,522 1,327 1,256 1,199 AMESA 3,651 3,657 3,674 APAC 2,919 2,794 2,884 Total division 67,161 64,661 63,525 11,597 11,506 11,446 Corporate unallocated expenses ( 1,306 ) ( 1,396 ) ( 1,170 ) Total $ 67,161 $ 64,661 $ 63,525 $ 10,291 $ 10,110 $ 10,276 (a) Our primary performance obligation is the distribution and sales of beverage products and food and snack products to our customers, with our food and snack business representing approximately 55 % of our consolidated net revenue. Internationally, LatAms food and snack business is approximately 90 % of the segments net revenue, Europes beverage business and food and snack business are approximately 55 % and 45 % , respectively, of the segments net revenue, AMESAs beverage business and food and snack business are approximately 40 % and 60 % , respectively, of the segments net revenue and APACs beverage business and food and snack business are approximately 25 % and 75 % , respectively, of the segments net revenue. Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. See Note 2 for further information. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 7,519 $ 6,577 $ 1,227 $ $ QFNA PBNA 31,449 29,878 1,053 LatAm 7,007 6,458 Europe 17,814 16,887 AMESA 3,672 3,252 APAC 4,113 3,704 Total division 72,515 67,626 4,016 3,132 2,883 Corporate (a) 6,032 10,022 Total $ 78,547 $ 77,648 $ 4,232 $ 3,282 $ 2,969 (a) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2019 , the change in assets was primarily due to a decrease in cash and cash equivalents and restricted cash. Refer to the cash flow statement for additional information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA PBNA LatAm Europe AMESA APAC Total division 2,196 2,144 2,107 Corporate Total $ $ $ $ 2,351 $ 2,330 $ 2,301 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 38,644 $ 37,148 $ 36,546 $ 30,601 $ 29,169 Mexico 4,190 3,878 3,650 1,666 1,404 Russia 3,263 3,191 3,232 4,314 3,926 Canada 2,831 2,736 2,691 2,695 2,565 United Kingdom 1,723 1,743 1,650 China 1,300 1,164 Brazil 1,295 1,335 1,427 All other countries 13,915 13,466 13,366 12,134 11,660 Total $ 67,161 $ 64,661 $ 63,525 $ 53,532 $ 50,631 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. As a result of the implementation of the revenue recognition guidance adopted in the first quarter of 2018, which did not have a material impact on our accounting policies, we recorded an adjustment in the first quarter of 2018 of $ 137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition. In addition, starting in 2018, we excluded from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions. The impact of these taxes previously recognized in net revenue and cost of sales was approximately $ 75 million for the fiscal year ended December 30, 2017, with no impact on operating profit. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2019 , sales to Walmart and its affiliates (including Sams) represented approximately 13 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 272 million as of December 28, 2019 and $ 218 million as of December 29, 2018 are included in prepaid expenses and other current assets and other assets on our balance sheet. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 4.7 billion in 2019 , $ 4.2 billion in 2018 and $ 4.1 billion in 2017 , including advertising expenses of $ 3.0 billion in 2019 , $ 2.6 billion in 2018 and $ 2.4 billion in 2017 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 55 million and $ 47 million as of December 28, 2019 and December 29, 2018 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 10.9 billion in 2019 , $ 10.5 billion in 2018 and $ 9.9 billion in 2017 . Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 166 million in 2019 , $ 204 million in 2018 and $ 224 million in 2017 . Net capitalized software and development costs were $ 572 million and $ 577 million as of December 28, 2019 and December 29, 2018 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 711 million , $ 680 million and $ 737 million in 2019 , 2018 and 2017 , respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite lived-intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or, in limited instances, last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2018, the Financial Accounting Standards Board (FASB) issued guidance related to the TCJ Act for the optional reclassification of the residual tax effects, arising from the change in corporate tax rate, in accumulated other comprehensive loss to retained earnings. The reclassification is the difference between the amount previously recorded in other comprehensive income at the historical U.S. federal tax rate that remains in accumulated other comprehensive loss at the time the TCJ Act was effective and the amount that would have been recorded using the newly enacted rate. This guidance became effective during the first quarter of 2019; however, we did not elect to make the optional reclassification. In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. Under this guidance, certain of our derivatives used to hedge commodity price risk that did not previously qualify for hedge accounting treatment can now qualify prospectively. We adopted this guidance during the first quarter of 2019; the adoption did not have a material impact on our consolidated financial statements or disclosures. See Note 9 for further information. In 2016, the FASB issued guidance on leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet, but does not change the manner in which expenses are recorded in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The two permitted transition methods under the guidance are the modified retrospective transition approach, which requires application of the guidance for all comparative periods presented, and the cumulative effect adjustment approach, which requires prospective application at the adoption date. We utilized a comprehensive approach to assess the impact of this guidance on our consolidated financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. We completed our comprehensive review of our lease portfolio, including significant leases by geography and by asset type that were impacted by the new guidance, and enhanced our controls. In addition, we implemented a new software platform, and corresponding controls, for administering our leases and facilitating compliance with the new guidance. We adopted the guidance prospectively during the first quarter of 2019. As part of our adoption, we elected not to reassess historical lease classification, recognize short-term leases on our balance sheet, nor separate lease and non-lease components for our real estate leases. In addition, we utilized the portfolio approach to group leases with similar characteristics and did not use hindsight to determine lease term. The adoption did not have a material impact on our consolidated financial statements, resulting in an increase of 2 % to each of our total assets and total liabilities on our balance sheet, and had an immaterial increase to retained earnings as of the beginning of 2019. See Note 13 for further information. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a stepup in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. The guidance is effective in the first quarter of 2021 with early adoption permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements and the timing of adoption. In 2016, the FASB issued guidance that changes the impairment model used to measure credit losses for most financial assets. For our trade, certain other receivables and certain other financial instruments, we will be required to use a new forward-looking expected credit loss model that will replace the existing incurred credit loss model, which would generally result in earlier recognition of allowances for credit losses. We will adopt the guidance when it becomes effective in the first quarter of 2020. The guidance is not expected to have a material impact on our consolidated financial statements or disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2019 Productivity Plan $ $ $ 2014 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 86 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $ 2.5 billion and cash expenditures of approximately $ 1.6 billion . These pre-tax charges are expected to consist of approximately 70 % of severance and other employee-related costs, 15 % for asset impairments (all non-cash) resulting from plant closures and related actions, and 15 % for other costs associated with the implementation of our initiatives. We expect to complete this plan by 2023. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges % % % % % % % % A summary of our 2019 Productivity Plan charges is as follows: Cost of sales $ $ Selling, general and administrative expenses Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ After-tax amount $ $ Net income attributable to PepsiCo per common share $ 0.21 $ 0.08 Plan to Date through 12/28/2019 FLNA $ $ $ QFNA PBNA LatAm Europe AMESA APAC Corporate Other pension and retiree medical benefits expense Total $ $ $ Plan to Date through 12/28/2019 Severance and other employee costs $ Asset impairments Other costs (a) Total $ (a) Includes other costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total 2018 restructuring charges $ $ $ $ Non-cash charges and translation ( 32 ) ( 32 ) Liability as of December 29, 2018 2019 restructuring charges Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation ( 92 ) ( 70 ) Liability as of December 28, 2019 $ $ $ $ (a) Excludes cash expenditures of $ 4 million reported in the cash flow statement in pension and retiree medical contributions. Substantially all of the restructuring accrual at December 28, 2019 is expected to be paid by the end of 2020 . 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, included the next generation of productivity initiatives that we believed would strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the plan through the end of 2019 to take advantage of additional opportunities within the initiatives described above that further strengthened our beverage, food and snack businesses. The 2014 Productivity Plan was completed in 2019. In 2019, there were no material pre-tax charges related to this plan and all cash payments were paid at year end. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $ 1.3 billion and $ 960 million , respectively. These total plan pre-tax charges consisted of 59 % of severance and other employee costs, 15 % of asset impairments and 26 % of other costs, including costs associated with the implementation of our initiatives, including certain consulting and other contract termination costs. These total plan pre-tax charges were incurred by division as follows: FLNA 14 % , QFNA 3 % , PBNA 29 % , LatAm 15 % , Europe 23 % , AMESA 3 % , APAC 3 % and Corporate 10 % . A summary of our 2014 Productivity Plan charges is as follows: Selling, general and administrative expenses $ $ Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ After-tax amount $ $ Net income attributable to PepsiCo per common share $ 0.10 $ 0.16 FLNA $ $ QFNA PBNA LatAm Europe AMESA APAC (a) ( 5 ) Corporate (b) ( 1 ) Total $ $ (a) Income amount primarily reflects a gain on the sale of property, plant and equipment. (b) Income amount primarily relates to other pension and retiree medical benefits. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 31, 2016 $ $ $ $ 2017 restructuring charges ( 6 ) (a) Cash payments ( 91 ) ( 22 ) ( 113 ) Non-cash charges and translation ( 65 ) ( 21 ) ( 52 ) Liability as of December 30, 2017 2018 restructuring charges Cash payments (b) ( 203 ) ( 52 ) ( 255 ) Non-cash charges and translation ( 4 ) ( 28 ) ( 27 ) Liability as of December 29, 2018 Cash payments ( 77 ) ( 16 ) ( 93 ) Non-cash charges and translation ( 14 ) ( 7 ) ( 21 ) Liability as of December 28, 2019 $ $ $ $ (a) Income amount represents adjustments for changes in estimates and a gain on the sale of property, plant, and equipment. (b) Excludes cash expenditures of $ 11 million reported in the cash flow statement in pension and retiree medical plan contributions. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,130 $ 1,078 Buildings and improvements 15 - 44 9,314 8,941 Machinery and equipment, including fleet and software 5 - 15 29,390 27,715 Construction in progress 3,169 2,430 43,003 40,164 Accumulated depreciation ( 23,698 ) ( 22,575 ) Total $ 19,305 $ 17,589 Depreciation expense $ 2,257 $ 2,241 $ 2,227 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Amortizable intangible assets, net Acquired franchise rights 56 60 $ $ ( 158 ) $ $ $ ( 140 ) $ Reacquired franchise rights 5 14 ( 105 ) ( 105 ) Brands 20 40 1,326 ( 1,066 ) 1,306 ( 1,032 ) Other identifiable intangibles (a) 10 24 ( 326 ) ( 288 ) Total $ 3,088 $ ( 1,655 ) $ 1,433 $ 3,209 $ ( 1,565 ) $ 1,644 Amortization expense $ $ $ (a) The change from 2018 to 2019 primarily reflects revisions to the purchase price allocation for our acquisition of SodaStream. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 28, 2019 and using average 2019 foreign exchange rates, is expected to be as follows: Five-year projected amortization $ $ $ $ $ Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . We did not recognize any material impairment charges for indefinite-lived intangible assets in each of the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . As of December 28, 2019 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there were no impairments for the year ended December 28, 2019 . However, there could be an impairment of the carrying value of certain brands in these countries, including juice and dairy brands in Russia, if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows (including perpetuity growth assumptions), if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For further information on our policies for indefinite-lived intangible assets, see Note 2. The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2018 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2018 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2019 FLNA Goodwill $ $ $ ( 11 ) $ $ ( 3 ) $ $ Brands ( 2 ) Total ( 13 ) ( 3 ) QFNA Goodwill ( 1 ) Brands ( 14 ) Total ( 8 ) ( 1 ) PBNA (a) Goodwill 9,854 ( 41 ) 9,813 9,898 Reacquired franchise rights 7,126 ( 68 ) 7,058 7,089 Acquired franchise rights 1,525 ( 15 ) 1,510 1,517 Brands ( 8 ) Total 18,858 ( 124 ) 18,734 19,267 LatAm Goodwill ( 46 ) ( 8 ) Brands ( 14 ) ( 2 ) Total ( 60 ) ( 10 ) Europe (b) (c) Goodwill 3,202 ( 367 ) 3,361 3,961 Reacquired franchise rights ( 1 ) ( 51 ) Acquired franchise rights ( 25 ) ( 9 ) ( 4 ) Brands 2,545 1,993 ( 350 ) 4,188 ( 139 ) 4,181 Total 6,491 2,493 ( 777 ) 8,207 8,804 AMESA Goodwill ( 2 ) Total ( 2 ) APAC Goodwill ( 34 ) Brands ( 10 ) ( 1 ) Total ( 44 ) ( 1 ) Total goodwill 14,744 ( 499 ) 14,808 15,501 Total reacquired franchise rights 7,675 ( 1 ) ( 119 ) 7,555 7,594 Total acquired franchise rights 1,720 ( 25 ) ( 24 ) 1,671 1,674 Total brands 3,175 2,156 ( 376 ) 4,955 5,342 Total $ 27,314 $ 2,693 $ ( 1,018 ) $ 28,989 $ $ $ 30,111 (a) The change in acquisitions/(divestitures) in 2019 is primarily related to our acquisition of CytoSport Inc. (b) The change in acquisitions/(divestitures) in 2019 and 2018 is primarily related to our acquisition of SodaStream. See Note 14 for further information. (c) The change in translation and other in 2019 primarily reflects the appreciation of the Russian ruble. The change in translation and other in 2018 primarily reflects the depreciation of the Russian ruble, euro and Pound sterling. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 4,123 $ 3,864 $ 3,452 Foreign 5,189 5,325 6,150 $ 9,312 $ 9,189 $ 9,602 The provision for/(benefit from) income taxes consisted of the following: Current: U.S. Federal $ $ $ 4,925 Foreign State 1,655 5,785 Deferred: U.S. Federal ( 1,159 ) Foreign ( 31 ) ( 4,379 ) ( 9 ) State ( 9 ) ( 4,248 ) ( 1,091 ) $ 1,959 $ ( 3,370 ) $ 4,694 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 21.0 % 21.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 1.6 0.5 0.9 Lower taxes on foreign results ( 0.9 ) ( 2.2 ) ( 9.4 ) One-time mandatory transition tax - TCJ Act ( 0.1 ) 0.1 41.4 Remeasurement of deferred taxes - TCJ Act ( 0.4 ) ( 15.9 ) International reorganizations ( 47.3 ) Tax settlements ( 7.8 ) Other, net ( 0.6 ) ( 0.6 ) ( 3.1 ) Annual tax rate 21.0 % ( 36.7 )% 48.9 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35 % to 21 % , effective January 1, 2018. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $ 2.5 billion ( $ 1.70 per share) in the fourth quarter of 2017. Included in the provisional net tax expense of $ 2.5 billion recognized in 2017, was a provisional mandatory one-time transition tax of approximately $ 4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $ 1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate , effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. The provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. As a result, in 2018, we recognized a net tax benefit of $ 28 million ( $ 0.02 per share) related to the TCJ Act, primarily reflecting the impact of the final analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries, partially offset by additional transition tax guidance issued by the United States Department of Treasury, as well as the TCJ Act impact of both the conclusion of certain international tax audits and the resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, each discussed below. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $ 8 million ( $ 0.01 per share) related to the TCJ Act, including the impact of additional guidance issued by the IRS in the first quarter of 2019 and adjustments related to the filing of our 2018 U.S. federal tax return. As of December 28, 2019 , our mandatory transition tax liability was $ 3.3 billion , which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 663 million in 2019 and $ 150 million in 2018. We currently expect to pay approximately $ 0.1 billion of this liability in 2020 . The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $ 24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. In 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $ 4.3 billion ( $ 3.05 per share) in 2018. The related deferred tax asset of $ 4.4 billion is being amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Deferred tax liabilities and assets are comprised of the following: Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,583 1,303 Recapture of net operating losses Right-of-use assets Other Gross deferred tax liabilities 3,008 2,366 Deferred tax assets Net carryforwards 4,168 4,353 Intangible assets other than nondeductible goodwill Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Lease liabilities Other Gross deferred tax assets 6,875 6,984 Valuation allowances ( 3,599 ) ( 3,753 ) Deferred tax assets, net 3,276 3,231 Net deferred tax assets $ ( 268 ) $ ( 865 ) A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 3,753 $ 1,163 $ 1,110 Provision ( 124 ) 2,639 Other (deductions)/additions ( 30 ) ( 49 ) Balance, end of year $ 3,599 $ 3,753 $ 1,163 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2018 2014-2016 Mexico 2017-2018 None United Kingdom 2017-2018 Canada (Domestic) 2015-2018 2015-2016 Canada (International) 2010-2018 2010-2016 Russia 2016-2018 None In 2018, we recognized a non-cash tax benefit of $ 364 million ( $ 0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, in 2018, we recognized non-cash tax benefits of $ 353 million ( $ 0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $ 717 million ( $ 0.50 per share) in 2018. Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 28, 2019 , the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.4 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 250 million as of December 28, 2019 , of which $ 84 million of tax expense was recognized in 2019 . The gross amount of interest accrued, reported in other liabilities, was $ 179 million as of December 29, 2018 , of which $ 64 million of tax benefit was recognized in 2018 . A reconciliation of unrecognized tax benefits is as follows: Balance, beginning of year $ 1,440 $ 2,212 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years ( 201 ) ( 822 ) Settlement payments ( 74 ) ( 233 ) Statutes of limitations expiration ( 47 ) ( 42 ) Translation and other ( 14 ) Balance, end of year $ 1,395 $ 1,440 Carryforwards and Allowances Operating loss carryforwards totaling $ 24.7 billion at year-end 2019 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.2 billion in 2020 , $ 20.3 billion between 2021 and 2039 and $ 4.2 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In 2018, we repatriated $ 20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability, related to the TCJ Act. As of December 28, 2019 , we had approximately $ 6 billion of undistributed international earnings. We intend to continue to reinvest $ 6 billion of earnings outside the United States for the foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 28, 2019 , 59 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense and excess tax benefits recognized: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring charges ( 2 ) ( 6 ) ( 2 ) Total (a) $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ $ $ (b) Excess tax benefits related to share-based compensation $ $ $ (a) Primarily recorded in selling, general and administrative expenses. (b) Reflects tax rates effective for the 2017 tax year. As of December 28, 2019 , there was $ 284 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 5 years 5 years Risk-free interest rate 2.4 % 2.6 % 2.0 % Expected volatility % % % Expected dividend yield 3.1 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 28, 2019 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 29, 2018 15,589 $ 79.94 Granted 1,286 $ 118.33 Exercised ( 4,882 ) $ 67.34 Forfeited/expired ( 368 ) $ 94.30 Outstanding at December 28, 2019 11,625 $ 89.03 4.68 $ 563,942 Exercisable at December 28, 2019 7,972 $ 78.27 3.13 $ 472,512 Expected to vest as of December 28, 2019 3,364 $ 112.25 8.04 $ 85,066 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. A summary of our RSU and PSU activity for the year ended December 28, 2019 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 29, 2018 7,175 $ 105.13 Granted (b) 2,754 $ 116.87 Converted ( 2,642 ) $ 99.35 Forfeited ( 852 ) $ 111.11 Actual performance change (c) ( 55 ) $ 108.32 Outstanding at December 28, 2019 (d) 6,380 $ 111.53 1.22 $ 877,487 Expected to vest as of December 28, 2019 5,876 $ 111.32 1.19 $ 808,220 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 28, 2019 , at the threshold, target and maximum award levels were zero , 0.7 million and 1.3 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three-year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model, which incorporates into the fair-value determination the possibility that the market condition may not be satisfied, until actual performance is determined. PEPunits were last granted in 2015 and all 248,000 units outstanding at December 30, 2017, with a weighted average grant date fair value of $ 68.94 , were converted to 278,000 shares in 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. A summary of our long-term cash activity for the year ended December 28, 2019 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 29, 2018 $ 54,710 Granted (b) 16,112 Vested ( 15,438 ) Forfeited ( 9,465 ) Actual performance change (c) ( 1,695 ) Outstanding at December 28, 2019 (d) $ 44,224 $ 45,875 1.10 Expected to Vest at December 28, 2019 $ 42,998 $ 44,557 1.10 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Reflects the net number of long-term cash awards above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding long-term cash awards for which the performance period has not ended as of December 28, 2019 , at the threshold, target and maximum award levels were zero , 28.5 million and 57.1 million, respectively . Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,286 1,429 1,481 Weighted-average grant-date fair value of options granted $ 10.89 $ 9.80 $ 8.25 Total intrinsic value of options exercised (a) $ 275,745 $ 224,663 $ 327,860 Total grant-date fair value of options vested (a) $ 9,838 $ 15,506 $ 23,122 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,754 2,634 2,824 Weighted-average grant-date fair value of RSUs/PSUs granted $ 116.87 $ 108.75 $ 109.92 Total intrinsic value of RSUs/PSUs converted (a) $ 333,951 $ 260,287 $ 380,269 Total grant-date fair value of RSUs/PSUs vested (a) $ 275,234 $ 232,141 $ 264,923 PEPunits Total intrinsic value of PEPunits converted (a) $ $ 30,147 $ 39,782 Total grant-date fair value of PEPunits vested (a) $ $ 9,430 $ 18,833 (a) In thousands. As of December 28, 2019 and December 29, 2018 , there were approximately 269,000 and 248,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ( $ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ( $ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ( $ 211 million after-tax or $ 0.15 per share). Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years ) and retiree medical (approximately 8 years ), or the remaining life expectancy for participants in Plan I (approximately 23 years ). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 13,807 $ 14,777 $ 3,098 $ 3,490 $ $ 1,187 Service cost Interest cost Plan amendments Participant contributions Experience loss/(gain) 2,091 ( 972 ) ( 230 ) ( 147 ) Benefit payments ( 341 ) ( 956 ) ( 100 ) ( 114 ) ( 105 ) ( 108 ) Settlement/curtailment ( 1,268 ) ( 74 ) ( 31 ) ( 35 ) Special termination benefits Other, including foreign currency adjustment ( 204 ) ( 3 ) Liability at end of year $ 15,230 $ 13,807 $ 3,753 $ 3,098 $ $ Change in fair value of plan assets Fair value at beginning of year $ 12,258 $ 12,582 $ 3,090 $ 3,460 $ $ Actual return on plan assets 3,101 ( 789 ) ( 136 ) ( 21 ) Employer contributions/funding 1,495 Participant contributions Benefit payments ( 341 ) ( 956 ) ( 100 ) ( 114 ) ( 105 ) ( 108 ) Settlement ( 1,266 ) ( 74 ) ( 31 ) ( 32 ) Other, including foreign currency adjustment ( 210 ) Fair value at end of year $ 14,302 $ 12,258 $ 3,732 $ 3,090 $ $ Funded status $ ( 928 ) $ ( 1,549 ) $ ( 21 ) $ ( 8 ) $ ( 686 ) $ ( 711 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities ( 52 ) ( 107 ) ( 1 ) ( 1 ) ( 58 ) ( 41 ) Other liabilities ( 1,620 ) ( 1,627 ) ( 119 ) ( 88 ) ( 628 ) ( 670 ) Net amount recognized $ ( 928 ) $ ( 1,549 ) $ ( 21 ) $ ( 8 ) $ ( 686 ) $ ( 711 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,516 $ 4,093 $ $ $ ( 285 ) $ ( 287 ) Prior service cost/(credit) ( 1 ) ( 32 ) ( 51 ) Total $ 3,630 $ 4,202 $ $ $ ( 317 ) $ ( 338 ) Changes recognized in net (gain)/loss included in other comprehensive loss Net (gain)/loss arising in current year $ ( 120 ) $ $ $ $ ( 24 ) $ ( 107 ) Amortization and settlement recognition ( 457 ) ( 187 ) ( 44 ) ( 56 ) Foreign currency translation loss/(gain) ( 49 ) ( 1 ) Total $ ( 577 ) $ $ $ ( 2 ) $ $ ( 98 ) Accumulated benefit obligation at end of year $ 14,255 $ 12,890 $ 3,441 $ 2,806 The net (gain)/loss arising in the current year is attributed to the change in discount rate, primarily offset by the actual asset returns different from expected returns. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International Service cost $ $ $ $ $ $ $ $ $ Other pension and retiree medical benefits expense/(income): Interest cost $ $ $ $ $ $ $ $ $ Expected return on plan assets ( 892 ) ( 943 ) ( 849 ) ( 188 ) ( 197 ) ( 176 ) ( 18 ) ( 19 ) ( 22 ) Amortization of prior service cost/(credits) ( 19 ) ( 20 ) ( 25 ) Amortization of net losses/(gains) ( 27 ) ( 8 ) ( 12 ) Settlement/curtailment losses (a) Special termination benefits Total other pension and retiree medical benefits expense/(income) $ $ ( 235 ) $ ( 189 ) $ ( 47 ) $ ( 51 ) $ ( 23 ) $ ( 28 ) $ ( 12 ) $ ( 21 ) Total $ $ $ $ $ $ $ ( 5 ) $ $ (a) In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million and a pension lump sum settlement charge of $ 53 million . The following table provides the weighted-average assumptions used to determine projected benefit liability and net periodic benefit cost for our pension and retiree medical plans: Pension Retiree Medical U.S. International Liability discount rate 3.3 % 4.4 % 3.7 % 2.5 % 3.4 % 3.0 % 3.1 % 4.2 % 3.5 % Service cost discount rate 4.4 % 3.8 % 4.5 % 4.2 % 3.5 % 3.6 % 4.3 % 3.6 % 4.0 % Interest cost discount rate 4.1 % 3.4 % 3.7 % 3.2 % 2.8 % 2.8 % 3.8 % 3.0 % 3.2 % Expected return on plan assets 7.1 % 7.2 % 7.5 % 5.8 % 6.0 % 6.0 % 6.6 % 6.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.3 % 3.7 % 3.7 % Expense rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.7 % 3.6 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ ( 9,194 ) $ ( 8,040 ) $ ( 192 ) $ ( 155 ) Fair value of plan assets $ 8,497 $ 7,223 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ ( 10,169 ) $ ( 8,957 ) $ ( 632 ) $ ( 514 ) $ ( 988 ) $ ( 996 ) Fair value of plan assets $ 8,497 $ 7,223 $ $ $ $ Of the total projected pension benefit liability as of December 28, 2019 , approximately $ 847 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2025 - 2029 Pension $ $ $ $ $ $ 5,275 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2020 through 2024 and approximately $ 4 million in total for 2025 through 2029. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ $ 1,417 $ $ $ $ Non-discretionary Total $ $ 1,615 $ $ $ $ (a) Includes $ 400 million contribution in 2019 and $ 1.4 billion contribution in 2018 to fund Plan A in the United States. In January 2020 , we made discretionary contributions of $ 150 million to Plan A in the United States. In addition, in 2020 , we expect to make non-discretionary contributions of approximately $ 150 million to our U.S. and international pension benefit plans and approximately $ 60 million for retiree medical benefits. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2020 and 2019 , our expected long-term rate of return on U.S. plan assets is 6.8 % and 7.1 % , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2019 and 2018 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 6,605 $ 6,605 $ $ $ 5,605 Government securities (c) 2,154 2,154 1,674 Corporate bonds (c) 4,737 4,737 4,145 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 13,939 $ 6,880 $ 7,050 $ 11,860 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 14,604 $ 12,543 International plan assets Equity securities (b) $ 1,973 $ 1,941 $ $ $ 1,651 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 3,532 $ 2,349 $ 1,141 $ 2,981 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,732 $ 3,090 (a) 2019 and 2018 amounts include $ 302 million and $ 285 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The commingled funds are based on the published price of the fund and the U.S. commingled funds include one large-cap fund that represents 16 % and 15 % of total U.S. plan assets for 2019 and 2018 , respectively. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 28 % of total U.S. plan assets for both 2019 and 2018 . (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 28, 2019 and December 29, 2018 . (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Base d on the published price of the fund. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase 106 These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2019 , 2018 and 2017 , our total Company contributions were $ 197 million , $ 180 million and $ 176 million , respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2019 (a) 2018 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 2,848 $ 3,953 Other borrowings (6.4% and 6.0%) $ 2,920 $ 4,026 Long-term debt obligations (b) Notes due 2019 (3.1%) 3,948 Notes due 2020 (2.7% and 3.9%) 2,840 3,784 Notes due 2021 (2.4% and 3.1%) 3,276 3,257 Notes due 2022 (2.7% and 2.8%) 3,831 3,802 Notes due 2023 (2.8% and 2.9%) 1,272 1,270 Notes due 2024 (3.4% and 3.2%) 1,839 1,816 Notes due 2025-2049 (3.4% and 3.7%) 18,910 14,345 Other, due 2019-2026 (1.3% and 1.3%) 31,996 32,248 Less: current maturities of long-term debt obligations ( 2,848 ) ( 3,953 ) Total $ 29,148 $ 28,295 (a) Amounts are shown net of unamortized net discounts of $ 163 million and $ 119 million for 2019 and 2018 , respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. As of December 28, 2019 , our international debt of $ 69 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2019 , we issued the following senior notes: Interest Rate Maturity Date Amount (a) 0.750 % March 2027 (b) 1.125 % March 2031 (b) 2.625 % July 2029 $ 1,000 3.375 % July 2049 $ 1,000 0.875 % October 2039 (b) 2.875 % October 2049 $ 1,000 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. (b) These notes, issued in euros, were designated as net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. The net proceeds from the issuances of the above notes were used for general corporate purposes, including the repayment of commercial paper, except for an amount equivalent to the net proceeds from our 2.875 % senior notes due 2049 that will be used to fund, in whole or in part, eligible green projects in the categories of investments in sustainable plastics and packaging, decarbonizing our operations and supply chain and water sustainability, which promote our selected Sustainable Development Goals, as defined by the United Nations. In 2019, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 3, 2024. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. In 2019, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 1, 2020. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $ 3.75 billion five-year credit agreement and our $ 3.75 billion 364-day credit agreement, both dated as of June 4, 2018. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 28, 2019 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2019, we entered into two unsecured bridge loan facilities (Bridge Loan Facilities) which together enable one of our consolidated subsidiaries to borrow up to 25.0 billion South African rand, or approximately $ 1.8 billion , to provide potential funding for our acquisition of Pioneer Foods. Each facility is available from the date the conditions precedent are met for the acquisition up through July 30, 2020 in the case of one facility and July 31, 2020 in the case of the other facility. Borrowings under the facilities are for up to one year once drawn and can be prepaid at any time. Interest rates are reset either every one month or three months. As of December 28, 2019, there were no outstanding borrowings under the Bridge Loan Facilities. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. In 2018, we completed a cash tender offer for certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $ 1.6 billion in cash to redeem the following amounts: Interest Rate Maturity Date Amount Tendered 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ 4.875 % November 2040 $ 5.500 % January 2040 $ Also in 2018, we completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for the following newly issued PepsiCo notes. These notes were issued in an aggregate principal amount equal to the exchanged notes: Interest Rate Maturity Date Amount Exchanged 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $ 253 million ( $ 191 million after-tax or $ 0.13 per share) to interest expense in 2018, primarily representing the tender price paid over the carrying value of the tendered notes. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 28, 2019 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position on December 28, 2019 was $ 415 million . We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 28, 2019. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for energy, agricultural products and metals . Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.1 billion as of December 28, 2019 and December 29, 2018 . Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $ 1.9 billion as of December 28, 2019 and $ 2.0 billion as of December 29, 2018 . The total notional amount of our debt instruments designated as net investment hedges was $ 2.5 billion as of December 28, 2019 and $ 0.9 billion as of December 29, 2018 . For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 5.0 billion as of December 28, 2019 and $ 10.5 billion as of December 29, 2018 . As of December 28, 2019 , approximately 9 % of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 29 % as of December 29, 2018 . Available-for-Sale Securities Investments in debt securities are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale debt securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 28, 2019 and December 29, 2018 were not material. Changes in the fair value of available-for-sale debt securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We recorded no other-than-temporary impairment charges on our available-for-sale debt securities for the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . In 2017, we recorded a pre-tax gain of $ 95 million ( $ 85 million after-tax or $ 0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. The gain on the sale of this equity investment was recorded in our Europe segment in selling, general and administrative expenses. Fair Value Measurements The fair values of our financial assets and liabilities as of December 28, 2019 and December 29, 2018 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale debt securities (b) $ $ $ 3,658 $ Short-term investments (c) $ $ $ $ Prepaid forward contracts (d) $ $ $ $ Deferred compensation (e) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) $ $ $ $ Interest rate (g) Commodity (h) Commodity (i) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (g) $ $ $ $ Commodity (h) Commodity (i) $ $ $ $ Total derivatives at fair value (j) $ $ $ $ Total $ $ $ 3,931 $ 1,018 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 29, 2018 , these debt securities were primarily classified as cash equivalents. The decrease in available-for-sale debt securities was due to maturities and sales during the current year. (c) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (d) Based primarily on the price of our common stock. (e) Based on the fair value of investments corresponding to employees investment elections. (f) Based on LIBOR forward rates. As of December 28, 2019 and December 29, 2018 , the carrying amount of hedged fixed-rate debt was $ 2.2 billion and $ 7.7 billion , respectively, and classified on our balance sheet within short-term and long-term debt obligations. As of December 28, 2019, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was $ 5 million . As of December 28, 2019 , the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 49 million loss, which is being amortized over the remaining life of the related debt obligations. (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 28, 2019 and December 29, 2018 were not material. Collateral received or posted against our asset or liability positions is classified as restricted cash. See Note 15 for further information. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 28, 2019 and December 29, 2018 was $ 34 billion and $ 32 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ ( 1 ) $ $ $ ( 52 ) $ $ ( 8 ) Interest rate ( 64 ) Commodity ( 17 ) Net investment ( 30 ) ( 77 ) Total $ ( 82 ) $ $ $ ( 16 ) $ $ (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $ 47 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 Preferred stock: Redemption premium (b) ( 2 ) ( 4 ) Net income available for PepsiCo common shareholders $ 7,314 1,399 $ 12,513 1,415 $ 4,853 1,425 Basic net income attributable to PepsiCo per common share $ 5.23 $ 8.84 $ 3.40 Net income available for PepsiCo common shareholders $ 7,314 1,399 $ 12,513 1,415 $ 4,853 1,425 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other (c) Employee stock ownership plan (ESOP) convertible preferred stock Diluted $ 7,314 1,407 $ 12,515 1,425 $ 4,857 1,438 Diluted net income attributable to PepsiCo per common share $ 5.20 $ 8.78 $ 3.38 (a) Weighted-average common shares outstanding (in millions). (b) See Note 11 for further information. (c) The dilutive effect of these securities is calculated using the treasury stock method. Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.3 0.7 0.4 Average exercise price per option $ 117.55 $ 109.83 $ 110.12 (a) In millions. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. As of December 30, 2017, there were 3 million shares of convertible preferred stock authorized, 803,953 preferred shares issued and 114,753 shares outstanding. The outstanding preferred shares had a fair value of $ 68 million as of December 30, 2017. Activities of our preferred stock are included in the equity statement. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 31, 2016 (a) $ ( 11,386 ) $ $ ( 2,645 ) $ $ ( 35 ) $ ( 13,919 ) Other comprehensive (loss)/income before reclassifications (b) 1,049 ( 375 ) Amounts reclassified from accumulated other comprehensive loss ( 171 ) ( 99 ) ( 112 ) Net other comprehensive (loss)/income 1,049 ( 41 ) ( 217 ) ( 74 ) Tax amounts Balance as of December 30, 2017 (a) ( 10,277 ) ( 2,804 ) ( 4 ) ( 19 ) ( 13,057 ) Other comprehensive (loss)/income before reclassifications (c) ( 1,664 ) ( 61 ) ( 813 ) ( 2,532 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income ( 1,620 ) ( 595 ) ( 2,159 ) Tax amounts ( 21 ) ( 10 ) Balance as of December 29, 2018 (a) ( 11,918 ) ( 3,271 ) ( 19 ) ( 15,119 ) Other comprehensive (loss)/income before reclassifications (d) ( 131 ) ( 89 ) ( 2 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income ( 117 ) ( 2 ) Tax amounts ( 8 ) ( 96 ) ( 77 ) Balance as of December 28, 2019 (a) $ ( 11,290 ) $ ( 3 ) $ ( 2,988 ) $ $ ( 19 ) $ ( 14,300 ) (a) Pension and retiree medical amounts are net of taxes of $ 1,280 million as of December 31, 2016 , $ 1,338 million as of December 30, 2017 , $ 1,466 million as of December 29, 2018 and $ 1,370 million as of December 28, 2019 . (b) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. (c) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. (d) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Divestitures $ $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ $ ( 1 ) $ Net revenue Foreign exchange contracts ( 7 ) Cost of sales Interest rate derivatives ( 184 ) Interest expense Commodity contracts Cost of sales Commodity contracts ( 3 ) ( 1 ) Selling, general and administrative expenses Net losses/(gains) before tax ( 171 ) Tax amounts ( 2 ) ( 27 ) Net losses/(gains) after tax $ $ $ ( 107 ) Pension and retiree medical items: Amortization of net prior service credit $ ( 9 ) $ ( 17 ) $ ( 24 ) Other pension and retiree medical benefits (expense)/income Amortization of net losses Other pension and retiree medical benefits (expense)/income Settlement/curtailment losses Other pension and retiree medical benefits (expense)/income Net losses before tax Tax amounts ( 102 ) ( 45 ) ( 44 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ $ $ ( 99 ) Selling, general and administrative expenses Tax amount Net gain after tax $ $ $ ( 89 ) Total net losses/(gains) reclassified for the year, net of tax $ $ $ ( 82 ) Note 13 L eases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years , some of which include options to extend the lease term for up to five years , and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Components of lease cost are as follows: Operating lease cost (a) $ Variable lease cost (b) $ Short-term lease cost (c) $ (a) Includes right-of-use asset amortization of $ 412 million . (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. In 2019, we recognized gains of $ 77 million on sale-leaseback transactions with terms under four years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification Right-of-use assets Other assets $ 1,548 Current lease liabilities Accounts payable and other current liabilities $ Non-current lease liabilities Other liabilities $ 1,118 Weighted-average remaining lease term and discount rate for our operating leases are as follows: Weighted-average remaining lease term 6 years Weighted-average discount rate % Maturities of lease liabilities by year for our operating leases are as follows: $ 2021 2022 2023 2024 2025 and beyond Total lease payments 1,763 Less: Imputed interest ( 203 ) Present value of lease liabilities $ 1,560 As of December 29, 2018, minimum lease payments under non-cancelable operating leases by period were expected to be as follows: $ 2020 2021 2022 2023 2024 and beyond Total $ 1,840 A summary of rent expense for the years ended December 29, 2018 and December 30, 2017 is as follows: Rent expense $ $ Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Note 14 Acquisitions and Divestitures Acquisition of Pioneer Food Group Ltd. On July 19, 2019, we entered into an agreement to acquire all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe , for 110.00 South African rand per share in cash, in a transaction valued at approximately $ 1.7 billion . Also in 2019, one of our consolidated subsidiaries entered into Bridge Loan Facilities to provide potential funding for our acquisition of Pioneer Foods. See Note 8 for further information. The transaction is subject to certain regulatory approvals and other customary conditions and is expected to be recorded primarily in the AMESA segment. Closing is expected in the first half of 2020. Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $ 144.00 per share in cash, in a transaction valued at approximately $ 3.3 billion . The total consideration transferred was approximately $ 3.3 billion (or $ 3.2 billion , net of cash and cash equivalents acquired). We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The purchase price allocation was finalized in the fourth quarter of 2019. The following table summarizes the fair value of identifiable assets acquired and liabilities assumed in the acquisition of SodaStream and the resulting goodwill as of the acquisition date, all of which are recorded in the Europe segment. Inventories $ Property, plant and equipment Amortizable intangible assets Nonamortizable intangible asset (brand) 1,840 Other assets and liabilities Net deferred income taxes ( 303 ) Total identifiable net assets $ 2,400 Goodwill Total purchase price $ 3,343 Goodwill is calculated as the excess of the aggregate of the fair value of the consideration transferred over the fair value of the net assets recognized. The goodwill recorded as part of the acquisition of SodaStream primarily reflects the value of expected synergies from our product portfolios and is not deductible for tax purposes. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 144 million ( $ 126 million after-tax or $ 0.09 per share) in selling, general and administrative expenses in our APAC segment as a result of this transaction. Refranchising in Czech Republic, Hungary, and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in CHS. We recorded a pre-tax gain of $ 58 million ( $ 46 million after-tax or $ 0.03 per share) in selling, general and administrative expenses in our Europe segment as a result of this transaction. Refranchising in Jordan In 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 140 million ( $ 107 million after-tax or $ 0.07 per share) in selling, general and administrative expenses in our AMESA segment as a result of this transaction. Inventory Fair Value Adjustments and Merger and Integration Charges In 2019, we recorded inventory fair value adjustments and merger and integration charges of $ 55 million ( $ 47 million after-tax or $ 0.03 per share), including $ 46 million in our Europe segment, $ 7 million in our AMESA segment and $ 2 million in corporate unallocated expenses. These charges are primarily related to fair value adjustments to the acquired inventory included in SodaStreams balance sheet at the acquisition date, recorded in cost of sales, as well as merger and integration charges, including employee-related costs, recorded in selling, general and administrative expenses. In 2018, we recorded merger and integration charges of $ 75 million ( $ 0.05 per share), including $ 57 million in our Europe segment and $ 18 million in corporate unallocated expenses, related to our acquisition of SodaStream, recorded in selling, general and administrative expenses. These charges include closing costs, advisory fees and employee-related costs. Note 15 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 6,447 $ 6,079 Other receivables 1,480 1,164 Total 7,927 7,243 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) ( 30 ) ( 33 ) ( 35 ) Other (b) ( 11 ) Allowance, end of year $ Net receivables $ 7,822 $ 7,142 Inventories (c) Raw materials and packaging $ 1,395 $ 1,312 Work-in-process Finished goods 1,743 1,638 Total $ 3,338 $ 3,128 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Right-of-use assets (e) 1,548 Other Total $ 3,011 $ Accounts payable and other current liabilities Accounts payable $ 8,013 $ 7,213 Accrued marketplace spending 2,765 2,541 Accrued compensation and benefits 1,835 1,755 Dividends payable 1,351 1,329 SodaStream consideration payable 1,997 Current lease liabilities (e) Other current liabilities 3,077 3,277 Total $ 17,541 $ 18,112 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 7 % and 5 % of the inventory cost in 2019 and 2018 , respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for further information. (e) See Note 13 for further information. Statement of Cash Flows Interest paid (a) $ 1,076 $ 1,388 $ 1,123 Income taxes paid, net of refunds (b) $ 2,226 $ 1,203 $ 1,962 (a) In 2018, excludes the premiums paid in accordance with the debt transactions discussed in Note 8. (b) In 2019 and 2018, includes tax payments of $ 423 million and $ 115 million , respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. Cash and cash equivalents $ 5,509 $ 8,721 Restricted cash (a) 1,997 Restricted cash included in other assets (b) Total cash and cash equivalents and restricted cash $ 5,570 $ 10,769 (a) In 2018, primarily represents consideration held by our paying agent in connection with our acquisition of SodaStream. (b) Primarily relates to collateral posted against our derivative asset or liability positions. Note 16 Selected Quarterly Financial Data (unaudited) Selected financial data for 2019 and 2018 is summarized as follows and highlights certain items that impacted our quarterly results: First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter Net revenue $ 12,884 $ 16,449 $ 17,188 $ 20,640 $ 12,562 $ 16,090 $ 16,485 $ 19,524 Gross profit $ 7,196 $ 9,045 $ 9,494 $ 11,294 $ 6,907 $ 8,827 $ 8,958 $ 10,588 Operating profit $ 2,008 $ 2,729 $ 2,855 $ 2,699 $ 1,807 $ 3,028 $ 2,844 $ 2,431 Mark-to-market net impact (a) $ $ ( 6 ) $ ( 4 ) $ $ ( 31 ) $ $ ( 29 ) $ ( 106 ) Restructuring and impairment charges (b) $ ( 26 ) $ ( 158 ) $ ( 98 ) $ ( 88 ) $ ( 12 ) $ ( 32 ) $ ( 35 ) $ ( 229 ) Inventory fair value adjustments and merger and integration charges (c) $ ( 15 ) $ ( 24 ) $ ( 7 ) $ ( 9 ) $ ( 75 ) Pension-related settlement charges (d) $ ( 273 ) Net tax related to the TCJ Act (e) $ $ ( 21 ) $ ( 1 ) $ ( 777 ) $ ( 76 ) $ Gains on sale of assets (f) $ $ $ $ $ $ Other net tax benefits (g) $ $ $ 4,386 Charges related to cash tender and exchange offers (h) $ ( 253 ) Tax reform bonus (i) $ ( 87 ) Gains on beverage refranchising (j) $ $ Provision for/(benefit from) income taxes (e)(f) $ $ $ $ $ $ 1,070 $ $ ( 4,932 ) Net income attributable to PepsiCo $ 1,413 $ 2,035 $ 2,100 $ 1,766 $ 1,343 $ 1,820 $ 2,498 $ 6,854 Net income attributable to PepsiCo per common share Basic $ 1.01 $ 1.45 $ 1.50 $ 1.27 $ 0.94 $ 1.28 $ 1.77 $ 4.86 Diluted $ 1.00 $ 1.44 $ 1.49 $ 1.26 $ 0.94 $ 1.28 $ 1.75 $ 4.83 Cash dividends declared per common share $ 0.9275 $ 0.955 $ 0.955 $ 0.955 $ 0.805 $ 0.9275 $ 0.9275 $ 0.9275 (a) Mark-to-market net gains and losses on commodity derivatives in corporate unallocated expenses. (b) Expenses related to the 2019 and 2014 Productivity Plans. See Note 3 to our consolidated financial statements for further information. (c) In 2019, inventory fair value adjustments and merger and integration charges primarily related to our acquisition of SodaStream. In 2018, merger and integration charges related to our acquisition of SodaStream. See Note 14 to our consolidated financial statements for further information. (d) In 2019, pension settlement charges of $ 220 million related to the purchase of a group annuity contract and settlement charges of $ 53 million related to one-time lump sum payments to certain former employees who had vested benefits , recorded in other pension and retiree medical benefits expense/income. See Note 7 to our consolidated financial statements for further information. (e) Net tax related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. (f) In 2019, gains associated with the sale of assets in the following segments: $ 31 million in FLNA and $ 46 million in PBNA. In 2018, gains associated with the sale of assets in the following segments: $ 64 million in PBNA and $ 12 million in AMESA. (g) In 2018, other net tax benefits of $ 4.3 billion resulting from the reorganization of our international operations, including the intercompany transfer of certain intangible assets. Also in 2018, non-cash tax benefits of $ 717 million associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. See Note 5 to our consolidated financial statements for further information. (h) In 2018, interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements for further information. (i) In 2018, bonus extended to certain U.S. employees related to the TCJ Act in the following segments: $ 44 million in FLNA, $ 2 million in QFNA and $ 41 million in PBNA. (j) In 2018, gains of $ 58 million and $ 144 million associated with refranchising our entire beverage bottling operations and snack distribution operations in CHS in the Europe segment and refranchising a portion of our beverage business in Thailand in the APAC segment, respectively. See Note 14 to our consolidated financial statements for further information. Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 28, 2019 and December 29, 2018 , and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 28, 2019 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 28, 2019 , based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2019 and December 29, 2018 , and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 28, 2019 , in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2019 , based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of certain sales incentive accruals As discussed in Note 2 of the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys sales incentive process, including (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Assessment of the carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 28, 2019 was $30.1 billion which represents 38% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 28, 2019. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys indefinite-lived assets impairment process to develop the forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Evaluation of unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 28, 2019, the Company recorded reserves for unrecognized tax benefits of $1.4 billion . The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, or new tax law or tax authority settlements. We identified the evaluation of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, and associated external counsel opinions. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 13, 2020 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees . Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending, plus sales of property, plant and equipment . Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, foreign exchange translation and, when applicable, the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Starting in 2018, our reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of these taxes previously recognized in net revenue. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 28, 2019 . Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2019 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +32,PepsiCo,2018," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into six reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) North America Beverages (NAB), which includes our beverage businesses in the United States and Canada; 4) Latin America, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe Sub-Saharan Africa (ESSA), which includes all of our beverage, food and snack businesses in Europe and Sub-Saharan Africa; and 6) Asia, Middle East and North Africa (AMENA), which includes all of our beverage, food and snack businesses in Asia, Middle East and North Africa. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oat squares, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. North America Beverages Either independently or in conjunction with third parties, NAB makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel, Sierra Mist and Tropicana. NAB also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, NAB manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). NAB operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. NAB also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, Latin America makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Europe Sub-Saharan Africa Either independently or in conjunction with third parties, ESSA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, ESSA operates its own bottling plants and distribution facilities. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, ESSA makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. In December 2018, we acquired SodaStream International Ltd. (SodaStream), a manufacturer and distributor of sparkling water makers. SodaStream products are included within ESSAs beverage business. See Note 14 to our consolidated financial statements for additional information about our acquisition of SodaStream. Asia, Middle East and North Africa Either independently or in conjunction with third parties, AMENA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMENA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi, Sting and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMENA operates its own bottling plants and distribution facilities. AMENA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, we license the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. Our products are also available on a growing number of e-commerce websites and mobile commerce applications as consumer consumption patterns continue to change and retail increasingly expands online. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it globally. See Note 9 to our consolidated financial statements for additional information on how we manage our exposure to commodity costs. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including 1893, Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewater, Aunt Jemima, Bare, bubly, Capn Crunch, Cheetos, Chesters, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet Sierra Mist, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Ice, Mountain Dew Kickstart, Mug, Munchies, Naked, Near East, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Black, Pepsi Max, Pepsi Next, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Farmstand, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks, Muscle Milk protein shakes and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. For instance, our beverage sales are higher during the warmer months and certain food and dairy sales are higher in the cooler months. Weekly beverage and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2018 , sales to Walmart Inc. (Walmart), including Sams Club (Sams), represented approximately 13% of our consolidated net revenue. Our top five retail customers represented approximately 33% of our 2018 net revenue in North America, with Walmart (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2018 , we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, the effectiveness of our advertising campaigns, marketing programs, product packaging, pricing, increased efficiency in production techniques, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, dispensing equipment, packaging technology (including investments in recycling-focused technologies), package design (including development of sustainable, bio-based packaging) and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of sweetener alternatives and flavor modifiers and innovation in existing sweeteners, further expanding our beyond the bottle portfolio (including through our acquisition of SodaStream) and offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; and improvements in energy efficiency and efforts focused on reducing our impact on the environment. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to develop nutritious and convenient beverages, foods and snacks. In 2018 , we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our state-of-the-art food and beverage healthy vending initiative to increase the availability of convenient and affordable nutrition; further expanding our portfolio of nutritious products by building on our important nutrition platforms and brands Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies), KeVita (probiotics, tonics and fermented teas), Bare (baked apple chips and other baked produce) and Health Warrior (nutrition bars); further expanding our whole grain products globally; and further expanding our portfolio of nutritious products in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water in our agricultural supply chain), and by incorporating improvements in the sustainability and resources of our agricultural supply chain into our operations; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to support increased packaging recovery, recycling rates and the amount of recycled content in our packaging; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers; and efforts to optimize packaging technology and design to minimize the amount of plastic in our packaging, and make our packaging increasingly recoverable or recyclable with lower environmental impact, including continuing to invest in developing compostable and biodegradable packaging. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are also subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some plastic beverage bottles and other single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 29, 2018 , we and our consolidated subsidiaries employed approximately 267,000 people worldwide, including approximately 114,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K, including the Managements Discussion and Analysis of Financial Condition and Results of Operations section and the consolidated financial statements and related notes. Any of the factors described below could occur or continue to occur and could have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and may also adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results, financial and business performance, events or trends. Demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics could result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers, including through e-commerce and hard discounters); or the location of origin or source of ingredients and products (including the environmental impact related to production of our products). Consumer preferences have been evolving, and are expected to continue to evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending, consumption and purchasing habits; consumer concerns or perceptions regarding the nutrition profile of products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic or locally sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including single-use and other plastic packaging, and their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or our respective social media posts, business practices or other information disseminated by or regarding them or us; product boycotts; or a downturn in economic conditions. Any of these factors may reduce consumers willingness to purchase our products and any inability on our part to anticipate or react to such changes could result in reduced demand for our products or erode our competitive and financial position and could adversely affect our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories (through acquisitions, such as SodaStream, and innovation, such as increasing non-carbonated beverage offerings and other alternatives to, or reformulations of, carbonated beverage offerings); respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients and packaging materials (including to respond to applicable regulations); develop sweetener alternatives and innovation; increase the recyclability or recoverability of our packaging; improve the production and distribution of our products; respond to competitive product and pricing pressures and changes in distribution channels, including in the e-commerce channel; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including correctly anticipating or effectively reacting to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively market or distribute our products could reduce demand for our products, result in inventory write-offs and erode our competitive and financial position and could adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to the use or disposal of plastics or other packaging of our products could continue to increase our costs, reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our food and beverage products are sold in plastic or other packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to low value, lack of infrastructure or otherwise. In addition, certain of our packaging may currently not be recyclable, compostable or biodegradable. There is a growing concern with the accumulation of plastic and other packaging waste in the environment, particularly in the worlds oceans and waterways. As a result, our branded packaging waste could result in negative publicity (whether or not valid) or reduce consumer demand and overall consumption of our products, which could adversely affect our business, financial condition or results of operations. In response to these concerns, the United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to increase the sustainability of packaging, encourage waste reduction and increase recycling rates or facilitate the waste management process or restricting the sale of products in certain packaging. These regulations vary in scope and form from taxes or fees designed to incentivize behavior to restrictions or bans on certain products and materials. For example, the state of California is one of 10 states in the United States that have a bottle deposit return system in effect, which requires a deposit charged to consumers to incentivize the return of the beverage container. In addition, 26 markets in the European Union have established extended producer responsibility policies, which make manufacturers such as us responsible for the costs of recycling products after consumers have used them. Further, certain jurisdictions are considering imposing other types of regulations or policies, including packaging taxes, requirements for bottle caps to be tethered to the plastic bottle, minimum recycled content mandates, which would require packaging to include a certain percentage of post-consumer recycled material in a new package, and even bans on the use of some plastic beverage bottles and other single-use plastics. These laws and regulations, whatever their scope or form, could increase the cost of our products, reduce consumer demand and overall consumption of our products or result in negative publicity (whether or not valid), which could adversely affect our business, financial condition or results of operations. While we continue to devote significant resources to increase the recyclability and sustainability of our packaging, the increased focus on reducing plastic waste may require us to increase capital expenditures, including requiring additional investments to minimize the amount of plastic across our packaging; increase the amount of recycled content in our packaging; and develop sustainable, bio-based packaging as a replacement for fossil fuel-based plastic packaging, including flexible film alternatives for our snacks packaging. Our failure to minimize our plastics use, increase the amount of recycled content in our packaging or develop sustainable packaging or consumers failure to accept such sustainable packaging could reduce consumer demand and overall consumption of our products and erode our competitive and financial position. Further, our reputation could be damaged for failure to achieve our sustainability goals with respect to our plastics use, including our goal to use 25% recycled content in our plastic packaging by 2025, or if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations could adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to differing regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold, as is the packaging, disposal and recyclability of our products. For example, five provinces in Canada, covering most of the Canadian market, have established extended producer responsibility policies, which make manufacturers such as us responsible for the costs of recycling products after consumers have used them. In addition, these laws and regulations and related interpretations may change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes may include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices, including restrictions on the audience to whom products are marketed; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, may result in higher compliance costs, capital expenditures and higher production costs, which could adversely affect our business, reputation, financial condition or results of operations. The imposition of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product, production, recovery or recycling requirements, or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products, commodities used in the production of our products or use, disposal, recovery or recyclability of our products and their packaging, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, which could adversely affect our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions may follow. For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing may result in decreased demand for our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) have been and continue to be underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials, such as 4-MeI, acrylamide, caffeine, glyphosate, furfuryl alcohol, added sugars, sodium, saturated fat and plastic. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and foods high in sugar, sodium or saturated fat. If, as a result of these studies and documents or otherwise, there is an increase in consumer concerns (whether or not valid) about the health implications of consumption of certain of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, demand for our products could decline, or we could be subject to lawsuits or new regulations that could affect sales of our products, any of which could adversely affect our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business could take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or could fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Failure to comply with such laws or regulations could subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, any of which could adversely affect our business, reputation, financial condition or results of operations. In addition, regulatory authorities under whose laws we operate may have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, which could have an adverse effect on the sales of products in our portfolio or could lead to damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. For example, effective January 2018, the City of Seattle, Washington in the United States enacted a per-ounce surcharge on all sugar-sweetened beverages. By contrast, France revised an existing flat tax to become a graduated tax, effective July 2018, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per-ounce tax rate, while Saudi Arabia enacted, effective June 2017, a flat tax rate of 50%, and Jordan increased, effective January 2018, its flat tax from 10% to 20%, on the retail price of carbonated soft drinks. These tax measures, whatever their scope or form, could increase the cost of our products, reduce consumer demand and overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may reduce demand for such products and could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which may adversely affect our business, financial condition or results of operations. Failure to realize anticipated benefits from our productivity initiatives or operating model could have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure and operate more efficiently in the highly competitive beverage, food and snack categories and markets. We are also continuing to implement our initiatives to improve efficiency, decision making, innovation and brand management across our global organization to enable us to compete more effectively. Further, in order to continue to capitalize on our cost reduction efforts and operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. Some of these measures could yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to continue to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, which could adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold may be difficult to predict and may adversely affect our business, financial condition and results of operations. The results of elections, referendums or other political conditions (including government shutdowns) in these markets could impact how existing laws, regulations and government programs or policies are implemented or create uncertainty as to how such laws, regulations and government programs or policies may change, including with respect to tariffs, sanctions, climate change regulation, taxes, benefit programs, the movement of goods, services and people between countries and other matters, and could result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products. For example, the United Kingdoms pending withdrawal from the European Union (commonly referred to as Brexit) could lead to differing laws and regulations in the United Kingdom and European Union. Any changes in, or the imposition of new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions could have an adverse impact on our business, financial conditions and results of operations. Our business, financial condition or results of operations could be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences or otherwise. The following factors could reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; our inability to hire or retain a highly skilled workforce; imposition of new or increased tariffs and other impositions on imported goods or sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations or tariffs on the products of such corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions, tariffs or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly inflationary economies, devaluation or fluctuation, such as the devaluation of the Russian ruble, Turkish lira, Brazilian real, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or could significantly affect our ability to effectively manage our operations in certain of these markets and could result in the deconsolidation of such businesses, such as occurred with respect to our Venezuelan businesses which were deconsolidated at the end of the third quarter of 2015; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our business, reputation, financial condition or results of operations could be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and may, from time to time, continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results may be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly-inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, may limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; may leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or may result in a decline in the market value of our investments in debt securities, which could have an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, contract manufacturers, distributors and joint venture partners and could result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which could also have an adverse impact on our business, reputation, financial condition or results of operations. Our business and reputation could suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage and operate our facilities; to conduct research and development; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals (including criminal hackers, hacktivists, state-sponsored actors, criminal and terrorist organizations, individuals or groups participating in organized crime and insiders) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of computing resources, financial fraud, operational disruption, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromises. As with other global companies, we are regularly subject to cyberattacks, including many of the types of attacks described above. Although we may incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, lapses in our controls or the intentional or negligent actions of employees, or from deliberate cyberattacks such as malicious or disruptive software, denial of service attacks, malicious social engineering, hackers or otherwise), our business could be disrupted and we could, among other things, be subject to: transaction errors; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which could cause errors or delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or supply chain disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and those of our third-party providers, and the information stored therein could be compromised, including through cyberattacks or other external or internal methods, resulting in unauthorized parties accessing or extracting sensitive data or confidential information. Failure to comply with data privacy laws could result in litigation, claims, legal or regulatory proceedings, inquiries or investigations. We continue to devote significant resources to network security, backup and disaster recovery, enhancing our internal controls, and other security measures, including training, to protect our systems and data, but these security measures cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that may arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies could heighten these and other operational risks, as certain aspects of the security of such technologies may be complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that may arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. We and our business partners use various raw materials, energy, water and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oats, oranges and other fruits, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, water, animal welfare and human rights concerns and other risks associated with the global food system may lead to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and could adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake or flooding), disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), limited or sole sources of supply, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. For example, in 2018, the United States imposed tariffs on steel and aluminum as well as on goods imported from China and certain other countries, which has resulted in retaliatory tariffs by China and other countries. Additional tariffs imposed by the United States on a broader range of imports, or further retaliatory trade measures taken by China or other countries in response, could result in an increase in supply chain costs that we may not be able to offset or otherwise adversely impact our results of operations. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs could adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality and increasing pressure to conserve water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; or damage to our reputation, any of which could adversely affect our business, financial condition or results of operations. Business disruptions could have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, distributors, joint venture partners and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations due to any of the following factors could impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power or water shortages; strikes, labor disputes or lack of availability of qualified personnel, such as truck drivers; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity could adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which could adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we could decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which could result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which could reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes could adversely affect our reputation or brands. Our business could also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts could materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image could adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image could be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals, including with respect to plastic packaging, or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, plastics or other packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, including the recyclability or recoverability of our packaging, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees engage in or are believed to have engaged in improper activities, we may be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, which may cause us to suffer damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information could also hurt our reputation. In addition, water is a limited resource in many parts of the world and demand for water continues to rise. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to water use. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, may also generate adverse publicity (whether or not valid) that could damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons could result in decreased demand for our products and could adversely affect our business, financial condition or results of operations, as well as require additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, could adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Potential issues associated with these activities could include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, including our recently completed acquisition of SodaStream, the following factors also pose potential risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees (both of the acquired company and our company); conforming standards, controls (including internal control over financial reporting and disclosure controls and procedures, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners may adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we may not be able to complete or effectively manage such transactions on terms commercially favorable to us or at all and may fail to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings may reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain may adversely impact our sales or business performance. If an acquisition or joint venture is not successfully completed, integrated into our existing operations or managed effectively, or if a divestiture or refranchising is not successfully completed or managed effectively or does not result in the benefits or cost savings we expect, our business, financial condition or results of operations may be adversely affected. A change in our estimates and underlying assumptions regarding the future performance of our businesses could result in an impairment charge, which could materially affect our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, could adversely affect our results of operations. Factors that could result in an impairment include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that may result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. Future impairment charges could have a significant adverse effect on our results of operations in the periods recognized. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction could reduce our after-tax income from such jurisdiction and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, in December 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the Internal Revenue Service (IRS) could impact our recorded amounts in future periods. For further information regarding the impact and potential impact of the TCJ Act, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations. For example, the Organization for Economic Cooperation and Development (OECD) has recommended changes to numerous long-standing international tax principles through its base erosion and profit shifting (BEPS) project. These changes, to the extent adopted, may increase tax uncertainty, result in higher compliance costs and adversely affect our provision for income taxes, results of operations and/or cash flow. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. In connection with the OECDs BEPS project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation could differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it could have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or to hire and retain a highly skilled and diverse workforce could deplete our institutional knowledge base and erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer could adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers could adversely affect our business, financial condition or results of operations. Disruption in the retail landscape, including rapid growth in hard discounters and the e-commerce channel, could adversely affect our business, financial condition or results of operations. Our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites, mobile commerce applications and subscription services as well as the integration of physical and digital operations among retailers. We continue to make significant investments in attracting talent to and building our global e-commerce capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which could adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce and hard discounters may result in consumer price deflation, which may affect our relationships with key retail customers. Further, the ability of consumers to compare prices on a real-time basis using digital technology puts additional pressure on us to maintain competitive prices. If these e-commerce and hard discounter retailers were to take significant market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, our ability to maintain and grow our profitability, share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers with increased purchasing power, which may impact our ability to compete in these areas. Such retailers may demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, could reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, could increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market could also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity could adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize information technology support services and administrative functions in certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. We may enter into new or additional agreements for shared services in other functions in the future to achieve cost savings and efficiencies as we continue to migrate to shared business service organizational models across our business operations. In addition, we utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. If any of these third-party service providers or vendors do not perform effectively, or if we fail to adequately monitor their performance (including compliance with service level agreements or regulatory or legal requirements), we may not be able to achieve the expected cost savings, we may have to incur additional costs to correct errors made by such service providers, our reputation could be harmed or we could be subject to litigation, claims, legal or regulatory proceedings, inquiries or investigations. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, or damage to our reputation, which could have a negative impact on employee morale. In addition, the management of multiple third-party service providers increases operational complexity and decreases our control. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which could result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and may continue to have, an adverse impact on our business, financial condition and results of operations. Climate change, water scarcity or legal, regulatory or market measures to address climate change or water scarcity may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, tornado, earthquake or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. The predicted effects of climate change may also exacerbate challenges regarding the availability and quality of water. As demand for water access continues to increase around the world, we may be subject to decreased availability of water, deteriorated quality of water or less favorable pricing for water, which could adversely impact our manufacturing and distribution operations. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency and water conservation, we may experience disruptions in, or significant increases in our costs of, operation and delivery and we may be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions could substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change or water scarcity could negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to water use and the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change or water scarcity could result in adverse publicity and could adversely affect our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact, water use and recyclability or recoverability of packaging, including plastic. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, could cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions could occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, could be reduced, which could have an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, could be reduced and there could be an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding could have an adverse impact on our business, reputation, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations could have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, may also require us to incur significant expense and devote significant resources, and may generate adverse publicity that may damage our reputation or brand image, which could have an adverse impact on our business, financial condition or results of operations. Many factors may adversely affect the price of our publicly traded securities. Many factors may adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, may include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, inquiries or investigations; changes in laws and regulations applicable to our products or business operations; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we may or may not take from time to time as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, may not have the impact we intend and may adversely affect the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, could adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2018 fiscal year and that remain unresolved. ," Item 2. Properties. Our principal executive offices located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products. The approximate number of such facilities utilized by each division is as follows: FLNA QFNA NAB Latin America ESSA AMENA Shared (a) Plants (b) Other Facilities (c) 1,660 (a) Shared properties are in addition to the other properties reported by our six divisions identified in this table. (b) Includes manufacturing and processing plants as well as bottling and production plants. (c) Includes warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities. Significant properties by division included in the table above are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. NABs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. Latin Americas three snack plants in Mexico (one in Vallejo, one in Celaya and one in Obregn) and one in Brazil (Sorocaba), all of which are owned. ESSAs snack plant in Leicester, United Kingdom, which is leased; its snack plant in Kashira, Russia, its fruit juice plant in Zeebrugge, Belgium, its beverage plant in Lebedyan, Russia and its dairy plant in Moscow, Russia, all of which are owned. AMENAs two beverage plants in Egypt (one in Tanta City and one in Sixth of October City) and its snack plant in Wuhan, China, all of which are owned; and its snack plant in Riyadh, Saudi Arabia, which is leased. Two concentrate plants in Cork, Ireland, which are shared by our NAB, ESSA and AMENA segments, both of which are owned; and one in Singapore, which is shared by our NAB and AMENA segments, which is leased. Shared service centers in Winston-Salem, North Carolina, and Plano, Texas, which are primarily shared by our FLNA, QFNA and NAB segments, both of which are leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. As previously disclosed, in April 2017, Corporacin Autnoma Regional de Cundinamarca, a Colombian environmental authority (the environmental authority), initiated an administrative proceeding regarding our subsidiary, PepsiCo Alimentos Z.F., Ltda. (PAZ), for allegedly delivering wastewater to a third party without first verifying that the third party had appropriate permits with respect to the discharge of such wastewater. In July 2018, the environmental authority initiated an administrative proceeding to impose a monetary sanction against PAZ with respect to the alleged permitting violation by the third party, and on August 13, 2018, PAZ submitted evidence of its defense to these allegations. If the environmental authority determines PAZ is responsible for the alleged permitting violations by the third party, the environmental authority may seek to impose monetary sanctions of up to $1.3 million, which PAZ would be entitled to appeal. In addition, we and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. Sanctions imposed by foreign authorities are levied in local currency and disclosed using the U.S. dollar equivalent at the time of imposition and are subject to currency fluctuations. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 8, 2019 , there were approximately 114,513 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 13, 2019, the Board of Directors declared a quarterly dividend of $0.9275 payable March 29, 2019, to shareholders of record on March 1, 2019. For the remainder of 2019, the dividend record dates for these payments are expected to be June 7, September 6 and December 6, 2019, subject to approval of the Board of Directors. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2018 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (b) 9/8/2018 $ 14,631 9/9/2018 - 10/6/2018 1.3 $ 112.64 1.3 (147 ) 14,484 10/7/2018 - 11/3/2018 1.3 $ 110.39 1.3 (145 ) 14,339 11/4/2018 - 12/1/2018 1.4 $ 116.68 1.4 (163 ) 14,176 12/2/2018 - 12/29/2018 0.8 $ 116.99 0.8 (92 ) Total 4.8 $ 113.91 4.8 $ 14,084 (a) All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs. (b) Represents shares authorized for repurchase under the $ 15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Such shares may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Non-GAAP Measures Items Affecting Comparability Results of Operations Division Review Frito-Lay North America Quaker Foods North America North America Beverages Latin America Europe Sub-Saharan Africa Asia, Middle East and North Africa Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Restricted Cash Note 14 Acquisitions and Divestitures Note 15 Supplemental Financial Information Managements Responsibility for Financial Reporting Report of Independent Registered Public Accounting Firm GLOSSARY 43 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. At PepsiCo, we are focused on an approach called Winning with Purpose that will help make our company faster, stronger and better at meeting the needs of our customers, consumers, partners and communities, while caring for our planet and inspiring our associates. Our strategies are designed to address key challenges facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. We intend to focus on the following areas to address and adapt to these challenges: Winning in the marketplace and accelerating growth by strengthening and broadening our portfolio, while focusing on locally meeting the needs of our consumers and customers; Continuing to implement our productivity initiatives to improve our operational efficiency and enhance our competitive advantage while continuing to transform our core capabilities with technology and building and retaining a talented workforce to drive cost savings; and Continuing to lead with purpose by focusing on our impact on the planet and our people, assisting in establishing a more sustainable food system, minimizing our impact on the environment, protecting human rights and securing supply while positioning our Company for sustainable growth. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for additional information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During 2018 and 2017 , certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging and encourage waste reduction and increased recycling rates. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. In addition, our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. In 2018, we recognized a net tax benefit of $28 million in connection with the TCJ Act. See further information in Items Affecting Comparability. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. For additional information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key public policy and sustainability matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors and the Audit Committee of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017 . At the end of 2018 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2018 by $100 million . Foreign Exchange Our operations outside of the United States generated 43% of our consolidated net revenue in 2018 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our consolidated net revenue in 2018 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. During 2018 , unfavorable foreign exchange reduced net revenue growth by one percentage point due to declines in the Russian ruble, Turkish lira and Brazilian real. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, India, Mexico, the Middle East, Russia and Turkey, and currency fluctuations in certain of these international markets continue to result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, as well as the economic, operating and political environment in Russia, and the potential impact for the ESSA segment and our other businesses. Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017 . The total notional amount of our debt instruments designated as net investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017 . At the end of 2018 , we estimate that an unfavorable 10% change in the underlying exchange rates would have decreased our net unrealized gains in 2018 by $149 million . Interest Rates Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017 . Assuming year-end 2018 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have increased our net interest expense in 2018 by $7 million due to lower cash and cash equivalents and short-term investments levels as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures, except as otherwise noted, reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Volume Our beverage volume in the NAB, Latin America, ESSA and AMENA segments reflects sales to authorized bottlers, independent distributors and retailers, as well as the sale of beverages bearing Company-owned or licensed trademarks that have been sold through our authorized independent bottlers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our beverage revenues are not entirely based on BCS volume, as there are independent bottlers in the supply chain, we believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the consumer level. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. NAB, Latin America, ESSA and AMENA, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and NAB, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, AMENA licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Our food and snack volume in the FLNA, QFNA, Latin America, ESSA and AMENA segments is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2018 , total servings increased 1% compared to 2017 . In 2017 , total servings decreased 1% compared to 2016 . Excluding the impact of the 53 rd reporting week in 2016, total servings in 2017 was even with the prior year. Servings growth reflects adjustments to the prior year results for divestitures and other structural changes. Consolidated Net Revenue and Operating Profit Change Net revenue $ 64,661 $ 63,525 $ 62,799 % % Operating profit (a) $ 10,110 $ 10,276 $ 9,804 (2 )% % Operating profit margin (a) 15.6 % 16.2 % 15.6 % (0.5 ) 0.6 (a) In 2017 and 2016, operating profit and operating profit margin reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2018 Operating profit decreased 2% and operating profit margin declined 0.5 percentage points. The operating profit performance was driven by certain operating cost increases and a 6-percentage-point impact of higher commodity costs, partially offset by productivity savings of more than $1 billion and net revenue growth. The impact of refranchising a portion of our beverage business in Jordan in 2017 and a prior-year gain associated with the sale of our minority stake in Britvic negatively impacted operating profit performance by 2.5 percentage points. These impacts were offset by a 2-percentage-point positive impact of refranchising a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in 2018. Items affecting comparability (see Items Affecting Comparability) negatively impacted operating profit performance by 3 percentage points and decreased operating profit margin by 0.5 percentage points, primarily due to higher mark-to-market net impact on commodity derivatives included in corporate unallocated expenses. 2017 Operating profit increased 5% and operating profit margin improved 0.6 percentage points. Operating profit growth was driven by productivity savings of more than $1 billion and effective net pricing, partially offset by certain operating cost increases, a 7-percentage-point impact of higher commodity costs and unfavorable foreign exchange. The impact of refranchising a portion of our beverage business in Jordan and a gain associated with the sale of our minority stake in Britvic each contributed 1 percentage point to operating profit growth. Items affecting comparability (see Items Affecting Comparability) also contributed 2 percentage points to operating profit growth and increased operating profit margin by 0.2 percentage points, primarily reflecting a prior-year impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value. Other Consolidated Results Change Other pension and retiree medical benefits income/(expense) (a) $ $ $ (19 ) $ $ Net interest expense $ (1,219 ) $ (907 ) $ (1,232 ) $ (312 ) $ Annual tax rate (b) (36.7 )% 48.9 % 25.4 % Net income attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 % (23 )% Net income attributable to PepsiCo per common share diluted $ 8.78 $ 3.38 $ 4.36 % (23 )% Mark-to-market net impact 0.09 (0.01 ) (0.08 ) Restructuring and impairment charges 0.18 0.16 0.09 Merger and integration charges 0.05 Net tax (benefit)/expense related to the TCJ Act (b) (0.02 ) 1.70 Other net tax benefits (b) (3.55 ) Charges related to cash tender and exchange offers 0.13 Charge related to the transaction with Tingyi 0.26 Charge related to debt redemption 0.11 Pension-related settlement charge 0.11 Net income attributable to PepsiCo per common share diluted, excluding above items (c) $ 5.66 $ 5.23 $ 4.85 % % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (c) % % (a) In 2017 and 2016, reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Note 5 to our consolidated financial statements. (c) See Non-GAAP Measures. Other pension and retiree medical benefits income increased $65 million , reflecting the impact of the $1.4 billion discretionary pension contribution to the PepsiCo Employees Retirement Plan A (Plan A) in the United States, as well as the recognition of net asset gains, partially offset by higher amortization of net losses. Net interest expense increased $312 million reflecting a charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. This increase also reflects higher interest rates on debt balances, as well as losses on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest income due to higher interest rates on cash balances. The reported tax rate decreased 85.6 percentage points, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo increased 158% and net income attributable to PepsiCo per common share increased 160% . Items affecting comparability (see Items Affecting Comparability) positively contributed 150 percentage points to net income attributable to PepsiCo growth and 152 percentage points to net income attributable to PepsiCo per common share growth. Other pension and retiree medical benefits income increased $252 million , primarily reflecting a settlement charge of $242 million related to the purchase of a group annuity contract in 2016. Net interest expense decreased $325 million reflecting a charge of $233 million in 2016 representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This decrease also reflects higher interest income due to higher interest rates and average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest expense due to higher average debt balances. The reported tax rate increased 23.5 percentage points primarily as a result of the provisional net tax expense related to the TCJ Act, which contributed 26 percentage points to the increase, partially offset by the impact of the 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in 2017. See Note 2 and Note 5 to our consolidated financial statements for additional information. Net income attributable to PepsiCo and net income attributable to PepsiCo per common share both decreased 23%. Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 30 percentage points, primarily as a result of the provisional net tax expense related to the TCJ Act. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring programs; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; gains or losses associated with mergers, acquisitions, divestitures and other structural changes; debt redemptions, cash tender or exchange offers; pension and retiree medical related items; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures are contained in this Form 10-K: cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income/expense, interest expense, benefit from/provision for income taxes and noncontrolling interests, each adjusted for items affecting comparability; operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates; organic revenue growth; free cash flow; and return on invested capital (ROIC) and net ROIC, excluding items affecting comparability. Cost of Sales, Gross Profit, Selling, General and Administrative Expenses, Other Pension and Retiree Medical Benefits Income/Expense, Interest Expense, Benefit from/Provision for Income Taxes, Annual Tax Rate and Noncontrolling Interests, Adjusted for Items Affecting Comparability; Operating Profit, Adjusted for Items Affecting Comparability, and Net Income Attributable to PepsiCo per Common Share Diluted, Adjusted for Items Affecting Comparability, and the Corresponding Constant Currency Growth Rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 and 2014 Productivity Plans, merger and integration charges associated with our acquisition of SodaStream, net tax benefit/expense associated with the enactment of the TCJ Act, other net tax benefits, charges related to cash tender and exchange offers, a charge related to the transaction with Tingyi, a charge related to debt redemption, and a pension-related settlement charge (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. We are not able to reconcile our full year projected 2019 annual tax rate, excluding items affecting comparability, to our full year projected 2019 reported annual tax rate because we are unable to predict the 2019 impact of foreign exchange or the mark-to-market net impact on commodity derivatives due to the unpredictability of future changes in foreign exchange rates and commodity prices. Therefore, we are unable to provide a reconciliation of this measure. Organic Revenue Growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of approximately $75 million of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. We believe organic revenue provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review. Free Cash Flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources. ROIC and Net ROIC, Excluding Items Affecting Comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Interest expense (Benefit from)/provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 29,381 $ 35,280 $ 25,170 $ 10,110 $ $ 1,525 $ (3,370 ) $ $ 12,515 Items Affecting Comparability Mark-to-market net impact (83 ) (80 ) Restructuring and impairment charges (3 ) (269 ) Merger and integration charges (75 ) Net tax benefit related to the TCJ Act (28 ) Other net tax benefits 5,064 (5,064 ) Charges related to cash tender and exchange offers (253 ) Core, Non-GAAP Measure $ 29,295 $ 35,366 $ 24,746 $ 10,620 $ $ 1,272 $ 1,878 $ $ 8,065 2017 (b) Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,796 $ 34,729 $ 24,453 $ 10,276 $ $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (229 ) Provisional net tax expense related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,804 $ 34,721 $ 24,231 $ 10,490 $ $ 2,307 $ 7,524 2016 (b) Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Interest expense Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 28,222 $ 34,577 $ 24,773 $ 9,804 $ (19 ) $ 1,342 $ 2,174 $ $ 6,329 Items Affecting Comparability Mark-to-market net impact (78 ) (167 ) (56 ) (111 ) Restructuring and impairment charges (155 ) Charge related to the transaction with Tingyi (373 ) Charge related to debt redemption (233 ) Pension-related settlement charge Core, Non-GAAP Measure $ 28,300 $ 34,499 $ 24,334 $ 10,165 $ $ 1,109 $ 2,301 $ $ 7,040 (a) Benefit from/provision for income taxes is the expected tax benefit/charge on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction and tax year. (b) Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan Our 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this program, we expect to incur pre-tax charges of approximately $2.5 billion, of which $138 million is included in our 2018 results, approximately $800 million is expected to be reflected in our 2019 results and the balance to be reflected in our 2020 through 2023 results. These pre-tax charges will consist of approximately 70% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 15% for other costs associated with the implementation of our initiatives. We expect that these pre-tax charges will result in cash expenditures of approximately $1.6 billion, of which we expect approximately $450 million to be reflected in our 2019 cash flows and the balance to be reflected in our 2020 through 2023 cash flows. We expect to incur the majority of the pre-tax charges and cash expenditures in our 2019 and 2020 results. The total expected program pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA NAB Latin America ESSA AMENA Corporate Expected pre-tax charges % % % % % % % 2014 Multi-Year Productivity Plan To build on the successful implementation of the 2014 Productivity Plan, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives of the 2014 Productivity Plan to further strengthen our beverage, food and snack businesses. In connection with this program, we expect to incur pre-tax charges and cash expenditures of approximately $1.3 billion and $960 million, respectively. This total pre-tax charge is expected to consist of approximately 55% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 30% for other costs associated with the implementation of our initiatives. To date, we have incurred $1.2 billion of pre-tax charges and $814 million of cash expenditures. We expect to complete the program and incur the programs remaining pre-tax charges and cash expenditures before the end of 2019. The total expected program pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA NAB Latin America ESSA AMENA Corporate Expected pre-tax charges % % % % % % % See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Merger and Integration Charges In 2018, we incurred merger and integration charges of $75 million ($0.05 per share) related to our acquisition of SodaStream, including $57 million recorded in the ESSA segment and $18 million recorded in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs . See Note 14 to our consolidated financial statements. Net Tax (Benefit)/Expense Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. In 2017, we recorded a provisional net tax expense of $2.5 billion ($1.70 per share) associated with the enactment of the TCJ Act. Included in the provisional net tax expense of $2.5 billion was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate. In 2018, we recorded a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act. See Note 5 to our consolidated financial statements. Other Net Tax Benefits In 2018, we reorganized our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). Also in 2018, we recognized non-cash tax benefits associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. The conclusion of certain international tax audits and the resolution with the IRS resulted in non-cash tax benefits of $364 million ($0.26 per share) and $353 million ($0.24 per share), respectively. See Note 5 to our consolidated financial statements. Charges Related to Cash Tender and Exchange Offers In 2018, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements. Charge Related to the Transaction with Tingyi In 2016, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in the AMENA segment to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair valu e. See Note 9 to our consolidated financial statements. Charge Related to Debt Redemption In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See Note 8 to our consolidated financial statements. Pension-Related Settlement Charge In 2016, we recorded a pre-tax pension settlement charge in corporate unallocated expenses of $242 million ($162 million after-tax or $0.11 per share) related to the purchase of a group annuity contract. See Note 7 to our consolidated financial statements. Results of Operations Division Review The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on organic revenue growth, see Non-GAAP Measures. Impact of Impact of Net revenue growth Foreign exchange translation Acquisitions and divestitures Sales and certain other taxes Organic revenue growth (a ) Volume (b) Effective net pricing (c) FLNA 3.5 % % QFNA (1.5 )% (2 )% (0.5 ) (1 ) NAB % 0.5 % (1 ) Latin America % % ESSA % 0.5 % AMENA (2 )% % Total % % Impact of Impact of Net revenue growth Foreign exchange translation Acquisitions and divestitures 53rd reporting week (d) Organic revenue growth (a) Volume (b) Effective net pricing (c) FLNA % % 2.5 QFNA (2 )% (1 )% (1 ) NAB (2 )% (1 ) (2 )% (2.5 ) Latin America % (1 ) 0.5 % (2 ) ESSA % (3 ) % AMENA (5 )% % Total % % (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our Company-owned and franchise-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. (c) Includes the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. (d) Our fiscal 2016 results included a 53rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. Frito-Lay North America % Change 2017 (a) 2016 (a) Net revenue $ 16,346 $ 15,798 $ 15,549 3.5 Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of 53 rd reporting week Organic revenue growth (b) (d) (d) Operating profit $ 5,008 $ 4,793 $ 4,612 4.5 Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 5,044 $ 4,847 $ 4,624 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 3.5%, primarily reflecting effective net pricing and volume growth. Volume grew 1%, reflecting mid-single-digit growth in variety packs and low-single-digit growth in trademark Doritos, partially offset by a double-digit decline in Santitas. Operating profit grew 4.5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and a 1-percentage-point impact of a bonus extended to certain U.S. employees in connection with the TCJ Act. 2017 Net revenue grew 2%, primarily reflecting effective net pricing, partially offset by the impact of the 53 rd reporting week in 2016, which reduced net revenue growth by 2 percentage points. Volume declined 1%, reflecting mid-single-digit declines in trademark Lays and Fritos and a low-single-digit decline in trademark Doritos, partially offset by high-single-digit growth in variety packs. The 53 rd reporting week in 2016 negatively impacted volume performance by 2 percentage points. Operating profit grew 4%, primarily reflecting productivity savings, the effective net pricing and a 1-percentage-point impact of 2016 incremental investments into our business. These impacts were partially offset by certain operating cost increases, including strategic initiatives, and a 1-percentage-point impact of higher commodity costs, primarily cooking oil. The 53 rd reporting week in 2016 reduced operating profit growth by 2 percentage points. Quaker Foods North America % Change 2017 (a) 2016 (a) Net revenue $ 2,465 $ 2,503 $ 2,564 (1.5 ) (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of 53 rd reporting week Organic revenue growth (b) (2 ) (d) (1 ) (d) Operating profit $ $ $ (1 ) Restructuring and impairment charges (c) Operating profit excluding above item (b) $ $ $ (1 ) Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (1 ) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue declined 1.5% and volume declined 0.5%. The net revenue performance reflects unfavorable net pricing and mix and the volume decline. The volume decline was driven by a double-digit decline in trademark Gamesa and a mid-single-digit decline in ready-to-eat cereals, partially offset by mid-single-digit growth in oatmeal. Operating profit decreased slightly, reflecting certain operating cost increases, the net revenue performance and a 3-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1-percentage-point positive contribution from insurance settlement recoveries related to the 2017 earthquake in Mexico. 2017 Net revenue declined 2%, reflecting the impact of the 53 rd reporting week in 2016, which negatively impacted net revenue performance by 2 percentage points, as well as unfavorable mix. Volume declined 2%, reflecting a low-single-digit decline in ready-to-eat cereals and high-single-digit declines in trademark Roni and Gamesa, in part reflecting the impact of the 53 rd reporting week in 2016 which negatively impacted volume performance by 2 percentage points. Operating profit decreased 1%, reflecting certain operating cost increases and the net revenue performance. The 53 rd reporting week in 2016 negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1.5-percentage-point impact of 2016 incremental investments into our business. Higher restructuring and impairment charges negatively impacted operating profit performance by 1 percentage point. North America Beverages % Change 2017 (a) 2016 (a) Net revenue $ 21,072 $ 20,936 $ 21,312 (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures (1 ) Impact of sales and certain other taxes (b) Impact of 53 rd reporting week Organic revenue growth (b) 0.5 (d) (2 ) Operating profit $ 2,276 $ 2,700 $ 2,947 (16 ) (8 ) Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 2,364 $ 2,743 $ 2,980 (14 ) (8 ) Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (14 ) (8 ) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 1%, driven by effective net pricing, partially offset by a decline in volume. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage volume. The non-carbonated beverage volume increase primarily reflected a high-single-digit increase in our overall water portfolio. Additionally, a low-single-digit increase in Gatorade sports drinks was offset by a low-single-digit decline in our juice and juice drinks portfolio. Operating profit decreased 16%, reflecting certain operating cost increases, including increased transportation costs, a 7-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. These impacts were partially offset by productivity savings and the net revenue growth. Higher gains on asset sales positively contributed 1.5 percentage points to operating profit performance. A bonus extended to certain U.S. employees in connection with the TCJ Act negatively impacted operating profit performance by 1.5 percentage points and was partially offset by prior-year costs related to hurricanes which positively contributed 1 percentage point to operating profit performance. 2017 Net revenue decreased 2%, primarily reflecting a decline in volume, partially offset by effective net pricing, as well as acquisitions which positively contributed 1 percentage point to the net revenue performance. The 53 rd reporting week in 2016 negatively impacted net revenue performance by 1 percentage point. Volume decreased 3.5%, driven by a 5% decline in CSD volume and a 1% decline in non-carbonated beverage volume. The non-carbonated beverage volume decrease primarily reflected mid-single-digit declines in Gatorade sports drinks and in our juice and juice drinks portfolio, partially offset by a mid-single-digit increase in our overall water portfolio and a low-single-digit increase in Lipton ready-to-drink teas. Acquisitions had a nominal positive contribution to the volume performance. The 53 rd reporting week in 2016 negatively impacted volume performance by 1.5 percentage points. Operating profit decreased 8%, primarily reflecting certain operating cost increases, the net revenue performance and a 2-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings and lower advertising and marketing expenses. Costs related to the hurricanes that occurred in 2017 negatively impacted operating profit performance by 1 percentage point and were offset by a gain associated with a sale of an asset. In addition, the 53 rd reporting week in 2016 negatively impacted operating profit performance by 1 percentage point and was offset by incremental investments in our business in 2016. Latin America % Change 2017 (a) 2016 (a) Net revenue $ 7,354 $ 7,208 $ 6,820 Impact of foreign exchange translation (1 ) Impact of acquisitions and divestitures 0.5 Organic revenue growth (b) (d) Operating profit $ 1,049 $ $ Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 1,089 $ $ Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 2%, reflecting effective net pricing, partially offset by a 6-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, reflecting low-single-digit growth in Mexico, partially offset by a mid-single-digit decline in Brazil. Beverage volume declined 1%, reflecting a high-single-digit decline in Brazil, a low-single-digit decline in Mexico and a mid-single-digit decline in Argentina, partially offset by double-digit growth in Colombia, mid-single-digit growth in Guatemala and low-single-digit growth in Honduras. Operating profit increased 13%, reflecting the net revenue growth, productivity savings and a 4-percentage-point impact of insurance settlement recoveries related to the 2017 earthquake in Mexico. These impacts were partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. 2017 Net revenue increased 6%, reflecting effective net pricing, partially offset by volume declines. Favorable foreign exchange contributed 1 percentage point to net revenue growth. Snacks volume declined 1.5%, reflecting low-single-digit declines in Brazil and Mexico. Beverage volume declined 2%, reflecting a mid-single-digit decline in Brazil and a low-single-digit decline in Argentina, partially offset by high-single-digit growth in Guatemala. Additionally, Mexico experienced a slight decline. Operating profit increased 2%, reflecting the effective net pricing and productivity savings. These impacts were partially offset by certain operating cost increases, the volume declines and a 16-percentage-point impact of higher commodity costs. Higher restructuring and impairment charges reduced operating profit growth by 3 percentage points. Europe Sub-Saharan Africa % Change 2017 (a) 2016 (a) Net revenue $ 11,523 $ 11,050 $ 10,216 Impact of foreign exchange translation (3 ) Impact of acquisitions and divestitures Impact of sales and certain other taxes (b) 0.5 Impact of 53 rd reporting week Organic revenue growth (b) (d) (d) Operating profit $ 1,364 $ 1,316 $ 1,061 Restructuring and impairment charges (c) Merger and integration charges (c) Operating profit excluding above items (b) $ 1,484 $ 1,369 $ 1,121 Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue increased 4%, reflecting volume growth and effective net pricing, partially offset by a 2-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 3%, reflecting mid-single-digit growth in the Netherlands, partially offset by low-single-digit declines in the United Kingdom and South Africa. Additionally, Russia and Turkey experienced low-single-digit growth. Beverage volume grew 7%, reflecting double-digit growth in Germany and Poland and high-single-digit growth in France and Nigeria, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Russia and Turkey experienced mid-single-digit growth. Operating profit increased 4%, reflecting the net revenue growth, productivity savings and a 4-percentage-point net impact of refranchising our entire beverage bottling operations and snack distribution operations in CHS. These impacts were partially offset by certain operating cost increases and an 8-percentage-point impact of higher commodity costs. Additionally, a prior-year gain on the sale of our minority stake in Britvic and the merger and integration charges related to our acquisition of SodaStream reduced operating profit growth by 7 percentage points and 4 percentage points, respectively. 2017 Net revenue increased 8%, reflecting volume growth and effective net pricing, as well as favorable foreign exchange, which contributed 3 percentage points to net revenue growth. Snacks volume grew 5%, reflecting high-single-digit growth in Russia, partially offset by a slight decline in the United Kingdom and a low-single-digit decline in Spain. Additionally, Turkey, South Africa and the Netherlands experienced mid-single-digit growth. Beverage volume grew 1%, reflecting mid-single-digit growth in Poland and Nigeria and low-single-digit growth in Turkey and France, partially offset by mid-single-digit declines in Russia and Germany, and a low-single-digit decline in the United Kingdom. Operating profit increased 24%, reflecting the net revenue growth and productivity savings. Additionally, a gain on the sale of our minority stake in Britvic in 2017 contributed 8 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, higher advertising and marketing expenses and a 7-percentage-point impact of higher commodity costs. Asia, Middle East and North Africa % Change Net revenue $ 5,901 $ 6,030 $ 6,338 (2 ) (5 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of sales and certain other taxes (a) Organic revenue growth (a) Operating profit $ 1,172 $ 1,073 $ Restructuring and impairment charges (b) (3 ) Charge related to the transaction with Tingyi (b) Operating profit excluding above items (a) $ 1,200 $ 1,070 $ 1,006 Impact of foreign exchange translation (1 ) Operating profit growth excluding above items, on a constant currency basis (a) (c) (a) See Non-GAAP Measures. (b) See Items Affecting Comparability. (c) Does not sum due to rounding. 2018 Net revenue declined 2%, reflecting an 8-percentage-point impact of refranchising a portion of our beverage businesses in Thailand in 2018 and Jordan in 2017, partially offset by net volume growth and effective net pricing. Snacks volume grew 5%, reflecting double-digit growth in India, China and Pakistan, partially offset by a mid-single-digit decline in the Middle East. Additionally, Australia experienced low-single-digit growth. Beverage volume declined slightly, reflecting a mid-single-digit decline in the Middle East and a double-digit decline in the Philippines, partially offset by double-digit growth in Vietnam, mid-single-digit growth in India and low-single-digit growth in Pakistan and China. Operating profit grew 9%, primarily reflecting the effective net pricing, productivity savings and the net volume growth, partially offset by certain operating cost increases, higher advertising and marketing expenses and a 4-percentage-point impact of higher commodity costs. The net impact of refranchising a portion of our beverage business in Thailand in 2018 contributed 13 percentage points to operating profit growth and was offset by a 16-percentage-point negative impact of the prior year refranchising of a portion of our beverage business in Jordan. 2017 Net revenue decreased 5%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 10 percentage points, primarily driven by a weak Egyptian pound. This impact was partially offset by effective net pricing. Snacks volume grew 5%, driven by high-single-digit growth in China and India and double-digit growth in Pakistan. Additionally, the Middle East experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume declined 1%, reflecting a double-digit decline in India and a mid-single-digit decline in the Middle East, partially offset by mid-single-digit growth in China, high-single-digit growth in Pakistan and low-single-digit growth in the Philippines. Operating profit improvement primarily reflected a 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value. The effective net pricing and productivity savings also increased operating profit growth. Additionally, the impact of refranchising a portion of our beverage business in Jordan contributed 14 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and a 32-percentage-point impact of higher commodity costs, primarily due to transaction-related foreign exchange on raw material purchases driven by the weak Egyptian pound. Unfavorable foreign exchange translation reduced operating profit growth by 8 percentage points. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments, debt repayments and transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper and long-term debt and cash, cash equivalents and short-term investments. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our credit facilities. See also Item 1A. Risk Factors and Our Business Risks for further discussion. As of December 29, 2018 , we had cash, cash equivalents, short-term investments and restricted cash in our consolidated subsidiaries of $5.7 billion outside the United States. The restricted cash of approximately $2.0 billion held outside the United States relates to our acquisition of SodaStream. Refer to Note 13 to our consolidated financial statements for further discussion of restricted cash. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 29, 2018, our mandatory transition tax liability is $3.8 billion. Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026. See Credit Facilities and Long-Term Contractual Commitments. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, this amount is based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amount in future periods. The IRS issued additional guidance in the first quarter of 2019 and we are currently evaluating the impact of this guidance. In connection with the TCJ Act, during 2018 we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. The repatriated cash was used primarily for repayment of commercial paper and to fund discretionary benefit plan contributions, debt repayments, dividend payments, share repurchases and our acquisition of SodaStream. See Item 1A. Risk Factors, Our Business Risks, Items Affecting Comparability, Our Critical Accounting Policies, as well as Note 5 to our consolidated financial statements. As of December 29, 2018 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,415 $ 10,030 $ 10,663 Net cash provided by/(used for) investing activities $ 4,564 $ (4,403 ) $ (7,150 ) Net cash used for financing activities $ (13,769 ) $ (4,186 ) $ (3,211 ) Operating Activities During 2018 , net cash provided by operating activities was $9.4 billion , compared to $10.0 billion in the prior year. The operating cash flow performance primarily reflects the discretionary contributions of $1.5 billion to our pension and retiree medical plans in the current year, partially offset by lower net cash tax payments in the current year. During 2017 , net cash provided by operating activities was $10 billion , compared to $10.7 billion in 2016. The operating cash flow performance primarily reflects unfavorable working capital comparisons to 2016. This decrease is mainly due to higher current year payments to vendors and customers, coupled with higher net cash tax payments in 2017, partially offset by lower pension and retiree medical plan contributions in 2017. See Note 7 to our consolidated financial statements for further discussion of pension contributions. Investing Activities During 2018 , net cash provided by investing activities was $4.6 billion , primarily reflecting net maturities and sales of debt securities with maturities greater than three months of $8.7 billion, partially offset by net capital spending of $3.1 billion and $1.2 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of SodaStream. During 2017 , net cash used for investing activities was $4.4 billion , primarily reflecting net capital spending of $2.8 billion and net purchases of debt securities with maturities greater than three months of $1.9 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2019 net capital spending to be approximately $4.5 billion . Financing Activities During 2018 , net cash used for financing activities was $13.8 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.9 billion, payments of long-term debt borrowings of $4.0 billion, cash tender and exchange offers of $1.6 billion and net payments of short-term borrowings of $1.4 billion. During 2017 , net cash used for financing activities was $4.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5 billion and net payments of short-term borrowings of $1.1 billion, partially offset by net proceeds from long-term debt of $3.1 billion and proceeds from exercises of stock options of $0.5 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 11, 2015, we announced a share repurchase program providing for the repurchase of up to $12.0 billion of PepsiCo common stock which commenced on July 1, 2015 and expired on June 30, 2018 (2015 share repurchase program). The 2015 share repurchase program had approximately $4.3 billion of authorized repurchase capacity unused at expiration. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. On February 15, 2019, we announced a 3% increase in our annualized dividend to $3.82 per share from $3.71 per share, effective with the dividend expected to be paid in June 2019. We expect to return a total of approximately $8 billion to shareholders in 2019 through share repurchases of approximately $3 billion and dividends of approximately $5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,415 $ 10,030 $ 10,663 (6 ) (6 ) Capital spending (3,282 ) (2,969 ) (3,040 ) Sales of property, plant and equipment Free cash flow (a) $ 6,267 $ 7,241 $ 7,722 (13 ) (6 ) (a) See Non-GAAP Measures. In addition, when evaluating free cash flow, we also consider the following items impacting comparability: $1.5 billion , $6 million and $459 million in discretionary pension and retiree medical contributions and associated net cash tax benefits of $473 million, $1 million and $151 million in 2018, 2017 and 2016, respectively; $266 million , $113 million and $125 million of payments related to restructuring charges and associated net cash tax benefits of $45 million , $30 million and $22 million in 2018, 2017 and 2016, respectively; tax payments related to the TCJ Act of $115 million in 2018; certain other items of $47 million in 2018; net cash tax benefit related to debt redemption charge of $83 million in 2016; and net cash received related to interest rate swaps of $5 million in 2016. We will also consider payments related to the transition tax liability of $3.8 billion as of December 29, 2018, which we currently expect to be paid over the period 2019 to 2026 under the provisions of the TCJ Act, as an item impacting comparability. We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2020 2022 2024 and beyond Long-term debt obligations (b) $ 28,351 $ $ 7,166 $ 5,093 $ 16,092 Interest on debt obligations (c) 11,157 1,044 1,759 1,322 7,032 Operating leases (d) 1,840 Purchasing commitments (e) 2,602 1,221 Marketing commitments (e) 1,686 $ 45,636 $ 2,937 $ 11,642 $ 7,272 $ 23,785 (a) Based on year-end foreign exchange rates. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. However, under the provisions of the TCJ Act, our transition tax liability of $3.8 billion, of which $3.4 billion is recorded in other liabilities on our balance sheet, must be paid over eight years. We expect to pay approximately $0.4 billion in 2019, $0.3 billion per year in 2020-2023, $0.6 billion in 2024, $0.7 billion in 2025 and $0.9 billion in 2026 and these amounts are excluded from the table above. (b) Excludes $3,953 million related to current maturities of debt, $56 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $119 million related to unamortized net discounts. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 29, 2018 . (d) See Note 15 to our consolidated financial statements for additional information on operating leases. (e) Primarily reflects non-cancelable commitments as of December 29, 2018 . Long-term contractual commitments, except for our long-term debt obligations and transition tax liability, are generally not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges, orange juice and certain other commodities. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in our long-term contractual commitments. See Note 7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo $ 12,515 (a) $ 4,857 (a) $ 6,329 Interest expense 1,525 1,151 1,342 Tax on interest expense (339 ) (415 ) (483 ) $ 13,701 $ 5,593 $ 7,188 Average debt obligations (b) $ 38,169 $ 38,707 $ 35,308 Average common shareholders equity (c) 11,368 12,004 11,943 Average invested capital $ 49,537 $ 50,711 $ 47,251 Return on invested capital 27.7 % (a) 11.0 % (a) 15.2 % (a) Our fiscal 2018 results include other net tax benefits related to the reorganization of our international operations. Our fiscal 2018 and 2017 results include the impact of the TCJ Act. See Note 5 to our consolidated financial statements. (b) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (c) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 27.7 % 11.0 % 15.2 % Impact of: Average cash, cash equivalents and short-term investments 7.8 7.6 6.0 Interest income (0.6 ) (0.5 ) (0.2 ) Tax on interest income 0.1 0.2 0.1 Mark-to-market net impact 0.2 (0.2 ) Restructuring and impairment charges 0.4 0.3 0.1 Merger and integration charges 0.1 Net tax (benefit)/expense related to the TCJ Act (1.1 ) 4.5 Other net tax benefits (9.7 ) 0.1 0.1 Charges related to cash tender and exchange offers (0.1 ) Charges related to the transaction with Tingyi (0.1 ) 0.6 Pension-related settlement charge 0.3 Venezuela impairment charges (0.2 ) (0.5 ) Net ROIC, excluding items affecting comparability 24.8 % 22.9 % 21.5 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. See Note 2 to our consolidated financial statements for additional information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ($1.70 per share) in the fourth quarter of 2017. Included in the provisional net tax expense of $2.5 billion recognized in 2017 is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act and reflected in our provision for income taxes. During 2018, we recognized a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act. See further information in Items Affecting Comparability. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. As a result of the TCJ Act, we currently expect our annual tax rate, excluding items affecting comparability, in percentage terms, to be in the low twenties in 2019. However, we continue to evaluate the impact of the TCJ Act on our annual tax rate due to certain provisions, such as the global intangible low-tax income (GILTI) provision, which may impact our tax rate in future years. In 2018 , our annual tax rate was (36.7)% compared to 48.9% in 2017 , as discussed in Other Consolidated Results. The tax rate decreased 85.6 percentage points compared to 2017, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2016, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the combination of two plans effective December 31, 2016, and the spinoff of a portion of the combined plan into a pre-existing plan effective January 1, 2017. The benefits offered to the plans participants were unchanged. The result of the reorganization was the creation of Plan A and the PepsiCo Employees Retirement Plan I (Plan I). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Note 7 to our consolidated financial statements. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 4.4 % 3.7 % 4.3 % Interest cost discount rate 3.9 % 3.2 % 3.5 % Expected rate of return on plan assets 6.8 % 6.9 % 7.2 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 4.3 % 3.6 % 4.0 % Interest cost discount rate 3.8 % 3.0 % 3.2 % Expected rate of return on plan assets 6.6 % 6.5 % 7.5 % Current health care cost trend rate 5.7 % 5.8 % 5.9 % Based on our assumptions, we expect our total pension and retiree medical expense to increase in 2019 primarily driven by the recognition of prior experience losses on return on plan assets, partially offset by the impact of higher discount rates and discretionary plan contributions. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2019 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $42 Expected rate of return $40 Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions except per share amounts) Net Revenue $ 64,661 $ 63,525 $ 62,799 Cost of sales 29,381 28,796 28,222 Gross profit 35,280 34,729 34,577 Selling, general and administrative expenses 25,170 24,453 24,773 Operating Profit 10,110 10,276 9,804 Other pension and retiree medical benefits income/(expense) (19 ) Interest expense (1,525 ) (1,151 ) (1,342 ) Interest income and other Income before income taxes 9,189 9,602 8,553 (Benefit from)/provision for income taxes (See Note 5) (3,370 ) 4,694 2,174 Net income 12,559 4,908 6,379 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 Net Income Attributable to PepsiCo per Common Share Basic $ 8.84 $ 3.40 $ 4.39 Diluted $ 8.78 $ 3.38 $ 4.36 Weighted-average common shares outstanding Basic 1,415 1,425 1,439 Diluted 1,425 1,438 1,452 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Net income $ 12,559 $ 4,908 $ 6,379 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment (1,641 ) 1,109 (302 ) Net change on cash flow hedges (36 ) Net pension and retiree medical adjustments (467 ) (159 ) (316 ) Net change on available-for-sale securities (68 ) (24 ) Other (2,062 ) (596 ) Comprehensive income 10,497 5,770 5,783 Comprehensive income attributable to noncontrolling interests (44 ) (51 ) (54 ) Comprehensive Income Attributable to PepsiCo $ 10,453 $ 5,719 $ 5,729 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Operating Activities Net income $ 12,559 $ 4,908 $ 6,379 Depreciation and amortization 2,399 2,369 2,368 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges (255 ) (113 ) (125 ) Charge related to the transaction with Tingyi Pension and retiree medical plan expenses Pension and retiree medical plan contributions (1,708 ) (220 ) (695 ) Deferred income taxes and other tax charges and credits (531 ) Other net tax benefits related to international reorganizations (4,347 ) Net tax (benefit)/expense related to the TCJ Act (28 ) 2,451 Change in assets and liabilities: Accounts and notes receivable (253 ) (202 ) (349 ) Inventories (174 ) (168 ) (75 ) Prepaid expenses and other current assets Accounts payable and other current liabilities Income taxes payable (338 ) Other, net (256 ) (305 ) Net Cash Provided by Operating Activities 9,415 10,030 10,663 Investing Activities Capital spending (3,282 ) (2,969 ) (3,040 ) Sales of property, plant and equipment Acquisition of SodaStream, net of cash and cash equivalents acquired (1,197 ) Other acquisitions and investments in noncontrolled affiliates (299 ) (61 ) (212 ) Divestitures Short-term investments, by original maturity: More than three months - purchases (5,637 ) (18,385 ) (12,504 ) More than three months - maturities 12,824 15,744 8,399 More than three months - sales 1,498 Three months or less, net Other investing, net Net Cash Provided by/(Used for) Investing Activities 4,564 (4,403 ) (7,150 ) Financing Activities Proceeds from issuances of long-term debt 7,509 7,818 Payments of long-term debt (4,007 ) (4,406 ) (3,105 ) Cash tender and exchange offers/debt redemptions (1,589 ) (2,504 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments (17 ) (128 ) (27 ) Three months or less, net (1,352 ) (1,016 ) 1,505 Cash dividends paid (4,930 ) (4,472 ) (4,227 ) Share repurchases - common (2,000 ) (2,000 ) (3,000 ) Share repurchases - preferred (2 ) (5 ) (7 ) Proceeds from exercises of stock options Withholding tax payments on RSUs, PSUs and PEPunits converted (103 ) (145 ) (130 ) Other financing (53 ) (76 ) (58 ) Net Cash Used for Financing Activities (13,769 ) (4,186 ) (3,211 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash (98 ) (252 ) Net Increase in Cash and Cash Equivalents and Restricted Cash 1,488 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 10,657 9,169 9,119 Cash and Cash Equivalents and Restricted Cash, End of Year $ 10,769 $ 10,657 $ 9,169 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 29, 2018 and December 30, 2017 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 8,721 $ 10,610 Short-term investments 8,900 Restricted cash 1,997 Accounts and notes receivable, net 7,142 7,024 Inventories 3,128 2,947 Prepaid expenses and other current assets 1,546 Total Current Assets 21,893 31,027 Property, Plant and Equipment, net 17,589 17,240 Amortizable Intangible Assets, net 1,644 1,268 Goodwill 14,808 14,744 Other indefinite-lived intangible assets 14,181 12,570 Indefinite-Lived Intangible Assets 28,989 27,314 Investments in Noncontrolled Affiliates 2,409 2,042 Deferred Income Taxes 4,364 Other Assets Total Assets $ 77,648 $ 79,804 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 4,026 $ 5,485 Accounts payable and other current liabilities 18,112 15,017 Total Current Liabilities 22,138 20,502 Long-Term Debt Obligations 28,295 33,796 Deferred Income Taxes 3,499 3,242 Other Liabilities 9,114 11,283 Total Liabilities 63,046 68,823 Commitments and contingencies Preferred Stock, no par value Repurchased Preferred Stock (197 ) PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,409 and 1,420 shares, respectively) Capital in excess of par value 3,953 3,996 Retained earnings 59,947 52,839 Accumulated other comprehensive loss (15,119 ) (13,057 ) Repurchased common stock, in excess of par value (458 and 446 shares, respectively) (34,286 ) (32,757 ) Total PepsiCo Common Shareholders Equity 14,518 11,045 Noncontrolling interests Total Equity 14,602 10,981 Total Liabilities and Equity $ 77,648 $ 79,804 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year 0.8 $ 0.8 $ 0.8 $ Conversion to common stock (0.1 ) (6 ) Retirement of preferred stock (0.7 ) (35 ) Balance, end of year 0.8 0.8 Repurchased Preferred Stock Balance, beginning of year (0.7 ) (197 ) (0.7 ) (192 ) (0.7 ) (186 ) Redemptions (2 ) (5 ) (6 ) Retirement of preferred stock 0.7 Balance, end of year (0.7 ) (197 ) (0.7 ) (192 ) Common Stock Balance, beginning of year 1,420 1,428 1,448 Share issued in connection with preferred stock conversion to common stock Change in repurchased common stock (12 ) (1 ) (8 ) (20 ) Balance, end of year 1,409 1,420 1,428 Capital in Excess of Par Value Balance, beginning of year 3,996 4,091 4,076 Share-based compensation expense Equity issued in connection with preferred stock conversion to common stock Stock option exercises, RSUs, PSUs and PEPunits converted (a) (193 ) (236 ) (138 ) Withholding tax on RSUs, PSUs and PEPunits converted (103 ) (145 ) (130 ) Other (3 ) (4 ) (6 ) Balance, end of year 3,953 3,996 4,091 Retained Earnings Balance, beginning of year 52,839 52,518 50,472 Cumulative effect of accounting changes (145 ) Net income attributable to PepsiCo 12,515 4,857 6,329 Cash dividends declared - common (b) (5,098 ) (4,536 ) (4,282 ) Cash dividends declared - preferred (1 ) Retirement of preferred stock (164 ) Balance, end of year 59,947 52,839 52,518 Accumulated Other Comprehensive Loss Balance, beginning of year (13,057 ) (13,919 ) (13,319 ) Other comprehensive (loss)/income attributable to PepsiCo (2,062 ) (600 ) Balance, end of year (15,119 ) (13,057 ) (13,919 ) Repurchased Common Stock Balance, beginning of year (446 ) (32,757 ) (438 ) (31,468 ) (418 ) (29,185 ) Share repurchases (18 ) (2,000 ) (18 ) (2,000 ) (29 ) (3,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year (458 ) (34,286 ) (446 ) (32,757 ) (438 ) (31,468 ) Total PepsiCo Common Shareholders Equity 14,518 11,045 11,246 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests (49 ) (62 ) (55 ) Currency translation adjustment Other, net (3 ) (1 ) (2 ) Balance, end of year Total Equity $ 14,602 $ 10,981 $ 11,199 (a) Includes total tax benefits of $110 million in 2016. (b) Cash dividends declared per common share were $3.5875 , $3.1675 and $2.96 for 2018, 2017 and 2016, respectively. See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50% or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. Our fiscal 2016 results included an extra week. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. Certain operations in our ESSA segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks (17 weeks for 2016) September, October, November and December See Our Divisions below, and for additional unaudited information on items affecting the comparability of our consolidated results, see further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years financial statements to conform to the current year presentation, including the adoption of the recently issued accounting pronouncements disclosed in Note 2. Our Divisions Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in North America, Mexico, Russia, the United Kingdom and Brazil. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions and are considered our reportable segments. For additional unaudited information on our divisions, see Our Operations contained in Item 1. Business. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: FLNA % % % QFNA % % % NAB % % % Latin America % % % ESSA % % % AMENA % % % Corporate unallocated expenses % % % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit (b) 2018 (a) 2017 (c) 2016 (c) FLNA $ 16,346 $ 15,798 $ 15,549 $ 5,008 $ 4,793 $ 4,612 QFNA 2,465 2,503 2,564 NAB 21,072 20,936 21,312 2,276 2,700 2,947 Latin America 7,354 7,208 6,820 1,049 ESSA 11,523 11,050 10,216 1,364 1,316 1,061 AMENA 5,901 6,030 6,338 1,172 1,073 Total division 64,661 63,525 62,799 11,506 11,446 10,792 Corporate unallocated expenses (1,396 ) (1,170 ) (988 ) $ 64,661 $ 63,525 $ 62,799 $ 10,110 $ 10,276 $ 9,804 (a) Our primary performance obligation is the distribution and sales of beverage products and food and snack products to our customers, each comprising approximately 50% of our consolidated net revenue. Internationally, our Latin America segment is predominantly a food and snack business, ESSAs beverage business and food and snack business are each approximately 50% of the segments net revenue and AMENAs beverage business and food and snack business are approximately 35% and 65% , respectively, of the segments net revenue. Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our NAB and ESSA segments, is approximately 40% of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. See Note 2 for additional information. (b) For further unaudited information on certain items that impacted our financial performance, see Item 6. Selected Financial Data. (c) Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 for additional information. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 6,577 $ 5,979 $ $ $ QFNA NAB 29,878 28,592 Latin America 6,458 4,976 ESSA (a) 17,410 13,556 AMENA 6,433 5,668 Total division 67,626 59,575 3,132 2,883 2,938 Corporate (b) 10,022 20,229 $ 77,648 $ 79,804 $ 3,282 $ 2,969 $ 3,040 (a) In 2018, the change in assets was primarily related to our acquisition of SodaStream. (b) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2018 , the change in assets was primarily due to a decrease in short-term investments and cash and cash equivalents. Refer to the cash flow statement for additional information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA NAB Latin America ESSA AMENA Total division 2,144 2,107 2,120 Corporate $ $ $ $ 2,330 $ 2,301 $ 2,298 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 37,148 $ 36,546 $ 36,732 $ 29,169 $ 28,418 Mexico 3,878 3,650 3,431 1,404 1,205 Russia (b) 3,191 3,232 2,648 3,926 4,708 Canada 2,736 2,691 2,692 2,565 2,739 United Kingdom 1,743 1,650 1,737 Brazil 1,335 1,427 1,305 All other countries (c) 14,630 14,329 14,254 12,169 9,200 $ 64,661 $ 63,525 $ 62,799 $ 50,631 $ 47,864 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. (b) Change in net revenue in 2017 primarily reflects appreciation of the Russian ruble. Change in long-lived assets in 2018 primarily reflects depreciation of the Russian ruble. (c) Change in long-lived assets in 2018 primarily related to our acquisition of SodaStream. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. In addition, upon adoption of the revenue recognition guidance (see subsequent discussion of Recently Issued Accounting Pronouncements - Adopted), we exclude from net revenue and cost of sales, all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2018 , sales to Walmart (including Sams) represented approximately 13% of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $218 million as of December 29, 2018 and $262 million as of December 30, 2017 are included in prepaid expenses and other current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see Our Customers in Item 1. Business. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $4.2 billion in 2018 , $4.1 billion in 2017 and $4.2 billion in 2016 , including advertising expenses of $2.6 billion in 2018 , $2.4 billion in 2017 and $2.5 billion in 2016 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $47 million and $46 million as of December 29, 2018 and December 30, 2017 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $10.5 billion in 2018 , $9.9 billion in 2017 and $9.7 billion in 2016 . Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software projects and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $204 million in 2018 , $224 million in 2017 and $214 million in 2016 . Net capitalized software and development costs were $577 million and $686 million as of December 29, 2018 and December 30, 2017 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional unaudited information on our commitments, see Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $680 million , $737 million and $ 760 million in 2018 , 2017 and 2016 , respectively, and are reported within selling, general and administrative expenses. See Research and Development in Item 1. Business for additional unaudited information about our research and development activities. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment of indefinite lived-intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See also Note 4, and for additional unaudited information on goodwill and other intangible assets, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Financial Instruments Note 9, and for additional unaudited information, see Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or, in limited instances, last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2017, the Financial Accounting Standards Board (FASB) issued guidance to retrospectively present the service cost component of net periodic benefit cost for pension and retiree medical plans along with other compensation costs in operating profit and present the other components of net periodic benefit cost separately below operating profit in the income statement. The guidance also allows only the service cost component of net periodic benefit cost to be eligible for capitalization within inventory or fixed assets on a prospective basis. We adopted the provisions of this guidance retrospectively in the first quarter of 2018, using historical information previously disclosed in our pension and retiree medical benefits footnote as the estimation basis. We also updated our allocation of service costs to our divisions to better approximate actual service cost. The impact from retrospective adoption of this guidance resulted in an increase to cost of sales and selling, general and administrative expenses of $11 million and $222 million , respectively, for the year ended December 30, 2017 and an increase of $13 million and a decrease of $32 million , respectively, for the year ended December 31, 2016. We recorded a corresponding increase of $233 million and decrease of $19 million for the years ended December 30, 2017 and December 31, 2016, respectively, to other pension and retiree medical benefits income/(expense) below operating profit. The (decreases)/increases to operating profit for each division and to corporate unallocated expenses are as follows: 2017 (a) 2016 (b) FLNA $ (30 ) $ (47 ) QFNA (2 ) (4 ) NAB (7 ) (12 ) Latin America ESSA (38 ) (47 ) AMENA Corporate unallocated expenses (172 ) (c) Total $ (233 ) $ (a) Includes restructuring charges of $66 million , including $13 million in our FLNA segment, $2 million in our QFNA segment, $11 million in our NAB segment, $7 million in our Latin America segment and $33 million in corporate unallocated expenses. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. (b) Includes restructuring charges of $5 million , including $1 million in our FLNA segment, $2 million in our NAB segment and $2 million in corporate unallocated expenses. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. (c) Reflects a settlement charge of $242 million related to a group annuity contract purchase. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The changes described above had no impact on our consolidated net revenue, net income or earnings per share. See Note 7 for further information on our service cost and other components of net periodic benefit cost for pension and retiree medical plans. In 2016, the FASB issued guidance to clarify how restricted cash should be presented in the cash flow statement. We adopted the provisions of this guidance retrospectively during the first quarter of 2018; the adoption did not have a material impact on our financial statements and primarily related to collateral posted against our derivative asset or liability positions. See Note 9 and Note 13 for further information. In 2016, the FASB issued guidance that requires companies to account for the income tax effects of intercompany transfers of assets, other than inventory, when the transfer occurs versus deferring income tax effects until the transferred asset is sold to an outside party or otherwise recognized. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have a material impact on our financial statements and we recorded an adjustment of $8 million to beginning retained earnings. In 2016, the FASB issued guidance that requires companies to measure investments in certain equity securities at fair value and recognize any changes in fair value in net income. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have an impact on our financial statements. See Note 9 for further information on our investments in equity securities. In 2014, the FASB issued guidance on revenue recognition, with final amendments issued in 2016. The guidance provides for a five-step model to determine the revenue recognized for the transfer of goods or services to customers that reflects the expected entitled consideration in exchange for those goods or services. It also provides clarification for principal versus agent considerations and identifying performance obligations. In addition, the FASB introduced practical expedients related to disclosures of remaining performance obligations, as well as other amendments related to guidance on collectibility, non-cash consideration and the presentation of sales and other similar taxes. Financial statement disclosures required under the guidance will enable users to understand the nature, amount, timing, judgments and uncertainty of revenue and cash flows relating to customer contracts. The two permitted transition methods under the guidance are the full retrospective approach or a cumulative effect adjustment to the opening retained earnings in the year of adoption (cumulative effect approach). We adopted the guidance applied to all contracts using the cumulative effect approach during the first quarter of 2018; the adoption did not have a material impact on our financial statements. We utilized a comprehensive approach to assess the impact of the guidance on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the new requirements to our revenue contracts, including evaluation of our performance obligations, principal versus agent considerations and variable consideration. We completed our contract and business process reviews and implemented changes to our controls and disclosures under the new guidance. As a result of the implementation of the guidance, which did not have a material impact on our accounting policies upon adoption, in the first quarter of 2018, we recorded an adjustment of $137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition. In addition, we excluded from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions that were not already excluded. The impact of these taxes previously recognized in net revenue and cost of sales was approximately $75 million for the fiscal year ended December 30, 2017, with no impact on operating profit. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2018, the FASB issued guidance related to the TCJ Act for the optional reclassification of the residual tax effects, arising from the change in corporate tax rate, in accumulated other comprehensive loss to retained earnings. The reclassification is the difference between the amount previously recorded in other comprehensive income at the historical U.S. federal tax rate that remains in accumulated other comprehensive loss at the time the TCJ Act was effective and the amount that would have been recorded using the newly enacted rate. If elected, the guidance can be applied retrospectively to each period during which the impact of the TCJ Act is recognized or in the period of adoption. We will adopt the guidance when it becomes effective in the first quarter of 2019, but we are not planning to make the optional reclassification. In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. Under this guidance, certain of our derivatives used to hedge commodity price risk that did not previously qualify for hedge accounting treatment will qualify prospectively. We will adopt the guidance when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements or disclosures. See Note 9 for further information. In 2016, the FASB issued guidance on leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but record expenses in the income statement in a manner similar to current accounting. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The two permitted transition methods under the guidance are the modified retrospective transition approach, which requires application of the guidance for all comparative periods presented, and the cumulative effect adjustment approach, which requires prospective application at the adoption date. We continue to utilize a comprehensive approach to assess the impact of this guidance on our financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. We are substantially complete with our comprehensive review of our lease portfolio including significant leases by geography and by asset type that will be impacted by the new guidance, and enhancing our controls. In addition, we are progressing on the implementation of a new software platform, and corresponding controls, for administering our leases and facilitating compliance with the new guidance. As part of our adoption, we will not reassess historical lease classification, will not recognize short-term leases on our balance sheet, will utilize the portfolio approach to group leases with similar characteristics and will not separate lease and non-lease components for our real estate leases. We will adopt the guidance prospectively when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements, with an expected increase of approximately 2% to each of our total assets and total liabilities on our balance sheet, subject to completion of our assessment. See Note 15 for our minimum lease payments under non-cancelable operating leases. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2019 Productivity Plan $ $ $ 2014 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint. A summary of our 2019 Productivity Plan charges is as follows: Costs of sales $ Selling, general and administrative expenses Other pension and retiree medical benefits expense Total restructuring and impairment charges $ After-tax amount $ Net income attributable to PepsiCo per common share $ 0.08 FLNA $ QFNA NAB Latin America ESSA AMENA Corporate Other pension and retiree medical benefits expense $ A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs (a) Total 2018 restructuring charges $ $ $ $ Non-cash charges and translation (32 ) (32 ) Liability as of December 29, 2018 $ $ $ $ (a) Includes other costs associated with the implementation of our initiatives, including consulting and other professional fees. Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019 . 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, includes the next generation of productivity initiatives that we believe will strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives described above to further strengthen our beverage, food and snack businesses. A summary of our 2014 Productivity Plan charges is as follows: Selling, general and administrative expenses $ $ $ Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ $ After-tax amount $ $ $ Net income attributable to PepsiCo per common share $ 0.10 $ 0.16 $ 0.09 Plan to Date FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA (a) (3 ) Corporate (b) (1 ) $ $ $ $ 1,204 (a) In 2017, income amount primarily reflects a gain on the sale of property, plant and equipment. (b) In 2018, income amount primarily relates to other pension and retiree medical benefits. Severance and Other Employee Costs Asset Impairments Other Costs (a) Total Plan to Date $ $ $ $ 1,204 (a) Includes other costs associated with the implementation of our initiatives, including certain consulting and contract termination costs. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 26, 2015 $ $ $ $ 2016 restructuring charges Cash payments (46 ) (49 ) (95 ) Non-cash charges and translation (15 ) (36 ) (50 ) Liability as of December 31, 2016 2017 restructuring charges (6 ) (a) Cash payments (91 ) (22 ) (113 ) Non-cash charges and translation (65 ) (21 ) (52 ) Liability as of December 30, 2017 2018 restructuring charges Cash payments (b) (203 ) (52 ) (255 ) Non-cash charges and translation (4 ) (28 ) (27 ) Liability as of December 29, 2018 $ $ $ $ (a) Income amount represents adjustments for changes in estimates and a gain on the sale of property, plant, and equipment. (b) Excludes cash expenditures of $11 million reported in the cash flow statement in pension and retiree medical plan contributions. Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019 . Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. See additional unaudited information in Items Affecting Comparability and Results of Operations Division Review in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,078 $ 1,148 Buildings and improvements 15 - 44 8,941 8,796 Machinery and equipment, including fleet and software 5 - 15 27,715 27,018 Construction in progress 2,430 2,144 40,164 39,106 Accumulated depreciation (22,575 ) (21,866 ) $ 17,589 $ 17,240 Depreciation expense $ 2,241 $ 2,227 $ 2,217 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Amortizable intangible assets, net Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights 56 60 $ $ (140 ) $ $ $ (128 ) $ Reacquired franchise rights 5 14 (105 ) (104 ) Brands 20 40 1,306 (1,032 ) 1,322 (1,026 ) Other identifiable intangibles (a) 10 24 (288 ) (281 ) $ 3,209 $ (1,565 ) $ 1,644 $ 2,807 $ (1,539 ) $ 1,268 Amortization expense $ $ $ (a) The change in 2018 is primarily related to our acquisition of SodaStream. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 29, 2018 and using average 2018 foreign exchange rates, is expected to be as follows: 2020 Five-year projected amortization $ $ $ $ $ Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our policies for amortizable brands, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . We recognized no material impairment charges for indefinite-lived intangible assets in each of the fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . As of December 29, 2018 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at NAB exceeded their carrying values. However, there could be an impairment of the carrying value of NABs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of NABs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there were no material impairments for the year ended December 29, 2018 . However, there could be an impairment of the carrying value of certain brands in these countries if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows, if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For additional information on our policies for indefinite-lived intangible assets, see Note 2. The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2017 Translation and Other Balance, End of 2017 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2018 FLNA Goodwill $ $ $ $ $ (11 ) $ Brands (2 ) 293 (13 ) QFNA Goodwill Brands NAB (a) Goodwill 9,843 9,854 (41 ) 9,813 Reacquired franchise rights 7,064 7,126 (68 ) 7,058 Acquired franchise rights 1,512 1,525 (15 ) 1,510 Brands 18,733 18,858 (124 ) 18,734 Latin America Goodwill (46 ) Brands (9 ) (14 ) 703 (7 ) (60 ) ESSA (b) Goodwill 3,177 3,452 (367 ) 3,611 Reacquired franchise rights (1 ) (51 ) Acquired franchise rights (25 ) (9 ) Brands 2,358 2,545 1,993 (350 ) 4,188 6,207 6,741 2,493 (777 ) 8,457 AMENA Goodwill (34 ) Brands (10 ) 515 (44 ) Total goodwill 14,430 14,744 (499 ) 14,808 Total reacquired franchise rights 7,552 7,675 (1 ) (119 ) 7,555 Total acquired franchise rights 1,696 1,720 (25 ) (24 ) 1,671 Total brands 2,948 3,175 2,156 (376 ) 4,955 $ 26,626 $ $ 27,314 $ 2,693 $ (1,018 ) $ 28,989 (a) The change in translation and other in 2018 primarily reflects the depreciation of the Canadian dollar. (b) The change in acquisitions/(divestitures) in 2018 is primarily related to the preliminary allocation of the purchase price for our acquisition of SodaStream. See Note 14 for further information. The change in translation and other in 2018 primarily reflects the depreciation of the Russian ruble, euro and Pound sterling. The change in translation and other in 2017 primarily reflects the appreciation of the Russian ruble and euro. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 3,864 $ 3,452 $ 2,630 Foreign 5,325 6,150 5,923 $ 9,189 $ 9,602 $ 8,553 The (benefit from)/provision for income taxes consisted of the following: Current: U.S. Federal $ $ 4,925 $ 1,219 Foreign State 5,785 2,120 Deferred: U.S. Federal (1,159 ) Foreign (4,379 ) (9 ) (33 ) State (9 ) (22 ) (4,248 ) (1,091 ) $ (3,370 ) $ 4,694 $ 2,174 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 21.0 % 35.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 0.5 0.9 0.4 Lower taxes on foreign results (2.2 ) (9.4 ) (8.0 ) One-time mandatory transition tax - TCJ Act 0.1 41.4 Remeasurement of deferred taxes - TCJ Act (0.4 ) (15.9 ) International reorganizations (47.3 ) Tax settlements (7.8 ) Other, net (0.6 ) (3.1 ) (2.0 ) Annual tax rate (36.7 )% 48.9 % 25.4 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ( $1.70 per share) in the fourth quarter of 2017. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Included in the provisional net tax expense of $2.5 billion recognized in the fourth quarter of 2017, was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. During 2018, we recognized a net tax benefit of $28 million ( $0.02 per share) primarily reflecting the impact of the final analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries, partially offset by additional transition tax guidance issued by the United States Department of Treasury, as well as the TCJ Act impact of both the conclusion of certain international tax audits and the resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, each discussed below. As of December 29, 2018, our mandatory transition tax liability is $ 3.8 billion . Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as GILTI, must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. The provisional measurement period ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. For further unaudited information and discussion, refer to Item 1A. Risk Factors, Our Business Risks, Our Liquidity and Capital Resources and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. International Reorganizations During the fourth quarter of 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ( $3.05 per share). The related deferred tax asset of $4.4 billion is expected to be amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Deferred tax liabilities and assets are comprised of the following: Deferred Tax Liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,303 1,397 Intangible assets other than nondeductible goodwill 3,169 Recapture of net operating losses Other Gross deferred tax liabilities 2,366 5,194 Deferred tax assets Net carryforwards 4,353 1,400 Intangible assets other than nondeductible goodwill Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Other Gross deferred tax assets 6,984 3,115 Valuation allowances (3,753 ) (1,163 ) Deferred tax assets, net 3,231 1,952 Net deferred tax (assets)/liabilities $ (865 ) $ 3,242 A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 1,163 $ 1,110 $ 1,136 Provision 2,639 Other (deductions)/additions (49 ) (39 ) Balance, end of year $ 3,753 $ 1,163 $ 1,110 For additional unaudited information on our income tax policies, including our reserves for income taxes, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2017 2014-2016 Mexico None United Kingdom 2016-2017 None Canada (Domestic) 2014-2017 2014-2015 Canada (International) 2010-2017 2010-2015 Russia 2014-2017 2014-2017 During 2018, we recognized a non-cash tax benefit of $364 million ( $0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, during 2018, we recognized non-cash tax benefits of $353 million ( $0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. For further unaudited information on the impact of the resolution of open tax issues, see Other Consolidated Results in Managements Discussion and Analysis of Financial Condition and Results of Operations. As of December 29, 2018 , the total gross amount of reserves for income taxes, reported in other liabilities, was $1.4 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $179 million as of December 29, 2018 , which reflects a reduction of the prior year liability of $64 million of tax benefit that was recognized in 2018 . The gross amount of interest accrued, reported in other liabilities, was $283 million as of December 30, 2017 , of which $89 million of expense was recognized in 2017 . A reconciliation of unrecognized tax benefits is as follows: Balance, beginning of year $ 2,212 $ 1,885 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years (822 ) (51 ) Settlement payments (233 ) (4 ) Statutes of limitations expiration (42 ) (33 ) Translation and other (14 ) Balance, end of year $ 1,440 $ 2,212 Carryforwards and Allowances Operating loss carryforwards totaling $24.9 billion at year-end 2018 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2 billion in 2019 , $20.5 billion between 2020 and 2038 and $4.2 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In connection with the enactment of the TCJ Act, during 2018, we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. As of December 29, 2018 , we had approximately $24 billion of undistributed international earnings. We intend to continue to reinvest $24 billion of earnings outside the United States for the foreseeable future and while U.S. federal tax expense has been recognized as a result of the TCJ Act, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, restricted stock units (RSUs), performance stock units (PSUs), PepsiCo equity performance units (PEPunits) and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and were granted 66% PSUs and 34% long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 29, 2018 , 66 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense and excess tax benefits recognized: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring and impairment charges (6 ) (2 ) Total $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ $ (a) $ Excess tax benefits related to share-based compensation (b) $ $ $ (a) Reflects tax rates effective for the 2017 tax year. (b) Included in provision for income taxes in the income statement in 2018 and 2017; included in capital in excess of par value in the equity statement in 2016. As of December 29, 2018 , there was $282 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years. Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years. Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 5 years 6 years Risk-free interest rate 2.6 % 2.0 % 1.4 % Expected volatility % % % Expected dividend yield 2.7 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 29, 2018 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 30, 2017 19,013 $ 74.23 Granted 1,429 $ 108.88 Exercised (4,377 ) $ 62.95 Forfeited/expired (476 ) $ 94.85 Outstanding at December 29, 2018 15,589 $ 79.94 4.29 $ 474,746 Exercisable at December 29, 2018 11,547 $ 70.74 2.92 $ 457,529 Expected to vest as of December 29, 2018 3,713 $ 106.02 8.17 $ 16,606 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs is measured at the market price of the Companys stock on the date of grant. The fair value of PSUs is measured at the market price of the Companys stock on the date of grant with the exception of awards with market conditions, for which we use the Monte-Carlo simulation model to determine the fair value. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. A summary of our RSU and PSU activity for the year ended December 29, 2018 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 30, 2017 7,293 $ 102.30 Granted (b) 2,634 $ 108.75 Converted (2,362 ) $ 99.73 Forfeited (647 ) $ 105.21 Actual performance change (c) $ 98.92 Outstanding at December 29, 2018 (d) 7,175 $ 105.13 1.22 $ 791,878 Expected to vest as of December 29, 2018 6,667 $ 104.90 1.15 $ 735,813 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 29, 2018 , at the threshold, target and maximum award levels were zero , 0.9 million and 1.6 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three -year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model. PEPunits were last granted in 2015 and all 248,000 units outstanding at December 30, 2017, with a weighted average grant date fair value of $68.94 , were converted to 278,000 shares during fiscal year 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model until actual performance is determined. A summary of our long-term cash activity for the year ended December 29, 2018 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 30, 2017 $ 33,200 Granted (b) 20,926 Forfeited (2,292 ) Actual performance change (c) 2,876 Outstanding at December 29, 2018 (d) $ 54,710 $ 55,809 1.22 Expected to vest as of December 29, 2018 $ 51,159 $ 52,148 1.17 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Reflects the net number of long-term cash awards above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding long-term cash awards for which the performance period has not ended as of December 29, 2018, at the threshold, target and maximum award levels were zero , 37.3 million and 74.5 million, respectively. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,429 1,481 1,743 Weighted-average grant-date fair value of options granted $ 9.80 $ 8.25 $ 6.94 Total intrinsic value of options exercised (a) $ 224,663 $ 327,860 $ 290,131 Total grant-date fair value of options vested (a) $ 15,506 $ 23,122 $ 18,840 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,634 2,824 3,054 Weighted-average grant-date fair value of RSUs/PSUs granted $ 108.75 $ 109.92 $ 99.06 Total intrinsic value of RSUs/PSUs converted (a) $ 260,287 $ 380,269 $ 359,401 Total grant-date fair value of RSUs/PSUs vested (a) $ 232,141 $ 264,923 $ 257,648 PEPunits Total intrinsic value of PEPunits converted (a) $ 30,147 $ 39,782 $ 38,558 Total grant-date fair value of PEPunits vested (a) $ 9,430 $ 18,833 $ 16,572 (a) In thousands. As of December 29, 2018 and December 30, 2017 , there were approximately 248,000 and 250,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ( $162 million after-tax or $0.11 per share). See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in other pension and retiree medical benefits income/(expense) for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years) and retiree medical (approximately 7 years), or the remaining life expectancy for participants in Plan I (approximately 25 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits income/(expense) on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 14,777 $ 13,192 $ 3,490 $ 3,124 $ 1,187 $ 1,208 Service cost Interest cost Plan amendments (5 ) Participant contributions Experience (gain)/loss (972 ) 1,529 (230 ) (147 ) Benefit payments (956 ) (825 ) (114 ) (104 ) (108 ) (107 ) Settlement/curtailment (74 ) (58 ) (35 ) (22 ) Special termination benefits Other, including foreign currency adjustment (204 ) (3 ) Liability at end of year $ 13,807 $ 14,777 $ 3,098 $ 3,490 $ $ 1,187 Change in fair value of plan assets Fair value at beginning of year $ 12,582 $ 11,458 $ 3,460 $ 2,894 $ $ Actual return on plan assets (789 ) 1,935 (136 ) (21 ) Employer contributions/funding 1,495 Participant contributions Benefit payments (956 ) (825 ) (114 ) (104 ) (108 ) (107 ) Settlement (74 ) (46 ) (32 ) (18 ) Other, including foreign currency adjustment (210 ) Fair value at end of year $ 12,258 $ 12,582 $ 3,090 $ 3,460 $ $ Funded status $ (1,549 ) $ (2,195 ) $ (8 ) $ (30 ) $ (711 ) $ (866 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities (107 ) (74 ) (1 ) (1 ) (41 ) (75 ) Other liabilities (1,627 ) (2,407 ) (88 ) (114 ) (670 ) (791 ) Net amount recognized $ (1,549 ) $ (2,195 ) $ (8 ) $ (30 ) $ (711 ) $ (866 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 4,093 $ 3,520 $ $ $ (287 ) $ (189 ) Prior service cost/(credit) (1 ) (3 ) (51 ) (71 ) Total $ 4,202 $ 3,549 $ $ $ (338 ) $ (260 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ $ $ $ (115 ) $ (107 ) $ (9 ) Amortization and settlement recognition (187 ) (131 ) (56 ) (60 ) Foreign currency translation (gain)/loss (49 ) Total $ $ $ (2 ) $ (102 ) $ (98 ) $ Accumulated benefit obligation at end of year $ 12,890 $ 13,732 $ 2,806 $ 2,985 The net loss/(gain) arising in the current year is attributed to actual asset returns different from expected returns, partially offset by the change in discount rate. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (943 ) (849 ) (834 ) (197 ) (176 ) (163 ) (19 ) (22 ) (24 ) Amortization of prior service cost/(credits) (1 ) (20 ) (25 ) (38 ) Amortization of net losses/(gains) (8 ) (12 ) (1 ) Settlement/curtailment losses/(gain) (a) (14 ) Special termination benefits Total $ $ $ $ $ $ $ $ $ (4 ) (a) U.S. includes a settlement charge of $ 242 million related to the group annuity contract purchase in 2016. See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The following table provides the weighted-average assumptions used to determine projected benefit liability and net periodic benefit cost for our pension and retiree medical plans: Pension Retiree Medical U.S. International Liability discount rate 4.4 % 3.7 % 4.4 % 3.4 % 3.0 % 3.1 % 4.2 % 3.5 % 4.0 % Service cost discount rate 3.8 % 4.5 % 4.6 % 3.5 % 3.6 % 4.1 % 3.6 % 4.0 % 4.3 % Interest cost discount rate 3.4 % 3.7 % 3.8 % 2.8 % 2.8 % 3.5 % 3.0 % 3.2 % 3.3 % Expected return on plan assets 7.2 % 7.5 % 7.5 % 6.0 % 6.0 % 6.2 % 6.5 % 7.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.7 % 3.6 % Expense rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.6 % 3.6 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ (8,040 ) $ (8,355 ) $ (155 ) $ (161 ) Fair value of plan assets $ 7,223 $ 6,919 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ (8,957 ) $ (9,400 ) $ (514 ) $ (1,273 ) $ (996 ) $ (1,187 ) Fair value of plan assets $ 7,223 $ 6,919 $ $ 1,158 $ $ Of the total projected pension benefit liability as of December 29, 2018 , approximately $830 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2024 - 2028 Pension $ 1,060 $ $ $ $ $ 5,265 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2019 through 2023 and approximately $6 million in total for 2024 through 2028. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ 1,417 $ $ $ $ $ Non-discretionary Total $ 1,615 $ $ $ $ $ (a) Includes $1.4 billion contribution in 2018 to fund Plan A in the United States. Includes $ 452 million in 2016 relating to the funding of the group annuity contract purchase from an unrelated insurance company. In January 2019, we made discretionary contributions of $ 150 million to Plan A in the United States. In addition, in 2019, we expect to make non-discretionary contributions of approximately $205 million to our U.S. and international pension benefit plans and approximately $40 million for retiree medical benefits. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2019 and 2018 , our expected long-term rate of return on U.S. plan assets is 7.1% and 7.2% , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five -year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of fiscal year-end 2018 and 2017 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 5,605 $ 5,595 $ $ $ 6,904 Government securities (c) 1,674 1,674 1,365 Corporate bonds (c) 4,145 4,145 3,429 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 11,860 $ 5,810 $ 6,041 $ 12,159 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 12,543 $ 12,903 International plan assets Equity securities (b) $ 1,651 $ 1,621 $ $ $ 1,928 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 2,981 $ 2,004 $ $ 3,351 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,090 $ 3,460 (a) 2018 and 2017 amounts include $285 million and $ 321 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The U.S. commingled funds are based on fair values of the investments owned by these funds that are benchmarked against various U.S. large, mid-cap and small company indices, and includes one large-cap fund that represents 15% and 19% of total U.S. plan assets for 2018 and 2017 , respectively. The international commingled funds are based on the fair values of the investments owned by these funds that track various non-U.S. equity indices. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 28% and 23% of total U.S. plan assets for 2018 and 2017 , respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 29, 2018 and December 30, 2017. (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase 111 These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2018 , 2017 and 2016 , our total Company contributions were $180 million , $176 million and $164 million , respectively. For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 8 Debt Obligations The following table summarizes the Companys debt obligations: 2018 (a) 2017 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,953 $ 4,020 Commercial paper (1.3%) 1,385 Other borrowings (6.0% and 4.7%) $ 4,026 $ 5,485 Long-term debt obligations (b) Notes due 2018 (2.4%) $ $ 4,016 Notes due 2019 (3.1% and 2.1%) 3,948 3,933 Notes due 2020 (3.9% and 3.1%) 3,784 3,792 Notes due 2021 (3.1% and 2.4%) 3,257 3,300 Notes due 2022 (2.8% and 2.6%) 3,802 3,853 Notes due 2023 (2.9% and 2.4%) 1,270 1,257 Notes due 2024-2047 (3.7% and 3.8%) 16,161 17,634 Other, due 2018-2026 (1.3% and 1.3%) 32,248 37,816 Less: current maturities of long-term debt obligations (3,953 ) (4,020 ) Total $ 28,295 $ 33,796 (a) Amounts are shown net of unamortized net discounts of $119 million and $155 million for 2018 and 2017, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for additional information regarding our interest rate derivative instruments. As of December 29, 2018 , our international debt of $62 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2018 , we completed a cash tender offer for certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $1.6 billion in cash to redeem the following amounts: Interest Rate Maturity Date Amount Tendered 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ 4.875 % November 2040 $ 5.500 % January 2040 $ We also completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for the following newly issued PepsiCo notes. These notes were issued in an aggregate principal amount equal to the exchanged notes: Interest Rate Maturity Date Amount 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $253 million ( $191 million after-tax or $0.13 per share) to interest expense, primarily representing the tender price paid over the carrying value of the tendered notes. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2018, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 4, 2023. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Also in 2018, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 3, 2019. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $3.75 billion five-year credit agreement and our $3.75 billion 364-day credit agreement, both dated as of June 5, 2017. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 29, 2018 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million , respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ( $156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. See Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our borrowings and long-term contractual commitments. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for energy, agricultural products and metals . Ineffectiveness for those derivatives that qualify for hedge accounting treatment was not material for all periods presented. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017 . Foreign Exchange Our operations outside of the United States generated 43% of our net revenue in 2018 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2018 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017 . The total notional amount of our debt instruments designated as net investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017 . Ineffectiveness for derivatives and non-derivatives that qualify for hedge accounting treatment was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017 . Ineffectiveness for derivatives that qualify for cash flow hedge accounting treatment was not material for all periods presented. As of December 29, 2018 , approximately 29% of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 43% as of December 30, 2017 . Available-for-Sale Securities Investments in debt securities are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale debt securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 29, 2018 and December 30, 2017 were not material. Changes in the fair value of available-for-sale debt securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We regularly review our investment portfolio to determine if any debt security is other-than-temporarily impaired. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a debt security is less than its cost; the financial condition of the issuer and any changes thereto; and our intent to sell, or whether we will more likely than not be required to sell, the debt security before recovery of its amortized cost basis. Our assessment of whether a debt security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular debt security. We recorded no other-than-temporary impairment charges on our available-for-sale debt securities for the years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . In 2017, we recorded a pre-tax gain of $95 million ( $85 million after-tax or $0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. The gain on the sale of this equity investment was recorded in our ESSA segment in selling, general and administrative expenses. See Note 2 for additional information on investments in certain equity securities. KSF Beverage Holding Co., Ltd. During 2016, we concluded that the decline in estimated fair value of our 5% indirect equity interest in KSFB was other than temporary based on significant negative economic trends in China and changes in assumptions associated with KSFBs future financial performance arising from the disclosure by KSFBs parent company, Tingyi, regarding the operating results of its beverage business. As a result, we recorded a pre- and after-tax impairment charge of $373 million ( $0.26 per share) in 2016 in the AMENA segment. This charge was recorded in selling, general and administrative expenses on our income statement and reduced the value of our 5% indirect equity interest in KSFB to its estimated fair value. The estimated fair value was derived using both an income and market approach, and is considered a non-recurring Level 3 measurement within the fair value hierarchy. The carrying value of the investment in KSFB was $166 million as of December 29, 2018 and December 30, 2017 . We continue to monitor the impact of economic and other developments on the remaining value of our investment in KSFB. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Fair Value Measurements The fair values of our financial assets and liabilities as of December 29, 2018 and December 30, 2017 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale debt securities (b) $ 3,658 $ $ 14,510 $ Short-term investments (c) $ $ $ $ Prepaid forward contracts (d) $ $ $ $ Deferred compensation (e) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) $ $ $ $ Interest rate (g) Commodity (h) Commodity (i) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (g) $ $ $ $ Commodity (h) Commodity (i) $ $ $ $ Total derivatives at fair value (j) $ $ $ $ Total $ 3,931 $ 1,018 $ 14,901 $ (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 29, 2018 , these debt securities were primarily classified as cash equivalents. As of December 30, 2017 , $5.8 billion and $8.7 billion of debt securities were classified as cash equivalents and short-term investments, respectively. The decrease primarily reflects net maturities and sales of debt securities with maturities greater than three months. Refer to the cash flow statement and Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further discussion on use of these proceeds. (c) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (d) Based primarily on the price of our common stock. (e) Based on the fair value of investments corresponding to employees investment elections. (f) Based on LIBOR forward rates. (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 29, 2018 and December 30, 2017 were not material. Collateral received or posted against any of our asset or liability positions were not material. Collateral posted is classified as restricted cash. See Note 13 for further information. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 29, 2018 and December 30, 2017 was $32 billion and $41 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ $ (15 ) $ (52 ) $ $ (8 ) $ Interest rate (195 ) (184 ) Commodity (48 ) Net investment (77 ) Total $ $ $ (16 ) $ $ $ (171 ) (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net gains of $5 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 Preferred shares: Dividends (1 ) Redemption premium (2 ) (4 ) (5 ) Net income available for PepsiCo common shareholders $ 12,513 1,415 $ 4,853 1,425 $ 6,323 1,439 Basic net income attributable to PepsiCo per common share $ 8.84 $ 3.40 $ 4.39 Net income available for PepsiCo common shareholders $ 12,513 1,415 $ 4,853 1,425 $ 6,323 1,439 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other Employee stock ownership plan (ESOP) convertible preferred stock Diluted $ 12,515 1,425 $ 4,857 1,438 $ 6,329 1,452 Diluted net income attributable to PepsiCo per common share $ 8.78 $ 3.38 $ 4.36 (a) Weighted-average common shares outstanding (in millions). Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.7 0.4 0.7 Average exercise price per option $ 109.83 $ 110.12 $ 99.98 (a) In millions. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock at the conversion ratio set forth in Exhibit A to our amended and restated articles of incorporation. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. As of December 30, 2017 , there were 3 million shares of convertible preferred stock authorized, 803,953 preferred shares issued and 114,753 shares outstanding. The outstanding preferred shares had a fair value of $68 million as of December 30, 2017 . Activities of our preferred stock are included in the equity statement. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 26, 2015 (a) $ (11,080 ) $ $ (2,329 ) $ $ (35 ) $ (13,319 ) Other comprehensive (loss)/income before reclassifications (313 ) (74 ) (750 ) (43 ) (1,180 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income (313 ) (343 ) (43 ) (623 ) Tax amounts (30 ) Balance as of December 31, 2016 (a) (11,386 ) (2,645 ) (35 ) (13,919 ) Other comprehensive (loss)/income before reclassifications (b) 1,049 (375 ) Amounts reclassified from accumulated other comprehensive loss (171 ) (99 ) (112 ) Net other comprehensive (loss)/income 1,049 (41 ) (217 ) (74 ) Tax amounts Balance as of December 30, 2017 (a) (10,277 ) (2,804 ) (4 ) (19 ) (13,057 ) Other comprehensive (loss)/income before reclassifications (c) (1,664 ) (61 ) (813 ) (2,532 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income (1,620 ) (595 ) (2,159 ) Tax amounts (21 ) (10 ) Balance as of December 29, 2018 (a) $ (11,918 ) $ $ (3,271 ) $ $ (19 ) $ (15,119 ) (a) Pension and retiree medical amounts are net of taxes of $1,253 million as of December 26, 2015, $1,280 million as of December 31, 2016, $1,338 million as of December 30, 2017 and $1,466 million as of December 29, 2018. (b) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. (c) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Divestitures $ $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ (1 ) $ $ Net revenue Foreign exchange contracts (7 ) (46 ) Cost of sales Interest rate derivatives (184 ) Interest expense Commodity contracts Cost of sales Commodity contracts (3 ) (1 ) Selling, general and administrative expenses Net losses/(gains) before tax (171 ) Tax amounts (27 ) (63 ) Net losses/(gains) after tax $ $ (107 ) $ Pension and retiree medical items: Amortization of net prior service credit $ (17 ) $ (24 ) $ (39 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses Other pension and retiree medical benefits income/(expense) Settlement/curtailment Other pension and retiree medical benefits income/(expense) Net losses before tax Tax amounts (45 ) (44 ) (144 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ $ (99 ) $ Selling, general and administrative expenses Tax amount Net gain after tax $ $ (89 ) $ Total net losses/(gains) reclassified for the year, net of tax $ $ (82 ) $ Note 13 Restricted Cash The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. Cash and cash equivalents $ 8,721 $ 10,610 Restricted cash (a) 1,997 Restricted cash included in other assets (b) Total cash and cash equivalents and restricted cash $ 10,769 $ 10,657 (a) Represents consideration held by our paying agent in connection with our acquisition of SodaStream. (b) Restricted cash included in other assets primarily relates to collateral posted against our derivative asset or liability positions. Note 14 Acquisitions and Divestitures Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $144.00 per share in cash, in a transaction valued at approximately $3.3 billion . The total consideration transferred was approximately $3.3 billion (or $3.2 billion , net of cash and cash equivalents acquired), including $2.0 billion of consideration held by our paying agent in connection with this acquisition and reported as restricted cash as of December 29, 2018. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The preliminary estimates of the fair value of the identifiable assets acquired and liabilities assumed in SodaStream as of the acquisition date include goodwill and other intangible assets of $3.0 billion and property, plant and equipment of $0.2 billion , all of which are recorded in our ESSA segment. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values discussed above as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the end of 2019. Under the guidance on accounting for business combinations, merger and integration costs are not included as components of consideration transferred but are accounted for as expenses in the period in which the costs are incurred. In 2018, we incurred merger and integration charges of $75 million ( $0.05 per share), including $57 million in our ESSA segment and $18 million in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs and were recorded in selling, general and administrative expenses. See Item 6. Selected Financial Data and Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $144 million ( $126 million after-tax or $0.09 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Refranchising in Czech Republic, Hungary, and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in CHS (included within our ESSA segment). We recorded a pre-tax gain of $58 million ( $46 million after-tax or $0.03 per share) in selling, general and administrative expenses in our ESSA segment as a result of this transaction. Refranchising in Jordan In 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $140 million ( $107 million after-tax or $0.07 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Note 15 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 6,079 $ 5,956 Other receivables 1,164 1,197 7,243 7,153 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) (33 ) (35 ) (30 ) Other (b) (11 ) (3 ) Allowance, end of year $ Net receivables $ 7,142 $ 7,024 Inventories (c) Raw materials and packaging $ 1,312 $ 1,344 Work-in-process Finished goods 1,638 1,436 $ 3,128 $ 2,947 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Other $ $ Accounts payable and other current liabilities Accounts payable $ 7,213 $ 6,727 Accrued marketplace spending 2,541 2,390 Accrued compensation and benefits 1,755 1,785 Dividends payable 1,329 1,161 SodaStream consideration payable 1,997 Other current liabilities 3,277 2,954 $ 18,112 $ 15,017 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 5% of the inventory cost in 2018 and 2017 were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for additional information regarding our pension plans. Statement of Cash Flows Interest paid (a) $ 1,388 $ 1,123 $ 1,102 Income taxes paid, net of refunds (b) $ 1,203 $ 1,962 $ 1,393 (a) In 2018 and 2016, excludes the premiums paid in accordance with the debt transactions discussed in Note 8. (b) In 2018, includes tax payments of $115 million related to the TCJ Act. Lease Information Rent expense $ $ $ Minimum lease payments under non-cancelable operating leases by period Operating Lease Payments $ 2020 2021 2022 2023 2024 and beyond Total minimum operating lease payments $ 1,840 Managements Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions the actions of all our associates are governed by our Global Code of Conduct. This Code is clearly aligned with our stated values a commitment to deliver sustained growth through empowered people acting with responsibility and building trust. Both the Code and our core values enable us to operate with integrity both within the letter and the spirit of the law. Our Code of Conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements, and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control Integrated Framework (2013). The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the United States. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Global Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Boards oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our Internal Auditor and with our General Counsel. We also have a Compliance Ethics Department, led by our Chief Compliance Ethics Officer, who coordinates our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the United States, which require estimates based on managements best judgment. PepsiCo has a strong history of doing whats right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. February 15, 2019 /s/ MARIE T. GALLAGHER Marie T. Gallagher Senior Vice President and Controller (Principal Accounting Officer) /s/ HUGH F. JOHNSTON Hugh F. Johnston Vice Chairman, Executive Vice President and Chief Financial Officer /s/ RAMON L. LAGUARTA Ramon L. Laguarta Chairman of the Board of Directors and Chief Executive Officer Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and Subsidiaries (the Company) as of December 29, 2018 and December 30, 2017, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 29, 2018 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 29, 2018 and December 30, 2017, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 29, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of internal control over financial reporting as of December 29, 2018 excluded SodaStream International Ltd. and its subsidiaries (SodaStream), which the Company acquired in December 2018. SodaStreams total assets and net revenue represented approximately 5% and 1%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 29, 2018. Our audit of internal control over financial reporting of PepsiCo, Inc. also excluded an evaluation of the internal control over financial reporting of SodaStream. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 15, 2019 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Derivatives : financial instruments, such as futures, swaps, Treasury locks, cross currency swaps and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates and foreign exchange rates. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending plus sales of property, plant and equipment. Hedge accounting : treatment for qualifying hedges that allows fluctuations in a hedging instruments fair value to offset corresponding fluctuations in the hedged item in the same reporting period. Hedge accounting is allowed only in cases where the hedging relationship between the hedging instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net gain or loss : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, and foreign exchange translation. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for additional information. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 29, 2018 . As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 29, 2018 excluded SodaStream International Ltd. and its subsidiaries (SodaStream), which we acquired in December 2018. SodaStreams total assets and net revenue represented approximately 5% and 1%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 29, 2018. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth fiscal quarter of 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth fiscal quarter of 2018 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity program, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +33,PepsiCo,2017," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of enjoyable brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into six reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) North America Beverages (NAB), which includes our beverage businesses in the United States and Canada; 4) Latin America, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe Sub-Saharan Africa (ESSA), which includes all of our beverage, food and snack businesses in Europe and Sub-Saharan Africa; and 6) Asia, Middle East and North Africa (AMENA), which includes all of our beverage, food and snack businesses in Asia, Middle East and North Africa. Our segment net revenue (in millions) and contributions to consolidated net revenue for each of the last three fiscal years were as follows: Net Revenue % of Total Net Revenue 2016 (a) FLNA $ 15,798 $ 15,549 $ 14,782 % % % QFNA 2,503 2,564 2,543 NAB 20,936 21,312 20,618 Latin America 7,208 6,820 8,228 ESSA 11,050 10,216 10,510 AMENA 6,030 6,338 6,375 $ 63,525 $ 62,799 $ 63,056 % % % (a) Our fiscal 2016 results included an extra week of results (53 rd reporting week). The 53 rd reporting week increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. See Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. See also Item 1A. Risk Factors below for a discussion of certain risks associated with our operations, including outside the United States. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips, Santitas tortilla chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oat squares, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. North America Beverages Either independently or in conjunction with third parties, NAB makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mist Twst, Mountain Dew, Pepsi, Propel and Tropicana. NAB also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, NAB manufactures and distributes certain brands licensed from Dr Pepper Snapple Group, Inc. (DPSG), including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). NAB operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. NAB also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, Latin America makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). See Note 1 to our consolidated financial statements for information about the deconsolidation of our Venezuelan subsidiaries, which was effective as of the end of the third quarter of 2015. Europe Sub-Saharan Africa Either independently or in conjunction with third parties, ESSA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses as well as through noncontrolled affiliates. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, ESSA operates its own bottling plants and distribution facilities. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, ESSA makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. Asia, Middle East and North Africa Either independently or in conjunction with third parties, AMENA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Crunchy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMENA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMENA operates its own bottling plants and distribution facilities. AMENA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, we license the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. Our products are also available on a growing number of e-commerce websites and mobile commerce applications as consumer consumption patterns continue to change and retail increasingly expands online. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it globally. See Note 9 to our consolidated financial statements for additional information on how we manage our exposure to commodity costs. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Aunt Jemima, Capn Crunch, Cheetos, Chesters, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mist Twst, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lifewater, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mist Twst, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Kickstart, Mug, Munchies, Naked, Near East, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Max, Pepsi Next, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SoBe Lifewater, Sonrics, Stacys, Sting, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Farmstand, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks, Muscle Milk protein shakes and various DPSG brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. For instance, our beverage sales are higher during the warmer months and certain food and dairy sales are higher in the cooler months. Weekly beverage and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2017 , sales to Walmart Inc. (Walmart), including Sams Club (Sams), represented approximately 13% of our consolidated net revenue. Our top five retail customers represented approximately 33% of our 2017 net revenue in North America, with Walmart (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers, economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, DPSG, Kellogg Company, The Kraft Heinz Company, Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Snyders-Lance, Inc. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2017 , we and The Coca-Cola Company represented approximately 23% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, the effectiveness of our advertising campaigns, marketing programs, product packaging, pricing, increased efficiency in production techniques, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, dispensing equipment, packaging technology, package design and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of sweetener alternatives and flavor modifiers and innovation in existing sweeteners, and by offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; and improvements in energy efficiency and efforts focused on reducing our impact on the environment. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, the United Arab Emirates, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to develop nutritious and convenient beverages, foods and snacks. In 2017 , we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our state-of-the-art food and beverage healthy vending initiative to increase the availability of convenient, affordable and enjoyable nutrition; further expanding our portfolio of nutritious products by building on our important nutrition platforms and brands Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies) and KeVita (probiotics, tonics and fermented teas); further expanding our whole grain products globally; and further expanding our portfolio of nutritious products in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water use in our agricultural supply chain), and by incorporating into our operations, improvements in the sustainability and resources of our agricultural supply chain; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to support increased packaging recovery and recycling rates; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers; and efforts to optimize packaging technology and design to make our packaging increasingly recoverable or recyclable with lower environmental impact, including continuing to invest in developing compostable and biodegradable packaging. Research and development costs were $737 million , $760 million and $ 754 million in 2017 , 2016 and 2015 , respectively, and are reported within selling, general and administrative expenses. Consumer research is excluded from such research and development costs and included in other marketing costs. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, disposal, recycling and use of our products, as well as our occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; customs and foreign trade laws and regulations; laws regulating the sale of certain of our products in schools; and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are also subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, occupational health and safety, competition, anti-corruption and data privacy. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. Regulators may also restrict consumers ability to use benefit programs, such as the Supplemental Nutrition Assistance Program in the United States, to purchase certain beverages and foods. In addition, legislation has been enacted in certain U.S. states and in certain other countries where our products are sold that requires collection and recycling of containers or that prohibits the sale of our beverages in certain non-refillable containers, unless a deposit, ecotax or other fee is charged. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated on-site and sent to third-party owned and operated off-site licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 30, 2017 , we and our consolidated subsidiaries employed approximately 263,000 people worldwide, including approximately 113,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The public may read and copy any materials that we file with the SEC at the SECs Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K. Any of the factors described below could occur or continue to occur and could have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and may also adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results, financial and business performance, events or trends. Demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics could result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers); or the location of origin or source of the ingredients and products (including the environmental impact related to the production of our products). Consumer preferences have been evolving, and are expected to continue to evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending and consumption habits; consumer concerns or perceptions regarding the nutrition profile of certain of our products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic or locally sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of social media posts or other information disseminated by us or our employees and agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties; perception of our employees, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties or the business practices of such parties; product boycotts; or a downturn in economic conditions. Any of these factors may reduce consumers willingness to purchase our products and any inability on our part to anticipate or react to such changes could result in reduced demand for our products and erosion of our competitive and financial position and could adversely affect our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories; respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients (including to respond to applicable regulations); develop or acquire a broader portfolio of product choices, including by continuing to increase non-carbonated beverage offerings and other alternatives to traditional carbonated beverage offerings and, in some cases, reformulations of our traditional carbonated beverage offerings; develop sweetener alternatives and innovation; improve the production, packaging and distribution of our products; respond to competitive product and pricing pressures and changes in distribution channels, including in the rapidly growing e-commerce channel; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including to correctly anticipate or effectively react to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively distribute our products could decrease demand for our existing products by negatively affecting consumer perception of our existing brands and may result in inventory write-offs and other costs that could adversely affect our business, financial condition or results of operations. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations could adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to varying regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold. In addition, these laws and regulations and related interpretations may change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes may include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs restricting the sale and advertising of certain of our products, including restrictions on the audience to whom products are marketed; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs, such as the Supplemental Nutrition Assistance Program (included within the Farm Bill in the United States), to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements, and competing regulations and standards, where our products are made, manufactured, distributed or sold, may result in higher compliance costs, capital expenditures and higher production costs, which could adversely affect our business, reputation, financial condition or results of operations. The imposition by any jurisdiction in the United States or outside the United States of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product or production requirements or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, which could adversely affect our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions may follow and the requirements or restrictions, or proposed requirements or restrictions, may also result in adverse publicity (whether or not valid). For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing may result in decreased demand for our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) are underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, caffeine, furfuryl alcohol, added sugars, sodium and saturated fat. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and other foods high in sugar, sodium or saturated fat. If, as a result of these studies and documents or otherwise, there is an increase in consumer concerns (whether or not valid) about the health implications of consumption of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, demand for our products could decline, or we could be subject to lawsuits or new regulations that could affect sales of our products, any of which could adversely affect our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business could take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or could fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Violations of laws or regulations could subject us to criminal or civil enforcement actions, including fines, penalties, disgorgement of profits or activity restrictions, any of which could result in adverse publicity or affect our business, financial condition or results of operations. In addition, regulatory authorities under whose laws we operate may have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, which could have an adverse effect on the sales of products in our portfolio or could lead to damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. For example, effective January 2018, the City of Seattle, Washington in the United States enacted a per-ounce surcharge on all sugar-sweetened beverages. By contrast, the United Kingdom enacted a graduated tax, effective April 2018, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per-ounce tax rate and Saudi Arabia enacted, effective June 2017, a flat tax rate of 50% on the retail price of carbonated soft drinks. These tax measures, whatever their scope or form, could increase the cost of our products, reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may reduce demand for such products and could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to packaging or disposal of our products could continue to increase our costs and reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our products are sold in packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to low value, lack of infrastructure or otherwise. The United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to encourage recycling, including requiring that deposits or certain taxes or fees be charged in connection with the sale, distribution, marketing and use of certain packaging; extended producer responsibility policies which makes brand owners responsible for the costs of recycling products after consumers have used them; and adopting or extending product stewardship policies which could require brand owners to plan for and, if necessary, pay for the recycling or disposal of packaging after consumers have used them. In addition, these jurisdictions may elect to impose regulations or policies to ban the use of certain packaging, such as plastic beverage bottles. Compliance with these laws and regulations could continue to affect our costs or require changes in our distribution model, which could adversely affect our business, financial condition or results of operations. Further, our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Our business, financial condition or results of operations could suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local, and private label manufacturers, economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, DPSG, Kellogg Company, The Kraft Heinz Company, Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Snyders-Lance, Inc. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which may adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold may be difficult to predict and may adversely affect our business, financial condition and results of operations. The results of elections, referendums or other political conditions in the markets in which our products are made, manufactured, distributed or sold could create uncertainty regarding how existing laws and regulations may change, including with respect to sanctions, climate change regulation, taxes, the movement of goods, services and people between countries and other matters, and could result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty. For example, there is continued uncertainty surrounding the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure. Any changes in, or the imposition of new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions could have an adverse impact on our business, financial conditions and results of operations. Our business, financial condition or results of operations could be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences or otherwise. The following factors could reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; imposition of new or increased sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly-inflationary economies, devaluation or fluctuation, such as the devaluation of the Egyptian pound, Turkish lira, Pound sterling, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or could significantly affect our ability to effectively manage our operations in certain of these markets and could result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our reputation, business, financial condition or results of operations could be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and may, from time to time, continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results may be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly-inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions, may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, may limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; may leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or may result in a decline in the market value of our investments in debt securities, which could have an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, distributors and joint venture partners and could result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which could also have an adverse impact on our reputation, business, financial condition or results of operations. Our business and reputation could suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage our facilities; to conduct research and development; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. As with other global companies, we are regularly subject to cyberattacks. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being made by groups and individuals (including criminal hackers, hacktivists, state-sponsored institutions, terrorist organizations and individuals or groups participating in organized crime) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and other credentials. Although we may incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, or from deliberate cyberattacks such as malicious or disruptive software, denial of service attacks, malicious social engineering, hackers or otherwise), our business could be disrupted and we could, among other things, be subject to: transaction errors; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which could cause delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or supply chain disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and the information stored therein could be compromised by, and we could experience similar adverse consequences due to, unauthorized outside parties accessing or extracting sensitive data or confidential information, corrupting information or disrupting business processes (or demonstrating an ability to do so) or by inadvertent or intentional actions by our employees, agents or third parties. We continue to devote significant resources to network security, backup and disaster recovery, and other security measures, including training, to protect our systems and data, but these security measures cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that may arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies could heighten these and other operational risks, as certain aspects of the security of such technologies may be complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that may arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. We and our business partners use various raw materials, energy, water and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, water, animal welfare and human rights concerns and other risks associated with the global food system may lead to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and could adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake or flooding), disease or pests, agricultural uncertainty, health epidemics or pandemics, governmental incentives and controls (including import/export restrictions), political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs could adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality and increasing pressure to conserve water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; or damage to our reputation, any of which could adversely affect our business, financial condition or results of operations. Business disruptions could have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, joint venture partners, distributors and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations due to any of the following factors could impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power or water shortages; strikes and other labor disputes; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity could adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which could adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we could decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which could result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which could reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes could adversely affect our reputation or brands. Our business could also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts could materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image could adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image could be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, distributors, suppliers, bottlers, contract manufacturers, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees engage in or are believed to have engaged in improper activities, we may be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, which may cause us to suffer damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information could also hurt our reputation. In addition, water is a limited resource in many parts of the world and demand for water continues to rise. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to water use. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, may also generate adverse publicity (whether or not valid) that could damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons could result in decreased demand for our products and could adversely affect our business, financial condition or results of operations, as well as require additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, could adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Potential issues associated with these activities could include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, the following factors also pose potential risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming standards, controls (including internal control over financial reporting, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners may adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we may not be able to complete or effectively manage such transactions on terms commercially favorable to us or at all and may fail to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings may reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain may adversely impact our sales or business performance. If an acquisition or joint venture is not successfully completed or integrated into our existing operations, or if a divestiture or refranchising is not successfully completed or managed or does not result in the benefits or cost savings we expect, our business, financial condition or results of operations may be adversely affected. A change in our estimates and underlying assumptions regarding the future performance of our businesses could result in an impairment charge, which could materially affect our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently, if circumstances indicate that the carrying value may not be recoverable or that an other-than-temporary impairment exists. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, could adversely affect our results of operations. Factors that could result in an impairment include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that may result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. Future impairment charges could have a significant adverse effect on our results of operations in the periods recognized. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction could reduce our after-tax income from such jurisdiction and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, on December 22, 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. The changes in the TCJ Act are broad and complex and we continue to examine the impact the TCJ Act may have on our business and financial results. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings regardless of whether they are repatriated, reduced the U.S. corporate income tax rate from 35% to 21%, imposed limitations on the deductibility of interest and certain other corporate deductions, and moved from a worldwide system of taxation that generally allows deferral of U.S. tax on international earnings until repatriated to a territorial/dividend exemption system with a minimum tax that will subject international earnings to U.S. tax when earned. In accordance with applicable SEC guidance, we recorded a provisional net tax expense in the fourth quarter of 2017 resulting from the enactment of the TCJ Act. This provisional expense is subject to change, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in Internal Revenue Service (IRS) interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For further information regarding the potential impact of the TCJ Act, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation could differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. In addition, in connection with the Organisation for Economic Co-operation and Development Base Erosion and Profit Shifting project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Failure to realize anticipated benefits from our productivity initiatives or global operating model could have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement strategic plans that we believe will position our business for future success and long-term sustainable growth by allowing us to achieve a lower cost structure and operate more efficiently in the highly competitive beverage, food and snack categories and markets. We are also continuing to implement our global operating model to improve efficiency, decision making, innovation and brand management across the global PepsiCo organization to enable us to compete more effectively. Further, in order to continue to capitalize on our cost reduction efforts and our global operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. Some of these measures could yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to continue to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives and global operating model as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, which could adversely affect our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it could have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or to hire and retain a highly skilled and diverse workforce could deplete our institutional knowledge base and erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing could adversely affect our reputation, business, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer or disruption in the retail landscape, including rapid growth in hard discounters and the e-commerce channel, could adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers could adversely affect our business, financial condition or results of operations. In addition, our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications as well as the integration of physical and digital operations among retailers. We are making significant investments in attracting talent to and building our global e-commerce capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which could adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce may result in consumer price deflation, which may affect our relationships with key retail customers. If these e-commerce retailers were to take significant market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, our ability to maintain and grow our share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers with increased purchasing power, which may impact our ability to compete in these areas. Such retailers may demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, could reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, could increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market could also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity could adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize certain information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and may enter into agreements for shared services in other functions in the future to achieve cost savings and efficiencies. In addition, we utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. If any of these third-party service providers or vendors do not perform effectively, or if we fail to adequately monitor their performance, we may not be able to achieve the expected cost savings or we may have to incur additional costs to correct errors made by such service providers and our reputation could be harmed. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, adverse effects on financial reporting, litigation or remediation costs, or damage to our reputation, which could have a negative impact on employee morale. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which could result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and may continue to have, an adverse impact on our business, financial condition and results of operations. Climate change, water scarcity or legal, regulatory or market measures to address climate change or water scarcity may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, earthquake or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. The predicted effects of climate change may also exacerbate challenges regarding the availability and quality of water. As demand for water access continues to increase around the world, we may be subject to decreased availability of water, deteriorated quality of water or less favorable pricing for water, which could adversely impact our manufacturing and distribution operations. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency and water conservation, we may experience disruptions in, or significant increases in our costs of, operation and delivery and we may be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions could substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change or water scarcity could negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to water use and the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change or water scarcity could result in adverse publicity and could adversely affect our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact and water use. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, could cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions could occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, could be reduced, which could have an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, could be reduced and there could be an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding could have an adverse impact on our reputation, business, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations could have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, may also require us to incur significant expense and devote significant resources, and may generate adverse publicity that may damage our reputation or brand image, which could have an adverse impact on our business, financial condition or results of operations. Many factors may adversely affect the price of our publicly traded securities. Many factors may adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, may include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, investigations or inquiries; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we may or may not take from time to time as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, may not have the impact we intend and may adversely affect the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, could adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2017 fiscal year and that remain unresolved. ," Item 2. Properties. Our principal executive offices located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products. The approximate number of such facilities utilized by each division is as follows: FLNA QFNA NAB Latin America ESSA AMENA Shared (a) Plants (b) Other Facilities (c) 1,680 (a) Shared properties are in addition to the other properties reported by our six divisions identified in this table. (b) Includes manufacturing and processing plants as well as bottling and production plants. (c) Includes warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities. Significant properties by division included in the table above are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. NABs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. Latin Americas three snack plants in Mexico (one in Vallejo, one in Celaya and one in Monterrey) and one in Brazil (Sorocaba), all of which are owned. ESSAs snack plant in Leicester, United Kingdom, which is leased; its snack plant in Kashira, Russia, its fruit juice plant in Zeebrugge, Belgium, its beverage plant in Lebedyan, Russia and its dairy plant in Moscow, Russia, all of which are owned. AMENAs beverage plants in Tanta City, Egypt and Rayong, Thailand, and its snack plant in Sixth of October City, Egypt, all of which are owned; and its snack plant in Riyadh, Saudi Arabia, which is leased. Two concentrate plants in Cork, Ireland, which are shared by our NAB, ESSA and AMENA divisions, both of which are owned. Shared service centers in Winston-Salem, North Carolina, and Plano, Texas, which are primarily shared by our FLNA, QFNA and NAB divisions, both of which are leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. As previously disclosed, in January 2011, Wojewodzka Inspekcja Ochrony Srodowiska, the Polish environmental control authority, began an audit of a bottling plant of our subsidiary, Pepsi-Cola General Bottlers Poland SP, z.o.o. (PCGB), in Michrow, Poland. In July 2013, Wojewodzka Inspekcja Ochrony Srodowiska alleged that the plant was not in compliance in 2009 with applicable regulations governing the taking of water samples for analysis of the plants waste and sought monetary sanctions of $650,000 and, in August 2013, PCGB appealed this decision. In April 2015, the General Environmental Inspector for Environmental Protection upheld the sanctions against PCGB and, in May 2015, PCGB further appealed this decision. In October 2015, Viovodeship Administrative Court in Warsaw rejected our appeal and, in December 2015, PCGB filed an extraordinary appeal in the Supreme Administrative Court. In October 2017, the Supreme Administrative Court issued a final, non-appealable decision, rejecting our appeal and we agreed to invest funds up to the penalty amount(s) into the bottling plant to fully resolve the matter. In addition, we and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. Sanctions imposed by foreign authorities are levied in local currency and disclosed using the U.S. dollar equivalent at the time of imposition and are subject to currency fluctuations. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings Since December 20, 2017, our common stock has traded on The Nasdaq Global Select Market. Before December 20, 2017, our common stock traded on The New York Stock Exchange. Our common stock is also listed on the Chicago Stock Exchange and SIX Swiss Exchange. Stock Prices The quarterly composite high and low sales prices for PepsiCo common stock for each fiscal quarter of 2017 and 2016 as reported on The New York Stock Exchange through December 19, 2017 and The Nasdaq Global Select Market from December 20, 2017 through December 30, 2017, are contained in Item 6. Selected Financial Data. Shareholders As of February 6, 2018 , there were approximately 120,156 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 5, 2018 , the Board of Directors declared a quarterly dividend of $0.805 payable March 30, 2018 , to shareholders of record on March 2, 2018 . For the remainder of 2018 , the dividend record dates for these payments are expected to be June 1 , September 7 and December 7 , 2018 , subject to approval of the Board of Directors. Information with respect to the quarterly dividends declared in 2017 and 2016 is contained in Item 6. Selected Financial Data. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2017 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (b) 9/9/2017 $ 5,857 9/10/2017 - 10/7/2017 1.5 $ 112.85 1.5 (167 ) 5,690 10/8/2017 - 11/4/2017 1.3 $ 111.00 1.3 (139 ) 5,551 11/5/2017 - 12/2/2017 1.1 $ 114.32 1.1 (126 ) 5,425 12/3/2017 - 12/30/2017 0.6 $ 117.55 0.6 (72 ) Total 4.5 $ 113.34 4.5 $ 5,353 (a) All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs. (b) Includes shares authorized for repurchase under the $ 12 billion repurchase program authorized by our Board of Directors and publicly announced on February 11, 2015, which commenced on July 1, 2015 and expires on June 30, 2018. On February 13, 2018, we publicly announced a new repurchase program of up to $15 billion of our common stock, which will commence on July 1, 2018 and expire on June 30, 2021, and such shares are excluded from the above table. Such shares may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an employee stock ownership plan (ESOP) fund established by Quaker. In the fourth quarter of 2017, PepsiCo repurchased shares of its convertible preferred stock from the ESOP in connection with share redemptions by ESOP participants. See Note 11 to our consolidated financial statements for additional information on our convertible preferred stock. The Company does not have any authorized, but unissued, blank check preferred stock. The following table summarizes our convertible preferred share repurchases during the fourth quarter of 2017 . Issuer Purchases of Convertible Preferred Stock Period Total Number of Shares Repurchased Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/10/2017 - 10/7/2017 $ N/A N/A 10/8/2017 - 11/4/2017 1,000 $ 548.21 N/A N/A 11/5/2017 - 12/2/2017 $ N/A N/A 12/3/2017 - 12/30/2017 $ 578.48 N/A N/A Total 1,900 $ 562.55 N/A N/A "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Non-GAAP Measures Items Affecting Comparability Results of Operations Division Review Frito-Lay North America Quaker Foods North America North America Beverages Latin America Europe Sub-Saharan Africa Asia, Middle East and North Africa Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Supplemental Financial Information Note 14 Divestitures MANAGEMENTS RESPONSIBILITY FOR FINANCIAL REPORTING REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM GLOSSARY 44 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary beginning on page 1 30. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview We are a leading global food and beverage company with a complementary portfolio of enjoyable brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. At PepsiCo, we are focused on operating our company in a way that generates sustained financial growth and consistently strong returns and is also responsive to the needs of the world around us. We call this approach Performance with Purpose it is embedded into our business and our strategy and it enabled us to deliver another year of strong performance in 2017. As we look to 2018 and beyond, we believe our Performance with Purpose strategy will enable us to continue delivering strong performance while positioning our Company for long-term sustainable growth. Our strategies are designed to address key challenges facing our Company, including: macroeconomic and political volatility and the continued rebalancing of the economic world; shifting consumer preferences and increasing demand for more nutritious foods and beverages; the disruption of retail; the expansion of hard discounters; and the emergence of niche brands laying claim to large consumer segments, particularly in developed markets. We intend to focus on the following areas to address and adapt to these challenges: Utilizing the strength of our distribution system to offer consumers a wide array of choices, from fun-for-you to better-for-you to good-for-you products to meet consumers demand for more nutritious foods and beverages; Continuing to strengthen our retail and foodservice relationships to sell our products faster, increase cash flow and engage consumers; Minimizing our environmental footprint to streamline costs and mitigate our operational impact on the communities in which we operate; Continuing to invest in our associates so that we have the best talent to position our company for continued growth; and Continuing our investments in e-commerce and digital solutions to meet changing consumer consumption patterns and capture cost savings while streamlining our operations. See also Item 1A. Risk Factors for additional information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During 2017 and 2016 , certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. The hurricanes and earthquakes which occurred in the third and fourth quarters of 2017 in North and Central America did not materially impact our consolidated financial results in 2017. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. We sell a wide variety of beverages, foods and snack in more than 200 countries and territories and the profile of the products we sell, and the amount of revenue attributable to such products, varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes or other potential limitations on our products may take, and therefore cannot predict the impact of such taxes or limitations on our financial results. In addition, taxes and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes or limitations. In addition, our industry has been affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. The changes in the TCJ Act are broad and complex and we continue to examine the impact the TCJ Act may have on our business and financial results. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further information in Items Affecting Comparability. The recorded impact of the TCJ Act is provisional and the final amount may differ from the above estimate, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For additional information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key public policy and sustainability matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors and the Audit Committee of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics Department leads and coordinates our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. and Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. in Item 1A. Risk Factors. See Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $0.9 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . At the end of 2017 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2017 by $96 million . Foreign Exchange Our operations outside of the United States generated 42% of our net revenue in 2017 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2017 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. During 2017 , unfavorable foreign exchange had a net nominal impact on net revenue growth due to declines in the Egyptian pound, Turkish lira and Pound sterling, offset by appreciation in the Russian ruble, Brazilian real and euro. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Brazil, China, India, Mexico, the Middle East, Russia and Turkey, and currency fluctuations in certain of these international markets continue to result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, and the potential impact for the ESSA segment and our other businesses. Starting in 2014, Russia announced economic sanctions against the United States and other nations that include a ban on imports of certain ingredients and finished goods from specific countries. These sanctions have not had and are not expected to have a material impact on the results of our operations in Russia or our consolidated results or financial position, and we will continue to monitor the economic, operating and political environment in Russia closely. For the years ended December 30, 2017 , December 31, 2016 and December 26, 2015 , net revenue generated by our operations in Russia represented 5%, 4% and 4% of our consolidated net revenue, respectively. As of December 30, 2017 , our long-lived assets in Russia were $4.7 billion . Our foreign currency derivatives had a total notional value of $1.6 billion as of December 30, 2017 and December 31, 2016 . The total notional amount of our debt instruments designated as net investment hedges was $1.5 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . At the end of 2017 , we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2017 by $125 million . Due to exchange restrictions and other conditions that significantly impact our ability to effectively manage our businesses in Venezuela and realize earnings generated by our Venezuelan businesses, effective at the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries and began accounting for our investments in our Venezuelan subsidiaries and joint venture using the cost method of accounting. In 2015, we recorded pre- and after-tax charges of $1.4 billion in our income statement to reduce the value of the cost method investments to their estimated fair values, resulting in a full impairment. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the end of 2017, and we expect these conditions will continue for the foreseeable future. We do not have any guarantees related to our Venezuelan entities, and our ongoing contractual commitments to our Venezuelan businesses are not material. We will recognize income from dividends and sales of inventory to our Venezuelan entities, which have not been and are not expected to be material, to the extent cash in U.S. dollars is received. We have not received any cash in U.S. dollars from our Venezuelan entities since our deconsolidation at the end of the third quarter of 2015. We continue to monitor the conditions in Venezuela and their impact on our accounting and disclosures. For further information, please refer to Note 1 to our consolidated financial statements and Items Affecting Comparability. Interest Rates Our interest rate derivatives had a total notional value of $14.2 billion as of December 30, 2017 and $11.2 billion as of December 31, 2016 . Assuming year-end 2017 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2017 by $25 million due to higher cash and cash equivalents and short-term investments levels as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures, except as otherwise noted, reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. The impact of the structural change related to the deconsolidation of our Venezuelan businesses is presented separately. Volume Our beverage volume in the NAB, Latin America, ESSA and AMENA segments reflects sales to authorized bottlers, independent distributors and retailers, as well as the sale of beverages bearing Company-owned or licensed trademarks that have been sold through our authorized independent bottlers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our beverage revenues are not entirely based on BCS volume, as there are independent bottlers in the supply chain, we believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the consumer level. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. NAB, Latin America, ESSA and AMENA, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and NAB further, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, AMENA licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Our food and snacks volume in the FLNA, QFNA, Latin America, ESSA and AMENA segments is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2017 , total servings decreased 1% compared to 2016 . In 2016 , total servings increased 3% compared to 2015 . Excluding the impact of the 53 rd reporting week in 2016, total servings in 2017 was even with the prior year and total servings in 2016 increased 2% compared to 2015. Servings growth reflects adjustments to the prior year results for divestitures and other structural changes, including the deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015. Consolidated Net Revenue and Operating Profit Change Net revenue $ 63,525 $ 62,799 $ 63,056 % % Operating profit $ 10,509 $ 9,785 $ 8,353 % % Operating profit margin 16.5 % 15.6 % 13.2 % 1.0 2.3 See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2017 Operating profit increased 7% and operating margin improved 1.0 percentage points. Operating profit growth was driven by the benefit of actions associated with our productivity initiatives, which contributed more than $1 billion in cost reductions across a number of expense categories, as well as effective net pricing. Items affecting comparability (see Items Affecting Comparability) also contributed 4 percentage points to operating profit growth and increased operating profit margin by 0.5 percentage points, primarily reflecting a prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value. Additionally, the impact of refranchising our beverage business in Jordan and a gain associated with the sale of our minority stake in Britvic each contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, higher commodity costs and unfavorable foreign exchange. Commodity inflation reduced operating profit growth by 6 percentage points, primarily attributable to inflation in the AMENA, Latin America, ESSA, NAB and FLNA segments. Corporate unallocated expenses (see Note 1 to our consolidated financial statements) decreased 9%, reflecting the impact of higher prior-year contributions to The PepsiCo Foundation, Inc. to fund charitable and social programs. 2016 Operating profit increased 17% and operating margin increased 2.3 percentage points. Operating profit growth was driven by the benefit of actions associated with our productivity initiatives, which contributed more than $1 billion in cost reductions across a number of expense categories, effective net pricing and volume growth. Additionally, the impact of recording an impairment charge in 2015 and ceasing the operations of our MQD joint venture contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, higher advertising and marketing expenses, unfavorable foreign exchange and higher commodity costs, as well as the deconsolidation of our Venezuelan businesses, which reduced operating profit growth by 2 percentage points. Items affecting comparability (see Items Affecting Comparability) contributed 13 percentage points to operating profit growth and increased operating profit margin by 1.5 percentage points, primarily reflecting a 17-percentage-point contribution from the 2015 Venezuela impairment charges. Higher commodity inflation reduced operating profit growth by 1 percentage point, primarily attributable to inflation in the Latin America, ESSA and AMENA segments, partially offset by deflation in the NAB, FLNA and QFNA segments. The impact of our 53 rd reporting week was fully offset by incremental investments we made in our business. Corporate unallocated expenses (see Note 1 to our consolidated financial statements) decreased 1%, driven by lower pension expense reflecting the change to the full yield curve approach, lower foreign exchange transaction losses and decreases in other corporate expenses, partially offset by increased contributions to The PepsiCo Foundation, Inc. to fund charitable and social programs and the net impact of items affecting comparability mentioned above included in corporate unallocated expenses. Other Consolidated Results Change Net interest expense $ (907 ) $ (1,232 ) $ (911 ) $ $ (321 ) Annual tax rate (a) 48.9 % 25.4 % 26.1 % Net income attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 (23 )% % Net income attributable to PepsiCo per common share diluted $ 3.38 $ 4.36 $ 3.67 (23 )% % Mark-to-market net impact (0.01 ) (0.08 ) Restructuring and impairment charges 0.16 0.09 0.12 Provisional net tax expense related to the TCJ Act (a) 1.70 Charges related to the transaction with Tingyi 0.26 0.05 Charge related to debt redemption 0.11 Pension-related settlement charge/(benefits) 0.11 (0.03 ) Venezuela impairment charges 0.91 Tax benefit (0.15 ) Net income attributable to PepsiCo per common share diluted, excluding above items (b) $ 5.23 $ 4.85 $ 4.57 % % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (b) % % (a) See Note 5 to our consolidated financial statements. (b) See Non-GAAP Measures. Net interest expense decreased $325 million reflecting a prior-year charge of $233 million representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This decrease also reflects higher interest income due to higher interest rates and average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest expense due to higher average debt balances. The reported tax rate increased 23.5 percentage points primarily as a result of the provisional net tax expense related to the TCJ Act , which contributed 26 percentage points to the increase, partially offset by the impact of the prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in the current year. See Note 2 and Note 5 to our consolidated financial statements for additional information. Net income attributable to PepsiCo and net income attributable to PepsiCo per common share both decreased 23% . Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo and net income attributable to PepsiCo per common share by 30 percentage points, primarily as a result of the provisional net tax expense related to the TCJ Act. 2016 Net interest expense increased $321 million reflecting a charge of $233 million representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This increase also reflects higher average debt balances, partially offset by higher interest income due to higher average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. The reported tax rate decreased 0.7 percentage points due to the impact of the 2015 Venezuela impairment charges, which had no corresponding tax benefit, partially offset by the 2015 favorable resolution with the IRS of substantially all open matters related to the audits for taxable years 2010 and 2011, as well as the 2016 impairment charge recorded to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit. Net income attributable to PepsiCo increased 16% and net income attributable to PepsiCo per common share increased 19% . Items affecting comparability (see Items Affecting Comparability) positively contributed 12 percentage points to net income attributable to PepsiCo and 13 percentage points to net income attributable to PepsiCo per common share. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring programs; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; gains or losses associated with mergers, acquisitions, divestitures and other structural changes; debt redemptions; pension and retiree medical related items; amounts related to the resolution of tax positions; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures are contained in this Form 10-K: cost of sales, gross profit, selling, general and administrative expenses, interest expense, noncontrolling interests and provision for income taxes, each adjusted for items affecting comparability; operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates; organic revenue; free cash flow; and return on invested capital (ROIC) and net ROIC, excluding items affecting comparability. Cost of Sales, Gross Profit, Selling, General and Administrative Expenses, Interest Expense, Noncontrolling Interests and Provision for Income Taxes, Adjusted for Items Affecting Comparability; Operating Profit/Loss, Adjusted for Items Affecting Comparability, and Net Income Attributable to PepsiCo per Common Share Diluted, Adjusted for Items Affecting Comparability, and the Corresponding Constant Currency Growth Rates Cost of sales, gross profit, selling, general and administrative expenses, interest expense, noncontrolling interests and provision for income taxes, adjusted for items affecting comparability; operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2014 and 2012 Productivity Plans, a provisional net tax expense associated with the enactment of the TCJ Act, charges related to the transaction with Tingyi, a charge related to debt redemption, pension-related settlements, Venezuela impairment charges and a tax benefit (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic Revenue We define organic revenue as net revenue adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes, including the Venezuela deconsolidation, for the comparable period. The Venezuela deconsolidation impact excluded the results of our Venezuelan businesses for the first three quarters of 2015. In addition, our fiscal 2016 reported results included an extra week of results. Organic revenue excludes the impact of the 53 rd reporting week in the fourth quarter of 2016. We believe organic revenue provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Organic Revenue Growth in Results of Operations Division Review. Free Cash Flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources. ROIC and Net ROIC, Excluding Items Affecting Comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,785 $ 34,740 $ 24,231 $ 10,509 $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (295 ) Provisional net tax expense related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,793 $ 34,732 $ 23,943 $ 10,789 $ 2,307 $ 7,524 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Interest expense Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 28,209 $ 34,590 $ 24,805 $ 9,785 $ 1,342 $ 2,174 $ $ 6,329 Items Affecting Comparability Mark-to-market net impact (78 ) (167 ) (56 ) (111 ) Restructuring and impairment charges (160 ) Charge related to the transaction with Tingyi (373 ) Charge related to debt redemption (233 ) Pension-related settlement charge (242 ) Core, Non-GAAP Measure $ 28,287 $ 34,512 $ 24,119 $ 10,393 $ 1,109 $ 2,301 $ $ 7,040 Cost of sales Gross profit Selling, general and administrative expenses Venezuela impairment charges Operating profit Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,731 $ 34,325 $ 24,613 $ 1,359 $ 8,353 $ 1,941 $ 5,452 Items Affecting Comparability Mark-to-market net impact (18 ) (11 ) (3 ) (8 ) Restructuring and impairment charges (230 ) Charge related to the transaction with Tingyi (73 ) Pension-related settlement benefits (67 ) (25 ) (42 ) Venezuela impairment charges (1,359 ) 1,359 1,359 Tax benefit (230 ) Core, Non-GAAP Measure $ 28,713 $ 34,343 $ 24,406 $ $ 9,937 $ 2,189 $ 6,788 (a) Provision for income taxes is the expected tax benefit/charge on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction and tax year and, in 2017, the impact of the TCJ Act is presented separately. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2014 Multi-Year Productivity Plan To build on the successful implementation of the 2014 Productivity Plan to date, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives of the 2014 Productivity Plan to further strengthen our food, snack and beverage businesses. We now expect to incur pre-tax charges and cash expenditures of approximately $1.3 billion and $985 million, respectively, as compared to our previous estimate of pre-tax charges and cash expenditures of approximately $990 million and $705 million, respectively. The expected pre-tax charges and cash expenditures are summarized by year as follows: Charges Cash Expenditures $ $ (b) (b) 2018 (expected) 2019 (expected) $ 1,305 (a) $ (a) This total pre-tax charge is expected to consist of approximately $795 million of severance and other employee-related costs, approximately $165 million for asset impairments (all non-cash) resulting from plant closures and related actions, and approximately $345 million for other costs associated with the implementation of our initiatives, including contract termination costs. This charge is expected to impact reportable segments and Corporate approximately as follows: FLNA 14%, QFNA 3%, NAB 30%, Latin America 15%, ESSA 25%, AMENA 4% and Corporate 9%. (b) In 2015 and 2014, cash expenditures include $2 million and $10 million , respectively, reported on our cash flow statement in pension and retiree medical plan contributions. See Note 3 to our consolidated financial statements for further information related to our 2014 and 2012 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Provisional Net Tax Expense Related to the TCJ Act In 2017, we recorded a provisional net tax expense of $2.5 billion ($1.70 per share) associated with the enactment of the TCJ Act in the fourth quarter of 2017. Included in the net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate. See Note 5 to our consolidated financial statements. Charges Related to the Transaction with Tingyi In 2016, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in the AMENA segment to reduce the value of our 5% indirect equity interest in TAB to its estimated fair valu e. In 2015, we recorded a pre- and after-tax charge of $73 million ($0.05 per share) in the AMENA segment related to a write-off of the value of a call option to increase our holding in TAB to 20%. See Note 9 to our consolidated financial statements. Charge Related to Debt Redemption In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See Note 8 to our consolidated financial statements. Pension-Related Settlements In 2016, we recorded a pre-tax pension settlement charge in corporate unallocated expenses of $242 million ($162 million after-tax or $0.11 per share) related to the purchase of a group annuity contract. See Note 7 to our consolidated financial statements. In 2015, we recorded pre-tax benefits of $67 million ($42 million after-tax or $0.03 per share) in the NAB segment associated with the settlement of pension-related liabilities from previous acquisitions. These benefits were recognized in selling, general and administrative expenses. Venezuela Impairment Charges In 2015, we recorded pre- and after-tax charges of $1.4 billion ($0.91 per share) in the Latin America segment related to the impairment of investments in our wholly-owned Venezuelan subsidiaries and beverage joint venture. See Note 1 to our consolidated financial statements and Our Business Risks. Tax Benefit In 2015, we recognized a non-cash tax benefit of $ 230 million ($ 0.15 per share) associated with our agreement with the IRS resolving substantially all open matters related to the audits for taxable years 2010 through 2011, which reduced our reserve for uncertain tax positions for the tax years 2010 and 2011. See Note 5 to our consolidated financial statements. Results of Operations Division Review The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. Accordingly, volume growth measures for 2016 reflect adjustments to the base year for divestitures and other structural changes, including the deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures. FLNA QFNA NAB Latin America ESSA AMENA Total Net Revenue, 2017 $ 15,798 $ 2,503 $ 20,936 $ 7,208 $ 11,050 $ 6,030 $ 63,525 Net Revenue, 2016 $ 15,549 $ 2,564 $ 21,312 $ 6,820 $ 10,216 $ 6,338 $ 62,799 % Impact of: Volume (a) % % (2.5 )% (2 )% % % % Effective net pricing (b) 2.5 (1 ) Foreign exchange translation (10 ) Acquisitions and divestitures (0.5 ) 53 rd reporting week (c) (2 ) (2 ) (1 ) (1 ) Reported growth (e) % (2 )% (2 )% % % (5 )% % FLNA QFNA NAB Latin America ESSA AMENA Total Net Revenue, 2016 $ 15,549 $ 2,564 $ 21,312 $ 6,820 $ 10,216 $ 6,338 $ 62,799 Net Revenue, 2015 $ 14,782 $ 2,543 $ 20,618 $ 8,228 $ 10,510 $ 6,375 $ 63,056 % Impact of: Volume (a) % % % % 1.5 % % % Effective net pricing (b) (1 ) 2.5 (1 ) Foreign exchange translation (11 ) (7 ) (5 ) (3 ) Acquisitions and divestitures (1 ) Venezuela deconsolidation (d) (14 ) (2 ) 53 rd reporting week (c) 1.5 Reported growth (e) % % % (17 )% (3 )% (1 )% % (a) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our Company-owned and franchised-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our beverage businesses, is based on CSE. (b) Includes the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. (c) Our fiscal 2016 results included a 53 rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. (d) The impact of the exclusion of the 2015 results of our Venezuelan businesses, which were deconsolidated effective as of the end of the third quarter of 2015. (e) Amounts may not sum due to rounding. Organic Revenue Growth Organic revenue is a non-GAAP financial measure. For further information on organic revenue see Non-GAAP Measures. FLNA QFNA NAB Latin America ESSA AMENA Total Reported Growth % (2 )% (2 )% % % (5 )% % % Impact of: Foreign exchange translation (1 ) (3 ) Acquisitions and divestitures (1 ) 0.5 53 rd reporting week (a) Organic Growth (c) % (1 )% (2 )% % % % % FLNA QFNA NAB Latin America ESSA AMENA Total Reported Growth % % % (17 )% (3 )% (1 )% % % Impact of: Foreign exchange translation Acquisitions and divestitures Venezuela deconsolidation (b) 53 rd reporting week (a) (2 ) (2 ) (1.5 ) (1 ) Organic Growth (c) 3.5 % % % % % % % (a) Our fiscal 2016 results included a 53 rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. Our 2017 organic revenue growth excludes the impact of the 53 rd reporting week from our 2016 results. (b) The impact of the exclusion of the 2015 results of our Venezuelan businesses, which were deconsolidated effective as of the end of the third quarter of 2015. (c) Amounts may not sum due to rounding. Frito-Lay North America % Change Net revenue $ 15,798 $ 15,549 $ 14,782 Impact of foreign exchange translation Impact of 53 rd reporting week (2 ) Organic revenue growth (a) (b) 3.5 (b) Operating profit $ 4,823 $ 4,659 $ 4,304 3.5 Restructuring and impairment charges Operating profit excluding above item (a) $ 4,890 $ 4,672 $ 4,330 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) 4.5 (b) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue grew 2%, primarily reflecting effective net pricing, partially offset by the impact of the 53 rd reporting week in the prior year, which reduced net revenue growth by 2 percentage points. Volume declined 1%, reflecting mid-single-digit declines in trademark Lays and Fritos and a low-single-digit decline in trademark Doritos, partially offset by high-single-digit growth in variety packs. The 53 rd reporting week in the prior year negatively impacted volume performance by 2 percentage points. Operating profit grew 3.5%, primarily reflecting planned cost reductions across a number of expense categories and the effective net pricing, as well as the impact of prior-year incremental investments into our business, which contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, including strategic initiatives, as well as higher commodity costs, primarily cooking oil, which reduced operating profit growth by 1 percentage point. The 53 rd reporting week in the prior year reduced operating profit growth by 2 percentage points. 2016 Net revenue grew 5%, driven by volume growth and effective net pricing. The 53 rd reporting week contributed 2 percentage points to the net revenue growth. Volume grew 3%, reflecting high-single-digit growth in variety packs, and mid-single-digit growth in trademark Doritos and Cheetos. These gains were partially offset by a mid-single-digit decline in our Sabra joint venture products. The 53 rd reporting week contributed 2 percentage points to the volume growth. Operating profit grew 8%, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as lower commodity costs, which contributed 3 percentage points to operating profit growth, primarily fuel and cooking oil. These impacts were partially offset by certain operating cost increases, including strategic initiatives, and higher advertising and marketing expenses. The 53 rd reporting week contributed 2 percentage points to operating profit growth, partially offset by incremental investments in our business, which reduced operating profit growth by 1.5 percentage points. Quaker Foods North America % Change Net revenue $ 2,503 $ 2,564 $ 2,543 (2 ) Impact of foreign exchange translation Impact of 53 rd reporting week (2 ) Organic revenue growth (a) (1 ) (b) (b) Operating profit $ $ $ (2 ) Restructuring and impairment charges Operating profit excluding above item (a) $ $ $ Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue declined 2%, reflecting the impact of the 53 rd reporting week in the prior year, which negatively impacted net revenue performance by 2 percentage points, as well as unfavorable mix. Volume declined 2%, reflecting a low-single-digit decline in ready-to-eat cereals and high-single-digit declines in trademark Roni and Gamesa, in part reflecting the impact of the 53 rd reporting week in the prior year which negatively impacted volume performance by 2 percentage points. Operating profit decreased 2%, reflecting certain operating cost increases and the net revenue performance. The 53 rd reporting week in the prior year negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories and lower advertising and marketing expenses, as well as the impact of prior-year incremental investments into our business, which positively contributed 1.5 percentage points to operating profit performance. Restructuring and impairment charges in the above table (see Items Affecting Comparability) negatively impacted operating profit performance by 1.5 percentage points. 2016 Net revenue grew 1%, driven by the 53 rd reporting week which contributed 2 percentage points to the net revenue growth, partially offset by unfavorable net pricing and mix and unfavorable foreign exchange. Volume grew 2%, reflecting mid-single-digit growth in Aunt Jemima syrup and mix and low-single-digit growth in ready-to-eat cereals, oatmeal and bars. The 53 rd reporting week contributed 2 percentage points to the volume growth. Operating profit increased 16%, impacted by 2015 impairment charges related to our dairy joint venture and ceasing its operations, which contributed 17 percentage points to operating profit growth. This increase also reflects planned cost reductions across a number of expense categories, as well as lower commodity costs, which contributed 6 percentage points to operating profit growth. These impacts were partially offset by higher advertising and marketing expenses, certain operating cost increases and the unfavorable net pricing and mix. The 53 rd reporting week contributed 2 percentage points to operating profit growth, partially offset by incremental investments in our business, which reduced operating profit growth by 1.5 percentage points. North America Beverages % Change Net revenue $ 20,936 $ 21,312 $ 20,618 (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures (1 ) Impact of 53 rd reporting week (1.5 ) Organic revenue growth (a) (2 ) (b) Operating profit $ 2,707 $ 2,959 $ 2,785 (9 ) Restructuring and impairment charges Pension-related settlement benefits (67 ) Operating profit excluding above items (a) $ 2,761 $ 2,994 $ 2,751 (8 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (8 ) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue decreased 2%, primarily reflecting a decline in volume, partially offset by effective net pricing, as well as acquisitions which positively contributed 1 percentage point to the net revenue performance. The 53 rd reporting week in the prior year negatively impacted net revenue performance by 1 percentage point. Volume decreased 3.5%, driven by a 5% decline in CSD volume and a 1% decline in non-carbonated beverage volume. The non-carbonated beverage volume decrease primarily reflected mid-single-digit declines in Gatorade sports drinks and in our juice and juice drinks portfolio, partially offset by a mid-single-digit increase in our overall water portfolio and a low-single-digit increase in Lipton ready-to-drink teas. Acquisitions had a nominal positive contribution to the volume performance. The 53 rd reporting week in the prior year negatively impacted volume performance by 1.5 percentage points. Operating profit decreased 9%, primarily reflecting certain operating cost increases and the net revenue performance, as well as higher commodity costs which negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories and lower advertising and marketing expenses. Costs related to the hurricanes that occurred in the current year negatively impacted operating profit performance by 1 percentage point and were offset by a gain associated with a sale of an asset. In addition, the 53 rd reporting week in the prior year negatively impacted operating profit performance by 1 percentage point and was offset by incremental investments in our business in the prior year. 2016 Net revenue increased 3%, primarily reflecting effective net pricing and volume growth. The 53 rd reporting week contributed 1.5 percentage points to the net revenue growth. Volume increased 2%, driven by a 7% increase in non-carbonated beverage volume, partially offset by a 1% decline in CSD volume. The non-carbonated beverage volume increase primarily reflected a double-digit increase in our overall water portfolio, a mid-single-digit increase in Gatorade sports drinks, and a high- single-digit increase in Lipton ready-to-drink teas. The 53 rd reporting week contributed 1.5 percentage points to the volume growth. Operating profit increased 6%, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as lower commodity costs which contributed 6 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses. The 53 rd reporting week contributed 1.5 percentage points to the operating profit growth. This was partially offset by incremental investments in our business which reduced operating profit growth by 1 percentage point. Items affecting comparability in the above table (see Items Affecting Comparability) reduced operating profit growth by 3 percentage points. Latin America % Change Net revenue $ 7,208 $ 6,820 $ 8,228 (17 ) Impact of foreign exchange translation (1 ) Impact of acquisitions and divestitures 0.5 Impact of Venezuela deconsolidation Organic revenue growth (a) (b) Operating profit/(loss) $ $ $ (206 ) n/m Restructuring and impairment charges Venezuela impairment charges 1,359 Operating profit excluding above items (a) $ $ $ 1,189 (23 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (9 ) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. n/m - Not meaningful due to the impact of impairment charges associated with a change in accounting for our Venezuela operations in 2015. 2017 Net revenue increased 6%, reflecting effective net pricing, partially offset by volume declines. Favorable foreign exchange contributed 1 percentage point to net revenue growth. Snacks volume declined 1.5%, reflecting low-single-digit declines in Brazil and Mexico. Beverage volume declined 2%, reflecting a mid-single-digit decline in Brazil and a low-single-digit decline in Argentina, partially offset by high-single-digit growth in Guatemala. Additionally, Mexico experienced a slight decline. Operating profit increased 2%, reflecting the effective net pricing and planned cost reductions across a number of expense categories. These impacts were partially offset by certain operating cost increases and the volume declines, as well as higher commodity costs which reduced operating profit growth by 17 percentage points. Restructuring and impairment charges in the above table (see Items Affecting Comparability) reduced operating profit growth by 4 percentage points. 2016 Net revenue decreased 17%, reflecting the impact of the deconsolidation of our Venezuelan businesses, effective as of the end of the third quarter of 2015, and unfavorable foreign exchange, which negatively impacted net revenue performance by 14 percentage points and 11 percentage points, respectively. These impacts were partially offset by effective net pricing and net volume growth. Snacks volume grew 3%, reflecting a mid-single-digit increase in Mexico. Additionally, Brazil experienced a slight increase. Beverage volume decreased 2%, reflecting a double-digit decline in Argentina and low-single-digit declines in Mexico and Honduras, partially offset by a low-single-digit increase in Brazil and a mid-single-digit increase in Guatemala. Operating profit improvement primarily reflected the 2015 Venezuela impairment charges, included in items affecting comparability in the above table (see Items Affecting Comparability). This improvement also reflects the effective net pricing, planned cost reductions across a number of expense categories and the net volume growth. Additionally, the impact of 2015 charges associated with productivity initiatives outside the scope of the 2014 and 2012 Productivity Plans contributed 4 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, as well as the deconsolidation of our Venezuelan businesses, which reduced operating profit growth by 19 percentage points. Additionally, higher commodity costs reduced operating profit growth by 22 percentage points, largely due to transaction-related foreign exchange on purchases of raw materials, driven by a strong U.S. dollar. Operating profit was also reduced by higher advertising and marketing expenses, as well as incremental investments in our business, which reduced operating profit growth by 4 percentage points. Unfavorable foreign exchange translation reduced operating profit growth by 14 percentage points. Europe Sub-Saharan Africa % Change Net revenue $ 11,050 $ 10,216 $ 10,510 (3 ) Impact of foreign exchange translation (3 ) Impact of 53 rd reporting week Organic revenue growth (a) (b) Operating profit $ 1,354 $ 1,108 $ 1,081 2.5 Restructuring and impairment charges Operating profit excluding above item (a) $ 1,407 $ 1,168 $ 1,170 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue increased 8%, reflecting volume growth and effective net pricing, as well as favorable foreign exchange, which contributed 3 percentage points to net revenue growth. Snacks volume grew 5%, reflecting high-single-digit growth in Russia, partially offset by a slight decline in the United Kingdom and a low-single-digit decline in Spain. Additionally, Turkey, South Africa and the Netherlands experienced mid-single-digit growth. Beverage volume grew 1%, reflecting mid-single-digit growth in Poland and Nigeria and low-single-digit growth in Turkey and France, partially offset by mid-single-digit declines in Russia and Germany, and a low-single-digit decline in the United Kingdom. Operating profit increased 22%, reflecting the net revenue growth and planned cost reductions across a number of expense categories. Additionally, a gain associated with the sale of our minority stake in Britvic in the second quarter of 2017 contributed 8 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses, as well as higher commodity costs, which reduced operating profit growth by 7 percentage points. 2016 Net revenue decreased 3%, primarily reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 7 percentage points. These impacts were partially offset by effective net pricing and volume growth. Snacks volume grew 3%, primarily reflecting mid-single-digit growth in South Africa and low-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in Russia. Additionally, the United Kingdom, Turkey and Spain experienced low-single-digit growth. Beverage volume grew 2%, primarily reflecting double-digit growth in Nigeria and high-single-digit growth in the United Kingdom and Poland, partially offset by a mid-single-digit decline in Russia and a low-single-digit decline in Germany. Additionally, Turkey and France each experienced low-single-digit growth. Operating profit increased 2.5%, reflecting planned cost reductions across a number of expense categories, the effective net pricing and the volume growth. These impacts were partially offset by higher commodity costs, which reduced operating profit growth by 19 percentage points, largely due to transaction-related foreign exchange on purchases of raw materials led by a strong U.S. dollar. Additionally, certain operating cost increases and higher advertising and marketing expenses reduced operating profit growth. The impact of unfavorable foreign exchange translation and incremental investments in our business also reduced operating profit growth by 6 percentage points and 2 percentage points, respectively. Asia, Middle East and North Africa % Change Net revenue $ 6,030 $ 6,338 $ 6,375 (5 ) (1 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Organic revenue growth (a) (b) Operating profit $ 1,073 $ $ (34 ) Restructuring and impairment charges (3 ) Charges related to the transaction with Tingyi Operating profit excluding above items (a) $ 1,070 $ 1,006 $ 1,044 (4 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (b) (1.5 ) (b) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue decreased 5%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 10 percentage points, primarily driven by a weak Egyptian pound. This impact was partially offset by effective net pricing. Snacks volume grew 5%, driven by high-single-digit growth in China and India and double-digit growth in Pakistan. Additionally, the Middle East experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume declined 1%, reflecting a double-digit decline in India and a mid-single-digit decline in the Middle East, partially offset by mid-single-digit growth in China, high-single-digit growth in Pakistan and low-single-digit growth in the Philippines. Operating profit improvement primarily reflected a prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, included in items affecting comparability in the above table (see Items Affecting Comparability). The effective net pricing and planned cost reductions across a number of expense categories also increased operating profit growth. Additionally, the impact of refranchising our beverage business in Jordan contributed 14 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, as well as higher commodity costs, which reduced operating profit growth by 32 percentage points, primarily due to transaction-related foreign exchange on raw material purchases driven by the weak Egyptian pound. Unfavorable foreign exchange translation reduced operating profit growth by 8 percentage points. 2016 Net revenue declined 1%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 5 percentage points, as well as unfavorable net pricing. These impacts were partially offset by volume growth. Snacks volume grew 7%, reflecting double-digit growth in China and the Middle East and high-single-digit growth in Pakistan. Additionally, India experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume grew 4%, driven by high-single-digit growth in Pakistan, double-digit growth in the Philippines and mid-single-digit growth in China. Additionally, the Middle East experienced low-single-digit growth and India experienced mid-single-digit growth. Operating profit decreased 34%, primarily reflecting the items affecting comparability in the above table (see Items Affecting Comparability). Additionally, operating profit performance was negatively impacted by certain operating cost increases, including strategic initiatives, higher advertising and marketing expenses and the unfavorable net pricing, partially offset by the volume growth and planned cost reductions across a number of expense categories. The impact from a 2015 gain related to the refranchising of a portion of our beverage business in India negatively impacted operating profit performance by 4 percentage points. This impact was partially offset by a 2015 impairment charge associated with a joint venture in the Middle East which positively contributed 3 percentage points to operating profit performance. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments and scheduled debt maturities, include cash from operations and proceeds obtained from issuances of commercial paper and long-term debt. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our credit facilities. See also Our Business Risks and Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. in Item 1A. Risk Factors. As of December 30, 2017 , we had cash, cash equivalents and short-term investments in our consolidated subsidiaries of $18.9 billion outside the United States. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including the $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017, as a result of which we recognized a provisional mandatory transition tax liability of approximately $4 billion in the fourth quarter of 2017. Under the provisions of the TCJ Act, this transition tax must be paid over eight years; we currently expect to pay this liability over the period 2019 to 2026 . The recorded impact of the TCJ Act is provisional and the final amount may differ from the above estimate, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. In addition, as a result of this transition tax, we may access and repatriate our cash, cash equivalents and short-term investments held in our foreign subsidiaries during 2018 without such funds being subject to further U.S. income tax liability. We are currently evaluating when to repatriate such funds currently held by our foreign subsidiaries and how to utilize such funds, including whether to utilize such funds or other available methods of debt financing, such as commercial paper borrowings, for our anticipated share repurchases, dividend payments, scheduled debt maturities, discretionary benefit plan contributions, capital expenditures, certain investments into our business or other uses. See Item 1A. Risk Factors, Our Business Risks, Items Affecting Comparability and Our Critical Accounting Policies as well as Note 5 to our consolidated financial statements. As of December 30, 2017 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,994 $ 10,673 $ 10,864 Net cash used for investing activities $ (4,403 ) $ (7,148 ) $ (3,569 ) Net cash used for financing activities $ (4,186 ) $ (3,211 ) $ (4,112 ) Operating Activities During 2017 , net cash provided by operating activities was approximately $10 billion , compared to $10.7 billion in the prior year. The operating cash flow performance primarily reflects unfavorable working capital comparisons to the prior year. This decrease is mainly due to higher current year payments to vendors and customers, coupled with higher net cash tax payments in the current year, partially offset by lower pension and retiree medical plan contributions in the current year. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to the PepsiCo Employees Retirement Plan A (Plan A) in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. During 2016 , net cash provided by operating activities was $10.7 billion , compared to $10.9 billion in the prior year. The operating cash flow performance reflects discretionary pension contributions of $459 million. In addition, working capital reflects unfavorable comparisons to the prior year. These decreases were partially offset by lower net cash tax payments in the current year. Investing Activities During 2017 , net cash used for investing activities was $4.4 billion , primarily reflecting net capital spending of $2.8 billion and net purchases of debt securities with maturities greater than three months of $1.9 billion. During 2016 , net cash used for investing activities was $7.1 billion , primarily reflecting net purchases of debt securities with maturities greater than three months of $4.1 billion and net capital spending of $2.9 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2018 net capital spending to be approximately $3.6 billion . Financing Activities During 2017 , net cash used for financing activities was $4.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5 billion and net payments of short-term borrowings of $1.1 billion, partially offset by net proceeds from long-term debt of $3.1 billion and proceeds from exercises of stock options of $0.5 billion. During 2016 , net cash used for financing activities was $3.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.2 billion, debt redemptions of $2.5 billion, and withholding tax payments on restricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted of $0.1 billion, partially offset by net proceeds from long-term debt of $4.7 billion, net proceeds from short-term borrowings of $1.5 billion, and proceeds from exercises of stock options of $0.5 billion. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 11, 2015, we announced a share repurchase program providing for the repurchase of up to $12.0 billion of PepsiCo common stock commencing from July 1, 2015 and expiring on June 30, 2018. On February 13, 2018, we announced a new share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock commencing on July 1, 2018 and expiring on June 30, 2021. In addition, on February 13, 2018, we announced a 15.2% increase in our annualized dividend to $3.71 per share from $3.22 per share, effective with the dividend expected to be paid in June 2018. We expect to return a total of approximately $7 billion to shareholders in 2018 through share repurchases of approximately $2 billion and dividends of approximately $5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,994 $ 10,673 $ 10,864 (6 ) (2 ) Capital spending (2,969 ) (3,040 ) (2,758 ) Sales of property, plant and equipment Free cash flow (a) $ 7,205 $ 7,732 $ 8,192 (7 ) (6 ) (a) See Non-GAAP Measures. In addition, when evaluating free cash flow, we also consider the following items impacting comparability: $6 million and $459 million in discretionary pension contributions and associated net cash tax benefits of $1 million and $151 million in 2017 and 2016, respectively; $113 million , $125 million and $214 million of payments related to restructuring charges and associated net cash tax benefits of $30 million, $22 million and $51 million in 2017, 2016 and 2015, respectively; net cash received related to interest rate swaps of $5 million in 2016; net cash tax benefit related to debt redemption charge of $83 million in 2016; and $88 million in pension-related settlements and associated net cash tax benefits of $31 million in 2015. We will also consider payments related to the provisional transition tax liability of approximately $4 billion, which we currently expect to be paid over the period 2019 to 2026 under the provisions of the TCJ Act, as an item impacting comparability. We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. in Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. in Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2019 2021 2023 and beyond Long-term debt obligations (b) $ 33,793 $ $ 7,803 $ 7,209 $ 18,781 Interest on debt obligations (c) 13,371 1,114 1,966 1,637 8,654 Operating leases (d) 1,894 Purchasing commitments (e) 2,910 1,076 1,394 Marketing commitments (e) 1,886 $ 53,854 $ 3,052 $ 12,657 $ 10,043 $ 28,102 (a) Based on year-end foreign exchange rates. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. However, under the provisions of the TCJ Act, our provisional transition tax liability of approximately $4 billion, recorded in other liabilities on our balance sheet, must be paid over eight years. We expect to pay approximately $0.3 billion per year in 2019-2023, $0.6 billion in 2024, $0.9 billion in 2025 and $1.0 billion in 2026 and these amounts are excluded from the table above. (b) Excludes $4,020 million related to current maturities of debt, $3 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $155 million related to unamortized net discount. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 30, 2017 . (d) See Note 13 to our consolidated financial statements for additional information on operating leases. (e) Primarily reflects non-cancelable commitments as of December 30, 2017 . Long-term contractual commitments, except for our long-term debt obligations and provisional transition tax liability, are generally not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges, orange juice and certain other commodities. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in our long-term contractual commitments. See Note 7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo $ 4,857 (a) $ 6,329 $ 5,452 (b) Interest expense 1,151 1,342 Tax on interest expense (415 ) (483 ) (349 ) $ 5,593 $ 7,188 $ 6,073 Average debt obligations (c) $ 38,707 $ 35,308 $ 31,169 Average common shareholders equity (d) 12,004 11,943 15,147 Average invested capital $ 50,711 $ 47,251 $ 46,316 Return on invested capital 11.0 % (a) 15.2 % 13.1 % (b) (a) Includes the provisional impact of the TCJ Act enacted in 2017. See Note 5 to our consolidated financial statements for additional information. (b) Reflects the impact of the Venezuela impairment charges in 2015. (c) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (d) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 11.0 % 15.2 % 13.1 % Impact of: Average cash, cash equivalents and short-term investments 7.6 6.0 4.1 Interest income (0.5 ) (0.2 ) (0.1 ) Tax on interest income 0.2 0.1 Commodity mark-to-market net impact (0.2 ) Restructuring and impairment charges 0.3 0.1 0.2 Provisional net tax expense related to the TCJ Act 4.5 Charges related to the transaction with Tingyi (0.1 ) 0.6 0.1 Pension-related settlement charge/(benefits) 0.3 (0.1 ) Venezuela impairment charges (0.2 ) (0.5 ) 2.7 Tax benefits 0.1 0.1 (0.4 ) Net ROIC, excluding items affecting comparability 22.9 % 21.5 % 19.6 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. With the exception of our provisional net tax expense related to the TCJ Act and the change in 2016 to the full yield approach to estimate the service and interest cost components for our pension and retiree medical plans described below, we applied our critical accounting policies and estimation methods consistently in all material respects, and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers. See Note 2 to our consolidated financial statements for additional information on our revenue recognition and related policies, including total marketplace spending, and the transition to the new revenue recognition guidance, which becomes effective in the first quarter of 2018. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these perpetual brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived, with the balance amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for nonamortizable intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for additional information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit. See Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. in Item 1A. Risk Factors. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further information in Items Affecting Comparability. Included in the provisional net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act and reflected in our provision for income taxes. The recorded impact of the TCJ Act is provisional and the final amount may differ, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. In 2017 , our annual tax rate was 48.9% compared to 25.4% in 2016 , as discussed in Other Consolidated Results. The tax rate increased 23.5 percentage points compared to 2016, primarily as a result of the provisional net tax expense related to the TCJ Act, which contributed 26 percentage points to the increase, partially offset by the impact of the prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in the current year. See Note 2 and Note 5 to our consolidated financial statements for additional information. The TCJ Act is currently expected to reduce our annual tax rate, in percentage terms, to the low twenties in 2018. However, we continue to evaluate the impact of the TCJ Act on our annual tax rate due to certain provisions, such as the global intangible low-tax income (GILTI) provision which may impact our tax rate in future years. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2016, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the combination of two plans effective December 31, 2016, and the spinoff of a portion of the combined plan into a pre-existing plan effective January 1, 2017. The benefits offered to the plans participants were unchanged. The result of the reorganization was the creation of Plan A and the PepsiCo Employees Retirement Plan I (Plan I). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Note 7 to our consolidated financial statements. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine the present value of liabilities and, beginning in 2016, to determine service and interest costs. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. Beginning 2016, we changed the method we use to estimate the service and interest cost components of net periodic benefit cost for our U.S. and the majority of our significant international pension and retiree medical plans. Historically, we estimated the service and interest cost components using a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation (or accumulated post-retirement benefit obligation for the retiree medical plans) at the beginning of the period. We now use a full yield curve approach in the estimation of these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. We have made this change to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates, which we believe will result in a more precise measurement of service and interest costs. This change does not affect the measurement of our benefit obligation. We have accounted for this change in estimate on a prospective basis as of the beginning of 2016. The pre-tax reduction in net periodic benefit cost associated with this change was $125 million ($81 million after-tax or $0.06 per share) for the full year 2016. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 3.7 % 4.3 % 4.5 % Interest cost discount rate 3.2 % 3.5 % 3.8 % Expected rate of return on plan assets (a) 6.9 % 7.2 % 7.2 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 3.6 % 4.0 % 4.3 % Interest cost discount rate 3.0 % 3.2 % 3.3 % Expected rate of return on plan assets (a) 6.5 % 7.5 % 7.5 % Current health care cost trend rate 5.8 % 5.9 % 6.0 % (a) Expected rate of return on plan assets in 2018 reflects a $1.4 billion contribution to Plan A in the United States that we intend to invest in fixed income securities, as well as our 2018 target investment allocations disclosed in Note 7 to our consolidated financial statements. In general, lower discount rates increase the size of the projected benefit obligation and pension expense in the following year, while higher discount rates reduce the size of the projected benefit obligation and pension expense. Based on our assumptions, we expect our total pension and retiree medical expense to remain consistent in 2018 primarily driven by cost savings due to the recognition of prior experience gains on plan assets and the impact of approved plan contributions, partially offset by the change in discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would increase 2018 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $47 Expected rate of return $42 See Note 7 to our consolidated financial statements for additional information about the sensitivity of our retiree medical cost assumptions. Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to Plan A in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. These contributions are reflected in our 2018 long-term expected rate of return on plan assets and target investment allocations. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions except per share amounts) Net Revenue $ 63,525 $ 62,799 $ 63,056 Cost of sales 28,785 28,209 28,731 Gross profit 34,740 34,590 34,325 Selling, general and administrative expenses 24,231 24,805 24,613 Venezuela impairment charges 1,359 Operating Profit 10,509 9,785 8,353 Interest expense (1,151 ) (1,342 ) (970 ) Interest income and other Income before income taxes 9,602 8,553 7,442 Provision for income taxes (See Note 5) 4,694 2,174 1,941 Net income 4,908 6,379 5,501 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 Net Income Attributable to PepsiCo per Common Share Basic $ 3.40 $ 4.39 $ 3.71 Diluted $ 3.38 $ 4.36 $ 3.67 Weighted-average common shares outstanding Basic 1,425 1,439 1,469 Diluted 1,438 1,452 1,485 Cash dividends declared per common share $ 3.1675 $ 2.96 $ 2.7625 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Net income $ 4,908 $ 6,379 $ 5,501 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment 1,109 (302 ) (2,827 ) Net change on cash flow hedges (36 ) Net pension and retiree medical adjustments (159 ) (316 ) Net change on securities (68 ) (24 ) Other (596 ) (2,652 ) Comprehensive income 5,770 5,783 2,849 Comprehensive income attributable to noncontrolling interests (51 ) (54 ) (47 ) Comprehensive Income Attributable to PepsiCo $ 5,719 $ 5,729 $ 2,802 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Operating Activities Net income $ 4,908 $ 6,379 $ 5,501 Depreciation and amortization 2,369 2,368 2,416 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges (113 ) (125 ) (208 ) Charges related to the transaction with Tingyi Venezuela impairment charges 1,359 Pension and retiree medical plan expenses Pension and retiree medical plan contributions (220 ) (695 ) (205 ) Deferred income taxes and other tax charges and credits Provisional net tax expense related to the TCJ Act 2,451 Change in assets and liabilities: Accounts and notes receivable (202 ) (349 ) (461 ) Inventories (168 ) (75 ) (244 ) Prepaid expenses and other current assets (50 ) Accounts payable and other current liabilities 1,692 Income taxes payable (338 ) Other, net (341 ) (134 ) Net Cash Provided by Operating Activities 9,994 10,673 10,864 Investing Activities Capital spending (2,969 ) (3,040 ) (2,758 ) Sales of property, plant and equipment Acquisitions and investments in noncontrolled affiliates (61 ) (212 ) (86 ) Reduction of cash due to Venezuela deconsolidation (568 ) Divestitures Short-term investments, by original maturity: More than three months - purchases (18,385 ) (12,504 ) (4,428 ) More than three months - maturities 15,744 8,399 4,111 More than three months - sales Three months or less, net Other investing, net (5 ) Net Cash Used for Investing Activities (4,403 ) (7,148 ) (3,569 ) Financing Activities Proceeds from issuances of long-term debt 7,509 7,818 8,702 Payments of long-term debt (4,406 ) (3,105 ) (4,095 ) Debt redemptions (2,504 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments (128 ) (27 ) (43 ) Three months or less, net (1,016 ) 1,505 Cash dividends paid (4,472 ) (4,227 ) (4,040 ) Share repurchases - common (2,000 ) (3,000 ) (5,000 ) Share repurchases - preferred (5 ) (7 ) (5 ) Proceeds from exercises of stock options Withholding tax payments on RSUs, PSUs and PEPunits converted (145 ) (130 ) (151 ) Other financing (76 ) (58 ) (52 ) Net Cash Used for Financing Activities (4,186 ) (3,211 ) (4,112 ) Effect of exchange rate changes on cash and cash equivalents (252 ) (221 ) Net Increase in Cash and Cash Equivalents 1,452 2,962 Cash and Cash Equivalents, Beginning of Year 9,158 9,096 6,134 Cash and Cash Equivalents, End of Year $ 10,610 $ 9,158 $ 9,096 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 30, 2017 and December 31, 2016 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 10,610 $ 9,158 Short-term investments 8,900 6,967 Accounts and notes receivable, net 7,024 6,694 Inventories 2,947 2,723 Prepaid expenses and other current assets 1,546 Total Current Assets 31,027 26,450 Property, Plant and Equipment, net 17,240 16,591 Amortizable Intangible Assets, net 1,268 1,237 Goodwill 14,744 14,430 Other nonamortizable intangible assets 12,570 12,196 Nonamortizable Intangible Assets 27,314 26,626 Investments in Noncontrolled Affiliates 2,042 1,950 Other Assets Total Assets $ 79,804 $ 73,490 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 5,485 $ 6,892 Accounts payable and other current liabilities 15,017 14,243 Total Current Liabilities 20,502 21,135 Long-Term Debt Obligations 33,796 30,053 Other Liabilities 11,283 6,669 Deferred Income Taxes 3,242 4,434 Total Liabilities 68,823 62,291 Commitments and contingencies Preferred Stock, no par value Repurchased Preferred Stock (197 ) (192 ) PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares, issued, net of repurchased common stock at par value: 1,420 and 1,428 shares, respectively) Capital in excess of par value 3,996 4,091 Retained earnings 52,839 52,518 Accumulated other comprehensive loss (13,057 ) (13,919 ) Repurchased common stock, in excess of par value (446 and 438 shares, respectively) (32,757 ) (31,468 ) Total PepsiCo Common Shareholders Equity 11,045 11,246 Noncontrolling interests Total Equity 10,981 11,199 Total Liabilities and Equity $ 79,804 $ 73,490 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock 0.8 $ 0.8 $ 0.8 $ Repurchased Preferred Stock Balance, beginning of year (0.7 ) (192 ) (0.7 ) (186 ) (0.7 ) (181 ) Redemptions (5 ) (6 ) (5 ) Balance, end of year (0.7 ) (197 ) (0.7 ) (192 ) (0.7 ) (186 ) Common Stock Balance, beginning of year 1,428 1,448 1,488 Change in repurchased common stock (8 ) (20 ) (40 ) (1 ) Balance, end of year 1,420 1,428 1,448 Capital in Excess of Par Value Balance, beginning of year 4,091 4,076 4,115 Share-based compensation expense Stock option exercises, RSUs, PSUs and PEPunits converted (a) (236 ) (138 ) (182 ) Withholding tax on RSUs, PSUs and PEPunits converted (145 ) (130 ) (151 ) Other (4 ) (6 ) (5 ) Balance, end of year 3,996 4,091 4,076 Retained Earnings Balance, beginning of year 52,518 50,472 49,092 Net income attributable to PepsiCo 4,857 6,329 5,452 Cash dividends declared - common (4,536 ) (4,282 ) (4,071 ) Cash dividends declared - preferred (1 ) (1 ) Balance, end of year 52,839 52,518 50,472 Accumulated Other Comprehensive Loss Balance, beginning of year (13,919 ) (13,319 ) (10,669 ) Other comprehensive income/(loss) attributable to PepsiCo (600 ) (2,650 ) Balance, end of year (13,057 ) (13,919 ) (13,319 ) Repurchased Common Stock Balance, beginning of year (438 ) (31,468 ) (418 ) (29,185 ) (378 ) (24,985 ) Share repurchases (18 ) (2,000 ) (29 ) (3,000 ) (52 ) (4,999 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year (446 ) (32,757 ) (438 ) (31,468 ) (418 ) (29,185 ) Total PepsiCo Common Shareholders Equity 11,045 11,246 12,068 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests (62 ) (55 ) (48 ) Currency translation adjustment (2 ) Other, net (1 ) (2 ) (2 ) Balance, end of year Total Equity $ 10,981 $ 11,199 $ 12,030 (a) Includes total tax benefits of $110 million in 2016 and $107 million in 2015 . See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50% or less. Intercompany balances and transactions are eliminated. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Effective as of the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries from our consolidated financial statements and began accounting for our investments in our wholly-owned Venezuelan subsidiaries and joint venture using the cost method of accounting. See subsequent discussion of Venezuela. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. Our fiscal 2016 results included an extra week. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. Certain operations in our ESSA segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks (17 weeks for 2016) September, October, November and December See Our Divisions below, and for additional unaudited information on items affecting the comparability of our consolidated results, see further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years financial statements to conform to the current year presentation, including the adoption of the recently issued accounting pronouncements disclosed in Note 2. Our Divisions Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in North America, Mexico, Russia, the United Kingdom and Brazil. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions and are considered our reportable segments. For additional unaudited information on our divisions, see Our Operations contained in Item 1. Business. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense in 2017 was approximately 13% to FLNA, 1% to QFNA, 18% to NAB, 7% to Latin America, 9% to ESSA, 9% to AMENA and 43% to corporate unallocated expenses. In 2016 , the allocation of share-based compensation expense was approximately 14% to FLNA, 2% to QFNA, 22% to NAB, 7% to Latin America, 11% to ESSA, 10% to AMENA and 34% to corporate unallocated expenses. We had similar allocations of share-based compensation expense to our divisions in 2015 . The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates, as well as amortization of costs related to certain pension plan amendments and gains and losses due to demographics (including mortality assumptions and salary experience) are reflected in division results. Division results also include interest costs, measured at fixed discount rates, for retiree medical plans. Interest costs for the pension plans, pension asset returns and the impact of pension funding, and gains and losses other than those due to demographics, are all reflected in corporate unallocated expenses. In addition, corporate unallocated expenses include the difference between the service costs included in division results and total service costs determined using the plans discount rates as disclosed in Note 7. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit/(loss) of each division are as follows: Net Revenue Operating Profit/(Loss) (a) FLNA $ 15,798 $ 15,549 $ 14,782 $ 4,823 $ 4,659 $ 4,304 QFNA 2,503 2,564 2,543 NAB 20,936 21,312 20,618 2,707 2,959 2,785 Latin America 7,208 6,820 8,228 (206 ) ESSA 11,050 10,216 10,510 1,354 1,108 1,081 AMENA 6,030 6,338 6,375 1,073 Total division 63,525 62,799 63,056 11,507 10,885 9,465 Corporate unallocated (998 ) (1,100 ) (1,112 ) $ 63,525 $ 62,799 $ 63,056 $ 10,509 $ 9,785 $ 8,353 (a) For further unaudited information on certain items that impacted our financial performance, see Item 6. Selected Financial Data. Corporate Unallocated Corporate unallocated includes costs of our corporate headquarters, centrally managed initiatives such as research and development projects, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, commodity derivative gains and losses, our ongoing business transformation initiatives and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 5,979 $ 5,731 $ $ $ QFNA NAB 28,592 28,172 Latin America 4,976 4,568 ESSA 13,556 12,302 AMENA 5,668 5,261 Total division 59,575 56,845 2,883 2,938 2,556 Corporate (a) 20,229 16,645 $ 79,804 $ 73,490 $ 2,969 $ 3,040 $ 2,758 (a) Corporate assets consist principally of certain cash and cash equivalents, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2017 , the change in total Corporate assets was primarily due to an increase in short-term investments and cash and cash equivalents. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA NAB Latin America ESSA AMENA Total division 2,107 2,120 2,175 Corporate $ $ $ $ 2,301 $ 2,298 $ 2,341 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 36,546 $ 36,732 $ 35,266 $ 28,418 $ 28,382 Mexico 3,650 3,431 3,687 1,205 Russia (b) 3,232 2,648 2,797 4,708 4,373 Canada 2,691 2,692 2,677 2,739 2,499 United Kingdom 1,650 1,737 1,966 Brazil 1,427 1,305 1,289 All other countries 14,329 14,254 15,374 9,200 8,504 $ 63,525 $ 62,799 $ 63,056 $ 47,864 $ 46,404 (a) Long-lived assets represent property, plant and equipment, nonamortizable intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. (b) Change in net revenue and long-lived assets in 2017 primarily reflects appreciation of the Russian ruble. Venezuela Due to exchange restrictions and other conditions that significantly impact our ability to effectively manage our businesses in Venezuela and realize earnings generated by our Venezuelan businesses, effective at the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries and began accounting for our investments in our Venezuelan subsidiaries and joint venture using the cost method of accounting. We recorded pre- and after-tax charges of $1.4 billion in our income statement to reduce the value of the cost method investments to their estimated fair values, resulting in a full impairment. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the end of 2017. We do not have any guarantees related to our Venezuelan entities, and our ongoing contractual commitments to our Venezuelan businesses are not material. We will recognize income from dividends and sales of inventory to our Venezuelan entities, which have not been and are not expected to be material, to the extent cash in U.S. dollars is received. We have not received any cash in U.S. dollars from our Venezuelan entities since our deconsolidation at the end of the third quarter of 2015. We continue to monitor the conditions in Venezuela and their impact on our accounting and disclosures. For further unaudited information, see Our Business Risks, Items Affecting Comparability and Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses in our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2017 , sales to Walmart (including Sams) represented approximately 13% of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Up-front payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $262 million as of December 30, 2017 and $291 million as of December 31, 2016 are included in prepaid expenses and other current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see Our Customers in Item 1. Business and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $4.1 billion in 2017 , $4.2 billion in 2016 and $3.9 billion in 2015 , including advertising expenses of $2.4 billion in 2017 , $2.5 billion in 2016 and $2.4 billion in 2015 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $46 million and $32 million as of December 30, 2017 and December 31, 2016 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $9.9 billion in 2017 , $9.7 billion in 2016 and $9.4 billion in 2015 . Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include(i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software projects and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $224 million in 2017 , $214 million in 2016 and $202 million in 2015 . Net capitalized software and development costs were $686 million and $791 million as of December 30, 2017 and December 31, 2016 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional unaudited information on our commitments, see Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $737 million , $760 million and $ 754 million in 2017 , 2016 and 2015 , respectively, and are reported within selling, general and administrative expenses. See Research and Development in Item 1. Business for additional unaudited information about our research and development activities. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment of indefinite-lived intangible assets, if the carrying amount of the indefinite-lived intangible asset exceeds its estimated fair value, as determined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. Quantitative assessment of goodwill is performed using a two-step impairment test at the reporting unit level. A reporting unit can be a division or business within a division. The first step compares the carrying value of a reporting unit, including goodwill, with its estimated fair value, as determined by its discounted cash flows. If the carrying value of a reporting unit exceeds its estimated fair value, we complete the second step to determine the amount of goodwill impairment loss that we should record, if any. In the second step, we determine an implied fair value of the reporting units goodwill by allocating the estimated fair value of the reporting unit to all of the assets and liabilities other than goodwill (including any unrecognized intangible assets). The amount of impairment loss is equal to the excess of the carrying value of the goodwill over the implied fair value of that goodwill. The quantitative assessment described above requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for nonamortizable intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See also Note 4, and for additional unaudited information on goodwill and other intangible assets, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 - Basis of Presentation for a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Financial Instruments Note 9, and for additional unaudited information, see Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Inventories Note 13. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2017, the SEC issued guidance related to the TCJ Act which allows recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective during our fourth quarter of 2017, resulting in a provisional net tax expense of $2.5 billion . This provisional net tax expense was recorded based on information available to us prior to the issuance of our 2017 consolidated financial statements, may be subject to further revision as disclosed in Note 5, and will be finalized no later than the end of 2018. In 2016, the Financial Accounting Standards Board (FASB) issued guidance that changes the accounting for certain aspects of share-based payments to employees. We adopted the provisions of this guidance during our first quarter of 2017, resulting in the following impacts to our financial statements: Income tax effects of vested or settled awards were recognized in the provision for income taxes on our income statement on a prospective basis. Previously, these tax effects were recorded on our equity statement in capital in excess of par value. For the year ended December 30, 2017, our excess tax benefits were $115 million , resulting in a $0.08 increase to diluted net income attributable to PepsiCo per common share. For the years ended December 31, 2016 and December 26, 2015, our excess tax benefits recognized were $110 million and $107 million , respectively. If we had applied this standard in 2016 and 2015, there would have been a $0.07 increase to diluted net income attributable to PepsiCo per common share for both years. The ongoing impact on our financial statements is dependent on the timing of when awards vest or are exercised, our tax rate and the intrinsic value when awards vest or are exercised. Excess tax benefits are retrospectively presented within operating activities and withholding tax payments upon vesting of RSUs, PSUs and PEPunits are retrospectively presented within financing activities in the cash flow statement. The adoption resulted in an increase of $295 million , $269 million and $284 million in our operating cash flow with a corresponding decrease in our financing cash flow for the years ended December 30, 2017, December 31, 2016 and December 26, 2015, respectively. The guidance also allows for the employer to repurchase more of an employees shares, up to the maximum statutory rate, for tax withholding purposes and not classify the award as a liability that requires valuation on a mark-to-market basis. Our accounting treatment for outstanding awards was not impacted by our adoption of this provision. In addition, the guidance allows for a policy election to account for forfeitures as they occur. We will continue to apply our policy of estimating forfeitures. In 2016, the FASB issued guidance that eliminates the requirement that an investor retrospectively apply equity method accounting for an investment originally accounted for by another method. The guidance requires that an equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investors previously held interest and adopt the equity method of accounting as of the date the investors ability to exercise significant influence over the investment is achieved. We adopted the provisions of this guidance prospectively during our first quarter of 2017; the adoption did not impact our financial statements. In 2015, the FASB issued guidance that requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet. We adopted the provisions of this guidance retrospectively during our first quarter of 2017, resulting in the reclassification of $639 million of deferred taxes from current to non-current on our balance sheet as of December 31, 2016. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. The guidance is effective beginning in 2019 with early adoption permitted. We are currently evaluating the impact of this guidance, including transition elections and required disclosures, on our financial statements and the timing of adoption. In 2017, the FASB issued guidance that requires companies to retrospectively present the service cost component of net periodic benefit cost for pension and retiree medical plans along with other compensation costs in operating profit and present the other components of net periodic benefit cost below operating profit in the income statement. The guidance also allows only the service cost component of net periodic benefit cost to be eligible for capitalization within inventory or fixed assets on a prospective basis. We will adopt the guidance when it becomes effective in the first quarter of 2018. We will also update our allocation of service costs to our divisions starting in 2018 to better approximate actual service cost. In connection with this adoption, we expect to record a decrease in operating profit of $ 233 million for the year ended December 30, 2017 and an increase in operating profit of $ 19 million for the year ended December 31, 2016, primarily impacting selling, general and administrative expenses. See Note 7 for further information on our service cost and other components of net periodic benefit cost for pension and retiree medical plans. In 2016, the FASB issued guidance to clarify how restricted cash should be presented in the cash flow statement. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In 2016, the FASB issued guidance that requires companies to account for the income tax effects of intercompany transfers of assets, other than inventory, when the transfer occurs versus deferring income tax effects until the transferred asset is sold to an outside party or otherwise recognized. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In 2016, the FASB issued guidance that requires lessees to recognize most leases on the balance sheet, but record expenses on the income statement in a manner similar to current accounting. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The guidance is effective beginning in 2019 with early adoption permitted. We are currently evaluating the impact of this guidance on our financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. To facilitate this, we are utilizing a comprehensive approach to review our lease portfolio, as well as assessing system requirements and control implications. We have identified our significant leases by geography and by asset type that will be impacted by the new guidance, as well as a software tool to begin tracking the requirements of the guidance. In addition, we are currently evaluating the timing of adoption of this guidance. See Note 13 for our minimum lease payments under non-cancelable operating leases. In 2016, the FASB issued guidance that requires companies to measure investments in certain equity securities at fair value and recognize any changes in fair value in net income. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In the second quarter of 2017, we sold our minority stake in Britvic, representing all of our available-for-sale equity securities, which reduced the risk and volatility of these investments in our income statement in the future. See Note 9 for further information on our available-for-sale securities. In 2014, the FASB issued guidance on revenue recognition, with final amendments issued in 2016. The guidance provides for a five-step model to determine the revenue recognized for the transfer of goods or services to customers that reflects the expected entitled consideration in exchange for those goods or services. It also provides clarification for principal versus agent considerations and identifying performance obligations. In addition, the FASB introduced practical expedients related to disclosures of remaining performance obligations, as well as other amendments related to guidance on collectibility, non-cash consideration and the presentation of sales and other similar taxes. Financial statement disclosures required under the guidance will enable users to understand the nature, amount, timing, judgments and uncertainty of revenue and cash flows relating to customer contracts. The two permitted transition methods under the guidance are the full retrospective approach or a cumulative effect adjustment to the opening retained earnings in the year of adoption (cumulative effect approach). We will adopt the guidance using the cumulative effect approach when it becomes effective in the first quarter of 2018. We are utilizing a comprehensive approach to assess the impact of the guidance on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the new requirements to our revenue contracts, including evaluation of our performance obligations, principal versus agent considerations and variable consideration. We are substantially complete with our contract and business process reviews and implemented changes to our controls to support recognition and disclosures under the new guidance. As a result of implementing certain changes to our accounting policies upon adoption, we plan to record an adjustment to opening retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition; exclude all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions from net revenue and cost of sales; and to record shipping and handling activities that are performed after a customer obtains control of the product as a fulfillment cost. Based on the foregoing, we currently do not expect this guidance to have a material impact on our financial statements or disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2014 Productivity Plan $ $ $ 2012 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, includes the next generation of productivity initiatives that we believe will strengthen our food, snack and beverage businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the successful implementation of the 2014 Productivity Plan to date, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives described above to further strengthen our food, snack and beverage businesses. In 2017 , 2016 and 2015 , we incurred restructuring charges of $295 million ($ 224 million after-tax or $0.16 per share), $160 million ( $131 million after-tax or $0.09 per share) and $169 million ( $134 million after-tax or $0.09 per share), respectively, in conjunction with our 2014 Productivity Plan. All of these charges were recorded in selling, general and administrative expenses and primarily relate to severance and other employee-related costs, asset impairments (all non-cash), and other costs associated with the implementation of our initiatives, including contract termination costs. Substantially all of the restructuring accrual at December 30, 2017 is expected to be paid by the end of 2018 . A summary of our 2014 Productivity Plan charges is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Severance and Other Employee Costs Asset Impairments Other Costs Total Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA (a) $ $ $ $ $ $ $ $ $ $ (1 ) $ $ QFNA NAB Latin America (a) (10 ) (2 ) ESSA AMENA (b) (5 ) (3 ) Corporate $ $ $ (6 ) $ $ $ $ $ $ $ $ $ (a) Income amounts represent adjustments for changes in estimates. (b) Income amount primarily reflects a gain on the sale of property, plant and equipment. Since the inception of the 2014 Productivity Plan, we incurred restructuring charges of $1,034 million : 2014 Productivity Plan Costs to Date Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ 1,034 A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 27, 2014 $ $ $ $ 2015 restructuring charges Cash payments (76 ) (87 ) (163 ) Non-cash charges and translation (11 ) (24 ) (3 ) (38 ) Liability as of December 26, 2015 2016 restructuring charges Cash payments (46 ) (49 ) (95 ) Non-cash charges and translation (15 ) (36 ) (50 ) Liability as of December 31, 2016 2017 restructuring charges (6 ) Cash payments (91 ) (22 ) (113 ) Non-cash charges and translation (65 ) (21 ) (52 ) Liability as of December 30, 2017 $ $ $ $ 2012 Multi-Year Productivity Plan The 2012 Productivity Plan, publicly announced on February 9, 2012, included actions in every aspect of our business that we believe would strengthen our complementary food, snack and beverage businesses. In 2015 , we incurred restructuring charges of $61 million ( $50 million after-tax or $0.03 per share) in conjunction with our 2012 Productivity Plan. All of these charges were recorded in selling, general and administrative expenses and primarily related to severance and other employee-related costs, asset impairments (all non-cash) and contract termination costs. The 2012 Productivity Plan was completed in 2016 and all cash payments were paid by the end of 2016. A summary of our 2012 Productivity Plan charges in 2015 is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ 95 Since the inception of the 2012 Productivity Plan, we incurred restructuring charges of $894 million : 2012 Productivity Plan Costs to Date Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ A summary of our 2012 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 27, 2014 $ $ $ $ 2015 restructuring charges Cash payments (24 ) (21 ) (45 ) Non-cash charges and translation (8 ) (4 ) (11 ) Liability as of December 26, 2015 Cash payments (28 ) (2 ) (30 ) Non-cash charges and translation (7 ) (1 ) (8 ) Liability as of December 31, 2016 $ $ $ $ Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2014 and 2012 Productivity Plans in 2017 and 2016. In 2015, we incurred charges of $90 million ( $66 million after-tax or $0.04 per share) related to other productivity and efficiency initiatives outside the scope of the 2014 and 2012 Productivity Plans. These charges were recorded in selling, general and administrative expenses and primarily reflect severance and other employee-related costs and asset impairments (all non-cash). These initiatives were not included in items affecting comparability. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. See additional unaudited information in Items Affecting Comparability and Results of Operations Division Review in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,148 $ 1,153 Buildings and improvements 15 - 44 8,796 8,306 Machinery and equipment, including fleet and software 5 - 15 27,018 25,277 Construction in progress 2,144 2,082 39,106 36,818 Accumulated depreciation (21,866 ) (20,227 ) $ 17,240 $ 16,591 Depreciation expense $ 2,227 $ 2,217 $ 2,248 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Amortizable intangible assets, net Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights 56 60 $ $ (128 ) $ $ $ (108 ) $ Reacquired franchise rights 5 14 (104 ) (102 ) Brands 20 40 1,322 (1,026 ) 1,277 (977 ) Other identifiable intangibles 10 24 (281 ) (308 ) $ 2,807 $ (1,539 ) $ 1,268 $ 2,732 $ (1,495 ) $ 1,237 Amortization expense $ $ $ Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 30, 2017 and using average 2017 foreign exchange rates, is expected to be as follows: 2019 Five-year projected amortization $ $ $ $ $ 96 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our policies for amortizable brands, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Nonamortizable Intangible Assets We did not recognize any impairment charges for goodwill in each of the fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . We recognized no material impairment charges for nonamortizable intangible assets in each of the fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . As of December 30, 2017 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at NAB exceeded their carrying values. However, there could be an impairment of the carrying value of NABs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of NABs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there is no impairment as of December 30, 2017 . However, there could be an impairment of the carrying value of certain brands in these countries if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For additional information on our policies for nonamortizable intangible assets, see Note 2. The change in the book value of nonamortizable intangible assets is as follows: Balance, Beginning 2016 Translation and Other Balance, End of 2016 Translation and Other Balance, End of 2017 FLNA Goodwill $ $ $ $ $ Brands 289 QFNA Goodwill NAB Goodwill (a) 9,754 9,843 9,854 Reacquired franchise rights 7,042 7,064 7,126 Acquired franchise rights 1,507 1,512 1,525 Brands (a) 18,411 18,733 18,858 Latin America Goodwill Brands (9 ) 658 (7 ) ESSA (b) Goodwill 3,042 3,177 3,452 Reacquired franchise rights Acquired franchise rights (6 ) Brands 2,212 2,358 2,545 5,932 6,207 6,741 AMENA Goodwill (6 ) Brands (2 ) 523 (8 ) Total goodwill 14,177 14,430 14,744 Total reacquired franchise rights 7,530 7,552 7,675 Total acquired franchise rights 1,697 (1 ) 1,696 1,720 Total brands 2,584 2,948 3,175 $ 25,988 $ $ 26,626 $ $ 27,314 (a) The change in 2016 is primarily related to our acquisition of KeVita, Inc. (b) The change in 2017 primarily reflects the currency appreciation of the Russian ruble and euro. The change in 2016 primarily reflects the currency appreciation of the Russian ruble. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 3,452 $ 2,630 $ 2,879 Foreign 6,150 5,923 4,563 $ 9,602 $ 8,553 $ 7,442 The provision for income taxes consisted of the following: Current: U.S. Federal $ 4,925 $ 1,219 $ 1,143 Foreign State 5,785 2,120 1,981 Deferred: U.S. Federal (1,159 ) (14 ) Foreign (9 ) (33 ) (32 ) State (22 ) (1,091 ) (40 ) $ 4,694 $ 2,174 $ 1,941 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 35.0 % 35.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 0.9 0.4 0.6 Lower taxes on foreign results (9.4 ) (8.0 ) (10.5 ) Impact of Venezuela impairment charges 6.4 Provisional one-time mandatory transition tax - TCJ Act 41.4 Provisional remeasurement of deferred taxes - TCJ Act (15.9 ) Tax settlements (3.1 ) Other, net (3.1 ) (2.0 ) (2.3 ) Annual tax rate 48.9 % 25.4 % 26.1 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Included in the provisional net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. The TCJ Act also creates a new requirement that certain income earned by foreign subsidiaries, known as GILTI, must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. Due to the complexity of calculating GILTI under the new law, we have not determined which method we will apply. Therefore, we have not made any adjustments related to potential GILTI tax in our financial statements. We expect to elect an accounting policy in the first quarter of 2018. The components of the provisional net tax expense recorded in 2017 are based on currently available information and additional information needs to be prepared, obtained and/or analyzed to determine the final amounts. The provisional tax expense for the mandatory repatriation of undistributed international earnings will require further analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as estimated cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries. The provisional tax benefit for the remeasurement of deferred taxes will require additional information necessary for the preparation of our U.S. federal tax return, and further analysis and interpretation of certain provisions of the TCJ Act impacting deferred taxes, for example 100% expensing of qualified assets as well as our accounting policy election for recognizing deferred taxes for GILTI, could impact our deferred tax balance as of December 30, 2017. Tax effects for these items will be recorded in subsequent quarters, as discrete adjustments to our income tax provision, once complete. The SEC has issued guidance that allows for a measurement period of up to one year after the enactment date of the TCJ Act to finalize the recording of the related tax impacts. We currently anticipate finalizing and recording any resulting adjustments by the end of 2018. The recorded impact of the TCJ Act is provisional and the final amount may differ, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For further unaudited information and discussion of the potential impact of the TCJ Act, refer to Item 1A. Risk Factors, Our Business Risks, Our Liquidity and Capital Resources and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Deferred tax liabilities and assets are comprised of the following: Deferred Tax Liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,397 1,967 Intangible assets other than nondeductible goodwill 3,169 4,124 Other Gross deferred tax liabilities 5,194 7,175 Deferred tax assets Net carryforwards 1,400 1,255 Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Other Gross deferred tax assets 3,115 3,851 Valuation allowances (1,163 ) (1,110 ) Deferred tax assets, net 1,952 2,741 Net deferred tax liabilities $ 3,242 $ 4,434 A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 1,110 $ 1,136 $ 1,230 Provision/(benefit) (26 ) Other additions/(deductions) (39 ) (68 ) Balance, end of year $ 1,163 $ 1,110 $ 1,136 For additional unaudited information on our income tax policies, including our reserves for income taxes, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2012-2016 2012-2013 Mexico 2014-2016 United Kingdom 2014-2016 None Canada (Domestic) 2013-2016 2013-2014 Canada (International) 2010-2016 2010-2014 Russia 2012-2016 2012-2016 While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. For further unaudited information on the impact of the resolution of open tax issues, see Other Consolidated Results in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2015, we reached an agreement with the IRS resolving substantially all open matters related to the audits of taxable years 2010 and 2011. The agreement resulted in a 2015 non-cash tax benefit totaling $230 million . As of December 30, 2017 , the total gross amount of reserves for income taxes, reported in other liabilities, was $2.2 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $283 million as of December 30, 2017 , of which $89 million of expense was recognized in 2017 . The gross amount of interest accrued, reported in other liabilities, was $193 million as of December 31, 2016 , of which $61 million of expense was recognized in 2016 . A reconciliation of unrecognized tax benefits, is as follows: Balance, beginning of year $ 1,885 $ 1,547 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years (51 ) (70 ) Settlement payments (4 ) (26 ) Statutes of limitations expiration (33 ) (27 ) Translation and other (27 ) Balance, end of year $ 2,212 $ 1,885 Carryforwards and Allowances Operating loss carryforwards totaling $12.6 billion at year-end 2017 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2 billion in 2018 , $11.1 billion between 2019 and 2037 and $1.3 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings As of December 30, 2017 , we had approximately $42.5 billion of undistributed international earnings. We intend to repatriate approximately $20 billion of our foreign earnings back to the United States and have recognized all tax expense on these earnings in the fourth quarter of 2017. We intend to continue to reinvest the remaining $22.5 billion of earnings outside the United States for the foreseeable future and while U.S. federal tax expense has been recognized as a result of the TCJ Act, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and, beginning in 2016, were granted 66% PSUs and 34% long-term cash, each of which are subject to pre-established performance targets. Previously, they were granted a combination of 60% PEPunits measuring both absolute and relative stock price performance and 40% long-term cash based on achievement of specific performance operating metrics. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 30, 2017 , 74 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring and impairment (credits)/charges (2 ) Total $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ (a) $ $ (a) Reflects tax rates effective for the 2017 tax year. As of December 30, 2017 , there was $314 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years. Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years. Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 6 years 7 years Risk-free interest rate 2.0 % 1.4 % 1.8 % Expected volatility % % % Expected dividend yield 2.7 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 30, 2017 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 31, 2016 25,190 $ 69.88 Granted 1,481 $ 110.15 Exercised (7,136 ) $ 65.31 Forfeited/expired (522 ) $ 88.36 Outstanding at December 30, 2017 19,013 $ 74.23 4.22 $ 868,750 Exercisable at December 30, 2017 14,589 $ 65.60 3.02 $ 792,560 Expected to vest as of December 30, 2017 3,994 $ 102.50 8.15 $ 69,578 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs is measured at the market price of the Companys stock on the date of grant. The fair value of PSUs is measured at the market price of the Companys stock on the date of grant with the exception of awards with market conditions, for which we use the Monte-Carlo simulation model to determine the fair value. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. A summary of our RSU and PSU activity for the year ended December 30, 2017 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 31, 2016 8,237 $ 91.81 Granted (b) 2,824 $ 109.92 Converted (3,226 ) $ 82.56 Forfeited (608 ) $ 100.17 Actual performance change (c) $ 100.33 Outstanding at December 30, 2017 (d) 7,293 $ 102.30 1.33 $ 874,517 Expected to vest as of December 30, 2017 6,695 $ 102.00 1.26 $ 802,826 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 30, 2017 , at the threshold, target and maximum award levels were zero , 0.9 million and 1.5 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three -year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model. A summary of our PEPunit activity for the year ended December 30, 2017 is as follows: PEPunits (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 31, 2016 $ 59.86 Converted (363 ) $ 49.11 Forfeited (13 ) $ 68.94 Actual performance change (b) $ 50.74 Outstanding at December 30, 2017 (c) $ 68.94 0.17 $ 29,734 Expected to vest as of December 30, 2017 $ 68.94 0.17 $ 28,034 (a) In thousands. (b) Reflects the net number of PEPunits above and below target levels based on actual performance measured at the end of the performance period. (c) The outstanding PEPunits for which the performance period has not ended as of December 30, 2017 , at the threshold, target and maximum award levels were zero , 0.2 million and 0.4 million , respectively. Long-Term Cash Beginning in 2016, certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model until actual performance is determined. A summary of our long-term cash activity for the year ended December 30, 2017 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 31, 2016 $ 15,670 Granted (b) 19,060 Forfeited (1,530 ) Outstanding at December 30, 2017 (c) $ 33,200 $ 32,592 1.73 Expected to vest as of December 30, 2017 $ 29,590 $ 29,092 1.71 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) The outstanding long-term cash awards for which the performance period has not ended as of December 30, 2017, at the threshold, target and maximum award levels were zero , $33.2 million and $66.4 million, respectively. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,481 1,743 1,884 Weighted-average grant-date fair value of options granted $ 8.25 $ 6.94 $ 10.80 Total intrinsic value of options exercised (a) $ 327,860 $ 290,131 $ 366,188 Total grant-date fair value of options vested (a) $ 23,122 $ 18,840 $ 21,837 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,824 3,054 2,759 Weighted-average grant-date fair value of RSUs/PSUs granted $ 109.92 $ 99.06 $ 99.17 Total intrinsic value of RSUs/PSUs converted (a) $ 380,269 $ 359,401 $ 375,510 Total grant-date fair value of RSUs/PSUs vested (a) $ 264,923 $ 257,648 $ 257,831 PEPunits Total number of PEPunits granted (a) Weighted-average grant-date fair value of PEPunits granted $ $ $ 68.94 Total intrinsic value of PEPunits converted (a) $ 39,782 $ 38,558 $ 37,705 Total grant-date fair value of PEPunits vested (a) $ 18,833 $ 16,572 $ 22,286 (a) In thousands. As of December 30, 2017 and December 31, 2016 , there were approximately 250,000 and 254,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ( $162 million after-tax or $0.11 per share). See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Effective as of the beginning of 2016, we prospectively changed the method we use to estimate the service and interest cost components of net periodic benefit cost. The pre-tax reduction in net periodic benefit cost associated with this change in 2016 was $ 125 million ($ 81 million after-tax or $0.06 per share). See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on this change in accounting estimate. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in expense for the following year based upon the average remaining service life for participants in Plan A (approximately 11 years) and retiree medical (approximately 7 years), or the remaining life expectancy for participants in Plan I (approximately 27 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service (credit)/cost) is included in earnings on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 13,192 $ 13,033 $ 3,124 $ 2,872 $ 1,208 $ 1,300 Service cost Interest cost Plan amendments (5 ) (15 ) Participant contributions Experience loss/(gain) 1,529 (51 ) Benefit payments (825 ) (347 ) (104 ) (83 ) (107 ) (100 ) Settlement/curtailment (58 ) (1,014 ) (22 ) (19 ) Special termination benefits Other, including foreign currency adjustment (383 ) Liability at end of year $ 14,777 $ 13,192 $ 3,490 $ 3,124 $ 1,187 $ 1,208 Change in fair value of plan assets Fair value at beginning of year $ 11,458 $ 11,397 $ 2,894 $ 2,823 $ $ Actual return on plan assets 1,935 Employer contributions/funding Participant contributions Benefit payments (825 ) (347 ) (104 ) (83 ) (107 ) (100 ) Settlement (46 ) (1,013 ) (18 ) (22 ) Other, including foreign currency adjustment (353 ) Fair value at end of year $ 12,582 $ 11,458 $ 3,460 $ 2,894 $ $ Funded status $ (2,195 ) $ (1,734 ) $ (30 ) $ (230 ) $ (866 ) $ (888 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities (74 ) (42 ) (1 ) (1 ) (75 ) (54 ) Other liabilities (2,407 ) (1,692 ) (114 ) (280 ) (791 ) (834 ) Net amount recognized $ (2,195 ) $ (1,734 ) $ (30 ) $ (230 ) $ (866 ) $ (888 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,520 $ 3,220 $ $ $ (189 ) $ (193 ) Prior service cost/(credit) (3 ) (5 ) (71 ) (91 ) Total $ 3,549 $ 3,240 $ $ $ (260 ) $ (284 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ $ $ (115 ) $ $ (9 ) $ (57 ) Amortization and settlement recognition (131 ) (413 ) (60 ) (46 ) Foreign currency translation loss/(gain) (117 ) Total $ $ $ (102 ) $ $ $ (55 ) Accumulated benefit obligation at end of year $ 13,732 $ 12,211 $ 2,985 $ 2,642 The amounts we report as pension and retiree medical cost consist of the following components: Service cost is the value of benefits earned by employees for working during the year. Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of benefit expense are as follows: Pension Retiree Medical U.S. International Components of benefit expense Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (849 ) (834 ) (850 ) (176 ) (163 ) (174 ) (22 ) (24 ) (27 ) Amortization of prior service cost/(credit) (1 ) (3 ) (25 ) (38 ) (39 ) Amortization of net loss/(gain) (12 ) (1 ) Settlement/curtailment loss/(gain) (a) (14 ) Special termination benefits Total $ $ $ $ $ $ $ $ (4 ) $ (a) U.S. includes a settlement charge of $ 242 million related to the group annuity contract purchase in 2016. See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The estimated amounts to be amortized from accumulated other comprehensive loss/(gain) into pre-tax expense in 2018 for our pension and retiree medical plans are as follows: Pension Retiree Medical U.S. International Net loss/(gain) $ $ $ (10 ) Prior service cost/(credit) (20 ) Total $ $ $ (30 ) The following table provides the weighted-average assumptions used to determine projected benefit liability and benefit expense for our pension and retiree medical plans: Pension Retiree Medical U.S. International Weighted-average assumptions Liability discount rate 3.7 % 4.4 % 4.5 % 3.0 % 3.1 % 4.0 % 3.5 % 4.0 % 4.2 % Expense discount rate (a) n/a n/a 4.2 % n/a n/a 3.8 % n/a n/a 3.8 % Service cost discount rate (a) 4.5 % 4.6 % n/a 3.6 % 4.1 % n/a 4.0 % 4.3 % n/a Interest cost discount rate (a) 3.7 % 3.8 % n/a 2.8 % 3.5 % n/a 3.2 % 3.3 % n/a Expected return on plan assets 7.5 % 7.5 % 7.5 % 6.0 % 6.2 % 6.5 % 7.5 % 7.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.6 % 3.6 % Expense rate of salary increases 3.1 % 3.1 % 3.5 % 3.6 % 3.6 % 3.6 % (a) Effective as of the beginning of 2016, we prospectively changed the method we use to estimate the service and interest cost components of pension and retiree medical expense. See additional unaudited information in Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ (8,355 ) $ (12,211 ) $ (161 ) $ (134 ) Fair value of plan assets $ 6,919 $ 11,458 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ (9,400 ) $ (13,192 ) $ (1,273 ) $ (2,773 ) $ (1,187 ) $ (1,208 ) Fair value of plan assets $ 6,919 $ 11,458 $ 1,158 $ 2,492 $ $ Of the total projected pension benefit liability as of December 30, 2017 , approximately $905 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2023 - 27 Pension $ $ $ $ $ $ 5,210 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2018 through 2022 and approximately $6 million in total for 2023 through 2027. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ $ $ $ $ $ Non-discretionary Total $ $ $ $ $ $ (a) Includes $ 452 million in 2016 relating to the funding of the group annuity contract purchase from an unrelated insurance company. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to Plan A in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. These contributions are reflected in our 2018 long-term expected rate of return on plan assets and target investment allocations. In addition, in 2018, we expect to make non-discretionary contributions of approximately $ 175 million to our U.S. and international plans for pension benefits and approximately $ 75 million for retiree medical benefits. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2018 and 2017 , our expected long-term rate of return on U.S. plan assets is 7.2% and 7.5% , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five -year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of fiscal year-end 2017 and 2016 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 6,904 $ 6,896 $ $ $ 6,489 Government securities (c) 1,365 1,365 1,173 Corporate bonds (c) 3,429 3,429 3,012 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 12,159 $ 7,132 $ 5,019 $ 11,064 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 12,903 $ 11,778 International plan assets Equity securities (b) $ 1,928 $ 1,895 $ $ $ 1,556 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 3,351 $ 2,297 $ 1,018 $ 2,804 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,460 $ 2,894 (a) 2017 and 2016 amounts include $321 million and $ 320 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The U.S. commingled funds are based on fair values of the investments owned by these funds that are benchmarked against various U.S. large, mid-cap and small company indices, and includes one large-cap fund that represents 19% of total U.S. plan assets for 2017 and 2016 . The international commingled funds are based on the fair values of the investments owned by these funds that track various non-U.S. equity indices. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 23% and 22% of total U.S. plan assets for 2017 and 2016 , respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 30, 2017 and December 31, 2016. (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. A 1-percentage-point change in the assumed health care trend rate would have the following effects: 1% Increase 1% Decrease 2017 service and interest cost components $ $ (3 ) 2017 benefit liability $ $ (34 ) Savings Plan Certain U.S. employees are eligible to participate in 401(k) savings plans, which are voluntary defined contribution plans. The plans are designed to help employees accumulate additional savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2017 , 2016 and 2015 , our total Company contributions were $176 million , $164 million and $148 million , respectively. For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 8 Debt Obligations The following table summarizes the Companys debt obligations: 2017 (a) 2016 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 4,020 $ 4,401 Commercial paper (1.3% and 0.6%) 1,385 2,257 Other borrowings (4.7% and 4.4%) $ 5,485 $ 6,892 Long-term debt obligations (b) Notes due 2017 (1.4%) $ $ 4,398 Notes due 2018 (2.4% and 2.3%) 4,016 2,561 Notes due 2019 (2.1% and 1.7%) 3,933 2,837 Notes due 2020 (3.1% and 2.6%) 3,792 3,816 Notes due 2021 (2.4% and 2.4%) 3,300 2,249 Notes due 2022 (2.6% and 2.8%) 3,853 2,655 Notes due 2023-2047 (3.7% and 3.8%) 18,891 15,903 Other, due 2017-2026 (1.3% and 1.4%) 37,816 34,454 Less: current maturities of long-term debt obligations (4,020 ) (4,401 ) Total $ 33,796 $ 30,053 (a) Amounts are shown net of unamortized net discounts of $155 million and $142 million for 2017 and 2016, respectively. (b) The interest rates presented reflect weighted-average rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for additional information regarding our interest rate derivative instruments. In 2017 , we issued the following senior notes: Interest Rate Maturity Date Amount (a) Floating rate May 2019 $ Floating rate May 2022 $ 1.550 % May 2019 $ 2.250 % May 2022 $ 4.000 % May 2047 $ 2.150 % May 2024 C$ (b) Floating rate October 2018 $ 1,500 2.000 % April 2021 $ 1,000 3.000 % October 2027 $ 1,500 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. (b) These notes, issued in Canadian dollars, were designated as a net investment hedge to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. The net proceeds from the issuances of the above notes were used for general corporate purposes, including the repayment of commercial paper. In 2017 , we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 5, 2022. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Also in 2017 , we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 4, 2018. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $3.7225 billion five-year credit agreement and our $3.7225 billion 364-day credit agreement both dated as of June 6, 2016. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 30, 2017 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million , respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ( $156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. In addition, as of December 30, 2017 , our international debt of $73 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. See Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our borrowings and long-term contractual commitments. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals . Ineffectiveness for those derivatives that qualify for hedge accounting treatment was not material for all periods presented. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $0.9 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . Foreign Exchange Our operations outside of the United States generated 42% of our net revenue in 2017 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2017 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $1.6 billion as of December 30, 2017 and December 31, 2016 . The total notional amount of our debt instruments designated as net investment hedges was $1.5 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . Ineffectiveness for derivatives and non-derivatives that qualify for hedge accounting treatment was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $14.2 billion as of December 30, 2017 and $11.2 billion as of December 31, 2016 . Ineffectiveness for derivatives that qualify for cash flow hedge accounting treatment was not material for all periods presented. As of December 30, 2017 , approximately 43% of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 38% as of December 31, 2016 . Available-for-Sale Securities Investments in debt and marketable equity securities, other than investments accounted for under the equity method, are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 30, 2017 were not material. In 2017, we recorded a pre-tax gain of $95 million ( $85 million after-tax or $0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. This gain was recorded in our ESSA segment in selling, general and administrative expenses. The pre-tax unrealized gain on these available-for-sale equity securities was $72 million as of December 31, 2016 . See Note 2 for additional information on investments in certain equity securities. Changes in the fair value of available-for-sale securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We regularly review our investment portfolio to determine if any security is other-than-temporarily impaired. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and our intent to sell, or whether we will more likely than not be required to sell, the security before recovery of its amortized cost basis. Our assessment of whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular security. We recorded no other-than-temporary impairment charges on our available-for-sale securities for the years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . Tingyi-Asahi Beverages Holding Co. Ltd. During 2016, we concluded that the decline in estimated fair value of our 5% indirect equity interest in TAB was other than temporary based on significant negative economic trends in China and changes in assumptions associated with TABs future financial performance arising from the disclosure by TABs parent company, Tingyi, regarding the operating results of its beverage business. As a result, we recorded a pre- and after-tax impairment charge of $373 million ( $0.26 per share) in 2016 in the AMENA segment. This charge was recorded in selling, general and administrative expenses in our income statement and reduced the value of our 5% indirect equity interest in TAB to its estimated fair value. The estimated fair value was derived using both an income and market approach, and is considered a non-recurring Level 3 measurement within the fair value hierarchy. The carrying value of the investment in TAB was $166 million as of December 30, 2017 and December 31, 2016 . We continue to monitor the impact of economic and other developments on the remaining value of our investment in TAB. In connection with our transaction with Tingyi in 2012, we received a call option to increase our holding in TAB to 20% with an expiration date in 2015. Prior to its expiration, we concluded that the probability of exercising the option was remote and, accordingly, we recorded a pre- and after-tax charge of $73 million ( $0.05 per share) to write off the recorded value of this call option in 2015. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Fair Value Measurements The fair values of our financial assets and liabilities as of December 30, 2017 and December 31, 2016 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale securities: Equity securities (b) $ $ $ $ Debt securities (c) 14,510 11,369 $ 14,510 $ $ 11,451 $ Short-term investments (d) $ $ $ $ Prepaid forward contracts (e) $ $ $ $ Deferred compensation (f) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (g) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (h) $ $ $ $ Interest rate (h) Commodity (i) Commodity (j) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (h) $ $ $ $ Commodity (i) Commodity (j) $ $ $ $ Total derivatives at fair value (k) $ $ $ $ Total $ 14,901 $ $ 11,851 $ 1,001 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of common stock. These equity securities were classified as investments in noncontrolled affiliates. (c) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 30, 2017 , $5.8 billion and $8.7 billion of debt securities were classified as cash equivalents and short-term investments, respectively. As of December 31, 2016 , $4.6 billion and $6.8 billion of debt securities were classified as cash equivalents and short-term investments, respectively. All of our available-for-sale debt securities have maturities of one year or less. (d) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (e) Based primarily on the price of our common stock. (f) Based on the fair value of investments corresponding to employees investment elections. (g) Based on LIBOR forward rates. (h) Based on recently reported market transactions of spot and forward rates. (i) Based on quoted contract prices on futures exchange markets. (j) Based on recently reported market transactions of swap arrangements. (k) Unless otherwise noted, derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 30, 2017 and December 31, 2016 were not material. Collateral received against any of our asset positions was not material. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 30, 2017 and December 31, 2016 was $41 billion and $38 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ (15 ) $ $ $ (24 ) $ $ (44 ) Interest rate (195 ) (184 ) Commodity (48 ) (52 ) Net investment (39 ) Total $ $ $ $ $ (171 ) $ (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $33 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 Preferred shares: Dividends (1 ) (1 ) Redemption premium (4 ) (5 ) (5 ) Net income available for PepsiCo common shareholders $ 4,853 1,425 $ 6,323 1,439 $ 5,446 1,469 Basic net income attributable to PepsiCo per common share $ 3.40 $ 4.39 $ 3.71 Net income available for PepsiCo common shareholders $ 4,853 1,425 $ 6,323 1,439 $ 5,446 1,469 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other ESOP convertible preferred stock Diluted $ 4,857 1,438 $ 6,329 1,452 $ 5,452 1,485 Diluted net income attributable to PepsiCo per common share $ 3.38 $ 4.36 $ 3.67 (a) Weighted-average common shares outstanding (in millions). Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.4 0.7 1.5 Average exercise price per option $ 110.12 $ 99.98 $ 99.25 (a) In millions. Note 11 Preferred Stock As of December 30, 2017 and December 31, 2016 , there were 3 million shares of convertible preferred stock authorized. The preferred stock was issued for an ESOP established by Quaker. Quaker made the final award to its ESOP in June 2001. As of December 30, 2017 and December 31, 2016 , there were 803,953 preferred shares issued and 114,753 and 122,553 shares outstanding, respectively. The outstanding preferred shares had a fair value of $68 million as of December 30, 2017 and $64 million as of December 31, 2016 . Activities of our preferred stock are included in the equity statement. In January 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock at the conversion ratio set forth in Exhibit A to our amended and restated articles of incorporation. As a result, there are no shares of our convertible preferred stock outstanding as of February 13, 2018. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 27, 2014 (a) $ (8,255 ) $ $ (2,500 ) $ $ (35 ) $ (10,669 ) Other comprehensive (loss)/income before reclassifications (b) (2,936 ) (95 ) (88 ) (3,116 ) Amounts reclassified from accumulated other comprehensive loss Net current year other comprehensive (loss)/income (2,825 ) (2,642 ) Tax amounts (7 ) (2 ) (8 ) Balance as of December 26, 2015 (a) (11,080 ) (2,329 ) (35 ) (13,319 ) Other comprehensive (loss)/income before reclassifications (313 ) (74 ) (750 ) (43 ) (1,180 ) Amounts reclassified from accumulated other comprehensive loss Net current year other comprehensive (loss)/income (313 ) (343 ) (43 ) (623 ) Tax amounts (30 ) Balance as of December 31, 2016 (a) (11,386 ) (2,645 ) (35 ) (13,919 ) Other comprehensive (loss)/income before reclassifications (c) 1,049 (375 ) Amounts reclassified from accumulated other comprehensive loss (171 ) (99 ) (112 ) Net current year other comprehensive (loss)/income 1,049 (41 ) (217 ) (74 ) Tax amounts Balance as of December 30, 2017 (a) $ (10,277 ) $ $ (2,804 ) $ (4 ) $ (19 ) $ (13,057 ) (a) Pension and retiree medical amounts are net of taxes of $1,260 million in 2014, $1,253 million in 2015, $1,280 million in 2016 and $ 1,338 million in 2017. (b) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Brazilian real and Canadian dollar. (c) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Venezuelan entities $ $ $ Venezuela impairment charges Cash flow hedges: Foreign exchange contracts $ $ $ (3 ) Net revenue Foreign exchange contracts (46 ) (94 ) Cost of sales Interest rate derivatives (184 ) Interest expense Commodity contracts Cost of sales Commodity contracts (1 ) Selling, general and administrative expenses Net (gains)/losses before tax (171 ) Tax amounts (63 ) (47 ) Net (gains)/losses after tax $ (107 ) $ $ Pension and retiree medical items: Amortization of net prior service credit (a) $ (24 ) $ (39 ) $ (41 ) Amortization of net losses (a) Settlement/curtailment (a) Net losses before tax Tax amounts (44 ) (144 ) (74 ) Net losses after tax $ $ $ Venezuelan entities $ $ $ Venezuela impairment charges Tax amount (4 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ (99 ) $ $ Selling, general and administrative expenses Tax amount Net gain after tax $ (89 ) $ $ Total net (gains)/losses reclassified for the year, net of tax $ (82 ) $ $ (a) These items are included in the components of net periodic benefit cost for pension and retiree medical plans (see Note 7 for additional details). Note 13 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 5,956 $ 5,709 Other receivables 1,197 1,119 7,153 6,828 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) (35 ) (30 ) (27 ) Other (b) (3 ) (23 ) Allowance, end of year $ Net receivables $ 7,024 $ 6,694 Inventories (c) Raw materials and packaging $ 1,344 $ 1,315 Work-in-process Finished goods 1,436 1,258 $ 2,947 $ 2,723 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Other $ $ Accounts payable and other current liabilities Accounts payable $ 6,727 $ 6,158 Accrued marketplace spending 2,390 2,444 Accrued compensation and benefits 1,785 1,770 Dividends payable 1,161 1,097 Other current liabilities 2,954 2,774 $ 15,017 $ 14,243 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 5% of the inventory cost in 2017 and 2016 were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for additional information regarding our pension plans. Statement of Cash Flows Interest paid (a) $ 1,123 $ 1,102 $ Income taxes paid, net of refunds $ 1,962 $ 1,393 $ 1,808 (a) In 2016, interest paid excludes the premium paid in accordance with the make-whole provisions of the debt redemption discussed in Note 8. Lease Information Rent expense $ $ $ Minimum lease payments under non-cancelable operating leases by period Operating Lease Payments $ 2019 2020 2021 2022 2023 and beyond Total minimum operating lease payments $ 1,894 Note 14 Divestitures Refranchising in Jordan During the fourth quarter of 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations. We recorded a pre-tax gain of $140 million ( $107 million after-tax or $0.07 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Refranchising in Thailand During the fourth quarter of 2017, we entered into an agreement to refranchise our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations (included within our AMENA segment). The transaction is expected to be completed in 2018. Refranchising in Czech Republic, Hungary, and Slovakia (CHS) During the first quarter of 2018, we entered into an agreement to refranchise our entire beverage bottling operations and snack distribution operations in CHS (included within our ESSA segment). The transaction is expected to be completed in 2018. Managements Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions the actions of all our associates are governed by our Global Code of Conduct. This Code is clearly aligned with our stated values a commitment to deliver sustained growth through empowered people acting with responsibility and building trust. Both the Code and our core values enable us to operate with integrity both within the letter and the spirit of the law. Our Code of Conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements, and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control Integrated Framework (2013). The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the United States. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Global Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Boards oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our Internal Auditor and with our General Counsel. We also have a Compliance Ethics Department, led by our Chief Compliance Ethics Officer, who coordinates our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the United States, which require estimates based on managements best judgment. PepsiCo has a strong history of doing whats right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. February 13, 2018 /s/ MARIE T. GALLAGHER Marie T. Gallagher Senior Vice President and Controller (Principal Accounting Officer) /s/ HUGH F. JOHNSTON Hugh F. Johnston Vice Chairman, Executive Vice President and Chief Financial Officer /s/ INDRA K. NOOYI Indra K. Nooyi Chairman of the Board of Directors and Chief Executive Officer Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and Subsidiaries (the Company) as of December 30, 2017 and December 31, 2016, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 30, 2017 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 30, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 30, 2017 and December 31, 2016, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 30, 2017, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2017, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinion The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 13, 2018 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Derivatives : financial instruments, such as futures, swaps, Treasury locks, cross currency swaps and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates and foreign exchange rates. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending plus sales of property, plant and equipment. Hedge accounting : treatment for qualifying hedges that allows fluctuations in a hedging instruments fair value to offset corresponding fluctuations in the hedged item in the same reporting period. Hedge accounting is allowed only in cases where the hedging relationship between the hedging instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net gain or loss : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, including the Venezuela deconsolidation which was effective as of the end of the third quarter of 2015, and foreign exchange translation. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for additional information. This measure also excludes the impact of the 53 rd reporting week in 2016. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 30, 2017 . Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during our fourth fiscal quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth fiscal quarter of 2017 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. This transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. " +34,AbbVie,2021," ITEM 1. BUSINESS Overview AbbVie (1) is a global, diversified research-based biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions across immunology, hematologic oncology, neuroscience, aesthetics and eye care. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Impact of the Coronavirus Disease 2019 (COVID-19) The novel coronavirus (COVID-19) pandemic continues to spread throughout the United States and around the world. As COVID-19 continues to have an impact worldwide, AbbVie is focused on the health and safety of its employees, health care professionals and patients and communities. In the continued operation of its business, AbbVie has followed health and safety guidance from relevant health authorities, managed manufacturing and supply chain resources and monitored closely its clinical trial sites. See Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsImpact of the Coronavirus Disease 2019 (COVID-19)."" Segments AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, development, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. See Note 16, ""Segment and Geographic Area Information"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data"" and the sales information related to AbbVie's key products and geographies included under Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. | 2021 Form 10-K Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: Humira. Humira (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union Pediatric ulcerative colitis (moderate to severe) U.S., Canada, European Union Pediatric uveitis North America, European Union Humira is also approved in Japan for the treatment of intestinal Behet's disease and pyoderma gangrenosum. Humira is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 37% of AbbVie's total net revenues in 2021. Skyrizi. Skyrizi (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following two induction doses. Skyrizi is approved in the United States, Canada, Mexico and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In the United States and the European Union, Skyrizi is additionally approved for the treatment of active psoriatic arthritis in adult patients who have an inadequate response or intolerance to disease-modifying antirheumatic drugs (DMARDs). In Japan, Skyrizi is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. Rinvoq . Rinvoq (upadacitinib) is an oral, once-daily selective and reversible JAK inhibitor that is approved to treat the following inflammatory diseases in North America, Japan and the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union, Japan Psoriatic arthritis U.S., Canada, European Union, Japan Ankylosing spondylitis European Union Atopic dermatitis (moderate to severe) U.S., Canada, European Union, Japan In the United States, Rinvoq is indicated for both the treatment of moderate to severe active rheumatoid arthritis, and for active psoriatic arthritis, in adult patients who have an inadequate response or intolerance to one or more TNF blockers. It is also indicated for the treatment of moderate to severe atopic dermatitis in adults and children 12 years of age and older whose disease is not adequately controlled with other systemic drug products, including biologics, or when use of those therapies are inadvisable. 2021 Form 10-K | Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: Imbruvica. Imbruvica (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase. Imbruvica was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. Imbruvica currently is approved for the treatment of adult patients with blood cancers such as chronic lymphocytic leukemia (CLL), as well as certain forms of non-Hodgkin lymphoma. Venclexta/Venclyxto. Venclexta (venetoclax) is a B-cell lymphoma 2 (BCL-2) inhibitor used to treat hematological malignancies. Venclexta is approved by the FDA for adults with CLL or SLL. In addition, Venclexta is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Aesthetics products. AbbVies Aesthetics portfolio consists of facial injectables, plastics and regenerative medicine, body contouring and skincare products, which hold market-leading positions in the U.S. and in key markets around the world. These products are: Botox Cosmetic. Botox Cosmetic is an acetylcholine release inhibitor and a neuromuscular blocking agent indicated for treatment in three areas: temporary improvement in the appearance of moderate to severe glabellar lines (frown lines between the eyebrows), moderate to severe crow's feet and moderate to severe forehead lines in adults. Having received its initial FDA approval in 2002, Botox Cosmetic is now approved for use in all major markets around the world and has become one of the worlds most recognized and iconic brands. The Juvederm Collection of Fillers. The Juvederm Collection of Fillers is a portfolio of hyaluronic acid-based dermal fillers with a variety of approved indications in the U.S. and in other major markets around the world to augment or treat volume loss in the cheeks, chin, lips and lower face. Other aesthetics. Other aesthetics products include, but are not limited to, Coolsculpting body contouring technology, Alloderm regenerative dermal tissue, Natrelle breast implants, the SkinMedica skincare line and DiamondGlow dermabrasion technology. Neuroscience products. AbbVies neuroscience products address some of the most difficult-to-treat neurologic diseases. These products are: Botox Therapeutic. Botox Therapeutic (onabotulinumtoxinA injection) is a neuromuscular blocking agent that is injected into muscle tissue in treatment for the following indications in the United States: Prophylaxis of headaches in adult patients with chronic migraine ( 15 days per month with headache lasting 4 hours a day or longer). Overactive bladder with symptoms of urge urinary incontinence, urgency and frequency, in adults who have an inadequate response to or are intolerant of an anticholinergic medication. Urinary incontinence due to detrusor overactivity associated with a neurologic condition (e.g., spinal cord injury, multiple sclerosis) in adults who have an inadequate response to or are intolerant of an anticholinergic medication. Spasticity in patients 2 years of age and older. Cervical dystonia in adults to reduce the severity of abnormal head position and neck pain associated with cervical dystonia. Strabismus and blepharospasm associated with dystonia, including benign essential blepharospasm or VII nerve disorders in patients 12 years of age and older. Severe primary axillary hyperhidrosis that is inadequately managed with topical agents. Licenses around the world vary. Focal spasticity associated with dynamic equinus foot deformity due to spasticity in ambulant pediatric cerebral palsy patients 2 years of age or older. | 2021 Form 10-K Focal spasticity of the wrist and hand in adult post stroke patients. Focal spasticity of the ankle and foot in adult post stroke patients. Vraylar. Vraylar (cariprazine) is a dopamine D3-preferring D3/D2 receptor partial agonist and a 5-HT1A receptor partial agonist. Its D3 binding profile may be linked to observed improvements in the negative symptoms of schizophrenia and to antidepressant effects in bipolar I disorder (bipolar depression). Vraylar is indicated for acute and maintenance treatment of schizophrenia in adults, acute treatment of manic or mixed episodes associated with bipolar disorder in adults and acute treatment of depressive episodes associated with bipolar I disorder in adults. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Ubrelvy. Ubrelvy (ubrogepant) is indicated for the acute treatment of migraine with or without aura in adults and is only commercialized in the United States. Other neuroscience. Other neuroscience products include Qulipta (atogepant), which is indicated for preventive treatment of episodic migraine in adults. Eye care products. AbbVies eye care products address unmet needs and new approaches to help preserve and protect patients vision. These products are: Lumigan/Ganfort. Lumigan (bimatoprost ophthalmic solution) 0.01% is a once daily, topical prostaglandin analog indicated for the reduction of elevated intraocular pressure (IOP) in patients with open angle glaucoma (OAG) or ocular hypertension (OHT). Ganfort is a once daily topical fixed combination of bimatoprost 0.03% and timolol 0.5% for the reduction of IOP in adult patients with OAG or OHT. Lumigan is sold in the United States and numerous markets around the world, while Ganfort is approved in the European Union and some markets in South America, the Middle East and Asia. Alphagan/Combigan. Alphagan (brimonidine tartrate ophthalmic solution) is an alpha-adrenergic receptor agonist indicated for the reduction of elevated IOP in patients with open-angle glaucoma or ocular hypertension. Combigan (brimonidine tartrate/timolol maleate ophthalmic solution) is approved for reducing elevated IOP in patients with glaucoma who require additional or adjunctive IOP-lowering therapy. Both Alphagan and Combigan are available for sale in the United States and numerous markets around the world. Restasis. Restasis is a calcineurin inhibitor immunosuppressant indicated to increase tear production in patients whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca. Restasis is approved in the United States and a number of other markets in South America, the Middle East and Asia. Other eye care. Other eye care products include Xen, Durysta, Ozurdex, Refresh/Optive and Vuity. Women's health products. AbbVies women's health products are: Lo Loestrin . Lo Loestrin Fe is an oral contraceptive. It is indicated for prevention of pregnancy with the lowest dose of estrogen with only 10mcg and is dispensed in a unique 24/2/2 regimen with a two-day hormone-free interval. It is marketed in the U.S. as Lo Loestrin Fe (norethindrone acetate and ethinyl estradiol tablets, ethinyl estradiol tablets and ferrous fumarate tablets) and in select markets outside the U.S. as Lolo. Orilissa/Oriahnn. Orilissa (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. Orilissa inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, Orilissa is also launched in Canada. Oriahnn (elagolix, estradiol and norethindrone acetate capsules; elagolix capsules) is a combination prescription medicine used to control heavy menstrual bleeding related to uterine fibroids in women before menopause. Other women's health. Other women's health includes Liletta, a sterile, levonorgestrel-releasing intrauterine system indicated for prevention of pregnancy for up to six years. Other key products. AbbVies other key products include, among other things, treatments for patients with hepatitis C virus (HCV), metabolic and hormone products that target a number of conditions, including exocrine pancreatic insufficiency and hypothyroidism, as well as endocrinology products for the palliative treatment of advanced prostate 2021 Form 10-K | cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. These products are: Mavyret/Maviret. Mavyret (glecaprevir/pibrentasvir) is approved in the United States and European Union (Maviret) for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. Creon. Creon (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Lupron. Lupron (leuprolide acetate), which is also marketed as Lucrin and Lupron Depot, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Linzess/Constella. Linzess (linaclotide) is a once-daily guanylate cyclase-C agonist used in adults to treat irritable bowel syndrome with constipation (IBSC) and chronic idiopathic constipation (CIC). The product is marketed as Linzess in the United States and as Constella outside of the United States. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell Creon and Synthroid only in the United States. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States many of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its promotional and market access efforts on key opinion leaders, payers, physicians and health systems. AbbVie also provides patient support programs closely related to its products. Throughout the COVID-19 pandemic AbbVie has maintained its promotional activities with key stakeholders by leveraging digital engagement where permitted and in compliance with the locally applicable government guidance. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. In 2021, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's pharmaceutical product sales in the United States. No individual wholesaler accounted for greater than 37% of AbbVie's 2021 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products, therapies | 2021 Form 10-K and biologics. For example, Humira competes with anti-TNF products, JAK inhibitors and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available HCV treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded conventional (small-molecule) pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for small molecule medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. Humira is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug, and Cosmetic Act (the FFDCA), the Public Health Service Act (PHSA) and the regulations implementing these statutes. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the PHSA, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered by the FDA as substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its full ultimate impact, implementation and meaning remains subject to uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the FFDCA. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the PHSA are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a conventional drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Specific conditions of use approved for 2021 Form 10-K | individual products may also be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of exclusivity. Other types of regulatory exclusivity may also be available, such as Generating New Antibiotic Incentives Now (GAIN) exclusivity, which can provide new antibiotic or new antifungal drugs an additional five years of exclusivity to be added to certain exclusivities already provided for by law. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained or sometimes even later. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not generally be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2022 to the early 2040s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark Humira), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the licenses in the United States will begin in 2023 and the licenses in Europe began in 2018. In addition, the following patents, licenses and trademarks are significant: those related to ibrutinib (which is sold under the trademark Imbruvica) and those related to risankizumab (which is sold under the trademark Skyrizi). The United States composition of matter patent covering ibrutinib is expected to expire in 2027, however no generic entry for any ibrutinib product is expected prior to March 30, 2032, assuming pediatric exclusivity is granted. The United States composition of matter patent covering risankizumab is expected to expire in 2033. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. | 2021 Form 10-K Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie seeks to maintain sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. Despite the disruption to the global supply chain caused by COVID-19, AbbVie has continued to supply patients with no material supply impact, except for the previously-disclosed near-term supply issues impacting Lupron. Given the general increased global volatility due to the pandemic, AbbVie is monitoring and taking actions to mitigate potential supply shortages which may impact the fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds (and complementary devices) in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. AbbVie also supplements its research and development efforts with acquisitions. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1 involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and doses for later phases. Phase 2 tests different doses of the drug in a disease state in order to assess efficacy. Phase 3 tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety in order to meet requirements to enable global approval. Preclinical data and clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. 2021 Form 10-K | The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products, delivery devices, and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Compliance with regulatory requirements is assured through periodic, announced or unannounced inspections by the FDA and other regulatory authorities, and these inspections associated with clinical development may include the sponsor, investigator sites, laboratories, hospitals and manufacturing facilities of AbbVie's subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, including rejection of an NDA or BLA. Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be submitted and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Further, the FDA continues to regulate product labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from applicable supervising regulatory authorities before it can commence clinical trials or marketing of the product in target markets. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency. After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Japan-specific trials and/or bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. Similarly, applications for a new product in China are submitted to the Center for Drug Evaluation (CDE) of the National Medical Products Administration for technical review and approval of a product for marketing in China. Clinical data in Chinese subjects are usually required to support approval in China, requiring the inclusion of China in global pivotal studies, or a separate China/Asian clinical trial. | 2021 Form 10-K The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Similar to the requirements in Japan and China, certain countries (notably South Korea, Taiwan, India and Russia) also generally require that local clinical studies be conducted in order to support regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacturing, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can lead to updates to the data regarding utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates may affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In 2021 Form 10-K | addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 70% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2022 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is difficult to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. | 2021 Form 10-K Regulation Medical Devices Medical devices are subject to regulation by the FDA, state agencies and foreign government health authorities. FDA regulations, as well as various U.S. federal and state laws, govern the development, clinical testing, manufacturing, labeling, record keeping and marketing of medical device products agencies in the United States. AbbVies medical device product candidates, including AbbVies breast implants, must undergo rigorous clinical testing and an extensive government regulatory clearance or approval process prior to sale in the United States and other countries. The lengthy process of clinical development and submissions for clearance or approval, and the continuing need for compliance with applicable laws and regulations, require the expenditure of substantial resources. Regulatory clearance or approval, when and if obtained, may be limited in scope, and may significantly limit the indicated uses for which a product may be marketed. Cleared or approved products and their manufacturers are subject to ongoing review, and discovery of previously unknown problems with products may result in restrictions on their manufacture, sale and/or use or require their withdrawal from the market. United States . AbbVies medical device products are subject to extensive regulation by the FDA in the United States. Unless an exemption applies, each medical device AbbVie markets in the United States must have a 510(k) clearance or a Premarket Approval Application (PMA) in accordance with the FFDCA and its implementing regulations. The FDA classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose a lower risk are placed in either Class I or Class II, and devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or a device deemed to be not substantially equivalent to a previously cleared 510(k) device, are placed in Class III. In general, a Class III device cannot be marketed in the United States unless the FDA approves the device after submission of a PMA, and any changes to the device subsequent to initial FDA approval must also be reviewed and approved by the FDA. The majority of AbbVies medical device products, including AbbVies breast implants, are regulated as Class III medical devices. A Class III device may have significant additional obligations imposed in its conditions of approval, and the time in which it takes to obtain approval can be long. Compliance with regulatory requirements is assured through periodic, unannounced facility inspections by the FDA and other regulatory authorities, and these inspections may include the manufacturing facilities of AbbVies subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions: warning letters or untitled letters; fines, injunctions and civil penalties; recall or seizure of AbbVie products; operating restrictions, partial suspension or total shutdown of production; refusing AbbVie request for 510(k) clearance or PMA approval of new products; withdrawing 510(k) clearance or PMA approvals that are already granted; and criminal prosecution. A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. Clinical trials generally require submission of an application for an investigational device exemption (IDE), which must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. A study sponsor must obtain approval for its IDE from the FDA, and it must also obtain approval of its study from the Institutional Review Board overseeing the trial. The results of clinical testing may not be sufficient to obtain approval of the investigational device. Once a device is approved, the manufacture and distribution of the device remains subject to continuing regulation by the FDA, including Quality System Regulation requirements, which involve design, testing, control, documentation and other quality assurance procedures during the manufacturing process. Medical device manufacturers and their subcontractors are required to register their establishments and list their manufactured devices with the FDA and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with regulatory requirements. Manufacturers must also report to the FDA if their devices may have caused or contributed to a death or serious injury or malfunctioned in a way that could likely cause or contribute to a death or serious injury, or if the manufacturer conducts a field correction or product recall or removal to reduce a risk to health posed by a device or to remedy a violation of the FFDCA that may present a health risk. Further, the FDA continues to regulate device labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. European Union. Medical device products that are marketed in the European Union must comply with the requirements of the Medical Device Regulation (the MDR), which came into effect in May 2021. The MDR provides for regulatory oversight with respect to the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices to ensure that medical devices marketed in the European Union are safe and effective for their intended uses. Medical devices that comply with the MDR are entitled to bear a Conformit Europenne marking evidencing such compliance and may be marketed in the European Union. Failure to comply with these domestic and international regulatory requirements could affect AbbVies ability to market and sell AbbVies products in these countries. 2021 Form 10-K | Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2021 were approximately $17 million and operating expenditures were approximately $33 million. In 2022, capital expenditures for pollution control are estimated to be approximately $14 million and operating expenditures are estimated to be approximately $34 million. Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 50,000 employees in over 70 countries as of January 31, 2022. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Human Capital Management Attracting, retaining and providing meaningful growth and development opportunities to AbbVie's employees is critical to the company's success in making a remarkable impact on peoples lives around the world. AbbVie leverages numerous resources to identify and enhance strategic and leadership capability, foster employee engagement and create a culture where diverse talent is productive and engaged. AbbVie invests in its employees through competitive compensation, benefits and employee support programs and offers best-in-class development and leadership opportunities. AbbVie has developed a deep talent base through ongoing investment in functional and leadership training and by sourcing world-class external talent, ensuring a sustainable talent pipeline. AbbVie continuously cultivates and enhances its working culture and embraces equality, diversity and inclusion as fundamental to the company's mission. Attracting and Developing Talent. Attracting and developing high-performing talent is essential to AbbVies continued success. AbbVie implements detailed talent attraction strategies, with an emphasis on STEM skill sets, a diverse talent base and other critical skillsets, including drug discovery, clinical development, market access and business development. AbbVie also invests in competitive compensation and benefits programs. In addition to offering a comprehensive suite of benefits ranging from medical and dental coverage to retirement, disability and life insurance programs, AbbVie also provides health promotion programs, mental health awareness campaigns and employee assistance programs in several countries, financial wellness support, on-site health screenings and immunizations in several countries and on-site fitness and rehabilitation centers. In addition, the AbbVie Employee Assistance Fund (a part of the AbbVie Foundation) supports two programs for global employees: the AbbVie Possibilities Scholarship for children of employees, which is an annual merit-based scholarship for use at accredited colleges, universities or vocational-technical schools; and the Employee Relief Program, which is financial assistance to support short term needs of employees when faced with large-scale disasters (e.g. a hurricane), individual disasters (e.g. a home fire) or financial hardship (e.g. the death of a spouse). Finally, AbbVie empowers managers and their teams with tools, tips and guidelines on effectively managing workloads, managing teams from a distance and supporting flexible work practices. New AbbVie employees are given a tailored onboarding experience for faster integration and to support performance. AbbVie's mentorship program allows employees to self-nominate as mentors or mentees and facilitates meaningful relationships supporting employees career and development goals. AbbVie also provides structured, broad-based development opportunities, focusing on high-performance skills and leadership training. AbbVie's talent philosophy holds leaders accountable for building a high-performing organization, and the company provides development opportunities to all levels of leadership. AbbVie's Learn, Develop, Perform program offers year-long, self-directed leadership education, supplemented with tools and resources, and leverages leaders as role models and teachers. In addition, the foundation to AbbVie's leadership pipeline is the company's Professional Development | 2021 Form 10-K Programs, which attract graduates, postgraduates and post-doctoral talent to participate in formal development programs lasting up to three years, with the objective of strengthening functional and leadership capabilities. Culture. AbbVies shared values of transforming lives, acting with integrity, driving innovation, embracing diversity and inclusion and serving the community form the core of the company's culture. AbbVie articulates the behaviors associated with these values in the Ways We Work, a core set of working behaviors that emphasize how the company achieves results is equally as important as achieving them. The Ways We Work are designed to ensure that every AbbVie employee is aware of the company's cultural expectations. AbbVie integrates the Ways We Work into all talent processes, forming the basis for assessing performance, prioritizing development and ultimately rewarding employees. AbbVie believes its culture creates strong engagement, which is measured regularly through a confidential, third party all-employee survey, and this engagement supports AbbVies mission of making a remarkable impact on peoples lives. Equity, Equality, Diversity Inclusion (EEDI). A cornerstone of AbbVies human capital management approach is to prioritize fostering an inclusive and diverse workforce. In 2019, AbbVie adopted a five-year Equality, Diversity Inclusion roadmap that defines key global focus areas, objectives and associated initiatives, and includes implementation plans organized by business function and geography. AbbVies senior leaders have adopted formal goals aligned with executing this strategy. In recent years, AbbVie's board of directors has prioritized oversight of AbbVie's response to the U.S. racial justice movement, including overseeing internal programs designed to ensure that AbbVie is attracting, retaining and developing diverse talent. Through December 2021, women represented 51 percent of management positions globally and in the United States, 35 percent of AbbVie's workforce was comprised of members of historically underrepresented populations, an increase from 2020. Further, AbbVie is committed to pay equity and conducts pay equity analyses annually. A critical component of AbbVie's strategy is to instill an inclusive mindset in all AbbVie leaders and employees, so the company can realize the full value of a diverse workforce from recruitment through retirement. AbbVie recently launched a new resource for people who manage others to reinforce the importance of EEDI to the business, educate leaders on inclusive recruiting practices and modeling inclusive behavior, and encourage participation in the company's inclusive culture learning opportunities. AbbVie's Employee Resource Groups also help the company nurture an inclusive culture by building community, hosting awareness events and providing leadership and career opportunities. In 2021, AbbVie reiterated its commitment to racial equality and social justice by, among other things, expanding its employee matching program to $3-to-$1 for donations to civil rights nonprofits fostering racial equity and by reaffirming its commitment to clinical trial diversity. Additional information about AbbVie's efforts on racial equality and social justice is provided on the company's website at: https://abbvie.com/our-company/equality-inclusion-diversity/our-commitment-to-racial-justice.html. COVID-19 Health and Safety. AbbVie has effectively prioritized the health and safety of its employees during the COVID-19 pandemic, while continuing to drive strong business performance. AbbVie implemented, among other things, temporary office and facility closures and establishment of new safety and cleaning protocols and procedures; regular communication regarding the effect of the pandemic on AbbVie's business and employees; establishment of physical distancing procedures, modification of workspaces and provision of personal protective equipment and cleaning supplies for employees; provision of on-site vaccinations and temperature screenings; a variety of testing and vaccination resources including on-site vaccinations and on-site and at-home testing and COVID case management programs; and remote working accommodations and related services to support employees needs for flexibility. In addition, COVID-19 is a covered event under the AbbVie Employee Assistance Fund's Employee Relief Program, entitling eligible AbbVie employees and their families to financial assistance to pay for mortgage/rent, utilities, food, childcare and medical expenses not covered by insurance. AbbVie also provided paid leave and other support and accommodations to the company's employees with relevant medical, pharmaceutical, research and development, science, public health and public safety skills, knowledge, training and experience who desired or were requested or mandated to serve as volunteers during the pandemic. Lastly, AbbVies commitment to employees has been evidenced by no workforce reductions and no salary reductions associated with COVID-19 . Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( investors.abbvie.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( investors.abbvie.com ). 2021 Form 10-K | "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business Public health outbreaks, epidemics or pandemics, such as the coronavirus (COVID-19), have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. Public health outbreaks, epidemics or pandemics have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. The continuing pandemic caused by the novel strain of coronavirus (COVID-19) has caused many countries, including the United States, to declare national emergencies and implement preventive measures such as travel bans and shelter in place or total lock-down orders, some of which have eased. The continuation or re-implementation of these bans and orders remains uncertain. The COVID-19 pandemic has caused AbbVie to modify its business practices (including instituting remote work for many of AbbVies employees), and AbbVie may take further actions as may be required by government authorities or as AbbVie determines are in the best interests of AbbVies employees, patients, customers and business partners. While the impact of COVID-19 on AbbVies operations, including, among others, its manufacturing and supply chain, sales and marketing, commercial and clinical trial operations, to date has not been material, AbbVie has experienced lower new patient starts in certain products and markets. The impact of COVID-19 on AbbVie over the long-term is uncertain and cannot be predicted with confidence. The extent of the adverse impact of COVID-19 on AbbVies operations will depend on the extent and severity of the continued spread of COVID-19 globally, the timing and nature of actions taken to respond to COVID-19 and the resulting economic consequences. Ultimately, efforts to mitigate the impact of COVID-19 may not completely prevent AbbVie's business from being adversely affected and future impacts remain uncertain. The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1, ""BusinessIntellectual Property Protection and Regulatory Exclusivity"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of Operations,"" and litigation regarding these patents is described in Item 3, ""Legal Proceedings."" The United States composition of matter patent for Humira, which is AbbVie's largest product and had worldwide net revenues of approximately $20.7 billion in 2021, expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. | 2021 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects Humira revenues could have a material and negative impact on AbbVie's results of operations and cash flows. Humira accounted for approximately 37% of AbbVie's total net revenues in 2021. Any significant event that adversely affects Humira's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for Humira (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of Humira, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of Humira for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, 2021 Form 10-K | inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances and joint ventures with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding Humiracould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including Humira. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, Humira competes with anti-TNF products | 2021 Form 10-K and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available hepatitis C treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. All of these competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Certain aspects of AbbVies operations are highly dependent upon third party service providers. AbbVie relies on suppliers, vendors and other third party service providers to research, develop, manufacture, commercialize, promote and sell its products. Reliance on third party manufacturers reduces AbbVies oversight and control of the manufacturing process. Some of these third party providers are subject to legal and regulatory requirements, privacy and security risks and market risks of their own. The failure of a critical third party service provider to meet its obligations could have a material adverse impact on AbbVies operations and results. If any third party service providers have violated or are alleged to have violated any laws or regulations during the performance of their obligations to AbbVie, it is possible that AbbVie could suffer financial and reputational harm or other negative outcomes, including possible legal consequences. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be 2021 Form 10-K | taken by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. For example, lawsuits are pending against Allergan, AbbVies recently acquired subsidiary, and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans textured breast implants. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. Additionally, Allergan has been named as a defendant in approximately 3,130 matters relating to the promotion and sale of prescription opioid pain relievers and additional suits may be filed. See Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" AbbVie cannot predict the outcome of these proceedings. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. | 2021 Form 10-K AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1, ""BusinessRegulationDiscovery and Clinical Development, BusinessRegulationCommercialization, Distribution and Manufacturing, and BusinessRegulationMedical Devices. The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act, the U.S. Physician Payments Sunshine Act, the TRICARE program, the government pricing rules applicable to the Medicaid, Medicare Part B, 340B Drug Pricing Program and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 23% of AbbVie's total net revenues in 2021. The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; 2021 Form 10-K | political and economic instability, including as a result of the United Kingdoms exit from the European Union and the COVID-19 pandemic; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action and regulation; inflation, recession and fluctuations in interest rates; restrictions on transfers of funds; potential deterioration in the economic position and credit quality of certain non-U.S. countries; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, joint ventures and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, joint ventures, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2021, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's pharmaceutical product sales in the United States. If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. | 2021 Form 10-K AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. In particular, AbbVie incurred significant debt in connection with its acquisition of Allergan. AbbVies substantially increased indebtedness and higher debt to equity ratio as a result of the acquisition may exacerbate these risks and have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions and/or lowering its credit ratings. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase further. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could have a material adverse effect on AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may in the future result in the failure of critical business operations. Such breaches may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. To date, AbbVies business or operations have not been materially impacted by such incidents. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent material breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. In connection with the acquisition of Allergan, AbbVies balances of intangible assets, including developed product rights and goodwill acquired, have increased significantly. Such balances are subject to impairment testing and may result in impairment charges, which will adversely affect AbbVies results of operations and financial condition. A significant amount of AbbVies total assets is related to acquired intangibles and goodwill. As of December 31, 2021, the carrying value of AbbVies developed product rights and other intangible assets was $76.0 billion and the carrying value of AbbVies goodwill was $32.4 billion. AbbVies developed product rights are stated at cost, less accumulated amortization. AbbVie determines original fair value and amortization periods for developed product rights based on its assessment of various factors impacting estimated useful lives and cash flows of the acquired products. Significant adverse changes to any of these factors require AbbVie to perform an impairment test on the affected asset and, if evidence of impairment exists, require AbbVie to take an impairment charge with respect to the asset. For assets that are not impaired, AbbVie may adjust the remaining useful lives. Such a charge could have a material adverse effect on AbbVies results of operations and financial condition. AbbVies other significant intangible assets include in-process research and development (IPRD) intangible projects, acquired in recent business combinations, which are indefinite-lived intangible assets. Goodwill and AbbVies IPRD intangible assets are tested for impairment annually, or when events occur or circumstances change that could potentially reduce the fair value of the reporting unit or intangible asset. Impairment testing compares the fair value of the reporting unit or intangible asset to its carrying amount. A goodwill or IPRD impairment, if any, would be recorded in operating income and could have a material adverse effect on AbbVies results of operations and financial condition. 2021 Form 10-K | Failure to attract, develop and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract, develop and retain diverse, highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development (RD), governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws, particularly in the European Union and the United States, and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; environmental liabilities in connection with AbbVies manufacturing processes and distribution logistics, including the handling of hazardous materials; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; business interruptions stemming from natural disasters, such as climate change, earthquakes, hurricanes, flooding, fires, or efforts taken by third parties to prevent or mitigate such disasters; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5, ""Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. | 2021 Form 10-K In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2021 Form 10-K | CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1, ""Business,"" Item 1A, ""Risk Factors,"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A, ""Risk Factors"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. As of December 31, 2021, AbbVie owns or leases approximately 645 facilities worldwide, containing an aggregate of approximately 20 million square feet of floor space dedicated to production, distribution, and administration. AbbVie's significant manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Clonshaugh, Ireland Branchburg, New Jersey* La Aurora, Costa Rica Campbell, California Ludwigshafen, Germany Cincinnati, Ohio Pringy, France Dublin, California* Singapore* Irvine, California Sligo, Ireland North Chicago, Illinois Westport, Ireland* Waco, Texas Worcester, Massachusetts* Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. AbbVie believes its facilities are suitable and provide adequate production capacity for its current and projected operations. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has two central distribution centers. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; Branchburg, New Jersey; Cambridge, Massachusetts; Irvine, California; Madison, New Jersey; North Chicago, Illinois; Pleasanton, California; Santa Cruz, California; South San Francisco, California; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. | 2021 Form 10-K "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 46,139 stockholders of record of AbbVie common stock as of January 31, 2022. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2016 through December 31, 2021. This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2016 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. | 2021 Form 10-K Dividends On October 29, 2021, AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.30 per share to $1.41 per share, payable on February 15, 2022 to stockholders of record as of January 14, 2022. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2021 - October 31, 2021 3,808 (1) $ 108.90 (1) $ 2,643,316,927 November 1, 2021 - November 30, 2021 845 (1) $ 116.08 (1) $ 2,643,316,927 December 1, 2021 - December 31, 2021 904,176 (1) $ 136.23 (1) 879,703 $ 2,523,316,993 Total 908,829 (1) $ 136.10 (1) 879,703 $ 2,523,316,993 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 3,808 in October; 845 in November; and 24,473 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 2021 Form 10-K | "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company). This commentary should be read in conjunction with the Consolidated Financial Statements and accompanying notes appearing in Item 8, ""Financial Statements and Supplementary Data."" This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2020. EXECUTIVE OVERVIEW Company Overview AbbVie is a global, diversified research-based biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions across immunology, hematologic oncology, neuroscience, aesthetics and eye care. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 50,000 employees. AbbVie operates as a single global business segment. 2021 Financial Results AbbVie's strategy has focused on delivering strong financial results, maximizing the benefits of the Allergan acquisition, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2021 included delivering worldwide net revenues of $56.2 billion, operating earnings of $17.9 billion, diluted earnings per share of $6.45 and cash flows from operations of $22.8 billion. Worldwide net revenues increased by 23% on a reported basis and 22% on a constant currency basis, reflecting growth across its immunology, hematologic oncology, neuroscience, aesthetics and eye care portfolios as well as a full period of Allergan results in 2021 compared to the prior year. Diluted earnings per share in 2021 was $6.45 and included the following after-tax costs: (i) $6.4 billion related to the amortization of intangible assets; (ii) $2.7 billion for the change in fair value of contingent consideration liabilities; (iii) $948 million for acquired in-process research and development (IPRD); (iv) $500 million as a result of a collaboration agreement extension with Calico Life Sciences LLC; (v) $307 million for milestones and other research and development (RD) expenses; (vi) $253 million for charges related to litigation matters; and (vii) $215 million of acquisition and integration expenses. These costs were partially offset by $265 million of certain tax benefits. Additionally, financial results reflected continued funding to support all stages of AbbVies pipeline assets and continued investment in AbbVies on-market brands. In October 2021, AbbVie's board of directors declared a quarterly cash dividend of $1.41 per share of common stock payable in February 2022. This reflects an increase of approximately 8.5% over the previous quarterly dividend of $1.30 per share of common stock. Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. The integration plan is expected to realize approximately $2.5 billion of annual cost synergies in 2022 . 2021 Form 10-K | To achieve these integration objectives, AbbVie expects to incur total cumulative charges of approximately $2 billion through 2022. These costs consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. Impact of the Coronavirus Disease 2019 (COVID-19) In response to the ongoing public health crisis posed by COVID-19, AbbVie continues to focus on ensuring the safety of employees. Throughout the pandemic, AbbVie has followed health and safety guidance from state and local health authorities and implemented safety measures for those employees who are returning to the workplace. AbbVie also continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie continues to experience lower new patient starts in certain products and markets. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the pandemic. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain and is dependent on numerous evolving factors, including the measures being taken by authorities to mitigate against the spread of COVID-19, the emergence of new variants and the availability and successful administration of effective vaccines. 2022 Strategic Objectives AbbVie's mission is to discover and develop innovative medicines and products that solve serious health issues today and address the medical challenges of tomorrow while achieving top-tier financial performance through outstanding execution. AbbVie intends to continue to advance its mission in a number of ways, including: (i) maximizing the benefits of a diversified revenue base with multiple long-term growth drivers; (ii) growing revenues by leveraging AbbVie's commercial strength and international infrastructure across therapeutic areas and ensuring strong commercial execution of new product launches; (iii) continuing to invest in and expand its pipeline in support of opportunities in immunology, oncology, aesthetics, neuroscience and eye care as well as continued investment in key on-market products; (iv) expanding operating margins; and (v) returning cash to shareholders via a strong and growing dividend while also reducing debt. In addition, AbbVie anticipates several regulatory submissions and data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Immunology revenue growth driven by increasing market share and indication expansion of Skyrizi and Rinvoq, as well as Humira U.S. sales growth. Hematologic oncology revenue growth driven by increasing market share and indication expansion of Venclexta, as well as maintaining the strong leadership position of Imbruvica. Aesthetics revenue growth driven by global expansion and increasing market penetration of Botox and Juvederm Collection. Neuroscience revenue growth driven by Vraylar, Botox Therapeutic, Ubrelvy and recently launched Qulipta. Sustaining eye care leadership by maximizing AbbVie's current eye care portfolio. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2022. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7. AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued realization of expense synergies from the Allergan acquisition, leverage from revenue growth, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. | 2021 Form 10-K Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes approximately 90 compounds, devices or indications in development individually or under collaboration or license agreements and is focused on such important specialties as immunology, oncology, aesthetics, neuroscience and eye care. Of these programs, more than 50 are in mid- and late-stage development. The following sections summarize transitions of significant programs from mid-stage development to late-stage development as well as developments in significant late-stage and registration programs. AbbVie expects multiple mid-stage programs to transition into late-stage programs in the next 12 months. Significant Programs and Developments Immunology Skyrizi In January 2021, AbbVie announced top-line results from its Phase 3 KEEPsAKE-1 and KEEPsAKE-2 clinical trials of Skyrizi in adults with active psoriatic arthritis (PsA) met the primary and ranked secondary endpoints. In January 2021, AbbVie announced top-line results from its Phase 3 ADVANCE and MOTIVATE induction studies of Skyrizi in patients with Crohns disease met the primary and key secondary endpoints. In April 2021, AbbVie received U.S. Food and Drug Administration (FDA) approval of Skyrizi in a single dose pre-filled syringe and pre-filled pen. This approval will reduce the number of injections administered per treatment. In June 2021, AbbVie announced top-line results from its Phase 3 FORTIFY study for Skyrizi in patients with moderate to severe Crohns disease met the co-primary endpoints. In September 2021, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for Skyrizi for the treatment of patients 16 years and older with moderate to severe Crohns disease. In November 2021, AbbVie submitted a marketing authorization application (MAA) to the European Medicines Agency (EMA) for Skyrizi for the treatment of patients 16 years or older with moderate to severe active Crohn's disease who have had inadequate response, lost response or were intolerant to conventional or biologic therapy. In November 2021, Ab bVie announced that the European Commission (EC) approved Skyrizi alone or in combination with methotrexate for the treatment of active PsA in adults who have had an inadequate response or who have been intolerant to one or more disease-modifying antirheumatic drugs. In January 2022, A bbVie announced that the FDA approved Skyrizi for the treatment of adults with active PsA. Rinvoq In January 2021, AbbVie announced that the EC approved Rinvoq for the treatment of adults with active PsA and ankylosing spondylitis (AS). In February 2021, AbbVie announced its Phase 3 U-ACCOMPLISH induction study of Rinvoq for the treatment of adult patients with moderate to severe ulcerative colitis (UC) met the primary and all ranked secondary endpoints. In June 2021, AbbVie announced the FDA will not meet the Prescription Drug User Fee Act action dates for the sNDA of Rinvoq for the treatment of adults with active AS. No formal regulatory action has been taken on the sNDA for Rinvoq in AS. In June 2021, AbbVie announced the results from its Phase 3 maintenance study of Rinvoq in patients with UC met the primary and all secondary endpoints. In August 2021, AbbVie announced that the EC approved Rinvoq for the treatment of moderate to severe atopic dermatitis (AD) in adults and adolescents 12 years and older who are candidates for systemic therapy. 2021 Form 10-K | In September 2021, AbbVie submitted an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adults with moderately to severely active UC. In October 2021, A bbVie announced the results from Study 1 of the Phase 3 SELECT-AXIS 2 clinical trial for Rinvoq in patients with active AS and inadequate response to biologic disease-modifying antirheumatic drugs met the primary and all ranked secondary endpoints. In October 2021, A bbVie announced the results from Study 2 of the Phase 3 SELECT-AXIS 2 clinical trial for Rinvoq in adults with non-radiographic axial spondyloarthritis met the primary and 12 of 14 ranked secondary endpoints. In December 2021, AbbVie announced top-line results from its Phase 3 U-EXCEED induction study for Rinvoq in patients with moderate to severe Crohn's disease who had an inadequate response or were intolerant to biologic therapy met the primary and key secondary endpoints. In December 2021, AbbVie announced an update to the U.S. Prescribing Information and Medication Guide for Rinvoq for the treatment of adults with moderate to severe rheumatoid arthritis (RA). This update follows a Drug Safety Communication (DSC) issued by the FDA in September 2021 based on its final review of the post-marketing study evaluating another JAK inhibitor (tofacitinib) in patients with RA. The DSC and this label update apply to the class of systematically administered FDA-approved JAK inhibitors for the treatment of RA and other inflammatory diseases. Based on this class-wide update, the U.S. label for Rinvoq will now include additional information about risks within the Boxed Warnings and Warnings Precautions sections. The indication has also been updated to be indicated for the treatment of adults with moderately to severely active RA who have had an inadequate response or intolerance to one or more tumor necrosis factor (TNF) blockers. In December 2021, A bbVie announced that the FDA approved Rinvoq for the treatment of adults with active PsA who have had an inadequate response or intolerance to one or more TNF blockers. In January 2022, Abb Vie announced its submission of an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adults with active nr-axSpA with objective signs of inflammation who have responded inadequately to nonsteroidal anti-inflammatory drugs. In January 2022, Ab bVie announced that the FDA approved Rinvoq for the treatment of moderate to severe AD in adults and children 12 years of age and older whose disease did not respond to previous treatment and is not well controlled with other pills or injections, including biologic medicines, or when use of other pills or injections is not recommended. In February 2022, AbbVie was notified that the EC is requesting the EMA to assess safety concerns associated with JAK inhibitor products authorized in inflammatory diseases and to evaluate the impact of these events on their benefit-risk balance. The assessment covers all JAK inhibitors approved for use in inflammatory diseases. The request is for an opinion from the EMA by September 30, 2022. Oncology Imbruvica In June 2021, AbbVie announced results from its Phase 3 GLOW study comparing the efficacy and safety of Imbruvica in combination with Venclexta versus chlorambucil plus obinutuzumab for first-line treatment in patients with chronic lymphocytic leukemia (CLL) or small lymphocytic lymphoma met its primary endpoint. Venclexta In May 2021, AbbVie received European Commission approval for Venclyxto in combination with a hypomethylating agent for patients with newly diagnosed acute myeloid leukemia (AML) who are ineligible for intensive chemotherapy. | 2021 Form 10-K In July 2021, AbbVie announced that the FDA granted Breakthrough Therapy Designation to Venclexta in combination with azacitidine for the potential treatment of adult patients with previously untreated intermediate-, high- and very high-risk myelodysplastic syndromes. Teliso-V In January 2022, AbbVie announced that the FDA granted Breakthrough Therapy Designation to investigational telisotuzumab vedotin (Teliso-V) for the treatment of patients with advanced/metastatic epidermal growth factor receptor wild type, nonsquamous non-small cell lung cancer with high levels of c-Met overexpression whose disease has progressed on or after platinum-based therapy. Neuroscience Botox Therapeutic In February 2021, AbbVie received FDA approval of Botox for the treatment of detrusor overactivity associated with a neurological condition in certain pediatric patients 5 years of age and older. Qulipta In September 2021, AbbVie announced that the FDA approved Qulipta (atogepant) for the preventive treatment of episodic migraine in adults. Vraylar In October 2021, A bbVie announced top-line results from two Phase 3 clinical trials, Study 3111-301-001 and Study 3111-302-001, evaluating the efficacy and safety of cariprazine (Vraylar) as an adjunctive treatment for patients with major depressive disorder (MDD). In Study 3111-301-001, Vraylar met its primary endpoint demonstrating statistically significant change from baseline to week six in the Montgomery-sberg Depression Rating Scale (MADRS) total score compared with placebo in patients with MDD. In Study 3111-302-001, Vraylar demonstrated numerical improvement in depressive symptoms from baseline to week six in MADRS total score compared with placebo but did not achieve statistical significance. Safety data were consistent with the established safety profile of Vraylar across indications with no new safety signals identified. ABBV-951 In October 2021, Abb Vie announced that results from its pivotal Phase 3 M15-736 study of ABBV-951 (foslevodopa/foscarbidopa) in patients with advanced Parkinsons disease met its primary endpoint in a 12-week study. Eye Care Vuity In October 2021, AbbVie announced that the FDA approved Vuity (pilocarpine HCl ophthalmic solution) for the treatment of presbyopia. 2021 Form 10-K | RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 United States $ 43,510 $ 34,879 $ 23,907 24.7 % 45.9 % 24.7 % 45.9 % International 12,687 10,925 9,359 16.1 % 16.7 % 12.6 % 17.8 % Net revenues $ 56,197 $ 45,804 $ 33,266 22.7 % 37.7 % 21.9 % 38.0 % | 2021 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 Immunology Humira United States $ 17,330 $ 16,112 $ 14,864 7.6 % 8.4 % 7.6 % 8.4 % International 3,364 3,720 4,305 (9.6) % (13.6) % (12.8) % (12.5) % Total $ 20,694 $ 19,832 $ 19,169 4.3 % 3.5 % 3.7 % 3.7 % Skyrizi United States $ 2,486 $ 1,385 $ 311 79.6 % 100.0% 79.6 % 100.0% International 453 205 44 100.0 % 100.0% 100.0 % 100.0% Total $ 2,939 $ 1,590 $ 355 84.9 % 100.0% 84.0 % 100.0% Rinvoq United States $ 1,271 $ 653 $ 47 94.8 % 100.0% 94.8 % 100.0% International 380 78 100.0 % 100.0% 100.0 % 100.0% Total $ 1,651 $ 731 $ 47 100.0 % 100.0% 100.0 % 100.0% Hematologic Oncology Imbruvica United States $ 4,321 $ 4,305 $ 3,830 0.4 % 12.4 % 0.4 % 12.4 % Collaboration revenues 1,087 1,009 844 7.7 % 19.5 % 7.7 % 19.5 % Total $ 5,408 $ 5,314 $ 4,674 1.8 % 13.7 % 1.8 % 13.7 % Venclexta United States $ 934 $ 804 $ 521 16.1 % 54.4 % 16.1 % 54.4 % International 886 533 271 66.2 % 97.0 % 60.9 % 97.8 % Total $ 1,820 $ 1,337 $ 792 36.1 % 69.0 % 34.0 % 69.3 % Aesthetics Botox Cosmetic (a) United States $ 1,424 $ 687 $ 100.0 % n/m 100.0 % n/m International 808 425 90.0 % n/m 83.9 % n/m Total $ 2,232 $ 1,112 $ 100.0 % n/m 98.4 % n/m Juvederm Collection (a) United States $ 658 $ 318 $ 100.0 % n/m 100.0 % n/m International 877 400 100.0 % n/m 100.0 % n/m Total $ 1,535 $ 718 $ 100.0 % n/m 100.0 % n/m Other Aesthetics (a) United States $ 1,268 $ 666 $ 90.2 % n/m 90.2 % n/m International 198 94 100.0 % n/m 100.0 % n/m Total $ 1,466 $ 760 $ 93.0 % n/m 91.9 % n/m Neuroscience Botox Therapeutic (a) United States $ 2,012 $ 1,155 $ 74.3 % n/m 74.3 % n/m International 439 232 89.0 % n/m 78.8 % n/m Total $ 2,451 $ 1,387 $ 76.7 % n/m 75.0 % n/m Vraylar (a) United States $ 1,728 $ 951 $ 81.7 % n/m 81.7 % n/m Duodopa United States $ 102 $ 103 $ 97 (1.0) % 5.9 % (1.0) % 5.9 % International 409 391 364 4.6 % 7.4 % (0.1) % 6.3 % Total $ 511 $ 494 $ 461 3.4 % 7.1 % (0.3) % 6.2 % Ubrelvy (a) United States $ 552 $ 125 $ 100.0 % n/m 100.0 % n/m Other Neuroscience (a) United States $ 667 $ 528 $ 26.3 % n/m 26.3 % n/m International 18 11 77.4 % n/m 64.7 % n/m Total $ 685 $ 539 $ 27.2 % n/m 27.0 % n/m 2021 Form 10-K | Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 Eye Care Lumigan/Ganfort (a) United States $ 273 $ 165 $ 64.7 % n/m 64.7 % n/m International 306 213 44.1 % n/m 38.1 % n/m Total $ 579 $ 378 $ 53.1 % n/m 49.7 % n/m Alphagan/Combigan (a) United States $ 373 $ 223 $ 66.5 % n/m 66.5 % n/m International 156 103 52.5 % n/m 50.6 % n/m Total $ 529 $ 326 $ 62.1 % n/m 61.5 % n/m Restasis (a) United States $ 1,234 $ 755 $ 63.3 % n/m 63.3 % n/m International 56 32 75.3 % n/m 80.1 % n/m Total $ 1,290 $ 787 $ 63.8 % n/m 64.0 % n/m Other Eye Care (a) United States $ 523 $ 305 $ 72.7 % n/m 72.7 % n/m International 646 388 66.1 % n/m 61.0 % n/m Total $ 1,169 $ 693 $ 69.0 % n/m 66.1 % n/m Women's Health Lo Loestrin (a) United States $ 423 $ 346 $ 21.9 % n/m 21.9 % n/m International 14 10 43.3 % n/m 33.0 % n/m Total $ 437 $ 356 $ 22.5 % n/m 22.2 % n/m Orilissa/Oriahnn United States $ 139 $ 121 $ 91 15.4 % 33.3 % 15.4 % 33.3 % International 6 4 2 57.7 % 96.1 % 47.6 % 97.7 % Total $ 145 $ 125 $ 93 16.7 % 34.6 % 16.4 % 34.6 % Other Women's Health (a) United States $ 209 $ 181 $ 16.2 % n/m 16.2 % n/m International 5 11 (57.5) % n/m (61.5) % n/m Total $ 214 $ 192 $ 11.7 % n/m 11.5 % n/m Other Key Products Mavyret United States $ 754 $ 785 $ 1,473 (4.0) % (46.7) % (4.0) % (46.7) % International 956 1,045 1,420 (8.5) % (26.4) % (10.8) % (26.8) % Total $ 1,710 $ 1,830 $ 2,893 (6.5) % (36.7) % (7.8) % (36.9) % Creon United States $ 1,191 $ 1,114 $ 1,041 6.9 % 6.9 % 6.9 % 6.9 % Lupron United States $ 604 $ 600 $ 720 0.5 % (16.6) % 0.5 % (16.6) % International 179 152 167 18.0 % (9.1) % 15.0 % (5.4) % Total $ 783 $ 752 $ 887 4.0 % (15.2) % 3.4 % (14.5) % Linzess/Constella (a) United States $ 1,006 $ 649 $ 55.1 % n/m 55.1 % n/m International 32 18 77.3 % n/m 66.4 % n/m Total $ 1,038 $ 667 $ 55.7 % n/m 55.4 % n/m Synthroid United States $ 767 $ 771 $ 786 (0.6) % (1.9) % (0.6) % (1.9) % All other $ 2,673 $ 2,923 $ 2,068 (8.6) % 41.3 % (9.7) % 42.4 % Total net revenues $ 56,197 $ 45,804 $ 33,266 22.7 % 37.7 % 21.9 % 38.0 % n/m Not meaningful (a) Net revenues include Allergan product revenues after the acquisition closing date of May 8, 2020. The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global Humira sales increased 4% in 2021 primarily driven by market growth across therapeutic categories, partially offset by direct biosimilar competition in certain international markets. In the United States, Humira sales increased 8% in 2021 driven by market growth across all indications. This increase was partially offset by slightly lower market share following corresponding market share gains of Skyrizi and Rinvoq. Internationally, Humira revenues decreased 13% in 2021 primarily driven by direct biosimilar competition in certain international markets. Net revenues for Skyrizi increased 84% in 2021 primarily driven by continued strong volume and market share uptake since launch in 2019 as a treatment for plaque psoriasis as well as market growth over the prior year. Net revenues for Rinvoq increased by more than 100% in 2021 primarily driven by continued strong volume and market share uptake since launch in 2019 for the treatment of moderate to severe rheumatoid arthritis as well as market growth over the prior year. Net revenues were also favorably impacted by recent regulatory approvals and expansion of Rinvoq for the treatment of psoriatic arthritis, atopic dermatitis and ankylosing spondylitis in certain international markets. | 2021 Form 10-K Net revenues for Imbruvica represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of Imbruvica profit. AbbVie's global Imbruvica revenues increased 2% in 2021 as a result of modest favorable pricing in the United States and increased collaboration revenues, partially offset by lower new patient starts due to the COVID-19 pandemic and share loss in the United States. Net revenues for Venclexta increased 34% in 2021 primarily due to continued expansion of Venclexta for the treatment of patients with first-line CLL, relapsed/refractory CLL and first-line AML. Net revenues for Botox Cosmetic used in facial aesthetics increased 98% in 2021 due to increased brand investment and strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Juvederm Collection (including Juvederm Ultra XC, Juvederm Voluma XC and other Juvederm products) used in facial aesthetics increased by more than 100% in 2021 due to increased brand investment and strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Botox Therapeutic used primarily in neuroscience and urology therapeutic areas increased 75% in 2021 due to a strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Vraylar for the treatment of schizophrenia, bipolar I disorder and bipolar depression increased 82% in 2021 due to higher market share and market growth. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Ubrelvy for the acute treatment of migraine with or without aura in adults increased by more than 100% in 2021 primarily due to increased volume and market share uptake since launch in 2020. Net revenues for Mavyret decreased 8% in 2021 primarily driven by the continued disruption of global HCV markets due to the COVID-19 pandemic. Gross Margin Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Gross margin $ 38,751 $ 30,417 $ 25,827 27 % 18 % as a percent of net revenues 69 % 66 % 78 % Gross margin as a percentage of net revenues in 2021 increased from 2020 primarily due to lower amortization of inventory fair value step-up adjustment associated with the Allergan acquisition and favorable changes in product mix, partially offset by higher amortization of intangible assets associated with the Allergan acquisition. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Selling, general and administrative $ 12,349 $ 11,299 $ 6,942 9 % 63 % as a percent of net revenues 22 % 25 % 21 % SGA expenses as a percentage of net revenues in 2021 decreased primarily due to lower transaction and integration costs related to the acquisition of Allergan as well as leverage from revenue growth and synergies realized in the period subsequent to completion of the Allergan acquisition. 2021 Form 10-K | Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Research and development $ 7,084 $ 6,557 $ 6,407 8 % 2 % as a percent of net revenues 13 % 14 % 19 % Acquired in-process research and development $ 962 $ 1,198 $ 385 (20) % 100% RD expenses as a percentage of net revenues decreased in 2021 primarily due to the increased scale of the combined company and synergies realized for the period subsequent to completion of the Allergan acquisition as well as lower integration costs related to the acquisition of Allergan. Acquired IPRD expenses represent initial costs to acquire rights to in-process RD projects through RD collaborations, licensing arrangements or other asset acquisitions. Acquired IPRD expense in 2021 included a charge of $400 million as a result of exercising the company's exclusive right to acquire TeneoOne, an affiliate of Teneobio, Inc., and TNB-383B, a BCMA-targeting immunotherapeutic for the potential treatment of relapsed or refractory multiple myeloma and a charge of $370 million as a result of entering into a collaboration agreement with REGENXBIO Inc. for the development and commercialization of RGX-314, an investigational gene therapy for wet age-related macular degeneration, diabetic retinopathy and other chronic retinal diseases. Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering into a collaboration agreement with Genmab A/S to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer. Acquired IPRD expense in 2020 also included a charge of $200 million as a result of entering into a collaboration agreement with I-Mab Biopharma for the development and commercialization of lemzoparlimab for the treatment of multiple cancers. See Note 5 to the Consolidated Financial Statements for additional information. Other Operating Expense (Income), Net Other operating expense in 2021 included a $500 million charge related to the extension of the Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Other Non-Operating Expenses years ended December 31 (in millions) 2021 2020 2019 Interest expense $ 2,423 $ 2,454 $ 1,784 Interest income (39) (174) (275) Interest expense, net $ 2,384 $ 2,280 $ 1,509 Net foreign exchange loss $ 51 $ 71 $ 42 Other expense, net 2,500 5,614 3,006 Interest expense in 2021 decreased compared to 2020 primarily due to the favorable impact of lower interest rates on the companys floating rate debt obligations and deleveraging, partially offset by a higher average debt balance associated with the incremental Allergan debt acquired. Interest income in 2021 decreased compared to 2020 primarily due to a lower average cash and cash equivalents balance as a result of the cash paid for the Allergan acquisition and the unfavorable impact of lower interest rates. Other expense, net included charges related to changes in fair value of the contingent consideration liabilities of $2.7 billion in 2021 and $5.8 billion in 2020. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products and other market-based factors. In 2021, the change in fair value included the increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, favorable clinical trial results and the passage of time, partially offset by higher discount rates. In 2020, the change in fair value primarily included the increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, lower discount rates, the passage of time and favorable clinical trial results. | 2021 Form 10-K Income Tax Expense The effective income tax rate was 11% in 2021, negative 36% in 2020 and 6% in 2019. The effective income tax rates differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, tax audit settlements and accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) 2021 2020 2019 Cash flows provided by (used in) Operating activities $ 22,777 $ 17,588 $ 13,324 Investing activities (2,344) (37,557) 596 Financing activities (19,039) (11,501) 18,708 Operating cash flows in 2021 increased from 2020. Operating cash flows in 2021 were favorably impacted by higher net revenues of the combined company and lower acquisition-related cash expenses, partially offset by higher income tax payments and the timing of working capital cash flows. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $376 million in 2021 and $367 million in 2020. Investing cash flows in 2021 included $535 million cash consideration paid to acquire Soliton, Inc. offset by cash acquired, payments made for other acquisitions and investments of $1.4 billion, capital expenditures of $787 million and net purchases of investment securities totaling $21 million. Investing cash flows in 2020 included $39.7 billion cash consideration paid to acquire Allergan offset by cash acquired of $1.5 billion, net sales and maturities of investment securities totaling $1.5 billion, payments made for other acquisitions and investments of $1.4 billion and capital expenditures of $798 million. Financing cash flows in 2021 included early repayments of $1.8 billion aggregate principal amount of the company's 2.3% principal notes, $1.2 billion aggregate principal amount of the company's 5.0% senior notes and 750 million aggregate principal amount of the company's 0.5% senior Euro notes. Financing cash flows also included the May 2021 repayment of $750 million aggregate principal amount of floating rate senior notes and the November 2021 repayment of $1.3 billion aggregate principal amount of 3.375% senior notes, $1.8 billion aggregate principal amount of 2.15% senior notes and $750 million aggregate principal amount of floating rate senior notes at maturity. Additionally, financing cash flows included repayment of a $1.0 billion floating rate term loan due May 2023 and issuance of a new $1.0 billion floating rate term loan as part of the term loan refinancing in September 2021. Financing cash flows in 2020 included the issuance of term loans totaling $3.0 billion under the existing $6.0 billion term loan credit agreement which were used to finance the acquisition of Allergan. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. Additionally, financing cash flows included the May 2020 repayment of $3.8 billion aggregate principal amount of the company's 2.50% senior notes, the September 2020 repayment of $650 million aggregate principal amount of 3.375% senior notes and the November 2020 repayments of 700 million aggregate principal amount of floating rate senior Euro notes at maturity as well as the $450 million aggregate principal amount of 4.875% senior notes due February 2021. Financing cash flows also included cash dividend payments of $9.3 billion in 2021 and $7.7 billion in 2020. The increase in cash dividend payments was primarily driven by an increase of the dividend rate and higher outstanding shares following the 286 million shares of AbbVie common stock issued to Allergan shareholders in May 2020. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 6 million shares for $670 million in 2021 and 8 million shares for $757 million in 2020. AbbVie's remaining stock repurchase authorization was $2.5 billion as of December 31, 2021. 2021 Form 10-K | No commercial paper borrowings were issued during 2021. In 2020, the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2021 or December 31, 2020. AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance for credit losses equal to the estimate of future losses over the contractual life of outstanding accounts receivable. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2021, the company was in compliance with all covenants, and commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facility as of December 31, 2021 and 2020. Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations or has the ability to issue additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes to the company's credit ratings during 2021. Following the acquisition of Allergan in 2020, SP Global Ratings revised its ratings outlook to stable from negative and lowered the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1. There were no changes in Moody's Investor Service of its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the companys ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the companys outstanding debt. Future Cash Requirements Contractual Obligations The following table summarizes AbbVie's estimated material contractual obligations as of December 31, 2021: (in millions) Total Current Long-term Long-term debt, including current portion $ 75,962 $ 12,428 $ 63,534 Interest on long-term debt (a) 30,002 2,392 27,610 Contingent consideration liabilities (b) 14,887 1,249 13,638 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2021. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2021. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2021. | 2021 Form 10-K (b) Includes contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. AbbVie enters into certain unconditional purchase obligations and other commitments in the normal course of business. There have been no changes to these commitments that would have a material impact on the companys ability to meet either short-term or long-term future cash requirements. Income Taxes Future income tax cash requirements include a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax liability was $3.9 billion as of December 31, 2021 and is payable in five future annual installments. Liabilities for unrecognized tax benefits totaled $6.0 billion as of December 31, 2021. It is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. Quarterly Cash Dividend On October 29, 2021, AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.30 per share to $1.41 per share beginning with the dividend payable on February 15, 2022 to stockholders of record as of January 14, 2022. This reflects an increase of approximately 8.5% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Collaborations, Licensing and Other Arrangements AbbVie enters into collaborative, licensing, and other arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements. Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. 2021 Form 10-K | Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Provisions for rebates and chargebacks totaled $33.9 billion in 2021, $27.0 billion in 2020 and $18.8 billion in 2019. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest accruals for rebates and chargebacks, which comprise approximately 95% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2021. Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2018 $ 1,645 $ 1,439 $ 656 Provisions 4,035 5,772 7,947 Payments (3,915) (5,275) (7,917) Balance at December 31, 2019 1,765 1,936 686 Additions (a) 1,266 649 71 Provisions 6,715 8,656 8,677 Payments (6,801) (8,334) (8,693) Balance at December 31, 2020 2,945 2,907 741 Provisions 9,622 11,306 11,286 Payments (8,751) (11,116) (11,125) Balance at December 31, 2021 $ 3,816 $ 3,097 $ 902 (a) Represents rebate accruals and chargeback allowances assumed in the Allergan acquisition. Cash Discounts and Product Returns Cash discounts and product returns, which totaled $3.6 billion in 2021, $2.4 billion in 2020 and $1.6 billion in 2019, are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements. | 2021 Form 10-K The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2021. A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2022 and projected benefit obligations as of December 31, 2021: 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (90) $ 100 Projected benefit obligation (1,014) 1,159 Other post-employment plans Service and interest cost $ (7) $ 7 Projected benefit obligation (61) 69 The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2021 and will be used in the calculation of net periodic benefit cost in 2022. A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2022 by $101 million. The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2021 and will be used in the calculation of net periodic benefit cost in 2022. Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur between companies in 2021 Form 10-K | the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for additional information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs, which are disclosed in Note 11 to the Consolidated Financial Statements. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. | 2021 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar, Chinese yuan and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2021 and 2020: 2021 2020 as of December 31 (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 10,253 1.155 $ 195 $ 7,818 1.213 $ (39) Chinese yuan 673 6.400 (1) 247 6.584 (1) British pound 605 1.331 9 275 1.341 3 Japanese yen 602 113.3 9 837 103.9 (7) Canadian dollar 571 1.258 9 591 1.328 (23) All other currencies 1,549 n/a 5 1,459 n/a (14) Total $ 14,253 $ 226 $ 11,227 $ (81) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.4 billion at December 31, 2021. If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2021, the company has 5.9 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive loss. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $244 million at December 31, 2021. If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.0 billion at December 31, 2021. A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 2021 Form 10-K | "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm (PC AOB ID: 42 ) 49 | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) 2021 2020 2019 Net revenues $ 56,197 $ 45,804 $ 33,266 Cost of products sold 17,446 15,387 7,439 Selling, general and administrative 12,349 11,299 6,942 Research and development 7,084 6,557 6,407 Acquired in-process research and development 962 1,198 385 Other operating expense (income), net 432 ( 890 ) Total operating costs and expenses 38,273 34,441 20,283 Operating earnings 17,924 11,363 12,983 Interest expense, net 2,384 2,280 1,509 Net foreign exchange loss 51 71 42 Other expense, net 2,500 5,614 3,006 Earnings before income tax expense 12,989 3,398 8,426 Income tax expense (benefit) 1,440 ( 1,224 ) 544 Net earnings 11,549 4,622 7,882 Net earnings attributable to noncontrolling interest 7 6 Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Per share data Basic earnings per share attributable to AbbVie Inc. $ 6.48 $ 2.73 $ 5.30 Diluted earnings per share attributable to AbbVie Inc. $ 6.45 $ 2.72 $ 5.28 Weighted-average basic shares outstanding 1,770 1,667 1,481 Weighted-average diluted shares outstanding 1,777 1,673 1,484 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) 2021 2020 2019 Net earnings $ 11,549 $ 4,622 $ 7,882 Foreign currency translation adjustments, net of tax expense (benefit) of $( 35 ) in 2021, $ 28 in 2020 and $( 4 ) in 2019 ( 1,153 ) 1,511 ( 98 ) Net investment hedging activities, net of tax expense (benefit) of $ 193 in 2021, $( 221 ) in 2020 and $ 22 in 2019 699 ( 799 ) 74 Pension and post-employment benefits, net of tax expense (benefit) of $ 124 in 2021, $( 47 ) in 2020 and $( 323 ) in 2019 521 ( 102 ) ( 1,243 ) Marketable security activities, net of tax expense (benefit) of $ in 2021, $ in 2020 and $ in 2019 10 Cash flow hedging activities, net of tax expense (benefit) of $ 20 in 2021, $( 23 ) in 2020 and $ 70 in 2019 151 ( 131 ) 141 Other comprehensive income (loss) $ 218 $ 479 $ ( 1,116 ) Comprehensive income 11,767 5,101 6,766 Comprehensive income attributable to noncontrolling interest 7 6 Comprehensive income attributable to AbbVie Inc. $ 11,760 $ 5,095 $ 6,766 The accompanying notes are an integral part of these consolidated financial statements. | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) 2021 2020 Assets Current assets Cash and equivalents $ 9,746 $ 8,449 Short-term investments 84 30 Accounts receivable, net 9,977 8,822 Inventories 3,128 3,310 Prepaid expenses and other 4,993 3,562 Total current assets 27,928 24,173 Investments 277 293 Property and equipment, net 5,110 5,248 Intangible assets, net 75,951 82,876 Goodwill 32,379 33,124 Other assets 4,884 4,851 Total assets $ 146,529 $ 150,565 Liabilities and Equity Current liabilities Short-term borrowings $ 14 $ 34 Current portion of long-term debt and finance lease obligations 12,481 8,468 Accounts payable and accrued liabilities 22,699 20,159 Total current liabilities 35,194 28,661 Long-term debt and finance lease obligations 64,189 77,554 Deferred income taxes 3,009 3,646 Other long-term liabilities 28,701 27,607 Commitments and contingencies Stockholders' equity (deficit) Common stock, $ 0.01 par value, 4,000,000,000 shares authorized, 1,803,195,293 shares issued as of December 31, 2021 and 1,792,140,764 as of December 31, 2020 18 18 Common stock held in treasury, at cost, 34,857,597 shares as of December 31, 2021 and 27,007,945 as of December 31, 2020 ( 3,143 ) ( 2,264 ) Additional paid-in capital 18,305 17,384 Retained earnings 3,127 1,055 Accumulated other comprehensive loss ( 2,899 ) ( 3,117 ) Total stockholders' equity 15,408 13,076 Noncontrolling interest 28 21 Total equity 15,436 13,097 Total liabilities and equity $ 146,529 $ 150,565 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Noncontrolling interest Total Balance at December 31, 2018 1,479 $ 18 $ ( 24,108 ) $ 14,756 $ 3,368 $ ( 2,480 ) $ $ ( 8,446 ) Net earnings attributable to AbbVie Inc. 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other 5 32 437 469 Balance at December 31, 2019 1,479 18 ( 24,504 ) 15,193 4,717 ( 3,596 ) ( 8,172 ) Net earnings attributable to AbbVie Inc. 4,616 4,616 Other comprehensive income, net of tax 479 479 Dividends declared ( 8,278 ) ( 8,278 ) Common shares and equity awards issued for acquisition of Allergan plc 286 23,166 1,243 24,409 Purchases of treasury stock ( 10 ) ( 978 ) ( 978 ) Stock-based compensation plans and other 10 52 948 1,000 Change in noncontrolling interest 21 21 Balance at December 31, 2020 1,765 18 ( 2,264 ) 17,384 1,055 ( 3,117 ) 21 13,097 Net earnings attributable to AbbVie Inc. 11,542 11,542 Other comprehensive income, net of tax 218 218 Dividends declared ( 9,470 ) ( 9,470 ) Purchases of treasury stock ( 8 ) ( 934 ) ( 934 ) Stock-based compensation plans and other 11 55 921 976 Change in noncontrolling interest 7 7 Balance at December 31, 2021 1,768 $ 18 $ ( 3,143 ) $ 18,305 $ 3,127 $ ( 2,899 ) $ 28 $ 15,436 The accompanying notes are an integral part of these consolidated financial statements. | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) 2021 2020 2019 Cash flows from operating activities Net earnings $ 11,549 $ 4,622 $ 7,882 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation 803 666 464 Amortization of intangible assets 7,718 5,805 1,553 Deferred income taxes ( 898 ) ( 2,325 ) 122 Change in fair value of contingent consideration liabilities 2,679 5,753 3,091 Stock-based compensation 692 753 430 Upfront costs and milestones related to collaborations 1,624 1,376 490 Gain on divestitures ( 68 ) ( 330 ) Stemcentrx impairment 1,030 Other, net 832 43 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable ( 1,321 ) ( 929 ) ( 74 ) Inventories ( 142 ) ( 40 ) ( 231 ) Prepaid expenses and other assets ( 197 ) 134 ( 225 ) Accounts payable and other liabilities 1,628 1,514 97 Income tax assets and liabilities, net ( 1,290 ) ( 573 ) ( 1,018 ) Cash flows from operating activities 22,777 17,588 13,324 Cash flows from investing activities Acquisition of businesses, net of cash acquired ( 525 ) ( 38,260 ) Other acquisitions and investments ( 1,377 ) ( 1,350 ) ( 1,135 ) Acquisitions of property and equipment ( 787 ) ( 798 ) ( 552 ) Purchases of investment securities ( 119 ) ( 61 ) ( 583 ) Sales and maturities of investment securities 98 1,525 2,699 Other, net 366 1,387 167 Cash flows from investing activities ( 2,344 ) ( 37,557 ) 596 Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 1,000 3,000 31,482 Repayments of long-term debt and finance lease obligations ( 9,414 ) ( 5,683 ) ( 1,536 ) Debt issuance costs ( 20 ) ( 424 ) Dividends paid ( 9,261 ) ( 7,716 ) ( 6,366 ) Purchases of treasury stock ( 934 ) ( 978 ) ( 629 ) Proceeds from the exercise of stock options 244 209 8 Payments of contingent consideration liabilities ( 698 ) ( 321 ) ( 163 ) Other, net 24 8 35 Cash flows from financing activities ( 19,039 ) ( 11,501 ) 18,708 Effect of exchange rate changes on cash and equivalents ( 97 ) ( 5 ) 7 Net change in cash and equivalents 1,297 ( 31,475 ) 32,635 Cash and equivalents, beginning of year 8,449 39,924 7,289 Cash and equivalents, end of year $ 9,746 $ 8,449 $ 39,924 Other supplemental information Interest paid, net of portion capitalized $ 2,712 $ 2,619 $ 1,794 Income taxes paid 3,648 1,674 1,447 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 23,979 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacturing and sale of a broad line of therapies that address some of the world's most complex and serious diseases. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On May 8, 2020, AbbVie completed its acquisition of Allergan plc (Allergan). Refer to Note 5 for additional information regarding this acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are | 2021 Form 10-K typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaborations with Janssen Biotech, Inc. and Genentech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 2.1 billion in 2021, $ 1.8 billion in 2020 and $ 1.1 billion in 2019. Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (loss) (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are generally amortized to net periodic benefit cost over a five-year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. 2021 Form 10-K | Investments Investments consist primarily of equity securities, held-to-maturity debt securities, marketable debt securities and time deposits. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. AbbVie periodically assesses its marketable debt securities for impairment and credit losses. When a decline in fair value of marketable debt security is due to credit related factors, an allowance for credit losses is recorded with a corresponding charge to other expense, net in the consolidated statements of earnings. When AbbVie determines that a non-credit related impairment has occurred, the amortized cost basis of the investment, net of allowance for credit losses, is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any impairments and credit losses that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) 2021 2020 Finished goods $ 932 $ 1,318 Work-in-process 1,193 1,201 Raw materials 1,003 791 Inventories $ 3,128 $ 3,310 Property and Equipment as of December 31 (in millions) 2021 2020 Land $ 287 $ 288 Buildings 2,791 2,555 Equipment 6,850 6,976 Construction in progress 799 1,040 Property and equipment, gross 10,727 10,859 Less accumulated depreciation ( 5,617 ) ( 5,611 ) Property and equipment, net $ 5,110 $ 5,248 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 803 million in 2021, $ 666 million in 2020 and $ 464 million in 2019. | 2021 Form 10-K Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease 2021 Form 10-K | the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs to acquire rights to IPRD projects are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. AbbVie adopted the standard in the first quarter of 2021. The adoption did not have a material impact on its consolidated financial statements. | 2021 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) 2021 2020 2019 Interest expense $ 2,423 $ 2,454 $ 1,784 Interest income ( 39 ) ( 174 ) ( 275 ) Interest expense, net $ 2,384 $ 2,280 $ 1,509 Accounts Payable and Accrued Liabilities as of December 31 (in millions) 2021 2020 Sales rebates $ 8,254 $ 7,188 Dividends payable 2,543 2,335 Accounts payable 2,882 2,276 Salaries, wages and commissions 1,785 1,669 Royalty and license arrangements 661 483 Other 6,574 6,208 Accounts payable and accrued liabilities $ 22,699 $ 20,159 Other Long-Term Liabilities as of December 31 (in millions) 2021 2020 Contingent consideration liabilities $ 13,638 $ 12,289 Liabilities for unrecognized tax benefits 5,970 5,680 Income taxes payable 3,442 3,847 Pension and other post-employment benefits 3,153 3,413 Other 2,498 2,378 Other long-term liabilities $ 28,701 $ 27,607 2021 Form 10-K | Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) 2021 2020 2019 Basic EPS Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Earnings allocated to participating securities 74 60 40 Earnings available to common shareholders $ 11,468 $ 4,556 $ 7,842 Weighted average basic shares of common stock outstanding 1,770 1,667 1,481 Basic earnings per share attributable to AbbVie Inc. $ 6.48 $ 2.73 $ 5.30 Diluted EPS Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Earnings allocated to participating securities 74 60 40 Earnings available to common shareholders $ 11,468 $ 4,556 $ 7,842 Weighted average shares of common stock outstanding 1,770 1,667 1,481 Effect of dilutive securities 7 6 3 Weighted average diluted shares of common stock outstanding 1,777 1,673 1,484 Diluted earnings per share attributable to AbbVie Inc. $ 6.45 $ 2.72 $ 5.28 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Allergan On May 8, 2020, AbbVie completed its acquisition of all outstanding equity interests in Allergan in a cash and stock transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. The combination created a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. Under the terms of the acquisition, each ordinary share of Allergan common stock was converted into the right to receive (i) $ 120.30 in cash and (ii) 0.8660 of a share of AbbVie common stock. Total consideration for the acquisition of Allergan is summarized as follows: (in millions) Cash consideration paid to Allergan shareholders (a) $ 39,675 Fair value of AbbVie common stock issued to Allergan shareholders (b) 23,979 Fair value of AbbVie equity awards issued to Allergan equity award holders (c) 430 Total consideration $ 64,084 (a) Represents cash consideration transferred of $ 120.30 per outstanding Allergan ordinary share based on 330 million Allergan ordinary shares outstanding at closing. | 2021 Form 10-K (b) Represents the acquisition date fair value of 286 million shares of AbbVie common stock issued to Allergan shareholders based on the exchange ratio of 0.8660 AbbVie shares for each outstanding Allergan ordinary share at the May 8, 2020 closing price of $ 83.96 per share. (c) Represents the pre-acquisition service portion of the fair value of 11 million AbbVie stock options and 8 million RSUs issued to Allergan equity award holders. The acquisition of Allergan has been accounted for as a business combination using the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The valuation of assets acquired and liabilities assumed was finalized during the second quarter of 2021. Measurement period adjustments to the preliminary purchase price allocation during 2021 included (i) an increase to intangible assets of $ 710 million; (ii) an increase to deferred income tax liabilities of $ 148 million; (iii) other individually insignificant adjustments for a net increase to identifiable net assets of $ 2 million; and (iv) a corresponding decrease to goodwill of $ 564 million. The measurement period adjustments primarily resulted from the completion of the valuation of certain license agreement intangible assets based on facts and circumstances that existed as of the acquisition date and did not result from intervening events subsequent to such date. These adjustments did not have a significant impact on AbbVie's results of operations in 2021 and would not have had a significant impact on prior period results if these adjustments had been made as of the acquisition date. The following table summarizes t he final fair value of assets acquired and liabilities assumed as of the acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ 1,537 Short-term investments 1,421 Accounts receivable 2,374 Inventories 2,340 Prepaid expenses and other current assets 1,982 Investments 137 Property and equipment 2,129 Intangible assets Definite-lived intangible assets 68,190 In-process research and development 1,600 Other noncurrent assets 1,395 Short-term borrowings ( 60 ) Current portion of long-term debt and finance lease obligations ( 1,899 ) Accounts payable and accrued liabilities ( 5,852 ) Long-term debt and finance lease obligations ( 18,937 ) Deferred income taxes ( 3,940 ) Other long-term liabilities ( 4,765 ) Total identifiable net assets 47,652 Goodwill 16,432 Total assets acquired and liabilities assumed $ 64,084 The fair value step-up adjustment to inventories of $ 1.2 billion was amortized to cost of products sold when the inventory was sold to customers and was fully amortized as of December 31, 2021. Intangible assets relate to $ 68.2 billion of definite-lived intangible assets and $ 1.6 billion of IPRD. The acquired definite-lived intangible assets consist of developed product rights and license agreements and are being amortized over a weighted-average estimated useful life of approximately twelve years using the estimated pattern of economic benefit. The estimated fair values of identifiable intangible assets were determined using the ""income approach"" which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product, the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, competitive trends impacting the asset and each cash flow stream, as well as other factors. 2021 Form 10-K | The fair value of long-term debt was determined by quoted market prices as of the acquisition date and the total purchase price adjustment of $ 1.3 billion is being amortized as a reduction to interest expense, net over the lives of the related debt. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from the other assets acquired that could not be individually identified and separately recognized. Specifically, the goodwill recognized from the acquisition of Allergan represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Allergan have been included in the consolidated financial statements. For the period from the acquisition date through December 31, 2020, net revenues attributable to Allergan were $ 10.3 billion and operating losses attributable to Allergan were $ 1.1 billion, inclusive of $ 4.0 billion of intangible asset amortization and $ 1.2 billion of inventory fair value step-up amortization. Acquisition-related expenses, which were comprised primarily of regulatory, financial advisory and legal fees, totaled $ 781 million for the year ended December 31, 2020 and $ 103 million for the year ended December 31, 2019 which were included in SGA expenses in the consolidated statements of earnings . In the fourth quarter of 2021, AbbVie recovered certain acquisition-related regulatory fees totaling $ 401 million which was recorded as a reduction to SGA expenses in the consolidated statement of earnings for the year ended December 31, 2021. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of AbbVie and Allergan for 2020 and 2019 as if the acquisition of Allergan had occurred on January 1, 2019: years ended December 31 (in millions) 2020 2019 Net revenues $ 50,521 $ 49,028 Net earnings (loss) 6,746 ( 38 ) The unaudited pro forma combined financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Allergan. In order to reflect the occurrence of the acquisition on January 1, 2019 as required, the unaudited pro forma financial information includes adjustments to reflect incremental amortization expense to be incurred based on the final fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with acquisition date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition-related costs incurred during the year ended December 31, 2020 to the year ended December 31, 2019. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2019. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. Acquisition of Soliton, Inc. In December 2021, AbbVie completed its previously announced acquisition of Soliton, Inc. (Soliton). Soliton's RESONIC (Rapid Acoustic Pulse device) has U.S. Food and Drug Administration (FDA) 510(k) clearance for the long-term improvement in the appearance of cellulite up to one year. The transaction was accounted for as a business combination using the acquisition method of accounting. Total consideration transferred allocated to the purchase price consisted of cash consideration of $ 535 million paid to holders of Soliton common stock, equity-based awards and warrants. As of the transaction date, AbbVie acquired $ 407 million of intangible assets for developed product rights and assumed deferred tax liabilities totaling $ 63 million. Other assets and liabilities were insignificant. The acquisition resulted in the recognition of $ 177 million of goodwill which is not deductible for tax purposes. Acquisition of Luminera In October 2020, AbbVie entered into an agreement with Luminera, a privately held aesthetics company based in Israel, to acquire Luminera's full dermal filler portfolio and RD pipeline including HArmonyCa, a dermal filler intended for facial soft tissue augmentation. The aggregate accounting purchase price of $ 186 million was comprised of a $ 122 million upfront cash payment and $ 64 million for the acquisition date fair value of contingent consideration liabilities, for which AbbVie may owe up to $ 90 million in future payments upon achievement of certain commercial milestones. The agreement was accounted for as a business combination using the acquisition method of accounting. As of the acquisition date, AbbVie acquired $ 127 million of intangible assets for in-process research and development and $ 33 million of intangible assets for developed | 2021 Form 10-K product rights. Other assets and liabilities assumed were insignificant. The acquisition resulted in the recognition of $ 12 million of goodwill which is not deductible for tax purposes. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.4 billion in 2021, $ 1.4 billion in 2020 and $ 1.1 billion in 2019. AbbVie recorded acquired IPRD charges of $ 962 million in 2021, $ 1.2 billion in 2020 and $ 385 million in 2019. Significant arrangements impacting 2021, 2020 and 2019, some of which require contingent milestone payments, are summarized below. Calico Life Sciences LLC In July 2021, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of their collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. This is the second collaboration extension and builds on the partnership established in 2014 and extended in 2018. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million and the term is extended for an additional three years. AbbVies contribution is payable in two equal installments beginning in 2023. Calico will be responsible for research and early development until 2025 and will advance collaboration projects into Phase 2a through 2030. Following completion of the Phase 2a studies, AbbVie will have the option to exclusively license the collaboration compounds. Upon exercise, AbbVie would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During the third quarter of 2021, AbbVie recorded $ 500 million as other operating expense in the consolidated statement of earnings related to its commitments under the agreement. TeneoOne and TNB-383B In September 2021, AbbVie acquired TeneoOne, an affiliate of Teneobio, Inc., and TNB-383B, a BCMA-targeting immunotherapeutic for the potential treatment of relapsed or refractory multiple myeloma (R/R MM). In February 2019, AbbVie and TeneoOne entered a strategic transaction to develop and commercialize TNB-383B, a bispecific antibody that simultaneously targets BCMA and CD3 and is designed to direct the body's own immune system to target and kill BCMA-expressing tumor cells. AbbVie exercised its exclusive right to acquire TeneoOne and TNB-383B based on an interim analysis of an ongoing Phase 1 study and accounted for the transaction as an asset acquisition. Under the terms of the agreement, AbbVie made an exercise payment of $ 400 million which was recorded to IPRD in the consolidated statement of earnings in the third quarter of 2021. The agreement also included additional payments of up to $ 250 million upon the achievement of certain development, regulatory and commercial milestones. REGENXBIO Inc. In September 2021, AbbVie and REGENXBIO Inc. (REGENXBIO) entered into a collaboration to develop and commercialize RGX-314, an investigational gene therapy for wet age-related macular degeneration, diabetic retinopathy and other chronic retinal diseases. The collaboration provides AbbVie with an exclusive global license to develop and commercialize RGX-314. REGENXBIO will be responsible for completion of ongoing trials, AbbVie and REGENXBIO will collaborate and share costs of additional trials, and AbbVie will lead the clinical development and commercialization of RGX-314 globally. REGENXBIO and AbbVie will share equally in pre-tax profits from net revenues of RGX-314 in the U.S. and AbbVie will pay REGENXBIO tiered royalties on net revenues outside the U.S. Upon closing in the fourth quarter of 2021, AbbVie made an upfront payment of $ 370 million to exclusively license RGX-314 which was recorded to IPRD in the consolidated statement of earnings for the year ended December 31, 2021 . The agreement also included additional payments of up to $ 1.4 billion upon the achievement of certain development, regulatory and commercial milestones. I-Mab Biopharma In September 2020, AbbVie and I-Mab Biopharma (I-Mab) entered into a collaboration agreement for the development and commercialization of lemzoparlimab, an anti-CD47 monoclonal antibody internally discovered and developed by I-Mab for the treatment of multiple cancers. Both companies will collaborate to design and conduct further global clinical trials to evaluate lemzoparlimab. The collaboration provides AbbVie an exclusive global license, excluding greater China, to develop and commercialize lemzoparlimab. The companies will share manufacturing responsibilities with AbbVie being the primary manufacturer for global supply. The agreement also allows for potential collaboration on future CD47-related therapeutic agents, subject to further licenses to explore each other's related programs in their respective territories. The terms of the arrangement include an initial upfront payment of $ 180 million to exclusively license lemzoparlimab along with a milestone payment of $ 20 million based on the Phase I results, for a total of $ 200 million, which was recorded to IPRD in the consolidated statement of earnings in the fourth quarter of 2020 after regulatory approval of the transaction. In addition, I-Mab will be eligible to receive up to $ 1.7 billion upon the achievement of certain clinical development, regulatory and 2021 Form 10-K | commercial milestones, and AbbVie will pay tiered royalties from low-to-mid teen percentages on global net revenues outside of greater China. Genmab A/S In June 2020, AbbVie and Genmab A/S (Genmab) entered into a collaboration agreement to jointly develop and commercialize three of Genmab's early-stage investigational bispecific antibody therapeutics and entered into a discovery research collaboration for future differentiated antibody therapeutics for the treatment of cancer. Under the terms of the agreement, Genmab granted to AbbVie an exclusive license to its epcoritamab (DuoBody-CD3xCD20), DuoHexaBody-CD37 and DuoBody-CD3x5T4 programs. For epcoritamab, the companies will share commercial responsibilities in the U.S. and Japan, with AbbVie responsible for further global commercialization. Genmab will record net revenues in the U.S. and Japan, and the parties will share equally in pre-tax profits from these sales. Genmab will receive tiered royalties on remaining global sales. For the discovery research partnership, Genmab will conduct Phase 1 studies for these programs and AbbVie retains the right to opt-in to program development. During 2020, AbbVie made an upfront payment of $ 750 million, which was recorded to IPRD in the consolidated statement of earnings. AbbVie could make additional payments of up to $ 3.2 billion upon the achievement of certain development, regulatory and commercial milestones for all programs. Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators. As consideration for the rights reacquired by Reata, AbbVie received a total of $ 250 million as of December 31, 2020 and $ 80 million in cash in 2021. Total consideration of $ 330 million was recognized in other operating (income) expense in the consolidated statement of earnings in 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 192 million in 2021, $ 248 million in 2020 and $ 385 million in 2019 . In connection with the other individually insignificant early-stage arrangements entered into in 2021, AbbVie could make additional payments of up to $ 5.5 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaborations The company has ongoing transactions with other entities through collaboration agreements. The following represent the significant collaboration agreements impacting 2021, 2020 and 2019. Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of Imbruvica, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to Imbruvica, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize Imbruvica outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. | 2021 Form 10-K In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of Imbruvica are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize Imbruvica. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) 2021 2020 2019 United States - Janssen's share of profits (included in cost of products sold) $ 2,018 $ 2,012 $ 1,803 International - AbbVie's share of profits (included in net revenues) 1,087 1,009 844 Global - AbbVie's share of other costs (included in respective line items) 304 295 321 AbbVies receivable from Janssen, included in accounts receivable, net, was $ 294 million at December 31, 2021 and $ 283 million at December 31, 2020. AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 509 million at December 31, 2021 and $ 562 million at December 31, 2020. Collaboration with Genentech, Inc. AbbVie and Genentech, Inc. (Genentech), a member of the Roche Group, are parties to a collaboration and license agreement executed in 2007 to jointly research, develop and commercialize human therapeutic products containing BCL-2 inhibitors and certain other compound inhibitors which includes Venclexta, a BCL-2 inhibitor used to treat certain hematological malignancies. AbbVie shares equally with Genentech all pre-tax profits and losses from the development and commercialization of Venclexta in the United States. AbbVie pays royalties on Venclexta net revenues outside the United States. AbbVie manufactures and distributes Venclexta globally and is the principal in the end-customer product sales. Sales of Venclexta are included in AbbVie's net revenues. Genentech's share of United States profits is included in AbbVie's cost of products sold. AbbVie records sales and marketing costs associated with the United States collaboration as part of SGA expenses and global development costs as part of RD expenses, net of Genentechs share. Royalties paid for Venclexta revenues outside the United States are also included in AbbVies cost of products sold. The following table shows the profit and cost sharing relationship between Genentech and AbbVie: years ended December 31 (in millions) 2021 2020 2019 Genentech's share of profits, including royalties (included in cost of products sold) $ 703 $ 533 $ 320 AbbVie's share of sales and marketing costs from U.S. collaboration (included in SGA) 40 46 41 AbbVie's share of development costs (included in RD) 140 129 128 2021 Form 10-K | Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2019 $ 15,604 Additions (a) 17,008 Foreign currency translation adjustments 512 Balance as of December 31, 2020 33,124 Additions (b) 177 Measurement period adjustments (c) ( 564 ) Foreign currency translation adjustments and other ( 358 ) Balance as of December 31, 2021 $ 32,379 (a) Goodwill additions related to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020 (see Note 5). (b) Goodwill additions related to the acquisition of Soliton in the fourth quarter of 2021 (see Note 5). (c) Measurement period adjustments recorded in 2021 related to the acquisition of Allergan (see Note 5). The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2021, there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: 2021 2020 as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 88,945 $ ( 18,463 ) $ 70,482 $ 87,707 $ ( 11,620 ) $ 76,087 License agreements 8,487 ( 3,688 ) 4,799 7,828 ( 2,916 ) 4,912 Total definite-lived intangible assets 97,432 ( 22,151 ) 75,281 95,535 ( 14,536 ) 80,999 Indefinite-lived research and development 670 670 1,877 1,877 Total intangible assets, net $ 98,102 $ ( 22,151 ) $ 75,951 $ 97,412 $ ( 14,536 ) $ 82,876 Definite-Lived Intangible Assets The increase in definite-lived intangible assets during 2021 was primarily due to the measurement period adjustments from the completion of the valuation of certain license agreements acquired in the Allergan acquisition as well as the acquisition of Soliton. Refer to Note 5 for additional information regarding these acquisitions and related adjustments. In 2021, AbbVie also reclassified $ 1.0 billion of indefinite-lived research and development intangible assets to developed product rights upon receiving certain regulatory approvals for Vuity, Qulipta, and HArmonyCa. Definite-lived intangible assets are amortized over their estimated useful lives, which range between 1 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $ 7.7 billion in 2021, $ 5.8 billion in 2020 and $ 1.6 billion in 2019 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2021 is as follows: (in billions) 2022 2023 2024 2025 2026 Anticipated annual amortization expense $ 7.2 $ 7.5 $ 8.0 $ 8.4 $ 7.9 | 2021 Form 10-K Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2021 primarily relate to the acquisition of Allergan. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. In 2019, following the announcement of the decision to terminate the rovalpituzumab tesirine (Rova-T) RD program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. The impairment charge was recorded to RD expense in the consolidated statements of earnings in 2019. Note 8 Integration and Restructuring Plans Allergan Integration Plan Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. To achieve these integration objectives, AbbVie expects to incur total cumulative charges of approximately $ 2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. The following table summarizes the charges associated with the Allergan acquisition integration plan: Severance and employee benefits Other integration year ended December 31 (in millions) 2021 2020 2021 2020 Cost of products sold $ 5 $ 109 $ 127 $ 21 Research and development 199 102 177 Selling, general and administrative 64 388 289 237 Total charges $ 69 $ 696 $ 518 $ 435 The following table summarizes the cash activity in the recorded liability associated with the integration plan: year ended December 31 (in millions) Severance and employee benefits Other integration Charges $ 594 $ 435 Payments and other adjustments ( 227 ) ( 415 ) Accrued balance as of December 31, 2020 $ 367 $ 20 Charges 65 461 Payments and other adjustments ( 210 ) ( 448 ) Accrued balance as of December 31, 2021 $ 222 $ 33 Other Restructuring AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2021, 2020 and 2019, no such plans were individually significant. Restructuring charges recorded were $ 59 million in 2021, $ 60 million in 2020 and $ 234 million in 2019 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. 2021 Form 10-K | The following table summarizes the cash activity in the restructuring reserve for 2021, 2020 and 2019: (in millions) Accrued balance as of December 31, 2018 $ 99 Restructuring charges 219 Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 140 Restructuring charges 58 Payments and other adjustments ( 108 ) Accrued balance as of December 31, 2020 90 Restructuring charges 54 Payments and other adjustments ( 111 ) Accrued balance as of December 31, 2021 $ 33 Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheets: as of December 31 (in millions) Balance sheet caption 2021 2020 Assets Operating Other assets $ 762 $ 895 Finance Property and equipment, net 33 27 Total lease assets $ 795 $ 922 Liabilities Operating Current Accounts payable and accrued liabilities $ 178 $ 175 Noncurrent Other long-term liabilities 713 832 Finance Current Current portion of long-term debt and finance lease obligations 9 8 Noncurrent Long-term debt and finance lease obligations 25 21 Total lease liabilities $ 925 $ 1,036 The following table summarizes the lease costs recognized in the consolidated statements of earnings: years ended December 31 (in millions) 2021 2020 2019 Operating lease cost $ 226 $ 192 $ 124 Short-term lease cost 56 59 34 Variable lease cost 71 60 62 Total lease cost $ 353 $ 311 $ 220 Sublease income and finance lease costs were insignificant in 2021, 2020 and 2019. | 2021 Form 10-K The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: years ended December 31 2021 2020 2019 Weighted-average remaining lease term (years) Operating 7 8 5 Finance 3 3 3 Weighted-average discount rate Operating 2.4 % 2.5 % 3.9 % Finance 1.1 % 1.4 % 3.9 % The following table presents supplementary cash flow information regarding the company's leases: years ended December 31 (in millions) 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 236 $ 185 $ 125 Right-of-use assets obtained in exchange for new operating lease liabilities 66 692 26 Finance lease cash flows were insignificant in 2021, 2020 and 2019. Right-of-use assets obtained in exchange for new operating lease liabilities as of December 31, 2020 included $ 453 million of right-of-use assets acquired in the Allergan acquisition. The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2021: (in millions) Operating leases Finance leases Total (a) 2022 $ 179 $ 9 $ 188 2023 162 9 171 2024 126 7 133 2025 105 5 110 2026 91 9 100 Thereafter 317 317 Total lease payments 980 39 1,019 Less: Interest 89 5 94 Present value of lease liabilities $ 891 $ 34 $ 925 (a) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. 2021 Form 10-K | Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2021 (a) 2021 Effective interest rate in 2020 (a) 2020 Senior notes issued in 2012 2.90 % notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40 % notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 3.20 % notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60 % notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50 % notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70 % notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30 % notes due 2021 2.40 % 2.40 % 1,800 2.85 % notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20 % notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30 % notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45 % notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 1.375 % notes due 2024 ( 1,450 principal) 1.46 % 1,643 1.46 % 1,783 2.125 % notes due 2028 ( 750 principal) 2.18 % 850 2.18 % 922 Senior notes issued in 2018 3.375 % notes due 2021 3.51 % 3.51 % 1,250 3.75 % notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25 % notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875 % notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75 % notes due 2027 ( 750 principal) 0.86 % 850 0.86 % 922 1.25 % notes due 2031 ( 650 principal) 1.30 % 737 1.30 % 799 Senior notes issued in 2019 Floating rate notes due May 2021 0.74 % 1.33 % 750 Floating rate notes due November 2021 0.78 % 1.42 % 750 Floating rate notes due 2022 0.99 % 750 1.62 % 750 2.15 % notes due 2021 2.23 % 2.23 % 1,750 2.30 % notes due 2022 2.42 % 3,000 2.42 % 3,000 2.60 % notes due 2024 2.69 % 3,750 2.69 % 3,750 2.95 % notes due 2026 3.02 % 4,000 3.02 % 4,000 3.20 % notes due 2029 3.25 % 5,500 3.25 % 5,500 4.05 % notes due 2039 4.11 % 4,000 4.11 % 4,000 4.25 % notes due 2049 4.29 % 5,750 4.29 % 5,750 Term loan facilities Floating rate notes due 2023 1.23 % 1.29 % 1,000 Floating rate notes due 2023 0.81 % 1,000 % Floating rate notes due 2025 1.36 % 2,000 1.42 % 2,000 | 2021 Form 10-K as of December 31 (dollars in millions) Effective interest rate in 2021 (a) 2021 Effective interest rate in 2020 (a) 2020 Senior notes acquired in 2020 5.000 % notes due 2021 1.53 % 1.53 % 1,200 3.450 % notes due 2022 1.97 % 2,878 1.97 % 2,878 3.250 % notes due 2022 1.92 % 1,700 1.92 % 1,700 2.800 % notes due 2023 2.13 % 350 2.13 % 350 3.850 % notes due 2024 2.07 % 1,032 2.07 % 1,032 3.800 % notes due 2025 2.09 % 3,021 2.09 % 3,021 4.550 % notes due 2035 3.52 % 1,789 3.52 % 1,789 4.625 % notes due 2042 4.00 % 457 4.00 % 457 4.850 % notes due 2044 4.11 % 1,074 4.11 % 1,074 4.750 % notes due 2045 4.20 % 881 4.20 % 881 Senior Euro notes acquired in 2020 0.500 % notes due 2021 ( 750 principal) 0.72 % 0.72 % 922 1.500 % notes due 2023 ( 500 principal) 0.49 % 567 0.49 % 615 1.250 % notes due 2024 ( 700 principal) 0.65 % 793 0.65 % 861 2.625 % notes due 2028 ( 500 principal) 1.20 % 567 1.20 % 615 2.125 % notes due 2029 ( 550 principal) 1.19 % 623 1.19 % 677 Other 33 29 Fair value hedges 102 278 Unamortized bond discounts ( 130 ) ( 146 ) Unamortized deferred financing costs ( 251 ) ( 287 ) Unamortized bond premiums (b) 954 1,200 Total long-term debt and finance lease obligations 76,670 86,022 Current portion 12,481 8,468 Noncurrent portion $ 64,189 $ 77,554 (a) Excludes the effect of any related interest rate swaps. (b) Represents unamortized purchase price adjustments of Allergan debt. In April 2021, the company repaid $ 1.8 billion aggregate principal amount of 2.3 % senior notes that were scheduled to mature in May 2021. In May 2021, the company repaid 750 million aggregate principal amount of 0.5 % senior Euro notes that were scheduled to mature in June 2021. These repayments were made by exercising, under the terms of the notes, 30-day early redemptions at 100% of the principal amounts. The company also repaid $ 750 million aggregate principal amount of floating rate senior notes at maturity in May 2021. In September 2021, the company refinanced its $ 1.0 billion floating rate three-year term loan. As part of the refinancing, the company repaid the existing $ 1.0 billion term loan due May 2023 and borrowed $ 1.0 billion under a new term loan at a lower floating rate. All other significant terms of the loan, including the maturity date, remained unchanged after the refinancing. In September 2021, the company repaid $ 1.2 billion aggregate principal amount of 5.0 % senior notes that were scheduled to mature in December 2021. This repayment was made by exercising, under the terms of the notes, 90-day early redemption at 100% of the principal amount. In November 2021, the company repaid $ 1.3 billion aggregate principal amount of 3.375 % senior notes and $ 1.8 billion aggregate principal amount of 2.15 % senior notes at maturity. The company also repaid $ 750 million aggregate principal amount of floating rate senior notes at maturity in November 2021. 2021 Form 10-K | In January 2022, the company repaid $ 2.9 billion aggregate principal amount of 3.450 % senior notes that were scheduled to mature in March 2022. This repayment was made by exercising, under the terms of the notes, 60-day early redemption at 100% of the principal amount. In connection with the acquisition of Allergan, in May 2020, the company borrowed $ 3.0 billion under a $ 6.0 billion term loan credit agreement, of which $ 1.0 billion was outstanding under a floating rate three-year term loan tranche and $ 2.0 billion outstanding under a floating rate five-year term loan tranche as of December 31, 2021. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. In May 2020, AbbVie completed its previously announced offers to exchange any and all outstanding notes of certain series issued by Allergan for new notes to be issued by AbbVie and cash. Following the settlement of the exchange offers, AbbVie issued $ 14.0 billion and 3.1 billion of new notes in exchange for the Allergan notes tendered in the exchange offers. The aggregate principal amount of Allergan notes that remained outstanding following the settlement of the exchange offers was approximately $ 1.5 billion and 635 million. The exchange transaction was accounted for as a modification of the assumed debt instruments. In May 2020, the company repaid $ 3.8 billion aggregate principal amount of 2.5 % senior notes at maturity. In September 2020, the company repaid $ 650 million aggregate principal amount of 3.375 % senior notes at maturity. In November 2020, the company repaid 700 million aggregate principal amount of floating rate senior Euro notes at maturity and $ 450 million aggregate principal amount of 4.875 % senior notes due February 2021 three months prior to maturity. In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million, which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie used the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the acquisition described in Note 5 and to pay related fees and expenses. AbbVie has outstanding $ 4.8 billion aggregate principal amount of unsecured senior notes which were issued in 2018. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one month and six months prior to maturity. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 6.0 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 10.0 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. | 2021 Form 10-K At December 31, 2021, the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings There were no commercial paper borrowings outstanding as of December 31, 2021 and December 31, 2020. No commercial paper borrowings were issued during 2021. The weighted-average interest rate on commercial paper borrowings was 1.8 % in 2020 and 2.5 % in 2019. In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2021. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2021, 2020 and 2019. No amounts were outstanding under the company's credit facilities as of December 31, 2021 and December 31, 2020. In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2021: as of and for the years ending December 31 (in millions) 2022 $ 12,428 2023 4,167 2024 7,219 2025 8,771 2026 6,000 Thereafter 37,377 Total obligations and commitments 75,962 Fair value hedges, unamortized bond premiums and discounts, deferred financing costs and finance lease obligations 708 Total long-term debt and finance lease obligations $ 76,670 Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. 2021 Form 10-K | Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 1.1 billion at December 31, 2021 and $ 1.5 billion at December 31, 2020, are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than 18 months. Accumulated gains and losses as of December 31, 2021 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a pre-tax gain of $ 383 million recognized in other comprehensive income (loss). This gain is reclassified to interest expense, net over the term of the related debt. The company is a party to interest rate swap contracts designed as cash flow hedges with notional amounts totaling $ 750 million at December 31, 2021 and $ 2.3 billion at December 31, 2020. The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. Realized and unrealized gains or losses are included in AOCI and are reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 8.2 billion at December 31, 2021 and $ 8.6 billion at December 31, 2020. The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had an aggregate principal amount of senior Euro notes designated as net investment hedges of 5.9 billion at December 31, 2021 and 6.6 billion at December 31, 2020. In addition, the company had foreign currency forward exchange contracts designated as net investment hedges with notional amounts totaling 4.3 billion at December 31, 2021 and 971 million at December 31, 2020. The company uses the spot method of assessing hedge effectiveness for derivative instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. The company is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 4.5 billion at December 31, 2021 and $ 4.8 billion at December 31, 2020. The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. | 2021 Form 10-K The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2021 2020 Balance sheet caption 2021 2020 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ 51 $ 2 Accounts payable and accrued liabilities $ 2 $ 82 Designated as cash flow hedges Other assets Other long-term liabilities 6 Designated as net investment hedges Prepaid expenses and other 149 Accounts payable and accrued liabilities 11 Designated as net investment hedges Other assets 15 Other long-term liabilities Not designated as hedges Prepaid expenses and other 26 49 Accounts payable and accrued liabilities 13 33 Interest rate swap contracts Designated as cash flow hedges Prepaid expenses and other Accounts payable and accrued liabilities 7 14 Designated as cash flow hedges Other assets Other long-term liabilities 20 Designated as fair value hedges Prepaid expenses and other 7 Accounts payable and accrued liabilities Designated as fair value hedges Other assets 26 131 Other long-term liabilities 15 Total derivatives $ 267 $ 189 $ 37 $ 166 While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) 2021 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges $ 82 $ ( 71 ) $ ( 5 ) Designated as net investment hedges 341 ( 95 ) 33 Interest rate swap contracts designated as cash flow hedges 2 ( 53 ) 4 Treasury rate lock agreements designated as cash flow hedges 383 Assuming market rates remain constant through contract maturities, the company expects to reclassify pre-tax gains of $ 65 million into cost of products sold for foreign currency cash flow hedges, pre-tax losses of $ 7 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax gains of $ 577 million in 2021, pre-tax losses of $ 907 million in 2020 and pre-tax gains of $ 90 million in 2019. 2021 Form 10-K | The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption 2021 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ ( 87 ) $ 23 $ 167 Designated as net investment hedges Interest expense, net 26 18 27 Not designated as hedges Net foreign exchange loss ( 100 ) 58 ( 70 ) Treasury rate lock agreements designated as cash flow hedges Interest expense, net 24 24 3 Interest rate swap contracts Designated as cash flow hedges Interest expense, net ( 24 ) ( 17 ) 1 Designated as fair value hedges Interest expense, net ( 127 ) 365 418 Debt designated as hedged item in fair value hedges Interest expense, net 127 ( 365 ) ( 418 ) Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. | 2021 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2021: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 9,746 $ 4,451 $ 5,295 $ Money market funds and time deposits 45 45 Debt securities 46 46 Equity securities 121 100 21 Interest rate swap contracts 26 26 Foreign currency contracts 241 241 Total assets $ 10,225 $ 4,551 $ 5,674 $ Liabilities Interest rate swap contracts $ 22 $ $ 22 $ Foreign currency contracts 15 15 Contingent consideration 14,887 14,887 Total liabilities $ 14,924 $ $ 37 $ 14,887 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2020: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 8,449 $ 2,758 $ 5,691 $ Money market funds and time deposits 12 12 Debt securities 50 50 Equity securities 159 149 10 Interest rate swap contracts 138 138 Foreign currency contracts 51 51 Total assets $ 8,859 $ 2,907 $ 5,952 $ Liabilities Interest rate swap contracts $ 34 $ $ 34 $ Foreign currency contracts 132 132 Contingent consideration 12,997 12,997 Total liabilities $ 13,163 $ $ 166 $ 12,997 Equity securities primarily consist of investments for which the fair values were determined by using the published market prices per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones 2021 Form 10-K | and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities was calculated using the following significant unobservable inputs: 2021 2020 years ended December 31 (in millions) Range Weighted Average (a) Range Weighted Average (a) Discount rate 0.2 % - 2.6 % 1.7 % 0.1 % - 2.2 % 1.1 % Probability of payment for unachieved milestones 89 % - 100 % 90 % 56 % - 92 % 64 % Probability of payment for royalties by indication (b) 56 % - 100 % 96 % 56 % - 100 % 91 % Projected year of payments 2022 - 2034 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excluding approved indications, the estimated probability of payment ranged from 56 % to 89 % at December 31, 2021 and 56 % to 89 % at December 31, 2020. There have been no transfers of assets or liabilities into or out of Level 3 of the fair value hierarchy. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) 2021 2020 2019 Beginning balance $ 12,997 $ 7,340 $ 4,483 Additions (a) 225 Change in fair value recognized in net earnings 2,679 5,753 3,091 Payments ( 789 ) ( 321 ) ( 234 ) Ending balance $ 14,887 $ 12,997 $ 7,340 (a) Additions during the year ended December 31, 2020 represent contingent consideration liabilities assumed in the Allergan acquisition as well as contingent consideration resulting from the Luminera acquisition (see Note 5). The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the year-ended December 31, 2021, the company recorded a $ 2.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, favorable clinical trial results and the passage of time, partially offset by higher discount rates. During the year-ended December 31, 2020, the company recorded a $ 5.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake, lower discount rates, the passage of time and favorable clinical trial results. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the Skyrizi contingent consideration liability due to higher probabilities of success, higher estimated future sales and lower discount rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. | 2021 Form 10-K Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2021 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 14 $ 14 $ $ 14 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 12,455 11,830 11,329 501 Long-term debt and finance lease obligations, excluding fair value hedges 64,113 71,810 70,757 1,053 Total liabilities $ 76,582 $ 83,654 $ 82,086 $ 1,568 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2020 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 34 $ 34 $ $ 34 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 8,461 $ 8,542 $ 8,249 $ 293 $ Long-term debt and finance lease obligations, excluding fair value hedges 77,283 87,761 86,137 1,624 Total liabilities $ 85,778 $ 96,337 $ 94,386 $ 1,951 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 149 million as of December 31, 2021 and $ 102 million as of December 31, 2020. No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2021. Concentrations of Risk Of total net accounts receivable, three U.S. wholesalers accounted for 75 % as of December 31, 2021 and 72 % as of December 31, 2020, and substantially all of AbbVie's pharmaceutical product net revenues in the United States were to these three wholesalers. Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 37 % of AbbVie's total net revenues in 2021, 43 % in 2020 and 58 % in 2019. 2021 Form 10-K | Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2021 and 2020. The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) 2021 2020 2021 2020 Projected benefit obligations Beginning of period $ 11,792 $ 8,646 $ 795 $ 1,050 Service cost 440 370 48 42 Interest cost 237 264 19 34 Employee contributions 2 2 Amendments ( 397 ) Actuarial (gain) loss ( 8 ) 1,105 10 40 Benefits paid ( 281 ) ( 249 ) ( 22 ) ( 17 ) Acquisition 1,409 43 Other, primarily foreign currency translation adjustments ( 176 ) 245 End of period 12,006 11,792 850 795 Fair value of plan assets Beginning of period 9,702 7,116 Actual return on plan assets 1,000 979 Company contributions 376 367 22 17 Employee contributions 2 2 Benefits paid ( 281 ) ( 249 ) ( 22 ) ( 17 ) Acquisition 1,296 Other, primarily foreign currency translation adjustments ( 144 ) 191 End of period 10,655 9,702 Funded status, end of period $ ( 1,351 ) $ ( 2,090 ) $ ( 850 ) $ ( 795 ) Amounts recognized on the consolidated balance sheets Other assets $ 991 $ 563 $ $ Accounts payable and accrued liabilities ( 13 ) ( 12 ) ( 26 ) ( 23 ) Other long-term liabilities ( 2,329 ) ( 2,641 ) ( 824 ) ( 772 ) Net obligation $ ( 1,351 ) $ ( 2,090 ) $ ( 850 ) $ ( 795 ) Actuarial loss, net $ 3,504 $ 4,163 $ 461 $ 482 Prior service cost (credit) 5 8 ( 370 ) ( 408 ) Accumulated other comprehensive loss $ 3,509 $ 4,171 $ 91 $ 74 The projected benefit obligations in the table above included $ 3.2 billion at December 31, 2021 and $ 3.5 billion at December 31, 2020, related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations were $ 10.5 billion at December 31, 2021 and December 31, 2020. | 2021 Form 10-K Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2021 2020 Accumulated benefit obligation $ 6,395 $ 7,527 Fair value of plan assets 5,412 6,066 Information For Pension Plans With A Projected Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2021 2020 Projected benefit obligation $ 7,788 $ 8,719 Fair value of plan assets 5,447 6,066 The 2021 actuarial gain of $ 8 million for qualified pension plans and actuarial loss of $ 10 million for other post-employment plans were primarily driven by an increase in the assumed discount rate offset by change in demographic assumptions from 2020. The 2020 actuarial losses of $ 1.1 billion for qualified pension plans and $ 40 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2019. AbbVie's U.S. pension plan was modified to close the plan to new entrants effective January 1, 2022. In addition, a change to AbbVie's U.S. retiree health benefit plan was approved in 2020 and communicated to employees and retirees in October 2020. Beginning in 2022, Medicare-eligible retirees and Medicare-eligible dependents will choose health care coverage from insurance providers through a private Medicare exchange. AbbVie will continue to provide financial support to Medicare-eligible retirees. This change to the U.S. retiree health benefit plan decreased AbbVie's post-employment benefit obligation and increased AbbVie's unrecognized prior service credit as of December 31, 2020 by $ 397 million. In connection with the Allergan acquisition, AbbVie assumed certain post-employment benefit obligations which were recorded at fair value. Upon acquisition in the second quarter of 2020, the excess of projected benefit obligations over the plan assets was recognized as a liability totaling $ 156 million. 2021 Form 10-K | Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) 2021 2020 2019 Defined benefit plans Actuarial loss (gain) $ ( 345 ) $ 701 $ 1,231 Amortization of prior service cost ( 2 ) ( 2 ) Amortization of actuarial loss ( 288 ) ( 227 ) ( 109 ) Foreign exchange loss (gain) and other ( 27 ) 56 ( 6 ) Total loss (gain) $ ( 662 ) $ 528 $ 1,116 Other post-employment plans Actuarial loss $ 10 $ 40 $ 451 Prior service credit ( 397 ) Amortization of prior service credit 39 4 Amortization of actuarial loss ( 32 ) ( 26 ) ( 1 ) Total loss (gain) $ 17 $ ( 379 ) $ 450 Net Periodic Benefit Cost years ended December 31 (in millions) 2021 2020 2019 Defined benefit plans Service cost $ 440 $ 370 $ 269 Interest cost 237 264 259 Expected return on plan assets ( 663 ) ( 575 ) ( 474 ) Amortization of prior service cost 2 2 Amortization of actuarial loss 288 227 109 Net periodic benefit cost $ 304 $ 288 $ 163 Other post-employment plans Service cost $ 48 $ 42 $ 25 Interest cost 19 34 29 Amortization of prior service credit ( 39 ) ( 4 ) Amortization of actuarial loss 32 26 1 Net periodic benefit cost $ 60 $ 98 $ 55 The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 2021 2020 Defined benefit plans Discount rate 2.8 % 2.4 % Rate of compensation increases 5.2 % 4.6 % Cash balance interest crediting rate 2.7 % 2.8 % Other post-employment plans Discount rate 3.1 % 2.8 % The assumptions used in calculating the December 31, 2021 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2022. | 2021 Form 10-K Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 2021 2020 2019 Defined benefit plans Discount rate for determining service cost 2.6 % 3.1 % 4.0 % Discount rate for determining interest cost 2.2 % 3.0 % 4.0 % Expected long-term rate of return on plan assets 7.1 % 7.1 % 7.6 % Expected rate of change in compensation 4.6 % 4.6 % 4.6 % Cash balance interest crediting rate 2.8 % 2.8 % 2.8 % Other post-employment plans Discount rate for determining service cost 3.0 % 3.7 % 4.7 % Discount rate for determining interest cost 2.2 % 3.2 % 4.3 % For the December 31, 2021 post-retirement health care obligations remeasurement, the company assumed a 5.9 % pre-65 ( 2.1 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The pre-65 rate was assumed to decrease gradually to 4.5 % ( 1.8 % post-65) in 2029 and remain at that level thereafter. For purposes of measuring the 2021 post-retirement health care costs, the company assumed a 6.0 % pre-65 ( 2.3 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The pre-65 rate was assumed to decrease gradually to 4.5 % ( 2.0 % post-65) for 2029 and remain at that level thereafter. 2021 Form 10-K | Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) 2021 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,428 $ 1,428 $ $ U.S. mid cap (b) 198 198 International (c) 458 458 Fixed income securities U.S. government securities (d) 228 95 133 Corporate debt instruments (d) 945 179 766 Non-U.S. government securities (d) 602 445 157 Other (d) 273 268 5 Absolute return funds (e) 100 5 95 Real assets 10 10 Other (f) 261 216 45 Total $ 4,503 $ 3,302 $ 1,201 $ Total assets measured at NAV 6,152 Fair value of plan assets $ 10,655 Basis of fair value measurement as of December 31 (in millions) 2020 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,143 $ 1,143 $ $ U.S. mid cap (b) 164 164 International (c) 524 524 Fixed income securities U.S. government securities (d) 132 18 114 Corporate debt instruments (d) 854 178 676 Non-U.S. government securities (d) 544 397 147 Other (d) 297 294 3 Absolute return funds (e) 310 4 306 Real assets 10 10 Other (f) 252 250 2 Total $ 4,230 $ 2,982 $ 1,248 $ Total assets measured at NAV 5,472 Fair value of plan assets $ 9,702 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. | 2021 Form 10-K (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2021 target investment allocation for the AbbVie Pension Plan was 62.5 % in equity securities, 22.5 % in fixed income securities and 15 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans 2022 $ 293 $ 27 2023 312 30 2024 334 31 2025 356 34 2026 379 36 2027 to 2031 2,291 224 Defined Contribution Plan AbbVie maintains defined contribution savings plans for the benefit of its eligible employees. The expense recognized for these plans was $ 267 million in 2021, $ 191 million in 2020 and $ 102 million in 2019. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation In May 2021, stockholders of the company approved the AbbVie Amended and Restated 2013 Incentive Stock Program (the Amended Plan), which amends and restates the AbbVie 2013 Incentive Stock Program (2013 ISP). AbbVie grants stock-based awards to eligible employees pursuant to the Amended Plan, which provides for several different forms of benefits, including non-qualified stock options, RSUs and various performance-based awards. Under the Amended Plan, a total of 144 million shares of AbbVie common stock have been reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. 2021 Form 10-K | AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and the Amended Plan and is summarized as follows: years ended December 31 (in millions) 2021 2020 2019 Cost of products sold $ 46 $ 47 $ 29 Research and development 226 247 171 Selling, general and administrative 420 459 230 Pre-tax compensation expense 692 753 430 Tax benefit 126 131 80 After-tax compensation expense $ 566 $ 622 $ 350 Realized excess tax benefits associated with stock-based compensation totaled $ 50 million in 2021, $ 34 million in 2020 and $ 15 million in 2019. Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three-year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 16.28 in 2021, $ 12.14 in 2020 and $ 12.54 in 2019. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 11.2 million stock options to holders of Allergan options as a result of the conversion of such options. These options were fair-valued using a lattice valuation model. Refer to Note 5 for additional information regarding the Allergan acquisition. The following table summarizes AbbVie stock option activity in 2021: (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted-average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2020 15,691 $ 73.90 4.7 $ 559 Granted 1,147 105.94 Exercised ( 4,278 ) 57.77 Lapsed and forfeited ( 186 ) 105.28 Outstanding at December 31, 2021 12,374 $ 81.98 4.7 $ 661 Exercisable at December 31, 2021 9,424 $ 78.03 3.6 $ 541 The total intrinsic value of options exercised was $ 239 million in 2021, $ 186 million in 2020 and $ 22 million in 2019. The total fair value of options vested during 2021 was $ 21 million. As of December 31, 2021, $ 10 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in ratable increments over a three or four-year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three-year performance period. For awards granted in 2021 and 2020, performance is based on AbbVie's return on invested capital relative to a defined peer group of pharmaceutical, biotech and life science companies. For awards granted in 2019, the tranches tied to 2021 performance are based on AbbVies return on | 2021 Form 10-K equity relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three-year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2021: (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2020 15,918 $ 87.03 Granted 7,556 105.79 Vested ( 6,735 ) 91.63 Forfeited ( 1,849 ) 83.35 Outstanding at December 31, 2021 14,890 $ 94.93 The fair market value of RSUs and performance shares (as applicable) vested was $ 718 million in 2021, $ 618 million in 2020 and $ 371 million in 2019. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 8.2 million RSUs to holders of Allergan equity awards based on a conversion factor described in the transaction agreement. Refer to Note 5 for additional information regarding the Allergan acquisition. As of December 31, 2021, $ 592 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 5.31 in 2021, $ 4.84 in 2020 and $ 4.39 in 2019. The following table summarizes quarterly cash dividends declared during 2021, 2020 and 2019: 2021 2020 2019 Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/29/21 02/15/22 $ 1.41 10/30/20 02/16/21 $ 1.30 11/01/19 02/14/20 $ 1.18 09/10/21 11/15/21 $ 1.30 09/11/20 11/16/20 $ 1.18 09/06/19 11/15/19 $ 1.07 06/17/21 08/16/21 $ 1.30 06/17/20 08/14/20 $ 1.18 06/20/19 08/15/19 $ 1.07 02/18/21 05/14/21 $ 1.30 02/20/20 05/15/20 $ 1.18 02/21/19 05/15/19 $ 1.07 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 6 million shares for $ 670 million in 2021, 8 million shares for $ 757 million in 2020 and 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was $ 2.5 billion as of December 31, 2021. 2021 Form 10-K | Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2021, 2020 and 2019: (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post-employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2018 $ ( 830 ) $ ( 65 ) $ ( 1,722 ) $ ( 10 ) $ 147 $ ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) 95 ( 1,330 ) 12 298 ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 87 ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) 74 ( 1,243 ) 10 141 ( 1,116 ) Balance as of December 31, 2019 ( 928 ) 9 ( 2,965 ) 288 ( 3,596 ) Other comprehensive income (loss) before reclassifications 1,511 ( 785 ) ( 300 ) ( 108 ) 318 Net losses (gains) reclassified from accumulated other comprehensive loss ( 14 ) 198 ( 23 ) 161 Net current-period other comprehensive income (loss) 1,511 ( 799 ) ( 102 ) ( 131 ) 479 Balance as of December 31, 2020 583 ( 790 ) ( 3,067 ) 157 ( 3,117 ) Other comprehensive income (loss) before reclassifications ( 1,153 ) 720 298 76 ( 59 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 223 75 277 Net current-period other comprehensive income (loss) ( 1,153 ) 699 521 151 218 Balance as of December 31, 2021 $ ( 570 ) $ ( 91 ) $ ( 2,546 ) $ $ 308 $ ( 2,899 ) Other comprehensive income (loss) for 2021 included foreign currency translation adjustments totaling losses of $ 1.2 billion and the offsetting impact of net investment hedging activities totaling gains of $ 699 million, which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive income (loss) for 2020 included foreign currency translation adjustments totaling gains of $ 1.5 billion and the offsetting impact of net investment hedging activities totaling losses of $ 799 million, which were principally due to the impact of the strengthening of the Euro on the translation of the company's Euro-denominated assets. Other comprehensive income (loss) for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. | 2021 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) 2021 2020 2019 Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 26 ) $ ( 18 ) $ ( 27 ) Tax expense 5 4 6 Total reclassifications, net of tax $ ( 21 ) $ ( 14 ) $ ( 21 ) Pension and post-employment benefits Amortization of actuarial losses and other (b) $ 283 $ 251 $ 110 Tax benefit ( 60 ) ( 53 ) ( 23 ) Total reclassifications, net of tax $ 223 $ 198 $ 87 Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ 87 $ ( 23 ) $ ( 167 ) Gains on treasury rate lock agreements (a) ( 24 ) ( 24 ) ( 3 ) Losses (gains) on interest rate swap contracts (a) 24 17 ( 1 ) Tax expense (benefit) ( 12 ) 7 14 Total reclassifications, net of tax $ 75 $ ( 23 ) $ ( 157 ) (a) Amounts are included in interest expense, net (see Note 11). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12). (c) Amounts are included in cost of products sold (see Note 11). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2021, no shares of preferred stock were issued or outstanding. 2021 Form 10-K | Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2021 2020 2019 Domestic $ ( 1,644 ) $ ( 4,467 ) $ ( 2,784 ) Foreign 14,633 7,865 11,210 Total earnings before income tax expense $ 12,989 $ 3,398 $ 8,426 Income Tax Expense years ended December 31 (in millions) 2021 2020 2019 Current Domestic $ 1,987 $ 907 $ 102 Foreign 351 194 320 Total current taxes $ 2,338 $ 1,101 $ 422 Deferred Domestic $ ( 839 ) $ ( 58 ) $ ( 137 ) Foreign ( 59 ) ( 2,267 ) 259 Total deferred taxes $ ( 898 ) $ ( 2,325 ) $ 122 Total income tax expense (benefit) $ 1,440 $ ( 1,224 ) $ 544 Effective Tax Rate Reconciliation years ended December 31 2021 2020 2019 Statutory tax rate 21.0 % 21.0 % 21.0 % Effect of foreign operations ( 5.4 ) 2.4 ( 8.4 ) U.S. tax credits ( 2.8 ) ( 10.6 ) ( 3.3 ) Impacts related to U.S. tax reform ( 1.1 ) ( 1.6 ) Non-deductible expenses 0.3 7.2 1.0 Tax law changes and related restructuring ( 2.0 ) ( 48.5 ) 3.1 Tax audit settlements ( 0.4 ) ( 5.1 ) ( 4.7 ) All other, net 0.4 ( 1.3 ) ( 0.6 ) Effective tax rate 11.1 % ( 36.0 %) 6.5 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2021, 2020 and 2019 differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, tax audit settlements and accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $ 1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2020 and 2019 included impacts related to U.S. tax reform. The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system, including a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. The effective income tax rates for 2019 also included the effects of Stemcentrx impairment related expenses. | 2021 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) 2021 2020 Deferred tax assets Compensation and employee benefits $ 937 $ 1,109 Accruals and reserves 667 438 Chargebacks and rebates 837 555 Advance payments 809 324 Net operating losses and other credit carryforwards 10,095 2,765 Other 1,234 1,371 Total deferred tax assets 14,579 6,562 Valuation allowances ( 9,391 ) ( 1,203 ) Total net deferred tax assets 5,188 5,359 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 4,711 ) ( 5,274 ) Excess of book basis over tax basis in investments ( 308 ) ( 335 ) Other ( 904 ) ( 982 ) Total deferred tax liabilities ( 5,923 ) ( 6,591 ) Net deferred tax liabilities $ ( 735 ) $ ( 1,232 ) The decrease in net deferred tax assets is primarily related to the utilization of net operating losses and other carryforwards offset by an increase in advance payments. The decrease in deferred tax liabilities is primarily related to amortization of intangible assets. In connection with the Allergan acquisition, the company recorded adjustments within the measurement period in 2021 related to foreign net operating losses and other credit carryforwards that are not expected to be realized. The adjustments reflected an increase of $ 8.2 billion to deferred tax assets and an offsetting increase to valuation allowances, resulting in no net impact to deferred tax assets. The company had valuation allowances of $ 9.4 billion as of December 31, 2021 and $ 1.2 billion as of December 31, 2020. These were principally related to foreign and state net operating losses and other credit carryforwards that are not expected to be realized. As of December 31, 2021, the company had U.S. federal and state credit carryforwards of $ 214 million as well as U.S. federal, state and foreign net operating loss carryforwards of $ 34.4 billion, which will expire at various times through 2041. The remaining U.S. federal and foreign loss carryforwards of $ 3.2 billion have no expiration. The Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings subject to the Acts transition tax are not considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings or eligible for the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. However, the company generally considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. 2021 Form 10-K | Unrecognized Tax Benefits years ended December 31 (in millions) 2021 2020 2019 Beginning balance $ 5,264 $ 2,661 $ 2,852 Increase due to acquisition 2,674 Increase due to current year tax positions 208 91 113 Increase due to prior year tax positions 137 59 499 Decrease due to prior year tax positions ( 62 ) ( 7 ) ( 21 ) Settlements ( 24 ) ( 141 ) ( 749 ) Lapse of statutes of limitations ( 34 ) ( 73 ) ( 33 ) Ending balance $ 5,489 $ 5,264 $ 2,661 If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 5.2 billion in 2021 and $ 5.0 billion in 2020. Of the unrecognized tax benefits recorded in the table above as of December 31, 2021, AbbVie would be indemnified for approximately $ 79 million. The ""Increase due to current year tax positions"" and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. ""Increase due to acquisition"" in the table above includes amounts related to federal, state and international tax items recorded in acquisition accounting related to the Allergan acquisition. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 161 million in 2021, $ 142 million in 2020 and $ 51 million in 2019, for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $ 803 million at December 31, 2021, $ 642 million at December 31, 2020 and $ 191 million at December 31, 2019. The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 225 million. All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. The most significant matters are described below. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. For litigation matters discussed below for which a loss is probable or reasonably possible, the company is unable to estimate the possible loss or range of loss, if any, beyond the amounts accrued. Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Antitrust Litigation Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits | 2021 Form 10-K pending in federal court consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payors. The cases are pending in the United States District Court for the Eastern District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In June 2020 and August 2021, the court denied the end-payors' motion to certify a class. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2006 patent litigation settlements and related agreements by Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) with three generic companies violated federal antitrust law, and also alleging that 2011 patent litigation by Abbott with two generic companies regarding AndroGel was sham litigation and the settlements of those litigations violated federal antitrust law. In May 2020, Perrigo Company and related entities filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that Abbott's 2011 AndroGel patent lawsuit filed against Perrigo was sham litigation. In October 2020, the Perrigo lawsuit was transferred to the United States District Court for New Jersey. In September 2021, the New Jersey court granted AbbVie's motion for judgment on the pleadings in the Perrigo lawsuit, dismissing it with prejudice. Perrigo has appealed the dismissal. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect Humira purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies Humira patent portfolio violated state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In June 2020, the court dismissed the consolidated litigation with prejudice. The plaintiffs have appealed the dismissal. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2009 and 2010 patent litigation settlements involving Namenda entered into between Forest and generic companies and other conduct by Forest involving Namenda, violated state antitrust, unfair and deceptive trade practices, and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, purported class actions filed by indirect purchasers of Namenda, are consolidated as In re: Namenda Indirect Purchaser Antitrust Litigation in the United States District Court for the Southern District of New York. Lawsuits are pending against Allergan Inc. generally alleging that Allergans petitioning to the U.S. Patent Office and Food and Drug Administration and other conduct by Allergan involving Restasis violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, certified as a class action filed on behalf of indirect purchasers of Restasis, are consolidated for pre-trial purposes in the United States District Court for the Eastern District of New York under the MDL Rules as In re: Restasis (Cyclosporine Ophthalmic Emulsion) Antitrust Litigation , MDL No. 2819. In May 2021, the parties reached an agreement to settle this matter that is subject to final court approval. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2012 and 2013 patent litigation settlements involving Bystolic with six generic manufacturers violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief, and attorneys fees. The lawsuits, purported class actions filed on behalf of direct and indirect purchasers of Bystolic, are consolidated as In re: Bystolic Antitrust Litigation in the United States District Court for the Southern District of New York. Government Proceedings Lawsuits are pending against Allergan and several other manufacturers generally alleging that they improperly promoted and sold prescription opioid products. Approximately 3,130 matters are pending against Allergan. The federal court cases are consolidated for pre-trial purposes in the United States District Court for the Northern District of Ohio under the MDL rules as In re: National Prescription Opiate Litigation , MDL No. 2804. Approximately 251 of the claims are pending in various state courts. The plaintiffs in these cases, which include states, counties, cities, other municipal entities, Native American tribes, union trust funds and other third-party payors, private hospitals, and personal injury claimants, generally seek compensatory and punitive damages. In December 2021, a California state court reached a judgment for Allergan and other defendants in the trial of an opioid lawsuit by Orange, Los Angeles, and Santa Clara Counties and the City of Oakland. In December 2021, Allergan reached an agreement to settle a lawsuit brought by the State of New York and two New York counties, which also provides all other New York counties and political subdivisions the opportunity to participate in the settlement. 2021 Form 10-K | In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In October 2020, the state added a claim under the New Mexico False Advertising Act. Shareholder and Securities Litigation In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. The court granted motions dismissing the claims of three investment-fund plaintiffs, which they appealed. In March 2021, in the first of those appeals, the dismissal was affirmed. One of these plaintiffs refiled its lawsuit in New York state court in June 2020 while the appeal of its dismissal in Illinois is pending. In November 2020, the New York Supreme Court for the County of New York dismissed that lawsuit, which is being appealed. In September 2021, the Illinois court granted AbbVie's motion for summary judgment against all remaining plaintiffs on all the remaining claims, dismissing them with prejudice. The plaintiffs have appealed the dismissals. In October 2018, a federal securities lawsuit, Holwill v. AbbVie Inc., et al ., was filed in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for Humira sales growth in financial filings between 2013 and 2017 were misleading because they omitted alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value that allegedly induced Humira prescriptions. In September 2021, the court granted plaintiffs' motion to certify a class. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergan's textured breast implants. The lawsuits, which were filed by Allergan shareholders, have been consolidated in the United States District Court for the Southern District of New York as In re: Allergan plc Securities Litigation . The plaintiffs generally seek compensatory damages and attorneys fees. In September 2019, the court partially granted Allergan's motion to dismiss. In September 2021, the court granted plaintiffs' motion to certify a class. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans former Actavis generics unit and its alleged anticompetitive conduct with other generic drug companies. The lawsuits were filed by Allergan shareholders and consist of three purported class actions and one individual action that have been consolidated in the U.S. District Court for the District of New Jersey as In re: Allergan Generic Drug Pricing Securities Litigation . In July 2021, the parties reached an agreement to settle the class action lawsuits, which received court approval in November 2021. Product Liability and General Litigation In 2018, a qui tam lawsuit, U.S. ex rel. Silbersher v. Allergan Inc., et al. , was filed in the United States District Court for the Northern District of California against several Allergan entities and others, alleging that their conduct before the U.S. Patent Office resulted in false claims for payment being made to federal and state healthcare payors for Namenda XR and Namzaric. The plaintiff-relator seeks damages and attorneys' fees under the federal False Claims Act and state law analogues. The federal government and state governments declined to intervene in the lawsuit. Intellectual Property Litigation AbbVie Inc. and AbbVie Biotechnology Ltd are seeking to enforce their patent rights relating to adalimumab (a drug AbbVie sells under the trademark Humira). In April 2021 and May 2021, cases were filed in the United States District Court for the Northern District of Illinois against Alvotech hf. AbbVie alleges defendants proposed biosimilar adalimumab product infringes certain AbbVie patents and seeks declaratory and injunctive relief. In August 2021, the court denied Defendants motion to dismiss on jurisdictional grounds in the first case; a motion in the second case remains pending. The court has set a trial on a subset of patents for August 2022. The court order provides that Alvotech will stay off the market until that decision. Litigation on the remaining patents is stayed. In October 2021, the May 2021 declaratory judgment action filed by Alvotech hf. and its U.S. subsidiary Alvotech USA, Inc. in the United States Eastern District of Virginia was transferred to the Northern District of Illinois and subsequently dismissed. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark Imbruvica). Cases were filed in the United States District Court for the District of Delaware in March 2019 against Alvogen Pine Brook LLC and Natco Pharma Ltd.. In August 2021, the court issued a decision holding all asserted patents infringed and valid. The judgment precludes Defendants from obtaining regulatory approval and launching until the last patent expires in 2036. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in these suits. | 2021 Form 10-K Allergan USA, Inc., Allergan Sales, LLC, and Forest Laboratories Holdings Limited, wholly owned subsidiaries of AbbVie, are seeking to enforce patent rights relating to cariprazine (a drug sold under the trademark Vraylar). Litigation was filed in the United States District Court for the District of Delaware in December 2019 against Sun Pharmaceutical Industries Limited and Sun Pharma Global FZE; Aurobindo Pharma Limited and Aurobindo Pharma USA, Inc.; and Zydus Pharmaceuticals (USA), Inc. and Cadila Healthcare Limited. Allergan alleges defendants' proposed generic cariprazine products infringe certain patents and seeks declaratory and injunctive relief. Gedeon Richter Plc, Inc. which is in a global collaboration with Allergan concerning the development and marketing of Vraylar, is the co-plaintiff in this suit. 2021 Form 10-K | Note 16 Segment and Geographic Area Information AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) 2021 2020 2019 Immunology Humira United States $ 17,330 $ 16,112 $ 14,864 International 3,364 3,720 4,305 Total $ 20,694 $ 19,832 $ 19,169 Skyrizi United States $ 2,486 $ 1,385 $ 311 International 453 205 44 Total $ 2,939 $ 1,590 $ 355 Rinvoq United States $ 1,271 $ 653 $ 47 International 380 78 Total $ 1,651 $ 731 $ 47 Hematologic Oncology Imbruvica United States $ 4,321 $ 4,305 $ 3,830 Collaboration revenues 1,087 1,009 844 Total $ 5,408 $ 5,314 $ 4,674 Venclexta United States $ 934 $ 804 $ 521 International 886 533 271 Total $ 1,820 $ 1,337 $ 792 Aesthetics Botox Cosmetic (a) United States $ 1,424 $ 687 $ International 808 425 Total $ 2,232 $ 1,112 $ Juvederm Collection (a) United States $ 658 $ 318 $ International 877 400 Total $ 1,535 $ 718 $ Other Aesthetics (a) United States $ 1,268 $ 666 $ International 198 94 Total $ 1,466 $ 760 $ Neuroscience Botox Therapeutic (a) United States $ 2,012 $ 1,155 $ International 439 232 Total $ 2,451 $ 1,387 $ Vraylar (a) United States $ 1,728 $ 951 $ Duodopa United States $ 102 $ 103 $ 97 International 409 391 364 Total $ 511 $ 494 $ 461 Ubrelvy (a) United States $ 552 $ 125 $ Other Neuroscience (a) United States $ 667 $ 528 $ International 18 11 Total $ 685 $ 539 $ | 2021 Form 10-K years ended December 31 (in millions) 2021 2020 2019 Eye Care Lumigan/Ganfort (a) United States $ 273 $ 165 $ International 306 213 Total $ 579 $ 378 $ Alphagan/Combigan (a) United States $ 373 $ 223 $ International 156 103 Total $ 529 $ 326 $ Restasis (a) United States $ 1,234 $ 755 $ International 56 32 Total $ 1,290 $ 787 $ Other Eye Care (a) United States $ 523 $ 305 $ International 646 388 Total $ 1,169 $ 693 $ Women's Health Lo Loestrin (a) United States $ 423 $ 346 $ International 14 10 Total $ 437 $ 356 $ Orilissa/Oriahnn United States $ 139 $ 121 $ 91 International 6 4 2 Total $ 145 $ 125 $ 93 Other Women's Health (a) United States $ 209 $ 181 $ International 5 11 Total $ 214 $ 192 $ Other Key Products Mavyret United States $ 754 $ 785 $ 1,473 International 956 1,045 1,420 Total $ 1,710 $ 1,830 $ 2,893 Creon United States $ 1,191 $ 1,114 $ 1,041 Lupron United States $ 604 $ 600 $ 720 International 179 152 167 Total $ 783 $ 752 $ 887 Linzess/Constella (a) United States $ 1,006 $ 649 $ International 32 18 Total $ 1,038 $ 667 $ Synthroid United States $ 767 $ 771 $ 786 All other $ 2,673 $ 2,923 $ 2,068 Total net revenues $ 56,197 $ 45,804 $ 33,266 (a) Net revenues include Allergan product revenues after the acquisition closing date of May 8, 2020. 2021 Form 10-K | Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) 2021 2020 2019 United States $ 43,510 $ 34,879 $ 23,907 Canada 1,397 1,159 813 Germany 1,223 1,049 909 Japan 1,090 1,198 1,211 France 936 797 695 China 857 471 195 Australia 533 527 395 Spain 519 453 472 Italy 506 379 372 United Kingdom 497 509 372 Brazil 368 406 359 All other countries 4,761 3,977 3,566 Total net revenues $ 56,197 $ 45,804 $ 33,266 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) 2021 2020 United States and Puerto Rico $ 3,369 $ 3,354 Europe 1,400 1,534 All other 341 360 Total long-lived assets $ 5,110 $ 5,248 Note 17 Fourth Quarter Financial Results (unaudited) quarter ended December 31 (in millions except per share data) 2021 Net revenues $ 14,886 Gross margin 10,566 Net earnings attributable to AbbVie Inc. 4,044 Basic earnings per share attributable to AbbVie Inc. $ 2.27 Diluted earnings per share attributable to AbbVie Inc. $ 2.26 Cash dividends declared per common share $ 1.41 | 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 18, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 2021 Form 10-K | Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period the related product is sold. At December 31, 2021, the Company had $ 8,254 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate, and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions considering industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. | 2021 Form 10-K Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2021, the Company had $ 14,887 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry, including commercial dynamics, trends and utilization, as well as knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 18, 2022 2021 Form 10-K | "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2021. Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021. Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. | 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2021 and 2020, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 18, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 18, 2022 2021 Form 10-K | " +35,AbbVie,2020," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. On May 8, 2020, AbbVie completed the acquisition of Allergan plc (Allergan). The acquisition of Allergan creates a diversified biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions in key therapeutic areas of immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. See Note 5, ""Licensing, Acquisitions and Other ArrangementsAcquisition of Allergan,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Subsequent to the acquisition date, AbbVie's consolidated financial statements include the assets, liabilities, operating results and cash flows of Allergan. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Impact of the Coronavirus Disease 2019 (COVID-19) The novel coronavirus (COVID-19) pandemic continues to spread throughout the United States and around the world. In response to the growing public health crisis, AbbVie has partnered with global authorities to support the experimental use of multiple AbbVie assets to determine their efficacy in the treatment of COVID-19. AbbVie continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie has experienced lower new patient starts across the therapeutic portfolio. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the outbreak. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain. Segments AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, development, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. See Note 16, ""Segment and Geographic Area Information"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data"" and the sales information related to AbbVie's key products and geographies included under Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. | 2020 Form 10-K Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: Humira. Humira (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union Pediatric ulcerative colitis (moderate to severe) European Union Pediatric uveitis European Union Humira is also approved in Japan for the treatment of intestinal Behet's disease and pyoderma gangrenosum. Humira is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 43% of AbbVie's total net revenues in 2020. Skyrizi. Skyrizi (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following an induction dose. Skyrizi is approved in the United States, Canada and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In Japan, Skyrizi is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. Rinvoq . Rinvoq (upadacitinib) is an oral, once-daily selective and reversible JAK inhibitor and is approved in the United States, Canada, Japan and the European Union. Rinvoq is indicated for the treatment of moderate to severe active rheumatoid arthritis in adult patients who have responded inadequately to, or who are intolerant to one or more disease-modifying anti-rheumatic drugs (DMARDs). Rinvoq is also approved in the European Union for the treatment of adult patients with active psoriatic arthritis and adult patients with active ankylosing spondylitis. Rinvoq may be used as monotherapy or in combination with methotrexate. Rinvoq is also indicated in Japan in patients with rheumatoid arthritis with inadequate response to conventional therapy (including inhibition of the progression of structural damage). 2020 Form 10-K | Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: Imbruvica. Imbruvica (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). Imbruvica was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. Imbruvica currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. Venclexta/Venclyxto. Venclexta (venetoclax) is a BCL-2 inhibitor used to treat hematological malignancies. Venclexta is approved by the FDA for adults with CLL or SLL. In addition, Venclexta is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Venclyxto is approved in Europe for CLL in combination with obinutuzumab for patients with previously untreated CLL and in combination with rituximab in patients who have received at least one previous treatment. Aesthetics products. AbbVies Allergan Aesthetics portfolio consists of toxins and dermal fillers, plastics and regenerative medicine, body contouring, and skincare products, which hold market-leading positions in the U.S. and in key markets around the world. In 2020, U.S. sales comprised approximately two-thirds of total global sales. These products are: Botox Cosmetic. Botox Cosmetic is an acetylcholine release inhibitor and a neuromuscular blocking agent indicated for temporary improvement in the appearance of moderate to severe glabellar lines (frown lines between the eyebrows), moderate to severe crow's feet and forehead lines in adults. Having received its initial U.S. Food and Drug Administration (FDA) approval in 2002, Botox Cosmetic is now approved for use in all major markets around the world and has become one of the worlds most recognized and iconic brands. Juvederm Collection. T he Juvederm Collection is a portfolio of hyaluronic acid-based dermal fillers with a variety of approved indications in the U.S. and in all other major markets around the world to treat volume loss in the cheeks, chin, lips and lower face. Other aesthetics. Other aesthetics products include, but are not limited to, Coolsculpting body contouring technology, Alloderm regenerative dermal tissue, Natrelle breast implants, the SkinMedica skincare line, and DiamondGlow. Neuroscience products. AbbVies neuroscience products address some of the most difficult-to-treat neurologic diseases. These products are: Botox Therapeutic. Botox Therapeutic (onabotulinumtoxinA injection) is a neuromuscular blocking agent that is injected into muscle tissue in treatment for the following indications in the United States: For the treatment of overactive bladder with symptoms of urge urinary incontinence, urgency, and frequency, in adults who have an inadequate response to or are intolerant of an anticholinergic medication. For the treatment of urinary incontinence due to detrusor overactivity associated with a neurologic condition (e.g., spinal cord injury, multiple sclerosis) in adults who have an inadequate response to or are intolerant of an anticholinergic medication. For the prophylaxis of headaches in adult patients with chronic migraine ( 15 days per month with headache lasting 4 hours a day or longer). | 2020 Form 10-K For the treatment of spasticity in patients 2 years of age and older. For the treatment of adults with cervical dystonia to reduce the severity of abnormal head position and neck pain associated with cervical dystonia. For the treatment of strabismus and blepharospasm associated with dystonia, including benign essential blepharospasm or VII nerve disorders in patients 12 years of age and older. For the treatment of severe primary axillary hyperhidrosis that is inadequately managed with topical agents. Licenses around the world vary. Focal spasticity associated with dynamic equinus foot deformity due to spasticity in ambulant pediatric cerebral palsy patients, two years of age or older. Focal spasticity of the wrist and hand in adult post stroke patients. Focal spasticity of the ankle and foot in adult post stroke patients. Vraylar. Vraylar (cariprazine) is a dopamine D3-preferring D3/D2 receptor partial agonist and a 5-HT1A receptor partial agonist. Its D3 binding profile may be linked to observed improvements in the negative symptoms of schizophrenia and to antidepressant effects in Bipolar I disorder. Vraylar is indicated for acute and maintenance treatment of schizophrenia in adults, acute treatment of manic or mixed episodes associated with bipolar disorder in adults and acute treatment of depressive episodes associated with bipolar I disorder (bipolar depression) in adults. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Ubrelvy. Ubrelvy (ubrogepant) is indicated for the acute treatment of migraine with or without aura in adults and is only commercialized in the United States. Eye care products. AbbVies eye care products address unmet needs and new approaches to help preserve and protect patients vision. These products are: Lumigan/Ganfort. Lumigan (bimatoprost ophthalmic solution) 0.01% is a once daily, topical prostaglandin analog indicated for the reduction of elevated intraocular pressure (IOP) in patients with open angle glaucoma (OAG) or ocular hypertension (OHT). Ganfort is a once daily topical fixed combination of bimatoprost 0.03% and timolol 0.5% for the reduction of IOP in adult patients with OAG or OHT. Lumigan is sold in the United States and numerous markets around the world, while Ganfort is approved in the EU and some markets in South America, the Middle East, and Asia. Alphagan/Combigan. Alphagan (brimonidine tartrate ophthalmic solution) is an alpha-adrenergic receptor agonist indicated for the reduction of elevated intraocular pressure (IOP) in patients with open-angle glaucoma or ocular hypertension. Combigan (brimonidine tartrate/timolol maleate ophthalmic solution) is approved for reducing elevated intraocular pressure (IOP) in patients with glaucoma who require additional or adjunctive IOP-lowering therapy. Both Alphagan and Combigan are available for sale in the United States and numerous markets around the world. Restasis. Restasis is a calcineurin inhibitor immunosuppressant indicated to increase tear production in patients whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca. Restasis is approved in the United States and a number of other markets in South America, the Middle East, and Asia. Other eye care. Other eye care products include Xen, Durysta, Ozurdex and Refresh/Optive. Women's health products. AbbVies women's health products are: Lo Loestrin . Lo Loestrin Fe is an oral contraceptive. It is indicated for prevention of pregnancy with the lowest dose of estrogen with only 10mcg and is dispensed in a unique 24/2/2 regimen with a two-day hormone-free interval. It is marketed in the U.S. as Lo Loestrin Fe (norethindrone acetate and ethinyl estradiol tablets, ethinyl estradiol tablets and ferrous fumarate tablets) and in select markets outside the U.S. as Lolo. Orilissa/Oriahnn. Orilissa (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved Orilissa under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. Orilissa inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in 2020 Form 10-K | dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, Orilissa is also launched in Canada and Puerto Rico. Oriahnn (elagolix, estradiol, and norethindrone acetate capsules; elagolix capsules) is a combination prescription medicine used to control heavy menstrual bleeding related to uterine fibroids in women before menopause. Other women's health. Other women's health includes Liletta, a sterile, levonorgestrel-releasing intrauterine system indicated for prevention of pregnancy for up to six years. It is the only hormonal IUS (Intrauterine System) approved in the U.S. for up to six years of pregnancy prevention. Other key products. AbbVies other key products include, among other things, treatments for patients with hepatitis C virus (HCV), metabolic and hormone products that target a number of conditions, including exocrine pancreatic insufficiency and hypothyroidism, as well as endocrinology products for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. These products are: Mavyret/Maviret. Mavyret (glecaprevir/pibrentasvir) is approved in the United States and European Union (Maviret) for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. Creon. Creon (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Lupron. Lupron (leuprolide acetate), which is also marketed as Lucrin and Lupron Depot, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Linzess/Constella. Linzess (linaclotide) is a once-daily guanylate cyclase-C agonist used in adults to treat irritable bowel syndrome with constipation (IBSC) and chronic idiopathic constipation (CIC). The product is marketed as Linzess in the United States and as Constella outside of the United States. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell Creon and Synthroid only in the United States. AbbVie's commercial rights to the sale and distribution of Synagis outside of the United States will revert to AstraZeneca upon the expiry of the current agreement in 2021. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States many of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its promotional and market access efforts on key opinion leaders, payers, physicians and health systems. AbbVie also provides patient support programs closely related to its products. Throughout the COVID-19 pandemic AbbVie has maintained its promotional activities with key stakeholders by leveraging digital engagement where permitted and in compliance with the locally applicable government guidance. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. | 2020 Form 10-K In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. In 2020, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States. No individual wholesaler accounted for greater than 38% of AbbVie's 2020 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products, therapies and biologics. For example, Humira competes with anti-TNF products and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available HCV treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. Humira is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug, and Cosmetic Act (the FFDCA), the Public Health Service Act (PHSA) and the regulations implementing such acts. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the PHSA, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered by the FDA as substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, 2020 Form 10-K | the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the FFDCA. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the PHSA are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Other types of regulatory exclusivity may also be available, such as Generating New Antibiotic Incentives Now (GAIN) exclusivity, which can provide new antibiotic or new antifungal drugs an additional 5 years of marketing exclusivity to be added to certain exclusivities already provided for by law. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained or sometimes even later. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2021 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark Humira), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the license in the United States will begin in 2023 and the license in Europe began in 2018. | 2020 Form 10-K In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark Imbruvica) and those related to risankizumab (which is sold under the trademark Skyrizi). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patent covering risankizumab is expected to expire in 2033. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs, and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. Other than the Lupron near-term supply issue which has impacted availability of certain formulations, AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. AbbVie also supplements its research and development efforts with acquisitions. 2020 Form 10-K | The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be submitted and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Further, the FDA continues to regulate product labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. | 2020 Form 10-K Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from applicable supervising regulatory authorities before it can commence clinical trials or marketing of the product in target markets. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Japan-specific trials and/or bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. Similarly, applications for a new product in China are submitted to the Center for Drug Evaluation (CDE) of the National Medical Products Administration (NMPA) for technical review and approval of a product for marketing in China. Clinical data in Chinese subjects are required to support approval in China, requiring the inclusion of China in global pivotal studies, or a separate China/Asian clinical trial. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Similar to the requirements in Japan and China, certain countries (notably South Korea, Taiwan and Russia) also require that local clinical studies be conducted in order to support regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can lead to updates to the data regarding utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. 2020 Form 10-K | Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2021 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. | 2020 Form 10-K Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Regulation Medical Devices Medical devices are subject to regulation by the FDA, state agencies and foreign government health authorities. FDA regulations, as well as various U.S. federal and state laws, govern the development, clinical testing, manufacturing, labeling, record keeping and marketing of medical device products agencies in the United States. AbbVies medical device product candidates, including AbbVies breast implants, must undergo rigorous clinical testing and an extensive government regulatory clearance or approval process prior to sale in the United States and other countries. The lengthy process of clinical development and submissions for clearance or approval, and the continuing need for compliance with applicable laws and regulations, require the expenditure of substantial resources. Regulatory clearance or approval, when and if obtained, may be limited in scope, and may significantly limit the indicated uses for which a product may be marketed. Cleared or approved products and their manufacturers are subject to ongoing review, and discovery of previously unknown problems with products may result in restrictions on their manufacture, sale, and/or use or require their withdrawal from the market. United States . AbbVies medical device products are subject to extensive regulation by the FDA in the United States. Unless an exemption applies, each medical device AbbVie markets in the United States must have a 510(k) clearance or a Premarket Approval Application (PMA) in accordance with the FFDCA and its implementing regulations. The FDA classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose a lower risk are placed in either Class I or Class II, and devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or a device deemed to be not substantially equivalent to a previously cleared 510(k) device, are placed in Class III. In general, a Class III device cannot be marketed in the United States unless the FDA approves the device after submission of a PMA, and any changes to the device subsequent to initial FDA approval must also be reviewed and approved by the FDA. The majority of AbbVies medical device products, including AbbVies breast implants, are regulated as Class III medical devices. A Class III device may have significant additional obligations imposed in its conditions of approval, and the time in which it takes to obtain approval can be long. Compliance with regulatory requirements is assured through periodic, unannounced facility inspections by the FDA and other regulatory authorities, and these inspections may include the manufacturing facilities of AbbVies subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions: warning letters or untitled letters; fines, injunctions and civil penalties; recall or seizure of AbbVie products; operating restrictions, partial suspension or total shutdown of production; refusing AbbVie request for 510(k) clearance or PMA approval of new products; withdrawing 510(k) clearance or PMA approvals that are already granted; and criminal prosecution. A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. Clinical trials generally require submission of an application for an investigational device exemption (IDE), which must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. A study sponsor must obtain approval for its IDE from the FDA, and it must also obtain approval of its study from the Institutional Review Board (IRB) overseeing the trial. The results of clinical testing may not be sufficient to obtain approval of the investigational device. 2020 Form 10-K | Once a device is approved, the manufacture and distribution of the device remains subject to continuing regulation by the FDA, including Quality System Regulation requirements, which involve design, testing, control, documentation and other quality assurance procedures during the manufacturing process. Medical device manufacturers and their subcontractors are required to register their establishments and list their manufactured devices with the FDA and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with regulatory requirements. Manufacturers must also report to the FDA if their devices may have caused or contributed to a death or serious injury or malfunctioned in a way that could likely cause or contribute to a death or serious injury, or if the manufacturer conducts a field correction or product recall or removal to reduce a risk to health posed by a device or to remedy a violation of the FFDCA that may present a health risk. Further, the FDA continues to regulate device labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. European Union. Medical device products that are marketed in the European Union must comply with the requirements of the Medical Device Regulation (the MDR), which will come into effect in May 2021. The MDR provides for regulatory oversight with respect to the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices to ensure that medical devices marketed in the European Union are safe and effective for their intended uses. Medical devices that comply with the MDR are entitled to bear a Conformit Europenne marking evidencing such compliance and may be marketed in the European Union. Failure to comply with these domestic and international regulatory requirements could affect AbbVies ability to market and sell AbbVies products in these countries. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2020 were approximately $6 million and operating expenditures were approximately $34 million. In 2021, capital expenditures for pollution control are estimated to be approximately $9 million and operating expenditures are estimated to be approximately $36 million. Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 47,000 employees in over 70 countries as of January 31, 2021. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Human Capital Management Attracting, retaining and providing meaningful growth and development opportunities to AbbVie's employees is critical to the company's success in making a remarkable impact on peoples lives around the world. AbbVie leverages numerous resources to identify and enhance strategic and leadership capability, foster employee engagement and create a culture where diverse talent is productive and engaged. AbbVie invests in its employees through competitive compensation, benefits and employee support programs and offers best-in-class development and leadership opportunities. AbbVie has developed a deep talent base through ongoing investment in functional and leadership training and by sourcing world-class external talent, ensuring a sustainable talent pipeline. AbbVie continuously cultivates and enhances its working culture and embraces equality, diversity and inclusion as fundamental to the company's mission. | 2020 Form 10-K Attracting and Developing Talent. Attracting and developing high-performing talent is essential to AbbVies continued success. AbbVie implements detailed talent attraction strategies, with an emphasis on STEM skill sets, a diverse talent base and other critical skillsets, including drug discovery, clinical development, market access, and business development. AbbVie also invests in competitive compensation and benefits programs. In addition to offering a comprehensive suite of benefits ranging from medical and dental coverage to retirement, disability and life insurance programs, AbbVie also provides health promotion programs, mental health awareness campaigns and employee assistance programs in several countries, financial wellness support, on-site health screenings and immunizations in several countries and on-site fitness and rehabilitation centers. In addition, the AbbVie Employee Assistance Fund (a part of the AbbVie Foundation) supports two programs for global employees: the AbbVie Possibilities Scholarship for children of employees, which is an annual merit-based scholarship for use at accredited colleges, universities or vocational-technical schools; and the Employee Relief Program, which is financial assistance to support short term needs of employees when faced with large-scale disasters (e.g. a hurricane), individual disasters (e.g. a home fire) or financial hardship (e.g. the death of a spouse). Finally, AbbVie empowers managers and their teams with tools, tips and guidelines on effectively managing workloads, managing teams from a distance and supporting flexible work practices. New AbbVie employees are given a tailored onboarding experience for faster integration and to support performance. AbbVie's mentorship program allows employees to self-nominate as mentors or mentees and facilitates meaningful relationships supporting employees career and development goals. AbbVie also provides structured, broad-based development opportunities, focusing on high-performance skills and leadership training. AbbVie's talent philosophy holds leaders accountable for building a high-performing organization, and the company provides development opportunities to all levels of leadership. AbbVie's Learn, Develop, Perform program offers year-long, self-directed leadership education, supplemented with tools and resources, and leverages leaders as role models and teachers. In addition, the foundation to AbbVie's leadership pipeline is the company's Professional Development Programs, which attract graduates, postgraduates and post-doctoral talent to participate in formal development programs lasting up to three years, with the objective of strengthening functional and leadership capabilities. AbbVie also recently introduced additional development support to senior leaders who are managing increased integration and operational complexity following the transformational acquisition of Allergan. Culture. AbbVies shared values of transforming lives, acting with integrity, driving innovation, embracing diversity and inclusion, and serving the community form the core of the company's culture. AbbVie articulates the behaviors associated with these values in the Ways We Work, a core set of working behaviors that emphasize how the company achieves results is equally as important as achieving them. The Ways We Work are designed to ensure that every AbbVie employee is aware of the company's cultural expectations. AbbVie integrates the Ways We Work into all talent processes, forming the basis for assessing performance, prioritizing development, and ultimately rewarding employees. AbbVie believes it culture creates strong engagement, which is measured regularly through a confidential, third party all-employee survey, and this engagement supports AbbVies mission of making a remarkable impact on peoples lives. Equity, Equality, Diversity Inclusion (EEDI). A cornerstone of AbbVies human capital management approach is to prioritize fostering an inclusive and diverse workforce. In 2019, AbbVie adopted a five-year Equality, Diversity Inclusion roadmap that defines key global focus areas, objectives and associated initiatives, and includes implementation plans organized by business function and geography. AbbVies senior leaders have adopted formal goals aligned with executing this strategy. Over the past year, AbbVie's board of directors has prioritized oversight of AbbVie's response to the U.S. racial justice movement, including overseeing internal programs designed to ensure that AbbVie is attracting, retaining and developing diverse talent. Through June 2020, women represented 49 percent of management positions globally and in the United States, 33 percent of AbbVie's workforce was comprised of members of historically underrepresented populations, an increase from 2019. Further, AbbVie is committed to pay equity and conducts pay equity analyses annually. A critical component of AbbVie's strategy is to instill an inclusive mindset in all AbbVie leaders and employees, so the company can realize the full value of a diverse workforce from recruitment through retirement. AbbVie recently launched a new toolkit for people who manage others to reinforce the importance of EEDI to the business, educate leaders on inclusive recruiting practices and modeling inclusive behavior, and encourage participation in the company's inclusive culture learning opportunities. AbbVie's Employee Resource Groups also help the company nurture an inclusive culture by building community, hosting awareness events and providing leadership and career opportunities. In 2020, AbbVie reiterated its commitment to racial equality and social justice by appointing two additional senior level positions to drive change and awareness company-wide and taking deliberate steps to ensure AbbVie leads by example in promoting racial equity, as further described on the company's website at: https://www.abbvie.com/our-company/our-principles/our-commitment-to-racial-justice.html. 2020 Form 10-K | COVID-19 Health and Safety. AbbVie has effectively prioritized the health and safety of its employees during the COVID-19 pandemic, while continuing to drive strong business performance. AbbVie also implemented, among other things, temporary office and facility closures and establishment of new safety and cleaning protocols and procedures; regular communication regarding the effect of the pandemic on AbbVie's business and employees; establishment of physical distancing procedures, modification of workspaces, and provision of personal protective equipment and cleaning supplies for employees; temperature screening at all company locations; a variety of testing resources including on-site and at-home testing and COVID case management programs; and remote working accommodations and related services to support employees needs for flexibility. In addition, COVID-19 is a covered event under the AbbVie Employee Assistance Fund's Employee Relief Program, entitling eligible AbbVie employees and their families to financial assistance to pay for mortgage/rent, utilities, food, childcare and medical expenses not covered by insurance. AbbVie also provided paid leave and other support and accommodations to the company's employees with relevant medical, pharmaceutical, RD, science, public health and public safety skills, knowledge, training and experience who desired or were requested or mandated to serve as volunteers during the pandemic. Lastly, AbbVies commitment to employees was evidenced by no workforce reductions and no salary reductions associated with COVID-19 . Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business Public health outbreaks, epidemics or pandemics, such as the coronavirus (COVID-19), have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. Public health outbreaks, epidemics or pandemics have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. The continuing pandemic caused by the novel strain of coronavirus (COVID-19) has caused many countries, including the United States, to declare national emergencies and implement preventive measures such as travel bans and shelter in place or total lock-down orders, some of which have eased. The continuation or re-implementation of these bans and orders remains uncertain. The COVID-19 pandemic has caused AbbVie to modify its business practices (including instituting remote work for many of AbbVies employees), and AbbVie may take further actions as may be required by government authorities or as AbbVie determines are in the best interests of AbbVies employees, patients, customers and business partners. While the impact of COVID-19 on AbbVies operations, including, among others, its manufacturing and supply chain, sales and marketing, commercial and clinical trial operations, to-date has not been material, AbbVie has experienced lower | 2020 Form 10-K new patient starts across the therapeutic portfolio. The impact of COVID-19 on AbbVie over the long-term is uncertain and cannot be predicted with confidence. The extent of the adverse impact of COVID-19 on AbbVies operations will depend on the extent and severity of the continued spread of COVID-19 globally, the timing and nature of actions taken to respond to COVID-19 and the resulting economic consequences. Ultimately, the outbreak could have a material adverse impact on AbbVies operations and financial condition. The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1, ""BusinessIntellectual Property Protection and Regulatory Exclusivity"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of Operations,"" and litigation regarding these patents is described in Item 3, ""Legal Proceedings."" The United States composition of matter patent for Humira, which is AbbVie's largest product and had worldwide net revenues of approximately $19.8 billion in 2020, expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful 2020 Form 10-K | claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects Humira revenues could have a material and negative impact on AbbVie's results of operations and cash flows. Humira accounted for approximately 43% of AbbVie's total net revenues in 2020. Any significant event that adversely affects Humira's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for Humira (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of Humira, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of Humira for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances and joint ventures with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. | 2020 Form 10-K Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding Humiracould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including Humira. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, Humira competes with anti-TNF products and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available hepatitis C treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. All of these competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. 2020 Form 10-K | AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Certain aspects of AbbVies operations are highly dependent upon third party service providers. AbbVie relies on suppliers, vendors and other third party service providers to research, develop, manufacture, commercialize, promote and sell its products. Reliance on third party manufacturers reduces AbbVies oversight and control of the manufacturing process. Some of these third party providers are subject to legal and regulatory requirements, privacy and security risks and market risks of their own. The failure of a critical third party service provider to meet its obligations could have a material adverse impact on AbbVies operations and results. If any third party service providers have violated or are alleged to have violated any laws or regulations during the performance of their obligations to AbbVie, it is possible that AbbVie could suffer financial and reputational harm or other negative outcomes, including possible legal consequences. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be taken by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. For example, lawsuits are pending against Allergan, AbbVies newly acquired subsidiary, and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans textured breast implants. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. Additionally, Allergan has been named as a defendant in approximately 3,100 matters relating to the promotion and sale of prescription opioid pain | 2020 Form 10-K relievers and additional suits may be filed. See Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" AbbVie cannot predict the outcome of these proceedings. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1, ""BusinessRegulationDiscovery and Clinical Development, BusinessRegulationCommercialization, Distribution and Manufacturing, and BusinessRegulationMedical Devices. The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. 2020 Form 10-K | Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act, the U.S. Physician Payments Sunshine Act, the TRICARE program, the government pricing rules applicable to the Medicaid, Medicare Part B, 340B Drug Pricing Program and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 24% of AbbVie's total net revenues in 2020. The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including as a result of the United Kingdoms exit from the European Union and the COVID-19 pandemic; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action and regulation; inflation, recession and fluctuations in interest rates; restrictions on transfers of funds; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. | 2020 Form 10-K If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, joint ventures and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, joint ventures, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2020, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States. If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. In particular, AbbVie incurred significant debt in connection with its acquisition of Allergan. AbbVies substantially increased indebtedness and higher debt to equity ratio as a result of the acquisition may exacerbate these risks and have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions and/or lowering its credit ratings. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase further. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie 2020 Form 10-K | raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could have a material adverse effect on AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others have resulted, and may in the future result, in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. To date, AbbVies business or operations have not been materially impacted by such incidents. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent material breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. In connection with the acquisition of Allergan, AbbVies balances of intangible assets, including developed product rights and goodwill acquired, have increased significantly. Such balances are subject to impairment testing and may result in impairment charges, which will adversely affect AbbVies results of operations and financial condition. A significant amount of AbbVies total assets is related to acquired intangibles and goodwill. As of December 31, 2020, the carrying value of AbbVies developed product rights and other intangible assets was $82.9 billion and the carrying value of AbbVies goodwill was $33.1 billion. AbbVies developed product rights are stated at cost, less accumulated amortization. AbbVie determines original fair value and amortization periods for developed product rights based on its assessment of various factors impacting estimated useful lives and cash flows of the acquired products. Significant adverse changes to any of these factors require AbbVie to perform an impairment test on the affected asset and, if evidence of impairment exists, require AbbVie to take an impairment charge with respect to the asset. For assets that are not impaired, AbbVie may adjust the remaining useful lives. Such a charge could have a material adverse effect on AbbVies results of operations and financial condition. AbbVies other significant intangible assets include in-process research and development (IPRD) intangible projects, acquired in recent business combinations, which are indefinite-lived intangible assets. Goodwill and AbbVies IPRD intangible assets are tested for impairment annually, or when events occur or circumstances change that could potentially reduce the fair value of the reporting unit or intangible asset. Impairment testing compares the fair value of the reporting unit or intangible asset to its carrying amount. A goodwill or IPRD impairment, if any, would be recorded in operating income and could have a material adverse effect on AbbVies results of operations and financial condition. Failure to attract and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development (RD), governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws, particularly in the European Union and the United States, and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; | 2020 Form 10-K changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; environmental liabilities in connection with AbbVies manufacturing processes and distribution logistics, including the handling of hazardous materials; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5, ""Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; 2020 Form 10-K | a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. | 2020 Form 10-K CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1, ""Business,"" Item 1A, ""Risk Factors,"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A, ""Risk Factors"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Clonshaugh, Ireland Branchburg, New Jersey* Cork, Ireland Campbell, California Galway, Ireland* Cincinnati, Ohio Grace-Hollogne, Belgium* Dublin, California* Guarulhos, Brazil Houston, Texas La Aurora, Costa Rica Irvine, California Ludwigshafen, Germany North Chicago, Illinois Pringy, France Waco, Texas Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* Westport, Ireland _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has two central distribution centers. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; Branchburg, New Jersey; Irvine, California; Madison, New Jersey; North Chicago, Illinois; Pleasanton, California; Redwood City, California; Santa Cruz, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany and Liverpool, United Kingdom. 2020 Form 10-K | "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 47,754 stockholders of record of AbbVie common stock as of January 31, 2021. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2015 through December 31, 2020. This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2015 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. 2020 Form 10-K | Dividends On October 30, 2020, AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.18 per share to $1.30 per share, payable on February 16, 2021 to stockholders of record as of January 15, 2021. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2020 - October 31, 2020 4,783 (1) $ 84.46 (1) $ 3,450,069,690 November 1, 2020 - November 30, 2020 945 (1) $ 92.50 (1) $ 3,450,069,690 December 1, 2020 - December 31, 2020 2,431,776 (1) $ 105.61 (1) 2,430,910 $ 3,193,341,387 Total 2,437,504 (1) $ 105.56 (1) 2,430,910 $ 3,193,341,387 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,783 in October; 945 in November; and 866 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company). This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8, ""Financial Statements and Supplementary Data."" This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2019. EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. On May 8, 2020, AbbVie completed the acquisition of Allergan plc (Allergan). The acquisition of Allergan creates a diversified biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions in key therapeutic areas of immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. See Note 5 to the Consolidated Financial Statements for additional information on the acquisition. Subsequent to the acquisition date, AbbVie's consolidated financial statements include the assets, liabilities, operating results and cash flows of Allergan. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 47,000 employees. AbbVie operates as a single global business segment. 2020 Financial Results AbbVie's strategy has focused on delivering strong financial results, maximizing the benefits of the Allergan acquisition, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2020 included delivering worldwide net revenues of $45.8 billion, operating earnings of $11.4 billion, diluted earnings per share of $2.72 and cash flows from operations of $17.6 billion. Worldwide net revenues increased by 38% on a reported basis and on a constant currency basis, which included $10.3 billion of contributed revenues from the Allergan acquisition, growth in the immunology portfolio from Skyrizi, Rinvoq and the continued strength of Humira in the U.S. as well as revenue growth from Imbruvica and Venclexta. Diluted earnings per share in 2020 was $2.72 and included the following after-tax costs: (i) $5.7 billion for the change in fair value of contingent consideration liabilities; (ii) $4.8 billion related to the amortization of intangible assets; (iii) $3.0 billion of Allergan acquisition and integration expenses; (iv) $1.2 billion for acquired in-process research and development (IPRD); and $241 million for milestones and other research and development (RD) expenses. These costs were partially offset by $1.7 billion of certain tax benefits. Additionally, financial results reflected continued funding to support all stages of AbbVies pipeline assets and continued investment in AbbVies on-market brands. In October 2020, AbbVie's board of directors declared a quarterly cash dividend of $1.30 per share of common stock payable in February 2021. This reflects an increase of approximately 10.2% over the previous quarterly dividend of $1.18 per share of common stock. Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. The integration plan is expected to realize more than $2 billion of expected annual cost synergies over a three-year period, with approximately 50% realized in RD, 40% in selling, general and administrative (SGA) and 10% in cost of products sold. 2020 Form 10-K | To achieve these integration objectives, AbbVie expects to incur approximately $2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. Impact of the Coronavirus Disease 2019 (COVID-19) In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States and around the world. In response to the growing public health crisis, AbbVie has partnered with global authorities to support the experimental use of multiple AbbVie assets to determine their efficacy in the treatment of COVID-19. In June 2020, AbbVie announced that it entered into a collaboration with Harbour BioMed, Utrecht University and Erasmus Medical Center to develop a novel antibody therapeutic to prevent and treat COVID-19. Additionally, AbbVie donated $35 million to increase healthcare capacity, supply critical equipment and deliver food and essential supplies during the crisis. AbbVie continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie has experienced lower new patient starts across the therapeutic portfolio. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the outbreak. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain. 2021 Strategic Objectives AbbVie's mission is to discover and develop innovative medicines and products that solve serious health issues today and address the medical challenges of tomorrow while achieving top-tier financial performance through outstanding execution. AbbVie intends to continue to advance its mission in a number of ways, including: (i) maximizing the benefits of the Allergan acquisition to create a more diversified revenue base with multiple long-term growth drivers; (ii) growing revenues by leveraging AbbVie's commercial strength and international infrastructure across Allergan's therapeutic areas and ensuring strong commercial execution of new product launches; (iii) continuing to invest in and expand its pipeline in support of opportunities in immunology, oncology, aesthetics, neuroscience, eye care and women's health as well as continued investment in key on-market products; (iv) expanding operating margins; and (v) returning cash to shareholders via a strong and growing dividend while also reducing debt. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Immunology revenue growth driven by increasing market share and expanding patient access of Skyrizi and Rinvoq, as well as Humira U.S. sales growth. Hematologic oncology revenue growth from both Imbruvica and Venclexta. Expansion of the companys revenue base from additional Allergan products contributing to key aesthetics and neuroscience portfolios. Effective management of Humira international biosimilar erosion. Optimization of combined AbbVie and Allergan research and development, commercial, and manufacturing operations while maintaining key growth portfolios. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2021. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7. AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, realization of expense synergies from the Allergan acquisition, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. The combination of AbbVie and Allergan creates a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, women's health, eye care and virology. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. | 2020 Form 10-K Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 90 compounds, devices or indications in development individually or under collaboration or license agreements and is focused on such important specialties as immunology, oncology, aesthetics, neuroscience, eye care and women's health along with targeted investments in cystic fibrosis. Of these programs, more than 50 are in mid- and late-stage development. The following sections summarize transitions of significant programs from mid-stage development to late-stage development as well as developments in significant late-stage and registration programs. AbbVie expects multiple mid-stage programs to transition into late-stage programs in the next 12 months. Significant Programs and Developments Immunology Skyrizi In January 2021, AbbVie announced top-line results from its Phase 3 KEEPsAKE-1 and KEEPsAKE-2 clinical trials of Skyrizi in adults with active psoriatic arthritis (PsA) met the primary and ranked secondary endpoints. In January 2021, AbbVie announced top-line results from its Phase 3 ADVANCE and MOTIVATE induction studies of Skyrizi in patients with Crohns Disease met the primary and key secondary endpoints. Rinvoq In February 2020, AbbVie announced top-line results from its second Phase 3 clinical trial of Rinvoq in adult patients with active PsA. Results from the SELECT-PsA 1 study, which evaluated Rinvoq versus placebo in patients who did not adequately respond to treatment with one or more non-biologic disease-modifying anti-rheumatic drugs (DMARDs), showed that both doses of Rinvoq met the primary and key secondary endpoints. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In May 2020, AbbVie submitted a supplemental New Drug Application (sNDA) to the U.S. Food and Drug Administration (FDA) and, in June 2020, submitted a marketing authorization application (MAA) to the European Medicines Agency (EMA) for Rinvoq for the treatment of adult patients with active PsA. In June 2020, AbbVie announced top-line results from its Phase 3 Measure Up 1 study and, in July 2020, announced top-line results from its Phase 3 Measure Up 2 and AD Up studies of Rinvoq for the treatment of moderate to severe atopic dermatitis (AD) met all primary and secondary endpoints versus placebo. In August 2020, AbbVie submitted an sNDA to the FDA and, earlier this year, submitted an MAA to the EMA for Rinvoq for the treatment of adult patients with active ankylosing spondylitis (AS). In October 2020, AbbVie submitted an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adult and adolescent patients with moderate to severe AD. In December 2020, AbbVie announced its Phase 3 U-ACHIEVE induction study of Rinvoq for the treatment of adult patients with moderate to severe ulcerative colitis met the primary and all ranked secondary endpoints. In January 2021, AbbVie announced that the European Commission (EC) approved Rinvoq for the treatment of adults with active PsA and active AS. 2020 Form 10-K | Oncology Imbruvica In April 2020, AbbVie received FDA approval for the use of Imbruvica in combination with rituximab for the treatment of previously untreated patients with chronic lymphocytic leukemia (CLL) or small lymphocytic lymphoma (SLL). In August 2020, the EC granted marketing authorization for Imbruvica in combination with rituximab for the treatment of adult patients with previously untreated CLL. Venclexta In February 2020, AbbVie announced that the Phase 3 VIALE-C trial of Venclexta in combination with low-dose cytarabine in newly-diagnosed patients with acute myeloid leukemia (AML) did not meet its primary endpoint. In March 2020, AbbVie announced that top-line results from its Phase 3 VIALE-A trial of Venclexta in combination with azacitidine in patients with AML met its primary endpoints. In March 2020, AbbVie received EC approval of Venclyxto in combination with obinutuzumab for patients with previously untreated CLL. In June 2020, AbbVie submitted an MAA to the EMA for Venclyxto for the treatment of patients with AML. In October 2020, AbbVie received FDA full approval of Venclexta for the treatment of patients with AML. The approval is supported by data from a series of trials including the Phase 3 VIALE-A and VIALE-C studies. Aesthetics Juvederm Collection In June 2020, AbbVie received FDA approval of Juvederm Voluma XC for the augmentation of the chin region to improve the chin profile in adults over the age of 21. Neuroscience Botox Therapeutic In June 2020, the FDA accepted the company's supplemental Biologics License Application (sBLA) to expand the Botox prescribing information for the treatment of detrusor (bladder muscle) overactivity associated with an underlying neurologic condition in certain pediatric patients. In February 2021, AbbVie received FDA approval of Botox for the treatment of detrusor overactivity associated with a neurological condition in certain pediatric patients 5 years of age and older. In July 2020, AbbVie received FDA approval of Botox for the treatment of lower limb spasticity caused by cerebral palsy in pediatric patients over the age of 2. Atogepant In July 2020, AbbVie announced that the Phase 3 ADVANCE trial evaluating atogepant, an orally administered calcitonin gene-related peptide receptor antagonist, for migraine prevention met its primary endpoint for all doses (10mg, 30mg, and 60mg) compared to placebo, all secondary endpoints with 30mg and 60mg doses, and four out of six secondary endpoints with the 10mg dose. In January 2021, AbbVie submitted a New Drug Application to the FDA for atogepant for the prevention of episodic migraine. Elezanumab In September 2020, AbbVie announced that the FDA granted Orphan Drug and Fast Track designations for elezanumab, an investigational treatment for patients following spinal cord injury. | 2020 Form 10-K Virology/Liver Disease Mavyret In March 2020, AbbVie announced that the EC granted marketing authorization for Maviret to shorten once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic hepatitis C virus (HCV) patients with genotype 3 infection. Eye Care AGN-190584 In October 2020, AbbVie announced that top-line results from its Phase 3 GEMINI 1 and 2 studies of AGN-190584, an investigational ophthalmic solution, for the treatment of presbyopia met their primary endpoint and majority of the secondary endpoints. Abicipar pegol In June 2020, AbbVie announced that the FDA issued a Complete Response Letter (CRL) to the Biologics License Application (BLA) for abicipar pegol, a novel, investigational DARPin therapy for patients with neovascular (wet) age-related macular degeneration (nAMD). The CRL indicated that the rate of intraocular inflammation observed following administration of abicipar pegol results in an unfavorable benefit-risk ratio in the treatment of nAMD. In July 2020, AbbVie withdrew the regulatory application with the EMA for abicipar pegol for the treatment of nAMD. Women's Health Oriahnn In May 2020, the FDA approved Oriahnn (elagolix, estradiol, and norethindrone acetate capsules; elagolix capsules) for the management of heavy menstrual bleeding due to uterine fibroids in pre-menopausal women. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 United States $ 34,879 $ 23,907 $ 21,524 45.9 % 11.1 % 45.9 % 11.1 % International 10,925 9,359 11,229 16.7 % (16.7) % 17.8 % (13.6) % Net revenues $ 45,804 $ 33,266 $ 32,753 37.7 % 1.6 % 38.0 % 2.6 % 2020 Form 10-K | The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 Immunology Humira United States $ 16,112 $ 14,864 $ 13,685 8.4 % 8.6 % 8.4 % 8.6 % International 3,720 4,305 6,251 (13.6) % (31.1) % (12.5) % (27.8) % Total $ 19,832 $ 19,169 $ 19,936 3.5 % (3.9) % 3.7 % (2.9) % Skyrizi United States $ 1,385 $ 311 $ 100.0% n/m 100.0% n/m International 205 44 100.0% n/m 100.0% n/m Total $ 1,590 $ 355 $ 100.0% n/m 100.0% n/m Rinvoq United States $ 653 $ 47 $ 100.0% n/m 100.0% n/m International 78 100.0% n/m 100.0% n/m Total $ 731 $ 47 $ 100.0% n/m 100.0% n/m Hematologic Oncology Imbruvica United States $ 4,305 $ 3,830 $ 2,968 12.4 % 29.1 % 12.4 % 29.1 % Collaboration revenues 1,009 844 622 19.5 % 35.8 % 19.5 % 35.8 % Total $ 5,314 $ 4,674 $ 3,590 13.7 % 30.2 % 13.7 % 30.2 % Venclexta United States $ 804 $ 521 $ 247 54.4 % 100.0% 54.4 % 100.0% International 533 271 97 97.0 % 100.0% 97.8 % 100.0% Total $ 1,337 $ 792 $ 344 69.0 % 100.0% 69.3 % 100.0% Aesthetics Botox Cosmetic (a) United States $ 687 $ $ n/m n/m n/m n/m International 425 n/m n/m n/m n/m Total $ 1,112 $ $ n/m n/m n/m n/m Juvederm Collection (a) United States $ 318 $ $ n/m n/m n/m n/m International 400 n/m n/m n/m n/m Total $ 718 $ $ n/m n/m n/m n/m Other Aesthetics (a) United States $ 666 $ $ n/m n/m n/m n/m International 94 n/m n/m n/m n/m Total $ 760 $ $ n/m n/m n/m n/m Neuroscience Botox Therapeutic (a) United States $ 1,155 $ $ n/m n/m n/m n/m International 232 n/m n/m n/m n/m Total $ 1,387 $ $ n/m n/m n/m n/m Vraylar (a) United States $ 951 $ $ n/m n/m n/m n/m Duodopa United States $ 103 $ 97 $ 80 5.9 % 20.4 % 5.9 % 20.4 % International 391 364 350 7.4 % 4.2 % 6.3 % 9.8 % Total $ 494 $ 461 $ 430 7.1 % 7.2 % 6.2 % 11.7 % Ubrelvy (a) United States $ 125 $ $ n/m n/m n/m n/m Other Neuroscience (a) United States $ 528 $ $ n/m n/m n/m n/m International 11 n/m n/m n/m n/m Total $ 539 $ $ n/m n/m n/m n/m | 2020 Form 10-K Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 Eye Care Lumigan/Ganfort (a) United States $ 165 $ $ n/m n/m n/m n/m International 213 n/m n/m n/m n/m Total $ 378 $ $ n/m n/m n/m n/m Alphagan/Combigan (a) United States $ 223 $ $ n/m n/m n/m n/m International 103 n/m n/m n/m n/m Total $ 326 $ $ n/m n/m n/m n/m Restasis (a) United States $ 755 $ $ n/m n/m n/m n/m International 32 n/m n/m n/m n/m Total $ 787 $ $ n/m n/m n/m n/m Other Eye Care (a) United States $ 305 $ $ n/m n/m n/m n/m International 388 n/m n/m n/m n/m Total $ 693 $ $ n/m n/m n/m n/m Women's Health Lo Loestrin (a) United States $ 346 $ $ n/m n/m n/m n/m International 10 n/m n/m n/m n/m Total $ 356 $ $ n/m n/m n/m n/m Orilissa/Oriahnn United States $ 121 $ 91 $ 11 33.3 % 100.0% 33.3 % 100.0% International 4 2 96.1 % n/m 97.7 % n/m Total $ 125 $ 93 $ 11 34.6 % 100.0% 34.6 % 100.0% Other Women's Health (a) United States $ 181 $ $ n/m n/m n/m n/m International 11 n/m n/m n/m n/m Total $ 192 $ $ n/m n/m n/m n/m Other Key Products Mavyret United States $ 785 $ 1,473 $ 1,614 (46.7) % (8.8) % (46.7) % (8.8) % International 1,045 1,420 1,824 (26.4) % (22.1) % (26.8) % (19.6) % Total $ 1,830 $ 2,893 $ 3,438 (36.7) % (15.9) % (36.9) % (14.6) % Creon United States $ 1,114 $ 1,041 $ 928 6.9 % 12.2 % 6.9 % 12.2 % Lupron United States $ 600 $ 720 $ 726 (16.6) % (0.8) % (16.6) % (0.8) % International 152 167 166 (9.1) % 0.8 % (5.4) % 6.0 % Total $ 752 $ 887 $ 892 (15.2) % (0.5) % (14.5) % 0.5 % Linzess/Constella (a) United States $ 649 $ $ n/m n/m n/m n/m International 18 n/m n/m n/m n/m Total $ 667 $ $ n/m n/m n/m n/m Synthroid United States $ 771 $ 786 $ 776 (1.9) % 1.3 % (1.9) % 1.3 % All other $ 2,923 $ 2,068 $ 2,408 41.3 % (14.1) % 42.4 % (11.5) % Total net revenues $ 45,804 $ 33,266 $ 32,753 37.7 % 1.6 % 38.0 % 2.6 % n/m Not meaningful (a) Net revenues include Allergan product revenues from the date of the acquisition, May 8, 2020, through December 31, 2020. The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global Humira sales increased 4% in 2020 primarily driven by market growth across therapeutic categories, offset by direct biosimilar competition in certain international markets. In the United States, Humira sales increased 8% in 2020 driven by market growth across all indications and favorable pricing, partially offset by lower new patient starts due to the COVID-19 pandemic. Internationally, Humira revenues decreased 12% in 2020 primarily driven by direct biosimilar competition in certain international markets. Biosimilar competition for Humira is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to maintain market leadership among its installed patient base and add to the sustainability of Humira. Net revenues for Skyrizi increased more than 100% in 2020 primarily driven by market growth and market share gains over the prior year following the April 2019 regulatory approvals for the treatment of moderate to severe plaque psoriasis. Net revenues for Rinvoq increased more than 100% in 2020 primarily driven by the August 2019 FDA approval and December 2019 EC approval for the treatment of moderate to severe rheumatoid arthritis. 2020 Form 10-K | Net revenues for Imbruvica represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of Imbruvica profit. AbbVie's global Imbruvica revenues increased 14% in 2020 as a result of continued penetration of Imbruvica for patients with CLL, partially offset by lower new patient starts due to the COVID-19 pandemic in 2020. Net revenues for Venclexta increased 69% in 2020 primarily due to continued expansion of Venclexta for the treatment of patients with first-line CLL, relapsed/refractory CLL and first-line AML. Net revenues for Botox Cosmetic used in facial aesthetics were $1.1 billion in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Juvederm Collection (including Juvederm Ultra XC, Juvederm Voluma XC and other Juvederm products) used in facial aesthetics were $718 million in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Botox Therapeutic used primarily in neuroscience and urology therapeutic areas were $1.4 billion in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Vraylar for the treatment of schizophrenia, bipolar I disorder and bipolar depression were $951 million in 2020 for the period subsequent to the completion of the Allergan acquisition. Global Mavyret sales decreased 37% in 2020 primarily driven by lower global new patient starts due to the COVID-19 pandemic as well as competitive dynamics in the U.S. Net revenues for Creon increased 7% in 2020 primarily driven by continued market growth, partially offset by lower new patient starts due to the COVID-19 pandemic. Creon maintains market leadership in the pancreatic enzyme market with approximately 80% total market share. Net revenues for Lupron decreased 14% in 2020 primarily due to a near-term supply issue which has impacted product availability of certain formulations. Gross Margin Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Gross margin $ 30,417 $ 25,827 $ 25,035 18 % 3 % as a percent of net revenues 66 % 78 % 76 % Gross margin as a percentage of net revenues in 2020 decreased from 2019 primarily due to the unfavorable impacts of higher amortization of intangible assets and inventory fair value step-up adjustments associated with the Allergan acquisition as well as collaboration profit sharing arrangements for Imbruvica and Venclexta. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Selling, general and administrative $ 11,299 $ 6,942 $ 7,399 63 % (6) % as a percent of net revenues 25 % 21 % 23 % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2020 increased from 2019 primarily due to the unfavorable impacts of incremental SGA expenses of Allergan, including transaction and integration costs resulting from the acquisition. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Research and development $ 6,557 $ 6,407 $ 10,329 2 % (38) % as a percent of net revenues 14 % 19 % 32 % Acquired in-process research and development $ 1,198 $ 385 $ 424 100% (9) % Research and Development (RD) expenses as a percentage of net revenues decreased in 2020 primarily due to the $1.0 billion intangible asset impairment charge in 2019, which represented the remaining value of the IPRD acquired as part | 2020 Form 10-K of the 2016 Stemcentrx acquisition following the decision to terminate the Rova-T RD program. See Note 7 to the Consolidated Financial Statements for additional information regarding the impairment charge. RD expenses as a percentage of net revenues in 2020 were also favorably impacted by increased scale of the combined company for the period subsequent to the completion of the Allergan acquisition. Acquired IPRD expenses reflect upfront payments related to various collaborations. Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering a collaboration agreement with Genmab A/S (Genmab) to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer. Acquired IPRD expense in 2020 also included a charge of $200 million as a result of a collaboration agreement with I-Mab Biopharma (I-Mab) for the development and commercialization of lemzoparlimab for the treatment of multiple cancers. See Note 5 to the Consolidated Financial Statements for additional information regarding the Genmab and I-Mab agreements. There were no individually significant transactions or cash flows during 2019. Other Operating Expenses and Income Other operating income in 2019 included $550 million of income from a legal settlement related to an intellectual property dispute with a third party and $330 million of income related to an amended and restated license agreement between AbbVie and Reata. See Note 5 to the Consolidated Financial Statements for additional information on the Reata agreement. Other Non-Operating Expenses years ended December 31 (in millions) 2020 2019 2018 Interest expense $ 2,454 $ 1,784 $ 1,348 Interest income (174) (275) (204) Interest expense, net $ 2,280 $ 1,509 $ 1,144 Net foreign exchange loss $ 71 $ 42 $ 24 Other expense, net 5,614 3,006 18 Interest expense in 2020 increased compared to 2019 primarily due to a higher average debt balance associated with the financing of the Allergan acquisition as well as the incremental Allergan debt acquired, partially offset by the favorable impact of lower interest rates on the companys debt obligations. Interest income in 2020 decreased compared to 2019 primarily due to a lower average cash and cash equivalents balance as a result of the cash paid for the Allergan acquisition and the unfavorable impact of lower interest rates. Other expense, net included charges related to the change in fair value of the contingent consideration liabilities of $5.8 billion in 2020 and $3.1 billion in 2019. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products and other market-based factors. In 2020, the change in fair value primarily included the increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake and favorable clinical trial results as well as lower interest rates. In 2019, the Skyrizi contingent consideration liability increased due to higher probabilities of success, higher estimated future sales, declining interest rates and passage of time. The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. These changes were partially offset by a $91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. Income Tax Expense The effective income tax rate was negative 36% in 2020, 6% in 2019 and negative 9% in 2018. The effective tax rate in each period differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, the cost of repatriation decisions, tax audit settlements and Boehringer Ingelheim accretion on contingent consideration. The decrease in the effective tax rate for 2020 over the prior year was principally due to the recognition of a net tax benefit of $1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. 2020 Form 10-K | FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) 2020 2019 2018 Cash flows from: Operating activities $ 17,588 $ 13,324 $ 13,427 Investing activities (37,557) 596 (1,006) Financing activities (11,501) 18,708 (14,396) Operating cash flows in 2020 increased from 2019 and included the results of Allergan subsequent to the May 8 acquisition date. Operating cash flows in 2020 were favorably impacted by higher net revenues of the combined company and the timing of working capital cash flows, partially offset by acquisition-related cash expenses. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $367 million in 2020 and $727 million in 2019. Investing cash flows in 2020 primarily included $39.7 billion cash consideration paid to acquire Allergan offset by cash acquired of $1.5 billion. Investing cash flows also included net sales and maturities of investments totaling $1.5 billion, payments made for other acquisitions and investments of $1.4 billion and capital expenditures of $798 million. Investing cash flows in 2019 included net sales and maturities of investment securities totaling $2.1 billion resulting from the sale of substantially all of the company's investments in debt securities, payments made for other acquisitions and investments of $1.1 billion and capital expenditures of $552 million. Financing cash flows in 2020 included the issuance of term loans totaling $3.0 billion under the existing $6.0 billion term loan credit agreement which were used to finance the acquisition of Allergan. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. Additionally, financing cash flows included the May 2020 repayment of $3.8 billion aggregate principal amount of the company's 2.50% senior notes at maturity, the September 2020 repayment of $650 million aggregate principal amount of 3.375% Allergan exchange notes at maturity, and the November 2020 repayments of 700 million aggregate principal amount of floating rate Allergan exchange notes at maturity and $450 million aggregate principal amount of 4.875% Allergan exchange notes due February 2021. Financing cash flows in 2019 included the issuance of $30.0 billion aggregate principal amount of floating rate and fixed rate unsecured senior notes which were used to finance the acquisition of Allergan. Additionally, financing cash flows in 2019 included the issuance of 1.4 billion aggregate principal amount of unsecured senior Euro notes which the company used to redeem 1.4 billion aggregate principal amount of 0.38% senior Euro notes that were due to mature in November 2019, as well as the repayment of a $3.0 billion 364-day term loan credit agreement that was scheduled to mature in June 2019. Cash dividend payments totaled $7.7 billion in 2020 and $6.4 billion in 2019. The increase in cash dividend payments was primarily driven by higher outstanding shares following the 286 million shares of AbbVie common stock issued to Allergan shareholders in May 2020 as well as an increase in the dividend rate. On October 30, 2020, AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.18 per share to $1.30 per share beginning with the dividend payable on February 16, 2021 to stockholders of record as of January 15, 2021. This reflects an increase of approximately 10.2% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 8 million shares for $757 million in 2020 and 4 million shares for $300 million in 2019. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $3.2 billion as of December 31, 2020. In 2020 and 2019, the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2020 or December 31, 2019. AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an | 2020 Form 10-K allowance for credit losses equal to the estimate of future losses over the contractual life of outstanding accounts receivable. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2020, the company was in compliance with all covenants, and commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facility as of December 31, 2020 and 2019. Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations or has the ability to issue additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings Following the acquisition of Allergan, SP Global Ratings revised its ratings outlook to stable from negative and lowered the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1. There were no changes in Moody's Investor Service of its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the companys ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the companys outstanding debt. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2020: (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ 34 $ 34 $ $ $ Long-term debt, including current portion 84,948 8,422 16,643 16,197 43,686 Interest on long-term debt (a) 33,664 2,752 4,652 3,898 22,362 Non-cancelable operating and finance lease payments 1,154 229 323 208 394 Purchase obligations and other (b) 5,432 5,040 249 112 31 Other long-term liabilities (c) (d) (e) 18,478 1,029 3,036 4,144 10,269 Total $ 143,710 $ 17,506 $ 24,903 $ 24,559 $ 76,742 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2020. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2020. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2020. (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. 2020 Form 10-K | (d) Includes $13.0 billion of contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. (e) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements. Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Provisions for rebates and chargebacks totaled $27.0 billion in 2020, $18.8 billion in 2019 and $16.4 billion in 2018. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. | 2020 Form 10-K The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 89% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2020. Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2017 $ 1,340 $ 1,195 $ 522 Provisions 3,493 4,729 6,659 Payments (3,188) (4,485) (6,525) Balance at December 31, 2018 1,645 1,439 656 Provisions 4,035 5,772 7,947 Payments (3,915) (5,275) (7,917) Balance at December 31, 2019 1,765 1,936 686 Additions (a) 1,266 649 71 Provisions 6,715 8,656 8,677 Payments (6,801) (8,334) (8,693) Balance at December 31, 2020 $ 2,945 $ 2,907 $ 741 (a) Represents rebate accruals and chargeback allowances assumed in the Allergan acquisition. Cash Discounts and Product Returns Cash discounts and product returns, which totaled $2.4 billion in 2020, $1.6 billion in 2019 and $1.6 billion in 2018, are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements. The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2020. A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2021 and projected benefit obligations as of December 31, 2020: 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (89) $ 101 Projected benefit obligation (1,000) 1,140 Other post-employment plans Service and interest cost $ (6) $ 7 Projected benefit obligation (56) 63 2020 Form 10-K | The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2020 and will be used in the calculation of net periodic benefit cost in 2021. A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2021 by $94 million. The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2020 and will be used in the calculation of net periodic benefit cost in 2021. Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. | 2020 Form 10-K For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities as of December 31, 2020 was calculated using the following significant unobservable inputs: Range Weighted Average (a) Discount rate 0.1% - 2.2% 1.1% Probability of payment for unachieved milestones 56% - 92% 64% Probability of payment for royalties by indication (b) 56% - 100% 91% Projected year of payments 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excludes early stage indications with 0% estimated probability of payment and includes approved indications with 100% probability of payment. Excluding approved indications, the estimated probability of payment ranged from 56% to 89% at December 31, 2020. Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 2020 Form 10-K | "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2020 and 2019: 2020 2019 as of December 31 (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 7,818 1.213 $ (39) $ 6,217 1.116 $ (12) Japanese yen 837 103.9 (7) 820 108.7 Canadian dollar 591 1.328 (23) 504 1.324 (6) British pound 275 1.341 3 427 1.305 (6) All other currencies 1,706 n/a (15) 1,508 n/a (10) Total $ 11,227 $ (81) $ 9,476 $ (34) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.14 billion at December 31, 2020. If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2020, the company has 6.6 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive loss. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $111 million at December 31, 2020. If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.7 billion at December 31, 2020. A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. | 2020 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) 2020 2019 2018 Net revenues $ 45,804 $ 33,266 $ 32,753 Cost of products sold 15,387 7,439 7,718 Selling, general and administrative 11,299 6,942 7,399 Research and development 6,557 6,407 10,329 Acquired in-process research and development 1,198 385 424 Other operating (income) expense ( 890 ) 500 Total operating costs and expenses 34,441 20,283 26,370 Operating earnings 11,363 12,983 6,383 Interest expense, net 2,280 1,509 1,144 Net foreign exchange loss 71 42 24 Other expense, net 5,614 3,006 18 Earnings before income tax expense 3,398 8,426 5,197 Income tax expense (benefit) ( 1,224 ) 544 ( 490 ) Net earnings 4,622 7,882 5,687 Net earnings attributable to noncontrolling interest 6 Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Per share data Basic earnings per share attributable to AbbVie Inc. $ 2.73 $ 5.30 $ 3.67 Diluted earnings per share attributable to AbbVie Inc. $ 2.72 $ 5.28 $ 3.66 Weighted-average basic shares outstanding 1,667 1,481 1,541 Weighted-average diluted shares outstanding 1,673 1,484 1,546 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) 2020 2019 2018 Net earnings $ 4,622 $ 7,882 $ 5,687 Foreign currency translation adjustments, net of tax expense (benefit) of $ 28 in 2020, $( 4 ) in 2019 and $( 18 ) in 2018 1,511 ( 98 ) ( 391 ) Net investment hedging activities, net of tax expense (benefit) of $( 221 ) in 2020, $ 22 in 2019 and $ 40 in 2018 ( 799 ) 74 138 Pension and post-employment benefits, net of tax expense (benefit) of $( 47 ) in 2020, $( 323 ) in 2019 and $ 35 in 2018 ( 102 ) ( 1,243 ) 197 Marketable security activities, net of tax expense (benefit) of $ in 2020, $ in 2019 and $ in 2018 10 ( 10 ) Cash flow hedging activities, net of tax expense (benefit) of $( 23 ) in 2020, $ 70 in 2019 and $ 23 in 2018 ( 131 ) 141 313 Other comprehensive income (loss) $ 479 $ ( 1,116 ) $ 247 Comprehensive income 5,101 6,766 5,934 Comprehensive income attributable to noncontrolling interest 6 Comprehensive income attributable to AbbVie Inc. $ 5,095 $ 6,766 $ 5,934 The accompanying notes are an integral part of these consolidated financial statements. 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) 2020 2019 Assets Current assets Cash and equivalents $ 8,449 $ 39,924 Short-term investments 30 Accounts receivable, net 8,822 5,428 Inventories 3,310 1,813 Prepaid expenses and other 3,562 2,354 Total current assets 24,173 49,519 Investments 293 93 Property and equipment, net 5,248 2,962 Intangible assets, net 82,876 18,649 Goodwill 33,124 15,604 Other assets 4,851 2,288 Total assets $ 150,565 $ 89,115 Liabilities and Equity Current liabilities Short-term borrowings $ 34 $ Current portion of long-term debt and finance lease obligations 8,468 3,753 Accounts payable and accrued liabilities 20,159 11,832 Total current liabilities 28,661 15,585 Long-term debt and finance lease obligations 77,554 62,975 Deferred income taxes 3,646 1,130 Other long-term liabilities 27,607 17,597 Commitments and contingencies Stockholders equity (deficit) Common stock, $ 0.01 par value, 4,000,000,000 shares authorized, 1,792,140,764 shares issued as of December 31, 2020 and 1,781,582,608 as of December 31, 2019 18 18 Common stock held in treasury, at cost, 27,007,945 shares as of December 31, 2020 and 302,671,146 as of December 31, 2019 ( 2,264 ) ( 24,504 ) Additional paid-in capital 17,384 15,193 Retained earnings 1,055 4,717 Accumulated other comprehensive loss ( 3,117 ) ( 3,596 ) Total stockholders' equity (deficit) 13,076 ( 8,172 ) Noncontrolling interest 21 Total equity (deficit) 13,097 ( 8,172 ) Total liabilities and equity $ 150,565 $ 89,115 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Noncontrolling interest Total Balance at December 31, 2017 1,592 $ 18 $ ( 11,923 ) $ 14,270 $ 5,459 $ ( 2,727 ) $ $ 5,097 Adoption of new accounting standards (a) ( 1,733 ) ( 1,733 ) Net earnings attributable to AbbVie Inc. 5,687 5,687 Other comprehensive income, net of tax 247 247 Dividends declared ( 6,045 ) ( 6,045 ) Purchases of treasury stock ( 121 ) ( 12,215 ) ( 12,215 ) Stock-based compensation plans and other 8 30 486 516 Balance at December 31, 2018 1,479 18 ( 24,108 ) 14,756 3,368 ( 2,480 ) ( 8,446 ) Net earnings attributable to AbbVie Inc. 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other 5 32 437 469 Balance at December 31, 2019 1,479 18 ( 24,504 ) 15,193 4,717 ( 3,596 ) ( 8,172 ) Net earnings attributable to AbbVie Inc. 4,616 4,616 Other comprehensive income, net of tax 479 479 Dividends declared ( 8,278 ) ( 8,278 ) Common shares and equity awards issued for acquisition of Allergan plc 286 23,166 1,243 24,409 Purchases of treasury stock ( 10 ) ( 978 ) ( 978 ) Stock-based compensation plans and other 10 52 948 1,000 Change in noncontrolling interest 21 21 Balance at December 31, 2020 1,765 $ 18 $ ( 2,264 ) $ 17,384 $ 1,055 $ ( 3,117 ) $ 21 $ 13,097 (a) Adoption of new accounting standards primarily includes the cumulative-effect adjustment of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The accompanying notes are an integral part of these consolidated financial statements. 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) 2020 2019 2018 Cash flows from operating activities Net earnings $ 4,622 $ 7,882 $ 5,687 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation 666 464 471 Amortization of intangible assets 5,805 1,553 1,294 Deferred income taxes ( 2,325 ) 122 ( 1,517 ) Change in fair value of contingent consideration liabilities 5,753 3,091 49 Stock-based compensation 753 430 421 Upfront costs and milestones related to collaborations 1,376 490 1,061 Gain on divestitures ( 330 ) Intangible asset impairment 1,030 5,070 Impacts related to U.S. tax reform 424 Other, net 832 43 76 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable ( 929 ) ( 74 ) ( 591 ) Inventories ( 40 ) ( 231 ) ( 226 ) Prepaid expenses and other assets 134 ( 225 ) ( 200 ) Accounts payable and other liabilities 1,514 97 734 Income tax assets and liabilities, net ( 573 ) ( 1,018 ) 674 Cash flows from operating activities 17,588 13,324 13,427 Cash flows from investing activities Acquisition of businesses, net of cash acquired ( 38,260 ) Other acquisitions and investments ( 1,350 ) ( 1,135 ) ( 736 ) Acquisitions of property and equipment ( 798 ) ( 552 ) ( 638 ) Purchases of investment securities ( 61 ) ( 583 ) ( 1,792 ) Sales and maturities of investment securities 1,525 2,699 2,160 Other, net 1,387 167 Cash flows from investing activities ( 37,557 ) 596 ( 1,006 ) Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) 299 Proceeds from issuance of other short-term borrowings 3,002 Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 3,000 31,482 5,963 Repayments of long-term debt and finance lease obligations ( 5,683 ) ( 1,536 ) ( 6,035 ) Debt issuance costs ( 20 ) ( 424 ) ( 40 ) Dividends paid ( 7,716 ) ( 6,366 ) ( 5,580 ) Purchases of treasury stock ( 978 ) ( 629 ) ( 12,014 ) Proceeds from the exercise of stock options 209 8 73 Payments of contingent consideration liabilities ( 321 ) ( 163 ) ( 78 ) Other, net 8 35 14 Cash flows from financing activities ( 11,501 ) 18,708 ( 14,396 ) Effect of exchange rate changes on cash and equivalents ( 5 ) 7 ( 39 ) Net change in cash and equivalents ( 31,475 ) 32,635 ( 2,014 ) Cash and equivalents, beginning of year 39,924 7,289 9,303 Cash and equivalents, end of year $ 8,449 $ 39,924 $ 7,289 Other supplemental information Interest paid, net of portion capitalized $ 2,619 $ 1,794 $ 1,215 Income taxes paid (received) 1,674 1,447 ( 35 ) Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 23,979 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On May 8, 2020, AbbVie completed its previously announced acquisition of Allergan plc (Allergan). Refer to Note 5 for additional information regarding this acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. 2020 Form 10-K | For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaborations with Janssen Biotech, Inc. and Genentech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 1.8 billion in 2020, $ 1.1 billion in 2019 and $ 1.1 billion in 2018. Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (loss) (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five-year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of equity securities, held-to-maturity debt securities, marketable debt securities and time deposits. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in | 2020 Form 10-K equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. AbbVie periodically assesses its marketable debt securities for impairment and credit losses. When a decline in fair value of marketable debt security is due to credit related factors, an allowance for credit losses is recorded with a corresponding charge to other expense in the consolidated statements of earnings. When AbbVie determines that a non-credit related impairment has occurred, the amortized cost basis of the investment, net of allowance for credit losses, is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any impairments and credit losses that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) 2020 2019 Finished goods $ 1,318 $ 485 Work-in-process 1,201 942 Raw materials 791 386 Inventories $ 3,310 $ 1,813 Property and Equipment as of December 31 (in millions) 2020 2019 Land $ 288 $ 72 Buildings 2,555 1,613 Equipment 6,976 6,012 Construction in progress 1,040 491 Property and equipment, gross 10,859 8,188 Less accumulated depreciation ( 5,611 ) ( 5,226 ) Property and equipment, net $ 5,248 $ 2,962 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 666 million in 2020, $ 464 million in 2019 and $ 471 million in 2018. Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not 2020 Form 10-K | readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to | 2020 Form 10-K regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2016-13 In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. AbbVie adopted the standard in the first quarter of 2020. Upon adoption of the standard, accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. The adoption did not have a material impact on the company's consolidated financial statements. The allowance for credit losses was $ 262 million at December 31, 2020. There were no significant changes in credit loss risk factors that impacted the company's recorded allowance during 2020. 2020 Form 10-K | Recent Accounting Pronouncements Not Yet Adopted ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for AbbVie starting with the first quarter of 2021. AbbVie has completed its assessment of the new standard and concluded that the adoption will not have a material impact on its consolidated financial statements. Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) 2020 2019 2018 Interest expense $ 2,454 $ 1,784 $ 1,348 Interest income ( 174 ) ( 275 ) ( 204 ) Interest expense, net $ 2,280 $ 1,509 $ 1,144 Accounts Payable and Accrued Liabilities as of December 31 (in millions) 2020 2019 Sales rebates $ 7,188 $ 4,484 Dividends payable 2,335 1,771 Accounts payable 2,276 1,452 Salaries, wages and commissions 1,669 830 Royalty and license arrangements 483 324 Other 6,208 2,971 Accounts payable and accrued liabilities $ 20,159 $ 11,832 Other Long-Term Liabilities as of December 31 (in millions) 2020 2019 Contingent consideration liabilities $ 12,289 $ 7,201 Liabilities for unrecognized tax benefits 5,680 2,772 Income taxes payable 3,847 3,453 Pension and other post-employment benefits 3,413 2,949 Other 2,378 1,222 Other long-term liabilities $ 27,607 $ 17,597 | 2020 Form 10-K Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) 2020 2019 2018 Basic EPS Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Earnings allocated to participating securities 60 40 30 Earnings available to common shareholders $ 4,556 $ 7,842 $ 5,657 Weighted average basic shares of common stock outstanding 1,667 1,481 1,541 Basic earnings per share attributable to AbbVie Inc. $ 2.73 $ 5.30 $ 3.67 Diluted EPS Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Earnings allocated to participating securities 60 40 30 Earnings available to common shareholders $ 4,556 $ 7,842 $ 5,657 Weighted average shares of common stock outstanding 1,667 1,481 1,541 Effect of dilutive securities 6 3 5 Weighted average diluted shares of common stock outstanding 1,673 1,484 1,546 Diluted earnings per share attributable to AbbVie Inc. $ 2.72 $ 5.28 $ 3.66 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Allergan On May 8, 2020, AbbVie completed its previously announced acquisition of all outstanding equity interests in Allergan in a cash and stock transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. The combination creates a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. Under the terms of the acquisition, each ordinary share of Allergan common stock was converted into the right to receive (i) $ 120.30 in cash and (ii) 0.8660 of a share of AbbVie common stock. Total consideration for the acquisition of Allergan is summarized as follows: (in millions) Cash consideration paid to Allergan shareholders (a) $ 39,675 Fair value of AbbVie common stock issued to Allergan shareholders (b) 23,979 Fair value of AbbVie equity awards issued to Allergan equity award holders (c) 430 Total consideration $ 64,084 (a) Represents cash consideration transferred of $ 120.30 per outstanding Allergan ordinary share based on 330 million Allergan ordinary shares outstanding at closing. 2020 Form 10-K | (b) Represents the acquisition date fair value of 286 million shares of AbbVie common stock issued to Allergan shareholders based on the exchange ratio of 0.8660 AbbVie shares for each outstanding Allergan ordinary share at the May 8, 2020 closing price of $ 83.96 per share. (c) Represents the pre-acquisition service portion of the fair value of 11 million AbbVie stock options and 8 million RSUs issued to Allergan equity award holders. The acquisition of Allergan has been accounted for as a business combination using the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The valuation of assets acquired and liabilities assumed has not yet been finalized as of December 31, 2020. As a result, AbbVie recorded preliminary estimates for the fair value of assets acquired and liabilities assumed as of the acquisition date. Subsequent to the acquisition date, the company made certain measurement period adjustments to the preliminary purchase price allocation, including: (i) an increase to developed product rights intangible assets of $ 9.1 billion; (ii) an increase to IPRD intangible assets of $ 710 million; (iii) an increase to property and equipment of $ 215 million; (iv) other individually insignificant adjustments for a net increase to identifiable net assets of $ 73 million; and (v) a corresponding decrease to goodwill of $ 10.0 billion. The measurement period adjustments primarily resulted from revised future cash flow estimates for certain intangible assets and completing valuations of property and equipment. These measurement period adjustments have been reflected in the table below. The company made these measurement period adjustments to reflect facts and circumstances that existed as of the acquisition date and did not result from intervening events subsequent to such date. These adjustments did not have a significant impact on AbbVie's results of operations. Finalization of the valuation during the measurement period could result in a change in the amounts recorded for the acquisition date fair value of intangible assets, goodwill and income taxes among other items. The completion of the valuation will occur no later than one year from the acquisition date. The following table summarizes the preliminary fair value of assets acquired and liabilities assumed as of the acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ 1,537 Short-term investments 1,421 Accounts receivable 2,374 Inventories 2,340 Prepaid expenses and other current assets 1,982 Investments 137 Property and equipment 2,127 Intangible assets Developed product rights 67,330 In-process research and development 1,750 Other noncurrent assets 1,395 Short-term borrowings ( 60 ) Current portion of long-term debt and finance lease obligations ( 1,899 ) Accounts payable and accrued liabilities ( 5,852 ) Long-term debt and finance lease obligations ( 18,937 ) Deferred income taxes ( 3,792 ) Other long-term liabilities ( 4,765 ) Total identifiable net assets 47,088 Goodwill 16,996 Total assets acquired and liabilities assumed $ 64,084 The fair value step-up adjustment to inventories of $ 1.2 billion is being amortized to cost of products sold when the inventory is sold to customers, which is expected to be within approximately one year from the acquisition date. Intangible assets relate to $ 67.3 billion of developed product rights and $ 1.8 billion of IPRD. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of approximately twelve years using the estimated pattern of economic benefit. The estimated fair values of identifiable intangible assets were determined using the ""income approach"" which is a valuation technique that provides an estimate of the fair value of an asset based on market | 2020 Form 10-K participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product, the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of long-term debt was determined by quoted market prices as of the acquisition date and the total purchase price adjustment of $ 1.3 billion is being amortized as a reduction to interest expense, net over the lives of the related debt. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from the other assets acquired that could not be individually identified and separately recognized. Specifically, the goodwill recognized from the acquisition of Allergan represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Allergan have been included in the consolidated financial statements. For the period from the acquisition date through December 31, 2020, net revenues attributable to Allergan were $ 10.3 billion and operating losses attributable to Allergan were $ 1.1 billion, inclusive of $ 4.0 billion of intangible asset amortization and $ 1.2 billion of inventory fair value step-up amortization. Acquisition-related expenses, which were comprised primarily of regulatory, financial advisory and legal fees, totaled $ 781 million for the year ended December 31, 2020 and $ 103 million for the year ended December 31, 2019 which were included in SGA expenses in the consolidated statements of earnings. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of AbbVie and Allergan for 2020 and 2019 as if the acquisition of Allergan had occurred on January 1, 2019: years ended December 31 (in millions) 2020 2019 Net revenues $ 50,521 $ 49,028 Net earnings (loss) 6,746 ( 38 ) The unaudited pro forma combined financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Allergan. In order to reflect the occurrence of the acquisition on January 1, 2019 as required, the unaudited pro forma financial information includes adjustments to reflect incremental amortization expense to be incurred based on the current preliminary fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with acquisition date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition-related costs incurred during the year ended December 31, 2020 to the year ended December 31, 2019. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2019. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.4 billion in 2020, $ 1.1 billion in 2019 and $ 736 million in 2018. AbbVie recorded acquired IPRD charges of $ 1.2 billion in 2020, $ 385 million in 2019 and $ 424 million in 2018. Significant arrangements impacting 2020, 2019 and 2018, some of which require contingent milestone payments, are summarized below. Luminera In October 2020, AbbVie entered into an agreement with Luminera, a privately held aesthetics company based in Israel, to acquire Luminera's full dermal filler portfolio and RD pipeline including HArmonyCa, a dermal filler intended for facial soft tissue augmentation. The aggregate accounting purchase price of $ 186 million was comprised of a $ 122 million upfront cash payment and $ 64 million for the acquisition date fair value of contingent consideration liabilities, for which AbbVie may owe up to $ 90 million in future payments upon achievement of certain commercial milestones. HArmonyCa is currently commercially available in Israel and Brazil and AbbVie will continue to develop this product for its international and U.S. markets. The agreement was accounted for as a business combination using the acquisition method of accounting. As of the 2020 Form 10-K | acquisition date, AbbVie acquired $ 127 million of intangible assets for in-process research and development and $ 33 million of intangible assets for developed product rights. Other assets and liabilities assumed were insignificant. The acquisition resulted in the recognition of $ 12 million of goodwill which is not deductible for tax purposes. I-Mab Biopharma In September 2020, AbbVie and I-Mab Biopharma (I-Mab) entered into a collaboration agreement for the development and commercialization of lemzoparlimab, an anti-CD47 monoclonal antibody internally discovered and developed by I-Mab for the treatment of multiple cancers. Both companies will collaborate to design and conduct further global clinical trials to evaluate lemzoparlimab. The collaboration provides AbbVie an exclusive global license, excluding greater China, to develop and commercialize lemzoparlimab. The companies will share manufacturing responsibilities with AbbVie being the primary manufacturer for global supply. The agreement also allows for potential collaboration on future CD47-related therapeutic agents, subject to further licenses to explore each other's related programs in their respective territories. The terms of the arrangement include an initial upfront payment of $ 180 million to exclusively license lemzoparlimab along with a milestone payment of $ 20 million based on the Phase I results, for a total of $ 200 million, which was recorded to IPRD in the consolidated statements of earnings in the fourth quarter of 2020 after regulatory approval of the transaction. In addition, I-Mab will be eligible to receive up to $ 1.7 billion upon the achievement of certain clinical development, regulatory and commercial milestones, and AbbVie will pay tiered royalties from low-to-mid teen percentages on global net revenues outside of greater China. Genmab A/S In June 2020, AbbVie and Genmab A/S (Genmab) entered into a collaboration agreement to jointly develop and commercialize three of Genmab's early-stage investigational bispecific antibody therapeutics and entered into a discovery research collaboration for future differentiated antibody therapeutics for the treatment of cancer. Under the terms of the agreement, Genmab granted to AbbVie an exclusive license to its epcoritamab (DuoBody-CD3xCD20), DuoHexaBody-CD37 and DuoBody-CD3x5T4 programs. For epcoritamab, the companies will share commercial responsibilities in the U.S. and Japan, with AbbVie responsible for further global commercialization. Genmab will record net revenues in the U.S. and Japan, and the parties will share equally in pre-tax profits from these sales. Genmab will receive tiered royalties on remaining global sales. For the discovery research partnership, Genmab will conduct Phase 1 studies for these programs and AbbVie retains the right to opt-in to program development. During 2020, AbbVie made an upfront payment of $ 750 million, which was recorded to IPRD in the consolidated statements of earnings. AbbVie could make additional payments of up to $ 3.2 billion upon the achievement of certain development, regulatory and commercial milestones for all programs. Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators. As consideration for the rights reacquired by Reata, AbbVie received a total of $ 250 million as of December 31, 2020 and will receive $ 80 million in cash in 2021. Total consideration of $ 330 million was recognized in other operating (income) expense in the consolidated statements of earnings in 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million to the collaboration and the term is extended for an additional three years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018, AbbVie recorded $ 500 million in other operating (income) expense in the consolidated statements of earnings related to its commitments under the agreement. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 248 million in 2020, $ 385 million in 2019 and $ 424 million in 2018. In connection with the other | 2020 Form 10-K individually insignificant early-stage arrangements entered into in 2020, AbbVie could make additional payments of up to $ 5.1 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaborations The company has ongoing transactions with other entities through collaboration agreements. The following represent the significant collaboration agreements impacting 2020, 2019 and 2018. Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of Imbruvica, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to Imbruvica, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize Imbruvica outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of Imbruvica are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize Imbruvica. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) 2020 2019 2018 United States - Janssen's share of profits (included in cost of products sold) $ 2,012 $ 1,803 $ 1,372 International - AbbVie's share of profits (included in net revenues) 1,009 844 622 Global - AbbVie's share of other costs (included in respective line items) 295 321 326 AbbVies receivable from Janssen, included in accounts receivable, net, was $ 283 million at December 31, 2020 and $ 235 million at December 31, 2019. AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 562 million at December 31, 2020 and $ 455 million at December 31, 2019. Collaboration with Genentech, Inc. AbbVie and Genentech, Inc. (Genentech), a member of the Roche Group, are parties to a collaboration and license agreement executed in 2007 to jointly research, develop and commercialize human therapeutic products containing BCL-2 inhibitors and certain other compound inhibitors which includes Venclexta, a BCL-2 inhibitor used to treat certain hematological malignancies. AbbVie shares equally with Genentech all pre-tax profits and losses from the development and commercialization of Venclexta in the United States. AbbVie pays royalties on Venclexta net revenues outside the United States. AbbVie manufactures and distributes Venclexta globally and is the principal in the end-customer product sales. Sales of Venclexta are included in AbbVie's net revenues. Genentech's share of United States profits is included in AbbVie's cost of products sold. AbbVie records sales and marketing costs associated with the United States collaboration as part of SGA 2020 Form 10-K | expenses and global development costs as part of RD expenses, net of Genentechs share. Royalties paid for Venclexta revenues outside the United States are also included in AbbVies cost of products sold. The following table shows the profit and cost sharing relationship between Genentech and AbbVie: years ended December 31 (in millions) 2020 2019 2018 Genentech's share of profits, including royalties (included in cost of products sold) $ 533 $ 320 $ 141 AbbVie's share of sales and marketing costs from U.S. collaboration (included in SGA) 46 41 27 AbbVie's share of development costs (included in RD) 129 128 160 Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2018 $ 15,663 Foreign currency translation adjustments ( 59 ) Balance as of December 31, 2019 15,604 Additions (a) 17,008 Foreign currency translation adjustments 512 Balance as of December 31, 2020 $ 33,124 (a) Goodwill additions related to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020 (see Note 5). The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2020, there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: 2020 2019 as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 87,707 $ ( 11,620 ) $ 76,087 $ 19,547 $ ( 6,405 ) $ 13,142 License agreements 7,828 ( 2,916 ) 4,912 7,798 ( 2,291 ) 5,507 Total definite-lived intangible assets 95,535 ( 14,536 ) 80,999 27,345 ( 8,696 ) 18,649 Indefinite-lived research and development 1,877 1,877 Total intangible assets, net $ 97,412 $ ( 14,536 ) $ 82,876 $ 27,345 $ ( 8,696 ) $ 18,649 Definite-Lived Intangible Assets The increase in definite-lived intangible assets during 2020 was primarily due to the acquisition of Allergan in the second quarter of 2020. The intangible assets will be amortized using the estimated pattern of economic benefit. Refer to Note 5 for additional information regarding this acquisition. | 2020 Form 10-K Definite-lived intangible assets are amortized over their estimated useful lives, which range between 1 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $ 5.8 billion in 2020, $ 1.6 billion in 2019 and $ 1.3 billion in 2018 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2020 is as follows: (in billions) 2021 2022 2023 2024 2025 Anticipated annual amortization expense $ 7.7 $ 7.2 $ 7.5 $ 8.0 $ 8.4 No definite-lived intangible asset impairment charges were recorded in 2020, 2019 or 2018. Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. The increase in indefinite-lived research and development assets during 2020 was due to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020. Refer to Note 5 for additional information regarding these acquisitions. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. No indefinite-lived intangible asset impairment charges were recorded in 2020. In 2019, following the announcement of the decision to terminate the rovalpituzumab tesirine (Rova-T) RD program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. This termination was subsequent to the decision to stop enrollment for the TAHOE trial, which resulted in an impairment charge of $ 5.1 billion in 2018. These impairment charges were recorded to RD expense in the consolidated statements of earnings in 2019 and 2018. Note 8 Integration and Restructuring Plans Allergan Integration Plan Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. To achieve these integration objectives, AbbVie expects to incur approximately $ 2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. The following table summarizes the charges associated with the Allergan acquisition integration plan: 2020 year ended December 31 (in millions) Severance and employee benefits Other integration Cost of products sold $ 109 $ 21 Research and development 199 177 Selling, general and administrative 388 237 Total charges $ 696 $ 435 The following table summarizes the cash activity in the recorded liability associated with the integration plan: 2020 year ended December 31 (in millions) Severance and employee benefits Other integration Charges $ 594 $ 435 Payments and other adjustments ( 227 ) ( 415 ) Accrued balance as of December 31, 2020 $ 367 $ 20 2020 Form 10-K | Other Restructuring AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2020, 2019 and 2018, no such plans were individually significant. Restructuring charges recorded were $ 60 million in 2020, $ 234 million in 2019 and $ 70 million in 2018 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. The following table summarizes the cash activity in the restructuring reserve for 2020, 2019 and 2018: (in millions) Accrued balance as of December 31, 2017 $ 86 2018 restructuring charges 59 Payments and other adjustments ( 46 ) Accrued balance as of December 31, 2018 99 2019 restructuring charges 219 Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 140 2020 restructuring charges 58 Payments and other adjustments ( 108 ) Accrued balance as of December 31, 2020 $ 90 Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheets: as of December 31 (in millions) Balance sheet caption 2020 2019 Assets Operating Other assets $ 895 $ 344 Finance Property and equipment, net 27 23 Total lease assets $ 922 $ 367 Liabilities Operating Current Accounts payable and accrued liabilities $ 175 $ 109 Noncurrent Other long-term liabilities 832 251 Finance Current Current portion of long-term debt and finance lease obligations 8 7 Noncurrent Long-term debt and finance lease obligations 21 20 Total lease liabilities $ 1,036 $ 387 | 2020 Form 10-K The following table summarizes the lease costs recognized in the consolidated statements of earnings: years ended December 31 (in millions) 2020 2019 Operating lease cost $ 192 $ 124 Short-term lease cost 59 34 Variable lease cost 60 62 Total lease cost $ 311 $ 220 Sublease income and finance lease costs were insignificant in 2020 and 2019. Lease expense prior to the adoption of ASU No. 2016-02 was $ 161 million in 2018. The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: December 31, 2020 December 31, 2019 Weighted-average remaining lease term (years) Operating 8 5 Finance 3 3 Weighted-average discount rate Operating 2.5 % 3.9 % Finance 1.4 % 3.9 % The following table presents supplementary cash flow information regarding the company's leases: years ended December 31 (in millions) 2020 2019 Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 185 $ 125 Right-of-use assets obtained in exchange for new operating lease liabilities 692 26 Finance lease cash flows were insignificant in 2020 and 2019. Right-of-use assets obtained in exchange for new operating lease liabilities included $ 453 million of right-of-use assets acquired in the Allergan acquisition. The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2020: (in millions) Operating leases Finance leases Total (a) 2021 $ 202 $ 27 $ 229 2022 178 3 181 2023 140 2 142 2024 111 1 112 2025 96 96 Thereafter 394 394 Total lease payments 1,121 33 1,154 Less: Interest 114 4 118 Present value of lease liabilities $ 1,007 $ 29 $ 1,036 (a) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. 2020 Form 10-K | Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2020 (a) 2020 Effective interest rate in 2019 (a) 2019 Senior notes issued in 2012 2.90 % notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40 % notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 2.50 % notes due 2020 2.65 % 2.65 % 3,750 3.20 % notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60 % notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50 % notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70 % notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30 % notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85 % notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20 % notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30 % notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45 % notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 1.375 % notes due 2024 ( 1,450 principal) 1.46 % 1,783 1.46 % 1,625 2.125 % notes due 2028 ( 750 principal) 2.18 % 922 2.18 % 840 Senior notes issued in 2018 3.375 % notes due 2021 3.51 % 1,250 3.51 % 1,250 3.75 % notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25 % notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875 % notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75 % notes due 2027 ( 750 principal) 0.86 % 922 0.86 % 840 1.25 % notes due 2031 ( 650 principal) 1.30 % 799 1.30 % 728 Senior notes issued in 2019 Floating rate notes due May 2021 1.33 % 750 2.08 % 750 Floating rate notes due November 2021 1.42 % 750 2.12 % 750 Floating rate notes due 2022 1.62 % 750 2.29 % 750 2.15 % notes due 2021 2.23 % 1,750 2.23 % 1,750 2.30 % notes due 2022 2.42 % 3,000 2.42 % 3,000 2.60 % notes due 2024 2.69 % 3,750 2.69 % 3,750 2.95 % notes due 2026 3.02 % 4,000 3.02 % 4,000 3.20 % notes due 2029 3.25 % 5,500 3.25 % 5,500 4.05 % notes due 2039 4.11 % 4,000 4.11 % 4,000 4.25 % notes due 2049 4.29 % 5,750 4.29 % 5,750 Term loan facilities Floating rate notes due 2023 1.29 % 1,000 % Floating rate notes due 2025 1.42 % 2,000 % Senior notes acquired in 2020 5.000 % notes due 2021 1.59 % 1,200 % 3.450 % notes due 2022 1.89 % 2,878 % 3.250 % notes due 2022 1.85 % 1,700 % 2.800 % notes due 2023 2.08 % 350 % 3.850 % notes due 2024 1.98 % 1,032 % 3.800 % notes due 2025 2.00 % 3,021 % 4.550 % notes due 2035 3.43 % 1,789 % 4.625 % notes due 2042 3.93 % 457 % 4.850 % notes due 2044 4.02 % 1,074 % 4.750 % notes due 2045 4.13 % 881 % | 2020 Form 10-K as of December 31 (dollars in millions) Effective interest rate in 2020 (a) 2020 Effective interest rate in 2019 (a) 2019 Senior Euro notes acquired in 2020 0.500 % notes due 2021 ( 750 principal) 0.68 % 922 % 1.500 % notes due 2023 ( 500 principal) 0.48 % 615 % 1.250 % notes due 2024 ( 700 principal) 0.64 % 861 % 2.625 % notes due 2028 ( 500 principal) 1.18 % 615 % 2.125 % notes due 2029 ( 550 principal) 1.18 % 677 % Other 29 27 Fair value hedges 278 ( 48 ) Unamortized bond discounts ( 146 ) ( 161 ) Unamortized deferred financing costs ( 287 ) ( 323 ) Unamortized bond premiums (b) 1,200 Total long-term debt and finance lease obligations 86,022 66,728 Current portion 8,468 3,753 Noncurrent portion $ 77,554 $ 62,975 (a) Excludes the effect of any related interest rate swaps. (b) Represents unamortized purchase price adjustments of Allergan debt. Allergan-Related Financing In connection with the acquisition of Allergan, in May 2020, the company borrowed $ 3.0 billion under a $ 6.0 billion term loan credit agreement, of which $ 1.0 billion was outstanding under a floating rate three-year term loan tranche and $ 2.0 billion outstanding under a floating rate five-year term loan tranche as of December 31, 2020. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. In May 2020, AbbVie completed its previously announced offers to exchange any and all outstanding notes of certain series issued by Allergan for new notes to be issued by AbbVie and cash. Following the settlement of the exchange offers, AbbVie issued $ 14.0 billion and 3.1 billion of new notes in exchange for the Allergan notes tendered in the exchange offers. The aggregate principal amount of Allergan notes that remained outstanding following the settlement of the exchange offers was approximately $ 1.5 billion and 635 million. The exchange transaction was accounted for as a modification of the assumed debt instruments. In September 2020, the company repaid $ 650 million aggregate principal amount of 3.375 % Allergan exchange notes at maturity. In November 2020, the company repaid 700 million aggregate principal amount of floating rate Allergan exchange notes at maturity and $ 450 million aggregate principal amount of 4.875 % Allergan exchange notes due February 2021 three months prior to maturity. In November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million, which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie used the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the acquisition described in Note 5 and to pay related fees and expenses. Other Long-Term Debt In May 2020, the company repaid $ 3.8 billion aggregate principal amount of 2.50 % senior notes at maturity. In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In 2020 Form 10-K | connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In May 2018, the company also repaid $ 3.0 billion aggregate principal amount of 1.80 % senior notes at maturity. In September 2018, the company issued $ 6.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375 % notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 37 million and debt discounts totaled $ 37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $ 5.9 billion net proceeds, $ 2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $ 1.0 billion was used to repay the aggregate principal amount of 2.00 % senior notes at maturity in November 2018. The company used the remaining proceeds to repay term loan obligations in 2019 as they became due. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 7.8 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 10.0 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2020, the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings There were no commercial paper borrowings outstanding as of December 31, 2020 and December 31, 2019. The weighted-average interest rate on commercial paper borrowings was 1.8 % in 2020, 2.5 % in 2019 and 2.0 % in 2018. In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2020. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2020, 2019 and 2018. No amounts were outstanding under the company's credit facilities as of December 31, 2020 and December 31, 2019. In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. | 2020 Form 10-K Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2020: as of and for the years ending December 31 (in millions) 2021 $ 8,422 2022 12,428 2023 4,215 2024 7,426 2025 8,771 Thereafter 43,686 Total obligations and commitments 84,948 Fair value hedges, unamortized bond premiums and discounts, deferred financing costs and finance lease obligations 1,074 Total long-term debt and finance lease obligations $ 86,022 Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 1.5 billion at December 31, 2020 and $ 1.0 billion at December 31, 2019, are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than 18 months. Accumulated gains and losses as of December 31, 2020 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the proposed acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a gain of $ 383 million recognized in other comprehensive income (loss). This gain is reclassified to interest expense, net over the lives of the related debt. In the fourth quarter of 2019, the company entered into interest rate swap contracts with notional amounts totaling $ 2.3 billion at December 31, 2020 and December 31, 2019. The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. The contracts were designated as cash flow hedges 2020 Form 10-K | and are recorded at fair value. Realized and unrealized gains or losses are included in AOCI and are reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 8.6 billion at December 31, 2020 and $ 7.1 billion at December 31, 2019. The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had an aggregate principal amount of senior Euro notes designated as net investment hedges of 6.6 billion at December 31, 2020 and 3.6 billion at December 31, 2019. In addition, the company had foreign currency forward exchange contracts designated as net investment hedges with notional amounts totaling 971 million at December 31, 2020 and 971 million, 204 million, and CHF 62 million at December 31, 2019. The company uses the spot method of assessing hedge effectiveness for derivative instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. AbbVie is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 4.8 billion at December 31, 2020 and $ 10.8 billion at December 31, 2019. The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2020 2019 Balance sheet caption 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ 2 $ 3 Accounts payable and accrued liabilities $ 82 $ 14 Designated as cash flow hedges Other assets Other long-term liabilities 6 Designated as net investment hedges Prepaid expenses and other Accounts payable and accrued liabilities 11 24 Not designated as hedges Prepaid expenses and other 49 19 Accounts payable and accrued liabilities 33 18 Interest rate swap contracts Designated as cash flow hedges Prepaid expenses and other Accounts payable and accrued liabilities 14 Designated as cash flow hedges Other assets 3 Other long-term liabilities 20 Designated as fair value hedges Prepaid expenses and other 7 Accounts payable and accrued liabilities 2 Designated as fair value hedges Other assets 131 28 Other long-term liabilities 74 Total derivatives $ 189 $ 53 $ 166 $ 132 While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. | 2020 Form 10-K The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) 2020 2019 2018 Foreign currency forward exchange contracts Designated as cash flow hedges $ ( 71 ) $ ( 5 ) $ 175 Designated as net investment hedges ( 95 ) 33 Interest rate swap contracts designated as cash flow hedges ( 53 ) 4 Treasury rate lock agreements designated as cash flow hedges 383 Assuming market rates remain constant through contract maturities, the company expects to reclassify pre-tax losses of $ 93 million into cost of products sold for foreign currency cash flow hedges, pre-tax losses of $ 24 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax losses of $ 907 million in 2020, pre-tax gains of $ 90 million in 2019 and pre-tax gains of $ 178 million in 2018. The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption 2020 2019 2018 Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ 23 $ 167 $ ( 161 ) Designated as net investment hedges Interest expense, net 18 27 Not designated as hedges Net foreign exchange loss 58 ( 70 ) 83 Treasury rate lock agreements designated as cash flow hedges Interest expense, net 24 3 Interest rate swap contracts Designated as cash flow hedges Interest expense, net ( 17 ) 1 Designated as fair value hedges Interest expense, net 365 418 ( 71 ) Debt designated as hedged item in fair value hedges Interest expense, net ( 365 ) ( 418 ) 71 Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. 2020 Form 10-K | The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2020: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 8,449 $ 2,758 $ 5,691 $ Money market funds and time deposits 12 12 Debt securities 50 50 Equity securities 159 149 10 Interest rate swap contracts 138 138 Foreign currency contracts 51 51 Total assets $ 8,859 $ 2,907 $ 5,952 $ Liabilities Interest rate swap contracts $ 34 $ $ 34 $ Foreign currency contracts 132 132 Contingent consideration 12,997 12,997 Total liabilities $ 13,163 $ $ 166 $ 12,997 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2019: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 39,924 $ 1,542 $ 38,382 $ Debt securities 3 3 Equity securities 24 24 Interest rate swap contracts 31 31 Foreign currency contracts 22 22 Total assets $ 40,004 $ 1,566 $ 38,438 $ Liabilities Interest rate swap contracts $ 76 $ $ 76 $ Foreign currency contracts 56 56 Contingent consideration 7,340 7,340 Total liabilities $ 7,472 $ $ 132 $ 7,340 Equity securities consist of investments for which the fair values were determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones | 2020 Form 10-K and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities as of December 31, 2020 was calculated using the following significant unobservable inputs: Range Weighted Average (a) Discount rate 0.1 % - 2.2 % 1.1 % Probability of payment for unachieved milestones 56 % - 92 % 64 % Probability of payment for royalties by indication (b) 56 % - 100 % 91 % Projected year of payments 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excludes early stage indications with 0 % estimated probability of payment and includes approved indications with 100 % probability of payment. Excluding approved indications, the estimated probability of payment ranged from 56 % to 89 % at December 31, 2020. There have been no transfers of assets or liabilities into or out of Level 3 of the fair value hierarchy. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) 2020 2019 2018 Beginning balance $ 7,340 $ 4,483 $ 4,534 Additions (a) 225 Change in fair value recognized in net earnings 5,753 3,091 49 Payments ( 321 ) ( 234 ) ( 100 ) Ending balance $ 12,997 $ 7,340 $ 4,483 (a) Additions during the year ended December 31, 2020 represent contingent consideration liabilities assumed in the Allergan acquisition as well as contingent consideration resulting from the Luminera acquisition. The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the fourth quarter of 2020, the company recorded a $ 4.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake and favorable clinical trial results as well as lower interest rates. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the Skyrizi contingent consideration liability due to higher probabilities of success, higher estimated future sales and declining interest rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. During the fourth quarter of 2018, the company recorded a $ 428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 2020 Form 10-K | Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2020 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 34 $ 34 $ $ 34 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 8,461 8,542 8,249 293 Long-term debt and finance lease obligations, excluding fair value hedges 77,283 87,761 86,137 1,624 Total liabilities $ 85,778 $ 96,337 $ 94,386 $ 1,951 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2019 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 3,755 $ 3,760 $ 3,753 $ 7 $ Long-term debt and finance lease obligations, excluding fair value hedges 63,021 66,651 66,631 20 Total liabilities $ 66,776 $ 70,411 $ 70,384 $ 27 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 102 million as of December 31, 2020 and $ 66 million as of December 31, 2019. No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2020. Concentrations of Risk Of total net accounts receivable, three U.S. wholesalers accounted for 72 % as of December 31, 2020 and 68 % as of December 31, 2019, and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 43 % of AbbVie's total net revenues in 2020, 58 % in 2019 and 61 % in 2018. | 2020 Form 10-K Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2020 and 2019. The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) 2020 2019 2020 2019 Projected benefit obligations Beginning of period $ 8,646 $ 6,618 $ 1,050 $ 561 Service cost 370 269 42 25 Interest cost 264 259 34 29 Employee contributions 2 2 Amendments ( 397 ) Actuarial loss 1,105 1,703 40 451 Benefits paid ( 249 ) ( 206 ) ( 17 ) ( 17 ) Acquisition 1,409 43 Other, primarily foreign currency translation adjustments 245 1 1 End of period 11,792 8,646 795 1,050 Fair value of plan assets Beginning of period 7,116 5,637 Actual return on plan assets 979 946 Company contributions 367 727 17 17 Employee contributions 2 2 Benefits paid ( 249 ) ( 206 ) ( 17 ) ( 17 ) Acquisition 1,296 Other, primarily foreign currency translation adjustments 191 10 End of period 9,702 7,116 Funded status, end of period $ ( 2,090 ) $ ( 1,530 ) $ ( 795 ) $ ( 1,050 ) Amounts recognized on the consolidated balance sheets Other assets $ 563 $ 395 $ $ Accounts payable and accrued liabilities ( 12 ) ( 8 ) ( 23 ) ( 18 ) Other long-term liabilities ( 2,641 ) ( 1,917 ) ( 772 ) ( 1,032 ) Net obligation $ ( 2,090 ) $ ( 1,530 ) $ ( 795 ) $ ( 1,050 ) Actuarial loss, net $ 4,163 $ 3,633 $ 482 $ 469 Prior service cost (credit) 8 10 ( 408 ) ( 16 ) Accumulated other comprehensive loss $ 4,171 $ 3,643 $ 74 $ 453 The projected benefit obligations (PBO) in the table above included $ 3.5 billion at December 31, 2020 and $ 2.3 billion at December 31, 2019, related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $ 10.5 billion at December 31, 2020 and $ 7.6 billion at December 31, 2019. 2020 Form 10-K | Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2020 2019 Accumulated benefit obligation $ 7,527 $ 5,752 Fair value of plan assets 6,066 4,820 Information For Pension Plans With A Projected Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2020 2019 Projected benefit obligation $ 8,719 $ 6,820 Fair value of plan assets 6,066 4,895 The 2020 actuarial losses of $ 1.1 billion for qualified pension plans and $ 40 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2019. The 2019 actuarial losses of $ 1.7 billion for qualified pension plans and $ 451 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2018. A change to AbbVie's U.S. retiree health benefit plan was approved in 2020 and communicated to employees and retirees in October 2020. Beginning in 2022, Medicare-eligible retirees and Medicare-eligible dependents will choose health care coverage from insurance providers through a private Medicare exchange. AbbVie will continue to provide financial support to Medicare-eligible retirees. This change decreased AbbVie's post-employment benefit obligation and increased AbbVie's unrecognized prior service credit as of December 31, 2020 by $ 397 million. In connection with the Allergan acquisition, AbbVie assumed certain post-employment benefit obligations which were recorded at fair value. Upon acquisition in the second quarter of 2020, the excess of projected benefit obligations over the plan assets was recognized as a liability totaling $ 156 million. Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) 2020 2019 2018 Defined benefit plans Actuarial loss $ 701 $ 1,231 $ 209 Amortization of prior service cost ( 2 ) Amortization of actuarial loss ( 227 ) ( 109 ) ( 140 ) Foreign exchange loss (gain) and other 56 ( 6 ) ( 13 ) Total loss $ 528 $ 1,116 $ 56 Other post-employment plans Actuarial loss (gain) $ 40 $ 451 $ ( 287 ) Prior service cost (credit) ( 397 ) Amortization of prior service credit 4 Amortization of actuarial loss ( 26 ) ( 1 ) ( 1 ) Total loss (gain) $ ( 379 ) $ 450 $ ( 288 ) | 2020 Form 10-K Net Periodic Benefit Cost years ended December 31 (in millions) 2020 2019 2018 Defined benefit plans Service cost $ 370 $ 269 $ 285 Interest cost 264 259 227 Expected return on plan assets ( 575 ) ( 474 ) ( 439 ) Amortization of prior service cost 2 Amortization of actuarial loss 227 109 140 Net periodic benefit cost $ 288 $ 163 $ 213 Other post-employment plans Service cost $ 42 $ 25 $ 26 Interest cost 34 29 25 Amortization of prior service credit ( 4 ) Amortization of actuarial loss 26 1 1 Net periodic benefit cost $ 98 $ 55 $ 52 The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 2020 2019 Defined benefit plans Discount rate 2.4 % 3.0 % Rate of compensation increases 4.6 % 4.6 % Cash balance interest crediting rate 2.8 % 2.8 % Other post-employment plans Discount rate 2.8 % 3.6 % The assumptions used in calculating the December 31, 2020 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2021. Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 2020 2019 2018 Defined benefit plans Discount rate for determining service cost 3.1 % 4.0 % 3.4 % Discount rate for determining interest cost 3.0 % 4.0 % 3.1 % Expected long-term rate of return on plan assets 7.1 % 7.6 % 7.7 % Expected rate of change in compensation 4.6 % 4.6 % 4.4 % Cash balance interest crediting rate 2.8 % 2.8 % 2.8 % Other post-employment plans Discount rate for determining service cost 3.7 % 4.7 % 4.0 % Discount rate for determining interest cost 3.2 % 4.3 % 3.7 % For the December 31, 2020 post-retirement health care obligations remeasurement, the company assumed a 6.3 % pre-65 ( 6.7 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % in 2090 and remain at that level thereafter. For purposes of measuring the 2020 post-retirement health care costs, the company assumed a 6.4 % pre-65 ( 7.0 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % for 2050 and remain at that level thereafter. 2020 Form 10-K | Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) 2020 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,143 $ 1,143 $ $ U.S. mid cap (b) 164 164 International (c) 524 524 Fixed income securities U.S. government securities (d) 132 18 114 Corporate debt instruments (d) 854 178 676 Non-U.S. government securities (d) 544 397 147 Other (d) 297 294 3 Absolute return funds (e) 310 4 306 Real assets 10 10 Other (f) 252 250 2 Total $ 4,230 $ 2,982 $ 1,248 $ Total assets measured at NAV 5,472 Fair value of plan assets $ 9,702 Basis of fair value measurement as of December 31 (in millions) 2019 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 884 $ 884 $ $ U.S. mid cap (b) 138 138 International (c) 349 349 Fixed income securities U.S. government securities (d) 149 21 128 Corporate debt instruments (d) 372 112 260 Non-U.S. government securities (d) 202 84 118 Other (d) 320 318 2 Absolute return funds (e) 296 4 292 Real assets 9 9 Other (f) 132 132 Total $ 2,851 $ 2,051 $ 800 $ Total assets measured at NAV 4,265 Fair value of plan assets $ 7,116 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. | 2020 Form 10-K (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2020 target investment allocation for the AbbVie Pension Plan was 50 % in equity securities, 20 % in fixed income securities and 30 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans 2021 $ 284 $ 23 2022 301 29 2023 319 31 2024 339 33 2025 362 36 2026 to 2030 2,169 217 Defined Contribution Plan AbbVie's principal defined contribution plans are the AbbVie Savings Plan and the Allergan Savings Plan. AbbVie recorded expense of $ 191 million in 2020, $ 102 million in 2019 and $ 89 million in 2018 related to these plans. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for 2020 Form 10-K | stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: years ended December 31 (in millions) 2020 2019 2018 Cost of products sold $ 47 $ 29 $ 27 Research and development 247 171 169 Selling, general and administrative 459 230 225 Pre-tax compensation expense 753 430 421 Tax benefit 131 80 73 After-tax compensation expense $ 622 $ 350 $ 348 Realized excess tax benefits associated with stock-based compensation totaled $ 34 million in 2020, $ 15 million in 2019 and $ 78 million in 2018. Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three-year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 12.14 in 2020, $ 12.54 in 2019 and $ 21.63 in 2018. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 11.2 million stock options to holders of Allergan options as a result of the conversion of such options. These options were fair-valued using a lattice valuation model. Refer to Note 5 for additional information regarding the Allergan acquisition. The following table summarizes AbbVie stock option activity in 2020: (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted-average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2019 6,761 $ 60.39 5.9 $ 207 Granted 1,995 93.50 Granted in acquisition 11,152 70.48 Exercised ( 4,129 ) 51.29 Lapsed ( 88 ) 107.33 Outstanding at December 31, 2020 15,691 $ 73.90 4.7 $ 559 Exercisable at December 31, 2020 12,440 $ 69.99 3.6 $ 498 The total intrinsic value of options exercised was $ 186 million in 2020, $ 22 million in 2019 and $ 215 million in 2018. The total fair value of options vested during 2020 was $ 292 million. As of December 31, 2020, $ 13 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in ratable increments over a three or four-year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three-year performance period. For awards granted in 2020, performance is based on AbbVie's return on invested capital (ROIC) relative to a defined peer group of pharmaceutical, biotech and life science companies. For awards granted in 2018 and 2019, the tranches tied to 2020 performance are based on AbbVies return on equity (ROE) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest | 2020 Form 10-K over a three-year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2020: (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2019 10,232 $ 81.72 Granted 5,524 92.35 Granted in acquisition 8,234 83.96 Vested ( 6,667 ) 80.09 Forfeited ( 1,405 ) 84.13 Outstanding at December 31, 2020 15,918 $ 87.03 The fair market value of RSUs and performance shares (as applicable) vested was $ 618 million in 2020, $ 371 million in 2019 and $ 583 million in 2018. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 8.2 million RSUs to holders of Allergan equity awards based on a conversion factor described in the transaction agreement. Refer to Note 5 for additional information regarding the Allergan acquisition. As of December 31, 2020, $ 579 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 4.84 in 2020, $ 4.39 in 2019 and $ 3.95 in 2018. The following table summarizes quarterly cash dividends declared during 2020, 2019 and 2018: 2020 2019 2018 Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/30/20 02/16/21 $ 1.30 11/01/19 02/14/20 $ 1.18 11/02/18 02/15/19 $ 1.07 09/11/20 11/16/20 $ 1.18 09/06/19 11/15/19 $ 1.07 09/07/18 11/15/18 $ 0.96 06/17/20 08/14/20 $ 1.18 06/20/19 08/15/19 $ 1.07 06/14/18 08/15/18 $ 0.96 02/20/20 05/15/20 $ 1.18 02/21/19 05/15/19 $ 1.07 02/15/18 05/15/18 $ 0.96 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 8 million shares for $ 757 million in 2020 and 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was $ 3.2 billion as of December 31, 2020. On February 15, 2018, AbbVie's board of directors authorized a new $ 10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $ 5.0 billion increase to the existing $ 10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $ 10.7 billion in 2018. Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $ 1.3 billion in 2018. 2020 Form 10-K | Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2020, 2019 and 2018: (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post-employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2017 $ ( 439 ) $ ( 203 ) $ ( 1,919 ) $ $ ( 166 ) $ ( 2,727 ) Other comprehensive income (loss) before reclassifications ( 391 ) 138 84 ( 14 ) 156 ( 27 ) Net losses reclassified from accumulated other comprehensive loss 113 4 157 274 Net current-period other comprehensive income (loss) ( 391 ) 138 197 ( 10 ) 313 247 Balance as of December 31, 2018 ( 830 ) ( 65 ) ( 1,722 ) ( 10 ) 147 ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) 95 ( 1,330 ) 12 298 ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 87 ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) 74 ( 1,243 ) 10 141 ( 1,116 ) Balance as of December 31, 2019 ( 928 ) 9 ( 2,965 ) 288 ( 3,596 ) Other comprehensive income (loss) before reclassifications 1,511 ( 785 ) ( 300 ) ( 108 ) 318 Net losses (gains) reclassified from accumulated other comprehensive loss ( 14 ) 198 ( 23 ) 161 Net current-period other comprehensive income (loss) 1,511 ( 799 ) ( 102 ) ( 131 ) 479 Balance as of December 31, 2020 $ 583 $ ( 790 ) $ ( 3,067 ) $ $ 157 $ ( 3,117 ) Other comprehensive income (loss) included foreign currency translation adjustments totaling gains of $ 1.5 billion in 2020 which were principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive income (loss) included foreign currency translation adjustments totaling losses of $ 98 million in 2019 and $ 391 million in 2018 which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. | 2020 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) 2020 2019 2018 Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 18 ) $ ( 27 ) $ Tax expense 4 6 Total reclassifications, net of tax $ ( 14 ) $ ( 21 ) $ Pension and post-employment benefits Amortization of actuarial losses and other (b) $ 251 $ 110 $ 141 Tax benefit ( 53 ) ( 23 ) ( 28 ) Total reclassifications, net of tax $ 198 $ 87 $ 113 Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ ( 23 ) $ ( 167 ) $ 161 Gains on treasury rate lock agreements (a) ( 24 ) ( 3 ) Losses (gains) on interest rate swap contracts (a) 17 ( 1 ) Tax expense (benefit) 7 14 ( 4 ) Total reclassifications, net of tax $ ( 23 ) $ ( 157 ) $ 157 (a) Amounts are included in interest expense, net (see Note 11). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12). (c) Amounts are included in cost of products sold (see Note 11). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2020, no shares of preferred stock were issued or outstanding. Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2020 2019 2018 Domestic $ ( 4,467 ) $ ( 2,784 ) $ ( 4,274 ) Foreign 7,865 11,210 9,471 Total earnings before income tax expense $ 3,398 $ 8,426 $ 5,197 Income Tax Expense years ended December 31 (in millions) 2020 2019 2018 Current Domestic $ 907 $ 102 $ 593 Foreign 194 320 434 Total current taxes $ 1,101 $ 422 $ 1,027 Deferred Domestic $ ( 58 ) $ ( 137 ) $ ( 1,497 ) Foreign ( 2,267 ) 259 ( 20 ) Total deferred taxes $ ( 2,325 ) $ 122 $ ( 1,517 ) Total income tax expense (benefit) $ ( 1,224 ) $ 544 $ ( 490 ) 2020 Form 10-K | Effective Tax Rate Reconciliation years ended December 31 2020 2019 2018 Statutory tax rate 21.0 % 21.0 % 21.0 % Effect of foreign operations 2.4 ( 8.4 ) ( 28.7 ) U.S. tax credits ( 10.6 ) ( 3.3 ) ( 7.3 ) Impacts related to U.S. tax reform ( 1.1 ) ( 1.6 ) 8.2 Non-deductible expenses 7.2 1.0 1.2 Tax law changes and related restructuring ( 48.5 ) 3.1 Stock-based compensation excess tax benefit ( 0.9 ) ( 0.2 ) ( 1.5 ) Tax audit settlements ( 5.1 ) ( 4.7 ) ( 2.5 ) All other, net ( 0.4 ) ( 0.4 ) 0.2 Effective tax rate ( 36.0 ) % 6.5 % ( 9.4 ) % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2020, 2019 and 2018 differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, the cost of repatriation decisions, tax audit settlements and Boehringer Ingelheim accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $ 1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2020, 2019 and 2018 included impacts related to U.S. tax reform. The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system, including a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. In 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. For 2019, the impact of the Act affected the full year earnings of these subsidiaries, resulting in additional tax expense compared to the previous year. The effective income tax rates for 2019 and 2018 also included the effects of Stemcentrx impairment related expenses. | 2020 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) 2020 2019 Deferred tax assets Compensation and employee benefits $ 1,109 $ 810 Accruals and reserves 438 371 Chargebacks and rebates 555 477 Advance payments 324 615 Net operating losses and other credit carryforwards 2,765 838 Other 1,371 406 Total deferred tax assets 6,562 3,517 Valuation allowances ( 1,203 ) ( 731 ) Total net deferred tax assets 5,359 2,786 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 5,274 ) ( 2,712 ) Excess of book basis over tax basis in investments ( 335 ) ( 249 ) Other ( 982 ) ( 440 ) Total deferred tax liabilities ( 6,591 ) ( 3,401 ) Net deferred tax liabilities $ ( 1,232 ) $ ( 615 ) The increases in deferred tax liabilities are primarily due to the acquisition of Allergan in which the company recorded the excess of book basis over tax basis of intangible assets. The increases in deferred tax assets are primarily due to deferred tax asset recognition related to the intra-group transfer of intellectual property. As of December 31, 2020, the company had U.S. federal and state credit carryforwards of $ 293 million as well as U.S. federal, state and non-U.S. net operating loss carryforwards of $ 4.3 billion, which will expire at various times through 2040. The remaining U.S. federal and non-U.S. loss carryforwards of $ 5.8 billion have no expiration. The company had valuation allowances of $ 1.2 billion as of December 31, 2020 and $ 731 million as of December 31, 2019. These were principally related to foreign and state net operating losses and credit carryforwards that are not expected to be realized. The Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings or eligible for the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. However, the company generally considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Unrecognized Tax Benefits years ended December 31 (in millions) 2020 2019 2018 Beginning balance $ 2,661 $ 2,852 $ 2,701 Increase due to acquisition 2,674 Increase due to current year tax positions 91 113 163 Increase due to prior year tax positions 59 499 110 Decrease due to prior year tax positions ( 7 ) ( 21 ) ( 36 ) Settlements ( 141 ) ( 749 ) ( 79 ) Lapse of statutes of limitations ( 73 ) ( 33 ) ( 7 ) Ending balance $ 5,264 $ 2,661 $ 2,852 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will 2020 Form 10-K | be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 5.0 billion in 2020 and $ 2.4 billion in 2019. Of the unrecognized tax benefits recorded in the table above as of December 31, 2020, AbbVie would be indemnified for approximately $ 81 million. The ""Increase due to current year tax positions"" and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. ""Increase due to acquisition"" in the table above includes amounts related to federal, state and international tax items recorded in acquisition accounting related to the Allergan acquisition. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 142 million in 2020, $ 51 million in 2019 and $ 73 million in 2018, for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $ 642 million at December 31, 2020, $ 191 million at December 31, 2019 and $ 190 million at December 31, 2018. The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 68 million. All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. The most significant matters are described below. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $ 60 million as of December 31, 2020 and approximately $ 290 million as of December 31, 2019. Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. In addition, other operating income in 2019 included $ 550 million of income from a legal settlement related to an intellectual property dispute with a third party. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Antitrust Litigation Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits pending in federal court consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payers. The cases are pending in the United States District Court for the Eastern District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In June 2020, the court denied the end-payers' motion to certify a class. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. | 2020 Form 10-K In September 2014, the Federal Trade Commission (FTC) filed a lawsuit, FTC v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $ 448 million, plus prejudgment interest. The court denied the FTCs request for injunctive relief. In September 2020, the United States Court of Appeals for the Third Circuit reversed the district courts finding of sham litigation with respect to one generic company and affirmed with respect to the other but held the FTC lacked authority to obtain a disgorgement remedy and vacated the district courts award. The Third Circuit also affirmed the district courts denial of the FTCs injunction request and reinstated the FTCs settlement-related claim for further proceedings in the district court. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2006 patent litigation settlements and related agreements by Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) with three generic companies violated federal antitrust law, and also making allegations similar to those in FTC v. AbbVie Inc. (above). In May 2020, Perrigo Company and related entities filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, making sham litigation allegations similar to those in FTC v. AbbVie Inc . (above). In October 2020, the Perrigo lawsuit was transferred to the United States District Court for New Jersey. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect Humira purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies Humira patent portfolio violated state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In June 2020, the court dismissed the consolidated litigation with prejudice. The plaintiffs have appealed the dismissal. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2009 and 2010 patent litigation settlements involving Namenda entered into between Forest and generic companies and other conduct by Forest involving Namenda, violated state antitrust, unfair and deceptive trade practices, and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, purported class actions filed by indirect purchasers of Namenda, are consolidated as In re: Namenda Indirect Purchaser Antitrust Litigation in the United States District Court for the Southern District of New York. Lawsuits are pending against Allergan Inc. generally alleging that Allergans petitioning to the U.S. Patent Office and Food and Drug Administration and other conduct by Allergan involving Restasis violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, certified as a class action filed on behalf of indirect purchasers of Restasis, are consolidated for pre-trial purposes in the United States District Court for the Eastern District of New York under the MDL Rules as In re: Restasis (Cyclosporine Ophthalmic Emulsion) Antitrust Litigation , MDL No. 2819. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2012 and 2013 patent litigation settlements involving Bystolic with six generic manufacturers violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief, and attorneys fees. The lawsuits, purported class actions filed on behalf of direct and indirect purchasers of Bystolic, are consolidated as In re: Bystolic Antitrust Litigation in the United States District Court for the Southern District of New York. Government Proceedings Lawsuits are pending against Allergan and several other manufacturers generally alleging that they improperly promoted and sold prescription opioid products. Approximately 3,100 matters are pending against Allergan. The federal court cases are consolidated for pre-trial purposes in the United States District Court for the Northern District of Ohio under the MDL rules as In re: National Prescription Opiate Litigation , MDL No. 2804. Approximately 300 of the claims are pending in various state courts. The plaintiffs in these cases, which include states, counties, cities, and Native American tribes, generally seek compensatory damages. In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In October 2020, the state added a claim under the New Mexico False Advertising Act. 2020 Form 10-K | Shareholder and Securities Litigation In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. The court granted motions dismissing the claims of three investment-fund plaintiffs, which they are appealing. One of these plaintiffs refiled its lawsuit in New York state court in June 2020 while the appeal of its dismissal in Illinois is pending. In November 2020, the New York Supreme Court for the County of New York dismissed that lawsuit. Plaintiffs seek compensatory and punitive damages. In October 2018, a federal securities lawsuit, Holwill v. AbbVie Inc., et al ., was filed in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for Humira sales growth in financial filings between 2013 and 2017 were misleading because they omitted alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value that allegedly induced Humira prescriptions. In February 2020, a shareholder derivative lawsuit, Elfers v. Gonzalez, et al. , was filed in the United States District Court for the District of Delaware alleging that certain AbbVie directors and officers breached their fiduciary duties regarding alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value and in connection with the announcements of results of AbbVies 2018 Dutch auction tender offer. In December 2020, the court dismissed the lawsuit. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergan's textured breast implants. The lawsuits, which were filed by Allergan shareholders, have been consolidated in the United States District Court for the Southern District of New York as In re: Allergan plc Securities Litigation . The plaintiffs generally seek compensatory damages and attorneys fees. In September 2019, the court partially granted Allergan's motion to dismiss. In September 2020, the court denied plaintiffs class certification motion because it found the lead plaintiff to be an inadequate representative of the proposed class but allowed another putative class member to propose itself as a new lead plaintiff. In December 2020, the court appointed a new lead plaintiff. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans former Actavis generics unit and its alleged anticompetitive conduct with other generic drug companies. The lawsuits were filed by Allergan shareholders and consist of three purported class actions and one individual action that have been consolidated in the U.S. District Court for the District of New Jersey as In re: Allergan Generic Drug Pricing Securities Litigation . Another individual action in New Jersey state court was dismissed in September 2020. The plaintiffs seek monetary damages and attorneys fees. Product Liability and General Litigation Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 92 cases are pending in the United States District Court for the Southern District of Illinois along with one other pending in s tate court. Plaintiffs generally seek compensatory and punitive damages. Approximately ninety-eight percent of these pending cases, plus other unfiled claims, are subject to confidential settlement agreements or agreements-in-principle and are expected to be dismissed with prejudice. In 2018, a qui tam lawsuit, U.S. ex rel. Silbersher v. Allergan Inc., et al. , was filed in the United States District Court for the Northern District of California against several Allergan entities and others, alleging that their conduct before the U.S. Patent Office resulted in false claims for payment being made to federal and state healthcare payors for Namenda XR and Namzaric. The plaintiff-relator seeks damages and attorneys' fees under the federal False Claims Act and state law analogues. The federal government and state governments declined to intervene in the lawsuit. Intellectual Property Litigation Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark Imbruvica). In February 2018 a lawsuit was filed in the United States District Court for the District of Delaware against Sandoz Inc. and Lek Pharmaceuticals D.D. In the case, Pharmacyclics alleges the defendants' proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in this suit. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark Imbruvica). Cases were filed in the United States District Court for the | 2020 Form 10-K District of Delaware in March 2019 and March 2020 against Alvogen Pine Brook LLC and Natco Pharma Ltd., and in April 2020 against Zydus Worldwide DMCC and Cadila Healthcare Limited. In each case, Pharmacyclics alleges defendants proposed generic ibrutinib tablet product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in these suits. Allergan USA, Inc., Allergan Sales, LLC, and Forest Laboratories Holdings Limited, wholly owned subsidiaries of AbbVie, are seeking to enforce patent rights relating to cariprazine (a drug sold under the trademark Vraylar). Litigation was filed in the United States District Court for the District of Delaware in December 2019 against Sun Pharmaceutical Industries Limited and Sun Pharma Global FZE; Aurobindo Pharma Limited and Aurobindo Pharma USA, Inc.; and Zydus Pharmaceuticals (USA), Inc. and Cadila Healthcare Limited. Allergan alleges defendants' proposed generic cariprazine products infringe certain patents and seeks declaratory and injunctive relief. Gedeon Richter Plc, Inc. which is in a global collaboration with Allergan concerning the development and marketing of Vraylar, is the co-plaintiff in this suit. In January 2019, Allergan, Inc. and Allergan plc (now Allergan Limited) and Medytox Inc. (collectively, ""Complainants"") filed a complaint with the United States International Trade Commission (ITC) against Daewoong Pharmaceuticals Co., Ltd., Daewoong Co., Ltd., and Evolus Inc. (collectively, ""Respondents"") requesting the ITC commence an investigation regarding the importation into the United States of Respondents' botulinum neurotoxin products, including Jeuveau, which Complainants assert were developed using Medytox's trade secrets. Complainants seek permanent exclusion and cease and desist orders covering Respondents' products, including Jeuveau. In July 2020, the administrative law judge issued an initial ruling in favor of Allergan and Medytox. In December 2020, the full Commission affirmed, in part, and reversed, in part, the initial ruling. In August 2020, BTL Industries, Inc. (BTL) filed an ITC action against Allergan USA, Inc., Allergan Limited, Allergan, Inc., Zeltiq Aesthetics, Inc., Zeltiq Ireland Unlimited Company, and Zimmer Medizinsysteme GmbH, for patent infringement alleging that the CoolTone and CoolSculpting devices infringe its patents and seeking an exclusion order preventing importation of the devices and any components used to make or use the devices. 2020 Form 10-K | Note 16 Segment and Geographic Area Information AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) 2020 2019 2018 Immunology Humira United States $ 16,112 $ 14,864 $ 13,685 International 3,720 4,305 6,251 Total $ 19,832 $ 19,169 $ 19,936 Skyrizi United States $ 1,385 $ 311 $ International 205 44 Total $ 1,590 $ 355 $ Rinvoq United States $ 653 $ 47 $ International 78 Total $ 731 $ 47 $ Hematologic Oncology Imbruvica United States $ 4,305 $ 3,830 $ 2,968 Collaboration revenues 1,009 844 622 Total $ 5,314 $ 4,674 $ 3,590 Venclexta United States $ 804 $ 521 $ 247 International 533 271 97 Total $ 1,337 $ 792 $ 344 Aesthetics Botox Cosmetic (a) United States $ 687 $ $ International 425 Total $ 1,112 $ $ Juvederm Collection (a) United States $ 318 $ $ International 400 Total $ 718 $ $ Other Aesthetics (a) United States $ 666 $ $ International 94 Total $ 760 $ $ Neuroscience Botox Therapeutic (a) United States $ 1,155 $ $ International 232 Total $ 1,387 $ $ Vraylar (a) United States $ 951 $ $ Duodopa United States $ 103 $ 97 $ 80 International 391 364 350 Total $ 494 $ 461 $ 430 Ubrelvy (a) United States $ 125 $ $ Other Neuroscience (a) United States $ 528 $ $ International 11 Total $ 539 $ $ | 2020 Form 10-K years ended December 31 (in millions) 2020 2019 2018 Eye Care Lumigan/Ganfort (a) United States $ 165 $ $ International 213 Total $ 378 $ $ Alphagan/Combigan (a) United States $ 223 $ $ International 103 Total $ 326 $ $ Restasis (a) United States $ 755 $ $ International 32 Total $ 787 $ $ Other Eye Care (a) United States $ 305 $ $ International 388 Total $ 693 $ $ Women's Health Lo Loestrin (a) United States $ 346 $ $ International 10 Total $ 356 $ $ Orilissa/Oriahnn United States $ 121 $ 91 $ 11 International 4 2 Total $ 125 $ 93 $ 11 Other Women's Health (a) United States $ 181 $ $ International 11 Total $ 192 $ $ Other Key Products Mavyret United States $ 785 $ 1,473 $ 1,614 International 1,045 1,420 1,824 Total $ 1,830 $ 2,893 $ 3,438 Creon United States $ 1,114 $ 1,041 $ 928 Lupron United States $ 600 $ 720 $ 726 International 152 167 166 Total $ 752 $ 887 $ 892 Linzess/Constella (a) United States $ 649 $ $ International 18 Total $ 667 $ $ Synthroid United States $ 771 $ 786 $ 776 All other $ 2,923 $ 2,068 $ 2,408 Total net revenues $ 45,804 $ 33,266 $ 32,753 (a) Net revenues include Allergan product revenues from the date of the acquisition, May 8, 2020, through December 31, 2020. 2020 Form 10-K | Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) 2020 2019 2018 United States $ 34,879 $ 23,907 $ 21,524 Japan 1,198 1,211 1,591 Canada 1,159 813 730 Germany 1,049 909 1,292 France 797 695 783 Australia 527 395 350 United Kingdom 509 372 855 China 471 195 152 Spain 453 472 611 Brazil 406 359 350 Italy 379 372 652 All other countries 3,977 3,566 3,863 Total net revenues $ 45,804 $ 33,266 $ 32,753 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) 2020 2019 United States and Puerto Rico $ 3,354 $ 2,026 Europe 1,534 646 All other 360 290 Total long-lived assets $ 5,248 $ 2,962 Note 17 Fourth Quarter Financial Results (unaudited) quarter ended December 31 (in millions except per share data) 2020 Net revenues $ 13,858 Gross margin 9,174 Net earnings attributable to AbbVie Inc. (a) 36 Basic earnings per share attributable to AbbVie Inc. $ 0.01 Diluted earnings per share attributable to AbbVie Inc. $ 0.01 Cash dividends declared per common share $ 1.30 (a) Fourth quarter results in 2020 included after-tax charges of $ 4.7 billion related to the change in fair value of contingent consideration liabilities partially offset by an after-tax benefit of $ 1.5 billion due to impacts related to tax law changes. | 2020 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 2020 Form 10-K | Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period the related product is sold. At December 31, 2020, the Company had $7,188 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate, and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions considering industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2020, the Company had $12,997 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry, including commercial dynamics, trends and utilization, as well as knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. | 2020 Form 10-K How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. Accounting for Allergan plc acquisition Valuation of intangible assets Description of the Matter As discussed in Note 5 to the consolidated financial statements under the caption Licensing, Acquisitions and Other Arrangements, the Company completed the acquisition of Allergan plc (Allergan) on May 8, 2020 for approximately $64,084 million. The Company measured the assets acquired and liabilities assumed at fair value, which resulted in the recognition of $69,080 million of intangible assets, comprised of $67,330 million of developed product rights and $1,750 million of in-process research and development (IPRD). Auditing the valuation of intangible assets was complex and required significant auditor judgment due to the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of the identified intangible assets. In particular, the fair value measurement was sensitive to managements forecasts of net revenues, including growth rates used to estimate future net cash flows for acquired aesthetics and recently launched products. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys accounting for acquisitions including, among others, managements process to establish the significant assumptions used in determining the fair values of intangible assets. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of estimated future net revenues, the determination of future net cash flows, estimated growth rates, and review of the valuation model. To test the estimated fair value of intangible assets, our audit procedures included, among others, inspecting the terms of the executed agreement, evaluating the valuation methods used, and testing the significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources, and historical product trends, including those of comparable products, to the extent applicable. Estimated future net revenues were evaluated for reasonableness against internal and external analyses, including analyst expectations, industry trends, and market trends. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the valuation model and to perform corroborative fair value calculations. 2020 Form 10-K | Accounting for Allergan plc acquisition Unrecognized tax benefits Description of the Matter As discussed in Note 14 under the caption Income Taxes, as part of the acquisition of Allergan plc, the Company recorded $2,674 million of unrecognized tax benefits resulting from uncertain tax positions. The Company applied judgment in evaluating the completeness of unrecognized tax benefits assumed as of the acquisition date. Some of the more significant judgments inherent in the Companys evaluation of assumed uncertain tax positions included whether a tax positions technical merits were more-likely-than-not to be sustained, including consideration of applicable tax statutes and related interpretations and precedents and the expected outcome of proceedings (or negotiations) with taxing and legal authorities. Auditing the Companys analysis and accounting for uncertain tax positions was complex due to the interpretation of tax laws and legal rulings in multiple tax paying jurisdictions and required significant judgment in determining whether an assumed tax positions technical merits were more-likely-than-not to be sustained. In particular, each assumed unrecognized tax benefit involved unique facts and circumstances and multiple potential outcomes that were evaluated, with many uncertainties around initial recognition, including regulatory changes, litigation and examination activity. Management utilized outside tax and legal counsel, where appropriate, in its evaluation. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys accounting for acquisitions including, among others, managements process to evaluate the completeness and estimation of unrecognized tax benefits. This included testing controls over managements determination of whether an assumed tax positions technical merits were more-likely-than-not to be sustained and, if so, recognizing the estimated amount of qualified tax benefit. We also obtained an understanding, evaluated the design and tested the operating effectiveness of controls to ensure that the data used to evaluate and support the significant fair value assumptions and unrecognized tax benefits was complete, accurate and, where applicable, verified to external data sources. To test the completeness and recognition of unrecognized tax benefits, our audit procedures included, among others, testing managements process for estimating the unrecognized tax benefits. Testing managements process included assessing managements interpretation of the unique facts, circumstances and related tax laws and legal rulings in each tax paying jurisdiction, examining whether the technical merits of each tax position were more-likely-than-not to be sustained, and evaluating the recognition of the amount of qualified tax benefit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the completeness and recognition of the Companys unrecognized tax benefits, including consideration of applicable tax statutes and related interpretations and precedents. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 19, 2021 | 2020 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2020. Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020. Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 2020 Form 10-K | Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2020 and 2019, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 19, 2021 | 2020 Form 10-K " +36,AbbVie,2019," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. In June 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. Allergan markets a portfolio of brands and products primarily focused on key therapeutic areas including aesthetics, eye care, neuroscience, gastroenterology and women's health. See Note 5 to the Consolidated Financial Statements for additional information regarding the proposed acquisition. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 16 to the Consolidated Financial Statements and the sales information related to HUMIRA, IMBRUVICA and MAVYRET included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2019 Form 10-K | 1 HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 58% of AbbVie's total net revenues in 2019 . SKYRIZI. SKYRIZI (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following an induction dose. SKYRIZI is approved in the United States, Canada and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In Japan, SKYRIZI is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. RINVOQ . RINVOQ (upadacitinib) is a once-daily oral selective and reversible JAK inhibitor and is approved in the United States, Canada and the European Union. RINVOQ is indicated for the treatment of moderate to severe active rheumatoid arthritis in adult patients who have responded inadequately to, or who are intolerant to one or more disease-modifying anti-rheumatic drugs (DMARDs). RINVOQ may be used as monotherapy or in combination with methotrexate. Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA/VENCLYXTO. VENCLEXTA (venetoclax) is a BCL-2 inhibitor used to treat hematological malignancies. VENCLEXTA is approved by the FDA for adults with CLL or SLL. In addition, VENCLEXTA is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. VENCLYXTO is approved in Europe for CLL in combination with rituximab in patients who have received at least one previous treatment. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV. HCV products. AbbVie's HCV products are: MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. MAVIRET is now also indicated for the treatment of HCV genotypes 1-6 in children between 12-18 years. VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and 2 | 2019 Form 10-K ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. The use of VIEKIRA in the United States, Europe and Japan is currently limited given the significant use of pangenotypic regimens, including MAVIRET. Additional Virology products. AbbVie's additional virology products include: SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by respiratory syncytial virus (RSV). KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as ALUVIA in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: ORILISSA. ORILISSA (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved ORILISSA under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. ORILISSA inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, ORILISSA is also launched in Canada and Puerto Rico. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Sevoflurane. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. 2019 Form 10-K | 3 In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2019 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2019 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. HUMIRA is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for 4 | 2019 Form 10-K patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2020 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the license in the United States will begin in 2023 and the license in Europe began in 2018. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA) and those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently 2019 Form 10-K | 5 discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs, and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity ,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity ,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. 6 | 2019 Form 10-K The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory 2019 Form 10-K | 7 procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and 8 | 2019 Form 10-K teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2020 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2019 were approximately $29 million and operating expenditures were approximately $34 million . In 2020 , capital expenditures for pollution control are estimated to be approximately $5 million and operating expenditures are estimated to be approximately $35 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. 2019 Form 10-K | 9 Employees AbbVie employed approximately 30,000 persons as of January 31, 2020 . Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into three groups: risks related to AbbVie's business, risks related to AbbVie's proposed acquisition of Allergan (the ""Acquisition"") and the combined company upon completion of the Acquisition, and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $19.2 billion in 2019 , expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. 10 | 2019 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 58% of AbbVie's total net revenues in 2019 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, 2019 Form 10-K | 11 including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including HUMIRA. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant 12 | 2019 Form 10-K exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be taken 2019 Form 10-K | 13 by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. 14 | 2019 Form 10-K AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 28% of AbbVie's total net revenues in 2019 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes, including in connection with the ongoing trade negotiations between the United States and China; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; 2019 Form 10-K | 15 political and economic instability, including the United Kingdoms exit from the European Union; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions (such as the pending acquisition of Allergan), technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2019 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. 16 | 2019 Form 10-K AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may result in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. Failure to attract and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical RD, governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; 2019 Form 10-K | 17 changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to the Acquisition and the Combined Company Upon Completion of the Acquisition The pending acquisition of Allergan may not be completed on the currently contemplated timeline or terms, or at all, and may not achieve the intended benefits. Consummation of the Acquisition is conditioned on, among other things, obtaining necessary governmental and regulatory approvals. If any of the conditions to the Acquisition is not satisfied, it could delay or prevent the Acquisition from occurring, which could negatively impact AbbVies share price and future business and financial results. Further, as a condition to their approval of the Acquisition, agencies may impose requirements, limitations or costs or require divestitures or place restrictions on the conduct of the AbbVies business after the closing. These requirements, limitations, costs, divestitures or restrictions could jeopardize or delay the consummation of the Acquisition or may reduce the anticipated benefits of the transaction. In addition, changes in laws and regulations, including Irish legislation implementing a tax increase payable upon completion of the Acquisition, could adversely impact AbbVies post-Acquisition profitability and financial results. Following the Acquisition, AbbVie may not realize the Acquisitions intended benefits within the expected timeframe or at all. The indebtedness of the combined company following the consummation of the Acquisition will be substantially greater than AbbVies indebtedness on a standalone basis and greater than the combined indebtedness of AbbVie and Allergan prior to the announcement of the acquisition. This increased level of indebtedness could adversely affect the combined companys business flexibility and increase its borrowing costs. AbbVie expects that the cash consideration due to Allergans shareholders under the transaction agreement and related fees and expenses will be approximately $41 billion. In addition to using cash on hand, AbbVie has incurred significant Acquisition-related debt financing, including unsecured term loans and senior notes. For more information, see Note 10 Debt, Credit Facilities and Commitments and Contingencies , to the Consolidated Financial Statements included under Item 8 , Financial Statements and Supplementary Data . AbbVie also intends to assume all the existing indebtedness of Allergan and its subsidiaries. AbbVies substantially increased indebtedness and higher debt to equity ratio following the consummation of the Acquisition may have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions, lowering its credit ratings, increasing its borrowing costs and/or requiring it to reduce or delay investments, strategic acquisitions and capital expenditures or to seek additional capital or restructure or refinance its indebtedness. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions 18 | 2019 Form 10-K (including AbbVie's pending acquisition of Allergan), or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2019 Form 10-K | 19 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland North Chicago, Illinois Ludwigshafen, Germany Worcester, Massachusetts* Singapore* Wyandotte, Michigan* Sligo, Ireland _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 46,544 stockholders of record of AbbVie common stock as of January 31, 2020 . Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2014 through December 31, 2019 . This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2014 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. 2019 Form 10-K | 23 Dividends On November 1, 2019 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.07 per share to $1.18 per share, payable on February 14, 2020 to stockholders of record as of January 15, 2020 . The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2019 - October 31, 2019 4,293 (1) $ 77.19 (1) $ 3,950,021,071 November 1, 2019 - November 30, 2019 1,086 (1) $ 80.53 (1) $ 3,950,021,071 December 1, 2019 - December 31, 2019 1,016 (1) $ 87.39 (1) $ 3,950,021,071 Total 6,395 (1) $ 79.38 (1) $ 3,950,021,071 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,293 in October; 1,086 in November; and 1,016 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 24 | 2019 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2019 and 2018 and results of operations for each of the three years in the period ended December 31, 2019 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 30,000 employees. AbbVie operates in one business segmentpharmaceutical products. On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). See Note 5 to the Consolidated Financial Statements for additional information regarding the proposed acquisition. 2019 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2019 included delivering worldwide net revenues of $33.3 billion , operating earnings of $13.0 billion , diluted earnings per share of $5.28 and cash flows from operations of $13.3 billion . Worldwide net revenues grew by 3% on a constant currency basis, primarily driven by revenue growth related to IMBRUVICA and VENCLEXTA as well as the continued strength of HUMIRA in the U.S. and newly launched immunology assets SKYRIZI and RINVOQ, offset by international HUMIRA biosimilar competition. Diluted earnings per share in 2019 was $5.28 and included the following after-tax costs: (i) $3.2 billion for the change in fair value of contingent consideration liabilities; (ii) $1.3 billion related to the amortization of intangible assets; (iii) a Stemcentrx-related impairment charge of $823 million net of the related fair value adjustment to contingent consideration liabilities; (iv) $364 million for acquired in-process research and development (IPRD); and (v) $338 million of expenses related to the proposed Allergan acquisition. These costs were partially offset by the following after-tax benefits: (i) $414 million from litigation matters primarily due to the settlement of an intellectual property dispute with a third party ; (ii) $400 million due to the favorable resolution of various tax positions; and (iii) $297 million from an amended and restated license agreement between AbbVie and Reata Pharmaceuticals, Inc. (Reata). Additionally, financial results reflected continued funding to support all stages of AbbVies emerging pipeline assets and continued investment in AbbVies on-market brands. In November 2019 , AbbVie's board of directors declared a quarterly cash dividend of $1.18 per share of common stock payable in February 2020 . This reflects an increase of approximately 10.3% over the previous quarterly dividend of $1.07 per share of common stock. 26 | 2019 Form 10-K 2020 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, ensuring strong commercial execution of new product launches and driving late-stage pipeline assets to the market; (ii) continuing to invest and expand its pipeline in support of opportunities in immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via a strong and growing dividend while also reducing incremental debt. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Completion and successful integration of the proposed Allergan acquisition. Hematologic oncology revenue growth from both IMBRUVICA and VENCLEXTA. Immunology revenue growth driven by successful commercial launches of SKYRIZI and RINVOQ, as well as HUMIRA U.S. sales growth. Effective management of HUMIRA international biosimilar erosion. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2020 . These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. The combination of AbbVie and Allergan will create a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, women's health, eye care and virology. AbbVie's existing product portfolio and pipeline will be enhanced with numerous Allergan assets and Allergan's product portfolio will benefit from AbbVie's commercial strength, expertise and international infrastructure. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes approximately 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neuroscience along with targeted investments in cystic fibrosis and women's health. Of these programs, approximately 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next 12 months. Significant Programs and Developments Immunology RINVOQ In February 2019, the U.S. Food and Drug Administration (FDA) accepted for priority review AbbVie's New Drug Application (NDA) for upadacitinib, an investigational oral JAK1-selective inhibitor, for the treatment of adult patients with moderate to severe rheumatoid arthritis (RA). In February 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of upadacitinib in subjects with giant cell arteritis. 2019 Form 10-K | 27 In August 2019, the FDA approved RINVOQ (upadacitinib) for the treatment of adults with moderately to severely active RA who have had an inadequate response or intolerance to methotrexate. In October 2019, AbbVie announced top-line results from its first Phase 3 clinical trial of RINVOQ in adult patients with active psoriatic arthritis (PsA). Results from the SELECT-PsA 2 study, which evaluated RINVOQ versus placebo in patients who did not adequately respond to treatment with one or more biologic DMARDs, showed that both doses of RINVOQ (15 mg and 30 mg) met the primary and key secondary endpoints at week 12. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In November 2019, AbbVie announced data from the Phase 2/3 SELECT-AXIS 1 trial in which twice as many adult patients with ankylosing spondylitis treated with RINVOQ achieved the primary endpoint at week 14 versus placebo. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In November 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of RINVOQ in adult patients with axial spondyloarthritis. In December 2019, the European Commission (EC) granted marketing authorization for RINVOQ for the treatment of adult patients with moderate to severe active rheumatoid arthritis who have had an inadequate response or intolerance to one or more DMARDs. In February 2020, AbbVie announced top-line results from its second Phase 3 clinical trial of RINVOQ in adult patients with active PsA. Results from the SELECT-PsA 1 study, which evaluated RINVOQ versus placebo in patients who did not adequately respond to treatment with one or more non-biologic DMARDs, showed that both doses of RINVOQ (15 mg and 30 mg) met the primary and key secondary endpoints. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. SKYRIZI In March 2019, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of risankizumab, an investigational interleukin-23 (IL-23) inhibitor, in subjects with psoriatic arthritis. In April 2019, the FDA approved SKYRIZI (risankizumab) for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In April 2019, the EC granted marketing authorization for SKYRIZI for the treatment of moderate to severe plaque psoriasis in adult patients who are candidates for systemic therapy. Oncology IMBRUVICA In January 2019, the FDA approved IMBRUVICA, in combination with GAZYVA (obinutuzumab), for adult patients with previously untreated chronic lymphocytic leukemia (CLL)/small lymphocytic lymphoma (SLL). In June 2019, AbbVie announced results from the Phase 3 CLL12 trial, evaluating IMBRUVICA in patients with previously untreated CLL, which demonstrated that IMBRUVICA significantly improved event- and progression-free survival. In November 2019, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for IMBRUVICA in combination with rituximab for the first-line treatment of younger patients with CLL or SLL. VENCLEXTA In March 2019, AbbVie announced that the FDA placed a partial clinical hold on all clinical trials evaluating VENCLEXTA for the investigational treatment of multiple myeloma (MM). The partial clinical hold followed a review of data from the ongoing Phase 3 BELLINI trial, a study in relapsed/refractory MM, in which a higher proportion of deaths was observed in the VENCLEXTA arm compared to the control arm of the trial. In June 2019, AbbVie announced that the FDA lifted the partial clinical hold placed on the Phase 3 CANOVA trial, evaluating VENCLEXTA for the investigational treatment of relapsed/refractory MM positive for the translocation (11;14) abnormality, based upon agreement on revisions to the CANOVA study protocol, including new risk mitigation measures, protocol-specified guidelines and updated futility criteria. This action does not impact any of the approved indications for VENCLEXTA, such as CLL or acute myeloid leukemia (AML). 28 | 2019 Form 10-K In May 2019, the FDA approved VENCLEXTA, in combination with obinutuzumab, for adult patients with previously untreated CLL/SLL. The approval was based on data from the Phase 3 CLL14 trial, evaluating the efficacy and safety of VENCLEXTA plus obinutuzumab versus obinutuzumab plus chlorambucil in previously untreated patients with CLL, which demonstrated that VENCLEXTA plus obinutuzumab prolonged progression-free survival and achieved higher rates of complete response and minimal residual disease-negativity compared to commonly used standard of care obinutuzumab plus chlorambucil. In January 2020, AbbVie announced that the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) granted a positive opinion for VENCLYXTO in combination with obinutuzumab for patients with previously untreated CLL. Depatux-M In May 2019, AbbVie announced the decision to discontinue the Phase 3 INTELLANCE-1 study of depatuxizumab mafodotin (Depatux-M, previously known as ABT-414) in patients with newly diagnosed glioblastoma, whose tumors have EGFR (epidermal growth factor receptor) amplification, at an interim analysis. An Independent Data Monitoring Committee recommended stopping enrollment in INTELLANCE-1 due to lack of survival benefit for patients receiving Depatux-M compared with placebo when added to the standard regimen of radiation and temozolomide. Enrollment has been halted in all ongoing Depatux-M studies. Veliparib In July 2019, AbbVie announced that top-line results from the Phase 3 BROCADE3 study evaluating veliparib, an investigational, oral poly (adenosine diphosphate-ribose) polymerase (PARP) inhibitor, in combination with carboplatin and paclitaxel met its primary endpoint of progression-free survival in patients with HER2 negative germline BRCA-mutated advanced breast cancer. In July 2019, AbbVie announced that top-line results from the Phase 3 VELIA study, conducted in collaboration with the GOG Foundation, Inc., evaluating veliparib with carboplatin and paclitaxel followed by veliparib maintenance therapy met its primary endpoint of progression-free survival in patients with newly diagnosed ovarian cancer, regardless of biomarker status. Rova-T In August 2019, AbbVie announced the decision to terminate the MERU trial, a Phase 3 study evaluating rovalpituzumab tesirine (Rova-T) as a first-line maintenance therapy for advanced small-cell lung cancer (SCLC). An Independent Data Monitoring Committee recommended terminating the study after results demonstrated no survival benefit at a pre-planned interim analysis for patients receiving Rova-T as compared with placebo. With the closing of the MERU trial, AbbVie announced the termination of the Rova-T research and development program. Virology/Liver Disease In August 2019, the EC granted marketing authorization for MAVIRET (glecaprevir/pibrentasvir) to shorten the once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients with genotype (GT)1, 2, 4, 5 and 6 infection. In September 2019, the FDA approved MAVYRET (glecaprevir/pibrentasvir) to shorten the once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients across all genotypes (GT1-6). In January 2020, AbbVie announced that the CHMP of the EMA has recommended a change to the marketing authorization for MAVIRET to shorten once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients with GT 3 infection. Neuroscience In May 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and tolerability of ABBV-951, a subcutaneous levodopa/carbidopa delivery system, in subjects with Parkinson's disease. In July 2019, AbbVie announced the decision to discontinue the Phase 2 ARISE study evaluating ABBV-8E12, an investigational anti-tau antibody, in patients with progressive supranuclear palsy, after an Independent Data 2019 Form 10-K | 29 Monitoring Committee recommended stopping the trial for futility after the trial showed that ABBV-8E12 did not provide efficacy. Other In July 2019, AbbVie submitted an NDA to the FDA for elagolix in combination with estradiol/norethindrone acetate (E2/NETA) daily add-back therapy for the management of heavy menstrual bleeding associated with uterine fibroids. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) United States $ 23,907 $ 21,524 $ 18,251 11.1 % 17.9 % 11.1 % 17.9 % International 9,359 11,229 9,965 (16.7 )% 12.8 % (13.6 )% 10.4 % Net revenues $ 33,266 $ 32,753 $ 28,216 1.6 % 16.1 % 2.6 % 15.2 % 30 | 2019 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) Immunology HUMIRA United States $ 14,864 $ 13,685 $ 12,361 8.6 % 10.7 % 8.6 % 10.7 % International 4,305 6,251 6,066 (31.1 )% 3.1 % (27.8 )% 0.6 % Total $ 19,169 $ 19,936 $ 18,427 (3.9 )% 8.2 % (2.9 )% 7.4 % SKYRIZI United States $ $ $ n/m n/m n/m n/m International n/m n/m n/m n/m Total $ $ $ n/m n/m n/m n/m RINVOQ United States $ $ $ n/m n/m n/m n/m International n/m n/m n/m n/m Total $ $ $ n/m n/m n/m n/m Hematologic Oncology IMBRUVICA United States $ 3,830 $ 2,968 $ 2,144 29.1 % 38.4 % 29.1 % 38.4 % Collaboration revenues 35.8 % 45.0 % 35.8 % 45.0 % Total $ 4,674 $ 3,590 $ 2,573 30.2 % 39.5 % 30.2 % 39.5 % VENCLEXTA United States $ $ $ 100.0% 100.0% 100.0% 100.0% International 100.0% 100.0% 100.0% 100.0% Total $ $ $ 100.0% 100.0% 100.0% 100.0% HCV MAVYRET United States $ 1,473 $ 1,614 $ (8.8 )% 100.0% (8.8 )% 100.0% International 1,420 1,824 (22.1 )% 100.0% (19.6 )% 100.0% Total $ 2,893 $ 3,438 $ (15.9 )% 100.0% (14.6 )% 100.0% VIEKIRA United States $ $ $ (100.0 )% (96.7 )% (100.0 )% (96.7 )% International (79.2 )% (75.6 )% (77.2 )% (74.8 )% Total $ $ $ (79.6 )% (77.2 )% (77.6 )% (76.5 )% Other Key Products Creon United States $ 1,041 $ $ 12.2 % 11.7 % 12.2 % 11.7 % Lupron United States $ $ $ (0.8 )% 8.6 % (0.8 )% 8.6 % International 0.8 % 3.4 % 6.0 % 4.7 % Total $ $ $ (0.5 )% 7.6 % 0.5 % 7.9 % Synthroid United States $ $ $ 1.3 % (0.6 )% 1.3 % (0.6 )% Synagis International $ $ $ (1.2 )% (1.6 )% 0.9 % (2.8 )% Duodopa United States $ $ $ 20.4 % 31.4 % 20.4 % 31.4 % International 4.2 % 19.1 % 9.8 % 14.8 % Total $ $ $ 7.2 % 21.2 % 11.7 % 17.7 % Sevoflurane United States $ $ $ 2.0 % (6.2 )% 2.0 % (6.2 )% International (13.8 )% (4.4 )% (9.5 )% (4.3 )% Total $ $ $ (10.9 )% (4.7 )% (7.4 )% (4.6 )% Kaletra United States $ $ $ (31.0 )% (22.1 )% (31.0 )% (22.1 )% International (12.9 )% (20.2 )% (9.5 )% (20.1 )% Total $ $ $ (15.8 )% (20.5 )% (12.9 )% (20.4 )% AndroGel United States $ $ $ (63.3 )% (18.8 )% (63.3 )% (18.8 )% ORILISSA United States $ $ $ 100.0% n/m 100.0% n/m International n/m n/m n/m n/m Total $ $ $ 100.0% n/m 100.0% n/m All other $ $ $ 66.1 % (64.9 )% 73.0 % (73.2 )% Total net revenues $ 33,266 $ 32,753 $ 28,216 1.6 % 16.1 % 2.6 % 15.2 % n/m Not meaningful 2019 Form 10-K | 31 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales decreased 3% in 2019 and increased 7% in 2018 . The sales decrease in 2019 was primarily driven by direct biosimilar competition in certain international markets, partially offset by market growth across therapeutic categories. The sales increase in 2018 was primarily driven by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. In the United States, HUMIRA sales increased 9% in 2019 and 11% in 2018 . The sales increases in 2019 and 2018 were primarily driven by market growth across all indications and favorable pricing. Internationally, HUMIRA revenues decreased 28% in 2019 and increased 1% in 2018 . The sales decrease in 2019 was primarily driven by direct biosimilar competition in Europe following the expiration of the European Union composition of matter patent for adalimumab in October 2018. The sales increase in 2018 was primarily driven by market growth across indications partially offset by direct biosimilar competition. Biosimilar competition for HUMIRA is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability of HUMIRA. Net revenues for SKYRIZI were $355 million in 2019 following the April 2019 regulatory approvals for the treatment of moderate to severe plaque psoriasis. Net revenues for RINVOQ were $47 million in 2019 following the August 2019 FDA approval for the treatment of moderate to severe rheumatoid arthritis. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. AbbVie's global IMBRUVICA revenues increased 30% in 2019 and 39% in 2018 as a result of continued penetration of IMBRUVICA for patients with CLL as well as favorable pricing. Net revenues for VENCLEXTA increased by more than 100% in 2019 and 2018 primarily due to market share gains following additional regulatory approvals of VENCLEXTA for the treatment of patients with relapsed/refractory CLL and first-line AML in 2018 and first-line CLL in 2019. Global MAVYRET sales decreased by 15% in 2019 primarily driven by lower patient volumes in certain international markets and competitive dynamics in the U.S. Global MAVYRET sales increased more than 100% in 2018 as a result of market share gains following the FDA and EMA approvals of MAVYRET in the second half of 2017 as well as further geographic expansion. Global VIEKIRA sales decreased by 78% in 2019 and 76% in 2018 primarily due to lower market share following the launch of MAVYRET. Net revenues for Creon increased 12% in 2019 and 12% in 2018 , primarily driven by continued market growth and favorable pricing. Creon maintains market leadership in the pancreatic enzyme market. Net revenues for Duodopa increased 12% in 2019 and 18% in 2018 , primarily driven by increased market penetration. Gross Margin Percent change years ended December 31 (dollars in millions) Gross margin $ 25,827 $ 25,035 $ 21,174 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2019 increased from 2018 primarily due to the full year effect of the expiration of HUMIRA royalties, partially offset by the IMBRUVICA profit sharing arrangement and unfavorable impact from higher intangible asset amortization. Gross margin as a percentage of net revenues in 2018 increased from 2017 primarily due to the expiration of HUMIRA royalties and a 2017 intangible asset impairment charge of $354 million partially offset by the IMBRUVICA profit sharing arrangement. 32 | 2019 Form 10-K Selling, General and Administrative Percent change years ended December 31 (dollars in millions) Selling, general and administrative $ 6,942 $ 7,399 $ 6,295 (6 )% % as a percent of net revenues % % % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2019 decreased from 2018 primarily due to the favorable impacts of international HUMIRA expense reductions and lower litigation reserve charges that decreased by $326 million . This favorability was partially offset by new product launch expenses, higher restructuring charges and $103 million of transaction expenses associated with the proposed Allergan transaction. Additionally, SGA expenses in 2018 included non-recurring philanthropic contributions of $350 million to certain U.S. not-for-profit organizations. SGA expenses as a percentage of net revenues in 2018 increased from 2017 primarily due to new product launch expenses and non-recurring philanthropic contributions to certain U.S. not-for-profit organizations partially offset by continued leverage from revenue growth. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 6,407 $ 10,329 $ 5,007 (38 )% 100% as a percent of net revenues % % % Acquired in-process research and development $ $ $ (9 )% % Research and Development (RD) expenses decreased in 2019 and increased in 2018 principally due to impairment charges related to IPRD acquired as part of the 2016 Stemcentrx acquisition. In 2019, the company recorded a $1.0 billion intangible asset impairment charge which represented the remaining value of the IPRD acquired following the decision to terminate the Rova-T RD program. In 2018, the company recorded a $5.1 billion intangible asset impairment charge following the decision to stop enrollment in the TAHOE trial, which lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. See Note 7 to the Consolidated Financial Statements for additional information regarding these impairment charges. Acquired IPRD expenses reflect upfront payments related to various collaborations. There were no individually significant transactions or cash flows during 2019 or 2018. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector agreement. Other Operating Expenses and Income Other operating income in 2019 included $550 million of income from a legal settlement related to an intellectual property dispute with a third party and $330 million of income related to an amended and restated license agreement between AbbVie and Reata . See Note 5 to the Consolidated Financial Statements for additional information on the Reata agreement. Other operating expenses in 2018 included a $500 million charge related to the extension of the previously announced Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. See Note 5 to the Consolidated Financial Statements for additional information regarding the Calico agreement. 2019 Form 10-K | 33 Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,784 $ 1,348 $ 1,150 Interest income (275 ) (204 ) (146 ) Interest expense, net $ 1,509 $ 1,144 $ 1,004 Net foreign exchange loss $ $ $ Other expense, net 3,006 Interest expense in 2019 increased compared to 2018 primarily due to $363 million of incremental interest and debt issuance costs associated with financing the proposed acquisition of Allergan, as well as the unfavorable impact of higher interest rates on the company's debt obligations. Interest expense in 2018 increased compared to 2017 primarily due to the unfavorable impact of higher interest rates on the company's debt obligations and a higher average outstanding debt balance during 2018 . Interest income in 2019 increased compared to 2018 primarily due to a higher average cash and cash equivalents balance during 2019, partially offset by decreased investments in debt securities. Interest income in 2018 increased compared to 2017 primarily due to higher interest rates. Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Other expense, net included charges related to the change in fair value of the contingent consideration liabilities of $3.1 billion in 2019 , $49 million in 2018 and $626 million in 2017 . The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2019 , the Boehringer Ingelheim (BI) contingent consideration liability increased due to higher probabilities of success, higher estimated future sales, declining interest rates and passage of time. The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. These changes were partially offset by a $91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program during the third quarter of 2019. In 2018 , the BI contingent consideration liability increased due to the passage of time and higher estimated future sales partially offset by the effect of rising interest rates. This increase in the BI contingent consideration liability was primarily offset by a $428 million decrease in the Stemcentrx contingent consideration liability recorded during the fourth quarter of 2018 due to a reduction in probabilities of success of achieving regulatory approval across Rova-T and other early-stage Stemcentrx assets. In 2017 , the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million. Income Tax Expense The effective income tax rate was 6% in 2019 , negative 9% in 2018 and 31% in 2017 . The effective tax rate in each period differed from the statutory tax rate principally due to the allocation of the company's taxable earnings among jurisdictions, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions and business development activities. The increase in the effective tax rate for 2019 over the prior year was principally due to the timing of provisions of the Tax Cuts and Jobs Act (the Act) related to the earnings from certain foreign subsidiaries. The increase is also attributable to changes in the jurisdictional mix of earnings, including a change in fair value of contingent consideration liabilities. These increases were partially offset by the favorable resolution of various tax positions in the current year. The effective tax rate for 2018 also included the effects of Stemcentrx intangible impairment related expenses. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. 34 | 2019 Form 10-K The Act significantly changed the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system that included new taxes on certain foreign sourced earnings. See Note 14 to the Consolidated Financial Statements for additional information regarding the Act. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 13,324 $ 13,427 $ 9,960 Investing activities (1,006 ) (274 ) Financing activities 18,708 (14,396 ) (5,512 ) Operating cash flows in 2019 decreased slightly from 2018 primarily due to higher payments for income taxes offset by improved results of operations resulting from an increase in operating earnings. Operating cash flows in 2018 increased from 2017 primarily due to improved results of operations from revenue growth and a decrease in income tax payments. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $727 million in 2019 , $873 million in 2018 and $246 million in 2017 . Investing cash flows in 2019 included net sales and maturities of investments totaling $2.1 billion resulting from the sale of substantially all of the company's investments in debt securities, payments made for other acquisitions and investments of $1.1 billion and capital expenditures of $552 million . Investing cash flows in 2018 included payments made for other acquisitions and investments of $736 million and capital expenditures of $638 million , partially offset by net sales and maturities of investment securities totaling $368 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Financing cash flows in 2019 included the issuance of $30.0 billion aggregate principal amount of floating rate and fixed rate unsecured senior notes at maturities ranging from 18 months to 30 years . AbbVie expects to use the net proceeds of $29.8 billion to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the proposed acquisition and to pay related fees and expenses. Pending the consummation of the proposed Allergan acquisition, the net proceeds from the offering are permitted to be invested temporarily in short-term investments. All of the notes are subject to special mandatory redemption at a redemption price equal to 101% of the aggregate principal amount of the notes plus accrued and unpaid interest if the proposed acquisition of Allergan is not completed by January 30, 2021 or the company notifies the trustee in respect of the notes that it will not pursue the consummation of the proposed Allergan acquisition. Additionally, financing cash flows in 2019 included the issuance of 1.4 billion aggregate principal amount of unsecured senior Euro notes which the company used to redeem 1.4 billion aggregate principal amount of 0.38% senior Euro notes that were due to mature in November 2019, as well as the repayment of a $3.0 billion 364 -day term loan credit agreement that was scheduled to mature in June 2019. Financing cash flows in 2018 included proceeds from the issuance of $3.0 billion drawn under the term loan in June 2018. In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. Financing cash flows in 2018 also included the May 2018 repayment of $3.0 billion aggregate principal amount of the company's 1.80% senior notes at maturity. In 2019 , 2018 and 2017 , the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2019 and there was $699 million outstanding as of December 31, 2018 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Cash dividend payments totaled $6.4 billion in 2019 , $5.6 billion in 2018 and $4.1 billion in 2017 . The increase in cash dividend payments was primarily driven by an increase in the dividend rate. On November 1, 2019 , AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.07 per share to $1.18 per share beginning with the dividend payable on February 14, 2020 to stockholders of record as of January 15, 2020 . This reflects an increase of approximately 10.3% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's 2019 Form 10-K | 35 debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 4 million shares for $300 million in 2019 and 109 million shares for $10.7 billion in 2018. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $4.0 billion as of December 31, 2019 . Under previous stock repurchase programs, AbbVie made open market share repurchases of 11 million shares for $1.3 billion in 2018 and 13 million shares for $1.0 billion in 2017. AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017. In 2019, AbbVie made contingent consideration milestone and royalty payments to BI totaling $234 million following the commercial launch of SKYRIZI in certain geographies. $163 million of these payments were included in financing cash flows and $71 million of the payments were included in operating cash flows. In 2018, AbbVie paid $100 million of contingent consideration to BI related to BLA and MAA acceptance milestones. $78 million of these payments were included in financing cash flows and $22 million of the payments were included in operating cash flows. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. In connection with the proposed acquisition of Allergan, on June 25, 2019, AbbVie entered into a $38.0 billion 364-day bridge credit agreement and on July 12, 2019, AbbVie entered into a $6.0 billion term loan credit agreement. The company incurred a total of $242 million of debt issuance costs related to the two agreements. On October 25, 2019, AbbVie commenced offers to exchange any and all outstanding notes of certain series issued by Allergan for up to $15.5 billion aggregate principal amount and 3.7 billion aggregate principal amount of new notes to be issued by AbbVie and cash, subject to conditions including the closing of the proposed acquisition. See Note 10 to the Consolidated Financial Statements for additional information. In February 2020, the remaining commitments under the bridge credit agreement were reduced to $0 as a result of cash on hand at AbbVie. AbbVie subsequently terminated the bridge credit agreement in its entirety as permitted under its terms. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility In August 2019, AbbVie entered into an amended and restated $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2019 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facilities as of December 31, 2019 and 2018 . Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. 36 | 2019 Form 10-K Credit Ratings Following the announcement of the proposed acquisition of Allergan and the $30.0 billion senior notes issuance, Moody's Investor Service affirmed its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. SP Global Ratings revised its ratings outlook to negative from stable and expects to lower the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1 when the acquisition is complete. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2019 : (in millions) Total Less than one year One to three years Three to five years More than five years Long-term debt, including current portion $ 67,233 $ 3,750 $ 14,150 $ 7,625 $ 41,708 Interest on long-term debt (a) 30,494 2,146 4,087 3,479 20,782 Non-cancelable operating and finance lease payments (f) Purchase obligations and other (b) 3,532 3,295 Other long-term liabilities (c) (d) (e) 11,544 1,395 2,123 7,860 Total $ 113,577 $ 9,486 $ 20,042 $ 13,397 $ 70,652 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2019 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2019 . See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2019 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (d) Includes $7.3 billion of contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. (e) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 14 to the Consolidated Financial Statements for additional information regarding these tax liabilities. (f) Lease payments include approximately $350 million of contractual minimum lease payments for leases executed but not yet commenced. These leases will commence in 2020 with lease terms of approximately 11 years . AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual 2019 Form 10-K | 37 obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $18.8 billion in 2019 , $16.4 billion in 2018 and $12.9 billion in 2017 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. 38 | 2019 Form 10-K The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 94% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2019 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2016 $ 1,167 $ 1,167 $ Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 1,340 1,195 Provisions 3,493 4,729 6,659 Payments (3,188 ) (4,485 ) (6,525 ) Balance at December 31, 2018 1,645 1,439 Provisions 4,035 5,772 7,947 Payments (3,915 ) (5,275 ) (7,917 ) Balance at December 31, 2019 $ 1,765 $ 1,936 $ Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.6 billion in 2019 , $1.6 billion in 2018 and $1.3 billion in 2017 , are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements . The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2019 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2020 and projected benefit obligations as of December 31, 2019 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (76 ) $ Projected benefit obligation (723 ) Other post-employment plans Service and interest cost $ (11 ) $ Projected benefit obligation (101 ) The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The 2019 Form 10-K | 39 current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2019 and will be used in the calculation of net periodic benefit cost in 2020 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2020 by $71 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2019 and will be used in the calculation of net periodic benefit cost in 2020 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2020 and the projected benefit obligation as of December 31, 2019 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (28 ) Projected benefit obligation (186 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial 40 | 2019 Form 10-K performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2019 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $280 million . Additionally, at December 31, 2019 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $150 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 2019 Form 10-K | 41 "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2019 and 2018 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,217 1.116 $ (12 ) $ 6,660 1.157 $ Japanese yen 108.7 1,076 111.5 (12 ) Canadian dollar 1.324 (6 ) 1.314 British pound 1.305 (6 ) 1.328 All other currencies 1,508 n/a (10 ) 1,370 n/a Total $ 9,476 $ (34 ) $ 10,011 $ The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $942 million at December 31, 2019 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2019 , the company has 3.6 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $280 million at December 31, 2019 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.0 billion at December 31, 2019 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 42 | 2019 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2019 Form 10-K | 43 AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 33,266 $ 32,753 $ 28,216 Cost of products sold 7,439 7,718 7,042 Selling, general and administrative 6,942 7,399 6,295 Research and development 6,407 10,329 5,007 Acquired in-process research and development Other operating expense (income) ( 890 ) Total operating costs and expenses 20,283 26,370 18,671 Operating earnings 12,983 6,383 9,545 Interest expense, net 1,509 1,144 1,004 Net foreign exchange loss Other expense, net 3,006 Earnings before income tax 8,426 5,197 7,727 Income tax expense (benefit) ( 490 ) 2,418 Net earnings $ 7,882 $ 5,687 $ 5,309 Per share data Basic earnings per share $ 5.30 $ 3.67 $ 3.31 Diluted earnings per share $ 5.28 $ 3.66 $ 3.30 Weighted-average basic shares outstanding 1,481 1,541 1,596 Weighted-average diluted shares outstanding 1,484 1,546 1,603 The accompanying notes are an integral part of these consolidated financial statements. 44 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 7,882 $ 5,687 $ 5,309 Foreign currency translation adjustments, net of tax expense (benefit) of $(4) in 2019, $(18) in 2018 and $34 in 2017 ( 98 ) ( 391 ) Net investment hedging activities, net of tax expense (benefit) of $22 in 2019, $40 in 2018 and $(194) in 2017 ( 343 ) Pension and post-employment benefits, net of tax expense (benefit) of $(323) in 2019, $35 in 2018 and $(94) in 2017 ( 1,243 ) ( 406 ) Marketable security activities, net of tax expense (benefit) of $ in 2019, $ in 2018 and $(8) in 2017 ( 10 ) ( 46 ) Cash flow hedging activities, net of tax expense (benefit) of $70 in 2019, $23 in 2018 and $(26) in 2017 ( 342 ) Other comprehensive income (loss) ( 1,116 ) ( 141 ) Comprehensive income $ 6,766 $ 5,934 $ 5,168 The accompanying notes are an integral part of these consolidated financial statements. 2019 Form 10-K | 45 AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 39,924 $ 7,289 Short-term investments Accounts receivable, net 5,428 5,384 Inventories 1,813 1,605 Prepaid expenses and other 2,354 1,895 Total current assets 49,519 16,945 Investments 1,420 Property and equipment, net 2,962 2,883 Intangible assets, net 18,649 21,233 Goodwill 15,604 15,663 Other assets 2,288 1,208 Total assets $ 89,115 $ 59,352 Liabilities and Equity Current liabilities Short-term borrowings $ $ 3,699 Current portion of long-term debt and finance lease obligations 3,753 1,609 Accounts payable and accrued liabilities 11,832 11,931 Total current liabilities 15,585 17,239 Long-term debt and finance lease obligations 62,975 35,002 Deferred income taxes 1,130 1,067 Other long-term liabilities 17,597 14,490 Commitments and contingencies Stockholders equity (deficit) Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,781,582,608 shares issued as of December 31, 2019 and 1,776,510,871 as of December 31, 2018 Common stock held in treasury, at cost, 302,671,146 shares as of December 31, 2019 and 297,686,473 as of December 31, 2018 ( 24,504 ) ( 24,108 ) Additional paid-in capital 15,193 14,756 Retained earnings 4,717 3,368 Accumulated other comprehensive loss ( 3,596 ) ( 2,480 ) Total stockholders equity (deficit) ( 8,172 ) ( 8,446 ) Total liabilities and equity $ 89,115 $ 59,352 The accompanying notes are an integral part of these consolidated financial statements. 46 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2016 1,593 $ $ ( 10,852 ) $ 13,678 $ 4,378 $ ( 2,586 ) $ 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax ( 141 ) ( 141 ) Dividends declared ( 4,221 ) ( 4,221 ) Purchases of treasury stock ( 15 ) ( 1,125 ) ( 1,125 ) Stock-based compensation plans and other ( 7 ) Balance at December 31, 2017 1,592 ( 11,923 ) 14,270 5,459 ( 2,727 ) 5,097 Adoption of new accounting standards (a) ( 1,733 ) ( 1,733 ) Net earnings 5,687 5,687 Other comprehensive income, net of tax Dividends declared ( 6,045 ) ( 6,045 ) Purchases of treasury stock ( 121 ) ( 12,215 ) ( 12,215 ) Stock-based compensation plans and other Balance at December 31, 2018 1,479 ( 24,108 ) 14,756 3,368 ( 2,480 ) ( 8,446 ) Net earnings 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other Balance at December 31, 2019 1,479 $ $ ( 24,504 ) $ 15,193 $ 4,717 $ ( 3,596 ) $ ( 8,172 ) (a) Adoption of new accounting standards primarily includes the cumulative-effect adjustment of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The accompanying notes are an integral part of these consolidated financial statements. 2019 Form 10-K | 47 AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 7,882 $ 5,687 $ 5,309 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,553 1,294 1,076 Change in fair value of contingent consideration liabilities 3,091 Stock-based compensation Upfront costs and milestones related to collaborations 1,061 Gain on divestitures ( 330 ) Intangible asset impairment 1,030 5,070 Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities: Accounts receivable ( 74 ) ( 591 ) ( 391 ) Inventories ( 231 ) ( 226 ) Prepaid expenses and other assets ( 499 ) ( 118 ) Accounts payable and other liabilities ( 1,121 ) Cash flows from operating activities 13,324 13,427 9,960 Cash flows from investing activities Acquisitions and investments ( 1,135 ) ( 736 ) ( 308 ) Acquisitions of property and equipment ( 552 ) ( 638 ) ( 529 ) Purchases of investment securities ( 583 ) ( 1,792 ) ( 2,230 ) Sales and maturities of investment securities 2,699 2,160 2,793 Other Cash flows from investing activities ( 1,006 ) ( 274 ) Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) Proceeds from issuance of other short-term borrowings 3,002 Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 31,482 5,963 Repayments of long-term debt and finance lease obligations ( 1,536 ) ( 6,035 ) ( 25 ) Debt issuance costs ( 424 ) ( 40 ) Dividends paid ( 6,366 ) ( 5,580 ) ( 4,107 ) Purchases of treasury stock ( 629 ) ( 12,014 ) ( 1,410 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities ( 163 ) ( 78 ) ( 268 ) Other, net Cash flows from financing activities 18,708 ( 14,396 ) ( 5,512 ) Effect of exchange rate changes on cash and equivalents ( 39 ) Net change in cash and equivalents 32,635 ( 2,014 ) 4,203 Cash and equivalents, beginning of year 7,289 9,303 5,100 Cash and equivalents, end of year $ 39,924 $ 7,289 $ 9,303 Other supplemental information Interest paid, net of portion capitalized $ 1,794 $ 1,215 $ 1,099 Income taxes paid (received) 1,447 ( 35 ) 1,696 The accompanying notes are an integral part of these consolidated financial statements. 48 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). See Note 5 for additional information regarding the proposed acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. 2019 Form 10-K | 49 For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaboration with Janssen Biotech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 1.1 billion in 2019 , $ 1.1 billion in 2018 and $ 846 million in 2017 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any 50 | 2019 Form 10-K unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. AbbVie periodically assesses its marketable debt securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other-than-temporary decline has occurred, the cost basis of the investment is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $ 46 million at December 31, 2019 and $ 51 million at December 31, 2018 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process Raw materials Inventories $ 1,813 $ 1,605 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,613 1,603 Equipment 6,012 6,362 Construction in progress Property and equipment, gross 8,188 8,396 Less accumulated depreciation ( 5,226 ) ( 5,513 ) Property and equipment, net $ 2,962 $ 2,883 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 464 million in 2019 , $ 471 million in 2018 and $ 425 million in 2017 . 2019 Form 10-K | 51 Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease 52 | 2019 Form 10-K the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2016-02 In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, Leases (Topic 842) . The standard outlined a comprehensive lease accounting model that superseded the previous lease guidance and required lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changed the definition of a lease and expanded the disclosure requirements of lease arrangements. AbbVie adopted the standard in the first quarter of 2019 using the modified retrospective method. Results for reporting periods beginning after December 31, 2018 have been presented in accordance with the standard, while results for prior periods have not been adjusted and continue to be reported in accordance with AbbVie's historical accounting. The cumulative effect of initially applying the new leases standard was recognized as an adjustment to the opening consolidated balance sheet as of January 1, 2019. The company elected a package of practical expedients for leases that commenced prior to January 1, 2019 and did not reassess historical conclusions on: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. 2019 Form 10-K | 53 Under the new standard, on January 1, 2019, the company recognized a cumulative-effect adjustment to its consolidated balance sheet primarily related to the recognition of liabilities and corresponding right-of-use assets for operating leases. The adjustment to the consolidated balance sheet included: (i) a $ 405 million increase to other assets; (ii) a $ 115 million increase to accounts payable and accrued liabilities; and (iii) a $ 290 million increase to other long-term liabilities. Other cumulative-effect adjustments to the consolidated balance sheet were insignificant. Adoption of the standard did not have a significant impact on AbbVie's consolidated statement of earnings in 2019. ASU No. 2018-02 In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allowed a reclassification from AOCI to retained earnings for stranded tax effects related to adjustments to deferred taxes resulting from the December 2017 enactment of the Tax Cuts and Jobs Act (the Act). AbbVie adopted the standard in the first quarter of 2019. Upon adoption, the company made an election to not reclassify the income tax effects of the Act from AOCI to retained earnings. Therefore, the adoption of the standard had no impact on AbbVie's consolidated financial statements. Recent Accounting Pronouncements Not Yet Adopted ASU No. 2016-13 In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie has completed its assessment of the new standard as of December 31, 2019 and concluded that the adoption will not have a material impact on its consolidated financial statements based on the company's current portfolio of financial assets. ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for AbbVie starting with the first quarter of 2021, with early adoption permitted. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. 54 | 2019 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,784 $ 1,348 $ 1,150 Interest income ( 275 ) ( 204 ) ( 146 ) Interest expense, net $ 1,509 $ 1,144 $ 1,004 Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 4,484 $ 3,939 Dividends payable 1,771 1,607 Accounts payable 1,452 1,546 Salaries, wages and commissions Royalty and license arrangements Other 2,971 3,748 Accounts payable and accrued liabilities $ 11,832 $ 11,931 Other Long-Term Liabilities as of December 31 (in millions) Contingent consideration liabilities $ 7,201 $ 4,306 Income taxes payable 3,453 4,311 Pension and other post-employment benefits 2,949 1,840 Liabilities for unrecognized tax benefits 2,772 2,726 Other 1,222 1,307 Other long-term liabilities $ 17,597 $ 14,490 Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2019 Form 10-K | 55 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) Basic EPS Net earnings $ 7,882 $ 5,687 $ 5,309 Earnings allocated to participating securities Earnings available to common shareholders $ 7,842 $ 5,657 $ 5,283 Weighted-average basic shares outstanding 1,481 1,541 1,596 Basic earnings per share $ 5.30 $ 3.67 $ 3.31 Diluted EPS Net earnings $ 7,882 $ 5,687 $ 5,309 Earnings allocated to participating securities Earnings available to common shareholders $ 7,842 $ 5,657 $ 5,283 Weighted-average shares of common stock outstanding 1,481 1,541 1,596 Effect of dilutive securities Weighted-average diluted shares outstanding 1,484 1,546 1,603 Diluted earnings per share $ 5.28 $ 3.66 $ 3.30 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Proposed Acquisition of Allergan plc On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan) in a cash and stock transaction for a transaction equity value of approximately $ 63 billion , based on the closing price of AbbVies common stock of $ 78.45 on June 24, 2019. Under the terms of the transaction agreement, Allergan shareholders will receive 0.8660 AbbVie shares and $ 120.30 in cash for each Allergan share. On October 14, 2019, Allergan shareholders approved the proposed transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. Allergan markets a portfolio of brands and products primarily focused on key therapeutic areas including aesthetics, eye care, neuroscience, gastroenterology and women's health. The transaction is subject to customary closing conditions and regulatory approvals. In September 2019, AbbVie and Allergan each received a Request for Additional Information (Second Request) from the Federal Trade Commission (FTC) in connection with the transaction. AbbVie and Allergan are cooperating fully with the FTC. In January 2020, the European Commission approved the proposed acquisition of Allergan by AbbVie conditional upon the divestiture of brazikumab, Allergan's IL-23 inhibitor pipeline product. In January 2020, Allergan entered into a definitive agreement to divest brazikumab contingent upon regulatory approvals and closing of AbbVie's acquisition of Allergan. In anticipation of the proposed acquisition, AbbVie entered into several debt and financing arrangements in 2019. See Note 10 for additional information. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.1 billion in 2019 , $ 736 million in 2018 and $ 308 million in 2017 . AbbVie recorded acquired IPRD charges of $ 385 million in 2019 , $ 424 million in 2018 and $ 327 million in 2017 . Significant arrangements impacting 2019 , 2018 and 2017 , some of which require contingent milestone payments, are summarized below. 56 | 2019 Form 10-K Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators . As consideration for the rights reacquired by Reata, AbbVie will receive a total of $ 330 million in cash payable in three installments through 2021, which was recognized in other operating expense (income) in the fourth quarter of 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million to the collaboration and the term is extended for an additional three years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018, AbbVie recorded $ 500 million in other operating expense (income) in the consolidated statement of earnings related to its commitments under the agreement. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets, and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $ 205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $ 986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 385 million in 2019 , $ 424 million in 2018 and $ 122 million in 2017 . In connection with the other individually insignificant early-stage arrangements entered into in 2019 , AbbVie could make additional payments of up to $ 5.8 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. 2019 Form 10-K | 57 In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,803 $ 1,372 $ 1,001 International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) AbbVies receivable from Janssen, included in accounts receivable, net, was $ 235 million at December 31, 2019 and $ 177 million at December 31, 2018 . AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 455 million at December 31, 2019 and $ 376 million at December 31, 2018 . Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2017 $ 15,785 Foreign currency translation ( 122 ) Balance as of December 31, 2018 15,663 Foreign currency translation ( 59 ) Balance as of December 31, 2019 $ 15,604 The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2019 , there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 19,547 $ ( 6,405 ) $ 13,142 $ 15,872 $ ( 5,614 ) $ 10,258 License agreements 7,798 ( 2,291 ) 5,507 7,865 ( 1,810 ) 6,055 Total definite-lived intangible assets 27,345 ( 8,696 ) 18,649 23,737 ( 7,424 ) 16,313 Indefinite-lived research and development 4,920 4,920 Total intangible assets, net $ 27,345 $ ( 8,696 ) $ 18,649 $ 28,657 $ ( 7,424 ) $ 21,233 58 | 2019 Form 10-K Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. In April 2019, the U.S. Food and Drug Administration (FDA) and the European Commission approved SKYRIZI (risankizumab) for the treatment of moderate to severe plaque psoriasis. As a result, AbbVie reclassified $ 3.9 billion of indefinite-lived intangible assets related to SKYRIZI to developed product rights definite-lived intangible assets. This amount will be amortized over its estimated useful life using the estimated pattern of economic benefit. During the fourth quarter of 2018, the company made a decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating rovalpituzumab tesirine (Rova-T) as a second-line therapy for advanced small-cell lung cancer following a recommendation from an Independent Data Monitoring Committee. This decision lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets and represented a triggering event which required the company to evaluate for impairment the IPRD assets associated with the Stemcentrx acquisition. The company utilized multi-period excess earnings models of the income approach and determined that the fair value was $ 1.0 billion as of December 31, 2018, which was lower than the carrying value of $ 6.1 billion and resulted in an impairment charge of $ 5.1 billion . This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2018. In the third quarter of 2019, following the announcement of the decision to terminate the Rova-T research and development program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2019. No indefinite-lived intangible asset impairment charges were recorded in 2017 . Definite-Lived Intangible Assets Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 11 years for both developed product rights and license agreements. Amortization expense was $ 1.6 billion in 2019 , $ 1.3 billion in 2018 and $ 1.1 billion in 2017 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2019 is as follows: (in billions) Anticipated annual amortization expense $ 1.8 $ 2.0 $ 2.3 $ 2.4 $ 2.5 No definite-lived intangible asset impairment charges were recorded in 2019 or 2018 . In 2017, an impairment charge of $ 354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. The impairment charge was based on discounted cash flow analyses and was included in cost of products sold in the consolidated statements of earnings. Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2019 , 2018 and 2017 , no such plans were individually significant. Restructuring charges recorded were $ 234 million in 2019 , $ 70 million in 2018 and $ 86 million in 2017 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. 2019 Form 10-K | 59 The following table summarizes the cash activity in the restructuring reserve for 2019 , 2018 and 2017 : (in millions) Accrued balance as of December 31, 2016 $ 2017 restructuring charges Payments and other adjustments ( 87 ) Accrued balance as of December 31, 2017 2018 restructuring charges Payments and other adjustments ( 46 ) Accrued balance as of December 31, 2018 2019 restructuring charges Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 $ Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheet: (in millions) Balance sheet caption December 31, 2019 Assets Operating Other assets $ Finance Property and equipment, net Total lease assets $ Liabilities Operating Current Accounts payable and accrued liabilities $ Noncurrent Other long-term liabilities Finance Current Current portion of long-term debt and finance lease obligations Noncurrent Long-term debt and finance lease obligations Total lease liabilities $ The following table summarizes the lease costs recognized in the consolidated statement of earnings: year ended December 31 (in millions) Operating lease cost $ Short-term lease cost Variable lease cost Total lease cost $ Sublease income and finance lease costs were insignificant in 2019 . Lease expense prior to the adoption of ASU No. 2016-02 was $ 161 million in 2018 and $ 169 million in 2017 . 60 | 2019 Form 10-K The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: December 31, 2019 Weighted-average remaining lease term (years) Operating Finance Weighted-average discount rate Operating 3.9 % Finance 3.9 % The following table presents supplementary cash flow information regarding the company's leases: year ended December 31 (in millions) Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ Right-of-use assets obtained in exchange for new operating lease liabilities Finance lease cash flows were insignificant in 2019 . The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2019 : (in millions) Operating leases Finance leases Total (a)(b) $ $ $ 2021 2022 2023 2024 Thereafter Total lease payments Less: Interest Present value of lease liabilities $ $ $ (a) Total lease payments exclude approximately $ 350 million of contractual minimum lease payments for leases executed but not yet commenced. These leases will commence in 2020 with lease terms of approximately 11 years . (b) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. Future minimum lease payments for non-cancelable operating leases and capital leases as of December 31, 2018 prior to the adoption of ASU No. 2016-02 did not differ materially from future lease payments, inclusive of payments for leases executed but not yet commenced, under the new standard. 2019 Form 10-K | 61 Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2019 (a) Effective interest rate in 2018 (a) Senior notes issued in 2012 2.90% notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.375% notes due 2019 (1,400 principal) 0.55 % 0.55 % 1,604 1.375% notes due 2024 (1,450 principal) 1.46 % 1,625 1.46 % 1,661 2.125% notes due 2028 (750 principal) 2.18 % 2.18 % Senior notes issued in 2018 3.375% notes due 2021 3.51 % 1,250 3.51 % 1,250 3.75% notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25% notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875% notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75% notes due 2027 (750 principal) 0.86 % 1.25% notes due 2031 (650 principal) 1.30 % Senior notes issued in 2019 Floating rate notes due May 2021 2.08 % Floating rate notes due November 2021 2.12 % Floating rate notes due 2022 2.29 % 2.15% notes due 2021 2.23 % 1,750 2.30% notes due 2022 2.42 % 3,000 2.60% notes due 2024 2.69 % 3,750 2.95% notes due 2026 3.02 % 4,000 3.20% notes due 2029 3.25 % 5,500 4.05% notes due 2039 4.11 % 4,000 4.25% notes due 2049 4.29 % 5,750 Other Fair value hedges ( 48 ) ( 466 ) Unamortized bond discounts ( 161 ) ( 120 ) Unamortized deferred financing costs ( 323 ) ( 163 ) Total long-term debt and finance lease obligations 66,728 36,611 Current portion 3,753 1,609 Noncurrent portion $ 62,975 $ 35,002 (a) Excludes the effect of any related interest rate swaps. 62 | 2019 Form 10-K Allergan-Related Financing In connection with the proposed acquisition of Allergan, in November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes, consisting of $ 750 million aggregate principal amount of floating rate senior notes due May 2021, $ 750 million aggregate principal amount of floating rate senior notes due November 2021, $ 750 million aggregate principal amount of floating rate senior notes due 2022, $ 1.75 billion aggregate principal amount of 2.15 % senior notes due 2021, $ 3.0 billion aggregate principal amount of 2.30 % senior notes due 2022, $ 3.75 billion aggregate principal amount of 2.60 % senior notes due 2024, $ 4.0 billion aggregate principal amount of 2.95 % senior notes due 2026, $ 5.5 billion aggregate principal amount of 3.20 % senior notes due 2029, $ 4.0 billion aggregate principal amount of 4.05 % senior notes due 2039 and $ 5.75 billion aggregate principal amount of 4.25 % senior notes due 2049. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million , which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie expects to use the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the proposed acquisition described in Note 5 and to pay related fees and expenses. Pending the consummation of the proposed Allergan acquisition, the net proceeds from the offering are permitted to be invested temporarily in short-term investments. All of the notes are subject to special mandatory redemption at a redemption price equal to 101 % of the aggregate principal amount of the notes plus accrued and unpaid interest if the proposed acquisition of Allergan is not completed by January 30, 2021 or the company notifies the trustee in respect of the notes that it will not pursue the consummation of the proposed Allergan acquisition. On June 25, 2019, AbbVie entered into a $ 38.0 billion 364 -day bridge credit agreement. On July 12, 2019, AbbVie entered into a term loan credit agreement with an aggregate principal amount of $ 6.0 billion consisting of a $ 1.5 billion 364 -day term loan tranche, a $ 2.5 billion three-year term loan tranche and a $ 2.0 billion five-year term loan tranche. In connection with the agreements, debt issuance costs incurred totaled $ 242 million and were recorded to interest expense, net in the consolidated statements of earnings. Upon commencement of the $ 6.0 billion term loan credit agreement and upon issuance of the $ 30.0 billion aggregate principal amount of senior notes, commitments under the bridge credit agreement were reduced to $ 2.0 billion . No amounts were drawn under the bridge credit agreement or term loan credit agreement at December 31, 2019 . In February 2020, the remaining commitments under the bridge credit agreement were reduced to $ 0 as a result of cash on hand at AbbVie. AbbVie subsequently terminated the bridge credit agreement in its entirety as permitted under its terms. On October 25, 2019, AbbVie commenced offers to exchange any and all outstanding notes of certain series issued by Allergan for up to $ 15.5 billion aggregate principal amount and 3.7 billion aggregate principal amount of new notes to be issued by AbbVie and cash, subject to conditions including the closing of the pending acquisition of Allergan. Concurrently with the offers to exchange the Allergan notes for AbbVie notes, the company solicited consents to adopt certain proposed amendments to each of the indentures governing the Allergan notes to, among other things, eliminate substantially all of the restrictive covenants in such indentures. In November 2019, the company announced that the requisite number of consents had been received to adopt the proposed amendments with respect to all Allergan notes and that Allergan executed a supplemental indenture with respect to each Allergan indenture implementing the amendments, which will become operative only upon settlement of the exchange offers. The expiration of the exchange offers is expected to occur on or about the closing date of AbbVies acquisition of Allergan. Other Long-Term Debt In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes, consisting of 750 million aggregate principal amount of 0.75 % senior notes due 2027 and 650 million aggregate principal amount of 1.25 % senior notes due 2031. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In September 2018, the company issued $ 6.0 billion aggregate principal amount of unsecured senior notes, consisting of $ 1.25 billion aggregate principal amount of 3.375 % senior notes due 2021, $ 1.25 billion aggregate principal amount of 3.75 % 2019 Form 10-K | 63 senior notes due 2023, $ 1.75 billion aggregate principal amount of 4.25 % senior notes due 2028 and $ 1.75 billion aggregate principal amount of 4.875 % senior notes due 2048. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375 % notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 37 million and debt discounts totaled $ 37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $ 5.9 billion net proceeds, $ 2.0 billion was used to repay the company's outstanding three -year term loan credit agreement in September 2018 and $ 1.0 billion was used to repay the aggregate principal amount of 2.00 % senior notes at maturity in November 2018. The company used the remaining proceeds to repay term loan obligations in 2019 as they became due. In May 2018, the company also repaid $ 3.0 billion aggregate principal amount of 1.80 % senior notes at maturity. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 7.8 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 13.7 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2019 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $ 699 million as of December 31, 2018 . There were no commercial paper borrowings as of December 31, 2019 . The weighted-average interest rate on commercial paper borrowings was 2.5 % in 2019 , 2.0 % in 2018 and 1.3 % in 2017 . In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2019 . Commitment fees under AbbVie's revolving credit facilities were insignificant in 2019 , 2018 and 2017 . No amounts were outstanding under the company's credit facilities as of December 31, 2019 and December 31, 2018 . In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2019 : as of and for the years ending December 31 (in millions) $ 3,750 6,300 7,850 2,250 5,375 Thereafter 41,708 Total obligations and commitments 67,233 Fair value hedges, unamortized bond discounts, deferred financing costs and finance lease obligations ( 505 ) Total long-term debt and finance lease obligations $ 66,728 64 | 2019 Form 10-K Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 957 million at December 31, 2019 and $ 1.4 billion at December 31, 2018 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months . Accumulated gains and losses as of December 31, 2019 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the proposed acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a gain of $ 383 million recognized in other comprehensive income (loss). This gain will be reclassified to interest expense, net over the lives of the related debt. In the fourth quarter of 2019, the company entered into interest rate swap contracts with notional amounts totaling $ 2.3 billion at December 31, 2019 . The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. The contracts were designated as cash flow hedges and are recorded at fair value. Realized and unrealized gains or losses are included in AOCI and will be reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 7.1 billion at December 31, 2019 and $ 8.6 billion at December 31, 2018 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had 3.6 billion aggregate principal amount of senior Euro notes designated as net investment hedges at December 31, 2019 and December 31, 2018 . In the third quarter of 2019, the company issued 1.4 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company elected to de-designate hedge accounting for 1.4 billion aggregate principal amount of existing senior Euro notes which were subsequently repaid in October 2019. In addition, in 2019, the company entered into foreign currency forward exchange contracts and designated the instruments as net investment hedges. These contracts had notional amounts totaling 971 million , 204 million and CHF 62 million at December 31, 2019 . The company uses the spot method of assessing hedge effectiveness for derivative 2019 Form 10-K | 65 instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. AbbVie is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 10.8 billion at December 31, 2019 and December 31, 2018 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2018 Balance sheet caption 2018 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Designated as net investment hedges Prepaid expenses and other Accounts payable and accrued liabilities Not designated as hedges Prepaid expenses and other 19 Accounts payable and accrued liabilities 26 Interest rate swap contracts Designated as cash flow hedges Other assets Other long-term liabilities Designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Designated as fair value hedges Other assets Other long-term liabilities 466 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) Foreign currency forward exchange contracts Designated as cash flow hedges $ ( 5 ) $ $ ( 250 ) Designated as net investment hedges Interest rate swap contracts designated as cash flow hedges Treasury rate lock agreements designated as cash flow hedges Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax losses of $ 10 million into cost of products sold for foreign currency cash flow hedges, pre-tax gains of $ 7 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax gains of $ 90 million in 2019 , pre-tax gains of $ 178 million in 2018 and pre-tax losses of $ 537 million in 2017 . 66 | 2019 Form 10-K The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ $ ( 161 ) $ Designated as net investment hedges Interest expense, net Not designated as hedges Net foreign exchange loss ( 70 ) ( 96 ) Treasury rate lock agreements designated as cash flow hedges Interest expense, net Interest rate swap contracts Designated as cash flow hedges Interest expense, net Designated as fair value hedges Interest expense, net ( 71 ) ( 63 ) Debt designated as hedged item in fair value hedges Interest expense, net ( 418 ) Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2019 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 39,924 $ 1,542 $ 38,382 $ Debt securities Equity securities Interest rate swap contracts Foreign currency contracts Total assets $ 40,004 $ 1,566 $ 38,438 $ Liabilities Interest rate swap contracts $ $ $ $ Foreign currency contracts Contingent consideration 7,340 7,340 Total liabilities $ 7,472 $ $ $ 7,340 2019 Form 10-K | 67 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2018 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 7,289 $ 1,209 $ 6,080 $ Time deposits Debt securities 1,536 1,536 Equity securities Foreign currency contracts Total assets $ 9,529 $ 1,213 $ 8,316 $ Liabilities Interest rate swap contracts $ $ $ $ Foreign currency contracts Contingent consideration 4,483 4,483 Total liabilities $ 4,975 $ $ $ 4,483 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2019 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $ 280 million . Additionally, at December 31, 2019 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $ 150 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,483 $ 4,534 $ 4,213 Change in fair value recognized in net earnings 3,091 Payments ( 234 ) ( 100 ) ( 305 ) Ending balance $ 7,340 $ 4,483 $ 4,534 The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the SKYRIZI contingent consideration liability due to higher probabilities of success, higher estimated future sales and declining interest rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T research and development program. During the fourth quarter of 2018, the company recorded a $ 428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 68 | 2019 Form 10-K Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2019 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 3,755 $ 3,760 $ 3,753 $ $ Long-term debt and finance lease obligations, excluding fair value hedges 63,021 66,651 66,631 Total liabilities $ 66,776 $ 70,411 $ 70,384 $ $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2018 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Short-term borrowings $ 3,699 $ 3,693 $ $ 3,693 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 1,609 1,617 1,609 Long-term debt and finance lease obligations, excluding fair value hedges 35,468 34,052 34,024 Total liabilities $ 40,776 $ 39,362 $ 35,633 $ 3,729 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 66 million as of December 31, 2019 and $ 84 million as of December 31, 2018 . No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2019 . Available-for-sale Securities Substantially all of the companys investments in debt securities were classified as available-for-sale with changes in fair value recognized in other comprehensive income. In the third quarter of 2019, the company sold substantially all of its investments in debt securities. There were no debt securities classified as short-term as of December 31, 2019 and $ 204 million as of December 31, 2018 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale debt securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2018 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ ( 2 ) $ Corporate debt securities 1,042 ( 9 ) 1,034 Other debt securities Total $ 1,546 $ $ ( 11 ) $ 1,536 AbbVie had no other-than-temporary impairments as of December 31, 2019 . Net realized gains and losses were insignificant in 2019 and 2018 . Net realized gains were $ 90 million in 2017 . 2019 Form 10-K | 69 Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. Of total net accounts receivable, three U.S. wholesalers accounted for 68 % as of December 31, 2019 and 63 % as of December 31, 2018 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 58 % of AbbVie's total net revenues in 2019 , 61 % in 2018 and 65 % in 2017 . Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2019 and 2018 . The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 6,618 $ 6,985 $ $ Service cost Interest cost Employee contributions Actuarial (gain) loss 1,703 ( 614 ) ( 287 ) Benefits paid ( 206 ) ( 191 ) ( 17 ) ( 16 ) Other, primarily foreign currency translation adjustments ( 76 ) End of period 8,646 6,618 1,050 Fair value of plan assets Beginning of period 5,637 5,399 Actual return on plan assets ( 384 ) Company contributions Employee contributions Benefits paid ( 206 ) ( 191 ) ( 17 ) ( 16 ) Other, primarily foreign currency translation adjustments ( 62 ) End of period 7,116 5,637 Funded status, end of period $ ( 1,530 ) $ ( 981 ) $ ( 1,050 ) $ ( 561 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities ( 8 ) ( 8 ) ( 18 ) ( 15 ) Other long-term liabilities ( 1,917 ) ( 1,294 ) ( 1,032 ) ( 546 ) Net obligation $ ( 1,530 ) $ ( 981 ) $ ( 1,050 ) $ ( 561 ) Actuarial loss, net $ 3,633 $ 2,516 $ $ Prior service cost (credit) ( 16 ) ( 22 ) Accumulated other comprehensive loss $ 3,643 $ 2,527 $ $ Actuarial losses for 2019 in the table above were primarily driven by lower discount rates. 70 | 2019 Form 10-K The projected benefit obligations (PBO) in the table above included $ 2.3 billion at December 31, 2019 and $ 1.9 billion at December 31, 2018 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $ 7.6 billion at December 31, 2019 and $ 6.0 billion at December 31, 2018 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2019 , the ABO was $ 5.8 billion , the PBO was $ 6.7 billion and aggregate plan assets were $ 4.8 billion . Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) Defined benefit plans Actuarial loss $ 1,231 $ $ Amortization of actuarial loss and prior service cost ( 109 ) ( 140 ) ( 107 ) Foreign exchange loss (gain) and other ( 6 ) ( 13 ) Total loss $ 1,116 $ $ Other post-employment plans Actuarial loss (gain) $ $ ( 287 ) $ Amortization of actuarial loss and prior service credit ( 1 ) ( 1 ) Total loss (gain) $ $ ( 288 ) $ The pre-tax amounts included in AOCI at December 31, 2019 expected to be recognized in net periodic benefit cost in 2020 consisted of $ 219 million of expense related to actuarial losses and prior service costs for defined benefit plans and $ 25 million of income related to actuarial losses and prior service credits for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets ( 474 ) ( 439 ) ( 382 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service credit Net periodic benefit cost $ $ $ The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 3.0 % 4.0 % Rate of compensation increases 4.6 % 4.6 % Other post-employment plans Discount rate 3.6 % 4.6 % The assumptions used in calculating the December 31, 2019 measurement date benefit obligations will be used in the calculation of net periodic benefit co st in 2020 . 2019 Form 10-K | 71 Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 4.0 % 3.4 % 3.9 % Discount rate for determining interest cost 4.0 % 3.1 % 3.7 % Expected long-term rate of return on plan assets 7.6 % 7.7 % 7.8 % Expected rate of change in compensation 4.6 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.7 % 4.0 % 4.9 % Discount rate for determining interest cost 4.3 % 3.7 % 4.1 % For the December 31, 2019 post-retirement health care obligations remeasurement, the company assumed a 6.4 % pre-65 ( 7.0 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % in 2050 and remain at that level thereafter. For purposes of measuring the 2019 post-retirement health care costs, the company assumed a 6.6 % pre-65 ( 7.3 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % for 2050 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2019 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2019 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ ( 10 ) Projected benefit obligation ( 186 ) Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,851 $ 2,051 $ $ Total assets measured at NAV 4,265 Fair value of plan assets $ 7,116 72 | 2019 Form 10-K Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,359 $ 1,586 $ $ Total assets measured at NAV 3,278 Fair value of plan assets $ 5,637 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2019 target investment allocation for the AbbVie Pension Plan was 35 % in equity securities, 20 % in fixed income securities and 45 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. 2019 Form 10-K | 73 Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2021 2022 2023 2024 2025 to 2029 1,737 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $ 102 million in 2019 , $ 89 million in 2018 and $ 82 million in 2017 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Realized excess tax benefits associated with stock-based compensation totaled $ 15 million in 2019 , $ 78 million in 2018 and $ 71 million in 2017 . 74 | 2019 Form 10-K Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 12.54 in 2019 , $ 21.63 in 2018 and $ 9.80 in 2017 . The following table summarizes AbbVie stock option activity in 2019 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2018 6,143 $ 55.05 6.2 $ Granted 1,002 79.02 Exercised ( 375 ) 23.72 Lapsed ( 9 ) 20.09 Outstanding at December 31, 2019 6,761 $ 60.39 5.9 $ Exercisable at December 31, 2019 4,924 $ 51.90 4.9 $ The total intrinsic value of options exercised was $ 22 million in 2019 , $ 215 million in 2018 and $ 371 million in 2017 . The total fair value of options vested during 2019 was $ 13 million . As of December 31, 2019 , $ 6 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2019 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2018 9,868 $ 79.90 Granted 5,584 78.03 Vested ( 4,616 ) 71.30 Forfeited ( 604 ) 82.19 Outstanding at December 31, 2019 10,232 $ 81.72 The fair market value of RSUs and performance shares (as applicable) vested was $ 371 million in 2019 , $ 583 million in 2018 and $ 348 million in 2017 . 2019 Form 10-K | 75 As of December 31, 2019 , $ 327 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 4.39 in 2019 , $ 3.95 in 2018 and $ 2.63 in 2017 . The following table summarizes quarterly cash dividends declared during 2019 , 2018 and 2017 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 11/01/19 02/14/20 $ 1.18 11/02/18 02/15/19 $ 1.07 10/27/17 02/15/18 $ 0.71 09/06/19 11/15/19 $ 1.07 09/07/18 11/15/18 $ 0.96 09/08/17 11/15/17 $ 0.64 06/20/19 08/15/19 $ 1.07 06/14/18 08/15/18 $ 0.96 06/22/17 08/15/17 $ 0.64 02/21/19 05/15/19 $ 1.07 02/15/18 05/15/18 $ 0.96 02/16/17 05/15/17 $ 0.64 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was approximately $ 4.0 billion as of December 31, 2019 . On February 15, 2018, AbbVie's board of directors authorized a new $ 10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $ 5.0 billion increase to the existing $ 10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $ 10.7 billion in 2018. Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $ 1.3 billion in 2018 and approximately 13 million shares for $ 1.0 billion in 2017 . 76 | 2019 Form 10-K Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2019 , 2018 and 2017 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2016 $ ( 1,435 ) $ $ ( 1,513 ) $ $ $ ( 2,586 ) Other comprehensive income (loss) before reclassifications ( 343 ) ( 480 ) ( 230 ) ( 344 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 75 ) ( 112 ) Net current-period other comprehensive income (loss) ( 343 ) ( 406 ) ( 46 ) ( 342 ) ( 141 ) Balance as of December 31, 2017 ( 439 ) ( 203 ) ( 1,919 ) ( 166 ) ( 2,727 ) Other comprehensive income (loss) before reclassifications ( 391 ) ( 14 ) ( 27 ) Net losses reclassified from accumulated other comprehensive loss Net current-period other comprehensive income (loss) ( 391 ) ( 10 ) Balance as of December 31, 2018 ( 830 ) ( 65 ) ( 1,722 ) ( 10 ) ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) ( 1,330 ) ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) ( 1,243 ) ( 1,116 ) Balance as of December 31, 2019 $ ( 928 ) $ $ ( 2,965 ) $ $ $ ( 3,596 ) Other comprehensive loss included foreign currency translation adjustments totaling losses of $ 98 million in 2019 and $ 391 million in 2018 which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. In 2017, AbbVie reclassified $ 316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $ 680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. 2019 Form 10-K | 77 The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 27 ) $ $ Tax expense Total reclassifications, net of tax $ ( 21 ) $ $ Pension and post-employment benefits Amortization of actuarial losses and other (b) $ $ $ Tax benefit ( 23 ) ( 28 ) ( 33 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ ( 167 ) $ $ ( 118 ) Gains on treasury rate lock agreements and interest rate swap contracts (a) ( 4 ) Tax expense (benefit) ( 4 ) Total reclassifications, net of tax $ ( 157 ) $ $ ( 112 ) (a) Amounts are included in interest expense, net (see Note 11 ). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12 ). (c) Amounts are included in cost of products sold (see Note 11 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2019 , no shares of preferred stock were issued or outstanding. Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) Domestic $ ( 2,784 ) $ ( 4,274 ) $ ( 2,678 ) Foreign 11,210 9,471 10,405 Total earnings before income tax expense $ 8,426 $ 5,197 $ 7,727 Income Tax Expense years ended December 31 (in millions) Current Domestic $ $ $ 6,204 Foreign Total current taxes $ $ 1,027 $ 6,580 Deferred Domestic $ ( 137 ) $ ( 1,497 ) $ ( 4,898 ) Foreign ( 20 ) Total deferred taxes $ $ ( 1,517 ) $ ( 4,162 ) Total income tax expense (benefit) $ $ ( 490 ) $ 2,418 78 | 2019 Form 10-K Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35 % to 21 % and required companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. These changes were generally effective for tax years beginning in 2018. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. Additionally, the Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings and the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. As such, the company records foreign withholding tax liabilities related to the future cash repatriation of such earnings. However, the company considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Effective Tax Rate Reconciliation years ended December 31 Statutory tax rate 21.0 % 21.0 % 35.0 % Effect of foreign operations ( 8.4 ) ( 28.7 ) ( 12.2 ) U.S. tax credits ( 3.3 ) ( 7.3 ) ( 4.0 ) Impacts related to U.S. tax reform ( 1.6 ) 8.2 12.0 Stock-based compensation excess tax benefit ( 0.2 ) ( 1.5 ) ( 0.9 ) Tax audit settlements ( 4.7 ) ( 2.5 ) ( 1.2 ) Deferred tax remeasurements due to change in tax rate 3.1 All other, net 0.6 1.4 2.6 Effective tax rate 6.5 % ( 9.4 )% 31.3 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2019 , 2018 and 2017 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, the cost of repatriation decisions, Boehringer Ingelheim accretion on contingent consideration and Stemcentrx impairment related expenses. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2019 , 2018 and 2017 included impacts related to U.S. tax reform. In 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. For 2019, the impact of the Act affected the full year earnings of these subsidiaries, resulting in additional tax expense compared to prior year. The 2019 effective income tax rate also reflects the effects of deferred tax remeasurement due to a change in foreign tax law, accretion for contingent consideration and impairment related expenses. In addition, the company recognized a net tax benefit of $ 400 million in 2019 , $ 131 million in 2018 and $ 91 million in 2017 related to the resolution of various tax positions pertaining to prior years. 2019 Form 10-K | 79 Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Advance payments Net operating losses and other credit carryforwards Other Total deferred tax assets 3,517 2,765 Valuation allowances ( 731 ) ( 103 ) Total net deferred tax assets 2,786 2,662 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 2,712 ) ( 2,940 ) Excess of book basis over tax basis in investments ( 249 ) ( 211 ) Other ( 440 ) ( 250 ) Total deferred tax liabilities ( 3,401 ) ( 3,401 ) Net deferred tax liabilities $ ( 615 ) $ ( 739 ) As of December 31, 2019 , gross state net operating losses were $ 1.0 billion and tax credit carryforwards were $ 188 million . The state tax carryforwards expire between 2020 and 2039. As of December 31, 2019 , foreign net operating loss carryforwards were $ 2.9 billion . Foreign net operating loss carryforwards of $ 2.8 billion expire between 2020 and 2036 and the remaining do not have an expiration period. The company had valuation allowances of $ 731 million as of December 31, 2019 and $ 103 million as of December 31, 2018 . These were principally related to foreign and state net operating losses and credit carryforwards that are not expected to be realized. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 2,852 $ 2,701 $ 1,168 Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions ( 21 ) ( 36 ) ( 2 ) Settlements ( 749 ) ( 79 ) ( 233 ) Lapse of statutes of limitations ( 33 ) ( 7 ) ( 16 ) Ending balance $ 2,661 $ 2,852 $ 2,701 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 2.4 billion in 2019 and $ 2.7 billion in 2018 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2019 , AbbVie would be indemnified for approximately $ 83 million . The Increase due to current year tax positions and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 51 million in 2019 , $ 73 million in 2018 and $ 24 million in 2017 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross 80 | 2019 Form 10-K interest and penalties of $ 191 million at December 31, 2019 , $ 190 million at December 31, 2018 and $ 120 million at December 31, 2017 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 54 million . All significant federal, state, local and international matters have been concluded for years through 2012. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $ 290 million as of December 31, 2019 and approximately $ 350 million as of December 31, 2018 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. In addition, other operating income in 2019 included $ 550 million of income from a legal settlement related to an intellectual property dispute with a third party . While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Four lawsuits against Unimed Pharmaceuticals, LLC, Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others remained consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation , MDL No. 2084. These cases, brought by direct AndroGel purchasers, generally allege Solvay's 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs seek monetary damages and attorneys' fees. Three of those lawsuits were settled in December 2019 and will be dismissed. In September 2014, the FTC filed a lawsuit, FTC v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $ 448 million , plus prejudgment interest. The court denied the FTCs request for injunctive relief. AbbVie is appealing the courts liability and disgorgement rulings and, based on an assessment of the merits of that appeal, no liability has been accrued for this matter. The FTC is also appealing aspects of the courts trial ruling and the dismissal of its settlement-related claim. In July 2018, a purported class action was filed in the United States District Court for the Eastern District of Pennsylvania on behalf of direct AndroGel purchasers based on the trial courts ruling in the FTCs case. In September 2019, two individual direct AndroGel purchasers substituted in as the plaintiffs in that lawsuit and withdrew the class allegations. That case, which was pending as Rochester Drug Co-Operative, Inc., et al. v. AbbVie Inc., et al., was settled in December 2019 and will be dismissed. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, making allegations similar to those in In re: AndroGel Antitrust Litigation (No. II) , MDL No. 2084 (above) and FTC v. AbbVie Inc. (above). Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payers. The cases are pending in the United States District Court for the Eastern 2019 Form 10-K | 81 District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In May 2018, the California Court of Appeal ruled that the District Attorneys Office may not bring monetary claims beyond the scope of Orange County, which the District Attorneys Office is appealing. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect HUMIRA purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies HUMIRA patent portfolio violate state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al. , was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted included violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint sought monetary damages and injunctive relief. In July 2018, the court denied the plaintiffs motion for class certification. In November 2019, the United States Court of Appeals for the Seventh Circuit affirmed the district courts grant of the defendants summary judgment motion. In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In September 2018, the Commissioner of the California Department of Insurance intervened in a qui tam lawsuit, State of California and Lazaro Suarez v. AbbVie Inc., et al. , brought under the California Insurance Frauds Prevention Act, in California Superior Court for Alameda County. The Department of Insurances complaint alleges that, through patient and reimbursement support services and other services and items of value provided in connection with HUMIRA, AbbVie caused the submission of fraudulent commercial insurance claims for HUMIRA in violation of the California statute. The complaint seeks injunctive relief, an assessment of up to three times the amount of the claims at issue, and civil penalties. In addition, a federal securities lawsuit ( Holwill v. AbbVie Inc., et al .) is pending in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for HUMIRA sales growth in financial filings between 2013 and 2017 were misleading because they omitted the conduct alleged in the Department of Insurances complaint. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al., on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In October 2019, the court granted final approval to the parties class settlement agreement. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connec tion with its proposed t ransaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. Plaintiffs seek compensatory and punitive damages. Product liability cases were filed in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 3,500 claims against AbbVie are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation , MDL No. 2545. Approximately 175 claims against AbbVie are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. In November 2018, AbbVie entered into a Master Settlement Agreement with the Plaintiffs Steering Committee in the MDL encompassing existing claims in all courts. All proceedings in pending cases are effectively stayed during the settlement administration process. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 120 cases are pending in the United States District Court for the Southern District of Illinois, and approximately 14 others are pending in various federal and state courts. Plaintiffs generally seek compensatory and punitive damages. Approximately eighty percent of these pending 82 | 2019 Form 10-K cases, plus other unfiled claims, are subject to confidential settlement agreements and are expected to be dismissed with prejudice. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. In January 2020, the Court of Appeals for the Federal Circuit affirmed the decisions. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd. , in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that 11 HCV-related patents licensed to AbbVie in 2002 are invalid. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In February 2018, cases were filed in the United States District Court for the District of Delaware against the following defendants: Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limited; Sun Pharma Global FZE and Sun Pharmaceutical Industries Ltd.; Cipla Limited and Cipla USA Inc.; and Zydus Worldwide DMCC, Cadila Healthcare Limited, Sandoz Inc., and Lek Pharmaceuticals D.D. In each case, Pharmacyclics alleges the defendants proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in these suits. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark IMBRUVICA). In a case filed in the United States District Court for the District of Delaware in March 2019, Pharmacyclics alleges that Alvogen Pine Brook LLCs and Natco Pharma Ltd.s proposed generic ibrutinib tablet product infringes certain Pharmacyclics patents. Pharmacyclics seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in this suit. 2019 Form 10-K | 83 Note 16 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) Immunology HUMIRA United States $ 14,864 $ 13,685 $ 12,361 International 4,305 6,251 6,066 Total $ 19,169 $ 19,936 $ 18,427 SKYRIZI United States $ $ $ International Total $ $ $ RINVOQ United States $ $ $ International Total $ $ $ Hematologic Oncology IMBRUVICA United States $ 3,830 $ 2,968 $ 2,144 Collaboration revenues Total $ 4,674 $ 3,590 $ 2,573 VENCLEXTA United States $ $ $ International Total $ $ $ HCV MAVYRET United States $ 1,473 $ 1,614 $ International 1,420 1,824 Total $ 2,893 $ 3,438 $ VIEKIRA United States $ $ $ International Total $ $ $ Other Key Products Creon United States $ 1,041 $ $ Lupron United States $ $ $ International Total $ $ $ Synthroid United States $ $ $ Synagis International $ $ $ Duodopa United States $ $ $ International Total $ $ $ Sevoflurane United States $ $ $ International Total $ $ $ Kaletra United States $ $ $ International Total $ $ $ AndroGel United States $ $ $ ORILISSA United States $ $ $ International Total $ $ $ All other $ $ $ Total net revenues $ 33,266 $ 32,753 $ 28,216 84 | 2019 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 23,907 $ 21,524 $ 18,251 Japan 1,211 1,591 Germany 1,292 1,157 Canada France Spain United Kingdom Italy Brazil The Netherlands All other countries 3,993 4,013 4,080 Total net revenues $ 33,266 $ 32,753 $ 28,216 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 2,026 $ 1,993 Europe All other 291 Total long-lived assets $ 2,962 $ 2,883 2019 Form 10-K | 85 Note 17 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 7,828 $ 7,934 Gross margin 6,134 6,007 Net earnings (a) 2,456 2,783 Basic earnings per share $ 1.65 $ 1.74 Diluted earnings per share $ 1.65 $ 1.74 Cash dividends declared per common share $ 1.07 $ 0.96 Second Quarter Net revenues $ 8,255 $ 8,278 Gross margin 6,436 6,344 Net earnings (b) 1,983 Basic earnings per share $ 0.49 $ 1.26 Diluted earnings per share $ 0.49 $ 1.26 Cash dividends declared per common share $ 1.07 $ 0.96 Third Quarter Net revenues $ 8,479 $ 8,236 Gross margin 6,559 6,401 Net earnings (c) 1,884 2,747 Basic earnings per share $ 1.27 $ 1.81 Diluted earnings per share $ 1.26 $ 1.81 Cash dividends declared per common share $ 1.07 $ 0.96 Fourth Quarter Net revenues $ 8,704 $ 8,305 Gross margin 6,698 6,283 Net earnings (loss) (d) 2,801 ( 1,826 ) Basic earnings (loss) per share $ 1.88 $ ( 1.23 ) Diluted earnings (loss) per share $ 1.88 $ ( 1.23 ) Cash dividends declared per common share $ 1.18 $ 1.07 (a) First quarter results in 2019 included after-tax charges of $ 171 million related to the change in fair value of contingent consideration liabilities and restructuring charges of $ 133 million . First quarter results in 2018 included an after-tax benefit of $ 148 million related to the change in fair value of contingent consideration liabilities partially offset by after-tax litigation reserves charges of $ 100 million . (b) Second quarter results in 2019 included an after-tax charge of $ 2.3 billion related to the change in fair value of contingent consideration liabilities resulting from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. Second quarter results in 2018 included after-tax charges of $ 500 million as a result of a collaboration agreement extension with Calico and $ 485 million related to the change in fair value of contingent consideration liabilities. (c) Third quarter results in 2019 included after-tax charges of $ 912 million related to intangible asset impairment and $ 182 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2018 included after-tax litigation reserves charges of $ 176 million and $ 95 million related to the change in fair value of contingent consideration liabilities. 86 | 2019 Form 10-K (d) Fourth quarter results in 2019 included an after-tax charge of $ 438 million related to the change in fair value of contingent consideration liabilities offset by after-tax income of $ 435 million from a legal settlement related to an intellectual property dispute with a third party and $ 297 million from an amended and restated license agreement between AbbVie and Reata . Fourth quarter results in 2018 included an after-tax intangible asset impairment charge of $ 4.5 billion partially offset by an after-tax benefit of $ 375 million related to the change in fair value of contingent consideration liabilities. 2019 Form 10-K | 87 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2020 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 88 | 2019 Form 10-K Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period as the related product is sold. At December 31, 2019, the Company had $4,484 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions in light of industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2019, the Company had $7,340 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry and knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. 2019 Form 10-K | 89 How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments in light of observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 21, 2020 90 | 2019 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2019 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . 2019 Form 10-K | 91 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 92 | 2019 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2019 and 2018 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 21, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 21, 2020 2019 Form 10-K | 93 " +37,AbbVie,2018," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 15 to the Consolidated Financial Statements and the sales information related to HUMIRA, IMBRUVICA and MAVYRET included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 61% of AbbVie's total net revenues in 2018 . _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2018 Form 10-K | 1 Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA. VENCLEXTA (venetoclax) is a BCL-2 inhibitor used to treat adults with CLL or SLL, with or without 17p deletion, who have received at least one prior treatment. In addition, VENCLEXTA is used in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV. HCV products. AbbVie's HCV products are: MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. Additional Virology products. AbbVie's additional virology products include: SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by respiratory syncytial virus (RSV). KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as Aluvia in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. NORVIR. NORVIR (ritonavir) is a protease inhibitor that is indicated in combination with other antiretroviral agents for the treatment of HIV-1 infection. 2 | 2018 Form 10-K Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: ORILISSA. ORILISSA (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved ORILISSA under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. ORILISSA inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Sevoflurane. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2018 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2018 gross revenues in the United States. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's 2018 Form 10-K | 3 business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. HUMIRA is now facing direct biosimilar competition in Europe and other countries, which represent approximately 75% of AbbVie's international HUMIRA business or approximately 25% of total global HUMIRA revenues. AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is more complex than the approval process for, and science behind, generic or other follow-on versions of small molecule products. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after 4 | 2018 Form 10-K regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product is entitled upon its approval in any particular country. In certain instances, regulatory exclusivity may protect a product where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over, and more rigorous requirements for approval of, follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2019 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA) and those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. 2018 Form 10-K | 5 Licensing and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. These licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments (if applicable), milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. 6 | 2018 Form 10-K In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw 2018 Form 10-K | 7 materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of 8 | 2018 Form 10-K countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2019 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2018 were approximately $20 million and operating expenditures were approximately $31 million . In 2019 , capital expenditures for pollution control are estimated to be approximately $26 million and operating expenditures are estimated to be approximately $33 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. 2018 Form 10-K | 9 Employees AbbVie employed approximately 30,000 persons as of January 31, 2019. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $19.9 billion in 2018 , expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. 10 | 2018 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged or circumvented or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 61% of AbbVie's total net revenues in 2018 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA, the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of 2018 Form 10-K | 11 competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including HUMIRA. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. 12 | 2018 Form 10-K New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market, and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product 2018 Form 10-K | 13 withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and 14 | 2018 Form 10-K field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls, or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States make up approximately 34% of AbbVie's total net revenues in 2018 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. 2018 Form 10-K | 15 If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2018 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate 16 | 2018 Form 10-K funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may result in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. 2018 Form 10-K | 17 An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions, or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 18 | 2018 Form 10-K CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland Jayuya, Puerto Rico Ludwigshafen, Germany North Chicago, Illinois Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. 2018 Form 10-K | 19 "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 48,516 stockholders of record of AbbVie common stock as of January 31, 2019 . Dividends On November 2, 2018 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $0.96 per share to $1.07 per share, payable on February 15, 2019 to stockholders of record as of January 15, 2019. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2013 through December 31, 2018 . This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2013 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. 2018 Form 10-K | 23 This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2018 - October 31, 2018 4,246 (1) $ 88.24 (1) $ 1,500,000,050 November 1, 2018 - November 30, 2018 17,119,956 (1) $ 87.62 (1) 17,118,625 $ 8,924 December 1, 2018 - December 31, 2018 8,546,698 (1) $ 87.89 (1) 8,533,255 $ 4,250,016,122 (2) Total 25,670,900 (1) $ 87.71 (1) 25,651,880 $ 4,250,016,122 (2) 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,246 in October; 1,331 in November; and 13,443 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 2. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing stock repurchase program. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. 24 | 2018 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2018 and 2017 and results of operations for each of the three years in the period ended December 31, 2018 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 30,000 employees. AbbVie operates in one business segmentpharmaceutical products. 2018 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2018 included delivering worldwide net revenues of $32.8 billion , operating earnings of $6.4 billion , diluted earnings per share of $3.66 and cash flows from operations of $13.4 billion . Worldwide net revenues grew by 16% , or 15% on a constant currency basis, driven primarily by revenue growth related to MAVYRET, IMBRUVICA and VENCLEXTA, and the continued strength of HUMIRA. Diluted earnings per share in 2018 was $3.66 and included the following after-tax costs: (i) a Stemcentrx-related impairment charge of $4.1 billion net of the related fair value adjustment to contingent consideration liabilities; (ii) $1.1 billion of intangible asset amortization; (iii) $500 million as a result of a collaboration agreement extension with Calico Life Sciences LLC (Calico); (iv) $424 million for acquired in-process research and development (IPRD); (v) $478 million for the change in fair value of contingent consideration liabilities excluding the fair value adjustment associated with the Stemcentrx-related impairment; (vi) litigation reserve charges of $282 million ; (vii) charitable contributions of $271 million as part of AbbVie's previously announced plan to make contributions to U.S. not-for-profit organizations in 2018; and (viii) milestone payments of $137 million . 2018 financial results were also impacted by U.S. tax reform and the timing of the new legislation's phase in on certain subsidiaries. Additionally, financial results reflected continued added funding to support all stages of AbbVies emerging pipeline assets and continued investment in AbbVies growth brands. In November 2018 , AbbVie's board of directors declared a quarterly cash dividend of $1.07 per share of common stock payable in February 2019 . This reflected an increase of approximately 11.5% over the previous quarterly dividend of $0.96 per share of common stock. 26 | 2018 Form 10-K 2019 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, driving late-stage pipeline assets to the market and ensuring strong commercial execution of new product launches; (ii) continued investment and expansion in its pipeline in support of opportunities in immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via dividends and share repurchases. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next twelve months. AbbVie expects to achieve its strategic objectives through: Hematologic oncology revenue growth from both IMBRUVICA and VENCLEXTA. The strong execution of new product launches across multiple therapeutic areas. HUMIRA U.S. sales growth by driving biologic penetration across disease categories and maintaining market leadership. Effective management of HUMIRA international biosimilar erosion. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2019. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, the reduction of HUMIRA royalty expense, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neuroscience along with targeted investments in cystic fibrosis and women's health. Of these programs, more than 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next twelve months. Significant Programs and Developments Immunology Upadacitinib In January 2018, the U.S. Food and Drug Administration (FDA) granted breakthrough therapy designation for upadacitinib, an investigational oral JAK1-selective inhibitor, in adult patients with moderate to severe atopic dermatitis who are candidates for systemic therapy. In April 2018, AbbVie announced that top-line results from the Phase 3 SELECT-COMPARE clinical trial evaluating upadacitinib met all primary and ranked secondary endpoints in patients with moderate to severe rheumatoid arthritis (RA) who are on a stable background of methotrexate and who have an inadequate response. The safety profile of upadacitinib was consistent with previously reported clinical trials and no new safety signals were detected. 2018 Form 10-K | 27 In June 2018, AbbVie announced that top-line results from the Phase 3 SELECT-EARLY clinical trial evaluating upadacitinib versus methotrexate in adult patients with moderate to severe RA who were methotrexate-nave met all primary and ranked secondary endpoints. The safety profile of upadacitinib was consistent with previously reported clinical trials and no new safety signals were detected. In July 2018, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of upadacitinib in subjects with moderate to severe atopic dermatitis. In September 2018, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of upadacitinib in subjects with moderate to severe ulcerative colitis. In December 2018, AbbVie submitted a New Drug Application (NDA) to the FDA and a marketing authorisation application (MAA) to the European Medicines Agency (EMA) for upadacitinib for the treatment of adult patients with moderate to severe RA. Risankizumab In January 2018, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of risankizumab, an investigational interleukin-23 (IL-23) inhibitor, versus placebo during induction therapy in subjects with moderately to severely active Crohns disease. In February 2018, AbbVie announced that top-line results from two Phase 3 clinical trials evaluating risankizumab with 12-week dosing compared to ustekinumab met ranked additional secondary endpoints for the treatment of patients with moderate to severe chronic plaque psoriasis. The initial results from these clinical trials were previously announced in October 2017. The safety profile was consistent with all previously reported studies, and there were no new safety signals detected across the two studies. In April 2018, AbbVie submitted a Biologics License Application (BLA) to the FDA and an MAA to the EMA for risankizumab for the treatment of plaque psoriasis in adults. In May 2018, AbbVie initiated a Phase 2b/3 clinical trial to evaluate the efficacy and safety of risankizumab versus placebo in subjects with moderately to severely active ulcerative colitis. Oncology IMBRUVICA In April 2018, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and efficacy of IMBRUVICA in combination with VENCLEXTA versus chlorambucil plus GAZYVA (obinutuzumab) for the first-line treatment of subjects with chronic lymphocytic leukemia (CLL)/small lymphocytic lymphoma (SLL). In May 2018, AbbVie announced that results from the Phase 3 iLLUMINATE study evaluating IMBRUVICA in combination with GAZYVA in previously untreated CLL/SLL met its primary endpoint. In December 2018, AbbVie announced additional results from the Phase 3 iLLUMINATE study that demonstrated significantly prolonged progression-free survival (PFS). In June 2018, AbbVie announced that results from an interim analysis of the Phase 3 iNNOVATE study evaluating IMBRUVICA plus Rituxan (rituximab) in previously untreated and relapsed/refractory (R/R) patients with Waldenstrms macroglobulinemia (WM) met its primary endpoint. In July 2018, AbbVie announced that results from a Phase 3 study evaluating the addition of IMBRUVICA to a chemotherapy regimen consisting of five different agents used in combination did not meet its primary endpoint in a subset of untreated diffuse large B-cell lymphoma patients identified to have the non-germinal center B-cell or activated B-cell subtypes of this disease. In August 2018, the FDA approved IMBRUVICA, in combination with Rituxan, for the treatment of adult patients with WM. In December 2018, AbbVie announced that results from an interim analysis of the Phase 3 ECOG1912E study evaluating IMBRUVICA in combination with Rituxan versus the chemoimmunotherapy FCR (fludarabine, cyclophosphamide and rituximab) in previously untreated and younger CLL patients met its primary endpoint. In January 2019, AbbVie announced an update on the Phase 3 RESOLVE study evaluating IMBRUVICA in combination with nab-paclitaxel and gemcitabine versus nab-paclitaxel and gemcitabine combination in patients 28 | 2018 Form 10-K with metastatic pancreatic adenocarcinoma. Results showed the study did not meet its primary endpoint of improving PFS or overall survival (OS) benefit among the study population. Safety data collected from the study were consistent with the existing safety information for the study therapies. In January 2019, the FDA approved IMBRUVICA, in combination with GAZYVA, for adult patients with previously untreated CLL/SLL. VENCLEXTA In January 2018, AbbVie submitted an sNDA to the FDA for VENCLEXTA monotherapy in patients with CLL who are refractory to or have relapsed B-cell receptor pathway inhibitors. In June 2018, the FDA approved VENCLEXTA in combination with Rituxan for the treatment of patients with CLL/SLL, with or without 17p deletion, who have received at least one prior therapy. VENCLEXTA plus Rituxan is the first oral-based, chemotherapy-free combination in CLL that allows patients an option for fixed treatment duration. In September 2018, the FDA expanded the label for VENCLEXTA in combination with Rituxan to include information about patients with previously-treated CLL who achieved minimal residual disease (MRD)-negativity in the Phase 3 MURANO trial. In October 2018, the European Commission approved the type-II variation application for VENCLYXTO in combination with Rituxan for the treatment of patients with R/R CLL who have received at least one prior therapy. In November, AbbVie received notification from the European Commission that conditions of the original conditional marketing authorisation have been fulfilled, granting VENCLYXTO official receipt of approval. In October 2018, AbbVie announced that the results from the Phase 3 CLL14 study comparing the efficacy and safety of VENCLEXTA plus obinutuzumab versus obinutuzumab plus chlorambucil in previously untreated patients with CLL and coexisting medical conditions met its primary endpoint. In November 2018, the FDA granted accelerated approval for VENCLEXTA in combination with azacitidine, or decitabine, or low dose cytarabine (LDAC) for the treatment of newly-diagnosed acute myeloid leukemia (AML) in adults who are age 75 years or older, or who have comorbidities that preclude use of intensive induction chemotherapy. This indication is approved under accelerated approval based on response rates. Continued approval for this indication may be contingent upon verification and description of clinical benefit in confirmatory trials. Rova-T In March 2018, AbbVie announced top-line results from the Phase 2 TRINITY study evaluating rovalpituzumab tesirine (Rova-T) for third-line R/R small cell lung cancer (SCLC). Although Rova-T demonstrated single agent responses in advanced SCLC patients, after consulting with the FDA, based on the magnitude of effect across multiple parameters in this single-arm study, the company will not seek accelerated approval for Rova-T in third-line R/R SCLC. In December 2018, AbbVie announced the decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating Rova-T as a second-line therapy for advanced SCLC. An Independent Data Monitoring Committee recommended stopping enrollment in TAHOE due to shorter overall survival in the Rova-T arm compared with the topotecan control arm. AbbVie will continue its ongoing Phase 3 study of Rova-T in first-line SCLC. Other In November 2018, Bristol-Myers Squibb Company (BMS) announced that the FDA expanded the label for Empliciti in combination with pomalidomide and dexamethasone for the treatment of adult patients with multiple myeloma who have received at least two prior therapies. BMS and AbbVie are co-developing Empliciti, with BMS solely responsible for commercial activities. 2018 Form 10-K | 29 Virology/Liver Disease In November 2018, AbbVie presented EXPEDITION 8 data at the Annual Meeting of the American Association for the Study of Liver Diseases (AASLD), in which 8 weeks of MAVYRET in treatment nave, cirrhotic patients was safe and effective with no virologic failures reported. Neuroscience In March 2018, Biogen and AbbVie announced the voluntary worldwide withdrawal of marketing authorizations for ZINBRYTA, a prescription medicine used to treat adults with relapsing forms of multiple sclerosis. Other In February 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-I study evaluating elagolix, an investigational, orally administered gonadotropin-releasing hormone (GnRH) antagonist, being investigated in combination with low-dose hormone (add-back) therapy for uterine fibroids met its primary efficacy endpoint and all ranked secondary endpoints. In March 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-II study evaluating elagolix in combination with low-dose hormone (add-back) therapy for uterine fibroids met its primary efficacy endpoint and all ranked secondary endpoints. In July 2018, the FDA approved ORILISSA (elagolix) for the management of moderate to severe pain associated with endometriosis. In August 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-EXTEND study evaluating elagolix in combination with low-dose hormone (add-back) therapy for uterine fibroids were consistent with findings observed in the ELARIS UF-I and ELARIS UF-II Phase 3 studies. In October 2018, AbbVie announced that it will assume full development and commercial responsibility for its collaboration with Galapagos to discover and develop new therapies to treat cystic fibrosis (CF). Under a revised agreement, AbbVie will assume full development and commercial responsibility over the investigational program comprising several clinical and pre-clinical compounds originally discovered and developed jointly by AbbVie and Galapagos. Galapagos will not pursue further research and development in CF, but is eligible for future milestones and royalties on commercialized programs. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates for the years ended (dollars in millions) United States $ 21,524 $ 18,251 $ 15,947 17.9 % 14.4 % 17.9 % 14.4 % International 11,229 9,965 9,691 12.8 % 2.8 % 10.4 % 2.1 % Net revenues $ 32,753 $ 28,216 $ 25,638 16.1 % 10.1 % 15.2 % 9.8 % 30 | 2018 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) Immunology HUMIRA United States $ 13,685 $ 12,361 $ 10,432 10.7 % 18.5 % 10.7 % 18.5 % International 6,251 6,066 5,646 3.1 % 7.4 % 0.6 % 6.7 % Total $ 19,936 $ 18,427 $ 16,078 8.2 % 14.6 % 7.4 % 14.4 % Hematologic Oncology IMBRUVICA United States $ 2,968 $ 2,144 $ 1,580 38.4 % 35.8 % 38.4 % 35.8 % Collaboration revenues 45.0 % 70.0 % 45.0 % 70.0 % Total $ 3,590 $ 2,573 $ 1,832 39.5 % 40.5 % 39.5 % 40.5 % VENCLEXTA United States $ $ $ 100.0% 100.0% 100.0% 100.0% International 100.0% 100.0% 100.0% 100.0% Total $ $ $ 100.0% 100.0% 100.0% 100.0% HCV MAVYRET United States $ 1,614 $ $ 100.0% n/m 100.0% n/m International 1,824 100.0% n/m 100.0% n/m Total $ 3,438 $ $ 100.0% n/m 100.0% n/m VIEKIRA United States $ $ $ (96.7 )% (82.8 )% (96.7 )% (82.8 )% International 1,180 (75.6 )% (38.7 )% (74.8 )% (38.6 )% Total $ $ $ 1,522 (77.2 )% (48.6 )% (76.5 )% (48.5 )% Other Key Products Creon United States $ $ $ 11.7 % 13.9 % 11.7 % 13.9 % Lupron United States $ $ $ 8.6 % 0.8 % 8.6 % 0.8 % International 3.4 % 1.4 % 4.7 % 0.5 % Total $ $ $ 7.6 % 0.9 % 7.9 % 0.7 % Synthroid United States $ $ $ (0.6 )% 2.3 % (0.6 )% 2.3 % Synagis International $ $ $ (1.6 )% 1.2 % (2.8 )% 0.6 % AndroGel United States $ $ $ (18.8 )% (14.5 )% (18.8 )% (14.5 )% Duodopa United States $ $ $ 31.4 % 66.1 % 31.4 % 66.1 % International 19.1 % 14.6 % 14.8 % 13.1 % Total $ $ $ 21.2 % 21.1 % 17.7 % 19.8 % Sevoflurane United States $ $ $ (6.2 )% (2.1 )% (6.2 )% (2.1 )% International (4.4 )% (4.6 )% (4.3 )% (3.7 )% Total $ $ $ (4.7 )% (4.1 )% (4.6 )% (3.4 )% Kaletra United States $ $ $ (22.1 )% (38.6 )% (22.1 )% (38.6 )% International (20.2 )% (18.8 )% (20.1 )% (21.1 )% Total $ $ $ (20.5 )% (22.9 )% (20.4 )% (24.7 )% All other $ $ $ 1,199 (63.6 )% (26.9 )% (71.9 )% (27.9 )% Total net revenues $ 32,753 $ 28,216 $ 25,638 16.1 % 10.1 % 15.2 % 9.8 % n/m Not meaningful 2018 Form 10-K | 31 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales increased 7% in 2018 and 14% in 2017 . The sales increases in 2018 and 2017 were driven primarily by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. In the United States, HUMIRA sales increased 11% in 2018 and 18% in 2017 . The sales increase in 2018 and 2017 was driven by market growth across all indications and favorable pricing. Internationally, HUMIRA revenues increased 1% in 2018 and 7% in 2017 . The sales increase in 2018 was driven primarily by market growth across indications partially offset by direct biosimilar competition in Europe following the expiration of the European Union composition of matter patent for adalimumab in October 2018. Due to the entry of biosimilar competition, AbbVie expects international HUMIRA net revenues to decline in 2019. Biosimilar competition for HUMIRA is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability of HUMIRA. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. AbbVie's global IMBRUVICA revenues increased 39% in 2018 and 40% in 2017 as a result of continued penetration of IMBRUVICA as a first-line treatment for patients with CLL as well as favorable pricing. Net revenues for VENCLEXTA increased by more than 100% in 2018 primarily due to market share gains following FDA and EMA approvals of VENCLEXTA in combination with Rituxan for certain patients with R/R CLL. Global MAVYRET sales increased by more than 100% in 2018 as a result of market share gains following the FDA and EMA approvals of MAVYRET in the second half of 2017 as well as further geographic expansion in 2018. Global VIEKIRA sales decreased by 76% in 2018 and 49% in 2017 primarily due to lower market share following the launch of MAVYRET. Net revenues for Creon increased 12% in 2018 and 14% in 2017 , driven primarily by continued market growth, higher market share and favorable pricing. Creon maintains market leadership in the pancreatic enzyme market. AndroGel net revenues decreased 19% in 2018 and 14% in 2017 primarily due to market contraction and the entry of generic competition for the AndroGel 1.62% formulation in October 2018. AbbVie expects net revenues for AndroGel to continue to decline in 2019. Net revenues for Duodopa increased 18% in 2018 and 20% in 2017 , primarily as a result of market penetration. Gross Margin Percent change years ended December 31 (dollars in millions) Gross margin $ 25,035 $ 21,174 $ 19,806 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2018 increased from 2017 primarily due to the reduction of HUMIRA royalty expense and a 2017 intangible asset impairment charge of $354 million partially offset by the IMBRUVICA profit sharing arrangement. Gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017, as well as the unfavorable impacts of higher intangible asset amortization and the IMBRUVICA profit sharing arrangement. These drivers were partially offset by lower amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics as well as favorable changes in product mix and operational efficiencies. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) Selling, general and administrative $ 7,399 $ 6,295 $ 5,881 % % as a percent of net revenues % % % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2018 increased from 2017 primarily due to the unfavorable impacts of new product launch expenses and charitable contributions of $350 million to 32 | 2018 Form 10-K select U.S. not-for-profit organizations in 2018 as part of AbbVie's previously announced plan partially offset by continued leverage from revenue growth. SGA expense percentage in 2017 decreased from 2016 . SGA expense percentage in 2017 was favorably impacted by continued leverage from revenue growth partially offset by litigation reserves charges that increased by $370 million in 2017 compared to the prior year and new product launch expenses. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 10,329 $ 5,007 $ 4,385 100% % as a percent of net revenues % % % Acquired in-process research and development $ $ $ % % Research and Development (RD) expenses in 2018 increased from 2017 principally due to a $5.1 billion intangible asset impairment charge related to IPRD acquired as part of the 2016 Stemcentrx acquisition following the decision to stop enrollment in the TAHOE trial. The impairment was primarily due to lower probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. The remaining increase reflected greater funding to support all stages of the company's pipeline assets. See Note 7 to the Consolidated Financial Statements for additional information regarding the impairment charge. RD expenses in 2017 increased from 2016 principally due to increased funding to support all stages of the companys pipeline assets, the impact of the post-acquisition RD expenses of Stemcentrx and Boehringer Ingelheim (BI) compounds and an increase in development milestones of $63 million . These factors were partially offset by a decrease in acquisition related costs of $135 million . Acquired IPRD expenses reflect upfront payments related to various collaborations. There were no individually significant transactions or cash flows during 2018. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. There were no individually significant transactions or cash flows during 2016. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector agreement. Other Operating Expenses Other operating expenses in 2018 included a $500 million charge related to the extension of the previously announced Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,348 $ 1,150 $ 1,047 Interest income (204 ) (146 ) (82 ) Interest expense, net $ 1,144 $ 1,004 $ Net foreign exchange loss $ $ $ Other expense, net Interest expense in 2018 increased compared to 2017 primarily due to the unfavorable impact of higher interest rates on the company's debt obligations and a higher average outstanding debt balance during 2018. Interest expense in 2017 increased compared to 2016 due to a full year of expense associated with the May 2016 issuance of $7.8 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Stemcentrx and to repay an outstanding term loan. Interest income in 2018 increased compared to 2017 primarily due to higher interest rates. Interest income in 2017 increased compared to 2016 primarily due to growth in the companys investment securities. 2018 Form 10-K | 33 Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Net foreign exchange loss in 2016 included losses totaling $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. See Note 10 to the Consolidated Financial Statements for additional information regarding the Venezuelan devaluation. Other expense, net included charges related to the change in fair value of the BI and Stemcentrx contingent consideration liabilities of $49 million in 2018 , $626 million in 2017 and $228 million in 2016 . The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2018 , the BI contingent consideration liability increased due to the passage of time and higher estimated future sales partially offset by the effect of rising interest rates. The increase in the BI contingent consideration liability was primarily offset by a $428 million decrease in the Stemcentrx contingent consideration liability recorded during the fourth quarter of 2018 due to a reduction in probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. In 2017 , the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. In 2016 , the change in fair value represented mainly the passage of time, as increases to the BI contingent consideration liability due to higher probabilities of success were fully offset by the effects of rising interest rates and changes in other market-based assumptions. See Note 5 to the Consolidated Financial Statements for additional information regarding the acquisitions of Stemcentrx and BI compounds. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million. Income Tax Expense The effective income tax rate was negative 9% in 2018 , was 31% in 2017 and was 24% in 2016 . The effective tax rate in each period differed from the statutory tax rate principally due to the allocation of the company's taxable earnings among jurisdictions, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, and business development activities. The effective tax rate for 2018 reflects the impact of the effective date of provisions of the Tax Cuts and Jobs Act (the Act) related to the earnings from certain foreign subsidiaries and the effects of Stemcentrx intangible impairment related expenses. Given these factors, the effective income tax rate may change significantly in future periods. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. The Act significantly changed the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system that included new taxes on certain foreign sourced earnings. See Note 13 to the Consolidated Financial Statements for additional information regarding the Act. The effective tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 13,427 $ 9,960 $ 7,041 Investing activities (1,006 ) (274 ) (6,074 ) Financing activities (14,396 ) (5,512 ) (3,928 ) Operating cash flows in 2018 increased from 2017 primarily due to improved results of operations from revenue growth and a decrease in income tax payments. Operating cash flows in 2017 increased from 2016 primarily due to improved results of operations resulting from revenue growth, an improvement in operating earnings and a decrease in income tax payments. Realized excess tax benefits associated with stock-based compensation totaled $78 million in 2018 and $71 million in 2017 and were presented within operating cash flows as a result of the adoption of a new accounting pronouncement. Prior to the adoption of the new accounting pronouncement, realized excess benefits of $55 million in 2016 were presented within cash flows from financing activities. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $873 million in 2018, $246 million in 2017 and $273 million in 2016. 34 | 2018 Form 10-K Investing cash flows in 2018 included payments made for other acquisitions and investments of $736 million and capital expenditures of $638 million , partially offset by net sales and maturities of investment securities totaling $368 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Investing cash flows in 2016 primarily included $1.9 billion of cash consideration paid to acquire Stemcentrx in June 2016, a $595 million upfront payment to acquire certain rights from BI in April 2016, net purchases of investment securities totaling $3.0 billion and capital expenditures of $479 million . In 2018 , 2017 and 2016 , the company issued and redeemed commercial paper. The balance of commercial paper outstanding was $699 million as of December 31, 2018 and $400 million as of December 31, 2017 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Financing cash flows in 2018 also included proceeds from the issuance of a $3.0 billion 364 -day term loan credit agreement (term loan) entered into in May 2018 . In June 2018, the company drew on this term loan and as of December 31, 2018 , $3.0 billion was outstanding and was included in short-term borrowings on the consolidated balance sheet. Borrowings under the term loan bear interest at one month LIBOR plus applicable margin. The term loan may be prepaid without penalty upon prior notice and contains customary covenants, all of which the company was in compliance with as of December 31, 2018 . In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. The company intends to use the remaining proceeds to repay term loan obligations in 2019 as they become due. Financing cash flows in 2018 also included the May 2018 repayment of $3.0 billion aggregate principal amount of the company's 1.80% senior notes at maturity. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. In May 2016, the company issued $7.8 billion aggregate principal amount of senior notes. Approximately $2.0 billion of the net proceeds were used to repay an outstanding term loan that was due to mature in November 2016, approximately $1.9 billion of the net proceeds were used to finance the acquisition of Stemcentrx and approximately $3.8 billion of the net proceeds were used to finance an accelerated share repurchase (ASR). See Note 12 to the Consolidated Financial Statements for additional information on the 2016 ASR transaction. Cash dividend payments totaled $5.6 billion in 2018 , $4.1 billion in 2017 and $3.7 billion in 2016 . The increase in cash dividend payments was primarily driven by an increase in the dividend rate. On November 2, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.96 per share to $1.07 per share beginning with the dividend payable on February 15, 2019 to stockholders of record as of January 15, 2019. This reflects an increase of approximately 11.5% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. The new stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased approximately 109 million shares for $10.7 billion in 2018. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $4.3 billion as of December 31, 2018 . Under previous stock repurchase programs, AbbVie made open market share repurchases of approximately 11 million shares for $1.3 billion in 2018, approximately 13 million shares for $1.0 billion in 2017 and approximately 34 million shares for $2.1 billion in 2016 . AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017 and cash-settled $300 million of its December 2015 open market purchases in January 2016. In 2018, AbbVie paid $100 million of contingent consideration to BI related to BLA and MAA acceptance milestones. $78 million of these payments were included in financing cash flows and $22 million of the payments were included in operating cash flows. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. 2018 Form 10-K | 35 Cash and equivalents were impacted by net unfavorable exchange rate changes totaling $39 million in 2018 , net favorable exchange rate changes totaling $29 million in 2017 and net unfavorable exchange rate changes totaling $338 million in 2016 . The unfavorable exchange rate changes in 2018 were primarily due to the weakening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The favorable exchange rate changes in 2017 were primarily due to the strengthening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The unfavorable exchange rate changes in 2016 were primarily due to the devaluation of AbbVie's net monetary assets denominated in the Venezuelan bolivar. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility In August 2018, AbbVie replaced its existing revolving credit facility with a new $3.0 billion five -year revolving credit facility. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2018 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. No amounts were outstanding under the credit facility as of December 31, 2018 and 2017 . Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes in the companys credit ratings during 2018 . Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt obligations. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2018 : (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ 3,699 $ 3,699 $ $ $ Long-term debt and capital lease obligations, including current portion 37,360 1,612 6,808 6,370 22,570 Interest on long-term debt (a) 17,204 1,433 2,613 2,024 11,134 Future minimum non-cancelable operating lease commitments Purchase obligations and other (b) 1,843 1,710 Other long-term liabilities (c) (d) (e) (f) 9,994 1,392 1,478 6,388 Total $ 70,909 $ 9,306 $ 11,128 $ 10,038 $ 40,437 36 | 2018 Form 10-K (a) Includes estimated future interest payments on long-term debt and capital lease obligations. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2018 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2018 . See Note 9 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 10 for additional information on the interest rate swap agreements outstanding at December 31, 2018 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Amounts less than one year includes a voluntary contribution of $150 million that AbbVie made to its principal domestic defined benefit plan subsequent to December 31, 2018 . Amounts otherwise exclude pension and other post-employment benefits and related deferred compensation cash outflows. Timing of future funding is uncertain and dependent on future movements in interest rates and investment returns, changes in laws and regulations and other variables. Also included in this amount are components of other long-term liabilities including restructuring. See Note 8 to the Consolidated Financial Statements for additional information on restructuring and Note 11 for additional information on the pension and other post-employment benefit plans. (d) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 13 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (e) Includes $4.5 billion of contingent consideration liabilities primarily related to the acquisition of BI compounds which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Notes 5 and 10 to the Consolidated Financial Statements for additional information regarding these liabilities. (f) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 13 to the Consolidated Financial Statements for additional information regarding these tax liabilities. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. 2018 Form 10-K | 37 Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $16.4 billion in 2018 , $12.9 billion in 2017 and $10.8 billion in 2016 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 91% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2018 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2015 $ 1,032 $ $ Provisions 2,606 3,146 3,987 Payments (2,471 ) (2,899 ) (3,967 ) Balance at December 31, 2016 1,167 1,167 Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 1,340 1,195 Provisions 3,493 4,729 6,659 Payments (3,188 ) (4,485 ) (6,525 ) Balance at December 31, 2018 $ 1,645 $ 1,439 $ Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.6 billion in 2018 , $1.3 billion in 2017 and $964 million in 2016 , are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 11 to the Consolidated Financial Statements . 38 | 2018 Form 10-K The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. Beginning in 2016, AbbVie also reflected the plans' specific cash flows and applied them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2018 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2019 and projected benefit obligations as of December 31, 2018 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (54 ) $ Projected benefit obligation (512 ) Other post-employment plans Service and interest cost $ (2 ) $ Projected benefit obligation (47 ) The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2018 and will be used in the calculation of net periodic benefit cost in 2019 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2019 by $62 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2018 and will be used in the calculation of net periodic benefit cost in 2019 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2019 and the projected benefit obligation as of December 31, 2018 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (9 ) Projected benefit obligation (87 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 14 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum 2018 Form 10-K | 39 loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2018 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $160 million . Additionally, at December 31, 2018 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $420 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 40 | 2018 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2018 and 2017 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,660 1.157 $ $ 6,366 1.175 $ (88 ) Japanese yen 1,076 111.5 (12 ) 112.4 British pound 1.328 1.310 (22 ) All other currencies 1,776 n/a 1,877 n/a (18 ) Total $ 10,011 $ $ 9,943 $ (126 ) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.0 billion at December 31, 2018 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes, which are exposed to foreign currency risk. The company has designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 9 to the Consolidated Financial Statements for additional information related to the senior Euro note issuance and Note 10 to the Consolidated Financial Statements for additional information related to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $403 million at December 31, 2018 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $2.4 billion at December 31, 2018 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. Market Price Risk AbbVies debt securities investment portfolio (the portfolio) is its main exposure to market price risk. The portfolio is subject to changes in fair value as a result of interest rate fluctuations and other market factors. It is AbbVies policy to mitigate market price risk by maintaining a diversified portfolio that limits the amount of exposure to a particular issuer and security type while placing limits on the amount of time to maturity. AbbVies investment policy limits investments to investment grade credit ratings. The company estimates that an increase in interest rates of 100 basis points would decrease the fair value of the portfolio by approximately $16 million as of December 31, 2018 . If the portfolio were to be liquidated, the fair value reduction would affect the statement of earnings in the period sold. 2018 Form 10-K | 41 "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 42 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 32,753 $ 28,216 $ 25,638 Cost of products sold 7,718 7,042 5,832 Selling, general and administrative 7,399 6,295 5,881 Research and development 10,329 5,007 4,385 Acquired in-process research and development Other expense Total operating costs and expenses 26,370 18,671 16,298 Operating earnings 6,383 9,545 9,340 Interest expense, net 1,144 1,004 Net foreign exchange loss Other expense, net Earnings before income taxes 5,197 7,727 7,884 Income tax expense (benefit) (490 ) 2,418 1,931 Net earnings $ 5,687 $ 5,309 $ 5,953 Per share data Basic earnings per share $ 3.67 $ 3.31 $ 3.65 Diluted earnings per share $ 3.66 $ 3.30 $ 3.63 Weighted-average basic shares outstanding 1,541 1,596 1,622 Weighted-average diluted shares outstanding 1,546 1,603 1,631 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 43 AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 5,687 $ 5,309 $ 5,953 Foreign currency translation adjustments, net of tax expense (benefit) of $(18) in 2018, $34 in 2017 and $(31) in 2016 (391 ) (165 ) Net investment hedging activities, net of tax expense (benefit) of $40 in 2018, $(194) in 2017 and $79 in 2016 (343 ) Pension and post-employment benefits, net of tax expense (benefit) of $35 in 2018, $(94) in 2017 and $(75) in 2016 (406 ) (135 ) Marketable security activities, net of tax expense (benefit) of $ in 2018, $(8) in 2017 and $(11) in 2016 (10 ) (46 ) (1 ) Cash flow hedging activities, net of tax expense (benefit) of $23 in 2018, $(26) in 2017 and $18 in 2016 (342 ) Other comprehensive income (loss) (141 ) (25 ) Comprehensive income $ 5,934 $ 5,168 $ 5,928 The accompanying notes are an integral part of these consolidated financial statements. 44 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 7,289 $ 9,303 Short-term investments Accounts receivable, net 5,384 5,088 Inventories 1,605 1,605 Prepaid expenses and other 1,895 4,741 Total current assets 16,945 21,223 Investments 1,420 2,090 Property and equipment, net 2,883 2,803 Intangible assets, net 21,233 27,559 Goodwill 15,663 15,785 Other assets 1,208 1,326 Total assets $ 59,352 $ 70,786 Liabilities and Equity Current liabilities Short-term borrowings $ 3,699 $ Current portion of long-term debt and lease obligations 1,609 6,015 Accounts payable and accrued liabilities 11,931 10,226 Total current liabilities 17,239 16,641 Long-term debt and lease obligations 35,002 30,953 Deferred income taxes 1,067 2,490 Other long-term liabilities 14,490 15,605 Commitments and contingencies Stockholders equity (deficit) Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,776,510,871 shares issued as of December 31, 2018 and 1,768,738,550 as of December 31, 2017 Common stock held in treasury, at cost, 297,686,473 shares as of December 31, 2018 and 176,607,525 as of December 31, 2017 (24,108 ) (11,923 ) Additional paid-in-capital 14,756 14,270 Retained earnings 3,368 5,459 Accumulated other comprehensive loss (2,480 ) (2,727 ) Total stockholders equity (deficit) (8,446 ) 5,097 Total liabilities and equity $ 59,352 $ 70,786 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 45 AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2015 1,610 $ $ (8,839 ) $ 13,080 $ 2,248 $ (2,561 ) $ 3,945 Net earnings 5,953 5,953 Other comprehensive loss, net of tax (25 ) (25 ) Dividends declared (3,823 ) (3,823 ) Common shares issued to Stemcentrx stockholders 3,958 (35 ) 3,923 Purchases of treasury stock (94 ) (6,018 ) (6,018 ) Stock-based compensation plans and other Balance at December 31, 2016 1,593 (10,852 ) 13,678 4,378 (2,586 ) 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax (141 ) (141 ) Dividends declared (4,221 ) (4,221 ) Purchases of treasury stock (15 ) (1,125 ) (1,125 ) Stock-based compensation plans and other (7 ) Balance at December 31, 2017 1,592 (11,923 ) 14,270 5,459 (2,727 ) 5,097 Adoption of new accounting standards (a) (1,733 ) (1,733 ) Net earnings 5,687 5,687 Other comprehensive income, net of tax Dividends declared (6,045 ) (6,045 ) Purchases of treasury stock (121 ) (12,215 ) (12,215 ) Stock-based compensation plans and other Balance at December 31, 2018 1,479 $ $ (24,108 ) $ 14,756 $ 3,368 $ (2,480 ) $ (8,446 ) (a) See Note 2 for additional information regarding the cumulative effect of the adoption of accounting standards in 2018. The accompanying notes are an integral part of these consolidated financial statements. 46 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 5,687 $ 5,309 $ 5,953 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,294 1,076 Change in fair value of contingent consideration liabilities Stock-based compensation Upfront costs and milestones related to collaborations 1,061 Devaluation loss related to Venezuela Intangible asset impairment 5,070 Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (591 ) (391 ) (71 ) Inventories (226 ) (38 ) Prepaid expenses and other assets (499 ) (118 ) (393 ) Accounts payable and other liabilities (1,187 ) Cash flows from operating activities 13,427 9,960 7,041 Cash flows from investing activities Acquisition of businesses, net of cash acquired (2,495 ) Other acquisitions and investments (736 ) (308 ) (262 ) Acquisitions of property and equipment (638 ) (529 ) (479 ) Purchases of investment securities (1,792 ) (2,230 ) (5,315 ) Sales and maturities of investment securities 2,160 2,793 2,359 Other Cash flows from investing activities (1,006 ) (274 ) (6,074 ) Cash flows from financing activities Net change in commercial paper borrowings (23 ) Proceeds from issuance of other short-term borrowings 3,002 Proceeds from issuance of long-term debt 5,963 11,627 Repayments of long-term debt and lease obligations (6,035 ) (25 ) (6,010 ) Debt issuance costs (40 ) (69 ) Dividends paid (5,580 ) (4,107 ) (3,717 ) Purchases of treasury stock (12,014 ) (1,410 ) (6,033 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities (78 ) (268 ) Other, net Cash flows from financing activities (14,396 ) (5,512 ) (3,928 ) Effect of exchange rate changes on cash and equivalents (39 ) (338 ) Net change in cash and equivalents (2,014 ) 4,203 (3,299 ) Cash and equivalents, beginning of year 9,303 5,100 8,399 Cash and equivalents, end of year $ 7,289 $ 9,303 $ 5,100 Other supplemental information Interest paid, net of portion capitalized $ 1,215 $ 1,099 $ Income taxes paid (received) (35 ) 1,696 3,563 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 3,923 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 47 AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. 48 | 2018 Form 10-K In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaboration with Janssen Biotech, Inc. Additionally, see Note 15 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $1.1 billion in 2018 , $846 million in 2017 and $764 million in 2016 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive loss (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to- 2018 Form 10-K | 49 maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. AbbVie periodically assesses its marketable debt securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other-than-temporary decline has occurred, the cost basis of the investment is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $51 million at December 31, 2018 and $58 million at December 31, 2017 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process Raw materials Inventories $ 1,605 $ 1,605 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,603 1,428 Equipment 6,362 5,991 Construction in progress Property and equipment, gross 8,396 8,071 Less accumulated depreciation (5,513 ) (5,268 ) Property and equipment, net $ 2,883 $ 2,803 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $471 million in 2018 , $425 million in 2017 and $425 million in 2016 . Assets related to capital leases were insignificant at December 31, 2018 and 2017 . Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information 50 | 2018 Form 10-K becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that r esults of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed twelve months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are 2018 Form 10-K | 51 remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2014-09 In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40) . The amendments in this standard superseded most existing revenue recognition requirements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AbbVie adopted the standard in the first quarter of 2018 using the modified retrospective method. Results for reporting periods beginning after December 31, 2017 have been presented in accordance with the standard, while results for prior periods have not been adjusted and continue to be reported in accordance with AbbVies historical accounting. The cumulative effect of initially applying the new revenue standard was recognized as an adjustment to the opening balance of retained earnings as of January 1, 2018. There were no significant changes to the amounts or timing of revenue recognition for product sales, the company's primary revenue stream. For certain licensing arrangements where revenue was previously deferred and recognized over time, revenue is now recognized at the point in time when the license is granted. Additionally, for certain contract manufacturing arrangements where revenue was previously recognized at a point in time at the end of the manufacturing process, revenue is now recognized over time throughout the manufacturing process. Under the new standard, on January 1, 2018, the company recognized a cumulative-effect adjustment to retained earnings primarily related to certain deferred license revenues that were originally expected to be recognized through early 2020. The adjustment to the consolidated balance sheet included: (i) a $42 million increase to prepaid expenses and other; (ii) a $39 million decrease to inventories; (iii) a $57 million decrease to accounts payable and accrued liabilities; (iv) a $75 million decrease to other long-term liabilities; (v) a $22 million increase to deferred income taxes; and (vi) a $124 million increase to retained earnings. Other cumulative-effect adjustments to the consolidated balance sheet were insignificant. 52 | 2018 Form 10-K The impact of adoption on the companys consolidated statements of earnings in 2018 was as follows: year ended December 31, 2018 (in millions, except per share data) As Reported Balances Without Adoption of ASU 2014-09 Effect of Change Higher/(Lower) Net revenues $ 32,753 $ 32,812 $ (59 ) Cost of products sold 7,718 7,730 (12 ) Income tax benefit (490 ) (487 ) (3 ) Net earnings 5,687 5,731 (44 ) Diluted earnings per share $ 3.66 $ 3.69 $ (0.03 ) As of December 31, 2018 , due to the impact of the adoption of ASU 2014-09, prepaid expenses and other were $40 million higher, inventories were $27 million lower, accounts payable and accrued liabilities were $53 million lower, other long-term liabilities were $18 million lower, deferred income taxes were $11 million higher and retained earnings were $80 million higher on the companys consolidated balance sheet than they would have been had ASU 2014-09 not been adopted. Other impacts to the consolidated balance sheet were insignificant. ASU No. 2016-01 In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . The standard requires several targeted changes including that equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net earnings. AbbVie adopted the standard in the first quarter of 2018. The adoption did not impact the accounting for AbbVie's investments in debt securities and did not have a material impact on the company's consolidated financial statements. ASU No. 2016-16 In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The standard requires entities to recognize the income tax consequences of an intercompany transfer of an asset other than inventory when the transfer occurs. Under previous U.S. GAAP, the income tax consequences of these intercompany asset transfers were deferred until the asset was sold to a third party or otherwise recovered through use. AbbVie adopted the standard in the first quarter of 2018 using the modified retrospective method. As a result, on January 1, 2018, the company recorded a cumulative-effect adjustment to its consolidated balance sheet that included a $1.9 billion decrease to retained earnings, a $1.4 billion decrease to prepaid expenses and other and a $0.5 billion decrease to other assets. ASU No. 2017-07 In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . The standard requires that an employer continue to report the service cost component of net periodic benefit cost in the same income statement line item or items as other employee compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented separately outside of income from operations and are not eligible for capitalization. AbbVie adopted the standard in the first quarter of 2018 and applied the income statement classification provisions of this standard retrospectively. As a result, the company reclassified income of $47 million from operating earnings to non-operating income in 2017 and $44 million in 2016. Additionally, the company recorded approximately $34 million of non-operating income in 2018 which would have been recorded in operating earnings under the previous guidance. ASU No. 2017-12 In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The standard simplifies the application of hedge accounting and more closely aligns the accounting with an entitys risk management activities. AbbVie elected to early adopt the standard in the first quarter of 2018. The adoption did not have a material impact on the company's consolidated financial statements. 2018 Form 10-K | 53 Recent Accounting Pronouncements Not Yet Adopted ASU No. 2016-02 In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The standard outlines a comprehensive lease accounting model that supersedes the current lease guidance and requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changes the definition of a lease and expands the disclosure requirements of lease arrangements. AbbVie has substantially completed its assessment of the new standard as of December 31, 2018. AbbVie will adopt the standard effective in the first quarter of 2019 and will not restate comparative periods upon adoption. AbbVie will elect a package of practical expedients for leases that commenced prior to January 1, 2019 and will not reassess: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. AbbVie does not expect the adoption will have a material impact on its consolidated statement of earnings. However, the new standard will require AbbVie to establish liabilities and corresponding right-of-use assets on its consolidated balance sheet of approximately $0.3 billion to $0.5 billion for operating leases that exist as of the adoption date. ASU No. 2016-13 In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. Early adoption beginning in the first quarter of 2019 is permitted. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. ASU No. 2018-02 In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from AOCI to retained earnings for stranded tax effects related to adjustments to deferred taxes resulting from the December 2017 enactment of the Tax Cuts and Jobs Act. The standard will be effective for AbbVie starting with the first quarter of 2019. AbbVie is currently assessing the impact of adopting this guidance on its consolidated financial statements. 54 | 2018 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,348 $ 1,150 $ 1,047 Interest income (204 ) (146 ) (82 ) Interest expense, net $ 1,144 $ 1,004 $ Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 3,939 $ 3,069 Dividends payable 1,607 1,143 Accounts payable 1,546 1,474 Salaries, wages and commissions Royalty and license arrangements Other 3,748 3,263 Accounts payable and accrued liabilities $ 11,931 $ 10,226 Other Long-Term Liabilities as of December 31 (in millions) Income taxes payable $ 4,311 $ 4,675 Contingent consideration liabilities 4,306 4,266 Liabilities for unrecognized tax benefits 2,726 2,683 Pension and other post-employment benefits 1,840 2,740 Other 1,307 1,241 Other long-term liabilities $ 14,490 $ 15,605 Note 4 Earnings Per Share AbbVie grants certain restricted stock awards (RSAs) and restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2018 Form 10-K | 55 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share information) Basic EPS Net earnings $ 5,687 $ 5,309 $ 5,953 Earnings allocated to participating securities Earnings available to common shareholders $ 5,657 $ 5,283 $ 5,923 Weighted-average basic shares outstanding 1,541 1,596 1,622 Basic earnings per share $ 3.67 $ 3.31 $ 3.65 Diluted EPS Net earnings $ 5,687 $ 5,309 $ 5,953 Earnings allocated to participating securities Earnings available to common shareholders $ 5,657 $ 5,283 $ 5,923 Weighted-average shares of common stock outstanding 1,541 1,596 1,622 Effect of dilutive securities Weighted-average diluted shares outstanding 1,546 1,603 1,631 Diluted earnings per share $ 3.66 $ 3.30 $ 3.63 As further described in Note 12 , AbbVie entered into and executed an accelerated share repurchase agreement (ASR) with a third party financial institution in 2016. For purposes of calculating EPS, AbbVie reflected the ASR as a repurchase of AbbVie common stock. Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Stemcentrx On June 1, 2016, AbbVie acquired all of the outstanding equity interests in Stemcentrx, a privately-held biotechnology company. The transaction expanded AbbVies oncology pipeline by adding the late-stage asset rovalpituzumab tesirine (Rova-T), four additional early-stage clinical compounds in solid tumor indications and a significant portfolio of pre-clinical assets. Rova-T is currently in registrational trials for small cell lung cancer. The acquisition of Stemcentrx was accounted for as a business combination using the acquisition method of accounting. The aggregate upfront consideration for the acquisition of Stemcentrx consisted of approximately 62.4 million shares of AbbVie common stock, issued from common stock held in treasury, and cash. AbbVie may make certain contingent payments upon the achievement of defined development and regulatory milestones. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was $4.0 billion . The acquisition-date fair value of these milestones was $620 million and was estimated using a combination of probability-weighted discounted cash flow models and Monte Carlo simulation models. The estimate was determined based on significant inputs that are not observable in the market, referred to as Level 3 inputs, as described in more detail in Note 10 . The following table summarizes total consideration: (in millions) Cash $ 1,883 Fair value of AbbVie common stock 3,923 Contingent consideration Total consideration $ 6,426 56 | 2018 Form 10-K The following table summarizes fair values of assets acquired and liabilities assumed as of the June 1, 2016 acquisition date: (in millions) Assets acquired and liabilities assumed Accounts receivable $ Prepaid expenses and other Property and equipment Intangible assets - Indefinite-lived research and development 6,100 Accounts payable and accrued liabilities (31 ) Deferred income taxes (1,933 ) Other long-term liabilities (7 ) Total identifiable net assets 4,154 Goodwill 2,272 Total assets acquired and liabilities assumed $ 6,426 Intangible assets were related to IPRD for Rova-T, four additional early-stage clinical compounds in solid tumor indications and several additional pre-clinical compounds. The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of those asset valuations include the estimated annual cash flows for each asset or product (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. See Note 7 for additional information on the 2018 partial impairment of Stemcentrx-related intangible assets. The goodwill recognized represented expected synergies, including the ability to: (i) leverage the respective strengths of each business; (ii) expand the combined companys product portfolio; (iii) accelerate AbbVie's clinical and commercial presence in oncology; and (iv) establish a strong leadership position in oncology. Goodwill was also impacted by the establishment of a deferred tax liability for the acquired identifiable intangible assets which have no tax basis. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Stemcentrx have been included in the company's financial statements. AbbVies consolidated statement of earnings for the year ended December 31, 2016 included no net revenues and an operating loss of $165 million associated with Stemcentrx's operations. This operating loss included $43 million of post-acquisition stock-based compensation expense for Stemcentrx options and excluded interest expense and certain acquisition costs. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Stemcentrx for the year ended December 31, 2016 as if the acquisition of Stemcentrx had occurred on January 1, 2015: year ended December 31 (in millions, except per share information) Net revenues $ 25,641 Net earnings 5,907 Basic earnings per share $ 3.58 Diluted earnings per share $ 3.56 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Stemcentrx. In order to reflect the occurrence of the acquisition on January 1, 2015 as required, the unaudited pro forma financial information includes adjustments to reflect the additional interest expense associated with the issuance of debt to finance the acquisition and the reclassification of acquisition, integration and financing-related costs incurred during the year ended December 31, 2016 to the year ended December 31, 2018 Form 10-K | 57 2015. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2015. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Acquisition of BI 655066 and BI 655064 from Boehringer Ingelheim On April 1, 2016, AbbVie acquired all rights to risankizumab (BI 655066), an anti-IL-23 monoclonal biologic antibody in Phase 3 development for psoriasis, from Boehringer Ingelheim (BI) pursuant to a global collaboration agreement. AbbVie is also evaluating the potential of this biologic therapy in other indications, including Crohns disease, psoriatic arthritis and ulcerative colitis. In addition to risankizumab, AbbVie also gained rights to an anti-CD40 antibody, BI 655064, currently in Phase 1 development. BI will retain responsibility for further development of BI 655064, and AbbVie may elect to advance the program after completion of certain clinical achievements. The acquired assets include all patents, data, know-how, third-party agreements, regulatory filings and manufacturing technology related to BI 655066 and BI 655064. The company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. Under the terms of the agreement, AbbVie made an upfront payment of $595 million . Additionally, $18 million of payments to BI, pursuant to a contractual obligation to reimburse BI for certain development costs it incurred prior to the acquisition date, were initially deferred. AbbVie may make certain contingent payments upon the achievement of defined development, regulatory and commercial milestones, as well as royalty payments based on net revenues of licensed products. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was approximately $1.6 billion . The acquisition-date fair value of these milestones was $606 million . The acquisition-date fair value of contingent royalty payments was $2.8 billion . The potential contingent consideration payments were estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs. The following table summarizes total consideration: (in millions) Cash $ Deferred consideration payable Contingent consideration 3,365 Total consideration $ 3,978 The following table summarizes fair values of assets acquired as of the April 1, 2016 acquisition date: (in millions) Assets acquired Identifiable intangible assets - Indefinite-lived research and development $ 3,890 Goodwill Total assets acquired $ 3,978 The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach. The goodwill recognized represented expected synergies, including an expansion of the companys immunology product portfolio. Pro forma results of operations for this acquisition have not been presented because this acquisition was insignificant to AbbVies consolidated results of operations. Other Licensing Acquisitions Activity Excluding the acquisitions above, cash outflows related to other acquisitions and investments totaled $736 million in 2018 , $308 million in 2017 and $262 million in 2016 . AbbVie recorded acquired IPRD charges of $424 million in 2018 , $327 million in 2017 and $200 million in 2016 . Significant arrangements impacting 2018 , 2017 and 2016 , some of which require contingent milestone payments, are summarized below. 58 | 2018 Form 10-K Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $500 million to the collaboration and the term is extended for an additional 3 years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018 , AbbVie recorded $500 million in other expense in the consolidated statement of earnings related to its commitments under the agreement. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $424 million in 2018 , $122 million in 2017 and $200 million in 2016 . In connection with the other individually insignificant early-stage arrangements entered into in 2018 , AbbVie could make additional payments of up to $4.8 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60% of collaboration development costs and AbbVie is responsible for the remaining 40% of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. 2018 Form 10-K | 59 The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,372 $ 1,001 $ International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) AbbVies receivable from Janssen, included in accounts receivable, net, was $177 million at December 31, 2018 and $124 million at December 31, 2017 . AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $376 million at December 31, 2018 and $253 million at December 31, 2017 . Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2016 $ 15,416 Foreign currency translation Balance as of December 31, 2017 15,785 Foreign currency translation (122 ) Balance as of December 31, 2018 $ 15,663 The latest impairment assessment of goodwill was completed in the third quarter of 2018 . As of December 31, 2018 , there were no accumulated goodwill impairment losses. Future impairment tests for goodwill will be performed annually in the third quarter, or earlier if impairment indicators exist. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 15,872 $ (5,614 ) $ 10,258 $ 16,138 $ (4,982 ) $ 11,156 License agreements 7,865 (1,810 ) 6,055 7,822 (1,409 ) 6,413 Total definite-lived intangible assets 23,737 (7,424 ) 16,313 23,960 (6,391 ) 17,569 Indefinite-lived research and development 4,920 4,920 9,990 9,990 Total intangible assets, net $ 28,657 $ (7,424 ) $ 21,233 $ 33,950 $ (6,391 ) $ 27,559 Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2018 and 2017 related to the acquisitions of Stemcentrx and BI compounds. See Note 5 for additional information. The latest annual impairment assessment of indefinite-lived intangible assets was completed in the third quarter of 2018 which supported that no impairment existed at that time. During the fourth quarter of 2018, the company made a decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating Rova-T as a second-line therapy for advanced small cell lung cancer following a recommendation from an Independent Data Monitoring Committee. This decision lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets and represented a triggering event which required the company to evaluate for impairment the IPRD assets associated with the Stemcentrx acquisition. The company utilized multi-period excess earnings models of the income approach and determined that the current fair value was $1.0 billion as of December 31, 2018 , which was lower than the carrying value of $6.1 billion and resulted in a pre-tax impairment charge of $5.1 billion ( $4.5 billion after 60 | 2018 Form 10-K tax). The fair value measurements were based on Level 3 inputs. Some of the more significant assumptions inherent in the development of the models included the estimated annual cash flows for each asset (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2018 . AbbVie continues to evaluate information as it becomes available with respect to the Stemcentrx-related clinical development programs and will monitor the remaining IPRD assets for further impairment. No indefinite-lived intangible asset impairment charges were recorded in 2017 and 2016 . Future impairment tests for indefinite-lived intangible assets will be performed annually in the third quarter, or earlier if impairment indicators exist. Definite-Lived Intangible Assets Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 11 years for both developed product rights and license agreements. Amortization expense was $1.3 billion in 2018 , $1.1 billion in 2017 and $764 million in 2016 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2018 is as follows: (in billions) Anticipated annual amortization expense $ 1.5 $ 1.7 $ 1.9 $ 2.1 $ 2.2 No definite-lived intangible asset impairment charges were recorded in 2018 . In 2017 , an impairment charge of $354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. In 2016 , an impairment charge of $39 million was recorded related to certain developed product rights in the United States due to a decline in the market for the product. The 2017 and 2016 impairment charges were based on discounted cash flow analyses and were included in cost of products sold in the consolidated statements of earnings. Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2018 , 2017 and 2016 , no such plans were individually significant. Restructuring charges recorded were $70 million in 2018 , $86 million in 2017 and $52 million in 2016 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. The following table summarizes the cash activity in the restructuring reserve for 2018 , 2017 and 2016 : (in millions) Accrued balance as of December 31, 2015 $ 2016 restructuring charges Payments and other adjustments (113 ) Accrued balance as of December 31, 2016 2017 restructuring charges Payments and other adjustments (87 ) Accrued balance as of December 31, 2017 2018 restructuring charges Payments and other adjustments (46 ) Accrued balance as of December 31, 2018 $ 2018 Form 10-K | 61 Note 9 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2018 (a) Effective interest rate in 2017 (a) Senior notes issued in 2012 2.00% notes due 2018 2.15 % $ 2.15 % $ 1,000 2.90% notes due 2022 2.97 % 3,100 2.97 % 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 1.80% notes due 2018 1.92 % 1.92 % 3,000 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.38% notes due 2019 (1,400 principal) 0.55 % 1,604 0.55 % 1,673 1.38% notes due 2024 (1,450 principal) 1.46 % 1,661 1.46 % 1,733 2.13% notes due 2028 (750 principal) 2.18 % 2.18 % Senior notes issued in 2018 3.375% notes due 2021 3.51 % 1,250 % 3.75% notes due 2023 3.84 % 1,250 % 4.25% notes due 2028 4.38 % 1,750 % 4.875% notes due 2048 4.94 % 1,750 % Term loan facilities Floating rate notes due 2018 3.06 % 2.26 % 2,000 Other Fair value hedges (466 ) (401 ) Unamortized bond discounts (120 ) (97 ) Unamortized deferred financing costs (163 ) (146 ) Total long-term debt and lease obligations 36,611 36,968 Current portion 1,609 6,015 Noncurrent portion $ 35,002 $ 30,953 (a) Excludes the effect of any related interest rate swaps. In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes, consisting of $1.25 billion aggregate principal amount of 3.375% senior notes due 2021, $1.25 billion aggregate principal amount of 3.75% senior notes due 2023, $1.75 billion aggregate principal amount of 4.25% senior notes due 2028 and $1.75 billion aggregate principal amount of 4.875% senior notes due 2048. These senior notes rank equally with all other unsecured and 62 | 2018 Form 10-K unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375% notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $37 million and debt discounts totaled $37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three -year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. The company intends to use the remaining proceeds to repay term loan obligations in 2019 as they become due. In May 2018, the company also repaid $3.0 billion aggregate principal amount of 1.80% senior notes at maturity. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $17 million and debt discounts totaled $9 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. As a result of this redemption, the company incurred a charge of $39 million ( $25 million after tax) related to the make-whole premium, write-off of unamortized debt issuance costs and other expenses. The charge was recorded in interest expense, net in the consolidated statement of earnings. In May 2016, the company issued $7.8 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $52 million and debt discounts totaled $29 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $7.7 billion net proceeds, $2.0 billion was used to repay the companys outstanding term loan that was due to mature in November 2016, approximately $1.9 billion was used to finance the acquisition of Stemcentrx and approximately $3.8 billion was used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Stemcentrx and Note 12 for additional information related to the ASR. In connection with the May 2016 unsecured senior notes issuance, AbbVie repaid a $2.0 billion 364 -day term loan credit agreement. AbbVie has outstanding $13.7 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2018 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $699 million at December 31, 2018 and $400 million at December 31, 2017 . The weighted-average interest rate on commercial paper borrowings was 2.0% in 2018 , 1.3% in 2017 and 0.6% in 2016 . In August 2018, AbbVie replaced its existing revolving credit facility with a new $3.0 billion five -year revolving credit facility that matures in August 2023. The new facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2018 , the company was in compliance with all its credit facility covenants. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2018 , 2017 and 2016 . No amounts were outstanding under the credit facility as of December 31, 2018 and December 31, 2017 . In May 2018 , AbbVie entered into a $3.0 billion 364 -day term loan credit agreement (term loan). In June 2018, the company drew on this term loan and as of December 31, 2018 , $3.0 billion was outstanding and was included in short-term borrowings on the consolidated balance sheet. Borrowings under the term loan bear interest at one month LIBOR plus 2018 Form 10-K | 63 applicable margin. The term loan may be prepaid without penalty upon prior notice and contains customary covenants, all of which the company was in compliance with as of December 31, 2018 . Maturities of Long-Term Debt and Capital Lease Obligations The following table summarizes AbbVie's future minimum lease payments under non-cancelable operating leases, debt maturities and future minimum lease payments for capital lease obligations as of December 31, 2018 : as of and for the years ending December 31 (in millions) Operating leases Debt maturities and capital leases $ $ 1,612 105 3,755 100 3,053 81 4,120 64 2,250 Thereafter 22,570 Total obligations and commitments 37,360 Fair value hedges, unamortized bond discounts and deferred financing costs (749 ) Total long-term debt and lease obligations $ $ 36,611 Lease expense was $161 million in 2018 , $169 million in 2017 and $159 million in 2016 . AbbVie's operating leases generally include renewal options and provide for the company to pay taxes, maintenance, insurance and other operating costs of the leased property. As of December 31, 2018 , annual future minimum lease payments for capital lease obligations were insignificant. Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 10 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $1.4 billion at December 31, 2018 and $2.2 billion at December 31, 2017 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months . Accumulated gains and losses as of December 31, 2018 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. 64 | 2018 Form 10-K The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $8.6 billion at December 31, 2018 and $7.7 billion at December 31, 2017 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. In the fourth quarter of 2016, the company issued 3.6 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company settled foreign currency forward exchange contracts with aggregate notional amounts of 3.5 billion that were designated as net investment hedges. AbbVie is a party to interest rate hedge contracts designated as fair value hedges with notional amounts totaling $10.8 billion at December 31, 2018 and $11.8 billion at December 31, 2017 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges, net investment hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2017 Balance sheet caption 2017 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Not designated as hedges Prepaid expenses and other 22 Accounts payable and accrued liabilities 29 Interest rate swaps designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Interest rate swaps designated as fair value hedges Other assets Other long-term liabilities 393 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended December 31 (in millions) Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Foreign currency forward exchange contracts $ $ $ $ (250 ) $ $ (250 ) $ $ $ Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax gains of $159 million into cost of products sold for foreign currency cash flow hedges during the next 12 months. The company recognized, in other comprehensive loss, pre-tax gains of $178 million in 2018 , pre-tax losses of $537 million in 2017 and pre-tax gains of $101 million in 2016 related to non-derivative, foreign currency denominated debt designated as net investment hedges. 2018 Form 10-K | 65 The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 12 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ (161 ) $ $ Not designated as hedges Net foreign exchange loss (96 ) Non-designated treasury rate lock agreements Other expense, net (12 ) Interest rate swaps designated as fair value hedges Interest expense, net (71 ) (63 ) (266 ) Debt designated as hedged item in fair value hedges Interest expense, net Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2018 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 7,289 $ 1,209 $ 6,080 $ Time deposits Debt securities 1,536 1,536 Equity securities Foreign currency contracts Total assets $ 9,529 $ 1,213 $ 8,316 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,483 4,483 Total liabilities $ 4,975 $ $ $ 4,483 66 | 2018 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2017 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 9,303 $ $ 8,454 $ Debt securities 2,524 2,524 Equity securities Foreign currency contracts Total assets $ 11,854 $ $ 11,001 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,534 4,534 Total liabilities $ 5,084 $ $ $ 4,534 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. The derivatives entered into by the company were valued using published spot curves for interest rate hedges and published forward curves for foreign currency contracts. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2018 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $160 million . Additionally, at December 31, 2018 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $420 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,534 $ 4,213 $ Additions (See Note 5) 3,985 Change in fair value recognized in net earnings Milestone payments (100 ) (305 ) Ending balance $ 4,483 $ 4,534 $ 4,213 The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the fourth quarter of 2018, the company recorded a $428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 2018 Form 10-K | 67 Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2018 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Short-term borrowings $ 3,699 $ 3,693 $ $ 3,693 $ Current portion of long-term debt and lease obligations, excluding fair value hedges 1,609 1,617 1,609 Long-term debt and lease obligations, excluding fair value hedges 35,468 34,052 34,024 Total liabilities $ 40,776 $ 39,362 $ 35,633 $ 3,729 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $84 million as of December 31, 2018 . No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2018 . Prior to the adoption of ASU No. 2016-01 discussed in Note 2 , these investments were accounted for under the cost method and disclosed in the table below as of December 31, 2017 . The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2017 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 6,023 6,034 4,004 2,030 Long-term debt and lease obligations, excluding fair value hedges 31,346 32,846 32,763 Total liabilities $ 37,769 $ 39,280 $ 36,767 $ 2,513 $ 68 | 2018 Form 10-K Available-for-sale Securities Substantially all of the companys investments in debt securities were classified as available-for-sale with changes in fair value recognized in other comprehensive income. Debt securities classified as short-term were $204 million as of December 31, 2018 and $482 million as of December 31, 2017 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale debt securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2018 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ (2 ) $ Corporate debt securities 1,042 (9 ) 1,034 Other debt securities Total $ 1,546 $ $ (11 ) $ 1,536 The following table summarizes available-for-sale securities by type as of December 31, 2017 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ (3 ) $ Corporate debt securities 1,451 (2 ) 1,453 Other debt securities (1 ) Equity securities (2 ) Total $ 2,529 $ $ (8 ) $ 2,528 AbbVie had no other-than-temporary impairments as of December 31, 2018 . Net realized gains and losses were insignificant in 2018 and 2016 . Net realized gains in 2017 were $90 million . Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. The functional currency of the company's Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2018 and 2017 , AbbVies net monetary assets in Venezuela were insignificant. Of total net accounts receivable, three U.S. wholesalers accounted for 63% as of December 31, 2018 and 56% as of December 31, 2017 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 61% of AbbVie's total net revenues in 2018 , 65% in 2017 and 63% in 2016 . Note 11 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2018 and 2017 . 2018 Form 10-K | 69 The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 6,985 $ 5,829 $ $ Service cost Interest cost Employee contributions Actuarial (gain) loss (614 ) (287 ) Benefits paid (191 ) (173 ) (16 ) (15 ) Other, primarily foreign currency translation adjustments (76 ) End of period 6,618 6,985 Fair value of plan assets Beginning of period 5,399 4,572 Actual return on plan assets (384 ) Company contributions Employee contributions Benefits paid (191 ) (173 ) (16 ) (15 ) Other, primarily foreign currency translation adjustments (62 ) End of period 5,637 5,399 Funded status, end of period $ (981 ) $ (1,586 ) $ (561 ) $ (813 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities (8 ) (32 ) (15 ) (15 ) Other long-term liabilities (1,294 ) (1,942 ) (546 ) (798 ) Net obligation $ (981 ) $ (1,586 ) $ (561 ) $ (813 ) Actuarial loss, net $ 2,516 $ 2,471 $ $ Prior service cost (credit) (22 ) (29 ) Accumulated other comprehensive loss $ 2,527 $ 2,483 $ $ The projected benefit obligations (PBO) in the table above included $1.9 billion at December 31, 2018 and $2.0 billion at December 31, 2017 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $6.0 billion at December 31, 2018 and $6.3 billion at December 31, 2017 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2018 , the ABO was $4.0 billion , the PBO was $4.5 billion and aggregate plan assets were $3.3 billion . Subsequent to December 31, 2018 , the company made a voluntary contribution of $150 million to its principal domestic defined benefit plan, the AbbVie Pension Plan. 70 | 2018 Form 10-K Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax gains and losses included in other comprehensive income (loss): years ended December 31 (in millions) Defined benefit plans Actuarial loss $ $ $ Amortization of actuarial loss and prior service cost (140 ) (107 ) (85 ) Foreign exchange gain (loss) and other (13 ) (22 ) Total $ $ $ Other post-employment plans Actuarial loss (gain) $ (287 ) $ $ Amortization of actuarial loss and prior service credit (1 ) Total $ (288 ) $ $ The pre-tax amounts included in AOCI at December 31, 2018 expected to be recognized in net periodic benefit cost in 2019 consisted of $103 million of expense related to actuarial losses and prior service costs for defined benefit plans and $5 million of income related to actuarial losses and prior service credits for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets (439 ) (382 ) (354 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service credit Net periodic benefit cost $ $ $ Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 4.0 % 3.4 % Rate of compensation increases 4.6 % 4.5 % Other post-employment plans Discount rate 4.6 % 3.9 % The assumptions used in calculating the December 31, 2018 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2019 . 2018 Form 10-K | 71 Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 3.4 % 3.9 % 4.4 % Discount rate for determining interest cost 3.1 % 3.7 % 4.0 % Expected long-term rate of return on plan assets 7.7 % 7.8 % 7.9 % Expected rate of change in compensation 4.4 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.0 % 4.9 % 5.1 % Discount rate for determining interest cost 3.7 % 4.1 % 4.3 % For the December 31, 2018 post-retirement health care obligations remeasurement, the company assumed a 6.6% pre-65 ( 7.3% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% in 2050 and remain at that level thereafter. For purposes of measuring the 2018 post-retirement health care costs, the company assumed a 7.7% pre-65 ( 9.5% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% for 2050 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2018 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2018 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ (10 ) Projected benefit obligation (87 ) Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,359 $ 1,586 $ $ Total assets measured at NAV 3,278 Fair value of plan assets $ 5,637 72 | 2018 Form 10-K Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,715 $ 1,208 $ $ Total assets measured at NAV 3,684 Fair value of plan assets $ 5,399 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The target investment allocations for the AbbVie Pension Plan is 35% in equity securities, 20% in fixed income securities and 45% in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. 2018 Form 10-K | 73 Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2020 2021 2022 2023 2024 to 2028 1,589 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $89 million in 2018 , $82 million in 2017 and $75 million in 2016 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 12 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSAs, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least ten years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Realized excess tax benefits associated with stock-based compensation totaled $78 million in 2018 , $71 million in 2017 and $55 million in 2016 . Since 2017, all excess tax benefits associated with stock-based awards have been recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity as a result of the adoption of a new accounting pronouncement. 74 | 2018 Form 10-K Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100% of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $21.63 in 2018 , $9.80 in 2017 and $9.29 in 2016 . The following table summarizes AbbVie stock option activity in 2018 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2017 8,316 $ 41.69 5.1 $ Granted 114.36 Exercised (2,781 ) 28.75 Lapsed (26 ) 17.03 Outstanding at December 31, 2018 6,143 $ 55.05 6.2 $ Exercisable at December 31, 2018 4,293 $ 45.23 5.3 $ The total intrinsic value of options exercised was $215 million in 2018 , $371 million in 2017 and $325 million in 2016 . The total fair value of options vested during 2018 was $22 million . As of December 31, 2018 , $6 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSAs, RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Such awards granted before 2016 consisted of RSAs or RSUs for which vesting was contingent upon AbbVie achieving a minimum annual return on equity (ROE). Since 2016, equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSAs, RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSA, RSU and performance share activity for 2018 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2017 10,682 $ 59.47 Granted 4,771 103.31 Vested (5,073 ) 59.41 Forfeited (512 ) 73.45 Outstanding at December 31, 2018 9,868 $ 79.90 The fair market value of RSAs, RSUs and performance shares (as applicable) vested was $583 million in 2018 , $348 million in 2017 and $362 million in 2016 . 2018 Form 10-K | 75 As of December 31, 2018 , $307 million of unrecognized compensation cost related to RSAs, RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $3.95 in 2018, $2.63 in 2017 and $2.35 in 2016. The following table summarizes quarterly cash dividends declared during 2018 , 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 11/02/18 02/15/19 $1.07 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/07/18 11/15/18 $0.96 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/14/18 08/15/18 $0.96 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/15/18 05/15/18 $0.96 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $10.7 billion in 2018. AbbVie's remaining share repurchase authorization was $4.3 billion as of December 31, 2018 . Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $1.3 billion in 2018 , approximately 13 million shares for $1.0 billion in 2017 and approximately 34 million shares for $2.1 billion in 2016 . Additionally, in 2016 , AbbVie executed an ASR in connection with the Stemcentrx acquisition and repurchased approximately 60 million shares for $3.8 billion . 76 | 2018 Form 10-K Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2018 , 2017 and 2016 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2015 $ (1,270 ) $ $ (1,378 ) $ $ $ (2,561 ) Other comprehensive income (loss) before reclassifications (165 ) (194 ) (52 ) Net losses (gains) reclassified from accumulated other comprehensive loss (8 ) (24 ) Net current-period other comprehensive income (loss) (165 ) (135 ) (1 ) (25 ) Balance as of December 31, 2016 (1,435 ) (1,513 ) (2,586 ) Other comprehensive income (loss) before reclassifications (343 ) (480 ) (230 ) (344 ) Net losses (gains) reclassified from accumulated other comprehensive loss (75 ) (112 ) Net current-period other comprehensive income (loss) (343 ) (406 ) (46 ) (342 ) (141 ) Balance as of December 31, 2017 (439 ) (203 ) (1,919 ) (166 ) (2,727 ) Other comprehensive income (loss) before reclassifications (391 ) (14 ) (27 ) Net losses reclassified from accumulated other comprehensive loss Net current-period other comprehensive income (loss) (391 ) (10 ) Balance as of December 31, 2018 $ (830 ) $ (65 ) $ (1,722 ) $ (10 ) $ $ (2,480 ) Other comprehensive loss in 2018 included foreign currency translation adjustments totaling a loss of $391 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. In 2017, AbbVie reclassified $316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2016 included foreign currency translation adjustments totaling a loss of $165 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. 2018 Form 10-K | 77 The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Pension and post-employment benefits Amortization of actuarial losses and other (a) $ $ $ Tax benefit (28 ) (33 ) (26 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on designated cash flow hedges (b) $ $ (118 ) $ (20 ) Tax expense (benefit) (4 ) (4 ) Total reclassifications, net of tax $ $ (112 ) $ (24 ) (a) Amounts are included in the computation of net periodic benefit cost (see Note 11 ). (b) Amounts are included in cost of products sold (see Note 10 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $0.01 . As of December 31, 2018 , no shares of preferred stock were issued or outstanding. Note 13 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) Domestic $ (4,274 ) $ (2,678 ) $ (1,651 ) Foreign 9,471 10,405 9,535 Total earnings before income tax expense $ 5,197 $ 7,727 $ 7,884 Income Tax Expense years ended December 31 (in millions) Current Domestic $ $ 6,204 $ 2,229 Foreign Total current taxes $ 1,027 $ 6,580 $ 2,727 Deferred Domestic $ (1,497 ) $ (4,898 ) $ (792 ) Foreign (20 ) (4 ) Total deferred taxes $ (1,517 ) $ (4,162 ) $ (796 ) Total income tax expense (benefit) $ (490 ) $ 2,418 $ 1,931 Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and required companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. These changes were generally effective for tax years beginning in 2018. 78 | 2018 Form 10-K The Act also created a minimum tax on certain foreign sourced earnings. The taxability of the foreign earnings and the applicable tax rates are dependent on future events. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. Additionally, the Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings and the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. As such, the company records foreign withholding tax liabilities related to the future cash repatriation of such earnings. However, the company considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Prior to the enactment of the Act, the company did not provide deferred income taxes on undistributed earnings of foreign subsidiaries that were indefinitely reinvested for continued use in foreign operations. Due to the provision of the Act that required a one-time deemed repatriation of earnings of foreign subsidiaries, in 2017, the company recorded a transition tax expense of $4.5 billion . The company also recognized income tax expense of $338 million related to transition tax on income from the sale of inventory in 2018. The transition tax is generally payable in eight annual installments. Additionally, in 2017, the company remeasured certain deferred tax assets and liabilities based on tax rates at which they were expected to reverse in the future. In 2017, the net tax benefit of U.S. tax reform from the remeasurement of deferred taxes related to the Act and foreign tax law changes was $3.6 billion . Given the complexity of the Act and anticipated guidance from the U.S. Treasury about implementing the Act, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118) which allowed companies to record provisional amounts during a measurement period not extending beyond one year from the enactment date of the Act. As a result, in 2017, the companys analysis and accounting for the tax effects of the Act was preliminary. In 2017, as a direct result of the Act, the company recorded $4.5 billion of transition tax expense, as well as $4.1 billion of net tax benefit for deferred tax remeasurement. Both of these amounts were provisional estimates, as the company had not fully completed its analysis and calculation of foreign earnings subject to the transition tax or its analysis of certain other aspects of the Act that impacted the remeasurement of deferred tax balances. In 2018, the company finalized its provisional estimates and recognized income tax expense related to the Act of $86 million , which primarily related to the transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries. Effective Tax Rate Reconciliation years ended December 31 Statutory tax rate 21.0 % 35.0 % 35.0 % Effect of foreign operations (28.7 ) (12.2 ) (10.3 ) U.S. tax credits (7.3 ) (4.0 ) (4.4 ) Impacts related to U.S. tax reform 8.2 12.0 Tax law change related to foreign currency 2.4 Stock-based compensation excess tax benefit (1.5 ) (0.9 ) Tax audit settlements (2.5 ) (1.2 ) All other, net 1.4 2.6 1.8 Effective tax rate (9.4 )% 31.3 % 24.5 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2018 , 2017 and 2016 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, the cost of repatriation decisions and Stemcentrx impairment related expenses. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. 2018 Form 10-K | 79 The effective income tax rate in 2018 and 2017 included impacts related to U.S. tax reform. Specific to 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. The 2018 effective income tax rate also reflects the effects of Stemcentrx impairment related expenses. In addition, the company recognized a net tax benefit of $131 million in 2018 and $91 million in 2017 related to the resolution of various tax positions pertaining to prior years. The effective income tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Advance payments Net operating losses and other credit carryforwards Other Total deferred tax assets 2,765 2,032 Valuation allowances (103 ) (108 ) Total net deferred tax assets 2,662 1,924 Deferred tax liabilities Excess of book basis over tax basis of intangible assets (2,940 ) (3,762 ) Excess of book basis over tax basis in investments (211 ) (181 ) Other (250 ) (203 ) Total deferred tax liabilities (3,401 ) (4,146 ) Net deferred tax liabilities $ (739 ) $ (2,222 ) As of December 31, 2018 , gross state net operating losses were $717 million and tax credit carryforwards were $210 million . The state tax carryforwards expire between 2019 and 2038. As of December 31, 2018 , foreign net operating loss carryforwards were $427 million . Foreign net operating loss carryforwards of $350 million expire between 2020 and 2028 and the remaining do not have an expiration period. The company had valuation allowances of $103 million as of December 31, 2018 and $108 million as of December 31, 2017 . These were principally related to state net operating losses and credit carryforwards that are not expected to be realized. Current income taxes receivable were $488 million as of December 31, 2018 and $2.1 billion as of December 31, 2017 and were included in prepaid expenses and other on the consolidated balance sheets. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 2,701 $ 1,168 $ Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions (36 ) (2 ) (7 ) Settlements (79 ) (233 ) Lapse of statutes of limitations (7 ) (16 ) (8 ) Ending balance $ 2,852 $ 2,701 $ 1,168 80 | 2018 Form 10-K AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $2.7 billion in 2018 and $2.6 billion in 2017 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2018 , AbbVie would be indemnified for approximately $84 million . The Increase due to current year tax positions in the table above includes amounts related to federal, state and international tax items. The ""Increase due to prior year tax positions"" in the table above includes amounts relating to federal, state and international items as well as prior positions acquired through business development activities during the year. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $73 million in 2018 , $24 million in 2017 and $35 million in 2016 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $190 million at December 31, 2018 , $120 million at December 31, 2017 and $112 million at December 31, 2016 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $486 million . All significant federal, state, local and international matters have been concluded for years through 2010. The company believes adequate provision has been made for all income tax uncertainties. Note 14 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $350 million as of December 31, 2018 and approximately $445 million as of December 31, 2017 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Several pending lawsuits filed against Unimed Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others are consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation , MDL No. 2084. These cases, brought by private plaintiffs and the Federal Trade Commission (FTC), generally allege Solvay's patent litigation involving AndroGel was sham litigation and the 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. These cases include: (a) four individual plaintiff lawsuits; (b) three purported class actions; and (c) Federal Trade Commission v. Actavis, Inc. et al. Following the district court's dismissal of all plaintiffs' claims, appellate proceedings led to the reinstatement of the claims regarding the patent litigation settlements, which are proceeding in the district court. In July 2018, the court denied the private plaintiffs' motion for class certification. Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits 2018 Form 10-K | 81 consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by three named direct purchasers of Niaspan and the other brought by ten named end-payer purchasers of Niaspan. The cases are consolidated for pre-trial proceedings in the United States District Court for the Eastern District of Pennsylvania under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In May 2018, the California Court of Appeals ruled that the District Attorneys Office may not bring monetary claims beyond the scope of Orange County. In September 2014, the FTC filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $448 million , plus prejudgment interest. The court denied the FTCs request for injunctive relief. AbbVie is appealing the courts liability and disgorgement rulings and, based on an assessment of the merits of that appeal, no liability has been accrued for this matter. The FTC is also appealing aspects of the courts trial ruling and the dismissal of its settlement-related claim. In July and August 2018, several direct AndroGel purchasers brought two individual and one class action cases in the United States District Court for the Eastern District of Pennsylvania alleging sham litigation based on the courts trial ruling in the FTCs case. Those cases are stayed pending the appeals in the FTCs case. In March 2015, the State of Louisiana filed a lawsuit, State of Louisiana v. Fournier Industrie et Sante, et al. , against AbbVie, Abbott and affiliated Abbott entities in Louisiana state court. Plaintiff alleges that patent applications and patent litigation filed and other alleged conduct from the early 2000's and before related to the drug TriCor violated Louisiana State antitrust and unfair trade practices laws. The lawsuit seeks monetary damages and attorneys' fees. Plaintiff has filed a writ of certiorari with the Louisiana Supreme Court seeking to appeal the August 2018 dismissal of this lawsuit by the Louisiana Court of Appeal. In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al. , was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted include violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint seeks monetary damages and injunctive relief. In July 2018, the court denied the plaintiffs motion for class certification. Product liability cases are pending in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 4,000 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation , MDL No. 2545. Approximately 200 claims against AbbVie are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. Six cases have gone to trial. Four of those have resulted in complete verdicts for AbbVie: three by juries in the United States District Court for the Northern District of Illinois in January, May, and June 2018, and one by a jury in the Cook County, Illinois Circuit Court in August 2017. Another case in the United States District Court for the Northern District of Illinois resulted in a March 2018 jury verdict for AbbVie on strict liability and fraud and for the plaintiff on negligence and awarded $200,000 in compensatory damages and $3 million in punitive damages, which is the subject of post-trial proceedings. Another case in the United States District Court for the Northern District of Illinois resulted in a jury verdict for AbbVie on strict liability and for the plaintiff on remaining claims and an award of $140,000 in compensatory damages and $140 million in punitive damages in August 2017. In July 2018, the court vacated that verdict and ordered a new trial. In November 2018, AbbVie entered into a Master Settlement Agreement with the Plaintiffs Steering Committee in the MDL encompassing all existing claims in all courts. All proceedings in pending cases are effectively stayed, including post-trial proceedings in cases that had been tried to verdict with appellate rights preserved. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 404 cases are pending in the United States District Court for the Southern District of Illinois, and approximately six others are pending in various other federal and state courts. Plaintiffs generally seek compensatory and punitive damages. Over ninety percent of these pending cases, plus other unfiled claims, are subject to confidential settlement agreements and are expected to be dismissed with prejudice. To date, approximately 185 cases have been dismissed with prejudice. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al. , on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made 82 | 2018 Form 10-K and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2018 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. Plaintiffs seek compensatory and punitive damages. In May 2017, a shareholder derivative lawsuit, Ellis v. Gonzalez, et al. , was filed in Delaware Chancery Court, alleging that AbbVie's directors breached their fiduciary duties in connection with statements made regarding the Shire transaction. The lawsuit sought unspecified compensatory damages for AbbVie, among other relief. In July 2018, the court dismissed this case with prejudice. In August 2018, plaintiff appealed that dismissal to the Delaware Supreme Court. In September 2018, the Commissioner of the California Department of Insurance intervened in a qui tam lawsuit, State of California and Lazaro Suarez v. AbbVie Inc., et al. , brought under the California Insurance Frauds Prevention Act, in California Superior Court for Alameda County. The Department of Insurances complaint alleges that, through patient and reimbursement support services and other services and items of value provided in connection with HUMIRA, AbbVie caused the submission of fraudulent commercial insurance claims for HUMIRA in violation of the California statute. The complaint seeks injunctive relief, an assessment of up to three times the amount of the claims at issue, and civil penalties. In addition, two federal securities lawsuits were filed in September ( Pippins v. AbbVie Inc., et al. , in the United States District Court for the Central District of California) and October ( Holwill v. AbbVie Inc., et al ., in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and then-chief financial officer, alleging that reasons stated for HUMIRA sales growth in financial filings between 2013 and 2017 were misleading because they omitted the conduct alleged in the Department of Insurances complaint. In November 2018, the Pippins case was voluntarily dismissed. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. AbbVies appeal of the decisions is pending in the Court of Appeals for the Federal Circuit. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd. , in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that eleven HCV-related patents licensed to AbbVie in 2002 are invalid. AbbVie is seeking to enforce certain patent rights related to adalimumab (a drug AbbVie sells under the trademark HUMIRA). In a case filed in United States District Court for the District of Delaware in August 2017, AbbVie alleges that Boehringer Ingelheim International GmbHs, Boehringer Ingelheim Pharmaceutical, Inc.s, and Boehringer Ingelheim Fremont, Inc.s proposed biosimilar adalimumab product infringes certain AbbVie patents. AbbVie seeks declaratory and injunctive relief. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In February 2018, four separate cases were filed in the United States District Court for the District of Delaware against the following defendants: Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limited; Shilpa Medicare Limited, Sun Pharma Global FZE and Sun Pharmaceutical Industries Ltd.; Cipla Limited and Cipla USA Inc.; and Zydus Worldwide DMCC, Cadila Healthcare Limited, Teva Pharmaceuticals USA, Inc., Teva Pharmaceutical Industries Ltd., Sandoz Inc., and Lek Pharmaceuticals D.D. In November 2018, Pharmacyclics filed a fifth suit in the United States District Court for the District of Delaware against Hetero USA Inc., Hetero Labs Limited and Hetero Labs Limited Unit-I and Unit-V. In each case, Pharmacyclics alleges the defendants proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in these suits. 2018 Form 10-K | 83 Note 15 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) Immunology HUMIRA United States $ 13,685 $ 12,361 $ 10,432 International 6,251 6,066 5,646 Total $ 19,936 $ 18,427 $ 16,078 Hematologic Oncology IMBRUVICA United States $ 2,968 $ 2,144 $ 1,580 Collaboration revenues Total $ 3,590 $ 2,573 $ 1,832 VENCLEXTA United States $ $ $ International Total $ $ $ HCV MAVYRET United States $ 1,614 $ $ International 1,824 Total $ 3,438 $ $ VIEKIRA United States $ $ $ International 1,180 Total $ $ $ 1,522 Other Key Products Creon United States $ $ $ Lupron United States $ $ $ International Total $ $ $ Synthroid United States $ $ $ Synagis International $ $ $ AndroGel United States $ $ $ Duodopa United States $ $ $ International Total $ $ $ Sevoflurane United States $ $ $ International Total $ $ $ Kaletra United States $ $ $ International Total $ $ $ All other $ $ $ 1,199 Total net revenues $ 32,753 $ 28,216 $ 25,638 84 | 2018 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 21,524 $ 18,251 $ 15,947 Japan 1,591 Germany 1,292 1,157 1,104 United Kingdom France Canada Italy Spain The Netherlands Brazil All other countries 4,013 4,080 3,885 Total net revenues $ 32,753 $ 28,216 $ 25,638 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 1,993 $ 1,862 Europe All other 320 Total long-lived assets $ 2,883 $ 2,803 2018 Form 10-K | 85 Note 16 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 7,934 $ 6,538 Gross margin 6,007 4,922 Net earnings (a) 2,783 1,711 Basic earnings per share $ 1.74 $ 1.07 Diluted earnings per share $ 1.74 $ 1.06 Cash dividends declared per common share $ 0.96 $ 0.64 Second Quarter Net revenues $ 8,278 $ 6,944 Gross margin 6,344 5,415 Net earnings (b) 1,983 1,915 Basic earnings per share $ 1.26 $ 1.20 Diluted earnings per share $ 1.26 $ 1.19 Cash dividends declared per common share $ 0.96 $ 0.64 Third Quarter Net revenues $ 8,236 $ 6,995 Gross margin 6,401 5,379 Net earnings (c) 2,747 1,631 Basic earnings per share $ 1.81 $ 1.02 Diluted earnings per share $ 1.81 $ 1.01 Cash dividends declared per common share $ 0.96 $ 0.64 Fourth Quarter Net revenues $ 8,305 $ 7,739 Gross margin 6,283 5,458 Net earnings (loss) (d) (1,826 ) Basic earnings (loss) per share $ (1.23 ) $ 0.03 Diluted earnings (loss) per share $ (1.23 ) $ 0.03 Cash dividends declared per common share $ 1.07 $ 0.71 (a) First quarter results in 2018 included an after-tax benefit of $148 million related to the change in fair value of contingent consideration liabilities partially offset by after-tax litigation reserves charges of $100 million . First quarter results in 2017 included after-tax costs of $84 million related to the change in fair value of contingent consideration liabilities. (b) Second quarter results in 2018 included after-tax charges of $500 million as a result of a collaboration agreement extension with Calico and $485 million related to the change in fair value of contingent consideration liabilities. Second quarter results in 2017 included an after-tax charge of $62 million to increase litigation reserves and after-tax costs of $61 million related to the change in fair value of contingent consideration liabilities. (c) Third quarter results in 2018 included after-tax litigation reserves charges of $176 million and $95 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2017 included after-tax costs of $401 million related to the change in fair value of contingent consideration liabilities. (d) Fourth quarter results in 2018 included an after-tax intangible asset impairment charge of $4.5 billion partially offset by an after-tax benefit of $375 million related to the change in fair value of contingent consideration liabilities. Fourth quarter results in 2017 were impacted by net charges related to the December 2017 enactment of the Tax Cuts and 86 | 2018 Form 10-K Jobs Act, including an after-tax charge of $4.5 billion related to the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by after-tax benefits of $3.3 billion due to remeasurement of net deferred tax liabilities and other related impacts. Additional after-tax costs that impacted fourth quarter results in 2017 included $244 million for an intangible asset impairment charge, $221 million for a charge to increase litigation reserves, $205 million as a result of entering into a global strategic collaboration with Alector and $79 million related to the change in fair value of contingent consideration liabilities. 2018 Form 10-K | 87 Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 27, 2019 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-16 As discussed in Note 2 to the financial statements, the Company changed its method of accounting for the income tax consequences of intercompany transfers of assets other than inventory in 2018 due to the adoption of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 27, 2019 88 | 2018 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2018 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 . 2018 Form 10-K | 89 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 90 | 2018 Form 10-K Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2018 and 2017 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 27, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 27, 2019 2018 Form 10-K | 91 " +38,AbbVie,2017," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease and multiple sclerosis; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neurology, with additional targeted investment in cystic fibrosis and women's health. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 15 to the Consolidated Financial Statements and the sales information related to HUMIRA included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 65% of AbbVie's total net revenues in 2017 . AbbVie continues to work on HUMIRA formulation and delivery enhancements to improve convenience and the overall patient experience. _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2017 Form 10-K | 1 Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is a first-in-class, oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive an FDA approval after being granted a Breakthrough Therapy Designation and IMBRUVICA is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA. VENCLEXTA (venetoclax) is approved to treat people with CLL with 17p deletion, who have received at least one prior treatment. VENCLEXTA is the first FDA-approved treatment that targets the B-cell lymphoma 2 (BCL-2) protein, which supports cancer cell growth and is overexpressed in many patients with CLL. VENCLEXTA has been approved in the EU for the treatment of CLL in patients with 17p deletion or TP53 mutation and are unsuitable for or have failed a B-cell receptor pathway inhibitor and for the treatment of CLL in absence of 17p deletion or TP53 mutation who have failed both chemoimmunotherapy and a B-cell receptor pathway inhibitor. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV-1. HCV products. AbbVie's HCV products are: VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. Additional Virology products. AbbVie's additional virology products include: KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as Aluvia in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. NORVIR. NORVIR (ritonavir) is a protease inhibitor that is indicated in combination with other antiretroviral agents for the treatment of HIV-1 infection. SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by RSV. 2 | 2017 Form 10-K Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions that is available in two strengths: 1 percent and 1.62 percent. CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Anesthesia products. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. ZINBRYTA. ZINBRYTA (daclizumab) is a once-monthly, self-administered, subcutaneous treatment for relapsing forms of multiple sclerosis (MS), which was approved by the FDA in May 2016 and by the European Commission in July 2016. Due to the risk of serious liver damage, the use of ZINBRYTA is restricted to adult patients with relapsing forms of MS who have had an inadequate response to at least two disease modifying therapies (DMTs) and for whom treatment with any other DMT is contraindicated or otherwise unsuitable. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2017 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2017 gross revenues in the United States. Outside the United States, sales are made either directly to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's 2017 Form 10-K | 3 business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The advent of biologics has also raised complex regulatory issues and significant pharmacoeconomic concerns because the cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and because many expensive biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products, as are significant investments in marketing, distribution, and sales organization activities, which may limit the number of biosimilar competitors. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is more complex than the approval process for, and science behind, generic or other follow-on versions of small molecule products. This added complexity is due to steps needed to ensure that the safety and efficacy of biosimilars is highly similar to that of an original biologic, such as HUMIRA. Ultimate approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. The law also requires that the biosimilar must be for a condition of use approved for the original biologic and that the manufacturing facility meets the standards necessary to assure that the biosimilar is safe, pure and potent. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. In the European Union, while a pathway for the approval of biosimilars has existed since 2005, the products that have come to market to date have had a mixed impact on the market share of incumbent products, with significant variation by product. Other Competitive Products. Although a number of competitive biologic branded products have been approved since HUMIRA was first introduced in 2003, most have gained only a modest share of the worldwide market. AbbVie will continue to face competitive pressure from these biologics and from orally administered products. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are 4 | 2017 Form 10-K often obtained early in the development process, and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days the longest existing exclusivity (patent or regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product is entitled upon its approval in any particular country. In certain instances, regulatory exclusivity may protect a product where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to greater regulatory scrutiny and more rigorous requirements for approval of follow-on biosimilar products than for small molecule generic pharmaceutical products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents, and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2018 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent is expected to expire in the majority of European Union countries in October 2018. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA), those related to ombitasvir/paritaprevir/ritonavir and dasabuvir (which are sold under the trademarks VIEKIRA PAK, VIEKIRAX, EXVIERA, and HOLKIRA PAK), those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET), and those related to testosterone (which is sold under the trademark AndroGel). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States 2017 Form 10-K | 5 composition of matter patents covering ombitasvir, paritaprevir and dasabuvir are expected to expire in 2032, 2031 and 2029, respectively. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as licensing arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. These licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. 6 | 2017 Form 10-K Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. AbbVie spent approximately $5.0 billion in 2017 , $4.4 billion in 2016 and $4.3 billion in 2015 on research to discover and develop new products, indications and processes and to improve existing products and processes. These expenses consisted primarily of salaries and related expenses for personnel, license fees, consulting payments, contract research, clinical drug supply manufacturing, the costs of laboratory equipment and facilities, clinical trial costs and collaboration fees and expenses. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA, and approved by the FDA. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials or patient registries, or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. 2017 Form 10-K | 7 The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user, establishment and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under 8 | 2017 Form 10-K Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2018 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. AbbVie is subject to a Corporate Integrity Agreement (CIA) entered into by Abbott on May 7, 2012 that requires enhancements to AbbVie's compliance program and contains reporting obligations, including disclosure of financial payments to doctors. If AbbVie fails to comply with the CIA, the Office of Inspector General for the United States Department of Health and Human Services may impose monetary penalties or exclude AbbVie from federal health care programs, including Medicare and Medicaid. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United 2017 Form 10-K | 9 States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2017 were approximately $17 million and operating expenditures were approximately $28 million . In 2018 , capital expenditures for pollution control are estimated to be approximately $3 million and operating expenditures are estimated to be approximately $30 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 29,000 persons as of January 31, 2018. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. 10 | 2017 Form 10-K Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $18.4 billion in 2017 , expired in December 2016, and the equivalent European Union patent is expected to expire in the majority of European Union countries in October 2018. Because HUMIRA is a biologic and biologics cannot be readily substituted, it is uncertain what impact the loss of patent protection would have on the sales of HUMIRA. AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged or circumvented or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction 2017 Form 10-K | 11 preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 65% of AbbVie's total net revenues in 2017 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA, the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. For example, AbbVie is collaborating with Roche Holding AG to develop and commercialize a next-generation Bcl-2 inhibitor, Venclexta (venetoclax), for patients with relapsed/refractory chronic lymphocytic leukemia and AbbVie is investigating its efficacy for additional indications. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. 12 | 2017 Form 10-K Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could compete with AbbVies biologic products. As competitors are able to obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market, and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. 2017 Form 10-K | 13 AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing 14 | 2017 Form 10-K changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls, or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. AbbVie could be subject to increased monetary penalties and/or other sanctions, including exclusion from federal health care programs, if it fails to comply with the terms of the May 7, 2012 resolution of the Department of Justice's investigation into sales and marketing activities for Depakote. On May 7, 2012, Abbott settled United States federal and 49 state investigations into its sales and marketing activities for Depakote by pleading guilty to a misdemeanor violation of the Food, Drug and Cosmetic Act, agreeing to pay 2017 Form 10-K | 15 approximately $700 million in criminal fines and forfeitures and approximately $900 million to resolve civil claims, and submitting to a term of probation. The term of probation ended January 1, 2016 upon AbbVie satisfying all of the probation conditions. However, if AbbVie violates any remaining terms of the plea agreement, it may face additional monetary sanctions and other such remedies as the court deems appropriate. In addition, Abbott entered into a five-year CIA with the Office of Inspector General for the United States Department of Health and Human Services (OIG). The effective date of the CIA is October 11, 2012. The obligations of the CIA have transferred to and become fully binding on AbbVie. The CIA requires enhancements to AbbVie's compliance program, fulfillment of reporting and monitoring obligations, management certifications and resolutions from AbbVie's board of directors, among other requirements. Compliance with the requirements of the settlement will impose additional costs and burdens on AbbVie, including in the form of employee training, third party reviews, compliance monitoring, reporting obligations and management attention. If AbbVie fails to comply with the CIA, the OIG may impose monetary penalties or exclude AbbVie from federal health care programs, including Medicare and Medicaid. AbbVie and Abbott may be subject to third party claims and shareholder lawsuits in connection with the settlement, and AbbVie may be required to indemnify all or a portion of Abbott's costs. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States make up approximately 35% of AbbVie's total net revenues in 2017 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize IMBRUVICA, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize IMBRUVICA by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient for IMBRUVICA and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers IMBRUVICA to AbbVie's customers. The commercialization of 16 | 2017 Form 10-K IMBRUVICA may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow the approved indications, the relative price of IMBRUVICA as compared to alternative treatment options and changes to the label for IMBRUVICA that further restrict its marketing. If the commercialization of IMBRUVICA is unsuccessful, AbbVie's ability to generate revenue from product sales and realize the anticipated benefits of the merger with Pharmacyclics will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2017 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. 2017 Form 10-K | 17 AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, or breakdown. Data privacy or security breaches by employees or others may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions, or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. 18 | 2017 Form 10-K In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2017 Form 10-K | 19 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland Jayuya, Puerto Rico Ludwigshafen, Germany North Chicago, Illinois Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. 20 | 2017 Form 10-K "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (NYSE). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Market Price Per Share High Low High Low First Quarter $66.79 $59.27 $59.81 $50.71 Second Quarter $73.67 $63.12 $65.37 $56.36 Third Quarter $90.95 $69.38 $68.12 $61.77 Fourth Quarter $99.10 $85.24 $65.05 $55.06 Stockholders There were 50,095 stockholders of record of AbbVie common stock as of January 31, 2018 . Dividends The following table summarizes quarterly cash dividends declared for the years ended December 31, 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 On October 27, 2017 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $0.64 per share to $0.71 per share, payable on February 15, 2018 to stockholders of record as of January 12, 2018 . The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index. This graph covers the period from January 2, 2013 (the first day AbbVie's common stock began ""regular-way"" trading on the NYSE) through December 31, 2017 . This graph assumes $100 was invested in AbbVie common stock and each index on January 2, 2013 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. 24 | 2017 Form 10-K This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2017 - October 31, 2017 8,469 (1) $ 94.35 $ 4,536,288,945 November 1, 2017 - November 30, 2017 5,279,237 (1) $ 94.76 5,276,274 $ 4,036,289,077 December 1, 2017 - December 31, 2017 20,588 (1) $ 97.85 $ 4,036,289,077 Total 5,308,294 (1) 94.77 5,276,274 $ 4,036,289,077 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares included the shares deemed surrendered to AbbVie to pay the exercise price in connection with the exercise of employee stock options 4,552 in October; 1,855 in November; and 5,368 in December, with average exercise prices of $95.96 in October; $93.36 in November; and $97.33 in December. These shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 3,917 in October; 1,108 in November; and 15,220 in December. 2017 Form 10-K | 25 These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. 26 | 2017 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2017 and 2016 and results of operations for each of the three years in the period ended December 31, 2017 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie's mission is to use its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease and multiple sclerosis; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines across such important medical specialties as immunology, oncology and neurology, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, sales are made either directly to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 29,000 employees. AbbVie operates in one business segmentpharmaceutical products. 2017 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2017 included delivering worldwide net revenues of $28.2 billion , operating earnings of $9.6 billion and diluted earnings per share of $3.30 . Worldwide net revenues grew by 10% on a constant currency basis, driven primarily by the continued strength of HUMIRA, revenue growth related to IMBRUVICA and other key products including Creon and Duodopa and the launch of HCV product MAVYRET. These increases were partially offset by a decline in net revenues of HCV product VIEKIRA. Diluted earnings per share in 2017 was $3.30 and included net charges related to the December 2017 enactment of the Tax Cuts and Jobs Act . The net charges included $4.5 billion for the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries , partially offset by after-tax benefits of $3.3 billion due to the remeasurement of net deferred tax liabilities and other related impacts . Additional after-tax costs that impacted 2017 diluted earnings per share included the following: (i) $809 million related to the amortization of intangible assets; (ii) $625 million for the change in fair value of contingent consideration liabilities; (iii) $327 million for acquired in-process research and development (IPRD); (iv) litigation reserve charges of $286 million ; (v) an intangible asset impairment charge of $244 million ; (vi) milestone payments of $143 million ; and (vii) acquisition related costs of $49 million . These costs were partially offset by an after-tax benefit of $91 million due to a tax audit settlement. 2017 financial results also reflected continued added funding to support AbbVies emerging mid- and late-stage pipeline assets and continued investment in AbbVies growth brands. In 2017 , the company generated cash flows from operations of $10.0 billion , which AbbVie utilized to continue to enhance its pipeline through licensing and collaboration activities, pay cash dividends to stockholders of $4.1 billion and repurchase approximately 13 million shares for $1.0 billion in the open market. In October 2017 , AbbVie's board of directors declared a quarterly cash dividend of $0.71 per share of common stock payable in February 2018 . This reflected an increase of approximately 11% over the previous quarterly dividend of $0.64 per share of common stock. 28 | 2017 Form 10-K 2018 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, driving late-stage pipeline assets to the market and ensuring strong commercial execution of new product launches; (ii) continued investment and expansion in its pipeline in support of opportunities in immunology, oncology and neurology as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via dividends and share repurchases. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next twelve months. AbbVie expects to achieve its strategic objectives through: HUMIRA sales growth by driving biologic penetration across disease categories, maintaining market leadership and effectively managing biosimilar erosion. IMBRUVICA revenue growth driven by increasing market share with its eight currently approved indications in six different disease areas. The strong execution of new product launches, including MAVYRET. The favorable impact of pipeline products approved in 2017 or currently under regulatory review where approval is expected in 2018. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, the reduction of HUMIRA royalty expense, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neurology along with targeted investments in cystic fibrosis and women's health. Of these programs, more than 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next twelve months. Significant Programs and Developments Immunology Upadacitinib In June 2017, AbbVie announced that top-line results from the Phase 3 SELECT-NEXT clinical trial evaluating upadacitinib (ABT-494), the companys selective JAK1 inhibitor currently in late-stage development for rheumatoid arthritis (RA), met all primary and ranked secondary endpoints in patients with moderate to severe RA who did not adequately respond to treatment with conventional synthetic disease modifying anti-rheumatic drugs (DMARDs). The safety profile of upadacitinib was consistent with previously reported Phase 2 trials and no new safety signals were detected. In September 2017, AbbVie announced that top-line results from the Phase 3 SELECT-BEYOND clinical trial evaluating upadacitinib met all primary and ranked secondary endpoints in patients with moderate to severe RA who did not adequately respond or were intolerant to treatment with biologic DMARDs. The safety profile of upadacitinib was consistent with previously reported Phase 2 trials and the Phase 3 SELECT-NEXT clinical trial, with no new safety signals detected. 2017 Form 10-K | 29 In December 2017, AbbVie announced that top-line results from the Phase 3 SELECT-MONOTHERAPY clinical trial evaluating upadacitinib met all primary and key secondary endpoints in patients with moderate to severe RA who did not adequately respond to treatment with methotrexate. The safety profile of upadacitinib was consistent with previously reported Phase 3 SELECT clinical trials and Phase 2 trials, with no new safety signals detected. In 2017, AbbVie initiated Phase 3 clinical trials to evaluate the safety and efficacy of upadacitinib in subjects with moderately to severely active Crohns disease and in subjects with moderately to severely active psoriatic arthritis. In January 2018, the U.S. Food and Drug Administration (FDA) granted breakthrough therapy designation for upadacitinib in adult patients with moderate to severe atopic dermatitis who are candidates for systemic therapy. Risankizumab In October 2017, AbbVie announced that top-line results from three Phase 3 clinical trials evaluating risankizumab, an investigational interleukin-23 (IL-23) inhibitor, with 12-week dosing compared to ustekinumab and adalimumab met all co-primary and ranked secondary endpoints for the treatment of patients with moderate to severe chronic plaque psoriasis. The safety profile was consistent with all previously reported studies, and there were no new safety signals detected across the three studies. In December 2017, AbbVie announced that top-line results from the Phase 3 IMMhance clinical trial evaluating risankizumab at 16 weeks and 52 weeks of treatment compared to placebo met all primary and ranked secondary endpoints for the treatment of patients with moderate to severe plaque psoriasis. The safety profile was consistent with all previously reported Phase 3 studies, and there were no new safety signals detected across the Phase 3 program. In December 2017, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and efficacy of risankizumab in subjects with moderately to severely active Crohns disease. Oncology IMBRUVICA In January 2017, the FDA approved IMBRUVICA for the treatment of patients with relapsed/refractory marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy. This indication is approved under accelerated approval based on overall response rate (ORR) and continued approval may be contingent upon verification and description of clinical benefit in a confirmatory trial. MZL is a slow-growing form of non-Hodgkin's lymphoma. In August 2017, the FDA approved IMBRUVICA for the treatment of adult patients with chronic graft-versus-host-disease (cGVHD) after failure of one or more lines of systemic therapy. IMBRUVICA is the first therapy specifically approved for adults with cGVHD, a severe and potentially life-threatening consequence of stem cell or bone marrow transplant. This marked the sixth U.S. disease indication for IMBRUVICA since the medication's initial approval in 2013 and the first approved indication outside of cancer. In December 2017, AbbVie announced that the Phase 3 iNNOVATE clinical trial evaluating IMBRUVICA in combination with rituximab in patients with untreated (treatment-nave) and previously-treated Waldenstrms macroglobulinemia (WM) met its primary endpoint. This is the first and only treatment approved for newly or previously-treated patients with WM. VENCLEXTA In February 2017, AbbVie initiated a Phase 3 clinical trial to study the safety and efficacy of venetoclax in combination with azacitidine in treatment-nave elderly subjects with acute myeloid leukemia (AML) who are ineligible for standard induction therapy (high-dose chemotherapy). 30 | 2017 Form 10-K In May 2017, AbbVie initiated a Phase 3 clinical trial to evaluate if venetoclax when co-administered with low dose cytarabine (LDAC) improves overall survival (OS) versus LDAC and placebo, in treatment nave subjects with AML. In September 2017, AbbVie announced that top-line results from the Phase 3 MURANO clinical trial evaluating venetoclax tablets in combination with Rituxan (rituximab) met the primary endpoint of prolonged progression-free survival compared with bendamustine in combination with Rituxan in patients with relapsed/refractory chronic lymphocytic leukemia (CLL). In December 2017, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for VENCLEXTA (venetoclax) in combination with Rituxan in patients with relapsed or refractory CLL and in January 2018, AbbVie submitted an sNDA for VENCLEXTA monotherapy in patients with CLL who have relapsed or are refractory to B-cell receptor inhibitors. Rova-T In February 2017, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy of rovalpituzumab tesirine (Rova-T) as maintenance therapy following first-line platinum based chemotherapy in participants with extensive stage small cell lung cancer (SCLC). In April 2017, AbbVie initiated a Phase 3 clinical trial to evaluate Rova-T compared with topotecan for subjects with advanced or metastatic SCLC with high levels of delta-like protein 3 who have first disease progression during or following front-line platinum-based chemotherapy. ABT-414 In November 2017, AbbVie presented results from the INTELLANCE-2 trial, a potential registration-enabling Phase 2 study evaluating depatuxizumab mafodotin (ABT-414), an investigational, antibody drug conjugate (ADC) targeting epidermal growth factor receptor (EGFR) alone or in combination with temozolomide (TMZ) in subjects with recurrent glioblastoma multiforme (GBM). Results from the INTELLANCE-2 study failed to meet the primary endpoint of overall survival and AbbVie will not be submitting regulatory applications for ABT-414 in recurrent GBM. In INTELLANCE-2, the combination of ABT-414 and TMZ performed numerically better than lomustine or TMZ and a positive trend in overall survival was observed. While AbbVie will not file in recurrent GBM based on these data, the Phase 2/3 INTELLANCE-1 trial evaluating the safety and efficacy of ABT-414 in combination with TMZ in subjects with newly diagnosed GBM with EGFR amplification is ongoing. Veliparib In April 2017, AbbVie announced that two Phase 3 studies evaluating veliparib, an investigational, oral poly (adenosine diphosphate-ribose) polymerase (PARP) inhibitor in combination with chemotherapy did not meet their primary endpoints. The studies evaluated veliparib in combination with carboplatin and paclitaxel in patients with squamous non-small cell lung cancer (NSCLC) and triple negative breast cancer (TNBC). Ongoing Phase 3 studies include non-squamous non-small cell lung cancer, BRCA1/2 breast cancer and ovarian cancer. Virology/Liver Disease In February 2017, the European Committee for Medicinal Products for Human Use (CHMP) granted a positive opinion for a shorter, eight-week treatment of VIEKIRAX (ombitasvir/paritaprevir/ritonavir tablets) + EXVIERA (dasabuvir tablets) as an option for previously untreated adult patients with genotype 1b chronic HCV and minimal to moderate fibrosis. In July 2017, the European Commission granted marketing authorization for MAVIRET (glecaprevir/pibrentasvir), a once-daily, ribavirin-free treatment for adults with HCV infection across all major genotypes (GT1-6). MAVIRET is also indicated for patients with specific treatment challenges, including those with compensated cirrhosis across all major genotypes, and those who previously had limited treatment options, such as patients with severe chronic kidney disease (CKD) or those with genotype 3 chronic HCV infection. In August 2017, the FDA approved MAVYRET (glecaprevir/pibrentasvir) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). MAVYRET is also 2017 Form 10-K | 31 indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. MAVYRET/MAVIRET is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. Other In September 2017, AbbVie submitted a New Drug Application to the FDA for elagolix, an investigational, orally administered gonadotropin-releasing hormone (GnRH) antagonist, being evaluated for the management of endometriosis with associated pain. In October, AbbVie was granted priority review for elagolix by the FDA for the management of endometriosis with associated pain. In November, AbbVie announced detailed results from two replicate Phase 3 extension studies evaluating the long-term efficacy and safety of elagolix, being evaluated for the management of endometriosis with associated pain. In December 2017, AbbVie announced the strategic decision to close the SONAR study, a Phase 3 clinical trial evaluating the effects of the investigational compound atrasentan on progression of kidney disease in patients with stage 2 to 4 chronic kidney disease and type 2 diabetes when added to standard of care. The ongoing monitoring of renal events observed in the study revealed considerably fewer endpoints than expected at the time of analysis, which will likely affect the ability to test the SONAR study hypothesis. Therefore, AbbVie determined that it cannot justify continuing the participation of patients in the study. The decision to close the SONAR study early was not related to any safety concerns. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates for the years ended (dollars in millions) United States $ 18,251 $ 15,947 $ 13,561 14.4 % 17.6 % 14.4 % 17.6 % International 9,965 9,691 9,298 2.8 % 4.2 % 2.1 % 7.3 % Net revenues $ 28,216 $ 25,638 $ 22,859 10.1 % 12.2 % 9.8 % 13.5 % 32 | 2017 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates Years ended December 31 (dollars in millions) HUMIRA United States $ 12,361 $ 10,432 $ 8,405 18.5 % 24.1 % 18.5 % 24.1 % International 6,066 5,646 5,607 7.4 % 0.7 % 6.7 % 4.3 % Total $ 18,427 $ 16,078 $ 14,012 14.6 % 14.7 % 14.4 % 16.1 % IMBRUVICA United States $ 2,144 $ 1,580 $ 35.8 % 100.0 % 35.8 % 100.0 % Collaboration revenues 70.0 % 100.0 % 70.0 % 100.0 % Total $ 2,573 $ 1,832 $ 40.5 % 100.0 % 40.5 % 100.0 % HCV United States $ $ $ (1.4 )% (57.4 )% (1.4 )% (57.4 )% International 1,180 (20.6 )% 41.3 % (20.5 )% 42.7 % Total $ 1,274 $ 1,522 $ 1,639 (16.3 )% (7.1 )% (16.2 )% (6.4 )% Lupron United States $ $ $ 0.8 % 1.5 % 0.8 % 1.5 % International 1.4 % (8.5 )% 0.5 % (5.2 )% Total $ $ $ 0.9 % (0.6 )% 0.7 % 0.1 % Creon United States $ $ $ 13.9 % 15.5 % 13.9 % 15.5 % Synagis International $ $ $ 1.2 % (1.5 )% 0.6 % (0.4 )% Synthroid United States $ $ $ 2.3 % 1.1 % 2.3 % 1.1 % AndroGel United States $ $ $ (14.5 )% (2.8 )% (14.5 )% (2.8 )% Kaletra United States $ $ $ (38.6 )% (28.8 )% (38.6 )% (28.8 )% International (18.8 )% (19.3 )% (21.1 )% (13.3 )% Total $ $ $ (22.9 )% (21.5 )% (24.7 )% (16.9 )% Sevoflurane United States $ $ $ (2.1 )% (1.0 )% (2.1 )% (1.0 )% International (4.6 )% (11.4 )% (3.7 )% (6.9 )% Total $ $ $ (4.1 )% (9.7 )% (3.4 )% (6.0 )% Duodopa United States $ $ $ 66.1 % 100.0 % 66.1 % 100.0 % International 14.6 % 16.9 % 13.1 % 18.1 % Total $ $ $ 21.1 % 26.9 % 19.8 % 28.1 % All other $ $ 1,217 $ 1,402 (18.0 )% (13.2 )% (18.2 )% (12.3 )% Total net revenues $ 28,216 $ 25,638 $ 22,859 10.1 % 12.2 % 9.8 % 13.5 % 2017 Form 10-K | 33 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales increased 14% in 2017 and 16% in 2016 . The sales increases in 2017 and 2016 were driven by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. The sales increase in 2016 was also driven by the approval of new indications. In the United States, HUMIRA sales increased 18% in 2017 and 24% in 2016 . The sales increase in 2017 was driven by market growth across all indications and favorable pricing. The sales increase in 2016 was driven by market growth across all indications, higher market share and favorable pricing. Internationally, HUMIRA revenues increased 7% in 2017 and 4% in 2016 , driven primarily by market growth across indications. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability and future growth of HUMIRA. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. Net revenues for IMBRUVICA commenced following the completion of the Pharmacyclics acquisition on May 26, 2015. Global IMBRUVICA sales increased 40% in 2017 as a result of continued penetration of IMBRUVICA as a first-line treatment for patients with CLL as well as favorable pricing. The sales increase in 2016 was driven by market share gains following the FDA and EMA approval of IMBRUVICA as a first-line treatment for patients with CLL as well as having a full year of sales in 2016. Global HCV sales decreased 16% in 2017 and 6% in 2016 . The sales decrease in 2017 and 2016 was a result of market contraction, lower market share and price erosion of VIEKIRA. These factors were partially offset for 2017 by the launch of MAVYRET in certain geographies during the second half of 2017. Net revenues for Creon increased 14% in 2017 and 15% in 2016 , driven primarily by continued market growth and higher market share. Creon maintains market leadership in the pancreatic enzyme market. Global Kaletra net revenues decreased 25% in 2017 and 17% in 2016 , primarily due to lower market share resulting from the impact of increasing competition in the HIV marketplace. AbbVie expects net revenues for Kaletra to continue to decline in 2018 . Net revenues for Duodopa increased 20% in 2017 and 28% in 2016 , primarily as a result of market penetration and geographic expansion. Gross Margin Percent change years ended December 31 (dollars in millions) 2016 2017 Gross margin $ 21,176 $ 19,805 $ 18,359 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017, as well as the unfavorable impacts of higher intangible asset amortization and the IMBRUVICA profit sharing arrangement. These drivers were partially offset by lower amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics as well as favorable changes in product mix and operational efficiencies. Gross margin as a percentage of net revenues in 2016 decreased from 2015 primarily due to unfavorable foreign exchange rates as well as unfavorable impacts of higher intangible asset amortization, the IMBRUVICA profit sharing arrangement and higher amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics. Additionally, 2016 gross margin included an intangible asset impairment charge of $39 million and 2015 gross margin included milestone revenue of $40 million from an oncology collaboration partner. These drivers were partially offset by favorable changes in product mix and operational efficiencies. 34 | 2017 Form 10-K Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2016 2017 Selling, general and administrative $ 6,275 $ 5,855 $ 6,387 % (8 )% as a percent of net revenues % % % SGA expenses as a percentage of net revenues in 2017 decreased from 2016 due to continued leverage from revenue growth partially offset by litigation reserve charges of $370 million in 2017 and new product launch expenses. SGA expenses as a percentage of net revenues in 2016 decreased from 2015 due to continued leverage from revenue growth and lower costs in 2016 . SGA expenses in 2015 included costs associated with the separation from Abbott of $265 million , Pharmacyclics acquisition and integration costs of $294 million and litigation reserve charges of $165 million . Additionally, SGA expense in 2015 reflected marketing support for the global launch of VIEKIRA. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 4,982 $ 4,366 $ 4,285 % % as a percent of net revenues % % % Acquired in-process research and development $ $ $ % % Research and Development (RD) expenses in 2017 increased from 2016 principally due to increased funding to support the companys emerging mid- and late-stage pipeline assets, the impact of the post-acquisition RD expenses of Stemcentrx and Boehringer Ingelheim (BI) compounds and an increase in development milestones of $63 million . These factors were partially offset by a decrease in acquisition related costs of $135 million . RD expenses in 2016 increased from 2015 due primarily to increased funding to support the companys emerging mid- and late-stage pipeline assets. This increase was partially offset by the following factors: (i) 2015 RD expenses included a $350 million charge related to the purchase of a priority review voucher from a third party; (ii) development milestones decreased by $53 million; and (iii) 2015 results included restructuring charges of $32 million. Acquired in-process research and development (IPRD) expenses reflect upfront payments related to various collaborations. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. There were no individually significant transactions or cash flows during 2016 . Acquired IPRD expense in 2015 included a charge of $100 million as a result of entering into an exclusive worldwide license agreement with C 2 N Diagnostics (C 2 N) to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector and C 2 N agreements. Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,150 $ 1,047 $ Interest income (146 ) (82 ) (33 ) Interest expense, net $ 1,004 $ $ Net foreign exchange loss $ $ $ Other expense, net Interest expense in 2017 increased compared to 2016 due to a full year of expense associated with the May 2016 issuance of $7.8 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Stemcentrx and to repay an outstanding term loan. 2017 Form 10-K | 35 Interest expense in 2016 increased compared to 2015 due to a full year of expense associated with the May 2015 issuance of $16.7 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Pharmacyclics in addition to the incremental expense associated with the May 2016 senior notes issuance discussed above. Interest expense in 2016 also included a debt extinguishment charge of $39 million related to the redemption of the 1.75% senior notes that were due to mature in November 2017. These increases were partially offset by the absence of bridge financing-related costs of $86 million in 2015 incurred in connection with the acquisition of Pharmacyclics. Interest income continued to increase in both 2017 and 2016 due to growth in the companys investment securities. Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Net foreign exchange loss in 2016 included losses totaling $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. See Note 10 to the Consolidated Financial Statements for additional information regarding the Venezuelan devaluation. Net foreign exchange loss in 2015 included losses of $170 million to complete the liquidation of the companys remaining foreign currency positions related to the terminated proposed combination with Shire. Other expense, net included charges related to the change in fair value of the BI and Stemcentrx contingent consideration liabilities of $626 million in 2017 and $228 million in 2016. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2017, the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. In 2016, the change in fair value represented mainly the passage of time, as increases to the BI contingent consideration liability due to higher probabilities of success were fully offset by the effects of rising interest rates and changes in other market-based assumptions. See Note 5 to the Consolidated Financial Statements for additional information regarding the acquisitions of Stemcentrx and BI compounds. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million . Other expense, net for 2015 included impairment charges totaling $36 million related to certain of the company's equity investment securities. Income Tax Expense The effective income tax rate was 31% in 2017 , 24% in 2016 and 23% in 2015 . The effective tax rate in each period differed from the statutory tax rate principally due to the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions and business development activities. The increase in the effective tax rate for 2017 over the prior year was principally due to the estimated tax effects of the enactment of the Tax Cuts and Jobs Act (the Act) in 2017. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. The Act significantly changed the U.S. corporate tax system. The Act reduces the U.S. federal corporate tax rate from 35% to 21% and creates a territorial tax system that includes new taxes on certain foreign sourced earnings. As a result, the effective income tax rate may change significantly in future periods. See Note 13 to the Consolidated Financial Statements for additional information regarding the Act. The effective tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 9,960 $ 7,041 $ 7,535 Investing activities (274 ) (6,074 ) (12,936 ) Financing activities (5,512 ) (3,928 ) 5,752 Operating cash flows in 2017 increased from 2016 primarily due to improved results of operations resulting from revenue growth, an improvement in operating earnings and a decrease in income tax payments. Operating cash flows in 2016 36 | 2017 Form 10-K decreased from 2015 primarily due to improved results of operations resulting from revenue growth and an improvement in operating margin, offset by income tax payments. Realized excess tax benefits associated with stock-based compensation totaled $71 million in 2017 and were presented within operating cash flows as a result of the adoption of a new accounting pronouncement. Prior to the adoption of the new accounting pronouncement, realized excess benefits of $55 million in 2016 and $61 million in 2015 were presented within cash flows from financing activities. See Note 2 to the Consolidated Financial Statements for additional information regarding the adoption of this new accounting pronouncement. Operating cash flows also reflected AbbVie's voluntary contributions, primarily to its principal domestic defined benefit plan of $150 million in 2017, 2016 and 2015 . In 2018, AbbVie plans to make voluntary contributions to its various defined benefit plans in excess of $750 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Investing cash flows in 2016 primarily included $1.9 billion of cash consideration paid to acquire Stemcentrx in June 2016, a $595 million upfront payment to acquire certain rights from BI in April 2016, net purchases of investment securities totaling $3.0 billion and capital expenditures of $479 million . Investing activities in 2015 primarily included $11.5 billion of cash consideration paid to acquire Pharmacyclics in May 2015 (net of cash acquired of $877 million ). Investing activities in 2015 also included cash outflows related to other acquisitions and investments of $964 million, including a $500 million payment to Calico, $100 million related to an exclusive worldwide license agreement with C 2 N to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders and $130 million paid to Infinity due to the achievement of a development milestone under the collaboration agreement. Cash flows from investing activities in 2015 also included capital expenditures of $532 million . In 2017 , 2016 and 2015 , the company issued and redeemed commercial paper. The balance of commercial paper outstanding was $400 million as of December 31, 2017 and $377 million as of December 31, 2016 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. In connection with the offering, AbbVie incurred $17 million of issuance costs. In May 2016, the company issued $7.8 billion aggregate principal amount of senior notes. Approximately $2.0 billion of the net proceeds were used to repay an outstanding term loan that was due to mature in November 2016, approximately $1.9 billion of the net proceeds were used to finance the acquisition of Stemcentrx and approximately $3.8 billion of the net proceeds were used to finance an ASR. See Note 12 to the Consolidated Financial Statements for additional information on the ASR transactions. In connection with the May 2016 issuance of senior notes, AbbVie incurred $52 million of issuance costs. In May 2015, the company issued $16.7 billion aggregate principal amount of unsecured senior notes. Approximately $11.5 billion of the net proceeds were used to finance the acquisition of Pharmacyclics and $5.0 billion of the net proceeds were used to finance an ASR. In 2015, the company paid $86 million of costs relating to an $18.0 billion , 364-Day Bridge Term Loan Credit Agreement (the bridge loan) as well as $93 million of costs relating to the May 2015 issuance of senior notes. No amounts were drawn under the bridge loan, which was terminated as a result of the issuance of the senior notes. In September 2015, AbbVie entered into a three-year $2.0 billion term loan credit facility and a 364-day $2.0 billion term loan credit facility. In November 2015, AbbVie drew on these term facilities and used the proceeds to refinance its $4.0 billion of senior notes that matured in 2015. Cash dividend payments totaled $4.1 billion in 2017 , $3.7 billion in 2016 and $3.3 billion in 2015 . The increase in cash dividend payments was primarily due to an increase in the dividend rate. On October 27, 2017 , AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.64 per share to $0.71 per share beginning with the dividend payable on February 15, 2018 to stockholders of record as of January 12, 2018 . This reflects an increase of approximately 11% over the previous quarterly rate. On February 15, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.71 per share to $0.96 per share beginning with the dividend payable on May 15, 2018 to stockholders of record as of April 13, 2018. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. In addition to the ASRs, under AbbVie's existing stock repurchase program, the company repurchased approximately 13 million shares for $1.0 billion in 2017 , approximately 34 million shares for $2.1 billion in 2016 and approximately 46 million shares for $2.8 billion in 2015 . AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017 and cash-settled $300 million of its December 2015 open market purchases in January 2016. The stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at management's 2017 Form 10-K | 37 discretion. The program has no time limit and can be discontinued at any time. AbbVie's remaining stock repurchase authorization was $4.0 billion as of December 31, 2017 . On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. Cash and equivalents were impacted by net favorable exchange rate changes totaling $29 million in 2017 , net unfavorable exchange rate changes totaling $338 million in 2016 and $300 million in 2015 . The favorable exchange rate changes in 2017 were primarily due to the strengthening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The unfavorable exchange rate changes in 2016 were primarily due to the devaluation of AbbVie's net monetary assets denominated in the Venezuelan bolivar. The unfavorable exchange rate changes in 2015 were principally due to the weakening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. Prior to the enactment of the Tax Cuts and Jobs Act in December 2017, a significant portion of cash and equivalents were considered reinvested indefinitely in foreign subsidiaries. The enactment of U.S. tax reform significantly changed the U.S. corporate tax system, including imposing a mandatory one-time transition tax on previously untaxed earnings of foreign subsidiaries and the creation of a territorial tax system that generally allows the repatriation of future foreign sourced earnings without incurring additional U.S. taxes. The company has not fully completed its analysis and calculation of foreign earnings subject to the transition tax. The provisional estimate of the one-time transition tax was $4.5 billion and is generally payable in eight annual installments. AbbVie does not expect the transition tax liability to materially affect its liquidity and capital resources. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. AbbVie continues to do business with foreign governments in certain countries, including Greece, Portugal, Italy and Spain, which have historically experienced challenges in credit and economic conditions. Substantially all of AbbVie's trade receivables in Greece, Portugal, Italy and Spain are with government health systems. Outstanding governmental receivables in these countries, net of allowances for doubtful accounts, totaled $255 million as of December 31, 2017 and $244 million at December 31, 2016 . The company also continues to do business with foreign governments in certain oil-exporting countries that have experienced a deterioration in economic conditions, including Saudi Arabia and Russia, which may result in delays in the collection of receivables. Outstanding governmental receivables related to Saudi Arabia, net of allowances for doubtful accounts, were $149 million as of December 31, 2017 and $122 million as of December 31, 2016 . Outstanding governmental receivables related to Russia, net of allowances for doubtful accounts, were $152 million as of December 31, 2017 and $110 million as of December 31, 2016 . Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. Currently, AbbVie does not believe the economic conditions in oil-exporting countries will have a significant impact on the company's liquidity, cash flow or financial flexibility. However, if government funding were to become unavailable in these countries or if significant adverse changes in their reimbursement practices were to occur, AbbVie may not be able to collect the entire balance outstanding as of December 31, 2017 . Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $3.0 billion five -year revolving credit facility which matures in October 2019. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2017 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. There were no amounts outstanding under the credit facility as of December 31, 2017 and 2016 . 38 | 2017 Form 10-K Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes in the companys credit ratings in 2017. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt. 2017 Form 10-K | 39 Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2017 : (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ $ $ $ $ Long-term debt and capital lease obligations, including current portion 37,612 6,026 5,469 5,938 20,179 Interest on long-term debt (a) 15,617 1,154 2,250 2,080 10,133 Future minimum non-cancelable operating lease commitments Purchase obligations and other (b) 1,135 Other long-term liabilities (c) (d) (e) (f) 10,605 1,135 1,610 1,331 6,529 Total $ 66,326 $ 9,830 $ 9,679 $ 9,546 $ 37,271 (a) Includes estimated future interest payments on long-term debt and capital lease obligations. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2017 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2017 . See Note 9 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 10 for additional information on the interest rate swap agreements outstanding at December 31, 2017 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Amounts less than one year includes voluntary contributions in excess of $750 million that AbbVie plans to make to its various defined benefit plans subsequent to December 31, 2017 . Amounts otherwise exclude pension and other post-employment benefits and related deferred compensation cash outflows. Timing of funding is uncertain and dependent on future movements in interest rates and investment returns, changes in laws and regulations and other variables. Also included in this amount are components of other long-term liabilities including restructuring. See Note 8 to the Consolidated Financial Statements for additional information on restructuring and Note 11 for additional information on the pension and other post-employment benefit plans. (d) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 13 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (e) Includes $4.5 billion of contingent consideration liabilities related to the acquisitions of Stemcentrx and BI compounds which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Notes 5 and 10 to the Consolidated Financial Statements for additional information regarding these liabilities. (f) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform, enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 13 to the Consolidated Financial Statements for additional information regarding the provisional estimates of these tax liabilities. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. 40 | 2017 Form 10-K CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability of the sales price is reasonably assured. Revenue from product sales is recognized when title and risk of loss have passed to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $12.9 billion in 2017 , $10.8 billion in 2016 and $8.6 billion in 2015 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 92% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2017 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2014 $ $ $ Provisions 1,716 2,215 3,866 Payments (1,396 ) (1,771 ) (3,756 ) Balance at December 31, 2015 1,032 Provisions 2,606 3,146 3,987 Payments (2,471 ) (2,899 ) (3,967 ) Balance at December 31, 2016 1,167 1,167 Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 $ 1,340 $ 1,195 $ 2017 Form 10-K | 41 Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.3 billion in 2017 , $964 million in 2016 and $898 million in 2015 , are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates. The significant assumptions used in determining these calculations are disclosed in Note 11 to the Consolidated Financial Statements . The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. Beginning in 2016, AbbVie also reflected the plans' specific cash flows and applied them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2017 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2018 and projected benefit obligations as of December 31, 2017 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (64 ) $ Projected benefit obligation (572 ) Other post-employment plans Service and interest cost $ (9 ) $ Projected benefit obligation (77 ) Effective December 31, 2015, AbbVie elected to change the method it uses to estimate the service and interest cost components of net periodic benefit costs. Historically, AbbVie estimated these service and interest cost components of this expense utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. In late 2015, AbbVie elected to utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. AbbVie elected to make this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. AbbVie accounted for this change prospectively as a change in accounting estimate that is inseparable from a change in accounting principle. This change reduced AbbVies net periodic benefit cost by approximately $41 million in 2016 . This change had no effect on the 2015 expense and did not affect the measurement of AbbVies total benefit obligations. The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2017 and will be used in the calculation of net periodic benefit cost in 2018 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2018 by $54 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of 42 | 2017 Form 10-K December 31, 2017 and will be used in the calculation of net periodic benefit cost in 2018 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2018 and the projected benefit obligation as of December 31, 2017 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (24 ) Projected benefit obligation (140 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 14 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, which could have a significant effect on earnings or cash flows, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets using a quantitative impairment test. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The 2017 Form 10-K | 43 estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2017 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $170 million . Additionally, at December 31, 2017 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $390 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 44 | 2017 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2017 and 2016 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,366 1.175 $ (88 ) $ 5,544 1.078 $ Japanese yen 112.4 111.6 British pound 1.310 (22 ) 1.303 All other currencies 1,877 n/a (18 ) 1,693 n/a Total $ 9,943 $ (126 ) $ 8,783 $ The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.0 billion at December 31, 2017 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes, which are exposed to foreign currency risk. The company has designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 9 to the Consolidated Financial Statements for additional information related to the senior Euro note issuance and Note 10 to the Consolidated Financial Statements for additional information related to the net investment hedging program. The functional currency of the companys Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2017 , AbbVies net monetary assets in Venezuela were insignificant. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $509 million at December 31, 2017 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $2.2 billion at December 31, 2017 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 2017 Form 10-K | 45 Market Price Risk AbbVies debt securities investment portfolio (the portfolio) is its main exposure to market price risk. The portfolio is subject to changes in fair value as a result of interest rate fluctuations and other market factors. It is AbbVies policy to mitigate market price risk by maintaining a diversified portfolio that limits the amount of exposure to a particular issuer and security type while placing limits on the amount of time to maturity. AbbVies investment policy limits investments to investment grade credit ratings. The company estimates that an increase in interest rates of 100 basis points would decrease the fair value of the portfolio by approximately $34 million as of December 31, 2017 . If the portfolio were to be liquidated, the fair value reduction would affect the income statement in the period sold. Non-Publicly Traded Equity Securities AbbVie holds equity securities in other pharmaceutical and biotechnology companies that are not traded on public stock exchanges. The carrying value of these investments was $48 million as of December 31, 2017 and $42 million as of December 31, 2016 . AbbVie monitors these investments for other than temporary declines in market value and charges impairment losses to net earnings when an other than temporary decline in estimated value occurs. In 2017 and 2016 , impairment charges recorded were insignificant. In 2015, AbbVie recorded impairment charges totaling $36 million related to certain of the company's investments in non-publicly traded equity securities. 46 | 2017 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2017 Form 10-K | 47 AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 28,216 $ 25,638 $ 22,859 Cost of products sold 7,040 5,833 4,500 Selling, general and administrative 6,275 5,855 6,387 Research and development 4,982 4,366 4,285 Acquired in-process research and development Total operating costs and expenses 18,624 16,254 15,322 Operating earnings 9,592 9,384 7,537 Interest expense, net 1,004 Net foreign exchange loss Other expense, net Earnings before income tax expense 7,727 7,884 6,645 Income tax expense 2,418 1,931 1,501 Net earnings $ 5,309 $ 5,953 $ 5,144 Per share data Basic earnings per share $ 3.31 $ 3.65 $ 3.15 Diluted earnings per share $ 3.30 $ 3.63 $ 3.13 Cash dividends declared per common share $ 2.63 $ 2.35 $ 2.10 Weighted-average basic shares outstanding 1,596 1,622 1,625 Weighted-average diluted shares outstanding 1,603 1,631 1,637 The accompanying notes are an integral part of these consolidated financial statements. 48 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 5,309 $ 5,953 $ 5,144 Foreign currency translation adjustments, net of tax expense (benefit) of $34 in 2017, $(31) in 2016 and $(139) in 2015 (165 ) (667 ) Net investment hedging activities, net of tax expense (benefit) of $(194) in 2017, $79 in 2016 and $ in 2015 (343 ) Pension and post-employment benefits, net of tax expense (benefit) of $(94) in 2017, $(75) in 2016 and $96 in 2015 (406 ) (135 ) Marketable security activities, net of tax expense (benefit) of $(8) in 2017, $(11) in 2016 and $22 in 2015 (46 ) (1 ) Cash flow hedging activities, net of tax expense (benefit) of $(26) in 2017, $18 in 2016 and $(6) in 2015 (342 ) (137 ) Other comprehensive loss (141 ) (25 ) (530 ) Comprehensive income $ 5,168 $ 5,928 $ 4,614 The accompanying notes are an integral part of these consolidated financial statements. 2017 Form 10-K | 49 AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 9,303 $ 5,100 Short-term investments 1,323 Accounts receivable, net 5,088 4,758 Inventories 1,605 1,444 Prepaid expenses and other 4,741 3,562 Total current assets 21,223 16,187 Investments 2,090 1,783 Property and equipment, net 2,803 2,604 Intangible assets, net 27,559 28,897 Goodwill 15,785 15,416 Other assets 1,326 1,212 Total assets $ 70,786 $ 66,099 Liabilities and Equity Current liabilities Short-term borrowings $ $ Current portion of long-term debt and lease obligations 6,015 Accounts payable and accrued liabilities 10,226 9,379 Total current liabilities 16,641 9,781 Long-term debt and lease obligations 30,953 36,440 Deferred income taxes 2,490 6,890 Other long-term liabilities 15,605 8,352 Commitments and contingencies Stockholders equity Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,768,738,550 shares issued as of December 31, 2017 and 1,754,900,486 as of December 31, 2016 Common stock held in treasury, at cost, 176,607,525 shares as of December 31, 2017 and 162,387,762 as of December 31, 2016 (11,923 ) (10,852 ) Additional paid-in-capital 14,270 13,678 Retained earnings 5,459 4,378 Accumulated other comprehensive loss (2,727 ) (2,586 ) Total stockholders equity 5,097 4,636 Total liabilities and equity $ 70,786 $ 66,099 The accompanying notes are an integral part of these consolidated financial statements. 50 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2014 1,591 $ $ (972 ) $ 4,194 $ $ (2,031 ) $ 1,742 Net earnings 5,144 5,144 Other comprehensive loss, net of tax (530 ) (530 ) Dividends declared (3,431 ) (3,431 ) Common shares issued to Pharmacyclics stockholders 8,404 8,405 Purchases of treasury stock (119 ) (7,886 ) (7,886 ) Stock-based compensation plans and other Balance at December 31, 2015 1,610 (8,839 ) 13,080 2,248 (2,561 ) 3,945 Net earnings 5,953 5,953 Other comprehensive loss, net of tax (25 ) (25 ) Dividends declared (3,823 ) (3,823 ) Common shares issued to Stemcentrx stockholders 3,958 (35 ) 3,923 Purchases of treasury stock (94 ) (6,018 ) (6,018 ) Stock-based compensation plans and other Balance at December 31, 2016 1,593 (10,852 ) 13,678 4,378 (2,586 ) 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax (141 ) (141 ) Dividends declared (4,221 ) (4,221 ) Purchases of treasury stock (15 ) (1,125 ) (1,125 ) Stock-based compensation plans and other (7 ) Balance at December 31, 2017 1,592 $ $ (11,923 ) $ 14,270 $ 5,459 $ (2,727 ) $ 5,097 The accompanying notes are an integral part of these consolidated financial statements. 2017 Form 10-K | 51 AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 5,309 $ 5,953 $ 5,144 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,076 Change in fair value of contingent consideration liabilities Stock-based compensation Upfront costs and milestones related to collaborations Devaluation loss related to Venezuela Intangible asset impairment Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (391 ) (71 ) (1,076 ) Inventories (38 ) (434 ) Prepaid expenses and other assets (118 ) (393 ) Accounts payable and other liabilities (1,187 ) 1,503 Cash flows from operating activities 9,960 7,041 7,535 Cash flows from investing activities Acquisition of businesses, net of cash acquired (2,495 ) (11,488 ) Other acquisitions and investments (308 ) (262 ) (964 ) Acquisitions of property and equipment (529 ) (479 ) (532 ) Purchases of investment securities (2,230 ) (5,315 ) (851 ) Sales and maturities of investment securities 2,793 2,359 Other Cash flows from investing activities (274 ) (6,074 ) (12,936 ) Cash flows from financing activities Net change in short-term borrowings (29 ) (19 ) Proceeds from issuance of long-term debt 11,627 20,660 Repayments of long-term debt and lease obligations (25 ) (6,010 ) (4,018 ) Debt issuance costs (69 ) (182 ) Dividends paid (4,107 ) (3,717 ) (3,294 ) Purchases of treasury stock (1,410 ) (6,033 ) (7,586 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities (268 ) Other, net Cash flows from financing activities (5,512 ) (3,928 ) 5,752 Effect of exchange rate changes on cash and equivalents (338 ) (300 ) Net change in cash and equivalents 4,203 (3,299 ) Cash and equivalents, beginning of year 5,100 8,399 8,348 Cash and equivalents, end of year $ 9,303 $ 5,100 $ 8,399 Other supplemental information Interest paid, net of portion capitalized $ 1,099 $ $ Income taxes paid 1,696 3,563 1,108 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 3,923 8,405 The accompanying notes are an integral part of these consolidated financial statements. 52 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background and Basis of Presentation Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. AbbVie incurred separation-related expenses of $270 million in 2015, which were principally classified in selling, general and administrative expenses (SGA) in the consolidated statements of earnings. Basis of Historical Presentation For a certain portion of AbbVies operations, the legal transfer of AbbVies assets (net of liabilities) did not occur with the separation of AbbVie on January 1, 2013 due to the time required to transfer marketing authorizations and satisfy other regulatory requirements in certain countries. Under the terms of the separation agreement with Abbott, AbbVie was responsible for the business activities conducted by Abbott on its behalf and was subject to the risks and entitled to the benefits generated by these operations and assets. As a result, the related assets and liabilities and results of operations were reported in AbbVies consolidated financial statements. All of these operations were transferred to AbbVie as of December 31, 2016. Net revenues related to these operations were insignificant in 2016 and were $213 million in 2015 . Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. All other investments are generally accounted for using the cost method. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability of the sales price is reasonably assured. Revenue from product sales is recognized when title and risk of loss have passed to the customer. Provisions for discounts, rebates, sales incentives to customers, returns and other adjustments are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual include the identification of the products subject to the 2017 Form 10-K | 53 rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. Historical data is readily available and reliable and is used for estimating the amount of the reduction in gross revenues. Revenue from the launch of a new product, from an improved version of an existing product, or for shipments in excess of a customer's normal requirements are recorded when the conditions noted above are met. In those situations, management records a returns reserve for such revenue, if necessary. Sales of product rights for marketable products are recorded as revenue upon disposition of the rights. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations for pre-commercialization milestones, the milestone payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in SGA in the consolidated statements of earnings. Advertising expenses were $846 million in 2017 , $764 million in 2016 and $704 million in 2015 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive loss (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets. Investments in equity securities that are not traded on public stock exchanges and held-to-maturity debt securities are recorded at cost. 54 | 2017 Form 10-K AbbVie periodically assesses its investment securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other than temporary decline has occurred, a cost basis investment is written down with a charge to other expense (income), net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense (income), net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $58 million at December 31, 2017 and $72 million at December 31, 2016 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process 1,080 Raw materials Inventories $ 1,605 $ 1,444 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,428 1,344 Equipment 5,991 5,726 Construction in progress Property and equipment, gross 8,071 7,526 Less accumulated depreciation (5,268 ) (4,922 ) Property and equipment, net $ 2,803 $ 2,604 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $425 million in 2017 , $425 million in 2016 and $417 million in 2015 . Assets related to capital leases were insignificant at December 31, 2017 and 2016 . Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. 2017 Form 10-K | 55 Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that r esults of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense (income), net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time generally not to exceed twelve months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets using a quantitative impairment test. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, future foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive (loss) income (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. 56 | 2017 Form 10-K Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter, whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business . The standard provides clarifying guidance to assist in the evaluation of whether transactions are treated as business combinations or asset acquisitions. AbbVie elected to early adopt the changes prospectively in the first quarter of 2017. In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . AbbVie adopted the standard in the first quarter of 2017. As a result, all excess tax benefits associated with stock-based awards are recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity. In addition, excess tax benefits in the statement of cash flows are now classified as an operating activity rather than as a financing activity. AbbVie adopted these changes prospectively. Accordingly, the company recognized excess tax benefits in income tax expense of $71 million in 2017 and classified them within cash flows from operating activities. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the FASB issued ASU No. 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40) . The amendments in this standard supersede most current revenue recognition requirements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AbbVie can apply the amendments using one of the following two methods: (i) retrospectively to each prior reporting period presented, or (ii) modified retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. AbbVie will adopt the standard effective the first quarter of 2018 and apply the amendments using the modified retrospective method. The company has completed its assessment of the new standard as of December 31, 2017. AbbVie does not expect significant changes to the amounts or timing of revenue recognition for product sales, which is its primary revenue stream. However, the adoption of the new standard will require a cumulative-effect adjustment to retained earnings on January 1, 2018 of approximately $120 million , net of tax, primarily related to certain deferred license revenues that were originally expected to be recognized through early 2020. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . The standard requires several targeted changes including that equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net earnings. These provisions will not impact the accounting for AbbVie's investments in debt securities. The new guidance also changes certain disclosure requirements and other aspects of current U.S. GAAP. Amendments are to be applied as a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. This standard will be effective for AbbVie starting with the 2017 Form 10-K | 57 first quarter of 2018. Based on historical trends, AbbVie does not believe the adoption will have a material impact on its consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The standard outlines a comprehensive lease accounting model that supersedes the current lease guidance and requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changes the definition of a lease and expands the disclosure requirements of lease arrangements. The new standard must be adopted using the modified retrospective approach and will be effective for AbbVie starting with the first quarter of 2019, with early adoption permitted. AbbVie will adopt the standard effective in the first quarter of 2019 and is currently assessing the impact of adopting this guidance on its consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. Early adoption beginning in the first quarter of 2019 is permitted. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740) . The new standard requires entities to recognize the income tax consequences of an intercompany transfer of an asset other than inventory when the transfer occurs. Under current U.S. GAAP, the income tax consequences of these intercompany asset transfers are deferred until the asset is sold to a third party or otherwise recovered through use. The standard will be effective for AbbVie starting with the first quarter of 2018. Adjustments for this update are to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings with any adjustments reflected as of the beginning of the fiscal year of adoption. The company has completed its assessment of the new standard as of December 31, 2017 . The adoption will require a cumulative-effect adjustment to retained earnings on January 1, 2018 of approximately $1.8 billion related to prepaid income tax assets that will be affected by this standard, of which $1.4 billion was included in prepaid expenses and other on the consolidated balance sheet as of December 31, 2017 . In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . The standard requires that an employer continue to report the service cost component of net periodic benefit cost in the same income statement line item or items as other employee compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented separately outside of income from operations and are not eligible for capitalization. The standard will be effective for AbbVie starting with the first quarter of 2018. Upon adoption, the company will apply the income statement classification provisions of this standard retrospectively and will reclassify income of $47 million from operating earnings to non-operating income for the year ended December 31, 2017. Additionally, the company preliminarily expects to record approximately $20 million of non-operating income in 2018 which would have been recorded in operating earnings under the previous guidance. In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities . The standard simplifies the application of hedge accounting and more closely aligns the accounting with an entitys risk management activities. AbbVie will early adopt the standard effective in the first quarter of 2018 and does not believe the adoption will have a material impact on its consolidated financial statements. 58 | 2017 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,150 $ 1,047 $ Interest income (146 ) (82 ) (33 ) Interest expense, net $ 1,004 $ $ Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 3,069 $ 2,887 Accounts payable 1,474 1,407 Dividends payable 1,143 1,028 Salaries, wages and commissions Royalty and license arrangements Other 3,263 2,979 Accounts payable and accrued liabilities $ 10,226 $ 9,379 Other Long-Term Liabilities as of December 31 (in millions) Contingent consideration liabilities $ 4,266 $ 3,941 Pension and other post-employment benefits 2,740 2,085 Liabilities for unrecognized tax benefits 2,683 1,166 Income taxes payable 4,675 Other 1,241 1,160 Other long-term liabilities $ 15,605 $ 8,352 Note 4 Earnings Per Share AbbVie grants certain restricted stock awards (RSAs) and restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2017 Form 10-K | 59 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share information) Basic EPS Net earnings $ 5,309 $ 5,953 $ 5,144 Earnings allocated to participating securities Earnings available to common shareholders $ 5,283 $ 5,923 $ 5,118 Weighted-average basic shares outstanding 1,596 1,622 1,625 Basic earnings per share $ 3.31 $ 3.65 $ 3.15 Diluted EPS Net earnings $ 5,309 $ 5,953 $ 5,144 Earnings allocated to participating securities Earnings available to common shareholders $ 5,283 $ 5,923 $ 5,118 Weighted-average shares of common stock outstanding 1,596 1,622 1,625 Effect of dilutive securities Weighted-average diluted shares outstanding 1,603 1,631 1,637 Diluted earnings per share $ 3.30 $ 3.63 $ 3.13 As further described in Note 12 , AbbVie entered into and executed an accelerated share repurchase agreement (ASR) with third party financial institutions in 2016 and 2015. For purposes of calculating EPS, AbbVie reflected the ASR as a repurchase of AbbVie common stock in the relevant periods. Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Stemcentrx On June 1, 2016, AbbVie acquired all of the outstanding equity interests in Stemcentrx, a privately-held biotechnology company. The transaction expanded AbbVies oncology pipeline by adding the late-stage asset rovalpituzumab tesirine (Rova-T), four additional early-stage clinical compounds in solid tumor indications and a significant portfolio of pre-clinical assets. Rova-T is currently in registrational trials for small cell lung cancer. The acquisition of Stemcentrx was accounted for as a business combination using the acquisition method of accounting. The aggregate upfront consideration for the acquisition of Stemcentrx consisted of approximately 62.4 million shares of AbbVie common stock, issued from common stock held in treasury, and cash. AbbVie may make certain contingent payments upon the achievement of defined development and regulatory milestones. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was $4.0 billion . The acquisition-date fair value of these milestones was $620 million and was estimated using a combination of probability-weighted discounted cash flow models and Monte Carlo simulation models. The estimate was determined based on significant inputs that are not observable in the market, referred to as Level 3 inputs, as described in more detail in Note 10 . The following table summarizes total consideration: (in millions) Cash $ 1,883 Fair value of AbbVie common stock 3,923 Contingent consideration Total consideration $ 6,426 60 | 2017 Form 10-K The following table summarizes fair values of assets acquired and liabilities assumed as of the June 1, 2016 acquisition date: (in millions) Assets acquired and liabilities assumed Accounts receivable $ Prepaid expenses and other Property and equipment Intangible assets - Indefinite-lived research and development 6,100 Accounts payable and accrued liabilities (31 ) Deferred income taxes (1,933 ) Other long-term liabilities (7 ) Total identifiable net assets 4,154 Goodwill 2,272 Total assets acquired and liabilities assumed $ 6,426 Intangible assets were related to IPRD for Rova-T, four additional early-stage clinical compounds in solid tumor indications and several additional pre-clinical compounds. The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of those asset valuations include the estimated annual cash flows for each asset or product (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. The goodwill recognized represents expected synergies, including the ability to: (i) leverage the respective strengths of each business; (ii) expand the combined companys product portfolio; (iii) accelerate AbbVie's clinical and commercial presence in oncology; and (iv) establish a strong leadership position in oncology. Goodwill was also impacted by the establishment of a deferred tax liability for the acquired identifiable intangible assets which have no tax basis. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Stemcentrx have been included in the company's financial statements. AbbVies consolidated statement of earnings for the year ended December 31, 2016 included no net revenues and an operating loss of $165 million associated with Stemcentrx's operations. This operating loss included $43 million of post-acquisition stock-based compensation expense for Stemcentrx options and excluded interest expense and certain acquisition costs. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Stemcentrx for the years ended December 31, 2016 and 2015 as if the acquisition of Stemcentrx had occurred on January 1, 2015: Years ended December 31, (in millions, except per share information) Net revenues $ 25,641 $ 22,869 Net earnings 5,907 4,894 Basic earnings per share $ 3.58 $ 2.90 Diluted earnings per share $ 3.56 $ 2.88 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Stemcentrx. In order to reflect the occurrence of the acquisition on January 1, 2015 as required, the unaudited pro forma financial information includes adjustments to reflect the additional interest expense associated with the issuance of debt to finance the acquisition and the reclassification of acquisition, 2017 Form 10-K | 61 integration and financing-related costs incurred during the year ended December 31, 2016 to the year ended December 31, 2015. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2015. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Acquisition of BI 655066 and BI 655064 from Boehringer Ingelheim On April 1, 2016, AbbVie acquired all rights to risankizumab (BI 655066), an anti-IL-23 monoclonal biologic antibody in Phase 3 development for psoriasis, from Boehringer Ingelheim (BI) pursuant to a global collaboration agreement. AbbVie is also evaluating the potential of this biologic therapy in other indications, including Crohns disease, psoriatic arthritis and asthma. In addition to risankizumab, AbbVie also gained rights to an anti-CD40 antibody, BI 655064, currently in Phase 1 development. BI will retain responsibility for further development of BI 655064, and AbbVie may elect to advance the program after completion of certain clinical achievements. The acquired assets include all patents, data, know-how, third-party agreements, regulatory filings and manufacturing technology related to BI 655066 and BI 655064. The company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. Under the terms of the agreement, AbbVie made an upfront payment of $595 million . Additionally, $18 million of payments to BI, pursuant to a contractual obligation to reimburse BI for certain development costs it incurred prior to the acquisition date, were initially deferred. AbbVie may make certain contingent payments upon the achievement of defined development, regulatory and commercial milestones, as well as royalty payments based on net revenues of licensed products. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was approximately $1.6 billion . The acquisition-date fair value of these milestones was $606 million . The acquisition-date fair value of contingent royalty payments was $2.8 billion . The potential contingent consideration payments were estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs. The following table summarizes total consideration: (in millions) Cash $ Deferred consideration payable Contingent consideration 3,365 Total consideration $ 3,978 The following table summarizes fair values of assets acquired as of the April 1, 2016 acquisition date: (in millions) Assets acquired Identifiable intangible assets - Indefinite-lived research and development $ 3,890 Goodwill Total assets acquired $ 3,978 The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach. The goodwill recognized represents expected synergies, including an expansion of the companys immunology product portfolio. Pro forma results of operations for this acquisition have not been presented because this acquisition is insignificant to AbbVies consolidated results of operations. Acquisition of Pharmacyclics On May 26, 2015, AbbVie acquired Pharmacyclics, a biopharmaceutical company that develops and commercializes novel therapies for people impacted by cancer. Pharmacyclics markets IMBRUVICA (ibrutinib), a Bruton's tyrosine kinase (BTK) inhibitor, targeting B-cell malignancies. 62 | 2017 Form 10-K The acquisition of Pharmacyclics was accounted for as a business combination using the acquisition method of accounting. The total consideration for the acquisition of Pharmacyclics consisted of cash and approximately 128 million shares of AbbVie common stock and is summarized as follows: (in millions) Cash $ 12,365 Fair value of AbbVie common stock 8,405 Total consideration $ 20,770 The following table summarizes the fair values of assets acquired and liabilities assumed as of the May 26, 2015 acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ Short-term investments Accounts receivable Inventories Other assets Intangible assets Definite-lived developed product rights 4,590 Definite-lived license agreements 6,780 Indefinite-lived research and development 7,180 Accounts payable and accrued liabilities (381 ) Deferred income taxes (6,453 ) Other long-term liabilities (254 ) Total identifiable net assets 13,160 Goodwill 7,610 Total assets acquired and liabilities assumed $ 20,770 The amortization of the fair market value step-up fo r acquired inventory was included in cost of products sold and RD in the consolidated statements of earnings. The related amortization was $58 million in 2017 , $274 million in 2016 and $113 million in 2015. Intangible assets were related to the IMBRUVICA developed product rights, IPRD in the United States for additional IMBRUVICA indications and the contractual rights to IMBRUVICA profits and losses outside the United States as a result of the collaboration agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson. See Note 6 for additional information regarding the collaboration with Janssen. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of 12 years using the estimated pattern of economic benefit. The estimated fair value of the IPRD and identifiable intangible assets was determined using the ""income approach."" The goodwill recognized from the acquisition of Pharmacyclics includes expected synergies, including the ability to leverage the respective strengths of each business, expanding the combined company's product portfolio, acceleration of clinical and commercial presence in oncology and establishment of a strong leadership position in hematological oncology. The goodwill is not deductible for tax purposes. From the acquisition date through December 31, 2015, AbbVie's 2015 consolidated statement of earnings included net revenues of $774 million and an operating loss of $519 million associated with Pharmacyclics' operations. The operating loss included $346 million of acquisition-related compensation expense, $261 million of inventory step-up and intangible asset amortization and $100 million of transaction and integration costs. Of these costs, $294 million was recorded within SGA expenses, $152 million within RD expense and $261 million within cost of products sold in the 2015 consolidated statement of earnings. 2017 Form 10-K | 63 Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Pharmacyclics for 2015 as if the acquisition of Pharmacyclics had occurred on January 1, 2014: year ended December 31 (in millions, except per share information) Net revenues $ 23,215 Net earnings 5,345 Basic earnings per share $ 3.18 Diluted earnings per share $ 3.16 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Pharmacyclics. In order to reflect the occurrence of the acquisition on January 1, 2014 as required, the unaudited pro forma financial information includes adjustments to reflect the incremental amortization expense to be incurred based on the fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with the acquisition-date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition, integration and financing-related costs incurred during the year ended December 31, 2015 to the year ended December 31, 2014. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2014. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Other Licensing Acquisitions Activity Excluding the acquisitions above, cash outflows related to other acquisitions and investments totaled $308 million in 2017 , $262 million in 2016 and $964 million in 2015 . AbbVie recorded IPRD charges of $327 million in 2017 , $200 million in 2016 and $150 million in 2015 . Significant arrangements impacting 2017 , 2016 and 2015 , some of which require contingent milestone payments, are summarized below. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. C 2 N Diagnostics In March 2015, AbbVie entered into an exclusive worldwide license agreement with C 2 N Diagnostics (C 2 N) to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders. As part of the agreement, AbbVie made an initial upfront payment of $100 million , which was expensed to IPRD in 2015. AbbVie made additional payments of $35 million in both 2016 and 2017, which were recorded in RD expense, due to the achievement of development milestones under the license agreement. Upon the achievement of certain development, regulatory and commercial milestones, AbbVie could make additional payments of up to $615 million , as well as royalties on net revenues. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $122 million in 2017 , $200 million in 2016 and $50 million in 2015 . In connection with the other individually insignificant early stage arrangements entered into in 2017 , AbbVie could make additional payments of up to $2.4 billion upon the achievement of certain development, regulatory and commercial milestones. 64 | 2017 Form 10-K Other Activity Priority Review Voucher (PRV) In August 2015, AbbVie entered into an agreement to purchase a rare pediatric disease PRV from a third party. The PRV entitles AbbVie to receive an FDA priority review of a single New Drug Application or Biologics License Application, which reduces the target review time and could lead to an expedited approval. In exchange for the PRV, AbbVie made a payment of $350 million , which was recorded in RD expense in the consolidated statement of earnings and as an operating cash outflow in the consolidated statement of cash flows for 2015. AbbVie intends to use the PRV for an existing RD project. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics entered into a worldwide collaboration and license agreement with Janssen for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of BTK and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60% of collaboration development costs and AbbVie is responsible for the remaining 40% of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,001 $ $ International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) 2017 Form 10-K | 65 Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2015 $ 13,168 Additions (see Note 5) 2,360 Foreign currency translation (112 ) Balance as of December 31, 2016 15,416 Foreign currency translation Balance as of December 31, 2017 $ 15,785 The latest impairment assessment of goodwill was completed in the third quarter of 2017 . As of December 31, 2017 , there were no accumulated goodwill impairment losses. Future impairment tests for goodwill will be performed annually in the third quarter, or earlier if impairment indicators exist. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 16,138 $ (4,982 ) $ 11,156 $ 16,464 $ (4,256 ) $ 12,208 License agreements 7,822 (1,409 ) 6,413 7,809 (1,110 ) 6,699 Total definite-lived intangible assets 23,960 (6,391 ) 17,569 24,273 (5,366 ) 18,907 Indefinite-lived research and development 9,990 9,990 9,990 9,990 Total intangible assets, net $ 33,950 $ (6,391 ) $ 27,559 $ 34,263 $ (5,366 ) $ 28,897 Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $1.1 billion in 2017 , $764 million in 2016 and $419 million in 2015 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2017 is as follows: (in billions) Anticipated annual amortization expense $ 1.3 $ 1.5 $ 1.7 $ 1.9 $ 2.1 In 2017, an impairment charge of $354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. In 2016, an impairment charge of $39 million was recorded related to certain developed product rights in the United States due to a decline in the market for the product. In 2015, no intangible asset impairment charges were recorded. The 2017 and 2016 impairment charges were based on discounted cash flow analyses and were included in cost of products sold in the consolidated statements of earnings. Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2017 and 2016 related to the acquisitions of Stemcentrx and BI compounds. See Note 5 for additional information. The latest impairment assessment of indefinite-lived intangible assets was completed in the third quarter of 2017 . No impairment charges were recorded in 2017 , 2016 and 2015 . Future impairment tests for indefinite-lived intangible assets will be performed annually in the third quarter, or earlier if impairment indicators exist. 66 | 2017 Form 10-K Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment, for example, in conjunction with the loss and expected loss of exclusivity of certain products. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2017 , 2016 and 2015 , no such plans were individually significant. Restructuring charges recorded were $86 million in 2017 , $52 million in 2016 and $138 million in 2015 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on classification of the affected employees or operations. The following summarizes the cash activity in the restructuring reserve for 2017 , 2016 and 2015 : (in millions) Accrued balance at December 31, 2014 $ 2015 restructuring charges Payments and other adjustments (100 ) Accrued balance at December 31, 2015 2016 restructuring charges Payments and other adjustments (113 ) Accrued balance at December 31, 2016 2017 restructuring charges Payments and other adjustments (87 ) Accrued balance at December 31, 2017 $ 2017 Form 10-K | 67 Note 9 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2017 (a) Effective interest rate in 2016 (a) Senior notes issued in 2012 2.00% notes due 2018 2.15 % 1,000 2.15 % 1,000 2.90% notes due 2022 2.97 % 3,100 2.97 % 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 1.80% notes due 2018 1.92 % 3,000 1.92 % 3,000 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.38% notes due 2019 (1,400 principal) 0.55 % 1,673 0.55 % 1,464 1.38% notes due 2024 (1,450 principal) 1.46 % 1,733 1.46 % 1,516 2.13% notes due 2028 (750 principal) 2.18 % 2.18 % Term loan facilities Floating rate notes due 2018 2.26 % 2,000 1.64 % 2,000 Other Fair value hedges (401 ) (338 ) Unamortized bond discounts (97 ) (110 ) Unamortized deferred financing costs (146 ) (164 ) Total long-term debt and lease obligations 36,968 36,465 Current portion 6,015 Noncurrent portion $ 30,953 $ 36,440 (a) Excludes the effect of any related interest rate swaps. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs totaled $17 million and debt discounts incurred totaled $9 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. As a result of this redemption, the company incurred a charge of $39 million ( $25 million after tax) related to the make-whole premium, write-off of unamortized debt issuance costs and other expenses. The charge was recorded in interest expense, net in the consolidated statement of earnings. 68 | 2017 Form 10-K In May 2016, the company issued $7.8 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs totaled $52 million and debt discounts incurred totaled $29 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $7.7 billion net proceeds, $2.0 billion was used to repay the companys outstanding term loan that was due to mature in November 2016, approximately $1.9 billion was used to finance the acquisition of Stemcentrx and approximately $3.8 billion was used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Stemcentrx and Note 12 for additional information related to the ASR. In September 2015, AbbVie entered into a $2.0 billion three -year term loan credit agreement and a $2.0 billion 364 -day term loan credit agreement (collectively, the term loan facilities). In November 2015, AbbVie drew on these term loan facilities and used the proceeds to refinance its $4.0 billion of senior notes that matured in November 2015. In connection with the May 2016 unsecured senior notes issuance, AbbVie repaid the 364 -day term loan credit agreement. The borrowings under the term loan facilities bear interest at variable rates which are adjusted based on AbbVie's public debt ratings. In May 2015, the company issued $16.7 billion aggregate principal amount of unsecured senior notes. The senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and, except for the 1.80% notes due 2018, AbbVie may redeem the senior notes at par between one and six months prior to maturity. Debt issuance costs incurred in connection with the offering totaled $93 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Approximately $11.5 billion of the net proceeds were used to finance the acquisition of Pharmacyclics and approximately $5.0 billion of the net proceeds were used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Pharmacyclics and Note 12 for additional information related to the ASR. In March 2015, AbbVie entered into an $18.0 billion bridge loan in support of the then planned acquisition of Pharmacyclics. No amounts were drawn under the bridge loan, which was terminated as a result of the company's May 2015 senior notes issuance. Interest expense, net in 2015 included $86 million of costs related to the bridge loan. AbbVie has outstanding $6.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2017 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $400 million at December 31, 2017 and $377 million at December 31, 2016 . The weighted-average interest rate on commercial paper borrowings was 1.3% in 2017 , 0.6% in 2016 and 0.3% in 2015 . In October 2014, AbbVie entered into a $3.0 billion five -year revolving credit facility, which matures in October 2019. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2017 , the company was in compliance with all its credit facility covenants. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2017 , 2016 and 2015 . No amounts were outstanding under the credit facility as of December 31, 2017 and December 31, 2016 . 2017 Form 10-K | 69 Maturities of Long-Term Debt and Capital Lease Obligations The following table summarizes AbbVie's future minimum lease payments under non-cancelable operating leases, debt maturities and future minimum lease payments for capital lease obligations as of December 31, 2017 : as of and for the years ending December 31 (in millions) Operating leases Debt maturities and capital leases $ $ 6,026 126 1,698 109 3,771 85 1,836 66 4,102 Thereafter 20,179 Total obligations and commitments 37,612 Fair value hedges, unamortized bond discounts and deferred financing costs (644 ) Total long-term debt and lease obligations $ $ 36,968 Lease expense was $169 million in 2017 , $159 million in 2016 and $146 million in 2015 . AbbVie's operating leases generally include renewal options and provide for the company to pay taxes, maintenance, insurance and other operating costs of the leased property. As of December 31, 2017 , annual future minimum lease payments for capital lease obligations were insignificant. Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 10 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps, in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $2.2 billion at December 31, 2017 and $2.2 billion at December 31, 2016 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months. Accumulated gains and losses as of December 31, 2017 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of 70 | 2017 Form 10-K earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $7.7 billion at December 31, 2017 and $6.6 billion at December 31, 2016 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. In the fourth quarter of 2016, the company issued 3.6 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company settled foreign currency forward exchange contracts with aggregate notional amounts of 3.5 billion that were designated as net investment hedges. AbbVie is a party to interest rate hedge contracts designated as fair value hedges with notional amounts totaling $11.8 billion at December 31, 2017 and $11.8 billion at December 31, 2016 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2016 Balance sheet caption 2016 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Not designated as hedges Prepaid expenses and other 55 Accounts payable and accrued liabilities 33 Interest rate swaps designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Interest rate swaps designated as fair value hedges Other assets Other long-term liabilities 338 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive loss: years ended December 31 (in millions) Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Foreign currency forward exchange contracts $ (250 ) $ $ (250 ) $ $ $ $ $ $ The amount of hedge ineffectiveness was insignificant for all periods presented. Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax unrealized losses of $174 million into cost of products sold for foreign currency cash flow hedges during the next 12 months. The company recognized, in other comprehensive loss, pre-tax losses of $537 million in 2017 and pre-tax gains of $101 million in 2016 related to non-derivative, foreign currency denominated debt designated as net investment hedges. 2017 Form 10-K | 71 The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the effective portions of the net gains (losses) reclassified out of AOCI into net earnings. See Note 12 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ $ $ Not designated as hedges Net foreign exchange loss (96 ) (155 ) Non-designated treasury rate lock agreements Other expense, net (12 ) Interest rate swaps designated as fair value hedges Interest expense, net (63 ) (266 ) Total $ (41 ) $ (252 ) $ The gain (loss) related to outstanding interest rate swaps designated as fair value hedges is recognized in interest expense, net and directly offsets the (loss) gain on the underlying hedged item, the fixed-rate debt, resulting in no net impact to interest expense, net for all periods presented. Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities that were carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2017 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 9,303 $ $ 8,454 $ Debt securities 2,524 2,524 Equity securities Foreign currency contracts Total assets $ 11,854 $ $ 11,001 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,534 4,534 Total liabilities $ 5,084 $ $ $ 4,534 72 | 2017 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities that were carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2016 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 5,100 $ 1,191 $ 3,909 $ Time deposits 1,014 1,014 Debt securities 1,974 1,974 Equity securities Foreign currency contracts Total assets $ 8,389 $ 1,267 $ 7,122 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,213 4,213 Total liabilities $ 4,589 $ $ $ 4,213 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. Available-for-sale equity securities consists of investments for which the fair values were determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using publicized spot curves for interest rate hedges and publicized forward curves for foreign currency contracts. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2017 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $170 million . Additionally, at December 31, 2017 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $390 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,213 $ Additions (See Note 5) 3,985 Change in fair value recognized in net earnings Milestone payments (305 ) Ending balance $ 4,534 $ 4,213 The change in fair value recognized in net earnings was recorded in other expense, net in the consolidated statements of earnings in 2017 and 2016 . 2017 Form 10-K | 73 In addition to the financial instruments that the company carries at fair value on the consolidated balance sheets, certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2017 are shown in the table below: Basis of fair value measurement (in millions) Book Value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 6,023 6,034 4,004 2,030 Long-term debt and lease obligations, excluding fair value hedges 31,346 32,846 32,763 Total liabilities $ 37,769 $ 39,280 $ 36,767 $ 2,513 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2016 are shown in the table below: Basis of fair value measurement (in millions) Book Value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 25 Long-term debt and lease obligations, excluding fair value hedges 36,778 36,664 34,589 2,075 Total liabilities $ 37,180 $ 37,066 $ 34,589 $ 2,477 $ Investments primarily consist of cost method investments, for which the company takes into consideration recent transactions and financial information of the investee, which represents a Level 3 basis of fair value measurement. The fair values of short-term borrowings approximate the carrying values due to the short maturities of these instruments. The fair values of long-term debt, excluding fair value hedges and the term loans, were determined by using the published market price for the debt instruments, without consideration of transaction costs, which represents a Level 1 basis of fair value measurement. The fair values of the term loans were determined based on a discounted cash flow analysis using quoted market rates, which represents a Level 2 basis of fair value measurement. The counterparties to financial instruments consist of select major international financial institutions. 74 | 2017 Form 10-K Available-for-sale Securities Substantially all of the companys investments in debt and equity securities were classified as available-for-sale. Debt securities classified as short-term were $482 million as of December 31, 2017 and $309 million as of December 31, 2016 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2017 : Amortized Cost Gross unrealized Fair Value (in millions) Gains Losses Asset backed securities $ $ $ (3 ) $ Corporate debt securities 1,451 (2 ) 1,453 Other debt securities (1 ) Equity securities (2 ) Total $ 2,529 $ $ (8 ) $ 2,528 The following table summarizes available-for-sale securities by type as of December 31, 2016 : Amortized Cost Gross unrealized Fair Value (in millions) Gains Losses Asset backed securities $ $ $ (4 ) $ Corporate debt securities (2 ) Other debt securities (1 ) Equity securities (2 ) Total $ 1,997 $ $ (9 ) $ 2,050 AbbVie had no other-than-temporary impairments as of December 31, 2017 . Net realized gains were $90 million in 2017 . Net realized gains in 2016 and 2015 were insignificant. Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. The functional currency of the company's Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2017 and 2016 , AbbVies net monetary assets in Venezuela were insignificant. AbbVie continues to do business with foreign governments in certain countries, including Greece, Portugal, Italy and Spain, which have historically experienced challenges in credit and economic conditions. Substantially all of AbbVies trade receivables in Greece, Portugal, Italy and Spain are with government health systems. Outstanding governmental receivables in these countries, net of allowances for doubtful accounts, totaled $255 million as of December 31, 2017 and $244 million as of December 31, 2016 . The company also continues to do business with foreign governments in certain oil-exporting countries that have experienced a deterioration in economic conditions, including Saudi Arabia and Russia, which may result in delays in the collection of receivables. Outstanding governmental receivables related to Saudi Arabia, net of allowances for doubtful accounts, were $149 million as of December 31, 2017 and $122 million at December 31, 2016 . Outstanding governmental receivables related to Russia, net of allowances for doubtful accounts, were $152 million as of December 31, 2017 and $110 million as of December 31, 2016 . Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. 2017 Form 10-K | 75 Of total net accounts receivable, three U.S. wholesalers accounted for 56% as of December 31, 2017 and 51% as of December 31, 2016 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 65% of AbbVie's total net revenues in 2017 , 63% in 2016 and 61% in 2015 . Note 11 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2017 and 2016 . AbbVie's principal domestic defined benefit plan is the AbbVie Pension Plan. AbbVie made voluntary contributions of $150 million in 2017 , 2016 and 2015 to this plan. In 2018, AbbVie plans to make voluntary contributions to its various defined benefit plans in excess of $750 million . The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 5,829 $ 5,387 $ $ Service cost Interest cost Employee contributions Actuarial loss Benefits paid (173 ) (163 ) (15 ) (12 ) Other, primarily foreign currency translation adjustments (120 ) End of period 6,985 5,829 Fair value of plan assets Beginning of period 4,572 4,174 Actual return on plan assets Company contributions Employee contributions Benefits paid (173 ) (163 ) (15 ) (12 ) Other, primarily foreign currency translation adjustments (96 ) End of period 5,399 4,572 Funded status, end of period $ (1,586 ) $ (1,257 ) $ (813 ) $ (627 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities (32 ) (25 ) (15 ) (14 ) Other long-term liabilities (1,942 ) (1,472 ) (798 ) (613 ) Net obligation $ (1,586 ) $ (1,257 ) $ (813 ) $ (627 ) Actuarial loss, net $ 2,471 $ 2,118 $ $ Prior service cost (credit) (29 ) (37 ) Accumulated other comprehensive loss $ 2,483 $ 2,132 $ $ 76 | 2017 Form 10-K The projected benefit obligations (PBO) in the table above included $2.0 billion at December 31, 2017 and $1.7 billion at December 31, 2016 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $6.3 billion at December 31, 2017 and $5.3 billion at December 31, 2016 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2017 , the ABO was $3.8 billion , the PBO was $4.4 billion and aggregate plan assets were $2.5 billion . Amounts Recognized in Other Comprehensive Loss The following table summarizes the pre-tax gains and losses included in other comprehensive loss: years ended December 31 (in millions) Defined benefit plans Actuarial loss (gain) $ $ $ (117 ) Amortization of actuarial loss and prior service cost (107 ) (85 ) (127 ) Foreign exchange gain (loss) (22 ) (37 ) Total pre-tax loss (gain) recognized in other comprehensive loss $ $ $ (281 ) Other post-employment plans Actuarial loss (gain) $ $ $ (17 ) Amortization of actuarial loss and prior service cost (credit) (2 ) Total pre-tax loss (gain) recognized in other comprehensive loss $ $ $ (19 ) The pre-tax amount of actuarial loss and prior service cost included in AOCI at December 31, 2017 that is expected to be recognized in net periodic benefit cost in 2018 is $149 million for defined benefit plans and $14 million for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets (382 ) (354 ) (325 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 3.4 % 3.9 % Rate of compensation increases 4.5 % 4.4 % Other post-employment plans Discount rate 3.9 % 4.7 % 2017 Form 10-K | 77 The assumptions used in calculating the December 31, 2017 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2018 . Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 3.9 % 4.4 % 3.9 % Discount rate for determining interest cost 3.7 % 4.0 % 3.9 % Expected long-term rate of return on plan assets 7.8 % 7.9 % 7.8 % Expected rate of change in compensation 4.4 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.9 % 5.1 % 4.5 % Discount rate for determining interest cost 4.1 % 4.3 % 4.5 % Effective December 31, 2015, AbbVie elected to change the method it uses to estimate the service and interest cost components of net periodic benefit costs. Historically, AbbVie estimated these service and interest cost components of this expense utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. In late 2015, AbbVie elected to utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. AbbVie elected to make this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. AbbVie accounted for this change prospectively as a change in accounting estimate that is inseparable from a change in accounting principle. This change reduced AbbVie's net periodic benefit cost by approximately $41 million in 2016 . This change had no effect on the 2015 expense and did not affect the measurement of AbbVie's total benefit obligations. For the December 31, 2017 post-retirement health care obligations remeasurement, the company assumed a 7.7% pre-65 ( 9.5% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% in 2050 and remain at that level thereafter. For purposes of measuring the 2017 post-retirement health care costs, the company assumed a 6.8% pre-65 ( 7.8% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% for 2064 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2017 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2017 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ (9 ) Projected benefit obligation (140 ) 78 | 2017 Form 10-K Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,715 $ 1,208 $ $ Total assets measured at NAV 3,684 Fair value of plan assets $ 5,399 Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,552 $ 1,145 $ $ Total assets measured at NAV 3,020 Fair value of plan assets $ 4,572 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. 2017 Form 10-K | 79 (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The target investment allocations for the AbbVie Pension Plan is 35% in equity securities, 20% in fixed income securities and 45% in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2019 2020 2021 2022 2023 to 2027 1,474 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $82 million in 2017 , $75 million in 2016 and $73 million in 2015 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. 80 | 2017 Form 10-K Note 12 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSAs, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least ten years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Stock-based compensation expense for the year ended December 31, 2016 also included the post-combination impact related to Stemcentrx options. See Note 5 for additional information related to the Stemcentrx acquisition. The realized excess tax benefits associated with stock-based compensation totaled $71 million in 2017 , $55 million in 2016 and $61 million in 2015 . Beginning in 2017, all excess tax benefits associated with stock-based awards are recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity as a result of the adoption of a new accounting pronouncement. See Note 2 for additional information regarding the adoption of this new accounting pronouncement. Stock Options Stock options awarded pursuant to the 2013 ISP typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100% of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $9.80 in 2017 , $9.29 in 2016 and $9.96 in 2015 . 2017 Form 10-K | 81 The following table summarizes AbbVie stock option activity in 2017 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2016 15,962 $ 33.63 3.7 $ Granted 1,241 61.36 Exercised (8,836 ) 30.06 Lapsed (51 ) 32.58 Outstanding at December 31, 2017 8,316 $ 41.69 5.1 $ Exercisable at December 31, 2017 5,661 $ 35.51 3.6 $ The total intrinsic value of options exercised was $371 million in 2017 , $325 million in 2016 and $216 million in 2015 . The total fair value of options vested during 2017 was $32 million . On June 1, 2016, AbbVie issued stock options for 1.1 million AbbVie shares to holders of unvested Stemcentrx options as a result of the conversion of such options in connection with the Stemcentrx acquisition. These options were fair-valued using a lattice valuation model. See Note 5 for additional information related to the Stemcentrx acquisition. As of December 31, 2017 , $14 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSAs, RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees pursuant to the 2013 ISP generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees under the 2013 ISP are performance-based. Such awards granted before 2016 consisted of RSAs (or RSUs to the extent necessary for global employees) that generally vest in one-third increments over a three -to- five year period, with vesting contingent upon AbbVie achieving a minimum annual return on equity (ROE). Recipients are entitled to receive dividends (or dividend equivalents for RSUs) as dividends are declared and paid during the award vesting period. In 2016, AbbVie redesigned certain aspects of its long-term incentive program. As a result, equity awards granted in 2016 and 2017 to senior executives and other key employees consisted of a combination of performance-vested RSUs and performance shares. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSAs, RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. 82 | 2017 Form 10-K The following table summarizes AbbVie RSA, RSU and performance share activity for 2017 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2016 10,715 $ 56.47 Granted 6,109 61.89 Vested (5,532 ) 56.34 Forfeited (610 ) 59.50 Outstanding at December 31, 2017 10,682 $ 59.47 The fair market value of RSAs, RSUs and performance shares (as applicable) vested was $348 million in 2017 , $362 million in 2016 and $335 million in 2015 . As of December 31, 2017 , $250 million of unrecognized compensation cost related to RSAs, RSUs and performance shares is expected to be recognized as expense over approximately the next two years. Cash Dividends The following table summarizes quarterly cash dividends declared for the years ended December 31, 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 On February 15, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.71 per share to $0.96 per share beginning with the dividend payable on May 15, 2018 to stockholders of record as of April 13, 2018. Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie's board of directors authorized increases to its existing stock repurchase program of $4.0 billion in April 2016 in anticipation of executing an ASR in connection with the Stemcentrx acquisition and of $5.0 billion in March 2015 in anticipation of executing an ASR in connection with the Pharmacyclics acquisition. The following table shows details about AbbVies ASR transactions: (shares in millions, repurchase amounts in billions) Execution date Purchase amount Initial delivery of shares Final delivery of shares Related acquisition 05/26/15 $5.0 68.1 5.0 Pharmacyclics 06/01/16 3.8 54.4 5.4 Stemcentrx On February 16, 2017, AbbVie's board of directors authorized a $5.0 billion increase to AbbVie's existing stock repurchase program. AbbVie's remaining share repurchase authorization was $4.0 billion as of December 31, 2017 . On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. 2017 Form 10-K | 83 In addition to the ASRs, AbbVie repurchased on the open market approximately 13 million shares for $1.0 billion in 2017 , 34 million shares for $2.1 billion in 2016 and 46 million shares for $2.8 billion in 2015 . Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of AOCI, net of tax, for 2017 , 2016 and 2015 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2014 $ (603 ) $ $ (1,608 ) $ $ $ (2,031 ) Other comprehensive income (loss) before reclassifications (667 ) (350 ) Net losses (gains) reclassified from accumulated other comprehensive loss (4 ) (259 ) (180 ) Net current-period other comprehensive income (loss) (667 ) (137 ) (530 ) Balance as of December 31, 2015 (1,270 ) (1,378 ) (2,561 ) Other comprehensive income (loss) before reclassifications (165 ) (194 ) (52 ) Net losses (gains) reclassified from accumulated other comprehensive loss (8 ) (24 ) Net current-period other comprehensive income (loss) (165 ) (135 ) (1 ) (25 ) Balance as of December 31, 2016 (1,435 ) (1,513 ) (2,586 ) Other comprehensive income (loss) before reclassifications (343 ) (480 ) (230 ) (344 ) Net losses (gains) reclassified from accumulated other comprehensive loss (75 ) (112 ) Net current-period other comprehensive income (loss) (343 ) (406 ) (46 ) (342 ) (141 ) Balance as of December 31, 2017 $ (439 ) $ (203 ) $ (1,919 ) $ $ (166 ) $ (2,727 ) In 2017, AbbVie reclassified $316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2016 included foreign currency translation adjustments totaling a loss of $165 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2015 included foreign currency translation adjustments totaling a loss of $667 million , which was principally driven by the impact of the weakening of the Euro on the translation of the company's Euro-denominated assets. 84 | 2017 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Pension and post-employment benefits Amortization of actuarial losses and other (a) $ $ $ Tax benefit (33 ) (26 ) (46 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on designated cash flow hedges (b) $ (118 ) $ (20 ) $ (265 ) Tax expense (benefit) (4 ) Total reclassifications, net of tax $ (112 ) $ (24 ) $ (259 ) (a) Amounts are included in the computation of net periodic benefit cost (see Note 11 ). (b) Amounts are included in cost of products sold (see Note 10 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $0.01 . As of December 31, 2017 , no shares of preferred stock were issued or outstanding. Note 13 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2016 Domestic $ (2,678 ) $ (1,651 ) $ (1,038 ) Foreign 10,405 9,535 7,683 Total earnings before income tax expense $ 7,727 $ 7,884 $ 6,645 Income Tax Expense years ended December 31 (in millions) Current Domestic $ 6,204 $ 2,229 $ 1,036 Foreign Total current taxes $ 6,580 $ 2,727 $ 1,349 Deferred Domestic $ (4,898 ) $ (792 ) $ Foreign (4 ) Total deferred taxes $ (4,162 ) $ (796 ) $ Total income tax expense $ 2,418 $ 1,931 $ 1,501 Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduces the U.S. federal corporate tax rate from 35% to 21% , requires companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed and creates new taxes on certain foreign sourced earnings. These changes are effective beginning in 2018. 2017 Form 10-K | 85 Prior to the enactment of the Act, the company did not provide deferred income taxes on undistributed earnings of foreign subsidiaries that were indefinitely reinvested for continued use in foreign operations. Due to the provision of the Act that requires a one-time deemed repatriation of earnings of foreign subsidiaries, the company no longer considers those earnings to be indefinitely reinvested. The transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries was $4.5 billion , generally payable in eight annual installments. Additionally, the company remeasured certain deferred tax assets and liabilities based on tax rates at which they are expected to reverse in the future. The net tax benefit of U.S. tax reform from the remeasurement of deferred taxes related to the Act and foreign tax law changes was $3.6 billion . Given the complexity of the Act and anticipated guidance from the U.S. Treasury about implementing the Act, the companys analysis and accounting for the tax effects of the Act is preliminary. As a direct result of the Act, the company recorded $4.5 billion of transition tax expense, as well as $4.1 billion of net tax benefit for deferred tax remeasurement. Both of these amounts are provisional estimates, as the company has not fully completed its analysis and calculation of foreign earnings subject to the transition tax or its analysis of certain other aspects of the Act that could result in adjustments to the remeasurement of deferred tax balances. Upon completion of the analysis in 2018, these estimates may be adjusted through income tax expense in the consolidated statement of earnings. Effective Tax Rate Reconciliation years ended December 31 2016 Statutory tax rate 35.0 % 35.0 % 35.0 % Effect of foreign operations (12.2 ) (10.3 ) (9.4 ) U.S. tax credits (4.0 ) (4.4 ) (4.5 ) Impacts related to U.S. tax reform 12.0 Tax law change related to foreign currency 2.4 All other, net 0.5 1.8 1.5 Effective tax rate 31.3 % 24.5 % 22.6 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2017 , 2016 and 2015 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities and the cost of repatriation decisions. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2017 included impacts related to U.S. tax reform. In addition, in 2017, the company recognized a net tax benefit of $91 million related to the resolution of various tax positions pertaining to prior years. The effective income tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances. 86 | 2017 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Deferred revenue Net operating losses and other credit carryforwards Other Total deferred tax assets 2,032 2,447 Valuation allowances (108 ) (76 ) Total net deferred tax assets 1,924 2,371 Deferred tax liabilities Excess of book basis over tax basis of intangible assets (3,762 ) (5,487 ) Excess of book basis over tax basis in investments (181 ) (3,367 ) Other (203 ) (182 ) Total deferred tax liabilities (4,146 ) (9,036 ) Net deferred tax liabilities $ (2,222 ) $ (6,665 ) The decreases in deferred tax assets and liabilities were primarily due to the enactment of the U.S. tax reform that reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system, which will generally allow repatriation of future foreign sourced earnings without incurring additional U.S. taxes. The Act also created a minimum tax on certain foreign sourced earnings. The taxability of the foreign sourced earnings and the applicable tax rates are dependent on future events. While the company is still evaluating its accounting policy for the minimum tax on foreign sourced earnings, the provisional estimates of the tax effects of the Act were reported on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. As of December 31, 2017 , gross state net operating losses were $1.2 billion and tax credit carryforwards were $228 million . The state tax carryforwards expire between 2018 and 2038. As of December 31, 2017 , foreign net operating loss carryforwards were $209 million . Foreign net operating loss carryforwards of $155 million expire between 2018 and 2027 and the remaining do not have an expiration period. The company had valuation allowances of $108 million as of December 31, 2017 and $76 million as of December 31, 2016 . These were principally related to state net operating losses and credit carryforwards that are not expected to be realized. Current income taxes receivable were $2.1 billion as of December 31, 2017 and $347 million as of December 31, 2016 and were included in prepaid expenses and other on the consolidated balance sheets. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 1,168 $ $ Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions (2 ) (7 ) (15 ) Settlements (233 ) Lapse of statutes of limitations (16 ) (8 ) (8 ) Ending balance $ 2,701 $ 1,168 $ 2017 Form 10-K | 87 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $2.6 billion in 2017 and $1.1 billion in 2016 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2017 , AbbVie would be indemnified for approximately $85 million . The Increases due to current year tax positions in the table above includes amounts related to federal, state and international tax items, including a provisional estimate of the remeasurement of unrecognized tax benefits related to earnings of foreign subsidiaries following the enactment of U.S. tax reform in 2017. The ""Increase due to prior year tax positions"" in the table above includes amounts relating to federal, state and international items as well as prior positions acquired through business development activities during the year. Uncertain tax positions are generally included as a long-term liability on the consolidated balance sheets. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $24 million in 2017 , $35 million in 2016 and $13 million in 2015 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $120 million at December 31, 2017 , $112 million at December 31, 2016 and $83 million at December 31, 2015 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $31 million . All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 14 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $445 million as of December 31, 2017 and approximately $225 million at December 31, 2016 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Several pending lawsuits filed against Unimed Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others are consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation, MDL No. 2084. These cases, brought by private plaintiffs and the Federal Trade Commission (FTC), generally allege Solvay's patent litigation involving AndroGel was sham litigation and the 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. These cases include: (a) four individual plaintiff lawsuits; (b) three purported class actions; and (c) Federal Trade Commission v. Actavis, Inc. et al. Following the district court's dismissal of all plaintiffs' claims, appellate proceedings led to the reinstatement of the claims regarding the patent litigation settlements, which are proceeding in the district court. 88 | 2017 Form 10-K Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by three named direct purchasers of Niaspan and the other brought by ten named end-payer purchasers of Niaspan. The cases are consolidated for pre-trial proceedings in the United States District Court for the Eastern District of Pennsylvania under the MDL Rules as In re: Niaspan Antitrust Litigation, MDL No. 2460. In October 2016, the State of California filed a lawsuit regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In September 2014, the FTC filed suit in the United States District Court for the Eastern District of Pennsylvania against AbbVie and others, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the patent litigation settlement with one of those generic companies violates federal antitrust laws. The FTC's complaint seeks monetary damages and injunctive relief. In May 2015, the court dismissed the FTC's claim regarding the patent litigation settlement. In March 2015, the State of Louisiana filed a lawsuit, State of Louisiana v. Fournier Industrie et Sante, et al., against AbbVie, Abbott and affiliated Abbott entities in Louisiana state court. Plaintiff alleges that patent applications and patent litigation filed and other alleged conduct from the early 2000's and before related to the drug TriCor violated Louisiana State antitrust and unfair trade practices laws. The lawsuit seeks monetary damages and attorneys' fees. In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al., was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted include violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint seeks monetary damages and injunctive relief. Product liability cases are pending in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 4,300 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation, MDL No. 2545. Approximately 210 claims are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. In July 2017, a jury in the United States District Court for the Northern District of Illinois reached a verdict in the first case to be tried. The jury found for AbbVie on the plaintiff's strict liability and negligence claims and for the plaintiff on the plaintiff's fraud claim. The jury awarded no compensatory damages, but did award plaintiffs $150 million in punitive damages. In December 2017, the court vacated the jurys verdict and punitive damage award on the fraud claim and ordered a new trial on that claim. In a second case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in August 2017 on all claims, which is the subject of post-trial proceedings. In another case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in October 2017 on strict liability but for the plaintiff on remaining claims and awarded $140,000 in compensatory damages and $140 million in punitive damages, which is the subject of post-trial proceedings. In a separate case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in January 2018 on all claims. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Over ninety percent of the approximately 635 claims are pending in the United States District Court for the Southern District of Illinois, and the rest are pending in various other federal and state courts. Plaintiffs generally seek compensatory and punitive damages. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al., on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc., was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July and September 2017 against AbbVie and in some 2017 Form 10-K | 89 instances its chief executive officer in the same court by twelve additional investment funds. Plaintiffs seek compensatory and punitive damages. In May 2017, a shareholder derivative lawsuit, Ellis v. Gonzalez, et al., was filed in Delaware Chancery Court, alleging that AbbVie's directors breached their fiduciary duties in connection with statements made regarding the Shire transaction. The lawsuit seeks unspecified compensatory damages for AbbVie, among other relief. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. AbbVies appeal of the decisions is pending in the Court of Appeals for the Federal Circuit. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd., in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that eleven HCV-related patents licensed to AbbVie in 2002 are invalid. AbbVie is seeking to enforce certain patent rights related to adalimumab (a drug AbbVie sells under the trademark HUMIRA). In a case filed in United States District Court for the District of Delaware in August 2017, AbbVie alleges that Boehringer Ingelheim International GmbHs, Boehringer Ingelheim Pharmaceutical, Inc.s, and Boehringer Ingelheim Fremont, Inc.s proposed biosimilar adalimumab product infringes certain AbbVie patents. AbbVie seeks declaratory and injunctive relief. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In a case filed in the United States District Court for the District of Delaware on February 1, 2018, Pharmacyclics alleges that Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limiteds proposed generic ibrutinib product infringes Pharmacyclics patents and Pharmacyclics seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in this suit. Note 15 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) HUMIRA $ 18,427 $ 16,078 $ 14,012 IMBRUVICA 2,573 1,832 HCV 1,274 1,522 1,639 Lupron Creon Synagis Synthroid AndroGel Kaletra Sevoflurane Duodopa All other 1,217 1,402 Total net revenues $ 28,216 $ 25,638 $ 22,859 90 | 2017 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 18,251 $ 15,947 $ 13,561 Germany 1,157 1,104 1,082 United Kingdom Japan France Canada Spain Italy Brazil The Netherlands All other countries 4,080 3,885 4,001 Total net revenues $ 28,216 $ 25,638 $ 22,859 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 1,862 $ 1,822 Europe All other 278 Total long-lived assets $ 2,803 $ 2,604 2017 Form 10-K | 91 Note 16 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 6,538 $ 5,958 Gross margin 4,922 4,589 Net earnings (a) 1,711 1,354 Basic earnings per share $ 1.07 $ 0.83 Diluted earnings per share $ 1.06 $ 0.83 Cash dividends declared per common share $ 0.64 $ 0.57 Second Quarter Net revenues $ 6,944 $ 6,452 Gross margin 5,416 5,047 Net earnings (b) 1,915 1,610 Basic earnings per share $ 1.20 $ 0.99 Diluted earnings per share $ 1.19 $ 0.98 Cash dividends declared per common share $ 0.64 $ 0.57 Third Quarter Net revenues $ 6,995 $ 6,432 Gross margin 5,379 4,928 Net earnings (c) 1,631 1,598 Basic earnings per share $ 1.02 $ 0.97 Diluted earnings per share $ 1.01 $ 0.97 Cash dividends declared per common share $ 0.64 $ 0.57 Fourth Quarter Net revenues $ 7,739 $ 6,796 Gross margin 5,459 5,241 Net earnings (d) 1,391 Basic earnings per share $ 0.03 $ 0.86 Diluted earnings per share $ 0.03 $ 0.85 Cash dividends declared per common share $ 0.71 $ 0.64 (a) First quarter results in 2017 included after-tax costs of $84 million related to the change in fair value of contingent consideration liabilities. First quarter results in 2016 included a net foreign exchange loss of $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. (b) Second quarter results in 2017 included an after-tax charge of $62 million to increase litigation reserves and after-tax costs of $61 million related to the change in fair value of contingent consideration liabilities. Second quarter results in 2016 included after-tax costs totaling $122 million related to the acquisition of Stemcentrx and BI compounds as well as the amortization of the acquisition date fair value step-up for inventory related to the acquisition of Pharmacyclics. (c) Third quarter results in 2017 included after-tax costs of $401 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2016 included after-tax costs of $104 million related to the change in fair value of contingent consideration liabilities. (d) Fourth quarter results in 2017 were impacted by net charges related to the December 2017 enactment of the Tax Cuts and Jobs Act , including an after-tax charge of $4.5 billion related to the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries , partially offset by after-tax benefits of $3.3 billion due to 92 | 2017 Form 10-K remeasurement of net deferred tax liabilities and other related impacts . Additional after-tax costs that impacted fourth quarter results in 2017 included $244 million for an intangible asset impairment charge, $221 million for a charge to increase litigation reserves, $205 million as a result of entering into a global strategic collaboration with Alector, Inc. and $79 million related to the change in fair value of contingent consideration liabilities. These costs were partially offset by an after-tax benefit of $91 million due to a tax audit settlement. Fourth quarter results in 2016 included after-tax costs totaling $187 million associated with a tax law change for regulations issued in the fourth quarter of 2016 that revised the treatment of foreign currency translation gains and losses for certain operations as well as after-tax costs totaling $85 million related to the change in fair value of contingent consideration liabilities. 2017 Form 10-K | 93 Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2017 and 2016 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 16, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 16, 2018 94 | 2017 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, William J. Chase, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2017 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 . 2017 Form 10-K | 95 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 96 | 2017 Form 10-K Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2017 and 2016 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes of the Company and our report dated February 16, 2018 expressed an unqualified opinion thereon. Basis of Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 16, 2018 2017 Form 10-K | 97 " +39,Coca-Cola,2021," ITEM 1. BUSINESS In this report, the terms The Coca-Cola Company, Company, we, us and our mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to the Company account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. We are guided by our purpose, which is to refresh the world and make a difference, and rooted in our strategy to drive net operating revenue growth and generate long-term value. Our vision for growth has three connected pillars: Loved Brands. We craft meaningful brands and a choice of drinks that people love and that refresh them in body and spirit. Done Sustainably. We use our leadership to be part of the solution to achieve positive change in the world and to build a more sustainable future for our planet. For A Better Shared Future. We invest to improve peoples lives, from our employees to all those who touch our business system, to our investors, to the broad communities we call home. Effective January 1, 2021, we transformed our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace by building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We created new operating units, which are focused on regional and local execution. The operating units, which sit under four geographic operating segments, as discussed below, are highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units work closely with five global marketing category leadership teams to rapidly scale ideas while staying close to the consumer. The global marketing category leadership teams primarily focus on innovation as well as marketing efficiency and effectiveness. Our organizational structure also includes a center and a platform services organization, as discussed below. The Coca-Cola Company was incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Companys operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments: Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focusing on strategic initiatives, policy, governance and scaling global initiatives; and (2) a platform services organization supporting the operating units, global marketing category leadership teams and the center by providing efficient and scaled global services and capabilities including, but not limited to, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. For additional information about our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: concentrates means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes powders/minerals for purified water products; syrups means intermediate products in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); fountain syrups means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; Company Trademark Beverages means beverages bearing our trademarks and certain other beverages bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive an economic benefit; and Trademark Coca-Cola Beverages or Trademark Coca-Cola means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word Trademark together with the name of one of our other beverage products (such as Trademark Fanta, Trademark Sprite or Trademark Simply), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that Trademark Fanta includes Fanta Orange, Fanta Zero Orange, Fanta Zero Sugar, Fanta Apple, etc.; Trademark Sprite includes Sprite, Sprite Zero Sugar, etc.; and Trademark Simply includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa Limited (Costa). These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading Our Business General set forth in Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (Coca-Cola system), refer to the heading Operations Review Beverage Volume set forth in Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of this report. We own and market numerous valuable beverage brands, including the following: sparkling soft drinks: Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, 1 Sprite and Thums Up; hydration, sports, coffee and tea: Aquarius, Ayataka, BODYARMOR, Ciel, Costa, doadan, Dasani, FUZE TEA, Georgia, glacau smartwater, glacau vitaminwater, Gold Peak, Ice Dew, I LOHAS, Powerade and Topo Chico; and nutrition, juice, dairy and plant-based beverages: AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy and Simply. 1 Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other beverage brands through licenses, joint ventures and strategic partnerships. For example, certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (Monster), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Our Company continually seeks to further optimize its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to the Company at a rate of 2.1 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 31.3 billion and 29.0 billion unit cases of our products in 2021 and 2020, respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume in both 2021 and 2020. Trademark Coca-Cola accounted for 47 percent of our worldwide unit case volume in both 2021 and 2020. In 2021, unit case volume in the United States represented 17 percent of the Companys worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 42 percent of U.S. unit case volume. Unit case volume outside the United States represented 83 percent of the Companys worldwide unit case volume in 2021. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2021 were as follows: Coca-Cola FEMSA, S.A.B. de C.V. (Coca-Cola FEMSA), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (a major part of the states of So Paulo and Minas Gerais, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois and part of the state of Rio de Janeiro), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola Europacific Partners plc (CCEP), which has bottling and distribution operations in Andorra, Australia, Belgium, Fiji, continental France, Germany, Great Britain, Iceland, Indonesia, Luxembourg, Monaco, the Netherlands, New Zealand, Norway, Papua New Guinea, Portugal, Samoa, Spain and Sweden; Coca-Cola HBC AG (Coca-Cola Hellenic), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan and territories in 13 states in the western United States. In 2021, these five bottling partners combined represented 41 percent of our total worldwide unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottlers Agreements We have separate contracts, to which we generally refer as bottlers agreements, with our bottling partners under which our bottling partners are granted certain authorizations by us. Subject to specified terms and conditions and certain variations, the bottlers agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers. However, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottlers agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Companys ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. However, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model in most markets. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrates are sold, and package mix. As further discussed below, our bottlers agreements for territories outside the United States differ in some respects from our bottlers agreements for territories within the United States. Bottlers Agreements Outside the United States Bottlers agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottlers agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottlers agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottlers Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a Comprehensive Beverage Agreement (CBA) that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottlers agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. In all instances, the bottlers agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers have been granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage brands (as defined by the CBAs). We refer to these bottlers as expanding participating bottlers or EPBs. EPBs operate under CBAs (EPB CBAs) under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. Each EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company has also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights, which we refer to as participating bottlers, converted their legacy bottlers agreements to CBAs, to which we refer as participating bottler CBAs, each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottlers agreements that include pricing formulas that generally provide for a baseline price for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume prepared, packaged, sold and distributed under these legacy bottlers agreements is not material. Under the terms of the bottlers agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups, or deliver them on our behalf, to restaurants and other retailers. Promotional and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottlers agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing support and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers and other customers of our Companys products, principally for participation in promotional and marketing programs, was $4.7 billion in 2021. Investments in Bottling Operations Most of our branded beverage products are prepared, packaged, distributed and sold by independent bottling partners. However, from time to time we acquire or take control of a bottling operation, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning a bottling operation enables us to compensate for limited local resources; help focus the bottlers sales and marketing programs; assist in the development of the bottlers business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a consolidated bottling operation, typically by selling all or a portion of our interest in the bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell a consolidated bottling operation to an independent bottling partner in which we have an equity method investment, our Company continues to participate in the bottlers results of operations through our share of the equity method investees earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola systems production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Companys concentrate operations. When our equity investment provides us with the ability to exercise significant influence over the investee bottlers operating and financial policies, we account for the investment under the equity method. Seasonality Sales of our ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The commercial beverage industry is highly competitive and consists of numerous companies, ranging from small or emerging to very large and well established. These include companies that, like our Company, compete globally in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; water products, including flavored and enhanced waters; juices, juice drinks and nectars; dilutables (including syrups and powders); coffees; teas; energy drinks; sports drinks; milk and other dairy-based drinks; plant-based beverages; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive products are sold to consumers in both ready-to-drink and non-ready-to-drink form. The Company has directly entered the alcohol beverage segment in numerous markets outside the United States. In the United States, the Company has authorized alcohol-licensed third parties to use certain of our brands on alcohol beverages. Competitive products include all flavored alcohol beverages of varying alcohol bases. In many of the countries in which we do business, PepsiCo, Inc. is a primary competitor. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Danone S.A., Suntory Beverage Food Limited, Unilever, AB InBev, Kirin Holdings, Heineken N.V., Diageo and Red Bull GmbH. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing microbrands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private-label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, digital marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging as well as new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.), and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer recognition and loyalty; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated employees. Our competitive challenges include strong competitors in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers own store or private-label beverage brands; new industry entrants; and dramatic shifts in consumer shopping methods and patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (HFCS), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers requirements with the assistance of Coca-Cola Bottlers Sales Services Company LLC (CCBSS). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our North American operations and to our U.S. bottling partners for the purchase of various goods and services, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Companys standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions that can impact the quality and supply of orange juice and orange juice concentrate. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. We generate most of our coffee revenues through Costa. Costa purchases Rainforest Alliance Certified green coffee through multiple suppliers. While most of Costas coffee is sourced as readily available bulked commercial grade from Brazil, Vietnam and Colombia, many of Costas suppliers have vertically integrated supply chains with direct access to yields from cooperatives and producer groups. Our consolidated bottling operations and our non-bottling finished product operations also purchase various other raw materials including, but not limited to, polyethylene terephthalate (PET) resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and beverage gases, including carbon dioxide and liquid nitrogen. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as technology. This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulas are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottlers agreements, we authorize our bottlers to use applicable Company trademarks in connection with their preparation, packaging, distribution and sale of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Companys products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under the Safe Drinking Water and Toxic Enforcement Act of 1986 (Proposition 65) of the state of California, if the state has determined that a substance causes cancer or harms human reproduction or development, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a safe harbor threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. However, the state of California and other parties have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer, among other beverage containers, nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at federal, state and local levels, both in the United States and elsewhere around the world. All of our Companys facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance will have, any material adverse effect on our Companys capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (GDPR) as well as the California Consumer Privacy Act of 2018 (CCPA), which became effective on January 1, 2020, and its extension, the California Privacy Rights Act (CPRA), which will take effect on January 1, 2023. The interpretation and application of data privacy, cross-border data transfers and data protection laws and regulations are often uncertain and are evolving in the United States and internationally, such as in the European Union, China and other jurisdictions. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Globally, we see a growing trend toward data protection laws and regulations increasing in complexity and number, and we anticipate that our obligations will expand commensurately. Human Capital Management Our people and culture agendas are critical business priorities. Our Board of Directors, through the Talent and Compensation Committee, provides oversight of the Companys policies and strategies relating to talent, leadership and culture, including diversity, equity and inclusion, as well as the Companys compensation philosophy and programs. The Talent and Compensation Committee also evaluates and approves the Companys compensation plans, policies and programs applicable to our senior executives. In addition, the Committee on Directors and Corporate Governance of the Board of Directors oversees succession planning and talent development for our senior executives. Employees We believe people are our most important asset, and we strive to attract and retain high-performing talent. As of December 31, 2021 and 2020, our Company had approximately 79,000 and 80,300 employees, respectively, of which approximately 9,400 and 9,300, respectively, were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2021, approximately 700 employees in North America were covered by collective bargaining agreements. These agreements typically have terms of three to five years. We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. Diversity, Equity and Inclusion We believe that a diverse, equitable and inclusive workplace that mirrors the markets we serve is a strategic business priority and critical to the Companys success. We take a comprehensive view of diversity, equity and inclusion across different races, ethnicities, tribes, religions, socioeconomic backgrounds, generations, abilities, and expressions of gender and sexual identity. As of December 31, 2021, we had approximately 8,400 employees located in the United States, excluding the employees of the Global Ventures operating segment, fairlife, LLC and BA Sports Nutrition, LLC. Of these employees, 39 percent and 46 percent were female and people of color, respectively. We are focused on social justice issues, including racial and gender equity, both in the United States and around the world. In 2021, we announced our 2030 aspirations to be 50 percent led by women globally, and in the United States, to reflect the U.S. Census racial and ethnic representation at all job grade levels. Each of our operating units outside the United States has developed locally relevant diversity, equity and inclusion aspirations. Diversity and inclusion metrics, which highlight progress and help drive accountability, are shared with our senior leaders on a quarterly basis. Our Global Womens Leadership Council, composed of eight executives, focuses on accelerating the development and promotion of women into roles of increasing responsibility and influence. We conduct annual pay equity analyses, with regard to gender globally and race/ethnicity in the United States, to help ensure our base pay structures are fair and to identify and address potential issues or disparities. We make adjustments to base pay, where appropriate. Also, as permitted by local law, during the annual rewards cycle, we perform an adverse impact analysis on base pay, annual incentives and long-term incentives to help ensure fairness. We support many employee-led inclusion networks, which are an integral part of our diversity, equity and inclusion strategy. Our inclusion networks are regionally structured in order to meet relevant local needs, and they provide employees with the opportunity to engage with colleagues globally based on common interests or backgrounds. Compensation and Benefits Through comprehensive and competitive compensation and benefits, ongoing employee learning and development, and a focus on health and well-being, we strive to support our employees in all aspects of their lives. Our compensation programs are designed to reinforce our growth agenda and our talent strategy as well as to drive a strong connection between the contributions of our employees and their pay. We believe the structure of our compensation packages provides the appropriate incentives to attract, retain and motivate our employees. We provide base pay that is competitive and that aligns with employee positions, skill levels, experience and geographic location. In addition to base pay, we seek to reward employees with annual incentive awards, recognition programs, and equity awards for employees at certain job levels. We also offer competitive employee benefits packages, which vary by country and region. These employee benefits packages may include: 401(k) plan, pension plan, core and supplemental life insurance, financial courses and advisors, employee assistance programs, tuition assistance, commuter assistance, adoption assistance, medical and dental insurance, vision insurance, health savings accounts, health reimbursement and flexible spending accounts, well-being rewards programs, vacation pay, holiday pay, and parental and adoption leave . Culture and Engagement As our employees work together to achieve our purpose to Refresh the World and Make a Difference, they collectively build and reinforce our culture. Our culture is rooted in our growth mindset, which expects each employee, leader and function to be curious, empowered, inclusive and agile. We use a variety of practices to measure and support progress against these growth behaviors and to ensure that our employees are engaged and fulfilled at work. For example, our Performance Enablement and Culture Engagement Pulse platforms provide regular opportunities for employees across the organization to provide feedback on how their leaders, teammates and work experiences support the growth behaviors. Data from questionnaires are anonymized and plotted against historical results to inform teams and functions on areas of strength and opportunities for improvement. We also encourage regular, live communication across the organization and host quarterly global town halls with our senior leadership that include employee question-and-answer sessions. In addition, function-level town halls are held on a regular basis. Leadership, Training and Development We focus on investing in inspirational leadership, learning opportunities and capabilities to equip our global workforce with the skills they need while improving engagement and retention. We provide a range of formal and informal learning programs, which are designed to help our employees continuously grow and strengthen their skills throughout their careers. We offer a variety of programs that contribute to our leadership, training and development goals, including: Coca-Cola University, a robust catalog of digital content, including courseware from Harvard, eCornell, and LinkedIn Learning; Opportunity Marketplace, a people-centered technology solution that helps connect project opportunities to interested employees who have the capacity, skills and interest in short-term experiences and assignments; and comprehensive enterprise-wide coaching and mentoring programs that support leadership and employee development. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Companys website is not incorporated by reference in this report. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (SEC) in accordance with the Securities Exchange Act of 1934, as amended (Exchange Act). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the Investors page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the Investors page of our website and review the information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition and results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. RISKS RELATED TO OUR OPERATIONS The COVID-19 pandemic and related ongoing impacts may have a material adverse effect on our results of operations, financial condition and cash flows. The COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus have negatively impacted, and could continue to negatively impact, our business globally. Our recovery has been asynchronous and the full extent to which theCOVID-19 pandemic will affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted, including, among others, new information which may emerge concerning the pandemic, vaccine adoption rates (including boosters) and the effectiveness of vaccines in limiting or stopping the spread of COVID-19, either over the long term or against new, emerging variants of COVID-19, and any related actions by governments. The extent and nature of government actions related to the COVID-19 pandemic varied throughout 2020 and 2021 based upon the then-current extent and severity of the COVID-19 pandemic within the respective markets. At times we experienced a decrease in sales of certain of our products in markets around the world, including consumer demand shifting to more at-home consumption versus away-from-home consumption. While in 2021 we have experienced improved trends in away-from-home channels and improved margins, if COVID-19 infection rates increase, the pandemic intensifies or expands geographically, or continued efforts to curb the pandemic are ineffective, the negative impacts of the pandemic on our sales could be more prolonged and may become more severe than we are currently experiencing. In addition, continuing economic and political uncertainties, such as increased unemployment, decreases in disposable income, declines in consumer confidence, or economic slowdowns or recessions in any of our major markets, may slow down or prevent the recovery of the demand for our products or may erode such demand. The COVID-19 pandemic has disrupted and could continue to disrupt our global supply chain . We and our bottling partners have experienced temporary disruptions in certain of our operations; delays in delivery of concentrates, ingredients, packaging and equipment; temporary plant closures; production slowdowns; and difficulty or delays in sourcing key ingredients and beverage containers. We and our bottling partners may face similar disruptions in the future, which may increase supply chain and packaging costs, or may result in an inability to secure key ingredients and inputs, which could cause delays in delivering our products to our customers and consumers. Although we are unable to predict the impact on our ability to source materials in the future, we expect supply chain pressures to continue into 2022. In addition to the above risks, the COVID-19 pandemic may exacerbate other risks related to our business, including risks related to changes in the retail landscape or the loss of key retail or foodservice customers; fluctuations in input costs, inflation rates, and foreign currency exchange rates; and the ability of third-party service providers and business partners to fulfill their respective commitments and responsibilities to us in a timely manner and in accordance with the agreed-upon terms. The continuing evolution of the pandemic may also present risks not currently known to us. Increased competition could hurt our business. We operate in the highly competitive commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading Competition set forth in Part I, Item 1. Business of this report. Our ability to maintain or gain share of sales in the global market or in local markets may be limited as a result of actions by competitors. Competitive pressures may cause the Company and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers ability to increase prices, as may be necessary in response to commodity and other cost increases. Such pressures may also increase marketing costs along with in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain consumer interest, brand loyalty and market share while we selectively expand into other profitable categories in the commercial beverage industry, our business could be negatively affected. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial results. Our industry is being affected by the trend toward consolidation in, and the blurring of the lines between, retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private-label brands, any of which could negatively affect the Coca-Cola systems profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we and our bottling partners build e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumer demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. If we do not successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. Consequently, we continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Companys and the Coca-Cola systems ability to attract, hire, develop, motivate and retain a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Companys purpose and work that matters most. Competition and compensation expectations for existing and prospective personnel have increased. In addition, the broader labor market is experiencing a shortage of qualified workers which has further increased the competition we face for qualified employees. We may not be able to successfully compete for, attract or retain the highly skilled and diverse workforce that we want and that our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled employees due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Failure to attract, hire, develop, motivate and retain highly skilled and diverse talent; to meet our goals related to fostering an inclusive and diverse culture, including increasing the number of underrepresented employees in the United States to develop and implement an adequate succession plan for our management team; to maintain a corporate culture that fosters innovation, collaboration and inclusion; or to design and successfully implement flexible work models that meet the expectations of employees and prospective employees could disrupt our operations and adversely affect our business and our future success. Increases in the cost, disruption of supply or shortages of energy or fuel could affect our profitability. Our consolidated bottling operations operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our production plants and the bottling plants and distribution facilities operated by our consolidated bottling operations. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries where we have production plants, or in markets where our consolidated bottling operations operate, which may be caused by increasing demand, by events such as natural disasters, power outages and extreme weather, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners operating costs and thus could indirectly negatively impact our results of operations. Increases in the cost, disruption of supply or shortages of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as coffee, orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading Raw Materials set forth in Part I, Item 1. Business of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions, governmental actions, climate change and other factors beyond our control, including the COVID-19 pandemic. Substantial increases in the prices of our or our bottling partners ingredients, other raw materials, packaging materials, aluminum cans and other containers, to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce our or our bottling partners sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are only available from one source. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredients that are available from a limited number of suppliers or from only one source. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS. The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply and quality of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. We may not be able to increase prices to fully offset inflationary pressures on various costs, such as our costs for materials and labor, which may adversely impact our financial condition or results of operations. In connection with our manufacturing and bottling operations, we are dependent upon, among other things, raw materials, packaging materials, plant labor and transportation providers. In 2021 and the early part of 2022, the costs of raw materials, packaging materials, labor, energy, fuel, transportation and other inputs necessary for the production and distribution of our products have rapidly increased. In addition, many of these items are subject to price fluctuations from a number of factors, including, but not limited to, market conditions, geopolitical developments, demand for raw materials, weather, growing and harvesting conditions, climate change, energy costs, currency fluctuations, supplier capacities, governmental actions, import and export requirements (including tariffs), and other factors beyond our control. We expect the inflationary pressures on input and other costs to continue to impact our business in 2022. Our attempts to offset these cost pressures, such as through price increases of some of our products, may not be successful. Higher product prices may result in reductions in sales volume. Consumers may be less willing to pay a price differential for our branded products and may increasingly purchase lower-priced offerings, or may forgo some purchases altogether. To the extent that price increases are not sufficient to offset higher costs adequately or in a timely manner, and/or if they result in significant decreases in sales volume, our financial condition or results of operations may be adversely affected. Furthermore, we may not be able to offset cost increases through productivity initiatives or through our commodity hedging activity. If we do not successfully integrate and manage our acquired businesses, brands or bottling operations, our financial results could suffer. We routinely evaluate opportunities to acquire businesses or brands to expand our beverage portfolio and capabilities. Additionally, from time to time, we have acquired or taken control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. We may incur unforeseen liabilities and obligations in connection with acquiring businesses, brands or bottling operations. The expected benefits of business or brand acquisitions, including cost and growth synergies associated with such acquisitions, may take longer to realize than expected or may not be realized at all. Moreover, we may encounter challenges to successfully integrating the operations, technologies, services, products and systems of any acquired businesses in an effective, timely and cost-efficient manner. We may also encounter unexpected difficulties, costs or delays in restructuring and integrating acquired businesses, brands or bottling operations into our Companys operating and internal control structures, including extending our Companys internal control over financial reporting to newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our quality management program, which is designed to ensure product quality and safety, may not be sufficiently robust to effectively manage the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing various supply chain models as we expand our product offerings. Our financial performance is impacted by how well we can integrate and manage acquired businesses, brands and bottling operations, and we may not be able to achieve our strategic and financial objectives for acquired businesses, brands or bottling operations. If we incur unforeseen liabilities or costs in connection with acquiring or integrating businesses, brands or bottling operations, experience internal control or product quality failures, or are unable to achieve our strategic and financial objectives for acquired businesses, brands or bottling operations, our consolidated results could be negatively affected. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed-upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. If we are unable to renew collective bargaining agreements on satisfactory terms, or if we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our employees at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with employees and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our employees. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations or our major bottlers plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Companys overall reputation and brand image, which in turn could have a negative impact on our products acceptance by consumers. RISKS RELATED TO CONSUMER DEMAND FOR OUR PRODUCTS Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental, social and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained in, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners periodically have not met, and may not always meet, these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as synthetic colors, non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (4-MEI), a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-flavored beverages; or substances used in packaging materials, such as bisphenol A (BPA), an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans, may affect consumers preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our efforts to digitize the Coca-Cola system, our financial results could be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the Coca-Cola systems retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up the brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights have not always had, and may not in the future always have, the desired impact on our products brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or spurious products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives have engaged, and may in the future engage, in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates have been, and could in the future be, the subject of backlash from advocacy groups or others that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships have subjected us in the past, and could subject us in the future, to negative publicity as a result of actual or alleged misconduct by individuals, hosts or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, have in the past, and could in the future, generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, the Guiding Principles on Business and Human Rights, endorsed by the United Nations Human Rights Council, outline how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations Protect, Respect and Remedy framework on human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Companys overall reputation and brand image, which in turn could have a negative impact on our products acceptance by consumers. In addition, if we fail to protect our employees and our supply chain employees human rights, or inadvertently discriminate against any group of employees or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Unfavorable general economic and political conditions could negatively impact our financial results. Many of the jurisdictions in which our products are sold have experienced and could continue to experience unfavorable general economic conditions, such as a recession or economic slowdown, which could negatively affect the affordability of, and consumer demand for, our beverages. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private-label brands, which could reduce our profitability and could negatively affect our overall financial performance. Other financial uncertainties in our major markets and unstable political conditions in certain markets, including civil unrest and governmental changes, could undermine global consumer confidence and reduce consumers purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. If we are unable to successfully manage new product launches, our business and financial results could be adversely affected. Due to the highly competitive nature of the commercial beverage industry, the Company continually introduces new products and evolves existing products to stimulate consumer demand. For instance, the Company has directly entered the ready-to-drink alcohol beverages segment in numerous markets outside the United States, and in the United States, the Company has authorized alcohol-licensed third parties to use certain of its brands on ready-to-drink alcohol beverages. The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance. Such endeavors may also involve significant risks and uncertainties, including greater execution risks, higher costs, distraction of management from current operations, inadequate return on investments, increased competitive pressures, exposure to additional regulations and reliance on the performance of third parties. If we become subject to additional government regulations, including alcohol regulations related to licensing, trade and pricing practices, labeling, advertising, promotion and marketing practices, and relationships with distributors, we may become exposed to the risk of increased compliance costs and disruption to our core business. RISKS RELATED TO THE COCA-COLA SYSTEM We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, some of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to maintain operating and strategic alignment or agree on appropriate pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their resources to business opportunities or products other than those of the Company. Such actions could, in the long term, have an adverse effect on our profitability. If our bottling partners financial condition deteriorates, our business and financial results could be affected. In the vast majority of our markets, our products are sold and distributed by independent bottling partners, and we therefore derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners. Accordingly, the success of our business depends in part on our bottling partners financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners income or loss. Our bottling partners financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions; the availability of capital and other financing resources on reasonable terms; loss of major customers; changes in or additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our equity method investee bottling partners, it could also result in a decrease in our equity income and/or impairments of our equity method investments. We may from time to time engage in refranchising activities or divestitures of certain brands or businesses, which could adversely affect our business and results of operations. As part of our strategic initiative to focus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise our consolidated bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on terms and conditions favorable to us, or if our refranchising partners are not efficient or not aligned with our long-term vision for the Coca-Cola system, our business and results of operations could be adversely affected. Additionally, we have divested and may in the future divest certain brands or businesses. These divestitures may adversely impact our business, results of operations, cash flows and financial condition if we are unable to offset impacts from the loss of revenue associated with the divested brands or businesses, or if we are otherwise unable to achieve the anticipated benefits or cost savings from such divestitures. RISKS RELATED TO REGULATORY AND LEGAL MATTERS Increases in income tax rates, changes in income tax laws, regulations or unfavorable resolutions of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates in the jurisdictions in which we operate, tax treaties between such jurisdictions, and the geographic mix of our income before income taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix or foreign exchange rates could reduce our net income. Tax laws and regulations, including rates of taxation, are subject to revision by individual taxing jurisdictions which may result from multilateral agreements. Many jurisdictions have enacted legislation and adopted policies resulting from the Organization for Economic Co-operation and Developments (OECD) anti-Base Erosion and Profit Shifting project. The OECD is currently coordinating a project on behalf of the G20 and other participating countries which would grant additional taxing rights over profits earned by multinational enterprises to the countries in which their products are sold and services rendered. A second pillar would establish a global per-country minimum tax of 15 percent. It is possible that the adoption of these or other proposals could have a material impact on our net income and cash flows. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions, estimates and accruals. The results of audits or related disputes could have a material adverse effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (IRS) is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. The Company firmly believes that the IRS claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. On November 18, 2020, the U.S. Tax Court (Tax Court) issued an opinion (Opinion) predominantly siding with the IRS. Although the Company disagrees with the unfavorable portions of the Opinion and intends to vigorously defend its position, considering all avenues of appeal, there is no assurance that the courts will ultimately rule in the Companys favor. It is therefore possible that all or some of the unfavorable portions of the Opinion could ultimately be upheld. In that event, the Company would be subject to significant additional liabilities for the years at issue and potentially also for the subsequent years if the unfavorable portions of the Opinion were to be applied to the foreign licensees covered within the scope of the Opinion. Moreover, the IRS could successfully appeal the portions of the Opinion that are favorable to the Company and/or assert new claims for additional tax relating to the subsequent years by broadening the scope to cover additional foreign licensees. These adjustments could have a material adverse impact on the Companys financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or thereafter, may also have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (Tax Reform Act). For additional information regarding the tax litigation, refer to the heading Legal Proceedings set forth in Part I, Item 3. Legal Proceedings of this report. Increased or new indirect taxes could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as indirect taxes, including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers offer, among other beverage containers, nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, recycling content, tethered bottle caps, ecotax and/or product stewardship, or even prohibitions on certain types of plastic products, packages and cups, have been introduced and/or adopted in various jurisdictions, and we anticipate that similar legislation or regulations may be proposed in the future at federal, state and local levels, both in the United States and elsewhere. Consumers increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions have adopted and may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction or development, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading Governmental Regulation set forth in Part I, Item 1. Business of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, those arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our employees and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our employees and agents with all applicable legal requirements. Improper conduct by our employees or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulas and other intellectual property rights could harm our business. Our trademarks, formulas and other intellectual property rights (refer to the heading Patents, Copyrights, Trade Secrets and Trademarks in Part I, Item 1. Business of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading Governmental Regulation set forth in Part I, Item 1. Business of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change; to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns; or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with various laws and regulations, such as U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and the Office of Foreign Assets Control trade sanction regulations and anti-boycott regulations, antitrust and competition laws, anti-modern slavery laws, anti-bribery and anti-corruption laws, data privacy laws, including the European Union General Data Protection Regulation, tax laws and regulations and a variety of other applicable local, national and multinational regulations and laws could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners facilities, as well as damage to our or our bottling partners image and reputation, all of which could harm our or our bottling partners profitability. RISKS RELATED TO FINANCE, ACCOUNTING AND INVESTMENTS Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using many currencies other than the U.S. dollar. In 2021, we used 70 functional currencies in addition to the U.S. dollar and derived $25.6 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. Because of the geographic diversity of our operations, weakness in some currencies may be offset by strength in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. On December 31, 2021, the United Kingdoms Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (LIBOR), ceased to publish certain LIBOR reference rates. However, other LIBOR reference rates, including U.S. dollar overnight, 1-month, 3-month, 6-month and 12-month maturities, will continue to be published through June 2023. In preparation for the discontinuation of LIBOR, we have amended, or will amend, our LIBOR-referencing agreements to either reference the Secured Overnight Financing Rate or include mechanics for selecting an alternative rate, but it is possible that these changes may have an adverse impact on our financing costs as compared to LIBOR in the long term. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners financial performance; changes in the credit rating agencies methodology in assessing our credit strength; the credit agencies perception of the impact of credit market conditions on our or our major bottling partners current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners interest expense could increase, which would reduce our equity income. If we are unable to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives are based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterpartys liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial results could be adversely affected. We have a long-term strategic relationship in the global energy drink category with Monster. If we are unable to successfully manage our relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. RISKS RELATED TO INFORMATION TECHNOLOGY AND DATA PRIVACY If we are unable to protect our information systems against service interruption, misappropriation of data or cybersecurity incidents, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (information systems), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company employees and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Companys operating activities, our business may be impacted by system shutdowns, service disruptions or cybersecurity incidents. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by hackers, criminal groups or nation-state organizations (which may include social engineering, business email compromise, cyber extortion, denial of service, or attempts to exploit vulnerabilities), geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated personal data. If our information systems or third-party information systems on which we rely suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrates or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data protection laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands, and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight, including governmental investigations, enforcement actions and regulatory fines. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems. These risks also may be present to the extent any of our bottling partners, distributors, joint venture partners or suppliers using separate information systems, not integrated with the information systems of the Company, suffers a cybersecurity incident and could result in increased costs related to involvement in investigations or notifications conducted by these third parties. These risks may also be present to the extent a business we have acquired, but which does not use our information systems, experiences a system shutdown, service disruption, or cybersecurity incident. Like most major corporations, the Companys information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners, suppliers or acquired businesses that use separate information systems, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date, as well as those reported to us by our third-party partners, have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies and training. Data protection laws and regulations around the world often require reasonable, appropriate or adequate technical and organizational security measures, and the interpretation and application of those laws and regulations are often uncertain and evolving; there can be no assurance that our security measures will be deemed adequate, appropriate or reasonable by a regulator or court. Moreover, even security measures that are deemed appropriate, reasonable or in accordance with applicable legal requirements may not be able to protect the information we maintain. In addition to potential fines, we could be subject to mandatory corrective action due to a cybersecurity incident, which could adversely affect our business operations and result in substantial costs for years to come. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks, as well as the Companys plans and strategies to address them, are regularly presented to senior management and the Audit Committee of the Board of Directors. While we have purchased cybersecurity insurance, there are no assurances that the coverage would be adequate in relation to any incurred losses. Moreover, as cyberattacks increase in frequency and magnitude, we may be unable to obtain cybersecurity insurance in amounts and on terms we view as appropriate for our operations. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (personal data), primarily employees, former employees and consumers with whom we interact. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. These laws impose operational requirements for companies receiving or processing personal data, and many provide for significant penalties for noncompliance. Some laws and regulations also impose obligations regarding cross-border data transfers of personal data. These requirements with respect to personal data have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and information security systems, policies, procedures and practices. In addition, some countries are considering or have enacted data localization laws requiring that certain data in their country be maintained, stored and/or processed in their country. Maintaining local data centers in individual countries could increase our operating costs significantly. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data by us or the third-party service providers and vendors whose technology, systems and services we use in connection with the receipt, storage and transmission of personal data. Unauthorized access to or improper disclosure of personal data in violation of personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to regulatory enforcement actions (including penalties, fines and investigations), and result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. We have incurred, and will continue to incur, expenses to comply with privacy and data protection standards and protocols imposed by law, regulation, industry standards and contractual obligations. Increased regulation of data collection, use, and retention practices, including self-regulation and industry standards, changes in existing laws and regulations, enactment of new laws and regulations, increased enforcement activity, and changes in interpretation of laws, could increase our cost of compliance and operation, limit our ability to grow our business or otherwise harm our business. RISKS RELATED TO ENVIRONMENTAL AND SOCIAL FACTORS Our ability to achieve our environmental, social and governance goals are subject to risks, many of which are outside of our control, and our reputation and brands could be harmed if we fail to meet such goals. Companies across all industries are facing increasing scrutiny from stakeholders related to environmental, social and governance (ESG) matters, including practices and disclosures related to environmental stewardship; social responsibility; diversity, equity and inclusion; and workplace rights. Our ability to achieve our ESG goals and objectives and to accurately and transparently report our progress presents numerous operational, financial, legal and other risks, and are dependent on the actions of our bottling partners, suppliers and other third parties, all of which are outside of our control. If we are unable to meet our ESG goals or evolving stakeholder expectations and industry standards, or if we are perceived to have not responded appropriately to the growing concern for ESG issues, our reputation, and therefore our ability to sell products, could be negatively impacted. In addition, in recent years, investor advocacy groups and certain institutional investors have placed increasing importance on ESG matters. If, as a result of their assessment of our ESG practices, certain investors are unsatisfied with our actions or progress, they may reconsider their investment in our Company. As the nature, scope and complexity of ESG reporting, diligence and disclosure requirements expand, we may have to undertake additional costs to control, assess and report on ESG metrics. Any failure or perceived failure, whether or not valid, to pursue or fulfill our ESG goals, targets and objectives or to satisfy various ESG reporting standards within the timelines we announce, or at all, could increase the risk of litigation. Increasing concerns about the environmental impact of plastic bottles and other packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the accumulation of plastic bottles and other packaging materials in the environment, particularly in the worlds waterways, lakes and oceans, as well as inefficient use of resources when packaging materials are not included in a circular economy. We and our bottling partners sell certain of our beverage products in plastic bottles and use other packaging materials that, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola systems impact on the environment by increasing our use of recycled content in our packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; expanding our use of reusable packaging (including refillable or returnable glass and plastic bottles, as well as dispensed and fountain delivery models where consumers use refillable containers for our beverages); participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted, or are considering adopting, regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase in recycling rates and/or recycled content minimums, or, in some cases, restrict or even prohibit the use of certain plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us or our bottling partners to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Water scarcity and poor quality could negatively impact the Coca-Cola systems costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve and the ecosystems in which we operate. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability. Increased demand for food products and decreased agricultural productivity may negatively affect our business. As part of the manufacture of our beverage products, we and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products; decreased agricultural productivity in certain regions of the world as a result of changing weather patterns; increased agricultural regulations; and other factors have in the past, and may in the future, limit the availability and/or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola systems bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola systems carbon footprint by increasing our use of recycled packaging materials, expanding our renewable energy usage, and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industrywide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre complex in Atlanta, Georgia. The complex includes several office buildings which are used by Corporate employees and North America operating segment employees. In addition, the complex includes technical and engineering facilities along with a reception center. We own or lease additional facilities, real estate and office space throughout the world, which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our Costa retail stores, which are included in the Global Ventures operating segment, and facilities related to our consolidated bottling and distribution operations, which are included in the Bottling Investments operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2021: Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Facilities Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa 5 2 7 27 13 Latin America 5 2 3 North America 11 7 4 23 Asia Pacific 7 2 1 Global Ventures 1 2 8 1,587 Bottling Investments 82 3 105 99 Corporate 3 5 Total 32 93 7 116 166 1,600 Management believes that our Companys facilities used for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of our production facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in U.S. Federal Income Tax Dispute below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (Georgia Case), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (Aqua-Chem), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Companys filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (Wisconsin Case). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chems general and product liability claims arising from occurrences prior to the Companys sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chems asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chems losses up to policy limits. The courts judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (Chartis insurers) would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Companys interpretation of the courts judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial courts summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (Notice) from the IRS seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arms-length pricing of transactions between related parties such as the Companys U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arms-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (Closing Agreement). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Companys compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Companys matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS designation of the Companys matter for litigation, the Company was forced to either accept the IRS newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the Tax Court in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Companys case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Companys foreign licensees to increase the Companys U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors, and we reviewed and considered relevant laws, rules, and regulations, including, but not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Companys tax positions, that it is more likely than not the Companys tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (Tax Court Methodology), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Companys analysis. The Companys conclusion that it is more likely than not the Companys tax positions will ultimately be sustained on appeal is unchanged as of December 31, 2021. However, we updated our calculation of the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of the application of the required probability analysis to these updated calculations and the accrual of interest through the current reporting period, we updated our tax reserve as of December 31, 2021 to $ 400 million. While the Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for tax years 2007 through 2009, and potentially also for subsequent years, which could have a material adverse impact on the Companys financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology were to be ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2021 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 through 2021. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the 2017 Tax Cuts and Jobs Act. The Company estimates that the potential aggregate incremental tax and interest liability could be approximately $ 13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. We currently project the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2021, would result in an incremental annual tax liability that would increase the Companys effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Companys Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax years. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax years, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Companys common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is KO. While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 18, 2022, there were 191,391 shareowner accounts of record. This figure does not include a substantially greater number of street name holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading Equity Compensation Plan Information under the principal heading Compensation in the Companys definitive Proxy Statement for the 2022 Annual Meeting of Shareowners (Companys 2022 Proxy Statement), to be filed with the SEC, is incorporated herein by reference. During the year ended December 31, 2021, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2021 by the Company or any affiliated purchaser of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act: Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 October 2, 2021 through October 29, 2021 9,480 $ 54.48 161,029,667 October 30, 2021 through November 26, 2021 161,029,667 November 27, 2021 through December 31, 2021 106,605 53.64 161,029,667 Total 116,085 $ 53.71 1 The total number of shares purchased includes: (i) shares purchased, if any, pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (2012 Plan) for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (2019 Plan) for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Shareowner Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Shareowner Return Stock Price Plus Reinvested Dividends December 31, 2016 2017 2018 2019 2020 2021 The Coca-Cola Company $ 100 $ 114 $ 122 $ 147 $ 151 $ 168 Peer Group Index 100 111 90 112 121 139 SP 500 Index 100 122 116 153 181 233 The total shareowner return is based on a $100 investment on December 31, 2016 and assumes that dividends were reinvested on the day of issuance. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, ConAgra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., Freshpet Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrims Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2021, the Dow Jones Food Beverage Index and the Peer Group Index included Freshpet Inc., which was not included in the indices in 2020. Additionally, in 2021 these indices do not include Jefferies Financial Group Inc. and TreeHouse Foods, Inc., which were included in the indices in 2020. ITEM 6. INTENTIONALLY OMITTED "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto contained in Item 8. Financial Statements and Supplementary Data of this report. MDA includes the following sections: Our Business a general description of our business and its challenges and risks. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our consolidated results of operations for 2021 and 2020 and year-to-year comparisons between 2021 and 2020. An analysis of our consolidated results of operations for 2020 and 2019 and year-to-year comparisons between 2020 and 2019 can be found in MDA in Part II, Item 7 of the Companys Form 10-K for the year ended December 31, 2020. Liquidity, Capital Resources and Financial Position an analysis of cash flows, contractual obligations, foreign exchange, and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Companys consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to us account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa. These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 Concentrate operations 56 % 56 % Finished product operations 44 44 Total 100 % 100 % The following table sets forth the percentage of total worldwide unit case volume attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 Concentrate operations 83 % 82 % Finished product operations 17 18 Total 100 % 100 % We operate in the highly competitive commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climates, local and national laws and regulations, foreign currency fluctuations, fuel prices, weather patterns and the COVID-19 pandemic. Throughout 2021, the effects of the COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus continued to impact our business globally. In particular, the number of people contracting COVID-19 and the preventive measures taken to contain COVID-19, including the spread of new variants, negatively impacted our unit case volume and increased our costs to manufacture and distribute our products. Our price, product and geographic mix was also negatively impacted, primarily due to unfavorable channel and product mix as consumer demand shifted to more at-home consumption versus away-from-home consumption. However, the timing and number of people receiving vaccinations, the governmental actions to reopen certain economies around the world, and the substance and pace of the economic recovery favorably impacted our business when compared to 2020. While uncertainties caused by the COVID-19 pandemic remain, and factors such as the state of the supply chain, labor shortages and the inflationary environment are likely to impact the pace of the economic recovery, we expect to continue to see improvements in our business as we continue to learn and adapt to the ever-changing environment. The Companys priorities during the COVID-19 pandemic and related business disruptions are ensuring the health and safety of our employees; supporting and making a difference in the communities we serve; keeping our brands in supply; maintaining the quality and safety of our products; and serving our customers across all channels as they adapt to the shifting demands of consumers during the pandemic. Throughout the pandemic, business continuity and adapting to the needs of our customers have been critical. We have developed systemwide knowledge-sharing routines and processes, which include the management of any supply chain challenges. As of the date of this filing, while we have experienced some temporary supply chain disruptions, there has been no material impact, and we do not foresee a material impact, on our and our bottling partners ability to manufacture or distribute our products. Despite the pandemic, we are not losing sight of long-term opportunities for our business. The pandemic helped us realize we could be much bolder in our efforts to change. We identified the following key objectives to navigate the pandemic and position us to capture growth: winning more consumers; gaining market share; maintaining strong system economics; strengthening stakeholder impact; and equipping the organization to win. In order to deliver against these objectives, we focused on the following priorities: unlocking the potential of our portfolio of strong global, regional and scaled local brands; developing a robust innovation pipeline focusing on scalable initiatives; increasing consumer-centric marketing effectiveness and efficiency; winning in the marketplace with aligned data-driven revenue growth management and execution capabilities; and further embedding ESG goals into our operations. In August 2020, the Company announced strategic steps to transform our organizational structure to better enable us to capture growth in the fast-changing marketplace. The Company has transformed into a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information about our strategic realignment initiatives. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of our Company and the commercial beverage industry. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers lifestyles and dietary choices. Therefore, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Product Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more beverage choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating growth through our evolving portfolio of beverage brands and products (including numerous low- and no-calorie products), selectively expanding into other profitable categories of the commercial beverage industry, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to the planet. Evolving Competitive Landscape and Competing in the Digital Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce in many markets has led to dramatic shifts in consumer shopping habits and patterns. Consumers are rapidly embracing shopping via mobile device applications, e-commerce retailers and e-commerce websites or platforms, which presents new challenges to maintain the competitiveness and relevancy of our brands. As a result, we must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share. In addition, we are increasing our investments in e-commerce to support retail and meal delivery services, offering more package sizes that are fit-for-purpose for online sales, and shifting more consumer and trade promotions to digital. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to satisfy consumers evolving needs and preferences. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management program also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Environmental and Social Matters As investors and stakeholders increasingly focus on ESG issues, our Company and companies across all industries are facing challenges and risks related to, among other things, environmental stewardship; social responsibility; diversity, equity and inclusion; and workplace rights. Where these challenges and risks relate to our business, we acknowledge that we have a role to play in developing and implementing solutions related to these important challenges. We have established specific ESG goals related to water quality and scarcity; packaging materials used for our products; reduction of added sugar in our beverages; reduction of carbon dioxide and other greenhouse gas emissions; sustainable agriculture; diversity, equity and inclusion; and human and workplace rights. Our ability to achieve our ESG goals is dependent on many factors, including, but not limited to, our actions along with the actions of various stakeholders, such as our bottling partners, suppliers, governments, nongovernmental organizations, communities, and other third parties, all of which are outside of our control. See Item 1A. Risk Factors in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Companys Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Companys significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entitys voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which another entity holds a variable interest is referred to as a VIE. An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether the VIEs are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over the operating and financial policies of the investee. Our consolidated net income includes our Companys proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading Our Business Challenges and Risks above and Item 1A. Risk Factors in Part I of this report. As a result, management must make numerous assumptions, which involve a significant amount of judgment, when performing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The performance of recoverability and impairment tests of current and noncurrent assets involves critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, the impact of any supply chain disruptions, inflation, long-term growth rates, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers financial condition. These factors are even more difficult to estimate as a result of uncertainties associated with the scope, severity and duration of the global COVID-19 pandemic and any resurgences of the pandemic, including, but not limited to, the number of people contracting the virus; the impact of shelter-in-place and social distancing requirements; the impact of governmental actions across the globe to contain the virus; vaccine availability, rates of vaccination and effectiveness of vaccines against existing and new variants of the virus; governmental or other vaccine mandates and any associated business and supply chain disruptions; and the substance and pace of the economic recovery. The estimates we use when performing recoverability tests of assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using managements best assumptions, which we believe are consistent with those a market participant would use. The variability of these factors depends on a number of conditions, including uncertainties associated with the COVID-19 pandemic, and thus our accounting estimates may change from period to period. While uncertainties still exist, we expect to see continued improvements in our business as vaccines become more widely available, as vaccination rates increase, and as consumers return to many of their previous work routines as well as socializing and traveling. The Company has certain intangible and other long-lived assets that are more dependent on cash flows generated in the away-from-home channels and/or that generate cash flows in geographic areas that are more heavily impacted by the COVID-19 pandemic and are therefore more susceptible to impairment. In addition, intangible and other long-lived assets we acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions at the time of acquisition. If we had used other assumptions and estimates when tests of these assets were performed, impairment charges could have resulted. Furthermore, if management uses different assumptions in future periods, or if different conditions exist in future periods, impairment charges could result. The total future impairment charges we may be required to record could be material. Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion of recent acquisitions. Refer to Note 16 of Notes to Consolidated Financial Statements for the discussion of impairment charges. Refer to the heading Operations Review below for additional information related to our present business environment. As of December 31, 2021, the carrying value of our investment in Coca-Cola Bottlers Japan Holdings Inc. (CCBJHI) exceeded its fair value by $87 million, or 18 percent. Based on the length of time and the extent to which the fair value has been less than our carrying value and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge related to the investment. Our equity method investees also perform such recoverability and impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charge may be impacted by items such as basis differences, deferred taxes and deferred gains. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of accumulated other comprehensive income (loss), except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Companys investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, managements assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe a market participant would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Managements assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses and/or projected future losses. When such events or changes in circumstances are present and a recoverability test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, recoverability tests must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, impairment tests must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The performance of recoverability and impairment tests of intangible assets involves critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, the impact of any supply chain disruptions, inflation, long-term growth rates, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers financial condition. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when performing recoverability tests of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using managements best assumptions, which we believe are consistent with those a market participant would use. The estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions in future periods or if different conditions exist in future periods, impairment charges could result. Refer to the heading Operations Review below for additional information related to our present business environment. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, we are required to ensure that the assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Companys actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is generally one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are generally subdivided into smaller geographic regions. These geographic regions are our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting units fair value. However, the impairment charge recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management performs a recoverability test of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment tests of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees in the United States. In addition, our Company and its subsidiaries have various pension plans outside the United States. Management is required to make certain critical estimates related to the actuarial assumptions used to determine our net periodic pension cost or income and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. Our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost or income and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic pension cost or income by applying the specific spot rates along the yield curve to the plans projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our expected long-term rates of return on plan assets. Our investment objective for our pension assets is to ensure all funded pension plans have sufficient assets to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to seek to improve returns and manage risk. In 2021, the Companys total income related to defined benefit pension plans was $61 million, which included net periodic pension income of $180 million and net charges of $119 million related to settlements, curtailments and special termination benefits. In 2022, we expect our net periodic pension income to be approximately $188 million. The increase in 2022 expected net periodic pension income is primarily due to an increase in the weighted-average discount rate at December 31, 2021 compared to December 31, 2020, favorable asset performance in 2021 and a reduction in the number of plan participants arising from our strategic realignment initiatives, partially offset by a decrease in the expected weighted-average long-term rate of return on plan assets assumption. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $17 million decrease in our 2022 net periodic pension income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $26 million decrease in our 2022 net periodic pension income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2021, the Companys primary U.S. pension plan represented 61 percent and 57 percent of the Companys consolidated projected benefit obligation and pension plan assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrates are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained, but for a lesser amount; or (3) the tax position is more likely than not to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading Operations Review Income Taxes below and Note 14 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 11 of Notes to Consolidated Financial Statements. Tax laws require certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the book basis and tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Companys local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of a center and a platform services organization. For additional information regarding our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Companys operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands and their related operations or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Companys performance. Unit case volume growth is a metric used by management to evaluate the Companys performance because it measures demand for our products at the consumer level. The Companys unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading Beverage Volume below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of beverages, primarily measured in number of transactions (in all instances expressed in unit case equivalents), sold by the Company to customers or consumers. Refer to the heading Beverage Volume below. When we analyze our net operating revenues, we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading Net Operating Revenues below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we do not recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party, regardless of our ownership interest in the bottling partner, if any. We generally refer to acquisitions and divestitures of bottling operations as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Companys unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Companys acquisitions and divestitures. Acquired brands refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to an acquired brand are incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. Licensed brands refers to brands not owned by the Company but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to a licensed brand in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to a licensed brand are incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2021, the Company acquired the remaining ownership interest in BA Sports Nutrition, LLC (BodyArmor). The impact of this acquisition has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. In 2020, the Company discontinued our Odwalla juice business. The impact of discontinuing our Odwalla juice business has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, unit case means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings), with the exception of unit case equivalents for Costa non-ready-to-drink beverage products, which are primarily measured in number of transactions; and unit case volume means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers. Unit case volume consists primarily of beverage products bearing Company trademarks. Also included in unit case volume are certain brands licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive an economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an ownership interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of beverages, primarily measured in number of transactions (in all instances expressed in unit case equivalents), sold by the Company to customers or consumers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to these items, the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2021 versus 2020 Unit Cases 1,2 Concentrate Sales Worldwide 8 % 9 % Europe, Middle East Africa 9 % 12 % Latin America 6 6 North America 5 7 Asia Pacific 10 11 Global Ventures 17 20 Bottling Investments 11 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic and Global Ventures operating segment data reflect unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. Global Ventures operating segment data also reflects unit case volume growth for Costa retail stores. Unit Case Volume Sparkling soft drinks represented 69 percent of our worldwide unit case volume in both 2021 and 2020. Trademark CocaCola accounted for 47 percent of our worldwide unit case volume in both 2021 and 2020. In 2021, unit case volume in the United States represented 17 percent of the Companys worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 42 percent of U.S. unit case volume. Unit case volume outside the United States represented 83 percent of the Companys worldwide unit case volume in 2021. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. The Coca-Cola system sold 31.3 billion and 29.0 billion unit cases of our products in 2021 and 2020, respectively. The increase was primarily a result of the gradual recovery in away-from-home channels in many markets throughout 2021, along with the larger impact of shelter-in-place and social distancing requirements in 2020. Unit case volume in Europe, Middle East and Africa increased 9 percent, which included 9 percent growth in both Trademark Coca-Cola and sparkling flavors, 17 percent growth in nutrition, juice, dairy and plant-based beverages, and 6 percent growth in hydration, sports, coffee and tea. The operating segment reported growth in unit case volume of 7 percent in the Europe operating unit, 12 percent in the Eurasia and Middle East operating unit and 10 percent in the Africa operating unit. In Latin America, unit case volume increased 6 percent, which included 5 percent growth in Trademark Coca-Cola, 7 percent growth in hydration, sports, coffee and tea, 6 percent growth in sparkling flavors and 10 percent growth in nutrition, juice, dairy and plant-based beverages. The operating segments volume performance included 3 percent growth in Mexico, 14 percent growth in Argentina and 3 percent growth in Brazil. Unit case volume in North America increased 5 percent, which included 9 percent growth in sparkling flavors, 6 percent growth in hydration, sports, coffee and tea, 2 percent growth in Trademark Coca-Cola, and 7 percent growth in nutrition, juice, dairy and plant-based beverages. In Asia Pacific, unit case volume increased 10 percent, which included 11 percent growth in both Trademark Coca-Cola and sparkling flavors, 6 percent growth in hydration, sports, coffee and tea, and 18 percent growth in nutrition, juice, dairy and plant-based beverages. The operating segment reported growth in unit case volume of 11 percent in the Greater China and Mongolia operating unit, 33 percent in the India and Southwest Asia operating unit, 3 percent in the ASEAN and South Pacific operating unit and 2 percent in the Japan and South Korea operating unit. Unit case volume for Global Ventures increased 17 percent, driven by 16 percent growth in hydration, sports, coffee and tea, along with growth in energy drinks, partially offset by a decline of 3 percent in nutrition, juice, dairy and plant-based beverages. Unit case volume for Bottling Investments increased 11 percent, which primarily reflects growth in India, South Africa and the Philippines. Concentrate Sales Volume In 2021, worldwide concentrate sales volume increased 9 percent and unit case volume increased 8 percent compared to 2020. The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments and the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. The timing of concentrate shipments was primarily a result of certain bottlers building inventory due to concerns associated with potential supply chain disruptions. Net Operating Revenues Net operating revenues were $38,655 million in 2021, compared to $33,014 million in 2020, an increase of $5,641 million, or 17 percent. The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2021 versus 2020 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated 9 % 6 % 1 % % 17 % Europe, Middle East Africa 12 % 6 % 1 % % 19 % Latin America 6 12 18 North America 7 7 15 Asia Pacific 11 (2) 3 12 Global Ventures 20 13 7 41 Bottling Investments 11 2 2 15 Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in unit case equivalents) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes, if any. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only after considering the impact of structural changes, if any. Refer to the heading Beverage Volume above. 2 Includes structural changes, if any. Refer to the heading Structural Changes, Acquired Brands and Newly Licensed Brands above. Refer to the heading Beverage Volume above for additional information related to changes in our unit case and concentrate sales volumes. Price, product and geographic mix refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Companys net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) changes in the mix of products and packages sold; (3) changes in the mix of channels where products were sold; and (4) changes in the mix of geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Price, product and geographic m ix had a 6 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable channel and package mix, partially offset by unfavorable geographic mix; Latin America favorable pricing initiatives, inflationary pricing in Argentina, and favorable channel and package mix; North America favorable pricing initiatives and favorable channel and category mix; Asia Pacific unfavorable geographic mix, partially offset by favorable product and package mix; Global Ventures favorable channel mix primarily due to the reopening of Costa retail stores, partially offset by unfavorable product mix; and Bottling Investments favorable price, category and package mix, partially offset by unfavorable geographic mix. The favorable channel and package mix for the year ended December 31, 2021 in all applicable operating segments was primarily a result of the gradual recovery in away-from-home channels in many markets throughout 2021 and the larger impact of shelter-in-place and social distancing requirements in 2020. Foreign currency fluctuations increased our consolidated net operating revenues by 1 percent. This favorable impact was primarily due to a weaker U.S. dollar compared to certain foreign currencies, including the British pound sterling, South African rand, euro, Chinese yuan and Mexican peso, which had a favorable impact on our Europe, Middle East and Africa; Asia Pacific; Latin America; Global Ventures; and Bottling Investments operating segments. The favorable impact of a weaker U.S. dollar compared to the currencies listed above was partially offset by the impact of a stronger U.S. dollar compared to certain other foreign currencies, including the Argentine peso, Brazilian real, Turkish lira, Ethiopian birr and Japanese yen, which had an unfavorable impact on our Latin America; Europe, Middle East and Africa; Asia Pacific; and Bottling Investments operating segments. Refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. Acquisitions and divestitures generally refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or a divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Companys net operating revenues provides investors with useful information to enhance their understanding of the Companys net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Companys performance. Refer to the heading Structural Changes, Acquired Brands and Newly Licensed Brands above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. Based on current spot rates and our hedging coverage in place, we expect foreign currency fluctuations will have a negative impact on our full year 2022 net operating revenues. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, 2021 2020 Europe, Middle East Africa 17.0 % 16.8 % Latin America 10.7 10.6 North America 34.1 34.7 Asia Pacific 12.1 12.8 Global Ventures 7.3 6.0 Bottling Investments 18.6 19.0 Corporate 0.2 0.1 Total 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in some operating segments growing at a faster rate compared to other operating segments. For additional information about the impact of foreign currency fluctuations, refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Our gross profit margin increased to 60.3 percent in 2021 from 59.3 percent in 2020. This increase was primarily due to the impact of favorable pricing initiatives and favorable channel and package mix as well as the gradual recovery in away-from-home channels in many markets throughout 2021, partially offset by the impact of increased commodity and transportation costs. We expect commodity and transportation costs to continue to increase in 2022, and we will continue to proactively take actions in an effort to mitigate the impact of these incremental costs. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2021 2020 Selling and distribution expenses $ 2,574 $ 2,638 Advertising expenses 4,098 2,777 Stock-based compensation expense 337 126 Other operating expenses 5,135 4,190 Selling, general and administrative expenses $ 12,144 $ 9,731 Selling, general and administrative expenses increased $2,413 million, or 25 percent, in 2021. This increase was primarily due to higher annual incentive and stock-based compensation expense, increased charitable donations and increased marketing spending, which was reduced in 2020 as a result of uncertainties associated with the COVID-19 pandemic. The increase in annual incentive and stock-based compensation expense was primarily due to improved financial performance in 2021 and a more favorable outlook of our future financial performance, which resulted in higher payout assumptions as compared to 2020. In 2021, foreign currency exchange rate fluctuations increased selling, general and administrative expenses by 2 percent. The decrease in selling and distribution expenses was primarily due to the continued impact of the COVID-19 pandemic on away-from-home channels, partially offset by the impact of foreign currency exchange rate fluctuations. As of December 31, 2021, we had $335 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2021 2020 Europe, Middle East Africa $ 141 $ 73 Latin America 11 29 North America 39 379 Asia Pacific 12 31 Global Ventures 4 Bottling Investments 34 Corporate 643 303 Total $ 846 $ 853 In 2021, the Company recorded other operating charges of $846 million. These charges primarily consisted of $369 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition, $146 million related to the Companys strategic realignment initiatives, $119 million related to the BodyArmor acquisition, which includes various transition and transaction costs, distributor termination fees, employee retention costs and the amortization of noncompete agreements, and $115 million related to the Companys productivity and reinvestment program. In addition, other operating charges included an impairment charge of $78 million related to a trademark in Europe, which was driven by a change in the long-term outlook on the licensing arrangement for a certain brand, charges of $15 million related to tax litigation and a net charge of $4 million related to the restructuring of our manufacturing operations in the United States. In 2020, the Company recorded other operating charges of $853 million. These charges primarily consisted of $413 million related to the Companys strategic realignment initiatives and $99 million related to the Companys productivity and reinvestment program. In addition, other operating charges included impairment charges of $160 million related to the Odwalla trademark and charges of $33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $55 million related to a trademark in North America, which was driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Companys portfolio. In addition, other operating charges included $51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and $16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the BodyArmor and fairlife acquisitions. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Companys strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2021 2020 Europe, Middle East Africa 36.2 % 36.8 % Latin America 24.6 23.5 North America 32.3 27.5 Asia Pacific 22.6 23.7 Global Ventures 2.8 (1.4) Bottling Investments 4.6 3.4 Corporate (23.1) (13.5) Total 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2021 2020 Consolidated 26.7 % 27.3 % Europe, Middle East Africa 56.9 59.9 Latin America 61.2 60.5 North America 25.3 21.5 Asia Pacific 49.7 50.6 Global Ventures 10.5 (6.2) Bottling Investments 6.6 4.9 Corporate * * * Calculation is not meaningful. Operating income was $10,308 million in 2021, compared to $8,997 million in 2020, an increase of $1,311 million, or 15 percent. The increase in operating income was primarily driven by concentrate sales volume growth of 9 percent, favorable channel and package mix, effective cost management and a favorable currency exchange rate impact, partially offset by higher annual incentive and stock-based compensation expense, increased charitable donations and increased marketing spending. In 2021, fluctuations in foreign currency exchange rates favorably impacted consolidated operating income by 2 percent due to a weaker U.S. dollar compared to certain foreign currencies, including the Mexican peso, Chinese yuan and British pound sterling, which had a favorable impact on our Latin America; Asia Pacific; Europe, Middle East and Africa; and Global Ventures operating segments. The favorable impact of a weaker U.S. dollar compared to the currencies listed above was partially offset by the impact of a stronger U.S. dollar compared to certain other foreign currencies, including the Argentine peso, Brazilian real, Turkish lira and Japanese yen, which had an unfavorable impact on our Latin America; Europe, Middle East and Africa; and Asia Pacific operating segments. Refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. The Companys Europe, Middle East and Africa operating segment reported operating income of $3,735 million and $3,313 million for the years ended December 31, 2021 and 2020, respectively. The increase in operating income was primarily driven by a 12 percent increase in concentrate sales volume, favorable channel and package mix, and a favorable foreign currency exchange rate impact of 2 percent, partially offset by higher annual incentive expense, increased marketing spending and higher other operating charges. Latin America reported operating income of $2,534 million and $2,116 million for the years ended December 31, 2021 and 2020, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 6 percent, favorable pricing initiatives, favorable channel and package mix, and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Operating income for North America for the years ended December 31, 2021 and 2020 was $3,331 million and $2,471 million, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 7 percent, favorable pricing initiatives, favorable channel and category mix, effective cost management and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Asia Pacifics operating income for the years ended December 31, 2021 and 2020 was $2,325 million and $2,133 million, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 11 percent, a favorable foreign currency exchange rate impact of 4 percent and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Global Ventures operating income for the year ended December 31, 2021 was $293 million, while the operating segments operating loss for the year ended December 31, 2020 was $123 million. The change in operating income was primarily driven by revenue growth as a result of the reopening of Costa retail stores in the United Kingdom and a favorable foreign currency exchange rate impact of 6 percent. Bottling Investments operating income for the years ended December 31, 2021 and 2020 was $473 million and $308 million, respectively. The increase in operating income was primarily driven by volume growth of 11 percent, lower other operating charges and favorable price, category and package mix, partially offset by an unfavorable foreign currency exchange rate impact of 1 percent. Corporates operating loss for the years ended December 31, 2021 and 2020 was $2,383 million and $1,221 million, respectively. Operating loss in 2021 increased primarily as a result of higher annual incentive and stock-based compensation expense, increased marketing spending, increased charitable donations and higher other operating charges. Interest Income Interest income was $276 million in 2021, compared to $370 million in 2020, a decrease of $94 million, or 25 percent. This decrease was primarily driven by lower interest rates in certain of our international locations as well as lower investment balances. Interest Expense Interest expense was $1,597 million in 2021, compared to $1,437 million in 2020, an increase of $160 million, or 11 percent. This increase was primarily due to charges of $650 million in 2021 versus charges of $484 million in 2020 associated with the extinguishment of long-term debt. Refer to Note 10 of Notes to Consolidated Financial Statements. Equity Income (Loss) Net Equity income (loss) net represents our Companys proportionate share of net income or loss from each of our equity method investees. In 2021, equity income was $1,438 million, compared to equity income of $978 million in 2020, an increase of $460 million, or 47 percent. This increase reflects, among other items, the impact of more favorable operating results reported by most of our equity method investees in 2021, as results in 2020 were more negatively impacted by the COVID-19 pandemic, along with a favorable foreign currency exchange rate impact. In addition, the Company recorded net charges of $13 million and $216 million during the years ended December 31, 2021 and 2020, respectively, which represent the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost or income for pension and other postretirement benefit plans; other charges and credits related to pension and other postretirement benefit plans; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; other-than-temporary impairment charges; and net foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2021, other income (loss) net was income of $2,000 million. The Company recognized a gain of $834 million in conjunction with the BodyArmor acquisition, a net gain of $695 million related to the sale of our ownership interest in Coca-Cola Amatil Limited (CCA), an equity method investee, to CCEP, also an equity method investee, and a net gain of $114 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Additionally, the Company recognized a net gain of $467 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Additionally, other income (loss) net included income of $277 million related to the non-service cost components of net periodic benefit income and dividend income of $73 million. Other income (loss) net also included charges of $266 million related to the restructuring of our manufacturing operations in the United States, pension plan settlement charges of $117 million related to our strategic realignment initiatives and net foreign currency exchange losses of $61 million. In 2020, other income (loss) net was income of $841 million. The Company recognized a gain of $902 million in conjunction with the fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value, a net gain of $148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, and a net gain of $35 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee . These gains were partially offset by an other-than-temporary impairment charge of $252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $38 million related to one of our equity method investees in Latin America, an impairment charge of $26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $55 million related to economic hedging activities. The Company also recorded net charges of $25 million related to the restructuring of our manufacturing operations in the United States and charges of $14 million for pension and other postretirement benefit plan settlements and curtailments related to the Companys strategic realignment initiatives. Other income (loss) net also included income of $171 million related to the non-service cost components of net periodic benefit income, $72 million of dividend income and net foreign currency exchange losses of $64 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the sale of our ownership interest in CCA and the BodyArmor and fairlife acquisitions. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on our economic hedging activities. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the restructuring of our manufacturing operations in the United States and the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Companys strategic realignment initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Eswatini. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $381 million and $317 million for the years ended December 31, 2021 and 2020, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2021 2020 Statutory U.S. federal tax rate 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 2.3 1 0.9 3 Equity income or loss (2.0) (1.4) Excess tax benefits on stock-based compensation (0.5) (0.8) Other net (0.8) 2 (0.5) 4,5 Effective tax rate 21.1 % 20.3 % 1 Includes net tax charges of $375 million (or a 3.0 percent impact on our effective tax rate) related to changes in tax laws in certain foreign jurisdictions, amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other discrete items. 2 Includes a tax benefit of $14 million (or a 1.5 percent impact on our effective tax rate) associated with the $834 million gain recorded upon the acquisition of the remaining ownership interest in BodyArmor. Refer to Note 2 of Notes to Consolidated Financial Statements. 3 Includes net tax charges of $110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 4 Includes net tax expense of $431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 5 Includes a tax benefit of $40 million (or a 2.4 percent impact on our effective tax rate) associated with the $902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements. On November 18, 2020, the Tax Court issued the Opinion regarding the Companys 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11 of Notes to Consolidated Financial Statements. As of December 31, 2021, the gross amount of unrecognized tax benefits was $906 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $600 million, exclusive of any benefits related to interest and penalties. The remaining $306 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2021 2020 Balance of unrecognized tax benefits at beginning of year $ 915 $ 392 Increase related to prior period tax positions 9 528 Decrease related to prior period tax positions (50) (1) Increase related to current period tax positions 37 26 Decrease related to settlements with taxing authorities (4) (19) Effect of foreign currency translation (1) (11) Balance of unrecognized tax benefits at end of year $ 906 $ 915 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11 of Notes to Consolidated Financial Statements. The Company recognizes interest and penalties related to unrecognized tax benefits in the line item income taxes on our consolidated statement of income. The Company had $453 million and $391 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2021 and 2020, respectively. Of these amounts, expense of $62 million and $190 million was recognized in 2021 and 2020, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Companys effective tax rate. Based on current tax laws, the Companys effective tax rate in 2022 is expected to be approximately 20 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of the fundamental strengths of our business. Refer to the heading Cash Flows from Operating Activities below. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners equity. Refer to the heading Cash Flows from Financing Activities below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to continue to borrow funds at reasonable rates over the long term. Our debt financing also includes the use of a commercial paper program. We currently have the ability to borrow funds in this market at levels that are consistent with our debt financing strategy and expect to continue to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and, as a result of this review, during 2021 we issued U.S. dollar- and euro-denominated long-term notes of $6.0 billion and 3.2 billion, respectively, across various maturities. We used a portion of the proceeds from these issuances to extinguish certain tranches of our previously issued long-term debt. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information on these issuances and extinguishments. The Companys cash, cash equivalents, short-term investments and marketable securities totaled $12.6 billion as of December 31, 2021. In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $8.1 billion in unused backup lines of credit for general corporate purposes as of December 31, 2021. These backup lines of credit expire at various times from 2022 through 2027. While uncertainties caused by the COVID-19 pandemic remain, we expect to continue to see improvements in our business as vaccines become more widely available. The timing and availability of vaccines will be different around the world, and therefore we believe the pace of the recovery will vary by geography depending on vaccine availability, rates of vaccination and the effectiveness of vaccines against existing and new variants of the virus, along with other macroeconomic factors. We will remain flexible so that we can adjust to uncertainties resulting from the COVID-19 pandemic. Our current capital allocation priorities are as follows: investing wisely to support our business operations, continuing to grow our dividend payment, enhancing our beverage portfolio and capabilities through opportunistic and disciplined acquisitions, and using excess cash to repurchase shares over time. We currently expect 2022 capital expenditures to be approximately $1.5 billion. During 2022, we also expect to repurchase approximately $500 million of shares in addition to repurchasing shares equivalent to the proceeds from the issuances of stock under our stock-based compensation plans. We are currently in litigation with the IRS for tax years 2007 through 2009. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS; however, a final decision is still pending and the timing of such decision is not currently known. The Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions and intends to vigorously defend our positions utilizing every available avenue of appeal. While the Company believes that it is more likely than not that we will ultimately prevail in this litigation upon appeal, it is possible that all, or some portion of, the adjustments proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In the event that all of the adjustments proposed by the IRS are ultimately upheld for tax years 2007 through 2009 and the IRS, with the consent of the federal courts, were to decide to apply the Tax Court Methodology to the subsequent years up to and including 2021, the Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. Once the Tax Court renders a final decision, the Company will have 90 days to file a notice of appeal and pay the portion of the potential aggregate incremental tax and interest liability related to the 2007 through 2009 tax years, which we currently estimate to be approximately $4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information on the tax litigation. While we believe it is more likely than not that we will prevail in the tax litigation discussed above, we are confident that, between our ability to generate cash flows from operating activities and our ability to borrow funds at reasonable interest rates, we can manage the range of possible outcomes in the final resolution of the matter. Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities As part of our continued efforts to improve our working capital efficiency, we have worked with our suppliers over the past several years to revisit terms and conditions, including the extension of payment terms. Our current payment terms with the majority of our suppliers are 120 days. Additionally, two global financial institutions offer a voluntary supply chain finance (SCF) program which enables our suppliers, at their sole discretion, to sell their receivables from the Company to these financial institutions on a non-recourse basis at a rate that leverages our credit rating and thus may be more beneficial to them. The SCF program is available to suppliers of goods and services included in cost of goods sold as well as suppliers of goods and services included in selling, general and administrative expenses in our consolidated statement of income. The Company and our suppliers agree on the contractual terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. The suppliers sell goods or services, as applicable, to the Company and issue the associated invoices to the Company based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. Our suppliers voluntary inclusion of invoices in the SCF program has no bearing on our payment terms. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. We have no economic interest in a suppliers decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable and accrued expenses in our consolidated balance sheet. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected within the operating activities section of our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2021 and 2020, suppliers had elected to sell $882 million and $703 million, respectively, of our outstanding payment obligations to the financial institutions. The amounts settled through the SCF program were $3,237 million and $2,810 million during the years ended December 31, 2021 and 2020, respectively. We do not believe there is a risk that our payment terms will be shortened in the near future. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company collects customer payments related to the factored receivables and remits those payments to the financial institutions. The Company sold $6,266 million and $185 million of trade accounts receivables under this program during the years ended December 31, 2021 and 2020, respectively, and the costs of factoring such receivables were not material. The cash received from the financial institutions is classified within the operating activities section in our consolidated statement of cash flows. Net cash provided by operating activities for the years ended December 31, 2021 and 2020 was $12,625 million and $9,844 million, respectively, an increase of $2,781 million, or 28 percent. This increase was primarily driven by increased operating income, which includes a benefit from our trade accounts receivable factoring program, a favorable impact of foreign currency exchange rate fluctuations, lower annual incentive payments in 2021 as a result of the impact of the COVID-19 pandemic on our operating performance in 2020, lower payments in 2021 of prior year-end marketing accruals due to lower spending in 2020 as a result of the COVID-19 pandemic, and lower prepayments to customers in 2021. These items were partially offset by higher payments related to our strategic realignment initiatives along with higher tax payments in 2021. Cash Flows from Investing Activities Net cash used in investing activities was $2,765 million and $1,477 million in 2021 and 2020, respectively. Purchases of Investments and Proceeds from Disposals of Investments In 2021, purchases of investments were $6,030 million and proceeds from disposals of investments were $7,059 million, resulting in a net cash inflow of $1,029 million. In 2020, purchases of investments were $13,583 million and proceeds from disposals of investments were $13,835 million, resulting in a net cash inflow of $252 million. This activity primarily represents the purchases of, and proceeds from the disposals of, investments in marketable securities and short-term investments that were made as part of the Companys overall cash management strategy. Also included in this activity are purchases of, and proceeds from the disposals of, investments held by our captive insurance companies. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2021, the Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $4,766 million, which primarily related to the acquisition of the remaining ownership interest in BodyArmor. In 2020, the Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions. Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2021, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $2,180 million, which primarily related to the sale of our ownership interest in CCA, an equity method investee, to CCEP, also an equity method investee. In 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals. Purchases of Property, Plant and Equipment Purchases of property, plant and equipment during the years ended December 31, 2021 and 2020 were $1,367 million and $1,177 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2021 2020 Capital expenditures $ 1,367 $ 1,177 Europe, Middle East Africa 2.6 % 2.3 % Latin America 0.1 0.5 North America 16.7 15.5 Asia Pacific 4.8 1.7 Global Ventures 20.8 22.2 Bottling Investments 41.0 40.3 Corporate 14.0 17.6 Cash Flows from Financing Activities Net cash used in financing activities was $6,786 million and $8,070 million in 2021 and 2020, respectively. Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2021, our long-term debt was rated A+ by Standard Poors and A1 by Moodys. Our commercial paper program was rated A-1 by Standard Poors and P-1 by Moodys. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Companys business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers financial performance, changes in the credit rating agencies methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers credit ratings were to decline, the Companys equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to borrow funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt as well as our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. During 2021, the Company had issuances of debt of $13,094 million, which included $3,391 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $80 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Companys total long-term debt issuances were $9,623 million, net of related discounts and issuance costs. During 2021, the Company made payments of debt of $12,866 million, which consisted of $2,357 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $10,509 million. During 2020, the Company had issuances of debt of $26,934 million, which included $8,260 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $18,674 million, net of related discounts and issuance costs. During 2020, the Company made payments of debt of $28,796 million, which included $15,292 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $1,768 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Companys total payments of long-term debt were $11,736 million. On December 31, 2021, the United Kingdoms Financial Conduct Authority, the governing body responsible for regulating LIBOR, ceased to publish certain LIBOR reference rates. However, other LIBOR reference rates, including U.S. dollar overnight, 1-month, 3-month, 6-month and 12-month maturities will continue to be published through June 2023. In preparation for the discontinuation of LIBOR, we have amended, or will amend, our LIBOR-referencing agreements to either reference the Secured Overnight Financing Rate or include mechanics for selecting an alternative rate. We do not plan to enter into variable-rate agreements that reference LIBOR after December 31, 2021. Issuances of Stock The issuances of stock in 2021 and 2020 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Companys common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. During 2021 and 2020, the Company did not repurchase common stock under the share repurchase plan authorized by our Board of Directors. Since the inception of our share repurchase program in 1984, we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Companys treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. The Companys treasury stock activity during 2021 resulted in a cash outflow of $111 million. Dividends The Company paid dividends of $7,252 million and $7,047 million during the years ended December 31, 2021 and 2020, respectively. At its February 2022 meeting, our Board of Directors increased our regular quarterly dividend to $0.44 per share, equivalent to a full year dividend of $1.76 per share in 2022. This is our 60 th consecutive annual increase. Our annualized common stock dividend was $1.68 per share and $1.64 per share in 2021 and 2020, respectively. Contractual Obligations As of December 31, 2021, the Companys contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2022 2023-2024 2025-2026 2027 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 2,462 $ 2,462 $ $ $ Lines of credit and other short-term borrowings 845 845 Current maturities of long-term debt 2 1,333 1,333 Long-term debt, net of current maturities 2 37,846 2,192 1,732 33,922 Estimated interest payments 3 10,648 620 1,125 1,059 7,844 Accrued income taxes 4 3,594 686 1,709 1,199 Purchase obligations 5 21,118 12,569 2,316 1,617 4,616 Marketing obligations 6 3,589 2,331 623 326 309 Lease obligations 1,688 330 526 351 481 Acquisition obligations 7 1,716 795 564 357 Held-for-sale obligations 8 264 238 15 3 8 Total contractual obligations $ 85,103 $ 22,209 $ 9,070 $ 6,644 $ 47,180 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives for settling this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2021 rate for all periods presented. We expect to fund such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,294 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $1,347 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. Currently, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms. These agreements include long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these purchase obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents obligations related to our acquisitions of fairlife and BodyArmor. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. 8 Represents liabilities and contractual obligations of the Companys bottling operations that are classified as held for sale. The total accrued liability for pension and other postretirement benefit plans recognized as of December 31, 2021 was $1,497 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost or income, plan funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the table above. We expect to make all contributions to our pension trusts with cash flows from operating activities. Our pension plans are generally funded in accordance with local laws and tax regulations. The Company expects to contribute $26 million in 2022 to our pension trusts, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension trusts in the table above. As of December 31, 2021, the projected benefit obligation of the U.S. qualified pension plans was $5,486 million, and the fair value of the plans assets was $5,383 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,094 million, and the fair value of the plans assets was $3,522 million. The Company sponsors various unfunded pension plans outside the United States as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain employees, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be approximately $63 million for 2022 through 2027. Thereafter, the expected annual benefit payments will decrease. Refer to Note 13 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Companys risk of catastrophic loss. Our reserves for the Companys self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. As of December 31, 2021, our self-insurance reserves totaled $229 million. Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2021 were $2,821 million. Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the table above because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the underlying assets or liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future years. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. As of December 31, 2021, we were contingently liable for guarantees of indebtedness owed by third parties of $440 million, of which $93 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers and vendors and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2021, we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in currencies. In 2021, we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2021 and 2020, the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, 2021 2020 All operating currencies 2 % (4) % Australian dollar 10 % (2) % Brazilian real (4) (23) British pound sterling 3 1 Euro 5 1 Japanese yen (2) 2 Mexican peso 6 (10) South African rand 6 (18) The percentages in the table above do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was an increase of 1 percent in 2021 and a decrease of 2 percent in 2020. The total currency impact on income before income taxes, including the effect of our hedging activities, was an increase of 2 percent in 2021 and a decrease of 6 percent in 2020. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are recorded in the line item other income (loss) net in our consolidated statement of income. Refer to the heading Operations Review Other Income (Loss) Net above. The Company recorded net foreign currency exchange losses of $61 million and $64 million during the years ended December 31, 2021 and 2020, respectively. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instruments and the underlying exposures, fluctuations in the values of the instruments are generally offset by reciprocal changes in the values of the underlying exposures. We monitor our exposure to market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2021, we used 70 functional currencies in addition to the U.S. dollar and generated $25.6 billion of our net operating revenues from operations outside the United States; therefore, weakness in some currencies may be offset by strength in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $13,691 million and $16,663 million as of December 31, 2021 and 2020, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of foreign currency derivatives that qualify for hedge accounting resulted in a net unrealized gain of $174 million as of December 31, 2021, and we estimate that a 10 percent weakening of the U.S. dollar would have decreased the net unrealized gain to $172 million. The fair value of the foreign currency derivatives that do not qualify for hedge accounting resulted in a net unrealized gain of $10 million as of December 31, 2021, and we estimate that a 10 percent weakening of the U.S. dollar would have resulted in a $58 million increase in fair value. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Companys variable-rate debt and derivative instruments outstanding as of December 31, 2021, we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $125 million in 2021. However, this increase in interest expense would have been partially offset by the increase in interest income due to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Companys investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would have resulted in a $52 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements, which enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to further manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $918 million and $726 million as of December 31, 2021 and 2020, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. There were no significant commodity derivatives that qualify for hedge accounting as of December 31, 2021 . The fair value of the commodity derivatives that do not qualify for hedge accounting resulted in a net gain of $127 million as of December 31, 2021, and we estimate that a 10 percent decrease in underlying commodity prices would have resulted in a $71 million decrease in fair value. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Fir m (PCAOB ID: 42 ) Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting 59 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2021 2020 2019 Net Operating Revenues $ 38,655 $ 33,014 $ 37,266 Cost of goods sold 15,357 13,433 14,619 Gross Profit 23,298 19,581 22,647 Selling, general and administrative expenses 12,144 9,731 12,103 Other operating charges 846 853 458 Operating Income 10,308 8,997 10,086 Interest income 276 370 563 Interest expense 1,597 1,437 946 Equity income (loss) net 1,438 978 1,049 Other income (loss) net 2,000 841 34 Income Before Income Taxes 12,425 9,749 10,786 Income taxes 2,621 1,981 1,801 Consolidated Net Income 9,804 7,768 8,985 Less: Net income (loss) attributable to noncontrolling interests 33 21 65 Net Income Attributable to Shareowners of The Coca-Cola Company $ 9,771 $ 7,747 $ 8,920 Basic Net Income Per Share 1 $ 2.26 $ 1.80 $ 2.09 Diluted Net Income Per Share 1 $ 2.25 $ 1.79 $ 2.07 Average Shares Outstanding Basic 4,315 4,295 4,276 Effect of dilutive securities 25 28 38 Average Shares Outstanding Diluted 4,340 4,323 4,314 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2021 2020 2019 Consolidated Net Income $ 9,804 $ 7,768 $ 8,985 Other Comprehensive Income: Net foreign currency translation adjustments ( 699 ) ( 911 ) 74 Net gains (losses) on derivatives 214 15 ( 54 ) Net change in unrealized gains (losses) on available-for-sale debt securities ( 90 ) ( 47 ) 18 Net change in pension and other postretirement benefit liabilities 712 ( 267 ) ( 159 ) Total Comprehensive Income 9,941 6,558 8,864 Less: Comprehensive income (loss) attributable to noncontrolling interests ( 101 ) ( 132 ) 110 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 10,042 $ 6,690 $ 8,754 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2021 2020 ASSETS Current Assets Cash and cash equivalents $ 9,684 $ 6,795 Short-term investments 1,242 1,771 Total Cash, Cash Equivalents and Short-Term Investments 10,926 8,566 Marketable securities 1,699 2,348 Trade accounts receivable, less allowances of $ 516 and $ 526 , respectively 3,512 3,144 Inventories 3,414 3,266 Prepaid expenses and other current assets 2,994 1,916 Total Current Assets 22,545 19,240 Equity method investments 17,598 19,273 Other investments 818 812 Other noncurrent assets 6,731 6,184 Deferred income tax assets 2,129 2,460 Property, plant and equipment net 9,920 10,777 Trademarks with indefinite lives 14,465 10,395 Goodwill 19,363 17,506 Other intangible assets 785 649 Total Assets $ 94,354 $ 87,296 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 14,619 $ 11,145 Loans and notes payable 3,307 2,183 Current maturities of long-term debt 1,338 485 Accrued income taxes 686 788 Total Current Liabilities 19,950 14,601 Long-term debt 38,116 40,125 Other noncurrent liabilities 8,607 9,453 Deferred income tax liabilities 2,821 1,833 The Coca-Cola Company Shareowners Equity Common stock, $ 0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 18,116 17,601 Reinvested earnings 69,094 66,555 Accumulated other comprehensive income (loss) ( 14,330 ) ( 14,601 ) Treasury stock, at cost 2,715 and 2,738 shares, respectively ( 51,641 ) ( 52,016 ) Equity Attributable to Shareowners of The Coca-Cola Company 22,999 19,299 Equity attributable to noncontrolling interests 1,861 1,985 Total Equity 24,860 21,284 Total Liabilities and Equity $ 94,354 $ 87,296 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Operating Activities Consolidated net income $ 9,804 $ 7,768 $ 8,985 Depreciation and amortization 1,452 1,536 1,365 Stock-based compensation expense 337 126 201 Deferred income taxes 894 ( 18 ) ( 280 ) Equity (income) loss net of dividends ( 615 ) ( 511 ) ( 421 ) Foreign currency adjustments 86 ( 88 ) 91 Significant (gains) losses net ( 1,365 ) ( 914 ) ( 467 ) Other operating charges 506 556 127 Other items 201 699 504 Net change in operating assets and liabilities 1,325 690 366 Net Cash Provided by Operating Activities 12,625 9,844 10,471 Investing Activities Purchases of investments ( 6,030 ) ( 13,583 ) ( 4,704 ) Proceeds from disposals of investments 7,059 13,835 6,973 Acquisitions of businesses, equity method investments and nonmarketable securities ( 4,766 ) ( 1,052 ) ( 5,542 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 2,180 189 429 Purchases of property, plant and equipment ( 1,367 ) ( 1,177 ) ( 2,054 ) Proceeds from disposals of property, plant and equipment 108 189 978 Other investing activities 51 122 ( 56 ) Net Cash Provided by (Used in) Investing Activities ( 2,765 ) ( 1,477 ) ( 3,976 ) Financing Activities Issuances of debt 13,094 26,934 23,009 Payments of debt ( 12,866 ) ( 28,796 ) ( 24,850 ) Issuances of stock 702 647 1,012 Purchases of stock for treasury ( 111 ) ( 118 ) ( 1,103 ) Dividends ( 7,252 ) ( 7,047 ) ( 6,845 ) Other financing activities ( 353 ) 310 ( 227 ) Net Cash Provided by (Used in) Financing Activities ( 6,786 ) ( 8,070 ) ( 9,004 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents ( 159 ) 76 ( 72 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 2,915 373 ( 2,581 ) Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 7,110 6,737 9,318 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 10,025 7,110 6,737 Less: Restricted cash and restricted cash equivalents at end of year 341 315 257 Cash and Cash Equivalents at End of Year $ 9,684 $ 6,795 $ 6,480 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS EQUITY (In millions except per share data) Year Ended December 31, 2021 2020 2019 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,302 4,280 4,268 Treasury stock issued to employees related to stock-based compensation plans 23 22 33 Purchases of stock for treasury ( 21 ) Balance at end of year 4,325 4,302 4,280 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 17,601 17,154 16,520 Stock issued to employees related to stock-based compensation plans 216 307 433 Stock-based compensation expense 299 141 201 Other activities ( 1 ) Balance at end of year 18,116 17,601 17,154 Reinvested Earnings Balance at beginning of year 66,555 65,855 63,234 Adoption of accounting standards 1 19 546 Net income attributable to shareowners of The Coca-Cola Company 9,771 7,747 8,920 Dividends (per share $ 1.68 , $ 1.64 and $ 1.60 in 2021, 2020 and 2019, respectively) ( 7,251 ) ( 7,047 ) ( 6,845 ) Balance at end of year 69,094 66,555 65,855 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 14,601 ) ( 13,544 ) ( 12,814 ) Adoption of accounting standards 1 ( 564 ) Net other comprehensive income (loss) 271 ( 1,057 ) ( 166 ) Balance at end of year ( 14,330 ) ( 14,601 ) ( 13,544 ) Treasury Stock Balance at beginning of year ( 52,016 ) ( 52,244 ) ( 51,719 ) Treasury stock issued to employees related to stock-based compensation plans 375 228 501 Purchases of stock for treasury ( 1,026 ) Balance at end of year ( 51,641 ) ( 52,016 ) ( 52,244 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 22,999 $ 19,299 $ 18,981 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 1,985 $ 2,117 $ 2,077 Net income attributable to noncontrolling interests 33 21 65 Net foreign currency translation adjustments ( 132 ) ( 153 ) 45 Dividends paid to noncontrolling interests ( 43 ) ( 18 ) ( 48 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests 20 17 3 Net change in pension and other postretirement benefit liabilities ( 2 ) Business combinations 1 59 Total Equity Attributable to Noncontrolling Interests $ 1,861 $ 1,985 $ 2,117 1 The 2021 amount represents the adoption of Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes , effective January 1, 2021. For information regarding the 2019 amounts, refer to Note 1 and Note 5. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms The Coca-Cola Company, Company, we, us and our mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is a total beverage company. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Companys consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to us account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entitys voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a VIE. An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs economic performance. Our Companys investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 1,980 million and $ 2,567 million as of December 31, 2021 and 2020, respectively, representing our maximum exposures to loss. The Companys investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Companys consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Companys investments, plus any loans and guarantees, related to these VIEs totaled $ 103 million and $ 74 million as of December 31, 2021 and 2020, respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Companys consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Companys proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Our Company recognizes revenue when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Refer to Note 3. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 4 billion, $ 3 billion and $ 4 billion in 2021, 2020 and 2019, respectively. As of December 31, 2021 and 2020, advertising and production costs of $ 57 million and $ 83 million, respectively, were primarily recorded in the line item prepaid expenses and other current assets in our consolidated balance sheets. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our consolidated bottlers to our customers, which are included in the line item selling, general and administrative expenses in our consolidated statement of income. Our customers generally do not pay us separately for shipping and handling costs. We recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. We exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 6 million stock options were excluded from the computation of diluted net income per share in both 2021 and 2020 because the stock options would have been antidilutive. The number of stock options excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other noncurrent assets on our consolidated balance sheet. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in our consolidated statements of cash flows (in millions): December 31, 2021 2020 2019 Cash and cash equivalents $ 9,684 $ 6,795 $ 6,480 Restricted cash and restricted cash equivalents included in other noncurrent assets 1,2 341 315 257 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 10,025 $ 7,110 $ 6,737 1 Amounts represent restricted cash and restricted cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4. 2 As of December 31, 2021, restricted cash and restricted cash equivalents includes amounts related to assets held for sale. Refer to Note 2. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any expected loss on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on available relevant information, in addition to historical loss information, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company collects customer payments related to the factored receivables and remits those payments to the financial institutions. The Company sold $ 6,266 million and $ 185 million of trade accounts receivables under this program during the years ended December 31, 2021 and 2020, respectively, and the costs of factoring such receivables were not material. The Company accounts for this program as a sale, and accordingly, the trade receivables sold are excluded from trade accounts receivable on our consolidated balance sheet. The cash received from the financial institutions is classified within the operating activities section in our consolidated statement of cash flows. Inventories Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2021 2020 Raw materials and packaging $ 2,133 $ 2,106 Finished goods 982 791 Other 299 369 Total inventories $ 3,414 $ 3,266 Derivative Instruments When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other current assets; other noncurrent assets; accounts payable and accrued expenses; and other noncurrent liabilities. The cash flow impact of the Companys derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 5. Leases We determine if a contract contains a lease at its inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating lease right-of-use (ROU) assets represent our right to use an underlying asset for the lease term and are included in the line item other noncurrent assets on our consolidated balance sheet. Operating lease liabilities represent our obligation to make lease payments arising from the lease and are included in the line items accounts payable and accrued expenses and other noncurrent liabilities on our consolidated balance sheet. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. When determining the lease term, we include renewal or termination options that we are reasonably certain to exercise. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 9. We have various contracts for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewal options that we are reasonably certain to exercise, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,262 million, $ 1,301 million and $ 1,208 million in 2021, 2020 and 2019, respectively. Amortization expense for leasehold improvements totaled $ 15 million, $ 18 million and $ 18 million in 2021, 2020 and 2019, respectively. The following table summarizes our property, plant and equipment (in millions): December 31, 2021 2020 Land $ 652 $ 676 Buildings and improvements 4,349 4,782 Machinery and equipment 13,861 14,242 Property, plant and equipment cost 18,862 19,700 Less: Accumulated depreciation 8,942 8,923 Property, plant and equipment net $ 9,920 $ 10,777 Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and a recoverability test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Companys long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally less than 20 years. Refer to Note 7. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management performs a recoverability test of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment tests of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is generally one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are generally subdivided into smaller geographic regions. These geographic regions are our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (Costa), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (Monster), each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the impairment charge recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing discussed above. Otherwise, the Company does not need to perform any further assessment. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11. Stock-Based Compensation Our Company grants long-term equity awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, performance share units, restricted stock and restricted stock units. The fair value of stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option award is earned by the employee, which is generally four years . The fair value of restricted stock, restricted stock units and certain performance share units is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the vesting period. The Company included a relative total shareowner return (TSR) modifier for most performance share unit awards granted from 2014 through 2017 as well as for performance share unit awards granted to executives from 2018 through 2021. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of performance share units that include a TSR modifier is determined using a Monte Carlo valuation model. In the reporting period it becomes probable that the minimum performance threshold specified in the performance share unit award will be achieved, we recognize compensation expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the performance share units expected to vest. The remaining fair value of the performance share units expected to vest is expensed on a straight-line basis over the remainder of the vesting period. In the event the Company determines it is no longer probable that the minimum performance threshold specified in the award will be achieved, we reverse all of the previously recognized compensation expense in the reporting period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that will ultimately vest to determine the amount of compensation expense recognized each reporting period. Forfeiture estimates are trued-up at the end of the vesting period in order to ensure that compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12. Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the book basis and the tax basis of assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained, but for a lesser amount; or (3) the tax position is more likely than not to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14. Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying values of these assets and liabilities attributable to fluctuations in spot rates are recognized in net foreign currency translation adjustments, a component of accumulated other comprehensive income (loss) (AOCI). Refer to Note 15. Accounts in our consolidated statement of income are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entitys functional currency must first be remeasured from the applicable currency to the legal entitys functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5. Recently Adopted Accounting Guidance In February 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (Tax Reform Act) on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as stranded tax effects. The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019. We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. NOTE 2: ACQUISITIONS AND DIVESTITURES Acquisitions During 2021, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 4,766 million, which primarily related to the acquisition of the remaining ownership interest in BA Sports Nutrition, LLC (BodyArmor). During 2020, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife, LLC (fairlife). During 2019, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million, which primarily related to the acquisitions of Costa, the remaining ownership interest in C.H.I. Limited (CHI) and controlling interests in bottling operations in Zambia, Kenya and Eswatini. BA Sports Nutrition, LLC In November 2021, the Company acquired the remaining 85 percent ownership interest in, and now owns 100 percent of, BodyArmor, which offers a line of sports performance and hydration beverages in the United States. We acquired the remaining ownership interest in exchange for approximately $ 5,600 million of cash, of which $ 4,745 million was paid at close, net of cash acquired. The purchase price reflected the contractual discount included in the purchase option we obtained with our initial investment in 2018. The remaining $ 860 million of the purchase price was held back related to indemnification obligations, of which $ 540 million was included in the line item accounts payable and accrued expenses and $ 320 million was included in the line item other noncurrent liabilities in our consolidated balance sheet. Upon consolidation, we recognized a gain of $ 834 million resulting from the remeasurement of our previously held equity interest in BodyArmor to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. As of December 31, 2021, $ 4.2 billion of the purchase price was preliminarily allocated to the BodyArmor trademark and $ 2.2 billion was preliminarily allocated to goodwill, of which $ 1.2 billion is tax deductible. The goodwill recognized as part of this acquisition is primarily related to the synergistic value created from leveraging the capabilities, assets and scale of the Company and the opportunity for international expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. Of the total amount preliminarily allocated to goodwill, $ 1.9 billion has been assigned to the North America operating segment and $ 0.3 billion has been assigned to our other geographic operating segments. The preliminary allocation of the purchase price is subject to refinement when valuations are finalized. As of December 31, 2021, the valuations that have not been finalized primarily relate to other intangible assets and operating lease ROU assets and operating lease liabilities. The final purchase price allocation will be completed no later than the fourth quarter of 2022. fairlife, LLC In January 2020, the Company acquired the remaining 57.5 percent ownership interest in, and now owns 100 percent of, fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. Upon consolidation, we recognized a gain of $ 902 million resulting from the remeasurement of our previously held equity interest in fairlife to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. We acquired the remaining ownership interest in exchange for $ 979 million of cash, net of cash acquired, and effectively settled our $ 306 million note receivable from fairlife at the recorded amount. Under the terms of the agreement, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlifes operating results, the resulting values of which are not subject to a ceiling. Under the applicable accounting guidance, we recorded a $ 270 million liability representing our best estimate of the fair value of this contingent consideration as of the acquisition date. The fair value of this contingent consideration was determined using a Monte Carlo valuation model based on Level 3 inputs, including managements latest estimates of future operating results. We are required to remeasure this liability to fair value quarterly with any changes in the fair value recorded in income until the final milestone payment is made. Upon finalization of purchase accounting, $ 1.3 billion of the purchase price was allocated to the fairlife trademark and $ 0.8 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the North America operating segment. During the years ended December 31, 2021 and 2020, we recorded charges of $ 369 million and $ 51 million, respectively. These charges related to the remeasurement of the contingent consideration liability to fair value and were recorded in the line item other operating charges in our consolidated statements of income. During the year ended December 31, 2021, we made the first milestone payment of $ 100 million based on fairlife meeting its financial targets in 2020. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail stores in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market, as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. Upon finalization of purchase accounting, $ 2.4 billion of the purchase price was allocated to the Costa trademark and $ 2.5 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million which was assigned to the Europe, Middle East and Africa operating segment. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent ownership interest in CHI, a Nigerian producer of value-added dairy and juice beverages and iced tea, in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net loss was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2021, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 2,180 million, which primarily related to the sale of our ownership interest in Coca-Cola Amatil Limited (CCA), an equity method investee, to Coca-Cola Europacific Partners plc (CCEP), also an equity method investee. We received cash proceeds of $ 1,738 million and recognized a net gain of $ 695 million as a result of the sale and the related reversal of cumulative translation adjustments. Also included were the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. We received cash proceeds of $ 293 million and recognized a net gain of $ 114 million as a result of these sales. During 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. We received cash proceeds of $ 100 million and recognized a net loss of $ 2 million as a result of this sale. Also included were the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. We received cash proceeds of $ 62 million and recognized a net gain of $ 35 million as a result of these sales. During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million, which primarily related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (Andina) and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million, respectively. We continue to account for our remaining ownership interest in Andina as an equity method investment as a result of our representation on Andinas Board of Directors and other governance rights. Coca-Cola Beverages Africa Proprietary Limited Due to the Companys original intent to refranchise Coca-Cola Beverages Africa Proprietary Limited (CCBA), it was accounted for as held for sale and as a discontinued operation from October 2017 through the first quarter of 2019. Additionally, CCBAs property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized during this period. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans with the intent to maintain its controlling stake in CCBA, which resulted in CCBA no longer qualifying as held for sale or as a discontinued operation. As a result of this change, we recorded a $ 160 million adjustment to reduce the carrying value of CCBAs property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million, respectively, to reflect additional depreciation and amortization that would have been recognized during the period CCBA was held for sale. This adjustment was recorded in the line item other income (loss) net in our consolidated statement of income. Assets and Liabilities Held for Sale As of December 31, 2021, the Company had certain bottling operations in Asia Pacific that met the criteria to be classified as held for sale. As a result, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As the fair value less any costs to sell exceeded the carrying value, the related assets and liabilities were recorded at their carrying value. These assets and liabilities were included in the Bottling Investments operating segment. The Company expects these bottling operations to be refranchised during 2022. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale and were included in the line items prepaid expenses and other current assets and accounts payable and accrued expenses, respectively, in our consolidated balance sheet (in millions): December 31, 2021 Cash, cash equivalents and short-term investments $ 228 Trade accounts receivable, less allowances 21 Inventories 55 Prepaid expenses and other current assets 36 Other noncurrent assets 9 Deferred income tax assets 6 Property, plant and equipment net 282 Goodwill 37 Assets held for sale $ 674 Accounts payable and accrued expenses $ 139 Accrued income taxes 4 Other noncurrent liabilities 9 Deferred income tax liabilities 5 Liabilities held for sale $ 157 NOTE 3: REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa. These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrates they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2021 related to performance obligations satisfied in prior periods was immaterial. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2021 Concentrate operations $ 6,551 $ 15,248 $ 21,799 Finished product operations 6,459 10,397 16,856 Total $ 13,010 $ 25,645 $ 38,655 Year Ended December 31, 2020 Concentrate operations $ 5,443 $ 13,139 $ 18,582 Finished product operations 5,838 8,594 14,432 Total $ 11,281 $ 21,733 $ 33,014 Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Refer to Note 19 for additional revenue disclosures by operating segment and Corporate. NOTE 4: INVESTMENTS We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair values of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Refer to Note 5 for additional information related to the Companys fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Companys investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, managements assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe a market participant would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Managements assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities The carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2021 Marketable securities $ 376 $ Other investments 771 47 Other noncurrent assets 1,576 Total equity securities $ 2,723 $ 47 December 31, 2020 Marketable securities $ 330 $ Other investments 762 50 Other noncurrent assets 1,282 Total equity securities $ 2,374 $ 50 The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2021 2020 Net gains (losses) recognized during the year related to equity securities $ 509 $ 146 Less: Net gains (losses) recognized during the year related to equity securities sold during the year 71 ( 22 ) Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ 438 $ 168 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2021 Trading securities $ 39 $ 1 $ $ 40 Available-for-sale securities 1,648 33 ( 132 ) 1,549 Total debt securities $ 1,687 $ 34 $ ( 132 ) $ 1,589 December 31, 2020 Trading securities $ 36 $ 2 $ $ 38 Available-for-sale securities 2,227 51 ( 13 ) 2,265 Total debt securities $ 2,263 $ 53 $ ( 13 ) $ 2,303 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2021 December 31, 2020 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Marketable securities $ 40 $ 1,283 $ 38 $ 1,980 Other noncurrent assets 266 285 Total debt securities $ 40 $ 1,549 $ 38 $ 2,265 The contractual maturities of these available-for-sale debt securities as of December 31, 2021 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 28 $ 28 After 1 year through 5 years 1,355 1,241 After 5 years through 10 years 88 98 After 10 years 177 182 Total $ 1,648 $ 1,549 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2021 2020 2019 Gross gains $ 6 $ 20 $ 39 Gross losses ( 10 ) ( 13 ) ( 8 ) Proceeds 1,197 1,559 3,956 Captive Insurance Companies In accordance with local insurance regulations, our consolidated captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of our consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the obligations of certain of our European and Canadian pension plans. This captives solvency capital funds included total equity and debt securities of $ 1,670 million and $ 1,389 million as of December 31, 2021 and 2020, respectively, which were classified in the line item other noncurrent assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5: HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Companys financial performance and are referred to as market risks. When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheet, primarily in the following line items, as applicable: prepaid expenses and other current assets; other noncurrent assets; accounts payable and accrued expenses; and other noncurrent liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized in earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in other comprehensive income (OCI). No components of the Companys hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019, we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019, we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million, net of taxes. The following table presents the fair values of the Companys derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2021 December 31, 2020 Assets: Foreign currency contracts Prepaid expenses and other current assets $ 151 $ 26 Foreign currency contracts Other noncurrent assets 27 74 Commodity contracts Prepaid expenses and other current assets 2 Interest rate contracts Prepaid expenses and other current assets 1 Interest rate contracts Other noncurrent assets 282 659 Total assets $ 461 $ 761 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 15 $ 29 Foreign currency contracts Other noncurrent liabilities 17 Interest rate contracts Accounts payable and accrued expenses 5 Interest rate contracts Other noncurrent liabilities 14 Total liabilities $ 46 $ 34 1 All of the Companys derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Companys derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Companys derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2021 December 31, 2020 Assets: Foreign currency contracts Prepaid expenses and other current assets $ 53 $ 28 Foreign currency contracts Other noncurrent assets 1 Commodity contracts Prepaid expenses and other current assets 131 76 Commodity contracts Other noncurrent assets 3 9 Other derivative instruments Prepaid expenses and other current assets 9 20 Other derivative instruments Other noncurrent assets 3 Total assets $ 196 $ 137 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 34 $ 41 Foreign currency contracts Other noncurrent liabilities 9 Commodity contracts Accounts payable and accrued expenses 6 15 Commodity contracts Other noncurrent liabilities 1 1 Total liabilities $ 50 $ 57 1 All of the Companys derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Companys derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Companys master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by fluctuations in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that were designated and qualified for the Companys foreign currency cash flow hedging program were $ 7,399 million and $ 7,785 million as of December 31, 2021 and 2020, respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company recognizes in earnings each period the changes in carrying values of these foreign currency denominated assets and liabilities due to fluctuations in exchange rates. The changes in fair values of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the changes in fair values attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that were designated as cash flow hedges for the Companys foreign currency denominated assets and liabilities were $ 1,994 million and $ 2,700 million as of December 31, 2021 and 2020, respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments were designated as part of the Companys commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that were designated and qualified for this program were $ 10 million and $ 11 million as of December 31, 2021 and 2020, respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Companys interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Companys future interest payments. The total notional value of these interest rate swap agreements that were designated and qualified for the Companys interest rate cash flow hedging program was $ 1,233 million as of December 31, 2020. As of December 31, 2021, we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on OCI, AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income Gain (Loss) Reclassified from AOCI into Income 2021 Foreign currency contracts $ 36 Net operating revenues $ ( 77 ) Foreign currency contracts ( 2 ) Cost of goods sold ( 10 ) Foreign currency contracts Interest expense ( 13 ) Foreign currency contracts 19 Other income (loss) net 74 Interest rate contracts 110 Interest expense ( 90 ) Commodity contracts ( 1 ) Cost of goods sold Total $ 162 $ ( 116 ) 2020 Foreign currency contracts $ ( 93 ) Net operating revenues $ ( 73 ) Foreign currency contracts 4 Cost of goods sold 9 Foreign currency contracts Interest expense ( 16 ) Foreign currency contracts 37 Other income (loss) net 60 Interest rate contracts 15 Interest expense ( 54 ) Commodity contracts 2 Cost of goods sold Total $ ( 35 ) $ ( 74 ) 2019 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) Foreign currency contracts 1 Cost of goods sold 11 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts 1 Cost of goods sold Total $ ( 200 ) $ ( 162 ) As of December 31, 2021, the Company estimates that it will reclassify into earnings during the next 12 months net gains of $ 36 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that result from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to fluctuations in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured or has been extinguished. The total notional values of derivatives that were designated and qualified as fair value hedges of this type were $ 12,113 million and $ 10,215 million as of December 31, 2021 and 2020, respectively. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 2021 Interest rate contracts Interest expense $ ( 67 ) Fixed-rate debt Interest expense 66 Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) 2020 Interest rate contracts Interest expense $ 275 Fixed-rate debt Interest expense ( 274 ) Net impact to interest expense $ 1 Foreign currency contracts Other income (loss) net $ ( 4 ) Available-for-sale securities Other income (loss) net 5 Net impact to other income (loss) net $ 1 Net impact of fair value hedging instruments $ 2 2019 Interest rate contracts Interest expense $ 368 Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) The following table summarizes the amounts recorded in our consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Cumulative Amount of Fair Value Hedging Adjustments 1 Carrying Values of Hedged Items Included in the Carrying Values of Hedged Items Remaining for Which Hedge Accounting Has Been Discontinued Balance Sheet Location of Hedged Items December 31, 2021 December 31, 2020 December 31, 2021 December 31, 2020 December 31, 2021 December 31, 2020 Current maturities of long-term debt $ 200 $ $ 1 $ $ $ Long-term debt 12,353 11,129 255 646 228 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rate fluctuations. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the fair values of the derivative financial instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the carrying values of the designated portions of the non-derivative financial instruments due to fluctuations in foreign currency exchange rates are recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2021 2020 2021 2020 2019 Foreign currency contracts $ 40 $ 451 $ ( 10 ) $ ( 5 ) $ 51 Foreign currency denominated debt 12,812 13,336 928 ( 1,089 ) 144 Total $ 12,852 $ 13,787 $ 918 $ ( 1,094 ) $ 195 The Company reclassified a loss of $ 4 million related to net investment hedges from AOCI into earnings during the year ended December 31, 2021. The Company did not reclassify any gains or losses related to net investment hedges from AOCI into earnings during the years ended December 31, 2020 and 2019. In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2021, 2020 and 2019. The cash inflows and outflows associated with the Companys derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in the fair values of economic hedges are immediately recognized in earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in the fair values of economic hedges used to offset those monetary assets and liabilities are immediately recognized in earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in the fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are immediately recognized in earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 4,258 million and $ 5,727 million as of December 31, 2021 and 2020, respectively. The Company uses interest rate contracts as economic hedges to minimize exposure to changes in the fair value of fixed-rate debt that result from fluctuations in benchmark interest rates. The total notional value of derivatives related to our economic hedges of this type was $ 200 million as of both December 31, 2021 and 2020. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and vehicle fuel. The changes in the fair values of these economic hedges are immediately recognized in earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 908 million and $ 715 million as of December 31, 2021 and 2020, respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, 2021 2020 2019 Foreign currency contracts Net operating revenues $ 6 $ 58 $ ( 4 ) Foreign currency contracts Cost of goods sold ( 10 ) 6 1 Foreign currency contracts Other income (loss) net ( 84 ) ( 13 ) ( 66 ) Commodity contracts Cost of goods sold 171 54 ( 23 ) Interest rate contracts Interest expense ( 187 ) 6 Other derivative instruments Selling, general and administrative expenses 34 21 47 Other derivative instruments Other income (loss) net ( 3 ) ( 55 ) 48 Total $ ( 73 ) $ 77 $ 3 NOTE 6: EQUITY METHOD INVESTMENTS Our consolidated net income includes our Companys proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. The Companys proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value of those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity method investees AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Companys equity method investments include, but are not limited to, our ownership interests in CCEP, Monster, AC Bebidas, S. de R.L. de C.V., Coca-Cola FEMSA, S.A.B. de C.V., Coca-Cola HBC AG and Coca-Cola Bottlers Japan Holdings Inc. (CCBJHI). As of December 31, 2021, we owned approximately 19 percent, 19 percent, 20 percent, 28 percent, 21 percent and 19 percent, respectively, of these companies outstanding shares. As of December 31, 2021, our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 7,298 million. This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 2021 2020 2019 Net operating revenues $ 79,934 $ 69,384 $ 75,980 Cost of goods sold 47,847 41,139 44,881 Gross profit $ 32,087 $ 28,245 $ 31,099 Operating income $ 9,089 $ 7,056 $ 7,748 Consolidated net income $ 6,050 $ 4,176 $ 4,597 Less: Net income attributable to noncontrolling interests 91 54 63 Net income attributable to common shareowners $ 5,959 $ 4,122 $ 4,534 Company equity income (loss) net $ 1,438 $ 978 $ 1,049 1 The financial information represents the results of the equity method investees during the Companys period of ownership. December 31, 2021 2020 Current assets $ 30,992 $ 29,431 Noncurrent assets 72,064 67,900 Total assets $ 103,056 $ 97,331 Current liabilities $ 21,362 $ 20,033 Noncurrent liabilities 37,353 33,613 Total liabilities $ 58,715 $ 53,646 Equity attributable to shareowners of investees $ 43,422 $ 42,622 Equity attributable to noncontrolling interests 919 1,063 Total equity $ 44,341 $ 43,685 Company equity method investments $ 17,598 $ 19,273 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,471 million, $ 13,041 million and $ 14,832 million in 2021, 2020 and 2019, respectively. Total payments, primarily related to marketing, made to equity method investees were $ 516 million, $ 547 million and $ 897 million in 2021, 2020 and 2019, respectively. The increase in net sales to equity method investees in 2021 was primarily due to recovery from the COVID-19 pandemic. In addition, purchases of beverage products from equity method investees were $ 496 million, $ 452 million and $ 426 million in 2021, 2020 and 2019, respectively. The increase in purchases of beverage products in 2021 was primarily due to increased purchases of Monster products as a result of international expansion and category growth. The following table presents the difference between calculated fair value, based on quoted closing prices of publicly traded shares, and our Companys carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2021 Fair Value Carrying Value Difference Monster Beverage Corporation $ 9,808 $ 4,323 $ 5,485 Coca-Cola Europacific Partners plc 4,919 3,578 1,341 Coca-Cola FEMSA, S.A.B. de C.V. 3,182 1,568 1,614 Coca-Cola HBC AG 2,705 1,115 1,590 Coca-Cola Consolidated, Inc. 1,537 224 1,313 Coca-Cola Bottlers Japan Holdings Inc. 1 387 474 ( 87 ) Coca-Cola ecek A.. 340 123 217 Embotelladora Andina S.A. 130 98 32 Total $ 23,008 $ 11,503 $ 11,505 1 The carrying value of our investment in CCBJHI exceeded its fair value as of December 31, 2021 by $ 87 million. Based on the length of time and the extent to which the fair value has been less than our carrying value and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge related to the investment. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 882 million and $ 1,025 million as of December 31, 2021 and 2020, respectively. The total amount of dividends received from equity method investees was $ 823 million, $ 467 million and $ 628 million for the years ended December 31, 2021, 2020 and 2019, respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2021 was $ 6,143 million. NOTE 7: INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2021 2020 Trademarks 1 $ 14,465 $ 10,395 Goodwill 19,363 17,506 Other 211 225 Indefinite-lived intangible assets $ 34,039 $ 28,126 1 For information related to the Companys acquisitions, refer to Note 2. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total 2020 Balance at beginning of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 Effect of foreign currency translation 40 ( 6 ) 7 84 ( 216 ) ( 91 ) Acquisitions 1 775 775 Purchase accounting adjustments 1,2 ( 26 ) 74 24 2 ( 2 ) 72 Impairments ( 14 ) ( 14 ) Balance at end of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 2021 Balance at beginning of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 Effect of foreign currency translation ( 83 ) ( 8 ) ( 6 ) 46 ( 285 ) ( 336 ) Acquisitions 1 55 44 1,886 227 45 2,257 Impairments ( 7 ) ( 7 ) Divestitures, deconsolidations and other 3 ( 13 ) ( 7 ) ( 37 ) ( 57 ) Balance at end of year $ 1,280 $ 200 $ 10,665 $ 422 $ 2,976 $ 3,820 $ 19,363 1 For information related to the Companys acquisitions, refer to Note 2. 2 Includes the allocation of goodwill from the Europe, Middle East and Africa segment to other reporting units expected to benefit from the CHI acquisition as well as purchase accounting adjustments related to fairlife. Refer to Note 2. 3 The decrease in the Bottling Investments segment was a result of certain bottling operations in Asia Pacific being classified as held for sale. Refer to Note 2. Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2021 December 31, 2020 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ 336 1 $ ( 86 ) $ 250 $ 195 $ ( 61 ) $ 134 Trademarks 189 ( 87 ) 102 245 ( 77 ) 168 Other 273 2 ( 51 ) 222 332 ( 210 ) 122 Total $ 798 $ ( 224 ) $ 574 $ 772 $ ( 348 ) $ 424 1 Includes $ 150 million related to the BodyArmor acquisition. Refer to Note 2. 2 Includes $ 102 million for BodyArmor noncompete agreements. Refer to Note 2. Total amortization expense for intangible assets subject to amortization was $ 165 million, $ 203 million and $ 120 million in 2021, 2020 and 2019, respectively. The increase in amortization expense in 2020 was due to the recognition of a full year of intangible amortization related to CCBA versus seven months in 2019. Based on the carrying value of definite-lived intangible assets as of December 31, 2021, we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense 2022 $ 106 2023 81 2024 66 2025 59 2026 47 NOTE 8: ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, 2021 2020 Accounts payable $ 4,602 $ 3,517 Accrued marketing expenses 2,830 1,930 Variable consideration payable 1,118 1,137 Accrued compensation 1,051 609 Other accrued expenses 5,018 3,952 Accounts payable and accrued expenses $ 14,619 $ 11,145 NOTE 9: LEASES We have operating leases primarily for real estate, aircraft, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2021 2020 Operating lease ROU assets 1 $ 1,418 $ 1,548 Current portion of operating lease liabilities 2 $ 310 $ 322 Noncurrent portion of operating lease liabilities 3 1,161 1,300 Total operating lease liabilities $ 1,471 $ 1,622 1 Operating lease ROU assets are included in the line item other noncurrent assets in our consolidated balance sheets. 2 The current portion of operating lease liabilities is included in the line item accounts payable and accrued expenses in our consolidated balance sheets. 3 The noncurrent portion of operating lease liabilities is included in the line item other noncurrent liabilities in our consolidated balance sheets. We had operating lease costs of $ 342 million and $ 353 million for the years ended December 31, 2021 and 2020, respectively. During 2021 and 2020, cash paid for amounts included in the measurement of operating lease liabilities was $ 352 million and $ 365 million, respectively. Operating lease ROU assets obtained in exchange for operating lease obligations were $ 194 million and $ 528 million for the years ended December 31, 2021 and 2020, respectively. Information associated with the measurement of our operating lease obligations as of December 31, 2021 is as follows: Weighted-average remaining lease term 8 years Weighted-average discount rate 2.7 % Our leases have remaining lease terms of 1 year to 43 years, inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturities of our operating lease liabilities as of December 31, 2021 (in millions): Maturities of Operating Lease Liabilities 2022 $ 324 2023 284 2024 231 2025 190 2026 142 Thereafter 476 Total operating lease payments 1,647 Less: Imputed interest 176 Total operating lease liabilities $ 1,471 NOTE 10: DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2021 and 2020, we had $ 2,462 million and $ 1,329 million, respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 0.1 percent and 1.3 percent as of December 31, 2021 and 2020, respectively. As of December 31, 2021 and 2020, the Company also had $ 845 million and $ 854 million, respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were related to our international operations. In addition, we had $ 9,972 million in unused lines of credit and other short-term credit facilities as of December 31, 2021, of which $ 8,060 million was in corporate backup lines of credit for general purposes. These backup lines of credit expire at various times from 2022 through 2027. There were no borrowings under these corporate backup lines of credit during 2021. These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2021, the Company issued fixed interest rate U.S. dollar- and euro-denominated notes of $ 5,950 million and 3,150 million, respectively, with maturity dates ranging from 2028 to 2051 and interest rates ranging from 0.125 percent to 3.000 percent. The carrying value of these notes as of December 31, 2021 was $ 9,410 million. During 2021, the Company retired upon maturity variable interest rate euro-denominated notes of 371 million with an interest rate equal to the three-month Euro Interbank Offered Rate (EURIBOR) plus 0.200 percent. During 2021, the Company also extinguished prior to maturity fixed interest rate U.S. dollar- and euro-denominated notes of $ 6,500 million and 2,430 million, respectively, with maturity dates ranging from 2023 to 2026 and interest rates ranging from 0.750 percent to 3.200 percent. These extinguishments resulted in associated charges of $ 559 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying value of the notes extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 91 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. During 2020, the Company issued fixed interest rate U.S. dollar- and euro-denominated notes of $ 15,600 million and 2,600 million, respectively, with maturity dates ranging from 2025 to 2060 and interest rates ranging from 0.125 percent to 4.200 percent. The carrying value of these notes as of December 31, 2020 was $ 17,616 million. During 2020, the Company retired upon maturity fixed interest rate Australian dollar- and U.S. dollar-denominated notes of AUD 450 million and $ 3,750 million, respectively, with interest rates ranging from 1.875 percent to 3.150 percent. Additionally, the Company retired upon maturity U.S. dollar zero coupon notes of $ 171 million. During 2020, the Company also extinguished prior to maturity fixed interest rate U.S. dollar- and euro-denominated notes of $ 3,815 million and 2,300 million, respectively, with maturity dates ranging from 2021 to 2050 and interest rates ranging from 0.000 percent to 4.200 percent. Additionally, the Company extinguished prior to maturity variable interest rate euro-denominated notes of 379 million with a maturity date in 2021 and an interest rate equal to the three-month EURIBOR plus 0.200 percent. These extinguishments resulted in associated charges of $ 459 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying value of the notes extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 25 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. During 2019, the Company issued fixed interest rate euro- and U.S. dollar-denominated notes of 2,750 million and $ 2,000 million, respectively, with maturity dates ranging from 2022 to 2031 and interest rates ranging from 0.125 percent to 2.125 percent. Additionally, the Company issued variable interest rate euro-denominated notes of 750 million maturing in 2021 with an interest rate equal to the three-month EURIBOR plus 0.200 percent. The carrying value of these notes as of December 31, 2019 was $ 5,891 million. During 2019, the Company retired upon maturity variable interest rate euro-denominated notes of 3,500 million with interest rates equal to the three-month EURIBOR plus 0.230 percent and the three-month EURIBOR plus 0.250 percent. Additionally, the Company retired upon maturity fixed interest rate U.S. dollar-denominated notes of $ 1,000 million with an interest rate of 1.375 percent. The Companys long-term debt consisted of the following (in millions except average rate data): December 31, 2021 December 31, 2020 Amount Average Rate 1 Amount Average Rate 1 Fixed interest rate long-term debt: U.S. dollar notes due 2023-2093 $ 21,953 2.2 % $ 22,550 2.0 % U.S. dollar debentures due 2022-2098 1,316 5.2 1,342 5.1 Australian dollar notes due 2024 398 2.5 400 2.5 Euro notes due 2023-2041 13,249 0.4 13,369 0.3 Swiss franc notes due 2022-2028 1,234 2.3 1,236 2.7 Variable interest rate long-term debt: Euro notes due 2021 452 0.0 Other, due through 2098 2 821 6.0 615 5.2 Fair value adjustments 3 483 N/A 646 N/A Total 4,5 39,454 1.7 % 40,610 1.6 % Less: Current portion 1,338 485 Long-term debt $ 38,116 $ 40,125 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 As of December 31, 2021, the amount shown includes $ 690 million of debt instruments and finance leases that are due through 2046. 3 Amounts represent the changes in fair values due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 4 As of December 31, 2021 and 2020, the fair value of our long-term debt, including the current portion, was $ 40,311 million and $ 43,218 million, respectively. 5 The above notes and debentures include various restrictions, none of which is presently significant to our Company. Total interest paid was $ 738 million, $ 935 million and $ 921 million in 2021, 2020 and 2019, respectively. The following table summarizes the maturities of long-term debt for the five years succeeding December 31, 2021 (in millions): Maturities of Long-Term Debt 2022 $ 1,338 2023 177 2024 2,023 2025 18 2026 1,733 NOTE 11: COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2021, we were contingently liable for guarantees of indebtedness owed by third parties of $ 440 million, of which $ 93 million was related to VIEs. Refer to Note 1 for additional information related to the Companys maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers and vendors and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings (excluding tax audit claims) will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an ownership interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained but for a lesser amount; or (3) the tax position is more likely than not to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities, such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the quarter in which the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (Notice) from the U.S. Internal Revenue Service (IRS) seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $ 9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arms-length pricing of transactions between related parties such as the Companys U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arms-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (Closing Agreement). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Companys compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $ 9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Companys matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS designation of the Companys matter for litigation, the Company was forced to either accept the IRS newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the U.S. Tax Court (Tax Court) in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued an opinion (Opinion) in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Companys case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Companys foreign licensees to increase the Companys U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors and we reviewed and considered relevant laws, rules, and regulations, including, but not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Companys tax positions, that it is more likely than not the Companys tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (Tax Court Methodology), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Companys analysis. The Companys conclusion that it is more likely than not the Companys tax positions will ultimately be sustained on appeal is unchanged as of December 31, 2021. However, we updated our calculation of the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of the application of the required probability analysis to these updated calculations and the accrual of interest through the current reporting period, we updated our tax reserve as of December 31, 2021 to $ 400 million. While the Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for tax years 2007 through 2009, and potentially also for subsequent years, which could have a material adverse impact on the Companys financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology were to be ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2021 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 through 2021. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the 2017 Tax Cuts and Jobs Act. The Company estimates that the potential aggregate incremental tax and interest liability could be approximately $ 13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. We currently project the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2021, would result in an incremental annual tax liability that would increase the Companys effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Companys Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax years. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax years, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Companys risk of catastrophic loss. Our reserves for the Companys self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. Our self-insurance reserves totaled $ 229 million and $ 265 million as of December 31, 2021 and 2020, respectively. NOTE 12: STOCK-BASED COMPENSATION PLANS Our Company grants long-term equity awards under its stock-based compensation plans to certain employees of the Company. The Coca-Cola Company 2014 Equity Plan (2014 Equity Plan) was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued through the grant of equity awards. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock, restricted stock units and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2021, there were approximately 329 million shares available to be granted under the 2014 Equity Plan. In addition, there were approximately 3 million shares available for stock option and restricted stock award grants under plans approved by shareowners prior to 2014. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance-based cash awards. Employees who received these performance-based cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for employees previously eligible for the performance-based cash award. These employees no longer participate in the long-term incentive program and were granted a final restricted stock unit award that vests ratably over five years . Total stock-based compensation expense was $ 337 million, $ 141 million and $ 201 million in 2021, 2020 and 2019, respectively. In 2020, for certain employees who accepted voluntary separation from the Company as a result of our strategic realignment initiatives, the Company modified their outstanding equity awards granted prior to 2020 so that the employees retained all or some of their awards, whereas otherwise the awards would have been forfeited. The incremental stock-based compensation expense in 2020 arising from the modifications was $ 15 million, which was recorded in the line item other operating charges in our consolidated statement of income. Refer to Note 18 for additional information on the Companys strategic realignment initiatives. The remainder of stock-based compensation expense in 2020 of $ 126 million and all stock-based compensation expense in 2021 and 2019 were recorded in the line item selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to total stock-based compensation expense was $ 60 million, $ 32 million and $ 43 million in 2021, 2020 and 2019, respectively. As of December 31, 2021, we had $ 335 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Stock Option Awards Stock option awards are generally granted with an exercise price equal to the average of the high and low market prices per share of the Companys stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is expensed on a straight-line basis over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2021, 2020 and 2019 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, 2021 2020 2019 Fair value of stock options on grant date $ 5.08 $ 6.44 $ 4.94 Dividend yield 1 3.3 % 2.7 % 3.5 % Expected volatility 2 18.0 % 16.0 % 15.5 % Risk-free interest rate 3 0.9 % 1.4 % 2.6 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the closing market price per share of the Companys stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Companys stock, historical volatility of the Companys stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Stock option awards generally expire 10 years after the date of grant. The shares of common stock to be issued and/or sold upon the exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. Since 2007, the Company has issued common stock under its stock-based compensation plans from treasury shares. Stock option activity during the year ended December 31, 2021 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2021 88 $ 40.55 Granted 7 50.59 Exercised ( 19 ) 36.32 Forfeited/expired ( 1 ) 54.18 Outstanding on December 31, 2021 75 $ 42.43 4.2 years $ 1,264 Expected to vest 74 $ 42.32 4.1 years $ 1,256 Exercisable on December 31, 2021 59 $ 40.08 3.1 years $ 1,138 The total intrinsic value of the stock options exercised was $ 358 million, $ 453 million and $ 609 million in 2021, 2020 and 2019, respectively. The total number of stock options exercised was approximately 19 million, 23 million and 34 million in 2021, 2020 and 2019, respectively. Performance-Based Share Unit Awards Performance share unit awards require achievement of certain performance criteria, which are predefined by the Talent and Compensation Committee of the Board of Directors at the time of grant. For performance share unit awards granted from 2015 through 2017, the performance criteria were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved by the Audit Committee of the Companys Board of Directors (Audit Committee). The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These awards included a relative TSR modifier to determine the final number of performance share units earned. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria was reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share unit awards granted from 2015 through 2017 were subject to a one-year holding period after the performance period before the shares were released. For performance share unit awards granted from 2018 through 2021, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. For purposes of these performance criteria, earnings per share is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved by the Audit Committee. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Performance share unit awards granted to executives include a relative TSR modifier to determine the final number of performance share units earned. The fair value of performance share units that include a TSR modifier is determined using a Monte Carlo valuation model. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of performance share units that do not include a TSR modifier is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the performance period. The performance share unit awards will generally vest at the end of the respective performance period. During 2021, in addition to granting performance share unit awards with a three-year performance period, the Company granted emerging stronger performance share unit awards with a predefined performance period of two years. The awards performance criterion is earnings per share, and the award includes a relative TSR modifier. Earnings per share for these purposes is diluted net income per share adjusted for certain items, which are approved by the Audit Committee. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the performance criterion. The performance share unit awards will generally vest at the end of the two-year performance period. For performance share unit awards, in the event the certified results equal the predefined performance criteria, the number of performance share units earned will be equal to the target award. In the event the certified results exceed the predefined performance criteria, additional performance share units up to the maximum award will be earned. In the event the certified results fall below the predefined performance criteria but are at or above the minimum threshold, a reduced number of performance share units will be earned. If the certified results fall below the minimum threshold, no performance share units will be earned. Performance share unit awards do not entitle participants to vote or receive dividends until the performance share units are settled in stock. In the reporting period it becomes probable that the minimum performance threshold specified in the award will be achieved, we recognize compensation expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the performance share units expected to vest. The remaining fair value of the performance share units expected to vest is expensed on a straight-line basis over the remainder of the vesting period. In the event the Company determines it is no longer probable that the minimum performance threshold specified in the award will be achieved, we reverse all previously recognized compensation expense in the reporting period such a determination is made. Performance share units earned are generally settled in stock, except for certain circumstances such as death or disability, in which case beneficiaries or employees are provided cash payments. As of December 31, 2021, nonvested performance share units of approximately 1,587,000 , 578,000 and 2,021,000 were outstanding for the 2020-2022, 2021-2022 and 2021-2023 performance periods, respectively, based on the target award amounts. The following table summarizes information about outstanding nonvested performance share units based on the target award levels: Performance Share Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2021 3,771 $ 48.29 Granted 2,728 47.04 Vested 1 ( 1,846 ) 40.29 Forfeited ( 467 ) 49.18 Nonvested on December 31, 2021 2 4,186 $ 50.90 1 Represents the target level of performance share units vested at December 31, 2021 for the 2019-2021 performance period. Upon certification in February 2022 of the financial results for the performance period, the final number of shares earned will be determined and released. 2 The outstanding nonvested performance share units as of December 31, 2021 at the threshold award and maximum award levels were approximately 1,725,000 and 9,759,000 , respectively. The weighted-average grant date fair value of performance share unit awards granted in 2021, 2020 and 2019 was $ 47.04 , $ 57.00 and $ 40.29 , respectively. The following table summarizes information about vested performance share units based on the certified award level: 2017-2020 Award 2018-2020 Award Performance Share Units (In thousands) Weighted- Average Grant Date Fair Value Performance Share Units (In thousands) Weighted- Average Grant Date Fair Value Certified 3,728 $ 35.30 1,014 $ 41.02 Released during 2021 ( 3,720 ) 36.31 ( 1,008 ) 41.72 Forfeited during 2021 ( 8 ) 35.30 ( 6 ) 41.02 The total intrinsic value of performance share units that were released was $ 237 million, $ 191 million and $ 118 million in 2021, 2020 and 2019, respectively. Time-Based Restricted Stock and Restricted Stock Unit Awards Time-based restricted stock and restricted stock unit awards granted under the 2014 Equity Plan do not entitle recipients to vote or receive dividends during the vesting period and will be forfeited in the event of the recipients termination of employment, except for certain circumstances such as death or disability. The fair value of restricted stock and restricted stock units is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the vesting period. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2021, the Company had outstanding nonvested time-based restricted stock and restricted stock units totaling approximately 3,394,000 . The following table summarizes information about outstanding nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2021 4,162 $ 44.18 Granted 1,242 46.20 Vested and released ( 1,495 ) 41.91 Forfeited ( 515 ) 46.46 Nonvested on December 31, 2021 3,394 $ 46.56 NOTE 13: PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the primary U.S. plan. As of December 31, 2021, the primary U.S. plan represented 61 percent and 57 percent of the Companys consolidated projected benefit obligation and pension plan assets, respectively. Obligations and Funded Status The following table sets forth the changes in the benefit obligations and the fair value of plan assets for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2021 2020 Benefit obligation at beginning of year 1 $ 9,414 $ 8,757 $ 769 $ 757 Service cost 97 112 9 11 Interest cost 183 235 15 21 Participant contributions 5 1 13 12 Foreign currency exchange rate changes ( 33 ) 67 ( 1 ) ( 1 ) Amendments 3 ( 13 ) Net actuarial loss (gain) 2 ( 226 ) 746 ( 28 ) 22 Benefits paid ( 375 ) ( 485 ) ( 67 ) ( 59 ) Settlements 3 ( 491 ) ( 81 ) Curtailments 3 ( 15 ) ( 1 ) 6 Special termination benefits 3 2 Other 3 72 Benefit obligation at end of year 1 $ 8,580 $ 9,414 $ 696 $ 769 Fair value of plan assets at beginning of year $ 8,639 $ 8,080 $ 396 $ 339 Actual return on plan assets 1,003 830 15 51 Employer contributions 33 30 Participant contributions 6 1 8 7 Foreign currency exchange rate changes ( 42 ) 97 Benefits paid ( 315 ) ( 419 ) ( 1 ) Settlements 3 ( 421 ) ( 53 ) Other 2 73 Fair value of plan assets at end of year $ 8,905 $ 8,639 $ 419 $ 396 Net asset (liability) recognized $ 325 $ ( 775 ) $ ( 277 ) $ ( 373 ) 1 For pension plans, the benefit obligation is the projected benefit obligation. For other postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 8,431 million and $ 9,263 million as of December 31, 2021 and 2020, respectively. 2 A change in the weighted-average discount rate was the primary driver of net actuarial loss (gain) during 2021 and 2020. For our primary U.S. pension plan, an increase in the discount rate resulted in an actuarial gain of $ 197 million during 2021, and a decrease in the discount rate resulted in an actuarial loss of $ 491 million during 2020. Other drivers of net actuarial loss (gain) included assumption updates, plan experience and our strategic realignment initiatives. Refer to Note 18. 3 Settlements and curtailments were primarily related to our strategic realignment initiatives. Refer to Note 18. Pension and other postretirement benefit plan amounts recognized in our consolidated balance sheets were as follows (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Other noncurrent assets $ 1,545 $ 1,151 $ $ Accounts payable and accrued expenses ( 70 ) ( 116 ) ( 18 ) ( 19 ) Other noncurrent liabilities ( 1,150 ) ( 1,810 ) ( 259 ) ( 354 ) Net asset (liability) recognized $ 325 $ ( 775 ) $ ( 277 ) $ ( 373 ) Certain of our pension plans have a projected benefit obligation in excess of the fair value of plan assets. For these plans, the projected benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2021 2020 Projected benefit obligation $ 6,862 $ 7,722 Fair value of plan assets 5,641 5,796 Certain of our pension plans have an accumulated benefit obligation in excess of the fair value of plan assets. For these plans, the accumulated benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2021 2020 Accumulated benefit obligation $ 6,689 $ 7,553 Fair value of plan assets 5,584 5,745 All of our other postretirement benefit plans have an accumulated postretirement benefit obligation in excess of the fair value of plan assets. Pension Plan Assets The following table presents total assets by asset class for our U.S. and non-U.S. pension plans (in millions): U.S. Pension Plans Non-U.S. Pension Plans December 31, 2021 2020 2021 2020 Cash and cash equivalents $ 272 $ 279 $ 233 $ 399 Equity securities: U.S.-based companies 1,463 1,382 968 757 International-based companies 876 988 830 738 Fixed-income securities: Government bonds 182 220 495 417 Corporate bonds and debt securities 899 926 124 116 Mutual, pooled and commingled funds 1 290 301 560 513 Hedge funds/limited partnerships 682 588 38 34 Real estate 381 326 8 6 Derivative financial instruments ( 1 ) ( 1 ) ( 8 ) ( 14 ) Other 339 364 274 300 Total pension plan assets 2 $ 5,383 $ 5,373 $ 3,522 $ 3,266 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. pension plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2021, no investment manager was responsible for more than 8 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small-cap and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 5 percent of total global equities and approximately 3 percent of total U.S. pension plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small-cap and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans The long-term target allocation for 70 percent of our international subsidiaries pension plan assets, primarily certain of our European and Canadian plans, was 66 percent equity securities, 4 percent fixed-income securities and 30 percent other investments. The actual allocation for the remaining 30 percent of the Companys international subsidiaries pension plan assets consisted of 44 percent mutual, pooled and commingled funds; 21 percent fixed-income securities; 1 percent equity securities and 34 percent other investments. The investment strategies for our international subsidiaries pension plans vary greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (VEBA), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets by asset class for our other postretirement benefit plans (in millions): December 31, 2021 2020 Cash and cash equivalents $ 33 $ 30 Equity securities: U.S.-based companies 184 170 International-based companies 12 12 Fixed-income securities: Government bonds 3 3 Corporate bonds and debt securities 82 80 Mutual, pooled and commingled funds 87 86 Hedge funds/limited partnerships 9 7 Real estate 5 4 Other 4 4 Total other postretirement benefit plan assets 1 $ 419 $ 396 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost or income for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2019 2021 2020 2019 Service cost $ 97 $ 112 $ 104 $ 9 $ 11 $ 9 Interest cost 183 235 291 15 21 28 Expected return on plan assets 1 ( 606 ) ( 587 ) ( 552 ) ( 17 ) ( 16 ) ( 13 ) Amortization of prior service cost (credit) 3 ( 4 ) ( 2 ) ( 3 ) ( 2 ) Amortization of net actuarial loss 2 146 171 151 4 5 2 Net periodic benefit cost (income) ( 180 ) ( 66 ) ( 10 ) 9 18 24 Settlement charges 3 117 23 6 Curtailment charges (credits) ( 1 ) 1 ( 1 ) 6 ( 2 ) Special termination benefits 3 2 1 Other ( 4 ) 1 Total cost (income) $ ( 61 ) $ ( 44 ) $ ( 2 ) $ 8 $ 24 $ 22 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlement charges were primarily related to our strategic realignment initiatives. Refer to Note 18 . All of the amounts in the table above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the pretax changes in AOCI for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2021 2020 Balance in AOCI at beginning of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) Recognized prior service cost (credit) 1 3 ( 2 ) ( 3 ) Recognized net actuarial loss 261 195 3 11 Prior service credit (cost) occurring during the year ( 3 ) 13 Net actuarial (loss) gain occurring during the year 623 ( 488 ) 27 7 Net foreign currency translation adjustments 2 ( 41 ) 2 ( 3 ) Balance in AOCI at end of year $ ( 2,125 ) $ ( 3,012 ) $ ( 4 ) $ ( 47 ) 1 Includes $ 117 million of recognized net actuarial loss due to the impact of settlements, which were primarily related to our strategic realignment initiatives. Refer to Note 18. 2 Includes $ 23 million of recognized net actuarial loss due to the impact of settlements, which were primarily related to our strategic realignment initiatives. Refer to Note 18. 3 Includes $ 15 million of net actuarial loss occurring during the year due to the impact of curtailments. The following table sets forth the pretax amounts in AOCI for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Prior service credit (cost) $ ( 9 ) $ ( 10 ) $ 28 $ 17 Net actuarial loss ( 2,116 ) ( 3,002 ) ( 32 ) ( 64 ) Balance in AOCI at end of year $ ( 2,125 ) $ ( 3,012 ) $ ( 4 ) $ ( 47 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations for our pension and other postretirement benefit plans were as follows: Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Discount rate 3.00 % 2.50 % 3.25 % 2.75 % Interest crediting rate 3.00 % 3.00 % N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost or income were as follows: Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2019 2021 2020 2019 Discount rate 2.50 % 3.25 % 4.00 % 2.75 % 3.50 % 4.25 % Interest crediting rate 3.00 % 3.50 % 3.75 % N/A N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % 3.75 % N/A N/A N/A Expected long-term rate of return on plan assets 7.25 % 7.50 % 7.75 % 4.25 % 4.50 % 4.50 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2021 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate assumption on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost or income for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The current cash balance interest crediting rate for the primary U.S. pension plan is the yield on six-month U.S. Treasury bills on the last day of September of the previous plan year, plus 150 basis points. The Company assumes that the current cash balance interest crediting rate will grow linearly over 10 years to the ultimate interest crediting rate assumption. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2021 net periodic benefit income for the U.S. pension plans was 7.25 percent. As of December 31, 2021, the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 10.7 percent, 9.7 percent and 6.8 percent, respectively. The annualized return since inception was 10.6 percent. The weighted-average assumptions for health care cost trend rates were as follows: December 31, 2021 2020 Health care cost trend rate assumed for next year 6.75 % 6.75 % Rate to which the trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.25 % Year that the trend rate reaches the ultimate trend rate 2027 2025 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Companys U.S. postretirement benefit plans are primarily defined-dollar benefit plans that limit the effects of health care inflation because the plans have established dollar limits for determining our contributions. Cash Flows The expected benefit payments for our pension and other postretirement benefit plans for the 10 years succeeding December 31, 2021 are as follows (in millions): Year Ended December 31, 2022 2023 2024 2025 2026 2027-2031 Benefit payments for pension plans $ 486 $ 454 $ 464 $ 470 $ 471 $ 2,390 Benefit payments for other postretirement benefit plans 59 56 53 51 48 211 Total $ 545 $ 510 $ 517 $ 521 $ 519 $ 2,601 The Company anticipates making contributions to our pension trusts in 2022 of $ 26 million, all of which will be allocated to our international plans. These contributions are generally made in accordance with local laws and tax regulations. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants contributions up to a maximum of 3.5 percent of compensation, subject to an IRS limit on compensation. The Companys expense for the U.S. plans totaled $ 32 million, $ 43 million and $ 43 million in 2021, 2020 and 2019, respectively. We also sponsor defined contribution plans in certain locations outside the United States. The Companys expense for these plans totaled $ 79 million, $ 63 million and $ 64 million in 2021, 2020 and 2019, respectively. Multi-Employer Retirement Plans The Company participates in various multi-employer retirement plans. Multi-employer retirement plans are designed to provide benefits to or on behalf of employees of multiple employers. These plans are typically established under collective bargaining agreements. Multi-employer retirement plans are generally governed by a board of trustees composed of representatives of both management and labor and are generally funded through employer contributions. The Companys expense for multi-employer retirement plans totaled $ 1 million, $ 2 million and $ 5 million in 2021, 2020 and 2019, respectively. The plans we currently participate in have contractual arrangements that extend into 2025. If, in the future, we choose to withdraw from any of the multi-employer retirement plans in which we currently participate, we would record the appropriate withdrawal liability, if any, at that time . NOTE 14: INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, 2021 2020 2019 United States $ 3,538 $ 3,149 $ 3,249 International 8,887 6,600 7,537 Total $ 12,425 $ 9,749 $ 10,786 Income taxes consisted of the following (in millions): United States State and Local International Total 2021 Current $ 243 $ 106 $ 1,378 $ 1,727 Deferred 229 ( 10 ) 675 894 2020 Current $ 296 $ 396 $ 1,307 $ 1,999 Deferred ( 220 ) 21 181 ( 18 ) 2019 Current $ 508 $ 94 $ 1,479 $ 2,081 Deferred ( 65 ) 52 ( 267 ) ( 280 ) 1 Includes net tax expense of $ 195 million related to the changes in tax laws in certain foreign jurisdictions. We made income tax payments of $ 2,168 million, $ 1,268 million and $ 2,126 million in 2021, 2020 and 2019, respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Eswatini. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 381 million, $ 317 million and $ 335 million for the years ended December 31, 2021, 2020 and 2019, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2021 2020 2019 Statutory U.S. federal tax rate 21.0 % 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 1.1 0.9 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 2.3 0.9 1.1 6,7,8 Equity income or loss ( 2.0 ) ( 1.4 ) ( 1.6 ) Excess tax benefits on stock-based compensation ( 0.5 ) ( 0.8 ) ( 0.9 ) Other net ( 0.8 ) ( 0.5 ) 4,5 ( 3.8 ) Effective tax rate 21.1 % 20.3 % 16.7 % 1 Includes net tax charges of $ 375 million (or a 3.0 percent impact on our effective tax rate) related to changes in tax laws in certain foreign jurisdictions, amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other discrete items. 2 Includes a tax benefit of $ 14 million (or a 1.5 percent impact on our effective tax rate) associated with the $ 834 million gain recorded upon the acquisition of the remaining ownership interest in BodyArmor. Refer to Note 2. 3 Includes net tax charges of $ 110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 4 Includes net tax expense of $ 431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $ 107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 5 Includes a tax benefit of $ 40 million (or a 2.4 percent impact on our effective tax rate) associated with the $ 902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2. 6 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 7 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 8 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 9 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon audit issues. As of December 31, 2021, we have not recorded incremental income taxes for any additional outside basis differences of approximately $ 5.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (GILTI) provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiarys earnings in excess of an allowable return on the foreign subsidiarys tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company and its subsidiaries file income tax returns in all applicable jurisdictions, including the U.S. federal jurisdiction, U.S. state jurisdictions and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007. With respect to U.S. state jurisdictions and foreign jurisdictions, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years prior to 2006. For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of CocaCola Enterprises Inc.s former North America business that were generated from the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for in accordance with the applicable accounting guidance. On November 18, 2020, the Tax Court issued the Opinion regarding the Companys 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11. As of December 31, 2021, the gross amount of unrecognized tax benefits was $ 906 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 600 million, exclusive of any benefits related to interest and penalties. The remaining $ 306 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2021 2020 2019 Balance of unrecognized tax benefits at beginning of year $ 915 $ 392 $ 336 Increase related to prior period tax positions 9 528 204 Decrease related to prior period tax positions ( 50 ) ( 1 ) Increase related to current period tax positions 37 26 29 Decrease related to settlements with taxing authorities ( 4 ) ( 19 ) ( 174 ) Effect of foreign currency translation ( 1 ) ( 11 ) ( 3 ) Balance of unrecognized tax benefits at end of year $ 906 $ 915 $ 392 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11. 2 The increase was primarily related to a change in judgment about the Companys tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Companys tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes interest and penalties related to unrecognized tax benefits in the line item income taxes on our consolidated statement of income. The Company had $ 453 million, $ 391 million and $ 201 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2021, 2020 and 2019, respectively. Of these amounts, expense of $ 62 million, $ 190 million and $ 11 million was recognized in 2021, 2020 and 2019, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Companys effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect any changes will have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. Currently, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, 2021 2020 Deferred tax assets: Property, plant and equipment $ 36 $ 44 Trademarks and other intangible assets 1,910 2,214 Equity method investments (including net foreign currency translation adjustments) 595 580 Derivative financial instruments 215 523 Other liabilities 1,255 1,401 Benefit plans 670 893 Net operating/capital loss carryforwards 280 320 Other 377 391 Gross deferred tax assets 5,338 6,366 Valuation allowances ( 401 ) ( 406 ) Total deferred tax assets $ 4,937 $ 5,960 Deferred tax liabilities: Property, plant and equipment $ ( 721 ) $ ( 837 ) Trademarks and other intangible assets ( 1,783 ) ( 1,661 ) Equity method investments (including net foreign currency translation adjustments) ( 1,619 ) ( 1,533 ) Derivative financial instruments ( 500 ) ( 435 ) Other liabilities ( 315 ) ( 402 ) Benefit plans ( 527 ) ( 321 ) Other ( 164 ) ( 144 ) Total deferred tax liabilities $ ( 5,629 ) $ ( 5,333 ) Net deferred tax assets (liabilities) $ ( 692 ) $ 627 As of December 31, 2021 and 2020, we had net deferred tax assets of $ 0.7 billion and $ 1.4 billion, respectively, located in countries outside the United States. As of December 31, 2021, we had $ 2,313 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 849 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, 2021 2020 2019 Balance at beginning of year $ 406 $ 303 $ 419 Additions 25 240 148 Deductions ( 30 ) ( 137 ) ( 264 ) Balance at end of year $ 401 $ 406 $ 303 The Companys deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards and foreign tax credit carryforwards from operations in various jurisdictions and basis differences in certain equity investments. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2021, the Company recognized a net decrease of $ 5 million in its valuation allowances. The decrease was primarily due to net decreases in the deferred tax assets and related valuation allowances on certain equity investments and the changes in net operating losses in the normal course of business. In 2020, the Company recognized a net increase of $ 103 million in its valuation allowances. The increase was primarily due to net increases in the deferred tax assets and related valuation allowances on certain equity investments. The increase was also due to the increase of valuation allowances after considering significant negative evidence on the utilization of certain net operating losses and excess foreign tax credits. In 2019, the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be nondeductible and the changes in net operating losses in the normal course of business. The decrease was partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. NOTE 15: OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Companys shareowners equity, which also includes our proportionate share of equity method investees AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, 2021 2020 Net foreign currency translation adjustments $ ( 12,595 ) $ ( 12,028 ) Accumulated net gains (losses) on derivatives 20 ( 194 ) Unrealized net gains (losses) on available-for-sale debt securities ( 62 ) 28 Adjustments to pension and other postretirement benefit liabilities ( 1,693 ) ( 2,407 ) Accumulated other comprehensive income (loss) $ ( 14,330 ) $ ( 14,601 ) The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2021 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 9,771 $ 33 $ 9,804 Other comprehensive income: Net foreign currency translation adjustments ( 567 ) ( 132 ) ( 699 ) Net gains (losses) on derivatives 1 214 214 Net change in unrealized gains (losses) on available-for-sale debt securities 2 ( 90 ) ( 90 ) Net change in pension and other postretirement benefit liabilities 3 714 ( 2 ) 712 Total comprehensive income $ 10,042 $ ( 101 ) $ 9,941 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Companys pension and other postretirement benefit liabilities. The following tables present OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees OCI (in millions): Before-Tax Amount Income Tax After-Tax Amount 2021 Foreign currency translation adjustments: Translation adjustments arising during the year $ 263 $ 19 $ 282 Reclassification adjustments recognized in net income 257 257 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,798 ) ( 1,798 ) Gains (losses) on net investment hedges arising during the year 1 918 ( 230 ) 688 Reclassification adjustments for net investment hedges recognized in net income 1 4 4 Net foreign currency translation adjustments $ ( 356 ) $ ( 211 ) $ ( 567 ) Derivatives: Gains (losses) arising during the year $ 160 $ ( 41 ) $ 119 Reclassification adjustments recognized in net income 124 ( 29 ) 95 Net gains (losses) on derivatives 1 $ 284 $ ( 70 ) $ 214 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 141 ) $ 48 $ ( 93 ) Reclassification adjustments recognized in net income 4 ( 1 ) 3 Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 137 ) $ 47 $ ( 90 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ 653 $ ( 138 ) $ 515 Reclassification adjustments recognized in net income 265 ( 66 ) 199 Net change in pension and other postretirement benefit liabilities 3 $ 918 $ ( 204 ) $ 714 Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ 709 $ ( 438 ) $ 271 2020 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 2,223 ) $ 150 $ ( 2,073 ) Reclassification adjustments recognized in net income 3 3 Gains (losses) on intra-entity transactions that are of a long-term investment nature 2,133 2,133 Gains (losses) on net investment hedges arising during the year 1 ( 1,094 ) 273 ( 821 ) Net foreign currency translation adjustments $ ( 1,181 ) $ 423 $ ( 758 ) Derivatives: Gains (losses) arising during the year $ ( 54 ) $ 13 $ ( 41 ) Reclassification adjustments recognized in net income 74 ( 18 ) 56 Net gains (losses) on derivatives 1 $ 20 $ ( 5 ) $ 15 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 64 ) $ 22 $ ( 42 ) Reclassification adjustments recognized in net income ( 7 ) 2 ( 5 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 71 ) $ 24 $ ( 47 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 560 ) $ 138 $ ( 422 ) Reclassification adjustments recognized in net income 206 ( 51 ) 155 Net change in pension and other postretirement benefit liabilities 3 $ ( 354 ) $ 87 $ ( 267 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,586 ) $ 529 $ ( 1,057 ) Before-Tax Amount Income Tax After-Tax Amount 2019 Foreign currency translation adjustments: Translation adjustments arising during the year $ 52 $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income 192 192 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 195 ( 49 ) 146 Net foreign currency translation adjustments $ 132 $ ( 103 ) $ 29 Derivatives: Gains (losses) arising during the year $ ( 225 ) $ 49 $ ( 176 ) Reclassification adjustments recognized in net income 163 ( 41 ) 122 Net gains (losses) on derivatives 1 $ ( 62 ) $ 8 $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ 47 $ ( 4 ) $ 43 Reclassification adjustments recognized in net income ( 31 ) 6 ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ 16 $ 2 $ 18 Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 379 ) $ 105 $ ( 274 ) Reclassification adjustments recognized in net income 151 ( 36 ) 115 Net change in pension and other postretirement benefit liabilities 3 $ ( 228 ) $ 69 $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Companys pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2021 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ 261 Income before income taxes 261 Income taxes Consolidated net income $ 261 Derivatives: Foreign currency contracts Net operating revenues $ 77 Foreign currency and commodity contracts Cost of goods sold 10 Foreign currency contracts Other income (loss) net ( 74 ) Divestitures, deconsolidations and other 1 Other income (loss) net 8 Foreign currency and interest rate contracts Interest expense 103 Income before income taxes 124 Income taxes ( 29 ) Consolidated net income $ 95 Available-for-sale debt securities: Sale of debt securities Other income (loss) net $ 4 Income before income taxes 4 Income taxes ( 1 ) Consolidated net income $ 3 Pension and other postretirement benefit liabilities: Settlement charges 2 Other income (loss) net $ 117 Curtailment charges (credits) 2 Other income (loss) net ( 2 ) Recognized net actuarial loss Other income (loss) net 150 Recognized prior service cost (credit) Other income (loss) net ( 2 ) Divestitures, deconsolidations and other 1 Other income (loss) net 2 Income before income taxes 265 Income taxes ( 66 ) Consolidated net income $ 199 1 Refer to Note 2. 2 The settlement charges and curtailment credits were related to our strategic realignment initiatives. Refer to Note 13 and Note 18. NOTE 16: FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale, derivative financial instruments and our contingent consideration liability. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Companys fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract prices as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (CDS) rates applied to each contract, by counterparty. We use our counterpartys CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2021 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,372 $ 230 $ 17 $ 104 $ $ 2,723 Debt securities 1 1,556 33 1,589 Derivatives 2 69 588 ( 459 ) 198 Total assets $ 2,441 $ 2,374 $ 50 $ 104 $ ( 459 ) $ 4,510 Liabilities: Contingent consideration liability $ $ $ 590 5 $ $ $ 590 Derivatives 2 96 ( 82 ) 14 Total liabilities $ $ 96 $ 590 $ $ ( 82 ) $ 604 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 331 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Companys derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 198 million in the line item other noncurrent assets and $ 14 million in the line item other noncurrent liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2020 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,049 $ 210 $ 12 $ 103 $ $ 2,374 Debt securities 1 4 2,267 32 2,303 Derivatives 2 63 835 ( 669 ) 229 Total assets $ 2,116 $ 3,312 $ 44 $ 103 $ ( 669 ) $ 4,906 Liabilities: Contingent consideration liability $ $ $ 321 $ $ $ 321 Derivatives 2 91 ( 81 ) 10 Total liabilities $ $ 91 $ 321 $ $ ( 81 ) $ 331 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 546 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Companys derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 229 million in the line item other noncurrent assets, $ 9 million in the line item accounts payable and accrued expenses and $ 1 million in the line item other noncurrent liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2021 and 2020. The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2021 and 2020. Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, 2021 2020 Assets held for sale $ ( 266 ) $ Other-than-temporary impairment charges ( 290 ) Impairment of intangible assets ( 78 ) ( 215 ) Impairment of equity investment without a readily determinable fair value ( 26 ) Total $ ( 344 ) $ ( 531 ) 1 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. The Company recorded charges of $ 266 million in the line item other income (loss) net in our consolidated statement of income related to the restructuring of our manufacturing operations in the United States. These charges, which were calculated based on Level 3 inputs, primarily impacted the line item property, plant and equipment in our consolidated balance sheet. 2 The Company recorded an impairment charge of $ 78 million related to a trademark in Europe, which was driven by a change in the long-term outlook on the licensing arrangement for a certain brand. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 3 During the year ended December 31, 2020, the Company recorded an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee. Based on the length of time and the extent to which the market value of our investment in CCBJHI was less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. This impairment charge was determined using the quoted market price (a Level 1 measurement) of CCBJHI. The Company also recorded an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 4 The Company recorded impairment charges of $ 160 million related to its Odwalla trademark in North America, as the Company decided in June 2020 to discontinue its Odwalla juice business. The Company also recorded an impairment charge of $ 55 million related to a trademark in North America, which was driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Companys portfolio. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recorded an impairment charge of $ 26 million related to an investment in an equity security without a readily determinable fair value. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheet but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Companys future net periodic benefit cost or income as well as amounts recognized in our consolidated balance sheet. Refer to Note 13. The Company uses the fair value hierarchy to measure the fair value of assets held by our pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2021 December 31, 2020 Level 1 Level 2 Level 3 Other Total Level 1 Level 2 Level 3 Other Total Cash and cash equivalents $ 479 $ 26 $ $ $ 505 $ 558 $ 120 $ $ $ 678 Equity securities: U.S.-based companies 2,382 22 27 2,431 2,123 12 4 2,139 International-based companies 1,684 22 1,706 1,694 32 1,726 Fixed-income securities: Government bonds 677 677 637 637 Corporate bonds and debt securities 994 29 1,023 1,011 31 1,042 Mutual, pooled and commingled funds 36 283 531 850 44 268 502 814 Hedge funds/limited partnerships 720 720 622 622 Real estate 389 389 332 332 Derivative financial instruments ( 9 ) ( 9 ) ( 15 ) ( 15 ) Other 283 330 613 302 3 362 664 Total $ 4,581 $ 2,015 $ 339 $ 1,970 $ 8,905 $ 4,419 $ 2,065 $ 337 $ 1,818 $ 8,639 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 This class of assets includes investments in credit contracts. 3 Includes purchased annuity insurance contracts. 4 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developing and emerging markets. There are no liquidity restrictions on these investments. 5 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semiannually, with a redemption notice period of up to one year and/or initial lock-up periods of up to three years, and private equity funds that are primarily closed-end funds in which the Companys investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 6 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation and can be subject to redemption restrictions, ranging from quarterly to semiannually, with a redemption notice period of up to 90 days. 7 Primarily includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semiannual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Other Total 2020 Balance at beginning of year $ 21 $ 40 $ 273 $ 334 Actual return on plan assets 1 6 7 Purchases, sales and settlements net ( 18 ) ( 17 ) 4 ( 31 ) Transfers into Level 3 net 1 7 8 Net foreign currency translation adjustments 19 19 Balance at end of year $ 4 $ 31 $ 302 $ 337 2021 Balance at beginning of year $ 4 $ 31 $ 302 $ 337 Actual return on plan assets 21 ( 3 ) ( 6 ) 12 Purchases, sales and settlements net 2 7 ( 2 ) 7 Transfers into Level 3 net ( 6 ) ( 6 ) Net foreign currency translation adjustments ( 11 ) ( 11 ) Balance at end of year $ 27 $ 29 $ 283 $ 339 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2021 December 31, 2020 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ 32 $ 1 $ $ 33 $ 29 $ 1 $ $ 30 Equity securities: U.S.-based companies 183 1 184 169 1 170 International-based companies 12 12 12 12 Fixed-income securities: Government bonds 3 3 3 3 Corporate bonds and debt securities 82 82 80 80 Mutual, pooled and commingled funds 85 2 87 84 2 86 Hedge funds/limited partnerships 9 9 7 7 Real estate 5 5 4 4 Other 4 4 4 4 Total $ 227 $ 172 $ 20 $ 419 $ 210 $ 169 $ 17 $ 396 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13 . Other Fair Value Disclosures The carrying values of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2021, the carrying value and fair value of our long-term debt, including the current portion, were $ 39,454 million and $ 40,311 million, respectively. As of December 31, 2020, the carrying value and fair value of our long-term debt, including the current portion, were $ 40,610 million and $ 43,218 million, respectively. NOTE 17: SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2021, the Company recorded other operating charges of $ 846 million. These charges primarily consisted of $ 369 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition, $ 146 million related to the Companys strategic realignment initiatives, $ 119 million related to the BodyArmor acquisition, which includes various transition and transaction costs, distributor termination fees, employee retention costs and the amortization of noncompete agreements, and $ 115 million related to the Companys productivity and reinvestment program. In addition, other operating charges included an impairment charge of $ 78 million related to a trademark in Europe, charges of $ 15 million related to tax litigation and a net charge of $ 4 million related to the restructuring of our manufacturing operations in the United States. In 2020, the Company recorded other operating charges of $ 853 million. These charges primarily consisted of $ 413 million related to the Companys strategic realignment initiatives and $ 99 million related to the Companys productivity and reinvestment program. In addition, other operating charges included impairment charges of $ 160 million related to the Odwalla trademark and net charges of $ 33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $ 55 million related to a trademark in North America. In addition, other operating charges included $ 51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and net charges of $ 16 million related to the restructuring of our manufacturing operations in the United States. In 2019, the Company recorded other operating charges of $ 458 million. These charges included $ 264 million related to the Companys productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisitions of BodyArmor, fairlife and Costa. Refer to Note 11 for additional information related to the tax litigation. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Companys strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the years ended December 31, 2021 and 2020, the Company recorded charges of $ 650 million and $ 484 million, respectively, related to the extinguishment of long-term debt. Refer to Note 10. Equity Income (Loss) Net The Company recorded net charges of $ 13 million, $ 216 million and $ 100 million in equity income (loss) net during the years ended December 31, 2021, 2020 and 2019, respectively. These amounts represent the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net During 2021, the Company recognized a gain of $ 834 million in conjunction with the BodyArmor acquisition, a net gain of $ 695 million related to the sale of our ownership interest in CCA, an equity method investee, and a net gain of $ 114 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Additionally, the Company recognized a net gain of $ 467 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. The Company also recorded charges of $ 266 million related to the restructuring of our manufacturing operations in the United States and pension plan settlement charges of $ 117 million related to our strategic realignment initiatives. During 2020, the Company recognized a gain of $ 902 million in conjunction with the fairlife acquisition, a net gain of $ 148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, and a net gain of $ 35 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee . These gains were partially offset by an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America, an impairment charge of $ 26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $ 55 million related to economic hedging activities. The Company also recorded net charges of $ 25 million related to the restructuring of our manufacturing operations in the United States and pension and other postretirement benefit plan settlement and curtailment charges of $ 14 million related to the Companys strategic realignment initiatives. During 2019, the Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBAs fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recorded net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America. Refer to Note 2 for additional information on the acquisitions of BodyArmor, fairlife and CHI, the sale of our ownership interest in CCA, the sale of a portion of our ownership interest in Andina, the refranchising activity in India, and the CCBA asset adjustment. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 5 for additional information on our economic hedging activities. Refer to Note 16 for additional information on the impairment charges and charges related to the restructuring of our manufacturing operations in the United States. Refer to Note 18 for additional information on the Companys strategic realignment initiatives. Refer to Note 19 for the impact these items had on our operating segments and Corporate. NOTE 18: RESTRUCTURING Strategic Realignment In August 2020, the Company announced strategic steps to transform our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace. The Company has transformed into a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We created new operating units effective January 1, 2021, which are focused on regional and local execution. The operating units, which sit under the four existing geographic operating segments, are highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units work closely with five global marketing category leadership teams to rapidly scale ideas while staying close to the consumer. The global marketing category leadership teams primarily focus on innovation as well as marketing efficiency and effectiveness. The organizational structure also includes a center and a platform services organization. Refer to Note 19 for additional information on our organizational structure. The Company has incurred total pretax expenses of $ 690 million related to these strategic realignment initiatives since they commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these expenses had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal and consulting activities. These initiatives were substantially complete as of December 31, 2021. The following table summarizes the balance of accrued expenses related to these strategic realignment initiatives (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2020 Costs incurred $ 386 $ 37 $ 4 $ 427 Payments ( 170 ) ( 36 ) ( 1 ) ( 207 ) Noncash and exchange ( 35 ) ( 35 ) Accrued balance at end of year $ 181 $ 1 $ 3 $ 185 2021 Accrued balance at beginning of year $ 181 $ 1 $ 3 $ 185 Costs incurred 224 37 2 263 Payments ( 265 ) ( 35 ) ( 3 ) ( 303 ) Noncash and exchange ( 120 ) ( 2 ) ( 122 ) Accrued balance at end of year $ 20 $ 1 $ 2 $ 23 1 Includes stock-based compensation modifications, pension settlement charges, and other postretirement benefit plan curtailment charges. Refer to Note 12 and Note 13. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program was expanded multiple times, with the last expansion occurring in April 2017. While we expect most of the remaining initiatives included in this program, which are primarily designed to further simplify and standardize our organization, to be completed by the end of 2023, certain initiatives may extend into 2024. The Company has incurred total pretax expenses of $ 4,044 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily include costs associated with outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2019 Accrued balance at beginning of year $ 76 $ 10 $ 4 $ 90 Costs incurred 36 87 141 264 Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 3 2 ( 19 ) ( 14 ) Accrued balance at end of year $ 58 $ 1 $ 7 $ 66 2020 Accrued balance at beginning of year $ 58 $ 1 $ 7 $ 66 Costs incurred ( 12 ) 69 42 99 Payments ( 29 ) ( 70 ) ( 36 ) ( 135 ) Noncash and exchange ( 2 ) ( 11 ) ( 13 ) Accrued balance at end of year $ 15 $ $ 2 $ 17 2021 Accrued balance at beginning of year $ 15 $ $ 2 $ 17 Costs incurred 4 97 14 115 Payments ( 6 ) ( 97 ) ( 14 ) ( 117 ) Noncash and exchange ( 1 ) 3 2 Accrued balance at end of year $ 12 $ $ 5 $ 17 NOTE 19: OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focusing on strategic initiatives, policy, governance and scaling global initiatives; and (2) a platform services organization supporting operating units, global marketing category leadership teams and the center by providing efficient and scaled global services and capabilities including, but not limited to, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. Segment Products and Services The business of our Company is primarily nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investees. Our consolidated bottling operations derive the majority of their revenues from the manufacture and sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins than concentrate operations. Refer to Note 3. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 2019 Concentrate operations 56 % 56 % 55 % Finished product operations 44 44 45 Total 100 % 100 % 100 % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and interest expense, on a global basis within Corporate. We evaluate operating segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2021 2020 2019 United States $ 13,010 $ 11,281 $ 11,715 International 25,645 21,733 25,551 Net operating revenues $ 38,655 $ 33,014 $ 37,266 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2021 2020 2019 United States $ 3,420 $ 3,988 $ 4,062 International 6,500 6,789 6,776 Property, plant and equipment net $ 9,920 $ 10,777 $ 10,838 Information about our Companys operations by operating segment and Corporate is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated As of and for the Year Ended December 31, 2021 Net operating revenues: Third party $ 6,564 $ 4,143 $ 13,184 $ 4,682 $ 2,805 $ 7,194 $ 83 $ $ 38,655 Intersegment 629 6 609 9 2 ( 1,255 ) Total net operating revenues 7,193 4,143 13,190 5,291 2,805 7,203 85 ( 1,255 ) 38,655 Operating income (loss) 3,735 2,534 3,331 2,325 293 473 ( 2,383 ) 10,308 Interest income 40 10 226 276 Interest expense 1,597 1,597 Depreciation and amortization 76 39 388 49 135 529 236 1,452 Equity income (loss) net 33 9 22 8 ( 6 ) 1,071 301 1,438 Income (loss) before income taxes 3,821 2,542 3,140 2,350 310 1,596 ( 1,334 ) 12,425 Identifiable operating assets 7,908 1,720 25,730 2,355 3 7,949 10,312 2,3 19,964 75,938 Investments 1 436 594 21 230 12,669 4,466 18,416 Capital expenditures 35 2 228 65 285 560 192 1,367 As of and for the Year Ended December 31, 2020 Net operating revenues: Third party $ 5,534 $ 3,499 $ 11,473 $ 4,213 $ 1,991 $ 6,258 $ 46 $ $ 33,014 Intersegment 523 4 509 7 ( 1,043 ) Total net operating revenues 6,057 3,499 11,477 4,722 1,991 6,265 46 ( 1,043 ) 33,014 Operating income (loss) 3,313 2,116 2,471 2,133 ( 123 ) 308 ( 1,221 ) 8,997 Interest income 64 11 295 370 Interest expense 1,437 1,437 Depreciation and amortization 86 45 439 47 122 551 246 1,536 Equity income (loss) net 31 ( 72 ) 8 ( 9 ) 779 241 978 Income (loss) before income taxes 3,379 2,001 2,500 2,158 ( 120 ) 898 ( 1,067 ) 9,749 Identifiable operating assets 8,098 1,597 19,444 2,073 3 7,575 10,521 2,3 17,903 67,211 Investments 1 517 603 345 240 4 14,183 4,193 20,085 Capital expenditures 27 6 182 20 261 474 207 1,177 Year Ended December 31, 2019 Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ 94 $ $ 37,266 Intersegment 624 9 604 2 9 ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 94 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 334 358 ( 1,408 ) 10,086 Interest income 65 12 486 563 Interest expense 946 946 Depreciation and amortization 86 35 439 31 117 446 211 1,365 Equity income (loss) net 35 ( 32 ) ( 6 ) 11 ( 3 ) 836 208 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 343 716 ( 824 ) 10,786 Capital expenditures 108 140 392 47 209 836 322 2,054 1 Principally equity method investments and other investments in bottling companies. 2 Property, plant and equipment net in South Africa represented 16 percent and 15 percent of consolidated property, plant and equipment net as of December 31, 2021 and 2020, respectively. 3 Property, plant and equipment net in the Philippines represented 10 percent of consolidated property, plant and equipment net as of December 31, 2021 and 2020. During 2021, 2020 and 2019, our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2021, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 369 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for Corporate due to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 98 million for Corporate and $ 21 million for North America related to various costs incurred in conjunction with our acquisition of BodyArmor. Refer to Note 2 and Note 17. Operating income (loss) and income (loss) before income taxes were reduced by $ 78 million for Europe, Middle East and Africa related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 63 million and $ 61 million, respectively, for Europe, Middle East and Africa, $ 46 million and $ 160 million, respectively, for Corporate, $ 12 million and $ 14 million, respectively, for Asia Pacific, and $ 11 million and $ 12 million, respectively, for Latin America due to the Companys strategic realignment initiatives. In addition, operating income (loss) and income (loss) before income taxes were both reduced by $ 14 million for North America and income (loss) before income taxes was reduced by $ 2 million for Bottling Investments due to the Companys strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 52 million and $ 316 million, respectively, for North America, and income (loss) before income taxes was reduced by $ 2 million for Corporate related to the restructuring of our manufacturing operations in the United States. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 15 million for Corporate related to tax litigation expense. Refer to Note 11. Income (loss) before income taxes was increased by $ 834 million for Corporate in conjunction with our acquisition of BodyArmor, which resulted from the remeasurement of our previously held equity interest in BodyArmor to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 695 million for Corporate related to the sale of our ownership interest in CCA, an equity method investee. Refer to Note 2. Income (loss) before income taxes was increased by $ 467 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 114 million for Corporate related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Refer to Note 2. Income (loss) before income taxes was reduced by $ 650 million for Corporate related to charges associated with the extinguishment of long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 45 million for Bottling Investments and was increased by $ 32 million for Corporate due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2020, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes for North America were reduced by $ 160 million related to the impairment of the Odwalla trademark and $ 33 million related to the cost of discontinuing the Odwalla juice business. Operating income (loss) and income (loss) before income taxes were reduced by $ 145 million and $ 153 million, respectively, for Corporate, $ 31 million and $ 30 million, respectively, for Asia Pacific, $ 21 million and $ 26 million, respectively, for Bottling Investments, and $ 19 million and $ 21 million, respectively, for Latin America due to the Companys strategic realignment initiatives. Additionally, operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for North America, $ 78 million for Europe, Middle East and Africa and $ 4 million for Global Ventures due to the Companys strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 104 million for Corporate due to the Companys productivity and reinvestment program. Operating income (loss) and income (loss) before income taxes were increased by $ 5 million for Europe, Middle East and Africa due to the refinement of previously established accruals related to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 59 million and $ 84 million, respectively, for North America related to the restructuring of our manufacturing operations in the United States. Operating income (loss) and income (loss) before income taxes were reduced by $ 55 million for North America related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 51 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Income (loss) before income taxes was increased by $ 902 million for Corporate in conjunction with our fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 148 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 35 million for Corporate related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Refer to Note 2. Income (loss) before income taxes was reduced by $ 484 million for Corporate related to charges associated with the extinguishment of long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 252 million for Bottling Investments and $ 38 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 145 million for Bottling Investments, $ 70 million for Latin America and $ 1 million for North America due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 26 million for Corporate due to an impairment charge associated with an investment in an equity security without a readily determinable fair value. Refer to Note 16. In 2019, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2. Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our ownership interest in Andina. Refer to Note 2. Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2. Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Refer to Note 2. Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. NOTE 20: NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities was composed of the following (in millions): Year Ended December 31, 2021 2020 2019 (Increase) decrease in trade accounts receivable 1 $ ( 225 ) $ 882 $ ( 158 ) (Increase) decrease in inventories ( 135 ) 99 ( 183 ) (Increase) decrease in prepaid expenses and other current assets ( 241 ) 78 ( 87 ) Increase (decrease) in accounts payable and accrued expenses 2 2,843 ( 860 ) 1,318 Increase (decrease) in accrued income taxes 3 ( 566 ) ( 16 ) 96 Increase (decrease) in other noncurrent liabilities 4 ( 351 ) 507 ( 620 ) Net change in operating assets and liabilities $ 1,325 $ 690 $ 366 1 The increase in trade accounts receivable in 2021 was primarily due to improved business performance. The decrease in trade accounts receivable in 2020 was primarily due to the impact of the COVID-19 pandemic and the start of a trade accounts receivable factoring program. Refer to Note 1 for additional information on the factoring program. 2 The increase in accounts payable and accrued expenses in 2021 was primarily driven by an increase in trade accounts payable, higher marketing accruals, BodyArmor acquisition-related accruals and higher annual incentive accruals. The decrease in accounts payable and accrued expenses in 2020 was primarily driven by the impact of the COVID-19 pandemic and lower annual incentive accruals. Refer to Note 2 for information regarding the BodyArmor acquisition. 3 The decrease in accrued income taxes in 2021 was primarily driven by increased tax payments in 2021. Refer to Note 14. 4 The increase in other noncurrent liabilities in 2020 was primarily due to the increase in income tax reserves related to the litigation with the IRS. Refer to Note 11 . REPORT OF MANAGEMENT Managements Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this report is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Companys Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Companys Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Managements Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (Exchange Act). Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (COSO) in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2021. The Companys independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of our Companys Board of Directors, subject to ratification by our Companys shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Companys internal control over financial reporting. The reports of the independent auditors are contained in this report. Audit Committees Responsibility The Audit Committee of our Companys Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Companys Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committees Report can be found in the Companys 2022 Proxy Statement. James R. Quincey John Murphy Chairman of the Board of Directors and Chief Executive Officer February 22, 2022 Executive Vice President and Chief Financial Officer February 22, 2022 Kathy Loveless Mark Randazza Vice President and Controller February 22, 2022 Vice President, Assistant Controller and Chief Accounting Officer February 22, 2022 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 11 and Note 14 to the Companys consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2021, the gross amount of unrecognized tax benefits was $906 million. As described in Note 11, on September 17, 2015 the Company received a Statutory Notice of Deficiency from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period. On November 18, 2020, the U.S. Tax Court issued an opinion predominantly siding with the IRS related to the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates for tax years 2007 through 2009. While the Company continues to disagree with the IRS positions and the portions of the opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS could ultimately be upheld. As a result of the application of ASC 740, Accounting for Income Taxes , the Company has recorded a tax reserve of $400 million for this matter as of December 31, 2021. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS notice and opinion, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of managements assessment of the opinion, including inquiries of tax counsel, inspection of technical memos, and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 11 and Note 14. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 to the Companys consolidated financial statements, the Company performs an annual impairment test of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment test may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $14.5 billion and $19.4 billion, respectively, as of December 31, 2021. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, royalty rates, long-term growth rates, and cost of capital, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment tests for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative test and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment tests of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of certain significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment tests included in Note 1. /s/ Ernst Young LLP We have served as the Companys auditor since 1921. Atlanta, Georgia February 22, 2022 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, shareowners equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 22, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 22, 2022 "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Companys disclosure controls and procedures were effective as of December 31, 2021. Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2021 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, Item 8. Financial Statements and Supplementary Data in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Companys internal control over financial reporting during the quarter ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. " +40,Coca-Cola,2020," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to the Company account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. We are guided by our purpose, which is to refresh the world and make a difference, and rooted in our strategy to drive net operating revenue growth and generate long-term value. We are determined to emerge from the COVID-19 pandemic a better and stronger company. The vision for our next stage of growth has three connected pillars: Loved Brands. We craft meaningful brands and a choice of drinks that people love and that refresh them in body and spirit. Done Sustainably. We use our leadership to be part of the solution to achieve positive change in the world and to build a more sustainable future for our planet. For A Better Shared Future. We invest to improve peoples lives, from our employees to all those who touch our business system, to our investors, to the broad communities we call home. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For additional information about our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes powders/minerals for purified water products; ""syrups"" means an intermediate product in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa Limited (""Costa""), which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We own and market numerous valuable beverage brands, including the following: sparkling soft drinks: Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, * Sprite, and Thums Up; water, enhanced water and sports drinks: Aquarius, Ciel, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade, and Topo Chico; juice, dairy and plant-based beverages: AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy, and Simply; and tea and coffee: Ayataka, Costa, doadan, FUZE TEA, Georgia, Gold Peak, HONEST TEA, and Kochakaden. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further optimize its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of 1.9 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 29.0 billion, 30.3 billion and 29.6 billion unit cases of our products in 2020, 2019 and 2018, respectively. In 2019, with the exception of ready-to-drink products, the Company did not report unit case volume for Costa, a component of the Global Ventures operating segment. However, unit case volume reported in 2020 includes both Costa ready-to-drink and non-ready-to-drink products. Sparkling soft drinks represented 69 percent of our worldwide unit case volume in 2020, 2019 and 2018. Trademark Coca-Cola accounted for 47 percent, 45 percent and 45 percent of our worldwide unit case volume in 2020, 2019 and 2018, respectively. In 2020, unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2020. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 32 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2020 were as follows: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2020, these five bottling partners combined represented 40 percent of our total worldwide unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners under which our bottling partners are granted certain authorizations by us. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a ""Comprehensive Beverage Agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. In all instances, the bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers have been granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage brands (as defined by the CBAs). We refer to these bottlers as expanding participating bottlers or ""EPBs."" EPBs operate under CBAs (""EPB CBAs"") under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights, which we refer to as participating bottlers (""PBs""), converted their legacy bottler's agreements to CBAs, to which we refer as ""PB CBAs,"" each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume prepared, packaged, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups, or deliver them on our behalf, to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing support and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers and other customers of our Company's products, principally for participation in promotional and marketing programs, was $4.1 billion in 2020. Investments in Bottling Operations Most of our branded beverage products are prepared, packaged, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of a bottling operation, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning a bottling operation enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a consolidated bottling operation, typically by selling all or a portion of our interest in the bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell a consolidated bottling operation to an independent bottling partner in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method. Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic and alcoholic beverage segments of the commercial beverage industry are highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete globally in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy drinks; sports and other performance-enhancing hydration beverages; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive products are sold to consumers in both ready-to-drink and non-ready-to-drink form. The Company has directly entered the alcoholic beverage segment in numerous markets outside the United States. In the United States, the Company has chosen to authorize alcohol-licensed third parties to use certain of its brands on alcoholic beverages. Competitive products include all flavored alcoholic beverages of varying alcoholic bases. In many of the countries in which we do business, PepsiCo, Inc., is a primary competitor. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, The Kraft Heinz Company, Suntory Beverage Food Limited, Unilever, AB InBev, Constellation Brands, Kirin Holdings, Heineken Holdings and Diageo. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private-label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, digital marking, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer recognition and loyalty; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition across both nonalcoholic and alcoholic beverages in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private-label beverage brands; new industry entrants; and dramatic shifts in consumer shopping methods and patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions that can impact the quality and supply of orange juice and orange juice concentrate. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our consolidated bottling operations and our non-bottling finished product operations also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere around the world. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (""GDPR"") as well as the California Consumer Privacy Act of 2018 (""CCPA""), which became effective on January 1, 2020. The interpretation and application of data privacy and data protection laws and regulations are often uncertain and are evolving in the United States and internationally. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Human Capital Management Our people and culture agendas are critical business priorities. Our Board of Directors, through the Talent and Compensation Committee, provides oversight of the Company's policies and strategies relating to talent, leadership and culture, including diversity and inclusion, as well as the Company's compensation philosophy and programs. The Talent and Compensation Committee also evaluates and approves the Company's compensation plans, policies and programs applicable to our senior executives. In addition, the Management Development Committee of our Board of Directors oversees succession planning and talent development for our senior executives. Employees We believe people are our most important asset, and we strive to attract high-performing talent. As of December 31, 2020 and 2019, our Company had approximately 80,300 and 86,200 employees, respectively, of which approximately 9,300 and 10,100, respectively, were located in the United States. The decrease in the total number of employees was primarily due to the Company's strategic realignment initiatives and the impact of the COVID-19 pandemic on our Costa retail stores, partially offset by the January 2020 acquisition of fairlife, LLC (""fairlife""). Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2020, approximately 900 employees in North America were covered by collective bargaining agreements. These agreements typically have terms of three to five years. We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. Diversity, Equity and Inclusion We believe that a diverse, equitable and inclusive workplace that mirrors the markets we serve is a strategic business priority and critical to the Company's success. We take a comprehensive view of diversity and inclusion across different races, ethnicities, tribes, religions, socioeconomic backgrounds, generations, abilities, and expressions of gender and sexual identity. As of December 31, 2020, we had approximately 8,900 employees located in the United States, excluding the employees of fairlife. Of these employees, 38 percent and 43 percent were female and people of color, respectively. We are focused on social justice issues, including racial and gender equity, both in the United States and around the world. In 2020, we started implementing a multifaceted racial equity plan in the United States, which set 10-year employee representation goals that reflect the country's racial and ethnic diversity. We also strive to be 50 percent led by women, in addition to growing and developing our female workforce overall. Diversity and inclusion metrics, which highlight progress and drive accountability, are shared with our senior leaders on a quarterly basis, and our Global Women's Leadership Council, composed of 15 female and male executives, focuses on accelerating the development and promotion of women into roles of increasing responsibility and influence. We also periodically conduct pay equity analyses to help identify any unsupported distinctions in pay between employees of different races, gender and/or age, as permitted by local law. We make adjustments to base pay, where appropriate. Also, during the annual rewards cycle, we perform an adverse impact analysis on base pay, annual incentives and long-term incentives to help ensure fairness. We support a number of employee business resource groups (""BRGs"") that are an integral part of our diversity, equity and inclusion strategy. Our BRGs provide employees with the opportunity to engage with colleagues based on shared interests in ethnic backgrounds, gender, sexual orientation, military service and work roles. Compensation and Benefits Through comprehensive and competitive compensation and benefits, ongoing employee learning and development, and a focus on health and well-being, we strive to support our employees in all aspects of their lives. Our compensation programs are designed to reinforce our growth agenda and our talent strategy as well as to drive a strong connection between the contributions of our employees and their pay. We believe the structure of our compensation packages provides the appropriate incentives to attract, retain and motivate our employees. We provide base pay that is competitive and that aligns with employee positions, skill levels, experience and geographic location. In addition to base pay, we seek to reward employees with annual incentive awards, recognition programs, and equity awards for employees at certain job grades. We also offer competitive employee benefits packages, which vary by country and region. These employee benefits packages may include: 401(k) plan, pension plan, core and supplemental life insurance, financial courses and advisors, employee assistance programs, tuition assistance, commuter assistance, adoption assistance, medical and dental insurance, vision insurance, health savings accounts, health reimbursement and flexible spending accounts, well-being rewards programs, vacation pay, holiday pay, and parental and adoption leave . Leadership, Training and Development We focus on investing in inspirational leadership, learning opportunities and capabilities to equip our global workforce with the skills they need while improving engagement and retention. We provide a range of formal and informal learning programs, which are designed to help our employees continuously grow and strengthen their skills throughout their careers . We offer a variety of programs that contribute to our leadership, training and development goals, including: (1) Coca-Cola U Digital Classroom, a hybrid space, equal parts classroom, studio, and online experience that combines the engaged learning environment of a traditional classroom with the flexibility, efficiency and scalability of digital delivery; (2) LinkedIn Learning, an online learning platform that provides relevant content of more than 16,000 expert-led courses; (3) Opportunity Marketplace, a people-centered technology solution that helps connect project opportunities to interested employees who have the capacity, skills and interest in short-term experiences and assignments; and (4) Emerging Stronger Coaching Program, a customized virtual coaching application that offers access to professional development coaches to support leadership development. COVID-19 Health Measures In response to the COVID-19 pandemic, we implemented measures to help ensure the health, safety and security of our employees, while constantly monitoring the rapidly evolving situation and adapting our efforts and responses. Around the world, we are endeavoring to follow guidance from authorities and health officials. This includes having the majority of our office-based employees work remotely, imposing travel restrictions and implementing safety measures for employees continuing critical on-site work including, but not limited to, social distancing practices, temperature checks, health symptom attestations when entering our facilities, and the use of personal protective equipment as appropriate and in accordance with local laws and regulations. Our system and production facilities have also implemented additional cleaning and sanitization routines and split shifts to ensure that we can continue to keep our brands in supply. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this report. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the ""Investors"" page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the ""Investors"" page of our website and review the information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. RISKS RELATED TO OUR OPERATIONS The COVID-19 pandemic has had, and we expect will continue to have, certain negative impacts on our business, and such impacts have had, and may continue to have, a material adverse effect on our results of operations, financial condition and cash flows. The public health crisis caused by theCOVID-19 pandemic and the measures that have been taken or that may be taken in the future by governments, businesses, including us and our bottling partners, and the public at large to limitthe spread of COVID-19 have had, and we expect will continue to have, certain negative impacts on our business including, without limitation, the following: We have experienced a decrease in sales of certain of our products in markets around the world as a result of the COVID-19 pandemic. In particular, sales of our products in the away-from-home channels have been significantly negatively affected by shelter-in-place regulations or recommendations, closings of restaurants and cancellations of major sporting and other events that were imposed as a result of the initial COVID-19 outbreak. While some of these restrictions have been lifted or eased in many jurisdictions as the rates of COVID-19 infections have decreased or stabilized, resurgence of the pandemic in some markets has slowed the reopening process. If COVID-19 infection trends increase, the pandemic intensifies or expands geographically or efforts to curb the pandemic are ineffective, the negative impacts of the pandemic on our sales could be more prolonged and may become more severe. While we initially experienced increased sales in the at-home channels from pantry loading as consumers stocked up on certain of our products with the expectation of spending more time at home during the crisis, such increased sales levels have not, and we expect will not, fully offset the sales pressures we have experienced, and we expect will continue to experience, in the away-from-home channels while shelter-in-place and social distancing mandates or recommendations are in effect. In certain COVID-19 affected markets, consumer demand has shifted away from some of our more profitable beverages and away-from-home consumption to lower-margin products and at-home consumption, and this shift in consumer purchasing patterns is likely to continue while shelter-in-place and social distancing behaviors are mandated or encouraged. We are accelerating our business strategy and are taking certain actions to address challenges posed by the COVID-19 pandemic and deliver on our commitment to emerge stronger from this crisis. These actions include focusing investments on a defined growth portfolio by prioritizing brands best positioned for consumer reach; streamlining the innovation pipeline through initiatives that are scalable regionally or globally, as well as maintaining a disciplined approach to local experimentation; refreshing our marketing approach, with a focus on improving our marketing investment effectiveness and efficiency; and investing in new capabilities to capitalize on emerging shifts in consumer behaviors that we anticipate may last beyond this crisis. These actions, which may require substantial additional investment of management time and financial resources, may not be sufficient to accomplish our goals. We have experienced temporary disruptions in certain of our concentrate production operations. We have taken measures to protect our employees and facilities around the world, which efforts have included, but have not been limited to, checking the temperature of employees when they enter our facilities, requiring employees to wear masks and other protective clothing as appropriate, and implementing additional cleaning and sanitization routines. These measures may not be sufficient to prevent the spread of COVID-19 among our employees and, therefore, we may face additional concentrate production disruptions in the future, which may place constraints on our ability to supply concentrates to our bottling partners in a timely manner or may increase our concentrate supply costs. We have faced, and may continue to face, delays in the delivery of concentrates to our bottling partners as a result of shipping delays due to, among other things, additional safety requirements imposed by port authorities, closures of or congestion at ports, and capacity constraints experienced by our transportation contractors. Some of our bottling partners have experienced, and may experience in the future, temporary plant closures, production slowdowns and disruptions in distribution operations as a result of the impact of the COVID-19 pandemic on their respective businesses. Disruptions in supply chains have placed, and may continue to place, constraints on our and our bottling partners' ability to source beverage containers, such as glass bottles and cans, which has increased, and in the future may increase, our and their packaging costs. As a result of the COVID-19 pandemic, including related governmental guidance or directives, we have required most office-based employees, including most employees based at our global headquarters in Atlanta, to work remotely. We may experience reductions in productivity and disruptions to our business routines while our remote work policy remains in place. Actions we have taken or may take, or decisions we have made or may make, as a consequence of the COVID-19 pandemic may result in legal claims or litigation against us. Deteriorating economic and political conditions in many of our major markets affected by the COVID-19 pandemic, such as increased unemployment, decreases in disposable income, declines in consumer confidence, or economic slowdowns or recessions, have caused a decrease in demand for our products. Continuing economic and political uncertainties in such markets may slow down or prevent the recovery of the demand for our products or may even further erode such demand. Governmental authorities in the United States and throughout the world may increase or impose new income taxes or indirect taxes, or revise interpretations of existing tax rules and regulations, as a means of financing the costs of stimulus and other measures enacted or taken, or that may be enacted or taken in the future, to protect populations and economies from the impact of the COVID-19 pandemic. Such actions could have an adverse effect on our results of operations and/or cash flows. We may be required to record significant impairment charges with respect to noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments, and other long-lived assets whose fair values may be negatively affected by the effects of the COVID-19 pandemic on our operations. In addition, we are required to record impairment charges related to our proportionate share of impairment charges that may be recorded by equity method investees, and such charges may be significant. In addition to the above risks, the COVID-19 pandemic may exacerbate existing risks related to our business including risks related to changes in the retail landscape or the loss of key retail or foodservice customers, fluctuations in foreign currency exchange rates; the ability of third-party service providers and business partners to fulfill their respective commitments and responsibilities to us in a timely manner and in accordance with the agreed-upon terms; and failure of or default by one or more of our counterparty financial institutions on their obligations to us. The resumption of normal business operations after the disruptions caused by the COVID-19 pandemic may be delayed or constrained by the pandemic's lingering effects on our bottling partners, consumers, suppliers and/or third-party service providers. Any of the negative impacts of the COVID-19 pandemic, including those described above, alone or in combination with others, may have a material adverse effect on our results of operations, financial condition and cash flows. The full extent to which theCOVID-19 pandemic will negatively affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the duration of the various shelter-in-place orders and reopening plans across the globe, and actions taken, or that may be taken in the future, by governmental authorities and other third parties in response to the pandemic. If we do not realize the economic benefits we anticipate from our productivity initiatives, including our recently announced reorganization and related strategic realignment initiatives, or are unable to successfully manage their possible negative consequences, our business operations could be adversely affected. Over the last three years, we worked to develop the strategies and evolve our culture to equip us to grow and become a total beverage company, while improving efficiency. In late 2020, we took a series of strategic steps to transform our organizational structure and to reallocate certain resources aimed at emerging stronger from the pandemic, including voluntary and involuntary reductions in employees. We have incurred and expect we will incur in future periods significant expenses in connection with the reorganization and related reduction in employees. If we are unable to timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these actions, our results of operations in future periods could be negatively affected. In addition, the reorganization and related reduction in employees may become a distraction for our managers and employees remaining with the Company; disrupt our ongoing business operations; cause deterioration in employee morale, which may make it more difficult for us to retain or attract qualified managers and employees in the future; disrupt or weaken our internal control and financial reporting structures; and/or give rise to negative publicity, which could affect our corporate reputation. If we are unable to successfully manage these possible negative consequences of our reorganization and reduction in employees, our business operations could be adversely affected. In addition, we believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may give rise to the same risks described above. If we are unable to successfully manage the possible negative consequences of our future productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Company's and the Coca-Cola system's ability to attract, develop, retain and motivate a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Company's purpose and work that matters most. We may not be able to successfully compete for, attract and/or retain the high-quality and diverse employee talent that we want and that our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic and alcoholic beverage segments of the global beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to maintain or gain share of sales in the global market or in various local markets and segments may be limited as a result of actions by competitors. Competitive pressures may cause the Company and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices, as may be necessary in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain consumer interest and brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic and alcoholic beverage segments of the commercial beverage industry, our business could be negatively affected. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial results. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private-label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. Increases in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our consolidated bottling operations operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our consolidated bottling operations. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our consolidated bottling operations operate, which may be caused by increasing demand, by events such as natural disasters, power outages and the like, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increases in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers, to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source. The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply and quality of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS. An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners' relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs that may be caused by the United Kingdom's withdrawal from the European Union, commonly referred to as ""Brexit""; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. If we are unable to successfully manage new product launches, our business and financial results could be adversely affected. Due to the highly competitive nature of the global beverage industry, the Company continually introduces new products and evolves existing products to stimulate customer demand. For instance, the Company has directly entered the alcoholic beverages segment in numerous markets outside the United States, and in the United States, the Company has authorized alcohol-licensed third parties to use certain of its brands on alcoholic beverages. The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance. Such endeavors may also involve significant risks and uncertainties, including distraction of management from current operations, greater than expected liabilities and expenses, inadequate return on capital, exposure to additional regulations and reliance on the performance of third parties. If we become subject to additional government regulations, including alcohol regulations related to licensing, trade and pricing practices, labeling, advertising, promotion and marketing practices, and relationships with distributors, we may become exposed to the risk of increased compliance costs and disruption to our core business. RISKS RELATED TO CONSUMER DEMAND FOR OUR PRODUCTS Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and potential delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained by, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; dramatic shifts in consumer shopping patterns as a result of the rapidly evolving digital landscape; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI""), a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages; or substances used in packaging materials, such as bisphenol A (""BPA""), an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans, may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, the Guiding Principles on Business and Human Rights, endorsed by the United Nations Human Rights Council, outline how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. RISKS RELATED TO THE COCA-COLA SYSTEM We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity method investee bottling partners, it could also result in a decrease in our equity income and/or impairments of our equity method investments. If we do not successfully integrate and manage our consolidated bottling operations or other acquired businesses or brands, our financial results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or consolidated bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our product quality and safety programs and controls may not be sufficiently robust to effectively cope with the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing the various supply chain models as we expand our product offerings and seek to manage acquired businesses in a more independent, less integrated manner. Our financial performance depends in large part on how well we can manage and improve the performance of consolidated bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations, businesses or brands. If we incur unforeseen liabilities, obligations and costs in connection with acquiring or integrating bottling operations or other businesses, experience internal control or product quality failures, or are unable to achieve our strategic and financial objectives for consolidated bottling operations and other acquired businesses or brands, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise consolidated bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. RISKS RELATED TO REGULATORY AND LEGAL MATTERS Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates in the jurisdictions in which we operate, tax treaties between such jurisdictions, and the geographic mix of our income before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix or foreign exchange rates could reduce our after-tax income. Tax laws, including rates of taxation, are subject to revision by individual taxing jurisdictions which may result from multilateral agreements. Many jurisdictions have enacted legislation and adopted policies resulting from the Organization for Economic Co-operation and Developments (""OECD"") anti-Base Erosion and Profit Shifting project. The OECD is currently considering proposals that could expand the jurisdictional scope and level of taxation of certain cross-border income and potentially impose some form of global minimum tax. It is possible that the adoption of these or other proposals could have a material impact on our after-tax income and cash flows. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions, estimates and accruals. The results of audits or related disputes could have a material adverse effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open . For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. On November 18, 2020, the U.S. Tax Court (""Tax Court"") issued an opinion (""Opinion"") predominantly siding with the IRS. Although the Company disagrees with the unfavorable portions of the Opinion and intends to vigorously defend its position, considering all avenues of appeal, there is no assurance that the courts will ultimately rule in the Company's favor. It is therefore possible that all or some of the unfavorable portions of the Opinion could ultimately be upheld. In that event, the Company would be subject to significant additional liabilities for the years at issue and potentially also for the subsequent years if the unfavorable portions of the Opinion were to be applied to the foreign licensees covered within the scope of the Opinion. Moreover, the IRS could successfully appeal the portions of the Opinion that are favorable to the Company and/or assert new claims for additional tax relating to the subsequent years by broadening the scope to cover additional foreign licensees. These adjustments could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or thereafter, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act""). Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship or even prohibitions on certain types of plastic products, packages and cups have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. RISKS RELATED TO FINANCE, ACCOUNTING AND INVESTMENTS Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2020, we used 70 functional currencies in addition to the U.S. dollar and derived $21.7 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2020 and 2019, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weakness in some currencies may be offset by strength in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. In addition, in July 2017, the United Kingdom's Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (""LIBOR""), announced that it will no longer compel or persuade financial institutions and panel banks to submit rates for the calculation of LIBOR after 2021. This decision is expected to result in the discontinuance of the use of LIBOR as a reference rate for commercial loans and other indebtedness. Although the impact of the possible discontinuance of LIBOR publication and transition to alternative reference rates remains unclear, it is possible that these changes may have an adverse impact on our financing costs. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottling partners' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners' interest expense could increase, which would reduce our equity income. Unfavorable general economic and political conditions in the United States and international markets could negatively impact our financial results. In 2020, our net operating revenues in the United States were $11.3 billion, or 34 percent, of our total net operating revenues, and our operations outside the United States accounted for $21.7 billion, or 66 percent, of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, could negatively affect the affordability of, and consumer demand for, our beverages. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private-label brands, which could reduce our profitability and could negatively affect our overall financial performance. Other financial uncertainties in our major markets, including uncertainties related to Brexit implementation and unstable political conditions, including civil unrest and governmental changes, could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. In connection with our long-term strategic planning, in 2020 a cross-functional, networked team reviewed the Company's total portfolio, earmarking thriving global, regional and local brands with track records of sequential and incremental growth. Following this exercise, the Company expects to offer a portfolio of approximately 200 master brands, an approximate 50 percent reduction from the current number. The portfolio optimization is intended to free up resources to invest in growing trademarks and better position the Company to nurture promising local innovations, and graduate regional wins to the global stage. If we are unsuccessful in implementing this portfolio optimization, our long-term growth may be adversely affected. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial results could be adversely affected. In June 2015, we entered into a long-term strategic relationship in the global energy drink category with Monster. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. RISKS RELATED TO INFORMATION TECHNOLOGY, DATA PRIVACY AND DIGITIZATION If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems. Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees, former employees and consumers with whom we interact. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. These laws impose operational requirements for companies receiving or processing personal data, and many provide for significant penalties for noncompliance. These requirements with respect to personal data have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and information security systems, policies, procedures and practices. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data by us or the third-party service providers and vendors whose technology, systems and services we use in connection with the receipt, storage and transmission of personal data. Unauthorized access or improper disclosure of personal data in violation of personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to regulatory enforcement actions (including fines), and result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial results could be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed-upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. RISKS RELATED TO ENVIRONMENTAL AND SOCIAL FACTORS Increasing concerns about the environmental impact of plastic bottles and other plastic packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the proliferation and accumulation of plastic bottles and other packaging materials in the environment, particularly in the world's waterways, lakes and oceans. We and our bottling partners sell certain of our beverage products in plastic bottles and use other plastic packaging materials that are not biodegradable and, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's impact on the environment by increasing our use of recycled plastic and other packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted or are considering adopting regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase of recycling rates or, in some cases, restricting or even prohibiting the use of plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our beverage products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. As part of the manufacture of our beverage products, we and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's carbon footprint by increasing our use of recycled packaging materials and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industrywide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The office complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The office complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities, and a reception center. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world, which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our Costa retail stores, which are included in the Global Ventures operating segment, and facilities related to our consolidated bottling and distribution operations, which are included in the Bottling Investments operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2020: Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Facilities Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa 6 7 26 12 Latin America 5 2 5 North America 11 9 4 17 Asia Pacific 6 2 Global Ventures 1 1 1 1,731 Bottling Investments 87 8 109 99 Corporate 3 6 Total 32 97 12 120 154 1,743 Management believes that our Company's facilities used for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of our production facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in ""U.S. Federal Income Tax Dispute"" below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Company's transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arm's-length pricing of transactions between related parties such as the Company's U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arm's-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (""Closing Agreement""). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Company's income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Company's compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years, in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Company's matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS' designation of the Company's matter for litigation, the Company was forced either to accept the IRS' newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS' litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the Tax Court in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS' potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Company's case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Company's foreign licensees to increase the Company's U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors, and we reviewed and considered relevant laws, rules, and regulations, including, though not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Company's tax positions, that it is more likely than not the Company's tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (""Tax Court Methodology""), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Company's tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Company's analysis. While the Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for the years at issue, and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology is ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2020 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 to 2020. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the Tax Cuts and Jobs Act of 2017. The Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $12 billion. Additional interest would continue to accrue until the time any such potential liability, or portion thereof, is paid. The Company currently projects that the impact of the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2020, would result in an incremental annual tax liability that would increase the Company's effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Company's Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the United States Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax period. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax period, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 22, 2021, there were 197,226 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 20, 2021 (""Company's 2021 Proxy Statement""), to be filed with the SEC, is incorporated herein by reference. During the year ended December 31, 2020, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2020 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act: Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 September 26, 2020 through October 23, 2020 11,879 $ 50.02 161,029,667 October 24, 2020 through November 20, 2020 1,966,820 54.00 161,029,667 November 21, 2020 through December 31, 2020 127,023 53.32 161,029,667 Total 2,105,722 $ 53.93 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (""2019 Plan"") for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Shareowner Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Shareowner Return Stock Price Plus Reinvested Dividends December 31, 2015 2016 2017 2018 2019 2020 The Coca-Cola Company $ 100 $ 100 $ 114 $ 122 $ 147 $ 150 Peer Group Index 100 111 123 100 123 133 SP 500 Index 100 112 136 130 171 203 The total shareowner return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2015. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. ITEM 6. INTENTIONALLY OMITTED "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. MDA includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our progress toward emerging stronger from the COVID-19 pandemic; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our consolidated results of operations for 2020 and 2019 and year-to-year comparisons between 2020 and 2019. An analysis of our consolidated results of operations for 2019 and 2018 and year-to-year comparisons between 2019 and 2018 can be found in MDA in Part II, Item 7 of the Company's Form 10-K for the year ended December 31, 2019. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Company's consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa, which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 Concentrate operations 56 % 55 % Finished product operations 44 45 Total 100 % 100 % The following table sets forth the percentage of total worldwide unit case volume attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 Concentrate operations 82 % 83 % Finished product operations 18 17 Total 100 % 100 % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Emerging Stronger from the COVID-19 Pandemic Throughout 2020, the effects of the COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus have significantly impacted our business. In particular, the outbreak and preventive measures taken to contain COVID-19 negatively impacted our unit case volume and our price, product and geographic mix in all of our operating segments, primarily due to unfavorable channel and product mix as consumer demand shifted to more at-home versus away-from-home consumption. The Company's priorities during the COVID-19 pandemic and related business disruption are ensuring the health and safety of our employees; supporting and making a difference in the communities we serve; keeping our brands in supply and maintaining the quality and safety of our products; serving our customers across all channels as they adapt to the shifting demands of consumers during the crisis; and positioning ourselves to emerge stronger when this crisis ends. We deployed global and regional teams to monitor the rapidly evolving situation in each of our local markets and recommended risk mitigation actions; we implemented travel restrictions; and we are following social distancing practices. Around the world, we are endeavoring to follow guidance from authorities and health officials including, but not limited to, checking the temperature of associates when entering our facilities, requiring associates to wear masks and other protective clothing as appropriate, and implementing additional cleaning and sanitization routines at system facilities. In addition, most office-based employees around the world are required to work remotely. During times of crisis, business continuity and adapting to the needs of our customers are critical. We have developed systemwide knowledge-sharing routines and processes, which include the management of any supply chain challenges. As of the date of this filing, there has been no material impact, and we do not foresee a material impact, on our and our bottling partners' ability to manufacture or distribute our products. We are moving with speed to best serve our customers impacted by COVID-19. In partnership with our bottlers and retail customers, we are working to ensure adequate inventory levels in key channels while prioritizing core brands, key packages and consumer affordability. We are increasing investments in e-commerce to support retailer and meal delivery services, shifting toward package sizes that are fit-for-purpose for online sales, and shifting more consumer and trade promotions to digital. Although we are experiencing a time of crisis, we are not losing sight of long-term opportunities for our business. The pandemic helped us realize we could be much bolder in our efforts to change. We believe that we will come out of this situation a better and stronger company. We identified the following key objectives to navigate the pandemic and position us to emerge stronger: winning more consumers; gaining market share; maintaining strong system economics; strengthening stakeholder impact; and equipping the organization to win. We leveraged the crisis as a catalyst to accelerate our strategy and to begin to deliver against these objectives by focusing on the following priorities: optimizing our portfolio of strong global, regional and scaled local brands; establishing a disciplined innovation framework; increasing consumer-centric marketing effectiveness and efficiency; strengthening data-driven revenue growth management and execution capabilities; enhancing system collaboration and capturing supply chain efficiencies; and evolving our organization and investing in new capabilities to support the accelerated strategy. In August 2020, the Company announced strategic steps to transform our organizational structure to better enable us to capture growth in the fast-changing marketplace. The Company is building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information about our strategic realignment initiatives. Core Capabilities To support our ability to emerge stronger from the COVID-19 pandemic, we must continue to enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising, sales promotions and digital marketing. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets, and grow net operating revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to create enhanced value for themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Product and Shopping Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our evolving portfolio of beverage brands and products (including numerous low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to the planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share, while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies, and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. We believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part will help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over the operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers' financial condition. These factors are even more difficult to estimate as a result of uncertainties associated with the scope, severity and duration of the global COVID-19 pandemic and any resurgences of the pandemic including, but not limited to, the number of people contracting the virus, the impact of shelter-in-place and social distancing requirements, the impact of governmental actions across the globe to contain the virus, the timing and number of people receiving vaccinations, and the substance and pace of the post-pandemic economic recovery. The estimates we use when assessing the recoverability of assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe are consistent with those a market participant would use. The variability of these factors depends on a number of conditions, including uncertainties associated with the COVID-19 pandemic, and thus our accounting estimates may change from period to period. Our current estimates reflect our belief that we expect COVID-19 to impact our business for the better part of 2021, with the first half of the year likely to be more challenging than the second half. We expect to see improvements in our business as vaccines become more widely available throughout the year and consumers begin to return to many of their previous routines of socializing, work and travel. The Company has certain intangible and other long-lived assets that are more dependent on cash flows generated in the away-from-home channels and/or that generate cash flows in geographic areas that are more heavily impacted by the COVID-19 pandemic and are therefore more susceptible to impairment. In addition, intangible and other long-lived assets we acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions at the time of acquisition. If we had used other assumptions and estimates when tests of these assets were performed, impairment charges could have resulted. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. The total future impairment charges we may be required to record could be material. Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion of recent acquisitions. Refer to Note 16 of Notes to Consolidated Financial Statements for the discussion of impairment charges. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe are consistent with those a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees and participate in multi-employer retirement plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. Management is required to make certain critical estimates related to the actuarial assumptions used to determine our net periodic pension cost and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our investment objective for our pension plan assets is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to seek to improve returns and manage risk. In 2020, the Company's total income related to defined benefit pension plans was $44 million, which included $66 million of net periodic benefit income and net charges of $22 million, primarily due to settlements, curtailments and special termination benefits. In 2021, we expect our net periodic benefit income related to defined benefit pension plans to be approximately $146 million. We currently expect to incur settlement charges in 2021 related to our strategic realignment initiatives. The increase in 2021 expected net periodic benefit income is primarily due to favorable asset performance in 2020 and a reduction in the number of plan participants arising from our strategic realignment initiatives, partially offset by a decrease in the weighted-average discount rate at December 31, 2020 compared to December 31, 2019. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $17 million decrease in our 2021 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $26 million decrease in our 2021 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2020, the Company's primary U.S. pension plan represented 61 percent and 59 percent of the Company's consolidated projected benefit obligation and pension plan assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 14 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 11 of Notes to Consolidated Financial Statements. Tax law requires certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of coffee beans and finished beverages (in all instances expressed in unit case equivalents) sold by the Company to customers or consumers. Refer to the heading ""Beverage Volume"" below. When we analyze our net operating revenues we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading ""Net Operating Revenues"" below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party or independent customer regardless of our ownership interest in the bottling partner. We generally refer to acquisitions and divestitures of bottling operations as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to these brands is incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to the brand is incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2020, the Company acquired the remaining ownership interest in fairlife. The impact on revenues for fairlife products not previously sold by the Company has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. Also in 2020, the Company discontinued our Odwalla juice business. The impact of discontinuing our Odwalla juice business has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. In 2019, the Company acquired the remaining ownership interest in C.H.I. Limited (""CHI""). The impact of this acquisition has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Other acquisitions by the Company included controlling interests in bottling operations in Zambia, Kenya and Eswatini. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2019, the Company refranchised certain of its bottling operations in India. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings), with the exception of unit case equivalents for Costa non-ready-to-drink beverage products, which are primarily measured in number of transactions; and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an ownership interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of coffee beans and finished beverages (in all instances expressed in unit case equivalents) sold by the Company to customers or consumers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to these items, the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2020 versus 2019 Unit Cases 1,2 Concentrate Sales Worldwide (6) % 3 (7) % Europe, Middle East Africa (6) % (8) % Latin America (2) (2) North America (7) (7) Asia Pacific (9) (9) Global Ventures (13) 3 (13) Bottling Investments (15) 4 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic and Global Ventures operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. Global Ventures operating segment data also reflects unit case volume growth for Costa retail stores. 3 In 2019, with the exception of ready-to-drink products, the Company did not report unit case volume for Costa, a component of the Global Ventures operating segment. However, unit case volume in 2020 includes both Costa ready-to-drink and non-ready-to-drink products. The Company adjusted 2019 to include Costa non-ready-to-drink unit case volume when calculating 2020 versus 2019 volume growth rates. 4 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2020 declined 13 percent. 5 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2020 declined 10 percent. Unit Case Volume Sparkling soft drinks represented 69 percent of our worldwide unit case volume in 2020 and 2019. Trademark CocaCola accounted for 47 percent and 45 percent of our worldwide unit case volume in 2020 and 2019, respectively. In 2020, unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2020. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 32 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. The Coca-Cola system sold 29.0 billion and 30.3 billion unit cases of our products in 2020 and 2019, respectively. The decline was primarily due to the COVID-19 pandemic. Unit case volume in Europe, Middle East and Africa declined 6 percent, which included a 4 percent decline in sparkling soft drinks, an 18 percent decline in both water, enhanced water and sports drinks and tea and coffee, and a 9 percent decline in juice, dairy and plant-based beverages. The group's sparkling soft drinks volume performance reflected a decline of 2 percent in Trademark Coca-Cola. The group reported declines in unit case volume in all business units with the exception of the West Africa business unit, which reported a 3 percent increase in unit case volume. In Latin America, unit case volume declined 2 percent, which included a 1 percent decline in sparkling soft drinks, a 4 percent decline in water, enhanced water and sports drinks, a 6 percent decline in juice, dairy and plant-based beverages and a 1 percent decline in tea and coffee. Trademark Coca-Cola grew 1 percent. The group reported declines in unit case volume of 4 percent in the Mexico business unit and 6 percent in the South Latin business unit, which were partially offset by a 3 percent increase in unit case volume in the Brazil business unit and even volume in the Latin Center business unit. Unit case volume in North America declined 7 percent, which included a 15 percent decline in tea and coffee and a 4 percent decline in both water, enhanced water and sports drinks and juice, dairy and plant-based beverages. The group's sparkling soft drinks volume declined 7 percent, which included a 5 percent decline in Trademark Coca-Cola. In Asia Pacific, unit case volume declined 9 percent, which included a 16 percent decline in both water, enhanced water and sports drinks and juice, dairy and plant-based beverages, a 5 percent decline in sparkling soft drinks and an 8 percent decline in tea and coffee. The group's sparkling soft drinks volume performance included growth of 2 percent in Trademark Coca-Cola. The group reported declines in unit case volume of 27 percent in the India South West Asia business unit, 7 percent in both the ASEAN and Japan business units, 4 percent in the South Pacific business unit and 3 percent in the Greater China Korea business unit. Unit case volume for Global Ventures declined 13 percent, driven by a 29 percent decrease in tea and coffee, partially offset by growth in energy drinks. Performance was even in juice, dairy and plant-based beverages. Unit case volume for Bottling Investments declined 15 percent. Through early February 2021, the Company has experienced a volume decline of mid single digits globally. Concentrate Sales Volume In 2020, worldwide concentrate sales volume declined 7 percent and unit case volume declined 6 percent compared to 2019. The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. Net Operating Revenues Net operating revenues were $33,014 million in 2020, compared to $37,266 million in 2019, a decrease of $4,252 million, or 11 percent. The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2020 versus 2019 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated (7) % (2) % (2) % % (11) % Europe, Middle East Africa (8) % (5) % (2) % % (14) % Latin America (2) 2 (14) (15) North America (7) 2 2 (4) Asia Pacific (10) (2) (11) Global Ventures (13) (9) 1 (22) Bottling Investments (13) 2 (4) (2) (16) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Company's net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) the change in the mix of products and packages sold; (3) the change in the mix of channels where products were sold; and (4) the change in the mix of geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Price, product and geographic m ix had a 2 percent unfavorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa unfavorable channel, package and geographic mix; Latin America favorable pricing initiatives in Mexico and the impact of inflationary environments in certain markets, partially offset by unfavorable channel and package mix; North America favorable product mix, partially offset by unfavorable channel and package mix; Asia Pacific unfavorable channel and package mix across a majority of the business units, partially offset by favorable geographic mix; Global Ventures unfavorable product and channel mix primarily due to the impact of the COVID-19 pandemic on the Costa retail stores; and Bottling Investments favorable pricing and geographic mix, partially offset by unfavorable channel and package mix. The unfavorable channel and package mix for the year ended December 31, 2020 in all operating segments was primarily a result of the shift in consumer demand due to the impact of the COVID-19 pandemic. Consumers were purchasing more products in the at-home channels and fewer in the away-from-home channels. We expect any shift in consumer demand back to the away-from-home channels to be closely correlated with the timing and availability of COVID-19 vaccines and consumers returning to many of their previous routines of socializing, work and travel. Foreign currency fluctuations decreased our consolidated net operating revenues by 2 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Mexican peso, Brazilian real, South African rand, Turkish lira and Indian rupee, which had an unfavorable impact on our Latin America, Europe, Middle East and Africa, Asia Pacific and Bottling Investments operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and Philippine peso, which had a favorable impact on our Europe, Middle East and Africa, Global Ventures, Asia Pacific and Bottling Investments operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Company's net operating revenues provides investors with useful information to enhance their understanding of the Company's net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Company's performance. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. Based on current spot rates and our hedging coverage in place, we expect foreign currency fluctuations will have a slightly favorable impact on our full year 2021 net operating revenues. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, 2020 2019 Europe, Middle East Africa 16.8 % 17.3 % Latin America 10.6 11.0 North America 34.7 31.9 Asia Pacific 12.8 12.7 Global Ventures 6.0 6.9 Bottling Investments 19.0 19.9 Corporate 0.1 0.3 Total 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below, and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Our gross profit margin decreased to 59.3 percent in 2020 from 60.8 percent in 2019. This decrease was primarily driven by unfavorable channel and package mix, the unfavorable impact of foreign currency exchange rate fluctuations, and unfavorable manufacturing overhead variances, partially offset by the impact of acquisitions and divestitures . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2020 2019 Stock-based compensation expense $ 126 $ 201 Advertising expenses 2,777 4,246 Selling and distribution expenses 2,638 2,873 Other operating expenses 4,190 4,783 Selling, general and administrative expenses $ 9,731 $ 12,103 Selling, general and administrative expenses decreased $2,372 million, or 20 percent, in 2020. This decrease was primarily due to effective cost management and a reduction in marketing spending as a result of uncertainties related to the impact of the COVID-19 pandemic, the impact of savings from our productivity initiatives, the impact of a reduction in stock-based compensation expense resulting from a change in estimated payout, and a foreign currency exchange rate impact of 1 percent. The decrease in selling and distribution expenses was primarily due to volume declines, effective cost management as a result of uncertainties related to the COVID-19 pandemic and a foreign currency exchange rate impact of 2 percent, partially offset by amortization and depreciation expense in the current year for Coca-Cola Beverages Africa Proprietary Limited (""CCBA""). During the first five months of 2019, CCBA was classified as held for sale, and therefore amortization and depreciation expense were not recorded. As of December 31, 2020, we had $180 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2020 2019 Europe, Middle East Africa $ 73 $ 2 Latin America 29 1 North America 379 62 Asia Pacific 31 42 Global Ventures 4 Bottling Investments 34 100 Corporate 303 251 Total $ 853 $ 458 In 2020, the Company recorded other operating charges of $853 million. These charges primarily consisted of $413 million related to the Company's strategic realignment initiatives and $99 million related to the Company's productivity and reinvestment program. In addition, other operating charges included impairment charges of $160 million related to the Odwalla trademark and charges of $33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $55 million related to a trademark in North America, which was primarily driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Company's portfolio. In addition, other operating charges included $51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and $16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the fairlife acquisition. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2019, the Company recorded other operating charges of $458 million. These charges primarily consisted of $264 million related to the Company's productivity and reinvestment program and $42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the acquisition of Costa and refranchising of our bottling operations. Refer to Note 16 of Notes to Consolidated Financial Statements for information on the trademark impairment charge. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2020 2019 Europe, Middle East Africa 36.8 % 35.2 % Latin America 23.5 23.6 North America 27.5 25.7 Asia Pacific 23.7 22.6 Global Ventures (1.4) 3.3 Bottling Investments 3.4 3.6 Corporate (13.5) (14.0) Total 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2020 2019 Consolidated 27.3 % 27.1 % Europe, Middle East Africa 59.9 55.2 Latin America 60.5 57.7 North America 21.5 21.8 Asia Pacific 50.6 48.3 Global Ventures (6.2) 13.1 Bottling Investments 4.9 4.8 Corporate * * * Calculation is not meaningful. Operating income was $8,997 million in 2020, compared to $10,086 million in 2019, a decrease of $1,089 million, or 11 percent. The decrease in operating income was primarily driven by a decline in net operating revenues due to the impact of the COVID-19 pandemic, an unfavorable foreign currency exchange rate impact and higher other operating charges, partially offset by lower selling, general and administrative expenses. Operating income for each operating segment and Corporate was impacted by a decline in net operating revenues due to the impact of the COVID-19 pandemic. In addition, operating income for each operating segment and Corporate was impacted by the following: Europe, Middle East and Africa lower selling, general and administrative expenses, partially offset by higher other operating charges and an unfavorable foreign currency exchange rate impact of 3 percent; Latin America lower selling, general and administrative expenses, partially offset by higher other operating charges and an unfavorable foreign currency exchange rate impact of 21 percent; North America lower selling, general and administrative expenses, partially offset by higher other operating charges; Asia Pacific lower selling, general and administrative expenses and lower other operating charges, partially offset by an unfavorable foreign currency exchange rate impact of 1 percent; Global Ventures operating loss in 2020 was primarily due to the temporary closures and gradual reopenings of the Costa retail stores; Bottling Investments lower selling, general and administrative expenses, lower other operating charges and a favorable foreign currency exchange rate impact of 1 percent; and Corporate operating loss in 2020 decreased primarily as a result of lower stock-based compensation expense, lower annual incentive expense and savings from productivity initiatives, partially offset by higher other operating charges and unfavorable manufacturing overhead variances due to lower volume. In 2020, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Mexican peso, Brazilian real, Chilean peso and Turkish lira, which had an unfavorable impact on our Latin America and Europe, Middle East and Africa operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the British pound sterling, Japanese yen and Philippine peso, which had a favorable impact on our Europe, Middle East and Africa, Global Ventures, Asia Pacific and Bottling Investments operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Interest Income Interest income was $370 million in 2020, compared to $563 million in 2019, a decrease of $193 million, or 34 percent. This decrease was primarily driven by lower returns in certain of our international locations, as well as the unfavorable impact of fluctuations in foreign currency exchange rates. Interest Expense Interest expense was $1,437 million in 2020, compared to $946 million in 2019, an increase of $491 million, or 52 percent. This increase was primarily due to charges of $484 million associated with the extinguishment of certain long-term debt. The increase in interest expense was also driven by higher average balances resulting from long-term debt issuances in 2020, partially offset by lower short-term U.S. interest rates and balances. Refer to Note 10 of Notes to Consolidated Financial Statements. Equity Income (Loss) Net Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2020, equity income was $978 million, compared to equity income of $1,049 million in 2019, a decrease of $71 million, or 7 percent. This decrease reflects the impact of the COVID-19 pandemic on operating results reported by our equity method investees and the unfavorable impact of foreign currency exchange rate fluctuations. In addition, the Company recorded net charges of $216 million and $100 million in the line item equity income (loss) net during the years ended December 31, 2020 and 2019, respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost for pension and other postretirement benefit plans; other charges and credits related to pension and other postretirement benefit plans; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; other-than-temporary impairment charges; and net foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2020, other income (loss) net was income of $841 million. The Company recognized a gain of $902 million in conjunction with the fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value, a net gain of $148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a net gain of $18 million related to the sale of a portion of our ownership interest in one of our equity method investees and a gain of $17 million related to the sale of our ownership interest in an equity method investee in North America . These gains were partially offset by an other-than-temporary impairment charge of $252 million related to Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""), an equity method investee, an other-than-temporary impairment charge of $38 million related to one of our equity method investees in Latin America, an impairment charge of $26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $55 million related to economic hedging activities. The Company also recorded net charges of $25 million related to the restructuring of our manufacturing operations in the United States and charges of $14 million for pension and other postretirement benefit plan settlements and curtailments related to the Company's strategic realignment initiatives. Other income (loss) net also included income of $171 million related to the non-service cost components of net periodic benefit cost, $72 million of dividend income and net foreign currency exchange losses of $64 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the fairlife acquisition. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on our economic hedging activities. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's strategic realignment initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2019, other income (loss) net was income of $34 million. The Company recognized a gain of $739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $73 million related to the refranchising of certain bottling operations in India and a gain of $39 million related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (""Andina""). These gains were partially offset by other-than-temporary impairment charges of $406 million related to CCBJHI, an equity method investee, $255 million related to certain equity method investees in the Middle East, $57 million related to one of our equity method investees in North America and $49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million and recognized a $118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recognized net charges of $105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Other income (loss) net also included income of $99 million related to the non-service cost components of net periodic benefit cost, $62 million of dividend income and net foreign currency exchange losses of $120 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining ownership interest in CHI and the sale of a portion of our ownership interest in Andina. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $317 million and $335 million for the years ended December 31, 2020 and 2019, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2020 2019 Statutory U.S. federal tax rate 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 0.9 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 0.9 1 1.1 4,5,6 Equity income or loss (1.4) (1.6) Excess tax benefits on stock-based compensation (0.8) (0.9) Other net (0.5) 2,3 (3.8) 7 Effective tax rate 20.3 % 16.7 % 1 Includes net tax charges of $110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes net tax expense of $431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 3 Includes a tax benefit of $40 million (or a 2.4 percent impact on our effective tax rate) associated with the $902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes net tax charges of $199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 6 Includes a tax benefit of $199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2 of Notes to Consolidated Financial Statements. 7 Includes a net tax benefit of $184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. On November 18, 2020, the Tax Court issued the Opinion regarding the Company's 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11 of Notes to Consolidated Financial Statements. As of December 31, 2020, the gross amount of unrecognized tax benefits was $915 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $588 million, exclusive of any benefits related to interest and penalties. The remaining $327 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2020 2019 Balance of unrecognized tax benefits at beginning of year $ 392 $ 336 Increase related to prior period tax positions 528 204 Decrease related to prior period tax positions (1) Increase related to current period tax positions 26 29 Decrease related to settlements with taxing authorities (19) (174) Increase (decrease) due to effect of foreign currency exchange rate changes (11) (3) Balance of unrecognized tax benefits at end of year $ 915 $ 392 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11 of Notes to Consolidated Financial Statements. 2 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $391 million and $201 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2020 and 2019, respectively. Of these amounts, $190 million and $11 million of expense were recognized in income tax expense in 2020 and 2019, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2021 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of the fundamental strengths of our business. Refer to the heading ''Cash Flows from Operating Activities'' below. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to continue to borrow funds at reasonable rates over the long term. Our debt financing also includes the use of a commercial paper program. While the COVID-19 pandemic initially caused a disruption in the commercial paper market, we currently have the ability to borrow funds in this market at levels that are consistent with our debt financing strategy and expect to continue to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and, as a result of this review, during 2020 we issued U.S. dollar- and euro-denominated long-term debt of $15.6 billion and 2.6 billion, respectively, across various maturities with certain tranches having a longer duration than other recent long-term debt issuances. We used a portion of the proceeds from the long-term debt issuances to extinguish certain tranches of our previously issued long-term debt which had either near-term maturity dates and/or high coupon rates. While we intend to remain active in the commercial paper market, we also used a portion of the proceeds from the long-term debt issuances to reduce our commercial paper balance. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information on the debt issuances and extinguishments. The Company's cash, cash equivalents, short-term investments and marketable securities totaled $10.9 billion as of December 31, 2020. In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $7.5 billion in lines of credit for general corporate purposes as of December 31, 2020. These backup lines of credit expire at various times from 2021 through 2025. While near-term uncertainty caused by the COVID-19 pandemic remains, we expect to see improvements in our business as vaccines become more widely available. The timing and availability of vaccines will be different around the world, and therefore we believe the pace of the recovery will vary by geography depending on both vaccine distribution and other macroeconomic factors. We will remain flexible so that we can adjust to near-term uncertainties while we continue to move forward on the initiatives we implemented to emerge stronger from the COVID-19 pandemic. In 2021, we plan to increase marketing spending behind our brands to drive increased net operating revenues. We expect the return on that spend to become more favorable as mobility stabilizes and away-from-home channels regain momentum. While many of the operating expenses that were significantly reduced in 2020 are likely to return in 2021, we will continue to focus on cash flow generation. Our current capital allocation priorities are focused on investing wisely to support our business operations and continuing to grow our dividend payment. We currently expect 2021 capital expenditures to be approximately $1.5 billion. In addition, we do not intend to repurchase shares under our Board of Directors' authorized plan during the year ending December 31, 2021, and we do not intend to change our approach toward paying dividends. We are currently in litigation with the IRS for tax years 2007 through 2009. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS; however, a final decision is still pending and the timing of such decision is currently not known. The Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions and intends to vigorously defend our positions utilizing every available avenue of appeal. While the Company believes that it is more likely than not that we will ultimately prevail in this litigation upon appeal, it is possible that all, or some portion of, the adjustments proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In the event that all of the adjustments proposed by the IRS are ultimately upheld for the years at issue and the IRS, with the consent of the federal court, were to decide to apply the underlying methodology to the subsequent years up to and including 2020, the Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $12 billion. Once the Tax Court renders a final decision, the Company will have 90 days to file a notice of appeal and pay the portion of the potential aggregate incremental tax and interest liability related to the 2007 through 2009 litigation period, which we currently estimate to be approximately $4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information on the tax litigation. While we believe it is more likely than not that we will prevail in the tax litigation discussed above, we are confident that, between our ability to generate cash flow from operations and our ability to borrow funds at reasonable interest rates, we can manage the range of possible outcomes in the final resolution of the matter. Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities As part of our continued efforts to improve our working capital efficiency, we have worked with our suppliers over the past several years to revisit terms and conditions, including the extension of payment terms. Our current payment terms with the majority of our suppliers are 120 days. Additionally, two global financial institutions offer a voluntary supply chain finance (""SCF"") program which enables our suppliers, at their sole discretion, to sell their receivables from the Company to these financial institutions on a non-recourse basis at a rate that leverages our credit rating and thus may be more beneficial to them. The SCF program is available to suppliers of goods and services included in cost of goods sold as well as suppliers of goods and services included in selling, general and administrative expenses in our consolidated statement of income. The Company and our suppliers agree on the contractual terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. The suppliers sell goods or services, as applicable, to the Company and issue the associated invoices to the Company based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. Our suppliers' voluntary inclusion of invoices in the SCF program has no bearing on our payment terms. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. We have no economic interest in a supplier's decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable and accrued expenses in our consolidated balance sheet. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected in the line item cash flows from operating activities in our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2020 and 2019, suppliers had elected to sell $703 million and $784 million, respectively, of our outstanding payment obligations to the financial institutions. The amount settled through the SCF program was $2,810 million and $2,883 million during the years ended December 31, 2020 and 2019, respectively. Net cash provided by operating activities for the years ended December 31, 2020 and 2019 was $9,844 million and $10,471 million, respectively, a decrease of $627 million, or 6 percent. This decrease was primarily driven by the decline in operating income, the extension of payment terms with certain of our suppliers in the prior year and the unfavorable impact of foreign currency exchange rate fluctuations. Net cash provided by operating activities included estimated benefits of $869 million for the year ended December 31, 2019 from the extension of payment terms with certain of our suppliers. We do not believe there is a risk that our payment terms will be shortened in the near future, and we do not currently expect our net cash provided by operating activities to be significantly impacted by additional extensions of payment terms in the foreseeable future. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables and remit those payments to the financial institutions. The Company sold $185 million of trade accounts receivables under this program during the year ended December 31, 2020, and the costs of factoring such receivables were not material. The Company classifies the cash received from the financial institutions within the operating activities section in the consolidated statement of cash flows. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, 2020 2019 Purchases of investments $ (13,583) $ (4,704) Proceeds from disposals of investments 13,835 6,973 Acquisitions of businesses, equity method investments and nonmarketable securities (1,052) (5,542) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 189 429 Purchases of property, plant and equipment (1,177) (2,054) Proceeds from disposals of property, plant and equipment 189 978 Other investing activities 122 (56) Net cash provided by (used in) investing activities $ (1,477) $ (3,976) Purchases of Investments and Proceeds from Disposals of Investments Purchases of investments and proceeds from disposals of investments resulted in net cash inflows of $252 million and $2,269 million in 2020 and 2019, respectively. This activity primarily represents the purchases of, and proceeds from the disposals of, investments in marketable securities and short-term investments that were made as part of the Company's overall cash management strategy. Also included in this activity are purchases of, and proceeds from the disposals of, investments held by our captive insurance companies. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2020, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife. In 2019, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $5,542 million, which primarily related to the acquisitions of Costa and the remaining ownership interest in CHI. During 2019, the Company also acquired controlling interests in bottling operations in Zambia, Kenya and Eswatini. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2020 and 2019. Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. In 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $429 million, which primarily related to the sale of a portion of our ownership interest in Andina and the refranchising of certain of our bottling operations in India. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2020 and 2019. Purchases of Property, Plant and Equipment Purchases of property, plant and equipment for the years ended December 31, 2020 and 2019 were $1,177 million and $2,054 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2020 2019 Capital expenditures $ 1,177 $ 2,054 Europe, Middle East Africa 2.3 % 5.2 % Latin America 0.5 6.8 North America 15.5 19.1 Asia Pacific 1.7 2.3 Global Ventures 22.2 10.2 Bottling Investments 40.3 40.7 Corporate 17.6 15.7 Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, 2020 2019 Issuances of debt $ 26,934 $ 23,009 Payments of debt (28,796) (24,850) Issuances of stock 647 1,012 Purchases of stock for treasury (118) (1,103) Dividends (7,047) (6,845) Other financing activities 310 (227) Net cash provided by (used in) financing activities $ (8,070) $ (9,004) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2020, our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to borrow funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2020, the Company had issuances of debt of $26,934 million, which included $8,260 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $18,674 million, net of related discounts and issuance costs. During 2020, the Company made payments of debt of $28,796 million, which included $15,292 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $1,768 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $11,736 million. In 2019, the Company had issuances of debt of $23,009 million, which included $16,842 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $6,167 million, net of related discounts and issuance costs. During 2019, the Company made payments of debt of $24,850 million, which included $17,577 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $2,244 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $5,029 million. Issuances of Stock The issuances of stock in 2020 and 2019 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Company's common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. During 2020, the Company did not repurchase common stock under the share repurchase plan authorized by our Board of Directors. In 2019, the Company repurchased 21 million shares of our common stock at an average price per share of $48.86 under the share repurchase plan authorized by our Board of Directors. Since the inception of our share repurchase program in 1984 through December 31, 2020, we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. The Company's treasury stock activity during 2020 resulted in a cash outflow of $118 million. Dividends The Company paid dividends of $7,047 million and $6,845 million during the years ended December 31, 2020 and 2019, respectively. At its February 2021 meeting, our Board of Directors increased our regular quarterly dividend to $0.42 per share, equivalent to a full year dividend of $1.68 per share in 2021. This is our 59 th consecutive annual increase. Our annualized common stock dividend was $1.64 per share and $1.60 per share in 2020 and 2019, respectively. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative financial instruments; and any obligation arising out of a material variable interest held by the Registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Registrant, or engages in leasing, hedging or research and development services with the Registrant. As of December 31, 2020, we were contingently liable for guarantees of indebtedness owed by third parties of $431 million, of which $109 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2020, we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivative financial instruments as either assets or liabilities at fair value in our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2020, the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2021 2022-2023 2024-2025 2026 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 1,329 $ 1,329 $ $ $ Lines of credit and other short-term borrowings 854 854 Current maturities of long-term debt 2 485 485 Long-term debt, net of current maturities 2 39,591 5,604 4,816 29,171 Estimated interest payments 3 9,452 681 1,358 1,117 6,296 Accrued income taxes 4 4,042 788 1,091 2,163 Purchase obligations 5 17,592 10,867 1,455 950 4,320 Marketing obligations 6 4,106 2,091 758 472 785 Lease obligations 1,876 349 562 397 568 Total contractual obligations $ 79,327 $ 17,444 $ 10,828 $ 9,915 $ 41,140 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2020 rate for all years presented. We typically expect to fund such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,639 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $1,296 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms. These agreements include long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these purchase obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2020 was $2,299 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost or income, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the table above. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. The Company expects to contribute $25 million in 2021 to our pension trusts, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension trusts in the table above. As of December 31, 2020, the projected benefit obligation of the U.S. qualified pension plans was $6,019 million, and the fair value of the plans' assets was $5,373 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,395 million, and the fair value of the plans' assets was $3,266 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain employees, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $108 million in 2021, $57 million in 2022 and increasing to $64 million by 2025. Thereafter, the annual benefit payments will decrease. Refer to Note 13 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. As of December 31, 2020, our self-insurance reserves totaled $265 million. Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2020 were $1,833 million. Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the table above because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the underlying assets or liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future years. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. In connection with our acquisition of the remaining ownership interest in fairlife, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting values of which are not subject to a ceiling. Based on fairlife's operating results in 2020, we anticipate making the first milestone payment of $100 million during the first quarter of 2021. As of December 31, 2020, we have accrued $321 million, which represents our best estimate of the present value of these milestone payments. These estimated milestone payments are not included in the table above. As of December 31, 2020, the Company had entered into a lease agreement for a production facility, which commences in the first quarter of 2021. Under the agreement, the Company will make future payments of approximately $540 million over the expected term, assuming we do not exercise any of the contractual purchase options. These future payments are not included in the table above. Additionally, under the terms of the agreement for our investment in BA Sports Nutrition, LLC (""BodyArmor""), the Company has an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreed-upon formula. The Company intends on exercising its option; however, the acquisition is subject to regulatory approval. Any potential payments related to this potential acquisition are not included in the table above. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in currencies. In 2020, we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2020 and 2019, the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, 2020 2019 All operating currencies (4) % (5) % Australian dollar (2) % (7) % Brazilian real (23) (10) British pound sterling 1 (4) Euro 1 (5) Japanese yen 2 1 Mexican peso (10) (1) South African rand (18) (10) The percentages in the table above do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 2 percent and 4 percent in 2020 and 2019, respectively. The total currency impact on income before income taxes, including the effect of our hedging activities, was a decrease of 6 percent and 10 percent in 2020 and 2019, respectively. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statement of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $64 million and $120 million during the years ended December 31, 2020 and 2019, respectively. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instruments and the underlying exposures, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposures. We monitor our exposure to market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2020, we used 70 functional currencies in addition to the U.S. dollar and generated $21.7 billion of our net operating revenues from operations outside the United States; therefore, weakness in some currencies may be offset by strength in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $16,663 million and $14,276 million as of December 31, 2020 and 2019, respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of foreign currency derivatives that qualify for hedge accounting resulted in a net unrealized gain of $117 million as of December 31, 2020, and we estimate that a 10 percent weakening of the U.S. dollar would have increased the net unrealized gain to $140 million. The fair value of the foreign currency derivatives that do not qualify for hedge accounting resulted in a net unrealized loss of $12 million as of December 31, 2020, and we estimate that a 10 percent weakening of the U.S. dollar would have resulted in a $143 million increase in fair value. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2020, we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $104 million in 2020. However, this increase in interest expense would have been partially offset by the increase in interest income due to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $53 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements, which enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to further manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $726 million and $427 million as of December 31, 2020 and 2019, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the commodity derivatives that qualify for hedge accounting resulted in a net unrealized gain of $2 million as of December 31, 2020, and we estimate that a 10 percent decrease in underlying commodity prices would reduce the net unrealized gain to $1 million. The fair value of the commodity derivatives that do not qualify for hedge accounting resulted in a net gain of $69 million as of December 31, 2020, and we estimate that a 10 percent decrease in underlying commodity prices would have resulted in a $64 million decrease in fair value. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting 63 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2020 2019 2018 Net Operating Revenues $ 33,014 $ 37,266 $ 34,300 Cost of goods sold 13,433 14,619 13,067 Gross Profit 19,581 22,647 21,233 Selling, general and administrative expenses 9,731 12,103 11,002 Other operating charges 853 458 1,079 Operating Income 8,997 10,086 9,152 Interest income 370 563 689 Interest expense 1,437 946 950 Equity income (loss) net 978 1,049 1,008 Other income (loss) net 841 34 ( 1,674 ) Income Before Income Taxes 9,749 10,786 8,225 Income taxes 1,981 1,801 1,749 Consolidated Net Income 7,768 8,985 6,476 Less: Net income (loss) attributable to noncontrolling interests 21 65 42 Net Income Attributable to Shareowners of The Coca-Cola Company $ 7,747 $ 8,920 $ 6,434 Basic Net Income Per Share 1 $ 1.80 $ 2.09 $ 1.51 Diluted Net Income Per Share 1 $ 1.79 $ 2.07 $ 1.50 Average Shares Outstanding Basic 4,295 4,276 4,259 Effect of dilutive securities 28 38 40 Average Shares Outstanding Diluted 4,323 4,314 4,299 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2020 2019 2018 Consolidated Net Income $ 7,768 $ 8,985 $ 6,476 Other Comprehensive Income: Net foreign currency translation adjustments ( 911 ) 74 ( 2,035 ) Net gains (losses) on derivatives 15 ( 54 ) ( 7 ) Net change in unrealized gains (losses) on available-for-sale debt securities ( 47 ) 18 ( 34 ) Net change in pension and other postretirement benefit liabilities ( 267 ) ( 159 ) 29 Total Comprehensive Income 6,558 8,864 4,429 Less: Comprehensive income attributable to noncontrolling interests ( 132 ) 110 95 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 6,690 $ 8,754 $ 4,334 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2020 2019 ASSETS Current Assets Cash and cash equivalents $ 6,795 $ 6,480 Short-term investments 1,771 1,467 Total Cash, Cash Equivalents and Short-Term Investments 8,566 7,947 Marketable securities 2,348 3,228 Trade accounts receivable, less allowances of $ 526 and $ 524 , respectively 3,144 3,971 Inventories 3,266 3,379 Prepaid expenses and other assets 1,916 1,886 Total Current Assets 19,240 20,411 Equity method investments 19,273 19,025 Other investments 812 854 Other assets 6,184 6,075 Deferred income tax assets 2,460 2,412 Property, plant and equipment net 10,777 10,838 Trademarks with indefinite lives 10,395 9,266 Goodwill 17,506 16,764 Other intangible assets 649 736 Total Assets $ 87,296 $ 86,381 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 11,145 $ 11,312 Loans and notes payable 2,183 10,994 Current maturities of long-term debt 485 4,253 Accrued income taxes 788 414 Total Current Liabilities 14,601 26,973 Long-term debt 40,125 27,516 Other liabilities 9,453 8,510 Deferred income tax liabilities 1,833 2,284 The Coca-Cola Company Shareowners' Equity Common stock, $ 0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 17,601 17,154 Reinvested earnings 66,555 65,855 Accumulated other comprehensive income (loss) ( 14,601 ) ( 13,544 ) Treasury stock, at cost 2,738 and 2,760 shares, respectively ( 52,016 ) ( 52,244 ) Equity Attributable to Shareowners of The Coca-Cola Company 19,299 18,981 Equity attributable to noncontrolling interests 1,985 2,117 Total Equity 21,284 21,098 Total Liabilities and Equity $ 87,296 $ 86,381 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Operating Activities Consolidated net income $ 7,768 $ 8,985 $ 6,476 Depreciation and amortization 1,536 1,365 1,086 Stock-based compensation expense 126 201 225 Deferred income taxes ( 18 ) ( 280 ) ( 413 ) Equity (income) loss net of dividends ( 511 ) ( 421 ) ( 457 ) Foreign currency adjustments ( 88 ) 91 ( 50 ) Significant (gains) losses net ( 914 ) ( 467 ) 743 Other operating charges 556 127 558 Other items 699 504 699 Net change in operating assets and liabilities 690 366 ( 1,240 ) Net Cash Provided by Operating Activities 9,844 10,471 7,627 Investing Activities Purchases of investments ( 13,583 ) ( 4,704 ) ( 7,789 ) Proceeds from disposals of investments 13,835 6,973 14,977 Acquisitions of businesses, equity method investments and nonmarketable securities ( 1,052 ) ( 5,542 ) ( 1,263 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 189 429 1,362 Purchases of property, plant and equipment ( 1,177 ) ( 2,054 ) ( 1,548 ) Proceeds from disposals of property, plant and equipment 189 978 248 Other investing activities 122 ( 56 ) ( 60 ) Net Cash Provided by (Used in) Investing Activities ( 1,477 ) ( 3,976 ) 5,927 Financing Activities Issuances of debt 26,934 23,009 27,605 Payments of debt ( 28,796 ) ( 24,850 ) ( 30,600 ) Issuances of stock 647 1,012 1,476 Purchases of stock for treasury ( 118 ) ( 1,103 ) ( 1,912 ) Dividends ( 7,047 ) ( 6,845 ) ( 6,644 ) Other financing activities 310 ( 227 ) ( 272 ) Net Cash Provided by (Used in) Financing Activities ( 8,070 ) ( 9,004 ) ( 10,347 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents 76 ( 72 ) ( 262 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 373 ( 2,581 ) 2,945 Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 6,737 9,318 6,373 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 7,110 6,737 9,318 Less: Restricted cash and restricted cash equivalents at end of year 315 257 241 Cash and Cash Equivalents at End of Year $ 6,795 $ 6,480 $ 9,077 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (In millions except per share data) Year Ended December 31, 2020 2019 2018 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,280 4,268 4,259 Treasury stock issued to employees related to stock-based compensation plans 22 33 48 Purchases of stock for treasury ( 21 ) ( 39 ) Balance at end of year 4,302 4,280 4,268 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 17,154 16,520 15,864 Stock issued to employees related to stock-based compensation plans 307 433 467 Stock-based compensation expense 141 201 225 Other activities ( 1 ) ( 36 ) Balance at end of year 17,601 17,154 16,520 Reinvested Earnings Balance at beginning of year 65,855 63,234 60,430 Adoption of accounting standards 1 546 3,014 Net income attributable to shareowners of The Coca-Cola Company 7,747 8,920 6,434 Dividends (per share $ 1.64 , $ 1.60 and $ 1.56 in 2020, 2019 and 2018, respectively) ( 7,047 ) ( 6,845 ) ( 6,644 ) Balance at end of year 66,555 65,855 63,234 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 13,544 ) ( 12,814 ) ( 10,305 ) Adoption of accounting standards 1 ( 564 ) ( 409 ) Net other comprehensive income (loss) ( 1,057 ) ( 166 ) ( 2,100 ) Balance at end of year ( 14,601 ) ( 13,544 ) ( 12,814 ) Treasury Stock Balance at beginning of year ( 52,244 ) ( 51,719 ) ( 50,677 ) Treasury stock issued to employees related to stock-based compensation plans 228 501 704 Purchases of stock for treasury ( 1,026 ) ( 1,746 ) Balance at end of year ( 52,016 ) ( 52,244 ) ( 51,719 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 19,299 $ 18,981 $ 16,981 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 2,117 $ 2,077 $ 1,905 Net income attributable to noncontrolling interests 21 65 42 Net foreign currency translation adjustments ( 153 ) 45 53 Dividends paid to noncontrolling interests ( 18 ) ( 48 ) ( 31 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests 17 3 Business combinations 1 59 101 Other activities 7 Total Equity Attributable to Noncontrolling Interests $ 1,985 $ 2,117 $ 2,077 1 Refer to Note 1 and Note 5. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Company's consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 2,567 million and $ 3,179 million as of December 31, 2020 and 2019, respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 74 million and $ 51 million as of December 31, 2020 and 2019, respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Our Company recognizes revenue when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Refer to Note 3. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 3 billion in 2020 and $ 4 billion in 2019 and 2018. As of December 31, 2020 and 2019, advertising and production costs of $ 83 million and $ 55 million, respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our consolidated bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. We recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. We exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 6 million and 5 million stock option awards were excluded from the computations of diluted net income per share in 2020 and 2018, respectively, because the awards would have been antidilutive for the years presented. The number of stock option awards excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheet. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2020 2019 2018 Cash and cash equivalents $ 6,795 $ 6,480 $ 9,077 Restricted cash and restricted cash equivalents included in other assets 1 315 257 241 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 7,110 $ 6,737 $ 9,318 1 Amounts represent restricted cash and restricted cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any expected loss on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on available relevant information, in addition to historical loss information, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables and remit those payments to the financial institutions. The Company sold $ 185 million of trade accounts receivables under this program during the year ended December 31, 2020, and the costs of factoring such receivables were not material. The Company accounts for this program as a sale, and accordingly, the trade receivables sold are excluded from trade accounts receivable on our consolidated balance sheet. The cash received from the financial institutions is classified within the operating activities section in the consolidated statement of cash flows. Inventories Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2020 2019 Raw materials and packaging $ 2,106 $ 2,180 Finished goods 791 851 Other 369 348 Total inventories $ 3,266 $ 3,379 Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 5. Leases Effective January 1, 2019, we adopted Accounting Standards Codification (""ASC"") 842, Leases . We determine if an arrangement contains a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in the line items other assets, accounts payable and accrued expenses, and other liabilities in our consolidated balance sheet. Operating lease right-of-use (""ROU"") assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 9. We have various arrangements for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,301 million, $ 1,208 million and $ 999 million in 2020, 2019 and 2018, respectively. Amortization expense for leasehold improvements totaled $ 18 million in 2020, 2019 and 2018. The following table summarizes our property, plant and equipment (in millions): December 31, 2020 2019 Land $ 676 $ 659 Buildings and improvements 4,782 4,576 Machinery and equipment 14,242 13,686 Property, plant and equipment cost 19,700 18,921 Less: Accumulated depreciation 8,923 8,083 Property, plant and equipment net $ 10,777 $ 10,838 Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally less than 25 years. Refer to Note 7. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (""Costa""), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""), each of which is its own reporting unit. The Bottling Investments operating segment includes all consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11. Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performance-based share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, which is generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018, 2019 and 2020, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12. Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14. Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying values of these assets and liabilities attributable to fluctuations in spot rates are recognized in net foreign currency translation adjustments, a component of AOCI. Refer to Note 15. Accounts in our consolidated statement of income are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5. Recently Adopted Accounting Guidance In August 2017, the Financial Accounting Standards Board (""FASB"") issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (""ASU 2017-12""), which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments in this update include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2019 by $ 12 million, net of tax. Refer to Note 5 for additional disclosures required by this ASU. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (""ASU 2018-02""), which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act"") on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019. We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers . ASU 2014-09, and its amendments, were primarily included in ASC 606, Revenue from Contracts with Customers , which we adopted effective January 1, 2018 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $ 257 million, net of tax. In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $ 409 million, net of tax. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $ 2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Reform Act. The amendments also require any provisional amounts or subsequent adjustments to be included in net income. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018. Refer to Note 14. NOTE 2: ACQUISITIONS AND DIVESTITURES Acquisitions During 2020, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife, LLC (""fairlife""). During 2019, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million, which primarily related to the acquisitions of Costa, the remaining ownership interest in C.H.I. Limited (""CHI"") and controlling interests in bottling operations in Zambia, Kenya, and Eswatini. During 2018, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million, which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. fairlife, LLC In January 2020, the Company acquired the remaining 57.5 percent ownership interest in, and now owns 100 percent of, fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. A significant portion of fairlife's revenues was already reflected in our consolidated financial statements, as we have operated as the sales and distribution organization for certain fairlife products. Upon consolidation, we recognized a gain of $ 902 million resulting from the remeasurement of our previously held equity interest in fairlife to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. We acquired the remaining ownership interest in exchange for $ 979 million of cash, net of cash acquired, and effectively settled our $ 306 million note receivable from fairlife at the recorded amount. Under the terms of the agreement, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting values of which are not subject to a ceiling. Under the applicable accounting guidance, we recorded a $ 270 million liability representing our best estimate of the fair value of this contingent consideration. The fair value of this contingent consideration was determined using a Monte Carlo valuation model based on Level 3 inputs. We will be required to remeasure this liability to fair value quarterly with any changes in the fair value recorded in income until the final milestone payment is made. During the year ended December 31, 2020, we recorded charges of $ 51 million related to this remeasurement in the line item other operating charges in our consolidated statement of income. Upon finalization of purchase accounting, $ 1.3 billion of the purchase price was allocated to the fairlife trademark and $ 0.8 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the North America operating segment. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail outlets in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market, as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. Upon finalization of purchase accounting, $ 2.4 billion of the purchase price was allocated to the Costa trademark and $ 2.5 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million, which was allocated to the Europe, Middle East and Africa operating segment. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent ownership interest in CHI, a Nigerian producer of value-added dairy and juice beverages and iced tea, in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net loss was recorded in the line item other income (loss) net in our consolidated statement of income. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $ 715 million of cash. The acquired business had $ 345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $ 32 million, which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee, for cash proceeds of $ 100 million. Also included was the sale of our ownership interest in an equity method investee in North America and the sale of a portion of our ownership interest in one of our other equity method investees. We recognized a net loss of $ 2 million, a gain of $ 17 million, and a net gain of $ 18 million, respectively, as a result of these sales, which were recorded in the line item other income (loss) net in our consolidated statement of income. During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million, which primarily related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (""Andina"") and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million, respectively, which were recorded in the line item other income (loss) net in our consolidated statement of income. We continue to account for our remaining ownership interest in Andina as an equity method investment as a result of our representation on Andina's Board of Directors and other governance rights. During 2018, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 1,362 million, which primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the sale of our ownership interest in Corporacin Lindley S.A. (""Lindley""). Latin America Bottling Operations During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $ 289 million as a result of these sales and recognized a net gain of $ 47 million, which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018, we sold our ownership interest in Lindley to AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), an equity method investee. We received net cash proceeds of $ 507 million and recognized a net gain of $ 296 million during the year ended December 31, 2018, which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018, the Company completed its North America refranchising, which began in 2014, with the sale of its Canadian bottling operations. We received initial net cash proceeds of $ 518 million and recognized a net charge of $ 385 million during the year ended December 31, 2018. During the year ended December 31, 2019, we recognized a charge of $ 122 million, primarily related to post-closing adjustments as contemplated by the related agreements. These charges were included in the line item other income (loss) net in our consolidated statements of income. North America Refranchising United States In 2018, the Company completed the refranchising of all of our bottling territories in the United States to certain of our unconsolidated bottling partners. We recognized a net gain of $ 17 million during the year ended December 31, 2019 and recognized net charges of $ 91 million during the year ended December 31, 2018, primarily related to post-closing adjustments as contemplated by the related agreements. Included in these amounts is a net gain of $ 5 million during the year ended December 31, 2019 and a net charge of $ 21 million during the year ended December 31, 2018 from transactions with equity method investees or former management. During the years ended December 31, 2019 and 2018, the Company recorded charges of $ 4 million and $ 34 million, respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single new form of bottling agreement with additional requirements. The net gain and charges were included in the line item other income (loss) net in our consolidated statements of income. Coca-Cola Beverages Africa Proprietary Limited Due to the Company's original intent to refranchise Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), it was accounted for as held for sale and a discontinued operation from October 2017 through the first quarter of 2019. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As a result, during the year ended December 31, 2018, we recorded an impairment charge of $ 554 million, reflecting management's view of the proceeds that were expected to be received upon sale based on revised projections of future operating results and foreign currency exchange rate fluctuations. This charge was previously reflected in the line item income (loss) from discontinued operations in our consolidated statement of income and the corresponding reduction to assets was reflected as an allowance for reduction of assets held for sale discontinued operations in our consolidated balance sheet. Additionally, CCBA's property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans for CCBA and now intends to maintain its controlling stake in CCBA for the foreseeable future. As a result, CCBA no longer qualifies as held for sale or as a discontinued operation, and CCBA's financial results are now presented within the Company's continuing operations for all periods presented. As a result of this change in presentation, the Company reflected the impairment charge in other income (loss) net in our consolidated statement of income for the year ended December 31, 2018 and reallocated the allowance for reduction of assets held for sale discontinued operations balance to reduce the carrying value of CCBA's property, plant and equipment by $ 225 million and CCBA's definite-lived intangible assets by $ 329 million based on the relative amount of depreciation and amortization that would have been recognized during the period CCBA was held for sale. We also recorded a $ 160 million adjustment to reduce the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million, respectively, during the year ended December 31, 2019. These additional adjustments were included in the line item other income (loss) net in our consolidated statement of income. NOTE 3: REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa, which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrates they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2020 related to performance obligations satisfied in prior periods was immaterial. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2020 Concentrate operations $ 5,443 $ 13,139 $ 18,582 Finished product operations 5,838 8,594 14,432 Total $ 11,281 $ 21,733 $ 33,014 Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,323 $ 19,894 Finished product operations 6,773 7,633 14,406 Total $ 11,344 $ 22,956 $ 34,300 Refer to Note 19 for additional revenue disclosures by operating segment and Corporate. NOTE 4: INVESTMENTS We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Refer to Note 5 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities The carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2020 Marketable securities $ 330 $ Other investments 762 50 Other assets 1,282 Total equity securities $ 2,374 $ 50 December 31, 2019 Marketable securities $ 329 $ Other investments 772 82 Other assets 1,118 Total equity securities $ 2,219 $ 82 The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2020 2019 Net gains (losses) recognized during the year related to equity securities $ 146 $ 218 Less: Net gains (losses) recognized during the year related to equity securities sold during the year ( 22 ) 27 Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ 168 $ 191 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2020 Trading securities $ 36 $ 2 $ $ 38 Available-for-sale securities 2,227 51 ( 13 ) 2,265 Total debt securities $ 2,263 $ 53 $ ( 13 ) $ 2,303 December 31, 2019 Trading securities $ 46 $ 1 $ $ 47 Available-for-sale securities 3,172 113 ( 4 ) 3,281 Total debt securities $ 3,218 $ 114 $ ( 4 ) $ 3,328 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2020 December 31, 2019 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ 123 Marketable securities 38 1,980 47 2,852 Other assets 285 306 Total debt securities $ 38 $ 2,265 $ 47 $ 3,281 The contractual maturities of these available-for-sale debt securities as of December 31, 2020 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 701 $ 720 After 1 year through 5 years 1,236 1,237 After 5 years through 10 years 90 103 After 10 years 200 205 Total $ 2,227 $ 2,265 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2020 2019 2018 Gross gains $ 20 $ 39 $ 22 Gross losses ( 13 ) ( 8 ) ( 27 ) Proceeds 1,559 3,956 13,710 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $ 1,389 million and $ 1,266 million as of December 31, 2020 and 2019, respectively, which were classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5: HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in OCI. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019, we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019, we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million, net of taxes. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2020 December 31, 2019 Assets: Foreign currency contracts Prepaid expenses and other assets $ 26 $ 24 Foreign currency contracts Other assets 74 91 Commodity contracts Prepaid expenses and other assets 2 Interest rate contracts Prepaid expenses and other assets 10 Interest rate contracts Other assets 659 427 Total assets $ 761 $ 552 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 29 $ 40 Foreign currency contracts Other liabilities 48 Interest rate contracts Accounts payable and accrued expenses 5 Interest rate contracts Other liabilities 21 Total liabilities $ 34 $ 109 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2020 December 31, 2019 Assets: Foreign currency contracts Prepaid expenses and other assets $ 28 $ 13 Foreign currency contracts Other assets 1 Commodity contracts Prepaid expenses and other assets 76 8 Commodity contracts Other assets 9 2 Other derivative instruments Prepaid expenses and other assets 20 12 Other derivative instruments Other assets 3 1 Total assets $ 137 $ 36 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 41 $ 39 Commodity contracts Accounts payable and accrued expenses 15 13 Commodity contracts Other liabilities 1 1 Total liabilities $ 57 $ 53 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 7,785 million and $ 6,957 million as of December 31, 2020 and 2019, respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the changes in carrying values of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair values of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the changes in fair values attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 2,700 million and $ 3,028 million as of December 31, 2020 and 2019, respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 11 million and $ 2 million as of December 31, 2020 and 2019, respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional value of these interest rate swap agreements that were designated and qualified for the Company's interest rate cash flow hedging program was $ 1,233 million as of December 31, 2020. As of December 31, 2019, we did not have any interest rate swaps designated as a cash flow hedge. During the year ended December 31, 2018, we discontinued a cash flow hedge relationship related to these types of swaps. We reclassified a loss of $ 8 million into earnings as a result of the discontinuance. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on OCI, AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) 2 2020 Foreign currency contracts $ ( 93 ) Net operating revenues $ ( 73 ) $ Foreign currency contracts 4 Cost of goods sold 9 Foreign currency contracts Interest expense ( 16 ) Foreign currency contracts 37 Other income (loss) net 60 Interest rate contracts 15 Interest expense ( 54 ) Commodity contracts 2 Cost of goods sold Total $ ( 35 ) $ ( 74 ) $ 2019 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) $ Foreign currency contracts 1 Cost of goods sold 11 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts 1 Cost of goods sold Total $ ( 200 ) $ ( 162 ) $ 2018 Foreign currency contracts $ 9 Net operating revenues $ 136 $ 1 Foreign currency contracts 15 Cost of goods sold 8 ( 3 ) Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts 23 Other income (loss) net ( 5 ) ( 4 ) Interest rate contracts 22 Interest expense ( 40 ) ( 8 ) Commodity contracts ( 1 ) Cost of goods sold ( 5 ) Total $ 68 $ 90 $ ( 19 ) 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and the ineffective portion, if any, to the same line items in our consolidated statement of income. 2 Effective January 1, 2019, ASU 2017-12 eliminated the requirement to separately measure and report hedge ineffectiveness for cash flow hedges. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. As of December 31, 2020, the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 68 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured or has been extinguished. The total notional values of derivatives related to our fair value hedges of this type were $ 10,215 million and $ 12,523 million as of December 31, 2020 and 2019, respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair values of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in the fair values of derivatives designated as fair value hedges and the offsetting changes in the fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. As of December 31, 2020 and 2019, we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 2020 Interest rate contracts Interest expense $ 275 Fixed-rate debt Interest expense ( 274 ) Net impact to interest expense $ 1 Foreign currency contracts Other income (loss) net $ ( 4 ) Available-for-sale securities Other income (loss) net 5 Net impact to other income (loss) net $ 1 Net impact of fair value hedging instruments $ 2 2019 Interest rate contracts Interest expense $ 368 Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) 2018 Interest rate contracts Interest expense $ 34 Fixed-rate debt Interest expense ( 38 ) Net impact to interest expense $ ( 4 ) Foreign currency contracts Other income (loss) net $ ( 6 ) Available-for-sale securities Other income (loss) net 6 Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ ( 4 ) The following table summarizes the amounts recorded in the consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Carrying Values of Hedged Items Cumulative Amount of Fair Value Hedging Adjustments Included in the Carrying Values of Hedged Items 1 Balance Sheet Location of Hedged Items December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Current maturities of long-term debt $ $ 1,004 $ $ 5 Long-term debt 11,129 12,087 646 448 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rate fluctuations. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the carrying values of the designated portions of the non-derivative financial instruments due to changes in foreign currency exchange rates are recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2020 2019 2020 2019 2018 Foreign currency contracts $ 451 $ $ ( 5 ) $ 51 $ ( 14 ) Foreign currency denominated debt 13,336 12,334 ( 1,089 ) 144 653 Total $ 13,787 $ 12,334 $ ( 1,094 ) $ 195 $ 639 The Company did not reclassify any gains or losses related to net investment hedges from AOCI into earnings during the years ended December 31, 2020, 2019 and 2018. In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2020, 2019 and 2018. The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in the fair values of economic hedges are immediately recognized in earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in the fair values of economic hedges used to offset those monetary assets and liabilities are immediately recognized in earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in the fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are immediately recognized in earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 5,727 million and $ 4,291 million as of December 31, 2020 and 2019, respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and vehicle fuel. The changes in the fair values of these economic hedges are immediately recognized in earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 715 million and $ 425 million as of December 31, 2020 and 2019, respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, 2020 2019 2018 Foreign currency contracts Net operating revenues $ 58 $ ( 4 ) $ 22 Foreign currency contracts Cost of goods sold 6 1 9 Foreign currency contracts Other income (loss) net ( 13 ) ( 66 ) ( 264 ) Commodity contracts Cost of goods sold 54 ( 23 ) ( 25 ) Interest rate contracts Interest expense 6 ( 1 ) Other derivative instruments Selling, general and administrative expenses 21 47 ( 18 ) Other derivative instruments Other income (loss) net ( 55 ) 48 ( 22 ) Total $ 77 $ 3 $ ( 299 ) NOTE 6: EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value of those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity method investees' AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in Coca-Cola European Partners plc (""CCEP""), Monster, AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic"") and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2020, we owned approximately 19 percent, 19 percent, 20 percent, 28 percent, 23 percent and 19 percent, respectively, of these companies' outstanding shares. As of December 31, 2020, our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 8,762 million. This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 2020 2019 2018 Net operating revenues $ 69,384 $ 75,980 $ 75,482 Cost of goods sold 41,139 44,881 44,933 Gross profit $ 28,245 $ 31,099 $ 30,549 Operating income $ 7,056 $ 7,748 $ 7,511 Consolidated net income $ 4,176 $ 4,597 $ 4,646 Less: Net income attributable to noncontrolling interests 54 63 101 Net income attributable to common shareowners $ 4,122 $ 4,534 $ 4,545 Company equity income (loss) net $ 978 $ 1,049 $ 1,008 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, 2020 2019 Current assets $ 29,431 $ 25,654 Noncurrent assets 67,900 68,269 Total assets $ 97,331 $ 93,923 Current liabilities $ 20,033 $ 20,271 Noncurrent liabilities 33,613 31,321 Total liabilities $ 53,646 $ 51,592 Equity attributable to shareowners of investees $ 42,622 $ 41,203 Equity attributable to noncontrolling interests 1,063 1,128 Total equity $ 43,685 $ 42,331 Company equity method investments $ 19,273 $ 19,025 Net sales to equity method investees, the majority of which are located outside the United States, were $ 13,041 million, $ 14,832 million and $ 14,799 million in 2020, 2019 and 2018, respectively. Total payments, primarily related to marketing, made to equity method investees were $ 547 million, $ 897 million and $ 1,131 million in 2020, 2019 and 2018, respectively. The decrease in net sales to, and payments made to, equity method investees in 2020 was primarily due to the impact of the COVID-19 pandemic. The decrease in payments made to equity method investees in 2019 was primarily due to changes in bottler funding arrangements. In addition, purchases of beverage products from equity method investees were $ 452 million, $ 426 million and $ 536 million in 2020, 2019 and 2018, respectively. The decrease in purchases of beverage products in 2019 was primarily due to reduced purchases of Monster products as a result of the North America refranchising activities. Refer to Note 2. The following table presents the difference between calculated fair value, based on quoted closing prices of publicly traded shares, and our Company's carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2020 Fair Value Carrying Value Difference Monster Beverage Corporation $ 9,444 $ 4,020 $ 5,424 Coca-Cola European Partners plc 4,383 3,959 424 Coca-Cola FEMSA, S.A.B. de C.V. 2,657 1,632 1,025 Coca-Cola HBC AG 2,657 1,282 1,375 Coca-Cola Amatil Limited 2,222 707 1,515 Coca-Cola Consolidated, Inc. 661 169 492 Coca-Cola Bottlers Japan Holdings Inc. 522 522 Coca-Cola ecek A.. 440 197 243 Embotelladora Andina S.A. 143 116 27 Total $ 23,129 $ 12,604 $ 10,525 Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,025 million and $ 1,707 million as of December 31, 2020 and 2019, respectively. The total amount of dividends received from equity method investees was $ 467 million, $ 628 million and $ 551 million for the years ended December 31, 2020, 2019 and 2018, respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2020 was $ 5,498 million. NOTE 7: INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2020 2019 Trademarks 1 $ 10,395 $ 9,266 Goodwill 17,506 16,764 Other 225 219 Indefinite-lived intangible assets $ 28,126 $ 26,249 1 For information related to the Company's acquisitions, refer to Note 2. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total 2019 Balance at beginning of year $ 1,051 $ 168 $ 7,943 $ 152 $ 414 $ 4,381 $ 14,109 Effect of foreign currency translation ( 8 ) 2 1 1 79 75 Acquisitions 1 141 2,505 173 2,819 Purchase accounting adjustments 1,2 110 17 ( 114 ) ( 252 ) ( 239 ) Balance at end of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 2020 Balance at beginning of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 Effect of foreign currency translation 40 ( 6 ) 7 84 ( 216 ) ( 91 ) Acquisitions 1 775 775 Purchase accounting adjustments 1,3 ( 26 ) 74 24 2 ( 2 ) 72 Impairments ( 14 ) ( 14 ) Balance at end of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 1 For information related to the Company's acquisitions, refer to Note 2. 2 Includes the allocation of goodwill from the Global Ventures segment to other reporting units expected to benefit from the Costa acquisition as well as the finalization of purchase accounting related to CCBA and the Philippine bottling operations. Refer to Note 2. 3 Includes the allocation of goodwill from the Europe, Middle East and Africa segment to other reporting units expected to benefit from the CHI acquisition as well as purchase accounting adjustments related to fairlife. Refer to Note 2. Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2020 December 31, 2019 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ 195 $ ( 61 ) $ 134 $ 344 $ ( 177 ) $ 167 Trademarks 245 ( 77 ) 168 177 ( 99 ) 78 Other 332 ( 210 ) 122 396 ( 124 ) 272 Total $ 772 $ ( 348 ) $ 424 $ 917 $ ( 400 ) $ 517 Total amortization expense for intangible assets subject to amortization was $ 203 million, $ 120 million and $ 49 million in 2020, 2019 and 2018, respectively. The increase in amortization expense in 2020 was due to the recognition of a full year of intangible amortization related to CCBA versus seven months in 2019. Based on the carrying value of definite-lived intangible assets as of December 31, 2020, we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense 2021 $ 163 2022 74 2023 43 2024 31 2025 25 NOTE 8: ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, 2020 2019 Accounts payable $ 3,517 $ 3,804 Accrued marketing expenses 1,930 2,059 Variable consideration payable 1,137 979 Other accrued expenses 3,352 2,856 Accrued compensation 609 1,021 Accrued sales, payroll and other taxes 443 442 Container deposits 157 151 Accounts payable and accrued expenses $ 11,145 $ 11,312 NOTE 9: LEASES We have operating leases primarily for real estate, aircraft, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2020 2019 Operating lease ROU assets 1 $ 1,548 $ 1,372 Current portion of operating lease liabilities 2 $ 322 $ 281 Noncurrent portion of operating lease liabilities 3 1,300 1,111 Total operating lease liabilities $ 1,622 $ 1,392 1 Operating lease ROU assets are recorded in the line item other assets in our consolidated balance sheet. 2 The current portion of operating lease liabilities is recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet. 3 The noncurrent portion of operating lease liabilities is recorded in the line item other liabilities in our consolidated balance sheet. We had operating lease costs of $ 353 million and $ 327 million for the years ended December 31, 2020 and 2019, respectively. During 2020 and 2019, cash paid for amounts included in the measurement of operating lease liabilities was $ 365 million and $ 339 million, respectively. Operating lease ROU assets obtained in exchange for operating lease obligations were $ 528 million and $ 308 million for the years ended December 31, 2020 and 2019, respectively. Information associated with the measurement of our remaining operating lease obligations as of December 31, 2020 is as follows: Weighted-average remaining lease term 9 years Weighted-average discount rate 3 % Our leases have remaining lease terms of 1 year to 44 years, inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturities of our operating lease liabilities as of December 31, 2020 (in millions): 2021 $ 340 2022 299 2023 252 2024 207 2025 170 Thereafter 565 Total operating lease payments 1,833 Less: Imputed interest 211 Total operating lease liabilities $ 1,622 NOTE 10: DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2020 and 2019, we had $ 1,329 million and $ 10,007 million, respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 1.3 percent and 2.0 percent per year as of December 31, 2020 and 2019, respectively. As of December 31, 2020 and 2019, the Company also had $ 854 million and $ 987 million, respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were primarily related to our international operations. In addition, we had $ 10,467 million in unused lines of credit and other short-term credit facilities as of December 31, 2020, of which $ 7,490 million was in backup lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2021 through 2025. There were no borrowings under these corporate backup lines of credit during 2020. These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2020, the Company issued U.S. dollar- and euro-denominated debt of $ 15,600 million and 2,600 million, respectively. The carrying value of this debt as of December 31, 2020 was $ 17,616 million. The general terms of the notes issued are as follows: $ 1,000 million total principal amount of notes due March 25, 2025, at a fixed interest rate of 2.950 percent; $ 1,000 million total principal amount of notes due March 25, 2027, at a fixed interest rate of 3.375 percent; $ 1,500 million total principal amount of notes due June 1, 2027, at a fixed interest rate of 1.450 percent; $ 1,300 million total principal amount of notes due March 15, 2028, at a fixed interest rate of 1.000 percent; 1,000 million total principal amount of notes due March 15, 2029, at a fixed interest rate of 0.125 percent; $ 1,250 million total principal amount of notes due March 25, 2030, at a fixed interest rate of 3.450 percent; $ 1,500 million total principal amount of notes due June 1, 2030, at a fixed interest rate of 1.650 percent; $ 1,300 million total principal amount of notes due March 15, 2031, at a fixed interest rate of 1.375 percent; 750 million total principal amount of notes due March 15, 2033, at a fixed interest rate of 0.375 percent; 850 million total principal amount of notes due March 15, 2040, at a fixed interest rate of 0.800 percent; $ 500 million total principal amount of notes due March 25, 2040, at a fixed interest rate of 4.125 percent; $ 1,000 million total principal amount of notes due June 1, 2040, at a fixed interest rate of 2.500 percent; $ 1,250 million total principal amount of notes due March 25, 2050, at a fixed interest rate of 4.200 percent; $ 1,500 million total principal amount of notes due June 1, 2050, at a fixed interest rate of 2.600 percent; $ 1,500 million total principal amount of notes due March 15, 2051, at a fixed interest rate of 2.500 percent; and $ 1,000 million total principal amount of notes due June 1, 2060, at a fixed interest rate of 2.750 percent. During 2020, the Company retired upon maturity Australian dollar- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.600 percent; $ 171 million total principal amount of zero coupon notes due June 20, 2020; $ 1,500 million total principal amount of notes due October 27, 2020, at a fixed interest rate of 1.875 percent; $ 1,250 million total principal amount of notes due November 1, 2020, at a fixed interest rate of 2.450 percent; and $ 1,000 million total principal amount of notes due November 15, 2020, at a fixed interest rate of 3.150 percent. During 2020, the Company also extinguished prior to maturity U.S. dollar- and euro-denominated debt of $ 3,815 million and 2,679 million, respectively, resulting in associated charges of $ 459 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 25 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. The general terms of the notes that were extinguished are as follows: 379 million total principal amount of notes due March 8, 2021, at a variable interest rate equal to the three-month Euro Interbank Offered Rate (""EURIBOR"") plus 0.200 percent; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.000 percent; $ 1,324 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 3.300 percent; $ 1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.550 percent; $ 500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.200 percent; 1,000 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 0.125 percent; 800 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 1.125 percent; $ 282 million total principal amount of notes due March 25, 2040, at a fixed interest rate of 4.125 percent; and $ 709 million total principal amount of notes due March 25, 2050, at a fixed interest rate of 4.200 percent. During 2019, the Company issued euro- and U.S. dollar-denominated debt of 3,500 million and $ 2,000 million, respectively. The carrying value of this debt as of December 31, 2019 was $ 5,891 million. The general terms of the notes issued are as follows: 750 million total principal amount of notes due March 8, 2021, at a variable interest rate equal to the three-month EURIBOR plus 0.200 percent; 1,000 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 0.125 percent; 1,000 million total principal amount of notes due September 22, 2026, at a fixed interest rate of 0.750 percent; 750 million total principal amount of notes due March 8, 2031, at a fixed interest rate of 1.250 percent; $ 1,000 million total principal amount of notes due September 6, 2024, at a fixed interest rate of 1.750 percent; and $ 1,000 million total principal amount of notes due September 6, 2029, at a fixed interest rate of 2.125 percent. During 2019, the Company retired upon maturity euro- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three-month EURIBOR plus 0.250 percent; 2,000 million total principal amount of notes due September 9, 2019, at a variable interest rate equal to the three-month EURIBOR plus 0.230 percent; and $ 1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent. During 2018, the Company retired upon maturity U.S. dollar-denominated notes and debentures. The general terms of the notes and debentures retired are as follows: $ 26 million total principal amount of debentures due January 29, 2018, at a fixed interest rate of 9.660 percent; $ 750 million total principal amount of notes due March 14, 2018, at a fixed interest rate of 1.650 percent; $ 1,250 million total principal amount of notes due April 1, 2018, at a fixed interest rate of 1.150 percent; and $ 1,250 million total principal amount of notes due November 1, 2018, at a fixed interest rate of 1.650 percent. The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $ 94 million that was due to mature on May 15, 2098, at a fixed interest rate of 7.000 percent. Related to this extinguishment, the Company recorded a net gain of $ 27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018. The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2020 December 31, 2019 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20232093 $ 22,550 2.0 % $ 14,621 2.4 % U.S. dollar debentures due 20222098 1,342 5.1 1,366 4.9 U.S. dollar zero coupon notes due 2020 2 168 8.4 Australian dollar notes due 20202024 400 2.5 677 2.4 Euro notes due 20212040 13,821 0.3 12,807 0.5 Swiss franc notes due 20222028 1,236 2.7 1,129 3.7 Other, due through 2098 3 615 5.2 548 6.2 Fair value adjustments 4 646 N/A 453 N/A Total 5,6 40,610 1.6 % 31,769 1.9 % Less: Current portion 485 4,253 Long-term debt $ 40,125 $ 27,516 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 As of December 31, 2019, the amount shown is net of an unamortized discount of $ 3 million. 3 As of December 31, 2020, the amount shown includes $ 473 million of debt instruments and finance leases that are due through 2031. 4 Amounts represent the changes in fair values due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 5 As of December 31, 2020 and 2019, the fair value of our long-term debt, including the current portion, was $ 43,218 million and $ 32,725 million, respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. Total interest paid was $ 935 million, $ 921 million and $ 903 million in 2020, 2019 and 2018, respectively. Maturities of long-term debt for the five years succeeding December 31, 2020 are as follows (in millions): Maturities of Long-Term Debt 2021 $ 485 2022 1,391 2023 4,272 2024 2,061 2025 2,753 NOTE 11: COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2020, we were contingently liable for guarantees of indebtedness owed by third parties of $ 431 million, of which $ 109 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings (excluding tax audit claims) will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an ownership interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities, such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $ 9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Company's transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arm's-length pricing of transactions between related parties such as the Company's U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arm's-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (""Closing Agreement""). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Company's income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987-1995 tax years. The IRS audited and confirmed the Company's compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years, in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $ 9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Company's matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS' designation of the Company's matter for litigation, the Company was forced either to accept the IRS' newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS' litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the U.S. Tax Court (""Tax Court"") in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS' potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued an opinion (""Opinion"") in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Company's case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Company's foreign licensees to increase the Company's U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by ASC 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors and we reviewed and considered relevant laws, rules, and regulations, including, though not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Company's tax positions, that it is more likely than not the Company's tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (""Tax Court Methodology""), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Company's tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020, related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Company's analysis. While the Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for the years at issue, and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology was ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2020 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 to 2020. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the Tax Reform Act. The Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $ 12 billion. Additional interest would continue to accrue until the time any such potential liability, or portion thereof, is paid. The Company currently projects that the impact of the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2020, would result in an incremental annual tax liability that would increase the Company's effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Company's Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the United States Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax period. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax period, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. Our self-insurance reserves totaled $ 265 million and $ 301 million as of December 31, 2020 and 2019, respectively . NOTE 12: STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued through the grant of equity awards to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2020, there were 345.3 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available for grants of stock option and restricted stock awards. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were granted a final restricted stock unit award that vests ratably over five years . Total stock-based compensation expense was $ 141 million, $ 201 million and $ 225 million in 2020, 2019 and 2018, respectively. In 2020, for certain employees who accepted voluntary separation from the Company as a result of our strategic realignment initiatives, the Company modified their outstanding equity awards granted prior to 2020 so that the employees retained all or some of their awards, whereas otherwise the awards would have been forfeited. The incremental stock-based compensation expense arising from the modifications was $ 15 million, which was recorded in the line item other operating charges in our consolidated statement of income. Refer to Note 18 for additional information on the Company's strategic realignment initiatives. The remainder of stock-based compensation expense in 2020 of $ 126 million as well as all stock-based compensation expense in 2019 and 2018 were included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to total stock-based compensation expense was $ 32 million, $ 43 million and $ 47 million in 2020, 2019 and 2018, respectively. As of December 31, 2020, we had $ 180 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Stock Option Awards Stock options are generally granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2020, 2019 and 2018 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, 2020 2019 2018 Fair value of stock options on grant date $ 6.44 $ 4.94 $ 4.97 Dividend yield 1 2.7 % 3.5 % 3.5 % Expected volatility 2 16.0 % 15.5 % 15.5 % Risk-free interest rate 3 1.4 % 2.6 % 2.8 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from treasury shares. Stock option activity during the year ended December 31, 2020 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2020 105 $ 38.43 Granted 7 59.38 Exercised ( 23 ) 35.67 Forfeited/expired ( 1 ) 53.82 Outstanding on December 31, 2020 88 $ 40.55 4.16 years $ 1,289 Expected to vest 87 $ 40.44 4.11 years $ 1,283 Exercisable on December 31, 2020 72 $ 38.43 3.29 years $ 1,188 The total intrinsic value of the stock options exercised was $ 453 million, $ 609 million and $ 721 million in 2020, 2019 and 2018, respectively. The total number of stock options exercised was 23 million, 34 million and 47 million in 2020, 2019 and 2018, respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share units granted from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are vested and released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018, 2019 and 2020, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include a TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018, 2019 and 2020 will be vested and released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends until the shares are vested and released. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case former employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2020, growth share units of approximately 1,872,000 , 1,983,000 and 1,788,000 were outstanding for the 2018-2020, 2019-2021 and 2020-2022 performance periods, respectively, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2020 6,831 $ 38.57 Granted 1,983 57.00 Conversions into restricted stock units 1 ( 2,662 ) 35.30 Paid in cash equivalent ( 5 ) 38.20 Canceled/forfeited ( 504 ) 46.36 Outstanding on December 31, 2020 2 5,643 $ 45.89 1 Represents the target amount of performance share units converted into restricted stock units for the 2017-2019 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding growth share units as of December 31, 2020 at the threshold award and maximum award levels were approximately 2,384,000 and 12,950,000 , respectively. The weighted-average grant date fair value of growth share units granted in 2020, 2019 and 2018 was $ 57.00 , $ 40.29 and $ 41.02 , respectively. The Company converted performance share units and growth share units of approximately 5,000 in 2020 and approximately 1,000 in 2019 into cash equivalent payments of $ 0.2 million and $ 0.1 million, respectively, to former employees or their beneficiaries due to certain circumstances such as death or disability. The Company did not convert any performance share units or growth share units into cash equivalent payments in 2018. The following table summarizes information about performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2020 3,195 $ 39.70 Conversions from performance share units 3,785 35.30 Vested and released ( 3,189 ) 39.72 Canceled/forfeited ( 63 ) 35.71 Nonvested on December 31, 2020 3,728 $ 35.30 The total intrinsic value of restricted shares that were vested and released was $ 191 million, $ 118 million and $ 305 million in 2020, 2019 and 2018, respectively. Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle recipients to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle recipients to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2020, the Company had outstanding nonvested time-based restricted stock and restricted stock units totaling approximately 4,162,000 , most of which do not have voting rights or pay dividends. The following table summarizes information about time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2020 4,054 $ 40.73 Granted 1,354 53.90 Vested and released ( 735 ) 41.52 Canceled/forfeited ( 511 ) 46.30 Nonvested on December 31, 2020 4,162 $ 44.18 NOTE 13: PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2020, the primary U.S. plan represented 61 percent and 59 percent of the Company's consolidated projected benefit obligation and pension plan assets, respectively. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2020 2019 Benefit obligation at beginning of year 1 $ 8,757 $ 8,015 $ 757 $ 719 Service cost 112 104 11 9 Interest cost 235 291 21 28 Participant contributions 1 1 12 20 Foreign currency exchange rate changes 67 ( 28 ) ( 1 ) ( 2 ) Amendments 3 ( 1 ) Net actuarial loss 2 746 931 22 71 Benefits paid ( 485 ) ( 537 ) ( 59 ) ( 86 ) Settlements 3 ( 81 ) ( 19 ) Curtailments 3 ( 15 ) ( 2 ) 6 ( 2 ) Special termination benefits 2 1 Other 72 1 Benefit obligation at end of year 1 $ 9,414 $ 8,757 $ 769 $ 757 Fair value of plan assets at beginning of year $ 8,080 $ 7,429 $ 339 $ 289 Actual return on plan assets 830 1,111 51 38 Employer contributions 30 36 Participant contributions 1 1 7 15 Foreign currency exchange rate changes 97 ( 26 ) Benefits paid ( 419 ) ( 453 ) ( 1 ) ( 3 ) Settlements 3 ( 53 ) ( 18 ) Other 73 Fair value of plan assets at end of year $ 8,639 $ 8,080 $ 396 $ 339 Net liability recognized $ ( 775 ) $ ( 677 ) $ ( 373 ) $ ( 418 ) 1 For pension plans, the benefit obligation is the projected benefit obligation. For other postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 9,263 million and $ 8,607 million as of December 31, 2020 and 2019, respectively. 2 A decrease in the weighted-average discount rate was the primary driver of net actuarial loss during 2020 and 2019. For our primary U.S. pension plan, a decrease in the discount rate resulted in actuarial loss of $ 491 million and $ 611 million during 2020 and 2019, respectively. Other drivers of net actuarial loss included assumption updates, plan experience, our strategic realignment initiatives and our productivity and reinvestment program. Refer to Note 18. 3 Settlements and curtailments were primarily related to our strategic realignment initiatives and our productivity and reinvestment program. Refer to Note 18. Pension and other postretirement benefit plan amounts recognized in our consolidated balance sheets were as follows (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Other assets $ 1,151 $ 998 $ $ Accounts payable and accrued expenses ( 116 ) ( 72 ) ( 19 ) ( 21 ) Other liabilities ( 1,810 ) ( 1,603 ) ( 354 ) ( 397 ) Net liability recognized $ ( 775 ) $ ( 677 ) $ ( 373 ) $ ( 418 ) Certain of our pension plans have a projected benefit obligation in excess of the fair value of plan assets. For these plans, the projected benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2020 2019 Projected benefit obligation $ 7,722 $ 7,194 Fair value of plan assets 5,796 5,515 Certain of our pension plans have an accumulated benefit obligation in excess of the fair value of plan assets. For these plans, the accumulated benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2020 2019 Accumulated benefit obligation $ 7,553 $ 7,052 Fair value of plan assets 5,745 5,485 All of our other postretirement benefit plans have an accumulated postretirement benefit obligation in excess of the fair value of plan assets. Pension Plan Assets The following table presents total assets by asset class for our U.S. and non-U.S. pension plans (in millions): U.S. Pension Plans Non-U.S. Pension Plans December 31, 2020 2019 2020 2019 Cash and cash equivalents $ 279 $ 364 $ 399 $ 377 Equity securities: U.S.-based companies 1,382 1,231 757 673 International-based companies 988 770 738 617 Fixed-income securities: Government bonds 220 263 417 273 Corporate bonds and debt securities 926 899 116 65 Mutual, pooled and commingled funds 1 301 279 513 619 Hedge funds/limited partnerships 588 652 34 37 Real estate 326 337 6 5 Derivative financial instruments ( 1 ) ( 14 ) Other 364 354 300 265 Total pension plan assets 2 $ 5,373 $ 5,149 $ 3,266 $ 2,931 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. pension plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2020, no investment manager was responsible for more than 9 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 4 percent of our total global equities and approximately 3 percent of total U.S. pension plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2020, the long-term target allocation for 69 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, was 64 percent equity securities, 4 percent fixed-income securities and 32 percent other investments. The actual allocation for the remaining 31 percent of the Company's international subsidiaries' pension plan assets consisted of 42 percent mutual, pooled and commingled funds; 21 percent fixed-income securities; 1 percent equity securities and 36 percent other investments. The investment strategies for our international subsidiaries' pension plans vary greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets by asset class for our other postretirement benefit plans (in millions): December 31, 2020 2019 Cash and cash equivalents $ 30 $ 57 Equity securities: U.S.-based companies 170 124 International-based companies 12 9 Fixed-income securities: Government bonds 3 3 Corporate bonds and debt securities 80 47 Mutual, pooled and commingled funds 86 84 Hedge funds/limited partnerships 7 7 Real estate 4 4 Other 4 4 Total other postretirement benefit plan assets 1 $ 396 $ 339 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2018 2020 2019 2018 Service cost $ 112 $ 104 $ 124 $ 11 $ 9 $ 11 Interest cost 235 291 296 21 28 25 Expected return on plan assets 1 ( 587 ) ( 552 ) ( 650 ) ( 16 ) ( 13 ) ( 13 ) Amortization of prior service cost (credit) 3 ( 4 ) ( 3 ) ( 3 ) ( 2 ) ( 14 ) Amortization of net actuarial loss 2 171 151 128 5 2 3 Net periodic benefit cost (income) ( 66 ) ( 10 ) ( 105 ) 18 24 12 Settlement charges 3 23 6 240 Curtailment charges (credits) 3 1 5 6 ( 2 ) ( 4 ) Special termination benefits 3 2 1 7 Other ( 4 ) 1 ( 1 ) Total cost (income) recognized in consolidated statements of income $ ( 44 ) $ ( 2 ) $ 147 $ 24 $ 22 $ 7 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to our strategic realignment initiatives, our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 18 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our pension and other postretirement benefit plans (in millions, pretax): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2020 2019 Balance in AOCI at beginning of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) Recognized prior service cost (credit) 3 ( 4 ) ( 3 ) ( 4 ) Recognized net actuarial loss 195 157 11 2 Prior service credit (cost) occurring during the year ( 3 ) 1 Net actuarial (loss) gain occurring during the year ( 488 ) ( 370 ) 7 ( 44 ) Net foreign currency translation adjustments ( 41 ) 20 ( 3 ) 2 Balance in AOCI at end of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) 1 Includes $ 23 million of recognized net actuarial loss due to the impact of settlements. 2 Includes $ 15 million of net actuarial loss occurring during the year due to the impact of curtailments . The following table sets forth the amounts in AOCI for our pension and other postretirement benefit plans (in millions, pretax): Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Prior service credit (cost) $ ( 10 ) $ ( 12 ) $ 17 $ 23 Net actuarial loss ( 3,002 ) ( 2,666 ) ( 64 ) ( 82 ) Balance in AOCI at end of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations for our pension and other postretirement benefit plans were as follows: Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Discount rate 2.50 % 3.25 % 2.75 % 3.50 % Interest crediting rate 3.00 % 3.50 % N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost (income) were as follows: Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2018 2020 2019 2018 Discount rate 3.25 % 4.00 % 3.50 % 3.50 % 4.25 % 3.50 % Interest crediting rate 3.50 % 3.75 % 3.25 % N/A N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 7.50 % 7.75 % 8.00 % 4.50 % 4.50 % 4.50 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2020 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate assumption on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The current cash balance interest crediting rate for the primary U.S. pension plan is the yield on six-month U.S. Treasury bills on the last day of September of the previous plan year, plus 150 basis points. The Company assumes that the current cash balance interest crediting rate will grow linearly over 10 years to the ultimate interest crediting rate assumption. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2020 net periodic pension cost for the U.S. pension plans was 7.50 percent. As of December 31, 2020, the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 10.2 percent, 8.4 percent and 6.9 percent, respectively. The annualized return since inception was 10.5 percent. The weighted-average assumptions for health care cost trend rates were as follows: December 31, 2020 2019 Health care cost trend rate assumed for next year 6.75 % 6.75 % Rate to which the trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.25 % Year that the trend rate reaches the ultimate trend rate 2025 2025 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of health care inflation because the plans have established dollar limits for determining our contributions. Cash Flows The estimated future benefit payments for our pension and other postretirement benefit plans are as follows (in millions): Year Ended December 31, 2021 2022 2023 2024 2025 20262030 Benefit payments for pension plans $ 657 1 $ 437 $ 472 $ 483 $ 491 $ 2,492 Benefit payments for other postretirement benefit plans 2 60 56 54 51 50 226 Total estimated benefit payments $ 717 $ 493 $ 526 $ 534 $ 541 $ 2,718 1 The estimated benefit payments in 2021 are higher due to our strategic realignment initiatives. Refer to Note 18. 2 The estimated benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $ 2 million for the period 20212025 and $ 2 million for the period 20262030. The Company anticipates making contributions to our pension trusts in 2021 of $ 25 million, all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or laws. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limits. The Company's expense for the U.S. plans totaled $ 43 million, $ 43 million and $ 39 million in 2020, 2019 and 2018, respectively. We also sponsor defined contribution plans in certain locations outside the United States. The Company's expense for these plans totaled $ 63 million, $ 64 million and $ 59 million in 2020, 2019 and 2018, respectively. Multi-Employer Retirement Plans The Company participates in various multi-employer retirement plans. Multi-employer retirement plans are designed to provide benefits to or on behalf of employees of multiple employers. These plans are typically established under collective bargaining agreements. Multi-employer retirement plans are generally governed by a board of trustees composed of representatives of both management and labor and are generally funded through employer contributions. The Company's expense for multi-employer retirement plans totaled $ 2 million, $ 5 million and $ 6 million in 2020, 2019 and 2018, respectively. The plans we currently participate in have contractual arrangements that extend into 2025. If, in the future, we choose to withdraw from any of the multi-employer retirement plans in which we currently participate, we would record the appropriate withdrawal liability, if any, at that time . NOTE 14: INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, 2020 2019 2018 United States $ 3,149 $ 3,249 $ 888 International 6,600 7,537 7,337 Total $ 9,749 $ 10,786 $ 8,225 Income taxes consisted of the following (in millions): United States State and Local International Total 2020 Current $ 296 $ 396 $ 1,307 $ 1,999 Deferred ( 220 ) 21 181 ( 18 ) 2019 Current $ 508 $ 94 $ 1,479 $ 2,081 Deferred ( 65 ) 52 ( 267 ) ( 280 ) 2018 Current $ 591 $ 145 $ 1,426 $ 2,162 Deferred ( 386 ) ( 81 ) 54 ( 413 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). We made income tax payments of $ 1,268 million, $ 2,126 million and $ 2,120 million in 2020, 2019 and 2018, respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 317 million, $ 335 million and $ 318 million for the years ended December 31, 2020, 2019 and 2018, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2020 2019 2018 Statutory U.S. federal tax rate 21.0 % 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 0.9 1.5 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 0.9 1.1 4,5,6 3.1 8,9 Equity income or loss ( 1.4 ) ( 1.6 ) ( 2.5 ) Tax Reform Act 0.1 10 Excess tax benefits on stock-based compensation ( 0.8 ) ( 0.9 ) ( 1.3 ) Other net ( 0.5 ) 2,3 ( 3.8 ) ( 0.6 ) Effective tax rate 20.3 % 16.7 % 21.3 % 1 Includes net tax charges of $ 110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes net tax expense of $ 431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $ 107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 3 Includes a tax benefit of $ 40 million (or a 2.4 percent impact on our effective tax rate) associated with the $ 902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2. 4 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 6 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 7 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 8 Includes the impact of pretax charges of $ 591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $ 554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. 9 Includes net tax expense of $ 28 million on net pretax charges of $ 403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. 10 Includes net tax expense of $ 8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits of approximately $ 41 billion. Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017, following enactment of the Tax Reform Act, we recorded a provisional $ 4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $ 0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $ 0.3 billion in tax for our one-time transition tax and a tax benefit of $ 0.3 billion, primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. As of December 31, 2020, we have not recorded incremental income taxes for any additional outside basis differences of approximately $ 5.7 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiary's earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007. With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years prior to 2006. For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for in accordance with the applicable accounting guidance. On November 18, 2020, the Tax Court issued the Opinion regarding the Company's 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11. As of December 31, 2020, the gross amount of unrecognized tax benefits was $ 915 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 588 million, exclusive of any benefits related to interest and penalties. The remaining $ 327 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2020 2019 2018 Balance of unrecognized tax benefits at beginning of year $ 392 $ 336 $ 331 Increase related to prior period tax positions 528 204 11 Decrease related to prior period tax positions ( 1 ) ( 2 ) Increase related to current period tax positions 26 29 17 Decrease related to settlements with taxing authorities ( 19 ) ( 174 ) ( 4 ) Increase (decrease) due to effect of foreign currency exchange rate changes ( 11 ) ( 3 ) ( 17 ) Balance of unrecognized tax benefits at end of year $ 915 $ 392 $ 336 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11. 2 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 391 million, $ 201 million and $ 190 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2020, 2019 and 2018, respectively. Of these amounts, $ 190 million, $ 11 million and $ 13 million of expense were recognized in income tax expense in 2020, 2019 and 2018, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, 2020 2019 Deferred tax assets: Property, plant and equipment $ 44 $ 53 Trademarks and other intangible assets 2,214 2,267 Equity method investments (including net foreign currency translation adjustments) 580 372 Derivative financial instruments 523 389 Other liabilities 1,401 1,066 Benefit plans 893 880 Net operating/capital loss carryforwards 320 259 Other 391 311 Gross deferred tax assets 6,366 5,597 Valuation allowances ( 406 ) ( 303 ) Total deferred tax assets $ 5,960 $ 5,294 Deferred tax liabilities: Property, plant and equipment $ ( 837 ) $ ( 877 ) Trademarks and other intangible assets ( 1,661 ) ( 1,533 ) Equity method investments (including net foreign currency translation adjustments) ( 1,533 ) ( 1,667 ) Derivative financial instruments ( 435 ) ( 348 ) Other liabilities ( 402 ) ( 351 ) Benefit plans ( 321 ) ( 286 ) Other ( 144 ) ( 104 ) Total deferred tax liabilities $ ( 5,333 ) $ ( 5,166 ) Net deferred tax assets $ 627 $ 128 As of December 31, 2020 and 2019, we had net deferred tax assets of $ 1.4 billion and $ 1.3 billion, respectively, located in countries outside the United States. As of December 31, 2020, we had $ 2,669 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 687 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, 2020 2019 2018 Balance at beginning of year $ 303 $ 419 $ 519 Additions 240 148 83 Deductions ( 137 ) ( 264 ) ( 183 ) Balance at end of year $ 406 $ 303 $ 419 The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions and basis differences in certain equity investments. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2020, the Company recognized a net increase of $ 103 million in its valuation allowances. The increase was primarily due to net increases in the deferred tax assets and related valuation allowances on certain equity investments. The increase was also due to the increase of valuation allowances after considering significant negative evidence on the utilization of certain net operating losses and excess foreign tax credits. In 2019, the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be nondeductible and the changes in net operating losses in the normal course of business. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. In 2018, the Company recognized a net decrease of $ 100 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. NOTE 15: OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, 2020 2019 Net foreign currency translation adjustments $ ( 12,028 ) $ ( 11,270 ) Accumulated net gains (losses) on derivatives ( 194 ) ( 209 ) Unrealized net gains (losses) on available-for-sale debt securities 28 75 Adjustments to pension and other postretirement benefit liabilities ( 2,407 ) ( 2,140 ) Accumulated other comprehensive income (loss) $ ( 14,601 ) $ ( 13,544 ) T he following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2020 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 7,747 $ 21 $ 7,768 Other comprehensive income: Net foreign currency translation adjustments ( 758 ) ( 153 ) ( 911 ) Net gains (losses) on derivatives 1 15 15 Net change in unrealized gains (losses) on available-for-sale debt securities 2 ( 47 ) ( 47 ) Net change in pension and other postretirement benefit liabilities 3 ( 267 ) ( 267 ) Total comprehensive income $ 6,690 $ ( 132 ) $ 6,558 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2020, 2019 and 2018 was as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount 2020 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 2,223 ) $ 150 $ ( 2,073 ) Reclassification adjustments recognized in net income 3 3 Gains (losses) on intra-entity transactions that are of a long-term investment nature 2,133 2,133 Gains (losses) on net investment hedges arising during the year 1 ( 1,094 ) 273 ( 821 ) Net foreign currency translation adjustments $ ( 1,181 ) $ 423 $ ( 758 ) Derivatives: Gains (losses) arising during the year $ ( 54 ) $ 13 $ ( 41 ) Reclassification adjustments recognized in net income 74 ( 18 ) 56 Net gains (losses) on derivatives 1 $ 20 $ ( 5 ) $ 15 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 64 ) $ 22 $ ( 42 ) Reclassification adjustments recognized in net income ( 7 ) 2 ( 5 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 71 ) $ 24 $ ( 47 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 560 ) $ 138 $ ( 422 ) Reclassification adjustments recognized in net income 206 ( 51 ) 155 Net change in pension and other postretirement benefit liabilities 3 $ ( 354 ) $ 87 $ ( 267 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,586 ) $ 529 $ ( 1,057 ) 2019 Foreign currency translation adjustments: Translation adjustments arising during the year $ 52 $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income 192 192 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 195 ( 49 ) 146 Net foreign currency translation adjustments $ 132 $ ( 103 ) $ 29 Derivatives: Gains (losses) arising during the year $ ( 225 ) $ 49 $ ( 176 ) Reclassification adjustments recognized in net income 163 ( 41 ) 122 Net gains (losses) on derivatives 1 $ ( 62 ) $ 8 $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ 47 $ ( 4 ) $ 43 Reclassification adjustments recognized in net income ( 31 ) 6 ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ 16 $ 2 $ 18 Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 379 ) $ 105 $ ( 274 ) Reclassification adjustments recognized in net income 151 ( 36 ) 115 Net change in pension and other postretirement benefit liabilities 3 $ ( 228 ) $ 69 $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) Before-Tax Amount Income Tax After-Tax Amount 2018 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,728 ) $ 59 $ ( 1,669 ) Reclassification adjustments recognized in net income 398 398 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,296 ) ( 1,296 ) Gains (losses) on net investment hedges arising during the year 1 639 ( 160 ) 479 Net foreign currency translation adjustments $ ( 1,987 ) $ ( 101 ) $ ( 2,088 ) Derivatives: Gains (losses) arising during the year $ 59 $ ( 16 ) $ 43 Reclassification adjustments recognized in net income ( 68 ) 18 ( 50 ) Net gains (losses) on derivatives 1 $ ( 9 ) $ 2 $ ( 7 ) Available-for-sale securities: Unrealized gains (losses) arising during the year $ ( 50 ) $ 11 $ ( 39 ) Reclassification adjustments recognized in net income 5 5 Net change in unrealized gains (losses) on available-for-sale securities 2 $ ( 45 ) $ 11 $ ( 34 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 299 ) $ 75 $ ( 224 ) Reclassification adjustments recognized in net income 341 ( 88 ) 253 Net change in pension and other postretirement benefit liabilities 3 $ 42 $ ( 13 ) $ 29 Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,999 ) $ ( 101 ) $ ( 2,100 ) 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2020 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ 3 Income before income taxes 3 Income taxes Consolidated net income $ 3 Derivatives: Foreign currency contracts Net operating revenues $ 73 Foreign currency and commodity contracts Cost of goods sold ( 9 ) Foreign currency contracts Other income (loss) net ( 60 ) Foreign currency and interest rate contracts Interest expense 70 Income before income taxes 74 Income taxes ( 18 ) Consolidated net income $ 56 Available-for-sale securities: Sale of securities Other income (loss) net $ ( 7 ) Income before income taxes ( 7 ) Income taxes 2 Consolidated net income $ ( 5 ) Pension and other postretirement benefit liabilities: Settlement charges 2 Other income (loss) net $ 23 Curtailment charges 2 Other income (loss) net 7 Recognized net actuarial loss Other income (loss) net 176 Recognized prior service cost (credit) Other income (loss) net Income before income taxes 206 Income taxes ( 51 ) Consolidated net income $ 155 1 Related to the sale of a portion of our ownership interest in one of our equity method investees. Refer to Note 2. 2 The settlement and curtailment charges were related to our strategic realignment initiatives. Refer to Note 13 and Note 18. NOTE 16: FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2020 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,049 $ 210 $ 12 $ 103 $ $ 2,374 Debt securities 1 4 2,267 32 2,303 Derivatives 2 63 835 ( 669 ) 229 Total assets $ 2,116 $ 3,312 $ 44 $ 103 $ ( 669 ) $ 4,906 Liabilities: Contingent consideration liability $ $ $ 321 5 $ $ $ 321 Derivatives 2 91 ( 81 ) 10 Total liabilities $ $ 91 $ 321 $ $ ( 81 ) $ 331 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 546 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 229 million in the line item other assets, $9 million in the line item accounts payable and accrued expenses and $ 1 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2019 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,877 $ 219 $ 14 $ 109 $ $ 2,219 Debt securities 1 3,291 37 3,328 Derivatives 2 9 579 ( 392 ) 196 Total assets $ 1,886 $ 4,089 $ 51 $ 109 $ ( 392 ) $ 5,743 Liabilities: Derivatives 2 $ $ 162 $ $ $ ( 130 ) $ 32 Total liabilities $ $ 162 $ $ $ ( 130 ) $ 32 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 The Company is obligated to return $ 261 million in cash collateral it has netted against its derivative position. 6 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 196 million in the line item other assets and $ 32 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2020 and 2019. The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2020 and 2019. Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, 2020 2019 Other-than-temporary impairment charges $ ( 290 ) $ ( 767 ) Impairment of intangible assets ( 215 ) ( 42 ) Impairment of equity investment without a readily determinable fair value ( 26 ) CCBA asset adjustments ( 160 ) Total $ ( 531 ) $ ( 969 ) 1 During the years ended December 31, 2020 and 2019, the Company recorded other-than-temporary impairment charges of $ 252 million and $ 406 million, respectively, related to CCBJHI, an equity method investee. Based on the length of time and the extent to which the market value of our investment in CCBJHI was less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. These impairment charges were determined using the quoted market prices (a Level 1 measurement) of CCBJHI. The Company also recorded other-than-temporary impairment charges of $ 38 million and $ 49 million, respectively, related to certain equity method investees in Latin America. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results. During the year ended December 31, 2019, the Company recognized other-than-temporary impairment charges of $ 255 million related to certain equity method investees in the Middle East. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results largely related to instability in the region and changes in local excise taxes. The Company also recognized an other-than-temporary impairment charge of $ 57 million related to one of our equity method investees in North America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 2 The Company recorded impairment charges of $ 160 million related to its Odwalla trademark in North America, as the Company decided in June 2020 to discontinue its Odwalla juice business. The Company also recorded an impairment charge of $ 55 million related to a trademark in North America, which was primarily driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Company's portfolio. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 3 The Company recorded an impairment charge of $ 26 million related to an investment in an equity security without a readily determinable fair value. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 4 The Company recorded an impairment charge of $ 42 million related to a trademark in Asia Pacific, which was primarily driven by revised projections of future operating results for the trademark. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 As a result of CCBA no longer being classified as held for sale, the Company was required to measure CCBA's property, plant and equipment and definite-lived intangible assets at the lower of their current fair values or their carrying amounts before they were classified as held for sale, adjusted for depreciation and amortization expense that would have been recognized had the business been classified as held and used during the period that CCBA was classified as held for sale. As a result, we reduced the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by $ 34 million and $ 126 million, respectively, based on Level 3 inputs. Refer to Note 2. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost as well as amounts recognized in our consolidated balance sheets. Refer to Note 13. The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2020 December 31, 2019 Level 1 Level 2 Level 3 Other Total Level 1 Level 2 Level 3 Other Total Cash and cash equivalents $ 558 $ 120 $ $ $ 678 $ 597 $ 144 $ $ $ 741 Equity securities: U.S.-based companies 2,123 12 4 2,139 1,876 7 21 1,904 International-based companies 1,694 32 1,726 1,354 33 1,387 Fixed-income securities: Government bonds 637 637 536 536 Corporate bonds and debt securities 1,011 31 1,042 924 40 964 Mutual, pooled and commingled funds 44 268 502 814 40 258 600 898 Hedge funds/limited partnerships 622 622 689 689 Real estate 332 332 342 342 Derivative financial instruments ( 15 ) ( 15 ) Other 302 362 664 273 3 346 619 Total $ 4,419 $ 2,065 $ 337 $ 1,818 $ 8,639 $ 3,867 $ 1,902 $ 334 $ 1,977 $ 8,080 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 This class of assets includes investments in credit contracts. 3 Includes purchased annuity insurance contracts. 4 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developing and emerging markets. There are no liquidity restrictions on these investments. 5 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semiannually, with a redemption notice period of up to one year and/or initial lock-up periods of up to three years, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 6 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semiannually, with a redemption notice period of up to 90 days. 7 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semiannual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Other Total 2019 Balance at beginning of year $ 17 $ 16 $ 270 $ 303 Actual return on plan assets 1 10 11 Purchases, sales, and settlements net 1 21 1 23 Transfers into Level 3 net 2 3 5 Net foreign currency translation adjustments ( 8 ) ( 8 ) Balance at end of year $ 21 $ 40 $ 273 $ 334 2020 Balance at beginning of year $ 21 $ 40 $ 273 $ 334 Actual return on plan assets 1 6 7 Purchases, sales, and settlements net ( 18 ) ( 17 ) 4 ( 31 ) Transfers into Level 3 net 1 7 8 Net foreign currency translation adjustments 19 19 Balance at end of year $ 4 $ 31 $ 302 $ 337 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2020 December 31, 2019 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ 29 $ 1 $ $ 30 $ 56 $ 1 $ $ 57 Equity securities: U.S.-based companies 169 1 170 124 124 International-based companies 12 12 9 9 Fixed-income securities: Government bonds 3 3 3 3 Corporate bonds and debt securities 80 80 47 47 Mutual, pooled and commingled funds 84 2 86 2 82 84 Hedge funds/limited partnerships 7 7 7 7 Real estate 4 4 4 4 Other 4 4 4 4 Total $ 210 $ 169 $ 17 $ 396 $ 189 $ 53 $ 97 $ 339 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2020, the carrying amount and fair value of our long-term debt, including the current portion, were $ 40,610 million and $ 43,218 million, respectively. As of December 31, 2019, the carrying amount and fair value of our long-term debt, including the current portion, were $ 31,769 million and $ 32,725 million, respectively. NOTE 17: SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2020, the Company recorded other operating charges of $ 853 million. These charges primarily consisted of $ 413 million related to the Company's strategic realignment initiatives and $ 99 million related to the Company's productivity and reinvestment program. In addition, other operating charges included impairment charges of $ 160 million related to the Odwalla trademark and net charges of $ 33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $ 55 million related to a trademark in North America. In addition, other operating charges included $ 51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and net charges of $ 16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 for additional information on the fairlife acquisition. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Company's strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. In 2019, the Company recorded other operating charges of $ 458 million. These charges included $ 264 million related to the Company's productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisition of Costa and the refranchising of our bottling operations. Refer to Note 16 for additional information on the trademark impairment charge. Refer to Note 18 for additional information on the Company's productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $ 1,079 million. These charges primarily consisted of $ 450 million of North America bottling operations' asset impairments and $ 440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $ 33 million related to tax litigation expense and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 11 for additional information related to the tax litigation. Refer to Note 18 for additional information on the Company's productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2020, the Company recorded charges of $ 484 million related to the extinguishment of certain long-term debt. Refer to Note 10. During the year ended December 31, 2018, the Company recorded a net gain of $ 27 million related to the extinguishment of certain long-term debt. Refer to Note 10. Equity Income (Loss) Net The Company recorded net charges of $ 216 million, $ 100 million and $ 111 million in equity income (loss) net during the years ended December 31, 2020, 2019 and 2018, respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2020, other income (loss) net was income of $ 841 million. The Company recognized a gain of $ 902 million in conjunction with the fairlife acquisition, a net gain of $ 148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a net gain of $ 18 million related to the sale of a portion of our ownership interest in one of our equity method investees and a gain of $ 17 million related to the sale of our ownership interest in an equity method investee in North America . These gains were partially offset by an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America, an impairment charge of $ 26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $ 55 million related to economic hedging activities. The Company also recorded net charges of $ 25 million related to the restructuring of our manufacturing operations in the United States and pension and other postretirement benefit plan settlement and curtailment charges of $ 14 million related to the Company's strategic realignment initiatives. Refer to Note 2 for additional information on the fairlife acquisition. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 5 for additional information on our economic hedging activities. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Company's strategic realignment initiatives. Refer to Note 19 for the impact these items had on our operating segments and Corporate. In 2019, other income (loss) net was income of $ 34 million. The Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recognized net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $ 4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Refer to Note 2 for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining ownership interest in CHI and the sale of a portion of our ownership interest in Andina. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 19 for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $ 1,674 million. The Company recorded other-than-temporary impairment charges of $ 591 million related to certain of our equity method investees, an impairment charge of $ 554 million related to assets held by CCBA and net charges of $ 476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $ 278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $ 240 million related to pension settlements, and a net loss of $ 79 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Additionally, we recorded charges of $ 34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements, a net loss of $ 33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $ 32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $ 296 million related to the sale of our equity ownership in Lindley and a net gain of $ 47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley, our acquisition of the controlling interest in the Philippine bottling operations and our acquisition of Costa. Refer to Note 5 for additional information on our hedging activities. Refer to Note 19 for the impact these items had on our operating segments and Corporate. NOTE 18: RESTRUCTURING Strategic Realignment In August 2020, the Company announced strategic steps to transform our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace. The Company is building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We are creating new operating units effective January 1, 2021, which will be focused on regional and local execution. The operating units, which will sit under the four existing geographic segments, will be highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units will work closely with five global marketing category leadership teams to rapidly scale ideas. The global marketing category leadership teams will primarily focus on innovation, marketing efficiency and effectiveness. The organizational structure will also include our existing center that will provide strategy, governance and scale for global initiatives. The operating units, global marketing category leadership teams and the center will be supported by a platform services organization, which will focus on providing efficient and scaled global services and capabilities including, but not limited to, governance, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. The expenses related to these strategic realignment initiatives were recorded in the line items other operating charges and other income (loss) net in our consolidated statement of income. Refer to Note 19 for the impact these expenses had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal and consulting activities. The Company currently expects the total cost of the strategic realignment initiatives will be up to $ 550 million. We expect the new networked organization to be established and functioning at the beginning of 2021, and the platform services activities will be integrated, standardized and scaled over the course of 2021. The following table summarizes the balance of accrued expenses related to these strategic realignment initiatives (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2020 Costs incurred $ 386 $ 37 $ 4 $ 427 Payments ( 170 ) ( 36 ) ( 1 ) ( 207 ) Noncash and exchange ( 35 ) ( 35 ) Accrued balance at end of year $ 181 $ 1 $ 3 $ 185 1 Includes stock-based compensation modification and other postretirement benefit plan curtailment charges. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focused on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units are supported by an enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The enabling services organization focuses on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Certain productivity initiatives included in the April 2017 expansion, primarily related to our enabling services organization, will continue beyond 2020. The Company has incurred total pretax expenses of $ 3,929 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2018 Accrued balance at beginning of year $ 190 $ 1 $ 15 $ 206 Costs incurred 164 92 252 508 Payments ( 209 ) ( 83 ) ( 211 ) ( 503 ) Noncash and exchange ( 69 ) ( 52 ) ( 121 ) Accrued balance at end of year $ 76 $ 10 $ 4 $ 90 2019 Accrued balance at beginning of year $ 76 $ 10 $ 4 $ 90 Costs incurred 36 87 141 264 Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 3 2 ( 19 ) ( 14 ) Accrued balance at end of year $ 58 $ 1 $ 7 $ 66 2020 Accrued balance at beginning of year $ 58 $ 1 $ 7 $ 66 Costs incurred ( 12 ) 69 42 99 Payments ( 29 ) ( 70 ) ( 36 ) ( 135 ) Noncash and exchange ( 2 ) ( 11 ) ( 13 ) Accrued balance at end of year $ 15 $ $ 2 $ 17 1 Includes pension settlement charges. Refer to Note 13. NOTE 19: OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investees. Our consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 2018 Concentrate operations 56 % 55 % 58 % Finished product operations 44 45 42 Total 100 % 100 % 100 % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2020 2019 2018 United States $ 11,281 $ 11,715 $ 11,344 International 21,733 25,551 22,956 Net operating revenues $ 33,014 $ 37,266 $ 34,300 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2020 2019 2018 United States $ 3,988 $ 4,062 $ 4,154 International 6,789 6,776 5,444 Property, plant and equipment net $ 10,777 $ 10,838 $ 9,598 Information about our Company's operations by operating segment and Corporate as of and for the years ended December 31, 2020, 2019 and 2018 is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated 2020 Net operating revenues: Third party $ 5,534 $ 3,499 $ 11,473 $ 4,213 $ 1,991 $ 6,258 $ 46 $ $ 33,014 Intersegment 523 4 509 7 ( 1,043 ) Total net operating revenues 6,057 3,499 11,477 4,722 1,991 6,265 46 ( 1,043 ) 33,014 Operating income (loss) 3,313 2,116 2,471 2,133 ( 123 ) 308 ( 1,221 ) 8,997 Interest income 64 11 295 370 Interest expense 1,437 1,437 Depreciation and amortization 86 45 439 47 122 551 246 1,536 Equity income (loss) net 31 ( 72 ) 8 ( 9 ) 779 241 978 Income (loss) before income taxes 3,379 2,001 2,500 2,158 ( 120 ) 898 ( 1,067 ) 9,749 Identifiable operating assets 8,098 1,597 19,444 2,073 3 7,575 10,521 2,3 17,903 67,211 Investments 1 517 603 345 240 4 14,183 4,193 20,085 Capital expenditures 27 6 182 20 261 474 207 1,177 2019 Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ 94 $ $ 37,266 Intersegment 624 9 604 2 9 ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 94 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 334 358 ( 1,408 ) 10,086 Interest income 65 12 486 563 Interest expense 946 946 Depreciation and amortization 86 35 439 31 117 446 211 1,365 Equity income (loss) net 35 ( 32 ) ( 6 ) 11 ( 3 ) 836 208 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 343 716 ( 824 ) 10,786 Identifiable operating assets 8,143 1,801 17,687 2,060 7,265 11,170 18,376 66,502 Investments 1 543 716 358 224 14 14,093 3,931 19,879 Capital expenditures 108 140 392 47 209 836 322 2,054 2018 Net operating revenues: Third party $ 6,535 $ 3,971 $ 11,370 $ 4,797 $ 767 $ 6,768 $ 92 $ $ 34,300 Intersegment 564 39 260 388 3 19 ( 1,273 ) Total net operating revenues 7,099 4,010 11,630 5,185 770 6,787 92 ( 1,273 ) 34,300 Operating income (loss) 3,693 2,318 2,318 2,271 152 ( 197 ) ( 1,403 ) 9,152 Interest income 57 13 619 689 Interest expense 950 950 Depreciation and amortization 77 30 422 58 8 239 252 1,086 Equity income (loss) net 2 ( 19 ) ( 2 ) 12 828 187 1,008 Income (loss) before income taxes 3,386 2,243 2,345 2,298 165 ( 159 ) ( 2,053 ) 8,225 Capital expenditures 66 90 429 31 11 517 404 1,548 1 Principally equity method investments and other investments in bottling companies. 2 Property, plant and equipment net in South Africa represented 15 percent and 16 percent of consolidated property, plant and equipment net in 2020 and 2019, respectively. 3 Property, plant and equipment net in the Philippines represented 10 percent of consolidated property, plant and equipment net in 2020. During 2020, 2019 and 2018, our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2020, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes for North America were reduced by $ 160 million related to the impairment of the Odwalla trademark and $ 33 million related to the cost of discontinuing the Odwalla juice business. Operating income (loss) and income (loss) before income taxes were reduced by $ 145 million and $ 153 million, respectively, for Corporate, $ 31 million and $ 30 million, respectively, for Asia Pacific, $ 21 million and $ 26 million, respectively, for Bottling Investments and $ 19 million and $ 21 million, respectively, for Latin America due to the Company's strategic realignment initiatives. Additionally, operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for North America, $ 78 million for Europe, Middle East and Africa and $ 4 million for Global Ventures due to the Company's strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 104 million for Corporate due to the Company's productivity and reinvestment program. Operating income (loss) and income (loss) before income taxes were increased by $ 5 million for Europe, Middle East and Africa due to the refinement of previously established accruals related to the Company's productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 59 million and $ 84 million, respectively, for North America related to the restructuring of our manufacturing operations in the United States. Operating income (loss) and income (loss) before income taxes were reduced by $ 55 million for North America related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 51 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Income (loss) before income taxes was increased by $ 902 million for Corporate in conjunction with our fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 148 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 18 million for Corporate related to the sale of a portion of our ownership interest in one of our equity method investees. Income (loss) before income taxes was increased by $ 17 million for Corporate related to the sale of our ownership interest in one of our equity method investees. Income (loss) before income taxes was reduced by $ 484 million for Corporate related to charges associated with the extinguishment of certain long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 252 million for Bottling Investments and $ 38 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 145 million for Bottling Investments, $ 70 million for Latin America and $ 1 million for North America due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 26 million for Corporate due to an impairment charge associated with an investment in an equity security without a readily determinable fair value. Refer to Note 16. In 2019, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Refer to Note 16. Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2. Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our ownership interest in Andina. Refer to Note 2. Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2. Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Refer to Note 2. Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2. Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2018, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 4 million for Latin America, $ 175 million for North America, $ 31 million for Bottling Investments and $ 237 million for Corporate, and were increased by $ 3 million for Europe, Middle East and Africa and $ 4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) before income taxes was reduced by $ 64 million for Corporate and $ 4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 13 and Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 450 million for Bottling Investments due to asset impairment charges. Operating income (loss) and income (loss) before income taxes were reduced by $ 139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 33 million for Corporate due to tax litigation expense. Refer to Note 11. Operating income (loss) and income (loss) before income taxes were reduced by $ 19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) before income taxes was increased by $ 296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2. Income (loss) before income taxes was increased by $ 47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2. Income (loss) before income taxes was increased by $ 27 million for Corporate related to a net gain on the extinguishment of certain long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 554 million for Corporate as a result of an impairment charge related to assets held by CCBA. Refer to Note 2. Income (loss) before income taxes was reduced by $ 476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2. Income (loss) before income taxes was reduced by $ 334 million for Europe, Middle East and Africa, $ 205 million for Bottling Investments and $ 52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Income (loss) before income taxes was reduced by $ 278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was reduced by $ 124 million for Bottling Investments and was increased by $ 13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 149 million for Bottling Investments due to pension settlements related to the refranchising of certain of our North America bottling operations. Refer to Note 13. Income (loss) before income taxes was reduced by $ 79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Income (loss) before income taxes was reduced by $ 34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Refer to Note 2. Income (loss) before income taxes was reduced by $ 33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) before income taxes was reduced by $ 32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2. NOTE 20: NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities was composed of the following (in millions): Year Ended December 31, 2020 2019 2018 (Increase) decrease in trade accounts receivable 1 $ 882 $ ( 158 ) $ 27 (Increase) decrease in inventories 99 ( 183 ) ( 203 ) (Increase) decrease in prepaid expenses and other assets 78 ( 87 ) ( 221 ) Increase (decrease) in accounts payable and accrued expenses 2 ( 860 ) 1,318 ( 251 ) Increase (decrease) in accrued income taxes ( 16 ) 96 ( 17 ) Increase (decrease) in other liabilities 3 507 ( 620 ) ( 575 ) Net change in operating assets and liabilities $ 690 $ 366 $ ( 1,240 ) 1 The decrease in trade accounts receivable in 2020 was primarily due to the impacts of the COVID-19 pandemic and the start of a trade accounts receivable factoring program. Refer to Note 1 for additional information on the factoring program. 2 The decrease in accounts payable and accrued expenses in 2020 was primarily driven by the impacts of the COVID-19 pandemic and incentive payments related to prior year exceeding current year incentive accruals. The increase in accounts payable and accrued expenses in 2019 was primarily due to extending payment terms with our suppliers. 3 The increase in other liabilities in 2020 was primarily due to the increase in tax reserves related to IRS litigation. Refer to Note 11. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this report is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2021 Proxy Statement. James R. Quincey Kathy Loveless Chairman of the Board of Directors and Chief Executive Officer February 25, 2021 Vice President and Controller February 25, 2021 John Murphy Mark Randazza Executive Vice President and Chief Financial Officer February 25, 2021 Vice President, Assistant Controller and Chief Accounting Officer February 25, 2021 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 25, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 11 and Note 14 to the consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2020, the gross amount of unrecognized tax benefits was $915 million. As described in Note 11, on September 17, 2015 the Company received a Statutory Notice of Deficiency from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period, plus interest. On November 18, 2020, the U.S. Tax Court issued an opinion predominantly siding with the IRS related to the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates for tax years 2007 through 2009. While the Company continues to disagree with the IRS positions and the portions of the opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS could ultimately be upheld. As a result of the application of ASC 740, Accounting for Income Taxes, the Company recorded a tax reserve of $438 million for this matter for the year ended December 31, 2020. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS notice and opinion, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. How We Addressed the Matter in Our Audit Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of managements assessment of the opinion, including inquiries of tax counsel, inspection of technical memos, and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 11 and Note 14. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 of the Companys consolidated financial statements, the Company performs an annual impairment assessment of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment assessment may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $10.4 billion and $17.5 billion, respectively, at December 31, 2020. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, royalty rates, cost of raw materials, inflation, cost of capital, marketing spending, foreign currency exchange rates, and tax rates, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment assessments for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative assessment and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment assessments of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment assessments included in Note 1. /s/ Ernst Young LLP We have served as the Company's auditor since 1921. Atlanta, Georgia February 25, 2021 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 25, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 25, 2021 "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2020. Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2020 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +41,Coca-Cola,2019," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to execute our growth strategy centered around disciplined portfolio growth; an aligned and engaged bottling system; and winning with our stakeholders all supported by revenue growth management and brand-building initiatives to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For additional information about our operating segments and Corporate, refer to Note 21 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes minerals and other powders for purified water products; ""syrups"" means an intermediate product in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We own and market numerous valuable nonalcoholic beverage brands, including the following: sparkling soft drinks : Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, * Sprite, Thums Up; water, enhanced water and sports drinks : Aquarius, Ciel, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade, Topo Chico; juice, dairy and plant-based beverages : AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy, Simply, ZICO; and tea and coffee : Ayataka, Costa, doadan, FUZE TEA, Georgia, Gold Peak, HONEST TEA, Kochakaden. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of 2.0 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 30.3 billion , 29.6 billion and 29.2 billion unit cases of our products in 2019 , 2018 and 2017 , respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for each of 2019 , 2018 and 2017 . Trademark Coca-Cola accounted for 45 percent of our worldwide unit case volume for each of 2019 , 2018 and 2017 . In 2019 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2019 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2019 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2019 , these five bottling partners combined represented 40 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. In all instances, the bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers, which were granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) in connection with the refranchising of bottler territories that had previously been managed by Coca-Cola Refreshments (""CCR"") (we refer to these bottlers as ""expanding participating bottlers"" or ""EPBs""), operate under CBAs (to which we refer as ""EPB CBAs"") under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights (to which we refer as ""participating bottlers"" or ""PBs"") converted their legacy bottler's agreements to CBAs, to which we refer as ""PB CBAs,"" each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 4.4 billion in 2019 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc., is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, The Kraft Heinz Company, Suntory Beverage Food Limited and Unilever. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands; new industry entrants; and dramatic shifts in consumer shopping patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Our supply chain for non-nutritive sweeteners and certain other ingredients for our products includes suppliers in China. As a result of the outbreak of the novel coronavirus COVID-19, beginning in January 2020, our suppliers in China have experienced some delays in the production and export of these ingredients. We have initiated contingency supply plans and do not foresee a short-term impact due to these delays. However, we may see tighter supplies of some of these ingredients in the longer term should production or export operations in China deteriorate. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (""GDPR""), which became effective in May 2018, and the California Consumer Privacy Act of 2018 (""CCPA""), which became effective on January 1, 2020. The interpretation and application of data privacy and data protection laws and regulations are often uncertain and are evolving in the United States and internationally. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Employees As of December 31, 2019 and 2018 , our Company had approximately 86,200 and 62,600 employees, respectively, of which approximately 10,100 and 11,400 , respectively, were located in the United States. The increase in the total number of employees was primarily due to the acquisition of Costa Limited (""Costa""). Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2019 , approximately 1,100 employees in North America were covered by collective bargaining agreements. These agreements have terms of three years to five years . We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. The Company believes that its relations with its employees are generally satisfactory. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the ""Investors"" page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the ""Investors"" page of our website and review information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and potential delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained by, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; dramatic shifts in consumer shopping patterns as a result of the rapidly evolving digital landscape; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. Competitive pressures may cause us and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use in the manufacture of our beverage products a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees and former employees but also some consumers. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. In the European Union (""EU""), the GDPR, which became effective on May 25, 2018 for all EU member states, includes operational requirements for companies receiving or processing personal data of EU residents and provides for significant penalties for noncompliance. In the United States, the CCPA, which became effective on January 1, 2020, provides for a private right of action for data breaches and requires companies that process information about California residents to make disclosures to consumers about their data collection, use and sharing practices and to allow consumers to opt out of certain data sharing with third parties. The changes introduced by the GDPR and the CCPA, as well as any other changes to existing personal data protection or privacy laws and the introduction of such laws in other jurisdictions, have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and security systems, policies, procedures and practices. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data. Improper disclosure of personal data in violation of the GDPR, the CCPA and/or of other personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to government enforcement actions (including fines), or result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial performance will be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2019 , we used 70 functional currencies in addition to the U.S. dollar and derived $25.6 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2019 and 2018, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies may be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. In addition, in July 2017, the United Kingdom's Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (""LIBOR""), announced that it will no longer compel or persuade financial institutions and panel banks to submit rates for the calculation of LIBOR after 2021. This decision is expected to result in the discontinuance of the use of LIBOR as a reference rate for commercial loans and other indebtedness. Although the impact of the possible discontinuance of LIBOR publication and transition to alternative reference rates remains unclear, it is possible that these changes may have an adverse impact on our financing costs. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottling partners' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. If this income tax dispute were to be ultimately determined adversely to us, any additional taxes, interest and potential penalties in the litigated or subsequent years could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act""). For additional information regarding this income tax dispute, refer to Note 13 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. Consequently, we continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Company's and the Coca-Cola system's ability to attract, develop, retain and motivate a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Company purpose and work that matters most. We may not be able to successfully compete for, attract and/or retain the high-quality and diverse employee talent we want and our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, which may be caused by increasing demand, by events such as natural disasters, power outages and the like, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners' relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs that may be caused by the United Kingdom's withdrawal from the European Union, commonly referred to as ""Brexit""; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the recent outbreak of the novel coronavirus COVID-19), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Increasing concerns about the environmental impact of plastic bottles and other plastic packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the proliferation and accumulation of plastic bottles and other packaging materials in the environment, particularly in the world's waterways, lakes and oceans. We and our bottling partners sell certain of our beverage products in plastic bottles and use other plastic packaging materials that are not biodegradable and, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's impact on the environment by increasing our use of recycled plastic and other packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted or are considering adopting regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase of recycling rates or, in some cases, restricting or even prohibiting the use of plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our beverage products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship or even prohibitions on certain types of plastic products, packages and cups have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2019 , our net operating revenues in the United States were $11.7 billion , or 31 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2019 , our operations outside the United States accounted for $25.6 billion , or 69 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties related to Brexit implementation, and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's carbon footprint by increasing our use of recycled packaging materials and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industry-wide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, bottler franchise rights, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021 . If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our product quality and safety programs and controls may not be sufficiently robust to effectively cope with the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing the various supply chain models as we expand our product offerings and seek to manage acquired businesses in a more independent, less integrated manner. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations, businesses or brands. If we incur unforeseen liabilities, obligations and costs in connection with acquiring or integrating bottling operations or other businesses, experience internal control or product quality failures or are unable to achieve our strategic and financial objectives for Company-owned or -controlled bottling operations and other acquired businesses or brands, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise Company-owned or -controlled bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases such as the recent outbreak of the novel coronavirus COVID-19. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our retail stores which are primarily included in the Global Ventures operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2019 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Warehouses Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures 1,718 Bottling Investments Corporate Total 1,730 Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in ""U.S. Federal Income Tax Dispute"" below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (the ""Notice"") from the IRS for the tax years 2007 through 2009 after a five-year audit. In the Notice, the IRS claimed that the Company's U.S. taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in certain foreign markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement (the ""Closing Agreement"") that applied back to 1987. The Closing Agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent a change in material facts or circumstances or relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the Closing Agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the Closing Agreement. The IRS designated the matter for litigation on October 15, 2015. Due to the fact that the matter remains designated, the Company is prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million , resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in April 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's opinion. In the interim, or subsequent to the court's opinion, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. Environmental Matter In April 2019, the Company received a Finding and Notice of Violation (""NOV"") from the United States Environmental Protection Agency (""EPA"") alleging that the Company violated the California Truck and Bus Regulation and the California Drayage Truck Regulation by failing to verify compliance with such regulations by certain diesel-fueled vehicles owned by third parties that the Company caused to be operated in California. The Company reached a settlement with the EPA regarding this matter under which it paid a civil penalty of $145,000. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 19, 2020 , there were 200,770 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 22, 2020 (""Company's 2020 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the year ended December 31, 2019 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2019 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 September 28, 2019 through October 25, 2019 955,091 $ 54.22 945,000 167,390,321 October 26, 2019 through November 22, 2019 3,769,586 52.92 3,770,300 163,620,021 November 23, 2019 through December 31, 2019 4,131,840 54.16 2,590,354 161,029,667 Total 8,856,517 $ 53.64 7,305,654 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (""2019 Plan"") for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2015 2017 2019 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 113 139 140 SP 500 Index 101 138 174 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2014. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, The Kraft Heinz Company, Keurig Dr Pepper Inc., Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2019, the Dow Jones Food Beverage Index and the Peer Group Index included Beyond Meat, Inc. and The Boston Beer Company, Inc., which were not included in the indices in 2018. Additionally, in 2019, these indices do not include BG Foods, Inc., which was included in the indices in 2018. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our platform for sustained performance; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our independent network of bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 42 Total % % % The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 18 Total % % % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Platform for Sustained Performance We have established a platform for sustained performance centered around disciplined portfolio growth; an aligned and engaged bottling system; and winning with our stakeholders all supported by revenue growth management and brand-building initiatives. Disciplined Portfolio Growth Continuous innovation to offer consumers more personalized product solutions that match their tastes and lifestyles Leveraging the Coca-Cola system to lift, shift and scale leading brands and winning concepts quickly and efficiently around the world Utilizing mergers and acquisitions opportunities that strike the right balance between strategic rationale, financial returns and risk profile as an enabler to further our growth strategy An Aligned and Engaged Bottling System Strategically aligned bottling partners with a sharper focus on value growth rather than volume growth Gaining efficiencies through scale and improved supply chains Strong marketplace execution across the bottling system A winning culture Winning with Our Stakeholders Succeeding as a company by empowering our employees, satisfying consumers with a wide variety of beverage options, and providing solutions to grow our customers' beverage businesses Making a positive difference in the communities where we operate Helping to create value for all of our stakeholders for a better shared future Underpinning our platform for sustained performance are three enablers: digitizing the enterprise; fostering a growth culture; and growing sustainably. Digitizing the Enterprise The digital evolution is changing consumers' behaviors, influencing the way consumers think, interact and ultimately how they shop. We believe this evolution impacts every aspect of the Coca-Cola system and creates an opportunity to partner in different ways with our customers and re-engineer our supply chain and route-to-market. Fostering a Growth Culture We believe that sustainable and profitable growth is the product of a strong culture, with a focus on our employees, customers and consumers worldwide. As we move our business into the future, we will continue to drive a growth culture centered around curiosity, empowerment, inclusion and agility. Our belief is that focusing on these behaviors will enhance our associates' work performance and help us become a more growth-minded company. Growing Sustainably We are focused on giving people the drinks they want while trying to improve the world we all share, turning our passion for consumers into brands people love and creating shared opportunities through growth. We act in ways which we believe will create a more sustainable and better shared future for all of our stakeholders. We attempt to make a positive difference in peoples' lives, communities and our planet by doing business the right way. Core Capabilities To support our platform for sustained performance, we must continue to enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net operating revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to create enhanced value for themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,700 beverage products (including more than 1,600 low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to our planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part will help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. Coronavirus Impact Beginning in January 2020, concerns related to the spread of the novel coronavirus COVID-19 have caused a disruption to our business, primarily in China. While we currently expect this business disruption to be temporary, there is uncertainty around its duration and its broader impact, and therefore the effects it will have on our business. However, based on our current expectations, we believe this disruption will negatively impact our unit case volume and financial results for the first quarter of 2020. At this time, we do not expect this disruption to have a significant impact on our full year 2020 unit case volume or financial results. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 13 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charge may be impacted by items such as basis differences, deferred taxes and deferred gains. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our net periodic pension cost and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. In 2019 , the Company's total income related to defined benefit pension plans was $2 million , which included $10 million of net periodic benefit income and $8 million of settlement charges and special termination benefit costs. In 2020, we expect our net periodic benefit income related to defined benefit pension plans to be approximately $69 million. We currently do not expect to incur any settlement charges or special termination benefit costs in 2020. The increase in 2020 expected net periodic benefit income is primarily due to favorable asset performance in 2019 and a reduction in the number of plan participants in the primary U.S. pension plan, partially offset by a decrease in the weighted-average discount rate at December 31, 2019 compared to December 31, 2018 . The estimated impact of a 50 basis-point decrease in the discount rate would result in a $19 million decrease in our 2020 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $25 million decrease in our 2020 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2019 , the Company's primary U.S. pension plan represented 61 percent of both the Company's consolidated projected benefit obligation and plan assets. Refer to Note 15 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Refer to Note 3 of Notes to Consolidated Financial Statements. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. Refer to Note 3 of Notes to Consolidated Financial Statements. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 16 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 13 of Notes to Consolidated Financial Statements. Tax law requires certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 16 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 21 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. When we analyze our net operating revenues we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading ""Net Operating Revenues"" below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party or independent customer regardless of our ownership interest in the bottling partner. We generally refer to acquisitions and divestitures of bottling partners as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, with the exception of Costa non-ready-to-drink products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to these brands is incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to the brand is incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2019, the Company acquired Costa and the remaining equity interest in C.H.I. Limited (""CHI""). The impact of these acquisitions has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the Global Ventures and Europe, Middle East and Africa operating segments. Other acquisitions by the Company included controlling interests in bottling operations in Zambia, Kenya and Eswatini. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2019, the Company refranchised certain of its bottling operations in India. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. In 2018, the Company acquired a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. The Company also acquired a controlling interest in the franchise bottler in Oman. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Other acquisitions by the Company included controlling interests in bottling operations in Zambia and Botswana. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2018, the Company refranchised our Canadian and Latin American bottling operations. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America, Latin America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the Canadian refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the base year when calculating 2018 versus 2017 volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. Refer to the headings ""Beverage Volume"" and ""Net Operating Revenues"" below. In 2017, Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") was transitioned to the Company, resulting in CCBA's consolidation. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa and Bottling Investments operating segments. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. With the exception of ready-to-drink products, the Company does not report unit case volume or concentrate sales volume for Costa, a component of the Global Ventures operating segment. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2019 versus 2018 2018 versus 2017 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % 4 % % Europe, Middle East Africa % % % % 8 Latin America North America (1 ) 5 (2 ) 9 Asia Pacific 6 10 Global Ventures Bottling Investments 3 N/A (15 ) 7 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2019 grew 6 percent. 4 After considering the impact of acquisitions and divestitures, worldwide concentrate sales volume for the year ended December 31, 2019 grew 1 percent. 5 After considering the impact of acquisitions and divestitures, concentrate sales volume for North America for the year ended December 31, 2019 was even. 6 After considering the impact of acquisitions and divestitures, concentrate sales volume for Asia Pacific for the year ended December 31, 2019 grew 5 percent. 7 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2018 grew 12 percent. 8 After considering the impact of acquisitions and divestitures, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2018 grew 4 percent. 9 After considering the impact of acquisitions and divestitures, concentrate sales volume for North America for the year ended December 31, 2018 was even. 10 After considering the impact of acquisitions and divestitures, concentrate sales volume for Asia Pacific for the year ended December 31, 2018 grew 5 percent. Unit Case Volume The Coca-Cola system sold 30.3 billion , 29.6 billion and 29.2 billion unit cases of our products in 2019 , 2018 and 2017 , respectively. The unit case volume for 2019 , 2018 and 2017 reflects the impact of brands acquired or licensed during the applicable year. The unit case volume for 2019 , 2018 and 2017 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2019 versus 2018 and 2018 versus 2017 unit case volume growth rates. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for 2019 , 2018 and 2017 . Trademark CocaCola accounted for 45 percent of our worldwide unit case volume for 2019 , 2018 and 2017 . In 2019 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2019 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks, 3 percent in water, enhanced water and sports drinks and 3 percent in tea and coffee. Growth in sparkling soft drinks was primarily driven by 4 percent growth in Trademark Coca-Cola. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; South East Africa; West Africa; and Western Europe business units. The unit case volume in the Middle East North Africa business unit was even. In Latin America, unit case volume grew 1 percent, which included growth of 5 percent in water, enhanced water and sports drinks and 6 percent in tea and coffee, with even performance in sparkling soft drinks, partially offset by a 1 percent decline in juice, dairy and plant-based beverages. Trademark Coca-Cola grew 1 percent. The group's volume reflected growth of 5 percent in both the Brazil and Latin Center business units and 1 percent in the Mexico business unit, partially offset by a 5 percent decline in the South Latin business unit. Unit case volume in North America was even, with even performance in both sparkling soft drinks and juice, dairy and plant-based beverages. Unit case volume in water, enhanced water and sports drinks grew 1 percent, driven by 7 percent growth in sports drinks. Growth in this category cluster was offset by a 1 percent decline in tea and coffee. In Asia Pacific, unit case volume grew 5 percent, reflecting 8 percent growth in sparkling soft drinks, 1 percent growth in water, enhanced water and sports drinks, and 2 percent growth in both juice, dairy and plant-based beverages and tea and coffee. Growth in sparkling soft drinks volume included 9 percent growth in Trademark Coca-Cola and 5 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 2 percent in packaged water. The group's volume reflects growth of 11 percent in the India South West Asia business unit, 10 percent in the ASEAN business unit, 3 percent in the Greater China Korea business unit and 1 percent in the South Pacific business unit. The growth in these business units was partially offset by a decline of 2 percent in the Japan business unit. Unit case volume for Global Ventures grew 7 percent, which included growth of 8 percent in juice, dairy and plant-based beverages and growth in energy drinks, partially offset by a decline in tea. Unit case volume for Bottling Investments grew 24 percent. This increase primarily reflects the impact of the acquisition of a controlling interest in the Philippine bottling operations as well as growth in India and South Africa. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks and 3 percent in water, enhanced water and sports drinks. Growth in sparkling soft drinks was primarily driven by 2 percent growth in Trademark Coca-Cola and 3 percent growth in Trademark Fanta. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; and Middle East North Africa business units. The unit case volume growth in these business units was partially offset by a decline in the West Africa business unit. Volume in the South East Africa and Western Europe business units was even. In Latin America, unit case volume was even, which included growth of 4 percent in juice, dairy and plant-based beverages and 1 percent in water, enhanced water and sports drinks. Sparkling soft drinks volume was even. The group's volume reflected growth of 1 percent in each of the Mexico, Brazil and Latin Center business units, offset by a 4 percent decline in the South Latin business unit. The growth in Mexico's volume was primarily driven by 1 percent growth in sparkling soft drinks and 8 percent growth in juice, dairy and plant-based beverages. The decline in South Latin's volume was driven by a 4 percent decline in sparkling soft drinks. Unit case volume in North America was even. Sparkling soft drinks grew 1 percent, which included growth of 3 percent in Trademark Sprite and 1 percent in Trademark CocaCola. Unit case volume in water, enhanced water and sports drinks grew 2 percent, primarily driven by 2 percent growth in packaged water and 1 percent growth in sports drinks. Growth in these category clusters was offset by a 3 percent decline in juice, dairy and plant-based beverages. In Asia Pacific, unit case volume grew 4 percent, reflecting 4 percent growth in sparkling soft drinks, 5 percent growth in water, enhanced water and sports drinks, and 4 percent growth in tea and coffee. Growth in sparkling soft drinks volume included 5 percent growth in Trademark Coca-Cola and 6 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 7 percent in packaged water. The group's volume reflects growth of 6 percent in the Greater China Korea business unit, 10 percent in the India South West Asia business unit and 1 percent in the Japan business unit. Volume in the South Pacific and ASEAN business units was even. Unit case volume for Global Ventures grew 8 percent, which included growth of 8 percent in juice, dairy and plant-based beverages and growth in energy drinks, partially offset by a decline in tea. Unit case volume for Bottling Investments declined 15 percent. This decrease primarily reflects the impact of refranchising activities, partially offset by growth in India as well as the impact of bottler acquisitions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Concentrate Sales Volume In 2019 , worldwide concentrate sales volume and unit case sales volume both grew 2 percent compared to 2018 . In 2018 , worldwide concentrate sales volume grew 3 percent and unit case sales volume grew 2 percent compared to 2017 . The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. Net Operating Revenues Year Ended December 31, 2019 versus Year Ended December 31, 2018 Net operating revenues were $37,266 million in 2019, compared to $34,300 million in 2018, an increase of $2,966 million , or 9 percent . The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2019 versus 2018 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated % % (4 )% % % Europe, Middle East Africa % % (9 )% % (1 )% Latin America 13 (10 ) North America Asia Pacific (1 ) (1 ) Global Ventures (1 ) (16 ) 233 Bottling Investments 3 (5 ) 10 Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (excluding Costa non-ready-to-drink products) (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Company's net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) the change in the mix of products and packages sold; and (3) the change in the mix of channels and geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Price, product and geographic m ix had a 5 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix across a majority of the business units; Latin America favorable price mix across all business units and the impact of inflationary environments in certain markets; North America favorable price mix driven by revenue growth management initiatives across the beverage categories; Asia Pacific favorable price mix in all business units offset by unfavorable geographic mix; Global Ventures unfavorable product mix; and Bottling Investments favorable price, product and package mix in certain bottling operations, partially offset by unfavorable geographic mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 4 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the euro, British pound sterling, Mexican peso, Brazilian real, South African rand and Australian dollar, which had an unfavorable impact on all of our operating segments, except for our North America operating segment. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Company's net operating revenues provides investors with useful information to enhance their understanding of the Company's net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Company's performance. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a slightly favorable impact on full year 2020 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect foreign currencies will have a slightly unfavorable impact on our full year 2020 net operating revenues. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Net operating revenues were $34,300 million in 2018, compared to $36,212 million in 2017, a decrease of $1,912 million , or 5 percent . The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2018 versus 2017 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Accounting Changes Total Consolidated % % (1 )% (11 )% % (5 )% Europe, Middle East Africa % % (2 )% % (3 )% % Latin America 10 (9 ) (3 ) North America (1 ) 9 Asia Pacific (1 ) (5 ) Global Ventures (1 ) Bottling Investments 1 (55 ) (40 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Price, product and geographic m ix had a 2 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix in all of the segment's business units as well as favorable product and package mix; Latin America favorable price mix and the impact of inflationary environments in certain markets; North America favorable pricing initiatives, offset by incremental freight costs; Asia Pacific favorably impacted as a result of pricing initiatives as well as product and package mix, offset by geographic mix; Global Ventures unfavorable product mix; and Bottling Investments favorable geographic mix, partially offset by unfavorable price, product and package mix in certain bottling operations. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Accounting changes"" refers to the impact of our adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 17.3 % 19.1 % 18.7 % Latin America 11.0 11.6 10.9 North America 31.9 33.1 24.0 1 Asia Pacific 12.7 14.0 13.1 Global Ventures 6.9 2.2 2.0 Bottling Investments 19.9 19.7 31.0 1 Corporate 0.3 0.3 0.3 Total 100.0 % 100.0 % 100.0 % 1 Amounts have been adjusted to reflect the reclassification of certain revenue streams from the Bottling Investments operating segment to the North America operating segment effective January 1, 2018. The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; acquisitions and divestitures; and accounting changes. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below, and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Our gross profit margin decreased to 60.8 percent in 2019 from 61.9 percent in 2018 . The decrease was primarily due to the impact of structural changes as well as the unfavorable impact of foreign currency exchange rate fluctuations. Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Our gross profit margin decreased to 61.9 percent in 2018 from 62.1 percent in 2017 . The decrease was primarily due to the consolidation of CCBA, the unfavorable impact of foreign currency exchange rate fluctuations and the impact of accounting changes related to the new revenue recognition accounting standard, partially offset by the impact of divestitures. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information on the adoption of the new revenue recognition accounting standard. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2018 Stock-based compensation expense $ $ $ Advertising expenses 4,246 4,113 3,958 Selling and distribution expenses 2,873 2,182 3,402 Other operating expenses 4,783 4,482 5,255 Selling, general and administrative expenses $ 12,103 $ 11,002 $ 12,834 Year Ended December 31, 2019 versus Year Ended December 31, 2018 Selling, general and administrative expenses increased $1,101 million , or 10 percent . This increase was primarily the result of acquisitions, partially offset by the impact of divestitures and a foreign currency exchange rate impact of 4 percent. The increase in advertising costs also reflects the Company's increased investments to strengthen our brands. Other operating expenses also reflect the impact of savings from our productivity initiatives. As of December 31, 2019 , we had $258 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.0 years as stock-based compensation expense, and it does not include the impact of any future stock-based compensation awards. Refer to Note 14 of Notes to Consolidated Financial Statements. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Selling, general and administrative expenses decreased $1,832 million , or 14 percent . The decrease in selling and distribution expenses during 2018 reflects the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017, partially offset by the impact of the consolidation of CCBA. The decrease in other operating expenses during 2018 reflects savings from our productivity initiatives, the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2018 Europe, Middle East Africa $ $ (3 ) $ Latin America 4 North America 175 Asia Pacific (4 ) Global Ventures Bottling Investments 617 1,079 Corporate 290 Total $ $ 1,079 $ 1,902 In 2019, the Company recorded other operating charges of $458 million . These charges primarily consisted of $264 million related to the Company's productivity and reinvestment program and $42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $95 million for costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the acquisition of Costa and refranchising of our bottling operations. Refer to Note 18 of Notes to Consolidated Financial Statements for information on the trademark impairment charge. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 18 of Notes to Consolidated Financial Statements for information on the asset impairment charges. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2018 Europe, Middle East Africa 35.2 % 40.4 % 46.2 % Latin America 23.6 25.3 28.6 North America 25.7 25.3 31.9 Asia Pacific 22.6 24.8 27.5 Global Ventures 3.3 1.7 2.1 Bottling Investments 3.6 (2.2 ) (10.4 ) Corporate (14.0 ) (15.3 ) (25.9 ) Total 100.0 % 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2018 Consolidated 27.1 % 26.7 % 21.4 % Europe, Middle East Africa 55.2 56.5 52.9 Latin America 57.7 58.4 56.0 North America 21.8 20.4 28.5 Asia Pacific 48.3 47.3 44.9 Global Ventures 13.1 19.8 22.3 Bottling Investments 4.8 (2.9 ) (7.2 ) Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Operating income was $10,086 million in 2019 , compared to $9,152 million in 2018 , an increase of $934 million , or 10 percent . The increase in operating income was driven by concentrate sales volume growth of 2 percent, favorable price and product mix, savings from our productivity initiatives, lower other operating charges and a benefit from acquisitions. These favorable impacts were partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. In 2019, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 9 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the euro, British pound sterling, Mexican peso, Brazilian real, South African rand and Australian dollar, which had an unfavorable impact on all of our operating segments, except for our North America operating segment. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2019 and 2018 was $3,551 million and $3,693 million , respectively. The decrease in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 12 percent, partially offset by favorable price and product mix and concentrate sales volume growth of 1 percent. Operating income for the Latin America segment for the years ended December 31, 2019 and 2018 was $2,375 million and $2,318 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 14 percent. North America's operating income for the years ended December 31, 2019 and 2018 was $2,594 million and $2,318 million , respectively. Operating income growth for this segment was primarily driven by favorable price mix and lower other operating charges. These favorable impacts were partially offset by a decline in concentrate sales volume of 1 percent and the impact of prior year structural changes. Operating income for Asia Pacific for the years ended December 31, 2019 and 2018 was $2,282 million and $2,271 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent, partially offset by higher other operating charges, an unfavorable foreign currency exchange rate impact of 1 percent and the impact of structural changes. Operating income for Global Ventures for the years ended December 31, 2019 and 2018 was $334 million and $152 million , respectively. Operating income growth was primarily due to the acquisition of Costa, partially offset by an unfavorable foreign currency exchange rate impact of 4 percent. Operating income for our Bottling Investments segment for the year ended December 31, 2019 was $358 million compared to an operating loss of $197 million for the year ended December 31, 2018 . Operating income growth in 2019 was impacted by strong performance in India and South Africa, the favorable impact of the acquisition of a controlling interest in the Philippine bottling operations in December 2018 and lower other operating charges, partially offset by an unfavorable foreign currency exchange rate impact. Corporate's operating loss for the years ended December 31, 2019 and 2018 was $1,408 million and $1,403 million , respectively. The operating loss in 2019 was unfavorably impacted by mark-to-market adjustments related to our economic hedging activities, partially offset by lower other operating charges and savings from our productivity initiatives. Based on current spot rates and our hedging coverage in place, we expect foreign currencies will have an unfavorable impact on our full year 2020 operating income. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Operating income was $9,152 million in 2018 , compared to $7,755 million in 2017 , an increase of $1,397 million , or 18 percent . The increase in operating income was driven by concentrate sales volume growth of 3 percent, favorable price mix and lower other operating charges. Additionally, operating income was favorably impacted by savings from our productivity initiatives. These favorable impacts were partially offset by the unfavorable impact of refranchising activities and foreign currency exchange rate fluctuations. In 2018, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar, which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand, which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2018 and 2017 was $3,693 million and $3,585 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 6 percent, favorable price, product and geographic mix, and lower other operating charges, partially offset by increased marketing investments primarily related to key product launches and an unfavorable foreign currency exchange rate impact of 5 percent. Operating income for the Latin America segment for the years ended December 31, 2018 and 2017 was $2,318 million and $2,215 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 12 percent. North America's operating income for the years ended December 31, 2018 and 2017 was $2,318 million and $2,472 million , respectively. The decrease in operating income was driven by higher freight costs and the impact of structural changes, partially offset by lower other operating charges. The operating margin decrease in 2018 was primarily related to the adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Operating income for Asia Pacific for the years ended December 31, 2018 and 2017 was $2,271 million and $2,136 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent. Foreign currency exchange rates had a nominal impact. Operating income for Global Ventures for the years ended December 31, 2018 and 2017 was $152 million and $159 million , respectively. The operating income decline for the segment reflects concentrate sales volume growth of 7 percent offset by unfavorable product mix and an unfavorable foreign currency exchange rate impact of 1 percent. Our Bottling Investments segment's operating loss for the years ended December 31, 2018 and 2017 was $197 million and $806 million , respectively. The decrease in operating loss reflects lower other operating charges, partially offset by the unfavorable impact of divestitures. Corporate's operating loss for the years ended December 31, 2018 and 2017 was $1,403 million and $2,006 million , respectively. The operating loss in 2018 was favorably impacted by lower selling, general and administrative expenses as a result of productivity initiatives, lower other operating charges and mark-to-market adjustments related to our economic hedging activities. Interest Income Year Ended December 31, 2019 versus Year Ended December 31, 2018 Interest income was $ 563 million in 2019 , compared to $ 689 million in 2018 , a decrease of $126 million , or 18 percent . This decrease was primarily driven by the liquidation of a portion of our short-term investments in connection with the acquisition of Costa, partially offset by higher cash balances in certain of our international locations. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest income was $ 689 million in 2018 , compared to $ 679 million in 2017 , an increase of $10 million , or 1 percent . The increase primarily reflects higher interest rates earned on certain investments, partially offset by lower investment balances in certain of our international locations. Interest Expense Year Ended December 31, 2019 versus Year Ended December 31, 2018 Interest expense was $946 million in 2019 , compared to $950 million in 2018 , a decrease of $4 million , or less than 1 percent. This decrease was primarily due to lower short-term U.S. debt balances, partially offset by higher average short-term U.S. debt interest rates and higher long-term debt balances. In addition, prior year interest expense included a net gain of $27 million related to the extinguishment of certain long-term debt. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest expense was $ 950 million in 2018 , compared to $ 853 million in 2017 , an increase of $97 million , or 11 percent . This increase was primarily due to the impact of higher short-term U.S. interest rates, partially offset by a net gain of $27 million related to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 12 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2019 versus Year Ended December 31, 2018 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2019 , equity income was $1,049 million , compared to equity income of $1,008 million in 2018 , an increase of $41 million , or 4 percent . This increase reflects, among other things, the impact of more favorable operating results reported by several of our equity method investees and a decrease in the Company's proportionate share of significant operating and nonoperating charges recorded by certain of our equity method investees. These favorable impacts were partially offset by the sale of our equity ownership interest in Corporacin Lindley S.A. (""Lindley""), the sale of a portion of our equity ownership interest in Embotelladora Andina S.A. (""Andina""), and the acquisition of a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee, as well as the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2018 versus Year Ended December 31, 2017 In 2018 , equity income was $ 1,008 million , compared to equity income of $ 1,072 million in 2017 , a decrease of $64 million , or 6 percent . This decrease reflects, among other things, the dissolution of our Beverage Partners Worldwide joint venture and the consolidation of CCBA. In addition, the Company recorded net charges of $111 million and $92 million in the line item equity income (loss) net during the years ended December 31, 2018 and 2017 , respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost for pension and postretirement benefit plans; other benefit plan charges and credits; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; and the impact of foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 of Notes to Consolidated Financial Statements. In 2019 , other income (loss) net was income of $34 million . The Company recognized a gain of $739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $73 million related to the refranchising of certain bottling operations in India and a gain of $39 million related to the sale of a portion of our equity ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $406 million related to Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""), an equity method investee, $255 million related to certain equity method investees in the Middle East, $57 million related to one of our equity method investees in North America, and $49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million and recognized a $118 million net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Additionally, the Company recognized net charges of $105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Other income (loss) net also included income of $99 million related to the non-service cost components of net periodic benefit cost, $62 million of dividend income and net foreign currency exchange losses of $120 million . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, impairment charges and the loss recognized in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $1,674 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees, an impairment charge of $554 million related to assets held by CCBA and charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Lindley and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Other income (loss) net also included a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, net foreign currency exchange losses of $143 million , charges of $240 million related to pension settlements, income of $228 million related to the non-service cost components of net periodic benefit cost and $72 million of dividend income. Refer to Note 1 and Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $1,763 million . The Company recognized net charges of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $56 million . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 335 million , $ 318 million and $ 221 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 21.0 % 21.0 % 35.0 % State and local income taxes net of federal benefit 0.9 1.5 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.1 1,2,3 3.1 5,6 (9.5 ) Equity income or loss (1.6 ) (2.5 ) (3.3 ) Tax Reform Act 0.1 7 52.4 8 Excess tax benefits on stock-based compensation (0.9 ) (1.3 ) (1.9 ) Other net (3.8 ) 4 (0.6 ) 7.6 9,10 Effective tax rate 16.7 % 21.3 % 81.4 % 1 Includes net tax charges of $199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes the impact of pretax charges of $710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 3 Includes a tax benefit of $199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes a net tax benefit of $184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. Refer to Note 18 of Notes to Consolidated Financial Statements. 6 Includes net tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 7 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 8 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 9 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 9.9 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""). The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 10 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. As of December 31, 2019 , the gross amount of unrecognized tax benefits was $ 392 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 173 million , exclusive of any benefits related to interest and penalties. The remaining $ 219 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2017 Balance of unrecognized tax benefits at beginning of year $ $ $ Increase related to prior period tax positions 1 18 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (174 ) 2 (4 ) Increase (decrease) due to effect of foreign currency exchange rate changes (3 ) (17 ) Balance of unrecognized tax benefits at end of year $ $ $ 1 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 2 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 201 million , $ 190 million and $ 177 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2019 , 2018 and 2017 , respectively. Of these amounts, $11 million , $13 million and $35 million of expense were recognized through income tax expense in 2019 , 2018 and 2017 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2020 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2020 . As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. The Company's cash, cash equivalents, short-term investments and marketable securities totaled $11.2 billion as of December 31, 2019 . In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $ 8.9 billion in lines of credit for general corporate purposes as of December 31, 2019 . These backup lines of credit expire at various times from 2020 through 2024 . Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2019 , 2018 and 2017 was $ 10,471 million , $ 7,627 million and $ 7,041 million , respectively. Net cash provided by operating activities increased $2,844 million , or 37 percent , in 2019 compared to 2018 . This increase was primarily driven by operating income growth, the acquisition of Costa in January 2019, the efficient management of working capital, primarily due to the extension of payment terms with our suppliers, and lower payments related to the Company's productivity and reinvestment program, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Net cash provided by operating activities increased $586 million , or 8 percent , in 2018 compared to 2017 . This increase was primarily driven by operating income growth, the efficient management of working capital and the consolidation of CCBA, partially offset by the impact of refranchising bottling operations and higher interest and tax payments. Refer to Note 12 and Note 16 of Notes to Consolidated Financial Statements for additional information on interest payments and tax payments, respectively. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, 2018 Purchases of investments $ (4,704 ) $ (7,789 ) $ (17,296 ) Proceeds from disposals of investments 6,973 14,977 16,694 Acquisitions of businesses, equity method investments and nonmarketable securities (5,542 ) (1,263 ) (3,809 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 Purchases of property, plant and equipment (2,054 ) (1,548 ) (1,750 ) Proceeds from disposals of property, plant and equipment 248 Other investing activities (56 ) (60 ) (80 ) Net cash provided by (used in) investing activities $ (3,976 ) $ 5,927 $ (2,312 ) Purchases of Investments and Proceeds from Disposals of Investments Purchases of investments and proceeds from disposals of investments resulted in net cash inflows of $2,269 million and $7,188 million in 2019 and 2018, respectively, and a net cash outflow of $602 million in 2017. The investments purchased in all three years include time deposits that had maturities greater than three months but less than one year and were classified in the line item short-term investments in our consolidated balance sheets. The remaining activity primarily represents the purchases of, and proceeds from the disposals of, short-term investments that were made as part of the Company's overall cash management strategy as well as our insurance captive investments. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2019 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $5,542 million , which primarily related to the acquisitions of Costa and the remaining interest in CHI. During 2019 , the Company also acquired controlling interests in bottling operations in Zambia, Kenya, and Eswatini. In 2018 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million , which was primarily related to the acquisition of a controlling interest in the Philippine bottling operations and an equity interest in BA Sports Nutrition, LLC (""BodyArmor""). Additionally, the Company acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity was primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2019 , 2018 and 2017 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2019 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $429 million , primarily related to the sale of a portion of our equity method investment in Andina and the refranchising of certain of our bottling operations in India. In 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 1,362 million , primarily related to the proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the the sale of our equity ownership in Lindley. In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2019 , 2018 and 2017 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment for the years ended December 31, 2019 , 2018 and 2017 were $2,054 million , $1,548 million and $1,750 million , respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, Capital expenditures $ 2,054 $ 1,548 $ 1,750 Europe, Middle East Africa 5.2 % 4.3 % 4.4 % Latin America 6.8 5.8 3.1 North America 19.1 27.7 30.9 Asia Pacific 2.3 2.0 2.9 Global Ventures 10.2 0.7 0.2 Bottling Investments 40.7 33.4 42.1 Corporate 15.7 26.1 16.4 We expect our full year 2020 capital expenditures to be approximately $2.0 billion . Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 23,009 $ 27,605 $ 29,926 Payments of debt (24,850 ) (30,600 ) (28,871 ) Issuances of stock 1,012 1,476 1,595 Purchases of stock for treasury (1,103 ) (1,912 ) (3,682 ) Dividends (6,845 ) (6,644 ) (6,320 ) Other financing activities (227 ) (272 ) (95 ) Net cash provided by (used in) financing activities $ (9,004 ) $ (10,347 ) $ (7,447 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2019 , our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2019 , the Company had issuances of debt of $23,009 million , which included $16,842 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $6,167 million , net of related discounts and issuance costs. During 2019 , the Company made payments of debt of $24,850 million , which included $17,577 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $2,244 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $5,029 million . In 2018, the Company had issuances of debt of $27,605 million , which primarily included $24,510 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $3,093 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. During 2018, the Company made payments of debt of $30,600 million , which included $27,281 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,319 million . In 2017, the Company had issuances of debt of $29,926 million , which included issuances of $26,287 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million , net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,871 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,259 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million . The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Coca-Cola Enterprises Inc.'s former North America business. Issuances of Stock The issuances of stock in 2019 , 2018 and 2017 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Company's common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. The following table presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 48.86 $ 45.09 $ 44.09 Since the inception of our share repurchase program in 1984 through December 31, 2019 , we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2019 , we repurchased $1.1 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2019 resulted in a net cash outflow of $0.1 billion . After investing for growth and paying dividends, we intend to use excess cash to repurchase shares over time. Dividends The Company paid dividends of $6,845 million , $6,644 million and $6,320 million during the years ended December 31, 2019 , 2018 and 2017 , respectively. At its February 2020 meeting, our Board of Directors increased our regular quarterly dividend to $0.41 per share, equivalent to a full year dividend of $1.64 per share in 2020. This is our 58 th consecutive annual increase. Our annualized common stock dividend was $ 1.60 per share, $ 1.56 per share and $ 1.48 per share in 2019 , 2018 and 2017 , respectively. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2019 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 621 million , of which $ 249 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2019 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2019 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2021-2022 2023-2024 2025 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 10,007 $ 10,007 $ $ $ Lines of credit and other short-term borrowings 987 Current maturities of long-term debt 2 4,255 4,255 Long-term debt, net of current maturities 2 27,017 7,507 6,035 13,475 Estimated interest payments 3 3,613 733 1,893 Accrued income taxes 4 4,143 838 1,686 1,205 Purchase obligations 5 16,100 10,008 1,450 1,008 3,634 Marketing obligations 6 5,015 2,404 1,090 896 Lease obligations 1,710 533 485 Total contractual obligations $ 72,847 $ 28,876 $ 12,151 $ 10,232 $ 21,588 1 Refer to Note 12 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 12 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2019 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 16 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,986 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $584 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2019 was $2,093 million . Refer to Note 15 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. The Company expects to contribute $28 million in 2020 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 15 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension plans in the table above. As of December 31, 2019 , the projected benefit obligation of the U.S. qualified pension plans was $5,623 million , and the fair value of the related plan assets was $5,149 million . The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,134 million , and the fair value of the related plan assets was $2,931 million . The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $67 million in 2020, increasing to $69 million by 2025 and then decreasing annually thereafter. Refer to Note 15 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2019 , our self-insurance reserves totaled $ 301 million . Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2019 were $2,284 million . Refer to Note 16 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, in January 2020, the Company acquired the remaining 57.5 percent stake in fairlife, LLC for $1.0 billion, which is not included in the table above. Refer to Note 23 of Notes to Consolidated Financial Statements. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2019 , we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2019 and 2018 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies (5 )% (1 )% Australian dollar (7 )% (2 )% Brazilian real (10 ) (12 ) British pound sterling (4 ) Euro (5 ) Japanese yen Mexican peso (1 ) (2 ) South African rand (10 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 4 percent and 1 percent in 2019 and 2018 , respectively. The total currency impact on income before income taxes, including the effect of our hedging activities, was a decrease of 10 percent and 7 percent in 2019 and 2018 , respectively. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statement of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $120 million , $143 million and $56 million during the years ended December 31, 2019 , 2018 and 2017 , respectively. Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. We have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of the impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 48 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2019 , we used 70 functional currencies in addition to the U.S. dollar and generated $25.6 billion of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies may be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $14,276 million and $17,142 million as of December 31, 2019 and 2018 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $6 million as of December 31, 2019 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $84 million . The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $26 million as of December 31, 2019 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the unrealized loss and created a net unrealized gain of $31 million . Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2019 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $241 million in 2019 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $47 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $427 million and $382 million as of December 31, 2019 and 2018 , respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of less than $1 million as of December 31, 2019 , and we estimate that a 10 percent decrease in underlying commodity prices would have an insignificant impact. The fair value of the contracts that do not qualify for hedge accounting resulted in a net loss of $4 million as of December 31, 2019 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $38 million . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 67 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2018 Net Operating Revenues $ 37,266 $ 34,300 $ 36,212 Cost of goods sold 14,619 13,067 13,721 Gross Profit 22,647 21,233 22,491 Selling, general and administrative expenses 12,103 11,002 12,834 Other operating charges 1,079 1,902 Operating Income 10,086 9,152 7,755 Interest income 689 Interest expense 950 Equity income (loss) net 1,049 1,008 1,072 Other income (loss) net ( 1,674 ) ( 1,763 ) Income Before Income Taxes 10,786 8,225 6,890 Income taxes 1,801 1,749 5,607 Consolidated Net Income 8,985 6,476 1,283 Less: Net income (loss) attributable to noncontrolling interests 42 Net Income Attributable to Shareowners of The Coca-Cola Company $ 8,920 $ 6,434 $ 1,248 Basic Net Income Per Share 1 $ 2.09 $ 1.51 $ 0.29 Diluted Net Income Per Share 1 $ 2.07 $ 1.50 $ 0.29 Average Shares Outstanding Basic 4,276 4,259 4,272 Effect of dilutive securities 40 Average Shares Outstanding Diluted 4,314 4,299 4,324 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2018 Consolidated Net Income $ 8,985 $ 6,476 $ 1,283 Other comprehensive income: Net foreign currency translation adjustments ( 2,035 ) Net gains (losses) on derivatives ( 54 ) ( 7 ) ( 433 ) Net change in unrealized gains (losses) on available-for-sale securities ( 34 ) Net change in pension and other benefit liabilities ( 159 ) 322 Total Comprehensive Income 8,864 4,429 2,221 Less: Comprehensive income attributable to noncontrolling interests 95 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 8,754 $ 4,334 $ 2,148 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2018 ASSETS Current Assets Cash and cash equivalents $ 6,480 $ 9,077 Short-term investments 1,467 2,025 Total Cash, Cash Equivalents and Short-Term Investments 7,947 11,102 Marketable securities 3,228 5,013 Trade accounts receivable, less allowances of $524 and $501, respectively 3,971 3,685 Inventories 3,379 3,071 Prepaid expenses and other assets 1,886 2,059 Total Current Assets 20,411 24,930 Equity method investments 19,025 19,412 Other investments 867 Other assets 6,075 4,148 Deferred income tax assets 2,412 2,674 Property, plant and equipment net 10,838 9,598 Trademarks with indefinite lives 9,266 6,682 Bottlers' franchise rights with indefinite lives 51 Goodwill 16,764 14,109 Other intangible assets 745 Total Assets $ 86,381 $ 83,216 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 11,312 $ 9,533 Loans and notes payable 10,994 13,835 Current maturities of long-term debt 4,253 5,003 Accrued income taxes 411 Total Current Liabilities 26,973 28,782 Long-term debt 27,516 25,376 Other liabilities 8,510 7,646 Deferred income tax liabilities 2,284 2,354 The Coca-Cola Company Shareowners' Equity Common stock, $0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 17,154 16,520 Reinvested earnings 65,855 63,234 Accumulated other comprehensive income (loss) ( 13,544 ) ( 12,814 ) Treasury stock, at cost 2,760 and 2,772 shares, respectively ( 52,244 ) ( 51,719 ) Equity Attributable to Shareowners of The Coca-Cola Company 18,981 16,981 Equity attributable to noncontrolling interests 2,117 2,077 Total Equity 21,098 19,058 Total Liabilities and Equity $ 86,381 $ 83,216 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2018 Operating Activities Consolidated net income $ 8,985 $ 6,476 $ 1,283 Depreciation and amortization 1,365 1,086 1,260 Stock-based compensation expense 225 Deferred income taxes ( 280 ) ( 413 ) ( 1,252 ) Equity (income) loss net of dividends ( 421 ) ( 457 ) ( 628 ) Foreign currency adjustments ( 50 ) Significant (gains) losses net ( 467 ) 1,459 Other operating charges 558 1,218 Other items 699 ( 252 ) Net change in operating assets and liabilities ( 1,240 ) 3,442 Net Cash Provided by Operating Activities 10,471 7,627 7,041 Investing Activities Purchases of investments ( 4,704 ) ( 7,789 ) ( 17,296 ) Proceeds from disposals of investments 6,973 14,977 16,694 Acquisitions of businesses, equity method investments and nonmarketable securities ( 5,542 ) ( 1,263 ) ( 3,809 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 Purchases of property, plant and equipment ( 2,054 ) ( 1,548 ) ( 1,750 ) Proceeds from disposals of property, plant and equipment 248 Other investing activities ( 56 ) ( 60 ) ( 80 ) Net Cash Provided by (Used in) Investing Activities ( 3,976 ) 5,927 ( 2,312 ) Financing Activities Issuances of debt 23,009 27,605 29,926 Payments of debt ( 24,850 ) ( 30,600 ) ( 28,871 ) Issuances of stock 1,012 1,476 1,595 Purchases of stock for treasury ( 1,103 ) ( 1,912 ) ( 3,682 ) Dividends ( 6,845 ) ( 6,644 ) ( 6,320 ) Other financing activities ( 227 ) ( 272 ) ( 95 ) Net Cash Provided by (Used in) Financing Activities ( 9,004 ) ( 10,347 ) ( 7,447 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents ( 72 ) ( 262 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year ( 2,581 ) 2,945 ( 2,477 ) Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 9,318 6,373 8,850 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 6,737 9,318 6,373 Less: Restricted cash and restricted cash equivalents at end of year 241 Cash and Cash Equivalents at End of Year $ 6,480 $ 9,077 $ 6,102 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (In millions except per share data) Year Ended December 31, 2018 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,268 4,259 4,288 Treasury stock issued to employees related to stock-based compensation plans 48 Purchases of stock for treasury ( 21 ) ( 39 ) ( 82 ) Balance at end of year 4,280 4,268 4,259 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 16,520 15,864 14,993 Stock issued to employees related to stock-based compensation plans 467 Stock-based compensation expense 225 Other activities ( 36 ) ( 3 ) Balance at end of year 17,154 16,520 15,864 Reinvested Earnings Balance at beginning of year 63,234 60,430 65,502 Adoption of accounting standards 1 3,014 Net income attributable to shareowners of The Coca-Cola Company 8,920 6,434 1,248 Dividends (per share $1.60, $1.56 and $1.48 in 2019, 2018 and 2017, respectively) ( 6,845 ) ( 6,644 ) ( 6,320 ) Balance at end of year 65,855 63,234 60,430 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 12,814 ) ( 10,305 ) ( 11,205 ) Adoption of accounting standards 1 ( 564 ) ( 409 ) Net other comprehensive income (loss) ( 166 ) ( 2,100 ) Balance at end of year ( 13,544 ) ( 12,814 ) ( 10,305 ) Treasury Stock Balance at beginning of year ( 51,719 ) ( 50,677 ) ( 47,988 ) Treasury stock issued to employees related to stock-based compensation plans 704 Purchases of stock for treasury ( 1,026 ) ( 1,746 ) ( 3,598 ) Balance at end of year ( 52,244 ) ( 51,719 ) ( 50,677 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 18,981 $ 16,981 $ 17,072 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 2,077 $ 1,905 $ Net income attributable to noncontrolling interests 42 Net foreign currency translation adjustments 53 Dividends paid to noncontrolling interests ( 48 ) ( 31 ) ( 15 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests Business combinations 101 1,805 Deconsolidation of certain entities ( 157 ) Other activities 41 Total Equity Attributable to Noncontrolling Interests $ 2,117 $ 2,077 $ 1,905 1 Refer to Note 1 , Note 3 , Note 4 , Note 6 and Note 16 . Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 13 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,179 million and $ 3,916 million as of December 31, 2019 and 2018 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 51 million and $ 49 million as of December 31, 2019 and 2018 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. Refer to Note 3 . Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 4 billion in 2019 , 2018 and 2017 . As of December 31, 2019 and 2018 , advertising and production costs of $ 55 million and $ 54 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our Company-owned bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. Effective January 1, 2018, we adopted ASC 606. Upon adoption, we made a policy election to recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Refer to Note 3 for additional information regarding revenue recognition. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. Upon adoption of ASC 606, we made a policy election to exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Refer to Note 3 for additional information regarding revenue recognition. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 5 million stock option awards were excluded from the computations of diluted net income per share in both 2018 and 2017 because the awards would have been antidilutive for the years presented. The number of stock option awards excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheets, and amounts classified in assets held for sale. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2018 Cash and cash equivalents $ 6,480 $ 9,077 $ 6,102 Cash and cash equivalents included in assets held for sale Cash and cash equivalents included in other assets 1 241 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 6,737 $ 9,318 $ 6,373 1 Amounts represent cash and cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4 . Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") 2016-01 Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 6 . Leases Effective January 1, 2019 , we adopted Accounting Standards Codification 842, Leases (""ASC 842""). We determine if an arrangement contains a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in the line items other assets, accounts payable and accrued expenses, and other liabilities in our consolidated balance sheet. Operating lease right-of-use (""ROU"") assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 11 . We have various arrangements for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,208 million , $ 999 million and $ 1,131 million in 2019 , 2018 and 2017 , respectively. Amortization expense for leasehold improvements totaled $ 18 million , $ 18 million and $ 19 million in 2019 , 2018 and 2017 , respectively. Refer to Note 8 . Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe market participants would use. Refer to Note 18 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 9 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe market participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (""Costa""), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""), each of which is its own reporting unit. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 13 . Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performance-based share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, which is generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018 and 2019, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 14 . Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 13 and Note 16 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 17 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 . Recently Adopted Accounting Guidance ASC 842 requires lessees to recognize operating lease ROU assets, representing their right to use the underlying asset for the lease term, and operating lease liabilities on the balance sheet for all leases with lease terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted ASC 842 using the modified retrospective method and utilized the optional transition method under which we continue to apply the legacy guidance in ASC 840, Leases , including its disclosure requirements, in the comparative periods presented. In addition, we elected the package of practical expedients permitted under the transition guidance which permits us to carry forward the historical lease classification, among other things. As a result of the adoption, our operating lease ROU assets and operating lease liabilities were $ 1,372 million and $ 1,392 million , respectively, as of December 31, 2019 . The adoption of this standard did not impact our consolidated statement of income or our consolidated statement of cash flows. Refer to Note 11 . In August 2017, the Financial Accounting Standards Board (""FASB"") issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments in this update include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2019 by $ 12 million , net of tax. Refer to Note 6 for additional disclosures required by this ASU. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act"") on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019 . We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , which replaces most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. ASU 2014-09 and its amendments were included primarily in ASC 606. The core principle of ASC 606 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASC 606 also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. We adopted ASC 606 effective January 1, 2018 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $ 257 million , net of tax. The Company has changed our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data for the reporting process. Refer to Note 3 . In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $ 409 million , net of tax. Refer to Note 4 for additional disclosures required by this ASU. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $ 2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. Refer to Note 16 . In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Reform Act. The amendments also require any provisional amounts or subsequent adjustments to be included in net income. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018 . Refer to Note 16 . NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2019, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million , which primarily related to the acquisitions of Costa, the remaining equity ownership interest in C.H.I. Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages and iced tea, and controlling interests in bottling operations in Zambia, Kenya, and Eswatini. Refer to the ""Costa Limited"" and ""C.H.I. Limited"" sections within this note below for further details. During 2018, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million , which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Refer to the ""Philippine Bottling Operations"" section within this note below for further details. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. During 2017, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , of which $ 3,150 million related to the transition of Anheuser-Busch InBev's (""ABI"") 54.5 percent controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company, resulting in its consolidation in October 2017. Refer to the ""Coca-Cola Beverages Africa Proprietary Limited"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for noncash consideration. Refer to the ""North America Refranchising United States"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail outlets in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. As of December 31, 2019 , $ 2.4 billion of the purchase price was preliminarily allocated to the Costa trademark and $ 2.5 billion was preliminarily allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million , which was allocated to the Europe, Middle East and Africa operating segment. The preliminary allocation of the purchase price is subject to refinement when valuations are finalized. As of December 31, 2019 , the valuations that have not been finalized primarily relate to operating lease ROU assets, operating lease liabilities and certain fixed assets. The final purchase price allocation will be completed in the first quarter of 2020. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent interest in CHI in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million , which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $ 715 million of cash. The acquired business had $ 345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $ 32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Coca-Cola Beverages Africa Proprietary Limited In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $ 3,150 million . Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $ 150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those market participants would use. We recorded $ 1,805 million for the noncontrolling interests of CCBA. The fair value of the noncontrolling interests was determined in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $ 4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. As a result, upon finalization of purchase accounting $ 411 million of the final goodwill balance of $ 4,186 million was allocated to other reporting units expected to benefit from this transaction. Due to the Company's original intent to refranchise CCBA, it was accounted for as held for sale and a discontinued operation from October 2017 through the first quarter of 2019. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As a result, during the year ended December 31, 2018 , we recorded an impairment charge of $ 554 million , reflecting management's view of the proceeds that were expected to be received upon sale based on revised projections of future operating results and foreign currency exchange rate fluctuations. This charge was previously reflected in the line item income (loss) from discontinued operations in our consolidated statement of income and the corresponding reduction to assets was reflected as an allowance for reduction of assets held for sale discontinued operations in our consolidated balance sheet. Refer to Note 18 . Additionally, CCBA's property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans for CCBA and now intends to maintain its controlling stake in CCBA for the foreseeable future. As a result, CCBA no longer qualifies as held for sale or as a discontinued operation, and CCBA's financial results are now presented within the Company's continuing operations for all periods presented. As a result of this change in presentation, the Company reflected the impairment charge in other income (loss) net in our consolidated statement of income for the year ended December 31, 2018 and reallocated the allowance for reduction of assets held for sale discontinued operations balance to reduce the carrying value of CCBA's property, plant and equipment by $ 225 million and CCBA's definite-lived intangible assets by $ 329 million based on the relative amount of depreciation and amortization that would have been recognized during the period CCBA was held for sale. We also recorded a $ 160 million adjustment to reduce the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million , respectively, during the year ended December 31, 2019 . These additional adjustments were included in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million , primarily related to the sale of a portion of our equity method investment in Embotelladora Andina S.A. (""Andina"") and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million , respectively, which were recorded in the line item other income (loss) net in our consolidated statement of income. We continue to account for our remaining interest in Andina as an equity method investment as a result of our representation on Andina's Board of Directors and other governance rights. During 2018, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 1,362 million , primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations, as well as the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley""). During 2017, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. Latin America Bottling Operations During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $ 289 million as a result of these sales and recognized a net gain of $ 47 million , which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018 , we sold our equity ownership in Lindley to AC Bebidas, an equity method investee. We received net cash proceeds of $ 507 million and recognized a net gain of $ 296 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018 , the Company completed its North America refranchising with the sale of its Canadian bottling operations. We received initial net cash proceeds of $ 518 million and recognized a net charge of $ 385 million during the year ended December 31, 2018 . During the year ended December 31, 2019 , we recognized an additional charge of $ 122 million primarily related to post-closing adjustments as contemplated by the related agreements. These charges were included in the line item other income (loss) net in our consolidated statements of income. North America Refranchising United States In 2018, the Company completed the refranchising of all of our bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas, as well as the CBA entered into with Liberty Coca-Cola Beverages, the bottlers make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories to the respective bottlers in exchange for cash, except for the territory included in the Southwest Transaction. As discussed further below, we did not receive cash in the Southwest Transaction for these items. During the years ended December 31, 2018 and 2017 , cash proceeds from these sales totaled $ 3 million and $ 2,860 million , respectively. Included in the cash proceeds for the year ended December 31, 2017 was $ 336 million from Coca-Cola Bottling Co. Consolidated now known as Coca-Cola Consolidated, Inc., an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017 was $ 220 million from AC Bebidas and $ 39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized a net gain of $ 17 million during the year ended December 31, 2019 and recognized net charges of $ 91 million and $ 3,177 million during the years ended December 31, 2018 and 2017 , respectively. Included in these amounts is a net gain of $ 5 million during the year ended December 31, 2019 and net charges of $ 21 million and $ 1,104 million during the years ended December 31, 2018 and 2017 , respectively, from transactions with equity method investees or former management. The net gain in 2019 and net charges in 2018 were primarily related to post-closing adjustments as contemplated by the related agreements. The net charges in 2017 were primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The net charges in 2017 included $ 236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain refranchised territories participate. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the statement of income only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the statement of income as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2019 , 2018 and 2017 , the Company recorded charges of $ 4 million , $ 34 million and $ 313 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, as well as consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The charges related to these payments were included in the line item other income (loss) net in our consolidated statements of income. On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. CCR also made cash payments of $ 144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $ 1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $ 2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refranchising of China Bottling Operations In 2017, the Company sold its bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and sold a related cost method investment to one of the franchise bottlers. We received net cash proceeds of $ 963 million as a result of these sales and recognized a gain of $ 88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. NOTE 3 : REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers or Company-owned Costa retail outlets. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We adopted ASC 606 effective January 1, 2018 using the modified retrospective method. We have applied this standard to all contracts at the effective date and contracts entered into thereafter. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrate they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2019 related to performance obligations satisfied in prior periods was immaterial. In addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification of certain costs relating to revenue arrangements with customers. As a result, during the years ended December 31, 2019 and 2018 , we recorded certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also re-evaluated the principal versus agent considerations pertaining to certain of its arrangements with third-party manufacturers and co-packers. We recorded certain costs in net operating revenues which were previously recorded in cost of goods sold related to arrangements in which we concluded we did not control the goods before they were delivered to our customers. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,323 $ 19,894 Finished product operations 6,773 7,633 14,406 Total $ 11,344 $ 22,956 $ 34,300 Refer to Note 21 for additional revenue disclosures by operating segment and Corporate. NOTE 4 : INVESTMENTS Effective January 1, 2018, we adopted ASU 2016-01, which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $ 409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to AOCI as of January 1, 2018 in connection with the adoption of ASU 2016-01. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Refer to Note 6 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities T he carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2019 Marketable securities $ $ Other investments 82 Other assets 1,118 Total equity securities $ 2,219 $ December 31, 2018 Marketable securities $ $ Other investments 80 Other assets Total equity securities $ 1,934 $ The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2018 Net gains (losses) recognized during the year related to equity securities $ $ ( 250 ) Less: Net gains (losses) recognized during the year related to equity securities sold during the year 8 Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ $ ( 258 ) The sale and/or maturity of available-for-sale equity securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ Gross losses ( 19 ) Proceeds 86 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2019 Trading securities $ $ $ $ Available-for-sale securities 3,172 ( 4 ) 3,281 Total debt securities $ 3,218 $ $ ( 4 ) $ 3,328 December 31, 2018 Trading securities $ $ $ ( 1 ) $ Available-for-sale securities 4,901 ( 27 ) 4,993 Total debt securities $ 4,946 $ $ ( 28 ) $ 5,037 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2019 December 31, 2018 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ Marketable securities 2,852 4,691 Other assets Total debt securities $ $ 3,281 $ $ 4,993 The contractual maturities of these available-for-sale debt securities as of December 31, 2019 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 1,943 $ 1,982 After 1 year through 5 years 1,022 After 5 years through 10 years 84 After 10 years 193 Total $ 3,172 $ 3,281 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2018 Gross gains $ $ $ Gross losses ( 8 ) ( 27 ) ( 13 ) Proceeds 3,956 13,710 13,930 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $ 1,266 million as of December 31, 2019 and $ 1,056 million as of December 31, 2018 , which are classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2018 Raw materials and packaging $ 2,180 $ 2,025 Finished goods 773 Other 273 Total inventories $ 3,379 $ 3,071 NOTE 6 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 18 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in other comprehensive income. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019 , we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019 , we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million , net of taxes. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2019 December 31, 2018 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Prepaid expenses and other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Commodity contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 18 for the net presentation of the Company's derivative instruments. 2 Refer to Note 18 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2019 December 31, 2018 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Other derivative instruments Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Other derivative instruments Accounts payable and accrued expenses Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 18 for the net presentation of the Company's derivative instruments. 2 Refer to Note 18 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically four years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 6,957 million and $ 3,175 million as of December 31, 2019 and 2018 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. As of December 31, 2019 and 2018 , the total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $ 3,028 million . The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 2 million and $ 9 million as of December 31, 2019 and 2018 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. During the year ended December 31, 2018 , we discontinued the cash flow hedge relationship related to these swaps. We reclassified a loss of $ 8 million into earnings as a result of the discontinuance. As of December 31, 2019 and 2018 , we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) 2 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) $ Foreign currency contracts Cost of goods sold Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts Cost of goods sold Total $ ( 200 ) $ ( 162 ) $ Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold ( 3 ) Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts Other income (loss) net ( 5 ) ( 4 ) Interest rate contracts Interest expense ( 40 ) ( 8 ) Commodity contracts ( 1 ) Cost of goods sold ( 5 ) Total $ $ $ ( 19 ) Foreign currency contracts $ ( 226 ) Net operating revenues $ $ Foreign currency contracts ( 26 ) Cost of goods sold ( 2 ) 3 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts Other income (loss) net Interest rate contracts ( 22 ) Interest expense ( 37 ) Commodity contracts ( 6 ) Cost of goods sold ( 1 ) Total $ ( 188 ) $ $ 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and the ineffective portion, if any, to the same line items in our consolidated statement of income. 2 Effective January 1, 2019, ASU 2017-12 eliminated the requirement to separately measure and report hedge ineffectiveness for cash flow hedges. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. 3 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2019 , the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 72 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives related to our fair value hedges of this type were $ 12,523 million and $ 8,023 million as of December 31, 2019 and 2018 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. As of December 31, 2019 and 2018 , we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Interest rate contracts Interest expense $ Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) Interest rate contracts Interest expense $ Fixed-rate debt Interest expense ( 38 ) Net impact to interest expense $ ( 4 ) Foreign currency contracts Other income (loss) net $ ( 6 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ ( 4 ) Interest rate contracts Interest expense $ ( 69 ) Fixed-rate debt Interest expense Net impact to interest expense $ ( 6 ) Foreign currency contracts Other income (loss) net $ ( 37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ The following table summarizes the amounts recorded in the consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Carrying Value of the Hedged Item Cumulative Amount of Fair Value Hedging Adjustments Included in the Carrying Value of the Hedged Item 1 Balance Sheet Location of Hedged Item December 31, 2019 December 31, 2018 December 31, 2019 December 31, 2018 Current maturities of long-term debt $ 1,004 $ $ $ Long-term debt 12,087 8,043 62 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rates. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the change in the carrying value of the designated portion of the non-derivative financial instrument due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2018 2018 Foreign currency contracts $ $ $ $ ( 14 ) $ ( 7 ) Foreign currency denominated debt 12,334 12,494 653 ( 1,505 ) Total $ 12,334 $ 12,494 $ $ $ ( 1,512 ) The Company did not reclassify any gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2019 , 2018 and 2017 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2019 , 2018 and 2017 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 4,291 million and $ 10,939 million as of December 31, 2019 and 2018 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 425 million and $ 373 million as of December 31, 2019 and 2018 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ ( 4 ) $ $ ( 30 ) Foreign currency contracts Cost of goods sold ( 1 ) Foreign currency contracts Other income (loss) net ( 66 ) ( 264 ) Commodity contracts Net operating revenues Commodity contracts Cost of goods sold ( 23 ) ( 25 ) Commodity contracts Selling, general and administrative expenses Interest rate contracts Interest expense ( 1 ) Other derivative instruments Selling, general and administrative expenses ( 18 ) Other derivative instruments Other income (loss) net ( 22 ) Total $ $ ( 299 ) $ NOTE 7 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value in those investments. Refer to Note 19 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in Coca-Cola European Partners plc (""CCEP""), Monster, AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic"") and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2019 , we owned approximately 19 percent , 19 percent , 20 percent , 28 percent , 23 percent and 19 percent , respectively, of these companies' outstanding shares. As of December 31, 2019 , our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 8,679 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 75,980 $ 75,482 $ 73,343 Cost of goods sold 44,881 44,933 42,871 Gross profit $ 31,099 $ 30,549 $ 30,472 Operating income $ 7,748 $ 7,511 $ 7,577 Consolidated net income $ 4,597 $ 4,646 $ 4,545 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,534 $ 4,545 $ 4,425 Company equity income (loss) net $ 1,049 $ 1,008 $ 1,072 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, 2018 Current assets $ 25,654 $ 23,249 Noncurrent assets 68,269 66,733 Total assets $ 93,923 $ 89,982 Current liabilities $ 20,271 $ 18,100 Noncurrent liabilities 31,321 29,144 Total liabilities $ 51,592 $ 47,244 Equity attributable to shareowners of investees $ 41,203 $ 41,558 Equity attributable to noncontrolling interests 1,128 1,180 Total equity $ 42,331 $ 42,738 Company equity method investments $ 19,025 $ 19,412 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,832 million , $ 14,799 million and $ 14,144 million in 2019 , 2018 and 2017 , respectively. Total payments, primarily marketing, made to equity method investees were $ 897 million , $ 1,131 million and $ 930 million in 2019 , 2018 and 2017 , respectively. The decrease in payments made to equity method investees in 2019 was primarily due to changes in bottler funding arrangements. In addition, purchases of beverage products from equity method investees were $ 426 million , $ 536 million and $ 1,299 million in 2019 , 2018 and 2017 , respectively. The decrease in purchases of beverage products in 2019 and 2018 was primarily due to reduced purchases of Monster products as a result of the North America refranchising activities. Refer to Note 2. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2019 Fair Value Carrying Value Difference Monster Beverage Corporation $ 6,490 $ 3,781 $ 2,709 Coca-Cola European Partners plc 4,475 3,604 Coca-Cola FEMSA, S.A.B. de C.V. 3,461 1,758 1,703 Coca-Cola HBC AG 2,801 1,109 1,692 Coca-Cola Amatil Limited 1,674 1,063 Coca-Cola Bottlers Japan Holdings Inc. Coca-Cola Consolidated, Inc. Coca-Cola ecek A.. Embotelladora Andina S.A. Total $ 20,982 $ 12,089 $ 8,893 Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,707 million and $ 1,564 million as of December 31, 2019 and 2018 , respectively. The total amount of dividends received from equity method investees was $ 628 million , $ 551 million and $ 443 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2019 was $ 4,983 million . NOTE 8 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, 2018 Land $ $ Buildings and improvements 4,576 4,322 Machinery and equipment 13,686 12,804 Property, plant and equipment cost 18,921 17,611 Less: Accumulated depreciation 8,083 8,013 Property, plant and equipment net $ 10,838 $ 9,598 NOTE 9 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2018 Trademarks 1 $ 9,266 $ 6,682 Bottlers' franchise rights 51 Goodwill 1 16,764 14,109 Other 106 Indefinite-lived intangible assets $ 26,249 $ 20,948 1 Refer to Note 2 for information related to the Company's acquisitions and divestitures. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total Balance at beginning of year $ $ $ 7,954 $ $ $ 4,302 $ 13,649 Effect of foreign currency translation ( 58 ) ( 9 ) ( 4 ) ( 202 ) ( 273 ) Acquisitions 1 798 Purchase accounting adjustments 1,2 27 ( 11 ) ( 487 ) ( 60 ) Divestitures, deconsolidations and other 1 ( 5 ) ( 5 ) Balance at end of year $ 1,051 $ $ 7,943 $ $ $ 4,381 $ 14,109 Balance at beginning of year $ 1,051 $ $ 7,943 $ $ $ 4,381 $ 14,109 Effect of foreign currency translation ( 8 ) 1 75 Acquisitions 1 2,505 2,819 Purchase accounting adjustments 1,3 ( 114 ) ( 252 ) ( 239 ) Balance at end of year $ 1,294 $ $ 7,943 $ $ 2,806 $ 4,381 $ 16,764 1 For information related to the Company's acquisitions and divestitures, refer to Note 2 . 2 Includes the allocation of goodwill from the Bottling Investments segment to other reporting units expected to benefit from the consolidation of CCBA. Refer to Note 2 . 3 Includes the allocation of goodwill from the Global Ventures segment to other reporting units expected to benefit from the Costa acquisition as well as the finalization of purchase accounting related to CCBA and the Philippine bottling operations. Refer to Note 2 . Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2019 December 31, 2018 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ $ ( 177 ) $ $ $ ( 151 ) $ Bottlers' franchise rights ( 94 ) ( 18 ) Trademarks ( 99 ) ( 91 ) Other ( 30 ) ( 61 ) Total $ $ ( 400 ) $ $ $ ( 321 ) $ Total amortization expense for intangible assets subject to amortization was $ 120 million , $ 49 million and $ 68 million in 2019 , 2018 and 2017 , respectively. The increase in amortization expense in 2019 was due to the amortization of CCBA's definite-lived intangible assets that were previously classified as held for sale. Based on the carrying value of definite-lived intangible assets as of December 31, 2019 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2021 2022 2023 2024 NOTE 10 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accounts payable $ 3,804 1 $ 2,719 Accrued marketing expenses 2,059 1,787 Other accrued expenses 3,835 3,560 Accrued compensation 1,021 Accrued sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 11,312 $ 9,533 1 The increase in accounts payable in 2019 was primarily driven by extending payment terms with our suppliers. NOTE 11 : LEASES We have operating leases primarily for real estate, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2019 Operating lease ROU assets 1 $ 1,372 Current portion of operating lease liabilities 2 $ Noncurrent portion of operating lease liabilities 3 1,111 Total operating lease liabilities $ 1,392 1 Operating lease ROU assets are recorded in the line item other assets in our consolidated balance sheet. 2 The current portion of operating lease liabilities is recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet. 3 The noncurrent portion of operating lease liabilities is recorded in the line item other liabilities in our consolidated balance sheet. We had operating lease costs of $ 327 million for the year ended December 31, 2019 . During 2019, cash paid for amounts included in the measurement of operating lease liabilities was $ 339 million . Operating lease ROU assets obtained in exchange for operating lease obligations were $ 308 million for the year ended December 31, 2019 . Information associated with the measurement of our remaining operating lease obligations as of December 31, 2019 is as follows: Weighted-average remaining lease term 7 years Weighted-average discount rate % Our leases have remaining lease terms of 1 year to 25 years , inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturity of our operating lease liabilities as of December 31, 2019 (in millions): $ 2021 2022 2023 2024 Thereafter Total operating lease payments $ 1,545 Less: Imputed interest Total operating lease liabilities $ 1,392 The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2018 (in millions): $ 2020 2021 2022 2023 Thereafter Total minimum operating lease payments $ 99 NOTE 12 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2019 and 2018 , we had $ 10,007 million and $ 13,063 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 2.0 percent and 2.6 percent per year as of December 31, 2019 and 2018 , respectively. As of December 31, 2019 and 2018 , the Company also had $ 987 million and $ 772 million , respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were primarily related to our international operations. In addition, we had $ 11,911 million in unused lines of credit and other short-term credit facilities as of December 31, 2019 , of which $ 8,940 million was in backup lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2020 through 2024 . There were no borrowings under these corporate backup lines of credit during 2019 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2019 , the Company issued euro- and U.S. dollar-denominated debt of 3,500 million and $ 2,000 million , respectively. The carrying value of this debt as of December 31, 2019 was $ 5,891 million . The general terms of the notes issued are as follows: 750 million total principal amount of notes due March 8, 2021 , at a variable interest rate equal to the three month Euro Interbank Offered Rate (""EURIBOR"") plus 0.20 percent ; 1,000 million total principal amount of notes due September 22, 2022 , at a fixed interest rate of 0.125 percent ; 1,000 million total principal amount of notes due September 22, 2026 , at a fixed interest rate of 0.75 percent ; 750 million total principal amount of notes due March 8, 2031 , at a fixed interest rate of 1.25 percent ; $ 1,000 million total principal amount of notes due September 6, 2024 , at a fixed interest rate of 1.75 percent ; and $ 1,000 million total principal amount of notes due September 6, 2029 , at a fixed interest rate of 2.125 percent . During 2019 , the Company retired upon maturity euro- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: 1,500 million total principal amount of notes due March 8, 2019 , at a variable interest rate equal to the three month EURIBOR plus 0.25 percent ; 2,000 million total principal amount of notes due September 9, 2019 , at a variable interest rate equal to the three month EURIBOR plus 0.23 percent ; and $ 1,000 million total principal amount of notes due May 30, 2019 , at a fixed interest rate of 1.375 percent . During 2018 , the Company retired upon maturity U.S. dollar-denominated notes and debentures. The general terms of the notes and debentures retired are as follows: $ 26 million total principal amount of debentures due January 29, 2018 , at a fixed interest rate of 9.66 percent ; $ 750 million total principal amount of notes due March 14, 2018 , at a fixed interest rate of 1.65 percent ; $ 1,250 million total principal amount of notes due April 1, 2018 , at a fixed interest rate of 1.15 percent ; and $ 1,250 million total principal amount of notes due November 1, 2018 , at a fixed interest rate of 1.65 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $ 94 million that was due to mature on May 15, 2098 , at a fixed interest rate of 7.00 percent . Related to this extinguishment, the Company recorded a net gain of $ 27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018 . During 2017 , the Company issued U.S. dollar- and euro-denominated debt of $ 1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 was $ 3,974 million . The general terms of the notes issued are as follows: $ 500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $ 500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three month EURIBOR plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017 , the Company retired upon maturity euro-, U.S. dollar-, and Swiss franc-denominated notes. The general terms of the notes retired are as follows: 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three month EURIBOR plus 0.15 percent ; $ 206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent ; $ 750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent ; and $ 225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent ; and SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent . In 2017 , the Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of Old CCE. The extinguished notes had a carrying value of $ 417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $ 95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $ 38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $ 11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $ 36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $ 9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $ 53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $ 41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $ 32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $ 3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $ 24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $ 4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $ 38 million related to the early extinguishment of long-term debt in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017 . The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2019 December 31, 2018 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20202093 $ 14,621 2.4 % $ 13,619 2.6 % U.S. dollar debentures due 20222098 1,366 4.9 1,390 5.2 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.4 2.2 Euro notes due 20212036 12,807 0.5 12,994 0.6 Swiss franc notes due 20222028 1,129 3.7 1,128 3.6 Other, due through 2098 3 6.2 4.0 Fair value adjustments 4 N/A N/A Total 5,6 31,769 1.9 % 30,379 1.9 % Less: Current portion 4,253 5,003 Long-term debt $ 27,516 $ 25,376 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 6 for a more detailed discussion on interest rate management. 2 Amount is shown net of unamortized discounts of $ 3 million and $ 8 million as of December 31, 2019 and 2018 , respectively. 3 As of December 31, 2019 , the amount shown includes $ 409 million of debt instruments and finance leases that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 6 for additional information about our fair value hedging strategy. 5 As of December 31, 2019 and 2018 , the fair value of our long-term debt, including the current portion, was $ 32,725 million and $ 30,456 million , respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE in 2010 of $ 186 million and $ 212 million as of December 31, 2019 and 2018 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2019 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 921 million , $ 903 million and $ 803 million in 2019 , 2018 and 2017 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2019 are as follows (in millions): Maturities of Long-Term Debt $ 4,253 3,767 3,788 4,097 1,974 NOTE 13 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2019 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 621 million , of which $ 249 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 16 . On September 17, 2015, the Company received a Statutory Notice of Deficiency (the ""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009 after a five-year audit. In the Notice, the IRS claimed that the Company's U.S. taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $ 3.3 billion for the period plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing, and promotion of products in certain foreign markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement (the ""Closing Agreement"") that applied back to 1987. The Closing Agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent a change in material facts or circumstances or relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the Closing Agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the Closing Agreement. The IRS designated the matter for litigation on October 15, 2015. Due to the fact that the matter remains designated, the Company is prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $ 385 million resulting in an additional tax adjustment of $ 135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $ 138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in April 2019. It is not known how much time will elapse thereafter prior to the issuance of the court's opinion. In the interim, or subsequent to the court's opinion, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the Notice ultimately could be sustained. In that event, the Company may be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Reform Act. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 301 million and $ 362 million as of December 31, 2019 and 2018 , respectively . NOTE 14 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 201 million , $ 225 million and $ 219 million in 2019 , 2018 and 2017 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 43 million , $ 47 million and $ 44 million in 2019 , 2018 and 2017 , respectively. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2019 , we had $ 258 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.0 years as stockbased compensation expense, and it does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2019 , there were 367.8 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available for grants of stock option and restricted stock awards. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2019 , 2018 and 2017 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, Fair value of stock options on grant date $ 4.94 $ 4.97 $ 3.98 Dividend yield 1 3.5 % 3.5 % 3.6 % Expected volatility 2 15.5 % 15.5 % 15.5 % Risk-free interest rate 3 2.6 % 2.8 % 2.2 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from treasury shares. Stock option activity for all plans for the year ended December 31, 2019 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2019 $ 36.74 Granted 45.46 Exercised ( 34 ) 33.29 Forfeited/expired ( 2 ) 42.88 Outstanding on December 31, 2019 $ 38.43 4.41 years $ 1,785 Expected to vest $ 38.37 4.37 years $ 1,773 Exercisable on December 31, 2019 $ 37.33 3.69 years $ 1,599 The total intrinsic value of the stock options exercised was $ 609 million , $ 721 million and $ 744 million in 2019 , 2018 and 2017 , respectively. The total number of stock options exercised was 34 million , 47 million and 53 million in 2019 , 2018 and 2017 , respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share units granted from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are vested and released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018 and 2019, performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include the TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018 and 2019 will be vested and released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends until the shares are vested and released. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2019 , performance share units of approximately 2,662,000 were outstanding for the 2017-2019 performance period and growth share units of approximately 1,949,000 and 2,220,000 were outstanding for the 2018-2020 and 2019-2021 performance periods, respectively, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2019 7,698 $ 38.45 Granted 2,348 40.29 Conversions into restricted stock units 1 ( 2,756 ) 39.70 Paid in cash equivalent ( 1 ) 40.62 Canceled/forfeited ( 458 ) 38.53 Outstanding on December 31, 2019 2 6,831 $ 38.57 1 Represents the target amount of performance share units converted into restricted stock units for the 2016-2018 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units and growth share units as of December 31, 2019 at the threshold award and maximum award levels were 2.6 million and 14.2 million , respectively. The weighted-average grant date fair value of growth share units granted in 2019 and 2018 was $ 40.29 and $ 41.02 , respectively. The weighted-average grant date fair value of performance share units granted in 2017 was $ 34.75 . The Company converted performance share units of 1,418 in 2019 and 11,052 in 2017 into cash equivalent payments of $ 0.1 million and $ 0.4 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The Company did not convert any performance share units into cash equivalent payments in 2018 . The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2019 2,591 $ 36.24 Conversions from performance share units 3,355 39.70 Vested and released ( 2,575 ) 36.12 Canceled/forfeited ( 176 ) 39.37 Nonvested on December 31, 2019 3,195 $ 39.70 The total intrinsic value of restricted shares that were vested and released in 2019 was $ 118 million . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2019 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of approximately 4,054,000 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2019 3,422 $ 40.31 Granted 1,615 42.31 Vested and released ( 528 ) 42.35 Forfeited/expired ( 455 ) 41.41 Nonvested on December 31, 2019 4,054 $ 40.73 NOTE 15 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2019 , the primary U.S. plan represented 61 percent of both the Company's consolidated projected benefit obligation and pension assets. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Benefit obligation at beginning of year 1 $ 8,015 $ 9,469 $ $ Service cost 124 11 Interest cost 296 25 Participant contributions 2 1 9 Foreign currency exchange rate changes ( 28 ) ( 112 ) ( 2 ) ( 7 ) Amendments ( 1 ) ( 8 ) Net actuarial loss (gain) ( 470 ) ( 35 ) Benefits paid 3 ( 537 ) ( 358 ) ( 86 ) ( 70 ) Business combinations 4 Divestitures ( 11 ) Settlements 5 ( 19 ) ( 932 ) Curtailments 5 ( 2 ) ( 63 ) ( 2 ) Special termination benefits 5 7 Other 3 ( 2 ) Benefit obligation at end of year 1 $ 8,757 $ 8,015 $ $ Fair value of plan assets at beginning of year $ 7,429 $ 8,866 $ $ Actual return on plan assets 1,111 ( 269 ) ( 5 ) Employer contributions 107 Participant contributions 2 1 9 Foreign currency exchange rate changes ( 26 ) ( 131 ) Benefits paid ( 453 ) ( 287 ) ( 3 ) ( 3 ) Business combinations 4 Divestitures ( 1 ) Settlements 5 ( 18 ) ( 892 ) Other Fair value of plan assets at end of year $ 8,080 $ 7,429 $ $ Net liability recognized $ ( 677 ) $ ( 586 ) $ ( 418 ) $ ( 430 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 8,607 million and $ 7,867 million as of December 31, 2019 and 2018 , respectively. 2 In prior year disclosures, participant contributions were included in the Other line item. 3 Benefits paid to pension plan participants during 2019 and 2018 included $ 84 million and $ 71 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2019 and 2018 included $ 83 million and $ 67 million , respectively, that were paid from Company assets. 4 Business combinations were primarily related to the acquisition of a controlling interest in the Philippine bottling operations in 2018. Refer to Note 2 . 5 Settlements, curtailments and special termination benefits were primarily related to our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 20 . Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, 2018 2018 Other assets $ $ $ $ Accounts payable and accrued expenses ( 72 ) ( 70 ) ( 21 ) ( 21 ) Other liabilities ( 1,603 ) ( 1,329 ) ( 397 ) ( 409 ) Net liability recognized $ ( 677 ) $ ( 586 ) $ ( 418 ) $ ( 430 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, 2018 Projected benefit obligations $ 7,194 $ 6,562 Fair value of plan assets 5,515 5,163 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, 2018 Accumulated benefit obligations $ 7,052 $ 6,451 Fair value of plan assets 5,485 5,157 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, 2018 2018 Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,231 1,116 644 International-based companies 659 462 Fixed-income securities: Government bonds 192 271 Corporate bonds and debt securities 745 90 Mutual, pooled and commingled funds 1 238 637 Hedge funds/limited partnerships 785 43 Real estate 385 6 Other 412 261 Total pension plan assets 2 $ 5,149 $ 4,842 $ 2,931 $ 2,587 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 18 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2019 , no investment manager was responsible for more than 11 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 5 percent of our total global equities and approximately 3 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent . These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2019 , the long-term target allocation for 68 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 64 percent equity securities, 4 percent fixed-income securities and 32 percent other investments. The actual allocation for the remaining 32 percent of the Company's international subsidiaries' plan assets consisted of 57 percent mutual, pooled and commingled funds; 7 percent fixed-income securities; 1 percent equity securities and 35 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, 2018 Cash and cash equivalents $ $ Equity securities: U.S.-based companies 93 International-based companies 7 Fixed-income securities: Government bonds 2 Corporate bonds and debt securities 16 Mutual, pooled and commingled funds 82 Hedge funds/limited partnerships 8 Real estate 4 Other 4 Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 18 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Service cost $ $ $ $ $ $ Interest cost 296 25 Expected return on plan assets 1 ( 552 ) ( 650 ) ( 650 ) ( 13 ) ( 13 ) ( 12 ) Amortization of prior service credit ( 4 ) ( 3 ) ( 2 ) ( 14 ) ( 18 ) Amortization of net actuarial loss 2 128 3 Net periodic benefit cost (income) ( 10 ) ( 105 ) 12 Settlement charges 3 240 Curtailment charges (credits) 3 4 ( 2 ) ( 4 ) ( 79 ) Special termination benefits 3 7 Other ( 1 ) Total cost (income) recognized in consolidated statements of income $ ( 2 ) $ $ $ $ $ ( 55 ) 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 20 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ ( 2,482 ) $ ( 2,493 ) $ ( 15 ) $ ( 26 ) Recognized prior service cost (credit) ( 4 ) 3 ( 4 ) 5 ( 18 ) 6 Recognized net actuarial loss 1 4 Prior service credit (cost) occurring during the year ( 1 ) Net actuarial (loss) gain occurring during the year ( 370 ) 2 ( 386 ) 3 ( 44 ) 5 Impact of divestitures Foreign currency translation gain Balance in AOCI at end of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) 1 Includes $ 6 million of recognized net actuarial loss due to the impact of settlements. 2 Includes $ 2 million of net actuarial gain occurring during the year due to the impact of curtailments . 3 Includes $ 4 million of recognized prior service cost and $ 63 million of net actuarial gain occurring during the year due to the impact of curtailments. 4 Includes $ 240 million of recognized net actuarial loss due to the impact of settlements. 5 Includes $ 2 million of recognized prior service credit and $ 2 million of net actuarial gain occurring during the year due to the impact of curtailments. 6 Includes $ 4 million of recognized prior service credit due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, 2018 2018 Prior service credit (cost) $ ( 12 ) $ ( 12 ) $ $ Net actuarial loss ( 2,666 ) ( 2,470 ) ( 82 ) ( 43 ) Balance in AOCI at end of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2020 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service credit $ $ ( 2 ) Amortization of net actuarial loss 5 Total $ $ 112 Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, 2018 2018 Discount rate 3.25 % 4.00 % 3.50 % 4.25 % Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost (income) are as follows: Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Discount rate 4.00 % 3.50 % 4.00 % 4.25 % 3.50 % 4.00 % Rate of increase in compensation levels 3.75 % 3.50 % 3.75 % N/A N/A N/A Expected long-term rate of return on plan assets 7.75 % 8.00 % 8.00 % 4.50 % 4.50 % 4.75 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2019 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2019 net periodic pension cost for the U.S. plans was 7.75 percent . As of December 31, 2019 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 7.4 percent , 8.9 percent and 6.7 percent , respectively. The annualized return since inception was 10.5 percent . The weighted-average assumptions for health care cost trend rates are as follows : December 31, 2018 Health care cost trend rate assumed for next year 6.75 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.00 % Year that the rate reaches the ultimate trend rate 2023 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 2021 2023 20252029 Pension benefit payments $ $ $ $ $ $ 2,543 Other benefit payments 1 58 54 240 Total estimated benefit payments $ $ $ $ $ $ 2,783 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $ 3 million for the period 20202024 and $ 2 million for the period 20252029. The Company anticipates making pension contributions in 2020 of $ 28 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limits. Company costs related to the U.S. plans were $ 43 million , $ 39 million and $ 61 million in 2019 , 2018 and 2017 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $ 64 million , $ 59 million and $ 42 million in 2019 , 2018 and 2017 , respectively. Multi-Employer Pension Plans The Company participates in various multi-employer pension plans. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for multi-employer pension plans totaled $ 5 million , $ 6 million and $ 35 million in 2019 , 2018 and 2017 , respectively. The decrease in 2018 was primarily driven by the refranchising of certain bottling territories in the United States during 2017. The plans we currently participate in have contractual arrangements that extend into 2021 . If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. Refer to Note 2 for additional information on North America refranchising. NOTE 16 : INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, United States $ 3,249 $ $ ( 690 ) 1 International 7,537 7,337 7,580 Total $ 10,786 $ 8,225 $ 6,890 1 Includes net charges of $ 2,140 million related to refranchising certain bottling territories in North America in 2017 . Refer to Note 2 . Income taxes consisted of the following (in millions): United States State and Local International Total Current $ $ $ 1,479 $ 2,081 Deferred ( 65 ) ( 267 ) ( 280 ) Current $ 1 $ $ 1,426 $ 2,162 Deferred ( 386 ) 1 ( 81 ) 1 1 ( 413 ) Current $ 5,438 2 $ $ 1,300 $ 6,859 Deferred ( 1,783 ) 2,3 2 ( 1,252 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). 2 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017 . The provisional amount as of December 31, 2017 related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $ 4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated at that time to be $ 42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $ 1.0 billion . 3 Includes the net tax benefit from net charges related to refranchising certain bottling territories in North America. Refer to Note 2 . We made income tax payments of $ 2,126 million , $ 2,120 million and $ 1,950 million in 2019 , 2018 and 2017 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 335 million , $ 318 million and $ 221 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 21.0 % 21.0 % 35.0 % State and local income taxes net of federal benefit 0.9 1.5 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.1 1,2,3 3.1 5,6 ( 9.5 ) Equity income or loss ( 1.6 ) ( 2.5 ) ( 3.3 ) Tax Reform Act 0.1 7 52.4 8 Excess tax benefits on stock-based compensation ( 0.9 ) ( 1.3 ) ( 1.9 ) Other net ( 3.8 ) 4 ( 0.6 ) 7.6 9,10 Effective tax rate 16.7 % 21.3 % 81.4 % 1 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 3 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 4 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $ 591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $ 554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. Refer to Note 18 . 6 Includes net tax expense of $ 28 million on net pretax charges of $ 403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 . 7 Includes net tax expense of $ 8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 8 Includes net tax expense of $ 3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 9 Includes net tax expense of $ 1,048 million on a pretax gain of $ 1,037 million (or a 9.9 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment, and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 . 10 Includes a $ 156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits of approximately $ 41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $ 4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $ 0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $ 0.3 billion in tax for our one-time transition tax and a tax benefit of $ 0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $ 13.4 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiary's earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2006 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 13 . As of December 31, 2019 , the gross amount of unrecognized tax benefits was $ 392 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 173 million , exclusive of any benefits related to interest and penalties. The remaining $ 219 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Balance of unrecognized tax benefits at the beginning of year $ $ $ Increase related to prior period tax positions 1 18 Decrease related to prior period tax positions ( 2 ) ( 13 ) Increase related to current period tax positions 17 Decrease related to settlements with taxing authorities ( 174 ) 2 ( 4 ) Increase (decrease) due to effect of foreign currency exchange rate changes ( 3 ) ( 17 ) Balance of unrecognized tax benefits at the end of year $ $ $ 1 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 2 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 201 million , $ 190 million and $ 177 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2019 , 2018 and 2017 , respectively. Of these amounts, $ 11 million , $ 13 million and $ 35 million of expense were recognized through income tax expense in 2019 , 2018 and 2017 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets 2,267 2,540 Equity method investments (including foreign currency translation adjustments) Derivative financial instruments Other liabilities 1,066 Benefit plans Net operating/capital loss carryforwards Other Gross deferred tax assets 5,597 5,484 Valuation allowances ( 303 ) ( 419 ) Total deferred tax assets $ 5,294 $ 5,065 Deferred tax liabilities: Property, plant and equipment $ ( 877 ) $ ( 922 ) Trademarks and other intangible assets ( 1,533 ) ( 1,179 ) Equity method investments (including foreign currency translation adjustments) ( 1,667 ) ( 1,707 ) Derivative financial instruments ( 348 ) ( 162 ) Other liabilities ( 351 ) ( 67 ) Benefit plans ( 286 ) ( 255 ) Other ( 104 ) ( 453 ) Total deferred tax liabilities $ ( 5,166 ) $ ( 4,745 ) Net deferred tax assets $ $ As of December 31, 2019 and 2018 , we had net deferred tax assets of $ 1.3 billion and $ 1.6 billion , respectively, located in countries outside the United States. As of December 31, 2019 , we had $ 2,396 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 472 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Deductions ( 264 ) ( 183 ) ( 213 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2019 , the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be non-deductible and the changes in net operating losses in the normal course of business. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. In 2018 , the Company recognized a net decrease of $ 100 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. In 2017 , the Company recognized a net decrease of $ 11 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity method investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity method investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. NOTE 17 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments 1 $ ( 11,270 ) $ ( 11,045 ) Accumulated derivative net gains (losses) 1,2 ( 209 ) ( 126 ) Unrealized net gains (losses) on available-for-sale securities 1 Adjustments to pension and other benefit liabilities 1 ( 2,140 ) ( 1,693 ) Accumulated other comprehensive income (loss) $ ( 13,544 ) $ ( 12,814 ) 1 The change in the balance from December 31, 2018 includes a portion of a $ 558 million reclassification to reinvested earnings from AOCI upon the adoption of ASU 2018-02. Refer to Note 1 . 2 The change in the balance from December 31, 2018 includes a $ 6 million reclassification to reinvested earnings from AOCI upon the adoption of ASU 2017-12. Refer to Note 6 . The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2019 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 8,920 $ $ 8,985 Other comprehensive income: Net foreign currency translation adjustments 45 Net gains (losses) on derivatives 1 ( 54 ) ( 54 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 Net change in pension and other benefit liabilities 3 ( 159 ) ( 159 ) Total comprehensive income $ 8,754 $ $ 8,864 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2019 , 2018 and 2017 is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 ( 49 ) Net foreign currency translation adjustments $ $ ( 103 ) $ Derivatives: Gains (losses) arising during the year $ ( 225 ) $ $ ( 176 ) Reclassification adjustments recognized in net income ( 41 ) Net gains (losses) on derivatives 1 $ ( 62 ) $ $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ $ ( 4 ) $ Reclassification adjustments recognized in net income ( 31 ) ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ $ $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ ( 379 ) $ $ ( 274 ) Reclassification adjustments recognized in net income ( 36 ) Net change in pension and other benefit liabilities 3 $ ( 228 ) $ $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,728 ) $ $ ( 1,669 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,296 ) ( 1,296 ) Gains (losses) on net investment hedges arising during the year 1 ( 160 ) Net foreign currency translation adjustments $ ( 1,987 ) $ ( 101 ) $ ( 2,088 ) Derivatives: Gains (losses) arising during the year $ $ ( 16 ) $ Reclassification adjustments recognized in net income ( 68 ) ( 50 ) Net gains (losses) on derivatives 1 $ ( 9 ) $ $ ( 7 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 50 ) $ $ ( 39 ) Reclassification adjustments recognized in net income Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 45 ) $ $ ( 34 ) Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ ( 299 ) $ $ ( 224 ) Reclassification adjustments recognized in net income ( 88 ) Net change in pension and other benefit liabilities 3 $ $ ( 13 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,999 ) $ ( 101 ) $ ( 2,100 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,350 ) $ ( 242 ) $ ( 1,592 ) Reclassification adjustments recognized in net income ( 6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year 1 ( 1,512 ) ( 934 ) Net foreign currency translation adjustments $ $ $ Derivatives: Gains (losses) arising during the year $ ( 184 ) $ $ ( 119 ) Reclassification adjustments recognized in net income ( 506 ) ( 314 ) Net gains (losses) on derivatives 1 $ ( 690 ) $ $ ( 433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year $ $ ( 136 ) $ Reclassification adjustments recognized in net income ( 123 ) ( 81 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ ( 94 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ $ ( 7 ) $ Reclassification adjustments recognized in net income ( 116 ) Net change in pension and other benefit liabilities 3 $ $ ( 123 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2019 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ Income before income taxes Income taxes Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ Foreign currency and commodity contracts Cost of goods sold ( 11 ) Foreign currency contracts Other income (loss) net Divestitures, deconsolidations and other Other income (loss) net Foreign currency and interest rate contracts Interest expense Income before income taxes Income taxes ( 41 ) Consolidated net income $ Available-for-sale securities: Sale of securities Other income (loss) net $ ( 31 ) Income before income taxes ( 31 ) Income taxes Consolidated net income $ ( 25 ) Pension and other benefit liabilities: Settlement charges 2 Other income (loss) net $ Curtailment charges 2 Other income (loss) net ( 2 ) Recognized net actuarial loss Other income (loss) net Recognized prior service cost (credit) Other income (loss) net ( 6 ) Income before income taxes Income taxes ( 36 ) Consolidated net income $ 1 Primarily related to our previously held equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . 2 The settlement and curtailment charges were primarily related to our productivity and reinvestment program. Refer to Note 15 and Note 20 . NOTE 18 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2019 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,877 $ $ $ $ $ 2,219 Debt securities 1 3,291 3,328 Derivatives 2 579 ( 392 ) 5 6 Total assets $ 1,886 $ 4,089 $ $ $ ( 392 ) $ 5,743 Liabilities: Derivatives 2 $ $ ( 162 ) $ $ $ $ ( 32 ) 6 Total liabilities $ $ ( 162 ) $ $ $ $ ( 32 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $ 261 million in cash collateral it has netted against its derivative position. 6 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 196 million in the line item other assets and $ 32 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. December 31, 2018 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,681 $ $ $ $ $ 1,934 Debt securities 1 5,018 5,037 Derivatives 2 313 ( 261 ) 5 7 Total assets $ 1,683 $ 5,517 $ $ $ ( 261 ) $ 7,025 Liabilities: Derivatives 2 $ ( 14 ) $ ( 221 ) $ $ $ 6 $ ( 53 ) 7 Total liabilities $ ( 14 ) $ ( 221 ) $ $ $ $ ( 53 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $ 96 million in cash collateral it has netted against its derivative position. 6 The Company has the right to reclaim $ 4 million in cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 54 million in the line item other assets; $ 3 million in the line item accounts payable and accrued expenses; and $ 50 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2019 and 2018 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2019 and 2018 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges, or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, Other-than-temporary impairment charges $ ( 767 ) 1 $ ( 591 ) 1 CCBA asset adjustments ( 160 ) 2 ( 554 ) 2 Investment in former equity method investee ( 118 ) 3 ( 32 ) 3 Other long-lived asset impairment charges ( 312 ) 5 Intangible asset impairment charges ( 42 ) 4 ( 138 ) 5 Total $ ( 1,087 ) $ ( 1,627 ) 1 During the year ended December 31, 2019 , the Company recorded other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee. Based on the extent to which the market value of our investment in CCBJHI has been less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. These impairment charges were determined using the quoted market prices (a Level 1 measurement) of CCBJHI. During the year ended December 31, 2019 , we also recorded other-than-temporary impairment charges of $ 255 million related to certain equity method investees in the Middle East. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results largely related to instability in the region and changes in local excise taxes. During the year ended December 31, 2019 , we recorded an other-than-temporary impairment charge of $ 57 million related to one of our equity method investees in North America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. During the year ended December 31, 2019 , we also recorded an other-than-temporary impairment charge of $ 49 million related to one of our equity method investees in Latin America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. During the year ended December 31, 2018 , we recognized other-than-temporary impairment charges of $ 334 million related to certain equity method investees in the Middle East. These impairments were primarily driven by revised projections of future operating results largely related to instability in the region, which include sanctions imposed locally. During the year ended December 31, 2018 , we recognized an other-than-temporary impairment charge of $ 205 million related to our equity method investee in Indonesia. This impairment was primarily driven by revised projections of future operating results reflecting unfavorable macroeconomic conditions and foreign currency exchange rate fluctuations. This impairment charge was derived using discounted cash flow analyses based on Level 3 inputs. During the year ended December 31, 2018 , we recognized an other-than-temporary impairment charge of $ 52 million related to one of our equity method investees in Latin America. This impairment was primarily driven by revised projections of future operating results. This impairment charge was derived using discounted cash flow analyses based on Level 3 inputs. 2 During the year ended December 31, 2018 , the Company recorded an impairment charge of $ 554 million related to assets held by CCBA. This charge was incurred primarily as a result of management's view of the proceeds that were expected to be received upon the sale of CCBA based on revised projections of future operating results and foreign currency exchange rate fluctuations. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. As a result of CCBA no longer being classified as held for sale, during the year ended December 31, 2019 , the Company was required to measure CCBA's property, plant and equipment and definite-lived intangible assets at the lower of their current fair values or their carrying amounts before they were classified as held for sale, adjusted for depreciation and amortization expense that would have been recognized had the business been classified as held and used during the period that CCBA was classified as held for sale. As a result, we reduced the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by $ 34 million and $ 126 million , respectively, based on Level 3 inputs. Refer to Note 2 . 3 During the year ended December 31, 2019 , the Company recognized a net loss of $ 118 million in conjunction with our acquisition of the remaining equity ownership interest in CHI, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. During the year ended December 31, 2018 , the Company recognized a loss of $ 32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. Refer to Note 2 . 4 The Company recorded an impairment charge of $ 42 million related to a trademark in Asia Pacific, which was primarily driven by revised projections of future operating results for the trademark. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recognized charges of $ 312 million related to CCR's property, plant and equipment and $ 138 million related to CCR's intangible assets. These charges were a result of management's revised estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 15 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The f ollowing table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2019 December 31, 2018 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 1,876 21 1,904 1,728 17 1,760 International-based companies 1,354 1,387 1,098 1,121 Fixed-income securities: Government bonds Corporate bonds and debt securities 40 16 Mutual, pooled and commingled funds 258 3 130 3 Hedge funds/limited partnerships 4 4 Real estate 5 5 Other 2 6 2 6 Total $ 3,867 $ 1,902 $ $ 1,977 $ 8,080 $ 3,333 $ 1,472 $ $ 2,321 $ 7,429 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 15 . 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semi-annually, with a redemption notice period of up to 180 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually, with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The f ollowing table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date ( 2 ) ( 1 ) Purchases, sales and settlements net ( 7 ) ( 2 ) ( 5 ) Transfers into (out of) Level 3 net Foreign currency translation adjustments ( 13 ) ( 13 ) Balance at end of year $ $ $ $ 1 $ 2019 Actual return on plan assets held at the reporting date Purchases, sales and settlements net 21 Transfers into (out of) Level 3 net 3 Foreign currency translation adjustments ( 8 ) ( 8 ) Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The f ollowing table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2019 December 31, 2018 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 82 82 Hedge funds/limited partnerships 7 8 Real estate 4 4 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 15 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2019 , the carrying amount and fair value of our long-term debt, including the current portion, were $ 31,769 million and $ 32,725 million , respectively. As of December 31, 2018 , the carrying amount and fair value of our long-term debt, including the current portion, were $ 30,379 million and $ 30,456 million , respectively. NOTE 19 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2019, the Company recorded other operating charges of $ 458 million . These charges included $ 264 million related to the Company's productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisition of Costa and the refranchising of our bottling operations. Refer to Note 18 for additional information on the trademark impairment charge. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $ 1,079 million . These charges primarily consisted of $ 450 million of CCR asset impairments and $ 440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $ 33 million related to tax litigation expense and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 13 for additional information related to the tax litigation. Refer to Note 18 for additional information on the impairment charges. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $ 1,902 million . These charges primarily consisted of $ 737 million of CCR asset impairments and $ 534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $ 225 million related to a cash contribution we made to The Coca-Cola Foundation, $ 67 million related to tax litigation expense, $ 34 million related to impairments of Venezuelan intangible assets and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2018 , the Company recorded a net gain of $ 27 million related to the early extinguishment of long-term debt. Refer to Note 12 . During the year ended December 31, 2017, the Company recorded a net charge of $ 38 million related to the early extinguishment of long-term debt. Refer to Note 12 . Equity Income (Loss) Net The Company recorded net charges of $ 100 million , $ 111 million and $ 92 million in equity income (loss) net during the years ended December 31, 2019 , 2018 and 2017 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2019, other income (loss) net was income of $ 34 million . The Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our equity ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America, and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Additionally, the Company recognized net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $ 4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 18 for additional information on the CCBA asset adjustment, impairment charges and the loss recognized in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 21 for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $ 1,674 million . The Company recorded other-than-temporary impairment charges of $ 591 million related to certain of our equity method investees, an impairment charge of $ 554 million related to assets held by CCBA and net charges of $ 476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $ 278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $ 240 million related to pension settlements, and a net loss of $ 79 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Additionally, we recorded charges of $ 34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $ 33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and a $ 32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $ 296 million related to the sale of our equity ownership in Lindley and a net gain of $ 47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley, our acquisition of the controlling interest in the Philippine bottling operations and our acquisition of Costa. Refer to Note 6 for additional information on our hedging activities. Refer to Note 18 for additional information on the impairment charges. Refer to Note 21 for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $ 1,763 million . The Company recognized net charges of $ 2,140 million due to the refranchising of certain bottling territories in North America and charges of $ 313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $ 255 million resulting from settlements, special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $ 50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $ 26 million related to our former German bottling operations. These charges were partially offset by a gain of $ 445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $ 150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $ 88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $ 25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 21 for the impact these items had on our operating segments and Corporate. NOTE 20 : PRODUCTIVITY AND REINVESTMENT PROGRAM In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focuses on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Certain productivity initiatives included in this program, primarily related to our enabling services organization, will continue beyond 2019. The Company has incurred total pretax expenses of $ 3,830 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 181 ) ( 83 ) ( 267 ) ( 531 ) Noncash and exchange ( 62 ) 1 ( 1 ) ( 1 ) ( 64 ) Accrued balance at end of year $ $ $ $ 2018 Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 209 ) ( 83 ) ( 211 ) ( 503 ) Noncash and exchange ( 69 ) 1 ( 52 ) ( 121 ) Accrued balance at end of year $ $ $ $ 2019 Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 1 ( 19 ) ( 14 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 15 . NOTE 21 : OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3 . The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 42 Total % % % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2018 United States $ 11,715 $ 11,344 $ 14,727 International 25,551 22,956 21,485 Net operating revenues $ 37,266 $ 34,300 $ 36,212 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2018 United States $ 4,062 $ 4,154 $ 4,163 International 6,776 5,444 5,475 Property, plant and equipment net $ 10,838 $ 9,598 $ 9,638 Information about our Company's operations by operating segment and Corporate as of and for the years ended December 31, 2019 , 2018 and 2017 is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ $ $ 37,266 Intersegment ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 ( 1,408 ) 10,086 Interest income Interest expense Depreciation and amortization 1,365 Equity income (loss) net ( 32 ) ( 6 ) ( 3 ) 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 ( 824 ) 10,786 Identifiable operating assets 8,143 1 1,801 17,687 2,060 7,265 11,170 1 18,376 66,502 Investments 2 14,093 3,931 19,879 Capital expenditures 2,054 Net operating revenues: Third party $ 6,535 $ 3,971 $ 11,370 $ 4,797 $ $ 6,768 $ $ $ 34,300 Intersegment ( 1,273 ) Total net operating revenues 7,099 4,010 11,630 5,185 6,787 ( 1,273 ) 34,300 Operating income (loss) 3,693 2,318 2,318 2,271 ( 197 ) ( 1,403 ) 9,152 Interest income Interest expense Depreciation and amortization 1,086 Equity income (loss) net ( 19 ) ( 2 ) 1,008 Income (loss) before income taxes 3,386 2,243 2,345 2,298 ( 159 ) ( 2,053 ) 8,225 Identifiable operating assets 7,414 1 1,715 17,519 1,996 10,525 1 22,800 62,937 Investments 2 14,372 3,718 20,279 Capital expenditures 1,548 Net operating revenues: Third party $ 6,780 $ 3,953 $ 8,678 $ 4,753 $ $ 11,223 $ $ $ 36,212 Intersegment 1,951 ( 2,561 ) Total net operating revenues 6,822 4,026 10,629 5,162 11,306 ( 2,561 ) 36,212 Operating income (loss) 3,585 2,215 2,472 2,136 ( 806 ) ( 2,006 ) 7,755 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net ( 3 ) ( 3 ) 1,072 Income (loss) before income taxes 3,666 2,209 2,192 2,168 ( 2,202 ) ( 1,310 ) 6,890 Capital expenditures 1,750 1 Property, plant and equipment net in South Africa represented 16 percent and 14 percent of consolidated property, plant and equipment net in 2019 and 2018, respectively. 2 Principally equity method investments and other investments in bottling companies. During 2019 , 2018 and 2017 , our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2 . In 2019 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2 . Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Refer to Note 18 . Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2 . Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2018 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 4 million for Latin America, $ 175 million for North America, $ 31 million for Bottling Investments and $ 237 million for Corporate, and increased by $ 3 million for Europe, Middle East and Africa and $ 4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) before income taxes was reduced by $ 64 million for Corporate and $ 4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 15 and Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 450 million for Bottling Investments due to asset impairment charges. Refer to Note 18 . Operating income (loss) and income (loss) before income taxes were reduced by $ 139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 33 million for Corporate due to tax litigation expense. Refer to Note 13 . Operating income (loss) and income (loss) before income taxes were reduced by $ 19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) before income taxes was increased by $ 296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2 . Income (loss) before income taxes was increased by $ 47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2 . Income (loss) before income taxes was increased by $ 27 million for Corporate related to a net gain on the extinguishment of long-term debt. Refer to Note 12 . Income (loss) before income taxes was reduced by $ 554 million for Corporate as a result of an impairment charge related to assets held by CCBA. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 334 million for Europe, Middle East and Africa, $ 205 million for Bottling Investments and $ 52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) before income taxes was reduced by $ 124 million for Bottling Investments and increased by $ 13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 149 million for Bottling Investments due to pension settlements related to the refranchising of certain of our North America bottling operations. Refer to Note 15 . Income (loss) before income taxes was reduced by $ 79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Income (loss) before income taxes was reduced by $ 34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) before income taxes was reduced by $ 32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . In 2017 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 26 million for Europe, Middle East and Africa, $ 7 million for Latin America, $ 241 million for North America, $ 10 million for Asia Pacific, $ 57 million for Bottling Investments and $ 193 million for Corporate due to the Company's productivity and reinvestment program. Income (loss) before income taxes was also reduced by $ 116 million for Corporate due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 15 and Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 737 million for Bottling Investments and $ 34 million for Corporate due to asset impairment charges. Operating income (loss) was reduced by $ 280 million and income (loss) before income taxes was reduced by $ 419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 . Operating income (loss) and income (loss) before income taxes were reduced by $ 225 million for Corporate as a result of a cash contribution we made to The Coca-Cola Foundation. Operating income (loss) and income (loss) before income taxes were reduced by $ 67 million for Corporate due to tax litigation expense. Refer to Note 13 . Income (loss) before income taxes was increased by $ 445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 19 . Income (loss) before income taxes was increased by $ 150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) before income taxes was increased by $ 88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and selling a related cost method investment. Refer to Note 2 . Income (loss) before income taxes was increased by $ 25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Income (loss) before income taxes was reduced by $ 2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Income (loss) before income taxes was reduced by $ 38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 12 . Income (loss) before income taxes was reduced by $ 26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) before income taxes was reduced by $ 4 million for Europe, Middle East and Africa, $ 2 million for North America, $ 70 million for Bottling Investments and $ 16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. NOTE 22 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, 2018 (Increase) decrease in trade accounts receivable $ ( 158 ) $ $ ( 108 ) (Increase) decrease in inventories ( 183 ) ( 203 ) ( 276 ) (Increase) decrease in prepaid expenses and other assets ( 87 ) ( 221 ) Increase (decrease) in accounts payable and accrued expenses 1 1,318 ( 251 ) ( 573 ) Increase (decrease) in accrued income taxes ( 17 ) ( 159 ) Increase (decrease) in other liabilities 2 ( 620 ) ( 575 ) 4,052 Net change in operating assets and liabilities $ $ ( 1,240 ) $ 3,442 1 The increase in accounts payable and accrued expenses in 2019 was primarily due to extending payment terms with our suppliers. 2 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 16 . NOTE 23 : SUBSEQUENT EVENT In January 2020, the Company acquired the remaining 57.5 percent stake in fairlife, LLC (""fairlife"") and now owns 100 percent of fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. Value-added dairy products have been one of the fastest-growing nonalcoholic beverage categories in the United States, with fairlife being a large contributor to sales growth. fairlife's success has been supported by new product innovations, ranging from lactose-free, ultra-filtered milk with less sugar and more protein than competing brands, to high-protein recovery and nutrition shakes and drinkable snacks. A significant portion of fairlife's revenues is already reflected in our consolidated financial statements, as we have operated as the sales and distribution organization for certain fairlife products. Under the terms of the agreement, we paid $ 1.0 billion upon the close of the transaction and are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting value of which is not subject to a ceiling. We are currently in the process of finalizing the accounting for this transaction, including the valuation of the expected milestone payments and the remeasurement of our previously held equity interest. We expect to complete these valuations, as well as our preliminary allocation of the purchase consideration to the assets acquired and liabilities assumed, by the end of the first quarter of 2020. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2019 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2020 Proxy Statement. James R. Quincey Larry M. Mark Chairman of the Board of Directors and Chief Executive Officer February 24, 2020 Vice President and Controller February 24, 2020 John Murphy Mark Randazza Executive Vice President and Chief Financial Officer February 24, 2020 Vice President, Assistant Controller and Chief Accounting Officer February 24, 2020 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2020 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 13 and Note 16 to the consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2019, the gross amount of unrecognized tax benefits was $392 million. Additionally, as described in Note 13, on September 17, 2015 the Company received a Statutory Notice of Deficiency (Notice) from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period, plus interest. While the Company continues to disagree strongly with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS Notice, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of the status of the litigation with the IRS, including inquiries of tax counsel and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 13 and Note 16. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 of the Companys consolidated financial statements, the Company performs an annual impairment assessment of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment assessment may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $9,266 million and $16,764 million, respectively, at December 31, 2019. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, and tax rates, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment assessments for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative assessment and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment assessments of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment assessments included in Note 1. /s/ Ernst Young LLP We have served as the Company's auditor since 1921. Atlanta, Georgia February 24, 2020 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 24, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 24, 2020 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 8,694 $ 9,997 $ 9,507 $ 9,068 $ 37,266 Gross profit 5,329 6,076 5,740 5,502 22,647 Net income attributable to shareowners of The Coca-Cola Company 1,678 2,607 2,593 2,042 8,920 Basic net income per share $ 0.39 $ 0.61 $ 0.61 $ 0.48 $ 2.09 Diluted net income per share $ 0.39 $ 0.61 $ 0.60 $ 0.47 $ 2.07 Net operating revenues $ 8,298 $ 9,421 $ 8,775 $ 7,806 $ 34,300 Gross profit 5,222 5,878 5,429 4,704 21,233 Net income attributable to shareowners of The Coca-Cola Company 1,368 2,316 1,880 6,434 Basic net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.51 1 Diluted net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.50 1 The sum of the quarterly net income per share amounts does not agree to the full year net income per share amounts. We calculate net income per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2019 and 2018 , our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2019 results were impacted by one less day compared to the first quarter of 2018 . Furthermore, the Company recorded the following transactions which impacted results: An other-than-temporary impairment charge of $286 million related to CCBJHI, an equity method investee. Refer to Note 18 . A net gain of $149 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net loss of $121 million related to acquiring a controlling interest in CHI. Refer to Note 2 . Charges of $68 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An other-than-temporary impairment charge of $57 million related to one of our equity method investees in North America. Refer to Note 18 . Charges of $46 million for transaction costs associated with the purchase of Costa. Refer to Note 2 . Net charges of $42 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A gain of $39 million related to the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . Charges of $11 million related to costs incurred to refranchise certain of our North America bottling operations. Charges of $4 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . In the second quarter of 2019 , the Company recorded the following transactions which impacted results: An adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million as a result of the Company's change in plans for CCBA. Refer to Note 2 . Charges of $55 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An other-than-temporary impairment charge of $49 million related to one of our equity method investees in Latin America. Refer to Note 18 . Charges of $29 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $26 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $10 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . In the third quarter of 2019 , the Company recorded the following transactions which impacted results: A gain of $739 million on the sale of a retail and office building in New York City. Other-than-temporary impairment charges of $255 million related to certain of our equity method investees in the Middle East. Refer to Note 18 . An other-than-temporary impairment charge of $120 million related to CCBJHI, an equity method investee. Refer to Note 18 . Charges of $103 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $61 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An impairment charge of $42 million related to a trademark in Asia Pacific. Refer to Note 18 . A net charge of $39 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $38 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $21 million related to costs incurred to refranchise certain of our North America bottling operations. The Company's fourth quarter 2019 results were impacted by one additional day compared to the fourth quarter of 2018 . Furthermore, the Company recorded the following transactions which impacted results: Charges of $80 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net gain of $73 million related to the refranchising of certain of our bottling operations in India. Refer to Note 2 . A net gain of $53 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $7 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $3 million related to acquiring a controlling interest in CHI. Refer to Note 2 . A net gain of $2 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . In the first quarter of 2018 , the Company recorded the following transactions which impacted results: Charges of $390 million related to the impairment of certain CCR assets. Refer to Note 18 . Charges of $95 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net loss of $85 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net charge of $51 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $45 million related to costs incurred to refranchise certain of our North America bottling operations. A net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Charges of $19 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In the second quarter of 2018 , the Company recorded the following transactions which impacted results: Charges of $150 million due to the Company's productivity and reinvestment program. Refer to Note 20 . Charges of $102 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $60 million related to the impairment of certain assets. Refer to Note 18 . An other-than-temporary impairment charge of $52 million related to one of our Latin American equity method investees. Refer to Note 18 . Charges of $47 million related to pension settlements as a result of North America refranchising. Refer to Note 15 . A net gain of $36 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . A net gain of $36 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $33 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $22 million related to tax litigation expense. Refer to Note 13 . In the third quarter of 2018 , the Company recorded the following transactions which impacted results: An impairment charge of $554 million related to assets held by CCBA. Refer to Note 2 . A net gain of $370 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . Charges of $275 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . An other-than-temporary impairment charge of $205 million related to our equity method investee in Indonesia. Refer to Note 18 . Charges of $132 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net gain of $64 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A gain of $41 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 6 . Charges of $38 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 12 . A net gain of $19 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $12 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . A gain of $11 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . In the fourth quarter of 2018 , the Company recorded the following transactions which impacted results: Other-than-temporary impairment charges of $334 million related to certain of our equity method investees in the Middle East. Refer to Note 18 . A net loss of $293 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $131 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net loss of $120 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 6 . Charges of $102 million related to pension settlements as a result of North America refranchising. Refer to Note 15 . Charges of $97 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . A loss of $74 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . A net charge of $46 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net loss of $32 million related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Charges of $22 million related to costs incurred to refranchise certain of our North America bottling operations. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2019 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2019 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +42,Coca-Cola,2018," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. As of December 31, 2018 , our operating structure included the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Bottling Investments Our operating structure as of December 31, 2018 also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. In January 2019, we established a new operating segment, Global Ventures, which includes the results of Costa Limited (""Costa""), which we acquired on January 3, 2019, and the results of our innocent and Doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""). Refer to Note 22 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report for information regarding the Costa acquisition. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavoring ingredients and, depending on the product, sweeteners used to prepare syrups or finished beverages and includes powders or minerals for purified water products; ""syrups"" means beverage ingredients produced by combining concentrates and, depending on the product, sweeteners and added water; ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners, who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. We own and market numerous valuable nonalcoholic beverage brands, including the following: sparkling soft drinks : Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Schweppes, * Sprite, Thums Up; water, enhanced water and sports drinks : Aquarius, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade; juice, dairy and plant-based beverages : AdeS, Del Valle, innocent, Minute Maid, Minute Maid Pulpy, Simply, ZICO; and tea and coffee : Ayataka, Costa, FUZE TEA, Georgia, Gold Peak, HONEST TEA. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster, primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. We and certain of our bottling partners distribute products of fairlife, LLC (""fairlife""), our joint venture with Select Milk Producers, Inc., a dairy cooperative, including fairlife ultra-filtered milk and Core Power, a high-protein milk shake, in the United States and Canada. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of more than 1.9 billion servings each day. We continue to expand our marketing presence in an effort to increase our unit case volume and net operating revenues in developed, developing and emerging markets. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to our consumers throughout the world. The Coca-Cola system sold 29.6 billion , 29.2 billion and 29.3 billion unit cases of our products in 2018 , 2017 and 2016 , respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for each of 2018 , 2017 and 2016 . Trademark Coca-Cola accounted for 45 percent of our worldwide unit case volume for each of 2018 , 2017 and 2016 . In 2018 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2018 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2018 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, the Former Yugoslav Republic of Macedonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2018 , these five bottling partners combined represented 40 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) manufacture Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. Certain bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. The bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers, which were granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) in connection with the refranchising of bottler territories that had previously been managed by Coca-Cola Refreshments (""CCR""), operate under ""expanding bottler CBAs,"" under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The expanding bottler CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain expanding bottlers that have executed expanding bottler CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights converted or agreed to convert their legacy bottler's agreements to a form of CBA to which we sometimes refer as ""non-expanding bottler CBA."" This form of CBA has a term of 10 years and is renewable by the bottler indefinitely for successive additional terms of 10 years each and is substantially similar in most material respects to the expanding bottler CBA, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the expanding bottler CBA. Those bottlers that have not signed a CBA continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 4.3 billion in 2018 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc., is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, Mondelz International, Inc., The Kraft Heinz Company, Suntory Beverage Food Limited and Unilever. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions and, in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners, and we do not anticipate such difficulties in the future. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. The state maintains lists of these substances and periodically adds other substances to these lists. Proposition 65 exposes all food and beverage producers to the possibility of having to provide warnings on their products in California because it does not provide for any generally applicable quantitative threshold below which the presence of a listed substance is exempt from the warning requirement. Consequently, the detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. Employees As of December 31, 2018 and 2017 , our Company had approximately 62,600 and 61,800 employees, respectively, of which approximately 11,400 and 12,400 , respectively, were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2018 , approximately 900 employees in North America were covered by collective bargaining agreements. These agreements have terms of three years to five years . We currently anticipate that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its employees are generally satisfactory. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of the product manufacturing process; consumer emphasis on transparency related to our products and packaging; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, or do not successfully anticipate and prepare for future changes in such preferences, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. Competitive pressures may cause us and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution, poor management, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use in the manufacture of our beverage products a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the marketing, labeling or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, there can be no assurance that such incidents will not have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees and former employees. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. In the European Union (""EU""), the General Data Protection Regulation (""GDPR"") became effective on May 25, 2018 for all member states. The GDPR includes operational requirements for companies receiving or processing personal data of EU residents that are partially different from those that had previously been in place and includes significant penalties for noncompliance. The changes introduced by the GDPR, as well as any other changes to existing personal data protection laws and the introduction of such laws in other jurisdictions, have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and security systems, policies, procedures and practices. There is no assurance that our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future will prevent the improper disclosure of personal data. Improper disclosure of personal data in violation of the GDPR and/or of other personal data protection laws could harm our reputation, cause loss of consumer confidence, subject us to government enforcement actions (including fines), or result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial performance will be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity or heavy competition for talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, there can be no assurance that our products will be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2018 , we used 72 functional currencies in addition to the U.S. dollar and derived $20.5 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2018 and 2017, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies may be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottlers. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottlers' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottlers' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottlers in which we have equity method investments were to be downgraded, such bottlers' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income from continuing operations before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. If this income tax dispute were to be ultimately determined adversely to us, any additional taxes, interest and potential penalties in the litigated or subsequent years could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (the ""Tax Reform Act""). For additional information regarding this income tax dispute, refer to Note 12 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. The Tax Reform Act, which was signed into law on December 22, 2017, significantly affected U.S. income tax law by changing how the United States imposes income tax on multinational corporations. As permitted by Staff Accounting Bulletin No. 118 (""SAB 118""), we recorded an original provisional estimate of the effect of the Tax Reform Act in our 2017 consolidated financial statements and have subsequently finalized our accounting analysis based on the guidance, interpretations and data available as of December 31, 2018. For additional information regarding the Tax Reform Act and the final tax amounts recorded in our consolidated financial statements, refer to the heading ""Critical Accounting Policies and Estimates Income Taxes"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not realize the economic benefits we anticipate from our productivity and reinvestment program or are unable to successfully manage its possible negative consequences, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. For information regarding our productivity and reinvestment program, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. We have incurred, and we expect will continue to incur, significant costs and expenses in connection with our productivity and reinvestment program and associated initiatives. If we are unable to implement some or all of these productivity and reinvestment initiatives fully or in the envisioned timeframe, or we otherwise do not timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these initiatives, our results of operations for future periods could be negatively affected. In addition, some of the actions we are taking in furtherance of our productivity and reinvestment initiatives may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity and reinvestment initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our ability to attract, train, develop and retain a highly skilled and diverse workforce. We may not be able to successfully compete for, attract and retain the high-quality and diverse employee talent we want and our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills and capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to insecurity resulting from our ongoing productivity initiatives, organizational changes and changes in compensation structure could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, that may be caused by increasing demand or by events such as natural disasters, power outages, or the like could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices for these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, sucralose, saccharin and ascorbic acid, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by a deterioration of our or our bottling partners' relationships with suppliers; by supplier quality and reliability issues; by trade disruptions, changes in supply chain and increases in tariffs that may be caused by the United Kingdom's impending withdrawal from the European Union, commonly referred to as ""Brexit;"" or by events such as natural disasters, power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable recyclable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of such legislation or regulations. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2018 , our net operating revenues in the United States were $11.3 billion , or 36 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2018 , our operations outside the United States accounted for $20.5 billion , or 64 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties surrounding Brexit, and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitation on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations. If negative publicity, whether or not warranted, concerning product safety or quality, human and workplace rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with human and workplace rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable labor and workplace rights laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, and employment and labor practices. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic, including regulations relating to recovery and/or disposal of plastic packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. There can be no assurance that we will realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative impacts on employee morale, work performance, escalation of grievances and the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, bottler franchise rights, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021. If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations or other acquisitions. If we are unable to achieve such objectives, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise Company-owned or -controlled bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. We also own an office and retail building at 711 Fifth Avenue in New York, New York. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located. The following table summarizes our principal production, distribution and storage facilities by operating segment and Corporate as of December 31, 2018 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Distribution and Storage Warehouses Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Total 1 1 Does not include 36 owned and 2 leased principal beverage manufacturing/bottling plants and 23 owned and 30 leased distribution and storage warehouses related to our discontinued operations. Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in U.S. Federal Income Tax Dispute below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit ( The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50 ) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit ( Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit ( Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Companys continued adherence to the prescribed methodology absent change in material facts or circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Reform Act. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 15, 2019 , there were 206,575 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 24, 2019 (""Company's 2019 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the year ended December 31, 2018 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2018 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under the Publicly Announced Plan September 29, 2018 through October 26, 2018 2,584,881 $ 45.93 2,584,800 35,604,612 October 27, 2018 through November 23, 2018 4,499,050 49.25 3,584,201 32,020,411 November 24, 2018 through December 31, 2018 186,525 48.48 32,020,411 Total 7,270,456 $ 48.05 6,169,001 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2014 2016 2018 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 113 142 128 SP 500 Index 114 129 150 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2013. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, BG Foods, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, The Kraft Heinz Company, Keurig Dr Pepper Inc., Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2018, the indices included Jefferies Financial Group Inc., Keurig Dr Pepper Inc., National Beverage Corp., Performance Food Group Company, Pilgrim's Pride Corporation and Seaboard Corporation, which were not included in the indices in 2017. Additionally, the indices do not include Dean Foods Company, Dr Pepper Snapple Group, Inc., Leucadia National Corporation, Pinnacle Foods Inc. and Snyder's-Lance, Inc., which were included in the indices in 2017. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our objective; our strategic priorities; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; the impact of inflation and changing prices; and an overview of financial position. Our Business General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2017 Concentrate operations % % % Finished product operations 49 Total % % % The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2017 Concentrate operations % % % Finished product operations 22 Total % % % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Objective Our objective is to use our formidable assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to achieve long-term sustainable growth. To accomplish our objective, we are focused on: Disciplined growth Turning our passion for consumers into drinks people come back to again and again, whether that means less sugar, more vitamins, or exciting new flavors Building relevant brands people love and scaling them around the world quickly and consistently Using the Coca-Cola system advantage to put our drinks in more hands in more places more quickly than anyone else Doing business the right way, not just the easy way Being leaders in responsible water use and giving back to nature and communities Contributing to the elimination of waste, including through package innovation, sharing of package innovation and recycling initiatives Caring for people and communities, with a special focus on womens economic empowerment Tapping into the passion of our people Building an inclusive culture of curiosity and empowerment where diverse perspectives are essential as we strive for progress, not perfection Strategic Priorities We have five strategic priorities designed to help us achieve our objective. These strategic priorities are accelerating growth of a consumer-centric brand portfolio; driving our revenue growth algorithm; strengthening the Coca-Cola system; digitizing the enterprise; and unlocking the power of our people. In order to execute on these strategic priorities, we must further enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Core Capabilities Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to deliver enhanced value to themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,300 beverage products (including more than 1,400 low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to our planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established, global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment, maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part to help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Certain prior year amounts in Management's Discussion and Analysis of Financial Condition and Results of Operations have been revised to conform to the current year presentation as a result of the adoption of certain accounting standards that became effective January 1, 2018 , as applicable. Refer to Note 1 of Notes to Consolidated Financial Statements for further details. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 12 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,916 million and $ 4,523 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 49 million and $ 1 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charges may be impacted by items such as basis differences, deferred taxes and deferred gains. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair values of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to accumulated other comprehensive income (loss) (""AOCI"") as of January 1, 2018 in connection with the adoption of ASU 2016-01. Refer to Note 1 of Notes to Consolidated Financial Statements. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. The following table presents the carrying values of our investments in equity and debt securities (in millions): December 31, 2018 Carrying Value Percentage of Total Assets Equity method investments $ 19,407 % Debt securities classified as available-for-sale 4,993 Equity securities with readily determinable fair values 1,934 Debt securities classified as trading * Equity securities without readily determinable fair values * Total $ 26,458 % * Accounts for less than 1 percent of the Company's total assets. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. During 2018 and 2017 , we recognized other-than-temporary impairment charges related to certain of our equity method investees of $591 million and $50 million , respectively. Refer to Note 17 of Notes to Consolidated Financial Statements. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's cost basis in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2018 Fair Value Carrying Value Difference Monster Beverage Corporation $ 5,026 $ 3,573 $ 1,453 Coca-Cola European Partners plc 4,033 3,551 Coca-Cola FEMSA, S.A.B. de C.V. 3,401 1,714 1,687 Coca-Cola HBC AG 2,681 1,260 1,421 Coca-Cola Amatil Limited 1,325 Coca-Cola Bottlers Japan Holdings Inc. 1 1,142 (164 ) Embotelladora Andina S.A. CocaCola Consolidated, Inc. 2 Coca-Cola ecek A.. Total $ 18,680 $ 12,471 $ 6,209 1 The carrying value of our investment in Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI"") exceeded its fair value as of December 31, 2018 . Based on the length of time and the extent to which the market value has been less than our cost basis and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. 2 Formerly known as Coca-Cola Bottling Co. Consolidated. Other Assets Our Company invests in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. Additionally, our Company advances payments to certain customers for distribution rights as well as to fund future marketing activities intended to generate profitable volume, and we expense such payments over the periods benefited. Payments under these programs are generally capitalized and reported in the line item prepaid expenses and other assets or other assets, as appropriate, in our consolidated balance sheet. When facts and circumstances indicate that the carrying value of these assets or asset groups may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. During the year ended December 31, 2017 , the Company recorded an impairment charge of $19 million related to CCR's other assets. Refer to Note 17 of Notes to Consolidated Financial Statements. Property, Plant and Equipment As of December 31, 2018 , the carrying value of our property, plant and equipment, net of depreciation, was $ 8,232 million , or 10 percent of our total assets. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe a hypothetical marketplace participant would use. During the year ended December 31, 2018 and December 31, 2017 , the Company recorded impairment charges of $312 million and $310 million , respectively, related to CCR's property, plant and equipment. Refer to Note 17 of Notes to Consolidated Financial Statements. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into one of three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The following table presents the carrying values of intangible assets included in our consolidated balance sheet (in millions): December 31, 2018 Carrying Value Percentage of Total Assets Goodwill $ 10,263 % Trademarks with indefinite lives 6,682 Bottlers' franchise rights with indefinite lives * Definite-lived intangible assets, net * Other intangible assets not subject to amortization * Total $ 17,270 % * Accounts for less than 1 percent of the Company's total assets. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. During 2018, the Company recorded impairment charges of $138 million related to certain intangible assets. These charges included $100 million related to bottlers' franchise rights with indefinite lives and $38 million related to definite-lived intangible assets. Refer to Note 17 of Notes to Consolidated Financial Statements. During 2017, the Company recorded impairment charges of $457 million related to certain intangible assets. These charges included $390 million related to goodwill and $33 million related to bottlers' franchise rights with indefinite lives. As a result of these charges, the carrying value of CCR's goodwill is zero. Additionally, we recorded impairment charges of $34 million related to Venezuelan intangible assets. As a result of these charges, the carrying value of these assets is zero. Refer to Note 17 of Notes to Consolidated Financial Statements. During 2016, the Company recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights and $10 million related to the impairment of goodwill. Refer to Note 17 of Notes to Consolidated Financial Statements. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our pension expense and obligations. We believe the most critical assumptions are related to (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our pension expense and obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future payments we anticipate making under the plans. As of December 31, 2018 and 2017 , the weighted-average discount rate used to compute our pension obligations was 4.00 percent and 3.50 percent , respectively. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. The weighted-average expected long-term rate of return used to calculate our pension expense was 8.00 percent , 8.00 percent and 8.25 percent in 2018, 2017 and 2016, respectively. In 2018 , the Company's total pension expense related to defined benefit plans was $145 million , which included $107 million of net periodic benefit income and $252 million of settlement charges, curtailment charges and special termination benefit costs. In 2019, we expect our total pension income to be approximately $11 million. We currently do not expect to incur any settlement charges or special termination benefit costs in 2019. The decrease in 2019 expected net periodic benefit income is primarily due to unfavorable asset performance in 2018, partially offset by an increase in the weighted-average discount rate at December 31, 2018 compared to December 31, 2017. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $19 million decrease in our 2019 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $23 million decrease in our 2019 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2018 , the Company's primary U.S. pension plan represented 62 percent of both the Company's consolidated projected benefit obligation and plan assets. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Refer to Note 3 of Notes to Consolidated Financial Statements. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Once control is transferred to the customer, we have completed our performance obligation, and revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we work with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606 and an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 15 of Notes to Consolidated Financial Statements. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent change in material facts and circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. As of December 31, 2018 , the Company's valuation allowances on deferred tax assets were $ 399 million and were primarily related to uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards generated in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes it will generate sufficient future taxable income to realize the tax benefits related to the remaining deferred tax assets in our consolidated balance sheet. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference, which primarily results from earnings, meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 15 of Notes to Consolidated Financial Statements. The Tax Reform Act was signed into law on December 22, 2017. Among other things, the Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017 , transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") of approximately $41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $0.3 billion in tax for our one-time transition tax and a tax benefit of $0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $8.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. Based on current tax laws, the Company's effective tax rate in 2019 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Operations Review Our organizational structure as of December 31, 2018 consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; and Bottling Investments. Our operating structure also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 20 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. Our Bottling Investments operating segment and our other finished product operations typically generate net operating revenues by selling sparkling soft drinks and a variety of other beverages, such as juices, juice drinks, sports drinks, waters, teas and coffees, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. For these consolidated finished product operations, we recognize the associated concentrate sales volume at the time the unit case or unit case equivalent is sold to the customer. Our concentrate operations typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations. For these concentrate operations, we recognize concentrate revenue and concentrate sales volume when we sell concentrate and syrups to the authorized unconsolidated bottling operations, and we typically report unit case volume when finished products manufactured from the concentrates and syrups are sold to the customer. When we analyze our net operating revenues we generally consider the following five factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) acquisitions and divestitures (including structural changes defined below), as applicable; (3) changes in price, product and geographic mix; (4) foreign currency fluctuations; and (5) the impact of our adoption of the new revenue recognition accounting standard. Refer to the heading ""Net Operating Revenues"" below. We generally refer to acquisitions and divestitures of bottling and distribution operations as structural changes, which are a component of acquisitions and divestitures (""structural changes""). Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider acquired brands to be structural changes. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when these brands are ultimately sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that the licenses are entered into, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider newly licensed brands to be structural changes. In 2018, the Company acquired a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. The Company also acquired a controlling interest in the franchise bottler in Oman. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments operating segment. In 2018, the Company refranchised our Canadian and Latin American bottling operations. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America, Latin America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the Canadian refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the base year when calculating 2018 versus 2017 volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. Refer to the headings ""Beverage Volume"" and ""Net Operating Revenues"" below. In 2017, Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") was transitioned to the Company, resulting in its consolidation. The results of CCBA have been recorded as discontinued operations. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017 and 2016, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the applicable base year when calculating volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. During 2016, the Company deconsolidated its South African bottling operations and disposed of its related equity method investment in exchange for equity method investments in CCBA and CCBA's South African subsidiary. As part of the transaction, the Company also acquired and licensed several brands. The impacts of the deconsolidation, the disposal of the related equity method investment, and the new equity method investments have been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The brands and licenses that the Company acquired impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. During 2016, the Company also deconsolidated our German bottling operations as a result of their being combined to create CCEP. As a result of the transaction, the Company now owns an equity method investment in CCEP. Accordingly, the impact of the deconsolidation and new equity method investment has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The Company also changed our funding arrangement with our bottling partners in China, which resulted in a reduction in net operating revenues with an offsetting reduction in direct marketing expense. The impact of the change in the arrangement has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific operating segment. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can impact unit case volume and concentrate sales volume and can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest but to which the Company does not sell concentrates, syrups, beverage bases, source waters or powders/minerals may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2018 versus 2017 2017 versus 2016 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % % % Europe, Middle East Africa % % 4 % % 8 Latin America (2 ) (3 ) North America (1 ) 5 9 Asia Pacific 6 10 Bottling Investments (15 ) 3 N/A (41 ) 7 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2018 grew 11 percent. 4 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2018 grew 4 percent. 5 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2018 grew 1 percent. 6 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2018 grew 5 percent. 7 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2017 declined 3 percent. 8 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2017 grew 2 percent. 9 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2017 was even. 10 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2017 grew 1 percent. Unit Case Volume The Coca-Cola system sold 29.6 billion , 29.2 billion and 29.3 billion unit cases of our products in 2018 , 2017 and 2016 , respectively. The unit case volume for 2018 , 2017 and 2016 reflects the impact of brands acquired and licensed during the applicable year. The unit case volume for 2018 , 2017 and 2016 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2018 versus 2017 and 2017 versus 2016 unit case volume growth rates. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for 2018 , 2017 and 2016 . Trademark CocaCola accounted for 45 percent of our worldwide unit case volume for 2018 , 2017 and 2016 . In 2018 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2018 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks and 3 percent in water, enhanced water and sports drinks. Growth in sparkling soft drinks was primarily driven by 2 percent growth in Trademark Coca-Cola and 3 percent growth in Trademark Fanta. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; and Middle East North Africa business units. The unit case volume growth in these business units was partially offset by a decline in the West Africa business unit. Volume in the South East Africa and Western Europe business units was even. In Latin America, unit case volume was even, which included growth of 4 percent in juice, dairy and plant-based beverages and 1 percent in water, enhanced water and sports drinks. Sparkling soft drinks volume was even. The group's volume reflected growth of 1 percent in each of the Mexico, Brazil and Latin Center business units, offset by a 4 percent decline in the South Latin business unit. The growth in Mexico's volume was primarily driven by 1 percent growth in sparkling soft drinks and 8 percent growth in juice, dairy and plant-based beverages. The decline in South Latin's volume was driven by a 4 percent decline in sparkling soft drinks. Unit case volume in North America grew 1 percent. Sparkling soft drinks grew 1 percent, which included growth of 3 percent in Trademark Sprite and 1 percent in Trademark CocaCola. Unit case volume in water, enhanced water and sports drinks grew 2 percent, primarily driven by 2 percent growth in packaged water and 1 percent growth in sports drinks. Growth in these category clusters was partially offset by a 3 percent decline in juice, dairy and plant-based beverages. In Asia Pacific, unit case volume grew 4 percent, reflecting 4 percent growth in sparkling soft drinks, 5 percent growth in water, enhanced water and sports drinks, and 4 percent growth in tea and coffee. Growth in sparkling soft drinks volume included 5 percent growth in Trademark Coca-Cola and 6 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 7 percent in packaged water. The group's volume reflects growth of 6 percent in the Greater China Korea business unit, 10 percent in the India South West Asia business unit and 1 percent in the Japan business unit. Volume in the South Pacific and ASEAN business units was even. Unit case volume for Bottling Investments declined 15 percent. This decrease primarily reflects the impact of refranchising activities, partially offset by growth in India as well as the impact of bottler acquisitions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In Europe, Middle East and Africa, unit case volume grew 1 percent, reflecting an 8 percent increase in tea and coffee, a 5 percent increase in water, enhanced water and sports drinks and a 1 percent increase in sparkling soft drinks. These increases were partially offset by a decrease of 3 percent in juice, dairy and plant-based beverages. The group reported increases in unit case volume in our Central Eastern Europe, Turkey, Caucasus Central Asia, South East Africa and West Africa business units. The increases in these business units were partially offset by even results in both our Middle East North Africa and Western Europe business units. Unit case volume in Latin America decreased 2 percent, which included declines of 3 percent in sparkling soft drinks and 1 percent in water, enhanced water and sports drinks. The group's volume reflected declines of 10 percent in the Latin Center business unit and 6 percent in the Brazil business unit. These declines were partially offset by 1 percent growth in the Mexico business unit, which included 1 percent growth in water, enhanced water and sports drinks, and even performance in sparkling soft drinks. In North America, unit case volume was even, reflecting even volume for sparkling soft drinks, a 2 percent decline in water, enhanced water and sports drinks, and growth in energy drinks. North America's volume performance in sparkling soft drinks included 4 percent growth in Trademark Sprite and 5 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. Unit case volume in Asia Pacific increased 1 percent, reflecting a 2 percent increase in both sparkling soft drinks and juice, dairy and plant-based beverages. The increase in sparkling soft drinks included 4 percent growth in Trademark Coca-Cola. The group's unit case volume reflected an increase of 2 percent in both the ASEAN and Greater China Korea business units and a 1 percent increase in the India South West Asia business unit, partially offset by a 2 percent decline in the South Pacific business unit. Unit case volume in the Japan business unit was even. Unit case volume for Bottling Investments decreased 41 percent. This decrease primarily reflects the North America refranchising activities and the refranchising of our China bottling operations. Concentrate Sales Volume In 2018 , worldwide unit case sales volume grew 2 percent and concentrate sales volume grew 3 percent compared to 2017 . In 2017 , worldwide concentrate sales volume and unit case volume were both even compared to 2016 . The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, beverage bases or powders. The difference between the unit case volume and concentrate sales volume growth rates in 2018 for both worldwide and Europe, Middle East and Africa included the impact of the dissolution of Beverage Partners Worldwide (""BPW""), a former tea joint venture to whom we did not sell concentrate. The BPW joint venture was replaced by the launch of Fuze Tea, for which the Company produces and sells the related concentrate. Analysis of Consolidated Statements of Income Percent Change Year Ended December 31, 2018 vs. 2017 2017 vs. 2016 (In millions except percentages and per share data) NET OPERATING REVENUES $ 31,856 $ 35,410 $ 41,863 (10)% (15)% Cost of goods sold 11,770 13,255 16,465 (11) (19) GROSS PROFIT 20,086 22,155 25,398 (9) (13) GROSS PROFIT MARGIN 63.1 % 62.6 % 60.7 % Selling, general and administrative expenses 10,307 12,654 15,370 (19) (18) Other operating charges 1,079 1,902 1,371 (43) OPERATING INCOME 8,700 7,599 8,657 (12) OPERATING MARGIN 27.3 % 21.5 % 20.7 % Interest income Interest expense Equity income (loss) net 1,008 1,071 (6) Other income (loss) net (1,121 ) (1,764 ) (1,265 ) (39) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 8,350 6,742 8,136 (17) Income taxes from continuing operations 1,623 5,560 1,586 (71) Effective tax rate 19.4 % 82.5 % 19.5 % NET INCOME FROM CONTINUING OPERATIONS 6,727 1,182 6,550 (82) Income (loss) from discontinued operations (net of income taxes of $126, $47 and $0, respectively) (251 ) * * CONSOLIDATED NET INCOME 6,476 1,283 6,550 (80) Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 6,434 $ 1,248 $ 6,527 416% (81)% * Calculation is not meaningful. Net Operating Revenues Year Ended December 31, 2018 versus Year Ended December 31, 2017 The Company's net operating revenues decreased $3,554 million, or 10 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2018 versus 2017 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Accounting Changes Total Consolidated % (16 )% % (1 )% % (10 )% Europe, Middle East Africa % % % (1 )% (3 )% % Latin America (9 ) (3 ) North America (1 ) 9 Asia Pacific (1 ) (5 ) Bottling Investments (78 ) (64 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. ""Accounting changes"" refers to the impact of our adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Price, product and geographic m ix had a 2 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix in all of the segment's business units as well as favorable product and package mix; Latin America favorable price mix and the impact of inflationary environments in certain markets; North America favorable pricing initiatives, offset by incremental freight costs; Asia Pacific favorably impacted as a result of pricing initiatives as well as product and package mix, offset by geographic mix; and Bottling Investments unfavorable price, product and package mix in certain bottling operations, offset by geographic mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a favorable impact of 8 percent to 9 percent on full year 2019 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect currencies will have an unfavorable impact on our full year 2019 net operating revenues. Year Ended December 31, 2017 versus Year Ended December 31, 2016 The Company's net operating revenues decreased $6,453 million, or 15 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2017 vs. 2016 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (17 )% % (1 )% (15 )% Europe, Middle East Africa % (2 )% % (2 )% % Latin America (3 ) North America Asia Pacific (1 ) (4 ) (2 ) Bottling Investments (3 ) (48 ) (47 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorably impacted as a result of pricing initiatives and product and package mix, partially offset by geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets; North America favorably impacted as a result of pricing initiatives and product and package mix; Asia Pacific unfavorably impacted by geographic mix, partially offset by the favorable impact of pricing initiatives and product and package mix; and Bottling Investments favorably impacted as a result of pricing initiatives and product and package mix in North America. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the British pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 22.8 % 20.7 % 16.8 % Latin America 12.7 11.2 8.9 North America 36.7 24.9 1 15.8 1 Asia Pacific 15.4 13.5 11.4 Bottling Investments 12.1 29.3 1 46.8 1 Corporate 0.3 0.4 0.3 Total 100.0 % 100.0 % 100.0 % 1 Amounts have been adjusted to reflect the reclassification of certain revenue streams from the Bottling Investments operating segment to the North America operating segment effective January 1, 2018. The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; foreign currency fluctuations and accounting changes. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin As a result of our finished goods operations, which are primarily included in our North America and Bottling Investments operating segments, the following inputs represent a substantial portion of the Company's total cost of goods sold: (1) sweeteners, (2) metals, (3) juices and (4) PET. The Company enters into hedging activities related to certain commodities in order to mitigate a portion of the price risk associated with forecasted purchases. Many of the derivative financial instruments used by the Company to mitigate the risk associated with these commodity exposures, including any related foreign currency exposure, do not qualify for hedge accounting. As a result, the changes in fair value of these derivative instruments have been, and will continue to be, included as a component of net income in each reporting period. The Company recorded a net loss related to these derivatives of $20 million during the year December 31, 2018 and recorded net gains of $14 million and $79 million during the years ended December 31, 2017 and December 31, 2016 , respectively, in the line item cost of goods sold in our consolidated statements of income. Refer to Note 6 of Notes to Consolidated Financial Statements. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Our gross profit margin increased to 63.1 percent in 2018 from 62.6 percent in 2017. The increase was primarily due to the impact of divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations and the impact of accounting changes related to the new revenue recognition accounting standard. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information on the adoption of the new revenue recognition accounting standard. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Our gross profit margin increased to 62.6 percent in 2017 from 60.7 percent in 2016. The increase was primarily due to the impact of divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the significant components of selling, general and administrative expenses (in millions): Year Ended December 31, Stock-based compensation expense $ $ $ Advertising expenses 4,113 3,958 4,004 Selling and distribution expenses 1,701 3,266 5,189 Other operating expenses 4,268 5,211 5,919 Selling, general and administrative expenses $ 10,307 $ 12,654 $ 15,370 Year Ended December 31, 2018 versus Year Ended December 31, 2017 Selling, general and administrative expenses decreased $2,347 million, or 19 percent. The decrease in selling and distribution expenses during 2018 reflects the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. The decrease in other operating expenses during 2018 reflects savings from our productivity and reinvestment initiatives and the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. As of December 31, 2018 , we had $ 271 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.5 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 13 of Notes to Consolidated Financial Statements. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Selling, general and administrative expenses decreased $2,716 million, or 18 percent. During the year ended December 31, 2017, fluctuations in foreign currency exchange rates had a nominal impact on selling, general and administrative expenses. The decrease in selling and distribution expenses and advertising expenses during 2017 reflects the impact of divestitures. Additionally, advertising expenses during 2017 decreased 1 percent as a result of foreign currency exchange rate fluctuations. The decrease in other operating expenses during 2017 reflects savings from our productivity and reinvestment initiatives. Foreign currency exchange rate fluctuations had a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they were generally transacted in local currency. Our selling and distribution expenses were primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and were primarily denominated in U.S. dollars. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, Europe, Middle East Africa $ (3 ) $ $ Latin America North America Asia Pacific (4 ) Bottling Investments 1,079 Corporate Total $ 1,079 $ 1,902 $ 1,371 In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 12 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 17 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information about the Venezuelan intangible assets. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 17 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2016, the Company recorded other operating charges of $1,371 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $276 million related to costs incurred to refranchise certain of our bottling operations. The Company also recorded a charge of $200 million related to cash contributions we made to The CocaCola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. In 2016, the Company also recorded impairment charges of $153 million related to certain intangible assets. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan exchange rates. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 17 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, Europe, Middle East Africa 42.7 % 47.7 % 42.4 % Latin America 26.7 29.2 22.6 North America 28.2 34.1 30.2 Asia Pacific 26.2 28.3 25.5 Bottling Investments (7.5 ) (12.7 ) 0.0 Corporate (16.3 ) (26.6 ) (20.7 ) Total 100.0 % 100.0 % 100.0 % Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, Consolidated 27.3 % 21.5 % 20.7 % Europe, Middle East Africa 48.2 49.2 52.3 Latin America 58.4 56.1 52.1 North America 21.3 29.5 39.7 Asia Pacific 47.4 45.0 46.2 Bottling Investments (17.2 ) (9.3 ) 0.0 Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2018 versus Year Ended December 31, 2017 In 2018, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar, which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand, which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2018 and 2017 was $3,714 million and $3,625 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 6 percent and favorable price, product and geographic mix and lower other operating charges, partially offset by increased marketing investments primarily related to key product launches and an unfavorable foreign currency exchange rate impact of 5 percent. Operating income for the Latin America segment for the years ended December 31, 2018 and 2017 was $2,321 million and $2,218 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 12 percent. North America's operating income for the years ended December 31, 2018 and 2017 was $2,453 million and $2,591 million , respectively. The decrease in operating income was driven by higher freight costs and the impact of structural changes, partially offset by lower other operating charges. The operating margin decrease in 2018 was primarily related to the adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Operating income for Asia Pacific for the years ended December 31, 2018 and 2017 was $2,278 million and $2,147 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent. Foreign currency exchange rates had a nominal impact. Our Bottling Investments segment's operating loss for the years ended December 31, 2018 and 2017 was $649 million and $962 million , respectively. The decrease in operating loss reflects lower other operating charges, partially offset by the unfavorable impact of divestitures. Corporate's operating loss for the years ended December 31, 2018 and 2017 was $1,417 million and $2,020 million , respectively. The operating loss in 2018 was favorably impacted by lower selling, general and administrative expenses as a result of productivity initiatives, lower other operating charges and mark-to-market adjustments related to our economic hedging activities. Based on current spot rates and our hedging coverage in place, we expect currencies will have an unfavorable impact on operating income in 2019. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 3 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the British pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2017 and 2016 was $3,625 million and $3,668 million , respectively. Operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 3 percent, partially offset by favorable price, product and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2017 and 2016 was $2,218 million and $1,953 million , respectively. Operating income for the segment reflects favorable price mix, a reduction in other operating charges and a nominal impact from foreign currency exchange rate fluctuations. North America's operating income for the years ended December 31, 2017 and 2016 was $2,591 million and $2,614 million , respectively. The decrease in the segment's operating income was due to higher other operating charges and an unfavorable foreign currency exchange rate impact of 1 percent, partially offset by favorable price and product and package mix. Operating income for Asia Pacific for the years ended December 31, 2017 and 2016 was $2,147 million and $2,210 million , respectively. The decline in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 6 percent and unfavorable price, product and geographic mix. Our Bottling Investments segment's operating loss for the year ended December 31, 2017 was $962 million , compared to operating income for the year ended December 31, 2016 of $1 million . The Bottling Investments segment was unfavorably impacted by acquisitions and divestitures and $737 million of asset impairment charges related to CCR in 2017. Corporate's operating loss for the years ended December 31, 2017 and 2016 was $2,020 million and $1,789 million , respectively. The operating loss in 2017 was unfavorably impacted by higher other operating charges. Interest Income Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest income was $ 682 million in 2018 , compared to $ 677 million in 2017 , an increase of $5 million, or 1 percent. The increase primarily reflects higher interest rates earned on certain investments, partially offset by lower investment balances in certain of our international locations. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest income was $ 677 million in 2017 , compared to $ 642 million in 2016 , an increase of $35 million, or 6 percent. The increase primarily reflects higher investment balances in certain of our international locations, partially offset by lower interest rates earned on certain investments. Interest Expense Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest expense was $ 919 million in 2018 , compared to $ 841 million in 2017 , an increase of $78 million, or 9 percent. This increase was primarily due to the impact of higher short-term U.S. interest rates, which was partially offset by a net gain of $27 million related to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest expense was $ 841 million in 2017 , compared to $ 733 million in 2016 , an increase of $108 million, or 15 percent. The increase primarily reflects the impact of short-term U.S. interest rates and longer debt maturities, both of which resulted in higher interest rates on the Company's debt portfolio. Additionally, interest expense during the year ended December 31, 2017 included a net charge of $38 million due to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2018 versus Year Ended December 31, 2017 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2018 , equity income was $ 1,008 million , compared to equity income of $ 1,071 million in 2017 , a decrease of $63 million, or 6 percent. This decrease reflects, among other things, the dissolution of our BPW joint venture and the consolidation of CCBA. In addition, the Company recorded net charges of $111 million and $92 million in the line item equity income (loss) net during the years ended December 31, 2018 and December 31, 2017 , respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017 , equity income was $ 1,071 million , compared to equity income of $ 835 million in 2016 , an increase of $236 million, or 28 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees. Additionally, the increase was attributable to the impact of the equity investment in CCEP acquired in 2016 and the impact of the equity investment in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas"") that was acquired in 2017. The favorable impact of these items was partially offset by the derecognition of the Company's former equity method investment in South Africa in 2016. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Other Income (Loss) Net Other income (loss) net includes, among other things, the impact of foreign currency exchange gains and losses; dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to business combinations and disposals; non-service cost components of net periodic benefit cost for pension and postretirement benefit plans; other benefit plan charges and credits; realized and unrealized gains and losses on equity securities and trading debt securities; and realized gains and losses on available-for-sale debt securities. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. In 2018, other income (loss) net was a loss of $1,121 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees and charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities and charges of $240 million related to pension settlements. Other income (loss) net also included net foreign currency exchange losses of $144 million. Additionally, we recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley"") and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information on our hedging activities. Refer to Note 17 of Notes to Consolidated Financial Statements for information on the impairment charges. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $1,764 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $57 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America and China bottling refranchising, the conversion payments and our consolidation of CCBA. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2016, other income (loss) net was a loss of $1,265 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a net charge of $139 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. The Company also recorded a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred net foreign currency exchange losses of $246 million, including a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These losses were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations, dividend income of $55 million and net gains of $83 million related to trading securities and the sale of available-for-sale securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising, the deconsolidation of our South African bottling operations, the conversion payments and the deconsolidation of our German bottling operations. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2019 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 318 million , $ 221 million and $ 105 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2017 Statutory U.S. federal tax rate 21.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.5 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.2 1,2 (9.7 ) (17.5 ) 7 Equity income or loss (2.4 ) (3.4 ) (3.0 ) Tax Reform Act 0.1 3 53.5 4 Excess tax benefits on stock-based compensation (1.2 ) (2.0 ) Other net (0.8 ) 7.9 5,6 3.8 8 Effective tax rate 19.4 % 82.5 % 19.5 % 1 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees. Refer to Note 17 of Notes to Consolidated Financial Statements. 2 Includes tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 3 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 4 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 5 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 6 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 7 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 8 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. As of December 31, 2018 , the gross amount of unrecognized tax benefits was $ 336 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 182 million , exclusive of any benefits related to interest and penalties. The remaining $ 154 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 18 1 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (4 ) (40 ) 1 Decrease due to lapse of the applicable statute of limitations Increase (decrease) due to effect of foreign currency exchange rate changes (17 ) (6 ) Ending balance of unrecognized tax benefits $ $ $ 1 The net increase was primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 190 million , $ 177 million and $ 142 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2018 , 2017 and 2016 , respectively. Of these amounts, $13 million , $35 million and $31 million of expense were recognized through income tax expense in 2018 , 2017 and 2016 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2019 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2019. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates. In addition, our domestic entities have recently borrowed and continue to have the ability to borrow funds in international markets at reasonable interest rates. Our debt financing includes the use of an extensive commercial paper program as part of our overall cash management strategy. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. In addition to the Company's cash balances, commercial paper program, and our ability to issue long-term debt, we also had $ 7,895 million in lines of credit for general corporate purposes as of December 31, 2018 . These backup lines of credit expire at various times from 2019 through 2022 . We have significant operations outside the United States. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume in 2018. We earn a substantial amount of our consolidated operating income and income from continuing operations before income taxes from foreign subsidiaries that either sell concentrates and syrups to our local bottling partners or, in certain instances, sell finished products directly to our customers to fulfill the demand for Company beverage products outside the United States. A significant portion of these foreign earnings was previously considered to be indefinitely reinvested in foreign jurisdictions where the Company has made, and will continue to make, substantial investments to support the ongoing development and growth of our international operations. Accordingly, no U.S. federal and state income taxes were previously provided on the portion of our foreign earnings that was considered to be indefinitely reinvested in foreign jurisdictions. On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017, transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. As a result, the Company recognized a provisional tax charge related to the one-time transition tax in the amount of $4.6 billion in 2017. During 2018, we recognized $0.3 billion of additional provisional transition tax expense. The Company's cash, cash equivalents, short-term investments and marketable securities held by our foreign subsidiaries totaled $14.4 billion as of December 31, 2018 . Net operating revenues in the United States were $11.3 billion in 2018, or 36 percent of the Company's consolidated net operating revenues. We expect existing domestic cash, cash equivalents, short-term investments, marketable securities, cash flows from operations, the repatriation of foreign earnings and the issuance of debt to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities. In addition, we expect foreign cash, cash equivalents, short-term investments and marketable securities remaining after repatriation, as well as cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities. Based on all the aforementioned factors, the Company believes its current liquidity position is strong, and we will continue to meet all of our financial commitments for the foreseeable future. These obligations and anticipated cash outflows include, but are not limited to, regular quarterly dividends, debt maturities, capital expenditures, share repurchases and obligations included under the heading ""Off-Balance Sheet Arrangements and Aggregate Contractual Obligations"" below. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2018 , 2017 and 2016 was $ 7,320 million , $ 6,930 million and $ 8,792 million , respectively. Net cash provided by operating activities increased $390 million , or 6 percent, in 2018 compared to 2017 . This increase was primarily driven by operating income growth and the efficient management of working capital partially offset by the impact of refranchising bottling operations and higher interest and tax payments. Refer to Note 11 and Note 15 of Notes to Consolidated Financial Statements for additional information on interest payments and tax payments. Net cash provided by operating activities decreased $1,862 million, or 21 percent, in 2017 compared to 2016 . This decrease was primarily driven by the refranchising of certain bottling operations, the unfavorable impact of foreign currency exchange rate fluctuations, one less day in 2017, and increased payments related to income taxes and restructuring. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 15 of Notes to Consolidated Financial Statements for additional information on the tax payments. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, Purchases of investments $ (7,789 ) $ (17,296 ) $ (16,626 ) Proceeds from disposals of investments 14,977 16,694 17,842 Acquisitions of businesses, equity method investments and nonmarketable securities (1,040 ) (3,809 ) (838 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 1,035 Purchases of property, plant and equipment (1,347 ) (1,675 ) (2,262 ) Proceeds from disposals of property, plant and equipment Other investing activities (60 ) (93 ) (305 ) Net cash provided by (used in) investing activities $ 6,348 $ (2,254 ) $ (1,004 ) Purchases of Investments and Proceeds from Disposals of Investments In 2018 , purchases of investments were $ 7,789 million and proceeds from disposals of investments were $ 14,977 million . This activity resulted in a net cash inflow of $7,188 million during 2018 . In 2017 , purchases of investments were $ 17,296 million and proceeds from disposals of investments were $ 16,694 million , resulting in a net cash outflow of $602 million . In 2016 , purchases of investments were $ 16,626 million and proceeds from disposals of investments were $ 17,842 million , resulting in a net cash inflow of $1,216 million . The investments purchased in all three years include time deposits that had maturities greater than three months but less than one year and were classified in the line item short-term investments in our consolidated balance sheets. The disposals in 2016 included proceeds from the disposal of the Company's investment in Keurig Green Mountain, Inc. (""Keurig"") of $2,380 million. The remaining activity primarily represents the purchases of and proceeds from short-term investments that were made as part of the Company's overall cash management strategy as well as our insurance captive investments. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in Keurig. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2018 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,040 million , which was primarily related to the acquisition of a controlling interest in the Philippine bottling operations and an equity interest in BA Sports Nutrition, LLC (""BodyArmor""). Additionally, the Company acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity was primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. In 2016 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $838 million , which was primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd., a maker of plant-based protein beverages in China, and a minority investment in CHI Limited, a Nigerian producer of value-added dairy and juice beverages. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2018 , 2017 and 2016 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 1,362 million , primarily related to the proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the the sale of our equity ownership in Lindley. In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. In 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $1,035 million , primarily related to proceeds from the refranchising of certain bottling territories in North America. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2018 , 2017 and 2016 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment net of disposals for the years ended December 31, 2018 , 2017 and 2016 were $1,102 million , $1,571 million and $2,112 million , respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, Capital expenditures $ 1,347 $ 1,675 $ 2,262 Europe, Middle East Africa 5.7 % 4.8 % 2.7 % Latin America 6.7 3.3 2.0 North America 31.8 32.3 19.4 Asia Pacific 2.3 3.0 4.7 Bottling Investments 23.5 39.5 58.8 Corporate 30.0 17.1 12.4 We expect our annual 2019 capital expenditures to be approximately $2.0 billion as we continue to make investments to enable growth in our business and further enhance our operational effectiveness. The increase in 2019 is primarily the result of the acquisition of Costa in January 2019 and the acquisition of a controlling interest in the Philippine bottling operations in December 2018. Other Investing Activities In 2016, cash used in other investing activities was primarily related to the cash flow impact of the Company's derivative contracts designated as net investment hedges and the purchases of trademarks. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information on the Company's derivative contracts designated as net investment hedges. Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 27,339 $ 29,857 $ 27,281 Payments of debt (30,568 ) (28,768 ) (25,615 ) Issuances of stock 1,476 1,595 1,434 Purchases of stock for treasury (1,912 ) (3,682 ) (3,681 ) Dividends (6,644 ) (6,320 ) (6,043 ) Other financing activities (243 ) (91 ) Net cash provided by (used in) financing activities $ (10,552 ) $ (7,409 ) $ (6,545 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2018 , our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc. (formerly Coca-Cola Bottling Co. Consolidated), Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2018, the Company had issuances of debt of $27,339 million , which primarily included $24,253 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $3,083 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. During 2018, the Company made payments of debt of $30,568 million , which included $27,249 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,319 million. In 2017, the Company had issuances of debt of $29,857 million , which included issuances of $26,218 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million, net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,768 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,156 of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million. The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Coca-Cola Enterprises Inc.'s former North America business (""Old CCE""). This resulted in a net charge of $38 million that was recorded in the line item interest expense in our consolidated statement of income. This net charge reflects the difference between the reacquisition price and the net carrying amount of the debt extinguished. In 2016, the Company had issuances of debt of $27,281 million , which included net issuances of $773 million of commercial paper and short-term debt with maturities of 90 days or less and $21,525 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $4,983 million, net of related discounts and issuance costs. During 2016, the Company made payments of debt of $25,615 million , which included $22,920 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $2,695 million. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE of $ 212 million and $ 263 million as of December 31, 2018 and 2017 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2018 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 871 million , $ 757 million and $ 663 million in 2018 , 2017 and 2016 , respectively. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt balances. Issuances of Stock The issuances of stock in 2018 , 2017 and 2016 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase program of up to 500 million shares of the Company's common stock. The table below presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 45.09 $ 44.09 $ 43.62 Since the inception of our initial share repurchase program in 1984 through our current program as of December 31, 2018 , we have purchased 3.5 billion shares of our Company's common stock at an average price per share of $17.06. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2018, we repurchased $1.9 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2018 resulted in a net cash outflow of $0.4 billion . In 2019, we expect to repurchase shares to offset dilution resulting from employee stock-based compensation plans. Dividends The Company paid dividends of $6,644 million , $6,320 million and $6,043 million during the years ended December 31, 2018 , 2017 and 2016 , respectively. At its February 2019 meeting, our Board of Directors increased our regular quarterly dividend by 2.6 percent, raising it to $0.40 per share, equivalent to a full year dividend of $1.60 per share in 2019. This is our 57 th consecutive annual increase. Our annualized common stock dividend was $ 1.56 per share, $ 1.48 per share and $ 1.40 per share in 2018 , 2017 and 2016 , respectively. The 2018 dividend represented a 5 percent increase from 2017 , and the 2017 dividend represented a 6 percent increase from 2016 . Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2018 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 600 million , of which $ 247 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. Management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2018 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2018 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2020-2021 2022-2023 2024 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 13,063 $ 13,063 $ $ $ Lines of credit and other short-term borrowings Current maturities of long-term debt 2 4,999 4,999 Long-term debt, net of current maturities 2 25,230 7,203 6,463 11,564 Estimated interest payments 3 3,907 2,105 Accrued income taxes 4 4,364 1,128 2,206 Purchase obligations 5 14,840 8,344 1,512 1,066 3,918 Marketing obligations 6 4,260 2,333 1,035 Lease obligations Held-for-sale obligations 7 1,722 1,722 Total contractual obligations $ 73,211 $ 31,612 $ 11,369 $ 9,842 $ 20,388 1 Refer to Note 11 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 11 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2018 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 15 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,986 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $522 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for these liabilities cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents liabilities and contractual obligations of the Company's bottling operations that are classified as held for sale. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2018 was $1,817 million . Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, pension expense, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. As of December 31, 2018 , the projected benefit obligation of the U.S. qualified pension plans was $5,170 million, and the fair value of the related plan assets was $4,842 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $2,834 million, and the fair value of the related plan assets was $2,567 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $66 million in 2019, increasing to $70 million by 2025 and then decreasing annually thereafter. Refer to Note 14 of Notes to Consolidated Financial Statements. The Company expects to contribute $32 million in 2019 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 14 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our various plans in the table above. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2018 , our self-insurance reserves totaled $ 362 million . Refer to Note 12 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2018 were $1,933 million . Refer to Note 15 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, on January 3, 2019, the Company completed the acquisition of Costa for $4.9 billion , which is not included in the table above. Refer to Note 22 of Notes to Consolidated Financial Statements. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2018 , we used 72 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weaknesses in some of these currencies may be offset by strengths in others. In 2018 and 2017 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies (1 )% % Brazilian real (12 )% % Mexican peso (2 ) (2 ) Australian dollar (2 ) South African rand British pound sterling (6 ) Euro Japanese yen (3 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 1 percent in 2018 and 2017 . The total currency impact on income from continuing operations before income taxes, including the effect of our hedging activities, was a decrease of 7 percent in 2018 and was nominal in 2017 . Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statements of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $144 million, $57 million and $246 million during the years ended December 31, 2018 , 2017 and 2016 , respectively. Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. During the year ended December 31, 2016 the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the former open market exchange rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. We sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the year ended December 31, 2016 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expected to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded a write-down of $76 million , which was recorded in the line item other operating charges in our consolidated statement of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of the impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. Overview of Financial Position The following table illustrates the change in the individual line items of the Company's consolidated balance sheet (in millions): December 31, Increase (Decrease) Percent Change Cash and cash equivalents $ 8,926 $ 6,006 $ 2,920 % Short-term investments 2,025 9,352 (7,327 ) (78 ) Marketable securities 5,013 5,317 (304 ) (6 ) Trade accounts receivable net 3,396 3,667 (271 ) (7 ) Inventories 2,766 2,655 Prepaid expenses and other assets 1,962 2,000 (38 ) (2 ) Assets held for sale (219 ) (100 ) Assets held for sale discontinued operations 6,546 7,329 (783 ) (11 ) Equity method investments 19,407 20,856 (1,449 ) (7 ) Other investments 1,096 (229 ) (21 ) Other assets 4,139 4,230 (91 ) (2 ) Deferred income tax assets 2,667 2,337 Property, plant and equipment net 8,232 8,203 Trademarks with indefinite lives 6,682 6,729 (47 ) (1 ) Bottlers' franchise rights with indefinite lives (87 ) (63 ) Goodwill 10,263 9,401 Other intangible assets (94 ) (26 ) Total assets $ 83,216 $ 87,896 $ (4,680 ) (5 )% Accounts payable and accrued expenses $ 8,932 $ 8,748 $ % Loans and notes payable 13,194 13,205 (11 ) Current maturities of long-term debt 4,997 3,298 1,699 Accrued income taxes (32 ) (8 ) Liabilities held for sale (37 ) (100 ) Liabilities held for sale discontinued operations 1,722 1,496 Long-term debt 25,364 31,182 (5,818 ) (19 ) Other liabilities 7,638 8,021 (383 ) (5 ) Deferred income tax liabilities 1,933 2,522 (589 ) (23 ) Total liabilities $ 64,158 $ 68,919 $ (4,761 ) (7 )% Net assets $ 19,058 $ 18,977 $ 1 % 1 Includes a decrease in net assets of $2,035 million resulting from foreign currency translation adjustments in various balance sheet line items. The increases (decreases) in the table above include the impact of the following transactions and events: Assets held for sale discontinued operations decreased primarily due to a $554 million impairment charge and a $411 million allocation of goodwill to other reporting units. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements. Equity method investments decreased primarily due to the derecognition of our equity method interest in the Philippine bottling operations as well as other-than-temporary impairment charges of $591 million related to certain of our equity method investees. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements. Deferred income tax assets increased primarily as a result of our adoption of ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory , which required us to record a deferred tax asset of $2.9 billion during the year ended December 31, 2018 . Refer to Note 1 and Note 15 of Notes to Consolidated Financial Statements. Goodwill increased primarily due to the acquisition of the Philippine bottling operations and the allocation of goodwill from CCBA to other reporting units. Refer to Note 2 and Note 9 of Notes to Consolidated Financial Statements. Current maturities of long-term debt increased and long-term debt decreased primarily due to a portion of the Company's long-term debt maturing within the next 12 months and being reclassified as current. Current maturities of long-term debt were reduced by payments. Refer to the heading ""Cash Flows from Financing Activities"" above for additional information. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2018 , we used 72 functional currencies in addition to the U.S. dollar and generated $20,512 million of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies may be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options (principally euros, British pounds sterling and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $17,142 million and $13,057 million as of December 31, 2018 and 2017 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $83 million as of December 31, 2018 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $191 million. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $40 million as of December 31, 2018 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized loss and created a net unrealized gain of $217 million. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2018 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $251 million in 2018 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $100 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. Open commodity derivatives that qualify for hedge accounting had notional values of $9 million and $35 million as of December 31, 2018 and 2017 , respectively. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of $1 million as of December 31, 2018 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $2 million. Open commodity derivatives that do not qualify for hedge accounting had notional values of $373 million and $357 million as of December 31, 2018 and 2017 , respectively. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $44 million as of December 31, 2018 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $69 million. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 70 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, (In millions except per share data) NET OPERATING REVENUES $ 31,856 $ 35,410 $ 41,863 Cost of goods sold 11,770 13,255 16,465 GROSS PROFIT 20,086 22,155 25,398 Selling, general and administrative expenses 10,307 12,654 15,370 Other operating charges 1,079 1,902 1,371 OPERATING INCOME 8,700 7,599 8,657 Interest income Interest expense Equity income (loss) net 1,008 1,071 Other income (loss) net (1,121 ) (1,764 ) (1,265 ) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 8,350 6,742 8,136 Income taxes from continuing operations 1,623 5,560 1,586 NET INCOME FROM CONTINUING OPERATIONS 6,727 1,182 6,550 Income (loss) from discontinued operations (net of income taxes of $126, $47 and $0, respectively) (251 ) CONSOLIDATED NET INCOME 6,476 1,283 6,550 Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 6,434 $ 1,248 $ 6,527 Basic net income per share from continuing operations 1 $ 1.58 $ 0.28 $ 1.51 Basic net income (loss) per share from discontinued operations 2 (0.07 ) 0.02 BASIC NET INCOME PER SHARE $ 1.51 $ 0.29 3 $ 1.51 Diluted net income per share from continuing operations 1 $ 1.57 $ 0.27 $ 1.49 Diluted net income (loss) per share from discontinued operations 2 (0.07 ) 0.02 DILUTED NET INCOME PER SHARE $ 1.50 $ 0.29 $ 1.49 AVERAGE SHARES OUTSTANDING BASIC 4,259 4,272 4,317 Effect of dilutive securities AVERAGE SHARES OUTSTANDING DILUTED 4,299 4,324 4,367 1 Calculated based on net income from continuing operations less net income from continuing operations attributable to noncontrolling interests. 2 Calculated based on net income (loss) from discontinued operations less net income from discontinued operations attributable to noncontrolling interests. 3 Per share amounts do not add due to rounding. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, (In millions) CONSOLIDATED NET INCOME $ 6,476 $ 1,283 $ 6,550 Other comprehensive income: Net foreign currency translation adjustments (2,035 ) (626 ) Net gains (losses) on derivatives (7 ) (433 ) (382 ) Net unrealized gains (losses) on available-for-sale securities (34 ) Net change in pension and other benefit liabilities (53 ) TOTAL COMPREHENSIVE INCOME 4,429 2,221 5,506 Less: Comprehensive income attributable to noncontrolling interests TOTAL COMPREHENSIVE INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 4,334 $ 2,148 $ 5,496 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions except par value) ASSETS CURRENT ASSETS Cash and cash equivalents $ 8,926 $ 6,006 Short-term investments 2,025 9,352 TOTAL CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS 10,951 15,358 Marketable securities 5,013 5,317 Trade accounts receivable, less allowances of $489 and $477, respectively 3,396 3,667 Inventories 2,766 2,655 Prepaid expenses and other assets 1,962 2,000 Assets held for sale Assets held for sale discontinued operations 6,546 7,329 TOTAL CURRENT ASSETS 30,634 36,545 EQUITY METHOD INVESTMENTS 19,407 20,856 OTHER INVESTMENTS 1,096 OTHER ASSETS 4,139 4,230 DEFERRED INCOME TAX ASSETS 2,667 PROPERTY, PLANT AND EQUIPMENT net 8,232 8,203 TRADEMARKS WITH INDEFINITE LIVES 6,682 6,729 BOTTLERS' FRANCHISE RIGHTS WITH INDEFINITE LIVES GOODWILL 10,263 9,401 OTHER INTANGIBLE ASSETS TOTAL ASSETS $ 83,216 $ 87,896 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 8,932 $ 8,748 Loans and notes payable 13,194 13,205 Current maturities of long-term debt 4,997 3,298 Accrued income taxes Liabilities held for sale Liabilities held for sale discontinued operations 1,722 1,496 TOTAL CURRENT LIABILITIES 29,223 27,194 LONG-TERM DEBT 25,364 31,182 OTHER LIABILITIES 7,638 8,021 DEFERRED INCOME TAX LIABILITIES 1,933 2,522 THE COCA-COLA COMPANY SHAREOWNERS' EQUITY Common stock, $0.25 par value; Authorized 11,200 shares; Issued 7,040 and 7,040 shares, respectively 1,760 1,760 Capital surplus 16,520 15,864 Reinvested earnings 63,234 60,430 Accumulated other comprehensive income (loss) (12,814 ) (10,305 ) Treasury stock, at cost 2,772 and 2,781 shares, respectively (51,719 ) (50,677 ) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY 16,981 17,072 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS 2,077 1,905 TOTAL EQUITY 19,058 18,977 TOTAL LIABILITIES AND EQUITY $ 83,216 $ 87,896 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (In millions) OPERATING ACTIVITIES Consolidated net income $ 6,476 $ 1,283 $ 6,550 (Income) loss from discontinued operations (101 ) Net income from continuing operations 6,727 1,182 6,550 Depreciation and amortization 1,086 1,260 1,787 Stock-based compensation expense Deferred income taxes (450 ) (1,256 ) (856 ) Equity (income) loss net of dividends (457 ) (628 ) (449 ) Foreign currency adjustments (38 ) Significant (gains) losses on sales of assets net 1,459 1,146 Other operating charges 1,218 Other items (269 ) (224 ) Net change in operating assets and liabilities (1,202 ) 3,464 (225 ) Net cash provided by operating activities 7,320 6,930 8,792 INVESTING ACTIVITIES Purchases of investments (7,789 ) (17,296 ) (16,626 ) Proceeds from disposals of investments 14,977 16,694 17,842 Acquisitions of businesses, equity method investments and nonmarketable securities (1,040 ) (3,809 ) (838 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 1,035 Purchases of property, plant and equipment (1,347 ) (1,675 ) (2,262 ) Proceeds from disposals of property, plant and equipment Other investing activities (60 ) (93 ) (305 ) Net cash provided by (used in) investing activities 6,348 (2,254 ) (1,004 ) FINANCING ACTIVITIES Issuances of debt 27,339 29,857 27,281 Payments of debt (30,568 ) (28,768 ) (25,615 ) Issuances of stock 1,476 1,595 1,434 Purchases of stock for treasury (1,912 ) (3,682 ) (3,681 ) Dividends (6,644 ) (6,320 ) (6,043 ) Other financing activities (243 ) (91 ) Net cash provided by (used in) financing activities (10,552 ) (7,409 ) (6,545 ) CASH FLOWS FROM DISCONTINUED OPERATIONS Net cash provided by (used in) operating activities from discontinued operations Net cash provided by (used in) investing activities from discontinued operations (421 ) (58 ) Net cash provided by (used in) financing activities from discontinued operations (38 ) Net cash provided by (used in) discontinued operations EFFECT OF EXCHANGE RATE CHANGES ON CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS (262 ) (5 ) CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 2,945 (2,477 ) 1,238 Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 6,373 8,850 7,612 Cash, cash equivalents, restricted cash and restricted cash equivalents at end of year 9,318 6,373 8,850 Less: Restricted cash and restricted cash equivalents at end of year Cash and cash equivalents at end of year $ 8,926 $ 6,006 $ 8,555 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY Year Ended December 31, (In millions except per share data) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year 4,259 4,288 4,324 Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (39 ) (82 ) (86 ) Balance at end of year 4,268 4,259 4,288 COMMON STOCK $ 1,760 $ 1,760 $ 1,760 CAPITAL SURPLUS Balance at beginning of year 15,864 14,993 14,016 Stock issued to employees related to stock compensation plans Tax benefit (charge) from stock compensation plans Stock-based compensation expense Other activities (36 ) (3 ) Balance at end of year 16,520 15,864 14,993 REINVESTED EARNINGS Balance at beginning of year 60,430 65,502 65,018 Adoption of accounting standards 1 3,014 Net income attributable to shareowners of The Coca-Cola Company 6,434 1,248 6,527 Dividends (per share $1.56, $1.48 and $1.40 in 2018, 2017 and 2016, respectively) (6,644 ) (6,320 ) (6,043 ) Balance at end of year 63,234 60,430 65,502 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year (10,305 ) (11,205 ) (10,174 ) Adoption of accounting standards 1 (409 ) Net other comprehensive income (loss) (2,100 ) (1,031 ) Balance at end of year (12,814 ) (10,305 ) (11,205 ) TREASURY STOCK Balance at beginning of year (50,677 ) (47,988 ) (45,066 ) Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (1,746 ) (3,598 ) (3,733 ) Balance at end of year (51,719 ) (50,677 ) (47,988 ) TOTAL EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 16,981 $ 17,072 $ 23,062 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS Balance at beginning of year $ 1,905 $ $ Net income attributable to noncontrolling interests Net foreign currency translation adjustments (13 ) Dividends paid to noncontrolling interests (31 ) (15 ) (25 ) Contributions by noncontrolling interests Business combinations 1,805 Deconsolidation of certain entities (157 ) (34 ) Other activities (4 ) TOTAL EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS $ 2,077 $ 1,905 $ 1 Refer to Note 1 , Note 3 , Note 4 and Note 15 . Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system (""Coca-Cola system""). Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Certain prior year amounts in the consolidated financial statements and accompanying notes have been revised to conform to the current year presentation as a result of the adoption of certain accounting standards that became effective January 1, 2018 , as applicable. Refer to the ""Recently Adopted Accounting Guidance"" section within this note below for further details. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 12 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,916 million and $ 4,523 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 49 million and $ 1 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Assets and Liabilities Held for Sale Our Company classifies long-lived assets or disposal groups to be sold as held for sale in the period in which all of the following criteria are met: (1) management, having the authority to approve the action, commits to a plan to sell the asset or disposal group; (2) the asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets or disposal groups; (3) an active program to locate a buyer and other actions required to complete the plan to sell the asset or disposal group have been initiated; (4) the sale of the asset or disposal group is probable, and transfer of the asset or disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond our control extend the period of time required to sell the asset or disposal group beyond one year; (5) the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We initially measure a long-lived asset or disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held-for-sale criteria are met. Conversely, gains are not recognized on the sale of a long-lived asset or disposal group until the date of sale. We assess the fair value of a long-lived asset or disposal group less any costs to sell each reporting period it remains classified as held for sale and report any subsequent changes as an adjustment to the carrying value of the asset or disposal group, as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. Upon determining that a long-lived asset or disposal group meets the criteria to be classified as held for sale, the Company ceases depreciation and reports long-lived assets and/or the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale, respectively, in our consolidated balance sheet. Refer to Note 2 . Discontinued Operations A disposal group is classified as a discontinued operation when the following criteria are met: (1) the disposal group is a component of an entity; (2) the component of the entity meets the held-for-sale criteria in accordance with our policy described above; and (3) the component of the entity represents a strategic shift in the entity's operating and financial results. Alternatively, if a business meets the criteria for held for sale on the acquisition date, the business is accounted for as a discontinued operation. In October 2017, the Company and Anheuser-Busch InBev (""ABI"") completed the transition of ABI's controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company for $3,150 million , resulting in its consolidation. As CCBA met the criteria for held for sale upon consolidation, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. Refer to Note 3 . Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $4 billion in 2018 , 2017 and 2016 . As of December 31, 2018 and 2017 , advertising and production costs of $ 54 million and $ 95 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statements of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statements of income, except for costs incurred to distribute goods sold by our Company-owned bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. Effective January 1, 2018, we adopted ASC 606. Upon adoption, we made a policy election to recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Refer to Note 3 for additional information regarding revenue recognition. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. Upon adoption of ASC 606, we made a policy election to exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Refer to Note 3 for additional information regarding revenue recognition. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 51 million , 47 million and 51 million stock option awards were excluded from the computations of diluted net income per share in 2018 , 2017 and 2016 , respectively, because the awards would have been antidilutive for the years presented. The following table presents information related to net income from continuing operations and net income from discontinued operations (in millions): Year Ended December 31, 2017 CONTINUING OPERATIONS Net income from continuing operations $ 6,727 $ 1,182 $ 6,550 Less: Net income (loss) from continuing operations attributable to noncontrolling interests (7 ) Net income from continuing operations attributable to shareowners of The Coca-Cola Company $ 6,734 $ 1,181 $ 6,527 DISCONTINUED OPERATIONS Net income (loss) from discontinued operations $ (251 ) $ $ Less: Net income from discontinued operations attributable to noncontrolling interests Net income (loss) from discontinued operations attributable to shareowners of The Coca-Cola Company $ (300 ) $ $ CONSOLIDATED Consolidated net income $ 6,476 $ 1,283 $ 6,550 Less: Net income attributable to noncontrolling interests Net income attributable to shareowners of The Coca-Cola Company $ 6,434 $ 1,248 $ 6,527 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheets, and amounts classified in assets held for sale and assets held for sale discontinued operations. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2018 December 31, 2017 December 31, 2016 Cash and cash equivalents $ 8,926 $ 6,006 $ 8,555 Cash and cash equivalents included in assets held for sale 49 Cash and cash equivalents included in assets held for sale discontinued operations 97 Cash and cash equivalents included in other assets 1 257 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 9,318 $ 6,373 $ 8,850 1 Amounts represent cash and cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4 . Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") 2016-01 Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments which include our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Activity in the allowance for doubtful accounts was as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Net charges to costs and expenses 1 Write-offs (4 ) (10 ) (10 ) Other 2 (13 ) (11 ) (2 ) Balance at end of year $ $ $ 1 The 2016 amount was primarily related to concentrate sales receivables from our bottling partner in Venezuela. See ""Hyperinflationary Economies"" discussion below for additional information. 2 Other includes foreign currency translation adjustments and the impact of reclassifying certain assets to assets held for sale. Refer to Note 2. A significant portion of our net operating revenues and corresponding accounts receivable is derived from sales of our products in international markets. Refer to Note 3 and Note 20 . We also generate a significant portion of our net operating revenues by selling concentrates and syrups to bottlers in which we have a noncontrolling interest. Refer to Note 7 . Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheets in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statements of cash flows in net cash provided by operating activities. Refer to Note 6 . Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery, equipment and vehicle fleet: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under capital lease, totaled $ 999 million , $ 1,131 million and $ 1,575 million in 2018 , 2017 and 2016 , respectively. Amortization expense for leasehold improvements totaled $ 18 million , $ 19 million and $ 22 million in 2018 , 2017 and 2016 , respectively. Refer to Note 8 . Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. Refer to Note 17 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 9 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statements of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 12 . Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performancebased share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 13 . Income Taxes Income tax expense includes U.S., state, local and international income taxes, plus a provision for U.S. taxes on undistributed earnings of foreign subsidiaries and other prescribed foreign entities not deemed to be indefinitely reinvested. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company records taxes that are collected from customers and remitted to governmental authorities on a net basis in our consolidated statements of income. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 12 and Note 15 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 16 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statements of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the former open market exchange rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. We sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the year ended December 31, 2016 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expected to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded a write-down of $76 million , which was recorded in the line item other operating charges in our consolidated statement of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of this impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Recently Adopted Accounting Guidance In May 2014, the Financial Accounting Standards Board (""FASB"") issued ASU 2014-09, Revenue from Contracts with Customers , which replaces most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. ASU 2014-09 and its amendments were included primarily in ASC 606. The core principle of ASC 606 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASC 606 also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. We adopted ASC 606 effective January 1, 2018, using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $257 million , net of tax. The Company has changed our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data for the reporting process. Refer to Note 3 . In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $409 million , net of tax. Refer to Note 4 for additional disclosures required by this ASU. In March 2016, the FASB issued ASU 2016-09, Compensation Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The Company adopted ASU 2016-09 on January 1, 2017 by prospectively recognizing excess tax benefits and tax deficiencies in our consolidated statement of income as the awards vested or were settled. Effective January 1, 2017, the Company also prospectively presented excess tax benefits as an operating activity, rather than a financing activity, in our consolidated statement of cash flows. Had these changes been required to be adopted retrospectively, during the year ended December 31, 2016 , the Company would have recognized an additional $130 million of excess tax benefits in our consolidated statement of income. Additionally, during the year ended December 31, 2016 , the Company would have reduced our financing activities and increased our operating activities by $130 million in our consolidated statement of cash flows. The Company has elected, consistent with past practice, to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments , which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 was effective for the Company beginning January 1, 2018 and was adopted using the retrospective transition approach to all periods presented. The impact of the adoption of ASU 2016-15 on our consolidated statement of cash flows was a change in presentation related to our proceeds from the settlement of corporate-owned life insurance policies. We revised our consolidated statement of cash flows to reflect these proceeds in the line item other investing activities, which were previously presented in the line item net change in operating assets and liabilities. During the years ended December 31, 2017 and 2016 , the amount of proceeds received from the settlement of corporate-owned life insurance policies was $65 million and $3 million , respectively. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. Refer to Note 15 . In November 2016, the FASB issued ASU 2016-18, Restricted Cash . The amendments in this update address diversity in practice that exists in the classification and presentation of changes in amounts generally described as restricted cash and require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts that an entity defines as restricted cash for purposes of this standard or otherwise does not present in the line item cash and cash equivalents on its balance sheet. ASU 2016-18 was effective for the Company beginning January 1, 2018 and was adopted using the retrospective transition method to all periods presented. Prior to the adoption of ASU 2016-18, we presented the transfer of cash and cash equivalents into or out of our captive insurance companies in the line items purchases of investments and proceeds from disposals of investments in our consolidated statement of cash flows. We did not present the purchases of investments and proceeds from disposals of investments within our captive insurance companies. Cash flows related to cash and cash equivalents included in our insurance captives are now presented in the line items purchases of investments and proceeds from disposals of investments within the investing activities section of our consolidated statement of cash flows. During the year ended December 31, 2017 , the purchases of investments and proceeds from disposals of investments within our captive insurance companies were $777 million and $773 million , respectively. During the year ended December 31, 2016 , the purchases of investments and proceeds from disposals of investments within our captive insurance companies were $1,388 million and $1,304 million , respectively. Prior to the adoption of ASU 2016-18, we treated the change in cash and cash equivalents included in assets held for sale as an adjustment to the line item other investing activities within our consolidated statement of cash flows. With the adoption of this ASU, we no longer make this adjustment and we revised the prior year to remove this adjustment. During the year ended December 31, 2017 , the change in cash and cash equivalents included in assets held for sale was $36 million . During the year ended December 31, 2016 , the change in cash and cash equivalents included in assets held for sale was $94 million . Refer to the heading ""Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents"" above for additional disclosures required by this ASU. In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost , which requires that the service cost component of the Company's net periodic pension cost and net periodic postretirement benefit cost be included in the same line item as other compensation costs arising from services rendered by employees, with the non-service cost components of net periodic benefit cost and other benefit plan charges and credits being classified outside of a subtotal of income from operations. ASU 2017-07 was effective for the Company beginning January 1, 2018 and was adopted retrospectively for the presentation of the other components of net periodic benefit cost and other benefit plan charges and credits in our consolidated statements of income. As part of our adoption, we elected to use a practical expedient which allows us to use information previously disclosed in our note on pension and other postretirement benefit plans as the estimation basis for applying the retrospective presentation requirements of this ASU. During the years ended December 31, 2017 and December 31, 2016 , we reclassified $98 million and $31 million of expense, respectively, related to our non-service cost components of net periodic benefit cost and other benefit plan charges and credits from operating income to other income (loss) net in our consolidated statements of income. Refer to Note 14 for additional disclosures required by this ASU. In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Cuts and Jobs Act (""Tax Reform Act""). The amendments also require any provisional amounts or subsequent adjustments to be included in net income from continuing operations. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018 . Refer to Note 15 for additional information on the Tax Reform Act. Accounting Guidance Not Yet Adopted In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize right-of-use assets, representing their right to use the underlying asset for the lease term, and lease liabilities on the balance sheet for all leases with terms greater than 12 months. The guidance also modifies the classification criteria and the accounting for sales-type and direct financing leases by lessors. Additionally, the guidance requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The Company has substantially completed its preparation for the adoption of this new accounting standard. This included assessing the completeness of our lease arrangements, evaluating practical expedients and accounting policy elections, executing changes to our business process, which include our systems and controls, and implementing software to meet the reporting requirements of this standard. ASU 2016-02 is effective for the Company beginning January 1, 2019 . The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. The Company expects to elect certain practical expedients, including the package of practical expedients to not reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs, and is evaluating the other practical expedients available under the guidance. The Company also plans to elect the optional transition method that will give companies the option to use the effective date as the date of initial application on transition, and as a result, we will not adjust our comparative period financial information or make the new required lease disclosures for periods before the effective date. The Company anticipates the adoption of this new standard will result in an increase of approximately 1 percent of total assets and liabilities on our consolidated balance sheet. This estimate does not include transactions that closed in the first quarter of 2019, such as Costa Limited (""Costa""). While we are substantially complete with the process of quantifying the impacts that will result from applying the new guidance, our assessment will be finalized during the first quarter of 2019. We do not expect the new standard to have a material impact on the Company's consolidated statement of income. As the impact of this standard is noncash in nature, we do not anticipate its adoption having an impact on the Company's consolidated statement of cash flows. In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. Finally, the standard introduces new alternatives that permit companies to reduce the risk of material error if the shortcut method is misapplied. ASU 2017-12 is effective for the Company beginning January 1, 2019 and is required to be applied prospectively. The adoption of this ASU is not expected to have a material impact on our consolidated balance sheet, statement of income or statement of cash flows. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , which permits entities to reclassify the disproportionate income tax effects of the Tax Reform Act on items within accumulated other comprehensive income (loss) (""AOCI"") to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" Amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income from continuing operations is not affected by this update. ASU 2018-02 is effective for the Company beginning January 1, 2019 and should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Reform Act is recognized. We have elected to apply this standard in the period of adoption and will recognize a cumulative effect adjustment to the opening balance of reinvested earnings as of January 1, 2019 . We expect this cumulative effect adjustment to increase reinvested earnings by approximately $500 million . NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2018 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,040 million , which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Refer to the ""Philippine Bottling Operations"" section within this note below for further details. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor has the option to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2017 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $3,809 million , of which $3,150 million related to the transition of ABI's 54.5 percent controlling interest in CCBA to the Company, resulting in its consolidation in October 2017. The financial position and results of operations of CCBA are being accounted for as a discontinued operation. Refer to the ""Discontinued Operations"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for noncash consideration. Refer to the ""North America Refranchising United States"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. During 2016 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 838 million , which primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd. (""China Green""), a maker of plant-based protein beverages in China, and a minority investment in CHI Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages, which is accounted for under the equity method of accounting. Under the terms of the agreement for our investment in CHI, the Company acquired the remaining ownership interest from the existing shareowners in January 2019. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $715 million of cash. The acquired business had $345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,362 million , primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations, as well as the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley""). During 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. During 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,035 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America. Latin America Bottling Operations As of December 31, 2017 , certain of the Company's bottling operations in Latin America were classified as held for sale. During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $289 million as a result of these sales and recognized a net gain of $47 million , which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018 , we sold our equity ownership in Lindley to AC Bebidas, an equity method investee. We received net cash proceeds of $507 million and recognized a net gain of $296 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018 , the Company completed its North America refranchising with the sale of its Canadian bottling operations. We received initial net cash proceeds of $518 million and recognized a net charge of $385 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising United States In conjunction with implementing a new beverage partnership model in North America, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas as well as the CBA entered into with Liberty Coca-Cola Beverages, the bottlers make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories to the respective bottlers in exchange for cash, except for the territory included in the Southwest Transaction. As discussed further below, we did not receive cash in the Southwest Transaction for these items. In 2016, the Company formed a new National Product Supply System (""NPSS"") to facilitate optimal operation of the U.S. product supply system. Under the NPSS, the Company and several of its independent producing bottlers administer key national product supply activities for these bottlers. Additionally, CCR sold production assets to these independent producing bottlers in exchange for cash, excluding production facilities included in the Southwest Transaction. During the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , cash proceeds from these sales totaled $3 million , $2,860 million and $1,017 million , respectively. Included in the cash proceeds for the years ended December 31, 2017 and December 31, 2016 was $336 million and $279 million , respectively, from Coca-Cola Bottling Co. Consolidated now known as Coca-Cola Consolidated, Inc. (""CCCI""), an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017 was $220 million from AC Bebidas and $39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized net charges of $91 million , $3,177 million and $2,456 million during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , respectively. Included in these amounts are net charges from transactions with equity method investees or former management of $21 million , $1,104 million and $492 million , during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , respectively. The net charges in 2018 were primarily related to post-closing adjustments as contemplated by the related agreements. The net charges in 2017 and 2016 were primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The net charges in 2017 included $236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain refranchised territories participate. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the statement of income only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the statement of income as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , the Company recorded charges of $34 million , $313 million and $31 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, as well as consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The charges related to these payments were included in the line item other income (loss) net in our consolidated statements of income during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 . On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. CCR also made cash payments of $144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Refranchising of China Bottling Operations In 2017, the Company sold its bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and sold a related cost method investment to one of the franchise bottlers. We received net cash proceeds of $963 million as a result of these sales and recognized a gain of $88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. Coca-Cola European Partners In May 2016, the Company merged our German bottling operations with Coca-Cola Enterprises, Inc. (""CCE"") and Coca-Cola Iberian Partners, S.A.U., formerly known as Coca-Cola Iberian Partners, S.A. (""CCIP""), to create Coca-Cola European Partners plc (""CCEP""). In exchange for our German bottling operations, we received an 18 percent interest in CCEP. As a result of recording our interest in CCEP at fair value based on its quoted market price (a Level 1 measurement), the deconsolidation of our German bottling operations, and the related reversal of its cumulative translation adjustments, we recognized a gain of $1,400 million . This gain was partially offset by a $77 million charge incurred as a result of reclassifying losses related to our net investment hedges of our German bottling operations from AOCI into earnings as well as transaction costs incurred resulting in a net gain of $1,287 million during the year ended December 31, 2016. Refer to Note 16 . With the exception of the transaction costs, the net gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in CCEP as an equity method investment based on our equity ownership percentage, our representation on CCEP's Board of Directors, material intercompany transactions and other governance rights. Coca-Cola Beverages Africa Proprietary Limited In July 2016, the Company, SABMiller plc and Gutsche Family Investments combined the bottling operations of each of the parties' nonalcoholic ready-to-drink beverage businesses in Southern and East Africa to form a new bottler, which is called CCBA. The Company: (1) contributed its South African bottling operations to CCBA, which included certain wholly owned subsidiaries and an equity method investment; (2) paid $150 million in cash; (3) obtained a 12 percent interest in CCBA and a 3 percent interest in CCBA's South African subsidiary; and (4) acquired several trademarks that are generally indefinite-lived. As a result of recording our interests in CCBA and its South African subsidiary at fair value, the deconsolidation of our South African bottling operations, the derecognition of the equity method investment, and the reversal of related cumulative translation adjustments, we recognized a charge of $21 million . The fair values of the equity investments in CCBA and CCBA's South African subsidiary, along with the acquired trademarks, were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. The loss recognized resulted primarily from the reversal of the related cumulative translation adjustments. This loss was recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016. Based on the level of equity ownership, the Company's representation on CCBA's Board of Directors (two of its ten members) and other governance rights, the Company accounted for its interests in CCBA and CCBA's South African subsidiary as equity method investments. The Company's interest in CCBA provided it with a call option to acquire the ownership interest of SABMiller plc at fair value upon the occurrence of certain events, including upon a change in control of SABMiller plc. In October 2016, ABI acquired SABMiller plc, including its 54.5 percent controlling interest in CCBA, and as a result, we exercised our call option. In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of acquisition. Refer to the ""Discontinued Operations"" section within this note below for further discussion. Keurig Green Mountain, Inc. In March 2016, a JAB Holding Company-led investor group acquired Keurig Green Mountain, Inc. (""Keurig""). As a result, the Company received proceeds of $2,380 million , which were recorded in the line item proceeds from disposals of investments in our consolidated statement of cash flows, and recorded a gain of $18 million related to the disposal of our shares of Keurig in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016. Assets and Liabilities Held for Sale As of December 31, 2017 , the Company had certain bottling operations in North America and Latin America that met the criteria to be classified as held for sale, which requires us to present the related assets and liabilities as separate line items in our consolidated balance sheet. As these bottling territories met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price and present the related assets and liabilities as separate line items in our consolidated balance sheet. These operations were refranchised in 2018. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale in our consolidated balance sheet (in millions): December 31, 2017 Cash, cash equivalents and short-term investments $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Other assets Property, plant and equipment net Bottlers' franchise rights with indefinite lives Goodwill Other intangible assets Allowance for reduction of assets held for sale (28 ) Assets held for sale $ 1 Accounts payable and accrued expenses $ Other liabilities Deferred income taxes Liabilities held for sale $ 2 1 Consists of total assets relating to North America refranchising of $9 million and Latin America bottling operations of $210 million , which are included in the Bottling Investments operating segment. 2 Consists of total liabilities relating to North America refranchising of $5 million and Latin America bottling operations of $32 million , which are included in the Bottling Investments operating segment. We determined that the operations included in the table above did not meet the criteria to be classified as discontinued operations under the applicable guidance. Discontinued Operations In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold a controlling interest in CCBA temporarily. We anticipate that we will divest a portion of our ownership interest in 2019, which will result in the Company no longer having a controlling interest in CCBA. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell and present the related assets and liabilities as separate line items in our consolidated balance sheet. During the year ended December 31, 2018 , we recorded an impairment charge of $554 million , reflecting management's view of the proceeds that are expected to be received based on revised projections of future operating results and foreign currency exchange rate fluctuations. Refer to Note 17 . Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. We recorded $1,805 million for the noncontrolling interests of CCBA. The fair value of the noncontrolling interests was determined in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. As a result, upon finalization of purchase accounting $411 million of the final goodwill balance of $4,186 million was allocated to other reporting units expected to benefit from this transaction. During 2018, the Company acquired additional bottling operations in Zambia and Botswana, which have also been included in assets held for sale discontinued operations and liabilities held for sale discontinued operations. The following table presents information related to the major classes of assets and liabilities of CCBA that were classified as held for sale discontinued operations in our consolidated balance sheets (in millions): December 31, 2018 December 31, 2017 Cash, cash equivalents and short-term investments $ $ Trade accounts receivable, less allowances 299 Inventories 299 Prepaid expenses and other assets 52 Equity method investments 7 Other assets 29 Property, plant and equipment net 1,587 1,436 Goodwill 3,847 4,248 Other intangible assets 862 Allowance for reduction of assets held for sale (546 ) Assets held for sale discontinued operations $ 6,546 $ 7,329 Accounts payable and accrued expenses $ $ Loans and notes payable 404 Current maturities of long-term debt 6 Accrued income taxes 40 Long-term debt 19 Other liabilities 10 Deferred income taxes 419 Liabilities held for sale discontinued operations $ 1,722 $ 1,496 NOTE 3 : REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. We adopted ASC 606 effective January 1, 2018 , using the modified retrospective method. We have applied this standard to all contracts at the effective date and contracts entered into thereafter. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Once control is transferred to the customer, we have completed our performance obligation, and revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606 and an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2018 related to performance obligations satisfied in prior periods was immaterial. In addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification of certain costs relating to revenue arrangements with customers. As a result, during the year ended December 31, 2018 , we recorded certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also re-evaluated the principal versus agent considerations pertaining to certain of its arrangements with third-party manufacturers and co-packers. We recorded certain costs in net operating revenues which were previously recorded in cost of goods sold related to arrangements in which we concluded we did not control the goods before they were delivered to our customers. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. The following tables compare the amounts reported in the consolidated statement of income and consolidated balance sheet to the amounts had the previous revenue recognition guidance been in effect (in millions): Year Ended December 31, 2018 As Reported Balances without Adoption of ASC 606 Increase (Decrease) Due to Adoption Net operating revenues $ 31,856 $ 31,191 $ 1 Cost of goods sold 11,770 10,930 1 Gross profit 20,086 20,261 (175 ) Selling, general and administrative expenses 10,307 10,488 (181 ) Operating income 8,700 8,694 Income from continuing operations before income taxes 8,350 8,344 Income taxes from continuing operations 1,623 1,626 Net income from continuing operations 6,727 6,718 Income (loss) from discontinued operations (251 ) (253 ) Consolidated net income 6,476 6,465 Net income attributable to shareowners of The Coca-Cola Company 6,434 6,423 1 The increase was primarily due to the reclassification of shipping and handling costs. December 31, 2018 As Reported Balances without Adoption of ASC 606 Increase (Decrease) Due to Adoption ASSETS Trade accounts receivable $ 3,396 $ 3,302 $ 1 Prepaid expenses and other assets 1,962 1,970 (8 ) Total current assets 30,634 30,548 Deferred income tax assets 2,667 2,649 Total assets 83,216 83,112 LIABILITIES AND EQUITY Accounts payable and accrued expenses $ 8,932 $ 8,513 $ 2 Total current liabilities 29,223 28,804 Deferred income tax liabilities 1,933 2,002 (69 ) Reinvested earnings 63,234 63,480 (246 ) Total equity 19,058 19,304 (246 ) Total liabilities and equity 83,216 83,112 1 The increase was primarily due to incremental estimated variable consideration receivables from third-party customers. 2 The increase was primarily due to incremental estimated variable consideration payables due to third-party customers. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,886 $ 20,457 Finished product operations 6,773 4,626 11,399 Total $ 11,344 $ 20,512 $ 31,856 Refer to Note 20 for additional revenue disclosures by operating segment and Corporate. NOTE 4 : INVESTMENTS Equity Securities Effective January 1, 2018, we adopted ASU 2016-01, which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to AOCI as of January 1, 2018 in connection with the adoption of ASU 2016-01. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. The cost basis is determined by the specific identification method. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Refer to Note 6 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01, equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As of December 31, 2018 , the carrying values of our equity securities were included in the following line items in our consolidated balance sheet (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value Marketable securities $ $ Other investments 80 Other assets Total equity securities $ 1,934 $ The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at December 31, 2018 is as follows (in millions): Year Ended December 31, 2018 Net gains (losses) recognized during the year related to equity securities $ (250 ) Less: Net gains (losses) recognized during the year related to equity securities sold during the year Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ (258 ) As of December 31, 2017 , our equity securities consisted of the following (in millions): Gross Unrealized Estimated Cost Gains Losses Fair Value Trading securities $ $ $ (4 ) $ Available-for-sale securities 1,276 (66 ) 1,895 Total equity securities $ 1,600 $ $ (70 ) $ 2,290 As of December 31, 2017 , the fair values of our equity securities were included in the following line items in our consolidated balance sheet (in millions): Trading Securities Available-for-Sale Securities Marketable securities $ $ Other investments Other assets 890 Total equity securities $ $ 1,895 The sale and/or maturity of available-for-sale equity securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ Gross losses (19 ) Proceeds 95 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Cost Gains Losses Fair Value December 31, 2018 Trading securities $ $ $ (1 ) $ Available-for-sale securities 4,901 (27 ) 4,993 Total debt securities $ 4,946 $ $ (28 ) $ 5,037 December 31, 2017 Trading securities $ $ $ $ Available-for-sale securities 5,782 (27 ) 5,912 Total debt securities $ 5,794 $ $ (27 ) $ 5,924 The fair values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2018 December 31, 2017 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ Marketable securities 4,691 4,970 Other assets Total debt securities $ $ 4,993 $ $ 5,912 The contractual maturities of these available-for-sale debt securities as of December 31, 2018 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ $ After 1 year through 5 years 3,871 3,948 After 5 years through 10 years 122 After 10 years 241 Total $ 4,901 $ 4,993 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ $ Gross losses (27 ) (13 ) Proceeds 13,710 13,930 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $1,056 million as of December 31, 2018 and $1,159 million as of December 31, 2017 , which are classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, Raw materials and packaging $ 1,862 $ 1,729 Finished goods Other Total inventories $ 2,766 $ 2,655 NOTE 6 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign-denominated third-party debt, in hedging relationships. All derivatives are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statements of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statements of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a financial instrument's change in fair value is immediately recognized into earnings. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 17 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2018 December 31, 2017 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Liabilities held for sale discontinued operations Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 17 for the net presentation of the Company's derivative instruments. 2 Refer to Note 17 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2018 December 31, 2017 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Commodity contracts Liabilities held for sale discontinued operations Other derivative instruments Accounts payable and accrued expenses Other derivative instruments Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 17 for the net presentation of the Company's derivative instruments. 2 Refer to Note 17 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statements of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 3,175 million and $ 4,068 million as of December 31, 2018 and 2017 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $3,028 million and $1,851 million as of December 31, 2018 and 2017 , respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 9 million and $ 35 million as of December 31, 2018 and 2017 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional values of these interest rate swap agreements that was designated and qualified for the Company's interest rate cash flow hedging program was $ 500 million as of December 31, 2017 . During the year ended December 31, 2018 , we discontinued the cash flow hedge relationship related to these swaps. We reclassified a loss of $8 million into earnings as a result of the discontinuance. As of December 31, 2018, we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (5 ) (4 ) Foreign currency contracts Income (loss) from discontinued operations (3 ) Interest rate contracts Interest expense (40 ) (8 ) Commodity contracts (1 ) Cost of goods sold Commodity contracts Income (loss) from discontinued operations (5 ) Total $ $ $ (19 ) Foreign currency contracts $ (226 ) Net operating revenues $ $ Foreign currency contracts (23 ) Cost of goods sold (2 ) 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net Foreign currency contracts (3 ) Income (loss) from discontinued operations Interest rate contracts (22 ) Interest expense (37 ) Commodity contracts (1 ) Cost of goods sold (1 ) Commodity contracts (5 ) Income (loss) from discontinued operations Total $ (188 ) $ $ Foreign currency contracts $ Net operating revenues $ $ (3 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (3 ) (3 ) Interest rate contracts (126 ) Interest expense (17 ) (2 ) Commodity contracts (1 ) Cost of goods sold (1 ) Total $ (37 ) $ $ (9 ) 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and ineffective portion, if any, to the same line items in our consolidated statements of income. 2 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2018 , the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 29 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. The ineffective portions of these hedges are immediately recognized into earnings. As of December 31, 2018 , such adjustments had cumulatively increased the carrying value of our long-term debt by $ 42 million . When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives related to our fair value hedges of this type were $ 8,023 million and $ 8,121 million as of December 31, 2018 and 2017 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. The total notional value of derivatives related to fair value hedges of this type was $ 311 million as of December 31, 2017 . As of December 31, 2018 , we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 1 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (38 ) Net impact to interest expense $ (4 ) Foreign currency contracts Other income (loss) net $ (6 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ (4 ) Interest rate contracts Interest expense $ (69 ) Fixed-rate debt Interest expense Net impact to interest expense $ (6 ) Foreign currency contracts Other income (loss) net $ (37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ 2016 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (152 ) Net impact to interest expense $ Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (73 ) Net impact to other income (loss) net $ (4 ) Net impact of fair value hedging instruments $ 1 The net impacts represent the ineffective portions of the hedge relationships and the amounts excluded from the assessment of hedge effectiveness. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustment, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the change in the carrying value of the designated portion of the non-derivative financial instrument due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustment. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. During the years ended December 31, 2018 , 2017 and 2016 , the Company designated a portion of its euro-denominated debt as a hedge of a net investment in our European operations. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2017 2017 Foreign currency contracts $ $ $ (14 ) $ (7 ) $ (237 ) Foreign currency denominated debt 12,494 13,147 (1,505 ) Total $ 12,494 $ 13,147 $ $ (1,512 ) $ The Company did not reclassify any deferred gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2018 and 2017 . The Company reclassified net deferred losses of $77 million related to the deconsolidation of our German bottling operations from AOCI into earnings during the year ended December 31, 2016 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2018 , 2017 and 2016 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statements of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statements of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statements of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 10,939 million and $ 6,827 million as of December 31, 2018 and 2017 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statements of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 373 million and $ 357 million as of December 31, 2018 and 2017 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ $ (30 ) $ (45 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Other income (loss) net (264 ) (168 ) Commodity contracts Net operating revenues Commodity contracts Cost of goods sold (29 ) Commodity contracts Selling, general and administrative expenses Commodity contracts Income (loss) from discontinued operations Interest rate contracts Interest expense (1 ) (39 ) Other derivative instruments Selling, general and administrative expenses (18 ) Other derivative instruments Other income (loss) net (22 ) (15 ) Total $ (299 ) $ $ (156 ) NOTE 7 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statements of income and our carrying value in those investments. Refer to Note 18 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in CCEP, Monster Beverage Corporation (""Monster""), AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic""), and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2018 , we owned approximately 19 percent , 19 percent , 20 percent , 28 percent , 23 percent and 18 percent , respectively, of these companies' outstanding shares. As of December 31, 2018 , our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 9,071 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 75,462 $ 73,339 $ 58,054 Cost of goods sold 44,914 42,867 34,338 Gross profit $ 30,548 $ 30,472 $ 23,716 Operating income $ 7,511 $ 7,577 $ 5,652 Consolidated net income $ 4,645 $ 4,545 $ 2,967 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,544 $ 4,425 $ 2,889 Equity income (loss) net $ 1,008 $ 1,071 $ 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, Current assets $ 23,239 $ 25,023 Noncurrent assets 66,731 66,578 Total assets $ 89,970 $ 91,601 Current liabilities $ 18,097 $ 17,890 Noncurrent liabilities 29,143 29,986 Total liabilities $ 47,240 $ 47,876 Equity attributable to shareowners of investees $ 41,550 $ 41,773 Equity attributable to noncontrolling interests 1,180 1,952 Total equity $ 42,730 $ 43,725 Company equity investment $ 19,407 $ 20,856 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,799 million , $ 14,144 million and $ 10,495 million in 2018 , 2017 and 2016 , respectively. The increase in net sales to equity method investees in 2017 was primarily due to our acquisition of equity method investments in CCEP and AC Bebidas, as well as the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI in 2017 . Refer to Note 2. Total payments, primarily marketing, made to equity method investees were $ 1,131 million , $ 930 million and $ 946 million in 2018 , 2017 and 2016 , respectively. In addition, purchases of beverage products from equity method investees were $ 533 million , $ 1,298 million and $ 1,857 million in 2018 , 2017 and 2016 , respectively. The decrease in purchases of beverage products in 2018 was primarily due to reduced purchases of Monster products as a result of North America refranchising activities. Refer to Note 2. If valued at the December 31, 2018 quoted closing prices of shares actively traded on stock markets, the value of our equity method investments in publicly traded bottlers would have exceeded our carrying value by $ 6,209 million . However, the carrying value of our investment in CCBJHI exceeded the fair value of the investment as of December 31, 2018 by $164 million . Based on the length of time and the extent to which the market value has been less than our cost basis and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,563 million and $ 2,053 million as of December 31, 2018 and 2017 , respectively. The total amount of dividends received from equity method investees was $ 551 million , $ 443 million and $ 386 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2018 was $4,546 million . NOTE 8 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, Land $ $ Buildings and improvements 3,838 3,917 Machinery, equipment and vehicle fleet 11,922 12,198 Property, plant and equipment cost 16,245 16,449 Less accumulated depreciation 8,013 8,246 Property, plant and equipment net $ 8,232 $ 8,203 NOTE 9 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, Trademarks $ 6,682 $ 6,729 Bottlers' franchise rights Goodwill 10,263 9,401 Other Indefinite-lived intangible assets $ 17,102 $ 16,374 The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Total Balance at beginning of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Effect of foreign currency translation (1 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment charges (390 ) (390 ) Divestitures, deconsolidations and other 1,2 (999 ) (999 ) Balance at end of year $ $ $ 8,349 $ $ $ 9,401 Balance at beginning of year $ $ $ 8,349 $ $ $ 9,401 Effect of foreign currency translation (58 ) (9 ) (4 ) (2 ) (73 ) Acquisitions 1,3 Adjustments related to the finalization of purchase accounting 1,4 (11 ) Divestitures, deconsolidations and other 1 (5 ) (5 ) Balance at end of year $ 1,068 $ $ 8,338 $ $ $ 10,263 1 Refer to Note 2 for information related to the Company's acquisitions and divestitures. 2 The 2017 decrease in the Bottling Investments segment was primarily a result of North America bottling operations being refranchised. Refer to Note 2 . 3 The increase in 2018 was primarily due to the acquisition of the Philippine bottling operations. Refer to Note 2 . 4 The increase in 2018 was primarily due to the allocation of goodwill from CCBA to other reporting units expected to benefit from the acquisition of CCBA. Refer to Note 2 . Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2018 December 31, 2017 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ $ (151 ) $ $ $ (143 ) $ Bottlers' franchise rights (18 ) (152 ) Trademarks (91 ) (73 ) Other (61 ) (64 ) Total $ $ (321 ) $ $ $ (432 ) $ Total amortization expense for intangible assets subject to amortization was $ 49 million , $ 68 million and $ 139 million in 2018 , 2017 and 2016 , respectively. Based on the carrying value of definite-lived intangible assets as of December 31, 2018 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2020 2021 2022 2023 NOTE 10 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accrued marketing $ 1,787 $ 2,108 Trade accounts payable 2,498 2,288 Other accrued expenses 3,352 1 3,071 Accrued compensation Sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 8,932 $ 8,748 1 The increase in other accrued expenses is primarily due to incremental estimated variable consideration due to third-party customers. Refer to Note 1 and Note 3 for additional information on our adoption of ASC 606 that became effective on January 1, 2018 . NOTE 11 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2018 and 2017 , we had $ 13,063 million and $ 12,931 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 2.6 percent and 1.4 percent per year as of December 31, 2018 and 2017 , respectively. In addition, we had $ 10,483 million in lines of credit and other short-term credit facilities as of December 31, 2018 . The Company's total lines of credit included $ 131 million that was outstanding and primarily related to our international operations. Included in the credit facilities discussed above, the Company had $ 7,895 million in lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2019 through 2022 . There were no borrowings under these backup lines of credit during 2018 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2018, the Company retired upon maturity $3,276 million total principal amount of notes and debentures. The general terms of the notes and debentures retired are as follows: $26 million total principal amount of debentures due January 29, 2018 , at a fixed interest rate of 9.66 percent ; $750 million total principal amount of notes due March 14, 2018 , at a fixed interest rate of 1.65 percent ; $1,250 million total principal amount of notes due April 1, 2018 , at a fixed interest rate of 1.15 percent ; and $1,250 million total principal amount of notes due November 1, 2018 , at a fixed interest rate of 1.65 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $94 million that was due to mature on May 15, 2098 , at a fixed interest rate of 7.00 percent . Related to this extinguishment, the Company recorded a net gain of $27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018. During 2017, the Company issued U.S. dollar- and euro-denominated debt of $1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 was $3,974 million . The general terms of the notes issued are as follows: $500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three -month Euro Interbank Offered Rate (""EURIBOR"") plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017, the Company retired upon maturity 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent , $206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent , SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent , $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent , and $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of Old CCE. The extinguished notes had a carrying value of $417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $38 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017. During 2016, the Company issued Australian dollar-, euro- and U.S. dollar-denominated debt of AUD 1,000 million , 500 million and $3,725 million , respectively. The general terms of the notes issued are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.60 percent ; AUD 550 million total principal amount of notes due June 11, 2024, at a fixed interest rate of 3.25 percent ; 500 million total principal amount of notes due September 2, 2036, at a fixed interest rate of 1.10 percent ; $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month LIBOR plus 0.05 percent ; $1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent ; $1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.55 percent ; $500 million total principal amount of notes due June 1, 2026, at a fixed interest rate of 2.55 percent ; and $1,000 million total principal amount of notes due September 1, 2026, at a fixed interest rate of 2.25 percent . During 2016, the Company retired upon maturity $1,654 million total principal amount of notes due September 1, 2016 at a fixed interest rate of 1.80 percent , $500 million total principal amount of notes due November 1, 2016 at a fixed interest rate of 0.75 percent and $500 million total principal amount of notes due November 1, 2016 at a variable interest rate equal to the three -month LIBOR plus 0.10 percent . The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2018 December 31, 2017 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20192093 $ 13,619 2.6 % $ 16,854 2.3 % U.S. dollar debentures due 20202098 1,390 5.2 1,559 5.5 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.2 2.1 Euro notes due 20192036 12,994 0.6 13,663 0.7 Swiss franc notes due 20222028 1,128 3.6 1,148 3.0 Other, due through 2098 3 3.4 3.4 Fair value adjustments 4 N/A N/A Total 5,6 30,361 1.9 % 34,480 1.8 % Less current portion 4,997 3,298 Long-term debt $ 25,364 $ 31,182 1 These rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 6 for a more detailed discussion on interest rate management. 2 Amount is shown net of unamortized discounts of $ 8 million and $ 13 million as of December 31, 2018 and 2017 , respectively. 3 As of December 31, 2018 , the amount shown includes $ 136 million of debt instruments that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 6 for additional information about our fair value hedging strategy. 5 As of December 31, 2018 and 2017 , the fair value of our long-term debt, including the current portion, was $ 30,438 million and $ 35,169 million , respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE's former North America business in 2010 of $ 212 million and $ 263 million as of December 31, 2018 and 2017 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2018 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 871 million , $ 757 million and $ 663 million in 2018 , 2017 and 2016 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2018 are as follows (in millions): Maturities of Long-Term Debt $ 4,997 4,265 2,929 2,414 4,099 NOTE 12 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2018 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 600 million , of which $ 247 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 15 . On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent change in material facts or circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 362 million and $ 480 million as of December 31, 2018 and 2017 , respectively. Operating Leases The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2018 (in millions): Operating Lease Payments $ 2020 2021 2022 2023 Thereafter Total minimum operating lease payments 1 $ 1 Income associated with sublease arrangements is not significant. NOTE 13 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 225 million , $ 219 million and $ 258 million in 2018 , 2017 and 2016 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 47 million , $ 44 million and $ 71 million in 2018 , 2017 and 2016 , respectively. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2018 , we had $ 271 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.5 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2018 , there were 391.9 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available to be granted under stock option and restricted stock award plans. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, generally four years . The weighted-average fair value of stock options granted during the past three years and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, Fair value of stock options at grant date $ 4.97 $ 3.98 $ 4.17 Dividend yield 1 3.5 % 3.6 % 3.2 % Expected volatility 2 15.5 % 15.5 % 16.0 % Risk-free interest rate 3 2.8 % 2.2 % 1.5 % Expected term of the stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock at the time of the grant. 2 Expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued Company common stock or from the Company's treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from the Company's treasury shares. Stock option activity for all plans for the year ended December 31, 2018 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2018 $ 35.02 Granted 44.49 Exercised (47 ) 31.51 Forfeited/expired (1 ) 41.22 Outstanding on December 31, 2018 1 $ 36.74 4.59 years $ 1,407 Expected to vest $ 36.69 4.56 years $ 1,402 Exercisable on December 31, 2018 $ 35.74 4.02 years $ 1,327 1 Includes 0.1 million stock option replacement awards in connection with our acquisition of Old CCE in 2010. These options had a weighted-average exercise price of $ 17.35 and generally vest over 3 years and expire 10 years from the original date of grant. The total intrinsic value of the stock options exercised was $ 721 million , $ 744 million and $ 787 million in 2018 , 2017 and 2016 , respectively. The total shares exercised were 47 million , 53 million and 50 million in 2018 , 2017 and 2016 , respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share unit grants from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018, performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share from continuing operations and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include the TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018 will be released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2018 , performance share units of 2,756,000 and 2,837,000 were outstanding for the 2016-2018 and 2017-2019 performance periods, respectively, and growth share units of 2,105,000 were outstanding for the 2018-2020 performance period, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2018 8,212 $ 37.14 Granted 2,183 41.02 Conversions to restricted stock units 1 (2,111 ) 36.24 Canceled/forfeited (586 ) 37.58 Outstanding on December 31, 2018 2 7,698 $ 38.45 1 Represents the target amount of performance share units converted to restricted stock units for the 20152017 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units and growth share units as of December 31, 2018 at the threshold award and maximum award levels were 2.4 million and 15.3 million , respectively. The weightedaverage grant date fair value of growth share units granted in 2018 was $41.02 . The weightedaverage grant date fair value of performance share units granted in 2017 and 2016 was $34.75 and $39.70 , respectively. The Company did not convert any performance share units into cash equivalent payments in 2018. The Company converted performance share units of 11,052 in 2017 and 52,545 in 2016 to cash equivalent payments of $0.4 million and $ 1.9 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2018 6,748 $ 32.35 Conversions from performance share units 2,692 36.24 Vested and released (6,747 ) 32.34 Canceled/forfeited (102 ) 36.18 Nonvested on December 31, 2018 2,591 $ 36.24 The total intrinsic value of restricted shares that were vested and released in 2018 was $305 million . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2018 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of 3,422,323 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2018 3,535 $ 40.99 Granted 1,457 40.12 Vested and released (1,015 ) 41.80 Forfeited/expired (555 ) 41.32 Nonvested on December 31, 2018 3,422 $ 40.31 NOTE 14 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2018 , the primary U.S. plan represented 62 percent of both the Company's consolidated projected benefit obligation and pension assets. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, Benefit obligation at beginning of year 1 $ 9,455 $ 9,428 $ $ Service cost Interest cost Foreign currency exchange rate changes (110 ) (5 ) Amendments (8 ) (21 ) Net actuarial loss (gain) (469 ) (33 ) (28 ) Benefits paid 2 (356 ) (341 ) (70 ) (71 ) Business combinations 3 Divestitures (11 ) (7 ) (66 ) Settlements 4 (932 ) (832 ) Curtailments 4 (63 ) (10 ) (48 ) Special termination benefits 4 Other Benefit obligation at end of year 1 $ 8,004 $ 9,455 $ $ Fair value of plan assets at beginning of year $ 8,843 $ 8,371 $ $ Actual return on plan assets (271 ) 1,139 (5 ) Employer contributions Foreign currency exchange rate changes (128 ) Benefits paid (285 ) (285 ) (3 ) (3 ) Business combinations 3 Divestitures (1 ) Settlements 4 (892 ) (794 ) Other Fair value of plan assets at end of year $ 7,409 $ 8,843 $ $ Net liability recognized $ (595 ) $ (612 ) $ (419 ) $ (494 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $7,856 million and $9,175 million as of December 31, 2018 and 2017 , respectively. 2 Benefits paid to pension plan participants during 2018 and 2017 included $71 million and $56 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2018 and 2017 included $67 million and $68 million , respectively, that were paid from Company assets. 3 Business combinations primarily related to the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 2 . 4 Settlements, curtailments and special termination benefits were primarily related to productivity, integration and restructuring initiatives and the refranchising of our North America bottling operations. Refer to Note 2 and Note 19 . Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, Other assets $ $ $ $ Accounts payable and accrued expenses (70 ) (72 ) (21 ) (21 ) Other liabilities (1,328 ) (1,461 ) (398 ) (473 ) Net liability recognized $ (595 ) $ (612 ) $ (419 ) $ (494 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Projected benefit obligations $ 6,561 $ 7,833 Fair value of plan assets 5,163 6,330 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Accumulated benefit obligations $ 6,450 $ 7,614 Fair value of plan assets 5,157 6,305 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,116 1,427 International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 1 Hedge funds/limited partnerships Real estate Other Total pension plan assets 2 $ 4,842 $ 6,028 $ 2,567 $ 2,815 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 17 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the services of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2018 , no investment manager was responsible for more than 9 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in the common stock of our Company accounted for approximately 5 percent of our total global equities and approximately 3 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. In addition to equity investments and fixed-income investments, we have a target allocation of 28 percent in alternative investments. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2018 , the long-term target allocation for 68 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 65 percent equity securities, 10 percent fixed-income securities and 25 percent other investments. The actual allocation for the remaining 32 percent of the Company's international subsidiaries' plan assets consisted of 54 percent mutual, pooled and commingled funds; 7 percent fixed-income securities; 1 percent global equities and 38 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, Cash and cash equivalents $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds Hedge funds/limited partnerships Real estate Other Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 17 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets 1 (650 ) (650 ) (653 ) (13 ) (12 ) (11 ) Amortization of prior service credit (3 ) (2 ) (14 ) (18 ) (19 ) Amortization of net actuarial loss 2 Net periodic benefit cost (income) (107 ) Settlement charges 3 Curtailment charges (credits) 3 (4 ) (79 ) Special termination benefits 3 Other (3 ) (1 ) Total cost (income) recognized in consolidated statements of income $ $ $ $ $ (55 ) $ 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to productivity, integration and restructuring initiatives and the refranchising of our North America bottling operations. Refer to Note 2 and Note 19 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) Recognized prior service cost (credit) 1 (18 ) 4 (54 ) 5 Recognized net actuarial loss (gain) 2 3 (36 ) 5 Prior service credit (cost) occurring during the year (1 ) (1 ) Net actuarial (loss) gain occurring during the year (389 ) 1 5 Impact of divestitures Foreign currency translation gain (loss) (42 ) (1 ) Balance in AOCI at end of year $ (2,482 ) $ (2,493 ) $ (15 ) $ (26 ) 1 Includes $4 million of recognized prior service cost and $63 million of actuarial gains occurring during the year due to the impact of curtailments. 2 Includes $240 million of recognized net actuarial losses due to the impact of settlements. 3 Includes $228 million of recognized net actuarial losses due to the impact of settlements. 4 Includes $4 million of recognized prior service credit due to the impact of curtailments. 5 Includes $36 million of recognized prior service credit, $43 million of recognized net actuarial gains and $45 million of actuarial gains occurring during the year due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, Prior service credit (cost) $ (12 ) $ (10 ) $ $ Net actuarial loss (2,470 ) (2,483 ) (44 ) (62 ) Balance in AOCI at end of year $ (2,482 ) $ (2,493 ) $ (15 ) $ (26 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2019 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service credit $ (4 ) $ (2 ) Amortization of net actuarial loss Total $ $ Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, Discount rate 4.00 % 3.50 % 4.25 % 3.50 % Rate of increase in compensation levels 3.75 % 3.50 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost are as follows: Pension Benefits Other Benefits Year Ended December 31, Discount rate 3.50 % 4.00 % 4.25 % 3.50 % 4.00 % 4.25 % Rate of increase in compensation levels 3.50 % 3.75 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 8.00 % 8.00 % 8.25 % 4.50 % 4.75 % 4.75 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2018 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2018 net periodic pension cost for the U.S. plans was 8.00 percent . As of December 31, 2018 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 5.5 percent , 9.2 percent and 6.4 percent , respectively. The annualized return since inception was 10.3 percent . The assumed health care cost trend rates are as follows: December 31, Health care cost trend rate assumed for next year 7.00 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 20242028 Pension benefit payments $ $ $ $ $ $ 2,517 Other benefit payments 1 Total estimated benefit payments $ $ $ $ $ $ 2,767 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $3 million for the period 20192023 and $2 million for the period 20242028. The Company anticipates making pension contributions in 2019 of $32 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limitations. Company costs related to the U.S. plans were $39 million , $61 million and $82 million in 2018 , 2017 and 2016 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $33 million , $35 million and $37 million in 2018 , 2017 and 2016 , respectively. Multi-Employer Pension Plans The Company participates in various multi-employer pension plans. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for multi-employer pension plans totaled $6 million , $35 million and $41 million in 2018 , 2017 and 2016 , respectively. The decrease in 2018 was primarily driven by the refranchising of certain bottling territories in the United States during 2017. The plans we currently participate in have contractual arrangements that extend into 2021. If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. Refer to Note 2 for additional information on North America refranchising. NOTE 15 : INCOME TAXES Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, United States $ 1 $ (690 ) 1 $ 1 International 7,462 1 7,432 8,023 Total $ 8,350 $ 6,742 $ 8,136 1 Includes charges of $476 million , $2,140 million and $2,456 million related to refranchising certain bottling territories in North America in 2018 , 2017 and 2016 , respectively. Refer to Note 2 . Income taxes from continuing operations consisted of the following (in millions): United States State and Local International Total Current $ 1 $ $ 1,337 $ 2,073 Deferred (386 ) 1,3 (81 ) 1,3 1,3 (450 ) Current $ 5,438 2 $ $ 1,257 $ 6,816 Deferred (1,783 ) 2,3 2 (1,256 ) Current $ 1,147 $ $ 1,182 $ 2,442 Deferred (838 ) 3 (91 ) (856 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). 2 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017 . The provisional amount as of December 31, 2017 , related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated at that time to be $42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $1.0 billion . 3 Includes the benefit from charges related to refranchising certain bottling territories in North America. Refer to Note 2 . Income taxes from discontinued operations consisted of $87 million and $55 million of current expense and $38 million of deferred tax expense and $8 million of deferred tax benefit for the years ended December 31, 2018 and 2017 , respectively. We made income tax payments of $ 2,037 million , $ 1,904 million and $ 1,554 million in 2018 , 2017 and 2016 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2019 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 318 million , $ 221 million and $ 105 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2017 Statutory U.S. federal tax rate 21.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.5 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.2 1,2 (9.7 ) (17.5 ) 7 Equity income or loss (2.4 ) (3.4 ) (3.0 ) Tax Reform Act 0.1 3 53.5 4 Excess tax benefits on stock-based compensation (1.2 ) (2.0 ) Other net (0.8 ) 7.9 5,6 3.8 8 Effective tax rate 19.4 % 82.5 % 19.5 % 1 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees. Refer to Note 17 . 2 Includes tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 . 3 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 4 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 5 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 . 6 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 7 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 . 8 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") of approximately $41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $0.3 billion in tax for our one-time transition tax and a tax benefit of $0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $8.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2004 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 12 . As of December 31, 2018 , the gross amount of unrecognized tax benefits was $ 336 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 182 million , exclusive of any benefits related to interest and penalties. The remaining $ 154 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 18 1 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (4 ) (40 ) 1 Increase (decrease) due to effect of foreign currency exchange rate changes (17 ) (6 ) Ending balance of unrecognized tax benefits $ $ $ 1 The net increase was primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 190 million , $ 177 million and $ 142 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2018 , 2017 and 2016 , respectively. Of these amounts, $13 million , $ 35 million and $31 million of expense were recognized through income tax expense in 2018 , 2017 and 2016 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets 2,540 2 Equity method investments (including foreign currency translation adjustment) Derivative financial instruments Other liabilities Benefit plans Net operating/capital loss carryforwards Other Gross deferred tax assets 5,452 3,405 Valuation allowances (399 ) (501 ) Total deferred tax assets 1 $ 5,053 $ 2,904 Deferred tax liabilities: Property, plant and equipment $ (724 ) $ (819 ) Trademarks and other intangible assets (951 ) (978 ) Equity method investments (including foreign currency translation adjustment) (1,707 ) (1,835 ) Derivative financial instruments (162 ) (436 ) Other liabilities (67 ) (50 ) Benefit plans (255 ) (289 ) Other (453 ) (688 ) Total deferred tax liabilities $ (4,319 ) $ (5,095 ) Net deferred tax assets (liabilities) $ $ (2,191 ) 1 Noncurrent deferred tax assets of $2,667 million and $330 million were included in the line item Deferred income tax assets in our consolidated balance sheets as of December 31, 2018 and 2017 , respectively. 2 The increase was primarily the result of a $2.9 billion cumulative effect adjustment related to our adoption of ASU 2016-16. In October 2016, the FASB issued ASU 2016-16, which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings with the majority of the offset being recorded as a deferred tax asset. This amount is primarily related to trademarks and other intangible assets and was recorded in the line item deferred income tax assets in our consolidated balance sheet. As of December 31, 2018 , we had net deferred tax assets of $ 2.0 billion and as of December 31, 2017 , we had net deferred tax liabilities of $ 539 million located in countries outside the United States. As of December 31, 2018 , we had $ 2,906 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 372 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Decrease due to reclassification to assets held for sale (9 ) Deductions (183 ) (213 ) (6 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2018, the Company recognized a net decrease of $102 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. In 2017, the Company recognized a net decrease of $29 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. In 2016, the Company recognized a net increase of $53 million in its valuation allowances. This increase was primarily due to the increase in non-deductible expenses incurred during the normal course of business operations. NOTE 16 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheets as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheets as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments $ (11,045 ) $ (8,957 ) Accumulated derivative net gains (losses) (126 ) (119 ) Unrealized net gains (losses) on available-for-sale securities 1 Adjustments to pension and other benefit liabilities (1,693 ) (1,722 ) Accumulated other comprehensive income (loss) $ (12,814 ) $ (10,305 ) 1 The change in the balance from December 31, 2017 includes the $409 million reclassification to reinvested earnings upon the adoption of ASU 2016-01. Refer to Note 1 and Note 4 . The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2018 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 6,434 $ $ 6,476 Other comprehensive income: Net foreign currency translation adjustments (2,088 ) (2,035 ) Net gains (losses) on derivatives 1 (7 ) (7 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 (34 ) (34 ) Net change in pension and other benefit liabilities 3 Total comprehensive income $ 4,334 $ $ 4,429 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2018 , 2017 and 2016 is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,728 ) $ $ (1,669 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature (1,296 ) (1,296 ) Gains (losses) on net investment hedges arising during the year 1 (160 ) Net foreign currency translation adjustments $ (1,987 ) $ (101 ) $ (2,088 ) Derivatives: Gains (losses) arising during the year (16 ) Reclassification adjustments recognized in net income (68 ) (50 ) Net gains (losses) on derivatives 1 $ (9 ) $ $ (7 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year (50 ) (39 ) Reclassification adjustments recognized in net income Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ (45 ) $ $ (34 ) Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (299 ) (224 ) Reclassification adjustments recognized in net income (88 ) Net change in pension and other benefit liabilities 3 $ $ (13 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,999 ) $ (101 ) $ (2,100 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,350 ) $ (242 ) $ (1,592 ) Reclassification adjustments recognized in net income (6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year 1 (1,512 ) (934 ) Net foreign currency translation adjustments $ $ $ Derivatives: Gains (losses) arising during the year (184 ) (119 ) Reclassification adjustments recognized in net income (506 ) (314 ) Net gains (losses) on derivatives 1 $ (690 ) $ $ (433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (136 ) Reclassification adjustments recognized in net income (123 ) (81 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ (94 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (7 ) Reclassification adjustments recognized in net income (116 ) Net change in pension and other benefit liabilities 3 $ $ (123 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,103 ) $ $ (1,052 ) Reclassification adjustments recognized in net income (18 ) Gains (losses) on net investment hedges arising during the year (25 ) Reclassification adjustments for net investment hedges recognized in net income (30 ) Net foreign currency translation adjustments $ (591 ) $ (22 ) $ (613 ) Derivatives: Gains (losses) arising during the year (43 ) (32 ) Reclassification adjustments recognized in net income (563 ) (350 ) Net gains (losses) on derivatives 1 $ (606 ) $ $ (382 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (28 ) Reclassification adjustments recognized in net income (105 ) (79 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ (2 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (374 ) (275 ) Reclassification adjustments recognized in net income (120 ) Net change in pension and other benefit liabilities 3 $ (32 ) $ (21 ) $ (53 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,210 ) $ $ (1,031 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2018 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1,2 Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ (137 ) Foreign currency contracts Cost of goods sold (8 ) Foreign currency contracts Other income (loss) net Divestitures, deconsolidations and other Other income (loss) net Foreign currency and interest rate contracts Interest expense Income from continuing operations before income taxes $ (76 ) Income taxes from continuing operations Net income from continuing operations $ (56 ) Foreign currency and commodity contracts Income from discontinued operations (net of income taxes) $ Consolidated net income $ (50 ) Available-for-sale securities: Sale of securities Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations Consolidated net income $ Pension and other benefit liabilities: Settlement charges 3 Other income (loss) net $ Curtailment charges 3 Other income (loss) net Recognized net actuarial loss Other income (loss) net Recognized prior service cost (credit) Other income (loss) net (17 ) Divestitures, deconsolidations and other 2 Other income (loss) net (14 ) Income from continuing operations before income taxes $ Income taxes from continuing operations (88 ) Consolidated net income $ 1 Primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and the deconsolidation of our Canadian bottling operations. 2 Primarily related to our previously held equity method investment in the Philippine bottling operations and the refranchising of our Latin American bottling operations. 3 The settlement and curtailment charges were primarily related to productivity, restructuring and integration initiatives and the refranchising of our North America bottling operations. Refer to Note 14 and Note 19 . NOTE 17 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair value of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2018 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,681 $ $ $ $ $ 1,934 Debt securities 1 5,018 5,037 Derivatives 2 (261 ) 5 7 Total assets $ 1,683 $ 5,517 $ $ $ (261 ) $ 7,025 Liabilities: Derivatives 2 $ (14 ) $ (221 ) $ $ $ 6 $ (53 ) 7 Total liabilities $ (14 ) $ (221 ) $ $ $ $ (53 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $96 million in cash collateral it has netted against its derivative position. 6 The Company has the right to reclaim $4 million in cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $54 million in the line item other assets; $3 million in the line item liabilities held for sale discontinued operations and $50 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. December 31, 2017 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,899 5,739 3 7,807 Derivatives 2 (198 ) 6 8 Total assets $ 2,118 $ 6,116 $ $ $ (198 ) $ 8,273 Liabilities: Derivatives 2 $ (3 ) $ (262 ) $ $ $ 7 $ (118 ) 8 Total liabilities $ (3 ) $ (262 ) $ $ $ $ (118 ) 1 Refer to Note 4 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Primarily related to debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 6 The Company is obligated to return $55 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $2 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $59 million in the line item other assets; $28 million in the line item accounts payable and accrued expenses; $12 million in the line item liabilities held for sale discontinued operations and $78 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2018 and 2017 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2018 and 2017 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges, or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the table below (in millions): Gains (Losses) Year Ended December 31, Other-than-temporary impairment charges $ (591 ) 1 $ (50 ) 5 Assets held for sale discontinued operations (554 ) 2 Other long-lived assets (312 ) 3 (329 ) 6 Intangible assets (138 ) 3 (442 ) 7 Assets held for sale (1,819 ) 8 Investment in formerly unconsolidated subsidiary (32 ) 4 9 Valuation of shares in equity method investee 10 Total $ (1,627 ) $ (2,465 ) 1 The Company recognized other-than-temporary impairment charges of $334 million related to certain equity method investees in the Middle East. These impairments were primarily driven by revised projections of future operating results largely related to instability in the region, which include recent sanctions imposed locally. The Company also recognized an other-than-temporary impairment charge of $205 million related to an equity method investee in Indonesia. This impairment was primarily driven by revised projections of future operating results reflecting unfavorable macroeconomic conditions and foreign currency exchange rate fluctuations. Additionally, the Company recognized an other-than-temporary impairment charge of $52 million related to one of our equity method investees in Latin America. This impairment was primarily driven by revised projections of future operating results. The fair value of each of these investments was derived using discounted cash flow analyses based on Level 3 inputs. 2 The Company recorded impairment charges of $554 million related to assets held by CCBA. These charges were incurred primarily as a result of management's view of the proceeds that are expected to be received based on revised projections of future operating results and foreign currency exchange rate fluctuations. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. We recorded these impairment charges in the line item income (loss) from discontinued operations in our consolidated statements of income. 3 The Company recognized charges of $312 million related to CCR's property, plant and equipment and $138 million related to CCR's intangible assets. These charges were a result of management's revised estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. Refer to Note 18 . 4 The Company recognized a loss of $32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. 5 The Company recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. 6 The Company recognized impairment charges of $310 million related to CCR's property, plant and equipment and $19 million related to CCR's other assets primarily as a result of refranchising activities in North America. The fair value of these assets was derived using management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. 7 The Company recognized an impairment charge of $375 million related to CCR's goodwill. This impairment charge was determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. The Company also recognized an impairment charge of $33 million related to certain U.S. bottlers' franchise rights. This charge was determined by comparing the fair value of the asset to its current carrying value. Each of these impairment charges was primarily a result of refranchising activities in North America and management's estimates of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. Additionally, the Company recorded impairment charges of $34 million related to Venezuelan intangible assets due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. 8 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. These losses related to refranchising activities in North America. The charges were calculated based on Level 3 inputs. Refer to Note 2 . 9 The Company recognized a gain of $150 million on our previously held equity interests in CCBA and its South African subsidiary, which were accounted for under the equity method of accounting prior to our consolidation of the bottler in October 2017. U.S. GAAP requires the acquirer to remeasure its previously held noncontrolling equity interest in the acquired entity to fair value as of the acquisition date and recognize any gains or losses in earnings. The Company remeasured our equity interests in CCBA and its South African subsidiary based on Level 3 inputs. Refer to Note 2 . 10 The Company recognized a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock at a per share amount greater than the carrying value of the Company's per share investment. Accordingly, the Company is required to treat this type of transaction as if the Company had sold a proportionate share of its investment in Coca-Cola FEMSA. This gain was determined using Level 1 inputs. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 14 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2018 December 31, 2017 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 1,728 17 1,760 2,080 14 2,097 International-based companies 1,098 1,121 1,465 1,465 Fixed-income securities: Government bonds Corporate bonds and debt securities 16 24 Mutual, pooled and commingled funds 130 3 42 3 Hedge funds/limited partnerships 4 4 Real estate 5 5 Other 2 6 2 6 Total $ 3,313 $ 1,472 $ $ 2,321 $ 7,409 $ 4,410 $ 1,287 $ $ 2,843 $ 8,843 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 14 . 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to tri-annually, with a redemption notice period of up to 120 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually, with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date (3 ) Purchases, sales and settlements net (9 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments Balance at end of year $ $ $ $ 1 $ 2018 Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date (2 ) (1 ) Purchases, sales and settlements net (7 ) (2 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments (13 ) (13 ) Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2018 December 31, 2017 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 82 80 Hedge funds/limited partnerships 8 8 Real estate 4 5 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 14 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2018 , the carrying amount and fair value of our long-term debt, including the current portion, were $30,361 million and $ 30,438 million , respectively. As of December 31, 2017 , the carrying amount and fair value of our long-term debt, including the current portion, were $34,480 million and $ 35,169 million , respectively. NOTE 18 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 12 for additional information related to the tax litigation. Refer to Note 17 for additional information on the impairment charges. Refer to Note 19 for additional information on the Company's productivity and reinvestment program. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information about the Venezuelan intangible assets. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 17 for information on how the Company determined the asset impairment charges. Refer to Note 19 for additional information on the Company's productivity and reinvestment program. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. In 2016, the Company recorded other operating charges of $1,371 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $276 million related to costs incurred to refranchise certain of our bottling operations. The Company also recorded a charge of $200 million related to cash contributions we made to The CocaCola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates, and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. In 2016, the Company also recorded impairment charges of $153 million related to certain intangible assets. Refer to Note 1 for additional information on the Venezuelan exchange rates. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 17 for additional information on the impairment charges. Refer to Note 19 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2018, the Company recorded a net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 11 for additional information. During the year ended December 31, 2017, the Company recorded a net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 11 for additional information. Equity Income (Loss) Net The Company recorded net charges of $111 million , $ 92 million and $ 61 million in equity income (loss) net during the years ended December 31, 2018 , 2017 and 2016 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2018, other income (loss) net was a loss of $1,121 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees and net charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $240 million related to pension settlements, and a net loss of $79 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Additionally, we recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Lindley and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and our acquisition of the controlling interest in the Philippine bottling operations. Refer to Note 6 for additional information on our hedging activities. Refer to Note 17 for information on how the Company determined the impairment charges. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Refer to Note 22 for additional information on the acquisition of Costa. In 2017, other income (loss) net was a loss of $1,764 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from settlements, special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of CCW and CCEJ to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on our North America and China refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 20 for the impact these items had on our operating segments and Corporate. In 2016, other income (loss) net was a loss of $1,265 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a net charge of $139 million resulting from settlements and special termination benefits primarily related to North America refranchising. The Company also recorded a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These charges were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations, the deconsolidation of our South African bottling operations, the North America refranchising and the conversion payments. Refer to Note 20 for the impact these items had on our operating segments and Corporate. NOTE 19 : PRODUCTIVITY, INTEGRATION AND RESTRUCTURING INITIATIVES Productivity and Reinvestment In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focuses on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,566 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments (114 ) (30 ) (205 ) (349 ) Noncash and exchange (2 ) (55 ) (56 ) Accrued balance at end of year $ $ $ $ 2017 Costs incurred $ $ $ $ Payments (181 ) (83 ) (267 ) (531 ) Noncash and exchange (62 ) 1 (1 ) (1 ) (64 ) Accrued balance at end of year $ $ $ $ 2018 Costs incurred $ $ $ $ Payments (209 ) (83 ) (211 ) (503 ) Noncash and exchange (69 ) 1 (52 ) (121 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 14 . Integration Initiatives Integration of Our German Bottling Operations In 2008, the Company began an integration initiative related to our German bottling operations acquired in 2007. The Company incurred $ 240 million of expenses related to this initiative in 2016 and has incurred total pretax expenses of $ 1,367 million related to this initiative since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income and impacted the Bottling Investments operating segment. The expenses recorded in connection with these integration activities have been primarily due to involuntary terminations. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Therefore, there was no remaining accrual balance as of December 31, 2016. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations. NOTE 20 : OPERATING SEGMENTS As of December 31, 2018 , our organizational structure consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; and Bottling Investments. Our operating structure also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance, and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, with the exception of those that are classified as discontinued operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3 . The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, Concentrate operations % % % Finished product operations 49 Total % % % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes from continuing operations and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based on income or loss from continuing operations before income taxes. Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, United States $ 11,344 $ 14,727 $ 19,899 International 20,512 20,683 21,964 Net operating revenues $ 31,856 $ 35,410 $ 41,863 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, United States $ 4,154 $ 4,163 $ 6,784 International 4,078 4,040 3,851 Property, plant and equipment net $ 8,232 $ 8,203 $ 10,635 Information about our Company's continuing operations by operating segment and Corporate as of and for the years ended December 31, 2018 , 2017 and 2016 , is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 7,138 $ 3,975 $ 11,505 $ 4,809 $ 3,760 $ $ $ 31,292 Intersegment (701 ) 4 Total net operating revenues 7,702 4,014 11,768 5,197 3,771 (701 ) 31,856 Operating income (loss) 3,714 2,321 2,453 2,278 (649 ) (1,417 ) 8,700 Interest income Interest expense Depreciation and amortization 1,086 Equity income (loss) net (19 ) (2 ) 1,008 Income (loss) from continuing operations before income taxes 3,406 2,247 2,494 2,305 (612 ) (1,490 ) 8,350 Identifiable operating assets 1 7,985 1,715 17,913 1,999 2 4,135 2 22,649 56,396 5 Investments 3 14,367 3,718 20,274 Capital expenditures 1,347 Net operating revenues: Third party $ 7,332 $ 3,956 $ 8,796 $ 4,767 $ 10,379 $ $ $ 35,368 Intersegment 1,954 (2,517 ) 4 Total net operating revenues 7,374 4,029 10,750 5,176 10,460 (2,517 ) 35,410 Operating income (loss) 3,625 2,218 2,591 2,147 (962 ) (2,020 ) 7,599 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net (3 ) (3 ) 1,071 Income (loss) from continuing operations before income taxes 3,706 2,211 2,320 2,179 (2,358 ) (1,316 ) 6,742 Identifiable operating assets 1 5,475 1,896 17,619 2,072 2 4,493 2 27,060 58,615 5 Investments 3 1,238 15,998 3,536 21,952 Capital expenditures 1,675 Net operating revenues: Third party $ 7,014 $ 3,746 $ 6,587 $ 4,788 $ 19,601 $ $ $ 41,863 Intersegment 3,738 (4,720 ) Total net operating revenues 7,278 3,819 10,325 5,294 19,735 (4,720 ) 41,863 Operating income (loss) 3,668 1,953 2,614 2,210 (1,789 ) 8,657 Interest income Interest expense Depreciation and amortization 1,013 1,787 Equity income (loss) net (17 ) Income (loss) from continuing operations before income taxes 3,749 1,966 2,592 2,238 (1,955 ) (454 ) 8,136 Capital expenditures 1,329 2,262 1 Principally cash and cash equivalents, short-term investments, marketable securities, trade accounts receivable, inventories, goodwill, trademarks and other intangible assets, and property, plant and equipment net. 2 Property, plant and equipment net in India represented 10 percent and 11 percent of consolidated property, plant and equipment net in 2018 and 2017, respectively. 3 Principally equity method investments and other investments in bottling companies. 4 Intersegment revenues do not eliminate on a consolidated basis in the table above due to intercompany sales to our discontinued operations. 5 Identifiable operating assets excludes $6,546 million and $7,329 million of assets held for sale discontinued operations as of December 31, 2018 and December 31, 2017 , respectively. During 2018 , 2017 and 2016 , our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2018 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $4 million for Latin America, $175 million for North America, $31 million for Bottling Investments and $237 million for Corporate, and increased by $3 million for Europe, Middle East and Africa and $4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) from continuing operations before income taxes was reduced by $64 million for Corporate and $4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 14 and Note 19 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $450 million for Bottling Investments due to asset impairment charges. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $33 million for Corporate due to tax litigation expense. Refer to Note 12 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) from continuing operations before income taxes was reduced by $476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $334 million for Europe, Middle East and Africa, $205 million for Bottling Investments and $52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) from continuing operations before income taxes was reduced by $124 million for Bottling Investments and increased by $13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $149 million for Bottling Investments due to pension settlements related to the refranchising of North America bottling operations. Refer to Note 14 . Income (loss) from continuing operations before income taxes was reduced by $79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 and Note 22 . Income (loss) from continuing operations before income taxes was reduced by $34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) from continuing operations before income taxes was reduced by $32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $27 million for Corporate related to a net gain on the extinguishment of long-term debt. Refer to Note 11 . In 2017 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $26 million for Europe, Middle East and Africa, $7 million for Latin America, $241 million for North America, $10 million for Asia Pacific, $57 million for Bottling Investments and $193 million for Corporate due to the Company's productivity and reinvestment program. Income (loss) from continuing operations before income taxes was also reduced by $116 million for Corporate due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 14 and Note 19 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $737 million for Bottling Investments and $34 million for Corporate due to asset impairment charges. Refer to Note 17 . Operating income (loss) was reduced by $280 million and income (loss) from continuing operations before income taxes was reduced by $419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $225 million for Corporate as a result of a cash contribution we made to The Coca-Cola Foundation. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $67 million for Corporate due to tax litigation expense. Refer to Note 12 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa, $2 million for North America, $70 million for Bottling Investments and $16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 18 . Income (loss) from continuing operations before income taxes was reduced by $313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and selling a related cost method investment. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 11 . Income (loss) from continuing operations before income taxes was reduced by $26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) from continuing operations before income taxes was increased by $25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 17 . In 2016 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $32 million for Europe, Middle East and Africa, $134 million for North America, $1 million for Asia Pacific, $322 million for Bottling Investments and $105 million for Corporate and increased by $2 million for Latin America due to the Company's productivity and reinvestment program, including refinements to prior period accruals. Refer to Note 19 . Operating income (loss) was reduced by $276 million and income (loss) from continuing operations before income taxes was reduced by $297 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $200 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $153 million for Bottling Investments due to impairment charges recorded on certain of the Company's intangible assets. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $76 million for Latin America due to the write-down we recorded related to our receivables from our bottling partner in Venezuela due to changes in exchange rates. Refer to Note 1 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $9 million for Bottling Investments and $32 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) from continuing operations before income taxes was reduced by $118 million for Bottling Investments due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 14 . Income (loss) from continuing operations before income taxes was reduced by $52 million for Bottling Investments and $9 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $2,456 million for Bottling Investments primarily due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $1,323 million for Corporate as a result of the deconsolidation of our German bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $72 million for Corporate as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 18 . Income (loss) from continuing operations before income taxes was reduced by $31 million for North America related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . NOTE 21 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, (Increase) decrease in trade accounts receivable $ $ (141 ) $ (28 ) (Increase) decrease in inventories (171 ) (355 ) (142 ) (Increase) decrease in prepaid expenses and other assets (221 ) Increase (decrease) in accounts payable and accrued expenses (289 ) (445 ) (540 ) Increase (decrease) in accrued income taxes (12 ) (153 ) Increase (decrease) in other liabilities 1 (575 ) 4,052 (544 ) Net change in operating assets and liabilities $ (1,202 ) $ 3,464 $ (225 ) 1 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 15 . NOTE 22 : SUBSEQUENT EVENT On January 3, 2019, the Company acquired Costa in exchange for $4.9 billion of cash. Costa is a coffee company with retail outlets in over 30 countries, a coffee vending operation, for-home coffee formats and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverages market platform. We are currently in the process of finalizing the accounting for this transaction and expect to complete our preliminary allocation of the purchase consideration to the assets acquired and liabilities assumed by the end of the first quarter of 2019. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2018 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls and auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2019 Proxy Statement. James R. Quincey Larry M. Mark Chief Executive Officer February 21, 2019 Vice President and Controller February 21, 2019 Kathy N. Waller Mark Randazza Executive Vice President and Chief Financial Officer February 21, 2019 Vice President, Assistant Controller and Chief Accounting Officer February 21, 2019 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with US generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal controls over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company's auditor since 1921. Atlanta, Georgia February 21, 2019 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 21, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Atlanta, Georgia February 21, 2019 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 7,626 $ 8,927 $ 8,245 $ 7,058 $ 31,856 Gross profit 4,888 5,675 5,186 4,337 20,086 Net income attributable to shareowners of The Coca-Cola Company 1,368 2,316 1,880 6,434 Basic net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.51 1 Diluted net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.50 Net operating revenues $ 9,118 $ 9,702 $ 9,078 $ 7,512 $ 35,410 Gross profit 5,605 6,043 5,684 4,823 22,155 Net income (loss) attributable to shareowners of The Coca-Cola Company 1,182 1,371 1,447 (2,752 ) 1,248 Basic net income (loss) per share $ 0.28 $ 0.32 $ 0.34 $ (0.65 ) $ 0.29 Diluted net income (loss) per share $ 0.27 $ 0.32 $ 0.33 $ (0.65 ) $ 0.29 1 1 The sum of the quarterly net income (loss) per share amounts does not agree to the full year net income per share amounts. We calculate net income (loss) per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2018 and 2017, our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2018 results were impacted by one less day compared to the first quarter of 2017. Furthermore, the Company recorded the following transactions which impacted results: Charges of $390 million related to the impairment of certain assets. Refer to Note 17 . Charges of $95 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net loss of $85 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net charge of $51 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $45 million related to costs incurred to refranchise certain of our North America bottling operations. A net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Charges of $19 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In the second quarter of 2018, the Company recorded the following transactions which impacted results: Charges of $150 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $102 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $60 million related to the impairment of certain assets. Refer to Note 17 . A n other-than-temporary impairment charge of $52 million related to one of our international equity method investees. Refer to Note 17 . Charges of $47 million related to pension settlements as a result of North America refranchising. Refer to Note 14 . A net gain of $36 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . A net gain of $36 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $33 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $22 million related to tax litigation expense. Refer to Note 12 . In the third quarter of 2018, the Company recorded the following transactions which impacted results: A net gain of $370 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . Charges of $275 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . An other-than-temporary impairment charge of $205 million related to our equity method investee in Indonesia. Refer to Note 17 . Charges of $132 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net gain of $64 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A gain of $41 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 . Charges of $38 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 11 . A net gain of $19 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $12 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . A gain of $11 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . The Company's fourth quarter 2018 results were impacted by one additional day compared to the fourth quarter of 2017. Furthermore, the Company recorded the following transactions which impacted results: Other-than-temporary impairment charges of $334 million related to certain of our equity method investees in the Middle East. Refer to Note 17 . A net loss of $293 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $131 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net loss of $120 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 . Charges of $102 million related to pension settlements as a result of North America refranchising. Refer to Note 14 . Charges of $97 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . A loss of $74 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . A net charge of $46 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net loss of $32 million related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Charges of $22 million related to costs incurred to refranchise certain of our North America bottling operations. In the first quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $497 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $139 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $106 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Charges of $104 million related to the impairment of certain intangible assets. Refer to Note 17 . A net charge of $58 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $60 million related to costs incurred to refranchise certain of our bottling operations. In the second quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $667 million related to the impairment of certain intangible assets. Refer to Note 17 . A gain of $445 million related to the integration of CCW and CCEJ to establish CCBJHI. Refer to Note 18 . Charges of $214 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $109 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Charges of $87 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $44 million related to costs incurred to refranchise certain of our bottling operations. A net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 11 . A net gain of $37 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A gain of $9 million related to refranchising a substantial portion of our China bottling operations. Refer to Note 2 . In the third quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $762 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $213 million related to costs incurred to refranchise certain of our bottling operations. Charges of $129 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A gain of $79 million related to the refranchising of our remaining China bottling operations and related cost method investment. Refer to Note 2 . Charges of $72 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . An other-than-temporary impairment charge of $50 million related to one of our international equity method investees. Refer to Note 17 . A net charge of $16 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In the fourth quarter of 2017, the Company recorded the following transactions which impacted results: A net provisional tax charge of $3,610 million as a result of the Tax Reform Act that was signed into law on December 22, 2017. Refer to Note 15 . Charges of $667 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $295 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A charge of $225 million as a result of a cash contribution we made to The Coca-Cola Foundation. A gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Charges of $105 million related to costs incurred to refranchise certain of our bottling operations. A net charge of $55 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $26 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2018 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2018 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +43,Coca-Cola,2017," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations as well as independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. As of December 31, 2017 , our operating structure included the following operating segments, the first five of which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Bottling Investments Corporate Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. For financial information about our operating segments and geographic areas, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report, incorporated herein by reference. For certain risks attendant to our non-U.S. operations, refer to ""Item 1A. Risk Factors"" below. Products and Brands As used in this report: ""concentrates"" means flavoring ingredients and, depending on the product, sweeteners used to prepare syrups or finished beverages and includes powders or minerals for purified water products such as Dasani; ""syrups"" means beverage ingredients produced by combining concentrates and, depending on the product, sweeteners and added water; ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. In our finished product operations, we typically generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, including water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. These finished product operations consist primarily of our Company-owned or -controlled bottling, sales and distribution operations which are included in our Bottling Investments operating segment. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers, such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. Our finished product business also includes juice and other still beverage production operations in North America. Our fountain syrup sales in the United States and the juice and other still beverage production operations in North America are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. For information regarding how we measure the volume of Company beverage products sold by the Coca-Cola system, refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. We own numerous valuable nonalcoholic beverage brands, including the following: Coca-Cola Georgia 2 Dasani Ice Dew 10 Diet Coke/Coca-Cola Light Powerade Simply 6 I LOHAS 11 Coca-Cola Zero Sugar 1 Del Valle 3 Glacau Vitaminwater Ayataka 12 Fanta Schweppes 4 Gold Peak 7 Sprite Aquarius FUZE TEA 8 Minute Maid Minute Maid Pulpy 5 Glacau Smartwater 9 1 Including Coca-Cola No Sugar and Coca-Cola Zero. 2 Georgia is primarily a coffee brand sold mainly in Japan. 3 Del Valle is a juice and juice drink brand sold in Latin America. In Mexico and Brazil, we manufacture, market and sell Del Valle beverage products through joint ventures with our bottling partners. 4 Schweppes is owned by the Company in certain countries other than the United States. 5 Minute Maid Pulpy is a juice drink brand sold primarily in Asia Pacific. 6 Simply is a juice and juice drink brand sold in North America. 7 Gold Peak is primarily a tea brand sold in North America. 8 FUZE TEA is a brand sold outside of North America. 9 Glacau Smartwater is a vapor-distilled water with added electrolytes which is sold mainly in North America and Great Britain. 10 Ice Dew is a water brand sold in China. 11 I LOHAS is a water brand sold primarily in Japan. 12 Ayataka is a green tea brand sold primarily in Japan. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: We and certain of our bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Company-owned or -controlled bottling operations and independent bottling and distribution partners. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. fairlife, LLC (fairlife), our joint venture with Select Milk Producers, Inc., a dairy cooperative, is a health and wellness dairy company whose products include fairlife ultra-filtered milk and Core Power, a high-protein milkshake. We and certain of our bottling partners distribute fairlife products in the United States and Canada. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries through our network of Company-owned or -controlled bottling and distribution operations, independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of more than 1.9 billion servings each day. We continue to expand our marketing presence in an effort to increase our unit case volume and net operating revenues in developed, developing and emerging markets. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to our consumers throughout the world. The Coca-Cola system sold 29.2 billion , 29.3 billion and 29.2 billion unit cases of our products in 2017 , 2016 and 2015 , respectively. Sparkling soft drinks represented 69 percent , 69 percent and 70 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. Trademark Coca-Cola accounted for 45 percent , 45 percent and 46 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. In 2017 , unit case volume in the United States represented 19 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume for 2017 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 45 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2017 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (Guatemala City and surrounding areas), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and the Philippines (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, the Former Yugoslav Republic of Macedonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in Hong Kong, Taiwan, 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, and territories in 13 states in the western United States. In 2017 , these five bottling partners combined represented 41 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare specified Company Trademark Beverages, to package the same in authorized containers, and to distribute and sell the same in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory, (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law), and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned incentives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production rights to the bottlers. In such instances, we or our authorized suppliers sell Company Trademark Beverages to the bottlers for sale and distribution throughout the designated territory, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. Certain bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. The bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. In conjunction with implementing a new beverage partnership model in North America, the Company granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) to certain U.S. bottlers. These expanding bottlers entered into new CBAs, to which we sometimes refer as ""expanding bottler CBAs,"" which apply to newly granted territories as well as any legacy territories, and provide consistency across each such bottler's respective territory and consistency with other U.S. bottlers that have executed an expanding bottler CBA. Under the expanding bottler CBAs, the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The expanding bottler CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each, and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain expanding bottlers that have executed expanding bottler CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights converted or agreed to convert their legacy bottler's agreements to a form of CBA to which we sometimes refer as ""non-expanding bottler CBA."" This form of CBA has a term of 10 years and is renewable by the bottler indefinitely for successive additional terms of 10 years each and is substantially similar in most material respects to the expanding bottler CBA, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the expanding bottler CBA. Those bottlers that have not signed a CBA continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount of funds provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 6.2 billion in 2017 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; filtered milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc. (""PepsiCo""), is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A. (""Nestl""), Dr Pepper Snapple Group, Inc. (""DPSG""), Groupe Danone, Mondelz International, Inc. (""Mondelz""), The Kraft Heinz Company (""Kraft""), Suntory Beverage Food Limited (""Suntory"") and Unilever. We also compete against numerous regional and local companies and, in some markets, against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions and, in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. However, our Company purchases aspartame, an important non-nutritive sweetener that is used alone or in combination with other important non-nutritive sweeteners such as saccharin or acesulfame potassium in our low- and no-calorie sparkling beverage products, primarily from Ajinomoto Co., Inc. and SinoSweet Co., Ltd., which we consider to be our primary sources for the supply of this product. In addition, we purchase sucralose, which we consider a critical raw material, from a limited number of suppliers in the United States and China. We work closely with our primary sucralose suppliers to maintain continuity of supply. However, global demand for sucralose has increased in recent years as consumer products companies are reformulating food and beverages to replace high-intensity sweeteners with non-nutritive sweeteners, primarily sucralose. In addition, the Chinese sucralose industry has been impacted by the imposition of stringent environmental requirements that have reduced or closed production. To mitigate the impact of the increase in demand and tightening of supply of sucralose, we are working with our existing suppliers to secure additional volume and are expanding our sucralose supplier base as well as assessing additional internal contingency plans to address any potential shortages. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners and we do not anticipate such difficulties in the future. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets, as well as substantial know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to our Company's products and the processes for their production; the packages used for our products; and the design and operation of various processes and equipment used in our business. Some of the technology is licensed to suppliers and other parties. Our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. The state maintains lists of these substances and periodically adds other substances to these lists. Proposition 65 exposes all food and beverage producers to the possibility of having to provide warnings on their products in California because it does not provide for any generally applicable quantitative threshold below which the presence of a listed substance is exempt from the warning requirement. Consequently, the detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. Employees As of December 31, 2017 and 2016 , our Company had approximately 61,800 and 100,300 employees, respectively, of which approximately 2,900 were employed by consolidated variable interest entities (""VIEs"") as of December 31, 2016. There were no employees employed by consolidated VIEs as of December 31, 2017. The decrease in the total number of employees in 2017 was primarily due to the refranchising of certain bottling territories that were previously managed by Coca-Cola Refreshments (""CCR""), the refranchising of our China bottling operations, and our productivity initiatives. This decrease was partially offset by an increase in the number of employees due to the transition of Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company in October 2017. For additional information about the North America and China refranchising transactions, as well as the transition of ABI's controlling interest in CCBA, refer to Note 2 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. As of December 31, 2017 and 2016, our Company had approximately 12,400 and 51,000 employees, respectively, located in the United States, of which zero and approximately 400, respectively, were employed by consolidated VIEs. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2017 , approximately 3,700 employees, excluding seasonal hires, in North America were covered by collective bargaining agreements. These agreements typically have terms of three years to five years . We currently expect that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its employees are generally satisfactory. Securities Exchange Act Reports The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution, poor management and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints that could adversely affect our profitability or net operating revenues in the long run. If we do not address evolving consumer preferences, our business could suffer. Consumer preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, especially the perceived undesirability of artificial ingredients and obesity concerns; shifting consumer demographics, including aging populations; changes in consumer tastes and needs; changes in consumer lifestyles; location of origin or source of products and ingredients; and competitive product and pricing pressures. If we fail to address these changes, or do not successfully anticipate future changes in consumer preferences, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, we cannot assure you that despite our strong commitment to product safety and quality we or all of our bottling partners will always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the marketing, labeling or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends, obtain, maintain and enforce necessary intellectual property protections and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea in the manufacture and packaging of our beverage products. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, the affordability of our products and ultimately our business and results of operations could be negatively impacted. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, there can be no assurance that such incidents will not have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in the retail channel, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets, discounters and value stores, as well as the volume of transactions through e-commerce, are growing at a rapid pace. The nonalcoholic beverage retail landscape is also very dynamic and constantly evolving in emerging and developing markets, where modern trade is growing at a faster pace than traditional trade outlets. If we are unable to successfully adapt to the rapidly changing environment and retail landscape, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and staff to establish and manage our operations in these markets. Scarcity or heavy competition for talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, there can be no assurance that our products will be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2017, we used 73 functional currencies in addition to the U.S. dollar and derived $20.7 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2017 and 2016, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies might be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, we cannot assure you that fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, would not materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. We cannot assure you, however, that our financial risk management program will be successful in reducing the risks inherent in exposures to interest rate fluctuations. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottlers. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottlers' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottlers' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottlers in which we have equity method investments were to be downgraded, such bottlers' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income from continuing operations before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for the period, plus interest. For additional information regarding this income tax dispute, refer to Note 11 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. If this income tax dispute were to be ultimately determined adversely to us, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Tax Cuts and Jobs Act (""Tax Reform Act""), which was signed into law on December 22, 2017, significantly affected U.S. income tax law by changing how the United States imposes income tax on multinational corporations. We have recorded in our consolidated financial statements provisional amounts based on our current estimates of the effects of the Tax Reform Act in accordance with our current understanding of the Tax Reform Act and currently available guidance. For additional information regarding the Tax Reform Act and the provisional tax amounts recorded in our consolidated financial statements, refer to the heading ""Critical Accounting Policies and Estimates Income Taxes"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. The final amounts may be significantly affected by regulations and interpretive guidance expected to be issued by the tax authorities, clarifications of the accounting treatment of various items, our additional analysis, and our refinement of our estimates of the effects of the Tax Reform Act and, therefore, such final amounts may be materially different than our current provisional amounts, which could materially affect our tax obligations and effective tax rate. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not realize the economic benefits we anticipate from our productivity initiatives or are unable to successfully manage their possible negative consequences, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. For information regarding our productivity initiatives, refer to the heading ""Operations Review Other Operating Charges Productivity and Reinvestment Program"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We have incurred, and we expect will continue to incur, significant costs and expenses with the programs and activities associated with our productivity initiatives. If we are unable to implement some or all of these actions fully or in the envisioned timeframe, or we otherwise do not timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these actions, our results of operations for future periods could be negatively affected. In addition, some of the actions we are taking in furtherance of our productivity initiatives may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our ability to attract, train, develop and retain a highly skilled and diverse workforce. We may not be able to successfully compete for and attract the high-quality and diverse employee talent we want and our future business needs may require. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to insecurity resulting from our ongoing productivity initiatives, refranchising transactions and organizational changes could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, that may be caused by increasing demand or by events such as natural disasters, power outages, or the like could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices for these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, sucralose, saccharin and ascorbic acid, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We cannot assure you that we and our bottling partners will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans will be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by a deterioration of our or our bottling partners' relationships with suppliers; by supplier quality and reliability issues; or by events such as natural disasters, power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable recyclable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, ecotax and/or product stewardship have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of such legislation or regulations. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2017 , our net operating revenues in the United States were $14.7 billion , or 42 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2017 , our operations outside the United States accounted for $20.7 billion , or 58 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties surrounding the United Kingdom's impending withdrawal from the European Union, commonly referred to as ""Brexit,"" and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitation on profits, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. We caution you that actual outcomes or losses may differ materially from those envisioned by our current assessments and estimates. In addition, we have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, we cannot assure you that our policies, procedures and related training programs will always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations. If negative publicity, whether or not warranted, concerning product safety or quality, human and workplace rights, obesity or other issues damages our brand image and corporate reputation, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions and maintain our corporate reputation. We cannot assure you, however, that our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights will have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with human and workplace rights issues could adversely impact our corporate image and reputation. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable labor and workplace rights laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, and employment and labor practices. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic, including regulations relating to recovery and/or disposal of plastic packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. There can be no assurance that we will realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative implications on employee morale, work performance, escalation of grievances and successful negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our trademarks, bottler franchise rights, goodwill and other intangible assets as well as our other long-lived assets as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our operating or equity income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. Our U.S. multi-employer pension plan expense totaled $35 million in 2017. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021. If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. We cannot assure you, however, that we will be able to achieve our strategic and financial objectives for such bottling operations or other acquisitions. If we are unable to achieve such objectives, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we have refranchised substantially all of our Company-owned or -controlled bottling operations in the United States and all such bottling operations in China, and are continuing the process of refranchising Company-owned or -controlled bottling operations in Canada and Africa. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. For information regarding our relationship with Monster and related transactions, refer to Note 2 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. We also own an office and retail building at 711 Fifth Avenue in New York, New York. These properties, except for the North America group's main offices, are included in the Corporate operating segment. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located. The following table summarizes our principal production, distribution and storage facilities by operating segment as of December 31, 2017 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Distribution and Storage Warehouses Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Total 1 1 Does not include 34 owned and 1 leased principal beverage manufacturing/bottling plants and 28 owned and 17 leased distribution and storage warehouses related to our discontinued operations. Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that the total liabilities to the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit ( The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50 ) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit ( Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit ( Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. A trial date has been set for March 5, 2018. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange. The following table sets forth, for the quarterly reporting periods indicated, the high and low market prices per share for the Company's common stock, as reported on the New York Stock Exchange composite tape, and dividend per share information: Common Stock Market Prices High Low Dividends Declared Fourth quarter $ 47.48 $ 44.75 $ 0.37 Third quarter 46.98 44.15 0.37 Second quarter 46.06 42.27 0.37 First quarter 42.70 40.22 0.37 Fourth quarter $ 43.03 $ 39.88 $ 0.35 Third quarter 45.94 41.85 0.35 Second quarter 47.13 42.87 0.35 First quarter 46.88 40.75 0.35 While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 16, 2018 , there were 212,331 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the heading ""EQUITY COMPENSATION PLAN INFORMATION"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 25, 2018 (""Company's 2018 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the fiscal year ended December 31, 2017 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2017 , by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under the Publicly Announced Plan September 30, 2017 through October 27, 2017 5,256,426 $ 46.00 5,255,817 78,256,636 October 28, 2017 through November 24, 2017 1,660,944 45.84 1,660,597 76,596,039 November 25, 2017 through December 31, 2017 5,878,681 45.84 5,845,920 70,750,119 Total 12,796,051 $ 45.91 12,762,334 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below, and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees, totaling 609 shares, 347 shares and 32,761 shares for the fiscal months of October, November and December 2017, respectively. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2013 2015 2017 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 126 163 200 SP 500 Index 132 153 208 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2012. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer-Daniels-Midland Company, BG Foods, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Dean Foods Company, Dr Pepper Snapple Group, Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion, Incorporated, The J.M. Smucker Company, Kellogg Company, The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, Leucadia National Corporation, McCormick Company, Incorporated., Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, PepsiCo, Inc., Philip Morris International Inc., Pinnacle Foods Inc., Post Holdings, Inc., Snyder's-Lance, Inc., TreeHouse Foods, Inc., Tyson Foods, Inc., and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2017, the indices included US Foods Holding Corp., which was not included in the indices in 2016. Additionally, the indices do not include Mead Johnson Nutrition Company, Reynolds American Inc. and The WhiteWave Foods Company, which were included in the indices in 2016. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our objective; our strategic priorities; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; the impact of inflation and changing prices; and an overview of financial position. Our Business General The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations, bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our finished product operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, including CCR's bottling and associated supply chain operations in the United States and Canada, and are included in our Bottling Investments operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, such as water and sports drinks; juice, dairy and plantbased beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2016 Concentrate operations 1 % % % Finished product operations 2 60 Total % % % 1 Includes concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2016 Concentrate operations 1 % % % Finished product operations 2 24 Total % % % 1 Includes unit case volume related to concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes unit case volume related to fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Objective Our objective is to use our formidable assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to achieve long-term sustainable growth. Our vision for sustainable growth includes the following: People: Being a great place to work where people are inspired to be the best they can be. Portfolio: Bringing to the world a portfolio of beverage brands that anticipates and satisfies people's desires and needs. Partners: Nurturing a winning network of partners and building mutual loyalty. Planet: Being a responsible global citizen that makes a difference. Profit: Maximizing return to shareowners while being mindful of our overall responsibilities. Productivity: Managing our people, time and money for greatest effectiveness. Strategic Priorities We have five strategic priorities designed to help us achieve our objective. These strategic priorities are accelerating growth of a consumer-centric brand portfolio; driving our revenue growth algorithm; strengthening the Coca-Cola system; digitizing the enterprise; and unlocking the power of our people. In order to execute on these strategic priorities, we must further enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Core Capabilities Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to deliver enhanced value to themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in joint brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, six key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- or no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Water Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part to help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles, aging populations and consumers who are empowered with more information than ever. As a consequence of these changes, consumers want more choices. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,100 beverage products, including nearly 1,300 low- and no-calorie products, new product offerings, innovative packaging and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers to meet their ever-changing needs, desires and lifestyles. Increased Competition and Capabilities in the Marketplace Our Company is facing strong competition from some well-established global companies and numerous regional and local companies. We must continuously strengthen our capabilities in marketing and innovation in order to maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality As the world's largest beverage company, we strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions and engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Food Security Increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; water quality and quantity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and food security have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance, and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 4,523 million and $ 3,709 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 1 million and $ 203 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charges may be impacted by items such as basis differences, deferred taxes and deferred gains. Management's assessments of the recoverability and impairment tests of noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities The carrying values of our investments in equity securities are determined using the equity method, the cost method or the fair value method. We account for investments in companies that we do not control or account for under the equity method either at fair value or under the cost method, as applicable. Investments in equity securities, other than investments accounted for under the equity method, are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as either trading or available-for-sale securities. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in net income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Trading securities are reported as either marketable securities or other assets in our consolidated balance sheets. Securities classified as available-for-sale are reported as either cash and cash equivalents, marketable securities, other investments or other assets in our consolidated balance sheets. Investments in equity securities that do not qualify for fair value accounting or equity method accounting are accounted for under the cost method. In accordance with the cost method, our initial investment is recorded at cost and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets. The following table presents the carrying values of our investments in equity and debt securities (in millions): December 31, 2017 Carrying Value Percentage of Total Assets Equity method investments $ 20,856 % Securities classified as available-for-sale 7,807 Securities classified as trading * Cost method investments * Total $ 29,213 % * Accounts for less than 1 percent of the Company's total assets. Investments classified as trading securities are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. We review our investments in equity and debt securities that are accounted for using the equity method or cost method or that are classified as available-for-sale or held-to-maturity each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. During 2017, we recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company will adopt Accounting Standards Update (""ASU"") 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities , on January 1, 2018. Adoption of this standard will require us to revise our policy to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income. Refer to Note 1 of Notes to Consolidated Financial Statements. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's cost basis in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2017 Fair Value Carrying Value Difference Monster Beverage Corporation $ 6,463 $ 3,382 $ 3,081 Coca-Cola FEMSA, S.A.B. de C.V. 4,065 1,865 2,200 Coca-Cola European Partners plc 1 3,505 3,701 (196 ) Coca-Cola HBC AG 2,754 1,315 1,439 Coca-Cola Amatil Limited 1,449 Coca-Cola Bottlers Japan Inc. 1,251 1,151 Embotelladora Andina S.A. Coca-Cola Bottling Co. Consolidated Coca-Cola ecek A.. Corporacin Lindley S.A. Total $ 21,400 $ 12,896 $ 8,504 1 The carrying value of our investment in Coca-Cola European Partners plc (""CCEP"") exceeded its fair value as of December 31, 2017 . Based on the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Other Assets Our Company invests in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. Additionally, our Company advances payments to certain customers for distribution rights as well as to fund future marketing activities intended to generate profitable volume and expenses such payments over the periods benefited. Payments under these programs are generally capitalized and reported in the line item prepaid expenses and other assets or other assets, as appropriate, in our consolidated balance sheets. When facts and circumstances indicate that the carrying value of these assets or asset groups may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. During 2017, the Company recorded an impairment charge of $19 million related to CCR's other assets as a result of current year refranchising activities in North America and management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. This charge was recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and was determined by comparing the fair value of the asset to its carrying value. Property, Plant and Equipment As of December 31, 2017 , the carrying value of our property, plant and equipment, net of depreciation, was $ 8,203 million , or 9 percent of our total assets. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment review is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. During 2017, the Company recorded impairment charges of $310 million related to CCR's property, plant and equipment as a result of current year refranchising activities in North America and management's estimate of the proceeds (a Level 3 measurement) that were expected to be received for the remaining bottling territories upon their refranchising. These charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the assets to their carrying value. Refer to Note 16 of Notes to Consolidated Financial Statements. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into one of three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The following table presents the carrying values of intangible assets included in our consolidated balance sheet (in millions): December 31, 2017 Carrying Value Percentage of Total Assets Goodwill $ 9,401 % Trademarks with indefinite lives 6,729 Bottlers' franchise rights with indefinite lives * Definite-lived intangible assets, net * Other intangible assets not subject to amortization * Total $ 16,636 % * Accounts for less than 1 percent of the Company's total assets. When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment reviews as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. During 2017, the Company recorded impairment charges of $457 million related to certain intangible assets. These charges included $390 million related to goodwill and $33 million related to bottlers' franchise rights with indefinite lives. The impairment charges related to goodwill were determined by comparing the fair values of the reporting units, based on Level 3 inputs, to their carrying values. As a result of these charges, the carrying value of CCR's goodwill is zero. The impairment charge related to bottlers' franchise rights with indefinite lives was determined by comparing the fair value of the assets, based on Level 3 inputs, to the current carrying value. These impairment charges were incurred primarily as a result of current year refranchising activities in North America and management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income. Additionally, we recorded impairment charges related to Venezuelan intangible assets of $34 million. The Venezuelan intangible assets were written down due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. These charges were recorded in Corporate in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to the respective carrying values. During 2016, the Company recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's view of the proceeds that would be ultimately received upon refranchising. The remaining charge of $10 million was related to the impairment of goodwill and resulted from management's revised outlook on market conditions. These impairment charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to their respective carrying values. During 2015, the Company recorded a charge of $55 million related to the impairment of a Venezuelan trademark. The Venezuelan trademark impairment was due to the Company's revised expectations regarding the convertibility of the local currency. In 2015, the Company also closed a transaction with Monster. Under the terms of the transaction, the Company was required to discontinue selling energy products under one of the trademarks included in the glacau portfolio. During the year ended December 31, 2015, the Company recognized impairment charges of $418 million, primarily as a result of discontinuing these products. The charges for the impairment of these trademarks were recorded in Corporate in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the trademarks, derived using discounted cash flow analyses, to the respective carrying values. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our pension expense and obligations. We believe the most critical assumptions are related to (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our pension expense and obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future payments we anticipate making under the plans. As of December 31, 2017 and 2016 , the weighted-average discount rate used to compute our pension obligations was 3.50 percent and 4.00 percent , respectively. Effective January 1, 2016, the Company changed its method of measuring the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The Company believes the approach adopted in 2016 provides a more precise measurement of these components by improving the correlation between projected cash flows and the corresponding spot rates. The change does not affect the measurement of the Company's pension and other postretirement benefit obligations for those plans. During the year ended December 31, 2015, for plans using the yield curve approach, the Company measured the service cost and interest cost components utilizing the single weighted-average discount rate derived from the yield curve. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. The weighted-average expected long-term rate of return used to calculate our pension expense was 8.00 percent and 8.25 percent in 2017 and 2016, respectively. In 2017 , the Company's total pension expense related to defined benefit plans was $368 million , which included $28 million of net periodic benefit cost and $340 million of settlement charges, curtailment charges and special termination benefit costs. In 2018, we expect our total pension expense to be approximately $17 million, which includes $108 million of net periodic benefit income and $125 million of estimated settlement charges and special termination benefit costs expected to be incurred. The decrease in 2018 expected net periodic benefit cost is primarily due to 2017 North America refranchising activities, which decreased the size of the active workforce and, therefore, the number of employees earning pension benefits. Favorable asset performance in 2017 further decreased expected 2018 expense, although this was partially offset by a decrease in the weighted-average discount rate at December 31, 2017 compared to December 31, 2016. The estimated impact of a 50 basis-point decrease in the discount rate on our 2018 net periodic benefit cost would be an increase to our pension expense of $25 million. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets on our 2018 net periodic benefit cost would be an increase to our pension expense of $29 million. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2017 , the Company's primary U.S. plan represented 64 percent and 65 percent of the Company's consolidated projected pension benefit obligation and pension assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. The Company will adopt ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, on January 1, 2018. In accordance with this standard, we will record the service cost component of net periodic benefit cost in selling, general and administrative expenses, and we will record the non-service cost components in other income (loss) net. We expect to record service cost of $128 million and record a benefit of $111 million related to our non-service cost components of net periodic benefit cost and other benefit plan charges. Refer to Note 1 of Notes to Consolidated Financial Statements. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. For our Company, this generally means that we recognize revenue when title to our products is transferred to our bottling partners, resellers or other customers. Title usually transfers upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers can earn certain incentives which are included in deductions from revenue, a component of net operating revenues in our consolidated statements of income. These incentives include, but are not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. Refer to Note 1 of Notes to Consolidated Financial Statements. The aggregate deductions from revenue recorded by the Company in relation to these programs, including amortization expense on infrastructure programs, were $ 6.2 billion , $ 6.6 billion and $ 6.8 billion in 2017 , 2016 and 2015 , respectively. In preparing the financial statements, management must make estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considers past results in making such estimates. The actual amounts ultimately paid may be different from our estimates. Such differences are recorded once they have been determined and have historically not been significant. The Company will adopt ASU 2014-09, Revenue from Contracts with Customers , and its amendments on January 1, 2018. Adoption of this standard will result in a change in our revenue recognition policy. Refer to Note 1 of Notes to Consolidated Financial Statements. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information, (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position, and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 14 of Notes to Consolidated Financial Statements. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. A trial date has been set for March 5, 2018. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The Company regularly assesses the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of its tax reserves. The Company believes that the final adjudication of this matter will not have a material impact on its consolidated financial position, results of operations or cash flows. However, the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail in any material respect on its assertions, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. A number of years may elapse before a particular matter for which we have established a reserve is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. As of December 31, 2017 , the Company's valuation allowances on deferred tax assets were $ 501 million and were primarily related to uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards generated in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference results from earnings that meet the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. The Tax Reform Act was signed into law on December 22, 2017. Among other things, the Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017 , transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017 . At December 31, 2017 , we have not yet finalized the calculations of the tax effects of the Tax Reform Act; however, we have calculated a reasonable estimate of the effects on our year end income tax provision in accordance with our current understanding of the Tax Reform Act and the available guidance. As a result, the Company recognized a net provisional tax charge in the amount of $3.6 billion in 2017, which is included as a component of income taxes from continuing operations on our consolidated statement of income. We will continue to refine our calculations as additional analysis is completed. In addition, our estimates may also be affected as we gain a more thorough understanding of the Tax Reform Act as a result of potential legislative or regulatory provisions or interpretive guidance. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") estimated to be $42 billion , the majority of which was previously considered to be indefinitely reinvested and, accordingly, no U.S. federal and state income taxes had been provided. We recorded a provisional tax amount of $4.6 billion as a reasonable estimate for our one-time transition tax liability and a $0.6 billion provisional deferred tax for the related withholding taxes and state income taxes. Because of the complexities of the Tax Reform Act, we are still finalizing our calculation of the total accumulated post-1986 prescribed EP for the applicable foreign entities. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of post-1986 prescribed foreign EP and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any additional outside basis differences inherent in these entities, as these amounts continue to be provisionally indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities (i.e., basis differences in excess of that subject to the one-time transition tax) is not practicable. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. However, we are still analyzing certain aspects of the Tax Reform Act and refining our calculations, which could affect the measurement of these balances or give rise to new deferred tax amounts. The provisional amount recorded related to the remeasurement and adjustments of our deferred tax balance was a tax benefit of $1.6 billion. On December 22, 2017, Staff Accounting Bulletin No. 118 (""SAB 118"") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to finalize the calculations for certain income tax effects of the Tax Reform Act. In accordance with SAB 118, the Company has determined that the net tax charge of $3.6 billion recorded in connection with the Tax Reform Act is a provisional amount and a reasonable estimate as of December 31, 2017 . Additional work is necessary to finalize the calculations for certain income tax effects of the Tax Reform Act. Additionally, certain of our equity method investees are impacted by the Tax Reform Act and have recorded provisional tax amounts. To the extent their provisional amounts are refined in 2018, we will record our proportionate share in the line item equity income (loss) net in our consolidated statement of income. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The Company has not yet elected an accounting policy related to how it will account for GILTI and therefore has not provided any deferred tax impacts of GILTI in its consolidated financial statements for the year ended December 31, 2017 . The Company's effective tax rate is expected to be approximately 21.0 percent in 2018. This estimated tax rate does not reflect the potential impact of further clarification of certain matters related to the Tax Reform Act and any unusual or special items that may affect our tax rate in 2018. Operations Review Our organizational structure as of December 31, 2017 consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Bottling Investments; and Corporate. For further information regarding our operating segments, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. Our Bottling Investments operating segment and our other finished product operations typically generate net operating revenues by selling sparkling soft drinks and a variety of other beverages, such as juices, juice drinks, sports drinks, waters, teas and coffees, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. For these consolidated finished product operations, we recognize the associated concentrate sales volume at the time the unit case or unit case equivalent is sold to the customer. Our concentrate operations typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations. For these concentrate operations, we recognize concentrate revenue and concentrate sales volume when we sell concentrate and syrups to the authorized unconsolidated bottling operations, and we typically report unit case volume when finished products manufactured from the concentrates and syrups are sold to the customer. When we analyze our net operating revenues we generally consider the following four factors: (1) volume growth (concentrate sales volume or unit case volume, as appropriate), (2) acquisitions and divestitures (including structural changes defined below), as applicable, (3) changes in price, product and geographic mix and (4) foreign currency fluctuations. Refer to the heading ""Net Operating Revenues"" below. We generally refer to acquisitions and divestitures of bottling and distribution operations and consolidation or deconsolidation of bottling and distribution entities for accounting purposes as structural changes, which are a component of acquisitions and divestitures (""structural changes""). Typically, structural changes do not impact the Company's unit case volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider acquired brands to be structural changes. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when these brands are ultimately sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that the licenses are entered into, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider newly licensed brands to be structural changes. In 2017, ABI's controlling interest in CCBA was transitioned to the Company, resulting in its consolidation. The results of CCBA have been recorded as discontinued operations. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017, 2016 and 2015, the Company refranchised bottling territories in North America that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed beverage products sold in the refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the applicable base year when calculating volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. During 2016, the Company deconsolidated its South African bottling operations and disposed of its related equity method investment in exchange for equity method investments in CCBA and CCBA's South African subsidiary. As part of the transaction, the Company also acquired and licensed several brands. The impacts of the deconsolidation, the disposal of the related equity method investment and the new equity method investments have been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The brands and licenses that the Company acquired impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. During 2016, the Company also deconsolidated our German bottling operations as a result of their being combined to create CCEP. As a result of the transaction, the Company now owns an equity method investment in CCEP. Accordingly, the impact of the deconsolidation and new equity method investment has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The Company also changed our funding arrangement with our bottling partners in China, which resulted in a reduction in net operating revenues with an offsetting reduction in direct marketing expense. The impact of the change in the arrangement has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific operating segment. In 2015, the Company closed a transaction with Monster (""Monster Transaction""), which has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for each of the Company's operating segments. This transaction consisted of multiple elements including, but not limited to, the acquisition of Monster's non-energy brands and the expansion of our distribution territories for Monster's energy brands. These elements of the transaction impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. Also during 2015, the Company acquired a South African bottler, which has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments operating segment. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can impact unit case volume and concentrate sales volume and can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest but to which the Company does not sell concentrates, syrups, beverage bases, source waters, or powders/minerals may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2017 versus 2016 2016 versus 2015 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % % % 6 Europe, Middle East Africa % % 3 % % Latin America (2 ) (3 ) (1 ) (1 ) North America 4 6 Asia Pacific 5 Bottling Investments (41 ) N/A (16 ) N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2017 grew 2 percent. 4 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2017 was even. 5 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2017 grew 1 percent. 6 After considering the impact of structural changes, concentrate sales volume both worldwide and for North America for the year ended December 31, 2016 grew 1 percent. Unit Case Volume The Coca-Cola system sold 29.2 billion , 29.3 billion and 29.2 billion unit cases of our products in 2017 , 2016 and 2015 , respectively. The unit case volume for 2017, 2016 and 2015 reflects the impact of brands acquired and licensed during the applicable year. The unit case volume for 2017, 2016 and 2015 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2017 versus 2016 and 2016 versus 2015 unit case volume growth rates. Sparkling soft drinks represented 69 percent, 69 percent and 70 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. Trademark Coca-Cola accounted for 45 percent, 45 percent and 46 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. In 2017 , unit case volume in the United States represented 19 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume for 2017 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 45 percent of non-U.S. unit case volume. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In Europe, Middle East and Africa, unit case volume grew 1 percent, reflecting an 8 percent increase in tea and coffee, a 5 percent increase in water, enhanced water and sports drinks and a 1 percent increase in sparkling soft drinks. These increases were partially offset by a decrease of 3 percent in juice, dairy and plant-based beverages. The group reported increases in unit case volume in our Central Eastern Europe, Turkey, Caucasus Central Asia, South East Africa and West Africa business units. The increases in these business units were partially offset by even results in both our Middle East North Africa and Western Europe business units. Unit case volume in Latin America decreased 2 percent, which included declines of 3 percent in sparkling soft drinks and 1 percent in water, enhanced water and sports drinks. The group's volume reflected declines of 10 percent in the Latin Center business unit and 6 percent in the Brazil business unit. These declines were partially offset by 1 percent growth in the Mexico business unit, which included 1 percent growth in water, enhanced water and sports drinks, and even performance in sparkling soft drinks. In North America, unit case volume was even, reflecting even volume for sparkling soft drinks, a 2 percent decline in water, enhanced water and sports drinks and growth in energy drinks. North America's volume performance in sparkling soft drinks included 4 percent growth in Trademark Sprite and 5 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. Unit case volume in Asia Pacific increased 1 percent, reflecting a 2 percent increase in both sparkling soft drinks and juice, dairy and plant-based beverages. The increase in sparkling soft drinks included 4 percent growth in Trademark Coca-Cola. The group's unit case volume reflected an increase of 2 percent in both the ASEAN and Greater China Korea business units and a 1 percent increase in the India South West Asia business unit, partially offset by a 2 percent decline in the South Pacific business unit. Unit case volume in the Japan business unit was even. Unit case volume for Bottling Investments decreased 41 percent. This decrease primarily reflects the North America refranchising activities and the refranchising of our China bottling operations. Year Ended December 31, 2016 versus Year Ended December 31, 2015 In Europe, Middle East and Africa, unit case volume grew 1 percent, which included even volume in sparkling soft drinks. The group's sparkling soft drinks performance included a 1 percent decline in Trademark Coca-Cola, offset by an increase of 4 percent in Trademark Sprite and an increase of 1 percent in Trademark Fanta. The group had unit case volume growth in water, tea and sports drinks, while volume for juice and juice drinks declined. The group reported increases in unit case volume in our Western Europe, Middle East North Africa, West Africa and South East Africa business units. The increases in these business units were partially offset by declines in unit case volume in both our Central Eastern Europe and Turkey, Caucasus Central Asia business units. Unit case volume in Latin America decreased 1 percent, which included a decline of 2 percent in sparkling soft drinks. Unit case volume growth was reported for water, tea and sports drinks. The group's volume reflected a decline of 7 percent in both the Brazil and Latin Center business units and a decline of 3 percent in the South Latin business unit. These declines were partially offset by unit case volume growth of 5 percent in the Mexico business unit, which reflected 5 percent growth in sparkling soft drinks. Mexico's sparkling soft drinks unit case growth was led by 4 percent growth in Trademark Coca-Cola. In North America, unit case volume grew 1 percent. Sparkling soft drinks volume was even, which included 3 percent growth in Trademark Sprite and 6 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. The group had unit case growth in water, sports drinks, juice and juice drinks and dairy. Unit case volume for vitaminwater grew 6 percent. Unit case volume in Asia Pacific increased 2 percent. Volume for sparkling soft drinks was even, which included 2 percent growth in Trademark Coca-Cola offset by a 4 percent decline in Trademark Sprite. The group had unit case volume growth in water, teas and coffee, while volume for juice and juice drinks declined. The group's unit case volume reflected an increase of 6 percent in the ASEAN business unit and an increase of 3 percent in both the India South West Asia and Japan business units. The growth in these business units was partially offset by a unit case volume decline of 1 percent in the Greater China Korea business unit. Unit case volume for Bottling Investments decreased 16 percent. This decrease primarily reflects the deconsolidation of our German bottling operations in May 2016, a decline in CCR's unit case volume of 14 percent as well as a decline in China. The decline in CCR's unit case volume was primarily driven by North America refranchising activities. The unfavorable impact of these items on the group's unit case volume results was partially offset by growth in India and other markets where we own or otherwise consolidate bottling operations. The Company's consolidated bottling operations accounted for 33 percent and 67 percent of the unit case volume in China and India, respectively. CCR accounted for 51 percent of the total bottlerdistributed unit case volume in North America. Concentrate Sales Volume In 2017 , worldwide concentrate sales volume and unit case volume were both even compared to 2016 . In 2016 , worldwide unit case sales volume grew 1 percent and concentrate sales volume was even compared to 2015 . After considering the impact of structural changes, concentrate sales volume grew 1 percent during the year ended December 31, 2016. The differences between concentrate sales volume and unit case volume growth rates for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, beverage bases or powders. Analysis of Consolidated Statements of Income Percent Change Year Ended December 31, 2017 vs. 2016 2016 vs. 2015 (In millions except percentages and per share data) NET OPERATING REVENUES $ 35,410 $ 41,863 $ 44,294 (15 )% (5 )% Cost of goods sold 13,256 16,465 17,482 (19 ) (6 ) GROSS PROFIT 22,154 25,398 26,812 (13 ) (5 ) GROSS PROFIT MARGIN 62.6 % 60.7 % 60.5 % Selling, general and administrative expenses 12,496 15,262 16,427 (18 ) (7 ) Other operating charges 2,157 1,510 1,657 (9 ) OPERATING INCOME 7,501 8,626 8,728 (13 ) (1 ) OPERATING MARGIN 21.2 % 20.6 % 19.7 % Interest income Interest expense (14 ) Equity income (loss) net 1,071 Other income (loss) net (1,666 ) (1,234 ) (35 ) * INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 6,742 8,136 9,605 (17 ) (15 ) Income taxes from continuing operations 5,560 1,586 2,239 (29 ) Effective tax rate 82.5 % 19.5 % 23.3 % NET INCOME FROM CONTINUING OPERATIONS 1,182 6,550 7,366 (82 ) (11 ) Income from discontinued operations (net of income taxes of $47, $0 and $0, respectively) * * CONSOLIDATED NET INCOME 1,283 6,550 7,366 (80 ) (11 ) Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 1,248 $ 6,527 $ 7,351 (81 )% (11 )% BASIC NET INCOME PER SHARE 1 $ 0.29 $ 1.51 $ 1.69 (81 )% (11 )% DILUTED NET INCOME PER SHARE 1 $ 0.29 $ 1.49 $ 1.67 (81 )% (10 )% * Calculation is not meaningful. 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Net Operating Revenues Year Ended December 31, 2017 versus Year Ended December 31, 2016 The Company's net operating revenues decreased $6,453 million, or 15 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2017 vs. 2016 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (17 )% % (1 )% (15 )% Europe, Middle East Africa % (2 )% % (2 )% % Latin America (3 ) North America Asia Pacific (1 ) (4 ) (2 ) Bottling Investments (3 ) (48 ) (47 ) Corporate * * * * * Note: Certain rows may not add due to rounding. * Calculation is not meaningful. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. ""Price, product and geographic mix"" refers to the change in revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorably impacted as a result of pricing initiatives and product and package mix, partially offset by geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets; North America favorably impacted as a result of pricing initiatives and product and package mix; Asia Pacific unfavorably impacted by geographic mix, partially offset by the favorable impact of pricing initiatives and product and package mix; and Bottling Investments favorably impacted as a result of pricing initiatives and product and package mix in North America. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the U.K. pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a 17 percent unfavorable impact on full year 2018 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect currencies will have a slight favorable impact on our full year 2018 net operating revenues. Year Ended December 31, 2016 versus Year Ended December 31, 2015 The Company's net operating revenues decreased $2,431 million, or 5 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2016 vs. 2015 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (6 )% % (3 )% (5 )% Europe, Middle East Africa % (4 )% % (3 )% (4 )% Latin America (1 ) (18 ) (6 ) North America Asia Pacific (2 ) (2 ) Bottling Investments (13 ) (1 ) (14 ) Corporate * * * * * Note: Certain rows may not add due to rounding. * Calculation is not meaningful. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and Divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. The acquisitions and divestitures percent change for 2016 versus 2015 in the table above consisted entirely of structural changes. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable product and geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets, partially offset by unfavorable geographic mix; North America favorably impacted as a result of pricing initiatives and product and package mix; and Asia Pacific unfavorable product and channel mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 3 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Argentine peso, Mexican peso and Australian dollar, which had an unfavorable impact on our Europe, Middle East and Africa, Latin America, Asia Pacific and Bottling Investments operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net Operating Revenues by Operating Segment Information about our net operating revenues by operating segment as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 20.7 % 16.8 % 15.7 % Latin America 11.2 8.9 9.0 North America 24.4 15.4 12.6 Asia Pacific 13.5 11.4 10.6 Bottling Investments 29.8 47.2 51.7 Corporate 0.4 0.3 0.4 Total 100.0 % 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin As a result of our finished goods operations, which are primarily included in our North America and Bottling Investments operating segments, the following inputs represent a substantial portion of the Company's total cost of goods sold: (1) sweeteners, (2) metals, (3) juices and (4) PET. The Company enters into hedging activities related to certain commodities in order to mitigate a portion of the price risk associated with forecasted purchases. Many of the derivative financial instruments used by the Company to mitigate the risk associated with these commodity exposures, including any related foreign currency exposure, do not qualify for hedge accounting. As a result, the changes in fair value of these derivative instruments have been, and will continue to be, included as a component of net income in each reporting period. The Company recorded gains related to these derivatives of $14 million and $79 million during the years ended December 31, 2017 and December 31, 2016 , respectively, and recorded a loss of $206 million during the year ended December 31, 2015 in the line item cost of goods sold in our consolidated statements of income. Refer to Note 5 of Notes to Consolidated Financial Statements. We do not currently expect changes in commodity costs to have a significant impact on our 2018 gross profit margin as compared to 2017. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Our gross profit margin increased to 62.6 percent in 2017 from 60.7 percent in 2016. The increase was primarily due to the impact of acquisitions and divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Our gross profit margin increased to 60.7 percent in 2016 from 60.5 percent in 2015. The increase was primarily due to the impact of positive price mix and lower commodity costs, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations and acquisitions and divestitures. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the significant components of selling, general and administrative expenses (in millions): Year Ended December 31, Stock-based compensation expense $ $ $ Advertising expenses 3,958 4,004 3,976 Selling and distribution expenses 1 3,257 5,177 6,025 Other operating expenses 5,062 5,823 6,190 Selling, general and administrative expenses $ 12,496 $ 15,262 $ 16,427 1 Includes operating expenses as well as general and administrative expenses primarily related to our Bottling Investments operating segment. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Selling, general and administrative expenses decreased $2,766 million, or 18 percent. During the year ended December 31, 2017, fluctuations in foreign currency exchange rates had a nominal impact on selling, general and administrative expenses. The decrease in selling and distribution expenses and advertising expenses during 2017 reflects the impact of divestitures. Additionally, advertising expenses during 2017 decreased 1 percent as a result of foreign currency exchange rate fluctuations. The decrease in other operating expenses during 2017 reflects savings from our productivity and reinvestment initiatives and a reduction in net periodic benefit cost. Foreign currency exchange rate fluctuations have a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they are generally transacted in local currency. Our selling and distribution expenses are primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and are primarily denominated in U.S. dollars. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. As of December 31, 2017 , we had $ 286 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our plans. This cost is expected to be recognized over a weighted-average period of 3.0 years years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Selling, general and administrative expenses decreased $1,165 million, or 7 percent. During the year ended December 31, 2016, fluctuations in foreign currency decreased selling, general and administrative expenses by 2 percent. The increase in advertising expenses reflects the Company's increased investments to strengthen our brands, partially offset by a foreign currency exchange impact of 3 percent. The decrease in selling and distribution expenses reflects the impact of divestitures. The decrease in other operating expenses reflects the shift of the Company's marketing spending to more consumer-facing advertising expenses as well as savings from our productivity and reinvestment initiatives. Foreign currency exchange rate fluctuations have a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they are generally transacted in local currency. Our selling and distribution expenses are primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and are primarily denominated in U.S. dollars. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. Other Operating Charges Other operating charges incurred by operating segment were as follows (in millions): Year Ended December 31, Europe, Middle East Africa $ $ $ (9 ) Latin America North America Asia Pacific Bottling Investments 1,218 Corporate Total $ 2,157 $ 1,510 $ 1,657 In 2017, the Company recorded other operating charges of $2,157 million . These charges primarily consisted of $737 million of CCR asset impairments and $650 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $419 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information about the Venezuelan intangible assets. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 16 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. In 2016, the Company recorded other operating charges of $1,510 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $415 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. The Company also recorded a charge of $200 million related to cash contributions we made to The Coca-Cola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan exchange rates. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. In 2015, the Company incurred other operating charges of $1,657 million . These charges included $ 691 million due to the Company's productivity and reinvestment program and $ 292 million due to the integration of our German bottling operations. In addition, the Company recorded impairment charges of $418 million primarily due to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction and incurred a charge of $100 million due to a cash contribution we made to The Coca-Cola Foundation. The Company also incurred a charge of $ 111 million due to the write-down we recorded related to receivables from our bottling partner in Venezuela and an impairment of a Venezuelan trademark primarily due to changes in exchange rates as a result of the establishment of the new open market exchange system. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan currency change. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Coca-Cola Enterprises Inc.'s (""Old CCE"") former North America bottling operations. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives will focus on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. The Company expects that the expanded productivity initiatives will generate an incremental $2.0 billion in annualized productivity. This productivity will enable the Company to fund marketing initiatives and innovation required to deliver sustainable net revenue growth and will also support margin expansion and increased returns on invested capital over time. We expect to achieve total annualized productivity of approximately $ 3.0 billion by 2019 as a result of initiatives implemented under the 2014 expansions of the program. In April 2017, the Company announced that we were expanding the current productivity and reinvestment program, with planned initiatives that are expected to generate an incremental $800 million in annualized savings by 2019. We expect to achieve these savings through additional efficiencies in both our supply chain and our marketing expenditures as well as the transition to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,058 million related to this program since it began in 2012. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information. Integration of Our German Bottling Operations In 2008, the Company began the integration of our German bottling operations acquired in 2007. The Company incurred total pretax expenses of $ 1,367 million as a result of this initiative, primarily related to involuntary terminations. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Refer to Note 2 and Note 18 of Notes to Consolidated Financial Statements for additional information. Operating Income and Operating Margin Information about our operating income contribution by operating segment on a percentage basis is as follows: Year Ended December 31, Europe, Middle East Africa 48.6 % 42.6 % 44.4 % Latin America 29.5 22.6 24.9 North America 34.4 30.0 27.1 Asia Pacific 28.8 25.8 25.1 Bottling Investments (14.9 ) (1.6 ) 1.4 Corporate (26.4 ) (19.4 ) (22.9 ) Total 100.0 % 100.0 % 100.0 % Information about our operating margin on a consolidated basis and by operating segment is as follows: Year Ended December 31, Consolidated 21.2 % 20.6 % 19.7 % Europe, Middle East Africa 49.7 % 52.4 % 55.6 % Latin America 56.0 52.1 54.3 North America 29.8 40.1 42.4 Asia Pacific 45.4 46.5 46.5 Bottling Investments (10.6 ) (0.7 ) 0.5 Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 3 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the U.K. pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2017 and 2016 was $3,646 million and $3,676 million , respectively. Operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 3 percent, partially offset by favorable price, product and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2017 and 2016 was $2,214 million and $1,951 million , respectively. Operating income for the segment reflects favorable price mix, a reduction in other operating charges and a nominal impact from foreign currency exchange rate fluctuations. North America's operating income for the years ended December 31, 2017 and 2016 was $2,578 million and $2,582 million , respectively. The decrease in the segment's operating income was due to higher other operating charges and an unfavorable foreign currency exchange rate impact of 1 percent, partially offset by favorable price and product and package mix. Operating income for Asia Pacific for the years ended December 31, 2017 and 2016 was $2,163 million and $2,224 million , respectively. The decline in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 6 percent and unfavorable price, product and geographic mix. Our Bottling Investments segment's operating loss for the year ended December 31, 2017 was $1,117 million , compared to an operating loss for the year ended December 31, 2016 of $137 million . The Bottling Investments segment was unfavorably impacted by acquisitions and divestitures and $737 million of asset impairment charges related to CCR. The Corporate segment's operating loss for the years ended December 31, 2017 and 2016 was $1,983 million and $1,670 million , respectively. The operating loss in 2017 was unfavorably impacted by higher other operating charges. Year Ended December 31, 2016 versus Year Ended December 31, 2015 During the years ended December 31, 2016 and 2015, the Company's operating income was unfavorably impacted by the refranchising of certain bottling territories in North America, which unfavorably impacted our Bottling Investments operating segment. During the year ended December 31, 2016, the Company's operating income was unfavorably impacted by the sale of the Company's energy brands as part of the Monster Transaction which closed on June 12, 2015. The sale of the energy brands unfavorably impacted our Europe, Middle East and Africa, Latin America, North America, Asia Pacific and Bottling Investments operating segments. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising and the Monster Transaction. In 2016, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 8 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Argentine peso, Mexican peso and Australian dollar, which had an unfavorable impact on our Europe, Middle East and Africa, Latin America, Asia Pacific, Bottling Investments and Corporate operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2016 and 2015 was $3,676 million and $3,875 million , respectively. Foreign currency exchange rate fluctuations unfavorably impacted operating income by 3 percent and the segment was also unfavorably impacted by an increase in other operating charges and the impact of acquisitions and divestitures. The impact of these items was partially offset by favorable product mix and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2016 and 2015 was $1,951 million and $2,169 million , respectively. Foreign currency exchange rate fluctuations unfavorably impacted operating income by 27 percent and the segment was also unfavorably impacted by an increase in other operating charges. The impact of these items was partially offset by favorable price mix in all of the segment's business units. North America's operating income for the years ended December 31, 2016 and 2015 was $2,582 million and $2,366 million , respectively. The increase in the segment's operating income was due to price increases and favorable package mix and a decrease in other operating charges, partially offset by the impact of acquisitions and divestitures. Operating income in Asia Pacific for the years ended December 31, 2016 and 2015 was $2,224 million and $2,189 million , respectively. Operating income for the segment reflects an increase in concentrate sales partially offset by the unfavorable impact of acquisitions and divestitures. Our Bottling Investments segment's operating loss for the year ended December 31, 2016 was $137 million , compared to operating income for the year ended December 31, 2015 of $124 million . The Bottling Investments segment was unfavorably impacted by an increase in other operating charges and the impact of acquisitions and divestitures, partially offset by a favorable impact of 1 percent due to fluctuations in foreign currency exchange rates. The Corporate segment's operating loss for the years ended December 31, 2016 and 2015 was $1,670 million and $1,995 million , respectively. Operating loss in 2016 was favorably impacted by a decrease in other operating charges, partially offset by an unfavorable impact of 2 percent due to fluctuations in foreign currency exchange rates. Interest Income Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest income was $ 677 million in 2017 , compared to $ 642 million in 2016 , an increase of $35 million, or 6 percent. The increase primarily reflects higher investment balances in certain of our international locations, partially offset by lower interest rates earned on certain investments. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Interest income was $ 642 million in 2016 , compared to $ 613 million in 2015 , an increase of $29 million, or 5 percent. The increase primarily reflects higher cash balances and higher average interest rates in certain of our international locations, partially offset by the unfavorable impact of fluctuations in foreign currency exchange rates due to a stronger U.S. dollar against most major currencies. Interest Expense Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest expense was $ 841 million in 2017 , compared to $ 733 million in 2016 , an increase of $108 million, or 15 percent. The increase primarily reflects the impact of short-term U.S. interest rates and longer debt maturities, both of which resulted in higher interest rates on the Company's debt portfolio. Additionally, interest expense during the year ended December 31, 2017 included a net charge of $38 million due to the early extinguishment of certain long-term debt. This net charge included the difference between the reacquisition price and the net carrying amount of the debt extinguished. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Interest expense was $ 733 million in 2016 , compared to $ 856 million in 2015 , a decrease of $123 million, or 14 percent. Interest expense during the year ended December 31, 2016 included the impact of recently issued long-term debt and interest rate swaps on our fixed-rate debt. Interest expense during the year ended December 31, 2015 included charges of $320 million the Company recorded on the early extinguishment of certain long-term debt. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information related to the Company's hedging program. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2017 versus Year Ended December 31, 2016 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2017 , equity income was $ 1,071 million , compared to equity income of $ 835 million in 2016 , an increase of $236 million, or 28 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees. Additionally, the increase was attributable to the impact of the equity investment in CCEP acquired in 2016 and the impact of the equity investment in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas"") that was acquired in 2017. The favorable impact of these items was partially offset by the derecognition of the Company's former equity method investment in South Africa in 2016. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in AC Bebidas and former investments in CCBA and CCBA's South African subsidiary. Year Ended December 31, 2016 versus Year Ended December 31, 2015 In 2016 , equity income was $ 835 million , compared to equity income of $ 489 million in 2015 , an increase of $346 million, or 71 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees, the impact of the June 2015 investment in Monster, as well as our investments in CCEP, CCBA and CCBA's South African subsidiary, which were acquired in 2016. The favorable impact of these items was partially offset by the unfavorable impact of fluctuations in foreign currency exchange rates due to a stronger U.S. dollar against most major currencies and the derecognition of the Company's former equity method investment in South Africa. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction and our investments in CCEP, CCBA and CCBA's South African subsidiary. Other Income (Loss) Net Other income (loss) net includes, among other things, the impact of foreign currency exchange gains and losses; dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to business combinations and disposals; realized and unrealized gains and losses on trading securities; realized gains and losses on available-for-sale securities; and other-than-temporary impairments of available-for-sale securities. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2017, other income (loss) net was a loss of $1,666 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Additionally, the Company incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish Coca-Cola Bottlers Japan Inc. (""CCBJI""). In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $57 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America and China bottling refranchising, the conversion payments and our consolidation of CCBA. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. In 2016, other income (loss) net was a loss of $1,234 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred net foreign currency exchange losses of $246 million, including a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These losses were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations, dividend income of $55 million and net gains of $83 million related to trading securities and the sale of available-for-sale securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising, the deconsolidation of our South African bottling operations, the conversion payments and the deconsolidation of our German bottling operations. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. In 2015, other income (loss) net was income of $631 million. This income included a net gain of $ 1,403 million as a result of the Monster Transaction, primarily due to the difference in the recorded carrying value of the assets transferred, including an allocated portion of goodwill, compared to the value of the total assets and business acquired. Other income (loss) net also included net foreign currency exchange gains of $149 million and dividend income of $83 million. This income was partially offset by losses of $1,006 million due to refranchising activities in North America. The net foreign currency exchange gains included a gain of $300 million associated with our foreign-denominated debt partially offset by a charge of $27 million due to the initial remeasurement of the net monetary assets of our Venezuelan subsidiary using the SIMADI exchange rate. The Company determined that based on its economic circumstances, the SIMADI rate best represented the applicable rate at which future transactions could be settled, including the payment of dividends. As such, the Company remeasured the net assets related to its operations in Venezuela using the current SIMADI rate. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and Note 1 of Notes to Consolidated Financial Statements for additional information related to the charge due to the change in Venezuelan exchange rates. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to the Monster Transaction and North America refranchising. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate of 35.0 percent . As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2018 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 221 million , $ 105 million and $ 223 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 35.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.2 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal rate (9.7 ) (17.5 ) 5 (12.7 ) Equity income or loss (3.4 ) (3.0 ) (1.7 ) Tax Reform Act 53.5 1 Other net 5.9 2,3,4 3.8 6 1.5 Effective tax rate 82.5 % 19.5 % 23.3 % 1 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. Refer to Note 14 of Notes to Consolidated Financial Statements. 2 Includes excess tax benefits of $132 million (or a 2 percent impact on our effective tax rate) recognized as awards issued under the Company's share-based compensation arrangements vested or were settled. 3 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. 5 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 6 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. As of December 31, 2017 , the gross amount of unrecognized tax benefits was $ 331 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 205 million , exclusive of any benefits related to interest and penalties. The remaining $ 126 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 1 Decrease related to prior period tax positions (13 ) (9 ) Increase related to current period tax positions Decrease related to settlements with taxing authorities (40 ) 1 (5 ) Decrease due to lapse of the applicable statute of limitations (23 ) Increase (decrease) due to effect of foreign currency exchange rate changes (6 ) (15 ) Ending balance of unrecognized tax benefits $ $ $ 1 The increase is primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 177 million , $ 142 million and $ 111 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2017 , 2016 and 2015 , respectively. Of these amounts, $35 million and $31 million of expense were recognized through income tax expense in 2017 and 2016 , respectively. An insignificant amount of interest and penalties was recognized through income tax expense for the year ended December 31, 2015. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2018 is expected to be approximately 21.0 percent before considering the potential impact of further clarification of certain matters related to the Tax Reform Act and any unusual or special items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2018. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates. In addition, our domestic entities have recently borrowed and continue to have the ability to borrow funds in international markets at reasonable interest rates. Our debt financing includes the use of an extensive commercial paper program as part of our overall cash management strategy. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. In addition to the Company's cash balances, commercial paper program, and our ability to issue long-term debt, we also had $ 7,295 million in lines of credit for general corporate purposes as of December 31, 2017 . These backup lines of credit expire at various times from 2018 through 2022 . We have significant operations outside the United States. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume in 2017. We earn a substantial amount of our consolidated operating income and income from continuing operations before income taxes from foreign subsidiaries that either sell concentrates and syrups to our local bottling partners or, in certain instances, sell finished products directly to our customers to fulfill the demand for Company beverage products outside the United States. A significant portion of these foreign earnings was previously considered to be indefinitely reinvested in foreign jurisdictions where the Company has made, and will continue to make, substantial investments to support the ongoing development and growth of our international operations. Accordingly, no U.S. federal and state income taxes were previously provided on the portion of our foreign earnings that was considered to be indefinitely reinvested in foreign jurisdictions. On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017, transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. As a result, the Company recognized a provisional tax charge related to the one-time transition tax in the amount of $4.6 billion in 2017. The Company's cash, cash equivalents, short-term investments and marketable securities held by our foreign subsidiaries totaled $19.6 billion as of December 31, 2017 . Net operating revenues in the United States were $14.7 billion in 2017, or 42 percent of the Company's consolidated net operating revenues. We expect existing domestic cash, cash equivalents, short-term investments, marketable securities, cash flows from operations, the repatriation of foreign earnings and the issuance of debt to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities. In addition, we expect foreign cash, cash equivalents, short-term investments, marketable securities remaining after repatriation and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities. Based on all the aforementioned factors, the Company believes its current liquidity position is strong, and we will continue to meet all of our financial commitments for the foreseeable future. These obligations and anticipated cash outflows include, but are not limited to, regular quarterly dividends, debt maturities, capital expenditures, share repurchases and obligations included under the heading ""Off-Balance Sheet Arrangements and Aggregate Contractual Obligations"" below. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2017 , 2016 and 2015 was $ 6,995 million , $ 8,796 million and $ 10,528 million , respectively. Net cash provided by operating activities decreased $1,801 million, or 20 percent, in 2017 compared to 2016 . This decrease was primarily driven by the refranchising of certain bottling operations, the unfavorable impact of foreign currency exchange rate fluctuations, one less day in the current year, and increased payments related to income taxes and restructuring. Net cash provided by operating activities in 2018 will be impacted by a tax payment of $370 million related to the one-time transition tax resulting from the Tax Reform Act. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information on the tax payments. Net cash provided by operating activities decreased $1,732 million, or 16 percent, in 2016 compared to 2015 . This decrease included the unfavorable impact of foreign currency exchange rate fluctuations, the impact of $471 million in incremental contributions made to the Company's pension plans and the impact of acquisitions and divestitures. The impact of these items was partially offset by lower income tax payments. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information on the tax payments. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, Purchases of investments $ (16,520 ) $ (15,499 ) $ (15,831 ) Proceeds from disposals of investments 15,911 16,624 14,079 Acquisitions of businesses, equity method investments and nonmarketable securities (3,900 ) (838 ) (2,491 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 3,821 1,035 Purchases of property, plant and equipment (1,675 ) (2,262 ) (2,553 ) Proceeds from disposals of property, plant and equipment Other investing activities (126 ) (209 ) (40 ) Net cash provided by (used in) investing activities $ (2,385 ) $ (999 ) $ (6,186 ) Purchases of Investments and Proceeds from Disposals of Investments In 2017 , purchases of investments were $ 16,520 million and proceeds from disposals of investments were $ 15,911 million . This activity resulted in a net cash outflow of $609 million during 2017 . In 2016 , purchases of investments were $ 15,499 million and proceeds from disposals of investments were $ 16,624 million , resulting in a net cash inflow of $1,125 million. In 2015 , purchases of investments were $ 15,831 million and proceeds from disposals of investments were $ 14,079 million , resulting in a net cash outflow of $1,752 million. These investments include time deposits that have maturities greater than three months but less than one year and are classified in the line item short-term investments in our consolidated balance sheets. The disposals in 2016 include proceeds from the disposal of the Company's investment in Keurig of $2,380 million. The purchases in 2015 include our investment in Keurig of $830 million. The remaining activity primarily represents the purchases of and proceeds from short-term investments that were made as part of the Company's overall cash management strategy. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in Keurig. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,900 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. In 2016 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 838 million , which was primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd., a maker of plant-based protein beverages in China, and a minority investment in CHI Limited, a Nigerian producer of value-added dairy and juice beverages. Under the terms of the agreement related to our investment in CHI Limited, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. In 2015 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 2,491 million , which primarily included our equity investments in Monster and in Indonesian bottling operations and the acquisition of a controlling interest in a South African bottling operation. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2017 , 2016 and 2015 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. In 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $1,035 million , primarily related to proceeds from the refranchising of certain bottling territories in North America. In 2015 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $565 million , which included cash received as a result of a Brazilian bottling entity's majority interest owners exercising their option to acquire from us an additional equity interest. The proceeds from disposals of businesses, equity method investments and nonmarketable securities during 2015 also included the proceeds from the refranchising of certain of our bottling territories in North America. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2017 , 2016 and 2015 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment net of disposals for the years ended December 31, 2017 , 2016 and 2015 were $1,571 million, $2,112 million and $2,468 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment were as follows (in millions): Year Ended December 31, Capital expenditures $ 1,675 $ 2,262 $ 2,553 Europe, Middle East Africa 4.8 % 2.7 % 2.1 % Latin America 3.3 2.0 2.7 North America 32.3 19.4 14.8 Asia Pacific 3.0 4.7 3.2 Bottling Investments 39.5 58.8 66.5 Corporate 17.1 12.4 10.7 We expect our annual 2018 capital expenditures to be approximately $1.9 billion as we continue to make investments to enable growth in our business and further enhance our operational effectiveness. Other Investing Activities In 2016, cash used in other investing activities was primarily related to the cash flow impact of the Company's derivative contracts designated as net investment hedges and the purchases of trademarks. In 2015, cash used in other investing activities included a $530 million payment related to the Monster Transaction, partially offset by the cash flow impact of the Company's derivative contracts designated as net investment hedges. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction and Note 5 of Notes to Consolidated Financial Statements for additional information on the Company's derivative contracts designated as net investment hedges. Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 29,857 $ 27,281 $ 40,434 Payments of debt (28,768 ) (25,615 ) (37,738 ) Issuances of stock 1,595 1,434 1,245 Purchases of stock for treasury (3,682 ) (3,681 ) (3,564 ) Dividends (6,320 ) (6,043 ) (5,741 ) Other financing activities (91 ) Net cash provided by (used in) financing activities $ (7,409 ) $ (6,545 ) $ (5,113 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2017, our long-term debt was rated ""AA-"" by Standard Poor's and ""Aa3"" by Moody's. Our commercial paper program was rated ""A-1+"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the aggregated balance sheet and other financial information of the Company. In addition, some rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Bottling Co. Consolidated, Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2017, the Company had issuances of debt of $29,857 million , which included net issuances of $26,218 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million, net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,768 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,156 of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million. The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Old CCE's former North America business. This resulted in a net charge of $38 million that was recorded in the line item interest expense in our consolidated statement of income. This net charge included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including fair value adjustments recorded as part of purchase accounting. In 2016, the Company had issuances of debt of $27,281 million , which included net issuances of $773 million of commercial paper and short-term debt with maturities of 90 days or less and $21,525 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $4,983 million, net of related discounts and issuance costs. Refer below for additional details on our long-term debt issuances. During 2016, the Company made payments of debt of $25,615 million , which included $22,920 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $2,695 million. In 2015, the Company had issuances of debt of $40,434 million, which included net issuances of $25,923 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $14,511 million, net of related discounts, premiums and issuance costs. During 2015, the Company made payments of debt of $37,738 million, which included net payments of $208 million of commercial paper and short-term debt with maturities of 90 days or less, $31,711 million of payments of commercial paper and short-term debt with maturities greater than 90 days and long-term debt payments of $5,819 million. The long-term debt payments included the extinguishment of $2,039 million of long-term debt prior to maturity, which resulted in associated charges of $320 million that were recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE of $ 263 million and $ 361 million as of December 31, 2017 and 2016 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2017 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 24 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 757 million , $ 663 million and $ 515 million in 2017 , 2016 and 2015 , respectively. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt balances. Issuances of Stock The issuances of stock in 2017 , 2016 and 2015 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase program of up to 500 million shares of the Company's common stock. The table below presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 44.09 $ 43.62 $ 41.33 Since the inception of our initial share repurchase program in 1984 through our current program as of December 31, 2017 , we have purchased 3.4 billion shares of our Company's common stock at an average price per share of $16.74. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2017, we repurchased $3.7 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2017 resulted in a net cash outflow of $2.1 billion. We currently expect to repurchase approximately $1.0 billion of our stock during 2018, net of proceeds from the issuance of treasury stock due to the exercise of employee stock options. Dividends The Company paid dividends of $6,320 million , $6,043 million and $5,741 million during the years ended December 31, 2017 , 2016 and 2015 , respectively. At its February 2018 meeting, our Board of Directors increased our quarterly dividend by 5 percent, raising it to $0.39 per share, equivalent to a full year dividend of $1.56 per share in 2018. This is our 56 th consecutive annual increase. Our annual common stock dividend was $ 1.48 per share, $ 1.40 per share and $ 1.32 per share in 2017 , 2016 and 2015 , respectively. The 2017 dividend represented a 6 percent increase from 2016 , and the 2016 dividend represented a 6 percent increase from 2015 . Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2017 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 609 million , of which $ 256 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees was individually significant. The amount represents the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. Management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2017 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2017 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2019-2020 2021-2022 2023 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 12,931 $ 12,931 $ $ $ Lines of credit and other short-term borrowings Current maturities of long-term debt 2 3,300 3,300 Long-term debt, net of current maturities 2 31,082 9,501 5,398 16,183 Estimated interest payments 3 5,064 2,960 Accrued income taxes 4 4,663 2,773 Purchase obligations 5 14,582 8,132 1,464 4,154 Marketing obligations 6 4,629 2,439 1,033 Lease obligations Held-for-sale obligations 7 1,592 1,591 Total contractual obligations $ 78,934 $ 29,778 $ 13,853 $ 8,467 $ 26,836 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be paid by the Company in future periods and excludes the noncash portion of debt, including the fair market value markup, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2017 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes includes $4,623 million related to the one-time transition tax required by the Tax Reform Act. Unrecognized tax benefits, including accrued interest and penalties of $505 million, were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits would be partially offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents liabilities and contractual obligations of the Company's bottling operations that are classified as held for sale. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2017 , was $2,027 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, pension expense, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. As of December 31, 2017 , the projected benefit obligation of the U.S. qualified pension plans was $6,384 million, and the fair value of the related plan assets was $6,028 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,071 million, and the fair value of the related plan assets was $2,815 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $67 million in 2018, increasing to $72 million by 2024 and then decreasing annually thereafter. Refer to Note 13 of Notes to Consolidated Financial Statements. The Company expects to contribute $59 million in 2018 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our various plans in the table above. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2017 , our self-insurance reserves totaled $ 480 million . Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2017 were $2,522 million . Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, as of December 31, 2017, the Company had entered into agreements related to the following future investing activities which are not included in the table above: Under the terms of the agreement for our investment in CHI Limited, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. The Company has also agreed in principle to acquire ABI's interest in bottling operations in Zambia, Zimbabwe, Botswana, Swaziland, Lesotho, El Salvador and Honduras. We plan to hold all of these bottling operations temporarily until they can be refranchised to other partners. The Company will negotiate the terms of these transactions with ABI according to the contractual parameters. The transactions are subject to the relevant regulatory approvals. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2017 , we used 74 functional currencies. Due to the geographic diversity of our operations, weakness in some of these currencies might be offset by strength in others. In 2017 , 2016 and 2015 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies % (5 )% (15 )% Brazilian real % (9 )% (27 )% Mexican peso (2 ) (14 ) (16 ) Australian dollar (1 ) (17 ) South African rand (13 ) (15 ) British pound (6 ) (11 ) (8 ) Euro (17 ) Japanese yen (3 ) (14 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 1 percent and 3 percent in 2017 and 2016 , respectively. The total currency impact on income from continuing operations before income taxes, including the effect of our hedging activities, was nominal in 2017 and was a decrease of 12 percent in 2016 . Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated financial statements. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded foreign currency exchange losses of $57 million in 2017 , foreign currency exchange losses of $246 million in 2016 and foreign currency exchange gains of $149 million in 2015 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. In February 2015, the Venezuelan government introduced a new open market exchange rate system, SIMADI. As a result, we remeasured the net monetary assets of our Venezuelan subsidiary, resulting in a charge of $27 million recorded in the line item other income (loss) net in our consolidated statement of income. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the SIMADI rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. In addition, we sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the years ended December 31, 2016 and December 31, 2015 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expect to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded write-downs of $76 million and $56 million , respectively. These write-downs were recorded in the line item other operating charges in our consolidated statements of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized impairment charges of $34 million and $55 million during the years ended December 31, 2017 and December 31, 2015 , respectively. These charges were recorded in the line item other operating charges in our consolidated statements of income. As a result of these impairment charges, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. Overview of Financial Position The following table illustrates the change in the individual line items of the Company's consolidated balance sheet (in millions): December 31, Increase (Decrease) Percent Change Cash and cash equivalents $ 6,006 $ 8,555 $ (2,549 ) (30 )% Short-term investments 9,352 9,595 (243 ) (3 ) Marketable securities 5,317 4,051 1,266 Trade accounts receivable net 3,667 3,856 (189 ) (5 ) Inventories 2,655 2,675 (20 ) (1 ) Prepaid expenses and other assets 2,000 2,481 (481 ) (19 ) Assets held for sale 2,797 (2,578 ) (92 ) Assets held for sale discontinued operations 7,329 7,329 Equity method investments 20,856 16,260 4,596 Other investments 1,096 Other assets 4,560 4,248 Property, plant and equipment net 8,203 10,635 (2,432 ) (23 ) Trademarks with indefinite lives 6,729 6,097 Bottlers' franchise rights with indefinite lives 3,676 (3,538 ) (96 ) Goodwill 9,401 10,629 (1,228 ) (12 ) Other intangible assets (358 ) (49 ) Total assets $ 87,896 $ 87,270 $ % Accounts payable and accrued expenses $ 8,748 $ 9,490 $ (742 ) (8 )% Loans and notes payable 13,205 12,498 Current maturities of long-term debt 3,298 3,527 (229 ) (6 ) Accrued income taxes Liabilities held for sale (673 ) (95 ) Liabilities held for sale discontinued operations 1,496 1,496 Long-term debt 31,182 29,684 1,498 Other liabilities 8,021 4,081 3,940 Deferred income taxes 2,522 3,753 (1,231 ) (33 ) Total liabilities $ 68,919 $ 64,050 $ 4,869 % Net assets $ 18,977 $ 23,220 $ (4,243 ) 1 (18 )% 1 Includes an increase in net assets of $861 million resulting from foreign currency translation adjustments in various balance sheet line items. The increases (decreases) in the table above include the impact of the following transactions and events: Assets held for sale and liabilities held for sale decreased primarily due to the North America and China bottling refranchising activities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Assets held for sale discontinued operations and liabilities held for sale discontinued operations increased as a result of CCBA meeting the criteria to be classified as held for sale. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Equity method investments increased primarily due to our new investments in AC Bebidas and CCBJI. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements for additional information. Property, plant and equipment, bottlers' franchise rights with indefinite lives and goodwill decreased primarily as a result of additional North America bottling territories being refranchised as well as impairment charges recorded. Refer to Note 2 and Note 16 of Notes to Consolidated Financial Statements for additional information. Other liabilities increased and deferred income taxes decreased primarily due to the Tax Reform Act signed into law on December 22, 2017. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2017 , we used 74 functional currencies and generated $20,683 million of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies might be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $13,057 million and $14,464 million as of December 31, 2017 and 2016 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $22 million as of December 31, 2017 . At the end of 2017 , we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $253 million. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $50 million, and we estimate that a 10 percent weakening of the U.S. dollar would have increased the net unrealized loss to $105 million. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2017 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $252 million in 2017 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $97 million decrease in the fair value of our portfolio of highly liquid securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution business. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases of materials used in our manufacturing processes and the fuel used to operate our extensive vehicle fleet. Open commodity derivatives that qualify for hedge accounting had notional values of $35 million and $12 million as of December 31, 2017 and 2016 , respectively. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of $5 million. The potential change in fair value of these commodity derivative instruments, assuming a 10 percent decrease in underlying commodity prices, would have increased the net unrealized loss to $6 million. Open commodity derivatives that do not qualify for hedge accounting had notional values of $357 million and $447 million as of December 31, 2017 and 2016 , respectively. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized gain of $20 million. The potential change in fair value of these commodity derivative instruments, assuming a 10 percent decrease in underlying commodity prices, would have eliminated the net unrealized gain and created a net unrealized loss of $18 million. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 71 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, (In millions except per share data) NET OPERATING REVENUES $ 35,410 $ 41,863 $ 44,294 Cost of goods sold 13,256 16,465 17,482 GROSS PROFIT 22,154 25,398 26,812 Selling, general and administrative expenses 12,496 15,262 16,427 Other operating charges 2,157 1,510 1,657 OPERATING INCOME 7,501 8,626 8,728 Interest income Interest expense Equity income (loss) net 1,071 Other income (loss) net (1,666 ) (1,234 ) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 6,742 8,136 9,605 Income taxes from continuing operations 5,560 1,586 2,239 NET INCOME FROM CONTINUING OPERATIONS 1,182 6,550 7,366 Income from discontinued operations (net of income taxes of $47, $0 and $0, respectively) CONSOLIDATED NET INCOME 1,283 6,550 7,366 Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 1,248 $ 6,527 $ 7,351 Basic net income per share from continuing operations 1 $ 0.28 $ 1.51 $ 1.69 Basic net income per share from discontinued operations 2 0.02 BASIC NET INCOME PER SHARE $ 0.29 3 $ 1.51 $ 1.69 Diluted net income per share from continuing operations 1 $ 0.27 $ 1.49 $ 1.67 Diluted net income per share from discontinued operations 2 0.02 DILUTED NET INCOME PER SHARE $ 0.29 $ 1.49 $ 1.67 AVERAGE SHARES OUTSTANDING BASIC 4,272 4,317 4,352 Effect of dilutive securities AVERAGE SHARES OUTSTANDING DILUTED 4,324 4,367 4,405 1 Calculated based on net income from continuing operations less net income from continuing operations attributable to noncontrolling interests. 2 Calculated based on net income from discontinued operations less net income from discontinued operations attributable to noncontrolling interests. 3 Per share amounts do not add due to rounding. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, (In millions) CONSOLIDATED NET INCOME $ 1,283 $ 6,550 $ 7,366 Other comprehensive income: Net foreign currency translation adjustment (626 ) (3,959 ) Net gain (loss) on derivatives (433 ) (382 ) Net unrealized gain (loss) on available-for-sale securities (684 ) Net change in pension and other benefit liabilities (53 ) TOTAL COMPREHENSIVE INCOME (LOSS) 2,221 5,506 2,951 Less: Comprehensive income (loss) attributable to noncontrolling interests (3 ) TOTAL COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 2,148 $ 5,496 $ 2,954 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions except par value) ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,006 $ 8,555 Short-term investments 9,352 9,595 TOTAL CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS 15,358 18,150 Marketable securities 5,317 4,051 Trade accounts receivable, less allowances of $477 and $466, respectively 3,667 3,856 Inventories 2,655 2,675 Prepaid expenses and other assets 2,000 2,481 Assets held for sale 2,797 Assets held for sale discontinued operations 7,329 TOTAL CURRENT ASSETS 36,545 34,010 EQUITY METHOD INVESTMENTS 20,856 16,260 OTHER INVESTMENTS 1,096 OTHER ASSETS 4,560 4,248 PROPERTY, PLANT AND EQUIPMENT net 8,203 10,635 TRADEMARKS WITH INDEFINITE LIVES 6,729 6,097 BOTTLERS' FRANCHISE RIGHTS WITH INDEFINITE LIVES 3,676 GOODWILL 9,401 10,629 OTHER INTANGIBLE ASSETS TOTAL ASSETS $ 87,896 $ 87,270 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 8,748 $ 9,490 Loans and notes payable 13,205 12,498 Current maturities of long-term debt 3,298 3,527 Accrued income taxes Liabilities held for sale Liabilities held for sale discontinued operations 1,496 TOTAL CURRENT LIABILITIES 27,194 26,532 LONG-TERM DEBT 31,182 29,684 OTHER LIABILITIES 8,021 4,081 DEFERRED INCOME TAXES 2,522 3,753 THE COCA-COLA COMPANY SHAREOWNERS' EQUITY Common stock, $0.25 par value; Authorized 11,200 shares; Issued 7,040 and 7,040 shares, respectively 1,760 1,760 Capital surplus 15,864 14,993 Reinvested earnings 60,430 65,502 Accumulated other comprehensive income (loss) (10,305 ) (11,205 ) Treasury stock, at cost 2,781 and 2,752 shares, respectively (50,677 ) (47,988 ) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY 17,072 23,062 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS 1,905 TOTAL EQUITY 18,977 23,220 TOTAL LIABILITIES AND EQUITY $ 87,896 $ 87,270 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (In millions) OPERATING ACTIVITIES Consolidated net income $ 1,283 $ 6,550 $ 7,366 (Income) loss from discontinued operations (101 ) Net income from continuing operations 1,182 6,550 7,366 Depreciation and amortization 1,260 1,787 1,970 Stock-based compensation expense Deferred income taxes (1,256 ) (856 ) Equity (income) loss net of dividends (628 ) (449 ) (122 ) Foreign currency adjustments (137 ) Significant (gains) losses on sales of assets net 1,459 1,146 (374 ) Other operating charges 1,218 Other items (269 ) (224 ) Net change in operating assets and liabilities 3,529 (221 ) (157 ) Net cash provided by operating activities 6,995 8,796 10,528 INVESTING ACTIVITIES Purchases of investments (16,520 ) (15,499 ) (15,831 ) Proceeds from disposals of investments 15,911 16,624 14,079 Acquisitions of businesses, equity method investments and nonmarketable securities (3,900 ) (838 ) (2,491 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 3,821 1,035 Purchases of property, plant and equipment (1,675 ) (2,262 ) (2,553 ) Proceeds from disposals of property, plant and equipment Other investing activities (126 ) (209 ) (40 ) Net cash provided by (used in) investing activities (2,385 ) (999 ) (6,186 ) FINANCING ACTIVITIES Issuances of debt 29,857 27,281 40,434 Payments of debt (28,768 ) (25,615 ) (37,738 ) Issuances of stock 1,595 1,434 1,245 Purchases of stock for treasury (3,682 ) (3,681 ) (3,564 ) Dividends (6,320 ) (6,043 ) (5,741 ) Other financing activities (91 ) Net cash provided by (used in) financing activities (7,409 ) (6,545 ) (5,113 ) CASH FLOWS FROM DISCONTINUED OPERATIONS Net cash provided by (used in) operating activities from discontinued operations Net cash provided by (used in) investing activities from discontinued operations (65 ) Net cash provided by (used in) financing activities from discontinued operations (38 ) Net cash provided by (used in) discontinued operations EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (6 ) (878 ) CASH AND CASH EQUIVALENTS Net increase (decrease) during the year (2,549 ) 1,246 (1,649 ) Balance at beginning of year 8,555 7,309 8,958 Balance at end of year $ 6,006 $ 8,555 $ 7,309 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY Year Ended December 31, (In millions except per share data) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year 4,288 4,324 4,366 Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (82 ) (86 ) (86 ) Balance at end of year 4,259 4,288 4,324 COMMON STOCK $ 1,760 $ 1,760 $ 1,760 CAPITAL SURPLUS Balance at beginning of year 14,993 14,016 13,154 Stock issued to employees related to stock compensation plans Tax benefit (charge) from stock compensation plans Stock-based compensation expense Other activities (3 ) Balance at end of year 15,864 14,993 14,016 REINVESTED EARNINGS Balance at beginning of year 65,502 65,018 63,408 Net income attributable to shareowners of The Coca-Cola Company 1,248 6,527 7,351 Dividends (per share $1.48, $1.40 and $1.32 in 2017, 2016 and 2015, respectively) (6,320 ) (6,043 ) (5,741 ) Balance at end of year 60,430 65,502 65,018 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year (11,205 ) (10,174 ) (5,777 ) Net other comprehensive income (loss) (1,031 ) (4,397 ) Balance at end of year (10,305 ) (11,205 ) (10,174 ) TREASURY STOCK Balance at beginning of year (47,988 ) (45,066 ) (42,225 ) Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (3,598 ) (3,733 ) (3,537 ) Balance at end of year (50,677 ) (47,988 ) (45,066 ) TOTAL EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 17,072 $ 23,062 $ 25,554 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS Balance at beginning of year $ $ $ Net income attributable to noncontrolling interests Net foreign currency translation adjustment (13 ) (18 ) Dividends paid to noncontrolling interests (15 ) (25 ) (31 ) Contributions by noncontrolling interests Business combinations 1,805 (3 ) Deconsolidation of certain entities (157 ) (34 ) Other activities (4 ) TOTAL EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS $ 1,905 $ $ Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations, as well as independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our finished product operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations which are included in our Bottling Investments operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, including water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers, such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Certain amounts in the prior years' consolidated financial statements and accompanying notes have been revised to conform to the current year presentation. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance, and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 4,523 million and $ 3,709 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 1 million and $ 203 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Assets and Liabilities Held for Sale Our Company classifies long-lived assets or disposal groups to be sold as held for sale in the period in which all of the following criteria are met: management, having the authority to approve the action, commits to a plan to sell the asset or disposal group; the asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets or disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell the asset or disposal group have been initiated; the sale of the asset or disposal group is probable, and transfer of the asset or disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond our control extend the period of time required to sell the asset or disposal group beyond one year; the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We initially measure a long-lived asset or disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held-for-sale criteria are met. Conversely, gains are not recognized on the sale of a long-lived asset or disposal group until the date of sale. We assess the fair value of a long-lived asset or disposal group less any costs to sell each reporting period it remains classified as held for sale and report any subsequent changes as an adjustment to the carrying value of the asset or disposal group, as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. Upon determining that a long-lived asset or disposal group meets the criteria to be classified as held for sale, the Company ceases depreciation and reports long-lived assets and/or the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale, respectively, in our consolidated balance sheet. Refer to Note 2. Discontinued Operations When the following criteria are met: the disposal group is a component of an entity, the component of the entity meets the held for sale criteria in accordance with our policy described above and the component of the entity represents a strategic shift in the entity's operating and financial results, the disposal group is classified as a discontinued operation. Alternatively, if a business meets the criteria for held for sale on the acquisition date, the business is accounted for as a discontinued operation. In October 2017, the Company and Anheuser-Busch InBev (""ABI"") completed the transition of ABI's controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company for $3,150 million , resulting in its consolidation. As CCBA met the criteria for held for sale upon consolidation, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. Revenue Recognition Our Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price charged is fixed or determinable, and collectibility is reasonably assured. For our Company, this generally means that we recognize revenue when title to our products is transferred to our bottling partners, resellers or other customers. In particular, title usually transfers upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of the transactions. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part. Deductions from Revenue Our customers can earn certain incentives including, but not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. The costs associated with these incentives are included in deductions from revenue, a component of net operating revenues in our consolidated statements of income. For customer incentives that must be earned, management must make estimates related to the contractual terms, customer performance and sales volume to determine the total amounts earned and to be recorded in deductions from revenue. In making these estimates, management considers past results. The actual amounts ultimately paid may be different from our estimates. In some situations, the Company may determine it to be advantageous to make advance payments to specific customers to fund certain marketing activities intended to generate profitable volume and/or invest in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. The Company also makes advance payments to certain customers for distribution rights. The advance payments made to customers are initially capitalized and included in our consolidated balance sheets in prepaid expenses and other assets and noncurrent other assets, depending on the duration of the agreements. The assets are amortized over the applicable periods and included in deductions from revenue. The duration of these agreements typically ranges up to 10 years. Amortization expense for infrastructure programs was $ 36 million , $ 45 million and $ 61 million in 2017 , 2016 and 2015 , respectively. The aggregate deductions from revenue recorded by the Company in relation to these programs, including amortization expense on infrastructure programs, were $ 6.2 billion , $ 6.6 billion and $ 6.8 billion in 2017 , 2016 and 2015 , respectively. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $4 billion in 2017 , 2016 and 2015 . As of December 31, 2017 and 2016 , advertising and production costs of $ 95 million and $ 113 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of finished goods from manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statements of income. Shipping and handling costs incurred to move finished goods from our sales distribution centers to customer locations are included in the line item selling, general and administrative expenses in our consolidated statements of income. During the years ended December 31, 2017 , 2016 and 2015 , the Company recorded shipping and handling costs of $ 1.1 billion , $2.0 billion and $2.5 billion , respectively, in the line item selling, general and administrative expenses. Our customers do not pay us separately for shipping and handling costs related to finished goods. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 47 million , 51 million and 27 million stock option awards were excluded from the computations of diluted net income per share in 2017 , 2016 and 2015 , respectively, because the awards would have been antidilutive for the years presented. The following table presents information related to net income from continuing operations and net income from discontinued operations attributable to shareowners of The Coca-Cola Company (in millions): Year Ended December 31, CONTINUING OPERATIONS Net income from continuing operations $ 1,182 $ 6,550 $ 7,366 Less: Net income from continuing operations attributable to noncontrolling interests Net income from continuing operations attributable to shareowners of The Coca-Cola Company $ 1,181 $ 6,527 $ 7,351 DISCONTINUED OPERATIONS Net income from discontinued operations $ $ $ Less: Net income from discontinued operations attributable to noncontrolling interests Net income from discontinued operations attributable to shareowners of The Coca-Cola Company $ $ $ CONSOLIDATED Consolidated net income $ 1,283 $ 6,550 $ 7,366 Less: Net income attributable to noncontrolling interests Net income attributable to shareowners of The Coca-Cola Company $ 1,248 $ 6,527 $ 7,351 Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our credit risk concentrations. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We use the equity method to account for our investments in equity securities if our investment gives us the ability to exercise significant influence over operating and financial policies of the investee. We include our proportionate share of earnings and/or losses of our equity method investees in equity income (loss) net in our consolidated statements of income. The carrying value of our equity investments is reported in equity method investments in our consolidated balance sheets. Refer to Note 6 . We account for investments in companies that we do not control or account for under the equity method either at fair value or under the cost method, as applicable. Investments in equity securities, other than investments accounted for under the equity method, are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as either trading or available-for-sale securities with their cost basis determined by the specific identification method. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in other income (loss) net in our consolidated statements of income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in other income (loss) net in our consolidated statements of income. Trading securities are reported as either marketable securities or other assets in our consolidated balance sheets. Securities classified as available-for-sale are reported as either cash and cash equivalents, marketable securities, other investments or other assets in our consolidated balance sheets, depending on the length of time we intend to hold the investment. Refer to Note 3 . Investments in equity securities that we do not control or account for under the equity method and do not have readily determinable fair values for are accounted for under the cost method. Cost method investments are originally recorded at cost, and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets, and dividend income from cost method investments is reported in the line item other income (loss) net in our consolidated statements of income. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Each reporting period we review all of our investments in equity and debt securities, except for those classified as trading, to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis exceeded the fair value. The fair values of most of our investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds, and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Activity in the allowance for doubtful accounts was as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Net charges to costs and expenses 1 Write-offs (10 ) (10 ) (10 ) Other 2 (11 ) (2 ) (14 ) Balance at end of year $ $ $ 1 The increases in 2016 were primarily related to concentrate sales receivables from our bottling partner in Venezuela. See Hyperinflationary Economies discussion below for additional information. 2 Other includes foreign currency translation adjustments and the impact of reclassifying certain assets to assets held for sale. Refer to Note 2. A significant portion of our net operating revenues and corresponding accounts receivable is derived from sales of our products in international markets. Refer to Note 19 . We also generate a significant portion of our net operating revenues by selling concentrates and syrups to bottlers in which we have a noncontrolling interest. Refer to Note 6 . Inventories Inventories consist primarily of raw materials and packaging (which includes ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Refer to Note 4 . Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheets in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statements of cash flows in net cash provided by operating activities. Refer to Note 5 . Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery, equipment and vehicle fleet: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under capital lease, totaled $ 1,131 million , $ 1,575 million and $ 1,735 million in 2017 , 2016 and 2015 , respectively. Amortization expense for leasehold improvements totaled $ 19 million , $ 22 million and $ 18 million in 2017 , 2016 and 2015 , respectively. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. Refer to Note 7 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 8 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment reviews as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statements of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11 . Stock-Based Compensation Our Company sponsors equity plans that provide for the grant of awards including stock options, restricted stock units, restricted stock and performance share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the grant is earned by the employee, generally four years . The fair value of our restricted stock units, restricted stock and certain performance share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance share units granted beginning in 2014, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance criteria specified in the performance share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance criteria specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12 . Pension and Other Postretirement Benefit Plans Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Refer to Note 13 . Income Taxes Income tax expense includes U.S., state, local and international income taxes, plus a provision for U.S. taxes on undistributed earnings of foreign subsidiaries and other prescribed foreign entities not deemed to be indefinitely reinvested. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company records taxes that are collected from customers and remitted to governmental authorities on a net basis in our consolidated statements of income. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 15 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statements of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. In February 2015, the Venezuelan government introduced a new open market exchange rate system, SIMADI. As a result, we remeasured the net monetary assets of our Venezuelan subsidiary, resulting in a charge of $27 million recorded in the line item other income (loss) net in our consolidated statement of income. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the SIMADI rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. In addition, we sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the years ended December 31, 2016 and December 31, 2015 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expect to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded write-downs of $76 million and $56 million , respectively. These write-downs were recorded in the line item other operating charges in our consolidated statements of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized impairment charges of $34 million and $55 million during the years ended December 31, 2017 and December 31, 2015 , respectively. These charges were recorded in the line item other operating charges in our consolidated statements of income. As a result of these impairment charges, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Refer to Note 19 for the impact these items had on our operating segments. Recently Issued Accounting Guidance In May 2014, the Financial Accounting Standards Board (""FASB"") issued Accounting Standards Update (""ASU"") 2014-09, Revenue from Contracts with Customers , which will replace most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. The core principle of ASU 2014-09 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU 2014-09 also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU 2014-09 allows for adoption either on a full retrospective basis to each prior reporting period presented or on a modified retrospective basis with the cumulative effect of initially applying the new guidance recognized at the date of initial application, which will be effective for the Company beginning January 1, 2018. The Company will adopt ASU 2014-09 and its amendments on a modified retrospective basis. We have closely assessed the new guidance, including the interpretations by the FASB Transition Resource Group for Revenue Recognition, throughout 2017. We have concluded that ASU 2014-09's broad definition of variable consideration will require the Company to estimate and record certain variable payments resulting from collaborative funding arrangements, rebates and other pricing allowances earlier than it currently does. While we do not expect this change to have a material impact on our net operating revenues on an annual basis, as revenue recognized from the sale of concentrate and finished goods occurs at a point in time when goods are transferred to the customer and the transfer of control is determined, we do expect that it will have an impact on our revenue in interim periods. The cumulative-effect adjustment upon adoption of the new revenue recognition standard as of January 1, 2018 is comprised primarily of the Company's estimated variable consideration and is expected to decrease the opening balance of retained earnings by less than $350 million , net of tax. As a result of electing certain of the practical expedients available under the ASU, the Company expects there will be some reclassifications to or from net operating revenues, cost of goods sold, and selling, general and administrative expenses, primarily related to the classification of shipping and handling costs. Additionally, the provisions of the new guidance provided clarification relating to the classification of certain costs incurred relating to revenue arrangements with customers. As a result, we will be classifying certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also evaluated the principal versus agent considerations as it relates to certain of its arrangements with third-party manufacturers and co-packers. We concluded that certain costs from these arrangements will be reflected in net operating revenues rather than in cost of goods sold. These changes will have no impact on the Company's consolidated operating income. The Company has also identified and implemented changes to our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data into the reporting process. While we are substantially complete with the process of quantifying the impacts that will result from applying the new guidance, our assessment will be finalized during the first quarter of 2018. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes . The amendments in this update are intended to simplify the presentation of deferred income taxes and require that deferred tax liabilities and assets be classified as noncurrent in a consolidated statement of financial position. The standard was prospectively adopted by the Company on January 1, 2017. Had the Company retrospectively adopted the standard as of December 31, 2016, the line items prepaid expenses and other assets and accounts payable and accrued expenses in our consolidated balance sheet would have been reduced by $80 million and $692 million , respectively, as a result of reclassifying the current deferred tax assets and liabilities. The offsetting impact for the reclassifications as of December 31, 2016 would have increased the noncurrent line items other assets and deferred income taxes in our consolidated balance sheet by $54 million and $666 million , respectively. In January 2016, the FASB issued ASU 2016-01, Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities , which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. The amendment will be effective for the Company beginning January 1, 2018 and will require us to recognize any changes in the fair value of certain equity investments in net income. These changes are currently recognized in other comprehensive income (""OCI""). We have evaluated the impact of this standard and will recognize a cumulative effect adjustment to the opening balance of retained earnings as of January 1, 2018. We expect this cumulative effect adjustment to increase retained earnings by approximately $425 million . In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize right-of-use assets, representing their right to use the underlying asset for the lease term, and lease liabilities on the balance sheet for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The Company has initiated its plan for the adoption and implementation of this new accounting standard, including assessing our lease arrangements, evaluating practical expedient and accounting policy elections, and implementing software to meet the reporting requirements of this standard. The Company is also in the process of identifying changes to our business processes and controls to support adoption of the new standard. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019. The Company anticipates the adoption of this new standard to result in a significant increase in lease-related assets and liabilities on our consolidated balance sheets. The impact on the Company's consolidated statements of income is being evaluated. As the impact of this standard is non-cash in nature, we do not anticipate its adoption having an impact on the Company's consolidated statement of cash flows. In March 2016, the FASB issued ASU 2016-09, Compensation Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The Company adopted ASU 2016-09 on January 1, 2017 by prospectively recognizing excess tax benefits and tax deficiencies in our consolidated statement of income as the awards vested or were settled. Effective January 1, 2017, the Company also prospectively presented excess tax benefits as an operating activity, rather than a financing activity, in our consolidated statement of cash flows. Had these changes been required to be adopted retrospectively, during the years ended December 31, 2016 and December 31, 2015 , the Company would have recognized an additional $130 million and $95 million , respectively, of excess tax benefits in our consolidated statements of income. Additionally, during the years ended December 31, 2016 and December 31, 2015 , the Company would have reduced our financing activities and increased our operating activities by $130 million and $95 million , respectively, in our consolidated statements of cash flows. The Company has elected, consistent with past practice, to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. In June 2016, the FASB issued ASU 2016-13, Financial Instruments Measurement of Credit Losses on Financial Instruments , which requires measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for the Company beginning January 1, 2020 and we are currently evaluating the impact that it will have on our consolidated financial statements. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments , which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for the Company beginning January 1, 2018 and will be applied using the retrospective transition approach to all periods presented. We expect that the only impact of the adoption of ASU 2016-15 on our consolidated statement of cash flows will be the change in presentation related to our proceeds from the settlement of corporate-owned life insurance policies. We currently reflect these proceeds in operating activities, however upon adoption of the new standard, we will reflect these proceeds in investing activities. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory , which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for the Company beginning January 1, 2018 and will be applied using a modified retrospective basis. We currently expect the cumulative-effect adjustment will result in a net deferred tax asset of approximately $2.8 billion . This amount will primarily be recorded as a deferred tax asset in the line item other assets in our consolidated balance sheet. In November 2016, the FASB issued ASU 2016-18, Restricted Cash . The amendments in this update address diversity in practice that exists in the classification and presentation of changes in restricted cash and require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts that an entity defines as restricted cash for purposes of this standard or otherwise does not present in the line item cash and cash equivalents on its balance sheet. ASU 2016-18 is effective for the Company beginning January 1, 2018 and is required to be applied using a retrospective transition method to all periods presented. We expect that adoption of ASU 2016-18 will change how we report changes in cash within our insurance captives and assets held for sale in our consolidated statement of cash flows. In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business , which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is required to be applied prospectively and will be effective for the Company beginning January 1, 2018. The impact on our consolidated financial statements will depend on the facts and circumstances of any specific future transactions. In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost , which requires that the service cost component of the Company's net periodic pension cost and net periodic postretirement benefit cost be included in the same line item as other compensation costs arising from services rendered by employees, with the non-service cost components of net periodic benefit cost being classified outside of a subtotal of income from operations. Of the components of net periodic benefit cost, only the service cost component will be eligible for asset capitalization. ASU 2017-07 is effective for the Company beginning January 1, 2018 and is required to be applied retrospectively for all periods presented. We will elect to use the practical expedient which allows entities to use information previously disclosed in their pension and other postretirement benefit plans note as the estimation basis to apply the retrospective presentation requirements in this ASU. For the years ended December 31, 2017 and 2016 , we expect to reclassify $99 million and $31 million , respectively, related to our non-service cost components of net periodic benefit cost and other benefit plan charges from operating income to other income (loss) net in our consolidated statements of income. In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same income statement line item where the hedged item resides. The amendments include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. Finally, the standard introduces new alternatives that permit companies to reduce the risk of material error if the shortcut method is misapplied. ASU 2017-12 is effective for the Company beginning January 1, 2019 and is required to be applied prospectively. The Company is currently evaluating the impact that ASU 2017-12 will have on our consolidated financial statements. NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2017 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $3,900 million , of which $3,150 million related to the transition of ABI's 54.5 percent controlling interest in CCBA to the Company, resulting in its consolidation in October 2017. The financial position and results of operations of CCBA are being accounted for as a discontinued operation. Refer to the ""Discontinued Operations"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for non-cash consideration. Refer to the ""North America Refranchising"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. During 2016 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $838 million , which primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd. (""China Green""), a maker of plant-based protein beverages in China, and a minority investment in CHI Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages, which is accounted for under the equity method of accounting. Under the terms of the agreement for our investment in CHI, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. During 2015 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 2,491 million , which primarily related to our strategic partnership with Monster Beverage Corporation (""Monster"") and an investment in a bottling partner in Indonesia that is accounted for under the equity method of accounting. The bottling partner in Indonesia is a subsidiary of Coca-Cola Amatil Limited, an equity method investee. We also acquired the remaining outstanding shares of a bottling partner in South Africa (""South African bottler""), which was previously accounted for as an equity method investment. We remeasured our previously held equity interest in the South African bottler to fair value upon the close of the transaction and recorded a loss on the remeasurement of $19 million during the year ended December 31, 2015. This bottler was deconsolidated in conjunction with the Coca-Cola Beverages Africa Proprietary Limited transaction discussed further below. Monster Beverage Corporation In June 2015, the Company and Monster entered into a long-term strategic relationship in the global energy drink category (""Monster Transaction""). As a result of the Monster Transaction, (1) the Company purchased newly issued shares of Monster common stock representing approximately 17 percent of the outstanding shares of Monster common stock (after giving effect to the new issuance); (2) the Company sold its global energy drink business (including NOS, Full Throttle, Burn, Mother, Play and Power Play, and Relentless) to Monster, and the Company acquired Monster's non-energy drink business (including Hansen's Natural Sodas, Peace Tea, Hubert's Lemonade and Hansen's Juice Products); and (3) the parties amended their distribution coordination agreements to expand distribution of Monster products into additional territories pursuant to long-term agreements with the Company's existing network of Company-owned or -controlled bottling operations and independent distribution partners. The Company and its bottling partners (""Coca-Cola system"") also became Monster's preferred global distribution partner. The Company made a net cash payment of $2,150 million to Monster, of which $125 million was originally held in escrow, subject to release upon achievement of milestones relating to the transfer of Monster's domestic distribution rights to our distribution network. The $125 million originally held in escrow was transferred to Monster in 2017 upon achievement of the related milestones. The Monster Transaction consisted of multiple elements including the purchase of common stock, the acquisition and divestiture of businesses and the expansion of distribution territories. When consideration transferred is not solely in the form of cash, measurement is based on either the cost to the acquiring entity (the fair value of the assets given) or the fair value of the assets acquired, whichever is more clearly evident and, thus, more reliably measurable. As the majority of the consideration transferred was cash, we believe the fair value of the consideration transferred is more reliably measurable. The consideration transferred consists of $2,150 million of cash (including $125 million initially held in escrow) and the fair value of our global energy business of $2,046 million , which we determined using discounted cash flow analyses, resulting in total consideration transferred of $4,196 million . As such, we have allocated the total consideration transferred to the individual assets and business acquired based on a relative fair value basis, using the closing date fair values of each element, as follows (in millions): June 12, 2015 Equity investment in Monster $ 3,066 Expansion of distribution territories 1,035 Monster non-energy drink business Total assets and business acquired $ 4,196 In addition to our ownership interest in Monster's outstanding common stock, the Company is represented by two directors on Monster's 10 member Board of Directors. Based on our equity ownership percentage, the significance that our expanded distribution and coordination agreements have on Monster's operations, and our representation on Monster's Board of Directors, the Company is accounting for its interest in Monster as an equity method investment. As a result of the Monster Transaction, the North America Coca-Cola system obtained the right to distribute Monster products in territories for which it was not previously the authorized distributor (""expanded territories""). These distribution rights are governed by an agreement with an initial term of 20 years , after which it will continue to remain in effect unless otherwise terminated by either party, and there are no future costs of renewal. As such, these rights were determined to be indefinite-lived intangible assets and were classified in the line item bottlers' franchise rights with indefinite lives on our consolidated balance sheet. At the time of the Monster Transaction, CCR was the distributor in the majority of the expanded territories. The remainder of the territories were serviced by independent bottling partners. Of the $1,035 million allocated to the expanded distribution rights, the Company derecognized $341 million related to the expanded territories serviced by the independent bottling partners upon the close of the transaction. As consideration for these rights, the Company received an upfront payment of $28 million related to these territories, and we will receive a payment per case on all future sales made by these independent bottlers for the duration of the distribution agreements. As these payments are dependent on future sales, they are a form of contingent consideration. We elected to account for this consideration in the same manner as the contingent consideration to be received in the North America refranchising, discussed below. This resulted in a net loss of $313 million recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2015. During the year ended December 31, 2015, the Company recognized a gain of $1,715 million on the sale of our global energy drink business, primarily due to the difference in the recorded carrying value of the assets transferred, including an allocated portion of goodwill, compared to the value of the total assets and business acquired. After considering the loss resulting from the derecognition of the expanded territory rights serviced by the independent bottling partners, the net gain recognized on the Monster Transaction was $1,403 million , which was recorded in the line item other income (loss) net in our consolidated statement of income. Additionally, under the terms of the Monster Transaction, we were required to discontinue selling energy products under certain trademarks, including one trademark in the glacau portfolio. The Company recognized an impairment charge of $380 million upon closing, primarily related to the discontinuation of the energy products in the glacau portfolio, which was recorded in the line item other operating charges in our consolidated statement of income. During the year ended December 31, 2015, based on the relative fair values of the total assets and business acquired, $1,620 million of the $2,150 million cash payment made was classified in the line item acquisitions of businesses, equity method investments and nonmarketable securities in our consolidated statement of cash flows. The remaining $530 million was classified in the line item other investing activities in our consolidated statement of cash flows. Divestitures During 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. During 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,035 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America. During 2015 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $565 million , which included proceeds from the refranchising of certain of our bottling territories in North America and proceeds from the sale of a 10 percent interest in a Brazilian bottling partner as a result of the majority owners exercising their right to acquire additional shares from us. North America Refranchising In conjunction with implementing a new beverage partnership model in North America, the Company refranchised bottling territories that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas, the bottlers will make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories, excluding the territory included in the Southwest Transaction, to the respective bottlers in exchange for cash. In 2016, the Company formed a new National Product Supply System (""NPSS"") to facilitate optimal operation of the U.S. product supply system. Under the NPSS, the Company and several of its existing independent producing bottlers administer key national product supply activities for these bottlers. Additionally, we have sold certain production facilities from CCR to these independent producing bottlers in exchange for cash, excluding production facilities included in the Southwest Transaction. During the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , cash proceeds from these sales totaled $2,860 million , $1,017 million and $362 million , respectively. Included in the cash proceeds for the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 was $336 million , $279 million and $83 million , respectively, from Coca-Cola Bottling Co. Consolidated (""CCBCC""), an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017, was $220 million from AC Bebidas, and $39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized losses of $3,177 million , $2,456 million and $1,006 million during the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , respectively. Included in these amounts are losses from transactions with equity method investees or former management of $1,104 million , $492 million and $379 million , during the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , respectively. These losses primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The losses in 2017 included $236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain of its refranchised territories participate. As of December 31, 2017, CCR had completed the refranchising of its U.S. bottling operations, with the exception of its operations in the U.S. Virgin Islands, which are classified as held for sale. See further discussion of assets and liabilities held for sale below. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the income statement only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the income statement as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2017 and December 31, 2016 , the Company incurred losses of $313 million and $31 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, and consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The losses related to these payments were included in the line item other income (loss) net in our consolidated statements of income during the years ended December 31, 2017 and December 31, 2016 . On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. Additionally, CCR made cash payments of $144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. AC Bebidas will participate in the NPSS as it relates to its U.S. territory. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refer to Note 19 for the impact these items had on our operating segments. Refranchising of China Bottling Operations In November 2016, the Company entered into definitive agreements for the sale of the Company-owned bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and to sell a related cost method investment to one of the franchise bottlers. As a result, the Company's bottling operations in China and a related cost method investment were classified as held for sale as of December 31, 2016. We received net proceeds of $963 million as a result of these sales and recognized a gain of $88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. Coca-Cola European Partners In May 2016, the Company merged our German bottling operations with Coca-Cola Enterprises, Inc. (""CCE"") and Coca-Cola Iberian Partners, S.A.U., formerly known as Coca-Cola Iberian Partners, S.A. (""CCIP""), to create Coca-Cola European Partners plc (""CCEP""). In exchange for our German bottling operations, we received an 18 percent interest in CCEP. As a result of recording our interest in CCEP at fair value based on its quoted market price (a Level 1 measurement), the deconsolidation of our German bottling operations, and the related reversal of its cumulative translation adjustments, we recognized a gain of $1,400 million . This gain was partially offset by a $77 million loss incurred as a result of reclassifying losses related to our net investment hedges of our German bottling operations from AOCI into earnings as well as transaction costs incurred resulting in a net gain of $1,287 million during the year ended December 31, 2016 . Refer to Note 15. With the exception of the transaction costs, the net gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in CCEP as an equity method investment based on our equity ownership percentage, our representation on CCEP's Board of Directors, material intercompany transactions and other governance rights. Coca-Cola Beverages Africa Proprietary Limited In July 2016, the Company, SABMiller plc and Gutsche Family Investments combined the bottling operations of each of the parties' nonalcoholic ready-to-drink beverage businesses in Southern and East Africa to form a new bottler, which is called CCBA. The Company: (1) contributed its South African bottling operations to CCBA, which included certain wholly owned subsidiaries and an equity method investment, (2) paid $150 million in cash, (3) obtained a 12 percent interest in CCBA and a 3 percent interest in CCBA's South African subsidiary and (4) acquired several trademarks that are generally indefinite-lived. As a result of recording our interests in CCBA and its South African subsidiary at fair value, the deconsolidation of our South African bottling operations, the derecognition of the equity method investment, and the reversal of related cumulative translation adjustments, we recognized a loss of $21 million . The fair values of the equity investments in CCBA and CCBA's South African subsidiary, along with the acquired trademarks, were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. The loss recognized resulted primarily from the reversal of the related cumulative translation adjustments. This loss is recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016 . Based on the level of equity ownership, the Company's representation on CCBA's Board of Directors (two of its ten members) and other governance rights, the Company accounted for its interests in CCBA and CCBA's South African subsidiary as equity method investments. The Company's interest in CCBA provided it with a call option to acquire the ownership interest of SABMiller plc at fair value upon the occurrence of certain events, including upon a change in control of SABMiller plc. In October 2016, ABI acquired SABMiller plc, including its 54.5 percent controlling interest in CCBA. In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily and are currently in discussions with several potential buyers. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of acquisition. See further discussion of discontinued operations below. Keurig Green Mountain, Inc. In 2014, the Company purchased a 12 percent equity position in Keurig Green Mountain, Inc. (""Keurig"") for $1,567 million . In February 2015, the Company purchased an additional 4 percent ownership interest from Credit Suisse Capital LLC under an agreement for a total purchase price of $830 million . As this agreement qualified as a derivative, we recognized a loss of $58 million in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2015. The purchases of the shares were included in the line item purchases of investments in our consolidated statement of cash flows, net of any related derivative impact. The Company accounted for the investment in Keurig as an available-for-sale security. In March 2016, a JAB Holding Company-led investor group acquired Keurig. The Company received proceeds of $2,380 million , which were recorded in the line item proceeds from disposals of investments in our consolidated statement of cash flows, and recorded a gain of $18 million related to the disposal of our shares of Keurig in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016 . Brazilian Bottling Operations In January 2015, the owners of the majority interest in a Brazilian bottling operation exercised their option to acquire from us shares representing a 10 percent interest in the entity's outstanding shares. We recorded a loss of $6 million as a result of the exercise price being lower than our carrying value of these shares. As a result of this transaction, the Company's ownership was reduced to 34 percent of the entity's outstanding shares. The owners of the majority interest have a remaining option to acquire an additional 14 percent interest of the entity's outstanding shares at any time through December 31, 2019, based on an agreed-upon formula. Assets and Liabilities Held for Sale As of December 31, 2017 , the Company had entered into agreements to refranchise its U.S. Virgin Islands bottling territories. As these bottling territories met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price and present the related assets and liabilities as separate line items in our consolidated balance sheet. These bottling territories were refranchised in January 2018. In addition, the Company had certain bottling operations in Latin America that met the criteria to be classified as held for sale, which requires us to present the related assets and liabilities as separate line items in our consolidated balance sheet. We were not required to record these assets and liabilities at fair value less any costs to sell because their fair value approximates their carrying value. The Company expects these operations to be refranchised during 2018. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale in our consolidated balance sheets (in millions): December 31, 2017 December 31, 2016 Cash, cash equivalents and short-term investments $ $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Equity method investments Other investments Other assets Property, plant and equipment net 1,780 Bottlers' franchise rights with indefinite lives 1,388 Goodwill Other intangible assets Allowance for reduction of assets held for sale (28 ) (1,342 ) Assets held for sale $ 1 $ 2,797 3 Accounts payable and accrued expenses $ $ Accrued income taxes Other liabilities Deferred income taxes Liabilities held for sale $ 2 $ 4 1 Consists of total assets relating to North America refranchising of $9 million and Latin America bottling operations of $210 million , which are included in the Bottling Investments operating segment. 2 Consists of total liabilities relating to North America refranchising of $5 million and Latin America bottling operations of $32 million , which are included in the Bottling Investments operating segment. 3 Consists of total assets relating to North America refranchising of $1,247 million , China bottling operations of $1,533 million and other assets held for sale of $17 million , which are included in the Bottling Investments and Corporate operating segments. 4 Consists of total liabilities relating to North America refranchising of $224 million , China bottling operations of $483 million and other liabilities held for sale of $3 million , which are included in the Bottling Investments and Corporate operating segments. We determined that the operations included in the table above did not meet the criteria to be classified as discontinued operations under the applicable guidance. Discontinued Operations In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily and are currently in discussions with several potential buyers, and anticipate divesting of this interest in 2018. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of consolidation. Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. We recorded the noncontrolling interests of CCBA at an estimated fair value of $1,805 million . The fair value of the noncontrolling interests was assessed in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. The initial accounting for the business combination is currently incomplete, although preliminary purchase accounting entries have been recorded. The disclosures that are expected to be impacted by the completion of purchase accounting are the classification of assets held for sale discontinued operations and liabilities held for sale discontinued operations in the notes to the consolidated financial statements. The following table presents information related to the major classes of assets and liabilities of CCBA that were classified as held for sale discontinued operations in our consolidated balance sheet (in millions): December 31, 2017 Cash, cash equivalents and short-term investments $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Equity method investments Other assets Property, plant and equipment net 1,436 Goodwill 4,248 Other intangible assets Assets held for sale discontinued operations $ 7,329 Accounts payable and accrued expenses $ Loans and notes payable Current maturities of long-term debt Accrued income taxes Long-term debt Other liabilities Deferred income taxes Liabilities held for sale discontinued operations $ 1,496 NOTE 3 : INVESTMENTS Investments in debt and marketable securities, other than investments accounted for under the equity method, are classified as trading, available-for-sale or held-to-maturity. Our marketable equity investments are classified as either trading or available-for-sale with their cost basis determined by the specific identification method. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in net income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged. Refer to Note 5 for additional information related to the Company's fair value hedges of available-for-sale securities. Trading Securities As of December 31, 2017 and 2016 , our trading securities had a fair value of $ 407 million and $ 384 million , respectively, and consisted primarily of equity securities. The Company had net unrealized gains on trading securities of $ 67 million , $ 39 million and $ 19 million as of December 31, 2017 , 2016 and 2015 , respectively. The Company's trading securities were included in the following line items in our consolidated balance sheets (in millions): December 31, Marketable securities $ $ Other assets Total $ $ 94 Available-for-Sale and Held-to-Maturity Securities As of December 31, 2017 and 2016 , the Company did not have any held-to-maturity securities. Available-for-sale securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses Available-for-sale securities: 1 Equity securities $ 1,276 $ $ (66 ) $ 1,895 Debt securities 5,782 (27 ) 5,912 Total $ 7,058 $ $ (93 ) $ 7,807 Available-for-sale securities: 1 Equity securities $ 1,252 $ $ (22 ) $ 1,655 Debt securities 4,700 (31 ) 4,758 Total $ 5,952 $ $ (53 ) $ 6,413 1 Refer to Note 16 for additional information related to the estimated fair value. The sale and/or maturity of available-for-sale securities resulted in the following realized activity (in millions): Year Ended December 31, Gross gains $ $ $ Gross losses (32 ) (51 ) (42 ) Proceeds 14,205 11,540 4,043 As of December 31, 2017 and 2016 , the Company had investments classified as available-for-sale securities in which our cost basis exceeded the fair value of our investment. Management assessed each of these investments on an individual basis to determine if the decline in fair value was other than temporary. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As a result of these assessments, management determined that the decline in fair value of these investments was not other than temporary and did not record any impairment charges. The Company uses two of its consolidated insurance captives to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. In accordance with local insurance regulations, our insurance captives are required to meet and maintain minimum solvency capital requirements. The Company elected to invest its solvency capital in a portfolio of available-for-sale securities, which have been classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. As of December 31, 2017 and 2016 , the Company's available-for-sale securities included solvency capital funds of $ 1,159 million and $ 985 million , respectively. As of December 31, 2017 and 2016 , the Company did not have any held-to-maturity securities. The Company's available-for-sale securities were included in the following line items in our consolidated balance sheets (in millions): December 31, Cash and cash equivalents $ $ Marketable securities 5,022 3,769 Other investments Other assets 1,165 1,113 Total $ 7,807 $ 6,413 The contractual maturities of these available-for-sale securities as of December 31, 2017 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 1,433 $ 1,491 After 1 year through 5 years 3,929 3,983 After 5 years through 10 years After 10 years Equity securities 1,276 1,895 Total $ 7,058 $ 7,807 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. Cost Method Investments Cost method investments are initially recorded at cost, and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets, and dividend income from cost method investments is reported in other income (loss) net in our consolidated statements of income. We review all of our cost method investments quarterly to determine if impairment indicators are present; however, we are not required to determine the fair value of these investments unless impairment indicators exist. When impairment indicators exist, we generally use discounted cash flow analyses to determine the fair value. We estimate that the fair values of our cost method investments approximated or exceeded their carrying values as of December 31, 2017 and 2016 . Our cost method investments had a carrying value of $ 143 million and $ 140 million as of December 31, 2017 and 2016 , respectively. NOTE 4 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, Raw materials and packaging $ 1,729 $ 1,565 Finished goods Other Total inventories $ 2,655 $ 2,675 NOTE 5 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date, and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign-denominated debt, in hedging relationships. All derivatives are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a financial instrument's change in fair value is immediately recognized into earnings. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2017 December 31, 2016 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Liabilities held for sale discontinued operations Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2017 December 31, 2016 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Other derivative instruments Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Other derivative instruments Accounts payable and accrued expenses Other derivative instruments Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 4,068 million and $ 6,074 million as of December 31, 2017 and 2016 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of the foreign currency denominated debt due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. During the year ended December 31, 2015 , the Company discontinued the cash flow hedge relationships related to these swaps. Upon discontinuance, the Company recognized a loss of $92 million in other comprehensive income, which will be reclassified from AOCI into interest expense over the remaining life of the debt, a weighted-average period of approximately 10 years . The Company did not discontinue any cross-currency swaps designated as a cash flow hedge during the years ended December 31, 2017 and 2016 . The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated debt were $1,851 million as of December 31, 2017 and 2016 , respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that have been designated and qualify for this program were $ 35 million and $ 12 million as of December 31, 2017 and 2016 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional values of these interest rate swap agreements that were designated and qualified for the Company's interest rate cash flow hedging program were $ 500 million and $ 1,500 million as of December 31, 2017 and 2016 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) Foreign currency contracts $ (226 ) Net operating revenues $ $ Foreign currency contracts (23 ) Cost of goods sold (2 ) 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net Foreign currency contracts (3 ) Income from discontinued operations Interest rate contracts (22 ) Interest expense (37 ) Commodity contracts (1 ) Cost of goods sold (1 ) Commodity contracts (5 ) Income from discontinued operations Total $ (188 ) $ $ Foreign currency contracts $ Net operating revenues $ $ (3 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (3 ) (3 ) Interest rate contracts (126 ) Interest expense (17 ) (2 ) Commodity contracts (1 ) Cost of goods sold (1 ) Total $ (37 ) $ $ (9 ) Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts (38 ) Other income (loss) net (40 ) Interest rate contracts (153 ) Interest expense (3 ) Commodity contracts (1 ) Cost of goods sold (3 ) Total $ $ $ 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and ineffective portion, if any, to the same line items in our consolidated statements of income. 2 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2017 , the Company estimates that it will reclassify into earnings during the next 12 months net gains of $ 93 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. The ineffective portions of these hedges are immediately recognized into earnings. As of December 31, 2017 , such adjustments had cumulatively increased the carrying value of our long-term debt by $ 4 million . When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives that related to our fair value hedges of this type were $ 8,121 million and $ 6,158 million as of December 31, 2017 and 2016 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. The total notional values of derivatives that related to our fair value hedges of this type were $ 311 million and $ 1,163 million as of December 31, 2017 and 2016 , respectively. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 1 Interest rate contracts Interest expense $ (69 ) Fixed-rate debt Interest expense Net impact to interest expense $ (6 ) Foreign currency contracts Other income (loss) net $ (37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ 2016 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (152 ) Net impact to interest expense $ Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (73 ) Net impact to other income (loss) net $ (4 ) Net impact of fair value hedging instruments $ 2015 Interest rate contracts Interest expense $ (172 ) Fixed-rate debt Interest expense Net impact to interest expense $ (3 ) Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (131 ) Net impact to other income (loss) net $ (21 ) Net impact of fair value hedging instruments $ (24 ) 1 The net impacts represent the ineffective portions of the hedge relationships and the amounts excluded from the assessment of hedge effectiveness. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and non-derivative financial instruments to protect the value of our net investments in a number of foreign operations. During the years ended December 31, 2017 , 2016 and 2015, the Company designated a portion of its euro-denominated debt as a hedge of a net investment in our European operations. The change in the carrying value of the designated portion of the euro-denominated debt due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustment, a component of AOCI. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustment to offset the changes in the values of the net investments being hedged. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2016 2016 Foreign currency contracts $ $ $ (7 ) $ (237 ) $ Foreign currency denominated debt 13,147 11,113 (1,505 ) (24 ) Total $ 13,147 $ 11,213 $ (1,512 ) $ $ The Company reclassified net deferred losses of $77 million related to the deconsolidation of our German bottling operations from AOCI into earnings during the year ended December 31, 2016 . The Company did not reclassify any deferred gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2017 and 2015 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2017 , 2016 and 2015 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statements of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statements of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues or cost of goods sold in our consolidated statements of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 6,827 million and $ 5,276 million as of December 31, 2017 and 2016 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, and selling, general and administrative expenses in our consolidated statements of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 357 million and $ 447 million as of December 31, 2017 and 2016 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ (30 ) $ (45 ) $ Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Other income (loss) net (168 ) (92 ) Commodity contracts Net operating revenues (16 ) Commodity contracts Cost of goods sold (209 ) Commodity contracts Selling, general and administrative expenses (25 ) Interest rate contracts Interest expense (39 ) Other derivative instruments Selling, general and administrative expenses Other derivative instruments Other income (loss) net (15 ) (37 ) Total $ $ (156 ) $ (334 ) NOTE 6 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statements of income and our carrying value in those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in CCEP, Monster, AC Bebidas, Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), Coca-Cola HBC AG (""Coca-Cola Hellenic""), and Coca-Cola Bottlers Japan Inc. (""CCBJI""). As of December 31, 2017 , we owned approximately 18 percent , 18 percent , 20 percent , 28 percent , 23 percent , and 17 percent , respectively, of these companies' outstanding shares. As of December 31, 2017 , our investment in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 9,932 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 73,339 $ 58,054 $ 47,498 Cost of goods sold 42,867 34,338 28,749 Gross profit $ 30,472 $ 23,716 $ 18,749 Operating income $ 7,577 $ 5,652 $ 4,483 Consolidated net income $ 4,545 $ 2,967 $ 2,299 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,425 $ 2,889 $ 2,234 Equity income (loss) net $ 1,071 $ $ 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, Current assets $ 25,023 $ 19,586 Noncurrent assets 66,578 58,529 Total assets $ 91,601 $ 78,115 Current liabilities $ 17,890 $ 16,125 Noncurrent liabilities 29,986 25,610 Total liabilities $ 47,876 $ 41,735 Equity attributable to shareowners of investees $ 41,773 $ 35,204 Equity attributable to noncontrolling interests 1,952 1,176 Total equity $ 43,725 $ 36,380 Company equity investment $ 20,856 $ 16,260 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,144 million , $ 10,495 million and $ 8,984 million in 2017 , 2016 and 2015 , respectively. The increase in net sales to equity method investees in 2017 was primarily due to our acquisition of equity method investments in CCEP and AC Bebidas, as well as the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJI in 2017 . Refer to Note 2. Total payments, primarily marketing, made to equity method investees were $ 930 million , $ 946 million and $ 1,380 million in 2017 , 2016 and 2015 , respectively. In addition, purchases of beverage products from equity method investees were $ 1,298 million , $ 1,857 million and $ 1,131 million in 2017 , 2016 and 2015 , respectively. The decrease in purchases of beverage products in 2017 was primarily due to reduced purchases of Monster products as a result of North America refranchising activities. Refer to Note 2. If valued at the December 31, 2017 quoted closing prices of shares actively traded on stock markets, the value of our equity method investments in publicly traded bottlers would have exceeded our carrying value by $ 8,504 million . However, the carrying value of our investment in CCEP exceeded the fair value of the investment as of December 31, 2017 by $196 million . Based on the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 2,053 million and $ 1,696 million as of December 31, 2017 and 2016 , respectively. The total amount of dividends received from equity method investees was $ 443 million , $ 386 million and $ 367 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2017 was $4,471 million . NOTE 7 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, Land $ $ Buildings and improvements 3,917 4,574 Machinery, equipment and vehicle fleet 12,198 16,093 16,449 21,256 Less accumulated depreciation 8,246 10,621 Property, plant and equipment net $ 8,203 $ 10,635 NOTE 8 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table summarizes information related to indefinite-lived intangible assets (in millions): December 31, Trademarks 1 $ 6,729 $ 6,097 Bottlers' franchise rights 2 3,676 Goodwill 9,401 10,629 Other Indefinite-lived intangible assets $ 16,374 $ 20,530 1 The increase in 2017 was primarily due to the acquisitions of AdeS and the U.S. rights to Topo Chico. Refer to Note 2 . 2 The decrease in 2017 was primarily the result of additional North America bottling territories being refranchised. Refer to Note 2 . The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Total Balance at beginning of year $ $ $ 8,311 $ $ 2,084 $ 11,289 Effect of foreign currency translation (10 ) (6 ) (11 ) (6 ) (33 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment (10 ) (10 ) Divestitures, deconsolidations and other 1 (633 ) (633 ) Balance at end of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Balance at beginning of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Effect of foreign currency translation (1 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment (390 ) (390 ) Divestitures, deconsolidations and other 1,2 (999 ) (999 ) Balance at end of year $ $ $ 8,349 $ $ $ 9,401 Refer to Note 2 for information related to the Company's acquisitions and divestitures. 2 The 2017 decrease in the Bottling Investments segment was primarily a result of additional North America bottling territories being refranchised. Refer to Note 2 . Definite-Lived Intangible Assets The following table summarizes information related to definite-lived intangible assets (in millions): December 31, 2017 December 31, 2016 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Customer relationships 1 $ $ (143 ) $ $ $ (185 ) $ Bottlers' franchise rights 1 (152 ) (381 ) Trademarks (73 ) (64 ) Other (64 ) (58 ) Total $ $ (432 ) $ $ 1,286 $ (688 ) $ 1 The decrease in 2017 was primarily due to the derecognition of intangible assets as a result of the North America refranchising. Refer to Note 2 . Total amortization expense for intangible assets subject to amortization was $ 68 million , $ 139 million and $ 156 million in 2017 , 2016 and 2015 , respectively. Based on the carrying value of definite-lived intangible assets as of December 31, 2017 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2019 2020 2021 2022 NOTE 9 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accrued marketing $ 2,108 $ 2,186 Trade accounts payable 2,288 2,682 Other accrued expenses 3,071 2,593 Accrued compensation Deferred tax liabilities 1 Sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 8,748 $ 9,490 1 As a result of our adoption of ASU 2015-17, all deferred tax liabilities are now recorded in noncurrent liabilities. Refer to Note 1. NOTE 10 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2017 and 2016 , we had $ 12,931 million and $ 12,330 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 1.4 percent and 0.8 percent per year as of December 31, 2017 and 2016 , respectively. In addition, we had $ 9,199 million in lines of credit and other short-term credit facilities as of December 31, 2017 . The Company's total lines of credit included $ 274 million that was outstanding and primarily related to our international operations. Included in the credit facilities discussed above, the Company had $ 7,295 million in lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2018 through 2022 . There were no borrowings under these backup lines of credit during 2017 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2017 , the Company issued U.S. dollar- and euro-denominated debt of $1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 , was $3,974 million . The general terms of the notes issued are as follows: $500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three -month Euro Interbank Offered Rate (""EURIBOR"") plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017, the Company retired upon maturity 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent , $206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent , SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent , $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent , and $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CCE's former North America business (""Old CCE""). The extinguished notes had a carrying value of $417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $38 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017 . This net charge was due to the early extinguishment of long-term debt described above. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished. During 2016 , the Company issued Australian dollar-, euro- and U.S. dollar-denominated debt of AUD 1,000 million , 500 million and $3,725 million , respectively. The general terms of the notes issued are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.60 percent ; AUD 550 million total principal amount of notes due June 11, 2024, at a fixed interest rate of 3.25 percent ; $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month LIBOR plus 0.05 percent ; $1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent ; $1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.55 percent ; $500 million total principal amount of notes due June 1, 2026, at a fixed interest rate of 2.55 percent ; $1,000 million total principal amount of notes due September 1, 2026, at a fixed interest rate of 2.25 percent ; and 500 million total principal amount of notes due September 2, 2036, at a fixed interest rate of 1.10 percent . During 2016 , the Company retired upon maturity $1,654 million total principal amount of notes due September 1, 2016, at a fixed interest rate of 1.80 percent , $500 million total principal amount of notes due November 1, 2016 at a fixed interest rate of 0.75 percent and $500 million total principal amount of notes due November 1, 2016 at a variable interest rate equal to the three -month LIBOR plus 0.10 percent . During 2015 , the Company issued SFr 1,325 million , 8,500 million and $4,000 million of long-term debt. The general terms of the notes issued are as follows: SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent ; SFr 550 million total principal amount of notes due December 22, 2022, at a fixed interest rate of 0.25 percent ; SFr 575 million total principal amount of notes due October 2, 2028, at a fixed interest rate of 1.00 percent ; 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent ; 2,000 million total principal amount of notes due September 9, 2019, at a variable interest rate equal to the three -month EURIBOR plus 0.23 percent ; 1,500 million total principal amount of notes due March 9, 2023, at a fixed interest rate of 0.75 percent ; 1,500 million total principal amount of notes due March 9, 2027, at a fixed interest rate of 1.125 percent ; 1,500 million total principal amount of notes due March 9, 2035, at a fixed interest rate of 1.625 percent ; $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent ; $1,500 million total principal amount of notes due October 27, 2020, at a fixed interest rate of 1.875 percent ; and $1,750 million total principal amount of notes due October 27, 2025, at a fixed interest rate of 2.875 percent . During 2015 , the Company retired $3,500 million of long-term debt upon maturity. The Company also extinguished $2,039 million of long-term debt prior to maturity, incurring associated charges of $320 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. The general terms of the notes that were extinguished were as follows: $1,148 million total principal amount of notes due November 15, 2017, at a fixed interest rate of 5.35 percent ; and $891 million total principal amount of notes due March 15, 2019, at a fixed interest rate of 4.875 percent . The Company's long-term debt consisted of the following (in millions, except average rate data): December 31, 2017 December 31, 2016 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20182093 $ 16,854 2.3 % $ 16,922 2.0 % U.S. dollar debentures due 20182098 1,559 5.5 2,111 4.1 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.1 1.2 Euro notes due 20192036 13,663 0.7 11,567 0.7 Swiss franc notes due 20222028 1,148 3.0 1,304 2.5 Other, due through 2098 3 3.4 3.5 Fair value adjustment 4 N/A N/A Total 5,6 34,480 1.8 % 33,211 1.7 % Less current portion 3,298 3,527 Long-term debt $ 31,182 $ 29,684 1 These rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 This amount is shown net of unamortized discounts of $ 13 million and $ 18 million as of December 31, 2017 and 2016 , respectively. 3 As of December 31, 2017 , the amount shown includes $ 165 million of debt instruments that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 5 As of December 31, 2017 and 2016 , the fair value of our long-term debt, including the current portion, was $ 35,169 million and $ 33,752 million , respectively. The fair value of our long-term debt is estimated based on quoted prices for those or similar instruments. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE's former North America business in 2010 of $ 263 million and $ 361 million as of December 31, 2017 and 2016 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2017 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 24 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 757 million , $ 663 million and $ 515 million in 2017 , 2016 and 2015 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2017 , are as follows (in millions): Maturities of Long-Term Debt $ 3,298 5,209 4,298 2,930 2,480 NOTE 11 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2017 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 609 million , of which $ 256 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees was individually significant. The amount represents the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities to the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . A trial date has been set for March 5, 2018. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The Company regularly assesses the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of its tax reserves. The Company believes that the final adjudication of this matter will not have a material impact on its consolidated financial position, results of operations or cash flows. However, the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail in any material respect on its assertions, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 480 million and $ 527 million as of December 31, 2017 and 2016 , respectively. Workforce (Unaudited) We refer to our employees as ""associates."" As of December 31, 2017 , our Company had approximately 61,800 associates, of which approximately 12,400 associates were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2017 , approximately 3,700 associates, excluding seasonal hires, in North America were covered by collective bargaining agreements. These agreements typically have terms of three years to five years years. We currently expect that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its associates are generally satisfactory. Operating Leases The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2017 (in millions): Year Ended December 31, Operating Lease Payments $ 2019 2020 2021 2022 Thereafter Total minimum operating lease payments 1 $ 1 Income associated with sublease arrangements is not significant. NOTE 12 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 219 million , $ 258 million and $ 236 million in 2017 , 2016 and 2015 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 44 million , $ 71 million and $ 65 million in 2017 , 2016 and 2015 , respectively. Beginning in 2015, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who receive these performance cash awards do not receive equity awards as part of the long-term incentive program. In late 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2017 , we had $ 286 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 3.0 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. Beginning in 2015, the 2014 Equity Plan was the primary plan in use for equity awards and performance cash awards. There were no grants made from the 2014 Equity Plan prior to 2015. As of December 31, 2017 , there were 413.6 million shares available to be granted under the 2014 Equity Plan. In addition to the 2014 Equity Plan, there were 2.7 million shares available to be granted under stock option plans approved by shareowners in 1999 and 2008 and 0.2 million shares available to be granted under a restricted stock award plan approved by shareowners in 1989. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, generally four years . The weighted-average fair value of stock options granted during the past three years and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Fair value of stock options at grant date $ 3.98 $ 4.17 $ 4.38 Dividend yield 1 3.6 % 3.2 % 3.1 % Expected volatility 2 15.5 % 16.0 % 16.0 % Risk-free interest rate 3 2.2 % 1.5 % 1.8 % Expected term of the stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock at the time of the grant. 2 Expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expire 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued Company common stock or from the Company's treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from the Company's treasury shares. Stock option activity for all plans for the year ended December 31, 2017 , was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2017 $ 33.70 Granted 40.89 Exercised (53 ) 30.28 Forfeited/expired (3 ) 38.34 Outstanding on December 31, 2017 1 $ 35.02 4.84 years $ 1,879 Expected to vest $ 34.96 4.81 years $ 1,869 Exercisable on December 31, 2017 $ 33.89 4.27 years $ 1,700 1 Includes 0.3 million stock option replacement awards in connection with our acquisition of Old CCE's North America business in 2010. These options had a weighted-average exercise price of $ 12.86 and generally vest over 3 years and expire 10 years from the original date of grant. The total intrinsic value of the stock options exercised was $ 744 million , $ 787 million and $ 594 million in 2017 , 2016 and 2015 , respectively. The total shares exercised were 53 million , 50 million and 44 million in 2017 , 2016 and 2015 , respectively. Performance Share Unit Awards Performance share units require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. The primary performance criterion used is compound annual growth in economic profit over a predefined performance period, which is generally three years . Economic profit is our net operating profit after tax less the cost of the capital used in our business. Beginning in 2015, the Company added net operating revenues as an additional performance criterion. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. In the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria, a reduced number of shares will be granted. If the certified results fall below the threshold award performance level, no shares will be granted. The performance share units granted under this program are then generally subject to a holding period of one year before the shares are released. Performance share units generally do not entitle participants to vote or receive dividends. For most performance share units granted beginning in 2014, the Company includes a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance share units that include the TSR modifier is determined using a Monte Carlo valuation model. For the remaining awards that do not include the TSR modifier, the fair value of the performance share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. In the period it becomes probable that the minimum performance criteria specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance criteria specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units are generally settled in stock, except for certain circumstances such as death or disability, in which case former employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2017 , performance share units of 2,088,000 , 2,985,000 and 3,139,000 were outstanding for the 20152017, 20162018 and 20172019 performance periods, respectively, based on the target award amounts in the performance share unit agreements. The following table summarizes information about performance share units based on the target award amounts in the performance share unit agreements: Performance Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2017 9,773 $ 35.77 Granted 4,133 34.75 Conversions to restricted stock units 1 (4,851 ) 32.35 Paid in cash equivalent (11 ) 34.15 Canceled/forfeited (832 ) 37.20 Outstanding on December 31, 2017 2 8,212 $ 37.14 1 Represents the target amount of performance share units converted to restricted stock units for the 20142016 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units as of December 31, 2017 , at the threshold award and maximum award levels were 2.2 million and 15.4 million , respectively. The weighted-average grant date fair value of performance share units granted was $34.75 in 2017 , $39.70 in 2016 and $37.99 in 2015 . The Company did not convert any performance share units into cash equivalent payments in 2015. The Company converted performance share units of 11,052 in 2017 and 52,545 in 2016 to cash equivalent payments of $0.4 million and $ 1.9 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2017 $ Conversions from performance share units 7,181 32.33 Vested and released (3 ) 32.35 Canceled/forfeited (430 ) 32.30 Nonvested on December 31, 2017 6,748 $ 32.35 The total intrinsic value of restricted shares that were vested and released was less than $1 million in both 2017 and 2016 and $ 5 million in 2015 . The total restricted share units vested and released were 3,037 in 2017 , 7,101 in 2016 and 130,017 in 2015 . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2017 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of 3,534,660 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock awards: Restricted Stock and Stock Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2017 $ 37.54 Granted 2,994 41.62 Vested and released (179 ) 37.36 Forfeited/expired (50 ) 38.35 Outstanding on December 31, 2017 3,535 $ 40.99 NOTE 13 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining organizations as the ""primary U.S. plan."" As of December 31, 2017 , the primary U.S. plan represented 64 percent and 65 percent of the Company's consolidated projected benefit obligation and pension assets, respectively. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, Benefit obligation at beginning of year 1 $ 9,428 $ 9,159 $ $ Service cost Interest cost Foreign currency exchange rate changes (38 ) (2 ) Amendments (21 ) (4 ) Actuarial loss (gain) (28 ) Benefits paid 2 (341 ) (346 ) (71 ) (64 ) Divestitures 3 (7 ) (16 ) (66 ) (2 ) Settlements 4 (832 ) (384 ) Curtailments 4 (10 ) (48 ) (17 ) Special termination benefits 4 Other Benefit obligation at end of year 1 $ 9,455 $ 9,428 $ $ Fair value of plan assets at beginning of year $ 8,371 $ 7,689 $ $ Actual return on plan assets 1,139 Employer contributions Foreign currency exchange rate changes (70 ) Benefits paid (285 ) (270 ) (3 ) (3 ) Divestitures 3 (16 ) Settlements 4 (794 ) (374 ) Other Fair value of plan assets at end of year $ 8,843 $ 8,371 $ $ Net liability recognized $ (612 ) $ (1,057 ) $ (494 ) $ (707 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $9,175 million and $9,141 million as of December 31, 2017 and 2016 , respectively. 2 Benefits paid to pension plan participants during 2017 and 2016 included $56 million and $76 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2017 and 2016 included $68 million and $61 million , respectively, that were paid from Company assets. 3 Divestitures were primarily related to the deconsolidation of the Company's German bottling operations in May 2016 and the Company's North America refranchising in 2017. Refer to Note 2. 4 Settlements, curtailments and special termination benefits were primarily related to the Company's North America refranchising and productivity, restructuring and integration initiatives. Refer to Note 2 and Note 18. Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, Noncurrent asset $ $ $ $ Current liability (72 ) (71 ) (21 ) (23 ) Long-term liability (1,461 ) (1,558 ) (473 ) (684 ) Net liability recognized $ (612 ) $ (1,057 ) $ (494 ) $ (707 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Projected benefit obligation $ 7,833 $ 7,907 Fair value of plan assets 6,330 6,303 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Accumulated benefit obligation $ 7,614 $ 7,668 Fair value of plan assets 6,305 6,257 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,427 1,208 International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 1 Hedge funds/limited partnerships 1,172 Real estate Other Total pension plan assets 2 $ 6,028 $ 6,061 $ 2,815 $ 2,310 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension assets are included in Note 16 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension assets. Investment Strategy for U.S. Pension Plans The Company utilizes the services of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2017 , no investment manager was responsible for more than 9 percent of total U.S. plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in the common stock of our Company accounted for approximately 4 percent of our total global equities and approximately 2 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. In addition to equity investments and fixed-income investments, we have a target allocation of 28 percent in alternative investments. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that available from publicly traded equity securities. These investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2017 , the long-term target allocation for 73 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 71 percent equity securities, 10 percent fixed-income securities and 19 percent other investments. The actual allocation for the remaining 27 percent of the Company's international subsidiaries' plan assets consisted of 55 percent mutual, pooled and commingled funds; 5 percent fixed-income securities; and 40 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, Cash and cash equivalents $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds Hedge funds/limited partnerships Real estate Other Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost Net periodic benefit cost for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets 1 (650 ) (653 ) (705 ) (12 ) (11 ) (11 ) Amortization of prior service credit (2 ) (2 ) (18 ) (19 ) (19 ) Amortization of actuarial loss 2 Net periodic benefit cost Settlement charges 3 Curtailment charge (credit) 3 (79 ) Special termination benefits 3 Other (3 ) Total cost (income) recognized in consolidated statements of income $ $ $ $ (55 ) $ $ 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 The settlement charges, curtailment charge (credit) and special termination benefits were primarily related to the Company's North America refranchising and productivity, restructuring and integration initiatives. Refer to Note 2 and Note 18 . The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ (2,932 ) $ (2,907 ) $ (48 ) $ (26 ) Recognized prior service cost (credit) (2 ) (54 ) 4 (28 ) 5 Recognized net actuarial loss (gain) 2 3 (36 ) 4 Prior service credit (cost) arising in current year (1 ) (17 ) Net actuarial (loss) gain arising in current year (404 ) 4 (6 ) 5 Impact of divestitures 1 Foreign currency translation gain (loss) (42 ) (1 ) Balance in AOCI at end of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) 1 Related to the deconsolidation of our German bottling operations. Refer to Note 2 . 2 Includes $228 million of recognized net actuarial losses due to the impact of settlements. 3 Includes $118 million of recognized net actuarial losses due to the impact of settlements. 4 Includes $36 million of recognized prior service credit, $43 million of recognized net actuarial gains and $45 million of actuarial gains arising in the current year due to the impact of curtailments. 5 Includes $9 million of recognized prior service credit and $17 million of actuarial gains arising in the current year due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, Prior service credit (cost) $ (10 ) $ (14 ) $ $ Net actuarial loss (2,483 ) (2,918 ) (62 ) (117 ) Balance in AOCI at end of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2018 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service cost (credit) $ (3 ) $ (14 ) Amortization of actuarial loss Total $ $ (10 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, Discount rate 3.50 % 4.00 % 3.50 % 4.00 % Rate of increase in compensation levels 3.50 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost are as follows: Pension Benefits Other Benefits Year Ended December 31, Discount rate 4.00 % 4.25 % 3.75 % 4.00 % 4.25 % 3.75 % Rate of increase in compensation levels 3.75 % 3.50 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 8.00 % 8.25 % 8.25 % 4.75 % 4.75 % 4.75 % The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2017 net periodic pension cost for the U.S. plans was 8.00 percent . As of December 31, 2017 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 8.8 percent , 5.4 percent and 8.5 percent , respectively. The annualized return since inception was 10.7 percent . The assumed health care cost trend rates are as follows: December 31, Health care cost trend rate assumed for next year 7.00 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2017 , were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The rate of compensation increase assumption is determined by the Company based upon annual reviews. We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. Effective January 1, 2016, for benefit plans using the yield curve approach, the Company changed the method used to calculate the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans and is measuring these components by applying the specific spot rates along the yield curve to the plans' projected cash flows. The Company believes the new approach provides a more precise measurement of service and interest costs by improving the correlation between projected cash flows and the corresponding spot rates. The change did not affect the measurement of the Company's pension and other postretirement benefit obligations for those plans and was accounted for as a change in accounting estimate, which was applied prospectively. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 20232027 Pension benefit payments $ $ $ $ $ $ 2,642 Other benefit payments 1 Total estimated benefit payments $ $ $ $ $ $ 2,900 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $4 million for the period 20182022, and $3 million for the period 20232027. The Company anticipates making pension contributions in 2018 of $59 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limitations. Company costs related to the U.S. plans were $61 million , $82 million and $94 million in 2017 , 2016 and 2015 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $35 million , $37 million and $35 million in 2017 , 2016 and 2015 , respectively. Multi-Employer Pension Plans As a result of our acquisition of Old CCE's North America business in 2010, the Company participates in various multi-employer pension plans in the United States. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for U.S. multi-employer pension plans totaled $35 million , $ 41 million and $40 million in 2017 , 2016 and 2015 , respectively. The plans we currently participate in have contractual arrangements that extend into 2021. If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. NOTE 14 : INCOME TAXES Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, United States $ (690 ) 1 $ 1 $ 1,801 1 International 7,432 8,023 7,804 Total $ 6,742 $ 8,136 $ 9,605 1 Includes charges of $2,140 million , $2,456 million and $1,006 million related to refranchising certain bottling territories in North America in 2017, 2016 and 2015, respectively. Refer to Note 2. Income taxes from continuing operations consisted of the following for the years ended December 31, 2017 , 2016 and 2015 (in millions): United States State and Local International Total Current $ 5,438 1 $ $ 1,257 $ 6,816 Deferred (1,783 ) 1,2 1 (1,256 ) Current $ 1,147 $ $ 1,182 $ 2,442 Deferred (838 ) 2 (91 ) (856 ) Current $ $ $ 1,386 $ 2,166 Deferred (92 ) 1 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Cuts and Jobs Act (""Tax Reform Act"") that was signed into law on December 22, 2017 . The provisional amount related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated to be $42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $1.0 billion . 2 Includes the benefit from charges related to refranchising certain bottling territories in North America. Refer to Note 2. Income taxes from discontinued operations consisted of $55 million of current expense and $8 million of deferred tax benefit for the year ended December 31, 2017 . We made income tax payments of $ 1,904 million , $ 1,554 million and $ 2,357 million in 2017 , 2016 and 2015 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate of 35.0 percent . As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2018 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 221 million , $ 105 million and $ 223 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 35.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.2 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal rate (9.7 ) (17.5 ) 5 (12.7 ) Equity income or loss (3.4 ) (3.0 ) (1.7 ) Tax Reform Act 53.5 1 Other net 5.9 2,3,4 3.8 6 1.5 Effective tax rate 82.5 % 19.5 % 23.3 % 1 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 2 Includes excess tax benefits of $132 million (or a 2 percent impact on our effective tax rate) recognized as awards issued under the Company's share-based compensation arrangements vested or were settled. 3 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2. 4 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 5 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2. 6 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2003 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE's North America business that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 11. As of December 31, 2017 , the gross amount of unrecognized tax benefits was $ 331 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 205 million , exclusive of any benefits related to interest and penalties. The remaining $ 126 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 1 Decrease related to prior period tax positions (13 ) (9 ) Increase related to current period tax positions Decrease related to settlements with taxing authorities (40 ) 1 (5 ) Decrease due to lapse of the applicable statute of limitations (23 ) Increase (decrease) due to effect of foreign currency exchange rate changes (6 ) (15 ) Ending balance of unrecognized tax benefits $ $ $ 1 The increase is primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 177 million , $ 142 million and $ 111 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2017 , 2016 and 2015 , respectively. Of these amounts, $35 million and $ 31 million of expense were recognized through income tax expense in 2017 and 2016 , respectively. An insignificant amount of interest and penalties was recognized through income tax expense for the year ended December 31, 2015. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") estimated to be $42 billion , the majority of which was previously considered to be indefinitely reinvested and, accordingly, no U.S. federal and state income taxes were provided. We recorded a provisional tax amount of $4.6 billion as a reasonable estimate for our one-time transition tax liability and a $0.6 billion provisional deferred tax of related withholding taxes and state income taxes. Because of the complexities of the Tax Reform Act, we are still finalizing our calculation of the total accumulated post-1986 prescribed EP for the applicable foreign entities. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of accumulated post-1986 prescribed foreign EP and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any additional outside basis differences inherent in these entities, as these amounts continue to be provisionally indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities (i.e., basis differences in excess of that subject to the one-time transition tax) is not practicable. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent . On December 22, 2017, Staff Accounting Bulletin No. 118 (""SAB 118"") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to finalize the calculations for certain income tax effects of the Tax Reform Act. In accordance with SAB 118, the Company has determined that the net tax charge of $3.6 billion recorded in connection with the tax effect of the Tax Reform Act is a provisional amount and a reasonable estimate as of December 31, 2017 . Additional work is necessary to finalize the calculation for certain income tax effects of the Tax Reform Act. Additionally, certain of our equity method investees are impacted by the Tax Reform Act and have recorded provisional tax amounts. To the extent their provisional amounts are refined in 2018, we will record our proportionate share in the line item equity income (loss) net in our consolidated statement of income. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The Company has not yet elected an accounting policy related to how it will account for GILTI and therefore has not provided any deferred tax impacts of GILTI in its consolidated financial statements for the year ended December 31, 2017 . The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consist of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets Equity method investments (including foreign currency translation adjustment) Derivative financial instruments Other liabilities 1,141 Benefit plans 1,599 Net operating/capital loss carryforwards Other Gross deferred tax assets 3,405 4,471 Valuation allowances (501 ) (530 ) Total deferred tax assets 1,2 $ 2,904 $ 3,941 Deferred tax liabilities: Property, plant and equipment $ (819 ) $ (1,176 ) Trademarks and other intangible assets (978 ) (2,694 ) Equity method investments (including foreign currency translation adjustment) (1,835 ) (1,718 ) Derivative financial instruments (436 ) (1,121 ) Other liabilities (50 ) (149 ) Benefit plans (289 ) (487 ) Other (688 ) (635 ) Total deferred tax liabilities 3 (5,095 ) (7,980 ) Net deferred tax liabilities 4 $ (2,191 ) $ (4,039 ) 1 Current deferred tax assets of $80 million were included in the line item prepaid expenses and other assets in our consolidated balance sheet as of December 31, 2016 . 2 Noncurrent deferred tax assets of $331 million and $326 million were included in the line item other assets in our consolidated balance sheets as of December 31, 2017 and 2016 , respectively. 3 Current deferred tax liabilities of $692 million were included in the line item accounts payable and accrued expenses in our consolidated balance sheet as of December 31, 2016 . 4 The decrease in the net deferred tax liabilities was primarily the result of the remeasurement in accordance with the Tax Reform Act and the impact of refranchising certain bottling territories in North America. Refer to Note 2 . As of December 31, 2017 , we had net deferred tax liabilities of $ 539 million and as of December 31, 2016 , we had net deferred tax assets of $ 83 million located in countries outside the United States. As of December 31, 2017 , we had $ 4,893 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 335 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Decrease due to reclassification to assets held for sale (9 ) (163 ) Deductions (213 ) (6 ) (51 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2017, the Company recognized a net decrease of $29 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. In 2016, the Company recognized a net increase of $53 million in its valuation allowances. This increase was primarily due to the increase in non-deductible expenses incurred during the normal course of business operations. In 2015, the Company recognized a net decrease of $172 million in its valuation allowances. As a result of our German bottling operations meeting the criteria to be classified as held for sale, the Company was required to present the related assets and liabilities as separate line items in our consolidated balance sheets. In addition, the changes in net operating losses during the normal course of business and changes in deferred tax assets and related valuation allowances on certain equity investments also contributed to a decrease in the valuation allowances. These decreases were partially offset by an increase in the valuation allowances primarily due to the impact of currency devaluations in Venezuela on certain receivables. NOTE 15 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheets as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheets as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments $ (8,957 ) $ (9,780 ) Accumulated derivative net gain (loss) (119 ) Unrealized net gain (loss) on available-for-sale securities Adjustments to pension and other benefit liabilities (1,722 ) (2,044 ) Accumulated other comprehensive income (loss) $ (10,305 ) $ (11,205 ) The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2017 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 1,248 $ $ 1,283 Other comprehensive income: Net foreign currency translation adjustment 38 Net gain (loss) on derivatives 1 (433 ) (433 ) Net change in unrealized gain (loss) on available-for-sale securities 2 Net change in pension and other benefit liabilities 3 Total comprehensive income $ 2,148 $ $ 2,221 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. Refer to Note 3 for additional information related to the net unrealized gain or loss on available-for-sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2017 , 2016 and 2015 , is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,350 ) $ (242 ) $ (1,592 ) Reclassification adjustments recognized in net income (6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year (1,512 ) (934 ) Net foreign currency translation adjustments Derivatives: Gains (losses) arising during the year (184 ) (119 ) Reclassification adjustments recognized in net income (506 ) (314 ) Net gain (loss) on derivatives 1 (690 ) (433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (136 ) Reclassification adjustments recognized in net income (123 ) (81 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (94 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (7 ) Reclassification adjustments recognized in net income (116 ) Net change in pension and other benefit liabilities 3 (123 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,103 ) $ $ (1,052 ) Reclassification adjustments recognized in net income (18 ) Gains (losses) on net investment hedges arising during the year (25 ) Reclassification adjustments for net investment hedges recognized in net income (30 ) Net foreign currency translation adjustments (591 ) (22 ) (613 ) Derivatives: Gains (losses) arising during the year (43 ) (32 ) Reclassification adjustments recognized in net income (563 ) (350 ) Net gain (loss) on derivatives 1 (606 ) (382 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (28 ) Reclassification adjustments recognized in net income (105 ) (79 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (2 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (374 ) (275 ) Reclassification adjustments recognized in net income (120 ) Net change in pension and other benefit liabilities 3 (32 ) (21 ) (53 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,210 ) $ $ (1,031 ) 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (4,626 ) $ $ (4,383 ) Reclassification adjustments recognized in net income (14 ) Unrealized gains (losses) on net investment hedges arising during the year (244 ) Net foreign currency translation adjustments (3,926 ) (15 ) (3,941 ) Derivatives: Unrealized gains (losses) arising during the year (314 ) Reclassification adjustments recognized in net income (638 ) (397 ) Net gain (loss) on derivatives 1 (73 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (973 ) (645 ) Reclassification adjustments recognized in net income (61 ) (39 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (1,034 ) (684 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (169 ) (126 ) Reclassification adjustments recognized in net income (125 ) Net change in pension and other benefit liabilities 3 (82 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (4,577 ) $ $ (4,397 ) 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statements of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2017 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations (6 ) Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ (444 ) Foreign currency and commodity contracts Cost of goods sold Foreign currency and interest rate contracts Interest expense Foreign currency contracts Other income (loss) net (110 ) Divestitures, deconsolidations and other 2 Other income (loss) net Income from continuing operations before income taxes $ (506 ) Income taxes from continuing operations Consolidated net income $ (314 ) Available-for-sale securities: Divestitures, deconsolidations and other 2 Other income (loss) net $ (87 ) Sale of securities Other income (loss) net (36 ) Income from continuing operations before income taxes $ (123 ) Income taxes from continuing operations Consolidated net income $ (81 ) Pension and other benefit liabilities: Curtailment charges (credits) 3 Other operating charges $ (75 ) Settlement charges (credits) 3 Other operating charges Divestitures, deconsolidations and other 2 Other income (loss) net Recognized net actuarial loss (gain) * Recognized prior service cost (credit) * (18 ) Income from continuing operations before income taxes $ Income taxes from continuing operations (116 ) Consolidated net income $ 1 Includes a $104 million loss related to the integration of CCW and CCEJ to establish CCBJI and an $80 million gain related to the derecognition of our previously held equity interests in CCBA and its South African subsidiary upon the consolidation of CCBA. Refer to Note 2 and Note 17 . 2 Primarily related to the integration of CCW and CCEJ to establish CCBJI. Refer to Note 17 . 3 The curtailment charges (credits) and settlement charges (credits) were primarily related to North America refranchising and the Company's productivity, restructuring and integration initiatives. Refer to Note 13 and Note 18 . * This component of AOCI is included in the Company's computation of net periodic benefit cost and is not reclassified out of AOCI into a single line item in our consolidated statements of income in its entirety. Refer to Note 13 . NOTE 16 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity and debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Trading and Available-for-Sale Securities The fair values of our investments in trading and available-for-sale securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in trading and available-for-sale securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair value of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair value of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2017 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,899 5,739 3 7,807 Derivatives 2 (198 ) 6 8 Total assets $ 2,118 $ 6,116 $ $ $ (198 ) $ 8,273 Liabilities: Derivatives 2 $ (3 ) $ (262 ) $ $ $ 7 $ (118 ) 8 Total liabilities $ (3 ) $ (262 ) $ $ $ $ (118 ) 1 Refer to Note 3 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Primarily related to debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 3. 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5 . 6 The Company is obligated to return $55 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $2 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 59 million in the line item other assets; $28 million in the line item accounts payable and accrued expenses; $12 million in the line item liabilities held for sale discontinued operations and $ 78 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2016 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,655 4,619 3 6,413 Derivatives 2 (369 ) 6 8 Total assets $ 1,861 $ 5,612 $ $ $ (369 ) $ 7,310 Liabilities: Derivatives 2 $ $ $ $ $ (192 ) 7 $ 8 Total liabilities $ $ $ $ $ (192 ) $ 1 Refer to Note 3 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Primarily related to long-term debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 3. 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5 . 6 The Company is obligated to return $ 201 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $ 17 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 347 million in the line item prepaid expenses and other assets; $ 166 million in the line item other assets; $42 million in the line item accounts payable and accrued expenses; and $ 53 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2017 and 2016 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2017 and 2016 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. The gains or losses on assets measured at fair value on a nonrecurring basis are summarized in the table below (in millions): Gains (Losses) December 31, Assets held for sale 1 $ (1,819 ) $ (2,264 ) Intangible assets (442 ) 2 (153 ) 7 Other long-lived assets (329 ) 3 Other-than-temporary impairment charge (50 ) 4 Investment in formerly unconsolidated subsidiary 5 Valuation of shares in equity method investee 6 Total $ (2,465 ) $ (2,417 ) 1 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. These losses related to refranchising activities in North America. The charges were calculated based on Level 3 inputs. Refer to Note 2. 2 The Company recognized an impairment charge of $375 million related to CCR's goodwill. This impairment charge was determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. The Company also recognized an impairment charge of $33 million related to certain U.S. bottlers' franchise rights. This charge was determined by comparing the fair value of the asset to its current carrying value. Each of these impairment charges was primarily a result of refranchising activities in North America and management's estimates of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. Additionally, the Company recorded impairment charges of $34 million related to Venezuelan intangible assets due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. 3 The Company recognized impairment charges of $310 million related to CCR's property, plant and equipment and $19 million related to CCR's other assets primarily as a result of refranchising activities in North America. The fair value of these assets was derived using management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. 4 The Company recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recognized a gain of $150 million on our previously held equity interests in CCBA and its South African subsidiary, which were accounted for under the equity method of accounting prior to our consolidation of the bottler in October 2017. U.S. GAAP requires the acquirer to remeasure its previously held noncontrolling equity interest in the acquired entity to fair value as of the acquisition date and recognize any gains or losses in earnings. The Company remeasured our equity interests in CCBA and its South African subsidiary based on Level 3 inputs. Refer to Note 2. 6 The Company recognized a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock at a per share amount greater than the carrying value of the Company's per share investment. Accordingly, the Company is required to treat this type of transaction as if the Company had sold a proportionate share of its investment in Coca-Cola FEMSA. This gain was determined using Level 1 inputs. 7 The Company recognized losses of $153 million during the year ended December 31, 2016 due to impairment charges related to certain intangible assets. The charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights. This charge was related to a number of factors, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's estimates of the proceeds that were expected to be received upon refranchising the territories. The losses also included a $10 million goodwill impairment charge, primarily the result of management's revised outlook on market conditions. The charges were determined by comparing the fair value of the assets to the current carrying value. The fair value of the assets was derived using discounted cash flow analyses based on Level 3 inputs. Refer to Note 17. Fair Value Measurements for Pension and Other Postretirement Benefit Plans The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 13 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets as of December 31, 2017 and 2016 (in millions): December 31, 2017 December 31, 2016 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 2,080 14 2,097 1,812 14 1,827 International-based companies 1,465 1,465 4 Fixed-income securities: Government bonds 1 Corporate bonds and debt securities 24 18 Mutual, pooled and commingled funds 42 3 20 1,022 3 1,133 Hedge funds/limited partnerships 4 1,213 4 1,213 Real estate 5 5 Other 2 6 211 2 6 Total $ 4,410 $ 1,287 $ $ 2,843 $ 8,843 $ 3,211 $ 1,560 $ $ 3,354 $ 8,371 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to tri-annually with a redemption notice period of up to 120 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans for the years ended December 31, 2017 and 2016 (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets: Related to assets held at the reporting date Related to assets sold during the year (2 ) Purchases, sales and settlements net (23 ) (11 ) Transfers into/(out of) Level 3 net (1 ) Foreign currency translation adjustments (2 ) (2 ) Balance at end of year $ $ $ $ 1 $ 2017 Balance at beginning of year $ $ $ $ $ Actual return on plan assets: Related to assets held at the reporting date (3 ) Purchases, sales and settlements net (9 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets as of December 31, 2017 and 2016 (in millions): December 31, 2017 December 31, 2016 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 80 103 Hedge funds/limited partnerships 8 9 Real estate 5 4 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivables; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. The fair value of our long-term debt is estimated using Level 2 inputs based on quoted prices for those instruments. Where quoted prices are not available, fair value is estimated using discounted cash flows and market-based expectations for interest rates, credit risk and the contractual terms of the debt instruments. As of December 31, 2017 , the carrying amount and fair value of our long-term debt, including the current portion, were $34,480 million and $ 35,169 million , respectively. As of December 31, 2016 , the carrying amount and fair value of our long-term debt, including the current portion, were $33,211 million and $ 33,752 million , respectively. NOTE 17 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2017, the Company recorded other operating charges of $2,157 million . These charges primarily consisted of $737 million of CCR asset impairments and $650 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $419 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information about the Venezuelan intangible assets and Note 16 for information on how the Company determined the CCR asset impairment charges. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. In 2016, the Company recorded other operating charges of $1,510 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $415 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. The Company also recorded a charge of $200 million related to cash contributions we made to The Coca-Cola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information on the Venezuelan exchange rates. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. In 2016, the Company also recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights recorded in our Bottling Investments operating segment. This charge was related to a number of factors, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's view of the proceeds that may be ultimately received upon refranchising the territories. The remaining charge of $10 million was related to the impairment of goodwill recorded in our Bottling Investments operating segment. This charge was primarily the result of management's revised outlook on market conditions. The total impairment charges of $153 million were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to their respective carrying values. In 2015, the Company incurred other operating charges of $1,657 million . These charges included $ 691 million due to the Company's productivity and reinvestment program and $ 292 million due to the integration of our German bottling operations. In addition, the Company recorded impairment charges of $418 million primarily due to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction and incurred a charge of $100 million due to a cash contribution we made to The Coca-Cola Foundation. The Company also incurred a charge of $ 111 million due to the write-down we recorded related to receivables from our bottling partner in Venezuela and an impairment of a Venezuelan trademark primarily due to changes in exchange rates as a result of the establishment of the new open market exchange system. Refer to Note 1 for additional information on the Venezuelan currency change. Refer to Note 2 for additional information on the Monster Transaction. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. Other Nonoperating Items Interest Expense During the year ended December 31, 2017 , the Company recorded a net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 10 for additional information and Note 19 for the impact this charge had on our operating segments.. During the year ended December 31, 2015, the Company recorded charges of $ 320 million due to the early extinguishment of certain long-term debt. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. Refer to Note 10 for additional information and Note 19 for the impact these charges had on our operating segments. Equity Income (Loss) Net The Company recorded net charges of $92 million , $ 61 million and $ 87 million in equity income (loss) net during the years ended December 31, 2017 , 2016 and 2015 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments. Other Income (Loss) Net In 2017, other income (loss) net was a loss of $1,666 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Additionally, the Company incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of CCW and CCEJ to establish CCBJI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJI. The fair value of our equity investment in CCBJI was based on its quoted market price (a Level 1 measurement). The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on our North America and China refranchising activities and our consolidation of CCBA. Refer to Note 19 for the impact these items had on our operating segments. In 2016, other income (loss) net was a loss of $1,234 million . This loss included a net charge of $2,456 million due to the refranchising of certain bottling territories in North America and a charge of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These charges were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations, the deconsolidation of our South African bottling operations, the North America refranchising and the conversion payments. Refer to Note 19 for the impact these items had on our operating segments. In 2015, the Company recorded a net gain of $ 1,403 million as a result of the Monster Transaction and a net charge of $ 1,006 million due to the refranchising of certain bottling territories in North America. In addition, the Company recognized a foreign currency exchange gain of $ 300 million associated with our foreign-denominated debt partially offset by a charge of $ 27 million due to the remeasurement of the net monetary assets of our Venezuelan subsidiary using the SIMADI exchange rate. Refer to Note 1 for additional information related to the charge due to the remeasurement in Venezuela. Refer to Note 2 for additional information related to the Monster Transaction and North America refranchising. Refer to Note 19 for the impact these items had on our operating segments. NOTE 18 : PRODUCTIVITY, INTEGRATION AND RESTRUCTURING INITIATIVES Productivity and Reinvestment In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE's North American bottling operations. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives will focus on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced its plans to transition to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,058 million related to this program since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments (200 ) (47 ) (265 ) (512 ) Noncash and exchange (185 ) 1 (5 ) (70 ) (260 ) Accrued balance at end of year $ $ $ $ 2016 Costs incurred $ $ $ $ Payments (114 ) (30 ) (205 ) (349 ) Noncash and exchange (2 ) (55 ) (56 ) Accrued balance at end of year $ $ $ $ 2017 Costs incurred $ $ $ $ Payments (181 ) (83 ) (267 ) (531 ) Noncash and exchange (62 ) 1 (1 ) (1 ) (64 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 13. Integration Initiatives Integration of Our German Bottling Operations In 2008, the Company began an integration initiative related to our German bottling operations acquired in 2007. The Company incurred $ 240 million and $ 292 million of expenses related to this initiative in 2016 and 2015 , respectively and has incurred total pretax expenses of $ 1,367 million related to this initiative since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income and impacted the Bottling Investments operating segment. The expenses recorded in connection with these integration activities have been primarily due to involuntary terminations. The Company had $122 million accrued related to these integration costs as of December 31, 2015. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Therefore, there was no remaining accrual balance as of December 31, 2016. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations. NOTE 19 : OPERATING SEGMENTS As of December 31, 2017 , our organizational structure consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Bottling Investments; and Corporate. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, with the exception of those that are classified as discontinued operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, Concentrate operations 1 % % % Finished product operations 2 60 Total % % % 1 Includes concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes from continuing operations and certain treasury-related items, such as interest income and expense, on a global basis within the Corporate operating segment. We evaluate segment performance based on income or loss from continuing operations before income taxes. Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, United States $ 14,727 $ 19,899 $ 20,360 International 20,683 21,964 23,934 Net operating revenues $ 35,410 $ 41,863 $ 44,294 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, United States $ 4,163 $ 6,784 $ 8,266 International 4,040 3,851 4,305 Property, plant and equipment net $ 8,203 $ 10,635 $ 12,571 Information about our Company's continuing operations by operating segment as of and for the years ended December 31, 2017 , 2016 and 2015 , is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 7,332 $ 3,956 $ 8,651 $ 4,767 $ 10,524 $ $ $ 35,368 Intersegment 1,986 (2,549 ) 4 Total net operating revenues 7,374 4,029 10,637 5,176 10,605 (2,549 ) 35,410 Operating income (loss) 3,646 2,214 2,578 2,163 (1,117 ) (1,983 ) 7,501 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net (3 ) (3 ) 1,071 Income (loss) from continuing operations before income taxes 3,706 2,211 2,307 2,179 (2,345 ) (1,316 ) 6,742 Identifiable operating assets 1 5,475 1,896 17,619 2,072 2 4,493 2 27,060 58,615 5 Investments 3 1,238 15,998 3,536 21,952 Capital expenditures 1,675 Net operating revenues: Third party $ 7,014 $ 3,746 $ 6,437 $ 4,788 $ 19,751 $ $ $ 41,863 Intersegment 3,773 (4,755 ) Total net operating revenues 7,278 3,819 10,210 5,294 19,885 (4,755 ) 41,863 Operating income (loss) 3,676 1,951 2,582 2,224 (137 ) (1,670 ) 8,626 Interest income Interest expense Depreciation and amortization 1,013 1,787 Equity income (loss) net (17 ) Income (loss) from continuing operations before income taxes 3,749 1,966 2,560 2,238 (1,923 ) (454 ) 8,136 Identifiable operating assets 1 4,067 1,785 16,566 2,024 15,973 29,606 70,021 Investments 3 1,302 11,456 3,414 17,249 Capital expenditures 1,329 2,262 Net operating revenues: Third party $ 6,966 $ 3,999 $ 5,581 $ 4,707 $ 22,885 $ $ $ 44,294 Intersegment 4,259 (5,688 ) Total net operating revenues 7,587 4,074 9,840 5,252 23,063 (5,688 ) 44,294 Operating income (loss) 3,875 2,169 2,366 2,189 (1,995 ) 8,728 Interest income Interest expense Depreciation and amortization 1,211 1,970 Equity income (loss) net (7 ) (18 ) Income (loss) from continuing operations before income taxes 3,923 2,164 2,356 2,207 (427 ) (618 ) 9,605 Identifiable operating assets 1 4,156 2 1,627 16,396 1,639 22,688 2 27,702 74,208 Investments 3 1,138 8,084 5,644 15,788 Capital expenditures 1,699 2,553 1 Principally cash and cash equivalents, short-term investments, marketable securities, trade accounts receivable, inventories, goodwill, trademarks and other intangible assets, and property, plant and equipment net. 2 Property, plant and equipment net in India represented 11 percent of consolidated property, plant and equipment net in 2017. Property, plant and equipment net in Germany represented 10 percent of consolidated property, plant and equipment net in 2015. The 2015 amount includes property, plant and equipment net classified as held for sale. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Refer to Note 2 . 3 Principally equity method investments and other investments in bottling companies. 4 Intersegment revenues do not eliminate on a consolidated basis in the table above due to intercompany sales to our discontinued operations. 5 Identifiable operating assets excludes $7,329 million of assets held for sale discontinued operations. During 2017, 2016 and 2015, our operating segments were impacted by acquisition and divestiture activities. Refer to Note 2. In 2017 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $26 million for Europe, Middle East and Africa, $7 million for Latin America, $241 million for North America, $10 million for Asia Pacific, $57 million for Bottling Investments and $309 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $737 million for Bottling Investments and $34 million for Corporate due to asset impairment charges. Refer to Note 1 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $225 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $67 million for Corporate due to tax litigation expense. Refer to Note 11 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa, $2 million for North America, $70 million for Bottling Investments and $16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and related cost method investment. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 10 . Income (loss) from continuing operations before income taxes was reduced by $26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) from continuing operations before income taxes was increased by $25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. In 2016 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $32 million for Europe, Middle East and Africa, $134 million for North America, $1 million for Asia Pacific, $322 million for Bottling Investments and $105 million for Corporate due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Operating income (loss) and income (loss) from continuing operations before income taxes were increased by $2 million for Latin America due to the refinement of previously established accruals related to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $297 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $200 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $153 million for Bottling Investments due to impairment charges recorded on certain of the Company's intangible assets. Refer to Note 17. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $118 million for Bottling Investments due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 17. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $76 million for Latin America due to the write-down we recorded related to our receivables from our bottling partner in Venezuela due to changes in exchange rates. Refer to Note 1. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $9 million for Bottling Investments and $32 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $52 million for Bottling Investments and $9 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $2,456 million for Bottling Investments primarily due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was increased by $1,323 million for Corporate as a result of the deconsolidation of our German bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $72 million for Corporate as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $31 million for North America related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In 2015 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $ 7 million for Latin America, $ 141 million for North America, $ 2 million for Asia Pacific, $ 596 million for Bottling Investments and $ 246 million for Corporate due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Operating income (loss) and income (loss) from continuing operations before income taxes were increased by $ 9 million for Europe, Middle East and Africa due to the refinement of previously established accruals, partially offset by additional charges related to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $418 million for Corporate primarily due to an impairment charge primarily related to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $100 million for Corporate as a result of a cash contribution to The Coca-Cola Foundation. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa and $83 million for Bottling Investments due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was increased by $1,403 million for Corporate as a result of the Monster Transaction. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $1,006 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $320 million for Corporate due to charges the Company recognized on the early extinguishment of certain long-term debt. Refer to Note 10 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $33 million for Latin America and $105 million for Corporate due to the remeasurement of the net monetary assets of our local Venezuelan subsidiary into U.S. dollars using the SIMADI exchange rate, an impairment of a Venezuelan trademark, and a write-down the Company recorded on receivables from our bottling partner in Venezuela. Refer to Note 1 and Note 17 . NOTE 20 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, (Increase) decrease in trade accounts receivable $ (141 ) $ (28 ) $ (212 ) (Increase) decrease in inventories (355 ) (142 ) (250 ) (Increase) decrease in prepaid expenses and other assets Increase (decrease) in accounts payable and accrued expenses (445 ) (540 ) 1,004 Increase (decrease) in accrued income taxes (153 ) (306 ) Increase (decrease) in other liabilities 1 4,052 (544 ) (516 ) Net change in operating assets and liabilities $ 3,529 $ (221 ) $ (157 ) 1 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 14 . REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls and auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2018 Proxy Statement. James R. Quincey Larry M. Mark President and Chief Executive Officer February 23, 2018 Vice President and Controller February 23, 2018 Kathy N. Waller Mark Randazza Executive Vice President, Chief Financial Officer and President, Enabling Services February 23, 2018 Vice President, Assistant Controller and Chief Accounting Officer February 23, 2018 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2017 and 2016 , the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations for the Treadway Commission (2013 framework) and our report dated February 23, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company's auditor since 1921. Atlanta, Georgia February 23, 2018 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries' internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria. As indicated in the accompanying Management's Report on Internal Control Over Financial Reporting, management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Coca-Cola Beverages Africa Proprietary Limited (CCBA), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of the Company and constituted 8 percent of the total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of CCBA. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows, for each of the three years in the period ended December 31, 2017, and related notes and our report dated February 23, 2018 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Atlanta, Georgia February 23, 2018 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 9,118 $ 9,702 $ 9,078 $ 7,512 $ 35,410 Gross profit 5,605 6,043 5,683 4,823 22,154 Net income (loss) attributable to shareowners of The Coca-Cola Company 1,182 1,371 1,447 (2,752 ) 1,248 Basic net income (loss) per share $ 0.28 $ 0.32 $ 0.34 $ (0.65 ) $ 0.29 Diluted net income (loss) per share $ 0.27 $ 0.32 $ 0.33 $ (0.65 ) $ 0.29 1 Net operating revenues $ 10,282 $ 11,539 $ 10,633 $ 9,409 $ 41,863 Gross profit 6,213 7,068 6,502 5,615 25,398 Net income attributable to shareowners of The Coca-Cola Company 1,483 3,448 1,046 6,527 Basic net income per share $ 0.34 $ 0.80 $ 0.24 $ 0.13 $ 1.51 Diluted net income per share $ 0.34 $ 0.79 $ 0.24 $ 0.13 $ 1.49 1 1 The sum of the quarterly net income per share amounts does not agree to the full year net income per share amounts. We calculate net income per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2017 and 2016, our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2017 results were impacted by two fewer days compared to the first quarter of 2016. Furthermore, the Company recorded the following transactions which impacted results: Charges of $497 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $139 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $106 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. Charges of $104 million related to the impairment of certain intangible assets. Refer to Note 17. A net charge of $58 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. Charges of $60 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the second quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $667 million related to the impairment of certain intangible assets. Refer to Note 17. A gain of $445 million related to the integration of CCW and CCEJ to establish CCBJI. Refer to Note 17. Charges of $214 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $109 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. Charges of $87 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $44 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. A net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 10 . A net gain of $37 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. A gain of $9 million related to refranchising a substantial portion of our China bottling operations. Refer to Note 2 and Note 17. In the third quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $762 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $213 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $129 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. A gain of $79 million related to the refranchising of our remaining China bottling operations and related cost method investment. Refer to Note 2 and Note 17. Charges of $72 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. A n other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Refer to Note 16 and Note 17. A net charge of $16 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17 The Company's fourth quarter 2017 results were impacted by one additional day compared to the fourth quarter of 2016. Furthermore, the Company recorded the following transactions which impacted results: A net provisional tax charge of $3,610 million as a result of the Tax Reform Act that was signed into law on December 22, 2017. Refer to Note 14. Charges of $667 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $295 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. A charge of $225 million as a result of a cash contribution to The Coca-Cola Foundation. Refer to Note 17. A gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 and Note 17. Charges of $105 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. A net charge of $55 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. Charges of $26 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. In the first quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $369 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $262 million due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Refer to Note 17 and Note 18. Charges of $45 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the second quarter of 2016, the Company recorded the following transactions which impacted results: A benefit of $1,292 million, net of transaction costs, as a result of the deconsolidation of our German bottling operations. Refer to Note 2 and Note 17. Charges of $199 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $106 million due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Refer to Note 17 and Note 18. A charge of $100 million as a result of a cash donation to The Coca-Cola Foundation. Refer to Note 17. A net tax charge of $83 million primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties. Refer to Note 14. Charges of $52 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the third quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $1,089 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. A charge of $80 million resulting from the accrual of tax on temporary differences related to the investment in foreign subsidiaries that are now expected to reverse in the foreseeable future. Refer to Note 14. A charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela. Refer to Note 1 and Note 17. Charges of $73 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $59 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. In the fourth quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $799 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $165 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $153 million related to the impairment of certain intangible assets. Refer to Note 17. Charges of $127 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $118 million due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 2 and Note 17. A charge of $100 million as a result of a cash donation to The Coca-Cola Foundation. Refer to Note 17. A charge of $72 million as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 17. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2017 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2017 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Changes in Internal Control Over Financial Reporting Except as described below, there have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company began consolidating the operations and related assets of CCBA in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . " +44,Mastercard,2021," ITEM 1. BUSINESS Item 1. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through our unique and proprietary core global payments network, we switch (authorize, clear and settle) payment transactions. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, we offer integrated payment products and services and capture new payment flows. Our value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on our principled use of consumer and merchant data . Our franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. Our payment solutions are designed to ensure safety and security for the global payments ecosystem. For a full discussion of our business, please see page 9. Our Performance The following are our key financial and operational highlights for 2021, including growth rates over the prior year: GAAP Net revenue Net income Diluted EPS $18.9B $8.7B $8.76 up 23% up 35% up 38% Non-GAAP 1 (currency-neutral) Net revenue Adjusted net income Adjusted diluted EPS $18.9B $8.3B $8.40 up 22% up 28% up 30% $7.6B $5.9B Repurchased shares $9.5B in capital returned to stockholders $1.7B Dividends paid cash flows from operations Gross dollar volume (growth on a local currency basis) Cross-border volume growth (on a local currency basis) Switched transactions $7.7T up 32% 112.1B up 21% up 25% 1 Non-GAAP results exclude the impact of gains and losses on equity investments, Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. For a full discussion of our results of operations, including impacts of the COVID-19 pandemic, see Managements Discussion and Analysis of Financial Condition and Results of Operations in Item II, Part 7. 6 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Strategy We remain committed to our strategy to grow our core payments network, diversify our customers and geographies and build new capabilities through a combination of organic and inorganic strategic initiatives. We are executing on this strategy through a focus on three key priorities: expand in payments for consumers, businesses and governments extend our services to enhance transactions and drive customer value embrace new network opportunities to enable open banking, digital identity and other adjacent network capabilities Each of our priorities supports and builds upon each other and are fundamentally interdependent. Our Key Strategic Priorities Expand in payments. We continue to focus on expanding upon our core payments network to enable payment flows for consumers, businesses, governments and others, providing them with choice and flexibility to transact across multiple payment rails (including cards, real-time payments and account-to-account) while ensuring that all payments are done safely, securely and seamlessly. We do so by: Driving growth in consumer purchases with a focus on accelerating digitization, growing acceptance and pursuing an expanded set of use cases, including through partnerships MASTERCARD 2021 FORM 10-K 7 PART I ITEM 1. BUSINESS Capturing new payment flows by expanding our multi-rail capabilities and applications to penetrate key flows such as disbursements and remittances (through Mastercard Send and Cross-Border Services), business-to-business (B2B) (including Mastercard Track Business Payment Service (Track BPS) and areas beyond payments such as enablement of supply chain financing) and consumer bill payments Leaning into new payment innovations such as our planned launch in 2022 of Mastercard Installments, our buy-now-pay-later solution, and developing solutions that support digital currencies and blockchain applications Extend our services. Our services drive value for our customers and the broader payments ecosystem. We continue to do that as well as diversify our business, by extending our services, which include cyber and intelligence solutions, insights and analytics, test and learn, consulting, managed services, loyalty, processing and payment gateway solutions for e-commerce merchants. As we drive value, our services help accelerate our top-line financial performance by supporting revenue growth in our core payments network. We extend our services by: Enhancing the value of payments by making payments safe, secure, intelligent and seamless Expanding services to new segments and use cases to address the needs of a larger set of customers, including financial institutions, merchants, governments, digital players and others, while expanding our geographic reach Supporting and strengthening new network capabilities, including expanding services associated with digital identities and deploying our expertise in open banking and open data, including with improved analytics Embrace new network opportunities. We are building and managing new adjacent network capabilities to power commerce, creating new opportunities to develop and embed services. We do so by: Applying our open banking solutions to help institutions and individuals exchange data securely and easily, by enabling the reliable access, transmission and management of consumer data (including for opening new accounts, securing loans, increasing credit scores and enabling consumer choice in money movement and personal finance management) Enabling digital identity solutions , including device intelligence, document proofing, internet protocol (IP) intelligence, biometrics, transaction fraud data, location, identity attributes and payment authorization to make transactions across individual devices and accounts efficient, safe and secure Each of our priorities supports and builds upon each other and are fundamentally interdependent: Payments provide data and distribution to drive scale and differentiation in services and enable the development and adoption of new network capabilities Services improve the security, efficiency and intelligence of payments, improve portfolio performance, differentiate our offerings and strengthen our customer relationships. They also power our open banking and digital identity platforms New network opportunities strengthen our digital payments value proposition, including improved authentication with digital identity, and new opportunities to develop and embed services in our expanding product offerings Powering Our Success These priorities are supported by six key drivers: People. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries. Our people and our winning culture is based on decency, respect and inclusion where people have opportunities to perform purpose-driven work that impacts communities, customers and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Brand. Our brands and brand identities (including our sonic brand identity) serve as a differentiator for our business, representing our values and enabling us to accelerate growth in new areas. Data. We use our data assets, infrastructure and platforms to create a range of products and services for our customers, while incorporating our data principles in how we design, implement and deliver those solutions. Our Privacy by Design and Data by Design processes have been developed to ensure we embed privacy, security and data controls in all of our products and services, keeping a clear focus on protecting customers and individuals data. Technology. Our technology provides resiliency, scalability and flexibility in how we serve customers. It enables broader reach to scale digital payment services to multiple channels, including mobile devices. Our technology standards, services and governance model help us to serve as the connection that allows financial institutions, financial technology companies (fintechs) and others to interoperate and enable consumers, businesses, governments and merchants to engage through digital channels. 8 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Franchise. We manage an ecosystem of stakeholders who participate in our network. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We provide a balanced ecosystem where all participants benefit from the availability, innovation and safety and security of our network and platforms. Our franchise enables the scale of our payments network and helps ensure our multiple payment capabilities operate under a single governance structure, which can be extended to new opportunities. Doing Well by Doing Good. We apply the full breadth of our technology, insights, partnerships and people to build a more financially inclusive and sustainable digital economy, with a commitment to diversity, equity and inclusion and a focus on a sustainable future. We are committed to our core values of operating ethically, responsibly and with decency. This commitment is directly connected to our continuing success as a business. We refer you to our most recently published Sustainability Report and Proxy Statement (each located on our website) for our efforts and initiatives in the area of sustainability. Our Business Our Multi-Rail Network and Payment Capabilities We enable a wide variety of payment capabilities (including integrated products and value-added service solutions) over our multi-rail network among account holders, merchants, financial institutions, businesses, governments and others, offering our customers one partner for their payment needs. Core Network Our core network links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at tens of millions of acceptance locations worldwide. This network facilitates an efficient, safe and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We enable transactions for our customers through our core network in more than 150 currencies and in more than 210 countries and territories. MASTERCARD 2021 FORM 10-K 9 PART I ITEM 1. BUSINESS Core Network Transactions. Our core network supports what is often referred to as a four-party payments network and includes the following participants: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. The following graphic depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below) and other applicable fees, and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs and benefits that consumers and merchants derive. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for the customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate. Issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and settle the transaction by facilitating the exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and country of issuance are different (cross-border transactions), providing account holders with the ability to use, and merchants 10 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the country of issuance are the same (domestic transactions). We switch over 60% of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers or the availability of unspent prepaid account holder account balances. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture that enables the network to adapt to the needs of each transaction. The network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring, tokenization services, etc.) to appropriate transactions in real time. This architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Additional Payment Capabilities ACH Batch and Real-Time Account-Based Payments Infrastructure and Applications. We offer ACH batch and real-time account-based payments capabilities, enabling payments for ACH transactions between bank accounts in real-time. These capabilities provide consumers and businesses the ability to make instant (faster) payments while providing enhanced data and messaging capabilities. We build, implement, enhance and operate real-time clearing and settlement infrastructure, payment platforms and direct debit systems for jurisdictions globally. As of December 31, 2021, we either operated or were implementing real-time payments infrastructure in 12 of the top 50 markets as measured by GDP. We also apply our real-time payments capabilities to new payment flows, such as consumer bill payments using our real-time bill pay solutions. Account to Account. We enable consumers, businesses, governments and merchants to send and receive money directly from account to account. We apply these capabilities to help these stakeholders with various disbursements and remittances. We discuss below under Our Payment Products and Applications the ways in which we apply our real-time account-based and account to account payment capabilities to capture new payment flows. Security and Franchise Payments System Security. We have a multi-layered approach to protect the global payments ecosystem. As part of this approach, we have a robust program to protect our network from cyber and information security threats. Our network and platforms incorporate multiple layers of protection, providing greater resiliency and best-in-class security protection. Our programs are assessed by third parties and incorporate benchmarking and other data from peer companies and consultants. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, an enterprise resilience program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. Through the combined efforts of our Security Operations Centers, Fusion Centers and the Mastercard Intelligence Center, we work with experts across the organization (as well as through other sources such as public-private partnerships) to monitor and respond quickly to a range of cyber and physical threats. As another feature of our multi-layered approach to protect the global payments ecosystem, we work with issuers, acquirers, merchants, governments and payments industry associations to develop and put in place technical standards (such as EMV standards for chips and smart payment cards) for safe and secure transactions and we provide solutions and products that are designed to ensure safety and security for the global payments ecosystem. We discuss specific cyber and intelligence solutions that we offer to our customers in Our Value-Added Services. Our Franchise. We manage an ecosystem of stakeholders that participate in our network and payments platforms. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We ensure a balanced ecosystem where all participants benefit from the availability, innovation, safety and security of our network. We achieve this through the following key activities: Participant Onboarding. We ensure the capability of new customers to use our network and define the roles and responsibilities for their operations once on the network Safety and Security. We establish the core principles, including ensuring consumer protections and integrity, so participants feel confident to transact on the network Operating Standards. We define the operational, technical and financial policies to which network participants are required to adhere MASTERCARD 2021 FORM 10-K 11 PART I ITEM 1. BUSINESS Responsible Stewardship. We establish performance standards to support ecosystem growth and optimization and establish proactive monitoring to ensure participant performance Issue Resolution. We operate a framework to enable the resolution of disputes for both customers and consumers Our Payment Products and Applications We provide a wide variety of integrated products and services that support payment products that customers can offer to consumers and merchants. These offerings facilitate transactions across our multi-rail payments network and platforms among account holders, merchants, financial institutions, digital partners, businesses, governments and other organizations in markets globally. Core Payment Products Consumer Credit. We offer a number of products that enable issuers to provide consumers with credit, allowing them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. How We Benefit Consumers We enable our customers to benefit consumers by: making electronic payments more convenient, secure and efficient delivering better, seamless consumer experiences providing consumers choice, empowering them to make and receive payments in the ways that best meet their daily needs protecting consumers and all other participants in a transaction, as well as consumer data providing loyalty rewards Consumer Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid accounts are a type of electronic payment that enables consumers to pay in advance whether or not they previously had a bank account or a credit history. These accounts can be tailored to meet specific program, customer or consumer needs, such as paying bills, sending person-to-person payments or withdrawing cash from an ATM. Our focus ranges from digital accounts (such as fintech and gig economy platforms) to business programs such as employee payroll, health savings accounts and solutions for small business owners. Our prepaid programs also offer opportunities in the private and public sectors to drive financial inclusion of previously unbanked individuals through social security payments, unemployment benefits and salary cards. We also provide prepaid program management services, primarily outside of the United States, that provide processing and end-to-end services on behalf of issuers or distributor partners such as airlines, foreign exchange bureaus and travel agents. Commercial Credit and Debit. We offer commercial credit and debit payment products and solutions that meet the payment needs of large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our point of sale offerings include small business (debit and credit), travel and entertainment, purchasing cards and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our virtual card offerings, supported by our Mastercard In Control platform, generate virtual account numbers which provide businesses with enhanced controls, more security and better data. 12 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS The following chart provides gross dollar volume (GDV) and number of cards featuring our brands in 2021 for select programs and solutions: Year Ended December 31, 2021 As of December 31, 2021 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2020 Mastercard-branded Programs 1,2 Consumer Credit $ 2,899 18 % 38 % 968 9 % Consumer Debit and Prepaid 3,953 22 % 51 % 1,509 13 % Commercial Credit and Debit 867 25 % 11 % 111 11 % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. New Payment Flows We offer platforms that apply our payment capabilities to support and capture new payment flows beyond cards. Disbursements and Remittances. We offer applications that enable consumers, businesses, governments and merchants to send and receive money domestically and across borders with greater speed and ease. Using Mastercard Send, we partner with digital messaging and payment platforms to enable consumers to send and receive money directly within applications. We partner with central banks, fintechs and financial institutions to help governments and nonprofits more efficiently enable, as applicable, distribution of social and economic assistance and business-to-consumer (B2C) disbursements. Mastercard Cross-Border Services enables a wide range of payment flows and use cases to customers, including trade payments, remittances and disbursements. These flows are enabled via a distribution network with a single point of access that allows financial institutions, fintechs and digital partners to send and receive money globally through multiple channels, including bank accounts, mobile wallets, cards and cash payouts. B2B Payments. We continue to focus on developing solutions to address ways that businesses move money, building on our point of sale capabilities to capture B2B payments. We offer B2B solutions globally that optimize customer choice, enabling payments through card, ACH and real-time payment rails. Mastercard Track BPS, our two-sided open-loop commercial service platform, is aimed at improving the way businesses pay and get paid by simplifying and automating payments between suppliers and buyers. It provides a single connection enabling access to multiple payment rails, providing greater control, richer data and working capital optimization capabilities to enhance B2B transactions for both buyers and suppliers. Track BPS leverages multiple payment options, including both real-time payments and batch ACH, as well as our core network. Consumer Bill Payments. We offer applications including those that make it easier for consumers and small businesses to present, view, manage and pay their bills through their online or mobile banking apps. Payments can be made in a variety of ways, using cards, real-time payments or batch ACH payments through a digital interface, providing a convenient, secure and paperless means to manage household bills in one place. Our bill pay solutions, which include Bill Pay Exchange, provide an open, Application Programming Interface (API) based bill pay network that leverages real-time messaging to connect consumers with billers and merchants through the home banking channel. We also provide real-time bill pay solutions as well as clearing and instant payment services. Our solutions enable enhanced biller setup and expanded bill presentment. They facilitate payment choice using multiple payment rails (including real-time account-based payments) and deliver immediate payment confirmation, providing an experience that benefits consumers, financial institutions and billers. MASTERCARD 2021 FORM 10-K 13 PART I ITEM 1. BUSINESS Innovation and Technology Our innovation capabilities and our technology provide resiliency, scalability and flexibility in how we serve customers. They enable broader reach to scale digital payment services across multiple channels, including mobile devices. Our technology standards, services and governance model help us to serve as the connection that allows financial institutions, fintechs and technology companies to interoperate and enable consumers, businesses, governments and merchants to engage through digital channels. Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base. Our contactless payment solutions help deliver a simple and intuitive way to pay, as well as health and safety benefits when consumers are looking for low-touch options Key 2021 Developments During 2021, we announced the expansion of several programs that enabled consumers to either use their cards to purchase cryptocurrencies or to convert their cryptocurrencies back into fiat currencies at their respective financial institutions. During 2021, we announced Mastercard Installments, our new open loop solution to deliver buy-now-pay-later installments capabilities at scale. The solution connects lenders with merchants across our acceptance network to provide buy-now-pay-later options for consumers. The program is expected to launch in 2022. Our Click to Pay checkout experience is designed to provide consumers the same convenience and security in a digital environment that they have when paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. This experience is based on the EMV Secure Remote Commerce industry standard that enables a faster, more secure checkout experience across web and mobile sites, mobile apps and connected devices Our Digital First Card program enables customers to offer their cardholders a fully digital payment experience with an optional physical card, meeting cardholder expectations of immediacy, safety and convenience during card application, authentication and instant card access, securing purchases (whether contactless, in-store, in-app or via the web) and managing alerts, controls and benefits Our Digital Doors program helps small businesses establish and protect an online presence, including accepting digital payments Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class APIs across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Foundry (formerly known as Mastercard Labs), we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. 14 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Value-Added Services Our services encompass a wide-ranging portfolio of value-added and differentiating capabilities that: instill trust in the ecosystem to allow parties to transact and operate with confidence provide actionable insights to our customers to assist in their decision making enable our customers to strengthen their engagement with their own end-users enable connectivity and access for a fragmented and diverse set of parties Cyber and Intelligence Solutions As part of the security we bring to the payments ecosystem, we offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer is designed to protect against attacks on infrastructure, devices and data. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Our solutions include SafetyNet, which protects financial institutions by helping to stop real-time attacks that are visible in the network, but not easily detected by financial institutions. The Identify layer allows us to help banks and merchants verify the authenticity of consumers during the payment process using various biometric technologies, including fingerprint, face and iris scanning, and behavioral user data assessment technology to verify online purchases on mobile devices, as well as a card with biometric technology built in. Key 2021 Developments We acquired CipherTrace, a leading digital currency intelligence platform that can map and trace blockchain-based transactions between entities, providing greater transparency and helping manage regulatory and compliance obligations. We became the first company to announce the retirement of legacy magnetic stripe technology enabling us to focus on technologies, such as chip and contactless, which provide increased security. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Our offerings in this space include alerts when accounts are exposed to data breaches or security incidents, fraud scoring technology that scans billions of dollars of money flows each day while increasing approvals and reducing false declines, and network-level monitoring on a global scale to help detect the occurrence of widespread fraud attacks when the customer (or their processor) may be unable to detect or defend against them. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions (enhancing approvals for online and card-on-file payments) to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include solutions for consumer alerts and controls and a suite of digital token services. We also offer an e-commerce fraud and dispute management network that enables merchants to stop delivery when a fraudulent or disputed transaction is identified, and issuers to refund the cardholder to avoid the chargeback process. The Network layer extends the services we provide to transactions in the payments ecosystem and across all of our rails, including decision intelligence and tokenization capabilities, to help secure our customers and transactions on a real-time basis. Moreover, we use our artificial intelligence (AI) and data analytics, along with our cyber risk assessment capabilities, to help financial institutions, merchants, corporations and governments secure their digital assets across each of these five layers. We have also worked with our customers to provide products to consumers globally with increased confidence through the benefit of zero liability, where the consumer bears no responsibility for counterfeit or lost card losses in the event of fraud. MASTERCARD 2021 FORM 10-K 15 PART I ITEM 1. BUSINESS Insights, Analytics and Test and Learn Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. We offer business intelligence to monitor key performance indicators (KPIs) and benchmark performance through self-service digital platforms, tools, and reports for financial institutions, merchants and others. We enable clients to better understand consumer behavior and improve segmentation and targeting by using our anonymized and aggregated data assets, third-party data and AI technologies. Through our Test Learn software as a service platform, we can help our customers accurately measure the impact of their decisions and improve them by leveraging data analytics to conduct disciplined business experiments for in-market tests to drive more profitable decision making. Consulting and Innovation We provide advisory services that help clients make better decisions and improve performance. By observing patterns of payments behavior based on billions of transactions switched globally, we are able to leverage anonymized and aggregated information to provide advice based on data. We also utilize our expertise, digital technology, innovation tools, methodologies and processes to collaborate with, and increasingly drive innovation at, financial institutions, merchants and governments. Through our global innovation and development arm, Mastercard Foundry, we offer Launchpad, a five-day app prototyping workshop, as well as other customized innovation programs such as in-lab usability testing and concept design. Managed Services We deliver marketing services, digital implementation and program management with performance-based solutions at every stage of the consumer lifecycle to assist our customers in implementing actions based on insights and driving adoption and usage. These services include developing messaging, targeting key groups, launching campaigns and training staff, all of which help our customers drive engagement and portfolio profitability. Issuer and Merchant Loyalty We have built a scalable rewards platform that enables issuers to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. We also provide a loyalty platform that enables stronger relationships with retailers, restaurants, airlines and consumer packaged goods companies by creating experiences that drive loyalty and impactful consumer engagement. Processing and Gateway We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions 16 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Expanded Network Capabilities Open Banking We offer an open banking platform that enables data providers and third parties, on a permissioned basis, to reliably access, securely transmit and confidently manage consumer data to improve the customer experience. Our platform enables consumers to have choice of financial services, providing them the ability to access, control and benefit from the use of their data, as well as an improved payment experience. Our platform is also used to serve the needs of the lending market, including through streamlining loan application processes and improving credit decisioning, thereby driving further financial inclusion. The network connections that underpin this platform leverage our data principles (including data usage guardrails, consumer protection and consent management), as well as API technology. Digital Identity We enable digital identity solutions, which provide smooth digital experiences and strengthen and secure digital payments across individuals, devices and accounts. Our digital identity capabilities focus on the identity of people, devices and transactions. They embody privacy by design principles and are consent-centric. Our solutions include device intelligence and behavioral biometrics (to determine whether the user is genuine or a fraudulent device), document proofing, IP intelligence, biometrics, transaction fraud data (from which we derive insights that can be used to significantly improve the global approval rate of transactions), location, identity attributes and payment authorization. Key 2021 Developments We acquired Ekata, Inc., a leader in digital identity verification solutions, broadening our fraud prevention and digital identity verification programs by adding Ekata's identity verification data, machine learning technology and global experience. Our People As of December 31, 2021, we employed approximately 24,000 persons globally. Our employee base is predominantly full-time and approximately 65% were employed outside of the United States in more than 80 countries around the world. We also had approximately 3,900 contractors which we used to supplement our employee base in order to meet specific needs. Our voluntary workforce turnover (rolling 12-month attrition) was 11% as of December 31, 2021. The total cost of our workforce for the year ended December 31, 2021 was $4.5 billion, which primarily consists of compensation, benefits and other personnel- and contractor-related costs. We provide more detailed information regarding our employees, including additional workforce demographics such as gender and racial/ethnic representation, in our Sustainability Report, our Proxy Statement, our Global Inclusion Report and our U.S. Consolidated EEO-1 Report, all of which are located on our website. We continue to support our employees during the ongoing global COVID-19 pandemic. We have extended a variety of global COVID-related employee benefits through 2022, including flexible hybrid working arrangements and additional paid time off due to illness, to get vaccinated, or to tend to childcare or eldercare-related demands. Our focus remains on the safety and well-being of our employees while maintaining health and safety protocols at each office location. Management reviews our people strategy and culture, as well as related risks, with our Human Resources and Compensation Committee on a quarterly basis, and annually with our Board of Directors. Additionally, our Board of Directors and our Board committees are tasked with overseeing other human capital management matters on a regular basis, such as ensuring processes are in place for maintaining an ethical corporate culture, overseeing key diversity initiatives, policies and practices, and monitoring governance trends in areas such as human rights. Our ability to attract, retain and engage top talent and build a culture centered around decency, with an overall focus on diversity, equity and inclusion (DEI), is critical to our business strategy. Specifically, to enable our business strategy effectively, our aim is to: attract talent with the key skills needed develop and retain an agile workforce that is able to compete in a fast-paced, digitally native and innovative environment and build on our DEI efforts to support our employees MASTERCARD 2021 FORM 10-K 17 PART I ITEM 1. BUSINESS Attract talent. Leveraging the strength of our brand, we attract talent through acquisitions, workforce planning and recruitment that incorporates a variety of sources. Develop and retain talent. Our efforts to develop and retain our employees include: An annual cycle that is focused on objective setting, performance assessment, talent evaluation, skill development, opportunities and career progression Succession planning for key roles, including talent and leadership programs across various levels. These programs embed our culture principles, include diverse populations and aim to develop talent and managerial skills through personalized coaching and group executive development Learning opportunities, such as Learning Academies that support our corporate business strategy and priorities and offer programs aligned to regional priorities Mentorship programs that give mentees tools and resources to help build and enhance their skills, inspire personal growth, overcome dilemmas, foster inclusion and support well-being A competitive compensation approach under which eligible employees across multiple job levels can receive long-term incentive equity awards Holistic physical, mental, professional and other benefits to our employees and their families to provide support when and where they need it Contributions to employees financial well-being as they plan for retirement. All employees globally are entitled to receive a matching Company contribution of $1.67 for every $1 contributed to a 401(k) or other retirement plan on the first 6% of base pay Support for charitable contributions of our employees time and money. We support employee charitable donations with matching Company gifts of up to $15,000 per employee annually and permit full-time employees to use five paid days per year for eligible volunteer work A culture of high ethical business practices and compliance standards, grounded in honesty, decency, trust and personal accountability. It is driven by tone at the top, reinforced with regular training, fostered in a speak-up environment, and measured by periodic employee surveys and other metrics that are designed to enable our Board of Directors to gauge the health of our culture Diversity, equity and inclusion underpin everything we do: We monitor our recruitment, development, succession and retention practices with a focus on gender, race (in the U.S.) and generational mix of our employee population We have developed regional and functional action plans to identify priorities and actions that will help us make more progress for DEI, including appropriate balance and inclusion in gender and racial representation We remain committed to our In Solidarity initiative through alignment of our DEI plans, introduction of new training programs and partnerships with historically Black colleges and universities (HBCUs) and other schools with diverse talent We introduced a modifier to our 2021 executive compensation plan that includes quantitative goals for gender pay and other key environmental, social and governance (ESG) items We expect to provide additional updates in 2022 on our diversity, equity and inclusion efforts, including the executive compensation modifier, in our upcoming Sustainability Report, Proxy Statement and Global Inclusion Report, all of which will be located on our website. 18 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands and brand identities (including our sonic brand identity) through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, preference and overall usage among account holders globally. Our Priceless advertising campaign, which has run in more than 50 languages and in more than 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Data We use our data assets, infrastructure and platforms to create a range of products and services for our customers, including the majority of our value-added services, which help reduce fraud, increase security, provide actionable insights to our customers to assist in their decision making and enable our customers to increase their engagement with consumers. We do all this while incorporating our data principles in how we design, implement and deliver those solutions. Our Privacy by Design and Data by Design processes have been developed to ensure we embed privacy, security and data controls in all of our products and services, keeping a clear focus on protecting customers and individuals data. We do this in a number of ways: Practicing data minimization. We collect and retain only the data that is needed for a given product or service, and limit the amount and type of personal information shared with third parties Being transparent and providing control. We explain how we use personal information and give individuals access and control over how their data is used and shared Working with trusted partners. We select partners and service providers who share our principled-approach to protecting data Addressing data bias. We ensure our use of advanced analytics, including AI and Machine Learning, utilizes diverse data sets to create fair and inclusive solutions that reflect individual, group and societal interests Advancing positive social impact. We utilize our data sets to create innovative solutions to societal challenges, promoting inclusive financial, social, climate, health and education growth Revenue Sources We generate revenue primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 and Note 3, Revenue for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other technologies, which are important to our business operations. These patents expire at varying times depending on the jurisdiction and filing date. MASTERCARD 2021 FORM 10-K 19 PART I ITEM 1. BUSINESS Competition We face a number of competitors both within and outside of the global payments industry and compete in all categories of payment, including paper-based payments and all forms of electronic payments. Among electronic payments, we face the following competition: General Purpose Payments Networks. We compete worldwide with payments networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. These competitors tend to offer a range of card-based payment products. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. Globally, financial institutions may issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express, China UnionPay and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. Debit and Local Networks. We compete with ATM and point of sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Real-time Account-based Payments Systems. We face competition in the real-time account-based payments space from other companies that provide infrastructure, applications and services to support these payment solutions. Alternative Payments Systems and New Entrants. As the global payments industry becomes more complex, we face increasing competition from alternative payments systems and emerging payments providers. Many of these providers, who in many circumstances can also be our partners or customers, have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payments networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), point of sale financing/buy-now-pay-later providers (such as Klarna), mobile operator services, mobile phone-based money transfer and microfinancing services (such as M-PESA) and handset manufacturers. We also compete with merchants and governments. National (Government-Backed) Networks. Governments have been increasingly creating regional payments structures, such as the newly established European Payments Initiative (EPI). Backed by numerous Eurozone banks and acquirers, EPI is aimed at creating a unified pan-European payments system, offering card, digital wallet and person-to-person (P2P) payment solutions for consumers and merchants. EPI is being positioned as an alternative to existing international payment solutions and schemes such as ours. In addition to regional networks, more than 80 national governments are exploring the use of central bank digital currencies (CBDCs). Digital Currencies. Stablecoins and floating cryptocurrencies may become more popular as they are increasingly viewed as providing immediacy, 24/7 accessibility, immutability and efficiency. Such currencies are starting to be accepted by person-to-merchant (P2M) players (such as Square). These currencies are also introducing into the payments ecosystem an emerging set of providers referred to as crypto natives, who have the ability to disrupt traditional financial markets. The increased prominence of digital currencies could compete with our products and services. Value-Added Service Providers and Adjacent Network Capabilities Players. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, merchants and governments and technology companies that provide cyber and fraud solutions, as well as companies that compete against us as providers of loyalty and program management solutions. We also face competition from companies that provide alternatives to our open banking and digital identity solutions. Regulatory initiatives could also lead to increased competition in this space. Mastercard plays a valuable role as a trusted intermediary in a complex system, creating value for individual stakeholders and the payments ecosystem overall. Our competitive advantages include our: globally recognized and trusted brands highly adaptable global acceptance network built over more than 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance 20 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS settlement guarantee backed by our strong credit standing expertise in real-time account-based payments and open banking development and adoption of innovative products and digital solutions safety and security solutions offered on our network, which reduce fraud and increase security for the payments ecosystem analytics insights and consulting services that help issuers and merchants optimize their payments and related businesses loyalty solutions that enhance the payments value proposition for issuers and merchants ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent and culture, with a focus on inclusion and being a force for good Collectively, the capabilities that we have created organically, and those that we have obtained through acquisitions, continue to enhance the total proposition we offer our customers. They enable us to partner with many participants in the broader payments ecosystem and provide choice, security and services to improve the value we provide to our customers. Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. We are committed to comply with all applicable laws and regulations and implement policies, procedures and programs designed to promote compliance. We coordinate globally while acting locally and leverage our relationships to manage the effects of regulation on us. See Risk Factors in Part I, Item 1A for more detail and examples of the regulation to which we are subject. Payments Oversight and Regulation. Central banks and other regulators in several jurisdictions around the world either have, or are seeking to establish, formal oversight over the payments industry, as well as authority to regulate certain aspects of the payments systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, Mastercard is subject to systemic importance regulation, which includes various requirements we must meet, including obligations related to governance and risk management. In the U.K., the Bank of England designated Vocalink, our real-time account-based payments network platform, as a specified service provider, and Mastercard Europe as a recognized payment system, which includes supervisions and examination requirements. In addition, European Union legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switching activities and other processing in terms of how we go to market, make decisions and organize our structure. Certain of our subsidiaries are regulated as payments institutions, including as money transmitters. This regulation subjects us to licensing obligations and regulatory supervision, as well as various business conduct and risk management requirements. Interchange Fees. Interchange fees that support the function and value of four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities, our settlement with the European Commission resolving its investigation into our interregional interchange fees and the European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the European Economic Area (the EEA). For more detail, see Risk Factors - Other Regulation in Part I, Item 1A and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Some jurisdictions are currently considering adopting or have adopted data localization requirements, which mandate the collection, processing, and/or storage of data within their borders. This is the case, for instance, in India, China, Saudi Arabia and South Africa. Various forms of data localization requirements or data transfer restrictions are also under consideration in other countries and jurisdictions, including the European Union. Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter-financing of terrorism (CFT) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CFT program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payments MASTERCARD 2021 FORM 10-K 21 PART I ITEM 1. BUSINESS network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in these countries and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer and Acquirer Practices Legislation and Regulation. Our issuers and acquirers are subject to numerous regulations and investigations applicable to banks, financial institutions and other licensed entities, impacting us as a consequence. Additionally, regulations such as the revised Payment Services Directive (commonly referred to as PSD2) in the EEA require financial institutions to provide third-party payment processors access to consumer payment accounts, enabling them to route transactions away from Mastercard products and provide payment initiation and account information services directly to consumers who use our products. PSD2 also requires a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Regulation of Internet, Digital Transactions and High-Risk Merchant Categories. Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports, as well as certain legally permissible but high-risk merchant categories, such as alcohol, tobacco, firearms and adult content. Privacy, Data and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the General Data Protection Regulation (the GDPR), which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California, Virginia and Colorado), Argentina, Brazil, Canada (Quebec), Chile, China, India, Indonesia, Kenya and Saudi Arabia. Due to increasing data collection and data flows, numerous data breaches and security incidents as well as the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to regulate data and protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Sustainability. Various jurisdictions are increasingly considering or adopting laws and regulations that would impact us pertaining to ESG performance, transparency and reporting. Regulations being considered include mandated corporate reporting on sustainability matters generally (such as the European Union Corporate Sustainability Reporting Directive) as well as in specific areas such as mandated reporting on climate-related financial disclosures. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. 22 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website, including, but not limited to, our Sustainability Report, our Global Inclusion Report and our U.S. Consolidated EEO-1 Report, is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. "," Item 1A. Risk factors RISK HIGHLIGHTS Legal and Regulatory Business and Operations Payments Industry Regulation COVID-19 Global Economic and Political Environment Preferential or Protective Government Actions Competition and Technology Brand and Reputational Impact Privacy, Data and Security Information Security and Service Disruptions Talent and Culture Other Regulation Stakeholder Relationships Acquisitions Litigation Settlement and Third-Party Obligations Class A Common Stock and Governance Structure Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations, establishing, and potentially further expanding, obligations or restrictions with respect to the types of products and services that we may offer, the countries in which our integrated products and services MASTERCARD 2021 FORM 10-K 23 PART I ITEM 1A. RISK FACTORS may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). Several jurisdictions have also inquired about the network fees we charge to our customers (typically as part of broader market reviews of retail payments). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. In several jurisdictions, we have been designated as a systemically important payment system, and other regulators are considering designating us as systemically important or in a similar category resulting in heightened regulatory oversight. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payments systems. Moreover, as regulators around the world increasingly look to replicate similar regulation of payments and other industries, efforts in any one jurisdiction may influence approaches in other jurisdictions. Similarly, new initiatives within a jurisdiction involving one product may lead to regulation of similar or related products (for example, debit regulations could lead to regulation of credit products). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. The expansion of our products and services as part of our multi-rail strategy have also created the need for us to obtain new types and increasing numbers of regulatory licenses, resulting in increased supervision and additional compliance burdens distinct from those imposed on our core network activities. For example, certain of our subsidiaries maintain money transfer licenses to support certain activities. These licenses typically impose supervisory and examination requirements, as well as capital, safeguarding, risk management and other business obligations. Increased regulation and oversight of payments systems, as well as increased exposure to regulation resulting from changes to our products and services, have resulted and may continue to result in costly compliance burdens or otherwise increase our costs. As a result, issuers, acquirers and other customers could be less willing to participate in our payments system and/or use our other products or services, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. In addition, any regulation that is enacted related to the type and level of network fees we charge our customers could also materially and adversely impact our results of operations. Regulators could also require us to obtain prior approval for changes to our system rules, procedures or operations, or could require customization with regard to such changes, which could negatively impact us. Such changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Business - Government Regulation in Part I, Item 1 and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are required to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek a fee reduction from us to decrease the expense of their payment programs, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. 24 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries have implemented, or may implement, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. Some jurisdictions have implemented, or are considering, requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications as well as increased compliance burdens and other costs. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead affected jurisdictions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. In addition, to the extent a jurisdiction determines us not to be in compliance with regulatory requirements (including those related to data localization), we have, and may continue to be, subject to resource and time pressures in order to come back into compliance. Our inability to effect change in, or work with, these jurisdictions could adversely affect our ability to maintain or increase our revenues and extend our global brand. Additionally, some jurisdictions have implemented, or may implement, foreign ownership restrictions, which could potentially have the effect of forcing or inducing the transfer of our technology and proprietary information as a condition of access to their markets. Such restrictions could adversely impact our ability to compete in these markets. Privacy, Data and Security Regulation of privacy, data, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated and personalized products and services to meet the needs of a changing marketplace, and acquire new companies, we have expanded our information profile through the collection of additional data from additional sources and across multiple channels. This expansion has amplified the impact of these regulations on our business. Regulation of privacy, data and information security requires monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information, as well as increased care in our data management, governance and quality practices. While we make every effort to comply with all regulatory requirements and we deploy a privacy-by-design and data-by-design approach to all of our product development, the speed and pace of change may not allow us to meet rapidly evolving expectations. We are also MASTERCARD 2021 FORM 10-K 25 PART I ITEM 1A. RISK FACTORS subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions have implemented or are otherwise considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions have adopted or are otherwise considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements, as well as regulations on artificial intelligence and data governance, that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or changing interpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and/or restrict our ability to leverage data for innovation. This could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the need for improved data management, governance and quality practices, the development of information-based products and solutions, and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity and increasing cyberattacks have encouraged legislative and regulatory intervention, and could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer personal information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to legislative or regulatory intervention, such as enhanced security requirements and liabilities, as well as damage to our reputation. Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption - We are subject to AML and CFT laws and regulations globally. Economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies, and persons and entities. We are also subject to anti-corruption laws and regulations globally, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. Account-based Payments Systems - In the U.K., aspects of our Vocalink business are subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer and Acquirer Practices Legislation and Regulation - Certain regulations (such as PSD2 in the EEA) may impact various aspects of our business. For example, PSD2s strong authentication requirement could increase the number of transactions that consumers abandon if we are unable to secure a frictionless authentication experience under the new standards. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, 26 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS amplifying any potential compliance burden. Additionally, our compliance with new economic sanctions and related laws with respect to particular jurisdictions or customers could result in a loss of business, which could be significant. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. In particular, a violation and subsequent judgment or settlement against us, or those with whom we may be associated, under economic sanctions and AML, CFT, and anti-corruption laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Each instance may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective income tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective income tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective income tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant in a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations COVID-19 The global COVID-19 pandemic and measures taken in response have adversely impacted our business, results of operations and financial condition, and may continue to do so depending on future developments, which are uncertain. The global COVID-19 pandemic continues to have negative effects on the global economy. The pandemic has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. Variants of the virus have emerged, resulting in a resurgence of infections that have affected regions at different times. New variants may emerge with similar results. The extent to which the resurgence and severity of infections has affected, and may in the future affect, regions is impacted by the ongoing global administration of vaccines and the availability of therapeutic treatments in those locations. Governments, businesses and consumers continue to react to the changing conditions, tightening or loosening safety measures or voluntarily making personal safety decisions, as applicable, based on the current environment of their location. The pandemic has caused us to modify our business practices (including employee travel, employee work locations, and working in remote or hybrid environments). We continue to monitor the effects of the pandemic and may take further actions as required that are in the best interests of our employees, customers and business partners and which otherwise meet the responses by MASTERCARD 2021 FORM 10-K 27 PART I ITEM 1A. RISK FACTORS governments, businesses and consumers. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or otherwise be satisfactory to government authorities or voluntary actions taken by the public. The COVID-19 pandemic has adversely impacted our business, results of operations and financial condition. There are no comparable recent events which may provide guidance as to the effect of a global pandemic such as COVID-19, and, as a result, the ultimate impact of this pandemic or a similar health epidemic in the future is highly uncertain and subject to change. The full extent to which the COVID-19 pandemic, and measures taken in response, further impacts our business, results of operations and financial condition will depend on future developments, which are uncertain, including, but not limited to, the duration of the pandemic and its impact on the global economy, including how quickly and to what extent we can continue to progress toward more consistent economic and operating conditions. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business and our result of operations as a result of its global economic impact, including any recession that has occurred or may occur in the future. Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against competitors both within and outside of the global payments industry and compete in all categories of payment, including paper-based payments and all forms of electronic payments. We compete against general purpose payments networks, debit and local networks, ACH and real-time account-based payments systems, alternative payments systems and new entrants (focused on online activity across various channels and processing payments using in-house capabilities), national networks and digital currencies. We also face competition from companies that provide alternatives to our value-added services and adjacent network capabilities (including open banking and digital identity). Our traditional competitors may have substantially greater financial and other resources than we have, may offer a wider range of programs, services, and payment capabilities than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition and merchant acceptance than we have. They may also introduce their own innovative programs, value-added services and capabilities that adversely impact our growth. Certain of our competitors to our core network operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business - Competition in Part I, Item 1. New entrants against whom we compete have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on technology to support their services that provides cost advantages, and as a result may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our ability to compete may also be affected by regulatory and legislative initiatives, as well as the outcomes of litigation, competition-related regulatory proceedings and central bank activity and legislative activity. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Industry participants continue to invest in and develop alternative capabilities, such as account to account payments, which could facilitate P2M transactions that compete with our core payments network. 28 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Regulation (such as PSD2 in the EEA) may disintermediate issuers by enabling third-party providers opportunities to route payment transactions away from our network and products and towards other forms of payment by offering account information or payment initiation services directly to those who currently use our products. Such regulation may also provide these processors with the opportunity to commoditize the data that are included in the transactions they are servicing. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. Although we partner with fintechs and technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. When we do partner with fintechs and technology companies, we face a heightened risk when those relationships involve sharing Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data standards, without proper oversight we could give the partner a competitive advantage. Competitors, customers, fintechs, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop or encourage the creation of national payments platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets, or require us to compete differently. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our products and services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. We continue to experience pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. MASTERCARD 2021 FORM 10-K 29 PART I ITEM 1A. RISK FACTORS Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with fintechs, technology companies (such as digital players and mobile providers) and traditional customers that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. Regulatory or government requirements could require us to host and deliver certain products and services on-soil in certain markets, which would require us to alter our technology and delivery model, potentially resulting in additional expenses. Various central banks are experimenting with digital currencies called Central Bank Digital Currencies (CBDC). CBDCs may be launched with their own networks to transfer money between participants. Policy and design considerations that governments adopt could impact the extent of our role in facilitating CBDC-based payment transactions, potentially impacting the transactions that we may process over our network. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payments network presents risks that could materially affect our business. U.K. regulators have designated Vocalink, our real-time account-based payments network platform, to be a specified service provider and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payments systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payments platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payments network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our multi-rail solutions and integrated products and services can present operational and onboarding challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments markets, we are continually involved in developing complex multi-rail solutions and diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users other than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. These new customers are typically less regulated, and as a result, enhanced infrastructure and monitoring is required. Our failure to effectively design and deliver these multi-rail solutions and integrated products and services could make our other offerings less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, or we are unable to adequately anticipate 30 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS risks related to new types of customers, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code (including ransomware), phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. The advent of the global COVID-19 pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce working from home in a mostly remote environment. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information and technology in our computer systems and networks, as well as the systems of our third-party providers. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks, as well as the systems of our third-party providers, have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems (including third-party provider systems) or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the MASTERCARD 2021 FORM 10-K 31 PART I ITEM 1A. RISK FACTORS trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings have experienced in limited instances and may continue to experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events (including those related to climate change). Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a enterprise resiliency program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Stakeholder Relationships Losing a significant portion of business from one or more of our largest customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Many of our customer relationships are not exclusive. Our customers can reassess their future commitments to us subject to the terms of our contracts, and they separately may develop their own services that compete with ours. Our business agreements with these customers may not ultimately reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. While we have exclusive, or nearly-exclusive, relationships with certain of our customers to issue payment products, other customers have similar exclusive, or nearly-exclusive, relationships with our competitors. These relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with these customers to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation amongst our customers could materially and adversely affect our overall business and results of operations. Our customers industries have undergone substantial, accelerated consolidation in the past. These consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. 32 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments, fintechs and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. Some merchants are increasingly asking regulators to review and potentially regulate our own network fees, in addition to interchange. See our risk factor in Risk Factors Other Regulation in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination, of the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. MASTERCARD 2021 FORM 10-K 33 PART I ITEM 1A. RISK FACTORS Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us Consumers and businesses lowering spending, which could impact domestic and cross-border spend Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity has, and may continue to be, adversely affected by world geopolitical, economic, health, weather and other conditions. These include COVID-19, as well as the threat of terrorism and separate outbreaks of flu, viruses and other diseases (any of which could result in future epidemics or pandemics), as well as major environmental and extreme weather events, including those related to climate change. As governments, investors and other stakeholders face pressure to address climate change and other sustainability matters, these stakeholders may express new expectations, focus investments and require additional disclosures in ways that cause significant shifts in commerce and consumption behaviors. The impact of and uncertainty that could result from any of these events or factors could ultimately decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. Our operations as a global payments network rely in part on global interoperable standards to help facilitate safe and simple payments. To the extent geopolitical events result in jurisdictions no longer participating in the creation or adoption of these standards, or the creation of competing standards, the products and services we offer could be negatively impacted. Any of these developments could have a material adverse impact on our overall business and results of operations. 34 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2021, approximately 68% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers or other companies and organizations that use our products and services (including certain legally permissible but high- risk merchant categories, such as alcohol, tobacco, firearms and adult content) may also, by association, impair our reputation, or result in greater public, regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. To the extent any of our published sustainability metrics are subsequently viewed as inaccurate or we are unable to execute on our sustainability initiatives, we may be viewed negatively by consumers, investors and other stakeholders concerned about these matters. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Any of the above issues could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments ecosystem, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. MASTERCARD 2021 FORM 10-K 35 PART I ITEM 1A. RISK FACTORS Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and visa regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Moreover, as a result of the global COVID-19 pandemic, a significant portion of our workforce is working in either a remote or hybrid environment. Such environments may continue after the pandemic due to potential resulting trends, and could impact the quality of our corporate culture, as well as our ability to attract and retain talent. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity and decency. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Our efforts to enter into acquisitions, strategic investments or entry into new businesses could be impacted or prevented by regulatory scrutiny and could otherwise result in issues that could disrupt our business and harm our results of operations or reputation. We continue to evaluate our strategic acquisitions of complementary businesses, products or technologies, as well as acquiring interests in related joint ventures or other entities. As we do so, we face increasing regulatory scrutiny with respect to antitrust and other considerations that could impact these efforts. We also face competition for acquisition targets due to the nature of the market for technology companies. As a result, we could be prevented from successfully completing such acquisitions in the future. If we are not successful in these efforts, we could lose strategic opportunities that are dependent, in part, on inorganic growth. To the extent we do make these acquisitions, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations, both directly as a result of the new business as well as in the other existing parts of our business, with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Additionally, targets that we acquire may have data practices that do not initially conform to our privacy and data protection standards and data governance model, which could lead to regulatory scrutiny and reputational harm. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent 36 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 8, 2022, Mastercard Foundation owned 105,091,311 shares of Class A common stock, representing approximately 10.8% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted and have occurred. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", Item 1B. Unresolved staff comments Not applicable. ," Item 2. Properties We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center, located in OFallon, Missouri. As of December 31, 2021, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries around the world, consisting of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business and address climate-related impacts, or consolidate and dispose of facilities that are no longer required. "," Item 3. Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF EQUITY SECURITIES Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 8, 2022, we had 71 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 240 holders of record of our non-voting Class B common stock as of February 8, 2022, constituting approximately 0.8% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 and the SP 500 Financials for the five-year period ended December 31, 2021. The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index 2016 2017 2018 2019 2020 2021 Mastercard $ 100.00 $ 147.68 $ 185.07 $ 294.55 $ 353.98 $ 358.07 SP 500 100.00 121.83 116.49 153.17 181.35 233.41 SP 500 Financials 100.00 122.18 106.26 140.40 138.02 186.38 42 MASTERCARD 2021 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF EQUITY SECURITIES Dividend Declaration and Policy On November 30, 2021, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of record on January 7, 2022 of our Class A common stock and Class B common stock. On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share payable on May 9, 2022 to holders of record on April 8, 2022 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities During the fourth quarter of 2021, we repurchased a total of 3.7 million shares for $1.3 billion at an average price of $342.86 per share of Class A common stock. See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion with respect to our share repurchase programs. The following table presents our repurchase activity on a cash basis during the fourth quarter of 2021: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 1,282,075 $ 351.18 1,282,075 $ 4,752,404,601 November 1 30 1,126,537 340.52 1,126,537 12,368,795,391 December 1 31 1,312,321 336.75 1,312,321 11,926,866,431 Total 3,720,933 342.86 3,720,933 1 Dollar value of shares that may yet be purchased under the share repurchase programs is as of the end of the period. 2 In November 2021 and December 2020, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion and $6.0 billion respectively, of our Class A common stock under each plan. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through our unique and proprietary core global payments network, we switch (authorize, clear and settle) payment transactions. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, we offer integrated payment products and services and capture new payment flows. Our value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on our principled use of consumer and merchant data. Our franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. Our payment solutions are designed to ensure safety and security for the global payments ecosystem. Mastercard is not a financial institution. We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. COVID-19 In 2021, our growth rates, which are at various stages of recovery, increased as compared to the respective year ago period as consumer and business spend recovers and we lap the initial effects of the COVID-19 pandemic. The following tables provide a summary of trends in our key metrics for 2021 and 2020 as compared to the respective year ago periods: 2021 Quarter ended Year ended December 31, 2021 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % 33 % 20 % 23 % 21 % Cross-border volume (local currency basis) (17) % 58 % 52 % 53 % 32 % Switched transactions 9 % 41 % 25 % 27 % 25 % 2020 Quarter ended Year ended December 31, 2020 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % (10) % 1 % 1 % % Cross-border volume (local currency basis) (1) % (45) % (36) % (29) % (29) % Switched transactions 13 % (10) % 5 % 4 % 3 % The impact of the COVID-19 pandemic, which began in the first quarter of 2020, continues to have negative effects on the global economy. The pandemic has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. Variants of the virus have emerged, resulting in a resurgence of infections that have affected regions at different times. New variants may emerge with similar results. The extent to which the resurgence and severity of infections has affected regions is impacted by the ongoing global administration of vaccines and the availability of therapeutic 44 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS treatments in those locations. Governments, businesses and consumers continue to react to the changing conditions, tightening or loosening safety measures or voluntarily making personal safety decisions, as applicable, based on the current environment of their location. We continue to monitor the effects of the pandemic and the related impact on our business. The full extent to which the pandemic, and measures and actions taken by stakeholders in response, affect our business, results of operations and financial condition will depend on future developments, including the duration of the pandemic and its impact on the global economy, which are uncertain, and cannot be predicted at this time. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2021 Increase/ (Decrease) 2020 Increase/ (Decrease) 2021 2020 2019 ($ in millions, except per share data) Net revenue $ 18,884 $ 15,301 $ 16,883 23% (9)% Operating expenses $ 8,802 $ 7,220 $ 7,219 22% % Operating income $ 10,082 $ 8,081 $ 9,664 25% (16)% Operating margin 53.4 % 52.8 % 57.2 % 0.6 ppt (4.4) ppt Income tax expense $ 1,620 $ 1,349 $ 1,613 20% (16)% Effective income tax rate 15.7 % 17.4 % 16.6 % (1.7) ppt 0.8 ppt Net income $ 8,687 $ 6,411 $ 8,118 35% (21)% Diluted earnings per share $ 8.76 $ 6.37 $ 7.94 38% (20)% Diluted weighted-average shares outstanding 992 1,006 1,022 (1)% (2)% The following table provides a summary of our key non-GAAP operating results 1 , adjusted to exclude the impact of gains and losses on our equity investments, Special Items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, 2021 Increase/(Decrease) 2020 Increase/(Decrease) 2021 2020 2019 As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 18,884 $ 15,301 $ 16,883 23% 22% (9)% (8)% Adjusted operating expenses $ 8,627 $ 7,147 $ 7,219 21% 19% (1)% (1)% Adjusted operating margin 54.3 % 53.3 % 57.2 % 1.0 ppt 1.2 ppt (4.0) ppt (3.7) ppt Adjusted effective income tax rate 15.4 % 17.2 % 17.0 % (1.8) ppt (1.8) ppt 0.2 ppt 0.3 ppt Adjusted net income $ 8,333 $ 6,463 $ 7,937 29% 28% (19)% (17)% Adjusted diluted earnings per share $ 8.40 $ 6.43 $ 7.77 31% 30% (17)% (16)% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. MASTERCARD 2021 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Key highlights for 2021 as compared to 2020 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue increased 22% on a currency-neutral basis, which includes 2 percentage points of growth from acquisitions. The remaining increase was primarily due to: up 23% up 22% - Gross dollar volume growth of 21% on a local currency basis - Cross-border volume growth of 32% on a local currency basis - Switched transactions growth of 25% - Other revenues increased 32%, or 31% on a currency-neutral basis, which includes 8 percentage points of growth due to acquisitions. The remaining growth was driven primarily by our Cyber Intelligence and Data Services solutions. These increases to net revenue were partially offset by: - Rebates and incentives growth of 32%, or 31% on a currency-neutral basis, primarily due to increased volumes and transactions and new and renewed deals. Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expenses increased 19% on a currency-neutral basis, which includes 7 percentage points of growth due to acquisitions. The remaining increase was primarily due to higher personnel costs, increased spending on advertising and marketing and increased data processing costs. up 22% up 19% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) The adjusted effective income tax rate of 15.4% was lower than prior year, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rate. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. 15.7% 15.4% Other 2021 financial highlights were as follows: We generated net cash flows from operations of $9.5 billion. We completed the acquisitions of businesses for total consideration of $4.7 billion. We repurchased 16.5 million shares of our common stock for $5.9 billion and paid dividends of $1.7 billion. We completed debt offerings for an aggregate principal amount of $2.1 billion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of gains and losses on our equity investments which includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. Our non-GAAP financial measures also exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2021, 2020 and 2019, we recorded net gains of $645 million ($497 million after tax, or $0.50 per diluted share), $30 million ($15 million after tax, or $0.01 per diluted share) and $167 million ($124 million after tax, or $0.12 per diluted share), respectively. These net gains were primarily related to unrealized fair market value adjustments on marketable and nonmarketable equity securities. In addition, in 2021, net gains also included realized gains on sales of marketable equity securities. 46 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Items Litigation provisions During 2021, we recorded pre-tax charges of $94 million ($74 million after tax, or $0.07 per diluted share) related to litigation settlements and estimated attorneys fees with U.K. and Pan-European merchants. During 2020, we recorded pre-tax charges of $73 million ($67 million after tax, or $0.07 per diluted share) related to litigation provisions which included pre-tax charges of: $45 million related to a legal matter associated with our prepaid cards in the U.K., and $28 million related to estimated attorneys fees and litigation settlements with U.K. and Pan-European merchants. Indirect tax matter During 2021, we recorded a pre-tax charge of $88 million ($69 million after tax, or $0.07 per diluted share) to resolve a foreign indirect tax matter for 2015 through the current period and the related interest. Tax act During 2019, we recorded a $57 million net tax benefit ($0.06 per diluted share), which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the transition tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. See Note 7 (Investments), Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and non-recurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Currency-neutral Growth Rates We present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency of the entity. The impact of the related realized gains and losses resulting from our foreign exchange derivative contracts designated as cash flow hedging instruments is recognized in the respective financial statement line item on the statement of operations when the underlying forecasted transactions impact earnings. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. The translational and transactional impact of currency and the related impact of our foreign exchange derivative contracts designated as cash flow hedging instruments (Currency impact) has been excluded from our currency-neutral growth rates and has been identified in our drivers of change impact tables. See Foreign Currency - Currency Impact for further information on our currency impacts and Financial Results - Revenue and Operating Expenses for our drivers of change impact tables. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. MASTERCARD 2021 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2021 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 8,802 53.4 % $ 225 15.7 % $ 8,687 $ 8.76 (Gains) losses on equity investments ** ** (645) (0.5) % (497) (0.50) Litigation provisions (94) 0.5 % ** 0.1 % 74 0.07 Indirect tax matter (82) 0.4 % 6 0.1 % 69 0.07 Non-GAAP $ 8,627 54.3 % $ (413) 15.4 % $ 8,333 $ 8.40 Year ended December 31, 2020 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,220 52.8 % $ (321) 17.4 % $ 6,411 $ 6.37 (Gains) losses on equity investments ** ** (30) (0.1) % (15) (0.01) Litigation provisions (73) 0.5 % ** (0.1) % 67 0.07 Non-GAAP $ 7,147 53.3 % $ (351) 17.2 % $ 6,463 $ 6.43 Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 67 16.6 % $ 8,118 7.94 (Gains) losses on equity investments ** ** (167) (0.2) % (124) (0.12) Tax act ** ** ** 0.6 % (57) (0.06) Non-GAAP $ 7,219 57.2 % $ (100) 17.0 % $ 7,937 $ 7.77 Note: Tables may not sum due to rounding. ** Not applicable 48 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2021 as compared to the Year Ended December 31, 2020 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP 23 % 22 % 0.6 ppt (1.7) ppt 35 % 38 % (Gains) losses on equity investments ** ** ** (0.4) ppt (7) % (8) % Litigation provisions ** % ppt 0.1 ppt % % Indirect tax matter ** (1) % 0.4 ppt 0.1 ppt 1 % 1 % Non-GAAP 23 % 21 % 1.0 ppt (1.8) ppt 29 % 31 % Currency impact 1 (1) % (2) % 0.2 ppt ppt (1) % (1) % Non-GAAP - currency-neutral 22 % 19 % 1.2 ppt (1.8) ppt 28 % 30 % Year Ended December 31, 2020 as compared to the Year Ended December 31, 2019 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP (9) % % (4.4) ppt 0.8 ppt (21) % (20) % (Gains) losses on equity investments ** ** ** ppt 1 % 1 % Litigation provisions ** (1) % 0.5 ppt (0.1) ppt 1 % 1 % Tax act ** ** ** (0.6) ppt 1 % 1 % Non-GAAP (9) % (1) % (4.0) ppt 0.2 ppt (19) % (17) % Currency impact 1 1 % % 0.3 ppt 0.2 ppt 1 % 1 % Non-GAAP - currency-neutral (8) % (1) % (3.7) ppt 0.3 ppt (17) % (16) % Note: Tables may not sum due to rounding. ** Not applicable 1 See Non-GAAP Financial Information for further information on Currency impact. Key Metrics In addition to the financial measures described above in Financial Results Overview, we review the following metrics to evaluate and identify trends in our business, measure our performance, prepare financial projections and make strategic decisions. We believe that the key metrics presented facilitate an understanding of our operating and financial performance and provide a meaningful comparison of our results between periods. Gross Dollar Volume (GDV) 1 measures dollar volume of activity on cards carrying our brands during the period, on a local currency basis and U.S. dollar-converted basis. GDV represents purchase volume plus cash volume and includes the impact of balance transfers and convenience checks; purchase volume means the aggregate dollar amount of purchases made with Mastercard-branded cards for the relevant period; and cash volume means the aggregate dollar amount of cash disbursements and includes the impact of balance transfers and convenience checks obtained with Mastercard-branded cards for the relevant period. Information denominated in U.S. dollars relating to GDV is calculated by applying an established U.S. dollar/local currency exchange rate for each local currency in which our volumes are reported. These exchange rates are calculated on a quarterly basis using the average exchange rate for each quarter. We report period-over-period rates of change in purchase volume and cash volume on the basis of local currency information, in order to eliminate the impact of changes in the value of currencies against the U.S. dollar in calculating such rates of change. Cross-border Volume 2 measures cross-border dollar volume initiated and switched through our network during the period, on a local currency basis and U.S. dollar-converted basis, for all Mastercard-branded programs. Switched Transactions 2 measures the number of transactions switched by Mastercard, which is defined as the number of transactions initiated and switched through our network during the period. MASTERCARD 2021 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating Margin measures how much profit we make on each dollar of sales after our operating costs but before other income (expense) and income tax expense. Operating margin is calculated by dividing our operating income by net revenue. 1 Data used in the calculation of GDV is provided by Mastercard customers and is subject to verification by Mastercard and partial cross-checking against information provided by Mastercards transaction switching systems. All data is subject to revision and amendment by Mastercard or Mastercards customers. 2 Growth rates are normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the Company does not clear and settle are processed. In the fourth quarter of 2021, we began clearing and settling transactions and volumes on a daily basis. Foreign Currency Currency Impact Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results are also impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and certain volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, certain of our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2021, GDV on a U.S. dollar-converted basis increased 21.9%, while GDV on a local currency basis increased 20.5% versus 2020. In 2020, GDV on a U.S. dollar-converted basis decreased 1.9%, while GDV on a local currency basis increased 0.1% versus 2019. Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items is different than the functional currency of the entity. Through December 31, 2020, our approach to managing transactional currency exposure consisted of hedging a portion of anticipated revenues impacted by transactional currencies by entering into foreign exchange derivative contracts, and recording the related changes in fair value in general and administrative expenses on the consolidated statement of operations. During the first quarter of 2021, we started to formally designate certain newly-executed foreign exchange derivative contracts, which meet the established accounting criteria, as cash flow hedges. Gains and losses resulting from changes in fair value of these designated contracts are deferred in accumulated other comprehensive income (loss) and subsequently recognized in the respective component of net revenue when the underlying forecasted transactions impact earnings. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities, including settlement assets and obligations, that are denominated in a currency other than the functional currency of the entity. To manage this foreign exchange risk, we may enter into foreign exchange derivative contracts to economically hedge the foreign currency exposure of a portion of our nonfunctional monetary assets and liabilities. The gains or losses resulting from changes in fair value of these contracts are intended to reduce the potential effect of the underlying hedged exposure and are recorded net within general and administrative expenses on the consolidated statement of operations. The impact of this foreign exchange activity, including the related hedging activities, has not been eliminated in our currency-neutral results. Our foreign exchange risk management activities are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. 50 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Results Revenue Primary drivers of net revenue, versus the prior year, were as follows: Gross revenue increased 26%, or 25% on a currency-neutral basis, which includes growth of 2 percentage points from acquisitions. The remaining increase was primarily driven by transaction and volume growth and an increase in our Cyber Intelligence and Data Services solutions within other revenue. Rebates and incentives increased 32%, or 31% on a currency-neutral basis, primarily due to increased volumes and transactions and new and renewed deals. Net revenue increased 23%, or 22% on a currency-neutral basis, and includes 2 percentage points of growth from acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Domestic assessments $ 8,158 $ 6,656 $ 6,781 23% (2)% Cross-border volume fees 4,664 3,512 5,606 33% (37)% Transaction processing 10,799 8,731 8,469 24% 3% Other revenues 6,224 4,717 4,124 32% 14% Gross revenue 29,845 23,616 24,980 26% (5)% Rebates and incentives (contra-revenue) (10,961) (8,315) (8,097) 32% 3% Net revenue $ 18,884 $ 15,301 $ 16,883 23% (9)% The following table summarizes the drivers of change in net revenue: For the Years Ended December 31, Operational Acquisitions Currency Impact 3 Total 2021 2020 2021 2020 2021 2020 2021 2020 Domestic assessments 22% 1 1% 1 % % % (3)% 23 % (2) % Cross-border volume fees 30% 1 (37)% 1 % % 3% % 33 % (37) % Transaction processing 22% 1,2 3% 1,2 % % 1% % 24 % 3 % Other revenues 23% 2 12% 2 8% 3% 1% (1)% 32 % 14 % Rebates and incentives (contra-revenue) 31% 4% % % 1% (2)% 32 % 3 % Net revenue 20% (9)% 2% 1% 1% (1)% 23 % (9) % Note: Table may not sum due to rounding 1 Includes impacts from our key metrics, other non-volume based fees, pricing and mix. 2 Includes impacts from our cyber and intelligence solution fees, data analytics and consulting fees and other value-added services. 3 Includes the translational and transactional impact of currency and the related impact of our foreign exchange derivative contracts designated as cash flow hedging instruments. MASTERCARD 2021 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables provide a summary of the trend in volumes and transactions. For the Years Ended December 31, 2021 2020 Increase/(Decrease) USD Local USD Local Mastercard-branded GDV 1 22 % 21 % (2) % % United States 23 % 23 % 2 % 2 % Worldwide less United States 22 % 20 % (4) % (1) % Cross-border volume 1 32 % (29) % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Increase/(Decrease) 2021 2020 Switched transactions 25 % 3 % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2021, the net revenue from these customers was approximately $4.2 billion, or 23%, of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses increased 22% in 2021 versus the prior year. Adjusted operating expenses increased 21%, or 19% on a currency-neutral basis, versus the prior year. Current year results include growth of approximately 7 percentage points from acquisitions. Excluding acquisitions, expenses increased 12% primarily due to higher personnel costs to support our continued investment in our strategic initiatives, increased spending on advertising and marketing and increased data processing costs. The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) General and administrative $ 7,087 $ 5,910 $ 5,763 20 % 3 % Advertising and marketing 895 657 934 36 % (30) % Depreciation and amortization 726 580 522 25 % 11 % Provision for litigation 94 73 ** ** Total operating expenses 8,802 7,220 7,219 22 % % Special Items 1 (176) (73) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 8,627 $ 7,147 $ 7,219 21 % (1) % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 52 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 1 Acquisitions Currency Impact 2 Total 2021 2020 2021 2020 2021 2020 2021 2020 2021 2020 General and administrative 11% (1) % 1 % ** 6 % 4 % 2 % % 20 % 3 % Advertising and marketing 35% (30) % ** ** 1 % % 1 % (1) % 36 % (30) % Depreciation and amortization 3% 5 % ** ** 20 % 6 % 2 % % 25 % 11 % Provision for litigation ** ** ** ** ** ** ** ** ** ** Total operating expenses 12% (5) % 1 % 1 % 7 % 4 % 2 % % 22 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 Represents the translational and transactional impact of currency. General and Administrative General and administrative expenses increased 20%, or 18% on a currency-neutral basis, in 2021 versus the prior year. Current year results include growth of 6 percentage points from acquisitions and 1 percentage point from Special Items. The remaining increase was primarily due to higher personnel costs to support our continued investment in our strategic initiatives and increased data processing costs. The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Personnel $ 4,489 $ 3,787 $ 3,537 19% 7% Professional fees 433 384 447 13% (14)% Data processing and telecommunications 898 756 666 19% 14% Foreign exchange activity 1 51 9 32 ** ** Other 2 1,216 974 1,081 25% (10)% Total general and administrative expenses $ 7,087 $ 5,910 $ 5,763 20% 3% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Includes a special item related to a foreign indirect tax matter of $82 million, pre-tax, recorded during 2021. See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. Advertising and Marketing Advertising and marketing expenses increased 36%, on both an as reported and currency-neutral basis, in 2021 versus the prior year, primarily due to an increase in spending on certain marketing campaigns and an increase in advertising and sponsorship spend driven by the reinstatement of sponsored events as the effects of the pandemic recede. Depreciation and Amortization Depreciation and amortization expenses increased 25%, or 23% on a currency-neutral basis, in 2021 versus the prior year, which includes growth of 20 percentage points from acquisitions due to the amortization of acquired intangible assets. Provision for Litigation In 2021 and 2020, we recorded $ 94 million and $73 million, respectively, related to various litigation settlements and legal costs. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2021 FORM 10-K 53 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other Income (Expense) Other income (expense) was favorable $546 million in 2021 versus the prior year, primarily due to higher net gains in the current period versus the prior period related to unrealized fair market value adjustments on marketable and nonmarketable equity securities and realized gains on sales of marketable equity securities. Adjusted other income (expense) was unfavorable $62 million versus the prior year, primarily due to increased interest expense related to our recent debt issuances and a decrease in our investment income. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Investment Income $ 11 $ 24 $ 97 (52) % (75) % Gains (losses) on equity investments, net 645 30 167 ** ** Interest expense (431) (380) (224) 13 % 70 % Other income (expense), net 5 27 ** ** Total other income (expense) 225 (321) 67 ** ** (Gains) losses on equity investments 1 (645) (30) (167) ** ** Special Items 1 6 ** ** Adjusted total other income (expense) 1 $ (413) $ (351) $ (100) 18 % ** Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. Income Taxes The effective income tax rates for the years ended December 31, 2021 and 2020 were 15.7% and 17.4%, respectively. The adjusted effective income tax rates for the years ended December 31, 2021 and 2020 were 15.4% and 17.2%, respectively. Both the as reported and as adjusted effective income tax rates in 2021 were lower than the prior year, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rates. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31: 2021 2020 (in billions) Cash, cash equivalents and investments 1 $ 7.9 $ 10.6 Unused line of credit 6.0 6.0 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.5 billion and $2.3 billion at December 31, 2021 and 2020, respectively. We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations which include litigation provisions and credit and settlement exposure. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; 54 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities: For the Years Ended December 31, 2021 2020 2019 (in millions) Net cash provided by operating activities $ 9,463 $ 7,224 $ 8,183 Net cash used in investing activities (5,272) (1,879) (1,640) Net cash used in financing activities (6,555) (2,152) (5,867) Net cash provided by operating activities increased $2.2 billion in 2021 versus the prior year, primarily due to higher net income adjusted for non-cash items and the timing of customer incentive payments, partially offset by higher outstanding receivables in the current period due to increased volumes and timing of settlement with customers. Net cash used in investing activities increased $3.4 billion in 2021 versus the prior year, primarily due to increased acquisition activity in the current year. Net cash used in financing activities increased $4.4 billion in 2021 versus the prior year, primarily due to lower proceeds from debt issuances, higher repurchases of our Class A common stock and repayment of debt in the current year. Debt and Credit Availability In March 2021, we issued $600 million principal amount of notes due March 2031 and $700 million principal amount of notes due March 2051 and in November 2021, we issued $750 million principal amount of notes due November 2031 (collectively the 2021 USD Notes). Additionally, during 2021, $650 million of principal related to the 2016 USD Notes was redeemed. Our total debt outstanding was $13.9 billion at December 31, 2021, with the earliest maturity of 700 million (approximately $793 million as of December 31, 2021) of principal occurring in December 2022. The proceeds of the 2021 USD Notes due March 2031 are to be used to fund eligible green and social projects, examples of which are described in the Use of Proceeds section of the Prospectus Supplement filed on March 4, 2021. All other notes are to be used for general corporate purposes. As of December 31, 2021, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which now expires in November 2026. Borrowings under the Commercial Paper Program and the Credit Facility are to be used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2021. See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. MASTERCARD 2021 FORM 10-K 55 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, 2021 2020 2019 (in millions, except per share data) Cash dividend, per share $ 1.76 $ 1.60 $ 1.32 Cash dividends paid $ 1,741 $ 1,605 $ 1,345 On November 30, 2021, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of record on January 7, 2022 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $479 million. On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share payable on May 9, 2022 to holders of record on April 8, 2022 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $479 million. Repurchased shares of our common stock are considered treasury stock. In November 2021, December 2020 and December 2019, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion, $6.0 billion and $8.0 billion, respectively, of our Class A common stock. The program approved in 2021 will become effective after completion of the share repurchase program approved in 2020. The timing and actual number of additional shares repurchased will depend on a variety of factors, including cash requirements to meet the operating needs of the business, legal requirements, as well as the share price and economic and market conditions. The following table summarizes our share repurchase activity of our Class A common stock through December 31, 2021, under the plans approved in 2020 and 2019: (in millions, except per share data) Remaining authorization at December 31, 2020 $ 9,831 Dollar-value of shares repurchased in 2021 $ 5,904 Remaining authorization at December 31, 2021 $ 11,927 Shares repurchased in 2021 16.5 Average price paid per share in 2021 $ 356.82 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates and incentives when customers meet certain volume thresholds or other incentives tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction- based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. 56 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. Income Taxes In calculating our effective income tax rate, estimates are required regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. In assessing the need for a valuation allowance, we consider all sources of taxable income, including projected future taxable income, reversing taxable temporary differences and ongoing tax planning strategies. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price, including contingent consideration, if any, is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. MASTERCARD 2021 FORM 10-K 57 PART II "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $70 million and $58 million on our foreign exchange derivative contracts outstanding at December 31, 2021 and 2020, respectively, before considering the offsetting effect of the underlying hedged activity. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into short duration foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with our customers. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $1 million and $23 million on our short duration foreign exchange derivative contracts outstanding at December 31, 2021 and 2020, respectively. We are further exposed to foreign exchange rate risk related to translation of our foreign operating results where the functional currency is different than our U.S. dollar reporting currency. To manage this risk, we may enter into foreign exchange derivative contracts to hedge a portion of our net investment in foreign subsidiaries. The effect of a hypothetical 10% adverse change in the value of the U.S. dollar could result in a fair value loss of approximately $165 million on our foreign exchange derivative contracts designated as a net investment hedge at December 31, 2021, before considering the offsetting effect of the underlying hedged activity. We did not have similar foreign exchange derivative contracts outstanding as of December 31, 2020. Interest Rate Risk Our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact to the fair value of our investments at December 31, 2021 and 2020. We are also exposed to interest rate risk related to our fixed-rate debt. To manage this risk, we may enter into interest rate derivative contracts to hedge a portion of our fixed-rate debt that is exposed to changes in fair value attributable to changes in a benchmark interest rate. The effect of a hypothetical 100 basis point adverse change in interest rates could result in a fair value loss of $49 million on our interest rate derivative contracts designated as a fair value hedge of our fixed-rate debt at December 31, 2021, before considering the offsetting effect of the underlying hedged activity. We did not have similar interest rate derivative contracts outstanding as of December 31, 2020. 58 MASTERCARD 2021 FORM 10-K PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019 Managements report on internal control over financial reporting Report of independent registered public accounting firm (PCAOB ID 238 ) Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements MASTERCARD 2021 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2021. In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2021. The effectiveness of Mastercards internal control over financial reporting as of December 31, 2021 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. 60 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on internal control over financial reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. MASTERCARD 2021 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates and incentives which totaled $11.0 billion for the year ended December 31, 2021. The Company has business agreements with certain customers that provide for rebates and incentives that could be either fixed or variable-based. Variable rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Variable rebates and incentives are calculated based upon estimated customer performance, such as volume thresholds, and the terms of the related business agreements. As disclosed by management, various factors are considered in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter are (i) the significant judgment by management when developing estimates related to rebates and incentives based on customer performance; and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance, including the reasonableness of the various applicable factors considered by management in the estimate. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to rebates and incentives, including controls over evaluating estimated customer performance. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating the agreements to identify whether all rebates and incentives are identified and recorded accurately; (ii) testing managements process for developing estimated customer performance, including evaluating the reasonableness of the various applicable factors considered by management; and (iii) evaluating estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 11, 2022 We have served as the Companys auditor since 1989. 62 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, 2021 2020 2019 (in millions, except per share data) Net Revenue $ 18,884 $ 15,301 $ 16,883 Operating Expenses: General and administrative 7,087 5,910 5,763 Advertising and marketing 895 657 934 Depreciation and amortization 726 580 522 Provision for litigation 94 73 Total operating expenses 8,802 7,220 7,219 Operating income 10,082 8,081 9,664 Other Income (Expense): Investment income 11 24 97 Gains (losses) on equity investments, net 645 30 167 Interest expense ( 431 ) ( 380 ) ( 224 ) Other income (expense), net 5 27 Total other income (expense) 225 ( 321 ) 67 Income before income taxes 10,307 7,760 9,731 Income tax expense 1,620 1,349 1,613 Net Income $ 8,687 $ 6,411 $ 8,118 Basic Earnings per Share $ 8.79 $ 6.40 $ 7.98 Basic weighted-average shares outstanding 988 1,002 1,017 Diluted Earnings per Share $ 8.76 $ 6.37 $ 7.94 Diluted weighted-average shares outstanding 992 1,006 1,022 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, 2021 2020 2019 (in millions) Net Income $ 8,687 $ 6,411 $ 8,118 Other comprehensive income (loss): Foreign currency translation adjustments ( 442 ) 345 10 Income tax effect 55 ( 59 ) 13 Foreign currency translation adjustments, net of income tax effect ( 387 ) 286 23 Translation adjustments on net investment hedges 269 ( 177 ) 36 Income tax effect ( 60 ) 40 ( 8 ) Translation adjustments on net investment hedges, net of income tax effect 209 ( 137 ) 28 Cash flow hedges 6 ( 189 ) 14 Income tax effect ( 1 ) 42 ( 3 ) Reclassification adjustment for cash flow hedges 5 4 Income tax effect ( 1 ) ( 1 ) Cash flow hedges, net of income tax effect 9 ( 144 ) 11 Defined benefit pension and other postretirement plans 57 ( 12 ) ( 21 ) Income tax effect ( 14 ) 2 3 Reclassification adjustment for defined benefit pension and other postretirement plans ( 2 ) ( 1 ) ( 1 ) Income tax effect Defined benefit pension and other postretirement plans, net of income tax effect 41 ( 11 ) ( 19 ) Investment securities available-for-sale ( 1 ) ( 1 ) 3 Income tax effect ( 1 ) Investment securities available-for-sale, net of income tax effect ( 1 ) ( 1 ) 2 Other comprehensive income (loss), net of income tax effect ( 129 ) ( 7 ) 45 Comprehensive Income $ 8,558 $ 6,404 $ 8,163 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, 2021 2020 (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 7,421 $ 10,113 Restricted cash for litigation settlement 586 586 Investments 473 483 Accounts receivable 3,006 2,646 Settlement assets 1,319 1,706 Restricted security deposits held for customers 1,873 1,696 Prepaid expenses and other current assets 2,271 1,883 Total current assets 16,949 19,113 Property, equipment and right-of-use assets, net 1,907 1,902 Deferred income taxes 486 491 Goodwill 7,662 4,960 Other intangible assets, net 3,671 1,753 Other assets 6,994 5,365 Total Assets $ 37,669 $ 33,584 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ 738 $ 527 Settlement obligations 913 1,475 Restricted security deposits held for customers 1,873 1,696 Accrued litigation 840 842 Accrued expenses 6,642 5,430 Current portion of long-term debt 792 649 Other current liabilities 1,364 1,228 Total current liabilities 13,162 11,847 Long-term debt 13,109 12,023 Deferred income taxes 395 86 Other liabilities 3,591 3,111 Total Liabilities 30,257 27,067 Commitments and Contingencies Redeemable Non-controlling Interests 29 29 Stockholders Equity Class A common stock, $ 0.0001 par value; authorized 3,000 shares, 1,397 and 1,396 shares issued and 972 and 987 shares outstanding, respectively Class B common stock, $ 0.0001 par value; authorized 1,200 shares, 8 shares issued and outstanding Additional paid-in-capital 5,061 4,982 Class A treasury stock, at cost, 425 and 409 shares, respectively ( 42,588 ) ( 36,658 ) Retained earnings 45,648 38,747 Accumulated other comprehensive income (loss) ( 809 ) ( 680 ) Mastercard Incorporated Stockholders' Equity 7,312 6,391 Non-controlling interests 71 97 Total Equity 7,383 6,488 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 37,669 $ 33,584 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2018 $ $ $ 4,580 $ ( 25,750 ) $ 27,283 $ ( 718 ) $ 5,395 $ 23 $ 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests 1 1 Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) 45 45 45 Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments 207 8 215 215 Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 Net income 6,411 6,411 6,411 Activity related to non-controlling interests 73 73 Redeemable non-controlling interest adjustments ( 7 ) ( 7 ) ( 7 ) Other comprehensive income (loss) ( 7 ) ( 7 ) ( 7 ) Dividends ( 1,641 ) ( 1,641 ) ( 1,641 ) Purchases of treasury stock ( 4,459 ) ( 4,459 ) ( 4,459 ) Share-based payments 195 6 201 201 Balance at December 31, 2020 4,982 ( 36,658 ) 38,747 ( 680 ) 6,391 97 6,488 66 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2020 4,982 ( 36,658 ) 38,747 ( 680 ) 6,391 97 6,488 Net income 8,687 8,687 8,687 Activity related to non-controlling interests ( 9 ) ( 9 ) Acquisition of non-controlling interest ( 122 ) ( 122 ) ( 17 ) ( 139 ) Redeemable non-controlling interest adjustments ( 5 ) ( 5 ) ( 5 ) Other comprehensive income (loss) ( 129 ) ( 129 ) ( 129 ) Dividends ( 1,781 ) ( 1,781 ) ( 1,781 ) Purchases of treasury stock ( 5,934 ) ( 5,934 ) ( 5,934 ) Share-based payments 201 4 205 205 Balance at December 31, 2021 $ $ $ 5,061 $ ( 42,588 ) $ 45,648 $ ( 809 ) $ 7,312 $ 71 $ 7,383 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, 2021 2020 2019 (in millions) Operating Activities Net income $ 8,687 $ 6,411 $ 8,118 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,371 1,072 1,141 Depreciation and amortization 726 580 522 (Gains) losses on equity investments, net ( 645 ) ( 30 ) ( 167 ) Share-based compensation 273 254 250 Deferred income taxes ( 69 ) 73 ( 7 ) Other 36 14 24 Changes in operating assets and liabilities: Accounts receivable ( 397 ) ( 86 ) ( 246 ) Income taxes receivable ( 87 ) ( 2 ) ( 202 ) Settlement assets 390 1,288 ( 444 ) Prepaid expenses ( 2,087 ) ( 1,552 ) ( 1,661 ) Accrued litigation and legal settlements ( 1 ) ( 73 ) ( 662 ) Restricted security deposits held for customers 177 326 290 Accounts payable 100 26 ( 42 ) Settlement obligations ( 568 ) ( 1,242 ) 477 Accrued expenses 1,355 ( 114 ) 657 Long-term taxes payable ( 52 ) ( 37 ) 2 Net change in other assets and liabilities 254 316 133 Net cash provided by operating activities 9,463 7,224 8,183 Investing Activities Purchases of investment securities available-for-sale ( 389 ) ( 220 ) ( 643 ) Purchases of investments held-to-maturity ( 294 ) ( 198 ) ( 215 ) Proceeds from sales of investment securities available-for-sale 83 361 1,098 Proceeds from maturities of investment securities available-for-sale 291 140 376 Proceeds from maturities of investments held-to-maturity 296 121 383 Purchases of property and equipment ( 407 ) ( 339 ) ( 422 ) Capitalized software ( 407 ) ( 369 ) ( 306 ) Purchases of equity investments ( 228 ) ( 214 ) ( 467 ) Proceeds from sales of equity investments 186 Acquisition of businesses, net of cash acquired ( 4,436 ) ( 989 ) ( 1,440 ) Settlement of interest rate derivative contracts ( 175 ) Other investing activities 33 3 ( 4 ) Net cash used in investing activities ( 5,272 ) ( 1,879 ) ( 1,640 ) Financing Activities Purchases of treasury stock ( 5,904 ) ( 4,473 ) ( 6,497 ) Dividends paid ( 1,741 ) ( 1,605 ) ( 1,345 ) Proceeds from debt, net 2,024 3,959 2,724 Payment of debt ( 650 ) ( 500 ) Acquisition of redeemable non-controlling interests ( 49 ) Acquisition of non-controlling interest ( 133 ) Contingent consideration paid ( 64 ) ( 199 ) Tax withholdings related to share-based payments ( 133 ) ( 150 ) ( 161 ) Cash proceeds from exercise of stock options 61 97 126 Other financing activities ( 15 ) 69 ( 15 ) Net cash used in financing activities ( 6,555 ) ( 2,152 ) ( 5,867 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents ( 153 ) 257 ( 44 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents ( 2,517 ) 3,450 632 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 12,419 8,969 8,337 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 9,902 $ 12,419 $ 8,969 The accompanying notes are an integral part of these consolidated financial statements. 68 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. The Company operates a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through its unique and proprietary core global payments network, the Company switches (authorizes, clears and settles) payment transactions. The Company has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, the Company offers integrated payment products and services and captures new payment flows. The Companys value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on Mastercards principled use of consumer and merchant data. The Companys franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. The Companys payment solutions are designed to ensure safety and security for the global payments ecosystem. Mastercard is not a financial institution. The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as marketable, equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2021 and 2020, there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date on which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2021, 2020 and 2019, net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. These financial statements were prepared using information reasonably available as of December 31, 2021 and through the date of this Report. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated from assessing customers based on the dollar volume of activity, or gross dollar volume (GDV), on the products that carry the Companys brands, from fees to issuers, acquirers and other stakeholders for providing switching services, as well as from value-added products and services that are often integrated and sold with the Companys payment offerings. MASTERCARD 2021 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is primarily based on the related volume generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. For services provided to customers where delivery involves the use of a third-party, the Company recognizes revenue on a gross basis if it acts as the principal, controlling the service to the customer and on a net basis if it acts as the agent, arranging for the service to be provided. Mastercard has business agreements with certain customers that provide for rebates and incentives that could be either fixed or variable-based. Fixed incentives typically represent payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis as a reduction of gross revenue. Variable rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Variable rebates and incentives are calculated based upon estimated customer performance, such as volume thresholds, and the terms of the related business agreements. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payments network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, any non-controlling interest in the acquiree and contingent consideration at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses on the consolidated statement of operations. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date are recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy (as defined in Fair value subsection below). Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. 70 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires certain customers to enter into risk mitigation arrangements, including cash collateral and/or other forms of credit enhancement such as letters of credit and guarantees, for settlement of their transactions. Certain risk mitigation arrangements for settlement, such as standby letters of credit and bank guarantees, are not recorded on the consolidated balance sheet. The Company also holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. MASTERCARD 2021 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company also measures certain financial and non-financial assets and liabilities at fair value on a non-recurring basis, when a change in fair value or impairment is evidenced. The Company classifies these recurring and non-recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data The Companys financial assets and liabilities measured at fair value on a recurring basis include investment securities available for sale, marketable securities, derivative instruments and deferred compensation. The Companys financial assets and liabilities measured at fair value on a non-recurring basis include nonmarketable securities, debt and other financial instruments. The Companys non-financial assets measured at fair value on a non-recurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions are recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Investments in debt securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment is recognized as an allowance and recorded in other income (expense), net on the consolidated statement of operations while the non-credit related loss remains in accumulated other comprehensive income (loss) until realized from a sale or subsequent impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as other assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. 72 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gains (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the measurement alternative method or equity method. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operations of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gains (losses) on equity investments, net on the consolidated statement of operations. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the operations of the investee, generally when it holds between 20 % and 50 % ownership in the entity. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the operations of the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The Companys share of net earnings or losses for these investments are included in gains (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. The Company does not enter into derivative instruments for trading or speculative purposes. For derivatives that are not designated as hedging instruments, realized and unrealized gains and losses from the change in fair value of the derivatives are recognized in current earnings. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. The Company may designate derivative instruments as cash flow, fair value and net investment hedges, as follows: Cash flow hedges - Fair value adjustments to derivative instruments are recorded, net of tax, in other comprehensive income (loss) on the consolidated statement of comprehensive income. Any gains and losses deferred in accumulated other comprehensive income (loss) are subsequently reclassified to the corresponding line item on the consolidated statement of operations when the underlying hedged transactions impact earnings. For hedges that are no longer deemed highly effective, hedge accounting is discontinued prospectively, and any gains and losses remaining in accumulated other comprehensive income (loss) are reclassified to earnings when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, the associated gains or losses in accumulated other comprehensive income (loss) are reclassified to the corresponding line item on the consolidated statement of operations in current earnings. MASTERCARD 2021 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair value hedges - Changes in the fair value of derivative instruments are recorded in current-period earnings, along with the gain or loss on the hedged asset or liability (hedged item) that is attributable to the hedged risk. All amounts recognized in earnings are recorded to the corresponding line item on the consolidated statement of operations as the earnings effect of the hedged item. Hedged items are measured on the consolidated balance sheet at their carrying amount adjusted for any changes in fair value attributable to the hedged risk (basis adjustments). The Company defers the amortization of any basis adjustments until the end of the derivative instruments term. If the hedge designation is discontinued for reasons other than derecognition of the hedged item, the remaining basis adjustments are amortized in accordance with applicable GAAP for the hedged item. Net investment hedges - The Company has numerous investments in foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company may use foreign currency denominated debt and/or derivative instruments to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the hedging instruments are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as a cumulative translation adjustment component of equity. Gains and losses in accumulated other comprehensive income (loss) are reclassified to earnings only if the Company sells or substantially liquidates its net investments in foreign subsidiaries. Amounts excluded from effectiveness testing of net investment hedges are recognized in earnings over the life of the hedging instrument. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement assets/obligations - The Company operates systems for settling payment transactions among participants in the payments ecosystem in which the Company operates. Settlement is generally completed on a same-day basis, however, in some circumstances, funds may not settle until subsequent business days. In addition, the Company may receive or post funds in advance of transactions related to certain payment capabilities over its multi-rail payments network. The Company classifies the balances arising from these various activities as settlement assets and settlement obligations. Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. 74 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense), net on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. MASTERCARD 2021 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounting pronouncements not yet adopted Accounting for contract assets and contract liabilities in a business combination - In October 2021, the Financial Accounting Standards Board issued accounting guidance that requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers . The guidance is effective for periods beginning after December 15, 2022 with early adoption permitted. The Company will early adopt this guidance effective January 1, 2022 and does not expect the impacts to be material. Note 2. Acquisitions In 2021, 2020 and 2019, the Company acquired several businesses for total consideration of $ 4.7 billion, $ 1.1 billion and $ 1.5 billion, respectively, representing both cash and contingent consideration. These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations and contingent consideration. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a majority of the goodwill is not expected to be deductible for local tax purposes. On March 5, 2021, Mastercard acquired a majority of the Corporate Services business of Nets Denmark A/S (Nets) for 3.0 billion (approximately $ 3.6 billion as of the date of acquisition) in cash consideration based on a 2.85 billion enterprise value, adjusted for cash and net working capital at closing. The business acquired is primarily comprised of clearing and instant payment services and e-billing solutions. In relation to this acquisition, the Companys preliminary estimate of net assets acquired primarily relates to intangible assets, including goodwill of $ 2.1 billion, of which $ 0.8 billion is expected to be deductible for local tax purposes. The goodwill arising from this acquisition is primarily attributable to the synergies expected to arise through geographic, product and customer expansion, the underlying technology and workforce acquired. On June 9, 2021, Mastercard acquired a 100 % equity interest in Ekata, Inc. (Ekata) for cash consideration of $ 861 million, based on an $ 850 million enterprise value, adjusted for cash and net working capital at closing. The acquisition of Ekata is expected to broaden the Companys digital identity verification capabilities. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and none of the goodwill is expected to be deductible for local tax purposes. Mastercard acquired additional businesses in 2021 for consideration of $ 272 million. These businesses were not considered individually material to Mastercard. Among the businesses acquired in 2020, the largest acquisition relates to Finicity Corporation (Finicity), an open-banking provider, headquartered in Salt Lake City, Utah. On November 18, 2020, Mastercard acquired 100 % equity interest in Finicity for cash consideration of $ 809 million. In addition, the Finicity sellers earned additional contingent consideration of $ 64 million upon meeting 2021 revenue targets in accordance with terms of the purchase agreement. The additional businesses acquired in 2020 and the businesses acquired in 2019 were not considered individually material to Mastercard. 76 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is evaluating and finalizing the purchase accounting for the businesses acquired during 2021. In 2021, the Company finalized the purchase accounting for businesses acquired during 2020. The estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for the years ended December 31. 2021 2020 2019 (in millions) Assets: Cash and cash equivalents $ 253 $ 6 $ 54 Other current assets 41 14 143 Other intangible assets 2,071 237 395 Goodwill 2,842 844 1,076 Other assets 15 11 48 Total assets 5,222 1,112 1,716 Liabilities: Other current liabilities 112 15 121 Deferred income taxes 398 23 52 Other liabilities 12 8 32 Total liabilities 522 46 205 Net assets acquired $ 4,700 $ 1,066 $ 1,511 The following table summarizes the identified intangible assets acquired during the years ended December 31: 2021 2020 2019 2021 2020 2019 Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ 433 $ 122 $ 199 11.7 6.3 7.7 Customer relationships 1,614 114 178 19.2 12.0 12.6 Other 24 1 18 7.1 1.0 5.0 Other intangible assets $ 2,071 $ 237 $ 395 17.5 9.0 9.7 Proforma information related to these acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. Pending Acquisition As of December 31, 2021, Mastercard has entered into a definitive agreement to acquire Dynamic Yield LTD. This acquisition is expected to close in the second quarter of 2022. Note 3. Revenue Mastercards core network involves four participants in addition to the Company: account holders (a person or entity who holds a card or uses another device enabled for payment), issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payments network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or GDV, on the products that carry the Companys brands. Revenue is generally derived from information accumulated by Mastercards systems or reported by customers. In addition, the Company generates other revenues from value-added products and services, often integrated and sold with the Companys payment offerings, that are recognized as revenue in the period in which the related transactions occur or services are performed. MASTERCARD 2021 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates switched or not switched by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization, which is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing, which is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement, which facilitates the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions, payment gateways for e-commerce merchants, mobile gateways for mobile-initiated transactions, and safety and security. Other revenues consist of value-added products and services that are often sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Cyber and intelligence solutions fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Data analytics and consulting fees are for insights, analytics, and test and learn capabilities as well as Mastercards advisory and managed services. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services and platforms, including account and transaction enhancement services, open banking and digital identity solutions, rules compliance and publications. 78 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Rebates and incentives (contra-revenue) are provided to customers and can be either fixed or variable-based. Fixed incentives typically represent payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis as a reduction of gross revenue. Variable rebates and incentives are typically tied to customer performance, such as volume thresholds, and are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31: 2021 2020 2019 (in millions) Revenue by source: Domestic assessments $ 8,158 $ 6,656 $ 6,781 Cross-border volume fees 4,664 3,512 5,606 Transaction processing 10,799 8,731 8,469 Other revenues 6,224 4,717 4,124 Gross revenue 29,845 23,616 24,980 Rebates and incentives (contra-revenue) ( 10,961 ) ( 8,315 ) ( 8,097 ) Net revenue $ 18,884 $ 15,301 $ 16,883 Net revenue by geographic region: North American Markets $ 6,594 $ 5,424 $ 5,843 International Markets 12,068 9,701 10,869 Other 1 222 176 171 Net revenue $ 18,884 $ 15,301 $ 16,883 1 Includes revenues managed by corporate functions. The Companys customers are generally billed weekly, however the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. The following table sets forth the location of the amounts recognized on the consolidated balance sheet from contracts with customers at December 31: 2021 2020 (in millions) Receivables from contracts with customers Accounts receivable $ 2,829 $ 2,505 Contract assets Prepaid expenses and other current assets 134 59 Other assets 487 245 Deferred revenue 1 Other current liabilities 482 355 Other liabilities 180 143 1 Revenue recognized from performance obligations satisfied in 2021, 2020 and 2019 was $ 1.5 billion, $ 1.1 billion and $ 994 million, respectively. The Companys remaining performance periods for its contracts with customers for its payments network services are typically long-term in nature (generally up to 10 years). As a payments network service provider, the Company provides its customers with continuous access to its global payments network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates volume- and transaction-based revenues from assessing its customers current period activity. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payments network services. The Company also earns revenues primarily from other value-added services comprised of both batch and real-time account-based payments services, cyber and intelligence solutions, consulting fees, loyalty programs, gateway services, processing, and other payment-related products and services. At December 31, 2021, the estimated MASTERCARD 2021 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion, which is expected to be recognized through 2024. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: 2021 2020 2019 (in millions, except per share data) Numerator Net income $ 8,687 $ 6,411 $ 8,118 Denominator Basic weighted-average shares outstanding 988 1,002 1,017 Dilutive stock options and stock units 4 4 5 Diluted weighted-average shares outstanding 1 992 1,006 1,022 Earnings per Share Basic $ 8.79 $ 6.40 $ 7.98 Diluted $ 8.76 $ 6.37 $ 7.94 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31: 2021 2020 (in millions) Cash and cash equivalents $ 7,421 $ 10,113 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement 586 586 Restricted security deposits held for customers 1,873 1,696 Prepaid expenses and other current assets 22 24 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 9,902 $ 12,419 80 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: 2021 2020 2019 (in millions) Cash paid for income taxes, net of refunds $ 1,820 $ 1,349 $ 1,644 Cash paid for interest 399 311 199 Cash paid for legal settlements 98 149 668 Non-cash investing and financing activities Dividends declared but not yet paid 479 439 403 Accrued property, equipment and right-of-use assets 15 154 468 Fair value of assets acquired, net of cash acquired 4,969 1,106 1,662 Fair value of liabilities assumed related to acquisitions 522 46 205 Note 7. Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity debt securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31: 2021 2020 (in millions) Available-for-sale securities 1 $ 314 $ 321 Held-to-maturity securities 2 159 162 Total investments $ 473 $ 483 1 See Available-for-Sale Securities section below for further detail. 2 The cost of these securities approximates fair value. Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2021 December 31, 2020 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ 2 $ $ $ 2 $ 10 $ $ $ 10 Government and agency securities 98 98 64 64 Corporate securities 214 214 246 1 247 Total $ 314 $ $ $ 314 $ 320 $ 1 $ $ 321 The Companys corporate and municipal available-for-sale investment securities held at December 31, 2021 and 2020, primarily carried a credit rating of A- or better. Corporate securities are comprised of commercial paper and corporate bonds. Municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds which are denominated in the national currency of the issuing country. Unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. MASTERCARD 2021 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys available-for-sale investment securities at December 31, 2021 was as follows: Amortized Cost Fair Value (in millions) Due within 1 year $ 132 $ 132 Due after 1 year through 5 years 182 182 Total $ 314 $ 314 Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits and available-for-sale investment securities, as well as realized gains and losses on the Companys available-for-sale investment securities. The realized gains and losses from the sales of available-for-sale securities for 2021, 2020 and 2019 were not material. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are equity interests in publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (Measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2020 Purchases Sales Changes in Fair Value 1 Other 2 Balance at December 31, 2021 (in millions) Marketable securities $ 476 $ $ ( 165 ) $ 91 $ 225 $ 627 Nonmarketable securities 696 228 ( 21 ) 554 ( 250 ) 1,207 Total equity investments $ 1,172 $ 228 $ ( 186 ) $ 645 $ ( 25 ) $ 1,834 1 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations. 2 Includes translational impact of currency and $ 227 million of transfers between equity investment categories due to changes to the existence of readily determinable fair values. The following table sets forth the components of the Companys Nonmarketable securities at December 31: 2021 2020 (in millions) Measurement alternative $ 952 $ 539 Equity method 255 157 Total Nonmarketable securities $ 1,207 $ 696 82 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the total carrying value of the Companys Measurement alternative investments, including cumulative unrealized gains and losses, at December 31: 2021 (in millions) Initial cost basis $ 448 Adjustments: Upward adjustments 514 Downward adjustments (including impairment) ( 10 ) Carrying amount, end of period $ 952 Unrealized gains and losses included in the carrying value of the Companys Measurement alternative investments still held as of December 31, 2021 and 2020, were as follows: For the Years Ended December 31, 2021 2020 (in millions) Upward adjustments $ 468 $ 21 Downward adjustments (including impairment) $ ( 2 ) $ ( 3 ) Note 8. Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy (the Valuation Hierarchy). Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. MASTERCARD 2021 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2021 December 31, 2020 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available-for-sale 1 : Municipal securities $ $ 2 $ $ 2 $ $ 10 $ $ 10 Government and agency securities 35 63 98 26 38 64 Corporate securities 214 214 247 247 Derivative instruments 2 : Foreign exchange contracts 8 8 19 19 Interest rate contracts 6 6 Marketable securities 3 : Equity securities 627 627 476 476 Deferred compensation plan 4 : Deferred compensation assets 89 89 78 78 Liabilities Derivative instruments 2 : Foreign exchange contracts $ $ 15 $ $ 15 $ $ 28 $ $ 28 Interest rate contracts 8 8 Deferred compensation plan 5 : Deferred compensation liabilities 89 89 81 81 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, non-U.S. government and agency securities and corporate securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign exchange for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . 84 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt securities are classified as Level 2 of the Valuation Hierarchy as they are not traded in active markets. At December 31, 2021, the carrying value and fair value of total long-term debt (including the current portion) was $ 13.9 billion and $ 15.3 billion, respectively. At December 31, 2020, the carrying value and fair value of long-term debt (including the current portion) was $ 12.7 billion and $ 14.8 billion, respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain other financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement assets, restricted security deposits held for customers, accounts payable, settlement obligations and other accrued liabilities. Note 9. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 1,326 $ 1,086 Prepaid income taxes 92 78 Other 853 719 Total prepaid expenses and other current assets $ 2,271 $ 1,883 Other assets consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 3,798 $ 3,220 Equity investments 1,834 1,172 Income taxes receivable 645 553 Other 717 420 Total other assets $ 6,994 $ 5,365 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Payments directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. MASTERCARD 2021 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31: 2021 2020 (in millions) Building, building equipment and land $ 615 $ 522 Equipment 1,456 1,321 Furniture and fixtures 96 99 Leasehold improvements 371 380 Operating lease right-of-use assets 983 970 Property, equipment and right-of-use assets 3,521 3,292 Less: Accumulated depreciation and amortization ( 1,614 ) ( 1,390 ) Property, equipment and right-of-use assets, net $ 1,907 $ 1,902 Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 424 million, $ 400 million and $ 336 million for 2021, 2020 and 2019, respectively. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows at December 31: 2021 2020 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ 671 $ 748 Other current liabilities 127 125 Other liabilities 645 726 Operating lease amortization expense for 2021, 2020 and 2019 was $ 122 million, $ 123 million and $ 99 million, respectively. As of December 31, 2021 and 2020, the weighted-average remaining lease term of operating leases was 8.8 years and 9.1 years and the weighted-average discount rate for operating leases was 2.6 % and 2.7 %, respectively. The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2021 based on lease term: Operating Leases (in millions) 2022 $ 145 2023 130 2024 109 2025 83 2026 75 Thereafter 322 Total operating lease payments 864 Less: Interest ( 92 ) Present value of operating lease liabilities $ 772 86 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: 2021 2020 (in millions) Beginning balance $ 4,960 $ 4,021 Additions 2,842 844 Foreign currency translation ( 140 ) 95 Ending balance $ 7,662 $ 4,960 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2021 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2021. Note 12. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: 2021 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 2,929 $ ( 1,288 ) $ 1,641 $ 2,276 $ ( 1,126 ) $ 1,150 Customer relationships 2,272 ( 429 ) 1,843 743 ( 322 ) 421 Other 59 ( 38 ) 21 44 ( 41 ) 3 Total 5,260 ( 1,755 ) 3,505 3,063 ( 1,489 ) 1,574 Indefinite-lived intangible assets Customer relationships 166 166 179 179 Total $ 5,426 $ ( 1,755 ) $ 3,671 $ 3,242 $ ( 1,489 ) $ 1,753 The increase in the gross carrying amount of amortized intangible assets in 2021 was primarily related to businesses acquired in 2021 and software additions. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2021, it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $ 424 million, $ 303 million and $ 285 million in 2021, 2020 and 2019, respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2021 for the years ending December 31: (in millions) 2022 $ 429 2023 378 2024 355 2025 347 2026 and thereafter 1,996 Total $ 3,505 MASTERCARD 2021 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 4,730 $ 3,998 Personnel costs 980 727 Income and other taxes 337 208 Other 595 497 Total accrued expenses $ 6,642 $ 5,430 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2021 and 2020, long-term customer and merchant incentives included in other liabilities were $ 1,835 million and $ 1,215 million, respectively. As of December 31, 2021 and 2020, the Companys provision for litigation was $ 840 million and $ 842 million, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 175 million, $ 150 million and $ 127 million in 2021, 2020 and 2019, respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 20 million as of December 31, 2021) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). 88 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, on the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized on the Companys consolidated balance sheet at December 31: Pension Plans Postretirement Plan 2021 2020 2021 2020 ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ 604 $ 531 $ 70 $ 64 Service cost 14 13 1 1 Interest cost 9 9 2 2 Actuarial (gain) loss ( 6 ) 43 ( 7 ) 7 Benefits paid ( 17 ) ( 18 ) ( 4 ) ( 4 ) Transfers in 4 3 Foreign currency translation ( 12 ) 23 Benefit obligation at end of year 596 604 62 70 Change in plan assets Fair value of plan assets at beginning of year 617 518 Actual gain on plan assets 63 56 Employer contributions 32 34 4 4 Benefits paid ( 17 ) ( 18 ) ( 4 ) ( 4 ) Transfers in 4 5 Foreign currency translation ( 11 ) 22 Fair value of plan assets at end of year 688 617 Funded status at end of year $ 92 $ 13 $ ( 62 ) $ ( 70 ) Amounts recognized on the consolidated balance sheet consist of: Noncurrent assets $ 105 $ 28 $ $ Other liabilities, short-term ( 3 ) ( 4 ) Other liabilities, long-term ( 13 ) ( 15 ) ( 59 ) ( 66 ) $ 92 $ 13 $ ( 62 ) $ ( 70 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ ( 38 ) $ 12 $ 2 $ 9 Prior service credit 1 1 ( 2 ) ( 4 ) Balance at end of year $ ( 37 ) $ 13 $ $ 5 Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.90 % 0.70 % * * Vocalink Plan 1.75 % 1.55 % * * Postretirement Plan * * 2.75 % 2.50 % Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % * * Vocalink Plan 3.20 % 2.75 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD 2021 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2021 and 2020, the Companys aggregated Pension Plan assets exceed the benefit obligations. For plans where the benefit obligations exceeded plan assets, the projected benefit obligation was $ 116 million and $ 112 million, the accumulated benefit obligation was $ 115 million and $ 111 million and plan assets were $ 104 million and $ 97 million at December 31, 2021 and 2020, respectively. Information on the Pension Plans were as follows as of December 31: 2021 2020 (in millions) Projected benefit obligation $ 596 $ 604 Accumulated benefit obligation 592 601 Fair value of plan assets 688 617 For the year ended December 31, 2021, the Companys projected benefit obligation related to its Pension Plans decreased $ 8 million, primarily attributable to actuarial gains related to higher discount rate assumptions. For the year ended December 31, 2020, the Companys projected benefit obligation related to its Pension Plans increased $ 73 million, primarily attributable to actuarial losses related to lower discount rate assumptions. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 (in millions) Service cost $ 14 $ 13 $ 11 $ 1 $ 1 $ 1 Interest cost 9 9 13 2 2 2 Expected return on plan assets ( 19 ) ( 18 ) ( 18 ) Amortization of actuarial loss ( 1 ) 1 Amortization of prior service credit ( 1 ) ( 1 ) ( 1 ) Net periodic benefit cost $ 3 $ 4 $ 7 $ 2 $ 2 $ 2 The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 (in millions) Current year actuarial loss (gain) $ ( 50 ) $ 5 $ 12 $ ( 7 ) $ 7 $ 9 Amortization of prior service credit 2 1 1 Total other comprehensive loss (income) $ ( 50 ) $ 5 $ 12 $ ( 5 ) $ 8 $ 10 Total net periodic benefit cost and other comprehensive loss (income) $ ( 47 ) $ 9 $ 19 $ ( 3 ) $ 10 $ 12 90 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 Discount rate Non-U.S. Plans 0.70 % 0.70 % 1.80 % * * * Vocalink Plan 1.55 % 1.55 % 2.00 % * * * Postretirement Plan * * * 2.50 % 3.25 % 4.25 % Expected return on plan assets Non-U.S. Plans 1.60 % 1.60 % 2.10 % * * * Vocalink Plan 3.20 % 3.20 % 3.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % 1.50 % * * * Vocalink Plan 2.75 % 2.75 % 2.50 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: 2021 2020 Healthcare cost trend rate assumed for next year 6.75 % 7.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate 7 8 Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed with the following target asset allocations: cash and cash equivalents 42 %, U.K. government securities 18 %, fixed income 17 %, equity 15 % and real estate 8 %. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. MASTERCARD 2021 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2021 December 31, 2020 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ 246 $ $ $ 246 $ 59 $ $ $ 59 Mutual funds 2 185 102 287 270 117 387 Insurance contracts 3 104 104 96 96 Total $ 431 $ 206 $ $ 637 $ 329 $ 213 $ $ 542 Investments at Net Asset Value (NAV) 4 51 75 Total Plan Assets $ 688 $ 617 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 3 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 4 Investments at NAV include mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) and are valued using the net asset value provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2021) through 2031 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) 2022 $ 27 $ 3 2023 18 3 2024 21 3 2025 21 4 2026 19 4 2027 - 2031 124 19 92 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15. Debt Long-term debt consisted of the following at December 31: 2021 2020 Effective Interest Rate (in millions) 2021 USD Notes 2.000 % Senior Notes due November 2031 $ 750 $ 2.112 % 1.900 % Senior Notes due March 2031 600 1.981 % 2.950 % Senior Notes due March 2051 700 3.013 % 2020 USD Notes 3.300 % Senior Notes due March 2027 1,000 1,000 3.420 % 3.350 % Senior Notes due March 2030 1,500 1,500 3.430 % 3.850 % Senior Notes due March 2050 1,500 1,500 3.896 % 2019 USD Notes 2.950 % Senior Notes due June 2029 1,000 1,000 3.030 % 3.650 % Senior Notes due June 2049 1,000 1,000 3.689 % 2.000 % Senior Notes due March 2025 750 750 2.147 % 2018 USD Notes 3.500 % Senior Notes due February 2028 500 500 3.598 % 3.950 % Senior Notes due February 2048 500 500 3.990 % 2016 USD Notes 2.000 % Senior Notes due November 2021 650 2.236 % 2.950 % Senior Notes due November 2026 750 750 3.044 % 3.800 % Senior Notes due November 2046 600 600 3.893 % 2015 EUR Notes 1 1.100 % Senior Notes due December 2022 793 859 1.265 % 2.100 % Senior Notes due December 2027 906 982 2.189 % 2.500 % Senior Notes due December 2030 170 184 2.562 % 2014 USD Notes 3.375 % Senior Notes due April 2024 1,000 1,000 3.484 % 14,019 12,775 Less: Unamortized discount and debt issuance costs ( 116 ) ( 103 ) Less: Cumulative hedge accounting fair value adjustments 2 ( 2 ) Total debt outstanding 13,901 12,672 Less: Current portion 3 ( 792 ) ( 649 ) Long-term debt $ 13,109 $ 12,023 1 1.650 billion euro-denominated debt issued in December 2015. 2 In 2021, the Company entered into an interest rate swap which is accounted for as a fair value hedge. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 2015 EUR Notes due December 2022 and 2016 USD Notes due November 2021 are classified as current portion of long-term debt on the consolidated balance sheet as of December 31, 2021 and 2020, respectively. In March 2021, the Company issued $ 600 million principal amount of notes due March 2031 and $ 700 million principal amount of notes due March 2051. In November 2021, the Company also issued $ 750 million principal amount of notes due November 2031. The two issuances in 2021 are collectively referred to as the 2021 USD Notes. The net proceeds from the issuance of the 2021 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.024 billion. In March 2020, the Company issued $ 1 billion principal amount of notes due March 2027, $ 1.5 billion principal amount of notes due March 2030 and $ 1.5 billion principal amount notes due March 2050 (collectively the 2020 USD Notes). The net proceeds from the issuance of the 2020 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 3.959 billion. MASTERCARD 2021 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049. In December 2019, the Company also issued $ 750 million principal amount of notes due March 2025. The two issuances in 2019 are collectively referred to as the 2019 USD Notes. The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion. The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2021 are summarized below. (in millions) 2022 $ 793 2023 2024 1,000 2025 750 2026 750 Thereafter 10,726 Total $ 14,019 As of December 31, 2021, the Company has a commercial paper program (the Commercial Paper Program) under which the Company is authorized to issue up to $ 6 billion in unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company has a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility). The Credit Facility, which previously expired on November 13, 2025, was amended and extended on November 13, 2021 for an additional year and now expires on November 12, 2026. The amendment and extension did not result in material changes to the terms and conditions of the Credit Facility. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2021 and 2020. Borrowings under the Commercial Paper Program and the Credit Facility are to be used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2021 and 2020. Note 16. Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 300 No shares issued or outstanding at December 31, 2021 and 2020. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. 94 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2021, 2020 and 2019. The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2021 2020 2019 (in millions, except per share data) Dividends declared per share $ 1.81 $ 1.64 $ 1.39 Total dividends declared $ 1,781 $ 1,641 $ 1,408 Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31: 2021 2020 Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.4 % 89.2 % 88.2 % 88.9 % Principal or Affiliate Customers (Class B stockholders) 0.8 % % 0.8 % % Mastercard Foundation (Class A stockholders) 10.8 % 10.8 % 11.0 % 11.1 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements pursuant to Canadian tax law. Under such current law, Mastercard Foundation must annually disburse at least 3.5 % of its assets not used in its charitable activities and administration in the previous eight quarters (Disbursement Quota). However, Mastercard Foundation obtained permission from the Canada Revenue Agency to, until December 31, 2021, meet its cumulative Disbursement Quota obligations over a period of time that, on average, demonstrates compliance with the requirement for such established time period. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. MASTERCARD 2021 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Common Stock Activity The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31: Outstanding Shares Class A Class B (in millions) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 Purchases of treasury stock ( 14.3 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.9 ( 2.9 ) Balance at December 31, 2020 986.9 8.3 Purchases of treasury stock ( 16.5 ) Share-based payments 1.2 Conversion of Class B to Class A common stock 0.5 ( 0.5 ) Balance at December 31, 2021 972.1 7.8 The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. The following table summarizes the Companys share repurchase authorizations of its Class A common stock for the years ended December 31: 2021 2020 2019 (In millions, except per share data) Board authorization $ 8,000 $ 6,000 $ 8,000 Dollar-value of shares repurchased $ 5,904 $ 4,473 $ 6,497 Shares repurchased 16.5 14.3 26.4 Average price paid per share $ 356.82 $ 312.68 $ 245.89 As of December 31, 2021, the remaining authorization under the share repurchase programs approved by the Companys Board of Directors was $ 11.9 billion. 96 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2021 and 2020 were as follows: December 31, 2020 Increase / (Decrease) Reclassifications December 31, 2021 (in millions) Foreign currency translation adjustments 1 $ ( 352 ) $ ( 387 ) $ $ ( 739 ) Translation adjustments on net investment hedges 2 ( 175 ) 209 34 Cash flow hedges Foreign exchange contracts 3 5 ( 1 ) 4 Interest rate contracts 4 ( 133 ) 5 ( 128 ) Defined benefit pension and other postretirement plans 5 ( 20 ) 43 ( 2 ) 21 Investment securities available-for-sale ( 1 ) ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 680 ) $ ( 131 ) $ 2 $ ( 809 ) December 31, 2019 Increase / (Decrease) Reclassifications December 31, 2020 (in millions) Foreign currency translation adjustments 1 $ ( 638 ) $ 286 $ $ ( 352 ) Translation adjustments on net investment hedges 2 ( 38 ) ( 137 ) ( 175 ) Cash flow hedges Interest rate contracts 4 11 ( 147 ) 3 ( 133 ) Defined benefit pension and other postretirement plans 5 ( 9 ) ( 10 ) ( 1 ) ( 20 ) Investment securities available-for-sale 1 ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 673 ) $ ( 9 ) $ 2 $ ( 680 ) 1 During 2021, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily b y the depreciation of the euro against the U.S. dollar. During 2020, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro and British pound partially offset by the depreciation of the Brazilian real. 2 During 2021, t he increase in the accumulated other comprehensive income related to the net investment hedges was driven by the depreciation of the euro against the U.S. dollar. During 2020, the increase in the accumulated other comprehensive loss related to the net investment hedge was driven by the appreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 Beginning in 2021, certain foreign exchange derivative contracts are designated as cash flow hedging instruments. Gains and losses resulting from changes in the fair value of these contracts are deferred in accumulated other comprehensive income (loss) and subsequently reclassified to the consolidated statement of operations when the underlying hedged transactions impact earnings. See Note 23 (Derivative and Hedging Instruments) for additional information. 4 In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled for a loss of $ 175 million, or $ 136 million net of tax, recorded in accumulated other comprehensive income (loss). The cumulative loss will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. See Note 23 (Derivative and Hedging Instruments) for additional information. 5 During 2021, the increase in the accumulated other comprehensive income related to the Plans was driven primarily by a net actuarial gain within the Pension Plans. During 2020, the increase in the accumulated other comprehensive loss related to the Plans was driven primarily by an actuarial loss within the Postretirement Plan. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. MASTERCARD 2021 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18. Share-Based Payments In May 2006, the Company granted the following awards under the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, however, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per Option granted for the years ended December 31: 2021 2020 2019 Risk-free rate of return 0.9 % 1.0 % 2.6 % Expected term (in years) 6.00 6.00 6.00 Expected volatility 26.1 % 19.3 % 19.6 % Expected dividend yield 0.5 % 0.6 % 0.6 % Weighted-average fair value per Option granted $ 91.70 $ 80.92 $ 53.09 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2021: Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2021 5.7 $ 137 Granted 0.3 $ 363 Exercised ( 0.6 ) $ 96 Forfeited/expired $ 259 Outstanding at December 31, 2021 5.4 $ 152 5.3 $ 1,109 Exercisable at December 31, 2021 4.2 $ 122 4.6 $ 986 Options vested and expected to vest at December 31, 2021 5.3 $ 152 5.3 $ 1,109 As of December 31, 2021, there was $ 26 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 1.9 years. 98 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restricted Stock Units For RSUs granted on or after March 1, 2020, the awards generally vest ratably over four years . For RSUs granted before March 1, 2020, the awards generally vest after three years . A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than seven months . The following table summarizes the Companys RSU activity for the year ended December 31, 2021: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2021 2.5 $ 231 Granted 0.8 $ 358 Converted ( 1.0 ) $ 199 Forfeited ( 0.1 ) $ 282 Outstanding at December 31, 2021 2.2 $ 291 $ 781 RSUs expected to vest at December 31, 2021 2.1 $ 289 $ 751 The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2021, there was $ 283 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 2.6 years. Performance Stock Units PSUs vest after three years , however, awards granted on or after March 1, 2019 are subject to a mandatory one-year post-vest hold. A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. The following table summarizes the Companys PSU activity for the year ended December 31, 2021: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2021 0.4 $ 259 Granted 0.2 $ 385 Converted ( 0.1 ) $ 226 Other ( 0.1 ) $ 231 Outstanding at December 31, 2021 0.4 $ 334 $ 128 PSUs expected to vest at December 31, 2021 0.4 $ 334 $ 128 Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. MASTERCARD 2021 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Compensation expense for PSUs is recognized over the requisite service period, or the date the individual becomes eligible to retire but not less than seven months , if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. During the year ended December 31, 2020, performance targets related to PSU awards granted in 2018 (2018 PSU Awards) were adjusted to exclude certain pandemic-related financial impacts deemed outside of the Companys control. The adjustment during the year ended December 31, 2020 required the Company to apply modification accounting to the 2018 PSU Awards which had an immaterial impact on compensation expense. As of December 31, 2021, there was $ 34 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.5 years. Additional Information The following table includes additional share-based payment information for each of the years ended December 31: 2021 2020 2019 (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ 273 $ 254 $ 250 Income tax benefit recognized for equity awards 57 53 53 Income tax benefit realized related to Options exercised 36 68 69 Options: Total intrinsic value of Options exercised 169 317 317 RSUs: Weighted-average grant-date fair value of awards granted 358 288 226 Total intrinsic value of RSUs converted into shares of Class A common stock 360 330 394 PSUs: Weighted-average grant-date fair value of awards granted 385 291 231 Total intrinsic value of PSUs converted into shares of Class A common stock 32 92 85 Note 19. Commitments At December 31, 2021, the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements. The Company has accrued $ 17 million of these future payments as of December 31, 2021. (in millions) 2022 $ 424 2023 202 2024 114 2025 48 2026 3 Thereafter 1 Total $ 792 100 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20. Income Taxes Components of Income and Income Tax Expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: 2021 2020 2019 (in millions) United States $ 4,261 $ 3,304 $ 4,213 Foreign 6,046 4,456 5,518 Income before income taxes $ 10,307 $ 7,760 $ 9,731 The total income tax provision for the years ended December 31 is comprised of the following components: 2021 2020 2019 (in millions) Current Federal $ 663 $ 439 $ 642 State and local 51 56 81 Foreign 976 781 897 1,690 1,276 1,620 Deferred Federal ( 31 ) 106 40 State and local ( 4 ) 9 Foreign ( 35 ) ( 42 ) ( 47 ) ( 70 ) 73 ( 7 ) Income tax expense $ 1,620 $ 1,349 $ 1,613 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: 2021 2020 2019 Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 10,307 $ 7,760 $ 9,731 Federal statutory tax 2,164 21.0 % 1,630 21.0 % 2,044 21.0 % State tax effect, net of federal benefit 60 0.6 % 57 0.7 % 65 0.7 % Foreign tax effect ( 283 ) ( 2.7 ) % ( 193 ) ( 2.5 ) % ( 208 ) ( 2.1 ) % U.S. tax benefits 1 ( 132 ) ( 1.3 ) % % % Windfall benefit ( 67 ) ( 0.7 ) % ( 119 ) ( 1.5 ) % ( 129 ) ( 1.3 ) % Other, net 2 ( 122 ) ( 1.2 ) % ( 26 ) ( 0.3 ) % ( 159 ) ( 1.7 ) % Income tax expense $ 1,620 15.7 % $ 1,349 17.4 % $ 1,613 16.6 % 1 Refer to the description below for the components that represent U.S. tax benefits. 2 Included within the impact of other is $ 27 million of tax benefits for 2019 relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2021, 2020 and 2019 were 15.7 %, 17.4 % and 16.6 %, respectively. The effective income tax rate for 2021 was lower than the effective income tax rate for 2020, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to the Companys lower effective tax rate. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. MASTERCARD 2021 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effective income tax rate for 2020 was higher than the effective income tax rate for 2019, primarily due to higher discrete tax benefits in 2019, partially offset by a more favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S. tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2021, 2020 and 2019, the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 300 million, or $ 0.30 per diluted share, $ 260 million, or $ 0.26 per diluted share, and $ 300 million, or $ 0.29 per diluted share, respectively. Indefinite Reinvestment As of December 31, 2021 the Company had immaterial deferred tax liabilities related to the tax effect of the estimated foreign exchange impact on unremitted earnings. The Company expects that foreign withholding taxes associated with future repatriation of these earnings will not be material. Earnings of approximately $ 1.1 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax benefits would result, primarily from foreign exchange, if these earnings were to be repatriated. 102 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: 2021 2020 (in millions) Deferred Tax Assets Accrued liabilities $ 497 $ 324 Compensation and benefits 260 218 State taxes and other credits 40 47 Net operating and capital losses 136 147 Unrealized gain/loss - 2015 EUR Notes 24 58 U.S. foreign tax credits 333 276 Intangible assets 206 182 Other items 137 142 Less: Valuation allowance ( 415 ) ( 353 ) Total Deferred Tax Assets 1,218 1,041 Deferred Tax Liabilities Prepaid expenses and other accruals 114 78 Gains on equity investments 153 60 Goodwill and intangible assets 571 216 Property, plant and equipment 174 183 Previously taxed earnings and profits 3 61 Other items 112 38 Total Deferred Tax Liabilities 1,127 636 Net Deferred Tax Assets $ 91 $ 405 The valuation allowance balance at December 31, 2021 and 2020 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current and prior periods and certain foreign losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is dependent on the timing and character of future taxable income in such jurisdictions. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31, is as follows: 2021 2020 2019 (in millions) Beginning balance $ 388 $ 203 $ 164 Additions: Current year tax positions 17 19 22 Prior year tax positions 4 192 37 Reductions: Prior year tax positions ( 31 ) ( 10 ) ( 11 ) Settlements with tax authorities ( 15 ) ( 12 ) ( 2 ) Expired statute of limitations ( 3 ) ( 4 ) ( 7 ) Ending balance $ 360 $ 388 $ 203 MASTERCARD 2021 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2021, the amount of unrecognized tax benefit was $ 360 million. This amount, if recognized, would reduce the effective income tax rate. The Companys unrecognized tax benefits increased in 2020 primarily due to a prior year tax issue resulting from a refund claim filed in 2020. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2021 and 2020, the Company had a net income tax-related interest payable of $ 20 million and $ 24 million, respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2021, 2020 and 2019 was not material. In addition, as of December 31, 2021 and 2020, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 21. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services, resulting in merchants paying excessive costs for the acceptance of Mastercard and Visa credit and debit cards. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. 104 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the merchant litigation cases. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed and oral argument on the appeal is scheduled for March 2022. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. Briefing on summary judgment motions in the Rules Relief Class and opt-out merchant cases was completed in December 2020. In September 2021, the district court granted the Rules Relief Classs motion for class certification. As of December 31, 2021 and 2020, Mastercard had accrued a liability of $ 783 million as a reserve for both the Damages Class litigation and the opt-out merchant cases. As of December 31, 2021 and 2020, Mastercard had $ 586 million in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. The reserve as of December 31, 2021 for both the Damages Class litigation and the opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Europe. Since May 2012, a number of United Kingdom (U.K.) merchants filed claims or threatened litigation against Mastercard seeking damages for excessive costs paid for acceptance of Mastercard credit and debit cards arising out of alleged anti-competitive conduct with respect to, among other things, Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). Mastercard has resolved a substantial amount of these damages claims through settlement or judgment. Approximately 1 billion (approximately $ 1.2 billion as of December 31, 2021) of unresolved damages claims remain. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court heard the appeals of MASTERCARD 2021 FORM 10-K 105 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the four merchant claimants and ruled against both Mastercard and Visa on two of the three legal issues being considered. The parties appealed the rulings to the U.K. Supreme Court. In June 2020, the U.K. Supreme Court ruled against Mastercard and Visa with respect to one of the liability issues being considered by the Court related to U.K domestic interchange fees. Additionally, the U.K Supreme Court set out the legal standard that should be applied by lower trial courts with respect to determining whether interchange was exemptible under applicable law, and provided guidance to lower courts with regard to the legal standard that should be applied in assessing merchants damages claims. The U.K. Supreme Court sent three of the merchant cases back to the trial court solely for the purpose of determining damages issues which is scheduled to commence in January 2023. Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. The majority of these merchant claims generally had been stayed pending the decision of the U.K. Supreme Court, and a number of those matters are now progressing with motion practice and discovery. In one of the actions involving multiple merchant plaintiff claims, in November 2021 the trial court denied the plaintiffs motion for summary judgment on certain liability issues. The plaintiffs were granted permission to appeal that ruling. In 2021 and 2020, Mastercard incurred charges of $ 94 million and $ 28 million, respectively, to reflect both the litigation settlements and estimated attorneys fees with a number of U.K. merchants as well as settlements with a number of Pan-European merchants. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 19 billion as of December 31, 2021). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. In December 2020, the U.K. Supreme Court rejected Mastercards appeal of this ruling. In March 2021, the trial court held a re-hearing on the plaintiffs collective action application, during which Mastercard sought to narrow the scope of the proposed class. In August 2021, the trial court issued a decision in which it granted class certification but agreed with Mastercards argument and narrowed the scope of the class. The plaintiffs did not appeal the trial courts decision narrowing the class. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. In August 2021, the trial court issued an order granting the plaintiffs request for class certification. Visa and Mastercards request for permission to appeal the certification decision to the appellate court was granted. Briefing on the appeal is expected to take place over the course of 2022. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims. 106 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the district court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the district court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. In August 2020, the district court issued an order granting the plaintiffs request for class certification. In January 2021, the Network Defendants request for permission to appeal the district courts certification decision to the appellate court was denied. The plaintiffs have submitted expert reports that allege aggregate damages in excess of $ 1 billion against the four Network Defendants. The Network Defendants have submitted expert reports rebutting both liability and damages. Briefing on summary judgment is expected to occur in 2022. Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the district court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. In January 2021, the magistrate judge serving on the district court issued an opinion recommending that the district court judge deny plaintiffs class certification motion. In light of an appellate court decision, issued subsequent to the magistrates recommendation, the district court judge instructed the parties to re-brief the motion for class certification, and the motion has been fully briefed. In December 2021, the trial court narrowed the scope of the potential class as it denied the plaintiffs motion for class certification of a class of all fax recipients (both stand-alone faxes and online faxes sent via email). However, the court granted class certification for a narrower class of online fax recipients only. Mastercard has filed a motion for reconsideration of the part of the trial courts order granting partial certification. U.S. Federal Trade Commission Investigation In June 2020, the U.S. Federal Trade Commissions Bureau of Competition (FTC) informed Mastercard that it has initiated a formal investigation into compliance with the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In particular, the investigation focuses on Mastercards compliance with the debit routing provisions of the Durbin Amendment. The FTC has issued a subpoena and Mastercard is cooperating with it in the investigation. U.K. Prepaid Cards Matter In 2019, Mastercard was informed by the U.K. Payment Systems Regulator (PSR) that Mastercard was a target of its investigation into alleged anti-competitive conduct by public sector prepaid card program managers in the U.K. This matter focused exclusively on historic behavior. In March 2021, the PSR announced the resolution and settlement of this investigation. As part of the resolution, Mastercard agreed to pay a maximum fine of 32 million. This matter has no prospective impact on Mastercards on-going business. In connection with this matter, in the fourth quarter of 2020, Mastercard recorded a litigation charge of $ 45 million. In January 2022, the PSR issued a decision which concludes the matter and which requires that Mastercard pay its previously agreed fine in March 2022. Note 22. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months prior to period end multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which MASTERCARD 2021 FORM 10-K 107 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to enter into risk mitigation arrangements, including cash collateral and/or other forms of credit enhancement such as letters of credit and guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio and the adequacy of its risk mitigation arrangements on a regular basis. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31: 2021 2020 (in millions) Gross settlement exposure $ 59,571 $ 52,360 Risk mitigation arrangements applied to settlement exposure ( 7,710 ) ( 6,021 ) Net settlement exposure $ 51,861 $ 46,339 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 361 million and $ 370 million at December 31, 2021 and 2020, respectively, of which the Company has risk mitigation arrangements for $ 287 million and $ 294 million at December 31, 2021 and 2020, respectively. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 23. Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts and foreign currency denominated debt. In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances. Cash Flow Hedges The Company may enter into foreign exchange derivative contracts, including forwards and options, to manage the impact of foreign currency variability on anticipated revenues and expenses, which fluctuate based on currencies other than the functional currency of the entity. The objective of these hedging activities is to reduce the effect of movement in foreign exchange rates for a portion of revenues and expenses forecasted to occur. As these contracts are designated as cash flow hedging instruments, gains and losses resulting from changes in fair value of these contracts are deferred in accumulated other comprehensive income (loss) and subsequently reclassified to the consolidated statement of operations when the underlying hedged transactions impact earnings. In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances, and designate such derivatives as hedging instruments in a cash flow hedging relationship. In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled at a loss of $ 136 million, after tax, in accumulated other comprehensive income (loss). As of December 31, 2021, a cumulative loss of $ 128 million, after tax, remains in accumulated other comprehensive income (loss) associated with these contracts and will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes due in March 2030 and March 2050. 108 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value Hedges The Company may enter into interest rate derivative contracts, including interest rate swaps, to manage the effects of interest rate movements on the fair value of the Company's fixed-rate debt and designate such derivatives as hedging instruments in a fair value hedging relationship. Changes in fair value of these contracts and changes in fair value of fixed-rate debt attributable to changes in the hedged benchmark interest rate generally offset each other and are recorded in interest expense on the consolidated statement of operations. Gains or losses related to the net settlements of interest rate swaps are also recorded in interest expense on the consolidated statement of operations. The periodic cash settlements are included in operating activities on the consolidated statement of cash flows. During the fourth quarter of 2021, the Company entered into an interest rate swap designated as a fair value hedge related to $ 1.0 billion of the 3.850 % Senior Notes due March 2050. In effect, the interest rate swap synthetically converts the fixed interest rate on this debt to a variable interest rate based on the Secured Overnight Financing Rate (SOFR) Overnight Index Swap Rate. The net impact to interest expense for the year ended December 31, 2021 was not material. Net Investment Hedges The Company may use foreign currency denominated debt and/or foreign exchange derivative contracts to hedge a portion of its net investment in foreign subsidiaries against adverse movements in exchange rates. The effective portion of the net investment hedge is recorded as a currency translation adjustment in accumulated other comprehensive income (loss). Forward points are designated as an excluded component and recognized in general and administrative expenses on the consolidated statement of operations over the hedge period. The amounts recognized in earnings related to forward points for 2021 were not material. In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in its European operations. During 2021, 2020 and 2019 the Company recorded a pre-tax net foreign currency gain of $ 155 million, loss of $ 177 million and gain of $ 36 million, respectively, in other comprehensive income (loss). As of December 31, 2021 and 2020, the Company had a net foreign currency gain of $ 34 million and loss of $ 175 million, after tax, respectively, in accumulated other comprehensive income (loss) associated with this hedging activity. Non-designated Derivatives The Company may also enter into foreign exchange derivative contracts to serve as economic hedges, such as to offset possible changes in the value of monetary assets and liabilities due to foreign exchange fluctuations, without designating these derivative contracts as hedging instruments. In addition, the Company is subject to foreign exchange risk as part of its daily settlement activities. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with customers. To manage this risk, the Company may enter into short duration foreign exchange derivative contracts based upon anticipated receipts and disbursements for the respective currency position. The objective of these activities is to reduce the Companys exposure to volatility arising from gains and losses resulting from fluctuations of foreign currencies against its functional currencies. Gains and losses resulting from changes in fair value of these contracts are recorded in general and administrative expenses on the consolidated statement of operations, net, along with the foreign currency gains and losses on monetary assets and liabilities. MASTERCARD 2021 FORM 10-K 109 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the fair value of the Companys derivative financial instruments and the related notional amounts: December 31, 2021 December 31, 2020 Notional Fair Value Notional Fair Value (in millions) Derivative assets: Derivatives designated as hedging instruments Foreign exchange contracts in a cash flow hedge 1 $ 102 $ 7 $ $ Interest rate contracts in a fair value hedge 2 ** 6 Derivatives not designated as hedging instruments Foreign exchange contracts 1 124 1 483 19 Total Derivative Assets $ 226 $ 14 $ 483 $ 19 Derivative liabilities: Derivatives designated as hedging instruments Foreign exchange contracts in a cash flow hedge 1 $ 104 $ 3 $ $ Interest rate contracts in a fair value hedge 2 1,000 8 Foreign exchange contracts in a net investment hedge 1 1,473 4 Derivatives not designated as hedging instruments Foreign exchange contracts 1 406 8 1,016 28 Total Derivative Liabilities $ 2,983 $ 23 $ 1,016 $ 28 1 Foreign exchange derivative assets and liabilities are recorded at fair value and are included within prepaid expenses and other current assets and other current liabilities, respectively, on the consolidated balance sheet. 2 Interest rate derivative assets and liabilities are recorded at fair value and are included within prepaid and other current assets and other liabilities, respectively, on the consolidated balance sheet. ** As of December 31, 2021, the total notional of interest rate contracts in a fair value hedge is $ 1.0 billion. The pre-tax gain (loss) related to the Company's derivative financial instruments designated as hedging instruments are as follows: Gain (Loss) Recognized in OCI Gain (Loss) Reclassified from AOCI Year ended December 31, Location of Gain (Loss) Reclassified from AOCI into Earnings Year ended December 31, 2021 2020 2019 2021 2020 2019 (in millions) (in millions) Derivative financial instruments in a cash flow hedge relationship: Foreign exchange contracts $ 6 $ $ Net revenue $ 1 $ $ Interest rate contracts $ $ ( 189 ) $ 14 Interest expense $ ( 6 ) $ ( 4 ) $ Derivative financial instruments in a net investment hedge relationship: Foreign exchange contracts $ 114 $ $ The Company estimates that $ 1 million, pre-tax, of the net deferred loss on cash flow hedges recorded in accumulated other comprehensive income (loss) at December 31, 2021 will be reclassified into the consolidated statement of operations within the next 12 months. The term of the foreign exchange derivative contracts designated in hedging relationships are generally less than 18 months. 110 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amount of gain (loss) recognized on the consolidated statement of operations for non-designated derivative contracts is summarized below: Year ended December 31, Derivatives not designated as hedging instruments: 2021 2020 2019 (in millions) Foreign exchange derivative contracts General and administrative $ ( 10 ) $ 40 $ ( 39 ) The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. The Companys derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Note 24. Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, the location of the merchant acquirer where the card is being used or the location of the customer receiving services. Revenue generated in the U.S. was approximately 32 % of total revenue in 2021, 33 % in 2020 and 32 % in 2019. No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2021, 2020 or 2019. The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31: 2021 2020 2019 (in millions) United States $ 1,117 $ 1,185 $ 1,147 Other countries 790 717 681 Total $ 1,907 $ 1,902 $ 1,828 MASTERCARD 2021 FORM 10-K 111 PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2021 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2021. Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2021 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +45,Mastercard,2020," ITEM 1. BUSINESS Item 1. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction switching and from other payment-related products and services. For a full discussion of our business, please see page 8. Our Performance The following are our key financial and operational highlights for 2020, including growth rates over the prior year: GAAP Net revenue Net income Diluted EPS $15.3B $6.4B $6.37 down 9% down 21% down 20% Non-GAAP 1 (currency-neutral) Net revenue Adjusted net income Adjusted diluted EPS $15.3B $6.5B $6.43 down 8% down 17% down 16% $6.1B $4.5B Repurchased shares $7.2B in capital returned to stockholders $1.6B Dividends paid cash flows from operations Gross dollar volume (growth on a local currency basis) Cross-border volume growth (on a local currency basis) Switched transactions $6.3T down 29% 90.1B flat up 3% 1 Non-GAAP results exclude the impact of gains and losses on equity investments, Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. 6 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS The coronavirus (COVID-19) outbreak and its negative impact on the global economy affected our 2020 performance, during which we saw unfavorable trends compared to historical periods. For a full discussion of this impact, see Managements Discussion and Analysis of Financial Condition and Results of Operation in Item II, Part 7. Our Strategy We grow, diversify and build our business through a combination of organic and inorganic strategic initiatives. Our ability to grow our business is influenced by: personal consumption expenditure (PCE) growth driving cash and check transactions toward electronic forms of payment increasing our share in the payments space providing integrated value-added products and services providing enhanced payment capabilities to capture new payment flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government payments. GROW DIVERSIFY BUILD CORE CUSTOMERS AND GEOGRAPHIES NEW AREAS Credit Debit Commercial Prepaid Digital-Physical Convergence Acceptance Financial Inclusion New Markets Businesses Governments Merchants Digital Players Local Schemes/Switches Data Analytics Consulting Marketing Services Loyalty Cyber and Intelligence Processing New Payment Flows Open Banking ENABLED BY BRAND, DATA, TECHNOLOGY AND PEOPLE Grow. We focus on growing our core business globally, including growing our consumer and commercial products and solutions, as well as increasing the number of payment transactions we switch. We also look to provide effective and efficient payments solutions that cater to the evolving ways people interact and transact in the growing digital economy. This includes expanding merchant access to electronic payments through new technologies in an effort to deliver a better consumer experience, while creating greater efficiencies and security. Diversify. We diversify our business by: working with new customers, including governments, merchants, financial technology companies (fintechs), digital players, mobile providers and other corporate businesses scaling our capabilities and business into new geographies, including growing acceptance in markets with limited electronic payments acceptance today broadening financial inclusion for the unbanked and underbanked Build. We build our business by: creating and acquiring differentiated products and platforms to provide unique, innovative solutions that we bring to market to support new payment flows and related applications, such as real-time account-based payments and the Mastercard Track suite of products providing services across data analytics, consulting, marketing services, loyalty, cyber and intelligence, and processing providing open banking capabilities to enable the reliable access, transmission and management of consumer-consented data Strategic Partners. We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for our products and services. We help merchants, financial institutions, governments, and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer MASTERCARD 2020 FORM 10-K 7 PART I ITEM 1. BUSINESS experiences. We partner with technology companies such as digital players, fintechs and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments improve financial inclusion and efficiencies, reduce costs, increase transparency of financial transactions and data to reduce crime and corruption and advance social programs. For consumers, we provide faster, safer and more convenient ways to pay and transfer funds and exchange information to enable services. Talent and Culture. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries by building a world-class culture based on decency, respect and inclusion where people have opportunities to perform purpose-driven work that impacts customers, communities and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Our Business Our Operations and Network We operate a multi-rail network that offers our customers one partner to turn to for their domestic and cross-border needs. Our core network links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We enable transactions for our customers through our core network in more than 150 currencies and in more than 210 countries and territories. Our range of capabilities extend beyond our core network into real-time account-based payments and open banking. Core Network Transactions. Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs and benefits that consumers and merchants derive. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for the customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. 8 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate. Issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and country of issuance are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the country of issuance are the same (domestic transactions). We switch over 55% of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture with an intelligent edge that enables the network to adapt to the needs of each transaction. Our core network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring, tokenization services, etc.) to appropriate transactions in real time. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Infrastructure and Applications. Augmenting our core network, we offer real-time account-based payment capabilities, enabling payments between bank accounts in real-time in countries in which it has been deployed. Open Banking. We offer a platform that enables data providers and third parties to reliably access, securely transmit and confidently manage customer-consented data to improve the customer experience. Payments System Security. Our payment solutions and products are designed to ensure safety and security for the global payments system. Our core network and additional platforms incorporate multiple layers of protection, providing greater resiliency and best-in-class security protection. Our programs are assessed by third parties and incorporate benchmarking and other data from peer companies and consultants. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, an enterprise resilience program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. Through the combined efforts of our Security Operations Centers, Fusion Centers and Mastercard Intelligence Center, we work with experts across the organization (as well as through other sources such as public-private partnerships), to monitor and respond quickly to a range of cyber and physical threats. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our network supports and enables our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. For a full discussion of the ways our innovation capabilities enable digital payments, see Our Products and Services - Digital Enablement below. Customer Risk. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers or the availability of unspent prepaid account holder account balances. Our Franchise. We manage an ecosystem of stakeholders who participate in our network. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We ensure a balanced ecosystem where all participants benefit from the availability, innovation and safety and security of our network. We achieve this through the following key activities: Participant Onboarding. We ensure the capability of new customers to use our network, and define the roles and responsibilities for their operations once on the network MASTERCARD 2020 FORM 10-K 9 PART I ITEM 1. BUSINESS Safety and Security. We establish the core principles, including ensuring consumer protections and integrity, so participants feel confident to transact on the network. Operating Standards. We define the operational, technical and financial policies to which network participants are required to adhere. Responsible Stewardship. We establish performance standards to support ecosystem growth and optimization and establish proactive monitoring to ensure participant performance. Issue Resolution. We operate a framework to enable the resolution of disputes for both customers and consumers. Our Products and Services We provide a wide variety of integrated products and services that support products that customers can offer to their account holders and merchants. These offerings facilitate transactions across our multi-rail payment network among account holders, merchants, financial institutions, businesses, governments and other organizations in markets globally. Core Payment Products Consumer Credit. We offer a number of products that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Consumer Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid accounts are a type of electronic payment that enables consumers to pay in advance whether or not they previously had a bank account or a credit history. These accounts can be tailored to meet specific program, customer or consumer needs, such as paying bills, sending person-to-person payments or withdrawing cash from an ATM. Our focus ranges from digital accounts (such as fintech and gig economy platforms) to business programs such as employee payroll, health savings accounts and solutions for small business owners). Our prepaid programs also offer opportunities in the private and public sectors to drive financial inclusion of previously unbanked individuals through social security payments, unemployment benefits and salary cards. 10 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS We also provide prepaid program management services, primarily outside of the United States, that provide processing and end-to-end services on behalf of issuers or distributor partners such as airlines, foreign exchange bureaus and travel agents. Commercial Credit and Debit. We offer commercial credit and debit payment products and solutions that meet the payment needs of large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our card offerings include travel, small business (debit and credit), purchasing and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our Mastercard In Control platform generates virtual account numbers which provide businesses with enhanced controls, more security and better data. Our Mastercard Track Business Payment Service (Track BPS) is aimed at improving the way businesses pay and get paid by providing a single connection enabling access to multiple payment rails, greater control and richer data to optimize B2B transactions for both buyers and suppliers. The following chart provides GDV and number of cards featuring our brands in 2020 for select programs and solutions: Year Ended December 31, 2020 As of December 31, 2020 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2019 Mastercard-branded Programs 1,2 Consumer Credit $ 2,425 (7) % 38 % 894 2 % Consumer Debit and Prepaid 3,230 8 % 51 % 1,338 11 % Commercial Credit and Debit 682 (6) % 11 % 102 22 % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. New Payment Products and Open Banking In addition to the switching capabilities of our core network, we offer platforms with payment capabilities that support new payment flows and related applications: We offer real-time account-based payments for ACH transactions. This platform enables payments between bank accounts in real time and provides enhanced data and messaging capabilities. We offer applications including those that make it easier for consumers to view, manage and pay their bills either with cards or real-time and batch ACH payments from their bank accounts, and that enable consumers, businesses, governments and merchants to send and receive money beyond borders with greater speed and ease. We offer an open banking platform that allows data providers and third parties to reliably access, securely transmit and confidently manage customer-consented data to improve the customer experience. Value-Added Products and Services Cyber and Intelligence. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number of EMV cards issued and the transaction volume on EMV cards. The Identify layer allows us to help banks and merchants verify the authenticity of consumers during the payment process using various biometric technologies, including fingerprint, face and iris scanning technology to verify online purchases on mobile devices, as well as a card with biometric technology built in. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Our offerings in this space include alerts when accounts are exposed to data breaches or security incidents, fraud scoring technology that scans billions of dollars of money flows each day while increasing approvals and reducing false declines, and network-level monitoring on a global scale to help identify the occurrence of widespread fraud attacks when the customer (or their processor) may be unable to detect or defend against them. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, enhancing approvals for online and card-on-file payments, to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include solutions for consumer alerts and controls and a suite of digital token services. We also offer an e- MASTERCARD 2020 FORM 10-K 11 PART I ITEM 1. BUSINESS commerce fraud and dispute management network that enables merchants to stop delivery when a fraudulent or disputed transaction is identified, and issuers to refund the cardholder to avoid the chargeback process. Moreover, we use our AI and data analytics, along with our cyber risk assessment capabilities, to help financial institutions, merchants, corporations and governments secure their digital assets We have also worked with our customers to provide products to consumers globally with increased confidence through the benefit of zero liability, where the consumer bears no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards. We have built a scalable rewards platform that enables customers to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. We also provide a loyalty platform that enables stronger relationships with retailers, restaurants, airlines and consumer packaged goods companies by creating experiences that drive loyalty and impactful consumer engagement. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions. Data Analytics and Consulting. We provide proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and program management allow us to assist customers to implement actions based on these insights. We utilize our expertise and tools to collaborate with, and increasingly drive, innovation at financial institutions, merchants and governments. Through our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five-day app prototyping workshop, as well as other customized innovation programs such as in-lab usability testing and concept design. Through our Test Learn software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests to drive more profitable decision making. Digital Enablement Our innovation capabilities enable broader reach to scale digital payment services beyond cards to multiple channels, including mobile devices, and our standards, services and governance model help us to serve as the connection that allows financial institutions, fintechs and technology companies to interoperate and enable consumers to engage through digital channels: Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base, as well as products and practices to facilitate acceptance via mobile devices. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. We provide solutions that enable our customers to offer consumers the ability to send and receive money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and often in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. 12 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands and brand identities (including our sonic brand identity) through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, preference and overall usage among account holders globally. Our Priceless advertising campaign, which has run in more than 50 languages and in more than 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Human Capital Management As of December 31, 2020, we employed approximately 21,000 persons globally. We are dedicated to supporting our workforce during the global COVID-19 pandemic: We had no COVID-19 related layoffs in 2020 We introduced a COVID-19 global employee benefit providing up to 10 business days of additional paid leave for sick, childcare or eldercare related needs We covered 100% of the costs associated with COVID-19 testing for all employees and provided access to free COVID-related telemedicine consultations for our U.S. employees We provided employees with flexibility for how and where they get work done and put precautionary health and safety measures in place at each office location Management regularly reviews our people strategy and culture, as well as related risks, with our Human Resources and Compensation Committee, and reviews this annually with our Board of Directors. Our strategy focuses on recruitment, development, succession and retention, including: Attracting top talent with the strength of our talent brand, which includes our culture of being a force for good Developing our depth of talent through acquisitions and recruitment Strong development and succession planning for key roles, including talent and leadership programs across various levels that: Embed our culture principles Focus on diverse populations and Aim to develop talent and people managers through personalized and group executive development programs Using learning to drive innovation and growth, including a focus on scaling digital fluency globally, product training certification, creating an environment for employees to drive their own learning, and focusing on developing capability in key skill areas Retaining and growing an inclusive workforce, including: Ongoing development conversations and personalized development plans A focus on talent movement, including career moves and rotations and Competitive and differentiated pay and benefits, including pay equity on the basis of gender and (in the U.S.) race and ethnicity, as well as a flexible work model As an organization, we are focused on maintaining a world-class culture, built on a foundation of decency: We are mindful of the health of our culture, looking at retention of critical roles, our external brand reputation, internal levels of engagement, and diverse representation MASTERCARD 2020 FORM 10-K 13 PART I ITEM 1. BUSINESS We are committed to providing a safe and respectful workplace built on a culture of decency and a focus on the well-being of our employees, as well as monitoring for potential disruptions to our culture and reputation - especially with respect to such events as the COVID-19 pandemic We are focused on providing and supporting a culture of volunteering We have established a culture of high ethical business practices and compliance standards, grounded in honesty, decency, trust and personal accountability. It is driven by tone at the top, reinforced with regular training, fostered in a speak-up environment, and measured by a risk culture and climate survey Diversity and inclusion underpin everything we do: We look at our recruitment, development, succession and retention practices (including global attrition rates) with a focus on gender, race (in the U.S.) and generational mix of our employee population We have developed regional and functional action plans to identify priorities and actions that will help us make more progress for diversity and inclusion, including balance and inclusion in gender and racial representation As part of our commitment to racial justice, we have committed to our In Solidarity initiative, which focuses on people, market and society to harness our culture of decency and build on our efforts to advance inclusion and equality We encourage you to review our Sustainability Report (located on our website) for more detailed information regarding our people strategy. Recent Developments We are focused on helping individuals and businesses weather the challenges presented by the COVID-19 pandemic by ensuring our network remains secure, resilient and reliable. We are applying our technology, philanthropy, and data and cybersecurity expertise to help rebuild communities, ensure that economic growth is inclusive and help address new challenges facing governments, small businesses and consumers. Consumer While technology has increasingly changed the way people get information, interact, shop and make purchases, consumers continue to expect a seamless experience where their payment is simple and secure. Our teams are creating innovative solutions that meet the needs of consumers and merchants in a digital environment by applying emerging technologies. During the global COVID-19 pandemic, we have seen continued trends toward a preference for contactless and the rapid adoption of e-commerce. These trends are further accelerating the secular shift to digital forms of payment. In 2020, we: expanded click to pay, the activation of the EMV Secure Remote Commerce industry standard that enables a faster, more secure checkout experience across web and mobile sites, mobile apps and connected devices. This checkout experience is designed to provide consumers the same convenience and security in a digital environment that they have when paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. continued our focus on contactless payments technology to help deliver a simple and intuitive way to pay, as well as health and safety benefits when consumers are looking for low-touch options. These efforts include raising contactless purchase limits in virtually all geographies. announced a suite of frictionless solutions in various markets designed to deliver low-touch high engagement experiences for retailers and the consumer. For example, our Shop Anywhere platform enables merchants to create simple, personalized shopping experiences in store, offering consumers no wait, no checkout lines and a secure way to pay. expanded our Digital First Card Program to each of our regions to provide our customers with foundational guidelines that will enable them to offer their cardholders a fully digital payment experience with an optional physical card. This solution enables our customers to meet cardholder expectations of immediacy, safety, and convenience, including during card application, authentication and instant card access, making secure purchases (whether contactless in-store, in-app, or via the web), and managing alerts, controls, and benefits. 14 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Commercial and B2B Building on our corporate TE, fleet, purchasing card and small business capabilities, we have been increasingly focused on developing solutions to address other ways that businesses move money. In 2020, we: added account-to-account payment functionality to Mastercard Track BPS, our open-loop commercial service platform built to simplify and automate payments between suppliers and buyers. With this launch, businesses in the United States can now have a similar experience within this service for account-to-account payments as they do for card payments - exchanging data with greater efficiency and facilitating payments across multiple payment rails including real-time and batch ACH payments. launched Digital Doors, a dedicated program to help small businesses successfully adapt to the changing needs of their customers by establishing and protecting an online presence, including accepting digital payments. We have also created a free Small Business Digital Readiness Diagnostic to identify the first steps needed in this transition. New Payment Products and Open Banking In order to help grow our business and offer more electronic payment options to consumers, businesses and governments, Mastercard has developed and enhanced solutions beyond the principal switching capabilities available on our core network. We believe this will allow us to capture more payment flows, including B2B, P2P, B2C and government disbursements. In 2020, we: continued to expand our support of real-time payments globally, including being selected to build and operate a new real-time clearing and settlement platform in Canada and partnering with the Saudi Arabian Monetary Authority to enable instant account-to-account payments in the country for the first time. These developments build on other recent achievements, including our selection to enhance the InstaPay real-time retail payment system in the Philippines (including operating the infrastructure for and providing anti-money laundering tools to the its national clearing switch). As of December 31, 2020, we either operated or were implementing real-time payments infrastructure in 12 of the top 50 markets as measured by GDP. positioned ourselves to add to our real-time payments solutions, including our pending acquisition of the majority of the Corporate Services business of Nets Denmark A/S. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of the business. strengthened Mastercards open-banking platform with our acquisition of Finicity, a leading North American provider of real-time access to financial data and insights. The acquisition enables a greater choice of financial services, reinforcing our long-standing partnerships with and commitment to financial institutions and fintechs across the globe. This acquisition also enables us to expand our capabilities across North America and globally, and in particular accelerate the adoption of Finicitys services in North America. Together with Finicity, we will be able to focus on serving the needs of the lending market, including through helping to streamline loan application processes and improve credit decisioning, thereby helping to drive further financial inclusion. further extended Mastercard Cross-Border Services to customers, including financial institutions and fintechs, in every region across the globe. These services enable a wide range of payment flows and use cases, including trade, remittances and disbursements. These flows are enabled via a distribution network that continues to evolve across multiple channels, including account, card, and wallets. In particular, these services have enabled inbound B2B payments into China. extended our blockchain initiatives, providing additional transparency and efficiencies to the cross-border B2B payments space and proof of provenance - innovative, secure solutions across the global supply chain. Value-Added Products and Services We provide products and services including cyber and intelligence, loyalty, processing, data analytics and consulting that meet evolving requirements and the expectations of our stakeholders. We recently: extended our investments in Artificial Intelligence (AI) by: launching Mastercard ThreatScan, an AI-powered solution that helps banks proactively identify potential vulnerabilities in their authorization systems. The service works alongside an issuers existing fraud tools, imitating known criminal transaction behavior to identify potential weaknesses and prompt action before fraud potentially occurs. MASTERCARD 2020 FORM 10-K 15 PART I ITEM 1. BUSINESS scaling Decision Intelligence, our fraud scoring technology, to score billions of transactions in real time every day while increasing approvals and reducing false declines. scaled digital services in our Loyalty and Engagement capabilities to support customers in their response to the accelerated demand of digital services from consumers during the pandemic. This scaling includes additional capabilities for real-time promotions and cash back offers, digital acquisition, digital training and online offers to bring a full suite of digital loyalty and marketing solutions to merchants and financial institutions. enhanced the services we are able to offer to customers based on account-to-account flows, including data insights we are providing U.K. and U.S. customers to help them with anti-money laundering compliance and identification and prevention of other financial crimes. launched Recovery Insights, a set of data, tech and research tools that can help airlines, restaurants, consumer packaged goods companies, banks, governments and others navigate the rise in e-commerce, fine-tune operations, and prioritize investments. Key Initiatives In light of the digital inequality gaps being exacerbated by COVID-19, we have expanded our worldwide commitment to financial inclusion, pledging to bring a total of 1 billion people and 50 million micro and small businesses into the digital economy by 2025. As part of this effort, we are focused on providing 25 million women entrepreneurs with solutions that can help them grow their businesses. Engaged with several hundred national and local governments around the world to support their efforts to respond to the pandemic crisis, including facilitating electronic disbursements of vital benefits and providing access to data-driven insights in order to assess the impact of COVID-19 on their communities and optimize their recovery plans. We have committed $250 million in financial, technology, product and insight assets over the next five years to support the financial security and vitality of small businesses and their workers, including supporting the transition of low-income entrepreneurs to digital banking and helping small businesses access federal relief. We began to implement our In Solidarity initiative, which focuses on people, market and society to harness our culture of decency and build on our efforts to advance inclusion and equality. We launched the Priceless Planet Coalition, a platform to unite corporate sustainability efforts and make meaningful investments to preserve the environment. Together with partners who share a commitment to doing well by doing good, the coalition is pledging to plant 100 million trees over five years. We announced the expansion of Start Path, our startup engagement program, adding new seed businesses and more technology partners. Through this program, we provide entrepreneurs access to expert engineers and specialists that can help them deploy new services quickly and efficiently and help them grow their businesses and scale sustainably. Revenue Sources We generate revenue primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 and Note 3, Revenue for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other technologies, which are important to our business operations. These patents expire at varying times depending on the jurisdiction and filing date. 16 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Competition We face competition in all categories of payment, including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments and wire transfers We face a number of competitors both within and outside of the global payments industry: Cash, Check and Legacy ACH. Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. General Purpose Payment Networks. We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. Globally, financial institutions may issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Real-time Account-based Payment Systems. We face competition in the real-time account-based payment space from other companies that provide infrastructure, applications and services to support these payment solutions. Alternative Payments Systems and New Entrants. As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers, who in many circumstances can also be our partners or customers, have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), POS financing/buy now pay later providers (such as Klarna), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. We also compete with merchants and governments. Value-Added Products and Service Providers. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, merchants and governments and technology companies that provide cyber and fraud solutions, as well as companies that compete against us as providers of loyalty and program management solutions. Regulatory initiatives could also lead to increased competition in this space. Mastercard is a trusted intermediary in a complex system. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over more than 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance expertise in real-time account-based payments and open banking development and adoption of innovative products and digital solutions safety and security solutions embedded in our networks analytics insights and consulting services that help issuers and merchants optimize their payments and related businesses loyalty solutions that enhance the payments value proposition for issuers and merchants MASTERCARD 2020 FORM 10-K 17 PART I ITEM 1. BUSINESS ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent and culture, with a focus on inclusion and being a force for good Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. We are committed to comply with all applicable laws and regulations and implement policies, procedures and programs designed to promote compliance. We coordinate globally while acting locally and leverage our relationships to manage the effects of regulation on us. See Risk Factors in Part I, Item 1A for more detail and examples of the regulation to which we are subject. Payments Oversight and Regulation. Central banks and other regulators in several jurisdictions around the world either have, or are seeking to establish, formal oversight over the payments industry, as well as authority to regulate certain aspects of the payment systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, Mastercard is subject to systemic importance regulation, which includes various requirements we must meet, including obligations related to governance and risk management. In the U.K., the Bank of England designated Vocalink, our real-time account-based payment network platform, to be a specified service provider, which includes supervisions and examination requirements. In addition, European Union legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switching activities and other processing in terms of how we go to market, make decisions and organize our structure. Interchange Fees. Interchange fees that support the function and value of four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities, our settlement with the European Commission resolving its investigation into our interregional interchange fees and the European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the European Economic Area (the EEA). For more detail, see Risk Factors - Other Regulation in Part I, Item 1A and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter-financing of terrorism (CFT) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CFT program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in these countries and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with 18 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks, financial institutions and others in their capacity as issuers and otherwise, impacting us as a consequence. Additionally, regulations such as the revised Payment Services Directive (commonly referred to as PSD2) in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to route transactions away from Mastercard products and provide payment initiation and account information services directly to consumers who use our products. PSD2 also requires a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Regulation of Internet and Digital Transactions. Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security and copyright and trademark infringement. Privacy, Data and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the General Data Protection Regulation (the GDPR), which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California), Argentina, Brazil, Canada, Chile, India, Indonesia and Kenya. Some jurisdictions, such as India, are currently considering adopting or have adopted data localization requirements, which mandate the collection, processing, and/or storage of data within their borders. We believe that various forms of data localization requirements are under consideration in other countries and jurisdictions, including the European Union. Due to increasing data collection and data flows, numerous data breaches and security incidents as well as the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to regulate data and protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. MASTERCARD 2020 FORM 10-K 19 PART I "," ITEM 1A. RISK FACTORS Item 1A. Risk factors RISK HIGHLIGHTS Legal and Regulatory Business and Operations Payments Industry Regulation COVID-19 Global Economic and Political Environment Preferential or Protective Government Actions Competition and Technology Brand and Reputational Impact Privacy, Data and Security Information Security and Service Disruptions Talent and Culture Other Regulation Stakeholder Relationships Acquisitions Litigation Settlement and Third-Party Obligations Class A Common Stock and Governance Structure Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations, establishing, and potentially further expanding, obligations or restrictions with respect to the types of products and services that we may offer, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). Several jurisdictions have also inquired about the network fees we charge to our customers (typically as part of broader market reviews of retail payments). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. In some cases, we have been designated as a systemically important payment system, and other regulators may consider designating us as systemically important or in a similar category resulting in heightened regulatory oversight. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. Moreover, as regulators around the world increasingly look to replicate similar regulation of payments and other industries, efforts in any one jurisdiction may influence approaches in other jurisdictions. Similarly, new initiatives within a jurisdiction involving one product may lead to regulation of similar or related products (for example, debit regulations could lead to regulation of credit products). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. Increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. As a result, issuers and acquirers could be less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. In addition, any regulation that is enacted related to the type and level of network fees we charge our customers could also materially and adversely 20 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS impact our results of operations. Regulators could also require us to obtain prior approval for changes to our system rules, procedures or operations, or could require customization with regard to such changes, which could negatively impact us. Such changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Business - Government Regulation in Part I, Item 1 and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, changes to interregional interchange fees as a result of the resolution of the European Commissions investigation could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek a fee reduction from us to decrease the expense of their payment programs, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries have implemented, or may implement, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. MASTERCARD 2020 FORM 10-K 21 PART I ITEM 1A. RISK FACTORS Some jurisdictions are considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our inability to effect change in, or work with, these jurisdictions could adversely affect our ability to maintain or increase our revenues and extend our global brand. Additionally, some jurisdictions have implemented, or may implement, foreign ownership restrictions, which could potentially have the effect of forcing or inducing the transfer of our technology and proprietary information as a condition of access to their markets. Such restrictions could adversely impact our ability to compete in these markets. Privacy, Data and Security Regulation of privacy, data, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated and personalized products and services to meet the needs of a changing marketplace, as well as acquire new companies, we have expanded our information profile through the collection of additional data from additional sources and across multiple channels. This expansion has amplified the impact of these regulations on our business. Regulation of privacy and data and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information, as well as increased care in our data management, governance and quality practices. While we make every effort to comply with all regulatory requirements and we deploy a privacy-by-design and data-by-design approach to all of our product development, the speed and pace of change may not allow us to meet rapidly evolving expectations. We are also subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions are also considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions are considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or interpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and/or restrict our ability to leverage data for innovation. This could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the need for improved data management, governance and quality practices, the development of information-based products and solutions, and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity and increasing cyberattacks have encouraged legislative and regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer personal information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to legislative or regulatory intervention, such as enhanced security requirements and liabilities, as well as damage to our reputation. 22 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption - We are subject to AML and CFT laws and regulations globally. Economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies, and persons and entities. We are also subject to anti-corruption laws and regulations globally, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. Account-based Payment Systems - In the U.K., aspects of our Vocalink business are subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Certain regulations (such as PSD2 in the EEA) may impact various aspects of our business. For example, PSD2s strong authentication requirement could increase the number of transactions that consumers abandon if we are unable to secure a frictionless authentication experience under the new standards. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. In particular, a violation and subsequent judgment or settlement against us, or those with whom we may be associated, under economic sanctions and AML, CFT, and anti-corruption laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Each instance may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective income tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective income tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective income tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. MASTERCARD 2020 FORM 10-K 23 PART I ITEM 1A. RISK FACTORS Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations COVID-19 The global COVID-19 pandemic and containment measures taken in response to it have adversely impacted our business, results of operations and financial condition, and may continue to do so depending on future developments, which are uncertain. Global health concerns relating to the COVID-19 outbreak have impacted the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The outbreak resulted in governments in countries across the globe implementing measures to try to contain the virus, such as travel restrictions, social distancing, and restrictions on business operations which have impacted consumers and businesses. These measures have adversely impacted and may further impact our workforce and operations and the operations of our customers, suppliers and business partners. While some of these measures have eased in certain jurisdictions, others have remained in place. The extent to which current measures are removed or new measures are put in place will depend how the pandemic evolves, as well as the progress of the global roll-out of vaccines. The spread of COVID-19 has caused us to modify our business practices (including employee travel, employee work locations, and working in a remote environment), and we may take further actions as required by government authorities or that are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or otherwise be satisfactory to government authorities. The COVID-19 pandemic has adversely impacted our business, results of operations and financial condition. There are no comparable recent events which may provide guidance as to the effect of the spread of COVID-19 and a global pandemic, and, as a result, the ultimate impact of COVID-19 or a similar health epidemic is highly uncertain and subject to change. The extent to which COVID-19 further impacts our business, results of operations and financial condition will depend on future developments, which are uncertain, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business and our result of operations as a result of its global economic impact, including any recession that has occurred or may occur in the future. Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business - Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also introduce their own innovative programs and services that adversely impact our growth. Beyond our traditional competitors, we also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our 24 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation (such as PSD2 in the EEA) may disintermediate issuers by enabling third-party providers opportunities to route payment transactions away from our network and products and towards other forms of payment by offering account information or payment initiation services directly to those who currently use our products. This may also allow these processors to commoditize the data that are included in the transactions. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. Although we partner with fintechs and technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data standards, without proper oversight we could give the partner a competitive advantage. Competitors, customers, fintechs, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop or encourage the creation of national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets, or require us to compete differently. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our products and services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. We continue to experience pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. MASTERCARD 2020 FORM 10-K 25 PART I ITEM 1A. RISK FACTORS Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with fintechs and technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. Regulatory or government requirements could require us to host and deliver certain products and services on-soil in certain markets, which would require us to alter our technology and delivery model, potentially resulting in additional expenses. Various central banks are experimenting with digital currencies called Central Bank Digital Currencies (CBDC). CBDCs may be launched with their own networks to transfer money between participants. Policy and design considerations that governments adopt could impact the extent of our role in facilitating CBDC-based payment transactions, potentially impacting the transactions that we may process over our network. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payment network presents risks that could materially affect our business. U.K. regulators have designated Vocalink, our real-time account-based payment network platform, to be a specified service provider and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payment systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payment platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payment network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our integrated products and services can present operational and onboarding challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the 26 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS payments markets, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users other than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. These new customers are typically less regulated, and as a result, enhanced infrastructure and monitoring is required. Our failure to deliver these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, or we are unable to adequately anticipate risks related to new types of customers, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. The advent of the global COVID-19 pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce working from home in a mostly remote environment. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information and technology in our computer systems and networks, as well as the systems of our third-party providers. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks, as well as the systems of our third-party providers, have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems (including third-party provider systems) or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks MASTERCARD 2020 FORM 10-K 27 PART I ITEM 1A. RISK FACTORS from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings have experienced in limited instances and may continue to experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a enterprise resiliency program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Stakeholder Relationships Losing a significant portion of business from one or more of our largest customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. 28 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments, fintechs and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. Some merchants are increasingly asking regulators to review and potentially regulate our own network fees, in addition to interchange. See our risk factor in Risk Factors Other Regulation in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. MASTERCARD 2020 FORM 10-K 29 PART I ITEM 1A. RISK FACTORS Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination, of the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us Consumers and businesses lowering spending, which could impact domestic and cross-border spend Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity has, and may continue to be, adversely affected by world geopolitical, economic, health, weather and other conditions. These include COVID-19, as well as the threat of terrorism and separate outbreaks of flu, viruses and other diseases, as well as major environmental events (including those related to climate change). The uncertainty that could result from such events could decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. 30 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Our operations as a global payments network rely in part on global interoperable standards to help facilitate safe and simple payments. To the extent geopolitical events result in jurisdictions no longer participating in the creation or adoption of these standards, or the creation of competing standards, the products and services we offer could be negatively impacted. Any of these developments could have a material adverse impact on our overall business and results of operations. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2020, approximately 67% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers or other companies and organizations that use our products and services (including certain legally permissible but high risk merchant categories, such as alcohol, tobacco, fire-arms and adult content) may also, by association, impair our reputation, or result in greater public, regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. To the extent any of our published sustainability metrics are subsequently viewed as inaccurate or we are unable to execute on our sustainability initiatives, we may be viewed negatively by consumers, investors and other stakeholders concerned about these matters. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Any of the above issues could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments system, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. MASTERCARD 2020 FORM 10-K 31 PART I ITEM 1A. RISK FACTORS Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and visa regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Moreover, as a result of the global COVID-19 pandemic, a significant portion of our workforce is working in a mostly remote environment. This remote environment may continue after the pandemic due to potential resulting trends, and could impact the quality of our corporate culture. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity and decency. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Acquisitions, strategic investments or entry into new businesses could be impacted by regulatory scrutiny, and if successful, could disrupt our business and harm our results of operations or reputation. As we continue to evaluate our strategic acquisitions of, or acquiring interests in joint ventures or other entities related to, complementary businesses, products or technologies, we face increasing regulatory scrutiny with respect to antitrust and other considerations. Such scrutiny could prevent us from successfully completing such acquisitions in the future. To the extent we do make these acquisitions, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations, both directly as a result of the new business as well as in the other existing parts of our business, with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors 32 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 9, 2021, Mastercard Foundation owned 108,210,635 shares of Class A common stock, representing approximately 11.0% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted and have occurred. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", Item 1B. Unresolved staff comments Not applicable. ," Item 2. Properties We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center, located in OFallon, Missouri. As of December 31, 2020, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries around the world, consisting of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," Item 3. Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 9, 2021, we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 257 holders of record of our non-voting Class B common stock as of February 9, 2021, constituting approximately 0.8% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 and the SP 500 Financials for the five-year period ended December 31, 2020. The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index 2015 2016 2017 2018 2019 2020 Mastercard $ 100.00 $ 106.91 $ 157.88 $ 197.86 $ 314.91 $ 378.44 SP 500 100.00 111.96 136.40 130.42 171.49 203.04 SP 500 Financials 100.00 122.80 150.04 130.49 172.41 169.49 38 MASTERCARD 2020 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Dividend Declaration and Policy On December 8, 2020, our Board of Directors declared a quarterly cash dividend of $0.44 per share paid on February 9, 2021 to holders of record on January 8, 2021 of our Class A common stock and Class B common stock. On February 8, 2021, our Board of Directors declared a quarterly cash dividend of $0.44 per share payable on May 7, 2021 to holders of record on April 9, 2021 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities During the fourth quarter of 2020, we repurchased a total of approximately 3.1 million shares for $1.03 billion at an average price of $330.34 per share of Class A common stock. See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion with respect to our share repurchase programs. The following table presents our repurchase activity on a cash basis during the fourth quarter of 2020: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 1,552,273 $ 335.39 1,552,273 $ 4,340,730,451 November 1 30 779,892 314.13 779,892 4,095,745,017 December 1 31 785,846 336.44 785,846 9,831,351,292 Total 3,118,011 330.34 3,118,011 1 Dollar value of shares that may yet be purchased under the share repurchase programs are as of the end of each period presented. MASTERCARD 2020 FORM 10-K 39 PART II "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2019 compared to the year ended December 31, 2018, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. COVID-19 The coronavirus (COVID-19) pandemic has spread rapidly across the globe and has had significant negative effects on the global economy. This outbreak has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. We continue to monitor the effects of the pandemic and actions taken by governments as they relate to travel restrictions, social distancing measures and restrictions on business operations, as well as the continued impact of these actions on consumers and businesses. While some of these measures have eased in certain jurisdictions, others have remained in place. The extent to which current measures are removed or new measures are put in place will depend upon how the pandemic evolves, as well as the progress of the global roll-out of vaccines. The COVID-19 outbreak affected our 2020 performance, during which we noted unfavorable trends compared to historical periods. The following table provides a summary of trends in our key metrics for 2020 as compared to the respective periods in 2019: Quarter ended Year ended December 31 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % (10) % 1 % 1 % % Cross-border volume (local currency basis) (1) % (45) % (36) % (29) % (29) % Switched transactions 13 % (10) % 5 % 4 % 3 % The impact of this outbreak started in the first quarter of 2020 as we experienced declines in our key metrics compared to historical periods, primarily due to travel restrictions and stay-at-home orders implemented by governments in many regions and countries across the globe. Our key metrics continued to be impacted throughout 2020 as follows: Gross dollar volumes were flat in 2020 as compared to 2019, recovering gradually in the second half of the year from a decline during the second quarter in part due to the global relaxation of both restrictions on business operations and social distancing measures. MASTERCARD 2020 FORM 10-K 41 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cross-border volumes were negatively impacted by the pandemic during 2020 due to a significant decrease in global travel as a result of compliance with travel restrictions and quarantine requirements. While cross-border volumes are still lower compared to prior year periods, these volumes have improved throughout the second half of 2020. Switched transactions were negatively impacted by the pandemic primarily in the second quarter. Subsequently, switched transactions improved during the third quarter in part due to the global relaxation of both restrictions on business operations and social distancing measures. During the fourth quarter, switched transactions growth slowed slightly as compared to the third quarter. The full extent to which the pandemic, and measures taken in response, affect our business, results of operations and financial condition will depend on future developments, including the duration of the pandemic and its impact on the global economy, which are uncertain, and cannot be predicted at this time. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2020 Increase/ (Decrease) 2019 Increase/ (Decrease) 2020 2019 2018 ($ in millions, except per share data) Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% 13% Operating expenses $ 7,220 $ 7,219 $ 7,668 % (6)% Operating income $ 8,081 $ 9,664 $ 7,282 (16)% 33% Operating margin 52.8 % 57.2 % 48.7 % (4.4) ppt 8.5 ppt Income tax expense $ 1,349 $ 1,613 $ 1,345 (16)% 20% Effective income tax rate 17.4 % 16.6 % 18.7 % 0.8 ppt (2.1) ppt Net income $ 6,411 $ 8,118 $ 5,859 (21)% 39% Diluted earnings per share $ 6.37 $ 7.94 $ 5.60 (20)% 42% Diluted weighted-average shares outstanding 1,006 1,022 1,047 (2)% (2)% The following table provides a summary of our key non-GAAP operating results 1 , adjusted to exclude the impact of gains and losses on our equity investments, special items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, 2020 Increase/(Decrease) 2019 Increase/(Decrease) 2020 2019 2018 As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% (8)% 13% 16% Adjusted operating expenses $ 7,147 $ 7,219 $ 6,540 (1)% (1)% 10% 12% Adjusted operating margin 53.3 % 57.2 % 56.2 % (4.0) ppt (3.7) ppt 1.0 ppt 1.3 ppt Adjusted effective income tax rate 17.2 % 17.0 % 18.5 % 0.2 ppt 0.3 ppt (1.5) ppt (1.3) ppt Adjusted net income $ 6,463 $ 7,937 $ 6,792 (19)% (17)% 17% 20% Adjusted diluted earnings per share $ 6.43 $ 7.77 $ 6.49 (17)% (16)% 20% 23% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 42 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Key highlights for 2020 as compared to 2019 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue decreased 8% on a currency-neutral basis due to COVID-19 impacts, and includes a 1 percentage point benefit from acquisitions. Gross dollar volume was flat on a local currency basis. The primary drivers of net revenue were: down 9% down 8% - Cross-border volume decline of 29% on a local currency basis - Rebates and incentives growth of 3%, or 4% on a currency-neutral basis These decreases to net revenue were partially offset by: - Switched transactions growth of 3% - Other revenues growth of 14%, or 15% on a currency-neutral basis, which includes 3 percentage points of growth due to acquisitions Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expense decreased 1% on a currency-neutral basis, which included a 4 percentage point increase due to acquisitions. Excluding acquisitions, expenses declined 5 percentage points primarily due to reduced spending on advertising and marketing, travel and professional fees, partially offset by higher personnel and data processing costs to support continued investment in our strategic initiatives. flat down 1% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) Adjusted effective income tax rate of 17.2% was higher than prior year primarily due to a discrete tax benefit related to a favorable court ruling in 2019. 17.4% 17.2% Other 2020 financial highlights were as follows: We generated net cash flows from operations of $7.2 billion. We completed the acquisitions of businesses for total consideration of $1.1 billion. We repurchased 14.3 million shares of our common stock for $4.5 billion and paid dividends of $1.6 billion. We completed debt offerings for an aggregate principal amount of $4.0 billion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). Starting in 2019, our non-GAAP financial measures also exclude the impact of gains and losses on our equity investments which primarily includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. The 2018 amounts were not restated, as the impact of the change was immaterial in relation to our non-GAAP results. Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2020 and 2019, we recorded net gains of $30 million ($15 million after tax, or $0.01 per diluted share) and $167 million ($124 million after tax, or $0.12 per diluted share), respectively. The net gains were primarily related to unrealized fair market value adjustments on marketable and non-marketable equity securities. MASTERCARD 2020 FORM 10-K 43 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Items Litigation provisions During 2020, we recorded pre-tax charges of $73 million ($67 million after tax, or $0.07 per diluted share) related to litigation provisions which included pre-tax charges of: $45 million related to an ongoing confidential legal matter associated with our prepaid cards in the U.K., and $28 million related to estimated attorneys fees and litigation settlements with U.K. and Pan-European merchants. During 2018, we recorded pre-tax charges of $1,128 million ($1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission, $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases, and $237 million related to litigation settlements with U.K. and Pan-European merchants. Tax act During 2019, we recorded a $57 million net tax benefit ($0.06 per diluted share), which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. During 2018, we recorded a $75 million net tax benefit ($0.07 per diluted share), which included a $90 million benefit related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense primarily related to an increase to our Transition Tax. See Note 7 (Investments), Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and nonrecurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. In addition, we present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. 44 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2020 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,220 52.8 % $ (321) 17.4 % $ 6,411 $ 6.37 (Gains) losses on equity investments ** ** (30) (0.1) % (15) (0.01) Litigation provisions (73) 0.5 % ** (0.1) % 67 0.07 Non-GAAP $ 7,147 53.3 % $ (351) 17.2 % $ 6,463 $ 6.43 Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 67 16.6 % $ 8,118 $ 7.94 (Gains) losses on equity investments ** ** (167) (0.2) % (124) (0.12) Tax act ** ** ** 0.6 % (57) (0.06) Non-GAAP $ 7,219 57.2 % $ (100) 17.0 % $ 7,937 $ 7.77 Year ended December 31, 2018 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % $ (78) 18.7 % $ 5,859 5.60 Ligitation provisions (1,128) 7.5 % ** (1.1) % 1,008 0.96 Tax act ** ** ** 0.9 % (75) (0.07) Non-GAAP $ 6,540 56.2 % $ (78) 18.5 % $ 6,792 $ 6.49 Note: Tables may not sum due to rounding. ** Not applicable MASTERCARD 2020 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2020 as compared to the Year Ended December 31, 2019 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP (9) % % (4.4) ppt 0.8 ppt (21) % (20) % (Gains) losses on equity investments ** ** ** ppt 1 % 1 % Litigation provisions ** (1) % 0.5 ppt (0.1) ppt 1 % 1 % Tax act ** ** ** (0.6) ppt 1 % 1 % Non-GAAP (9) % (1) % (4.0) ppt 0.2 ppt (19) % (17) % Currency impact 2 1 % % 0.3 ppt 0.2 ppt 1 % 1 % Non-GAAP - currency-neutral (8) % (1) % (3.7) ppt 0.3 ppt (17) % (16) % Year Ended December 31, 2019 as compared to the Year Ended December 31, 2018 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP 13 % (6) % 8.5 ppt (2.1) ppt 39 % 42 % (Gains) losses on equity investments 1 ** ** ** (0.2) ppt (2) % (2) % Tax act ** ** ** (0.3) ppt 1 % 1 % Litigation provisions ** 16 % (7.5) ppt 1.1 ppt (20) % (21) % Non-GAAP 13 % 10 % 1.0 ppt (1.5) ppt 17 % 20 % Currency impact 2 3 % 2 % 0.3 ppt 0.2 ppt 3 % 3 % Non-GAAP - currency-neutral 16 % 12 % 1.3 ppt (1.3) ppt 20 % 23 % Note: Tables may not sum due to rounding. ** Not applicable 1 In 2019 we updated our non-GAAP methodology to prospectively exclude the impact of gains and losses on our equity investments. The 2018 period was not restated as the impact of the change was immaterial in relation to our non-GAAP results. 2 Represents the translational and transactional impact of currency. Key Metrics In addition to the financial measures described above in Financial Results Overview, we review the following metrics to evaluate and identify trends in our business, measure our performance, prepare financial projections and make strategic decisions. We believe that the key metrics presented facilitate an understanding of our operating and financial performance and provide a meaningful comparison of our results between periods. Gross Dollar Volume (GDV) 1 measures dollar volume of activity on cards carrying our brands during the period, on a local currency basis and U.S. dollar-converted basis. Dollar volume represents purchase volume plus cash volume and includes the impact of balance transfers and convenience checks; purchase volume means the aggregate dollar amount of purchases made with Mastercard-branded cards for the relevant period; and cash volume means the aggregate dollar amount of cash disbursements and includes the impact of balance transfers and convenience checks obtained with Mastercard-branded cards for the relevant period. Information denominated in U.S. dollars relating to GDV is calculated by applying an established U.S. dollar/local currency exchange rate for each local currency in which Mastercard volumes are reported. These exchange rates are calculated on a quarterly basis using the average exchange rate for each quarter. Mastercard reports period-over-period rates of change in purchase volume and cash volume on the basis of local currency information, in order to eliminate the impact of changes in the value of currencies against the U.S. dollar in calculating such rates of change. Cross-border Volume 2 measures cross-border dollar volume initiated and switched through our network during the period, on a local currency basis and U.S. dollar-converted basis, for all Mastercard-branded programs. 46 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Switched Transactions 2 measures the number of transactions switched by Mastercard. We define transactions switched as the number of transactions initiated and switched through our network during the period. Operating Margin measures how much profit we make on each dollar of sales after our operating costs but before other income (expense) and income tax expense. Operating margin is calculated by dividing our operating income by net revenue. 1 Data used in the calculation of GDV is provided by Mastercard customers and is subject to verification by Mastercard and partial cross-checking against information provided by Mastercards transaction switching systems. All data is subject to revision and amendment by Mastercard or Mastercards customers. 2 Normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. Foreign Currency Currency Impact Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results are also impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and certain volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, certain of our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2020, GDV on a U.S. dollar-converted basis decreased 2.0%, while GDV on a local currency basis increased 0.1% versus 2019. In 2019, GDV on a U.S. dollar-converted basis increased 9.8%, while GDV on a local currency basis increased 13.1% versus 2018. Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items is different than the functional currency of the entity. The translational and transactional impact of currency (Currency impact) has been identified in our drivers of change tables and has been excluded from our currency-neutral growth rates, which are non-GAAP financial measures. See Financial Results - Revenue and Operating Expenses for our drivers of change impact tables and Non-GAAP Financial Information for further information on our non-GAAP adjustments. 2021 Hedge Accounting Designation Through December 31, 2020, our approach to manage our transactional currency exposure consisted of hedging a portion of anticipated revenues impacted by transactional currencies by entering into foreign exchange derivative contracts, and recording the related changes in fair value in general and administrative expenses on the consolidated statement of operations. Beginning in January 2021, we started to formally designate certain newly-executed foreign exchange derivative contracts, which meet the established accounting criteria, as cash flow hedges. Starting in the first quarter of 2021, gains and losses resulting from changes in fair value of these designated contracts will be deferred in accumulated other comprehensive income (loss) and subsequently recognized in the respective component of net revenue when the underlying forecasted transactions impact earnings. The related impact of our foreign exchange cash flow hedging activities will be excluded from our currency-neutral growth rates as part of our Currency impact. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities, including settlement receivables and payables with our customers, that are denominated in a currency other than the functional currency of the entity. To manage this foreign exchange risk, we may enter into foreign exchange derivative contracts to economically hedge the foreign currency exposure of a portion of our nonfunctional monetary assets and liabilities. The gains or losses resulting from changes in fair value of these contracts are intended to reduce the potential effect of the underlying hedged exposure and are recorded net within general and MASTERCARD 2020 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS administrative expenses on the consolidated statement of operations. The impact of foreign exchange activity, including the related hedging activities, has not been eliminated in our currency-neutral results. Our foreign exchange risk management activities are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Financial Results Revenue Primary drivers of net revenue, versus the prior year, were as follows: Gross revenue decreased 5%, or 4% on a currency-neutral basis, driven by decreased cross-border volumes reflecting impacts of the COVID-19 outbreak, partially offset by increases in our value-added products and services and the number of switched transactions. Gross dollar volume of $6.3 trillion was flat. Rebates and incentives increased 3%, or 4% on a currency-neutral basis, due to new and renewed deals partially offset by a favorable mix of volume-based incentives. Net revenue decreased 9%, or 8% on a currency-neutral basis, including 1 percentage point of growth from our acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Domestic assessments $ 6,656 $ 6,781 $ 6,138 (2)% 10% Cross-border volume fees 3,512 5,606 4,954 (37)% 13% Transaction processing 8,731 8,469 7,391 3% 15% Other revenues 4,717 4,124 3,348 14% 23% Gross revenue 23,616 24,980 21,831 (5)% 14% Rebates and incentives (contra-revenue) (8,315) (8,097) (6,881) 3% 18% Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% 13% 48 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of change in net revenue: For the Years Ended December 31, Volume Acquisitions Currency Impact 1 Other 2 Total 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 Domestic assessments % 13% % % (3)% (3)% 1 % 3 1 % 3 (2) % 10 % Cross-border volume fees (30)% 14% % % % (3)% (7) % 2 % (37) % 13 % Transaction processing 3% 14% % % % (2)% % 3 % 3 % 15 % Other revenues ** ** 3% 2% (1)% (1)% 12 % 4 22 % 4 14 % 23 % Rebates and incentives (6)% 5 9% 5 % % (2)% (3)% 10 % 6 11 % 6 3 % 18 % Net revenue (5)% 13% 1% 1% (1)% (3)% (4) % 2 % (9) % 13 % Note: Table may not sum due to rounding ** Not applicable 1 Represents the translational and transactional impact of currency. 2 Includes impact from pricing, other non-volume based fees and geographic mix. 3 Includes impact of the allocation of revenue to service deliverables, which are primarily recorded in other revenue when services are performed. 4 Includes impacts from cyber and intelligence fees, data analytics and consulting fees and other payment-related products and services. 5 Includes the impact from mix on volume-based incentives. 6 Includes the impact of new, renewed and expired agreements. The following tables provide a summary of the trend in volumes and transactions. For the Years Ended December 31, 2020 2019 Increase/(Decrease) USD Local USD Local Mastercard-branded GDV 1 (2) % % 10 % 13 % Asia Pacific/Middle East/Africa (3) % (2) % 8 % 12 % Canada (4) % (3) % 4 % 7 % Europe (2) % 1 % 12 % 18 % Latin America (17) % (2) % 9 % 15 % United States 2 % 2 % 10 % 10 % Cross-border volume 1 (29) % 16 % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Increase/(Decrease) 2020 2019 Switched transactions 3 % 19 % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2020, the net revenue from these customers was approximately $3.4 billion, or 22%, of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses were flat in 2020 versus the prior year. Adjusted operating expenses decreased 1% on both an as adjusted and a currency-neutral basis versus the prior year. Current year results include growth of approximately 4 percentage points from acquisitions. Excluding acquisitions, expenses declined 5% primarily due to reduced spending on advertising and marketing, travel and professional fees, partially offset by higher personnel and data processing costs to support continued investment in our strategic initiatives. MASTERCARD 2020 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) General and administrative $ 5,910 $ 5,763 $ 5,174 3 % 11 % Advertising and marketing 657 934 907 (30) % 3 % Depreciation and amortization 580 522 459 11 % 14 % Provision for litigation 73 1,128 ** ** Total operating expenses 7,220 7,219 7,668 % (6) % Special Items 1 (73) (1,128) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 7,147 $ 7,219 $ 6,540 (1) % 10 % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 1 Acquisitions Currency Impact 2 Total 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 General and administrative (1)% 11 % ** ** 4 % 2 % % (2) % 3 % 11 % Advertising and marketing (30)% 5 % ** ** % % (1) % (2) % (30) % 3 % Depreciation and amortization 5% 9 % ** ** 6 % 7 % % (2) % 11 % 14 % Provision for litigation ** ** ** ** ** ** ** ** ** ** Total operating expenses (5)% 10 % 1 % (16) % 4 % 2 % % (2) % % (6) % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 Represents the translational and transactional impact of currency. General and Administrative General and administrative expenses increased 3% on both an as reported and a currency-neutral basis in 2020 versus the prior year. Current year results include growth of approximately 4 percentage points from acquisitions. Excluding acquisitions, expenses declined 1% primarily due to reduced spending on travel and professional fees, partially offset by an increase in personnel and data processing costs to support continued investment in our strategic initiatives. 50 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Personnel $ 3,787 $ 3,537 $ 3,214 7% 10% Professional fees 384 447 377 (14)% 19% Data processing and telecommunications 756 666 600 14% 11% Foreign exchange activity 1 9 32 (36) ** ** Other 974 1,081 1,019 (10)% 6% Total general and administrative expenses 5,910 5,763 5,174 3% 11% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. Advertising and Marketing Advertising and marketing expenses decreased 30%, or 29% on a currency-neutral basis in 2020 versus the prior year, primarily due to lower advertising and sponsorship spend in response to COVID-19. Depreciation and Amortization Depreciation and amortization expenses increased 11% on both an as reported and a currency-neutral basis in 2020 versus the prior year. Current year results include growth of approximately 6 percentage points from acquisitions. The remaining increase was primarily due to higher depreciation from capital investments. Provision for Litigation In 2020, we recorded $73 million related to various litigation settlements and legal costs. There were no litigation charges in the prior year. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) was unfavorable in 2020 versus the prior year primarily due to increased interest expense related to our recent debt issuances, as well as lower net gains in the current year versus the prior year related to unrealized fair market value adjustments on marketable and non-marketable equity securities and a decrease in our investment income. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Investment Income $ 24 $ 97 $ 122 (75) % (21) % Gains (losses) on equity investments, net 30 167 (82) % ** Interest expense (380) (224) (186) 70 % 20 % Other income (expense), net 5 27 (14) (81) % ** Total other income (expense) (321) 67 (78) ** ** Note: Table may not sum due to rounding. ** Not meaningful Income Taxes The effective income tax rates for the years ended December 31, 2020 and 2019 were 17.4% and 16.6%, respectively. The effective income tax rate for 2020 was higher than the prior year, primarily due to discrete tax benefits in 2019, partially offset by a more MASTERCARD 2020 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. The adjusted effective income tax rates for the years ended December 31, 2020 and 2019 were 17.2% and 17.0%, respectively. The adjusted effective income tax rate was higher than the prior year, primarily due to a discrete tax benefit related to a favorable court ruling in 2019. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31: 2020 2019 (in billions) Cash, cash equivalents and investments 1 $ 10.6 $ 7.7 Unused line of credit 6.0 6.0 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.3 billion and $2.0 billion at December 31, 2020 and 2019, respectively. We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities: For the Years Ended December 31, 2020 2019 2018 (in millions) Net cash provided by operating activities $ 7,224 $ 8,183 $ 6,223 Net cash used in investing activities (1,879) (1,640) (506) Net cash used in financing activities (2,152) (5,867) (4,966) Net cash provided by operating activities decreased $1.0 billion in 2020 versus the prior year, primarily due to lower net income adjusted for non-cash items, partially offset by a decrease in litigation payments. Net cash used in investing activities increased $239 million in 2020 versus the prior year, primarily due to lower net proceeds from our investments in available-for-sale and held-to-maturity securities, partially offset by higher prior year acquisition payments. Net cash used in financing activities decreased $3.7 billion in 2020 versus the prior year, primarily due to lower repurchases of our Class A common stock, higher net debt proceeds in the current period and the repayment of debt that matured in the prior year. 52 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Debt and Credit Availability In March 2020, we issued $1 billion principal amount of notes due March 2027, $1.5 billion principal amount of notes due March 2030 and $1.5 billion principal amount notes due March 2050. Our total debt outstanding was $12.7 billion at December 31, 2020, with the earliest maturity of $650 million of principal occurring in November 2021. As of December 31, 2020, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which, in 2020, was extended for an additional year and now expires in November 2025. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2020. See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, 2020 2019 2018 (in millions, except per share data) Cash dividend, per share $ 1.60 $ 1.32 $ 1.00 Cash dividends paid $ 1,605 $ 1,345 $ 1,044 On December 8, 2020, our Board of Directors declared a quarterly cash dividend of $0.44 per share paid on February 9, 2021 to holders of record on January 8, 2021 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $439 million. On February 8, 2021, our Board of Directors declared a quarterly cash dividend of $0.44 per share payable on May 7, 2021 to holders of record on April 9, 2021 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $437 million. Repurchased shares of our common stock are considered treasury stock. In December 2020, 2019 and 2018, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $6.0 billion, $8.0 billion and $6.5 billion, respectively, of our Class A common stock. The program approved in 2020 will become effective after completion of the share repurchase program authorized in 2019. The timing and actual number of additional shares repurchased will depend on a variety of factors, including cash requirements to meet the operating needs of the business, legal requirements, as well as the share price and economic and market conditions. The following table summarizes our share repurchase activity of our Class A common stock through December 31, 2020, under the plans approved in 2019 and 2018: (in millions, except per share data) Remaining authorization at December 31, 2019 $ 8,304 Dollar-value of shares repurchased in 2020 $ 4,473 Remaining authorization at December 31, 2020 $ 9,831 Shares repurchased in 2020 14.3 Average price paid per share in 2020 $ 312.68 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2020 FORM 10-K 53 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates or support when customers meet certain volume thresholds as well as other support incentives, which are tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction- based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. Income Taxes In calculating our effective income tax rate, estimates are required regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. In assessing the need for a valuation allowance, we consider all sources of taxable income including, projected future taxable income, reversing taxable temporary differences and ongoing tax planning strategies. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price, including contingent consideration, is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization 54 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. "," Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $58 million and $144 million on our foreign exchange derivative contracts outstanding at December 31, 2020 and 2019, respectively, before considering the offsetting effect of the underlying hedged activity. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into short duration foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with our customers. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $23 million on our short duration foreign exchange derivative contracts outstanding at December 31, 2020. The Company did not have any outstanding short duration foreign exchange derivative contracts related to this activity at December 31, 2019. Interest Rate Risk Our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact to the fair value of our investments at December 31, 2020 and 2019. MASTERCARD 2020 FORM 10-K 55 PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019 and 2018 Managements report on internal control over financial reporting Report of independent registered public accounting firm Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements 56 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2020. In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2020. The effectiveness of Mastercards internal control over financial reporting as of December 31, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. MASTERCARD 2020 FORM 10-K 57 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2020 and 2019 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2020, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on internal control over financial reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 58 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates or incentives which totaled $8.3 billion for the year ended December 31, 2020. The Company has business agreements with certain customers that provide for rebates or other support when customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. As disclosed by management, various factors are considered in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter are (i) the significant judgment by management when developing estimates related to rebates and incentives based on customer performance; and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance, including the reasonableness of the various applicable factors considered by management in the estimate. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to rebates and incentives, including controls over evaluating estimated customer performance. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating rebate and incentive contracts to identify whether all incentives are identified and recorded accurately; (ii) testing managements process for developing estimated customer performance, including evaluating the reasonableness of the various applicable factors considered by management; and (iii) evaluating estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 12, 2021 We have served as the Companys auditor since 1989. MASTERCARD 2020 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, 2020 2019 2018 (in millions, except per share data) Net Revenue $ 15,301 $ 16,883 $ 14,950 Operating Expenses General and administrative 5,910 5,763 5,174 Advertising and marketing 657 934 907 Depreciation and amortization 580 522 459 Provision for litigation 73 1,128 Total operating expenses 7,220 7,219 7,668 Operating income 8,081 9,664 7,282 Other Income (Expense) Investment income 24 97 122 Gains (losses) on equity investments, net 30 167 Interest expense ( 380 ) ( 224 ) ( 186 ) Other income (expense), net 5 27 ( 14 ) Total other income (expense) ( 321 ) 67 ( 78 ) Income before income taxes 7,760 9,731 7,204 Income tax expense 1,349 1,613 1,345 Net Income $ 6,411 $ 8,118 $ 5,859 Basic Earnings per Share $ 6.40 $ 7.98 $ 5.63 Basic weighted-average shares outstanding 1,002 1,017 1,041 Diluted Earnings per Share $ 6.37 $ 7.94 $ 5.60 Diluted weighted-average shares outstanding 1,006 1,022 1,047 The accompanying notes are an integral part of these consolidated financial statements. 60 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, 2020 2019 2018 (in millions) Net Income $ 6,411 $ 8,118 $ 5,859 Other comprehensive income (loss): Foreign currency translation adjustments 345 10 ( 319 ) Income tax effect ( 59 ) 13 40 Foreign currency translation adjustments, net of income tax effect 286 23 ( 279 ) Translation adjustments on net investment hedge ( 177 ) 36 96 Income tax effect 40 ( 8 ) ( 21 ) Translation adjustments on net investment hedge, net of income tax effect ( 137 ) 28 75 Cash flow hedges ( 189 ) 14 Income tax effect 42 ( 3 ) Reclassification adjustment for cash flow hedges 4 Income tax effect ( 1 ) Cash flow hedges, net of income tax effect ( 144 ) 11 Defined benefit pension and other postretirement plans ( 12 ) ( 21 ) ( 16 ) Income tax effect 2 3 3 Reclassification adjustment for defined benefit pension and other postretirement plans ( 1 ) ( 1 ) ( 2 ) Income tax effect Defined benefit pension and other postretirement plans, net of income tax effect ( 11 ) ( 19 ) ( 15 ) Investment securities available-for-sale ( 1 ) 3 ( 3 ) Income tax effect ( 1 ) 1 Investment securities available-for-sale, net of income tax effect ( 1 ) 2 ( 2 ) Other comprehensive income (loss), net of income tax effect ( 7 ) 45 ( 221 ) Comprehensive Income $ 6,404 $ 8,163 $ 5,638 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2020 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, 2020 2019 (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 10,113 $ 6,988 Restricted cash for litigation settlement 586 584 Investments 483 688 Accounts receivable 2,646 2,514 Settlement due from customers 1,706 2,995 Restricted security deposits held for customers 1,696 1,370 Prepaid expenses and other current assets 1,883 1,763 Total current assets 19,113 16,902 Property, equipment and right-of-use assets, net 1,902 1,828 Deferred income taxes 491 543 Goodwill 4,960 4,021 Other intangible assets, net 1,753 1,417 Other assets 5,365 4,525 Total Assets $ 33,584 $ 29,236 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ 527 $ 489 Settlement due to customers 1,475 2,714 Restricted security deposits held for customers 1,696 1,370 Accrued litigation 842 914 Accrued expenses 5,430 5,489 Current portion of long-term debt 649 Other current liabilities 1,228 928 Total current liabilities 11,847 11,904 Long-term debt 12,023 8,527 Deferred income taxes 86 85 Other liabilities 3,111 2,729 Total Liabilities 27,067 23,245 Commitments and Contingencies Redeemable Non-controlling Interests 29 74 Stockholders Equity Class A common stock, $ 0.0001 par value; authorized 3,000 shares, 1,396 and 1,391 shares issued and 987 and 996 shares outstanding, respectively Class B common stock, $ 0.0001 par value; authorized 1,200 shares, 8 and 11 shares issued and outstanding, respectively Additional paid-in-capital 4,982 4,787 Class A treasury stock, at cost, 409 and 395 shares, respectively ( 36,658 ) ( 32,205 ) Retained earnings 38,747 33,984 Accumulated other comprehensive income (loss) ( 680 ) ( 673 ) Mastercard Incorporated Stockholders' Equity 6,391 5,893 Non-controlling interests 97 24 Total Equity 6,488 5,917 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 33,584 $ 29,236 The accompanying notes are an integral part of these consolidated financial statements. 62 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2017 $ $ $ 4,365 $ ( 20,764 ) $ 22,364 $ ( 497 ) $ 5,468 $ 29 $ 5,497 Adoption of revenue standard 366 366 366 Adoption of intra-entity asset transfers standard ( 183 ) ( 183 ) ( 183 ) Net income 5,859 5,859 5,859 Activity related to non-controlling interests ( 6 ) ( 6 ) Redeemable non-controlling interest adjustments ( 3 ) ( 3 ) ( 3 ) Other comprehensive income (loss) ( 221 ) ( 221 ) ( 221 ) Dividends ( 1,120 ) ( 1,120 ) ( 1,120 ) Purchases of treasury stock ( 4,991 ) ( 4,991 ) ( 4,991 ) Share-based payments 215 5 220 220 Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 23 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests 1 1 Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) 45 45 45 Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments 207 8 215 215 Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 MASTERCARD 2020 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 Net income 6,411 6,411 6,411 Activity related to non-controlling interests 73 73 Redeemable non-controlling interest adjustments ( 7 ) ( 7 ) ( 7 ) Other comprehensive income (loss) ( 7 ) ( 7 ) ( 7 ) Dividends ( 1,641 ) ( 1,641 ) ( 1,641 ) Purchases of treasury stock ( 4,459 ) ( 4,459 ) ( 4,459 ) Share-based payments 195 6 201 201 Balance at December 31, 2020 $ $ $ 4,982 $ ( 36,658 ) $ 38,747 $ ( 680 ) $ 6,391 $ 97 $ 6,488 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, 2020 2019 2018 (in millions) Operating Activities Net income $ 6,411 $ 8,118 $ 5,859 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,072 1,141 1,235 Depreciation and amortization 580 522 459 (Gains) losses on equity investments, net ( 30 ) ( 167 ) Share-based compensation 254 250 196 Deferred income taxes 73 ( 7 ) ( 244 ) Other 14 24 31 Changes in operating assets and liabilities: Accounts receivable ( 86 ) ( 246 ) ( 317 ) Income taxes receivable ( 2 ) ( 202 ) ( 120 ) Settlement due from customers 1,288 ( 444 ) ( 1,078 ) Prepaid expenses ( 1,552 ) ( 1,661 ) ( 1,769 ) Accrued litigation and legal settlements ( 73 ) ( 662 ) 869 Restricted security deposits held for customers 326 290 ( 6 ) Accounts payable 26 ( 42 ) 101 Settlement due to customers ( 1,242 ) 477 849 Accrued expenses ( 114 ) 657 439 Long-term taxes payable ( 37 ) 2 ( 20 ) Net change in other assets and liabilities 316 133 ( 261 ) Net cash provided by operating activities 7,224 8,183 6,223 Investing Activities Purchases of investment securities available-for-sale ( 220 ) ( 643 ) ( 1,300 ) Purchases of investments held-to-maturity ( 198 ) ( 215 ) ( 509 ) Proceeds from sales of investment securities available-for-sale 361 1,098 604 Proceeds from maturities of investment securities available-for-sale 140 376 379 Proceeds from maturities of investments held-to-maturity 121 383 929 Purchases of property and equipment ( 339 ) ( 422 ) ( 330 ) Capitalized software ( 369 ) ( 306 ) ( 174 ) Purchases of equity investments ( 214 ) ( 467 ) ( 91 ) Acquisition of businesses, net of cash acquired ( 989 ) ( 1,440 ) Settlement of interest rate derivative contracts ( 175 ) Other investing activities 3 ( 4 ) ( 14 ) Net cash used in investing activities ( 1,879 ) ( 1,640 ) ( 506 ) Financing Activities Purchases of treasury stock ( 4,473 ) ( 6,497 ) ( 4,933 ) Dividends paid ( 1,605 ) ( 1,345 ) ( 1,044 ) Proceeds from debt, net 3,959 2,724 991 Payment of debt ( 500 ) Acquisition of redeemable non-controlling interests ( 49 ) Contingent consideration paid ( 199 ) Tax withholdings related to share-based payments ( 150 ) ( 161 ) ( 80 ) Cash proceeds from exercise of stock options 97 126 104 Other financing activities 69 ( 15 ) ( 4 ) Net cash used in financing activities ( 2,152 ) ( 5,867 ) ( 4,966 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents 257 ( 44 ) ( 6 ) Net increase in cash, cash equivalents, restricted cash and restricted cash equivalents 3,450 632 745 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 8,969 8,337 7,592 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 12,419 $ 8,969 $ 8,337 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2020 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known brands, including Mastercard, Maestro and Cirrus. The Company operates a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through its unique and proprietary global payments network, which is referred to as the core network, the Company switches (authorizes, clears and settles) payment transactions and delivers related products and services. Mastercard has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). The Company also provides integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. The Companys payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2020 and 2019, there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date in which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2020, 2019 and 2018, net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty, including the potential impacts and duration of the COVID-19 pandemic, as well as other factors; accordingly, accounting estimates require the exercise of judgment. These financial statements were prepared using information reasonably available as of December 31, 2020 and through the date of this Report. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated from assessing customers based on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands, from fees to issuers, acquirers and other stakeholders for providing switching services, as well as from value-added products and services that are typically integrated and sold with the Companys payment offerings. 66 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is primarily based on the related volume generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. For services provided to customers where delivery involves the use of a third-party, the Company recognizes revenue on a gross basis if it acts as the principal, controlling the service to the customer and on a net basis if it acts as the agent, arranging for the service to be provided. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, any non-controlling interest in the acquiree and contingent consideration at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses on the consolidated statement of operations. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date are recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. MASTERCARD 2020 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets 68 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions are recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Investments in debt securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment is recognized as an allowance and recorded in other income (expense), net on the consolidated statement of operations while the non-credit related loss remains in accumulated other comprehensive income (loss) until realized from a sale or subsequent impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. MASTERCARD 2020 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gain (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the equity method or measurement alternative method. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20 % and 50 % ownership in the entity. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The Companys share of net earnings or losses for these investments are included in gains (losses) on equity investments, net on the consolidated statement of operations. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gain (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. The Company does not enter into derivative contracts for trading or speculative purposes. For derivative contracts that are not designated as hedging instruments, realized and unrealized gains and losses from the change in fair value of the contracts are recognized in current earnings. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. For cash flow hedges, the fair value adjustments are recorded, net of tax, in other comprehensive income (loss) on the consolidated statement of comprehensive income. Any gains and losses deferred in accumulated other comprehensive income (loss) are subsequently reclassified to the corresponding line item on the consolidated statement of operations when the underlying hedged transactions impact earnings. For hedging instruments that are no longer deemed highly effective, hedge accounting is discontinued prospectively, and any gains and losses remaining in accumulated other comprehensive income (loss) are reclassified to earnings when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, the associated gains or losses in accumulated other comprehensive income (loss) are reclassified to the corresponding line item on the consolidated statement of operations in current earnings. The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company may use foreign currency denominated debt and/or derivative instruments to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the hedging instruments are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as a cumulative translation adjustment component of equity. Amounts excluded from 70 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS effectiveness testing of net investment hedges are recognized in earnings over the life of the hedging instrument. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. MASTERCARD 2020 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. Accounting pronouncements not yet adopted Simplifying the accounting for income taxes - In December 2019, the FASB issued accounting guidance to simplify the accounting for income taxes. This guidance includes the removal of certain exceptions to the general income tax accounting principles and provides clarity and simplification to other areas of income tax accounting by amending the existing guidance. The guidance is effective for periods beginning after December 15, 2020. The Company will adopt this guidance effective January 1, 2021 and does not expect the impacts to be material. Reference Rate Reform - In March 2020, the FASB issued accounting guidance to provide temporary optional expedients and exceptions to the current contract modifications and hedge accounting guidance in light of the expected market transition from LIBOR to alternative rates. The new guidance provides optional expedients and exceptions to transactions affected by reference rate reform if certain criteria are met. The transactions primarily include (1) contract modifications, (2) hedging relationships, and (3) sale or transfer of debt securities classified as held-to-maturity. The amendments were effective immediately upon issuance of the update. Companies may elect to adopt the amendments prospectively to transactions existing as of or entered from the date of adoption through December 31, 2022. The Company does not expect the impacts to be material. 72 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2. Acquisitions In 2020 and 2019, the Company acquired several businesses for total consideration of $ 1.1 billion and $ 1.5 billion, respectively, representing both cash and contingent consideration. There were no acquisitions in 2018. These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations and contingent consideration. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a majority of the goodwill is not expected to be deductible for local tax purposes. In 2020, the Company finalized the purchase accounting for businesses acquired during 2019 and $ 185 million of the businesses acquired in 2020. The Company is evaluating and finalizing the purchase accounting for the remainder of the businesses acquired during 2020. The preliminary estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for the years ended December 31. 2020 2019 (in millions) Assets: Cash and cash equivalents $ 6 $ 54 Other current assets 14 143 Other intangible assets 237 395 Goodwill 844 1,076 Other assets 11 48 Total assets 1,112 1,716 Liabilities: Other current liabilities 15 121 Deferred income taxes 23 52 Other liabilities 8 32 Total liabilities 46 205 Net assets acquired $ 1,066 $ 1,511 The following table summarizes the identified intangible assets acquired during the years ended December 31: 2020 2019 2020 2019 Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ 122 $ 199 6.3 7.7 Customer relationships 114 178 12.0 12.6 Other 1 18 1.0 5.0 Other intangible assets $ 237 $ 395 9.0 9.7 Pro forma information related to the acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. Among the businesses acquired in 2020, the largest acquisition relates to Finicity Corporation (Finicity), an open-banking provider, headquartered in Salt Lake City, Utah. On November 18, 2020, Mastercard acquired 100 % equity interest in Finicity for cash consideration of $ 809 million. In addition, the Finicity sellers have the potential to earn contingent consideration of up to $ 160 million if certain revenue targets are met in 2021. As of the acquisition date, the fair value of the contingent consideration was $ 71 million. The businesses acquired in 2019 were not individually significant to Mastercard. Pending Acquisition In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $ 3.5 billion as of December 31, 2020 ) after adjusting for cash and certain other MASTERCARD 2020 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS liabilities at closing. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of Nets Denmark A/Ss Corporate Services business. The Company has secured conditional approval from the European Commission and, subject to other closing conditions, anticipates completing the acquisition in the first quarter of 2021, or shortly thereafter. Note 3. Revenue Mastercards core network involves four participants in addition to the Company: account holders (a person or entity who holds a card or uses another device enabled for payment), issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from information accumulated by Mastercards systems or reported by customers. In addition, the Company generates other revenues from value-added products and services that are typically integrated and sold with the Companys payment offerings and are recognized as revenue in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile-initiated transactions; and safety and security. 74 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other revenues consist of value-added products and services that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Data analytics and consulting fees. Cyber and intelligence fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services and platforms, including account and transaction enhancement services, open banking solutions, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31: 2020 2019 2018 (in millions) Revenue by source: Domestic assessments $ 6,656 $ 6,781 $ 6,138 Cross-border volume fees 3,512 5,606 4,954 Transaction processing 8,731 8,469 7,391 Other revenues 4,717 4,124 3,348 Gross revenue 23,616 24,980 21,831 Rebates and incentives (contra-revenue) ( 8,315 ) ( 8,097 ) ( 6,881 ) Net revenue $ 15,301 $ 16,883 $ 14,950 Net revenue by geographic region: North American Markets $ 5,424 $ 5,843 $ 5,312 International Markets 9,701 10,869 9,514 Other 1 176 171 124 Net revenue $ 15,301 $ 16,883 $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $ 2.5 billion and $ 2.3 billion as of December 31, 2020 and 2019, respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are generally billed weekly, however, the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2020 in the amounts of $ 59 million and $ 245 million, respectively. The comparable amounts included in prepaid expenses and other current assets and other assets at December 31, 2019 were $ 48 million and $ 152 million, respectively. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2020 in the amounts of $ 355 million and $ 143 million, respectively. The comparable amounts included in other current liabilities and MASTERCARD 2020 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS other liabilities at December 31, 2019 were $ 238 million and $ 106 million, respectively. In 2020, 2019 and 2018 revenue recognized from the satisfaction of such performance obligations was $ 1.1 billion, $ 994 million and $ 904 million, respectively. The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years). As a payment network service provider, the Company provides its customers with continuous access to its global payments network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates volume- and transaction-based revenues from assessing its customers current period activity. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues primarily from other value-added services comprised of both batch and real-time account-based payment services, consulting fees, gateway services, processing, loyalty programs and other payment-related products and services. At December 31, 2020, the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion, which is expected to be recognized through 2023. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: 2020 2019 2018 (in millions, except per share data) Numerator Net income $ 6,411 $ 8,118 $ 5,859 Denominator Basic weighted-average shares outstanding 1,002 1,017 1,041 Dilutive stock options and stock units 4 5 6 Diluted weighted-average shares outstanding 1 1,006 1,022 1,047 Earnings per Share Basic $ 6.40 $ 7.98 $ 5.63 Diluted $ 6.37 $ 7.94 $ 5.60 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31: 2020 2019 (in millions) Cash and cash equivalents $ 10,113 $ 6,988 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement 586 584 Restricted security deposits held for customers 1,696 1,370 Prepaid expenses and other current assets 24 27 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 12,419 $ 8,969 76 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: 2020 2019 2018 (in millions) Cash paid for income taxes, net of refunds $ 1,349 $ 1,644 $ 1,790 Cash paid for interest 311 199 153 Cash paid for legal settlements 149 668 260 Non-cash investing and financing activities Dividends declared but not yet paid 439 403 340 Accrued property, equipment and right-of-use assets 154 468 10 Fair value of assets acquired, net of cash acquired 1,106 1,662 Fair value of liabilities assumed related to acquisitions 46 205 Note 7. Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31: 2020 2019 (in millions) Available-for-sale securities $ 321 $ 591 Held-to-maturity securities 162 97 Total investments $ 483 $ 688 Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2020 December 31, 2019 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ 10 $ $ $ 10 $ 15 $ $ $ 15 Government and agency securities 64 64 108 108 Corporate securities 246 1 247 381 1 382 Asset-backed securities 85 1 86 Total $ 320 $ 1 $ $ 321 $ 589 $ 2 $ $ 591 The Companys available-for-sale investment securities held at December 31, 2020 and 2019, primarily carried a credit rating of A- or better with unrealized gains and losses recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. The municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. MASTERCARD 2020 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2020 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ 115 $ 115 Due after 1 year through 5 years 205 206 Total $ 320 $ 321 Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits, and realized gains and losses on the Companys debt securities. The realized gains and losses from the sale of available-for-sale securities for 2020, 2019 and 2018 were not significant. Held-to-Maturity Securities The Company classifies time deposits with maturities greater than three months but less than one year as held-to-maturity. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. The cost of these securities approximates fair value. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2019 Purchases (Sales), net Changes in Fair Value 1 Other 2 Balance at December 31, 2020 (in millions) Marketable securities $ 479 $ 1 $ ( 5 ) $ 1 $ 476 Nonmarketable securities 435 204 35 22 696 Total equity investments $ 914 $ 205 $ 30 $ 23 $ 1,172 1 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations 2 Includes translational impact of currency At December 31, 2020 , the total carrying value of Nonmarketable securities included $ 157 million of measurement alternative investments and $ 539 million of equity method investments. At December 31, 2019, the total carrying value of Nonmarketable securities included $ 317 million of measurement alternative investments and $ 118 million of equity method investments. Cumulative impairments and downward fair value adjustments on measurement alternative investments were $ 14 million and cumulative upward fair value adjustments were $ 86 million as of December 31, 2020 . Note 8. Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy within the Valuation Hierarchy. Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. There were no transfers made among the three levels in the Valuation Hierarchy for 2020 and 2019. 78 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2020 December 31, 2019 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ 10 $ $ 10 $ $ 15 $ $ 15 Government and agency securities 26 38 64 66 42 108 Corporate securities 247 247 382 382 Asset-backed securities 86 86 Derivative instruments 2 : Foreign exchange contracts 19 19 12 12 Interest rate contracts 14 14 Marketable securities 3 : Equity securities 476 476 479 479 Deferred compensation plan 4 : Deferred compensation assets 78 78 67 67 Liabilities Derivative instruments 2 : Foreign exchange derivative liabilities $ $ ( 28 ) $ $ ( 28 ) $ $ ( 32 ) $ $ ( 32 ) Deferred compensation plan 5 : Deferred compensation liabilities ( 81 ) ( 81 ) ( 67 ) ( 67 ) 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . MASTERCARD 2020 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2020, the carrying value and fair value of total long-term debt (including the current portion) was $ 12.7 billion and $ 14.8 billion, respectively. At December 31, 2019, the carrying value and fair value of long-term debt (including the current portion) was $ 8.5 billion and $ 9.2 billion, respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Note 9. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 1,086 $ 872 Prepaid income taxes 78 105 Other 719 786 Total prepaid expenses and other current assets $ 1,883 $ 1,763 Other assets consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 3,220 $ 2,838 Equity investments 1,172 914 Income taxes receivable 553 460 Other 420 313 Total other assets $ 5,365 $ 4,525 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. See Note 7 (Investments) for further information on the Companys equity investments. 80 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31: 2020 2019 (in millions) Building, building equipment and land $ 522 $ 505 Equipment 1,321 1,218 Furniture and fixtures 99 92 Leasehold improvements 380 303 Operating lease right-of-use assets 970 810 Property, equipment and right-of-use assets 3,292 2,928 Less: Accumulated depreciation and amortization ( 1,390 ) ( 1,100 ) Property, equipment and right-of-use assets, net $ 1,902 $ 1,828 Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 400 million, $ 336 million and $ 209 million for 2020, 2019 and 2018, respectively. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows at December 31: 2020 2019 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ 748 $ 711 Other current liabilities 125 106 Other liabilities 726 656 Operating lease amortization expense for 2020 and 2019 was $ 123 million and $ 99 million, respectively. As of December 31, 2020 and 2019, the weighted-average remaining lease term of operating leases was 9.1 years and 9.5 years and the weighted-average discount rate for operating leases was 2.7 % and 2.9 %, respectively. The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2020 based on lease term: Operating Leases (in millions) 2021 $ 137 2022 130 2023 108 2024 95 2025 72 Thereafter 383 Total operating lease payments 925 Less: Interest ( 74 ) Present value of operating lease liabilities $ 851 Prior to adoption of the lease accounting standard in 2019, consolidated rental expense for the Companys leased office space was $ 94 million for 2018. Consolidated lease expense for automobiles, computer equipment and office equipment was $ 20 million for 2018, respectively. MASTERCARD 2020 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: 2020 2019 (in millions) Beginning balance $ 4,021 $ 2,904 Additions 844 1,076 Foreign currency translation 95 41 Ending balance $ 4,960 $ 4,021 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2020 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2020. Note 12. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: 2020 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 2,276 $ ( 1,126 ) $ 1,150 $ 1,884 $ ( 988 ) $ 896 Customer relationships 743 ( 322 ) 421 621 ( 264 ) 357 Other 44 ( 41 ) 3 44 ( 44 ) Total 3,063 ( 1,489 ) 1,574 2,549 ( 1,296 ) 1,253 Indefinite-lived intangible assets Customer relationships 179 179 164 164 Total $ 3,242 $ ( 1,489 ) $ 1,753 $ 2,713 $ ( 1,296 ) $ 1,417 The increase in the gross carrying amount of amortized intangible assets in 2020 was primarily related to software additions and businesses acquired in 2020. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2020, it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $ 303 million, $ 285 million and $ 250 million in 2020, 2019 and 2018, respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2020 for the years ending December 31: (in millions) 2021 $ 332 2022 260 2023 211 2024 194 2025 and thereafter 577 $ 1,574 82 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 3,998 $ 3,892 Personnel costs 727 713 Income and other taxes 208 332 Other 497 552 Total accrued expenses $ 5,430 $ 5,489 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2020 and 2019, the Companys provision for litigation was $ 842 million and $ 914 million, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 150 million, $ 127 million and $ 98 million in 2020, 2019 and 2018, respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 20 million as of December 31, 2020) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD 2020 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31: Pension Plans Postretirement Plan 2020 2019 2020 2019 ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ 531 $ 438 $ 64 $ 57 Service cost 13 11 1 1 Interest cost 9 13 2 2 Actuarial (gain) loss 43 73 7 9 Benefits paid ( 18 ) ( 15 ) ( 4 ) ( 5 ) Transfers in 3 2 Foreign currency translation 23 9 Benefit obligation at end of year 604 531 70 64 Change in plan assets Fair value of plan assets at beginning of year 518 410 Actual (loss) gain on plan assets 56 79 Employer contributions 34 32 4 5 Benefits paid ( 18 ) ( 15 ) ( 4 ) ( 5 ) Transfers in 5 2 Foreign currency translation 22 10 Fair value of plan assets at end of year 617 518 Funded status at end of year $ 13 $ ( 13 ) $ ( 70 ) $ ( 64 ) Amounts recognized on the consolidated balance sheet consist of: Noncurrent assets $ 28 $ $ $ Other liabilities, short-term ( 4 ) ( 3 ) Other liabilities, long-term ( 15 ) ( 13 ) ( 66 ) ( 61 ) $ 13 $ ( 13 ) $ ( 70 ) $ ( 64 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ 12 $ 7 $ 9 $ 2 Prior service credit 1 1 ( 4 ) ( 5 ) Balance at end of year $ 13 $ 8 $ 5 $ ( 3 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.70 % 0.70 % * * Vocalink Plan 1.55 % 2.00 % * * Postretirement Plan * * 2.50 % 3.25 % Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % * * Vocalink Plan 2.75 % 2.50 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable 84 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2020, the Companys aggregated Pension Plan assets exceed the benefit obligations. For plans where the benefit obligations exceeded plan assets, the projected benefit obligation was $ 112 million, the accumulated benefit obligation was $ 111 million and plan assets were $ 97 million. At December 31, 2019, all of the Pension Plans had benefit obligations in excess of plan assets. Information on the Pension Plans were as follows as of December 31: 2020 2019 (in millions) Projected benefit obligation $ 604 $ 531 Accumulated benefit obligation 601 524 Fair value of plan assets 617 518 For the years ended December 31, 2020 and 2019, the Companys projected benefit obligation related to its Pension Plans increased $ 73 million and $ 93 million, respectively, primarily attributable to actuarial losses related to lower discount rate assumptions. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 (in millions) Service cost $ 13 $ 11 $ 9 $ 1 $ 1 $ 1 Interest cost 9 13 12 2 2 2 Expected return on plan assets ( 18 ) ( 18 ) ( 20 ) Amortization of actuarial loss 1 Amortization of prior service credit ( 1 ) ( 1 ) ( 2 ) Net periodic benefit cost $ 4 $ 7 $ 1 $ 2 $ 2 $ 1 The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 (in millions) Current year actuarial loss (gain) $ 5 $ 12 $ 17 $ 7 $ 9 $ ( 2 ) Current year prior service credit 1 Amortization of prior service credit 1 1 2 Total other comprehensive loss (income) $ 5 $ 12 $ 18 $ 8 $ 10 $ Total net periodic benefit cost and other comprehensive loss (income) $ 9 $ 19 $ 19 $ 10 $ 12 $ 1 MASTERCARD 2020 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 Discount rate Non-U.S. Plans 0.70 % 1.80 % 1.80 % * * * Vocalink Plan 1.55 % 2.00 % 2.80 % * * * Postretirement Plan * * * 3.25 % 4.25 % 3.50 % Expected return on plan assets Non-U.S. Plans 1.60 % 2.10 % 3.00 % * * * Vocalink Plan 3.20 % 3.75 % 4.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % 2.60 % * * * Vocalink Plan 2.75 % 2.50 % 3.85 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: 2020 2019 Healthcare cost trend rate assumed for next year 7.00 % 6.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate 8 2 Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed with the following target asset allocations: fixed income 35 %, U.K. government securities 23 %, equity 22 %, cash and cash equivalents 12 % and real estate 8 %. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. 86 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2020 December 31, 2019 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ 59 $ $ $ 59 $ 16 $ $ $ 16 Mutual funds 2 270 117 387 153 193 346 Insurance contracts 3 96 96 75 75 Total $ 329 $ 213 $ $ 542 $ 169 $ 268 $ $ 437 Investments at Net Asset Value (NAV) 4 75 81 Total Plan Assets $ 617 $ 518 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 3 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 4 Investments at NAV include mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) and are valued using the net asset value provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2020 ) through 2030 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) 2021 $ 19 $ 4 2022 12 4 2023 14 4 2024 15 4 2025 15 4 2026 - 2030 77 20 MASTERCARD 2020 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15. Debt Long-term debt consisted of the following at December 31: 2020 2019 Effective Interest Rate (in millions) 2020 USD Notes 3.300 % Senior Notes due March 2027 $ 1,000 $ 3.420 % 3.350 % Senior Notes due March 2030 1,500 3.430 % 3.850 % Senior Notes due March 2050 1,500 3.896 % 2019 USD Notes 2.950 % Senior Notes due June 2029 1,000 1,000 3.030 % 3.650 % Senior Notes due June 2049 1,000 1,000 3.689 % 2.000 % Senior Notes due March 2025 750 750 2.147 % 2018 USD Notes 3.500 % Senior Notes due February 2028 500 500 3.598 % 3.950 % Senior Notes due February 2048 500 500 3.990 % 2016 USD Notes 2.000 % Senior Notes due November 2021 650 650 2.236 % 2.950 % Senior Notes due November 2026 750 750 3.044 % 3.800 % Senior Notes due November 2046 600 600 3.893 % 2015 EUR Notes 1 1.100 % Senior Notes due December 2022 859 785 1.265 % 2.100 % Senior Notes due December 2027 982 896 2.189 % 2.500 % Senior Notes due December 2030 184 169 2.562 % 2014 USD Notes 3.375 % Senior Notes due April 2024 1,000 1,000 3.484 % 12,775 8,600 Less: Unamortized discount and debt issuance costs ( 103 ) ( 73 ) Total debt outstanding 12,672 8,527 Less: Current portion 2 ( 649 ) Long-term debt $ 12,023 $ 8,527 1 Relates to euro-denominated debt issuance of 1.650 billion in December 2015 2 Relates to current portion of the 2016 USD Notes, due in November 2021, classified as current portion of long-term debt on the consolidated balance sheet In March 2020, the Company issued $ 1 billion principal amount of notes due March 2027, $ 1.5 billion principal amount of notes due March 2030 and $ 1.5 billion principal amount notes due March 2050 (collectively the 2020 USD Notes). The net proceeds from the issuance of the 2020 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 3.959 billion. In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049 and in December 2019, the Company issued $ 750 million principal amount of notes due March 2025 (collectively the 2019 USD Notes). The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion. The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2018 USD Notes were $ 991 million. 88 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2020 are summarized below. (in millions) 2021 $ 650 2022 859 2023 2024 1,000 2025 750 Thereafter 9,516 Total $ 12,775 On November 14, 2019, the Company increased its commercial paper program (the Commercial Paper Program) from $ 4.5 billion to $ 6 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility) on November 14, 2019. The Credit Facility, which previously expired on November 14, 2024, was extended on November 14, 2020 for an additional year and now expires on November 13, 2025. The extension did not result in material changes to the terms and conditions of the Credit Facility. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2020 and 2019. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2020 and 2019. Note 16. Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 300 No shares issued or outstanding at December 31, 2020 and 2019. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. MASTERCARD 2020 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2020, 2019 and 2018. The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2020 2019 2018 (in millions, except per share data) Dividends declared per share $ 1.64 $ 1.39 $ 1.08 Total dividends declared $ 1,641 $ 1,408 $ 1,120 Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31: 2020 2019 Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.2 % 88.9 % 87.8 % 88.8 % Principal or Affiliate Customers (Class B stockholders) 0.8 % % 1.1 % % Mastercard Foundation (Class A stockholders) 11.0 % 11.1 % 11.1 % 11.2 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements pursuant to Canadian tax law. Under such current law, Mastercard Foundation must annually disburse at least 3.5 % of its assets not used in its charitable activities and administration in the previous eight quarters (Disbursement Quota). However, Mastercard Foundation obtained permission from the Canada Revenue Agency to, until December 31, 2021, meet its cumulative Disbursement Quota obligations over a period of time that, on average, demonstrates compliance with the requirement for such established time period. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. 90 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2020, as well as historical purchases: Board authorization dates December 2020 December 2019 December 2018 December 2017 December 2016 Date program became effective Not yet effective January 2020 January 2019 March 2018 April 2017 Total (in millions, except average price data) Board authorization $ 6,000 $ 8,000 $ 6,500 $ 4,000 $ 4,000 $ 28,500 Dollar-value of shares repurchased in 2018 $ $ $ $ 3,699 $ 1,234 $ 4,933 Remaining authorization at December 31, 2018 $ $ $ 6,500 $ 301 $ $ 6,801 Dollar-value of shares repurchased in 2019 $ $ $ 6,196 $ 301 $ $ 6,497 Remaining authorization at December 31, 2019 $ $ 8,000 $ 304 $ $ $ 8,304 Dollar-value of shares repurchased in 2020 $ $ 4,169 $ 304 $ $ $ 4,473 Remaining authorization at December 31, 2020 $ 6,000 $ 3,831 $ $ $ $ 9,831 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ $ $ 194.77 $ 171.11 $ 188.26 Shares repurchased in 2019 24.8 1.6 26.4 Average price paid per share in 2019 $ $ $ 249.58 $ 188.38 $ $ 245.89 Shares repurchased in 2020 13.3 1.0 14.3 Average price paid per share in 2020 $ $ 313.26 $ 304.89 $ $ $ 312.68 Cumulative shares repurchased through December 31, 2020 13.3 25.8 20.6 28.2 87.9 Cumulative average price paid per share $ $ 313.26 $ 251.72 $ 194.27 $ 141.99 $ 212.41 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31: Outstanding Shares Class A Class B (in millions) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock ( 26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 ( 2.3 ) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 Purchases of treasury stock ( 14.3 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.9 ( 2.9 ) Balance at December 31, 2020 986.9 8.3 MASTERCARD 2020 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2020 and 2019 were as follows: December 31, 2019 Increase / (Decrease) Reclassifications December 31, 2020 (in millions) Foreign currency translation adjustments 1 $ ( 638 ) $ 286 $ $ ( 352 ) Translation adjustments on net investment hedge 2 ( 38 ) ( 137 ) ( 175 ) Cash flow hedges Interest rate contracts 3 11 ( 147 ) 3 ( 133 ) Defined benefit pension and other postretirement plans 4 ( 9 ) ( 10 ) ( 1 ) ( 20 ) Investment securities available-for-sale 1 ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 673 ) $ ( 9 ) $ 2 $ ( 680 ) December 31, 2018 Increase / (Decrease) Reclassifications December 31, 2019 (in millions) Foreign currency translation adjustments 1 $ ( 661 ) $ 23 $ $ ( 638 ) Translation adjustments on net investment hedge 2 ( 66 ) 28 ( 38 ) Cash flow hedges Interest rate contracts 3 11 11 Defined benefit pension and other postretirement plans 4 10 ( 17 ) ( 2 ) ( 9 ) Investment securities available-for-sale ( 1 ) 2 1 Accumulated Other Comprehensive Income (Loss) $ ( 718 ) $ 47 $ ( 2 ) $ ( 673 ) 1. During 2020, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the Euro and British pound partially offset by the depreciation of the Brazilian real. During 2019, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the British pound partially offset by the depreciation of the euro. 2. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. Changes in the value of the debt are recorded in accumulated other comprehensive income (loss). During 2020, the increase in the accumulated other comprehensive loss related to the net investment hedge was driven by the appreciation of the euro. During 2019, the decrease in the accumulated other comprehensive loss related to the net investment hedge was driven by the depreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3. In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled for a loss of $ 175 million, or $ 136 million net of tax, recorded in accumulated other comprehensive income (loss). The cumulative loss will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. See Note 23 (Derivative and Hedging Instruments) for additional information. 4. During 2020, the increase in the accumulated other comprehensive loss related to the Companys Plans was driven primarily by an actuarial loss within the Postretirement Plan. During 2019, the decrease in the accumulated other comprehensive gain related to the Companys Plans was primarily driven by actuarial losses within the Vocalink and non-U.S. Plans. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. Note 18. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. 92 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, however, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: 2020 2019 2018 Risk-free rate of return 1.0 % 2.6 % 2.7 % Expected term (in years) 6.00 6.00 6.00 Expected volatility 19.3 % 19.6 % 19.7 % Expected dividend yield 0.6 % 0.6 % 0.6 % Weighted-average fair value per Option granted $ 80.92 $ 53.09 $ 40.90 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2020: Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2020 6.6 $ 117 Granted 0.4 $ 263 Exercised ( 1.3 ) $ 75 Forfeited/expired $ 229 Outstanding at December 31, 2020 5.7 $ 137 6.0 $ 1,259 Exercisable at December 31, 2020 3.8 $ 106 5.1 $ 962 Options vested and expected to vest at December 31, 2020 5.7 $ 137 6.0 $ 1,257 As of December 31, 2020, there was $ 37 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.1 years. Restricted Stock Units For RSUs granted on or after March 1, 2020, the awards generally vest ratably over four years. For RSUs granted before March 1, 2020, the awards generally vest after three years . A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than seven months . MASTERCARD 2020 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys RSU activity for the year ended December 31, 2020: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2020 2.9 $ 166 Granted 0.9 $ 288 Converted ( 1.2 ) $ 116 Forfeited ( 0.1 ) $ 218 Outstanding at December 31, 2020 2.5 $ 231 $ 898 RSUs expected to vest at December 31, 2020 2.4 $ 230 $ 861 The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2020, there was $ 233 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 2.4 years. Performance Stock Units PSUs vest after three years , however, awards granted on or after March 1, 2019 are subject to a mandatory one-year post-vest hold. A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. The following table summarizes the Companys PSU activity for the year ended December 31, 2020: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2020 0.5 $ 167 Granted 0.2 $ 291 Converted ( 0.3 ) $ 126 Outstanding at December 31, 2020 0.4 $ 259 $ 148 PSUs expected to vest at December 31, 2020 0.4 $ 259 $ 148 Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expense for PSUs is recognized over the requisite service period, or the date the individual becomes eligible to retire but not less than seven months , if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. During the year ended December 31, 2020, performance targets related to PSU awards granted in 2018, and scheduled to vest in 2021 (2018 PSU Awards), were adjusted to exclude certain pandemic-related financial impacts deemed outside of the Companys control. The adjustment required the Company to apply modification accounting to the 2018 PSU Awards. The modification had an immaterial impact on compensation expense expected to be recognized over the remaining service period. As of December 31, 2020, there was $ 38 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.4 years. 94 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Additional Information The following table includes additional share-based payment information for each of the years ended December 31: 2020 2019 2018 (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ 254 $ 250 $ 196 Income tax benefit recognized for equity awards 53 53 41 Income tax benefit realized related to Options exercised 68 69 53 Options: Total intrinsic value of Options exercised 317 317 242 RSUs: Weighted-average grant-date fair value of awards granted 288 226 171 Total intrinsic value of RSUs converted into shares of Class A common stock 330 394 194 PSUs: Weighted-average grant-date fair value of awards granted 291 231 226 Total intrinsic value of PSUs converted into shares of Class A common stock 92 85 40 Note 19. Commitments At December 31, 2020, the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements and a commitment to purchase the remaining shares of a majority-owned joint venture. The Company has accrued $ 22 million of these future payments as of December 31, 2020. (in millions) 2021 $ 573 2022 255 2023 117 2024 78 2025 1 Thereafter Total $ 1,024 Note 20. Income Taxes Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: 2020 2019 2018 (in millions) United States $ 3,304 $ 4,213 $ 3,510 Foreign 4,456 5,518 3,694 Income before income taxes $ 7,760 $ 9,731 $ 7,204 MASTERCARD 2020 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The total income tax provision for the years ended December 31 is comprised of the following components: 2020 2019 2018 (in millions) Current Federal $ 439 $ 642 $ 649 State and local 56 81 69 Foreign 781 897 871 1,276 1,620 1,589 Deferred Federal 106 40 ( 228 ) State and local 9 ( 11 ) Foreign ( 42 ) ( 47 ) ( 5 ) 73 ( 7 ) ( 244 ) Income tax expense $ 1,349 $ 1,613 $ 1,345 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: 2020 2019 2018 Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 7,760 $ 9,731 $ 7,204 Federal statutory tax 1,630 21.0 % 2,044 21.0 % 1,513 21.0 % State tax effect, net of federal benefit 57 0.7 % 65 0.7 % 46 0.6 % Foreign tax effect ( 193 ) ( 2.5 ) % ( 208 ) ( 2.1 ) % ( 92 ) ( 1.3 ) % European Commission fine % % 194 2.7 % Foreign tax credits 1 % ( 32 ) ( 0.3 ) % ( 110 ) ( 1.5 ) % Windfall benefit ( 119 ) ( 1.5 ) % ( 129 ) ( 1.3 ) % ( 72 ) ( 1.0 ) % Other, net ( 26 ) ( 0.3 ) % ( 127 ) ( 1.4 ) % ( 134 ) ( 1.8 ) % Income tax expense $ 1,349 17.4 % $ 1,613 16.6 % $ 1,345 18.7 % 1 Included within the impact of the foreign tax credits is $ 27 million for 2019 and $ 90 million for 2018 of tax benefits relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2020, 2019 and 2018 were 17.4 %, 16.6 % and 18.7 %, respectively. The effective income tax rate for 2020 was higher than the effective income tax rate for 2019, primarily due to discrete tax benefits in 2019, partially offset by a more favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S. tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019. These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. 96 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2020, 2019 and 2018, the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 260 million, or $ 0.26 per diluted share, $ 300 million, or $ 0.29 per diluted share, and $ 212 million, or $ 0.20 per diluted share, respectively. Indefinite Reinvestment As of December 31, 2020 the Company had deferred tax liabilities of $ 61 million primarily related to the tax effect of the estimated foreign exchange impact on unremitted earnings. The Company expects that foreign withholding taxes associated with future repatriation of these earnings will not be material. Earnings of approximately $ 0.6 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax expense would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: 2020 2019 (in millions) Deferred Tax Assets Accrued liabilities $ 324 $ 354 Compensation and benefits 218 214 State taxes and other credits 47 41 Net operating and capital losses 147 119 Unrealized gain/loss - 2015 EUR Notes 58 20 U.S. foreign tax credits 276 145 Intangible assets 182 157 Other items 142 74 Less: Valuation allowance ( 353 ) ( 205 ) Total Deferred Tax Assets 1,041 919 Deferred Tax Liabilities Prepaid expenses and other accruals 78 83 Goodwill and intangible assets 216 187 Property, plant and equipment 183 128 Previously taxed earnings and profits 61 Other items 98 63 Total Deferred Tax Liabilities 636 461 Net Deferred Tax Assets $ 405 $ 458 The valuation allowance balance at December 31, 2020 and 2019 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current and prior periods and certain foreign net operating losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is MASTERCARD 2020 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31, is as follows: 2020 2019 2018 (in millions) Beginning balance $ 203 $ 164 $ 183 Additions: Current year tax positions 19 22 23 Prior year tax positions 192 37 5 Reductions: Prior year tax positions ( 10 ) ( 11 ) ( 17 ) Settlements with tax authorities ( 12 ) ( 2 ) ( 18 ) Expired statute of limitations ( 4 ) ( 7 ) ( 12 ) Ending balance $ 388 $ 203 $ 164 As of December 31, 2020, the amount of unrecognized tax benefit was $ 388 million. This amount, if recognized, would reduce the effective income tax rate. The Companys unrecognized tax benefits increased primarily due to a prior year tax issue resulting from a refund claim filed in 2020. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2020 and 2019, the Company had a net income tax-related interest payable of $ 24 million and $ 13 million, respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2020, 2019 and 2018 was not material. In addition, as of December 31, 2020 and 2019, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 21. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. 98 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services, resulting in merchants paying excessive costs for the acceptance of Mastercard and Visa credit and debit cards. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $ 237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. In December 2020, the Rules Relief Class filed a motion for class certification. Briefing on summary judgment motions in the Rules Relief Class and opt-out merchant cases was completed in December 2020. MASTERCARD 2020 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2020 and 2019, Mastercard had accrued a liability of $ 783 million and $ 914 million, respectively, as a reserve for both the Damages Class litigation and the opt-out merchant cases. As of December 31, 2020 and 2019, Mastercard had $ 586 million and $ 584 million, respectively, in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. The reserve as of December 31, 2020 for both the Damages Class litigation and the opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $ 5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. All appellate courts have rejected the objectors appeals. In one of the appeals, the objectors have until April 2021 to request an appeal to the Supreme Court of Canada. For the remainder of the appeals, the Supreme Court has previously denied such requests. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The EC issued a decision accepting the settlement in April 2019, with changes to interregional interchange fees going into effect in the fourth quarter of 2019. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but included a fine of 571 million, which was paid in April 2019. Mastercard incurred a charge of $ 654 million in 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) merchants filed claims or threatened litigation against Mastercard seeking damages for merchants allegedly paying excessive costs for the acceptance of Mastercard credit and debit cards arising out of alleged anti-competitive conduct with respect to, among other things, Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $ 4.5 billion as of December 31, 2020). Mastercard has resolved over 2 billion (approximately $ 3 billion as of December 31, 2020) of these damages claims through settlement or judgment. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court heard the appeals of the four merchants and ruled against both Mastercard and Visa on two of the three legal issues being considered. The parties appealed the rulings to the U.K. Supreme Court. In June 2020, the U.K. Supreme Court ruled against Mastercard and Visa with respect to one of the liability issues being considered by the Court related to U.K domestic interchange fees. Additionally, the U.K Supreme Court set out the legal standard that should be applied by lower trial courts with respect to determining whether interchange was exemptible under applicable law, and provided guidance to lower courts with regard to the legal standard that should be applied in assessing merchants damages claims. The U.K. Supreme Court sent one of the four merchant cases back to the trial court for a determination of liability and damages issues and sent the remaining three merchant cases back to the trial court for a determination of damages issues only. A hearing in one of these merchant cases on liability and damages issues is expected to be scheduled for the fourth quarter of 2021, while a trial on damages for the other three merchant claims is not expected to occur until 2023. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $ 237 million in 2018. Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. The majority of these merchant claims 100 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS generally had been stayed pending the decision of the U.K. Supreme Court, and a number of those matters are now progressing with motion practice and discovery. Mastercard incurred charges of $ 22 million in 2020 to reflect both the estimated attorneys fees incurred by the four merchant claimants in the U.K. Supreme Court appeal, as well as settlements with a number of Pan-European merchants. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 19 billion as of December 31, 2020). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. In December 2020, the U.K. Supreme Court rejected Mastercards appeal of this ruling. The case has been sent back to the trial court for a re-hearing on the plaintiffs collective action application in light of the Supreme Court decision. The hearing is scheduled to occur in late March 2021. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims and has opposed class certification. Briefing on class certification is complete. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the district court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the district court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. In August 2020, the district court issued an order granting the plaintiffs request for class certification. In January 2021, the Network Defendants request for permission to appeal the district courts certification decision to the appellate court was denied. The case is proceeding with substantive expert discovery. MASTERCARD 2020 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the district court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. In January 2021, the magistrate judge serving on the district court issued a decision recommending that the district court judge deny plaintiffs class certification motion. The plaintiffs have the opportunity to file objections to this decision with the district court judge. U.S. Federal Trade Commission Investigation In June 2020, the U.S. Federal Trade Commissions Bureau of Competition (FTC) informed Mastercard that it has initiated a formal investigation into compliance with the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In particular, the investigation focuses on Mastercards compliance with the debit routing provisions of the Durbin Amendment. The FTC has issued a subpoena and Mastercard is cooperating with it in the investigation. U.K. Prepaid Cards Matter Mastercard is subject to an ongoing confidential legal matter related to prepaid cards in the U.K. This matter focuses exclusively on historic behavior, and has no prospective impact on Mastercards on-going business. In connection with this matter, in the fourth quarter of 2020, Mastercard recorded a litigation charge of $ 45 million. Note 22. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months prior to period end multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, such as cash, letters of credit, guarantees, or other risk mitigating arrangements. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31: 2020 2019 (in millions) Gross settlement exposure $ 52,360 $ 55,800 Collateral applied to settlement exposure ( 6,021 ) ( 4,772 ) Net uncollateralized settlement exposure $ 46,339 $ 51,028 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 370 million and $ 367 million at December 31, 2020 and 2019, respectively, of which $ 294 million and $ 290 million at December 31, 2020 and 2019, respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements 102 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 23. Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances (Cash Flow Hedges). Foreign Exchange Risk Derivatives The Company enters into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currency of the entity. The Company may also enter into foreign exchange derivative contracts to offset possible changes in value due to foreign exchange fluctuations of assets and liabilities. In addition, the Company is subject to foreign exchange risk as part of its daily settlement activities. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with customers. To manage this risk, the Company enters into short duration foreign exchange derivative contracts based upon anticipated receipts and disbursements for the respective currency position. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. The Companys derivative contracts are summarized below: December 31, 2020 December 31, 2019 Notional Fair Value Notional Fair Value (in millions) Commitments to purchase foreign currency $ 389 $ 17 $ 185 $ 3 Commitments to sell foreign currency 1,110 ( 26 ) 1,506 ( 25 ) Options to sell foreign currency 21 2 Balance sheet location Prepaid expenses and other current assets 1 $ 19 $ 12 Other current liabilities 1 ( 28 ) ( 32 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, 2020 2019 2018 (in millions) Foreign exchange derivative contracts General and administrative $ 40 $ ( 39 ) $ 53 The fair value of the foreign exchange derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign exchange derivative contracts are generally less than 18 months. The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2020 and 2019, as these contracts were not designated as hedging instruments for accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as MASTERCARD 2020 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European operations. As of December 31, 2020, the Company had a net foreign currency transaction loss of $ 175 million after tax, in accumulated other comprehensive income (loss) associated with hedging activity. Interest Rate Risk Cash Flow Hedges During the fourth quarter of 2019, the Company entered into treasury rate locks for a total notional amount of $ 1 billion, which were accounted for as cash flow hedges. These contracts were entered into to hedge a portion of the Companys interest rate exposure attributable to changes in the treasury rates related to the forecasted debt issuance during 2020. The maximum length of time over which the Company had hedged its exposure was 30 years. In connection with the issuance of the 2020 USD Notes, these contracts were settled and the Company paid $ 175 million. As of December 31, 2020, a cumulative loss of $ 133 million, after tax, was recorded in accumulated other comprehensive income (loss) associated with these contracts and will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. As of December 31, 2019, the Company recorded a pre-tax net unrealized gain of $ 14 million ($ 11 million, after tax) in accumulated other comprehensive income (loss) associated with these contracts. In 2020, the Company reclassified $ 4 million, pre-tax, of the deferred loss on cash flow derivative contracts recorded in accumulated other comprehensive income (loss) to interest expense on the statement of operations. The Company estimates that $ 6 million, pre-tax, of the deferred loss will be reclassified into interest expense within the next 12 months. Note 24. Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 33 % of total revenue in 2020, 32 % in 2019 and 33 % in 2018. No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2020, 2019 or 2018. The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31: 2020 2019 2018 (in millions) United States $ 1,185 $ 1,147 $ 613 Other countries 717 681 308 Total $ 1,902 $ 1,828 $ 921 104 MASTERCARD 2020 FORM 10-K PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2020 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2020. Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2020 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +46,Mastercard,2019, Item 1. Business , Item 1A. Risk factors , Item 1B. Unresolved staff comments , Item 2. Properties , Item 3. Legal proceedings ," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 11, 2020 , we had 68 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 271 holders of record of our non-voting Class B common stock as of February 11, 2020 , constituting approximately 1.1% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 Financials and the SP 500 Index for the five-year period ended December 31, 2019 . The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index Mastercard $ 100.00 $ 113.80 $ 121.67 $ 179.67 $ 225.17 $ 358.38 SP 500 Financials 100.00 98.47 120.92 147.75 128.50 169.78 SP 500 Index 100.00 101.38 113.51 138.29 132.23 173.86 36 MASTERCARD 2019 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Dividend Declaration and Policy On December 3, 2019, our Board of Directors declared a quarterly cash dividend of $0.40 per share paid on February 7, 2020 to holders of record on January 9, 2020 of our Class A common stock and Class B common stock. On February 4, 2020, our Board of Directors declared a quarterly cash dividend of $0.40 per share payable on May 8, 2020 to holders of record on April 9, 2020 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 4, 2018, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $6.5 billion of our Class A common stock (the 2018 Share Repurchase Program). This program became effective in January 2019. On December 3, 2019, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $8.0 billion of our Class A common stock (the 2019 Share Repurchase Program). This program became effective in January 2020. During the fourth quarter of 2019 , we repurchased a total of approximately 3.6 million shares for $994 million at an average price of $275.00 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2019 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,128,776 $ 271.55 2,128,776 $ 719,951,874 November 1 30 1,363,616 278.93 1,363,616 339,605,253 December 1 31 121,837 291.38 121,837 8,304,104,890 Total 3,614,229 275.00 3,614,229 1 Dollar value of shares that may yet be purchased under the 2018 Share Repurchase Program and the 2019 Share Repurchase Program are as of the end of each period presented. MASTERCARD 2019 FORM 10-K 37 PART II "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2018 compared to the year ended December 31, 2017, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs and processing. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2019 Increase/ (Decrease) 2018 Increase/ (Decrease) ($ in millions, except per share data) Net revenue $ 16,883 $ 14,950 $ 12,497 13% 20% Operating expenses $ 7,219 $ 7,668 $ 5,875 (6)% 31% Operating income $ 9,664 $ 7,282 $ 6,622 33% 10% Operating margin 57.2 % 48.7 % 53.0 % 8.5 ppt (4.3) ppt Income tax expense $ 1,613 $ 1,345 $ 2,607 20% (48)% Effective income tax rate 16.6 % 18.7 % 40.0 % (2.1) ppt (21.3) ppt Net income $ 8,118 $ 5,859 $ 3,915 39% 50% Diluted earnings per share $ 7.94 $ 5.60 $ 3.65 42% 53% Diluted weighted-average shares outstanding 1,022 1,047 1,072 (2)% (2)% MASTERCARD 2019 FORM 10-K 39 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table provides a summary of key non-GAAP operating results 1, 2 , adjusted to exclude the impact of gains and losses on our equity investments, special items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, Increase/(Decrease) Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 16,883 $ 14,950 $ 12,497 13% 16% 20% 20% Adjusted operating expenses $ 7,219 $ 6,540 $ 5,693 10% 12% 15% 15% Adjusted operating margin 57.2 % 56.2 % 54.4 % 1.0 ppt 1.3 ppt 1.8 ppt 1.8 ppt Adjusted effective income tax rate 2 17.0 % 18.5 % 26.8 % (1.5) ppt (1.3) ppt (8.3) ppt (8.2) ppt Adjusted net income 2 $ 7,937 $ 6,792 $ 4,906 17% 20% 38% 38% Adjusted diluted earnings per share 2 $ 7.77 $ 6.49 $ 4.58 20% 23% 42% 41% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 For 2019 we updated our non-GAAP methodology to exclude the impact of gains and losses on our equity investments. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. Key highlights for 2019 as compared to 2018 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue increased 16% on a currency-neutral basis, which included growth of approximately 1 percentage point from acquisitions. The primary drivers of our up 13% up 16% net revenue growth were 1 : - Gross dollar volume growth of 13% on a local currency basis - Cross-border growth of 16% on a local currency basis - Switched transaction growth of 19% - Other revenues growth of 23%, or 24% on a currency-neutral basis. This includes 2 percentage points of growth due to acquisitions. The remaining growth was primarily driven by our Cyber Intelligence and Data Services solutions. - These increases were partially offset by higher rebates and incentives, which increased 18%, or 20% on a currency-neutral basis, primarily due to the impact from new and renewed agreements and increased volumes. 1 The cross-border volume and switched transactions growth rates have been normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. 40 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expenses on a currency-neutral basis included growth of approximately 2 percentage points from acquisitions and 1 percentage point related to the differential in hedging gains and losses versus the year-ago period. The remaining 9 percentage points of growth was primarily related to our continued investment in strategic initiatives. down 6% up 12% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) Adjusted effective income tax rate of 17.0% primarily attributable to a more favorable geographic mix of earnings and discrete tax benefits including a favorable court ruling in the current period. 16.6% 17.0% Other 2019 financial highlights were as follows: We generated net cash flows from operations of $8.2 billion . We completed the acquisitions of businesses for total consideration of $1.5 billion . We repurchased 26 million shares of our common stock for $6.5 billion and paid dividends of $1.3 billion We completed debt offerings for an aggregate principal amount of $2.8 billion and separately repaid $500 million of principal that matured related to our 2014 USD Notes. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). For 2019, our non-GAAP financial measures also exclude the impact of gains and losses on our equity investments which includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2019 , we recorded net gains of $167 million ( $124 million after tax, or $0.12 per diluted share), primarily related to unrealized fair market value adjustments on marketable and non-marketable equity securities. Special Items Tax act During 2019, we recorded a $57 million net tax benefit ( $0.06 per diluted share) which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. During 2018, we recorded a $75 million net tax benefit ( $0.07 per diluted share) which included a $90 million benefit related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense primarily related to an increase to our Transition Tax. During 2017, we recorded additional tax expense of $873 million ( $0.81 per diluted share) which included $825 million of provisional charges attributable to the Transition Tax, the remeasurement of our net deferred tax asset in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million additional tax expense related to a foregone foreign tax credit benefit on 2017 repatriations. Litigation provisions During 2018, we recorded pre-tax charges of $1,128 million ( $1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission MASTERCARD 2019 FORM 10-K 41 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017, we recorded pre-tax charges of $15 million ( $10 million after tax, or $0.01 per diluted share) related to a litigation settlement with Canadian merchants. Venezuela charge During 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries. See Note 1 (Summary of Significant Accounting Policies) , Note 7 (Investments) , Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and nonrecurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. In addition, we present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. 42 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 16.6 % $ 8,118 $ 7.94 (Gains) losses on equity investments ** ** (167 ) (0.2 )% (124 ) (0.12 ) Tax act ** ** ** 0.6 % (57 ) (0.06 ) Non-GAAP $ 7,219 57.2 % $ (100 ) 17.0 % $ 7,937 $ 7.77 Year ended December 31, 2018 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % $ (78 ) 18.7 % $ 5,859 $ 5.60 Litigation provisions (1,128 ) 7.5 % ** (1.1 )% 1,008 0.96 Tax act ** ** ** 0.9 % (75 ) (0.07 ) Non-GAAP $ 6,540 56.2 % $ (78 ) 18.5 % $ 6,792 $ 6.49 Year ended December 31, 2017 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % $ (100 ) 40.0 % $ 3,915 $ 3.65 Tax act ** ** ** (13.4 )% 0.81 Venezuela charge (167 ) 1.3 % ** 0.2 % 0.10 Litigation provisions (15 ) 0.1 % ** % 0.01 Non-GAAP $ 5,693 54.4 % $ (100 ) 26.8 % $ 4,906 $ 4.58 Note: Tables may not sum due to rounding. ** Not applicable MASTERCARD 2019 FORM 10-K 43 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2019 as compared to the Year Ended December 31, 2018 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % (6 )% 8.5 (2.1) ppt % % (Gains) losses on equity investments 1 ** ** ** (0.2) ppt (2 )% (2 )% Tax act ** ** ** (0.3) ppt % % Litigation provisions ** % (7.5) ppt 1.1 ppt (20 )% (21 )% Non-GAAP % % 1.0 ppt (1.5) ppt % % Currency impact 2 % % 0.3 ppt 0.2 ppt % % Non-GAAP - currency-neutral % % 1.3 ppt (1.3) ppt % % Year Ended December 31, 2018 as compared to the Year Ended December 31, 2017 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (4.3) ppt (21.3) ppt % % Litigation provisions ** (19 )% 7.4 ppt (1.0) ppt % % Tax act ** ** ** 14.2 ppt (33 )% (34 )% Venezuela charge ** % (1.3) ppt (0.2) ppt (3 )% (3 )% Non-GAAP % % 1.8 ppt (8.3) ppt % % Currency impact 2 % % 0.1 ppt % % Non-GAAP - currency-neutral % % 1.8 ppt (8.2) ppt % % Note: Tables may not sum due to rounding. ** Not applicable 1 For 2019 we updated our non-GAAP methodology to exclude the impact of gains and losses on our equity investments. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. 2 Represents the currency translational and transactional impact. 44 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foreign Currency Currency Impact (Translation and Transactional) Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2019 , GDV on a U.S. dollar-converted basis increased 9.6% , while GDV on a local currency basis increased 13.0% versus 2018 . In 2018 , GDV on a U.S. dollar-converted basis increased 12.8% , while GDV on a local currency basis increased 13.8% versus 2017 . Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. The translational and transactional impact of currency (Currency impact) has been identified in our growth impact tables and has been excluded from our currency neutral growth rates, which are non-GAAP financial measures. See Non-GAAP Financial Information for further information on our non-GAAP adjustments. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses on the consolidated statement of operations. We manage foreign currency balance sheet remeasurement and transactional currency exposure through our foreign exchange risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign exchange derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives immediately in current-period earnings, with the related hedged item being recognized as the exposures materialize. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in 2017, due to foreign exchange regulations which were restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we transitioned to the cost method of accounting. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in 2017. We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2019 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Results Revenue Gross revenue increased 14% , or 17% on a currency-neutral basis in 2019 versus the prior year, primarily due to an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 18% , or 20% on a currency-neutral basis in 2019 versus the prior year, primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 13% , or 16% on a currency-neutral basis in 2019 versus the prior year, including growth of 1 percentage point from our acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Domestic assessments $ 6,781 $ 6,138 $ 5,130 10% 20% Cross-border volume fees 5,606 4,954 4,174 13% 19% Transaction processing 8,469 7,391 6,188 15% 19% Other revenues 4,124 3,348 2,853 23% 17% Gross revenue 24,980 21,831 18,345 14% 19% Rebates and incentives (contra-revenue) (8,097 ) (6,881 ) (5,848 ) 18% 18% Net revenue $ 16,883 $ 14,950 $ 12,497 13% 20% The following table summarizes the drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Revenue Standard 1 Currency Impact 2 Other 3 Total Domestic assessments 13% 14% % % ** 6% (3)% (1)% % 4 % 4 % % Cross-border volume fees 14% 17% % % ** 1% (3)% 1% % % % % Transaction processing 14% 14% % % ** % (2)% % % % % % Other revenues ** ** 2% 2% ** % (1)% (1)% % 5 % 5 % % Rebates and incentives 9% 10% % % ** (2)% (3)% (1)% % 6 % 6 % % Net revenue 13% 14% 1% 0.5% ** 4% (3)% % % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the impact of our adoption of the revenue guidance in 2018. For a more detailed discussion on the impact of the revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 2 Represents the currency translational and transactional impact. 3 Includes impact from pricing and other non-volume based fees. 4 Includes impact of the allocation of revenue to service deliverables, which are primarily recorded in other revenue when services are performed. 5 Includes impacts from cyber and intelligence fees, data analytics and consulting fees and other payment-related products and services. 6 Includes the impact of new, renewed and expired agreements. 46 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables provide a summary of the trend in volume and transaction growth. The cross-border volume and switched transactions growth rates have been normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. Additionally, we adjusted the switched transactions growth rate in the prior period for the deconsolidation of our Venezuelan subsidiaries in 2017. For a more detailed discussion of the deconsolidation of our Venezuelan subsidiaries, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. For the Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border volume 1 % % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Switched transactions % % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2019 , the net revenue from these customers was approximately $3.5 billion , or 21% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses decreased 6% in 2019 versus the prior year. Adjusted operating expenses increased 10% , or 12% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 2 percentage points from acquisitions and 1 percentage point primarily from foreign exchange derivative contracts. The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 5,763 $ 5,174 $ 4,653 % % Advertising and marketing % % Depreciation and amortization % % Provision for litigation 1,128 ** ** Total operating expenses 7,219 7,668 5,875 (6 )% % Special Items 1 (1,128 ) (182 ) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 7,219 $ 6,540 $ 5,693 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. MASTERCARD 2019 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 2 Acquisitions Revenue Standard 3 Currency Impact 4 Total General and administrative 11% % 1 ** (4 )% % % ** % (2 )% % % % Advertising and marketing 5% (4 )% ** ** % % ** % (2 )% % % % Depreciation and amortization 9% (5 )% ** ** % % ** % (2 )% % % % Provision for litigation ** ** ** ** ** ** ** ** ** ** ** ** Total operating expenses 10% % 1 (16 )% % % % ** % (2 )% % (6 )% % Note: Table may not sum due to rounding. ** Not meaningful 1 Includes a 2 percentage point impact to general and administrative and total operating expenses growth due to contributions made in 2018 to support inclusive growth efforts. Contributions made in 2019 were comparable to the prior year. 2 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts . 3 Represents the impact of our adoption of the revenue guidance in 2018. For a more detailed discussion on the impact of the revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 4 Represents the currency translational and transactional impact. General and Administrative General and administrative expenses increased 11% , or 13% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 2 percentage points from acquisitions and 1 percentage point primarily from foreign exchange derivative contracts. The remaining increase was primarily driven by an increase in personnel to support our continued investment in our strategic initiatives. The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Personnel $ 3,537 $ 3,214 $ 2,687 10% 20% Professional fees 19% 6% Data processing and telecommunications 11% 19% Foreign exchange activity 1 (36 ) ** ** Other 1,081 1,019 1,001 6% 2% Total general and administrative expenses 5,763 5,174 4,653 11% 11% Special Items 2 (167 ) ** ** Adjusted general and administrative expenses (excluding Special Items 2 ) $ 5,763 $ 5,174 $ 4,486 11% 15% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts . Advertising and Marketing Advertising and marketing expenses increased 3% , or 5% on a currency-neutral basis in 2019 versus the prior year, primarily due to higher spending on certain sponsorship initiatives. 48 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Depreciation and Amortization Depreciation and amortization expenses increased 14% , or 15% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 7 percentage points from acquisitions with the remaining increase primarily driven by amortization of certain intangible assets and depreciation on data center assets. Provision for Litigation Provision for litigation decreased in 2019 versus the prior year as there were no litigation charges in the current year. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) increased in 2019 versus the prior year primarily due to net gains of $167 million which were related to unrealized fair market value adjustments on marketable and non-marketable equity securities in the current period. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Investment Income $ $ $ (21 )% ** Gains (losses) on equity investments, net ** ** Interest expense (224 ) (186 ) (154 ) % % Other income (expense), net (14 ) (2 ) ** ** Total other income (expense) (78 ) (100 ) ** (22 )% Note: Table may not sum due to rounding. ** Not meaningful Income Taxes The effective income tax rates for the years ended December 31, 2019 and 2018 were 16.6% and 18.7% , respectively. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 , primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019 . These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. The adjusted effective income tax rates for the years ended December 31, 2019 and 2018 were 17.0% and 18.5% , respectively. The adjusted effective income tax rate was lower than the prior year primarily due to a more favorable geographic mix of earnings and discrete tax benefits including a favorable court ruling in 2019. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 7.7 $ 8.4 Unused line of credit 6.0 4.5 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.0 billion and $1.7 billion at December 31, 2019 and 2018 , respectively. MASTERCARD 2019 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Net cash provided by operating activities $ 8,183 $ 6,223 $ 5,664 Net cash used in investing activities (1,640 ) (506 ) (1,781 ) Net cash used in financing activities (5,867 ) (4,966 ) (4,764 ) Net cash provided by operating activities increased $2.0 billion in 2019 versus the prior year, primarily due to higher net income as adjusted for non-cash items. Net cash used in investing activities increased $1.1 billion in 2019 versus the prior year, primarily due to acquisitions and purchases of equity investments, partially offset by higher net proceeds from our investments in available-for-sale and held-to-maturity securities. Net cash used in financing activities increased $901 million in 2019 versus the prior year, primarily due to higher repurchases of our Class A common stock, higher dividends paid and the settlement of the contingent consideration attributable to our 2017 acquisitions, partially offset by higher net debt proceeds in the current period. Debt and Credit Availability In May 2019, we issued $1.0 billion principal amount of notes due June 2029 and $1.0 billion principal amount of notes due June 2049 and in December 2019, we issued $750 million principal amount of notes due March 2025. Additionally, during 2019, $500 million of principal related to the 2014 USD Notes matured and was paid. Our total debt outstanding was $8.5 billion at December 31, 2019 , with the earliest maturity of $650 million of principal occurring in November 2021. As of December 31, 2019 , we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which expires in November 2024. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2019 . See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating 50 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 1.32 $ 1.00 $ 0.88 Cash dividends paid $ 1,345 $ 1,044 $ On December 4, 2019, our Board of Directors declared a quarterly cash dividend of $0.40 per share paid on February 7, 2020 to holders of record on January 9, 2020 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $403 million . On February 4, 2020, our Board of Directors declared a quarterly cash dividend of $0.40 per share payable on May 8, 2020 to holders of record on April 9, 2020 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $402 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2019 , 2018 and 2017 , our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion , $6.5 billion and $4.0 billion , respectively, of our Class A common stock. The program approved in 2019 became effective in January 2020 after completion of the share repurchase program authorized in 2018. The following table summarizes our share repurchase authorizations of our Class A common stock through December 31, 2019 , under the plans approved in 2018 and 2017: (in millions, except per share data) Remaining authorization at December 31, 2018 $ 6,801 Dollar-value of shares repurchased in 2019 $ 6,497 Remaining authorization at December 31, 2019 $ 8,304 Shares repurchased in 2019 26.4 Average price paid per share in 2019 $ 245.89 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than the commitments presented in the Future Obligations table that follows. MASTERCARD 2019 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Future Obligations The following table summarizes our obligations as of December 31, 2019 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period 2021 - 2022 2023 - 2024 2025 and thereafter Total (in millions) Debt $ $ 1,435 $ 1,000 $ 6,165 $ 8,600 Interest on debt 2,235 3,370 Operating leases 1 Other obligations Sponsorship, licensing and other Employee benefits 2 Transition Tax 3 Redeemable non-controlling interests 4 Total 5 $ $ 2,616 $ 1,926 $ 9,050 $ 14,488 1 Amounts relate to the maturity of our operating lease liabilities. See Note 10 (Property, Equipment and Right-of-Use Assets) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts relate to severance along with expected funding requirements for defined benefit pension and postretirement plans. 3 Amounts relate to the U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 4 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 The table does not include the following: Payment related to a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $3.19 billion as of December 31, 2019 ) as the transaction is subject to regulatory approval and other customary closing conditions. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liability for unrecognized tax benefits of $203 million as of December 31, 2019 . These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated and the timing of these payments will depend on the progress of tax examinations with the various authorities. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Litigation provision of $914 million as of December 31, 2019 as the timing of payments is not fixed and determinable. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Future cash payments that will become due to customers and merchants under business agreements as the amounts due are contingent on future performance. We have accrued $4.8 billion as of December 31, 2019 related to these customer and merchant agreements. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates or support when customers meet certain volume thresholds as well as other support incentives, which are tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction - based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. 52 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. "," Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. MASTERCARD 2019 FORM 10-K 53 PART II ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage transactional currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $144 million and $113 million on our foreign exchange derivative contracts outstanding at December 31, 2019 and 2018 , respectively, related to the hedging program. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between the timing of when a payment transaction takes place and the subsequent settlement with our customers. Interest Rate Risk During the fourth quarter of 2019, we entered into interest rate derivative contracts that were designated as cash flow hedges in order to manage our exposure to interest rate changes on future forecasted debt issuances. At December 31, 2019 , the total notional amount of these contracts was $1 billion . The maximum length of time over which we have hedged our exposure to the variability in future cash flows is 30 years. The effect of a hypothetical 100 basis point adverse change in interest rates could result in a fair value loss of approximately $168 million on our interest rate derivative contracts outstanding at December 31, 2019 . There were no similar contracts outstanding as of December 31, 2018 . In addition, our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2019 and 2018 . 54 MASTERCARD 2019 FORM 10-K PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 Managements report on internal control over financial reporting Report of independent registered public accounting firm Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements MASTERCARD 2019 FORM 10-K 55 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2019 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. 56 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2019 and 2018 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2019 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. MASTERCARD 2019 FORM 10-K 57 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates or incentives which totaled $8.1 billion for the year ended December 31, 2019. The Company has business agreements with certain customers that provide for rebates or other support when customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction to gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. Management considers various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter was the significant judgment of management when developing estimates related to rebates and incentives based on customer performance. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance and the reasonableness of assumptions related to the forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer rebates and incentives, including controls over evaluating customer performance based upon historical experience with that customer, forecasted transactions, card issuance and card conversion volumes and expected payments. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating rebate and incentive contracts to identify whether all incentives are identified and recorded accurately; (ii) testing managements process for developing the estimated customer performance, including evaluating the reasonableness of the assumptions related to the forecasted transactions, card issuance and card conversion volumes, expected payments and historical customer experience; and (iii) evaluating the estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 14, 2020 We have served as the Companys auditor since 1989. 58 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 16,883 $ 14,950 $ 12,497 Operating Expenses General and administrative 5,763 5,174 4,653 Advertising and marketing Depreciation and amortization Provision for litigation 1,128 Total operating expenses 7,219 7,668 5,875 Operating income 9,664 7,282 6,622 Other Income (Expense) Investment income Gains (losses) on equity investments, net Interest expense ( 224 ) ( 186 ) ( 154 ) Other income (expense), net ( 14 ) ( 2 ) Total other income (expense) ( 78 ) ( 100 ) Income before income taxes 9,731 7,204 6,522 Income tax expense 1,613 1,345 2,607 Net Income $ 8,118 $ 5,859 $ 3,915 Basic Earnings per Share $ 7.98 $ 5.63 $ 3.67 Basic weighted-average shares outstanding 1,017 1,041 1,067 Diluted Earnings per Share $ 7.94 $ 5.60 $ 3.65 Diluted weighted-average shares outstanding 1,022 1,047 1,072 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, (in millions) Net Income $ 8,118 $ 5,859 $ 3,915 Other comprehensive income (loss): Foreign currency translation adjustments ( 319 ) Income tax effect Foreign currency translation adjustments, net of income tax effect ( 279 ) Translation adjustments on net investment hedge ( 236 ) Income tax effect ( 8 ) ( 21 ) Translation adjustments on net investment hedge, net of income tax effect ( 153 ) Cash flow hedges Income tax effect ( 3 ) Cash flow hedges, net of income tax effect Defined benefit pension and other postretirement plans ( 22 ) ( 18 ) Income tax effect ( 1 ) Defined benefit pension and other postretirement plans, net of income tax effect ( 19 ) ( 15 ) Investment securities available-for-sale ( 3 ) ( 3 ) Income tax effect ( 1 ) Investment securities available-for-sale, net of income tax effect ( 2 ) ( 1 ) Other comprehensive income (loss), net of income tax effect ( 221 ) Comprehensive Income $ 8,163 $ 5,638 $ 4,342 The accompanying notes are an integral part of these consolidated financial statements. 60 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 6,988 $ 6,682 Restricted cash for litigation settlement Investments 1,696 Accounts receivable 2,514 2,276 Settlement due from customers 2,995 2,452 Restricted security deposits held for customers 1,370 1,080 Prepaid expenses and other current assets 1,763 1,432 Total current assets 16,902 16,171 Property, equipment and right-of-use assets, net 1,828 Deferred income taxes Goodwill 4,021 2,904 Other intangible assets, net 1,417 Other assets 4,525 3,303 Total Assets $ 29,236 $ 24,860 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ $ Settlement due to customers 2,714 2,189 Restricted security deposits held for customers 1,370 1,080 Accrued litigation 1,591 Accrued expenses 5,489 4,747 Current portion of long-term debt Other current liabilities Total current liabilities 11,904 11,593 Long-term debt 8,527 5,834 Deferred income taxes Other liabilities 2,729 1,877 Total Liabilities 23,245 19,371 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,391 and 1,387 shares issued and 996 and 1,019 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 11 and 12 issued and outstanding, respectively Additional paid-in-capital 4,787 4,580 Class A treasury stock, at cost, 395 and 368 shares, respectively ( 32,205 ) ( 25,750 ) Retained earnings 33,984 27,283 Accumulated other comprehensive income (loss) ( 673 ) ( 718 ) Mastercard Incorporated Stockholders' Equity 5,893 5,395 Non-controlling interests Total Equity 5,917 5,418 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 29,236 $ 24,860 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2016 $ $ $ 4,183 $ ( 17,021 ) $ 19,418 $ ( 924 ) $ 5,656 $ $ 5,684 Net income 3,915 3,915 3,915 Activity related to non-controlling interests Redeemable non-controlling interest adjustments ( 2 ) ( 2 ) ( 2 ) Other comprehensive income (loss) Dividends ( 967 ) ( 967 ) ( 967 ) Purchases of treasury stock ( 3,747 ) ( 3,747 ) ( 3,747 ) Share-based payments Balance at December 31, 2017 4,365 ( 20,764 ) 22,364 ( 497 ) 5,468 5,497 Adoption of revenue standard Adoption of intra-entity asset transfers standard ( 183 ) ( 183 ) ( 183 ) Net income 5,859 5,859 5,859 Activity related to non-controlling interests ( 6 ) ( 6 ) Redeemable non-controlling interest adjustments ( 3 ) ( 3 ) ( 3 ) Other comprehensive income (loss) ( 221 ) ( 221 ) ( 221 ) Dividends ( 1,120 ) ( 1,120 ) ( 1,120 ) Purchases of treasury stock ( 4,991 ) ( 4,991 ) ( 4,991 ) Share-based payments Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 5,418 62 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments Balance at December 31, 2019 $ $ $ 4,787 $ ( 32,205 ) $ 33,984 $ ( 673 ) $ 5,893 $ $ 5,917 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, (in millions) Operating Activities Net income $ 8,118 $ 5,859 $ 3,915 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,141 1,235 1,001 Depreciation and amortization (Gains) losses on equity investments, net ( 167 ) Share-based compensation Deferred income taxes ( 7 ) ( 244 ) Venezuela charge Other Changes in operating assets and liabilities: Accounts receivable ( 246 ) ( 317 ) ( 445 ) Income taxes receivable ( 202 ) ( 120 ) ( 8 ) Settlement due from customers ( 444 ) ( 1,078 ) ( 281 ) Prepaid expenses ( 1,661 ) ( 1,769 ) ( 1,402 ) Accrued litigation and legal settlements ( 662 ) ( 12 ) Restricted security deposits held for customers ( 6 ) Accounts payable ( 42 ) Settlement due to customers Accrued expenses Long-term taxes payable ( 20 ) Net change in other assets and liabilities ( 261 ) Net cash provided by operating activities 8,183 6,223 5,664 Investing Activities Purchases of investment securities available-for-sale ( 643 ) ( 1,300 ) ( 714 ) Purchases of investments held-to-maturity ( 215 ) ( 509 ) ( 1,145 ) Proceeds from sales of investment securities available-for-sale 1,098 Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property and equipment ( 422 ) ( 330 ) ( 300 ) Capitalized software ( 306 ) ( 174 ) ( 123 ) Purchases of equity investments ( 467 ) ( 91 ) ( 147 ) Acquisition of businesses, net of cash acquired ( 1,440 ) ( 1,175 ) Other investing activities ( 4 ) ( 14 ) ( 1 ) Net cash used in investing activities ( 1,640 ) ( 506 ) ( 1,781 ) Financing Activities Purchases of treasury stock ( 6,497 ) ( 4,933 ) ( 3,762 ) Dividends paid ( 1,345 ) ( 1,044 ) ( 942 ) Proceeds from debt 2,724 Payment of debt ( 500 ) ( 64 ) Contingent consideration paid ( 199 ) Tax withholdings related to share-based payments ( 161 ) ( 80 ) ( 47 ) Cash proceeds from exercise of stock options Other financing activities ( 15 ) ( 4 ) ( 6 ) Net cash used in financing activities ( 5,867 ) ( 4,966 ) ( 4,764 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents ( 44 ) ( 6 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents ( 681 ) Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 8,337 7,592 8,273 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 8,969 $ 8,337 $ 7,592 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1 . Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known brands, including Mastercard, Maestro and Cirrus. The Company is a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through its unique and proprietary global payments network, which is referred to as the core network, the Company switches (authorizes, clears and settles) payment transactions and delivers related products and services. Mastercard has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). The Company also provides integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs and processing. The Companys payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2019 and 2018 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date in which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2019 presentation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. In 2017, due to foreign exchange regulations restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar impacted the Companys ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the measurement alternative method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $ 167 million ( $ 108 million after tax or $ 0.10 per diluted share) that was recorded in general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2017. Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2019, 2018 and 2017 , net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is MASTERCARD 2019 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree, at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date will be recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated 66 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). MASTERCARD 2019 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The investments in debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. 68 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gain (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the equity method or measurement alternative method. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20 % and 50 % ownership in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gain (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. As the Company does not designate foreign exchange contracts as hedging instruments, realized and unrealized gains and losses from the change in fair value of the contracts are recognized immediately in current-period earnings. The Companys foreign exchange contracts are not entered into for trading or speculative purposes. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. For cash flow hedges, the fair value adjustments are recorded, net of tax, in other comprehensive income (loss). Any gains and losses deferred in other comprehensive income (loss) are then recognized in current-period earnings when earnings are affected by the variability of cash flows of the hedged forecasted transaction. The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. MASTERCARD 2019 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted- 70 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. Accounting pronouncements adopted Leases - In February 2016, the Financial Accounting Standards Board (the FASB) issued accounting guidance that changed how companies account for and present lease arrangements. This guidance requires companies to recognize lease assets and liabilities for both finance and operating leases on the consolidated balance sheet. The Company adopted this guidance effective January 1, 2019, under the modified retrospective transition method with the available practical expedients. The following table summarizes the impact of the changes made to the January 1, 2019 consolidated balance sheet for the adoption of the new accounting standard pertaining to leases. The prior periods have not been restated and have been reported under the accounting standard in effect for those periods. Balance at December 31, 2018 Impact of lease standard Balance at January 1, 2019 (in millions) Assets Property, equipment and right-of-use assets, net $ $ $ 1,296 Liabilities Other current liabilities 1,021 Other liabilities 1,877 2,180 For a more detailed discussion on lease arrangements, refer to Note 10 (Property, Equipment and Right-of-Use Assets) . Comprehensive income - In February 2018, the FASB issued accounting guidance that allows for a one-time reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from U.S. tax reform. The Company adopted this guidance effective January 1, 2019, electing to retain the stranded tax effects in accumulated other comprehensive income (loss). The adoption did not result in a material impact on the Companys consolidated financial statements. MASTERCARD 2019 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted this guidance effective January 1, 2018 under the modified retrospective transition method, applying the standard to contracts not completed as of January 1, 2018 and considered the aggregate amount of modifications. This revenue guidance impacts the timing of certain customer incentives recognized in the Companys consolidated statement of operations, as they are recognized over the life of the contract. Previously, such incentives were recognized when earned by the customer. This revenue guidance also impacts the Companys accounting recognition for certain market development fund contributions and expenditures. Historically, these items were recorded on a net basis in net revenue and will now be recognized on a gross basis, resulting in an increase to both revenues and expenses. The following tables summarize the impact of the revenue standard on the Companys consolidated statement of operations and consolidated balance sheet: Year Ended December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Net Revenue $ 14,471 $ $ 14,950 Operating Expenses Advertising and marketing Income before income taxes 6,889 7,204 Income tax expense 1,278 1,345 Net Income 5,611 5,859 December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Assets Accounts receivable $ 2,214 $ $ 2,276 Prepaid expenses and other current assets 1,176 1,432 Deferred income taxes ( 96 ) Other assets 2,388 3,303 Liabilities Accounts payable ( 422 ) Accrued expenses 4,375 4,747 Other current liabilities 1,085 ( 136 ) Other liabilities 1,145 1,877 Equity Retained earnings 26,692 27,283 For a more detailed discussion on revenue recognition, refer to Note 3 (Revenue) . Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies are required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. 72 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cumulative effect of the 2018 adopted accounting pronouncements The following table summarizes the cumulative impact of the changes made to the January 1, 2018 consolidated balance sheet for the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers. The prior periods have not been restated and have been reported under the accounting standards in effect for those periods. Balance at December 31, 2017 Impact of revenue standard Impact of intra-entity asset transfers standard Balance at January 1, 2018 (in millions) Assets Accounts receivable $ 1,969 $ $ $ 2,013 Prepaid expenses and other current assets 1,040 ( 17 ) 1,204 Deferred income taxes ( 69 ) Other assets 2,298 ( 352 ) 2,636 Liabilities Accounts payable ( 495 ) Accrued expenses 3,931 4,322 Other current liabilities ( 44 ) Other liabilities 1,438 2,066 Equity Retained earnings 22,364 ( 183 ) 22,547 Accounting pronouncements not yet adopted Implementation costs incurred in a hosting arrangement that is a service contract - In August 2018, the FASB issued accounting guidance which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for periods beginning after December 15, 2019. Companies are required to adopt this guidance either retrospectively or by prospectively applying the guidance to all implementation costs incurred after the date of adoption. The Company will adopt this guidance effective January 1, 2020 by applying the prospective approach as of the date of adoption and this guidance will not have a material impact on its consolidated financial statements. Disclosure requirements for fair value measurement - In August 2018, the FASB issued accounting guidance which modifies disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for periods beginning after December 15, 2019. Companies are required to adopt the guidance for certain added disclosures prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption and all other amendments retrospectively to all periods presented upon their effective date. The Company will adopt this guidance effective January 1, 2020 and the impact will not be material. Note 2 . Acquisitions In 2019 and 2017 , the Company acquired several businesses in separate transactions for total consideration of $ 1.5 billion in each year, representing both cash and contingent consideration. There were no acquisitions in 2018 . These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a portion of the goodwill is expected to be deductible for tax purposes. MASTERCARD 2019 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is evaluating and finalizing the purchase accounting for businesses acquired during 2019 . In 2018 , the Company finalized the purchase accounting for businesses acquired during 2017 . The preliminary estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for 2019 and 2017 , respectively. There were no acquisitions in 2018. (in millions) Assets: Cash and cash equivalents $ $ Other current assets Other intangible assets Goodwill 1,076 1,135 Other assets Total assets 1,716 1,935 Liabilities: Other current liabilities Deferred income taxes Other liabilities Total liabilities Net assets acquired $ 1,511 $ 1,571 The following table summarizes the identified intangible assets acquired for 2019 and 2017: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ $ 7.7 7.5 Customer relationships 12.6 9.9 Other 5.0 1.4 Other intangible assets $ $ 9.7 8.3 Pro forma information related to the acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. The businesses acquired in 2019 were not individually significant to Mastercard. For the businesses acquired in 2017, the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4 % controlling interest in Vocalink for cash consideration of 719 million ( $ 929 million ). In addition, the Vocalink sellers earned additional contingent consideration of 169 million ( $ 219 million ) upon meeting 2018 revenue targets in accordance with terms of the purchase agreement. Refer to Note 8 (Fair Value Measurements) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6 % ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $ 76 million as of December 31, 2019 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. 74 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pending Acquisition In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $ 3.19 billion as of December 31, 2019 ) after adjusting for cash and certain other liabilities at closing. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of Nets Denmark A/Ss Corporate Services business. While the Company anticipates completing the acquisition in the first half of 2020, the transaction is subject to regulatory approval and other customary closing conditions. Note 3 . Revenue Mastercards business model involves four participants in addition to the Company: account holders, issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. In addition, the Company recognizes revenue from other payment-related products and services in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile-initiated transactions; and safety and security. MASTERCARD 2019 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other revenues consist of value-added service offerings that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Data analytics and consulting fees. Cyber and intelligence fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31 : (in millions) Revenue by source: Domestic assessments $ 6,781 $ 6,138 Cross-border volume fees 5,606 4,954 Transaction processing 8,469 7,391 Other revenues 4,124 3,348 Gross revenue 24,980 21,831 Rebates and incentives (contra-revenue) ( 8,097 ) ( 6,881 ) Net revenue $ 16,883 $ 14,950 Net revenue by geographic region: North American Markets $ 5,843 $ 5,312 International Markets 10,869 9,514 Other 1 Net revenue $ 16,883 $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $ 2.3 billion and $ 2.1 billion as of December 31, 2019 and 2018 , respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are generally billed weekly, however the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2019 in the amounts of $ 48 million and $ 152 million , respectively. The comparable amounts included in prepaid expenses and other current assets and other assets at December 31, 2018 were $ 40 million and $ 92 million , respectively. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2019 in the amounts of $ 238 million and $ 106 million , respectively. The comparable amounts included in other current liabilities and other 76 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS liabilities at December 31, 2018 were $ 218 million and $ 101 million , respectively. In 2019 and 2018 , revenue recognized from the satisfaction of such performance obligations was $ 904 million in each year. The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years ). As a payment network service provider, the Company provides its customers with continuous access to its global payment processing network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates revenues from assessing its customers based on the GDV of activity on the products that carry the Companys brands. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues from other value-added services comprised of both batch and real-time account-based payment services, consulting fees, loyalty programs and other payment-related products and services. At December 31, 2019 , the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion , which is expected to be recognized through 2022. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4 . Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 8,118 $ 5,859 $ 3,915 Denominator Basic weighted-average shares outstanding 1,017 1,041 1,067 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,022 1,047 1,072 Earnings per Share Basic $ 7.98 $ 5.63 $ 3.67 Diluted $ 7.94 $ 5.60 $ 3.65 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5 . Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31 : (in millions) Cash and cash equivalents $ 6,988 $ 6,682 $ 5,933 $ 6,721 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement Restricted security deposits held for customers 1,370 1,080 1,085 Prepaid expenses and other current assets Other assets Cash, cash equivalents, restricted cash and restricted cash equivalents $ 8,969 $ 8,337 $ 7,592 $ 8,273 MASTERCARD 2019 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 . Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31 : (in millions) Cash paid for income taxes, net of refunds $ 1,644 $ 1,790 $ 1,893 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Accrued property, equipment and right-of-use assets Fair value of assets acquired, net of cash acquired 1,662 1,825 Fair value of liabilities assumed related to acquisitions Note 7 . Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31 : (in millions) Available-for-sale securities $ $ 1,432 Held-to-maturity securities Total investments $ $ 1,696 Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2019 December 31, 2018 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,044 ( 2 ) 1,043 Asset-backed securities Total $ $ $ $ $ 1,433 $ $ ( 2 ) $ 1,432 The Companys available-for-sale investment securities held at December 31, 2019 and 2018 , primarily carried a credit rating of A- or better with unrealized gains and losses recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. The municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. 78 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2019 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years Total $ $ Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits, and realized gains and losses on the Companys debt securities. The realized gains and losses from the sale of available-for-sale securities for 2019 , 2018 and 2017 were not significant. Held-to-Maturity Securities The Company classifies time deposits with maturities greater than three months but less than one year as held-to-maturity. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. The cost of these securities approximates fair value. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2018 Purchases (Sales), net 1 Changes in Fair Value 2 Balance at December 31, 2019 (in millions) Marketable securities $ $ $ $ Nonmarketable securities Total equity investments $ $ $ $ 1 Includes impact of balance sheet foreign currency translation 2 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations At December 31, 2019 , the total carrying value of Nonmarketable securities included $ 317 million of measurement alternative investments and $ 118 million of equity method investments. At December 31, 2018 , the total carrying value of Nonmarketable securities included $ 232 million of measurement alternative investments and $ 105 million of equity method investments. Note 8 . Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy within the Valuation Hierarchy. Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. There were no transfers made among the three levels in the Valuation Hierarchy for 2019 and 2018 . MASTERCARD 2019 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2019 December 31, 2018 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,043 1,043 Asset-backed securities Derivative instruments 2 : Foreign exchange contracts Interest rate contracts Marketable securities 3 : Equity securities Deferred compensation plan 4 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign exchange derivative liabilities $ $ ( 32 ) $ $ ( 32 ) $ $ ( 6 ) $ $ ( 6 ) Deferred compensation plan 5 : Deferred compensation liabilities ( 67 ) ( 67 ) ( 54 ) ( 54 ) 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . 80 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2019 , the carrying value and fair value of total long-term debt (including the current portion) was $ 8.5 billion and $ 9.2 billion , respectively. At December 31, 2018 , the carrying value and fair value of long-term debt (including the current portion) was $ 6.3 billion and $ 6.5 billion , respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Contingent Consideration The contingent consideration attributable to acquisitions made in 2017 was primarily based on the achievement of 2018 revenue targets and was measured at fair value on a recurring basis. This contingent consideration liability of $ 219 million was included in other current liabilities on the consolidated balance sheet at December 31, 2018 . This liability was classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices and unobservable inputs used to measure fair value that require managements judgment. During 2019, the Company paid $ 219 million to settle the contingent consideration . Note 9 . Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,763 $ 1,432 Other assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 2,838 $ 2,458 Equity investments Income taxes receivable Other Total other assets $ 4,525 $ 3,303 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. See Note 7 (Investments) for further information on the Companys equity investments. MASTERCARD 2019 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10 . Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31 : (in millions) Building, building equipment and land $ $ Equipment 1,218 Furniture and fixtures Leasehold improvements Operating lease right-of-use assets Property, equipment and right-of-use assets 2,928 1,768 Less accumulated depreciation and amortization ( 1,100 ) ( 847 ) Property, equipment and right-of-use assets, net $ 1,828 $ Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 336 million , $ 209 million and $ 185 million for 2019 , 2018 and 2017 , respectively. The increase in property, equipment and right-of-use assets at December 31, 2019 from December 31, 2018 was primarily due to the impact from the adoption of the new accounting standard pertaining to lease arrangements as of January 1, 2019 as well as leases that commenced in 2019 . See Note 1 (Summary of Significant Accounting Policies) for additional information of the accounting policy under the new leasing standard. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows: December 31, 2019 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ Other current liabilities Other liabilities Operating lease amortization expense for 2019 was $ 99 million . As of December 31, 2019 , weighted-average remaining lease term of operating leases was 9.5 years and weighted-average discount rate for operating leases was 2.9 % . The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2019 based on lease term: Operating Leases (in millions) $ 2021 2022 2023 2024 Thereafter Total operating lease payments Less: Interest ( 111 ) Present value of operating lease liabilities $ As of December 31, 2019 , the Company has entered into additional operating leases as a lessee, primarily for real estate. These leases have not yet commenced and will result in ROU assets and corresponding lease liabilities of approximately $ 23 million . These operating leases are expected to commence in fiscal year 2020, with lease terms between one and ten years. 82 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following disclosures relate to periods prior to adoption of the new lease accounting standard, including those operating leases entered into during 2018, but not yet commenced: At December 31, 2018, the Company had the following future minimum payments due under noncancelable leases: Operating Leases (in millions) $ 2020 2021 2022 2023 Thereafter Total $ Consolidated rental expense for the Companys leased office space was $ 94 million and $ 77 million for 2018 and 2017 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $ 20 million and $ 22 million for 2018 and 2017 , respectively. Note 11 . Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: (in millions) Beginning balance $ 2,904 $ 3,035 Additions 1,076 Foreign currency translation ( 133 ) Ending balance $ 4,021 $ 2,904 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2019 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2019 . Note 12 . Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31 : Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 1,884 $ ( 988 ) $ $ 1,514 $ ( 898 ) $ Customer relationships ( 264 ) ( 232 ) Other ( 44 ) ( 45 ) Total 2,549 ( 1,296 ) 1,253 1,999 ( 1,175 ) Indefinite-lived intangible assets Customer relationships Total $ 2,713 $ ( 1,296 ) $ 1,417 $ 2,166 $ ( 1,175 ) $ The increase in the gross carrying amount of amortized intangible assets in 2019 was primarily related to the businesses acquired in 2019. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2019 , it was determined that the Companys indefinite-lived intangible assets were not impaired. MASTERCARD 2019 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amortization on the assets above amounted to $ 285 million , $ 250 million and $ 252 million in 2019, 2018 and 2017 , respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2019 for the years ending December 31 : (in millions) $ 2021 2022 2023 2024 and thereafter $ 1,253 Note 13 . Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 3,892 $ 3,275 Personnel costs Income and other taxes Other Total accrued expenses $ 5,489 $ 4,747 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2019 and 2018 , the Companys provision for litigation was $ 914 million and $ 1,591 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14 . Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 127 million , $ 98 million and $ 84 million in 2019, 2018 and 2017 , respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 19 million as of December 31, 2019 ) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). 84 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Service cost Interest cost Actuarial (gain) loss ( 7 ) ( 2 ) Benefits paid ( 15 ) ( 22 ) ( 5 ) ( 5 ) Transfers in Foreign currency translation ( 23 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Actual (loss) gain on plan assets ( 8 ) Employer contributions Benefits paid ( 15 ) ( 23 ) ( 5 ) ( 5 ) Transfers in Foreign currency translation ( 21 ) Fair value of plan assets at end of year Funded status at end of year $ ( 13 ) $ ( 28 ) $ ( 64 ) $ ( 57 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term ( 3 ) ( 3 ) Other liabilities, long-term ( 13 ) ( 28 ) ( 61 ) ( 54 ) $ ( 13 ) $ ( 28 ) $ ( 64 ) $ ( 57 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ $ ( 5 ) $ $ ( 7 ) Prior service credit ( 5 ) ( 6 ) Balance at end of year $ $ ( 4 ) $ ( 3 ) $ ( 13 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.70 % 1.80 % * * Vocalink Plan 2.00 % 3.10 % * * Postretirement Plan * * 3.25 % 4.25 % Rate of compensation increase Non-U.S. Plans 1.50 % 2.60 % * * Vocalink Plan 2.50 % 4.00 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD 2019 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2019 and 2018 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets For the year ended December 31, 2019 , the Companys projected benefit obligation related to its Pension Plans increased $ 93 million primarily attributable to actuarial losses related to lower discount rate assumptions. For the year ended December 31, 2018 , the Companys projected benefit obligation related to its Pension Plans decreased $ 30 million primarily attributable to foreign currency translation and benefits paid. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets ( 18 ) ( 20 ) ( 13 ) Amortization of actuarial loss Amortization of prior service credit ( 1 ) ( 2 ) ( 2 ) Net periodic benefit cost $ $ $ $ $ $ The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Current year actuarial loss (gain) $ $ $ ( 22 ) $ $ ( 2 ) $ Current year prior service credit Amortization of prior service credit Total other comprehensive loss (income) $ $ $ ( 22 ) $ $ $ Total net periodic benefit cost and other comprehensive loss (income) $ $ $ ( 18 ) $ $ $ 86 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.80 % 1.80 % 1.60 % * * * Vocalink Plan 2.00 % 2.80 % 2.50 % * * * Postretirement Plan * * * 4.25 % 3.50 % 4.00 % Expected return on plan assets Non-U.S. Plans 2.10 % 3.00 % 3.25 % * * * Vocalink Plan 3.75 % 4.75 % 4.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 2.60 % 2.59 % * * * Vocalink Plan 2.50 % 3.85 % 3.95 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: Health care cost trend rate assumed for next year 6.00 % 6.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed within the following target asset allocations: fixed income 36 % , U.K. government securities 25 % , equity 25 % , real estate 9 % and cash and cash equivalents 5 % . For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. MASTERCARD 2019 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2019 December 31, 2018 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ $ $ $ $ $ $ $ Government and agency securities 2 Mutual funds 3 Insurance contracts 4 Asset-backed securities 5 Other 6 Total $ $ $ $ $ $ $ $ Investments at Net Asset Value (NAV) 7 Mutual funds Other Total Plan Assets $ $ 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Governmental and agency securities are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 3 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 4 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 5 Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. These assets were sold during 2019. 6 Other represents hedge fund pooled vehicles which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 7 Mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) are valued using the NAV provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2019 ) through 2029 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2021 2022 2023 2024 2025 - 2029 88 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 . Debt Long-term debt consisted of the following at December 31 : Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2019 USD Notes May 2019 Semi-annually $ 1,000 2.950 % 3.030 % $ 1,000 $ 1,000 3.650 % 3.689 % 1,000 December 2019 Semi-annually 2.000 % 2.147 % $ $ 2,750 2018 USD Notes February 2018 Semi-annually $ 3.500 % 3.598 % 3.950 % 3.990 % $ 1,000 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 8,600 6,389 Less: Unamortized discount and debt issuance costs ( 73 ) ( 55 ) Total debt outstanding $ 8,527 $ 6,334 Less: Current portion 1 ( 500 ) Long-term debt $ 8,527 $ 5,834 1 Relates to the 2014 USD Notes, which was classified in current liabilities as of December 31, 2018 , matured and was paid during 2019 In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049 and in December 2019, the Company issued $ 750 million principal amount of notes due March 2025 (collectively the 2019 USD Notes). The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion . The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2018 USD Notes were $ 991 million . MASTERCARD 2019 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2019 are summarized below. (in millions) $ 2022 2023 1,000 Thereafter 6,165 Total $ 8,600 On November 14, 2019, the Company increased its commercial paper program (the Commercial Paper Program) from $ 4.5 billion to $ 6 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility) on November 14, 2019. The Credit Facility, which expires on November 14, 2024, amended and restated the Companys prior $ 4.5 billion credit facility which was set to expire on November 15, 2023. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2019 and 2018 . Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2019 and 2018 . Note 16 . Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 No shares issued or outstanding at December 31, 2019 and 2018. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. 90 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2019 , 2018 and 2017 . For the years ended December 31, 2019, 2018 and 2017 , the Company declared total per share dividends of $ 1.39 , $ 1.08 , and $ 0.91 , respectively, resulting in total annual dividends of $ 1,408 million , $ 1,120 million and $ 967 million , respectively. Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 87.8 % 88.8 % 88.0 % 89.0 % Principal or Affiliate Customers (Class B stockholders) 1.1 % % 1.1 % % Mastercard Foundation (Class A stockholders) 11.1 % 11.2 % 10.9 % 11.0 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5 % of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. MASTERCARD 2019 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2019 , as well as historical purchases: Board authorization dates December 2019 December 2018 December 2017 December 2016 December Date program became effective January 2020 January 2019 March 2018 April 2017 February 2016 Total (in millions, except average price data) Board authorization $ 8,000 $ 6,500 $ 4,000 $ 4,000 $ 4,000 $ 26,500 Dollar-value of shares repurchased in 2017 $ $ $ $ 2,766 $ $ 3,762 Remaining authorization at December 31, 2017 $ $ $ 4,000 $ 1,234 $ $ 5,234 Dollar-value of shares repurchased in 2018 $ $ $ 3,699 $ 1,234 $ $ 4,933 Remaining authorization at December 31, 2018 $ $ 6,500 $ $ $ $ 6,801 Dollar-value of shares repurchased in 2019 $ $ 6,196 $ $ $ $ 6,497 Remaining authorization at December 31, 2019 $ 8,000 $ $ $ $ $ 8,304 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ $ $ 131.97 $ 109.16 $ 125.05 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ $ 194.77 $ 171.11 $ $ 188.26 Shares repurchased in 2019 24.8 1.6 26.4 Average price paid per share in 2019 $ $ 249.58 $ 188.38 $ $ $ 245.89 Cumulative shares repurchased through December 31, 2019 24.8 20.6 28.2 40.4 114.0 Cumulative average price paid per share $ $ 249.58 $ 194.27 $ 141.99 $ 99.10 $ 159.68 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock ( 30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 ( 5.2 ) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock ( 26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 ( 2.3 ) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 92 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 . Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2019 and 2018 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge 2 Cash Flow Hedges 3 Defined Benefit Pension and Other Postretirement Plans 4 Investment Securities Available-for-Sale 5 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2017 $ ( 382 ) $ ( 141 ) $ $ $ $ ( 497 ) Other comprehensive income (loss) ( 279 ) ( 15 ) ( 2 ) ( 221 ) Balance at December 31, 2018 ( 661 ) ( 66 ) ( 1 ) ( 718 ) Other comprehensive income (loss) ( 19 ) Balance at December 31, 2019 $ ( 638 ) $ ( 38 ) $ $ ( 9 ) $ $ ( 673 ) 1 During 2018, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the depreciation of the euro, British pound and Brazilian real. During 2019, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the British pound partially offset by the depreciation of the euro. 2 The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. Changes in the value of the debt are recorded in accumulated other comprehensive income (loss). During 2018 and 2019, the decreases in the accumulated other comprehensive loss related to the net investment hedge were driven by the depreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. During 2019, in connection with these cash flow hedges, the Company recorded unrealized gains, net of tax, of $ 11 million in accumulated other comprehensive income (loss). See Note 23 (Derivative and Hedging Instruments) for additional information. 4 During 2018, the decrease in the accumulated other comprehensive gain related to the Companys Plans was driven primarily by an actuarial loss within the Vocalink Plan. During 2019, the decrease in the accumulated other comprehensive gain related to the Companys Plans was primarily driven by actuarial losses within the Vocalink and non-U.S. Plans. During 2018 and 2019, amounts reclassified from accumulated other comprehensive income (loss) to earnings, were not material. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. 5 During 2018 and 2019, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not material. See Note 7 (Investments) for additional information. Note 18 . Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. MASTERCARD 2019 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock Options Stock Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. However, in the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense continues to be recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31 : Risk-free rate of return 2.6 % 2.7 % 2.0 % Expected term (in years) 6.00 6.00 5.00 Expected volatility 19.6 % 19.7 % 19.3 % Expected dividend yield 0.6 % 0.6 % 0.8 % Weighted-average fair value per Option granted $ 53.09 $ 40.90 $ 21.23 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2019 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2019 7.6 $ Granted 0.9 $ Exercised ( 1.8 ) $ Forfeited/expired ( 0.1 ) $ Outstanding at December 31, 2019 6.6 $ 6.2 $ 1,206 Exercisable at December 31, 2019 3.9 $ 5.1 $ Options vested and expected to vest at December 31, 2019 6.6 $ 6.2 $ 1,200 As of December 31, 2019 , there was $ 34 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.3 years . Restricted and Performance Stock Units RSUs and PSUs generally vest after three years . For all RSUs and PSUs granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all RSUs and PSUs granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). 94 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys RSU activity for the year ended December 31, 2019 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2019 3.7 $ Granted 1.0 $ Converted ( 1.6 ) $ Forfeited ( 0.2 ) $ Outstanding at December 31, 2019 2.9 $ $ RSUs expected to vest at December 31, 2019 2.8 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2019 , there was $ 180 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . The following table summarizes the Companys PSU activity for the year ended December 31, 2019 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2019 0.6 $ Granted 0.1 $ Converted ( 0.4 ) $ Other 1 0.2 $ Outstanding at December 31, 2019 0.5 $ $ PSUs expected to vest at December 31, 2019 0.5 $ $ 1 Represents additional shares issued in March 2019 related to the 2016 PSU grant based on performance and market conditions achieved over the three-year measurement period. These shares vested upon issuance. Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2019 , there was $ 13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . MASTERCARD 2019 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Additional Information The following table includes additional share-based payment information for each of the years ended December 31 : (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock Note 19 . Commitments At December 31, 2019 , the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements. The Company has accrued $ 20 million of these future payments as of December 31, 2019 . (in millions) $ 2021 2022 2023 2024 Thereafter Total $ Note 20 . Income Taxes Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 4,213 $ 3,510 $ 3,482 Foreign 5,518 3,694 3,040 Income before income taxes $ 9,731 $ 7,204 $ 6,522 96 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ $ $ 1,704 State and local Foreign 1,620 1,589 2,521 Deferred Federal ( 228 ) State and local ( 11 ) Foreign ( 47 ) ( 5 ) ( 49 ) ( 7 ) ( 244 ) Income tax expense $ 1,613 $ 1,345 $ 2,607 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 9,731 $ 7,204 $ 6,522 Federal statutory tax 2,044 21.0 % 1,513 21.0 % 2,283 35.0 % State tax effect, net of federal benefit 0.7 % 0.6 % 0.7 % Foreign tax effect ( 208 ) ( 2.1 )% ( 92 ) ( 1.3 )% ( 380 ) ( 5.8 )% European Commission fine % 2.7 % % Foreign tax credits 1 ( 32 ) ( 0.3 )% ( 110 ) ( 1.5 )% ( 27 ) ( 0.4 )% Transition Tax ( 30 ) ( 0.3 )% 0.3 % 9.6 % Remeasurement of deferred taxes % ( 7 ) ( 0.1 )% 2.4 % Windfall benefit ( 129 ) ( 1.3 )% ( 72 ) ( 1.0 )% ( 43 ) ( 0.7 )% Other, net ( 97 ) ( 1.1 )% ( 149 ) ( 2.0 )% ( 55 ) ( 0.8 )% Income tax expense $ 1,613 16.6 % $ 1,345 18.7 % $ 2,607 40.0 % 1 Included within the impact of the foreign tax credits is $ 27 million for 2019 and $ 90 million for 2018 of tax benefits relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2019, 2018 and 2017 were 16.6 % , 18.7 % and 40.0 % , respectively. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 , primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019 . These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $ 873 million in 2017 attributable to U.S. tax reform (which included provisional amounts of $ 825 million related to the one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax), the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $ 48 million due to a foregone foreign tax credit benefit on 2017 repatriations). Additionally, the lower effective income tax rate in 2018 was due to a lower 2018 statutory tax rate in the U.S. and Belgium, a more favorable geographic mix of earnings and discrete tax benefits, relating primarily to $ 90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service, along with provisions for legal matters in the United States. These benefits were partially offset by the MASTERCARD 2019 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS nondeductible nature of the fine issued by the European Commission. See Note 21 (Legal and Regulatory Proceedings) for further discussion of the European Commission fine and U.S. merchant class litigation. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2019, 2018 and 2017 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 300 million , or $ 0.29 per diluted share, $ 212 million , or $ 0.20 per diluted share, and $ 104 million , or $ 0.10 per diluted share, respectively. Indefinite Reinvestment During 2019 and 2018 , the Company repatriated approximately $ 2.5 billion and $ 3.3 billion , respectively. As of December 31, 2019 and 2018 the Company had approximately $ 3.5 billion and $ 2.5 billion , respectively, of accumulated earnings to be repatriated in the future, for which immaterial deferred tax benefits were recorded. The tax effect is primarily related to the estimated foreign exchange impact recognized when earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Earnings of approximately $ 0.8 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax benefit would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses U.S. foreign tax credits 1 Intangible assets Other items Less: Valuation allowance ( 205 ) ( 94 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Goodwill and intangible assets Property, plant and equipment Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ 1 A deferred tax asset has been established in 2019 for $ 145 million related to foreign taxes paid in the current period, which are not expected to be utilized as credits in the current or future period, with a corresponding full valuation allowance. The valuation allowance balance at December 31, 2019 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current period and certain foreign net operating losses. The valuation allowance balance at December 31, 2018 relates primarily to the Companys ability to recognize tax benefits associated 98 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS with certain foreign net operating losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions ( 11 ) ( 17 ) ( 1 ) Settlements with tax authorities ( 2 ) ( 18 ) ( 4 ) Expired statute of limitations ( 7 ) ( 12 ) ( 11 ) Ending balance $ $ $ The unrecognized tax benefit of $ 203 million , if recognized, would reduce the effective income tax rate. In 2019, there was an increase to the Companys unrecognized tax benefits primarily due to various U.S. and non-U.S. tax issues, compared to a reduction in the prior year primarily due to a favorable court decision and settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2019 and 2018 , the Company had a net income tax-related interest payable of $ 13 million and $ 8 million , respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2019 , 2018 and 2017 was not material. In addition, as of December 31, 2019 and 2018 , the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. MASTERCARD 2019 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 . Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court 100 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $ 237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. As of December 31, 2019 and 2018 , Mastercard had accrued a liability of $ 914 million as a reserve for both the Damages Class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2019 and 2018 , Mastercard had $ 584 million and $ 553 million , respectively, in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. During the first quarter of 2019, Mastercard increased its qualified cash settlement fund by $ 108 million in accordance with a January 2019 preliminary approval of the settlement. The Damages Class settlement agreement provided for a return to the defendants of a portion of the cash settlement fund, based upon the percentage of interchange volume represented by the opt out merchants. During the fourth quarter of 2019, $ 84 million of the qualified cash settlement fund was reclassified from restricted cash to cash and cash equivalents in accordance with the December 2019 final approval of the settlement. The reserve as of December 31, 2019 for both the Damages Class litigation and the filed opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $ 5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. Certain appellate courts have rejected the objectors appeals, while outstanding appeals remain in a few provinces. In 2017, Mastercard recorded a provision for litigation of $ 15 million related to this matter. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The EC issued a decision accepting the settlement in April 2019, with changes to interregional interchange fees going into effect in the fourth quarter of 2019. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but included a fine of 571 million , which was paid in April 2019. Mastercard incurred a charge of $ 654 million in 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic MASTERCARD 2019 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $ 4 billion as of December 31, 2019 ). Mastercard has resolved over 2 billion (approximately $ 3 billion as of December 31, 2019 ) of these damages claims through settlement or judgment. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $ 237 million in 2018. As detailed below, Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court ruled against both Mastercard and Visa on two of the three legal issues being considered, concluding that U.K. interchange rates restricted competition and that they were not objectively necessary for the payment networks. The appellate court sent the cases back to trial for reconsideration on the remaining issue concerning the lawful level of interchange. The U.K. Supreme Court granted the parties permission to appeal the appellate courts rulings and oral argument on the appeals was heard in January 2020. Mastercard expects the litigation process to be delayed pending the decision of the U.K. Supreme Court on the appeals. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 17 billion as of December 31, 2019 ). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. Mastercard has been granted permission to appeal the appellate court ruling to the U.K. Supreme Court and oral argument on that appeal is scheduled to occur in May 2020. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims and to oppose class certification. Mastercard expects briefing on class certification to be completed in the second quarter of 2020. 102 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. The plaintiffs have filed a renewed motion for class certification, following the district courts denial of their initial motion. Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the court granted Mastercards motion to stay the proceedings until the Federal Communications Commission (FCC) makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. Note 22 . Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months ended December 31, 2019 multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, such as cash, letters of credit, or guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31 : (in millions) Gross settlement exposure $ 55,800 $ 49,666 Collateral held for settlement exposure ( 4,772 ) ( 4,711 ) Net uncollateralized settlement exposure $ 51,028 $ 44,955 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 367 million and $ 377 million at December 31, 2019 and 2018 , respectively, of which $ 290 million and $ 297 million at December 31, 2019 and 2018 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. MASTERCARD 2019 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23 . Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances (Cash Flow Hedges). Foreign Exchange Risk Derivatives The Company enters into foreign exchange derivative contracts to manage transactional currency exposure associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currency of the entity. The Company may also enter into foreign exchange derivative contracts to offset possible changes in value due to foreign exchange fluctuations of assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. The Companys foreign exchange derivative contracts are summarized below: December 31, 2019 December 31, 2018 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ ( 1 ) Commitments to sell foreign currency 1,506 ( 25 ) 1,066 Options to sell foreign currency Balance sheet location Prepaid expenses and other current assets 1 $ $ Other current liabilities 1 ( 32 ) ( 6 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign exchange derivative contracts General and administrative $ ( 39 ) $ $ ( 75 ) The fair value of the foreign exchange derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign exchange derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2019 and 2018 , as these contracts were not designated as hedging instruments for accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. 104 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European operations. As of December 31, 2019 , the Company had a net foreign currency transaction pre-tax loss of $ 84 million in accumulated other comprehensive income (loss) associated with hedging activity. Interest Rate Risk Cash Flow Hedges The Company is exposed to interest rate volatility on future debt issuances. To manage this risk, in the fourth quarter of 2019, the Company entered into treasury rate locks to lock the benchmark rate on a portion of the interest payments related to forecasted debt issuances. These locks are linked to future interest payments on anticipated U.S. dollar debt issuances forecasted to occur during 2020 and are accounted for as cash flow hedges. The maximum length of time over which the Company has hedged its exposure to the variability in future cash flows is 30 years. As of December 31, 2019 , the total notional amount of interest rate contracts outstanding was $ 1 billion . The Company did not have any derivative instruments relating to this program outstanding as of December 31, 2018. As of December 31, 2019 , in connection with these cash flow hedges, the Company recorded pre-tax net unrealized gains of $ 14 million in accumulated other comprehensive income. As of December 31, 2019 , the fair value of these contracts was $ 14 million and is included in prepaid expenses and other current assets on the consolidated balance sheet. Note 24 . Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 32 % of total revenue in 2019 , 33 % in 2018 and 35 % in 2017 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2019 , 2018 or 2017 . The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31 : (in millions) United States $ 1,147 $ $ Other countries Total $ 1,828 $ $ MASTERCARD 2019 FORM 10-K 105 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Note 25 . Summary of Quarterly Data (Unaudited) 2019 Quarter Ended March 31 June 30 September 30 December 31 2019 Total (in millions, except per share data) Net revenue $ 3,889 $ 4,113 $ 4,467 $ 4,414 $ 16,883 Operating income 2,213 2,397 2,655 2,399 9,664 Net income 1,862 2,048 2,108 2,100 8,118 Basic earnings per share $ 1.81 $ 2.01 $ 2.08 $ 2.08 $ 7.98 Basic weighted-average shares outstanding 1,026 1,020 1,013 1,008 1,017 Diluted earnings per share $ 1.80 $ 2.00 $ 2.07 $ 2.07 $ 7.94 Diluted weighted-average shares outstanding 1,032 1,025 1,019 1,013 1,022 2018 Quarter Ended March 31 June 30 September 30 December 31 2018 Total (in millions, except per share data) Net revenue $ 3,580 $ 3,665 $ 3,898 $ 3,807 $ 14,950 Operating income 1,825 1,936 2,287 1,234 7,282 Net income 1,492 1,569 1,899 5,859 Basic earnings per share $ 1.42 $ 1.50 $ 1.83 $ 0.87 $ 5.63 Basic weighted-average shares outstanding 1,051 1,043 1,037 1,032 1,041 Diluted earnings per share $ 1.41 $ 1.50 $ 1.82 $ 0.87 $ 5.60 Diluted weighted-average shares outstanding 1,057 1,049 1,043 1,038 1,047 Note: Tables may not sum due to rounding. 106 MASTERCARD 2019 FORM 10-K PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +47,Mastercard,2018," ITEM 1. BUSINESS Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network. Through our core global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. With additional payment capabilities that include real-time account-based payments (including automated clearing house (ACH) transactions), we offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. We also provide value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. Our payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction switching and from other payment-related products and services. Our Performance The following are our key financial and operational results for 2018: 1 Non-GAAP results excludes the impact of Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. 2 Adjusted to normalize for the effects of differing switching days between periods. 3 Adjusted for the deconsolidation of our Venezuelan subsidiaries in 2017. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results- Revenue in Part II, Item 7. Our Strategy We grow, diversify and build our business through a combination of organic growth and strategic investments. Our ability to grow our business is influenced by personal consumption expenditure (PCE) growth, driving cash and check transactions toward electronic forms of payment, increasing our share in electronic payments and providing value-added products and services. In addition, growing our business includes supplementing our core network with enhanced payment capabilities to capture new payment flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government payments, through a combination of product offerings and expanded solutions for our customers. Grow . We focus on growing our core business globally, including growing our consumer credit, debit, prepaid and commercial products and solutions, as well as increasing the number of payment transactions we switch. We also look to take advantage of the opportunities presented by the evolving ways people interact and transact in the growing digital economy. This includes expanding merchant access to electronic payments through new technologies in an effort to deliver a better consumer experience, while creating greater efficiencies and security. Diversify . We diversify our business by: working with new customers, including governments, merchants, financial technology companies, digital players, mobile providers and other corporate businesses scaling our capabilities and business into new geographies, including growing acceptance in markets with limited electronic payments acceptance today broadening financial inclusion for the unbanked and underbanked Build . We build our business by: creating and acquiring differentiated products to provide unique, innovative solutions that we bring to market to support new payment flows, such as real-time account-based payment, Mastercard B2B Hub and Mastercard Send platforms providing services across data analytics, consulting, managed services, safety and security, loyalty and processing Strategic Partners . We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for Mastercard-branded products. We help merchants, financial institutions and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer experiences. We partner with technology companies such as digital players and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments drive increased financial inclusion and efficiency, reduce costs, increase transparency to reduce crime and corruption and advance social programs. For consumers, we provide faster, safer and more convenient ways to pay and transfer funds. Talent and Culture. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries by building a world-class culture based on decency, respect and inclusion in which people have opportunities to do purpose-driven work that impacts customers, communities and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Recent Business and Legal/Regulatory Developments Digital Payments . Technology is increasingly changing the way people get information, interact with each other, shop and make purchases. As a result of these changes, digital commerce is growing significantly. In this digital environment, consumers continue to seek a seamless experience where their payment is simple, secure and familiar. These consumer demands are driving us to think and act differently. Our teams are innovating to create solutions that meet the needs of our consumers and merchants, and applying emerging technologies to maximize our opportunities from those needs. In 2018, we: supported the development and implementation of EMVCos global standards for a simple and unified digital experience for consumers, issuers and merchants in the form of a common checkout button. This button is designed to provide consumers the same convenience and security in a digital environment that they have when shopping and paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. announced plans to enable token services on all cards, removing the primary account number from the transaction flow. Enabling these services will help make the payment process simpler, more seamless and more secure, while supporting our merchant partners in their card on file activities. reinforced our support for contactless payments across all markets, including in Europe, where we are working with issuers, acquirers and merchants to ensure availability and support of contactless payments across the continent by 2020. New payment flows. In order to help grow our business and offer more electronic payment options to consumers, businesses and governments, Mastercard has developed and enhanced solutions beyond the principal switching capabilities available on our core network. We believe this will allow us to capture more payment flows, including B2B, P2P, B2C and government disbursements. In 2018, we: advanced business development efforts around the world with our real-time account-based payments capabilities that we acquired with Vocalink in 2017. These efforts include the launch of a real-time payment service in the U.S. in conjunction with The Clearing House that enables consumers and businesses to send and receive immediate payments. combined our proprietary Mastercard Send assets with Vocalink strategic partnerships to enable financial institutions, financial technology companies (or fintechs), digital customers and other businesses to send real-time payments to U.K. bank accounts. Mastercard Send will connect to Faster Payments, enabling a variety of use cases such as P2P payments and B2C disbursements. This effort is part of our continued expansion of Mastercard Sends capabilities, connecting more people, businesses and governments to facilitate the transfer of funds quickly and securely both domestically and cross-border. expanded the reach of Vocalinks Pay by Bank application in the United Kingdom, enabling real-time payments directly from a consumers bank account using a mobile banking app, with real-time clearing and without the need for a card. continued to invest in and test proprietary permission-based Blockchain, with an initial focus on the cross-border B2B payments space. Safety and Security. As new technologies and cyber-security threats evolve, including organized cyber-crime and nation state attacks, there is a growing need to protect the security and resilience of the payments ecosystem for every stakeholder. It is critical to protect all transactional and personal data that is stored, processed or transmitted regardless of the device or channel used to make a purchase, while at the same time continuing to improve the payment experience for all stakeholders. We focus on security across networks, and it is embedded in our policies, products, systems and analytics to prevent fraud. In 2018, we: implemented EMVCos 3D Secure 2.0 specification as part of a new solution (launched with issuer and merchant partners globally) that supports app-based authentication, integration with digital wallets and browser-based e-commerce. This is complemented by biometrics, machine learning and artificial intelligence solutions, alongside incremental transaction data, to help merchants seamlessly verify a consumers identity. At the same time, the solution reduces friction during the checkout process, as well as reduces fraud while increasing payment approvals. continued to extend our investments in Artificial Intelligence (AI) by: introducing AI Express, a new accelerated technology implementation service to help issuers, acquirers and merchants develop AI models to solve priority problems, including anti-money laundering, fraud, risk management and cybersecurity. scaling Decision Intelligence, our fraud scoring technology, to score billions of transactions in real time every day while increasing approvals and reducing false declines. piloted biometric cards in multiple markets, placing fingerprint readers directly onto a card to authenticate a cardholders identity (as an alternative to a PIN or signature) using existing chip and contactless acceptance terminals. modified our rules so that signatures will no longer be required on either cards or receipts and merchants no longer need to capture or compare a signature at the point of sale, helping to provide a faster checkout and more advanced authentication methods. Inclusive Growth. We are dedicated to increasing the opportunity for individuals and micro and small merchants to achieve financial security and greater prosperity, with the benefits of economic growth shared among all segments of society. Together with our partners, we are more than two-thirds of the way toward an important initial step towards that goal by providing access to 500 million people previously excluded from financial services by 2020. We also help communities build the ecosystems that support usage. In 2018, we worked with governments and private sector partners across several geographies to develop and roll out electronic payments solutions, social payment distribution mechanisms and digital identity solutions. We organized a global network of cities to help city leaders address the challenges of urbanization and co-develop solutions to improve life for residents and visitors and promote economic growth. We also deployed our services, partnerships and technologies to develop platforms that help small business owners accept electronic payments, manage their records, access market information, build a financial footprint and use digital communications channels to receive training and business advice. In 2018, we made an initial $100 million contribution to the Mastercard Impact Fund (formerly referred to as Mastercards Center for Inclusive Growth Fund), a non-profit charitable organization. This contribution is part of a $500 million commitment to support initiatives that focus on inclusive growth, such as financial inclusion, economic development, the future of work and data science for social impact. Legal and Regulatory . We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny, expansion of local regulatory schemes and other legal challenges, particularly with respect to interchange fees (as discussed below under Our Operations and Network). These challenges create both risks and opportunities for our industry. Our recent legal and regulatory developments include: Payments Regulation In December 2018, we announced the anticipated resolution of an investigation by the European Commission (EC) related to the interregional interchange rates we set and our central acquiring rule within the European Economic Area (the EEA). With respect to interregional interchange fees, the proposed settlement included changes to those fees that, if accepted by the EC following market testing, would avoid prolonged litigation and gain certainty concerning our business practices. With respect to our historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification in 2015. The decision does not require any modification of our current business practices but includes a fine of 571 million . We recorded a charge of $654 million in the fourth quarter of 2018 in relation to this matter. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Several jurisdictions have implemented payments regulation or initiated payments reviews in 2018. In the U.K., the Payment Systems Regulator (the PSR) published draft terms of reference for a formal review of card-acquiring services provided by Mastercard, Visa and other card scheme operators that could lead to future regulation. The European Commission expects to issue proposals in 2020 to revise the E.U. Interchange Fee Regulation. In Australia, the Productivity Commission released a report recommending, among other things, that regulators ban interchange fees by the end of 2019 and consider regulating merchant service fees. In Brazil, the Central Bank implemented a weighted average and cap for domestic debit interchange. Jurisdictions around the globe continue to implement or consider open banking initiatives. Initiatives such as the EEAs revised Payment Services Directive (commonly referred to as PSD2) which went into effect in 2018, require financial institutions to provide third-party payment processors access to consumer payment accounts, as well as requiring additional verification information from consumers to complete transactions. Other jurisdictions considering open banking initiatives include Australia, Canada, Hong Kong, Japan, Singapore and the United States. The U.K. Treasury has extended the U.K. payment systems oversight to include our Vocalink business due to its role as a payment service provider. Privacy and Data Protection In 2018, the European Union General Data Protection Regulation (the GDPR) became effective. The GDPR is a data protection regulation that has increased our compliance burden for collecting, using and processing personal and sensitive data of EEA residents. We have reviewed our products, services and processes involving EEA personal data to ensure privacy and data protection requirements are embedded into their design. We have also launched online data portals to allow EEA residents to request a copy of their personal data, and to ask for their data to be updated, corrected or deleted as appropriate. In addition, we have taken steps to assist our customers with their compliance efforts. As part of our implementation approach, we co-founded with IBM a data trust called Truata to provide anonymization and analytics services in a GDPR-compliant manner. Some jurisdictions are currently considering adopting data localization requirements, which mandate the collection, processing, and/or storage of data within their borders, including India, Kenya and Vietnam. Litigation - In September 2018, we entered into an amended class settlement agreement with the merchant damages class plaintiffs to settle their monetary damages claims in a U.S. antitrust litigation that was brought against Mastercard, Visa and a number of financial institutions. Visa and the financial institutions are also parties to the agreement, which is subject to court approval. In addition to the monetary amounts that constituted the financial settlement under the original agreement, the agreement requires an additional payment from the defendants. We took a charge during 2018 to reflect our share of this payment. Under the agreement, Mastercard and its customer financial institutions will receive a release of all damages claims that were alleged, or could have been alleged by the merchant class members concerning our interchange and fee structure and merchant acceptance rules. This release covers all retrospective claims, as well as prospective claims for a period of five years after the resolution of all appeals relating to court approval of the agreement. In January 2019, the district court issued an order granting preliminary approval of the settlement. The agreement does not relate to the merchants' claims seeking changes to business practices. Separate settlement negotiations for those claims are ongoing. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Our Business Our Operations and Network We operate a unique and proprietary global payments network, our core network, that links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We authorize, clear and settle transactions through our core network for our issuer customers in more than 150 currencies and in more than 210 countries and territories. Vocalink expands our range of payment capabilities beyond our core network into real-time account-based payments. Typical Transaction . Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs consumers and merchants incur. We do not earn revenues from interchange fees. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for their customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate, and issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the determination and exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the acquirer country and issuer country are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the acquirer country and the issuer country are the same (domestic transactions). We switch more than half of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Outside of these countries, most domestic transactions on our products are switched without our involvement. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture with an intelligent edge that enables the network to adapt to the needs of each transaction. Our core network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring or rewards at the point of sale) to appropriate transactions in real time. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Systems. Augmenting our core network, we now offer real-time account-based payment capabilities through our acquisition of Vocalink, which enables payments between bank accounts in near real-time in countries in which it has been deployed. Payments System Security. Our payment solutions and products are designed to ensure safety and security for the global payments system. The core network and additional platforms incorporate multiple layers of protection, both for continuity purposes and to provide best-in-class security protection. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, a business continuity program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our networks support and enable our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. Customer Risk. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers, or the availability of unspent prepaid account holder account balances. Our Products and Services We provide a wide variety of integrated products and services that support payment products that customers can offer to their account holders. These offerings facilitate transactions on our core network among account holders, merchants, financial institutions, businesses, governments and other organizations in markets globally. Core Products Consumer Credit. We offer a number of programs that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid programs involve a balance that is funded prior to use and can be accessed via one of our payment products. We offer prepaid payment programs using any of our brands, which we support with processing products and services. Segments on which we focus include government programs such as Social Security payments, unemployment benefits and others; commercial programs such as payroll, health savings accounts, employee benefits and others; and reloadable programs for consumers without formal banking relationships and non-traditional users of electronic payments. We also provide prepaid program management services, primarily outside of the United States, that manage and enable switching and issuer processing for consumer and commercial prepaid travel cards for business partners such as financial institutions, retailers, telecommunications companies, travel agents, foreign exchange bureaus, colleges and universities, airlines and governments. Commercial. We offer commercial payment products and solutions that help large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our card offerings include travel, small business (debit and credit), purchasing and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our Mastercard In Control platform generates virtual account numbers which provide businesses with enhanced controls, more security and better data. The following chart provides GDV and number of cards featuring our brands in 2018 for select programs and solutions: Year Ended December 31, 2018 As of December 31, 2018 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2017 Mastercard Branded Programs 1,2 Consumer Credit $ 2,520 % % % Consumer Debit and Prepaid 2,724 % % 1,126 % Commercial Credit and Debit % % % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. Additional Platforms. In addition to the switching capabilities of our core network, we offer additional platforms with payment capabilities that extend to new payment flows: We offer commercial payment products and solutions, such as the Mastercard B2B Hub, which enables small and midsized businesses to optimize their invoice and payment processes. With Vocalink, we offer real-time account-based payments for ACH transactions. This platform enables payments between bank accounts in real-time and provides enhanced data and messaging capabilities, making them particularly well-suited for B2B and bill payment flows. Value-Added Products and Services We provide additional integrated products and services to our customers and stakeholders, including financial institutions, retailers and governments that enhance the value proposition of our products and solutions. Safety and Security. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number of EMV cards issued and the transaction volume on EMV cards. While this technology is prevalent in Europe, the U.S. market has been adopting this technology in recent years. The Identify layer allows us to help banks and merchants verify genuine consumers during the payment process. Examples of solutions under this layer include Mastercard Identity Check, a fingerprint, face and iris scanning biometric technology to verify online purchases on mobile devices, and our recently launched Biometric Card which has a fingerprint scanner built in to the card and is compatible with existing EMV payment terminals. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Examples of our capabilities under this layer include our Early Detection System, Decision Intelligence and Safety Net services and technologies. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, enhancing approvals for online and card-on-file payments, to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include Mastercard In Control, for consumer alerts and controls and our suite of digital token services available through our Mastercard Digital Enablement Service (MDES). We have also worked with our financial institution customers to provide products to consumers globally with increased confidence through the benefit of zero liability, or no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards . We have built a scalable rewards platform that enables financial institutions to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions. Analytics Insights and Consulting . We provide proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and staff augmentation allow us to assist clients implement actions based on these insights. Increasingly, we have been helping financial institutions, retailers and governments innovate. Drawing on rapid prototyping methodologies from our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five day app prototyping workshop. Through our Applied Predictive Technology business, a software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests. Digital Enablement Leveraging our global innovations capability, we work to digitize payment services across all channels and devices: Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base and are developing products and practices to facilitate acceptance via mobile devices. The successful implementation of our loyalty and reward programs is an important part of enabling these digital purchasing experiences. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. We provide solutions that enable our customers to offer consumers the ability to send and receive money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, our global innovation and development arm, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, usage and overall preference among account holders globally. Our Priceless advertising campaign, which has run in 52 languages in 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Revenue Sources We generate revenues primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other matters, many of which are important to our business operations. Patents are of varying duration depending on the jurisdiction and filing date. Competition We compete in the global payments industry against all forms of payment including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments, wire transfers, electronic benefits transfers and bill payments We face a number of competitors both within and outside of the global payments industry: Cash, Check and Legacy ACH . Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. General Purpose Payment Networks . We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit (e.g., MIR in Russia). Competition for Customer Business . We compete intensely with other payments companies for customer business. Globally, financial institutions typically issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. We also compete for merchants, governments and mobile providers. Real-time Account-based Payment Systems. Through Vocalink, we face competition in the real-time account-based payment space from other companies that provide these payment solutions. In addition, real-time account-based payments face competition from other payment methods, such as cash and checks, cards, electronic, mobile and e-commerce payment platforms, cryptocurrencies and other payments networks. Alternative Payments Systems and New Entrants . As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. In some circumstances, these providers can be a partner or customer, as well as a competitor. Value-Added Products and Services. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, as well as companies that compete against us as providers of loyalty and program management solutions. In addition, our integrated products and services offerings face competition and potential displacement from transaction processors throughout the world, which are seeking to enhance their networks that link issuers directly with point-of-sale devices for payment transaction authorization and processing services. Regulatory initiatives could also lead to increased competition in this space. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance expertise in real-time account-based payments through our Vocalink business adoption of innovative products and digital solutions safety and security solutions embedded in our networks analytics insights and consulting services dedicated solely to the payments industry ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. See Risk Factors in Part I, Item 1A for more detail and examples. Payments Oversight . Several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. Actions by these organizations could influence other organizations around the world to adopt or consider adopting similar oversight. As a result, Mastercard could be subject to new regulation, supervisions and examination requirements. For example, in the U.K., the Bank of England has expanded its oversight of systemically important payment systems to include service providers, as well. Also, in the EEA, the implementation of PSD2 will require financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. PSD2 will also require a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Interchange Fees. Interchange fees associated with four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities and European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the EEA. For more detail, see our risk factors in Risk Factors-Regulations Related to Our Participation in the Payments Industry in Part I, Item 1A. Also see Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Payment Systems Regulation . Regulators in several countries around the world either have, or are seeking to establish, authority to regulate certain aspects of the payment systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switched transactions and other processing in terms of how we go to market, make decisions and organize our structure. Additionally, several jurisdictions have created or granted authority to create new regulatory bodies that either have or would have the authority to regulate payment systems, including the United Kingdoms PSR (Vocalink and Mastercard are both participants in the payments system and are therefore subject to the PSRs duties and powers), India (which has also designated us as a payments system subject to regulation), the National Bank of Belgium and regulators in Brazil, Hong Kong, Mexico and Russia. Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter terrorist financing (CTF) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks and other financial institutions in their capacity as issuers and otherwise, impacting us as a consequence. Such regulations and investigations have been related to payment card add-on products, campus cards, bank overdraft practices, fees issuers charge to account holders and the transparency of terms and conditions. Additionally, regulations such as PSD2 in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to provide payment initiation and account information services directly to consumers. Regulation of Internet and Digital Transactions . Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security and copyright and trademark infringement. Privacy, Data Protection and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the GDPR, which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California), Argentina, Brazil, Chile, India, Indonesia and Kenya. Some jurisdictions are currently considering adopting data localization requirements, which mandate the collection, processing, and/or storage of data within their borders, including India, Kenya and Vietnam. Due to constant changes to the nature of data and the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. Seasonality We do not experience meaningful seasonality. Employees As of December 31, 2018 , we employed approximately 14,800 persons, of whom approximately 8,800 were employed outside of the United States. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 15 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. "," ITEM 1A. RISK FACTORS Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations. These regulations have established, and could further expand, obligations or restrictions with respect to the types of products and services that we may offer to financial institutions for consumers, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry and, in some cases, are considering designating certain payments networks as systemically important payment systems or critical infrastructure. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. Some enacted regulations require financial institutions to provide third party payment processors access to consumer payment accounts. This may enable these third party payment processors to route transactions away from Mastercard products by offering account information or payment initiation services directly to people who currently use our products. This may also allow these processors to commoditize the data that are included in the transactions. New authentication standards have been enacted requiring additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. Such laws or compliance burdens could result in issuers and acquirers being less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. Regulators could also require us to obtain prior approval for changes to its system rules, procedures or operations, or could require customization with regard to such changes, which could impact market participant risk and therefore risk to us. Such regulatory changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route debit transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Government Regulation and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, potential changes to interregional interchange fees as a result of the proposed resolution of the European Commissions investigation could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek to decrease the expense of their payment programs by seeking a reduction in the fees that we charge to them, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Current regulatory activity could be extended to additional jurisdictions or products, which could materially and adversely affect our overall business and results of operations. Regulators around the world increasingly replicate other regulators approaches with regard to the regulation of payments and other industries. Consequently, regulation in any one country, state or region may influence regulatory approaches in other countries, states or regions. Similarly, new laws and regulations within a country, state or region involving one product may lead to regulation of similar or related products. For example, regulations affecting debit transactions could lead to regulation of other products (such as credit). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. These include matters like interchange rates, potential direct regulation of our network fees and pricing, network standards and network exclusivity and routing agreements. Conversely, if widely varying regulations come into existence worldwide, we may have difficulty adjusting our products, services, fees and other important aspects of our business to meet the varying requirements. Either of these outcomes could materially and adversely affect our overall business and results of operations. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries are considering, or may consider, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. Some jurisdictions are considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our efforts to effect change in, or work with, these countries may not succeed. This could adversely affect our ability to maintain or increase our revenues and extend our global brand. Privacy, Data Protection and Security Regulation of privacy, data protection, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data protection and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated products and services to meet the needs of a changing marketplace, as well as acquire new companies, we may expand our information profile through the collection of additional data from additional sources and across multiple channels. This expansion could amplify the impact of these regulations on our business. Regulation of privacy and data protection and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information. We are also subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions are also considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions are considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or reinterpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the development of information-based products and solutions and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity could encourage regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer account information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to regulatory intervention, such as enhanced security requirements, as well as damage to our reputation. Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption - We are subject to AML and CTF laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by OFAC. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including the SDN List. Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. A violation and subsequent judgment or settlement against us, or those with whom we may be associated, under these laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Account-based Payment Systems In the U.K., the Treasury has expanded the Bank of Englands oversight of certain payment system providers that are systemically important to U.K.s payment network. As a result of these changes, aspects of our Vocalink business are now subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Our financial institution customers are subject to numerous regulations, which impact us as a consequence. In addition, certain regulations (such as PSD2 in the EEA) may disintermediate issuers. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. In addition, existing or new regulations in these or other areas may diminish the attractiveness of our products to our customers. Regulation of Internet and Digital Transactions - Proposed legislation in various jurisdictions relating to Internet gambling and other digital areas such as cyber-security and copyright and trademark infringement could impose additional compliance burdens on us and/or our customers, including requiring us or our customers to monitor, filter, restrict, or otherwise oversee various categories of payment transactions. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. Each may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business-Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also more effectively introduce their own innovative programs and services that adversely impact our growth. We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation in the EEA may disintermediate us by enabling third-party providers opportunities to route payment transactions away from our networks and towards other forms of payment. Although we partner with technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data protection standards, without proper oversight we could inadvertently share too much data which could give the partner a competitive advantage. Competitors, customers, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. Over the past several years, we have experienced continued pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payment network presents risks that could materially affect our business. Our acquisition of Vocalink in 2017 added real-time account-based payment technology to the suite of capabilities we offer. While expansion into this space presents business opportunities, there are also regulatory and operational risks associated with administering a real-time account-based payment network. British regulators have designated this platform to be critical national infrastructure and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payment systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payment platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payment network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our integrated products and services can present operational challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments market, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. Our failure to render these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings may experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a business continuity program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Financial Institution Customers and Other Stakeholder Relationships Losing a significant portion of business from one or more of our largest financial institution customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our financial institution customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest financial institution customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. See our risk factor in Risk Factors Risks Related to Our Participation in the Payments Industry in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination of, the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us. Consumers and businesses lowering spending, which could impact cross-border travel patterns (on which a significant portion of our revenues is dependent). Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products. Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility. Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity may be adversely affected by world geopolitical, economic, weather and other conditions. These include the threat of terrorism and outbreaks of flu, viruses and other diseases, as well as major environmental events. The uncertainty that could result from such events could decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. Any of these developments could have a material adverse impact on our overall business and results of operations. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2018 , approximately 67% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. The United Kingdoms proposed withdrawal from the European Union could harm our business and financial results. In June 2016, voters in the United Kingdom approved the withdrawal of the U.K. from the E.U. (commonly referred to as Brexit). The U.K. government triggered Article 50 of the Lisbon Treaty on March 29, 2017, which commenced the official E.U. withdrawal process. Uncertainty over the terms of the U.K.s departure from the E.U. could cause political and economic uncertainty in the U.K. and the rest of Europe, which could harm our business and financial results. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations in the U.K. and E.U. We, as well as our clients who have significant operations in the U.K., may incur additional costs and expenses as we adapt to potentially divergent regulatory frameworks from the rest of the E.U. We may also face additional complexity with regard to immigration and travel rights for our employees located in the U.K. and the E.U. These factors may impact our ability to operate in the E.U. and U.K. seamlessly. Any of these effects of Brexit, among others, could harm our business and financial results. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers may also, by association, impair our reputation, or result in greater regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Such perception and damage to our reputation could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments system, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Acquisitions, strategic investments or entry into new businesses could disrupt our business and harm our results of operations or reputation. Although we may continue to evaluate and/or make strategic acquisitions of, or acquire interests in joint ventures or other entities related to, complementary businesses, products or technologies, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 8, 2019 , Mastercard Foundation owned 112,181,762 shares of Class A common stock, representing approximately 11.1% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2018 , Mastercard and its subsidiaries owned or leased 169 commercial properties. We own our corporate headquarters, located in Purchase, New York. The building is approximately 500,000 square feet. There is no outstanding debt on this building. Our principal technology and operations center, a leased facility located in OFallon, Missouri, is also approximately 500,000 square feet. Our leased properties in the United States are located in nine states and in the District of Columbia. We also lease and own properties in 74 other countries. These facilities primarily consist of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," ITEM 3. LEGAL PROCEEDINGS Refer to Note 12 (Accrued Expenses and Accrued Litigation) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 8, 2019 , we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 287 holders of record of our non-voting Class B common stock as of February 8, 2019 , constituting approximately 1.1% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 Financials and the SP 500 Index for the five-year period ended December 31, 2018 . The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Total returns to stockholders for each of the years presented were as follows: Indexed Returns Base period For the Years Ended December 31, Company/Index Mastercard $ 100.00 $ 103.73 $ 118.05 $ 126.20 $ 186.37 $ 233.56 SP 500 Financials 100.00 115.20 113.44 139.31 170.21 148.03 SP 500 Index 100.00 113.69 115.26 129.05 157.22 150.33 Dividend Declaration and Policy During the years ended December 31, 2018 and 2017 , we paid the following quarterly cash dividends per share on our Class A common stock and Class B common stock: Dividend per Share First Quarter $ 0.25 $ 0.22 Second Quarter 0.25 0.22 Third Quarter 0.25 0.22 Fourth Quarter 0.25 0.22 On December 4, 2018, our Board of Directors declared a quarterly cash dividend of $0.33 per share paid on February 8, 2019 to holders of record on January 9, 2019 of our Class A common stock and Class B common stock. On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.33 per share payable on May 9, 2019 to holders of record on April 9, 2019 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 4, 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the 2017 Share Repurchase Program). This program became effective in 2018. On December 4, 2018, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $6.5 billion of our Class A common stock (the 2018 Share Repurchase Program). This program became effective in January 2019. During the fourth quarter of 2018 , we repurchased a total of approximately 4.4 million shares for $888 million at an average price of $201.20 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2018 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,390,996 $ 206.39 2,390,996 $ 695,528,134 November 1 30 1,027,633 197.12 1,027,633 492,962,254 December 1 31 996,945 192.94 996,945 6,800,613,788 Total 4,415,574 201.20 4,415,574 1 Dollar value of shares that may yet be purchased under the 2017 Share Repurchase Program and the 2018 Share Repurchase Program are as of the end of each period presented. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Certain prior period amounts have been reclassified to conform to the 2018 presentation. For 2017 and 2016, $127 million and $113 million , respectively, of expenses were reclassified from advertising and marketing expenses to general and administrative expenses. The reclassification had no impact on total operating expenses, operating income or net income. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network. Through our core global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. With additional payment capabilities that include real-time account based payments (including automated clearing house (ACH) transactions), we offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. We also provide value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. Our payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. Financial Results Overview The following tables provide a summary of our operating results: Year ended December 31, Increase/ (Decrease) Year ended December 31, Increase/ (Decrease) ($ in millions, except per share data) Net revenue $ 14,950 $ 12,497 20% $ 12,497 $ 10,776 16% Operating expenses $ 7,668 $ 5,875 31% $ 5,875 $ 5,015 17% Operating income $ 7,282 $ 6,622 10% $ 6,622 $ 5,761 15% Operating margin 48.7 % 53.0 % (4.3) ppt 53.0 % 53.5 % (0.5) ppt Income tax expense $ 1,345 $ 2,607 (48)% $ 2,607 $ 1,587 64% Effective income tax rate 18.7 % 40.0 % (21.3) ppt 40.0 % 28.1 % 11.9 ppt Net income $ 5,859 $ 3,915 50% $ 3,915 $ 4,059 (4)% Diluted earnings per share $ 5.60 $ 3.65 53% $ 3.65 $ 3.69 (1)% Diluted weighted-average shares outstanding 1,047 1,072 (2)% 1,072 1,101 (3)% Summary of Non-GAAP Results 1 : Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 14,950 $ 12,497 20% 20% $ 12,497 $ 10,776 16% 15% Adjusted operating expenses $ 6,540 $ 5,693 15% 15% $ 5,693 $ 4,898 16% 16% Adjusted operating margin 56.2 % 54.4 % 1.8 ppt 1.8 ppt 54.4 % 54.5 % (0.1) ppt (0.2) ppt Adjusted effective income tax rate 18.5 % 26.8 % (8.3) ppt (8.2) ppt 26.8 % 28.1 % (1.3) ppt (1.3) ppt Adjusted net income $ 6,792 $ 4,906 38% 38% $ 4,906 $ 4,144 18% 17% Adjusted diluted earnings per share $ 6.49 $ 4.58 42% 41% $ 4.58 $ 3.77 21% 21% Note: Tables may not sum due to rounding. 1 The Summary of Non-GAAP Results excludes the impact of Special Items (subsequently defined) and/or foreign currency. See Non-GAAP Financial Information for further information on the Special Items, the impact of foreign currency and the reconciliation to GAAP reported amounts. Key highlights for 2018 were as follows: Net revenue increased 20% both as reported and on a currency-neutral basis, in 2018 versus 2017 . Current year results include growth of 4 percentage points from the impact of the adoption of the new revenue standard and an additional 0.5 percentage points from our prior year acquisitions. The remaining 15 percentage points of growth was primarily driven by: Switched transaction growth of 17% , adjusted for the impact of the Venezuela deconsolidation 1 Cross-border growth of 18% on a local currency basis 1 1 Adjusted to normalize for the effects of differing switching days between periods. Gross dollar volume growth of 14% on a local currency basis These increases were partially offset by higher rebates and incentives, which increased 18% both as reported and on a currency-neutral basis. Operating expenses increased 31% in 2018 versus 2017 . Excluding the impact of Special Items (defined below), operating expenses increased 15% both as adjusted and on a currency-neutral basis, primarily driven by: 3 percentage point increase from the adoption of the new revenue guidance 2 percentage point increase from acquisitions 2 percentage point increase from the $100 million contribution to the Mastercard Impact Fund (formerly referred to as Mastercards Center for Inclusive Growth Fund), a non-profit charitable organization. The remaining 8 percentage points of growth was primarily related to our continued investment in strategic initiatives and higher operating costs. The effective income tax rate was 18.7% in 2018 versus 40.0% in 2017. The lower effective tax rate for the period was primarily due to additional tax expense in 2017 attributable to comprehensive U.S. tax legislation (U.S. Tax Reform) passed on December 22, 2017, a lower enacted statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate for the period was also attributable to discrete tax benefits, relating primarily to the carryback of foreign tax credits due to transition rules, along with provisions for legal matters in the United States. These benefits were partially offset by the non-deductible fine issued by the European Commission. Other financial highlights for 2018 were as follows: We generated net cash flows from operations of $6.2 billion . We completed a debt offering for an aggregate principal amount of $1.0 billion . We repurchased 26 million shares of our common stock for $4.9 billion and paid dividends of $1.0 billion . We recorded litigation provision charges of $1.1 billion . See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of the following special items (Special Items). Litigation provisions During 2018, we recorded pre-tax charges of $1,128 million ( $1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017, we recorded pre-tax charges of $15 million ( $10 million after tax, or $0.01 per diluted share) related to a litigation settlement with Canadian merchants. During 2016, we recorded pre-tax charges of $117 million ( $85 million after tax, or $0.08 per diluted share) related to litigation settlements with U.K. merchants. Tax act During 2018, we recorded a $75 million net tax benefit ( $0.07 per diluted share) which included a $90 million benefit ( $0.09 per diluted share) related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense ( $0.01 per diluted share) primarily related to the true-up to our 2017 mandatory deemed repatriation tax on accumulated foreign earnings. During 2017, we recorded additional tax expense of $873 million ( $0.81 per diluted share) which includes $825 million of provisional charges attributable to a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax), the remeasurement of our net deferred tax asset in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million additional tax expense related to a foregone foreign tax credit benefit on 2017 repatriations. Venezuela charge During 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries. See Note 1 (Summary of Significant Accounting Policies) , Note 19 (Income Taxes) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these Special Items as management evaluates the underlying operations and performance of the Company separately from litigation judgments and settlements related to interchange and other one-time items, as well as the related tax impacts. In addition, we present growth rates adjusted for the impact of foreign currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of foreign currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of the impact of foreign currency provides relevant information. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables reconcile our as-reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2018 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % 18.7 % $ 5,859 $ 5.60 Litigation provisions (1,128 ) 7.5 % (1.1 )% 1,008 0.96 Tax act ** ** 0.9 % (75 ) (0.07 ) Non-GAAP $ 6,540 56.2 % 18.5 % $ 6,792 $ 6.49 Year ended December 31, 2017 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % 40.0 % $ 3,915 $ 3.65 Tax act ** ** (13.4 )% 0.81 Venezuela charge (167 ) 1.3 % 0.2 % 0.10 Litigation provisions (15 ) 0.1 % % 0.01 Non-GAAP $ 5,693 54.4 % 26.8 % $ 4,906 $ 4.58 Year ended December 31, 2016 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,015 53.5 % 28.1 % $ 4,059 $ 3.69 Litigation provisions (117 ) 1.0 % % 0.08 Non-GAAP $ 4,898 54.5 % 28.1 % $ 4,144 $ 3.77 Note: Tables may not sum due to rounding. ** Not applicable Net revenue, operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items and/or the impact of foreign currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables represent the reconciliation of our growth rates reported under GAAP to our Non-GAAP growth rates: Year Ended December 31, 2018 as compared to the Year Ended December 31, 2017 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (4.3) ppt (21.3) ppt % % Litigation provisions ** (19 )% 7.4 ppt (1.0) ppt % % Tax act ** ** ** 14.2 ppt (33 )% (34 )% Venezuela charge ** % (1.3) ppt (0.2) ppt (3 )% (3 )% Non-GAAP % % 1.8 ppt (8.3) ppt % % Foreign currency 1 % % ppt 0.1 ppt % % Non-GAAP - currency-neutral % % 1.8 ppt (8.2) ppt % % Year Ended December 31, 2017 as compared to the Year Ended December 31, 2016 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (0.5) ppt 11.9 ppt (4 )% (1 )% Tax act ** ** ** (13.4) ppt % % Venezuela charge ** (3 )% 1.3 ppt 0.2 ppt % % Litigation provisions ** % (1.0) ppt ppt (2 )% (3 )% Non-GAAP % % (0.1) ppt (1.3) ppt % % Foreign currency 1 (1 )% (1 )% (0.1) ppt ppt (1 )% % Non-GAAP - currency-neutral % % (0.2) ppt (1.3) ppt % % Note: Tables may not sum due to rounding. ** Not applicable 1 Represents the foreign currency translational and transactional impact. Impact of Foreign Currency Rates Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by foreign currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional foreign currency. The impact of the transactional foreign currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in foreign currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The foreign currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2018 , GDV on a U.S. dollar-converted basis increased 13.0% , while GDV on a local currency basis increased 14.0% versus 2017 . In 2017 , GDV on a U.S. dollar-converted basis increased 8.5% , while GDV on a local currency basis increased 8.4% versus 2016 . Further, the impact from transactional foreign currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. We incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses. We manage foreign currency balance sheet remeasurement and cash flow risk through our foreign exchange risk management activities, which are discussed further in Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign currency derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives immediately in current-period earnings, with the related hedged item being recognized as the exposures materialize. We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in 2017, due to foreign exchange regulations which were restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we transitioned to the cost method of accounting. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in 2017. We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. Financial Results Revenue Gross revenue increased 19% and 18% , or 19% and 17% on a currency-neutral basis, in 2018 and 2017 , respectively, versus the prior year. The increase in both 2018 and 2017 was primarily driven by an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 18% and 22% in 2018 and 2017 , respectively, versus the prior year, both as reported and on a currency-neutral basis. The increases in rebates and incentives in 2018 and 2017 were primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 20% and 16% , or 20% and 15% on a currency-neutral basis, in 2018 and 2017 , respectively, versus the prior year. Current year results include growth of 4 percentage points from the impact of the adoption of the new revenue standard and an additional 0.5 percentage points from our prior year acquisitions. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for a further discussion of the new revenue guidance. Additionally, see Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The significant components of our net revenue were as follows: For the Years Ended December 31, Percent Increase (Decrease) ($ in millions) Domestic assessments $ 6,138 $ 5,130 $ 4,411 20% 16% Cross-border volume fees 4,954 4,174 3,568 19% 17% Transaction processing 7,391 6,188 5,143 19% 20% Other revenues 3,348 2,853 2,431 17% 17% Gross revenue 21,831 18,345 15,553 19% 18% Rebates and incentives (contra-revenue) (6,881 ) (5,848 ) (4,777 ) 18% 22% Net revenue $ 14,950 $ 12,497 $ 10,776 20% 16% The following table summarizes the primary drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Revenue Standard 1 Foreign Currency 2 Other 3 Total Domestic assessments % % % % % % (1 )% % % 4 % 4 % % Cross-border volume fees % % % % % % % % % % % % Transaction processing % % % % % % % % % % % % Other revenues ** ** % % % % (1 )% % % 5 % 5 % % Rebates and incentives % % % % (2 )% % (1 )% % % 6 % 6 % % Net revenue % % 0.5 % % % % % % % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the impact of our adoption of the new revenue guidance. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 2 Represents the foreign currency translational and transactional impact versus the prior year. 3 Includes impact from pricing and other non-volume based fees. 4 Includes impact of the allocation of revenue to service deliverables, which are recorded in other revenue when services are performed. 5 Includes impacts from Advisors fees, safety and security fees, loyalty and reward solution fees and other payment-related products and services. 6 Includes the impact from timing of new, renewed and expired agreements. The following table provides a summary of the trend in volume and transaction growth: Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border volume 1 % % Switched transactions % % 1 Excludes volume generated by Maestro and Cirrus cards. In 2016, our GDV was impacted by the EU Interchange Fee Regulation related to card payments which became effective in June 2016. The regulation requires that we no longer collect fees on domestic European Economic Area payment transactions that do not use our network brand. Prior to that, we collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non Mastercard co-badged volume is no longer being included. The following table reflects GDV growth rates for Europe and Worldwide Mastercard. For comparability purposes, we adjusted growth rates for the impact of Article 8 of the EU Interchange Fee Regulation related to card payments, to exclude the prior period co-badged volume processed by other networks. For the Years Ended December 31, Growth (Local) GDV 1 Worldwide as reported 14% 8% Worldwide as adjusted for EU Regulation 14% 10% Europe as reported 19% 10% Europe as adjusted for EU Regulation 19% 16% 1 Excludes volume generated by Maestro and Cirrus cards. The following table reflects cross-border volume and switched transactions growth rates. For comparability purposes, we normalized the growth rates for the effects of differing switching days between periods. Additionally, we adjusted the switched transactions growth rate for the deconsolidation of our Venezuelan subsidiaries in 2017. For a more detailed discussion of the deconsolidation of our Venezuelan subsidiaries, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. For the Years Ended December 31, Growth (Local) Cross-border volume as reported 19% 15% Cross-border volume, normalized 18% 15% Switched transactions as reported 13% 17% Switched transactions, normalized 1 17% 16% 1 Adjusted for the deconsolidation of Venezuela subsidiaries. No individual country, other than the United States, generated more than 10% of total net revenue in any such period. A significant portion of our revenue is concentrated among our five largest customers. In 2018 , the net revenue from these customers was approximately $3.1 billion , or 21% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses increased 31% and 17% in 2018 and 2017 , respectively, versus the prior year. Excluding the impact of the Special Items, adjusted operating expenses increased 15% and 16% in 2018 and 2017 , respectively, versus the prior year, both as adjusted and on a currency-neutral basis. Acquisitions contributed 2 percentage points of growth in 2018 . The components of operating expenses were as follows: Year ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 5,174 $ 4,653 $ 3,827 % % Advertising and marketing % % Depreciation and amortization % % Provision for litigation 1,128 ** ** Total operating expenses 7,668 5,875 5,015 % % Special Items 1 (1,128 ) (182 ) (117 ) ** ** Adjusted total operating expenses (excluding Special Items 1 ) $ 6,540 $ 5,693 $ 4,898 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on Special Items. The following table summarizes the primary drivers of changes in operating expenses in 2018 and 2017 : For the Years Ended December 31, Operational Special Items 1 Acquisitions Revenue Standard 2 Mastercard Impact Fund 3 Foreign Currency 4 Total General and administrative % % (4 )% % % % % % % % % % % % Advertising and marketing (4 )% % % % % % % % % % % % % % Depreciation and amortization (5 )% % % % % % % % % % % % % % Provision for litigation ** ** ** ** ** ** ** ** ** ** ** ** ** ** Total operating expenses % % % % % % % % % % % % % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on Special Items. 2 Represents the impact of our adoption of the new revenue guidance. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 3 Represents contribution to a non-profit entity. 4 Represents the foreign currency translational and transactional impact versus the prior year. General and Administrative The significant components of our general and administrative expenses were as follows: For the Years Ended December 31, Percent Increase (Decrease) ($ in millions) Personnel $ 3,214 $ 2,687 $ 2,225 20% 21% Professional fees 6% 5% Data processing and telecommunications 19% 20% Foreign exchange activity 1 (36 ) ** ** Other 1,019 1,001 2% 23% General and administrative expenses 5,174 4,653 3,827 11% 22% Special Item 2 (167 ) ** ** Adjusted general and administrative expenses (excluding Special Item) 2 $ 5,174 $ 4,486 $ 3,827 15% 17% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 See Non-GAAP Financial Information for further information on Special Items. The primary drivers of general and administrative expenses in 2018 and 2017, versus the prior year, were as follows: Personnel expenses increased 20% and 21% , or 19% and 20% on a currency-neutral basis, respectively. The 2018 and 2017 increases were driven by a higher number of employees to support our continued investment in the areas of real-time account-based payments, digital, services, data analytics and geographic expansion. The impact of acquisitions contributed 2 and 6 percentage points of growth for 2018 and 2017 , respectively. Data processing and telecommunication expenses increased 19% and 20% , respectively, both as reported and on a currency-neutral basis, due to capacity growth of our business. Acquisitions contributed 3 and 8 percentage points, respectively. Foreign exchange activity contributed a benefit of 3 percentage points in 2018 related to gains from our foreign exchange activity for derivative contracts primarily due to the strengthening of the U.S. dollar, partially offset by balance sheet remeasurement losses. In 2017, foreign exchange activity had a negative impact of 2 percentage points due to greater losses from foreign exchange derivative contracts. Other expenses increased 2% and 23% , or 2% and 25% on a currency-neutral basis, respectively. In 2018 , other expenses increased primarily due to the $100 million contribution to the Mastercard Impact Fund. The remaining increase was due to costs to support our strategic development efforts. These increases were primarily offset by the non-recurring Venezuela charge of $167 million recorded in 2017 which was the primary driver of growth for that period. Other expenses include costs to provide loyalty and rewards solutions, travel and meeting expenses and rental expense for our facilities and other costs associated with our business. Advertising and Marketing In 2018 , advertising and marketing expenses increased 18% both as reported and on a currency-neutral basis versus 2017 , primarily due to a change in accounting for certain marketing fund arrangements as a result of our adoption of the new revenue guidance, partially offset by a net decrease in spending on certain marketing campaigns. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) . In 2017 , advertising and marketing expenses increased 11% , or 10% on a currency-neutral basis versus 2016 , mainly due to higher marketing spend primarily related to certain marketing campaigns. Depreciation and Amortization Depreciation and amortization expenses increased 5% and 17% in 2018 and 2017 , respectively, versus the prior year, both as reported and on a currency-neutral basis. The increase in 2018 was primarily due to the impact of acquisitions partially offset by the full amortization of certain intangible assets. In 2017 , the increase was primarily due to the impact of acquisitions. Provision for Litigation In 2018 , we recorded pre-tax charges of $1,128 million which includes $654 million related to a fine issued by the European Commission, $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases and $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017 and 2016 , we recorded pre-tax charges of $15 million and $117 million related to litigations with merchants in Canada and the U.K., respectively. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) is comprised primarily of investment income, interest expense, our share of income (losses) from equity method investments and other gains and losses. Total other expense decreased $22 million to $78 million in 2018 versus $100 million in 2017 due to higher investment income partially offset by higher interest expense related to our debt issuance in February 2018 and higher equity losses in the current year. Total other expense decreased $15 million to $100 million in 2017 versus $115 million in 2016 due to lower impairment charges taken on certain investments last year and a gain on an investment recorded in 2017, partially offset by higher interest expense from debt issued in the fourth quarter of 2017. Income Taxes On December 22, 2017, U.S. Tax Reform was enacted into law with the effective date for most provisions being January 1, 2018. U.S. Tax Reform represents significant changes to the U.S. internal revenue code and, among other things: lowered the corporate income tax rate from 35% to 21% imposed a one-time deemed repatriation tax on accumulated foreign earnings provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduced further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations and eliminates the domestic production activities deduction. While the effective date of the law for most provisions was January 1, 2018, GAAP requires the effects of changes in tax rates be accounted for in the reporting period of enactment, which was the 2017 reporting period. The effective tax rates for the years ended December 31, 2018, 2017 and 2016 were 18.7% , 40.0% and 28.1% , respectively. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $873 million attributable to U.S. Tax Reform in 2017, a lower 2018 statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate is also attributable to discrete tax benefits, relating primarily to $90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules in the proposed foreign tax credit regulations issued on November 28, 2018, along with provisions for legal matters in the United States. These benefits were partially offset by the nondeductible nature of the fine issued by the European Commission. Excluding the impact of Special Items, the 2018 adjusted effective income tax rate improved by 8.3 percentage points to 18.5% from 26.8% in 2017 primarily due to the lower tax rate in the U.S. and a more favorable geographical mix of earnings. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to U.S. Tax reform, which included provisional amounts of $825 million related to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of our foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on current year repatriations. Excluding the impact of U.S. Tax Reform and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of earnings, partially offset by a lower U.S. foreign tax credit benefit. The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 21% for 2018 and 35.0% for 2017 and 2016 to pretax income for the years ended December 31, as a result of the following: For the Years Ended December 31, Amount Percent Amount Percent Amount Percent ($ in millions) Income before income taxes $ 7,204 $ 6,522 $ 5,646 Federal statutory tax 1,513 21.0 % 2,283 35.0 % 1,976 35.0 % State tax effect, net of federal benefit 0.6 % 0.7 % 0.4 % Foreign tax effect (92 ) (1.3 )% (380 ) (5.8 )% (188 ) (3.3 )% European Commission fine 2.7 % % % Foreign tax credits 1 (110 ) (1.5 )% (27 ) (0.4 )% (141 ) (2.5 )% Transition Tax 0.3 % 9.6 % % Remeasurement of deferred taxes (7 ) (0.1 )% 2.4 % % Windfall benefit (72 ) (1.0 )% (43 ) (0.7 )% % Other, net (149 ) (2.0 )% (55 ) (0.8 )% (82 ) (1.5 )% Income tax expense $ 1,345 18.7 % $ 2,607 40.0 % $ 1,587 28.1 % 1 Included within the impact of the 2018 foreign tax credits is a $90 million tax benefit relating to the carry back of certain foreign tax credits. Additionally, included in 2016 is a $116 million benefit associated with the repatriation of 2016 foreign earnings. There was no benefit associated with the repatriation of foreign earnings in 2018 and 2017 due to the enactment of U.S. Tax Reform. Our GAAP effective income tax rates for 2018 , 2017 and 2016 were affected by the tax benefits related to the Special Items as previously discussed. Our unrecognized tax benefits related to positions taken during the current and prior periods were $164 million and $183 million , as of December 31, 2018 and 2017 , respectively, all of which would reduce our effective tax rate if recognized. Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local tax examinations is reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. In 2010, in connection with the expansion of our operations in the Asia Pacific, Middle East and Africa region, our subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL), received an incentive grant from the Singapore Ministry of Finance. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 8.4 $ 7.8 Unused line of credit 4.5 3.8 1 Investments include available-for-sale securities and short-term held-to-maturity securities. At December 31, 2018 and 2017 , this amount excludes restricted cash related to the U.S. merchant class litigation settlement of $553 million and $546 million , respectively. This amount also excludes restricted security deposits held for customers of $1.1 billion at both December 31, 2018 and 2017 . In 2017, as a result of U.S. Tax Reform, among other things, we changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates and recognized a provisional deferred tax liability of $36 million . In 2018, we completed our analysis of global working capital and cash needs. It is our present intention to indefinitely reinvest approximately $0.9 billion of our historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the U.S. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. See Note 21 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven significantly by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see our risk factor in Risk Factors - Legal and Regulatory Risks in Part I, Item 1A and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Cash Flow Data: Net cash provided by operating activities $ 6,223 $ 5,664 $ 4,637 Net cash used in investing activities (506 ) (1,781 ) (1,163 ) Net cash used in financing activities (4,966 ) (4,764 ) (2,344 ) Net cash provided by operating activities increased $559 million in 2018 versus 2017 , primarily due to higher net income as adjusted for non-cash items, partially offset by deferred payments associated with U.S. Tax Reform in the prior year and the timing of settlement with customers. Net cash provided by operating activities in 2017 versus 2016 , increased by $1.0 billion , primarily due to higher net income as adjusted for non-cash items and deferred payments associated with U.S. Tax Reform. Net cash used in investing activities decreased $1.3 billion in 2018 versus 2017 , primarily due to 2017 acquisitions. Net cash used in investing activities increased $618 million in 2017 versus 2016 , primarily due to 2017 acquisitions and investments in nonmarketable equity investments, partially offset by higher net proceeds of investment securities. Net cash used in financing activities increased $202 million in 2018 versus 2017 , primarily due to higher repurchases of our Class A common stock and dividends paid, partially offset by the proceeds from debt issued in the current year. Net cash used in financing activities increased $2.4 billion in 2017 versus 2016 , primarily due to proceeds from debt issued in 2016, higher repurchases of our Class A common stock and dividends paid. The table below shows a summary of select balance sheet data at December 31 : (in millions) Balance Sheet Data: Current assets $ 16,171 $ 13,797 Current liabilities 11,593 8,793 Long-term liabilities 7,778 6,968 Equity 5,418 5,497 We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, our borrowing capacity and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Debt and Credit Availability In February 2018, we issued $500 million principal amount of notes due in 2028 and an additional $500 million principal amount of notes due in 2048. Our total debt outstanding (including the current portion) was $6.3 billion and $5.4 billion at December 31, 2018 and 2017 , respectively, with the earliest maturity of $500 million of principal occurring in April 2019. As of December 31, 2018, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $4.5 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $4.5 billion revolving credit facility (the Credit Facility) which expires in November 2023. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2018 and 2017 . In March 2018, we filed a universal shelf registration statement (replacing a previously filed shelf registration statement that was set to expire) to provide additional access to capital, if needed. Pursuant to the shelf registration statement, we may from time to time offer to sell debt securities, guarantees of debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. See Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 1.00 $ 0.88 $ 0.76 Cash dividends paid $ 1,044 $ $ On December 4, 2018, our Board of Directors declared a quarterly cash dividend of $0.33 per share paid on February 8, 2019 to holders of record on January 9, 2019 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $340 million . On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.33 per share payable on May 9, 2019 to holders of record on April 9, 2019 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $339 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2018, 2017 and 2016, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $6.5 billion , $4 billion and $4 billion , respectively, of our Class A common stock. The program approved in 2018 became effective in January 2019 after completion of the share repurchase program authorized in 2017. The following table summarizes our share repurchase authorizations of our Class A common stock through December 31, 2018 , under the plans approved in 2018, 2017 and 2016: (in millions, except per share data) Board authorization $ 14,500 Remaining authorization at December 31, 2017 $ 5,234 Dollar-value of shares repurchased in 2018 $ 4,933 Remaining authorization at December 31, 2018 $ 6,801 Shares repurchased in 2018 26.2 Average price paid per share in 2018 $ 188.26 See Note 15 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than lease arrangements and other commitments as presented in the Future Obligations table that follows. Future Obligations The following table summarizes our obligations as of December 31, 2018 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period Total 2020 - 2021 2022 - 2023 2024 and thereafter (in millions) Debt $ 6,389 $ $ $ $ 4,438 Interest on debt 2,072 1,295 Capital leases Operating leases Other obligations 1 Sponsorship, licensing and other 2 Employee benefits 3 Transition Tax 4 Redeemable non-controlling interests 5 Total 6 $ 10,691 $ 1,164 $ 1,576 $ 1,479 $ 6,472 1 The table does not include the $1.6 billion provision as of December 31, 2018 related to litigation as the timing of payments is not fixed and determinable. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. The table also does not include the $219 million accrual as of December 31, 2018 related to the contingent consideration attributable to acquisitions made in 2017, which is pending our final assessment in accordance with the terms of the purchase agreement. This payment is expected to be completed in 2019. See Note 7 (Fair Value and Investment Securities) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts primarily relate to sponsorships to promote the Mastercard brand. Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance. We have accrued $4.1 billion as of December 31, 2018 related to customer and merchant agreements. 3 Amounts relate to severance liabilities along with expected funding requirements for defined benefit pension and postretirement plans. 4 Amounts relate to the U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 6 We have recorded a liability for unrecognized tax benefits of $164 million at December 31, 2018 . Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated. The timing of these payments will ultimately depend on the progress of tax examinations with the various authorities. Seasonality We do not experience meaningful seasonality. No individual quarter in 2018 , 2017 or 2016 accounted for more than 30% of net revenue. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. We have established detailed policies and control procedures to provide reasonable assurance that the methods used to make estimates and assumptions are well controlled and are applied consistently from period to period. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to our financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to our financial condition. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Domestic assessment revenue requires an estimate of our customers performance in order to recognize this revenue. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates. We consider various factors in estimating customer performance, including a review of specific transactions, historical experience with that customer and market and economic conditions. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Valuation of Assets The valuation of assets acquired in a business combination and asset impairment reviews require the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired, liabilities assumed and any non-controlling interest in the acquiree to properly allocate purchase price consideration. Impairment testing for assets, other than goodwill and indefinite-lived intangible assets, requires the allocation of cash flows to those assets or group of assets and if required, an estimate of fair value for the assets or group of assets. We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis or sooner if indicators of impairment exist. Goodwill is tested for impairment at the reporting unit level utilizing a quantitative assessment. We use market capitalization for estimating the fair value of our reporting unit. If the fair value exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds the fair value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate all relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. In performing these qualitative assessments, we consider relevant events and conditions, including but not limited to, macroeconomic trends, industry and market conditions, overall financial performance, cost factors, company-specific events, and legal and regulatory factors. If the qualitative assessments indicate that it is more likely than not that the fair value of the indefinite-lived intangible assets is less than their carrying amounts, we must perform a quantitative impairment test. Our estimates in the valuation of these assets are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of managements assumptions, which would not reflect unanticipated events and circumstances that may occur. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments. We monitor risk exposures on an ongoing basis. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $113 million on our foreign currency derivative contracts outstanding at December 31, 2018 related to the hedging program. In addition, a 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2018 and 2017 . Foreign Exchange Risk Our settlement activities are subject to foreign exchange risk resulting from foreign exchange rate fluctuations. This risk is typically limited to the one business day between setting the foreign exchange rates and clearing the financial transactions. We enter into foreign currency contracts to manage risk associated with anticipated receipts and disbursements which are either transacted in a non-functional currency or valued based on a currency other than the functional currencies of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities denominated in currencies other than the functional currency of the entity. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. Foreign currency exposures are managed together through our foreign exchange risk management activities, which are discussed further in Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. The terms of the forward contracts are generally less than 18 months . As of December 31, 2018 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with our customers. Our derivative contracts are summarized below: December 31, 2018 December 31, 2017 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ (1 ) $ $ Commitments to sell foreign currency 1,066 (26 ) Options to sell foreign currency We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates, with changes in the translated value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations. Our euro-denominated debt is vulnerable to changes in the euro to U.S. dollar exchange rates. The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8. Interest Rate Risk Our interest rate sensitive assets are our investments in fixed income securities, which we generally hold as available-for-sale investments. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows: Maturity Fair Market Value at December 31, 2018 2024 and there-after Financial Instrument Summary Terms (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest 1,043 Asset-backed securities Fixed / Variable Interest Total $ 1,432 $ $ $ $ $ $ Maturity Financial Instrument Summary Terms Fair Market Value at December 31, 2017 2023 and there-after (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,148 $ $ $ $ $ $ We also have time deposits that are classified as held-to-maturity securities. At December 31, 2018 and 2017 , the cost which approximates fair value, of our short-term held-to-maturity securities was $264 million and $700 million , respectively. At December 31, 2018 , we have U.S. dollar-denominated and euro-denominated debt, which is subject to interest rate risk. The principal amounts of this debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8. See Future Obligations for estimated interest payments due by period relating to the U.S. dollar-denominated and euro-denominated debt. At December 31, 2018 , we have the Commercial Paper Program and the Credit Facility which provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. Borrowing rates under the Commercial Paper Program are based on market conditions. Borrowing rates under the Credit Facility are variable rates, which are applied to the borrowing based on terms and conditions set forth in the agreement. See Note 14 (Debt) to the consolidated financial statements in Part II, Item 8 for additional information on the Credit Facility and the Commercial Paper Program. We had no borrowings under the Commercial Paper Program or the Credit Facility at December 31, 2018 and 2017 . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MASTERCARD INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Mastercard Incorporated As of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016 Managements Report on Internal Control over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheet Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 58 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2018 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2018 and 2017 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2018 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York February 13, 2019 We have served as the Companys auditor since 1989. MASTERCARD INCORPORATED CONSOLIDATED BALANCE SHEET December 31, (in millions, except per share data) ASSETS Cash and cash equivalents $ 6,682 $ 5,933 Restricted cash for litigation settlement Investments 1,696 1,849 Accounts receivable 2,276 1,969 Settlement due from customers 2,452 1,375 Restricted security deposits held for customers 1,080 1,085 Prepaid expenses and other current assets 1,432 1,040 Total Current Assets 16,171 13,797 Property, plant and equipment, net Deferred income taxes Goodwill 2,904 3,035 Other intangible assets, net 1,120 Other assets 3,303 2,298 Total Assets $ 24,860 $ 21,329 LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS AND EQUITY Accounts payable $ $ Settlement due to customers 2,189 1,343 Restricted security deposits held for customers 1,080 1,085 Accrued litigation 1,591 Accrued expenses 4,747 3,931 Current portion of long-term debt Other current liabilities Total Current Liabilities 11,593 8,793 Long-term debt 5,834 5,424 Deferred income taxes Other liabilities 1,877 1,438 Total Liabilities 19,371 15,761 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,387 and 1,382 shares issued and 1,019 and 1,040 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 12 and 14 issued and outstanding, respectively Additional paid-in-capital 4,580 4,365 Class A treasury stock, at cost, 368 and 342 shares, respectively (25,750 ) (20,764 ) Retained earnings 27,283 22,364 Accumulated other comprehensive income (loss) (718 ) (497 ) Total Stockholders Equity 5,395 5,468 Non-controlling interests Total Equity 5,418 5,497 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 24,860 $ 21,329 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF OPERATIONS For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 14,950 $ 12,497 $ 10,776 Operating Expenses General and administrative 5,174 4,653 3,827 Advertising and marketing Depreciation and amortization Provision for litigation 1,128 Total operating expenses 7,668 5,875 5,015 Operating income 7,282 6,622 5,761 Other Income (Expense) Investment income Interest expense (186 ) (154 ) (95 ) Other income (expense), net (14 ) (2 ) (63 ) Total other income (expense) (78 ) (100 ) (115 ) Income before income taxes 7,204 6,522 5,646 Income tax expense 1,345 2,607 1,587 Net Income $ 5,859 $ 3,915 $ 4,059 Basic Earnings per Share $ 5.63 $ 3.67 $ 3.70 Basic weighted-average shares outstanding 1,041 1,067 1,098 Diluted Earnings per Share $ 5.60 $ 3.65 $ 3.69 Diluted weighted-average shares outstanding 1,047 1,072 1,101 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the Years Ended December 31, (in millions) Net Income $ 5,859 $ 3,915 $ 4,059 Other comprehensive income (loss): Foreign currency translation adjustments (319 ) (275 ) Income tax effect (11 ) Foreign currency translation adjustments, net of income tax effect (279 ) (286 ) Translation adjustments on net investment hedge (236 ) Income tax effect (21 ) (22 ) Translation adjustments on net investment hedge, net of income tax effect (153 ) Defined benefit pension and other postretirement plans (18 ) (2 ) Income tax effect (1 ) Defined benefit pension and other postretirement plans, net of income tax effect (15 ) (2 ) Investment securities available-for-sale (3 ) (3 ) Income tax effect (1 ) Investment securities available-for-sale, net of income tax effect (2 ) (1 ) Other comprehensive income (loss), net of income tax effect (221 ) (248 ) Comprehensive Income $ 5,638 $ 4,342 $ 3,811 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2015 $ $ $ 4,004 $ (13,522 ) $ 16,222 $ (676 ) $ $ 6,062 Net income 4,059 4,059 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (248 ) (248 ) Cash dividends declared on Class A and Class B common stock, $0.79 per share (863 ) (863 ) Purchases of treasury stock (3,503 ) (3,503 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2016 4,183 (17,021 ) 19,418 (924 ) 5,684 Net income 3,915 3,915 Activity related to non-controlling interests Other comprehensive income (loss), net of tax Cash dividends declared on Class A and Class B common stock, $0.91 per share (969 ) (969 ) Purchases of treasury stock (3,747 ) (3,747 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2017 4,365 (20,764 ) 22,364 (497 ) 5,497 Adoption of revenue standard Adoption of intra-entity asset transfers standard (183 ) (183 ) Net income 5,859 5,859 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (221 ) (221 ) Cash dividends declared on Class A and Class B common stock, $1.08 per share (1,123 ) (1,123 ) Purchases of treasury stock (4,991 ) (4,991 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2018 $ $ $ 4,580 $ (25,750 ) $ 27,283 $ (718 ) $ $ 5,418 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS For the Years Ended December 31, (in millions) Operating Activities Net income $ 5,859 $ 3,915 $ 4,059 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,235 1,001 Depreciation and amortization Share-based compensation Tax benefit for share-based payments (48 ) Deferred income taxes (244 ) (20 ) Venezuela charge Other Changes in operating assets and liabilities: Accounts receivable (317 ) (445 ) (338 ) Income taxes receivable (120 ) (8 ) (1 ) Settlement due from customers (1,078 ) (281 ) (10 ) Prepaid expenses (1,769 ) (1,402 ) (1,073 ) Accrued litigation and legal settlements (12 ) Restricted security deposits held for customers (6 ) Accounts payable Settlement due to customers Accrued expenses Long-term taxes payable (20 ) Net change in other assets and liabilities (261 ) (187 ) Net cash provided by operating activities 6,223 5,664 4,637 Investing Activities Purchases of investment securities available-for-sale (1,300 ) (714 ) (957 ) Purchases of investments held-to-maturity (509 ) (1,145 ) (867 ) Proceeds from sales of investment securities available-for-sale Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property, plant and equipment (330 ) (300 ) (215 ) Capitalized software (174 ) (123 ) (167 ) Acquisition of businesses, net of cash acquired (1,175 ) Investment in nonmarketable equity investments (91 ) (147 ) (31 ) Other investing activities (14 ) (1 ) Net cash used in investing activities (506 ) (1,781 ) (1,163 ) Financing Activities Purchases of treasury stock (4,933 ) (3,762 ) (3,511 ) Proceeds from debt 1,972 Payment of debt (64 ) Dividends paid (1,044 ) (942 ) (837 ) Tax benefit for share-based payments Tax withholdings related to share-based payments (80 ) (47 ) (51 ) Cash proceeds from exercise of stock options Other financing activities (4 ) (6 ) (2 ) Net cash used in financing activities (4,966 ) (4,764 ) (2,344 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents (6 ) (50 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents (681 ) 1,080 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 7,592 8,273 7,193 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 8,337 $ 7,592 $ 8,273 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard, Maestro and Cirrus. The Company is a multi-rail network. Through its core global payments processing network, Mastercard facilitates the switching (authorization, clearing and settlement) of payment transactions, and delivers related products and services. With additional payment capabilities that include real-time account based payments (including automated clearing house (ACH) transactions), Mastercard offers customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. The Company also provides value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. The Companys payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys branded products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or cost method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2018 and 2017 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2018 presentation. For 2017 and 2016, $127 million and $113 million , respectively, of expenses were reclassified from advertising and marketing expenses to general and administrative expenses. The reclassification had no impact on total operating expenses, operating income or net income. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. In 2017, due to foreign exchange regulations restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar impacted the Companys ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax or $0.10 per diluted share) that was recorded in general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2017 . Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100% of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2018, 2017 and 2016 , losses from non-controlling interests were de minimis and, as a result, amounts are included on the consolidated statement of operations within other income (expense). The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5% of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense) on the consolidated statement of operations. The Company accounts for investments in common stock or in-substance common stock under the cost method of accounting when it does not exercise significant influence, generally when it holds less than 20% ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5% and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the cost method of accounting. These investments for which there is no readily determinable fair value and the cost method of accounting is used are adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Investments for which the equity method or cost method of accounting is used are classified as nonmarketable equity investments and recorded in other assets on the consolidated balance sheet. Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the cards and other devices that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives such as marketing, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed consulting, data analytic and research services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from consulting, data analytic and research services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed and any non-controlling interest MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the acquiree, at their fair values at the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years. Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but are tested annually for impairment in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a quantitative assessment. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. The Company will recognize earnings of foreign affiliates that are determined to be global intangible low taxed income (GILTI) in the period it arises and it will not recognize deferred taxes for basis differences that may reverse as GILTI in future years. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with a maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to a preliminary settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability. Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data. Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. The Company uses market capitalization for estimating the fair value of its reporting unit. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. Measurement period adjustments, if any, to the preliminary estimated fair value of contingent consideration as of the acquisition date will be recorded to goodwill, however, changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments in debt securities as available-for-sale. Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets. Available-for-sale securities that are not available to meet the Companys current operational needs are classified as non-current assets on the consolidated balance sheet. The investments in debt securities are carried at fair value, with unrealized gains and losses, net of applicable taxes, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. The Company classifies time deposits with maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. Derivative financial instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange forward and option contracts are included in Level 2 of the Valuation Hierarchy as the fair value of these contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. As the Company does not elect hedge accounting for any derivative instruments, realized and unrealized gains and losses from the change in fair value of these contracts are recognized immediately in current-period earnings. The Companys derivative contracts hedge foreign exchange risk and are not entered into for trading or speculative purposes. The Company did not have any derivative contracts accounted for under hedge accounting as of December 31, 2018 and 2017 . The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The ineffective portion, if any, is recognized in earnings in the current period. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Property, plant and equipment - Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Depreciation of leasehold improvements and amortization of capital leases is included in depreciation and amortization expense on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Capital leases Shorter of life of the asset or lease term Leases - The Company enters into operating and capital leases for the use of premises and equipment. Rent expense related to lease agreements that contain lease incentives is recorded on a straight-line basis over the term of the lease. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded when employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards products, services and brand are recognized in advertising and marketing on the consolidated statement of operations. The cost of media advertising is expensed when the advertising takes place. Advertising production costs are expensed as incurred. Promotional items are expensed at the time the promotional event occurs. Sponsorship costs are recognized over the period of benefit. Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. These interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to their estimated redemption value. These adjustments to the redemption value will impact retained earnings or additional paid-in capital on the consolidated balance sheet, but will not impact the consolidated statement of operations. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. For 2018 , 2017 and 2016 , there was no impact to EPS for adjustments related to redeemable non-controlling interests. Recently adopted accounting pronouncements Disclosure requirements for defined benefit plans - In August 2018, the Financial Accounting Standards Board (the FASB) issued accounting guidance which modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans by removing, modifying and adding certain disclosures. This guidance is required to be applied retrospectively and is effective for periods ending after December 15, 2020, with early adoption permitted. The Company adopted this guidance effective December 31, 2018, which did not result in a material impact on the Companys current year consolidated financial statements. Income taxes - In March 2018, the FASB incorporated the Securities and Exchange Commissions (the SECs) interpretive guidance from Staff Accounting Bulletin No. 118 (SAB 118), issued on December 22, 2017, into the income tax accounting codification under GAAP. The guidance allows for the recognition of provisional amounts related to 2017 U.S. tax reform (U.S. Tax Reform) during a one year measurement period with changes recorded as a component of income tax expense. This guidance was effective upon issuance. Refer to Note 19 (Income Taxes) for further discussion. Net periodic pension cost and net periodic postretirement benefit cost - In March 2017, the FASB issued accounting guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. Under this guidance, the service cost component is required to be reported in the same line item as other compensation costs arising from services rendered by employees during the period. The other components of the net periodic benefit costs are required to be presented on the consolidated statement of operations separately from the service cost component and outside of operating income. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018, which did not result in a material impact on the Companys current year consolidated financial statements. The Company did not apply this guidance retrospectively, as the impact was de minimis to the prior year consolidated financial statements. Refer to Note 13 (Pension, Postretirement and Savings Plans) for the components of the Companys net periodic pension cost and net periodic postretirement benefit costs. Restricted cash - In November 2016, the FASB issued accounting guidance to address diversity in the classification and presentation of changes in restricted cash on the consolidated statement of cash flows. Under this guidance, companies are required to present restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company adopted this guidance effective January 1, 2018. In accordance with the adoption of this standard, the Company includes restricted cash, which currently consists of restricted cash for litigation settlement, restricted security deposits held for customers and other restricted cash balances in its reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. Refer to Note 5 (Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents) for related disclosures. Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies are required to recognize MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. Refer to Note 19 (Income Taxes) for further discussion. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. Financial instruments - In January 2016, the FASB issued accounting guidance to amend certain aspects of recognition, measurement, presentation and disclosure of financial instruments, including the requirement to measure certain equity investments at fair value with changes in fair value recognized in income. This guidance is required to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Amendments related to equity securities without readily determinable fair values should be applied prospectively to equity investments that exist as of the date of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. The cumulative effect of the adoption of the standard was de minimis to the Companys balance sheet upon adoption. For the year ended December 31, 2018, the Company recorded a gain on non-marketable equity investments, which resulted in a pre-tax increase of $12 million . Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted this guidance effective January 1, 2018 under the modified retrospective transition method, applying the standard to contracts not completed as of January 1, 2018 and considered the aggregate amount of modifications. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. This new revenue guidance impacts the timing of certain customer incentives recognized in the Companys consolidated statement of operations, as they are recognized over the life of the contract. Previously, such incentives were recognized when earned by the customer. The new revenue guidance also impacts the Companys accounting recognition for certain market development fund contributions and expenditures. Historically, these items were recorded on a net basis in net revenue and will now be recognized on a gross basis, resulting in an increase to both revenues and expenses. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following tables summarize the impact of the revenue standard on the Companys consolidated statement of operations for the year ended December 31, 2018 and consolidated balance sheet as of December 31, 2018 : Year Ended December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Net Revenue $ 14,471 $ $ 14,950 Operating Expenses Advertising and marketing Income before income taxes 6,889 7,204 Income tax expense 1,278 1,345 Net Income 5,611 5,859 December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Assets Accounts receivable $ 2,214 $ $ 2,276 Prepaid expenses and other current assets 1,176 1,432 Deferred income taxes (96 ) Other assets 2,388 3,303 Liabilities Accounts payable (422 ) Accrued expenses 4,375 4,747 Other current liabilities 1,085 (136 ) Other liabilities 1,145 1,877 Equity Retained earnings 26,692 27,283 For a more detailed discussion on revenue recognition, refer to Note 3 (Revenue) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Cumulative Effect of the Adopted Accounting Pronouncements The following table summarizes the cumulative impact of the changes made to the January 1, 2018 consolidated balance sheet for the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers. The prior periods have not been restated and have been reported under the accounting standards in effect for those periods. Balance at December 31, 2017 Impact of revenue standard Impact of intra-entity asset transfers standard Balance at January 1, 2018 (in millions) Assets Accounts receivable $ 1,969 $ $ $ 2,013 Prepaid expenses and other current assets 1,040 (17 ) 1,204 Deferred income taxes (69 ) Other assets 2,298 (352 ) 2,636 Liabilities Accounts payable (495 ) Accrued expenses 3,931 4,322 Other current liabilities (44 ) Other liabilities 1,438 2,066 Equity Retained earnings 22,364 (183 ) 22,547 Recent accounting pronouncements not yet adopted Implementation costs incurred in a hosting arrangement that is a service contract - In August 2018, the FASB issued accounting guidance which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for periods beginning after December 15, 2019 and early adoption is permitted. Companies are required to adopt this guidance either retrospectively or by prospectively applying the guidance to all implementation costs incurred after the date of adoption. The Company is in the process of evaluating when it will adopt this guidance and the potential effects this guidance will have on its consolidated financial statements. Disclosure requirements for fair value measurement - In August 2018, the FASB issued accounting guidance which modifies disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for periods beginning after December 15, 2019. Companies are permitted to early adopt the removed or modified disclosures and delay adoption of added disclosures until the effective date. Companies are required to adopt the guidance for certain added disclosures prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption and all other amendments retrospectively to all periods presented upon their effective date. The Company is in the process of evaluating when it will adopt this guidance and the potential effects this guidance will have on its disclosures. Comprehensive income - In February 2018, the FASB issued accounting guidance that allows for a one-time reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from U.S. Tax Reform. The guidance is effective for periods beginning after December 15, 2018, with early adoption permitted. The Company will adopt this guidance effective January 1, 2019 and does not expect the impacts of this standard to be material. Derivatives and hedging - In August 2017, the FASB issued accounting guidance to improve and simplify existing guidance to allow companies to better reflect their risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, eliminates the requirement to separately measure and recognize hedge ineffectiveness and eases requirements of an entitys assessment of hedge effectiveness. This guidance is effective for periods beginning after December 15, 2018 and early adoption is permitted. The Company currently does not account for its foreign currency derivative contracts under hedge accounting. The Company will adopt this guidance effective January 1, 2019 and does not expect the impacts of this standard to be material. For a more detailed discussion of the Companys foreign exchange risk management activities, refer to Note 22 (Foreign Exchange Risk Management) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Credit losses - In June 2016, the FASB issued accounting guidance to amend the measurement of credit losses for financial instruments. The guidance requires all expected credit losses for most financial assets held at the reporting date to be measured based on historical experience, current conditions, and reasonable and supportable forecasts, generally resulting in the earlier recognition of allowance for losses. The guidance is effective for periods beginning after December 15, 2019, with early adoption permitted. The Company is required to apply the provisions of this guidance as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company will adopt this guidance effective January 1, 2020 and does not expect the impacts of this standard to be material. Leases - In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. This guidance requires companies to recognize leased assets and liabilities for both financing and operating leases. This guidance is effective for periods beginning after December 15, 2018. The Company will adopt this guidance effective January 1, 2019 using the modified retrospective approach as of the date of adoption with the available practical expedients. Upon adoption of the standard, the estimated impact on the Companys consolidated financial statements is expected to be an increase in non-current assets with a corresponding increase in current and non-current liabilities. The Company estimates that the increase in assets and liabilities will represent approximately 2% of the Companys total assets and total liabilities as of December 31, 2018 and expects no significant impact to retained earnings. Note 2. Acquisitions In 2017 , the Company acquired businesses for total consideration of $1.5 billion , representing both cash and contingent consideration. For the businesses acquired, Mastercard allocated the values associated with the assets, liabilities and redeemable non-controlling interests based on their respective fair values on the acquisition dates. Refer to Note 1 (Summary of Significant Accounting Policies) , for the valuation techniques Mastercard utilizes to fair value the assets and liabilities acquired in business combinations. The residual value allocated to goodwill is not expected to be deductible for local tax purposes. The Company has finalized the purchase accounting for businesses acquired during 2017. The final fair values of the purchase price allocations, as of the acquisition dates, are noted below: (in millions) Cash consideration $ 1,286 Contingent consideration Redeemable non-controlling interests Gain on previously held minority interest Total fair value of businesses acquired $ 1,571 Assets: Cash and cash equivalents $ Other current assets Other intangible assets Goodwill 1,135 Other assets Total assets 1,935 Liabilities: Short-term debt 1 Other current liabilities Net pension liability Other liabilities Total liabilities Net assets acquired $ 1,571 1 The short-term debt assumed through acquisitions was repaid during 2017. The following table summarizes the identified intangible assets acquired: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (Years) Developed technologies $ 7.5 Customer relationships 9.9 Other 1.4 Other intangible assets $ 8.3 For the businesses acquired in 2017, the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4% controlling interest in Vocalink for cash consideration of 719 million ( $929 million as of the acquisition date). In addition, the Vocalink sellers have the potential to earn additional contingent consideration of 169 million (approximately $214 million as of December 31, 2018 ), upon meeting 2018 revenue targets in accordance with terms of the purchase agreement. Refer to Note 7 (Fair Value and Investment Securities) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6% ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $73 million as of December 31, 2018 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. The consolidated financial statements include the operating results of the acquired businesses from the dates of their respective acquisition. Pro forma information related to the acquisitions was not included because the impact on the Companys consolidated results of operations was not considered to be material. Note 3. Revenue Mastercards business model involves four participants in addition to the Company: account holders, issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the cards and other devices that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. In addition, the Company recognizes revenue from other payment-related products and services in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the acquirer country and the issuer country are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based on the dollar volume of activity on cards and other devices that carry the Companys brands where the acquirer country and the issuer country are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile initiated transactions; and safety and security. Other revenues consist of value added service offerings that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Consulting, data analytic and research fees. Safety and security services fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Bank account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The following table disaggregates the Companys net revenue by source and geographic region for the year ended December 31, 2018 : (in millions) Revenue by source: Domestic assessments $ 6,138 Cross-border volume fees 4,954 Transaction processing 7,391 Other revenues 3,348 Gross revenue 21,831 Rebates and incentives (contra-revenue) (6,881 ) Net revenue $ 14,950 Net revenue by geographic region: North American Markets $ 5,311 International Markets 9,441 Other 1 Net revenue $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $2.1 billion and $1.9 billion as of December 31, 2018 and 2017 , respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are billed quarterly or more frequently dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2018 in the amounts of $40 million and $92 million , respectively. The Company did not have contract assets at December 31, 2017 . Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2018 in the amounts of $218 million and $101 million , respectively. The comparable amounts included in other current liabilities and other liabilities at December 31, 2017 were $230 million and $17 million , respectively. Revenue recognized from such performance obligations satisfied during 2018 was $904 million . The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years ). As a payment network service provider, the Company provides its customers with continuous access to its global payment processing network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable based upon the number of transactions processed and volume activity on the cards and other devices that carry the Companys brands. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues from other value added services comprised of bank account-based payment services, consulting and research fees, loyalty programs and other payment-related products and services. At December 31, 2018 , the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value added services is $1.0 billion , which is expected to be recognized through 2022. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 5,859 $ 3,915 $ 4,059 Denominator Basic weighted-average shares outstanding 1,041 1,067 1,098 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,047 1,072 1,101 Earnings per Share Basic $ 5.63 $ 3.67 $ 3.70 Diluted $ 5.60 $ 3.65 $ 3.69 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows. December 31, (in millions) Cash and cash equivalents $ 6,682 $ 5,933 $ 6,721 $ 5,747 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement Restricted security deposits held for customers 1,080 1,085 Prepaid expenses and other current assets Other assets Cash, cash equivalents, restricted cash and restricted cash equivalents $ 8,337 $ 7,592 $ 8,273 $ 7,193 Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: (in millions) Cash paid for income taxes, net of refunds $ 1,790 $ 1,893 $ 1,579 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Capital leases and other Fair value of assets acquired, net of cash acquired 1,825 Fair value of liabilities assumed related to acquisitions MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 7. Fair Value and Investment Securities Financial Instruments - Recurring Measurements The Company classifies its fair value measurements of financial instruments within the Valuation Hierarchy. There were no transfers made among the three levels in the Valuation Hierarchy for 2018 . The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2018 December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,043 1,043 Asset-backed securities Equity securities Derivative instruments 2 : Foreign currency derivative assets Deferred compensation plan 3 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign currency derivative liabilities $ $ (6 ) $ $ (6 ) $ $ (30 ) $ $ (30 ) Deferred compensation plan 4 : Deferred compensation liabilities (54 ) (54 ) (54 ) (54 ) 1 The Companys U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign currency derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 22 (Foreign Exchange Risk Management) for further details. 3 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 4 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet. Settlement and Other Guarantee Liabilities The Company estimates the fair value of its settlement and other guarantees using market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At December 31, 2018 and 2017 , the carrying value and fair value of settlement and other guarantee liabilities were not material MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) and accordingly are not included in the Valuation Hierarchy table above. Settlement and other guarantee liabilities are classified within Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not observable in the market. See Note 21 (Settlement and Other Risk Management) for additional information regarding the Companys settlement and other guarantee liabilities. Financial Instruments - Non-Recurring Measurements Held-to-Maturity Securities Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Held-to-maturity securities are not measured at fair value on a recurring basis and are not included in the Valuation Hierarchy table above. At December 31, 2018 and 2017 , the Company held $264 million and $700 million , respectively, of held-to-maturity securities due within one year. The cost of these securities approximates fair value. Nonmarketable Equity Investments The Companys nonmarketable equity investments are measured at fair value at initial recognition. In addition, nonmarketable equity investments accounted for under the cost method of accounting are adjusted for changes resulting from identifiable price changes in orderly transactions for the identical or similar investments of the same issuer. Nonmarketable equity investments are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity, and the fact that inputs used to measure fair value are unobservable and require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. These investments are included in other assets on the consolidated balance sheet. See Note 8 (Prepaid Expenses and Other Assets) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2018 , the carrying value and fair value of total long-term debt (including the current portion) was $6.3 billion and $6.5 billion , respectively. At December 31, 2017 , the carrying value and fair value of long-term debt was $5.4 billion and $5.7 billion , respectively. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Contingent Consideration The contingent consideration attributable to acquisitions made in 2017 is primarily based on the achievement of 2018 revenue targets and is measured at fair value on a recurring basis. This contingent consideration liability is included in other current liabilities on the consolidated balance sheet and is classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices. The activity of the Companys contingent consideration liability for 2018 was as follows: (in millions) Balance at December 31, 2017 $ Net change in valuation Payments (5 ) Foreign currency translation (14 ) Balance at December 31, 2018 $ 82 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amortized Costs and Fair Values Available-for-Sale Investment Securities The major classes of the Companys available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of December 31, 2018 and 2017 were as follows: December 31, 2018 December 31, 2017 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,044 (2 ) 1,043 (1 ) Asset-backed securities Equity securities Total $ 1,433 $ $ (2 ) $ 1,432 $ 1,147 $ $ (1 ) $ 1,149 The Companys available-for-sale investment securities held at December 31, 2018 and 2017 , primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. Investment Maturities: The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2018 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years 1,056 1,055 Due after 5 years through 10 years Total $ 1,433 $ 1,432 Investment Income Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Companys consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for 2018 , 2017 and 2016 were not significant. Note 8. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,432 $ 1,040 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Other assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 2,458 $ 1,434 Nonmarketable equity investments Prepaid income taxes Income taxes receivable Other Total other assets $ 3,303 $ 2,298 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. The increase in customer and merchant incentives and the decrease in prepaid income taxes at December 31, 2018 from December 31, 2017 are primarily due to the impact from the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers, respectively. See Note 1 (Summary of Significant Accounting Policies) for additional information on the cumulative impact of the adoption of these accounting pronouncements. Note 9. Property, Plant and Equipment Property, plant and equipment consisted of the following at December 31 : (in millions) Building, building equipment and land $ $ Equipment Furniture and fixtures Leasehold improvements Property, plant and equipment 1,768 1,543 Less: accumulated depreciation and amortization (847 ) (714 ) Property, plant and equipment, net $ $ As of December 31, 2018 and 2017 , capital leases of $33 million and $32 million , respectively, were included in equipment. Accumulated amortization of these capital leases was $24 million and $18 million as of December 31, 2018 and 2017 , respectively. Depreciation and amortization expense for the above property, plant and equipment was $209 million , $185 million and $151 million for 2018 , 2017 and 2016 , respectively. Note 10. Goodwill The changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017 were as follows: (in millions) Beginning balance $ 3,035 $ 1,756 Additions 1,136 Foreign currency translation (133 ) Ending balance $ 2,904 $ 3,035 The Company had no accumulated impairment losses for goodwill at December 31, 2018 . Based on annual impairment testing, the Companys goodwill is not impaired. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 11. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31 : Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 1,514 $ (898 ) $ $ 1,572 $ (888 ) $ Customer relationships (232 ) (214 ) Other (45 ) (55 ) Total 1,999 (1,175 ) 2,102 (1,157 ) Indefinite-lived intangible assets Customer relationships Total $ 2,166 $ (1,175 ) $ $ 2,277 $ (1,157 ) $ 1,120 The decrease in the gross carrying amount of amortized intangible assets in 2018 was primarily related to the retirement of fully amortized intangible assets, partially offset by additions to capitalized software. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2018 , it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $250 million , $252 million and $221 million in 2018, 2017 and 2016 , respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2018 for the years ending December 31 : (in millions) $ 2020 2021 2022 2023 and thereafter $ Note 12. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 3,275 $ 2,648 Personnel costs Advertising Income and other taxes Other Total accrued expenses $ 4,747 $ 3,931 Customer and merchant incentives represent amounts to be paid to customers under business agreements. The increase in customer and merchant incentives is due to the adoption of the new accounting standard pertaining to revenue recognition and timing of payments to customers. See Note 1 (Summary of Significant Accounting Policies) for additional information on the cumulative impact of the adoption of the revenue recognition guidance. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2018 and 2017 , the Companys provision for litigation was $1,591 million and $709 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 20 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 13. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $98 million , $84 million and $73 million in 2018, 2017 and 2016 , respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. In 2017, the Company acquired a majority interest in Vocalink. Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $18 million as of December 31, 2018 ) annually until March 2020. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Benefit obligation acquired during the year Service cost Interest cost Actuarial (gain) loss (7 ) (44 ) (2 ) Benefits paid (22 ) (12 ) (5 ) (4 ) Transfers in Foreign currency translation (23 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Fair value of plan assets acquired during the year Actual (loss) gain on plan assets (8 ) (4 ) Employer contributions Benefits paid (23 ) (12 ) (5 ) (4 ) Transfers in Foreign currency translation (21 ) Fair value of plan assets at end of year Funded status at end of year $ (28 ) $ (41 ) $ (57 ) $ (61 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term $ $ $ (3 ) $ (3 ) Other liabilities, long-term (28 ) (41 ) (54 ) (58 ) $ (28 ) $ (41 ) $ (57 ) $ (61 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ (5 ) $ (22 ) $ (7 ) $ (5 ) Prior service credit (6 ) (8 ) Balance at end of year $ (4 ) $ (22 ) $ (13 ) $ (13 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 1.80 % 1.80 % * * Vocalink Plan 3.10 % 2.80 % * * Postretirement Plan * * 4.25 % 3.50 % Rate of compensation increase Non-U.S. Plans 2.60 % 2.60 % * * Vocalink Plan 4.00 % 3.85 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Each of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2018 and 2017 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets For the year ended December 31, 2018, the Companys projected benefit obligation related to its Pension Plans decreased $30 million attributable primarily to foreign currency translation and benefits paid. For the year ended December 31, 2017, the Companys projected benefit obligation related to its Pension Plans increased $422 million attributable primarily to the acquisition of Vocalink. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets (20 ) (13 ) (1 ) Curtailment gain Amortization of actuarial loss Amortization of prior service credit (2 ) (2 ) (1 ) Pension settlement charge Net periodic benefit cost $ $ $ $ $ $ Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Curtailment gain $ $ $ $ $ $ Current year actuarial loss (gain) (22 ) (2 ) Current year prior service credit Amortization of prior service credit Pension settlement charge Total other comprehensive loss (income) $ $ (22 ) $ $ $ $ Total net periodic benefit cost and other comprehensive loss (income) $ $ (18 ) $ $ $ $ 88 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.80 % 1.60 % 1.85 % * * * Vocalink Plan 2.80 % 2.50 % * * * * Postretirement Plan * * * 3.50 % 4.00 % 4.25 % Expected return on plan assets Non-U.S. Plans 3.00 % 3.25 % 3.25 % * * * Vocalink Plan 4.75 % 4.75 % * * * * Rate of compensation increase Non-U.S. Plans 2.60 % 2.59 % 2.64 % * * * Vocalink Plan 3.85 % 3.95 % * * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: Health care cost trend rate assumed for next year 6.00 % 6.50 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed within the following target asset allocations: non-government fixed income 39% , government securities (including U.K. governmental bonds) 28% , investment funds 25% and other 8% . The investment funds are currently comprised of approximately 44% derivatives, 28% equity, 16% fixed income and 12% other. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. Cash and cash equivalents and other public investment vehicles (including certain mutual funds and government and agency securities) are valued at quoted market prices, which represent the net asset value of the shares held by the Vocalink Plan, and are therefore included in Level 1 of the Valuation Hierarchy. Certain other mutual funds (including commingled funds), governmental and agency securities and insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2 of the Valuation Hierarchy. Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value as of December 31, 2018 and 2017 : December 31, 2018 December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents $ $ $ $ $ $ $ $ Government and agency securities Mutual funds Insurance contracts Asset-backed securities Other Total $ $ $ $ $ $ $ $ The following table summarizes expected benefit payments through 2028 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2020 2021 2022 2023 2024 - 2028 90 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 14. Debt Long-term debt consisted of the following at December 31: Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2018 USD Notes February 2018 Semi-annually $ 3.500 % 3.598 % $ $ $ 3.950 % 3.990 % $ 1,000 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 6,389 5,477 Less: Unamortized discount and debt issuance costs (55 ) (53 ) Total debt outstanding 6,334 5,424 Less: Current portion 1 (500 ) Long-term debt $ 5,834 $ 5,424 1 Relates to the current portion of the 2014 USD Notes, due in April 2019, classified as current portion of long-term debt on the consolidated balance sheet. In February 2018, the Company issued $500 million principal amount of notes due February 2028 and $500 million principal amount of notes due February 2048 (collectively the 2018 USD Notes). The net proceeds from the issuance of the 2018 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $991 million . The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2016 USD Notes, the 2015 Euro Notes and the 2014 USD Notes, were $1.969 billion , $1.723 billion and $1.484 billion , respectively. The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2018 are summarized below. (in millions) $ 2020 650 801 Thereafter 4,438 Total $ 6,389 On November 15, 2018, the Company increased its commercial paper program (the Commercial Paper Program) from $3.75 billion to $4.5 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $4.5 billion revolving credit facility (the Credit Facility) on November 15, 2018. The Credit Facility, which expires on November 15, 2023, amended and restated the Companys prior $3.75 billion credit facility which was set to expire in October 2022. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, events of default and affirmative and negative covenants, including a financial covenant limiting the maximum level of consolidated debt to earnings before interest, taxes, depreciation and amortization (EBITDA). The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2018 and 2017 . The majority of Credit Facility lenders are customers or affiliates of customers of Mastercard. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2018 and 2017 . In March 2018, the Company filed a universal shelf registration statement (replacing a previously filed shelf registration statement that was set to expire) to provide additional access to capital, if needed. Pursuant to the shelf registration statement, the Company may from time to time offer to sell debt securities, guarantees of debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Note 15. Stockholders Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $0.0001 3,000 One vote per share Dividend rights B $0.0001 1,200 Non-voting Dividend rights Preferred $0.0001 No shares issued or outstanding at December 31, 2018 and 2017, respectively. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.0 % 89.0 % 88.0 % 89.2 % Principal or Affiliate Customers (Class B stockholders) 1.1 % % 1.4 % % Mastercard Foundation (Class A stockholders) 10.9 % 11.0 % 10.6 % 10.8 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5% of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2018 , as well as historical purchases: Board authorization dates December 2018 December 2017 December 2016 December December Date program became effective January 2019 March 2018 April 2017 February 2016 January 2015 Total (in millions, except average price data) Board authorization $ 6,500 $ 4,000 $ 4,000 $ 4,000 $ 3,750 $ 22,250 Dollar-value of shares repurchased in 2016 $ $ $ $ 3,004 $ $ 3,511 Remaining authorization at December 31, 2016 $ $ $ 4,000 $ $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ $ 2,766 $ $ $ 3,762 Remaining authorization at December 31, 2017 $ $ 4,000 $ 1,234 $ $ $ 5,234 Dollar-value of shares repurchased in 2018 $ $ 3,699 $ 1,234 $ $ $ 4,933 Remaining authorization at December 31, 2018 $ 6,500 $ $ $ $ $ 6,801 Shares repurchased in 2016 31.2 5.7 36.9 Average price paid per share in 2016 $ $ $ $ 96.15 $ 89.76 $ 95.18 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ $ 131.97 $ 109.16 $ $ 125.05 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ 194.77 $ 171.11 $ $ $ 188.26 Cumulative shares repurchased through December 31, 2018 19.0 28.2 40.4 40.8 128.4 Cumulative average price paid per share $ $ 194.77 $ 141.99 $ 99.10 $ 92.03 $ 120.44 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2015 1,095.0 21.3 Purchases of treasury stock (36.9 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.0 (2.0 ) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock (30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 (5.2 ) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock (26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 (2.3 ) Balance at December 31, 2018 1,018.6 11.8 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 16. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2018 and 2017 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge Defined Benefit Pension and Other Postretirement Plans 2 Investment Securities Available-for-Sale 3 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2016 $ (949 ) $ $ $ $ (924 ) Other comprehensive income (loss) (153 ) (1 ) Balance at December 31, 2017 (382 ) (141 ) (497 ) Other comprehensive income (loss) (279 ) (15 ) (2 ) (221 ) Balance at December 31, 2018 $ (661 ) $ (66 ) $ $ (1 ) $ (718 ) 1 During 2017, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro. During 2018, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the devaluation of the euro, British pound and Brazilian real. 2 During 2017, the increase in the accumulated other comprehensive gain related to the Companys postretirement plans was driven primarily by the addition of the Vocalink Plan. Deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $2 million before tax and $1 million after tax. During 2018, the decrease in the accumulated other comprehensive gain related to the Companys postretirement plans was driven primarily by an actuarial loss related to the Vocalink Plan. Deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $1 million before and after tax. See Note 13 (Pension, Postretirement and Savings Plans) for additional information. 3 During 2017 and 2018, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant. Note 17. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Options, which expire ten years from the date of grant, generally vest ratably over four years from the date of grant. The RSUs and PSUs generally vest after three years . The Company uses the straight-line method of attribution for expensing equity awards. Compensation expense is recorded net of estimated forfeitures. Estimates are adjusted as appropriate. For all awards granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all awards granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Stock Options The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: Risk-free rate of return 2.7 % 2.0 % 1.3 % Expected term (in years) 6.00 5.00 5.00 Expected volatility 19.7 % 19.3 % 23.3 % Expected dividend yield 0.6 % 0.8 % 0.8 % Weighted-average fair value per Option granted $ 40.90 $ 21.23 $ 18.58 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2018 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2018 8.6 $ Granted 0.9 $ Exercised (1.8 ) $ Forfeited/expired (0.1 ) $ Outstanding at December 31, 2018 7.6 $ 6.4 $ Exercisable at December 31, 2018 4.3 $ 5.2 $ Options vested and expected to vest at December 31, 2018 7.6 $ 6.4 $ As of December 31, 2018 , there was $34 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.1 years . Restricted Stock Units The following table summarizes the Companys RSU activity for the year ended December 31, 2018 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2018 4.1 $ Granted 0.9 $ Converted (1.1 ) $ Forfeited (0.2 ) $ Outstanding at December 31, 2018 3.7 $ $ RSUs expected to vest at December 31, 2018 3.6 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) common stock after the vesting period. As of December 31, 2018 , there was $153 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.7 years . Performance Stock Units The following table summarizes the Companys PSU activity for the year ended December 31, 2018 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2018 0.5 $ Granted 0.1 $ Converted (0.3 ) $ Other 1 0.3 $ Outstanding at December 31, 2018 0.6 $ $ PSUs expected to vest at December 31, 2018 0.6 $ $ 1 Represents additional shares issued in March 2018 related to the 2015 PSU grant based on performance and market conditions achieved over the three-year measurement period. These shares vested upon issuance. Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2018 , there was $13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.3 years . Additional Information The following table includes additional share-based payment information for each of the years ended December 31: (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 18. Commitments At December 31, 2018 , the Company had the following future minimum payments due under non-cancelable agreements: Total Capital Leases Operating Leases Sponsorship, Licensing Other (in millions) $ $ $ $ 2020 2021 2022 2023 Thereafter Total $ 1,375 $ $ $ Included in the table above are capital leases with a net present value of minimum lease payments of $8 million . In addition, at December 31, 2018 , $25 million of the future minimum payments in the table above for sponsorship, licensing and other agreements was accrued. Consolidated rental expense for the Companys leased office space was $94 million , $77 million and $62 million for 2018 , 2017 and 2016 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $20 million , $22 million and $19 million for 2018 , 2017 and 2016 , respectively. Note 19. Income Taxes On December 22, 2017, U.S. Tax Reform was enacted into law with the effective date for most provisions being January 1, 2018. U.S. Tax Reform represents significant changes to the U.S. internal revenue code and, among other things: lowered the corporate income tax rate from 35% to 21% imposed a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduced further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations and eliminates the domestic production activities deduction. While the effective date of the law for most provisions was January 1, 2018, GAAP requires the effects of changes in tax rates be accounted for in the reporting period of enactment, which was the 2017 reporting period. Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 3,510 $ 3,482 $ 3,736 Foreign 3,694 3,040 1,910 Income before income taxes $ 7,204 $ 6,522 $ 5,646 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ $ 1,704 $ 1,074 State and local Foreign 1,589 2,521 1,607 Deferred Federal (228 ) (6 ) State and local (11 ) (2 ) Foreign (5 ) (49 ) (12 ) (244 ) (20 ) Income tax expense $ 1,345 $ 2,607 $ 1,587 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 7,204 $ 6,522 $ 5,646 Federal statutory tax 1,513 21.0 % 2,283 35.0 % 1,976 35.0 % State tax effect, net of federal benefit 0.6 % 0.7 % 0.4 % Foreign tax effect (92 ) (1.3 )% (380 ) (5.8 )% (188 ) (3.3 )% European Commission fine 2.7 % % % Foreign tax credits 1 (110 ) (1.5 )% (27 ) (0.4 )% (141 ) (2.5 )% Transition Tax 0.3 % 9.6 % % Remeasurement of deferred taxes (7 ) (0.1 )% 2.4 % % Windfall benefit (72 ) (1.0 )% (43 ) (0.7 )% % Other, net (149 ) (2.0 )% (55 ) (0.8 )% (82 ) (1.5 )% Income tax expense $ 1,345 18.7 % $ 2,607 40.0 % $ 1,587 28.1 % 1 Included within the impact of the 2018 foreign tax credits is a $90 million tax benefit relating to the carryback of certain foreign tax credits. Additionally, included in 2016 is a $116 million benefit associated with the repatriation of 2016 foreign earnings. There was no benefit associated with the repatriation of foreign earnings in 2018 and 2017 due to the enactment of U.S. Tax Reform. The effective tax rates for the years ended December 31, 2018, 2017 and 2016 were 18.7% , 40.0% and 28.1% , respectively. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $873 million attributable to U.S. Tax Reform in 2017, a lower 2018 statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate is also attributable to discrete tax benefits, relating primarily to $90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules in the proposed foreign tax credit regulations issued on November 28, 2018, along with provisions for legal matters in the United States. These benefits were partially offset by the nondeductible nature of the fine issued by the European Commission. See Note 20 (Legal and Regulatory Proceedings) for further discussion of the European Commission fine and U.S. merchant class litigation. The impact of U.S. Tax Reform for the period ending December 31, 2018 resulted in a net $75 million non-recurring tax benefit due to the carry back of certain foreign tax credits, incremental transition tax and the remeasurement of deferred taxes. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to U.S. Tax reform, which included provisional amounts of $825 million related to the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on 2017 repatriations. In addition, the MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Companys 2017 effective income tax rate versus 2016 was impacted by a more favorable geographic mix of earnings in 2017, partially offset by a lower U.S. foreign tax credit benefit. SAB 118 The Company was able to make reasonable estimates at December 31, 2017 and had recorded a provisional charge of $629 million related to the Transition Tax, $157 million for the remeasurement of the Companys net deferred tax asset in the U.S. and $36 million related to the change in assertion regarding the indefinite reinvestment of foreign earnings. However, these amounts were adjusted during the measurement period due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and Treasury of Notices and regulations, discussions with the Department of Treasury (Treasury), as well as interpretations of how accounting for income taxes should be applied. At the close of the measurement period, the Company has finalized its assessment of the impact of U.S. Tax Reform resulting in a Transition Tax liability of $687 million and a $150 million charge related to the remeasurement of the Companys net deferred tax assets in the U.S. In 2018, the Company recorded an increase in the transition tax liability of $36 million , with an offsetting decrease to its deferred tax liabilities. The Company recorded additional Transition Tax expense of $22 million and has recorded a $7 million reduction to the charge for the remeasurement of its net deferred tax assets. The adjustments in 2018 were primarily the result of additional administrative guidance and proposed regulations issued by the IRS and Treasury. The Transition Tax will be paid over eight annual installments. The initial installment of $55 million was due and paid by April 15, 2018. Additionally, the overpayment appearing on the 2017 U.S. federal tax return has been applied against the Companys Transition Tax liability. Approximately $509 million of the remaining tax due is recorded in other liabilities on the consolidated balance sheet at December 31, 2018. At December 31, 2017 the Company had reflected a current liability of $52 million and an other liability of $577 million . Under U.S. Tax Reform, for purposes of IRS examination of the Transition Tax, the statute of limitations is extended to six years. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2018, 2017 and 2016 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $212 million , or $0.20 per diluted share, $104 million , or $0.10 per diluted share, and $49 million , or $0.04 per diluted share, respectively. Intra-entity asset transfers During 2014, the Company implemented an initiative to better align its legal entity and tax structure with its operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property to a related foreign entity in the United Kingdom. The Company recorded a deferred charge related to the income tax expense on intercompany profits that resulted from the transfer. The tax associated with the transfer was deferred and amortized utilizing a 25 -year life. The deferred charge was included in other current assets and other assets on the consolidated balance sheet at December 31, 2017 in the amounts of $17 million and $352 million , respectively. The aforementioned deferred charge of $369 million at December 31, 2017 , was written off to retained earnings as a component of the cumulative-effect adjustment as of January 1, 2018. In addition, deferred taxes are a component of the cumulative-effect adjustment whereby the Company has recorded a $186 million deferred tax asset in this regard. See Note 1 (Summary of Significant Accounting Policies) for additional information related to this guidance. Indefinite Reinvestment In 2017, as a result of U.S. Tax Reform, among other things, the Company changed its assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates and recognized a provisional deferred tax liability of $36 million . In 2018, the Company completed its analysis of global working capital and cash needs. It is the Companys MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) present intention to indefinitely reinvest a portion of its historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the U.S. As part of its analysis, the Company determined that approximately $5.8 billion of the approximately $6.7 billion of unremitted foreign earnings as of December 31, 2017, were no longer permanently reinvested. Notwithstanding the fact that some earnings continue to be permanently reinvested, all historical earnings, approximately $7.0 billion , were taxed in the U.S. as part of transition tax pursuant to U.S. Tax Reform, of which $267 million was repatriated in 2017. Additionally, during 2018, the Company repatriated approximately $3.3 billion . As of December 31, 2018, the Company had approximately $2.5 billion of accumulated earnings to be repatriated in the future, for which $8 million of deferred tax benefit was recorded. The tax effect is primarily related to the estimated foreign exchange impact recognized when earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Earnings of approximately $0.9 billion remain permanently reinvested and the Company estimates that an immaterial U.S. federal and state and local income tax benefit would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses Unrealized gain/loss - 2015 Euro Notes Recoverable basis of deconsolidated entities Intangible assets 1 Previously taxed earnings and profits Other items Less: Valuation allowance (94 ) (91 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Intangible assets Property, plant and equipment Previously taxed earnings and profits Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ 1 On January 1, 2018 a $186 million deferred tax asset was established related to intra-entity transfers as discussed above. Both the 2018 and 2017 valuation allowances relate primarily to the Companys ability to recognize tax benefits associated with certain foreign net operating losses. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions (17 ) (1 ) (28 ) Settlements with tax authorities (18 ) (4 ) (2 ) Expired statute of limitations (12 ) (11 ) (15 ) Ending balance $ $ $ The entire unrecognized tax benefit of $164 million , if recognized, would reduce the effective tax rate. During 2018, there was a reduction to the balance of the Companys unrecognized tax benefits. This was primarily due to a favorable court decision and settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2018 and 2017 , the Company had a net income tax-related interest payable of $8 million and $10 million , respectively, in its consolidated balance sheet. Tax-related interest income /(expense) in the periods 2018 , 2017 and 2016, were not material. In addition, as of December 31, 2018 and 2017 , the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 20. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12% of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36% of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. Prior to the reversal of the settlement approval, merchants representing slightly more than 25% of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over 30 opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants motion to dismiss the opt-out merchant complaints for failure to state a claim. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. In January 2019, the district court issued an order granting preliminary approval of the settlement and authorized notice of the settlement to class members. Damages Class members will now have the opportunity to opt out of the class settlement agreement, after which the district court will schedule a hearing on final approval. The settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. As of December 31, 2018 and 2017 , Mastercard had accrued a liability of $915 million and $708 million , respectively, as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2018 and 2017 , Mastercard had $553 million and $546 million , respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted cash on its consolidated balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada . In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. In 2017, Mastercard recorded a provision for litigation of $15 million related to this matter. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The proposed settlement is subject to market testing by the EC before it is made binding in an EC decision. The EC has announced that Visa has entered into a parallel proposed settlement. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but includes a fine of 571 million . Mastercard incurred a charge of $654 million in the fourth quarter of 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $4 billion as of December 31, 2018 ). Mastercard has resolved over 2 billion (approximately $3 billion as of December 31, 2018 ) of these damages claims through settlement or judgment. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $237 million and $117 million in 2018 and 2016, respectively. There were no litigation charges relating to U.K. and Pan-European Merchant claimants in 2017. As detailed below, Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court ruled against both Mastercard and Visa on two of the three legal issues being considered, concluding that U.K. interchange rates restricted competition and that they were not objectively necessary for the payment networks. The appellate court sent the cases back to trial for reconsideration on the remaining issue concerning the lawful level of interchange. Mastercard and Visa have been granted permission to appeal the appellate court ruling to the U.K. Supreme Court. Mastercard expects the litigation process to be delayed pending the resolution of its appeal to the U.K. Supreme Court. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $18 billion as of December 31, 2018 ). In July 2017, the court denied the plaintiffs application for the case to proceed as a collective action. The plaintiffs were granted permission to appeal the denial of their collective action application and the appellate court heard an oral argument on the appeal in February 2019. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. The plaintiffs have filed a renewed motion for class certification, following the district courts denial of their initial motion. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. Note 21. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months ended December 31, 2018 multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under our rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows: December 31, 2018 December 31, 2017 (in millions) Gross settlement exposure $ 49,666 $ 47,002 Collateral held for settlement exposure (4,711 ) (4,360 ) Net uncollateralized settlement exposure $ 44,955 $ 42,642 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $377 million and $395 million at December 31, 2018 and 2017 , respectively, of which $297 million and $313 million at December 31, 2018 and 2017 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 22. Foreign Exchange Risk Management The Company monitors and manages its foreign currency exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign currency derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Derivatives The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currencies of the entity. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. As of December 31, 2018 and 2017 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercards derivative contracts are summarized below: December 31, 2018 December 31, 2017 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ (1 ) $ $ Commitments to sell foreign currency 1,066 (26 ) Options to sell foreign currency Balance sheet location Accounts receivable 1 $ $ Prepaid expenses and other current assets 1 Other current liabilities 1 (6 ) (30 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign currency derivative contracts General and administrative $ $ (75 ) $ (6 ) The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2018 and 2017 , as these contracts were not accounted for under hedge accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. The effect of a hypothetical 10% adverse change in U.S. dollar forward rates could result in a fair value loss of approximately $113 million on the Companys foreign currency derivative contracts outstanding at December 31, 2018 . Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of December 31, 2018 , the Company had a net foreign currency transaction pre-tax loss of $120 million in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 23. Segment Reporting Mastercard has concluded it has one operating and reportable segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 33% of total revenue in 2018 , 35% in 2017 and 38% in 2016 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2018 , 2017 or 2016 . The following table reflects the geographical location of the Companys property, plant and equipment, net, as of December 31: (in millions) United States $ $ $ Other countries Total $ $ $ 108 MASTERCARD INCORPORATED SUMMARY OF QUARTERLY DATA (Unaudited) 2018 Quarter Ended March 31 June 30 September 30 December 31 2018 Total (in millions, except per share data) Net revenue $ 3,580 $ 3,665 $ 3,898 $ 3,807 $ 14,950 Operating income 1,825 1,936 2,287 1,234 7,282 Net income 1,492 1,569 1,899 5,859 Basic earnings per share $ 1.42 $ 1.50 $ 1.83 $ 0.87 $ 5.63 Basic weighted-average shares outstanding 1,051 1,043 1,037 1,032 1,041 Diluted earnings per share $ 1.41 $ 1.50 $ 1.82 $ 0.87 $ 5.60 Diluted weighted-average shares outstanding 1,057 1,049 1,043 1,038 1,047 2017 Quarter Ended March 31 June 30 September 30 December 31 2017 Total (in millions, except per share data) Net revenue $ 2,734 $ 3,053 $ 3,398 $ 3,312 $ 12,497 Operating income 1,506 1,653 1,941 1,522 6,622 Net income 1,081 1,177 1,430 3,915 Basic earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.67 Basic weighted-average shares outstanding 1,078 1,070 1,063 1,057 1,067 Diluted earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.65 Diluted weighted-average shares outstanding 1,082 1,075 1,068 1,063 1,072 Note: Tables may not sum due to rounding. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2018 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +48,Mastercard,2017," ITEM 1. BUSINESS Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. Through our global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro, Cirrus and Masterpass. Our recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded our capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, we now offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions. We also provide value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. Our networks are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our Strategy We grow, diversify and build our business through a combination of organic growth and strategic investments, including acquisitions. Our ability to grow our business is influenced by personal consumption expenditure (PCE) growth, driving cash and check transactions toward electronic forms of payment, increasing our share in electronic payments and providing value-added products and services. In addition, our ability to grow our business extends to other payments flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government disbursements, among others. We have enhanced our capabilities to capture these payment flows through a combination of product offerings and expanded solutions for our customers. As a result, the total market opportunity for our addressable payment flows is approximately $225 trillion. Grow . We focus on growing our core businesses globally, including growing our consumer credit, debit, prepaid and commercial products and solutions, thereby increasing the number of payment transactions we switch. We also look to take advantage of the opportunities presented by the evolving ways people interact and transact in the growing digital economy. Diversify . We diversify our business by: adding new players to our customer base in new and existing markets by working with partners such as governments, merchants, technology companies (such as digital players and mobile providers) and other businesses expanding capabilities based on our core network into new areas to provide opportunities for electronic payments and to capture more payment flows, such as B2C transfers, B2B transfers, P2P transfers, including in the areas of transit and government disbursements driving acceptance at merchants of all sizes broadening financial inclusion for the unbanked and underbanked Build . We build our business by: creating and acquiring differentiated products to provide unique, innovative solutions that we bring to market, such as real-time account-based payment, Mastercard B2B Hub and Mastercard Send platforms providing value-added services across safety and security, consulting, data analytics, processing and loyalty. Strategic Partners . We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for Mastercard-branded products. We help merchants, financial institutions and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer experiences. We partner with technology companies such as digital players and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments drive increased financial inclusion and efficiency, reduce costs, increase transparency to reduce crime and corruption and advance social programs. For consumers, we provide better, safer and more convenient ways to pay. Recent Business and Legal/Regulatory Developments Digital Payments . Numerous trends in the digital economy, such as demand for faster payments and the application of emerging technology, present opportunities for growth and impetus for change in our business. We have launched and extended products and platforms that take advantage of the growing digital economy, where consumers are increasingly using technology to interact with other consumers and merchants. Among our recent developments in 2017 we: expanded our use of Masterpass globally, which is live in dozens of markets around the world. Masterpass is a global digital payment service that allows consumers to make fast, simple and secure transactions on any device and across any channel. Over the last year, we have enhanced the browser and in-app checkout experience globally and made significant platform improvements to make it easier and faster for consumers to checkout. We have also launched a new merchant onboarding experience and a new package of software to make it easier for merchants to integrate with Masterpass. continued to expand and scale Mastercard Send capabilities, using HomeSend, to connect more people, businesses and governments to facilitate the transfer of funds quickly and securely both domestically and cross-border in over 100 markets. broadened our acceptance solutions to offer Quick Response (QR) codes under a common set of new global specifications developed in conjunction with EMVCo and other industry players. Masterpass QR provides people with mobile phones the ability to safely make in-person purchases without a card and avoids the need for expensive point of sale equipment. Real-time Account-based Payment Systems. In 2017, we completed the acquisition of a controlling interest in Vocalink. Vocalink operates systems for ACH payments and ATM processing platforms in the United Kingdom and other countries. ACH payments constitute a significant amount of all payments made by consumers, businesses and governments. Adding ACH payments to our core card-based business will expand our ability to offer more electronic payment options to consumers, businesses and governments, and help us capture more payment flows. Safety and Security. As new technologies and cyber-security threats evolve, including organized cyber-crime and nation state attacks, there is a growing need to protect transactions and peoples identities regardless of the device or channel used to make a purchase, while at the same time continuing to improve the payment experience for all stakeholders. Our focus on security is embedded in our products, our systems and our networks, as well as our analytics to prevent fraud. In 2017, we: acquired Brighterion, Inc., a software company specializing in Artificial Intelligence (AI), that enhances our networks, improves our existing product suite and helps us build the next generation of solutions to tackle fraud and cybersecurity threats. acquired NuData Security, a global technology company that helps businesses prevent online and mobile fraud using session and behavioral biometric indicators, to enhance security of the internet of things (the IoT), including device-level security and authentication. launched Early Detection System, a service that provides issuers with a unique predictive capability to identify accounts with a heightened risk of fraud based on their exposure to security incidents or data breaches. Early Detection System determines if an account is at risk and sends an alert to the issuer with a quantification of the level of risk. The issuer then uses the level of risk to more accurately prioritize what action to take; from monitoring transactions more closely to proactively issuing a replacement card. embedded AI across our network with Decision Intelligence, a comprehensive decision and fraud detection solution that utilizes our networks to increase approvals and reduce false declines. This solution now applies AI scoring to every processed transaction on our networks and is used by multiple issuers globally. expanded Safety Net, a technology that intelligently detects and blocks large scale fraud events resulting from cyber-attacks against our issuers. This technology now features new advanced detection capabilities, and acts as an extra layer of defense for every issuer we work with globally, monitoring every processed transaction on our networks. helped stakeholders to increase approvals and reduce declines for consumers with our account continuity solution, Automated Billing Updater. This solution automatically updates expired card numbers at merchant card-on-file locations and is increasingly used by major digital merchants. leveraged MDES to tokenize Masterpass and enable third-party token vaults compliant with EMV (the global standard for chip technology) to tokenize Mastercard-branded products and services and extended the utility of MDES to tokenize credentials-on-file. Commercial. Our market share in commercial products is growing globally, as we offer solutions with travel and entertainment, procurement, fleet and virtual cards. We estimate there is $120 trillion in addressable payment flows in B2B globally, of which approximately $100 trillion is related to accounts payable. To address this opportunity, we are expanding our capabilities to capture non-carded payment flows with new solutions, such as the Mastercard B2B Hub, Mastercard Send for cross-border payments, and real-time account-based payment systems for ACH transactions. We launched the innovative Mastercard B2B Hub platform in 2017 to enable small and midsized businesses to optimize their invoice and payment processes with automation tools that improve the speed, ease and security of their commercial payments. Financial Inclusion . We are focused on addressing financial inclusion, reaching people without access to an account that allows them to store and use money. In 2015, we made a commitment to reach 500 million people previously excluded from financial services by 2020. We are more than halfway to delivering on that commitment. In 2017, we worked with governments across several geographies to develop and roll out electronic payments solutions, social payment distribution mechanisms and digital identity solutions. We also worked with merchants globally to help drive acceptance necessary to support these inclusion efforts. Legal and Regulatory . We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny, expansion of local regulatory schemes and other legal challenges, particularly with respect to interchange fees (as discussed below under Our Operations and Network). These create both risks and opportunities for our industry. See Part I, Item 1A for a more detailed discussion of our legal and regulatory developments and risks. Also see Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Our recent legal and regulatory developments include: European Union In 2015, the European Commission issued a statement of objections related to the interregional interchange rates we set and our central acquiring rules within the European Economic Area (the EEA). The statement of objections preliminarily concludes that these practices have anticompetitive effects, and the European Commission has indicated it intends to seek fines if it confirms these conclusions. We submitted a response in April 2016 and participated in a related oral hearing in May 2016. Since that time, we have remained in discussions with the European Commission and expect to obtain greater clarity with respect to these issues in the first half of 2018. E.U. member states were required to finish transposing the EEAs revised Payment Services Directive (commonly referred to as PSD2) into their national laws by January 2018. This directive requires financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. This directive also requires a new standard for authentication of transactions, which requires additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. In 2016, the European Parliament passed the General Data Protection Regulation (the GDPR), a new data protection regulation that will increase our compliance burden for using and processing personal and sensitive data of EEA residents. We have implemented an approach to achieve compliance by the May 2018 deadline. United States Merchant Class Litigation. In June 2016, the U.S. Court of Appeals for the Second Circuit reversed the approval of a settlement of an antitrust litigation among a class of merchants, Mastercard, Visa and a number of financial institutions. The court vacated the class action certification and sent the case back to the district court for further proceedings. The parties are proceeding with discovery while at the same time are involved in mediation. Tax Cuts and Jobs Act. On December 22, 2017, the U.S. passed a comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the TCJA). Among other things, the TCJA reduces the U.S. corporate income tax rate from 35% to 21% in 2018, puts into effect the migration towards a territorial tax system and imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax). The enactment of the tax legislation has resulted in additional tax expense of $873 million in the fourth quarter and year ended December 31, 2017, due primarily to provisional amounts recorded for the Transition Tax and the remeasurement of U.S. deferred tax assets and liabilities at lower enacted corporate tax rates. These provisional amounts are based on our initial analysis of the TCJA and may be adjusted in 2018. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. United Kingdom Beginning in May 2012, a number of retailers filed claims or threatened litigation against us seeking damages for alleged anti-competitive conduct with respect to our cross-border interchange fees and our U.K. and Ireland domestic interchange fees. In 2016, a tribunal in one of these cases issued a judgment against us for damages, and we entered into settlements with additional claimants. In January 2017, we received a favorable liability judgment on all significant matters in a separate action brought by ten of the claimants (who were seeking over $500 million in damages). Both the negative judgment and positive judgment for us are being appealed before the U.K. appellate court. In connection with the Vocalink part of our business, we expect to enter into a period of consultation with the U.K. Treasury regarding the possible extension of the U.K. payment systems oversight regime to include Vocalinks role as a service provider. China - In 2017, Peoples Bank of China issued the Service Guidelines for Market Access of Bank Card Clearing Institutions, providing more guidance and clarity in addition to the 2016 regulations on license application and operational requirements for network operators, including international networks such as ours, to process domestic payments in China. We have been engaged with regulators and other stakeholders in connection with steps required to advance an application. In the meantime, we continue to work to expand issuance and acceptance of Mastercard-branded products in the Chinese market to support our existing cross-border business and to prepare for potential domestic opportunities. Our Business Our Operations and Network We operate a unique and proprietary global payments network, our core network, that links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We authorize, clear and settle transactions through our core network for our issuer customers in more than 150 currencies and in more than 210 countries and territories. Our acquisition of Vocalink expands our range of payment capabilities beyond our core network. Typical Transaction . Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate, as further described below), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs consumers and merchants incur. We do not earn revenues from interchange fees. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for their customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate, and issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the determination and exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and issuer country are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the issuer country are the same (domestic transactions). We switch approximately half of all transactions using Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Outside of these countries, most domestic transactions on our products are switched without our involvement. Our Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It features an intelligent architecture that enables the network to adapt to the needs of each transaction by blending two distinct network structures: a distributed (peer-to-peer) switching structure for transactions that require fast, reliable switching to ensure they are switched close to where the transaction occurred; and a centralized (hub-and-spoke) switching structure for transactions that require value-added switching, such as real-time access to transaction data for fraud scoring or rewards at the point-of-sale. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Systems. Augmenting our core network, we now offer real-time account-based payments through our acquisition of Vocalink, which enables payments between bank accounts in near real-time in countries in which it has been deployed. Payments System Security. Our networks and products are designed to ensure safety and security for the global payments system. The networks incorporate multiple layers of protection, both for continuity purposes and to provide best-in-class security protection. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, a business continuity program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our networks support and enable our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. Customer Risk. We guarantee the settlement of many of the transactions between our issuers and acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers, or the availability of unspent prepaid account holder account balances. Our Products and Services We provide a wide variety of integrated products and services that support payment products that customers can offer to their account holders. These services facilitate transactions on our core network among account holders, merchants, financial institutions, businesses, governments, and other organizations in markets globally. Core Products Consumer Credit and Charge. We offer a number of programs that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid programs involve a balance that is funded prior to use and can be accessed via one of our payment products. We offer prepaid payment programs using any of our brands, which we support with processing products and services. Segments on which we focus include government programs such as Social Security payments, unemployment benefits and others; commercial programs such as payroll, health savings accounts, employee benefits and others; and reloadable programs for consumers without formal banking relationships and non-traditional users of electronic payments. We also provide prepaid program management services, primarily outside of the United States, that manage and enable switching and issuer processing for consumer and commercial prepaid travel cards for business partners such as financial institutions, retailers, telecommunications companies, travel agents, foreign exchange bureaus, colleges and universities, airlines and governments. Commercial. We offer commercial payment products and solutions that help large corporations, midsized companies, small businesses and government entities streamline their procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our offerings and platforms include premium, travel, purchasing and fleet cards and programs; our SmartData tool that provides information reporting and expense management capabilities; and credit and debit programs targeted for small businesses. The following chart provides GDV and number of cards featuring our brands in 2017 for select programs and solutions: Year Ended December 31, 2017 As of December 31, 2017 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2016 Mastercard Branded Programs 1,2 Consumer Credit $ 2,289 % % % Consumer Debit and Prepaid 2,369 % % % Commercial Credit and Debit % % % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Article 8 of the E.U. Interchange Fee Regulation related to card payments, which became effective in June 2016, states that a network can no longer charges fees on domestic EEA payment transactions that do not use its payment brand. Prior to that, Mastercard collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non-Mastercard co-badged volume is no longer being included. Please see Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations for a further discussion. Digital . Leveraging our global innovations capability, we are developing platforms, products and solutions in digital payments that help our customers and partners to offer digital solutions: Delivering better digital experiences everywhere. We work to enable digital payment services across all channels and devices. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base and are developing products and practices to facilitate acceptance via mobile devices. The successful implementation of our loyalty and reward programs is an important part of enabling these digital purchasing experiences. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. Through Mastercard Send, we provide money transfer and global remittance solutions to enable our customers to facilitate consumers sending and receiving money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows with the goal of enabling the movement of money from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best in class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, our global innovation and development arm, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Additional Platforms. We offer commercial payment products and solutions that utilize additional payment platforms that are in addition to our core network - for example, Mastercard B2B Hub, which enables small and midsized businesses to optimize their invoice and payment processes. In addition, through our acquisition of Vocalink, we offer real-time account-based payments for ACH transactions and will be able to offer commercial solutions utilizing these capabilities. These networks enable payments between bank accounts in near real-time and have key attributes, including enhanced data and messaging capabilities, making them particularly well-suited for B2B and bill payment flows. The real-time account-based payment landscape is rapidly evolving as more markets introduce real-time account-based payment infrastructure. Value-Added Products and Services We provide additional integrated products and services to our customers and stakeholders, including financial institutions, retailers and governments that enhance the value proposition of our products and networks. Safety and Security. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number EMV cards issued and the transaction volume on EMV cards. While this technology is prevalent in Europe, the U.S. market has been adopting this technology in recent years. The Identify layer allows us to help banks and merchants verify genuine consumers during the payment process. Examples of solutions under this layer include Mastercard Identity Check, a fingerprint, face and iris scanning biometric technology to verify online purchases on mobile devices, and our recently launched Biometric Card which has a fingerprint scanner built in to the card and is compatible with existing EMV payment terminals The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Examples of our capabilities under this layer include our Early Detection System, Decision Intelligence and Safety Net services and technologies. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, improving approvals for online and card-on-file payments, to the ability to differentiate good consumers from fraudsters. Our offerings in this space include Mastercard In Control, for consumer alerts and controls and our suite of digital token services available through our Mastercard Digital Enablement Service (MDES). We have also worked with our financial institution customers to provide products to consumers globally with increased confidence through the benefit of zero liability, or no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards . We have built a scalable rewards platform that enables financial institutions to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions for our customers. Mastercard Advisors . Mastercard Advisors is our global professional services group that provides proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Mastercard Advisors capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and staff augmentation allow us to assist clients implement actions based on these insights. Increasingly, Mastercard Advisors has been helping financial institutions, retailers and governments innovate. Drawing on rapid prototyping methodologies from our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five day app prototyping workshop that is one of our fastest growing offerings globally. Through our Applied Predictive Technology business, a software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests. Brand Our family of well-known brands includes Mastercard, Maestro, Cirrus and Masterpass. We manage and promote our brands through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, usage and overall preference among account holders globally. Our Priceless advertising campaign, which has run in 54 languages in 119 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. We have extended Priceless to create experiences through four platforms to drive brand preference: Priceless Cities provides account holders across all of our regions with access to special experiences in various cities, Priceless Causes provides account holders with opportunities to support philanthropic causes, Priceless Specials TM provides account holders with merchant offers and discounts and Priceless Surprises provides account holders with unexpected and unique surprises. Our Revenue Sources We generate revenues primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessment fees, cross-border volume fees, transaction processing fees, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payments solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems and other matters, many of which are important to our business operations. Patents are of varying duration depending on the jurisdiction and filing date. Competition We compete in the global payments industry against all forms of payment including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments, wire transfers, electronic benefits transfers and bill payments We face a number of competitors both within and outside of the global payments industry: Cash, Check and legacy ACH . Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. When combined, cash, checks and legacy ACH payments represent 90 percent of the $225 trillion of addressable payment flows. General Purpose Payment Networks . We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some of the competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively for a more detailed discussion. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes that are focused mostly on debit (including MIR in Russia). Competition for Customer Business . We compete intensely with other payments networks for customer business. Globally, financial institutions typically issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. We also compete for non-financial institution partners, such as merchants, governments and mobile providers. Real-time Account-based Payment Systems. Through our acquisition of Vocalink, we now face competition in the real-time account-based payment space from other companies that provide these payment solutions. In addition, real-time account-based payments face competition from other payment methods, such as cash and checks, credit cards, electronic, mobile and e-commerce payment platforms, cryptocurrencies and other payments networks. Alternative Payments Systems and New Entrants . As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. In some circumstances, these providers can be a partner or customer, as well as a competitor. Value-Added Products and Services. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, as well as companies that compete against us as providers of loyalty and program management solutions. In addition, our integrated products and services offerings face competition and potential displacement from transaction processors throughout the world, which are seeking to enhance their networks that link issuers directly with point-of-sale devices for payment transaction authorization and processing services. Regulatory initiatives could also lead to increased competition in this space. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over 50 years expertise in real-time account-based payments through our Vocalink acquisition adoption of innovative products and digital solutions Masterpass global digital payments ecosystem safety and security solutions embedded in our networks Mastercard Advisors group dedicated solely to the payments industry ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. See Risk Factors in Part I, Item 1A for more detail and examples. Payments Oversight . Several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. Actions by these organizations could influence other organizations around the world to adopt or consider adopting similar oversight. As a result, Mastercard could be subject to new regulation, supervisions and examination requirements. For example, in the U.K., the Bank of England has expanded its oversight of systemically important payment systems to include service providers, as well. Also, in the EEA, the implementation of the revised Payment Services Directive (PSD2) will require financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. PSD2 will also require a new standard for authentication of transactions, which necessitate additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Interchange Fees. Interchange fees associated with four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities and European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the EEA. For more detail, see our risk factors in Risk Factors-Regulations Related to Our Participation in the Payments Industry in Part I, Item 1A. Also see Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. Payments System Regulation . Regulators in several countries around the world either have, or are seeking to establish, authority to regulate certain aspects of the payments systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switched transactions and other processing in terms of how we go to market, make decisions and organize our structure. Additionally, several jurisdictions have created or granted authority to create new regulatory bodies that either have or would have the authority to regulate payment systems, including the United Kingdoms Payments Systems Regulator (PSR) (which has designated us (including our Vocalink business) as a payments system subject to regulation) and the National Bank of Belgium. Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter terrorist financing (CTF) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist- sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks and other financial institutions in their capacity as issuers and otherwise, impacting us as a consequence. Such regulations and investigations have been related to payment card add-on products, campus cards, bank overdraft practices, fees issuers charge to account holders and the transparency of terms and conditions. Additionally, regulations such as PSD2 in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to provide payment initiation and account information services directly to consumers. Regulation of Internet and Digital Transactions . Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security, copyright and trademark infringement and privacy. Data Protection and Information Security. Aspects of our operations or business are subject to privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we will be subject to the pending GDPR which goes into effect in May of 2018. This law will require a comprehensive data protection and privacy program to protect the personal and sensitive data of European citizens and residents. Due to constant changes to the nature of data, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world considering proposals to protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, privacy, disclosure rules, security and marketing that would impact our customers directly. Seasonality See Managements Discussion and Analysis of Financial Condition and Results of Operations-Seasonality in Part II, Item 7. Financial Information About Geographic Areas See Note 21 (Segment Reporting) to the consolidated financial statements included in Part II, Item 8 for certain geographic financial information. Employees As of December 31, 2017 , we employed approximately 13,400 persons, of whom approximately 7,900 were employed outside of the United States. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated (Mastercard International), a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 13 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. In addition, you may automatically receive email alerts and other information about Mastercard by enrolling your email address by visiting Investor Alerts in the investor relations section of our corporate website. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. You may also read and copy any materials that we file with the SEC at its Public Reference Room at 100 F Street N.E., Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, our filings are available electronically from the SEC at www.sec.gov. "," ITEM 1A. RISK FACTORS Legal and Regulatory Direct Regulation of the Payments Industry Global regulatory and legislative activity related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate, or establish or expand their authority to regulate, certain aspects of payments systems such as ours. Some recent examples of regulatory and legislative activity include: The European Unions adoption of its Interchange Fee Regulation in 2015 regulating electronic payments issued and acquired within the EEA, including caps on consumer credit and debit interchange fees (described in more detail in the risk factors below) and the separation of brand and switching (which Mastercard implemented in 2016) Several jurisdictions creation or grant of authority to create new regulations that either have or would enable the authority to regulate or increase formal oversight over payment systems, including the United Kingdom and India (both of which have designated us as a payments system subject to regulation), as well as Brazil, Hong Kong, Mexico and Russia The EEAs implementation of the revised PSD2, which requires: financial institutions to provide third party payment processors access to consumer payment accounts. This may enable these third party payment processors to route transactions away from Mastercard products by offering account information or payment initiation services directly to people who currently use our products. a different standard for authentication of transactions (strong customer authentication (SCA), as opposed to risk-based authentication). The new authentication standard requires additional verification information from consumers to complete transactions and may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience. An increase in the rate of abandoned transactions could adversely impact our volumes or other operations metrics. These regulations have established, and could further expand, obligations or restrictions with respect to the types of products and services that we may offer to financial institutions for consumers, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). In addition, several central banks or similar regulatory bodies around the world that have increased, or are seeking to increase, their formal oversight of the electronic payments industry and, in some cases, are considering designating certain payments networks as systemically important payment systems or critical infrastructure. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. As a result, increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. Such laws or compliance burdens could result in issuers being less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. Regulators could also require us to obtain prior approval for changes to its system rules, procedures or operations, or could require customization with regard to such changes, which could impact market participant risk and therefore risk to us. Such regulatory changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route debit transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking, low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. Examples of regulatory and legislative activity include: A Statement of Objections issued by the European Commission in July 2015 related to our interregional interchange fees and central acquiring rules within the EEA, to which we have responded and remain in discussions. Legislation regulating the level of domestic interchange rates that has been enacted, or is being considered, in many jurisdictions (for example, debit interchange in the United States is capped by statute for certain regulated entities). Merchants and consumers are also seeking interchange fee reductions and acceptance rule changes through litigation. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, any changes to interregional interchange fees as a result of the European Commissions Statement of Objections could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek to decrease the expense of their payment programs by seeking a reduction in the fees that we charge to them, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result in us being fined and/or having to pay civil damages, the amount of which could be material. Current regulatory activity could be extended to additional jurisdictions or products, which could materially and adversely affect our overall business and results of operations. Regulators around the world increasingly replicate other regulators approaches with regard to the regulation of payments and other industries. Consequently, regulation in any one country, state or region may influence regulatory approaches in other countries, states or regions. Similarly, new laws and regulations within a country, state or region involving one product may lead to regulation of similar or related products. For example, regulations affecting debit transactions could lead to regulation of other products (such as credit). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. These include matters like interchange rates, potential direct regulation of our network fees and pricing, network standards and network exclusivity and routing agreements. Conversely, if widely varying regulations come into existence worldwide, we may have difficulty adjusting our products, services, fees and other important aspects of our business to meet the varying requirements. Either of these outcomes could materially and adversely affect our overall business and results of operations. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries are considering, or may consider, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. In particular, we are currently excluded from domestic switching in China and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. In 2017, Peoples Bank of China issued the Service Guidelines for Market Access of Bank Card Clearing Institutions, which provide some guidance on the 2016 regulations on license application and operational requirements for network operators to process domestic payments in China. We have been engaged with regulators, business partners and other stakeholders in connection with steps required to advance an application. Additionally, Russia has amended its National Payments Systems laws to require all payment systems to process domestic transactions through a government-owned payment switch. As a result, all of our domestic transactions in Russia are currently processed by that system instead of by us. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries, such as the Gulf Cooperation Countries in the Middle East and a number of countries in South East Asia, are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our efforts to effect change in, or work with, these countries may not succeed. This could adversely affect our ability to maintain or increase our revenues and extend our global brand. Regulation Related to Our Participation in the Payments Industry Regulations that directly or indirectly affect the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business-Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption - We are subject to AML and CTF laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by OFAC. We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including the SDN List. We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. A violation and subsequent judgment or settlement against us, or those with whom we may be associated, under these laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Financial Sector Oversight - In the United States, we are subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. These regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. It is often not clear whether and/or to what extent these institutions will regulate broader aspects of payment networks. Real-time Account-based Payment Systems In 2017, we completed the acquisition of a controlling interest in Vocalink. In the U.K., the Bank of England has expanded its oversight of certain payment system providers that are systemically important to U.K.s payment network. As a result of these changes, aspects of our Vocalink business could become subject to the U.K. payment system oversight regime and be directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Our financial institution customers are subject to numerous regulations, which impact us as a consequence. In addition, certain regulations, such as PSD2 in the EEA, may disintermediate issuers. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. In addition, existing or new regulations in these or other areas may diminish the attractiveness of our products to our customers. Regulation of Internet and Digital Transactions - Proposed legislation in various jurisdictions relating to Internet gambling and other digital areas such as cyber-security, copyright, trademark infringement and privacy could impose additional compliance burdens on us and/or our customers, including requiring us or our customers to monitor, filter, restrict, or otherwise oversee various categories of payment transactions. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. Each may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws may impact our effective tax rate and tax payments. For example, the recent U.S. tax legislation enacted on December 22, 2017 represents a significant overhaul of the U.S. federal tax code. This tax legislation reduced the U.S. statutory corporate tax rate and made other changes that could have a favorable impact on our overall U.S. federal tax liability in a given period. However, the tax legislation also included a number of provisions that limit or eliminate various deductions, including interest expense, performance-based compensation for certain executives and the domestic production activities deduction, among others, that could affect our U.S. federal income tax position. We are continuing to evaluate the overall impact of this tax legislation on our operations and U.S. federal income tax position. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. While we expect the TCJA to be favorable to the Company overall, there can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective tax rate, tax payments, financial condition and results of operations. Privacy, Data Protection and Security Regulation of privacy, data protection, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to regulations related to privacy, data protection and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated products and services to meet the needs of a changing marketplace, we may expand our information profile through the collection of additional data across multiple channels. This expansion could amplify the impact of these regulations on our business. Regulation of privacy and data protection and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage and/or security of personal and sensitive information. In addition, due to the European Parliaments passage of the GDPR and the European Court of Justices invalidation of the Safe Harbor treaty, we are subject to enhanced compliance and operational requirements in the European Union. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or reinterpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and could impact aspects of our business such as fraud monitoring, the development of information-based products and solutions and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events, as well as the disclosure of the monitoring activities by certain governmental agencies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity could encourage regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer account information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to regulatory intervention, such as enhanced security requirements, as well as damage to our reputation. Litigation Liabilities we may incur for any litigation that has been or may be brought against us could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Limitations on our business resulting from litigation or litigation settlements may materially and adversely affect our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Within the global general purpose payments industry, we face substantial and increasingly intense competition worldwide. In certain jurisdictions, including the United States, Visa has greater volume, scale and market share than we do, which may provide significant competitive advantages. Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors, including American Express, Discover, private-label card networks and certain alternative payments systems, operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business-Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also more effectively introduce their own innovative programs and services that adversely impact our growth. We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation in the EEA may disintermediate us by enabling third-party processors opportunities to route payment transactions away from our networks and towards other forms of payment. Although we partner with technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and data privacy standards, without proper oversight we could inadvertently share too much data which could give the partner a competitive advantage. Competitors, customers, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment services that compete with our services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. Over the past several years, we have experienced continued pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to process additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and programs that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a new real-time account-based payments network in connection with our Vocalink acquisition presents risks that could materially affect our business. Our acquisition of Vocalink in 2017 added real-time account-based payment technology to the suite of capabilities we offer. While expansion into this space presents business opportunities, there are also regulatory and operational risks associated with administering a new type of payments network and with integrating this acquisition into our business. Operating a new type of payments system presents new regulatory and operational risks. English regulators have designated this platform to be critical national infrastructure and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payments systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payments platform, see our risk factor in Risk Factors - Regulation Related to Our Participation in the Payments Industry in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. While we are leveraging Vocalinks talent and expertise, we may face challenges in adapting to the complex requirements of operating a new payments system. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payments network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. We are also working to embed the new products and technology acquired from Vocalink into our existing markets. This product convergence requires tight working relationships and integration with the people and corporate culture of Vocalink as a critical success factor. Not managing the integration successfully could result in larger-than-expected integration costs, which could be significant. If we fail to successfully embed these new technologies, we may lose existing Vocalink business and may not remain competitive in our payment technology offerings as compared to our competitors. See our risk factor in Risk Factors - Acquisitions in this Part I, Item 1A for more information on risks relating to the integrating our acquisitions. Working with new customers and end users as we expand our integrated products and services can present operational challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments market, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. Our failure to render these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added systems), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. We maintain an information security program, a business continuity program and insurance coverage (each reviewed by our Board of Directors and its Audit Committee), and our processing systems incorporate multiple levels of protection, in order to address or otherwise mitigate these risks. We also continually test our systems to discover and address any potential vulnerabilities. Despite these mitigation efforts, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. These events, some of which have been high profile, typically involve external agents hacking the merchants or third-party processors systems and installing malware to compromise the confidentiality and integrity of those systems. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings may experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a business continuity program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Financial Institution Customers and Other Stakeholder Relationships Losing a significant portion of business from one or more of our largest financial institution customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our financial institution customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest financial institution customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. See our risk factor in Risk Factors Risks Related to Our Participation in the Payments Industry in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination of, the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor exposes us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of: principal customers, which are customers that participate directly in our programs and are responsible for their own settlement and other activities as well as those of their sponsored affiliate customers affiliate debit licensees In this capacity, we are exposed to risk of loss or illiquidity: We may incur obligations in connection with transaction settlements if an issuer or acquirer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. If our principal customer or affiliate debit licensee is unable to fulfill its settlement obligations to other customers, we may bear the loss. Although we are not obligated to do so, we may elect to keep merchants whole if an acquirer defaults on its merchant payment obligations, or to keep prepaid cardholders whole if an issuer defaults on its obligation to safeguard unspent prepaid funds. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our overall business and liquidity. Even if we have sufficient liquidity to cover a settlement failure, we may not be able to recover the cost of such a payment and may therefore be exposed to significant losses, which could materially and adversely affect our results of operations. Should an event occur that would trigger any significant indemnification obligation which we owe to any customers or other companies, such an obligation could materially and adversely affect our overall business and results of operations. We mitigate the contingent risk of a settlement failure using various strategies, including monitoring our customers financial condition, their economic and political operating environments and their compliance with our participation standards. For more information on our settlement exposure and risk assessment and mitigation practices, see Note 19 (Settlement and Other Risk Management) to the consolidated financial statements included in Part II, Item 8. Global Economic and Political Environment Global financial market activity could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends (including distress in financial markets, turmoil in specific economies around the world and additional government intervention) have impacted the environment in which we operate. The condition of the economic environment may accelerate the timing of or increase the impact of risks to our financial performance. Such impact may include, but is not limited to, the following: Our customers may: restrict credit lines to account holders or limit the issuance of new Mastercard products to mitigate increasing account holder defaults implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability default on their settlement obligations, including as a result of sovereign defaults, causing a liquidity crisis for our other customers Consumer spending can be negatively impacted by: declining economies, foreign currency fluctuations and the pace of economic recovery, which can change cross-border travel patterns, on which a significant portion of our revenues is dependent low levels of consumer and business confidence typically associated with recessionary environments and those markets experiencing relatively high unemployment Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products. Tightening of credit availability could impact the ability of participating financial institutions to lend to us under the terms of our credit facility. Any of these developments could have a material adverse impact on our overall business and results of operations. A decline in cross-border activity could adversely affect our results of operations. We switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity may be adversely affected by world geopolitical, economic, weather and other conditions. These include the threat of terrorism and outbreaks of flu, viruses and other diseases. Additionally, any regulation of interregional interchange fees could negatively impact our cross-border activity, which could decrease the revenue we receive. Any such decline in cross-border activity could materially adversely affect our results of operations. Negative trends in spending could negatively impact our results of operations. The global payments industry depends heavily upon the overall level of consumer, business and government spending. General economic conditions (such as unemployment, housing and changes in interest rates) and other political conditions (such as devaluation of currencies and government restrictions on consumer spending) in key countries in which we operate may adversely affect our financial performance by reducing the number or average purchase amount of transactions involving our products. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2017 , approximately 65% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. The United Kingdoms proposed withdrawal from the European Union could harm our business and financial results. In June 2016, voters in the United Kingdom approved the withdrawal of the U.K. from the E.U. (commonly referred to as Brexit). The U.K. government triggered Article 50 of the Lisbon Treaty on May 29, 2017, which commenced the official E.U. withdrawal process. Uncertainty over the terms of the U.K.s departure from the E.U. could cause political and economic uncertainty in the U.K. and the rest of Europe, which could harm our business and financial results. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations in the U.K. and E.U. We, as well as our clients who have significant operations in the U.K., may incur additional costs and expenses as we adapt to potentially divergent regulatory frameworks from the rest of the E.U. In addition, because we conduct business in and have operations in the U.K., we may need to apply for regulatory authorization and permission in separate E.U. member states. We may also face additional complexity with regard to immigration and travel rights for our employees located in the U.K. and the E.U. These factors may impact our ability to operate in the E.U. and U.K. seamlessly. Any of these effects of Brexit, among others, could harm our business and financial results. Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Additionally, large digital companies and other technology companies who are our customers use our networks to build their own acceptance brands, which could cause consumer confusion and decrease the value of our brand. Moreover, adverse developments with respect to our industry or the industries of our customers may also, by association, impair our reputation, or result in greater regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Such perception and damage to our reputation could have a material and adverse effect to our overall business. Acquisitions Acquisitions, strategic investments or entry into new businesses could disrupt our business and harm our results of operations or reputation. Although we may continue to evaluate and/or make strategic acquisitions of, or acquire interests in joint ventures or other entities related to, complementary businesses, products or technologies, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 9, 2018 , Mastercard Foundation owned 112,181,762 shares of Class A common stock, representing approximately 10.8% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2017 , Mastercard and its subsidiaries owned or leased 167 commercial properties. We own our corporate headquarters, located in Purchase, New York. The building is approximately 500,000 square feet. There is no outstanding debt on this building. Our principal technology and operations center, a leased facility located in OFallon, Missouri, is also approximately 500,000 square feet. The term of the lease on this facility is 10 years, which commenced on March 1, 2009. Our leased properties in the United States are located in 10 states and in the District of Columbia. We also lease and own properties in 69 other countries. These facilities primarily consist of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," ITEM 3. LEGAL PROCEEDINGS Refer to Notes 10 (Accrued Expenses and Accrued Litigation) and 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Price Range of Common Stock Our Class A common stock trades on the New York Stock Exchange under the symbol MA. The following table sets forth the intra-day high and low sale prices for our Class A common stock for the four quarterly periods in each of 2017 and 2016 . At February 9, 2018 , we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. High Low High Low First Quarter $ 113.50 $ 104.01 $ 95.83 $ 78.52 Second Quarter 126.19 111.01 100.00 87.59 Third Quarter 143.59 120.65 102.31 86.65 Fourth Quarter 154.65 140.61 108.93 99.51 There is currently no established public trading market for our Class B common stock. There were approximately 307 holders of record of our non-voting Class B common stock as of February 9, 2018 , constituting approximately 1.3% of our total outstanding equity. Dividend Declaration and Policy During the years ended December 31, 2017 and 2016 , we paid the following quarterly cash dividends per share on our Class A common stock and Class B Common stock: Dividend per Share First Quarter $ 0.22 $ 0.19 Second Quarter 0.22 0.19 Third Quarter 0.22 0.19 Fourth Quarter 0.22 0.19 On December 4, 2017, our Board of Directors declared a quarterly cash dividend of $0.25 per share paid on February 9, 2018 to holders of record on January 9, 2018 of our Class A common stock and Class B common stock. On February 5, 2018, our Board of Directors declared a quarterly cash dividend of $0.25 per share payable on May 9, 2018 to holders of record on April 9, 2018 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 6, 2016, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the December 2016 Share Repurchase Program). This program became effective in April 2017. On December 4, 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the December 2017 Share Repurchase Program). This program will become effective after completion of the December 2016 Share Repurchase Program. During the fourth quarter of 2017 , we repurchased a total of approximately 6.9 million shares for $1.0 billion at an average price of $148.44 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2017 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,276,450 $ 144.78 2,276,450 $ 1,935,087,778 November 1 30 2,314,860 150.22 2,314,860 1,587,353,507 December 1 31 2,353,069 150.22 2,353,069 5,233,867,141 Total 6,944,379 148.44 6,944,379 1 Dollar value of shares that may yet be purchased under the December 2016 Share Repurchase Program and the December 2017 Share Repurchase Program are as of the end of each period presented. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. This change only relates to terminology; no previously reported amounts have changed. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. Through our global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro, Cirrus and Masterpass. Our recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded our capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, we now offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions. We also provide value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. Our networks are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (the GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Business Environment We authorize, clear and settle transactions in more than 210 countries and territories and in more than 150 currencies. Net revenue generated in the United States was 35% of total revenue in 2017 and 38% in 2016 and 39% in 2015 . No individual country, other than the United States, generated more than 10% of total net revenue in any such period, but differences in market growth, economic health and foreign exchange fluctuations in certain countries can have an impact on the proportion of revenue generated outside the United States over time. While the global nature of our business helps protect our operating results from adverse economic conditions in a single or a few countries, the significant concentration of our revenue generated in the United States makes our business particularly susceptible to adverse economic conditions in the United States. The competitive and evolving nature of the global payments industry provides both challenges to and opportunities for the continued growth of our business. Adverse economic trends (including distress in financial markets, currency fluctuations, turmoil in specific economies around the world and additional government intervention) have impacted the environment in which we operate. Certain of our customers, merchants that accept our brands and account holders who use our brands, have been directly impacted by these adverse economic conditions. Our financial results may be negatively impacted by actions taken by individual financial institutions or by governmental or regulatory bodies. In addition, political instability or a decline in economic conditions in the countries in which we operate may accelerate the timing of or increase the impact of risks to our financial performance. As a result, our revenue or results of operations may be negatively impacted. We continue to monitor political and economic conditions around the world to identify opportunities for the continued growth of our business and to evaluate the evolution of the global payments industry. Notwithstanding recent encouraging trends, the extent and pace of economic recovery in various regions remains uncertain and the overall business environment may present challenges for us to grow our business. For a full discussion of the various legal, regulatory and business risks that could impact our financial results, see Risk Factors in Part I, Item 1A. Financial Results Overview The following tables provide a summary of our operating results: Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) ($ in millions, except per share data) Net revenue $ 12,497 $ 10,776 16% $ 10,776 $ 9,667 11% Operating expenses $ 5,875 $ 5,015 17% $ 5,015 $ 4,589 9% Operating income $ 6,622 $ 5,761 15% $ 5,761 $ 5,078 13% Operating margin 53.0 % 53.5 % (0.5) ppt 53.5 % 52.5 % 0.9 ppt Income tax expense $ 2,607 $ 1,587 64% $ 1,587 $ 1,150 38% Effective income tax rate 40.0 % 28.1 % 11.9 ppt 28.1 % 23.2 % 4.9 ppt Net income $ 3,915 $ 4,059 (4)% $ 4,059 $ 3,808 7% Diluted earnings per share $ 3.65 $ 3.69 (1)% $ 3.69 $ 3.35 10% Diluted weighted-average shares outstanding 1,072 1,101 (3)% 1,101 1,137 (3)% Summary of Non-GAAP Results 1 : Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 12,497 $ 10,776 16% 15% $ 10,776 $ 9,667 11% 13% Adjusted operating expenses $ 5,693 $ 4,898 16% 16% $ 4,898 $ 4,449 10% 12% Adjusted operating margin 54.4 % 54.5 % (0.1) ppt (0.2) ppt 54.5 % 54.0 % 0.6 ppt 0.6 ppt Adjusted effective income tax rate 26.8 % 28.1 % (1.3) ppt (1.3) ppt 28.1 % 23.4 % 4.6 ppt 4.7 ppt Adjusted net income $ 4,906 $ 4,144 18% 17% $ 4,144 $ 3,903 6% 7% Adjusted diluted earnings per share $ 4.58 $ 3.77 21% 21% $ 3.77 $ 3.43 10% 11% Note: Tables may not sum due to rounding. 1 The Summary of Non-GAAP Results excludes the impact of Special Items and/or foreign currency. See Non-GAAP Financial Information for further information on the Special Items, the impact of foreign currency and the reconciliation to GAAP reported amounts. Key highlights for 2017 were as follows: Net revenue increased 16% , or 15% on a currency-neutral basis, in 2017 versus 2016 , primarily driven by: Switched transaction growth of 17% Cross border growth of 15% on a local currency basis An increase of 10% in gross dollar volume, on a local currency basis and adjusted for the impact of the 2016 EU regulation change Acquisitions contributed 2 percentage points of growth These increases were partially offset by higher rebates and incentives Operating expenses increased 17% in 2017 versus 2016 . Excluding the impact of Special Items, adjusted operating expenses increased 16% , both as adjusted and on a currency-neutral basis, in 2017 versus 2016 . The impact of acquisitions contributed 6 percentage points of growth for the twelve months ended December 31, 2017 . Other factors contributing to the increase were continued investments in strategic initiatives as well as foreign exchange related charges. The effective income tax rate increased 11.9 percentage points to 40.0% in 2017 versus 28.1% in 2016 , primarily due to the Tax Cuts and Jobs Act (the TCJA). Excluding the impact of the TCJA and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of taxable earnings, partially offset by a lower U.S. foreign tax credit benefit. Other financial highlights for 2017 were as follows: We generated net cash flows from operations of $5.6 billion in 2017 , versus $4.5 billion in 2016 . We repurchased 30 million shares of our common stock for $3.8 billion and paid dividends of $942 million in 2017 . We acquired businesses for total consideration of $1.5 billion in 2017 , the largest of which was VocaLink Holdings Limited (Vocalink), which expanded our capability, among other things, to process real-time account-based payment transactions. The TCJA, enacted in 2017, will reduce the U.S. corporate income tax rate from 35% to 21% beginning in 2018, imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) and puts into effect the migration towards a territorial tax system. While the enactment of the TCJA resulted in additional tax expense of $873 million in 2017, it is expected to have a favorable impact on our effective tax rate in future periods. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA impact. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). These non-GAAP financial measures exclude the impact of the following special items (Special Items). We excluded these Special Items as management monitors significant changes in tax law, litigation judgments and settlements related to interchange and regulation, and significant one-time items separately from ongoing operations and evaluates ongoing performance without these amounts. In 2017, due to the passage of the TCJA, we incurred additional tax expense of $873 million , $0.81 per diluted share, which includes $825 million of provisional charges attributable to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million in additional tax expense related to a foregone foreign tax credit benefit on current year repatriations (collectively the Tax Act Impact). See Financial Results of this section and Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. In 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries (the Venezuela Charge). See Impact of Foreign Currency of this section and Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion of the Venezuela Charge. In 2017, we recorded a pre-tax charge of $15 million ( $10 million after tax, or $0.01 per diluted share) in provision for litigation settlements expense, related to a litigation settlement with Canadian merchants (the Canadian Merchant Litigation Provision). In 2016 and 2015, we recorded a pre-tax charge of $117 million ( $85 million after tax, or $0.08 per diluted share) and $61 million ( $45 million after tax, or $0.04 per diluted share), respectively, in provision for litigation settlements expense, related to separate litigations with merchants in the U.K. (collectively the U.K. Merchant Litigation Provision). See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion of the Canadian Merchant Litigation Provision and the U.K. Merchant Litigation Provision. In 2015, we recorded a settlement charge of $79 million ( $50 million after tax, or $0.04 per diluted share) in general and administrative expenses, relating to the termination of our qualified U.S. defined benefit pension plan (the U.S. Employee Pension Plan Settlement Charge). See Note 11 (Pension, Postretirement and Savings Plans) to the consolidated financial statements included in Part II, Item 8 for further discussion of the U.S. Employee Pension Plan Settlement Charge. In addition, we present growth rates adjusted for the impact of foreign currency, which is a non-GAAP financial measure. For 2017 and 2016 , we present currency-neutral growth rates, which are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of foreign currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. Our management believes the presentation of the impact of foreign currency provides relevant information. Our management believes that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. Our management uses non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Net revenue, operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items and/or the impact of foreign currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables reconcile our as-reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures. Year ended December 31, 2017 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % 40.0 % $ 3,915 $ 3.65 Tax Act Impact ** ** (13.4 )% 0.81 Venezuela Charge (167 ) 1.3 % 0.2 % 0.10 Canadian Merchant Litigation Provision (15 ) 0.1 % % 0.01 Non-GAAP $ 5,693 54.4 % 26.8 % $ 4,906 $ 4.58 Year ended December 31, 2016 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,015 53.5 % 28.1 % $ 4,059 $ 3.69 U.K. Merchant Litigation Provision (117 ) 1.0 % % 0.08 Non-GAAP $ 4,898 54.5 % 28.1 % $ 4,144 $ 3.77 Year ended December 31, 2015 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 4,589 52.5 % 23.2 % $ 3,808 $ 3.35 U.S. Employee Pension Plan Settlement Charge (79 ) 0.8 % 0.1 % 0.04 U.K. Merchant Litigation Provision (61 ) 0.6 % 0.1 % 0.04 Non-GAAP $ 4,449 54.0 % 23.4 % $ 3,903 $ 3.43 The following tables represent the reconciliation of our growth rates reported under GAAP to our Non-GAAP growth rates, adjusted for Special Items and foreign currency: Year Ended December 31, 2017 as compared to the Year Ended December 31, 2016 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (0.5) ppt 11.9 ppt (4 )% (1 )% Tax Act Impact ** ** ** (13.4) ppt % % Venezuela Charge ** (3 )% 1.3 ppt 0.2 ppt % % Canadian Merchant Litigation Provision ** % 0.1 ppt ppt % % U.K. Merchant Litigation Provision ** % (1.1) ppt ppt (2 )% (3 )% Non-GAAP % % (0.1) ppt (1.3) ppt % % Foreign currency 1 (1 )% (1 )% (0.1) ppt ppt (1 )% % Non-GAAP - currency-neutral % % (0.2) ppt (1.3) ppt % % Year Ended December 31, 2016 as compared to the Year Ended December 31, 2015 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % 0.9 ppt 4.9 ppt % % U.K. Merchant Litigation Provision ** (1 )% 0.5 ppt (0.1) ppt % % U.S. Employee Pension Plan Settlement Charge ** % (0.8) ppt (0.2) ppt (1 )% (1 )% Non-GAAP % % 0.6 ppt 4.6 ppt % % Foreign currency 1 % % ppt 0.1 ppt % % Non-GAAP - currency-neutral % % 0.6 ppt 4.7 ppt % % Note: Tables may not sum due to rounding. ** Not meaningful. 1 Represents the foreign currency translational and transactional impact. Impact of Foreign Currency Rates Our overall operating results are impacted by foreign currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional foreign currency. The impact of the transactional foreign currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in foreign currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The foreign currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2017 , GDV on a U.S. dollar-converted basis increased 8.7% , while GDV on a local currency basis increased 8.6% versus 2016 . In 2016 , GDV on a U.S. dollar-converted basis increased 5.5% , while GDV on a local currency basis increased 9.1% versus 2015 . Further, the impact from transactional foreign currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. In addition, we incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses. We attempt to manage foreign currency balance sheet remeasurement and cash flow risk through our foreign exchange risk management activities, which are discussed further in Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign currency derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives on a current basis, with the associated offset being recognized as the exposures materialize. We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict or prohibit the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in Venezuela, due to increasing foreign exchange regulations restricting access to U.S. dollars, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar has impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share). We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. We do not believe this accounting change will have a significant impact on our consolidated financial statements in future periods. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. Financial Results Revenue Revenue Description Our business model involves four participants in addition to us: account holders, merchants, issuers (the account holders financial institutions) and acquirers (the merchants financial institutions). We generate revenues from assessing our customers based on the GDV of activity on the products that carry our brands, from the fees that we charge our customers for providing transaction processing and from other payment-related products and services. Our revenue is based upon transactional information accumulated by our systems or reported by our customers. Our primary revenue billing currencies are the U.S. dollar, euro, Brazilian real and the British pound. The price structure for our products and services is complex and is dependent on the nature of volumes, types of transactions and type of products and services we offer to our customers. Our net revenue can be significantly impacted by the following: domestic or cross-border transactions signature-based or PIN-based transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by us amount of usage of our other products or services amount of rebates and incentives provided to customers We classify our net revenue into the following five categories: 1. Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are the same. Domestic assessments include items such as card assessments, which are fees charged on the number of cards issued or assessments for specific purposes, such as acceptance development or market development programs. 2. Cross-border volume fees are charged to issuers and acquirers based on the dollar volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are different. In general, a cross-border transaction generates higher revenue than a domestic transaction since cross-border fees are higher than domestic fees, and may include fees for currency conversion. 3. Transaction processing revenue is earned for both domestic and cross-border transactions and is primarily based on the number of transactions. Transaction processing includes the following: Switched transactions include the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others, on behalf of the issuer approve in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. We clear transactions among customers through our central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to our network. Other Processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile initiated transactions; and safety and security. 4. Other revenues: Other revenues consist of other payment-related products and services and are primarily associated with the following: Consulting, data analytic and research fees are primarily generated by Mastercard Advisors, our professional advisory services group. Safety and security services fees are for products and services we offer to prevent, detect and respond to fraud and to ensure the safety of transactions made on our products. We work with issuers, merchants and governments to help deploy standards for safe and secure transactions for the global payments system. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. For merchants, we provide targeted offers and rewards campaigns and management services for publishing offers, as well as opportunities for holders of co-brand or loyalty cards and rewards program members to obtain rewards points faster. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees, and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Real-time account-based payment services relating to ACH and other ACH related services. We also charge for a variety of other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. 5. Rebates and incentives (contra-revenue): Rebates and incentives are provided to certain of our customers and are recorded as contra-revenue. Revenue Analysis Gross revenue increased 18% and 14% , or 17% and 15% on a currency neutral basis, in 2017 and 2016 , respectively, versus the prior year. The increase in both 2017 and 2016 was primarily driven by an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 22% and 20% in 2017 and 2016 , respectively, or 22% on a currency neutral basis in both periods. The increases in rebates and incentives in 2017 and 2016 were primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 16% and 11% , or 15% and 13% on a currency neutral basis, respectively, versus the prior year. The significant components of our net revenue were as follows: For the Years Ended December 31, Percent Increase (Decrease) (in millions, except percentages) Domestic assessments $ 5,130 $ 4,411 $ 4,086 16% 8% Cross-border volume 4,174 3,568 3,225 17% 11% Transaction processing 6,188 5,143 4,345 20% 18% Other revenues 2,853 2,431 1,991 17% 22% Gross revenue 18,345 15,553 13,647 18% 14% Rebates and incentives (contra-revenue) (5,848 ) (4,777 ) (3,980 ) 22% 20% Net revenue $ 12,497 $ 10,776 $ 9,667 16% 11% The following table summarizes the primary drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Foreign Currency 1 Other 2 Total Domestic assessments % % % % % (2 )% % 3 (1 )% 3 % % Cross-border volume % % % % % (3 )% % % % % Transaction processing % % % % % % % % % % Other revenues ** ** % % % % % 4 % 4 % % Rebates and incentives % % % % % (2 )% % 5 % 5 % % Net revenue % % % % % (1 )% % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the foreign currency translational and transactional impact versus the prior year. 2 Includes impact from pricing and other non-volume based fees. 3 Includes impact of the allocation of revenue to service deliverables, which are recorded in other revenue when services are performed. 4 Includes impacts from Advisor fees, safety and security fees, loyalty and reward solution fees and other payment-related products and services. 5 Includes the impact from timing of new, renewed and expired agreements. The following table provides a summary of the trend in volume and transaction growth: Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border Volume 1 % % Switched Transactions Growth % % 1 Excludes volume generated by Maestro and Cirrus cards. In 2016, our GDV was impacted by the EU Interchange Fee Regulation related to card payments which became effective in June 2016. The regulation requires that we no longer collect fees on domestic European Economic Area payment transactions that do not use our network brand. Prior to that, we collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non-Mastercard co-badged volume is no longer being included. The following table reflects GDV growth rates for Europe and Worldwide Mastercard. For comparability purposes, we adjusted growth rates for the impact of Article 8 of the EU Interchange Fee Regulation related to card payments, to exclude the prior period co-badged volume processed by other networks. For the Years Ended December 31, Growth (Local) GDV 1 Worldwide as reported 9% 9% Worldwide as adjusted for EU Regulation 10% 11% Europe as reported 10% 10% Europe as adjusted for EU Regulation 16% 18% 1 Excludes volume generated by Maestro and Cirrus cards. A significant portion of our revenue is concentrated among our five largest customers. In 2017 , the net revenue from these customers was approximately $2.9 billion , or 23% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. In addition, as part of our business strategy, among other efforts, we enter into business agreements with customers. These agreements can be terminated in a variety of circumstances. See our risk factor in Risk Factor - Business Risks in Part I, Item 1A for further discussion. Operating Expenses Operating expenses increased 17% and 9% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of the Special Items, adjusted operating expenses increased 16% and 10% , or 16% and 12% on a currency neutral basis, in 2017 and 2016 , respectively. Acquisitions contributed 6 percentage points of growth in 2017 . The components of operating expenses were as follows: Year ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 4,526 $ 3,714 $ 3,341 % % Advertising and marketing % (1 )% Depreciation and amortization % % Provision for litigation settlement ** ** Total operating expenses 5,875 5,015 4,589 % % Special Items 1 (182 ) (117 ) (140 ) (1 )% % Adjusted total operating expenses (excluding Special Items 1 ) $ 5,693 $ 4,898 $ 4,449 % % Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. The following table summarizes the primary drivers of changes in operating expenses in 2017 and 2016 : For the Years Ended December 31, Operational Special Items 1 Acquisitions Foreign Currency 2 Total General and administrative % % % (3 )% % % % (1 )% % % Advertising and marketing % % % % % % % (1 )% % (1 )% Depreciation and amortization % % % % % % % (2 )% % % Provision for litigation settlements ** ** ** ** ** ** ** ** ** ** Total operating expenses % % % (1 )% % % % (1 )% % % Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. 2. Represents the foreign currency translational and transactional impact versus the prior year. General and Administrative General and administrative expenses increased 22% and 11% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of Special Items, adjusted general and administrative expenses increased 17% and 14% in 2017 and 2016 , respectively, versus the prior year. Acquisitions contributed 6 percentage points and 1 percentage point of growth in 2017 and 2016 , respectively. The significant components of our general and administrative expenses were as follows: For the Years Ended December 31, Percent Increase (Decrease) (in millions, except percentages) Personnel $ 2,687 $ 2,225 $ 2,105 21% 6% Professional fees 5% 9% Data processing and telecommunications 20% 16% Foreign exchange activity (82 ) ** ** Other 25% 8% General and administrative expenses 4,526 3,714 3,341 22% 11% Special Item 1 (167 ) (79 ) (5)% 3% Adjusted general and administrative expenses (excluding Special Item) 1 $ 4,359 $ 3,714 $ 3,262 17% 14% Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. The primary drivers of changes in general and administrative expenses in 2017 and 2016 were: Personnel expenses increased 21% and 6% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of U.S. Employee Pension Plan Settlement Charge of $79 million recorded in 2015, personnel expense grew 10% for 2016 versus 2015 . The 2017 and 2016 increases were driven by a higher number of employees to support our continued investment in the areas of real-time account payments, digital, services, data analytics and geographic expansion. The impact of acquisitions contributed 6 and 1 percentage points of growth for 2017 and 2016 , respectively. Professional fees consist primarily of third-party services, legal costs to defend our outstanding litigation and the evaluation of regulatory developments that impact our industry and brand. The increase in 2017 was primarily due to merger and acquisition related consulting costs. The increase in 2016 was primarily due to higher legal costs to defend litigation. Data processing and telecommunication charges consist of expenses to support our global payments network infrastructure, expenses to operate and maintain our computer systems and other telecommunication systems. These expenses increased in both 2017 and 2016 due to capacity growth of our business and higher third-party processing costs. Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8 for further discussion. During 2017 , foreign exchange activity negatively impacted general and administrative expense growth by 2 percentage points versus the comparable period in 2016 , due to greater losses from foreign exchange derivative contracts versus the prior year. During 2016 , foreign exchange activity negatively impacted general and administrative expense growth by 4 percentage points versus the comparable period in 2015 , due to the impact from foreign exchange derivative contracts and the lapping of balance sheet remeasurement gains in the prior year. Other expenses include costs to provide loyalty and rewards solutions, travel and meeting expenses and rental expense for our facilities and other miscellaneous charges. Other expenses increased 25% and 8% in 2017 and 2016 , respectively, versus the prior year. In 2017 , other expenses increased due to the impact of the Venezuelan Charge of $167 million . In 2016 , other expenses increased primarily due to higher cardholder services and loyalty costs. Advertising and Marketing In 2017 , advertising and marketing expenses increased 11% versus 2016 , mainly due to higher marketing spend primarily related to Masterpass. Advertising and marketing expenses decreased 1% in 2016 , mainly due to lower sponsorship promotions compared to 2015 . Depreciation and Amortization Depreciation and amortization expenses increased 17% and 2% in 2017 and 2016 , respectively, versus the prior year. The increase in 2017 was primarily due to the impact of acquisitions. In 2016 , the increase was primarily due to higher depreciation from capital investments partially offset by certain intangibles becoming fully amortized. Provision for Litigation Settlements During 2017 and 2016 , we recorded pre-tax charges of $15 million and $117 million related to litigations with merchants in Canada and the U.K., respectively. During 2015 , we recorded a pre-tax charge of $61 million related to litigations with merchants in the U.K. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) is comprised primarily of investment income, interest expense, our share of income (losses) from equity method investments and other gains and losses. Total other expense decreased $15 million to $100 million in 2017 versus $115 million in 2016 due to lower impairment charges taken on certain investments last year and a gain on an investment in the current year, partially offset by higher interest expense from debt issued in the fourth quarter of 2016 . Total other expense decreased $5 million to $115 million in 2016 versus $120 million in 2015 due to lower impairment charges taken on certain investments and higher investment income in 2016 , partially offset by higher interest expense from debt issued in 2015 and 2016 . Income Taxes On December 22, 2017, in the U.S., the TCJA was signed into law. The TCJA, represents significant changes to the U.S. internal revenue code and, among other things: lowers the corporate income tax rate from 35% to 21% imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduces further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations eliminates the domestic production activities deduction While the effective date of the law for most of the above provisions is January 1, 2018, GAAP requires the resulting tax effects be accounted for in the reporting period of enactment. The impact of the TCJA is discussed further below and in Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8. The effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were 40.0% , 28.1% and 23.2% , respectively. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to the TCJA, which includes $825 million of provisional charges related to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the reinvestment of foreign earnings, as well as $48 million in additional tax expense due to a foregone foreign tax credit benefit on current year repatriations. Excluding the impact of the TCJA and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of taxable earnings, partially offset by a lower U.S. foreign tax credit benefit. The effective income tax rate for 2016 was higher than the effective income tax rate for 2015 primarily due to benefits associated with the impact of settlements with tax authorities in multiple jurisdictions in 2015, the lapping of a discrete benefit relating to certain foreign taxes that became eligible to be claimed as credits in the United States in 2015, and a higher U.S. foreign tax credit benefit associated with the repatriation of current year foreign earnings in 2015. These items were partially offset by a more favorable geographic mix of taxable earnings in 2016. The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 35% to pretax income for the years ended December 31, as a result of the following: For the Years Ended December 31, Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 6,522 $ 5,646 $ 4,958 Federal statutory tax 2,283 35.0 % 1,976 35.0 % 1,735 35.0 % State tax effect, net of federal benefit 0.7 % 0.4 % 0.5 % Foreign earnings (380 ) (5.8 )% (188 ) (3.3 )% (144 ) (2.9 )% Impact of foreign tax credits 1 (27 ) (0.4 )% (141 ) (2.5 )% (281 ) (5.7 )% Impact of settlements with tax authorities % % (147 ) (2.9 )% Transition Tax 9.6 % % % Remeasurement of U.S. deferred taxes 2.4 % % % Other, net (98 ) (1.5 )% (82 ) (1.5 )% (40 ) (0.8 )% Income tax expense $ 2,607 40.0 % $ 1,587 28.1 % $ 1,150 23.2 % 1 Included within the impact of foreign tax credits are repatriation benefits of current year foreign earnings of $0 million , $116 million and $172 million , in addition to other foreign tax credit benefits which become eligible in the United States of $27 million , $25 million and $109 million for 2017 , 2016 and 2015 , respectively. Our GAAP effective income tax rates for 2017 , 2016 and 2015 were affected by the tax benefits related to the Special Items as previously discussed. As of December 31, 2017 , a provisional amount of the U.S. federal and state and local income taxes of $36 million has been provided on a substantial amount of our undistributed foreign earnings. This deferred tax charge has been established primarily on the estimated foreign exchange gain which will be recognized when such earnings are repatriated. We expect that foreign withholding taxes associated with these future repatriated earnings will not be material. Based upon the ongoing review of business requirements and capital needs of our non-U.S. subsidiaries, we believe a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, we will complete our analysis of global working capital and cash needs to determine the amount we consider indefinitely reinvested. We will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. Our unrecognized tax benefits related to positions taken during the current and prior periods were $183 million and $169 million , as of December 31, 2017 and 2016 , respectively, all of which would reduce our effective tax rate if recognized. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local tax examinations is reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. During 2015, our unrecognized tax benefits related to tax positions taken during the current and prior periods decreased by $183 million . This decrease was primarily due to settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. During 2014, we implemented an initiative to better align our legal entity and tax structure with our operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property to a related foreign entity in the United Kingdom. We believe this improved alignment has resulted in greater flexibility and efficiency with regard to the global deployment of cash, as well as ongoing benefits in our effective income tax rate. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. In 2010, in connection with the expansion of our operations in the Asia Pacific, Middle East and Africa region, our subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL), received an incentive grant from the Singapore Ministry of Finance. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 7.8 $ 8.3 Unused line of credit 3.8 3.8 1 Investments include available-for-sale securities and short-term held-to-maturity securities. At December 31, 2017 and 2016 , this amount excludes restricted cash related to the U.S. merchant class litigation settlement of $546 million and $543 million , respectively. This amount also excludes restricted security deposits held for customers of $1 billion at December 31, 2017 and 2016 . Cash, cash equivalents and investments held by our foreign subsidiaries was $4.8 billion and $3.8 billion at December 31, 2017 and 2016 , respectively, or 62% and 45% as of such dates. As described further in Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8, as a result of the enactment of the TCJA, among other things, we recorded a provisional amount of $629 million in tax expense due to the Transition Tax, which is payable over the next 8 years . In addition, we have changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates. As a result of this assertion change, we have recognized a provisional deferred tax liability of $36 million . It is our present intention to indefinitely reinvest a portion of our historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the United States. Based upon the ongoing review of business requirements and capital needs of our non-U.S. subsidiaries, we believe a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, we will complete our analysis of global working capital and cash needs to determine the amount we consider indefinitely reinvested. We will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many Mastercard, Cirrus and Maestro-branded transactions between our issuers and acquirers. See Note 19 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven significantly by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see our risk factor in Risk Factors - Legal and Regulatory Risks in Part I, Item 1A and Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Cash Flow Data: Net cash provided by operating activities $ 5,555 $ 4,535 $ 4,101 Net cash used in investing activities (1,779 ) (1,167 ) (715 ) Net cash used in financing activities (4,764 ) (2,344 ) (2,516 ) Net cash provided by operating activities increased $1.0 billion in 2017 versus 2016 , primarily due to higher net income as adjusted for non-cash items including deferred payments associated with the TCJA. Net cash provided by operating activities in 2016 versus 2015 , increased by $434 million , primarily due to higher net income as adjusted for non-cash items and accrued expenses, partially offset by higher prepaid taxes. Net cash used in investing activities increased $612 million in 2017 versus 2016 , primarily due to acquisitions and investments in nonmarketable equity investments, partially offset by higher net proceeds of investment securities. Net cash used in investing activities increased $452 million in 2016 versus 2015 , primarily due to lower sales and maturities of our investment securities, partially offset by cash used for acquisition activities in the prior year. Net cash used in financing activities increased $2.4 billion in 2017 versus 2016 , primarily due to proceeds from debt issued in the prior year, increased cash used in the repurchases of our Class A common stock and higher dividends paid. Net cash used in financing activities decreased $172 million in 2016 versus 2015 , primarily due to higher proceeds from debt, partially offset by higher dividends paid. The table below shows a summary of select balance sheet data at December 31 : (in millions) Balance Sheet Data: Current assets $ 13,797 $ 13,228 Current liabilities 8,793 7,206 Long-term liabilities 6,968 5,785 Equity 5,497 5,684 We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, our borrowing capacity and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Debt and Credit Availability Our long-term debt was $5.4 billion and $5.2 billion at December 31, 2017 and 2016 , respectively, with the earliest maturity of principal occurring in 2019. We have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $3.75 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have entered into a committed unsecured $3.75 billion revolving credit facility (the Credit Facility) which expires in October 2022. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2017 and 2016 . See Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on the Notes, the Commercial Paper Program and the Credit Facility. In June 2015, we filed a universal shelf registration statement to provide additional access to capital, if needed. Pursuant to the shelf registration statement, we may from time to time offer to sell debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 0.88 $ 0.76 $ 0.64 Cash dividends paid $ $ $ On December 4, 2017, our Board of Directors declared a quarterly cash dividend of $0.25 per share paid on February 9, 2018 to holders of record on January 9, 2018 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $263 million . On February 5, 2018, our Board of Directors declared a quarterly cash dividend of $0.25 per share payable on May 9, 2018 to holders of record on April 9, 2018 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $263 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock. This program is effective after completion of the share repurchase program authorized in December 2016. The following table summarizes our share repurchase authorizations of its Class A common stock through December 31, 2017 , as well as historical purchases: Authorization Dates December 2017 December 2016 December 2015 Total (in millions, except average price data) Board authorization $ 4,000 $ 4,000 $ 4,000 $ 12,000 Remaining authorization at December 31, 2016 $ $ 4,000 $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ 2,766 $ $ 3,762 Remaining authorization at December 31, 2017 $ 4,000 $ 1,234 $ $ 5,234 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ 131.97 $ 109.16 $ 125.05 See Note 13 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than lease arrangements and other commitments as presented in the Future Obligations table that follows. Future Obligations The following table summarizes our obligations as of December 31, 2017 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period Total 2019 - 2020 2021 - 2022 2023 and thereafter (in millions) Debt $ 5,477 $ $ $ 1,489 $ 3,488 Interest on debt 1,453 Capital leases Operating leases Other obligations 1 Sponsorship, licensing and other 2 Employee benefits 3 Transition Tax 4 Redeemable non-controlling interests 5 Total 6 $ 8,985 $ $ 1,450 $ 2,004 $ 4,804 1 The table does not include the $709 million provision as of December 31, 2017 related to litigation in the U.S. and the U.K. since the payments are not fixed and determinable. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. The table also does not include the $219 million provision as of December 31, 2017 related to the contingent consideration attributable to acquisitions made in 2017 (primarily based on the achievement of 2018 revenue targets) which are not fixed and determinable. See Note 5 (Fair Value and Investment Securities) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts primarily relate to sponsorships to promote the Mastercard brand. Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance. We have accrued $3.3 billion as of December 31, 2017 related to customer and merchant agreements. 3 Amounts relate to severance liabilities along with expected funding requirements for defined benefit pension and postretirement plans. 4 Amounts relate to the provisional U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 6 We have recorded a liability for unrecognized tax benefits of $183 million at December 31, 2017 . Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated. The timing of these payments will ultimately depend on the progress of tax examinations with the various authorities. Seasonality We do not experience meaningful seasonality. No individual quarter in 2017 , 2016 or 2015 accounted for more than 30% of net revenue. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. We have established detailed policies and control procedures to provide reasonable assurance that the methods used to make estimates and assumptions are well controlled and are applied consistently from period to period. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to its financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to our financial condition. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Domestic assessment revenue requires an estimate of our customers performance in order to recognize this revenue. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates. We consider various factors in estimating customer performance, including a review of specific transactions, historical experience with that customer and market and economic conditions. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to its pending claims and litigation and may revise its estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. We have changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates. As a result of the TCJA and the one-time deemed repatriation tax on untaxed accumulated foreign earnings, a provisional amount of U.S. federal and state and local income taxes have been provided on all of our undistributed foreign earnings. Future distributions from foreign affiliates from earnings which have not already been taxed in the U.S. will be eligible for a 100% dividends received deduction. Beginning in 2018, deferred taxes will be established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. On December 22, 2017, SEC staff issued Staff Accounting Bulletin No. 118 - Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which allows registrants to record provisional amounts during a measurement period, which is not to extend beyond one year. Accordingly, amounts recorded may require further adjustments due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and The Department of Treasury (Treasury) of Notices, regulations and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied to the TCJA. Consistent with SAB 118, we were able to make reasonable estimates and we have incorporated provisional amounts for the impact of the Transition Tax. This tax is on previously untaxed accumulated and current earnings and profits of our foreign subsidiaries. To compute the tax, we must determine the amount of post-1986 earnings and profits of relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. Further, we were able to make reasonable estimates and have recorded provisional amounts related to the remeasurement of our net deferred tax asset in the U.S. and the change in assertion regarding the indefinite reinvestment of foreign earnings. As with the Transition Tax, these amounts may require further adjustments during the measurement period due to evolving analysis and interpretations of law, including issuance by the IRS and Treasury of Notices and regulations, and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied. Valuation of Assets The valuation of assets acquired in a business combination and asset impairment reviews require the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree to properly allocate purchase price consideration. Impairment testing for assets, other than goodwill and indefinite-lived intangible assets, requires the allocation of cash flows to those assets or group of assets and if required, an estimate of fair value for the assets or group of assets. We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis or sooner if indicators of impairment exist. Goodwill is tested for impairment at the reporting unit level utilizing a quantitative assessment. We use the market capitalization for estimating the fair value of its reporting unit. If the fair value exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds the fair value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate all relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. In performing the qualitative assessment, we consider relevant events and conditions, including but not limited to, macroeconomic trends, industry and market conditions, overall financial performance, cost factors, company-specific events, and legal and regulatory factors. If the qualitative assessment indicates that it is more likely than not that the fair value of the indefinite-lived intangible asset is less than their carrying amounts, we must perform a quantitative impairment test. Our estimates in the valuation of these assets are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of managements assumptions, which would not reflect unanticipated events and circumstances that may occur. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as interest rates, foreign currency exchange rates and equity price risk. Our exposure to market risk from changes in interest rates, foreign exchange rates and equity price risk is limited. Management establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments. We monitor risk exposures on an ongoing basis. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $109 million on our foreign currency derivative contracts outstanding at December 31, 2017 related to the hedging program. A 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2017 and 2016 . In addition, there was no material equity price risk at December 31, 2017 or 2016 . Foreign Exchange Risk Our settlement activities are subject to foreign exchange risk resulting from foreign exchange rate fluctuations. This risk is typically limited to the one business day between setting the foreign exchange rates and clearing the financial transactions. We enter into foreign currency contracts to manage risk associated with anticipated receipts and disbursements which are either transacted in a non-functional currency or valued based on a currency other than the functional currencies of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities denominated in currencies other than the functional currency of the entity. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. Foreign currency exposures are managed together through our foreign exchange risk management activities, which are discussed further in Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. The terms of the forward contracts are generally less than 18 months . As of December 31, 2017 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with our customers. Our derivative contracts are summarized below: December 31, 2017 December 31, 2016 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ (2 ) Commitments to sell foreign currency (26 ) Options to sell foreign currency We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates, with changes in the translated value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations. Our euro-denominated debt is vulnerable to changes in the euro to U.S. dollar exchange rates. The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8. Interest Rate Risk Our interest rate sensitive assets are our investments in fixed income securities, which we generally hold as available-for-sale investments. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows: Maturity Fair Market Value at December 31, 2017 2023 and there-after Financial Instrument Summary Terms (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,148 $ $ $ $ $ $ Maturity Financial Instrument Summary Terms Fair Market Value at December 31, 2016 2022 and there-after (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,160 $ $ $ $ $ $ We also have time deposits that are classified as held-to-maturity securities. At December 31, 2017 and 2016 , the cost which approximates fair value, of our short-term held-to-maturity securities was $700 million and $452 million , respectively. In addition, at December 31, 2016 , we held $61 million of long-term held-to-maturity securities. We did not hold any long-term held-to-maturity securities at December 31, 2017 . At December 31, 2017 , we have U.S. dollar-denominated and euro-denominated debt, which is subject to interest rate risk. The principal amounts of this debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8. See Future Obligations for estimated interest payments due by period relating to the U.S. dollar-denominated and euro-denominated debt. At December 31, 2017 , we have the Commercial Paper Program and the Credit Facility which provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. Borrowing rates under the Commercial Paper Program are based on market conditions. Borrowing rates under the Credit Facility are variable rates, which are applied to the borrowing based on terms and conditions set forth in the agreement. See Note 12 (Debt) to the consolidated financial statements in Part II, Item 8 for additional information on the Credit Facility and the Commercial Paper Program. We had no borrowings under the Commercial Paper Program or the Credit Facility at December 31, 2017 and 2016 . Equity Price Risk We did not have significant equity price risk as of December 31, 2017 and 2016 . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MASTERCARD INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Mastercard Incorporated As of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015 Managements Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheet Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 57 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2017 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries as of December 31, 2017 and 2016 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2017 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016 , and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control over Financial Reporting appearing in the 2017 Annual Report under Item 8 on page 58. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York February 14, 2018 We have served as the Companys auditor since 1989. MASTERCARD INCORPORATED CONSOLIDATED BALANCE SHEET December 31, (in millions, except per share data) ASSETS Cash and cash equivalents $ 5,933 $ 6,721 Restricted cash for litigation settlement Investments 1,849 1,614 Accounts receivable 1,969 1,416 Settlement due from customers 1,375 1,093 Restricted security deposits held for customers 1,085 Prepaid expenses and other current assets 1,040 Total Current Assets 13,797 13,228 Property, plant and equipment, net Deferred income taxes Goodwill 3,035 1,756 Other intangible assets, net 1,120 Other assets 2,298 1,929 Total Assets $ 21,329 $ 18,675 LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS AND EQUITY Accounts payable $ $ Settlement due to customers 1,343 Restricted security deposits held for customers 1,085 Accrued litigation Accrued expenses 3,931 3,318 Other current liabilities Total Current Liabilities 8,793 7,206 Long-term debt 5,424 5,180 Deferred income taxes Other liabilities 1,438 Total Liabilities 15,761 12,991 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,382 and 1,374 shares issued and 1,040 and 1,062 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 14 and 19 issued and outstanding, respectively Additional paid-in-capital 4,365 4,183 Class A treasury stock, at cost, 342 and 312 shares, respectively (20,764 ) (17,021 ) Retained earnings 22,364 19,418 Accumulated other comprehensive income (loss) (497 ) (924 ) Total Stockholders Equity 5,468 5,656 Non-controlling interests Total Equity 5,497 5,684 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 21,329 $ 18,675 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF OPERATIONS For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 12,497 $ 10,776 $ 9,667 Operating Expenses General and administrative 4,526 3,714 3,341 Advertising and marketing Depreciation and amortization Provision for litigation settlements Total operating expenses 5,875 5,015 4,589 Operating income 6,622 5,761 5,078 Other Income (Expense) Investment income Interest expense (154 ) (95 ) (61 ) Other income (expense), net (2 ) (63 ) (84 ) Total other income (expense) (100 ) (115 ) (120 ) Income before income taxes 6,522 5,646 4,958 Income tax expense 2,607 1,587 1,150 Net Income $ 3,915 $ 4,059 $ 3,808 Basic Earnings per Share $ 3.67 $ 3.70 $ 3.36 Basic Weighted-Average Shares Outstanding 1,067 1,098 1,134 Diluted Earnings per Share $ 3.65 $ 3.69 $ 3.35 Diluted Weighted-Average Shares Outstanding 1,072 1,101 1,137 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the Years Ended December 31, (in millions) Net Income $ 3,915 $ 4,059 $ 3,808 Other comprehensive income (loss): Foreign currency translation adjustments (275 ) (460 ) Income tax effect (11 ) Foreign currency translation adjustments, net of income tax effect (286 ) (433 ) Translation adjustments on net investment hedge (236 ) (40 ) Income tax effect (22 ) Translation adjustments on net investment hedge, net of income tax effect (153 ) (26 ) Defined benefit pension and other postretirement plans (1 ) (19 ) Income tax effect (2 ) Defined benefit pension and other postretirement plans, net of income tax effect (1 ) (12 ) Reclassification adjustment for defined benefit pension and other postretirement plans (2 ) (1 ) Income tax effect (29 ) Reclassification adjustment for defined benefit pension and other postretirement plans, net of income tax effect (1 ) (1 ) Investment securities available-for-sale (3 ) (11 ) Income tax effect (1 ) Investment securities available-for-sale, net of income tax effect (1 ) (11 ) Reclassification adjustment for investment securities available-for-sale Income tax effect Reclassification adjustment for investment securities available-for-sale, net of income tax effect Other comprehensive income (loss), net of income tax effect (248 ) (416 ) Comprehensive Income $ 4,342 $ 3,811 $ 3,392 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Additional Paid-In Capital Class A Treasury Stock Non- Controlling Interests Total Class A Class B (in millions, except per share data) Balance at December 31, 2014 $ $ $ 13,169 $ (260 ) $ 3,876 $ (9,995 ) $ $ 6,824 Net income 3,808 3,808 Activity related to non-controlling interests Other comprehensive income (loss), net of tax (416 ) (416 ) Cash dividends declared on Class A and Class B common stock, $0.67 per share (755 ) (755 ) Purchases of treasury stock (3,532 ) (3,532 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2015 16,222 (676 ) 4,004 (13,522 ) 6,062 Net income 4,059 4,059 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (248 ) (248 ) Cash dividends declared on Class A and Class B common stock, $0.79 per share (863 ) (863 ) Purchases of treasury stock (3,503 ) (3,503 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2016 19,418 (924 ) 4,183 (17,021 ) 5,684 Net income 3,915 3,915 Activity related to non-controlling interests Other comprehensive income (loss), net of tax Cash dividends declared on Class A and Class B common stock, $0.91 per share (969 ) (969 ) Purchases of treasury stock (3,747 ) (3,747 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2017 $ $ $ 22,364 $ (497 ) $ 4,365 $ (20,764 ) $ $ 5,497 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS For the Years Ended December 31, (in millions) Operating Activities Net income $ 3,915 $ 4,059 $ 3,808 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,001 Depreciation and amortization Share-based compensation Tax benefit for share-based payments (48 ) (42 ) Deferred income taxes (20 ) (16 ) Venezuela charge Other (81 ) Changes in operating assets and liabilities: Accounts receivable (445 ) (338 ) (35 ) Settlement due from customers (281 ) (10 ) (98 ) Prepaid expenses (1,402 ) (1,073 ) (802 ) Accrued litigation and legal settlements (15 ) (63 ) Accounts payable Settlement due to customers (186 ) Accrued expenses Long-term taxes payable Net change in other assets and liabilities (194 ) (10 ) Net cash provided by operating activities 5,555 4,535 4,101 Investing Activities Purchases of investment securities available-for-sale (714 ) (957 ) (974 ) Purchases of investments held-to-maturity (1,145 ) (867 ) (918 ) Proceeds from sales of investment securities available-for-sale Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property, plant and equipment (300 ) (215 ) (177 ) Capitalized software (123 ) (167 ) (165 ) Acquisition of businesses, net of cash acquired (1,175 ) (584 ) Investment in nonmarketable equity investments (147 ) (31 ) Other investing activities (2 ) (1 ) Net cash used in investing activities (1,779 ) (1,167 ) (715 ) Financing Activities Purchases of treasury stock (3,762 ) (3,511 ) (3,518 ) Proceeds from debt 1,972 1,735 Payment of debt (64 ) Dividends paid (942 ) (837 ) (727 ) Tax benefit for share-based payments Tax withholdings related to share-based payments (47 ) (51 ) (58 ) Cash proceeds from exercise of stock options Other financing activities (6 ) (2 ) (17 ) Net cash used in financing activities (4,764 ) (2,344 ) (2,516 ) Effect of exchange rate changes on cash and cash equivalents (50 ) (260 ) Net (decrease) increase in cash and cash equivalents (788 ) Cash and cash equivalents - beginning of period 6,721 5,747 5,137 Cash and cash equivalents - end of period $ 5,933 $ 6,721 $ 5,747 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company facilitates the switching (authorization, clearing and settlement) of payment transactions, and delivers related products and services. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard, Maestro and Cirrus. The recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded the Companys capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, Mastercard now offers customers one partner to turn to for their payment needs for both domestic and cross-border transactions. The Company also provides value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. The Companys networks are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (an individual who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys branded products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Mastercard generates revenues from assessing its customers based on the gross dollar volume (GDV) of activity on the products that carry its brands, from the fees charged to customers for providing transaction processing and from other payment-related products and services. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or cost method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2017 and 2016 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2017 presentation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. Due to increasing foreign exchange regulations in Venezuela restricting access to U.S. dollars, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar has impacted the ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) included in general and administrative expenses in the consolidated statement of operations. Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100% of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2017, 2016 and 2015 , losses from non-controlling interests were de minimis and, as a result, amounts are included on the consolidated statement of operations within other income (expense). The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5% of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense) on the consolidated statement of operations. The Company accounts for investments in common stock or in-substance common stock under the cost method of accounting when it does not exercise significant influence, generally when it holds less than 20% ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5% and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the cost method of accounting. Investments for which the equity method or cost method of accounting is used are recorded in other assets on the consolidated balance sheet. Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. The Companys revenue is based on the volume of activity on cards that carry the Companys brands, the number of transactions processed or the nature of other payment-related products and services. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue is primarily based on the number and type of transactions and is recognized as revenue in the same period as the related transactions occur. Other payment-related products and services are recognized as revenue in the same period as the related transactions occur or services are rendered. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives such as marketing, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue either when the revenue is recognized by the Company or at the time the rebate or incentive is earned by the customer. Rebates and incentives are calculated based upon estimated performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally deferred and amortized over the life of the agreement on a straight-line basis. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree, at their fair values at the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years. Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized and are tested annually for impairment in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a quantitative assessment. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro-branded transactions between its issuers and acquirers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during the ordinary course activities of the Company. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense in its consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. On December 22, 2017, in the U.S., An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, a comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the TCJA), was enacted into law. Prior to the enactment of the TCJA, the Company did not historically provide for U.S. federal income tax and foreign withholding taxes on undistributed earnings from non-U.S. subsidiaries as such earnings were intended to be reinvested indefinitely outside of the U.S. The foreign earnings that the Company had repatriated to the United States, for periods prior to the enactment of the TCJA, were limited to the amount of current year foreign earnings and not made out of historic undistributed accumulated earnings. As of December 31, 2017, the Company has changed its assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain foreign affiliates. As a result of the TCJA and a one-time MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) deemed repatriation tax on untaxed accumulated foreign earnings, a provisional amount of U.S. federal and state and local income taxes have been provided on all undistributed foreign earnings. Future distributions from foreign affiliates from earnings which have not already been taxed in the U.S. will be eligible for a 100% dividends received deduction. Beginning in 2018, deferred taxes will be established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. The working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with a maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when the cash is unavailable for withdrawal or usage for general operations. Restrictions may include legally restricted deposits, contracts entered into with others, or the Companys statements of intention with regard to particular deposits. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability. Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data. Certain assets are measured at fair value on a nonrecurring basis. The Companys assets measured at fair value on a nonrecurring basis include property, plant and equipment, nonmarketable equity investments, goodwill and other intangible assets. These assets are subject to impairment evaluation and if impaired, would be adjusted to fair value. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. The Companys uses market capitalization for estimating the fair value of its reporting unit. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. Measurement period adjustments, if any, to the preliminary estimated fair value of contingent consideration as of the acquisition date will be recorded to goodwill, however, changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments in debt and equity securities as available-for-sale. Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets. Available-for-sale securities that are not available to meet the Companys current operational needs are classified as non-current assets on the consolidated balance sheet. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The investments in debt and equity securities are carried at fair value, with unrealized gains and losses, net of applicable taxes, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt and equity securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt and equity securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt or equity security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. The Company classifies time deposits with maturities greater than 3 months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. Derivative financial instruments - The Company records all derivatives at fair value. The Companys foreign exchange forward and option contracts are included in Level 2 of the Valuation Hierarchy as the fair value of these contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. Changes in the fair value of derivative instruments are reported in current-period earnings. The Companys derivative contracts hedge foreign exchange risk and are not entered into for trading or speculative purposes. The Company did not have any derivative contracts accounted for under hedge accounting as of December 31, 2017 and 2016 . The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The ineffective portion, if any, is recognized in earnings in the current period. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Restricted security deposits held for customers - Mastercard requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, Mastercard holds cash deposits and certificates of deposit from certain customers of Mastercard as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. Property, plant and equipment - Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of capital leases is included in depreciation and amortization expense on the consolidated balance sheet. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Capital leases Shorter of life of the asset or lease term MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Leases - The Company enters into operating and capital leases for the use of premises and equipment. Rent expense related to lease agreements that contain lease incentives is recorded on a straight-line basis over the term of the lease. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans or postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the benefit obligation at December 31, the measurement date. The fair value of plan assets represents the current market value of the pension assets. Overfunded plans are aggregated and recorded in long-term other assets, while underfunded plans are aggregated and recorded as accrued expenses and long-term other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income) is recognized in general and administrative expenses on the consolidated statement of operations. These costs include service costs, interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). Defined contribution plans - The Companys contributions to defined contribution plans are recorded when employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - The cost of media advertising is expensed when the advertising takes place. Advertising production costs are expensed as incurred. Promotional items are expensed at the time the promotional event occurs. Sponsorship costs are recognized over the period of benefit. Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company purchase additional interests in the subsidiary at their discretion. These interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to their estimated redemption value. These adjustments to the redemption value will impact retained earnings or additional paid-in capital on the consolidated balance sheet, but will not impact the consolidated statement of operations. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. For 2017, 2016 and 2015, there was no impact to EPS for adjustments related to redeemable non-controlling interests. Recent accounting pronouncements Derivatives and Hedging - In August 2017, the Financial Accounting Standards Board (the FASB) issued accounting guidance to improve and simplify existing guidance to allow companies to better reflect their risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, eliminates the requirement to separately measure and recognize hedge ineffectiveness and eases requirements of an entitys assessment of hedge effectiveness. This guidance is effective for periods beginning after December 15, 2018 and early adoption is permitted. The Company currently does not account for its foreign currency derivative contracts under hedge accounting and does not expect the standard to have an impact to the Company. For a more detailed discussion of the Companys foreign exchange risk management activities, refer to Note 20 (Foreign Exchange Risk Management). Net periodic pension cost and net periodic postretirement benefit cost - In March 2017, the FASB issued accounting guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. Under this guidance, the service cost component is required to be reported in the same line item as other compensation costs arising from services rendered by employees during the period. The other components of the net periodic benefit costs are required to be presented in the consolidated statement of operations separately from the service cost component and outside of operating income. This guidance is required to be applied retrospectively. This guidance is effective for periods beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company will adopt this guidance effective January 1, 2018. The Company does not expect the impacts of this standard to be material. Refer to Note 11 (Pension, Postretirement and Savings Plans) for the components of the Companys net periodic pension cost and net periodic postretirement benefit costs. Goodwill impairment - In January 2017, the FASB issued accounting guidance to simplify how companies are required to test goodwill for impairment. Under this guidance, step 2 of the goodwill impairment test has been eliminated. Step 2 of the goodwill impairment test required companies to determine the implied fair value of the reporting units goodwill. Under this guidance, companies will perform their annual, or interim, goodwill impairment test by comparing the reporting units carrying value, including goodwill, to its fair value. An impairment charge would be recorded if the reporting units carrying value exceeds its fair value. This guidance is required to be applied prospectively and is effective for periods beginning after December 15, 2019, with early adoption permitted. The Company adopted this guidance effective January 1, 2017 and there was no impact from the adoption of the new accounting guidance on its consolidated financial statements. Restricted cash - In November 2016, the FASB issued accounting guidance to address diversity in the classification and presentation of changes in restricted cash on the consolidated statement of cash flows. Under this guidance, companies will be required to present restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company will adopt this guidance effective January 1, 2018. Upon adoption of this standard, the Company will include restricted cash, which currently consists primarily of restricted cash for litigation settlement and restricted security deposits held for customers in its reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017 and early adoption is permitted. The Company will adopt this guidance effective January 1, 2018. The Company is in the process of evaluating the impacts this guidance will have on its consolidated financial statements. However, the Company expects that it will recognize a cumulative-effect adjustment to retained earnings upon adoption of the new guidance related to certain tax activity resulting from intra-entity asset transfers occurring before the date of adoption. For a more detailed discussion of an intra-entity transfer of intellectual property that occurred in 2014, refer to Note 17 (Income Taxes) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Share-based payments - In March 2016, the FASB issued accounting guidance related to share-based payments to employees. The Company adopted this guidance on January 1, 2017. The adoption had the following impacts on the consolidated financial statements: The Company is required to recognize the excess tax benefits and deficiencies from share-based awards on the consolidated statement of operations in the period in which they occurred rather than in additional paid-in-capital on the consolidated balance sheet. For the year ended December 31, 2017 , the Company recorded excess tax benefits of $49 million within income tax expense on the consolidated statement of operations. The Company is also required to revise its calculation of diluted weighted-average shares outstanding by excluding the tax effects from the assumed proceeds available to repurchase shares. For the year ended December 31, 2017 , diluted weighted-average shares outstanding included an additional 1 million shares as a result of the change in this calculation. For the year ended December 31, 2017 , the net impact of adoption resulted in an increase of $0.04 to diluted EPS. Lastly, the Company is required to change the classification of these tax effects on the consolidated statement of cash flows and classify them as an operating activity rather than as a financing activity. Each of these above items have been adopted prospectively. Retrospectively, the Company is required to change its classification of cash paid for employees withholding tax related to equity awards as a financing activity rather than as an operating activity on the consolidated statement of cash flows. As a result of this change in classification, cash provided by operating activities and cash used in financing activities on the consolidated statement of cash flows increased by $51 million and $58 million for the years ended December 31, 2016 and 2015 , respectively. This guidance allows a company-wide accounting policy election either to continue estimating forfeitures each period or to account for forfeitures as they occur. The Company elected to continue its existing practice to estimate the number of awards that will be forfeited. There was no impact on its consolidated financial statements. Leases - In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. This guidance requires companies to recognize leased assets and liabilities for both financing and operating leases. This guidance is effective for periods after December 15, 2018 and early adoption is permitted. Companies are required to adopt the guidance using a modified retrospective method. The Company expects to adopt this guidance effective January 1, 2019. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements. Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued accounting guidance that delayed the effective date of this standard by one year, making this guidance effective for fiscal years beginning after December 15, 2017. The Company will adopt this guidance effective January 1, 2018 under the modified retrospective transition method by recognizing the cumulative effect of initially applying the new standard as an increase to the opening balance of retained earnings. The comparative information will not be restated and will be reported under the accounting standards in effect for those periods. This new revenue guidance will primarily impact the timing of certain incentives which will be recognized over the life of the contract versus as earned by the customer. In addition, the Company will account for certain market development fund contributions and expenditures on a gross basis, instead of net, resulting in an increase to both revenues and expenses. Upon adoption of the standard, the estimated impact on the Companys consolidated financial statements is expected to be an increase of approximately $300 million in net revenue and $200 million in operating expenses in 2018. This estimate could change and is dependent upon how customer deals will be executed throughout 2018. Note 2. Acquisitions In 2017 , the Company acquired businesses for total consideration of $1.5 billion , representing both cash and contingent consideration. For the businesses acquired, Mastercard allocated the values associated with the assets, liabilities and redeemable non-controlling interests based on their respective fair values on the acquisition dates. Refer to Note 1 (Summary of Significant Accounting Policies), for the valuation techniques Mastercard utilizes to fair value the assets and liabilities acquired in business combinations. The residual value allocated to goodwill is not expected to be deductible for local tax purposes. For acquisitions occurring in 2017 , the Company is evaluating and finalizing the purchase price accounting; however, the preliminary estimated fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below: (in millions) Cash consideration $ 1,286 Contingent consideration Redeemable non-controlling interests Gain on previously held minority interest Total fair value of businesses acquired $ 1,571 Assets: Cash and cash equivalents $ Other current assets Other intangible assets Goodwill 1,136 Other assets Total assets 1,936 Liabilities: Short-term debt 1 Other current liabilities Net pension liability Other liabilities Total liabilities Net assets acquired $ 1,571 1 The short-term debt assumed through acquisitions was repaid during the second quarter of 2017. The following table summarizes the identified intangible assets acquired: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (Years) Developed technologies $ 7.5 Customer relationships 9.9 Other 1.4 Other intangible assets $ 8.3 For the businesses acquired in 2017 , the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4% controlling interest in Vocalink for cash consideration of 719 million ( $929 million as of the acquisition date). In addition, the Vocalink sellers have the potential to earn additional contingent consideration up to 169 million (approximately $228 million as of December 31, 2017 ) if certain revenue targets are met in 2018. Refer to Note 5 (Fair Value and Investment Securities) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6% ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $78 million as of December 31, 2017 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. The rollforward of redeemable non-controlling interests was not included as the activity was not considered to be material. In 2015 , the Company acquired two businesses for $609 million in cash. For these acquisitions, the Company recorded $481 million as goodwill representing the aggregate excess of the purchase consideration over the fair value of the net assets acquired. A portion of the goodwill related to the 2015 acquisitions is expected to be deductible for local tax purposes. The consolidated financial statements include the operating results of the acquired businesses from the dates of their respective acquisition. Pro forma information related to the acquisitions was not included because the impact on the Companys consolidated results of operations was not considered to be material. Note 3. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 3,915 $ 4,059 $ 3,808 Denominator Basic weighted-average shares outstanding 1,067 1,098 1,134 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,072 1,101 1,137 Earnings per Share Basic $ 3.67 $ 3.70 $ 3.36 Diluted $ 3.65 $ 3.69 $ 3.35 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 4. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: (in millions) Cash paid for income taxes, net of refunds $ 1,893 $ 1,579 $ 1,097 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Capital leases and other Fair value of assets acquired, net of cash acquired 1,825 Fair value of liabilities assumed related to acquisitions Note 5. Fair Value and Investment Securities Financial Instruments - Recurring Measurements The Company classifies its fair value measurements of financial instruments within the Valuation Hierarchy. There were no transfers made among the three levels in the Valuation Hierarchy for 2017 . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2017 December 31, 2016 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities Asset-backed securities Equity securities Derivative instruments 2 : Foreign currency derivative assets Deferred compensation plan 3 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign currency derivative liabilities $ $ (30 ) $ $ (30 ) $ $ (13 ) $ $ (13 ) Deferred compensation plan 4 : Deferred compensation liabilities (54 ) (54 ) (43 ) (43 ) 1 The Companys U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign currency derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 20 (Foreign Exchange Risk Management) for further details. 3 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. The Company had previously invested in corporate-owned life insurance contracts that were recorded at cash surrender value. The contracts were terminated during the third quarter of 2017. 4 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. They are included in other liabilities on the consolidated balance sheet. Settlement and Other Guarantee Liabilities The Company estimates the fair value of its settlement and other guarantees using market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At December 31, 2017 and 2016 , the carrying value and fair value of settlement and other guarantee liabilities were not material and accordingly are not included in the Valuation Hierarchy table above. Settlement and other guarantee liabilities are classified within Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not observable in the market. For additional information regarding the Companys settlement and other guarantee liabilities, see Note 19 (Settlement and Other Risk Management) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Financial Instruments - Non-Recurring Measurements Held-to-Maturity Securities Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Held-to-maturity securities are not measured at fair value on a recurring basis and are not included in the Valuation Hierarchy table above. At December 31, 2017 and 2016 , the Company held $700 million and $452 million , respectively, of short-term held-to-maturity securities. In addition, at December 31, 2016 , the Company held $61 million of long-term held-to-maturity securities included in other assets on the consolidated balance sheet. The Company did not hold any long-term held-to-maturity securities at December 31, 2017 . The cost of these securities approximates fair value. Nonmarketable Equity Investments The Companys nonmarketable equity investments are measured at fair value at initial recognition and for impairment testing. These investments are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity, and the fact that inputs used to measure fair value are unobservable and require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. These investments are included in other assets on the consolidated balance sheet and in Note 6 (Prepaid Expenses and Other Assets) . Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2017 , the carrying value and fair value of long-term debt was $5.4 billion and $5.7 billion , respectively. At December 31, 2016 , the carrying value and fair value of long-term debt was $5.2 billion and $5.3 billion , respectively. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Non-Financial Instruments Certain assets are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The contingent consideration attributable to acquisitions made in 2017 is primarily based on the achievement of 2018 revenue targets. The activity of the Companys contingent consideration liability for 2017 was as follows: (in millions) Balance at December 31, 2016 $ Preliminary estimated fair value as of acquisition date for businesses acquired Net change in valuation Foreign currency translation Balance at December 31, 2017 $ 76 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amortized Costs and Fair Values Available-for-Sale Investment Securities The major classes of the Companys available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of December 31, 2017 and 2016 were as follows: December 31, 2017 December 31, 2016 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities (1 ) (1 ) Asset-backed securities Equity securities Total $ 1,147 $ $ (1 ) $ 1,149 $ 1,159 $ $ (1 ) $ 1,162 The Companys available-for-sale investment securities held at December 31, 2017 and 2016 , primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. Investment Maturities: The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2017 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years Due after 5 years through 10 years Due after 10 years No contractual maturity 1 Total $ 1,147 $ 1,149 1 Equity securities have been included in the No contractual maturity category, as these securities do not have stated maturity dates. Investment Income Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Companys consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for 2017 , 2016 and 2015 were not significant. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 6. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,040 $ Other assets consisted of the following at December 31: (in millions) Customer and merchant incentives $ 1,434 $ 1,134 Nonmarketable equity investments Prepaid income taxes Income taxes receivable Other Total other assets $ 2,298 $ 1,929 Customer and merchant incentives represent payments made or amounts to be paid to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. Amounts to be paid for these incentives and the related liability were included in accrued expenses and other liabilities. Nonmarketable equity investments represent the Companys cost and equity method investments. For the year ended December 31, 2017 , the Company invested $147 million in nonmarketable cost method equity investments. Non-current prepaid income taxes, included in the other asset table above, primarily consists of taxes paid in 2014 relating to the deferred charge resulting from the reorganization of the Companys legal entity and tax structure to better align with its business footprint of its non-U.S. operations. See Note 17 (Income Taxes) for further discussion of this deferred charge. Note 7. Property, Plant and Equipment Property, plant and equipment consisted of the following at December 31: (in millions) Building, building equipment and land $ $ Equipment Furniture and fixtures Leasehold improvements Property, plant and equipment 1,543 1,336 Less: accumulated depreciation and amortization (714 ) (603 ) Property, plant and equipment, net $ $ As of December 31, 2017 and 2016 , capital leases of $32 million and $23 million , respectively, were included in equipment. Accumulated amortization of these capital leases was $18 million and $16 million as of December 31, 2017 and 2016 , respectively. Depreciation and amortization expense for the above property, plant and equipment was $185 million , $151 million and $131 million for 2017 , 2016 and 2015 , respectively. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 8. Goodwill The changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2016 were as follows: (in millions) Beginning balance $ 1,756 $ 1,891 Additions 1,136 Foreign currency translation (143 ) Ending balance $ 3,035 $ 1,756 The Company had no accumulated impairment losses for goodwill at December 31, 2017 . Based on annual impairment testing, the Companys goodwill is not impaired. Note 9. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Amortized intangible assets Capitalized software $ 1,572 $ (888 ) $ $ 1,210 $ (768 ) $ Trademarks and tradenames (29 ) (22 ) Customer relationships (214 ) (162 ) Other (26 ) (22 ) Total 2,102 (1,157 ) 1,542 (974 ) Unamortized intangible assets Customer relationships Total $ 2,277 $ (1,157 ) $ 1,120 $ 1,696 $ (974 ) $ The increase in the gross carrying amount of amortized intangible assets in 2017 was primarily related to the businesses acquired in 2017. See Note 2 (Acquisitions) for further details. Certain intangible assets, including amortizable and unamortizable customer relationships and trademarks and tradenames, are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2017 , it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $252 million , $221 million and $235 million in 2017, 2016 and 2015 , respectively. The following table sets forth the estimated future amortization expense on amortizable intangible assets on the consolidated balance sheet at December 31, 2017 for the years ending December 31: (in millions) $ 2019 2020 2021 2022 and thereafter $ 79 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 10. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: (in millions) Customer and merchant incentives $ 2,648 $ 2,286 Personnel costs Advertising Income and other taxes Other Total accrued expenses $ 3,931 $ 3,318 As of December 31, 2017 and 2016 , the Companys provision for litigation was $709 million and $722 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 18 (Legal and Regulatory Proceedings) for further discussion of the U.S. and Canadian merchant class litigations. Note 11. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension, postretirement, savings and other postemployment benefit plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $84 million , $73 million and $61 million in 2017, 2016 and 2015 , respectively. Defined Benefit and Other Postretirement Plans In 2015, the Company terminated its non-contributory, qualified, U.S. defined benefit pension plan (the U.S. Employee Pension Plan). Participants had the option to receive a lump sum distribution or to participate in an annuity with a third-party insurance company. As a result of this termination, the Company settled its obligation for $287 million , which resulted in a pension settlement charge of $79 million recorded in general and administrative expense during 2015. The Company also sponsors pension and postretirement plans for non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. In April 2017, the Company acquired a majority interest in Vocalink. Vocalink has a defined benefit pension plan (the Vocalink Plan) which is closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $20 million as of December 31, 2017 ) annually until March 2020. See Note 2 (Acquisitions) for additional information on the Vocalink acquisition. The term Pension Plans includes the non-U.S. Plans, the Vocalink Plan and the U.S. Employee Pension Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan (in millions, except percentages) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Benefit obligation acquired during the year Service cost Interest cost Actuarial (gain) loss (44 ) Benefits paid (12 ) (2 ) (4 ) (4 ) Transfers in Foreign currency translation (2 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Fair value of plan assets acquired during the year Actual gain (loss) on plan assets (4 ) Employer contributions Benefits paid (12 ) (2 ) (4 ) (4 ) Transfers in Foreign currency translation (1 ) Fair value of plan assets at end of year Funded status at end of year $ (41 ) $ (13 ) $ (61 ) $ (59 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term $ $ $ (3 ) $ (3 ) Other liabilities, long-term (41 ) (13 ) (58 ) (56 ) $ (41 ) $ (13 ) $ (61 ) $ (59 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ (22 ) $ $ (5 ) $ (10 ) Prior service credit (8 ) (10 ) Balance at end of year $ (22 ) $ $ (13 ) $ (20 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 1.80 % 1.60 % * * Vocalink Plan 2.80 % * * * Postretirement Plan * * 3.50 % 4.00 % Rate of compensation increase Non-U.S. Plans 2.60 % 2.59 % * * Vocalink Plan 3.85 % * * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Each of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2017 and 2016 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets Components of net periodic benefit cost recorded in general and administrative expenses were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets (13 ) (1 ) (1 ) Curtailment gain Amortization of actuarial loss Amortization of prior service credit (2 ) (1 ) Pension settlement charge Net periodic benefit cost $ $ $ $ $ $ Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Curtailment gain $ $ $ (1 ) $ $ $ Current year actuarial (gain) loss (22 ) Current year prior service credit Amortization of prior service credit Pension settlement charge (79 ) Total recognized in other comprehensive income (loss) $ (22 ) $ $ (80 ) $ $ $ Total recognized in net periodic benefit cost and other comprehensive income (loss) $ (18 ) $ $ $ $ $ The estimated amounts that are expected to be amortized from accumulated other comprehensive income into net periodic benefit cost in 2018 are as follows: Pension Plans Postretirement Plan (in millions) Prior service credit $ $ (1 ) MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.60 % 1.85 % 2.00 % * * * Vocalink Plan 2.50 % * * * * * Postretirement Plan * * * 4.00 % 4.25 % 4.00 % Expected return on plan assets Non-U.S. Plans 3.25 % 3.25 % 3.25 % * * * Vocalink Plan 4.75 % * * * * * Postretirement Plan * * * * * * Rate of compensation increase Non-U.S. Plans 2.59 % 2.64 % 2.92 % * * * Vocalink Plan 3.95 % * * * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows to each of the respective Plans. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plan assets and considering historical as well as expected returns on various classes of plan assets. The assumed health care cost trend rates at December 31 for the Postretirement Plan were as follows: Health care cost trend rate assumed for next year 6.50 % 7.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate The assumed health care cost trend rates have a significant effect on the amounts reported for the Postretirement Plan. A one-percentage point change in assumed health care cost trend rates for 2017 would have a $5 million increase and $4 million decrease effect with a one-percentage point increase and decrease, respectively, in the benefit obligation. The effect on total service and interest cost components would be less than $1 million . Assets Plan assets are managed with a long-term perspective intended to ensure that there is an adequate level of assets to support benefit payments to participants over the life of the Pension Plans. The Vocalink Plan assets are managed within the following target asset allocations: non-government fixed income 37% , government securities (including U.K. governmental bonds) 28% , investment funds 25% and other 10% . The investment funds are currently comprised of approximately 40% derivatives, 30% equity, 15% fixed income and 15% other. For the non-U.S. Plans the assets are concentrated 100% in Insurance Contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. Cash and cash equivalents and other public investment vehicles (including certain mutual funds and government and agency securities) are valued at quoted market prices, which represent the net asset value of the shares held by the Vocalink Plan, and are therefore included in Level 1 of the Valuation Hierarchy. Certain other mutual funds (including commingled funds), MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) governmental and agency securities and insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2 of the Valuation Hierarchy. Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. A separate roll-forward of Level 3 plan assets measured at fair value is not presented as activities during 2017 and 2016 were immaterial. The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value as of December 31, 2017 and 2016 : December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents $ $ $ $ Government and agency securities Mutual funds Insurance contracts Asset-backed securities Other Total $ $ $ $ December 31, 2016 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Insurance contracts $ $ $ $ Total $ $ $ $ The following table summarizes expected benefit payments through 2026 for the Pension Plans and the Postretirement Plans, including those payments expected to be paid from the Companys general assets. Since the majority of the benefit payments for the Pension Plans are made in the form of lump-sum distributions, actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2019 2020 2021 2022 2023- 2026 84 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 12. Debt Long-term debt consisted of the following at December 31: Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % $ $ 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 5,477 5,239 Less: Unamortized discount and debt issuance costs (53 ) (59 ) Long-term debt $ 5,424 $ 5,180 The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2016 USD Notes, the 2015 Euro Notes and the 2014 USD Notes (collectively the Notes), were $1.969 billion , $1.723 billion and $1.484 billion , respectively. The Company is not subject to any financial covenants under the Notes. The Notes may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. The Notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the Notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2017 are summarized below. Amounts exclude capital lease obligations disclosed in Note 16 (Commitments) . (in millions) $ 500 650 839 Thereafter 3,488 Total $ 5,477 In November 2015, the Company established a commercial paper program (the Commercial Paper Program). Under which it is authorized to issue up to $3.75 billion in outstanding notes, with maturities up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed unsecured $3.75 billion revolving credit facility (the Credit Facility). Borrowings under the Credit Facility are available in U.S. dollars and/or euros. In October 2017, the Company extended the Credit Facility for an additional year to October 2022. The extension did not result in any material changes to the terms and conditions of the Credit Facility. The facility fee and borrowing cost under the Credit Facility MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) are based upon the Companys credit rating. At December 31, 2017 , the applicable facility fee was 8 basis points on the average daily commitment (whether or not utilized). In addition to the facility fee, interest on borrowings under the Credit Facility would be charged at the London Interbank Offered Rate (LIBOR) plus an applicable margin of 79.5 basis points, or an alternative base rate. The Credit Facility contains customary representations, warranties, events of default and affirmative and negative covenants, including a financial covenant limiting the maximum level of consolidated debt to earnings before interest, taxes, depreciation and amortization (EBITDA). Mastercard was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2017 and 2016 . The majority of Credit Facility lenders are customers or affiliates of customers of Mastercard. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. Mastercard had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2017 and 2016 . In June 2015, the Company filed a universal shelf registration statement to provide additional access to capital, if needed. Pursuant to the shelf registration statement, the Company may from time to time offer to sell debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Note 13. Stockholders Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $0.0001 3,000 One vote per share Dividend rights B $0.0001 1,200 Non-voting Dividend rights Preferred $0.0001 No shares issued or outstanding at December 31, 2017 and 2016, respectively. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.0 % 89.2 % 87.7 % 89.3 % Principal or Affiliate Customers (Class B stockholders) 1.4 % % 1.8 % % Mastercard Foundation (Class A stockholders) 10.6 % 10.8 % 10.5 % 10.7 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5% of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2017 , as well as historical purchases: Board authorization dates December 2017 December 2016 December December December Date program became effective N/A 1 April 2017 February 2016 January 2015 January 2014 Total (in millions, except average price data) Board authorization $ 4,000 $ 4,000 $ 4,000 $ 3,750 $ 3,500 $ 19,250 Dollar-value of shares repurchased in 2015 $ $ $ $ 3,243 $ $ 3,518 Remaining authorization at December 31, 2015 $ $ $ 4,000 $ $ $ 4,507 Dollar-value of shares repurchased in 2016 $ $ $ 3,004 $ $ $ 3,511 Remaining authorization at December 31, 2016 $ $ 4,000 $ $ $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ 2,766 $ $ $ $ 3,762 Remaining authorization at December 31, 2017 $ 4,000 $ 1,234 $ $ $ $ 5,234 Shares repurchased in 2015 35.1 3.2 38.3 Average price paid per share in 2015 $ $ $ $ 92.39 $ 84.31 $ 91.70 Shares repurchased in 2016 31.2 5.7 36.9 Average price paid per share in 2016 $ $ $ 96.15 $ 89.76 $ $ 95.18 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ 131.97 $ 109.16 $ $ $ 125.05 Cumulative shares repurchased through December 31, 2017 21.0 40.4 40.8 45.8 148.0 Cumulative average price paid per share $ $ 131.97 $ 99.10 $ 92.03 $ 76.42 $ 94.78 1 The December share repurchase program will become effective after completion of the December 2016 share repurchase program. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2014 1,115.4 37.2 Purchases of treasury stock (38.3 ) Share-based payments 2.0 Conversion of Class B to Class A common stock 15.9 (15.9 ) Balance at December 31, 2015 1,095.0 21.3 Purchases of treasury stock (36.9 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.0 (2.0 ) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock (30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 (5.2 ) Balance at December 31, 2017 1,039.7 14.1 Note 14. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2017 and 2016 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge Defined Benefit Pension and Other Postretirement Plans 2 Investment Securities Available-for-Sale 3 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2015 $ (663 ) $ (26 ) $ $ $ (676 ) Other comprehensive income (loss) (286 ) (2 ) (248 ) Balance at December 31, 2016 (949 ) (924 ) Other comprehensive income (loss) (153 ) (1 ) Balance at December 31, 2017 $ (382 ) $ (141 ) $ $ $ (497 ) 1 During 2016, the increase in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the devaluation of the British pound and euro. During 2017, the decrease in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro. 2 During 2016, deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $1 million before and after tax. During 2017, the decrease in other comprehensive loss related to the Companys postretirement plan was driven by a tax deferred gain primarily related to a defined benefit pension plan, acquired as part of Vocalink. See Note 11 (Pension, Postretirement and Savings Plans) for additional information. In addition, deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $2 million before tax and $1 million after tax. 3 During 2016 and 2017, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant. Note 15. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company has granted Options, RSUs and PSUs under the LTIP. The Options, which expire ten years from the date of grant, generally vest ratably over four years from the date of grant. The RSUs and PSUs generally vest after three years . The Company uses the straight-line method of attribution for expensing equity awards. Compensation expense is recorded net of estimated forfeitures. Estimates are adjusted as appropriate. For all awards granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all awards granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: Risk-free rate of return 2.0 % 1.3 % 1.5 % Expected term (in years) 5.00 5.00 5.00 Expected volatility 19.3 % 23.3 % 20.6 % Expected dividend yield 0.8 % 0.8 % 0.7 % Weighted-average fair value per Option granted $ 21.23 $ 18.58 $ 17.29 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2017 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2017 8.3 $ Granted 1.7 $ Exercised (1.3 ) $ Forfeited/expired (0.1 ) $ Outstanding at December 31, 2017 8.6 $ 6.6 $ Exercisable at December 31, 2017 4.6 $ 5.2 $ Options vested and expected to vest at December 31, 2017 8.5 $ 6.6 $ As of December 31, 2017 , there was $32 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.2 years . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Restricted Stock Units The following table summarizes the Companys RSU activity for the year ended December 31, 2017 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2017 4.1 $ Granted 1.4 $ Converted (1.2 ) $ Forfeited (0.2 ) $ Outstanding at December 31, 2017 4.1 $ $ RSUs vested and expected to vest at December 31, 2017 4.0 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2017 , there was $156 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . Performance Stock Units The following table summarizes the Companys PSU activity for the year ended December 31, 2017 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2017 0.4 $ Granted 0.2 $ Converted (0.1 ) $ Outstanding at December 31, 2017 0.5 $ $ PSUs vested and expected to vest at December 31, 2017 0.5 $ $ Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth, and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2017 , there was $13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.6 years . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Additional Information The following table includes additional share-based payment information for each of the years ended December 31: (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock Note 16. Commitments At December 31, 2017 , the Company had the following future minimum payments due under non-cancelable agreements: Total Capital Leases Operating Leases Sponsorship, Licensing Other (in millions) $ $ $ $ 2019 2020 2021 2022 Thereafter Total $ 1,088 $ $ $ Included in the table above are capital leases with a net present value of minimum lease payments of $11 million . In addition, at December 31, 2017 , $20 million of the future minimum payments in the table above for sponsorship, licensing and other agreements was accrued. Consolidated rental expense for the Companys leased office space was $77 million , $62 million and $52 million for 2017 , 2016 and 2015 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $22 million , $19 million and $17 million for 2017 , 2016 and 2015 , respectively. Note 17. Income Taxes On December 22, 2017, in the U.S., the TCJA was enacted into law. The TCJA represents significant changes to the U.S. internal revenue code and, among other things: lowers the corporate income tax rate from 35% to 21% imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduces further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations eliminates the domestic production activities deduction While the effective date of the law for most provisions is January 1, 2018, GAAP requires the resulting tax effects be accounted for in the reporting period of enactment. This includes the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S., the dilution of foreign tax credit benefits on the repatriation of current year foreign earnings and the recognition of a deferred tax liability resulting from the change in the Companys indefinite reinvestment assertion for certain foreign affiliates. The impact of the TCJA is discussed further below. Also, on December 22, 2017, SEC staff issued Staff Accounting Bulletin No. 118 - Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which will allow registrants to record provisional amounts during a measurement period, which is not to extend beyond one year. Accordingly, amounts reflected below may require further adjustments due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and The Department of Treasury (Treasury) of Notices, regulations and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied to the TCJA. The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 3,482 $ 3,736 $ 3,399 Foreign 3,040 1,910 1,559 Income before income taxes $ 6,522 $ 5,646 $ 4,958 The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ 1,704 $ 1,074 $ State and local Foreign 2,521 1,607 1,166 Deferred Federal (6 ) State and local (2 ) (3 ) Foreign (49 ) (12 ) (17 ) (20 ) (16 ) Income tax expense $ 2,607 $ 1,587 $ 1,150 As of December 31, 2017 , a provisional amount of U.S. federal and state and local income taxes of $36 million has been provided on a substantial amount of the Companys undistributed foreign earnings. This deferred tax charge has been established primarily on the estimated foreign exchange gain which will be recognized when such earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Based upon the ongoing review of business requirements and capital needs of the Companys non-U.S. subsidiaries, the Company believes a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, the Company will complete its analysis of global working capital and cash needs to determine the amount it considers indefinitely reinvested. It will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 35% to pretax income for the years ended December 31, as a result of the following: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 6,522 $ 5,646 $ 4,958 Federal statutory tax 2,283 35.0 % 1,976 35.0 % 1,735 35.0 % State tax effect, net of federal benefit 0.7 % 0.4 % 0.5 % Foreign earnings (380 ) (5.8 )% (188 ) (3.3 )% (144 ) (2.9 )% Impact of foreign tax credits 1 (27 ) (0.4 )% (141 ) (2.5 )% (281 ) (5.7 )% Impact of settlements with tax authorities % % (147 ) (2.9 )% Transition Tax 9.6 % % % Remeasurement of U.S. deferred taxes 2.4 % % % Other, net (98 ) (1.5 )% (82 ) (1.5 )% (40 ) (0.8 )% Income tax expense $ 2,607 40.0 % $ 1,587 28.1 % $ 1,150 23.2 % 1 Included within the impact of foreign tax credits are repatriation benefits of current year foreign earnings of $0 million , $116 million and $172 million , in addition to other foreign tax credit benefits which become eligible in the United States of $27 million , $25 million and $109 million for 2017 , 2016 and 2015 , respectively. Effective Income Tax Rate The effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were 40.0% , 28.1% and 23.2% , respectively. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to the TCJA, which includes provisional amounts of $825 million related to the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on current year repatriations. In addition, the Companys effective income tax rate versus the prior year was impacted by a more favorable geographic mix of taxable earnings in 2017, partially offset by a lower U.S. foreign tax credit benefit. There are provisional current and noncurrent components of the Companys liability for the Transition Tax. The Transition Tax will be paid over 8 annual installments commencing April 15, 2018. Approximately $52 million and $577 million of the total amount due is recorded in other current liabilities and other liabilities, respectively, on the consolidated balance sheet at December 31, 2017. Under the TCJA, for purposes of IRS examination of the Transition Tax, the statute of limitations is extended to six years. Consistent with SAB 118, the Company was able to make reasonable estimates and has incorporated provisional amounts for the impact of the Transition Tax. This tax is on previously untaxed accumulated and current earnings and profits of the Companys foreign subsidiaries. To compute the tax, the Company must determine the amount of post-1986 earnings and profits of relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company was able to make reasonable estimates and has recorded provisional amounts of $629 million related to the Transition Tax, $157 million charge for the remeasurement of the Companys net deferred tax asset in the U.S. and $36 million related to the change in assertion regarding the indefinite reinvestment of foreign earnings. However, these amounts may require further adjustments during the measurement period due to evolving analysis and interpretations of law, including issuance by the IRS and Treasury of Notices and regulations, and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied. The effective income tax rate for 2016 was higher than the effective income tax rate for 2015 primarily due to benefits associated with the impact of settlements with tax authorities in multiple jurisdictions in 2015 , the lapping of a discrete benefit relating to certain foreign taxes that became eligible to be claimed as credits in the United States in 2015 , and a higher U.S. foreign tax credit benefit associated with the repatriation of current year foreign earnings in 2015 . These items were partially offset by a more favorable geographic mix of taxable earnings in 2016 . During 2014, the Company implemented an initiative to better align its legal entity and tax structure with its operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) to a related foreign entity in the United Kingdom. Management believes this improved alignment has resulted in greater flexibility and efficiency with regard to the global deployment of cash, as well as ongoing benefits in the Companys effective income tax rate. The Company recorded a deferred charge related to the income tax expense on intercompany profits that resulted from the transfer. The tax associated with the transfer is deferred and amortized utilizing a 25 -year life. This deferred charge is included in other current assets and other assets on the consolidated balance sheet at December 31, 2017 in the amounts of $17 million and $352 million , respectively. The comparable amounts included in other current assets and other assets were $15 million and $325 million , respectively, at December 31, 2016 , with the difference driven by changes in foreign exchange rates and current period amortization. In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. The guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The Company will adopt this accounting guidance on January 1, 2018. The aforementioned deferred charge of $369 million at December 31, 2017 , will be written off to retained earnings as a component of the cumulative-effect adjustment. In addition, deferred taxes will also be a component of the cumulative-effect adjustment whereby the Company expects to record a $186 million deferred tax asset in this regard. See Note 1 (Summary of Significant Accounting Policies) for additional information related to this guidance. In 2010, in connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2017, 2016 and 2015 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $104 million , or $0.10 per diluted share, $49 million , or $0.04 per diluted share, and $47 million , or $0.04 per diluted share, respectively. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses Unrealized gain/loss - 2015 Euro Notes Recoverable basis of deconsolidated entities Other items Less: Valuation allowance (91 ) (91 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Intangible assets Property, plant and equipment Unrealized gain/loss - 2015 Euro Notes Previously taxed earnings and profits Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ As a result of the TCJA, the December 31, 2017 deferred tax balance has been reduced by $157 million during 2017 through the provisional remeasurement of the U.S. deferred tax assets and liabilities. Both the 2017 and 2016 valuation allowances relate primarily to the Companys ability to recognize tax benefits associated with certain foreign net operating losses. The net activity related to the valuation allowance balance at December 31, 2017 from the December 31, 2016 balance is attributable to an increase from additional foreign losses offset by a reduction, due to remeasurement of the deferred tax attribute, for capital loss and capital asset impairments in the United States. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. The recognition of losses with regard to capital loss and impairments is dependent upon the recognition of future capital gains in the United States. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions (1 ) (28 ) (151 ) Settlements with tax authorities (4 ) (2 ) (53 ) Expired statute of limitations (11 ) (15 ) (9 ) Ending balance $ $ $ 95 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The entire unrecognized tax benefit of $183 million , if recognized, would reduce the effective tax rate. During 2015, there was a reduction to the balance of the Companys unrecognized tax benefits. This was primarily due to settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the United States, Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2008, with the exception of transfer pricing issues which are settled through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. It is the Companys policy to account for interest expense related to income tax matters as interest expense in its consolidated statement of operations, and to include penalties related to income tax matters in the income tax provision. The Company recorded tax-related interest expense of $1 million in 2017 and tax-related interest income of $4 million and $3 million in 2016 and 2015 , respectively, in its consolidated statement of operations. At December 31, 2017 and 2016 , the Company had a net income tax-related interest payable of $10 million and $9 million , respectively, in its consolidated balance sheet. At December 31, 2017 and 2016 , the amounts the Company had recognized for penalties payable in its consolidated balance sheet were not material. Other Impacts of the TCJA As mentioned above, the TCJA imposes significant changes to U.S. tax law. The Company expects to pay a marginal amount of GILTI. However, in accordance with FASB guidance, the Companys policy will be to recognize GILTI in the period it arises and it will not recognize a deferred charge with regard to GILTI. The Company does not expect to be subject to the BEAT. The Company expects to recognize income in the U.S. that will qualify as FDII and be taxed at the lower 13.125% effective tax rate. The Company will be eligible to expense qualifying fixed assets acquired after September 27, 2017, will be impacted by the additional limitations imposed on the deductibility of executive compensation, and does not expect to be impacted by the limitations placed on the deductibility of interest expense. Finally, the Company will lose its domestic production activities deduction. Note 18. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined, and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory and/or legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12% of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36% of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. Prior to the reversal of the settlement approval, merchants representing slightly more than 25% of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over 30 opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters (except for two state court actions) in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants motion to dismiss the opt-out merchant complaints for failure to state a claim. Deposition discovery commenced in December 2016 and the parties in the class action are in mediation. As of December 31, 2017 , Mastercard had accrued a liability of $708 million as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2017 and 2016 , Mastercard had $546 million and $543 million , respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) cash on its consolidated balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters at December 31, 2017 . The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada . In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which is subject to court approval in each applicable province, requires Mastercard to make a cash payment and modify its no surcharge rule. During the first quarter of 2017, the Company recorded a provision for litigation of $15 million related to this matter. Europe. In July 2015, the European Commission issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rules within the European Economic Area. The Statement of Objections, which follows an investigation opened in 2013, includes preliminary conclusions concerning the alleged anticompetitive effects of these practices. The European Commission has indicated it intends to seek fines if these conclusions are subsequently confirmed. In April 2016, Mastercard submitted a response to the Statement of Objections disputing the European Commissions preliminary conclusions and participated in a related oral hearing in May 2016. Since that time, Mastercard has remained in discussions with the European Commission. Although the Statement of Objections does not quantify the level of fines, based upon recent interactions with the European Commission, it is possible that they could be substantial, potentially in excess of $1 billion if the European Commission were to issue a negative decision. Fines may be less than this amount in the event of a negotiated resolution. Due to the uncertainty of numerous legal issues, including the potential for a negotiated resolution, Mastercard cannot estimate a possible range of loss at this time, although Mastercard expects to obtain greater clarity with respect to these issues in the first half of 2018. In the United Kingdom, beginning in May 2012, a number of retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants), with claimed purported damages exceeding $1 billion . The U.K. Merchant claimants (including all resolved matters) represent approximately 40% of Mastercards U.K. interchange volume over the relevant damages period. Additional merchants have filed or threatened litigation with respect to interchange rates in Europe (the Pan-European claimants) for purported damages exceeding $1 billion . Mastercard submitted statements of defense to the retailers claims disputing liability and damages. In June 2015, Mastercard entered into a settlement with one of the U.K. Merchant claimants for $61 million , recorded as a provision for litigation settlement. Following the conclusion of a trial for liability and damages for one of the U.K. merchant cases, in July 2016, the tribunal issued a judgment against Mastercard for damages. Mastercard recorded a litigation provision of $107 million in the second quarter of 2016 that includes the amount of the judgment and estimated legal fees and costs. Mastercard has been granted permission to appeal this judgment. In the fourth quarter of 2016, Mastercard recorded a charge of $10 million relating to settlements with multiple U.K. Merchant claimants. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants, who had been seeking in excess of $500 million in damages. Subsequently, Mastercard settled with six of these claimants to resolve their claims, with no financial payments required by Mastercard. Three of the U.K. Merchant claimants are appealing the judgment. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $19 billion as of December 31, 2017 ). In July 2017, the court denied the plaintiffs application for the case to proceed as a collective action. The plaintiffs request for permission to appeal this decision was denied, which they have appealed. The plaintiffs have also filed a separate request for judicial review of the courts denial of their collective action. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo, and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. Note 19. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro branded transactions between its issuers and acquirers (settlement risk). Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily card volume during the quarter multiplied by the estimated number of days to settle. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk. Customer-reported transaction data and the transaction clearing data underlying the settlement exposure calculation may be revised in subsequent reporting periods. In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during the ordinary course activities of the Company. The Company has global risk management policies and procedures aimed at managing the settlement exposure. These risk management procedures include interaction with the bank regulators of countries in which it operates, requiring customers to make adjustments to settlement processes, and requiring collateral from customers. As part of its policies, Mastercard requires MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) certain customers that are not in compliance with the Companys risk standards in effect at the time of review to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on managements review of the individual risk circumstances for each customer that is out of compliance. In addition to these amounts, Mastercard holds collateral to cover variability and future growth in customer programs. The Company may also hold collateral to pay merchants in the event of an acquirer failure. Although the Company is not contractually obligated under its rules to effect such payments to merchants, the Company may elect to do so to protect brand integrity. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure from Mastercard, Cirrus and Maestro branded transactions was as follows: December 31, 2017 December 31, 2016 (in millions) Gross settlement exposure 1 $ 47,002 $ 39,523 Collateral held for settlement exposure (4,360 ) (3,734 ) Net uncollateralized settlement exposure $ 42,642 $ 35,789 1. In the second quarter of 2017, Mastercard adjusted the methodology for estimating gross settlement exposure for certain customers whose exposures are now reported before the impact of potential offsetting positions. The gross settlement exposure as of December 31, 2016 has been updated to conform to the current years methodology. General economic and political conditions in countries in which Mastercard operates affect the Companys settlement risk. Many of the Companys financial institution customers have been directly and adversely impacted by political instability and uncertain economic conditions. These conditions present increased risk that the Company may have to perform under its settlement guarantee. This risk could increase if political, economic and financial market conditions deteriorate further. The Companys global risk management policies and procedures are revised and enhanced from time to time. Historically, the Company has experienced a low level of losses from financial institution failures. Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $395 million and $397 million at December 31, 2017 and 2016 , respectively, of which $313 million and $312 million at December 31, 2017 and 2016 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 20. Foreign Exchange Risk Management The Company monitors and manages its foreign currency exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A principal objective of the Companys risk management strategies is to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates principally through the use of derivative instruments. Derivatives The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currencies of the entity. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2017 and 2016 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercards derivative contracts are summarized below: December 31, 2017 December 31, 2016 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ (2 ) Commitments to sell foreign currency (26 ) Options to sell foreign currency Balance sheet location Accounts receivable 1 $ $ Other current liabilities 1 (30 ) (13 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized in income for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign currency derivative contracts General and administrative $ (75 ) $ (6 ) $ The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2017 and 2016 , as these contracts were not accounted for under hedge accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. The effect of a hypothetical 10% adverse change in foreign currency forward rates could result in a fair value loss of approximately $109 million on the Companys foreign currency derivative contracts outstanding at December 31, 2017 . Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of December 31, 2017 , the Company had a net foreign currency transaction pre-tax loss of $216 million in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period. Note 21. Segment Reporting Mastercard has concluded it has one operating and reportable segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 35% of total revenue in 2017 , 38% in 2016 and 39% in 2015 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Mastercard did not have any one customer that generated greater than 10% of net revenue in 2017 , 2016 or 2015 . The following table reflects the geographical location of the Companys property, plant and equipment, net, as of December 31: (in millions) United States $ $ $ Other countries Total $ $ $ 102 MASTERCARD INCORPORATED SUMMARY OF QUARTERLY DATA (Unaudited) 2017 Quarter Ended March 31 June 30 September 30 December 31 2017 Total (in millions, except per share data) Net revenue $ 2,734 $ 3,053 $ 3,398 $ 3,312 $ 12,497 Operating income 1,506 1,653 1,941 1,522 6,622 Net income 1,081 1,177 1,430 3,915 Basic earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.67 Basic weighted-average shares outstanding 1,078 1,070 1,063 1,057 1,067 Diluted earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.65 Diluted weighted-average shares outstanding 1,082 1,075 1,068 1,063 1,072 2016 Quarter Ended March 31 June 30 September 30 December 31 2016 Total (in millions, except per share data) Net revenue $ 2,446 $ 2,694 $ 2,880 $ 2,756 $ 10,776 Operating income 1,348 1,380 1,670 1,363 5,761 Net income 1,184 4,059 Basic earnings per share $ 0.86 $ 0.89 $ 1.08 $ 0.86 $ 3.70 Basic weighted-average shares outstanding 1,109 1,098 1,096 1,087 1,098 Diluted earnings per share $ 0.86 $ 0.89 $ 1.08 $ 0.86 $ 3.69 Diluted weighted-average shares outstanding 1,112 1,101 1,099 1,090 1,101 Note: Tables may not sum due to rounding. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2017 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " diff --git a/datasets/final/summarized_dataframe_sshleifer_distilbart-cnn-12-6.csv b/datasets/final/summarized_dataframe_sshleifer_distilbart-cnn-12-6.csv new file mode 100644 index 0000000..a47bb14 --- /dev/null +++ b/datasets/final/summarized_dataframe_sshleifer_distilbart-cnn-12-6.csv @@ -0,0 +1,50 @@ +Company,Year,Business,Risk Factor,Unresolved Staff Comments,Properties,Legal Proceedings,"Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities",Management’s Discussion and Analysis of Financial Condition and Results of Operations,Quantitative and Qualitative Disclosures About Market Risk,Financial Statements and Supplementary Data,Controls and Procedures +Meta,2021, Facebook's mission is to give people the power to build community and bring the world closer together . We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business . We offer most of our full-time employees the option to work remotely on a regular basis .," The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business . We receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations . The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules ."," Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution"""," Our corporate headquarters are located in Menlo Park, California . As of December 31, 2021, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas . We believe that our facilities are adequate for our current needs ."," Meta Platforms Ireland is subject to litigation and other proceedings involving law enforcement and other regulatory agencies . We believe the lawsuits described above are without merit, and we are vigorously defending them . We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020 and required us to pay a penalty of $5.0 billion ."," Meta Platforms, Inc. has never declared or paid any cash dividend on our common stock . Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012 . Our board of directors has authorized a share repurchase program . The timing and actual number of shares repurchased depend on a variety of factors, including price and market conditions ."," Marketing and sales expenses in 2021 increased $2.2 billion . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above . The impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain ."," Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values . Foreign currency losses of $140 million, $129 million, and $105 million were recognized in 2021, 2020, and 2019 . Volatility in the global economic climate and financial markets could result in a material impairment charge on our equity investments ."," Family of Apps revenue $ 117,929 $ 85,965 $ 70,697 in 2019 . Reality Labs revenue $ 56,946 $ 39,294 $ 28,489 . Revenue from operations $ 46,753 $ 32,671 $ 23,986 . For further information, see Legal and Related Matters in Note 11 ."," There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2021 that materially affected, or are reasonably likely to materially affect, the company's internal control of financial reporting . Management conducted an assessment of the effectiveness of our internal controls and procedures as of December 31, 2021 ." +Meta,2020," Facebook's mission is to give people the power to build community and bring the world closer together . Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States . The vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, and in the long term, we expect some personnel to transition to working remotely ."," The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business . We are subject to multiple putative class action suits in connection with our platform and user data practices . The Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements on products and services offered to users in Brazil ."," Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution"""," As of December 31, 2020, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas . In addition, we have offices in more than 80 cities across North America, Latin America, Europe, the Middle East, Africa, and Asia Pacific .", Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020 . FTC filed a complaint against us in the U.S. alleging that we engaged in anticompetitive conduct in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 . FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws .," The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2015 in the Class A common stock of Facebook, Inc. We have never declared or paid any cash dividend on our common stock . In January 2021, an additional $25 billion of repurchases was authorized under this program ."," This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes . We expect user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower . We entered into a definitive agreement to invest in Jio Platforms Limited, a subsidiary of Reliance Industries Limited ."," We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, equity investment risk, and inflation . Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities . Volatility in the global economic climate and financial markets could result in a material impairment charge on our equity investments ."," The following table reflects changes in the gross unrecognized tax benefits (in millions): Gross unrecognized tax benefits beginning of period $ 7,863 $ 4,678 . The Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 1). The Company's board of directors approved an increase of 16 million shares reserved for issuance effective January 1, 2021 ."," There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2020 that materially affected, or are reasonably likely to materially affect, the company's internal control of financial reporting . Management conducted an assessment of the effectiveness of our . internal control ." +Meta,2019," Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business ."," We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value . Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control . We are subject to a variety of risks inherent in doing business internationally ."," Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution"""," As of December 31, 2019, we owned and leased approximately nine million square feet of office and building space for our corporate headquarters and in the surrounding areas . We also own 15 data centers globally . Our corporate headquarters are located in Menlo Park, California . We believe that our facilities are adequate for our current needs ."," Multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers . The parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $550 million by us and is subject to approval by the court . We believe the remaining lawsuits are without merit, and we are vigorously defending them ."," The board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date . As of December 31, 2019, $4.0 billion of repurchases was authorized under this program . The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities ."," Revenue was $70. 67 billion and $1. 34 billion of taxes paid related to net share settlement of equity awards . Operating margin was 34% . 42 billion , or 37% , compared to 2018 . Average Revenue Per Person (ARPP) may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes ."," Interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities . Foreign currency losses of $105 million , $213 million , and $6 million were recognized in 2019 , 2018 , and 2017 as interest and other income, net in our consolidated statements of income ."," The Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2 . Holders of our Class A common stock and Class B common stock are entitled to dividends if, declared by our board of directors, subject to the rights of the holders of all classes of stock having priority rights to dividends . We determine realized gains or losses on sale of marketable securities on a specific identification method ."," Our management is responsible for establishing and maintaining adequate internal control over financial reporting . Management evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2019 . No changes in internal control were ""reasonably likely to materially affect"" internal control of financial reporting, management says ." +Meta,2018," Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. Our mission is to give people the power to build community and bring the world closer together . We compete to attract, engage, and retain people who use our products ."," We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value . Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control . We estimate that false accounts may have represented approximately 5% of our worldwide MAUs ."," Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution"""," Our corporate headquarters are located in Menlo Park, California . We also own and lease data centers throughout the United States and in various locations internationally . As of December 31, 2018, we owned and leased approximately six million square feet of office and building space for our corporate headquarters and in the surrounding areas ."," Two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 . We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties . We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations .", Many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders . We have never declared or paid any cash dividend on our common stock . We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future . The stock price of the stock price is not necessarily indicative of future stock price performance .," As of December 31, 2018, we had net unrecognized tax benefits of $3.3.9 billion . Effective tax rate was 13% . Net income was $22.54 billion, a decrease of $597 million from 2017 . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above ."," Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements . It is difficult to predict the effect hedging activities would have on our results of operations ."," Our responsibility is to express an opinion on the Companys financial statements based on our audits . We fully repaid all our capital lease obligations during 2016 . The amount of stranded tax effects that were reclassified from accumulated other comprehensive loss to retained earnings was not material . The increase in the deferred revenue balance for the year ended December 31, 2018 was driven by prepayments from marketers ."," There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2018 that materially affected, or are reasonably likely to materially affect, our internal controls . Management is responsible for establishing and maintaining adequate internal control ." +Meta,2017," Facebook's top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces . We compete to attract, engage, and retain people who use our products, to attract and retain marketers . We are also investing in a number of longer-term initiatives, such as connectivity efforts, artificial intelligence research, and augmented and virtual reality ."," Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above . We are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S."," Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution"""," As of December 31, 2017, we owned and leased approximately three million square feet of office buildings for our corporate headquarters . We also own and lease data centers throughout the United States and in various locations internationally . As such, we have excluded square footage from the total leased space and owned properties, disclosed above ."," Multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the U.S. and in other jurisdictions against us, our directors, and/or certain of our officers . The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO ."," In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion . We have never declared or paid any cash dividend on our common stock . We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future . Our Class B common stock is not listed nor traded on any stock exchange . The following graph shows a comparison from May 18, 2012 (the date our Class A common stock commenced trading on the Nasdaq Global Select Market) through December 31, 2017 ."," Worldwide DAUs increased 14% to 1.12 billion for the year ended December 31, 2017 . We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above ."," Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities . Foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements ."," Our responsibility is to express an opinion on the Companys financial statements based on our audits . For original programming, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable . RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material ."," Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) There were no changes in internal control in the fourth quarter of 2017 that materially affected, or are reasonably likely to materially affect, our internal financial reporting ." +Merck & Co.,2021," Merck has provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health . The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness ."," The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws . Product liability insurance for products may be limited, cost prohibitive or unavailable . The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action ."," Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B"""," Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey . Production facilities for human health products at seven locations in the U.S. and Puerto Rico . Capital expenditures were $4.4 billion in 2021, $1. 4 billion in 2020 and $3. 8 billion in . 2021 . A number of properties were transferred to Organon in the Spin-Off ."," The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 ."," The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of major U.S. pharmaceutical companies . As of January 31, 2022, there were approximately 99,932 shareholders of record of Merck Common Stock . All shares purchased during the period were made as part of a plan to purchase up to $10 billion in Merck shares for its treasury ."," Merck completed spin-off of health, established brands businesses into new, independent, publicly traded company named Organon Organon Co. Gross margin was 67.0% for federal income tax purposes . The U.S. Food and Drug Administration (FDA) approved Welireg (belzutifan), an oral hypoxia-inducible factor-2 alpha (HIF-2) inhibitor, for the treatment of adult patients with von Hippel-Lindau (VHL) Table o f Contents disease .", The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Managements Discussion and Analysis of Financial Condition and Results of Operations . Table o f Contents of the Item includes the discussion and analysis of financial condition and results of operations .," As a result of the spin-off of Organon, Merck incurred separation costs of $ 556 million in 2021 and $ 743 million in 2020 . The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters ."," The financial statements report on managements stewardship of Company assets . For the fourth quarter of 2021, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control of financial reporting . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the internal control ." +Merck & Co.,2020," MK-1242, vericiguat, is an orally administered soluble guanylate cyclase (sGC) stimulator under review in the EU and in Japan . Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health . The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world ."," The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action . The Company is subject to evolving and complex tax laws, which may result in additional liabilities . Product liability insurance for products may be limited, cost prohibitive or unavailable . The global COVID-19 pandemic is having an adverse impact on the Companys business ."," Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B"""," Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey . A number of properties will be transferred to Organon in the Spin-Off . Capital expenditures were $4.6 billion in 2018 . The Companys has production facilities for human health products at nine locations in the United States ."," The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Legal Proceedings are incorporated in this Item . Financial Statements and Supplementary Data, Note 10. Financial statements and Supplementary data are incorporated into the Item ."," The Company did not purchase any shares during the three months ended December 31, 2020 under the plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury . The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK ."," Pharmaceutical segment profits grew 5% in 2020 compared with 2019 driven primarily by higher sales, as well as lower selling and promotional costs . Gardasil 9 was approved by the PMDA in Japan for use in women and girls nine years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine . Keytruda received approval in the United States as monotherapy in the therapeutic areas of cutaneous squamous cell carcinoma (cSCC), metastatic microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) colorectal cancer, colore", The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Item 7A. Quantitative and Qualitative Disclifications about Market Risk . Item 7 . s . Managements Discussion and Analysis of Financial Condition and Results of Operations .," Merck is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters . The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs ."," The financial statements report on managements stewardship of Company assets . Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated s Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment ." +Merck & Co.,2019," Merck has provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health . The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development . The Spin-Off is expected to be completed in the first half of 2021, subject to market and certain conditions ."," The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries . Product liability insurance for products may be limited, cost prohibitive or unavailable . The Company cannot state with certainty when or whether any of its products now under development will be approved or launched . Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations ."," Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B"""," Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey . Production facilities for human health products at nine locations in the United States and Puerto Rico . Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs ."," The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Legal Proceedings are incorporated in this Item . Financial Statements and Supplementary Data, Note 10. Financial statements and Supplementary data are incorporated into the Item ."," The Performance Graph assumes a $100 investment on December 31, 2014, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. pharmaceutical companies . As of January 31, 2020, there were approximately 109,500 shareholders of record of the Companion Common Stock ."," Lower sales of diabetes products Januvia and Janumet and HIV products Isentress/Isentress HD also partially offset revenue growth in 2019 . Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 19% in 2019 driven primarily by higher demand in the Asia Pacific region, particularly in China . Varivax and RotaTeq also grew . Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin declined 35% . Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide clinical development collaboration", The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .," Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales . As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.4 billion . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing ."," Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended (the Act) The financial statements report on managements stewardship of Company assets ." +Merck & Co.,2018, August 2018 FDA approved Delstrigo for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience . The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development . Keytruda has received Breakthrough Drug and Cosmetic Therapy (QIDP) designation . The Company also recognizes that it has an important role to play in helping to improve access to its products .," There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials . Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area . Some health authorities appear to have become more cautious when making decisions about approvability of new products ."," Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B"""," Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey . In the United States, these amounted to $1. 5 billion in 2018 . In October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022 ."," The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 ."," Merck shares were purchased as part of a plan approved by the Board of Directors in November 2017 to purchase up to $10 billion in Mercks common stock for its treasury . Amgen Inc. , Amgen, Roche Holding AG, and Sanofi SA. 70 PEER GRP. Shares are approximated."," Sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $217 million in 2018, a decline of 68% compared with 2017 . In December 2018, the FDA approved Lynparza for use as maintenance treatment of adult patients with deleterious . germline or somatic BRCA -mutated advanced . ovarian, fallopian tube or primary peritoneal cancer . The Company recorded a net reduction in expenses of $54 million and $402 million to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs .", The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .," The Company determined the fair value of the contingent consideration was $223 million at the acquisition date . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing . Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales ."," The financial statements report on managements stewardship of Company assets . Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control ." +Merck & Co.,2017," V920 is an investigational rVSV-ZEBOV (Ebola) vaccine candidate being studied in large scale Phase 2/3 clinical trials . V419 is being marketed as Vaxelis in the EU . MK-5618, selumetinib, is an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinaseK pathway being developed for multiple cancer types ."," The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, expensive and uncertain process . Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing ."," Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B"""," The Companys U.S. and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory . The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico . Mercks Animal Health global headquarters is located in Madison, New Jersey ."," The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 ."," The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK . In November 2017, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury . The following graph assumes a $100 investment on December 31, 2012, and reinvestment of all dividends . The Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material .", Sales growth in 2016 as compared with 2015 was driven primarily by higher sales in the United States reflecting the effects of public sector purchasing and higher pricing that were partially offset by lower demand . The Company purchased $4. 87 $ 1. 48 per share on the Companys common stock for the second quarter of 2018 payable in April 2018 ., The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .," Merck is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation . The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material . The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant ."," The financial statements report on managements stewardship of Company assets . Management is responsible for establishing and maintaining adequate internal control over financial reporting . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control ." +Alphabet Inc.,2021," We focus on creating the best advertising experiences for our users and advertisers in many ways, including filtering out invalid traffic and removing billions of bad ads from our systems every year . We see significant opportunity in helping businesses utilize these strengths with features like data migration, modern development environments, and machine learning tools to provide enterprise-ready cloud services . Sustainability is one of our core values at Google, and we strive to build sustainability into everything we do ."," There can be no assurance we will be able to provide hardware that competes effectively . Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country . The unrealized gains and losses we record from fair value remeasurements of our non-marketable equity securities may differ significantly from the gains or losses we ultimately experience on such investments .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and RD sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business ."," For a description of our material pending legal proceedings, see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . Legal Matters is in note 10 of Item 10 of this Annual Report of this year's results ."," Alphabet Inc. regularly evaluates our cash and capital structure, including the size, pace, and form of capital return to stockholders . The primary use of capital continues to be to invest for the long-term growth of the business . The repurchases are being executed from time to time, subject to general business and market conditions . The returns shown are based on historical results and are not intended to suggest future performance ."," Impressions increased from 2020 to 2021 primarily driven by growth in AdMob, partially offset by a decline in impressions related to AdSense . Google Cloud revenues are comprised of the following: Google Cloud Platform, which includes fees for infrastructure, platform, and other services . Other income (expense), net, net, increased $5.3% ."," As of December 31, 2020 and 2021, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $18. 4 billion and $1. 0 billion . If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approxima tely $497 million and $285 million ."," Alphabet's responsibility is to express an opinion on the Companys financial statements based on our audits . The following table presents revenues disaggregated by geography, based on the addresses of our customers . Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 0. 4 billion . We recognized a charge of $ 2.7 billion in non-income tax audits ."," As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2021 . The implementation of certain of our subledgers, which included changes to our processes, procedures and internal controls over financial reporting during the second quarter of 2021, is expected to continue in phases over the next few years ." +Alphabet Inc.,2020," At Google, we build technology that helps people do more for the planet . We are making long-term investments that will grow revenues beyond advertising . We intend to enable 5 GW of new carbon-free energy across our key manufacturing regions by 2030 through investment . Google comprises two segments: Google Services and Google Cloud ."," Alphabet Inc. may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties . We may also experience downward pressure on our operating margin resulting from expansion of our business into new fields such as hardware, Google Cloud, and subscription products . There can be no assurance we will be able to provide hardware that competes effectively ."," Alphabet Inc. Unresolved Staff Comments Not applicable. Not applicable . Unresolvement of this article is not required. It is the result of a dispute between Alphabet and Alphabet . Alphabet is the parent company of Alphabet, Google, Apple, Facebook and YouTube ."," Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business ."," For a description of our material pending legal proceedings, please see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . Legal Matters is in note 10 of Item 8 ."," Alphabet's Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 . The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) The returns shown are based on historical results and are not intended to suggest future performance ."," Google Network Members' properties' revenues increased $1,543 million from 2019 to 2020 . European Commission Fines in March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law . The increase was partially offset by a $554 million charge recognized in 2019 relating to a legal settlement ."," The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2019 and 2020 are shown below . The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the impact . We use value-at-risk (""VaR"") analysis to determine the potential effect of fluctuations in interest rates on the value of interest rates . The success of our investment in any private company is typically dependent on the likelihood of our ability to realize appreciation in the value ."," The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions . We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters . In August 2020, Alphabet issued $ 10.4 billion in long-term debt ."," The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm . The design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls relative to their costs ." +Alphabet Inc.,2019," The Internet is one of the world's most powerful equalizers, capable of propelling new ideas and people forward . We strive to build sustainability into everything we do from designing and operating efficient data centers, advancing carbon-free energy, creating sustainable workplaces, building better devices and services, empowering users with technology, and enabling a responsible supply chain ."," Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings . We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business ."," For a description of our material pending legal proceedings, please see Note 10 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . ItEM 3: Legal Matters is a summary of the legal matters that are included in the annual report ."," The board of directors of Alphabet authorized the company to repurchase up to an additional $12.5 billion and $25. 0 billion of its Class C capital stock . The graph below matches Alphabet Inc.'s cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index . The returns are based on historical results and are not intended to suggest future performance ."," As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. The growth was primarily driven by Google Play and YouTube subscriptions . Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative . We expect these trends to continue to put pressure on our overall margins ."," We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar . If the U. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings . We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our debt security portfolio ."," The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development . AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market ."," There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019 that have . materially affected, or are reasonably likely to materially affect, our internal . control over . financial reporting . As the phased implementation of the new ERP system continues, we will change our processes and procedures which, in turn, could result in changes to internal control . As such changes occur, we will evaluate quarterly whether such changes ." +Alphabet Inc.,2018," Google CEO: ""We will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success"" Other Bets are emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization . The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward ."," Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below . The costs of compliance with these laws and regulations are high and are likely to increase in the future . The trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, including fluctuations in exchange rates .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our headquarters are located in Mountain View, California . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business . The company owns and leases data centers in North America, Europe, South America, and Asia ."," For a description of our material pending legal proceedings, please see Note 9 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . ItEM 3: Legal Matters is included in Item 8 of this Report on Annual Report on Form Form 10-K ."," In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock . The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions . The returns shown are based on historical results and are not intended to suggest future performance ."," The growth was driven by strength in both AdMob and programmatic advertising buying, offset by a decline in our traditional AdSense businesses . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,660 million, largely resulting from accrued performance fees related to gains on equity securities ."," Alphabet Inc. reflects the gains or losses of foreign currency spot rate changes as a component of AOCI . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar . If the U.K. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings . We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values ."," As of December 31, 2018, our federal and state net operating loss carryforwards for income tax purposes were approximately $1.3 billion , $3.5 billion and $2.9 billion respectively . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market . We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI ."," There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2018 that have . materially affected, or are reasonably likely to materially affect, our internal . control over . financial reporting . Management is responsible for establishing and maintaining adequate internal control of financial reporting, as defined in Rule 13a-15(f) of the Exchange Act ." +Microsoft Corporation,2021, Satya Nadella is the chairman of the board and chief executive officer . Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines . We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products ., Government litigation and regulatory activity relating to competition rules may limit how we design and market our products . Security threats are a significant challenge to companies like us whose business is providing technology products and services to others . Issues in the development and use of AI may result in reputational harm or liability ., No written comments regarding SEC reports issued 180 days before end of fiscal year 2022 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these unresolved issues . No comment has been made by the SEC since the end of last fiscal year's fiscal year .," Our corporate headquarters are located in Redmond, Washington . The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, and Singapore . The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2022 ."," Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved . Legal Proceedings in which the company is involved are referred to as legal proceedings .", The company returned $12.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2022 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . The following table includes the number of shares purchased as part of Publicly Announced Plans or Programs .," Microsoft: Surface revenue increased $226 million or 3% Windows Commercial products and cloud services revenue increased 11% driven by demand for Microsoft 365 . Nuance is reported as part of our Intelligent Cloud segment as of June 30, 2022 and 2021, respectively . Microsoft completed its acquisition of Nuance in the third quarter of fiscal year 2022 ."," The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions) Risk Categories include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar . We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices ."," Goodwill was assigned to our Intelligent Cloud segment and was primarily attributed to increased synergies that are expected to be achieved from the integration of Nuance . No material impairments of intangible assets were identified during fiscal years 2022, 2021, or 2020 . Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period ."," Microsoft's internal control over financial reporting is a process designed to provide reasonable assurance regarding reliability of financial reporting . Del Touche Touche LLP has audited the consolidated financial statements as of and for the year ended June 30, 2022, of the Company and its report dated July 28, 2022 . Management conducted an evaluation of the effectiveness of our internal control of our financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations ." +Microsoft Corporation,2020," Mr Hogan was appointed Executive Vice President, Human Resources in November 2014 . He served as Executive Vice . President, General Counsel, and Secretary from 2011 to 2015 . Microsoft is committed to supporting our employees, well-being and safety . Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities ."," Legal, regulatory activity relating to competition rules may limit how we design and market our products . Regulators may assert that our collection, use, and management of customer and other data is inconsistent with their laws and regulations . These events could negatively impact our results of operations, financial condition, and reputation .", No written comments regarding reports issued 180 days or more prior to end of fiscal year 2021 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these issues . Staff has issued no written comments to the SEC regarding the reports that were issued 180-days or more before the end of our fiscal year 2019 .," Our corporate headquarters are located in Redmond, Washington . The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, Singapore, and South Korea . We also own and lease facilities internationally for datacenters, research and development, and other operations . The table below shows a summary of the square footage of our office and datacenter facilities owned and leased domestically and internationally as of June 30, 2021 ."," The Company was required to make annual reports of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order) The Final Order expired in April of 2021 .", Microsoft returned $10.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2021 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .," Microsoft settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011 . Office Consumer products and cloud services revenue increased $474 million or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong prior year comparable that benefited from transactional strength in Japan . On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. 0 billion or 13% ."," We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,Impact)"," The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike . The resolution of each of these audits is not expected to be material to our financial statements ."," Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2021 their report is included in Item 9A . The Company's management is responsible for maintaining effective internal control . Management conducted an evaluation of the effectiveness of our internal . control over . financial reporting based on the criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ." +Microsoft Corporation,2019, Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines . We distribute our devices through third-party retailers . We believe our continuing research and product development are not materially dependent on any single license or other agreement relating to the development of our products .," Factors that may indicate that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate . Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures .", No written comments regarding reports issued 180 days or more prior to end of fiscal year 2020 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these issues . Staff has issued no written comments to the SEC regarding the reports that were issued 180-days or more before the end of our fiscal year .," The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2020 . The largest owned properties include: our research and development centers in China and India our datacenters in Ireland, the Netherlands, and Singapore ."," The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved ."," We returned $8.9 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2020 . Our Board of Directors declared the following dividends: June 17, 2020August 20, 2020September 10, 2020$0.51$3,861 ."," Microsoft revenue increased $7.1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox hardware revenue declined 31%, primarily due to a decrease in volume and price of consoles sold . Microsoft's net income before income taxes was $24. 5 billion and $133. 0 billion . Microsoft paid $2. 2 billion in other investing to facilitate the purchase of components . The resolution of these audits is not expected to be material to our consolidated financial statements ."," We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,Impact)", The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less . We record receivable related to revenue recognized for multi-year on-premises licenses .," Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2020 their report is included in Item 9A . Deloite Touches LLP believes that our audit provides a reasonable basis for our opinion . Company's management is responsible for maintaining effective internal control . Management conducted an evaluation of the effectiveness of our internal controls and procedures ." +Microsoft Corporation,2018, Microsoft Research is one of the worlds largest corporate research organizations . Microsoft Research works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines . We distribute our devices through third-party retailers . We believe our continuing research and product development are not materially dependent on any single license or other agreement relating to the development of our products .," Our operations and financial results are subject to various risks and uncertainties, including those described below . Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization . A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales .", No written comments regarding reports issued 180 days or more prior to end of fiscal year 2019 that remain unresolved . Staff of the Securities and Exchange Commission has issued no written comments . Staff has not commented on any of these unresolved issues . We have received no written comment from the SEC staff regarding these issues .," The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019 . We also own and lease facilities internationally that include space in Australia, Canada, China, Germany, India, Japan, and the United Kingdom ."," The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) These annual reports will continue through 2020 .", Microsoft returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .," Productivity and Business Processes revenue increased $6. 1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox software and services revenue growth of 20%, mainly from third-party title strength . LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. LinkedIn expenses increased $762 million to $1. 9 billion ."," We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements . The following table sets forth the potential loss in future earnings or fair values resulting from hypothetical changes in relevant market rates or prices .", The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . GitHub has an ESPP for all eligible employees . Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized . The resolution of each of these audits is not expected to be material to our financial statements .," Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019 . Company's internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America . Internal control is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected ." +Microsoft Corporation,2017, Microsoft Research is one of the worlds largest corporate research organizations . Microsoft Research works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines . We distribute our devices through third-party retailers . We believe our continuing research and product development are not materially dependent on any single license or other agreement relating to the development of our products .," Our operations and financial results are subject to various risks and uncertainties, including those described below . Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization . A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales .", No written comments regarding reports issued 180 days or more prior to end of fiscal year 2019 that remain unresolved . Staff of the Securities and Exchange Commission has issued no written comments . Staff has not commented on any of these unresolved issues . We have received no written comment from the SEC staff regarding these issues .," The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019 . We also own and lease facilities internationally that include space in Australia, Canada, China, Germany, India, Japan, and the United Kingdom ."," The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) These annual reports will continue through 2020 .", Microsoft returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .," Productivity and Business Processes revenue increased $6. 1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox software and services revenue growth of 20%, mainly from third-party title strength . LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. LinkedIn expenses increased $762 million to $1. 9 billion ."," We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements . The following table sets forth the potential loss in future earnings or fair values resulting from hypothetical changes in relevant market rates or prices .", The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . GitHub has an ESPP for all eligible employees . Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized . The resolution of each of these audits is not expected to be material to our financial statements .," Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019 . Company's internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America . Internal control is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected ." +Costco,2021," The SEC maintains a site that contains reports, proxy and information statements about issuers, such as the Company, that file electronically with the SEC at www. costco. gov.org . The Company operates e-commerce websites in the U.S. Business members may add additional cardholders (affiliates), to which the same annual fee applies ."," Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . Data we collect, store and process is subject to a variety of U.S. factors . Failure to identify and implement a succession plan for senior management could negatively impact our business . The failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services ."," Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo"""," At the end of 2021, our warehouses contained approximately 118. 9 million square feet of operating floor space: 83. 4 million . 121 of the 171 leases are land-only leases, where Costco owns the building . Total square feet associated with distribution and logistics facilities were approximately 31.9 million in Canada; and 20. 8 million in Other International .", Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Item 11: Legal Proceedings. Item 7: Item 8 includes discussion of legal proceedings. Item 8 is Item 3 of Item 9 of Item 8 .," The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . On September 28, 2021, we had 9,958 stockholders of record . The following graph provides information concerning average sales per warehouse over a 10 year period ."," Sales in all core merchandise categories increased, sales were particularly strong in non-foods . Warehouse operations and other businesses were lower by 24 basis points, largely attributable to payroll leveraging increased sales . Management believes that our cash and investment position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future . Insurance/Self-insurance Liabilities claims for employee health-care benefits, workers compensation, general liability, property damage and property damage are funded predominantly through self-insurers ."," Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . We use forward foreign-exchange contracts to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign currency ."," In July 2021, a former temporary staffing employee filed a class action against the Company and a staffing company alleging violations of the California Labor Code . In June 2021, the plaintiff agreed to dismiss his claims for failure to provide meal and rest breaks and to pay minimum wages . In the fourth quarter of 2020, the Company reached an agreement on a product tax audit resulting in a benefit of $ 84 . The Company acquired Innovel Solutions for $ 999 using existing cash and cash ."," Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . Because of its inherent limitations, internal control may not prevent or detect misstatements . There have been no changes in our internal control that occurred during the fourth quarter of 2021 ." +Costco,2020," Costco Wholesale has adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act . References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019 and September 2, 2018, respectively ."," Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . Failure to identify and implement a succession plan for senior management could negatively impact our business . Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes; acts of terrorism or violence, including active shooter situations; public health issues, including pandemics and quarantines, could negatively affect our operations ."," Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo"""," At the end of 2020, our warehouses contained approximately 116. 1 million square feet of operating floor space: 81. 3 million in Canada; and 20. 4 million in the U.S. and Puerto Rico . 119 of the 166 leases are land-only leases, where Costco owns the building .", Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Item 11: Legal Proceedings. Item 7: Item 8 includes discussion of legal proceedings. Item 8 is Item 3 of Item 9 of Item 8 .," The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years ."," Cash flow provided by operations is primarily derived from net sales and membership fees . U.S. dollar positively impacted SGA expenses by approximately $58 . E-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse business ."," Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . As of the end of 2020, long-term debt with fixed interest rates was $7,657."," Costco Wholesale Corporation (Costco or the Company) operates membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover . There were no impairment charges recognized in 2020, 2019 or 2018 .", Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP . +Costco,2019," Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively . Executive memberships are also available in Mexico, the U.S. , Korea, and Taiwan . We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers ."," Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . We are highly dependent on our California operations, which comprised 30% of U.S. operations, particularly in California, and our Canadian operations could arise from slow growth or declines in comparable warehouse sales (comparable sales)"," Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo"""," At September 1, 2019, Costco operated 782 membership warehouses . At the end of 2019, our warehouses contained approximately 113 warehouses . 114 of the 162 leases are land-only leases, where Costco owns the building . The following schedule shows warehouse openings, net of closings and relocations, and expected openings through 2019 .", Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .," The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 31, 2014 to September 1, 2019 ."," At September 1, 2019, our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 to 2022 2023 to 2024 2025 and thereafter . Cash flow provided by operations is primarily derived from net sales and membership fees . SGA expenses as a percentage of net sales 10. 65 per share and authorized a new share repurchase program in the amount of $4,000 ."," The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency ."," The Company maintained, in all material respects, effective internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and utilize the transition option, which allows for a cumulative-effect adjustment ."," Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . No other changes have been made in connection with the implementation of the remediation plan discussed above . No changes have materially affected or are reasonably likely to materially affect, the Companys internal control of financial reporting ." +Costco,2018, Costco has adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act . We operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers . Costco operated 741 and 715 warehouses worldwide at the end of 2018 .," Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . We are highly dependent on our California operations, which comprised 30% of U.S. operations, particularly in California, and our Canadian operations could arise from slow growth or declines in comparable warehouse sales . Failure to identify and implement a succession plan for key senior management could negatively impact business ."," Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo"""," The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2018 . At the end of fiscal 2018, our warehouses contained approximately 110. 3 million in Canada; and 19. 7 million square feet of operating floor space: 77. 5 million in the U.S. ; 13. 0million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses .", Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .," The information provided is from September 1, 2013 , through September 2, 2018 . The transition to a larger retail index provides a better representation of total retail market performance . The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019 ."," Cash flow provided by operations is primarily derived from net sales and membership fees . The increase in membership fees was primarily due to the annual fee increase and membership sign-ups at existing and new warehouses . The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss ."," Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency . The majority of our short-term investments are in fixed interest-rate securities ."," The proceeds from sales of available-for-sale securities were $39 , $202 , and $291 during 2018 , 2017 , and 2016 , respectively . At September 3, 2017, there were no securities included in cash and cash equivalents and $947 included in short-term investments in the accompanying condensed consolidated balance sheets . At the end of 2018 and 2017, these insurance liabilities were $1,148 and $ 1,059 in the aggregate, respectively ."," A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting . A material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis . The remediation of this material weakness will be completed prior to the end of fiscal 2019 ." +Costco,2017," Costco has adopted a code of ethics for senior financial officers . The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season . We believe Kirkland Signature products are high quality products, offered to our members at prices that are generally lower than those for similar national brand products . We sell gasoline in all countries except Korea and France ."," Our security measures may be undermined due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information . We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation ."," Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo"""," The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2017 . At the end of fiscal 2017, our warehouses contained approximately 107. 3 million square feet of operating floor space: 75. We operate 24 depots, consisting of approximately 11. 5 million in Canada; and 18 million in Other International locations .", Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .," The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019 . The company expects to continue to pay dividends on a quarterly basis . On October 10, 2017, we had 8,629 stockholders of record ."," E-commerce business growth both domestically and internationally has also increased our sales . Charges for non-recurring legal and regulatory matters during 2016 negatively impacted SGA expenses by two basis points . The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws ."," Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy that we consume, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities . We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships ."," The consolidated financial statements have been audited by KPMG LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Costcos management is responsible for the preparation of the related financial information included in this Annual Report on Form 10-K .", Our internal control over financial reporting Item 9AControls and Procedures (Continued) is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP . Management is responsible for establishing and maintaining adequate internal control of our financial reporting as defined in Rule 13a-15(f) under the Exchange Act . +Pfizer,2021," At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We have been generally successful in having our major products included on MCO formularies . We do not believe these potential risks are material to our operations at this time ."," In 2019, Pfizer and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes ."," The vaccine is authorized by the FDA to prevent COVID-19 in individuals 5 years of age and older . At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time ."," PGS had responsibility for 39 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S. As of December 31, 2021, we had 327 owned and leased properties, amounting to approximately 41 million square feet . Our global headquarters are located in New York City .", The executive officers of the Company are set forth in this table . Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2022 Annual Meeting of Shareholders . Each of the executive officers is a member of the Pfizer Executive Leadership Team .," Pfizer Inc. currently trades on the NYSE under the symbol PFE. Inc. and European-based pharmaceutical companies . The principal market for our common stock is the NYse. The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. pharmaceutical companies, which are: AbbVie Inc. , Amgen Inc. . and Amgen ."," In December 2021, a supplemental BLA was submitted to the FDA requesting to expand the approval of Comirnaty to include individuals ages 12 through 15 years . Lorbrena/Lorviqua (lorlatinib) First-line ALK-positive NSCLC Approved Mar. 31, 2021 . TicoVac (Vaccine) Immunization to prevent tick-borne encephalitis Approved Aug. 3 % 6. 2 billion, or 145%, and a favorable impact from foreign exchange of approximately 2% . At December 31, 2019, our remaining share-purchase authorization was approximately $5.3 billion ."," The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. 2021 Form 10-K . Pfizer Inc.    Pfizer announces qualified and qualified disclosures about market risk ."," Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented . Japan, which contributed 9 % of total revenue in 2021 and 6 % in each of 2020 and 2019, was Japan . The third and fourth quarters of 2021 primarily include employee termination costs associated with our Transforming to a More Focused Company program . For RSUs granted, in virtually all instances, the units vest on the third anniversary of the grant date assuming continuous service ."," There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Pfizer Inc. and Subsidiary Companies (the Company) have issued their auditors report on the . Companys management is responsible for maintaining effective internal control . Management assessed the effectiveness of the . Company's internal . control over . financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework (2013) Pfizer ." +Pfizer,2020," At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We have been generally, although not universally, successful in having our major products included on MCO formularies . We expect certain products to face significantly increased generic competition over the next few years ."," In 2019, Pfizer and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . The size and complexity of our information technology and information security systems make such systems potentially vulnerable to service interruptions . Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals ."," At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . We expect certain products to face significantly increased generic competition ."," As of December 31, 2020, we had 363 owned and leased properties, amounting to approximately 43 million square feet . PGS expects to exit five of these sites over the next several years . In many locations, our business and operations are co-located to achieve synergy and operational efficiencies .", Each of the executive officers is a member of the Pfizer Executive Leadership Team . Each holds office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2021 Annual Meeting of Shareholders . Certain legal proceedings in which we are involved are discussed in Note 16A .," As of February 23, 2021, there were 139,582 holders of record of our common stock . Pfizer Inc. currently trades on the NYSE under the symbol PFE. , Inc. The principal market for Pfizer common stock is the New YorkSE, AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline ."," Cost of sales increased $441 million, primarily due to increased sales volumes, increased royalty expenses and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory . International Operational growth/(decline): Growth from Prevnar 13/Prevenar 13, Ibrance, Eliquis, Vyndaqel/Vyndamax, Xtandi, Inlyta, Biosimilars and the Hospital therapeutic area, partially offset by Chantix/Champix ."," The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA section . Pfizer Inc. 2020 Form 10-K is required to provide certain information to the public .", The target Pfizer Inc. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease . Variable lease payments amounted to $ 380 million in 2020 and $ 327 million in 2019 . The adoption of this standard did not have a material impact on our consolidated statement of income .," There has not been any change in the Companys internal control over financial reporting that has . materially affected, or is reasonably likely to materially affect, the . Companys management is responsible for maintaining effective internal control . Management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) We believe that our audit provides a reasonable basis for our opinion ." +Pfizer,2019," The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses . The majority of our revenues come from the manufacture and sale of biopharmaceutical products . We acquired all the remaining shares of Therachon Holding AG, a privately-held clinical-stage biotechnology company ."," The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain . Pfizer does not have control over the joint venture, its management or its policies . The amount of synergies actually realized in the Combination, if any, and the time periods in which any such synergies are realized, could differ from the synergies anticipated to be realized, regardless of whether the two business operations are combined successfully .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Pfizer corporate headquarters are in New York City and Pfizers properties extend internationally to approximately 90 countries . Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions . As of December 31, 2019 , we had 453 owned and leased properties, amounting to approximately 47 million square feet ."," Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 16 A . Legal Proceedings in our 2019 Financial Report, which is incorporated by reference . ItEM 3. Legal Proceedings are discussed during our 2019 Financial Report ."," The principal market for our common stock is the NYSE . As of February 25, 2020, there were 142,524 holders of record of Pfizer's common stock . The average price paid per share is $5,292,881,709 . Additional information required by this item is incorporated by reference from the Selected Quarterly Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2019 Financial Report .", Information required is incorporated by reference from the discussion under the heading Financial Review in our 2019 Financial Report . Information required by reference is in the 2019 Financial Review . Management management reports and analyses of the company's financial business activities ., Pfizer Inc. Financial Instruments : Fair Value Measurements in our 2019 Financial Report . We manage these financial exposures through operational means and through the use of third-party instruments . The objective of our financial risk management program is to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings ., Information required by reference from the Report of Independent Registered Public Accounting Firm in our 2019 Financial Report . The information required by this item is incorporated by reference to the report of independent registered public accounting firm . The financial statements and related data are included in the 2019 Financial Reports of the firm's consolidated financial statements .," During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2019 Financial Report ." +Pfizer,2018," Our competitive position is affected by several factors, including the amount and effectiveness of our and our competitors promotional resources . Pfizer recorded direct product revenues of more than $1 billion for one EH product in 2017 . The majority of our revenues come from the manufacture and sale of biopharmaceutical products . We have been generally, although not universally, successful in having our major products included on MCO formularies ."," Risks and uncertainties apply if we provide something of value to a healthcare professional, other healthcare provider and/or government official . The outcome of identifying new compounds and developing new products is inherently uncertain . Abbreviated legal pathways for the approval of biosimilars exist in certain international markets . We encounter similar regulatory and legislative issues in most other countries .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," As of December 31, 2017, Pfizer had 501 owned and leased properties, amounting to approximately 53 million square feet . Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries . Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, manufacturing and distribution, and administrative support functions ."," Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and Contingencies . Legal Proceedings in our 2017 Financial Report, which is incorporated by reference, are discussed by reference to the legal proceedings we are in ."," The principal market for our common stock is the NYSE . 59,102 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs . As of February 20, 2018, there were 158,190 holders of record of our stock . For additional information, see the Notes to Consolidated Financial Statements .", Information required by reference is incorporated by reference from the discussion under the heading Financial Review in our 2017 Financial Report . The information required by this item is included by reference to the discussion in the Financial Review of the company's 2017 Financial Review . Management management reports and examine their financial relationship and results of operations ., Information required by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future Results . Financial Risk Management section in our 2017 Financial Report . Information required in this item is incorporated by reference to the discussion in the discussion of the Forward Looking Information section of the Financial Risk and Factors that may affect future results .," Information required by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2017 Financial Report and from the consolidated financial statements, related notes and supplementary data . ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY Data ."," There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2017 Financial Report ." +Pfizer,2017," The majority of Pfizer's revenues come from the manufacture and sale of biopharmaceutical products . The government continues to exercise indirect price control by setting reimbursement standards through a negotiation mechanism between drug manufacturers and social insurance administrations . Pfizer must report specific prices to government agencies under healthcare programs, such as Medicaid Drug Rebate Program and Medicare Part B . Challenges against Pfizer patents in India are ongoing ."," The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost . The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio . Pfizer Inc. continues to maintain competitive insurance markets, but has also seen significant competition in insurance markets .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Pfizer Inc. reduced the number of properties in our portfolio by 28 sites and 2. 3 million square feet with the disposal of surplus real property assets and with reductions of operating space in all regions . Pfizer's corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries . As of December 31, 2016, we had 567 owned and leased properties ."," Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A . ITEM 3. Commitments and Contingencies in our 2016 Financial Report, which is incorporated by reference . Legal Proceedings in which they are involved include those in which the company is involved in legal proceedings ."," On October 23, 2014, the Board of Directors had authorized an $11 billion share-purchase plan (the October 2014 Stock Purchase Plan) On March 8, 2016, we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. based on a price of $29. 36 per share . As of February 21, 2017, there were 166,694 holders of record of our common stock . The stock currently trades on the NYSE under the symbol PFE. 57 $ 11,355,862,076 December 1, 2016 through December 31, 2016 ."," Pfizer Inc. 2016 Form 10-K . Pfizer filed a form 10,000-a-year financial report on January 1, 2017 . The information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2016 Financial Report . The financial review is required by reference to the discussion discussed in the Financial Review of Pfizer's 2016 financial report .", Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future Results in our 2016 Financial Report . Financial Risk Management section of this item includes the disclosure of our 2016 financial report . We are happy to provide a summary of this information to shareholders and investors .," Information required by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2016 Financial Report and from the consolidated financial statements, related notes and supplementary data . The information required by this item is incorporated by reference to the Report ."," There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2016 Financial Report ." +PepsiCo,2021," Latin America makes, markets, distributes and sells a number of convenient food brands including Cheetos, Doritos, Emperador, Lays, Mabel, Marias Gamesa, Ruffles, Sabritas, Saladitas and Tostitos . APAC also makes and markets beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Lubimy Sad, Mirinda, Pepsi and Pepsi Max . Fuel, electricity and natural gas are also important commodities for our businesses ."," The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors . The duration and scope of the pandemic, the emergence and spread of new variants of the virus, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus .", The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2021 year and that remain unresolved . Item 1B. Unresolved Staff Comments. Unresolve Staff Comments .," Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties . Each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities ."," We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A ."," PepsiCo has paid consecutive quarterly cash dividends since 1965 . The declaration and payment of future dividends are at the discretion of the Board of Directors . We expect to return a total of approximately $7.7 billion to shareholders in 2022 . Dividends are usually declared in February, May, July and November and paid at the end of March, June and September ."," Our primary sources of liquidity include cash from operations, pre-tax cash proceeds of approximately $3. 26 (a) $ 5. 26 (a), $ 5 billion and 88 billion (b) Notes due 2021 (2. 1 %) Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually ."," Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""", See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .," During our fourth quarter of 2021, we continued migrating certain of our financial processing systems to an ERP solution . These systems implementations are part of our ongoing global business transformation initiative . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K ." +PepsiCo,2020," The strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively . The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings and flavorings . Fuel, electricity and natural gas are also important commodities for our businesses due to their use ."," Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers . Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries . Poland enacted a graduated tax on all sweetened beverages, effective January 1, 2021 .", The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more prior to the end of our 2020 year and that remain unresolved . The SEC will not comment on any of these issues that are not resolved .," Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties . Each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities ."," We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A ."," On February 4, 2021, the Board of Directors declared a quarterly dividend of $1. 82 . We expect to return a total of approximately $5. 9 billion to shareholders in 2021 . The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . We have paid consecutive quarterly cash dividends since 1965 ."," Long-term debt obligations: Operating leases, operating leases, one-time mandatory transition tax - TCJ Act . Other long-term liabilities: Interest on debt obligations, Purchasing commitments and other commitments . The Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance ."," Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk"""," The scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020 . KPMG LLP has audited the consolidated financial statements included in this Annual Report on Form 10-K ."," As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020 . Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4% of PepsiCo, Inc. As of the end of the period covered by this report, our disclosure controls and procedures were effective ." +PepsiCo,2019," The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat . Fuel, electricity and natural gas are also important commodities for our businesses . The strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete ."," Changes in consumption in our product categories or consumer demographics can result in reduced demand for our products . 10 states in the United States as well as a growing number of European countries have a bottle deposit return system in effect . Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities .", The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more prior to the end of our 2019 year and that remain unresolved . Item 1B. Unresolved Staff Comments remain unresolved. Item 1A. We have received no written comments from the SEC .," In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities and other facilities . We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations ."," We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A ."," The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . The declaration and payment of future dividends are at the discretion of the Board of Directors . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases and dividends ."," In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2019 and December 29, 2018 . We recognize revenue when our performance obligation is satisfied . A bonus extended to certain U.S. companies is based on contract terms and our historical experience with similar programs ."," Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""", See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .," During our fourth quarter of 2019, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution . These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting . KPMG LLP has audited the consolidated financial statements included in this Annual Report on Form 10-K ." +PepsiCo,2018," In 2018, we continued to refine our beverage, food and snack portfolio to meet changing consumer demands . Concern over climate change may result in new or increased legal and regulatory requirements . We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act . Fuel, electricity and natural gas are also important commodities for our businesses ."," Historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results . The United States and many of the other countries in which our products are made, manufactured, distributed or sold, have recently made or are actively considering changes to existing tax laws . The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products .", The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more before the end of our 2018 fiscal year and that remain unresolved . Item 1B. Unresolved Staff Comments remain unresolved. Item 1A: We have received no written comments from the SEC from any of its staff regarding our quarterly or monthly or quarterly reports .," Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products . We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations ."," PepsiCo Alimentos Z. Z. (PAZ) submitted evidence of its defense to these allegations in July 2018 . If the environmental authority determines PAZ is responsible for the alleged permitting violations by the third party, the authority may seek to impose monetary sanctions of up to $1. 3 million, which PAZ would be entitled to appeal ."," On February 13, 2019, the Board of Directors declared a quarterly dividend of $0. 9275 payable March 29, 2019 . The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs . Dividends are usually declared in February, May, July and November and paid at the end of March, June and September ."," A bonus extended to certain U.S. 500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $253 million ( $191 million after-tax or $0.0) Operating profit excluding above item (b) $ 5,044 $ 4,847 $4,624 on a constant currency basis ."," Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""", See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .," There have been no changes in our internal control over financial reporting during our fourth fiscal quarter of 2018 . SodaStreams total assets and net revenue represented approximately 5% and 1% of the consolidated total assets of PepsiCo, Inc. and its subsidiaries (SodaStream), which we acquired in December 2018 . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements ." +PepsiCo,2017," Continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the U.S. to reduce or mitigate the potential effects of greenhouse gases . Changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance . We make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks ."," The U.S. and many of the other countries in which our products are made, manufactured, distributed or sold, have recently made or are actively considering changes to existing tax laws . Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, and introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and credentials .", The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2017 fiscal year and that remain unresolved . Item 1B. Unresolved Staff Comments. That remain unresolved.," Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products . The approximate number of such facilities utilized by each division is as follows: FLNA, QFNA, NAB Latin America, ESSA AMENA and AMENA ."," In October 2017, the Supreme Administrative Court issued a final, non-appealable decision, rejecting our appeal and we agreed to invest funds up to the penalty amount(s) into the bottling plant to fully resolve the matter . The results of litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows ."," On February 13, 2018, we publicly announced a new repurchase program of up to $15 billion of our common stock, which will commence on July 1, 2018 and expire on June 30, 2021 . The declaration and payment of future dividends are at the discretion of the Board of Directors . The Company does not have any authorized, but unissued, blank check preferred stock ."," Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo and net income . Venezuela deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015 . Higher commodity inflation reduced operating profit growth by 1 percentage point, primarily attributable to inflation in inflation in Latin America, ESSA and AMENA segments ."," Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""", See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .," KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . As of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms ." +AbbVie,2021," AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies . Humira is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia . The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use ."," Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies . Patent protection is important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. Third parties may claim that an AbbVie product infringes upon their intellectual property .", ItEM 1B. UNRESOLVED STAFF COMMENTS None. Unresolvement of the issue is not resolved . None of the issues are resolved by the end of this article . We are happy to clarify that this is not the case of any of these issues .," As of December 31, 2021, AbbVie owns or leases approximately 645 facilities worldwide, containing an aggregate of approximately 20 million square feet of floor space dedicated to production, distribution, and administration . In the United States, including Puerto Rico, Abvie has two central distribution centers . The company also has research and development facilities in the U.S. located at: Abbott Park, Illinois; Branchburg, New Jersey; Cambridge, Massachusetts; Irvine, California; Madison, New York; Pleasanton, California ."," Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 ."," The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries . The principal market for Abbvie's common stock is the New York Stock Exchange (Symbol: ABBV)"," AbbVie's pipeline includes approximately 90 compounds, devices or indications in development individually or under collaboration or license agreements . The pipeline is focused on immunology, oncology, aesthetics, neuroscience, neuroscience and eye care . Actual results may differ from the company's estimates ."," The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar, Chinese yuan and British pound . The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of its interest rate swap contracts by approximately $244 million at December 31, 2021 ."," At December 31, 2021, the company was in compliance with its senior note covenants and term loan covenants . In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and Cadila Healthcare Limited. At December 2011 PharmacyClics entered into an amended and restated license agreement . The effective income tax rates for 2019 also included the effects of Stemcentrx impairment related expenses ."," The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below . Ernst Young LLP expressed an unqualified opinion on the effectiveness of its internal control . The Chief Executive Officer, Richard A. Michael, evaluated the effectiveness ." +AbbVie,2020, AbbVie must obtain approval of a clinical trial application or product from applicable supervising regulatory authorities before it can commence clinical trials or marketing of the product in target markets . European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products .," Third parties may claim that an AbbVie product infringes upon their intellectual property . Patent protection is, in the aggregate, important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. In particular, a number of other companies have started to develop, have successfully developed and/or are marketing products that are being positioned as competitors to Botox .", ItEM 1B. UNRESOLVED STAFF COMMENTS None. Unresolvement of the issue is not resolved . None of the issues are resolved by the end of this article . We are happy to clarify that this is not the case of any of these issues .," AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . In the United States, including Puerto Rico, Abbvie has two central distribution centers . The company also has research and development facilities in the U.S. and abroad . There are no material encumbrances on the owned properties ."," Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 ."," The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries and other factors deemed relevant by its directors . The stock price performance on the following graph is not necessarily indicative of future stock market performance ."," Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering a collaboration agreement with Genmab A/S (Genmab) to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer . The pipeline includes more than 90 compounds, devices or indications in development individually or under collaboration or license agreements ."," The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar would decrease the fair value of foreign exchange forward contracts by $1.1 ."," At December 31, 2020, the company was in compliance with its senior note covenants and term loan covenants . Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 43 % of Abbvie's total net revenues in 2020, 58 % in 2019 and 61 % in 2018 ."," A company's internal control over financial reporting is designed to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . AbbVie Inc. believes that our audit provides a reasonable basis for our opinion . All internal control systems, no matter how well designed, have inherent limitations ." +AbbVie,2019, AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases . The government generally introduces price cut rounds every other year and also mandates price decreases for specific products . European governments also regulate pharmaceutical product prices through their control of national health care systems .," The pending acquisition of Allergan may not be completed on the currently contemplated timeline or terms, or at all, and may not achieve the intended benefits . Third parties may claim that an AbbVie product infringes upon their intellectual property . The ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets ."," None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution ."," AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico . There are no material encumbrances on the company's owned properties ."," Information pertaining to legal proceedings is provided in Note 15 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 ."," The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors . The performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934 ."," In November 2019, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for IMBRUVICA in combination with rituximab for the first-line treatment of younger patients with CLL or SLL . The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis ."," The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar would decrease the fair value of foreign exchange forward contracts ."," In the third quarter of 2019, the company issued 1. 0 billion and tax credit carryforwards were $ 188 million . (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders . (Reata) entered into an amended and restated license agreement with Reata . AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified Abbvie against all income tax liabilities for periods prior to the separation . Actual results may differ from the company's estimates ."," Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . All internal control systems, no matter how well designed, have inherent limitations . The Chief Executive Officer, Richard A. Michael, said there were no changes that have materially affected, or are reasonably likely to materially affect, the company's control of financial reporting ." +AbbVie,2018, AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases . The government generally introduces price cut rounds every other year and also mandates price decreases for specific products . The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use .," Factors that could cause actual results or events to differ from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations"" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets ."," None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution ."," AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico, and has other manufacturing facilities worldwide . There are no material encumbrances on the owned properties ."," Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 14 ."," The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, earnings and capital requirements of its operating subsidiaries . The performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934 ."," Worldwide net revenues grew by 16% , or 15% on a constant currency basis, driven primarily by revenue growth related to MAVYRET, IMBRUVICA and VENCLEXTA . In the United States, HUMIRA sales increased 11% in 2018 and 18% in 2017 ."," The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $403 million at December 31, 2018 ."," The company recognized a net tax benefit of $131 million in 2018 and $91 million in 2017 related to resolution of various tax positions pertaining to prior years . Approximately 4,000 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability ."," AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . All internal control systems, no matter how well designed, have inherent limitations . The design of any system of controls is based in part on certain assumptions about the likelihood of events, and there can be no assurance that any design will succeed ." +AbbVie,2017," AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV) The government generally introduces price cut rounds every other year and also mandates price decreases for specific products ."," AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets . Patent protection is important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. As patents for certain of its products expire, Abbvie will or could face competition from lower priced generic products . Third parties may claim that a product infringes upon their intellectual property ."," None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution ."," AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico, and other manufacturing facilities in the U.S. There are no material encumbrances on the company's owned properties ."," Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 14 ."," The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of Abbvie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its directors ."," AbbVie's gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017 . MAVYRET is indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both . This is the first and only treatment approved for newly or previously-treated patients with WM. The balance of commercial paper outstanding was $400 million as of December 31, 2017 ."," AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1 ."," The acquisition of Pharmacyclics was accounted for as a business combination using the acquisition method of accounting . The fair market value of RSAs, RSUs and performance shares vested was $348 million in 2017 , $362 million in 2016 and $335 million in 2015 . The estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies ."," AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . Ernst Young LLP, an independent registered public accounting firm, has expressed an unqualified opinion ." +Coca-Cola,2021," We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Diet Coke . Unit case volume outside the United States represented 83 percent of the Companys worldwide unit case volume in 2021 . We offer a variety of programs that contribute to our leadership, training and development goals ."," The full extent to which theCOVID-19 pandemic will affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted . The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance . The sales of our products are influenced to some extent by weather conditions in the markets in which we operate .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our worldwide headquarters is located on a 35-acre complex in Atlanta, Georgia . The extent of utilization of our production facilities varies based upon seasonal demand for our products . Management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities ."," The closing agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years . The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the . Companys foreign licensees . In that event, the . Company would likely be subject to significant additional liabilities for tax years 2007 through 2009 ."," The total shareowner return is based on a $100 investment on December 31, 2016 and assumes that dividends were reinvested on the day of issuance . No equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended . The Pecker Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food and the Pecker Index ."," We own and market five of the world's top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Diet Coke . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value . In 2021, the Companys total income related to defined benefit pension plans was $61 million ."," Company uses derivative financial instruments to reduce exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . Company enters into forward exchange contracts and purchases foreign currency options and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies . Company is subject to interest rate volatility with regard to existing and future issuances of debt ."," All of the amounts in the table above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income . For performance share unit awards granted from 2018 through 2021, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years ."," The report of management on our internal control over financial reporting as of December 31, 2021 and the attestation report of our independent registered public accounting firm on internal control are set forth in Part II, Item 8. The Company evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act)" +Coca-Cola,2020," Coca-Cola believes people are our most important asset, and we strive to attract high-performing talent . Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals . We make our branded beverage products available to consumers through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations ."," The sales of our products are influenced to some extent by weather conditions in the markets in which we operate . We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk . The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . The extent of utilization of our production facilities varies based upon seasonal demand for our products . Management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment . These properties, except for the North America group's main offices, are included in Corporate ."," The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years . The Company and Aqua-Chem continued to pursue and obtain coverage agreements with those insurance companies that did not settle in the Wisconsin insurance coverage litigation . The IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million . Some or all of this amount would be refunded if the Company were to prevail on appeal ."," This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange . No equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended ."," Other operating charges incurred by operating segment and Corporate were as follows (in millions): Europe, Middle East Africa, Africa $ 73 $ 2 Latin America 29 1 North America 379 62 Asia Pacific 31 42 Global Ventures 4 Bottling Investments 34 100 Corporate 303 251 Total $ 853 $ 458 In 2020, the Company recorded other operating charges of $853 million ."," Our Company uses derivative financial instruments to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . In 2020, we used 70 functional currencies in addition to the U.S. dollar would have increased the net unrealized gain to $140 million . The Company is subject to interest rate volatility with regard to existing and future issuances of debt . We enter into forward exchange contracts as hedges of net investments in foreign operations ."," It is expected that the amount of unrecognized tax benefits will change in the next 12 months . Fair value disclosures related to our pension plan assets are included in Note 16 . The total number of stock options exercised was 23 million, 34 million and 47 million in 2020, 2019 and 2018, respectively ."," The Company evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" as of the end of the period covered by this report . No changes in internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the company's internal control ." +Coca-Cola,2019," Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals . Mexico, China, Brazil and India accounted for 31 percent of our worldwide unit case volume . Competitive factors impacting our business include pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing ."," The success of our business depends on our ability to attract, develop, retain and motivate a highly skilled and diverse workforce . We conduct business in markets with high-risk legal compliance environments, exposing us to increased legal and reputational risk . The sales of our products are influenced to some extent by weather conditions in the markets in which we operate .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . The extent of utilization of such facilities varies based upon seasonal demand for our products . We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, storage and distribution operations . The North America group's main offices are included in the North America operating segment ."," The disputed amounts relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees . The IRS designated the matter for litigation on October 15, 2015 . The Company sold Aqua-Chem to Lyonnaise American Holding, Inc. The Company filed a motion for summary judgment on the portion of IRS' adjustments related to our licensee in Mexico ."," This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . In 2019, these indices do not include BG Foods, Inc. , Seaboard Corporation, The J. Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends ."," In 2018, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million . Unit case volume in water, enhanced water and sports drinks grew 1 percent, driven by 7 percent growth in sports drinks . ""Acquired brands"" refers to brands acquired during the past 12 months . Realized and unrealized gains and losses on trading debt securities are included in net income ."," The Company generally hedges anticipated exposures up to 48 months in advance; however, the majority of our derivative instruments expire within 24 months or less . We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis . The total notional values of our foreign currency derivatives were $14,276 million and $17,142 million as of December 31, 2019 and 2018 ."," It is expected that the amount of unrecognized tax benefits will change in the next 12 months . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value . The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model ."," The Company evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" The Chief Executive Officer and the Chief Financial Officer concluded that the company's disclosure controls were effective as of December 31, 2019 . There have been no changes in internal control over financial reporting during the quarter ended December 31 , 2019 ." +Coca-Cola,2018," Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals . The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides . Coca-Cola may periodically consider options for divesting or reducing its ownership interest in a Company-owned or -controlled bottler ."," The sales of our products are influenced to some extent by weather conditions in the markets in which we operate . We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk . An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase their operating costs and thus indirectly negatively impact our results of operations .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . We own or lease additional facilities, real estate and office space throughout the world . The extent of utilization of such facilities varies based upon seasonal demand for our products . Management believes that our Company's facilities for the production of our products are suitable and adequate ."," Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it . Management believes that, except as disclosed in U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. To that end, the Company filed a petition in the U."," On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock . This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . During the year ended December 31, 2018, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933 ."," In 2019, we expect to repurchase shares to offset dilution resulting from employee stock-based compensation plans . In 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers . The Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital ."," Our Company uses derivative financial instruments to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . The total notional values of our foreign currency derivatives were $17,142 million and $13,057 million as of December 31, 2018 and 2017 . The Company enters into forward exchange contracts and purchases foreign currency options to hedge certain portions of forecasted cash flows denominated in foreign currencies ."," The Company's first quarter 2018 results were impacted by one less day compared to the first quarter of 2017 . The Company consolidates all entities that we control by ownership of a majority voting interest . Realized and unrealized gains and losses on trading debt securities are included in net income . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value ."," There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2018 . The Company evaluated the effectiveness of the design and operation of its ""disclosure controls and procedures"" as of the end of the period covered by this report ." +Coca-Cola,2017," The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides . We manufacture fountain syrups and sell them to fountain retailers . Schweppes is owned by the Company in certain countries other than the United States . As of December 31, 2017, approximately 3,700 employees, excluding seasonal hires, in North America were covered under collective bargaining agreements ."," Failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.N. Human Rights are essential to the success of our business . Restructuring activities and the announcement of plans for future restructuring activities may result in an increase in insecurity among some Company associates and some employees .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," The extent of utilization of such facilities varies based upon seasonal demand for our products . Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes . The North America group's main offices are included in the North America operating segment ."," The Company owned Aqua-Chem from 1970 to 1981 . During that time, the Company purchased over $400 million of insurance coverage . Two of the insurers, one with a $15 million policy limit, asserted cross-claims against the Company . On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed . A trial date has been set for March 5, 2018 . The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits ."," On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock . This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and Dow Jones Tobacco Index, from which the Company has been excluded ."," Other liabilities increased and deferred income taxes decreased due to the Tax Reform Act signed into law on December 22, 2017 . ""Acquired brands"" refers to brands acquired during the past 12 months . The Company refranchised its bottling operations in China to the two local franchise bottlers ."," Company uses derivative financial instruments to reduce exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . Company is subject to interest rate risk related to its investments in highly liquid securities . Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less ."," The gains or losses on assets measured at fair value on a nonrecurring basis are summarized in the table below . The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price . As of December 31, 2017, we had $ 286 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans ."," The Company began consolidating the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited in October 2017 . Management has excluded from the scope of its assessment of internal control over financial reporting the operations of CCBA from the assessment . There have been no changes in the Company's internal control of financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the company's financial reporting ." +Mastercard,2021," Mastercard is based on a distributed (peer-to-peer) architecture that enables the network to adapt to the needs of each transaction . We use our data assets, infrastructure and platforms to create a range of products and services for our customers . We have implemented a comprehensive AML/CFT program, comprised of policies, procedures and internal controls, including the designation of a compliance officer ."," Risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies . Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations . Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them .", Item 1B. Unresolved staff comments Not applicable . Item 1A. Not applicable. Item 1C. Unresolve staff comments not applicable. Item 1D. A. Unrelaxed staff comments are not required to respond to any of these issues .," As of December 31, 2021, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries . We believe that our facilities are suitable and adequate for the business that we currently conduct . However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business and address climate-related impacts ."," Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Item 3. Item 3: Legal and regulatory Proceedings ."," The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends . On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of our . Class B common stock is not publicly listed on any exchange or . exchange quotation system ."," A more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rates . A significant portion of our net income is concentrated among our largest customers . We completed the acquisitions of businesses for total consideration of $4.3 billion at December 31, 2021 and 2020, respectively . The remaining growth was driven primarily by our Cyber Intelligence and Data Services solutions ."," Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates . Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks ."," In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U. merchants as well as settlements with a number of Pan-European merchants . The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique ."," PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2021 ." +Mastercard,2020," Mastercard makes payments easier and more efficient by providing a wide range of payment solutions and services using its family of well-known brands . We operate a multi-rail network that offers our customers one partner to turn to for their domestic and cross-border needs . We use our AI and data analytics, along with our cyber risk assessment capabilities, to help financial institutions, merchants, corporations and governments secure their digital assets . We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders .", Risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies . The ultimate impact of COVID-19 or a similar health epidemic is highly uncertain and subject to change . The advent of the global COVID pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce from working from home ., Item 1B. Unresolved staff comments Not applicable . Item 1A. Not applicable. Item 1C. Unresolve staff comments not applicable. Item 1D. A. Unrelaxed staff comments are not required to respond to any of these issues .," As of December 31, 2020, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries . We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center . We believe that our facilities are suitable and adequate for the business that we currently conduct ."," Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Item 3. Item 3: Legal and regulatory Proceedings .", The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends . The Board of Directors declared a quarterly cash dividend of $0. 03 billion at an average price of $330. 96 136 136. 91 . The graph and table below compare the cumulative total stockholder return of Mastercards .," The coronavirus (COVID-19) pandemic has spread rapidly across the globe and has had significant negative effects on the global economy . The full extent to which the pandemic, and measures taken in response, affect our business, results of operations and financial condition will depend on future developments . The impact of the transactional currency represents the effect of converting revenue and expense transactions in a currency other than the functional currency ."," Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates . Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements ."," In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique . The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2020 2019 2018 (in millions, except per share data)"," PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . Management assessed the effectiveness of Mastercard Incorporated's internal control over financial reporting as of December 31, 2020 ." +Mastercard,2019, Item 1: Business . Item 1 . Item 2: Business. Business. Item 3: Business needs a new CEO . Item 4: The CEO is responsible for the loss of the company . Item 5: Business is a new company that needs a CEO to make it to the top of the list. Item 1 is the CEO of a company that makes it to a new business., Item 1A. Risk factors Risk factors: Risk factors . Risk factors include a person with a history of having an adverse effect on a person's health . A person with an adverse history of being pregnant with an infantile disease may be at risk for life in the future .," Item 1B. Unresolved staff comments . Item 1A: Unresolve staff comments. Item 1b: ""Unresolved Staff Comments. Please submit your comments to comment@mailonline.co.uk . For confidential support call the Samaritans on 08457 909090 or visit a local Samaritans branch, see www.samaritans.org ."," Item 2. Item 2: Properties . Item 3: Properties. Item 4: Property . Item 5: Property properties. Item 5. Property property properties . Item 6: Properties; Item 7: Properties: Property, Property, Building, Building . Item 8: Properties, Properties; Property, Construction, Maintenance . Item 10: Property.", Item 3: Legal proceedings . Legal proceedings . Item 4: The case is brought before a judge and a judge . Item 5: The judge is entitled to a hearing on whether the case should be heard in court . Item 6: The court will hear the case for the first time in the next two weeks .," Our Class A common stock trades on the New York Stock Exchange under the symbol MA . Dividend declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs ."," No individual country, other than the United States, generated more than 10% of net revenue in any such period . GDV on a local currency basis increased 13. 8% . We repurchased 26 million shares of our common stock for $6.0 billion in 2019 versus the prior year ."," The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $144 million and $113 million on our foreign exchange derivative contracts outstanding at December 31, 2019 and 2018 . The maximum length of time over which we have hedged our exposure to the variability in future cash flows is 30 years . We are also subject to foreign exchange risk as part of our daily settlement activities ."," The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique . The realized gains and losses from the sale of available-for-sale securities for 2019 , 2018 and 2017 were not significant ."," PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2019 ." +Mastercard,2018," Mastercard has implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer . We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny, expansion of local regulatory schemes and other legal challenges . We offer real-time account-based payment capabilities through our acquisition of Vocalink ."," The risks described above could have a material adverse impact on our overall business and results of operations . We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity . The risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," As of December 31, Mastercard and its subsidiaries owned or leased 169 commercial properties . These facilities primarily consist of corporate and regional offices, as well as our operations centers . We believe that our facilities are suitable and adequate for the business that we currently conduct . We may acquire or lease new space to meet the needs of our business ."," Refer to Note 12 (Accrued Expenses and Accrued Litigation) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 . Item 8 refers to Part II of Item 8 of the Company's annual financial statements ."," Mastercard repurchased 4.4 million shares for $888 million at an average price of $201.20 per share . On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.25 per share of our Class A common stock and Class B common stock . Dividend declaration and payment of future dividends is at the sole discretion of the company's board of directors . The graph and table below compare the cumulative total stockholder return of Mastercards Class A . stockholders for each of the years presented were as follows ."," Net revenue increased 20% both as reported and on a currency-neutral basis, in 2018 versus 2017 . Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance . The table also does not include the $219 million accrual as of December 31, 2018 related to the contingent consideration attributable to acquisitions made in 2017 .", The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows . We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates . The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in .," The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership . As of December 31, 2018 and 2017, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material ."," PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . Management assessed the effectiveness of Mastercard Incorporated's internal control over financial reporting as of December 31, 2018 ." +Mastercard,2017," Mastercard has implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer . European Union issued a statement of objections related to the interregional interchange rates we set and our central acquiring rules within the European Economic Area (the EEA) We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny ."," We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer . We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices . Potential changes in existing tax laws may impact our effective tax rate and tax payments .", Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.," As of December 31, Mastercard and its subsidiaries owned or leased 167 commercial properties . Our leased properties in the United States are located in 10 states and in the District of Columbia . We also lease and own properties in 69 other countries . We believe that our facilities are suitable and adequate for the business that we currently conduct ."," Refer to Notes 10 (Accrued Expenses and Accrued Litigation) and 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 . Item 8 is Item 8 of Part II of Item 8. Item 3. Refer to Legal & Regulatory Proceedings ."," Our Class A common stock trades on the New York Stock Exchange under the symbol MA . There were approximately 307 holders of record of our non-voting Class B common stock as of February 9, 2018 . The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results and available cash ."," The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to its financial statements . Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance . Excluding the impact of Special Items, adjusted operating expenses increased 16% in 2017 versus 2016 ."," At December 31, 2017 and 2016, the cost which approximates fair value, of our short-term held-to-maturity securities was $700 million and $452 million , respectively . We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations . We had no borrowings under the Commercial Paper Program or the Credit Facility ."," The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting . The gross realized gains and losses from the sales of available-for-sale securities for 2017 , 2016 and 2015 were not significant . Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value ."," The President and Chief Executive Officer and the Chief Financial Officer reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2017 . 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million'), (1.0, 'short'), (1.0, 'respectively'), (1.0, 'portion'), (1.0, 'euro'), (1.0, 'designated'), (1.0, 'cost'), (1.0, 'borrowings'), (1.0, '2017'), (1.0, '2016')]","[(9.0, 'measuring fair value'), (9.0, 'level 3 due'), (9.0, 'gross realized gains'), (8.0, 'substance common stock'), (5.0, 'common stock'), (4.0, 'sale securities'), (4.0, 'observable inputs'), (4.0, 'equity method'), (4.0, 'company accounts'), (4.0, 'backed securities'), (1.0, 'significant'), (1.0, 'sales'), (1.0, 'losses'), (1.0, 'lack'), (1.0, 'investments'), (1.0, 'classified'), (1.0, 'available'), (1.0, 'asset'), (1.0, 'accounting'), (1.0, '2017'), (1.0, '2016'), (1.0, '2015')]","[(25.0, 'independent registered public accounting firm'), (16.0, 'consolidated financial statements included'), (15.0, 'chief financial officer reviewed'), (10.0, 'chief executive officer'), (4.0, 'pricewaterhousecoopers llp'), (4.0, 'form 10'), (4.0, 'disclosure controls'), (4.0, 'december 31'), (4.0, 'annual report'), (1.0, 'procedures'), (1.0, 'president'), (1.0, 'k'), (1.0, 'effectiveness'), (1.0, 'audited'), (1.0, '2017')]" diff --git a/datasets/labeled/sentement_analysis_final_labeled_data.csv b/datasets/labeled/sentement_analysis_final_labeled_data.csv new file mode 100644 index 0000000..6624ee6 --- /dev/null +++ b/datasets/labeled/sentement_analysis_final_labeled_data.csv @@ -0,0 +1,442 @@ +sentence,label +" The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business . We receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations . The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules .",NEGATIVE +" Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution""",NEGATIVE +" Our corporate headquarters are located in Menlo Park, California . As of December 31, 2021, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas . We believe that our facilities are adequate for our current needs .",POSITIVE +" Meta Platforms Ireland is subject to litigation and other proceedings involving law enforcement and other regulatory agencies . We believe the lawsuits described above are without merit, and we are vigorously defending them . We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020 and required us to pay a penalty of $5.0 billion .",NEGATIVE +" Meta Platforms, Inc. has never declared or paid any cash dividend on our common stock . Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012 . Our board of directors has authorized a share repurchase program . The timing and actual number of shares repurchased depend on a variety of factors, including price and market conditions .",NEGATIVE +" Marketing and sales expenses in 2021 increased $2.2 billion . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above . The impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain .",NEGATIVE +" Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values . Foreign currency losses of $140 million, $129 million, and $105 million were recognized in 2021, 2020, and 2019 . Volatility in the global economic climate and financial markets could result in a material impairment charge on our equity investments .",NEGATIVE +" Family of Apps revenue $ 117,929 $ 85,965 $ 70,697 in 2019 . Reality Labs revenue $ 56,946 $ 39,294 $ 28,489 . Revenue from operations $ 46,753 $ 32,671 $ 23,986 . For further information, see Legal and Related Matters in Note 11 .",NEGATIVE +" There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2021 that materially affected, or are reasonably likely to materially affect, the company's internal control of financial reporting . Management conducted an assessment of the effectiveness of our internal controls and procedures as of December 31, 2021 .",NEGATIVE +" The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business . We are subject to multiple putative class action suits in connection with our platform and user data practices . The Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements on products and services offered to users in Brazil .",NEGATIVE +" Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution""",NEGATIVE +" As of December 31, 2020, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas . In addition, we have offices in more than 80 cities across North America, Latin America, Europe, the Middle East, Africa, and Asia Pacific .",POSITIVE + Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020 . FTC filed a complaint against us in the U.S. alleging that we engaged in anticompetitive conduct in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 . FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws .,NEGATIVE +" The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2015 in the Class A common stock of Facebook, Inc. We have never declared or paid any cash dividend on our common stock . In January 2021, an additional $25 billion of repurchases was authorized under this program .",NEGATIVE +" This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes . We expect user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower . We entered into a definitive agreement to invest in Jio Platforms Limited, a subsidiary of Reliance Industries Limited .",NEGATIVE +" We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, equity investment risk, and inflation . Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities . Volatility in the global economic climate and financial markets could result in a material impairment charge on our equity investments .",NEGATIVE +" The following table reflects changes in the gross unrecognized tax benefits (in millions): Gross unrecognized tax benefits beginning of period $ 7,863 $ 4,678 . The Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 1). The Company's board of directors approved an increase of 16 million shares reserved for issuance effective January 1, 2021 .",NEGATIVE +" There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2020 that materially affected, or are reasonably likely to materially affect, the company's internal control of financial reporting . Management conducted an assessment of the effectiveness of our . internal control .",NEGATIVE +" We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value . Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control . We are subject to a variety of risks inherent in doing business internationally .",NEGATIVE +" Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution""",NEGATIVE +" As of December 31, 2019, we owned and leased approximately nine million square feet of office and building space for our corporate headquarters and in the surrounding areas . We also own 15 data centers globally . Our corporate headquarters are located in Menlo Park, California . We believe that our facilities are adequate for our current needs .",POSITIVE +" Multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers . The parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $550 million by us and is subject to approval by the court . We believe the remaining lawsuits are without merit, and we are vigorously defending them .",NEGATIVE +" The board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date . As of December 31, 2019, $4.0 billion of repurchases was authorized under this program . The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities .",NEGATIVE +" Revenue was $70. 67 billion and $1. 34 billion of taxes paid related to net share settlement of equity awards . Operating margin was 34% . 42 billion , or 37% , compared to 2018 . Average Revenue Per Person (ARPP) may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes .",NEGATIVE +" Interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities . Foreign currency losses of $105 million , $213 million , and $6 million were recognized in 2019 , 2018 , and 2017 as interest and other income, net in our consolidated statements of income .",NEGATIVE +" The Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2 . Holders of our Class A common stock and Class B common stock are entitled to dividends if, declared by our board of directors, subject to the rights of the holders of all classes of stock having priority rights to dividends . We determine realized gains or losses on sale of marketable securities on a specific identification method .",NEGATIVE +" Our management is responsible for establishing and maintaining adequate internal control over financial reporting . Management evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2019 . No changes in internal control were ""reasonably likely to materially affect"" internal control of financial reporting, management says .",NEGATIVE +" We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value . Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control . We estimate that false accounts may have represented approximately 5% of our worldwide MAUs .",NEGATIVE +" Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution""",NEGATIVE +" Our corporate headquarters are located in Menlo Park, California . We also own and lease data centers throughout the United States and in various locations internationally . As of December 31, 2018, we owned and leased approximately six million square feet of office and building space for our corporate headquarters and in the surrounding areas .",POSITIVE +" Two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 . We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties . We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations .",NEGATIVE + Many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders . We have never declared or paid any cash dividend on our common stock . We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future . The stock price of the stock price is not necessarily indicative of future stock price performance .,NEGATIVE +" As of December 31, 2018, we had net unrecognized tax benefits of $3.3.9 billion . Effective tax rate was 13% . Net income was $22.54 billion, a decrease of $597 million from 2017 . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above .",NEGATIVE +" Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements . It is difficult to predict the effect hedging activities would have on our results of operations .",NEGATIVE +" Our responsibility is to express an opinion on the Companys financial statements based on our audits . We fully repaid all our capital lease obligations during 2016 . The amount of stranded tax effects that were reclassified from accumulated other comprehensive loss to retained earnings was not material . The increase in the deferred revenue balance for the year ended December 31, 2018 was driven by prepayments from marketers .",NEGATIVE +" There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15 (d) of the Exchange Act during the fourth quarter of 2018 that materially affected, or are reasonably likely to materially affect, our internal controls . Management is responsible for establishing and maintaining adequate internal control .",NEGATIVE +" Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above . We are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S.",NEGATIVE +" Item 1B. Unresolved Staff Comments None. Item 1A. Unresolve Staff Comments . Item 1b: ""Unresolved staff Comments"" Item 1C: ""We are happy to have a solution to this problem."" Item 1D: ""I am not satisfied with this issue. I am happy with this resolution""",NEGATIVE +" As of December 31, 2017, we owned and leased approximately three million square feet of office buildings for our corporate headquarters . We also own and lease data centers throughout the United States and in various locations internationally . As such, we have excluded square footage from the total leased space and owned properties, disclosed above .",NEGATIVE +" Multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the U.S. and in other jurisdictions against us, our directors, and/or certain of our officers . The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO .",NEGATIVE +" In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion . We have never declared or paid any cash dividend on our common stock . We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future . Our Class B common stock is not listed nor traded on any stock exchange . The following graph shows a comparison from May 18, 2012 (the date our Class A common stock commenced trading on the Nasdaq Global Select Market) through December 31, 2017 .",NEGATIVE +" Worldwide DAUs increased 14% to 1.12 billion for the year ended December 31, 2017 . We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower . The number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above .",NEGATIVE +" Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities . Foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements .",NEGATIVE +" Our responsibility is to express an opinion on the Companys financial statements based on our audits . For original programming, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable . RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material .",NEGATIVE +" Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) There were no changes in internal control in the fourth quarter of 2017 that materially affected, or are reasonably likely to materially affect, our internal financial reporting .",NEGATIVE +" The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws . Product liability insurance for products may be limited, cost prohibitive or unavailable . The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action .",NEGATIVE +" Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B""",NEGATIVE +" Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey . Production facilities for human health products at seven locations in the U.S. and Puerto Rico . Capital expenditures were $4.4 billion in 2021, $1. 4 billion in 2020 and $3. 8 billion in . 2021 . A number of properties were transferred to Organon in the Spin-Off .",NEGATIVE +" The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 .",NEGATIVE +" The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of major U.S. pharmaceutical companies . As of January 31, 2022, there were approximately 99,932 shareholders of record of Merck Common Stock . All shares purchased during the period were made as part of a plan to purchase up to $10 billion in Merck shares for its treasury .",NEGATIVE +" Merck completed spin-off of health, established brands businesses into new, independent, publicly traded company named Organon Organon Co. Gross margin was 67.0% for federal income tax purposes . The U.S. Food and Drug Administration (FDA) approved Welireg (belzutifan), an oral hypoxia-inducible factor-2 alpha (HIF-2) inhibitor, for the treatment of adult patients with von Hippel-Lindau (VHL) Table o f Contents disease .",NEGATIVE + The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Managements Discussion and Analysis of Financial Condition and Results of Operations . Table o f Contents of the Item includes the discussion and analysis of financial condition and results of operations .,NEGATIVE +" As a result of the spin-off of Organon, Merck incurred separation costs of $ 556 million in 2021 and $ 743 million in 2020 . The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters .",NEGATIVE +" The financial statements report on managements stewardship of Company assets . For the fourth quarter of 2021, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control of financial reporting . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the internal control .",NEGATIVE +" The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action . The Company is subject to evolving and complex tax laws, which may result in additional liabilities . Product liability insurance for products may be limited, cost prohibitive or unavailable . The global COVID-19 pandemic is having an adverse impact on the Companys business .",NEGATIVE +" Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B""",NEGATIVE +" Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey . A number of properties will be transferred to Organon in the Spin-Off . Capital expenditures were $4.6 billion in 2018 . The Companys has production facilities for human health products at nine locations in the United States .",POSITIVE +" The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Legal Proceedings are incorporated in this Item . Financial Statements and Supplementary Data, Note 10. Financial statements and Supplementary data are incorporated into the Item .",NEGATIVE +" The Company did not purchase any shares during the three months ended December 31, 2020 under the plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury . The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK .",NEGATIVE +" Pharmaceutical segment profits grew 5% in 2020 compared with 2019 driven primarily by higher sales, as well as lower selling and promotional costs . Gardasil 9 was approved by the PMDA in Japan for use in women and girls nine years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine . Keytruda received approval in the United States as monotherapy in the therapeutic areas of cutaneous squamous cell carcinoma (cSCC), metastatic microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) colorectal cancer, colore",NEGATIVE + The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Item 7A. Quantitative and Qualitative Disclifications about Market Risk . Item 7 . s . Managements Discussion and Analysis of Financial Condition and Results of Operations .,NEGATIVE +" Merck is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters . The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs .",NEGATIVE +" The financial statements report on managements stewardship of Company assets . Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated s Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment .",NEGATIVE +" The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries . Product liability insurance for products may be limited, cost prohibitive or unavailable . The Company cannot state with certainty when or whether any of its products now under development will be approved or launched . Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations .",NEGATIVE +" Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B""",NEGATIVE +" Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey . Production facilities for human health products at nine locations in the United States and Puerto Rico . Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs .",POSITIVE +" The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Legal Proceedings are incorporated in this Item . Financial Statements and Supplementary Data, Note 10. Financial statements and Supplementary data are incorporated into the Item .",NEGATIVE +" The Performance Graph assumes a $100 investment on December 31, 2014, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. pharmaceutical companies . As of January 31, 2020, there were approximately 109,500 shareholders of record of the Companion Common Stock .",NEGATIVE +" Lower sales of diabetes products Januvia and Janumet and HIV products Isentress/Isentress HD also partially offset revenue growth in 2019 . Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 19% in 2019 driven primarily by higher demand in the Asia Pacific region, particularly in China . Varivax and RotaTeq also grew . Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin declined 35% . Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide clinical development collaboration",NEGATIVE + The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .,POSITIVE +" Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales . As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.4 billion . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing .",NEGATIVE +" Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended (the Act) The financial statements report on managements stewardship of Company assets .",NEGATIVE +" There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials . Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area . Some health authorities appear to have become more cautious when making decisions about approvability of new products .",NEGATIVE +" Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B""",NEGATIVE +" Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey . In the United States, these amounted to $1. 5 billion in 2018 . In October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022 .",POSITIVE +" The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 .",NEGATIVE +" Merck shares were purchased as part of a plan approved by the Board of Directors in November 2017 to purchase up to $10 billion in Mercks common stock for its treasury . Amgen Inc. , Amgen, Roche Holding AG, and Sanofi SA. 70 PEER GRP. Shares are approximated.",NEGATIVE +" Sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $217 million in 2018, a decline of 68% compared with 2017 . In December 2018, the FDA approved Lynparza for use as maintenance treatment of adult patients with deleterious . germline or somatic BRCA -mutated advanced . ovarian, fallopian tube or primary peritoneal cancer . The Company recorded a net reduction in expenses of $54 million and $402 million to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs .",NEGATIVE + The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .,POSITIVE +" The Company determined the fair value of the contingent consideration was $223 million at the acquisition date . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing . Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales .",NEGATIVE +" The financial statements report on managements stewardship of Company assets . Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control .",NEGATIVE +" The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, expensive and uncertain process . Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing .",NEGATIVE +" Item 1B. Unresolved Staff Comments. Item 1A. Unresolve Staff Comments . Item 1b: ""No.1"" Item 1C: No.1. ""No 1B: No 1.1."" Item 1D: No 2.1 ""No 3: 1C"" Item 2: 1A ""No 4: 1B""",NEGATIVE +" The Companys U.S. and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory . The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico . Mercks Animal Health global headquarters is located in Madison, New Jersey .",NEGATIVE +" The information called for by this Item is incorporated herein by reference to reference to Item 8. Contingencies and Environmental Liabilities . Item 3. Financial Statements and Supplementary Data, Note 11. . Legal Proceedings are incorporated in this Item . The information is incorporated in reference to the Item 8 .",NEGATIVE +" The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK . In November 2017, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury . The following graph assumes a $100 investment on December 31, 2012, and reinvestment of all dividends . The Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material .",NEGATIVE + Sales growth in 2016 as compared with 2015 was driven primarily by higher sales in the United States reflecting the effects of public sector purchasing and higher pricing that were partially offset by lower demand . The Company purchased $4. 87 $ 1. 48 per share on the Companys common stock for the second quarter of 2018 payable in April 2018 .,NEGATIVE + The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7.A. Item 7A. Item 7 .A. . Managements Discussion and Analysis of Financial Condition and Results of Operations . The information is incorporated in reference to discussion of Financial Instruments market risk .,POSITIVE +" Merck is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation . The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material . The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant .",NEGATIVE +" The financial statements report on managements stewardship of Company assets . Management is responsible for establishing and maintaining adequate internal control over financial reporting . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control .",NEGATIVE +" There can be no assurance we will be able to provide hardware that competes effectively . Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country . The unrealized gains and losses we record from fair value remeasurements of our non-marketable equity securities may differ significantly from the gains or losses we ultimately experience on such investments .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and RD sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business .",POSITIVE +" For a description of our material pending legal proceedings, see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . Legal Matters is in note 10 of Item 10 of this Annual Report of this year's results .",NEGATIVE +" Alphabet Inc. regularly evaluates our cash and capital structure, including the size, pace, and form of capital return to stockholders . The primary use of capital continues to be to invest for the long-term growth of the business . The repurchases are being executed from time to time, subject to general business and market conditions . The returns shown are based on historical results and are not intended to suggest future performance .",NEGATIVE +" Impressions increased from 2020 to 2021 primarily driven by growth in AdMob, partially offset by a decline in impressions related to AdSense . Google Cloud revenues are comprised of the following: Google Cloud Platform, which includes fees for infrastructure, platform, and other services . Other income (expense), net, net, increased $5.3% .",NEGATIVE +" As of December 31, 2020 and 2021, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $18. 4 billion and $1. 0 billion . If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approxima tely $497 million and $285 million .",NEGATIVE +" Alphabet's responsibility is to express an opinion on the Companys financial statements based on our audits . The following table presents revenues disaggregated by geography, based on the addresses of our customers . Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 0. 4 billion . We recognized a charge of $ 2.7 billion in non-income tax audits .",NEGATIVE +" As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2021 . The implementation of certain of our subledgers, which included changes to our processes, procedures and internal controls over financial reporting during the second quarter of 2021, is expected to continue in phases over the next few years .",NEGATIVE +" Alphabet Inc. may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties . We may also experience downward pressure on our operating margin resulting from expansion of our business into new fields such as hardware, Google Cloud, and subscription products . There can be no assurance we will be able to provide hardware that competes effectively .",NEGATIVE +" Alphabet Inc. Unresolved Staff Comments Not applicable. Not applicable . Unresolvement of this article is not required. It is the result of a dispute between Alphabet and Alphabet . Alphabet is the parent company of Alphabet, Google, Apple, Facebook and YouTube .",NEGATIVE +" Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business .",POSITIVE +" For a description of our material pending legal proceedings, please see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . Legal Matters is in note 10 of Item 8 .",NEGATIVE +" Alphabet's Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 . The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) The returns shown are based on historical results and are not intended to suggest future performance .",NEGATIVE +" Google Network Members' properties' revenues increased $1,543 million from 2019 to 2020 . European Commission Fines in March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law . The increase was partially offset by a $554 million charge recognized in 2019 relating to a legal settlement .",NEGATIVE +" The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2019 and 2020 are shown below . The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the impact . We use value-at-risk (""VaR"") analysis to determine the potential effect of fluctuations in interest rates on the value of interest rates . The success of our investment in any private company is typically dependent on the likelihood of our ability to realize appreciation in the value .",NEGATIVE +" The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions . We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters . In August 2020, Alphabet issued $ 10.4 billion in long-term debt .",NEGATIVE +" The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm . The design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls relative to their costs .",NEGATIVE +" Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings . We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our headquarters are located in Mountain View, California, Europe, South America, and Asia . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business .",POSITIVE +" For a description of our material pending legal proceedings, please see Note 10 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . ItEM 3: Legal Matters is a summary of the legal matters that are included in the annual report .",NEGATIVE +" The board of directors of Alphabet authorized the company to repurchase up to an additional $12.5 billion and $25. 0 billion of its Class C capital stock . The graph below matches Alphabet Inc.'s cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index . The returns are based on historical results and are not intended to suggest future performance .",NEGATIVE +" As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. The growth was primarily driven by Google Play and YouTube subscriptions . Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative . We expect these trends to continue to put pressure on our overall margins .",NEGATIVE +" We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar . If the U. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings . We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our debt security portfolio .",NEGATIVE +" The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development . AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market .",NEGATIVE +" There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019 that have . materially affected, or are reasonably likely to materially affect, our internal . control over . financial reporting . As the phased implementation of the new ERP system continues, we will change our processes and procedures which, in turn, could result in changes to internal control . As such changes occur, we will evaluate quarterly whether such changes .",NEGATIVE +" Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below . The costs of compliance with these laws and regulations are high and are likely to increase in the future . The trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, including fluctuations in exchange rates .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our headquarters are located in Mountain View, California . We own and lease office/building space and research and development sites around the world . We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business . The company owns and leases data centers in North America, Europe, South America, and Asia .",POSITIVE +" For a description of our material pending legal proceedings, please see Note 9 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference . ItEM 3: Legal Matters is included in Item 8 of this Report on Annual Report on Form Form 10-K .",NEGATIVE +" In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock . The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions . The returns shown are based on historical results and are not intended to suggest future performance .",NEGATIVE +" The growth was driven by strength in both AdMob and programmatic advertising buying, offset by a decline in our traditional AdSense businesses . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,660 million, largely resulting from accrued performance fees related to gains on equity securities .",NEGATIVE +" Alphabet Inc. reflects the gains or losses of foreign currency spot rate changes as a component of AOCI . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar . If the U.K. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings . We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values .",NEGATIVE +" As of December 31, 2018, our federal and state net operating loss carryforwards for income tax purposes were approximately $1.3 billion , $3.5 billion and $2.9 billion respectively . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market . We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI .",NEGATIVE +" There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2018 that have . materially affected, or are reasonably likely to materially affect, our internal . control over . financial reporting . Management is responsible for establishing and maintaining adequate internal control of financial reporting, as defined in Rule 13a-15(f) of the Exchange Act .",NEGATIVE + Government litigation and regulatory activity relating to competition rules may limit how we design and market our products . Security threats are a significant challenge to companies like us whose business is providing technology products and services to others . Issues in the development and use of AI may result in reputational harm or liability .,NEGATIVE + No written comments regarding SEC reports issued 180 days before end of fiscal year 2022 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these unresolved issues . No comment has been made by the SEC since the end of last fiscal year's fiscal year .,NEGATIVE +" Our corporate headquarters are located in Redmond, Washington . The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, and Singapore . The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2022 .",POSITIVE +" Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved . Legal Proceedings in which the company is involved are referred to as legal proceedings .",NEGATIVE + The company returned $12.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2022 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . The following table includes the number of shares purchased as part of Publicly Announced Plans or Programs .,NEGATIVE +" Microsoft: Surface revenue increased $226 million or 3% Windows Commercial products and cloud services revenue increased 11% driven by demand for Microsoft 365 . Nuance is reported as part of our Intelligent Cloud segment as of June 30, 2022 and 2021, respectively . Microsoft completed its acquisition of Nuance in the third quarter of fiscal year 2022 .",NEGATIVE +" The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions) Risk Categories include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar . We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices .",NEGATIVE +" Goodwill was assigned to our Intelligent Cloud segment and was primarily attributed to increased synergies that are expected to be achieved from the integration of Nuance . No material impairments of intangible assets were identified during fiscal years 2022, 2021, or 2020 . Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period .",NEGATIVE +" Microsoft's internal control over financial reporting is a process designed to provide reasonable assurance regarding reliability of financial reporting . Del Touche Touche LLP has audited the consolidated financial statements as of and for the year ended June 30, 2022, of the Company and its report dated July 28, 2022 . Management conducted an evaluation of the effectiveness of our internal control of our financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations .",NEGATIVE +" Legal, regulatory activity relating to competition rules may limit how we design and market our products . Regulators may assert that our collection, use, and management of customer and other data is inconsistent with their laws and regulations . These events could negatively impact our results of operations, financial condition, and reputation .",NEGATIVE + No written comments regarding reports issued 180 days or more prior to end of fiscal year 2021 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these issues . Staff has issued no written comments to the SEC regarding the reports that were issued 180-days or more before the end of our fiscal year 2019 .,NEGATIVE +" Our corporate headquarters are located in Redmond, Washington . The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, Singapore, and South Korea . We also own and lease facilities internationally for datacenters, research and development, and other operations . The table below shows a summary of the square footage of our office and datacenter facilities owned and leased domestically and internationally as of June 30, 2021 .",NEGATIVE +" The Company was required to make annual reports of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order) The Final Order expired in April of 2021 .",NEGATIVE + Microsoft returned $10.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2021 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .,NEGATIVE +" Microsoft settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011 . Office Consumer products and cloud services revenue increased $474 million or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong prior year comparable that benefited from transactional strength in Japan . On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. 0 billion or 13% .",NEGATIVE +" We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,Impact)",NEGATIVE +" The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike . The resolution of each of these audits is not expected to be material to our financial statements .",NEGATIVE +" Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2021 their report is included in Item 9A . The Company's management is responsible for maintaining effective internal control . Management conducted an evaluation of the effectiveness of our internal . control over . financial reporting based on the criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission .",NEGATIVE +" Factors that may indicate that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate . Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures .",NEGATIVE + No written comments regarding reports issued 180 days or more prior to end of fiscal year 2020 that remain unresolved . Staff of the Securities and Exchange Commission have not responded to any of these issues . Staff has issued no written comments to the SEC regarding the reports that were issued 180-days or more before the end of our fiscal year .,NEGATIVE +" The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2020 . The largest owned properties include: our research and development centers in China and India our datacenters in Ireland, the Netherlands, and Singapore .",POSITIVE +" The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved .",NEGATIVE +" We returned $8.9 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2020 . Our Board of Directors declared the following dividends: June 17, 2020August 20, 2020September 10, 2020$0.51$3,861 .",NEGATIVE +" Microsoft revenue increased $7.1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox hardware revenue declined 31%, primarily due to a decrease in volume and price of consoles sold . Microsoft's net income before income taxes was $24. 5 billion and $133. 0 billion . Microsoft paid $2. 2 billion in other investing to facilitate the purchase of components . The resolution of these audits is not expected to be material to our consolidated financial statements .",NEGATIVE +" We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,Impact)",NEGATIVE + The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less . We record receivable related to revenue recognized for multi-year on-premises licenses .,NEGATIVE +" Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2020 their report is included in Item 9A . Deloite Touches LLP believes that our audit provides a reasonable basis for our opinion . Company's management is responsible for maintaining effective internal control . Management conducted an evaluation of the effectiveness of our internal controls and procedures .",NEGATIVE +" Our operations and financial results are subject to various risks and uncertainties, including those described below . Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization . A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales .",NEGATIVE + No written comments regarding reports issued 180 days or more prior to end of fiscal year 2019 that remain unresolved . Staff of the Securities and Exchange Commission has issued no written comments . Staff has not commented on any of these unresolved issues . We have received no written comment from the SEC staff regarding these issues .,NEGATIVE +" The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019 . We also own and lease facilities internationally that include space in Australia, Canada, China, Germany, India, Japan, and the United Kingdom .",POSITIVE +" The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) These annual reports will continue through 2020 .",NEGATIVE + Microsoft returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .,NEGATIVE +" Productivity and Business Processes revenue increased $6. 1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox software and services revenue growth of 20%, mainly from third-party title strength . LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. LinkedIn expenses increased $762 million to $1. 9 billion .",NEGATIVE +" We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements . The following table sets forth the potential loss in future earnings or fair values resulting from hypothetical changes in relevant market rates or prices .",NEGATIVE + The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . GitHub has an ESPP for all eligible employees . Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized . The resolution of each of these audits is not expected to be material to our financial statements .,NEGATIVE +" Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019 . Company's internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America . Internal control is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected .",NEGATIVE +" Our operations and financial results are subject to various risks and uncertainties, including those described below . Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization . A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales .",NEGATIVE + No written comments regarding reports issued 180 days or more prior to end of fiscal year 2019 that remain unresolved . Staff of the Securities and Exchange Commission has issued no written comments . Staff has not commented on any of these unresolved issues . We have received no written comment from the SEC staff regarding these issues .,NEGATIVE +" The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019 . We also own and lease facilities internationally that include space in Australia, Canada, China, Germany, India, Japan, and the United Kingdom .",POSITIVE +" The Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. S. Ballmer et al, United States District Court for the Western District of Washington (Final Order) These annual reports will continue through 2020 .",NEGATIVE + Microsoft returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019 . The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards . Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT .,NEGATIVE +" Productivity and Business Processes revenue increased $6. 1 billion or 15%, driven by growth in Office Commercial and LinkedIn . Xbox software and services revenue growth of 20%, mainly from third-party title strength . LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. LinkedIn expenses increased $762 million to $1. 9 billion .",NEGATIVE +" We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices . We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements . The following table sets forth the potential loss in future earnings or fair values resulting from hypothetical changes in relevant market rates or prices .",NEGATIVE + The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition . GitHub has an ESPP for all eligible employees . Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized . The resolution of each of these audits is not expected to be material to our financial statements .,NEGATIVE +" Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019 . Company's internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America . Internal control is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected .",NEGATIVE +" Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . Data we collect, store and process is subject to a variety of U.S. factors . Failure to identify and implement a succession plan for senior management could negatively impact our business . The failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services .",NEGATIVE +" Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo""",NEGATIVE +" At the end of 2021, our warehouses contained approximately 118. 9 million square feet of operating floor space: 83. 4 million . 121 of the 171 leases are land-only leases, where Costco owns the building . Total square feet associated with distribution and logistics facilities were approximately 31.9 million in Canada; and 20. 8 million in Other International .",NEGATIVE + Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Item 11: Legal Proceedings. Item 7: Item 8 includes discussion of legal proceedings. Item 8 is Item 3 of Item 9 of Item 8 .,NEGATIVE +" The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . On September 28, 2021, we had 9,958 stockholders of record . The following graph provides information concerning average sales per warehouse over a 10 year period .",NEGATIVE +" Sales in all core merchandise categories increased, sales were particularly strong in non-foods . Warehouse operations and other businesses were lower by 24 basis points, largely attributable to payroll leveraging increased sales . Management believes that our cash and investment position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future . Insurance/Self-insurance Liabilities claims for employee health-care benefits, workers compensation, general liability, property damage and property damage are funded predominantly through self-insurers .",NEGATIVE +" Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . We use forward foreign-exchange contracts to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign currency .",NEGATIVE +" In July 2021, a former temporary staffing employee filed a class action against the Company and a staffing company alleging violations of the California Labor Code . In June 2021, the plaintiff agreed to dismiss his claims for failure to provide meal and rest breaks and to pay minimum wages . In the fourth quarter of 2020, the Company reached an agreement on a product tax audit resulting in a benefit of $ 84 . The Company acquired Innovel Solutions for $ 999 using existing cash and cash .",NEGATIVE +" Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . Because of its inherent limitations, internal control may not prevent or detect misstatements . There have been no changes in our internal control that occurred during the fourth quarter of 2021 .",NEGATIVE +" Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . Failure to identify and implement a succession plan for senior management could negatively impact our business . Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes; acts of terrorism or violence, including active shooter situations; public health issues, including pandemics and quarantines, could negatively affect our operations .",NEGATIVE +" Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo""",NEGATIVE +" At the end of 2020, our warehouses contained approximately 116. 1 million square feet of operating floor space: 81. 3 million in Canada; and 20. 4 million in the U.S. and Puerto Rico . 119 of the 166 leases are land-only leases, where Costco owns the building .",NEGATIVE + Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Item 11: Legal Proceedings. Item 7: Item 8 includes discussion of legal proceedings. Item 8 is Item 3 of Item 9 of Item 8 .,NEGATIVE +" The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years .",NEGATIVE +" Cash flow provided by operations is primarily derived from net sales and membership fees . U.S. dollar positively impacted SGA expenses by approximately $58 . E-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse business .",NEGATIVE +" Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . As of the end of 2020, long-term debt with fixed interest rates was $7,657.",NEGATIVE +" Costco Wholesale Corporation (Costco or the Company) operates membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover . There were no impairment charges recognized in 2020, 2019 or 2018 .",NEGATIVE + Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP .,NEGATIVE +" Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . We are highly dependent on our California operations, which comprised 30% of U.S. operations, particularly in California, and our Canadian operations could arise from slow growth or declines in comparable warehouse sales (comparable sales)",NEGATIVE +" Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo""",NEGATIVE +" At September 1, 2019, Costco operated 782 membership warehouses . At the end of 2019, our warehouses contained approximately 113 warehouses . 114 of the 162 leases are land-only leases, where Costco owns the building . The following schedule shows warehouse openings, net of closings and relocations, and expected openings through 2019 .",NEGATIVE + Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .,NEGATIVE +" The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023 . The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 31, 2014 to September 1, 2019 .",NEGATIVE +" At September 1, 2019, our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 to 2022 2023 to 2024 2025 and thereafter . Cash flow provided by operations is primarily derived from net sales and membership fees . SGA expenses as a percentage of net sales 10. 65 per share and authorized a new share repurchase program in the amount of $4,000 .",NEGATIVE +" The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations . We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency .",NEGATIVE +" The Company maintained, in all material respects, effective internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and utilize the transition option, which allows for a cumulative-effect adjustment .",NEGATIVE +" Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act . No other changes have been made in connection with the implementation of the remediation plan discussed above . No changes have materially affected or are reasonably likely to materially affect, the Companys internal control of financial reporting .",NEGATIVE +" Failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations . We are highly dependent on our California operations, which comprised 30% of U.S. operations, particularly in California, and our Canadian operations could arise from slow growth or declines in comparable warehouse sales . Failure to identify and implement a succession plan for key senior management could negatively impact business .",NEGATIVE +" Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo""",NEGATIVE +" The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2018 . At the end of fiscal 2018, our warehouses contained approximately 110. 3 million in Canada; and 19. 7 million square feet of operating floor space: 77. 5 million in the U.S. ; 13. 0million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses .",NEGATIVE + Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .,NEGATIVE +" The information provided is from September 1, 2013 , through September 2, 2018 . The transition to a larger retail index provides a better representation of total retail market performance . The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019 .",NEGATIVE +" Cash flow provided by operations is primarily derived from net sales and membership fees . The increase in membership fees was primarily due to the annual fee increase and membership sign-ups at existing and new warehouses . The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss .",NEGATIVE +" Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency . The majority of our short-term investments are in fixed interest-rate securities .",NEGATIVE +" The proceeds from sales of available-for-sale securities were $39 , $202 , and $291 during 2018 , 2017 , and 2016 , respectively . At September 3, 2017, there were no securities included in cash and cash equivalents and $947 included in short-term investments in the accompanying condensed consolidated balance sheets . At the end of 2018 and 2017, these insurance liabilities were $1,148 and $ 1,059 in the aggregate, respectively .",NEGATIVE +" A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting . A material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis . The remediation of this material weakness will be completed prior to the end of fiscal 2019 .",NEGATIVE +" Our security measures may be undermined due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information . We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation .",NEGATIVE +" Item 1B: Unresolved Staff Comments . Item 1A: Item 1C: Item 1D: ""Unresolve Staff Comments"" Item 1E: ""We are happy to clarify that we are not going to make changes to this item"" Item 2B: ""We will make a decision to make a change to the status quo""",NEGATIVE +" The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2017 . At the end of fiscal 2017, our warehouses contained approximately 107. 3 million square feet of operating floor space: 75. We operate 24 depots, consisting of approximately 11. 5 million in Canada; and 18 million in Other International locations .",NEGATIVE + Item 3: Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report . Item 8: Item 9: Item 10: Legal Proceedings to be discussed in Note 10 . Item 11: Item 10 includes discussion of legal proceedings relating to the Company's financial statements . Item 7: Shareholders and non-taxpayers should not be entitled to a share of interest in the Company .,NEGATIVE +" The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019 . The company expects to continue to pay dividends on a quarterly basis . On October 10, 2017, we had 8,629 stockholders of record .",NEGATIVE +" E-commerce business growth both domestically and internationally has also increased our sales . Charges for non-recurring legal and regulatory matters during 2016 negatively impacted SGA expenses by two basis points . The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws .",NEGATIVE +" Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates . We are exposed to fluctuations in prices for energy that we consume, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities . We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships .",NEGATIVE +" The consolidated financial statements have been audited by KPMG LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) Costcos management is responsible for the preparation of the related financial information included in this Annual Report on Form 10-K .",NEGATIVE + Our internal control over financial reporting Item 9AControls and Procedures (Continued) is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP . Management is responsible for establishing and maintaining adequate internal control of our financial reporting as defined in Rule 13a-15(f) under the Exchange Act .,NEGATIVE +" In 2019, Pfizer and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes .",NEGATIVE +" The vaccine is authorized by the FDA to prevent COVID-19 in individuals 5 years of age and older . At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time .",POSITIVE +" PGS had responsibility for 39 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S. As of December 31, 2021, we had 327 owned and leased properties, amounting to approximately 41 million square feet . Our global headquarters are located in New York City .",POSITIVE + The executive officers of the Company are set forth in this table . Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2022 Annual Meeting of Shareholders . Each of the executive officers is a member of the Pfizer Executive Leadership Team .,POSITIVE +" Pfizer Inc. currently trades on the NYSE under the symbol PFE. Inc. and European-based pharmaceutical companies . The principal market for our common stock is the NYse. The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. pharmaceutical companies, which are: AbbVie Inc. , Amgen Inc. . and Amgen .",NEGATIVE +" In December 2021, a supplemental BLA was submitted to the FDA requesting to expand the approval of Comirnaty to include individuals ages 12 through 15 years . Lorbrena/Lorviqua (lorlatinib) First-line ALK-positive NSCLC Approved Mar. 31, 2021 . TicoVac (Vaccine) Immunization to prevent tick-borne encephalitis Approved Aug. 3 % 6. 2 billion, or 145%, and a favorable impact from foreign exchange of approximately 2% . At December 31, 2019, our remaining share-purchase authorization was approximately $5.3 billion .",NEGATIVE +" The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. 2021 Form 10-K . Pfizer Inc.    Pfizer announces qualified and qualified disclosures about market risk .",NEGATIVE +" Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented . Japan, which contributed 9 % of total revenue in 2021 and 6 % in each of 2020 and 2019, was Japan . The third and fourth quarters of 2021 primarily include employee termination costs associated with our Transforming to a More Focused Company program . For RSUs granted, in virtually all instances, the units vest on the third anniversary of the grant date assuming continuous service .",NEGATIVE +" There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Pfizer Inc. and Subsidiary Companies (the Company) have issued their auditors report on the . Companys management is responsible for maintaining effective internal control . Management assessed the effectiveness of the . Company's internal . control over . financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework (2013) Pfizer .",NEGATIVE +" In 2019, Pfizer and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . The size and complexity of our information technology and information security systems make such systems potentially vulnerable to service interruptions . Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals .",NEGATIVE +" At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences . We and GSK combined their respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name . We expect certain products to face significantly increased generic competition .",NEGATIVE +" As of December 31, 2020, we had 363 owned and leased properties, amounting to approximately 43 million square feet . PGS expects to exit five of these sites over the next several years . In many locations, our business and operations are co-located to achieve synergy and operational efficiencies .",POSITIVE + Each of the executive officers is a member of the Pfizer Executive Leadership Team . Each holds office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2021 Annual Meeting of Shareholders . Certain legal proceedings in which we are involved are discussed in Note 16A .,POSITIVE +" As of February 23, 2021, there were 139,582 holders of record of our common stock . Pfizer Inc. currently trades on the NYSE under the symbol PFE. , Inc. The principal market for Pfizer common stock is the New YorkSE, AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline .",NEGATIVE +" Cost of sales increased $441 million, primarily due to increased sales volumes, increased royalty expenses and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory . International Operational growth/(decline): Growth from Prevnar 13/Prevenar 13, Ibrance, Eliquis, Vyndaqel/Vyndamax, Xtandi, Inlyta, Biosimilars and the Hospital therapeutic area, partially offset by Chantix/Champix .",NEGATIVE +" The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA section . Pfizer Inc. 2020 Form 10-K is required to provide certain information to the public .",NEGATIVE + The target Pfizer Inc. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease . Variable lease payments amounted to $ 380 million in 2020 and $ 327 million in 2019 . The adoption of this standard did not have a material impact on our consolidated statement of income .,NEGATIVE +" There has not been any change in the Companys internal control over financial reporting that has . materially affected, or is reasonably likely to materially affect, the . Companys management is responsible for maintaining effective internal control . Management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) We believe that our audit provides a reasonable basis for our opinion .",NEGATIVE +" The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain . Pfizer does not have control over the joint venture, its management or its policies . The amount of synergies actually realized in the Combination, if any, and the time periods in which any such synergies are realized, could differ from the synergies anticipated to be realized, regardless of whether the two business operations are combined successfully .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Pfizer corporate headquarters are in New York City and Pfizers properties extend internationally to approximately 90 countries . Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions . As of December 31, 2019 , we had 453 owned and leased properties, amounting to approximately 47 million square feet .",NEGATIVE +" Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 16 A . Legal Proceedings in our 2019 Financial Report, which is incorporated by reference . ItEM 3. Legal Proceedings are discussed during our 2019 Financial Report .",POSITIVE +" The principal market for our common stock is the NYSE . As of February 25, 2020, there were 142,524 holders of record of Pfizer's common stock . The average price paid per share is $5,292,881,709 . Additional information required by this item is incorporated by reference from the Selected Quarterly Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2019 Financial Report .",NEGATIVE + Information required is incorporated by reference from the discussion under the heading Financial Review in our 2019 Financial Report . Information required by reference is in the 2019 Financial Review . Management management reports and analyses of the company's financial business activities .,NEGATIVE + Pfizer Inc. Financial Instruments : Fair Value Measurements in our 2019 Financial Report . We manage these financial exposures through operational means and through the use of third-party instruments . The objective of our financial risk management program is to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings .,NEGATIVE + Information required by reference from the Report of Independent Registered Public Accounting Firm in our 2019 Financial Report . The information required by this item is incorporated by reference to the report of independent registered public accounting firm . The financial statements and related data are included in the 2019 Financial Reports of the firm's consolidated financial statements .,NEGATIVE +" During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2019 Financial Report .",NEGATIVE +" Risks and uncertainties apply if we provide something of value to a healthcare professional, other healthcare provider and/or government official . The outcome of identifying new compounds and developing new products is inherently uncertain . Abbreviated legal pathways for the approval of biosimilars exist in certain international markets . We encounter similar regulatory and legislative issues in most other countries .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" As of December 31, 2017, Pfizer had 501 owned and leased properties, amounting to approximately 53 million square feet . Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries . Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, manufacturing and distribution, and administrative support functions .",NEGATIVE +" Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and Contingencies . Legal Proceedings in our 2017 Financial Report, which is incorporated by reference, are discussed by reference to the legal proceedings we are in .",NEGATIVE +" The principal market for our common stock is the NYSE . 59,102 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs . As of February 20, 2018, there were 158,190 holders of record of our stock . For additional information, see the Notes to Consolidated Financial Statements .",NEGATIVE + Information required by reference is incorporated by reference from the discussion under the heading Financial Review in our 2017 Financial Report . The information required by this item is included by reference to the discussion in the Financial Review of the company's 2017 Financial Review . Management management reports and examine their financial relationship and results of operations .,NEGATIVE + Information required by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future Results . Financial Risk Management section in our 2017 Financial Report . Information required in this item is incorporated by reference to the discussion in the discussion of the Forward Looking Information section of the Financial Risk and Factors that may affect future results .,POSITIVE +" Information required by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2017 Financial Report and from the consolidated financial statements, related notes and supplementary data . ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY Data .",NEGATIVE +" There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2017 Financial Report .",NEGATIVE +" The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost . The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio . Pfizer Inc. continues to maintain competitive insurance markets, but has also seen significant competition in insurance markets .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Pfizer Inc. reduced the number of properties in our portfolio by 28 sites and 2. 3 million square feet with the disposal of surplus real property assets and with reductions of operating space in all regions . Pfizer's corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries . As of December 31, 2016, we had 567 owned and leased properties .",NEGATIVE +" Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A . ITEM 3. Commitments and Contingencies in our 2016 Financial Report, which is incorporated by reference . Legal Proceedings in which they are involved include those in which the company is involved in legal proceedings .",POSITIVE +" On October 23, 2014, the Board of Directors had authorized an $11 billion share-purchase plan (the October 2014 Stock Purchase Plan) On March 8, 2016, we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. based on a price of $29. 36 per share . As of February 21, 2017, there were 166,694 holders of record of our common stock . The stock currently trades on the NYSE under the symbol PFE. 57 $ 11,355,862,076 December 1, 2016 through December 31, 2016 .",NEGATIVE +" Pfizer Inc. 2016 Form 10-K . Pfizer filed a form 10,000-a-year financial report on January 1, 2017 . The information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2016 Financial Report . The financial review is required by reference to the discussion discussed in the Financial Review of Pfizer's 2016 financial report .",NEGATIVE + Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future Results in our 2016 Financial Report . Financial Risk Management section of this item includes the disclosure of our 2016 financial report . We are happy to provide a summary of this information to shareholders and investors .,POSITIVE +" Information required by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2016 Financial Report and from the consolidated financial statements, related notes and supplementary data . The information required by this item is incorporated by reference to the Report .",NEGATIVE +" There has not been any change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the company's internal control of financial reporting . Internal Control over Financial Reporting Managements report on internal control is included in our 2016 Financial Report .",NEGATIVE +" The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors . The duration and scope of the pandemic, the emergence and spread of new variants of the virus, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus .",NEGATIVE + The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2021 year and that remain unresolved . Item 1B. Unresolved Staff Comments. Unresolve Staff Comments .,NEGATIVE +" Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties . Each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities .",POSITIVE +" We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A .",POSITIVE +" PepsiCo has paid consecutive quarterly cash dividends since 1965 . The declaration and payment of future dividends are at the discretion of the Board of Directors . We expect to return a total of approximately $7.7 billion to shareholders in 2022 . Dividends are usually declared in February, May, July and November and paid at the end of March, June and September .",NEGATIVE +" Our primary sources of liquidity include cash from operations, pre-tax cash proceeds of approximately $3. 26 (a) $ 5. 26 (a), $ 5 billion and 88 billion (b) Notes due 2021 (2. 1 %) Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually .",NEGATIVE +" Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""",POSITIVE + See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .,NEGATIVE +" During our fourth quarter of 2021, we continued migrating certain of our financial processing systems to an ERP solution . These systems implementations are part of our ongoing global business transformation initiative . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K .",NEGATIVE +" Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers . Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries . Poland enacted a graduated tax on all sweetened beverages, effective January 1, 2021 .",NEGATIVE + The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more prior to the end of our 2020 year and that remain unresolved . The SEC will not comment on any of these issues that are not resolved .,NEGATIVE +" Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties . Each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities .",POSITIVE +" We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A .",POSITIVE +" On February 4, 2021, the Board of Directors declared a quarterly dividend of $1. 82 . We expect to return a total of approximately $5. 9 billion to shareholders in 2021 . The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . We have paid consecutive quarterly cash dividends since 1965 .",NEGATIVE +" Long-term debt obligations: Operating leases, operating leases, one-time mandatory transition tax - TCJ Act . Other long-term liabilities: Interest on debt obligations, Purchasing commitments and other commitments . The Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance .",NEGATIVE +" Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""",POSITIVE +" The scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020 . KPMG LLP has audited the consolidated financial statements included in this Annual Report on Form 10-K .",NEGATIVE +" As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020 . Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4% of PepsiCo, Inc. As of the end of the period covered by this report, our disclosure controls and procedures were effective .",NEGATIVE +" Changes in consumption in our product categories or consumer demographics can result in reduced demand for our products . 10 states in the United States as well as a growing number of European countries have a bottle deposit return system in effect . Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities .",NEGATIVE + The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more prior to the end of our 2019 year and that remain unresolved . Item 1B. Unresolved Staff Comments remain unresolved. Item 1A. We have received no written comments from the SEC .,NEGATIVE +" In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, research and development facilities and other facilities . We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations .",POSITIVE +" We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows . See also Item 1.A and Item 1A .",POSITIVE +" The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . The declaration and payment of future dividends are at the discretion of the Board of Directors . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases and dividends .",NEGATIVE +" In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2019 and December 29, 2018 . We recognize revenue when our performance obligation is satisfied . A bonus extended to certain U.S. companies is based on contract terms and our historical experience with similar programs .",NEGATIVE +" Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""",POSITIVE + See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .,NEGATIVE +" During our fourth quarter of 2019, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution . These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting . KPMG LLP has audited the consolidated financial statements included in this Annual Report on Form 10-K .",POSITIVE +" Historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results . The United States and many of the other countries in which our products are made, manufactured, distributed or sold, have recently made or are actively considering changes to existing tax laws . The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products .",NEGATIVE + The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more before the end of our 2018 fiscal year and that remain unresolved . Item 1B. Unresolved Staff Comments remain unresolved. Item 1A: We have received no written comments from the SEC from any of its staff regarding our quarterly or monthly or quarterly reports .,NEGATIVE +" Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products . We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations .",NEGATIVE +" PepsiCo Alimentos Z. Z. (PAZ) submitted evidence of its defense to these allegations in July 2018 . If the environmental authority determines PAZ is responsible for the alleged permitting violations by the third party, the authority may seek to impose monetary sanctions of up to $1. 3 million, which PAZ would be entitled to appeal .",NEGATIVE +" On February 13, 2019, the Board of Directors declared a quarterly dividend of $0. 9275 payable March 29, 2019 . The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange . All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs . Dividends are usually declared in February, May, July and November and paid at the end of March, June and September .",NEGATIVE +" A bonus extended to certain U.S. 500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $253 million ( $191 million after-tax or $0.0) Operating profit excluding above item (b) $ 5,044 $ 4,847 $4,624 on a constant currency basis .",NEGATIVE +" Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""",POSITIVE + See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .,NEGATIVE +" There have been no changes in our internal control over financial reporting during our fourth fiscal quarter of 2018 . SodaStreams total assets and net revenue represented approximately 5% and 1% of the consolidated total assets of PepsiCo, Inc. and its subsidiaries (SodaStream), which we acquired in December 2018 . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements .",NEGATIVE +" The U.S. and many of the other countries in which our products are made, manufactured, distributed or sold, have recently made or are actively considering changes to existing tax laws . Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, and introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and credentials .",NEGATIVE + The SEC has received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2017 fiscal year and that remain unresolved . Item 1B. Unresolved Staff Comments. That remain unresolved.,NEGATIVE +" Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products . The approximate number of such facilities utilized by each division is as follows: FLNA, QFNA, NAB Latin America, ESSA AMENA and AMENA .",POSITIVE +" In October 2017, the Supreme Administrative Court issued a final, non-appealable decision, rejecting our appeal and we agreed to invest funds up to the penalty amount(s) into the bottling plant to fully resolve the matter . The results of litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty . Management believes the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows .",NEGATIVE +" On February 13, 2018, we publicly announced a new repurchase program of up to $15 billion of our common stock, which will commence on July 1, 2018 and expire on June 30, 2021 . The declaration and payment of future dividends are at the discretion of the Board of Directors . The Company does not have any authorized, but unissued, blank check preferred stock .",NEGATIVE +" Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo and net income . Venezuela deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015 . Higher commodity inflation reduced operating profit growth by 1 percentage point, primarily attributable to inflation in inflation in Latin America, ESSA and AMENA segments .",NEGATIVE +" Included in Item 7.A. Item 7A. Item 7B: Quantitative and Qualitative Disclosures About Market Risk . Item 7b: Managements Discussion and Analysis of Financial Condition and Results of Operations . Item 7b: ""Our Business Risks"" Item 7a: ""Quantitative and Qualitative disclosures about Market Risk""",POSITIVE + See Item 8. Exhibits and Financial Statement Schedules . See Item 15. Financial Statements and Supplementary Data . See item 8.1 for the financial statements . Item 15 is the financial statement for the company . Item 8 is the Financial Statement Schedule for the Company .,NEGATIVE +" KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . As of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms .",NEGATIVE +" Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies . Patent protection is important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. Third parties may claim that an AbbVie product infringes upon their intellectual property .",NEGATIVE + ItEM 1B. UNRESOLVED STAFF COMMENTS None. Unresolvement of the issue is not resolved . None of the issues are resolved by the end of this article . We are happy to clarify that this is not the case of any of these issues .,NEGATIVE +" As of December 31, 2021, AbbVie owns or leases approximately 645 facilities worldwide, containing an aggregate of approximately 20 million square feet of floor space dedicated to production, distribution, and administration . In the United States, including Puerto Rico, Abvie has two central distribution centers . The company also has research and development facilities in the U.S. located at: Abbott Park, Illinois; Branchburg, New Jersey; Cambridge, Massachusetts; Irvine, California; Madison, New York; Pleasanton, California .",NEGATIVE +" Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 .",NEGATIVE +" The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries . The principal market for Abbvie's common stock is the New York Stock Exchange (Symbol: ABBV)",NEGATIVE +" AbbVie's pipeline includes approximately 90 compounds, devices or indications in development individually or under collaboration or license agreements . The pipeline is focused on immunology, oncology, aesthetics, neuroscience, neuroscience and eye care . Actual results may differ from the company's estimates .",NEGATIVE +" The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar, Chinese yuan and British pound . The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of its interest rate swap contracts by approximately $244 million at December 31, 2021 .",NEGATIVE +" At December 31, 2021, the company was in compliance with its senior note covenants and term loan covenants . In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and Cadila Healthcare Limited. At December 2011 PharmacyClics entered into an amended and restated license agreement . The effective income tax rates for 2019 also included the effects of Stemcentrx impairment related expenses .",NEGATIVE +" The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below . Ernst Young LLP expressed an unqualified opinion on the effectiveness of its internal control . The Chief Executive Officer, Richard A. Michael, evaluated the effectiveness .",NEGATIVE +" Third parties may claim that an AbbVie product infringes upon their intellectual property . Patent protection is, in the aggregate, important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. In particular, a number of other companies have started to develop, have successfully developed and/or are marketing products that are being positioned as competitors to Botox .",NEGATIVE + ItEM 1B. UNRESOLVED STAFF COMMENTS None. Unresolvement of the issue is not resolved . None of the issues are resolved by the end of this article . We are happy to clarify that this is not the case of any of these issues .,NEGATIVE +" AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . In the United States, including Puerto Rico, Abbvie has two central distribution centers . The company also has research and development facilities in the U.S. and abroad . There are no material encumbrances on the owned properties .",NEGATIVE +" Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 .",NEGATIVE +" The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries and other factors deemed relevant by its directors . The stock price performance on the following graph is not necessarily indicative of future stock market performance .",NEGATIVE +" Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering a collaboration agreement with Genmab A/S (Genmab) to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer . The pipeline includes more than 90 compounds, devices or indications in development individually or under collaboration or license agreements .",POSITIVE +" The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar would decrease the fair value of foreign exchange forward contracts by $1.1 .",NEGATIVE +" At December 31, 2020, the company was in compliance with its senior note covenants and term loan covenants . Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 43 % of Abbvie's total net revenues in 2020, 58 % in 2019 and 61 % in 2018 .",NEGATIVE +" A company's internal control over financial reporting is designed to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . AbbVie Inc. believes that our audit provides a reasonable basis for our opinion . All internal control systems, no matter how well designed, have inherent limitations .",NEGATIVE +" The pending acquisition of Allergan may not be completed on the currently contemplated timeline or terms, or at all, and may not achieve the intended benefits . Third parties may claim that an AbbVie product infringes upon their intellectual property . The ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets .",NEGATIVE +" None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution .",NEGATIVE +" AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico . There are no material encumbrances on the company's owned properties .",NEGATIVE +" Information pertaining to legal proceedings is provided in Note 15 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 15 .",NEGATIVE +" The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors . The performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934 .",NEGATIVE +" In November 2019, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for IMBRUVICA in combination with rituximab for the first-line treatment of younger patients with CLL or SLL . The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis .",NEGATIVE +" The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar would decrease the fair value of foreign exchange forward contracts .",NEGATIVE +" In the third quarter of 2019, the company issued 1. 0 billion and tax credit carryforwards were $ 188 million . (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders . (Reata) entered into an amended and restated license agreement with Reata . AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified Abbvie against all income tax liabilities for periods prior to the separation . Actual results may differ from the company's estimates .",NEGATIVE +" Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . All internal control systems, no matter how well designed, have inherent limitations . The Chief Executive Officer, Richard A. Michael, said there were no changes that have materially affected, or are reasonably likely to materially affect, the company's control of financial reporting .",NEGATIVE +" Factors that could cause actual results or events to differ from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations"" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets .",NEGATIVE +" None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution .",NEGATIVE +" AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico, and has other manufacturing facilities worldwide . There are no material encumbrances on the owned properties .",NEGATIVE +" Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 14 .",NEGATIVE +" The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, earnings and capital requirements of its operating subsidiaries . The performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934 .",NEGATIVE +" Worldwide net revenues grew by 16% , or 15% on a constant currency basis, driven primarily by revenue growth related to MAVYRET, IMBRUVICA and VENCLEXTA . In the United States, HUMIRA sales increased 11% in 2018 and 18% in 2017 .",NEGATIVE +" The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates . The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $403 million at December 31, 2018 .",NEGATIVE +" The company recognized a net tax benefit of $131 million in 2018 and $91 million in 2017 related to resolution of various tax positions pertaining to prior years . Approximately 4,000 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability .",NEGATIVE +" AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . All internal control systems, no matter how well designed, have inherent limitations . The design of any system of controls is based in part on certain assumptions about the likelihood of events, and there can be no assurance that any design will succeed .",NEGATIVE +" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets . Patent protection is important in marketing of pharmaceutical products in the United States and most major markets outside of the U.S. As patents for certain of its products expire, Abbvie will or could face competition from lower priced generic products . Third parties may claim that a product infringes upon their intellectual property .",NEGATIVE +" None of the issues have been resolved in this article . It is not the first time the government has attempted to resolve a resolution of these issues . The U.S. Senate will hold a hearing on the issue of this article on December 11, 2015 . The Senate will consider a resolution to this article's resolution .",NEGATIVE +" AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400 . The company has one distribution center in the United States, including Puerto Rico, and other manufacturing facilities in the U.S. There are no material encumbrances on the company's owned properties .",NEGATIVE +" Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein . Legal Proceedings are provided in Note 14 .",NEGATIVE +" The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of Abbvie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its directors .",NEGATIVE +" AbbVie's gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017 . MAVYRET is indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both . This is the first and only treatment approved for newly or previously-treated patients with WM. The balance of commercial paper outstanding was $400 million as of December 31, 2017 .",NEGATIVE +" AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound . The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1 .",NEGATIVE +" The acquisition of Pharmacyclics was accounted for as a business combination using the acquisition method of accounting . The fair market value of RSAs, RSUs and performance shares vested was $348 million in 2017 , $362 million in 2016 and $335 million in 2015 . The estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies .",NEGATIVE +" AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles . Ernst Young LLP, an independent registered public accounting firm, has expressed an unqualified opinion .",NEGATIVE +" The full extent to which theCOVID-19 pandemic will affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted . The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance . The sales of our products are influenced to some extent by weather conditions in the markets in which we operate .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our worldwide headquarters is located on a 35-acre complex in Atlanta, Georgia . The extent of utilization of our production facilities varies based upon seasonal demand for our products . Management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities .",POSITIVE +" The closing agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years . The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the . Companys foreign licensees . In that event, the . Company would likely be subject to significant additional liabilities for tax years 2007 through 2009 .",NEGATIVE +" The total shareowner return is based on a $100 investment on December 31, 2016 and assumes that dividends were reinvested on the day of issuance . No equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended . The Pecker Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food and the Pecker Index .",NEGATIVE +" We own and market five of the world's top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Diet Coke . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value . In 2021, the Companys total income related to defined benefit pension plans was $61 million .",POSITIVE +" Company uses derivative financial instruments to reduce exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . Company enters into forward exchange contracts and purchases foreign currency options and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies . Company is subject to interest rate volatility with regard to existing and future issuances of debt .",NEGATIVE +" All of the amounts in the table above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income . For performance share unit awards granted from 2018 through 2021, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years .",NEGATIVE +" The report of management on our internal control over financial reporting as of December 31, 2021 and the attestation report of our independent registered public accounting firm on internal control are set forth in Part II, Item 8. The Company evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act)",NEGATIVE +" The sales of our products are influenced to some extent by weather conditions in the markets in which we operate . We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk . The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . The extent of utilization of our production facilities varies based upon seasonal demand for our products . Management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment . These properties, except for the North America group's main offices, are included in Corporate .",NEGATIVE +" The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years . The Company and Aqua-Chem continued to pursue and obtain coverage agreements with those insurance companies that did not settle in the Wisconsin insurance coverage litigation . The IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million . Some or all of this amount would be refunded if the Company were to prevail on appeal .",NEGATIVE +" This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange . No equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended .",NEGATIVE +" Other operating charges incurred by operating segment and Corporate were as follows (in millions): Europe, Middle East Africa, Africa $ 73 $ 2 Latin America 29 1 North America 379 62 Asia Pacific 31 42 Global Ventures 4 Bottling Investments 34 100 Corporate 303 251 Total $ 853 $ 458 In 2020, the Company recorded other operating charges of $853 million .",NEGATIVE +" Our Company uses derivative financial instruments to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . In 2020, we used 70 functional currencies in addition to the U.S. dollar would have increased the net unrealized gain to $140 million . The Company is subject to interest rate volatility with regard to existing and future issuances of debt . We enter into forward exchange contracts as hedges of net investments in foreign operations .",NEGATIVE +" It is expected that the amount of unrecognized tax benefits will change in the next 12 months . Fair value disclosures related to our pension plan assets are included in Note 16 . The total number of stock options exercised was 23 million, 34 million and 47 million in 2020, 2019 and 2018, respectively .",POSITIVE +" The Company evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" as of the end of the period covered by this report . No changes in internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the company's internal control .",NEGATIVE +" The success of our business depends on our ability to attract, develop, retain and motivate a highly skilled and diverse workforce . We conduct business in markets with high-risk legal compliance environments, exposing us to increased legal and reputational risk . The sales of our products are influenced to some extent by weather conditions in the markets in which we operate .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . The extent of utilization of such facilities varies based upon seasonal demand for our products . We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, storage and distribution operations . The North America group's main offices are included in the North America operating segment .",POSITIVE +" The disputed amounts relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees . The IRS designated the matter for litigation on October 15, 2015 . The Company sold Aqua-Chem to Lyonnaise American Holding, Inc. The Company filed a motion for summary judgment on the portion of IRS' adjustments related to our licensee in Mexico .",NEGATIVE +" This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . In 2019, these indices do not include BG Foods, Inc. , Seaboard Corporation, The J. Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends .",NEGATIVE +" In 2018, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million . Unit case volume in water, enhanced water and sports drinks grew 1 percent, driven by 7 percent growth in sports drinks . ""Acquired brands"" refers to brands acquired during the past 12 months . Realized and unrealized gains and losses on trading debt securities are included in net income .",NEGATIVE +" The Company generally hedges anticipated exposures up to 48 months in advance; however, the majority of our derivative instruments expire within 24 months or less . We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis . The total notional values of our foreign currency derivatives were $14,276 million and $17,142 million as of December 31, 2019 and 2018 .",NEGATIVE +" It is expected that the amount of unrecognized tax benefits will change in the next 12 months . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value . The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model .",NEGATIVE +" The Company evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" The Chief Executive Officer and the Chief Financial Officer concluded that the company's disclosure controls were effective as of December 31, 2019 . There have been no changes in internal control over financial reporting during the quarter ended December 31 , 2019 .",NEGATIVE +" The sales of our products are influenced to some extent by weather conditions in the markets in which we operate . We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk . An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase their operating costs and thus indirectly negatively impact our results of operations .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia . We own or lease additional facilities, real estate and office space throughout the world . The extent of utilization of such facilities varies based upon seasonal demand for our products . Management believes that our Company's facilities for the production of our products are suitable and adequate .",NEGATIVE +" Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it . Management believes that, except as disclosed in U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. To that end, the Company filed a petition in the U.",NEGATIVE +" On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock . This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . During the year ended December 31, 2018, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933 .",NEGATIVE +" In 2019, we expect to repurchase shares to offset dilution resulting from employee stock-based compensation plans . In 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers . The Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital .",NEGATIVE +" Our Company uses derivative financial instruments to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . The total notional values of our foreign currency derivatives were $17,142 million and $13,057 million as of December 31, 2018 and 2017 . The Company enters into forward exchange contracts and purchases foreign currency options to hedge certain portions of forecasted cash flows denominated in foreign currencies .",NEGATIVE +" The Company's first quarter 2018 results were impacted by one less day compared to the first quarter of 2017 . The Company consolidates all entities that we control by ownership of a majority voting interest . Realized and unrealized gains and losses on trading debt securities are included in net income . The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value .",NEGATIVE +" There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2018 . The Company evaluated the effectiveness of the design and operation of its ""disclosure controls and procedures"" as of the end of the period covered by this report .",NEGATIVE +" Failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.N. Human Rights are essential to the success of our business . Restructuring activities and the announcement of plans for future restructuring activities may result in an increase in insecurity among some Company associates and some employees .",POSITIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" The extent of utilization of such facilities varies based upon seasonal demand for our products . Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes . The North America group's main offices are included in the North America operating segment .",NEGATIVE +" The Company owned Aqua-Chem from 1970 to 1981 . During that time, the Company purchased over $400 million of insurance coverage . Two of the insurers, one with a $15 million policy limit, asserted cross-claims against the Company . On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed . A trial date has been set for March 5, 2018 . The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits .",NEGATIVE +" On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock . This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions . The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and Dow Jones Tobacco Index, from which the Company has been excluded .",NEGATIVE +" Other liabilities increased and deferred income taxes decreased due to the Tax Reform Act signed into law on December 22, 2017 . ""Acquired brands"" refers to brands acquired during the past 12 months . The Company refranchised its bottling operations in China to the two local franchise bottlers .",NEGATIVE +" Company uses derivative financial instruments to reduce exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks . Company is subject to interest rate risk related to its investments in highly liquid securities . Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less .",NEGATIVE +" The gains or losses on assets measured at fair value on a nonrecurring basis are summarized in the table below . The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price . As of December 31, 2017, we had $ 286 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans .",NEGATIVE +" The Company began consolidating the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited in October 2017 . Management has excluded from the scope of its assessment of internal control over financial reporting the operations of CCBA from the assessment . There have been no changes in the Company's internal control of financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the company's financial reporting .",NEGATIVE +" Risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies . Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations . Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them .",NEGATIVE + Item 1B. Unresolved staff comments Not applicable . Item 1A. Not applicable. Item 1C. Unresolve staff comments not applicable. Item 1D. A. Unrelaxed staff comments are not required to respond to any of these issues .,NEGATIVE +" As of December 31, 2021, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries . We believe that our facilities are suitable and adequate for the business that we currently conduct . However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business and address climate-related impacts .",POSITIVE +" Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Item 3. Item 3: Legal and regulatory Proceedings .",NEGATIVE +" The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends . On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of our . Class B common stock is not publicly listed on any exchange or . exchange quotation system .",NEGATIVE +" A more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rates . A significant portion of our net income is concentrated among our largest customers . We completed the acquisitions of businesses for total consideration of $4.3 billion at December 31, 2021 and 2020, respectively . The remaining growth was driven primarily by our Cyber Intelligence and Data Services solutions .",NEGATIVE +" Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates . Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks .",NEGATIVE +" In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U. merchants as well as settlements with a number of Pan-European merchants . The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique .",NEGATIVE +" PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2021 .",NEGATIVE + Risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies . The ultimate impact of COVID-19 or a similar health epidemic is highly uncertain and subject to change . The advent of the global COVID pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce from working from home .,NEGATIVE + Item 1B. Unresolved staff comments Not applicable . Item 1A. Not applicable. Item 1C. Unresolve staff comments not applicable. Item 1D. A. Unrelaxed staff comments are not required to respond to any of these issues .,NEGATIVE +" As of December 31, 2020, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries . We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center . We believe that our facilities are suitable and adequate for the business that we currently conduct .",POSITIVE +" Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Item 3. Item 3: Legal and regulatory Proceedings .",NEGATIVE + The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends . The Board of Directors declared a quarterly cash dividend of $0. 03 billion at an average price of $330. 96 136 136. 91 . The graph and table below compare the cumulative total stockholder return of Mastercards .,NEGATIVE +" The coronavirus (COVID-19) pandemic has spread rapidly across the globe and has had significant negative effects on the global economy . The full extent to which the pandemic, and measures taken in response, affect our business, results of operations and financial condition will depend on future developments . The impact of the transactional currency represents the effect of converting revenue and expense transactions in a currency other than the functional currency .",NEGATIVE +" Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates . Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements .",NEGATIVE +" In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique . The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2020 2019 2018 (in millions, except per share data)",NEGATIVE +" PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . Management assessed the effectiveness of Mastercard Incorporated's internal control over financial reporting as of December 31, 2020 .",NEGATIVE + Item 1A. Risk factors Risk factors: Risk factors . Risk factors include a person with a history of having an adverse effect on a person's health . A person with an adverse history of being pregnant with an infantile disease may be at risk for life in the future .,NEGATIVE +" Item 1B. Unresolved staff comments . Item 1A: Unresolve staff comments. Item 1b: ""Unresolved Staff Comments. Please submit your comments to comment@mailonline.co.uk . For confidential support call the Samaritans on 08457 909090 or visit a local Samaritans branch, see www.samaritans.org .",NEGATIVE +" Item 2. Item 2: Properties . Item 3: Properties. Item 4: Property . Item 5: Property properties. Item 5. Property property properties . Item 6: Properties; Item 7: Properties: Property, Property, Building, Building . Item 8: Properties, Properties; Property, Construction, Maintenance . Item 10: Property.",POSITIVE + Item 3: Legal proceedings . Legal proceedings . Item 4: The case is brought before a judge and a judge . Item 5: The judge is entitled to a hearing on whether the case should be heard in court . Item 6: The court will hear the case for the first time in the next two weeks .,POSITIVE +" Our Class A common stock trades on the New York Stock Exchange under the symbol MA . Dividend declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs .",NEGATIVE +" No individual country, other than the United States, generated more than 10% of net revenue in any such period . GDV on a local currency basis increased 13. 8% . We repurchased 26 million shares of our common stock for $6.0 billion in 2019 versus the prior year .",NEGATIVE +" The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $144 million and $113 million on our foreign exchange derivative contracts outstanding at December 31, 2019 and 2018 . The maximum length of time over which we have hedged our exposure to the variability in future cash flows is 30 years . We are also subject to foreign exchange risk as part of our daily settlement activities .",NEGATIVE +" The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition . The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique . The realized gains and losses from the sale of available-for-sale securities for 2019 , 2018 and 2017 were not significant .",NEGATIVE +" PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2019 .",POSITIVE +" The risks described above could have a material adverse impact on our overall business and results of operations . We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity . The risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" As of December 31, Mastercard and its subsidiaries owned or leased 169 commercial properties . These facilities primarily consist of corporate and regional offices, as well as our operations centers . We believe that our facilities are suitable and adequate for the business that we currently conduct . We may acquire or lease new space to meet the needs of our business .",NEGATIVE +" Refer to Note 12 (Accrued Expenses and Accrued Litigation) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 . Item 8 refers to Part II of Item 8 of the Company's annual financial statements .",NEGATIVE +" Mastercard repurchased 4.4 million shares for $888 million at an average price of $201.20 per share . On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.25 per share of our Class A common stock and Class B common stock . Dividend declaration and payment of future dividends is at the sole discretion of the company's board of directors . The graph and table below compare the cumulative total stockholder return of Mastercards Class A . stockholders for each of the years presented were as follows .",NEGATIVE +" Net revenue increased 20% both as reported and on a currency-neutral basis, in 2018 versus 2017 . Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance . The table also does not include the $219 million accrual as of December 31, 2018 related to the contingent consideration attributable to acquisitions made in 2017 .",NEGATIVE + The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows . We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates . The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in .,NEGATIVE +" The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership . As of December 31, 2018 and 2017, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material .",NEGATIVE +" PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K . Management assessed the effectiveness of Mastercard Incorporated's internal control over financial reporting as of December 31, 2018 .",NEGATIVE +" We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer . We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices . Potential changes in existing tax laws may impact our effective tax rate and tax payments .",NEGATIVE + Not applicable. UNRESOLVED STAFF COMMENTS . ITEM 1B. Not applicable . Not applicable for any of the above issues. Unresolvement of these issues will not be resolved by the end of this article. Please submit a comment to the editor of this item.,NEGATIVE +" As of December 31, Mastercard and its subsidiaries owned or leased 167 commercial properties . Our leased properties in the United States are located in 10 states and in the District of Columbia . We also lease and own properties in 69 other countries . We believe that our facilities are suitable and adequate for the business that we currently conduct .",NEGATIVE +" Refer to Notes 10 (Accrued Expenses and Accrued Litigation) and 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 . Item 8 is Item 8 of Part II of Item 8. Item 3. Refer to Legal & Regulatory Proceedings .",NEGATIVE +" Our Class A common stock trades on the New York Stock Exchange under the symbol MA . There were approximately 307 holders of record of our non-voting Class B common stock as of February 9, 2018 . The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results and available cash .",NEGATIVE +" The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to its financial statements . Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance . Excluding the impact of Special Items, adjusted operating expenses increased 16% in 2017 versus 2016 .",NEGATIVE +" At December 31, 2017 and 2016, the cost which approximates fair value, of our short-term held-to-maturity securities was $700 million and $452 million , respectively . We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations . We had no borrowings under the Commercial Paper Program or the Credit Facility .",NEGATIVE +" The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting . The gross realized gains and losses from the sales of available-for-sale securities for 2017 , 2016 and 2015 were not significant . Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value .",NEGATIVE +" The President and Chief Executive Officer and the Chief Financial Officer reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2017 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K .",NEGATIVE diff --git a/datasets/labeled/summarization_final_labeled_data.csv b/datasets/labeled/summarization_final_labeled_data.csv new file mode 100644 index 0000000..c843533 --- /dev/null +++ b/datasets/labeled/summarization_final_labeled_data.csv @@ -0,0 +1,248 @@ +text,summary +"Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. General We operate membership warehouses and e-commerce websites based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. For our e- commerce operations we ship merchandise through our depots, our logistics operations for big and bulky items, as well as through drop-ship and other delivery arrangements with our suppliers. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"Item 2Properties Warehouse Properties At August 29, 2021, we operated 815 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 454 110 564 Canada 89 16 105 Other International 101 45 146 Total 644 171 815 _______________ (1) 121 of the 171 leases are land-only leases, where Costco owns the building. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items.","At August 29, 2021, we operated 815 membership warehouses. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million." +"Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2021 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 10June 6, 2021 102,000 $ 381.50 102,000 $ 3,338 June 7July 4, 2021 108,000 387.32 108,000 3,296 July 5August 1, 2021 63,000 412.73 63,000 3,270 August 2August 29, 2021 45,000 446.15 45,000 3,250 Total fourth quarter 318,000 $ 398.76 318,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 28, 2016, through August 29, 2021. The following graph provides information concerning average sales per warehouse over a 10 year period. Average Sales Per Warehouse* (Sales In Millions) Year Opened # of Whses 2021 20 $ 140 2020 13 $","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"SP 500 Retail Index over the five years from August 28, 2016, through August 29, 2021. The following graph provides information concerning average sales per warehouse over a 10 year period. Average Sales Per Warehouse* (Sales In Millions) Year Opened # of Whses 2021 20 $ 140 2020 13 $ 132 152 2019 20 $ 129 138 172 2018 21 $ 116 119 141 172 2017 26 $ 121 142 158 176 206 2016 29 $ 87 97 118 131 145 173 2015 23 $ 83 85 94 112 122 136 163 2014 30 $ 108 109 115 125 140 144 155 182 2013 26 $ 99 109 113 116 124 137 144 158 186 2012 Before 607 $ 155 163 169 170 169 175 188 195 205 232 Totals 815 155 160 164 162 159 163 176 182 192 217 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Fiscal Year *First year sales annualized. 2017 was a 53-week fiscal year","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to promote understanding of the results of operations and financial condition. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of operations for 2021 compared to 2020. For discussion related to the results of operations and changes in financial condition for 2020 compared to 2019 refer to Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2020 Form 10-K, which was filed with the United States Securities and Exchange Commission (SEC) on October 7, 2020. In 2021, we combined the hardlines and softlines merchandise categories into non-foods. This change did not have a material impact on the discussion of our results of operations. Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (foods and sundries, non-foods, and fresh foods), warehouse ancillary (includes gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and other businesses (includes e-commerce, business centers, travel and other). We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales-related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"for more than one year, including remodels, relocations and expansions, and sales-related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2021 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"rates as of the end of 2021 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2021, long-term debt with fixed interest rates was $7,531. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 29, 2021, would have decreased the fair value of the contracts by $149 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 29, 2021, would have decreased the fair value of the contracts by $149 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 29, 2021 and August 30, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 29, 2021 and August 30, 2020, and the results of its operations and its cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 5, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle The Company changed its method of accounting for leases as of September 2, 2019, due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not,","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not,","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"Item 2Properties Warehouse Properties At August 30, 2020, we operated 795 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 443 109 552 Canada 87 14 101 Other International 99 43 142 Total 629 166 795 _______________ (1) 119 of the 166 leases are land-only leases, where Costco owns the building. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items.","At August 30, 2020, we operated 795 membership warehouses. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million." +"Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2020 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 11June 7, 2020 $ $ 3,833 June 8July 5, 2020 94,000 301.79 94,000 3,805 July 6August 2, 2020 93,000 324.51 93,000 3,775 August 3August 30, 2020 88,000 340.17 88,000 3,745 Total fourth quarter 275,000 $ 321.73 275,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 30, 2015, through August 30, 2020.","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (food and sundries, hardlines, softlines, and fresh foods), warehouse ancillary and other businesses. We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business draws members, but it generally has a lower gross margin percentage relative to our non-gasoline business. It also has lower SGA expenses as a percent of net sales compared to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2020 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"rates as of the end of 2020 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2020, long-term debt with fixed interest rates was $7,657. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 30, 2020, would have decreased the fair value of the contracts by $111 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 30, 2020, would have decreased the fair value of the contracts by $111 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 30, 2020 and September 1, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 30, 2020 and September 1, 2019, and the results of its operations and its cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 6, 2020 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases as of September 2, 2019 due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"of September 2, 2019 due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash, checks, and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash, checks, and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"Item 2Properties Warehouse Properties At September 1, 2019 , we operated 782 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France China Total _______________ (1) 114 of the 162 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2019 : United States Canada Other International Total Total Warehouses in Operation 2015 and prior 2016 2017 2018 2019 2020 (expected through 12/31/2019) Total At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Additionally, we operate various fulfillment, processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations.","At September 1, 2019 , we operated 782 membership warehouses. At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations." +"Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2019 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 13June 9, 2019 39,000 $ 246.12 39,000 $ 3,985 June 10July 7, 2019 36,000 263.30 36,000 3,976 July 8August 4, 2019 54,000 278.15 54,000 3,961 August 5September 1, 2019 65,000 275.37 65,000 3,943 Total fourth quarter 194,000 $ 268.08 194,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. This authorization revoked previously authorized but unused amounts, totaling $2,237 . Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 31, 2014 , through September 1, 2019 .","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record." +"Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); changes in the cost of gasoline and associated competitive conditions; and changes from the revenue recognition standard. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private-label items, and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2019 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"as of the end of 2019 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 1, 2019 , would have decreased the fair value of the contracts by $79 and resulted in an unrealized loss in the consolidated statements of income for the same amount.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 1, 2019 , would have decreased the fair value of the contracts by $79 and resulted in an unrealized loss in the consolidated statements of income for the same amount.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 1, 2019 and September 2, 2018 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 1, 2019 and September 2, 2018 , and the results of its operations and its cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 10, 2019 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018 , and August 28, 2016 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 145,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"Item 2Properties Warehouse Properties At September 2, 2018 , we operated 762 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea (2) Taiwan Australia Spain Iceland France Total _______________ (1) 106 of the 157 leases are land-only leases, where Costco owns the building. (2) In fiscal 2018, Costco purchased the remaining equity interest and three formerly leased locations from its former joint-venture partner in Korea. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2018 : United States Canada Other International Total Total Warehouses in Operation 2014 and prior 2015 2016 2017 2018 2019 (expected through 12/31/2018) Total At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations.","At September 2, 2018 , we operated 762 membership warehouses. At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations." +"Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2018: Fourth Quarter $ 233.13 $ 195.48 $ 0.570 Third Quarter 197.16 180.84 0.570 Second Quarter 198.91 172.61 0.500 First Quarter 173.42 154.61 0.500 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2018 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 14June 10, 2018 96,000 $ 198.61 96,000 $ 2,497 June 11July 8, 2018 134,000 208.49 134,000 2,469 July 9August 5, 2018 111,000 216.06 111,000 2,445 August 6September 2, 2018 78,000 225.20 78,000 2,427 Total fourth quarter 419,000 $ 211.35 419,000 _______________","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"that May Yet be Purchased under the Program May 14June 10, 2018 96,000 $ 198.61 96,000 $ 2,497 June 11July 8, 2018 134,000 208.49 134,000 2,469 July 9August 5, 2018 111,000 216.06 111,000 2,445 August 6September 2, 2018 78,000 225.20 78,000 2,427 Total fourth quarter 419,000 $ 211.35 419,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation plus dividends) on our common stock for the last five years with the cumulative total return of the SP 500 Index, the SP 500 Retail Index, and a peer group previously selected by the Company. The SP 500 Retail Index is intended to replace the previously selected peer group to allow for a more broad representation of industry performance. The transition to a larger retail index provides a better representation of total retail market performance. For the year ended September 2, 2018 , the cumulative total return of the previous peer group is provided pursuant to SEC rules requiring presentation in the year of change, and consists of: Amazon.com Inc.; The Home Depot Inc.; Lowe's Companies; Best Buy Co., Inc.; Staples Inc.; Target Corporation; Kroger Company; and Walmart Stores, Inc. This group will not be presented in future periods. The information provided is from September 1, 2013 , through September 2, 2018 . The graph assumes the investment of $100 in Costco common stock, the SP 500 Index, the SP 500 Retail Index, and the previously selected peer group on September 1, 2013, and reinvestment of all dividends.","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"common stock, the SP 500 Index, the SP 500 Retail Index, and the previously selected peer group on September 1, 2013, and reinvestment of all dividends.","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable warehouse sales (comparable sales) growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items, and through our online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2018 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"end of 2018 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2018 , long-term debt with fixed interest rates was $6,577 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 2, 2018 , would have decreased the fair value of the contracts by $80 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 2, 2018 , would have decreased the fair value of the contracts by $80 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 2, 2018 and September 3, 2017 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 2, 2018 and September 3, 2017 , and the results of its operations and its cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 25, 2018 expressed an adverse opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 25, 2018 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of September 2, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"Corporation and subsidiaries (the Company) internal control over financial reporting as of September 2, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen, four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . References to 2016 and 2015 relate to the 52-week fiscal years ended August 28, 2016 , and August 30, 2015 , respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts when available. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to individual warehouses. This process creates freight volume and handling efficiencies, eliminating many costs associated with traditional multiple-step distribution channels. Item 1Business (Continued) Our average warehouse space is approximately 145,000 square feet, with newer units slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits of our warehouses and using a membership format, we have inventory losses (shrinkage) well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products to"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products to retain our existing member base and attract new members. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and regional depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations, and increase the cost of sites and of constructing, leasing and operating our warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us, within their jurisdictions. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"Item 2Properties Warehouse Properties At September 3, 2017 we operated 741 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France Total _______________ (1) 102 of the 154 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2017 : United States Canada Other International Total Total Warehouses in Operation 2013 and prior 2014 2015 2016 2017 2018 (expected through 12/31/2017) Total At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate depots for the consolidation and distribution of most merchandise shipments to the warehouses, and various processing, packaging, and other facilities to support ancillary and other businesses, including our online business. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations.","At September 3, 2017 we operated 741 membership warehouses. At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. " +"Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 2016: Fourth Quarter 169.04 141.29 0.450 Third Quarter 158.25 146.44 0.450 Second Quarter 168.87 143.28 0.400 First Quarter 163.10 138.30 0.400 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2017 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 8June 4, 2017 92,000 $171.87 92,000 $2,973 June 5July 2, 2017 573,000 162.00 573,000 $2,881 July 3July 30, 2017 451,000 155.06 451,000 $2,811 July 31September 3, 2017 396,000 156.95 396,000 $2,749 Total fourth quarter 1,512,000 $159.21 1,512,000 _______________ (1) The repurchase program is conducted","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"be Purchased under the Program May 8June 4, 2017 92,000 $171.87 92,000 $2,973 June 5July 2, 2017 573,000 162.00 573,000 $2,881 July 3July 30, 2017 451,000 155.06 451,000 $2,811 July 31September 3, 2017 396,000 156.95 396,000 $2,749 Total fourth quarter 1,512,000 $159.21 1,512,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019.","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) OVERVIEW We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items. Our philosophy is to provide our members with quality goods and services at the most competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We operate our lower-margin gasoline business in all countries except Korea and France. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure,","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"percentage of net sales. A decline in gasoline prices has the inverse effect. We operate our lower-margin gasoline business in all countries except Korea and France. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure,","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities, and asset and mortgage-backed securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2017 would have an incremental change in fair market value of $20. For those investments that are classified as available-for-sale, the unrealized gains or Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) (Continued) losses related to fluctuations in market","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." +"in interest rates as of the end of 2017 would have an incremental change in fair market value of $20. For those investments that are classified as available-for-sale, the unrealized gains or Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) (Continued) losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features. We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships. There can be no assurance that this practice is effective. These contracts are limited to","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." +engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features. We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships. There can be no assurance that this practice is effective. These contracts are limited to,"Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." +"ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of biopharmaceutical products. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . Our purpose fuels everything we do and reflects both our passion for science and our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the digital race in pharma ; and 5. Lead the conversation . In addition, Pfizer continues to enhance its ESG strategy, which is focused on six areas where we see opportunities to create a meaningful impact over the next decade: product innovation; equitable access and pricing; product quality and safety; diversity, equity and inclusion; climate change; and business ethics. We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities in 2021 include, among others: (i) the July 2021 global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader (the estrogen receptor is a well-known disease driver in most breast cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is Pfizer Inc. 2021 Form 10-K not meant to be a complete discussion of all potential risks or uncertainties. Additionally, our business is subject to general risks applicable to any company, such as economic conditions, geopolitical events, extreme weather and natural disasters. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. The negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and value-based pricing/contracting to improve their cost containment efforts. Such payers are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Also, business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence.","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence.","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"ITEM 2. PROPERTIES We own and lease space globally for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2021, we had 327 owned and leased properties, amounting to approximately 41 million square feet. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in the second half of 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2021, PGS had responsibility for 39 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment.","At August 29, 2021, we operated 815 membership warehouses. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million." +"ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 22, 2022, there were 133,758 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2021 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) October 4 through October 31, 2021 8,817 $ 44.74 $ 5,292,881,709 November 1 through November 30, 2021 4,687 $ 44.71 $ 5,292,881,709 December 1 through December 31, 2021 33,186 $ 55.35 $ 5,292,881,709 Total 46,690 $ 52.27 (a) See Note 12 . (b) Represents (i) 44,604 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 2,086 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. Pfizer Inc. 2021 Form 10-K PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche Holding AG and Sanofi SA. Five Year Performance 2016 2017","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche Holding AG and Sanofi SA. Five Year Performance 2016 2017 2018 2019 2020 2021 PFIZER $100.0 $115.8 $144.5 $134.5 $139.1 $232.0 PEER GROUP $100.0 $117.3 $126.7 $154.0 $160.4 $186.9 SP 500 $100.0 $121.8 $116.5 $153.1 $181.3 $233.3","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2021 Total Revenues$81.3 billion 2021 Net Cash Flow from Operations$32.6 billion An increase of 95% compared to 2020 An increase of 126% compared to 2020 2021 Reported Diluted EPS$3.85 2021 Adjusted Diluted EPS (Non-GAAP)$4.42* An increase of 137% compared to 2020 An increase of 96% compared to 2020 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our former Upjohn Business in the fourth quarter of 2020, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines and beginning in the fourth quarter of 2020 operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments: Biopharma and","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments: Biopharma and PC1. Biopharma is the only reportable segment. On December 31, 2021, we completed the sale of our Meridian subsidiary, and beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 75% has been incurred since inception and through December 31, 2021. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base and support model align appropriately with our new operating structure. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. We are taking steps to restructure our corporate enabling functions to appropriately support our business, RD and PGS platform functions. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA . RD: We","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"to appropriately support our business, RD and PGS platform functions. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA . RD: We","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Pfizer Inc. 2021 Form 10-K","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2022 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1C to the consolidated financial statements, the Company has elected to change its method of accounting for pension and postretirement plans in 2021 to immediately recognize actuarial gains and losses in the consolidated statements of income. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"immediately recognize actuarial gains and losses in the consolidated statements of income. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of our products, principally biopharmaceutical products, and to a lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people; 2. Deliver first-in-class science; 3. Transform our go-to-market model; 4. Win the digital race in pharma; and 5. Lead the conversation. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. Following (i) the recent spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan, which created a new global pharmaceutical company, Viatris, in November 2020 and (ii) the formation of the Consumer Healthcare JV in 2019, we saw the culmination of Pfizers transformation into a more focused, innovative science-based biopharmaceutical products business. Our significant recent business development activities in 2020 include: (i) the April 2020 agreement with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody,","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody,","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is not meant to be a complete discussion of all potential risks or uncertainties. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. Negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"ITEM 2. PROPERTIES We own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2020, we had 363 owned and leased properties, amounting to approximately 43 million square feet. In 2020, we reduced the number of properties in our portfolio by 90 sites and 4 million square feet, primarily due to the spin-off and combination of the Upjohn Business with Mylan to form Viatris. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2020, PGS had responsibility for 43 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit five of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See","At August 30, 2020, we operated 795 membership warehouses. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million." +"exit five of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment.","At August 30, 2020, we operated 795 membership warehouses. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million." +"ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 23, 2021, there were 139,582 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2020 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) September 28 through October 25, 2020 26,921 $ 36.99 $ 5,292,881,709 October 26 through November 30, 2020 84,279 $ 37.48 $ 5,292,881,709 December 1 through December 31, 2020 69,317 $ 37.39 $ 5,292,881,709 Total 180,517 $ 37.37 Pfizer Inc. 2020 Form 10-K (a) See Note 12 . (b) Represents (i) 174,555 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,962 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2015, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche and Sanofi. Five Year Performance 2015 2016 2017 2018 2019","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche and Sanofi. Five Year Performance 2015 2016 2017 2018 2019 2020 PFIZER $100.0 $104.5 $120.9 $151.0 $140.5 $145.4 PEER GROUP $100.0 $100.8 $118.1 $127.8 $155.3 $161.7 SP 500 $100.0 $112.0 $136.4 $130.4 $171.4 $203.0 Pfizer Inc. 2020 Form 10-K","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2020 Total Revenues$41.9 billion 2020 Net Cash Flow from Operations$14.4 billion An increase of 2% compared to 2019 An increase of 14% compared to 2019 2020 Reported Diluted EPS$1.71 2020 Adjusted Diluted EPS (Non-GAAP)$2.22* A decrease of 40% compared to 2019 An increase of 16% compared to 2019 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. Pfizer Inc. 2020 Form 10-K References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off and combination of our Upjohn Business with Mylan in November 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We now operate as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. Prior-period information has been","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 70% has been incurred since inception and through December 31, 2020. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base aligns appropriately with our revenue base. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. In addition, we are taking steps to restructure our corporate enabling functions to appropriately support and drive the purpose of our focused innovative biopharmaceutical products business and RD and PGS platform functions. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA. RD: We believe we have a strong pipeline and are well-positioned for future growth. RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new products, our RD efforts seek to add value to our existing","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new products, our RD efforts seek to add value to our existing","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Pfizer Inc. 2020 Form 10-K","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"Item 1. BusinessAbout Pfizer section in this 2019 Form 10-K. ** As of January 28, 2020 Pfizer Inc. 2019 Form 10-K iv PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture and distribution of healthcare products, including innovative medicines and vaccines. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us . The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our Companys purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. With the formation of the GSK Consumer Healthcare joint venture and the pending combination of Upjohn with Mylan, which are further discussed below, Pfizer is transforming itself into a more focused, global leader in science-based innovative medicines. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: License Agreement with Akcea Therapeutics, Inc. In October 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a majority-owned affiliate of Ionis. The transaction closed in November 2019 and we made an upfront payment of $250 million to Akcea and Ionis. Formation of a New Consumer Healthcare Joint Venture On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"2019 and we made an upfront payment of $250 million to Akcea and Ionis. Formation of a New Consumer Healthcare Joint Venture On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2019 Form 10-K and in our 2019 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, revenue contribution, growth, performance, timing of exclusivity and potential benefits, strategic reviews, capital allocation objectives, plans for and prospects of our acquisitions and other business-development activities, benefits anticipated from the reorganization of our commercial operations in 2019, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, government regulation, our ability to successfully capitalize on growth opportunities or prospects, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, including, among others, the expected timing, benefits, charges and/or costs in connection with our agreement to combine Upjohn with Mylan to create a new global pharmaceutical company, Viatris, set forth in the Item 1. BusinessAbout Pfizer and Item 1A. Risk","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"dividends. In particular, these include statements relating to future actions, including, among others, the expected timing, benefits, charges and/or costs in connection with our agreement to combine Upjohn with Mylan to create a new global pharmaceutical company, Viatris, set forth in the Item 1. BusinessAbout Pfizer and Item 1A. Risk FactorsPending Combination of Upjohn with Mylan sections in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Business Development Initiatives and Our Strategy sections and the Notes to Consolidated Financial StatementsNote 1A. Basis of Presentation and Significant Accounting PoliciesBasis of Presentation in our 2019 Financial Report; the expected impact of patent expiries on our business set forth in the Item 1. BusinessPatents and Other Intellectual Property Rights section in this 2019 Form 10-K and in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Operating EnvironmentIndustry-Specific ChallengesIntellectual Property Rights and Collaboration/Licensing Rights section in our 2019 Financial Report; the expected competition from certain generic manufacturers in China in the Item 1. BusinessCompetitionGeneric Products and Item 1A. Risk FactorsGeneric Competition sections in this 2019 Form 10-K; the anticipated costs related to our preparations for Brexit set forth in the Item 1. BusinessGovernment Regulation and Price ConstraintsOutside the United StatesBrexit section in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment section in our 2019 Financial Report; the availability of raw materials for 2020 set forth in Item 1. Business Raw Materials in this 2019 Form 10-K; the expected pricing pressures on our products in the U.S. and internationally and the anticipated impact to our business set forth in the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this 2019 Form 10-K; the anticipated impact of climate","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +10-K; the expected pricing pressures on our products in the U.S. and internationally and the anticipated impact to our business set forth in the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this 2019 Form 10-K; the anticipated impact of climate,"Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"ITEM 2. PROPERTIES As of December 31, 2019 , we had 453 owned and leased properties, amounting to approximately 47 million square feet. In 2019, we reduced the number of properties in our portfolio by 45 sites and 6 million square feet, which reflects the divestment of properties in connection with the formation of the GSK Consumer Healthcare joint venture and the addition of properties in connection with the acquisition of Array. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to approximately 90 countries. In April 2018, we entered an agreement to lease space at the Spiral, an office building in the Hudson Yards neighborhood of New York City. We will relocate our global headquarters to this property with occupancy expected beginning in 2022. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2019, we operationalized the new RD facilities in St. Louis, Missouri and Andover, Massachusetts. We also purchased an RD property in Durham, North Carolina in 2019 and expect to renovate and fit out the space over the next several years. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As","At September 1, 2019 , we operated 782 membership warehouses. At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations." +"We also purchased an RD property in Durham, North Carolina in 2019 and expect to renovate and fit out the space over the next several years. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2019 , PGS had responsibility for 42 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of two of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In 2019, seven manufacturing plants transferred from PGSs responsibility to Upjohns responsibility, and an additional two plants are expected to be fully migrated from PGSs responsibility to Upjohns responsibility over the next several years. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9 . Property, Plant and Equipment in our 2019 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference.","At September 1, 2019 , we operated 782 membership warehouses. At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations." +"ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 25, 2020 , there were 142,524 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Selected Quarterly Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2019 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2019 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) September 30, 2019 through October 27, 2019 32,848 $ 36.06 $ 5,292,881,709 October 28, 2019 through November 30, 2019 13,399 $ 37.50 $ 5,292,881,709 December 1, 2019 through December 31, 2019 67,767 $ 38.86 $ 5,292,881,709 Total 114,014 $ 37.89 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12 . Equity in our 2019 Financial Report, which is incorporated by reference. (b) These columns represent (i) 108,367 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,647 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards. Pfizer Inc. 2019 Form 10-K","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record." +ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2019 Financial Report.,"We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial Risk Management The objective of our financial risk management program is to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings. We manage these financial exposures through operational means and through the use of third-party instruments. These practices may change as economic conditions change. Foreign Exchange Risk We operate globally and, as such, we are subject to foreign exchange risk in our commercial operations, as well as in our financial assets (investments) and liabilities (borrowings). Our net investments in foreign subsidiaries are also subject to currency risk. On the commercial side, a significant portion of our revenues and earnings is exposed to changes in foreign exchange rates. See the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report for the key currencies in which we operate. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenues in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Where foreign exchange risk cannot be mitigated via operational means, we may use foreign currency forward-exchange contracts and/or foreign currency swaps to manage that risk. With respect to our financial assets and liabilities, our primary foreign exchange exposure arises predominantly from short-term and long-term intercompany receivables and payables, and, to a lesser extent, from short-term and long-term investments and debt, where the assets and/or liabilities are denominated in currencies other than the functional currency of the business entity. We also hedge some forecasted intercompany sales denominated in euro, Japanese yen, Chinese renminbi, U.K. pound, Canadian dollar, and Australian dollar to protect against longer-term movements. In addition, under certain market conditions, we may seek to protect against possible declines","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"currencies other than the functional currency of the business entity. We also hedge some forecasted intercompany sales denominated in euro, Japanese yen, Chinese renminbi, U.K. pound, Canadian dollar, and Australian dollar to protect against longer-term movements. In addition, under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. In these cases, we may use foreign currency swaps, foreign currency forward-exchange contracts and/or foreign currency debt. For details about these and other financial instruments, including fair valuation methodologies, see the Notes to Consolidated Financial Statements Note 7A. Financial Instruments : Fair Value Measurements in our 2019 Financial Report. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this sensitivity analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2019 , the expected adverse impact on our net income would not be significant. Interest Rate Risk We are subject to interest rate risk on our investments and on our borrowings. We manage interest rate risk in the aggregate, while focusing on Pfizers immediate and intermediate liquidity needs. With respect to our investments, we strive to maintain a predominantly floating-rate basis position, but our strategy may change based on prevailing market conditions. Our floating-rate assets are subject to the risk that short-term interest rates may fall and, as a result, the investments would generate less interest income. Fixed-rate investments provide a known amount of interest income regardless of a change in interest rates. We sometimes use interest","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"based on prevailing market conditions. Our floating-rate assets are subject to the risk that short-term interest rates may fall and, as a result, the investments would generate less interest income. Fixed-rate investments provide a known amount of interest income regardless of a change in interest rates. We sometimes use interest","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm in our 2019 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2019 Financial Report.","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: On February 3, 2017, we completed the sale of our global infusion systems net assets, HIS, to ICU Medical for up to approximately $900 million , composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS, which was acquired as part of the Hospira acquisition in September 2015, includes IV pumps, solutions and devices. On December 22, 2016, for $1,045 million we acquired the development and commercialization rights to AstraZenecas small molecule anti-infectives business, primarily outside the U.S., which includes the newly approved EU drug Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ( $13.9 billion , net of cash acquired). Medivation is a biopharmaceutical company focused on developing and","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ( $13.9 billion , net of cash acquired). Medivation is a biopharmaceutical company focused on developing and","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2017 Form 10-K and in our 2017 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, approvals, performance, timing of exclusivity and potential benefits of Pfizers products and product candidates, strategic reviews, capital allocation, business-development plans, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions and other business development activities, the disposition of the HIS net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the availability of raw materials for 2018 set forth in Item 1. BusinessRaw Materials in this 2017 Form 10-K; the expected impact of the recent hurricanes in Puerto Rico set forth","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the availability of raw materials for 2018 set forth in Item 1. BusinessRaw Materials in this 2017 Form 10-K; the expected impact of the recent hurricanes in Puerto Rico set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessImpact of Recent Hurricanes in Puerto Rico section in our 2017 Financial Report; the anticipated progress in remediation efforts at certain of our Hospira manufacturing facilities set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessProduct Manufacturing section in our 2017 Financial Report; the anticipated timeframe for any decision regarding strategic alternatives for Pfizer Consumer Healthcare set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyOur Business Development Initiatives section in our 2017 Financial Report; our anticipated liquidity position set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment and the Analysis of Financial Condition, Liquidity and Capital Resources sections in the 2017 Financial Report; the financial impact of the recently passed Tax Cuts and Jobs Act set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment, Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsIncome Tax Assets and Liabilities, Provision/(Benefit) for Taxes on IncomeChanges in Tax Laws and Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations sections in our 2017 Financial Report and in Notes to Consolidated Financial StatementsNote 1. Basis of Presentation and Significant Accounting Policies and Note 5. Tax Matters; plans relating to increasing investment in the U.S. following the expected positive net impact of the Tax Cuts and Jobs Act set forth in the Overview of","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +2017 Financial Report and in Notes to Consolidated Financial StatementsNote 1. Basis of Presentation and Significant Accounting Policies and Note 5. Tax Matters; plans relating to increasing investment in the U.S. following the expected positive net impact of the Tax Cuts and Jobs Act set forth in the Overview of,"Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"ITEM 2. PROPERTIES In 2017 , we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2017 , we had 501 owned and leased properties, amounting to approximately 53 million square feet. In 2017 , we reduced the number of properties in our portfolio by 66 sites and 4.2 million square feet, which includes the divestment of properties in connection with the sale of the HIS net assets to ICU Medical, the disposal of surplus real property assets and the reduction of operating space in all regions. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2018 , we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2018 , we continue to advance construction of new RD facilities in St. Louis, Missouri and Andover, Massachusetts. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2017 , PGS had responsibility for 58 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions","At September 2, 2018 , we operated 762 membership warehouses. At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations." +"York and in Peapack, New Jersey. As of December 31, 2017 , PGS had responsibility for 58 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2017 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2017 Financial Report, which is also incorporated by reference.","At September 2, 2018 , we operated 762 membership warehouses. At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations." +"ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 20, 2018 , there were 158,190 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2017 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2017 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 2, 2017 through October 29, 2017 31,838 $ 35.61 $ 6,355,862,076 October 30, 2017 through November 30, 2017 17,257 $ 35.11 $ 6,355,862,076 December 1, 2017 through December 31, 2017 15,332 $ 36.09 $ 16,355,862,076 Total 64,427 $ 35.59 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12. Equity in our 2017 Financial Report, which is incorporated by reference. (b) These columns reflect (i) 59,102 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs; and (ii) the open market purchase by the trustee of 5,325 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards.","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2017 Financial Report.,"We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2017 Financial Report.,"Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2017 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2017 Financial Report.","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"ITEM 1. BUSINESS GENERAL Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. On February 3, 2017, we completed the sale of our global infusion therapy net assets, HIS, to ICU Medical for up to approximately $900 million, composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS includes IV pumps, solutions and devices. Under the terms of the agreement, we received 3.2 million newly issued shares of ICU Medical common stock, which we valued at approximately $430 million (based upon the closing price of ICU Medical common stock on the closing date less a discount for lack of marketability), a promissory note from ICU Medical in the amount of $75 million and net cash of approximately $200 million before customary adjustments for net working capital. In addition, we are entitled to receive a contingent amount of up to an additional $225 million in cash based on ICU Medicals achievement of certain cumulative performance targets for","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"in the amount of $75 million and net cash of approximately $200 million before customary adjustments for net working capital. In addition, we are entitled to receive a contingent amount of up to an additional $225 million in cash based on ICU Medicals achievement of certain cumulative performance targets for","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2016 Form 10-K and in our 2016 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, target, forecast, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated future operating and financial performance, business plans and prospects, in-line products and product candidates, strategic reviews, capital allocation, business-development plans, and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business, the disposition of the Hospira Infusion Systems net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 section in our 2016 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"particular, the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 section in our 2016 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section in our 2016 Financial Report and in the Notes to Consolidated Financial StatementsNote 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section in our 2016 Financial Report; and the contributions that we expect to make from our general assets to the Companys pension and postretirement plans during 2017 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section and in the Notes to Consolidated Financial StatementsNote 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2016 Financial Report. We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"ITEM 2. PROPERTIES In 2016, we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2016, we had 567 owned and leased properties, amounting to approximately 57 million square feet. In 2016, we reduced the number of properties in our portfolio by 28 sites and 2.3 million square feet with the disposal of surplus real property assets and with reductions of operating space in all regions. These reductions include partial offsets due to acquisitions of Anacor, Bamboo Therapeutics Inc., substantially all of the assets of BIND Therapeutics, Inc. and Medivation. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizer Inc. 2016 Form 10-K Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2017, we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. In addition, we plan continued execution on consolidating properties related to Hospira and other acquired companies. We also plan to further expand our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2017, we will continue to consolidate our RD operations in Cambridge, Massachusetts into the Kendall Square neighborhood, and continue to advance our operations in St. Louis, Missouri and Andover, Massachusetts. Our Pfizer Global Supply (PGS) division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31,","At September 3, 2017 we operated 741 membership warehouses. At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. " +"Cambridge, Massachusetts into the Kendall Square neighborhood, and continue to advance our operations in St. Louis, Missouri and Andover, Massachusetts. Our Pfizer Global Supply (PGS) division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2016, PGS operated 63 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of eight of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2016 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2016 Financial Report, which is also incorporated by reference.","At September 3, 2017 we operated 741 membership warehouses. At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. " +"ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. The stock currently trades on the NYSE under the symbol PFE. As of February 21, 2017 , there were 166,694 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2016 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2016 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 3, 2016 through October 30, 2016 33,946 $ 33.64 $ 11,355,862,076 October 31, 2016 through November 30, 2016 14,578 $ 31.57 $ 11,355,862,076 December 1, 2016 through December 31, 2016 25,816 $ 32.28 $ 11,355,862,076 Total 74,340 $ 32.76 (a) On October 23, 2014, we announced that the Board of Directors had authorized an $11 billion share-purchase plan (the October 2014 Stock Purchase Plan), and share purchases commenced thereunder in January 2015. In December 2015, the Board of Directors authorized a new $11 billion share repurchase program to be utilized over time. On March 8, 2016, we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. (GSCo.) to repurchase $5 billion of our common stock. Pursuant to the terms of the agreement, on March 10, 2016, we paid $5 billion to GSCo. and received an initial delivery of approximately 136 million shares of our","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. (GSCo.) to repurchase $5 billion of our common stock. Pursuant to the terms of the agreement, on March 10, 2016, we paid $5 billion to GSCo. and received an initial delivery of approximately 136 million shares of our common stock from GSCo. based on a price of $29.36 per share, which represented, based on the closing share price of our common stock on the NYSE on March 8, 2016, approximately 80% of the notional amount of the accelerated share repurchase agreement. On June 20, 2016, the accelerated share repurchase agreement with GSCo. was completed, which, per the terms of the agreement, resulted in GSCo. owing us a certain number of shares of Pfizer common stock. Pursuant to the agreements settlement terms, we received an additional 18 million shares of our common stock from GSCo. on June 20, 2016. The average price paid for all of the shares delivered under the accelerated share repurchase agreement was $32.38 per share. The common stock received is included in Treasury stock . This agreement was entered into pursuant to our previously announced share repurchase authorization. At December 31, 2016, our remaining share-purchase authorization was approximately $11.4 billion at December 31, 2016 . (b) These columns reflect the following transactions during the fourth fiscal quarter of 2016 : (i) the surrender to Pfizer of 70,024 shares of common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock units issued to employees; (ii) the surrender to Pfizer of 2,105 shares of common stock to satisfy tax withholding obligations in connection with the vesting of performance share awards issued to employees; (iii) the surrender to Pfizer of 1,669 shares of common stock to pay the exercise price and to satisfy","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"issued to employees; (ii) the surrender to Pfizer of 2,105 shares of common stock to satisfy tax withholding obligations in connection with the vesting of performance share awards issued to employees; (iii) the surrender to Pfizer of 1,669 shares of common stock to pay the exercise price and to satisfy","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2016 Financial Report. Pfizer Inc. 2016 Form 10-K,"We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2016 Financial Report.,"Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." +"Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. We build technology that helps people connect, find communities, and grow businesses. Our useful and engaging products enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality (VR) headsets, wearables, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products. Meta is moving beyond 2D screens toward immersive experiences like augmented and virtual reality to help build the metaverse, which we believe is the next evolution in social technology. We report financial results for two segments: Family of Apps (FoA) and Reality Labs (RL). For FoA, we generate substantially all of our revenue from selling advertising placements to marketers. Ads on our platforms enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. RL generates revenue from sales of consumer hardware products, software and content. Our products include: Family of Apps Facebook. Facebook helps give people the power to build community and bring the world closer together. It's a place for people to share life's moments and discuss what's happening, nurture and build relationships, discover and connect to interests, and create economic opportunity. They can do this through News Feed, Stories,","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Facebook. Facebook helps give people the power to build community and bring the world closer together. It's a place for people to share life's moments and discuss what's happening, nurture and build relationships, discover and connect to interests, and create economic opportunity. They can do this through News Feed, Stories, Groups, Watch, Marketplace, Reels, Dating, and more. Instagram. Instagram brings people closer to the people and things they love. Instagram Feed, Stories, Reels, Video, Live, Shops, and messaging are places where people and creators can express themselves and push culture forward through photos, video, and private messaging, and connect with and shop from their favorite businesses. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, audio and video calls, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Reality Labs Reality Labs. Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Meta Quest lets people defy distance with cutting-edge VR hardware, software, and content. Facebook Portal video calling devices help friends and families stay connected and share the moments that matter in meaningful ways. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection, sharing, discovery, and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission (FTC); Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our,"Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products." +"Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2021, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 69 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Europe, the Middle East, Africa, Asia Pacific, and Latin America. We also own 18 data centers globally. We believe that our facilities are adequate for our current needs.","At August 29, 2021, we operated 815 membership warehouses. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million." +"Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. We expect our Class A common stock to cease trading under the symbol ""FB"" and begin trading under the new symbol, ""META,"" on the Nasdaq Global Select Market in the first half of 2022. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2021, there were 3,258 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $336.35 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2021, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2021: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2021: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2021 21,703 $ 326.20 21,703 $ 50,893 November 1 - 30, 2021 21,606 $ 335.09 21,606 $ 43,653 December 1 - 31, 2021 14,728 $ 329.97 14,728 $ 38,793 58,037 58,037 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Meta Platforms, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Meta Platforms, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record." +"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States (GAAP), we present revenue on a constant currency basis and free cash flow, which are non-GAAP financial measures. Revenue on a constant currency basis is presented in the section entitled "" Revenue Foreign Exchange Impact on Revenue."" To calculate revenue on a constant currency basis, we translated revenue for the full year 2021 using 2020 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. For a full description of our free cash flow non-GAAP measure, see the section entitled "" Liquidity and Capital ResourcesFree Cash Flow."" These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"cash flow non-GAAP measure, see the section entitled "" Liquidity and Capital ResourcesFree Cash Flow."" These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from nonGAAP financial measures used by other companies, limiting their usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe these non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable comparison of financial results between periods where certain items may vary independent of business performance, and allow for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2021 Results Our key community metrics and financial results for 2021 are as follows: Family of Apps metrics: Family daily active people (DAP) was 2.82 billion on average for December 2021, an increase of 8% year-over-year. Family monthly active people (MAP) was 3.59 billion as of December 31, 2021, an increase of 9% year-over-year. Facebook daily active users (DAUs) were 1.93 billion on average for December 2021, an increase of 5% year-over-year. Facebook monthly active users (MAUs) were 2.91 billion as of December 31, 2021, an increase of 4% year-over-year. Ad impressions delivered across our Family of Apps increased by 10% year-over-year in 2021, and the average price per ad increased by 24% year-over-year in 2021. Consolidated and segment results: Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"across our Family of Apps increased by 10% year-over-year in 2021, and the average price per ad increased by 24% year-over-year in 2021. Consolidated and segment results: Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality","In 2021, we combined the hardlines and softlines merchandise categories into non-foods. We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020. Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021. Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership. Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020. We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels." +"Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and equity investment risk. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $140 million, $129 million, and $105 million were recognized in 2021, 2020, and 2019, respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $714 million and $794 million in the market value of our available-for-sale debt securities as of December 31, 2021 and December 31, 2020, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial,"Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2021, long-term debt with fixed interest rates was $7,531." +"Item 8. Financial Statements and Supplementary Data META PLATFORMS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm (PCAOB ID No. 42 ) Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Meta Platforms, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Meta Platforms, Inc. (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not,","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"(1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not,","The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively." +"Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook and build community, including Facebook News Feed, Stories, Groups, Shops, Marketplace, News, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, and connect with and shop from their favorite businesses and creators. They can do this through Instagram Feed, Stories, Reels, IGTV, Live, Shops, and messaging. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, video, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Facebook Reality Labs. Facebook Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Oculus Quest lets people defy distance with cutting-edge virtual reality (VR) hardware, software, and content, while Portal helps friends and families stay connected and share the","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"communicate and transact in a private way. Facebook Reality Labs. Facebook Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Oculus Quest lets people defy distance with cutting-edge virtual reality (VR) hardware, software, and content, while Portal helps friends and families stay connected and share the moments that matter in meaningful ways. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Google, Apple, YouTube, Tencent, Snap, Twitter, ByteDance, Microsoft, and Amazon. We compete to attract, engage, and retain people who use our products, to attract and retain businesses who use our free or paid business and advertising services, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST" +"Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission; Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding,"Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand." +"Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2020, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Latin America, Europe, the Middle East, Africa, and Asia Pacific. We also own 17 data centers globally. We believe that our facilities are adequate for our current needs.","At August 30, 2020, we operated 795 membership warehouses. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million." +"Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2020, there were 3,471 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $273.16 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2020, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2020: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2020 2,310 $ 270.12 2,310 $","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2020 2,310 $ 270.12 2,310 $ 9,921 November 1 - 30, 2020 2,100 $ 276.32 2,100 $ 9,341 December 1 - 31, 2020 2,670 $ 276.38 2,670 $ 8,603 7,080 7,080 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In January 2021, an additional $25 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record." +"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2020 using 2019 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2020 Results Our key community metrics and financial results for 2020 are as follows: Community growth: Facebook daily active users (DAUs) were 1.84 billion on average for December 2020, an increase of 11% year-over-year. Facebook monthly active users (MAUs) were 2.80 billion as of December 31, 2020, an increase of 12% year-over-year. Family daily active people (DAP) was 2.60 billion on average for December 2020, an increase of 15% year-over-year. Family monthly active people (MAP) was 3.30 billion as of December 31, 2020, an increase of 14% year-over-year. Financial results: Revenue was $85.97 billion, up 22% year-over-year, and advertising revenue was $84.17 billion, up 21% year-over-year. Total costs and expenses were $53.29 billion. Income from operations was $32.67 billion and operating margin was 38%. Net income was $29.15 billion with diluted earnings per share of $10.09. Capital expenditures, including principal payments on finance leases, were $15.72 billion. Effective tax rate was 12.2%. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020. Headcount was 58,604 as of December 31, 2020, an increase of 30% year-over-year. Our mission is to give people the power to build community and bring the world closer","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"billion. Effective tax rate was 12.2%. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020. Headcount was 58,604 as of December 31, 2020, an increase of 30% year-over-year. Our mission is to give people the power to build community and bring the world closer","We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019. Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses. Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019. In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico." +"Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, equity investment risk, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $129 million, $105 million, and $213 million were recognized in 2020, 2019, and 2018, respectively, as interest and other income (expense), net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $794 million and $525 million in the market value of our available-for-sale debt securities as of December 31, 2020 and December 31, 2019, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2020, long-term debt with fixed interest rates was $7,657." +"Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 27, 2021 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 27, 2021 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements","At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively." +"Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed, Stories, Marketplace, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, including through Instagram Feed and Stories, and explore their interests in businesses, creators and niche communities. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"connect with each other through our Oculus virtual reality products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing heavily in other consumer hardware products and a number of longer-term initiatives, such as augmented reality, artificial intelligence (AI), and connectivity efforts, to develop technologies that we believe will help us better serve our mission over the long run. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. Companies that provide regional social networks and messaging products, many of which have","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. Companies that provide regional social networks and messaging products, many of which have","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation." +"Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2019 , we owned and leased approximately nine million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in approximately 70 cities across North America, Latin America, Europe, the Middle East, Africa and Asia Pacific. We also own 15 data centers globally. We believe that our facilities are adequate for our current needs.","At September 1, 2019 , we operated 782 membership warehouses. At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations." +"Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2019 , there were 3,624 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $205.25 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2019 , there were 39 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2019 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2019 2,415 $ 184.42 2,415 $ 5,757 November 1 - 30, 2019 2,100 $ 195.74 2,100 $ 5,346 December","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record." +"of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2019 2,415 $ 184.42 2,415 $ 5,757 November 1 - 30, 2019 2,100 $ 195.74 2,100 $ 5,346 December 1 - 31, 2019 2,205 $ 202.02 2,205 $ 4,901 6,720 6,720 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $4.90 billion remained available and authorized for repurchases. In January 2020, an additional $10.0 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record." +"filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record." +"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2019 using 2018 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2019 Results Our key community metrics and financial results for 2019 are as follows: Community growth: Facebook daily active users (DAUs) were 1.66 billion on average for December 2019 , an increase of 9% year-over-year. Facebook monthly active users (MAUs) were 2.50 billion as of December 31, 2019 , an increase of 8% year-over-year. Family daily active people (DAP) was 2.26 billion on average for December 2019 , an increase of 11% year-over-year. Family monthly active people (MAP) was 2.89 billion as of December 31, 2019 , an increase of 9% year-over-year. Financial results: Revenue was $70.70 billion , up 27% year-over-year, and advertising revenue was $69.66 billion , up 27% year-over-year. Total costs and expenses were $46.71 billion . Income from operations was $23.99 billion and operating margin was 34% . Net income was $18.48 billion with diluted earnings per share of $6.43 . Capital expenditures, including principal payments on finance leases, were $15.65 billion . Effective tax rate was 25.5% . Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 . Headcount was 44,942 as of December 31, 2019 , an increase of 26% year-over-year. In 2019 ,","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"expenditures, including principal payments on finance leases, were $15.65 billion . Effective tax rate was 25.5% . Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 . Headcount was 44,942 as of December 31, 2019 , an increase of 26% year-over-year. In 2019 ,","We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018. Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide." +"Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have negatively affected, and may continue to negatively affect, our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $105 million , $213 million , and $6 million were recognized in 2019 , 2018 , and 2017 , respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $525 million and $468 million in the market value of our available-for-sale debt securities as of December 31, 2019 and December 31, 2018 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 ." +"Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 29, 2020 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 29, 2020 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period","The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively." +"Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram brings people closer to the people and things they love. It is a community for sharing photos, videos, and messages, and enables people to discover interests that they care about. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality (VR) products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"through our Oculus virtual reality (VR) products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in other consumer hardware products and a number of longer-term initiatives, such as connectivity efforts, artificial intelligence (AI), and augmented reality, to develop technologies that we believe will help us better serve our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on the web, mobile devices and online generally. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. Companies that provide regional social networks, many of which have strong positions","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. Companies that provide regional social networks, many of which have strong positions","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products","Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. During 2018, we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations." +"Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2018 , we owned and leased approximately six million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 89 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately seven million square feet. We also own and lease data centers throughout the United States and in various locations internationally. We believe that our facilities are adequate for our current needs.","At September 2, 2018 , we operated 762 membership warehouses. At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations." +"Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2018 , there were 3,780 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $131.09 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018 , there were 41 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2018 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2018 $ $ 3,544 November 1 - 30, 2018 $ $ 3,544 December 1 - 31, 2018 25,708 $","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2018 $ $ 3,544 November 1 - 30, 2018 $ $ 3,544 December 1 - 31, 2018 25,708 $ 137.87 25,708 $ 9,000 25,708 25,708 (1) In November 2016, our board of directors authorized a share repurchase program that commenced in January 2017 and does not have an expiration date. We completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock during the second quarter of 2018. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion, and we completed repurchases under this authorization during the fourth quarter of 2018. In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program, all of which remained available for future repurchases as of December 31, 2018. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record." +"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2018 using 2017 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2018 Results Our key user metrics and financial results for 2018 are as follows: User growth: Daily active users (DAUs) were 1.52 billion on average for December 2018 , an increase of 9% year-over-year. Monthly active users (MAUs) were 2.32 billion as of December 31, 2018 , an increase of 9% year-over-year. Financial results: Revenue was $55.84 billion , up 37% year-over-year, and ad revenue was $55.01 billion , up 38% year-over-year. Total costs and expenses were $30.93 billion . Income from operations was $24.91 billion . Net income was $22.11 billion with diluted earnings per share of $7.57 . Capital expenditures were $13.92 billion . Effective tax rate was 13% . Cash and cash equivalents, and marketable securities were $41.11 billion as of December 31, 2018 . Headcount was 35,587 as of December 31, 2018 , an increase of 42% year-over-year. In 2018 , we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We continued to invest, based on our roadmap, in: (i) our most developed ecosystems, Facebook and Instagram, (ii) driving growth and","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We continued to invest, based on our roadmap, in: (i) our most developed ecosystems, Facebook and Instagram, (ii) driving growth and","We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017. Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017. Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses. Sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket" +"Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $213 million , $6 million , and $76 million in 2018 , 2017 , and 2016 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $468 million and $611 million in the market value of our available-for-sale debt securities as of December 31, 2018 and December 31, 2017 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2018 , long-term debt with fixed interest rates was $6,577." +"Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2007. San Francisco, California January 31, 2019 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2018 , based","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"since 2007. San Francisco, California January 31, 2019 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2018 , based","At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively." +"Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, the most important of which is News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram is a community for sharing visual stories through photos, videos, and direct messages. Instagram is also a place for people to stay connected with the interests and communities that they care about. Messenger. Messenger is a messaging application that makes it easy for people to connect with other people, groups and businesses across a variety of platforms and devices. WhatsApp. WhatsApp is a fast, simple, and reliable messaging application that is used by people around the world to connect securely and privately. Oculus. Our Oculus virtual reality technology and content platform power products that allow people to enter a completely immersive and interactive environment to train, learn, play games, consume content, and connect with others. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender,","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"allow people to enter a completely immersive and interactive environment to train, learn, play games, consume content, and connect with others. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in a number of longer-term initiatives, such as connectivity efforts, artificial intelligence research, and augmented and virtual reality, to develop technologies that we believe will help us better serve our communities and pursue our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. Companies that develop applications, particularly mobile applications, that provide social","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. Companies that develop applications, particularly mobile applications, that provide social","Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST." +"Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will continue to decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our"," Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations." +"Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2017 , we owned and leased approximately three million square feet of office buildings for our corporate headquarters, and 130 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately five million square feet. We also own and lease data centers throughout the United States and in various locations internationally. Further, we entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. As such, we have excluded the square footage from the total leased space and owned properties, disclosed above. We believe that our facilities are adequate for our current needs.","At September 3, 2017 we operated 741 membership warehouses. At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. " +"Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. The following table sets forth for the indicated periods the high and low intra-day sales prices per share for our Class A common stock on the Nasdaq Global Select Market. High Low High Low First Quarter $ 142.95 $ 115.51 $ 117.59 $ 89.37 Second Quarter $ 156.50 $ 138.81 $ 121.08 $ 106.31 Third Quarter $ 175.49 $ 147.80 $ 131.98 $ 112.97 Fourth Quarter $ 184.25 $ 168.29 $ 133.50 $ 113.55 Our Class B common stock is not listed nor traded on any stock exchange. Holders of Record As of December 31, 2017 , there were 3,967 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $176.46 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2017 , there were 52 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2017","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2017 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands) (in thousands) (in millions) October 1 31, 2017 1,008 $ 172.19 1,008 $ 4,788 November 1 30, 2017 $ $ 4,788 December 1 31, 2017 4,832 $ 177.64 4,832 $ 3,930 5,840 5,840 (1) In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act","Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record." +"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2017 using 2016 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2017 Results Our key user metrics and financial results for 2017 are as follows: User growth: Daily active users (DAUs) were 1.40 billion on average for December 2017 , an increase of 14% year-over-year. Monthly active users (MAUs) were 2.13 billion as of December 31, 2017 , an increase of 14% year-over-year. Financial results: Revenue was $40.65 billion , up 47% year-over-year, and ad revenue was $39.94 billion , up 49% year-over-year. Total costs and expenses were $20.45 billion . Income from operations was $20.20 billion . Net income was $15.93 billion with diluted earnings per share of $5.39 . Capital expenditures were $6.73 billion . Effective tax rate was 23% . Cash and cash equivalents, and marketable securities were $41.71 billion as of December 31, 2017 . Headcount was 25,105 as of December 31, 2017 . In 2017 , we continued to focus on our three main revenue growth priorities: (i) helping businesses expand their use of our mobile products, (ii) developing innovative ad products that help businesses get the most of their ad campaigns, and (iii) making our ads more relevant and effective through our targeting capabilities and outcome-based measurement. We continued to invest, based on","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"revenue growth priorities: (i) helping businesses expand their use of our mobile products, (ii) developing innovative ad products that help businesses get the most of their ad campaigns, and (iii) making our ads more relevant and effective through our targeting capabilities and outcome-based measurement. We continued to invest, based on","We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016. Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017. Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017. Changes in gasoline prices positively impacted net sales by approximately $785 due to an 8% increase in the average sales price per gallon." +"Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $6 million , $76 million , and $66 million in 2017 , 2016 , and 2015 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." +"Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $611 million and $403 million in the market value of our available-for-sale debt securities as of December 31, 2017 and December 31, 2016 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity.","Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 ." diff --git a/datasets/raw/abbvie.csv b/datasets/raw/abbvie.csv new file mode 100644 index 0000000..eba9fcd --- /dev/null +++ b/datasets/raw/abbvie.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,abbv,20211231," ITEM 1. BUSINESS Overview AbbVie (1) is a global, diversified research-based biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions across immunology, hematologic oncology, neuroscience, aesthetics and eye care. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Impact of the Coronavirus Disease 2019 (COVID-19) The novel coronavirus (COVID-19) pandemic continues to spread throughout the United States and around the world. As COVID-19 continues to have an impact worldwide, AbbVie is focused on the health and safety of its employees, health care professionals and patients and communities. In the continued operation of its business, AbbVie has followed health and safety guidance from relevant health authorities, managed manufacturing and supply chain resources and monitored closely its clinical trial sites. See Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsImpact of the Coronavirus Disease 2019 (COVID-19)."" Segments AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, development, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. See Note 16, ""Segment and Geographic Area Information"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data"" and the sales information related to AbbVie's key products and geographies included under Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. | 2021 Form 10-K Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: Humira. Humira (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union Pediatric ulcerative colitis (moderate to severe) U.S., Canada, European Union Pediatric uveitis North America, European Union Humira is also approved in Japan for the treatment of intestinal Behet's disease and pyoderma gangrenosum. Humira is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 37% of AbbVie's total net revenues in 2021. Skyrizi. Skyrizi (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following two induction doses. Skyrizi is approved in the United States, Canada, Mexico and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In the United States and the European Union, Skyrizi is additionally approved for the treatment of active psoriatic arthritis in adult patients who have an inadequate response or intolerance to disease-modifying antirheumatic drugs (DMARDs). In Japan, Skyrizi is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. Rinvoq . Rinvoq (upadacitinib) is an oral, once-daily selective and reversible JAK inhibitor that is approved to treat the following inflammatory diseases in North America, Japan and the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union, Japan Psoriatic arthritis U.S., Canada, European Union, Japan Ankylosing spondylitis European Union Atopic dermatitis (moderate to severe) U.S., Canada, European Union, Japan In the United States, Rinvoq is indicated for both the treatment of moderate to severe active rheumatoid arthritis, and for active psoriatic arthritis, in adult patients who have an inadequate response or intolerance to one or more TNF blockers. It is also indicated for the treatment of moderate to severe atopic dermatitis in adults and children 12 years of age and older whose disease is not adequately controlled with other systemic drug products, including biologics, or when use of those therapies are inadvisable. 2021 Form 10-K | Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: Imbruvica. Imbruvica (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase. Imbruvica was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. Imbruvica currently is approved for the treatment of adult patients with blood cancers such as chronic lymphocytic leukemia (CLL), as well as certain forms of non-Hodgkin lymphoma. Venclexta/Venclyxto. Venclexta (venetoclax) is a B-cell lymphoma 2 (BCL-2) inhibitor used to treat hematological malignancies. Venclexta is approved by the FDA for adults with CLL or SLL. In addition, Venclexta is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Aesthetics products. AbbVies Aesthetics portfolio consists of facial injectables, plastics and regenerative medicine, body contouring and skincare products, which hold market-leading positions in the U.S. and in key markets around the world. These products are: Botox Cosmetic. Botox Cosmetic is an acetylcholine release inhibitor and a neuromuscular blocking agent indicated for treatment in three areas: temporary improvement in the appearance of moderate to severe glabellar lines (frown lines between the eyebrows), moderate to severe crow's feet and moderate to severe forehead lines in adults. Having received its initial FDA approval in 2002, Botox Cosmetic is now approved for use in all major markets around the world and has become one of the worlds most recognized and iconic brands. The Juvederm Collection of Fillers. The Juvederm Collection of Fillers is a portfolio of hyaluronic acid-based dermal fillers with a variety of approved indications in the U.S. and in other major markets around the world to augment or treat volume loss in the cheeks, chin, lips and lower face. Other aesthetics. Other aesthetics products include, but are not limited to, Coolsculpting body contouring technology, Alloderm regenerative dermal tissue, Natrelle breast implants, the SkinMedica skincare line and DiamondGlow dermabrasion technology. Neuroscience products. AbbVies neuroscience products address some of the most difficult-to-treat neurologic diseases. These products are: Botox Therapeutic. Botox Therapeutic (onabotulinumtoxinA injection) is a neuromuscular blocking agent that is injected into muscle tissue in treatment for the following indications in the United States: Prophylaxis of headaches in adult patients with chronic migraine ( 15 days per month with headache lasting 4 hours a day or longer). Overactive bladder with symptoms of urge urinary incontinence, urgency and frequency, in adults who have an inadequate response to or are intolerant of an anticholinergic medication. Urinary incontinence due to detrusor overactivity associated with a neurologic condition (e.g., spinal cord injury, multiple sclerosis) in adults who have an inadequate response to or are intolerant of an anticholinergic medication. Spasticity in patients 2 years of age and older. Cervical dystonia in adults to reduce the severity of abnormal head position and neck pain associated with cervical dystonia. Strabismus and blepharospasm associated with dystonia, including benign essential blepharospasm or VII nerve disorders in patients 12 years of age and older. Severe primary axillary hyperhidrosis that is inadequately managed with topical agents. Licenses around the world vary. Focal spasticity associated with dynamic equinus foot deformity due to spasticity in ambulant pediatric cerebral palsy patients 2 years of age or older. | 2021 Form 10-K Focal spasticity of the wrist and hand in adult post stroke patients. Focal spasticity of the ankle and foot in adult post stroke patients. Vraylar. Vraylar (cariprazine) is a dopamine D3-preferring D3/D2 receptor partial agonist and a 5-HT1A receptor partial agonist. Its D3 binding profile may be linked to observed improvements in the negative symptoms of schizophrenia and to antidepressant effects in bipolar I disorder (bipolar depression). Vraylar is indicated for acute and maintenance treatment of schizophrenia in adults, acute treatment of manic or mixed episodes associated with bipolar disorder in adults and acute treatment of depressive episodes associated with bipolar I disorder in adults. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Ubrelvy. Ubrelvy (ubrogepant) is indicated for the acute treatment of migraine with or without aura in adults and is only commercialized in the United States. Other neuroscience. Other neuroscience products include Qulipta (atogepant), which is indicated for preventive treatment of episodic migraine in adults. Eye care products. AbbVies eye care products address unmet needs and new approaches to help preserve and protect patients vision. These products are: Lumigan/Ganfort. Lumigan (bimatoprost ophthalmic solution) 0.01% is a once daily, topical prostaglandin analog indicated for the reduction of elevated intraocular pressure (IOP) in patients with open angle glaucoma (OAG) or ocular hypertension (OHT). Ganfort is a once daily topical fixed combination of bimatoprost 0.03% and timolol 0.5% for the reduction of IOP in adult patients with OAG or OHT. Lumigan is sold in the United States and numerous markets around the world, while Ganfort is approved in the European Union and some markets in South America, the Middle East and Asia. Alphagan/Combigan. Alphagan (brimonidine tartrate ophthalmic solution) is an alpha-adrenergic receptor agonist indicated for the reduction of elevated IOP in patients with open-angle glaucoma or ocular hypertension. Combigan (brimonidine tartrate/timolol maleate ophthalmic solution) is approved for reducing elevated IOP in patients with glaucoma who require additional or adjunctive IOP-lowering therapy. Both Alphagan and Combigan are available for sale in the United States and numerous markets around the world. Restasis. Restasis is a calcineurin inhibitor immunosuppressant indicated to increase tear production in patients whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca. Restasis is approved in the United States and a number of other markets in South America, the Middle East and Asia. Other eye care. Other eye care products include Xen, Durysta, Ozurdex, Refresh/Optive and Vuity. Women's health products. AbbVies women's health products are: Lo Loestrin . Lo Loestrin Fe is an oral contraceptive. It is indicated for prevention of pregnancy with the lowest dose of estrogen with only 10mcg and is dispensed in a unique 24/2/2 regimen with a two-day hormone-free interval. It is marketed in the U.S. as Lo Loestrin Fe (norethindrone acetate and ethinyl estradiol tablets, ethinyl estradiol tablets and ferrous fumarate tablets) and in select markets outside the U.S. as Lolo. Orilissa/Oriahnn. Orilissa (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. Orilissa inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, Orilissa is also launched in Canada. Oriahnn (elagolix, estradiol and norethindrone acetate capsules; elagolix capsules) is a combination prescription medicine used to control heavy menstrual bleeding related to uterine fibroids in women before menopause. Other women's health. Other women's health includes Liletta, a sterile, levonorgestrel-releasing intrauterine system indicated for prevention of pregnancy for up to six years. Other key products. AbbVies other key products include, among other things, treatments for patients with hepatitis C virus (HCV), metabolic and hormone products that target a number of conditions, including exocrine pancreatic insufficiency and hypothyroidism, as well as endocrinology products for the palliative treatment of advanced prostate 2021 Form 10-K | cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. These products are: Mavyret/Maviret. Mavyret (glecaprevir/pibrentasvir) is approved in the United States and European Union (Maviret) for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. Creon. Creon (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Lupron. Lupron (leuprolide acetate), which is also marketed as Lucrin and Lupron Depot, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Linzess/Constella. Linzess (linaclotide) is a once-daily guanylate cyclase-C agonist used in adults to treat irritable bowel syndrome with constipation (IBSC) and chronic idiopathic constipation (CIC). The product is marketed as Linzess in the United States and as Constella outside of the United States. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell Creon and Synthroid only in the United States. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States many of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its promotional and market access efforts on key opinion leaders, payers, physicians and health systems. AbbVie also provides patient support programs closely related to its products. Throughout the COVID-19 pandemic AbbVie has maintained its promotional activities with key stakeholders by leveraging digital engagement where permitted and in compliance with the locally applicable government guidance. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. In 2021, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's pharmaceutical product sales in the United States. No individual wholesaler accounted for greater than 37% of AbbVie's 2021 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products, therapies | 2021 Form 10-K and biologics. For example, Humira competes with anti-TNF products, JAK inhibitors and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available HCV treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded conventional (small-molecule) pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for small molecule medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. Humira is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug, and Cosmetic Act (the FFDCA), the Public Health Service Act (PHSA) and the regulations implementing these statutes. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the PHSA, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered by the FDA as substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its full ultimate impact, implementation and meaning remains subject to uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the FFDCA. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the PHSA are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a conventional drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Specific conditions of use approved for 2021 Form 10-K | individual products may also be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of exclusivity. Other types of regulatory exclusivity may also be available, such as Generating New Antibiotic Incentives Now (GAIN) exclusivity, which can provide new antibiotic or new antifungal drugs an additional five years of exclusivity to be added to certain exclusivities already provided for by law. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained or sometimes even later. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not generally be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2022 to the early 2040s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark Humira), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the licenses in the United States will begin in 2023 and the licenses in Europe began in 2018. In addition, the following patents, licenses and trademarks are significant: those related to ibrutinib (which is sold under the trademark Imbruvica) and those related to risankizumab (which is sold under the trademark Skyrizi). The United States composition of matter patent covering ibrutinib is expected to expire in 2027, however no generic entry for any ibrutinib product is expected prior to March 30, 2032, assuming pediatric exclusivity is granted. The United States composition of matter patent covering risankizumab is expected to expire in 2033. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. | 2021 Form 10-K Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie seeks to maintain sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. Despite the disruption to the global supply chain caused by COVID-19, AbbVie has continued to supply patients with no material supply impact, except for the previously-disclosed near-term supply issues impacting Lupron. Given the general increased global volatility due to the pandemic, AbbVie is monitoring and taking actions to mitigate potential supply shortages which may impact the fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds (and complementary devices) in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. AbbVie also supplements its research and development efforts with acquisitions. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1 involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and doses for later phases. Phase 2 tests different doses of the drug in a disease state in order to assess efficacy. Phase 3 tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety in order to meet requirements to enable global approval. Preclinical data and clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. 2021 Form 10-K | The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products, delivery devices, and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Compliance with regulatory requirements is assured through periodic, announced or unannounced inspections by the FDA and other regulatory authorities, and these inspections associated with clinical development may include the sponsor, investigator sites, laboratories, hospitals and manufacturing facilities of AbbVie's subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, including rejection of an NDA or BLA. Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be submitted and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Further, the FDA continues to regulate product labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from applicable supervising regulatory authorities before it can commence clinical trials or marketing of the product in target markets. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency. After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Japan-specific trials and/or bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. Similarly, applications for a new product in China are submitted to the Center for Drug Evaluation (CDE) of the National Medical Products Administration for technical review and approval of a product for marketing in China. Clinical data in Chinese subjects are usually required to support approval in China, requiring the inclusion of China in global pivotal studies, or a separate China/Asian clinical trial. | 2021 Form 10-K The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Similar to the requirements in Japan and China, certain countries (notably South Korea, Taiwan, India and Russia) also generally require that local clinical studies be conducted in order to support regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacturing, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can lead to updates to the data regarding utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates may affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In 2021 Form 10-K | addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 70% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2022 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is difficult to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. | 2021 Form 10-K Regulation Medical Devices Medical devices are subject to regulation by the FDA, state agencies and foreign government health authorities. FDA regulations, as well as various U.S. federal and state laws, govern the development, clinical testing, manufacturing, labeling, record keeping and marketing of medical device products agencies in the United States. AbbVies medical device product candidates, including AbbVies breast implants, must undergo rigorous clinical testing and an extensive government regulatory clearance or approval process prior to sale in the United States and other countries. The lengthy process of clinical development and submissions for clearance or approval, and the continuing need for compliance with applicable laws and regulations, require the expenditure of substantial resources. Regulatory clearance or approval, when and if obtained, may be limited in scope, and may significantly limit the indicated uses for which a product may be marketed. Cleared or approved products and their manufacturers are subject to ongoing review, and discovery of previously unknown problems with products may result in restrictions on their manufacture, sale and/or use or require their withdrawal from the market. United States . AbbVies medical device products are subject to extensive regulation by the FDA in the United States. Unless an exemption applies, each medical device AbbVie markets in the United States must have a 510(k) clearance or a Premarket Approval Application (PMA) in accordance with the FFDCA and its implementing regulations. The FDA classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose a lower risk are placed in either Class I or Class II, and devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or a device deemed to be not substantially equivalent to a previously cleared 510(k) device, are placed in Class III. In general, a Class III device cannot be marketed in the United States unless the FDA approves the device after submission of a PMA, and any changes to the device subsequent to initial FDA approval must also be reviewed and approved by the FDA. The majority of AbbVies medical device products, including AbbVies breast implants, are regulated as Class III medical devices. A Class III device may have significant additional obligations imposed in its conditions of approval, and the time in which it takes to obtain approval can be long. Compliance with regulatory requirements is assured through periodic, unannounced facility inspections by the FDA and other regulatory authorities, and these inspections may include the manufacturing facilities of AbbVies subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions: warning letters or untitled letters; fines, injunctions and civil penalties; recall or seizure of AbbVie products; operating restrictions, partial suspension or total shutdown of production; refusing AbbVie request for 510(k) clearance or PMA approval of new products; withdrawing 510(k) clearance or PMA approvals that are already granted; and criminal prosecution. A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. Clinical trials generally require submission of an application for an investigational device exemption (IDE), which must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. A study sponsor must obtain approval for its IDE from the FDA, and it must also obtain approval of its study from the Institutional Review Board overseeing the trial. The results of clinical testing may not be sufficient to obtain approval of the investigational device. Once a device is approved, the manufacture and distribution of the device remains subject to continuing regulation by the FDA, including Quality System Regulation requirements, which involve design, testing, control, documentation and other quality assurance procedures during the manufacturing process. Medical device manufacturers and their subcontractors are required to register their establishments and list their manufactured devices with the FDA and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with regulatory requirements. Manufacturers must also report to the FDA if their devices may have caused or contributed to a death or serious injury or malfunctioned in a way that could likely cause or contribute to a death or serious injury, or if the manufacturer conducts a field correction or product recall or removal to reduce a risk to health posed by a device or to remedy a violation of the FFDCA that may present a health risk. Further, the FDA continues to regulate device labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. European Union. Medical device products that are marketed in the European Union must comply with the requirements of the Medical Device Regulation (the MDR), which came into effect in May 2021. The MDR provides for regulatory oversight with respect to the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices to ensure that medical devices marketed in the European Union are safe and effective for their intended uses. Medical devices that comply with the MDR are entitled to bear a Conformit Europenne marking evidencing such compliance and may be marketed in the European Union. Failure to comply with these domestic and international regulatory requirements could affect AbbVies ability to market and sell AbbVies products in these countries. 2021 Form 10-K | Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2021 were approximately $17 million and operating expenditures were approximately $33 million. In 2022, capital expenditures for pollution control are estimated to be approximately $14 million and operating expenditures are estimated to be approximately $34 million. Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 50,000 employees in over 70 countries as of January 31, 2022. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Human Capital Management Attracting, retaining and providing meaningful growth and development opportunities to AbbVie's employees is critical to the company's success in making a remarkable impact on peoples lives around the world. AbbVie leverages numerous resources to identify and enhance strategic and leadership capability, foster employee engagement and create a culture where diverse talent is productive and engaged. AbbVie invests in its employees through competitive compensation, benefits and employee support programs and offers best-in-class development and leadership opportunities. AbbVie has developed a deep talent base through ongoing investment in functional and leadership training and by sourcing world-class external talent, ensuring a sustainable talent pipeline. AbbVie continuously cultivates and enhances its working culture and embraces equality, diversity and inclusion as fundamental to the company's mission. Attracting and Developing Talent. Attracting and developing high-performing talent is essential to AbbVies continued success. AbbVie implements detailed talent attraction strategies, with an emphasis on STEM skill sets, a diverse talent base and other critical skillsets, including drug discovery, clinical development, market access and business development. AbbVie also invests in competitive compensation and benefits programs. In addition to offering a comprehensive suite of benefits ranging from medical and dental coverage to retirement, disability and life insurance programs, AbbVie also provides health promotion programs, mental health awareness campaigns and employee assistance programs in several countries, financial wellness support, on-site health screenings and immunizations in several countries and on-site fitness and rehabilitation centers. In addition, the AbbVie Employee Assistance Fund (a part of the AbbVie Foundation) supports two programs for global employees: the AbbVie Possibilities Scholarship for children of employees, which is an annual merit-based scholarship for use at accredited colleges, universities or vocational-technical schools; and the Employee Relief Program, which is financial assistance to support short term needs of employees when faced with large-scale disasters (e.g. a hurricane), individual disasters (e.g. a home fire) or financial hardship (e.g. the death of a spouse). Finally, AbbVie empowers managers and their teams with tools, tips and guidelines on effectively managing workloads, managing teams from a distance and supporting flexible work practices. New AbbVie employees are given a tailored onboarding experience for faster integration and to support performance. AbbVie's mentorship program allows employees to self-nominate as mentors or mentees and facilitates meaningful relationships supporting employees career and development goals. AbbVie also provides structured, broad-based development opportunities, focusing on high-performance skills and leadership training. AbbVie's talent philosophy holds leaders accountable for building a high-performing organization, and the company provides development opportunities to all levels of leadership. AbbVie's Learn, Develop, Perform program offers year-long, self-directed leadership education, supplemented with tools and resources, and leverages leaders as role models and teachers. In addition, the foundation to AbbVie's leadership pipeline is the company's Professional Development | 2021 Form 10-K Programs, which attract graduates, postgraduates and post-doctoral talent to participate in formal development programs lasting up to three years, with the objective of strengthening functional and leadership capabilities. Culture. AbbVies shared values of transforming lives, acting with integrity, driving innovation, embracing diversity and inclusion and serving the community form the core of the company's culture. AbbVie articulates the behaviors associated with these values in the Ways We Work, a core set of working behaviors that emphasize how the company achieves results is equally as important as achieving them. The Ways We Work are designed to ensure that every AbbVie employee is aware of the company's cultural expectations. AbbVie integrates the Ways We Work into all talent processes, forming the basis for assessing performance, prioritizing development and ultimately rewarding employees. AbbVie believes its culture creates strong engagement, which is measured regularly through a confidential, third party all-employee survey, and this engagement supports AbbVies mission of making a remarkable impact on peoples lives. Equity, Equality, Diversity Inclusion (EEDI). A cornerstone of AbbVies human capital management approach is to prioritize fostering an inclusive and diverse workforce. In 2019, AbbVie adopted a five-year Equality, Diversity Inclusion roadmap that defines key global focus areas, objectives and associated initiatives, and includes implementation plans organized by business function and geography. AbbVies senior leaders have adopted formal goals aligned with executing this strategy. In recent years, AbbVie's board of directors has prioritized oversight of AbbVie's response to the U.S. racial justice movement, including overseeing internal programs designed to ensure that AbbVie is attracting, retaining and developing diverse talent. Through December 2021, women represented 51 percent of management positions globally and in the United States, 35 percent of AbbVie's workforce was comprised of members of historically underrepresented populations, an increase from 2020. Further, AbbVie is committed to pay equity and conducts pay equity analyses annually. A critical component of AbbVie's strategy is to instill an inclusive mindset in all AbbVie leaders and employees, so the company can realize the full value of a diverse workforce from recruitment through retirement. AbbVie recently launched a new resource for people who manage others to reinforce the importance of EEDI to the business, educate leaders on inclusive recruiting practices and modeling inclusive behavior, and encourage participation in the company's inclusive culture learning opportunities. AbbVie's Employee Resource Groups also help the company nurture an inclusive culture by building community, hosting awareness events and providing leadership and career opportunities. In 2021, AbbVie reiterated its commitment to racial equality and social justice by, among other things, expanding its employee matching program to $3-to-$1 for donations to civil rights nonprofits fostering racial equity and by reaffirming its commitment to clinical trial diversity. Additional information about AbbVie's efforts on racial equality and social justice is provided on the company's website at: https://abbvie.com/our-company/equality-inclusion-diversity/our-commitment-to-racial-justice.html. COVID-19 Health and Safety. AbbVie has effectively prioritized the health and safety of its employees during the COVID-19 pandemic, while continuing to drive strong business performance. AbbVie implemented, among other things, temporary office and facility closures and establishment of new safety and cleaning protocols and procedures; regular communication regarding the effect of the pandemic on AbbVie's business and employees; establishment of physical distancing procedures, modification of workspaces and provision of personal protective equipment and cleaning supplies for employees; provision of on-site vaccinations and temperature screenings; a variety of testing and vaccination resources including on-site vaccinations and on-site and at-home testing and COVID case management programs; and remote working accommodations and related services to support employees needs for flexibility. In addition, COVID-19 is a covered event under the AbbVie Employee Assistance Fund's Employee Relief Program, entitling eligible AbbVie employees and their families to financial assistance to pay for mortgage/rent, utilities, food, childcare and medical expenses not covered by insurance. AbbVie also provided paid leave and other support and accommodations to the company's employees with relevant medical, pharmaceutical, research and development, science, public health and public safety skills, knowledge, training and experience who desired or were requested or mandated to serve as volunteers during the pandemic. Lastly, AbbVies commitment to employees has been evidenced by no workforce reductions and no salary reductions associated with COVID-19 . Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( investors.abbvie.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( investors.abbvie.com ). 2021 Form 10-K | "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business Public health outbreaks, epidemics or pandemics, such as the coronavirus (COVID-19), have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. Public health outbreaks, epidemics or pandemics have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. The continuing pandemic caused by the novel strain of coronavirus (COVID-19) has caused many countries, including the United States, to declare national emergencies and implement preventive measures such as travel bans and shelter in place or total lock-down orders, some of which have eased. The continuation or re-implementation of these bans and orders remains uncertain. The COVID-19 pandemic has caused AbbVie to modify its business practices (including instituting remote work for many of AbbVies employees), and AbbVie may take further actions as may be required by government authorities or as AbbVie determines are in the best interests of AbbVies employees, patients, customers and business partners. While the impact of COVID-19 on AbbVies operations, including, among others, its manufacturing and supply chain, sales and marketing, commercial and clinical trial operations, to date has not been material, AbbVie has experienced lower new patient starts in certain products and markets. The impact of COVID-19 on AbbVie over the long-term is uncertain and cannot be predicted with confidence. The extent of the adverse impact of COVID-19 on AbbVies operations will depend on the extent and severity of the continued spread of COVID-19 globally, the timing and nature of actions taken to respond to COVID-19 and the resulting economic consequences. Ultimately, efforts to mitigate the impact of COVID-19 may not completely prevent AbbVie's business from being adversely affected and future impacts remain uncertain. The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1, ""BusinessIntellectual Property Protection and Regulatory Exclusivity"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of Operations,"" and litigation regarding these patents is described in Item 3, ""Legal Proceedings."" The United States composition of matter patent for Humira, which is AbbVie's largest product and had worldwide net revenues of approximately $20.7 billion in 2021, expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. | 2021 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects Humira revenues could have a material and negative impact on AbbVie's results of operations and cash flows. Humira accounted for approximately 37% of AbbVie's total net revenues in 2021. Any significant event that adversely affects Humira's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for Humira (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of Humira, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of Humira for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, 2021 Form 10-K | inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances and joint ventures with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding Humiracould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including Humira. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, Humira competes with anti-TNF products | 2021 Form 10-K and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available hepatitis C treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. All of these competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Certain aspects of AbbVies operations are highly dependent upon third party service providers. AbbVie relies on suppliers, vendors and other third party service providers to research, develop, manufacture, commercialize, promote and sell its products. Reliance on third party manufacturers reduces AbbVies oversight and control of the manufacturing process. Some of these third party providers are subject to legal and regulatory requirements, privacy and security risks and market risks of their own. The failure of a critical third party service provider to meet its obligations could have a material adverse impact on AbbVies operations and results. If any third party service providers have violated or are alleged to have violated any laws or regulations during the performance of their obligations to AbbVie, it is possible that AbbVie could suffer financial and reputational harm or other negative outcomes, including possible legal consequences. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be 2021 Form 10-K | taken by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. For example, lawsuits are pending against Allergan, AbbVies recently acquired subsidiary, and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans textured breast implants. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. Additionally, Allergan has been named as a defendant in approximately 3,130 matters relating to the promotion and sale of prescription opioid pain relievers and additional suits may be filed. See Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" AbbVie cannot predict the outcome of these proceedings. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. | 2021 Form 10-K AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1, ""BusinessRegulationDiscovery and Clinical Development, BusinessRegulationCommercialization, Distribution and Manufacturing, and BusinessRegulationMedical Devices. The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act, the U.S. Physician Payments Sunshine Act, the TRICARE program, the government pricing rules applicable to the Medicaid, Medicare Part B, 340B Drug Pricing Program and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 23% of AbbVie's total net revenues in 2021. The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; 2021 Form 10-K | political and economic instability, including as a result of the United Kingdoms exit from the European Union and the COVID-19 pandemic; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action and regulation; inflation, recession and fluctuations in interest rates; restrictions on transfers of funds; potential deterioration in the economic position and credit quality of certain non-U.S. countries; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, joint ventures and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, joint ventures, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2021, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's pharmaceutical product sales in the United States. If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. | 2021 Form 10-K AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. In particular, AbbVie incurred significant debt in connection with its acquisition of Allergan. AbbVies substantially increased indebtedness and higher debt to equity ratio as a result of the acquisition may exacerbate these risks and have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions and/or lowering its credit ratings. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase further. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could have a material adverse effect on AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may in the future result in the failure of critical business operations. Such breaches may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. To date, AbbVies business or operations have not been materially impacted by such incidents. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent material breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. In connection with the acquisition of Allergan, AbbVies balances of intangible assets, including developed product rights and goodwill acquired, have increased significantly. Such balances are subject to impairment testing and may result in impairment charges, which will adversely affect AbbVies results of operations and financial condition. A significant amount of AbbVies total assets is related to acquired intangibles and goodwill. As of December 31, 2021, the carrying value of AbbVies developed product rights and other intangible assets was $76.0 billion and the carrying value of AbbVies goodwill was $32.4 billion. AbbVies developed product rights are stated at cost, less accumulated amortization. AbbVie determines original fair value and amortization periods for developed product rights based on its assessment of various factors impacting estimated useful lives and cash flows of the acquired products. Significant adverse changes to any of these factors require AbbVie to perform an impairment test on the affected asset and, if evidence of impairment exists, require AbbVie to take an impairment charge with respect to the asset. For assets that are not impaired, AbbVie may adjust the remaining useful lives. Such a charge could have a material adverse effect on AbbVies results of operations and financial condition. AbbVies other significant intangible assets include in-process research and development (IPRD) intangible projects, acquired in recent business combinations, which are indefinite-lived intangible assets. Goodwill and AbbVies IPRD intangible assets are tested for impairment annually, or when events occur or circumstances change that could potentially reduce the fair value of the reporting unit or intangible asset. Impairment testing compares the fair value of the reporting unit or intangible asset to its carrying amount. A goodwill or IPRD impairment, if any, would be recorded in operating income and could have a material adverse effect on AbbVies results of operations and financial condition. 2021 Form 10-K | Failure to attract, develop and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract, develop and retain diverse, highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development (RD), governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws, particularly in the European Union and the United States, and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; environmental liabilities in connection with AbbVies manufacturing processes and distribution logistics, including the handling of hazardous materials; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; business interruptions stemming from natural disasters, such as climate change, earthquakes, hurricanes, flooding, fires, or efforts taken by third parties to prevent or mitigate such disasters; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5, ""Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. | 2021 Form 10-K In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2021 Form 10-K | CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1, ""Business,"" Item 1A, ""Risk Factors,"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A, ""Risk Factors"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. As of December 31, 2021, AbbVie owns or leases approximately 645 facilities worldwide, containing an aggregate of approximately 20 million square feet of floor space dedicated to production, distribution, and administration. AbbVie's significant manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Clonshaugh, Ireland Branchburg, New Jersey* La Aurora, Costa Rica Campbell, California Ludwigshafen, Germany Cincinnati, Ohio Pringy, France Dublin, California* Singapore* Irvine, California Sligo, Ireland North Chicago, Illinois Westport, Ireland* Waco, Texas Worcester, Massachusetts* Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. AbbVie believes its facilities are suitable and provide adequate production capacity for its current and projected operations. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has two central distribution centers. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; Branchburg, New Jersey; Cambridge, Massachusetts; Irvine, California; Madison, New Jersey; North Chicago, Illinois; Pleasanton, California; Santa Cruz, California; South San Francisco, California; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. | 2021 Form 10-K "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 46,139 stockholders of record of AbbVie common stock as of January 31, 2022. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2016 through December 31, 2021. This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2016 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. | 2021 Form 10-K Dividends On October 29, 2021, AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.30 per share to $1.41 per share, payable on February 15, 2022 to stockholders of record as of January 14, 2022. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2021 - October 31, 2021 3,808 (1) $ 108.90 (1) $ 2,643,316,927 November 1, 2021 - November 30, 2021 845 (1) $ 116.08 (1) $ 2,643,316,927 December 1, 2021 - December 31, 2021 904,176 (1) $ 136.23 (1) 879,703 $ 2,523,316,993 Total 908,829 (1) $ 136.10 (1) 879,703 $ 2,523,316,993 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 3,808 in October; 845 in November; and 24,473 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 2021 Form 10-K | "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company). This commentary should be read in conjunction with the Consolidated Financial Statements and accompanying notes appearing in Item 8, ""Financial Statements and Supplementary Data."" This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020. Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Form 10-K can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2020. EXECUTIVE OVERVIEW Company Overview AbbVie is a global, diversified research-based biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions across immunology, hematologic oncology, neuroscience, aesthetics and eye care. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 50,000 employees. AbbVie operates as a single global business segment. 2021 Financial Results AbbVie's strategy has focused on delivering strong financial results, maximizing the benefits of the Allergan acquisition, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2021 included delivering worldwide net revenues of $56.2 billion, operating earnings of $17.9 billion, diluted earnings per share of $6.45 and cash flows from operations of $22.8 billion. Worldwide net revenues increased by 23% on a reported basis and 22% on a constant currency basis, reflecting growth across its immunology, hematologic oncology, neuroscience, aesthetics and eye care portfolios as well as a full period of Allergan results in 2021 compared to the prior year. Diluted earnings per share in 2021 was $6.45 and included the following after-tax costs: (i) $6.4 billion related to the amortization of intangible assets; (ii) $2.7 billion for the change in fair value of contingent consideration liabilities; (iii) $948 million for acquired in-process research and development (IPRD); (iv) $500 million as a result of a collaboration agreement extension with Calico Life Sciences LLC; (v) $307 million for milestones and other research and development (RD) expenses; (vi) $253 million for charges related to litigation matters; and (vii) $215 million of acquisition and integration expenses. These costs were partially offset by $265 million of certain tax benefits. Additionally, financial results reflected continued funding to support all stages of AbbVies pipeline assets and continued investment in AbbVies on-market brands. In October 2021, AbbVie's board of directors declared a quarterly cash dividend of $1.41 per share of common stock payable in February 2022. This reflects an increase of approximately 8.5% over the previous quarterly dividend of $1.30 per share of common stock. Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. The integration plan is expected to realize approximately $2.5 billion of annual cost synergies in 2022 . 2021 Form 10-K | To achieve these integration objectives, AbbVie expects to incur total cumulative charges of approximately $2 billion through 2022. These costs consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. Impact of the Coronavirus Disease 2019 (COVID-19) In response to the ongoing public health crisis posed by COVID-19, AbbVie continues to focus on ensuring the safety of employees. Throughout the pandemic, AbbVie has followed health and safety guidance from state and local health authorities and implemented safety measures for those employees who are returning to the workplace. AbbVie also continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie continues to experience lower new patient starts in certain products and markets. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the pandemic. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain and is dependent on numerous evolving factors, including the measures being taken by authorities to mitigate against the spread of COVID-19, the emergence of new variants and the availability and successful administration of effective vaccines. 2022 Strategic Objectives AbbVie's mission is to discover and develop innovative medicines and products that solve serious health issues today and address the medical challenges of tomorrow while achieving top-tier financial performance through outstanding execution. AbbVie intends to continue to advance its mission in a number of ways, including: (i) maximizing the benefits of a diversified revenue base with multiple long-term growth drivers; (ii) growing revenues by leveraging AbbVie's commercial strength and international infrastructure across therapeutic areas and ensuring strong commercial execution of new product launches; (iii) continuing to invest in and expand its pipeline in support of opportunities in immunology, oncology, aesthetics, neuroscience and eye care as well as continued investment in key on-market products; (iv) expanding operating margins; and (v) returning cash to shareholders via a strong and growing dividend while also reducing debt. In addition, AbbVie anticipates several regulatory submissions and data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Immunology revenue growth driven by increasing market share and indication expansion of Skyrizi and Rinvoq, as well as Humira U.S. sales growth. Hematologic oncology revenue growth driven by increasing market share and indication expansion of Venclexta, as well as maintaining the strong leadership position of Imbruvica. Aesthetics revenue growth driven by global expansion and increasing market penetration of Botox and Juvederm Collection. Neuroscience revenue growth driven by Vraylar, Botox Therapeutic, Ubrelvy and recently launched Qulipta. Sustaining eye care leadership by maximizing AbbVie's current eye care portfolio. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2022. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7. AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued realization of expense synergies from the Allergan acquisition, leverage from revenue growth, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. | 2021 Form 10-K Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes approximately 90 compounds, devices or indications in development individually or under collaboration or license agreements and is focused on such important specialties as immunology, oncology, aesthetics, neuroscience and eye care. Of these programs, more than 50 are in mid- and late-stage development. The following sections summarize transitions of significant programs from mid-stage development to late-stage development as well as developments in significant late-stage and registration programs. AbbVie expects multiple mid-stage programs to transition into late-stage programs in the next 12 months. Significant Programs and Developments Immunology Skyrizi In January 2021, AbbVie announced top-line results from its Phase 3 KEEPsAKE-1 and KEEPsAKE-2 clinical trials of Skyrizi in adults with active psoriatic arthritis (PsA) met the primary and ranked secondary endpoints. In January 2021, AbbVie announced top-line results from its Phase 3 ADVANCE and MOTIVATE induction studies of Skyrizi in patients with Crohns disease met the primary and key secondary endpoints. In April 2021, AbbVie received U.S. Food and Drug Administration (FDA) approval of Skyrizi in a single dose pre-filled syringe and pre-filled pen. This approval will reduce the number of injections administered per treatment. In June 2021, AbbVie announced top-line results from its Phase 3 FORTIFY study for Skyrizi in patients with moderate to severe Crohns disease met the co-primary endpoints. In September 2021, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for Skyrizi for the treatment of patients 16 years and older with moderate to severe Crohns disease. In November 2021, AbbVie submitted a marketing authorization application (MAA) to the European Medicines Agency (EMA) for Skyrizi for the treatment of patients 16 years or older with moderate to severe active Crohn's disease who have had inadequate response, lost response or were intolerant to conventional or biologic therapy. In November 2021, Ab bVie announced that the European Commission (EC) approved Skyrizi alone or in combination with methotrexate for the treatment of active PsA in adults who have had an inadequate response or who have been intolerant to one or more disease-modifying antirheumatic drugs. In January 2022, A bbVie announced that the FDA approved Skyrizi for the treatment of adults with active PsA. Rinvoq In January 2021, AbbVie announced that the EC approved Rinvoq for the treatment of adults with active PsA and ankylosing spondylitis (AS). In February 2021, AbbVie announced its Phase 3 U-ACCOMPLISH induction study of Rinvoq for the treatment of adult patients with moderate to severe ulcerative colitis (UC) met the primary and all ranked secondary endpoints. In June 2021, AbbVie announced the FDA will not meet the Prescription Drug User Fee Act action dates for the sNDA of Rinvoq for the treatment of adults with active AS. No formal regulatory action has been taken on the sNDA for Rinvoq in AS. In June 2021, AbbVie announced the results from its Phase 3 maintenance study of Rinvoq in patients with UC met the primary and all secondary endpoints. In August 2021, AbbVie announced that the EC approved Rinvoq for the treatment of moderate to severe atopic dermatitis (AD) in adults and adolescents 12 years and older who are candidates for systemic therapy. 2021 Form 10-K | In September 2021, AbbVie submitted an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adults with moderately to severely active UC. In October 2021, A bbVie announced the results from Study 1 of the Phase 3 SELECT-AXIS 2 clinical trial for Rinvoq in patients with active AS and inadequate response to biologic disease-modifying antirheumatic drugs met the primary and all ranked secondary endpoints. In October 2021, A bbVie announced the results from Study 2 of the Phase 3 SELECT-AXIS 2 clinical trial for Rinvoq in adults with non-radiographic axial spondyloarthritis met the primary and 12 of 14 ranked secondary endpoints. In December 2021, AbbVie announced top-line results from its Phase 3 U-EXCEED induction study for Rinvoq in patients with moderate to severe Crohn's disease who had an inadequate response or were intolerant to biologic therapy met the primary and key secondary endpoints. In December 2021, AbbVie announced an update to the U.S. Prescribing Information and Medication Guide for Rinvoq for the treatment of adults with moderate to severe rheumatoid arthritis (RA). This update follows a Drug Safety Communication (DSC) issued by the FDA in September 2021 based on its final review of the post-marketing study evaluating another JAK inhibitor (tofacitinib) in patients with RA. The DSC and this label update apply to the class of systematically administered FDA-approved JAK inhibitors for the treatment of RA and other inflammatory diseases. Based on this class-wide update, the U.S. label for Rinvoq will now include additional information about risks within the Boxed Warnings and Warnings Precautions sections. The indication has also been updated to be indicated for the treatment of adults with moderately to severely active RA who have had an inadequate response or intolerance to one or more tumor necrosis factor (TNF) blockers. In December 2021, A bbVie announced that the FDA approved Rinvoq for the treatment of adults with active PsA who have had an inadequate response or intolerance to one or more TNF blockers. In January 2022, Abb Vie announced its submission of an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adults with active nr-axSpA with objective signs of inflammation who have responded inadequately to nonsteroidal anti-inflammatory drugs. In January 2022, Ab bVie announced that the FDA approved Rinvoq for the treatment of moderate to severe AD in adults and children 12 years of age and older whose disease did not respond to previous treatment and is not well controlled with other pills or injections, including biologic medicines, or when use of other pills or injections is not recommended. In February 2022, AbbVie was notified that the EC is requesting the EMA to assess safety concerns associated with JAK inhibitor products authorized in inflammatory diseases and to evaluate the impact of these events on their benefit-risk balance. The assessment covers all JAK inhibitors approved for use in inflammatory diseases. The request is for an opinion from the EMA by September 30, 2022. Oncology Imbruvica In June 2021, AbbVie announced results from its Phase 3 GLOW study comparing the efficacy and safety of Imbruvica in combination with Venclexta versus chlorambucil plus obinutuzumab for first-line treatment in patients with chronic lymphocytic leukemia (CLL) or small lymphocytic lymphoma met its primary endpoint. Venclexta In May 2021, AbbVie received European Commission approval for Venclyxto in combination with a hypomethylating agent for patients with newly diagnosed acute myeloid leukemia (AML) who are ineligible for intensive chemotherapy. | 2021 Form 10-K In July 2021, AbbVie announced that the FDA granted Breakthrough Therapy Designation to Venclexta in combination with azacitidine for the potential treatment of adult patients with previously untreated intermediate-, high- and very high-risk myelodysplastic syndromes. Teliso-V In January 2022, AbbVie announced that the FDA granted Breakthrough Therapy Designation to investigational telisotuzumab vedotin (Teliso-V) for the treatment of patients with advanced/metastatic epidermal growth factor receptor wild type, nonsquamous non-small cell lung cancer with high levels of c-Met overexpression whose disease has progressed on or after platinum-based therapy. Neuroscience Botox Therapeutic In February 2021, AbbVie received FDA approval of Botox for the treatment of detrusor overactivity associated with a neurological condition in certain pediatric patients 5 years of age and older. Qulipta In September 2021, AbbVie announced that the FDA approved Qulipta (atogepant) for the preventive treatment of episodic migraine in adults. Vraylar In October 2021, A bbVie announced top-line results from two Phase 3 clinical trials, Study 3111-301-001 and Study 3111-302-001, evaluating the efficacy and safety of cariprazine (Vraylar) as an adjunctive treatment for patients with major depressive disorder (MDD). In Study 3111-301-001, Vraylar met its primary endpoint demonstrating statistically significant change from baseline to week six in the Montgomery-sberg Depression Rating Scale (MADRS) total score compared with placebo in patients with MDD. In Study 3111-302-001, Vraylar demonstrated numerical improvement in depressive symptoms from baseline to week six in MADRS total score compared with placebo but did not achieve statistical significance. Safety data were consistent with the established safety profile of Vraylar across indications with no new safety signals identified. ABBV-951 In October 2021, Abb Vie announced that results from its pivotal Phase 3 M15-736 study of ABBV-951 (foslevodopa/foscarbidopa) in patients with advanced Parkinsons disease met its primary endpoint in a 12-week study. Eye Care Vuity In October 2021, AbbVie announced that the FDA approved Vuity (pilocarpine HCl ophthalmic solution) for the treatment of presbyopia. 2021 Form 10-K | RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 United States $ 43,510 $ 34,879 $ 23,907 24.7 % 45.9 % 24.7 % 45.9 % International 12,687 10,925 9,359 16.1 % 16.7 % 12.6 % 17.8 % Net revenues $ 56,197 $ 45,804 $ 33,266 22.7 % 37.7 % 21.9 % 38.0 % | 2021 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 Immunology Humira United States $ 17,330 $ 16,112 $ 14,864 7.6 % 8.4 % 7.6 % 8.4 % International 3,364 3,720 4,305 (9.6) % (13.6) % (12.8) % (12.5) % Total $ 20,694 $ 19,832 $ 19,169 4.3 % 3.5 % 3.7 % 3.7 % Skyrizi United States $ 2,486 $ 1,385 $ 311 79.6 % 100.0% 79.6 % 100.0% International 453 205 44 100.0 % 100.0% 100.0 % 100.0% Total $ 2,939 $ 1,590 $ 355 84.9 % 100.0% 84.0 % 100.0% Rinvoq United States $ 1,271 $ 653 $ 47 94.8 % 100.0% 94.8 % 100.0% International 380 78 100.0 % 100.0% 100.0 % 100.0% Total $ 1,651 $ 731 $ 47 100.0 % 100.0% 100.0 % 100.0% Hematologic Oncology Imbruvica United States $ 4,321 $ 4,305 $ 3,830 0.4 % 12.4 % 0.4 % 12.4 % Collaboration revenues 1,087 1,009 844 7.7 % 19.5 % 7.7 % 19.5 % Total $ 5,408 $ 5,314 $ 4,674 1.8 % 13.7 % 1.8 % 13.7 % Venclexta United States $ 934 $ 804 $ 521 16.1 % 54.4 % 16.1 % 54.4 % International 886 533 271 66.2 % 97.0 % 60.9 % 97.8 % Total $ 1,820 $ 1,337 $ 792 36.1 % 69.0 % 34.0 % 69.3 % Aesthetics Botox Cosmetic (a) United States $ 1,424 $ 687 $ 100.0 % n/m 100.0 % n/m International 808 425 90.0 % n/m 83.9 % n/m Total $ 2,232 $ 1,112 $ 100.0 % n/m 98.4 % n/m Juvederm Collection (a) United States $ 658 $ 318 $ 100.0 % n/m 100.0 % n/m International 877 400 100.0 % n/m 100.0 % n/m Total $ 1,535 $ 718 $ 100.0 % n/m 100.0 % n/m Other Aesthetics (a) United States $ 1,268 $ 666 $ 90.2 % n/m 90.2 % n/m International 198 94 100.0 % n/m 100.0 % n/m Total $ 1,466 $ 760 $ 93.0 % n/m 91.9 % n/m Neuroscience Botox Therapeutic (a) United States $ 2,012 $ 1,155 $ 74.3 % n/m 74.3 % n/m International 439 232 89.0 % n/m 78.8 % n/m Total $ 2,451 $ 1,387 $ 76.7 % n/m 75.0 % n/m Vraylar (a) United States $ 1,728 $ 951 $ 81.7 % n/m 81.7 % n/m Duodopa United States $ 102 $ 103 $ 97 (1.0) % 5.9 % (1.0) % 5.9 % International 409 391 364 4.6 % 7.4 % (0.1) % 6.3 % Total $ 511 $ 494 $ 461 3.4 % 7.1 % (0.3) % 6.2 % Ubrelvy (a) United States $ 552 $ 125 $ 100.0 % n/m 100.0 % n/m Other Neuroscience (a) United States $ 667 $ 528 $ 26.3 % n/m 26.3 % n/m International 18 11 77.4 % n/m 64.7 % n/m Total $ 685 $ 539 $ 27.2 % n/m 27.0 % n/m 2021 Form 10-K | Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 2021 2020 Eye Care Lumigan/Ganfort (a) United States $ 273 $ 165 $ 64.7 % n/m 64.7 % n/m International 306 213 44.1 % n/m 38.1 % n/m Total $ 579 $ 378 $ 53.1 % n/m 49.7 % n/m Alphagan/Combigan (a) United States $ 373 $ 223 $ 66.5 % n/m 66.5 % n/m International 156 103 52.5 % n/m 50.6 % n/m Total $ 529 $ 326 $ 62.1 % n/m 61.5 % n/m Restasis (a) United States $ 1,234 $ 755 $ 63.3 % n/m 63.3 % n/m International 56 32 75.3 % n/m 80.1 % n/m Total $ 1,290 $ 787 $ 63.8 % n/m 64.0 % n/m Other Eye Care (a) United States $ 523 $ 305 $ 72.7 % n/m 72.7 % n/m International 646 388 66.1 % n/m 61.0 % n/m Total $ 1,169 $ 693 $ 69.0 % n/m 66.1 % n/m Women's Health Lo Loestrin (a) United States $ 423 $ 346 $ 21.9 % n/m 21.9 % n/m International 14 10 43.3 % n/m 33.0 % n/m Total $ 437 $ 356 $ 22.5 % n/m 22.2 % n/m Orilissa/Oriahnn United States $ 139 $ 121 $ 91 15.4 % 33.3 % 15.4 % 33.3 % International 6 4 2 57.7 % 96.1 % 47.6 % 97.7 % Total $ 145 $ 125 $ 93 16.7 % 34.6 % 16.4 % 34.6 % Other Women's Health (a) United States $ 209 $ 181 $ 16.2 % n/m 16.2 % n/m International 5 11 (57.5) % n/m (61.5) % n/m Total $ 214 $ 192 $ 11.7 % n/m 11.5 % n/m Other Key Products Mavyret United States $ 754 $ 785 $ 1,473 (4.0) % (46.7) % (4.0) % (46.7) % International 956 1,045 1,420 (8.5) % (26.4) % (10.8) % (26.8) % Total $ 1,710 $ 1,830 $ 2,893 (6.5) % (36.7) % (7.8) % (36.9) % Creon United States $ 1,191 $ 1,114 $ 1,041 6.9 % 6.9 % 6.9 % 6.9 % Lupron United States $ 604 $ 600 $ 720 0.5 % (16.6) % 0.5 % (16.6) % International 179 152 167 18.0 % (9.1) % 15.0 % (5.4) % Total $ 783 $ 752 $ 887 4.0 % (15.2) % 3.4 % (14.5) % Linzess/Constella (a) United States $ 1,006 $ 649 $ 55.1 % n/m 55.1 % n/m International 32 18 77.3 % n/m 66.4 % n/m Total $ 1,038 $ 667 $ 55.7 % n/m 55.4 % n/m Synthroid United States $ 767 $ 771 $ 786 (0.6) % (1.9) % (0.6) % (1.9) % All other $ 2,673 $ 2,923 $ 2,068 (8.6) % 41.3 % (9.7) % 42.4 % Total net revenues $ 56,197 $ 45,804 $ 33,266 22.7 % 37.7 % 21.9 % 38.0 % n/m Not meaningful (a) Net revenues include Allergan product revenues after the acquisition closing date of May 8, 2020. The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global Humira sales increased 4% in 2021 primarily driven by market growth across therapeutic categories, partially offset by direct biosimilar competition in certain international markets. In the United States, Humira sales increased 8% in 2021 driven by market growth across all indications. This increase was partially offset by slightly lower market share following corresponding market share gains of Skyrizi and Rinvoq. Internationally, Humira revenues decreased 13% in 2021 primarily driven by direct biosimilar competition in certain international markets. Net revenues for Skyrizi increased 84% in 2021 primarily driven by continued strong volume and market share uptake since launch in 2019 as a treatment for plaque psoriasis as well as market growth over the prior year. Net revenues for Rinvoq increased by more than 100% in 2021 primarily driven by continued strong volume and market share uptake since launch in 2019 for the treatment of moderate to severe rheumatoid arthritis as well as market growth over the prior year. Net revenues were also favorably impacted by recent regulatory approvals and expansion of Rinvoq for the treatment of psoriatic arthritis, atopic dermatitis and ankylosing spondylitis in certain international markets. | 2021 Form 10-K Net revenues for Imbruvica represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of Imbruvica profit. AbbVie's global Imbruvica revenues increased 2% in 2021 as a result of modest favorable pricing in the United States and increased collaboration revenues, partially offset by lower new patient starts due to the COVID-19 pandemic and share loss in the United States. Net revenues for Venclexta increased 34% in 2021 primarily due to continued expansion of Venclexta for the treatment of patients with first-line CLL, relapsed/refractory CLL and first-line AML. Net revenues for Botox Cosmetic used in facial aesthetics increased 98% in 2021 due to increased brand investment and strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Juvederm Collection (including Juvederm Ultra XC, Juvederm Voluma XC and other Juvederm products) used in facial aesthetics increased by more than 100% in 2021 due to increased brand investment and strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Botox Therapeutic used primarily in neuroscience and urology therapeutic areas increased 75% in 2021 due to a strong recovery from the COVID-19 pandemic. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Vraylar for the treatment of schizophrenia, bipolar I disorder and bipolar depression increased 82% in 2021 due to higher market share and market growth. Net revenues were also favorably impacted by a full period of Allergan results in 2021 compared to the prior year. Net revenues for Ubrelvy for the acute treatment of migraine with or without aura in adults increased by more than 100% in 2021 primarily due to increased volume and market share uptake since launch in 2020. Net revenues for Mavyret decreased 8% in 2021 primarily driven by the continued disruption of global HCV markets due to the COVID-19 pandemic. Gross Margin Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Gross margin $ 38,751 $ 30,417 $ 25,827 27 % 18 % as a percent of net revenues 69 % 66 % 78 % Gross margin as a percentage of net revenues in 2021 increased from 2020 primarily due to lower amortization of inventory fair value step-up adjustment associated with the Allergan acquisition and favorable changes in product mix, partially offset by higher amortization of intangible assets associated with the Allergan acquisition. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Selling, general and administrative $ 12,349 $ 11,299 $ 6,942 9 % 63 % as a percent of net revenues 22 % 25 % 21 % SGA expenses as a percentage of net revenues in 2021 decreased primarily due to lower transaction and integration costs related to the acquisition of Allergan as well as leverage from revenue growth and synergies realized in the period subsequent to completion of the Allergan acquisition. 2021 Form 10-K | Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) 2021 2020 2019 2021 2020 Research and development $ 7,084 $ 6,557 $ 6,407 8 % 2 % as a percent of net revenues 13 % 14 % 19 % Acquired in-process research and development $ 962 $ 1,198 $ 385 (20) % 100% RD expenses as a percentage of net revenues decreased in 2021 primarily due to the increased scale of the combined company and synergies realized for the period subsequent to completion of the Allergan acquisition as well as lower integration costs related to the acquisition of Allergan. Acquired IPRD expenses represent initial costs to acquire rights to in-process RD projects through RD collaborations, licensing arrangements or other asset acquisitions. Acquired IPRD expense in 2021 included a charge of $400 million as a result of exercising the company's exclusive right to acquire TeneoOne, an affiliate of Teneobio, Inc., and TNB-383B, a BCMA-targeting immunotherapeutic for the potential treatment of relapsed or refractory multiple myeloma and a charge of $370 million as a result of entering into a collaboration agreement with REGENXBIO Inc. for the development and commercialization of RGX-314, an investigational gene therapy for wet age-related macular degeneration, diabetic retinopathy and other chronic retinal diseases. Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering into a collaboration agreement with Genmab A/S to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer. Acquired IPRD expense in 2020 also included a charge of $200 million as a result of entering into a collaboration agreement with I-Mab Biopharma for the development and commercialization of lemzoparlimab for the treatment of multiple cancers. See Note 5 to the Consolidated Financial Statements for additional information. Other Operating Expense (Income), Net Other operating expense in 2021 included a $500 million charge related to the extension of the Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Other Non-Operating Expenses years ended December 31 (in millions) 2021 2020 2019 Interest expense $ 2,423 $ 2,454 $ 1,784 Interest income (39) (174) (275) Interest expense, net $ 2,384 $ 2,280 $ 1,509 Net foreign exchange loss $ 51 $ 71 $ 42 Other expense, net 2,500 5,614 3,006 Interest expense in 2021 decreased compared to 2020 primarily due to the favorable impact of lower interest rates on the companys floating rate debt obligations and deleveraging, partially offset by a higher average debt balance associated with the incremental Allergan debt acquired. Interest income in 2021 decreased compared to 2020 primarily due to a lower average cash and cash equivalents balance as a result of the cash paid for the Allergan acquisition and the unfavorable impact of lower interest rates. Other expense, net included charges related to changes in fair value of the contingent consideration liabilities of $2.7 billion in 2021 and $5.8 billion in 2020. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products and other market-based factors. In 2021, the change in fair value included the increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, favorable clinical trial results and the passage of time, partially offset by higher discount rates. In 2020, the change in fair value primarily included the increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, lower discount rates, the passage of time and favorable clinical trial results. | 2021 Form 10-K Income Tax Expense The effective income tax rate was 11% in 2021, negative 36% in 2020 and 6% in 2019. The effective income tax rates differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, tax audit settlements and accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) 2021 2020 2019 Cash flows provided by (used in) Operating activities $ 22,777 $ 17,588 $ 13,324 Investing activities (2,344) (37,557) 596 Financing activities (19,039) (11,501) 18,708 Operating cash flows in 2021 increased from 2020. Operating cash flows in 2021 were favorably impacted by higher net revenues of the combined company and lower acquisition-related cash expenses, partially offset by higher income tax payments and the timing of working capital cash flows. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $376 million in 2021 and $367 million in 2020. Investing cash flows in 2021 included $535 million cash consideration paid to acquire Soliton, Inc. offset by cash acquired, payments made for other acquisitions and investments of $1.4 billion, capital expenditures of $787 million and net purchases of investment securities totaling $21 million. Investing cash flows in 2020 included $39.7 billion cash consideration paid to acquire Allergan offset by cash acquired of $1.5 billion, net sales and maturities of investment securities totaling $1.5 billion, payments made for other acquisitions and investments of $1.4 billion and capital expenditures of $798 million. Financing cash flows in 2021 included early repayments of $1.8 billion aggregate principal amount of the company's 2.3% principal notes, $1.2 billion aggregate principal amount of the company's 5.0% senior notes and 750 million aggregate principal amount of the company's 0.5% senior Euro notes. Financing cash flows also included the May 2021 repayment of $750 million aggregate principal amount of floating rate senior notes and the November 2021 repayment of $1.3 billion aggregate principal amount of 3.375% senior notes, $1.8 billion aggregate principal amount of 2.15% senior notes and $750 million aggregate principal amount of floating rate senior notes at maturity. Additionally, financing cash flows included repayment of a $1.0 billion floating rate term loan due May 2023 and issuance of a new $1.0 billion floating rate term loan as part of the term loan refinancing in September 2021. Financing cash flows in 2020 included the issuance of term loans totaling $3.0 billion under the existing $6.0 billion term loan credit agreement which were used to finance the acquisition of Allergan. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. Additionally, financing cash flows included the May 2020 repayment of $3.8 billion aggregate principal amount of the company's 2.50% senior notes, the September 2020 repayment of $650 million aggregate principal amount of 3.375% senior notes and the November 2020 repayments of 700 million aggregate principal amount of floating rate senior Euro notes at maturity as well as the $450 million aggregate principal amount of 4.875% senior notes due February 2021. Financing cash flows also included cash dividend payments of $9.3 billion in 2021 and $7.7 billion in 2020. The increase in cash dividend payments was primarily driven by an increase of the dividend rate and higher outstanding shares following the 286 million shares of AbbVie common stock issued to Allergan shareholders in May 2020. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 6 million shares for $670 million in 2021 and 8 million shares for $757 million in 2020. AbbVie's remaining stock repurchase authorization was $2.5 billion as of December 31, 2021. 2021 Form 10-K | No commercial paper borrowings were issued during 2021. In 2020, the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2021 or December 31, 2020. AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance for credit losses equal to the estimate of future losses over the contractual life of outstanding accounts receivable. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2021, the company was in compliance with all covenants, and commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facility as of December 31, 2021 and 2020. Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations or has the ability to issue additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes to the company's credit ratings during 2021. Following the acquisition of Allergan in 2020, SP Global Ratings revised its ratings outlook to stable from negative and lowered the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1. There were no changes in Moody's Investor Service of its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the companys ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the companys outstanding debt. Future Cash Requirements Contractual Obligations The following table summarizes AbbVie's estimated material contractual obligations as of December 31, 2021: (in millions) Total Current Long-term Long-term debt, including current portion $ 75,962 $ 12,428 $ 63,534 Interest on long-term debt (a) 30,002 2,392 27,610 Contingent consideration liabilities (b) 14,887 1,249 13,638 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2021. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2021. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2021. | 2021 Form 10-K (b) Includes contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. AbbVie enters into certain unconditional purchase obligations and other commitments in the normal course of business. There have been no changes to these commitments that would have a material impact on the companys ability to meet either short-term or long-term future cash requirements. Income Taxes Future income tax cash requirements include a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax liability was $3.9 billion as of December 31, 2021 and is payable in five future annual installments. Liabilities for unrecognized tax benefits totaled $6.0 billion as of December 31, 2021. It is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. Quarterly Cash Dividend On October 29, 2021, AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.30 per share to $1.41 per share beginning with the dividend payable on February 15, 2022 to stockholders of record as of January 14, 2022. This reflects an increase of approximately 8.5% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Collaborations, Licensing and Other Arrangements AbbVie enters into collaborative, licensing, and other arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements. Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. 2021 Form 10-K | Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Provisions for rebates and chargebacks totaled $33.9 billion in 2021, $27.0 billion in 2020 and $18.8 billion in 2019. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest accruals for rebates and chargebacks, which comprise approximately 95% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2021. Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2018 $ 1,645 $ 1,439 $ 656 Provisions 4,035 5,772 7,947 Payments (3,915) (5,275) (7,917) Balance at December 31, 2019 1,765 1,936 686 Additions (a) 1,266 649 71 Provisions 6,715 8,656 8,677 Payments (6,801) (8,334) (8,693) Balance at December 31, 2020 2,945 2,907 741 Provisions 9,622 11,306 11,286 Payments (8,751) (11,116) (11,125) Balance at December 31, 2021 $ 3,816 $ 3,097 $ 902 (a) Represents rebate accruals and chargeback allowances assumed in the Allergan acquisition. Cash Discounts and Product Returns Cash discounts and product returns, which totaled $3.6 billion in 2021, $2.4 billion in 2020 and $1.6 billion in 2019, are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements. | 2021 Form 10-K The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2021. A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2022 and projected benefit obligations as of December 31, 2021: 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (90) $ 100 Projected benefit obligation (1,014) 1,159 Other post-employment plans Service and interest cost $ (7) $ 7 Projected benefit obligation (61) 69 The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2021 and will be used in the calculation of net periodic benefit cost in 2022. A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2022 by $101 million. The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2021 and will be used in the calculation of net periodic benefit cost in 2022. Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur between companies in 2021 Form 10-K | the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for additional information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs, which are disclosed in Note 11 to the Consolidated Financial Statements. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. | 2021 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar, Chinese yuan and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2021 and 2020: 2021 2020 as of December 31 (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 10,253 1.155 $ 195 $ 7,818 1.213 $ (39) Chinese yuan 673 6.400 (1) 247 6.584 (1) British pound 605 1.331 9 275 1.341 3 Japanese yen 602 113.3 9 837 103.9 (7) Canadian dollar 571 1.258 9 591 1.328 (23) All other currencies 1,549 n/a 5 1,459 n/a (14) Total $ 14,253 $ 226 $ 11,227 $ (81) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.4 billion at December 31, 2021. If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2021, the company has 5.9 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive loss. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $244 million at December 31, 2021. If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.0 billion at December 31, 2021. A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 2021 Form 10-K | "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm (PC AOB ID: 42 ) 49 | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) 2021 2020 2019 Net revenues $ 56,197 $ 45,804 $ 33,266 Cost of products sold 17,446 15,387 7,439 Selling, general and administrative 12,349 11,299 6,942 Research and development 7,084 6,557 6,407 Acquired in-process research and development 962 1,198 385 Other operating expense (income), net 432 ( 890 ) Total operating costs and expenses 38,273 34,441 20,283 Operating earnings 17,924 11,363 12,983 Interest expense, net 2,384 2,280 1,509 Net foreign exchange loss 51 71 42 Other expense, net 2,500 5,614 3,006 Earnings before income tax expense 12,989 3,398 8,426 Income tax expense (benefit) 1,440 ( 1,224 ) 544 Net earnings 11,549 4,622 7,882 Net earnings attributable to noncontrolling interest 7 6 Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Per share data Basic earnings per share attributable to AbbVie Inc. $ 6.48 $ 2.73 $ 5.30 Diluted earnings per share attributable to AbbVie Inc. $ 6.45 $ 2.72 $ 5.28 Weighted-average basic shares outstanding 1,770 1,667 1,481 Weighted-average diluted shares outstanding 1,777 1,673 1,484 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) 2021 2020 2019 Net earnings $ 11,549 $ 4,622 $ 7,882 Foreign currency translation adjustments, net of tax expense (benefit) of $( 35 ) in 2021, $ 28 in 2020 and $( 4 ) in 2019 ( 1,153 ) 1,511 ( 98 ) Net investment hedging activities, net of tax expense (benefit) of $ 193 in 2021, $( 221 ) in 2020 and $ 22 in 2019 699 ( 799 ) 74 Pension and post-employment benefits, net of tax expense (benefit) of $ 124 in 2021, $( 47 ) in 2020 and $( 323 ) in 2019 521 ( 102 ) ( 1,243 ) Marketable security activities, net of tax expense (benefit) of $ in 2021, $ in 2020 and $ in 2019 10 Cash flow hedging activities, net of tax expense (benefit) of $ 20 in 2021, $( 23 ) in 2020 and $ 70 in 2019 151 ( 131 ) 141 Other comprehensive income (loss) $ 218 $ 479 $ ( 1,116 ) Comprehensive income 11,767 5,101 6,766 Comprehensive income attributable to noncontrolling interest 7 6 Comprehensive income attributable to AbbVie Inc. $ 11,760 $ 5,095 $ 6,766 The accompanying notes are an integral part of these consolidated financial statements. | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) 2021 2020 Assets Current assets Cash and equivalents $ 9,746 $ 8,449 Short-term investments 84 30 Accounts receivable, net 9,977 8,822 Inventories 3,128 3,310 Prepaid expenses and other 4,993 3,562 Total current assets 27,928 24,173 Investments 277 293 Property and equipment, net 5,110 5,248 Intangible assets, net 75,951 82,876 Goodwill 32,379 33,124 Other assets 4,884 4,851 Total assets $ 146,529 $ 150,565 Liabilities and Equity Current liabilities Short-term borrowings $ 14 $ 34 Current portion of long-term debt and finance lease obligations 12,481 8,468 Accounts payable and accrued liabilities 22,699 20,159 Total current liabilities 35,194 28,661 Long-term debt and finance lease obligations 64,189 77,554 Deferred income taxes 3,009 3,646 Other long-term liabilities 28,701 27,607 Commitments and contingencies Stockholders' equity (deficit) Common stock, $ 0.01 par value, 4,000,000,000 shares authorized, 1,803,195,293 shares issued as of December 31, 2021 and 1,792,140,764 as of December 31, 2020 18 18 Common stock held in treasury, at cost, 34,857,597 shares as of December 31, 2021 and 27,007,945 as of December 31, 2020 ( 3,143 ) ( 2,264 ) Additional paid-in capital 18,305 17,384 Retained earnings 3,127 1,055 Accumulated other comprehensive loss ( 2,899 ) ( 3,117 ) Total stockholders' equity 15,408 13,076 Noncontrolling interest 28 21 Total equity 15,436 13,097 Total liabilities and equity $ 146,529 $ 150,565 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Noncontrolling interest Total Balance at December 31, 2018 1,479 $ 18 $ ( 24,108 ) $ 14,756 $ 3,368 $ ( 2,480 ) $ $ ( 8,446 ) Net earnings attributable to AbbVie Inc. 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other 5 32 437 469 Balance at December 31, 2019 1,479 18 ( 24,504 ) 15,193 4,717 ( 3,596 ) ( 8,172 ) Net earnings attributable to AbbVie Inc. 4,616 4,616 Other comprehensive income, net of tax 479 479 Dividends declared ( 8,278 ) ( 8,278 ) Common shares and equity awards issued for acquisition of Allergan plc 286 23,166 1,243 24,409 Purchases of treasury stock ( 10 ) ( 978 ) ( 978 ) Stock-based compensation plans and other 10 52 948 1,000 Change in noncontrolling interest 21 21 Balance at December 31, 2020 1,765 18 ( 2,264 ) 17,384 1,055 ( 3,117 ) 21 13,097 Net earnings attributable to AbbVie Inc. 11,542 11,542 Other comprehensive income, net of tax 218 218 Dividends declared ( 9,470 ) ( 9,470 ) Purchases of treasury stock ( 8 ) ( 934 ) ( 934 ) Stock-based compensation plans and other 11 55 921 976 Change in noncontrolling interest 7 7 Balance at December 31, 2021 1,768 $ 18 $ ( 3,143 ) $ 18,305 $ 3,127 $ ( 2,899 ) $ 28 $ 15,436 The accompanying notes are an integral part of these consolidated financial statements. | 2021 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) 2021 2020 2019 Cash flows from operating activities Net earnings $ 11,549 $ 4,622 $ 7,882 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation 803 666 464 Amortization of intangible assets 7,718 5,805 1,553 Deferred income taxes ( 898 ) ( 2,325 ) 122 Change in fair value of contingent consideration liabilities 2,679 5,753 3,091 Stock-based compensation 692 753 430 Upfront costs and milestones related to collaborations 1,624 1,376 490 Gain on divestitures ( 68 ) ( 330 ) Stemcentrx impairment 1,030 Other, net 832 43 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable ( 1,321 ) ( 929 ) ( 74 ) Inventories ( 142 ) ( 40 ) ( 231 ) Prepaid expenses and other assets ( 197 ) 134 ( 225 ) Accounts payable and other liabilities 1,628 1,514 97 Income tax assets and liabilities, net ( 1,290 ) ( 573 ) ( 1,018 ) Cash flows from operating activities 22,777 17,588 13,324 Cash flows from investing activities Acquisition of businesses, net of cash acquired ( 525 ) ( 38,260 ) Other acquisitions and investments ( 1,377 ) ( 1,350 ) ( 1,135 ) Acquisitions of property and equipment ( 787 ) ( 798 ) ( 552 ) Purchases of investment securities ( 119 ) ( 61 ) ( 583 ) Sales and maturities of investment securities 98 1,525 2,699 Other, net 366 1,387 167 Cash flows from investing activities ( 2,344 ) ( 37,557 ) 596 Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 1,000 3,000 31,482 Repayments of long-term debt and finance lease obligations ( 9,414 ) ( 5,683 ) ( 1,536 ) Debt issuance costs ( 20 ) ( 424 ) Dividends paid ( 9,261 ) ( 7,716 ) ( 6,366 ) Purchases of treasury stock ( 934 ) ( 978 ) ( 629 ) Proceeds from the exercise of stock options 244 209 8 Payments of contingent consideration liabilities ( 698 ) ( 321 ) ( 163 ) Other, net 24 8 35 Cash flows from financing activities ( 19,039 ) ( 11,501 ) 18,708 Effect of exchange rate changes on cash and equivalents ( 97 ) ( 5 ) 7 Net change in cash and equivalents 1,297 ( 31,475 ) 32,635 Cash and equivalents, beginning of year 8,449 39,924 7,289 Cash and equivalents, end of year $ 9,746 $ 8,449 $ 39,924 Other supplemental information Interest paid, net of portion capitalized $ 2,712 $ 2,619 $ 1,794 Income taxes paid 3,648 1,674 1,447 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 23,979 The accompanying notes are an integral part of these consolidated financial statements. 2021 Form 10-K | AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacturing and sale of a broad line of therapies that address some of the world's most complex and serious diseases. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On May 8, 2020, AbbVie completed its acquisition of Allergan plc (Allergan). Refer to Note 5 for additional information regarding this acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are | 2021 Form 10-K typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaborations with Janssen Biotech, Inc. and Genentech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 2.1 billion in 2021, $ 1.8 billion in 2020 and $ 1.1 billion in 2019. Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (loss) (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are generally amortized to net periodic benefit cost over a five-year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. 2021 Form 10-K | Investments Investments consist primarily of equity securities, held-to-maturity debt securities, marketable debt securities and time deposits. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. AbbVie periodically assesses its marketable debt securities for impairment and credit losses. When a decline in fair value of marketable debt security is due to credit related factors, an allowance for credit losses is recorded with a corresponding charge to other expense, net in the consolidated statements of earnings. When AbbVie determines that a non-credit related impairment has occurred, the amortized cost basis of the investment, net of allowance for credit losses, is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any impairments and credit losses that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) 2021 2020 Finished goods $ 932 $ 1,318 Work-in-process 1,193 1,201 Raw materials 1,003 791 Inventories $ 3,128 $ 3,310 Property and Equipment as of December 31 (in millions) 2021 2020 Land $ 287 $ 288 Buildings 2,791 2,555 Equipment 6,850 6,976 Construction in progress 799 1,040 Property and equipment, gross 10,727 10,859 Less accumulated depreciation ( 5,617 ) ( 5,611 ) Property and equipment, net $ 5,110 $ 5,248 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 803 million in 2021, $ 666 million in 2020 and $ 464 million in 2019. | 2021 Form 10-K Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease 2021 Form 10-K | the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs to acquire rights to IPRD projects are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. AbbVie adopted the standard in the first quarter of 2021. The adoption did not have a material impact on its consolidated financial statements. | 2021 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) 2021 2020 2019 Interest expense $ 2,423 $ 2,454 $ 1,784 Interest income ( 39 ) ( 174 ) ( 275 ) Interest expense, net $ 2,384 $ 2,280 $ 1,509 Accounts Payable and Accrued Liabilities as of December 31 (in millions) 2021 2020 Sales rebates $ 8,254 $ 7,188 Dividends payable 2,543 2,335 Accounts payable 2,882 2,276 Salaries, wages and commissions 1,785 1,669 Royalty and license arrangements 661 483 Other 6,574 6,208 Accounts payable and accrued liabilities $ 22,699 $ 20,159 Other Long-Term Liabilities as of December 31 (in millions) 2021 2020 Contingent consideration liabilities $ 13,638 $ 12,289 Liabilities for unrecognized tax benefits 5,970 5,680 Income taxes payable 3,442 3,847 Pension and other post-employment benefits 3,153 3,413 Other 2,498 2,378 Other long-term liabilities $ 28,701 $ 27,607 2021 Form 10-K | Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) 2021 2020 2019 Basic EPS Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Earnings allocated to participating securities 74 60 40 Earnings available to common shareholders $ 11,468 $ 4,556 $ 7,842 Weighted average basic shares of common stock outstanding 1,770 1,667 1,481 Basic earnings per share attributable to AbbVie Inc. $ 6.48 $ 2.73 $ 5.30 Diluted EPS Net earnings attributable to AbbVie Inc. $ 11,542 $ 4,616 $ 7,882 Earnings allocated to participating securities 74 60 40 Earnings available to common shareholders $ 11,468 $ 4,556 $ 7,842 Weighted average shares of common stock outstanding 1,770 1,667 1,481 Effect of dilutive securities 7 6 3 Weighted average diluted shares of common stock outstanding 1,777 1,673 1,484 Diluted earnings per share attributable to AbbVie Inc. $ 6.45 $ 2.72 $ 5.28 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Allergan On May 8, 2020, AbbVie completed its acquisition of all outstanding equity interests in Allergan in a cash and stock transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. The combination created a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. Under the terms of the acquisition, each ordinary share of Allergan common stock was converted into the right to receive (i) $ 120.30 in cash and (ii) 0.8660 of a share of AbbVie common stock. Total consideration for the acquisition of Allergan is summarized as follows: (in millions) Cash consideration paid to Allergan shareholders (a) $ 39,675 Fair value of AbbVie common stock issued to Allergan shareholders (b) 23,979 Fair value of AbbVie equity awards issued to Allergan equity award holders (c) 430 Total consideration $ 64,084 (a) Represents cash consideration transferred of $ 120.30 per outstanding Allergan ordinary share based on 330 million Allergan ordinary shares outstanding at closing. | 2021 Form 10-K (b) Represents the acquisition date fair value of 286 million shares of AbbVie common stock issued to Allergan shareholders based on the exchange ratio of 0.8660 AbbVie shares for each outstanding Allergan ordinary share at the May 8, 2020 closing price of $ 83.96 per share. (c) Represents the pre-acquisition service portion of the fair value of 11 million AbbVie stock options and 8 million RSUs issued to Allergan equity award holders. The acquisition of Allergan has been accounted for as a business combination using the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The valuation of assets acquired and liabilities assumed was finalized during the second quarter of 2021. Measurement period adjustments to the preliminary purchase price allocation during 2021 included (i) an increase to intangible assets of $ 710 million; (ii) an increase to deferred income tax liabilities of $ 148 million; (iii) other individually insignificant adjustments for a net increase to identifiable net assets of $ 2 million; and (iv) a corresponding decrease to goodwill of $ 564 million. The measurement period adjustments primarily resulted from the completion of the valuation of certain license agreement intangible assets based on facts and circumstances that existed as of the acquisition date and did not result from intervening events subsequent to such date. These adjustments did not have a significant impact on AbbVie's results of operations in 2021 and would not have had a significant impact on prior period results if these adjustments had been made as of the acquisition date. The following table summarizes t he final fair value of assets acquired and liabilities assumed as of the acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ 1,537 Short-term investments 1,421 Accounts receivable 2,374 Inventories 2,340 Prepaid expenses and other current assets 1,982 Investments 137 Property and equipment 2,129 Intangible assets Definite-lived intangible assets 68,190 In-process research and development 1,600 Other noncurrent assets 1,395 Short-term borrowings ( 60 ) Current portion of long-term debt and finance lease obligations ( 1,899 ) Accounts payable and accrued liabilities ( 5,852 ) Long-term debt and finance lease obligations ( 18,937 ) Deferred income taxes ( 3,940 ) Other long-term liabilities ( 4,765 ) Total identifiable net assets 47,652 Goodwill 16,432 Total assets acquired and liabilities assumed $ 64,084 The fair value step-up adjustment to inventories of $ 1.2 billion was amortized to cost of products sold when the inventory was sold to customers and was fully amortized as of December 31, 2021. Intangible assets relate to $ 68.2 billion of definite-lived intangible assets and $ 1.6 billion of IPRD. The acquired definite-lived intangible assets consist of developed product rights and license agreements and are being amortized over a weighted-average estimated useful life of approximately twelve years using the estimated pattern of economic benefit. The estimated fair values of identifiable intangible assets were determined using the ""income approach"" which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product, the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, competitive trends impacting the asset and each cash flow stream, as well as other factors. 2021 Form 10-K | The fair value of long-term debt was determined by quoted market prices as of the acquisition date and the total purchase price adjustment of $ 1.3 billion is being amortized as a reduction to interest expense, net over the lives of the related debt. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from the other assets acquired that could not be individually identified and separately recognized. Specifically, the goodwill recognized from the acquisition of Allergan represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Allergan have been included in the consolidated financial statements. For the period from the acquisition date through December 31, 2020, net revenues attributable to Allergan were $ 10.3 billion and operating losses attributable to Allergan were $ 1.1 billion, inclusive of $ 4.0 billion of intangible asset amortization and $ 1.2 billion of inventory fair value step-up amortization. Acquisition-related expenses, which were comprised primarily of regulatory, financial advisory and legal fees, totaled $ 781 million for the year ended December 31, 2020 and $ 103 million for the year ended December 31, 2019 which were included in SGA expenses in the consolidated statements of earnings . In the fourth quarter of 2021, AbbVie recovered certain acquisition-related regulatory fees totaling $ 401 million which was recorded as a reduction to SGA expenses in the consolidated statement of earnings for the year ended December 31, 2021. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of AbbVie and Allergan for 2020 and 2019 as if the acquisition of Allergan had occurred on January 1, 2019: years ended December 31 (in millions) 2020 2019 Net revenues $ 50,521 $ 49,028 Net earnings (loss) 6,746 ( 38 ) The unaudited pro forma combined financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Allergan. In order to reflect the occurrence of the acquisition on January 1, 2019 as required, the unaudited pro forma financial information includes adjustments to reflect incremental amortization expense to be incurred based on the final fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with acquisition date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition-related costs incurred during the year ended December 31, 2020 to the year ended December 31, 2019. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2019. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. Acquisition of Soliton, Inc. In December 2021, AbbVie completed its previously announced acquisition of Soliton, Inc. (Soliton). Soliton's RESONIC (Rapid Acoustic Pulse device) has U.S. Food and Drug Administration (FDA) 510(k) clearance for the long-term improvement in the appearance of cellulite up to one year. The transaction was accounted for as a business combination using the acquisition method of accounting. Total consideration transferred allocated to the purchase price consisted of cash consideration of $ 535 million paid to holders of Soliton common stock, equity-based awards and warrants. As of the transaction date, AbbVie acquired $ 407 million of intangible assets for developed product rights and assumed deferred tax liabilities totaling $ 63 million. Other assets and liabilities were insignificant. The acquisition resulted in the recognition of $ 177 million of goodwill which is not deductible for tax purposes. Acquisition of Luminera In October 2020, AbbVie entered into an agreement with Luminera, a privately held aesthetics company based in Israel, to acquire Luminera's full dermal filler portfolio and RD pipeline including HArmonyCa, a dermal filler intended for facial soft tissue augmentation. The aggregate accounting purchase price of $ 186 million was comprised of a $ 122 million upfront cash payment and $ 64 million for the acquisition date fair value of contingent consideration liabilities, for which AbbVie may owe up to $ 90 million in future payments upon achievement of certain commercial milestones. The agreement was accounted for as a business combination using the acquisition method of accounting. As of the acquisition date, AbbVie acquired $ 127 million of intangible assets for in-process research and development and $ 33 million of intangible assets for developed | 2021 Form 10-K product rights. Other assets and liabilities assumed were insignificant. The acquisition resulted in the recognition of $ 12 million of goodwill which is not deductible for tax purposes. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.4 billion in 2021, $ 1.4 billion in 2020 and $ 1.1 billion in 2019. AbbVie recorded acquired IPRD charges of $ 962 million in 2021, $ 1.2 billion in 2020 and $ 385 million in 2019. Significant arrangements impacting 2021, 2020 and 2019, some of which require contingent milestone payments, are summarized below. Calico Life Sciences LLC In July 2021, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of their collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. This is the second collaboration extension and builds on the partnership established in 2014 and extended in 2018. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million and the term is extended for an additional three years. AbbVies contribution is payable in two equal installments beginning in 2023. Calico will be responsible for research and early development until 2025 and will advance collaboration projects into Phase 2a through 2030. Following completion of the Phase 2a studies, AbbVie will have the option to exclusively license the collaboration compounds. Upon exercise, AbbVie would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During the third quarter of 2021, AbbVie recorded $ 500 million as other operating expense in the consolidated statement of earnings related to its commitments under the agreement. TeneoOne and TNB-383B In September 2021, AbbVie acquired TeneoOne, an affiliate of Teneobio, Inc., and TNB-383B, a BCMA-targeting immunotherapeutic for the potential treatment of relapsed or refractory multiple myeloma (R/R MM). In February 2019, AbbVie and TeneoOne entered a strategic transaction to develop and commercialize TNB-383B, a bispecific antibody that simultaneously targets BCMA and CD3 and is designed to direct the body's own immune system to target and kill BCMA-expressing tumor cells. AbbVie exercised its exclusive right to acquire TeneoOne and TNB-383B based on an interim analysis of an ongoing Phase 1 study and accounted for the transaction as an asset acquisition. Under the terms of the agreement, AbbVie made an exercise payment of $ 400 million which was recorded to IPRD in the consolidated statement of earnings in the third quarter of 2021. The agreement also included additional payments of up to $ 250 million upon the achievement of certain development, regulatory and commercial milestones. REGENXBIO Inc. In September 2021, AbbVie and REGENXBIO Inc. (REGENXBIO) entered into a collaboration to develop and commercialize RGX-314, an investigational gene therapy for wet age-related macular degeneration, diabetic retinopathy and other chronic retinal diseases. The collaboration provides AbbVie with an exclusive global license to develop and commercialize RGX-314. REGENXBIO will be responsible for completion of ongoing trials, AbbVie and REGENXBIO will collaborate and share costs of additional trials, and AbbVie will lead the clinical development and commercialization of RGX-314 globally. REGENXBIO and AbbVie will share equally in pre-tax profits from net revenues of RGX-314 in the U.S. and AbbVie will pay REGENXBIO tiered royalties on net revenues outside the U.S. Upon closing in the fourth quarter of 2021, AbbVie made an upfront payment of $ 370 million to exclusively license RGX-314 which was recorded to IPRD in the consolidated statement of earnings for the year ended December 31, 2021 . The agreement also included additional payments of up to $ 1.4 billion upon the achievement of certain development, regulatory and commercial milestones. I-Mab Biopharma In September 2020, AbbVie and I-Mab Biopharma (I-Mab) entered into a collaboration agreement for the development and commercialization of lemzoparlimab, an anti-CD47 monoclonal antibody internally discovered and developed by I-Mab for the treatment of multiple cancers. Both companies will collaborate to design and conduct further global clinical trials to evaluate lemzoparlimab. The collaboration provides AbbVie an exclusive global license, excluding greater China, to develop and commercialize lemzoparlimab. The companies will share manufacturing responsibilities with AbbVie being the primary manufacturer for global supply. The agreement also allows for potential collaboration on future CD47-related therapeutic agents, subject to further licenses to explore each other's related programs in their respective territories. The terms of the arrangement include an initial upfront payment of $ 180 million to exclusively license lemzoparlimab along with a milestone payment of $ 20 million based on the Phase I results, for a total of $ 200 million, which was recorded to IPRD in the consolidated statement of earnings in the fourth quarter of 2020 after regulatory approval of the transaction. In addition, I-Mab will be eligible to receive up to $ 1.7 billion upon the achievement of certain clinical development, regulatory and 2021 Form 10-K | commercial milestones, and AbbVie will pay tiered royalties from low-to-mid teen percentages on global net revenues outside of greater China. Genmab A/S In June 2020, AbbVie and Genmab A/S (Genmab) entered into a collaboration agreement to jointly develop and commercialize three of Genmab's early-stage investigational bispecific antibody therapeutics and entered into a discovery research collaboration for future differentiated antibody therapeutics for the treatment of cancer. Under the terms of the agreement, Genmab granted to AbbVie an exclusive license to its epcoritamab (DuoBody-CD3xCD20), DuoHexaBody-CD37 and DuoBody-CD3x5T4 programs. For epcoritamab, the companies will share commercial responsibilities in the U.S. and Japan, with AbbVie responsible for further global commercialization. Genmab will record net revenues in the U.S. and Japan, and the parties will share equally in pre-tax profits from these sales. Genmab will receive tiered royalties on remaining global sales. For the discovery research partnership, Genmab will conduct Phase 1 studies for these programs and AbbVie retains the right to opt-in to program development. During 2020, AbbVie made an upfront payment of $ 750 million, which was recorded to IPRD in the consolidated statement of earnings. AbbVie could make additional payments of up to $ 3.2 billion upon the achievement of certain development, regulatory and commercial milestones for all programs. Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators. As consideration for the rights reacquired by Reata, AbbVie received a total of $ 250 million as of December 31, 2020 and $ 80 million in cash in 2021. Total consideration of $ 330 million was recognized in other operating (income) expense in the consolidated statement of earnings in 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 192 million in 2021, $ 248 million in 2020 and $ 385 million in 2019 . In connection with the other individually insignificant early-stage arrangements entered into in 2021, AbbVie could make additional payments of up to $ 5.5 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaborations The company has ongoing transactions with other entities through collaboration agreements. The following represent the significant collaboration agreements impacting 2021, 2020 and 2019. Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of Imbruvica, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to Imbruvica, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize Imbruvica outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. | 2021 Form 10-K In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of Imbruvica are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize Imbruvica. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) 2021 2020 2019 United States - Janssen's share of profits (included in cost of products sold) $ 2,018 $ 2,012 $ 1,803 International - AbbVie's share of profits (included in net revenues) 1,087 1,009 844 Global - AbbVie's share of other costs (included in respective line items) 304 295 321 AbbVies receivable from Janssen, included in accounts receivable, net, was $ 294 million at December 31, 2021 and $ 283 million at December 31, 2020. AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 509 million at December 31, 2021 and $ 562 million at December 31, 2020. Collaboration with Genentech, Inc. AbbVie and Genentech, Inc. (Genentech), a member of the Roche Group, are parties to a collaboration and license agreement executed in 2007 to jointly research, develop and commercialize human therapeutic products containing BCL-2 inhibitors and certain other compound inhibitors which includes Venclexta, a BCL-2 inhibitor used to treat certain hematological malignancies. AbbVie shares equally with Genentech all pre-tax profits and losses from the development and commercialization of Venclexta in the United States. AbbVie pays royalties on Venclexta net revenues outside the United States. AbbVie manufactures and distributes Venclexta globally and is the principal in the end-customer product sales. Sales of Venclexta are included in AbbVie's net revenues. Genentech's share of United States profits is included in AbbVie's cost of products sold. AbbVie records sales and marketing costs associated with the United States collaboration as part of SGA expenses and global development costs as part of RD expenses, net of Genentechs share. Royalties paid for Venclexta revenues outside the United States are also included in AbbVies cost of products sold. The following table shows the profit and cost sharing relationship between Genentech and AbbVie: years ended December 31 (in millions) 2021 2020 2019 Genentech's share of profits, including royalties (included in cost of products sold) $ 703 $ 533 $ 320 AbbVie's share of sales and marketing costs from U.S. collaboration (included in SGA) 40 46 41 AbbVie's share of development costs (included in RD) 140 129 128 2021 Form 10-K | Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2019 $ 15,604 Additions (a) 17,008 Foreign currency translation adjustments 512 Balance as of December 31, 2020 33,124 Additions (b) 177 Measurement period adjustments (c) ( 564 ) Foreign currency translation adjustments and other ( 358 ) Balance as of December 31, 2021 $ 32,379 (a) Goodwill additions related to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020 (see Note 5). (b) Goodwill additions related to the acquisition of Soliton in the fourth quarter of 2021 (see Note 5). (c) Measurement period adjustments recorded in 2021 related to the acquisition of Allergan (see Note 5). The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2021, there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: 2021 2020 as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 88,945 $ ( 18,463 ) $ 70,482 $ 87,707 $ ( 11,620 ) $ 76,087 License agreements 8,487 ( 3,688 ) 4,799 7,828 ( 2,916 ) 4,912 Total definite-lived intangible assets 97,432 ( 22,151 ) 75,281 95,535 ( 14,536 ) 80,999 Indefinite-lived research and development 670 670 1,877 1,877 Total intangible assets, net $ 98,102 $ ( 22,151 ) $ 75,951 $ 97,412 $ ( 14,536 ) $ 82,876 Definite-Lived Intangible Assets The increase in definite-lived intangible assets during 2021 was primarily due to the measurement period adjustments from the completion of the valuation of certain license agreements acquired in the Allergan acquisition as well as the acquisition of Soliton. Refer to Note 5 for additional information regarding these acquisitions and related adjustments. In 2021, AbbVie also reclassified $ 1.0 billion of indefinite-lived research and development intangible assets to developed product rights upon receiving certain regulatory approvals for Vuity, Qulipta, and HArmonyCa. Definite-lived intangible assets are amortized over their estimated useful lives, which range between 1 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $ 7.7 billion in 2021, $ 5.8 billion in 2020 and $ 1.6 billion in 2019 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2021 is as follows: (in billions) 2022 2023 2024 2025 2026 Anticipated annual amortization expense $ 7.2 $ 7.5 $ 8.0 $ 8.4 $ 7.9 | 2021 Form 10-K Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2021 primarily relate to the acquisition of Allergan. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. In 2019, following the announcement of the decision to terminate the rovalpituzumab tesirine (Rova-T) RD program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. The impairment charge was recorded to RD expense in the consolidated statements of earnings in 2019. Note 8 Integration and Restructuring Plans Allergan Integration Plan Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. To achieve these integration objectives, AbbVie expects to incur total cumulative charges of approximately $ 2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. The following table summarizes the charges associated with the Allergan acquisition integration plan: Severance and employee benefits Other integration year ended December 31 (in millions) 2021 2020 2021 2020 Cost of products sold $ 5 $ 109 $ 127 $ 21 Research and development 199 102 177 Selling, general and administrative 64 388 289 237 Total charges $ 69 $ 696 $ 518 $ 435 The following table summarizes the cash activity in the recorded liability associated with the integration plan: year ended December 31 (in millions) Severance and employee benefits Other integration Charges $ 594 $ 435 Payments and other adjustments ( 227 ) ( 415 ) Accrued balance as of December 31, 2020 $ 367 $ 20 Charges 65 461 Payments and other adjustments ( 210 ) ( 448 ) Accrued balance as of December 31, 2021 $ 222 $ 33 Other Restructuring AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2021, 2020 and 2019, no such plans were individually significant. Restructuring charges recorded were $ 59 million in 2021, $ 60 million in 2020 and $ 234 million in 2019 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. 2021 Form 10-K | The following table summarizes the cash activity in the restructuring reserve for 2021, 2020 and 2019: (in millions) Accrued balance as of December 31, 2018 $ 99 Restructuring charges 219 Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 140 Restructuring charges 58 Payments and other adjustments ( 108 ) Accrued balance as of December 31, 2020 90 Restructuring charges 54 Payments and other adjustments ( 111 ) Accrued balance as of December 31, 2021 $ 33 Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheets: as of December 31 (in millions) Balance sheet caption 2021 2020 Assets Operating Other assets $ 762 $ 895 Finance Property and equipment, net 33 27 Total lease assets $ 795 $ 922 Liabilities Operating Current Accounts payable and accrued liabilities $ 178 $ 175 Noncurrent Other long-term liabilities 713 832 Finance Current Current portion of long-term debt and finance lease obligations 9 8 Noncurrent Long-term debt and finance lease obligations 25 21 Total lease liabilities $ 925 $ 1,036 The following table summarizes the lease costs recognized in the consolidated statements of earnings: years ended December 31 (in millions) 2021 2020 2019 Operating lease cost $ 226 $ 192 $ 124 Short-term lease cost 56 59 34 Variable lease cost 71 60 62 Total lease cost $ 353 $ 311 $ 220 Sublease income and finance lease costs were insignificant in 2021, 2020 and 2019. | 2021 Form 10-K The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: years ended December 31 2021 2020 2019 Weighted-average remaining lease term (years) Operating 7 8 5 Finance 3 3 3 Weighted-average discount rate Operating 2.4 % 2.5 % 3.9 % Finance 1.1 % 1.4 % 3.9 % The following table presents supplementary cash flow information regarding the company's leases: years ended December 31 (in millions) 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 236 $ 185 $ 125 Right-of-use assets obtained in exchange for new operating lease liabilities 66 692 26 Finance lease cash flows were insignificant in 2021, 2020 and 2019. Right-of-use assets obtained in exchange for new operating lease liabilities as of December 31, 2020 included $ 453 million of right-of-use assets acquired in the Allergan acquisition. The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2021: (in millions) Operating leases Finance leases Total (a) 2022 $ 179 $ 9 $ 188 2023 162 9 171 2024 126 7 133 2025 105 5 110 2026 91 9 100 Thereafter 317 317 Total lease payments 980 39 1,019 Less: Interest 89 5 94 Present value of lease liabilities $ 891 $ 34 $ 925 (a) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. 2021 Form 10-K | Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2021 (a) 2021 Effective interest rate in 2020 (a) 2020 Senior notes issued in 2012 2.90 % notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40 % notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 3.20 % notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60 % notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50 % notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70 % notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30 % notes due 2021 2.40 % 2.40 % 1,800 2.85 % notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20 % notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30 % notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45 % notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 1.375 % notes due 2024 ( 1,450 principal) 1.46 % 1,643 1.46 % 1,783 2.125 % notes due 2028 ( 750 principal) 2.18 % 850 2.18 % 922 Senior notes issued in 2018 3.375 % notes due 2021 3.51 % 3.51 % 1,250 3.75 % notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25 % notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875 % notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75 % notes due 2027 ( 750 principal) 0.86 % 850 0.86 % 922 1.25 % notes due 2031 ( 650 principal) 1.30 % 737 1.30 % 799 Senior notes issued in 2019 Floating rate notes due May 2021 0.74 % 1.33 % 750 Floating rate notes due November 2021 0.78 % 1.42 % 750 Floating rate notes due 2022 0.99 % 750 1.62 % 750 2.15 % notes due 2021 2.23 % 2.23 % 1,750 2.30 % notes due 2022 2.42 % 3,000 2.42 % 3,000 2.60 % notes due 2024 2.69 % 3,750 2.69 % 3,750 2.95 % notes due 2026 3.02 % 4,000 3.02 % 4,000 3.20 % notes due 2029 3.25 % 5,500 3.25 % 5,500 4.05 % notes due 2039 4.11 % 4,000 4.11 % 4,000 4.25 % notes due 2049 4.29 % 5,750 4.29 % 5,750 Term loan facilities Floating rate notes due 2023 1.23 % 1.29 % 1,000 Floating rate notes due 2023 0.81 % 1,000 % Floating rate notes due 2025 1.36 % 2,000 1.42 % 2,000 | 2021 Form 10-K as of December 31 (dollars in millions) Effective interest rate in 2021 (a) 2021 Effective interest rate in 2020 (a) 2020 Senior notes acquired in 2020 5.000 % notes due 2021 1.53 % 1.53 % 1,200 3.450 % notes due 2022 1.97 % 2,878 1.97 % 2,878 3.250 % notes due 2022 1.92 % 1,700 1.92 % 1,700 2.800 % notes due 2023 2.13 % 350 2.13 % 350 3.850 % notes due 2024 2.07 % 1,032 2.07 % 1,032 3.800 % notes due 2025 2.09 % 3,021 2.09 % 3,021 4.550 % notes due 2035 3.52 % 1,789 3.52 % 1,789 4.625 % notes due 2042 4.00 % 457 4.00 % 457 4.850 % notes due 2044 4.11 % 1,074 4.11 % 1,074 4.750 % notes due 2045 4.20 % 881 4.20 % 881 Senior Euro notes acquired in 2020 0.500 % notes due 2021 ( 750 principal) 0.72 % 0.72 % 922 1.500 % notes due 2023 ( 500 principal) 0.49 % 567 0.49 % 615 1.250 % notes due 2024 ( 700 principal) 0.65 % 793 0.65 % 861 2.625 % notes due 2028 ( 500 principal) 1.20 % 567 1.20 % 615 2.125 % notes due 2029 ( 550 principal) 1.19 % 623 1.19 % 677 Other 33 29 Fair value hedges 102 278 Unamortized bond discounts ( 130 ) ( 146 ) Unamortized deferred financing costs ( 251 ) ( 287 ) Unamortized bond premiums (b) 954 1,200 Total long-term debt and finance lease obligations 76,670 86,022 Current portion 12,481 8,468 Noncurrent portion $ 64,189 $ 77,554 (a) Excludes the effect of any related interest rate swaps. (b) Represents unamortized purchase price adjustments of Allergan debt. In April 2021, the company repaid $ 1.8 billion aggregate principal amount of 2.3 % senior notes that were scheduled to mature in May 2021. In May 2021, the company repaid 750 million aggregate principal amount of 0.5 % senior Euro notes that were scheduled to mature in June 2021. These repayments were made by exercising, under the terms of the notes, 30-day early redemptions at 100% of the principal amounts. The company also repaid $ 750 million aggregate principal amount of floating rate senior notes at maturity in May 2021. In September 2021, the company refinanced its $ 1.0 billion floating rate three-year term loan. As part of the refinancing, the company repaid the existing $ 1.0 billion term loan due May 2023 and borrowed $ 1.0 billion under a new term loan at a lower floating rate. All other significant terms of the loan, including the maturity date, remained unchanged after the refinancing. In September 2021, the company repaid $ 1.2 billion aggregate principal amount of 5.0 % senior notes that were scheduled to mature in December 2021. This repayment was made by exercising, under the terms of the notes, 90-day early redemption at 100% of the principal amount. In November 2021, the company repaid $ 1.3 billion aggregate principal amount of 3.375 % senior notes and $ 1.8 billion aggregate principal amount of 2.15 % senior notes at maturity. The company also repaid $ 750 million aggregate principal amount of floating rate senior notes at maturity in November 2021. 2021 Form 10-K | In January 2022, the company repaid $ 2.9 billion aggregate principal amount of 3.450 % senior notes that were scheduled to mature in March 2022. This repayment was made by exercising, under the terms of the notes, 60-day early redemption at 100% of the principal amount. In connection with the acquisition of Allergan, in May 2020, the company borrowed $ 3.0 billion under a $ 6.0 billion term loan credit agreement, of which $ 1.0 billion was outstanding under a floating rate three-year term loan tranche and $ 2.0 billion outstanding under a floating rate five-year term loan tranche as of December 31, 2021. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. In May 2020, AbbVie completed its previously announced offers to exchange any and all outstanding notes of certain series issued by Allergan for new notes to be issued by AbbVie and cash. Following the settlement of the exchange offers, AbbVie issued $ 14.0 billion and 3.1 billion of new notes in exchange for the Allergan notes tendered in the exchange offers. The aggregate principal amount of Allergan notes that remained outstanding following the settlement of the exchange offers was approximately $ 1.5 billion and 635 million. The exchange transaction was accounted for as a modification of the assumed debt instruments. In May 2020, the company repaid $ 3.8 billion aggregate principal amount of 2.5 % senior notes at maturity. In September 2020, the company repaid $ 650 million aggregate principal amount of 3.375 % senior notes at maturity. In November 2020, the company repaid 700 million aggregate principal amount of floating rate senior Euro notes at maturity and $ 450 million aggregate principal amount of 4.875 % senior notes due February 2021 three months prior to maturity. In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million, which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie used the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the acquisition described in Note 5 and to pay related fees and expenses. AbbVie has outstanding $ 4.8 billion aggregate principal amount of unsecured senior notes which were issued in 2018. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one month and six months prior to maturity. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 6.0 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 10.0 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. | 2021 Form 10-K At December 31, 2021, the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings There were no commercial paper borrowings outstanding as of December 31, 2021 and December 31, 2020. No commercial paper borrowings were issued during 2021. The weighted-average interest rate on commercial paper borrowings was 1.8 % in 2020 and 2.5 % in 2019. In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2021. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2021, 2020 and 2019. No amounts were outstanding under the company's credit facilities as of December 31, 2021 and December 31, 2020. In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2021: as of and for the years ending December 31 (in millions) 2022 $ 12,428 2023 4,167 2024 7,219 2025 8,771 2026 6,000 Thereafter 37,377 Total obligations and commitments 75,962 Fair value hedges, unamortized bond premiums and discounts, deferred financing costs and finance lease obligations 708 Total long-term debt and finance lease obligations $ 76,670 Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. 2021 Form 10-K | Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 1.1 billion at December 31, 2021 and $ 1.5 billion at December 31, 2020, are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than 18 months. Accumulated gains and losses as of December 31, 2021 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a pre-tax gain of $ 383 million recognized in other comprehensive income (loss). This gain is reclassified to interest expense, net over the term of the related debt. The company is a party to interest rate swap contracts designed as cash flow hedges with notional amounts totaling $ 750 million at December 31, 2021 and $ 2.3 billion at December 31, 2020. The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. Realized and unrealized gains or losses are included in AOCI and are reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 8.2 billion at December 31, 2021 and $ 8.6 billion at December 31, 2020. The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had an aggregate principal amount of senior Euro notes designated as net investment hedges of 5.9 billion at December 31, 2021 and 6.6 billion at December 31, 2020. In addition, the company had foreign currency forward exchange contracts designated as net investment hedges with notional amounts totaling 4.3 billion at December 31, 2021 and 971 million at December 31, 2020. The company uses the spot method of assessing hedge effectiveness for derivative instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. The company is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 4.5 billion at December 31, 2021 and $ 4.8 billion at December 31, 2020. The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. | 2021 Form 10-K The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2021 2020 Balance sheet caption 2021 2020 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ 51 $ 2 Accounts payable and accrued liabilities $ 2 $ 82 Designated as cash flow hedges Other assets Other long-term liabilities 6 Designated as net investment hedges Prepaid expenses and other 149 Accounts payable and accrued liabilities 11 Designated as net investment hedges Other assets 15 Other long-term liabilities Not designated as hedges Prepaid expenses and other 26 49 Accounts payable and accrued liabilities 13 33 Interest rate swap contracts Designated as cash flow hedges Prepaid expenses and other Accounts payable and accrued liabilities 7 14 Designated as cash flow hedges Other assets Other long-term liabilities 20 Designated as fair value hedges Prepaid expenses and other 7 Accounts payable and accrued liabilities Designated as fair value hedges Other assets 26 131 Other long-term liabilities 15 Total derivatives $ 267 $ 189 $ 37 $ 166 While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) 2021 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges $ 82 $ ( 71 ) $ ( 5 ) Designated as net investment hedges 341 ( 95 ) 33 Interest rate swap contracts designated as cash flow hedges 2 ( 53 ) 4 Treasury rate lock agreements designated as cash flow hedges 383 Assuming market rates remain constant through contract maturities, the company expects to reclassify pre-tax gains of $ 65 million into cost of products sold for foreign currency cash flow hedges, pre-tax losses of $ 7 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax gains of $ 577 million in 2021, pre-tax losses of $ 907 million in 2020 and pre-tax gains of $ 90 million in 2019. 2021 Form 10-K | The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption 2021 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ ( 87 ) $ 23 $ 167 Designated as net investment hedges Interest expense, net 26 18 27 Not designated as hedges Net foreign exchange loss ( 100 ) 58 ( 70 ) Treasury rate lock agreements designated as cash flow hedges Interest expense, net 24 24 3 Interest rate swap contracts Designated as cash flow hedges Interest expense, net ( 24 ) ( 17 ) 1 Designated as fair value hedges Interest expense, net ( 127 ) 365 418 Debt designated as hedged item in fair value hedges Interest expense, net 127 ( 365 ) ( 418 ) Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. | 2021 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2021: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 9,746 $ 4,451 $ 5,295 $ Money market funds and time deposits 45 45 Debt securities 46 46 Equity securities 121 100 21 Interest rate swap contracts 26 26 Foreign currency contracts 241 241 Total assets $ 10,225 $ 4,551 $ 5,674 $ Liabilities Interest rate swap contracts $ 22 $ $ 22 $ Foreign currency contracts 15 15 Contingent consideration 14,887 14,887 Total liabilities $ 14,924 $ $ 37 $ 14,887 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2020: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 8,449 $ 2,758 $ 5,691 $ Money market funds and time deposits 12 12 Debt securities 50 50 Equity securities 159 149 10 Interest rate swap contracts 138 138 Foreign currency contracts 51 51 Total assets $ 8,859 $ 2,907 $ 5,952 $ Liabilities Interest rate swap contracts $ 34 $ $ 34 $ Foreign currency contracts 132 132 Contingent consideration 12,997 12,997 Total liabilities $ 13,163 $ $ 166 $ 12,997 Equity securities primarily consist of investments for which the fair values were determined by using the published market prices per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones 2021 Form 10-K | and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities was calculated using the following significant unobservable inputs: 2021 2020 years ended December 31 (in millions) Range Weighted Average (a) Range Weighted Average (a) Discount rate 0.2 % - 2.6 % 1.7 % 0.1 % - 2.2 % 1.1 % Probability of payment for unachieved milestones 89 % - 100 % 90 % 56 % - 92 % 64 % Probability of payment for royalties by indication (b) 56 % - 100 % 96 % 56 % - 100 % 91 % Projected year of payments 2022 - 2034 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excluding approved indications, the estimated probability of payment ranged from 56 % to 89 % at December 31, 2021 and 56 % to 89 % at December 31, 2020. There have been no transfers of assets or liabilities into or out of Level 3 of the fair value hierarchy. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) 2021 2020 2019 Beginning balance $ 12,997 $ 7,340 $ 4,483 Additions (a) 225 Change in fair value recognized in net earnings 2,679 5,753 3,091 Payments ( 789 ) ( 321 ) ( 234 ) Ending balance $ 14,887 $ 12,997 $ 7,340 (a) Additions during the year ended December 31, 2020 represent contingent consideration liabilities assumed in the Allergan acquisition as well as contingent consideration resulting from the Luminera acquisition (see Note 5). The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the year-ended December 31, 2021, the company recorded a $ 2.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated sales driven by stronger market share uptake, favorable clinical trial results and the passage of time, partially offset by higher discount rates. During the year-ended December 31, 2020, the company recorded a $ 5.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake, lower discount rates, the passage of time and favorable clinical trial results. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the Skyrizi contingent consideration liability due to higher probabilities of success, higher estimated future sales and lower discount rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. | 2021 Form 10-K Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2021 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 14 $ 14 $ $ 14 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 12,455 11,830 11,329 501 Long-term debt and finance lease obligations, excluding fair value hedges 64,113 71,810 70,757 1,053 Total liabilities $ 76,582 $ 83,654 $ 82,086 $ 1,568 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2020 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 34 $ 34 $ $ 34 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 8,461 $ 8,542 $ 8,249 $ 293 $ Long-term debt and finance lease obligations, excluding fair value hedges 77,283 87,761 86,137 1,624 Total liabilities $ 85,778 $ 96,337 $ 94,386 $ 1,951 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 149 million as of December 31, 2021 and $ 102 million as of December 31, 2020. No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2021. Concentrations of Risk Of total net accounts receivable, three U.S. wholesalers accounted for 75 % as of December 31, 2021 and 72 % as of December 31, 2020, and substantially all of AbbVie's pharmaceutical product net revenues in the United States were to these three wholesalers. Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 37 % of AbbVie's total net revenues in 2021, 43 % in 2020 and 58 % in 2019. 2021 Form 10-K | Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2021 and 2020. The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) 2021 2020 2021 2020 Projected benefit obligations Beginning of period $ 11,792 $ 8,646 $ 795 $ 1,050 Service cost 440 370 48 42 Interest cost 237 264 19 34 Employee contributions 2 2 Amendments ( 397 ) Actuarial (gain) loss ( 8 ) 1,105 10 40 Benefits paid ( 281 ) ( 249 ) ( 22 ) ( 17 ) Acquisition 1,409 43 Other, primarily foreign currency translation adjustments ( 176 ) 245 End of period 12,006 11,792 850 795 Fair value of plan assets Beginning of period 9,702 7,116 Actual return on plan assets 1,000 979 Company contributions 376 367 22 17 Employee contributions 2 2 Benefits paid ( 281 ) ( 249 ) ( 22 ) ( 17 ) Acquisition 1,296 Other, primarily foreign currency translation adjustments ( 144 ) 191 End of period 10,655 9,702 Funded status, end of period $ ( 1,351 ) $ ( 2,090 ) $ ( 850 ) $ ( 795 ) Amounts recognized on the consolidated balance sheets Other assets $ 991 $ 563 $ $ Accounts payable and accrued liabilities ( 13 ) ( 12 ) ( 26 ) ( 23 ) Other long-term liabilities ( 2,329 ) ( 2,641 ) ( 824 ) ( 772 ) Net obligation $ ( 1,351 ) $ ( 2,090 ) $ ( 850 ) $ ( 795 ) Actuarial loss, net $ 3,504 $ 4,163 $ 461 $ 482 Prior service cost (credit) 5 8 ( 370 ) ( 408 ) Accumulated other comprehensive loss $ 3,509 $ 4,171 $ 91 $ 74 The projected benefit obligations in the table above included $ 3.2 billion at December 31, 2021 and $ 3.5 billion at December 31, 2020, related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations were $ 10.5 billion at December 31, 2021 and December 31, 2020. | 2021 Form 10-K Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2021 2020 Accumulated benefit obligation $ 6,395 $ 7,527 Fair value of plan assets 5,412 6,066 Information For Pension Plans With A Projected Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2021 2020 Projected benefit obligation $ 7,788 $ 8,719 Fair value of plan assets 5,447 6,066 The 2021 actuarial gain of $ 8 million for qualified pension plans and actuarial loss of $ 10 million for other post-employment plans were primarily driven by an increase in the assumed discount rate offset by change in demographic assumptions from 2020. The 2020 actuarial losses of $ 1.1 billion for qualified pension plans and $ 40 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2019. AbbVie's U.S. pension plan was modified to close the plan to new entrants effective January 1, 2022. In addition, a change to AbbVie's U.S. retiree health benefit plan was approved in 2020 and communicated to employees and retirees in October 2020. Beginning in 2022, Medicare-eligible retirees and Medicare-eligible dependents will choose health care coverage from insurance providers through a private Medicare exchange. AbbVie will continue to provide financial support to Medicare-eligible retirees. This change to the U.S. retiree health benefit plan decreased AbbVie's post-employment benefit obligation and increased AbbVie's unrecognized prior service credit as of December 31, 2020 by $ 397 million. In connection with the Allergan acquisition, AbbVie assumed certain post-employment benefit obligations which were recorded at fair value. Upon acquisition in the second quarter of 2020, the excess of projected benefit obligations over the plan assets was recognized as a liability totaling $ 156 million. 2021 Form 10-K | Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) 2021 2020 2019 Defined benefit plans Actuarial loss (gain) $ ( 345 ) $ 701 $ 1,231 Amortization of prior service cost ( 2 ) ( 2 ) Amortization of actuarial loss ( 288 ) ( 227 ) ( 109 ) Foreign exchange loss (gain) and other ( 27 ) 56 ( 6 ) Total loss (gain) $ ( 662 ) $ 528 $ 1,116 Other post-employment plans Actuarial loss $ 10 $ 40 $ 451 Prior service credit ( 397 ) Amortization of prior service credit 39 4 Amortization of actuarial loss ( 32 ) ( 26 ) ( 1 ) Total loss (gain) $ 17 $ ( 379 ) $ 450 Net Periodic Benefit Cost years ended December 31 (in millions) 2021 2020 2019 Defined benefit plans Service cost $ 440 $ 370 $ 269 Interest cost 237 264 259 Expected return on plan assets ( 663 ) ( 575 ) ( 474 ) Amortization of prior service cost 2 2 Amortization of actuarial loss 288 227 109 Net periodic benefit cost $ 304 $ 288 $ 163 Other post-employment plans Service cost $ 48 $ 42 $ 25 Interest cost 19 34 29 Amortization of prior service credit ( 39 ) ( 4 ) Amortization of actuarial loss 32 26 1 Net periodic benefit cost $ 60 $ 98 $ 55 The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 2021 2020 Defined benefit plans Discount rate 2.8 % 2.4 % Rate of compensation increases 5.2 % 4.6 % Cash balance interest crediting rate 2.7 % 2.8 % Other post-employment plans Discount rate 3.1 % 2.8 % The assumptions used in calculating the December 31, 2021 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2022. | 2021 Form 10-K Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 2021 2020 2019 Defined benefit plans Discount rate for determining service cost 2.6 % 3.1 % 4.0 % Discount rate for determining interest cost 2.2 % 3.0 % 4.0 % Expected long-term rate of return on plan assets 7.1 % 7.1 % 7.6 % Expected rate of change in compensation 4.6 % 4.6 % 4.6 % Cash balance interest crediting rate 2.8 % 2.8 % 2.8 % Other post-employment plans Discount rate for determining service cost 3.0 % 3.7 % 4.7 % Discount rate for determining interest cost 2.2 % 3.2 % 4.3 % For the December 31, 2021 post-retirement health care obligations remeasurement, the company assumed a 5.9 % pre-65 ( 2.1 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The pre-65 rate was assumed to decrease gradually to 4.5 % ( 1.8 % post-65) in 2029 and remain at that level thereafter. For purposes of measuring the 2021 post-retirement health care costs, the company assumed a 6.0 % pre-65 ( 2.3 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The pre-65 rate was assumed to decrease gradually to 4.5 % ( 2.0 % post-65) for 2029 and remain at that level thereafter. 2021 Form 10-K | Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) 2021 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,428 $ 1,428 $ $ U.S. mid cap (b) 198 198 International (c) 458 458 Fixed income securities U.S. government securities (d) 228 95 133 Corporate debt instruments (d) 945 179 766 Non-U.S. government securities (d) 602 445 157 Other (d) 273 268 5 Absolute return funds (e) 100 5 95 Real assets 10 10 Other (f) 261 216 45 Total $ 4,503 $ 3,302 $ 1,201 $ Total assets measured at NAV 6,152 Fair value of plan assets $ 10,655 Basis of fair value measurement as of December 31 (in millions) 2020 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,143 $ 1,143 $ $ U.S. mid cap (b) 164 164 International (c) 524 524 Fixed income securities U.S. government securities (d) 132 18 114 Corporate debt instruments (d) 854 178 676 Non-U.S. government securities (d) 544 397 147 Other (d) 297 294 3 Absolute return funds (e) 310 4 306 Real assets 10 10 Other (f) 252 250 2 Total $ 4,230 $ 2,982 $ 1,248 $ Total assets measured at NAV 5,472 Fair value of plan assets $ 9,702 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. | 2021 Form 10-K (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2021 target investment allocation for the AbbVie Pension Plan was 62.5 % in equity securities, 22.5 % in fixed income securities and 15 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans 2022 $ 293 $ 27 2023 312 30 2024 334 31 2025 356 34 2026 379 36 2027 to 2031 2,291 224 Defined Contribution Plan AbbVie maintains defined contribution savings plans for the benefit of its eligible employees. The expense recognized for these plans was $ 267 million in 2021, $ 191 million in 2020 and $ 102 million in 2019. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation In May 2021, stockholders of the company approved the AbbVie Amended and Restated 2013 Incentive Stock Program (the Amended Plan), which amends and restates the AbbVie 2013 Incentive Stock Program (2013 ISP). AbbVie grants stock-based awards to eligible employees pursuant to the Amended Plan, which provides for several different forms of benefits, including non-qualified stock options, RSUs and various performance-based awards. Under the Amended Plan, a total of 144 million shares of AbbVie common stock have been reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. 2021 Form 10-K | AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and the Amended Plan and is summarized as follows: years ended December 31 (in millions) 2021 2020 2019 Cost of products sold $ 46 $ 47 $ 29 Research and development 226 247 171 Selling, general and administrative 420 459 230 Pre-tax compensation expense 692 753 430 Tax benefit 126 131 80 After-tax compensation expense $ 566 $ 622 $ 350 Realized excess tax benefits associated with stock-based compensation totaled $ 50 million in 2021, $ 34 million in 2020 and $ 15 million in 2019. Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three-year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 16.28 in 2021, $ 12.14 in 2020 and $ 12.54 in 2019. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 11.2 million stock options to holders of Allergan options as a result of the conversion of such options. These options were fair-valued using a lattice valuation model. Refer to Note 5 for additional information regarding the Allergan acquisition. The following table summarizes AbbVie stock option activity in 2021: (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted-average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2020 15,691 $ 73.90 4.7 $ 559 Granted 1,147 105.94 Exercised ( 4,278 ) 57.77 Lapsed and forfeited ( 186 ) 105.28 Outstanding at December 31, 2021 12,374 $ 81.98 4.7 $ 661 Exercisable at December 31, 2021 9,424 $ 78.03 3.6 $ 541 The total intrinsic value of options exercised was $ 239 million in 2021, $ 186 million in 2020 and $ 22 million in 2019. The total fair value of options vested during 2021 was $ 21 million. As of December 31, 2021, $ 10 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in ratable increments over a three or four-year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three-year performance period. For awards granted in 2021 and 2020, performance is based on AbbVie's return on invested capital relative to a defined peer group of pharmaceutical, biotech and life science companies. For awards granted in 2019, the tranches tied to 2021 performance are based on AbbVies return on | 2021 Form 10-K equity relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three-year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2021: (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2020 15,918 $ 87.03 Granted 7,556 105.79 Vested ( 6,735 ) 91.63 Forfeited ( 1,849 ) 83.35 Outstanding at December 31, 2021 14,890 $ 94.93 The fair market value of RSUs and performance shares (as applicable) vested was $ 718 million in 2021, $ 618 million in 2020 and $ 371 million in 2019. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 8.2 million RSUs to holders of Allergan equity awards based on a conversion factor described in the transaction agreement. Refer to Note 5 for additional information regarding the Allergan acquisition. As of December 31, 2021, $ 592 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 5.31 in 2021, $ 4.84 in 2020 and $ 4.39 in 2019. The following table summarizes quarterly cash dividends declared during 2021, 2020 and 2019: 2021 2020 2019 Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/29/21 02/15/22 $ 1.41 10/30/20 02/16/21 $ 1.30 11/01/19 02/14/20 $ 1.18 09/10/21 11/15/21 $ 1.30 09/11/20 11/16/20 $ 1.18 09/06/19 11/15/19 $ 1.07 06/17/21 08/16/21 $ 1.30 06/17/20 08/14/20 $ 1.18 06/20/19 08/15/19 $ 1.07 02/18/21 05/14/21 $ 1.30 02/20/20 05/15/20 $ 1.18 02/21/19 05/15/19 $ 1.07 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 6 million shares for $ 670 million in 2021, 8 million shares for $ 757 million in 2020 and 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was $ 2.5 billion as of December 31, 2021. 2021 Form 10-K | Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2021, 2020 and 2019: (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post-employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2018 $ ( 830 ) $ ( 65 ) $ ( 1,722 ) $ ( 10 ) $ 147 $ ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) 95 ( 1,330 ) 12 298 ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 87 ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) 74 ( 1,243 ) 10 141 ( 1,116 ) Balance as of December 31, 2019 ( 928 ) 9 ( 2,965 ) 288 ( 3,596 ) Other comprehensive income (loss) before reclassifications 1,511 ( 785 ) ( 300 ) ( 108 ) 318 Net losses (gains) reclassified from accumulated other comprehensive loss ( 14 ) 198 ( 23 ) 161 Net current-period other comprehensive income (loss) 1,511 ( 799 ) ( 102 ) ( 131 ) 479 Balance as of December 31, 2020 583 ( 790 ) ( 3,067 ) 157 ( 3,117 ) Other comprehensive income (loss) before reclassifications ( 1,153 ) 720 298 76 ( 59 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 223 75 277 Net current-period other comprehensive income (loss) ( 1,153 ) 699 521 151 218 Balance as of December 31, 2021 $ ( 570 ) $ ( 91 ) $ ( 2,546 ) $ $ 308 $ ( 2,899 ) Other comprehensive income (loss) for 2021 included foreign currency translation adjustments totaling losses of $ 1.2 billion and the offsetting impact of net investment hedging activities totaling gains of $ 699 million, which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive income (loss) for 2020 included foreign currency translation adjustments totaling gains of $ 1.5 billion and the offsetting impact of net investment hedging activities totaling losses of $ 799 million, which were principally due to the impact of the strengthening of the Euro on the translation of the company's Euro-denominated assets. Other comprehensive income (loss) for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. | 2021 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) 2021 2020 2019 Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 26 ) $ ( 18 ) $ ( 27 ) Tax expense 5 4 6 Total reclassifications, net of tax $ ( 21 ) $ ( 14 ) $ ( 21 ) Pension and post-employment benefits Amortization of actuarial losses and other (b) $ 283 $ 251 $ 110 Tax benefit ( 60 ) ( 53 ) ( 23 ) Total reclassifications, net of tax $ 223 $ 198 $ 87 Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ 87 $ ( 23 ) $ ( 167 ) Gains on treasury rate lock agreements (a) ( 24 ) ( 24 ) ( 3 ) Losses (gains) on interest rate swap contracts (a) 24 17 ( 1 ) Tax expense (benefit) ( 12 ) 7 14 Total reclassifications, net of tax $ 75 $ ( 23 ) $ ( 157 ) (a) Amounts are included in interest expense, net (see Note 11). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12). (c) Amounts are included in cost of products sold (see Note 11). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2021, no shares of preferred stock were issued or outstanding. 2021 Form 10-K | Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2021 2020 2019 Domestic $ ( 1,644 ) $ ( 4,467 ) $ ( 2,784 ) Foreign 14,633 7,865 11,210 Total earnings before income tax expense $ 12,989 $ 3,398 $ 8,426 Income Tax Expense years ended December 31 (in millions) 2021 2020 2019 Current Domestic $ 1,987 $ 907 $ 102 Foreign 351 194 320 Total current taxes $ 2,338 $ 1,101 $ 422 Deferred Domestic $ ( 839 ) $ ( 58 ) $ ( 137 ) Foreign ( 59 ) ( 2,267 ) 259 Total deferred taxes $ ( 898 ) $ ( 2,325 ) $ 122 Total income tax expense (benefit) $ 1,440 $ ( 1,224 ) $ 544 Effective Tax Rate Reconciliation years ended December 31 2021 2020 2019 Statutory tax rate 21.0 % 21.0 % 21.0 % Effect of foreign operations ( 5.4 ) 2.4 ( 8.4 ) U.S. tax credits ( 2.8 ) ( 10.6 ) ( 3.3 ) Impacts related to U.S. tax reform ( 1.1 ) ( 1.6 ) Non-deductible expenses 0.3 7.2 1.0 Tax law changes and related restructuring ( 2.0 ) ( 48.5 ) 3.1 Tax audit settlements ( 0.4 ) ( 5.1 ) ( 4.7 ) All other, net 0.4 ( 1.3 ) ( 0.6 ) Effective tax rate 11.1 % ( 36.0 %) 6.5 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2021, 2020 and 2019 differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, tax audit settlements and accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $ 1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2020 and 2019 included impacts related to U.S. tax reform. The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system, including a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. The effective income tax rates for 2019 also included the effects of Stemcentrx impairment related expenses. | 2021 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) 2021 2020 Deferred tax assets Compensation and employee benefits $ 937 $ 1,109 Accruals and reserves 667 438 Chargebacks and rebates 837 555 Advance payments 809 324 Net operating losses and other credit carryforwards 10,095 2,765 Other 1,234 1,371 Total deferred tax assets 14,579 6,562 Valuation allowances ( 9,391 ) ( 1,203 ) Total net deferred tax assets 5,188 5,359 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 4,711 ) ( 5,274 ) Excess of book basis over tax basis in investments ( 308 ) ( 335 ) Other ( 904 ) ( 982 ) Total deferred tax liabilities ( 5,923 ) ( 6,591 ) Net deferred tax liabilities $ ( 735 ) $ ( 1,232 ) The decrease in net deferred tax assets is primarily related to the utilization of net operating losses and other carryforwards offset by an increase in advance payments. The decrease in deferred tax liabilities is primarily related to amortization of intangible assets. In connection with the Allergan acquisition, the company recorded adjustments within the measurement period in 2021 related to foreign net operating losses and other credit carryforwards that are not expected to be realized. The adjustments reflected an increase of $ 8.2 billion to deferred tax assets and an offsetting increase to valuation allowances, resulting in no net impact to deferred tax assets. The company had valuation allowances of $ 9.4 billion as of December 31, 2021 and $ 1.2 billion as of December 31, 2020. These were principally related to foreign and state net operating losses and other credit carryforwards that are not expected to be realized. As of December 31, 2021, the company had U.S. federal and state credit carryforwards of $ 214 million as well as U.S. federal, state and foreign net operating loss carryforwards of $ 34.4 billion, which will expire at various times through 2041. The remaining U.S. federal and foreign loss carryforwards of $ 3.2 billion have no expiration. The Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings subject to the Acts transition tax are not considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings or eligible for the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. However, the company generally considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. 2021 Form 10-K | Unrecognized Tax Benefits years ended December 31 (in millions) 2021 2020 2019 Beginning balance $ 5,264 $ 2,661 $ 2,852 Increase due to acquisition 2,674 Increase due to current year tax positions 208 91 113 Increase due to prior year tax positions 137 59 499 Decrease due to prior year tax positions ( 62 ) ( 7 ) ( 21 ) Settlements ( 24 ) ( 141 ) ( 749 ) Lapse of statutes of limitations ( 34 ) ( 73 ) ( 33 ) Ending balance $ 5,489 $ 5,264 $ 2,661 If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 5.2 billion in 2021 and $ 5.0 billion in 2020. Of the unrecognized tax benefits recorded in the table above as of December 31, 2021, AbbVie would be indemnified for approximately $ 79 million. The ""Increase due to current year tax positions"" and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. ""Increase due to acquisition"" in the table above includes amounts related to federal, state and international tax items recorded in acquisition accounting related to the Allergan acquisition. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 161 million in 2021, $ 142 million in 2020 and $ 51 million in 2019, for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $ 803 million at December 31, 2021, $ 642 million at December 31, 2020 and $ 191 million at December 31, 2019. The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 225 million. All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. The most significant matters are described below. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. For litigation matters discussed below for which a loss is probable or reasonably possible, the company is unable to estimate the possible loss or range of loss, if any, beyond the amounts accrued. Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Antitrust Litigation Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits | 2021 Form 10-K pending in federal court consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payors. The cases are pending in the United States District Court for the Eastern District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In June 2020 and August 2021, the court denied the end-payors' motion to certify a class. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2006 patent litigation settlements and related agreements by Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) with three generic companies violated federal antitrust law, and also alleging that 2011 patent litigation by Abbott with two generic companies regarding AndroGel was sham litigation and the settlements of those litigations violated federal antitrust law. In May 2020, Perrigo Company and related entities filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that Abbott's 2011 AndroGel patent lawsuit filed against Perrigo was sham litigation. In October 2020, the Perrigo lawsuit was transferred to the United States District Court for New Jersey. In September 2021, the New Jersey court granted AbbVie's motion for judgment on the pleadings in the Perrigo lawsuit, dismissing it with prejudice. Perrigo has appealed the dismissal. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect Humira purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies Humira patent portfolio violated state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In June 2020, the court dismissed the consolidated litigation with prejudice. The plaintiffs have appealed the dismissal. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2009 and 2010 patent litigation settlements involving Namenda entered into between Forest and generic companies and other conduct by Forest involving Namenda, violated state antitrust, unfair and deceptive trade practices, and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, purported class actions filed by indirect purchasers of Namenda, are consolidated as In re: Namenda Indirect Purchaser Antitrust Litigation in the United States District Court for the Southern District of New York. Lawsuits are pending against Allergan Inc. generally alleging that Allergans petitioning to the U.S. Patent Office and Food and Drug Administration and other conduct by Allergan involving Restasis violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, certified as a class action filed on behalf of indirect purchasers of Restasis, are consolidated for pre-trial purposes in the United States District Court for the Eastern District of New York under the MDL Rules as In re: Restasis (Cyclosporine Ophthalmic Emulsion) Antitrust Litigation , MDL No. 2819. In May 2021, the parties reached an agreement to settle this matter that is subject to final court approval. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2012 and 2013 patent litigation settlements involving Bystolic with six generic manufacturers violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief, and attorneys fees. The lawsuits, purported class actions filed on behalf of direct and indirect purchasers of Bystolic, are consolidated as In re: Bystolic Antitrust Litigation in the United States District Court for the Southern District of New York. Government Proceedings Lawsuits are pending against Allergan and several other manufacturers generally alleging that they improperly promoted and sold prescription opioid products. Approximately 3,130 matters are pending against Allergan. The federal court cases are consolidated for pre-trial purposes in the United States District Court for the Northern District of Ohio under the MDL rules as In re: National Prescription Opiate Litigation , MDL No. 2804. Approximately 251 of the claims are pending in various state courts. The plaintiffs in these cases, which include states, counties, cities, other municipal entities, Native American tribes, union trust funds and other third-party payors, private hospitals, and personal injury claimants, generally seek compensatory and punitive damages. In December 2021, a California state court reached a judgment for Allergan and other defendants in the trial of an opioid lawsuit by Orange, Los Angeles, and Santa Clara Counties and the City of Oakland. In December 2021, Allergan reached an agreement to settle a lawsuit brought by the State of New York and two New York counties, which also provides all other New York counties and political subdivisions the opportunity to participate in the settlement. 2021 Form 10-K | In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In October 2020, the state added a claim under the New Mexico False Advertising Act. Shareholder and Securities Litigation In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. The court granted motions dismissing the claims of three investment-fund plaintiffs, which they appealed. In March 2021, in the first of those appeals, the dismissal was affirmed. One of these plaintiffs refiled its lawsuit in New York state court in June 2020 while the appeal of its dismissal in Illinois is pending. In November 2020, the New York Supreme Court for the County of New York dismissed that lawsuit, which is being appealed. In September 2021, the Illinois court granted AbbVie's motion for summary judgment against all remaining plaintiffs on all the remaining claims, dismissing them with prejudice. The plaintiffs have appealed the dismissals. In October 2018, a federal securities lawsuit, Holwill v. AbbVie Inc., et al ., was filed in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for Humira sales growth in financial filings between 2013 and 2017 were misleading because they omitted alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value that allegedly induced Humira prescriptions. In September 2021, the court granted plaintiffs' motion to certify a class. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergan's textured breast implants. The lawsuits, which were filed by Allergan shareholders, have been consolidated in the United States District Court for the Southern District of New York as In re: Allergan plc Securities Litigation . The plaintiffs generally seek compensatory damages and attorneys fees. In September 2019, the court partially granted Allergan's motion to dismiss. In September 2021, the court granted plaintiffs' motion to certify a class. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans former Actavis generics unit and its alleged anticompetitive conduct with other generic drug companies. The lawsuits were filed by Allergan shareholders and consist of three purported class actions and one individual action that have been consolidated in the U.S. District Court for the District of New Jersey as In re: Allergan Generic Drug Pricing Securities Litigation . In July 2021, the parties reached an agreement to settle the class action lawsuits, which received court approval in November 2021. Product Liability and General Litigation In 2018, a qui tam lawsuit, U.S. ex rel. Silbersher v. Allergan Inc., et al. , was filed in the United States District Court for the Northern District of California against several Allergan entities and others, alleging that their conduct before the U.S. Patent Office resulted in false claims for payment being made to federal and state healthcare payors for Namenda XR and Namzaric. The plaintiff-relator seeks damages and attorneys' fees under the federal False Claims Act and state law analogues. The federal government and state governments declined to intervene in the lawsuit. Intellectual Property Litigation AbbVie Inc. and AbbVie Biotechnology Ltd are seeking to enforce their patent rights relating to adalimumab (a drug AbbVie sells under the trademark Humira). In April 2021 and May 2021, cases were filed in the United States District Court for the Northern District of Illinois against Alvotech hf. AbbVie alleges defendants proposed biosimilar adalimumab product infringes certain AbbVie patents and seeks declaratory and injunctive relief. In August 2021, the court denied Defendants motion to dismiss on jurisdictional grounds in the first case; a motion in the second case remains pending. The court has set a trial on a subset of patents for August 2022. The court order provides that Alvotech will stay off the market until that decision. Litigation on the remaining patents is stayed. In October 2021, the May 2021 declaratory judgment action filed by Alvotech hf. and its U.S. subsidiary Alvotech USA, Inc. in the United States Eastern District of Virginia was transferred to the Northern District of Illinois and subsequently dismissed. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark Imbruvica). Cases were filed in the United States District Court for the District of Delaware in March 2019 against Alvogen Pine Brook LLC and Natco Pharma Ltd.. In August 2021, the court issued a decision holding all asserted patents infringed and valid. The judgment precludes Defendants from obtaining regulatory approval and launching until the last patent expires in 2036. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in these suits. | 2021 Form 10-K Allergan USA, Inc., Allergan Sales, LLC, and Forest Laboratories Holdings Limited, wholly owned subsidiaries of AbbVie, are seeking to enforce patent rights relating to cariprazine (a drug sold under the trademark Vraylar). Litigation was filed in the United States District Court for the District of Delaware in December 2019 against Sun Pharmaceutical Industries Limited and Sun Pharma Global FZE; Aurobindo Pharma Limited and Aurobindo Pharma USA, Inc.; and Zydus Pharmaceuticals (USA), Inc. and Cadila Healthcare Limited. Allergan alleges defendants' proposed generic cariprazine products infringe certain patents and seeks declaratory and injunctive relief. Gedeon Richter Plc, Inc. which is in a global collaboration with Allergan concerning the development and marketing of Vraylar, is the co-plaintiff in this suit. 2021 Form 10-K | Note 16 Segment and Geographic Area Information AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) 2021 2020 2019 Immunology Humira United States $ 17,330 $ 16,112 $ 14,864 International 3,364 3,720 4,305 Total $ 20,694 $ 19,832 $ 19,169 Skyrizi United States $ 2,486 $ 1,385 $ 311 International 453 205 44 Total $ 2,939 $ 1,590 $ 355 Rinvoq United States $ 1,271 $ 653 $ 47 International 380 78 Total $ 1,651 $ 731 $ 47 Hematologic Oncology Imbruvica United States $ 4,321 $ 4,305 $ 3,830 Collaboration revenues 1,087 1,009 844 Total $ 5,408 $ 5,314 $ 4,674 Venclexta United States $ 934 $ 804 $ 521 International 886 533 271 Total $ 1,820 $ 1,337 $ 792 Aesthetics Botox Cosmetic (a) United States $ 1,424 $ 687 $ International 808 425 Total $ 2,232 $ 1,112 $ Juvederm Collection (a) United States $ 658 $ 318 $ International 877 400 Total $ 1,535 $ 718 $ Other Aesthetics (a) United States $ 1,268 $ 666 $ International 198 94 Total $ 1,466 $ 760 $ Neuroscience Botox Therapeutic (a) United States $ 2,012 $ 1,155 $ International 439 232 Total $ 2,451 $ 1,387 $ Vraylar (a) United States $ 1,728 $ 951 $ Duodopa United States $ 102 $ 103 $ 97 International 409 391 364 Total $ 511 $ 494 $ 461 Ubrelvy (a) United States $ 552 $ 125 $ Other Neuroscience (a) United States $ 667 $ 528 $ International 18 11 Total $ 685 $ 539 $ | 2021 Form 10-K years ended December 31 (in millions) 2021 2020 2019 Eye Care Lumigan/Ganfort (a) United States $ 273 $ 165 $ International 306 213 Total $ 579 $ 378 $ Alphagan/Combigan (a) United States $ 373 $ 223 $ International 156 103 Total $ 529 $ 326 $ Restasis (a) United States $ 1,234 $ 755 $ International 56 32 Total $ 1,290 $ 787 $ Other Eye Care (a) United States $ 523 $ 305 $ International 646 388 Total $ 1,169 $ 693 $ Women's Health Lo Loestrin (a) United States $ 423 $ 346 $ International 14 10 Total $ 437 $ 356 $ Orilissa/Oriahnn United States $ 139 $ 121 $ 91 International 6 4 2 Total $ 145 $ 125 $ 93 Other Women's Health (a) United States $ 209 $ 181 $ International 5 11 Total $ 214 $ 192 $ Other Key Products Mavyret United States $ 754 $ 785 $ 1,473 International 956 1,045 1,420 Total $ 1,710 $ 1,830 $ 2,893 Creon United States $ 1,191 $ 1,114 $ 1,041 Lupron United States $ 604 $ 600 $ 720 International 179 152 167 Total $ 783 $ 752 $ 887 Linzess/Constella (a) United States $ 1,006 $ 649 $ International 32 18 Total $ 1,038 $ 667 $ Synthroid United States $ 767 $ 771 $ 786 All other $ 2,673 $ 2,923 $ 2,068 Total net revenues $ 56,197 $ 45,804 $ 33,266 (a) Net revenues include Allergan product revenues after the acquisition closing date of May 8, 2020. 2021 Form 10-K | Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) 2021 2020 2019 United States $ 43,510 $ 34,879 $ 23,907 Canada 1,397 1,159 813 Germany 1,223 1,049 909 Japan 1,090 1,198 1,211 France 936 797 695 China 857 471 195 Australia 533 527 395 Spain 519 453 472 Italy 506 379 372 United Kingdom 497 509 372 Brazil 368 406 359 All other countries 4,761 3,977 3,566 Total net revenues $ 56,197 $ 45,804 $ 33,266 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) 2021 2020 United States and Puerto Rico $ 3,369 $ 3,354 Europe 1,400 1,534 All other 341 360 Total long-lived assets $ 5,110 $ 5,248 Note 17 Fourth Quarter Financial Results (unaudited) quarter ended December 31 (in millions except per share data) 2021 Net revenues $ 14,886 Gross margin 10,566 Net earnings attributable to AbbVie Inc. 4,044 Basic earnings per share attributable to AbbVie Inc. $ 2.27 Diluted earnings per share attributable to AbbVie Inc. $ 2.26 Cash dividends declared per common share $ 1.41 | 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 18, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 2021 Form 10-K | Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period the related product is sold. At December 31, 2021, the Company had $ 8,254 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate, and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions considering industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. | 2021 Form 10-K Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2021, the Company had $ 14,887 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry, including commercial dynamics, trends and utilization, as well as knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 18, 2022 2021 Form 10-K | "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2021. Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2021. Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. | 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2021 and 2020, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 18, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 18, 2022 2021 Form 10-K | " +1,abbv,20201231," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the worlds most complex and serious diseases. On May 8, 2020, AbbVie completed the acquisition of Allergan plc (Allergan). The acquisition of Allergan creates a diversified biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions in key therapeutic areas of immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. See Note 5, ""Licensing, Acquisitions and Other ArrangementsAcquisition of Allergan,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Subsequent to the acquisition date, AbbVie's consolidated financial statements include the assets, liabilities, operating results and cash flows of Allergan. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Impact of the Coronavirus Disease 2019 (COVID-19) The novel coronavirus (COVID-19) pandemic continues to spread throughout the United States and around the world. In response to the growing public health crisis, AbbVie has partnered with global authorities to support the experimental use of multiple AbbVie assets to determine their efficacy in the treatment of COVID-19. AbbVie continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie has experienced lower new patient starts across the therapeutic portfolio. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the outbreak. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain. Segments AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, development, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. See Note 16, ""Segment and Geographic Area Information"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data"" and the sales information related to AbbVie's key products and geographies included under Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. | 2020 Form 10-K Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: Humira. Humira (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union Pediatric ulcerative colitis (moderate to severe) European Union Pediatric uveitis European Union Humira is also approved in Japan for the treatment of intestinal Behet's disease and pyoderma gangrenosum. Humira is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 43% of AbbVie's total net revenues in 2020. Skyrizi. Skyrizi (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following an induction dose. Skyrizi is approved in the United States, Canada and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In Japan, Skyrizi is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. Rinvoq . Rinvoq (upadacitinib) is an oral, once-daily selective and reversible JAK inhibitor and is approved in the United States, Canada, Japan and the European Union. Rinvoq is indicated for the treatment of moderate to severe active rheumatoid arthritis in adult patients who have responded inadequately to, or who are intolerant to one or more disease-modifying anti-rheumatic drugs (DMARDs). Rinvoq is also approved in the European Union for the treatment of adult patients with active psoriatic arthritis and adult patients with active ankylosing spondylitis. Rinvoq may be used as monotherapy or in combination with methotrexate. Rinvoq is also indicated in Japan in patients with rheumatoid arthritis with inadequate response to conventional therapy (including inhibition of the progression of structural damage). 2020 Form 10-K | Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: Imbruvica. Imbruvica (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). Imbruvica was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. Imbruvica currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. Venclexta/Venclyxto. Venclexta (venetoclax) is a BCL-2 inhibitor used to treat hematological malignancies. Venclexta is approved by the FDA for adults with CLL or SLL. In addition, Venclexta is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Venclyxto is approved in Europe for CLL in combination with obinutuzumab for patients with previously untreated CLL and in combination with rituximab in patients who have received at least one previous treatment. Aesthetics products. AbbVies Allergan Aesthetics portfolio consists of toxins and dermal fillers, plastics and regenerative medicine, body contouring, and skincare products, which hold market-leading positions in the U.S. and in key markets around the world. In 2020, U.S. sales comprised approximately two-thirds of total global sales. These products are: Botox Cosmetic. Botox Cosmetic is an acetylcholine release inhibitor and a neuromuscular blocking agent indicated for temporary improvement in the appearance of moderate to severe glabellar lines (frown lines between the eyebrows), moderate to severe crow's feet and forehead lines in adults. Having received its initial U.S. Food and Drug Administration (FDA) approval in 2002, Botox Cosmetic is now approved for use in all major markets around the world and has become one of the worlds most recognized and iconic brands. Juvederm Collection. T he Juvederm Collection is a portfolio of hyaluronic acid-based dermal fillers with a variety of approved indications in the U.S. and in all other major markets around the world to treat volume loss in the cheeks, chin, lips and lower face. Other aesthetics. Other aesthetics products include, but are not limited to, Coolsculpting body contouring technology, Alloderm regenerative dermal tissue, Natrelle breast implants, the SkinMedica skincare line, and DiamondGlow. Neuroscience products. AbbVies neuroscience products address some of the most difficult-to-treat neurologic diseases. These products are: Botox Therapeutic. Botox Therapeutic (onabotulinumtoxinA injection) is a neuromuscular blocking agent that is injected into muscle tissue in treatment for the following indications in the United States: For the treatment of overactive bladder with symptoms of urge urinary incontinence, urgency, and frequency, in adults who have an inadequate response to or are intolerant of an anticholinergic medication. For the treatment of urinary incontinence due to detrusor overactivity associated with a neurologic condition (e.g., spinal cord injury, multiple sclerosis) in adults who have an inadequate response to or are intolerant of an anticholinergic medication. For the prophylaxis of headaches in adult patients with chronic migraine ( 15 days per month with headache lasting 4 hours a day or longer). | 2020 Form 10-K For the treatment of spasticity in patients 2 years of age and older. For the treatment of adults with cervical dystonia to reduce the severity of abnormal head position and neck pain associated with cervical dystonia. For the treatment of strabismus and blepharospasm associated with dystonia, including benign essential blepharospasm or VII nerve disorders in patients 12 years of age and older. For the treatment of severe primary axillary hyperhidrosis that is inadequately managed with topical agents. Licenses around the world vary. Focal spasticity associated with dynamic equinus foot deformity due to spasticity in ambulant pediatric cerebral palsy patients, two years of age or older. Focal spasticity of the wrist and hand in adult post stroke patients. Focal spasticity of the ankle and foot in adult post stroke patients. Vraylar. Vraylar (cariprazine) is a dopamine D3-preferring D3/D2 receptor partial agonist and a 5-HT1A receptor partial agonist. Its D3 binding profile may be linked to observed improvements in the negative symptoms of schizophrenia and to antidepressant effects in Bipolar I disorder. Vraylar is indicated for acute and maintenance treatment of schizophrenia in adults, acute treatment of manic or mixed episodes associated with bipolar disorder in adults and acute treatment of depressive episodes associated with bipolar I disorder (bipolar depression) in adults. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Ubrelvy. Ubrelvy (ubrogepant) is indicated for the acute treatment of migraine with or without aura in adults and is only commercialized in the United States. Eye care products. AbbVies eye care products address unmet needs and new approaches to help preserve and protect patients vision. These products are: Lumigan/Ganfort. Lumigan (bimatoprost ophthalmic solution) 0.01% is a once daily, topical prostaglandin analog indicated for the reduction of elevated intraocular pressure (IOP) in patients with open angle glaucoma (OAG) or ocular hypertension (OHT). Ganfort is a once daily topical fixed combination of bimatoprost 0.03% and timolol 0.5% for the reduction of IOP in adult patients with OAG or OHT. Lumigan is sold in the United States and numerous markets around the world, while Ganfort is approved in the EU and some markets in South America, the Middle East, and Asia. Alphagan/Combigan. Alphagan (brimonidine tartrate ophthalmic solution) is an alpha-adrenergic receptor agonist indicated for the reduction of elevated intraocular pressure (IOP) in patients with open-angle glaucoma or ocular hypertension. Combigan (brimonidine tartrate/timolol maleate ophthalmic solution) is approved for reducing elevated intraocular pressure (IOP) in patients with glaucoma who require additional or adjunctive IOP-lowering therapy. Both Alphagan and Combigan are available for sale in the United States and numerous markets around the world. Restasis. Restasis is a calcineurin inhibitor immunosuppressant indicated to increase tear production in patients whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca. Restasis is approved in the United States and a number of other markets in South America, the Middle East, and Asia. Other eye care. Other eye care products include Xen, Durysta, Ozurdex and Refresh/Optive. Women's health products. AbbVies women's health products are: Lo Loestrin . Lo Loestrin Fe is an oral contraceptive. It is indicated for prevention of pregnancy with the lowest dose of estrogen with only 10mcg and is dispensed in a unique 24/2/2 regimen with a two-day hormone-free interval. It is marketed in the U.S. as Lo Loestrin Fe (norethindrone acetate and ethinyl estradiol tablets, ethinyl estradiol tablets and ferrous fumarate tablets) and in select markets outside the U.S. as Lolo. Orilissa/Oriahnn. Orilissa (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved Orilissa under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. Orilissa inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in 2020 Form 10-K | dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, Orilissa is also launched in Canada and Puerto Rico. Oriahnn (elagolix, estradiol, and norethindrone acetate capsules; elagolix capsules) is a combination prescription medicine used to control heavy menstrual bleeding related to uterine fibroids in women before menopause. Other women's health. Other women's health includes Liletta, a sterile, levonorgestrel-releasing intrauterine system indicated for prevention of pregnancy for up to six years. It is the only hormonal IUS (Intrauterine System) approved in the U.S. for up to six years of pregnancy prevention. Other key products. AbbVies other key products include, among other things, treatments for patients with hepatitis C virus (HCV), metabolic and hormone products that target a number of conditions, including exocrine pancreatic insufficiency and hypothyroidism, as well as endocrinology products for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. These products are: Mavyret/Maviret. Mavyret (glecaprevir/pibrentasvir) is approved in the United States and European Union (Maviret) for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult and pediatric patients (12 years and older or weighing at least 45 kilograms) with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. Creon. Creon (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Lupron. Lupron (leuprolide acetate), which is also marketed as Lucrin and Lupron Depot, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Linzess/Constella. Linzess (linaclotide) is a once-daily guanylate cyclase-C agonist used in adults to treat irritable bowel syndrome with constipation (IBSC) and chronic idiopathic constipation (CIC). The product is marketed as Linzess in the United States and as Constella outside of the United States. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell Creon and Synthroid only in the United States. AbbVie's commercial rights to the sale and distribution of Synagis outside of the United States will revert to AstraZeneca upon the expiry of the current agreement in 2021. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States many of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its promotional and market access efforts on key opinion leaders, payers, physicians and health systems. AbbVie also provides patient support programs closely related to its products. Throughout the COVID-19 pandemic AbbVie has maintained its promotional activities with key stakeholders by leveraging digital engagement where permitted and in compliance with the locally applicable government guidance. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. | 2020 Form 10-K In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. In 2020, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States. No individual wholesaler accounted for greater than 38% of AbbVie's 2020 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products, therapies and biologics. For example, Humira competes with anti-TNF products and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available HCV treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. Humira is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug, and Cosmetic Act (the FFDCA), the Public Health Service Act (PHSA) and the regulations implementing such acts. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the PHSA, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered by the FDA as substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, 2020 Form 10-K | the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the FFDCA. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the PHSA are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Other types of regulatory exclusivity may also be available, such as Generating New Antibiotic Incentives Now (GAIN) exclusivity, which can provide new antibiotic or new antifungal drugs an additional 5 years of marketing exclusivity to be added to certain exclusivities already provided for by law. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained or sometimes even later. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2021 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark Humira), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the license in the United States will begin in 2023 and the license in Europe began in 2018. | 2020 Form 10-K In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark Imbruvica) and those related to risankizumab (which is sold under the trademark Skyrizi). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patent covering risankizumab is expected to expire in 2033. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs, and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5, ""Licensing, Acquisitions and Other ArrangementsOther Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. Other than the Lupron near-term supply issue which has impacted availability of certain formulations, AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. AbbVie also supplements its research and development efforts with acquisitions. 2020 Form 10-K | The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be submitted and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Further, the FDA continues to regulate product labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. | 2020 Form 10-K Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from applicable supervising regulatory authorities before it can commence clinical trials or marketing of the product in target markets. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Japan-specific trials and/or bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. Similarly, applications for a new product in China are submitted to the Center for Drug Evaluation (CDE) of the National Medical Products Administration (NMPA) for technical review and approval of a product for marketing in China. Clinical data in Chinese subjects are required to support approval in China, requiring the inclusion of China in global pivotal studies, or a separate China/Asian clinical trial. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Similar to the requirements in Japan and China, certain countries (notably South Korea, Taiwan and Russia) also require that local clinical studies be conducted in order to support regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can lead to updates to the data regarding utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. 2020 Form 10-K | Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2021 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. | 2020 Form 10-K Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Regulation Medical Devices Medical devices are subject to regulation by the FDA, state agencies and foreign government health authorities. FDA regulations, as well as various U.S. federal and state laws, govern the development, clinical testing, manufacturing, labeling, record keeping and marketing of medical device products agencies in the United States. AbbVies medical device product candidates, including AbbVies breast implants, must undergo rigorous clinical testing and an extensive government regulatory clearance or approval process prior to sale in the United States and other countries. The lengthy process of clinical development and submissions for clearance or approval, and the continuing need for compliance with applicable laws and regulations, require the expenditure of substantial resources. Regulatory clearance or approval, when and if obtained, may be limited in scope, and may significantly limit the indicated uses for which a product may be marketed. Cleared or approved products and their manufacturers are subject to ongoing review, and discovery of previously unknown problems with products may result in restrictions on their manufacture, sale, and/or use or require their withdrawal from the market. United States . AbbVies medical device products are subject to extensive regulation by the FDA in the United States. Unless an exemption applies, each medical device AbbVie markets in the United States must have a 510(k) clearance or a Premarket Approval Application (PMA) in accordance with the FFDCA and its implementing regulations. The FDA classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose a lower risk are placed in either Class I or Class II, and devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or a device deemed to be not substantially equivalent to a previously cleared 510(k) device, are placed in Class III. In general, a Class III device cannot be marketed in the United States unless the FDA approves the device after submission of a PMA, and any changes to the device subsequent to initial FDA approval must also be reviewed and approved by the FDA. The majority of AbbVies medical device products, including AbbVies breast implants, are regulated as Class III medical devices. A Class III device may have significant additional obligations imposed in its conditions of approval, and the time in which it takes to obtain approval can be long. Compliance with regulatory requirements is assured through periodic, unannounced facility inspections by the FDA and other regulatory authorities, and these inspections may include the manufacturing facilities of AbbVies subcontractors or other third-party manufacturers. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions: warning letters or untitled letters; fines, injunctions and civil penalties; recall or seizure of AbbVie products; operating restrictions, partial suspension or total shutdown of production; refusing AbbVie request for 510(k) clearance or PMA approval of new products; withdrawing 510(k) clearance or PMA approvals that are already granted; and criminal prosecution. A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. Clinical trials generally require submission of an application for an investigational device exemption (IDE), which must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. A study sponsor must obtain approval for its IDE from the FDA, and it must also obtain approval of its study from the Institutional Review Board (IRB) overseeing the trial. The results of clinical testing may not be sufficient to obtain approval of the investigational device. 2020 Form 10-K | Once a device is approved, the manufacture and distribution of the device remains subject to continuing regulation by the FDA, including Quality System Regulation requirements, which involve design, testing, control, documentation and other quality assurance procedures during the manufacturing process. Medical device manufacturers and their subcontractors are required to register their establishments and list their manufactured devices with the FDA and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with regulatory requirements. Manufacturers must also report to the FDA if their devices may have caused or contributed to a death or serious injury or malfunctioned in a way that could likely cause or contribute to a death or serious injury, or if the manufacturer conducts a field correction or product recall or removal to reduce a risk to health posed by a device or to remedy a violation of the FFDCA that may present a health risk. Further, the FDA continues to regulate device labeling, and prohibits the promotion of products for unapproved or off-label uses along with other labeling restrictions. European Union. Medical device products that are marketed in the European Union must comply with the requirements of the Medical Device Regulation (the MDR), which will come into effect in May 2021. The MDR provides for regulatory oversight with respect to the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices to ensure that medical devices marketed in the European Union are safe and effective for their intended uses. Medical devices that comply with the MDR are entitled to bear a Conformit Europenne marking evidencing such compliance and may be marketed in the European Union. Failure to comply with these domestic and international regulatory requirements could affect AbbVies ability to market and sell AbbVies products in these countries. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2020 were approximately $6 million and operating expenditures were approximately $34 million. In 2021, capital expenditures for pollution control are estimated to be approximately $9 million and operating expenditures are estimated to be approximately $36 million. Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 47,000 employees in over 70 countries as of January 31, 2021. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Human Capital Management Attracting, retaining and providing meaningful growth and development opportunities to AbbVie's employees is critical to the company's success in making a remarkable impact on peoples lives around the world. AbbVie leverages numerous resources to identify and enhance strategic and leadership capability, foster employee engagement and create a culture where diverse talent is productive and engaged. AbbVie invests in its employees through competitive compensation, benefits and employee support programs and offers best-in-class development and leadership opportunities. AbbVie has developed a deep talent base through ongoing investment in functional and leadership training and by sourcing world-class external talent, ensuring a sustainable talent pipeline. AbbVie continuously cultivates and enhances its working culture and embraces equality, diversity and inclusion as fundamental to the company's mission. | 2020 Form 10-K Attracting and Developing Talent. Attracting and developing high-performing talent is essential to AbbVies continued success. AbbVie implements detailed talent attraction strategies, with an emphasis on STEM skill sets, a diverse talent base and other critical skillsets, including drug discovery, clinical development, market access, and business development. AbbVie also invests in competitive compensation and benefits programs. In addition to offering a comprehensive suite of benefits ranging from medical and dental coverage to retirement, disability and life insurance programs, AbbVie also provides health promotion programs, mental health awareness campaigns and employee assistance programs in several countries, financial wellness support, on-site health screenings and immunizations in several countries and on-site fitness and rehabilitation centers. In addition, the AbbVie Employee Assistance Fund (a part of the AbbVie Foundation) supports two programs for global employees: the AbbVie Possibilities Scholarship for children of employees, which is an annual merit-based scholarship for use at accredited colleges, universities or vocational-technical schools; and the Employee Relief Program, which is financial assistance to support short term needs of employees when faced with large-scale disasters (e.g. a hurricane), individual disasters (e.g. a home fire) or financial hardship (e.g. the death of a spouse). Finally, AbbVie empowers managers and their teams with tools, tips and guidelines on effectively managing workloads, managing teams from a distance and supporting flexible work practices. New AbbVie employees are given a tailored onboarding experience for faster integration and to support performance. AbbVie's mentorship program allows employees to self-nominate as mentors or mentees and facilitates meaningful relationships supporting employees career and development goals. AbbVie also provides structured, broad-based development opportunities, focusing on high-performance skills and leadership training. AbbVie's talent philosophy holds leaders accountable for building a high-performing organization, and the company provides development opportunities to all levels of leadership. AbbVie's Learn, Develop, Perform program offers year-long, self-directed leadership education, supplemented with tools and resources, and leverages leaders as role models and teachers. In addition, the foundation to AbbVie's leadership pipeline is the company's Professional Development Programs, which attract graduates, postgraduates and post-doctoral talent to participate in formal development programs lasting up to three years, with the objective of strengthening functional and leadership capabilities. AbbVie also recently introduced additional development support to senior leaders who are managing increased integration and operational complexity following the transformational acquisition of Allergan. Culture. AbbVies shared values of transforming lives, acting with integrity, driving innovation, embracing diversity and inclusion, and serving the community form the core of the company's culture. AbbVie articulates the behaviors associated with these values in the Ways We Work, a core set of working behaviors that emphasize how the company achieves results is equally as important as achieving them. The Ways We Work are designed to ensure that every AbbVie employee is aware of the company's cultural expectations. AbbVie integrates the Ways We Work into all talent processes, forming the basis for assessing performance, prioritizing development, and ultimately rewarding employees. AbbVie believes it culture creates strong engagement, which is measured regularly through a confidential, third party all-employee survey, and this engagement supports AbbVies mission of making a remarkable impact on peoples lives. Equity, Equality, Diversity Inclusion (EEDI). A cornerstone of AbbVies human capital management approach is to prioritize fostering an inclusive and diverse workforce. In 2019, AbbVie adopted a five-year Equality, Diversity Inclusion roadmap that defines key global focus areas, objectives and associated initiatives, and includes implementation plans organized by business function and geography. AbbVies senior leaders have adopted formal goals aligned with executing this strategy. Over the past year, AbbVie's board of directors has prioritized oversight of AbbVie's response to the U.S. racial justice movement, including overseeing internal programs designed to ensure that AbbVie is attracting, retaining and developing diverse talent. Through June 2020, women represented 49 percent of management positions globally and in the United States, 33 percent of AbbVie's workforce was comprised of members of historically underrepresented populations, an increase from 2019. Further, AbbVie is committed to pay equity and conducts pay equity analyses annually. A critical component of AbbVie's strategy is to instill an inclusive mindset in all AbbVie leaders and employees, so the company can realize the full value of a diverse workforce from recruitment through retirement. AbbVie recently launched a new toolkit for people who manage others to reinforce the importance of EEDI to the business, educate leaders on inclusive recruiting practices and modeling inclusive behavior, and encourage participation in the company's inclusive culture learning opportunities. AbbVie's Employee Resource Groups also help the company nurture an inclusive culture by building community, hosting awareness events and providing leadership and career opportunities. In 2020, AbbVie reiterated its commitment to racial equality and social justice by appointing two additional senior level positions to drive change and awareness company-wide and taking deliberate steps to ensure AbbVie leads by example in promoting racial equity, as further described on the company's website at: https://www.abbvie.com/our-company/our-principles/our-commitment-to-racial-justice.html. 2020 Form 10-K | COVID-19 Health and Safety. AbbVie has effectively prioritized the health and safety of its employees during the COVID-19 pandemic, while continuing to drive strong business performance. AbbVie also implemented, among other things, temporary office and facility closures and establishment of new safety and cleaning protocols and procedures; regular communication regarding the effect of the pandemic on AbbVie's business and employees; establishment of physical distancing procedures, modification of workspaces, and provision of personal protective equipment and cleaning supplies for employees; temperature screening at all company locations; a variety of testing resources including on-site and at-home testing and COVID case management programs; and remote working accommodations and related services to support employees needs for flexibility. In addition, COVID-19 is a covered event under the AbbVie Employee Assistance Fund's Employee Relief Program, entitling eligible AbbVie employees and their families to financial assistance to pay for mortgage/rent, utilities, food, childcare and medical expenses not covered by insurance. AbbVie also provided paid leave and other support and accommodations to the company's employees with relevant medical, pharmaceutical, RD, science, public health and public safety skills, knowledge, training and experience who desired or were requested or mandated to serve as volunteers during the pandemic. Lastly, AbbVies commitment to employees was evidenced by no workforce reductions and no salary reductions associated with COVID-19 . Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business Public health outbreaks, epidemics or pandemics, such as the coronavirus (COVID-19), have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. Public health outbreaks, epidemics or pandemics have had, and could in the future have, an adverse impact on AbbVies operations and financial condition. The continuing pandemic caused by the novel strain of coronavirus (COVID-19) has caused many countries, including the United States, to declare national emergencies and implement preventive measures such as travel bans and shelter in place or total lock-down orders, some of which have eased. The continuation or re-implementation of these bans and orders remains uncertain. The COVID-19 pandemic has caused AbbVie to modify its business practices (including instituting remote work for many of AbbVies employees), and AbbVie may take further actions as may be required by government authorities or as AbbVie determines are in the best interests of AbbVies employees, patients, customers and business partners. While the impact of COVID-19 on AbbVies operations, including, among others, its manufacturing and supply chain, sales and marketing, commercial and clinical trial operations, to-date has not been material, AbbVie has experienced lower | 2020 Form 10-K new patient starts across the therapeutic portfolio. The impact of COVID-19 on AbbVie over the long-term is uncertain and cannot be predicted with confidence. The extent of the adverse impact of COVID-19 on AbbVies operations will depend on the extent and severity of the continued spread of COVID-19 globally, the timing and nature of actions taken to respond to COVID-19 and the resulting economic consequences. Ultimately, the outbreak could have a material adverse impact on AbbVies operations and financial condition. The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1, ""BusinessIntellectual Property Protection and Regulatory Exclusivity"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of Operations,"" and litigation regarding these patents is described in Item 3, ""Legal Proceedings."" The United States composition of matter patent for Humira, which is AbbVie's largest product and had worldwide net revenues of approximately $19.8 billion in 2020, expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful 2020 Form 10-K | claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects Humira revenues could have a material and negative impact on AbbVie's results of operations and cash flows. Humira accounted for approximately 43% of AbbVie's total net revenues in 2020. Any significant event that adversely affects Humira's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for Humira (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of Humira, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of Humira for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances and joint ventures with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. | 2020 Form 10-K Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding Humiracould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including Humira. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, Humira competes with anti-TNF products and other competitive products intended to treat a number of disease states and Mavyret/Maviret competes with other available hepatitis C treatment options. In addition, in the past few years, a number of other companies have started to develop, have successfully developed and/or are currently marketing products that are being positioned as competitors to Botox. All of these competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. 2020 Form 10-K | AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Certain aspects of AbbVies operations are highly dependent upon third party service providers. AbbVie relies on suppliers, vendors and other third party service providers to research, develop, manufacture, commercialize, promote and sell its products. Reliance on third party manufacturers reduces AbbVies oversight and control of the manufacturing process. Some of these third party providers are subject to legal and regulatory requirements, privacy and security risks and market risks of their own. The failure of a critical third party service provider to meet its obligations could have a material adverse impact on AbbVies operations and results. If any third party service providers have violated or are alleged to have violated any laws or regulations during the performance of their obligations to AbbVie, it is possible that AbbVie could suffer financial and reputational harm or other negative outcomes, including possible legal consequences. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be taken by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. For example, lawsuits are pending against Allergan, AbbVies newly acquired subsidiary, and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans textured breast implants. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. Additionally, Allergan has been named as a defendant in approximately 3,100 matters relating to the promotion and sale of prescription opioid pain | 2020 Form 10-K relievers and additional suits may be filed. See Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data."" AbbVie cannot predict the outcome of these proceedings. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1, ""BusinessRegulationDiscovery and Clinical Development, BusinessRegulationCommercialization, Distribution and Manufacturing, and BusinessRegulationMedical Devices. The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. 2020 Form 10-K | Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act, the U.S. Physician Payments Sunshine Act, the TRICARE program, the government pricing rules applicable to the Medicaid, Medicare Part B, 340B Drug Pricing Program and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 24% of AbbVie's total net revenues in 2020. The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including as a result of the United Kingdoms exit from the European Union and the COVID-19 pandemic; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action and regulation; inflation, recession and fluctuations in interest rates; restrictions on transfers of funds; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. | 2020 Form 10-K If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, joint ventures and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, joint ventures, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2020, three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States. If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. In particular, AbbVie incurred significant debt in connection with its acquisition of Allergan. AbbVies substantially increased indebtedness and higher debt to equity ratio as a result of the acquisition may exacerbate these risks and have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions and/or lowering its credit ratings. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase further. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie 2020 Form 10-K | raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could have a material adverse effect on AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others have resulted, and may in the future result, in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. To date, AbbVies business or operations have not been materially impacted by such incidents. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent material breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. In connection with the acquisition of Allergan, AbbVies balances of intangible assets, including developed product rights and goodwill acquired, have increased significantly. Such balances are subject to impairment testing and may result in impairment charges, which will adversely affect AbbVies results of operations and financial condition. A significant amount of AbbVies total assets is related to acquired intangibles and goodwill. As of December 31, 2020, the carrying value of AbbVies developed product rights and other intangible assets was $82.9 billion and the carrying value of AbbVies goodwill was $33.1 billion. AbbVies developed product rights are stated at cost, less accumulated amortization. AbbVie determines original fair value and amortization periods for developed product rights based on its assessment of various factors impacting estimated useful lives and cash flows of the acquired products. Significant adverse changes to any of these factors require AbbVie to perform an impairment test on the affected asset and, if evidence of impairment exists, require AbbVie to take an impairment charge with respect to the asset. For assets that are not impaired, AbbVie may adjust the remaining useful lives. Such a charge could have a material adverse effect on AbbVies results of operations and financial condition. AbbVies other significant intangible assets include in-process research and development (IPRD) intangible projects, acquired in recent business combinations, which are indefinite-lived intangible assets. Goodwill and AbbVies IPRD intangible assets are tested for impairment annually, or when events occur or circumstances change that could potentially reduce the fair value of the reporting unit or intangible asset. Impairment testing compares the fair value of the reporting unit or intangible asset to its carrying amount. A goodwill or IPRD impairment, if any, would be recorded in operating income and could have a material adverse effect on AbbVies results of operations and financial condition. Failure to attract and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development (RD), governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws, particularly in the European Union and the United States, and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; | 2020 Form 10-K changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; environmental liabilities in connection with AbbVies manufacturing processes and distribution logistics, including the handling of hazardous materials; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5, ""Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; 2020 Form 10-K | a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. | 2020 Form 10-K CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1, ""Business,"" Item 1A, ""Risk Factors,"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A, ""Risk Factors"" and Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Clonshaugh, Ireland Branchburg, New Jersey* Cork, Ireland Campbell, California Galway, Ireland* Cincinnati, Ohio Grace-Hollogne, Belgium* Dublin, California* Guarulhos, Brazil Houston, Texas La Aurora, Costa Rica Irvine, California Ludwigshafen, Germany North Chicago, Illinois Pringy, France Waco, Texas Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* Westport, Ireland _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has two central distribution centers. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; Branchburg, New Jersey; Irvine, California; Madison, New Jersey; North Chicago, Illinois; Pleasanton, California; Redwood City, California; Santa Cruz, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany and Liverpool, United Kingdom. 2020 Form 10-K | "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15, ""Legal Proceedings and Contingencies"" to the Consolidated Financial Statements included under Item 8, ""Financial Statements and Supplementary Data,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 47,754 stockholders of record of AbbVie common stock as of January 31, 2021. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2015 through December 31, 2020. This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2015 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. 2020 Form 10-K | Dividends On October 30, 2020, AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.18 per share to $1.30 per share, payable on February 16, 2021 to stockholders of record as of January 15, 2021. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2020 - October 31, 2020 4,783 (1) $ 84.46 (1) $ 3,450,069,690 November 1, 2020 - November 30, 2020 945 (1) $ 92.50 (1) $ 3,450,069,690 December 1, 2020 - December 31, 2020 2,431,776 (1) $ 105.61 (1) 2,430,910 $ 3,193,341,387 Total 2,437,504 (1) $ 105.56 (1) 2,430,910 $ 3,193,341,387 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,783 in October; 945 in November; and 866 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company). This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8, ""Financial Statements and Supplementary Data."" This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2019. EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. On May 8, 2020, AbbVie completed the acquisition of Allergan plc (Allergan). The acquisition of Allergan creates a diversified biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions in key therapeutic areas of immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. See Note 5 to the Consolidated Financial Statements for additional information on the acquisition. Subsequent to the acquisition date, AbbVie's consolidated financial statements include the assets, liabilities, operating results and cash flows of Allergan. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 47,000 employees. AbbVie operates as a single global business segment. 2020 Financial Results AbbVie's strategy has focused on delivering strong financial results, maximizing the benefits of the Allergan acquisition, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2020 included delivering worldwide net revenues of $45.8 billion, operating earnings of $11.4 billion, diluted earnings per share of $2.72 and cash flows from operations of $17.6 billion. Worldwide net revenues increased by 38% on a reported basis and on a constant currency basis, which included $10.3 billion of contributed revenues from the Allergan acquisition, growth in the immunology portfolio from Skyrizi, Rinvoq and the continued strength of Humira in the U.S. as well as revenue growth from Imbruvica and Venclexta. Diluted earnings per share in 2020 was $2.72 and included the following after-tax costs: (i) $5.7 billion for the change in fair value of contingent consideration liabilities; (ii) $4.8 billion related to the amortization of intangible assets; (iii) $3.0 billion of Allergan acquisition and integration expenses; (iv) $1.2 billion for acquired in-process research and development (IPRD); and $241 million for milestones and other research and development (RD) expenses. These costs were partially offset by $1.7 billion of certain tax benefits. Additionally, financial results reflected continued funding to support all stages of AbbVies pipeline assets and continued investment in AbbVies on-market brands. In October 2020, AbbVie's board of directors declared a quarterly cash dividend of $1.30 per share of common stock payable in February 2021. This reflects an increase of approximately 10.2% over the previous quarterly dividend of $1.18 per share of common stock. Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. The integration plan is expected to realize more than $2 billion of expected annual cost synergies over a three-year period, with approximately 50% realized in RD, 40% in selling, general and administrative (SGA) and 10% in cost of products sold. 2020 Form 10-K | To achieve these integration objectives, AbbVie expects to incur approximately $2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. Impact of the Coronavirus Disease 2019 (COVID-19) In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States and around the world. In response to the growing public health crisis, AbbVie has partnered with global authorities to support the experimental use of multiple AbbVie assets to determine their efficacy in the treatment of COVID-19. In June 2020, AbbVie announced that it entered into a collaboration with Harbour BioMed, Utrecht University and Erasmus Medical Center to develop a novel antibody therapeutic to prevent and treat COVID-19. Additionally, AbbVie donated $35 million to increase healthcare capacity, supply critical equipment and deliver food and essential supplies during the crisis. AbbVie continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie has experienced lower new patient starts across the therapeutic portfolio. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the outbreak. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain. 2021 Strategic Objectives AbbVie's mission is to discover and develop innovative medicines and products that solve serious health issues today and address the medical challenges of tomorrow while achieving top-tier financial performance through outstanding execution. AbbVie intends to continue to advance its mission in a number of ways, including: (i) maximizing the benefits of the Allergan acquisition to create a more diversified revenue base with multiple long-term growth drivers; (ii) growing revenues by leveraging AbbVie's commercial strength and international infrastructure across Allergan's therapeutic areas and ensuring strong commercial execution of new product launches; (iii) continuing to invest in and expand its pipeline in support of opportunities in immunology, oncology, aesthetics, neuroscience, eye care and women's health as well as continued investment in key on-market products; (iv) expanding operating margins; and (v) returning cash to shareholders via a strong and growing dividend while also reducing debt. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Immunology revenue growth driven by increasing market share and expanding patient access of Skyrizi and Rinvoq, as well as Humira U.S. sales growth. Hematologic oncology revenue growth from both Imbruvica and Venclexta. Expansion of the companys revenue base from additional Allergan products contributing to key aesthetics and neuroscience portfolios. Effective management of Humira international biosimilar erosion. Optimization of combined AbbVie and Allergan research and development, commercial, and manufacturing operations while maintaining key growth portfolios. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2021. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7. AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, realization of expense synergies from the Allergan acquisition, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. The combination of AbbVie and Allergan creates a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, women's health, eye care and virology. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. | 2020 Form 10-K Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 90 compounds, devices or indications in development individually or under collaboration or license agreements and is focused on such important specialties as immunology, oncology, aesthetics, neuroscience, eye care and women's health along with targeted investments in cystic fibrosis. Of these programs, more than 50 are in mid- and late-stage development. The following sections summarize transitions of significant programs from mid-stage development to late-stage development as well as developments in significant late-stage and registration programs. AbbVie expects multiple mid-stage programs to transition into late-stage programs in the next 12 months. Significant Programs and Developments Immunology Skyrizi In January 2021, AbbVie announced top-line results from its Phase 3 KEEPsAKE-1 and KEEPsAKE-2 clinical trials of Skyrizi in adults with active psoriatic arthritis (PsA) met the primary and ranked secondary endpoints. In January 2021, AbbVie announced top-line results from its Phase 3 ADVANCE and MOTIVATE induction studies of Skyrizi in patients with Crohns Disease met the primary and key secondary endpoints. Rinvoq In February 2020, AbbVie announced top-line results from its second Phase 3 clinical trial of Rinvoq in adult patients with active PsA. Results from the SELECT-PsA 1 study, which evaluated Rinvoq versus placebo in patients who did not adequately respond to treatment with one or more non-biologic disease-modifying anti-rheumatic drugs (DMARDs), showed that both doses of Rinvoq met the primary and key secondary endpoints. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In May 2020, AbbVie submitted a supplemental New Drug Application (sNDA) to the U.S. Food and Drug Administration (FDA) and, in June 2020, submitted a marketing authorization application (MAA) to the European Medicines Agency (EMA) for Rinvoq for the treatment of adult patients with active PsA. In June 2020, AbbVie announced top-line results from its Phase 3 Measure Up 1 study and, in July 2020, announced top-line results from its Phase 3 Measure Up 2 and AD Up studies of Rinvoq for the treatment of moderate to severe atopic dermatitis (AD) met all primary and secondary endpoints versus placebo. In August 2020, AbbVie submitted an sNDA to the FDA and, earlier this year, submitted an MAA to the EMA for Rinvoq for the treatment of adult patients with active ankylosing spondylitis (AS). In October 2020, AbbVie submitted an sNDA to the FDA and an MAA to the EMA for Rinvoq for the treatment of adult and adolescent patients with moderate to severe AD. In December 2020, AbbVie announced its Phase 3 U-ACHIEVE induction study of Rinvoq for the treatment of adult patients with moderate to severe ulcerative colitis met the primary and all ranked secondary endpoints. In January 2021, AbbVie announced that the European Commission (EC) approved Rinvoq for the treatment of adults with active PsA and active AS. 2020 Form 10-K | Oncology Imbruvica In April 2020, AbbVie received FDA approval for the use of Imbruvica in combination with rituximab for the treatment of previously untreated patients with chronic lymphocytic leukemia (CLL) or small lymphocytic lymphoma (SLL). In August 2020, the EC granted marketing authorization for Imbruvica in combination with rituximab for the treatment of adult patients with previously untreated CLL. Venclexta In February 2020, AbbVie announced that the Phase 3 VIALE-C trial of Venclexta in combination with low-dose cytarabine in newly-diagnosed patients with acute myeloid leukemia (AML) did not meet its primary endpoint. In March 2020, AbbVie announced that top-line results from its Phase 3 VIALE-A trial of Venclexta in combination with azacitidine in patients with AML met its primary endpoints. In March 2020, AbbVie received EC approval of Venclyxto in combination with obinutuzumab for patients with previously untreated CLL. In June 2020, AbbVie submitted an MAA to the EMA for Venclyxto for the treatment of patients with AML. In October 2020, AbbVie received FDA full approval of Venclexta for the treatment of patients with AML. The approval is supported by data from a series of trials including the Phase 3 VIALE-A and VIALE-C studies. Aesthetics Juvederm Collection In June 2020, AbbVie received FDA approval of Juvederm Voluma XC for the augmentation of the chin region to improve the chin profile in adults over the age of 21. Neuroscience Botox Therapeutic In June 2020, the FDA accepted the company's supplemental Biologics License Application (sBLA) to expand the Botox prescribing information for the treatment of detrusor (bladder muscle) overactivity associated with an underlying neurologic condition in certain pediatric patients. In February 2021, AbbVie received FDA approval of Botox for the treatment of detrusor overactivity associated with a neurological condition in certain pediatric patients 5 years of age and older. In July 2020, AbbVie received FDA approval of Botox for the treatment of lower limb spasticity caused by cerebral palsy in pediatric patients over the age of 2. Atogepant In July 2020, AbbVie announced that the Phase 3 ADVANCE trial evaluating atogepant, an orally administered calcitonin gene-related peptide receptor antagonist, for migraine prevention met its primary endpoint for all doses (10mg, 30mg, and 60mg) compared to placebo, all secondary endpoints with 30mg and 60mg doses, and four out of six secondary endpoints with the 10mg dose. In January 2021, AbbVie submitted a New Drug Application to the FDA for atogepant for the prevention of episodic migraine. Elezanumab In September 2020, AbbVie announced that the FDA granted Orphan Drug and Fast Track designations for elezanumab, an investigational treatment for patients following spinal cord injury. | 2020 Form 10-K Virology/Liver Disease Mavyret In March 2020, AbbVie announced that the EC granted marketing authorization for Maviret to shorten once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic hepatitis C virus (HCV) patients with genotype 3 infection. Eye Care AGN-190584 In October 2020, AbbVie announced that top-line results from its Phase 3 GEMINI 1 and 2 studies of AGN-190584, an investigational ophthalmic solution, for the treatment of presbyopia met their primary endpoint and majority of the secondary endpoints. Abicipar pegol In June 2020, AbbVie announced that the FDA issued a Complete Response Letter (CRL) to the Biologics License Application (BLA) for abicipar pegol, a novel, investigational DARPin therapy for patients with neovascular (wet) age-related macular degeneration (nAMD). The CRL indicated that the rate of intraocular inflammation observed following administration of abicipar pegol results in an unfavorable benefit-risk ratio in the treatment of nAMD. In July 2020, AbbVie withdrew the regulatory application with the EMA for abicipar pegol for the treatment of nAMD. Women's Health Oriahnn In May 2020, the FDA approved Oriahnn (elagolix, estradiol, and norethindrone acetate capsules; elagolix capsules) for the management of heavy menstrual bleeding due to uterine fibroids in pre-menopausal women. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 United States $ 34,879 $ 23,907 $ 21,524 45.9 % 11.1 % 45.9 % 11.1 % International 10,925 9,359 11,229 16.7 % (16.7) % 17.8 % (13.6) % Net revenues $ 45,804 $ 33,266 $ 32,753 37.7 % 1.6 % 38.0 % 2.6 % 2020 Form 10-K | The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 Immunology Humira United States $ 16,112 $ 14,864 $ 13,685 8.4 % 8.6 % 8.4 % 8.6 % International 3,720 4,305 6,251 (13.6) % (31.1) % (12.5) % (27.8) % Total $ 19,832 $ 19,169 $ 19,936 3.5 % (3.9) % 3.7 % (2.9) % Skyrizi United States $ 1,385 $ 311 $ 100.0% n/m 100.0% n/m International 205 44 100.0% n/m 100.0% n/m Total $ 1,590 $ 355 $ 100.0% n/m 100.0% n/m Rinvoq United States $ 653 $ 47 $ 100.0% n/m 100.0% n/m International 78 100.0% n/m 100.0% n/m Total $ 731 $ 47 $ 100.0% n/m 100.0% n/m Hematologic Oncology Imbruvica United States $ 4,305 $ 3,830 $ 2,968 12.4 % 29.1 % 12.4 % 29.1 % Collaboration revenues 1,009 844 622 19.5 % 35.8 % 19.5 % 35.8 % Total $ 5,314 $ 4,674 $ 3,590 13.7 % 30.2 % 13.7 % 30.2 % Venclexta United States $ 804 $ 521 $ 247 54.4 % 100.0% 54.4 % 100.0% International 533 271 97 97.0 % 100.0% 97.8 % 100.0% Total $ 1,337 $ 792 $ 344 69.0 % 100.0% 69.3 % 100.0% Aesthetics Botox Cosmetic (a) United States $ 687 $ $ n/m n/m n/m n/m International 425 n/m n/m n/m n/m Total $ 1,112 $ $ n/m n/m n/m n/m Juvederm Collection (a) United States $ 318 $ $ n/m n/m n/m n/m International 400 n/m n/m n/m n/m Total $ 718 $ $ n/m n/m n/m n/m Other Aesthetics (a) United States $ 666 $ $ n/m n/m n/m n/m International 94 n/m n/m n/m n/m Total $ 760 $ $ n/m n/m n/m n/m Neuroscience Botox Therapeutic (a) United States $ 1,155 $ $ n/m n/m n/m n/m International 232 n/m n/m n/m n/m Total $ 1,387 $ $ n/m n/m n/m n/m Vraylar (a) United States $ 951 $ $ n/m n/m n/m n/m Duodopa United States $ 103 $ 97 $ 80 5.9 % 20.4 % 5.9 % 20.4 % International 391 364 350 7.4 % 4.2 % 6.3 % 9.8 % Total $ 494 $ 461 $ 430 7.1 % 7.2 % 6.2 % 11.7 % Ubrelvy (a) United States $ 125 $ $ n/m n/m n/m n/m Other Neuroscience (a) United States $ 528 $ $ n/m n/m n/m n/m International 11 n/m n/m n/m n/m Total $ 539 $ $ n/m n/m n/m n/m | 2020 Form 10-K Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 2020 2019 Eye Care Lumigan/Ganfort (a) United States $ 165 $ $ n/m n/m n/m n/m International 213 n/m n/m n/m n/m Total $ 378 $ $ n/m n/m n/m n/m Alphagan/Combigan (a) United States $ 223 $ $ n/m n/m n/m n/m International 103 n/m n/m n/m n/m Total $ 326 $ $ n/m n/m n/m n/m Restasis (a) United States $ 755 $ $ n/m n/m n/m n/m International 32 n/m n/m n/m n/m Total $ 787 $ $ n/m n/m n/m n/m Other Eye Care (a) United States $ 305 $ $ n/m n/m n/m n/m International 388 n/m n/m n/m n/m Total $ 693 $ $ n/m n/m n/m n/m Women's Health Lo Loestrin (a) United States $ 346 $ $ n/m n/m n/m n/m International 10 n/m n/m n/m n/m Total $ 356 $ $ n/m n/m n/m n/m Orilissa/Oriahnn United States $ 121 $ 91 $ 11 33.3 % 100.0% 33.3 % 100.0% International 4 2 96.1 % n/m 97.7 % n/m Total $ 125 $ 93 $ 11 34.6 % 100.0% 34.6 % 100.0% Other Women's Health (a) United States $ 181 $ $ n/m n/m n/m n/m International 11 n/m n/m n/m n/m Total $ 192 $ $ n/m n/m n/m n/m Other Key Products Mavyret United States $ 785 $ 1,473 $ 1,614 (46.7) % (8.8) % (46.7) % (8.8) % International 1,045 1,420 1,824 (26.4) % (22.1) % (26.8) % (19.6) % Total $ 1,830 $ 2,893 $ 3,438 (36.7) % (15.9) % (36.9) % (14.6) % Creon United States $ 1,114 $ 1,041 $ 928 6.9 % 12.2 % 6.9 % 12.2 % Lupron United States $ 600 $ 720 $ 726 (16.6) % (0.8) % (16.6) % (0.8) % International 152 167 166 (9.1) % 0.8 % (5.4) % 6.0 % Total $ 752 $ 887 $ 892 (15.2) % (0.5) % (14.5) % 0.5 % Linzess/Constella (a) United States $ 649 $ $ n/m n/m n/m n/m International 18 n/m n/m n/m n/m Total $ 667 $ $ n/m n/m n/m n/m Synthroid United States $ 771 $ 786 $ 776 (1.9) % 1.3 % (1.9) % 1.3 % All other $ 2,923 $ 2,068 $ 2,408 41.3 % (14.1) % 42.4 % (11.5) % Total net revenues $ 45,804 $ 33,266 $ 32,753 37.7 % 1.6 % 38.0 % 2.6 % n/m Not meaningful (a) Net revenues include Allergan product revenues from the date of the acquisition, May 8, 2020, through December 31, 2020. The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global Humira sales increased 4% in 2020 primarily driven by market growth across therapeutic categories, offset by direct biosimilar competition in certain international markets. In the United States, Humira sales increased 8% in 2020 driven by market growth across all indications and favorable pricing, partially offset by lower new patient starts due to the COVID-19 pandemic. Internationally, Humira revenues decreased 12% in 2020 primarily driven by direct biosimilar competition in certain international markets. Biosimilar competition for Humira is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to maintain market leadership among its installed patient base and add to the sustainability of Humira. Net revenues for Skyrizi increased more than 100% in 2020 primarily driven by market growth and market share gains over the prior year following the April 2019 regulatory approvals for the treatment of moderate to severe plaque psoriasis. Net revenues for Rinvoq increased more than 100% in 2020 primarily driven by the August 2019 FDA approval and December 2019 EC approval for the treatment of moderate to severe rheumatoid arthritis. 2020 Form 10-K | Net revenues for Imbruvica represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of Imbruvica profit. AbbVie's global Imbruvica revenues increased 14% in 2020 as a result of continued penetration of Imbruvica for patients with CLL, partially offset by lower new patient starts due to the COVID-19 pandemic in 2020. Net revenues for Venclexta increased 69% in 2020 primarily due to continued expansion of Venclexta for the treatment of patients with first-line CLL, relapsed/refractory CLL and first-line AML. Net revenues for Botox Cosmetic used in facial aesthetics were $1.1 billion in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Juvederm Collection (including Juvederm Ultra XC, Juvederm Voluma XC and other Juvederm products) used in facial aesthetics were $718 million in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Botox Therapeutic used primarily in neuroscience and urology therapeutic areas were $1.4 billion in 2020 for the period subsequent to the completion of the Allergan acquisition. Net revenues for Vraylar for the treatment of schizophrenia, bipolar I disorder and bipolar depression were $951 million in 2020 for the period subsequent to the completion of the Allergan acquisition. Global Mavyret sales decreased 37% in 2020 primarily driven by lower global new patient starts due to the COVID-19 pandemic as well as competitive dynamics in the U.S. Net revenues for Creon increased 7% in 2020 primarily driven by continued market growth, partially offset by lower new patient starts due to the COVID-19 pandemic. Creon maintains market leadership in the pancreatic enzyme market with approximately 80% total market share. Net revenues for Lupron decreased 14% in 2020 primarily due to a near-term supply issue which has impacted product availability of certain formulations. Gross Margin Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Gross margin $ 30,417 $ 25,827 $ 25,035 18 % 3 % as a percent of net revenues 66 % 78 % 76 % Gross margin as a percentage of net revenues in 2020 decreased from 2019 primarily due to the unfavorable impacts of higher amortization of intangible assets and inventory fair value step-up adjustments associated with the Allergan acquisition as well as collaboration profit sharing arrangements for Imbruvica and Venclexta. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Selling, general and administrative $ 11,299 $ 6,942 $ 7,399 63 % (6) % as a percent of net revenues 25 % 21 % 23 % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2020 increased from 2019 primarily due to the unfavorable impacts of incremental SGA expenses of Allergan, including transaction and integration costs resulting from the acquisition. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) 2020 2019 2018 2020 2019 Research and development $ 6,557 $ 6,407 $ 10,329 2 % (38) % as a percent of net revenues 14 % 19 % 32 % Acquired in-process research and development $ 1,198 $ 385 $ 424 100% (9) % Research and Development (RD) expenses as a percentage of net revenues decreased in 2020 primarily due to the $1.0 billion intangible asset impairment charge in 2019, which represented the remaining value of the IPRD acquired as part | 2020 Form 10-K of the 2016 Stemcentrx acquisition following the decision to terminate the Rova-T RD program. See Note 7 to the Consolidated Financial Statements for additional information regarding the impairment charge. RD expenses as a percentage of net revenues in 2020 were also favorably impacted by increased scale of the combined company for the period subsequent to the completion of the Allergan acquisition. Acquired IPRD expenses reflect upfront payments related to various collaborations. Acquired IPRD expense in 2020 included a charge of $750 million as a result of entering a collaboration agreement with Genmab A/S (Genmab) to research, develop and commercialize investigational bispecific antibody therapeutics for the treatment of cancer. Acquired IPRD expense in 2020 also included a charge of $200 million as a result of a collaboration agreement with I-Mab Biopharma (I-Mab) for the development and commercialization of lemzoparlimab for the treatment of multiple cancers. See Note 5 to the Consolidated Financial Statements for additional information regarding the Genmab and I-Mab agreements. There were no individually significant transactions or cash flows during 2019. Other Operating Expenses and Income Other operating income in 2019 included $550 million of income from a legal settlement related to an intellectual property dispute with a third party and $330 million of income related to an amended and restated license agreement between AbbVie and Reata. See Note 5 to the Consolidated Financial Statements for additional information on the Reata agreement. Other Non-Operating Expenses years ended December 31 (in millions) 2020 2019 2018 Interest expense $ 2,454 $ 1,784 $ 1,348 Interest income (174) (275) (204) Interest expense, net $ 2,280 $ 1,509 $ 1,144 Net foreign exchange loss $ 71 $ 42 $ 24 Other expense, net 5,614 3,006 18 Interest expense in 2020 increased compared to 2019 primarily due to a higher average debt balance associated with the financing of the Allergan acquisition as well as the incremental Allergan debt acquired, partially offset by the favorable impact of lower interest rates on the companys debt obligations. Interest income in 2020 decreased compared to 2019 primarily due to a lower average cash and cash equivalents balance as a result of the cash paid for the Allergan acquisition and the unfavorable impact of lower interest rates. Other expense, net included charges related to the change in fair value of the contingent consideration liabilities of $5.8 billion in 2020 and $3.1 billion in 2019. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products and other market-based factors. In 2020, the change in fair value primarily included the increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake and favorable clinical trial results as well as lower interest rates. In 2019, the Skyrizi contingent consideration liability increased due to higher probabilities of success, higher estimated future sales, declining interest rates and passage of time. The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. These changes were partially offset by a $91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. Income Tax Expense The effective income tax rate was negative 36% in 2020, 6% in 2019 and negative 9% in 2018. The effective tax rate in each period differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, the cost of repatriation decisions, tax audit settlements and Boehringer Ingelheim accretion on contingent consideration. The decrease in the effective tax rate for 2020 over the prior year was principally due to the recognition of a net tax benefit of $1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. 2020 Form 10-K | FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) 2020 2019 2018 Cash flows from: Operating activities $ 17,588 $ 13,324 $ 13,427 Investing activities (37,557) 596 (1,006) Financing activities (11,501) 18,708 (14,396) Operating cash flows in 2020 increased from 2019 and included the results of Allergan subsequent to the May 8 acquisition date. Operating cash flows in 2020 were favorably impacted by higher net revenues of the combined company and the timing of working capital cash flows, partially offset by acquisition-related cash expenses. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $367 million in 2020 and $727 million in 2019. Investing cash flows in 2020 primarily included $39.7 billion cash consideration paid to acquire Allergan offset by cash acquired of $1.5 billion. Investing cash flows also included net sales and maturities of investments totaling $1.5 billion, payments made for other acquisitions and investments of $1.4 billion and capital expenditures of $798 million. Investing cash flows in 2019 included net sales and maturities of investment securities totaling $2.1 billion resulting from the sale of substantially all of the company's investments in debt securities, payments made for other acquisitions and investments of $1.1 billion and capital expenditures of $552 million. Financing cash flows in 2020 included the issuance of term loans totaling $3.0 billion under the existing $6.0 billion term loan credit agreement which were used to finance the acquisition of Allergan. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. Additionally, financing cash flows included the May 2020 repayment of $3.8 billion aggregate principal amount of the company's 2.50% senior notes at maturity, the September 2020 repayment of $650 million aggregate principal amount of 3.375% Allergan exchange notes at maturity, and the November 2020 repayments of 700 million aggregate principal amount of floating rate Allergan exchange notes at maturity and $450 million aggregate principal amount of 4.875% Allergan exchange notes due February 2021. Financing cash flows in 2019 included the issuance of $30.0 billion aggregate principal amount of floating rate and fixed rate unsecured senior notes which were used to finance the acquisition of Allergan. Additionally, financing cash flows in 2019 included the issuance of 1.4 billion aggregate principal amount of unsecured senior Euro notes which the company used to redeem 1.4 billion aggregate principal amount of 0.38% senior Euro notes that were due to mature in November 2019, as well as the repayment of a $3.0 billion 364-day term loan credit agreement that was scheduled to mature in June 2019. Cash dividend payments totaled $7.7 billion in 2020 and $6.4 billion in 2019. The increase in cash dividend payments was primarily driven by higher outstanding shares following the 286 million shares of AbbVie common stock issued to Allergan shareholders in May 2020 as well as an increase in the dividend rate. On October 30, 2020, AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.18 per share to $1.30 per share beginning with the dividend payable on February 16, 2021 to stockholders of record as of January 15, 2021. This reflects an increase of approximately 10.2% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 8 million shares for $757 million in 2020 and 4 million shares for $300 million in 2019. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $3.2 billion as of December 31, 2020. In 2020 and 2019, the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2020 or December 31, 2019. AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an | 2020 Form 10-K allowance for credit losses equal to the estimate of future losses over the contractual life of outstanding accounts receivable. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2020, the company was in compliance with all covenants, and commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facility as of December 31, 2020 and 2019. Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations or has the ability to issue additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings Following the acquisition of Allergan, SP Global Ratings revised its ratings outlook to stable from negative and lowered the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1. There were no changes in Moody's Investor Service of its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the companys ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the companys outstanding debt. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2020: (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ 34 $ 34 $ $ $ Long-term debt, including current portion 84,948 8,422 16,643 16,197 43,686 Interest on long-term debt (a) 33,664 2,752 4,652 3,898 22,362 Non-cancelable operating and finance lease payments 1,154 229 323 208 394 Purchase obligations and other (b) 5,432 5,040 249 112 31 Other long-term liabilities (c) (d) (e) 18,478 1,029 3,036 4,144 10,269 Total $ 143,710 $ 17,506 $ 24,903 $ 24,559 $ 76,742 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2020. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2020. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2020. (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. 2020 Form 10-K | (d) Includes $13.0 billion of contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. (e) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements. Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Provisions for rebates and chargebacks totaled $27.0 billion in 2020, $18.8 billion in 2019 and $16.4 billion in 2018. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. | 2020 Form 10-K The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 89% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2020. Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2017 $ 1,340 $ 1,195 $ 522 Provisions 3,493 4,729 6,659 Payments (3,188) (4,485) (6,525) Balance at December 31, 2018 1,645 1,439 656 Provisions 4,035 5,772 7,947 Payments (3,915) (5,275) (7,917) Balance at December 31, 2019 1,765 1,936 686 Additions (a) 1,266 649 71 Provisions 6,715 8,656 8,677 Payments (6,801) (8,334) (8,693) Balance at December 31, 2020 $ 2,945 $ 2,907 $ 741 (a) Represents rebate accruals and chargeback allowances assumed in the Allergan acquisition. Cash Discounts and Product Returns Cash discounts and product returns, which totaled $2.4 billion in 2020, $1.6 billion in 2019 and $1.6 billion in 2018, are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements. The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2020. A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2021 and projected benefit obligations as of December 31, 2020: 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (89) $ 101 Projected benefit obligation (1,000) 1,140 Other post-employment plans Service and interest cost $ (6) $ 7 Projected benefit obligation (56) 63 2020 Form 10-K | The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2020 and will be used in the calculation of net periodic benefit cost in 2021. A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2021 by $94 million. The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2020 and will be used in the calculation of net periodic benefit cost in 2021. Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. | 2020 Form 10-K For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities as of December 31, 2020 was calculated using the following significant unobservable inputs: Range Weighted Average (a) Discount rate 0.1% - 2.2% 1.1% Probability of payment for unachieved milestones 56% - 92% 64% Probability of payment for royalties by indication (b) 56% - 100% 91% Projected year of payments 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excludes early stage indications with 0% estimated probability of payment and includes approved indications with 100% probability of payment. Excluding approved indications, the estimated probability of payment ranged from 56% to 89% at December 31, 2020. Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 2020 Form 10-K | "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2020 and 2019: 2020 2019 as of December 31 (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 7,818 1.213 $ (39) $ 6,217 1.116 $ (12) Japanese yen 837 103.9 (7) 820 108.7 Canadian dollar 591 1.328 (23) 504 1.324 (6) British pound 275 1.341 3 427 1.305 (6) All other currencies 1,706 n/a (15) 1,508 n/a (10) Total $ 11,227 $ (81) $ 9,476 $ (34) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.14 billion at December 31, 2020. If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2020, the company has 6.6 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive loss. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $111 million at December 31, 2020. If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.7 billion at December 31, 2020. A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. | 2020 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) 2020 2019 2018 Net revenues $ 45,804 $ 33,266 $ 32,753 Cost of products sold 15,387 7,439 7,718 Selling, general and administrative 11,299 6,942 7,399 Research and development 6,557 6,407 10,329 Acquired in-process research and development 1,198 385 424 Other operating (income) expense ( 890 ) 500 Total operating costs and expenses 34,441 20,283 26,370 Operating earnings 11,363 12,983 6,383 Interest expense, net 2,280 1,509 1,144 Net foreign exchange loss 71 42 24 Other expense, net 5,614 3,006 18 Earnings before income tax expense 3,398 8,426 5,197 Income tax expense (benefit) ( 1,224 ) 544 ( 490 ) Net earnings 4,622 7,882 5,687 Net earnings attributable to noncontrolling interest 6 Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Per share data Basic earnings per share attributable to AbbVie Inc. $ 2.73 $ 5.30 $ 3.67 Diluted earnings per share attributable to AbbVie Inc. $ 2.72 $ 5.28 $ 3.66 Weighted-average basic shares outstanding 1,667 1,481 1,541 Weighted-average diluted shares outstanding 1,673 1,484 1,546 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) 2020 2019 2018 Net earnings $ 4,622 $ 7,882 $ 5,687 Foreign currency translation adjustments, net of tax expense (benefit) of $ 28 in 2020, $( 4 ) in 2019 and $( 18 ) in 2018 1,511 ( 98 ) ( 391 ) Net investment hedging activities, net of tax expense (benefit) of $( 221 ) in 2020, $ 22 in 2019 and $ 40 in 2018 ( 799 ) 74 138 Pension and post-employment benefits, net of tax expense (benefit) of $( 47 ) in 2020, $( 323 ) in 2019 and $ 35 in 2018 ( 102 ) ( 1,243 ) 197 Marketable security activities, net of tax expense (benefit) of $ in 2020, $ in 2019 and $ in 2018 10 ( 10 ) Cash flow hedging activities, net of tax expense (benefit) of $( 23 ) in 2020, $ 70 in 2019 and $ 23 in 2018 ( 131 ) 141 313 Other comprehensive income (loss) $ 479 $ ( 1,116 ) $ 247 Comprehensive income 5,101 6,766 5,934 Comprehensive income attributable to noncontrolling interest 6 Comprehensive income attributable to AbbVie Inc. $ 5,095 $ 6,766 $ 5,934 The accompanying notes are an integral part of these consolidated financial statements. 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) 2020 2019 Assets Current assets Cash and equivalents $ 8,449 $ 39,924 Short-term investments 30 Accounts receivable, net 8,822 5,428 Inventories 3,310 1,813 Prepaid expenses and other 3,562 2,354 Total current assets 24,173 49,519 Investments 293 93 Property and equipment, net 5,248 2,962 Intangible assets, net 82,876 18,649 Goodwill 33,124 15,604 Other assets 4,851 2,288 Total assets $ 150,565 $ 89,115 Liabilities and Equity Current liabilities Short-term borrowings $ 34 $ Current portion of long-term debt and finance lease obligations 8,468 3,753 Accounts payable and accrued liabilities 20,159 11,832 Total current liabilities 28,661 15,585 Long-term debt and finance lease obligations 77,554 62,975 Deferred income taxes 3,646 1,130 Other long-term liabilities 27,607 17,597 Commitments and contingencies Stockholders equity (deficit) Common stock, $ 0.01 par value, 4,000,000,000 shares authorized, 1,792,140,764 shares issued as of December 31, 2020 and 1,781,582,608 as of December 31, 2019 18 18 Common stock held in treasury, at cost, 27,007,945 shares as of December 31, 2020 and 302,671,146 as of December 31, 2019 ( 2,264 ) ( 24,504 ) Additional paid-in capital 17,384 15,193 Retained earnings 1,055 4,717 Accumulated other comprehensive loss ( 3,117 ) ( 3,596 ) Total stockholders' equity (deficit) 13,076 ( 8,172 ) Noncontrolling interest 21 Total equity (deficit) 13,097 ( 8,172 ) Total liabilities and equity $ 150,565 $ 89,115 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Noncontrolling interest Total Balance at December 31, 2017 1,592 $ 18 $ ( 11,923 ) $ 14,270 $ 5,459 $ ( 2,727 ) $ $ 5,097 Adoption of new accounting standards (a) ( 1,733 ) ( 1,733 ) Net earnings attributable to AbbVie Inc. 5,687 5,687 Other comprehensive income, net of tax 247 247 Dividends declared ( 6,045 ) ( 6,045 ) Purchases of treasury stock ( 121 ) ( 12,215 ) ( 12,215 ) Stock-based compensation plans and other 8 30 486 516 Balance at December 31, 2018 1,479 18 ( 24,108 ) 14,756 3,368 ( 2,480 ) ( 8,446 ) Net earnings attributable to AbbVie Inc. 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other 5 32 437 469 Balance at December 31, 2019 1,479 18 ( 24,504 ) 15,193 4,717 ( 3,596 ) ( 8,172 ) Net earnings attributable to AbbVie Inc. 4,616 4,616 Other comprehensive income, net of tax 479 479 Dividends declared ( 8,278 ) ( 8,278 ) Common shares and equity awards issued for acquisition of Allergan plc 286 23,166 1,243 24,409 Purchases of treasury stock ( 10 ) ( 978 ) ( 978 ) Stock-based compensation plans and other 10 52 948 1,000 Change in noncontrolling interest 21 21 Balance at December 31, 2020 1,765 $ 18 $ ( 2,264 ) $ 17,384 $ 1,055 $ ( 3,117 ) $ 21 $ 13,097 (a) Adoption of new accounting standards primarily includes the cumulative-effect adjustment of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The accompanying notes are an integral part of these consolidated financial statements. 2020 Form 10-K | AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) 2020 2019 2018 Cash flows from operating activities Net earnings $ 4,622 $ 7,882 $ 5,687 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation 666 464 471 Amortization of intangible assets 5,805 1,553 1,294 Deferred income taxes ( 2,325 ) 122 ( 1,517 ) Change in fair value of contingent consideration liabilities 5,753 3,091 49 Stock-based compensation 753 430 421 Upfront costs and milestones related to collaborations 1,376 490 1,061 Gain on divestitures ( 330 ) Intangible asset impairment 1,030 5,070 Impacts related to U.S. tax reform 424 Other, net 832 43 76 Changes in operating assets and liabilities, net of acquisitions: Accounts receivable ( 929 ) ( 74 ) ( 591 ) Inventories ( 40 ) ( 231 ) ( 226 ) Prepaid expenses and other assets 134 ( 225 ) ( 200 ) Accounts payable and other liabilities 1,514 97 734 Income tax assets and liabilities, net ( 573 ) ( 1,018 ) 674 Cash flows from operating activities 17,588 13,324 13,427 Cash flows from investing activities Acquisition of businesses, net of cash acquired ( 38,260 ) Other acquisitions and investments ( 1,350 ) ( 1,135 ) ( 736 ) Acquisitions of property and equipment ( 798 ) ( 552 ) ( 638 ) Purchases of investment securities ( 61 ) ( 583 ) ( 1,792 ) Sales and maturities of investment securities 1,525 2,699 2,160 Other, net 1,387 167 Cash flows from investing activities ( 37,557 ) 596 ( 1,006 ) Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) 299 Proceeds from issuance of other short-term borrowings 3,002 Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 3,000 31,482 5,963 Repayments of long-term debt and finance lease obligations ( 5,683 ) ( 1,536 ) ( 6,035 ) Debt issuance costs ( 20 ) ( 424 ) ( 40 ) Dividends paid ( 7,716 ) ( 6,366 ) ( 5,580 ) Purchases of treasury stock ( 978 ) ( 629 ) ( 12,014 ) Proceeds from the exercise of stock options 209 8 73 Payments of contingent consideration liabilities ( 321 ) ( 163 ) ( 78 ) Other, net 8 35 14 Cash flows from financing activities ( 11,501 ) 18,708 ( 14,396 ) Effect of exchange rate changes on cash and equivalents ( 5 ) 7 ( 39 ) Net change in cash and equivalents ( 31,475 ) 32,635 ( 2,014 ) Cash and equivalents, beginning of year 39,924 7,289 9,303 Cash and equivalents, end of year $ 8,449 $ 39,924 $ 7,289 Other supplemental information Interest paid, net of portion capitalized $ 2,619 $ 1,794 $ 1,215 Income taxes paid (received) 1,674 1,447 ( 35 ) Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 23,979 The accompanying notes are an integral part of these consolidated financial statements. | 2020 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On May 8, 2020, AbbVie completed its previously announced acquisition of Allergan plc (Allergan). Refer to Note 5 for additional information regarding this acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. 2020 Form 10-K | For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaborations with Janssen Biotech, Inc. and Genentech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 1.8 billion in 2020, $ 1.1 billion in 2019 and $ 1.1 billion in 2018. Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (loss) (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five-year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of equity securities, held-to-maturity debt securities, marketable debt securities and time deposits. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in | 2020 Form 10-K equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. AbbVie periodically assesses its marketable debt securities for impairment and credit losses. When a decline in fair value of marketable debt security is due to credit related factors, an allowance for credit losses is recorded with a corresponding charge to other expense in the consolidated statements of earnings. When AbbVie determines that a non-credit related impairment has occurred, the amortized cost basis of the investment, net of allowance for credit losses, is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any impairments and credit losses that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) 2020 2019 Finished goods $ 1,318 $ 485 Work-in-process 1,201 942 Raw materials 791 386 Inventories $ 3,310 $ 1,813 Property and Equipment as of December 31 (in millions) 2020 2019 Land $ 288 $ 72 Buildings 2,555 1,613 Equipment 6,976 6,012 Construction in progress 1,040 491 Property and equipment, gross 10,859 8,188 Less accumulated depreciation ( 5,611 ) ( 5,226 ) Property and equipment, net $ 5,248 $ 2,962 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 666 million in 2020, $ 464 million in 2019 and $ 471 million in 2018. Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not 2020 Form 10-K | readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to | 2020 Form 10-K regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2016-13 In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. AbbVie adopted the standard in the first quarter of 2020. Upon adoption of the standard, accounts receivable are stated at amortized cost less allowance for credit losses. The allowance for credit losses reflects the best estimate of future losses over the contractual life of outstanding accounts receivable and is determined on the basis of historical experience, specific allowances for known troubled accounts, other currently available information including customer financial condition, and both current and forecasted economic conditions. The adoption did not have a material impact on the company's consolidated financial statements. The allowance for credit losses was $ 262 million at December 31, 2020. There were no significant changes in credit loss risk factors that impacted the company's recorded allowance during 2020. 2020 Form 10-K | Recent Accounting Pronouncements Not Yet Adopted ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for AbbVie starting with the first quarter of 2021. AbbVie has completed its assessment of the new standard and concluded that the adoption will not have a material impact on its consolidated financial statements. Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) 2020 2019 2018 Interest expense $ 2,454 $ 1,784 $ 1,348 Interest income ( 174 ) ( 275 ) ( 204 ) Interest expense, net $ 2,280 $ 1,509 $ 1,144 Accounts Payable and Accrued Liabilities as of December 31 (in millions) 2020 2019 Sales rebates $ 7,188 $ 4,484 Dividends payable 2,335 1,771 Accounts payable 2,276 1,452 Salaries, wages and commissions 1,669 830 Royalty and license arrangements 483 324 Other 6,208 2,971 Accounts payable and accrued liabilities $ 20,159 $ 11,832 Other Long-Term Liabilities as of December 31 (in millions) 2020 2019 Contingent consideration liabilities $ 12,289 $ 7,201 Liabilities for unrecognized tax benefits 5,680 2,772 Income taxes payable 3,847 3,453 Pension and other post-employment benefits 3,413 2,949 Other 2,378 1,222 Other long-term liabilities $ 27,607 $ 17,597 | 2020 Form 10-K Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) 2020 2019 2018 Basic EPS Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Earnings allocated to participating securities 60 40 30 Earnings available to common shareholders $ 4,556 $ 7,842 $ 5,657 Weighted average basic shares of common stock outstanding 1,667 1,481 1,541 Basic earnings per share attributable to AbbVie Inc. $ 2.73 $ 5.30 $ 3.67 Diluted EPS Net earnings attributable to AbbVie Inc. $ 4,616 $ 7,882 $ 5,687 Earnings allocated to participating securities 60 40 30 Earnings available to common shareholders $ 4,556 $ 7,842 $ 5,657 Weighted average shares of common stock outstanding 1,667 1,481 1,541 Effect of dilutive securities 6 3 5 Weighted average diluted shares of common stock outstanding 1,673 1,484 1,546 Diluted earnings per share attributable to AbbVie Inc. $ 2.72 $ 5.28 $ 3.66 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Allergan On May 8, 2020, AbbVie completed its previously announced acquisition of all outstanding equity interests in Allergan in a cash and stock transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. The combination creates a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, eye care and women's health. AbbVie's existing product portfolio and pipeline is enhanced with numerous Allergan assets and Allergan's product portfolio benefits from AbbVie's commercial strength, expertise and international infrastructure. Under the terms of the acquisition, each ordinary share of Allergan common stock was converted into the right to receive (i) $ 120.30 in cash and (ii) 0.8660 of a share of AbbVie common stock. Total consideration for the acquisition of Allergan is summarized as follows: (in millions) Cash consideration paid to Allergan shareholders (a) $ 39,675 Fair value of AbbVie common stock issued to Allergan shareholders (b) 23,979 Fair value of AbbVie equity awards issued to Allergan equity award holders (c) 430 Total consideration $ 64,084 (a) Represents cash consideration transferred of $ 120.30 per outstanding Allergan ordinary share based on 330 million Allergan ordinary shares outstanding at closing. 2020 Form 10-K | (b) Represents the acquisition date fair value of 286 million shares of AbbVie common stock issued to Allergan shareholders based on the exchange ratio of 0.8660 AbbVie shares for each outstanding Allergan ordinary share at the May 8, 2020 closing price of $ 83.96 per share. (c) Represents the pre-acquisition service portion of the fair value of 11 million AbbVie stock options and 8 million RSUs issued to Allergan equity award holders. The acquisition of Allergan has been accounted for as a business combination using the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The valuation of assets acquired and liabilities assumed has not yet been finalized as of December 31, 2020. As a result, AbbVie recorded preliminary estimates for the fair value of assets acquired and liabilities assumed as of the acquisition date. Subsequent to the acquisition date, the company made certain measurement period adjustments to the preliminary purchase price allocation, including: (i) an increase to developed product rights intangible assets of $ 9.1 billion; (ii) an increase to IPRD intangible assets of $ 710 million; (iii) an increase to property and equipment of $ 215 million; (iv) other individually insignificant adjustments for a net increase to identifiable net assets of $ 73 million; and (v) a corresponding decrease to goodwill of $ 10.0 billion. The measurement period adjustments primarily resulted from revised future cash flow estimates for certain intangible assets and completing valuations of property and equipment. These measurement period adjustments have been reflected in the table below. The company made these measurement period adjustments to reflect facts and circumstances that existed as of the acquisition date and did not result from intervening events subsequent to such date. These adjustments did not have a significant impact on AbbVie's results of operations. Finalization of the valuation during the measurement period could result in a change in the amounts recorded for the acquisition date fair value of intangible assets, goodwill and income taxes among other items. The completion of the valuation will occur no later than one year from the acquisition date. The following table summarizes the preliminary fair value of assets acquired and liabilities assumed as of the acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ 1,537 Short-term investments 1,421 Accounts receivable 2,374 Inventories 2,340 Prepaid expenses and other current assets 1,982 Investments 137 Property and equipment 2,127 Intangible assets Developed product rights 67,330 In-process research and development 1,750 Other noncurrent assets 1,395 Short-term borrowings ( 60 ) Current portion of long-term debt and finance lease obligations ( 1,899 ) Accounts payable and accrued liabilities ( 5,852 ) Long-term debt and finance lease obligations ( 18,937 ) Deferred income taxes ( 3,792 ) Other long-term liabilities ( 4,765 ) Total identifiable net assets 47,088 Goodwill 16,996 Total assets acquired and liabilities assumed $ 64,084 The fair value step-up adjustment to inventories of $ 1.2 billion is being amortized to cost of products sold when the inventory is sold to customers, which is expected to be within approximately one year from the acquisition date. Intangible assets relate to $ 67.3 billion of developed product rights and $ 1.8 billion of IPRD. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of approximately twelve years using the estimated pattern of economic benefit. The estimated fair values of identifiable intangible assets were determined using the ""income approach"" which is a valuation technique that provides an estimate of the fair value of an asset based on market | 2020 Form 10-K participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product, the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of long-term debt was determined by quoted market prices as of the acquisition date and the total purchase price adjustment of $ 1.3 billion is being amortized as a reduction to interest expense, net over the lives of the related debt. Goodwill was calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from the other assets acquired that could not be individually identified and separately recognized. Specifically, the goodwill recognized from the acquisition of Allergan represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Allergan have been included in the consolidated financial statements. For the period from the acquisition date through December 31, 2020, net revenues attributable to Allergan were $ 10.3 billion and operating losses attributable to Allergan were $ 1.1 billion, inclusive of $ 4.0 billion of intangible asset amortization and $ 1.2 billion of inventory fair value step-up amortization. Acquisition-related expenses, which were comprised primarily of regulatory, financial advisory and legal fees, totaled $ 781 million for the year ended December 31, 2020 and $ 103 million for the year ended December 31, 2019 which were included in SGA expenses in the consolidated statements of earnings. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of AbbVie and Allergan for 2020 and 2019 as if the acquisition of Allergan had occurred on January 1, 2019: years ended December 31 (in millions) 2020 2019 Net revenues $ 50,521 $ 49,028 Net earnings (loss) 6,746 ( 38 ) The unaudited pro forma combined financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Allergan. In order to reflect the occurrence of the acquisition on January 1, 2019 as required, the unaudited pro forma financial information includes adjustments to reflect incremental amortization expense to be incurred based on the current preliminary fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with acquisition date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition-related costs incurred during the year ended December 31, 2020 to the year ended December 31, 2019. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2019. In addition, the unaudited pro forma financial information is not a projection of future results of operations of the combined company nor does it reflect the expected realization of any synergies or cost savings associated with the acquisition. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.4 billion in 2020, $ 1.1 billion in 2019 and $ 736 million in 2018. AbbVie recorded acquired IPRD charges of $ 1.2 billion in 2020, $ 385 million in 2019 and $ 424 million in 2018. Significant arrangements impacting 2020, 2019 and 2018, some of which require contingent milestone payments, are summarized below. Luminera In October 2020, AbbVie entered into an agreement with Luminera, a privately held aesthetics company based in Israel, to acquire Luminera's full dermal filler portfolio and RD pipeline including HArmonyCa, a dermal filler intended for facial soft tissue augmentation. The aggregate accounting purchase price of $ 186 million was comprised of a $ 122 million upfront cash payment and $ 64 million for the acquisition date fair value of contingent consideration liabilities, for which AbbVie may owe up to $ 90 million in future payments upon achievement of certain commercial milestones. HArmonyCa is currently commercially available in Israel and Brazil and AbbVie will continue to develop this product for its international and U.S. markets. The agreement was accounted for as a business combination using the acquisition method of accounting. As of the 2020 Form 10-K | acquisition date, AbbVie acquired $ 127 million of intangible assets for in-process research and development and $ 33 million of intangible assets for developed product rights. Other assets and liabilities assumed were insignificant. The acquisition resulted in the recognition of $ 12 million of goodwill which is not deductible for tax purposes. I-Mab Biopharma In September 2020, AbbVie and I-Mab Biopharma (I-Mab) entered into a collaboration agreement for the development and commercialization of lemzoparlimab, an anti-CD47 monoclonal antibody internally discovered and developed by I-Mab for the treatment of multiple cancers. Both companies will collaborate to design and conduct further global clinical trials to evaluate lemzoparlimab. The collaboration provides AbbVie an exclusive global license, excluding greater China, to develop and commercialize lemzoparlimab. The companies will share manufacturing responsibilities with AbbVie being the primary manufacturer for global supply. The agreement also allows for potential collaboration on future CD47-related therapeutic agents, subject to further licenses to explore each other's related programs in their respective territories. The terms of the arrangement include an initial upfront payment of $ 180 million to exclusively license lemzoparlimab along with a milestone payment of $ 20 million based on the Phase I results, for a total of $ 200 million, which was recorded to IPRD in the consolidated statements of earnings in the fourth quarter of 2020 after regulatory approval of the transaction. In addition, I-Mab will be eligible to receive up to $ 1.7 billion upon the achievement of certain clinical development, regulatory and commercial milestones, and AbbVie will pay tiered royalties from low-to-mid teen percentages on global net revenues outside of greater China. Genmab A/S In June 2020, AbbVie and Genmab A/S (Genmab) entered into a collaboration agreement to jointly develop and commercialize three of Genmab's early-stage investigational bispecific antibody therapeutics and entered into a discovery research collaboration for future differentiated antibody therapeutics for the treatment of cancer. Under the terms of the agreement, Genmab granted to AbbVie an exclusive license to its epcoritamab (DuoBody-CD3xCD20), DuoHexaBody-CD37 and DuoBody-CD3x5T4 programs. For epcoritamab, the companies will share commercial responsibilities in the U.S. and Japan, with AbbVie responsible for further global commercialization. Genmab will record net revenues in the U.S. and Japan, and the parties will share equally in pre-tax profits from these sales. Genmab will receive tiered royalties on remaining global sales. For the discovery research partnership, Genmab will conduct Phase 1 studies for these programs and AbbVie retains the right to opt-in to program development. During 2020, AbbVie made an upfront payment of $ 750 million, which was recorded to IPRD in the consolidated statements of earnings. AbbVie could make additional payments of up to $ 3.2 billion upon the achievement of certain development, regulatory and commercial milestones for all programs. Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators. As consideration for the rights reacquired by Reata, AbbVie received a total of $ 250 million as of December 31, 2020 and will receive $ 80 million in cash in 2021. Total consideration of $ 330 million was recognized in other operating (income) expense in the consolidated statements of earnings in 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million to the collaboration and the term is extended for an additional three years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018, AbbVie recorded $ 500 million in other operating (income) expense in the consolidated statements of earnings related to its commitments under the agreement. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 248 million in 2020, $ 385 million in 2019 and $ 424 million in 2018. In connection with the other | 2020 Form 10-K individually insignificant early-stage arrangements entered into in 2020, AbbVie could make additional payments of up to $ 5.1 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaborations The company has ongoing transactions with other entities through collaboration agreements. The following represent the significant collaboration agreements impacting 2020, 2019 and 2018. Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of Imbruvica, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to Imbruvica, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize Imbruvica outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of Imbruvica are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize Imbruvica. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) 2020 2019 2018 United States - Janssen's share of profits (included in cost of products sold) $ 2,012 $ 1,803 $ 1,372 International - AbbVie's share of profits (included in net revenues) 1,009 844 622 Global - AbbVie's share of other costs (included in respective line items) 295 321 326 AbbVies receivable from Janssen, included in accounts receivable, net, was $ 283 million at December 31, 2020 and $ 235 million at December 31, 2019. AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 562 million at December 31, 2020 and $ 455 million at December 31, 2019. Collaboration with Genentech, Inc. AbbVie and Genentech, Inc. (Genentech), a member of the Roche Group, are parties to a collaboration and license agreement executed in 2007 to jointly research, develop and commercialize human therapeutic products containing BCL-2 inhibitors and certain other compound inhibitors which includes Venclexta, a BCL-2 inhibitor used to treat certain hematological malignancies. AbbVie shares equally with Genentech all pre-tax profits and losses from the development and commercialization of Venclexta in the United States. AbbVie pays royalties on Venclexta net revenues outside the United States. AbbVie manufactures and distributes Venclexta globally and is the principal in the end-customer product sales. Sales of Venclexta are included in AbbVie's net revenues. Genentech's share of United States profits is included in AbbVie's cost of products sold. AbbVie records sales and marketing costs associated with the United States collaboration as part of SGA 2020 Form 10-K | expenses and global development costs as part of RD expenses, net of Genentechs share. Royalties paid for Venclexta revenues outside the United States are also included in AbbVies cost of products sold. The following table shows the profit and cost sharing relationship between Genentech and AbbVie: years ended December 31 (in millions) 2020 2019 2018 Genentech's share of profits, including royalties (included in cost of products sold) $ 533 $ 320 $ 141 AbbVie's share of sales and marketing costs from U.S. collaboration (included in SGA) 46 41 27 AbbVie's share of development costs (included in RD) 129 128 160 Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2018 $ 15,663 Foreign currency translation adjustments ( 59 ) Balance as of December 31, 2019 15,604 Additions (a) 17,008 Foreign currency translation adjustments 512 Balance as of December 31, 2020 $ 33,124 (a) Goodwill additions related to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020 (see Note 5). The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2020, there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: 2020 2019 as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 87,707 $ ( 11,620 ) $ 76,087 $ 19,547 $ ( 6,405 ) $ 13,142 License agreements 7,828 ( 2,916 ) 4,912 7,798 ( 2,291 ) 5,507 Total definite-lived intangible assets 95,535 ( 14,536 ) 80,999 27,345 ( 8,696 ) 18,649 Indefinite-lived research and development 1,877 1,877 Total intangible assets, net $ 97,412 $ ( 14,536 ) $ 82,876 $ 27,345 $ ( 8,696 ) $ 18,649 Definite-Lived Intangible Assets The increase in definite-lived intangible assets during 2020 was primarily due to the acquisition of Allergan in the second quarter of 2020. The intangible assets will be amortized using the estimated pattern of economic benefit. Refer to Note 5 for additional information regarding this acquisition. | 2020 Form 10-K Definite-lived intangible assets are amortized over their estimated useful lives, which range between 1 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $ 5.8 billion in 2020, $ 1.6 billion in 2019 and $ 1.3 billion in 2018 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2020 is as follows: (in billions) 2021 2022 2023 2024 2025 Anticipated annual amortization expense $ 7.7 $ 7.2 $ 7.5 $ 8.0 $ 8.4 No definite-lived intangible asset impairment charges were recorded in 2020, 2019 or 2018. Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. The increase in indefinite-lived research and development assets during 2020 was due to the acquisition of Allergan in the second quarter of 2020 and the acquisition of Luminera in the fourth quarter of 2020. Refer to Note 5 for additional information regarding these acquisitions. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. No indefinite-lived intangible asset impairment charges were recorded in 2020. In 2019, following the announcement of the decision to terminate the rovalpituzumab tesirine (Rova-T) RD program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. This termination was subsequent to the decision to stop enrollment for the TAHOE trial, which resulted in an impairment charge of $ 5.1 billion in 2018. These impairment charges were recorded to RD expense in the consolidated statements of earnings in 2019 and 2018. Note 8 Integration and Restructuring Plans Allergan Integration Plan Following the closing of the Allergan acquisition, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. To achieve these integration objectives, AbbVie expects to incur approximately $ 2 billion of charges through 2022. These costs will consist of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses. The following table summarizes the charges associated with the Allergan acquisition integration plan: 2020 year ended December 31 (in millions) Severance and employee benefits Other integration Cost of products sold $ 109 $ 21 Research and development 199 177 Selling, general and administrative 388 237 Total charges $ 696 $ 435 The following table summarizes the cash activity in the recorded liability associated with the integration plan: 2020 year ended December 31 (in millions) Severance and employee benefits Other integration Charges $ 594 $ 435 Payments and other adjustments ( 227 ) ( 415 ) Accrued balance as of December 31, 2020 $ 367 $ 20 2020 Form 10-K | Other Restructuring AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2020, 2019 and 2018, no such plans were individually significant. Restructuring charges recorded were $ 60 million in 2020, $ 234 million in 2019 and $ 70 million in 2018 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. The following table summarizes the cash activity in the restructuring reserve for 2020, 2019 and 2018: (in millions) Accrued balance as of December 31, 2017 $ 86 2018 restructuring charges 59 Payments and other adjustments ( 46 ) Accrued balance as of December 31, 2018 99 2019 restructuring charges 219 Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 140 2020 restructuring charges 58 Payments and other adjustments ( 108 ) Accrued balance as of December 31, 2020 $ 90 Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheets: as of December 31 (in millions) Balance sheet caption 2020 2019 Assets Operating Other assets $ 895 $ 344 Finance Property and equipment, net 27 23 Total lease assets $ 922 $ 367 Liabilities Operating Current Accounts payable and accrued liabilities $ 175 $ 109 Noncurrent Other long-term liabilities 832 251 Finance Current Current portion of long-term debt and finance lease obligations 8 7 Noncurrent Long-term debt and finance lease obligations 21 20 Total lease liabilities $ 1,036 $ 387 | 2020 Form 10-K The following table summarizes the lease costs recognized in the consolidated statements of earnings: years ended December 31 (in millions) 2020 2019 Operating lease cost $ 192 $ 124 Short-term lease cost 59 34 Variable lease cost 60 62 Total lease cost $ 311 $ 220 Sublease income and finance lease costs were insignificant in 2020 and 2019. Lease expense prior to the adoption of ASU No. 2016-02 was $ 161 million in 2018. The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: December 31, 2020 December 31, 2019 Weighted-average remaining lease term (years) Operating 8 5 Finance 3 3 Weighted-average discount rate Operating 2.5 % 3.9 % Finance 1.4 % 3.9 % The following table presents supplementary cash flow information regarding the company's leases: years ended December 31 (in millions) 2020 2019 Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 185 $ 125 Right-of-use assets obtained in exchange for new operating lease liabilities 692 26 Finance lease cash flows were insignificant in 2020 and 2019. Right-of-use assets obtained in exchange for new operating lease liabilities included $ 453 million of right-of-use assets acquired in the Allergan acquisition. The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2020: (in millions) Operating leases Finance leases Total (a) 2021 $ 202 $ 27 $ 229 2022 178 3 181 2023 140 2 142 2024 111 1 112 2025 96 96 Thereafter 394 394 Total lease payments 1,121 33 1,154 Less: Interest 114 4 118 Present value of lease liabilities $ 1,007 $ 29 $ 1,036 (a) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. 2020 Form 10-K | Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2020 (a) 2020 Effective interest rate in 2019 (a) 2019 Senior notes issued in 2012 2.90 % notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40 % notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 2.50 % notes due 2020 2.65 % 2.65 % 3,750 3.20 % notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60 % notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50 % notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70 % notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30 % notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85 % notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20 % notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30 % notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45 % notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 1.375 % notes due 2024 ( 1,450 principal) 1.46 % 1,783 1.46 % 1,625 2.125 % notes due 2028 ( 750 principal) 2.18 % 922 2.18 % 840 Senior notes issued in 2018 3.375 % notes due 2021 3.51 % 1,250 3.51 % 1,250 3.75 % notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25 % notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875 % notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75 % notes due 2027 ( 750 principal) 0.86 % 922 0.86 % 840 1.25 % notes due 2031 ( 650 principal) 1.30 % 799 1.30 % 728 Senior notes issued in 2019 Floating rate notes due May 2021 1.33 % 750 2.08 % 750 Floating rate notes due November 2021 1.42 % 750 2.12 % 750 Floating rate notes due 2022 1.62 % 750 2.29 % 750 2.15 % notes due 2021 2.23 % 1,750 2.23 % 1,750 2.30 % notes due 2022 2.42 % 3,000 2.42 % 3,000 2.60 % notes due 2024 2.69 % 3,750 2.69 % 3,750 2.95 % notes due 2026 3.02 % 4,000 3.02 % 4,000 3.20 % notes due 2029 3.25 % 5,500 3.25 % 5,500 4.05 % notes due 2039 4.11 % 4,000 4.11 % 4,000 4.25 % notes due 2049 4.29 % 5,750 4.29 % 5,750 Term loan facilities Floating rate notes due 2023 1.29 % 1,000 % Floating rate notes due 2025 1.42 % 2,000 % Senior notes acquired in 2020 5.000 % notes due 2021 1.59 % 1,200 % 3.450 % notes due 2022 1.89 % 2,878 % 3.250 % notes due 2022 1.85 % 1,700 % 2.800 % notes due 2023 2.08 % 350 % 3.850 % notes due 2024 1.98 % 1,032 % 3.800 % notes due 2025 2.00 % 3,021 % 4.550 % notes due 2035 3.43 % 1,789 % 4.625 % notes due 2042 3.93 % 457 % 4.850 % notes due 2044 4.02 % 1,074 % 4.750 % notes due 2045 4.13 % 881 % | 2020 Form 10-K as of December 31 (dollars in millions) Effective interest rate in 2020 (a) 2020 Effective interest rate in 2019 (a) 2019 Senior Euro notes acquired in 2020 0.500 % notes due 2021 ( 750 principal) 0.68 % 922 % 1.500 % notes due 2023 ( 500 principal) 0.48 % 615 % 1.250 % notes due 2024 ( 700 principal) 0.64 % 861 % 2.625 % notes due 2028 ( 500 principal) 1.18 % 615 % 2.125 % notes due 2029 ( 550 principal) 1.18 % 677 % Other 29 27 Fair value hedges 278 ( 48 ) Unamortized bond discounts ( 146 ) ( 161 ) Unamortized deferred financing costs ( 287 ) ( 323 ) Unamortized bond premiums (b) 1,200 Total long-term debt and finance lease obligations 86,022 66,728 Current portion 8,468 3,753 Noncurrent portion $ 77,554 $ 62,975 (a) Excludes the effect of any related interest rate swaps. (b) Represents unamortized purchase price adjustments of Allergan debt. Allergan-Related Financing In connection with the acquisition of Allergan, in May 2020, the company borrowed $ 3.0 billion under a $ 6.0 billion term loan credit agreement, of which $ 1.0 billion was outstanding under a floating rate three-year term loan tranche and $ 2.0 billion outstanding under a floating rate five-year term loan tranche as of December 31, 2020. Subsequent to these borrowings, AbbVie terminated the unused commitments of the lenders under the term loan. In May 2020, AbbVie completed its previously announced offers to exchange any and all outstanding notes of certain series issued by Allergan for new notes to be issued by AbbVie and cash. Following the settlement of the exchange offers, AbbVie issued $ 14.0 billion and 3.1 billion of new notes in exchange for the Allergan notes tendered in the exchange offers. The aggregate principal amount of Allergan notes that remained outstanding following the settlement of the exchange offers was approximately $ 1.5 billion and 635 million. The exchange transaction was accounted for as a modification of the assumed debt instruments. In September 2020, the company repaid $ 650 million aggregate principal amount of 3.375 % Allergan exchange notes at maturity. In November 2020, the company repaid 700 million aggregate principal amount of floating rate Allergan exchange notes at maturity and $ 450 million aggregate principal amount of 4.875 % Allergan exchange notes due February 2021 three months prior to maturity. In November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million, which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie used the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the acquisition described in Note 5 and to pay related fees and expenses. Other Long-Term Debt In May 2020, the company repaid $ 3.8 billion aggregate principal amount of 2.50 % senior notes at maturity. In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In 2020 Form 10-K | connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In May 2018, the company also repaid $ 3.0 billion aggregate principal amount of 1.80 % senior notes at maturity. In September 2018, the company issued $ 6.0 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375 % notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 37 million and debt discounts totaled $ 37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $ 5.9 billion net proceeds, $ 2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $ 1.0 billion was used to repay the aggregate principal amount of 2.00 % senior notes at maturity in November 2018. The company used the remaining proceeds to repay term loan obligations in 2019 as they became due. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 7.8 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 10.0 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2020, the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings There were no commercial paper borrowings outstanding as of December 31, 2020 and December 31, 2019. The weighted-average interest rate on commercial paper borrowings was 1.8 % in 2020, 2.5 % in 2019 and 2.0 % in 2018. In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2020. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2020, 2019 and 2018. No amounts were outstanding under the company's credit facilities as of December 31, 2020 and December 31, 2019. In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. | 2020 Form 10-K Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2020: as of and for the years ending December 31 (in millions) 2021 $ 8,422 2022 12,428 2023 4,215 2024 7,426 2025 8,771 Thereafter 43,686 Total obligations and commitments 84,948 Fair value hedges, unamortized bond premiums and discounts, deferred financing costs and finance lease obligations 1,074 Total long-term debt and finance lease obligations $ 86,022 Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 1.5 billion at December 31, 2020 and $ 1.0 billion at December 31, 2019, are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than 18 months. Accumulated gains and losses as of December 31, 2020 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the proposed acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a gain of $ 383 million recognized in other comprehensive income (loss). This gain is reclassified to interest expense, net over the lives of the related debt. In the fourth quarter of 2019, the company entered into interest rate swap contracts with notional amounts totaling $ 2.3 billion at December 31, 2020 and December 31, 2019. The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. The contracts were designated as cash flow hedges 2020 Form 10-K | and are recorded at fair value. Realized and unrealized gains or losses are included in AOCI and are reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 8.6 billion at December 31, 2020 and $ 7.1 billion at December 31, 2019. The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had an aggregate principal amount of senior Euro notes designated as net investment hedges of 6.6 billion at December 31, 2020 and 3.6 billion at December 31, 2019. In addition, the company had foreign currency forward exchange contracts designated as net investment hedges with notional amounts totaling 971 million at December 31, 2020 and 971 million, 204 million, and CHF 62 million at December 31, 2019. The company uses the spot method of assessing hedge effectiveness for derivative instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. AbbVie is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 4.8 billion at December 31, 2020 and $ 10.8 billion at December 31, 2019. The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2020 2019 Balance sheet caption 2020 2019 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ 2 $ 3 Accounts payable and accrued liabilities $ 82 $ 14 Designated as cash flow hedges Other assets Other long-term liabilities 6 Designated as net investment hedges Prepaid expenses and other Accounts payable and accrued liabilities 11 24 Not designated as hedges Prepaid expenses and other 49 19 Accounts payable and accrued liabilities 33 18 Interest rate swap contracts Designated as cash flow hedges Prepaid expenses and other Accounts payable and accrued liabilities 14 Designated as cash flow hedges Other assets 3 Other long-term liabilities 20 Designated as fair value hedges Prepaid expenses and other 7 Accounts payable and accrued liabilities 2 Designated as fair value hedges Other assets 131 28 Other long-term liabilities 74 Total derivatives $ 189 $ 53 $ 166 $ 132 While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. | 2020 Form 10-K The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) 2020 2019 2018 Foreign currency forward exchange contracts Designated as cash flow hedges $ ( 71 ) $ ( 5 ) $ 175 Designated as net investment hedges ( 95 ) 33 Interest rate swap contracts designated as cash flow hedges ( 53 ) 4 Treasury rate lock agreements designated as cash flow hedges 383 Assuming market rates remain constant through contract maturities, the company expects to reclassify pre-tax losses of $ 93 million into cost of products sold for foreign currency cash flow hedges, pre-tax losses of $ 24 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax losses of $ 907 million in 2020, pre-tax gains of $ 90 million in 2019 and pre-tax gains of $ 178 million in 2018. The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption 2020 2019 2018 Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ 23 $ 167 $ ( 161 ) Designated as net investment hedges Interest expense, net 18 27 Not designated as hedges Net foreign exchange loss 58 ( 70 ) 83 Treasury rate lock agreements designated as cash flow hedges Interest expense, net 24 3 Interest rate swap contracts Designated as cash flow hedges Interest expense, net ( 17 ) 1 Designated as fair value hedges Interest expense, net 365 418 ( 71 ) Debt designated as hedged item in fair value hedges Interest expense, net ( 365 ) ( 418 ) 71 Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. 2020 Form 10-K | The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2020: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 8,449 $ 2,758 $ 5,691 $ Money market funds and time deposits 12 12 Debt securities 50 50 Equity securities 159 149 10 Interest rate swap contracts 138 138 Foreign currency contracts 51 51 Total assets $ 8,859 $ 2,907 $ 5,952 $ Liabilities Interest rate swap contracts $ 34 $ $ 34 $ Foreign currency contracts 132 132 Contingent consideration 12,997 12,997 Total liabilities $ 13,163 $ $ 166 $ 12,997 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2019: Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Assets Cash and equivalents $ 39,924 $ 1,542 $ 38,382 $ Debt securities 3 3 Equity securities 24 24 Interest rate swap contracts 31 31 Foreign currency contracts 22 22 Total assets $ 40,004 $ 1,566 $ 38,438 $ Liabilities Interest rate swap contracts $ 76 $ $ 76 $ Foreign currency contracts 56 56 Contingent consideration 7,340 7,340 Total liabilities $ 7,472 $ $ 132 $ 7,340 Equity securities consist of investments for which the fair values were determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones | 2020 Form 10-K and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. The fair value of the company's contingent consideration liabilities as of December 31, 2020 was calculated using the following significant unobservable inputs: Range Weighted Average (a) Discount rate 0.1 % - 2.2 % 1.1 % Probability of payment for unachieved milestones 56 % - 92 % 64 % Probability of payment for royalties by indication (b) 56 % - 100 % 91 % Projected year of payments 2021 - 2034 (a) Unobservable inputs were weighted by the relative fair value of the contingent consideration liabilities. (b) Excludes early stage indications with 0 % estimated probability of payment and includes approved indications with 100 % probability of payment. Excluding approved indications, the estimated probability of payment ranged from 56 % to 89 % at December 31, 2020. There have been no transfers of assets or liabilities into or out of Level 3 of the fair value hierarchy. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) 2020 2019 2018 Beginning balance $ 7,340 $ 4,483 $ 4,534 Additions (a) 225 Change in fair value recognized in net earnings 5,753 3,091 49 Payments ( 321 ) ( 234 ) ( 100 ) Ending balance $ 12,997 $ 7,340 $ 4,483 (a) Additions during the year ended December 31, 2020 represent contingent consideration liabilities assumed in the Allergan acquisition as well as contingent consideration resulting from the Luminera acquisition. The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the fourth quarter of 2020, the company recorded a $ 4.7 billion increase in the Skyrizi contingent consideration liability due to higher estimated future sales driven by stronger market share uptake and favorable clinical trial results as well as lower interest rates. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the Skyrizi contingent consideration liability due to higher probabilities of success, higher estimated future sales and declining interest rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of Skyrizi for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program. During the fourth quarter of 2018, the company recorded a $ 428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 2020 Form 10-K | Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2020 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Short-term borrowings $ 34 $ 34 $ $ 34 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 8,461 8,542 8,249 293 Long-term debt and finance lease obligations, excluding fair value hedges 77,283 87,761 86,137 1,624 Total liabilities $ 85,778 $ 96,337 $ 94,386 $ 1,951 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2019 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Liabilities Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 3,755 $ 3,760 $ 3,753 $ 7 $ Long-term debt and finance lease obligations, excluding fair value hedges 63,021 66,651 66,631 20 Total liabilities $ 66,776 $ 70,411 $ 70,384 $ 27 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 102 million as of December 31, 2020 and $ 66 million as of December 31, 2019. No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2020. Concentrations of Risk Of total net accounts receivable, three U.S. wholesalers accounted for 72 % as of December 31, 2020 and 68 % as of December 31, 2019, and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. Humira (adalimumab) is AbbVie's single largest product and accounted for approximately 43 % of AbbVie's total net revenues in 2020, 58 % in 2019 and 61 % in 2018. | 2020 Form 10-K Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2020 and 2019. The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) 2020 2019 2020 2019 Projected benefit obligations Beginning of period $ 8,646 $ 6,618 $ 1,050 $ 561 Service cost 370 269 42 25 Interest cost 264 259 34 29 Employee contributions 2 2 Amendments ( 397 ) Actuarial loss 1,105 1,703 40 451 Benefits paid ( 249 ) ( 206 ) ( 17 ) ( 17 ) Acquisition 1,409 43 Other, primarily foreign currency translation adjustments 245 1 1 End of period 11,792 8,646 795 1,050 Fair value of plan assets Beginning of period 7,116 5,637 Actual return on plan assets 979 946 Company contributions 367 727 17 17 Employee contributions 2 2 Benefits paid ( 249 ) ( 206 ) ( 17 ) ( 17 ) Acquisition 1,296 Other, primarily foreign currency translation adjustments 191 10 End of period 9,702 7,116 Funded status, end of period $ ( 2,090 ) $ ( 1,530 ) $ ( 795 ) $ ( 1,050 ) Amounts recognized on the consolidated balance sheets Other assets $ 563 $ 395 $ $ Accounts payable and accrued liabilities ( 12 ) ( 8 ) ( 23 ) ( 18 ) Other long-term liabilities ( 2,641 ) ( 1,917 ) ( 772 ) ( 1,032 ) Net obligation $ ( 2,090 ) $ ( 1,530 ) $ ( 795 ) $ ( 1,050 ) Actuarial loss, net $ 4,163 $ 3,633 $ 482 $ 469 Prior service cost (credit) 8 10 ( 408 ) ( 16 ) Accumulated other comprehensive loss $ 4,171 $ 3,643 $ 74 $ 453 The projected benefit obligations (PBO) in the table above included $ 3.5 billion at December 31, 2020 and $ 2.3 billion at December 31, 2019, related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $ 10.5 billion at December 31, 2020 and $ 7.6 billion at December 31, 2019. 2020 Form 10-K | Information For Pension Plans With An Accumulated Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2020 2019 Accumulated benefit obligation $ 7,527 $ 5,752 Fair value of plan assets 6,066 4,820 Information For Pension Plans With A Projected Benefit Obligation In Excess Of Plan Assets as of December 31 (in millions) 2020 2019 Projected benefit obligation $ 8,719 $ 6,820 Fair value of plan assets 6,066 4,895 The 2020 actuarial losses of $ 1.1 billion for qualified pension plans and $ 40 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2019. The 2019 actuarial losses of $ 1.7 billion for qualified pension plans and $ 451 million for other post-employment plans were primarily driven by a decrease in the assumed discount rate from 2018. A change to AbbVie's U.S. retiree health benefit plan was approved in 2020 and communicated to employees and retirees in October 2020. Beginning in 2022, Medicare-eligible retirees and Medicare-eligible dependents will choose health care coverage from insurance providers through a private Medicare exchange. AbbVie will continue to provide financial support to Medicare-eligible retirees. This change decreased AbbVie's post-employment benefit obligation and increased AbbVie's unrecognized prior service credit as of December 31, 2020 by $ 397 million. In connection with the Allergan acquisition, AbbVie assumed certain post-employment benefit obligations which were recorded at fair value. Upon acquisition in the second quarter of 2020, the excess of projected benefit obligations over the plan assets was recognized as a liability totaling $ 156 million. Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) 2020 2019 2018 Defined benefit plans Actuarial loss $ 701 $ 1,231 $ 209 Amortization of prior service cost ( 2 ) Amortization of actuarial loss ( 227 ) ( 109 ) ( 140 ) Foreign exchange loss (gain) and other 56 ( 6 ) ( 13 ) Total loss $ 528 $ 1,116 $ 56 Other post-employment plans Actuarial loss (gain) $ 40 $ 451 $ ( 287 ) Prior service cost (credit) ( 397 ) Amortization of prior service credit 4 Amortization of actuarial loss ( 26 ) ( 1 ) ( 1 ) Total loss (gain) $ ( 379 ) $ 450 $ ( 288 ) | 2020 Form 10-K Net Periodic Benefit Cost years ended December 31 (in millions) 2020 2019 2018 Defined benefit plans Service cost $ 370 $ 269 $ 285 Interest cost 264 259 227 Expected return on plan assets ( 575 ) ( 474 ) ( 439 ) Amortization of prior service cost 2 Amortization of actuarial loss 227 109 140 Net periodic benefit cost $ 288 $ 163 $ 213 Other post-employment plans Service cost $ 42 $ 25 $ 26 Interest cost 34 29 25 Amortization of prior service credit ( 4 ) Amortization of actuarial loss 26 1 1 Net periodic benefit cost $ 98 $ 55 $ 52 The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 2020 2019 Defined benefit plans Discount rate 2.4 % 3.0 % Rate of compensation increases 4.6 % 4.6 % Cash balance interest crediting rate 2.8 % 2.8 % Other post-employment plans Discount rate 2.8 % 3.6 % The assumptions used in calculating the December 31, 2020 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2021. Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 2020 2019 2018 Defined benefit plans Discount rate for determining service cost 3.1 % 4.0 % 3.4 % Discount rate for determining interest cost 3.0 % 4.0 % 3.1 % Expected long-term rate of return on plan assets 7.1 % 7.6 % 7.7 % Expected rate of change in compensation 4.6 % 4.6 % 4.4 % Cash balance interest crediting rate 2.8 % 2.8 % 2.8 % Other post-employment plans Discount rate for determining service cost 3.7 % 4.7 % 4.0 % Discount rate for determining interest cost 3.2 % 4.3 % 3.7 % For the December 31, 2020 post-retirement health care obligations remeasurement, the company assumed a 6.3 % pre-65 ( 6.7 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % in 2090 and remain at that level thereafter. For purposes of measuring the 2020 post-retirement health care costs, the company assumed a 6.4 % pre-65 ( 7.0 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % for 2050 and remain at that level thereafter. 2020 Form 10-K | Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) 2020 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 1,143 $ 1,143 $ $ U.S. mid cap (b) 164 164 International (c) 524 524 Fixed income securities U.S. government securities (d) 132 18 114 Corporate debt instruments (d) 854 178 676 Non-U.S. government securities (d) 544 397 147 Other (d) 297 294 3 Absolute return funds (e) 310 4 306 Real assets 10 10 Other (f) 252 250 2 Total $ 4,230 $ 2,982 $ 1,248 $ Total assets measured at NAV 5,472 Fair value of plan assets $ 9,702 Basis of fair value measurement as of December 31 (in millions) 2019 Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ 884 $ 884 $ $ U.S. mid cap (b) 138 138 International (c) 349 349 Fixed income securities U.S. government securities (d) 149 21 128 Corporate debt instruments (d) 372 112 260 Non-U.S. government securities (d) 202 84 118 Other (d) 320 318 2 Absolute return funds (e) 296 4 292 Real assets 9 9 Other (f) 132 132 Total $ 2,851 $ 2,051 $ 800 $ Total assets measured at NAV 4,265 Fair value of plan assets $ 7,116 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. | 2020 Form 10-K (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2020 target investment allocation for the AbbVie Pension Plan was 50 % in equity securities, 20 % in fixed income securities and 30 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans 2021 $ 284 $ 23 2022 301 29 2023 319 31 2024 339 33 2025 362 36 2026 to 2030 2,169 217 Defined Contribution Plan AbbVie's principal defined contribution plans are the AbbVie Savings Plan and the Allergan Savings Plan. AbbVie recorded expense of $ 191 million in 2020, $ 102 million in 2019 and $ 89 million in 2018 related to these plans. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for 2020 Form 10-K | stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: years ended December 31 (in millions) 2020 2019 2018 Cost of products sold $ 47 $ 29 $ 27 Research and development 247 171 169 Selling, general and administrative 459 230 225 Pre-tax compensation expense 753 430 421 Tax benefit 131 80 73 After-tax compensation expense $ 622 $ 350 $ 348 Realized excess tax benefits associated with stock-based compensation totaled $ 34 million in 2020, $ 15 million in 2019 and $ 78 million in 2018. Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three-year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 12.14 in 2020, $ 12.54 in 2019 and $ 21.63 in 2018. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 11.2 million stock options to holders of Allergan options as a result of the conversion of such options. These options were fair-valued using a lattice valuation model. Refer to Note 5 for additional information regarding the Allergan acquisition. The following table summarizes AbbVie stock option activity in 2020: (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted-average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2019 6,761 $ 60.39 5.9 $ 207 Granted 1,995 93.50 Granted in acquisition 11,152 70.48 Exercised ( 4,129 ) 51.29 Lapsed ( 88 ) 107.33 Outstanding at December 31, 2020 15,691 $ 73.90 4.7 $ 559 Exercisable at December 31, 2020 12,440 $ 69.99 3.6 $ 498 The total intrinsic value of options exercised was $ 186 million in 2020, $ 22 million in 2019 and $ 215 million in 2018. The total fair value of options vested during 2020 was $ 292 million. As of December 31, 2020, $ 13 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in ratable increments over a three or four-year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three-year performance period. For awards granted in 2020, performance is based on AbbVie's return on invested capital (ROIC) relative to a defined peer group of pharmaceutical, biotech and life science companies. For awards granted in 2018 and 2019, the tranches tied to 2020 performance are based on AbbVies return on equity (ROE) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest | 2020 Form 10-K over a three-year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2020: (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2019 10,232 $ 81.72 Granted 5,524 92.35 Granted in acquisition 8,234 83.96 Vested ( 6,667 ) 80.09 Forfeited ( 1,405 ) 84.13 Outstanding at December 31, 2020 15,918 $ 87.03 The fair market value of RSUs and performance shares (as applicable) vested was $ 618 million in 2020, $ 371 million in 2019 and $ 583 million in 2018. In connection with the Allergan acquisition, during the second quarter of 2020, AbbVie issued 8.2 million RSUs to holders of Allergan equity awards based on a conversion factor described in the transaction agreement. Refer to Note 5 for additional information regarding the Allergan acquisition. As of December 31, 2020, $ 579 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 4.84 in 2020, $ 4.39 in 2019 and $ 3.95 in 2018. The following table summarizes quarterly cash dividends declared during 2020, 2019 and 2018: 2020 2019 2018 Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/30/20 02/16/21 $ 1.30 11/01/19 02/14/20 $ 1.18 11/02/18 02/15/19 $ 1.07 09/11/20 11/16/20 $ 1.18 09/06/19 11/15/19 $ 1.07 09/07/18 11/15/18 $ 0.96 06/17/20 08/14/20 $ 1.18 06/20/19 08/15/19 $ 1.07 06/14/18 08/15/18 $ 0.96 02/20/20 05/15/20 $ 1.18 02/21/19 05/15/19 $ 1.07 02/15/18 05/15/18 $ 0.96 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 8 million shares for $ 757 million in 2020 and 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was $ 3.2 billion as of December 31, 2020. On February 15, 2018, AbbVie's board of directors authorized a new $ 10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $ 5.0 billion increase to the existing $ 10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $ 10.7 billion in 2018. Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $ 1.3 billion in 2018. 2020 Form 10-K | Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2020, 2019 and 2018: (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post-employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2017 $ ( 439 ) $ ( 203 ) $ ( 1,919 ) $ $ ( 166 ) $ ( 2,727 ) Other comprehensive income (loss) before reclassifications ( 391 ) 138 84 ( 14 ) 156 ( 27 ) Net losses reclassified from accumulated other comprehensive loss 113 4 157 274 Net current-period other comprehensive income (loss) ( 391 ) 138 197 ( 10 ) 313 247 Balance as of December 31, 2018 ( 830 ) ( 65 ) ( 1,722 ) ( 10 ) 147 ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) 95 ( 1,330 ) 12 298 ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) 87 ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) 74 ( 1,243 ) 10 141 ( 1,116 ) Balance as of December 31, 2019 ( 928 ) 9 ( 2,965 ) 288 ( 3,596 ) Other comprehensive income (loss) before reclassifications 1,511 ( 785 ) ( 300 ) ( 108 ) 318 Net losses (gains) reclassified from accumulated other comprehensive loss ( 14 ) 198 ( 23 ) 161 Net current-period other comprehensive income (loss) 1,511 ( 799 ) ( 102 ) ( 131 ) 479 Balance as of December 31, 2020 $ 583 $ ( 790 ) $ ( 3,067 ) $ $ 157 $ ( 3,117 ) Other comprehensive income (loss) included foreign currency translation adjustments totaling gains of $ 1.5 billion in 2020 which were principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive income (loss) included foreign currency translation adjustments totaling losses of $ 98 million in 2019 and $ 391 million in 2018 which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. | 2020 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) 2020 2019 2018 Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 18 ) $ ( 27 ) $ Tax expense 4 6 Total reclassifications, net of tax $ ( 14 ) $ ( 21 ) $ Pension and post-employment benefits Amortization of actuarial losses and other (b) $ 251 $ 110 $ 141 Tax benefit ( 53 ) ( 23 ) ( 28 ) Total reclassifications, net of tax $ 198 $ 87 $ 113 Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ ( 23 ) $ ( 167 ) $ 161 Gains on treasury rate lock agreements (a) ( 24 ) ( 3 ) Losses (gains) on interest rate swap contracts (a) 17 ( 1 ) Tax expense (benefit) 7 14 ( 4 ) Total reclassifications, net of tax $ ( 23 ) $ ( 157 ) $ 157 (a) Amounts are included in interest expense, net (see Note 11). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12). (c) Amounts are included in cost of products sold (see Note 11). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2020, no shares of preferred stock were issued or outstanding. Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2020 2019 2018 Domestic $ ( 4,467 ) $ ( 2,784 ) $ ( 4,274 ) Foreign 7,865 11,210 9,471 Total earnings before income tax expense $ 3,398 $ 8,426 $ 5,197 Income Tax Expense years ended December 31 (in millions) 2020 2019 2018 Current Domestic $ 907 $ 102 $ 593 Foreign 194 320 434 Total current taxes $ 1,101 $ 422 $ 1,027 Deferred Domestic $ ( 58 ) $ ( 137 ) $ ( 1,497 ) Foreign ( 2,267 ) 259 ( 20 ) Total deferred taxes $ ( 2,325 ) $ 122 $ ( 1,517 ) Total income tax expense (benefit) $ ( 1,224 ) $ 544 $ ( 490 ) 2020 Form 10-K | Effective Tax Rate Reconciliation years ended December 31 2020 2019 2018 Statutory tax rate 21.0 % 21.0 % 21.0 % Effect of foreign operations 2.4 ( 8.4 ) ( 28.7 ) U.S. tax credits ( 10.6 ) ( 3.3 ) ( 7.3 ) Impacts related to U.S. tax reform ( 1.1 ) ( 1.6 ) 8.2 Non-deductible expenses 7.2 1.0 1.2 Tax law changes and related restructuring ( 48.5 ) 3.1 Stock-based compensation excess tax benefit ( 0.9 ) ( 0.2 ) ( 1.5 ) Tax audit settlements ( 5.1 ) ( 4.7 ) ( 2.5 ) All other, net ( 0.4 ) ( 0.4 ) 0.2 Effective tax rate ( 36.0 ) % 6.5 % ( 9.4 ) % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2020, 2019 and 2018 differed from the statutory tax rate principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, changes in enacted tax rates and laws and related restructuring, the cost of repatriation decisions, tax audit settlements and Boehringer Ingelheim accretion on contingent consideration. The 2020 effective income tax rate included the recognition of a net tax benefit of $ 1.7 billion related to changes in tax laws and related restructuring, including certain intra-group transfers of intellectual property and deferred tax remeasurement. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2020, 2019 and 2018 included impacts related to U.S. tax reform. The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system, including a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. In 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. For 2019, the impact of the Act affected the full year earnings of these subsidiaries, resulting in additional tax expense compared to the previous year. The effective income tax rates for 2019 and 2018 also included the effects of Stemcentrx impairment related expenses. | 2020 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) 2020 2019 Deferred tax assets Compensation and employee benefits $ 1,109 $ 810 Accruals and reserves 438 371 Chargebacks and rebates 555 477 Advance payments 324 615 Net operating losses and other credit carryforwards 2,765 838 Other 1,371 406 Total deferred tax assets 6,562 3,517 Valuation allowances ( 1,203 ) ( 731 ) Total net deferred tax assets 5,359 2,786 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 5,274 ) ( 2,712 ) Excess of book basis over tax basis in investments ( 335 ) ( 249 ) Other ( 982 ) ( 440 ) Total deferred tax liabilities ( 6,591 ) ( 3,401 ) Net deferred tax liabilities $ ( 1,232 ) $ ( 615 ) The increases in deferred tax liabilities are primarily due to the acquisition of Allergan in which the company recorded the excess of book basis over tax basis of intangible assets. The increases in deferred tax assets are primarily due to deferred tax asset recognition related to the intra-group transfer of intellectual property. As of December 31, 2020, the company had U.S. federal and state credit carryforwards of $ 293 million as well as U.S. federal, state and non-U.S. net operating loss carryforwards of $ 4.3 billion, which will expire at various times through 2040. The remaining U.S. federal and non-U.S. loss carryforwards of $ 5.8 billion have no expiration. The company had valuation allowances of $ 1.2 billion as of December 31, 2020 and $ 731 million as of December 31, 2019. These were principally related to foreign and state net operating losses and credit carryforwards that are not expected to be realized. The Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings or eligible for the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. However, the company generally considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Unrecognized Tax Benefits years ended December 31 (in millions) 2020 2019 2018 Beginning balance $ 2,661 $ 2,852 $ 2,701 Increase due to acquisition 2,674 Increase due to current year tax positions 91 113 163 Increase due to prior year tax positions 59 499 110 Decrease due to prior year tax positions ( 7 ) ( 21 ) ( 36 ) Settlements ( 141 ) ( 749 ) ( 79 ) Lapse of statutes of limitations ( 73 ) ( 33 ) ( 7 ) Ending balance $ 5,264 $ 2,661 $ 2,852 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will 2020 Form 10-K | be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 5.0 billion in 2020 and $ 2.4 billion in 2019. Of the unrecognized tax benefits recorded in the table above as of December 31, 2020, AbbVie would be indemnified for approximately $ 81 million. The ""Increase due to current year tax positions"" and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. ""Increase due to acquisition"" in the table above includes amounts related to federal, state and international tax items recorded in acquisition accounting related to the Allergan acquisition. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 142 million in 2020, $ 51 million in 2019 and $ 73 million in 2018, for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $ 642 million at December 31, 2020, $ 191 million at December 31, 2019 and $ 190 million at December 31, 2018. The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 68 million. All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. The most significant matters are described below. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $ 60 million as of December 31, 2020 and approximately $ 290 million as of December 31, 2019. Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. In addition, other operating income in 2019 included $ 550 million of income from a legal settlement related to an intellectual property dispute with a third party. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Antitrust Litigation Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits pending in federal court consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payers. The cases are pending in the United States District Court for the Eastern District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In June 2020, the court denied the end-payers' motion to certify a class. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. | 2020 Form 10-K In September 2014, the Federal Trade Commission (FTC) filed a lawsuit, FTC v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $ 448 million, plus prejudgment interest. The court denied the FTCs request for injunctive relief. In September 2020, the United States Court of Appeals for the Third Circuit reversed the district courts finding of sham litigation with respect to one generic company and affirmed with respect to the other but held the FTC lacked authority to obtain a disgorgement remedy and vacated the district courts award. The Third Circuit also affirmed the district courts denial of the FTCs injunction request and reinstated the FTCs settlement-related claim for further proceedings in the district court. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that 2006 patent litigation settlements and related agreements by Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) with three generic companies violated federal antitrust law, and also making allegations similar to those in FTC v. AbbVie Inc. (above). In May 2020, Perrigo Company and related entities filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, making sham litigation allegations similar to those in FTC v. AbbVie Inc . (above). In October 2020, the Perrigo lawsuit was transferred to the United States District Court for New Jersey. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect Humira purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies Humira patent portfolio violated state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In June 2020, the court dismissed the consolidated litigation with prejudice. The plaintiffs have appealed the dismissal. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2009 and 2010 patent litigation settlements involving Namenda entered into between Forest and generic companies and other conduct by Forest involving Namenda, violated state antitrust, unfair and deceptive trade practices, and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, purported class actions filed by indirect purchasers of Namenda, are consolidated as In re: Namenda Indirect Purchaser Antitrust Litigation in the United States District Court for the Southern District of New York. Lawsuits are pending against Allergan Inc. generally alleging that Allergans petitioning to the U.S. Patent Office and Food and Drug Administration and other conduct by Allergan involving Restasis violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief and attorneys fees. The lawsuits, certified as a class action filed on behalf of indirect purchasers of Restasis, are consolidated for pre-trial purposes in the United States District Court for the Eastern District of New York under the MDL Rules as In re: Restasis (Cyclosporine Ophthalmic Emulsion) Antitrust Litigation , MDL No. 2819. Lawsuits are pending against Forest Laboratories, LLC and others generally alleging that 2012 and 2013 patent litigation settlements involving Bystolic with six generic manufacturers violated federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages, injunctive relief, and attorneys fees. The lawsuits, purported class actions filed on behalf of direct and indirect purchasers of Bystolic, are consolidated as In re: Bystolic Antitrust Litigation in the United States District Court for the Southern District of New York. Government Proceedings Lawsuits are pending against Allergan and several other manufacturers generally alleging that they improperly promoted and sold prescription opioid products. Approximately 3,100 matters are pending against Allergan. The federal court cases are consolidated for pre-trial purposes in the United States District Court for the Northern District of Ohio under the MDL rules as In re: National Prescription Opiate Litigation , MDL No. 2804. Approximately 300 of the claims are pending in various state courts. The plaintiffs in these cases, which include states, counties, cities, and Native American tribes, generally seek compensatory damages. In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In October 2020, the state added a claim under the New Mexico False Advertising Act. 2020 Form 10-K | Shareholder and Securities Litigation In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. The court granted motions dismissing the claims of three investment-fund plaintiffs, which they are appealing. One of these plaintiffs refiled its lawsuit in New York state court in June 2020 while the appeal of its dismissal in Illinois is pending. In November 2020, the New York Supreme Court for the County of New York dismissed that lawsuit. Plaintiffs seek compensatory and punitive damages. In October 2018, a federal securities lawsuit, Holwill v. AbbVie Inc., et al ., was filed in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for Humira sales growth in financial filings between 2013 and 2017 were misleading because they omitted alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value that allegedly induced Humira prescriptions. In February 2020, a shareholder derivative lawsuit, Elfers v. Gonzalez, et al. , was filed in the United States District Court for the District of Delaware alleging that certain AbbVie directors and officers breached their fiduciary duties regarding alleged misconduct in connection with Humira patient and reimbursement support services and other services and items of value and in connection with the announcements of results of AbbVies 2018 Dutch auction tender offer. In December 2020, the court dismissed the lawsuit. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergan's textured breast implants. The lawsuits, which were filed by Allergan shareholders, have been consolidated in the United States District Court for the Southern District of New York as In re: Allergan plc Securities Litigation . The plaintiffs generally seek compensatory damages and attorneys fees. In September 2019, the court partially granted Allergan's motion to dismiss. In September 2020, the court denied plaintiffs class certification motion because it found the lead plaintiff to be an inadequate representative of the proposed class but allowed another putative class member to propose itself as a new lead plaintiff. In December 2020, the court appointed a new lead plaintiff. Lawsuits are pending against Allergan and certain of its current and former officers alleging they made misrepresentations and omissions regarding Allergans former Actavis generics unit and its alleged anticompetitive conduct with other generic drug companies. The lawsuits were filed by Allergan shareholders and consist of three purported class actions and one individual action that have been consolidated in the U.S. District Court for the District of New Jersey as In re: Allergan Generic Drug Pricing Securities Litigation . Another individual action in New Jersey state court was dismissed in September 2020. The plaintiffs seek monetary damages and attorneys fees. Product Liability and General Litigation Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 92 cases are pending in the United States District Court for the Southern District of Illinois along with one other pending in s tate court. Plaintiffs generally seek compensatory and punitive damages. Approximately ninety-eight percent of these pending cases, plus other unfiled claims, are subject to confidential settlement agreements or agreements-in-principle and are expected to be dismissed with prejudice. In 2018, a qui tam lawsuit, U.S. ex rel. Silbersher v. Allergan Inc., et al. , was filed in the United States District Court for the Northern District of California against several Allergan entities and others, alleging that their conduct before the U.S. Patent Office resulted in false claims for payment being made to federal and state healthcare payors for Namenda XR and Namzaric. The plaintiff-relator seeks damages and attorneys' fees under the federal False Claims Act and state law analogues. The federal government and state governments declined to intervene in the lawsuit. Intellectual Property Litigation Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark Imbruvica). In February 2018 a lawsuit was filed in the United States District Court for the District of Delaware against Sandoz Inc. and Lek Pharmaceuticals D.D. In the case, Pharmacyclics alleges the defendants' proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in this suit. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark Imbruvica). Cases were filed in the United States District Court for the | 2020 Form 10-K District of Delaware in March 2019 and March 2020 against Alvogen Pine Brook LLC and Natco Pharma Ltd., and in April 2020 against Zydus Worldwide DMCC and Cadila Healthcare Limited. In each case, Pharmacyclics alleges defendants proposed generic ibrutinib tablet product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of Imbruvica, is the co-plaintiff in these suits. Allergan USA, Inc., Allergan Sales, LLC, and Forest Laboratories Holdings Limited, wholly owned subsidiaries of AbbVie, are seeking to enforce patent rights relating to cariprazine (a drug sold under the trademark Vraylar). Litigation was filed in the United States District Court for the District of Delaware in December 2019 against Sun Pharmaceutical Industries Limited and Sun Pharma Global FZE; Aurobindo Pharma Limited and Aurobindo Pharma USA, Inc.; and Zydus Pharmaceuticals (USA), Inc. and Cadila Healthcare Limited. Allergan alleges defendants' proposed generic cariprazine products infringe certain patents and seeks declaratory and injunctive relief. Gedeon Richter Plc, Inc. which is in a global collaboration with Allergan concerning the development and marketing of Vraylar, is the co-plaintiff in this suit. In January 2019, Allergan, Inc. and Allergan plc (now Allergan Limited) and Medytox Inc. (collectively, ""Complainants"") filed a complaint with the United States International Trade Commission (ITC) against Daewoong Pharmaceuticals Co., Ltd., Daewoong Co., Ltd., and Evolus Inc. (collectively, ""Respondents"") requesting the ITC commence an investigation regarding the importation into the United States of Respondents' botulinum neurotoxin products, including Jeuveau, which Complainants assert were developed using Medytox's trade secrets. Complainants seek permanent exclusion and cease and desist orders covering Respondents' products, including Jeuveau. In July 2020, the administrative law judge issued an initial ruling in favor of Allergan and Medytox. In December 2020, the full Commission affirmed, in part, and reversed, in part, the initial ruling. In August 2020, BTL Industries, Inc. (BTL) filed an ITC action against Allergan USA, Inc., Allergan Limited, Allergan, Inc., Zeltiq Aesthetics, Inc., Zeltiq Ireland Unlimited Company, and Zimmer Medizinsysteme GmbH, for patent infringement alleging that the CoolTone and CoolSculpting devices infringe its patents and seeking an exclusion order preventing importation of the devices and any components used to make or use the devices. 2020 Form 10-K | Note 16 Segment and Geographic Area Information AbbVie operates as a single global business segment dedicated to the research and development, manufacturing, commercialization and sale of innovative medicines and therapies. This operating structure enables the Chief Executive Officer, as chief operating decision maker (CODM), to allocate resources and assess business performance on a global basis in order to achieve established long-term strategic goals. Consistent with this structure, a global research and development and supply chain organization is responsible for the discovery, manufacturing and supply of products. Commercial efforts that coordinate the marketing, sales and distribution of these products are organized by geographic region or therapeutic area. All of these activities are supported by a global corporate administrative staff. The determination of a single business segment is consistent with the consolidated financial information regularly reviewed by the CODM for purposes of assessing performance, allocating resources and planning and forecasting future periods. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) 2020 2019 2018 Immunology Humira United States $ 16,112 $ 14,864 $ 13,685 International 3,720 4,305 6,251 Total $ 19,832 $ 19,169 $ 19,936 Skyrizi United States $ 1,385 $ 311 $ International 205 44 Total $ 1,590 $ 355 $ Rinvoq United States $ 653 $ 47 $ International 78 Total $ 731 $ 47 $ Hematologic Oncology Imbruvica United States $ 4,305 $ 3,830 $ 2,968 Collaboration revenues 1,009 844 622 Total $ 5,314 $ 4,674 $ 3,590 Venclexta United States $ 804 $ 521 $ 247 International 533 271 97 Total $ 1,337 $ 792 $ 344 Aesthetics Botox Cosmetic (a) United States $ 687 $ $ International 425 Total $ 1,112 $ $ Juvederm Collection (a) United States $ 318 $ $ International 400 Total $ 718 $ $ Other Aesthetics (a) United States $ 666 $ $ International 94 Total $ 760 $ $ Neuroscience Botox Therapeutic (a) United States $ 1,155 $ $ International 232 Total $ 1,387 $ $ Vraylar (a) United States $ 951 $ $ Duodopa United States $ 103 $ 97 $ 80 International 391 364 350 Total $ 494 $ 461 $ 430 Ubrelvy (a) United States $ 125 $ $ Other Neuroscience (a) United States $ 528 $ $ International 11 Total $ 539 $ $ | 2020 Form 10-K years ended December 31 (in millions) 2020 2019 2018 Eye Care Lumigan/Ganfort (a) United States $ 165 $ $ International 213 Total $ 378 $ $ Alphagan/Combigan (a) United States $ 223 $ $ International 103 Total $ 326 $ $ Restasis (a) United States $ 755 $ $ International 32 Total $ 787 $ $ Other Eye Care (a) United States $ 305 $ $ International 388 Total $ 693 $ $ Women's Health Lo Loestrin (a) United States $ 346 $ $ International 10 Total $ 356 $ $ Orilissa/Oriahnn United States $ 121 $ 91 $ 11 International 4 2 Total $ 125 $ 93 $ 11 Other Women's Health (a) United States $ 181 $ $ International 11 Total $ 192 $ $ Other Key Products Mavyret United States $ 785 $ 1,473 $ 1,614 International 1,045 1,420 1,824 Total $ 1,830 $ 2,893 $ 3,438 Creon United States $ 1,114 $ 1,041 $ 928 Lupron United States $ 600 $ 720 $ 726 International 152 167 166 Total $ 752 $ 887 $ 892 Linzess/Constella (a) United States $ 649 $ $ International 18 Total $ 667 $ $ Synthroid United States $ 771 $ 786 $ 776 All other $ 2,923 $ 2,068 $ 2,408 Total net revenues $ 45,804 $ 33,266 $ 32,753 (a) Net revenues include Allergan product revenues from the date of the acquisition, May 8, 2020, through December 31, 2020. 2020 Form 10-K | Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) 2020 2019 2018 United States $ 34,879 $ 23,907 $ 21,524 Japan 1,198 1,211 1,591 Canada 1,159 813 730 Germany 1,049 909 1,292 France 797 695 783 Australia 527 395 350 United Kingdom 509 372 855 China 471 195 152 Spain 453 472 611 Brazil 406 359 350 Italy 379 372 652 All other countries 3,977 3,566 3,863 Total net revenues $ 45,804 $ 33,266 $ 32,753 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) 2020 2019 United States and Puerto Rico $ 3,354 $ 2,026 Europe 1,534 646 All other 360 290 Total long-lived assets $ 5,248 $ 2,962 Note 17 Fourth Quarter Financial Results (unaudited) quarter ended December 31 (in millions except per share data) 2020 Net revenues $ 13,858 Gross margin 9,174 Net earnings attributable to AbbVie Inc. (a) 36 Basic earnings per share attributable to AbbVie Inc. $ 0.01 Diluted earnings per share attributable to AbbVie Inc. $ 0.01 Cash dividends declared per common share $ 1.30 (a) Fourth quarter results in 2020 included after-tax charges of $ 4.7 billion related to the change in fair value of contingent consideration liabilities partially offset by an after-tax benefit of $ 1.5 billion due to impacts related to tax law changes. | 2020 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 2020 Form 10-K | Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period the related product is sold. At December 31, 2020, the Company had $7,188 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate, and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions considering industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2020, the Company had $12,997 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry, including commercial dynamics, trends and utilization, as well as knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. | 2020 Form 10-K How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. Accounting for Allergan plc acquisition Valuation of intangible assets Description of the Matter As discussed in Note 5 to the consolidated financial statements under the caption Licensing, Acquisitions and Other Arrangements, the Company completed the acquisition of Allergan plc (Allergan) on May 8, 2020 for approximately $64,084 million. The Company measured the assets acquired and liabilities assumed at fair value, which resulted in the recognition of $69,080 million of intangible assets, comprised of $67,330 million of developed product rights and $1,750 million of in-process research and development (IPRD). Auditing the valuation of intangible assets was complex and required significant auditor judgment due to the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of the identified intangible assets. In particular, the fair value measurement was sensitive to managements forecasts of net revenues, including growth rates used to estimate future net cash flows for acquired aesthetics and recently launched products. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys accounting for acquisitions including, among others, managements process to establish the significant assumptions used in determining the fair values of intangible assets. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of estimated future net revenues, the determination of future net cash flows, estimated growth rates, and review of the valuation model. To test the estimated fair value of intangible assets, our audit procedures included, among others, inspecting the terms of the executed agreement, evaluating the valuation methods used, and testing the significant assumptions discussed above. We evaluated the assumptions and judgments considering observable industry and economic trends and standards, external data sources, and historical product trends, including those of comparable products, to the extent applicable. Estimated future net revenues were evaluated for reasonableness against internal and external analyses, including analyst expectations, industry trends, and market trends. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the valuation model and to perform corroborative fair value calculations. 2020 Form 10-K | Accounting for Allergan plc acquisition Unrecognized tax benefits Description of the Matter As discussed in Note 14 under the caption Income Taxes, as part of the acquisition of Allergan plc, the Company recorded $2,674 million of unrecognized tax benefits resulting from uncertain tax positions. The Company applied judgment in evaluating the completeness of unrecognized tax benefits assumed as of the acquisition date. Some of the more significant judgments inherent in the Companys evaluation of assumed uncertain tax positions included whether a tax positions technical merits were more-likely-than-not to be sustained, including consideration of applicable tax statutes and related interpretations and precedents and the expected outcome of proceedings (or negotiations) with taxing and legal authorities. Auditing the Companys analysis and accounting for uncertain tax positions was complex due to the interpretation of tax laws and legal rulings in multiple tax paying jurisdictions and required significant judgment in determining whether an assumed tax positions technical merits were more-likely-than-not to be sustained. In particular, each assumed unrecognized tax benefit involved unique facts and circumstances and multiple potential outcomes that were evaluated, with many uncertainties around initial recognition, including regulatory changes, litigation and examination activity. Management utilized outside tax and legal counsel, where appropriate, in its evaluation. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys accounting for acquisitions including, among others, managements process to evaluate the completeness and estimation of unrecognized tax benefits. This included testing controls over managements determination of whether an assumed tax positions technical merits were more-likely-than-not to be sustained and, if so, recognizing the estimated amount of qualified tax benefit. We also obtained an understanding, evaluated the design and tested the operating effectiveness of controls to ensure that the data used to evaluate and support the significant fair value assumptions and unrecognized tax benefits was complete, accurate and, where applicable, verified to external data sources. To test the completeness and recognition of unrecognized tax benefits, our audit procedures included, among others, testing managements process for estimating the unrecognized tax benefits. Testing managements process included assessing managements interpretation of the unique facts, circumstances and related tax laws and legal rulings in each tax paying jurisdiction, examining whether the technical merits of each tax position were more-likely-than-not to be sustained, and evaluating the recognition of the amount of qualified tax benefit. Professionals with specialized skill and knowledge were used to assist in the evaluation of the completeness and recognition of the Companys unrecognized tax benefits, including consideration of applicable tax statutes and related interpretations and precedents. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 19, 2021 | 2020 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2020. Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2020. Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 2020 Form 10-K | Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2020 and 2019, and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 19, 2021 | 2020 Form 10-K " +2,abbv,1231x10k," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. In June 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. Allergan markets a portfolio of brands and products primarily focused on key therapeutic areas including aesthetics, eye care, neuroscience, gastroenterology and women's health. See Note 5 to the Consolidated Financial Statements for additional information regarding the proposed acquisition. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 16 to the Consolidated Financial Statements and the sales information related to HUMIRA, IMBRUVICA and MAVYRET included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. Immunology products. AbbVie maintains an extensive immunology portfolio across rheumatology, dermatology and gastroenterology. AbbVie's immunology products address unmet needs for patients with autoimmune diseases. These products are: HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2019 Form 10-K | 1 HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 58% of AbbVie's total net revenues in 2019 . SKYRIZI. SKYRIZI (risankizumab) is an interleukin-23 (IL-23) inhibitor that selectively blocks IL-23 by binding to its p19 subunit. It is a biologic therapy administered as a quarterly subcutaneous injection following an induction dose. SKYRIZI is approved in the United States, Canada and the European Union and is indicated for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In Japan, SKYRIZI is approved for the treatment of plaque psoriasis, generalized pustular psoriasis, erythrodermic psoriasis and psoriatic arthritis in adult patients who have an inadequate response to conventional therapies. RINVOQ . RINVOQ (upadacitinib) is a once-daily oral selective and reversible JAK inhibitor and is approved in the United States, Canada and the European Union. RINVOQ is indicated for the treatment of moderate to severe active rheumatoid arthritis in adult patients who have responded inadequately to, or who are intolerant to one or more disease-modifying anti-rheumatic drugs (DMARDs). RINVOQ may be used as monotherapy or in combination with methotrexate. Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA/VENCLYXTO. VENCLEXTA (venetoclax) is a BCL-2 inhibitor used to treat hematological malignancies. VENCLEXTA is approved by the FDA for adults with CLL or SLL. In addition, VENCLEXTA is approved in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. VENCLYXTO is approved in Europe for CLL in combination with rituximab in patients who have received at least one previous treatment. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV. HCV products. AbbVie's HCV products are: MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and following the EXPEDITION-8 study, also in patients with compensated cirrhosis who are new to treatment. MAVIRET is now also indicated for the treatment of HCV genotypes 1-6 in children between 12-18 years. VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and 2 | 2019 Form 10-K ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. The use of VIEKIRA in the United States, Europe and Japan is currently limited given the significant use of pangenotypic regimens, including MAVIRET. Additional Virology products. AbbVie's additional virology products include: SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by respiratory syncytial virus (RSV). KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as ALUVIA in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: ORILISSA. ORILISSA (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved ORILISSA under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. ORILISSA inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Outside the United States, ORILISSA is also launched in Canada and Puerto Rico. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Sevoflurane. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. 2019 Form 10-K | 3 In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2019 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2019 gross revenues in the United States. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. HUMIRA is now facing direct biosimilar competition in Europe and other countries, and AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is complex. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for 4 | 2019 Form 10-K patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product or particular characteristics of a product is entitled upon approval in any particular country. In certain instances, regulatory exclusivity may offer protection where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2020 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. AbbVie has entered into settlement and license agreements with several adalimumab biosimilar manufactures. Under the agreements, the license in the United States will begin in 2023 and the license in Europe began in 2018. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA) and those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently 2019 Form 10-K | 5 discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing, Acquisitions and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as acquisitions, option-to-acquire agreements, licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. The acquisitions and option-to-acquire agreements typically include, among other terms and conditions, non-refundable purchase price payments or option fees, option exercise payments, milestones or earn-outs, and other customary terms and obligations. The licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments, milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity ,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity ,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. 6 | 2019 Form 10-K The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory 2019 Form 10-K | 7 procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and 8 | 2019 Form 10-K teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2020 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2019 were approximately $29 million and operating expenditures were approximately $34 million . In 2020 , capital expenditures for pollution control are estimated to be approximately $5 million and operating expenditures are estimated to be approximately $35 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. 2019 Form 10-K | 9 Employees AbbVie employed approximately 30,000 persons as of January 31, 2020 . Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into three groups: risks related to AbbVie's business, risks related to AbbVie's proposed acquisition of Allergan (the ""Acquisition"") and the combined company upon completion of the Acquisition, and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $19.2 billion in 2019 , expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. 10 | 2019 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged, circumvented or weakened, or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 58% of AbbVie's total net revenues in 2019 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA (as described further in The expiration or loss of patent protection and licenses may adversely affect AbbVies future revenues and operating earnings above), the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, 2019 Form 10-K | 11 including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including HUMIRA. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant 12 | 2019 Form 10-K exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities and regulatory action could be taken 2019 Form 10-K | 13 by such regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and other lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is also the subject of other claims, legal proceedings and investigations in the ordinary course of business, which relate to the intellectual property, commercial, securities and other matters. Adverse outcomes in such claims, legal proceedings and investigations may also adversely affect AbbVies business and results of operations. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. 14 | 2019 Form 10-K AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States made up approximately 28% of AbbVie's total net revenues in 2019 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; international trade disruptions or disputes, including in connection with the ongoing trade negotiations between the United States and China; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; 2019 Form 10-K | 15 political and economic instability, including the United Kingdoms exit from the European Union; sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions (such as the pending acquisition of Allergan), technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2019 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. 16 | 2019 Form 10-K AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may result in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. Failure to attract and retain highly qualified personnel could affect AbbVies ability to successfully develop and commercialize products. AbbVies success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical RD, governmental regulation and commercialization. Competition for qualified personnel in the biopharmaceutical field is intense. AbbVie cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards, data privacy laws and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; 2019 Form 10-K | 17 changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to the Acquisition and the Combined Company Upon Completion of the Acquisition The pending acquisition of Allergan may not be completed on the currently contemplated timeline or terms, or at all, and may not achieve the intended benefits. Consummation of the Acquisition is conditioned on, among other things, obtaining necessary governmental and regulatory approvals. If any of the conditions to the Acquisition is not satisfied, it could delay or prevent the Acquisition from occurring, which could negatively impact AbbVies share price and future business and financial results. Further, as a condition to their approval of the Acquisition, agencies may impose requirements, limitations or costs or require divestitures or place restrictions on the conduct of the AbbVies business after the closing. These requirements, limitations, costs, divestitures or restrictions could jeopardize or delay the consummation of the Acquisition or may reduce the anticipated benefits of the transaction. In addition, changes in laws and regulations, including Irish legislation implementing a tax increase payable upon completion of the Acquisition, could adversely impact AbbVies post-Acquisition profitability and financial results. Following the Acquisition, AbbVie may not realize the Acquisitions intended benefits within the expected timeframe or at all. The indebtedness of the combined company following the consummation of the Acquisition will be substantially greater than AbbVies indebtedness on a standalone basis and greater than the combined indebtedness of AbbVie and Allergan prior to the announcement of the acquisition. This increased level of indebtedness could adversely affect the combined companys business flexibility and increase its borrowing costs. AbbVie expects that the cash consideration due to Allergans shareholders under the transaction agreement and related fees and expenses will be approximately $41 billion. In addition to using cash on hand, AbbVie has incurred significant Acquisition-related debt financing, including unsecured term loans and senior notes. For more information, see Note 10 Debt, Credit Facilities and Commitments and Contingencies , to the Consolidated Financial Statements included under Item 8 , Financial Statements and Supplementary Data . AbbVie also intends to assume all the existing indebtedness of Allergan and its subsidiaries. AbbVies substantially increased indebtedness and higher debt to equity ratio following the consummation of the Acquisition may have the effect of, among other things, reducing its flexibility to respond to changing business and economic conditions, lowering its credit ratings, increasing its borrowing costs and/or requiring it to reduce or delay investments, strategic acquisitions and capital expenditures or to seek additional capital or restructure or refinance its indebtedness. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions 18 | 2019 Form 10-K (including AbbVie's pending acquisition of Allergan), or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by encouraging prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2019 Form 10-K | 19 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland North Chicago, Illinois Ludwigshafen, Germany Worcester, Massachusetts* Singapore* Wyandotte, Michigan* Sligo, Ireland _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 15 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 46,544 stockholders of record of AbbVie common stock as of January 31, 2020 . Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2014 through December 31, 2019 . This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2014 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. 2019 Form 10-K | 23 Dividends On November 1, 2019 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $1.07 per share to $1.18 per share, payable on February 14, 2020 to stockholders of record as of January 15, 2020 . The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2019 - October 31, 2019 4,293 (1) $ 77.19 (1) $ 3,950,021,071 November 1, 2019 - November 30, 2019 1,086 (1) $ 80.53 (1) $ 3,950,021,071 December 1, 2019 - December 31, 2019 1,016 (1) $ 87.39 (1) $ 3,950,021,071 Total 6,395 (1) $ 79.38 (1) $ 3,950,021,071 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,293 in October; 1,086 in November; and 1,016 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 24 | 2019 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2019 and 2018 and results of operations for each of the three years in the period ended December 31, 2019 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 30,000 employees. AbbVie operates in one business segmentpharmaceutical products. On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). See Note 5 to the Consolidated Financial Statements for additional information regarding the proposed acquisition. 2019 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2019 included delivering worldwide net revenues of $33.3 billion , operating earnings of $13.0 billion , diluted earnings per share of $5.28 and cash flows from operations of $13.3 billion . Worldwide net revenues grew by 3% on a constant currency basis, primarily driven by revenue growth related to IMBRUVICA and VENCLEXTA as well as the continued strength of HUMIRA in the U.S. and newly launched immunology assets SKYRIZI and RINVOQ, offset by international HUMIRA biosimilar competition. Diluted earnings per share in 2019 was $5.28 and included the following after-tax costs: (i) $3.2 billion for the change in fair value of contingent consideration liabilities; (ii) $1.3 billion related to the amortization of intangible assets; (iii) a Stemcentrx-related impairment charge of $823 million net of the related fair value adjustment to contingent consideration liabilities; (iv) $364 million for acquired in-process research and development (IPRD); and (v) $338 million of expenses related to the proposed Allergan acquisition. These costs were partially offset by the following after-tax benefits: (i) $414 million from litigation matters primarily due to the settlement of an intellectual property dispute with a third party ; (ii) $400 million due to the favorable resolution of various tax positions; and (iii) $297 million from an amended and restated license agreement between AbbVie and Reata Pharmaceuticals, Inc. (Reata). Additionally, financial results reflected continued funding to support all stages of AbbVies emerging pipeline assets and continued investment in AbbVies on-market brands. In November 2019 , AbbVie's board of directors declared a quarterly cash dividend of $1.18 per share of common stock payable in February 2020 . This reflects an increase of approximately 10.3% over the previous quarterly dividend of $1.07 per share of common stock. 26 | 2019 Form 10-K 2020 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, ensuring strong commercial execution of new product launches and driving late-stage pipeline assets to the market; (ii) continuing to invest and expand its pipeline in support of opportunities in immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via a strong and growing dividend while also reducing incremental debt. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next 12 months. AbbVie expects to achieve its strategic objectives through: Completion and successful integration of the proposed Allergan acquisition. Hematologic oncology revenue growth from both IMBRUVICA and VENCLEXTA. Immunology revenue growth driven by successful commercial launches of SKYRIZI and RINVOQ, as well as HUMIRA U.S. sales growth. Effective management of HUMIRA international biosimilar erosion. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2020 . These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. The combination of AbbVie and Allergan will create a diverse entity with leadership positions across immunology, hematologic oncology, aesthetics, neuroscience, women's health, eye care and virology. AbbVie's existing product portfolio and pipeline will be enhanced with numerous Allergan assets and Allergan's product portfolio will benefit from AbbVie's commercial strength, expertise and international infrastructure. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes approximately 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neuroscience along with targeted investments in cystic fibrosis and women's health. Of these programs, approximately 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next 12 months. Significant Programs and Developments Immunology RINVOQ In February 2019, the U.S. Food and Drug Administration (FDA) accepted for priority review AbbVie's New Drug Application (NDA) for upadacitinib, an investigational oral JAK1-selective inhibitor, for the treatment of adult patients with moderate to severe rheumatoid arthritis (RA). In February 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of upadacitinib in subjects with giant cell arteritis. 2019 Form 10-K | 27 In August 2019, the FDA approved RINVOQ (upadacitinib) for the treatment of adults with moderately to severely active RA who have had an inadequate response or intolerance to methotrexate. In October 2019, AbbVie announced top-line results from its first Phase 3 clinical trial of RINVOQ in adult patients with active psoriatic arthritis (PsA). Results from the SELECT-PsA 2 study, which evaluated RINVOQ versus placebo in patients who did not adequately respond to treatment with one or more biologic DMARDs, showed that both doses of RINVOQ (15 mg and 30 mg) met the primary and key secondary endpoints at week 12. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In November 2019, AbbVie announced data from the Phase 2/3 SELECT-AXIS 1 trial in which twice as many adult patients with ankylosing spondylitis treated with RINVOQ achieved the primary endpoint at week 14 versus placebo. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. In November 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of RINVOQ in adult patients with axial spondyloarthritis. In December 2019, the European Commission (EC) granted marketing authorization for RINVOQ for the treatment of adult patients with moderate to severe active rheumatoid arthritis who have had an inadequate response or intolerance to one or more DMARDs. In February 2020, AbbVie announced top-line results from its second Phase 3 clinical trial of RINVOQ in adult patients with active PsA. Results from the SELECT-PsA 1 study, which evaluated RINVOQ versus placebo in patients who did not adequately respond to treatment with one or more non-biologic DMARDs, showed that both doses of RINVOQ (15 mg and 30 mg) met the primary and key secondary endpoints. The safety profile was consistent with that of previous studies across indications, with no new safety risks detected. SKYRIZI In March 2019, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of risankizumab, an investigational interleukin-23 (IL-23) inhibitor, in subjects with psoriatic arthritis. In April 2019, the FDA approved SKYRIZI (risankizumab) for the treatment of moderate to severe plaque psoriasis in adults who are candidates for systemic therapy or phototherapy. In April 2019, the EC granted marketing authorization for SKYRIZI for the treatment of moderate to severe plaque psoriasis in adult patients who are candidates for systemic therapy. Oncology IMBRUVICA In January 2019, the FDA approved IMBRUVICA, in combination with GAZYVA (obinutuzumab), for adult patients with previously untreated chronic lymphocytic leukemia (CLL)/small lymphocytic lymphoma (SLL). In June 2019, AbbVie announced results from the Phase 3 CLL12 trial, evaluating IMBRUVICA in patients with previously untreated CLL, which demonstrated that IMBRUVICA significantly improved event- and progression-free survival. In November 2019, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for IMBRUVICA in combination with rituximab for the first-line treatment of younger patients with CLL or SLL. VENCLEXTA In March 2019, AbbVie announced that the FDA placed a partial clinical hold on all clinical trials evaluating VENCLEXTA for the investigational treatment of multiple myeloma (MM). The partial clinical hold followed a review of data from the ongoing Phase 3 BELLINI trial, a study in relapsed/refractory MM, in which a higher proportion of deaths was observed in the VENCLEXTA arm compared to the control arm of the trial. In June 2019, AbbVie announced that the FDA lifted the partial clinical hold placed on the Phase 3 CANOVA trial, evaluating VENCLEXTA for the investigational treatment of relapsed/refractory MM positive for the translocation (11;14) abnormality, based upon agreement on revisions to the CANOVA study protocol, including new risk mitigation measures, protocol-specified guidelines and updated futility criteria. This action does not impact any of the approved indications for VENCLEXTA, such as CLL or acute myeloid leukemia (AML). 28 | 2019 Form 10-K In May 2019, the FDA approved VENCLEXTA, in combination with obinutuzumab, for adult patients with previously untreated CLL/SLL. The approval was based on data from the Phase 3 CLL14 trial, evaluating the efficacy and safety of VENCLEXTA plus obinutuzumab versus obinutuzumab plus chlorambucil in previously untreated patients with CLL, which demonstrated that VENCLEXTA plus obinutuzumab prolonged progression-free survival and achieved higher rates of complete response and minimal residual disease-negativity compared to commonly used standard of care obinutuzumab plus chlorambucil. In January 2020, AbbVie announced that the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) granted a positive opinion for VENCLYXTO in combination with obinutuzumab for patients with previously untreated CLL. Depatux-M In May 2019, AbbVie announced the decision to discontinue the Phase 3 INTELLANCE-1 study of depatuxizumab mafodotin (Depatux-M, previously known as ABT-414) in patients with newly diagnosed glioblastoma, whose tumors have EGFR (epidermal growth factor receptor) amplification, at an interim analysis. An Independent Data Monitoring Committee recommended stopping enrollment in INTELLANCE-1 due to lack of survival benefit for patients receiving Depatux-M compared with placebo when added to the standard regimen of radiation and temozolomide. Enrollment has been halted in all ongoing Depatux-M studies. Veliparib In July 2019, AbbVie announced that top-line results from the Phase 3 BROCADE3 study evaluating veliparib, an investigational, oral poly (adenosine diphosphate-ribose) polymerase (PARP) inhibitor, in combination with carboplatin and paclitaxel met its primary endpoint of progression-free survival in patients with HER2 negative germline BRCA-mutated advanced breast cancer. In July 2019, AbbVie announced that top-line results from the Phase 3 VELIA study, conducted in collaboration with the GOG Foundation, Inc., evaluating veliparib with carboplatin and paclitaxel followed by veliparib maintenance therapy met its primary endpoint of progression-free survival in patients with newly diagnosed ovarian cancer, regardless of biomarker status. Rova-T In August 2019, AbbVie announced the decision to terminate the MERU trial, a Phase 3 study evaluating rovalpituzumab tesirine (Rova-T) as a first-line maintenance therapy for advanced small-cell lung cancer (SCLC). An Independent Data Monitoring Committee recommended terminating the study after results demonstrated no survival benefit at a pre-planned interim analysis for patients receiving Rova-T as compared with placebo. With the closing of the MERU trial, AbbVie announced the termination of the Rova-T research and development program. Virology/Liver Disease In August 2019, the EC granted marketing authorization for MAVIRET (glecaprevir/pibrentasvir) to shorten the once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients with genotype (GT)1, 2, 4, 5 and 6 infection. In September 2019, the FDA approved MAVYRET (glecaprevir/pibrentasvir) to shorten the once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients across all genotypes (GT1-6). In January 2020, AbbVie announced that the CHMP of the EMA has recommended a change to the marketing authorization for MAVIRET to shorten once-daily treatment duration from 12 to 8 weeks in treatment-nave, compensated cirrhotic, chronic HCV patients with GT 3 infection. Neuroscience In May 2019, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and tolerability of ABBV-951, a subcutaneous levodopa/carbidopa delivery system, in subjects with Parkinson's disease. In July 2019, AbbVie announced the decision to discontinue the Phase 2 ARISE study evaluating ABBV-8E12, an investigational anti-tau antibody, in patients with progressive supranuclear palsy, after an Independent Data 2019 Form 10-K | 29 Monitoring Committee recommended stopping the trial for futility after the trial showed that ABBV-8E12 did not provide efficacy. Other In July 2019, AbbVie submitted an NDA to the FDA for elagolix in combination with estradiol/norethindrone acetate (E2/NETA) daily add-back therapy for the management of heavy menstrual bleeding associated with uterine fibroids. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates years ended (dollars in millions) United States $ 23,907 $ 21,524 $ 18,251 11.1 % 17.9 % 11.1 % 17.9 % International 9,359 11,229 9,965 (16.7 )% 12.8 % (13.6 )% 10.4 % Net revenues $ 33,266 $ 32,753 $ 28,216 1.6 % 16.1 % 2.6 % 15.2 % 30 | 2019 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) Immunology HUMIRA United States $ 14,864 $ 13,685 $ 12,361 8.6 % 10.7 % 8.6 % 10.7 % International 4,305 6,251 6,066 (31.1 )% 3.1 % (27.8 )% 0.6 % Total $ 19,169 $ 19,936 $ 18,427 (3.9 )% 8.2 % (2.9 )% 7.4 % SKYRIZI United States $ $ $ n/m n/m n/m n/m International n/m n/m n/m n/m Total $ $ $ n/m n/m n/m n/m RINVOQ United States $ $ $ n/m n/m n/m n/m International n/m n/m n/m n/m Total $ $ $ n/m n/m n/m n/m Hematologic Oncology IMBRUVICA United States $ 3,830 $ 2,968 $ 2,144 29.1 % 38.4 % 29.1 % 38.4 % Collaboration revenues 35.8 % 45.0 % 35.8 % 45.0 % Total $ 4,674 $ 3,590 $ 2,573 30.2 % 39.5 % 30.2 % 39.5 % VENCLEXTA United States $ $ $ 100.0% 100.0% 100.0% 100.0% International 100.0% 100.0% 100.0% 100.0% Total $ $ $ 100.0% 100.0% 100.0% 100.0% HCV MAVYRET United States $ 1,473 $ 1,614 $ (8.8 )% 100.0% (8.8 )% 100.0% International 1,420 1,824 (22.1 )% 100.0% (19.6 )% 100.0% Total $ 2,893 $ 3,438 $ (15.9 )% 100.0% (14.6 )% 100.0% VIEKIRA United States $ $ $ (100.0 )% (96.7 )% (100.0 )% (96.7 )% International (79.2 )% (75.6 )% (77.2 )% (74.8 )% Total $ $ $ (79.6 )% (77.2 )% (77.6 )% (76.5 )% Other Key Products Creon United States $ 1,041 $ $ 12.2 % 11.7 % 12.2 % 11.7 % Lupron United States $ $ $ (0.8 )% 8.6 % (0.8 )% 8.6 % International 0.8 % 3.4 % 6.0 % 4.7 % Total $ $ $ (0.5 )% 7.6 % 0.5 % 7.9 % Synthroid United States $ $ $ 1.3 % (0.6 )% 1.3 % (0.6 )% Synagis International $ $ $ (1.2 )% (1.6 )% 0.9 % (2.8 )% Duodopa United States $ $ $ 20.4 % 31.4 % 20.4 % 31.4 % International 4.2 % 19.1 % 9.8 % 14.8 % Total $ $ $ 7.2 % 21.2 % 11.7 % 17.7 % Sevoflurane United States $ $ $ 2.0 % (6.2 )% 2.0 % (6.2 )% International (13.8 )% (4.4 )% (9.5 )% (4.3 )% Total $ $ $ (10.9 )% (4.7 )% (7.4 )% (4.6 )% Kaletra United States $ $ $ (31.0 )% (22.1 )% (31.0 )% (22.1 )% International (12.9 )% (20.2 )% (9.5 )% (20.1 )% Total $ $ $ (15.8 )% (20.5 )% (12.9 )% (20.4 )% AndroGel United States $ $ $ (63.3 )% (18.8 )% (63.3 )% (18.8 )% ORILISSA United States $ $ $ 100.0% n/m 100.0% n/m International n/m n/m n/m n/m Total $ $ $ 100.0% n/m 100.0% n/m All other $ $ $ 66.1 % (64.9 )% 73.0 % (73.2 )% Total net revenues $ 33,266 $ 32,753 $ 28,216 1.6 % 16.1 % 2.6 % 15.2 % n/m Not meaningful 2019 Form 10-K | 31 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales decreased 3% in 2019 and increased 7% in 2018 . The sales decrease in 2019 was primarily driven by direct biosimilar competition in certain international markets, partially offset by market growth across therapeutic categories. The sales increase in 2018 was primarily driven by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. In the United States, HUMIRA sales increased 9% in 2019 and 11% in 2018 . The sales increases in 2019 and 2018 were primarily driven by market growth across all indications and favorable pricing. Internationally, HUMIRA revenues decreased 28% in 2019 and increased 1% in 2018 . The sales decrease in 2019 was primarily driven by direct biosimilar competition in Europe following the expiration of the European Union composition of matter patent for adalimumab in October 2018. The sales increase in 2018 was primarily driven by market growth across indications partially offset by direct biosimilar competition. Biosimilar competition for HUMIRA is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability of HUMIRA. Net revenues for SKYRIZI were $355 million in 2019 following the April 2019 regulatory approvals for the treatment of moderate to severe plaque psoriasis. Net revenues for RINVOQ were $47 million in 2019 following the August 2019 FDA approval for the treatment of moderate to severe rheumatoid arthritis. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. AbbVie's global IMBRUVICA revenues increased 30% in 2019 and 39% in 2018 as a result of continued penetration of IMBRUVICA for patients with CLL as well as favorable pricing. Net revenues for VENCLEXTA increased by more than 100% in 2019 and 2018 primarily due to market share gains following additional regulatory approvals of VENCLEXTA for the treatment of patients with relapsed/refractory CLL and first-line AML in 2018 and first-line CLL in 2019. Global MAVYRET sales decreased by 15% in 2019 primarily driven by lower patient volumes in certain international markets and competitive dynamics in the U.S. Global MAVYRET sales increased more than 100% in 2018 as a result of market share gains following the FDA and EMA approvals of MAVYRET in the second half of 2017 as well as further geographic expansion. Global VIEKIRA sales decreased by 78% in 2019 and 76% in 2018 primarily due to lower market share following the launch of MAVYRET. Net revenues for Creon increased 12% in 2019 and 12% in 2018 , primarily driven by continued market growth and favorable pricing. Creon maintains market leadership in the pancreatic enzyme market. Net revenues for Duodopa increased 12% in 2019 and 18% in 2018 , primarily driven by increased market penetration. Gross Margin Percent change years ended December 31 (dollars in millions) Gross margin $ 25,827 $ 25,035 $ 21,174 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2019 increased from 2018 primarily due to the full year effect of the expiration of HUMIRA royalties, partially offset by the IMBRUVICA profit sharing arrangement and unfavorable impact from higher intangible asset amortization. Gross margin as a percentage of net revenues in 2018 increased from 2017 primarily due to the expiration of HUMIRA royalties and a 2017 intangible asset impairment charge of $354 million partially offset by the IMBRUVICA profit sharing arrangement. 32 | 2019 Form 10-K Selling, General and Administrative Percent change years ended December 31 (dollars in millions) Selling, general and administrative $ 6,942 $ 7,399 $ 6,295 (6 )% % as a percent of net revenues % % % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2019 decreased from 2018 primarily due to the favorable impacts of international HUMIRA expense reductions and lower litigation reserve charges that decreased by $326 million . This favorability was partially offset by new product launch expenses, higher restructuring charges and $103 million of transaction expenses associated with the proposed Allergan transaction. Additionally, SGA expenses in 2018 included non-recurring philanthropic contributions of $350 million to certain U.S. not-for-profit organizations. SGA expenses as a percentage of net revenues in 2018 increased from 2017 primarily due to new product launch expenses and non-recurring philanthropic contributions to certain U.S. not-for-profit organizations partially offset by continued leverage from revenue growth. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 6,407 $ 10,329 $ 5,007 (38 )% 100% as a percent of net revenues % % % Acquired in-process research and development $ $ $ (9 )% % Research and Development (RD) expenses decreased in 2019 and increased in 2018 principally due to impairment charges related to IPRD acquired as part of the 2016 Stemcentrx acquisition. In 2019, the company recorded a $1.0 billion intangible asset impairment charge which represented the remaining value of the IPRD acquired following the decision to terminate the Rova-T RD program. In 2018, the company recorded a $5.1 billion intangible asset impairment charge following the decision to stop enrollment in the TAHOE trial, which lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. See Note 7 to the Consolidated Financial Statements for additional information regarding these impairment charges. Acquired IPRD expenses reflect upfront payments related to various collaborations. There were no individually significant transactions or cash flows during 2019 or 2018. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector agreement. Other Operating Expenses and Income Other operating income in 2019 included $550 million of income from a legal settlement related to an intellectual property dispute with a third party and $330 million of income related to an amended and restated license agreement between AbbVie and Reata . See Note 5 to the Consolidated Financial Statements for additional information on the Reata agreement. Other operating expenses in 2018 included a $500 million charge related to the extension of the previously announced Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. See Note 5 to the Consolidated Financial Statements for additional information regarding the Calico agreement. 2019 Form 10-K | 33 Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,784 $ 1,348 $ 1,150 Interest income (275 ) (204 ) (146 ) Interest expense, net $ 1,509 $ 1,144 $ 1,004 Net foreign exchange loss $ $ $ Other expense, net 3,006 Interest expense in 2019 increased compared to 2018 primarily due to $363 million of incremental interest and debt issuance costs associated with financing the proposed acquisition of Allergan, as well as the unfavorable impact of higher interest rates on the company's debt obligations. Interest expense in 2018 increased compared to 2017 primarily due to the unfavorable impact of higher interest rates on the company's debt obligations and a higher average outstanding debt balance during 2018 . Interest income in 2019 increased compared to 2018 primarily due to a higher average cash and cash equivalents balance during 2019, partially offset by decreased investments in debt securities. Interest income in 2018 increased compared to 2017 primarily due to higher interest rates. Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Other expense, net included charges related to the change in fair value of the contingent consideration liabilities of $3.1 billion in 2019 , $49 million in 2018 and $626 million in 2017 . The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2019 , the Boehringer Ingelheim (BI) contingent consideration liability increased due to higher probabilities of success, higher estimated future sales, declining interest rates and passage of time. The higher probabilities of success primarily resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. These changes were partially offset by a $91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T RD program during the third quarter of 2019. In 2018 , the BI contingent consideration liability increased due to the passage of time and higher estimated future sales partially offset by the effect of rising interest rates. This increase in the BI contingent consideration liability was primarily offset by a $428 million decrease in the Stemcentrx contingent consideration liability recorded during the fourth quarter of 2018 due to a reduction in probabilities of success of achieving regulatory approval across Rova-T and other early-stage Stemcentrx assets. In 2017 , the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million. Income Tax Expense The effective income tax rate was 6% in 2019 , negative 9% in 2018 and 31% in 2017 . The effective tax rate in each period differed from the statutory tax rate principally due to the allocation of the company's taxable earnings among jurisdictions, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions and business development activities. The increase in the effective tax rate for 2019 over the prior year was principally due to the timing of provisions of the Tax Cuts and Jobs Act (the Act) related to the earnings from certain foreign subsidiaries. The increase is also attributable to changes in the jurisdictional mix of earnings, including a change in fair value of contingent consideration liabilities. These increases were partially offset by the favorable resolution of various tax positions in the current year. The effective tax rate for 2018 also included the effects of Stemcentrx intangible impairment related expenses. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. 34 | 2019 Form 10-K The Act significantly changed the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system that included new taxes on certain foreign sourced earnings. See Note 14 to the Consolidated Financial Statements for additional information regarding the Act. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 13,324 $ 13,427 $ 9,960 Investing activities (1,006 ) (274 ) Financing activities 18,708 (14,396 ) (5,512 ) Operating cash flows in 2019 decreased slightly from 2018 primarily due to higher payments for income taxes offset by improved results of operations resulting from an increase in operating earnings. Operating cash flows in 2018 increased from 2017 primarily due to improved results of operations from revenue growth and a decrease in income tax payments. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $727 million in 2019 , $873 million in 2018 and $246 million in 2017 . Investing cash flows in 2019 included net sales and maturities of investments totaling $2.1 billion resulting from the sale of substantially all of the company's investments in debt securities, payments made for other acquisitions and investments of $1.1 billion and capital expenditures of $552 million . Investing cash flows in 2018 included payments made for other acquisitions and investments of $736 million and capital expenditures of $638 million , partially offset by net sales and maturities of investment securities totaling $368 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Financing cash flows in 2019 included the issuance of $30.0 billion aggregate principal amount of floating rate and fixed rate unsecured senior notes at maturities ranging from 18 months to 30 years . AbbVie expects to use the net proceeds of $29.8 billion to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the proposed acquisition and to pay related fees and expenses. Pending the consummation of the proposed Allergan acquisition, the net proceeds from the offering are permitted to be invested temporarily in short-term investments. All of the notes are subject to special mandatory redemption at a redemption price equal to 101% of the aggregate principal amount of the notes plus accrued and unpaid interest if the proposed acquisition of Allergan is not completed by January 30, 2021 or the company notifies the trustee in respect of the notes that it will not pursue the consummation of the proposed Allergan acquisition. Additionally, financing cash flows in 2019 included the issuance of 1.4 billion aggregate principal amount of unsecured senior Euro notes which the company used to redeem 1.4 billion aggregate principal amount of 0.38% senior Euro notes that were due to mature in November 2019, as well as the repayment of a $3.0 billion 364 -day term loan credit agreement that was scheduled to mature in June 2019. Financing cash flows in 2018 included proceeds from the issuance of $3.0 billion drawn under the term loan in June 2018. In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. Financing cash flows in 2018 also included the May 2018 repayment of $3.0 billion aggregate principal amount of the company's 1.80% senior notes at maturity. In 2019 , 2018 and 2017 , the company issued and redeemed commercial paper. There were no commercial paper borrowings outstanding as of December 31, 2019 and there was $699 million outstanding as of December 31, 2018 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Cash dividend payments totaled $6.4 billion in 2019 , $5.6 billion in 2018 and $4.1 billion in 2017 . The increase in cash dividend payments was primarily driven by an increase in the dividend rate. On November 1, 2019 , AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.07 per share to $1.18 per share beginning with the dividend payable on February 14, 2020 to stockholders of record as of January 15, 2020 . This reflects an increase of approximately 10.3% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's 2019 Form 10-K | 35 debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased 4 million shares for $300 million in 2019 and 109 million shares for $10.7 billion in 2018. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $4.0 billion as of December 31, 2019 . Under previous stock repurchase programs, AbbVie made open market share repurchases of 11 million shares for $1.3 billion in 2018 and 13 million shares for $1.0 billion in 2017. AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017. In 2019, AbbVie made contingent consideration milestone and royalty payments to BI totaling $234 million following the commercial launch of SKYRIZI in certain geographies. $163 million of these payments were included in financing cash flows and $71 million of the payments were included in operating cash flows. In 2018, AbbVie paid $100 million of contingent consideration to BI related to BLA and MAA acceptance milestones. $78 million of these payments were included in financing cash flows and $22 million of the payments were included in operating cash flows. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. In connection with the proposed acquisition of Allergan, on June 25, 2019, AbbVie entered into a $38.0 billion 364-day bridge credit agreement and on July 12, 2019, AbbVie entered into a $6.0 billion term loan credit agreement. The company incurred a total of $242 million of debt issuance costs related to the two agreements. On October 25, 2019, AbbVie commenced offers to exchange any and all outstanding notes of certain series issued by Allergan for up to $15.5 billion aggregate principal amount and 3.7 billion aggregate principal amount of new notes to be issued by AbbVie and cash, subject to conditions including the closing of the proposed acquisition. See Note 10 to the Consolidated Financial Statements for additional information. In February 2020, the remaining commitments under the bridge credit agreement were reduced to $0 as a result of cash on hand at AbbVie. AbbVie subsequently terminated the bridge credit agreement in its entirety as permitted under its terms. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility In August 2019, AbbVie entered into an amended and restated $4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2019 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facilities as of December 31, 2019 and 2018 . Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. 36 | 2019 Form 10-K Credit Ratings Following the announcement of the proposed acquisition of Allergan and the $30.0 billion senior notes issuance, Moody's Investor Service affirmed its Baa2 senior unsecured long-term rating and Prime-2 short-term rating with a stable outlook. SP Global Ratings revised its ratings outlook to negative from stable and expects to lower the issuer credit rating by one notch to BBB+ from A- and the short-term rating to A-2 from A-1 when the acquisition is complete. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2019 : (in millions) Total Less than one year One to three years Three to five years More than five years Long-term debt, including current portion $ 67,233 $ 3,750 $ 14,150 $ 7,625 $ 41,708 Interest on long-term debt (a) 30,494 2,146 4,087 3,479 20,782 Non-cancelable operating and finance lease payments (f) Purchase obligations and other (b) 3,532 3,295 Other long-term liabilities (c) (d) (e) 11,544 1,395 2,123 7,860 Total $ 113,577 $ 9,486 $ 20,042 $ 13,397 $ 70,652 (a) Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2019 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2019 . See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2019 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (d) Includes $7.3 billion of contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. (e) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 14 to the Consolidated Financial Statements for additional information regarding these tax liabilities. (f) Lease payments include approximately $350 million of contractual minimum lease payments for leases executed but not yet commenced. These leases will commence in 2020 with lease terms of approximately 11 years . AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual 2019 Form 10-K | 37 obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $18.8 billion in 2019 , $16.4 billion in 2018 and $12.9 billion in 2017 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. 38 | 2019 Form 10-K The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 94% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2019 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2016 $ 1,167 $ 1,167 $ Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 1,340 1,195 Provisions 3,493 4,729 6,659 Payments (3,188 ) (4,485 ) (6,525 ) Balance at December 31, 2018 1,645 1,439 Provisions 4,035 5,772 7,947 Payments (3,915 ) (5,275 ) (7,917 ) Balance at December 31, 2019 $ 1,765 $ 1,936 $ Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.6 billion in 2019 , $1.6 billion in 2018 and $1.3 billion in 2017 , are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 12 to the Consolidated Financial Statements . The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2019 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2020 and projected benefit obligations as of December 31, 2019 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (76 ) $ Projected benefit obligation (723 ) Other post-employment plans Service and interest cost $ (11 ) $ Projected benefit obligation (101 ) The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The 2019 Form 10-K | 39 current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2019 and will be used in the calculation of net periodic benefit cost in 2020 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2020 by $71 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2019 and will be used in the calculation of net periodic benefit cost in 2020 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2020 and the projected benefit obligation as of December 31, 2019 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (28 ) Projected benefit obligation (186 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial 40 | 2019 Form 10-K performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2019 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $280 million . Additionally, at December 31, 2019 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $150 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 2019 Form 10-K | 41 "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2019 and 2018 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,217 1.116 $ (12 ) $ 6,660 1.157 $ Japanese yen 108.7 1,076 111.5 (12 ) Canadian dollar 1.324 (6 ) 1.314 British pound 1.305 (6 ) 1.328 All other currencies 1,508 n/a (10 ) 1,370 n/a Total $ 9,476 $ (34 ) $ 10,011 $ The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $942 million at December 31, 2019 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. As of December 31, 2019 , the company has 3.6 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 10 to the Consolidated Financial Statements for additional information regarding to the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $280 million at December 31, 2019 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $5.0 billion at December 31, 2019 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 42 | 2019 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2019 Form 10-K | 43 AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 33,266 $ 32,753 $ 28,216 Cost of products sold 7,439 7,718 7,042 Selling, general and administrative 6,942 7,399 6,295 Research and development 6,407 10,329 5,007 Acquired in-process research and development Other operating expense (income) ( 890 ) Total operating costs and expenses 20,283 26,370 18,671 Operating earnings 12,983 6,383 9,545 Interest expense, net 1,509 1,144 1,004 Net foreign exchange loss Other expense, net 3,006 Earnings before income tax 8,426 5,197 7,727 Income tax expense (benefit) ( 490 ) 2,418 Net earnings $ 7,882 $ 5,687 $ 5,309 Per share data Basic earnings per share $ 5.30 $ 3.67 $ 3.31 Diluted earnings per share $ 5.28 $ 3.66 $ 3.30 Weighted-average basic shares outstanding 1,481 1,541 1,596 Weighted-average diluted shares outstanding 1,484 1,546 1,603 The accompanying notes are an integral part of these consolidated financial statements. 44 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 7,882 $ 5,687 $ 5,309 Foreign currency translation adjustments, net of tax expense (benefit) of $(4) in 2019, $(18) in 2018 and $34 in 2017 ( 98 ) ( 391 ) Net investment hedging activities, net of tax expense (benefit) of $22 in 2019, $40 in 2018 and $(194) in 2017 ( 343 ) Pension and post-employment benefits, net of tax expense (benefit) of $(323) in 2019, $35 in 2018 and $(94) in 2017 ( 1,243 ) ( 406 ) Marketable security activities, net of tax expense (benefit) of $ in 2019, $ in 2018 and $(8) in 2017 ( 10 ) ( 46 ) Cash flow hedging activities, net of tax expense (benefit) of $70 in 2019, $23 in 2018 and $(26) in 2017 ( 342 ) Other comprehensive income (loss) ( 1,116 ) ( 141 ) Comprehensive income $ 6,766 $ 5,934 $ 5,168 The accompanying notes are an integral part of these consolidated financial statements. 2019 Form 10-K | 45 AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 39,924 $ 7,289 Short-term investments Accounts receivable, net 5,428 5,384 Inventories 1,813 1,605 Prepaid expenses and other 2,354 1,895 Total current assets 49,519 16,945 Investments 1,420 Property and equipment, net 2,962 2,883 Intangible assets, net 18,649 21,233 Goodwill 15,604 15,663 Other assets 2,288 1,208 Total assets $ 89,115 $ 59,352 Liabilities and Equity Current liabilities Short-term borrowings $ $ 3,699 Current portion of long-term debt and finance lease obligations 3,753 1,609 Accounts payable and accrued liabilities 11,832 11,931 Total current liabilities 15,585 17,239 Long-term debt and finance lease obligations 62,975 35,002 Deferred income taxes 1,130 1,067 Other long-term liabilities 17,597 14,490 Commitments and contingencies Stockholders equity (deficit) Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,781,582,608 shares issued as of December 31, 2019 and 1,776,510,871 as of December 31, 2018 Common stock held in treasury, at cost, 302,671,146 shares as of December 31, 2019 and 297,686,473 as of December 31, 2018 ( 24,504 ) ( 24,108 ) Additional paid-in capital 15,193 14,756 Retained earnings 4,717 3,368 Accumulated other comprehensive loss ( 3,596 ) ( 2,480 ) Total stockholders equity (deficit) ( 8,172 ) ( 8,446 ) Total liabilities and equity $ 89,115 $ 59,352 The accompanying notes are an integral part of these consolidated financial statements. 46 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2016 1,593 $ $ ( 10,852 ) $ 13,678 $ 4,378 $ ( 2,586 ) $ 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax ( 141 ) ( 141 ) Dividends declared ( 4,221 ) ( 4,221 ) Purchases of treasury stock ( 15 ) ( 1,125 ) ( 1,125 ) Stock-based compensation plans and other ( 7 ) Balance at December 31, 2017 1,592 ( 11,923 ) 14,270 5,459 ( 2,727 ) 5,097 Adoption of new accounting standards (a) ( 1,733 ) ( 1,733 ) Net earnings 5,687 5,687 Other comprehensive income, net of tax Dividends declared ( 6,045 ) ( 6,045 ) Purchases of treasury stock ( 121 ) ( 12,215 ) ( 12,215 ) Stock-based compensation plans and other Balance at December 31, 2018 1,479 ( 24,108 ) 14,756 3,368 ( 2,480 ) ( 8,446 ) Net earnings 7,882 7,882 Other comprehensive loss, net of tax ( 1,116 ) ( 1,116 ) Dividends declared ( 6,533 ) ( 6,533 ) Purchases of treasury stock ( 5 ) ( 428 ) ( 428 ) Stock-based compensation plans and other Balance at December 31, 2019 1,479 $ $ ( 24,504 ) $ 15,193 $ 4,717 $ ( 3,596 ) $ ( 8,172 ) (a) Adoption of new accounting standards primarily includes the cumulative-effect adjustment of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The accompanying notes are an integral part of these consolidated financial statements. 2019 Form 10-K | 47 AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 7,882 $ 5,687 $ 5,309 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,553 1,294 1,076 Change in fair value of contingent consideration liabilities 3,091 Stock-based compensation Upfront costs and milestones related to collaborations 1,061 Gain on divestitures ( 330 ) Intangible asset impairment 1,030 5,070 Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities: Accounts receivable ( 74 ) ( 591 ) ( 391 ) Inventories ( 231 ) ( 226 ) Prepaid expenses and other assets ( 499 ) ( 118 ) Accounts payable and other liabilities ( 1,121 ) Cash flows from operating activities 13,324 13,427 9,960 Cash flows from investing activities Acquisitions and investments ( 1,135 ) ( 736 ) ( 308 ) Acquisitions of property and equipment ( 552 ) ( 638 ) ( 529 ) Purchases of investment securities ( 583 ) ( 1,792 ) ( 2,230 ) Sales and maturities of investment securities 2,699 2,160 2,793 Other Cash flows from investing activities ( 1,006 ) ( 274 ) Cash flows from financing activities Net change in commercial paper borrowings ( 699 ) Proceeds from issuance of other short-term borrowings 3,002 Repayments of other short-term borrowings ( 3,000 ) Proceeds from issuance of long-term debt 31,482 5,963 Repayments of long-term debt and finance lease obligations ( 1,536 ) ( 6,035 ) ( 25 ) Debt issuance costs ( 424 ) ( 40 ) Dividends paid ( 6,366 ) ( 5,580 ) ( 4,107 ) Purchases of treasury stock ( 629 ) ( 12,014 ) ( 1,410 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities ( 163 ) ( 78 ) ( 268 ) Other, net Cash flows from financing activities 18,708 ( 14,396 ) ( 5,512 ) Effect of exchange rate changes on cash and equivalents ( 39 ) Net change in cash and equivalents 32,635 ( 2,014 ) 4,203 Cash and equivalents, beginning of year 7,289 9,303 5,100 Cash and equivalents, end of year $ 39,924 $ 7,289 $ 9,303 Other supplemental information Interest paid, net of portion capitalized $ 1,794 $ 1,215 $ 1,099 Income taxes paid (received) 1,447 ( 35 ) 1,696 The accompanying notes are an integral part of these consolidated financial statements. 48 | 2019 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, AbbVie sells products primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100 % of the outstanding common stock of AbbVie to Abbott's shareholders. On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan). See Note 5 for additional information regarding the proposed acquisition. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. 2019 Form 10-K | 49 For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaboration with Janssen Biotech, Inc. Additionally, see Note 16 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $ 1.1 billion in 2019 , $ 1.1 billion in 2018 and $ 846 million in 2017 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive income (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any 50 | 2019 Form 10-K unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to-maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. AbbVie periodically assesses its marketable debt securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other-than-temporary decline has occurred, the cost basis of the investment is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $ 46 million at December 31, 2019 and $ 51 million at December 31, 2018 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process Raw materials Inventories $ 1,813 $ 1,605 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,613 1,603 Equipment 6,012 6,362 Construction in progress Property and equipment, gross 8,188 8,396 Less accumulated depreciation ( 5,226 ) ( 5,513 ) Property and equipment, net $ 2,962 $ 2,883 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $ 464 million in 2019 , $ 471 million in 2018 and $ 425 million in 2017 . 2019 Form 10-K | 51 Leases Short-term leases with a term of 12 months or less are not recorded on the balance sheet. For leases commencing or modified in 2019 or later, AbbVie does not separate lease components from non-lease components. The company records lease liabilities based on the present value of lease payments over the lease term. AbbVie generally uses an incremental borrowing rate to discount its lease liabilities, as the rate implicit in the lease is typically not readily determinable. Certain lease agreements include renewal options that are under the company's control. AbbVie includes optional renewal periods in the lease term only when it is reasonably certain that AbbVie will exercise its option. Variable lease payments include payments to lessors for taxes, maintenance, insurance and other operating costs as well as payments that are adjusted based on an index or rate. The company's lease agreements do not contain any significant residual value guarantees or restrictive covenants. Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that results of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed 12 months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease 52 | 2019 Form 10-K the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2016-02 In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, Leases (Topic 842) . The standard outlined a comprehensive lease accounting model that superseded the previous lease guidance and required lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changed the definition of a lease and expanded the disclosure requirements of lease arrangements. AbbVie adopted the standard in the first quarter of 2019 using the modified retrospective method. Results for reporting periods beginning after December 31, 2018 have been presented in accordance with the standard, while results for prior periods have not been adjusted and continue to be reported in accordance with AbbVie's historical accounting. The cumulative effect of initially applying the new leases standard was recognized as an adjustment to the opening consolidated balance sheet as of January 1, 2019. The company elected a package of practical expedients for leases that commenced prior to January 1, 2019 and did not reassess historical conclusions on: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. 2019 Form 10-K | 53 Under the new standard, on January 1, 2019, the company recognized a cumulative-effect adjustment to its consolidated balance sheet primarily related to the recognition of liabilities and corresponding right-of-use assets for operating leases. The adjustment to the consolidated balance sheet included: (i) a $ 405 million increase to other assets; (ii) a $ 115 million increase to accounts payable and accrued liabilities; and (iii) a $ 290 million increase to other long-term liabilities. Other cumulative-effect adjustments to the consolidated balance sheet were insignificant. Adoption of the standard did not have a significant impact on AbbVie's consolidated statement of earnings in 2019. ASU No. 2018-02 In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allowed a reclassification from AOCI to retained earnings for stranded tax effects related to adjustments to deferred taxes resulting from the December 2017 enactment of the Tax Cuts and Jobs Act (the Act). AbbVie adopted the standard in the first quarter of 2019. Upon adoption, the company made an election to not reclassify the income tax effects of the Act from AOCI to retained earnings. Therefore, the adoption of the standard had no impact on AbbVie's consolidated financial statements. Recent Accounting Pronouncements Not Yet Adopted ASU No. 2016-13 In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie has completed its assessment of the new standard as of December 31, 2019 and concluded that the adoption will not have a material impact on its consolidated financial statements based on the company's current portfolio of financial assets. ASU No. 2019-12 In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) . The standard includes simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for AbbVie starting with the first quarter of 2021, with early adoption permitted. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. 54 | 2019 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,784 $ 1,348 $ 1,150 Interest income ( 275 ) ( 204 ) ( 146 ) Interest expense, net $ 1,509 $ 1,144 $ 1,004 Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 4,484 $ 3,939 Dividends payable 1,771 1,607 Accounts payable 1,452 1,546 Salaries, wages and commissions Royalty and license arrangements Other 2,971 3,748 Accounts payable and accrued liabilities $ 11,832 $ 11,931 Other Long-Term Liabilities as of December 31 (in millions) Contingent consideration liabilities $ 7,201 $ 4,306 Income taxes payable 3,453 4,311 Pension and other post-employment benefits 2,949 1,840 Liabilities for unrecognized tax benefits 2,772 2,726 Other 1,222 1,307 Other long-term liabilities $ 17,597 $ 14,490 Note 4 Earnings Per Share AbbVie grants certain restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2019 Form 10-K | 55 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share data) Basic EPS Net earnings $ 7,882 $ 5,687 $ 5,309 Earnings allocated to participating securities Earnings available to common shareholders $ 7,842 $ 5,657 $ 5,283 Weighted-average basic shares outstanding 1,481 1,541 1,596 Basic earnings per share $ 5.30 $ 3.67 $ 3.31 Diluted EPS Net earnings $ 7,882 $ 5,687 $ 5,309 Earnings allocated to participating securities Earnings available to common shareholders $ 7,842 $ 5,657 $ 5,283 Weighted-average shares of common stock outstanding 1,481 1,541 1,596 Effect of dilutive securities Weighted-average diluted shares outstanding 1,484 1,546 1,603 Diluted earnings per share $ 5.28 $ 3.66 $ 3.30 Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Proposed Acquisition of Allergan plc On June 25, 2019, AbbVie announced that it entered into a definitive transaction agreement under which AbbVie will acquire Allergan plc (Allergan) in a cash and stock transaction for a transaction equity value of approximately $ 63 billion , based on the closing price of AbbVies common stock of $ 78.45 on June 24, 2019. Under the terms of the transaction agreement, Allergan shareholders will receive 0.8660 AbbVie shares and $ 120.30 in cash for each Allergan share. On October 14, 2019, Allergan shareholders approved the proposed transaction. Allergan is a global pharmaceutical leader focused on developing, manufacturing and commercializing branded pharmaceutical, device, biologic, surgical and regenerative medicine products for patients around the world. Allergan markets a portfolio of brands and products primarily focused on key therapeutic areas including aesthetics, eye care, neuroscience, gastroenterology and women's health. The transaction is subject to customary closing conditions and regulatory approvals. In September 2019, AbbVie and Allergan each received a Request for Additional Information (Second Request) from the Federal Trade Commission (FTC) in connection with the transaction. AbbVie and Allergan are cooperating fully with the FTC. In January 2020, the European Commission approved the proposed acquisition of Allergan by AbbVie conditional upon the divestiture of brazikumab, Allergan's IL-23 inhibitor pipeline product. In January 2020, Allergan entered into a definitive agreement to divest brazikumab contingent upon regulatory approvals and closing of AbbVie's acquisition of Allergan. In anticipation of the proposed acquisition, AbbVie entered into several debt and financing arrangements in 2019. See Note 10 for additional information. Other Licensing Acquisitions Activity Cash outflows related to other acquisitions and investments totaled $ 1.1 billion in 2019 , $ 736 million in 2018 and $ 308 million in 2017 . AbbVie recorded acquired IPRD charges of $ 385 million in 2019 , $ 424 million in 2018 and $ 327 million in 2017 . Significant arrangements impacting 2019 , 2018 and 2017 , some of which require contingent milestone payments, are summarized below. 56 | 2019 Form 10-K Reata Pharmaceuticals, Inc. In October 2019, AbbVie and Reata Pharmaceuticals, Inc. (Reata) entered into an amended and restated license agreement. Under the terms of the agreement, Reata reacquired exclusive development, manufacturing and commercialization rights concerning its proprietary Nrf2 activator product platform originally licensed to AbbVie for territories outside of the United States with respect to bardoxolone methyl and worldwide with respect to omaveloxolone and other next-generation Nrf2 activators . As consideration for the rights reacquired by Reata, AbbVie will receive a total of $ 330 million in cash payable in three installments through 2021, which was recognized in other operating expense (income) in the fourth quarter of 2019. In addition, AbbVie will receive low single-digit, tiered royalties from worldwide sales of omaveloxolone and certain next-generation Nrf2 activators. Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $ 500 million to the collaboration and the term is extended for an additional three years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018, AbbVie recorded $ 500 million in other operating expense (income) in the consolidated statement of earnings related to its commitments under the agreement. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets, and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $ 205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $ 986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $ 385 million in 2019 , $ 424 million in 2018 and $ 122 million in 2017 . In connection with the other individually insignificant early-stage arrangements entered into in 2019 , AbbVie could make additional payments of up to $ 5.8 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $ 200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60 % of collaboration development costs and AbbVie is responsible for the remaining 40 % of collaboration development costs. 2019 Form 10-K | 57 In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,803 $ 1,372 $ 1,001 International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) AbbVies receivable from Janssen, included in accounts receivable, net, was $ 235 million at December 31, 2019 and $ 177 million at December 31, 2018 . AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $ 455 million at December 31, 2019 and $ 376 million at December 31, 2018 . Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2017 $ 15,785 Foreign currency translation ( 122 ) Balance as of December 31, 2018 15,663 Foreign currency translation ( 59 ) Balance as of December 31, 2019 $ 15,604 The company performs its annual goodwill impairment assessment in the third quarter, or earlier if impairment indicators exist. As of December 31, 2019 , there were no accumulated goodwill impairment losses. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 19,547 $ ( 6,405 ) $ 13,142 $ 15,872 $ ( 5,614 ) $ 10,258 License agreements 7,798 ( 2,291 ) 5,507 7,865 ( 1,810 ) 6,055 Total definite-lived intangible assets 27,345 ( 8,696 ) 18,649 23,737 ( 7,424 ) 16,313 Indefinite-lived research and development 4,920 4,920 Total intangible assets, net $ 27,345 $ ( 8,696 ) $ 18,649 $ 28,657 $ ( 7,424 ) $ 21,233 58 | 2019 Form 10-K Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. The company performs its annual impairment assessment of indefinite-lived intangible assets in the third quarter, or earlier if impairment indicators exist. In April 2019, the U.S. Food and Drug Administration (FDA) and the European Commission approved SKYRIZI (risankizumab) for the treatment of moderate to severe plaque psoriasis. As a result, AbbVie reclassified $ 3.9 billion of indefinite-lived intangible assets related to SKYRIZI to developed product rights definite-lived intangible assets. This amount will be amortized over its estimated useful life using the estimated pattern of economic benefit. During the fourth quarter of 2018, the company made a decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating rovalpituzumab tesirine (Rova-T) as a second-line therapy for advanced small-cell lung cancer following a recommendation from an Independent Data Monitoring Committee. This decision lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets and represented a triggering event which required the company to evaluate for impairment the IPRD assets associated with the Stemcentrx acquisition. The company utilized multi-period excess earnings models of the income approach and determined that the fair value was $ 1.0 billion as of December 31, 2018, which was lower than the carrying value of $ 6.1 billion and resulted in an impairment charge of $ 5.1 billion . This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2018. In the third quarter of 2019, following the announcement of the decision to terminate the Rova-T research and development program, the company recorded an impairment charge of $ 1.0 billion which represented the remaining value of the IPRD acquired as part of the 2016 Stemcentrx acquisition. This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2019. No indefinite-lived intangible asset impairment charges were recorded in 2017 . Definite-Lived Intangible Assets Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 11 years for both developed product rights and license agreements. Amortization expense was $ 1.6 billion in 2019 , $ 1.3 billion in 2018 and $ 1.1 billion in 2017 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2019 is as follows: (in billions) Anticipated annual amortization expense $ 1.8 $ 2.0 $ 2.3 $ 2.4 $ 2.5 No definite-lived intangible asset impairment charges were recorded in 2019 or 2018 . In 2017, an impairment charge of $ 354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. The impairment charge was based on discounted cash flow analyses and was included in cost of products sold in the consolidated statements of earnings. Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2019 , 2018 and 2017 , no such plans were individually significant. Restructuring charges recorded were $ 234 million in 2019 , $ 70 million in 2018 and $ 86 million in 2017 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. 2019 Form 10-K | 59 The following table summarizes the cash activity in the restructuring reserve for 2019 , 2018 and 2017 : (in millions) Accrued balance as of December 31, 2016 $ 2017 restructuring charges Payments and other adjustments ( 87 ) Accrued balance as of December 31, 2017 2018 restructuring charges Payments and other adjustments ( 46 ) Accrued balance as of December 31, 2018 2019 restructuring charges Payments and other adjustments ( 178 ) Accrued balance as of December 31, 2019 $ Note 9 Leases AbbVie's lease portfolio primarily consists of real estate properties, vehicles and equipment. The following table summarizes the amounts and location of operating and finance leases on the consolidated balance sheet: (in millions) Balance sheet caption December 31, 2019 Assets Operating Other assets $ Finance Property and equipment, net Total lease assets $ Liabilities Operating Current Accounts payable and accrued liabilities $ Noncurrent Other long-term liabilities Finance Current Current portion of long-term debt and finance lease obligations Noncurrent Long-term debt and finance lease obligations Total lease liabilities $ The following table summarizes the lease costs recognized in the consolidated statement of earnings: year ended December 31 (in millions) Operating lease cost $ Short-term lease cost Variable lease cost Total lease cost $ Sublease income and finance lease costs were insignificant in 2019 . Lease expense prior to the adoption of ASU No. 2016-02 was $ 161 million in 2018 and $ 169 million in 2017 . 60 | 2019 Form 10-K The following table presents the weighted-average remaining lease term and weighted-average discount rate for operating and finance leases: December 31, 2019 Weighted-average remaining lease term (years) Operating Finance Weighted-average discount rate Operating 3.9 % Finance 3.9 % The following table presents supplementary cash flow information regarding the company's leases: year ended December 31 (in millions) Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ Right-of-use assets obtained in exchange for new operating lease liabilities Finance lease cash flows were insignificant in 2019 . The following table summarizes the future maturities of AbbVie's operating and finance lease liabilities as of December 31, 2019 : (in millions) Operating leases Finance leases Total (a)(b) $ $ $ 2021 2022 2023 2024 Thereafter Total lease payments Less: Interest Present value of lease liabilities $ $ $ (a) Total lease payments exclude approximately $ 350 million of contractual minimum lease payments for leases executed but not yet commenced. These leases will commence in 2020 with lease terms of approximately 11 years . (b) Lease payments recognized as part of lease liabilities for optional renewal periods are insignificant. Future minimum lease payments for non-cancelable operating leases and capital leases as of December 31, 2018 prior to the adoption of ASU No. 2016-02 did not differ materially from future lease payments, inclusive of payments for leases executed but not yet commenced, under the new standard. 2019 Form 10-K | 61 Note 10 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2019 (a) Effective interest rate in 2018 (a) Senior notes issued in 2012 2.90% notes due 2022 2.97 % $ 3,100 2.97 % $ 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.375% notes due 2019 (1,400 principal) 0.55 % 0.55 % 1,604 1.375% notes due 2024 (1,450 principal) 1.46 % 1,625 1.46 % 1,661 2.125% notes due 2028 (750 principal) 2.18 % 2.18 % Senior notes issued in 2018 3.375% notes due 2021 3.51 % 1,250 3.51 % 1,250 3.75% notes due 2023 3.84 % 1,250 3.84 % 1,250 4.25% notes due 2028 4.38 % 1,750 4.38 % 1,750 4.875% notes due 2048 4.94 % 1,750 4.94 % 1,750 Senior Euro notes issued in 2019 0.75% notes due 2027 (750 principal) 0.86 % 1.25% notes due 2031 (650 principal) 1.30 % Senior notes issued in 2019 Floating rate notes due May 2021 2.08 % Floating rate notes due November 2021 2.12 % Floating rate notes due 2022 2.29 % 2.15% notes due 2021 2.23 % 1,750 2.30% notes due 2022 2.42 % 3,000 2.60% notes due 2024 2.69 % 3,750 2.95% notes due 2026 3.02 % 4,000 3.20% notes due 2029 3.25 % 5,500 4.05% notes due 2039 4.11 % 4,000 4.25% notes due 2049 4.29 % 5,750 Other Fair value hedges ( 48 ) ( 466 ) Unamortized bond discounts ( 161 ) ( 120 ) Unamortized deferred financing costs ( 323 ) ( 163 ) Total long-term debt and finance lease obligations 66,728 36,611 Current portion 3,753 1,609 Noncurrent portion $ 62,975 $ 35,002 (a) Excludes the effect of any related interest rate swaps. 62 | 2019 Form 10-K Allergan-Related Financing In connection with the proposed acquisition of Allergan, in November 2019, the company issued $ 30.0 billion aggregate principal amount of unsecured senior notes, consisting of $ 750 million aggregate principal amount of floating rate senior notes due May 2021, $ 750 million aggregate principal amount of floating rate senior notes due November 2021, $ 750 million aggregate principal amount of floating rate senior notes due 2022, $ 1.75 billion aggregate principal amount of 2.15 % senior notes due 2021, $ 3.0 billion aggregate principal amount of 2.30 % senior notes due 2022, $ 3.75 billion aggregate principal amount of 2.60 % senior notes due 2024, $ 4.0 billion aggregate principal amount of 2.95 % senior notes due 2026, $ 5.5 billion aggregate principal amount of 3.20 % senior notes due 2029, $ 4.0 billion aggregate principal amount of 4.05 % senior notes due 2039 and $ 5.75 billion aggregate principal amount of 4.25 % senior notes due 2049. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the fixed-rate senior notes prior to maturity at a redemption price equal to the greater of the principal amount or the sum of present values of the remaining scheduled payments of principal and interest on the fixed-rate senior notes to be redeemed plus a make-whole premium. With exception of the fixed-rate notes due 2021 and 2022, AbbVie may also redeem the fixed-rate senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 173 million and debt discounts totaled $ 52 million , which are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. AbbVie expects to use the net proceeds to fund a portion of the aggregate cash consideration due to Allergan shareholders in connection with the proposed acquisition described in Note 5 and to pay related fees and expenses. Pending the consummation of the proposed Allergan acquisition, the net proceeds from the offering are permitted to be invested temporarily in short-term investments. All of the notes are subject to special mandatory redemption at a redemption price equal to 101 % of the aggregate principal amount of the notes plus accrued and unpaid interest if the proposed acquisition of Allergan is not completed by January 30, 2021 or the company notifies the trustee in respect of the notes that it will not pursue the consummation of the proposed Allergan acquisition. On June 25, 2019, AbbVie entered into a $ 38.0 billion 364 -day bridge credit agreement. On July 12, 2019, AbbVie entered into a term loan credit agreement with an aggregate principal amount of $ 6.0 billion consisting of a $ 1.5 billion 364 -day term loan tranche, a $ 2.5 billion three-year term loan tranche and a $ 2.0 billion five-year term loan tranche. In connection with the agreements, debt issuance costs incurred totaled $ 242 million and were recorded to interest expense, net in the consolidated statements of earnings. Upon commencement of the $ 6.0 billion term loan credit agreement and upon issuance of the $ 30.0 billion aggregate principal amount of senior notes, commitments under the bridge credit agreement were reduced to $ 2.0 billion . No amounts were drawn under the bridge credit agreement or term loan credit agreement at December 31, 2019 . In February 2020, the remaining commitments under the bridge credit agreement were reduced to $ 0 as a result of cash on hand at AbbVie. AbbVie subsequently terminated the bridge credit agreement in its entirety as permitted under its terms. On October 25, 2019, AbbVie commenced offers to exchange any and all outstanding notes of certain series issued by Allergan for up to $ 15.5 billion aggregate principal amount and 3.7 billion aggregate principal amount of new notes to be issued by AbbVie and cash, subject to conditions including the closing of the pending acquisition of Allergan. Concurrently with the offers to exchange the Allergan notes for AbbVie notes, the company solicited consents to adopt certain proposed amendments to each of the indentures governing the Allergan notes to, among other things, eliminate substantially all of the restrictive covenants in such indentures. In November 2019, the company announced that the requisite number of consents had been received to adopt the proposed amendments with respect to all Allergan notes and that Allergan executed a supplemental indenture with respect to each Allergan indenture implementing the amendments, which will become operative only upon settlement of the exchange offers. The expiration of the exchange offers is expected to occur on or about the closing date of AbbVies acquisition of Allergan. Other Long-Term Debt In September 2019, the company issued 1.4 billion aggregate principal amount of unsecured senior Euro notes, consisting of 750 million aggregate principal amount of 0.75 % senior notes due 2027 and 650 million aggregate principal amount of 1.25 % senior notes due 2031. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 9 million and debt discounts totaled $ 5 million and are being amortized over the respective terms of the notes to interest expense, net in the consolidated statements of earnings. In October 2019, the company used the proceeds to redeem 1.4 billion aggregate principal amount of 0.375 % senior Euro notes that were due to mature in November 2019. In September 2018, the company issued $ 6.0 billion aggregate principal amount of unsecured senior notes, consisting of $ 1.25 billion aggregate principal amount of 3.375 % senior notes due 2021, $ 1.25 billion aggregate principal amount of 3.75 % 2019 Form 10-K | 63 senior notes due 2023, $ 1.75 billion aggregate principal amount of 4.25 % senior notes due 2028 and $ 1.75 billion aggregate principal amount of 4.875 % senior notes due 2048. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375 % notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $ 37 million and debt discounts totaled $ 37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $ 5.9 billion net proceeds, $ 2.0 billion was used to repay the company's outstanding three -year term loan credit agreement in September 2018 and $ 1.0 billion was used to repay the aggregate principal amount of 2.00 % senior notes at maturity in November 2018. The company used the remaining proceeds to repay term loan obligations in 2019 as they became due. In May 2018, the company also repaid $ 3.0 billion aggregate principal amount of 1.80 % senior notes at maturity. AbbVie has outstanding 2.2 billion aggregate principal amount of unsecured senior Euro notes which were issued in 2016. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and three months prior to maturity. AbbVie has outstanding $ 7.8 billion aggregate principal amount of unsecured senior notes which were issued in 2016 and $ 13.7 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $ 5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2019 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $ 699 million as of December 31, 2018 . There were no commercial paper borrowings as of December 31, 2019 . The weighted-average interest rate on commercial paper borrowings was 2.5 % in 2019 , 2.0 % in 2018 and 1.3 % in 2017 . In August 2019, AbbVie entered into an amended and restated $ 4.0 billion five-year revolving credit facility that matures in August 2024. This amended facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants, all of which the company was in compliance with as of December 31, 2019 . Commitment fees under AbbVie's revolving credit facilities were insignificant in 2019 , 2018 and 2017 . No amounts were outstanding under the company's credit facilities as of December 31, 2019 and December 31, 2018 . In March 2019, AbbVie repaid a $ 3.0 billion 364 -day term loan credit agreement that was drawn on in June 2018 and was scheduled to mature in June 2019. Maturities of Long-Term Debt The following table summarizes AbbVie's debt maturities as of December 31, 2019 : as of and for the years ending December 31 (in millions) $ 3,750 6,300 7,850 2,250 5,375 Thereafter 41,708 Total obligations and commitments 67,233 Fair value hedges, unamortized bond discounts, deferred financing costs and finance lease obligations ( 505 ) Total long-term debt and finance lease obligations $ 66,728 64 | 2019 Form 10-K Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 11 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $ 957 million at December 31, 2019 and $ 1.4 billion at December 31, 2018 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months . Accumulated gains and losses as of December 31, 2019 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. In the third quarter of 2019, the company entered into treasury rate lock agreements with notional amounts totaling $ 10.0 billion to hedge exposure to variability in future cash flows resulting from changes in interest rates related to the issuance of long-term debt in connection with the proposed acquisition of Allergan. The treasury rate lock agreements were designated as cash flow hedges and recorded at fair value. The agreements were net settled upon issuance of the senior notes in November 2019 resulting in a gain of $ 383 million recognized in other comprehensive income (loss). This gain will be reclassified to interest expense, net over the lives of the related debt. In the fourth quarter of 2019, the company entered into interest rate swap contracts with notional amounts totaling $ 2.3 billion at December 31, 2019 . The effect of the hedge contracts is to change a floating-rate interest obligation to a fixed rate for that portion of the floating-rate debt. The contracts were designated as cash flow hedges and are recorded at fair value. Realized and unrealized gains or losses are included in AOCI and will be reclassified to interest expense, net over the lives of the floating-rate debt. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $ 7.1 billion at December 31, 2019 and $ 8.6 billion at December 31, 2018 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. The company had 3.6 billion aggregate principal amount of senior Euro notes designated as net investment hedges at December 31, 2019 and December 31, 2018 . In the third quarter of 2019, the company issued 1.4 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company elected to de-designate hedge accounting for 1.4 billion aggregate principal amount of existing senior Euro notes which were subsequently repaid in October 2019. In addition, in 2019, the company entered into foreign currency forward exchange contracts and designated the instruments as net investment hedges. These contracts had notional amounts totaling 971 million , 204 million and CHF 62 million at December 31, 2019 . The company uses the spot method of assessing hedge effectiveness for derivative 2019 Form 10-K | 65 instruments designated as net investment hedges. Realized and unrealized gains and losses from these hedges are included in AOCI and the initial fair value of hedge components excluded from the assessment of effectiveness is recognized in interest expense, net over the life of the hedging instrument. AbbVie is a party to interest rate swap contracts designated as fair value hedges with notional amounts totaling $ 10.8 billion at December 31, 2019 and December 31, 2018 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2018 Balance sheet caption 2018 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Designated as net investment hedges Prepaid expenses and other Accounts payable and accrued liabilities Not designated as hedges Prepaid expenses and other 19 Accounts payable and accrued liabilities 26 Interest rate swap contracts Designated as cash flow hedges Other assets Other long-term liabilities Designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Designated as fair value hedges Other assets Other long-term liabilities 466 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended in December 31 (in millions) Foreign currency forward exchange contracts Designated as cash flow hedges $ ( 5 ) $ $ ( 250 ) Designated as net investment hedges Interest rate swap contracts designated as cash flow hedges Treasury rate lock agreements designated as cash flow hedges Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax losses of $ 10 million into cost of products sold for foreign currency cash flow hedges, pre-tax gains of $ 7 million into interest expense, net for interest rate swap cash flow hedges and pre-tax gains of $ 24 million into interest expense, net for treasury rate lock agreement cash flow hedges during the next 12 months. Related to AbbVies non-derivative, foreign currency denominated debt designated as net investment hedges, the company recognized in other comprehensive income (loss) pre-tax gains of $ 90 million in 2019 , pre-tax gains of $ 178 million in 2018 and pre-tax losses of $ 537 million in 2017 . 66 | 2019 Form 10-K The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 13 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ $ ( 161 ) $ Designated as net investment hedges Interest expense, net Not designated as hedges Net foreign exchange loss ( 70 ) ( 96 ) Treasury rate lock agreements designated as cash flow hedges Interest expense, net Interest rate swap contracts Designated as cash flow hedges Interest expense, net Designated as fair value hedges Interest expense, net ( 71 ) ( 63 ) Debt designated as hedged item in fair value hedges Interest expense, net ( 418 ) Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2019 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 39,924 $ 1,542 $ 38,382 $ Debt securities Equity securities Interest rate swap contracts Foreign currency contracts Total assets $ 40,004 $ 1,566 $ 38,438 $ Liabilities Interest rate swap contracts $ $ $ $ Foreign currency contracts Contingent consideration 7,340 7,340 Total liabilities $ 7,472 $ $ $ 7,340 2019 Form 10-K | 67 The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2018 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 7,289 $ 1,209 $ 6,080 $ Time deposits Debt securities 1,536 1,536 Equity securities Foreign currency contracts Total assets $ 9,529 $ 1,213 $ 8,316 $ Liabilities Interest rate swap contracts $ $ $ $ Foreign currency contracts Contingent consideration 4,483 4,483 Total liabilities $ 4,975 $ $ $ 4,483 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. The derivatives entered into by the company were valued using observable market inputs including published interest rate curves and both forward and spot prices for foreign currencies. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2019 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $ 280 million . Additionally, at December 31, 2019 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $ 150 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,483 $ 4,534 $ 4,213 Change in fair value recognized in net earnings 3,091 Payments ( 234 ) ( 100 ) ( 305 ) Ending balance $ 7,340 $ 4,483 $ 4,534 The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the second quarter of 2019, the company recorded a $ 2.3 billion increase in the SKYRIZI contingent consideration liability due to higher probabilities of success, higher estimated future sales and declining interest rates. The higher probabilities of success resulted from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. During the third quarter of 2019, the company recorded a $ 91 million decrease in the Stemcentrx contingent consideration liability due to the termination of the Rova-T research and development program. During the fourth quarter of 2018, the company recorded a $ 428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 68 | 2019 Form 10-K Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2019 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Current portion of long-term debt and finance lease obligations, excluding fair value hedges $ 3,755 $ 3,760 $ 3,753 $ $ Long-term debt and finance lease obligations, excluding fair value hedges 63,021 66,651 66,631 Total liabilities $ 66,776 $ 70,411 $ 70,384 $ $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2018 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Short-term borrowings $ 3,699 $ 3,693 $ $ 3,693 $ Current portion of long-term debt and finance lease obligations, excluding fair value hedges 1,609 1,617 1,609 Long-term debt and finance lease obligations, excluding fair value hedges 35,468 34,052 34,024 Total liabilities $ 40,776 $ 39,362 $ 35,633 $ 3,729 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $ 66 million as of December 31, 2019 and $ 84 million as of December 31, 2018 . No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2019 . Available-for-sale Securities Substantially all of the companys investments in debt securities were classified as available-for-sale with changes in fair value recognized in other comprehensive income. In the third quarter of 2019, the company sold substantially all of its investments in debt securities. There were no debt securities classified as short-term as of December 31, 2019 and $ 204 million as of December 31, 2018 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale debt securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2018 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ ( 2 ) $ Corporate debt securities 1,042 ( 9 ) 1,034 Other debt securities Total $ 1,546 $ $ ( 11 ) $ 1,536 AbbVie had no other-than-temporary impairments as of December 31, 2019 . Net realized gains and losses were insignificant in 2019 and 2018 . Net realized gains were $ 90 million in 2017 . 2019 Form 10-K | 69 Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. Of total net accounts receivable, three U.S. wholesalers accounted for 68 % as of December 31, 2019 and 63 % as of December 31, 2018 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 58 % of AbbVie's total net revenues in 2019 , 61 % in 2018 and 65 % in 2017 . Note 12 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2019 and 2018 . The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 6,618 $ 6,985 $ $ Service cost Interest cost Employee contributions Actuarial (gain) loss 1,703 ( 614 ) ( 287 ) Benefits paid ( 206 ) ( 191 ) ( 17 ) ( 16 ) Other, primarily foreign currency translation adjustments ( 76 ) End of period 8,646 6,618 1,050 Fair value of plan assets Beginning of period 5,637 5,399 Actual return on plan assets ( 384 ) Company contributions Employee contributions Benefits paid ( 206 ) ( 191 ) ( 17 ) ( 16 ) Other, primarily foreign currency translation adjustments ( 62 ) End of period 7,116 5,637 Funded status, end of period $ ( 1,530 ) $ ( 981 ) $ ( 1,050 ) $ ( 561 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities ( 8 ) ( 8 ) ( 18 ) ( 15 ) Other long-term liabilities ( 1,917 ) ( 1,294 ) ( 1,032 ) ( 546 ) Net obligation $ ( 1,530 ) $ ( 981 ) $ ( 1,050 ) $ ( 561 ) Actuarial loss, net $ 3,633 $ 2,516 $ $ Prior service cost (credit) ( 16 ) ( 22 ) Accumulated other comprehensive loss $ 3,643 $ 2,527 $ $ Actuarial losses for 2019 in the table above were primarily driven by lower discount rates. 70 | 2019 Form 10-K The projected benefit obligations (PBO) in the table above included $ 2.3 billion at December 31, 2019 and $ 1.9 billion at December 31, 2018 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $ 7.6 billion at December 31, 2019 and $ 6.0 billion at December 31, 2018 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2019 , the ABO was $ 5.8 billion , the PBO was $ 6.7 billion and aggregate plan assets were $ 4.8 billion . Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax losses (gains) included in other comprehensive income (loss): years ended December 31 (in millions) Defined benefit plans Actuarial loss $ 1,231 $ $ Amortization of actuarial loss and prior service cost ( 109 ) ( 140 ) ( 107 ) Foreign exchange loss (gain) and other ( 6 ) ( 13 ) Total loss $ 1,116 $ $ Other post-employment plans Actuarial loss (gain) $ $ ( 287 ) $ Amortization of actuarial loss and prior service credit ( 1 ) ( 1 ) Total loss (gain) $ $ ( 288 ) $ The pre-tax amounts included in AOCI at December 31, 2019 expected to be recognized in net periodic benefit cost in 2020 consisted of $ 219 million of expense related to actuarial losses and prior service costs for defined benefit plans and $ 25 million of income related to actuarial losses and prior service credits for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets ( 474 ) ( 439 ) ( 382 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service credit Net periodic benefit cost $ $ $ The components of net periodic benefit cost other than service cost are included in other expense, net in the consolidated statements of earnings. Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 3.0 % 4.0 % Rate of compensation increases 4.6 % 4.6 % Other post-employment plans Discount rate 3.6 % 4.6 % The assumptions used in calculating the December 31, 2019 measurement date benefit obligations will be used in the calculation of net periodic benefit co st in 2020 . 2019 Form 10-K | 71 Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 4.0 % 3.4 % 3.9 % Discount rate for determining interest cost 4.0 % 3.1 % 3.7 % Expected long-term rate of return on plan assets 7.6 % 7.7 % 7.8 % Expected rate of change in compensation 4.6 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.7 % 4.0 % 4.9 % Discount rate for determining interest cost 4.3 % 3.7 % 4.1 % For the December 31, 2019 post-retirement health care obligations remeasurement, the company assumed a 6.4 % pre-65 ( 7.0 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % in 2050 and remain at that level thereafter. For purposes of measuring the 2019 post-retirement health care costs, the company assumed a 6.6 % pre-65 ( 7.3 % post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5 % for 2050 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2019 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2019 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ ( 10 ) Projected benefit obligation ( 186 ) Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,851 $ 2,051 $ $ Total assets measured at NAV 4,265 Fair value of plan assets $ 7,116 72 | 2019 Form 10-K Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,359 $ 1,586 $ $ Total assets measured at NAV 3,278 Fair value of plan assets $ 5,637 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The 2019 target investment allocation for the AbbVie Pension Plan was 35 % in equity securities, 20 % in fixed income securities and 45 % in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. 2019 Form 10-K | 73 Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2021 2022 2023 2024 2025 to 2029 1,737 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $ 102 million in 2019 , $ 89 million in 2018 and $ 82 million in 2017 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 13 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least 10 years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Realized excess tax benefits associated with stock-based compensation totaled $ 15 million in 2019 , $ 78 million in 2018 and $ 71 million in 2017 . 74 | 2019 Form 10-K Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100 % of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $ 12.54 in 2019 , $ 21.63 in 2018 and $ 9.80 in 2017 . The following table summarizes AbbVie stock option activity in 2019 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2018 6,143 $ 55.05 6.2 $ Granted 1,002 79.02 Exercised ( 375 ) 23.72 Lapsed ( 9 ) 20.09 Outstanding at December 31, 2019 6,761 $ 60.39 5.9 $ Exercisable at December 31, 2019 4,924 $ 51.90 4.9 $ The total intrinsic value of options exercised was $ 22 million in 2019 , $ 215 million in 2018 and $ 371 million in 2017 . The total fair value of options vested during 2019 was $ 13 million . As of December 31, 2019 , $ 6 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSU and performance share activity for 2019 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2018 9,868 $ 79.90 Granted 5,584 78.03 Vested ( 4,616 ) 71.30 Forfeited ( 604 ) 82.19 Outstanding at December 31, 2019 10,232 $ 81.72 The fair market value of RSUs and performance shares (as applicable) vested was $ 371 million in 2019 , $ 583 million in 2018 and $ 348 million in 2017 . 2019 Form 10-K | 75 As of December 31, 2019 , $ 327 million of unrecognized compensation cost related to RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $ 4.39 in 2019 , $ 3.95 in 2018 and $ 2.63 in 2017 . The following table summarizes quarterly cash dividends declared during 2019 , 2018 and 2017 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 11/01/19 02/14/20 $ 1.18 11/02/18 02/15/19 $ 1.07 10/27/17 02/15/18 $ 0.71 09/06/19 11/15/19 $ 1.07 09/07/18 11/15/18 $ 0.96 09/08/17 11/15/17 $ 0.64 06/20/19 08/15/19 $ 1.07 06/14/18 08/15/18 $ 0.96 06/22/17 08/15/17 $ 0.64 02/21/19 05/15/19 $ 1.07 02/15/18 05/15/18 $ 0.96 02/16/17 05/15/17 $ 0.64 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie repurchased 4 million shares for $ 300 million in 2019. AbbVie's remaining stock repurchase authorization was approximately $ 4.0 billion as of December 31, 2019 . On February 15, 2018, AbbVie's board of directors authorized a new $ 10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $ 5.0 billion increase to the existing $ 10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $ 10.7 billion in 2018. Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $ 1.3 billion in 2018 and approximately 13 million shares for $ 1.0 billion in 2017 . 76 | 2019 Form 10-K Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2019 , 2018 and 2017 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2016 $ ( 1,435 ) $ $ ( 1,513 ) $ $ $ ( 2,586 ) Other comprehensive income (loss) before reclassifications ( 343 ) ( 480 ) ( 230 ) ( 344 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 75 ) ( 112 ) Net current-period other comprehensive income (loss) ( 343 ) ( 406 ) ( 46 ) ( 342 ) ( 141 ) Balance as of December 31, 2017 ( 439 ) ( 203 ) ( 1,919 ) ( 166 ) ( 2,727 ) Other comprehensive income (loss) before reclassifications ( 391 ) ( 14 ) ( 27 ) Net losses reclassified from accumulated other comprehensive loss Net current-period other comprehensive income (loss) ( 391 ) ( 10 ) Balance as of December 31, 2018 ( 830 ) ( 65 ) ( 1,722 ) ( 10 ) ( 2,480 ) Other comprehensive income (loss) before reclassifications ( 98 ) ( 1,330 ) ( 1,023 ) Net losses (gains) reclassified from accumulated other comprehensive loss ( 21 ) ( 2 ) ( 157 ) ( 93 ) Net current-period other comprehensive income (loss) ( 98 ) ( 1,243 ) ( 1,116 ) Balance as of December 31, 2019 $ ( 928 ) $ $ ( 2,965 ) $ $ $ ( 3,596 ) Other comprehensive loss included foreign currency translation adjustments totaling losses of $ 98 million in 2019 and $ 391 million in 2018 which were principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. In 2017, AbbVie reclassified $ 316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $ 680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss for 2019 included pension and post-employment benefit plan losses of $ 1.2 billion primarily due to an actuarial loss driven by lower discount rates. See Note 12 for additional information. 2019 Form 10-K | 77 The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Net investment hedging activities Gains on derivative amount excluded from effectiveness testing (a) $ ( 27 ) $ $ Tax expense Total reclassifications, net of tax $ ( 21 ) $ $ Pension and post-employment benefits Amortization of actuarial losses and other (b) $ $ $ Tax benefit ( 23 ) ( 28 ) ( 33 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on foreign currency forward exchange contracts (c) $ ( 167 ) $ $ ( 118 ) Gains on treasury rate lock agreements and interest rate swap contracts (a) ( 4 ) Tax expense (benefit) ( 4 ) Total reclassifications, net of tax $ ( 157 ) $ $ ( 112 ) (a) Amounts are included in interest expense, net (see Note 11 ). (b) Amounts are included in the computation of net periodic benefit cost (see Note 12 ). (c) Amounts are included in cost of products sold (see Note 11 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $ 0.01 . As of December 31, 2019 , no shares of preferred stock were issued or outstanding. Note 14 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) Domestic $ ( 2,784 ) $ ( 4,274 ) $ ( 2,678 ) Foreign 11,210 9,471 10,405 Total earnings before income tax expense $ 8,426 $ 5,197 $ 7,727 Income Tax Expense years ended December 31 (in millions) Current Domestic $ $ $ 6,204 Foreign Total current taxes $ $ 1,027 $ 6,580 Deferred Domestic $ ( 137 ) $ ( 1,497 ) $ ( 4,898 ) Foreign ( 20 ) Total deferred taxes $ $ ( 1,517 ) $ ( 4,162 ) Total income tax expense (benefit) $ $ ( 490 ) $ 2,418 78 | 2019 Form 10-K Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35 % to 21 % and required companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. These changes were generally effective for tax years beginning in 2018. The Act also created a minimum tax on certain foreign sourced earnings. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. Additionally, the Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings and the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. As such, the company records foreign withholding tax liabilities related to the future cash repatriation of such earnings. However, the company considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Effective Tax Rate Reconciliation years ended December 31 Statutory tax rate 21.0 % 21.0 % 35.0 % Effect of foreign operations ( 8.4 ) ( 28.7 ) ( 12.2 ) U.S. tax credits ( 3.3 ) ( 7.3 ) ( 4.0 ) Impacts related to U.S. tax reform ( 1.6 ) 8.2 12.0 Stock-based compensation excess tax benefit ( 0.2 ) ( 1.5 ) ( 0.9 ) Tax audit settlements ( 4.7 ) ( 2.5 ) ( 1.2 ) Deferred tax remeasurements due to change in tax rate 3.1 All other, net 0.6 1.4 2.6 Effective tax rate 6.5 % ( 9.4 )% 31.3 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2019 , 2018 and 2017 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, the cost of repatriation decisions, Boehringer Ingelheim accretion on contingent consideration and Stemcentrx impairment related expenses. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2019 , 2018 and 2017 included impacts related to U.S. tax reform. In 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. For 2019, the impact of the Act affected the full year earnings of these subsidiaries, resulting in additional tax expense compared to prior year. The 2019 effective income tax rate also reflects the effects of deferred tax remeasurement due to a change in foreign tax law, accretion for contingent consideration and impairment related expenses. In addition, the company recognized a net tax benefit of $ 400 million in 2019 , $ 131 million in 2018 and $ 91 million in 2017 related to the resolution of various tax positions pertaining to prior years. 2019 Form 10-K | 79 Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Advance payments Net operating losses and other credit carryforwards Other Total deferred tax assets 3,517 2,765 Valuation allowances ( 731 ) ( 103 ) Total net deferred tax assets 2,786 2,662 Deferred tax liabilities Excess of book basis over tax basis of intangible assets ( 2,712 ) ( 2,940 ) Excess of book basis over tax basis in investments ( 249 ) ( 211 ) Other ( 440 ) ( 250 ) Total deferred tax liabilities ( 3,401 ) ( 3,401 ) Net deferred tax liabilities $ ( 615 ) $ ( 739 ) As of December 31, 2019 , gross state net operating losses were $ 1.0 billion and tax credit carryforwards were $ 188 million . The state tax carryforwards expire between 2020 and 2039. As of December 31, 2019 , foreign net operating loss carryforwards were $ 2.9 billion . Foreign net operating loss carryforwards of $ 2.8 billion expire between 2020 and 2036 and the remaining do not have an expiration period. The company had valuation allowances of $ 731 million as of December 31, 2019 and $ 103 million as of December 31, 2018 . These were principally related to foreign and state net operating losses and credit carryforwards that are not expected to be realized. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 2,852 $ 2,701 $ 1,168 Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions ( 21 ) ( 36 ) ( 2 ) Settlements ( 749 ) ( 79 ) ( 233 ) Lapse of statutes of limitations ( 33 ) ( 7 ) ( 16 ) Ending balance $ 2,661 $ 2,852 $ 2,701 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $ 2.4 billion in 2019 and $ 2.7 billion in 2018 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2019 , AbbVie would be indemnified for approximately $ 83 million . The Increase due to current year tax positions and ""Increase due to prior year tax positions"" in the table above include amounts related to federal, state and international tax items. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $ 51 million in 2019 , $ 73 million in 2018 and $ 24 million in 2017 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross 80 | 2019 Form 10-K interest and penalties of $ 191 million at December 31, 2019 , $ 190 million at December 31, 2018 and $ 120 million at December 31, 2017 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next 12 months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next 12 months up to $ 54 million . All significant federal, state, local and international matters have been concluded for years through 2012. The company believes adequate provision has been made for all income tax uncertainties. Note 15 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $ 290 million as of December 31, 2019 and approximately $ 350 million as of December 31, 2018 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. In addition, other operating income in 2019 included $ 550 million of income from a legal settlement related to an intellectual property dispute with a third party . While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Four lawsuits against Unimed Pharmaceuticals, LLC, Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others remained consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation , MDL No. 2084. These cases, brought by direct AndroGel purchasers, generally allege Solvay's 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs seek monetary damages and attorneys' fees. Three of those lawsuits were settled in December 2019 and will be dismissed. In September 2014, the FTC filed a lawsuit, FTC v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $ 448 million , plus prejudgment interest. The court denied the FTCs request for injunctive relief. AbbVie is appealing the courts liability and disgorgement rulings and, based on an assessment of the merits of that appeal, no liability has been accrued for this matter. The FTC is also appealing aspects of the courts trial ruling and the dismissal of its settlement-related claim. In July 2018, a purported class action was filed in the United States District Court for the Eastern District of Pennsylvania on behalf of direct AndroGel purchasers based on the trial courts ruling in the FTCs case. In September 2019, two individual direct AndroGel purchasers substituted in as the plaintiffs in that lawsuit and withdrew the class allegations. That case, which was pending as Rochester Drug Co-Operative, Inc., et al. v. AbbVie Inc., et al., was settled in December 2019 and will be dismissed. In August 2019, direct purchasers of AndroGel filed a lawsuit, King Drug Co. of Florence, Inc., et al. v. AbbVie Inc., et al. , against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, making allegations similar to those in In re: AndroGel Antitrust Litigation (No. II) , MDL No. 2084 (above) and FTC v. AbbVie Inc. (above). Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by Niaspan direct purchasers and one brought by Niaspan end-payers. The cases are pending in the United States District Court for the Eastern 2019 Form 10-K | 81 District of Pennsylvania for coordinated or consolidated pre-trial proceedings under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In August 2019, the court certified a class of direct purchasers of Niaspan. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In May 2018, the California Court of Appeal ruled that the District Attorneys Office may not bring monetary claims beyond the scope of Orange County, which the District Attorneys Office is appealing. Between March and May 2019, 12 putative class action lawsuits were filed in the United States District Court for the Northern District of Illinois by indirect HUMIRA purchasers, alleging that AbbVies settlements with biosimilar manufacturers and AbbVies HUMIRA patent portfolio violate state and federal antitrust laws. The court consolidated these lawsuits as In re: Humira (Adalimumab) Antitrust Litigation . In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al. , was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted included violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint sought monetary damages and injunctive relief. In July 2018, the court denied the plaintiffs motion for class certification. In November 2019, the United States Court of Appeals for the Seventh Circuit affirmed the district courts grant of the defendants summary judgment motion. In July 2019, the New Mexico Attorney General filed a lawsuit, State of New Mexico ex rel. Balderas v. AbbVie Inc., et al. , in New Mexico District Court for Santa Fe County against AbbVie and other companies alleging their marketing of AndroGel violated New Mexicos Unfair Practices Act. In September 2018, the Commissioner of the California Department of Insurance intervened in a qui tam lawsuit, State of California and Lazaro Suarez v. AbbVie Inc., et al. , brought under the California Insurance Frauds Prevention Act, in California Superior Court for Alameda County. The Department of Insurances complaint alleges that, through patient and reimbursement support services and other services and items of value provided in connection with HUMIRA, AbbVie caused the submission of fraudulent commercial insurance claims for HUMIRA in violation of the California statute. The complaint seeks injunctive relief, an assessment of up to three times the amount of the claims at issue, and civil penalties. In addition, a federal securities lawsuit ( Holwill v. AbbVie Inc., et al .) is pending in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and former chief financial officer, alleging that reasons stated for HUMIRA sales growth in financial filings between 2013 and 2017 were misleading because they omitted the conduct alleged in the Department of Insurances complaint. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al., on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In October 2019, the court granted final approval to the parties class settlement agreement. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connec tion with its proposed t ransaction with Shire. Similar lawsuits were filed between July 2017 and October 2019 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. Plaintiffs seek compensatory and punitive damages. Product liability cases were filed in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 3,500 claims against AbbVie are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation , MDL No. 2545. Approximately 175 claims against AbbVie are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. In November 2018, AbbVie entered into a Master Settlement Agreement with the Plaintiffs Steering Committee in the MDL encompassing existing claims in all courts. All proceedings in pending cases are effectively stayed during the settlement administration process. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 120 cases are pending in the United States District Court for the Southern District of Illinois, and approximately 14 others are pending in various federal and state courts. Plaintiffs generally seek compensatory and punitive damages. Approximately eighty percent of these pending 82 | 2019 Form 10-K cases, plus other unfiled claims, are subject to confidential settlement agreements and are expected to be dismissed with prejudice. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. In January 2020, the Court of Appeals for the Federal Circuit affirmed the decisions. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd. , in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that 11 HCV-related patents licensed to AbbVie in 2002 are invalid. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In February 2018, cases were filed in the United States District Court for the District of Delaware against the following defendants: Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limited; Sun Pharma Global FZE and Sun Pharmaceutical Industries Ltd.; Cipla Limited and Cipla USA Inc.; and Zydus Worldwide DMCC, Cadila Healthcare Limited, Sandoz Inc., and Lek Pharmaceuticals D.D. In each case, Pharmacyclics alleges the defendants proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in these suits. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib tablets (a drug Pharmacyclics sells under the trademark IMBRUVICA). In a case filed in the United States District Court for the District of Delaware in March 2019, Pharmacyclics alleges that Alvogen Pine Brook LLCs and Natco Pharma Ltd.s proposed generic ibrutinib tablet product infringes certain Pharmacyclics patents. Pharmacyclics seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in this suit. 2019 Form 10-K | 83 Note 16 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) Immunology HUMIRA United States $ 14,864 $ 13,685 $ 12,361 International 4,305 6,251 6,066 Total $ 19,169 $ 19,936 $ 18,427 SKYRIZI United States $ $ $ International Total $ $ $ RINVOQ United States $ $ $ International Total $ $ $ Hematologic Oncology IMBRUVICA United States $ 3,830 $ 2,968 $ 2,144 Collaboration revenues Total $ 4,674 $ 3,590 $ 2,573 VENCLEXTA United States $ $ $ International Total $ $ $ HCV MAVYRET United States $ 1,473 $ 1,614 $ International 1,420 1,824 Total $ 2,893 $ 3,438 $ VIEKIRA United States $ $ $ International Total $ $ $ Other Key Products Creon United States $ 1,041 $ $ Lupron United States $ $ $ International Total $ $ $ Synthroid United States $ $ $ Synagis International $ $ $ Duodopa United States $ $ $ International Total $ $ $ Sevoflurane United States $ $ $ International Total $ $ $ Kaletra United States $ $ $ International Total $ $ $ AndroGel United States $ $ $ ORILISSA United States $ $ $ International Total $ $ $ All other $ $ $ Total net revenues $ 33,266 $ 32,753 $ 28,216 84 | 2019 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 23,907 $ 21,524 $ 18,251 Japan 1,211 1,591 Germany 1,292 1,157 Canada France Spain United Kingdom Italy Brazil The Netherlands All other countries 3,993 4,013 4,080 Total net revenues $ 33,266 $ 32,753 $ 28,216 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 2,026 $ 1,993 Europe All other 291 Total long-lived assets $ 2,962 $ 2,883 2019 Form 10-K | 85 Note 17 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 7,828 $ 7,934 Gross margin 6,134 6,007 Net earnings (a) 2,456 2,783 Basic earnings per share $ 1.65 $ 1.74 Diluted earnings per share $ 1.65 $ 1.74 Cash dividends declared per common share $ 1.07 $ 0.96 Second Quarter Net revenues $ 8,255 $ 8,278 Gross margin 6,436 6,344 Net earnings (b) 1,983 Basic earnings per share $ 0.49 $ 1.26 Diluted earnings per share $ 0.49 $ 1.26 Cash dividends declared per common share $ 1.07 $ 0.96 Third Quarter Net revenues $ 8,479 $ 8,236 Gross margin 6,559 6,401 Net earnings (c) 1,884 2,747 Basic earnings per share $ 1.27 $ 1.81 Diluted earnings per share $ 1.26 $ 1.81 Cash dividends declared per common share $ 1.07 $ 0.96 Fourth Quarter Net revenues $ 8,704 $ 8,305 Gross margin 6,698 6,283 Net earnings (loss) (d) 2,801 ( 1,826 ) Basic earnings (loss) per share $ 1.88 $ ( 1.23 ) Diluted earnings (loss) per share $ 1.88 $ ( 1.23 ) Cash dividends declared per common share $ 1.18 $ 1.07 (a) First quarter results in 2019 included after-tax charges of $ 171 million related to the change in fair value of contingent consideration liabilities and restructuring charges of $ 133 million . First quarter results in 2018 included an after-tax benefit of $ 148 million related to the change in fair value of contingent consideration liabilities partially offset by after-tax litigation reserves charges of $ 100 million . (b) Second quarter results in 2019 included an after-tax charge of $ 2.3 billion related to the change in fair value of contingent consideration liabilities resulting from the April 2019 regulatory approvals of SKYRIZI for the treatment of moderate to severe plaque psoriasis. Second quarter results in 2018 included after-tax charges of $ 500 million as a result of a collaboration agreement extension with Calico and $ 485 million related to the change in fair value of contingent consideration liabilities. (c) Third quarter results in 2019 included after-tax charges of $ 912 million related to intangible asset impairment and $ 182 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2018 included after-tax litigation reserves charges of $ 176 million and $ 95 million related to the change in fair value of contingent consideration liabilities. 86 | 2019 Form 10-K (d) Fourth quarter results in 2019 included an after-tax charge of $ 438 million related to the change in fair value of contingent consideration liabilities offset by after-tax income of $ 435 million from a legal settlement related to an intellectual property dispute with a third party and $ 297 million from an amended and restated license agreement between AbbVie and Reata . Fourth quarter results in 2018 included an after-tax intangible asset impairment charge of $ 4.5 billion partially offset by an after-tax benefit of $ 375 million related to the change in fair value of contingent consideration liabilities. 2019 Form 10-K | 87 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2020 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 88 | 2019 Form 10-K Sales rebate accruals for Medicaid, Medicare and managed care programs Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Revenue Recognition, the Company established provisions for sales rebates in the same period as the related product is sold. At December 31, 2019, the Company had $4,484 million in sales rebate accruals, a large portion of which were for rebates provided to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans and private entities for Medicaid, Medicare and managed care programs. In order to establish these sales rebate accruals, the Company estimated its rebates based upon the identification of the products subject to a rebate, the applicable price and rebate terms and the estimated lag time between the sale and payment of the rebate. Auditing the Medicaid, Medicare and managed care sales rebate accruals was complex and required significant auditor judgment because the accruals consider multiple subjective and complex estimates and assumptions. These estimates and assumptions included the estimated inventory in the distribution channel, which impacts the lag time between the sale to the customer and payment of the rebate and the final payer related to product sales, which impacts the applicable price and rebate terms. In deriving these estimates and assumptions, the Company used both internal and external sources of information to estimate product in the distribution channels, payer mix, prescription volumes and historical experience. Management supplemented its historical data analysis with qualitative adjustments based upon changes in rebate trends, rebate programs and contract terms, legislative changes, or other significant events which indicate a change in the reserve is appropriate. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys sales rebate accruals for Medicaid, Medicare and managed care programs. This included testing controls over managements review of the significant assumptions and other inputs used in the estimation of Medicaid, Medicare and managed care rebates, among others, including the significant assumptions discussed above. The testing was inclusive of managements controls to evaluate the accuracy of its reserve judgments to actual rebates paid, rebate validation and processing, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the sales rebate accruals for Medicaid, Medicare, and managed care programs, our audit procedures included, among others, understanding and evaluating the significant assumptions and underlying data used in managements calculations. Our testing of significant assumptions included corroboration to external data sources. We evaluated the reasonableness of assumptions in light of industry and economic trends, product profiles, and other regulatory factors. We assessed the historical accuracy of managements estimates by comparing actual activity to previous estimates and performed analytical procedures, based on internal and external data sources, to evaluate the completeness of the reserves. For Medicaid, we involved a specialist with an understanding of statutory reimbursement requirements to assess the consistency of the Companys calculation methodologies with applicable government regulations and policy. Valuation of contingent consideration Description of the Matter As discussed in Note 2 to the consolidated financial statements under the caption Business Combinations and in Note 11 under the caption Financial Instruments and Fair Value Measures, the Company recognized contingent consideration liabilities at the estimated fair value on the acquisition date in connection with applying the acquisition method of accounting for business combinations. Subsequent changes to the fair value of the contingent consideration liabilities were recorded within the consolidated statement of earnings in the period of change. At December 31, 2019, the Company had $7,340 million in contingent consideration liabilities, which represented a Level 3 fair value measurement in the fair value hierarchy due to the significant unobservable inputs used in determining the fair value and the use of management judgment about the assumptions market participants would use in pricing the liabilities. Auditing the valuation of contingent consideration liabilities was complex and required significant auditor judgment due to the use of a Monte Carlo simulation model and the high degree of subjectivity in evaluating certain assumptions required to estimate the fair value of contingent royalty payments. In particular, the fair value measurement was sensitive to the significant assumptions underlying the estimated amount of future sales of the acquired products. Management utilized its expertise within the industry and knowledge of clinical development and regulatory approval processes to determine certain of these assumptions. 2019 Form 10-K | 89 How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys contingent consideration liabilities process including, among others, managements process to establish the significant assumptions and measure the liability. This included testing controls over managements review of the significant assumptions and other inputs used in the determination of fair value. The testing was inclusive of key management review controls to monitor and evaluate clinical development of the acquired products and estimated future sales, and controls to ensure that the data used to evaluate and support the significant assumptions was complete, accurate and, where applicable, verified to external data sources. To test the estimated fair value of contingent consideration liabilities, our audit procedures included, among others, inspecting the terms of the executed agreement, assessing the Monte Carlo simulation model used and testing the key contractual inputs and significant assumptions discussed above. We evaluated the assumptions and judgments in light of observable industry and economic trends and standards, external data sources and regulatory factors. Estimated amounts of future sales were evaluated for reasonableness in relation to internal and external analyses, clinical development progress and timelines, probability of success benchmarks, and regulatory notices. Our procedures included evaluating the data sources used by management in determining its assumptions and, where necessary, included an evaluation of available information that either corroborated or contradicted managements conclusions. We involved a valuation specialist to assess the Companys Monte Carlo simulation model and to perform corroborative fair value calculations. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 21, 2020 90 | 2019 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2019 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2019 . 2019 Form 10-K | 91 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 92 | 2019 Form 10-K Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2019 and 2018 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 21, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 21, 2020 2019 Form 10-K | 93 " +3,abbv,1231x10k," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 15 to the Consolidated Financial Statements and the sales information related to HUMIRA, IMBRUVICA and MAVYRET included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 61% of AbbVie's total net revenues in 2018 . _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2018 Form 10-K | 1 Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is an oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive a United States Food and Drug Administration (FDA) approval after being granted a Breakthrough Therapy Designation and is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA. VENCLEXTA (venetoclax) is a BCL-2 inhibitor used to treat adults with CLL or SLL, with or without 17p deletion, who have received at least one prior treatment. In addition, VENCLEXTA is used in combination with azacitidine, or decitabine, or low-dose cytarabine to treat adults with newly-diagnosed acute myeloid leukemia (AML) who are 75 years of age or older or have other medical conditions that prevent the use of standard chemotherapy. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV. HCV products. AbbVie's HCV products are: MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. Additional Virology products. AbbVie's additional virology products include: SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by respiratory syncytial virus (RSV). KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as Aluvia in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. NORVIR. NORVIR (ritonavir) is a protease inhibitor that is indicated in combination with other antiretroviral agents for the treatment of HIV-1 infection. 2 | 2018 Form 10-K Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: ORILISSA. ORILISSA (elagolix) is the first and only orally-administered, nonpeptide small molecule gonadotropin-releasing hormone (GnRH) antagonist specifically developed for women with moderate to severe endometriosis pain. The FDA approved ORILISSA under priority review. It represents the first FDA-approved oral treatment for the management of moderate to severe pain associated with endometriosis in over a decade. ORILISSA inhibits endogenous GnRH signaling by binding competitively to GnRH receptors in the pituitary gland. Administration results in dose-dependent suppression of luteinizing hormone and follicle-stimulating hormone, leading to decreased blood concentrations of ovarian sex hormones, estradiol and progesterone. Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Sevoflurane. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2018 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2018 gross revenues in the United States. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's 2018 Form 10-K | 3 business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and many biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products. HUMIRA is now facing direct biosimilar competition in Europe and other countries, which represent approximately 75% of AbbVie's international HUMIRA business or approximately 25% of total global HUMIRA revenues. AbbVie will continue to face competitive pressure from these biologics and from orally administered products. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is more complex than the approval process for, and science behind, generic or other follow-on versions of small molecule products. Approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data, bioequivalence studies and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company, and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are often obtained early in the development process and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after 4 | 2018 Form 10-K regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days all existing exclusivities (patent and regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product is entitled upon its approval in any particular country. In certain instances, regulatory exclusivity may protect a product where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of regulatory exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to close regulatory scrutiny over, and more rigorous requirements for approval of, follow-on biosimilar products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2019 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent expired in October 2018 in the majority of European Union countries. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA) and those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. 2018 Form 10-K | 5 Licensing and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as licensing arrangements, option-to-license arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. These licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, option fees and option exercise payments (if applicable), milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. 6 | 2018 Form 10-K In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA and approved by the FDA prior to implementation. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials, patient registries, observational data or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States for approval and marketing of pharmaceutical products. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw 2018 Form 10-K | 7 materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of oversight, investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Political and budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of 8 | 2018 Form 10-K countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2019 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. Many governments are also following a similar path for biosimilar therapies. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic/biosimilar alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2018 were approximately $20 million and operating expenditures were approximately $31 million . In 2019 , capital expenditures for pollution control are estimated to be approximately $26 million and operating expenditures are estimated to be approximately $33 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. 2018 Form 10-K | 9 Employees AbbVie employed approximately 30,000 persons as of January 31, 2019. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic or biosimilar products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics, biosimilars or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs or biosimilars. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $19.9 billion in 2018 , expired in December 2016, and the equivalent European Union patent expired in the majority of European Union countries in October 2018. 10 | 2018 Form 10-K AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged or circumvented or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 61% of AbbVie's total net revenues in 2018 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA, the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of 2018 Form 10-K | 11 competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could and do compete with AbbVies biologic products, including HUMIRA. As competitors obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. 12 | 2018 Form 10-K New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market, and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product 2018 Form 10-K | 13 withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and 14 | 2018 Form 10-K field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls, or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States make up approximately 34% of AbbVie's total net revenues in 2018 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. 2018 Form 10-K | 15 If AbbVie does not effectively and profitably commercialize its products, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize its principal products by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient(s) for a product and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers AbbVie's products to its customers. The commercialization of AbbVie products may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow approved indications, the relative price of AbbVie's product as compared to alternative treatment options and changes to a product's label that further restrict its marketing. If the commercialization of AbbVie's principal products is unsuccessful, AbbVie's ability to generate revenue from product sales will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2018 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness or interest rates increase, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate 16 | 2018 Form 10-K funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated software applications and complex information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, disruption, degradation or breakdown. Data privacy or security breaches by employees or others may result in the failure of critical business operations or may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Such adverse consequences could include loss of revenue, or the loss of critical or sensitive information from AbbVies or third-party providers databases or IT systems and could also result in legal, financial, reputational or business harm to AbbVie and potentially substantial remediation costs. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. 2018 Form 10-K | 17 An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions, or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 18 | 2018 Form 10-K CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland Jayuya, Puerto Rico Ludwigshafen, Germany North Chicago, Illinois Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. 2018 Form 10-K | 19 "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (Symbol: ABBV). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Stockholders There were 48,516 stockholders of record of AbbVie common stock as of January 31, 2019 . Dividends On November 2, 2018 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $0.96 per share to $1.07 per share, payable on February 15, 2019 to stockholders of record as of January 15, 2019. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index for the period from December 31, 2013 through December 31, 2018 . This graph assumes $100 was invested in AbbVie common stock and each index on December 31, 2013 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. 2018 Form 10-K | 23 This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2018 - October 31, 2018 4,246 (1) $ 88.24 (1) $ 1,500,000,050 November 1, 2018 - November 30, 2018 17,119,956 (1) $ 87.62 (1) 17,118,625 $ 8,924 December 1, 2018 - December 31, 2018 8,546,698 (1) $ 87.89 (1) 8,533,255 $ 4,250,016,122 (2) Total 25,670,900 (1) $ 87.71 (1) 25,651,880 $ 4,250,016,122 (2) 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 4,246 in October; 1,331 in November; and 13,443 in December. These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. 2. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing stock repurchase program. The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. 24 | 2018 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2018 and 2017 and results of operations for each of the three years in the period ended December 31, 2018 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; pain associated with endometriosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 30,000 employees. AbbVie operates in one business segmentpharmaceutical products. 2018 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2018 included delivering worldwide net revenues of $32.8 billion , operating earnings of $6.4 billion , diluted earnings per share of $3.66 and cash flows from operations of $13.4 billion . Worldwide net revenues grew by 16% , or 15% on a constant currency basis, driven primarily by revenue growth related to MAVYRET, IMBRUVICA and VENCLEXTA, and the continued strength of HUMIRA. Diluted earnings per share in 2018 was $3.66 and included the following after-tax costs: (i) a Stemcentrx-related impairment charge of $4.1 billion net of the related fair value adjustment to contingent consideration liabilities; (ii) $1.1 billion of intangible asset amortization; (iii) $500 million as a result of a collaboration agreement extension with Calico Life Sciences LLC (Calico); (iv) $424 million for acquired in-process research and development (IPRD); (v) $478 million for the change in fair value of contingent consideration liabilities excluding the fair value adjustment associated with the Stemcentrx-related impairment; (vi) litigation reserve charges of $282 million ; (vii) charitable contributions of $271 million as part of AbbVie's previously announced plan to make contributions to U.S. not-for-profit organizations in 2018; and (viii) milestone payments of $137 million . 2018 financial results were also impacted by U.S. tax reform and the timing of the new legislation's phase in on certain subsidiaries. Additionally, financial results reflected continued added funding to support all stages of AbbVies emerging pipeline assets and continued investment in AbbVies growth brands. In November 2018 , AbbVie's board of directors declared a quarterly cash dividend of $1.07 per share of common stock payable in February 2019 . This reflected an increase of approximately 11.5% over the previous quarterly dividend of $0.96 per share of common stock. 26 | 2018 Form 10-K 2019 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, driving late-stage pipeline assets to the market and ensuring strong commercial execution of new product launches; (ii) continued investment and expansion in its pipeline in support of opportunities in immunology, oncology and neuroscience, with additional targeted investment in cystic fibrosis and women's health as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via dividends and share repurchases. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next twelve months. AbbVie expects to achieve its strategic objectives through: Hematologic oncology revenue growth from both IMBRUVICA and VENCLEXTA. The strong execution of new product launches across multiple therapeutic areas. HUMIRA U.S. sales growth by driving biologic penetration across disease categories and maintaining market leadership. Effective management of HUMIRA international biosimilar erosion. The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2019. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, the reduction of HUMIRA royalty expense, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neuroscience along with targeted investments in cystic fibrosis and women's health. Of these programs, more than 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next twelve months. Significant Programs and Developments Immunology Upadacitinib In January 2018, the U.S. Food and Drug Administration (FDA) granted breakthrough therapy designation for upadacitinib, an investigational oral JAK1-selective inhibitor, in adult patients with moderate to severe atopic dermatitis who are candidates for systemic therapy. In April 2018, AbbVie announced that top-line results from the Phase 3 SELECT-COMPARE clinical trial evaluating upadacitinib met all primary and ranked secondary endpoints in patients with moderate to severe rheumatoid arthritis (RA) who are on a stable background of methotrexate and who have an inadequate response. The safety profile of upadacitinib was consistent with previously reported clinical trials and no new safety signals were detected. 2018 Form 10-K | 27 In June 2018, AbbVie announced that top-line results from the Phase 3 SELECT-EARLY clinical trial evaluating upadacitinib versus methotrexate in adult patients with moderate to severe RA who were methotrexate-nave met all primary and ranked secondary endpoints. The safety profile of upadacitinib was consistent with previously reported clinical trials and no new safety signals were detected. In July 2018, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of upadacitinib in subjects with moderate to severe atopic dermatitis. In September 2018, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy and safety of upadacitinib in subjects with moderate to severe ulcerative colitis. In December 2018, AbbVie submitted a New Drug Application (NDA) to the FDA and a marketing authorisation application (MAA) to the European Medicines Agency (EMA) for upadacitinib for the treatment of adult patients with moderate to severe RA. Risankizumab In January 2018, AbbVie initiated two Phase 3 clinical trials to evaluate the efficacy and safety of risankizumab, an investigational interleukin-23 (IL-23) inhibitor, versus placebo during induction therapy in subjects with moderately to severely active Crohns disease. In February 2018, AbbVie announced that top-line results from two Phase 3 clinical trials evaluating risankizumab with 12-week dosing compared to ustekinumab met ranked additional secondary endpoints for the treatment of patients with moderate to severe chronic plaque psoriasis. The initial results from these clinical trials were previously announced in October 2017. The safety profile was consistent with all previously reported studies, and there were no new safety signals detected across the two studies. In April 2018, AbbVie submitted a Biologics License Application (BLA) to the FDA and an MAA to the EMA for risankizumab for the treatment of plaque psoriasis in adults. In May 2018, AbbVie initiated a Phase 2b/3 clinical trial to evaluate the efficacy and safety of risankizumab versus placebo in subjects with moderately to severely active ulcerative colitis. Oncology IMBRUVICA In April 2018, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and efficacy of IMBRUVICA in combination with VENCLEXTA versus chlorambucil plus GAZYVA (obinutuzumab) for the first-line treatment of subjects with chronic lymphocytic leukemia (CLL)/small lymphocytic lymphoma (SLL). In May 2018, AbbVie announced that results from the Phase 3 iLLUMINATE study evaluating IMBRUVICA in combination with GAZYVA in previously untreated CLL/SLL met its primary endpoint. In December 2018, AbbVie announced additional results from the Phase 3 iLLUMINATE study that demonstrated significantly prolonged progression-free survival (PFS). In June 2018, AbbVie announced that results from an interim analysis of the Phase 3 iNNOVATE study evaluating IMBRUVICA plus Rituxan (rituximab) in previously untreated and relapsed/refractory (R/R) patients with Waldenstrms macroglobulinemia (WM) met its primary endpoint. In July 2018, AbbVie announced that results from a Phase 3 study evaluating the addition of IMBRUVICA to a chemotherapy regimen consisting of five different agents used in combination did not meet its primary endpoint in a subset of untreated diffuse large B-cell lymphoma patients identified to have the non-germinal center B-cell or activated B-cell subtypes of this disease. In August 2018, the FDA approved IMBRUVICA, in combination with Rituxan, for the treatment of adult patients with WM. In December 2018, AbbVie announced that results from an interim analysis of the Phase 3 ECOG1912E study evaluating IMBRUVICA in combination with Rituxan versus the chemoimmunotherapy FCR (fludarabine, cyclophosphamide and rituximab) in previously untreated and younger CLL patients met its primary endpoint. In January 2019, AbbVie announced an update on the Phase 3 RESOLVE study evaluating IMBRUVICA in combination with nab-paclitaxel and gemcitabine versus nab-paclitaxel and gemcitabine combination in patients 28 | 2018 Form 10-K with metastatic pancreatic adenocarcinoma. Results showed the study did not meet its primary endpoint of improving PFS or overall survival (OS) benefit among the study population. Safety data collected from the study were consistent with the existing safety information for the study therapies. In January 2019, the FDA approved IMBRUVICA, in combination with GAZYVA, for adult patients with previously untreated CLL/SLL. VENCLEXTA In January 2018, AbbVie submitted an sNDA to the FDA for VENCLEXTA monotherapy in patients with CLL who are refractory to or have relapsed B-cell receptor pathway inhibitors. In June 2018, the FDA approved VENCLEXTA in combination with Rituxan for the treatment of patients with CLL/SLL, with or without 17p deletion, who have received at least one prior therapy. VENCLEXTA plus Rituxan is the first oral-based, chemotherapy-free combination in CLL that allows patients an option for fixed treatment duration. In September 2018, the FDA expanded the label for VENCLEXTA in combination with Rituxan to include information about patients with previously-treated CLL who achieved minimal residual disease (MRD)-negativity in the Phase 3 MURANO trial. In October 2018, the European Commission approved the type-II variation application for VENCLYXTO in combination with Rituxan for the treatment of patients with R/R CLL who have received at least one prior therapy. In November, AbbVie received notification from the European Commission that conditions of the original conditional marketing authorisation have been fulfilled, granting VENCLYXTO official receipt of approval. In October 2018, AbbVie announced that the results from the Phase 3 CLL14 study comparing the efficacy and safety of VENCLEXTA plus obinutuzumab versus obinutuzumab plus chlorambucil in previously untreated patients with CLL and coexisting medical conditions met its primary endpoint. In November 2018, the FDA granted accelerated approval for VENCLEXTA in combination with azacitidine, or decitabine, or low dose cytarabine (LDAC) for the treatment of newly-diagnosed acute myeloid leukemia (AML) in adults who are age 75 years or older, or who have comorbidities that preclude use of intensive induction chemotherapy. This indication is approved under accelerated approval based on response rates. Continued approval for this indication may be contingent upon verification and description of clinical benefit in confirmatory trials. Rova-T In March 2018, AbbVie announced top-line results from the Phase 2 TRINITY study evaluating rovalpituzumab tesirine (Rova-T) for third-line R/R small cell lung cancer (SCLC). Although Rova-T demonstrated single agent responses in advanced SCLC patients, after consulting with the FDA, based on the magnitude of effect across multiple parameters in this single-arm study, the company will not seek accelerated approval for Rova-T in third-line R/R SCLC. In December 2018, AbbVie announced the decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating Rova-T as a second-line therapy for advanced SCLC. An Independent Data Monitoring Committee recommended stopping enrollment in TAHOE due to shorter overall survival in the Rova-T arm compared with the topotecan control arm. AbbVie will continue its ongoing Phase 3 study of Rova-T in first-line SCLC. Other In November 2018, Bristol-Myers Squibb Company (BMS) announced that the FDA expanded the label for Empliciti in combination with pomalidomide and dexamethasone for the treatment of adult patients with multiple myeloma who have received at least two prior therapies. BMS and AbbVie are co-developing Empliciti, with BMS solely responsible for commercial activities. 2018 Form 10-K | 29 Virology/Liver Disease In November 2018, AbbVie presented EXPEDITION 8 data at the Annual Meeting of the American Association for the Study of Liver Diseases (AASLD), in which 8 weeks of MAVYRET in treatment nave, cirrhotic patients was safe and effective with no virologic failures reported. Neuroscience In March 2018, Biogen and AbbVie announced the voluntary worldwide withdrawal of marketing authorizations for ZINBRYTA, a prescription medicine used to treat adults with relapsing forms of multiple sclerosis. Other In February 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-I study evaluating elagolix, an investigational, orally administered gonadotropin-releasing hormone (GnRH) antagonist, being investigated in combination with low-dose hormone (add-back) therapy for uterine fibroids met its primary efficacy endpoint and all ranked secondary endpoints. In March 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-II study evaluating elagolix in combination with low-dose hormone (add-back) therapy for uterine fibroids met its primary efficacy endpoint and all ranked secondary endpoints. In July 2018, the FDA approved ORILISSA (elagolix) for the management of moderate to severe pain associated with endometriosis. In August 2018, AbbVie announced that top-line results from the Phase 3 ELARIS UF-EXTEND study evaluating elagolix in combination with low-dose hormone (add-back) therapy for uterine fibroids were consistent with findings observed in the ELARIS UF-I and ELARIS UF-II Phase 3 studies. In October 2018, AbbVie announced that it will assume full development and commercial responsibility for its collaboration with Galapagos to discover and develop new therapies to treat cystic fibrosis (CF). Under a revised agreement, AbbVie will assume full development and commercial responsibility over the investigational program comprising several clinical and pre-clinical compounds originally discovered and developed jointly by AbbVie and Galapagos. Galapagos will not pursue further research and development in CF, but is eligible for future milestones and royalties on commercialized programs. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates for the years ended (dollars in millions) United States $ 21,524 $ 18,251 $ 15,947 17.9 % 14.4 % 17.9 % 14.4 % International 11,229 9,965 9,691 12.8 % 2.8 % 10.4 % 2.1 % Net revenues $ 32,753 $ 28,216 $ 25,638 16.1 % 10.1 % 15.2 % 9.8 % 30 | 2018 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates years ended December 31 (dollars in millions) Immunology HUMIRA United States $ 13,685 $ 12,361 $ 10,432 10.7 % 18.5 % 10.7 % 18.5 % International 6,251 6,066 5,646 3.1 % 7.4 % 0.6 % 6.7 % Total $ 19,936 $ 18,427 $ 16,078 8.2 % 14.6 % 7.4 % 14.4 % Hematologic Oncology IMBRUVICA United States $ 2,968 $ 2,144 $ 1,580 38.4 % 35.8 % 38.4 % 35.8 % Collaboration revenues 45.0 % 70.0 % 45.0 % 70.0 % Total $ 3,590 $ 2,573 $ 1,832 39.5 % 40.5 % 39.5 % 40.5 % VENCLEXTA United States $ $ $ 100.0% 100.0% 100.0% 100.0% International 100.0% 100.0% 100.0% 100.0% Total $ $ $ 100.0% 100.0% 100.0% 100.0% HCV MAVYRET United States $ 1,614 $ $ 100.0% n/m 100.0% n/m International 1,824 100.0% n/m 100.0% n/m Total $ 3,438 $ $ 100.0% n/m 100.0% n/m VIEKIRA United States $ $ $ (96.7 )% (82.8 )% (96.7 )% (82.8 )% International 1,180 (75.6 )% (38.7 )% (74.8 )% (38.6 )% Total $ $ $ 1,522 (77.2 )% (48.6 )% (76.5 )% (48.5 )% Other Key Products Creon United States $ $ $ 11.7 % 13.9 % 11.7 % 13.9 % Lupron United States $ $ $ 8.6 % 0.8 % 8.6 % 0.8 % International 3.4 % 1.4 % 4.7 % 0.5 % Total $ $ $ 7.6 % 0.9 % 7.9 % 0.7 % Synthroid United States $ $ $ (0.6 )% 2.3 % (0.6 )% 2.3 % Synagis International $ $ $ (1.6 )% 1.2 % (2.8 )% 0.6 % AndroGel United States $ $ $ (18.8 )% (14.5 )% (18.8 )% (14.5 )% Duodopa United States $ $ $ 31.4 % 66.1 % 31.4 % 66.1 % International 19.1 % 14.6 % 14.8 % 13.1 % Total $ $ $ 21.2 % 21.1 % 17.7 % 19.8 % Sevoflurane United States $ $ $ (6.2 )% (2.1 )% (6.2 )% (2.1 )% International (4.4 )% (4.6 )% (4.3 )% (3.7 )% Total $ $ $ (4.7 )% (4.1 )% (4.6 )% (3.4 )% Kaletra United States $ $ $ (22.1 )% (38.6 )% (22.1 )% (38.6 )% International (20.2 )% (18.8 )% (20.1 )% (21.1 )% Total $ $ $ (20.5 )% (22.9 )% (20.4 )% (24.7 )% All other $ $ $ 1,199 (63.6 )% (26.9 )% (71.9 )% (27.9 )% Total net revenues $ 32,753 $ 28,216 $ 25,638 16.1 % 10.1 % 15.2 % 9.8 % n/m Not meaningful 2018 Form 10-K | 31 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales increased 7% in 2018 and 14% in 2017 . The sales increases in 2018 and 2017 were driven primarily by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. In the United States, HUMIRA sales increased 11% in 2018 and 18% in 2017 . The sales increase in 2018 and 2017 was driven by market growth across all indications and favorable pricing. Internationally, HUMIRA revenues increased 1% in 2018 and 7% in 2017 . The sales increase in 2018 was driven primarily by market growth across indications partially offset by direct biosimilar competition in Europe following the expiration of the European Union composition of matter patent for adalimumab in October 2018. Due to the entry of biosimilar competition, AbbVie expects international HUMIRA net revenues to decline in 2019. Biosimilar competition for HUMIRA is not expected in the United States until 2023. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability of HUMIRA. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. AbbVie's global IMBRUVICA revenues increased 39% in 2018 and 40% in 2017 as a result of continued penetration of IMBRUVICA as a first-line treatment for patients with CLL as well as favorable pricing. Net revenues for VENCLEXTA increased by more than 100% in 2018 primarily due to market share gains following FDA and EMA approvals of VENCLEXTA in combination with Rituxan for certain patients with R/R CLL. Global MAVYRET sales increased by more than 100% in 2018 as a result of market share gains following the FDA and EMA approvals of MAVYRET in the second half of 2017 as well as further geographic expansion in 2018. Global VIEKIRA sales decreased by 76% in 2018 and 49% in 2017 primarily due to lower market share following the launch of MAVYRET. Net revenues for Creon increased 12% in 2018 and 14% in 2017 , driven primarily by continued market growth, higher market share and favorable pricing. Creon maintains market leadership in the pancreatic enzyme market. AndroGel net revenues decreased 19% in 2018 and 14% in 2017 primarily due to market contraction and the entry of generic competition for the AndroGel 1.62% formulation in October 2018. AbbVie expects net revenues for AndroGel to continue to decline in 2019. Net revenues for Duodopa increased 18% in 2018 and 20% in 2017 , primarily as a result of market penetration. Gross Margin Percent change years ended December 31 (dollars in millions) Gross margin $ 25,035 $ 21,174 $ 19,806 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2018 increased from 2017 primarily due to the reduction of HUMIRA royalty expense and a 2017 intangible asset impairment charge of $354 million partially offset by the IMBRUVICA profit sharing arrangement. Gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017, as well as the unfavorable impacts of higher intangible asset amortization and the IMBRUVICA profit sharing arrangement. These drivers were partially offset by lower amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics as well as favorable changes in product mix and operational efficiencies. Selling, General and Administrative Percent change years ended December 31 (dollars in millions) Selling, general and administrative $ 7,399 $ 6,295 $ 5,881 % % as a percent of net revenues % % % Selling, general and administrative (SGA) expenses as a percentage of net revenues in 2018 increased from 2017 primarily due to the unfavorable impacts of new product launch expenses and charitable contributions of $350 million to 32 | 2018 Form 10-K select U.S. not-for-profit organizations in 2018 as part of AbbVie's previously announced plan partially offset by continued leverage from revenue growth. SGA expense percentage in 2017 decreased from 2016 . SGA expense percentage in 2017 was favorably impacted by continued leverage from revenue growth partially offset by litigation reserves charges that increased by $370 million in 2017 compared to the prior year and new product launch expenses. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 10,329 $ 5,007 $ 4,385 100% % as a percent of net revenues % % % Acquired in-process research and development $ $ $ % % Research and Development (RD) expenses in 2018 increased from 2017 principally due to a $5.1 billion intangible asset impairment charge related to IPRD acquired as part of the 2016 Stemcentrx acquisition following the decision to stop enrollment in the TAHOE trial. The impairment was primarily due to lower probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. The remaining increase reflected greater funding to support all stages of the company's pipeline assets. See Note 7 to the Consolidated Financial Statements for additional information regarding the impairment charge. RD expenses in 2017 increased from 2016 principally due to increased funding to support all stages of the companys pipeline assets, the impact of the post-acquisition RD expenses of Stemcentrx and Boehringer Ingelheim (BI) compounds and an increase in development milestones of $63 million . These factors were partially offset by a decrease in acquisition related costs of $135 million . Acquired IPRD expenses reflect upfront payments related to various collaborations. There were no individually significant transactions or cash flows during 2018. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. There were no individually significant transactions or cash flows during 2016. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector agreement. Other Operating Expenses Other operating expenses in 2018 included a $500 million charge related to the extension of the previously announced Calico collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,348 $ 1,150 $ 1,047 Interest income (204 ) (146 ) (82 ) Interest expense, net $ 1,144 $ 1,004 $ Net foreign exchange loss $ $ $ Other expense, net Interest expense in 2018 increased compared to 2017 primarily due to the unfavorable impact of higher interest rates on the company's debt obligations and a higher average outstanding debt balance during 2018. Interest expense in 2017 increased compared to 2016 due to a full year of expense associated with the May 2016 issuance of $7.8 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Stemcentrx and to repay an outstanding term loan. Interest income in 2018 increased compared to 2017 primarily due to higher interest rates. Interest income in 2017 increased compared to 2016 primarily due to growth in the companys investment securities. 2018 Form 10-K | 33 Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Net foreign exchange loss in 2016 included losses totaling $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. See Note 10 to the Consolidated Financial Statements for additional information regarding the Venezuelan devaluation. Other expense, net included charges related to the change in fair value of the BI and Stemcentrx contingent consideration liabilities of $49 million in 2018 , $626 million in 2017 and $228 million in 2016 . The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2018 , the BI contingent consideration liability increased due to the passage of time and higher estimated future sales partially offset by the effect of rising interest rates. The increase in the BI contingent consideration liability was primarily offset by a $428 million decrease in the Stemcentrx contingent consideration liability recorded during the fourth quarter of 2018 due to a reduction in probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets obtained in the acquisition. In 2017 , the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. In 2016 , the change in fair value represented mainly the passage of time, as increases to the BI contingent consideration liability due to higher probabilities of success were fully offset by the effects of rising interest rates and changes in other market-based assumptions. See Note 5 to the Consolidated Financial Statements for additional information regarding the acquisitions of Stemcentrx and BI compounds. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million. Income Tax Expense The effective income tax rate was negative 9% in 2018 , was 31% in 2017 and was 24% in 2016 . The effective tax rate in each period differed from the statutory tax rate principally due to the allocation of the company's taxable earnings among jurisdictions, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, and business development activities. The effective tax rate for 2018 reflects the impact of the effective date of provisions of the Tax Cuts and Jobs Act (the Act) related to the earnings from certain foreign subsidiaries and the effects of Stemcentrx intangible impairment related expenses. Given these factors, the effective income tax rate may change significantly in future periods. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. The Act significantly changed the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system that included new taxes on certain foreign sourced earnings. See Note 13 to the Consolidated Financial Statements for additional information regarding the Act. The effective tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 13,427 $ 9,960 $ 7,041 Investing activities (1,006 ) (274 ) (6,074 ) Financing activities (14,396 ) (5,512 ) (3,928 ) Operating cash flows in 2018 increased from 2017 primarily due to improved results of operations from revenue growth and a decrease in income tax payments. Operating cash flows in 2017 increased from 2016 primarily due to improved results of operations resulting from revenue growth, an improvement in operating earnings and a decrease in income tax payments. Realized excess tax benefits associated with stock-based compensation totaled $78 million in 2018 and $71 million in 2017 and were presented within operating cash flows as a result of the adoption of a new accounting pronouncement. Prior to the adoption of the new accounting pronouncement, realized excess benefits of $55 million in 2016 were presented within cash flows from financing activities. Operating cash flows also reflected AbbVies contributions to its defined benefit plans of $873 million in 2018, $246 million in 2017 and $273 million in 2016. 34 | 2018 Form 10-K Investing cash flows in 2018 included payments made for other acquisitions and investments of $736 million and capital expenditures of $638 million , partially offset by net sales and maturities of investment securities totaling $368 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Investing cash flows in 2016 primarily included $1.9 billion of cash consideration paid to acquire Stemcentrx in June 2016, a $595 million upfront payment to acquire certain rights from BI in April 2016, net purchases of investment securities totaling $3.0 billion and capital expenditures of $479 million . In 2018 , 2017 and 2016 , the company issued and redeemed commercial paper. The balance of commercial paper outstanding was $699 million as of December 31, 2018 and $400 million as of December 31, 2017 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. Financing cash flows in 2018 also included proceeds from the issuance of a $3.0 billion 364 -day term loan credit agreement (term loan) entered into in May 2018 . In June 2018, the company drew on this term loan and as of December 31, 2018 , $3.0 billion was outstanding and was included in short-term borrowings on the consolidated balance sheet. Borrowings under the term loan bear interest at one month LIBOR plus applicable margin. The term loan may be prepaid without penalty upon prior notice and contains customary covenants, all of which the company was in compliance with as of December 31, 2018 . In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three-year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. The company intends to use the remaining proceeds to repay term loan obligations in 2019 as they become due. Financing cash flows in 2018 also included the May 2018 repayment of $3.0 billion aggregate principal amount of the company's 1.80% senior notes at maturity. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. In May 2016, the company issued $7.8 billion aggregate principal amount of senior notes. Approximately $2.0 billion of the net proceeds were used to repay an outstanding term loan that was due to mature in November 2016, approximately $1.9 billion of the net proceeds were used to finance the acquisition of Stemcentrx and approximately $3.8 billion of the net proceeds were used to finance an accelerated share repurchase (ASR). See Note 12 to the Consolidated Financial Statements for additional information on the 2016 ASR transaction. Cash dividend payments totaled $5.6 billion in 2018 , $4.1 billion in 2017 and $3.7 billion in 2016 . The increase in cash dividend payments was primarily driven by an increase in the dividend rate. On November 2, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.96 per share to $1.07 per share beginning with the dividend payable on February 15, 2019 to stockholders of record as of January 15, 2019. This reflects an increase of approximately 11.5% over the previous quarterly rate. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. The new stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Under this authorization, AbbVie repurchased approximately 109 million shares for $10.7 billion in 2018. AbbVie cash-settled $201 million of its December 2018 open market purchases in January 2019. AbbVie's remaining stock repurchase authorization was $4.3 billion as of December 31, 2018 . Under previous stock repurchase programs, AbbVie made open market share repurchases of approximately 11 million shares for $1.3 billion in 2018, approximately 13 million shares for $1.0 billion in 2017 and approximately 34 million shares for $2.1 billion in 2016 . AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017 and cash-settled $300 million of its December 2015 open market purchases in January 2016. In 2018, AbbVie paid $100 million of contingent consideration to BI related to BLA and MAA acceptance milestones. $78 million of these payments were included in financing cash flows and $22 million of the payments were included in operating cash flows. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. 2018 Form 10-K | 35 Cash and equivalents were impacted by net unfavorable exchange rate changes totaling $39 million in 2018 , net favorable exchange rate changes totaling $29 million in 2017 and net unfavorable exchange rate changes totaling $338 million in 2016 . The unfavorable exchange rate changes in 2018 were primarily due to the weakening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The favorable exchange rate changes in 2017 were primarily due to the strengthening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The unfavorable exchange rate changes in 2016 were primarily due to the devaluation of AbbVie's net monetary assets denominated in the Venezuelan bolivar. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. Credit Facility, Access to Capital and Credit Ratings Credit Facility In August 2018, AbbVie replaced its existing revolving credit facility with a new $3.0 billion five -year revolving credit facility. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2018 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. No amounts were outstanding under the credit facility as of December 31, 2018 and 2017 . Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes in the companys credit ratings during 2018 . Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt obligations. Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2018 : (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ 3,699 $ 3,699 $ $ $ Long-term debt and capital lease obligations, including current portion 37,360 1,612 6,808 6,370 22,570 Interest on long-term debt (a) 17,204 1,433 2,613 2,024 11,134 Future minimum non-cancelable operating lease commitments Purchase obligations and other (b) 1,843 1,710 Other long-term liabilities (c) (d) (e) (f) 9,994 1,392 1,478 6,388 Total $ 70,909 $ 9,306 $ 11,128 $ 10,038 $ 40,437 36 | 2018 Form 10-K (a) Includes estimated future interest payments on long-term debt and capital lease obligations. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2018 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2018 . See Note 9 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 10 for additional information on the interest rate swap agreements outstanding at December 31, 2018 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Amounts less than one year includes a voluntary contribution of $150 million that AbbVie made to its principal domestic defined benefit plan subsequent to December 31, 2018 . Amounts otherwise exclude pension and other post-employment benefits and related deferred compensation cash outflows. Timing of future funding is uncertain and dependent on future movements in interest rates and investment returns, changes in laws and regulations and other variables. Also included in this amount are components of other long-term liabilities including restructuring. See Note 8 to the Consolidated Financial Statements for additional information on restructuring and Note 11 for additional information on the pension and other post-employment benefit plans. (d) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 13 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (e) Includes $4.5 billion of contingent consideration liabilities primarily related to the acquisition of BI compounds which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Notes 5 and 10 to the Consolidated Financial Statements for additional information regarding these liabilities. (f) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 13 to the Consolidated Financial Statements for additional information regarding these tax liabilities. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. 2018 Form 10-K | 37 Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $16.4 billion in 2018 , $12.9 billion in 2017 and $10.8 billion in 2016 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 91% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2018 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2015 $ 1,032 $ $ Provisions 2,606 3,146 3,987 Payments (2,471 ) (2,899 ) (3,967 ) Balance at December 31, 2016 1,167 1,167 Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 1,340 1,195 Provisions 3,493 4,729 6,659 Payments (3,188 ) (4,485 ) (6,525 ) Balance at December 31, 2018 $ 1,645 $ 1,439 $ Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.6 billion in 2018 , $1.3 billion in 2017 and $964 million in 2016 , are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates, and are disclosed in Note 11 to the Consolidated Financial Statements . 38 | 2018 Form 10-K The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. Beginning in 2016, AbbVie also reflected the plans' specific cash flows and applied them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2018 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2019 and projected benefit obligations as of December 31, 2018 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (54 ) $ Projected benefit obligation (512 ) Other post-employment plans Service and interest cost $ (2 ) $ Projected benefit obligation (47 ) The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2018 and will be used in the calculation of net periodic benefit cost in 2019 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2019 by $62 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2018 and will be used in the calculation of net periodic benefit cost in 2019 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2019 and the projected benefit obligation as of December 31, 2018 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (9 ) Projected benefit obligation (87 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 14 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum 2018 Form 10-K | 39 loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and could potentially impact the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2018 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $160 million . Additionally, at December 31, 2018 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $420 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 40 | 2018 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2018 and 2017 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,660 1.157 $ $ 6,366 1.175 $ (88 ) Japanese yen 1,076 111.5 (12 ) 112.4 British pound 1.328 1.310 (22 ) All other currencies 1,776 n/a 1,877 n/a (18 ) Total $ 10,011 $ $ 9,943 $ (126 ) The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.0 billion at December 31, 2018 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes, which are exposed to foreign currency risk. The company has designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 9 to the Consolidated Financial Statements for additional information related to the senior Euro note issuance and Note 10 to the Consolidated Financial Statements for additional information related to the net investment hedging program. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $403 million at December 31, 2018 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $2.4 billion at December 31, 2018 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. Market Price Risk AbbVies debt securities investment portfolio (the portfolio) is its main exposure to market price risk. The portfolio is subject to changes in fair value as a result of interest rate fluctuations and other market factors. It is AbbVies policy to mitigate market price risk by maintaining a diversified portfolio that limits the amount of exposure to a particular issuer and security type while placing limits on the amount of time to maturity. AbbVies investment policy limits investments to investment grade credit ratings. The company estimates that an increase in interest rates of 100 basis points would decrease the fair value of the portfolio by approximately $16 million as of December 31, 2018 . If the portfolio were to be liquidated, the fair value reduction would affect the statement of earnings in the period sold. 2018 Form 10-K | 41 "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 42 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 32,753 $ 28,216 $ 25,638 Cost of products sold 7,718 7,042 5,832 Selling, general and administrative 7,399 6,295 5,881 Research and development 10,329 5,007 4,385 Acquired in-process research and development Other expense Total operating costs and expenses 26,370 18,671 16,298 Operating earnings 6,383 9,545 9,340 Interest expense, net 1,144 1,004 Net foreign exchange loss Other expense, net Earnings before income taxes 5,197 7,727 7,884 Income tax expense (benefit) (490 ) 2,418 1,931 Net earnings $ 5,687 $ 5,309 $ 5,953 Per share data Basic earnings per share $ 3.67 $ 3.31 $ 3.65 Diluted earnings per share $ 3.66 $ 3.30 $ 3.63 Weighted-average basic shares outstanding 1,541 1,596 1,622 Weighted-average diluted shares outstanding 1,546 1,603 1,631 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 43 AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 5,687 $ 5,309 $ 5,953 Foreign currency translation adjustments, net of tax expense (benefit) of $(18) in 2018, $34 in 2017 and $(31) in 2016 (391 ) (165 ) Net investment hedging activities, net of tax expense (benefit) of $40 in 2018, $(194) in 2017 and $79 in 2016 (343 ) Pension and post-employment benefits, net of tax expense (benefit) of $35 in 2018, $(94) in 2017 and $(75) in 2016 (406 ) (135 ) Marketable security activities, net of tax expense (benefit) of $ in 2018, $(8) in 2017 and $(11) in 2016 (10 ) (46 ) (1 ) Cash flow hedging activities, net of tax expense (benefit) of $23 in 2018, $(26) in 2017 and $18 in 2016 (342 ) Other comprehensive income (loss) (141 ) (25 ) Comprehensive income $ 5,934 $ 5,168 $ 5,928 The accompanying notes are an integral part of these consolidated financial statements. 44 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 7,289 $ 9,303 Short-term investments Accounts receivable, net 5,384 5,088 Inventories 1,605 1,605 Prepaid expenses and other 1,895 4,741 Total current assets 16,945 21,223 Investments 1,420 2,090 Property and equipment, net 2,883 2,803 Intangible assets, net 21,233 27,559 Goodwill 15,663 15,785 Other assets 1,208 1,326 Total assets $ 59,352 $ 70,786 Liabilities and Equity Current liabilities Short-term borrowings $ 3,699 $ Current portion of long-term debt and lease obligations 1,609 6,015 Accounts payable and accrued liabilities 11,931 10,226 Total current liabilities 17,239 16,641 Long-term debt and lease obligations 35,002 30,953 Deferred income taxes 1,067 2,490 Other long-term liabilities 14,490 15,605 Commitments and contingencies Stockholders equity (deficit) Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,776,510,871 shares issued as of December 31, 2018 and 1,768,738,550 as of December 31, 2017 Common stock held in treasury, at cost, 297,686,473 shares as of December 31, 2018 and 176,607,525 as of December 31, 2017 (24,108 ) (11,923 ) Additional paid-in-capital 14,756 14,270 Retained earnings 3,368 5,459 Accumulated other comprehensive loss (2,480 ) (2,727 ) Total stockholders equity (deficit) (8,446 ) 5,097 Total liabilities and equity $ 59,352 $ 70,786 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 45 AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2015 1,610 $ $ (8,839 ) $ 13,080 $ 2,248 $ (2,561 ) $ 3,945 Net earnings 5,953 5,953 Other comprehensive loss, net of tax (25 ) (25 ) Dividends declared (3,823 ) (3,823 ) Common shares issued to Stemcentrx stockholders 3,958 (35 ) 3,923 Purchases of treasury stock (94 ) (6,018 ) (6,018 ) Stock-based compensation plans and other Balance at December 31, 2016 1,593 (10,852 ) 13,678 4,378 (2,586 ) 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax (141 ) (141 ) Dividends declared (4,221 ) (4,221 ) Purchases of treasury stock (15 ) (1,125 ) (1,125 ) Stock-based compensation plans and other (7 ) Balance at December 31, 2017 1,592 (11,923 ) 14,270 5,459 (2,727 ) 5,097 Adoption of new accounting standards (a) (1,733 ) (1,733 ) Net earnings 5,687 5,687 Other comprehensive income, net of tax Dividends declared (6,045 ) (6,045 ) Purchases of treasury stock (121 ) (12,215 ) (12,215 ) Stock-based compensation plans and other Balance at December 31, 2018 1,479 $ $ (24,108 ) $ 14,756 $ 3,368 $ (2,480 ) $ (8,446 ) (a) See Note 2 for additional information regarding the cumulative effect of the adoption of accounting standards in 2018. The accompanying notes are an integral part of these consolidated financial statements. 46 | 2018 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 5,687 $ 5,309 $ 5,953 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,294 1,076 Change in fair value of contingent consideration liabilities Stock-based compensation Upfront costs and milestones related to collaborations 1,061 Devaluation loss related to Venezuela Intangible asset impairment 5,070 Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (591 ) (391 ) (71 ) Inventories (226 ) (38 ) Prepaid expenses and other assets (499 ) (118 ) (393 ) Accounts payable and other liabilities (1,187 ) Cash flows from operating activities 13,427 9,960 7,041 Cash flows from investing activities Acquisition of businesses, net of cash acquired (2,495 ) Other acquisitions and investments (736 ) (308 ) (262 ) Acquisitions of property and equipment (638 ) (529 ) (479 ) Purchases of investment securities (1,792 ) (2,230 ) (5,315 ) Sales and maturities of investment securities 2,160 2,793 2,359 Other Cash flows from investing activities (1,006 ) (274 ) (6,074 ) Cash flows from financing activities Net change in commercial paper borrowings (23 ) Proceeds from issuance of other short-term borrowings 3,002 Proceeds from issuance of long-term debt 5,963 11,627 Repayments of long-term debt and lease obligations (6,035 ) (25 ) (6,010 ) Debt issuance costs (40 ) (69 ) Dividends paid (5,580 ) (4,107 ) (3,717 ) Purchases of treasury stock (12,014 ) (1,410 ) (6,033 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities (78 ) (268 ) Other, net Cash flows from financing activities (14,396 ) (5,512 ) (3,928 ) Effect of exchange rate changes on cash and equivalents (39 ) (338 ) Net change in cash and equivalents (2,014 ) 4,203 (3,299 ) Cash and equivalents, beginning of year 9,303 5,100 8,399 Cash and equivalents, end of year $ 7,289 $ 9,303 $ 5,100 Other supplemental information Interest paid, net of portion capitalized $ 1,215 $ 1,099 $ Income taxes paid (received) (35 ) 1,696 3,563 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 3,923 The accompanying notes are an integral part of these consolidated financial statements. 2018 Form 10-K | 47 AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when control of promised goods or services is transferred to the companys customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. The company recognizes shipping and handling costs as an expense in cost of products sold when the company transfers control to the customer. Payment terms vary depending on the type and location of the customer, are based on customary commercial terms and are generally less than one year. AbbVie does not adjust revenue for the effects of a significant financing component for contracts where AbbVie expects the period between the transfer of the good or service and collection to be one year or less. Discounts, rebates, sales incentives to customers, returns and certain other adjustments are accounted for as variable consideration. Provisions for variable consideration are based on current pricing, executed contracts, government pricing legislation and historical data and are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, factors used in the calculation of the accrual include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. 48 | 2018 Form 10-K In addition to revenue from contracts with customers, the company also recognizes certain collaboration revenues. See Note 6 for additional information related to the collaboration with Janssen Biotech, Inc. Additionally, see Note 15 for disaggregation of revenue by product and geography. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations, prior to regulatory approval, the payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in selling, general and administrative (SGA) expense in the consolidated statements of earnings. Advertising expenses were $1.1 billion in 2018 , $846 million in 2017 and $764 million in 2016 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive loss (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable debt securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets until realized, at which time the gains or losses are recognized in earnings. Investments in equity securities that have readily determinable fair values are recorded at fair value. Investments in equity securities that do not have readily determinable fair values are recorded at cost and are remeasured to fair value based on certain observable price changes or impairment events as they occur. Held-to- 2018 Form 10-K | 49 maturity debt securities are recorded at cost. Gains or losses on investments are included in other expense, net in the consolidated statements of earnings. AbbVie periodically assesses its marketable debt securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other-than-temporary decline has occurred, the cost basis of the investment is written down with a charge to other expense, net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense, net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $51 million at December 31, 2018 and $58 million at December 31, 2017 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process Raw materials Inventories $ 1,605 $ 1,605 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,603 1,428 Equipment 6,362 5,991 Construction in progress Property and equipment, gross 8,396 8,071 Less accumulated depreciation (5,513 ) (5,268 ) Property and equipment, net $ 2,883 $ 2,803 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $471 million in 2018 , $425 million in 2017 and $425 million in 2016 . Assets related to capital leases were insignificant at December 31, 2018 and 2017 . Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information 50 | 2018 Form 10-K becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that r esults of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense, net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time not to exceed twelve months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive income (loss) (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are 2018 Form 10-K | 51 remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements ASU No. 2014-09 In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40) . The amendments in this standard superseded most existing revenue recognition requirements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AbbVie adopted the standard in the first quarter of 2018 using the modified retrospective method. Results for reporting periods beginning after December 31, 2017 have been presented in accordance with the standard, while results for prior periods have not been adjusted and continue to be reported in accordance with AbbVies historical accounting. The cumulative effect of initially applying the new revenue standard was recognized as an adjustment to the opening balance of retained earnings as of January 1, 2018. There were no significant changes to the amounts or timing of revenue recognition for product sales, the company's primary revenue stream. For certain licensing arrangements where revenue was previously deferred and recognized over time, revenue is now recognized at the point in time when the license is granted. Additionally, for certain contract manufacturing arrangements where revenue was previously recognized at a point in time at the end of the manufacturing process, revenue is now recognized over time throughout the manufacturing process. Under the new standard, on January 1, 2018, the company recognized a cumulative-effect adjustment to retained earnings primarily related to certain deferred license revenues that were originally expected to be recognized through early 2020. The adjustment to the consolidated balance sheet included: (i) a $42 million increase to prepaid expenses and other; (ii) a $39 million decrease to inventories; (iii) a $57 million decrease to accounts payable and accrued liabilities; (iv) a $75 million decrease to other long-term liabilities; (v) a $22 million increase to deferred income taxes; and (vi) a $124 million increase to retained earnings. Other cumulative-effect adjustments to the consolidated balance sheet were insignificant. 52 | 2018 Form 10-K The impact of adoption on the companys consolidated statements of earnings in 2018 was as follows: year ended December 31, 2018 (in millions, except per share data) As Reported Balances Without Adoption of ASU 2014-09 Effect of Change Higher/(Lower) Net revenues $ 32,753 $ 32,812 $ (59 ) Cost of products sold 7,718 7,730 (12 ) Income tax benefit (490 ) (487 ) (3 ) Net earnings 5,687 5,731 (44 ) Diluted earnings per share $ 3.66 $ 3.69 $ (0.03 ) As of December 31, 2018 , due to the impact of the adoption of ASU 2014-09, prepaid expenses and other were $40 million higher, inventories were $27 million lower, accounts payable and accrued liabilities were $53 million lower, other long-term liabilities were $18 million lower, deferred income taxes were $11 million higher and retained earnings were $80 million higher on the companys consolidated balance sheet than they would have been had ASU 2014-09 not been adopted. Other impacts to the consolidated balance sheet were insignificant. ASU No. 2016-01 In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . The standard requires several targeted changes including that equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net earnings. AbbVie adopted the standard in the first quarter of 2018. The adoption did not impact the accounting for AbbVie's investments in debt securities and did not have a material impact on the company's consolidated financial statements. ASU No. 2016-16 In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . The standard requires entities to recognize the income tax consequences of an intercompany transfer of an asset other than inventory when the transfer occurs. Under previous U.S. GAAP, the income tax consequences of these intercompany asset transfers were deferred until the asset was sold to a third party or otherwise recovered through use. AbbVie adopted the standard in the first quarter of 2018 using the modified retrospective method. As a result, on January 1, 2018, the company recorded a cumulative-effect adjustment to its consolidated balance sheet that included a $1.9 billion decrease to retained earnings, a $1.4 billion decrease to prepaid expenses and other and a $0.5 billion decrease to other assets. ASU No. 2017-07 In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . The standard requires that an employer continue to report the service cost component of net periodic benefit cost in the same income statement line item or items as other employee compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented separately outside of income from operations and are not eligible for capitalization. AbbVie adopted the standard in the first quarter of 2018 and applied the income statement classification provisions of this standard retrospectively. As a result, the company reclassified income of $47 million from operating earnings to non-operating income in 2017 and $44 million in 2016. Additionally, the company recorded approximately $34 million of non-operating income in 2018 which would have been recorded in operating earnings under the previous guidance. ASU No. 2017-12 In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The standard simplifies the application of hedge accounting and more closely aligns the accounting with an entitys risk management activities. AbbVie elected to early adopt the standard in the first quarter of 2018. The adoption did not have a material impact on the company's consolidated financial statements. 2018 Form 10-K | 53 Recent Accounting Pronouncements Not Yet Adopted ASU No. 2016-02 In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The standard outlines a comprehensive lease accounting model that supersedes the current lease guidance and requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changes the definition of a lease and expands the disclosure requirements of lease arrangements. AbbVie has substantially completed its assessment of the new standard as of December 31, 2018. AbbVie will adopt the standard effective in the first quarter of 2019 and will not restate comparative periods upon adoption. AbbVie will elect a package of practical expedients for leases that commenced prior to January 1, 2019 and will not reassess: (i) whether any expired or existing contracts are or contain leases; (ii) lease classification for any expired or existing leases; and (iii) initial direct costs capitalization for any existing leases. AbbVie does not expect the adoption will have a material impact on its consolidated statement of earnings. However, the new standard will require AbbVie to establish liabilities and corresponding right-of-use assets on its consolidated balance sheet of approximately $0.3 billion to $0.5 billion for operating leases that exist as of the adoption date. ASU No. 2016-13 In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. Early adoption beginning in the first quarter of 2019 is permitted. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. ASU No. 2018-02 In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from AOCI to retained earnings for stranded tax effects related to adjustments to deferred taxes resulting from the December 2017 enactment of the Tax Cuts and Jobs Act. The standard will be effective for AbbVie starting with the first quarter of 2019. AbbVie is currently assessing the impact of adopting this guidance on its consolidated financial statements. 54 | 2018 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,348 $ 1,150 $ 1,047 Interest income (204 ) (146 ) (82 ) Interest expense, net $ 1,144 $ 1,004 $ Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 3,939 $ 3,069 Dividends payable 1,607 1,143 Accounts payable 1,546 1,474 Salaries, wages and commissions Royalty and license arrangements Other 3,748 3,263 Accounts payable and accrued liabilities $ 11,931 $ 10,226 Other Long-Term Liabilities as of December 31 (in millions) Income taxes payable $ 4,311 $ 4,675 Contingent consideration liabilities 4,306 4,266 Liabilities for unrecognized tax benefits 2,726 2,683 Pension and other post-employment benefits 1,840 2,740 Other 1,307 1,241 Other long-term liabilities $ 14,490 $ 15,605 Note 4 Earnings Per Share AbbVie grants certain restricted stock awards (RSAs) and restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2018 Form 10-K | 55 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share information) Basic EPS Net earnings $ 5,687 $ 5,309 $ 5,953 Earnings allocated to participating securities Earnings available to common shareholders $ 5,657 $ 5,283 $ 5,923 Weighted-average basic shares outstanding 1,541 1,596 1,622 Basic earnings per share $ 3.67 $ 3.31 $ 3.65 Diluted EPS Net earnings $ 5,687 $ 5,309 $ 5,953 Earnings allocated to participating securities Earnings available to common shareholders $ 5,657 $ 5,283 $ 5,923 Weighted-average shares of common stock outstanding 1,541 1,596 1,622 Effect of dilutive securities Weighted-average diluted shares outstanding 1,546 1,603 1,631 Diluted earnings per share $ 3.66 $ 3.30 $ 3.63 As further described in Note 12 , AbbVie entered into and executed an accelerated share repurchase agreement (ASR) with a third party financial institution in 2016. For purposes of calculating EPS, AbbVie reflected the ASR as a repurchase of AbbVie common stock. Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Stemcentrx On June 1, 2016, AbbVie acquired all of the outstanding equity interests in Stemcentrx, a privately-held biotechnology company. The transaction expanded AbbVies oncology pipeline by adding the late-stage asset rovalpituzumab tesirine (Rova-T), four additional early-stage clinical compounds in solid tumor indications and a significant portfolio of pre-clinical assets. Rova-T is currently in registrational trials for small cell lung cancer. The acquisition of Stemcentrx was accounted for as a business combination using the acquisition method of accounting. The aggregate upfront consideration for the acquisition of Stemcentrx consisted of approximately 62.4 million shares of AbbVie common stock, issued from common stock held in treasury, and cash. AbbVie may make certain contingent payments upon the achievement of defined development and regulatory milestones. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was $4.0 billion . The acquisition-date fair value of these milestones was $620 million and was estimated using a combination of probability-weighted discounted cash flow models and Monte Carlo simulation models. The estimate was determined based on significant inputs that are not observable in the market, referred to as Level 3 inputs, as described in more detail in Note 10 . The following table summarizes total consideration: (in millions) Cash $ 1,883 Fair value of AbbVie common stock 3,923 Contingent consideration Total consideration $ 6,426 56 | 2018 Form 10-K The following table summarizes fair values of assets acquired and liabilities assumed as of the June 1, 2016 acquisition date: (in millions) Assets acquired and liabilities assumed Accounts receivable $ Prepaid expenses and other Property and equipment Intangible assets - Indefinite-lived research and development 6,100 Accounts payable and accrued liabilities (31 ) Deferred income taxes (1,933 ) Other long-term liabilities (7 ) Total identifiable net assets 4,154 Goodwill 2,272 Total assets acquired and liabilities assumed $ 6,426 Intangible assets were related to IPRD for Rova-T, four additional early-stage clinical compounds in solid tumor indications and several additional pre-clinical compounds. The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of those asset valuations include the estimated annual cash flows for each asset or product (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. See Note 7 for additional information on the 2018 partial impairment of Stemcentrx-related intangible assets. The goodwill recognized represented expected synergies, including the ability to: (i) leverage the respective strengths of each business; (ii) expand the combined companys product portfolio; (iii) accelerate AbbVie's clinical and commercial presence in oncology; and (iv) establish a strong leadership position in oncology. Goodwill was also impacted by the establishment of a deferred tax liability for the acquired identifiable intangible assets which have no tax basis. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Stemcentrx have been included in the company's financial statements. AbbVies consolidated statement of earnings for the year ended December 31, 2016 included no net revenues and an operating loss of $165 million associated with Stemcentrx's operations. This operating loss included $43 million of post-acquisition stock-based compensation expense for Stemcentrx options and excluded interest expense and certain acquisition costs. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Stemcentrx for the year ended December 31, 2016 as if the acquisition of Stemcentrx had occurred on January 1, 2015: year ended December 31 (in millions, except per share information) Net revenues $ 25,641 Net earnings 5,907 Basic earnings per share $ 3.58 Diluted earnings per share $ 3.56 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Stemcentrx. In order to reflect the occurrence of the acquisition on January 1, 2015 as required, the unaudited pro forma financial information includes adjustments to reflect the additional interest expense associated with the issuance of debt to finance the acquisition and the reclassification of acquisition, integration and financing-related costs incurred during the year ended December 31, 2016 to the year ended December 31, 2018 Form 10-K | 57 2015. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2015. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Acquisition of BI 655066 and BI 655064 from Boehringer Ingelheim On April 1, 2016, AbbVie acquired all rights to risankizumab (BI 655066), an anti-IL-23 monoclonal biologic antibody in Phase 3 development for psoriasis, from Boehringer Ingelheim (BI) pursuant to a global collaboration agreement. AbbVie is also evaluating the potential of this biologic therapy in other indications, including Crohns disease, psoriatic arthritis and ulcerative colitis. In addition to risankizumab, AbbVie also gained rights to an anti-CD40 antibody, BI 655064, currently in Phase 1 development. BI will retain responsibility for further development of BI 655064, and AbbVie may elect to advance the program after completion of certain clinical achievements. The acquired assets include all patents, data, know-how, third-party agreements, regulatory filings and manufacturing technology related to BI 655066 and BI 655064. The company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. Under the terms of the agreement, AbbVie made an upfront payment of $595 million . Additionally, $18 million of payments to BI, pursuant to a contractual obligation to reimburse BI for certain development costs it incurred prior to the acquisition date, were initially deferred. AbbVie may make certain contingent payments upon the achievement of defined development, regulatory and commercial milestones, as well as royalty payments based on net revenues of licensed products. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was approximately $1.6 billion . The acquisition-date fair value of these milestones was $606 million . The acquisition-date fair value of contingent royalty payments was $2.8 billion . The potential contingent consideration payments were estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs. The following table summarizes total consideration: (in millions) Cash $ Deferred consideration payable Contingent consideration 3,365 Total consideration $ 3,978 The following table summarizes fair values of assets acquired as of the April 1, 2016 acquisition date: (in millions) Assets acquired Identifiable intangible assets - Indefinite-lived research and development $ 3,890 Goodwill Total assets acquired $ 3,978 The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach. The goodwill recognized represented expected synergies, including an expansion of the companys immunology product portfolio. Pro forma results of operations for this acquisition have not been presented because this acquisition was insignificant to AbbVies consolidated results of operations. Other Licensing Acquisitions Activity Excluding the acquisitions above, cash outflows related to other acquisitions and investments totaled $736 million in 2018 , $308 million in 2017 and $262 million in 2016 . AbbVie recorded acquired IPRD charges of $424 million in 2018 , $327 million in 2017 and $200 million in 2016 . Significant arrangements impacting 2018 , 2017 and 2016 , some of which require contingent milestone payments, are summarized below. 58 | 2018 Form 10-K Calico Life Sciences LLC In June 2018, AbbVie and Calico Life Sciences LLC (Calico) entered into an extension of a collaboration to discover, develop and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. Under the terms of the agreement, AbbVie and Calico will each contribute an additional $500 million to the collaboration and the term is extended for an additional 3 years . Calico will be responsible for research and early development until 2022 and will advance collaboration projects through Phase 2a through 2027. Following completion of Phase 2a, AbbVie will have the option to exclusively license collaboration compounds. AbbVie will support Calico in its early research and development efforts and, upon exercise, would be responsible for late-stage development and commercial activities. Collaboration costs and profits will be shared equally by both parties post option exercise. During 2018 , AbbVie recorded $500 million in other expense in the consolidated statement of earnings related to its commitments under the agreement. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $424 million in 2018 , $122 million in 2017 and $200 million in 2016 . In connection with the other individually insignificant early-stage arrangements entered into in 2018 , AbbVie could make additional payments of up to $4.8 billion upon the achievement of certain development, regulatory and commercial milestones. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics, a wholly-owned subsidiary of AbbVie, entered into a worldwide collaboration and license agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson, for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of Bruton's tyrosine kinase (BTK) and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60% of collaboration development costs and AbbVie is responsible for the remaining 40% of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end-customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. 2018 Form 10-K | 59 The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,372 $ 1,001 $ International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) AbbVies receivable from Janssen, included in accounts receivable, net, was $177 million at December 31, 2018 and $124 million at December 31, 2017 . AbbVies payable to Janssen, included in accounts payable and accrued liabilities, was $376 million at December 31, 2018 and $253 million at December 31, 2017 . Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2016 $ 15,416 Foreign currency translation Balance as of December 31, 2017 15,785 Foreign currency translation (122 ) Balance as of December 31, 2018 $ 15,663 The latest impairment assessment of goodwill was completed in the third quarter of 2018 . As of December 31, 2018 , there were no accumulated goodwill impairment losses. Future impairment tests for goodwill will be performed annually in the third quarter, or earlier if impairment indicators exist. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 15,872 $ (5,614 ) $ 10,258 $ 16,138 $ (4,982 ) $ 11,156 License agreements 7,865 (1,810 ) 6,055 7,822 (1,409 ) 6,413 Total definite-lived intangible assets 23,737 (7,424 ) 16,313 23,960 (6,391 ) 17,569 Indefinite-lived research and development 4,920 4,920 9,990 9,990 Total intangible assets, net $ 28,657 $ (7,424 ) $ 21,233 $ 33,950 $ (6,391 ) $ 27,559 Indefinite-Lived Intangible Assets Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2018 and 2017 related to the acquisitions of Stemcentrx and BI compounds. See Note 5 for additional information. The latest annual impairment assessment of indefinite-lived intangible assets was completed in the third quarter of 2018 which supported that no impairment existed at that time. During the fourth quarter of 2018, the company made a decision to stop enrollment for the TAHOE trial, a Phase 3 study evaluating Rova-T as a second-line therapy for advanced small cell lung cancer following a recommendation from an Independent Data Monitoring Committee. This decision lowered the probabilities of success of achieving regulatory approval across Rova-T and other early-stage assets and represented a triggering event which required the company to evaluate for impairment the IPRD assets associated with the Stemcentrx acquisition. The company utilized multi-period excess earnings models of the income approach and determined that the current fair value was $1.0 billion as of December 31, 2018 , which was lower than the carrying value of $6.1 billion and resulted in a pre-tax impairment charge of $5.1 billion ( $4.5 billion after 60 | 2018 Form 10-K tax). The fair value measurements were based on Level 3 inputs. Some of the more significant assumptions inherent in the development of the models included the estimated annual cash flows for each asset (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. This impairment charge was recorded to RD expense in the consolidated statement of earnings for the year ended December 31, 2018 . AbbVie continues to evaluate information as it becomes available with respect to the Stemcentrx-related clinical development programs and will monitor the remaining IPRD assets for further impairment. No indefinite-lived intangible asset impairment charges were recorded in 2017 and 2016 . Future impairment tests for indefinite-lived intangible assets will be performed annually in the third quarter, or earlier if impairment indicators exist. Definite-Lived Intangible Assets Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 11 years for both developed product rights and license agreements. Amortization expense was $1.3 billion in 2018 , $1.1 billion in 2017 and $764 million in 2016 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2018 is as follows: (in billions) Anticipated annual amortization expense $ 1.5 $ 1.7 $ 1.9 $ 2.1 $ 2.2 No definite-lived intangible asset impairment charges were recorded in 2018 . In 2017 , an impairment charge of $354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. In 2016 , an impairment charge of $39 million was recorded related to certain developed product rights in the United States due to a decline in the market for the product. The 2017 and 2016 impairment charges were based on discounted cash flow analyses and were included in cost of products sold in the consolidated statements of earnings. Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2018 , 2017 and 2016 , no such plans were individually significant. Restructuring charges recorded were $70 million in 2018 , $86 million in 2017 and $52 million in 2016 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on the classification of the affected employees or operations. The following table summarizes the cash activity in the restructuring reserve for 2018 , 2017 and 2016 : (in millions) Accrued balance as of December 31, 2015 $ 2016 restructuring charges Payments and other adjustments (113 ) Accrued balance as of December 31, 2016 2017 restructuring charges Payments and other adjustments (87 ) Accrued balance as of December 31, 2017 2018 restructuring charges Payments and other adjustments (46 ) Accrued balance as of December 31, 2018 $ 2018 Form 10-K | 61 Note 9 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2018 (a) Effective interest rate in 2017 (a) Senior notes issued in 2012 2.00% notes due 2018 2.15 % $ 2.15 % $ 1,000 2.90% notes due 2022 2.97 % 3,100 2.97 % 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 1.80% notes due 2018 1.92 % 1.92 % 3,000 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.38% notes due 2019 (1,400 principal) 0.55 % 1,604 0.55 % 1,673 1.38% notes due 2024 (1,450 principal) 1.46 % 1,661 1.46 % 1,733 2.13% notes due 2028 (750 principal) 2.18 % 2.18 % Senior notes issued in 2018 3.375% notes due 2021 3.51 % 1,250 % 3.75% notes due 2023 3.84 % 1,250 % 4.25% notes due 2028 4.38 % 1,750 % 4.875% notes due 2048 4.94 % 1,750 % Term loan facilities Floating rate notes due 2018 3.06 % 2.26 % 2,000 Other Fair value hedges (466 ) (401 ) Unamortized bond discounts (120 ) (97 ) Unamortized deferred financing costs (163 ) (146 ) Total long-term debt and lease obligations 36,611 36,968 Current portion 1,609 6,015 Noncurrent portion $ 35,002 $ 30,953 (a) Excludes the effect of any related interest rate swaps. In September 2018, the company issued $6.0 billion aggregate principal amount of unsecured senior notes, consisting of $1.25 billion aggregate principal amount of 3.375% senior notes due 2021, $1.25 billion aggregate principal amount of 3.75% senior notes due 2023, $1.75 billion aggregate principal amount of 4.25% senior notes due 2028 and $1.75 billion aggregate principal amount of 4.875% senior notes due 2048. These senior notes rank equally with all other unsecured and 62 | 2018 Form 10-K unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium, and except for the 3.375% notes due 2021, AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $37 million and debt discounts totaled $37 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $5.9 billion net proceeds, $2.0 billion was used to repay the company's outstanding three -year term loan credit agreement in September 2018 and $1.0 billion was used to repay the aggregate principal amount of 2.00% senior notes at maturity in November 2018. The company intends to use the remaining proceeds to repay term loan obligations in 2019 as they become due. In May 2018, the company also repaid $3.0 billion aggregate principal amount of 1.80% senior notes at maturity. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $17 million and debt discounts totaled $9 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. As a result of this redemption, the company incurred a charge of $39 million ( $25 million after tax) related to the make-whole premium, write-off of unamortized debt issuance costs and other expenses. The charge was recorded in interest expense, net in the consolidated statement of earnings. In May 2016, the company issued $7.8 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs incurred totaled $52 million and debt discounts totaled $29 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $7.7 billion net proceeds, $2.0 billion was used to repay the companys outstanding term loan that was due to mature in November 2016, approximately $1.9 billion was used to finance the acquisition of Stemcentrx and approximately $3.8 billion was used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Stemcentrx and Note 12 for additional information related to the ASR. In connection with the May 2016 unsecured senior notes issuance, AbbVie repaid a $2.0 billion 364 -day term loan credit agreement. AbbVie has outstanding $13.7 billion aggregate principal amount of unsecured senior notes which were issued in 2015. AbbVie may redeem the senior notes, at any time, prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and AbbVie may redeem the senior notes at par between one and six months prior to maturity. AbbVie has outstanding $5.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2018 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $699 million at December 31, 2018 and $400 million at December 31, 2017 . The weighted-average interest rate on commercial paper borrowings was 2.0% in 2018 , 1.3% in 2017 and 0.6% in 2016 . In August 2018, AbbVie replaced its existing revolving credit facility with a new $3.0 billion five -year revolving credit facility that matures in August 2023. The new facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2018 , the company was in compliance with all its credit facility covenants. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2018 , 2017 and 2016 . No amounts were outstanding under the credit facility as of December 31, 2018 and December 31, 2017 . In May 2018 , AbbVie entered into a $3.0 billion 364 -day term loan credit agreement (term loan). In June 2018, the company drew on this term loan and as of December 31, 2018 , $3.0 billion was outstanding and was included in short-term borrowings on the consolidated balance sheet. Borrowings under the term loan bear interest at one month LIBOR plus 2018 Form 10-K | 63 applicable margin. The term loan may be prepaid without penalty upon prior notice and contains customary covenants, all of which the company was in compliance with as of December 31, 2018 . Maturities of Long-Term Debt and Capital Lease Obligations The following table summarizes AbbVie's future minimum lease payments under non-cancelable operating leases, debt maturities and future minimum lease payments for capital lease obligations as of December 31, 2018 : as of and for the years ending December 31 (in millions) Operating leases Debt maturities and capital leases $ $ 1,612 105 3,755 100 3,053 81 4,120 64 2,250 Thereafter 22,570 Total obligations and commitments 37,360 Fair value hedges, unamortized bond discounts and deferred financing costs (749 ) Total long-term debt and lease obligations $ $ 36,611 Lease expense was $161 million in 2018 , $169 million in 2017 and $159 million in 2016 . AbbVie's operating leases generally include renewal options and provide for the company to pay taxes, maintenance, insurance and other operating costs of the leased property. As of December 31, 2018 , annual future minimum lease payments for capital lease obligations were insignificant. Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 10 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $1.4 billion at December 31, 2018 and $2.2 billion at December 31, 2017 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months . Accumulated gains and losses as of December 31, 2018 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. 64 | 2018 Form 10-K The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $8.6 billion at December 31, 2018 and $7.7 billion at December 31, 2017 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. In the fourth quarter of 2016, the company issued 3.6 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company settled foreign currency forward exchange contracts with aggregate notional amounts of 3.5 billion that were designated as net investment hedges. AbbVie is a party to interest rate hedge contracts designated as fair value hedges with notional amounts totaling $10.8 billion at December 31, 2018 and $11.8 billion at December 31, 2017 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. No amounts are excluded from the assessment of effectiveness for cash flow hedges, net investment hedges or fair value hedges. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2017 Balance sheet caption 2017 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Not designated as hedges Prepaid expenses and other 22 Accounts payable and accrued liabilities 29 Interest rate swaps designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Interest rate swaps designated as fair value hedges Other assets Other long-term liabilities 393 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive income (loss): years ended December 31 (in millions) Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Foreign currency forward exchange contracts $ $ $ $ (250 ) $ $ (250 ) $ $ $ Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax gains of $159 million into cost of products sold for foreign currency cash flow hedges during the next 12 months. The company recognized, in other comprehensive loss, pre-tax gains of $178 million in 2018 , pre-tax losses of $537 million in 2017 and pre-tax gains of $101 million in 2016 related to non-derivative, foreign currency denominated debt designated as net investment hedges. 2018 Form 10-K | 65 The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the net gains (losses) reclassified out of AOCI into net earnings. See Note 12 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ (161 ) $ $ Not designated as hedges Net foreign exchange loss (96 ) Non-designated treasury rate lock agreements Other expense, net (12 ) Interest rate swaps designated as fair value hedges Interest expense, net (71 ) (63 ) (266 ) Debt designated as hedged item in fair value hedges Interest expense, net Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2018 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 7,289 $ 1,209 $ 6,080 $ Time deposits Debt securities 1,536 1,536 Equity securities Foreign currency contracts Total assets $ 9,529 $ 1,213 $ 8,316 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,483 4,483 Total liabilities $ 4,975 $ $ $ 4,483 66 | 2018 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2017 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 9,303 $ $ 8,454 $ Debt securities 2,524 2,524 Equity securities Foreign currency contracts Total assets $ 11,854 $ $ 11,001 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,534 4,534 Total liabilities $ 5,084 $ $ $ 4,534 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. The derivatives entered into by the company were valued using published spot curves for interest rate hedges and published forward curves for foreign currency contracts. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2018 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $160 million . Additionally, at December 31, 2018 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $420 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,534 $ 4,213 $ Additions (See Note 5) 3,985 Change in fair value recognized in net earnings Milestone payments (100 ) (305 ) Ending balance $ 4,483 $ 4,534 $ 4,213 The change in fair value recognized in net earnings is recorded in other expense, net in the consolidated statements of earnings. During the fourth quarter of 2018, the company recorded a $428 million decrease in the Stemcentrx contingent consideration liability due to a reduction in probabilities of success of achieving regulatory approval. 2018 Form 10-K | 67 Certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2018 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Liabilities Short-term borrowings $ 3,699 $ 3,693 $ $ 3,693 $ Current portion of long-term debt and lease obligations, excluding fair value hedges 1,609 1,617 1,609 Long-term debt and lease obligations, excluding fair value hedges 35,468 34,052 34,024 Total liabilities $ 40,776 $ 39,362 $ 35,633 $ 3,729 $ AbbVie also holds investments in equity securities that do not have readily determinable fair values. The company records these investments at cost and remeasures them to fair value based on certain observable price changes or impairment events as they occur. The carrying amount of these investments was $84 million as of December 31, 2018 . No significant cumulative upward or downward adjustments have been recorded for these investments as of December 31, 2018 . Prior to the adoption of ASU No. 2016-01 discussed in Note 2 , these investments were accounted for under the cost method and disclosed in the table below as of December 31, 2017 . The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2017 are shown in the table below: Basis of fair value measurement (in millions) Book value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 6,023 6,034 4,004 2,030 Long-term debt and lease obligations, excluding fair value hedges 31,346 32,846 32,763 Total liabilities $ 37,769 $ 39,280 $ 36,767 $ 2,513 $ 68 | 2018 Form 10-K Available-for-sale Securities Substantially all of the companys investments in debt securities were classified as available-for-sale with changes in fair value recognized in other comprehensive income. Debt securities classified as short-term were $204 million as of December 31, 2018 and $482 million as of December 31, 2017 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale debt securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2018 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ (2 ) $ Corporate debt securities 1,042 (9 ) 1,034 Other debt securities Total $ 1,546 $ $ (11 ) $ 1,536 The following table summarizes available-for-sale securities by type as of December 31, 2017 : Amortized cost Gross unrealized Fair value (in millions) Gains Losses Asset backed securities $ $ $ (3 ) $ Corporate debt securities 1,451 (2 ) 1,453 Other debt securities (1 ) Equity securities (2 ) Total $ 2,529 $ $ (8 ) $ 2,528 AbbVie had no other-than-temporary impairments as of December 31, 2018 . Net realized gains and losses were insignificant in 2018 and 2016 . Net realized gains in 2017 were $90 million . Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. The functional currency of the company's Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2018 and 2017 , AbbVies net monetary assets in Venezuela were insignificant. Of total net accounts receivable, three U.S. wholesalers accounted for 63% as of December 31, 2018 and 56% as of December 31, 2017 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 61% of AbbVie's total net revenues in 2018 , 65% in 2017 and 63% in 2016 . Note 11 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2018 and 2017 . 2018 Form 10-K | 69 The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 6,985 $ 5,829 $ $ Service cost Interest cost Employee contributions Actuarial (gain) loss (614 ) (287 ) Benefits paid (191 ) (173 ) (16 ) (15 ) Other, primarily foreign currency translation adjustments (76 ) End of period 6,618 6,985 Fair value of plan assets Beginning of period 5,399 4,572 Actual return on plan assets (384 ) Company contributions Employee contributions Benefits paid (191 ) (173 ) (16 ) (15 ) Other, primarily foreign currency translation adjustments (62 ) End of period 5,637 5,399 Funded status, end of period $ (981 ) $ (1,586 ) $ (561 ) $ (813 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities (8 ) (32 ) (15 ) (15 ) Other long-term liabilities (1,294 ) (1,942 ) (546 ) (798 ) Net obligation $ (981 ) $ (1,586 ) $ (561 ) $ (813 ) Actuarial loss, net $ 2,516 $ 2,471 $ $ Prior service cost (credit) (22 ) (29 ) Accumulated other comprehensive loss $ 2,527 $ 2,483 $ $ The projected benefit obligations (PBO) in the table above included $1.9 billion at December 31, 2018 and $2.0 billion at December 31, 2017 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $6.0 billion at December 31, 2018 and $6.3 billion at December 31, 2017 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2018 , the ABO was $4.0 billion , the PBO was $4.5 billion and aggregate plan assets were $3.3 billion . Subsequent to December 31, 2018 , the company made a voluntary contribution of $150 million to its principal domestic defined benefit plan, the AbbVie Pension Plan. 70 | 2018 Form 10-K Amounts Recognized in Other Comprehensive Income (Loss) The following table summarizes the pre-tax gains and losses included in other comprehensive income (loss): years ended December 31 (in millions) Defined benefit plans Actuarial loss $ $ $ Amortization of actuarial loss and prior service cost (140 ) (107 ) (85 ) Foreign exchange gain (loss) and other (13 ) (22 ) Total $ $ $ Other post-employment plans Actuarial loss (gain) $ (287 ) $ $ Amortization of actuarial loss and prior service credit (1 ) Total $ (288 ) $ $ The pre-tax amounts included in AOCI at December 31, 2018 expected to be recognized in net periodic benefit cost in 2019 consisted of $103 million of expense related to actuarial losses and prior service costs for defined benefit plans and $5 million of income related to actuarial losses and prior service credits for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets (439 ) (382 ) (354 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service credit Net periodic benefit cost $ $ $ Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 4.0 % 3.4 % Rate of compensation increases 4.6 % 4.5 % Other post-employment plans Discount rate 4.6 % 3.9 % The assumptions used in calculating the December 31, 2018 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2019 . 2018 Form 10-K | 71 Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 3.4 % 3.9 % 4.4 % Discount rate for determining interest cost 3.1 % 3.7 % 4.0 % Expected long-term rate of return on plan assets 7.7 % 7.8 % 7.9 % Expected rate of change in compensation 4.4 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.0 % 4.9 % 5.1 % Discount rate for determining interest cost 3.7 % 4.1 % 4.3 % For the December 31, 2018 post-retirement health care obligations remeasurement, the company assumed a 6.6% pre-65 ( 7.3% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% in 2050 and remain at that level thereafter. For purposes of measuring the 2018 post-retirement health care costs, the company assumed a 7.7% pre-65 ( 9.5% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% for 2050 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2018 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2018 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ (10 ) Projected benefit obligation (87 ) Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 2,359 $ 1,586 $ $ Total assets measured at NAV 3,278 Fair value of plan assets $ 5,637 72 | 2018 Form 10-K Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,715 $ 1,208 $ $ Total assets measured at NAV 3,684 Fair value of plan assets $ 5,399 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The target investment allocations for the AbbVie Pension Plan is 35% in equity securities, 20% in fixed income securities and 45% in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. 2018 Form 10-K | 73 Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2020 2021 2022 2023 2024 to 2028 1,589 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $89 million in 2018 , $82 million in 2017 and $75 million in 2016 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. Note 12 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSAs, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least ten years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Realized excess tax benefits associated with stock-based compensation totaled $78 million in 2018 , $71 million in 2017 and $55 million in 2016 . Since 2017, all excess tax benefits associated with stock-based awards have been recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity as a result of the adoption of a new accounting pronouncement. 74 | 2018 Form 10-K Stock Options Stock options awarded to employees typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100% of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $21.63 in 2018 , $9.80 in 2017 and $9.29 in 2016 . The following table summarizes AbbVie stock option activity in 2018 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2017 8,316 $ 41.69 5.1 $ Granted 114.36 Exercised (2,781 ) 28.75 Lapsed (26 ) 17.03 Outstanding at December 31, 2018 6,143 $ 55.05 6.2 $ Exercisable at December 31, 2018 4,293 $ 45.23 5.3 $ The total intrinsic value of options exercised was $215 million in 2018 , $371 million in 2017 and $325 million in 2016 . The total fair value of options vested during 2018 was $22 million . As of December 31, 2018 , $6 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSAs, RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees are performance-based. Such awards granted before 2016 consisted of RSAs or RSUs for which vesting was contingent upon AbbVie achieving a minimum annual return on equity (ROE). Since 2016, equity awards granted to senior executives and other key employees consist of a combination of performance-vested RSUs and performance shares as well as non-qualified stock options described above. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSAs, RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. The following table summarizes AbbVie RSA, RSU and performance share activity for 2018 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2017 10,682 $ 59.47 Granted 4,771 103.31 Vested (5,073 ) 59.41 Forfeited (512 ) 73.45 Outstanding at December 31, 2018 9,868 $ 79.90 The fair market value of RSAs, RSUs and performance shares (as applicable) vested was $583 million in 2018 , $348 million in 2017 and $362 million in 2016 . 2018 Form 10-K | 75 As of December 31, 2018 , $307 million of unrecognized compensation cost related to RSAs, RSUs and performance shares is expected to be recognized as expense over approximately the next two years . Cash Dividends Cash dividends declared per common share totaled $3.95 in 2018, $2.63 in 2017 and $2.35 in 2016. The following table summarizes quarterly cash dividends declared during 2018 , 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 11/02/18 02/15/19 $1.07 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/07/18 11/15/18 $0.96 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/14/18 08/15/18 $0.96 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/15/18 05/15/18 $0.96 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. On December 13, 2018, AbbVie's board of directors authorized a $5.0 billion increase to the existing $10.0 billion stock repurchase program. Under this authorization, AbbVie repurchased approximately 109 million shares for $10.7 billion in 2018. AbbVie's remaining share repurchase authorization was $4.3 billion as of December 31, 2018 . Under previous stock repurchase programs, AbbVie made open-market share repurchases of approximately 11 million shares for $1.3 billion in 2018 , approximately 13 million shares for $1.0 billion in 2017 and approximately 34 million shares for $2.1 billion in 2016 . Additionally, in 2016 , AbbVie executed an ASR in connection with the Stemcentrx acquisition and repurchased approximately 60 million shares for $3.8 billion . 76 | 2018 Form 10-K Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of accumulated other comprehensive loss, net of tax, for 2018 , 2017 and 2016 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2015 $ (1,270 ) $ $ (1,378 ) $ $ $ (2,561 ) Other comprehensive income (loss) before reclassifications (165 ) (194 ) (52 ) Net losses (gains) reclassified from accumulated other comprehensive loss (8 ) (24 ) Net current-period other comprehensive income (loss) (165 ) (135 ) (1 ) (25 ) Balance as of December 31, 2016 (1,435 ) (1,513 ) (2,586 ) Other comprehensive income (loss) before reclassifications (343 ) (480 ) (230 ) (344 ) Net losses (gains) reclassified from accumulated other comprehensive loss (75 ) (112 ) Net current-period other comprehensive income (loss) (343 ) (406 ) (46 ) (342 ) (141 ) Balance as of December 31, 2017 (439 ) (203 ) (1,919 ) (166 ) (2,727 ) Other comprehensive income (loss) before reclassifications (391 ) (14 ) (27 ) Net losses reclassified from accumulated other comprehensive loss Net current-period other comprehensive income (loss) (391 ) (10 ) Balance as of December 31, 2018 $ (830 ) $ (65 ) $ (1,722 ) $ (10 ) $ $ (2,480 ) Other comprehensive loss in 2018 included foreign currency translation adjustments totaling a loss of $391 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. In 2017, AbbVie reclassified $316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2016 included foreign currency translation adjustments totaling a loss of $165 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. 2018 Form 10-K | 77 The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Pension and post-employment benefits Amortization of actuarial losses and other (a) $ $ $ Tax benefit (28 ) (33 ) (26 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on designated cash flow hedges (b) $ $ (118 ) $ (20 ) Tax expense (benefit) (4 ) (4 ) Total reclassifications, net of tax $ $ (112 ) $ (24 ) (a) Amounts are included in the computation of net periodic benefit cost (see Note 11 ). (b) Amounts are included in cost of products sold (see Note 10 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $0.01 . As of December 31, 2018 , no shares of preferred stock were issued or outstanding. Note 13 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) Domestic $ (4,274 ) $ (2,678 ) $ (1,651 ) Foreign 9,471 10,405 9,535 Total earnings before income tax expense $ 5,197 $ 7,727 $ 7,884 Income Tax Expense years ended December 31 (in millions) Current Domestic $ $ 6,204 $ 2,229 Foreign Total current taxes $ 1,027 $ 6,580 $ 2,727 Deferred Domestic $ (1,497 ) $ (4,898 ) $ (792 ) Foreign (20 ) (4 ) Total deferred taxes $ (1,517 ) $ (4,162 ) $ (796 ) Total income tax expense (benefit) $ (490 ) $ 2,418 $ 1,931 Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduced the U.S. federal corporate tax rate from 35% to 21% and required companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed. These changes were generally effective for tax years beginning in 2018. 78 | 2018 Form 10-K The Act also created a minimum tax on certain foreign sourced earnings. The taxability of the foreign earnings and the applicable tax rates are dependent on future events. The companys accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. Additionally, the Act significantly changed the timing and manner in which earnings of foreign subsidiaries are subject to U.S. tax. Therefore, unremitted foreign earnings previously considered indefinitely reinvested that were subject to the Acts transition tax are no longer considered indefinitely reinvested. Post-2017 earnings subject to the U.S. minimum tax on foreign sourced earnings and the 100 percent foreign dividends received deduction are also not considered indefinitely reinvested earnings. As such, the company records foreign withholding tax liabilities related to the future cash repatriation of such earnings. However, the company considers instances of outside basis differences in foreign subsidiaries that would incur additional U.S. tax upon reversal (e.g., capital gain distribution) to be permanent in duration. The unrecognized tax liability is not practicable to determine. Prior to the enactment of the Act, the company did not provide deferred income taxes on undistributed earnings of foreign subsidiaries that were indefinitely reinvested for continued use in foreign operations. Due to the provision of the Act that required a one-time deemed repatriation of earnings of foreign subsidiaries, in 2017, the company recorded a transition tax expense of $4.5 billion . The company also recognized income tax expense of $338 million related to transition tax on income from the sale of inventory in 2018. The transition tax is generally payable in eight annual installments. Additionally, in 2017, the company remeasured certain deferred tax assets and liabilities based on tax rates at which they were expected to reverse in the future. In 2017, the net tax benefit of U.S. tax reform from the remeasurement of deferred taxes related to the Act and foreign tax law changes was $3.6 billion . Given the complexity of the Act and anticipated guidance from the U.S. Treasury about implementing the Act, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118) which allowed companies to record provisional amounts during a measurement period not extending beyond one year from the enactment date of the Act. As a result, in 2017, the companys analysis and accounting for the tax effects of the Act was preliminary. In 2017, as a direct result of the Act, the company recorded $4.5 billion of transition tax expense, as well as $4.1 billion of net tax benefit for deferred tax remeasurement. Both of these amounts were provisional estimates, as the company had not fully completed its analysis and calculation of foreign earnings subject to the transition tax or its analysis of certain other aspects of the Act that impacted the remeasurement of deferred tax balances. In 2018, the company finalized its provisional estimates and recognized income tax expense related to the Act of $86 million , which primarily related to the transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries. Effective Tax Rate Reconciliation years ended December 31 Statutory tax rate 21.0 % 35.0 % 35.0 % Effect of foreign operations (28.7 ) (12.2 ) (10.3 ) U.S. tax credits (7.3 ) (4.0 ) (4.4 ) Impacts related to U.S. tax reform 8.2 12.0 Tax law change related to foreign currency 2.4 Stock-based compensation excess tax benefit (1.5 ) (0.9 ) Tax audit settlements (2.5 ) (1.2 ) All other, net 1.4 2.6 1.8 Effective tax rate (9.4 )% 31.3 % 24.5 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2018 , 2017 and 2016 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities, the cost of repatriation decisions and Stemcentrx impairment related expenses. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. 2018 Form 10-K | 79 The effective income tax rate in 2018 and 2017 included impacts related to U.S. tax reform. Specific to 2018, there was a favorable impact of the effective date of provisions of the Act related to the earnings from certain foreign subsidiaries. The 2018 effective income tax rate also reflects the effects of Stemcentrx impairment related expenses. In addition, the company recognized a net tax benefit of $131 million in 2018 and $91 million in 2017 related to the resolution of various tax positions pertaining to prior years. The effective income tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Advance payments Net operating losses and other credit carryforwards Other Total deferred tax assets 2,765 2,032 Valuation allowances (103 ) (108 ) Total net deferred tax assets 2,662 1,924 Deferred tax liabilities Excess of book basis over tax basis of intangible assets (2,940 ) (3,762 ) Excess of book basis over tax basis in investments (211 ) (181 ) Other (250 ) (203 ) Total deferred tax liabilities (3,401 ) (4,146 ) Net deferred tax liabilities $ (739 ) $ (2,222 ) As of December 31, 2018 , gross state net operating losses were $717 million and tax credit carryforwards were $210 million . The state tax carryforwards expire between 2019 and 2038. As of December 31, 2018 , foreign net operating loss carryforwards were $427 million . Foreign net operating loss carryforwards of $350 million expire between 2020 and 2028 and the remaining do not have an expiration period. The company had valuation allowances of $103 million as of December 31, 2018 and $108 million as of December 31, 2017 . These were principally related to state net operating losses and credit carryforwards that are not expected to be realized. Current income taxes receivable were $488 million as of December 31, 2018 and $2.1 billion as of December 31, 2017 and were included in prepaid expenses and other on the consolidated balance sheets. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 2,701 $ 1,168 $ Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions (36 ) (2 ) (7 ) Settlements (79 ) (233 ) Lapse of statutes of limitations (7 ) (16 ) (8 ) Ending balance $ 2,852 $ 2,701 $ 1,168 80 | 2018 Form 10-K AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $2.7 billion in 2018 and $2.6 billion in 2017 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2018 , AbbVie would be indemnified for approximately $84 million . The Increase due to current year tax positions in the table above includes amounts related to federal, state and international tax items. The ""Increase due to prior year tax positions"" in the table above includes amounts relating to federal, state and international items as well as prior positions acquired through business development activities during the year. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $73 million in 2018 , $24 million in 2017 and $35 million in 2016 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $190 million at December 31, 2018 , $120 million at December 31, 2017 and $112 million at December 31, 2016 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $486 million . All significant federal, state, local and international matters have been concluded for years through 2010. The company believes adequate provision has been made for all income tax uncertainties. Note 14 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $350 million as of December 31, 2018 and approximately $445 million as of December 31, 2017 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Several pending lawsuits filed against Unimed Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others are consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation , MDL No. 2084. These cases, brought by private plaintiffs and the Federal Trade Commission (FTC), generally allege Solvay's patent litigation involving AndroGel was sham litigation and the 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. These cases include: (a) four individual plaintiff lawsuits; (b) three purported class actions; and (c) Federal Trade Commission v. Actavis, Inc. et al. Following the district court's dismissal of all plaintiffs' claims, appellate proceedings led to the reinstatement of the claims regarding the patent litigation settlements, which are proceeding in the district court. In July 2018, the court denied the private plaintiffs' motion for class certification. Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits 2018 Form 10-K | 81 consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by three named direct purchasers of Niaspan and the other brought by ten named end-payer purchasers of Niaspan. The cases are consolidated for pre-trial proceedings in the United States District Court for the Eastern District of Pennsylvania under the MDL Rules as In re: Niaspan Antitrust Litigation , MDL No. 2460. In October 2016, the Orange County, California District Attorneys Office filed a lawsuit on behalf of the State of California regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In May 2018, the California Court of Appeals ruled that the District Attorneys Office may not bring monetary claims beyond the scope of Orange County. In September 2014, the FTC filed a lawsuit against AbbVie and others in the United States District Court for the Eastern District of Pennsylvania, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the settlements of that litigation violated federal antitrust law. In May 2015, the court dismissed the FTCs settlement-related claim. In June 2018, following a bench trial, the court found for the FTC on its sham litigation claim and ordered a disgorgement remedy of $448 million , plus prejudgment interest. The court denied the FTCs request for injunctive relief. AbbVie is appealing the courts liability and disgorgement rulings and, based on an assessment of the merits of that appeal, no liability has been accrued for this matter. The FTC is also appealing aspects of the courts trial ruling and the dismissal of its settlement-related claim. In July and August 2018, several direct AndroGel purchasers brought two individual and one class action cases in the United States District Court for the Eastern District of Pennsylvania alleging sham litigation based on the courts trial ruling in the FTCs case. Those cases are stayed pending the appeals in the FTCs case. In March 2015, the State of Louisiana filed a lawsuit, State of Louisiana v. Fournier Industrie et Sante, et al. , against AbbVie, Abbott and affiliated Abbott entities in Louisiana state court. Plaintiff alleges that patent applications and patent litigation filed and other alleged conduct from the early 2000's and before related to the drug TriCor violated Louisiana State antitrust and unfair trade practices laws. The lawsuit seeks monetary damages and attorneys' fees. Plaintiff has filed a writ of certiorari with the Louisiana Supreme Court seeking to appeal the August 2018 dismissal of this lawsuit by the Louisiana Court of Appeal. In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al. , was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted include violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint seeks monetary damages and injunctive relief. In July 2018, the court denied the plaintiffs motion for class certification. Product liability cases are pending in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 4,000 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation , MDL No. 2545. Approximately 200 claims against AbbVie are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. Six cases have gone to trial. Four of those have resulted in complete verdicts for AbbVie: three by juries in the United States District Court for the Northern District of Illinois in January, May, and June 2018, and one by a jury in the Cook County, Illinois Circuit Court in August 2017. Another case in the United States District Court for the Northern District of Illinois resulted in a March 2018 jury verdict for AbbVie on strict liability and fraud and for the plaintiff on negligence and awarded $200,000 in compensatory damages and $3 million in punitive damages, which is the subject of post-trial proceedings. Another case in the United States District Court for the Northern District of Illinois resulted in a jury verdict for AbbVie on strict liability and for the plaintiff on remaining claims and an award of $140,000 in compensatory damages and $140 million in punitive damages in August 2017. In July 2018, the court vacated that verdict and ordered a new trial. In November 2018, AbbVie entered into a Master Settlement Agreement with the Plaintiffs Steering Committee in the MDL encompassing all existing claims in all courts. All proceedings in pending cases are effectively stayed, including post-trial proceedings in cases that had been tried to verdict with appellate rights preserved. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Approximately 404 cases are pending in the United States District Court for the Southern District of Illinois, and approximately six others are pending in various other federal and state courts. Plaintiffs generally seek compensatory and punitive damages. Over ninety percent of these pending cases, plus other unfiled claims, are subject to confidential settlement agreements and are expected to be dismissed with prejudice. To date, approximately 185 cases have been dismissed with prejudice. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al. , on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made 82 | 2018 Form 10-K and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc. , was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July 2017 and October 2018 against AbbVie and in some instances its chief executive officer in the same court by additional investment funds. Plaintiffs seek compensatory and punitive damages. In May 2017, a shareholder derivative lawsuit, Ellis v. Gonzalez, et al. , was filed in Delaware Chancery Court, alleging that AbbVie's directors breached their fiduciary duties in connection with statements made regarding the Shire transaction. The lawsuit sought unspecified compensatory damages for AbbVie, among other relief. In July 2018, the court dismissed this case with prejudice. In August 2018, plaintiff appealed that dismissal to the Delaware Supreme Court. In September 2018, the Commissioner of the California Department of Insurance intervened in a qui tam lawsuit, State of California and Lazaro Suarez v. AbbVie Inc., et al. , brought under the California Insurance Frauds Prevention Act, in California Superior Court for Alameda County. The Department of Insurances complaint alleges that, through patient and reimbursement support services and other services and items of value provided in connection with HUMIRA, AbbVie caused the submission of fraudulent commercial insurance claims for HUMIRA in violation of the California statute. The complaint seeks injunctive relief, an assessment of up to three times the amount of the claims at issue, and civil penalties. In addition, two federal securities lawsuits were filed in September ( Pippins v. AbbVie Inc., et al. , in the United States District Court for the Central District of California) and October ( Holwill v. AbbVie Inc., et al ., in the United States District Court for the Northern District of Illinois) against AbbVie, its chief executive officer and then-chief financial officer, alleging that reasons stated for HUMIRA sales growth in financial filings between 2013 and 2017 were misleading because they omitted the conduct alleged in the Department of Insurances complaint. In November 2018, the Pippins case was voluntarily dismissed. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. AbbVies appeal of the decisions is pending in the Court of Appeals for the Federal Circuit. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd. , in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that eleven HCV-related patents licensed to AbbVie in 2002 are invalid. AbbVie is seeking to enforce certain patent rights related to adalimumab (a drug AbbVie sells under the trademark HUMIRA). In a case filed in United States District Court for the District of Delaware in August 2017, AbbVie alleges that Boehringer Ingelheim International GmbHs, Boehringer Ingelheim Pharmaceutical, Inc.s, and Boehringer Ingelheim Fremont, Inc.s proposed biosimilar adalimumab product infringes certain AbbVie patents. AbbVie seeks declaratory and injunctive relief. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In February 2018, four separate cases were filed in the United States District Court for the District of Delaware against the following defendants: Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limited; Shilpa Medicare Limited, Sun Pharma Global FZE and Sun Pharmaceutical Industries Ltd.; Cipla Limited and Cipla USA Inc.; and Zydus Worldwide DMCC, Cadila Healthcare Limited, Teva Pharmaceuticals USA, Inc., Teva Pharmaceutical Industries Ltd., Sandoz Inc., and Lek Pharmaceuticals D.D. In November 2018, Pharmacyclics filed a fifth suit in the United States District Court for the District of Delaware against Hetero USA Inc., Hetero Labs Limited and Hetero Labs Limited Unit-I and Unit-V. In each case, Pharmacyclics alleges the defendants proposed generic ibrutinib product infringes certain Pharmacyclics patents and seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in these suits. 2018 Form 10-K | 83 Note 15 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) Immunology HUMIRA United States $ 13,685 $ 12,361 $ 10,432 International 6,251 6,066 5,646 Total $ 19,936 $ 18,427 $ 16,078 Hematologic Oncology IMBRUVICA United States $ 2,968 $ 2,144 $ 1,580 Collaboration revenues Total $ 3,590 $ 2,573 $ 1,832 VENCLEXTA United States $ $ $ International Total $ $ $ HCV MAVYRET United States $ 1,614 $ $ International 1,824 Total $ 3,438 $ $ VIEKIRA United States $ $ $ International 1,180 Total $ $ $ 1,522 Other Key Products Creon United States $ $ $ Lupron United States $ $ $ International Total $ $ $ Synthroid United States $ $ $ Synagis International $ $ $ AndroGel United States $ $ $ Duodopa United States $ $ $ International Total $ $ $ Sevoflurane United States $ $ $ International Total $ $ $ Kaletra United States $ $ $ International Total $ $ $ All other $ $ $ 1,199 Total net revenues $ 32,753 $ 28,216 $ 25,638 84 | 2018 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 21,524 $ 18,251 $ 15,947 Japan 1,591 Germany 1,292 1,157 1,104 United Kingdom France Canada Italy Spain The Netherlands Brazil All other countries 4,013 4,080 3,885 Total net revenues $ 32,753 $ 28,216 $ 25,638 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 1,993 $ 1,862 Europe All other 320 Total long-lived assets $ 2,883 $ 2,803 2018 Form 10-K | 85 Note 16 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 7,934 $ 6,538 Gross margin 6,007 4,922 Net earnings (a) 2,783 1,711 Basic earnings per share $ 1.74 $ 1.07 Diluted earnings per share $ 1.74 $ 1.06 Cash dividends declared per common share $ 0.96 $ 0.64 Second Quarter Net revenues $ 8,278 $ 6,944 Gross margin 6,344 5,415 Net earnings (b) 1,983 1,915 Basic earnings per share $ 1.26 $ 1.20 Diluted earnings per share $ 1.26 $ 1.19 Cash dividends declared per common share $ 0.96 $ 0.64 Third Quarter Net revenues $ 8,236 $ 6,995 Gross margin 6,401 5,379 Net earnings (c) 2,747 1,631 Basic earnings per share $ 1.81 $ 1.02 Diluted earnings per share $ 1.81 $ 1.01 Cash dividends declared per common share $ 0.96 $ 0.64 Fourth Quarter Net revenues $ 8,305 $ 7,739 Gross margin 6,283 5,458 Net earnings (loss) (d) (1,826 ) Basic earnings (loss) per share $ (1.23 ) $ 0.03 Diluted earnings (loss) per share $ (1.23 ) $ 0.03 Cash dividends declared per common share $ 1.07 $ 0.71 (a) First quarter results in 2018 included an after-tax benefit of $148 million related to the change in fair value of contingent consideration liabilities partially offset by after-tax litigation reserves charges of $100 million . First quarter results in 2017 included after-tax costs of $84 million related to the change in fair value of contingent consideration liabilities. (b) Second quarter results in 2018 included after-tax charges of $500 million as a result of a collaboration agreement extension with Calico and $485 million related to the change in fair value of contingent consideration liabilities. Second quarter results in 2017 included an after-tax charge of $62 million to increase litigation reserves and after-tax costs of $61 million related to the change in fair value of contingent consideration liabilities. (c) Third quarter results in 2018 included after-tax litigation reserves charges of $176 million and $95 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2017 included after-tax costs of $401 million related to the change in fair value of contingent consideration liabilities. (d) Fourth quarter results in 2018 included an after-tax intangible asset impairment charge of $4.5 billion partially offset by an after-tax benefit of $375 million related to the change in fair value of contingent consideration liabilities. Fourth quarter results in 2017 were impacted by net charges related to the December 2017 enactment of the Tax Cuts and 86 | 2018 Form 10-K Jobs Act, including an after-tax charge of $4.5 billion related to the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by after-tax benefits of $3.3 billion due to remeasurement of net deferred tax liabilities and other related impacts. Additional after-tax costs that impacted fourth quarter results in 2017 included $244 million for an intangible asset impairment charge, $221 million for a charge to increase litigation reserves, $205 million as a result of entering into a global strategic collaboration with Alector and $79 million related to the change in fair value of contingent consideration liabilities. 2018 Form 10-K | 87 Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 27, 2019 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-16 As discussed in Note 2 to the financial statements, the Company changed its method of accounting for the income tax consequences of intercompany transfers of assets other than inventory in 2018 due to the adoption of Accounting Standards Update (ASU) No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory . Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 27, 2019 88 | 2018 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, Robert A. Michael, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2018 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2018 . 2018 Form 10-K | 89 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 90 | 2018 Form 10-K Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2018 and 2017 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 27, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 27, 2019 2018 Form 10-K | 91 " +4,abbv,1231x10k," ITEM 1. BUSINESS Overview AbbVie (1) is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease and multiple sclerosis; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neurology, with additional targeted investment in cystic fibrosis and women's health. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. Segments AbbVie operates in one business segmentpharmaceutical products. See Note 15 to the Consolidated Financial Statements and the sales information related to HUMIRA included under Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations."" Products AbbVie's portfolio of products includes a broad line of therapies that address some of the world's most complex and serious diseases. HUMIRA. HUMIRA (adalimumab) is a biologic therapy administered as a subcutaneous injection. It is approved to treat the following autoimmune diseases in the United States, Canada and Mexico (collectively, North America) and in the European Union: Condition Principal Markets Rheumatoid arthritis (moderate to severe) North America, European Union Psoriatic arthritis North America, European Union Ankylosing spondylitis North America, European Union Adult Crohn's disease (moderate to severe) North America, European Union Plaque psoriasis (moderate to severe chronic) North America, European Union Juvenile idiopathic arthritis (moderate to severe polyarticular) North America, European Union Ulcerative colitis (moderate to severe) North America, European Union Axial spondyloarthropathy European Union Pediatric Crohn's disease (moderate to severe) North America, European Union Hidradenitis Suppurativa (moderate to severe) North America, European Union Pediatric enthesitis-related arthritis European Union Non-infectious intermediate, posterior and panuveitis North America, European Union HUMIRA is also approved in Japan for the treatment of intestinal Behet's disease. HUMIRA is sold in numerous other markets worldwide, including Japan, China, Brazil and Australia, and accounted for approximately 65% of AbbVie's total net revenues in 2017 . AbbVie continues to work on HUMIRA formulation and delivery enhancements to improve convenience and the overall patient experience. _______________________________________________________________________________ (1) As used throughout the text of this report on Form 10-K, the terms ""AbbVie"" or ""the company"" refer to AbbVie Inc., a Delaware corporation, or AbbVie Inc. and its consolidated subsidiaries, as the context requires. 2017 Form 10-K | 1 Oncology products. AbbVies oncology products target some of the most complex and difficult-to-treat cancers. These products are: IMBRUVICA. IMBRUVICA (ibrutinib) is a first-in-class, oral, once-daily therapy that inhibits a protein called Bruton's tyrosine kinase (BTK). IMBRUVICA was one of the first medicines to receive an FDA approval after being granted a Breakthrough Therapy Designation and IMBRUVICA is one of the few therapies to receive four separate designations. IMBRUVICA currently is approved for the treatment of adult patients with: Chronic lymphocytic leukemia (CLL)/Small lymphocytic lymphoma (SLL) and CLL/SLL with 17p deletion; Mantle cell lymphoma (MCL) who have received at least one prior therapy*; Waldenstrms macroglobulinemia (WM); Marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy*; and Chronic graft versus host disease (cGVHD) after failure of one or more lines of systemic therapy. _______________________________________________________________________________ * Accelerated approval was granted for this indication based on overall response rate. Continued approval for this indication may be contingent upon verification of clinical benefit in confirmatory trials. VENCLEXTA. VENCLEXTA (venetoclax) is approved to treat people with CLL with 17p deletion, who have received at least one prior treatment. VENCLEXTA is the first FDA-approved treatment that targets the B-cell lymphoma 2 (BCL-2) protein, which supports cancer cell growth and is overexpressed in many patients with CLL. VENCLEXTA has been approved in the EU for the treatment of CLL in patients with 17p deletion or TP53 mutation and are unsuitable for or have failed a B-cell receptor pathway inhibitor and for the treatment of CLL in absence of 17p deletion or TP53 mutation who have failed both chemoimmunotherapy and a B-cell receptor pathway inhibitor. Virology Products. AbbVie's virology products address unmet needs for patients living with HCV and HIV-1. HCV products. AbbVie's HCV products are: VIEKIRA PAK AND TECHNIVIE. VIEKIRA PAK (ombitasvir, paritaprevir and ritonavir tablets; dasabuvir tablets) is an all-oral, short-course, interferon-free therapy, with or without ribavirin, for the treatment of adult patients with genotype 1 chronic HCV, including those with compensated cirrhosis. In Europe, VIEKIRA PAK is marketed as VIEKIRAX + EXVIERA and is approved for use in patients with genotype 1 and genotype 4 HCV. AbbVie's TECHNIVIE (ombitasvir, paritaprevir and ritonavir) is FDA-approved for use in combination with ribavirin for the treatment of adults with genotype 4 HCV infection in the United States. MAVYRET/MAVIRET. MAVYRET (glecaprevir/pibrentasvir) is approved in the United States and European Union (MAVIRET) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). It is also indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. It is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. Additional Virology products. AbbVie's additional virology products include: KALETRA. KALETRA (lopinavir/ritonavir), which is also marketed as Aluvia in emerging markets, is a prescription anti-HIV-1 medicine that contains two protease inhibitors: lopinavir and ritonavir. KALETRA is used with other anti-HIV-1 medications as a treatment that maintains viral suppression in people with HIV-1. NORVIR. NORVIR (ritonavir) is a protease inhibitor that is indicated in combination with other antiretroviral agents for the treatment of HIV-1 infection. SYNAGIS. SYNAGIS (palivizumab) is a product marketed by AbbVie outside of the United States that protects at-risk infants from severe respiratory disease caused by RSV. 2 | 2017 Form 10-K Metabolics/Hormones products. Metabolic and hormone products target a number of conditions, including testosterone deficiency due to certain underlying conditions, exocrine pancreatic insufficiency and hypothyroidism. These products include: AndroGel. AndroGel (testosterone gel) is a testosterone replacement therapy for males diagnosed with symptomatic low testosterone due to certain underlying conditions that is available in two strengths: 1 percent and 1.62 percent. CREON. CREON (pancrelipase) is a pancreatic enzyme therapy for exocrine pancreatic insufficiency, a condition that occurs in patients with cystic fibrosis, chronic pancreatitis and several other conditions. Synthroid. Synthroid (levothyroxine sodium tablets, USP) is used in the treatment of hypothyroidism. AbbVie has the rights to sell AndroGel, CREON and Synthroid only in the United States. Endocrinology products. Lupron (leuprolide acetate), which is also marketed as Lucrin and LUPRON DEPOT, is a product for the palliative treatment of advanced prostate cancer, treatment of endometriosis and central precocious puberty and for the preoperative treatment of patients with anemia caused by uterine fibroids. Lupron is approved for daily subcutaneous injection and one-month, three-month, four-month and six-month intramuscular injection. Other products. AbbVie's other products include: Duopa and Duodopa (carbidopa and levodopa). AbbVie's levodopa-carbidopa intestinal gel for the treatment of advanced Parkinson's disease is marketed as Duopa in the United States and as Duodopa outside of the United States. Anesthesia products. Sevoflurane (sold under the trademarks Ultane and Sevorane) is an anesthesia product that AbbVie sells worldwide for human use. ZINBRYTA. ZINBRYTA (daclizumab) is a once-monthly, self-administered, subcutaneous treatment for relapsing forms of multiple sclerosis (MS), which was approved by the FDA in May 2016 and by the European Commission in July 2016. Due to the risk of serious liver damage, the use of ZINBRYTA is restricted to adult patients with relapsing forms of MS who have had an inadequate response to at least two disease modifying therapies (DMTs) and for whom treatment with any other DMT is contraindicated or otherwise unsuitable. Marketing, Sales and Distribution Capabilities AbbVie utilizes a combination of dedicated commercial resources, regional commercial resources and distributorships to market, sell and distribute its products worldwide. AbbVie directs its primary marketing efforts toward securing the prescription, or recommendation, of its brand of products by physicians, key opinion leaders and other health care providers. Managed care providers (for example, health maintenance organizations and pharmacy benefit managers), hospitals and state and federal government agencies (for example, the United States Department of Veterans Affairs and the United States Department of Defense) are also important customers. AbbVie also markets directly to consumers themselves, although in the United States all of the company's products must be sold pursuant to a prescription. Outside of the United States, AbbVie focuses its marketing efforts on key opinion leaders, payers, physicians and country regulatory bodies. AbbVie also provides patient support programs closely related to its products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Although AbbVie's business does not have significant seasonality, AbbVie's product revenues may be affected by end customer and retail buying patterns, fluctuations in wholesaler inventory levels and other factors. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. In 2017 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . No individual wholesaler accounted for greater than 42% of AbbVie's 2017 gross revenues in the United States. Outside the United States, sales are made either directly to customers or through distributors, depending on the market served. These wholesalers purchase product from AbbVie under standard terms and conditions of sale. Certain products are co-marketed or co-promoted with other companies. AbbVie has no single customer that, if the customer were lost, would have a material adverse effect on the company's business. No material portion of AbbVie's 2017 Form 10-K | 3 business is subject to renegotiation of profits or termination of contracts at the election of the government. Orders are generally filled on a current basis and order backlog is not material to AbbVie's business. Competition The markets for AbbVie's products are highly competitive. AbbVie competes with other research-based pharmaceuticals and biotechnology companies that discover, manufacture, market and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVie's virology products compete with other available HCV treatment options. The search for technological innovations in pharmaceutical products is a significant aspect of competition. The introduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. Price is also a competitive factor. In addition, the substitution of generic pharmaceutical products for branded pharmaceutical products creates competitive pressures on AbbVie's products that do not have patent protection. New products or treatments brought to market by AbbVies competitors could cause revenues for AbbVies products to decrease due to price reductions and sales volume decreases. Biosimilars. Competition for AbbVies biologic products is affected by the approval of follow-on biologics, also known as biosimilars. Biologics have added major therapeutic options for the treatment of many diseases, including some for which therapies were unavailable or inadequate. The advent of biologics has also raised complex regulatory issues and significant pharmacoeconomic concerns because the cost of developing and producing biologic therapies is typically dramatically higher than for conventional (small molecule) medications, and because many expensive biologic medications are used for ongoing treatment of chronic diseases, such as rheumatoid arthritis or inflammatory bowel disease, or for the treatment of previously untreatable cancer. Significant investments in biologics infrastructure and manufacturing are necessary to produce biologic products, as are significant investments in marketing, distribution, and sales organization activities, which may limit the number of biosimilar competitors. In the United States, the FDA regulates biologics under the Federal Food, Drug and Cosmetic Act, the Public Health Service Act and implementing regulations. The enactment of federal health care reform legislation in March 2010 provided a pathway for approval of biosimilars under the Public Health Service Act, but the approval process for, and science behind, biosimilars is more complex than the approval process for, and science behind, generic or other follow-on versions of small molecule products. This added complexity is due to steps needed to ensure that the safety and efficacy of biosimilars is highly similar to that of an original biologic, such as HUMIRA. Ultimate approval by the FDA is dependent upon many factors, including a showing that the biosimilar is ""highly similar"" to the original product and has no clinically meaningful differences from the original product in terms of safety, purity and potency. The types of data that could ordinarily be required in an application to show similarity may include analytical data and studies to demonstrate chemical similarity, animal studies (including toxicity studies) and clinical studies. The law also requires that the biosimilar must be for a condition of use approved for the original biologic and that the manufacturing facility meets the standards necessary to assure that the biosimilar is safe, pure and potent. Furthermore, the law provides that only a biosimilar product that is determined to be ""interchangeable"" will be considered substitutable for the original biologic product without the intervention of the health care provider who prescribed the original biologic product. To prove that a biosimilar product is interchangeable, the applicant must demonstrate that the product can be expected to produce the same clinical results as the original biologic product in any given patient, and if the product is administered more than once in a patient, that safety risks and potential for diminished efficacy of alternating or switching between the use of the interchangeable biosimilar biologic product and the original biologic product is no greater than the risk of using the original biologic product without switching. The law continues to be interpreted and implemented by the FDA. As a result, its ultimate impact, implementation and meaning remains subject to substantial uncertainty. In the European Union, while a pathway for the approval of biosimilars has existed since 2005, the products that have come to market to date have had a mixed impact on the market share of incumbent products, with significant variation by product. Other Competitive Products. Although a number of competitive biologic branded products have been approved since HUMIRA was first introduced in 2003, most have gained only a modest share of the worldwide market. AbbVie will continue to face competitive pressure from these biologics and from orally administered products. Intellectual Property Protection and Regulatory Exclusivity Generally, upon approval, products may be entitled to certain kinds of exclusivity under applicable intellectual property and regulatory regimes. AbbVies intellectual property is materially valuable to the company and AbbVie seeks patent protection, where available, in all significant markets and/or countries for each product in development. In the United States, the expiration date for patents is 20 years after the filing date. Given that patents relating to pharmaceutical products are 4 | 2017 Form 10-K often obtained early in the development process, and given the amount of time needed to complete clinical trials and other development activities required for regulatory approval, the length of time between product launch and patent expiration is significantly less than 20 years. The Drug Price Competition and Patent Term Restoration Act of 1984 (commonly known as the Hatch-Waxman Act) permits a patent holder to seek a patent extension, commonly called a patent term restoration, for patents on products (or processes for making the product) regulated by the Federal Food, Drug, and Cosmetic Act. The length of the patent extension is roughly based on 50 percent of the period of time from the filing of an Investigational New Drug Application (NDA) for a compound to the submission of the NDA for such compound, plus 100 percent of the time period from NDA submission to regulatory approval. The extension, however, cannot exceed five years and the patent term remaining after regulatory approval cannot exceed 14 years. Biological products licensed under the Public Health Service Act are similarly eligible for terms of patent restoration. Pharmaceutical products may be entitled to other forms of legal or regulatory exclusivity upon approval. The scope, length, and requirements for each of these exclusivities vary both in the United States and in other jurisdictions. In the United States, if the FDA approves a drug product that contains an active ingredient not previously approved, the product is typically entitled to five years of non-patent regulatory exclusivity. Other products may be entitled to three years of exclusivity if approval was based on the FDAs reliance on new clinical studies essential to approval submitted by the NDA applicant. If the NDA applicant studies the product for use by children, the FDA may grant pediatric exclusivity, which extends by 180 days the longest existing exclusivity (patent or regulatory) related to the product. For products that are either used to treat conditions that afflict a relatively small population or for which there is not a reasonable expectation that the research and development costs will be recovered, the FDA may designate the pharmaceutical as an orphan drug and grant it seven years of market exclusivity. Applicable laws and regulations dictate the scope of any exclusivity to which a product is entitled upon its approval in any particular country. In certain instances, regulatory exclusivity may protect a product where patent protection is no longer available or for a period of time in excess of patent protection. It is not possible to estimate for each product in development the total period and scope of exclusivity to which it may become entitled until regulatory approval is obtained. However, given the length of time required to complete clinical development of a pharmaceutical product, the periods of exclusivity that might be achieved in any individual case would not be expected to exceed a minimum of three years and a maximum of 14 years. These estimates do not consider other factors, such as the difficulty of recreating the manufacturing process for a particular product or other proprietary knowledge that may delay the introduction of a generic or other follow-on product after the expiration of applicable patent and other regulatory exclusivity periods. Biologics may be entitled to exclusivity under the Biologics Price Competition and Innovation Act, which was passed on March 23, 2010 as Title VII to the Patient Protection and Affordable Care Act. The law provides a pathway for approval of biosimilars following the expiration of 12 years of exclusivity for the innovator biologic and a potential additional 180 day-extension term for conducting pediatric studies. Biologics are also eligible for orphan drug exclusivity, as discussed above. The law also includes an extensive process for the innovator biologic and biosimilar manufacturer to litigate patent infringement, validity, and enforceability. The European Union has also created a pathway for approval of biosimilars and has published guidelines for approval of certain biosimilar products. The more complex nature of biologics and biosimilar products has led to greater regulatory scrutiny and more rigorous requirements for approval of follow-on biosimilar products than for small molecule generic pharmaceutical products, which can reduce the effect of biosimilars on sales of the innovator biologic as compared to the sales erosion caused by generic versions of small molecule pharmaceutical products. AbbVie owns or has licensed rights to a substantial number of patents and patent applications. AbbVie licenses or owns a patent portfolio of thousands of patent families, each of which includes United States patent applications and/or issued patents, and may also contain the non-United States counterparts to these patents and applications. These patents and applications, including various patents that expire during the period 2018 to the late 2030s, in aggregate are believed to be of material importance in the operation of AbbVies business. However, AbbVie believes that no single patent, license, trademark (or related group of patents, licenses, or trademarks), except for those related to adalimumab (which is sold under the trademark HUMIRA), are material in relation to the companys business as a whole. The United States composition of matter (that is, compound) patent covering adalimumab expired in December 2016, and the equivalent European Union patent is expected to expire in the majority of European Union countries in October 2018. In the United States, non-composition of matter patents covering adalimumab expire no earlier than 2022. In addition, the following patents, licenses, and trademarks are significant: those related to ibrutinib (which is sold under the trademark IMBRUVICA), those related to ombitasvir/paritaprevir/ritonavir and dasabuvir (which are sold under the trademarks VIEKIRA PAK, VIEKIRAX, EXVIERA, and HOLKIRA PAK), those related to glecaprevir and pibrentasvir (which are sold under the trademarks MAVYRET and MAVIRET), and those related to testosterone (which is sold under the trademark AndroGel). The United States composition of matter patent covering ibrutinib is expected to expire in 2027. The United States 2017 Form 10-K | 5 composition of matter patents covering ombitasvir, paritaprevir and dasabuvir are expected to expire in 2032, 2031 and 2029, respectively. The United States composition of matter patents covering glecaprevir and pibrentasvir are expected to expire in 2032. AbbVie may rely, in some circumstances, on trade secrets to protect its technology. However, trade secrets are difficult to protect. AbbVie seeks to protect its technology and product candidates, in part, by confidentiality agreements with its employees, consultants, advisors, contractors, and collaborators. These agreements may be breached and AbbVie may not have adequate remedies for any breach. In addition, AbbVies trade secrets may otherwise become known or be independently discovered by competitors. To the extent that AbbVies employees, consultants, advisors, contractors, and collaborators use intellectual property owned by others in their work for the company, disputes may arise as to the rights in related or resulting know-how and inventions. Licensing and Other Arrangements In addition to its independent efforts to develop and market products, AbbVie enters into arrangements such as licensing arrangements, strategic alliances, co-promotion arrangements, co-development and co-marketing agreements, and joint ventures. These licensing and other arrangements typically include, among other terms and conditions, non-refundable upfront license fees, milestone payments and royalty and/or profit sharing obligations. See Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Third Party Agreements AbbVie has agreements with third parties for process development, product distribution, analytical services and manufacturing of certain products. AbbVie procures certain products and services from a limited number of suppliers and, in some cases, a single supply source. In addition, AbbVie has agreements with third parties for active pharmaceutical ingredient and product manufacturing, formulation and development services, fill, finish and packaging services, transportation and distribution and logistics services for certain products. AbbVie does not believe that these manufacturing related agreements are material because AbbVie's business is not substantially dependent on any individual agreement. In most cases, AbbVie maintains alternate supply relationships that it can utilize without undue disruption of its manufacturing processes if a third party fails to perform its contractual obligations. AbbVie also maintains sufficient inventory of product to minimize the impact of any supply disruption. AbbVie is also party to certain collaborations and other arrangements, as discussed in Note 5 , "" Licensing, Acquisitions and Other Arrangements Other Licensing Acquisitions Activity,"" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ."" Sources and Availability of Raw Materials AbbVie purchases, in the ordinary course of business, raw materials and supplies essential to its operations from numerous suppliers around the world. In addition, certain medical devices and components necessary for the manufacture of AbbVie products are provided by unaffiliated third party suppliers. AbbVie has not experienced any recent significant availability problems or supply shortages that impacted fulfillment of product demand. Research and Development Activities AbbVie makes a significant investment in research and development and has numerous compounds in clinical development, including potential treatments for complex, life-threatening diseases. AbbVie's ability to discover and develop new compounds is enhanced by the company's use of integrated discovery and development project teams, which include chemists, biologists, physicians and pharmacologists who work on the same compounds as a team. AbbVie also partners with third parties, such as biotechnology companies, other pharmaceutical companies and academic institutions to identify and prioritize promising new treatments that complement and enhance AbbVies existing portfolio. The research and development process generally begins with discovery research which focuses on the identification of a molecule that has a desired effect against a given disease. If preclinical testing of an identified compound proves successful, the compound moves into clinical development which generally includes the following phases: Phase 1involves the first human tests in a small number of healthy volunteers or patients to assess safety, tolerability and potential dosing. Phase 2tests the drug's efficacy against the disease in a relatively small group of patients. 6 | 2017 Form 10-K Phase 3tests a drug that demonstrates favorable results in the earlier phases in a significantly larger patient population to further demonstrate efficacy and safety based on regulatory criteria. The clinical trials from all of the development phases provide the data required to prepare and submit an NDA, a Biological License Application (BLA) or other submission for regulatory approval to the FDA or similar government agencies outside the United States. The specific requirements (e.g., scope of clinical trials) for obtaining regulatory approval vary across different countries and geographic regions. The research and development process from discovery through a new drug launch typically takes 8 to 12 years and can be even longer. The research and development of new pharmaceutical products has a significant amount of inherent uncertainty. There is no guarantee when, or if, a molecule will receive the regulatory approval required to launch a new drug or indication. In addition to the development of new products and new formulations, research and development projects also may include Phase 4 trials, sometimes called post-marketing studies. For such projects, clinical trials are designed and conducted to collect additional data regarding, among other parameters, the benefits and risks of an approved drug. AbbVie spent approximately $5.0 billion in 2017 , $4.4 billion in 2016 and $4.3 billion in 2015 on research to discover and develop new products, indications and processes and to improve existing products and processes. These expenses consisted primarily of salaries and related expenses for personnel, license fees, consulting payments, contract research, clinical drug supply manufacturing, the costs of laboratory equipment and facilities, clinical trial costs and collaboration fees and expenses. RegulationDiscovery and Clinical Development United States. Securing approval to market a new pharmaceutical product in the United States requires substantial effort and financial resources and takes several years to complete. The applicant must complete preclinical tests and submit protocols to the FDA before commencing clinical trials. Clinical trials are intended to establish the safety and efficacy of the pharmaceutical product and typically are conducted in sequential phases, although the phases may overlap or be combined. If the required clinical testing is successful, the results are submitted to the FDA in the form of an NDA or BLA requesting approval to market the product for one or more indications. The FDA reviews an NDA or BLA to determine whether a product is safe and effective for its intended use and whether its manufacturing is compliant with current Good Manufacturing Practices (cGMP). Even if an NDA or a BLA receives approval, the applicant must comply with post-approval requirements. For example, holders of an approval must report adverse reactions, provide updated safety and efficacy information and comply with requirements concerning advertising and promotional materials and activities. Also, quality control and manufacturing procedures must continue to conform to cGMP after approval, and certain changes to the manufacturing procedures and finished product must be included in the NDA or BLA, and approved by the FDA. The FDA periodically inspects manufacturing facilities to assess compliance with cGMP, which imposes extensive procedural and record keeping requirements. In addition, as a condition of approval, the FDA may require post-marketing testing and surveillance to further assess and monitor the product's safety or efficacy after commercialization, which may require additional clinical trials or patient registries, or additional work on chemistry, manufacturing and controls. Any post-approval regulatory obligations, and the cost of complying with such obligations, could expand in the future. Outside the United States. AbbVie is subject to similar regulatory requirements outside the United States. AbbVie must obtain approval of a clinical trial application or product from the applicable regulatory authorities before it can commence clinical trials or marketing of the product. The approval requirements and process for each country can vary, and the time required to obtain approval may be longer or shorter than that required for FDA approval in the United States. For example, AbbVie may submit marketing authorizations in the European Union under either a centralized or decentralized procedure. The centralized procedure is mandatory for the approval of biotechnology products and many pharmaceutical products and provides for a single marketing authorization that is valid for all European Union member states. Under the centralized procedure, a single marketing authorization application is submitted to the European Medicines Agency (EMA). After the agency evaluates the application, it makes a recommendation to the European Commission, which then makes the final determination on whether to approve the application. The decentralized procedure provides for mutual recognition of individual national approval decisions and is available for products that are not subject to the centralized procedure. In Japan, applications for approval of a new product are made through the Pharmaceutical and Medical Devices Agency (PMDA). Bridging studies to demonstrate that the non-Japanese clinical data applies to Japanese patients may be required. After completing a comprehensive review, the PMDA reports to the Ministry of Health, Labour and Welfare, which then approves or denies the application. 2017 Form 10-K | 7 The regulatory process in many emerging markets continues to evolve. Many emerging markets, including those in Asia, generally require regulatory approval to have been obtained in a large developed market (such as the United States or Europe) before the country will begin or complete its regulatory review process. Some countries also require that local clinical studies be conducted in order to obtain regulatory approval in the country. The requirements governing the conduct of clinical trials and product licensing also vary. In addition, post-approval regulatory obligations such as adverse event reporting and cGMP compliance generally apply and may vary by country. For example, after a marketing authorization has been granted in the European Union, periodic safety reports must be submitted and other pharmacovigilance measures may be required (such as Risk Management Plans). RegulationCommercialization, Distribution and Manufacturing The manufacture, marketing, sale, promotion and distribution of AbbVie's products are subject to comprehensive government regulation. Government regulation by various national, regional, federal, state and local agencies, both in the United States and other countries, addresses (among other matters) inspection of, and controls over, research and laboratory procedures, clinical investigations, product approvals and manufacturing, labeling, packaging, marketing and promotion, pricing and reimbursement, sampling, distribution, quality control, post-marketing surveillance, record keeping, storage and disposal practices. AbbVie's operations are also affected by trade regulations in many countries that limit the import of raw materials and finished products and by laws and regulations that seek to prevent corruption and bribery in the marketplace (including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act, which provide guidance on corporate interactions with government officials) and require safeguards for the protection of personal data. In addition, AbbVie is subject to laws and regulations pertaining to health care fraud and abuse, including state and federal anti-kickback and false claims laws in the United States. Prescription drug manufacturers such as AbbVie are also subject to taxes, as well as application, product, user, establishment and other fees. Compliance with these laws and regulations is costly and materially affects AbbVie's business. Among other effects, health care regulations substantially increase the time, difficulty and costs incurred in obtaining and maintaining approval to market newly developed and existing products. AbbVie expects compliance with these regulations to continue to require significant technical expertise and capital investment to ensure compliance. Failure to comply can delay the release of a new product or result in regulatory and enforcement actions, the seizure or recall of a product, the suspension or revocation of the authority necessary for a product's production and sale and other civil or criminal sanctions, including fines and penalties. In addition to regulatory initiatives, AbbVie's business can be affected by ongoing studies of the utilization, safety, efficacy and outcomes of health care products and their components that are regularly conducted by industry participants, government agencies and others. These studies can call into question the utilization, safety and efficacy of previously marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of, or limitations on, marketing of such products domestically or worldwide, and may give rise to claims for damages from persons who believe they have been injured as a result of their use. Access to human health care products continues to be a subject of investigation and action by governmental agencies, legislative bodies and private organizations in the United States and other countries. A major focus is cost containment. Efforts to reduce health care costs are also being made in the private sector, notably by health care payers and providers, which have instituted various cost reduction and containment measures. AbbVie expects insurers and providers to continue attempts to reduce the cost of health care products. Outside the United States, many countries control the price of health care products directly or indirectly, through reimbursement, payment, pricing, coverage limitations, or compulsory licensing. Budgetary pressures in the United States and in other countries may also heighten the scope and severity of pricing pressures on AbbVie's products for the foreseeable future. United States. Specifically, U.S. federal laws require pharmaceutical manufacturers to pay certain statutorily-prescribed rebates to state Medicaid programs on prescription drugs reimbursed under state Medicaid plans, and the efforts by states to seek additional rebates affect AbbVie's business. Similarly, the Veterans Health Care Act of 1992, as a prerequisite to participation in Medicaid and other federal health care programs, requires that manufacturers extend additional discounts on pharmaceutical products to various federal agencies, including the United States Department of Veterans Affairs, Department of Defense and Public Health Service entities and institutions. In addition, recent legislative changes would require similarly discounted prices to be offered to TRICARE program beneficiaries. The Veterans Health Care Act of 1992 also established the 340B drug discount program, which requires pharmaceutical manufacturers to provide products at reduced prices to various designated health care entities and facilities. In the United States, most states also have generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed. In addition, the federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under 8 | 2017 Form 10-K Medicare or Medicaid and has implemented a prospective payment system (PPS) for services delivered in hospital outpatient, nursing home and home health settings. DRG and PPS entitle a health care facility to a fixed reimbursement based on the diagnosis and/or procedure rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. Medicare reimburses Part B drugs based on average sales price plus a certain percentage to account for physician administration costs, which have been reduced in the hospital outpatient setting. Medicare enters into contracts with private plans to negotiate prices for most patient-administered medicine delivered under Part D. Under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (together, the Affordable Care Act), AbbVie pays a fee related to its pharmaceuticals sales to government programs. In addition, AbbVie provides a discount of 50% for branded prescription drugs sold to patients who fall into the Medicare Part D coverage gap, or ""donut hole."" The Affordable Care Act also includes provisions known as the Physician Payments Sunshine Act, which require manufacturers of drugs and biologics covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to the Centers for Medicare and Medicaid Services for subsequent public disclosure. Similar reporting requirements have also been enacted on the state level in the United States, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring disclosure of interactions with health care professionals. Failure to report appropriate data may result in civil or criminal fines and/or penalties. AbbVie expects debate to continue during 2018 at all government levels worldwide over the marketing, availability, method of delivery and payment for health care products and services. AbbVie believes that future legislation and regulation in the markets it serves could affect access to health care products and services, increase rebates, reduce prices or the rate of price increases for health care products and services, change health care delivery systems, create new fees and obligations for the pharmaceuticals industry, or require additional reporting and disclosure. It is not possible to predict the extent to which AbbVie or the health care industry in general might be affected by the matters discussed above. AbbVie is subject to a Corporate Integrity Agreement (CIA) entered into by Abbott on May 7, 2012 that requires enhancements to AbbVie's compliance program and contains reporting obligations, including disclosure of financial payments to doctors. If AbbVie fails to comply with the CIA, the Office of Inspector General for the United States Department of Health and Human Services may impose monetary penalties or exclude AbbVie from federal health care programs, including Medicare and Medicaid. European Union. The European Union has adopted directives and other legislation governing labeling, advertising, distribution, supply, pharmacovigilance and marketing of pharmaceutical products. Such legislation provides mandatory standards throughout the European Union and permits member states to supplement these standards with additional regulations. European governments also regulate pharmaceutical product prices through their control of national health care systems that fund a large part of the cost of such products to consumers. As a result, patients are unlikely to use a pharmaceutical product that is not reimbursed by the government. In many European countries, the government either regulates the pricing of a new product at launch or subsequent to launch through direct price controls or reference pricing. In recent years, many countries have also imposed new or additional cost containment measures on pharmaceutical products. Differences between national pricing regimes create price differentials within the European Union that can lead to significant parallel trade in pharmaceutical products. Most governments also promote generic substitution by mandating or permitting a pharmacist to substitute a different manufacturer's generic version of a pharmaceutical product for the one prescribed and by permitting or mandating that health care professionals prescribe generic versions in certain circumstances. In addition, governments use reimbursement lists to limit the pharmaceutical products that are eligible for reimbursement by national health care systems. Japan. In Japan, the National Health Insurance system maintains a Drug Price List specifying which pharmaceutical products are eligible for reimbursement, and the Ministry of Health, Labour and Welfare sets the prices of the products on this list. The government generally introduces price cut rounds every other year and also mandates price decreases for specific products. New products judged innovative or useful, that are indicated for pediatric use, or that target orphan or small population diseases, however, may be eligible for a pricing premium. The government has also promoted the use of generics, where available. Emerging Markets. Many emerging markets take steps to reduce pharmaceutical product prices, in some cases through direct price controls and in others through the promotion of generic alternatives to branded pharmaceuticals. Since AbbVie markets its products worldwide, certain products of a local nature and variations of product lines must also meet other local regulatory requirements. Certain additional risks are inherent in conducting business outside the United 2017 Form 10-K | 9 States, including price and currency exchange controls, changes in currency exchange rates, limitations on participation in local enterprises, expropriation, nationalization and other governmental action. Environmental Matters AbbVie believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. AbbVie's capital expenditures for pollution control in 2017 were approximately $17 million and operating expenditures were approximately $28 million . In 2018 , capital expenditures for pollution control are estimated to be approximately $3 million and operating expenditures are estimated to be approximately $30 million . Abbott was identified as one of many potentially responsible parties in investigations and/or remediations at several locations in the United States, including Puerto Rico, under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. Some of these locations were transferred to AbbVie in connection with the separation and distribution, and AbbVie has become a party to these investigations and remediations. Abbott was also engaged in remediation at several other sites, some of which have been transferred to AbbVie in connection with the separation and distribution, in cooperation with the Environmental Protection Agency or similar agencies. While it is not feasible to predict with certainty the final costs related to those investigations and remediation activities, AbbVie believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the company's financial position, cash flows, or results of operations. Employees AbbVie employed approximately 29,000 persons as of January 31, 2018. Outside the United States, some of AbbVie's employees are represented by unions or works councils. AbbVie believes that it has good relations with its employees. Internet Information Copies of AbbVie's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through AbbVie's investor relations website ( www.abbvieinvestor.com ) as soon as reasonably practicable after AbbVie electronically files the material with, or furnishes it to, the Securities and Exchange Commission (SEC). AbbVie's corporate governance guidelines, outline of directorship qualifications, code of business conduct and the charters of AbbVie's audit committee, compensation committee, nominations and governance committee and public policy committee are all available on AbbVie's investor relations website ( www.abbvieinvestor.com ). "," ITEM 1A. RISK FACTORS You should carefully consider the following risks and other information in this Form 10-K in evaluating AbbVie and AbbVie's common stock. Any of the following risks could materially and adversely affect AbbVie's results of operations, financial condition or cash flows. The risk factors generally have been separated into two groups: risks related to AbbVie's business and risks related to AbbVie's common stock. Based on the information currently known to it, AbbVie believes that the following information identifies the most significant risk factors affecting it in each of these categories of risks. However, the risks and uncertainties AbbVie faces are not limited to those set forth in the risk factors described below and may not be in order of importance or probability of occurrence. Additional risks and uncertainties not presently known to AbbVie or that AbbVie currently believes to be immaterial may also adversely affect its business. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods. If any of the following risks and uncertainties develops into actual events, these events could have a material adverse effect on AbbVie's business, results of operations, financial condition or cash flows. In such case, the trading price of AbbVie's common stock could decline. 10 | 2017 Form 10-K Risks Related to AbbVie's Business The expiration or loss of patent protection and licenses may adversely affect AbbVie's future revenues and operating earnings. AbbVie relies on patent, trademark and other intellectual property protection in the discovery, development, manufacturing and sale of its products. In particular, patent protection is, in the aggregate, important in AbbVie's marketing of pharmaceutical products in the United States and most major markets outside of the United States. Patents covering AbbVie products normally provide market exclusivity, which is important for the profitability of many of AbbVie's products. As patents for certain of its products expire, AbbVie will or could face competition from lower priced generic products. The expiration or loss of patent protection for a product typically is followed promptly by substitutes that may significantly reduce sales for that product in a short amount of time. If AbbVie's competitive position is compromised because of generics or otherwise, it could have a material adverse effect on AbbVie's business and results of operations. In addition, proposals emerge from time to time for legislation to further encourage the early and rapid approval of generic drugs. Any such proposals that are enacted into law could increase the impact of generic competition. AbbVie's principal patents and trademarks are described in greater detail in Item 1 , "" Business Intellectual Property Protection and Regulatory Exclusivity"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations,"" and litigation regarding these patents is described in Item 3 , "" Legal Proceedings ."" The United States composition of matter patent for HUMIRA, which is AbbVie's largest product and had worldwide net revenues of approximately $18.4 billion in 2017 , expired in December 2016, and the equivalent European Union patent is expected to expire in the majority of European Union countries in October 2018. Because HUMIRA is a biologic and biologics cannot be readily substituted, it is uncertain what impact the loss of patent protection would have on the sales of HUMIRA. AbbVie's major products could lose patent protection earlier than expected, which could adversely affect AbbVie's future revenues and operating earnings. Third parties or government authorities may challenge or seek to invalidate or circumvent AbbVie's patents and patent applications. For example, manufacturers of generic pharmaceutical products file, and may continue to file, Abbreviated New Drug Applications with the FDA seeking to market generic forms of AbbVie's products prior to the expiration of relevant patents owned or licensed by AbbVie by asserting that the patents are invalid, unenforceable and/or not infringed. In addition, petitioners have filed, and may continue to file, challenges to the validity of AbbVie patents under the 2011 Leahy-Smith America Invents Act, which created inter partes review and post grant review procedures for challenging patent validity in administrative proceedings at the United States Patent and Trademark Office. Although most of the challenges to AbbVie's intellectual property have come from other businesses, governments may also challenge intellectual property rights. For example, court decisions and potential legislation relating to patents, such as legislation regarding biosimilars, and other regulatory initiatives may result in further erosion of intellectual property protection. In addition, certain governments outside the United States have indicated that compulsory licenses to patents may be sought to further their domestic policies or on the basis of national emergencies, such as HIV/AIDS. If triggered, compulsory licenses could diminish or eliminate sales and profits from those jurisdictions and negatively affect AbbVie's results of operations. AbbVie normally responds to challenges by vigorously defending its patents, including by filing patent infringement lawsuits. Patent litigation, administrative proceedings and other challenges to AbbVie's patents are costly and unpredictable and may deprive AbbVie of market exclusivity for a patented product. To the extent AbbVie's intellectual property is successfully challenged or circumvented or to the extent such intellectual property does not allow AbbVie to compete effectively, AbbVie's business will suffer. To the extent that countries do not enforce AbbVie's intellectual property rights or require compulsory licensing of AbbVie's intellectual property, AbbVie's future revenues and operating earnings will be reduced. A third party's intellectual property may prevent AbbVie from selling its products or have a material adverse effect on AbbVie's future profitability and financial condition. Third parties may claim that an AbbVie product infringes upon their intellectual property. Resolving an intellectual property infringement claim can be costly and time consuming and may require AbbVie to enter into license agreements. AbbVie cannot guarantee that it would be able to obtain license agreements on commercially reasonable terms. A successful claim of patent or other intellectual property infringement could subject AbbVie to significant damages or an injunction 2017 Form 10-K | 11 preventing the manufacture, sale, or use of the affected AbbVie product or products. Any of these events could have a material adverse effect on AbbVie's profitability and financial condition. Any significant event that adversely affects HUMIRA revenues could have a material and negative impact on AbbVie's results of operations and cash flows. HUMIRA accounted for approximately 65% of AbbVie's total net revenues in 2017 . Any significant event that adversely affects HUMIRA's revenues could have a material adverse impact on AbbVie's results of operations and cash flows. These events could include loss of patent protection for HUMIRA, the commercialization of biosimilars of HUMIRA, the discovery of previously unknown side effects or impaired efficacy, increased competition from the introduction of new, more effective or less expensive treatments and discontinuation or removal from the market of HUMIRA for any reason. AbbVie's research and development efforts may not succeed in developing and marketing commercially successful products and technologies, which may cause its revenues and profitability to decline. To remain competitive, AbbVie must continue to launch new products and new indications and/or brand extensions for existing products, and such launches must generate revenue sufficient both to cover its substantial research and development costs and to replace revenues of profitable products that are lost to or displaced by competing products or therapies. Failure to do so would have a material adverse effect on AbbVie's revenue and profitability. Accordingly, AbbVie commits substantial effort, funds, and other resources to research and development and must make ongoing substantial expenditures without any assurance that its efforts will be commercially successful. A high rate of failure in the biopharmaceutical industry is inherent in the research and development of new products, and failure can occur at any point in the research and development process, including after significant funds have been invested. Products that appear promising in development may fail to reach the market for numerous reasons, including failure to demonstrate effectiveness, safety concerns, superior safety or efficacy of competing therapies, failure to achieve positive clinical or pre-clinical outcomes beyond the current standards of care, inability to obtain necessary regulatory approvals or delays in the approval of new products and new indications, limited scope of approved uses, excessive costs to manufacture, the failure to obtain or maintain intellectual property rights, or infringement of the intellectual property rights of others. Decisions about research studies made early in the development process of a pharmaceutical product candidate can affect the marketing strategy once such candidate receives approval. More detailed studies may demonstrate additional benefits that can help in the marketing, but they also consume time and resources and may delay submitting the pharmaceutical product candidate for approval. AbbVie cannot guarantee that a proper balance of speed and testing will be made with respect to each pharmaceutical product candidate or that decisions in this area would not adversely affect AbbVie's future results of operations. Even if AbbVie successfully develops and markets new products or enhancements to its existing products, they may be quickly rendered obsolete by changing clinical preferences, changing industry standards, or competitors' innovations. AbbVie's innovations may not be accepted quickly in the marketplace because of existing clinical practices or uncertainty over third-party reimbursement. AbbVie cannot state with certainty when or whether any of its products under development will be launched, whether it will be able to develop, license, or otherwise acquire compounds or products, or whether any products will be commercially successful. Failure to launch successful new products or new indications for existing products may cause AbbVie's products to become obsolete, causing AbbVie's revenues and operating results to suffer. A portion of AbbVie's near-term pharmaceutical pipeline relies on collaborations with third parties, which may adversely affect the development and sale of its products. AbbVie depends on alliances with pharmaceutical and biotechnology companies for a portion of the products in its near-term pharmaceutical pipeline. For example, AbbVie is collaborating with Roche Holding AG to develop and commercialize a next-generation Bcl-2 inhibitor, Venclexta (venetoclax), for patients with relapsed/refractory chronic lymphocytic leukemia and AbbVie is investigating its efficacy for additional indications. Failures by these parties to meet their contractual, regulatory, or other obligations to AbbVie, or any disruption in the relationships between AbbVie and these third parties, could have an adverse effect on AbbVie's pharmaceutical pipeline and business. In addition, AbbVie's collaborative relationships for research and development extend for many years and may give rise to disputes regarding the relative rights, obligations and revenues of AbbVie and its collaboration partners, including the ownership of intellectual property and associated rights and obligations. This could result in the loss of intellectual property rights or protection, delay the development and sale of potential pharmaceutical products and lead to lengthy and expensive litigation, administrative proceedings or arbitration. 12 | 2017 Form 10-K Biologics carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful discovery, development, manufacturing and sale of biologics is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics. For example, access to and supply of necessary biological materials, such as cell lines, may be limited and governmental regulations restrict access to and regulate the transport and use of such materials. In addition, the development, manufacturing and sale of biologics is subject to regulations that are often more complex and extensive than the regulations applicable to other pharmaceutical products. Manufacturing biologics, especially in large quantities, is often complex and may require the use of innovative technologies. Such manufacturing also requires facilities specifically designed and validated for this purpose and sophisticated quality assurance and quality control procedures. Biologics are also frequently costly to manufacture because production inputs are derived from living animal or plant material, and some biologics cannot be made synthetically. Failure to successfully discover, develop, manufacture and sell biologicsincluding HUMIRAcould adversely impact AbbVie's business and results of operations. AbbVie's biologic products are subject to competition from biosimilars. The Biologics Price Competition and Innovation Act creates a framework for the approval of biosimilars in the United States and could allow competitors to reference data from biologic products already approved. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In addition, companies are developing biosimilars in other countries that could compete with AbbVies biologic products. As competitors are able to obtain marketing approval for biosimilars referencing AbbVies biologic products, AbbVies products may become subject to competition from such biosimilars, with the attendant competitive pressure and consequences. Expiration or successful challenge of AbbVies applicable patent rights could also trigger competition from other products, assuming any relevant exclusivity period has expired. As a result, AbbVie could face more litigation and administrative proceedings with respect to the validity and/or scope of patents relating to its biologic products. New products and technological advances by AbbVie's competitors may negatively affect AbbVie's results of operations. AbbVie competes with other research-based pharmaceutical and biotechnology companies that discover, manufacture, market, and sell proprietary pharmaceutical products and biologics. For example, HUMIRA competes with anti-TNF products and other competitive products intended to treat a number of disease states and AbbVies virology products compete with other available hepatitis C treatment options. These competitors may introduce new products or develop technological advances that compete with AbbVies products in therapeutic areas such as immunology, virology/liver disease, oncology and neuroscience. AbbVie cannot predict with certainty the timing or impact of the introduction by competitors of new products or technological advances. Such competing products may be safer, more effective, more effectively marketed or sold, or have lower prices or superior performance features than AbbVies products, and this could negatively impact AbbVies business and results of operations. The manufacture of many of AbbVie's products is a highly exacting and complex process, and if AbbVie or one of its suppliers encounters problems manufacturing AbbVie's products, AbbVie's business could suffer. The manufacture of many of AbbVie's products is a highly exacting and complex process, due in part to strict regulatory requirements. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for AbbVie's products, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in the types of products produced, physical limitations that could inhibit continuous supply, man-made or natural disasters and environmental factors. If problems arise during the production of a batch of product, that batch of product may have to be discarded and AbbVie may experience product shortages or incur added expenses. This could, among other things, lead to increased costs, lost revenue, damage to customer relations, time and expense spent investigating the cause and, depending on the cause, similar losses with respect to other batches or products. If problems are not discovered before the product is released to the market, recall and product liability costs may also be incurred. 2017 Form 10-K | 13 AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers, and an interruption in the supply of those products could adversely affect AbbVie's business and results of operations. AbbVie uses a number of products in its pharmaceutical and biologic manufacturing processes that are sourced from single suppliers. The failure of these single-source suppliers to fulfill their contractual obligations in a timely manner or as a result of regulatory noncompliance or physical disruption at a manufacturing site may impair AbbVie's ability to deliver its products to customers on a timely and competitive basis, which could adversely affect AbbVie's business and results of operations. Finding an alternative supplier could take a significant amount of time and involve significant expense due to the nature of the products and the need to obtain regulatory approvals. AbbVie cannot guarantee that it will be able to reach agreement with alternative providers or that regulatory authorities would approve AbbVie's use of such alternatives. AbbVie does, however, carry business interruption insurance, which provides a degree of protection in the case of a failure by a single-source supplier. Significant safety or efficacy issues could arise for AbbVie's products, which could have a material adverse effect on AbbVie's revenues and financial condition. Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, AbbVie may be required to amend the conditions of use for a product. For example, AbbVie may voluntarily provide or be required to provide updated information on a product's label or narrow its approved indication, either of which could reduce the product's market acceptance. If safety or efficacy issues with an AbbVie product arise, sales of the product could be halted by AbbVie or by regulatory authorities. Safety or efficacy issues affecting suppliers' or competitors' products also may reduce the market acceptance of AbbVie's products. New data about AbbVie's products, or products similar to its products, could negatively impact demand for AbbVie's products due to real or perceived safety issues or uncertainty regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about product misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of AbbVie's products or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of AbbVie's products. AbbVie is subject to product liability claims and lawsuits that may adversely affect its business and results of operations. In the ordinary course of business, AbbVie is the subject of product liability claims and lawsuits alleging that AbbVie's products or the products of other companies that it promotes have resulted or could result in an unsafe condition for or injury to patients. Product liability claims and lawsuits and safety alerts or product recalls, regardless of their ultimate outcome, may have a material adverse effect on AbbVie's business, results of operations and reputation and on its ability to attract and retain customers. Consequences may also include additional costs, a decrease in market share for the product in question, lower income and exposure to other claims. Product liability losses are self-insured. AbbVie is subject to cost-containment efforts and pricing pressures that could cause a reduction in future revenues and operating earnings, and changes in the terms of rebate and chargeback programs, which are common in the pharmaceuticals industry, could have a material adverse effect on AbbVie's operations. Cost-containment efforts by governments and private organizations are described in greater detail in Item 1, ""BusinessRegulationCommercialization, Distribution and Manufacturing."" To the extent these cost containment efforts are not offset by greater demand, increased patient access to health care, or other factors, AbbVie's future revenues and operating earnings will be reduced. In the United States, the European Union and other countries, AbbVie's business has experienced downward pressure on product pricing, and this pressure could increase in the future. AbbVie is subject to increasing public and legislative pressure with respect to pharmaceutical pricing. In the United States, practices of managed care groups, and institutional and governmental purchasers, and United States federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the Patient Protection and Affordable Care Act, contribute to pricing pressures. The potential for continuing 14 | 2017 Form 10-K changes to the health care system in the United States and the increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid and private sector beneficiaries could result in additional pricing pressures. In numerous major markets worldwide, the government plays a significant role in funding health care services and determining the pricing and reimbursement of pharmaceutical products. Consequently, in those markets, AbbVie is subject to government decision-making and budgetary actions with respect to its products. In particular, many European countries have ongoing government-mandated price reductions for many pharmaceutical products, and AbbVie anticipates continuing pricing pressures in Europe. Differences between countries in pricing regulations could lead to third-party cross-border trading in AbbVie's products that results in a reduction in future revenues and operating earnings. Rebates related to government programs, such as fee-for-service Medicaid or Medicaid managed care programs, arise from laws and regulations. AbbVie cannot predict if additional government initiatives to contain health care costs or other factors could lead to new or modified regulatory requirements that include higher or incremental rebates or discounts. Other rebate and discount programs arise from contractual agreements with private payers. Various factors, including market factors and the ability of private payers to control patient access to products, may provide payers the leverage to negotiate higher or additional rebates or discounts that could have a material adverse effect on AbbVie's operations. AbbVie is subject to numerous governmental regulations, and it can be costly to comply with these regulations and to develop compliant products and processes. AbbVie's products are subject to rigorous regulation by numerous international, supranational, federal and state authorities, as described in Item 1 , "" Business RegulationDiscovery and Clinical Development."" The process of obtaining regulatory approvals to market a pharmaceutical product can be costly and time consuming, and approvals might not be granted for future products, or additional indications or uses of existing products, on a timely basis, if at all. Delays in the receipt of, or failure to obtain approvals for, future products, or new indications and uses, could result in delayed realization of product revenues, reduction in revenues and substantial additional costs. In addition, AbbVie cannot guarantee that it will remain compliant with applicable regulatory requirements once approval has been obtained for a product. These requirements include, among other things, regulations regarding manufacturing practices, product labeling and advertising and post-marketing reporting, including adverse event reports and field alerts due to manufacturing quality concerns. AbbVie must incur expense and spend time and effort to ensure compliance with these complex regulations. Possible regulatory actions could result in substantial modifications to AbbVie's business practices and operations; refunds, recalls, or seizures of AbbVie's products; a total or partial shutdown of production in one or more of AbbVie's or its suppliers' facilities while AbbVie or its supplier remedies the alleged violation; the inability to obtain future approvals; and withdrawals or suspensions of current products from the market. Any of these events could disrupt AbbVie's business and have a material adverse effect on its business and results of operations. Laws and regulations affecting government benefit programs could impose new obligations on AbbVie, require it to change its business practices, and restrict its operations in the future. The health care industry is subject to various federal, state and international laws and regulations pertaining to government benefit programs reimbursement, rebates, price reporting and regulation and health care fraud and abuse. In the United States, these laws include anti-kickback and false claims laws, the Medicaid Rebate Statute, the Veterans Health Care Act and individual state laws relating to pricing and sales and marketing practices. Violations of these laws may be punishable by criminal and/or civil sanctions, including, in some instances, substantial fines, imprisonment and exclusion from participation in federal and state health care programs, including Medicare, Medicaid and Veterans Administration health programs. These laws and regulations are broad in scope and they are subject to change and evolving interpretations, which could require AbbVie to incur substantial costs associated with compliance or to alter one or more of its sales or marketing practices. In addition, violations of these laws, or allegations of such violations, could disrupt AbbVie's business and result in a material adverse effect on its business and results of operations. AbbVie could be subject to increased monetary penalties and/or other sanctions, including exclusion from federal health care programs, if it fails to comply with the terms of the May 7, 2012 resolution of the Department of Justice's investigation into sales and marketing activities for Depakote. On May 7, 2012, Abbott settled United States federal and 49 state investigations into its sales and marketing activities for Depakote by pleading guilty to a misdemeanor violation of the Food, Drug and Cosmetic Act, agreeing to pay 2017 Form 10-K | 15 approximately $700 million in criminal fines and forfeitures and approximately $900 million to resolve civil claims, and submitting to a term of probation. The term of probation ended January 1, 2016 upon AbbVie satisfying all of the probation conditions. However, if AbbVie violates any remaining terms of the plea agreement, it may face additional monetary sanctions and other such remedies as the court deems appropriate. In addition, Abbott entered into a five-year CIA with the Office of Inspector General for the United States Department of Health and Human Services (OIG). The effective date of the CIA is October 11, 2012. The obligations of the CIA have transferred to and become fully binding on AbbVie. The CIA requires enhancements to AbbVie's compliance program, fulfillment of reporting and monitoring obligations, management certifications and resolutions from AbbVie's board of directors, among other requirements. Compliance with the requirements of the settlement will impose additional costs and burdens on AbbVie, including in the form of employee training, third party reviews, compliance monitoring, reporting obligations and management attention. If AbbVie fails to comply with the CIA, the OIG may impose monetary penalties or exclude AbbVie from federal health care programs, including Medicare and Medicaid. AbbVie and Abbott may be subject to third party claims and shareholder lawsuits in connection with the settlement, and AbbVie may be required to indemnify all or a portion of Abbott's costs. The international nature of AbbVie's business subjects it to additional business risks that may cause its revenue and profitability to decline. AbbVie's business is subject to risks associated with doing business internationally, including in emerging markets. Net revenues outside of the United States make up approximately 35% of AbbVie's total net revenues in 2017 . The risks associated with AbbVie's operations outside the United States include: fluctuations in currency exchange rates; changes in medical reimbursement policies and programs; multiple legal and regulatory requirements that are subject to change and that could restrict AbbVie's ability to manufacture, market and sell its products; differing local product preferences and product requirements; trade protection measures and import or export licensing requirements; difficulty in establishing, staffing and managing operations; differing labor regulations; potentially negative consequences from changes in or interpretations of tax laws; political and economic instability, including sovereign debt issues; price and currency exchange controls, limitations on participation in local enterprises, expropriation, nationalization and other governmental action; inflation, recession and fluctuations in interest rates; potential deterioration in the economic position and credit quality of certain non-U.S. countries, including in Europe and Latin America; and potential penalties or other adverse consequences for violations of anti-corruption, anti-bribery and other similar laws and regulations, including the United States Foreign Corrupt Practices Act and the United Kingdom Bribery Act. Events contemplated by these risks may, individually or in the aggregate, have a material adverse effect on AbbVie's revenues and profitability. If AbbVie does not effectively and profitably commercialize IMBRUVICA, AbbVie's revenues and financial condition could be adversely affected. AbbVie must effectively and profitably commercialize IMBRUVICA by creating and meeting continued market demand; achieving market acceptance and generating product sales; ensuring that the active pharmaceutical ingredient for IMBRUVICA and the finished product are manufactured in sufficient quantities and in compliance with requirements of the FDA and similar foreign regulatory agencies and with acceptable quality and pricing to meet commercial demand; and ensuring that the entire supply chain efficiently and consistently delivers IMBRUVICA to AbbVie's customers. The commercialization of 16 | 2017 Form 10-K IMBRUVICA may not be successful due to, among other things, unexpected challenges from competitors, new safety issues or concerns being reported that may impact or narrow the approved indications, the relative price of IMBRUVICA as compared to alternative treatment options and changes to the label for IMBRUVICA that further restrict its marketing. If the commercialization of IMBRUVICA is unsuccessful, AbbVie's ability to generate revenue from product sales and realize the anticipated benefits of the merger with Pharmacyclics will be adversely affected. AbbVie may acquire other businesses, license rights to technologies or products, form alliances, or dispose of assets, which could cause it to incur significant expenses and could negatively affect profitability. AbbVie may pursue acquisitions, technology licensing arrangements, and strategic alliances, or dispose of some of its assets, as part of its business strategy. AbbVie may not complete these transactions in a timely manner, on a cost-effective basis, or at all, and may not realize the expected benefits. If AbbVie is successful in making an acquisition, the products and technologies that are acquired may not be successful or may require significantly greater resources and investments than originally anticipated. AbbVie may not be able to integrate acquisitions successfully into its existing business and could incur or assume significant debt and unknown or contingent liabilities. AbbVie could also experience negative effects on its reported results of operations from acquisition or disposition-related charges, amortization of expenses related to intangibles and charges for impairment of long-term assets. These effects could cause a deterioration of AbbVie's credit rating and result in increased borrowing costs and interest expense. Additionally, changes in AbbVie's structure, operations, revenues, costs, or efficiency resulting from major transactions such as acquisitions, divestitures, mergers, alliances, restructurings or other strategic initiatives, may result in greater than expected costs, may take longer than expected to complete or encounter other difficulties, including the need for regulatory approval where appropriate. AbbVie is dependent on wholesale distributors for distribution of its products in the United States and, accordingly, its results of operations could be adversely affected if they encounter financial difficulties. In 2017 , three wholesale distributors (McKesson Corporation, Cardinal Health, Inc. and AmerisourceBergen Corporation) accounted for substantially all of AbbVie's sales in the United States . If one of its significant wholesale distributors encounters financial or other difficulties, such distributor may decrease the amount of business that it does with AbbVie, and AbbVie may be unable to collect all the amounts that the distributor owes it on a timely basis or at all, which could negatively impact AbbVie's business and results of operations. AbbVie has debt obligations that could adversely affect its business and its ability to meet its obligations. The amount of debt that AbbVie has incurred and intends to incur could have important consequences to AbbVie and its investors. These consequences include, among other things, requiring a portion of AbbVie's cash flow from operations to make interest payments on this debt and reducing the cash flow available to fund capital expenditures and other corporate purposes and to grow AbbVie's business. To the extent AbbVie incurs additional indebtedness, these risks could increase. In addition, AbbVie's cash flow from operations may not be sufficient to repay all of the outstanding debt as it becomes due, and AbbVie may not be able to borrow money, sell assets, or otherwise raise funds on acceptable terms, or at all, to refinance its debt. AbbVie may need additional financing in the future to meet its capital needs or to make opportunistic acquisitions, and such financing may not be available on favorable terms, if at all. AbbVie may need to seek additional financing for its general corporate purposes. For example, it may need to increase its investment in research and development activities or need funds to make acquisitions. AbbVie may be unable to obtain any desired additional financing on terms favorable to it, if at all. If AbbVie loses its investment grade credit rating or adequate funds are not available on acceptable terms, AbbVie may be unable to fund its expansion, successfully develop or enhance products, or respond to competitive pressures, any of which could negatively affect AbbVie's business. If AbbVie raises additional funds by issuing debt or entering into credit facilities, it may be subject to limitations on its operations due to restrictive covenants. Failure to comply with these covenants could adversely affect AbbVie's business. 2017 Form 10-K | 17 AbbVie depends on information technology and a failure of those systems could adversely affect AbbVie's business. AbbVie relies on sophisticated information technology systems to operate its business. These systems are potentially vulnerable to malicious intrusion, random attack, loss of data privacy, or breakdown. Data privacy or security breaches by employees or others may cause sensitive data, including intellectual property, trade secrets or personal information belonging to AbbVie, its patients, customers or business partners, to be exposed to unauthorized persons or to the public. Although AbbVie has invested in the protection of its data and information technology and also monitors its systems on an ongoing basis, there can be no assurance that these efforts will prevent breakdowns or breaches in AbbVie's information technology systems that could adversely affect AbbVie's business. Other factors can have a material adverse effect on AbbVie's profitability and financial condition. Many other factors can affect AbbVie's results of operations, cash flows and financial condition, including: changes in or interpretations of laws and regulations, including changes in accounting standards, taxation requirements, product marketing application standards and environmental laws; differences between the fair value measurement of assets and liabilities and their actual value, particularly for pension and post-employment benefits, stock-based compensation, intangibles and goodwill; and for contingent liabilities such as litigation and contingent consideration, the absence of a recorded amount, or an amount recorded at the minimum, compared to the actual amount; changes in the rate of inflation (including the cost of raw materials, commodities and supplies), interest rates, market value of AbbVie's equity investments and the performance of investments held by it or its employee benefit trusts; changes in the creditworthiness of counterparties that transact business with or provide services to AbbVie or its employee benefit trusts; changes in the ability of third parties that provide information technology, accounting, human resources, payroll and other outsourced services to AbbVie to meet their contractual obligations to AbbVie; and changes in business, economic and political conditions, including: war, political instability, terrorist attacks, the threat of future terrorist activity and related military action; natural disasters; the cost and availability of insurance due to any of the foregoing events; labor disputes, strikes, slow-downs, or other forms of labor or union activity; and pressure from third-party interest groups. Risks Related to AbbVie's Common Stock AbbVie cannot guarantee the timing, amount, or payment of dividends on its common stock. Although AbbVie expects to pay regular cash dividends, the timing, declaration, amount and payment of future dividends to stockholders will fall within the discretion of AbbVie's board of directors. The board's decisions regarding the payment of dividends will depend on many factors, such as AbbVie's financial condition, earnings, capital requirements, debt service obligations, industry practice, legal requirements, regulatory constraints and other factors that the board deems relevant. For more information, see Item 5 , "" Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities ."" AbbVie's ability to pay dividends will depend on its ongoing ability to generate cash from operations and access capital markets. AbbVie cannot guarantee that it will continue to pay a dividend in the future. An AbbVie stockholder's percentage of ownership in AbbVie may be diluted in the future. In the future, a stockholder's percentage ownership in AbbVie may be diluted because of equity issuances for capital market transactions, equity awards that AbbVie will be granting to AbbVie's directors, officers and employees, acquisitions, or other purposes. AbbVie's employees have options to purchase shares of its common stock as a result of conversion of their Abbott stock options (in whole or in part) to AbbVie stock options. AbbVie anticipates its compensation committee will grant additional stock options or other stock-based awards to its employees. Such awards will have a dilutive effect on AbbVie's earnings per share, which could adversely affect the market price of AbbVie's common stock. From time to time, AbbVie will issue additional options or other stock-based awards to its employees under AbbVie's employee benefits plans. 18 | 2017 Form 10-K In addition, AbbVie's amended and restated certificate of incorporation authorizes AbbVie to issue, without the approval of AbbVie's stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over AbbVie's common stock respecting dividends and distributions, as AbbVie's board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of AbbVie's common stock. For example, AbbVie could grant the holders of preferred stock the right to elect some number of AbbVie's directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences AbbVie could assign to holders of preferred stock could affect the residual value of the common stock. Certain provisions in AbbVie's amended and restated certificate of incorporation and amended and restated by-laws, and of Delaware law, may prevent or delay an acquisition of AbbVie, which could decrease the trading price of AbbVie's common stock. AbbVie's amended and restated certificate of incorporation and amended and restated by-laws contain, and Delaware law contains, provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the bidder and to encourage prospective acquirors to negotiate with AbbVie's board of directors rather than to attempt a hostile takeover. These provisions include, among others: the inability of AbbVie's stockholders to call a special meeting; the division of AbbVie's board of directors into three classes of directors, with each class serving a staggered three-year term; a provision that stockholders may only remove directors for cause; the ability of AbbVie's directors, and not stockholders, to fill vacancies on AbbVie's board of directors; and the requirement that the affirmative vote of stockholders holding at least 80% of AbbVie's voting stock is required to amend certain provisions in AbbVie's amended and restated certificate of incorporation and AbbVie's amended and restated by-laws relating to the number, term and election of AbbVie's directors, the filling of board vacancies, the calling of special meetings of stockholders and director and officer indemnification provisions. In addition, Section 203 of the Delaware General Corporation Law provides that, subject to limited exceptions, persons that acquire, or are affiliated with a person that acquires, more than 15% of the outstanding voting stock of a Delaware corporation shall not engage in any business combination with that corporation, including by merger, consolidation or acquisitions of additional shares, for a three-year period following the date on which that person or its affiliates becomes the holder of more than 15% of the corporation's outstanding voting stock. AbbVie believes these provisions protect its stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with AbbVie's board of directors and by providing AbbVie's board of directors with more time to assess any acquisition proposal. These provisions are not intended to make the company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that AbbVie's board of directors determines is not in the best interests of AbbVie and AbbVie's stockholders. These provisions may also prevent or discourage attempts to remove and replace incumbent directors. 2017 Form 10-K | 19 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains certain forward looking statements regarding business strategies, market potential, future financial performance and other matters. The words ""believe,"" ""expect,"" ""anticipate,"" ""project"" and similar expressions, among others, generally identify ""forward looking statements,"" which speak only as of the date the statements were made. The matters discussed in these forward looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those projected, anticipated or implied in the forward looking statements. In particular, information included under Item 1 , "" Business ,"" Item 1A , "" Risk Factors ,"" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations "" contain forward looking statements. Where, in any forward looking statement, an expectation or belief as to future results or events is expressed, such expectation or belief is based on the current plans and expectations of AbbVie management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. Factors that could cause actual results or events to differ materially from those anticipated include the matters described under Item 1A , "" Risk Factors "" and Item 7 , "" Management's Discussion and Analysis of Financial Condition and Results of Operations ."" AbbVie does not undertake any obligation to update the forward-looking statements included in this Annual Report on Form 10-K to reflect events or circumstances after the date hereof, unless AbbVie is required by applicable securities law to do so. ", ITEM 1B. UNRESOLVED STAFF COMMENTS None. ," ITEM 2. PROPERTIES AbbVie's corporate offices are located at 1 North Waukegan Road, North Chicago, Illinois 60064-6400. AbbVie's manufacturing facilities are in the following locations: United States Outside the United States Abbott Park, Illinois* Campoverde di Aprilia, Italy Barceloneta, Puerto Rico Cork, Ireland Jayuya, Puerto Rico Ludwigshafen, Germany North Chicago, Illinois Singapore* Worcester, Massachusetts* Sligo, Ireland Wyandotte, Michigan* _______________________________________________________________________________ * Leased property. In addition to the above, AbbVie has other manufacturing facilities worldwide. AbbVie believes its facilities are suitable and provide adequate production capacity. There are no material encumbrances on AbbVie's owned properties. In the United States, including Puerto Rico, AbbVie has one distribution center. AbbVie also has research and development facilities in the United States located at: Abbott Park, Illinois; North Chicago, Illinois; Redwood City, California; South San Francisco, California; Sunnyvale, California; Cambridge, Massachusetts; and Worcester, Massachusetts. Outside the United States, AbbVie's principal research and development facilities are located in Ludwigshafen, Germany. 20 | 2017 Form 10-K "," ITEM 3. LEGAL PROCEEDINGS Information pertaining to legal proceedings is provided in Note 14 , "" Legal Proceedings and Contingencies "" to the Consolidated Financial Statements included under Item 8 , "" Financial Statements and Supplementary Data ,"" and is incorporated by reference herein. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Principal Market The principal market for AbbVie's common stock is the New York Stock Exchange (NYSE). AbbVie's common stock is also listed on the Chicago Stock Exchange and traded on various regional and electronic exchanges. Market Price Per Share High Low High Low First Quarter $66.79 $59.27 $59.81 $50.71 Second Quarter $73.67 $63.12 $65.37 $56.36 Third Quarter $90.95 $69.38 $68.12 $61.77 Fourth Quarter $99.10 $85.24 $65.05 $55.06 Stockholders There were 50,095 stockholders of record of AbbVie common stock as of January 31, 2018 . Dividends The following table summarizes quarterly cash dividends declared for the years ended December 31, 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 On October 27, 2017 , AbbVie's board of directors declared an increase in the quarterly cash dividend from $0.64 per share to $0.71 per share, payable on February 15, 2018 to stockholders of record as of January 12, 2018 . The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. Moreover, if AbbVie determines to pay any dividend in the future, there can be no assurance that it will continue to pay such dividends or the amount of such dividends. Performance Graph The following graph compares the cumulative total returns of AbbVie, the SP 500 Index and the NYSE Arca Pharmaceuticals Index. This graph covers the period from January 2, 2013 (the first day AbbVie's common stock began ""regular-way"" trading on the NYSE) through December 31, 2017 . This graph assumes $100 was invested in AbbVie common stock and each index on January 2, 2013 and also assumes the reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance. 24 | 2017 Form 10-K This performance graph is furnished and shall not be deemed ""filed"" with the SEC or subject to Section 18 of the Securities Exchange Act of 1934, nor shall it be deemed incorporated by reference in any of AbbVie's filings under the Securities Act of 1933, as amended. Issuer Purchases of Equity Securities Period (a) Total Number of Shares (or Units) Purchased (b) Average Price Paid per Share (or Unit) (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs October 1, 2017 - October 31, 2017 8,469 (1) $ 94.35 $ 4,536,288,945 November 1, 2017 - November 30, 2017 5,279,237 (1) $ 94.76 5,276,274 $ 4,036,289,077 December 1, 2017 - December 31, 2017 20,588 (1) $ 97.85 $ 4,036,289,077 Total 5,308,294 (1) 94.77 5,276,274 $ 4,036,289,077 1. In addition to AbbVie shares repurchased on the open market under a publicly announced program, if any, these shares included the shares deemed surrendered to AbbVie to pay the exercise price in connection with the exercise of employee stock options 4,552 in October; 1,855 in November; and 5,368 in December, with average exercise prices of $95.96 in October; $93.36 in November; and $97.33 in December. These shares also included the shares purchased on the open market for the benefit of participants in the AbbVie Employee Stock Purchase Plan 3,917 in October; 1,108 in November; and 15,220 in December. 2017 Form 10-K | 25 These shares do not include the shares surrendered to AbbVie to satisfy minimum tax withholding obligations in connection with the vesting or exercise of stock-based awards. On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. 26 | 2017 Form 10-K "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company) as of December 31, 2017 and 2016 and results of operations for each of the three years in the period ended December 31, 2017 . This commentary should be read in conjunction with the consolidated financial statements and accompanying notes appearing in Item 8 , "" Financial Statements and Supplementary Data ."" EXECUTIVE OVERVIEW Company Overview AbbVie is a global, research-based biopharmaceutical company formed in 2013 following separation from Abbott Laboratories (Abbott). AbbVie's mission is to use its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world's most complex and serious diseases. AbbVie's products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson's disease and multiple sclerosis; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines across such important medical specialties as immunology, oncology and neurology, with additional targeted investment in cystic fibrosis and women's health. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to pharmacies and patients. Outside the United States, sales are made either directly to customers or through distributors, depending on the market served. Certain products are co-marketed or co-promoted with other companies. AbbVie has approximately 29,000 employees. AbbVie operates in one business segmentpharmaceutical products. 2017 Financial Results AbbVie's strategy has focused on delivering strong financial results, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2017 included delivering worldwide net revenues of $28.2 billion , operating earnings of $9.6 billion and diluted earnings per share of $3.30 . Worldwide net revenues grew by 10% on a constant currency basis, driven primarily by the continued strength of HUMIRA, revenue growth related to IMBRUVICA and other key products including Creon and Duodopa and the launch of HCV product MAVYRET. These increases were partially offset by a decline in net revenues of HCV product VIEKIRA. Diluted earnings per share in 2017 was $3.30 and included net charges related to the December 2017 enactment of the Tax Cuts and Jobs Act . The net charges included $4.5 billion for the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries , partially offset by after-tax benefits of $3.3 billion due to the remeasurement of net deferred tax liabilities and other related impacts . Additional after-tax costs that impacted 2017 diluted earnings per share included the following: (i) $809 million related to the amortization of intangible assets; (ii) $625 million for the change in fair value of contingent consideration liabilities; (iii) $327 million for acquired in-process research and development (IPRD); (iv) litigation reserve charges of $286 million ; (v) an intangible asset impairment charge of $244 million ; (vi) milestone payments of $143 million ; and (vii) acquisition related costs of $49 million . These costs were partially offset by an after-tax benefit of $91 million due to a tax audit settlement. 2017 financial results also reflected continued added funding to support AbbVies emerging mid- and late-stage pipeline assets and continued investment in AbbVies growth brands. In 2017 , the company generated cash flows from operations of $10.0 billion , which AbbVie utilized to continue to enhance its pipeline through licensing and collaboration activities, pay cash dividends to stockholders of $4.1 billion and repurchase approximately 13 million shares for $1.0 billion in the open market. In October 2017 , AbbVie's board of directors declared a quarterly cash dividend of $0.71 per share of common stock payable in February 2018 . This reflected an increase of approximately 11% over the previous quarterly dividend of $0.64 per share of common stock. 28 | 2017 Form 10-K 2018 Strategic Objectives AbbVie's mission is to be an innovation-driven, patient-focused specialty biopharmaceutical company capable of achieving top-tier financial performance through outstanding execution and a consistent stream of innovative new medicines. AbbVie intends to continue to advance its mission in a number of ways, including: (i) growing revenues by diversifying revenue streams, driving late-stage pipeline assets to the market and ensuring strong commercial execution of new product launches; (ii) continued investment and expansion in its pipeline in support of opportunities in immunology, oncology and neurology as well as continued investment in key on-market products; (iii) expanding operating margins; and (iv) returning cash to shareholders via dividends and share repurchases. In addition, AbbVie anticipates several regulatory submissions and key data readouts from key clinical trials in the next twelve months. AbbVie expects to achieve its strategic objectives through: HUMIRA sales growth by driving biologic penetration across disease categories, maintaining market leadership and effectively managing biosimilar erosion. IMBRUVICA revenue growth driven by increasing market share with its eight currently approved indications in six different disease areas. The strong execution of new product launches, including MAVYRET. The favorable impact of pipeline products approved in 2017 or currently under regulatory review where approval is expected in 2018. These products are described in greater detail in the section labeled ""Research and Development"" included as part of this Item 7 . AbbVie remains committed to driving continued expansion of operating margins and expects to achieve this objective through continued leverage from revenue growth, the reduction of HUMIRA royalty expense, productivity initiatives in supply chain and ongoing efficiency programs to optimize manufacturing, commercial infrastructure, administrative costs and general corporate expenses. Research and Development Research and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative pharmaceutical products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies. AbbVie's pipeline currently includes more than 60 compounds or indications in clinical development individually or under collaboration or license agreements and is focused on such important medical specialties as immunology, oncology and neurology along with targeted investments in cystic fibrosis and women's health. Of these programs, more than 30 are in mid- and late-stage development. The following sections summarize transitions of significant programs from Phase 2 development to Phase 3 development as well as developments in significant Phase 3 and registration programs. AbbVie expects multiple Phase 2 programs to transition into Phase 3 programs in the next twelve months. Significant Programs and Developments Immunology Upadacitinib In June 2017, AbbVie announced that top-line results from the Phase 3 SELECT-NEXT clinical trial evaluating upadacitinib (ABT-494), the companys selective JAK1 inhibitor currently in late-stage development for rheumatoid arthritis (RA), met all primary and ranked secondary endpoints in patients with moderate to severe RA who did not adequately respond to treatment with conventional synthetic disease modifying anti-rheumatic drugs (DMARDs). The safety profile of upadacitinib was consistent with previously reported Phase 2 trials and no new safety signals were detected. In September 2017, AbbVie announced that top-line results from the Phase 3 SELECT-BEYOND clinical trial evaluating upadacitinib met all primary and ranked secondary endpoints in patients with moderate to severe RA who did not adequately respond or were intolerant to treatment with biologic DMARDs. The safety profile of upadacitinib was consistent with previously reported Phase 2 trials and the Phase 3 SELECT-NEXT clinical trial, with no new safety signals detected. 2017 Form 10-K | 29 In December 2017, AbbVie announced that top-line results from the Phase 3 SELECT-MONOTHERAPY clinical trial evaluating upadacitinib met all primary and key secondary endpoints in patients with moderate to severe RA who did not adequately respond to treatment with methotrexate. The safety profile of upadacitinib was consistent with previously reported Phase 3 SELECT clinical trials and Phase 2 trials, with no new safety signals detected. In 2017, AbbVie initiated Phase 3 clinical trials to evaluate the safety and efficacy of upadacitinib in subjects with moderately to severely active Crohns disease and in subjects with moderately to severely active psoriatic arthritis. In January 2018, the U.S. Food and Drug Administration (FDA) granted breakthrough therapy designation for upadacitinib in adult patients with moderate to severe atopic dermatitis who are candidates for systemic therapy. Risankizumab In October 2017, AbbVie announced that top-line results from three Phase 3 clinical trials evaluating risankizumab, an investigational interleukin-23 (IL-23) inhibitor, with 12-week dosing compared to ustekinumab and adalimumab met all co-primary and ranked secondary endpoints for the treatment of patients with moderate to severe chronic plaque psoriasis. The safety profile was consistent with all previously reported studies, and there were no new safety signals detected across the three studies. In December 2017, AbbVie announced that top-line results from the Phase 3 IMMhance clinical trial evaluating risankizumab at 16 weeks and 52 weeks of treatment compared to placebo met all primary and ranked secondary endpoints for the treatment of patients with moderate to severe plaque psoriasis. The safety profile was consistent with all previously reported Phase 3 studies, and there were no new safety signals detected across the Phase 3 program. In December 2017, AbbVie initiated a Phase 3 clinical trial to evaluate the safety and efficacy of risankizumab in subjects with moderately to severely active Crohns disease. Oncology IMBRUVICA In January 2017, the FDA approved IMBRUVICA for the treatment of patients with relapsed/refractory marginal zone lymphoma (MZL) who require systemic therapy and have received at least one prior anti-CD20-based therapy. This indication is approved under accelerated approval based on overall response rate (ORR) and continued approval may be contingent upon verification and description of clinical benefit in a confirmatory trial. MZL is a slow-growing form of non-Hodgkin's lymphoma. In August 2017, the FDA approved IMBRUVICA for the treatment of adult patients with chronic graft-versus-host-disease (cGVHD) after failure of one or more lines of systemic therapy. IMBRUVICA is the first therapy specifically approved for adults with cGVHD, a severe and potentially life-threatening consequence of stem cell or bone marrow transplant. This marked the sixth U.S. disease indication for IMBRUVICA since the medication's initial approval in 2013 and the first approved indication outside of cancer. In December 2017, AbbVie announced that the Phase 3 iNNOVATE clinical trial evaluating IMBRUVICA in combination with rituximab in patients with untreated (treatment-nave) and previously-treated Waldenstrms macroglobulinemia (WM) met its primary endpoint. This is the first and only treatment approved for newly or previously-treated patients with WM. VENCLEXTA In February 2017, AbbVie initiated a Phase 3 clinical trial to study the safety and efficacy of venetoclax in combination with azacitidine in treatment-nave elderly subjects with acute myeloid leukemia (AML) who are ineligible for standard induction therapy (high-dose chemotherapy). 30 | 2017 Form 10-K In May 2017, AbbVie initiated a Phase 3 clinical trial to evaluate if venetoclax when co-administered with low dose cytarabine (LDAC) improves overall survival (OS) versus LDAC and placebo, in treatment nave subjects with AML. In September 2017, AbbVie announced that top-line results from the Phase 3 MURANO clinical trial evaluating venetoclax tablets in combination with Rituxan (rituximab) met the primary endpoint of prolonged progression-free survival compared with bendamustine in combination with Rituxan in patients with relapsed/refractory chronic lymphocytic leukemia (CLL). In December 2017, AbbVie submitted a supplemental New Drug Application (sNDA) to the FDA for VENCLEXTA (venetoclax) in combination with Rituxan in patients with relapsed or refractory CLL and in January 2018, AbbVie submitted an sNDA for VENCLEXTA monotherapy in patients with CLL who have relapsed or are refractory to B-cell receptor inhibitors. Rova-T In February 2017, AbbVie initiated a Phase 3 clinical trial to evaluate the efficacy of rovalpituzumab tesirine (Rova-T) as maintenance therapy following first-line platinum based chemotherapy in participants with extensive stage small cell lung cancer (SCLC). In April 2017, AbbVie initiated a Phase 3 clinical trial to evaluate Rova-T compared with topotecan for subjects with advanced or metastatic SCLC with high levels of delta-like protein 3 who have first disease progression during or following front-line platinum-based chemotherapy. ABT-414 In November 2017, AbbVie presented results from the INTELLANCE-2 trial, a potential registration-enabling Phase 2 study evaluating depatuxizumab mafodotin (ABT-414), an investigational, antibody drug conjugate (ADC) targeting epidermal growth factor receptor (EGFR) alone or in combination with temozolomide (TMZ) in subjects with recurrent glioblastoma multiforme (GBM). Results from the INTELLANCE-2 study failed to meet the primary endpoint of overall survival and AbbVie will not be submitting regulatory applications for ABT-414 in recurrent GBM. In INTELLANCE-2, the combination of ABT-414 and TMZ performed numerically better than lomustine or TMZ and a positive trend in overall survival was observed. While AbbVie will not file in recurrent GBM based on these data, the Phase 2/3 INTELLANCE-1 trial evaluating the safety and efficacy of ABT-414 in combination with TMZ in subjects with newly diagnosed GBM with EGFR amplification is ongoing. Veliparib In April 2017, AbbVie announced that two Phase 3 studies evaluating veliparib, an investigational, oral poly (adenosine diphosphate-ribose) polymerase (PARP) inhibitor in combination with chemotherapy did not meet their primary endpoints. The studies evaluated veliparib in combination with carboplatin and paclitaxel in patients with squamous non-small cell lung cancer (NSCLC) and triple negative breast cancer (TNBC). Ongoing Phase 3 studies include non-squamous non-small cell lung cancer, BRCA1/2 breast cancer and ovarian cancer. Virology/Liver Disease In February 2017, the European Committee for Medicinal Products for Human Use (CHMP) granted a positive opinion for a shorter, eight-week treatment of VIEKIRAX (ombitasvir/paritaprevir/ritonavir tablets) + EXVIERA (dasabuvir tablets) as an option for previously untreated adult patients with genotype 1b chronic HCV and minimal to moderate fibrosis. In July 2017, the European Commission granted marketing authorization for MAVIRET (glecaprevir/pibrentasvir), a once-daily, ribavirin-free treatment for adults with HCV infection across all major genotypes (GT1-6). MAVIRET is also indicated for patients with specific treatment challenges, including those with compensated cirrhosis across all major genotypes, and those who previously had limited treatment options, such as patients with severe chronic kidney disease (CKD) or those with genotype 3 chronic HCV infection. In August 2017, the FDA approved MAVYRET (glecaprevir/pibrentasvir) for the treatment of patients with chronic HCV genotype 1-6 infection without cirrhosis and with compensated cirrhosis (Child-Pugh A). MAVYRET is also 2017 Form 10-K | 31 indicated for the treatment of adult patients with HCV genotype 1 infection, who previously have been treated with a regimen containing an HCV NS5A inhibitor or an NS3/4A protease inhibitor, but not both. MAVYRET/MAVIRET is an 8-week, pan-genotypic treatment for patients without cirrhosis and who are new to treatment. Other In September 2017, AbbVie submitted a New Drug Application to the FDA for elagolix, an investigational, orally administered gonadotropin-releasing hormone (GnRH) antagonist, being evaluated for the management of endometriosis with associated pain. In October, AbbVie was granted priority review for elagolix by the FDA for the management of endometriosis with associated pain. In November, AbbVie announced detailed results from two replicate Phase 3 extension studies evaluating the long-term efficacy and safety of elagolix, being evaluated for the management of endometriosis with associated pain. In December 2017, AbbVie announced the strategic decision to close the SONAR study, a Phase 3 clinical trial evaluating the effects of the investigational compound atrasentan on progression of kidney disease in patients with stage 2 to 4 chronic kidney disease and type 2 diabetes when added to standard of care. The ongoing monitoring of renal events observed in the study revealed considerably fewer endpoints than expected at the time of analysis, which will likely affect the ability to test the SONAR study hypothesis. Therefore, AbbVie determined that it cannot justify continuing the participation of patients in the study. The decision to close the SONAR study early was not related to any safety concerns. RESULTS OF OPERATIONS Net Revenues The comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and the current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another. Percent change At actual currency rates At constant currency rates for the years ended (dollars in millions) United States $ 18,251 $ 15,947 $ 13,561 14.4 % 17.6 % 14.4 % 17.6 % International 9,965 9,691 9,298 2.8 % 4.2 % 2.1 % 7.3 % Net revenues $ 28,216 $ 25,638 $ 22,859 10.1 % 12.2 % 9.8 % 13.5 % 32 | 2017 Form 10-K The following table details AbbVie's worldwide net revenues: Percent change At actual currency rates At constant currency rates Years ended December 31 (dollars in millions) HUMIRA United States $ 12,361 $ 10,432 $ 8,405 18.5 % 24.1 % 18.5 % 24.1 % International 6,066 5,646 5,607 7.4 % 0.7 % 6.7 % 4.3 % Total $ 18,427 $ 16,078 $ 14,012 14.6 % 14.7 % 14.4 % 16.1 % IMBRUVICA United States $ 2,144 $ 1,580 $ 35.8 % 100.0 % 35.8 % 100.0 % Collaboration revenues 70.0 % 100.0 % 70.0 % 100.0 % Total $ 2,573 $ 1,832 $ 40.5 % 100.0 % 40.5 % 100.0 % HCV United States $ $ $ (1.4 )% (57.4 )% (1.4 )% (57.4 )% International 1,180 (20.6 )% 41.3 % (20.5 )% 42.7 % Total $ 1,274 $ 1,522 $ 1,639 (16.3 )% (7.1 )% (16.2 )% (6.4 )% Lupron United States $ $ $ 0.8 % 1.5 % 0.8 % 1.5 % International 1.4 % (8.5 )% 0.5 % (5.2 )% Total $ $ $ 0.9 % (0.6 )% 0.7 % 0.1 % Creon United States $ $ $ 13.9 % 15.5 % 13.9 % 15.5 % Synagis International $ $ $ 1.2 % (1.5 )% 0.6 % (0.4 )% Synthroid United States $ $ $ 2.3 % 1.1 % 2.3 % 1.1 % AndroGel United States $ $ $ (14.5 )% (2.8 )% (14.5 )% (2.8 )% Kaletra United States $ $ $ (38.6 )% (28.8 )% (38.6 )% (28.8 )% International (18.8 )% (19.3 )% (21.1 )% (13.3 )% Total $ $ $ (22.9 )% (21.5 )% (24.7 )% (16.9 )% Sevoflurane United States $ $ $ (2.1 )% (1.0 )% (2.1 )% (1.0 )% International (4.6 )% (11.4 )% (3.7 )% (6.9 )% Total $ $ $ (4.1 )% (9.7 )% (3.4 )% (6.0 )% Duodopa United States $ $ $ 66.1 % 100.0 % 66.1 % 100.0 % International 14.6 % 16.9 % 13.1 % 18.1 % Total $ $ $ 21.1 % 26.9 % 19.8 % 28.1 % All other $ $ 1,217 $ 1,402 (18.0 )% (13.2 )% (18.2 )% (12.3 )% Total net revenues $ 28,216 $ 25,638 $ 22,859 10.1 % 12.2 % 9.8 % 13.5 % 2017 Form 10-K | 33 The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis. Global HUMIRA sales increased 14% in 2017 and 16% in 2016 . The sales increases in 2017 and 2016 were driven by market growth across therapeutic categories and geographies as well as favorable pricing in certain geographies. The sales increase in 2016 was also driven by the approval of new indications. In the United States, HUMIRA sales increased 18% in 2017 and 24% in 2016 . The sales increase in 2017 was driven by market growth across all indications and favorable pricing. The sales increase in 2016 was driven by market growth across all indications, higher market share and favorable pricing. Internationally, HUMIRA revenues increased 7% in 2017 and 4% in 2016 , driven primarily by market growth across indications. AbbVie continues to pursue strategies intended to further differentiate HUMIRA from competing products and add to the sustainability and future growth of HUMIRA. Net revenues for IMBRUVICA represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of IMBRUVICA profit. Net revenues for IMBRUVICA commenced following the completion of the Pharmacyclics acquisition on May 26, 2015. Global IMBRUVICA sales increased 40% in 2017 as a result of continued penetration of IMBRUVICA as a first-line treatment for patients with CLL as well as favorable pricing. The sales increase in 2016 was driven by market share gains following the FDA and EMA approval of IMBRUVICA as a first-line treatment for patients with CLL as well as having a full year of sales in 2016. Global HCV sales decreased 16% in 2017 and 6% in 2016 . The sales decrease in 2017 and 2016 was a result of market contraction, lower market share and price erosion of VIEKIRA. These factors were partially offset for 2017 by the launch of MAVYRET in certain geographies during the second half of 2017. Net revenues for Creon increased 14% in 2017 and 15% in 2016 , driven primarily by continued market growth and higher market share. Creon maintains market leadership in the pancreatic enzyme market. Global Kaletra net revenues decreased 25% in 2017 and 17% in 2016 , primarily due to lower market share resulting from the impact of increasing competition in the HIV marketplace. AbbVie expects net revenues for Kaletra to continue to decline in 2018 . Net revenues for Duodopa increased 20% in 2017 and 28% in 2016 , primarily as a result of market penetration and geographic expansion. Gross Margin Percent change years ended December 31 (dollars in millions) 2016 2017 Gross margin $ 21,176 $ 19,805 $ 18,359 % % as a percent of net revenues % % % Gross margin as a percentage of net revenues in 2017 decreased from 2016 primarily due to an intangible asset impairment charge of $354 million in 2017, as well as the unfavorable impacts of higher intangible asset amortization and the IMBRUVICA profit sharing arrangement. These drivers were partially offset by lower amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics as well as favorable changes in product mix and operational efficiencies. Gross margin as a percentage of net revenues in 2016 decreased from 2015 primarily due to unfavorable foreign exchange rates as well as unfavorable impacts of higher intangible asset amortization, the IMBRUVICA profit sharing arrangement and higher amortization of the fair market value step-up of acquisition-date inventory of Pharmacyclics. Additionally, 2016 gross margin included an intangible asset impairment charge of $39 million and 2015 gross margin included milestone revenue of $40 million from an oncology collaboration partner. These drivers were partially offset by favorable changes in product mix and operational efficiencies. 34 | 2017 Form 10-K Selling, General and Administrative Percent change years ended December 31 (dollars in millions) 2016 2017 Selling, general and administrative $ 6,275 $ 5,855 $ 6,387 % (8 )% as a percent of net revenues % % % SGA expenses as a percentage of net revenues in 2017 decreased from 2016 due to continued leverage from revenue growth partially offset by litigation reserve charges of $370 million in 2017 and new product launch expenses. SGA expenses as a percentage of net revenues in 2016 decreased from 2015 due to continued leverage from revenue growth and lower costs in 2016 . SGA expenses in 2015 included costs associated with the separation from Abbott of $265 million , Pharmacyclics acquisition and integration costs of $294 million and litigation reserve charges of $165 million . Additionally, SGA expense in 2015 reflected marketing support for the global launch of VIEKIRA. Research and Development and Acquired In-Process Research and Development Percent change years ended December 31 (dollars in millions) Research and development $ 4,982 $ 4,366 $ 4,285 % % as a percent of net revenues % % % Acquired in-process research and development $ $ $ % % Research and Development (RD) expenses in 2017 increased from 2016 principally due to increased funding to support the companys emerging mid- and late-stage pipeline assets, the impact of the post-acquisition RD expenses of Stemcentrx and Boehringer Ingelheim (BI) compounds and an increase in development milestones of $63 million . These factors were partially offset by a decrease in acquisition related costs of $135 million . RD expenses in 2016 increased from 2015 due primarily to increased funding to support the companys emerging mid- and late-stage pipeline assets. This increase was partially offset by the following factors: (i) 2015 RD expenses included a $350 million charge related to the purchase of a priority review voucher from a third party; (ii) development milestones decreased by $53 million; and (iii) 2015 results included restructuring charges of $32 million. Acquired in-process research and development (IPRD) expenses reflect upfront payments related to various collaborations. Acquired IPRD expense in 2017 included a charge of $205 million as a result of entering into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. There were no individually significant transactions or cash flows during 2016 . Acquired IPRD expense in 2015 included a charge of $100 million as a result of entering into an exclusive worldwide license agreement with C 2 N Diagnostics (C 2 N) to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders. See Note 5 to the Consolidated Financial Statements for additional information regarding the Alector and C 2 N agreements. Other Non-Operating Expenses years ended December 31 (in millions) Interest expense $ 1,150 $ 1,047 $ Interest income (146 ) (82 ) (33 ) Interest expense, net $ 1,004 $ $ Net foreign exchange loss $ $ $ Other expense, net Interest expense in 2017 increased compared to 2016 due to a full year of expense associated with the May 2016 issuance of $7.8 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Stemcentrx and to repay an outstanding term loan. 2017 Form 10-K | 35 Interest expense in 2016 increased compared to 2015 due to a full year of expense associated with the May 2015 issuance of $16.7 billion aggregate principal amount of senior notes which were issued primarily to finance the acquisition of Pharmacyclics in addition to the incremental expense associated with the May 2016 senior notes issuance discussed above. Interest expense in 2016 also included a debt extinguishment charge of $39 million related to the redemption of the 1.75% senior notes that were due to mature in November 2017. These increases were partially offset by the absence of bridge financing-related costs of $86 million in 2015 incurred in connection with the acquisition of Pharmacyclics. Interest income continued to increase in both 2017 and 2016 due to growth in the companys investment securities. Net foreign exchange loss in 2017 included $316 million of historical currency translation losses that were reclassified from accumulated other comprehensive income (AOCI) related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. Net foreign exchange loss in 2016 included losses totaling $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. See Note 10 to the Consolidated Financial Statements for additional information regarding the Venezuelan devaluation. Net foreign exchange loss in 2015 included losses of $170 million to complete the liquidation of the companys remaining foreign currency positions related to the terminated proposed combination with Shire. Other expense, net included charges related to the change in fair value of the BI and Stemcentrx contingent consideration liabilities of $626 million in 2017 and $228 million in 2016. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products still in development and other market-based factors. In 2017, the change in fair value represented mainly higher probabilities of success, the passage of time and declining interest rates. In 2016, the change in fair value represented mainly the passage of time, as increases to the BI contingent consideration liability due to higher probabilities of success were fully offset by the effects of rising interest rates and changes in other market-based assumptions. See Note 5 to the Consolidated Financial Statements for additional information regarding the acquisitions of Stemcentrx and BI compounds. Other expense, net for 2017 also included realized gains on available-for-sale investment securities of $90 million . Other expense, net for 2015 included impairment charges totaling $36 million related to certain of the company's equity investment securities. Income Tax Expense The effective income tax rate was 31% in 2017 , 24% in 2016 and 23% in 2015 . The effective tax rate in each period differed from the statutory tax rate principally due to the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions and business development activities. The increase in the effective tax rate for 2017 over the prior year was principally due to the estimated tax effects of the enactment of the Tax Cuts and Jobs Act (the Act) in 2017. The effective tax rate in 2017 included tax expense of $4.5 billion on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries, partially offset by a $3.6 billion net tax benefit for the remeasurement of deferred taxes related to the Act and foreign tax law changes. The Act significantly changed the U.S. corporate tax system. The Act reduces the U.S. federal corporate tax rate from 35% to 21% and creates a territorial tax system that includes new taxes on certain foreign sourced earnings. As a result, the effective income tax rate may change significantly in future periods. See Note 13 to the Consolidated Financial Statements for additional information regarding the Act. The effective tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances. FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions) Cash flows from: Operating activities $ 9,960 $ 7,041 $ 7,535 Investing activities (274 ) (6,074 ) (12,936 ) Financing activities (5,512 ) (3,928 ) 5,752 Operating cash flows in 2017 increased from 2016 primarily due to improved results of operations resulting from revenue growth, an improvement in operating earnings and a decrease in income tax payments. Operating cash flows in 2016 36 | 2017 Form 10-K decreased from 2015 primarily due to improved results of operations resulting from revenue growth and an improvement in operating margin, offset by income tax payments. Realized excess tax benefits associated with stock-based compensation totaled $71 million in 2017 and were presented within operating cash flows as a result of the adoption of a new accounting pronouncement. Prior to the adoption of the new accounting pronouncement, realized excess benefits of $55 million in 2016 and $61 million in 2015 were presented within cash flows from financing activities. See Note 2 to the Consolidated Financial Statements for additional information regarding the adoption of this new accounting pronouncement. Operating cash flows also reflected AbbVie's voluntary contributions, primarily to its principal domestic defined benefit plan of $150 million in 2017, 2016 and 2015 . In 2018, AbbVie plans to make voluntary contributions to its various defined benefit plans in excess of $750 million . Investing cash flows in 2017 included capital expenditures of $529 million and payments made for other acquisitions and investments of $308 million , partially offset by net sales and maturities of investment securities totaling $563 million . Investing cash flows in 2016 primarily included $1.9 billion of cash consideration paid to acquire Stemcentrx in June 2016, a $595 million upfront payment to acquire certain rights from BI in April 2016, net purchases of investment securities totaling $3.0 billion and capital expenditures of $479 million . Investing activities in 2015 primarily included $11.5 billion of cash consideration paid to acquire Pharmacyclics in May 2015 (net of cash acquired of $877 million ). Investing activities in 2015 also included cash outflows related to other acquisitions and investments of $964 million, including a $500 million payment to Calico, $100 million related to an exclusive worldwide license agreement with C 2 N to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders and $130 million paid to Infinity due to the achievement of a development milestone under the collaboration agreement. Cash flows from investing activities in 2015 also included capital expenditures of $532 million . In 2017 , 2016 and 2015 , the company issued and redeemed commercial paper. The balance of commercial paper outstanding was $400 million as of December 31, 2017 and $377 million as of December 31, 2016 . AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. In connection with the offering, AbbVie incurred $17 million of issuance costs. In May 2016, the company issued $7.8 billion aggregate principal amount of senior notes. Approximately $2.0 billion of the net proceeds were used to repay an outstanding term loan that was due to mature in November 2016, approximately $1.9 billion of the net proceeds were used to finance the acquisition of Stemcentrx and approximately $3.8 billion of the net proceeds were used to finance an ASR. See Note 12 to the Consolidated Financial Statements for additional information on the ASR transactions. In connection with the May 2016 issuance of senior notes, AbbVie incurred $52 million of issuance costs. In May 2015, the company issued $16.7 billion aggregate principal amount of unsecured senior notes. Approximately $11.5 billion of the net proceeds were used to finance the acquisition of Pharmacyclics and $5.0 billion of the net proceeds were used to finance an ASR. In 2015, the company paid $86 million of costs relating to an $18.0 billion , 364-Day Bridge Term Loan Credit Agreement (the bridge loan) as well as $93 million of costs relating to the May 2015 issuance of senior notes. No amounts were drawn under the bridge loan, which was terminated as a result of the issuance of the senior notes. In September 2015, AbbVie entered into a three-year $2.0 billion term loan credit facility and a 364-day $2.0 billion term loan credit facility. In November 2015, AbbVie drew on these term facilities and used the proceeds to refinance its $4.0 billion of senior notes that matured in 2015. Cash dividend payments totaled $4.1 billion in 2017 , $3.7 billion in 2016 and $3.3 billion in 2015 . The increase in cash dividend payments was primarily due to an increase in the dividend rate. On October 27, 2017 , AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.64 per share to $0.71 per share beginning with the dividend payable on February 15, 2018 to stockholders of record as of January 12, 2018 . This reflects an increase of approximately 11% over the previous quarterly rate. On February 15, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.71 per share to $0.96 per share beginning with the dividend payable on May 15, 2018 to stockholders of record as of April 13, 2018. The timing, declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors. In addition to the ASRs, under AbbVie's existing stock repurchase program, the company repurchased approximately 13 million shares for $1.0 billion in 2017 , approximately 34 million shares for $2.1 billion in 2016 and approximately 46 million shares for $2.8 billion in 2015 . AbbVie cash-settled $285 million of its December 2016 open market purchases in January 2017 and cash-settled $300 million of its December 2015 open market purchases in January 2016. The stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at management's 2017 Form 10-K | 37 discretion. The program has no time limit and can be discontinued at any time. AbbVie's remaining stock repurchase authorization was $4.0 billion as of December 31, 2017 . On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. In 2017, AbbVie paid $305 million of contingent consideration to BI related to a Phase 3 enrollment milestone. $268 million of this milestone was included in financing cash flows and $37 million was included in operating cash flows. Cash and equivalents were impacted by net favorable exchange rate changes totaling $29 million in 2017 , net unfavorable exchange rate changes totaling $338 million in 2016 and $300 million in 2015 . The favorable exchange rate changes in 2017 were primarily due to the strengthening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. The unfavorable exchange rate changes in 2016 were primarily due to the devaluation of AbbVie's net monetary assets denominated in the Venezuelan bolivar. The unfavorable exchange rate changes in 2015 were principally due to the weakening of the Euro and other foreign currencies on the translation of the company's Euro-denominated assets and cash denominated in foreign currencies. Prior to the enactment of the Tax Cuts and Jobs Act in December 2017, a significant portion of cash and equivalents were considered reinvested indefinitely in foreign subsidiaries. The enactment of U.S. tax reform significantly changed the U.S. corporate tax system, including imposing a mandatory one-time transition tax on previously untaxed earnings of foreign subsidiaries and the creation of a territorial tax system that generally allows the repatriation of future foreign sourced earnings without incurring additional U.S. taxes. The company has not fully completed its analysis and calculation of foreign earnings subject to the transition tax. The provisional estimate of the one-time transition tax was $4.5 billion and is generally payable in eight annual installments. AbbVie does not expect the transition tax liability to materially affect its liquidity and capital resources. Credit Risk AbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance against accounts receivable when it is probable they will not be collected. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables. AbbVie continues to do business with foreign governments in certain countries, including Greece, Portugal, Italy and Spain, which have historically experienced challenges in credit and economic conditions. Substantially all of AbbVie's trade receivables in Greece, Portugal, Italy and Spain are with government health systems. Outstanding governmental receivables in these countries, net of allowances for doubtful accounts, totaled $255 million as of December 31, 2017 and $244 million at December 31, 2016 . The company also continues to do business with foreign governments in certain oil-exporting countries that have experienced a deterioration in economic conditions, including Saudi Arabia and Russia, which may result in delays in the collection of receivables. Outstanding governmental receivables related to Saudi Arabia, net of allowances for doubtful accounts, were $149 million as of December 31, 2017 and $122 million as of December 31, 2016 . Outstanding governmental receivables related to Russia, net of allowances for doubtful accounts, were $152 million as of December 31, 2017 and $110 million as of December 31, 2016 . Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. Currently, AbbVie does not believe the economic conditions in oil-exporting countries will have a significant impact on the company's liquidity, cash flow or financial flexibility. However, if government funding were to become unavailable in these countries or if significant adverse changes in their reimbursement practices were to occur, AbbVie may not be able to collect the entire balance outstanding as of December 31, 2017 . Credit Facility, Access to Capital and Credit Ratings Credit Facility AbbVie currently has a $3.0 billion five -year revolving credit facility which matures in October 2019. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2017 , the company was in compliance with all its credit facility covenants. Commitment fees under the credit facility were insignificant. There were no amounts outstanding under the credit facility as of December 31, 2017 and 2016 . 38 | 2017 Form 10-K Access to Capital The company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations, or by issuing additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives. Credit Ratings There were no changes in the companys credit ratings in 2017. Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company's ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company's outstanding debt. 2017 Form 10-K | 39 Contractual Obligations The following table summarizes AbbVie's estimated contractual obligations as of December 31, 2017 : (in millions) Total Less than one year One to three years Three to five years More than five years Short-term borrowings $ $ $ $ $ Long-term debt and capital lease obligations, including current portion 37,612 6,026 5,469 5,938 20,179 Interest on long-term debt (a) 15,617 1,154 2,250 2,080 10,133 Future minimum non-cancelable operating lease commitments Purchase obligations and other (b) 1,135 Other long-term liabilities (c) (d) (e) (f) 10,605 1,135 1,610 1,331 6,529 Total $ 66,326 $ 9,830 $ 9,679 $ 9,546 $ 37,271 (a) Includes estimated future interest payments on long-term debt and capital lease obligations. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2017 . Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2017 . See Note 9 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 10 for additional information on the interest rate swap agreements outstanding at December 31, 2017 . (b) Includes the company's significant unconditional purchase obligations. These commitments do not exceed the company's projected requirements and are made in the normal course of business. (c) Amounts less than one year includes voluntary contributions in excess of $750 million that AbbVie plans to make to its various defined benefit plans subsequent to December 31, 2017 . Amounts otherwise exclude pension and other post-employment benefits and related deferred compensation cash outflows. Timing of funding is uncertain and dependent on future movements in interest rates and investment returns, changes in laws and regulations and other variables. Also included in this amount are components of other long-term liabilities including restructuring. See Note 8 to the Consolidated Financial Statements for additional information on restructuring and Note 11 for additional information on the pension and other post-employment benefit plans. (d) Excludes liabilities associated with the company's unrecognized tax benefits as it is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 13 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits. (e) Includes $4.5 billion of contingent consideration liabilities related to the acquisitions of Stemcentrx and BI compounds which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Notes 5 and 10 to the Consolidated Financial Statements for additional information regarding these liabilities. (f) Includes a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform, enacted in 2017. The one-time transition tax is generally payable in eight annual installments. See Note 13 to the Consolidated Financial Statements for additional information regarding the provisional estimates of these tax liabilities. AbbVie enters into RD collaboration arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements would happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. As a result, these potential payments are not included in the table of contractual obligations. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements. 40 | 2017 Form 10-K CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements . Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates. Revenue Recognition AbbVie recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability of the sales price is reasonably assured. Revenue from product sales is recognized when title and risk of loss have passed to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities. Rebate and chargeback accruals are recorded as a reduction to revenue in the period the related product is sold. Rebates and chargebacks totaled $12.9 billion in 2017 , $10.8 billion in 2016 and $8.6 billion in 2015 . Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings. The following table is an analysis of the three largest rebate accruals and chargeback allowances, which comprise approximately 92% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2017 . Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings. (in millions) Medicaid and Medicare Rebates Managed Care Rebates Wholesaler Chargebacks Balance at December 31, 2014 $ $ $ Provisions 1,716 2,215 3,866 Payments (1,396 ) (1,771 ) (3,756 ) Balance at December 31, 2015 1,032 Provisions 2,606 3,146 3,987 Payments (2,471 ) (2,899 ) (3,967 ) Balance at December 31, 2016 1,167 1,167 Provisions 2,909 3,990 5,026 Payments (2,736 ) (3,962 ) (4,887 ) Balance at December 31, 2017 $ 1,340 $ 1,195 $ 2017 Form 10-K | 41 Cash Discounts and Product Returns Cash discounts and product returns, which totaled $1.3 billion in 2017 , $964 million in 2016 and $898 million in 2015 , are recorded as a reduction to revenue in the same period the related product is sold. The reserve for cash discounts is readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Pension and Other Post-Employment Benefits AbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates. The significant assumptions used in determining these calculations are disclosed in Note 11 to the Consolidated Financial Statements . The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. Beginning in 2016, AbbVie also reflected the plans' specific cash flows and applied them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2017 . A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2018 and projected benefit obligations as of December 31, 2017 : 50 basis point (in millions) (brackets denote a reduction) Increase Decrease Defined benefit plans Service and interest cost $ (64 ) $ Projected benefit obligation (572 ) Other post-employment plans Service and interest cost $ (9 ) $ Projected benefit obligation (77 ) Effective December 31, 2015, AbbVie elected to change the method it uses to estimate the service and interest cost components of net periodic benefit costs. Historically, AbbVie estimated these service and interest cost components of this expense utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. In late 2015, AbbVie elected to utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. AbbVie elected to make this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. AbbVie accounted for this change prospectively as a change in accounting estimate that is inseparable from a change in accounting principle. This change reduced AbbVies net periodic benefit cost by approximately $41 million in 2016 . This change had no effect on the 2015 expense and did not affect the measurement of AbbVies total benefit obligations. The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2017 and will be used in the calculation of net periodic benefit cost in 2018 . A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2018 by $54 million . The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of 42 | 2017 Form 10-K December 31, 2017 and will be used in the calculation of net periodic benefit cost in 2018 . A one percentage point change in assumed health care cost trend rates would have the following effects on AbbVie's calculation of net periodic benefit costs in 2018 and the projected benefit obligation as of December 31, 2017 : One percentage point (in millions) (brackets denote a reduction) Increase Decrease Service and interest cost $ $ (24 ) Projected benefit obligation (140 ) Income Taxes AbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Litigation The company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 14 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected. Valuation of Goodwill and Intangible Assets AbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur with some frequency between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. IPRD acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPRD acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for further information. Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, which could have a significant effect on earnings or cash flows, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets using a quantitative impairment test. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The 2017 Form 10-K | 43 estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Contingent Consideration The fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2017 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $170 million . Additionally, at December 31, 2017 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $390 million . Recent Accounting Pronouncements See Note 2 to the Consolidated Financial Statements for additional information on recent accounting pronouncements. 44 | 2017 Form 10-K "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies. Foreign Currency Risk AbbVie's primary net foreign currency exposures are the Euro, Japanese yen and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2017 and 2016 : (in millions) Contract amount Weighted average exchange rate Fair and carrying value receivable/(payable) Contract amount Weighted average exchange rate Fair and carrying value receivable Receive primarily U.S. dollars in exchange for the following currencies: Euro $ 6,366 1.175 $ (88 ) $ 5,544 1.078 $ Japanese yen 112.4 111.6 British pound 1.310 (22 ) 1.303 All other currencies 1,877 n/a (18 ) 1,693 n/a Total $ 9,943 $ (126 ) $ 8,783 $ The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.0 billion at December 31, 2017 . If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes, which are exposed to foreign currency risk. The company has designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive income. See Note 9 to the Consolidated Financial Statements for additional information related to the senior Euro note issuance and Note 10 to the Consolidated Financial Statements for additional information related to the net investment hedging program. The functional currency of the companys Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2017 , AbbVies net monetary assets in Venezuela were insignificant. Interest Rate Risk The company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $509 million at December 31, 2017 . If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $2.2 billion at December 31, 2017 . A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 2017 Form 10-K | 45 Market Price Risk AbbVies debt securities investment portfolio (the portfolio) is its main exposure to market price risk. The portfolio is subject to changes in fair value as a result of interest rate fluctuations and other market factors. It is AbbVies policy to mitigate market price risk by maintaining a diversified portfolio that limits the amount of exposure to a particular issuer and security type while placing limits on the amount of time to maturity. AbbVies investment policy limits investments to investment grade credit ratings. The company estimates that an increase in interest rates of 100 basis points would decrease the fair value of the portfolio by approximately $34 million as of December 31, 2017 . If the portfolio were to be liquidated, the fair value reduction would affect the income statement in the period sold. Non-Publicly Traded Equity Securities AbbVie holds equity securities in other pharmaceutical and biotechnology companies that are not traded on public stock exchanges. The carrying value of these investments was $48 million as of December 31, 2017 and $42 million as of December 31, 2016 . AbbVie monitors these investments for other than temporary declines in market value and charges impairment losses to net earnings when an other than temporary decline in estimated value occurs. In 2017 and 2016 , impairment charges recorded were insignificant. In 2015, AbbVie recorded impairment charges totaling $36 million related to certain of the company's investments in non-publicly traded equity securities. 46 | 2017 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Financial Statements Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2017 Form 10-K | 47 AbbVie Inc. and Subsidiaries Consolidated Statements of Earnings years ended December 31 (in millions, except per share data) Net revenues $ 28,216 $ 25,638 $ 22,859 Cost of products sold 7,040 5,833 4,500 Selling, general and administrative 6,275 5,855 6,387 Research and development 4,982 4,366 4,285 Acquired in-process research and development Total operating costs and expenses 18,624 16,254 15,322 Operating earnings 9,592 9,384 7,537 Interest expense, net 1,004 Net foreign exchange loss Other expense, net Earnings before income tax expense 7,727 7,884 6,645 Income tax expense 2,418 1,931 1,501 Net earnings $ 5,309 $ 5,953 $ 5,144 Per share data Basic earnings per share $ 3.31 $ 3.65 $ 3.15 Diluted earnings per share $ 3.30 $ 3.63 $ 3.13 Cash dividends declared per common share $ 2.63 $ 2.35 $ 2.10 Weighted-average basic shares outstanding 1,596 1,622 1,625 Weighted-average diluted shares outstanding 1,603 1,631 1,637 The accompanying notes are an integral part of these consolidated financial statements. 48 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Comprehensive Income years ended December 31 (in millions) Net earnings $ 5,309 $ 5,953 $ 5,144 Foreign currency translation adjustments, net of tax expense (benefit) of $34 in 2017, $(31) in 2016 and $(139) in 2015 (165 ) (667 ) Net investment hedging activities, net of tax expense (benefit) of $(194) in 2017, $79 in 2016 and $ in 2015 (343 ) Pension and post-employment benefits, net of tax expense (benefit) of $(94) in 2017, $(75) in 2016 and $96 in 2015 (406 ) (135 ) Marketable security activities, net of tax expense (benefit) of $(8) in 2017, $(11) in 2016 and $22 in 2015 (46 ) (1 ) Cash flow hedging activities, net of tax expense (benefit) of $(26) in 2017, $18 in 2016 and $(6) in 2015 (342 ) (137 ) Other comprehensive loss (141 ) (25 ) (530 ) Comprehensive income $ 5,168 $ 5,928 $ 4,614 The accompanying notes are an integral part of these consolidated financial statements. 2017 Form 10-K | 49 AbbVie Inc. and Subsidiaries Consolidated Balance Sheets as of December 31 (in millions, except share data) Assets Current assets Cash and equivalents $ 9,303 $ 5,100 Short-term investments 1,323 Accounts receivable, net 5,088 4,758 Inventories 1,605 1,444 Prepaid expenses and other 4,741 3,562 Total current assets 21,223 16,187 Investments 2,090 1,783 Property and equipment, net 2,803 2,604 Intangible assets, net 27,559 28,897 Goodwill 15,785 15,416 Other assets 1,326 1,212 Total assets $ 70,786 $ 66,099 Liabilities and Equity Current liabilities Short-term borrowings $ $ Current portion of long-term debt and lease obligations 6,015 Accounts payable and accrued liabilities 10,226 9,379 Total current liabilities 16,641 9,781 Long-term debt and lease obligations 30,953 36,440 Deferred income taxes 2,490 6,890 Other long-term liabilities 15,605 8,352 Commitments and contingencies Stockholders equity Common stock, $0.01 par value, 4,000,000,000 shares authorized, 1,768,738,550 shares issued as of December 31, 2017 and 1,754,900,486 as of December 31, 2016 Common stock held in treasury, at cost, 176,607,525 shares as of December 31, 2017 and 162,387,762 as of December 31, 2016 (11,923 ) (10,852 ) Additional paid-in-capital 14,270 13,678 Retained earnings 5,459 4,378 Accumulated other comprehensive loss (2,727 ) (2,586 ) Total stockholders equity 5,097 4,636 Total liabilities and equity $ 70,786 $ 66,099 The accompanying notes are an integral part of these consolidated financial statements. 50 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Consolidated Statements of Equity years ended December 31 (in millions) Common shares outstanding Common stock Treasury stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total Balance at December 31, 2014 1,591 $ $ (972 ) $ 4,194 $ $ (2,031 ) $ 1,742 Net earnings 5,144 5,144 Other comprehensive loss, net of tax (530 ) (530 ) Dividends declared (3,431 ) (3,431 ) Common shares issued to Pharmacyclics stockholders 8,404 8,405 Purchases of treasury stock (119 ) (7,886 ) (7,886 ) Stock-based compensation plans and other Balance at December 31, 2015 1,610 (8,839 ) 13,080 2,248 (2,561 ) 3,945 Net earnings 5,953 5,953 Other comprehensive loss, net of tax (25 ) (25 ) Dividends declared (3,823 ) (3,823 ) Common shares issued to Stemcentrx stockholders 3,958 (35 ) 3,923 Purchases of treasury stock (94 ) (6,018 ) (6,018 ) Stock-based compensation plans and other Balance at December 31, 2016 1,593 (10,852 ) 13,678 4,378 (2,586 ) 4,636 Net earnings 5,309 5,309 Other comprehensive loss, net of tax (141 ) (141 ) Dividends declared (4,221 ) (4,221 ) Purchases of treasury stock (15 ) (1,125 ) (1,125 ) Stock-based compensation plans and other (7 ) Balance at December 31, 2017 1,592 $ $ (11,923 ) $ 14,270 $ 5,459 $ (2,727 ) $ 5,097 The accompanying notes are an integral part of these consolidated financial statements. 2017 Form 10-K | 51 AbbVie Inc. and Subsidiaries Consolidated Statements of Cash Flows years ended December 31 (in millions) (brackets denote cash outflows) Cash flows from operating activities Net earnings $ 5,309 $ 5,953 $ 5,144 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation Amortization of intangible assets 1,076 Change in fair value of contingent consideration liabilities Stock-based compensation Upfront costs and milestones related to collaborations Devaluation loss related to Venezuela Intangible asset impairment Impacts related to U.S. tax reform 1,242 Other, net Changes in operating assets and liabilities, net of acquisitions: Accounts receivable (391 ) (71 ) (1,076 ) Inventories (38 ) (434 ) Prepaid expenses and other assets (118 ) (393 ) Accounts payable and other liabilities (1,187 ) 1,503 Cash flows from operating activities 9,960 7,041 7,535 Cash flows from investing activities Acquisition of businesses, net of cash acquired (2,495 ) (11,488 ) Other acquisitions and investments (308 ) (262 ) (964 ) Acquisitions of property and equipment (529 ) (479 ) (532 ) Purchases of investment securities (2,230 ) (5,315 ) (851 ) Sales and maturities of investment securities 2,793 2,359 Other Cash flows from investing activities (274 ) (6,074 ) (12,936 ) Cash flows from financing activities Net change in short-term borrowings (29 ) (19 ) Proceeds from issuance of long-term debt 11,627 20,660 Repayments of long-term debt and lease obligations (25 ) (6,010 ) (4,018 ) Debt issuance costs (69 ) (182 ) Dividends paid (4,107 ) (3,717 ) (3,294 ) Purchases of treasury stock (1,410 ) (6,033 ) (7,586 ) Proceeds from the exercise of stock options Payments of contingent consideration liabilities (268 ) Other, net Cash flows from financing activities (5,512 ) (3,928 ) 5,752 Effect of exchange rate changes on cash and equivalents (338 ) (300 ) Net change in cash and equivalents 4,203 (3,299 ) Cash and equivalents, beginning of year 5,100 8,399 8,348 Cash and equivalents, end of year $ 9,303 $ 5,100 $ 8,399 Other supplemental information Interest paid, net of portion capitalized $ 1,099 $ $ Income taxes paid 1,696 3,563 1,108 Supplemental schedule of non-cash investing and financing activities Issuance of common shares associated with acquisitions of businesses 3,923 8,405 The accompanying notes are an integral part of these consolidated financial statements. 52 | 2017 Form 10-K AbbVie Inc. and Subsidiaries Notes to Consolidated Financial Statements Note 1 Background and Basis of Presentation Background The principal business of AbbVie Inc. (AbbVie or the company) is the discovery, development, manufacture and sale of a broad line of pharmaceutical products. AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to customers or through distributors, depending on the market served. AbbVie was incorporated in Delaware on April 10, 2012. On January 1, 2013, AbbVie became an independent, publicly-traded company as a result of the distribution by Abbott Laboratories (Abbott) of 100% of the outstanding common stock of AbbVie to Abbott's shareholders. AbbVie incurred separation-related expenses of $270 million in 2015, which were principally classified in selling, general and administrative expenses (SGA) in the consolidated statements of earnings. Basis of Historical Presentation For a certain portion of AbbVies operations, the legal transfer of AbbVies assets (net of liabilities) did not occur with the separation of AbbVie on January 1, 2013 due to the time required to transfer marketing authorizations and satisfy other regulatory requirements in certain countries. Under the terms of the separation agreement with Abbott, AbbVie was responsible for the business activities conducted by Abbott on its behalf and was subject to the risks and entitled to the benefits generated by these operations and assets. As a result, the related assets and liabilities and results of operations were reported in AbbVies consolidated financial statements. All of these operations were transferred to AbbVie as of December 31, 2016. Net revenues related to these operations were insignificant in 2016 and were $213 million in 2015 . Note 2 Summary of Significant Accounting Policies Use of Estimates The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) and necessarily include amounts based on estimates and assumptions by management. Actual results could differ from those amounts. Significant estimates include amounts for rebates, pension and other post-employment benefits, income taxes, litigation, valuation of goodwill and intangible assets, contingent consideration liabilities, financial instruments and inventory and accounts receivable exposures. Basis of Consolidation The consolidated financial statements include the accounts of AbbVie and all of its subsidiaries in which a controlling interest is maintained. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, where AbbVie is determined to be the primary beneficiary. Investments in companies over which AbbVie has a significant influence but not a controlling interest are accounted for using the equity method with AbbVie's share of earnings or losses reported in other expense, net in the consolidated statements of earnings. All other investments are generally accounted for using the cost method. Intercompany balances and transactions are eliminated. Certain reclassifications have been made to conform the prior period consolidated financial statements to the current period presentation. Revenue Recognition AbbVie recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability of the sales price is reasonably assured. Revenue from product sales is recognized when title and risk of loss have passed to the customer. Provisions for discounts, rebates, sales incentives to customers, returns and other adjustments are provided for in the period the related revenues are recorded. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual include the identification of the products subject to the 2017 Form 10-K | 53 rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant. Sales incentives to customers are insignificant. Historical data is readily available and reliable and is used for estimating the amount of the reduction in gross revenues. Revenue from the launch of a new product, from an improved version of an existing product, or for shipments in excess of a customer's normal requirements are recorded when the conditions noted above are met. In those situations, management records a returns reserve for such revenue, if necessary. Sales of product rights for marketable products are recorded as revenue upon disposition of the rights. Research and Development Expenses Internal research and development (RD) costs are expensed as incurred. Clinical trial costs incurred by third parties are expensed as the contracted work is performed. Where contingent milestone payments are due to third parties under research and development collaborations for pre-commercialization milestones, the milestone payment obligations are expensed when the milestone results are achieved. Payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the remaining useful life of the related product. Collaborations and Other Arrangements The company enters into collaborative agreements with third parties to develop and commercialize drug candidates. Collaborative activities may include joint research and development and commercialization of new products. AbbVie generally receives certain licensing rights under these arrangements. These collaborations often require upfront payments and may include additional milestone, research and development cost sharing, royalty or profit share payments, contingent upon the occurrence of certain future events linked to the success of the asset in development and commercialization. Upfront payments associated with collaborative arrangements during the development stage are expensed to acquired in-process research and development (IPRD) expenses in the consolidated statements of earnings. Subsequent payments made to the partner for the achievement of milestones during the development stage are expensed to RD expense in the consolidated statements of earnings when the milestone is achieved. Milestone payments made to the partner subsequent to regulatory approval are capitalized as intangible assets and amortized to cost of products sold over the estimated useful life of the related asset. Royalties are expensed to cost of products sold in the consolidated statements of earnings when incurred. Advertising Costs associated with advertising are expensed as incurred and are included in SGA in the consolidated statements of earnings. Advertising expenses were $846 million in 2017 , $764 million in 2016 and $704 million in 2015 . Pension and Other Post-Employment Benefits AbbVie records annual expenses relating to its defined benefit pension and other post-employment benefit plans based on calculations which utilize various actuarial assumptions, including discount rates, rates of return on assets, compensation increases, turnover rates and health care cost trend rates. AbbVie reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends. Actuarial gains and losses are deferred in accumulated other comprehensive loss (AOCI), net of tax and are amortized over the remaining service attribution periods of the employees under the corridor method. Differences between the expected long-term return on plan assets and the actual annual return are amortized to net periodic benefit cost over a five -year period. Income Taxes Income taxes are accounted for under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pretax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. Cash and Equivalents Cash and equivalents include money market funds and time deposits with original maturities of three months or less. Investments Investments consist primarily of time deposits, marketable debt securities, held-to-maturity debt securities and equity securities. Investments in marketable securities are classified as available-for-sale and are recorded at fair value with any unrealized holding gains or losses, net of tax, included in AOCI on the consolidated balance sheets. Investments in equity securities that are not traded on public stock exchanges and held-to-maturity debt securities are recorded at cost. 54 | 2017 Form 10-K AbbVie periodically assesses its investment securities for other-than-temporary impairment losses. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, intent to sell, or whether AbbVie will more likely than not be required to sell the security before recovery of its amortized cost basis. AbbVie also considers industry factors and general market trends. When AbbVie determines that an other than temporary decline has occurred, a cost basis investment is written down with a charge to other expense (income), net in the consolidated statements of earnings and an available-for-sale investment's unrealized loss is reclassified from AOCI to other expense (income), net in the consolidated statements of earnings. Realized gains and losses on sales of investments are computed using the first-in, first-out method adjusted for any other-than-temporary declines in fair value that were recorded in net earnings. Accounts Receivable Accounts receivable are stated at their net realizable value. The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the receivables portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available information. Accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. The allowance for doubtful accounts was $58 million at December 31, 2017 and $72 million at December 31, 2016 . Inventories Inventories are valued at the lower of cost (first-in, first-out basis) or market. Cost includes material and conversion costs. Inventories consisted of the following: as of December 31 (in millions) Finished goods $ $ Work-in-process 1,080 Raw materials Inventories $ 1,605 $ 1,444 Property and Equipment as of December 31 (in millions) Land $ $ Buildings 1,428 1,344 Equipment 5,991 5,726 Construction in progress Property and equipment, gross 8,071 7,526 Less accumulated depreciation (5,268 ) (4,922 ) Property and equipment, net $ 2,803 $ 2,604 Depreciation for property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful life for buildings ranges from 10 to 50 years. Buildings include leasehold improvements which are amortized over the life of the related facility lease (including any renewal periods, if appropriate) or the asset, whichever is shorter. The estimated useful life for equipment ranges from 2 to 25 years. Equipment includes certain computer software and software development costs incurred in connection with developing or obtaining software for internal use and is amortized over 3 to 10 years. Depreciation expense was $425 million in 2017 , $425 million in 2016 and $417 million in 2015 . Assets related to capital leases were insignificant at December 31, 2017 and 2016 . Litigation and Contingencies Loss contingency provisions are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on existing information. When a best estimate cannot be made, the minimum loss contingency amount in a probable range is recorded. Legal fees are expensed as incurred. AbbVie accrues for product liability claims on an undiscounted basis. The liabilities are evaluated quarterly and adjusted if necessary as additional information becomes available. Receivables for insurance recoveries for product liability claims, if any, are recorded as assets on an undiscounted basis when it is probable that a recovery will be realized. 2017 Form 10-K | 55 Business Combinations AbbVie utilizes the acquisition method of accounting for business combinations. This method requires, among other things, that r esults of operations of acquired companies are included in AbbVie's results of operations beginning on the respective acquisition dates and that assets acquired and liabilities assumed are recognized at fair value as of the acquisition date. Any excess of the fair value of consideration transferred over the fair values of the net assets acquired is recognized as goodwill. Contingent consideration liabilities are recognized at the estimated fair value on the acquisition date. Subsequent changes to the fair value of contingent consideration liabilities are recognized in other expense (income), net in the consolidated statements of earnings. The fair value of assets acquired and liabilities assumed in certain cases may be subject to revision based on the final determination of fair value during a period of time generally not to exceed twelve months from the acquisition date. Legal costs, due diligence costs, business valuation costs and all other business acquisition costs are expensed when incurred. Goodwill and Intangible Assets Intangible assets acquired in a business combination are recorded at fair value using a discounted cash flow model. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, the cost of capital and terminal values of market participants. Definite-lived intangibles are amortized over their estimated useful lives using the estimated pattern of economic benefit. AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. AbbVie first compares the projected undiscounted cash flows to be generated by the asset to its carrying value. If the undiscounted cash flows of an intangible asset are less than the carrying value, the intangible asset is written down to its fair value. Where cash flows cannot be identified for an individual asset, the review is applied at the lowest level for which cash flows are largely independent of the cash flows of other assets and liabilities. Goodwill and indefinite-lived assets are not amortized, but are subject to an impairment review annually and more frequently when indicators of impairment exist. An impairment of goodwill could occur if the carrying amount of a reporting unit exceeded the fair value of that reporting unit. An impairment of indefinite-lived intangible assets would occur if the fair value of the intangible asset is less than the carrying value. The company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets using a quantitative impairment test. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, future foreign currency exchange rates, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views of a company and similar companies. The use of alternative estimates and assumptions could increase or decrease the estimated fair value of the assets and potentially result in different impacts to the company's results of operations. Actual results may differ from the company's estimates. Acquired In-Process Research and Development In an asset acquisition, the initial costs of rights to IPRD projects acquired are expensed as IPRD in the consolidated statements of earnings unless the project has an alternative future use. These costs include initial payments incurred prior to regulatory approval in connection with research and development collaboration agreements that provide rights to develop, manufacture, market and/or sell pharmaceutical products. In a business combination, the fair value of IPRD projects acquired are capitalized and accounted for as indefinite-lived intangible assets until the underlying project receives regulatory approval, at which point the intangible asset will be accounted for as a definite-lived intangible asset, or discontinuation, at which point the intangible asset will be written off. RD costs incurred after the acquisition are expensed as incurred. Foreign Currency Translation Foreign subsidiary earnings are translated into U.S. dollars using average exchange rates. The net assets of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recognized in other comprehensive (loss) income (OCI) in the consolidated statements of comprehensive income. The net assets of subsidiaries in highly inflationary economies are remeasured as if the functional currency were the reporting currency. The remeasurement is recognized in net foreign exchange loss in the consolidated statements of earnings. 56 | 2017 Form 10-K Derivatives All derivative instruments are recognized as either assets or liabilities at fair value on the consolidated balance sheets and are classified as current or long-term based on the scheduled maturity of the instrument. For derivatives formally designated as hedges, the company assesses at inception and quarterly thereafter, whether the hedging derivatives are highly effective in offsetting changes in the fair value or cash flows of the hedged item. The changes in fair value of a derivative designated as a fair value hedge and of the hedged item attributable to the hedged risk are recognized in earnings immediately. The effective portions of changes in the fair value of a derivative designated as a cash flow hedge are reported in AOCI and are subsequently recognized in earnings consistent with the underlying hedged item. If it is determined that a derivative is no longer highly effective as a hedge, the company discontinues hedge accounting prospectively. If a hedged forecasted transaction becomes probable of not occurring, any gains or losses are reclassified from AOCI to earnings. Derivatives that are not designated as hedges are adjusted to fair value through current earnings. The company also uses derivative instruments or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. Realized and unrealized gains and losses from these hedges are included in AOCI. Derivative cash flows, with the exception of net investment hedges, are principally classified in the operating section of the consolidated statements of cash flows, consistent with the underlying hedged item. Cash flows related to net investment hedges are classified in the investing section of the consolidated statements of cash flows. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business . The standard provides clarifying guidance to assist in the evaluation of whether transactions are treated as business combinations or asset acquisitions. AbbVie elected to early adopt the changes prospectively in the first quarter of 2017. In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting . AbbVie adopted the standard in the first quarter of 2017. As a result, all excess tax benefits associated with stock-based awards are recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity. In addition, excess tax benefits in the statement of cash flows are now classified as an operating activity rather than as a financing activity. AbbVie adopted these changes prospectively. Accordingly, the company recognized excess tax benefits in income tax expense of $71 million in 2017 and classified them within cash flows from operating activities. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the FASB issued ASU No. 2014-09, Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40) . The amendments in this standard supersede most current revenue recognition requirements. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. AbbVie can apply the amendments using one of the following two methods: (i) retrospectively to each prior reporting period presented, or (ii) modified retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. AbbVie will adopt the standard effective the first quarter of 2018 and apply the amendments using the modified retrospective method. The company has completed its assessment of the new standard as of December 31, 2017. AbbVie does not expect significant changes to the amounts or timing of revenue recognition for product sales, which is its primary revenue stream. However, the adoption of the new standard will require a cumulative-effect adjustment to retained earnings on January 1, 2018 of approximately $120 million , net of tax, primarily related to certain deferred license revenues that were originally expected to be recognized through early 2020. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . The standard requires several targeted changes including that equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net earnings. These provisions will not impact the accounting for AbbVie's investments in debt securities. The new guidance also changes certain disclosure requirements and other aspects of current U.S. GAAP. Amendments are to be applied as a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. This standard will be effective for AbbVie starting with the 2017 Form 10-K | 57 first quarter of 2018. Based on historical trends, AbbVie does not believe the adoption will have a material impact on its consolidated financial statements. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The standard outlines a comprehensive lease accounting model that supersedes the current lease guidance and requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms greater than 12 months. The guidance also changes the definition of a lease and expands the disclosure requirements of lease arrangements. The new standard must be adopted using the modified retrospective approach and will be effective for AbbVie starting with the first quarter of 2019, with early adoption permitted. AbbVie will adopt the standard effective in the first quarter of 2019 and is currently assessing the impact of adopting this guidance on its consolidated financial statements. In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) . The standard changes how credit losses are measured for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other financial instruments, the standard requires the use of a new forward-looking ""expected credit loss"" model that generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, the standard now requires allowances to be recorded instead of reducing the amortized cost of the investment. Additionally, the standard requires new disclosures and will be effective for AbbVie starting with the first quarter of 2020. Early adoption beginning in the first quarter of 2019 is permitted. With certain exceptions, adjustments are to be applied using a modified-retrospective approach by reflecting adjustments through a cumulative-effect impact to retained earnings as of the beginning of the fiscal year of adoption. AbbVie is currently assessing the impact and timing of adopting this guidance on its consolidated financial statements. In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740) . The new standard requires entities to recognize the income tax consequences of an intercompany transfer of an asset other than inventory when the transfer occurs. Under current U.S. GAAP, the income tax consequences of these intercompany asset transfers are deferred until the asset is sold to a third party or otherwise recovered through use. The standard will be effective for AbbVie starting with the first quarter of 2018. Adjustments for this update are to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings with any adjustments reflected as of the beginning of the fiscal year of adoption. The company has completed its assessment of the new standard as of December 31, 2017 . The adoption will require a cumulative-effect adjustment to retained earnings on January 1, 2018 of approximately $1.8 billion related to prepaid income tax assets that will be affected by this standard, of which $1.4 billion was included in prepaid expenses and other on the consolidated balance sheet as of December 31, 2017 . In March 2017, the FASB issued ASU No. 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . The standard requires that an employer continue to report the service cost component of net periodic benefit cost in the same income statement line item or items as other employee compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented separately outside of income from operations and are not eligible for capitalization. The standard will be effective for AbbVie starting with the first quarter of 2018. Upon adoption, the company will apply the income statement classification provisions of this standard retrospectively and will reclassify income of $47 million from operating earnings to non-operating income for the year ended December 31, 2017. Additionally, the company preliminarily expects to record approximately $20 million of non-operating income in 2018 which would have been recorded in operating earnings under the previous guidance. In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities . The standard simplifies the application of hedge accounting and more closely aligns the accounting with an entitys risk management activities. AbbVie will early adopt the standard effective in the first quarter of 2018 and does not believe the adoption will have a material impact on its consolidated financial statements. 58 | 2017 Form 10-K Note 3 Supplemental Financial Information Interest Expense, Net years ended December 31 (in millions) Interest expense $ 1,150 $ 1,047 $ Interest income (146 ) (82 ) (33 ) Interest expense, net $ 1,004 $ $ Accounts Payable and Accrued Liabilities as of December 31 (in millions) Sales rebates $ 3,069 $ 2,887 Accounts payable 1,474 1,407 Dividends payable 1,143 1,028 Salaries, wages and commissions Royalty and license arrangements Other 3,263 2,979 Accounts payable and accrued liabilities $ 10,226 $ 9,379 Other Long-Term Liabilities as of December 31 (in millions) Contingent consideration liabilities $ 4,266 $ 3,941 Pension and other post-employment benefits 2,740 2,085 Liabilities for unrecognized tax benefits 2,683 1,166 Income taxes payable 4,675 Other 1,241 1,160 Other long-term liabilities $ 15,605 $ 8,352 Note 4 Earnings Per Share AbbVie grants certain restricted stock awards (RSAs) and restricted stock units (RSUs) that are considered to be participating securities. Due to the presence of participating securities, AbbVie calculates earnings per share (EPS) using the more dilutive of the treasury stock or the two-class method. For all periods presented, the two-class method was more dilutive. 2017 Form 10-K | 59 The following table summarizes the impact of the two-class method: Years ended December 31, (in millions, except per share information) Basic EPS Net earnings $ 5,309 $ 5,953 $ 5,144 Earnings allocated to participating securities Earnings available to common shareholders $ 5,283 $ 5,923 $ 5,118 Weighted-average basic shares outstanding 1,596 1,622 1,625 Basic earnings per share $ 3.31 $ 3.65 $ 3.15 Diluted EPS Net earnings $ 5,309 $ 5,953 $ 5,144 Earnings allocated to participating securities Earnings available to common shareholders $ 5,283 $ 5,923 $ 5,118 Weighted-average shares of common stock outstanding 1,596 1,622 1,625 Effect of dilutive securities Weighted-average diluted shares outstanding 1,603 1,631 1,637 Diluted earnings per share $ 3.30 $ 3.63 $ 3.13 As further described in Note 12 , AbbVie entered into and executed an accelerated share repurchase agreement (ASR) with third party financial institutions in 2016 and 2015. For purposes of calculating EPS, AbbVie reflected the ASR as a repurchase of AbbVie common stock in the relevant periods. Certain shares issuable under stock-based compensation plans were excluded from the computation of EPS because the effect would have been antidilutive. The number of common shares excluded was insignificant for all periods presented. Note 5 Licensing, Acquisitions and Other Arrangements Acquisition of Stemcentrx On June 1, 2016, AbbVie acquired all of the outstanding equity interests in Stemcentrx, a privately-held biotechnology company. The transaction expanded AbbVies oncology pipeline by adding the late-stage asset rovalpituzumab tesirine (Rova-T), four additional early-stage clinical compounds in solid tumor indications and a significant portfolio of pre-clinical assets. Rova-T is currently in registrational trials for small cell lung cancer. The acquisition of Stemcentrx was accounted for as a business combination using the acquisition method of accounting. The aggregate upfront consideration for the acquisition of Stemcentrx consisted of approximately 62.4 million shares of AbbVie common stock, issued from common stock held in treasury, and cash. AbbVie may make certain contingent payments upon the achievement of defined development and regulatory milestones. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was $4.0 billion . The acquisition-date fair value of these milestones was $620 million and was estimated using a combination of probability-weighted discounted cash flow models and Monte Carlo simulation models. The estimate was determined based on significant inputs that are not observable in the market, referred to as Level 3 inputs, as described in more detail in Note 10 . The following table summarizes total consideration: (in millions) Cash $ 1,883 Fair value of AbbVie common stock 3,923 Contingent consideration Total consideration $ 6,426 60 | 2017 Form 10-K The following table summarizes fair values of assets acquired and liabilities assumed as of the June 1, 2016 acquisition date: (in millions) Assets acquired and liabilities assumed Accounts receivable $ Prepaid expenses and other Property and equipment Intangible assets - Indefinite-lived research and development 6,100 Accounts payable and accrued liabilities (31 ) Deferred income taxes (1,933 ) Other long-term liabilities (7 ) Total identifiable net assets 4,154 Goodwill 2,272 Total assets acquired and liabilities assumed $ 6,426 Intangible assets were related to IPRD for Rova-T, four additional early-stage clinical compounds in solid tumor indications and several additional pre-clinical compounds. The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of those asset valuations include the estimated annual cash flows for each asset or product (including net revenues, cost of sales, RD costs, selling and marketing costs and working capital/contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each assets life cycle, the regulatory approval probabilities, commercial success risks, competitive landscape as well as other factors. The goodwill recognized represents expected synergies, including the ability to: (i) leverage the respective strengths of each business; (ii) expand the combined companys product portfolio; (iii) accelerate AbbVie's clinical and commercial presence in oncology; and (iv) establish a strong leadership position in oncology. Goodwill was also impacted by the establishment of a deferred tax liability for the acquired identifiable intangible assets which have no tax basis. The goodwill is not deductible for tax purposes. Following the acquisition date, the operating results of Stemcentrx have been included in the company's financial statements. AbbVies consolidated statement of earnings for the year ended December 31, 2016 included no net revenues and an operating loss of $165 million associated with Stemcentrx's operations. This operating loss included $43 million of post-acquisition stock-based compensation expense for Stemcentrx options and excluded interest expense and certain acquisition costs. Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Stemcentrx for the years ended December 31, 2016 and 2015 as if the acquisition of Stemcentrx had occurred on January 1, 2015: Years ended December 31, (in millions, except per share information) Net revenues $ 25,641 $ 22,869 Net earnings 5,907 4,894 Basic earnings per share $ 3.58 $ 2.90 Diluted earnings per share $ 3.56 $ 2.88 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Stemcentrx. In order to reflect the occurrence of the acquisition on January 1, 2015 as required, the unaudited pro forma financial information includes adjustments to reflect the additional interest expense associated with the issuance of debt to finance the acquisition and the reclassification of acquisition, 2017 Form 10-K | 61 integration and financing-related costs incurred during the year ended December 31, 2016 to the year ended December 31, 2015. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2015. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Acquisition of BI 655066 and BI 655064 from Boehringer Ingelheim On April 1, 2016, AbbVie acquired all rights to risankizumab (BI 655066), an anti-IL-23 monoclonal biologic antibody in Phase 3 development for psoriasis, from Boehringer Ingelheim (BI) pursuant to a global collaboration agreement. AbbVie is also evaluating the potential of this biologic therapy in other indications, including Crohns disease, psoriatic arthritis and asthma. In addition to risankizumab, AbbVie also gained rights to an anti-CD40 antibody, BI 655064, currently in Phase 1 development. BI will retain responsibility for further development of BI 655064, and AbbVie may elect to advance the program after completion of certain clinical achievements. The acquired assets include all patents, data, know-how, third-party agreements, regulatory filings and manufacturing technology related to BI 655066 and BI 655064. The company concluded that the acquired assets met the definition of a business and accounted for the transaction as a business combination using the acquisition method of accounting. Under the terms of the agreement, AbbVie made an upfront payment of $595 million . Additionally, $18 million of payments to BI, pursuant to a contractual obligation to reimburse BI for certain development costs it incurred prior to the acquisition date, were initially deferred. AbbVie may make certain contingent payments upon the achievement of defined development, regulatory and commercial milestones, as well as royalty payments based on net revenues of licensed products. As of the acquisition date, the maximum aggregate amount payable for development and regulatory milestones was approximately $1.6 billion . The acquisition-date fair value of these milestones was $606 million . The acquisition-date fair value of contingent royalty payments was $2.8 billion . The potential contingent consideration payments were estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which were then discounted to present value. The fair value measurements were based on Level 3 inputs. The following table summarizes total consideration: (in millions) Cash $ Deferred consideration payable Contingent consideration 3,365 Total consideration $ 3,978 The following table summarizes fair values of assets acquired as of the April 1, 2016 acquisition date: (in millions) Assets acquired Identifiable intangible assets - Indefinite-lived research and development $ 3,890 Goodwill Total assets acquired $ 3,978 The estimated fair value of the acquired IPRD was determined using the multi-period excess earnings model of the income approach. The goodwill recognized represents expected synergies, including an expansion of the companys immunology product portfolio. Pro forma results of operations for this acquisition have not been presented because this acquisition is insignificant to AbbVies consolidated results of operations. Acquisition of Pharmacyclics On May 26, 2015, AbbVie acquired Pharmacyclics, a biopharmaceutical company that develops and commercializes novel therapies for people impacted by cancer. Pharmacyclics markets IMBRUVICA (ibrutinib), a Bruton's tyrosine kinase (BTK) inhibitor, targeting B-cell malignancies. 62 | 2017 Form 10-K The acquisition of Pharmacyclics was accounted for as a business combination using the acquisition method of accounting. The total consideration for the acquisition of Pharmacyclics consisted of cash and approximately 128 million shares of AbbVie common stock and is summarized as follows: (in millions) Cash $ 12,365 Fair value of AbbVie common stock 8,405 Total consideration $ 20,770 The following table summarizes the fair values of assets acquired and liabilities assumed as of the May 26, 2015 acquisition date: (in millions) Assets acquired and liabilities assumed Cash and equivalents $ Short-term investments Accounts receivable Inventories Other assets Intangible assets Definite-lived developed product rights 4,590 Definite-lived license agreements 6,780 Indefinite-lived research and development 7,180 Accounts payable and accrued liabilities (381 ) Deferred income taxes (6,453 ) Other long-term liabilities (254 ) Total identifiable net assets 13,160 Goodwill 7,610 Total assets acquired and liabilities assumed $ 20,770 The amortization of the fair market value step-up fo r acquired inventory was included in cost of products sold and RD in the consolidated statements of earnings. The related amortization was $58 million in 2017 , $274 million in 2016 and $113 million in 2015. Intangible assets were related to the IMBRUVICA developed product rights, IPRD in the United States for additional IMBRUVICA indications and the contractual rights to IMBRUVICA profits and losses outside the United States as a result of the collaboration agreement with Janssen Biotech, Inc. and its affiliates (Janssen), one of the Janssen Pharmaceutical companies of Johnson Johnson. See Note 6 for additional information regarding the collaboration with Janssen. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of 12 years using the estimated pattern of economic benefit. The estimated fair value of the IPRD and identifiable intangible assets was determined using the ""income approach."" The goodwill recognized from the acquisition of Pharmacyclics includes expected synergies, including the ability to leverage the respective strengths of each business, expanding the combined company's product portfolio, acceleration of clinical and commercial presence in oncology and establishment of a strong leadership position in hematological oncology. The goodwill is not deductible for tax purposes. From the acquisition date through December 31, 2015, AbbVie's 2015 consolidated statement of earnings included net revenues of $774 million and an operating loss of $519 million associated with Pharmacyclics' operations. The operating loss included $346 million of acquisition-related compensation expense, $261 million of inventory step-up and intangible asset amortization and $100 million of transaction and integration costs. Of these costs, $294 million was recorded within SGA expenses, $152 million within RD expense and $261 million within cost of products sold in the 2015 consolidated statement of earnings. 2017 Form 10-K | 63 Pro Forma Financial Information The following table presents the unaudited pro forma combined results of operations of AbbVie and Pharmacyclics for 2015 as if the acquisition of Pharmacyclics had occurred on January 1, 2014: year ended December 31 (in millions, except per share information) Net revenues $ 23,215 Net earnings 5,345 Basic earnings per share $ 3.18 Diluted earnings per share $ 3.16 The unaudited pro forma financial information was prepared using the acquisition method of accounting and was based on the historical financial information of AbbVie and Pharmacyclics. In order to reflect the occurrence of the acquisition on January 1, 2014 as required, the unaudited pro forma financial information includes adjustments to reflect the incremental amortization expense to be incurred based on the fair values of the identifiable intangible assets acquired; the incremental cost of products sold related to the fair value adjustments associated with the acquisition-date inventory; the additional interest expense associated with the issuance of debt to finance the acquisition; and the reclassification of acquisition, integration and financing-related costs incurred during the year ended December 31, 2015 to the year ended December 31, 2014. The unaudited pro forma financial information is not necessarily indicative of what the consolidated results of operations would have been had the acquisition been completed on January 1, 2014. In addition, the unaudited pro forma financial information is not a projection of the future results of operations of the combined company nor does it reflect the expected realization of any cost savings or synergies associated with the acquisition. Other Licensing Acquisitions Activity Excluding the acquisitions above, cash outflows related to other acquisitions and investments totaled $308 million in 2017 , $262 million in 2016 and $964 million in 2015 . AbbVie recorded IPRD charges of $327 million in 2017 , $200 million in 2016 and $150 million in 2015 . Significant arrangements impacting 2017 , 2016 and 2015 , some of which require contingent milestone payments, are summarized below. Alector, Inc. In October 2017, AbbVie entered into a global strategic collaboration with Alector, Inc. (Alector) to develop and commercialize medicines to treat Alzheimers disease and other neurodegenerative disorders. AbbVie and Alector have agreed to research a portfolio of antibody targets and AbbVie has an option to global development and commercial rights to two targets. The terms of the arrangement included an initial upfront payment of $205 million , which was expensed to IPRD in the fourth quarter of 2017. Alector will conduct exploratory research, drug discovery and development for lead programs up to the conclusion of the proof of concept studies. If the option is exercised, AbbVie will lead development and commercialization activities and could make additional payments to Alector of up to $986 million upon achievement of certain development and regulatory milestones. Alector and AbbVie will co-fund development and commercialization and will share global profits equally. C 2 N Diagnostics In March 2015, AbbVie entered into an exclusive worldwide license agreement with C 2 N Diagnostics (C 2 N) to develop and commercialize anti-tau antibodies for the treatment of Alzheimer's disease and other neurological disorders. As part of the agreement, AbbVie made an initial upfront payment of $100 million , which was expensed to IPRD in 2015. AbbVie made additional payments of $35 million in both 2016 and 2017, which were recorded in RD expense, due to the achievement of development milestones under the license agreement. Upon the achievement of certain development, regulatory and commercial milestones, AbbVie could make additional payments of up to $615 million , as well as royalties on net revenues. Other Arrangements In addition to the significant arrangements described above, AbbVie entered into several other arrangements resulting in charges to IPRD of $122 million in 2017 , $200 million in 2016 and $50 million in 2015 . In connection with the other individually insignificant early stage arrangements entered into in 2017 , AbbVie could make additional payments of up to $2.4 billion upon the achievement of certain development, regulatory and commercial milestones. 64 | 2017 Form 10-K Other Activity Priority Review Voucher (PRV) In August 2015, AbbVie entered into an agreement to purchase a rare pediatric disease PRV from a third party. The PRV entitles AbbVie to receive an FDA priority review of a single New Drug Application or Biologics License Application, which reduces the target review time and could lead to an expedited approval. In exchange for the PRV, AbbVie made a payment of $350 million , which was recorded in RD expense in the consolidated statement of earnings and as an operating cash outflow in the consolidated statement of cash flows for 2015. AbbVie intends to use the PRV for an existing RD project. Note 6 Collaboration with Janssen Biotech, Inc. In December 2011, Pharmacyclics entered into a worldwide collaboration and license agreement with Janssen for the joint development and commercialization of IMBRUVICA, a novel, orally active, selective covalent inhibitor of BTK and certain compounds structurally related to IMBRUVICA, for oncology and other indications, excluding all immune and inflammatory mediated diseases or conditions and all psychiatric or psychological diseases or conditions, in the United States and outside the United States. The collaboration provides Janssen with an exclusive license to commercialize IMBRUVICA outside of the United States and co-exclusively with AbbVie in the United States. Both parties are responsible for the development, manufacturing and marketing of any products generated as a result of the collaboration. The collaboration has no set duration or specific expiration date and provides for potential future development, regulatory and approval milestone payments of up to $200 million to AbbVie. The collaboration also includes a cost sharing arrangement for associated collaboration activities. Except in certain cases, Janssen is responsible for approximately 60% of collaboration development costs and AbbVie is responsible for the remaining 40% of collaboration development costs. In the United States, both parties have co-exclusive rights to commercialize the products; however, AbbVie is the principal in the end customer product sales. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. Sales of IMBRUVICA are included in AbbVie's net revenues. Janssen's share of profits is included in AbbVie's cost of products sold. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. Outside the United States, Janssen is responsible for and has exclusive rights to commercialize IMBRUVICA. AbbVie and Janssen share pre-tax profits and losses equally from the commercialization of products. AbbVie's share of profits is included in AbbVie's net revenues. Other costs incurred under the collaboration are reported in their respective expense line items, net of Janssen's share. The following table shows the profit and cost sharing relationship between Janssen and AbbVie: years ended December 31 (in millions) United States - Janssen's share of profits (included in cost of products sold) $ 1,001 $ $ International - AbbVie's share of profits (included in net revenues) Global - AbbVie's share of other costs (included in respective line items) 2017 Form 10-K | 65 Note 7 Goodwill and Intangible Assets Goodwill The following table summarizes the changes in the carrying amount of goodwill: (in millions) Balance as of December 31, 2015 $ 13,168 Additions (see Note 5) 2,360 Foreign currency translation (112 ) Balance as of December 31, 2016 15,416 Foreign currency translation Balance as of December 31, 2017 $ 15,785 The latest impairment assessment of goodwill was completed in the third quarter of 2017 . As of December 31, 2017 , there were no accumulated goodwill impairment losses. Future impairment tests for goodwill will be performed annually in the third quarter, or earlier if impairment indicators exist. Intangible Assets, Net The following table summarizes intangible assets: as of December 31 (in millions) Gross carrying amount Accumulated amortization Net carrying amount Gross carrying amount Accumulated amortization Net carrying amount Definite-lived intangible assets Developed product rights $ 16,138 $ (4,982 ) $ 11,156 $ 16,464 $ (4,256 ) $ 12,208 License agreements 7,822 (1,409 ) 6,413 7,809 (1,110 ) 6,699 Total definite-lived intangible assets 23,960 (6,391 ) 17,569 24,273 (5,366 ) 18,907 Indefinite-lived research and development 9,990 9,990 9,990 9,990 Total intangible assets, net $ 33,950 $ (6,391 ) $ 27,559 $ 34,263 $ (5,366 ) $ 28,897 Definite-lived intangible assets are amortized over their estimated useful lives, which range between 2 to 16 years with an average of 12 years for developed product rights and 11 years for license agreements. Amortization expense was $1.1 billion in 2017 , $764 million in 2016 and $419 million in 2015 and was included in cost of products sold in the consolidated statements of earnings. The anticipated annual amortization expense for definite-lived intangible assets recorded as of December 31, 2017 is as follows: (in billions) Anticipated annual amortization expense $ 1.3 $ 1.5 $ 1.7 $ 1.9 $ 2.1 In 2017, an impairment charge of $354 million was recorded related to ZINBRYTA that reduced both the gross carrying amount and net carrying amount of the underlying intangible assets due to lower expected future cash flows for the product. In 2016, an impairment charge of $39 million was recorded related to certain developed product rights in the United States due to a decline in the market for the product. In 2015, no intangible asset impairment charges were recorded. The 2017 and 2016 impairment charges were based on discounted cash flow analyses and were included in cost of products sold in the consolidated statements of earnings. Indefinite-lived intangible assets represent acquired IPRD associated with products that have not yet received regulatory approval. Indefinite-lived intangible assets as of December 31, 2017 and 2016 related to the acquisitions of Stemcentrx and BI compounds. See Note 5 for additional information. The latest impairment assessment of indefinite-lived intangible assets was completed in the third quarter of 2017 . No impairment charges were recorded in 2017 , 2016 and 2015 . Future impairment tests for indefinite-lived intangible assets will be performed annually in the third quarter, or earlier if impairment indicators exist. 66 | 2017 Form 10-K Note 8 Restructuring Plans AbbVie continuously evaluates its operations to identify opportunities to optimize its manufacturing and RD operations, commercial infrastructure and administrative costs and to respond to changes in its business environment, for example, in conjunction with the loss and expected loss of exclusivity of certain products. As a result, AbbVie management periodically approves individual restructuring plans to achieve these objectives. In 2017 , 2016 and 2015 , no such plans were individually significant. Restructuring charges recorded were $86 million in 2017 , $52 million in 2016 and $138 million in 2015 and were primarily related to employee severance and contractual obligations. These charges were recorded in cost of products sold, RD expense and SGA expenses in the consolidated statements of earnings based on classification of the affected employees or operations. The following summarizes the cash activity in the restructuring reserve for 2017 , 2016 and 2015 : (in millions) Accrued balance at December 31, 2014 $ 2015 restructuring charges Payments and other adjustments (100 ) Accrued balance at December 31, 2015 2016 restructuring charges Payments and other adjustments (113 ) Accrued balance at December 31, 2016 2017 restructuring charges Payments and other adjustments (87 ) Accrued balance at December 31, 2017 $ 2017 Form 10-K | 67 Note 9 Debt, Credit Facilities and Commitments and Contingencies The following table summarizes long-term debt: as of December 31 (dollars in millions) Effective interest rate in 2017 (a) Effective interest rate in 2016 (a) Senior notes issued in 2012 2.00% notes due 2018 2.15 % 1,000 2.15 % 1,000 2.90% notes due 2022 2.97 % 3,100 2.97 % 3,100 4.40% notes due 2042 4.46 % 2,600 4.46 % 2,600 Senior notes issued in 2015 1.80% notes due 2018 1.92 % 3,000 1.92 % 3,000 2.50% notes due 2020 2.65 % 3,750 2.65 % 3,750 3.20% notes due 2022 3.28 % 1,000 3.28 % 1,000 3.60% notes due 2025 3.66 % 3,750 3.66 % 3,750 4.50% notes due 2035 4.58 % 2,500 4.58 % 2,500 4.70% notes due 2045 4.73 % 2,700 4.73 % 2,700 Senior notes issued in 2016 2.30% notes due 2021 2.40 % 1,800 2.40 % 1,800 2.85% notes due 2023 2.91 % 1,000 2.91 % 1,000 3.20% notes due 2026 3.28 % 2,000 3.28 % 2,000 4.30% notes due 2036 4.37 % 1,000 4.37 % 1,000 4.45% notes due 2046 4.50 % 2,000 4.50 % 2,000 Senior Euro notes issued in 2016 0.38% notes due 2019 (1,400 principal) 0.55 % 1,673 0.55 % 1,464 1.38% notes due 2024 (1,450 principal) 1.46 % 1,733 1.46 % 1,516 2.13% notes due 2028 (750 principal) 2.18 % 2.18 % Term loan facilities Floating rate notes due 2018 2.26 % 2,000 1.64 % 2,000 Other Fair value hedges (401 ) (338 ) Unamortized bond discounts (97 ) (110 ) Unamortized deferred financing costs (146 ) (164 ) Total long-term debt and lease obligations 36,968 36,465 Current portion 6,015 Noncurrent portion $ 30,953 $ 36,440 (a) Excludes the effect of any related interest rate swaps. In November 2016, the company issued 3.6 billion aggregate principal amount of unsecured senior Euro notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and three months prior to maturity. In connection with the offering, debt issuance costs totaled $17 million and debt discounts incurred totaled $9 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. The company used the proceeds to redeem $4.0 billion aggregate principal amount of 1.75% senior notes that were due to mature in November 2017. As a result of this redemption, the company incurred a charge of $39 million ( $25 million after tax) related to the make-whole premium, write-off of unamortized debt issuance costs and other expenses. The charge was recorded in interest expense, net in the consolidated statement of earnings. 68 | 2017 Form 10-K In May 2016, the company issued $7.8 billion aggregate principal amount of unsecured senior notes. These senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. AbbVie may redeem the senior notes at par between one and six months prior to maturity. In connection with the offering, debt issuance costs totaled $52 million and debt discounts incurred totaled $29 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Of the $7.7 billion net proceeds, $2.0 billion was used to repay the companys outstanding term loan that was due to mature in November 2016, approximately $1.9 billion was used to finance the acquisition of Stemcentrx and approximately $3.8 billion was used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Stemcentrx and Note 12 for additional information related to the ASR. In September 2015, AbbVie entered into a $2.0 billion three -year term loan credit agreement and a $2.0 billion 364 -day term loan credit agreement (collectively, the term loan facilities). In November 2015, AbbVie drew on these term loan facilities and used the proceeds to refinance its $4.0 billion of senior notes that matured in November 2015. In connection with the May 2016 unsecured senior notes issuance, AbbVie repaid the 364 -day term loan credit agreement. The borrowings under the term loan facilities bear interest at variable rates which are adjusted based on AbbVie's public debt ratings. In May 2015, the company issued $16.7 billion aggregate principal amount of unsecured senior notes. The senior notes rank equally with all other unsecured and unsubordinated indebtedness of the company. AbbVie may redeem the senior notes prior to maturity at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium and, except for the 1.80% notes due 2018, AbbVie may redeem the senior notes at par between one and six months prior to maturity. Debt issuance costs incurred in connection with the offering totaled $93 million and are being amortized over the respective terms of the senior notes to interest expense, net in the consolidated statements of earnings. Approximately $11.5 billion of the net proceeds were used to finance the acquisition of Pharmacyclics and approximately $5.0 billion of the net proceeds were used to finance an ASR with a third party financial institution. See Note 5 for additional information related to the acquisition of Pharmacyclics and Note 12 for additional information related to the ASR. In March 2015, AbbVie entered into an $18.0 billion bridge loan in support of the then planned acquisition of Pharmacyclics. No amounts were drawn under the bridge loan, which was terminated as a result of the company's May 2015 senior notes issuance. Interest expense, net in 2015 included $86 million of costs related to the bridge loan. AbbVie has outstanding $6.7 billion aggregate principal amount of unsecured senior notes which were issued in 2012. AbbVie may redeem all of the senior notes of each series, at any time, or some of the senior notes of each series, from time to time, at a redemption price equal to the principal amount of the senior notes redeemed plus a make-whole premium. At December 31, 2017 , the company was in compliance with its senior note covenants and term loan covenants. Short-Term Borrowings Short-term borrowings included commercial paper borrowings of $400 million at December 31, 2017 and $377 million at December 31, 2016 . The weighted-average interest rate on commercial paper borrowings was 1.3% in 2017 , 0.6% in 2016 and 0.3% in 2015 . In October 2014, AbbVie entered into a $3.0 billion five -year revolving credit facility, which matures in October 2019. The revolving credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2017 , the company was in compliance with all its credit facility covenants. Commitment fees under AbbVie's revolving credit facilities were insignificant in 2017 , 2016 and 2015 . No amounts were outstanding under the credit facility as of December 31, 2017 and December 31, 2016 . 2017 Form 10-K | 69 Maturities of Long-Term Debt and Capital Lease Obligations The following table summarizes AbbVie's future minimum lease payments under non-cancelable operating leases, debt maturities and future minimum lease payments for capital lease obligations as of December 31, 2017 : as of and for the years ending December 31 (in millions) Operating leases Debt maturities and capital leases $ $ 6,026 126 1,698 109 3,771 85 1,836 66 4,102 Thereafter 20,179 Total obligations and commitments 37,612 Fair value hedges, unamortized bond discounts and deferred financing costs (644 ) Total long-term debt and lease obligations $ $ 36,968 Lease expense was $169 million in 2017 , $159 million in 2016 and $146 million in 2015 . AbbVie's operating leases generally include renewal options and provide for the company to pay taxes, maintenance, insurance and other operating costs of the leased property. As of December 31, 2017 , annual future minimum lease payments for capital lease obligations were insignificant. Contingencies and Guarantees In connection with the separation, AbbVie has indemnified Abbott for all liabilities resulting from the operation of AbbVie's business other than income tax liabilities with respect to periods prior to the distribution date and other liabilities as agreed to by AbbVie and Abbott. AbbVie has no material exposures to off-balance sheet arrangements and no special-purpose entities. In the ordinary course of business, AbbVie has periodically entered into third-party agreements, such as the assignment of product rights, which have resulted in AbbVie becoming secondarily liable for obligations for which AbbVie had previously been primarily liable. Based upon past experience, the likelihood of payments under these agreements is remote. Note 10 Financial Instruments and Fair Value Measures Risk Management Policy The company is exposed to foreign currency exchange rate and interest rate risks related to its business operations. AbbVie's hedging policy attempts to manage these risks to an acceptable level based on the company's judgment of the appropriate trade-off between risk, opportunity and costs. The company uses derivative and nonderivative instruments to reduce its exposure to foreign currency exchange rates. AbbVie also periodically enters into interest rate swaps, in which the company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional amount. Derivative instruments are not used for trading purposes or to manage exposure to changes in interest rates for investment securities, and none of the company's outstanding derivative instruments contain credit risk related contingent features; collateral is generally not required. Financial Instruments Various AbbVie foreign subsidiaries enter into foreign currency forward exchange contracts to manage exposures to changes in foreign exchange rates for anticipated intercompany transactions denominated in a currency other than the functional currency of the local entity. These contracts, with notional amounts totaling $2.2 billion at December 31, 2017 and $2.2 billion at December 31, 2016 , are designated as cash flow hedges and are recorded at fair value. The durations of these forward exchange contracts were generally less than eighteen months. Accumulated gains and losses as of December 31, 2017 will be reclassified from AOCI and included in cost of products sold at the time the products are sold, generally not exceeding six months from the date of settlement. The company also enters into foreign currency forward exchange contracts to manage its exposure to foreign currency denominated trade payables and receivables and intercompany loans. These contracts are not designated as hedges and are recorded at fair value. Resulting gains or losses are reflected in net foreign exchange loss in the consolidated statements of 70 | 2017 Form 10-K earnings and are generally offset by losses or gains on the foreign currency exposure being managed. These contracts had notional amounts totaling $7.7 billion at December 31, 2017 and $6.6 billion at December 31, 2016 . The company also uses foreign currency forward exchange contracts or foreign currency denominated debt to hedge its net investments in certain foreign subsidiaries and affiliates. In the fourth quarter of 2016, the company issued 3.6 billion aggregate principal amount of senior Euro notes and designated the principal amounts of this foreign denominated debt as net investment hedges. Concurrently, the company settled foreign currency forward exchange contracts with aggregate notional amounts of 3.5 billion that were designated as net investment hedges. AbbVie is a party to interest rate hedge contracts designated as fair value hedges with notional amounts totaling $11.8 billion at December 31, 2017 and $11.8 billion at December 31, 2016 . The effect of the hedge contracts is to change a fixed-rate interest obligation to a floating rate for that portion of the debt. AbbVie records the contracts at fair value and adjusts the carrying amount of the fixed-rate debt by an offsetting amount. The following table summarizes the amounts and location of AbbVie's derivative instruments on the consolidated balance sheets: Fair value - Derivatives in asset position Fair value - Derivatives in liability position as of December 31 (in millions) Balance sheet caption 2016 Balance sheet caption 2016 Foreign currency forward exchange contracts Designated as cash flow hedges Prepaid expenses and other $ $ Accounts payable and accrued liabilities $ $ Not designated as hedges Prepaid expenses and other 55 Accounts payable and accrued liabilities 33 Interest rate swaps designated as fair value hedges Prepaid expenses and other Accounts payable and accrued liabilities Interest rate swaps designated as fair value hedges Other assets Other long-term liabilities 338 Total derivatives $ $ $ $ While certain derivatives are subject to netting arrangements with the company's counterparties, the company does not offset derivative assets and liabilities within the consolidated balance sheets. The following table presents the pre-tax amounts of gains (losses) from derivative instruments recognized in other comprehensive loss: years ended December 31 (in millions) Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Cash Flow Hedges Net Investment Hedges Total Foreign currency forward exchange contracts $ (250 ) $ $ (250 ) $ $ $ $ $ $ The amount of hedge ineffectiveness was insignificant for all periods presented. Assuming market rates remain constant through contract maturities, the company expects to transfer pre-tax unrealized losses of $174 million into cost of products sold for foreign currency cash flow hedges during the next 12 months. The company recognized, in other comprehensive loss, pre-tax losses of $537 million in 2017 and pre-tax gains of $101 million in 2016 related to non-derivative, foreign currency denominated debt designated as net investment hedges. 2017 Form 10-K | 71 The following table summarizes the pre-tax amounts and location of derivative instrument net gains (losses) recognized in the consolidated statements of earnings, including the effective portions of the net gains (losses) reclassified out of AOCI into net earnings. See Note 12 for the amount of net gains (losses) reclassified out of AOCI. years ended December 31 (in millions) Statement of earnings caption Foreign currency forward exchange contracts Designated as cash flow hedges Cost of products sold $ $ $ Not designated as hedges Net foreign exchange loss (96 ) (155 ) Non-designated treasury rate lock agreements Other expense, net (12 ) Interest rate swaps designated as fair value hedges Interest expense, net (63 ) (266 ) Total $ (41 ) $ (252 ) $ The gain (loss) related to outstanding interest rate swaps designated as fair value hedges is recognized in interest expense, net and directly offsets the (loss) gain on the underlying hedged item, the fixed-rate debt, resulting in no net impact to interest expense, net for all periods presented. Fair Value Measures The fair value hierarchy consists of the following three levels: Level 1Valuations based on unadjusted quoted prices in active markets for identical assets that the company has the ability to access; Level 2Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuations in which all significant inputs are observable in the market; and Level 3Valuations using significant inputs that are unobservable in the market and include the use of judgment by the company's management about the assumptions market participants would use in pricing the asset or liability. The following table summarizes the bases used to measure certain assets and liabilities that were carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2017 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 9,303 $ $ 8,454 $ Debt securities 2,524 2,524 Equity securities Foreign currency contracts Total assets $ 11,854 $ $ 11,001 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,534 4,534 Total liabilities $ 5,084 $ $ $ 4,534 72 | 2017 Form 10-K The following table summarizes the bases used to measure certain assets and liabilities that were carried at fair value on a recurring basis on the consolidated balance sheet as of December 31, 2016 : Basis of fair value measurement (in millions) Total Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Cash and equivalents $ 5,100 $ 1,191 $ 3,909 $ Time deposits 1,014 1,014 Debt securities 1,974 1,974 Equity securities Foreign currency contracts Total assets $ 8,389 $ 1,267 $ 7,122 $ Liabilities Interest rate hedges $ $ $ $ Foreign currency contracts Contingent consideration 4,213 4,213 Total liabilities $ 4,589 $ $ $ 4,213 The fair values of time deposits approximate their amortized cost due to the short maturities of these instruments. The fair values of available-for-sale debt securities were determined based on prices obtained from commercial pricing services. Available-for-sale equity securities consists of investments for which the fair values were determined by using the published market price per unit multiplied by the number of units held, without consideration of transaction costs. The derivatives entered into by the company were valued using publicized spot curves for interest rate hedges and publicized forward curves for foreign currency contracts. The fair value measurements of the contingent consideration liabilities were determined based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products still in development. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of these inputs. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period. At December 31, 2017 , a 50 basis point increase/decrease in the assumed discount rate would have decreased/increased the value of the contingent consideration liabilities by approximately $170 million . Additionally, at December 31, 2017 , a five percentage point increase/decrease in the assumed probability of success across all potential indications would have increased/decreased the value of the contingent consideration liabilities by approximately $390 million . There have been no transfers of assets or liabilities between the fair value measurement levels. The following table presents the changes in fair value of contingent consideration liabilities which are measured using Level 3 inputs: years ended December 31 (in millions) Beginning balance $ 4,213 $ Additions (See Note 5) 3,985 Change in fair value recognized in net earnings Milestone payments (305 ) Ending balance $ 4,534 $ 4,213 The change in fair value recognized in net earnings was recorded in other expense, net in the consolidated statements of earnings in 2017 and 2016 . 2017 Form 10-K | 73 In addition to the financial instruments that the company carries at fair value on the consolidated balance sheets, certain financial instruments are carried at historical cost or some basis other than fair value. The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2017 are shown in the table below: Basis of fair value measurement (in millions) Book Value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 6,023 6,034 4,004 2,030 Long-term debt and lease obligations, excluding fair value hedges 31,346 32,846 32,763 Total liabilities $ 37,769 $ 39,280 $ 36,767 $ 2,513 $ The book values, approximate fair values and bases used to measure the approximate fair values of certain financial instruments as of December 31, 2016 are shown in the table below: Basis of fair value measurement (in millions) Book Value Approximate fair values Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable Inputs (Level 3) Assets Investments $ $ $ $ $ Total assets $ $ $ $ $ Liabilities Short-term borrowings $ $ $ $ $ Current portion of long-term debt and lease obligations, excluding fair value hedges 25 Long-term debt and lease obligations, excluding fair value hedges 36,778 36,664 34,589 2,075 Total liabilities $ 37,180 $ 37,066 $ 34,589 $ 2,477 $ Investments primarily consist of cost method investments, for which the company takes into consideration recent transactions and financial information of the investee, which represents a Level 3 basis of fair value measurement. The fair values of short-term borrowings approximate the carrying values due to the short maturities of these instruments. The fair values of long-term debt, excluding fair value hedges and the term loans, were determined by using the published market price for the debt instruments, without consideration of transaction costs, which represents a Level 1 basis of fair value measurement. The fair values of the term loans were determined based on a discounted cash flow analysis using quoted market rates, which represents a Level 2 basis of fair value measurement. The counterparties to financial instruments consist of select major international financial institutions. 74 | 2017 Form 10-K Available-for-sale Securities Substantially all of the companys investments in debt and equity securities were classified as available-for-sale. Debt securities classified as short-term were $482 million as of December 31, 2017 and $309 million as of December 31, 2016 . Long-term debt securities mature primarily within five years . Estimated fair values of available-for-sale securities were based on prices obtained from commercial pricing services. The following table summarizes available-for-sale securities by type as of December 31, 2017 : Amortized Cost Gross unrealized Fair Value (in millions) Gains Losses Asset backed securities $ $ $ (3 ) $ Corporate debt securities 1,451 (2 ) 1,453 Other debt securities (1 ) Equity securities (2 ) Total $ 2,529 $ $ (8 ) $ 2,528 The following table summarizes available-for-sale securities by type as of December 31, 2016 : Amortized Cost Gross unrealized Fair Value (in millions) Gains Losses Asset backed securities $ $ $ (4 ) $ Corporate debt securities (2 ) Other debt securities (1 ) Equity securities (2 ) Total $ 1,997 $ $ (9 ) $ 2,050 AbbVie had no other-than-temporary impairments as of December 31, 2017 . Net realized gains were $90 million in 2017 . Net realized gains in 2016 and 2015 were insignificant. Concentrations of Risk The company invests excess cash in time deposits, money market funds and debt securities to diversify the concentration of cash among different financial institutions. The company has established credit exposure limits and monitors concentrations of credit risk associated with financial institution deposits. The functional currency of the company's Venezuela operations is the U.S. dollar due to the hyperinflationary status of the Venezuelan economy. During the first quarter of 2016, in consideration of declining economic conditions in Venezuela and a decline in transactions settled at the official rate, AbbVie determined that its net monetary assets denominated in the Venezuelan bolivar (VEF) were no longer expected to be settled at the official rate of 10 VEF per U.S. dollar, but rather at the Divisa Complementaria (DICOM) rate. Therefore, during the first quarter of 2016, AbbVie recorded a charge of $298 million to net foreign exchange loss to revalue its bolivar-denominated net monetary assets using the DICOM rate then in effect of approximately 270 VEF per U.S. dollar. As of December 31, 2017 and 2016 , AbbVies net monetary assets in Venezuela were insignificant. AbbVie continues to do business with foreign governments in certain countries, including Greece, Portugal, Italy and Spain, which have historically experienced challenges in credit and economic conditions. Substantially all of AbbVies trade receivables in Greece, Portugal, Italy and Spain are with government health systems. Outstanding governmental receivables in these countries, net of allowances for doubtful accounts, totaled $255 million as of December 31, 2017 and $244 million as of December 31, 2016 . The company also continues to do business with foreign governments in certain oil-exporting countries that have experienced a deterioration in economic conditions, including Saudi Arabia and Russia, which may result in delays in the collection of receivables. Outstanding governmental receivables related to Saudi Arabia, net of allowances for doubtful accounts, were $149 million as of December 31, 2017 and $122 million at December 31, 2016 . Outstanding governmental receivables related to Russia, net of allowances for doubtful accounts, were $152 million as of December 31, 2017 and $110 million as of December 31, 2016 . Global economic conditions and customer-specific factors may require the company to periodically re-evaluate the collectability of its receivables and the company could potentially incur credit losses. 2017 Form 10-K | 75 Of total net accounts receivable, three U.S. wholesalers accounted for 56% as of December 31, 2017 and 51% as of December 31, 2016 , and substantially all of AbbVie's net revenues in the United States were to these three wholesalers. HUMIRA (adalimumab) is AbbVie's single largest product and accounted for approximately 65% of AbbVie's total net revenues in 2017 , 63% in 2016 and 61% in 2015 . Note 11 Post-Employment Benefits AbbVie sponsors various pension and other post-employment benefit plans, including defined benefit, defined contribution and termination indemnity plans, which cover most employees worldwide. In addition, AbbVie provides medical benefits, primarily to eligible retirees in the United States and Puerto Rico, through other post-retirement benefit plans. Net obligations for these plans have been reflected on the consolidated balance sheets as of December 31, 2017 and 2016 . AbbVie's principal domestic defined benefit plan is the AbbVie Pension Plan. AbbVie made voluntary contributions of $150 million in 2017 , 2016 and 2015 to this plan. In 2018, AbbVie plans to make voluntary contributions to its various defined benefit plans in excess of $750 million . The following table summarizes benefit plan information for the global AbbVie-sponsored defined benefit and other post-employment plans: Defined benefit plans Other post-employment plans as of and for the years ended December 31 (in millions) Projected benefit obligations Beginning of period $ 5,829 $ 5,387 $ $ Service cost Interest cost Employee contributions Actuarial loss Benefits paid (173 ) (163 ) (15 ) (12 ) Other, primarily foreign currency translation adjustments (120 ) End of period 6,985 5,829 Fair value of plan assets Beginning of period 4,572 4,174 Actual return on plan assets Company contributions Employee contributions Benefits paid (173 ) (163 ) (15 ) (12 ) Other, primarily foreign currency translation adjustments (96 ) End of period 5,399 4,572 Funded status, end of period $ (1,586 ) $ (1,257 ) $ (813 ) $ (627 ) Amounts recognized on the consolidated balance sheets Other assets $ $ $ $ Accounts payable and accrued liabilities (32 ) (25 ) (15 ) (14 ) Other long-term liabilities (1,942 ) (1,472 ) (798 ) (613 ) Net obligation $ (1,586 ) $ (1,257 ) $ (813 ) $ (627 ) Actuarial loss, net $ 2,471 $ 2,118 $ $ Prior service cost (credit) (29 ) (37 ) Accumulated other comprehensive loss $ 2,483 $ 2,132 $ $ 76 | 2017 Form 10-K The projected benefit obligations (PBO) in the table above included $2.0 billion at December 31, 2017 and $1.7 billion at December 31, 2016 , related to international defined benefit plans. For plans reflected in the table above, the accumulated benefit obligations (ABO) were $6.3 billion at December 31, 2017 and $5.3 billion at December 31, 2016 . For those plans reflected in the table above in which the ABO exceeded plan assets at December 31, 2017 , the ABO was $3.8 billion , the PBO was $4.4 billion and aggregate plan assets were $2.5 billion . Amounts Recognized in Other Comprehensive Loss The following table summarizes the pre-tax gains and losses included in other comprehensive loss: years ended December 31 (in millions) Defined benefit plans Actuarial loss (gain) $ $ $ (117 ) Amortization of actuarial loss and prior service cost (107 ) (85 ) (127 ) Foreign exchange gain (loss) (22 ) (37 ) Total pre-tax loss (gain) recognized in other comprehensive loss $ $ $ (281 ) Other post-employment plans Actuarial loss (gain) $ $ $ (17 ) Amortization of actuarial loss and prior service cost (credit) (2 ) Total pre-tax loss (gain) recognized in other comprehensive loss $ $ $ (19 ) The pre-tax amount of actuarial loss and prior service cost included in AOCI at December 31, 2017 that is expected to be recognized in net periodic benefit cost in 2018 is $149 million for defined benefit plans and $14 million for other post-employment plans. Net Periodic Benefit Cost years ended December 31 (in millions) Defined benefit plans Service cost $ $ $ Interest cost Expected return on plan assets (382 ) (354 ) (325 ) Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Other post-employment plans Service cost $ $ $ Interest cost Amortization of actuarial loss and prior service cost Net periodic benefit cost $ $ $ Weighted-Average Assumptions Used in Determining Benefit Obligations at the Measurement Date as of December 31 Defined benefit plans Discount rate 3.4 % 3.9 % Rate of compensation increases 4.5 % 4.4 % Other post-employment plans Discount rate 3.9 % 4.7 % 2017 Form 10-K | 77 The assumptions used in calculating the December 31, 2017 measurement date benefit obligations will be used in the calculation of net periodic benefit cost in 2018 . Weighted-Average Assumptions Used in Determining Net Periodic Benefit Cost years ended December 31 Defined benefit plans Discount rate for determining service cost 3.9 % 4.4 % 3.9 % Discount rate for determining interest cost 3.7 % 4.0 % 3.9 % Expected long-term rate of return on plan assets 7.8 % 7.9 % 7.8 % Expected rate of change in compensation 4.4 % 4.4 % 4.4 % Other post-employment plans Discount rate for determining service cost 4.9 % 5.1 % 4.5 % Discount rate for determining interest cost 4.1 % 4.3 % 4.5 % Effective December 31, 2015, AbbVie elected to change the method it uses to estimate the service and interest cost components of net periodic benefit costs. Historically, AbbVie estimated these service and interest cost components of this expense utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. In late 2015, AbbVie elected to utilize a full yield curve approach in the estimation of these components by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. AbbVie elected to make this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows to the corresponding spot yield curve rates. AbbVie accounted for this change prospectively as a change in accounting estimate that is inseparable from a change in accounting principle. This change reduced AbbVie's net periodic benefit cost by approximately $41 million in 2016 . This change had no effect on the 2015 expense and did not affect the measurement of AbbVie's total benefit obligations. For the December 31, 2017 post-retirement health care obligations remeasurement, the company assumed a 7.7% pre-65 ( 9.5% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% in 2050 and remain at that level thereafter. For purposes of measuring the 2017 post-retirement health care costs, the company assumed a 6.8% pre-65 ( 7.8% post-65) annual rate of increase in the per capita cost of covered health care benefits. The rate was assumed to decrease gradually to 4.5% for 2064 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. As of December 31, 2017 , a one percentage point change in assumed health care cost trend rates would have the following effects: One percentage point year ended December 31, 2017 (in millions) (brackets denote a reduction) Increase Decrease Service cost and interest cost $ $ (9 ) Projected benefit obligation (140 ) 78 | 2017 Form 10-K Defined Benefit Pension Plan Assets Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,715 $ 1,208 $ $ Total assets measured at NAV 3,684 Fair value of plan assets $ 5,399 Basis of fair value measurement as of December 31 (in millions) Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Equities U.S. large cap (a) $ $ $ $ U.S. mid cap (b) International (c) Fixed income securities U.S. government securities (d) Corporate debt instruments (d) Non-U.S. government securities (d) Other (d) Absolute return funds (e) Real assets Other (f) Total $ 1,552 $ 1,145 $ $ Total assets measured at NAV 3,020 Fair value of plan assets $ 4,572 (a) A mix of index funds and actively managed equity accounts that are benchmarked to various large cap indices. (b) A mix of index funds and actively managed equity accounts that are benchmarked to various mid cap indices. 2017 Form 10-K | 79 (c) A mix of index funds and actively managed equity accounts that are benchmarked to various non-U.S. equity indices in both developed and emerging markets. (d) Securities held by actively managed accounts, index funds and mutual funds. (e) Primarily funds having global mandates with the flexibility to allocate capital broadly across a wide range of asset classes and strategies, including but not limited to equities, fixed income, commodities, financial futures, currencies and other securities, with objectives to outperform agreed upon benchmarks of specific return and volatility targets. (f) Investments in cash and cash equivalents. Equities and registered investment companies having quoted prices are valued at the published market prices. Fixed income securities that are valued using significant other observable inputs are quoted at prices obtained from independent financial service industry-recognized vendors. Investments held in pooled investment funds, common collective trusts or limited partnerships are valued at the net asset value (NAV) practical expedient to estimate fair value. The NAV is provided by the fund administrator and is based on the value of the underlying assets owned by the fund minus its liabilities. The investment mix of equity securities, fixed income and other asset allocation strategies is based upon achieving a desired return, balancing higher return, more volatile equity securities and lower return, less volatile fixed income securities. Investment allocations are established for each plan and are generally made across a range of markets, industry sectors, capitalization sizes and in the case of fixed income securities, maturities and credit quality. The target investment allocations for the AbbVie Pension Plan is 35% in equity securities, 20% in fixed income securities and 45% in asset allocation strategies and other holdings. There are no known significant concentrations of risk in the plan assets of the AbbVie Pension Plan or of any other plans. The expected return on plan assets assumption for each plan is based on management's expectations of long-term average rates of return to be achieved by the underlying investment portfolio. In establishing this assumption, management considers historical and expected returns for the asset classes in which the plans are invested, as well as current economic and capital market conditions. Expected Benefit Payments The following table summarizes total benefit payments expected to be paid to plan participants including payments funded from both plan and company assets: years ending December 31 (in millions) Defined benefit plans Other post-employment plans $ $ 2019 2020 2021 2022 2023 to 2027 1,474 Defined Contribution Plan AbbVie's principal defined contribution plan is the AbbVie Savings Plan. AbbVie recorded expense of $82 million in 2017 , $75 million in 2016 and $73 million in 2015 related to this plan. AbbVie provides certain other post-employment benefits, primarily salary continuation arrangements, to qualifying employees and accrues for the related cost over the service lives of the employees. 80 | 2017 Form 10-K Note 12 Equity Stock-Based Compensation AbbVie grants stock-based awards to eligible employees pursuant to the AbbVie 2013 Incentive Stock Program (2013 ISP), which provides for several different forms of benefits, including nonqualified stock options, RSAs, RSUs and various performance-based awards. Under the 2013 ISP, 100 million shares of AbbVie common stock were reserved for issuance as awards to AbbVie employees. The 2013 ISP also facilitated the assumption of certain awards granted under Abbotts incentive stock program, which were adjusted and converted into Abbott and AbbVie stock-based awards as a result of AbbVie's separation from Abbott. AbbVie measures compensation expense for stock-based awards based on the grant date fair value of the awards and the estimated number of awards that are expected to vest. Forfeitures are estimated based on historical experience at the time of grant and are revised in subsequent periods if actual forfeitures differ from those estimates. Compensation cost for stock-based awards is amortized over the service period, which could be shorter than the vesting period if an employee is retirement eligible. Retirement eligible employees generally are those who are age 55 or older and have at least ten years of service. Stock-based compensation expense is principally related to awards issued pursuant to the 2013 ISP and is summarized as follows: Years ended December 31, (in millions) Cost of products sold $ $ $ Research and development Selling, general and administrative Pre-tax compensation expense Tax benefit After-tax compensation expense $ $ $ Stock-based compensation expense for the year ended December 31, 2016 also included the post-combination impact related to Stemcentrx options. See Note 5 for additional information related to the Stemcentrx acquisition. The realized excess tax benefits associated with stock-based compensation totaled $71 million in 2017 , $55 million in 2016 and $61 million in 2015 . Beginning in 2017, all excess tax benefits associated with stock-based awards are recognized in the statement of earnings when the awards vest or settle, rather than in stockholders' equity as a result of the adoption of a new accounting pronouncement. See Note 2 for additional information regarding the adoption of this new accounting pronouncement. Stock Options Stock options awarded pursuant to the 2013 ISP typically have a contractual term of 10 years and generally vest in one-third increments over a three -year period. The exercise price is equal to at least 100% of the market value on the date of grant. The fair value is determined using the Black-Scholes model. The weighted-average grant-date fair values of stock options granted were $9.80 in 2017 , $9.29 in 2016 and $9.96 in 2015 . 2017 Form 10-K | 81 The following table summarizes AbbVie stock option activity in 2017 : (options in thousands, aggregate intrinsic value in millions) Options Weighted- average exercise price Weighted- average remaining life (in years) Aggregate intrinsic value Outstanding at December 31, 2016 15,962 $ 33.63 3.7 $ Granted 1,241 61.36 Exercised (8,836 ) 30.06 Lapsed (51 ) 32.58 Outstanding at December 31, 2017 8,316 $ 41.69 5.1 $ Exercisable at December 31, 2017 5,661 $ 35.51 3.6 $ The total intrinsic value of options exercised was $371 million in 2017 , $325 million in 2016 and $216 million in 2015 . The total fair value of options vested during 2017 was $32 million . On June 1, 2016, AbbVie issued stock options for 1.1 million AbbVie shares to holders of unvested Stemcentrx options as a result of the conversion of such options in connection with the Stemcentrx acquisition. These options were fair-valued using a lattice valuation model. See Note 5 for additional information related to the Stemcentrx acquisition. As of December 31, 2017 , $14 million of unrecognized compensation cost related to stock options is expected to be recognized as expense over approximately the next two years . RSAs, RSUs and Performance Shares RSUs awarded to employees other than senior executives and other key employees pursuant to the 2013 ISP generally vest in one-third increments over a three year period. Recipients of these RSUs are entitled to receive dividend equivalents as dividends are declared and paid during the RSU vesting period. The majority of the equity awards AbbVie grants to its senior executives and other key employees under the 2013 ISP are performance-based. Such awards granted before 2016 consisted of RSAs (or RSUs to the extent necessary for global employees) that generally vest in one-third increments over a three -to- five year period, with vesting contingent upon AbbVie achieving a minimum annual return on equity (ROE). Recipients are entitled to receive dividends (or dividend equivalents for RSUs) as dividends are declared and paid during the award vesting period. In 2016, AbbVie redesigned certain aspects of its long-term incentive program. As a result, equity awards granted in 2016 and 2017 to senior executives and other key employees consisted of a combination of performance-vested RSUs and performance shares. The performance-vested RSUs have the potential to vest in one-third increments during a three -year performance period based on AbbVies ROE relative to a defined peer group of pharmaceutical, biotech and life sciences companies. The recipient may receive one share of AbbVie common stock for each vested award. The performance shares have the potential to vest over a three -year performance period and may be earned based on AbbVies EPS achievement and AbbVies total stockholder return (TSR) (a market condition) relative to a defined peer group of pharmaceutical, biotech and life sciences companies. Dividend equivalents on performance-vested RSUs and performance shares accrue during the performance period and are payable at vesting only to the extent that shares are earned. The weighted-average grant-date fair value of RSAs, RSUs and performance shares generally is determined based on the number of shares/units granted and the quoted price of AbbVies common stock on the date of grant. The weighted-average grant-date fair values of performance shares with a TSR market condition are determined using the Monte Carlo simulation model. 82 | 2017 Form 10-K The following table summarizes AbbVie RSA, RSU and performance share activity for 2017 : (share units in thousands) Share units Weighted-average grant date fair value Outstanding at December 31, 2016 10,715 $ 56.47 Granted 6,109 61.89 Vested (5,532 ) 56.34 Forfeited (610 ) 59.50 Outstanding at December 31, 2017 10,682 $ 59.47 The fair market value of RSAs, RSUs and performance shares (as applicable) vested was $348 million in 2017 , $362 million in 2016 and $335 million in 2015 . As of December 31, 2017 , $250 million of unrecognized compensation cost related to RSAs, RSUs and performance shares is expected to be recognized as expense over approximately the next two years. Cash Dividends The following table summarizes quarterly cash dividends declared for the years ended December 31, 2017 and 2016 : Date Declared Payment Date Dividend Per Share Date Declared Payment Date Dividend Per Share 10/27/17 02/15/18 $0.71 10/28/16 02/15/17 $0.64 09/08/17 11/15/17 $0.64 09/09/16 11/15/16 $0.57 06/22/17 08/15/17 $0.64 06/16/16 08/15/16 $0.57 02/16/17 05/15/17 $0.64 02/18/16 05/16/16 $0.57 On February 15, 2018, AbbVie announced that its board of directors declared an increase in the company's quarterly cash dividend from $0.71 per share to $0.96 per share beginning with the dividend payable on May 15, 2018 to stockholders of record as of April 13, 2018. Stock Repurchase Program The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at managements discretion. The program has no time limit and can be discontinued at any time. Shares repurchased under these programs are recorded at acquisition cost, including related expenses and are available for general corporate purposes. AbbVie's board of directors authorized increases to its existing stock repurchase program of $4.0 billion in April 2016 in anticipation of executing an ASR in connection with the Stemcentrx acquisition and of $5.0 billion in March 2015 in anticipation of executing an ASR in connection with the Pharmacyclics acquisition. The following table shows details about AbbVies ASR transactions: (shares in millions, repurchase amounts in billions) Execution date Purchase amount Initial delivery of shares Final delivery of shares Related acquisition 05/26/15 $5.0 68.1 5.0 Pharmacyclics 06/01/16 3.8 54.4 5.4 Stemcentrx On February 16, 2017, AbbVie's board of directors authorized a $5.0 billion increase to AbbVie's existing stock repurchase program. AbbVie's remaining share repurchase authorization was $4.0 billion as of December 31, 2017 . On February 15, 2018, AbbVie's board of directors authorized a new $10.0 billion stock repurchase program, which superseded AbbVie's previous stock repurchase program. The new stock repurchase program permits purchases of AbbVie shares from time to time in open-market or private transactions, including accelerated share repurchases, at managements discretion. The program has no time limit and can be discontinued at any time. 2017 Form 10-K | 83 In addition to the ASRs, AbbVie repurchased on the open market approximately 13 million shares for $1.0 billion in 2017 , 34 million shares for $2.1 billion in 2016 and 46 million shares for $2.8 billion in 2015 . Accumulated Other Comprehensive Loss The following table summarizes the changes in each component of AOCI, net of tax, for 2017 , 2016 and 2015 : (in millions) (brackets denote losses) Foreign currency translation adjustments Net investment hedging activities Pension and post- employment benefits Marketable security activities Cash flow hedging activities Total Balance as of December 31, 2014 $ (603 ) $ $ (1,608 ) $ $ $ (2,031 ) Other comprehensive income (loss) before reclassifications (667 ) (350 ) Net losses (gains) reclassified from accumulated other comprehensive loss (4 ) (259 ) (180 ) Net current-period other comprehensive income (loss) (667 ) (137 ) (530 ) Balance as of December 31, 2015 (1,270 ) (1,378 ) (2,561 ) Other comprehensive income (loss) before reclassifications (165 ) (194 ) (52 ) Net losses (gains) reclassified from accumulated other comprehensive loss (8 ) (24 ) Net current-period other comprehensive income (loss) (165 ) (135 ) (1 ) (25 ) Balance as of December 31, 2016 (1,435 ) (1,513 ) (2,586 ) Other comprehensive income (loss) before reclassifications (343 ) (480 ) (230 ) (344 ) Net losses (gains) reclassified from accumulated other comprehensive loss (75 ) (112 ) Net current-period other comprehensive income (loss) (343 ) (406 ) (46 ) (342 ) (141 ) Balance as of December 31, 2017 $ (439 ) $ (203 ) $ (1,919 ) $ $ (166 ) $ (2,727 ) In 2017, AbbVie reclassified $316 million of historical currency translation losses from AOCI related to the liquidation of certain foreign entities following the enactment of U.S. tax reform. These losses were included in net foreign exchange loss in the consolidated statement of earnings and had no related income tax impacts. Other comprehensive loss in 2017 also included foreign currency translation adjustments totaling a gain of $680 million , which was principally due to the impact of the strengthening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2016 included foreign currency translation adjustments totaling a loss of $165 million , which was principally due to the impact of the weakening of the Euro on the translation of the companys Euro-denominated assets. Other comprehensive loss in 2015 included foreign currency translation adjustments totaling a loss of $667 million , which was principally driven by the impact of the weakening of the Euro on the translation of the company's Euro-denominated assets. 84 | 2017 Form 10-K The table below presents the impact on AbbVie's consolidated statements of earnings for significant amounts reclassified out of each component of accumulated other comprehensive loss: years ended December 31 (in millions) (brackets denote gains) Pension and post-employment benefits Amortization of actuarial losses and other (a) $ $ $ Tax benefit (33 ) (26 ) (46 ) Total reclassifications, net of tax $ $ $ Cash flow hedging activities Losses (gains) on designated cash flow hedges (b) $ (118 ) $ (20 ) $ (265 ) Tax expense (benefit) (4 ) Total reclassifications, net of tax $ (112 ) $ (24 ) $ (259 ) (a) Amounts are included in the computation of net periodic benefit cost (see Note 11 ). (b) Amounts are included in cost of products sold (see Note 10 ). Other In addition to common stock, AbbVie's authorized capital includes 200 million shares of preferred stock, par value $0.01 . As of December 31, 2017 , no shares of preferred stock were issued or outstanding. Note 13 Income Taxes Earnings Before Income Tax Expense years ended December 31 (in millions) 2016 Domestic $ (2,678 ) $ (1,651 ) $ (1,038 ) Foreign 10,405 9,535 7,683 Total earnings before income tax expense $ 7,727 $ 7,884 $ 6,645 Income Tax Expense years ended December 31 (in millions) Current Domestic $ 6,204 $ 2,229 $ 1,036 Foreign Total current taxes $ 6,580 $ 2,727 $ 1,349 Deferred Domestic $ (4,898 ) $ (792 ) $ Foreign (4 ) Total deferred taxes $ (4,162 ) $ (796 ) $ Total income tax expense $ 2,418 $ 1,931 $ 1,501 Impacts Related to U.S. Tax Reform The Tax Cuts and Jobs Act (the Act) was signed into law in December 2017, resulting in significant changes to the U.S. corporate tax system. The Act reduces the U.S. federal corporate tax rate from 35% to 21% , requires companies to pay a one-time transition tax on a mandatory deemed repatriation of earnings of certain foreign subsidiaries that were previously untaxed and creates new taxes on certain foreign sourced earnings. These changes are effective beginning in 2018. 2017 Form 10-K | 85 Prior to the enactment of the Act, the company did not provide deferred income taxes on undistributed earnings of foreign subsidiaries that were indefinitely reinvested for continued use in foreign operations. Due to the provision of the Act that requires a one-time deemed repatriation of earnings of foreign subsidiaries, the company no longer considers those earnings to be indefinitely reinvested. The transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries was $4.5 billion , generally payable in eight annual installments. Additionally, the company remeasured certain deferred tax assets and liabilities based on tax rates at which they are expected to reverse in the future. The net tax benefit of U.S. tax reform from the remeasurement of deferred taxes related to the Act and foreign tax law changes was $3.6 billion . Given the complexity of the Act and anticipated guidance from the U.S. Treasury about implementing the Act, the companys analysis and accounting for the tax effects of the Act is preliminary. As a direct result of the Act, the company recorded $4.5 billion of transition tax expense, as well as $4.1 billion of net tax benefit for deferred tax remeasurement. Both of these amounts are provisional estimates, as the company has not fully completed its analysis and calculation of foreign earnings subject to the transition tax or its analysis of certain other aspects of the Act that could result in adjustments to the remeasurement of deferred tax balances. Upon completion of the analysis in 2018, these estimates may be adjusted through income tax expense in the consolidated statement of earnings. Effective Tax Rate Reconciliation years ended December 31 2016 Statutory tax rate 35.0 % 35.0 % 35.0 % Effect of foreign operations (12.2 ) (10.3 ) (9.4 ) U.S. tax credits (4.0 ) (4.4 ) (4.5 ) Impacts related to U.S. tax reform 12.0 Tax law change related to foreign currency 2.4 All other, net 0.5 1.8 1.5 Effective tax rate 31.3 % 24.5 % 22.6 % The effective income tax rate fluctuates year to year due to the allocation of the company's taxable earnings among jurisdictions, as well as certain discrete factors and events in each year, including changes in tax law, acquisitions and collaborations. The effective income tax rates in 2017 , 2016 and 2015 differed from the statutory tax rate principally due to changes in enacted tax rates and laws, the benefit from foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities and the cost of repatriation decisions. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico excise tax credits relate to legislation enacted by Puerto Rico that assesses an excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. The effective income tax rate in 2017 included impacts related to U.S. tax reform. In addition, in 2017, the company recognized a net tax benefit of $91 million related to the resolution of various tax positions pertaining to prior years. The effective income tax rate in 2016 included additional expense of $187 million related to the recognition of the tax effect of regulations issued by the Internal Revenue Service on December 7, 2016 that changed the determination of the U.S. taxability of foreign currency gains and losses related to certain foreign operations. The effective income tax rate in 2015 included a tax benefit of $103 million from a reduction of state valuation allowances. 86 | 2017 Form 10-K Deferred Tax Assets and Liabilities as of December 31 (in millions) Deferred tax assets Compensation and employee benefits $ $ Accruals and reserves Chargebacks and rebates Deferred revenue Net operating losses and other credit carryforwards Other Total deferred tax assets 2,032 2,447 Valuation allowances (108 ) (76 ) Total net deferred tax assets 1,924 2,371 Deferred tax liabilities Excess of book basis over tax basis of intangible assets (3,762 ) (5,487 ) Excess of book basis over tax basis in investments (181 ) (3,367 ) Other (203 ) (182 ) Total deferred tax liabilities (4,146 ) (9,036 ) Net deferred tax liabilities $ (2,222 ) $ (6,665 ) The decreases in deferred tax assets and liabilities were primarily due to the enactment of the U.S. tax reform that reduced the U.S. federal corporate tax rate from 35% to 21% and created a territorial tax system, which will generally allow repatriation of future foreign sourced earnings without incurring additional U.S. taxes. The Act also created a minimum tax on certain foreign sourced earnings. The taxability of the foreign sourced earnings and the applicable tax rates are dependent on future events. While the company is still evaluating its accounting policy for the minimum tax on foreign sourced earnings, the provisional estimates of the tax effects of the Act were reported on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense. As of December 31, 2017 , gross state net operating losses were $1.2 billion and tax credit carryforwards were $228 million . The state tax carryforwards expire between 2018 and 2038. As of December 31, 2017 , foreign net operating loss carryforwards were $209 million . Foreign net operating loss carryforwards of $155 million expire between 2018 and 2027 and the remaining do not have an expiration period. The company had valuation allowances of $108 million as of December 31, 2017 and $76 million as of December 31, 2016 . These were principally related to state net operating losses and credit carryforwards that are not expected to be realized. Current income taxes receivable were $2.1 billion as of December 31, 2017 and $347 million as of December 31, 2016 and were included in prepaid expenses and other on the consolidated balance sheets. Unrecognized Tax Benefits years ended December 31 (in millions) Beginning balance $ 1,168 $ $ Increase due to current year tax positions 1,768 Increase due to prior year tax positions Decrease due to prior year tax positions (2 ) (7 ) (15 ) Settlements (233 ) Lapse of statutes of limitations (16 ) (8 ) (8 ) Ending balance $ 2,701 $ 1,168 $ 2017 Form 10-K | 87 AbbVie and Abbott entered into a tax sharing agreement, effective on the date of separation, which provides that Abbott is liable for and has indemnified AbbVie against all income tax liabilities for periods prior to the separation. AbbVie will be responsible for unrecognized tax benefits and related interest and penalties for periods after separation or in instances where an existing entity was transferred to AbbVie upon separation. If recognized, the net amount of potential tax benefits that would impact the company's effective tax rate is $2.6 billion in 2017 and $1.1 billion in 2016 . Of the unrecognized tax benefits recorded in the table above as of December 31, 2017 , AbbVie would be indemnified for approximately $85 million . The Increases due to current year tax positions in the table above includes amounts related to federal, state and international tax items, including a provisional estimate of the remeasurement of unrecognized tax benefits related to earnings of foreign subsidiaries following the enactment of U.S. tax reform in 2017. The ""Increase due to prior year tax positions"" in the table above includes amounts relating to federal, state and international items as well as prior positions acquired through business development activities during the year. Uncertain tax positions are generally included as a long-term liability on the consolidated balance sheets. AbbVie recognizes interest and penalties related to income tax matters in income tax expense in the consolidated statements of earnings. AbbVie recognized gross income tax expense of $24 million in 2017 , $35 million in 2016 and $13 million in 2015 , for interest and penalties related to income tax matters. AbbVie had an accrual for the payment of gross interest and penalties of $120 million at December 31, 2017 , $112 million at December 31, 2016 and $83 million at December 31, 2015 . The company is routinely audited by the tax authorities in significant jurisdictions and a number of audits are currently underway. It is reasonably possible during the next twelve months that uncertain tax positions may be settled, which could result in a decrease in the gross amount of unrecognized tax benefits. Due to the potential for resolution of federal, state and foreign examinations and the expiration of various statutes of limitation, the company's gross unrecognized tax benefits balance may change within the next twelve months up to $31 million . All significant federal, state, local and international matters have been concluded for years through 2008. The company believes adequate provision has been made for all income tax uncertainties. Note 14 Legal Proceedings and Contingencies AbbVie is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. Loss contingency provisions are recorded for probable losses at managements best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. The recorded accrual balance for litigation was approximately $445 million as of December 31, 2017 and approximately $225 million at December 31, 2016 . Initiation of new legal proceedings or a change in the status of existing proceedings may result in a change in the estimated loss accrued by AbbVie. While it is not feasible to predict the outcome of all proceedings and exposures with certainty, management believes that their ultimate disposition should not have a material adverse effect on AbbVies consolidated financial position, results of operations or cash flows. Subject to certain exceptions specified in the separation agreement by and between Abbott and AbbVie, AbbVie assumed the liability for, and control of, all pending and threatened legal matters related to its business, including liabilities for any claims or legal proceedings related to products that had been part of its business, but were discontinued prior to the distribution, as well as assumed or retained liabilities, and will indemnify Abbott for any liability arising out of or resulting from such assumed legal matters. Several pending lawsuits filed against Unimed Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc. (a company Abbott acquired in February 2010 and now known as AbbVie Products LLC) and others are consolidated for pre-trial purposes in the United States District Court for the Northern District of Georgia under the Multi-District Litigation (MDL) Rules as In re: AndroGel Antitrust Litigation, MDL No. 2084. These cases, brought by private plaintiffs and the Federal Trade Commission (FTC), generally allege Solvay's patent litigation involving AndroGel was sham litigation and the 2006 patent litigation settlement agreements and related agreements with three generic companies violate federal antitrust laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. These cases include: (a) four individual plaintiff lawsuits; (b) three purported class actions; and (c) Federal Trade Commission v. Actavis, Inc. et al. Following the district court's dismissal of all plaintiffs' claims, appellate proceedings led to the reinstatement of the claims regarding the patent litigation settlements, which are proceeding in the district court. 88 | 2017 Form 10-K Lawsuits are pending against AbbVie and others generally alleging that the 2005 patent litigation settlement involving Niaspan entered into between Kos Pharmaceuticals, Inc. (a company acquired by Abbott in 2006 and presently a subsidiary of AbbVie) and a generic company violates federal and state antitrust laws and state unfair and deceptive trade practices and unjust enrichment laws. Plaintiffs generally seek monetary damages and/or injunctive relief and attorneys' fees. The lawsuits consist of four individual plaintiff lawsuits and two consolidated purported class actions: one brought by three named direct purchasers of Niaspan and the other brought by ten named end-payer purchasers of Niaspan. The cases are consolidated for pre-trial proceedings in the United States District Court for the Eastern District of Pennsylvania under the MDL Rules as In re: Niaspan Antitrust Litigation, MDL No. 2460. In October 2016, the State of California filed a lawsuit regarding the Niaspan patent litigation settlement in Orange County Superior Court, asserting a claim under the unfair competition provision of the California Business and Professions Code seeking injunctive relief, restitution, civil penalties and attorneys fees. In September 2014, the FTC filed suit in the United States District Court for the Eastern District of Pennsylvania against AbbVie and others, alleging that the 2011 patent litigation with two generic companies regarding AndroGel was sham litigation and the patent litigation settlement with one of those generic companies violates federal antitrust laws. The FTC's complaint seeks monetary damages and injunctive relief. In May 2015, the court dismissed the FTC's claim regarding the patent litigation settlement. In March 2015, the State of Louisiana filed a lawsuit, State of Louisiana v. Fournier Industrie et Sante, et al., against AbbVie, Abbott and affiliated Abbott entities in Louisiana state court. Plaintiff alleges that patent applications and patent litigation filed and other alleged conduct from the early 2000's and before related to the drug TriCor violated Louisiana State antitrust and unfair trade practices laws. The lawsuit seeks monetary damages and attorneys' fees. In November 2014, a putative class action lawsuit, Medical Mutual of Ohio v. AbbVie Inc., et al., was filed against several manufacturers of testosterone replacement therapies (TRTs), including AbbVie, in the United States District Court for the Northern District of Illinois on behalf of all insurance companies, health benefit providers, and other third party payers who paid for TRTs, including AndroGel. The claims asserted include violations of the federal RICO Act and state consumer fraud and deceptive trade practices laws. The complaint seeks monetary damages and injunctive relief. Product liability cases are pending in which plaintiffs generally allege that AbbVie and other manufacturers of TRTs did not adequately warn about risks of certain injuries, primarily heart attacks, strokes and blood clots. Approximately 4,300 claims are consolidated for pre-trial purposes in the United States District Court for the Northern District of Illinois under the MDL Rules as In re: Testosterone Replacement Therapy Products Liability Litigation, MDL No. 2545. Approximately 210 claims are pending in various state courts. Plaintiffs generally seek compensatory and punitive damages. In July 2017, a jury in the United States District Court for the Northern District of Illinois reached a verdict in the first case to be tried. The jury found for AbbVie on the plaintiff's strict liability and negligence claims and for the plaintiff on the plaintiff's fraud claim. The jury awarded no compensatory damages, but did award plaintiffs $150 million in punitive damages. In December 2017, the court vacated the jurys verdict and punitive damage award on the fraud claim and ordered a new trial on that claim. In a second case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in August 2017 on all claims, which is the subject of post-trial proceedings. In another case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in October 2017 on strict liability but for the plaintiff on remaining claims and awarded $140,000 in compensatory damages and $140 million in punitive damages, which is the subject of post-trial proceedings. In a separate case, a jury in the United States District Court for the Northern District of Illinois reached a verdict for AbbVie in January 2018 on all claims. Product liability cases are pending in which plaintiffs generally allege that AbbVie did not adequately warn about risk of certain injuries, primarily various birth defects, arising from use of Depakote. Over ninety percent of the approximately 635 claims are pending in the United States District Court for the Southern District of Illinois, and the rest are pending in various other federal and state courts. Plaintiffs generally seek compensatory and punitive damages. In November 2014, five individuals filed a putative class action lawsuit, Rubinstein, et al. v Gonzalez, et al., on behalf of purchasers and sellers of certain Shire plc (Shire) securities between June 20 and October 14, 2014, against AbbVie and its chief executive officer in the United States District Court for the Northern District of Illinois alleging that the defendants made and/or are responsible for material misstatements in violation of federal securities laws in connection with AbbVie's proposed transaction with Shire. In June 2016, a lawsuit, Elliott Associates, L.P., et al. v. AbbVie Inc., was filed by five investment funds against AbbVie in the Cook County, Illinois Circuit Court alleging that AbbVie made misrepresentations and omissions in connection with its proposed transaction with Shire. Similar lawsuits were filed between July and September 2017 against AbbVie and in some 2017 Form 10-K | 89 instances its chief executive officer in the same court by twelve additional investment funds. Plaintiffs seek compensatory and punitive damages. In May 2017, a shareholder derivative lawsuit, Ellis v. Gonzalez, et al., was filed in Delaware Chancery Court, alleging that AbbVie's directors breached their fiduciary duties in connection with statements made regarding the Shire transaction. The lawsuit seeks unspecified compensatory damages for AbbVie, among other relief. Beginning in May 2016, the Patent Trial Appeal Board of the U.S. Patent Trademark Office (PTO) instituted five inter partes review proceedings brought by Coherus Biosciences and Boehringer Ingelheim related to three AbbVie patents covering methods of treatment of rheumatoid arthritis using adalimumab. In these proceedings, the PTO reviewed the validity of the patents and issued decisions of invalidity in May, June and July of 2017. AbbVies appeal of the decisions is pending in the Court of Appeals for the Federal Circuit. In March 2017, AbbVie filed a lawsuit, AbbVie Inc. v. Novartis Vaccines and Diagnostics, Inc. and Grifols Worldwide Operations Ltd., in the United States District Court for the Northern District of California against Novartis Vaccines and Grifols Worldwide seeking a declaratory judgment that eleven HCV-related patents licensed to AbbVie in 2002 are invalid. AbbVie is seeking to enforce certain patent rights related to adalimumab (a drug AbbVie sells under the trademark HUMIRA). In a case filed in United States District Court for the District of Delaware in August 2017, AbbVie alleges that Boehringer Ingelheim International GmbHs, Boehringer Ingelheim Pharmaceutical, Inc.s, and Boehringer Ingelheim Fremont, Inc.s proposed biosimilar adalimumab product infringes certain AbbVie patents. AbbVie seeks declaratory and injunctive relief. Pharmacyclics LLC, a wholly owned subsidiary of AbbVie, is seeking to enforce its patent rights relating to ibrutinib capsules (a drug Pharmacyclics sells under the trademark IMBRUVICA). In a case filed in the United States District Court for the District of Delaware on February 1, 2018, Pharmacyclics alleges that Fresenius Kabi USA, LLC, Fresenius Kabi USA, Inc., and Fresenius Kabi Oncology Limiteds proposed generic ibrutinib product infringes Pharmacyclics patents and Pharmacyclics seeks declaratory and injunctive relief. Janssen Biotech, Inc. which is in a global collaboration with Pharmacyclics concerning the development and marketing of IMBRUVICA, is the co-plaintiff in this suit. Note 15 Segment and Geographic Area Information AbbVie operates in one business segmentpharmaceutical products. Substantially all of AbbVie's net revenues in the United States are to three wholesalers. Outside the United States, products are sold primarily to health care providers or through distributors, depending on the market served. The following tables detail AbbVie's worldwide net revenues: years ended December 31 (in millions) HUMIRA $ 18,427 $ 16,078 $ 14,012 IMBRUVICA 2,573 1,832 HCV 1,274 1,522 1,639 Lupron Creon Synagis Synthroid AndroGel Kaletra Sevoflurane Duodopa All other 1,217 1,402 Total net revenues $ 28,216 $ 25,638 $ 22,859 90 | 2017 Form 10-K Net revenues to external customers by geographic area, based on product shipment destination, were as follows: years ended December 31 (in millions) United States $ 18,251 $ 15,947 $ 13,561 Germany 1,157 1,104 1,082 United Kingdom Japan France Canada Spain Italy Brazil The Netherlands All other countries 4,080 3,885 4,001 Total net revenues $ 28,216 $ 25,638 $ 22,859 Long-lived assets, primarily net property and equipment, by geographic area were as follows: as of December 31 (in millions) United States and Puerto Rico $ 1,862 $ 1,822 Europe All other 278 Total long-lived assets $ 2,803 $ 2,604 2017 Form 10-K | 91 Note 16 Quarterly Financial Data (unaudited) (in millions except per share data) First Quarter Net revenues $ 6,538 $ 5,958 Gross margin 4,922 4,589 Net earnings (a) 1,711 1,354 Basic earnings per share $ 1.07 $ 0.83 Diluted earnings per share $ 1.06 $ 0.83 Cash dividends declared per common share $ 0.64 $ 0.57 Second Quarter Net revenues $ 6,944 $ 6,452 Gross margin 5,416 5,047 Net earnings (b) 1,915 1,610 Basic earnings per share $ 1.20 $ 0.99 Diluted earnings per share $ 1.19 $ 0.98 Cash dividends declared per common share $ 0.64 $ 0.57 Third Quarter Net revenues $ 6,995 $ 6,432 Gross margin 5,379 4,928 Net earnings (c) 1,631 1,598 Basic earnings per share $ 1.02 $ 0.97 Diluted earnings per share $ 1.01 $ 0.97 Cash dividends declared per common share $ 0.64 $ 0.57 Fourth Quarter Net revenues $ 7,739 $ 6,796 Gross margin 5,459 5,241 Net earnings (d) 1,391 Basic earnings per share $ 0.03 $ 0.86 Diluted earnings per share $ 0.03 $ 0.85 Cash dividends declared per common share $ 0.71 $ 0.64 (a) First quarter results in 2017 included after-tax costs of $84 million related to the change in fair value of contingent consideration liabilities. First quarter results in 2016 included a net foreign exchange loss of $298 million related to the devaluation of AbbVies net monetary assets denominated in the Venezuelan bolivar. (b) Second quarter results in 2017 included an after-tax charge of $62 million to increase litigation reserves and after-tax costs of $61 million related to the change in fair value of contingent consideration liabilities. Second quarter results in 2016 included after-tax costs totaling $122 million related to the acquisition of Stemcentrx and BI compounds as well as the amortization of the acquisition date fair value step-up for inventory related to the acquisition of Pharmacyclics. (c) Third quarter results in 2017 included after-tax costs of $401 million related to the change in fair value of contingent consideration liabilities. Third quarter results in 2016 included after-tax costs of $104 million related to the change in fair value of contingent consideration liabilities. (d) Fourth quarter results in 2017 were impacted by net charges related to the December 2017 enactment of the Tax Cuts and Jobs Act , including an after-tax charge of $4.5 billion related to the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries , partially offset by after-tax benefits of $3.3 billion due to 92 | 2017 Form 10-K remeasurement of net deferred tax liabilities and other related impacts . Additional after-tax costs that impacted fourth quarter results in 2017 included $244 million for an intangible asset impairment charge, $221 million for a charge to increase litigation reserves, $205 million as a result of entering into a global strategic collaboration with Alector, Inc. and $79 million related to the change in fair value of contingent consideration liabilities. These costs were partially offset by an after-tax benefit of $91 million due to a tax audit settlement. Fourth quarter results in 2016 included after-tax costs totaling $187 million associated with a tax law change for regulations issued in the fourth quarter of 2016 that revised the treatment of foreign currency translation gains and losses for certain operations as well as after-tax costs totaling $85 million related to the change in fair value of contingent consideration liabilities. 2017 Form 10-K | 93 Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of AbbVie Inc. and subsidiaries (the Company) as of December 31, 2017 and 2016 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 16, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2013. Chicago, Illinois February 16, 2018 94 | 2017 Form 10-K "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures; Internal Control Over Financial Reporting Evaluation of disclosure controls and procedures. The Chief Executive Officer, Richard A. Gonzalez, and the Chief Financial Officer, William J. Chase, evaluated the effectiveness of AbbVie's disclosure controls and procedures as of the end of the period covered by this report, and concluded that AbbVie's disclosure controls and procedures were effective to ensure that information AbbVie is required to disclose in the reports that it files or submits with the Securities and Exchange Commission under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms, and to ensure that information required to be disclosed by AbbVie in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to AbbVie's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in internal control over financial reporting. There were no changes in AbbVie's internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, AbbVie's internal control over financial reporting during the quarter ended December 31, 2017 . Inherent limitations on effectiveness of controls. AbbVie's management, including its Chief Executive Officer and its Chief Financial Officer, do not expect that AbbVie's disclosure controls or internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Management's annual report on internal control over financial reporting. Management of AbbVie is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. AbbVie's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and reporting. Management assessed the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 framework). Based on that assessment, management concluded that AbbVie maintained effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. The effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in their attestation report below, which expresses an unqualified opinion on the effectiveness of AbbVie's internal control over financial reporting as of December 31, 2017 . 2017 Form 10-K | 95 Report of independent registered public accounting firm. The report of AbbVie's independent registered public accounting firm related to its assessment of the effectiveness of internal control over financial reporting is included below. 96 | 2017 Form 10-K Report Of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of AbbVie Inc. Opinion on Internal Control over Financial Reporting We have audited AbbVie Inc. and subsidiaries' internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, AbbVie Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of AbbVie Inc. and subsidiaries as of December 31, 2017 and 2016 , and the related consolidated statements of earnings, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes of the Company and our report dated February 16, 2018 expressed an unqualified opinion thereon. Basis of Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations on Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Chicago, Illinois February 16, 2018 2017 Form 10-K | 97 " diff --git a/datasets/raw/alphabet.csv b/datasets/raw/alphabet.csv new file mode 100644 index 0000000..b32b91e --- /dev/null +++ b/datasets/raw/alphabet.csv @@ -0,0 +1,5 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,goog,20211231," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history, inspiring us to tackle big problems and invest in moonshots like artificial intelligence (AI) research and quantum computing. We continue this work under the leadership of Sundar Pichai, who has served as CEO of Google since 2015 and as CEO of Alphabet since 2019. Alphabet is a collection of businesses the largest of which is Google. We report Google in two segments, Google Services and Google Cloud; we also report all non-Google businesses collectively as Other Bets. Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long-term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Alphabet's structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers; it propels ideas, people and businesses large and small. Our mission to organize the worlds information and make it universally accessible and useful is as relevant today as it was when we were founded in 1998. Since then, we have evolved from a company that helps people find answers to a company that also helps people get things done. We are focused on building an even more helpful Google for everyone, and we aspire to give everyone the tools they need to increase their knowledge, health, happiness, and success. Every year, there are trillions of searches on Google, and 15% of the searches we see every day are new. We continue to invest deeply in AI and other technologies to ensure the most helpful search experience possible. YouTube provides people with entertainment, information, and opportunities to learn something new. And Google Assistant offers the best way to get things done seamlessly across different devices, providing intelligent help throughout a person's day, no matter where they are. We are continually innovating and building new product features that will help our users, partners, customers, and communities. We have invested more than $100 billion in RD over the last five years. In addition, with the onset of Alphabet Inc. the pandemic, we have focused in particular on features that help people in their daily lives and that support businesses working to serve their customers. For example, we have added live busyness trends in Google Maps that help users instantly spot when a neighborhood or part of town is near or at its busiest. We have also helped businesses navigate uncertainty during an uneven economic recovery, and we have worked to address the complex challenge of distributing critical information about COVID-19 vaccines to billions of people around the world. Importantly, we have made authoritative content a key focus area across both Google Search and YouTube to help users find trusted public health information. Other Bets also remain focused on innovation through technology that can positively affect people's lives. For instance, Waymo is working toward our goal of making transportation safer and easier for everyone and Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and to invest for the long term within each of our segments. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in, as they are the key to our long-term success. The power of AI Across the company, investments in AI and machine learning are increasingly driving many of our latest innovations and have enabled us to build products that are smarter and more helpful. For example, in May of 2021, we introduced Multitask Unified Model or MUM which has the potential to transform how Google helps with complex tasks. MUM is trained across 75 different languages, which means that it can learn from sources written in one language and help bring that information to people in another. It is also multimodal, so it understands information across text and images and, in the future, can expand to more modalities like video and audio. We are currently experimenting with MUMs capabilities to make searching more natural and intuitive and even enable entirely new ways to search. DeepMind also made a significant AI-powered breakthrough, solving a 50-year-old protein folding challenge, which will help the world better understand one of lifes fundamental building blocks, and will enable researchers to tackle new and difficult problems, from fighting diseases to environmental sustainability. DeepMind has since shared its new AlphaFold protein structure database, which doubled the number of high-accuracy human protein structures available to researchers. Google For reporting purposes, Google comprises two segments: Google Services and Google Cloud. Google Services Serving our users We have always been a company committed to building helpful products that can improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google Services' core products and platforms include ads, Android, Chrome, hardware, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube, each with broad and growing adoption by users around the world. Our products and services have come a long way since the company was founded more than two decades ago. Rather than the ten blue links in our early search results, users can now get direct answers to their questions using their computer, mobile device, or their own voice, making it quicker, easier and more natural to find what they are looking for. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content both on the web and through platforms like Google Play and YouTube. With the continued adoption of mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are extraordinary platforms and hardware. That is why we continue to invest in platforms like our Android mobile operating system, Chrome browser, and Chrome operating system, as Alphabet Inc. well as growing our family of hardware devices. We see tremendous potential for devices to be helpful and make people's lives easier by combining the best of our AI, software and hardware. This potential is reflected in our latest generation of hardware products such as Pixel 5a 5G and Pixel 6 phones, the Fitbit Charge 5, Chromecast with Google TV, and the new Google Nest Cams and Nest Doorbell. Creating products that people rely on every day is a journey that we are investing in for the long run. The key to building helpful products for users is our commitment to privacy, security, and user choice. We protect user privacy and security with products that are secure by default and private by design, and that keep users in control of their data. Our privacy-preserving technologies safeguard individual privacy and enhance data protection. As the Internet evolves, so does our approach to privacy and security. We continue to enhance our anti-malware features in Chrome and drive improvements such as auto-delete controls that automatically delete web and app searches after 18 months. And we continue to keep users and their passwords safe through advances like our built-in password manager. How we make money We have built world-class advertising technologies for advertisers, agencies, and publishers to power their digital marketing businesses. Our advertising solutions help millions of companies grow their businesses through our wide range of products across devices and formats, and we aim to ensure positive user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. Google Services generates revenues primarily by delivering both performance and brand advertising that appears on Google Search other properties, YouTube and Google Network partners' properties (""Google Network properties""). We continue to invest in both performance and brand advertising and seek to improve the measurability of advertising so advertisers understand the effectiveness of their campaigns. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads. Brand advertising helps enhance users' awareness of and affinity for advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, including filtering out invalid traffic, removing billions of bad ads from our systems every year, and closely monitoring the sites, apps, and videos where ads appear and blocklisting them when necessary to ensure that ads do not fund bad content. We continue to look to the future and are making long-term investments that we expect to grow revenues beyond advertising, including revenues from Google Play, hardware, and YouTube non-advertising. Google Play generates revenues from sales of apps and in-app purchases and digital content sold in the Google Play store. Hardware generates revenues from sales of Fitbit wearable devices, Google Nest home products, Pixel phones, and other devices. YouTube non-advertising generates revenues from YouTube Premium and YouTube TV subscriptions and other services. Google Cloud Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics, and AI. We see significant opportunity in helping businesses utilize these strengths with features like data migration, modern development environments, and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. Google Cloud Platform enables developers to build, test, and deploy applications on its highly scalable and reliable infrastructure. Google Workspace collaboration tools which include apps like Gmail, Docs, Drive, Calendar, Meet and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays digital experiences are being built in the cloud, Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Google Cloud Platform generates revenues from infrastructure, platform and other services. Alphabet Inc. Google Workspace generates revenues from cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar and Meet. Our cloud services are generally provided on either a consumption or subscription basis and may have contract terms longer than a year. Other Bets Across Alphabet, we are also using technology to try to solve big problems that affect a wide variety of industries. Alphabets investment in the portfolio of Other Bets includes emerging businesses at various stages of development, ranging from those in the RD phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in the portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, including from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Yahoo, and Yandex. Vertical search engines and e-commerce providers, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks offered by ByteDance, Meta, Snap, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other online advertising platforms and networks, such as Amazon, AppNexus, Criteo, and Meta, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms, such as Amazon, Apple, and Microsoft. Digital assistant providers, such as Amazon and Apple. Providers of enterprise cloud services, such as Alibaba, Amazon, Microsoft, and Salesforce. Providers of digital video services, such as Amazon, Apple, ATT, ByteDance, Disney, Hulu, Meta, and Netflix. Other digital content and application platform providers, such as Amazon and Apple. Providers of workspace connectivity and productivity products, such as Meta, Microsoft, Salesforce, and Zoom. Competing successfully depends heavily on our ability to develop and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security, and availability of our products and services; advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels; and content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. For additional information about competition, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Alphabet Inc. Ongoing Commitment to Sustainability We believe that every business has the opportunity and obligation to protect our planet. Sustainability is one of our core values at Google, and we strive to build sustainability into everything we do. We have been a leader on sustainability and climate change since Googles founding over 20 years ago. These are some of our key achievements over the past two decades: In 2007, we became the first major company to be carbon neutral for our operations. In 2017, we became the first major company to match 100% of our annual electricity use with renewable energy, which we have achieved for four consecutive years. In 2020, we issued $5.75 billion in sustainability bondsthe largest sustainability or green bond issuance by any company in history at the time. The net proceeds from the issuance are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. As of December 31, 2020, we have allocated $3.47 billion of the net proceeds, as outlined in our Sustainability Bond Impact Report published in 2021. Also in 2020, we compensated for our legacy carbon footprint, making Google the first major company to be carbon neutral for its entire operating history. Our sustainability strategy is focused on three key pillars: accelerating the transition to carbon-free energy and a circular economy, empowering everyone with technology, and benefiting the people and places where we operate. To accelerate the transition to a carbon-free economy, in 2020, we launched our third decade of climate action, and we are now working toward a new set of ambitious goals. By 2030, we aim to: achieve net-zero emissions across all of our operations and value chain; become the first major company to run on carbon-free energy 24 hours a day, seven days a week, 365 days a year; enable 5 gigawatts of new carbon-free energy through investments in our key manufacturing regions; and help more than 500 cities and local governments reduce an aggregate of 1 gigaton of carbon emissions annually. To accelerate the transition to a circular economy, we are working to maximize the reuse of finite resources across our operations, products, and supply chains and to enable others to do the same. We are also working to empower everyone with technology by committing to help 1 billion people make more sustainable choices by the end of 2022 through our core products. To benefit the people and places where we operate, we have set goals to replenish more water than we consume by 2030 and to support water security in communities where we operate. We will focus on three areas: enhancing our stewardship of water resources across Google office campuses and data centers; replenishing our water use and improving watershed health and ecosystems in water-stressed communities; and sharing technology and tools that help everyone predict, prevent, and recover from water stress. We remain steadfast in our commitment to sustainability, and we will continue to lead and encourage others to join us in improving the health of our planet. We are proud of what we have achieved so far, and we are energized to help move the world closer to a more sustainable and carbon-free future for all. More information on our approach to sustainability can be found in our annual sustainability reports, including Googles Environmental Report and Alphabets 2021 Sustainability Bond Impact Report, which outlines the allocation of our net proceeds from our sustainability bonds. The contents of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. For additional information about risks and uncertainties applicable to our commitments to attain certain sustainability goals, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Culture and Workforce We are a company of curious, talented, and passionate people. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex challenges in technology and society. Our people are critical for our continued success, so we work hard to create an environment where employees can have fulfilling careers, and be happy, healthy, and productive. We offer industry-leading benefits and programs to take care of the diverse needs of our employees and their families, including opportunities for career growth and Alphabet Inc. development, resources to support their financial health, and access to excellent healthcare choices. Our competitive compensation programs help us to attract and retain top candidates, and we will continue to invest in recruiting talented people to technical and non-technical roles, and rewarding them well. We provide a variety of high quality training and support to our managers to build and strengthen their capabilities-ranging from courses for new managers, to learning resources that help them provide feedback and manage performance, to coaching and individual support. At Alphabet, we are committed to making diversity, equity, and inclusion part of everything we do and to growing a workforce that is representative of the users we serve. More information on Googles approach to diversity can be found in our annual diversity reports, available publicly at diversity.google. The contents of our diversity reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. As of December 31, 2021, Alphabet had 156,500 employees. We have work councils and statutory employee representation obligations in certain countries, and we are committed to supporting protected labor rights, maintaining an open culture and listening to all employees. Supporting healthy and open dialogue is central to how we work, and we communicate information about the company through multiple internal channels to our employees. When necessary, we contract with businesses around the world to provide specialized services where we do not have appropriate in-house expertise or resources, often in fields that require specialized training like cafe operations, content moderation, customer support, and physical security. We also contract with temporary staffing agencies when we need to cover short-term leaves, when we have spikes in business needs, or when we need to quickly incubate special projects. We choose our partners and staffing agencies carefully, and review their compliance with Googles Supplier Code of Conduct. We continually make improvements to promote a respectful and positive working environment for everyone employees, vendors, and temporary staff alike. Government Regulation We are subject to numerous United States (U.S.) federal, state, and foreign laws and regulations covering a wide variety of subject matters. Like other companies in the technology industry, we face heightened scrutiny from both U.S. and foreign governments with respect to our compliance with laws and regulations. Many of these laws and regulations are evolving and their applicability and scope, as interpreted by the courts, remain uncertain. Our compliance with these laws and regulations may be onerous and could, individually or in the aggregate, increase our cost of doing business, make our products and services less useful, limit our ability to pursue certain business models, cause us to change our business practices, affect our competitive position relative to our peers, and/or otherwise have an adverse effect on our business, reputation, financial condition, and operating results. For additional information about government regulation applicable to our business, see Risk Factors in Item 1A, Trends in Our Business and Financial Effect in Part II, Item 7, and Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. For additional information, see Risk Factors in Item 1A of this Annual Report on Form 10-K. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items that may be material or of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, that may be material or of interest to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance Alphabet Inc. guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The contents of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results, and affect the trading price of our Class A and Class C stock. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generated more than 80% of total revenues from the display of ads online in 2021. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising and/or data privacy practices have in the past, and may in the future, affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions have affected, and may in the future affect, the demand for advertising, resulting in fluctuations in the amounts our advertisers spend on advertising, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, customers, and other partners, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in RD, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories and well established relationships in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in RD and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Further, discrepancies in enforcement of existing laws may enable our lesser known competitors to aggressively interpret those laws without commensurate scrutiny, thereby affording them competitive advantages. Our competitors may also be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in providing compelling products and services or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could divert management attention and harm our financial condition and operating results. Alphabet Inc. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google Services, Google Cloud, and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google Services, Google Cloud, and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of resources and management attention from current operations and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google Services, we continue to invest heavily in hardware, including our smartphones, home devices, and wearables, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. Within Google Cloud, we devote significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale our salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large, experienced, and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use AI and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition, and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing regulations, increasing competition, and increased costs for many aspects of our business. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. For additional information, see Trends in Our Business and Financial Effect in Part II, Item 7 of this Annual Report on Form 10-K. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services, and brands as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. There is always the possibility that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. Alphabet Inc. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the U.S., may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google Services, Google Cloud, and Other Bets increases our ability to enter new categories and launch new and innovative products and services that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands have been, and may in the future be, negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to respond appropriately to the sharing of misinformation or objectionable content on our services and/or products or objectionable practices by advertisers, or otherwise to adequately address user concerns, our users may lose confidence in our brands. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, trustworthy, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our finished products; to design certain of our components and parts; to participate in the distribution of our products and services; and to design, manufacture, or assemble certain components and parts in our technical infrastructure. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We have experienced and/or may in the future experience supply shortages and/or price increases that could negatively affect our operations, driven by raw material, component or part availability, manufacturing capacity, labor shortages, industry allocations, logistics capacity, tariffs, trade disputes and barriers, natural disasters or pandemics, the effects of climate change (such as sea level rise, drought, flooding, heat waves, wildfires and resultant air quality effects and power shutoffs associated with wildfire prevention, and increased storm severity), and significant changes in the financial or business condition of our suppliers. In addition, some of the components we use in our technical infrastructure and products are available from only one or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant supply interruption that affects us or our vendors could delay critical data center upgrades or expansions and delay product availability. We may enter into long-term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because certain of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Alphabet Inc. Our products and services have had, and in the future may have, quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance, and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption to, interference with, or failure of our complex information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, problems with the design or implementation of our new global enterprise resource planning system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from modifications or upgrades, terrorist attacks, natural disasters or pandemics, the effects of climate change (such as sea level rise, drought, flooding, heat waves, wildfires and resultant air quality effects and power shutoffs associated with wildfire prevention, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster or pandemic, closure of a facility, or other unanticipated problems affecting our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and have contained in the past, and may contain in the future, errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. As the phased implementation continues, we may experience delays, increased costs, and other difficulties. Failure to successfully design and implement the ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2021. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.; import and export requirements, tariffs and other market access barriers that may prevent or impede us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs; longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud; an evolving foreign policy landscape that may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom and new customer requirements), in addition to other adverse effects that we are unable to effectively anticipate; Alphabet Inc. anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties; uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent; and different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we have faced, and will continue to face, exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on some interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available or may only be available with limited functionality for our users or our advertisers on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Concerns about, including the adequacy of, our practices with regard to the collection, use, governance, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations and regulations regarding privacy and data change. Our products and services involve the storage, handling, and transmission of proprietary and other sensitive information. Software bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss or improper use and disclosure of such information, which could result in litigation and other potential liability, including regulatory fines and penalties, as well as reputational harm. Additionally, our products incorporate highly technical and complex technologies, and thus our technologies and software have contained, and are likely in the future to contain, undetected errors, bugs, or vulnerabilities. We have in the past discovered, and may in the future discover, some errors in our software code only after we have released the code. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation, brand, and business, and impair our ability to attract and retain users or customers. Such incidents have occurred in the past and may continue to occur due to the scale and nature of our products and services. While there is no guarantee that such incidents will not cause significant damage, we expect to continue to expend significant resources to maintain security protections that limit the effect of bugs, theft, misuse, and security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. Cyber attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. We have seen, and will continue to see, industry-wide vulnerabilities, such as the Log4j vulnerability reported in December 2021, which could affect our or other parties systems. We expect to continue to experience such Alphabet Inc. incidents or vulnerabilities in the future. Our efforts to address undesirable activity on our platform may also increase the risk of retaliatory attack. We may experience future security issues, whether due to employee error or malfeasance or system errors or vulnerabilities in our or other parties systems. While we may not determine some of these issues to be material at the time they occur and may remedy them quickly, there is no guarantee that these issues will not ultimately result in significant legal, financial, and reputational harm, including government inquiries and enforcement actions, litigation, and negative publicity. Because the techniques used to obtain unauthorized access to, disable or degrade service provided by or otherwise sabotage systems change frequently and often are recognized only after being launched against a target, even taking all reasonable precautions, including those required by law, we have been unable in the past and may continue to be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Further, if any partners with whom we share user or other customer information fail to implement adequate data-security practices or fail to comply with our terms and policies or otherwise suffer a network or other security breach, our users information may be improperly accessed, used, or disclosed. If an actual or perceived breach of our or our business partners or service providers security occurs, the market perception of the effectiveness of our security measures would be harmed, we could lose users and customers, our trade secrets or those of our business partners may be compromised, and we may be exposed to significant legal and financial risks, including legal claims (which may include class-action litigation) and regulatory action, fines, and penalties. Any of the foregoing consequences could have a material and adverse effect on our business, reputation, and results of operations. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process, particularly during times of a natural disaster or pandemic, may not be adequate, may fail to accurately assess the severity of an incident, may not be fast enough to prevent or limit harm, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. For additional information, see also our risk factor on privacy and data protection regulations under Risks Related to Laws and Regulations below. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to prevent and mitigate cyber attacks, we are making significant investments in safety, security, and review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigation and review of platform applications that could access the information of users of our services. As a result of these efforts, we have in the past discovered, and may in the future discover, incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. However, we may not have discovered, and may in the future not discover, all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, including factors outside of our control such as a natural disaster or pandemic, and we may learn of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or off-line, or instances of spamming, scraping, or spreading disinformation. While we may not determine some of these incidents to be material at the time they occurred and we may remedy them quickly, there is no guarantee that these issues will not ultimately result in significant legal, financial, and reputational harm, including government inquiries and enforcement actions, litigation, and negative publicity. We may also be unsuccessful in our efforts to enforce our policies or otherwise prevent or remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in ways that harm our business operations and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content on our platforms, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines across our platforms, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and Alphabet Inc. invalid traffic, we have been unable and may continue to be unable to adequately detect and prevent all such abuses or promote uniformly high-quality content. Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts have affected, and may continue to affect, the quality of content on our platforms and lead them to display false, misleading, or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam on our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes designed to detect and prevent abuse from low-quality websites. We also face other challenges on our platforms, including violations of our content guidelines involving incidents such as attempted election interference, activities that threaten the safety and/or well-being of our users on- or off-line, and the spreading of misinformation or disinformation. If we fail to either detect and prevent an increase in problematic content or effectively promote high-quality content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory action, which could result in monetary penalties and damages and divert managements time and attention. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, by charging increased fees to us or our users to provide our offerings, or by providing our competitors preferential access. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the U.S. and elsewhere regarding such protections. For example, in 2018 the U.S. Federal Communications Commission repealed net neutrality rules, which could permit internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. These could harm existing key relationships, including with our users, customers, advertisers, and/or content providers, and impair our ability to attract new ones; damage our reputation; and increase costs, thereby negatively affecting our business. Risks Related to Laws, Regulations, and Policies We face increased regulatory scrutiny as well as changes in regulatory conditions, laws, and policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry face increased regulatory scrutiny, enforcement action, and other proceedings. For instance, the U.S. Department of Justice, joined by a number of state Attorneys General, filed an antitrust complaint against Google on October 20, 2020, alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Similarly, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the U.S. District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. Various other regulatory agencies in the U.S. and around the world, including competition enforcers, consumer protection agencies, data protection authorities, grand juries, inter-agency consultative groups, and a range of other governmental bodies have and continue to review and in some cases challenge our products and services and their compliance with laws and regulations around the world. We continue to cooperate with these investigations and defend litigation where appropriate. Various laws, regulations, investigations, enforcement lawsuits, and regulatory actions have in the past, and may in the future, result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral litigation, all of which could harm our business, reputation, financial condition, and operating results. Alphabet Inc. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies have in the past, and may in the future, increase our cost of doing business and limit our ability to pursue certain business models, offer products or services in certain jurisdictions, or cause us to change our business practices. We have in the past had to alter or stop offering certain products and services as a result of laws or regulations that made them unfeasible, and new laws or regulations could result in our having to terminate, alter, or withdraw products and services in the future. Additional costs of doing business, new limitations, or changes to our business model or practices could harm our business, reputation, financial condition, and operating results. We are subject to regulations, laws, and policies that govern a wide range of topics, including those related to matters beyond our core products and services. For instance, new regulations, laws, policies, and international accords relating to environmental and social matters, including sustainability, climate change, human capital, and diversity, are being developed and formalized in Europe, the U.S., and elsewhere, which may entail specific, target-driven frameworks and/or disclosure requirements. We have implemented robust environmental and social programs, adopted reporting frameworks and principles, and announced a number of goals and initiatives, including those related to environmental sustainability and diversity. The implementation of these goals and initiatives may require considerable investments, and our goals, with all of their contingencies, dependencies, and in certain cases, reliance on third-party verification and/or performance, are complex and ambitious, and we cannot guarantee that we will achieve them. Additionally, there can be no assurance that our current programs, reporting frameworks, and principles will be in compliance with any new environmental and social laws and regulations that may be promulgated in the U.S. and elsewhere, and the costs of changing any of our current practices to comply with any new legal and regulatory requirements in the U.S. and elsewhere may be substantial. Furthermore, industry and market practices may further develop to become even more robust than what is required under any new laws and regulations, and we may have to expend significant efforts and resources to keep up with market trends and stay competitive among our peers. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations, or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices, have made, and may continue to make, our products and services less useful, limit our ability to pursue certain business models or offer certain products and services in certain jurisdictions, require us to incur substantial costs, expose us to civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: Laws and regulations around the world focused on large technology platforms, including the Digital Markets Act in the European Union and proposed antitrust legislation on self-preferencing and mergers and acquisitions in the U.S., which may limit certain business practices, and in some cases, create the risk of significant penalties. Privacy laws, such as the GDPR, CCPA, CPRA, Virginia CDPA, and ColoPA (as defined and discussed further below). Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. Consumer protection laws, including EUs New Deal for Consumers, which could result in monetary penalties and create a range of new compliance obligations. New laws further restricting the collection, processing and/or sharing of advertising-related data. Copyright or similar laws around the world, including the EU Directive on Copyright in the Digital Single Market (EUCD) and EU member state transpositions. These and similar laws that have been adopted or proposed introduce new licensing regimes that could affect our ability to operate. The EUCD and similar laws could also increase the liability of some content-sharing services with respect to content uploaded by their users. Some of these laws, as well as follow-on administrative or judicial actions, have also created or may create a new property right in news publications that limits the ability of some online services to link to, interact with, or present such content. They may also require individual or collective compensation negotiations with news agencies and publishers for the use of such content, which may result in payment obligations that significantly exceed the value that such content provides to Google and its users, potentially harming our services, commercial operations, and business results. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Alphabet Inc. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors, including the Childrens Online Privacy Protection Act of 1998 and the United Kingdoms Age-Appropriate Design Code. Various laws with regard to content moderation and removal, and related disclosure obligations, such as the Network Enforcement Act in Germany and the European Union's pending Digital Services Act, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. Various legislative, litigation, and regulatory activity regarding our Google Play billing policies and business model, which could result in monetary penalties, damages and/or prohibition. Various legislative and regulatory activity requiring disclosure of information about the operation of our services and algorithms, which may make it easier for websites to artificially promote low-quality, deceptive, or harmful content on services like Google Search and YouTube, potentially harming the quality of our services. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act and Section 230 of the Communications Decency Act in the U.S. and the E-Commerce Directive in Europe, against liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. There are legislative proposals in both the U.S. and EU that could reduce our safe harbor protection. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take have subjected us, and will likely continue to subject us, to additional laws and regulations. Our investment in a variety of new fields, such as healthcare and payment services, has expanded, and will continue to expand, the scope of regulations that apply to our business. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, other proceedings, and consent decrees that may harm our business, financial condition, and operating results. We are subject to claims, suits, government investigations, other proceedings, and consent decrees involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products and services, including hardware as well as Google Cloud offerings, we also are subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental effects, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled around the world. Claims have been brought against us, and we Alphabet Inc. expect will continue to be brought against us, for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Any failure or alleged failure to comply with these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation have resulted in, and may continue to result in, fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business, and may be particularly challenging during certain times, such as a natural disaster or pandemic. Amongst others, we are and will be subject to the following laws and regulations: The General Data Protection Regulation (GDPR), which applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. Ensuring compliance with the range of obligations created by the GDPR is an ongoing commitment that involves substantial costs. Despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate the GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have an adverse effect on our business. Serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. Various state privacy laws, such as the California Consumer Privacy Act of 2018 (CCPA), which came into effect in January of 2020; the California Privacy Rights Act (CPRA), which will go into effect in 2023; the Virginia Consumer Data Protection Act (Virginia CDPA), which will go into effect in 2023; and the Colorado Privacy Act (ColoPA), which will go into effect in 2023; all of which give new data privacy rights to their respective residents (including, in California, a private right of action in the event of a data breach resulting from our failure to implement and maintain reasonable security procedures and practices) and impose significant obligations on controllers and processors of consumer data. SB-327 in California, which regulates the security of data in connection with internet connected devices. Further, we are subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive personal data. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks that previously allowed U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland have been invalidated by the CJEU. The CJEU upheld Standard Contractual Clauses (SCCs) as a valid transfer mechanism, provided they meet certain requirements. On June 4, 2021, the European Commission published new SCCs for this purpose, and we may have to adapt our existing contractual arrangements to meet these new requirements. The validity of data transfer mechanisms remains subject to legal, regulatory, and political developments in both Europe and the U.S., such as recent recommendations from the European Data Protection Board, decisions from supervisory authorities, recent proposals for reform of the data transfer mechanisms for transfers of personal data outside the United Kingdom, and potential invalidation of other data transfer mechanisms, which, together with increased enforcement action from supervisory authorities in relation to cross-border transfers of personal data, could have a significant adverse effect on our ability to process and transfer personal data outside of the European Economic Area and/or the United Kingdom. These laws and regulations are evolving and subject to interpretation, including developments which create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. For example, in the EU, several supervisory authorities have issued new guidance concerning the ePrivacy Directives requirements regarding the use of cookies and similar technologies, including limitations on the use of data across messaging products and specific requirements for enabling users to accept or reject cookies, and have in some cases brought (and may seek to bring in the future) enforcement action in relation to those requirements. In the U.S., certain types of cookies may be deemed sales of personal information Alphabet Inc. within the CCPA and other state laws, such that certain disclosure requirements and limitations apply to the use of such cookies. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data that could increase the cost and complexity of delivering our services and carries the potential of service interruptions in those countries. We face, and may continue to face, intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or will enhance long-term stockholder value, and share repurchases could increase the volatility of our stock prices and could diminish our cash reserves. We engage in share repurchases of our Class A and Class C stock from time to time in accordance with authorizations from the Board of Directors of Alphabet. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Further, our share repurchases could affect our share trading prices, increase their volatility, reduce our cash reserves and may be suspended or terminated at any time, which may result in a decrease in the trading prices of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B stock has 10 votes per share, our Class A stock has one vote per share, and our Class C stock has no voting rights. As of December 31, 2021, Larry Page and Sergey Brin beneficially owned approximately 85.9% of our outstanding Class B stock, which represented approximately 51.4% of the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C stock carries no voting rights (except as required by applicable law), the issuance of the Class C stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. The share repurchases made pursuant to our repurchase program may also Alphabet Inc. affect Larry and Sergeys relative voting power. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A stock and our Class C stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. Our Board of Directors has the right to elect directors to fill a vacancy created by the expansion of the Board of Directors or the resignation, death, or removal of a director. Our stockholders may not act by written consent, which makes it difficult to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the Board of Directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our Board of Directors may issue, without stockholder approval, shares of undesignated preferred stock, which makes it possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the Board of Directors has approved the transaction. Our Board of Directors could rely on Delaware law to prevent or delay an acquisition of us. General Risks The continuing effects of COVID-19 are highly unpredictable and could be significant, and may have an adverse effect on our business, operations and our future financial performance. Since COVID-19 was declared a global pandemic by the World Health Organization, our business, operations and financial performance have been, and may continue to be, affected by the macroeconomic impacts resulting from the efforts to control the spread of COVID-19. As a result of the scale of the ongoing pandemic, including the introduction of new variants of COVID-19 and vaccination and other efforts to control the spread, our revenue growth rate and expenses as a percentage of our revenues in future periods may differ significantly from our historical rates, and our future operating results may fall below expectations. Additionally, we may experience a significant and prolonged shift in user behavior such as a shift in interests to less commercial topics. As a result of the pandemic, our workforce shifted to operating in a primarily remote working environment, which continues to create inherent productivity, connectivity, and oversight challenges. The effects of the ongoing pandemic are dynamic and uneven. As we prepare to return our workforce in more locations back to the office, we may experience increased costs and/or disruption as we experiment with hybrid work models, in addition to potential effects on our ability to operate effectively and maintain our corporate culture. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results have fluctuated, and may in the future fluctuate, as a result of a number of factors, many outside of our control, including the cyclicality and seasonality in our business and geopolitical events. As a result, comparing our operating results (including our expenses as a percentage of our revenues) on a period-to-period basis may not be meaningful, and our past results should not be relied on as an indication of our future performance. Consequently, our operating results in future quarters may fall below expectations. Alphabet Inc. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of such potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions; failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction; failure to successfully integrate and further develop the acquired business or technology; implementation or remediation of controls, procedures, and policies at the acquired company; integration of the acquired companys accounting, human resource (including cultural integration and retention of employees), and other administrative systems, and coordination of product, engineering, and sales and marketing functions; transition of operations, users, and customers onto our existing platforms; in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries; liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, warranty claims, product liabilities, and other known and unknown liabilities; and litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology, maintaining our culture, and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our ability to compete effectively and our future success depends on our continuing to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Restrictive immigration policy and regulatory changes may also affect our ability to hire, mobilize, or retain some of our global talent. Alphabet Inc. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows and evolves, we may need to implement more complex organizational management structures or adapt our corporate culture and work environments to ever-changing circumstances, such as during times of a natural disaster or pandemic, and these changes could affect our ability to compete effectively or have an adverse effect on our corporate culture. We are exposed to fluctuations in the fair values of our investments and, in some instances, our financial statements incorporate valuation methodologies that are subjective in nature resulting in fluctuations over time. The fair value of our investments may in the future be, and certain investments have been in the past, negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying entities, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates, the effect of new or changing regulations, the stock market in general, or other factors. We measure certain of our non-marketable equity and debt securities, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, requires management judgment and estimation, and may change over time. We adjust the carrying value of our non-marketable equity securities to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, are recognized in other income (expense), which increases the volatility of our other income (expense). The unrealized gains and losses we record from fair value remeasurements of our non-marketable equity securities in any particular period may differ significantly from the gains or losses we ultimately experience on such investments. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, decreases in our stock price for shares paid as employee compensation, changes in the valuation of our deferred tax assets or liabilities, the application of different provisions of tax laws or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. Various jurisdictions around the world have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapping international tax regimes. The Organization for Economic Cooperation and Development (OECD) continues to advance proposals relating to its initiative for modernizing international tax rules, with the goal of having different countries implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. In addition, in response to significant market volatility and disruptions to business operations resulting from the global spread of COVID-19, legislatures and taxing authorities in many jurisdictions in which we operate may propose changes to their tax rules. These changes could include modifications that have temporary effect, and more permanent Alphabet Inc. changes. The effect of these potential new rules on us, our long-term tax planning, and our effective tax rate could be material. The trading price for our Class A stock and non-voting Class C stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. In addition to the factors discussed in this report, the trading price of our Class A stock and Class C stock have fluctuated, and may continue to fluctuate widely, in response to various factors, many of which are beyond our control, including, among others, the activities of our peers and changes in broader economic and political conditions around the world. These broad market and industry factors may harm the market price of our Class A stock and our Class C stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters. In addition, we own and lease office/building space and RD sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2021, there were approximately 4,907 and 1,733 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2021, there were approximately 64 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long-term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace, and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class A common stock and Class C capital stock during the quarter ended December 31, 2021: Period Total Number of Class A Shares Purchased (in thousands) (1) Total Number of Class C Shares Purchased (in thousands) (1) Average Price Paid per Class A Share (2) Average Price Paid per Class C Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 126 1,445 $ 2,812.76 $ 2,794.72 1,571 $ 26,450 November 1 - 30 289 1,393 $ 2,943.97 $ 2,956.73 1,682 $ 21,479 December 1 - 31 250 1,169 $ 2,880.79 $ 2,898.56 1,419 $ 17,371 Total 665 4,007 4,672 (1) The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-year total stockholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2016 to December 31, 2021. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE 5-YEAR TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2016 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2022 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-year total stockholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2016 to December 31, 2021. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE 5-YEAR TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2016 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2022 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with Note about Forward-Looking Statements, Part I, Item 1 ""Business,"" Part I, Item 1A ""Risk Factors,"" and our consolidated financial statements and related notes included under Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2019 results where it would be redundant to the discussion previously included in Item 7 of our 2020 Annual Report on Form 10-K. Understanding Alphabets Financial Results Alphabet is a collection of businesses the largest of which is Google. We report Google in two segments, Google Services and Google Cloud; we also report all non-Google businesses collectively as Other Bets. Other Bets include earlier stage technologies that are further afield from our core Google business. For further details on our segments, see Part I, Item 1 Business and Note 15 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Trends in Our Business and Financial Effect The following long-term trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to be able to be connected no matter where they are or what they are doing. We are focused on expanding our products and services to stay in front of these trends in order to maintain and grow our business. We are increasingly generating advertising revenues from different channels, including mobile, and newer advertising formats. The margins on advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures, our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners and Google Network partners to increase as our revenues grow and TAC as a percentage of our advertising revenues (""TAC rate"") to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; the percentage of queries channeled through paid access points; product mix; the relative revenue growth rates of advertising revenues from different channels; and revenue share terms. We expect these trends to continue to affect our revenue growth rates and put pressure on our margins. As online advertising evolves, we continue to expand our product offerings, which may affect our monetization. As interactions between users and advertisers change, and as online user behavior evolves, we continue to expand and evolve our product offerings to serve these changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in revenues from ads on YouTube and Google Play, which monetize at a lower rate than our traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, such as India. We continue to invest heavily and develop localized versions of our products and advertising programs relevant to our users in these markets. This has led to a trend of increased revenues from emerging markets. We expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could affect our revenues as developing markets initially monetize at a lower rate than more mature markets. Alphabet Inc. International revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. The portion of revenues that we derive from non-advertising revenues is increasing and may adversely affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. We currently derive non-advertising revenues primarily from sales of apps and in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud services and subscription and other services. A number of Other Bets initiatives are in their initial development stages, and as such, revenues from these businesses could be volatile. In addition, the margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus across Google Services, Google Cloud and Other Bets. We also expect to continue to invest in land and buildings for data centers and offices, and information technology assets, which includes servers and network equipment, to support the long-term growth of our business. In addition, acquisitions and strategic investments contribute to the breadth and depth of our offerings, expand our expertise in engineering and other functional areas, and build strong partnerships around strategic initiatives. For example, in January 2021 we closed the acquisition of Fitbit, Inc. for $2.1 billion, which is expected to help spur innovation in wearable devices. We face continuing changes in regulatory conditions, laws, and public policies, which could affect our business practices and financial results. Changes in social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics and related legal matters have resulted in fines and caused us to change our business practices. As these global trends continue, our cost of doing business may increase, and our ability to pursue certain business models or offer certain products or services may be limited. Examples include the antitrust complaints filed by the U.S. Department of Justice and a number of state Attorneys General, the Digital Markets Act in Europe, and various legislative proposals in the U.S. focused on large technology platforms. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs. For additional information see Culture and Workforce in Part I, Item 1 Business. Seasonality and other Our advertising revenues are affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends, such as traditional retail seasonality. Additionally, our non-advertising revenues, including those generated from Google Cloud, Google Play, hardware, and YouTube, may be affected by fluctuations driven by changes in pricing, digital content releases, fee structures, new product and service launches, other market dynamics, as well as seasonality. Revenues and Monetization Metrics Google Services Google Services revenues consist of revenues generated from advertising (Google advertising) as well as revenues from other sources (Google other revenues). Google Advertising Google advertising revenues are comprised of the following: Google Search other, which includes revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.), and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads, which includes revenues generated on YouTube properties; and Alphabet Inc. Google Network, which includes revenues generated on Google Network properties participating in AdMob, AdSense, and Google Ad Manager. We use certain metrics to track how well traffic across various properties is monetized as it relates to our advertising revenues: paid clicks and cost-per-click pertain to traffic on Google Search other properties, while impressions and cost-per-impressions pertain to traffic on our Network partners properties. Paid clicks represent engagement by users and include clicks on advertisements by end-users on Google search properties and other Google owned and operated properties including Gmail, Google Maps, and Google Play. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Impressions include impressions displayed to users on Google Network properties participating primarily in AdMob, AdSense, and Google Ad Manager. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions, and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine, and update our methodologies for monitoring, gathering, and counting the number of paid clicks and the number of impressions, and for identifying the revenues generated by the corresponding click and impression activity. Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google Search other properties and the change in impressions and cost-per-impression on Google Network properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions, including the effect of COVID-19; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Google Other Google other revenues are comprised of the following: Google Play, which includes sales of apps and in-app purchases and digital content sold in the Google Play store; Devices and Services, which includes sales of hardware, including Fitbit wearable devices, Google Nest home products, and Pixel phones; YouTube non-advertising, which includes YouTube Premium and YouTube TV subscriptions; and other products and services. Google Cloud Google Cloud revenues are comprised of the following: Google Cloud Platform, which includes fees for infrastructure, platform, and other services; Google Workspace, which includes fees for cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar and Meet; and other enterprise services. Other Bets Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Alphabet Inc. For further details on how we recognize revenue, see Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Costs and Expenses Our cost structure has two components: cost of revenues and operating expenses. Our operating expenses include costs related to RD, sales and marketing, and general and administrative functions. Certain of these expenses, including those associated with the operation of our technical infrastructure as well as components of our operating expenses, are generally less variable in nature and may not correlate to the changes in revenue. Cost of Revenues Cost of revenues is comprised of TAC and other costs of revenues. TAC includes: Amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Amounts paid to Google Network partners primarily for ads displayed on their properties. Other cost of revenues includes: Content acquisition costs, which are payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee). Expenses associated with our data centers (including bandwidth, compensation expenses, depreciation, energy, and other equipment costs) as well as other operations costs (such as content review as well as customer and product support costs). Inventory and other costs related to the hardware we sell. The cost of revenues as a percentage of revenues generated from ads placed on Google Network properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google Search other properties, because most of the advertiser revenues from ads served on Google Network properties are paid as TAC to our Google Network partners. Operating Expenses Operating expenses are generally incurred during our normal course of business, which we categorize as either RD, sales and marketing, or general and administrative. The main components of our RD expenses are: compensation expenses for engineering and technical employees responsible for RD related to our existing and new products and services; depreciation; and professional services fees primarily related to consulting and outsourcing services. The main components of our sales and marketing expenses are: compensation expenses for employees engaged in sales and marketing, sales support, and certain customer service functions; and spending relating to our advertising and promotional activities in support of our products and services. The main components of our general and administrative expenses are: compensation expenses for employees in finance, human resources, information technology, legal, and other administrative support functions; expenses related to legal matters, including fines and settlements; and professional services fees, including audit, consulting, outside legal, and outsourcing services. Alphabet Inc. Other Income (Expense), Net Other income (expense), net primarily consists of interest income (expense), the effect of foreign currency exchange gains (losses), net gains (losses) and impairment on our marketable and non-marketable securities, performance fees, and income (loss) and impairment from our equity method investments. For additional details, including how we account for our investments and factors that can drive fluctuations in the value of our investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K as well as Item 7A, Quantitative and Qualitative Disclosures About Market Risk. Provision for Income Taxes Provision for income taxes represents the estimated amount of federal, state, and foreign income taxes incurred in the U.S. and the many jurisdictions in which we operate. The provision includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. For additional details, including a reconciliation of the U.S. federal statutory rate to our effective tax rate, see Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Executive Overview The following table summarizes consolidated financial results for the years ended December 31, 2020 and 2021 unless otherwise specified (in millions, except for per share information and percentages): Year Ended December 31, 2020 2021 $ Change % Change Consolidated revenues $ 182,527 $ 257,637 $ 75,110 41 % Change in consolidated constant currency revenues 39 % Cost of revenues $ 84,732 $ 110,939 $ 26,207 31 % Operating expenses $ 56,571 $ 67,984 $ 11,413 20 % Operating income $ 41,224 $ 78,714 $ 37,490 91 % Operating margin 23 % 31 % 8 % Other income (expense), net $ 6,858 $ 12,020 $ 5,162 75 % Net Income $ 40,269 $ 76,033 $ 35,764 89 % Diluted EPS $ 58.61 $ 112.20 $ 53.59 91 % Number of Employees 135,301 156,500 21,199 16 % Revenues were $257.6 billion, an increase of 41%. The increase in revenues was primarily driven by Google Services and Google Cloud. The adverse effect of COVID-19 on 2020 advertising revenues also contributed to the year-over-year growth. Cost of revenues was $110.9 billion, an increase of 31%, primarily driven by increases in TAC and content acquisition costs. An overall increase in data centers and other operations costs was partially offset by a reduction in depreciation expense due to the change in the estimated useful life of our servers and certain network equipment. Operating expenses were $68.0 billion, an increase of 20%, primarily driven by headcount growth, increases in advertising and promotional expenses and charges related to legal matters. Other information: Operating cash flow was $91.7 billion, primarily driven by revenues generated from our advertising products. Share repurchases were $50.3 billion, an increase of 62%. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Alphabet Inc. Capital expenditures, which primarily reflected investments in technical infrastructure, were $24.6 billion. In January 2021, we updated the useful lives of certain of our servers and network equipment, resulting in a reduction in depreciation expense of $2.6 billion recorded primarily in cost of revenues and RD. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Our acquisition of Fitbit closed in early January 2021, and the related revenues are included in Google other. See Note 8 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. On February 1, 2022, the Company announced that the Board of Directors had approved and declared a 20-for-one stock split in the form of a one-time special stock dividend on each share of the Companys Class A, Class B, and Class C stock. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information. The Effect of COVID-19 on our Financial Results We began to observe the effect of COVID-19 on our financial results in March 2020 when, despite an increase in users' search activity, our advertising revenues declined compared to the prior year. This was due to a shift of user search activity to less commercial topics and reduced spending by our advertisers. For the quarter ended June 30, 2020 our advertising revenues declined due to the continued effects of COVID-19 and the related reductions in global economic activity, but we observed a gradual return in user search activity to more commercial topics. This was followed by increased spending by our advertisers, which continued throughout the second half of 2020. Additionally, over the course of 2020, we experienced variability in our margins as many of our expenses are less variable in nature and/or may not correlate to changes in revenues. Market volatility contributed to fluctuations in the valuation of our equity investments. Further, our assessment of the credit deterioration of our customers due to changes in the macroeconomic environment during the period was reflected in our allowance for credit losses for accounts receivable. Throughout 2021 we remained focused on innovating and investing in the services we offer to consumers and businesses to support our long-term growth. The impact of COVID-19 on 2020 financial results affected year-over-year growth trends. The COVID-19 pandemic continues to evolve, be unpredictable and affect our business and financial results. Our past results may not be indicative of our future performance, and historical trends in our financial results may differ materially. Financial Results Revenues The following table presents revenues by type (in millions): Year Ended December 31, 2020 2021 Google Search other $ 104,062 $ 148,951 YouTube ads 19,772 28,845 Google Network 23,090 31,701 Google advertising 146,924 209,497 Google other 21,711 28,032 Google Services total 168,635 237,529 Google Cloud 13,059 19,206 Other Bets 657 753 Hedging gains (losses) 176 149 Total revenues $ 182,527 $ 257,637 Google Services Google advertising revenues Google Search other Google Search other revenues increased $44.9 billion from 2020 to 2021. The overall growth was driven by interrelated factors including increases in search queries resulting from growth in user adoption and usage, primarily Alphabet Inc. on mobile devices, growth in advertiser spending, and improvements we have made in ad formats and delivery. The adverse effect of COVID-19 on 2020 revenues also contributed to the year-over-year increase. YouTube ads YouTube ads revenues increased $9.1 billion from 2020 to 2021. Growth was driven by our direct response and brand advertising products. Growth for our direct response advertising products was primarily driven by increased advertiser spending as well as improvements to ad formats and delivery. Growth for our brand advertising products was primarily driven by increased spending by our advertisers and the adverse effect of COVID-19 on 2020 revenues. Google Network Google Network revenues increased $8.6 billion from 2020 to 2021. The growth was primarily driven by strength in AdMob, Google Ad Manager, and AdSense. The adverse effect of COVID-19 on 2020 revenues also contributed to the year-over-year increase. Monetization Metrics Paid clicks and cost-per-click The following table presents changes in paid clicks and cost-per-click (expressed as a percentage) from 2020 to 2021: Year Ended December 31, 2021 Paid clicks change 23 % Cost-per-click change 15 % Paid clicks increased from 2020 to 2021 driven by a number of interrelated factors, including an increase in search queries resulting from growth in user adoption and usage, primarily on mobile devices; an increase in clicks relating to ads on Google Play; growth in advertiser spending; and improvements we have made in ad formats and delivery. The adverse effect of COVID-19 on 2020 paid clicks also contributed to the increase. The increase in cost-per-click from 2020 to 2021 was driven by a number of interrelated factors including changes in device mix, geographic mix, growth in advertiser spending, ongoing product changes, and property mix, as well as the adverse effect of COVID-19 in 2020. Impressions and cost-per-impression The following table presents changes in impressions and cost-per-impression (expressed as a percentage) from 2020 to 2021: Year Ended December 31, 2021 Impressions change 2 % Cost-per-impression change 35 % Impressions increased from 2020 to 2021 primarily driven by growth in AdMob, partially offset by a decline in impressions related to AdSense. The increase in cost-per-impression was primarily driven by the adverse effect of COVID-19 in 2020 as well as the effect of interrelated factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, and property mix. Google other revenues Google other revenues increased $6.3 billion from 2020 to 2021. The growth was primarily driven by YouTube non-advertising and hardware, followed by Google Play. Growth for YouTube non-advertising was primarily due to an increase in paid subscribers. Growth in hardware reflects the inclusion of Fitbit revenues, as the acquisition closed in January 2021, and an increase in phone sales. Growth for Google Play was primarily driven by sales of apps and in-app purchases. Alphabet Inc. Google Cloud Google Cloud revenues increased $6.1 billion from 2020 to 2021. The growth was primarily driven by GCP followed by Google Workspace offerings. Google Cloud's infrastructure and platform services were the largest drivers of growth in GCP. Revenues by Geography The following table presents revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, 2020 2021 United States 47 % 46 % EMEA 30 % 31 % APAC 18 % 18 % Other Americas 5 % 5 % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Percentage Change The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. We use non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (GAAP) results helps improve the ability to understand our performance because it excludes the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue percentage change on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior year comparable period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue percentage change is calculated by determining the change in current period revenues over prior year comparable period revenues where current period foreign currency revenues are translated using prior year comparable period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on international revenues and total revenues (in millions, except percentages): Year Ended December 31, 2020 2021 % Change from Prior Year EMEA revenues $ 55,370 $ 79,107 43 % EMEA constant currency revenues 76,321 38 % APAC revenues 32,550 46,123 42 % APAC constant currency revenues 45,666 40 % Other Americas revenues 9,417 14,404 53 % Other Americas constant currency revenues 14,317 52 % United States revenues 85,014 117,854 39 % Hedging gains (losses) 176 149 Total revenues $ 182,527 $ 257,637 41 % Revenues, excluding hedging effect $ 182,351 $ 257,488 Exchange rate effect (3,330) Total constant currency revenues $ 254,158 39 % EMEA revenue growth from 2020 to 2021 was favorably affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro and British pound. APAC revenue growth from 2020 to 2021 was favorably affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Australian dollar, partially offset by the U.S. dollar strengthening relative to the Japanese yen. Other Americas growth change from 2020 to 2021 was favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Canadian dollar, partially offset by the U.S. dollar strengthening relative to the Argentine peso and the Brazilian real. Costs and Expenses Cost of Revenues The following tables present cost of revenues, including TAC (in millions, except percentages): Year Ended December 31, 2020 2021 TAC $ 32,778 $ 45,566 Other cost of revenues 51,954 65,373 Total cost of revenues $ 84,732 $ 110,939 Total cost of revenues as a percentage of revenues 46.4 % 43.1 % Cost of revenues increased $26.2 billion from 2020 to 2021. The increase was due to an increase in other cost of revenues and TAC of $13.4 billion and $12.8 billion, respectively. The increase in TAC from 2020 to 2021 was due to an increase in TAC paid to distribution partners and to Google Network partners, primarily driven by growth in revenues subject to TAC. The TAC rate decreased from 22.3% to 21.8% from 2020 to 2021 primarily due to a revenue mix shift from Google Network properties to Google Search other properties. The TAC rate on Google Search other properties revenues and the TAC rate on Google Network revenues were both substantially consistent from 2020 to 2021. The increase in other cost of revenues from 2020 to 2021 was driven by increases in content acquisition costs primarily for YouTube, data center and other operations costs, and hardware costs. The increase in data center and Alphabet Inc. other operations costs was partially offset by a reduction in depreciation expense due to the change in the estimated useful life of our servers and certain network equipment beginning in the first quarter of 2021. Research and Development The following table presents RD expenses (in millions, except percentages): Year Ended December 31, 2020 2021 Research and development expenses $ 27,573 $ 31,562 Research and development expenses as a percentage of revenues 15.1 % 12.3 % RD expenses increased $4.0 billion from 2020 to 2021. The increase was primarily due to an increase in compensation expenses of $3.5 billion, largely resulting from an 11% increase in headcount, and an increase in professional service fees of $516 million. This increase was partially offset by a reduction in depreciation expense of $450 million including the effect of our change in the estimated useful life of our servers and certain network equipment. Sales and Marketing The following table presents sales and marketing expenses (in millions, except percentages): Year Ended December 31, 2020 2021 Sales and marketing expenses $ 17,946 $ 22,912 Sales and marketing expenses as a percentage of revenues 9.8 % 8.9 % Sales and marketing expenses increased $5.0 billion from 2020 to 2021, primarily driven by an increase in advertising and promotional activities of $2.5 billion and an increase in compensation expenses of $2.2 billion. The increase in advertising and promotional activities was driven by both increased spending in the current period and a reduction in spending in 2020 due to COVID-19. The increase in compensation expenses was largely due to a 14% increase in headcount. General and Administrative The following table presents general and administrative expenses (in millions, except percentages): Year Ended December 31, 2020 2021 General and administrative expenses $ 11,052 $ 13,510 General and administrative expenses as a percentage of revenues 6.1 % 5.2 % General and administrative expenses increased $2.5 billion from 2020 to 2021. The increase was primarily driven by a $1.7 billion increase in charges relating to legal matters and a $664 million increase in compensation expenses, largely resulting from a 14% increase in headcount. These increases were partially offset by a reduction in expense of $808 million related to a decline in allowance for credit losses for accounts receivable, as 2020 reflected a higher allowance related to the economic effect of COVID-19. Alphabet Inc. Segment Profitability The following table presents segment operating income (loss) (in millions). Year Ended December 31, 2020 2021 Operating income (loss): Google Services $ 54,606 $ 91,855 Google Cloud (5,607) (3,099) Other Bets (4,476) (5,281) Corporate costs, unallocated (1) (3,299) (4,761) Total income from operations $ 41,224 $ 78,714 (1) Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including certain fines and settlements, as well as costs associated with certain shared RD activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Google Services Google services operating income increased $37.2 billion from 2020 to 2021. The increase was due to growth in revenues partially offset by increases in TAC, content acquisition costs, compensation expenses, advertising and promotional expenses, and charges related to certain legal matters. The increase in expenses was partially offset by a reduction in costs driven by the change in the estimated useful life of our servers and certain network equipment. The effect of COVID-19 on 2020 results affected the year-over-year increase in operating income. Google Cloud Google Cloud operating loss decreased $2.5 billion from 2020 to 2021. The decrease in operating loss was primarily driven by growth in revenues, partially offset by an increase in expenses, primarily driven by compensation expenses. The increase in expenses was partially offset by a reduction in costs driven by the change in the estimated useful life of our servers and certain network equipment. Other Bets Other Bets operating loss increased $805 million from 2020 to 2021. The increase in operating loss was primarily driven by increases in compensation expenses, including an increase in valuation-based compensation charges during the second quarter of 2021. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, 2020 2021 Other income (expense), net $ 6,858 $ 12,020 Other income (expense), net, increased $5.2 billion from 2020 to 2021. The increase was primarily driven by increases in net unrealized gains recognized for our marketable and non-marketable equity securities of $6.9 billion, partially offset by an increase in accrued performance fees related to certain investments of $1.3 billion. See Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Provision for Income Taxes The following table presents provision for income taxes (in millions, except for effective tax rate): Year Ended December 31, 2020 2021 Provision for income taxes $ 7,813 $ 14,701 Effective tax rate 16.2 % 16.2 % The provision for income taxes increased from 2020 to 2021, primarily due to an increase in pre-tax earnings, including in countries that have higher statutory rates, partially offset by an increase in the stock-based compensation related tax benefit, and the U.S. federal Foreign-Derived Intangible Income tax deduction benefit. Our effective tax rate Alphabet Inc. was substantially consistent from 2020 to 2021. See Note 14 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information. Financial Condition Cash, Cash Equivalents, and Marketable Securities As of December 31, 2021, we had $139.6 billion in cash, cash equivalents, and short-term marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities, and marketable equity securities. Sources, Uses of Cash and Related Trends Our principal sources of liquidity are cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from operations. The primary use of capital continues to be to invest for the long-term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. The following table presents our cash flows (in millions): Year Ended December 31, 2020 2021 Net cash provided by operating activities $ 65,124 $ 91,652 Net cash used in investing activities $ (32,773) $ (35,523) Net cash used in financing activities $ (24,408) $ (61,362) Cash Provided by Operating Activities Our largest source of cash provided by operations are advertising revenues generated by Google Search other properties, Google Network properties, and YouTube ads. Additionally, we generate cash through sales of apps and in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from operating activities include payments to distribution and Google Network partners, for compensation and related costs, and for content acquisition costs. In addition, uses of cash from operating activities include hardware inventory costs, income taxes, and other general corporate expenditures. Net cash provided by operating activities increased from 2020 to 2021 primarily due to the net effect of an increase in cash received from revenues and cash paid for cost of revenues and operating expenses, and changes in operating assets and liabilities. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of marketable and non-marketable securities, purchases of property and equipment, and payments for acquisitions. Net cash used in investing activities increased from 2020 to 2021 primarily due to a decrease in maturities and sales of marketable securities, an increase in purchases of property and equipment, offset by a decrease in purchases of non-marketable securities. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Cash used in financing activities consists primarily of repurchases of common and capital stock, net payments related to stock-based award activities, and repayments of debt. Net cash used in financing activities increased from 2020 to 2021 primarily due to repayment of debt and an increase in cash payments for repurchases of common and capital stock. Liquidity and Material Cash Requirements We expect existing cash, cash equivalents, short-term marketable securities, cash flows from operations and financing activities to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for at least the next 12 months and thereafter for the foreseeable future. Alphabet Inc. Capital Expenditures and Leases We make investments in land and buildings for data centers and offices and information technology assets through purchases of property and equipment and lease arrangements to provide capacity for the growth of our services and products. Capital Expenditures Our capital investments in property and equipment consist primarily of the following major categories: technical infrastructure, which consists of our investments in servers and network equipment for computing, storage and networking requirements for ongoing business activities, including machine learning (collectively referred to as our information technology assets) and data center land and building construction; and office facilities, ground up development projects and related building improvements. Construction in progress consists primarily of technical infrastructure and office facilities which have not yet been placed in service for our intended use. The time frame from date of purchase to placement in service of these assets may extend from months to years. For example, our data center construction projects are generally multi-year projects with multiple phases, where we acquire qualified land and buildings, construct buildings, and secure and install information technology assets. During the years ended December 31, 2020 and 2021, we spent $22.3 billion and $24.6 billion on capital expenditures, respectively. Depreciation of our property and equipment commences when the deployment of such assets are completed and are ready for our intended use. Land is not depreciated. For the years ended December 31, 2020 and 2021, our depreciation and impairment expenses on property and equipment were $12.9 billion and $11.6 billion, respectively. Leases For the years ended December 31, 2020 and 2021, we recognized total operating lease assets of $2.8 billion and $3.0 billion, respectively. As of December 31, 2021, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 8 years, was $15.5 billion, of which $2.5 billion is short-term. As of December 31, 2021, we have entered into leases that have not yet commenced with future short-term and long-term lease payments of $606 million and $5.2 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2022 and 2026 with non-cancelable lease terms of 1 to 25 years. For the years ended December 31, 2020 and 2021, our operating lease expenses (including variable lease costs) were $2.9 billion and $3.4 billion, respectively. Finance lease costs were not material for the years ended December 31, 2020 and 2021. See Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information on leases. Financing We have a short-term debt financing program of up to $ 10.0 billion through the issuance of commercial paper, which increased from $5.0 billion in September 2021. Net proceeds from this program are used for general corporate purposes. As of December 31, 2021, we had no commercial paper outstanding. As of December 31, 2021, we had $ 10.0 billion of revolving credit facilities with no amounts outstanding. In April 2021, we terminated the existing revolving credit facilities, which were scheduled to expire in July 2023, and entered into two new revolving credit facilities in the amounts of $ 4.0 billion and $ 6.0 billion, which will expire in April 2022 and April 2026, respectively. The interest rates for the new credit facilities are determined based on a formula using certain market rates, as well as our progress toward the achievement of certain sustainability goals . No amounts have been borrowed under the new credit facilities. As of December 31, 2021, we have senior unsecured notes outstanding with a total carrying value of $12.8 billion with short-term and long-term future interest payments of $231 million and $4.0 billion, respectively. See Note 6 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further information on our debt. Share Repurchase Program In April 2021, the Board of Directors of Alphabet authorized the company to repurchase up to $ 50.0 billion of its Class C stock. In July 2021, the Alphabet board approved an amendment to the April 2021 authorization, permitting the company to repurchase both Class A and Class C shares in a manner deemed in the best interest of the company and its stockholders, taking into account the economic cost and prevailing market conditions, including the relative trading Alphabet Inc. prices and volumes of the Class A and Class C shares. In accordance with the authorizations of the Board of Directors of Alphabet, during 2021 we repurchased and subsequently retired 20.3 million aggregate shares for $ 50.3 billion. Of the aggregate amount repurchased and subsequently retired, 1.2 million shares were Class A stock repurchased for $ 3.4 billion. As of December 31, 2021, $ 17.4 billion remains available for Class A and Class C share repurchases under the amended authorization. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 11 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. European Commission Fines In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($ 2.7 billion as of June 27, 2017), 4.3 billion ($ 5.1 billion as of June 30, 2018), and 1.5 billion ($ 1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Taxes As of December 31, 2021, we had short-term and long-term income taxes payable of $784 million and $5.7 billion related to a one-time transition tax payable incurred as a result of the U.S. Tax Cuts and Jobs Act (""Tax Act""). As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. We also have taxes payable of $3.5 billion primarily related to uncertain tax positions as of December 31, 2021. Purchase Commitments We regularly enter into significant non-cancelable contractual obligations primarily related to data center operations and build-outs, information technology assets, office buildings, purchases of inventory, and network capacity arrangements. As of December 31, 2021, such purchase commitments, which do not qualify for recognition on our Consolidated Balance Sheets, amount to $13.7 billion, of which $11.9 billion is short-term. These amounts represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2021. Critical Accounting Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in them have had or are reasonably likely to have a material effect on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit and compliance committee of our Board of Directors. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Fair Value Measurements of Non-Marketable Equity Securities We measure certain financial instruments at fair value on a nonrecurring basis, consisting primarily of our non-marketable equity securities. These investments are accounted for under the measurement alternative and are measured at cost, less impairment, subject to upward and downward adjustments resulting from observable price changes for identical or similar investments of the same issuer. These adjustments require quantitative assessments of the fair value of our securities, which may require the use of unobservable inputs. Pricing adjustments are determined by using various valuation methodologies and involve the use of estimates using the best information available, which may include cash flow projections or other available market data. Non-marketable equity securities are also evaluated for impairment, based on qualitative factors including the companies' financial and liquidity position and access to capital resources, among others. When indicators of impairment exist, we prepare quantitative measurements of the fair value of our equity investments using a market approach or an income approach, which requires judgment and the use of unobservable inputs, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we write down the investment to its fair value. Alphabet Inc. We also have compensation arrangements with payouts based on realized returns from certain investments, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Property and Equipment We assess the reasonableness of the useful lives of our property and equipment periodically as well as when other changes occur, such as when there are changes to ongoing business operations, changes in the planned use and utilization of assets, or technological advancements, that could indicate a change in the period over which we expect to benefit from the assets. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Recording an uncertain tax position involves various qualitative considerations, including evaluation of comparable and resolved tax exposures, applicability of tax laws, and likelihood of settlement. We evaluate uncertain tax positions periodically, considering changes in facts and circumstances, such as new regulations or recent judicial opinions, as well as the status of audit activities by taxing authorities. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury consumer protection, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood and the estimated amount of a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Change in Accounting Estimate In January 2021, we completed an assessment of the useful lives of our servers and certain network equipment. In doing so, we determined we should adjust the estimated useful life. This change in accounting estimate was effective beginning fiscal year 2021 and is detailed further in Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. International revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro, and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in Alphabet Inc. foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on assets and liabilities denominated in currencies other than the functional currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on these assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approxima tely $497 million and $285 million as of December 31, 2020 and 2021, respectively, after consideration of the effect of foreign exchange contracts in place for the years ended December 31, 2020 and 2021. We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. I f the U.S. dollar weakened by 10% as of December 31, 2020 and 2021, the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $912 million and $1.3 billion lower as of December 31, 2020 and 2021, respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $1.0 billion lower as of both December 31, 2020 and 2021. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that w ill allow us to preserve capital and maintain liquidity. We invest primarily in debt securities, including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as compared to interest rates at the time of purchase. For certain fixed and variable rate debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. We measure securities for which we have not elected the fair value option at fair value with gains and losses recorded in AOCI until the securities are sold, less any expected credit losses. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of marketable debt securities as of December 31, 2020 and 2021 are shown below (in millions): As of December 31, 12-Month Average As of December 31, 2020 2021 2020 2021 Risk Category - Interest Rate $ 144 $ 139 $ 145 $ 148 Alphabet Inc. Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2020 and 2021 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $5.9 billion and $7.8 billion of our investments as of December 31, 2020 and 2021, respectively. A hypothetical adverse price change of 10% on our December 31, 2021 balance, which could be experienced in the near term, would decrease the fair value of marketable equity securities by $780 million. From time to time, we may enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value measured at the time of the observable transaction is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize, and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of investments through liquidity events such as public offerings, acquisitions, private sales or other market events. As of December 31, 2020 and 2021, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $18.9 billion and $27.6 billion, respectively. Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge relating to our non-marketable equity securities. Changes in valuation of non-marketable equity securities may not directly correlate with changes in valuation of marketable equity securities. Additionally, observable transactions at lower valuations could result in significant losses on our non-marketable equity securities. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the effect. The carrying values of our equity method investments, which totaled approximately $1.4 billion and $1.5 billion as of December 31, 2020 and 2021, respectively, generally do not fluctuate based on market price changes. However, these investments could be impaired if the carrying value exceeds the fair value and is not expected to recover. For further information about our equity investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm (PCAOB ID: 42 ) Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 45 Alphabet Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2020 and 2021, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 1, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, personal injury, consumer protection, and other matters. As described in Note 10 to the consolidated financial statements Contingencies such claims, suits, regulatory and government investigations, and other proceedings could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgment in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 1, 2022 Alphabet Inc. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2021 consolidated financial statements of the Company and our report dated February 1, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 1, 2022 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2020 2021 Assets Current assets: Cash and cash equivalents $ 26,465 $ 20,945 Marketable securities 110,229 118,704 Total cash, cash equivalents, and marketable securities 136,694 139,649 Accounts receivable, net 30,930 39,304 Income taxes receivable, net 454 966 Inventory 728 1,170 Other current assets 5,490 7,054 Total current assets 174,296 188,143 Non-marketable securities 20,703 29,549 Deferred income taxes 1,084 1,284 Property and equipment, net 84,749 97,599 Operating lease assets 12,211 12,959 Intangible assets, net 1,445 1,417 Goodwill 21,175 22,956 Other non-current assets 3,953 5,361 Total assets $ 319,616 $ 359,268 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 5,589 $ 6,037 Accrued compensation and benefits 11,086 13,889 Accrued expenses and other current liabilities 28,631 31,236 Accrued revenue share 7,500 8,996 Deferred revenue 2,543 3,288 Income taxes payable, net 1,485 808 Total current liabilities 56,834 64,254 Long-term debt 13,932 14,817 Deferred revenue, non-current 481 535 Income taxes payable, non-current 8,849 9,176 Deferred income taxes 3,561 5,257 Operating lease liabilities 11,146 11,389 Other long-term liabilities 2,269 2,205 Total liabilities 97,072 107,633 Contingencies (Note 10) Stockholders equity: Preferred stock, $ 0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding 0 0 Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $ 0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000 , Class B 3,000,000 , Class C 3,000,000 ); 675,222 (Class A 300,730 , Class B 45,843 , Class C 328,649 ) and 662,121 (Class A 300,737 , Class B 44,665 , Class C 316,719 ) shares issued and outstanding 58,510 61,774 Accumulated other comprehensive income (loss) 633 ( 1,623 ) Retained earnings 163,401 191,484 Total stockholders equity 222,544 251,635 Total liabilities and stockholders equity $ 319,616 $ 359,268 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2019 2020 2021 Revenues $ 161,857 $ 182,527 $ 257,637 Costs and expenses: Cost of revenues 71,896 84,732 110,939 Research and development 26,018 27,573 31,562 Sales and marketing 18,464 17,946 22,912 General and administrative 9,551 11,052 13,510 European Commission fines 1,697 0 0 Total costs and expenses 127,626 141,303 178,923 Income from operations 34,231 41,224 78,714 Other income (expense), net 5,394 6,858 12,020 Income before income taxes 39,625 48,082 90,734 Provision for income taxes 5,282 7,813 14,701 Net income $ 34,343 $ 40,269 $ 76,033 Basic net income per share of Class A and B common stock and Class C capital stock $ 49.59 $ 59.15 $ 113.88 Diluted net income per share of Class A and B common stock and Class C capital stock $ 49.16 $ 58.61 $ 112.20 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2019 2020 2021 Net income $ 34,343 $ 40,269 $ 76,033 Other comprehensive income (loss): Change in foreign currency translation adjustment ( 119 ) 1,139 ( 1,442 ) Available-for-sale investments: Change in net unrealized gains (losses) 1,611 1,313 ( 1,312 ) Less: reclassification adjustment for net (gains) losses included in net income ( 111 ) ( 513 ) ( 64 ) Net change, net of income tax benefit (expense) of $( 221 ), $( 230 ), and $ 394 1,500 800 ( 1,376 ) Cash flow hedges: Change in net unrealized gains (losses) 22 42 716 Less: reclassification adjustment for net (gains) losses included in net income ( 299 ) ( 116 ) ( 154 ) Net change, net of income tax benefit (expense) of $ 42 , $ 11 , and $( 122 ) ( 277 ) ( 74 ) 562 Other comprehensive income (loss) 1,104 1,865 ( 2,256 ) Comprehensive income $ 35,447 $ 42,134 $ 73,777 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2018 695,556 $ 45,049 $ ( 2,306 ) $ 134,885 $ 177,628 Cumulative effect of accounting change 0 0 ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 202 0 0 202 Stock-based compensation expense 0 10,890 0 0 10,890 Income tax withholding related to vesting of restricted stock units and other 0 ( 4,455 ) 0 0 ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) 0 ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities 0 160 0 0 160 Net income 0 0 0 34,343 34,343 Other comprehensive income (loss) 0 0 1,104 0 1,104 Balance as of December 31, 2019 688,335 50,552 ( 1,232 ) 152,122 201,442 Common and capital stock issued 8,398 168 0 0 168 Stock-based compensation expense 0 13,123 0 0 13,123 Income tax withholding related to vesting of restricted stock units and other 0 ( 5,969 ) 0 0 ( 5,969 ) Repurchases of capital stock ( 21,511 ) ( 2,159 ) 0 ( 28,990 ) ( 31,149 ) Sale of interest in consolidated entities 0 2,795 0 0 2,795 Net income 0 0 0 40,269 40,269 Other comprehensive income (loss) 0 0 1,865 0 1,865 Balance as of December 31, 2020 675,222 58,510 633 163,401 222,544 Common and capital stock issued 7,225 12 0 0 12 Stock-based compensation expense 0 15,539 0 0 15,539 Income tax withholding related to vesting of restricted stock units and other 0 ( 10,273 ) 0 0 ( 10,273 ) Repurchases of common and capital stock ( 20,326 ) ( 2,324 ) 0 ( 47,950 ) ( 50,274 ) Sale of interest in consolidated entities 0 310 0 0 310 Net income 0 0 0 76,033 76,033 Other comprehensive income (loss) 0 0 ( 2,256 ) 0 ( 2,256 ) Balance as of December 31, 2021 662,121 $ 61,774 $ ( 1,623 ) $ 191,484 $ 251,635 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2019 2020 2021 Operating activities Net income $ 34,343 $ 40,269 $ 76,033 Adjustments: Depreciation and impairment of property and equipment 10,856 12,905 11,555 Amortization and impairment of intangible assets 925 792 886 Stock-based compensation expense 10,794 12,991 15,376 Deferred income taxes 173 1,390 1,808 Gain on debt and equity securities, net ( 2,798 ) ( 6,317 ) ( 12,270 ) Other ( 592 ) 1,267 ( 213 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 4,340 ) ( 6,524 ) ( 9,095 ) Income taxes, net ( 3,128 ) 1,209 ( 625 ) Other assets ( 621 ) ( 1,330 ) ( 1,846 ) Accounts payable 428 694 283 Accrued expenses and other liabilities 7,170 5,504 7,304 Accrued revenue share 1,273 1,639 1,682 Deferred revenue 37 635 774 Net cash provided by operating activities 54,520 65,124 91,652 Investing activities Purchases of property and equipment ( 23,548 ) ( 22,281 ) ( 24,640 ) Purchases of marketable securities ( 100,315 ) ( 136,576 ) ( 135,196 ) Maturities and sales of marketable securities 97,825 132,906 128,294 Purchases of non-marketable securities ( 1,932 ) ( 7,175 ) ( 2,838 ) Maturities and sales of non-marketable securities 405 1,023 934 Acquisitions, net of cash acquired, and purchases of intangible assets ( 2,515 ) ( 738 ) ( 2,618 ) Other investing activities 589 68 541 Net cash used in investing activities ( 29,491 ) ( 32,773 ) ( 35,523 ) Financing activities Net payments related to stock-based award activities ( 4,765 ) ( 5,720 ) ( 10,162 ) Repurchases of common and capital stock ( 18,396 ) ( 31,149 ) ( 50,274 ) Proceeds from issuance of debt, net of costs 317 11,761 20,199 Repayments of debt ( 585 ) ( 2,100 ) ( 21,435 ) Proceeds from sale of interest in consolidated entities, net 220 2,800 310 Net cash used in financing activities ( 23,209 ) ( 24,408 ) ( 61,362 ) Effect of exchange rate changes on cash and cash equivalents ( 23 ) 24 ( 287 ) Net increase (decrease) in cash and cash equivalents 1,797 7,967 ( 5,520 ) Cash and cash equivalents at beginning of period 16,701 18,498 26,465 Cash and cash equivalents at end of period $ 18,498 $ 26,465 $ 20,945 Supplemental disclosures of cash flow information Cash paid for income taxes, net of refunds $ 8,203 $ 4,990 $ 13,412 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (""Alphabet"") became the successor issuer to Google. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates due to uncertainties, including the effects of COVID-19. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses; fair values of financial instruments, intangible assets, and goodwill; useful lives of intangible assets and property and equipment; income taxes; and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, and the results of which form the basis for making judgments about the carrying values of assets and liabilities. In January 2021, we completed an assessment of the useful lives of our servers and network equipment and adjusted the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years . This change in accounting estimate was effective beginning in fiscal year 2021. Based on the carrying value of servers and certain network equipment as of December 31, 2020 and those acquired during the year ended December 31, 2021, the effect of this change in estimate was a reduction in depreciation expense of $ 2.6 billion and an increase in net income of $ 2.0 billion, or $ 3.02 per basic share and $ 2.98 per diluted share, for the year ended December 31, 2021. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, and the collectibility of an amount that we expect in exchange for those goods or services is probable. Sales and other similar taxes are excluded from revenues. Advertising Revenues We generate advertising revenues primarily by delivering advertising on: Google Search and other properties, including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc. and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube properties; and Google Network properties, including revenues from Google Network properties participating in AdMob, AdSense, and Google Ad Manager. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager, and Google Marketing Platform, among others. We offer advertising by delivering both performance and brand advertising. We recognize revenues for performance advertising when a user engages with the advertisement, such as a click, a view, or a purchase. For brand advertising, we recognize revenues when the ad is displayed, or a user views the ad. For ads placed on Google Network properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network partners are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Alphabet Inc. Google Cloud Revenues Google Cloud revenues consist of revenues from: Google Cloud Platform, which includes fees for infrastructure, platform, and other services; Google Workspace, which includes fees for cloud-based collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar, and Meet; and other enterprise services. Our cloud services are generally provided on either a consumption or subscription basis and may have contract terms longer than a year. Revenues related to cloud services provided on a consumption basis are recognized when the customer utilizes the services, based on the quantity of services consumed. Revenues related to cloud services provided on a subscription basis are recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Google Other Revenues Google other revenues consist of revenues from: Google Play, which includes sales of apps and in-app purchases and digital content sold in the Google Play store; hardware, which includes sales of Fitbit wearable devices, Google Nest home products, and Pixel phones; YouTube non-advertising, which includes YouTube Premium and YouTube TV subscriptions; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a service fee. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Sales Commissions We expense sales commissions when incurred and when the amortization period (the period of the expected benefit) is one year or less. We recognize an asset for certain sales commissions if we expect the period of benefit of these costs to exceed one year and recognize the expense over the amortization period. These costs are recorded within sales and marketing expenses. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC includes: Amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Amounts paid to Google Network partners primarily for ads displayed on their properties. Other cost of revenues includes: Content acquisition costs, which are payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee). Alphabet Inc. Expenses associated with our data centers (including bandwidth, compensation expenses, depreciation, energy, and other equipment costs) as well as other operations costs (such as content review as well as customer and product support costs). Inventory and other costs related to the hardware we sell. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products. As a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory income tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding, and the income tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation also includes other stock-based awards, such as performance stock units (PSUs) that include market conditions and awards that may be settled in cash or the stock of certain Other Bets. PSUs and certain Other Bet awards are equity classified and expense is recognized over the requisite service period. Certain Other Bet awards are liability classified and remeasured at fair value through settlement. The fair value of Other Bet awards is based on the equity valuation of the respective Other Bet. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2019, 2020 and 2021, advertising and promotional expenses totaled approximately $ 6.8 billion, $ 5.4 billion, and $ 7.9 billion, respectively. Performance Fees Performance fees refer to compensation arrangements with payouts based on realized returns from certain investments. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Performance fees are recorded as a component of other income (expense), net. Fair Value Measurements Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. Alphabet Inc. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative financial instruments, and certain non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities. Other financial assets and liabilities are carried at cost with fair value disclosed, if required. We measure certain other instruments, including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, also at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. Financial Instruments Our financial instruments include cash, cash equivalents, marketable and non-marketable securities, derivative financial instruments and accounts receivable. Credit Risks We are subject to credit risk from cash equivalents, marketable securities, derivative financial instruments, including foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We manage our credit risk exposure by performing ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. Cash Equivalents We invest excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. Marketable Securities We classify all marketable debt securities that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities on our Consolidated Balance Sheets. We determine the appropriate classification of our investments in marketable debt securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for the changes in allowance for expected credit losses, which are recorded in other income (expense), net. For certain marketable debt securities we have elected the fair value option, for which changes in fair value are recorded in other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Our investments in marketable equity securities are measured at fair value with the related gains and losses, including unrealized, recognized in other income (expense), net. We classify our marketable equity securities subject to long-term lock-up restrictions beyond twelve months as other non-current assets on the Consolidated Balance Sheets. Non-Marketable Securities We account for non-marketable equity securities through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Adjustments are determined primarily based on a market approach as of the transaction date and are recorded as a component of other income (expense), net. Non-marketable debt securities are classified as available-for-sale securities. Alphabet Inc. Non-marketable securities that do not have stated contractual maturity dates are classified as other non-current assets on the Consolidated Balance Sheets. Derivative Financial Instruments See Note 3 for the accounting policy pertaining to derivative financial instruments. Accounts Receivable Our payment terms for accounts receivable vary by the types and locations of our customers and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customers, we require payment before the products or services are delivered to the customer. We maintain an allowance for credit losses for accounts receivable, which is recorded as an offset to accounts receivable, and changes in such are classified as general and administrative expense in the Consolidated Statements of Income. We assess collectibility by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with known disputes or collectibility issues. In determining the amount of the allowance for credit losses, we consider historical collectibility based on past due status and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information, current market conditions (such as the effects caused by COVID-19), and reasonable and supportable forecasts of future economic conditions. The allowance for credit losses on accounts receivable was $ 789 million and $ 550 million as of December 31, 2020 and 2021, respectively. Other Our financial instruments also include debt and equity investments in companies with which we also have commercial arrangements. For these transactions, judgment is required to assess the substance of the arrangements, such as the market value of similar transactions or the fair value of the investment based on stand-alone transactions, and whether the agreements should be accounted for as separate transactions under the applicable GAAP. Impairment of Investments We periodically review our debt and non-marketable equity securities for impairment. For debt securities in an unrealized loss position, we determine whether a credit loss exists. The credit loss is estimated by considering available information relevant to the collectibility of the security and information about past events, current conditions, and reasonable and supportable forecasts. Any credit loss is recorded as a charge to other income (expense), net, not to exceed the amount of the unrealized loss. Unrealized losses other than the credit loss are recognized in accumulated other comprehensive income (AOCI). If we have an intent to sell, or if it is more likely than not that we will be required to sell a debt security in an unrealized loss position before recovery of its amortized cost basis, we will write down the security to its fair value and record the corresponding charge as a component of other income (expense), net. For non-marketable equity securities, including equity method investments, we consider whether impairment indicators exist by evaluating the companies' financial and liquidity position and access to capital resources, among other indicators. If the assessment indicates that the investment is impaired, we write down the investment to its fair value by recording the corresponding charge as a component of other income (expense), net. We prepare quantitative measurements of the fair value of our equity investments using a market approach or an income approach. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. We are the primary beneficiary of a VIE when we have the power to direct activities that most significantly affect the economic performance of the VIE and have the obligation to absorb the majority of their losses or benefits. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is a VIE and, if so, whether we are the primary beneficiary. Alphabet Inc. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers, and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets, which we regularly evaluate. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of four to five years (generally, four years for servers and five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities, and the long-term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense (excluding variable lease costs) is recognized on a straight-line basis over the lease term. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets or asset group is not recoverable, the impairment recognized is measured as the amount by which the carrying value exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units periodically, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were no t material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives on a straight-line basis generally over periods ranging from one to twelve years . Alphabet Inc. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Foreign Currency We translate the financial statements of our international subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in AOCI as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Note 2. Revenues Revenue Recognition The following table presents revenues disaggregated by type (in millions): Year Ended December 31, 2019 2020 2021 Google Search other $ 98,115 $ 104,062 $ 148,951 YouTube ads 15,149 19,772 28,845 Google Network 21,547 23,090 31,701 Google advertising 134,811 146,924 209,497 Google other 17,014 21,711 28,032 Google Services total 151,825 168,635 237,529 Google Cloud 8,918 13,059 19,206 Other Bets 659 657 753 Hedging gains (losses) 455 176 149 Total revenues $ 161,857 $ 182,527 $ 257,637 No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2019, 2020, or 2021. Alphabet Inc. The following table presents revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, 2019 2020 2021 United States $ 74,843 46 % $ 85,014 47 % $ 117,854 46 % EMEA (1) 50,645 31 55,370 30 79,107 31 APAC (1) 26,928 17 32,550 18 46,123 18 Other Americas (1) 8,986 6 9,417 5 14,404 5 Hedging gains (losses) 455 0 176 0 149 0 Total revenues $ 161,857 100 % $ 182,527 100 % $ 257,637 100 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (""Other Americas""). Revenue Backlog and Deferred Revenues As of December 31, 2021 we had $ 51.0 billion of remaining performance obligations (revenue backlog), primarily related to Google Cloud, a nd expect to recognize approximately half of this amount as revenues over the next 24 months with the remaining thereafter. Our revenue backlog represents commitments in customer contracts for future services that have not yet been recog nized as revenues. The amount and timing of revenue recognition for these commitments is largely driven by when our customers utilize services and our ability to deliver in accordance with relevant contract terms, which could affect our estimate of revenue backlog and when we expect to recognize such as revenues. Revenue backlog includes related deferred revenue currently recorded as well as amounts that will be invoiced in future periods, and excludes contracts with an original expected term of one year or less and cancellable contracts. We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. Deferred revenues primarily relate to Google Cloud and Google other. Total deferred revenue as of December 31, 2020 was $ 3.0 billion, of which $ 2.3 billion was recognized as revenues for the year ending December 31, 2021. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities, which are accounted for as available-for-sale within Level 2 in the fair value hierarchy, because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. For certain marketable debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. The fair value option was elected for these securities to align with the unrealized gains and losses from related derivative contracts. Unrealized net gains (losses) related to debt securities still held where we have elected the fair value option were $ 87 million and $( 35 ) million as of December 31, 2020 and December 31, 2021, respectively. As of December 31, 2020 and December 31, 2021, the fair value of these debt securities was $ 2.0 billion and $ 4.7 billion, respectively. Alphabet Inc. The following tables summarize debt securities, for which we did not elect the fair value option, by significant investment categories as of December 31, 2020 and 2021 (in millions): As of December 31, 2020 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 3,564 $ 0 $ 0 $ 3,564 $ 3,564 $ 0 Government bonds 55,156 793 ( 9 ) 55,940 2,527 53,413 Corporate debt securities 31,521 704 ( 2 ) 32,223 8 32,215 Mortgage-backed and asset-backed securities 16,767 364 ( 7 ) 17,124 0 17,124 Total $ 107,008 $ 1,861 $ ( 18 ) $ 108,851 $ 6,099 $ 102,752 As of December 31, 2021 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 5,133 $ 0 $ 0 $ 5,133 $ 5,133 $ 0 Government bonds 53,288 258 ( 238 ) 53,308 5 53,303 Corporate debt securities 35,605 194 ( 223 ) 35,576 12 35,564 Mortgage-backed and asset-backed securities 18,829 96 ( 112 ) 18,813 0 18,813 Total $ 112,855 $ 548 $ ( 573 ) $ 112,830 $ 5,150 $ 107,680 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 292 million, $ 899 million, and $ 432 million for the years ended December 31, 2019, 2020, and 2021, respectively. We recognized gross realized losses of $ 143 million, $ 184 million, and $ 329 million for the years ended December 31, 2019, 2020, and 2021, respectively. We reflect these gains and losses as a component of other income (expense), net. The following table summarizes the estimated fair value of investments in marketable debt securities by stated contractual maturity dates (in millions): As of December 31, 2021 Due in 1 year or less $ 16,192 Due in 1 year through 5 years 78,625 Due in 5 years through 10 years 4,675 Due after 10 years 12,864 Total $ 112,356 The following tables present fair values and gross unrealized losses recorded to AOCI as of December 31, 2020 and 2021, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2020 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 5,516 $ ( 9 ) $ 3 $ 0 $ 5,519 $ ( 9 ) Corporate debt securities 1,999 ( 1 ) 0 0 1,999 ( 1 ) Mortgage-backed and asset-backed securities 929 ( 5 ) 242 ( 2 ) 1,171 ( 7 ) Total $ 8,444 $ ( 15 ) $ 245 $ ( 2 ) $ 8,689 $ ( 17 ) Alphabet Inc. As of December 31, 2021 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 32,843 $ ( 236 ) $ 71 $ ( 2 ) $ 32,914 $ ( 238 ) Corporate debt securities 22,737 ( 152 ) 303 ( 5 ) 23,040 ( 157 ) Mortgage-backed and asset-backed securities 11,502 ( 106 ) 248 ( 6 ) 11,750 ( 112 ) Total $ 67,082 $ ( 494 ) $ 622 $ ( 13 ) $ 67,704 $ ( 507 ) During the years ended December 31, 2020 and 2021, we did not recognize significant credit losses and the ending allowance for credit losses was immaterial. See Note 7 for further details on other income (expense), net. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value upon observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). Non-marketable equity securities that have been remeasured during the period based on observable transactions are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods which may include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The fair value of non-marketable equity securities that have been remeasured due to impairment are classified within Level 3. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, 2020 2021 Net gain (loss) on equity securities sold during the period $ 1,339 $ 1,196 Unrealized gain (loss) on equity securities held as of the end of the period 4,253 11,184 Total gain (loss) recognized in other income (expense), net $ 5,592 $ 12,380 In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains (losses) on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic net gains recognized on the securities sold during the period. Cumulative net gains are calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Alphabet Inc. Equity Securities Sold During the Year Ended December 31, 2020 2021 Total sale price $ 4,767 $ 5,604 Total initial cost 2,674 1,206 Cumulative net gains (1) $ 2,093 $ 4,398 (1) Cumulative net gains excludes cumulative losses of $ 738 million resulting from our equity derivatives, which hedged the changes in fair value of certain marketable equity securities sold during the year ended December 31, 2021. The associated derivative liabilities arising from these losses were settled against our holdings of the underlying equity securities. Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2020 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 2,227 $ 14,616 $ 16,843 Cumulative net gain (loss) (1) 3,631 4,277 7,908 Carrying value (2) $ 5,858 $ 18,893 $ 24,751 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 6.1 billion gains and $ 1.9 billion losses (including impairment). (2) The long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 429 million is included within other non-current assets. As of December 31, 2021 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 4,211 $ 15,135 $ 19,346 Cumulative net gain (loss) (1) 3,587 12,436 16,023 Carrying value (2) $ 7,798 $ 27,571 $ 35,369 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 14.1 billion gains and $ 1.7 billion losses (including impairment). (2) The long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 1.4 billion is included within other non-current assets. Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2020 and 2021 (in millions): As of December 31, 2020 As of December 31, 2021 Cash and Cash Equivalents Marketable Equity Securities Cash and Cash Equivalents Marketable Equity Securities Level 1: Money market funds $ 12,210 $ 0 $ 7,499 $ 0 Marketable equity securities (1)(2) 0 5,470 0 7,447 12,210 5,470 7,499 7,447 Level 2: Mutual funds 0 388 0 351 Total $ 12,210 $ 5,858 $ 7,499 $ 7,798 (1) The balance as of December 31, 2020 and 2021 includes investments that were reclassified from non-marketable equity securities following the commencement of public market trading of the issuers or acquisition by public entities (certain investments are subject to short-term lock-up restrictions). (2) As of December 31, 2020 and 2021, the long-term portion of marketable equity securities (subject to long-term lock-up restrictions) of $ 429 million and $ 1.4 billion, respectively, is included within other non-current assets. Alphabet Inc. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, which are included as adjustments to the carrying value of non-marketable equity securities held as of the end of the period (in millions): Year Ended December 31, 2020 2021 Unrealized gains on non-marketable equity securities $ 3,020 $ 9,971 Unrealized losses on non-marketable equity securities (including impairment) ( 1,489 ) ( 122 ) Total unrealized gain (loss) recognized on non-marketable equity securities $ 1,531 $ 9,849 During the year ended December 31, 2021, included in the $ 27.6 billion of non-marketable equity securities held as of the end of the period, $ 18.6 billion were measured at fair value resulting in a net unrealized gain of $ 9.8 billion. Equity securities accounted for under the Equity Method As of December 31, 2020 and 2021, equity securities accounted for under the equity method had a carrying value of approximately $ 1.4 billion and $ 1.5 billion, respectively. Our share of gains and losses, including impairments, are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We enter into derivative instruments to manage risks relating to our ongoing business operations. The primary risk managed with derivative instruments is foreign exchange risk. We use foreign currency contracts to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also enter into derivative instruments to partially offset our exposure to other risks and enhance investment returns. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value and classify the derivatives primarily within Level 2 in the fair value hierarchy. We present our collar contracts (an option strategy comprised of a combination of purchased and written options) at net fair values where both the purchased and written options are with the same counterparty. For other derivative contracts, we present at gross fair values. We primarily record changes in the fair value in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. Further, we enter into collateral security arrangements that provide for collateral to be received or pledged when the net fair value of certain financial instruments fluctuates from contractually established thresholds. Cash collateral received related to derivative instruments under our collateral security arrangements are included in other current assets with a corresponding liability. Cash and non-cash collateral pledged related to derivative instruments under our collateral security arrangements are included in other current assets. Cash Flow Hedges We designate foreign currency forward and option contracts (including collars) as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. These contracts have maturities of 24 months or less. Cash flow hedge amounts included in the assessment of hedge effectiveness are deferred in AOCI and subsequently reclassified to revenue when the hedged item is recognized in earnings. We exclude the change in forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are reclassified to other income (expense), net in the period of de-designation. As of December 31, 2021, the net accumulated gain on our foreign currency cash flow hedges before tax effect was $ 518 million, which is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We designate foreign currency forward contracts as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Fair value hedge amounts included in the Alphabet Inc. assessment of hedge effectiveness are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Net Investment Hedges We designate foreign currency forward contracts as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. Net investment hedge amounts included in the assessment of hedge effectiveness are recognized in AOCI along with the foreign currency translation adjustment. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Other Derivatives Other derivatives not designated as hedging instruments consist primarily of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the functional currency of a subsidiary. Gains and losses on these contracts, as well as the related costs, are recognized in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. We also use derivatives not designated as hedging instruments to manage risks relating to interest rates, commodity prices, credit exposures and to enhance investment returns. Additionally, from time to time, we enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Gains (losses) arising from these derivatives are reflected within the ""other"" component of other income (expense), net and the offsetting recognized gains (losses) on the marketable equity securities are reflected within the gain (loss) on equity securities, net component of other income (expense), net. See Note 7 for further details on other income (expense), net. The gross notional amounts of outstanding derivative instruments were as follows (in millions): As of December 31, 2020 2021 Derivatives Designated as Hedging Instruments: Foreign exchange contracts Cash flow hedges $ 10,187 $ 16,362 Fair value hedges $ 1,569 $ 2,556 Net investment hedges $ 9,965 $ 10,159 Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts $ 39,861 $ 41,031 Other contracts $ 2,399 $ 4,275 Alphabet Inc. The fair values of outstanding derivative instruments were as follows (in millions): As of December 31, 2020 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 33 $ 316 $ 349 Other contracts Other current and non-current assets 0 16 16 Total $ 33 $ 332 $ 365 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 395 $ 185 $ 580 Other contracts Accrued expenses and other liabilities, current and non-current 0 942 942 Total $ 395 $ 1,127 $ 1,522 As of December 31, 2021 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 867 $ 42 $ 909 Other contracts Other current and non-current assets 0 52 52 Total $ 867 $ 94 $ 961 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 8 $ 452 $ 460 Other contracts Accrued expenses and other liabilities, current and non-current 0 121 121 Total $ 8 $ 573 $ 581 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) were summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, 2019 2020 2021 Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ 38 $ 102 $ 806 Amount excluded from the assessment of effectiveness ( 14 ) ( 37 ) 48 Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness 131 ( 851 ) 754 Total $ 155 $ ( 786 ) $ 1,608 The effect of derivative instruments on income was summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, 2019 2020 2021 Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 161,857 $ 5,394 $ 182,527 $ 6,858 $ 257,637 $ 12,020 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ 367 $ 0 $ 144 $ 0 $ 165 $ 0 Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach 88 0 33 0 ( 16 ) 0 Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items 0 ( 19 ) 0 18 0 ( 95 ) Derivatives designated as hedging instruments 0 19 0 ( 18 ) 0 95 Amount excluded from the assessment of effectiveness 0 25 0 4 0 8 Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness 0 243 0 151 0 82 Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts 0 ( 413 ) 0 718 0 ( 860 ) Other Contracts 0 0 0 ( 906 ) 0 101 Total gains (losses) $ 455 $ ( 145 ) $ 177 $ ( 33 ) $ 149 $ ( 669 ) Alphabet Inc. Offsetting of Derivatives The gross amounts of derivative instruments subject to master netting arrangements with various counterparties, and cash and non-cash collateral received and pledged under such agreements were as follows (in millions): Offsetting of Assets As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 397 $ ( 32 ) $ 365 $ ( 295 ) (1) $ ( 16 ) $ 0 $ 54 As of December 31, 2021 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 999 $ ( 38 ) $ 961 $ ( 434 ) (1) $ ( 394 ) $ ( 12 ) $ 121 (1) The balances as of December 31, 2020 and 2021 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 1,554 $ ( 32 ) $ 1,522 $ ( 295 ) (2) $ ( 1 ) $ ( 943 ) $ 283 As of December 31, 2021 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 619 $ ( 38 ) $ 581 $ ( 434 ) (2) $ ( 4 ) $ ( 110 ) $ 33 (2) The balances as of December 31, 2020 and 2021 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2022 and 2063. Components of operating lease expense were as follows (in millions): Year Ended December 31, 2020 2021 Operating lease cost $ 2,267 $ 2,699 Variable lease cost 619 726 Total operating lease cost $ 2,886 $ 3,425 Alphabet Inc. Supplemental information related to operating leases was as follows (in millions): Year Ended December 31, 2020 2021 Cash payments for operating leases $ 2,004 $ 2,489 New operating lease assets obtained in exchange for operating lease liabilities $ 2,765 $ 2,951 As of December 31, 2021, our operating leases had a weighted average remaining lease term of 8 years and a weighted average discount rate of 2.3 %. Future lease payments under operating leases as of December 31, 2021 were as follows (in millions): 2022 $ 2,539 2023 2,527 2024 2,226 2025 1,815 2026 1,401 Thereafter 4,948 Total future lease payments 15,456 Less imputed interest ( 1,878 ) Total lease liability balance $ 13,578 As of December 31, 2021, we have entered into leases that have not yet commenced with short-term and long-term future lease payments of $ 606 million and $ 5.2 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2022 and 2026 with non-cancelable lease terms of 1 to 25 years. Note 5. Variable Interest Entities Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2020 and 2021, assets that can only be used to settle obligations of these VIEs were $ 5.7 billion and $ 6.0 billion, respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 2.3 billion and $ 2.5 billion, respectively. Total noncontrolling interests (NCI), including redeemable noncontrolling interests (RNCI), in our consolidated subsidiaries was $ 3.9 billion and $ 4.3 billion as of December 31, 2020 and 2021, respectively. NCI and RNCI are included within additional paid-in capital. Net loss attributable to noncontrolling interests was not material for any period presented and is included within the ""other"" component of other income (expense), net. See Note 7 for further details on other income (expense), net. Waymo In June 2021, Waymo, a self-driving technology development company and a consolidated VIE, completed an investment round of $ 2.5 billion, the majority of which represented investment from Alphabet. The investments from external parties were accounted for as equity transactions and resulted in recognition of noncontrolling interests. Unconsolidated VIEs We have investments in VIEs in which we are not the primary beneficiary. These VIEs include private companies that are primarily early stage companies and certain renewable energy entities in which activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we are not the primary beneficiary, and the results of operations and financial position of these VIEs are not included in our consolidated financial statements. We account for these investments as non-marketable equity securities or equity method investments. The maximum exposure of these unconsolidated VIEs is generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these Alphabet Inc. VIEs is our capital investments in them. The carrying value, and maximum exposure of these unconsolidated VIEs were $ 1.7 billion and $ 1.9 billion, respectively, as of December 31, 2020 and $ 2.7 billion and $ 2.9 billion, respectively, as of December 31, 2021 . Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 10.0 billion through the issuance of commercial paper, which increased from $ 5.0 billion in September 2021. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2020 and 2021. Our short-term debt balance also includes the current portion of certain long-term debt. Long-Term Debt Total outstanding debt is summarized below (in millions, except percentages): Effective Interest Rate As of December 31, Maturity Coupon Rate 2020 2021 Debt 2011-2020 Notes Issuances 2024 - 2060 0.45 % - 3.38 % 0.57 % - 3.38 % $ 14,000 $ 13,000 Future finance lease payments, net (1) 1,201 2,086 Total debt 15,201 15,086 Unamortized discount and debt issuance costs ( 169 ) ( 156 ) Less: Current portion of Notes (2) ( 999 ) Less: Current portion future finance lease payments, net (1)(2) ( 101 ) ( 113 ) Total long-term debt $ 13,932 $ 14,817 (1) Net of imputed interest. (2) Total current portion of long-term debt is included within other accrued expenses and current liabilities. See Note 7. The notes in the table above are comprised of fixed-rate senior unsecured obligations and generally rank equally with each other. We may redeem the notes at any time in whole or in part at specified redemption prices. The effective interest rates are based on proceeds received with interest payable semi-annually. The total estimated fair value of the outstanding notes, including the current portion, was approximately $ 14.0 billion and $ 12.4 billion as of December 31, 2020 and December 31, 2021, respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2021, the aggregate future principal payments for long-term debt, including finance lease liabilities, for each of the next five years and thereafter were as follows (in millions): 2022 $ 187 2023 146 2024 1,159 2025 1,162 2026 2,165 Thereafter 10,621 Total $ 15,440 Credit Facility As of December 31, 2021, we have $ 10.0 billion of revolving credit facilities. No amounts were outstanding under the credit facilities as of December 31, 2020 and 2021. Alphabet Inc. In April 2021, we terminated the existin g $ 4.0 billion revolving credit facilities, which were scheduled to expire in July 2023, and entered into two new revolving credit facilities in the amounts of $ 4.0 billion and $ 6.0 billion , which will expire in April 2022 and April 2026, respectively. The interest rates for the new credit facilities are determined based on a formula using certain market rates, as well as our progress toward the achievement of certain sustainability goals. No amounts have been borrowed under the new credit facilities. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2020 2021 Land and buildings $ 49,732 $ 58,881 Information technology assets 45,906 55,606 Construction in progress 23,111 23,171 Leasehold improvements 7,516 9,146 Furniture and fixtures 197 208 Property and equipment, gross 126,462 147,012 Less: accumulated depreciation ( 41,713 ) ( 49,414 ) Property and equipment, net $ 84,749 $ 97,599 Accrued expenses and other current liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2020 2021 European Commission fines (1) $ 10,409 $ 9,799 Payables to brokers for unsettled investment trades 754 397 Accrued customer liabilities 3,118 3,505 Accrued purchases of property and equipment 2,197 2,415 Current operating lease liabilities 1,694 2,189 Other accrued expenses and current liabilities 10,459 12,931 Accrued expenses and other current liabilities $ 28,631 $ 31,236 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) Components of AOCI, net of income tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2018 $ ( 1,884 ) $ ( 688 ) $ 266 $ ( 2,306 ) Cumulative effect of accounting change 0 0 ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 36 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 14 ) ( 14 ) Amounts reclassified from AOCI 0 ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 ( 2,003 ) 812 ( 41 ) ( 1,232 ) Other comprehensive income (loss) before reclassifications 1,139 1,313 79 2,531 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 37 ) ( 37 ) Amounts reclassified from AOCI 0 ( 513 ) ( 116 ) ( 629 ) Other comprehensive income (loss) 1,139 800 ( 74 ) 1,865 Balance as of December 31, 2020 ( 864 ) 1,612 ( 115 ) 633 Other comprehensive income (loss) before reclassifications ( 1,442 ) ( 1,312 ) 668 ( 2,086 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 48 48 Amounts reclassified from AOCI 0 ( 64 ) ( 154 ) ( 218 ) Other comprehensive income (loss) ( 1,442 ) ( 1,376 ) 562 ( 2,256 ) Balance as of December 31, 2021 $ ( 2,306 ) $ 236 $ 447 $ ( 1,623 ) The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location 2019 2020 2021 Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ 149 $ 650 $ 82 Benefit (provision) for income taxes ( 38 ) ( 137 ) ( 18 ) Net of income tax 111 513 64 Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue 367 144 165 Interest rate contracts Other income (expense), net 6 6 6 Benefit (provision) for income taxes ( 74 ) ( 34 ) ( 17 ) Net of income tax 299 116 154 Total amount reclassified, net of income tax $ 410 $ 629 $ 218 Alphabet Inc. Other Income (Expense), Net Components of other income (expense), net, were as follows (in millions): Year Ended December 31, 2019 2020 2021 Interest income $ 2,427 $ 1,865 $ 1,499 Interest expense (1) ( 100 ) ( 135 ) ( 346 ) Foreign currency exchange gain (loss), net (2) 103 ( 344 ) ( 240 ) Gain (loss) on debt securities, net 149 725 ( 110 ) Gain (loss) on equity securities, net 2,649 5,592 12,380 Performance fees ( 326 ) ( 609 ) ( 1,908 ) Income (loss) and impairment from equity method investments, net 390 401 334 Other (3) 102 ( 637 ) 411 Other income (expense), net $ 5,394 $ 6,858 $ 12,020 (1) Interest expense is net of interest capitalized of $ 167 million, $ 218 million, and $ 163 million for the years ended December 31, 2019, 2020, and 2021, respectively. (2) Our foreign currency exchange gain (loss), net, is primarily related to the forward points for our foreign currency hedging contracts and foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contracts' losses and gains. (3) During the year ended December 31, 2020, we entered into derivatives that hedged the changes in fair value of certain marketable equity securities, which resulted in losses of $ 902 million and gains of $ 92 million for the years ended December 31, 2020 and 2021, respectively. The offsetting recognized gains and losses on the marketable equity securities are reflected in Gain (loss) on equity securities, net. Note 8. Acquisitions Fitbit In January 2021, we closed the acquisition of Fitbit, a leading wearables brand for $ 2.1 billion. The addition of Fitbit to Google Services is expected to help spur innovation in wearable devices. The assets acquired and liabilities assumed were recorded at fair value. The purchase price excludes post acquisition compensation arrangements. The purchase price was attributed to $ 440 million cash acquired, $ 590 million of intangible assets, $ 1.2 billion of goodwill and $ 92 million of net liabilities assumed. Goodwill was recorded in the Google Services segment and primarily attributable to synergies expected to arise after the acquisition. Goodwill is not expected to be deductible for tax purposes. Other Acquisitions During the year ended December 31, 2021, we completed other acquisitions and purchases of intangible assets for total consideration of approximately $ 885 million, net of cash acquired, of which the total amount of goodwill expected to be deductible for tax purposes is approximately $ 118 million. Pro forma results of operations for these acquisitions have not been presented because they are not material to our consolidated results of operations, either individually or in the aggregate. Alphabet Inc. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2020 and 2021 were as follows (in millions): Google Google Services Google Cloud Other Bets Total Balance as of December 31, 2019 $ 19,921 $ 0 $ 0 $ 703 $ 20,624 Acquisitions 204 53 189 0 446 Foreign currency translation and other adjustments 46 56 5 ( 2 ) 105 Allocation in the fourth quarter of 2020 (1) ( 20,171 ) 18,408 1,763 0 0 Balance as of December 31, 2020 0 18,517 1,957 701 21,175 Acquisitions 0 1,325 382 103 1,810 Foreign currency translation and other adjustments 0 ( 16 ) ( 2 ) ( 11 ) ( 29 ) Balance as of December 31, 2021 $ 0 $ 19,826 $ 2,337 $ 793 $ 22,956 (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2020. See Note 15 for further details. Other Intangible Assets Information regarding purchased intangible assets was as follows (in millions): As of December 31, 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 4,639 $ 3,649 $ 990 Customer relationships 266 49 217 Trade names and other 624 461 163 Total definite-lived intangible assets 5,529 4,159 1,370 Indefinite-lived intangible assets 75 0 75 Total intangible assets $ 5,604 $ 4,159 $ 1,445 As of December 31, 2021 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,786 $ 4,112 $ 674 Customer relationships 506 140 366 Trade names and other 534 295 239 Total definite-lived intangible assets 5,826 4,547 1,279 Indefinite-lived intangible assets 138 0 138 Total intangible assets $ 5,964 $ 4,547 $ 1,417 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 0.7 years, 3.5 years, and 4.5 years, respectively. For all intangible assets acquired and purchased during the year ended December 31, 2021, patents and developed technology have a weighted-average useful life of 4.1 years, customer relationships have a weighted-average useful life of 4.3 years, and trade names and other have a weighted-average useful life of 9.9 years. Amortization expense relating to purchased intangible assets was $ 795 million, $ 774 million, and $ 875 million for the years ended December 31, 2019, 2020, and 2021, respectively. Alphabet Inc. As of December 31, 2021, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter was as follows (in millions): 2022 $ 537 2023 255 2024 226 2025 98 2026 61 Thereafter 102 $ 1,279 Note 10. Contingencies Indemnifications In the normal course of business, including to facilitate transactions in our services and products and corporate activities, we indemnify certain parties, including advertisers, Google Network partners, customers of Google Cloud offerings, lessors and service providers with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims, and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2021, we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision to the General Court, and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On November 10, 2021, the General Court rejected our appeal, and we subsequently filed an appeal with the European Court of Justice on January 20, 2022. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ($ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search partners' agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Alphabet Inc. From time to time we are subject to formal and informal inquiries and investigations on competition matters by regulatory authorities in the U.S., Europe, and other jurisdictions. In August 2019, we began receiving civil investigative demands from the U.S. Department of Justice (DOJ) requesting information and documents relating to our prior antitrust investigations and certain aspects of our business. The DOJ and a number of state Attorneys General filed a lawsuit on October 20, 2020 alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the U.S. District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. On June 22, 2021, the EC opened a formal investigation into Google's advertising technology business practices. On July 7, 2021, a number of state Attorneys General filed an antitrust complaint against us in the U.S. District Court for the Northern District of California, alleging that Googles operation of Android and Google Play violated U.S. antitrust laws and state antitrust and consumer protection laws. We believe these complaints are without merit and will defend ourselves vigorously. The DOJ and state Attorneys General continue their investigations into certain aspects of our business. We continue to cooperate with federal and state regulators in the U.S., the EC and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces (Java APIs). After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the Federal Circuit Court of Appeals reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the U.S. Supreme Court to review the case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. The Supreme Court heard oral arguments in our case on October 7, 2020. On April 5, 2021, the Supreme Court reversed the Federal Circuit's ruling and found that Googles use of the Java APIs was a fair use as a matter of law. The Supreme Court remanded the case to the Federal Circuit for further proceedings in conformity with the Supreme Court opinion. On May 14, 2021, the Federal Circuit entered an order affirming the district courts final judgment in favor of Google. On June 21, 2021, the Federal Circuit issued a mandate returning the case to the district court, and the case is now concluded. Other We are also regularly subject to claims, suits, regulatory and government investigations, other proceedings, and consent decrees involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. For example, we have a number of privacy investigations and suits ongoing in multiple jurisdictions. Such claims, suits, regulatory and government investigations, other proceedings, and consent decrees could result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral related civil litigation or other adverse consequences, all of which could harm our business, reputation, financial condition, and operating results. Alphabet Inc. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred, and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both the likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14. Note 11. Stockholders' Equity Preferred Stock Our Board of Directors has authorized 100 million shares of preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2020 and 2021, no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our Board of Directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In April 2021, the Board of Directors of Alphabet authorized the company to repurchase up to $ 50.0 billion of its Class C stock. In July 2021, the Alphabet board approved an amendment to the April 2021 authorization, permitting the company to repurchase both Class A and Class C shares in a manner deemed in the best interest of the company and its stockholders, taking into account the economic cost and prevailing market conditions, including the relative trading prices and volumes of the Class A and Class C shares. As of December 31, 2021, $ 17.4 billion remains available for Class A and Class C share repurchases under the amended authorization. In accordance with the authorizations of the Board of Directors of Alphabet, during the years ended December 31, 2020 and 2021, we repurchased and subsequently retired 21.5 million and 20.3 million aggregate shares for $ 31.1 billion and $ 50.3 billion, respectively. Of the aggregate amount repurchased and subsequently retired during 2021, 1.2 million shares were Class A stock for $ 3.4 billion. Stock Split Effected in Form of Stock Dividend (Stock Split) On February 1, 2022, the Company announced that the Board of Directors had approved and declared a 20-for-one stock split in the form of a one-time special stock dividend on each share of the Companys Class A, Class B, and Class C stock. The Stock Split is subject to stockholder approval of an amendment to the Companys Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Class A, Class B, and Class C stock to accommodate the Stock Split. Alphabet Inc. If approval is obtained, each of the Companys stockholders of record at the close of business on July 1, 2022 (the Record Date), will receive, after the close of business on July 15, 2022, a dividend of 19 additional shares of the same class of stock for every share held by such stockholder as of the Record Date. Note 12. Net Income Per Share We compute net income per share of Class A, Class B, and Class C stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A stock assumes the conversion of Class B stock, while the diluted net income per share of Class B stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A, Class B, and Class C stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our Board of Directors from declaring or paying unequal per share dividends on our Class A, Class B, and Class C stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our Board of Directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A, Class B, and Class C stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2019, 2020 and 2021, the net income per share amounts are the same for Class A, Class B, and Class C stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A, Class B, and Class C stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, 2019 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 0 0 Reallocation of undistributed earnings ( 126 ) ( 20 ) 126 Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 46,527 0 0 Restricted stock units and other contingently issuable shares 413 0 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Alphabet Inc. Year Ended December 31, 2020 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 17,733 $ 2,732 $ 19,804 Denominator Number of shares used in per share computation 299,815 46,182 334,819 Basic net income per share $ 59.15 $ 59.15 $ 59.15 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 17,733 $ 2,732 $ 19,804 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,732 0 0 Reallocation of undistributed earnings ( 180 ) ( 25 ) 180 Allocation of undistributed earnings $ 20,285 $ 2,707 $ 19,984 Denominator Number of shares used in basic computation 299,815 46,182 334,819 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 46,182 0 0 Restricted stock units and other contingently issuable shares 87 0 6,125 Number of shares used in per share computation 346,084 46,182 340,944 Diluted net income per share $ 58.61 $ 58.61 $ 58.61 Year Ended December 31, 2021 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 34,200 $ 5,174 $ 36,659 Denominator Number of shares used in per share computation 300,310 45,430 321,910 Basic net income per share $ 113.88 $ 113.88 $ 113.88 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 34,200 $ 5,174 $ 36,659 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 5,174 0 0 Reallocation of undistributed earnings ( 581 ) ( 77 ) 581 Allocation of undistributed earnings $ 38,793 $ 5,097 $ 37,240 Denominator Number of shares used in basic computation 300,310 45,430 321,910 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A shares outstanding 45,430 0 0 Restricted stock units and other contingently issuable shares 15 0 10,009 Number of shares used in per share computation 345,755 45,430 331,919 Diluted net income per share $ 112.20 $ 112.20 $ 112.20 Alphabet Inc. Note 13. Compensation Plans Stock Plans Our stock plans include the Alphabet Amended and Restated 2012 Stock Plan, the Alphabet 2021 Stock Plan and Other Bet stock-based plans. Under our stock plans, RSUs and other types of awards may be granted. An RSU award is an agreement to issue shares of our Class C stock at the time the award vests. RSUs generally vest over four years contingent upon employment on the vesting date. As of December 31, 2021, there were 37,479,707 shares of Class C stock reserved for future issuance under the Alphabet 2021 Stock Plan. Stock-Based Compensation For the years ended December 31, 2019, 2020, and 2021, total stock-based compensation expense was $ 11.7 billion, $ 13.4 billion, and $ 15.7 billion, including amounts associated with awards we expect to settle in Alphabet stock of $ 10.8 billion, $ 12.8 billion, and $ 15.0 billion, respectively. For the years ended December 31, 2019, 2020, and 2021, we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.8 billion, $ 2.7 billion, and $ 3.1 billion, respectively. For the years ended December 31, 2019, 2020, and 2021, tax benefit realized related to awards vested or exercised during the period was $ 2.2 billion, $ 3.6 billion, and $ 5.9 billion, respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the RD tax credit. Stock-Based Award Activities The following table summarizes the activities for unvested Alphabet RSUs for the year ended December 31, 2021: Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2020 19,288,793 $ 1,262.13 Granted 10,582,700 $ 1,949.16 Vested ( 11,209,486 ) $ 1,345.98 Forfeited/canceled ( 1,767,294 ) $ 1,425.48 Unvested as of December 31, 2021 16,894,713 $ 1,626.13 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2019 and 2020 was $ 1,092.36 and $ 1,407.97 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2019, 2020, and 2021 were $ 15.2 billion, $ 17.8 billion, and $ 28.8 billion, respectively. As of December 31, 2021, there was $ 25.8 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.5 years. 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 724 million, $ 855 million, and $ 916 million for the years ended December 31, 2019, 2020, and 2021, respectively. Note 14. Income Taxes Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, 2019 2020 2021 Domestic operations $ 16,426 $ 37,576 $ 77,016 Foreign operations 23,199 10,506 13,718 Total $ 39,625 $ 48,082 $ 90,734 Alphabet Inc. Provision for income taxes consisted of the following (in millions): Year Ended December 31, 2019 2020 2021 Current: Federal and state $ 2,424 $ 4,789 $ 10,126 Foreign 2,713 1,687 2,692 Total 5,137 6,476 12,818 Deferred: Federal and state 286 1,552 2,018 Foreign ( 141 ) ( 215 ) ( 135 ) Total 145 1,337 1,883 Provision for income taxes $ 5,282 $ 7,813 $ 14,701 The reconciliation of federal statutory income tax rate to our effective income tax rate was as follows: Year Ended December 31, 2019 2020 2021 U.S. federal statutory tax rate 21.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 4.9 ) ( 0.3 ) 0.2 Foreign-derived intangible income deduction ( 0.7 ) ( 3.0 ) ( 2.5 ) Stock-based compensation expense ( 0.7 ) ( 1.7 ) ( 2.5 ) Federal research credit ( 2.5 ) ( 2.3 ) ( 1.6 ) Deferred tax asset valuation allowance 0.0 1.4 0.6 State and local income taxes 1.1 1.1 1.0 Effective tax rate 13.3 % 16.2 % 16.2 % Our effective tax rate for 2019 was affected significantly by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate because substantially all of the income from foreign operations was earned by an Irish subsidiary. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S. On July 27, 2015, the U.S. Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the U.S. Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. In 2020, there was an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities were as follows (in millions): As of December 31, 2020 2021 Deferred tax assets: Accrued employee benefits $ 580 $ 549 Accruals and reserves not currently deductible 1,049 1,816 Tax credits 3,723 5,179 Net operating losses 1,085 1,790 Operating leases 2,620 2,503 Intangible assets 1,525 2,034 Other 981 925 Total deferred tax assets 11,563 14,796 Valuation allowance ( 4,823 ) ( 7,129 ) Total deferred tax assets net of valuation allowance 6,740 7,667 Deferred tax liabilities: Property and equipment, net ( 3,382 ) ( 5,237 ) Net investment gains ( 1,901 ) ( 3,229 ) Operating leases ( 2,354 ) ( 2,228 ) Other ( 1,580 ) ( 946 ) Total deferred tax liabilities ( 9,217 ) ( 11,640 ) Net deferred tax assets (liabilities) $ ( 2,477 ) $ ( 3,973 ) As of December 31, 2021, our federal, state, and foreign net operating loss carryforwards for income tax purposes were approximately $ 5.6 billion, $ 4.6 billion, and $ 1.7 billion respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2023, foreign net operating loss carryforwards will begin to expire in 2025 and the state net operating loss carryforwards will begin to expire in 2028. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2021, our California RD carryforwards for income tax purposes were approximately $ 5.0 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2021, our investment tax credit carryforwards for state income tax purposes were approximately $ 700 million and will begin to expire in 2025. We use the flow-through method of accounting for investment tax credits. We believe this tax credit is not likely to be realized. As of December 31, 2021, we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits, net deferred tax assets relating to certain Other Bets, and certain foreign net operating losses that we believe are not likely to be realized. We continue to reassess the remaining valuation allowance quarterly, and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, 2019 2020 2021 Beginning gross unrecognized tax benefits $ 4,652 $ 3,377 $ 3,837 Increases related to prior year tax positions 938 372 529 Decreases related to prior year tax positions ( 143 ) ( 557 ) ( 263 ) Decreases related to settlement with tax authorities ( 2,886 ) ( 45 ) ( 329 ) Increases related to current year tax positions 816 690 1,384 Ending gross unrecognized tax benefits $ 3,377 $ 3,837 $ 5,158 The total amount of gross unrecognized tax benefits was $ 3.4 billion, $ 3.8 billion, and $ 5.2 billion as of December 31, 2019, 2020, and 2021, respectively, of which $ 2.3 billion, $ 2.6 billion, and $ 3.7 billion, if recognized, would affect our effective tax rate, respectively. As of December 31, 2020 and 2021, we accrued $ 222 million and $ 270 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. Our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2014 through 2020 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, it is reasonably possible that our unrecognized tax benefits from certain U.S. federal, state and non U.S. tax positions could decrease by approximately $ 2.0 billion in the next 12 months. Positions that may be resolved include various U.S. and non-U.S. matters. Note 15. Information about Segments and Geographic Areas We report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps and in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and platform services, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues from fees received for Google Cloud Platform services, Google Workspace collaboration tools and other enterprise services. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from Other Bets are generated primarily from the sale of health technology and internet services. Revenues, certain costs, such as costs associated with content and traffic acquisition, certain engineering activities, and hardware, as well as certain operating expenses are directly attributable to our segments. Due to the integrated nature of Alphabet, other costs and expenses, such as technical infrastructure and office facilities, are managed centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Alphabet Inc. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including certain fines and settlements, as well as costs associated with certain shared RD activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Our operating segments are not evaluated using asset information. Information about segments during the periods presented were as follows (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2019 2020 2021 Revenues: Google Services $ 151,825 $ 168,635 $ 237,529 Google Cloud 8,918 13,059 19,206 Other Bets 659 657 753 Hedging gains (losses) 455 176 149 Total revenues $ 161,857 $ 182,527 $ 257,637 Operating income (loss): Google Services $ 48,999 $ 54,606 $ 91,855 Google Cloud ( 4,645 ) ( 5,607 ) ( 3,099 ) Other Bets ( 4,824 ) ( 4,476 ) ( 5,281 ) Corporate costs, unallocated (1) ( 5,299 ) ( 3,299 ) ( 4,761 ) Total income from operations $ 34,231 $ 41,224 $ 78,714 (1) Corporate costs, unallocated includes a fine and legal settlement totaling $ 2.3 billion for the year ended December 31, 2019. For revenues by geography, see Note 2. The following table presents long-lived assets by geographic area, which includes property and equipment, net and operating lease assets (in millions): As of December 31, 2020 2021 Long-lived assets: United States $ 69,315 $ 80,207 International 27,645 30,351 Total long-lived assets $ 96,960 $ 110,558 Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2021, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management and provide timely information to our management team. The implementation is expected to continue in phases over the next few years. We completed the implementation of certain of our subledgers, which included changes to our processes, procedures and internal controls over financial reporting during the second quarter of 2021. There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures, which in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2021. While we continue to evolve our work model in response to the uneven effects of the ongoing pandemic around the world, we believe that our internal controls over financial reporting continue to be eff ective. We have continued to re-evaluate and refine our financial reporting process to provide reasonable assurance that we could report our financial results accurately and in a timely manner. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2021. Management reviewed the results of its assessment with our Audit and Compliance Committee. The effectiveness of our internal control over financial reporting as of December 31, 2021 has been audited by Ernst Young LLP , an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +1,goog,20201231," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history, inspiring us to tackle big problems, and invest in moonshots like artificial intelligence (""AI"") research and quantum computing. We continue this work under the leadership of Sundar Pichai, who has served as CEO of Google since 2015 and as CEO of Alphabet since 2019. Alphabet is a collection of businesses the largest of which is Google which we report as two segments: Google Services and Google Cloud. We report all non-Google businesses collectively as Other Bets. Our Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Our Alphabet structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. Our mission to organize the worlds information and make it universally accessible and useful is as relevant today as it was when we were founded in 1998. Since then, weve evolved from a company that helps people find answers to a company that helps you get things done. Were focused on building an even more helpful Google for everyone, and we aspire to give everyone the tools they need to increase their knowledge, health, happiness and success. Across Alphabet, we're focused on continually innovating in areas where technology can have an impact on peoples lives. Every year, there are trillions of searches on Google, and we continue to invest deeply in AI and other technologies to ensure the most helpful Search experience possible. People come to YouTube for entertainment, information and opportunities to learn something new. And Google Assistant offers the best way to get things done seamlessly across different devices, providing intelligent help throughout your day, no matter where you are. Since the pandemic began, our teams have built new features to help users go about their daily lives, and to support businesses working to serve their customers during an uncertain time. In conjunction with Apple, we launched Exposure Notification apps that are being used by local governments globally. Our COVID-19 Community Mobility Reports are used by public health agencies and researchers around the globe, and weve committed hundreds of millions of dollars to help small businesses through a combination of small business loans, grants and ad credits. Importantly, we've made authoritative content a key focus area across both Google Search and YouTube to help users search for trusted public health information. Our Other Bets are also pursuing initiatives with similar goals. For instance, as a part of our efforts in the Metro Phoenix area, Waymo is working toward our goal of making transportation safer and easier for everyone while Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and AI are increasingly driving many of our latest innovations. Our investments in machine learning over the past decade have enabled us to build products that are smarter and more helpful. For example, a huge breakthrough in natural language understanding, called BERT, now improves results for almost every English language search query. DeepMind made a significant AI-powered breakthrough, solving a 50-year-old protein folding challenge, which will help us better understand one of lifes fundamental building blocks, and will enable researchers to tackle new and difficult problems, from fighting diseases to environmental sustainability. Alphabet Inc. Google For reporting purposes, Google comprises two segments: Google Services and Google Cloud. Google Services Serving our users We have always been a company committed to building helpful products that can improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google Services' core products and platforms include Android, Chrome, Gmail, Google Drive, Google Maps, Google Photos, Google Play, Search, and YouTube, each with broad and growing adoption by users around the world. Our products and services have come a long way since the company was founded more than two decades ago. Rather than the ten blue links in our early search results, users can now get direct answers to their questions using their computer, mobile device, or their own voice, making it quicker, easier and more natural to find what you're looking for. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. With the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of our AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 4a, Pixel 4a 5G and Pixel 5 phones, Chromecast with Google TV and the Google Nest Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Key to building helpful products for users is our commitment to privacy, security and user choice. As the Internet evolves, we continue to invest in keeping data safe, including enhanced malware features in Chrome and improvements to auto-delete controls that will automatically delete web and app searches after 18 months. How we make money Our advertising products deliver relevant ads at just the right time, to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across devices and formats. Google Services generates revenues primarily by delivering both performance advertising and brand advertising. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google Search other properties, YouTube and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have built a world-class ad technology platform for advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging Alphabet Inc. from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blocklisting them when necessary to ensure that ads do not fund bad content. We continue to look to the future and are making long-term investments that will grow revenues beyond advertising, including Google Play, hardware, and YouTube. We are also investing in research efforts in AI and quantum computing to foster innovation across our businesses and create new opportunities. Google Cloud Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics and AI. We see significant opportunity in helping businesses utilize these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and Google Workspace (formerly known as G Suite). Google Cloud Platform enables developers to build, test, and deploy applications on its highly scalable and reliable infrastructure. Our Google Workspace collaboration tools which include apps like Gmail, Docs, Drive, Calendar, Meet and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Google Cloud generates revenues primarily from fees received for Google Cloud Platform services and Google Workspace collaboration tools. Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets investment in our portfolio of Other Bets include emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues are primarily generated from internet and TV services, as well as licensing and RD services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in our portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Apple, ATT, Disney, Facebook, Hulu, Netflix and TikTok. In businesses that are further afield from our advertising business, we compete with companies that have longer operating histories and more established relationships with customers and users. We face competition from: Other digital content and application platform providers, such as Amazon and Apple. Alphabet Inc. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Ongoing Commitment to Sustainability At Google, we build technology that helps people do more for the planet. We strive to build sustainability into everything we do, including designing and operating efficient data centers, advancing carbon-free energy, creating sustainable workplaces, building better devices and services, empowering users with technology, and enabling a responsible supply chain. Google has been carbon neutral since 2007, and in 2019, for the third consecutive year, we matched 100% of our electricity consumption with renewable energy purchases. We are the largest annual corporate purchaser of renewable energy in the world, based on renewable electricity purchased in megawatt-hour (MWh). In 2020, we neutralized our entire legacy carbon footprint since our founding (covering all our operational emissions before we became carbon neutral in 2007), making Google the first major company to achieve carbon neutrality for its entire operating history. In our third decade of climate action, weve set our most ambitious goal yet: to run our business on carbon-free energy everywhere, at all times, by 2030. We're also investing in technologies to help our partners and people all over the world make sustainable choices. For example, we intend to enable 5 GW of new carbon-free energy across our key manufacturing regions by 2030 through investment. We anticipate this will spur more than $5 billion in clean energy investments, avoid the amount of emissions equal to taking more than 1 million cars off the road each year, and create more than 8,000 clean energy jobs. With the Environmental Insights Explorer, we're also working to help more than 500 cities and local governments globally reduce a total of 1 gigaton of carbon emissions annually by 2030 thats the equivalent of the annual carbon emissions of a country the size of Japan. Googles products are already helping people make more sustainable choices in their daily lives, whether its using Google Maps to find bike-shares and electric vehicle charging stations, or in many European countries, using Google Flights to sort the least carbon-intensive option flights. There are more tools and information we can provide, and our goal is to find new ways that our products can help 1 billion people make more sustainable choices by 2022. Climate change is one of the most significant global challenges of our time. In 2017, we developed a climate resilience strategy, which included conducting a climate scenario analysis. We've earned a spot on the CDP (formerly the Carbon Disclosure Project) Climate Change A List for seven consecutive years. We believe our CDP climate change response reflects the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). In 2020, we issued $5.75 billion in sustainability bonds, the largest sustainability or green bond issuance by any company in history. The net proceeds from the issuance are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. More information on our approach to sustainability can be found in our annual sustainability reports, including Googles environmental report. The content of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. Alphabet Inc. Culture and Workforce Were a company of curious, talented and passionate people. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex challenges in technology and society. Our people are critical for our continued success. We work hard to provide an environment where Googlers can have fulfilling careers, and be happy, healthy and productive. We offer industry-leading benefits and programs to take care of the diverse needs of our employees and their families, including access to excellent healthcare choices, opportunities for career growth and development, and resources to support their financial health. Our competitive compensation programs help us to attract and retain top candidates, and we will continue to invest in recruiting talented people to technical and non-technical roles and rewarding them well. Alphabet is committed to making diversity, equity, and inclusion part of everything we do and were committed to growing a workforce thats representative of the users we serve. More information on Googles approach to diversity can be found in our annual diversity reports, available publicly at diversity.google. The content of our diversity reports is not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. We have work councils and statutory employee representation obligations in certain countries and we are committed to supporting protected labor rights, maintaining an open culture and listening to all Googlers. Supporting healthy and open dialogue is central to how we work, and we communicate information about the company through multiple internal channels to our employees. As of December 31, 2020, Alphabet had 135,301 employees. When necessary, we contract with businesses around the world to provide specialized services where we dont have appropriate in-house expertise or resources, often in fields that require specialized training like cafe operations, customer support, content moderation and physical security. We also contract with temporary staffing agencies when we need to cover short-term leaves, when we have spikes in business needs, or when we need to quickly incubate special projects. We choose our partners and staffing agencies carefully, and review their compliance with Googles Supplier Code of Conduct. We continually make improvements to promote a respectful and positive working environment for everyone employees, vendors and temporary staff alike. Government Regulation We are subject to numerous U.S. federal, state, and foreign laws and regulations covering a wide variety of subject matters. Like other companies in the technology industry, we face heightened scrutiny from both U.S. and foreign governments with respect to our compliance with laws and regulations. Our compliance with these laws and regulations may be onerous and could, individually or in the aggregate, increase our cost of doing business, impact our competitive position relative to our peers, and/or otherwise have an adverse impact on our business, reputation, financial condition, and operating results. For additional information about government regulation applicable to our business, see Risk Factors in Part I, Item 1A, Trends in Our Business in Part II, Item 7, and Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality (including developments and volatility arising from COVID-19). Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or Alphabet Inc. announcements regarding our financial performance and other items that may be material or of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, that may be material or of interest to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generate d over 80% o f total revenues from the display of ads online in 2020. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising and/or data privacy practices may affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions, including COVID-19 and its effects on the global economy (as discussed in greater detail in our COVID-19 risk factor under General Risks below), have impacted the demand for advertising and resulted in fluctuations in the amounts our advertisers spend on advertising, and could have an adverse impact on such demand and spend, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories and well established relationships in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Further, discrepancies in enforcement of existing laws may enable our lesser known competitors to aggressively interpret those laws without commensurate scrutiny, thereby affording them competitive advantages. Our competitors may also be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This Alphabet Inc. may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could disrupt our current operations and harm our financial condition and operating results. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google Services, Google Cloud and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google Services, Google Cloud and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of management resources and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google Services, we continue to invest heavily in hardware, including our smartphones and home devices, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. Within Google Cloud, we devote significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and Google Workspace. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale our salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large experienced and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use artificial intelligence and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition, and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition, COVID-19 and its effects on the global economy has impacted and may continue to adversely impact our revenue growth rate (as discussed in greater detail in our COVID-19 risk factor under General Risks below). In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing regulations, increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix, property mix, and partner agreements can affect margin. The margin we earn on revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners as well as increased content acquisition Alphabet Inc. costs to content providers. We may also face an increase in infrastructure costs, supporting businesses such as Search, Google Cloud, and YouTube. Many of our expenses are less variable in nature and may not correlate to changes in revenues. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brands as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google Services, Google Cloud and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of misinformation or objectionable content on our services and/or products or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that, if not properly managed, could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our finished products, to design certain of our components and parts, and to participate in the distribution of our products and services. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We have experienced and/or may experience supply shortages and price increases driven by raw material, component or part availability, manufacturing capacity, labor shortages, industry allocations, tariffs, trade disputes Alphabet Inc. and barriers, natural disasters or pandemics (including COVID-19), the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We have experienced and/or may in the future, experience shortages or other supply chain disruptions that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available from only one or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant supply interruption could delay critical data center upgrades or expansions and delay product availability. We may enter into long term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because certain of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Our products and services may have quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property, could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption, interference with, or failure of our complex information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, complications with the design or implementation of our new global enterprise resource planning system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from modifications or upgrades, terrorist attacks, natural disasters or pandemics (including COVID-19), the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster or pandemic (including COVID-19), closure of a facility, or other unanticipated problems at, or impacting, our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. We may not be able to successfully implement the ERP system without experiencing delays, increased costs, and other difficulties. Failure to successfully design and implement the new ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Alphabet Inc. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 53% of our consolidated revenues in 2020. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Import and export requirements, tariffs and other market access barriers that may prevent or impede us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign events, including the effect of the United Kingdom's withdrawal from the European Union, may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom and new customer requirements), in addition to other adverse effects that we are unable to effectively anticipate. Anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings, particularly in light of market volatilities due to COVID-19. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on some interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available or may only be available with limited functionality for our users or our advertisers on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Alphabet Inc. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations regarding privacy and data change. Our products and services involve the storage and transmission of proprietary and other sensitive information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users or customers. We expect to continue to expend significant resources to maintain security protections that shield against bugs, theft, misuse, or security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. We may experience future security issues, whether due to employee error or malfeasance or system errors or vulnerabilities in our or other parties systems, which could result in significant legal and financial exposure. Government inquiries and enforcement actions, litigation, and adverse press coverage could harm our business. We may be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Attacks and security issues could also compromise trade secrets and other sensitive information, harming our business. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process, particularly during times of a natural disaster or pandemic (including COVID-19), may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to mitigate cyber attacks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigations and review of platform applications that could access the information of users of our services. As a result of these efforts, we could discover incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, including factors outside of our control such as a natural disaster or pandemic (including COVID-19), and we may be notified of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading disinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content on our platforms, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines across our platforms, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and invalid traffic, we may be unable to adequately detect and prevent such abuses or promote high-quality content, particularly during times of a natural disaster or pandemic (including COVID-19). Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts Alphabet Inc. (known as web spam) may affect the quality of content on our platforms and lead them to display false, misleading or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on detecting and preventing abuse from low-quality websites. We also face other challenges on our platforms, including violations of our content guidelines involving incidents such as attempted election interference, activities that threaten the safety and/or well-being of our users on- or offline, and the spreading of disinformation, among other challenges. If we fail to either detect and prevent an increase in problematic content or effectively promote high-quality content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, by charging increased fees to us or our users to provide our offerings, or by providing our competitors preferential access. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in 2018 the United States Federal Communications Commission repealed net neutrality rules, which could permit internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. COVID-19 has also resulted in quarantines, shelter in place orders, and work from home directives, all of which have increased demands for internet access and may create access challenges. These could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our business. Risks Related to Laws and Regulations We face increased regulatory scrutiny as well as changes in regulatory conditions, laws and policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry face increased regulatory scrutiny, enforcement action, and other proceedings. For instance, the U.S. Department of Justice, joined by a number of state Attorneys General, filed an antitrust complaint against Google on October 20, 2020, alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the United States District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. Various other regulatory agencies in the United States and around the world, including competition enforcers, consumer protection agencies, data protection authorities, grand juries, inter-agency consultative groups, and a range of other governmental bodies have and continue to review our products and services and their compliance with laws and regulations around the world. We continue to cooperate with these investigations. Various laws, regulations, investigations, enforcement lawsuits, and regulatory actions have in the past and may in the future result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring Alphabet Inc. obligations, changes to our products and services, alterations to our business models and operations, and collateral litigation, all of which could harm our business, reputation, financial condition, and operating results. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics may increase our cost of doing business, limit our ability to pursue certain business models, offer products or services in certain jurisdictions, or cause us to change our business practices. We have in the past had to alter or withdraw certain products and services as a result of laws or regulations that made them unfeasible, and new laws or regulations, such as the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission currently tabled in parliament, could result in our having to alter or withdraw products and services in the future. These additional costs of doing business, new limitations or changes to our business model or practices could harm our business, reputation, financial condition, and operating results. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices) may make our products and services less useful, limit our ability to pursue certain business models or offer certain products and services, require us to incur substantial costs, expose us to civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: New competition laws and related regulations around the world, that can limit certain business practices, and in some cases, create the risk of significant penalties. Privacy laws, such as the California Consumer Privacy Act of 2018 that came into effect in January of 2020 and the California Privacy Rights Act which will go into effect in 2023, both of which give new data privacy rights to California residents, and SB-327 in California, which regulates the security of data in connection with internet connected devices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. New laws further restricting the collection, processing and/or sharing of advertising-related data. Copyright or similar laws around the world, including the EU Directive on Copyright in the Digital Single Market (EUCD) of April 17, 2019, which EU Member States must implement by June 7, 2021; and the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission. These and similar laws that have been adopted or proposed introduce new constraining licensing regimes that could affect our ability to operate. The EUCD and similar laws could increase the liability of some content-sharing services with respect to content uploaded by their users. Some of these laws, as well as follow-on administrative or judicial actions, have also created or may create a new property right in news publications that limits the ability of some online services to interact with or present such content. They may also impose compensation negotiations with news agencies and publishers for the use of such content, which may result in payment obligations that significantly exceed the value that such content provides to Google and its users. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. Various legislative, litigation, and regulatory activity regarding our Google Play billing policies and business model, which could result in monetary penalties, damages and/or prohibition. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: Alphabet Inc. We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act and Section 230 of the Communications Decency Act in the United States and the E-Commerce Directive in Europe, against liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. There are legislative proposals in both the US and EU that could reduce our safe harbor protection. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take may subject us to additional laws and regulations. Our investment in a variety of new fields, such as healthcare and payment services, may expand the scope of regulations that apply to our business. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, and other proceedings that may harm our business, financial condition, and operating results. We are subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as Google Cloud offerings, we also are subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental impacts, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled around the world. Claims have been brought against us for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Adverse interpretations of these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation could result in fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business, and may be particularly challenging during certain times, such as a natural disaster or pandemic (including COVID-19). Recent legal developments in Europe have created compliance uncertainty regarding transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU Alphabet Inc. users or customers, or the monitoring of their behavior in the EU. The GDPR creates a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment that involves substantial costs, and despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have an adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland. Recently, the CJEU ruled that the EU-U.S. Privacy Shield is an invalid transfer mechanism, but upheld Standard Contractual Clauses as a valid transfer mechanism, provided they meet certain requirements. The validity of data transfer mechanisms remains subject to legal, regulatory, and political developments in both Europe and the U.S., such as recent recommendations from the European Data Protection Board, the invalidation of the EU-U.S. Privacy Shield and potential invalidation of other data transfer mechanisms, which could have a significant adverse impact on our ability to process and transfer personal data outside of the EEA. These developments create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. We face, and may continue to face intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or will enhance long-term stockholder value, and share repurchases could increase the volatility of our stock prices and could diminish our cash reserves . Alphabet Inc. We engage in share repurchases of our Class C capital stock from time to time in accordance with authorizations from the Board of Directors of Alphabet. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Further, our share repurchases could affect our share trading prices, increase their volatility, reduce our cash reserves and may be suspended or terminated at any time, which may result in a decrease in the trading prices of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2020, Larry Page and Sergey Brin beneficially owned approximate ly 85.3% of our outstanding Class B common stock, which represented approximate ly 51.5% o f the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A common stock and our Class C capital stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of continuing the influence of Larry and Sergey. Our Board of Directors has the right to elect directors to fill a vacancy created by the expansion of the Board of Directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our Board of Directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the Board of Directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our Board of Directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our Board of Directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the Board of Directors has approved the transaction. Our Board of Directors could rely on Delaware law to prevent or delay an acquisition of us. Alphabet Inc. General Risks The continuing impacts of COVID-19 are highly unpredictable and could be significant, and may have an adverse effect on our business, operations and our future financial performance. Since COVID-19 was declared a global pandemic by the World Health Organization, governments and municipalities around the world have instituted measures in an effort to control the spread of COVID-19, including quarantines, shelter-in-place orders, school closings, travel restrictions, and closure of non-essential businesses. The macroeconomic impacts on our business continue to evolve and be unpredictable and may continue to adversely affect our business, operations and financial performance. As a result of the scale of the ongoing pandemic and the speed at which the global community has been impacted, our revenue growth rate and expense as a percentage of our revenues in future periods may differ significantly from our historical rate, and our future operating results may fall below expectations. The future impacts of the ongoing pandemic on our business, operations and future financial performance could include, but are not limited to: Significant decline in advertising revenues as advertiser spending slows due to an economic downturn. This decline in advertising revenues could persist through and beyond a recessionary period. In addition, we may experience a significant and prolonged shift in user behavior such as a shift in interests to less commercial topics. Significant decline in other revenues due to a decline or shifts in customer demand. For example, if consumer demand for electronics significantly declines, our hardware revenues could be significantly impacted. Adverse impacts to our operating income, operating margin, net income, EPS and respective growth rates - particularly if expenses do not decrease across Alphabet at the same pace as revenue declines. Many of our expenses are less variable in nature and/or may not correlate to changes in revenues, including costs associated with our data centers and facilities as well as employee compensation. As such, we may not be able to decrease them significantly in the short-term, or we may choose not to significantly reduce them in an effort to remain focused on long-term outlook and investment opportunities. Significant decline in our operating cash flows as a result of decreased advertiser spending and deterioration in the credit quality and liquidity of our customers, which could adversely affect our accounts receivable. Investing cash flows could decrease due to slowing spend on data center and facilities construction projects due to a slowing or stopping of construction or significant restrictions placed on construction. The prolonged and broad-based shift to a remote working environment continues to create inherent productivity, connectivity, and oversight challenges and could affect our ability to enhance, develop and support existing products and services, detect and prevent spam and problematic content, hold product sales and marketing events, and generate new sales leads, among others. In addition, the changed environment under which we are operating could have an effect on our internal controls over financial reporting as well as our ability to meet a number of our compliance requirements in a timely or quality manner. Additional and/or extended, governmental lockdowns, restrictions or new regulations could significantly impact the ability of our employees and vendors to work productively. Governmental restrictions have been globally inconsistent and it remains unclear when a return to worksite locations or travel will be permitted or what restrictions will be in place in those environments. As we prepare to return our workforce in more locations back to the office in 2021, we may experience increased costs as we prepare our facilities for a safe return to work environment and experiment with hybrid work models, in addition to potential effects on our ability to compete effectively and maintain our corporate culture. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results (including our expenses as a percentage of our revenues) on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed under this Item 1A in addition to the following factors may affect our operating results: Our ability to attract user and/or customer adoption of, and generate significant revenues from, new products, services, and technologies in which we have invested considerable time and resources. Alphabet Inc. Our ability to monetize traffic on Google Search other properties, YouTube and our Google Network Members' properties across various devices. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Geopolitical events, including trade disputes. Changes in global business or macroeconomic conditions. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of such potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully integrate and further develop the acquired business or technology. Implementation or remediation of controls, procedures, and policies at the acquired company. Integration of the acquired companys accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Alphabet Inc. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology, maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our ability to compete effectively and our future success depends on our continuing to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Restrictive immigration policy and regulatory changes may also impact our ability to hire, mobilize or retain some of our global talent. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows and evolves, we may need to implement more complex organizational management structures or adapt our corporate culture and work environments to ever-changing circumstances, such as during times of a natural disaster or pandemic (including COVID-19), and these changes could impact our ability to compete effectively or have an adverse impact on our corporate culture. We are exposed to fluctuations in the market values of our investments and, in some instances, our financial statements incorporate valuation methodologies that are subjective in nature resulting in fluctuations over time. The market value of our investments can be negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying entities, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates, the effect of new or changing regulations, the stock market in general, or other factors. The effect of COVID-19 on our impairment assessment for non-marketable investments requires significant judgment due to the uncertainty around the duration and severity of the impact. We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, require management judgment and estimation, and may change over time. We adjust the carrying value of our non-marketable equity investments to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). The unrealized gains and losses we record on our non-marketable equity securities in any particular period may differ significantly from the realized gains or losses we ultimately experience on such investments. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax Alphabet Inc. assets or liabilities, the application of different provisions of tax laws or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. Various jurisdictions around the world have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapp ing international tax regimes. The Organization for Economic Cooperation and Development (OECD) recently released proposals relating to its initiative for modernizing international tax rules, with the goal of having different countries implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. In addition, in response to significant market volatility and disruptions to business operations resulting from the global spread of COVID-19, legislatures and taxing authorities in many jurisdictions in which we operate may propose changes to their tax rules. These changes could include modifications that have temporary effect, and more permanent changes. The impact of these potential new rules on us, our long-term tax planning, and our effective tax rate could be material. The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments; recommendations by securities analysts or changes in their earnings estimates; announcements about our or our competitors' earnings that are not in line with analyst expectations, the risk of which is enhanced, in our case, because it is our policy not to give guidance on earnings; commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy; the volume of shares of Class A common stock and Class C capital stock available for public sale; sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees); short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock; the size, timing and share class of any share repurchase program; and the perceived values of Class A common stock and Class C capital stock relative to one another. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. Alphabet Inc. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which we believe is sufficient to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Legal Matters in Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2020, there were approximately 4,337 and 1,942 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2020, there were approximately 64 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2020: Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 1,869 $ 1,540.84 1,869 $ 22,667 November 1 - 30 1,640 $ 1,748.65 1,640 $ 19,799 December 1 - 31 1,205 $ 1,787.62 1,205 $ 17,645 Total 4,714 4,714 (1) The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2015 to December 31, 2020. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2015 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-Year total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2015 to December 31, 2020. The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2015 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2018 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2019 Annual Report on Form 10-K. Trends in Our Business The following long-term trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of these trends in order to maintain and grow our business. We generate our advertising revenues increasingly from different channels, including mobile, and newer advertising formats, and the margins from the advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures, our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners and Google Network Members to increase as our revenues grow and to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; the percentage of queries channeled through paid access points; product mix; the relative revenue growth rates of advertising revenues from different channels; and revenue share terms. We expect these trends to continue to affect our revenue growth rates and put pressure on our overall margins. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube ads and Google Play ads, which monetize at a lower rate than our traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, such as India, where we continue to invest heavily and develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time, as regions with emerging markets, such as APAC, have demonstrated higher revenue growth rates. We expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could impact our margins as developing markets initially monetize at a lower rate than more mature markets. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. Alphabet Inc. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud services and subscription and other services. The margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. In addition, we expect to continue to invest in land and buildings for data centers and offices, and information technology assets, which includes servers and network equipment, to support the long-term growth of our business. In addition, acquisitions and strategic investments are an important part of our strategy and use of capital, contributing to the breadth and depth of our offerings, expanding our expertise in engineering and other functional areas, and building strong partnerships around strategic initiatives. For example, in 2020 we announced our Google for India Digitization Fund to invest approximately $10 billion into India over the next 5-7 years through a mix of equity investments, partnerships, and operational, infrastructure and ecosystem investments. We face continuing changes in regulatory conditions, laws and public policies, which could impact our business practices and financial results. Changes in social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics and related legal matters have resulted in fines and caused us to change our business practices. As these global trends continue, for example the recent antitrust complaints filed by the U.S. Department of Justice and a number of state Attorneys General as well as the News Media Bargaining Code drafted by the Australian Competition and Consumer Commission, our cost of doing business may increase and our ability to pursue certain business models or offer certain products or services may be limited. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. The Impact of COVID-19 on our Results and Operations In late 2019, an outbreak of COVID-19 emerged and by March 11, 2020 was declared a global pandemic by the World Health Organization. Across the United States and the world, governments and municipalities instituted measures in an effort to control the spread of COVID-19, including quarantines, shelter-in-place orders, school closings, travel restrictions and the closure of non-essential businesses. The macroeconomic impacts of COVID-19 are significant and continue to evolve, as exhibited by, among other things, a rise in unemployment, changes in consumer behavior, and market volatility. We began to observe the impact of COVID-19 and the related reductions in global economic activity on our financial results in March 2020 when, despite an increase in users' search activity, our advertising revenues declined compared to the prior year due to a shift of user search activity to less commercial topics and reduced spending by our advertisers. During the course of the quarter ended June 30, 2020, we observed a gradual return in user search activity to more commercial topics, followed by increased spending by our advertisers that continued throughout the second half of 2020. We continue to assess the realized and potential credit deterioration of our customers due to changes in the macroeconomic environment, which has been reflected in our allowance for credit losses for accounts receivable. Additionally, over the course of the year we experienced variability in our margins as many of our expenses are less variable in nature and/or may not correlate to changes in revenues, including costs associated with our data centers and facilities as well as employee compensation. Also, market volatility has contributed to fluctuations in the valuation of our equity investments. Alphabet Inc. While we continued to make investments in land and buildings for data centers, offices and information technology, in 2020 we slowed the pace of our investments, primarily as it relates to office facilities, as a result of COVID-19. The ongoing impact of COVID-19 on our business continues to evolve and be unpredictable. For example, to the extent the pandemic disrupts economic activity globally we, like other businesses, are not immune to continued adverse impacts to our business, operations and financial results from volatility in advertising spending, changes in user behavior and preferences, credit deterioration and liquidity of our customers, depressed economic activity, or volatility in capital markets. The ongoing impact will depend on a number of factors, including the duration and severity of the pandemic; the uneven impact to certain industries; advances in testing, treatment and prevention including vaccines; and the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. To address the potential impact to our business, over the near-term, we continue to evaluate the pace of our investment plans, including, but not limited to, our hiring, investments in data centers, servers, network equipment, real estate and facilities, marketing and travel spending, as well as taking certain measures to support our customers, our overall workforce, and communities we operate in. As we look to return our workforce in more locations back to the office in 2021, we may experience increased costs as we prepare our facilities for a safe return to work environment and experiment with hybrid work models. At the same time, we believe the current environment is accelerating digital transformation and we remain focused on innovating and investing in the services we offer to consumers and businesses. For example, as it relates to Google Cloud, we continue to invest aggressively around the globe in our go-to-market capabilities, product development and technical infrastructure to support long term growth. The ongoing impact of COVID-19 and the extent of these measures we have taken and the additional measures that we may implement could have a material impact on our financial results. Our past results may not be indicative of our future performance, and historical trends in our financial results may differ materially. Executive Overview The following table summarizes our consolidated financial results for the years ended December 31, 2019 and 2020 (in millions, except for per share information and percentages). Year Ended December 31, 2019 2020 Revenues $161,857 $182,527 Increase in revenues year over year 18 % 13 % Increase in constant currency revenues year over year 20 % 14 % Operating income (1) $ 34,231 $ 41,224 Operating margin (1) 21 % 23 % Other income (expense), net $ 5,394 $ 6,858 Net Income (1) $ 34,343 $ 40,269 Diluted EPS (1) $ 49.16 $ 58.61 (1) Results for 2019 include the effect of the $1.7 billion EC fine. See Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Total revenues were $182.5 billion, an increase of 13% year over year, primarily driven by an increase in Google Services segment revenues of $16.8 billion or 11% and an increase in Google Cloud segment revenues of $4.1 billion or 46%. Revenues from the United States, EMEA, APAC, and Other Americas were $85.0 billion, $55.4 billion, $32.6 billion, and $9.4 billion, respectively. Total cost of revenues was $84.7 billion, an increase of 18% year over year. TAC was $32.8 billion, an increase of 9% year over year, primarily driven by an increase in revenues subject to TAC. Other cost of revenues were $51.9 billion, an increase of 24% year over year, primarily driven by an increase in data centers and other operations costs and content acquisition costs. Alphabet Inc. Operating expenses were $56.6 billion, an increase of 5% year over year primarily driven by headcount growth and partially offset by declines in advertising and promotional expenses and travel and entertainment expenses. Other information: Operating cash flow was $65.1 billion. Capital expenditures, which primarily included investments in technical infrastructure, were $22.3 billion. Number of employees was 135,301 as of December 31, 2020. The majority of new hires during the year were engineers and product managers. Our Segments Beginning in the fourth quarter of 2020, we report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues primarily from fees received for Google Cloud Platform (""GCP"") services and Google Workspace (formerly known as G Suite) collaboration tools. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from the Other Bets are derived primarily through the sale of internet services as well as licensing and RD services. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including fines and settlements, as well as costs associated with certain shared research and development activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Financial Results Revenues The following table presents our revenues by type (in millions). Year Ended December 31, 2019 2020 Google Search other $ 98,115 $ 104,062 YouTube ads 15,149 19,772 Google Network Members' properties 21,547 23,090 Google advertising 134,811 146,924 Google other 17,014 21,711 Google Services total 151,825 168,635 Google Cloud 8,918 13,059 Other Bets 659 657 Hedging gains (losses) 455 176 Total revenues $ 161,857 $ 182,527 Google Services Google advertising revenues Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google Search other properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; Alphabet Inc. changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions including the impact of COVID-19; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has been affected over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels; changes in our product mix; changes in advertising quality or formats and delivery; the evolution of the online advertising market; increasing competition; our investments in new business strategies; query growth rates; and shifts in the geographic mix of our revenues. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Google advertising revenues consist primarily of the following: Google Search other consists of revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.) and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads consists of revenues generated on YouTube properties; and Google Network Members' properties consist of revenues generated on Google Network Members' properties participating in AdMob, AdSense, and Google Ad Manager. Google Search other Google Search other revenues increased $5,947 million from 2019 to 2020. The overall growth was primarily driven by interrelated factors including increases in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices, growth in advertiser spending primarily in the second half of the year, and improvements we have made in ad formats and delivery. This increase was partially offset by a decline in advertiser spending primarily in the first half of the year driven by the impact of COVID-19. YouTube ads YouTube ads revenues increased $4,623 million from 2019 to 2020. Growth was primarily driven by our direct response advertising products, which benefited from improvements to ad formats and delivery and increased advertiser spending. Brand advertising products also contributed to growth despite revenues being adversely impacted by a decline in advertiser spending primarily in the first half of the year driven by the impact of COVID-19. Google Network Members' properties Google Network Members' properties revenues increased $1,543 million from 2019 to 2020. The growth was primarily driven by strength in AdMob and Google Ad Manager. Use of Monetization Metrics Paid clicks for our Google Search other properties represent engagement by users and include clicks on advertisements by end-users on Google search properties and other owned and operated properties including Gmail, Google Maps, and Google Play. Historically, we included certain viewed YouTube engagement ads and the related revenues in our paid clicks and cost-per-click monetization metrics. Over time, advertising on YouTube has expanded to multiple advertising formats and the type of viewed engagement ads historically included in paid clicks and cost-per-click metrics have increasingly covered a smaller portion of YouTube advertising revenues. As a result, we removed these ads and the related revenues from the paid clicks and cost-per-click metrics for the current and historical periods presented. The revised metrics provide a better understanding of monetization trends on the properties included within Google Search other, as they now more closely correlate with the related changes in revenues. Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense and Google Ad Manager. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Alphabet Inc. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google Search other properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google Search other properties and the revenues generated by impression activity on Google Network Members properties. Paid clicks and cost-per-click The following table presents changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, 2019 2020 Paid clicks change 23 % 19 % Cost-per-click change (6) % (10) % Paid clicks increased from 2019 to 2020 primarily due to an increase in clicks due to interrelated factors, resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. Growth was also driven by an increase in clicks relating to ads on Google Play. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was primarily driven by reduced advertiser spending in response to COVID-19 primarily during the first half of the year. The decrease in cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Paid clicks increased from 2018 to 2019 primarily due to an increase in clicks due to interrelated factors, including an increase in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. Growth was also driven by an increase in clicks relating to ads on Google Play. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was driven by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Impressions and cost-per-impression The following table presents changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, 2020 Impressions change 15 % Cost-per-impression change (8) % Impressions increased from 2019 to 2020 primarily due to growth in Google Ad Manager. The positive effect on our revenues from an increase in impressions was partially offset by a decrease in the cost-per-impression paid by our advertisers which was driven by a reduction in advertiser spending in response to COVID-19, primarily during the first half of the year, as well as the effect of a combination of factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google other revenues Google other revenues consist primarily of revenues from: Google Play, which includes revenues from sales of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising, including YouTube Premium and YouTube TV subscriptions and other services; and other products and services. Alphabet Inc. Google other revenues increased $4,697 million from 2019 to 2020. The growth was primarily driven by Google Play and YouTube non-advertising. Growth for Google Play was primarily driven by sales of apps and in-app purchases, which benefited from elevated user engagement partially due to the impact of COVID-19. Growth for YouTube non-advertising was primarily driven by an increase in paid subscribers. Over time, our growth rate for Google other revenues may be affected by the seasonality associated with new product and service launches as well as market dynamics. Google Cloud Our Google Cloud revenues increased $4,141 million from 2019 to 2020. The growth was primarily driven by GCP followed by our Google Workspace offerings. Our infrastructure and our data and analytics platform products were the largest drivers of growth in GCP. Over time, our growth rate for Google Cloud revenues may be affected by customer usage, market dynamics, as well as new product and service launches. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, 2019 2020 United States 46 % 47 % EMEA 31 % 30 % APAC 17 % 18 % Other Americas 6 % 5 % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Percentage Change The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and non-GAAP percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (""GAAP"") results helps improve the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue percentage change on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue percentage change is calculated by determining the change in period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions, except percentages): Year Ended December 31, 2019 2020 EMEA revenues $ 50,645 $ 55,370 Exclude foreign exchange effect on current period revenues using prior year rates 2,397 (111) EMEA constant currency revenues $ 53,042 $ 55,259 Prior period EMEA revenues $ 44,739 $ 50,645 EMEA revenue percentage change 13 % 9 % EMEA constant currency revenue percentage change 19 % 9 % APAC revenues $ 26,928 $ 32,550 Exclude foreign exchange effect on current period revenues using prior year rates 388 11 APAC constant currency revenues $ 27,316 $ 32,561 Prior period APAC revenues $ 21,341 $ 26,928 APAC revenue percentage change 26 % 21 % APAC constant currency revenue percentage change 28 % 21 % Other Americas revenues $ 8,986 $ 9,417 Exclude foreign exchange effect on current period revenues using prior year rates 541 964 Other Americas constant currency revenues $ 9,527 $ 10,381 Prior period Other Americas revenues $ 7,608 $ 8,986 Other Americas revenue percentage change 18 % 5 % Other Americas constant currency revenue percentage change 25 % 16 % United States revenues $ 74,843 $ 85,014 United States revenue percentage change 18 % 14 % Hedging gains (losses) 455 176 Total revenues $ 161,857 $ 182,527 Total constant currency revenues $ 164,728 $ 183,215 Prior period revenues, excluding hedging effect (1) $ 136,957 $ 161,402 Total revenue percentage change 18 % 13 % Total constant currency revenue percentage change 20 % 14 % (1) Total revenues and hedging gains (losses) for the year ended December 31, 2018 were $136,819 million and $(138) million, respectively. EMEA revenue percentage change from 2019 to 2020 was not significantly affected by foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro offset by the U.S. dollar strengthening relative to the Turkish lira and Russian ruble. APAC revenue percentage change from 2019 to 2020 was not significantly affected by foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Indian rupee, partially offset by the U.S. dollar weakening relative to the Japanese yen. Other Americas revenue percentage change from 2019 to 2020 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Alphabet Inc. Costs and Operating Expenses Cost of Revenues Cost of revenues includes TAC which are paid to our distribution partners who make available our search access points and services, and amounts paid to Google Network Members primarily for ads displayed on their properties. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues as a percentage of revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google properties (which includes Google Search other and YouTube ads), because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers (including bandwidth, compensation expenses including stock-based compensation (""SBC""), depreciation, energy, and other equipment costs) as well as other operations costs (such as content review and customer support costs). These costs are generally less variable in nature and may not correlate with related changes in revenues; and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions, except percentages): Year Ended December 31, 2019 2020 TAC $ 30,089 $ 32,778 Other cost of revenues 41,807 51,954 Total cost of revenues $ 71,896 $ 84,732 Total cost of revenues as a percentage of revenues 44.4 % 46.4 % Cost of revenues increased $12,836 million from 2019 to 2020. The increase was due to increases in other cost of revenues and TAC of $10,147 million and $2,689 million, respectively. The increase in other cost of revenues from 2019 to 2020 was due to an increase in data center and other operations costs and an increase in content acquisition costs primarily for YouTube. This increase was partially offset by a decline in hardware costs. The increase in TAC from 2019 to 2020 was due to increases in TAC paid to distribution partners and to Google Network Members, driven by growth in revenues subject to TAC. The TAC rate was 22.3% in both 2019 and 2020. The TAC rate on Google properties revenues and the TAC rate on Google Network revenues were both substantially consistent from 2019 to 2020. Over time, cost of revenues as a percentage of total revenues may be affected by a number of factors, including the following: The amount of TAC paid to distribution partners, which is affected by changes in device mix, geographic mix, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; The amount of TAC paid to Google Network Members, which is affected by a combination of factors such as geographic mix, product mix, and revenue share terms; Relative revenue growth rates of Google properties and Google Network Members' properties; Certain costs that are less variable in nature and may not correlate with the related revenues; Costs associated with our data centers and other operations to support ads, Google Cloud, Search, YouTube and other products; Content acquisition costs, which are primarily affected by the relative growth rates in our YouTube advertising and subscription revenues; Costs related to hardware sales; and Increased proportion of non-advertising revenues, which generally have higher costs of revenues, relative to our advertising revenues. Alphabet Inc. Research and Development The following table presents our RD expenses (in millions, except percentages): Year Ended December 31, 2019 2020 Research and development expenses $ 26,018 $ 27,573 Research and development expenses as a percentage of revenues 16.1 % 15.1 % RD expenses consist primarily of: Compensation expenses (including SBC) for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $1,555 million from 2019 to 2020. The increase was primarily due to an increase in compensation expenses of $1,619 million, largely resulting from a 11% increase in headcount and partially offset by higher compensation charges in certain Other Bets in 2019. Additionally, the increase in RD expenses was partially offset by a decrease in travel and entertainment expenses of $383 million. Over time, RD expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues. In addition, RD expenses may be affected by a number of factors including continued investment in ads, Android, Chrome, Google Cloud, Google Play, hardware, machine learning, Other Bets, Search and YouTube. Sales and Marketing The following table presents our sales and marketing expenses (in millions, except percentages): Year Ended December 31, 2019 2020 Sales and marketing expenses $ 18,464 $ 17,946 Sales and marketing expenses as a percentage of revenues 11.4 % 9.8 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses decreased $518 million from 2019 to 2020. The decrease was primarily due to a decrease in advertising and promotional expenses of $1,395 million, as we reduced spending and paused or rescheduled campaigns and changed some events to digital-only formats as a result of COVID-19, and a decrease in travel and entertainment expenses of $371 million. The decrease was partially offset by an increase in compensation expenses of $1,347 million, largely resulting from an 8% increase in headcount. Over time, sales and marketing expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues. In addition, sales and marketing expenses may be affected by a number of factors including the seasonality associated with new product and service launches and strategic decisions regarding the timing and extent of our spending. General and Administrative The following table presents our general and administrative expenses (in millions, except percentages): Year Ended December 31, 2019 2020 General and administrative expenses $ 9,551 $ 11,052 General and administrative expenses as a percentage of revenues 5.9 % 6.1 % General and administrative expenses consist primarily of: Compensation expenses (including SBC) for employees in our finance, human resources, information technology, and legal organizations; Depreciation; Alphabet Inc. Equipment-related expenses; Legal-related expenses; and Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $1,501 million from 2019 to 2020. The increase was primarily due to an increase in compensation expenses of $887 million, largely resulting from a 16% increase in headcount. In addition, there was an increase of $440 million related to allowance for credit losses for accounts receivable. The increase was partially offset by a $554 million charge recognized in 2019 relating to a legal settlement. Over time, general and administrative expenses as a percentage of revenues may fluctuate due to certain expenses that are generally less variable in nature and may not correlate to the changes in revenues, the effect of discrete items such as legal settlements, or allowances for credit losses for accounts receivable. European Commission Fines In March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a 1.5 billion ( $1.7 billion as of March 20, 2019) fine, which was accrued in the first quarter of 2019. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Segment Profitability The following table presents our segment operating income (loss) (in millions). For comparative purposes, amounts in prior periods have been recast. Year Ended December 31, 2018 2019 2020 Operating income (loss): Google Services $ 43,137 $ 48,999 $ 54,606 Google Cloud (4,348) (4,645) (5,607) Other Bets (3,358) (4,824) (4,476) Corporate costs, unallocated (1) (7,907) (5,299) (3,299) Total income from operations $ 27,524 $ 34,231 $ 41,224 (1) Corporate costs, unallocated includes a fine of $5.1 billion for the year ended December 31, 2018 and a fine and legal settlement totaling $2.3 billion for the year ended December 31, 2019. Google Services Google services operating income increased $5,607 million from 2019 to 2020. The increase was primarily driven by an increase in revenues partially offset by increases in content acquisition costs primarily for YouTube, data center and other operations costs, and TAC. Additionally, there was an increase in operating expenses primarily driven by an increase in compensation expenses (including SBC) largely due to increases in headcount. Operating income benefited from a decline in hardware costs. Google services operating income increased $5,862 million from 2018 to 2019. The increase was primarily driven by an increase in revenues partially offset by increases in TAC, data center and other operations costs, and content acquisition costs primarily for YouTube. Additionally, there was an increase in operating expenses primarily driven by an increase in compensation expenses (including SBC) largely due to an increase in headcount. Google Cloud Google Cloud operating loss increased $962 million from 2019 to 2020 and increased $297 million from 2018 to 2019. The increase in operating loss in both periods was driven by an increase in total expenses of $5,103 million from 2019 to 2020 and $3,377 million from 2018 to 2019. Operating expenses increased primarily due to compensation expenses (including SBC), largely driven by an increase in headcount. Additionally, data center and other operating costs increased in both periods. Other Bets Other Bets operating loss decreased $348 million from 2019 to 2020 and increased $1,466 million from 2018 to 2019. The fluctuations were primarily driven by compensation expenses (including SBC). Alphabet Inc. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, 2019 2020 Other income (expense), net $ 5,394 $ 6,858 Other income (expense), net, increased $1,464 million from 2019 to 2020. The change was primarily driven by an increase in net gains on equity and debt securities of $3,519 million, partially offset by a $902 million loss resulting from our equity derivatives, which hedged the changes in fair value of certain marketable equity securities, and a decrease in interest income of $562 million. Over time, other income (expense), net, may be affected by market dynamics and other factors. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets, including the effects of COVID-19, could result in a significant change in the value of our investments. Fluctuations in the value of these investments has, and we expect will continue to, contribute to volatility of OIE in future periods. For additional information about our investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Provision for Income Taxes The following table presents our provision for income taxes (in millions, except for effective tax rate): Year Ended December 31, 2019 2020 Provision for income taxes $ 5,282 $ 7,813 Effective tax rate 13.3 % 16.2 % Our provision for income taxes and our effective tax rate increased from 2019 to 2020. The increase in the provision for income taxes and our effective tax rate is primarily due to benefits related to the resolution of multi-year audits in 2019 that did not recur in 2020, higher earnings in countries that have higher statutory rates resulting from the change in our corporate legal entity structure implemented as of December 31, 2019, and an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets, partially offset by an increase in the U.S. federal Foreign-Derived Intangible Income tax deduction benefits. See Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. We expect our future effective tax rate to be affected by the geographic mix of earnings in countries with different statutory rates. Additionally, our future effective tax rate may be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Alphabet Inc. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2020. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Seasonal fluctuations in internet usage and advertiser expenditures, underlying business trends such as traditional retail seasonality and macroeconomic conditions have affected, and are likely to continue to affect, our business (including developments and volatility arising from COVID-19). Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2019 Jun 30, 2019 Sept 30, 2019 Dec 31, 2019 Mar 31, 2020 Jun 30, 2020 Sept 30, 2020 Dec 31, 2020 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 36,339 $ 38,944 $ 40,499 $ 46,075 $ 41,159 $ 38,297 $ 46,173 56,898 Costs and expenses: Cost of revenues 16,012 17,296 17,568 21,020 18,982 18,553 21,117 26,080 Research and development 6,029 6,213 6,554 7,222 6,820 6,875 6,856 7,022 Sales and marketing 3,905 4,212 4,609 5,738 4,500 3,901 4,231 5,314 General and administrative 2,088 2,043 2,591 2,829 2,880 2,585 2,756 2,831 European Commission fines 1,697 0 0 0 0 0 0 0 Total costs and expenses 29,731 29,764 31,322 36,809 33,182 31,914 34,960 41,247 Income from operations 6,608 9,180 9,177 9,266 7,977 6,383 11,213 15,651 Other income (expense), net 1,538 2,967 (549) 1,438 (220) 1,894 2,146 3,038 Income before income taxes 8,146 12,147 8,628 10,704 7,757 8,277 13,359 18,689 Provision for income taxes 1,489 2,200 1,560 33 921 1,318 2,112 3,462 Net income $ 6,657 $ 9,947 $ 7,068 $ 10,671 $ 6,836 $ 6,959 $ 11,247 15,227 Basic net income per share of Class A and B common stock and Class C capital stock $ 9.58 $ 14.33 $ 10.20 $ 15.49 $ 9.96 $ 10.21 $ 16.55 $ 22.54 Diluted net income per share of Class A and B common stock and Class C capital stock $ 9.50 $ 14.21 $ 10.12 $ 15.35 $ 9.87 $ 10.13 $ 16.40 $ 22.30 Financial Condition Cash, Cash Equivalents, and Marketable Securities As of December 31, 2020, we had $136.7 billion in cash, cash equivalents, and short-term marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities and marketable equity securities. Sources, Uses of Cash and Related Trends Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Alphabet Inc. The following table presents our cash flows (in millions): Year Ended December 31, 2019 2020 Net cash provided by operating activities $ 54,520 $ 65,124 Net cash used in investing activities $ (29,491) $ (32,773) Net cash used in financing activities $ (23,209) $ (24,408) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google Search other properties, Google Network Members' properties and YouTube ads. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from our operating activities include compensation and related costs, payments to our distribution partners and Google Network Members, and payments for content acquisition costs. In addition, uses of cash from operating activities include hardware inventory costs, income taxes, and other general corporate expenditures. Net cash provided by operating activities increased from 2019 to 2020 primarily due to the net effect of increases in cash received from revenues and cash paid for cost of revenues and operating expenses, and changes in operating assets and liabilities. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of marketable and non-marketable securities, purchases of property and equipment, and payments for acquisitions. Net cash used in investing activities increased from 2019 to 2020 primarily due to a net increase in purchases of securities, partially offset by decreases in payments for acquisitions and purchases of property and equipment. The net decrease in purchases of property and equipment was driven by decreases in purchases of land and buildings for offices as well as data center construction, partially offset by increases in purchases of servers. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Cash used in financing activities consists primarily of repurchases of capital stock, net payments related to stock-based award activities, and repayments of debt. Net cash used in financing activities increased from 2019 to 2020 primarily due to an increase in cash payments for repurchases of capital stock, partially offset by increases in net proceeds from issuance of debt and proceeds from the sale of interest in consolidated entities. Liquidity and Material Cash Requirements We expect existing cash, cash equivalents, short-term marketable securities, cash flows from operations and financing activities to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for at least the next 12 months and thereafter for the foreseeable future. As of December 31, 2020, we had long-term taxes payable of $6.5 billion related to a one-time transition tax payable incurred as a result of the U.S. Tax Cuts and Jobs Act (""Tax Act""). As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($2.7 billion as of June 27, 2017), 4.3 billion ($5.1 billion as of June 30, 2018), and 1.5 billion ($1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. In January 2021, we closed the acquisition of Fitbit, a leading wearables brand, for $2.1 billion. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. As of December 31, 2020, we had no commercial paper outstanding. As of December 31, 2020, we have $4.0 billion of revolving credit facilities expiring Alphabet Inc. in July 2023 with no amounts outstanding. The interest rate for the credit facilities is determined based on a formula using certain market rates. In August 2020, we issued $10.0 billion of fixed-rate senior unsecured notes in six tranches: $1.0 billion due in 2025, $1.0 billion due in 2027, $2.25 billion due in 2030, $1.25 billion due in 2040, $2.5 billion due in 2050 and $2.0 billion due in 2060. The 2020 Notes had a weighted average duration of 21.5 years and weighted average coupon rate of 1.57%. Of the total issuance, $5.75 billion was designated as Sustainability Bonds, the net proceeds of which are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. The remaining net proceeds are used for general corporate purposes. As of December 31, 2020, we have senior unsecured notes outstanding with a total carrying value of $13.8 billion. Refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the debts. In accordance with the authorizations of the Board of Directors of Alphabet, in 2020 we repurchased and subsequently retired 21.5 million shares of Alphabet Class C capital stock for an aggregate amount of $31.1 billion. As of December 31, 2020, $17.6 billion remains authorized and available for repurchase. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Capital Expenditures and Leases We make investments in land and buildings for data centers and offices and information technology assets through purchases of property and equipment and lease arrangements to provide capacity for the growth of our services and products. Our capital investments in property and equipment consist primarily of the following major categories: Technical infrastructure, which consists of our investments in servers and network equipment for compute, storage and networking requirements for ongoing business activities, including machine learning, (collectively referred to as our information technology assets) and data center land and building construction; and Office facilities, ground up development projects and related building improvements. Due to the integrated nature of Alphabet, our technical infrastructure and office facilities are managed centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Our technical infrastructure investments are designed to support all of Alphabet, including primarily ads, Google Cloud, Search, and YouTube. Construction in progress consists primarily of technical infrastructure and office facilities which have not yet been placed in service for our intended use. The time frame from date of purchase to placement in service of these assets may extend to multiple periods. For example, our data center construction projects are generally multi-year projects with multiple phases, where we acquire qualified land and buildings, construct buildings, and secure and install information technology assets. During the years ended December 31, 2019 and 2020, we spent $23.5 billion and $22.3 billion on capital expenditures and recognized total operating lease assets of $4.4 billion and $2.8 billion, respectively. As of December 31, 2020, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 9 years, was $15.1 billion. As of December 31, 2020, we have entered into leases that have not yet commenced with future lease payments of $8.0 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2021 and 2026 with non-cancelable lease terms of 1 to 25 years. Depreciation of our property and equipment commences when the deployment of such assets are completed and are ready for our intended use. Land is not depreciated. For the years ended December 31, 2019 and 2020, our depreciation and impairment expenses on property and equipment were $10.9 billion and $12.9 billion, respectively. For the years ended December 31, 2019 and 2020, our operating lease expenses (including variable lease costs), were $2.4 billion and $2.9 billion, respectively. Finance leases were not material for the years ended December 31, 2019 and 2020. Please refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the leases. Alphabet Inc. Contractual Obligations as of December 31, 2020 The following summarizes our contractual obligations as of December 31, 2020 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations (1) $ 15,091 $ 2,198 $ 4,165 $ 3,127 $ 5,601 Obligations for leases that have not yet commenced (1) 8,049 370 1,198 1,469 5,012 Purchase obligations (2) 10,656 7,368 1,968 354 966 Long-term debt obligations (3) 19,840 1,357 634 2,587 15,262 Tax payable (4) 7,359 834 1,916 4,609 0 Other long-term liabilities reflected on our balance sheet (5) 1,421 532 616 185 88 Total contractual obligations $ 62,416 $ 12,659 $ 10,497 $ 12,331 $ 26,929 (1) For further information, refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to data center operations and build-outs; information technology assets; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2020. Excluded from the table above are open orders for purchases that support normal operations, which are generally cancelable. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $2.3 billion as of December 31, 2020 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing and outcomes of tax audits. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the EC fines, refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. See Note 10 included in Part II, Item 8 of this annual report on Form 10-K for more information on our commitments and contingencies. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit and compliance committee of our Board of Directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Alphabet Inc. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (""IRS"") and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury consumer protection, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair Value Measurements We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. The fair value hierarchy prioritizes the inputs used to measure fair value whereby it gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. We maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Our use of unobservable inputs reflects the assumptions that market participants would use and may include our own data adjusted based on reasonably available information. We apply judgment in assessing the relevance of observable market data to determine the priority of inputs under the fair value hierarchy, particularly in situations where there is very little or no market activity. Alphabet Inc. In determining the fair values of our non-marketable equity and debt investments, as well as assets acquired (especially with respect to intangible assets) and liabilities assumed in business combinations, we make significant estimates and assumptions, some of which include the use of unobservable inputs. Certain stock-based compensation awards may be settled in the stock of certain of our Other Bets or in cash. These awards are based on the equity values of the respective Other Bet, which requires use of unobservable inputs. We also have compensation arrangements with payouts based on realized investment returns, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Non-marketable Equity Securities Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include the companies' financial and liquidity position, access to capital resources and the time since the last adjustment to fair value, among others. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we write down the investment to its fair value. Change in Accounting Estimate In January 2021, we completed an assessment of the useful lives of our servers and network equipment and determined we should adjust the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years. This change in accounting estimate will be effective beginning fiscal year 2021. For assets that are in-service as of December 31, 2020, we expect operating results to be favorably impacted by approximately $2.1 billion for the full fiscal year 2021. The effect of the change may be different due to our capital investments during the fiscal year 2021. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the functional currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets, liabilities, and commitments denominated in currencies other than the functional currencies at the balance sheet date, it would have resulted in an adverse effect on income before income taxes of approximately $8 million and $497 million as of Alphabet Inc. December 31, 2019 and 2020, respectively, after consideration of the effect of foreign exchange contracts in place for the years ended December 31, 2019 and 2020. We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2019 and 2020, the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $1.1 billion and $912 million lower as of December 31, 2019 and 2020, respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (""CTA"") within AOCI related to our net investment hedge would have been approximately $936 million and $1 billion lower as of December 31, 2019 and 2020, respectively. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as compared to interest rates at the time of purchase. For certain fixed and variable rate debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. We measure securities for which we have not elected the fair value option at fair value with gains and losses recorded in AOCI until the securities are sold, less any expected credit losses. We use value-at-risk (""VaR"") analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2019 and 2020 are shown below (in millions): As of December 31, 12-Month Average As of December 31, 2019 2020 2019 2020 Risk Category - Interest Rate $ 104 $ 144 $ 90 $ 145 Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2019 and 2020 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. Alphabet Inc. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $3.3 billion and $5.9 billion of our investments as of December 31, 2019 and 2020, respectively. A hypothetical adverse price change of 30% on our December 31, 2020 balance, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $1.8 billion. From time to time, we may enter into derivatives to hedge the market price risk on certain of our marketable equity securities. Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value measured at the time of the observable transaction is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of our investments through liquidity events such as public offerings, acquisitions, private sales or other market events. As of December 31, 2019 and 2020, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $11.4 billion and $18.9 billion, respectively. Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge relating to our non-marketable equity securities. Changes in valuation of non-marketable equity securities may not directly correlate with changes in valuation of marketable equity securities. Additionally, observable transactions at lower valuations could result in significant losses on our non-marketable equity securities. The effect of COVID-19 on our impairment assessment requires significant judgment due to the uncertainty around the duration and severity of the impact. The carrying values of our equity method investments, which totaled approximately $1.3 billion and $1.4 billion as of December 31, 2019 and 2020, respectively, generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value and is not expected to recover. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2019 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 2, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, and government investigations involving competition, intellectual property, privacy, consumer protection, tax, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, and other matters. As described in Note 10 to the consolidated financial statements Commitments and Contingencies such claims could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgment in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 2, 2021 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2020 consolidated financial statements of the Company and our report dated February 2, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 2, 2021 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2019 As of December 31, 2020 Assets Current assets: Cash and cash equivalents $ 18,498 $ 26,465 Marketable securities 101,177 110,229 Total cash, cash equivalents, and marketable securities 119,675 136,694 Accounts receivable, net 25,326 30,930 Income taxes receivable, net 2,166 454 Inventory 999 728 Other current assets 4,412 5,490 Total current assets 152,578 174,296 Non-marketable investments 13,078 20,703 Deferred income taxes 721 1,084 Property and equipment, net 73,646 84,749 Operating lease assets 10,941 12,211 Intangible assets, net 1,979 1,445 Goodwill 20,624 21,175 Other non-current assets 2,342 3,953 Total assets $ 275,909 $ 319,616 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 5,561 $ 5,589 Accrued compensation and benefits 8,495 11,086 Accrued expenses and other current liabilities 23,067 28,631 Accrued revenue share 5,916 7,500 Deferred revenue 1,908 2,543 Income taxes payable, net 274 1,485 Total current liabilities 45,221 56,834 Long-term debt 4,554 13,932 Deferred revenue, non-current 358 481 Income taxes payable, non-current 9,885 8,849 Deferred income taxes 1,701 3,561 Operating lease liabilities 10,214 11,146 Other long-term liabilities 2,534 2,269 Total liabilities 74,467 97,072 Commitments and Contingencies (Note 10) Stockholders equity: Convertible preferred stock, $ 0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding 0 0 Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $ 0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000 , Class B 3,000,000 , Class C 3,000,000 ); 688,335 (Class A 299,828 , Class B 46,441 , Class C 342,066 ) and 675,222 (Class A 300,730 , Class B 45,843 , Class C 328,649 ) shares issued and outstanding 50,552 58,510 Accumulated other comprehensive income (loss) ( 1,232 ) 633 Retained earnings 152,122 163,401 Total stockholders equity 201,442 222,544 Total liabilities and stockholders equity $ 275,909 $ 319,616 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2018 2019 2020 Revenues $ 136,819 $ 161,857 $ 182,527 Costs and expenses: Cost of revenues 59,549 71,896 84,732 Research and development 21,419 26,018 27,573 Sales and marketing 16,333 18,464 17,946 General and administrative 6,923 9,551 11,052 European Commission fines 5,071 1,697 0 Total costs and expenses 109,295 127,626 141,303 Income from operations 27,524 34,231 41,224 Other income (expense), net 7,389 5,394 6,858 Income before income taxes 34,913 39,625 48,082 Provision for income taxes 4,177 5,282 7,813 Net income $ 30,736 $ 34,343 $ 40,269 Basic net income per share of Class A and B common stock and Class C capital stock $ 44.22 $ 49.59 $ 59.15 Diluted net income per share of Class A and B common stock and Class C capital stock $ 43.70 $ 49.16 $ 58.61 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2018 2019 2020 Net income $ 30,736 $ 34,343 $ 40,269 Other comprehensive income (loss): Change in foreign currency translation adjustment ( 781 ) ( 119 ) 1,139 Available-for-sale investments: Change in net unrealized gains (losses) 88 1,611 1,313 Less: reclassification adjustment for net (gains) losses included in net income ( 911 ) ( 111 ) ( 513 ) Net change, net of tax benefit (expense) of $ 156 , $( 221 ), and $( 230 ) ( 823 ) 1,500 800 Cash flow hedges: Change in net unrealized gains (losses) 290 22 42 Less: reclassification adjustment for net (gains) losses included in net income 98 ( 299 ) ( 116 ) Net change, net of tax benefit (expense) of $( 103 ), $ 42 , and $ 11 388 ( 277 ) ( 74 ) Other comprehensive income (loss) ( 1,216 ) 1,104 1,865 Comprehensive income $ 29,520 $ 35,447 $ 42,134 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2017 694,783 $ 40,247 $ ( 992 ) $ 113,247 $ 152,502 Cumulative effect of accounting change 0 0 ( 98 ) ( 599 ) ( 697 ) Common and capital stock issued 8,975 148 0 0 148 Stock-based compensation expense 0 9,353 0 0 9,353 Tax withholding related to vesting of restricted stock units 0 ( 4,782 ) 0 0 ( 4,782 ) Repurchases of capital stock ( 8,202 ) ( 576 ) 0 ( 8,499 ) ( 9,075 ) Sale of interest in consolidated entities 0 659 0 0 659 Net income 0 0 0 30,736 30,736 Other comprehensive income (loss) 0 0 ( 1,216 ) 0 ( 1,216 ) Balance as of December 31, 2018 695,556 45,049 ( 2,306 ) 134,885 177,628 Cumulative effect of accounting change 0 0 ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 202 0 0 202 Stock-based compensation expense 0 10,890 0 0 10,890 Tax withholding related to vesting of restricted stock units and other 0 ( 4,455 ) 0 0 ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) 0 ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities 0 160 0 0 160 Net income 0 0 0 34,343 34,343 Other comprehensive income (loss) 0 0 1,104 0 1,104 Balance as of December 31, 2019 688,335 50,552 ( 1,232 ) 152,122 201,442 Common and capital stock issued 8,398 168 0 0 168 Stock-based compensation expense 0 13,123 0 0 13,123 Tax withholding related to vesting of restricted stock units and other 0 ( 5,969 ) 0 0 ( 5,969 ) Repurchases of capital stock ( 21,511 ) ( 2,159 ) 0 ( 28,990 ) ( 31,149 ) Sale of interest in consolidated entities 0 2,795 0 0 2,795 Net income 0 0 0 40,269 40,269 Other comprehensive income (loss) 0 0 1,865 0 1,865 Balance as of December 31, 2020 675,222 $ 58,510 $ 633 $ 163,401 $ 222,544 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2018 2019 2020 Operating activities Net income $ 30,736 $ 34,343 $ 40,269 Adjustments: Depreciation and impairment of property and equipment 8,164 10,856 12,905 Amortization and impairment of intangible assets 871 925 792 Stock-based compensation expense 9,353 10,794 12,991 Deferred income taxes 778 173 1,390 Gain on debt and equity securities, net ( 6,650 ) ( 2,798 ) ( 6,317 ) Other ( 189 ) ( 592 ) 1,267 Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 2,169 ) ( 4,340 ) ( 6,524 ) Income taxes, net ( 2,251 ) ( 3,128 ) 1,209 Other assets ( 1,207 ) ( 621 ) ( 1,330 ) Accounts payable 1,067 428 694 Accrued expenses and other liabilities 8,614 7,170 5,504 Accrued revenue share 483 1,273 1,639 Deferred revenue 371 37 635 Net cash provided by operating activities 47,971 54,520 65,124 Investing activities Purchases of property and equipment ( 25,139 ) ( 23,548 ) ( 22,281 ) Purchases of marketable securities ( 50,158 ) ( 100,315 ) ( 136,576 ) Maturities and sales of marketable securities 48,507 97,825 132,906 Purchases of non-marketable investments ( 2,073 ) ( 1,932 ) ( 7,175 ) Maturities and sales of non-marketable investments 1,752 405 1,023 Acquisitions, net of cash acquired, and purchases of intangible assets ( 1,491 ) ( 2,515 ) ( 738 ) Other investing activities 98 589 68 Net cash used in investing activities ( 28,504 ) ( 29,491 ) ( 32,773 ) Financing activities Net payments related to stock-based award activities ( 4,993 ) ( 4,765 ) ( 5,720 ) Repurchases of capital stock ( 9,075 ) ( 18,396 ) ( 31,149 ) Proceeds from issuance of debt, net of costs 6,766 317 11,761 Repayments of debt ( 6,827 ) ( 585 ) ( 2,100 ) Proceeds from sale of interest in consolidated entities, net 950 220 2,800 Net cash used in financing activities ( 13,179 ) ( 23,209 ) ( 24,408 ) Effect of exchange rate changes on cash and cash equivalents ( 302 ) ( 23 ) 24 Net increase in cash and cash equivalents 5,986 1,797 7,967 Cash and cash equivalents at beginning of period 10,715 16,701 18,498 Cash and cash equivalents at end of period $ 16,701 $ 18,498 $ 26,465 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 5,671 $ 8,203 $ 4,990 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (""Alphabet"") became the successor issuer to Google. We generate revenues by delivering relevant, cost-effective online advertising, cloud-based solutions that provide customers with platforms, collaboration tools and services, and sales of other products and services, such as apps and in-app purchases, digital content and subscriptions for digital content, and hardware. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (""GAAP"") requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses, fair values of financial instruments (including non-marketable equity securities), intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. As of December 31, 2020 the impact of COVID-19 continues to unfold and the extent of the impact will depend on a number of factors, including the duration and severity of the pandemic; the uneven impact to certain industries; advances in testing, treatment and prevention; and the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. As a result, certain of our estimates and assumptions, including the allowance for credit losses for accounts receivable, the credit worthiness of customers entering into revenue arrangements, the valuation of non-marketable equity securities, including our impairment assessment, and the fair values of our financial instruments require increased judgment and carry a higher degree of variability and volatility that could result in material changes to our estimates in future periods. In January 2021, we completed an assessment of the useful lives of our servers and network equipment and determined we should adjust the estimated useful life of our servers from three years to four years and the estimated useful life of certain network equipment from three years to five years . This change in accounting estimate will be effective beginning fiscal year 2021. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers and the collectibility of an amount that we expect in exchange for those goods or services is probable. Sales and other similar taxes are excluded from revenues. Advertising Revenues We generate advertising revenues primarily by delivering advertising on Google Search other properties, including Google.com, the Google Search app, Google Play, Gmail and Google Maps; YouTube, and Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager and Google Marketing Platform, among others. We offer advertising by delivering both performance and brand advertising. We recognize revenues for performance advertising when a user engages with the advertisement, such as a click, a view, or a purchase. For brand advertising, we recognize revenues when the ad is displayed or a user views the ad. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues Alphabet Inc. for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Google Cloud Revenues Google Cloud revenues consist primarily of fees received for Google Cloud Platform services (which includes infrastructure and data analytics platform products and other services) and Google Workspace (formerly G Suite) collaboration tools and other enterprise services. Our cloud services are generally provided on either a consumption or subscription basis. Revenues related to cloud services provided on a consumption basis are recognized when the customer utilizes the services, based on the quantity of services consumed. Revenues related to cloud services provided on a subscription basis are recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Google Play, which includes revenues from sale of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising services including, YouTube premium and YouTube TV subscriptions and other services; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Sales Commissions We expense sales commissions when incurred when the amortization period is one year or less. We recognize an asset for certain sales commissions if we expect the period of benefit of these costs to exceed one year and amortize it over the period of expected benefit. These costs are recorded within sales and marketing expenses. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to our distribution partners who make available our search access points and services and amounts paid to Google Network Members primarily for ads displayed on their properties. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play. We pay fees to these content providers based on revenues generated or a flat fee; Alphabet Inc. Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (""RSUs""). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding and the tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation also includes other stock-based awards, such as performance stock units (""PSUs"") and awards that may be settled in cash or the stock of certain Other Bets. PSUs and certain Other Bet awards are equity classified and expense is recognized over the requisite service period. Certain Other Bet awards are liability classified and remeasured at fair value through settlement. The fair value of Other Bet awards is based on the equity valuation of the respective Other Bet. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2018, 2019 and 2020, advertising and promotional expenses totaled approximately $ 6.4 billion, $ 6.8 billion, and $ 5.4 billion, respectively. Performance Fees Performance fees refer to compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. Performance fees, which are primarily related to gains on equity securities, are recorded as a component of other income (expense), net. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of markets in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2018, 2019, or 2020. In 2018, 2019, and 2020, we generated approximately 46 %, 46 %, and 47 % of our revenues, respectively, from customers based in the U.S. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from Alphabet Inc. customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities, which are adjusted to fair value when observable price changes are identified or when the non-marketable equity securities are impaired (referred to as the measurement alternative) . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. We classify all marketable debt securities that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities on our Consolidated Balance Sheets. We determine the appropriate classification of our investments in marketable debt securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for the changes in allowance for expected credit losses, which are recorded in other income (expense), net. For certain marketable debt securities we have elected the fair value option, for which changes in fair value are recorded in other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Our investments in marketable equity securities are measured at fair value with the related gains and losses, realized and unrealized, recognized in other income (expense), net. Accounts Receivable Our payment terms for accounts receivable vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customers, we require payment before the products or services are delivered to the customer. Alphabet Inc. We maintain an allowance for credit losses for accounts receivable, which is recorded as an offset to accounts receivable and changes in such are classified as general and administrative expense in the Consolidated Statements of Income. We assess collectibility by reviewing accounts receivable on a collective basis where similar characteristics exist and on an individual basis when we identify specific customers with known disputes or collectibility issues. In determining the amount of the allowance for credit losses, we consider historical collectibility based on past due status and make judgments about the creditworthiness of customers based on ongoing credit evaluations. We also consider customer-specific information, current market conditions and reasonable and supportable forecasts of future economic conditions to inform adjustments to historical loss data. For the year ended December 31, 2020, our assessment considered the impact of COVID-19 and estimates of expected credit and collectibility trends. Volatility in market conditions and evolving credit trends are difficult to predict and may cause variability and volatility that may have a material impact on our allowance for credit losses in future periods. The allowance for credit losses on accounts receivable was $ 275 million and $ 789 million as of December 31, 2019 and 2020, respectively. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative. Under the measurement alternative, the carrying value of our non-marketable equity investments is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment. Adjustments are determined primarily based on a market approach as of the transaction date and are recorded as a component of other income (expense), net. Non-marketable debt investments are classified as available-for-sale securities. Non-marketable investments that do not have stated contractual maturity dates are classified as non-current assets on the Consolidated Balance Sheets. Impairment of Investments We periodically review our debt and non-marketable equity investments for impairment. For debt securities in an unrealized loss position, we determine whether a credit loss exists. The credit loss is estimated by considering available information relevant to the collectibility of the security and information about past events, current conditions, and reasonable and supportable forecasts. Any credit loss is recorded as a charge to other income (expense), net, not to exceed the amount of the unrealized loss. Unrealized losses other than the credit loss are recognized in accumulated other comprehensive income (""AOCI""). If we have an intent to sell, or if it is more likely than not that we will be required to sell a debt security in an unrealized loss position before recovery of its amortized cost basis, we will write down the security to its fair value and record the corresponding charge as a component of other income (expense), net. For non-marketable equity securities we consider whether impairment indicators exist by evaluating the companies' financial and liquidity position, access to capital resources and the time since the last adjustment to fair value, among others. If the assessment indicates that the investment is impaired, we write down the investment to its fair value by recording the corresponding charge as a component of other income (expense), net. Fair value is estimated using the best information available, which may include cash flow projections or other available market data. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests is considered a variable interest entity (""VIE""). We consolidate VIEs when we are the primary beneficiary. We are the primary beneficiary of a VIE when we have the power to direct activities that most significantly affect the economic performance of the VIE and have the obligation to absorb the majority of their losses or benefits. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is a VIE and, if so, whether we are the primary beneficiary. Alphabet Inc. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets, which we regularly evaluate. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet beginning January 1, 2019. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities and the long term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense (excluding variable lease costs) is recognized on a straight-line basis over the lease term. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets or asset group are not recoverable, the impairment recognized is measured as the amount by which the carrying value exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units periodically, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were no t material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives generally over periods ranging from one to twelve years . Alphabet Inc. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Recently Adopted Accounting Pronouncements In June 2016, the Financial Accounting Standards Board (""FASB"") issued Accounting Standards Update No. 2016-13 (""ASU 2016-13"") ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"", which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to certain available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes result in earlier recognition of credit losses. We adopted ASU 2016-13 using the modified retrospective approach as of January 1, 2020. The cumulative effect upon adoption was not material to our consolidated financial statements. See Impairment of Investments and ""Accounts Receivable"" above as well as Note 3 for the effect on our consolidated financial statements. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. See Note 15 for further details. Alphabet Inc. Note 2. Revenues Revenue Recognition The following table presents our revenues disaggregated by type (in millions). Year Ended December 31, 2018 2019 2020 Google Search other $ 85,296 $ 98,115 $ 104,062 YouTube ads 11,155 15,149 19,772 Google Network Members' properties 20,010 21,547 23,090 Google advertising 116,461 134,811 146,924 Google other 14,063 17,014 21,711 Google Services total 130,524 151,825 168,635 Google Cloud 5,838 8,918 13,059 Other Bets 595 659 657 Hedging gains (losses) ( 138 ) 455 176 Total revenues $ 136,819 $ 161,857 $ 182,527 The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, 2018 2019 2020 United States $ 63,269 46 % $ 74,843 46 % $ 85,014 47 % EMEA (1) 44,739 33 50,645 31 55,370 30 APAC (1) 21,341 15 26,928 17 32,550 18 Other Americas (1) 7,608 6 8,986 6 9,417 5 Hedging gains (losses) ( 138 ) 0 455 0 176 0 Total revenues $ 136,819 100 % $ 161,857 100 % $ 182,527 100 % (1) Regions represent Europe, the Middle East, and Africa (""EMEA""); Asia-Pacific (""APAC""); and Canada and Latin America (""Other Americas""). Deferred Revenues and Remaining Performance Obligations We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. Deferred revenues primarily relate to Google Cloud and Google other. Our total deferred revenue as of December 31, 2019 was $ 2.3 billion, of which $ 1.8 billion was recognized as revenues for the year ending December 31, 2020. Additionally, we have performance obligations associated with commitments in customer contracts, primarily related to Google Cloud, for future services that have not yet been recognized as revenues, also referred to as remaining performance obligations. Remaining performance obligations include related deferred revenue currently recorded as well as amounts that will be invoiced in future periods, and excludes (i) contracts with an original expected term of one year or less, (ii) cancellable contracts, and (iii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. As of December 31, 2020, the amount not yet recognized as revenues from these commitments is $ 29.8 billion. We expect to recognize approximately half over the next 24 months with the remaining thereafter. However, the amount and timing of revenue recognition is largely driven by when the customer utilizes the services and our ability to deliver in accordance with relevant contract terms, which could impact our estimate of the remaining performance obligations and when we expect to recognize such as revenues. Alphabet Inc. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities, which are accounted for as available-for-sale, within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. For certain marketable debt securities, we have elected the fair value option for which changes in fair value are recorded in other income (expense), net. The fair value option was elected for these securities to align with the unrealized gains and losses from related derivative contracts. Unrealized net gains related to debt securities still held where we have elected the fair value option were $ 87 million as of December 31, 2020. As of December 31, 2020, the fair value of these debt securities was $ 2 billion. Balances as of December 31, 2019 were not material. The following tables summarize our debt securities, for which we did not elect the fair value option, by significant investment categories as of December 31, 2019 and 2020 (in millions): As of December 31, 2019 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,294 $ 0 $ 0 $ 2,294 $ 2,294 $ 0 Government bonds 55,033 434 ( 30 ) 55,437 4,518 50,919 Corporate debt securities 27,164 337 ( 3 ) 27,498 44 27,454 Mortgage-backed and asset-backed securities 19,453 96 ( 41 ) 19,508 0 19,508 Total $ 103,944 $ 867 $ ( 74 ) $ 104,737 $ 6,856 $ 97,881 As of December 31, 2020 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 3,564 $ 0 $ 0 $ 3,564 $ 3,564 $ 0 Government bonds 55,156 793 ( 9 ) 55,940 2,527 53,413 Corporate debt securities 31,521 704 ( 2 ) 32,223 8 32,215 Mortgage-backed and asset-backed securities 16,767 364 ( 7 ) 17,124 0 17,124 Total $ 107,008 $ 1,861 $ ( 18 ) $ 108,851 $ 6,099 $ 102,752 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 1.3 billion, $ 292 million, and $ 899 million for the years ended December 31, 2018, 2019, and 2020, respectively. We recognized gross realized losses of $ 143 million, $ 143 million, and $ 184 million for the years ended December 31, 2018, 2019, and 2020, respectively. We reflect these gains and losses as a component of other income (expense), net. The following table summarizes the estimated fair value of our investments in marketable debt securities by stated contractual maturity dates (in millions): As of December 31, 2020 Due in 1 year or less $ 19,795 Due in 1 year through 5 years 69,228 Due in 5 years through 10 years 2,739 Due after 10 years 13,038 Total $ 104,800 Alphabet Inc. The following tables present fair values and gross unrealized losses recorded to AOCI as of December 31, 2019 and 2020, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2019 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 6,752 $ ( 20 ) $ 4,590 $ ( 10 ) $ 11,342 $ ( 30 ) Corporate debt securities 1,665 ( 2 ) 978 ( 1 ) 2,643 ( 3 ) Mortgage-backed and asset-backed securities 4,536 ( 13 ) 2,835 ( 28 ) 7,371 ( 41 ) Total $ 12,953 $ ( 35 ) $ 8,403 $ ( 39 ) $ 21,356 $ ( 74 ) As of December 31, 2020 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 5,516 $ ( 9 ) $ 3 $ 0 $ 5,519 $ ( 9 ) Corporate debt securities 1,999 ( 1 ) 0 0 1,999 ( 1 ) Mortgage-backed and asset-backed securities 929 ( 5 ) 242 ( 2 ) 1,171 ( 7 ) Total $ 8,444 $ ( 15 ) $ 245 $ ( 2 ) $ 8,689 $ ( 17 ) During the years ended December 31, 2018, and 2019 we did no t recognize any significant other-than-temporary impairment losses. During the year ended December 31, 2020, with the adoption of ASU 2016-13, we did not recognize significant credit losses and the ending allowance for credit losses was immaterial. See Note 7 for further details on other income (expense), net. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). Non-marketable equity securities that have been remeasured during the period based on observable transactions are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods which may include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The fair value of non-marketable equity securities that have been remeasured due to impairment are classified within Level 3. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for our marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, 2019 2020 Net gain (loss) on equity securities sold during the period $ ( 301 ) $ 1,339 Net unrealized gain (loss) on equity securities held as of the end of the period 2,950 4,253 Total gain (loss) recognized in other income (expense), net $ 2,649 $ 5,592 Alphabet Inc. In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains (losses) on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic realized net gains on the securities sold during the period. Cumulative net gains are calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Equity Securities Sold During the Year Ended December 31, 2019 2020 Total sale price $ 3,134 $ 4,767 Total initial cost 858 2,674 Cumulative net gains (losses) $ 2,276 $ 2,093 Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for our marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2019 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 1,935 $ 8,297 $ 10,232 Cumulative net gain (loss) (1) 1,361 3,056 4,417 Carrying value $ 3,296 $ 11,353 $ 14,649 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 3.5 billion unrealized gains and $ 445 million unrealized losses (including impairment). As of December 31, 2020 Marketable Equity Securities Non-Marketable Equity Securities Total Total initial cost $ 2,227 $ 14,616 $ 16,843 Cumulative net gain (loss) (1) 3,631 4,277 7,908 Carrying value (2) $ 5,858 $ 18,893 $ 24,751 (1) Non-marketable equity securities cumulative net gain (loss) is comprised of $ 6.1 billion unrealized gains and $ 1.9 billion unrealized losses (including impairment). (2) The long-term portion of marketable equity securities of $ 429 million is included in other non-current assets. Alphabet Inc. Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2019 and 2020 (in millions): As of December 31, 2019 As of December 31, 2020 Cash and Cash Equivalents Marketable Equity Securities Cash and Cash Equivalents Marketable Equity Securities Level 1: Money market funds $ 4,604 $ 0 $ 12,210 $ 0 Marketable equity securities (1)(2) 0 3,046 0 5,470 4,604 3,046 12,210 5,470 Level 2: Mutual funds 0 250 0 388 Total $ 4,604 $ 3,296 $ 12,210 $ 5,858 (1) The balance as of December 31, 2019 and 2020 includes investments that were reclassified from non-marketable equity securities following the commencement of public market trading of the issuers or acquisition by public entities. As of December 31, 2020 certain investments are subject to short-term lock-up restrictions. (2) As of December 31, 2020 the long-term portion of marketable equity securities of $ 429 million is included within other non-current assets. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities (in millions): Year Ended December 31, 2019 2020 Unrealized gains $ 2,163 $ 3,020 Unrealized losses (including impairment) ( 372 ) ( 1,489 ) Total unrealized gain (loss) for non-marketable equity securities $ 1,791 $ 1,531 During the year ended December 31, 2020, included in the $ 18.9 billion of non-marketable equity securities, $ 9.7 billion were measured at fair value resulting in a net unrealized gain of $ 1.5 billion. Equity securities accounted for under the Equity Method As of December 31, 2019 and 2020, equity securities accounted for under the equity method had a carrying value of approximately $ 1.3 billion and $ 1.4 billion, respectively. Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We enter into derivative instruments to manage risks relating to our ongoing business operations. The primary risk managed with derivative instruments is foreign exchange risk. We use foreign currency contracts to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also enter into derivative instruments to partially offset our exposure to other risks and enhance investment returns. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value and classify the derivatives primarily within Level 2 in the fair value hierarchy. We present our collar contracts (an option strategy comprised of a combination of purchased and written options) at net fair values where both the purchased and written options are with the same counterparty. For other derivative contracts, we present at gross fair values. We primarily record changes in the fair value in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. Further, we enter into collateral security arrangements that provide for collateral to be received or pledged when the net fair value of certain financial instruments fluctuates from contractually established thresholds. Cash collateral received related to derivative instruments under our collateral security arrangements are included in other current assets with a corresponding liability. Cash and non-cash Alphabet Inc. collateral pledged related to derivative instruments under our collateral security arrangements are included in other current assets. Cash Flow Hedges We designate foreign currency forward and option contracts (including collars) as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. These contracts have maturities of 24 months or less. Cash flow hedge amounts included in the assessment of hedge effectiveness are deferred in AOCI and subsequently reclassified to revenue when the hedged item is recognized in earnings. We exclude the change in forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are reclassified to other income (expense), net in the period of de-designation. As of December 31, 2020, the net accumulated loss on our foreign currency cash flow hedges before tax effect was $ 124 million, which is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We designate foreign currency forward contracts as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Fair value hedge amounts included in the assessment of hedge effectiveness are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Net Investment Hedges We designate foreign currency forward contracts as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. Net investment hedge amounts included in the assessment of hedge effectiveness are recognized in AOCI along with the foreign currency translation adjustment. We exclude changes in forward points from the assessment of hedge effectiveness and recognize changes in the excluded component in other income (expense), net. Other Derivatives Other derivatives not designated as hedging instruments consist primarily of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the functional currency of a subsidiary. Gains and losses on these contracts, as well as the related costs, are recognized in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. We also use derivatives not designated as hedging instruments to manage risks relating to interest rates, equity and commodity prices, credit exposures and to enhance investment returns. The gross notional amounts of our outstanding derivative instruments were as follows (in millions): As of December 31, 2019 As of December 31, 2020 Derivatives Designated as Hedging Instruments: Foreign exchange contracts Cash flow hedges $ 13,207 $ 10,187 Fair value hedges $ 455 $ 1,569 Net investment hedges $ 9,318 $ 9,965 Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts $ 43,497 $ 39,861 Other contracts $ 117 $ 2,399 Alphabet Inc. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2019 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 91 $ 253 $ 344 Other contracts Other current and non-current assets 0 1 1 Total $ 91 $ 254 $ 345 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 173 $ 196 $ 369 Other contracts Accrued expenses and other liabilities, current and non-current 0 13 13 Total $ 173 $ 209 $ 382 As of December 31, 2020 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ 33 $ 316 $ 349 Other contracts Other current and non-current assets 0 16 16 Total $ 33 $ 332 $ 365 Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ 395 $ 185 $ 580 Other contracts Accrued expenses and other liabilities, current and non-current 0 942 942 Total $ 395 $ 1,127 $ 1,522 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (""OCI"") are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, 2018 2019 2020 Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ 332 $ 38 $ 102 Amount excluded from the assessment of effectiveness 26 ( 14 ) ( 37 ) Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness 136 131 ( 851 ) Total $ 494 $ 155 $ ( 786 ) Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, 2018 2019 2020 Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 136,819 $ 7,389 $ 161,857 $ 5,394 $ 182,527 $ 6,858 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ ( 139 ) $ 0 $ 367 $ 0 $ 144 $ 0 Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach 1 0 88 0 33 0 Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items 0 ( 96 ) 0 ( 19 ) 0 18 Derivatives designated as hedging instruments 0 96 0 19 0 ( 18 ) Amount excluded from the assessment of effectiveness 0 37 0 25 0 4 Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness 0 78 0 243 0 151 Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts 0 54 0 ( 413 ) 0 718 Other Contracts 0 0 0 0 0 ( 906 ) Total gains (losses) $ ( 138 ) $ 169 $ 455 $ ( 145 ) $ 177 $ ( 33 ) Offsetting of Derivatives The gross amounts of our derivative instruments subject to master netting arrangements with various counterparties, and cash and non-cash collateral received and pledged under such agreements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 366 $ ( 21 ) $ 345 $ ( 88 ) (1) $ ( 234 ) $ 0 $ 23 As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ 397 $ ( 32 ) $ 365 $ ( 295 ) (1) $ ( 16 ) $ 0 $ 54 (1) The balances as of December 31, 2019 and 2020 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 403 $ ( 21 ) $ 382 $ ( 88 ) (2) $ 0 $ 0 $ 294 As of December 31, 2020 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ 1,554 $ ( 32 ) $ 1,522 $ ( 295 ) (2) $ ( 1 ) $ ( 943 ) $ 283 (2) The balances as of December 31, 2019 and 2020 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating and finance lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2021 and 2063. Components of operating lease expense were as follows (in millions): Year Ended December 31, 2019 2020 Operating lease cost $ 1,820 $ 2,267 Variable lease cost 541 619 Total operating lease cost $ 2,361 $ 2,886 Alphabet Inc. Supplemental information related to operating leases is as follows (in millions): Year Ended December 31, 2019 2020 Cash payments for operating leases $ 1,661 $ 2,004 New operating lease assets obtained in exchange for operating lease liabilities $ 4,391 $ 2,765 As of December 31, 2020, our operating leases had a weighted average remaining lease term of 9 years and a weighted average discount rate of 2.6 %. Future lease payments under operating leases as of December 31, 2020 were as follows (in millions): 2021 $ 2,198 2022 2,170 2023 1,995 2024 1,738 2025 1,389 Thereafter 5,601 Total future lease payments 15,091 Less imputed interest ( 2,251 ) Total lease liability balance $ 12,840 As of December 31, 2020, we have entered into leases that have not yet commenced with future lease payments of $ 8.0 billion, excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2021 and 2026 with non-cancelable lease terms of 1 to 25 years. Note 5. Variable Interest Entities Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2019 and 2020, assets that can only be used to settle obligations of these VIEs were $ 3.1 billion and $ 5.7 billion, respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 1.2 billion and $ 2.3 billion, respectively. Total noncontrolling interests (""NCI""), including redeemable noncontrolling interests (""RNCI""), in our consolidated subsidiaries increased from $ 1.2 billion to $ 3.9 billion f rom December 31, 2019 to December 31, 2020, primarily due to external investments in Waymo. NCI and RNCI are included within additional paid-in capital. Net loss attributable to noncontrolling interests was not material for any period presented and is included within other income (expense), net. Waymo Waymo is an autonomous driving technology development company with a mission to make it safe and easy for people and things to get where they're going. In the first half of 2020, Waymo completed an externally led investment round raising in total $ 3.2 billion, which includes investment from Alphabet. No gain or loss was recognized. The investments related to external parties were accounted for as equity transactions and resulted in recognition of noncontrolling interests. Unconsolidated VIEs We have investments in some VIEs in which we are not the primary beneficiary. These VIEs include private companies that are primarily early stage companies and certain renewable energy entities in which activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we are not the primary beneficiary, and the results of operations and financial position of these VIEs are not included in our consolidated financial statements. We account for these investments as non-marketable equity investments or equity method investments. Alphabet Inc. VIEs are generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these VIEs is our capital investments in them. The carrying value and maximum exposure of these unconsolidated VIEs were not material as of December 31, 2019 and 2020. Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2019 and 2020. Our short-term debt balance also includes the current portion of certain long-term debt. Long-Term Debt In August 2020, Alphabet issued $ 10.0 billion of fixed-rate senior unsecured notes in six tranches (collectively, 2020 Notes): $ 1.0 billion due in 2025, $ 1.0 billion due in 2027, $ 2.25 billion due in 2030, $ 1.25 billion due in 2040, $ 2.5 billion due in 2050 and $ 2.0 billion due in 2060. The 2020 Notes had a weighted average duration of 21.5 years and weighted average coupon rate of 1.57 %. Of the total issuance, $ 5.75 billion was designated as Sustainability Bonds, the net proceeds of which are used to fund environmentally and socially responsible projects in the following eight areas: energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity, and support for small businesses and COVID-19 crisis response. The remaining net proceeds are used for general corporate purposes. The total outstanding debt is summarized below (in millions, except percentages): Maturity Coupon Rate Effective Interest Rate As of December 31, 2019 As of December 31, 2020 Debt 2011-2016 Notes Issuances 2021 - 2026 2.00 % - 3.63 % 2.23 % - 3.73 % $ 4,000 $ 4,000 2020 Notes Issuance 2025 - 2060 0.45 % - 2.25 % 0.57 % - 2.33 % 0 10,000 Future finance lease payments, net (1) 711 1,201 Total debt 4,711 15,201 Unamortized discount and debt issuance costs ( 42 ) ( 169 ) Less: Current portion of Notes (2) 0 ( 999 ) Less: Current portion future finance lease payments, net (1)(2) ( 115 ) ( 101 ) Total long-term debt $ 4,554 $ 13,932 (1) Net of imputed interest. (2) Total current portion of long-term debt is included within other accrued expenses and current liabilities. See Note 7. The notes in the table above are comprised of fixed-rate senior unsecured obligations and generally rank equally with each other. We may redeem the notes at any time in whole or in part at specified redemption prices. The effective interest rates are based on proceeds received with interest payable semi-annually. The total estimated fair value of the outstanding notes, including the current portion, was approximately $ 4.1 billion and $ 14.0 billion as of December 31, 2019 and December 31, 2020, respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. Alphabet Inc. As of December 31, 2020, the aggregate future principal payments for long-term debt, including finance lease liabilities, for each of the next five years and thereafter are as follows (in millions): 2021 $ 1,104 2022 86 2023 86 2024 1,087 2025 1,088 Thereafter 11,868 Total $ 15,319 Credit Facility As of December 31, 2020, we have $ 4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2019 and 2020. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2019 As of December 31, 2020 Land and buildings $ 39,865 $ 49,732 Information technology assets 36,840 45,906 Construction in progress 21,036 23,111 Leasehold improvements 6,310 7,516 Furniture and fixtures 156 197 Property and equipment, gross 104,207 126,462 Less: accumulated depreciation ( 30,561 ) ( 41,713 ) Property and equipment, net $ 73,646 $ 84,749 Accrued expenses and other current liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2019 As of December 31, 2020 European Commission fines (1) $ 9,405 $ 10,409 Accrued customer liabilities 2,245 3,118 Accrued purchases of property and equipment 2,411 2,197 Current operating lease liabilities 1,199 1,694 Other accrued expenses and current liabilities 7,807 11,213 Accrued expenses and other current liabilities $ 23,067 $ 28,631 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2017 $ ( 1,103 ) $ 233 $ ( 122 ) $ ( 992 ) Cumulative effect of accounting change 0 ( 98 ) 0 ( 98 ) Other comprehensive income (loss) before reclassifications ( 781 ) 88 264 ( 429 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 26 26 Amounts reclassified from AOCI 0 ( 911 ) 98 ( 813 ) Other comprehensive income (loss) ( 781 ) ( 823 ) 388 ( 1,216 ) Balance as of December 31, 2018 ( 1,884 ) ( 688 ) 266 ( 2,306 ) Cumulative effect of accounting change 0 0 ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 36 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 14 ) ( 14 ) Amounts reclassified from AOCI 0 ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 ( 2,003 ) 812 ( 41 ) ( 1,232 ) Other comprehensive income (loss) before reclassifications 1,139 1,313 79 2,531 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI 0 0 ( 37 ) ( 37 ) Amounts reclassified from AOCI 0 ( 513 ) ( 116 ) ( 629 ) Other comprehensive income (loss) 1,139 800 ( 74 ) 1,865 Balance as of December 31, 2020 $ ( 864 ) $ 1,612 $ ( 115 ) $ 633 The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location 2018 2019 2020 Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ 1,190 $ 149 $ 650 Benefit (provision) for income taxes ( 279 ) ( 38 ) ( 137 ) Net of tax 911 111 513 Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue ( 139 ) 367 144 Interest rate contracts Other income (expense), net 6 6 6 Benefit (provision) for income taxes 35 ( 74 ) ( 34 ) Net of tax ( 98 ) 299 116 Total amount reclassified, net of tax $ 813 $ 410 $ 629 Alphabet Inc. Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, 2018 2019 2020 Interest income $ 1,878 $ 2,427 $ 1,865 Interest expense (1) ( 114 ) ( 100 ) ( 135 ) Foreign currency exchange gain (loss), net (2) ( 80 ) 103 ( 344 ) Gain (loss) on debt securities, net (3) 1,190 149 725 Gain (loss) on equity securities, net 5,460 2,649 5,592 Performance fees ( 1,203 ) ( 326 ) ( 609 ) Income (loss) and impairment from equity method investments, net ( 120 ) 390 401 Other (4) 378 102 ( 637 ) Other income (expense), net $ 7,389 $ 5,394 $ 6,858 (1) Interest expense is net of interest capitalized of $ 92 million, $ 167 million, and $ 218 million for the years ended December 31, 2018, 2019, and 2020, respectively. (2) Our foreign currency exchange gain (loss), net, is primarily related to the forward points for our foreign currency hedging contracts and foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contracts' losses and gains. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $ 1.3 billion gain. (4) During the year ended December 31, 2020, we entered into derivatives that hedged the changes in fair value of certain marketable equity securities, which resulted in a $ 902 million loss. The offsetting recognized gains on the marketable equity securities are reflected in Gain (loss) on equity securities, net. Note 8. Acquisitions 2020 Acquisitions During the year ended December 31, 2020, we completed acquisitions and purchases of intangible assets for total consideration of approximately $ 744 million, net of cash acquired. In aggregate, $ 248 million was attributed to intangible assets, $ 446 million to goodwill and $ 50 million to net assets acquired. These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. Pro forma results of operations for these acquisitions have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2020, patents and developed technology have a weighted-average useful life of 4.1 years, customer relationships have a weighted-average useful life of 4.7 years, and trade names and other have a weighted-average useful life of 4.6 years. Acquisition of Fitbit In January 2021, we closed the acquisition of Fitbit, a leading wearables brand for $ 2.1 billion. Alphabet Inc. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2020 were as follows (in millions): Google Google Services Google Cloud Other Bets Total Balance as of December 31, 2018 $ 17,521 $ 0 $ 0 $ 367 $ 17,888 Acquisitions 2,353 0 0 475 2,828 Transfers 9 0 0 ( 9 ) 0 Foreign currency translation and other adjustments 38 0 0 ( 130 ) ( 92 ) Balance as of December 31, 2019 19,921 0 0 703 20,624 Acquisitions 204 0 0 0 204 Foreign currency translation and other adjustments 46 0 0 ( 4 ) 42 Allocation in the fourth quarter of 2020 (1) ( 20,171 ) 18,408 1,763 0 0 Acquisitions 0 53 189 0 242 Foreign currency translation and other adjustments 0 56 5 2 63 Balance as of December 31, 2020 $ 0 $ 18,517 $ 1,957 $ 701 $ 21,175 (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2020. See Note 15 for further details Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 4,972 $ 3,570 $ 1,402 Customer relationships 254 30 224 Trade names and other 703 350 353 Total $ 5,929 $ 3,950 $ 1,979 As of December 31, 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,639 $ 3,649 $ 990 Customer relationships 266 49 217 Trade names and other 699 461 238 Total $ 5,604 $ 4,159 $ 1,445 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 1.6 years, 4.9 years, and 2.1 years, respectively. Amortization expense relating to purchased intangible assets was $ 865 million, $ 795 million, and $ 774 million for the years ended December 31, 2018, 2019, and 2020, respectively. Alphabet Inc. As of December 31, 2020, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): 2021 $ 719 2022 375 2023 104 2024 78 2025 53 Thereafter 116 $ 1,445 Note 10. Commitments and Contingencies Purchase Obligations As of December 31, 2020, we had $ 10.7 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, information technology assets and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, customers of Google Cloud offerings, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2020, we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ($ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search partners' agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. Alphabet Inc. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. From time to time we are subject to formal and informal inquiries and investigations on competition matters by regulatory authorities in the United States, Europe, and other jurisdictions. For example, in August 2019, we began receiving civil investigative demands from the U.S. Department of Justice (""DOJ"") requesting information and documents relating to our prior antitrust investigations and certain aspects of our business. The DOJ and a number of state Attorneys General filed a lawsuit on October 20, 2020 alleging that Google violated U.S. antitrust laws relating to Search and Search advertising. Separately, on December 16, 2020, a number of state Attorneys General filed an antitrust complaint against Google in the United States District Court for the Eastern District of Texas, alleging that Google violated U.S. antitrust laws as well as state deceptive trade laws relating to its advertising technology. We believe these complaints are without merit and will defend ourselves vigorously. The DOJ and state Attorneys General continue their investigations into certain aspects of our business. We continue to cooperate with federal and state regulators in the United States, and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices, and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (""ITC"") has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (""Oracle"") brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. The Supreme Court heard oral arguments in our case on October 7, 2020. If the Supreme Court does not rule in our favor, the case will be remanded to the district court for further determination of the remaining issues in the case, including damages, if any. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in substantial fines and penalties, injunctive relief, ongoing auditing and monitoring obligations, changes to our products and services, alterations to our business models and operations, and collateral related civil litigation or other adverse consequences, all of which could harm our business, reputation, financial condition, and operating results. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we Alphabet Inc. disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14. Note 11. Stockholders' Equity Convertible Preferred Stock Our Board of Directors has authorized 100 million shares of convertible preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2019 and 2020, no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our Board of Directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In July 2020, the Board of Directors of Alphabet authorized the company to repurchase up to an additional $ 28.0 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2019 and 2020, we repurchased and subsequently retired 15.3 million and 21.5 million shares of Alphabet Class C capital stock for an aggregate amount of $ 18.4 billion and $ 31.1 billion, respectively. Note 12. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of Alphabet Inc. safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our Board of Directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our Board of Directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2018, 2019 and 2020, the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, 2018 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 0 0 Reallocation of undistributed earnings ( 146 ) ( 24 ) 146 Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 0 0 Restricted stock units and other contingently issuable shares 689 0 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Alphabet Inc. Year Ended December 31, 2019 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 0 0 Reallocation of undistributed earnings ( 126 ) ( 20 ) 126 Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,527 0 0 Restricted stock units and other contingently issuable shares 413 0 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Year Ended December 31, 2020 Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 17,733 $ 2,732 $ 19,804 Denominator Number of shares used in per share computation 299,815 46,182 334,819 Basic net income per share $ 59.15 $ 59.15 $ 59.15 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 17,733 $ 2,732 $ 19,804 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,732 0 0 Reallocation of undistributed earnings ( 180 ) ( 25 ) 180 Allocation of undistributed earnings $ 20,285 $ 2,707 $ 19,984 Denominator Number of shares used in basic computation 299,815 46,182 334,819 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,182 0 0 Restricted stock units and other contingently issuable shares 87 0 6,125 Number of shares used in per share computation 346,084 46,182 340,944 Diluted net income per share $ 58.61 $ 58.61 $ 58.61 Alphabet Inc. Note 13. Compensation Plans Stock Plans Our stock plans include the Alphabet 2012 Stock Plan and Other Bet stock-based plans. Under our stock plans, RSUs and other types of awards may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. RSUs granted to participants under the Alphabet 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2020, there were 38,777,813 shares of stock reserved for future issuance under our Alphabet 2012 Stock Plan. Stock-Based Compensation For the years ended December 31, 2018, 2019 and 2020, total stock-based compensation expense was $ 10.0 billion, $ 11.7 billion and $ 13.4 billion, including amounts associated with awards we expect to settle in Alphabet stock of $ 9.4 billion, $ 10.8 billion, and $ 12.8 billion, respectively. For the years ended December 31, 2018, 2019 and 2020, we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.5 billion, $ 1.8 billion, and $ 2.7 billion, respectively. For the years ended December 31, 2018, 2019 and 2020, tax benefit realized related to awards vested or exercised during the period was $ 2.1 billion, $ 2.2 billion and $ 3.6 billion, respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Stock-Based Award Activities The following table summarizes the activities for our unvested Alphabet RSUs for the year ended December 31, 2020: Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2019 19,394,236 $ 1,055.22 Granted 12,647,562 1,407.97 Vested ( 11,643,670 ) 1,089.31 Forfeited/canceled ( 1,109,335 ) 1,160.01 Unvested as of December 31, 2020 19,288,793 $ 1,262.13 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2018 and 2019, was $ 1,095.89 and $ 1,092.36 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2018, 2019, and 2020 were $ 14.1 billion, $ 15.2 billion, and $ 17.8 billion, respectively. As of December 31, 2020, there was $ 22.8 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.6 years. 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 691 million, $ 724 million, and $ 855 million for the years ended December 31, 2018, 2019, and 2020, respectively. Note 14. Income Taxes Income from continuing operations before income taxes consists of the following (in millions): Year Ended December 31, 2018 2019 2020 Domestic operations $ 15,779 $ 16,426 $ 37,576 Foreign operations 19,134 23,199 10,506 Total $ 34,913 $ 39,625 $ 48,082 Alphabet Inc. The provision for income taxes consists of the following (in millions): Year Ended December 31, 2018 2019 2020 Current: Federal and state $ 2,153 $ 2,424 $ 4,789 Foreign 1,251 2,713 1,687 Total 3,404 5,137 6,476 Deferred: Federal and state 907 286 1,552 Foreign ( 134 ) ( 141 ) ( 215 ) Total 773 145 1,337 Provision for income taxes $ 4,177 $ 5,282 $ 7,813 The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, 2018 2019 2020 U.S. federal statutory tax rate 21.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 4.4 ) ( 4.9 ) ( 0.3 ) Foreign-derived intangible income deduction ( 0.5 ) ( 0.7 ) ( 3.0 ) Stock-based compensation expense ( 2.2 ) ( 0.7 ) ( 1.7 ) Federal research credit ( 2.4 ) ( 2.5 ) ( 2.3 ) Impact of the Tax Cuts and Jobs Act ( 1.3 ) ( 0.6 ) 0.0 European Commission fines 3.1 1.0 0.0 Deferred tax asset valuation allowance ( 2.0 ) 0.0 1.4 State and local income taxes ( 0.4 ) 1.1 1.1 Other adjustments 1.1 ( 0.4 ) 0.0 Effective tax rate 12.0 % 13.3 % 16.2 % Our effective tax rate for 2018 and 2019 was affected significantly by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate because substantially all of the income from foreign operations was earned by an Irish subsidiary. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the United States Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. In 2020, there was an increase in valuation allowance for net deferred tax assets that are not likely to be realized relating to certain of our Other Bets. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, 2019 2020 Deferred tax assets: Stock-based compensation expense $ 421 $ 518 Accrued employee benefits 463 580 Accruals and reserves not currently deductible 1,047 1,049 Tax credits 3,264 3,723 Net operating losses 771 1,085 Operating leases 1,876 2,620 Intangible assets 164 1,525 Other 226 463 Total deferred tax assets 8,232 11,563 Valuation allowance ( 3,502 ) ( 4,823 ) Total deferred tax assets net of valuation allowance 4,730 6,740 Deferred tax liabilities: Property and equipment, net ( 1,798 ) ( 3,382 ) Renewable energy investments ( 466 ) ( 415 ) Foreign Earnings ( 373 ) ( 383 ) Net investment gains ( 1,074 ) ( 1,901 ) Operating leases ( 1,619 ) ( 2,354 ) Other ( 380 ) ( 782 ) Total deferred tax liabilities ( 5,710 ) ( 9,217 ) Net deferred tax assets (liabilities) $ ( 980 ) $ ( 2,477 ) As of December 31, 2020, our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $ 3.1 billion, $ 3.1 billion, and $ 1.4 billion respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2023, foreign net operating loss carryforwards will begin to expire in 2024 and the state net operating loss carryforwards will begin to expire in 2028. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2020, our California research and development credit carryforwards for income tax purposes were approximately $ 3.7 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2020, we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits, net deferred tax assets relating to certain of our Other Bets, and certain foreign net operating losses that we believe are not likely to be realized. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, 2018 2019 2020 Beginning gross unrecognized tax benefits $ 4,696 $ 4,652 $ 3,377 Increases related to prior year tax positions 321 938 372 Decreases related to prior year tax positions ( 623 ) ( 143 ) ( 557 ) Decreases related to settlement with tax authorities ( 191 ) ( 2,886 ) ( 45 ) Increases related to current year tax positions 449 816 690 Ending gross unrecognized tax benefits $ 4,652 $ 3,377 $ 3,837 The total amount of gross unrecognized tax benefits was $ 4.7 billion, $ 3.4 billion, and $ 3.8 billion as of December 31, 2018, 2019, and 2020, respectively, of which, $ 2.9 billion, $ 2.3 billion, and $ 2.6 billion, if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2019 was primarily as a result of the resolution of multi-year audits. As of December 31, 2019 and 2020, we accrued $ 130 million and $ 222 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2011 through 2019 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, we do not believe it is reasonably possible that our unrecognized tax benefits will materially change in the next 12 months. Note 15. Information about Segments and Geographic Areas Beginning in the fourth quarter of 2020, we report our segment results as Google Services, Google Cloud, and Other Bets: Google Services includes products and services such as ads, Android, Chrome, hardware, Google Maps, Google Play, Search, and YouTube. Google Services generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and fees received for subscription-based products such as YouTube Premium and YouTube TV. Google Cloud includes Googles infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues primarily from fees received for Google Cloud Platform services and Google Workspace (formerly known as G Suite) collaboration tools. Other Bets is a combination of multiple operating segments that are not individually material. Revenues from the Other Bets are derived primarily through the sale of internet services as well as licensing and RD services. Revenues and certain costs, such as costs associated with content and traffic acquisition, certain engineering, and hardware costs and other operating expenses, are directly attributable to our segments. Due to the integrated nature of Alphabet, other costs and expenses, such as technical infrastructure and office facilities, are managed Alphabet Inc. centrally at a consolidated level. The associated costs, including depreciation and impairment, are allocated to operating segments as a service cost generally based on usage or headcount. Unallocated corporate costs primarily include corporate initiatives, corporate shared costs, such as finance and legal, including fines and settlements, as well as costs associated with certain shared research and development activities. Additionally, hedging gains (losses) related to revenue are included in corporate costs. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. Information about segments during the periods presented were as follows (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2018 2019 2020 Revenues: Google Services $ 130,524 $ 151,825 $ 168,635 Google Cloud 5,838 8,918 13,059 Other Bets 595 659 657 Hedging gains (losses) ( 138 ) 455 176 Total revenues $ 136,819 $ 161,857 $ 182,527 Operating income (loss): Google Services $ 43,137 $ 48,999 $ 54,606 Google Cloud ( 4,348 ) ( 4,645 ) ( 5,607 ) Other Bets ( 3,358 ) ( 4,824 ) ( 4,476 ) Corporate costs, unallocated (1) ( 7,907 ) ( 5,299 ) ( 3,299 ) Total income from operations $ 27,524 $ 34,231 $ 41,224 (1) Corporate costs, unallocated includes a fine of $ 5.1 billion for the year ended December 31, 2018 and a fine and legal settlement totaling $ 2.3 billion for the year ended December 31, 2019. For revenues by geography, see Note 2. The following table presents certain of our long-lived assets by geographic area, which includes property and equipment, net and operating lease assets (in millions). As of December 31, 2019 As of December 31, 2020 Long-lived assets: United States $ 63,102 $ 69,315 International 21,485 27,645 Total long-lived assets $ 84,587 $ 96,960 Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2020, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management and provide timely information to our management team. The implementation is expected to occur in phases over the next several years. The initial phase, which included changes to our general ledger and consolidated financial reporting systems, was completed during the third quarter of 2020. There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures, which in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. As a result of COVID-19, our global workforce continued to operate primarily in a work from home environment for the quarter ended December 31, 2020 . While pre-existing controls were not specifically designed to operate in our current work from home operating environment, we believe that our internal controls over financial reporting continue to be effective. We have continued to re-evaluate and refine our financial reporting process to provide reasonable assurance that we could report our financial results accurately and timely. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2020. Management reviewed the results of its assessment with our Audit and Compliance Committee. The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +2,goog,10-k2019," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history inspiring us to do things like tackling deep computer science problems, such as our investments in artificial intelligence (AI) and quantum computing. Alphabet is a collection of businesses the largest of which is Google. We report all non-Google businesses collectively as Other Bets. Our Other Bets include earlier stage technologies that are further afield from our core Google business. We take a long term view and manage the portfolio of Other Bets with the discipline and rigor needed to deliver long-term returns. Each of our businesses are designed to prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. Today, our mission to organize the worlds information and make it universally accessible and useful is as relevant as it was when we were founded in 1998. Since then, weve evolved from a company that helps people find answers to a company that helps you get things done. Were focused on building an even more helpful Google for everyone. We aspire to give everyone the tools they need to increase their knowledge, health, happiness, and success. Across Google, we're focused on continually innovating in areas where technology can have an impact on peoples lives. Our work in AI is helping to produce earlier and more precise flood warnings. Were also working hard to make sure that our products are accessible to the more than one billion individuals around the world with a disability. For example, Android 10 has automatic Live Captions for videos, podcasts and voicemails to make it easier to consume information on the phone. Our Other Bets are also pursuing initiatives with similar goals. For instance, as a part of our efforts in the Metro Phoenix area, Waymo is working toward our goal of making transportation safer and easier for everyone while Verily is developing tools and platforms to improve health outcomes. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and AI are increasingly driving many of our latest innovations. Within Google, our investments in machine learning over a decade have enabled us to build products that are smarter and more helpful. For example, our investments in AI are enabling doctors to detect cancer earlier. Machine learning powers the Google Assistant and many of our newer technologies. Google Serving our users We have always been a company committed to building products that have the potential to improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google's core products and platforms, such as Android, Chrome, Gmail, Google Drive, Google Maps, Google Play, Search, and YouTube each have over one billion monthly active users. As the majority of Alphabets big bets continue to reside within Google, an important benefit of the shift to Alphabet has been the tremendous focus that were able to have on Googles many extraordinary opportunities. Our products have come a long way since the company was founded more than two decades ago. Instead of just showing ten blue links in our search results, we are increasingly able to provide direct answers even if you're speaking your question using Voice Search which makes it quicker, easier and more natural to find what you're looking for. With Google Lens, you can use your phones camera to identify an unfamiliar landmark or find a trailer Alphabet Inc. from a movie poster. Over time, we have also added other services that let you access information quickly and easily like Google Maps, which helps you navigate to a store while showing you current traffic conditions, or Google Photos, which helps you store and organize your photos. This drive to make information more accessible and helpful has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. And with the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, and Daydream virtual reality platform, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of Google's AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 4 phones and the Google Nest Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Key to building helpful products for users is our commitment to keeping their data safe online. As the Internet evolves, we continue to invest in our industry-leading security technologies and privacy tools, such as the addition of auto-delete controls to enable users to automatically delete activity after 3 or 18 months and incognito mode in YouTube and Maps. Google was a company built in the cloud. We continue to invest in infrastructure, security, data management, analytics and AI. We see significant opportunity in helping businesses enhance these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and G Suite. Google Cloud Platform enables developers to build, test, and deploy applications on Googles highly scalable and reliable infrastructure. Our G Suite productivity tools which include apps like Gmail, Docs, Drive, Calendar, and more are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. How we make money The goal of our advertising products is to deliver relevant ads at just the right time and to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across devices and formats. We generate revenues primarily by delivering both performance advertising and brand advertising. Performance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google properties and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through videos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. We have built a world-class ad technology platform for advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blacklisting them when necessary to ensure that ads do not fund bad content. Alphabet Inc. We continue to look to the future and are making long-term investments that will grow revenues beyond advertising, including Google Cloud, Google Play, hardware, and YouTube. We are also investing in research efforts in AI and quantum computing to foster innovation across our businesses and create new opportunities . Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets investment in our portfolio of Other Bets include emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. Revenues are primarily generated from internet and TV services, as well as licensing and RD services. Other Bets operate as independent companies and some of them have their own boards with independent members and outside investors. We are investing in our portfolio of Other Bets and being very deliberate about the focus, scale, and pace of investments. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Apple, ATT, Disney, Facebook, Hulu, Netflix and TikTok. In businesses that are further afield from our advertising business, we compete with companies that have longer operating histories and more established relationships with customers and users. We face competition from: Other digital content and application platform providers, such as Amazon and Apple. Companies that design, manufacture, and market consumer hardware products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for advertising, competing successfully depends on attracting and retaining: Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Intellectual Property Alphabet Inc. We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Culture and Employees We take great pride in our culture. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex technical challenges. Transparency and open dialogue are central to how we work, and we aim to ensure that company news reaches our employees first through internal channels. Despite our rapid growth, we still cherish our roots as a startup and wherever possible empower employees to act on great ideas regardless of their role or function within the company. We strive to hire great employees, with backgrounds and perspectives as diverse as those of our global users. We work to provide an environment where these talented people can have fulfilling careers addressing some of the biggest challenges in technology and society. Our employees are among our best assets and are critical for our continued success. We expect to continue investing in hiring talented employees and to provide competitive compensation programs to our employees. As of December 31, 2019 , we had 118,899 full-time employees. Although we have work councils and statutory employee representation obligations in certain countries, our U.S. employees are not represented by a labor union. Competition for qualified personnel in our industry is intense, particularly for software engineers, computer scientists, and other technical staff. Ongoing Commitment to Sustainability We strive to build sustainability into everything we do from designing and operating efficient data centers, advancing carbon-free energy, creating sustainable workplaces, building better devices and services, empowering users with technology, and enabling a responsible supply chain. Google has been carbon neutral since 2007 and we are the largest corporate purchaser of renewable energy in the world. In 2018, for the second consecutive year, we matched 100% of our electricity consumption with renewable energy purchases, as reported in our 2019 Environmental Report. Some other 2019 highlights and achievements include: We made our largest corporate purchase of renewable energy: 18 new energy deals totaling 1,600 megawatts, which is anticipated to spur the construction of more than $2 billion in new energy infrastructure. 100% of Nest products launched in 2019 include recycled plastic content and we launched carbon neutral shipping for Googles direct customers who buy a product on Google Shopping or purchase Made by Google hardware. The Environmental Insights Explorer is enabling municipalities which represent more than 70% of global greenhouse gas emissions according to the 2016 United Nations Habitat World Cities Report to estimate emissions and develop climate action plans. In 2019, we expanded this tool to more than 100 cities worldwide. We believe that climate change is one of the most significant global challenges of our time. In 2017, we developed a climate resilience strategy, which included conducting a climate scenario analysis. We have been on CDPs (formerly the Carbon Disclosure Project) Climate Change A list for five consecutive years. We believe our CDP report reflects the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). More information on Google's approach to sustainability can be found in our annual sustainability reports. The content of our sustainability reports are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statements, and any amendments to these reports, are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. Alphabet Inc. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, which may be of interest or material to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could harm our business, reputation, financial condition, and operating results. Risks Specific to our Company We generate a significant portion of our revenues from advertising, and reduced spending by advertisers, a loss of partners, or new and existing technologies that block ads online and/or affect our ability to customize ads could harm our business. We generated over 83% of total revenues from the display of ads online in 2019. Many of our advertisers, companies that distribute our products and services, digital publishers, and content providers can terminate their contracts with us at any time. These partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. Changes to our advertising policies and data privacy practices, as well as changes to other companies advertising policies or practices may affect the advertising that we are able to provide, which could harm our business. In addition, technologies have been developed that make customized ads more difficult or that block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the availability and functionality of third-party digital advertising. Failing to provide superior value or deliver advertisements effectively and competitively could harm our reputation, financial condition, and operating results. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions can also have a material negative effect on the demand for advertising and cause our advertisers to reduce the amounts they spend on advertising, which could harm our financial condition and operating results. We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, which could harm our business and operating results. Our business environment is rapidly evolving and intensely competitive. Our businesses face changing technologies, shifting user needs, and frequent introductions of rival products and services. To compete successfully, we must accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. We must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and new and existing products and services. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some competitors have longer operating histories in various sectors. They can use their experience and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Our competitors may be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. For example, we are investing significantly in subscription-based products and services such as YouTube, which face intense competition from large experienced companies with well established relationships with users. Our operating results may also suffer if our products and services are not responsive to the needs of our users, advertisers, publishers, customers, and content providers. As technologies continue to develop, our competitors may be able to offer experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors Alphabet Inc. are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, publishers, customers, and content providers, our operating results could be harmed. Our ongoing investment in new businesses, products, services, and technologies is inherently risky, and could disrupt our current operations and harm our financial condition and operating results. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The investments that we are making across Google and Other Bets reflect our ongoing efforts to innovate and provide products and services that are useful to users, advertisers, publishers, customers, and content providers. Our investments in Google and Other Bets span a wide range of industries beyond online advertising. Such investments ultimately may not be commercially viable or may not result in an adequate return of capital and, in pursuing new strategies, we may incur unanticipated liabilities. These endeavors may involve significant risks and uncertainties, including diversion of management resources and, with respect to Other Bets, the use of alternative investment, governance, or compensation structures that may fail to adequately align incentives across the company or otherwise accomplish their objectives. Within Google, we continue to invest heavily in hardware, including our smartphones and home devices, which is a highly competitive market with frequent introduction of new products and services, rapid adoption of technological advancements by competitors, short product life cycles, evolving industry standards, continual improvement in product price and performance characteristics, and price and feature sensitivity on the part of consumers and businesses. There can be no assurance we will be able to provide hardware that competes effectively. We are also devoting significant resources to develop and deploy our enterprise-ready cloud services, including Google Cloud Platform and G Suite. We are incurring costs to build and maintain infrastructure to support cloud computing services and hire talent, particularly to support and scale the Cloud salesforce. At the same time, our competitors are rapidly developing and deploying cloud-based services. Pricing and delivery models are competitive and evolving, and we may not attain sufficient scale and profitability to achieve our business objectives. Within Other Bets, we are investing significantly in the areas of health, life sciences, and transportation, among others. These investment areas face intense competition from large experienced and well-funded competitors and our offerings may not be able to compete effectively or to operate at sufficient levels of profitability. In addition, new and evolving products and services, including those that use artificial intelligence and machine learning, raise ethical, technological, legal, regulatory, and other challenges, which may negatively affect our brands and demand for our products and services. Because all of these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not harm our reputation, financial condition , and operating results. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our advertising revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels, if there is a decrease in the rate of adoption of our products, services, and technologies, or due to deceleration or decline in demand for devices used to access our services, among other factors. In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into new fields, including products and services such as hardware, Google Cloud, Google Play, gaming, and subscription products, as well as significant investments in Other Bets, all of which may have margins lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix, property mix, and partner agreements can affect margin. The margin we earn on revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners as well as increased content acquisition costs to content providers. We may also face an increase in infrastructure costs, supporting businesses such as Search, Google Cloud, and YouTube. Additionally, our spend to promote new products and services or distribute certain products and services or increased investment in our innovation efforts across Google and our Other Bets businesses may affect our operating margins. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Alphabet Inc. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services, and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, but it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy and security issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of misinformation or objectionable content on our services or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Our brands may also be negatively affected by the use of our products or services to disseminate information that is deemed to be false or misleading. Furthermore, failure to maintain and enhance equity in our brands may harm our business, financial condition, and operating results. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a valuable role in a range of settings. We face a number of manufacturing and supply chain risks that, if not properly managed, could harm our financial condition, operating results, and prospects. We face a number of risks related to manufacturing and supply chain management, which could affect our ability to supply both our products and our internet-based services. We rely on other companies to manufacture many of our assemblies and finished products, to design certain of our components and parts, and to participate in the distribution of our products and services. Our business could be negatively affected if we are not able to engage these companies with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. We may experience supply shortages and price increases driven by raw material availability, manufacturing capacity, labor shortages, industry allocations, tariffs, trade disputes and barriers, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We may experience shortages or other supply chain disruptions that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available only from a single source or limited sources, and we may not be able to find replacement vendors on favorable terms in the event of a supply chain disruption. In addition, a significant hardware supply interruption could delay critical data center upgrades or expansions. Alphabet Inc. We may enter into long term contracts for materials and products that commit us to significant terms and conditions. We may be liable for materials and products that are not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because many of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. Our products and services may have quality issues resulting from design, manufacturing, or operations. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet expectations or our products or services are defective, it could harm our reputation, financial condition, and operating results. We require our suppliers and business partners to comply with laws and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. Violations of law or unethical business practices could result in supply chain disruptions, canceled orders, harm to key relationships, and damage to our reputation. Their failure to procure necessary license rights to intellectual property, could affect our ability to sell our products or services and expose us to litigation or financial claims. Interruption, interference with, or failure of our information technology and communications systems could hurt our ability to effectively provide our products and services, which could harm our reputation, financial condition, and operating results. In addition, complications with the design or implementation of our new global enterprise resource planning (ERP) system could harm our business and operations. The availability of our products and services and fulfillment of our customer contracts depend on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference, or interruption from terrorist attacks, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, ransomware attacks, computer denial of service attacks, phishing schemes, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and, in some cases, to potential disruptions resulting from problems experienced by facility operators. Some of our systems are not fully redundant, and disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, closure of a facility, or other unanticipated problems at our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in or failure of our services or systems. In addition, we rely extensively on information systems and technology to manage our business and summarize operating results. We are in the process of a multi-year implementation of a new ERP system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management, and provide timely information to our management team. We may not be able to successfully implement the ERP system without experiencing delays, increased costs, and other difficulties. Failure to successfully design and implement the new ERP system as planned could harm our business, financial condition, and operating results. Additionally, if we do not effectively implement the ERP system as planned or the ERP system does not operate as intended, the effectiveness of our internal control over financial reporting could be negatively affected. Our international operations expose us to additional risks that could harm our business, our financial condition, and operating results. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2019. In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Alphabet Inc. Import and export requirements, tariffs, trade disputes and barriers, and customs classifications that may prevent us from offering products or providing services to a particular market, or that could limit our ability to source assemblies and finished products from a particular market, and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign events, including Brexit, the United Kingdom's withdrawal from the European Union (EU). Brexit may adversely affect our revenues and could subject us to new regulatory costs and challenges (including the transfer of personal data between the EU and the United Kingdom), in addition to other adverse effects that we are unable to effectively anticipate. Anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to government officials, violations of which could result in civil and criminal penalties. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of works councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Because we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could harm our financial condition and operating results. Risks Related to our Industry People access the Internet through a variety of platforms and devices that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our products and services developed for these new interfaces, our business could be harmed. People access the Internet through a growing variety of devices such as desktop computers, mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television-streaming devices. Our products and services may be less popular on these new interfaces. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could harm our business. It is hard to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to creating and supporting products and services across multiple platforms and devices. Failing to attract and retain a substantial number of new device manufacturers, suppliers, distributors, developers, and users, or failing to develop products and technologies that work well on new devices and platforms, could harm our business, financial condition, and operating results and ability to capture future business opportunities. Data privacy and security concerns relating to our technology and our practices could damage our reputation, cause us to incur significant liability, and deter current and potential users or customers from using our products and services. Software bugs or defects, security breaches, and attacks on our systems could result in the improper disclosure and use of user data and interference with our users and customers ability to use our products and services, harming our business operations and reputation. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data-privacy-related matters, even if unfounded, could harm our reputation, financial condition, and operating results. Our policies and practices may change over time as expectations regarding privacy and data change. Our products and services involve the storage and transmission of proprietary information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems and control failures, security breaches, failure to comply with our privacy policies, and/or inadvertent disclosure of user data could result in government and legal exposure, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users or customers. We expect to continue to expend significant resources to maintain security protections that shield against bugs, theft, misuse, or security vulnerabilities or breaches. We experience cyber attacks and other attempts to gain unauthorized access to our systems on a regular basis. We may experience future security issues, whether due to employee error or malfeasance or system errors or Alphabet Inc. vulnerabilities in our or other parties systems, which could result in significant legal and financial exposure. Government inquiries and enforcement actions, litigation, and adverse press coverage could harm our business. We may be unable to anticipate or detect attacks or vulnerabilities or implement adequate preventative measures. Attacks and security issues could also compromise trade secrets and other sensitive information, harming our business. While we have dedicated significant resources to privacy and security incident response capabilities, including dedicated worldwide incident response teams, our response process may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident. As a result, we may suffer significant legal, reputational, or financial exposure, which could harm our business, financial condition, and operating results. Our ongoing investments in safety, security, and content review will likely continue to identify abuse of our platforms and misuse of user data. In addition to our efforts to mitigate cyber attacks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and unauthorized access to user data by third parties, including investigations and review of platform applications that could access the information of users of our services. As a result of these efforts, we could discover incidents of unnecessary access to or misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, and we may be notified of such incidents or activity via third parties. Such incidents and activities may include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading disinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Problematic content, including low-quality user-generated content, web spam, content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. We, like others in the industry, face violations of our content guidelines, including sophisticated attempts by bad actors to manipulate our hosting and advertising systems to fraudulently generate revenues, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to promote high-quality and relevant results and to detect and prevent low-quality content and invalid traffic, we may be unable to adequately detect and prevent such abuses. Many websites violate or attempt to violate our guidelines, including by seeking to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Such efforts (known as web spam) may affect the quality of content on our platforms and lead them to display false, misleading or undesirable content. Although English-language web spam in our search results has been reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek inappropriate ways to improve their rankings. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on low-quality websites. If we fail to detect and prevent an increase in problematic content, it could hurt our reputation for delivering relevant information or reduce use of our platforms, harming our financial condition or operating results. It may also subject us to litigation and regulatory inquiries, which could result in monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Alphabet Inc. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in 2018 the United States Federal Communications Commission repealed net neutrality rules, which could lead internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. Such interference could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our business. Risks Related to Laws and Regulations We are subject to increasing regulatory scrutiny as well as changes in public policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry are experiencing increased regulatory scrutiny. For instance, various regulatory agencies, including competition, consumer protection, and privacy authorities, are reviewing aspects of our products and services. We continue to cooperate with these investigations. Prior, existing, and new investigations have in the past and may in the future result in substantial fines and penalties, changes to our products and services, alterations to our business operations, and civil litigation, all of which could harm our business, reputation, financial condition, and operating results. Changes in international and local social, political, economic, tax, and regulatory conditions or in laws and policies governing a wide range of topics may increase our cost of doing business, limit our ability to pursue certain business models or offer certain products or services, and cause us to change our business practices. Further, our investment in a variety of new fields, including the health industry and payment services, also raises a number of new regulatory issues. These factors could harm our business and operating results in material ways. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations or applications of existing laws and regulations in a manner inconsistent with our practices) may make our products and services less useful, limit our ability to pursue certain business models or offer certain products and services, require us to incur substantial costs, expose us to unanticipated civil or criminal liability, or cause us to change our business practices. These laws and regulations are evolving and involve matters central to our business, including, among others: Competition laws and regulations around the world. Privacy laws, such as the California Consumer Privacy Act of 2018 that came into effect in January of 2020, which gives new data privacy rights to California residents, and SB-327 in California, which regulates the security of data in connection with internet connected devices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. Copyright laws, such as the EU Directive on Copyright in the Digital Single Market (EUCD) of April 17, 2019, which increases the liability of content-sharing services with respect to content uploaded by their users. It has also created a new property right in news publications that will limit the ability of some online services to interact with or present such content. Each EU Member State must implement the EUCD by June 7, 2021. In addition, there are new constraining licensing regimes that limit our ability to operate with respect to copyright protected works. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Alphabet Inc. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices or when we may not proactively discover such content due to the scale of third-party content and the limitations of existing technologies. Other countries, including Singapore, Australia, and the United Kingdom, have implemented or are considering similar legislation imposing penalties for failure to remove certain types of content. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain and could harm our business. For example: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. Court decisions such as the judgment of the Court of Justice of the European Union (CJEU) on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. Court decisions that require Google to remove links not just in the jurisdiction of the issuing court, but for all versions of the search engine worldwide, including in locations where the content at issue is lawful, may limit the content we can show to our users and impose significant operational burdens. The Supreme Court of Canada issued such a decision against Google in June 2017, and others could treat its decision as persuasive. With respect to the right to be forgotten, a follow-up case of the CJEU on September 24, 2019 ruled that a search engine operator is not required to remove links from all versions of the search engine worldwide, but the court also noted in some cases, removal of links from all versions of the search engine available from the EU (including non-EU specific versions) may be required. The introduction of new businesses, products, services, and technologies, our activities in certain jurisdictions, or other actions we take may subject us to additional laws and regulations. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are subject to claims, suits, government investigations, and other proceedings that may harm our business, financial condition, and operating results. We are subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as Google Cloud offerings, we may also be subject to a variety of claims including product warranty, product liability, and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental impacts, or service disruptions or failures. Any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted in, and may in the future result in, additional substantial fines, penalties, injunctions, and other sanctions that could harm our business, financial condition, and operating results. We may be subject to legal liability associated with providing online services or content. Our products and services let users exchange information, advertise products and services, conduct business, and engage in various online activities. We also place advertisements displayed on other companies websites, and we offer third-party products, services, and/or content. The law relating to the liability of online service providers for others activities on their services is still somewhat unsettled both within the U.S. and internationally. Claims have been brought against us for defamation, negligence, breaches of contract, copyright and trademark infringement, unfair competition, unlawful activity, torts, fraud, or other legal theories based on the nature and content of information available on or via our services. Alphabet Inc. We may be subject to claims by virtue of our involvement in hosting, transmitting, marketing, branding, or providing access to content created by third parties. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Privacy and data protection regulations are complex and rapidly evolving areas. Adverse interpretations of these laws could harm our business, reputation, financial condition, and operating results. Authorities around the world have adopted and are considering a number of legislative and regulatory proposals concerning data protection and limits on encryption of user data. Adverse legal rulings, legislation, or regulation could result in fines and orders requiring that we change our data practices, which could have an adverse effect on our ability to provide services, harming our business operations. Complying with these evolving laws could result in substantial costs and harm the quality of our products and services, negatively affecting our business. Recent legal developments in Europe have created compliance uncertainty regarding transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. The GDPR creates a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment that involves substantial costs, and despite our efforts, governmental authorities or others have asserted and may continue to assert that our business practices fail to comply with its requirements. If our operations are found to violate GDPR requirements, we may incur substantial fines, have to change our business practices, and face reputational harm, any of which could have a material adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to 4% of annual worldwide revenues. Fines of up to 2% of annual worldwide revenues can be levied for other specified violations. The EU-U.S. and the Swiss-U.S. Privacy Shield frameworks allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with specified requirements to import personal data from the EU and Switzerland. However, these frameworks face a number of legal challenges and their validity remains subject to legal, regulatory, and political developments in both Europe and the U.S. The potential invalidation of data transfer mechanisms could have a significant adverse impact on our ability to process and transfer personal data outside of the EEA. These developments create some uncertainty, and compliance obligations could cause us to incur costs or harm the operations of our products and services in ways that harm our business. We face, and may continue to face intellectual property and other claims that could be costly to defend, result in significant damage awards or other costs (including indemnification awards), and limit our ability to use certain technologies in the future. We, like other internet, technology and media companies, hold large numbers of patents, copyrights, trademarks, and trade secrets and are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent-holding companies may frequently seek to generate income from patents they have obtained by bringing claims against us. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Other parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease-and-desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services. They may also cause us to change our business practices and require development of non-infringing products, services, or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and in some cases indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property Alphabet Inc. infringement claims. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming and expensive to litigate or settle. To the extent such claims are successful, they may harm our business, including our product and service offerings, financial condition, or operating results. Risks Related to Ownership of our Stock We cannot guarantee that any share repurchase program will be fully consummated or that any share repurchase program will enhance long-term stockholder value, and share repurchases could increase the volatility of the price of our stock and could diminish our cash reserves. In January 2018, January 2019, and July 2019, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion , $12.5 billion , and $25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2018 and January 2019 authorizations were completed in 2019. As of December 31, 2019, $20.8 billion remains available for repurchase. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Our share repurchase program could affect the price of our stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2019, Larry Page and Sergey Brin beneficially owned approximately 84.3% of our outstanding Class B common stock, which represented approximately 51.2% of the voting power of our outstanding common stock. Through their stock ownership, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could continue Larry and Sergeys current relative voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts other stockholders ability to influence corporate matters and we may take actions that some of our stockholders do not view as beneficial, which could reduce the market price of our Class A common stock and our Class C capital stock. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry and Sergey have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of continuing the influence of Larry and Sergey. Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Alphabet Inc. Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us. General Risks Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly, year-to-date, and annual expenses as a percentage of our revenues may differ significantly from our historical rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this section in addition to the following factors may affect our operating results: Our ability to continue to attract and retain users and customers to our products and services. Our ability to attract user and/or customer adoption of, and generate significant revenues from, new products, services, and technologies in which we have invested considerable time and resources. Our ability to monetize traffic on Google properties and our Google Network Members' properties across various devices. Revenue fluctuations caused by changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix. The amount of revenues and expenses generated and incurred in currencies other than U.S. dollars, and our ability to manage the resulting risk through our foreign exchange risk management program. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Geopolitical events, including trade disputes. Changes in global business or macroeconomic conditions. Because our businesses are changing and evolving, our historical operating results may not be useful to you in predicting our future operating results. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may harm our business, financial condition, and operating results. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and operating results. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions, which could create unforeseen operating difficulties and expenditures. Some of the areas where we face risks include: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully integrate and further develop the acquired business or technology. Alphabet Inc. Implementation or remediation of controls, procedures, and policies at the acquired company. Integration of the acquired companys accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of a transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, data privacy and security issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or operating results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may harm our financial condition or operating results. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Our future success depends in large part upon the continued service of key members of our senior management team. For instance, Sundar Pichai is critical to the overall management of Alphabet and its subsidiaries and plays an important role in the development of our technology. He also plays a key role in maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, particularly in light of our holding company structure, adverse changes to our corporate culture could harm our business operations. In preparing our financial statements, we incorporate valuation methodologies that are subjective in nature and valuations may fluctuate over time. We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves use of appropriate valuation methods and certain unobservable inputs, require management judgment and estimation, and may change over time. Alphabet Inc. As it relates to our non-marketable investments, the market values can be negatively affected by liquidity, credit deterioration or losses, performance and financial results of the underlying companies, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates that replace LIBOR, the effect of new or changing regulations, the stock market in general, or other factors. Since January 2018, we adjust the carrying value of our non-marketable equity investments to fair value for observable transactions of identical or similar investments of the same issuer or for impairments. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could materially adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be negatively affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles (including changes in the interpretation of existing laws), as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions, including in Europe, on various tax-related assertions, such as transfer-pricing adjustments or permanent-establishment claims. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition and could require us to change our business practices in a manner adverse to our business. It may also subject us to additional litigation and regulatory inquiries, resulting in the diversion of managements time and attention. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations for which the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, or rates in various jurisdictions may be subject to significant changes in ways that impair our financial results. In particular, France, Italy, and other countries have enacted or are considering digital services taxes, which could lead to inconsistent and potentially overlapping international tax regimes. The Organization for Economic Cooperation and Development recently released a proposal relating to its initiative for modernizing international tax rules, with the goal of having different countries enact legislation to implement a modernized and aligned international tax framework, but there can be no guarantee that this will occur. The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. For example, from January 1, 2019 through December 31, 2019, the closing price of our Class A common stock ranged from $1,025.47 per share to $1,362.47 per share, and the closing price of our Class C capital stock ranged from $1,016.06 to $1,361.17 per share. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others: Quarterly variations in our operating results or those of our competitors. Announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments. Recommendations by securities analysts or changes in earnings estimates. Announcements about our earnings that are not in line with analyst expectations, the risk of which is enhanced because it is our policy not to give guidance on earnings. Announcements by our competitors of their earnings that are not in line with analyst expectations. Alphabet Inc. Commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy. The volume of shares of Class A common stock and Class C capital stock available for public sale. Sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees). Short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock. The perceived values of Class A common stock and Class C capital stock relative to one another. Any share repurchase program. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock, regardless of our actual operating performance. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which we believe is sufficient to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Note 10 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2019 , there were approximately 2,455 and 2,030 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2019 , there were approximately 66 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2019 : Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 1,970 $ 1,229.02 1,970 $ 24,470 November 1 - 30 1,626 $ 1,304.00 1,626 $ 22,350 December 1 - 31 1,164 $ 1,337.16 1,164 $ 20,793 Total 4,760 4,760 (1) In January and July 2019, the board of directors of Alphabet authorized the company to repurchase up to an additional $12.5 billion and $25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2019 authorization were completed during the fourth quarter of 2019. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2014 to December 31, 2019 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2014 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 5-Year total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from December 31, 2014 to December 31, 2019 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2014 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2020 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. We have omitted discussion of 2017 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2018 Annual Report on Form 10-K, as amended. Trends in Our Business The following trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from new formats. Our users are accessing the Internet via diverse devices and modalities, such as smartphones, wearables and smart home devices, and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of these trends in order to maintain and grow our business. We generate our advertising revenues increasingly from different channels, including mobile, and newer advertising formats, and the margins from the advertising revenues from these channels and newer products have generally been lower than those from traditional desktop search. Additionally, as the market for a particular device type or modality matures our revenues may be affected. For example, growth in the global smartphone market has slowed due to various factors, including increased market saturation in developed countries, which can affect our mobile advertising revenue growth rates. We expect TAC paid to our distribution partners to increase as our revenues grow and to be affected by changes in device mix; geographic mix; partner mix; partner agreement terms; and the percentage of queries channeled through paid access points. We expect these trends to continue to put pressure on our overall margins and affect our revenue growth rates. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube engagement ads, which monetize at a lower rate than traditional search ads. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, and we continue to develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time and we expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. This trend could impact our margins as developing markets initially monetize at a lower rate than more mature markets. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. Alphabet Inc. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription and other services. The margins on these revenues vary significantly and may be lower than the margins on our advertising revenues. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. As we continue to serve our users and expand our businesses, we will invest heavily in operating and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. In addition, our capital expenditures have grown over the last several years. We expect this trend to continue in the long term as we invest heavily in land and buildings for data centers and offices, and information technology infrastructure, which includes servers and network equipment . In addition, acquisitions remain an important part of our strategy and use of capital, and we expect to continue to spend cash on acquisitions and other investments. These acquisitions generally enhance the breadth and depth of our offerings, as well as expand our expertise in engineering and other functional areas. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. Executive Overview of Results Below are our key financial results for the fiscal year ended December 31, 2019 (consolidated unless otherwise noted): Revenues of $161.9 billion and revenue growth of 18% year over year, constant currency revenue growth of 20% year over year. Google segment revenues of $160.7 billion with revenue growth of 18% year over year and Other Bets revenues of $659 million with revenue growth of 11% year over year. Revenues from the United States , EMEA , APAC , and Other Americas were $74.8 billion , $50.6 billion , $26.9 billion , and $9.0 billion , respectively. Cost of revenues was $71.9 billion , consisting of TAC of $30.1 billion and other cost of revenues of $41.8 billion . Our TAC as a percentage of advertising revenues (TAC rate) was 22.3% . Operating expenses (excluding cost of revenues) were $55.7 billion . Income from operations was $34.2 billion . Other income (expense), net, was $5.4 billion . Effective tax rate was 13% . Net income was $34.3 billion with diluted net income per share of $49.16 . Operating cash flow was $54.5 billion . Capital expenditures were $23.5 billion . Number of employees was 118,899 as of December 31, 2019 . The majority of new hires during the year were engineers and product managers. By product area, the largest headcount additions were in Google Cloud and Search. Information about Segments We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Alphabet Inc. Our reported segments are: Google Google includes our main products such as ads, Android, Chrome, hardware, Google Cloud, Google Maps, Google Play, Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes Access, Calico, CapitalG, GV, Verily, Waymo, and X, among others. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Revenues The following table presents our revenues by segment and revenue source (in millions). Certain amounts in prior periods have been reclassified to conform with current period presentation. Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google properties 77,961 96,451 113,264 Google Network Members' properties 17,616 20,010 21,547 Google advertising 95,577 116,461 134,811 Google Cloud 4,056 5,838 8,918 Google other (1) 10,914 14,063 17,014 Google revenues 110,547 136,362 160,743 Other Bets revenues Hedging gains (losses) (169 ) (138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 (1) YouTube non-advertising revenues are included in Google other revenues. Google advertising revenues Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have been affected and may continue to be affected by various factors, including: advertiser competition for keywords; changes in advertising quality, formats, delivery or policy; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has been affected over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels; changes in our product mix; changes in advertising quality or formats and delivery; the evolution of the online advertising market; increasing competition; our investments in new business strategies; query growth rates; and shifts in the geographic mix of our revenues. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Alphabet Inc. The following table presents our Google advertising revenues (in millions): Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google Network Members' properties 17,616 20,010 21,547 Google advertising $ 95,577 $ 116,461 $ 134,811 Google advertising revenues as a percentage of Google segment revenues 86.5 % 85.4 % 83.9 % (1) YouTube non-advertising revenues are included in Google other revenues. Google advertising revenues are generated on our Google properties (including Google Search other properties and YouTube) and Google Network Members properties. Google advertising revenues consist primarily of the following: Google Search other consists of revenues generated on Google search properties (including revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.) and other Google owned and operated properties like Gmail, Google Maps, and Google Play; YouTube ads consists of revenues generated primarily on YouTube properties; and Google Network Members' properties consist of revenues generated primarily on Google Network Members' properties participating in AdMob, AdSense, and Google Ad Manager. Google Search other Our Google Search other revenues increased $12,819 million from 2018 to 2019. The growth was primarily driven by interrelated factors including increases in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices, continued growth in advertiser activity, and improvements we have made in ad formats and delivery. Revenue growth was partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. Our Google Search other revenues increased $15,485 million from 2017 to 2018. The growth was primarily driven by increases in mobile search resulting from ongoing growth in user adoption and usage, as well as continued growth in advertiser activity. Growth was also driven by improvements in ad formats and delivery, primarily on desktop. Additionally, revenue growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. YouTube ads YouTube ads revenues increased $3,994 million from 2018 to 2019 and increased $3,005 million from 2017 to 2018. The largest contributors to the growth during both periods were our direct response and brand advertising products, both of which benefited from improvements to ad formats and delivery and increased advertiser spending. Google Network Members' properties Our Google Network Members' properties revenues increased $1,537 million from 2018 to 2019. The growth was primarily driven by strength in both AdManager (included in what was previously referred to as programmatic advertising buying) and AdMob, partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. Our Google Network Members' properties revenues increased $2,394 million from 2017 to 2018, primarily driven by strength in both AdMob and AdManager, offset by a decline in our traditional AdSense businesses. Additionally, the growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. Use of Monetization Metrics Paid clicks for our Google properties represent engagement by users and include clicks on advertisements by end-users related to searches on Google.com and other owned and operated properties including Gmail, Google Maps, and Google Play; and viewed YouTube engagement ads (certain YouTube ad formats are not included in our click or impression based metrics). Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense and Google Ad Manager. Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Alphabet Inc. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google properties and the revenues generated by impression activity on Google Network Members properties. Google properties The following table presents changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, Paid clicks change % % Cost-per-click change (25 )% (7 )% The number of paid clicks through our advertising programs on Google properties increased from 2018 to 2019 due to growth in views of YouTube engagement ads; increase in clicks due to interrelated factors, including an increase in search queries resulting from ongoing growth in user adoption and usage, primarily on mobile devices; continued growth in advertiser activity; and improvements we have made in ad formats and delivery. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers. The decrease in cost-per-click was primarily driven by continued growth in YouTube engagement ads where cost-per-click remains lower than on our other advertising platforms. Cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google Network Members' properties The following table presents changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, Impressions change % % Cost-per-impression change % % Impressions increased from 2018 to 2019 primarily due to growth in AdManager. The cost-per-impression was relatively unchanged due to a combination of factors including ongoing product and policy changes and improvements we have made in ad formats and delivery, changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google Cloud The following table presents our Google Cloud revenues (in millions): Year Ended December 31, Google Cloud $ 4,056 $ 5,838 $ 8,918 Google Cloud revenues as a percentage of Google segment revenues 3.7 % 4.3 % 5.5 % Google Cloud revenues consist primarily of revenues from Cloud offerings, including Google Cloud Platform (GCP), which includes infrastructure, data and analytics, and other services G Suite productivity tools; and other enterprise cloud services. Our Google Cloud revenues increased $3,080 million from 2018 to 2019 and increased $1,782 million from 2017 to 2018. The growth during both periods was primarily driven by continued strength in our GCP and G Suite offerings. Our infrastructure and our data and analytics platform products have been the largest drivers of growth in GCP. Alphabet Inc. Google other revenues The following table presents our Google other revenues (in millions): Year Ended December 31, Google other 10,914 14,063 17,014 Google other revenues as a percentage of Google segment revenues 9.9 % 10.3 % 10.6 % Google other revenues consist primarily of revenues from: Google Play, which includes revenues from sales of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising, including YouTube Premium and YouTube TV subscriptions and other services; and other products and services. Our Google other revenues increased $2,951 million from 2018 to 2019. The growth was primarily driven by Google Play and YouTube subscriptions. Our Google other revenues increased $3,149 million from 2017 to 2018. The growth was primarily driven by Google Play and hardware. Over time, our growth rate for Google Cloud and Google other revenues may be affected by the seasonality associated with new product and service launches and market dynamics. Other Bets The following table presents our Other Bets revenues (in millions): Year Ended December 31, Other Bets revenues $ $ $ Other Bets revenues as a percentage of total revenues 0.4 % 0.4 % 0.4 % Other Bets revenues consist primarily of revenues from sales of Access internet and TV services and Verily licensing and RD services. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, United States % % EMEA % % APAC % % Other Americas % % For further details on revenues by geography, see Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Growth The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and constant currency revenue growth for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to U.S. Generally Accepted Accounting Principles (GAAP) results helps improve Alphabet Inc. the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue growth on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue growth (expressed as a percentage) is calculated by determining the increase in current period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions): Year Ended December 31, EMEA revenues $ 44,739 $ 50,645 Exclude foreign exchange effect on current period revenues using prior year rates (1,325 ) 2,397 EMEA constant currency revenues $ 43,414 $ 53,042 Prior period EMEA revenues $ 36,236 $ 44,739 EMEA revenue growth % % EMEA constant currency revenue growth % % APAC revenues $ 21,341 $ 26,928 Exclude foreign exchange effect on current period revenues using prior year rates (49 ) APAC constant currency revenues $ 21,292 $ 27,316 Prior period APAC revenues $ 16,192 $ 21,341 APAC revenue growth % % APAC constant currency revenue growth % % Other Americas revenues $ 7,608 $ 8,986 Exclude foreign exchange effect on current period revenues using prior year rates Other Americas constant currency revenues $ 8,012 $ 9,527 Prior period Other Americas revenues $ 6,147 $ 7,608 Other Americas revenue growth % % Other Americas constant currency revenue growth % % United States revenues $ 63,269 $ 74,843 United States revenue growth % % Hedging gains (losses) (138 ) Total revenues $ 136,819 $ 161,857 Total constant currency revenues $ 135,987 $ 164,728 Prior period revenues, excluding hedging effect (1) $ 111,024 $ 136,957 Total revenue growth % % Total constant currency revenue growth % % (1) Total revenues and hedging gains (losses) for the year ended December 31, 2017 were $110,855 million and $(169) million, respectively. Our EMEA revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Euro and British pound. Our APAC revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates primarily due to the U.S. dollar strengthening relative to the Australian dollar and South Korean won, partially offset by the U.S. dollar weakening relative to the Japanese yen. Our Other Americas revenue growth from 2018 to 2019 was unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Alphabet Inc. Costs and Expenses Cost of Revenues Cost of revenues consists of TAC which are paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues as a percentage of revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues as a percentage of revenues generated from ads placed on Google properties because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube advertising and subscription services and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expenses (including stock-based compensation (SBC)), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions): Year Ended December 31, TAC $ 26,726 $ 30,089 Other cost of revenues 32,823 41,807 Total cost of revenues $ 59,549 $ 71,896 Total cost of revenues as a percentage of revenues 43.5 % 44.4 % Cost of revenues increased $12,347 million from 2018 to 2019 . The increase was due to increases in other cost of revenues and TAC of $8,984 million and $3,363 million , respectively. The increase in other cost of revenues from 2018 to 2019 was due to an increase in data center and other operations costs. Additionally, there was an increase in content acquisition costs for YouTube consistent with the growth in YouTube revenues. The increase in TAC from 2018 to 2019 was due to increases in TAC paid to distribution partners and to Google Network Members, primarily driven by growth in revenues subject to TAC. The TAC rate decreased from 22.9% to 22.3% , primarily due to the favorable revenue mix shift from Google Network Members' properties to Google properties. The TAC rate on Google properties revenues increased primarily due to the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. The TAC rate on Google Network revenues decreased primarily due to changes in product mix to products that carry a lower TAC rate. Over time, cost of revenues as a percentage of total revenues may be affected by a number of factors, including the following: The amount of TAC paid to Google Network Members, which is affected by a combination of factors such as geographic mix, product mix, revenue share terms, and fluctuations of the U.S. dollar compared to certain foreign currencies ; The amount of TAC paid to distribution partners, which is affected by changes in device mix, geographic mix, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; Relative revenue growth rates of Google properties and Google Network Members' properties; Costs associated with our data centers and other operations to support ads, Google Cloud, Search, YouTube and other products ; Content acquisition costs, which are primarily affected by the relative growth rates in our YouTube advertising and subscription revenues; Costs related to hardware sales; and Increased proportion of non-advertising revenues, which generally have higher costs of revenues, relative to our advertising revenues. Alphabet Inc. Research and Development The following table presents our RD expenses (in millions): Year Ended December 31, Research and development expenses $ 21,419 $ 26,018 Research and development expenses as a percentage of revenues 15.7 % 16.1 % RD expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $4,599 million from 2018 to 2019 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $3,519 million, largely resulting from a 23% increase in headcount. Over time, RD expenses as a percentage of revenues may be affected by a number of factors including continued investment in ads, Android, Chrome, Google Cloud, Google Play, hardware, machine learning, Other Bets, and Search. Sales and Marketing The following table presents our sales and marketing expenses (in millions): Year Ended December 31, Sales and marketing expenses $ 16,333 $ 18,464 Sales and marketing expenses as a percentage of revenues 11.9 % 11.4 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) and facilities-related costs for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses increased $2,131 million from 2018 to 2019 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,371 million , largely resulting from a 15% increase in headcount. In addition, there was an increase in advertising and promotional expenses of $402 million . Over time, sales and marketing expenses as a percentage of revenues may be affected by a number of factors including the seasonality associated with new product and service launches. General and Administrative The following table presents our general and administrative expenses (in millions): Year Ended December 31, General and administrative expenses $ 6,923 $ 9,551 General and administrative expenses as a percentage of revenues 5.1 % 5.9 % General and administrative expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for employees in our finance, human resources, information technology, and legal organizations; Depreciation expenses; Equipment-related expenses; Legal-related expenses; and Alphabet Inc. Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $2,628 million from 2018 to 2019 . The increase was primarily due to an increase in legal-related expenses of $1,157 million , including a charge of $554 million from a legal settlement in 2019 and the effect of a legal settlement gain recorded in 2018. Additionally, there was an increase in compensation expenses (including SBC) and facilities-related costs of $687 million , largely resulting from a 19% increase in headcount. Performance fees of $1,203 million have been reclassified from general and administrative expenses to other income (expense), net, for 2018 to conform with current period presentation. See Note 7 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further details. Over time, general and administrative expenses as a percentage of revenues may be affected by discrete items such as legal settlements. European Commission Fines In July 2018, the EC announced its decision that certain provisions in Google's Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $5.1 billion as of June 30, 2018) fine, which was accrued in the second quarter of 2018. In March 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a 1.5 billion ( $1.7 billion as of March 20, 2019) fine, which was accrued in the first quarter of 2019. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, Other income (expense), net $ 7,389 $ 5,394 Other income (expense), net, as a percentage of revenues 5.4 % 3.3 % Other income (expense), net, decreased $1,995 million from 2018 to 2019 . This decrease was primarily driven by a decrease in gains on equity securities, which were $2,649 million in 2019 as compared to $5,460 million in 2018. The majority of the gains in both periods were unrealized. The effect of the decrease in gains on equity securities was partially offset by a decrease in performance fees. The decrease in other income (expense) was also driven by a decrease in gains on debt securities primarily due to an unrealized gain recognized in 2018 resulting from the modification of the terms of a non-marketable debt security. Performance fees of $1,203 million have been reclassified from general and administrative expenses to other income (expense), net, for 2018 to conform with current period presentation. See Note 7 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further details. Over time, other income (expense), net, as a percentage of revenues may be affected by market dynamics and other factors. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets could result in a significant change in the value of our equity securities. Fluctuations in the value of these investments has, and we expect will continue to, contribute to volatility of OIE in future periods. For additional information about equity investments, see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Alphabet Inc. Provision for Income Taxes The following table presents our provision for income taxes (in millions) and effective tax rate: Year Ended December 31, Provision for income taxes $ 4,177 $ 5,282 Effective tax rate 12.0 % 13.3 % Our provision for income taxes and our effective tax rate increased from 2018 to 2019 , due to discrete events in 2018 and 2019. In 2018, we released our deferred tax asset valuation allowance related to gains on equity securities and recognized the benefits of the U.S. Tax Cuts and Jobs Act (""Tax Act""). In 2019, we recognized an increase in discrete benefits related to the resolution of multi-year audits, partially offset by the reversal of Altera tax benefit as a result of the U.S. Court of Appeals decision. See Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda. This will affect our geographic mix of earnings . We expect our future effective tax rate to be affected by the geographic mix of earnings in countries with different statutory rates. Additionally, our future effective tax rate may be affected by changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Alphabet Inc. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2019 . This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Seasonal fluctuations in internet usage and advertiser expenditures, underlying business trends such as traditional retail seasonality and macroeconomic conditions have affected, and are likely to continue to affect, our business. Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2018 Jun 30, 2018 Sept 30, 2018 Dec 31, 2018 Mar 31, 2019 Jun 30, 2019 Sept 30, 2019 Dec 31, 2019 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 31,146 $ 32,657 $ 33,740 $ 39,276 $ 36,339 $ 38,944 $ 40,499 $ 46,075 Costs and expenses: Cost of revenues 13,467 13,883 14,281 17,918 16,012 17,296 17,568 21,020 Research and development 5,039 5,114 5,232 6,034 6,029 6,213 6,554 7,222 Sales and marketing 3,604 3,780 3,849 5,100 3,905 4,212 4,609 5,738 General and administrative 1,403 1,764 1,753 2,003 2,088 2,043 2,591 2,829 European Commission fines 5,071 1,697 Total costs and expenses 23,513 29,612 25,115 31,055 29,731 29,764 31,322 36,809 Income from operations 7,633 3,045 8,625 8,221 6,608 9,180 9,177 9,266 Other income (expense), net 2,910 1,170 1,458 1,851 1,538 2,967 (549 ) 1,438 Income from continuing operations before income taxes 10,543 4,215 10,083 10,072 8,146 12,147 8,628 10,704 Provision for income taxes 1,142 1,020 1,124 1,489 2,200 1,560 Net income $ 9,401 $ 3,195 $ 9,192 $ 8,948 $ 6,657 $ 9,947 $ 7,068 $ 10,671 Basic net income per share of Class A and B common stock and Class C capital stock $ 13.53 $ 4.60 $ 13.21 $ 12.87 $ 9.58 $ 14.33 $ 10.20 $ 15.49 Diluted net income per share of Class A and B common stock and Class C capital stock $ 13.33 $ 4.54 $ 13.06 $ 12.77 $ 9.50 $ 14.21 $ 10.12 $ 15.35 Capital Resources and Liquidity As of December 31, 2019 , we had $119.7 billion in cash, cash equivalents, and marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities and marketable equity securities. As of December 31, 2019 , we had long-term taxes payable of $7.3 billion related to a one-time transition tax payable incurred as a result of the Tax Act. As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. In 2017, 2018 and 2019, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ( $2.7 billion as of June 27, 2017), 4.3 billion ( $5.1 billion as of June 30, 2018), and 1.5 billion ( $1.7 billion as of March 20, 2019), respectively. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. Alphabet Inc. In November 2019, we entered into an agreement to acquire Fitbit, a leading wearables brand, for $7.35 per share, representing a total purchase price of approximately $2.1 billion as of the date of the agreement. The acquisition of Fitbit is expected to be completed in 2020, subject to customary closing conditions, including the receipt of regulatory approvals. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. The primary use of capital continues to be to invest for the long term growth of the business. We regularly evaluate our cash and capital structure, including the size, pace and form of capital return to stockholders. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2019 . We have $4.0 billion of revolving credit facilities expiring in July 2023 with no amounts outstanding as of December 31, 2019 . The interest rate for the credit facilities is determined based on a formula using certain market rates. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. As of December 31, 2019 , we have senior unsecured notes outstanding due in 2021, 2024, and 2026 with a total carrying value of $4.0 billion . As of December 31, 2019 , we had remaining authorization of $20.8 billion for repurchase of Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 11 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. We continue to make significant investments in land and buildings for data centers and offices and information technology infrastructure through purchases of property and equipment and lease arrangements to provide capacity for the growth of our business. During the year ended December 31, 2019, we spent $23.5 billion on capital expenditures and recognized total operating lease assets of $4.4 billion . As of December 31, 2019, the amount of total future lease payments under operating leases, which had a weighted average remaining lease term of 10 years , was $13.9 billion . Finance leases were not material for the year ended December 31, 2019. Please refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information on the leases. The following table presents our cash flows (in millions): Year Ended December 31, Net cash provided by operating activities $ 47,971 $ 54,520 Net cash used in investing activities $ (28,504 ) $ (29,491 ) Net cash used in financing activities $ (13,179 ) $ (23,209 ) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google properties and Google Network Members' properties. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Our primary uses of cash from our operating activities include payments to our Google Network Members and distribution partners, and payments for content acquisition costs. In addition, uses of cash from operating activities include compensation and related costs, hardware inventory costs, other general corporate expenditures, and income taxes. Net cash provided by operating activities increased from 2018 to 2019 primarily due to increases in cash received from revenues, offset by increases in cash paid for cost of revenues and operating expenses. Cash Used in Investing Activities Cash provided by investing activities consists primarily of maturities and sales of our investments in marketable and non-marketable securities. Cash used in investing activities consists primarily of purchases of property and Alphabet Inc. equipment, which primarily includes our investments in land and buildings for data centers and offices and information technology infrastructure to provide capacity for the growth of our businesses; purchases of marketable and non-marketable securities; and payments for acquisitions. Net cash used in investing activities increased from 2018 to 2019 primarily due to a net increase in purchases of securities and an increase in payments for acquisitions, partially offset by a decrease in payments for purchases of property and equipment. The decrease in purchases of property and equipment was driven by decreases in purchases of servers as well as land and buildings for offices, partially offset by an increase in data center construction. Cash Used in Financing Activities Cash provided by financing activities consists primarily of proceeds from issuance of debt and proceeds from sale of interest in consolidated entities. Cash used in financing activities consists primarily of net payments related to stock-based award activities, repurchases of capital stock, and repayments of debt. Net cash used in financing activities increased from 2018 to 2019 primarily due to an increase in cash payments for repurchases of capital stock and a decrease in proceeds from sale of interest in consolidated entities. Contractual Obligations as of December 31, 2019 The following summarizes our contractual obligations as of December 31, 2019 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations (1) $ 13,854 $ 1,757 $ 3,525 $ 2,809 $ 5,763 Obligations for leases that have not yet commenced (1) 7,418 1,314 5,005 Purchase obligations (2) 5,660 4,212 Long-term debt obligations (3) 5,288 1,258 1,224 2,579 Tax payable (4) 7,315 1,166 3,661 2,488 Other long-term liabilities reflected on our balance sheet (5) 1,484 Total contractual obligations $ 41,019 $ 6,690 $ 8,375 $ 9,577 $ 16,377 (1) For further information, refer to Note 4 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to information technology assets and data center operation costs; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2019 . Excluded from the table above are open orders for purchases that support normal operations. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 6 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $2.6 billion as of December 31, 2019 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for the construction of offices and certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the EC fines, refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2019 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Alphabet Inc. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, consumer protection, non-income taxes, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated Alphabet Inc. from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Fair Value Measurements We measure certain of our non-marketable equity and debt investments, certain other instruments including stock-based compensation awards settled in the stock of certain Other Bets, and certain assets and liabilities acquired in a business combination, at fair value on a nonrecurring basis. The determination of fair value involves the use of appropriate valuation methods and relevant inputs into valuation models. The fair value hierarchy prioritizes the inputs used to measure fair value whereby it gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. We maximize the use of relevant observable inputs and minimize the use of unobservable inputs. Our use of unobservable inputs reflects the assumptions that market participants would use and may include our own data adjusted based on reasonably available information. We apply judgment in assessing the relevance of observable market data to determine the priority of inputs under the fair value hierarchy, particularly in situations where there is very little or no market activity. In determining the fair values of our non-marketable equity and debt investments, as well as assets acquired (especially with respect to intangible assets) and liabilities assumed in business combinations, we make significant estimates and assumptions, some of which include the use of unobservable inputs. Certain stock-based compensation awards may be settled in the stock of certain of our Other Bets or in cash. These awards are based on the equity values of the respective Other Bet, which requires use of unobservable inputs. We also have compensation arrangements with payouts based on realized investment returns, i.e. performance fees. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized, and may require the use of unobservable inputs. Non-marketable Equity Securities Our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include industry and market conditions, financial performance, business prospects, and other relevant events and factors. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we measure our non-marketable securities at fair value. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the local currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign Alphabet Inc. currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets and liabilities denominated in currencies other than the local currencies at the balance sheet dates, it would have resulted in an adverse effect on income before income taxes of approximately $1 million and $8 million as of December 31, 2018 and 2019 , respectively. The adverse effect as of December 31, 2018 and 2019 is after consideration of the offsetting effect of approximately $374 million and $662 million , respectively, from foreign exchange contracts in place for the years ended December 31, 2018 and 2019 . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2018 and 2019 , the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $772 million and $1.1 billion lower as of December 31, 2018 and 2019 , respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. We use foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $635 million and $936 million lower as of December 31, 2018 and 2019 , respectively. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our Corporate Treasury investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as a result of higher market interest rates compared to interest rates at the time of purchase. We account for both fixed and variable rate securities at fair value with gains and losses recorded in AOCI until the securities are sold. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2018 and 2019 are shown below (in millions): As of December 31, 12-Month Average As of December 31, Risk Category - Interest Rate $ $ $ $ Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2018 and 2019 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Alphabet Inc. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of market-related risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $3.3 billion of our investments as of December 31, 2019 . A hypothetical adverse price change of 10%, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $330 million . Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). The fair value is measured at the time of the observable transaction, which is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize appreciation in the value of our investments through liquidity events such as public offerings, acquisitions, private sales or other favorable market events. As of December 31, 2019 , the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $11.4 billion . Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge on our non-marketable equity securities. The carrying values of our equity method investments generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2018 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedule listed in the Index at Item 15 (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 3, 2020 expressed an unqualified opinion thereon. Adoption of New Accounting Standard As discussed in Note 1 to the financial statements, the Company changed its method for accounting for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Alphabet Inc. Loss Contingencies Description of the Matter The Company is regularly subject to claims, suits, and government investigations involving competition, intellectual property, privacy, consumer protection, tax, labor and employment, commercial disputes, content generated by its users, goods and services offered by advertisers or publishers using their platforms, and other matters. As described in Note 10 to the financial statements Commitments and Contingencies such claims could result in adverse consequences. Significant judgment is required to determine both the likelihood, and the estimated amount, of a loss related to such matters. Auditing managements accounting for and disclosure of loss contingencies from these matters involved challenging and subjective auditor judgement in assessing the Companys evaluation of the probability of a loss, and the estimated amount or range of loss. How We Addressed the Matter in Our Audit We tested relevant controls over the identified risks associated with managements accounting for and disclosure of these matters. This included controls over managements assessment of the probability of incurrence of a loss and whether the loss or range of loss was reasonably estimable and the development of related disclosures. Our audit procedures included gaining an understanding of previous rulings issued by regulators and the status of ongoing lawsuits, reviewing letters addressing the matters from internal and external legal counsel, meeting with internal legal counsel to discuss the allegations, and obtaining a representation letter from management on these matters. We also evaluated the Companys disclosures in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 3, 2020 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2019 consolidated financial statements of the Company and our report dated February 3, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the U.S. Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 3, 2020 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2018 As of December 31, 2019 Assets Current assets: Cash and cash equivalents $ 16,701 $ 18,498 Marketable securities 92,439 101,177 Total cash, cash equivalents, and marketable securities 109,140 119,675 Accounts receivable, net of allowance of $729 and $753 20,838 25,326 Income taxes receivable, net 2,166 Inventory 1,107 Other current assets 4,236 4,412 Total current assets 135,676 152,578 Non-marketable investments 13,859 13,078 Deferred income taxes Property and equipment, net 59,719 73,646 Operating lease assets 10,941 Intangible assets, net 2,220 1,979 Goodwill 17,888 20,624 Other non-current assets 2,693 2,342 Total assets $ 232,792 $ 275,909 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 4,378 $ 5,561 Accrued compensation and benefits 6,839 8,495 Accrued expenses and other current liabilities 16,958 23,067 Accrued revenue share 4,592 5,916 Deferred revenue 1,784 1,908 Income taxes payable, net Total current liabilities 34,620 45,221 Long-term debt 4,012 4,554 Deferred revenue, non-current Income taxes payable, non-current 11,327 9,885 Deferred income taxes 1,264 1,701 Operating lease liabilities 10,214 Other long-term liabilities 3,545 2,534 Total liabilities 55,164 74,467 Commitments and Contingencies (Note 10) Stockholders equity: Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000, Class C 3,000,000); 695,556 (Class A 299,242, Class B 46,636, Class C 349,678) and 688,335 (Class A 299,828, Class B 46,441, Class C 342,066) shares issued and outstanding 45,049 50,552 Accumulated other comprehensive loss ( 2,306 ) ( 1,232 ) Retained earnings 134,885 152,122 Total stockholders equity 177,628 201,442 Total liabilities and stockholders equity $ 232,792 $ 275,909 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenues $ 110,855 $ 136,819 $ 161,857 Costs and expenses: Cost of revenues 45,583 59,549 71,896 Research and development 16,625 21,419 26,018 Sales and marketing 12,893 16,333 18,464 General and administrative 6,840 6,923 9,551 European Commission fines 2,736 5,071 1,697 Total costs and expenses 84,677 109,295 127,626 Income from operations 26,178 27,524 34,231 Other income (expense), net 1,015 7,389 5,394 Income before income taxes 27,193 34,913 39,625 Provision for income taxes 14,531 4,177 5,282 Net income $ 12,662 $ 30,736 $ 34,343 Basic net income per share of Class A and B common stock and Class C capital stock $ 18.27 $ 44.22 $ 49.59 Diluted net income per share of Class A and B common stock and Class C capital stock $ 18.00 $ 43.70 $ 49.16 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 12,662 $ 30,736 $ 34,343 Other comprehensive income (loss): Change in foreign currency translation adjustment 1,543 ( 781 ) ( 119 ) Available-for-sale investments: Change in net unrealized gains (losses) 1,611 Less: reclassification adjustment for net (gains) losses included in net income ( 911 ) ( 111 ) Net change (net of tax effect of $0, $156, and $221) ( 823 ) 1,500 Cash flow hedges: Change in net unrealized gains (losses) ( 638 ) Less: reclassification adjustment for net (gains) losses included in net income ( 299 ) Net change (net of tax effect of $247, $103, and $42) ( 545 ) ( 277 ) Other comprehensive income (loss) 1,410 ( 1,216 ) 1,104 Comprehensive income $ 14,072 $ 29,520 $ 35,447 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2016 691,293 $ 36,307 $ ( 2,402 ) $ 105,131 $ 139,036 Cumulative effect of accounting change ( 15 ) ( 15 ) Common and capital stock issued 8,652 Stock-based compensation expense 7,694 7,694 Tax withholding related to vesting of restricted stock units ( 4,373 ) ( 4,373 ) Repurchases of capital stock ( 5,162 ) ( 315 ) ( 4,531 ) ( 4,846 ) Sale of interest in consolidated entities Net income 12,662 12,662 Other comprehensive income (loss) 1,410 1,410 Balance as of December 31, 2017 694,783 40,247 ( 992 ) 113,247 152,502 Cumulative effect of accounting change ( 98 ) ( 599 ) ( 697 ) Common and capital stock issued 8,975 Stock-based compensation expense 9,353 9,353 Tax withholding related to vesting of restricted stock units and other ( 4,782 ) ( 4,782 ) Repurchases of capital stock ( 8,202 ) ( 576 ) ( 8,499 ) ( 9,075 ) Sale of interest in consolidated entities Net income 30,736 30,736 Other comprehensive income (loss) ( 1,216 ) ( 1,216 ) Balance as of December 31, 2018 695,556 45,049 ( 2,306 ) 134,885 177,628 Cumulative effect of accounting change ( 30 ) ( 4 ) ( 34 ) Common and capital stock issued 8,120 Stock-based compensation expense 10,890 10,890 Tax withholding related to vesting of restricted stock units and other ( 4,455 ) ( 4,455 ) Repurchases of capital stock ( 15,341 ) ( 1,294 ) ( 17,102 ) ( 18,396 ) Sale of interest in consolidated entities Net income 34,343 34,343 Other comprehensive income (loss) 1,104 1,104 Balance as of December 31, 2019 688,335 $ 50,552 $ ( 1,232 ) $ 152,122 $ 201,442 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Operating activities Net income $ 12,662 $ 30,736 $ 34,343 Adjustments: Depreciation and impairment of property and equipment 6,103 8,164 10,856 Amortization and impairment of intangible assets Stock-based compensation expense 7,679 9,353 10,794 Deferred income taxes (Gain) loss on debt and equity securities, net ( 6,650 ) ( 2,798 ) Other ( 189 ) ( 592 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable ( 3,768 ) ( 2,169 ) ( 4,340 ) Income taxes, net 8,211 ( 2,251 ) ( 3,128 ) Other assets ( 2,164 ) ( 1,207 ) ( 621 ) Accounts payable 1,067 Accrued expenses and other liabilities 4,891 8,614 7,170 Accrued revenue share 1,273 Deferred revenue Net cash provided by operating activities 37,091 47,971 54,520 Investing activities Purchases of property and equipment ( 13,184 ) ( 25,139 ) ( 23,548 ) Purchases of marketable securities ( 92,195 ) ( 50,158 ) ( 100,315 ) Maturities and sales of marketable securities 73,959 48,507 97,825 Purchases of non-marketable investments ( 1,745 ) ( 2,073 ) ( 1,932 ) Maturities and sales of non-marketable investments 1,752 Acquisitions, net of cash acquired, and purchases of intangible assets ( 287 ) ( 1,491 ) ( 2,515 ) Proceeds from collection of notes receivable 1,419 Other investing activities Net cash used in investing activities ( 31,401 ) ( 28,504 ) ( 29,491 ) Financing activities Net payments related to stock-based award activities ( 4,166 ) ( 4,993 ) ( 4,765 ) Repurchases of capital stock ( 4,846 ) ( 9,075 ) ( 18,396 ) Proceeds from issuance of debt, net of costs 4,291 6,766 Repayments of debt ( 4,377 ) ( 6,827 ) ( 585 ) Proceeds from sale of interest in consolidated entities Net cash used in financing activities ( 8,298 ) ( 13,179 ) ( 23,209 ) Effect of exchange rate changes on cash and cash equivalents ( 302 ) ( 23 ) Net increase (decrease) in cash and cash equivalents ( 2,203 ) 5,986 1,797 Cash and cash equivalents at beginning of period 12,918 10,715 16,701 Cash and cash equivalents at end of period $ 10,715 $ 16,701 $ 18,498 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 6,191 $ 5,671 $ 8,203 See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (Alphabet) became the successor issuer to Google. We generate revenues primarily by delivering relevant, cost-effective online advertising. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. Noncontrolling interests are not presented separately as the amounts are not material. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the bad debt allowance, sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Revenue Recognition We recognize revenues when we transfer control of promised goods or services to our customers in an amount that reflects the consideration to which we expect to be entitled to in exchange for those goods or services. See Note 2 for further discussion on Revenues. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding and the tax withholding is recorded as a reduction to additional paid-in capital. Additionally, stock-based compensation includes stock-based awards, such as performance stock units (PSUs) and awards that may be settled in cash or the stock of certain of our Other Bets. PSUs are equity classified and expense is recognized over the requisite service period. Awards that are liability classified are remeasured at fair value through Alphabet Inc. settlement or maturity (six months and one day after vesting). The fair value of such awards is based on the equity valuation of the respective Other Bet. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. Performance fees, which are primarily related to gains on equity securities, are recorded as a component of other income (expense), net. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of markets in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2017 , 2018 , or 2019 . In 2017 , 2018 , and 2019 , we generated approximately 47 % , 46 % , and 46 % of our revenues, respectively, from customers based in the U.S. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. We manage our credit risk exposure through timely assessment of our counterparty creditworthiness, credit limits and use of collateral management. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. We maintain reserves for estimated credit losses and these losses have generally been within our expectations. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets measured at fair value on a nonrecurring basis include non-marketable equity securities, which are adjusted to fair value when observable price changes are identified or when the non-marketable equity securities are impaired (referred to as the measurement alternative) . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. Alphabet Inc. We classify all marketable investments that have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities. We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for unrealized losses determined to be other-than-temporary, which we record within other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Our non-marketable equity securities not accounted for under the equity method are primarily accounted for under the measurement alternative in accordance with Accounting Standards Update No. 2016-01, which we adopted on January 1, 2018. Under the measurement alternative, the carrying value of our non-marketable equity investments is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment. Adjustments are determined primarily based on a market approach as of the transaction date. We account for our non-marketable investments that meet the definition of a debt security as available-for-sale securities. We classify our non-marketable investments that do not have stated contractual maturity dates, as non-current assets on the Consolidated Balance Sheets. Impairment of Investments We periodically review our debt and equity investments for impairment. For debt securities we consider the duration, severity and the reason for the decline in security value; whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or if the amortized cost basis cannot be recovered as a result of credit losses. If any impairment is considered other-than-temporary, we will write down the security to its fair value and record the corresponding charge as other income (expense), net. For equity securities we consider impairment indicators such as negative changes in industry and market conditions, financial performance, business prospects, and other relevant events and factors. If indicators exist and the fair value of the security is below the carrying amount, we write down the security to fair value. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests in is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE; and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Accounts Receivable We record accounts receivable at the invoiced amount. We maintain an allowance for doubtful accounts to reserve for potentially uncollectible receivables. We review the accounts receivable by amounts due from customers that are past due to identify specific customers with known disputes or collectability issues. In determining the amount of the reserve, we make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Alphabet Inc. Leases We determine if an arrangement is a lease at inception. Our lease agreements generally contain lease and non-lease components. Payments under our lease arrangements are primarily fixed. Non-lease components primarily include payments for maintenance and utilities. We combine fixed payments for non-lease components with lease payments and account for them together as a single lease component which increases the amount of our lease assets and liabilities. Certain lease agreements contain variable payments, which are expensed as incurred and not included in the lease assets and liabilities. These amounts include payments affected by the Consumer Price Index, payments contingent on wind or solar production for power purchase arrangements, and payments for maintenance and utilities. Lease assets and liabilities are recognized at the present value of the future lease payments at the lease commencement date. The interest rate used to determine the present value of the future lease payments is our incremental borrowing rate, because the interest rate implicit in our leases is not readily determinable. Our incremental borrowing rate is estimated to approximate the interest rate on a collateralized basis with similar terms and payments, and in economic environments where the leased asset is located. Our lease terms include periods under options to extend or terminate the lease when it is reasonably certain that we will exercise that option. We generally use the base, non-cancelable, lease term when determining the lease assets and liabilities. Lease assets also include any prepaid lease payments and lease incentives. Operating lease assets and liabilities are included on our Consolidated Balance Sheet beginning January 1, 2019. The current portion of our operating lease liabilities is included in accrued expenses and other current liabilities and the long term portion is included in operating lease liabilities. Finance lease assets are included in property and equipment, net. Finance lease liabilities are included in accrued expenses and other current liabilities or long-term debt. Operating lease expense is recognized on a straight-line basis over the lease term. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets. We depreciate buildings over periods of seven to 25 years. We depreciate information technology assets generally over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair Alphabet Inc. values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets are not recoverable, the impairment recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were not material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives generally over periods ranging from one to twelve years . Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange gain (loss) in other income (expense), net. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2017 , 2018 and 2019 , advertising and promotional expenses totaled approximately $ 5.1 billion , $ 6.4 billion , and $ 6.8 billion , respectively. Recent Accounting Pronouncements Recently issued accounting pronouncements not yet adopted In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-13 (ASU 2016-13) ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"", which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We will adopt ASU 2016-13 effective January 1, 2020 with the cumulative effect of adoption recorded as an adjustment to retained earnings. The effect on our consolidated financial statements and related disclosures is not expected to be material. Alphabet Inc. Recently adopted accounting pronouncements In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (Topic 842) ""Leases."" Topic 842 supersedes the lease requirements in Accounting Standards Codification Topic 840, ""Leases."" Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases continue to be classified as either finance or operating. We adopted Topic 842 effective January 1, 2019. The most significant effects of Topic 842 were the recognition of $ 8.0 billion of operating lease assets and $ 8.4 billion of operating lease liabilities and the de-recognition of $ 1.5 billion of build-to-suit assets and liabilities upon adoption. We applied Topic 842 to all leases as of January 1, 2019 with comparative periods continuing to be reported under Topic 840. In the adoption of Topic 842, we carried forward the assessment from Topic 840 of whether our contracts contain or are leases, the classification of our leases, and remaining lease terms. Our accounting for finance leases remains substantially unchanged. The standard did not have a significant effect on our consolidated results of operations or cash flows. See Note 4 for further details. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Hedging gains (losses), which were previously included in Google revenues, are now reported separately as a component of total revenues for all periods presented. See Note 2 for further details. Additionally, performance fees have been reclassified for all periods from general and administrative expenses to other income (expense), net to align with the presentation of the investment gains and losses on which the performance fees are based. See Note 7 for further details. Note 2. Revenues Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that we expect in exchange for those goods or services. Sales and other similar taxes are excluded from revenues. The following table presents our revenues disaggregated by type (in millions). Certain amounts in prior periods have been reclassified to conform with current period presentation. Year Ended December 31, Google Search other $ 69,811 $ 85,296 $ 98,115 YouTube ads (1) 8,150 11,155 15,149 Google properties 77,961 96,451 113,264 Google Network Members' properties 17,616 20,010 21,547 Google advertising 95,577 116,461 134,811 Google Cloud 4,056 5,838 8,918 Google other (1) 10,914 14,063 17,014 Google revenues 110,547 136,362 160,743 Other Bets revenues Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 (1) YouTube non-advertising revenues are included in Google other revenues. Alphabet Inc. The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, United States $ 52,449 % $ 63,269 % $ 74,843 % EMEA (1) 36,236 44,739 50,645 APAC (1) 16,192 21,341 26,928 Other Americas (1) 6,147 7,608 8,986 Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 % $ 136,819 % $ 161,857 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (Other Americas). Advertising Revenues We generate advertising revenues primarily by delivering advertising on Google properties, including Google.com, the Google Search app, YouTube, Google Play, Gmail and Google Maps; and Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads, Google Ad Manager as part of the Authorized Buyers marketplace, and Google Marketing Platform, among others. We offer advertising on a click, impression or view basis. We recognize revenue each time a user clicks on the ad, when the ad is displayed or a user views the ad. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Google Cloud Revenues Google Cloud revenues consist primarily of revenues from Google Cloud Platform (which includes infrastructure and data and analytics platform products, and other services), G Suite productivity tools and other enterprise cloud services. Our cloud revenues are provided on either a consumption or subscription basis. Revenue related to cloud services provided on a consumption basis is recognized when the customer utilizes the services, based on the quantity of services consumed. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract term as the customer receives and consumes the benefits of the cloud services. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Google Play, which includes revenues from sale of apps and in-app purchases (which we recognize net of payout to developers) and digital content sold in the Google Play store; hardware, including Google Nest home products, Pixelbooks, Pixel phones and other devices; YouTube non-advertising including, YouTube premium and YouTube TV subscriptions and other services; and other products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Alphabet Inc. Customer Incentives and Credits Certain customers receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues. We believe that there will not be significant changes to our estimates of variable consideration. Deferred Revenues We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. The increase in the deferred revenue balance for the year ended December 31, 2019 was primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $ 1.7 billion of revenues recognized that were included in the deferred revenue balance as of December 31, 2018 . Additionally, we have performance obligations associated with commitments in customer contracts, primarily related to Google Cloud, for future services that have not yet been recognized in revenue. This includes related deferred revenue currently recorded and amounts that will be invoiced in future periods. As of December 31, 2019 , the amount not yet recognized in revenue from these commitments is $ 11.4 billion , which reflects our assessment of relevant contract terms. This amount excludes contracts (i) with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. We expect to recognize approximately two thirds over the next 24 months with the remaining thereafter. However, the amount and timing of revenue recognition is largely driven by customer utilization, which could impact our estimate of the remaining amount of commitments and when we expect to recognize such revenues. Sales Commissions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. The following tables summarize our debt securities by significant investment categories as of December 31, 2018 and 2019 (in millions): As of December 31, 2018 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,202 $ $ $ 2,202 $ 2,202 $ Government bonds 53,634 ( 414 ) 53,291 3,717 49,574 Corporate debt securities 25,383 ( 316 ) 25,082 25,038 Mortgage-backed and asset-backed securities 16,918 ( 324 ) 16,605 16,605 Total $ 98,137 $ $ ( 1,054 ) $ 97,180 $ 5,963 $ 91,217 Alphabet Inc. As of December 31, 2019 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Level 2: Time deposits (1) $ 2,294 $ $ $ 2,294 $ 2,294 $ Government bonds 55,033 ( 30 ) 55,437 4,518 50,919 Corporate debt securities 27,164 ( 3 ) 27,498 27,454 Mortgage-backed and asset-backed securities 19,453 ( 41 ) 19,508 19,508 Total $ 103,944 $ $ ( 74 ) $ 104,737 $ 6,856 $ 97,881 (1) The majority of our time deposits are domestic deposits. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $ 185 million , $ 1.3 billion , and $ 292 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. We recognized gross realized losses of $ 295 million , $ 143 million , and $ 143 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. We reflect these gains and losses as a component of other income (expense), net, in the Consolidated Statements of Income. The following table summarizes the estimated fair value of our investments in marketable debt securities with stated contractual maturity dates, accounted for as available-for-sale securities and classified by the contractual maturity date of the securities (in millions): As of December 31, 2019 Due in 1 year $ 20,392 Due in 1 year through 5 years 63,151 Due in 5 years through 10 years 2,671 Due after 10 years 11,667 Total $ 97,881 The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2018 and 2019 , aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2018 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 12,019 $ ( 85 ) $ 23,877 $ ( 329 ) $ 35,896 $ ( 414 ) Corporate debt securities 10,171 ( 107 ) 11,545 ( 209 ) 21,716 ( 316 ) Mortgage-backed and asset-backed securities 5,534 ( 75 ) 8,519 ( 249 ) 14,053 ( 324 ) Total $ 27,724 $ ( 267 ) $ 43,941 $ ( 787 ) $ 71,665 $ ( 1,054 ) As of December 31, 2019 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds $ 6,752 $ ( 20 ) $ 4,590 $ ( 10 ) $ 11,342 $ ( 30 ) Corporate debt securities 1,665 ( 2 ) ( 1 ) 2,643 ( 3 ) Mortgage-backed and asset-backed securities 4,536 ( 13 ) 2,835 ( 28 ) 7,371 ( 41 ) Total $ 12,953 $ ( 35 ) $ 8,403 $ ( 39 ) $ 21,356 $ ( 74 ) Alphabet Inc. During the years ended December 31, 2017 , 2018 and 2019 , we did not recognize any significant other-than-temporary impairment losses. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. All gains and losses on marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Our non-marketable equity securities are investments in privately held companies without readily determinable market values. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Non-marketable equity securities that have been remeasured during the period are classified within Level 2 or Level 3 in the fair value hierarchy because we estimate the value based on valuation methods using the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. Gains and losses on marketable and non-marketable equity securities Gains and losses reflected in other income (expense), net, for our marketable and non-marketable equity securities are summarized below (in millions): Year Ended December 31, Net gain (loss) on equity securities sold during the period $ 1,458 $ ( 301 ) Net unrealized gain (loss) on equity securities held as of the end of the period (1) 4,002 2,950 Total gain (loss) recognized in other income (expense), net $ 5,460 $ 2,649 (1) Includes net gains of $ 4.1 billion and $ 1.8 billion related to non-marketable equity securities for the years ended December 31, 2018 and 2019 , respectively. In the table above, net gain (loss) on equity securities sold during the period reflects the difference between the sale proceeds and the carrying value of the equity securities at the beginning of the period or the purchase date, if later. Cumulative net gains on equity securities sold during the period, which is summarized in the following table (in millions), represents the total net gains (losses) recognized after the initial purchase date of the equity security. While these net gains may have been reflected in periods prior to the period of sale, we believe they are important supplemental information as they reflect the economic realized gain on the securities sold during the period. Cumulative net gains is calculated as the difference between the sale price and the initial purchase price for the equity security sold during the period. Equity Securities Sold During the Year Ended December 31, Total sale price $ 1,965 $ 3,134 Total initial cost Cumulative net gains $ 1,450 $ 2,276 Alphabet Inc. Carrying value of marketable and non-marketable equity securities The carrying value is measured as the total initial cost plus the cumulative net gain (loss). The carrying values for our marketable and non-marketable equity securities are summarized below (in millions): As of December 31, 2018 Marketable Securities Non-Marketable Securities Total Total initial cost $ 1,168 $ 8,168 $ 9,336 Cumulative net gain (1) 4,107 4,161 Carrying value $ 1,222 $ 12,275 $ 13,497 (1) Non-marketable securities cumulative net gain is comprised of $ 4.3 billion unrealized gains and $ 178 million unrealized losses (including impairment). As of December 31, 2019 Marketable Securities Non-Marketable Securities Total Total initial cost $ 1,935 $ 8,297 $ 10,232 Cumulative net gain (1) 1,361 3,056 4,417 Carrying value $ 3,296 $ 11,353 $ 14,649 (1) Non-marketable securities cumulative net gain is comprised of $ 3.5 billion unrealized gains and $ 445 million unrealized losses (including impairment). Marketable equity securities The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2018 and 2019 (in millions): As of December 31, 2018 As of December 31, 2019 Cash and Cash Equivalents Marketable Securities Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 3,493 $ $ 4,604 $ Marketable equity securities (1) 3,046 3,493 4,604 3,046 Level 2: Mutual funds Total $ 3,493 $ 1,222 $ 4,604 $ 3,296 (1) The balance a s of December 31, 2019 includes investments that were reclassified from non-marketable equity securities following the initial public offering of the issuers. Non-marketable equity securities The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities (in millions): Year Ended December 31, Unrealized gains $ 4,285 $ 2,163 Unrealized losses (including impairment) ( 178 ) ( 372 ) Total unrealized gain (loss) for non-marketable equity securities $ 4,107 $ 1,791 During the year ended December 31, 2019 , included in the $ 11.4 billion of non-marketable equity securities, $ 7.6 billion were measured at fair value primarily based on observable market transactions, resulting in a net unrealized gain of $ 1.8 billion . Alphabet Inc. Equity securities accounted for under the Equity Method Equity securities accounted for under the equity method had a carrying value of approximately $ 1.3 billion as of December 31, 2018 and 2019 . Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 7 for further details on other income (expense), net. Derivative Financial Instruments We classify our foreign currency and interest rate derivative contracts primarily within Level 2 in the fair value hierarchy as the valuation inputs are based on quoted prices and market observable data of similar instruments. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. Any components excluded from the assessment of hedge effectiveness are recognized in the same income statement line as the hedged item. We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also use interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and debt issuances. Our program is not used for trading or speculative purposes. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. As of December 31, 2018 and 2019 , we received cash collateral related to the derivative instruments under our collateral security arrangements of $ 327 million and $ 252 million , respectively, which was included in other current assets. Cash Flow Hedges We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options), designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $ 11.8 billion and $ 13.2 billion as of December 31, 2018 and 2019 , respectively. These contracts have maturities of 24 months or less. For forwards and option contracts, we exclude the change in the forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI and subsequently reclassify these gains and losses to revenues when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are immediately reclassified to other income (expense), net. As of December 31, 2019 , the net accumulated loss on our foreign currency cash flow hedges before tax effect was $ 82 million , of which $ 82 million is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $ 2.0 billion and $ 455 million as of December 31, 2018 and 2019 , respectively. Gains and losses on these forward contracts are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. Net Investment Hedges We use forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), Alphabet Inc. net. The notional principal of these contracts was $ 6.7 billion and $ 9.3 billion as of December 31, 2018 and 2019 , respectively. Gains and losses on these forward contracts are recognized in AOCI as part of the foreign currency translation adjustment. Other Derivatives Other derivatives not designated as hedging instruments consist of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of the outstanding foreign exchange contracts was $ 20.1 billion and $ 43.5 billion as of December 31, 2018 and 2019 , respectively. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2018 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ As of December 31, 2019 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ 67 Alphabet Inc. The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ ( 955 ) $ $ Amount excluded from the assessment of effectiveness ( 14 ) Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness Total $ ( 955 ) $ $ Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 110,855 $ 1,015 $ 136,819 $ 7,389 $ 161,857 $ 5,394 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ ( 169 ) $ $ ( 139 ) $ $ $ Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items ( 96 ) ( 19 ) Derivatives designated as hedging instruments ( 197 ) Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts Derivatives not designated as hedging instruments ( 230 ) ( 413 ) Total gains (losses) $ ( 169 ) $ ( 124 ) $ ( 138 ) $ $ $ ( 145 ) Offsetting of Derivatives We present our forwards and purchased options at gross fair values in the Consolidated Balance Sheets. For foreign currency collars, we present at net fair values where both purchased and written options are with the same counterparty. Our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2018 and 2019 , information related to these offsetting arrangements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ ( 56 ) $ $ ( 90 ) (1) $ ( 307 ) $ ( 14 ) $ As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ ( 21 ) $ $ ( 88 ) (1) $ ( 234 ) $ $ (1) The balances as of December 31, 2018 and 2019 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ ( 56 ) $ $ ( 90 ) (2) $ $ $ As of December 31, 2019 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ ( 21 ) $ $ ( 88 ) (2) $ $ $ (2) The balances as of December 31, 2018 and 2019 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Leases We have entered into operating and finance lease agreements primarily for data centers, land and offices throughout the world with lease periods expiring between 2020 and 2063 . Components of operating lease expense were as follows (in millions): Year Ended December 31, 2019 Operating lease cost $ 1,820 Variable lease cost Total operating lease cost $ 2,361 Alphabet Inc. Supplemental information related to operating leases was as follows (in millions): Year Ended December 31, 2019 Cash payments for operating leases $ 1,661 New operating lease assets obtained in exchange for operating lease liabilities $ 4,391 As of December 31, 2019 , our operating leases had a weighted average remaining lease term of 10 years and a weighted average discount rate of 2.8 % . Future lease payments under operating leases as of December 31, 2019 were as follows (in millions): $ 1,757 1,845 1,680 1,508 1,301 Thereafter 5,763 Total future lease payments 13,854 Less imputed interest ( 2,441 ) Total lease liability balance $ 11,413 As of December 31, 2019 , we have entered into leases that have not yet commenced with future lease payments of $ 7.4 billion , excluding purchase options, that are not yet recorded on our Consolidated Balance Sheets. These leases will commence between 2020 and 2026 with non-cancelable lease terms of 1 to 25 years. Supplemental Information for Comparative Periods As of December 31, 2018, prior to the adoption of Topic 842, future minimum payments under operating leases having initial or remaining non-cancelable lease terms in excess of one year, net of sublease income amounts, were as follows (in millions): Operating Leases (1) Sub-lease Income Net Operating Leases $ 1,319 $ $ 1,303 1,397 1,384 1,337 1,327 1,153 1,145 980 Thereafter 3,916 3,911 Total minimum payments $ 10,102 $ $ 10,047 (1) Includes future minimum payments for leases which have not yet commenced. Rent expense under operating leases was $ 1.1 billion and $ 1.3 billion for the years ended December 31, 2017, and 2018, respectively. Note 5. Variable Interest Entities (VIEs) Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. We are the primary beneficiary because we have the power to direct activities that most significantly affect their economic performance and have the obligation to absorb the majority of their losses or benefits. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2018 and 2019 , assets that can only be used to settle obligations of these VIEs were $ 2.4 billion and $ 3.1 billion , respectively, and the liabilities for which creditors only have recourse to the VIEs were $ 909 million and $ 1.2 billion , respectively. Alphabet Inc. Calico Calico is a life science company with a mission to harness advanced technologies to increase our understanding of the biology that controls lifespan. In September 2014, AbbVie Inc. (AbbVie) and Calico entered into a research and development collaboration agreement intended to help both companies discover, develop, and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. In the second quarter of 2018, AbbVie and Calico amended the collaboration agreement resulting in an increase in total commitments. As of December 31, 2019 , AbbVie has contributed $ 1,250 million to fund the collaboration pursuant to the agreement. As of December 31, 2019 , Calico has contributed $ 500 million and has committed up to an additional $ 750 million . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market. Both companies share costs and profits for projects covered under this agreement equally. AbbVie's contribution has been recorded as a liability on Calico's financial statements, which is reduced and reflected as a reduction to research and development expense as eligible research and development costs are incurred by Calico. As of December 31, 2019 , we have contributed $ 480 million to Calico in exchange for Calico convertible preferred units and are committed to fund up to an additional $ 750 million on an as-needed basis and subject to certain conditions. Verily Verily is a life science and healthcare company with a mission to make the world's health data useful so that people enjoy healthier lives. In December 2018, Verily received $ 900 million in cash from a $ 1.0 billion investment round. The remaining $ 100 million was received in the first quarter of 2019. As of December 31, 2019 , Verily has received an aggregate amount of $ 1.8 billion from sales of equity securities to external investors. These transactions were accounted for as equity transactions and no gain or loss was recognized. In the fourth quarter of 2019, Verily obtained a controlling financial interest in Onduo, an existing equity method investment. The transaction resulted in a $ 357 million gain from the revaluation of the previously held economic interest, which was recognized in other income (expense), net. Unconsolidated VIEs Certain of our non-marketable investments, including certain renewable energy investments accounted for under the equity method and certain other investments in private companies, are VIEs. The renewable energy entities' activities involve power generation using renewable sources. Private companies that we invest in are primarily early stage companies. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance. Therefore, we do not consolidate these VIEs in our consolidated financial statements. The maximum exposure of these unconsolidated VIEs is generally based on the current carrying value of the investments and any future funding commitments. We have determined that the single source of our exposure to these VIEs is our capital investments in them. The carrying value and maximum exposure of these unconsolidated VIEs were not material as of December 31, 2018 and 2019 . Note 6. Debt Short-Term Debt We have a debt financing program of up to $ 5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2018 and 2019 . Long-Term Debt Google issued $ 3.0 billion of senior unsecured notes in three tranches (collectively, 2011 Notes) in May 2011, due in 2014, 2016, and 2021, as well as $ 1.0 billion of senior unsecured notes (2014 Notes) in February 2014 due in 2024. In April 2016, we completed an exchange offer with eligible holders of Googles 2011 Notes due 2021 and 2014 Notes due 2024 (collectively, the Google Notes). An aggregate principal amount of approximately $ 1.7 billion of the Google Notes was exchanged for approximately $ 1.7 billion of Alphabet notes with identical interest rate and maturity. Alphabet Inc. Because the exchange was between a parent and the subsidiary company and for substantially identical notes, the change was treated as a debt modification for accounting purposes with no gain or loss recognized. In August 2016, Alphabet issued $ 2.0 billion of senior unsecured notes (2016 Notes) due 2026. The net proceeds from the issuance of the 2016 Notes were used for general corporate purposes, including the repayment of outstanding commercial paper. The Alphabet notes due in 2021, 2024, and 2026 rank equally with each other and are structurally subordinate to the outstanding Google Notes. The total outstanding long-term debt is summarized below (in millions): As of December 31, 2018 As of December 31, 2019 3.625% Notes due on May 19, 2021 $ 1,000 $ 1,000 3.375% Notes due on February 25, 2024 1,000 1,000 1.998% Notes due on August 15, 2026 2,000 2,000 Unamortized discount for the Notes above ( 50 ) ( 42 ) Subtotal (1) 3,950 3,958 Total future finance lease payments Less: imputed interest for finance leases ( 89 ) Total long-term debt $ 4,012 $ 4,554 (1) Includes the outstanding (and unexchanged) Google Notes issued in 2011 and 2014 and the Alphabet notes exchanged in 2016. The effective interest yields based on proceeds received from the outstanding notes due in 2021, 2024, and 2026 were 3.734 % , 3.377 % , and 2.231 % , respectively, with interest payable semi-annually. We may redeem these notes at any time in whole or in part at specified redemption prices. The total estimated fair value of all outstanding notes was approximately $ 3.9 billion and $ 4.1 billion as of December 31, 2018 and 2019 , respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2019 , the aggregate future principal payments for long-term debt including long-term finance leases for each of the next five years and thereafter are as follows (in millions): $ 2021 1,046 2023 2024 1,047 Thereafter 2,500 Total $ 4,685 Credit Facility As of December 31, 2019 , we have $ 4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2018 and 2019 . Alphabet Inc. Note 7. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2018 As of December 31, 2019 Land and buildings $ 30,179 $ 39,865 Information technology assets 30,119 36,840 Construction in progress 16,838 21,036 Leasehold improvements 5,310 6,310 Furniture and fixtures Property and equipment, gross 82,507 104,207 Less: accumulated depreciation ( 22,788 ) ( 30,561 ) Property and equipment, net $ 59,719 $ 73,646 As of December 31, 2018 and 2019, information technology assets and land and buildings under finance leases with a cost basis of $ 648 million and $ 1.6 billion , respectively, were included in property and equipment. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2018 As of December 31, 2019 European Commission fines (1) $ 7,754 $ 9,405 Accrued customer liabilities 1,810 2,245 Accrued purchases of property and equipment 1,603 2,411 Current operating lease liabilities 1,199 Other accrued expenses and current liabilities 5,791 7,807 Accrued expenses and other current liabilities $ 16,958 $ 23,067 (1) Includes the effects of foreign exchange and interest. See Note 10 for further details. Alphabet Inc. Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2016 $ ( 2,646 ) $ ( 179 ) $ $ ( 2,402 ) Other comprehensive income (loss) before reclassifications 1,543 ( 638 ) 1,212 Amounts reclassified from AOCI Other comprehensive income (loss) 1,543 ( 545 ) 1,410 Balance as of December 31, 2017 ( 1,103 ) ( 122 ) ( 992 ) Cumulative effect of accounting change ( 98 ) ( 98 ) Other comprehensive income (loss) before reclassifications ( 781 ) ( 429 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI Amounts reclassified from AOCI ( 911 ) ( 813 ) Other comprehensive income (loss) ( 781 ) ( 823 ) ( 1,216 ) Balance as of December 31, 2018 ( 1,884 ) ( 688 ) ( 2,306 ) Cumulative effect of accounting change ( 30 ) ( 30 ) Other comprehensive income (loss) before reclassifications ( 119 ) 1,611 1,528 Amounts excluded from the assessment of hedge effectiveness recorded in AOCI ( 14 ) ( 14 ) Amounts reclassified from AOCI ( 111 ) ( 299 ) ( 410 ) Other comprehensive income (loss) ( 119 ) 1,500 ( 277 ) 1,104 Balance as of December 31, 2019 $ ( 2,003 ) $ $ ( 41 ) $ ( 1,232 ) The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ ( 105 ) $ 1,190 $ Benefit (provision) for income taxes ( 279 ) ( 38 ) Net of tax ( 105 ) Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue ( 169 ) ( 139 ) Interest rate contracts Other income (expense), net Benefit (provision) for income taxes ( 74 ) Net of tax ( 93 ) ( 98 ) Total amount reclassified, net of tax $ ( 198 ) $ $ 75 Alphabet Inc. Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, Interest income $ 1,312 $ 1,878 $ 2,427 Interest expense (1) ( 109 ) ( 114 ) ( 100 ) Foreign currency exchange gain (loss), net (2) ( 121 ) ( 80 ) Gain (loss) on debt securities, net (3) ( 110 ) 1,190 Gain (loss) on equity securities, net 5,460 2,649 Performance fees (4) ( 32 ) ( 1,203 ) ( 326 ) Gain (loss) and impairment from equity method investments, net ( 156 ) ( 120 ) Other Other income (expense), net $ 1,015 $ 7,389 $ 5,394 (1) Interest expense is net of interest capitalized of $ 48 million , $ 92 million , and $ 167 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. (2) Our foreign currency exchange gain (loss), net, are related to the option premium costs and forwards points for our foreign currency hedging contracts, our foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contract losses and gains. The net foreign currency transaction losses were $ 226 million , $ 195 million , and $ 166 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $ 1.3 billion gain. (4) Performance fees were reclassified for prior periods from general and administrative expenses to other income (expense), net to conform with current period presentation. Note 8. Acquisitions 2019 Acquisitions Looker In December 2019, we obtained all regulatory clearances necessary to close the acquisition of Looker, a unified platform for business intelligence, data applications and embedded analytics for $ 2.4 billion , with integration pending approval from a UK regulatory review. The addition of Looker to Google Cloud is expected to help customers accelerate how they analyze data, deliver business intelligence, and build data-driven applications. The fair value of assets acquired and liabilities assumed was recorded based on a preliminary valuation and our estimates and assumptions are subject to change within the measurement period. The $ 2.4 billion purchase price includes our previously held equity interest and excludes post acquisition compensation arrangements. In aggregate, $ 91 million was cash acquired, $ 290 million was attributed to intangible assets, $ 1.9 billion to goodwill and $ 48 million to net assets acquired . Goodwill was recorded in the Google segment and primarily attributable to synergies expected to arise after the acquisition. Goodwill is not expected to be deductible for tax purposes. Other Acquisitions During the year ended December 31, 2019 , we completed other acquisitions and purchases of intangible assets for total consideration of approximately $ 1.0 billion . In aggregate, $ 28 million was cash acquired, $ 282 million was attributed to intangible assets, $ 904 million to goodwill and $ 185 million to net liabilities assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. Pro forma results of operations for these acquisitions, including Looker, have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2019 , patents and developed technology have a weighted-average useful life of 3.5 years, customer relationships have a weighted-average useful life of 6.3 years, and trade names and other have a weighted-average useful life of 4.5 years. Pending Acquisition of Fitbit In November 2019, we entered into an agreement to acquire Fitbit, a leading wearables brand, for $ 7.35 per share, representing a total purchase price of approximately $ 2.1 billion as of the date of the agreement. The acquisition Alphabet Inc. of Fitbit is expected to be completed in 2020, subject to customary closing conditions, including the receipt of regulatory approvals. Upon the close of the acquisition, Fitbit will be part of Google segment. Note 9. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2019 were as follows (in millions): Google Other Bets Total Consolidated Balance as of December 31, 2017 $ 16,295 $ $ 16,747 Acquisitions 1,227 1,227 Transfers ( 80 ) Foreign currency translation and other adjustments ( 81 ) ( 5 ) ( 86 ) Balance as of December 31, 2018 17,521 17,888 Acquisitions 2,353 2,828 Transfers ( 9 ) Foreign currency translation and other adjustments ( 130 ) ( 92 ) Balance as of December 31, 2019 $ 19,921 $ $ 20,624 Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2018 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 5,125 $ 3,394 $ 1,731 Customer relationships Trade names and other Total $ 6,177 $ 3,957 $ 2,220 As of December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 4,972 $ 3,570 $ 1,402 Customer relationships Trade names and other Total $ 5,929 $ 3,950 $ 1,979 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 2.3 years, 5.6 years, and 3.0 years, respectively. Amortization expense relating to purchased intangible assets was $ 796 million , $ 865 million , and $ 795 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. Alphabet Inc. As of December 31, 2019 , expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): $ 2021 2022 2023 2024 Thereafter $ 1,979 Note 10. Commitments and Contingencies Purchase Obligations As of December 31, 2019 , we had $ 5.7 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, customers of Google Cloud offerings, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2019 , we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ( $ 2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $ 2.7 billion for the fine in the second quarter of 2017. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $ 5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision. On October 29, 2018, we implemented changes to certain of our Android distribution practices. We recognized a charge of $ 5.1 billion for the fine in the second quarter of 2018. On March 20, 2019, the EC announced its decision that certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law. The EC decision imposed a fine of 1.5 billion ( $ 1.7 billion as of March 20, 2019) and directed actions related to AdSense for Search agreements, which we implemented prior to the decision. On June 4, 2019, we appealed the EC decision. We recognized a charge of $ 1.7 billion for the fine in the first quarter of 2019. Alphabet Inc. While each EC decision is under appeal, we included the fines in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees (in lieu of a cash payment) for the fines. From time to time we are subject to formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions. For example, in August 2019, we began receiving civil investigative demands from the U.S. Department of Justice requesting information and documents relating to our prior antitrust investigations and certain of our business practices. Attorneys general from 51 U.S. states and territories have also opened antitrust investigations into certain of our business practices. We continue to cooperate with federal and state regulators in the United States, and other regulators around the world. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe others' intellectual property rights. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services. As a result, we may have to change our business practices, and develop non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss in an ITC action can result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them against certain intellectual property infringement claims, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. In addition, our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for a rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. On April 29, 2019, the Supreme Court requested the views of the Solicitor General regarding our petition. On September 27, 2019, the Solicitor General recommended denying our petition, and we provided our response on October 16, 2019. On November 15, 2019, the Supreme Court granted our petition and made a decision to review the case. If the Supreme Court does not rule in our favor, the case will be remanded to the district court for further determination of the remaining issues in the case, including damages, if any. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition, intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil or criminal penalties, or other adverse consequences. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, Alphabet Inc. consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We believe these matters are without merit and we are defending ourselves vigorously. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. For information regarding income tax contingencies, see Note 14 . Note 11. Stockholders' Equity Convertible Preferred Stock Our board of directors has authorized 100 million shares of convertible preferred stock, $ 0.001 par value, issuable in series. As of December 31, 2018 and 2019 , no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our board of directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $ 8.6 billion of its Class C capital stock. In January and July 2019, the board of directors of Alphabet authorized the company to repurchase up to an additional $ 12.5 billion and $ 25.0 billion of its Class C capital stock, respectively. Share repurchases pursuant to the January 2018 and January 2019 authorizations were completed in 2019. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2018 and 2019 , we repurchased and subsequently retired 8.2 million shares of Alphabet Class C capital stock for an aggregate amount of $ 9.1 billion and 15.3 million shares of Alphabet Class C capital stock for an aggregate amount of $ 18.4 billion , respectively. Note 12. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our board of directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely Alphabet Inc. affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our board of directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2017 , 2018 and 2019 , the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 5,438 $ $ 6,362 Denominator Number of shares used in per share computation 297,604 47,146 348,151 Basic net income per share $ 18.27 $ 18.27 $ 18.27 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 5,438 $ $ 6,362 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares Reallocation of undistributed earnings ( 74 ) ( 14 ) Allocation of undistributed earnings $ 6,226 $ $ 6,436 Denominator Number of shares used in basic computation 297,604 47,146 348,151 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 47,146 Restricted stock units and other contingently issuable shares 1,192 9,491 Number of shares used in per share computation 345,942 47,146 357,642 Diluted net income per share $ 18.00 $ 18.00 $ 18.00 Alphabet Inc. Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 Reallocation of undistributed earnings ( 146 ) ( 24 ) Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 Restricted stock units and other contingently issuable shares 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 14,846 $ 2,307 $ 17,190 Denominator Number of shares used in per share computation 299,402 46,527 346,667 Basic net income per share $ 49.59 $ 49.59 $ 49.59 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 14,846 $ 2,307 $ 17,190 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,307 Reallocation of undistributed earnings ( 126 ) ( 20 ) Allocation of undistributed earnings $ 17,027 $ 2,287 $ 17,316 Denominator Number of shares used in basic computation 299,402 46,527 346,667 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,527 Restricted stock units and other contingently issuable shares 5,547 Number of shares used in per share computation 346,342 46,527 352,214 Diluted net income per share $ 49.16 $ 49.16 $ 49.16 Alphabet Inc. Note 13. Compensation Plans Stock Plans Under our 2012 Stock Plan, RSUs or stock options may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. Incentive and non-qualified stock options, or rights to purchase common stock, are generally granted for a term of 10 years. RSUs granted to participants under the 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2019 , there were 37,982,435 shares of stock reserved for future issuance under our Stock Plan. Additionally, we have stock-based awards that may be settled in the stock of certain of our Other Bets. Stock-Based Compensation For the years ended December 31, 2017 , 2018 and 2019 , total stock-based compensation expense was $ 7.9 billion , $ 10.0 billion and $ 11.7 billion , including amounts associated with awards we expect to settle in Alphabet stock of $ 7.7 billion , $ 9.4 billion , and $ 10.8 billion , respectively. For the years ended December 31, 2017 , 2018 and 2019 , we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $ 1.6 billion , $ 1.5 billion , and $ 1.8 billion , respectively. For the years ended December 31, 2017 , 2018 and 2019 , tax benefit realized related to awards vested or exercised during the period was $ 2.7 billion , $ 2.1 billion and $ 2.2 billion , respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Stock-Based Award Activities The following table summarizes the activities for our unvested RSUs in Alphabet stock for the year ended December 31, 2019 : Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2018 18,467,678 $ 936.96 Granted 13,934,041 $ 1,092.36 Vested ( 11,576,766 ) $ 919.28 Forfeited/canceled ( 1,430,717 ) $ 990.56 Unvested as of December 31, 2019 19,394,236 $ 1,055.22 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2017 and 2018 , was $ 845.06 and $ 1,095.89 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2017 , 2018 , and 2019 were $ 11.3 billion , $ 14.1 billion , and $ 15.2 billion , respectively. As of December 31, 2019 , there was $ 19.1 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.6 years . 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $ 448 million , $ 691 million , and $ 724 million for the years ended December 31, 2017 , 2018 , and 2019 , respectively. Alphabet Inc. Note 14. Income Taxes Income from continuing operations before income taxes consists of the following (in millions): Year Ended December 31, Domestic operations $ 10,680 $ 15,779 $ 16,426 Foreign operations 16,513 19,134 23,199 Total $ 27,193 $ 34,913 $ 39,625 The provision for income taxes consists of the following (in millions): Year Ended December 31, 2018 Current: Federal and state $ 12,608 $ 2,153 $ 2,424 Foreign 1,746 1,251 2,713 Total 14,354 3,404 5,137 Deferred: Federal and state Foreign ( 43 ) ( 134 ) ( 141 ) Total Provision for income taxes $ 14,531 $ 4,177 $ 5,282 The Tax Act enacted on December 22, 2017 introduced significant changes to U.S. income tax law. Effective 2018, the Tax Act reduced the U.S. statutory tax rate from 35% to 21% and created new taxes on certain foreign-sourced earnings and certain related-party payments. Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our consolidated financial statements as of December 31, 2017. As we collected and prepared necessary data, and interpreted the additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we made adjustments, over the course of 2018, to the provisional amounts including refinements to deferred taxes. The accounting for the tax effects of the Tax Act was completed as of December 31, 2018. Transition tax The Tax Act required us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our transitional tax liability and income tax expense of $ 10.2 billion as of December 31, 2017. Subsequent adjustments in 2018 and 2019 were not material. Deferred tax effects Due to the change in the statutory tax rate from the Tax Act, we remeasured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. We recognized a deferred tax benefit of $ 376 million to reflect the reduced U.S. tax rate and other effects of the Tax Act as of December 31, 2017. Alphabet Inc. The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, U.S. federal statutory tax rate 35.0 % 21.0 % 21.0 % Foreign income taxed at different rates ( 14.2 ) ( 4.9 ) ( 5.6 ) Effect of the Tax Act Transition tax 37.6 ( 0.1 ) ( 0.6 ) Deferred tax effects ( 1.4 ) ( 1.2 ) 0.0 Federal research credit ( 1.8 ) ( 2.4 ) ( 2.5 ) Stock-based compensation expense ( 4.5 ) ( 2.2 ) ( 0.7 ) European Commission fines 3.5 3.1 1.0 Deferred tax asset valuation allowance 0.9 ( 2.0 ) 0.0 State and local income taxes 0.1 ( 0.4 ) 1.1 Other adjustments ( 1.8 ) 1.1 ( 0.4 ) Effective tax rate 53.4 % 12.0 % 13.3 % Our effective tax rate for each of the years presented was affected by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. Substantially all of the income from foreign operations was earned by an Irish subsidiary. Beginning in 2018, earnings realized in foreign jurisdictions are subject to U.S. tax in accordance with the Tax Act. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. As a result of that decision, we recorded a tax benefit related to the anticipated reimbursement of cost share payment for previously shared stock-based compensation costs. On June 7, 2019, the United States Court of Appeals for the Ninth Circuit overturned the 2015 Tax Court decision in Altera Corp. v. Commissioner, and upheld the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. As a result of the Ninth Circuit court decision, our cumulative net tax benefit of $ 418 million related to previously shared stock-based compensation costs was reversed in the year ended December 31, 2019. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, Deferred tax assets: Stock-based compensation expense $ $ Accrued employee benefits Accruals and reserves not currently deductible 1,047 Tax credits 1,979 3,264 Basis difference in investment in Arris Prepaid cost sharing Net operating losses Operating leases 1,876 Other Total deferred tax assets 5,551 8,232 Valuation allowance ( 2,817 ) ( 3,502 ) Total deferred tax assets net of valuation allowance 2,734 4,730 Deferred tax liabilities: Property and equipment, net ( 1,382 ) ( 1,798 ) Renewable energy investments ( 500 ) ( 466 ) Foreign Earnings ( 111 ) ( 373 ) Net investment gains ( 1,143 ) ( 1,074 ) Operating leases ( 1,619 ) Other ( 125 ) ( 380 ) Total deferred tax liabilities ( 3,261 ) ( 5,710 ) Net deferred tax assets (liabilities) $ ( 527 ) $ ( 980 ) As of December 31, 2019 , our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $ 1.8 billion , $ 3.1 billion , and $ 1.9 billion respectively. If not utilized, the federal and foreign net operating loss carryforwards will begin to expire in 2021 and the state net operating loss carryforwards will begin to expire in 2020. It is more likely than not that certain net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. As of December 31, 2019 , our California research and development credit carryforwards for income tax purposes were approximately $ 3.0 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2019 , we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, certain state tax credits and certain foreign net operating losses that we believe are not likely to be realized. Due to gains from equity securities recognized, we released the valuation allowance in 2018 against the deferred tax asset for the book-to-tax basis difference in our investments in Arris shares received from the sale of the Motorola Home business to Arris in 2013. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits (in millions): Year Ended December 31, Beginning gross unrecognized tax benefits $ 5,393 $ 4,696 $ 4,652 Increases related to prior year tax positions Decreases related to prior year tax positions ( 257 ) ( 623 ) ( 143 ) Decreases related to settlement with tax authorities ( 1,875 ) ( 191 ) ( 2,886 ) Increases related to current year tax positions Ending gross unrecognized tax benefits $ 4,696 $ 4,652 $ 3,377 The total amount of gross unrecognized tax benefits was $ 4.7 billion , $ 4.7 billion , and $ 3.4 billion as of December 31, 2017 , 2018 , and 2019 , respectively, of which, $ 3.0 billion , $ 2.9 billion , and $ 2.3 billion , if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2017 and 2019 was primarily as a result of the resolution of multi-year audits. As of December 31, 2018 and 2019 , we had accrued $ 490 million and $ 130 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS completed its examination through our 2015 tax years; all issues have been concluded and the IRS will commence its examination of our 2016 through 2018 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. The tax years 2011 through 2018 remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, we do not believe it is reasonably possible that our unrecognized tax benefits will materially change in the next 12 months. Note 15. Information about Segments and Geographic Areas We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as ads, Android, Chrome, hardware, Google Cloud, Google Maps, Google Play, Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings and subscription-based products. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes Access, Calico, CapitalG, GV, Verily, Waymo, and X, among others. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Alphabet Inc. Revenues, cost of revenues, and operating expenses are generally directly attributed to our segments. Inter-segment revenues are not presented separately, as these amounts are immaterial. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. Information about segments during the periods presented were as follows (in millions): Year Ended December 31, Revenues: Google $ 110,547 $ 136,362 $ 160,743 Other Bets Hedging gains (losses) ( 169 ) ( 138 ) Total revenues $ 110,855 $ 136,819 $ 161,857 Year Ended December 31, Operating income (loss): Google $ 32,456 $ 36,655 $ 41,673 Other Bets ( 2,734 ) ( 3,358 ) ( 4,824 ) Reconciling items (1) ( 3,544 ) ( 5,773 ) ( 2,618 ) Total income from operations $ 26,178 $ 27,524 $ 34,231 (1) Reconciling items are generally comprised of corporate administrative costs, hedging gains (losses) and other miscellaneous items that are not allocated to individual segments. Reconciling items include t he European Commission fines for the years ended December 31, 2017, 2018 and 2019, and a charge from a legal settlement for the year ended December 31, 2019. Performance fees previously included in reconciling items were reclassified for the years ended December 31, 2017 and 2018 from general and administrative expenses to other income (expense), net to conform with current period presentation. For further information on the reclassification, see Note 1. Year Ended December 31, Capital expenditures: Google $ 12,619 $ 25,460 $ 25,251 Other Bets Reconciling items (2) ( 502 ) ( 1,984 ) Total capital expenditures as presented on the Consolidated Statements of Cash Flows $ 13,184 $ 25,139 $ 23,548 (2) Reconciling items are related to timing differences of payments as segment capital expenditures are on accrual basis while total capital expenditures shown on the Consolidated Statements of Cash Flow are on cash basis and other miscellaneous differences. Alphabet Inc. Stock-based compensation (SBC) and depreciation, amortization, and impairment are included in segment operating income (loss) as shown below (in millions): Year Ended December 31, Stock-based compensation: Google $ 7,168 $ 8,755 $ 10,185 Other Bets Reconciling items (3) Total stock-based compensation (4) $ 7,679 $ 9,353 $ 10,794 Depreciation, amortization, and impairment: Google $ 6,608 $ 8,708 $ 11,158 Other Bets Reconciling items (3) Total depreciation, amortization, and impairment $ 6,915 $ 9,035 $ 11,781 (3) Reconciling items relate to corporate administrative and other costs that are not allocated to individual segments. (4) For purposes of segment reporting, SBC represents awards that we expect to settle in Alphabet stock. The following table presents our long-lived assets by geographic area (in millions): As of December 31, 2018 As of December 31, 2019 Long-lived assets: United States $ 74,882 $ 94,907 International 22,234 28,424 Total long-lived assets $ 97,116 $ 123,331 For revenues by geography, see Note 2 . Alphabet Inc. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2019 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting We rely extensively on information systems to manage our business and summarize and report operating results. In 2019, we began a multi-year implementation of a new global enterprise resource planning (ERP) system, which will replace much of our existing core financial systems. The ERP system is designed to accurately maintain the Companys financial records, enhance the flow of financial information, improve data management and provide timely information to the Companys management team. The implementation is expected to occur in phases over the next several years, with initial changes to our general ledger and consolidated financial reporting to take place in 2020. There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However, as the phased implementation of the new ERP system continues, we will change our processes and procedures which, in turn, could result in changes to our internal control over financial reporting. As such changes occur, we will evaluate quarterly whether such changes materially affect our internal control over financial reporting. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2019 . Management reviewed the results of its assessment with our Audit Committee. The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +3,goog,-kq42017," ITEM 1. BUSINESS Overview As our founders Larry and Sergey wrote in the original founders' letter, ""Google is not a conventional company. We do not intend to become one."" That unconventional spirit has been a driving force throughout our history -- inspiring us to do things like rethink the mobile device ecosystem with Android and map the world with Google Maps. As part of that, our founders also explained that you could expect us to make ""smaller bets in areas that might seem very speculative or even strange when compared to our current businesses."" From the start, the company has always strived to do more, and to do important and meaningful things with the resources we have. Alphabet is a collection of businesses -- the largest of which is Google. It also includes businesses that are generally pretty far afield of our main internet products in areas such as self-driving cars, life sciences, internet access and TV services. We report all non-Google businesses collectively as Other Bets. Our Alphabet structure is about helping each of our businesses prosper through strong leaders and independence. Access and technology for everyone The Internet is one of the worlds most powerful equalizers, capable of propelling new ideas and people forward. At Google, our mission is to make sure that information serves everyone, not just a few. So whether you're a child in a rural village or a professor at an elite university, you can access the same information. We are helping people get online by tailoring digital experiences to the needs of emerging markets. For instance, our digital payments app in India, now called Google Pay, helps tens of millions of people and businesses easily pay with just a few taps. We're also making sure our core Google products are fast and useful, especially for users in areas where speed and connectivity are central concerns. Other Alphabet companies are also pursuing initiatives with similar goals. For instance, Loon announced that it will bring its balloon-powered internet to regions of central Kenya, starting in 2019. Moonshots Many companies get comfortable doing what they have always done, making only incremental changes. This incrementalism leads to irrelevance over time, especially in technology, where change tends to be revolutionary, not evolutionary. People thought we were crazy when we acquired YouTube and Android and when we launched Chrome, but those efforts have matured into major platforms for digital video and mobile devices and a safer, popular browser. We continue to look toward the future and continue to invest for the long-term. As we said in the original founders' letter, we will not shy away from high-risk, high-reward projects that we believe in because they are the key to our long-term success. The power of machine learning Across the company, machine learning and artificial intelligence (AI) are increasingly driving many of our latest innovations. Within Google, our investments in machine learning over a decade have enabled us to build products that are smarter and more useful -- it's what allows you to use your voice to ask the Google Assistant for information, to translate the web from one language to another, to see better YouTube recommendations, and to search for people and events in Google Photos. Our advertising tools also use machine learning to help marketers find the right audience, deliver the right creative, and optimize their campaigns through better auto-bidding and measurement tools. Machine learning is also showing great promise in helping us tackle big issues, like dramatically improving the energy efficiency of our data centers. Across Other Bets, machine learning helps self-driving cars better detect and respond to others on the road, assists delivery drones in determining whether a location is safe for drop off, and can also help clinicians more accurately detect sight-threatening eye diseases. Google Serving our users We have always been a company committed to building products that have the potential to improve the lives of millions of people. Our product innovations have made our services widely used, and our brand one of the most recognized in the world. Google's core products and platforms such as Android, Chrome, Gmail, Google Drive, Google Maps, Google Play, Search, and YouTube each have over one billion monthly active users. But most important, we believe we are just beginning to scratch the surface. Our vision is to remain a place of incredible creativity and innovation Alphabet Inc. that uses our technical expertise to tackle big problems. As the majority of Alphabets big bets continue to reside within Google, an important benefit of the shift to Alphabet has been the tremendous focus that were able to have on Googles many extraordinary opportunities. Googles mission to organize the worlds information and make it universally accessible and useful has always been our North Star, and our products have come a long way since the company was founded two decades ago. Instead of just showing ten blue links in our search results, we are increasingly able to provide direct answers -- even if you're speaking your question using Voice Search -- which makes it quicker, easier and more natural to find what you're looking for. You can also type or talk with the Google Assistant in a conversational way across multiple devices like phones, speakers, headphones, televisions and more. And with Google Lens, you can use your phones camera to identify an unfamiliar landmark or find a trailer from a movie poster. Over time, we have also added other services that let you access information quickly and easily -- like Google Maps, which helps you navigate to a store while showing you current traffic conditions, or Google Photos, which helps you store and organize your photos. This drive to make information more accessible has led us over the years to improve the discovery and creation of digital content, on the web and through platforms like Google Play and YouTube. And with the migration to mobile, people are consuming more digital content by watching more videos, playing more games, listening to more music, reading more books, and using more apps than ever before. Working with content creators and partners, we continue to build new ways for people around the world to find great digital content. Fueling all of these great digital experiences are powerful platforms and hardware. Thats why we continue to invest in platforms like our Android mobile operating system, Chrome browser, Chrome operating system, and Daydream virtual reality platform, as well as growing our family of great hardware devices. We see tremendous potential for devices to be helpful, make your life easier, and get better over time, by combining the best of Google's AI, software, and hardware. This is reflected in our latest generation of hardware products like Pixel 3 phones and the Google Home Hub smart display. Creating beautiful products that people rely on every day is a journey that we are investing in for the long run. Google was a company built in the cloud and has been investing in infrastructure, security, data management, analytics, and AI from the very beginning. We have continued to enhance these strengths with features like data migration, modern development environments and machine learning tools to provide enterprise-ready cloud services, including Google Cloud Platform and G Suite, to our customers. Google Cloud Platform enables developers to build, test, and deploy applications on Googles highly scalable and reliable infrastructure. Our G Suite productivity tools -- which include apps like Gmail, Docs, Drive, Calendar, Hangouts, and more -- are designed with real-time collaboration and machine intelligence to help people work smarter. Because more and more of todays great digital experiences are being built in the cloud, our Google Cloud products help businesses of all sizes take advantage of the latest technology advances to operate more efficiently. Key to building helpful products for users is our commitment to keeping their data safe online. As the Internet evolves, we continue to invest in our industry-leading security technologies and privacy tools. How we make money The goal of our advertising business is to deliver relevant ads at just the right time and to give people useful commercial information, regardless of the device theyre using. We also provide advertisers with tools that help them better attribute and measure their advertising campaigns across screens. Our advertising solutions help millions of companies grow their businesses, and we offer a wide range of products across screens and formats. We generate revenues primarily by delivering both performance advertising and brand advertising. Perf ormance advertising creates and delivers relevant ads that users will click on, leading to direct engagement with advertisers. Most of our performance advertisers pay us when a user engages in their ads. Performance advertising lets our advertisers connect with users while driving measurable results. Our ads tools allow performance advertisers to create simple text-based ads that appear on Google properties and the properties of Google Network Members. In addition, Google Network Members use our platforms to display relevant ads on their properties, generating revenues when site visitors view or click on the ads. We continue to invest in our advertising programs and make significant upgrades. Brand advertising helps enhance users' awareness of and affinity with advertisers' products and services, through v ideos, text, images, and other interactive ads that run across various devices. We help brand advertisers deliver digital videos and other types of ads to specific audiences for their brand-building marketing campaigns. Alphabet Inc. We have built a world-class ad technology platform for brand advertisers, agencies, and publishers to power their digital marketing businesses. We aim to ensure great user experiences by serving the right ads at the right time and by building deep partnerships with brands and agencies. We also seek to improve the measurability of brand advertising so advertisers know when their campaigns are effective. We have allocated substantial resources to stopping bad advertising practices and protecting users on the web. We focus on creating the best advertising experiences for our users and advertisers in many ways, ranging from filtering out invalid traffic, removing billions of bad ads from our systems every year to closely monitoring the sites, apps, and videos where ads appear and blacklisting them when necessary to ensure that ads do not fund bad content. Beyond our advertising business, we also generate revenues in other areas. For instance, we generate revenue when users purchase digital content like apps, movies and music through Google Play or when they purchase our Made by Google hardware devices. Businesses also pay for the use of our cloud services like Google Cloud Platform and G Suite. Other Bets Throughout Alphabet, we are also using technology to try and solve big problems across many industries. Alphabets Other Bets are emerging businesses at various stages of development, ranging from those in the research and development phase to those that are in the beginning stages of commercialization, and our goal is for them to become thriving, successful businesses in the medium to long term. To do this, we make sure we have a strong CEO to run each company while also rigorously handling capital allocation and working to make sure each business is executing well. While these early-stage businesses naturally come with considerable uncertainty, some of them are already generating revenue and making important strides in their industries. We continue to build these businesses thoughtfully and systematically to capitalize on the opportunities ahead. We are investing for the long term while being very deliberate about the focus, scale and pace of investments. Other Bets primarily generate revenues from internet and TV services and licensing and RD services. Competition Our business is characterized by rapid change as well as new and disruptive technologies. We face formidable competition in every aspect of our business, particularly from companies that seek to connect people with online information and provide them with relevant advertising. We face competition from: General purpose search engines and information services, such as Baidu, Microsoft's Bing, Naver, Seznam, Verizon's Yahoo, and Yandex. Vertical search engines and e-commerce websites, such as Amazon and eBay (e-commerce), Booking's Kayak (travel queries), Microsoft's LinkedIn (job queries), and WebMD (health queries). Some users will navigate directly to such content, websites, and apps rather than go through Google. Social networks, such as Facebook, Snapchat, and Twitter. Some users increasingly rely on social networks for product or service referrals, rather than seeking information through traditional search engines. Other forms of advertising, such as billboards, magazines, newspapers, radio, and television. Our advertisers typically advertise in multiple media, both online and offline. Other online advertising platforms and networks, including Amazon, AppNexus, Criteo, and Facebook, that compete for advertisers that use Google Ads, our primary auction-based advertising platform. Providers of digital video services, such as Amazon, Facebook, Hulu, and Netflix. We compete with companies that have longer operating histories and more established relationships with customers and users in businesses that are further afield from our advertising business. We face competition from: Other digital content and application platform providers, such as Apple. Companies that design, manufacture, and market consumer electronics products, including businesses that have developed proprietary platforms. Providers of enterprise cloud services, including Alibaba, Amazon, and Microsoft. Digital assistant providers, such as Amazon and Apple. Competing successfully depends heavily on our ability to deliver and distribute innovative products and technologies to the marketplace across our businesses. Specifically, for our advertising-related businesses, competing successfully depends on attracting and retaining: Alphabet Inc. Users, for whom other products and services are literally one click away, largely on the basis of the relevance of our advertising, as well as the general usefulness, security and availability of our products and services. Advertisers, primarily based on our ability to generate sales leads, and ultimately customers, and to deliver their advertisements in an efficient and effective manner across a variety of distribution channels. Content providers, primarily based on the quality of our advertiser base, our ability to help these partners generate revenues from advertising, and the terms of our agreements with them. Intellectual Property We rely on various intellectual property laws, confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We have registered, and applied for the registration of, U.S. and international trademarks, service marks, domain names and copyrights. We have also filed patent applications in the U.S. and foreign countries covering certain of our technology, and acquired patent assets to supplement our portfolio. We have licensed in the past, and expect that we may license in the future, certain of our rights to other parties. Culture and Employees We take great pride in our culture. We embrace collaboration and creativity, and encourage the iteration of ideas to address complex technical challenges. Transparency and open dialogue are central to how we work, and we aim to ensure that company news reaches our employees first through internal channels. Despite our rapid growth, we still cherish our roots as a startup and wherever possible empower employees to act on great ideas regardless of their role or function within the company. We strive to hire great employees, with backgrounds and perspectives as diverse as those of our global users. We work to provide an environment where these talented people can have fulfilling careers addressing some of the biggest challenges in technology and society. Our employees are among our best assets and are critical for our continued success. We expect to continue investing in hiring talented employees and to provide competitive compensation programs to our employees. As of December 31, 2018 , we had 98,771 full-time employees. Although we have work councils and statutory employee representation obligations in certain countries, our U.S. employees are not represented by a labor union. Competition for qualified personnel in our industry is intense, particularly for software engineers, computer scientists, and other technical staff. Seasonality Our business is affected by seasonal fluctuations in internet usage, advertising expenditures, and underlying business trends such as traditional retail seasonality. Other Items We believe that climate change is one of the most significant global challenges of our time. We have established a climate change strategy based on four dimensions: matching 100% of the electricity consumption of our operations with purchases of renewable energy; understanding the effect of climate change on the resiliency of our core business operations; being a vocal advocate for greening electrical grids worldwide; and empowering everyonebusinesses, governments, nonprofit organizations, communities, and individualsto use Google technology to help create a more sustainable and resource-efficient world. Google's approach to climate change and our broader sustainability efforts are provided in our annual sustainability reports. Available Information Our website is located at www.abc.xyz, and our investor relations website is located at www.abc.xyz/investor. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and our Proxy Statements are available through our investor relations website, free of charge, after we file them with the SEC. We also provide a link to the section of the SEC's website at www.sec.gov that has all of the reports that we file or furnish with the SEC. We webcast via our investor relations website our earnings calls and certain events we participate in or host with members of the investment community. Our investor relations website also provides notifications of news or announcements regarding our financial performance and other items of interest to our investors, including SEC filings, investor events, press and earnings releases, and blogs. We also share Google news and product updates on Google's Keyword blog at https://www.blog.google/, which may be of interest or material to our investors. Further, corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of conduct, is also available on our investor relations website under the heading ""Other."" The content of our websites are not incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only. Alphabet Inc. "," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including but not limited to those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common and capital stock. Risks Related to Our Businesses and Industries We face intense competition. If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, and our revenues and operating results could be adversely affected. Our businesses are rapidly evolving, intensely competitive, and subject to changing technologies, shifting user needs, and frequent introductions of new products and services. Competing successfully depends heavily on our ability to accurately anticipate technology developments and deliver innovative, relevant and useful products, services, and technologies to the marketplace in a timely manner. As our businesses evolve, the competitive pressure to innovate will encompass a wider range of products and services. As a result, we must continue to invest significant resources in research and development, including through acquisitions, in order to enhance our technology and our existing products and services, and introduce new products and services that people can easily and effectively use. We have many competitors in different industries. Our current and potential domestic and international competitors range from large and established companies to emerging start-ups. Some companies have longer operating histories and more established relationships with customers and users. They can use their experiences and resources in ways that could affect our competitive position, including by making acquisitions, continuing to invest heavily in research and development and in hiring talent, aggressively initiating intellectual property claims (whether or not meritorious), and continuing to compete aggressively for users, advertisers, customers, and content providers. Our competitors may be able to innovate and provide products and services faster than we can or may foresee the need for products and services before us. In addition, new products and services, including those that incorporate or utilize artificial intelligence and machine learning, can raise new or exacerbate existing ethical, technological, legal, and other challenges, which may negatively affect our brands and demand for our products and services and adversely affect our revenues and operating results. Our operating results may also suffer if our innovations are not responsive to the needs of our users, advertisers, customers, and content providers; are not appropriately timed with market opportunities; or are not effectively brought to market. As technologies continue to develop, our competitors may be able to offer our users and/or customers experiences that are, or that are seen to be, substantially similar to or better than ours. This may force us to compete in different ways and expend significant resources in order to remain competitive. If our competitors are more successful than we are in developing compelling products or in attracting and retaining users, advertisers, customers, and content providers, our revenues and operating results could be adversely affected. We generate a significant portion of our revenues from advertising, and reduced spending by advertisers or a loss of partners could harm our advertising business. We generated over 85% of total revenues from advertising in 2018 . Many of our advertisers, companies that distribute our products and services, digital publishers, and content partners can terminate their contracts with us at any time. Those partners may not continue to do business with us if we do not create more value (such as increased numbers of users or customers, new sales leads, increased brand awareness, or more effective monetization) than their available alternatives. For example, changes to our data privacy practices, as well as changes to third-party advertising policies or practices may affect the type of ads and/or manner of advertising that we are able to provide which could have an adverse effect on our business. If we do not provide superior value or deliver advertisements efficiently and competitively, our reputation could be affected, we could see a decrease in revenue from advertisers and/or experience other adverse effects to our business. In addition, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Adverse macroeconomic conditions can also have a material negative effect on user activity and the demand for advertising and cause our advertisers to reduce the amounts they spend on advertising, which could adversely affect our revenues and advertising business. We are subject to increasing regulatory scrutiny as well as changes in public policies governing a wide range of topics that may negatively affect our business. We and other companies in the technology industry have experienced increased regulatory scrutiny recently. For instance, various regulatory agencies are reviewing aspects of our search and other businesses. This can lead to increased scrutiny from other regulators and legislators, that may affect our reputation, brand and third-party Alphabet Inc. relationships. Such reviews have and may in the future also result in substantial regulatory fines, changes to our business practices and other penalties, which could negatively affect our business and results of operations. We continue to cooperate with regulatory authorities around the world in investigations they are conducting with respect to our business. Changes in social, political, and regulatory conditions or in laws and policies governing a wide range of topics may cause us to change our business practices. Further, our expansion into a variety of new fields also raises a number of new regulatory issues. These factors could negatively affect our business and results of operations in material ways. Our ongoing investment in new businesses and new products, services, and technologies is inherently risky, and could disrupt our current operations. We have invested and expect to continue to invest in new businesses, products, services, and technologies. The creation of Alphabet as a holding company in 2015 and the investments that we are making across various areas in Google and Other Bets are a reflection of our ongoing efforts to innovate and provide products and services that are useful to users. Our investments in Google and Other Bets span a wide range of industries. Such endeavors may involve significant risks and uncertainties, including distraction of management from our advertising and related business, use of alternative investment, governance or compensation structures, the fact that such offerings or strategies may not be commercially viable for an indefinite amount of time or at all, or may not result in adequate return of capital on our investments; and unidentified issues may not be discovered in our due diligence of such strategies and offerings which could cause us to fail to realize the anticipated benefits of such investments and incur unanticipated liabilities. Because these new ventures are inherently risky, no assurance can be given that such strategies and offerings will be successful and will not adversely affect our reputation, financial condition, and operating results. The Internet is accessed through a variety of platforms and form factors that continue to evolve with the advancement of technology and user preferences. If manufacturers and users do not widely adopt versions of our search technology, products, or operating systems developed for these devices and modalities, our business could be adversely affected. The number of people who access the Internet through devices other than desktop computers, including mobile phones, smartphones, laptops and tablets, video game consoles, voice-activated speakers, wearables, automobiles, and television set-top devices, is increasing dramatically. The functionality and user experience associated with some alternative devices and modalities may make the use of our products and services or the generation of advertising revenue through such devices more difficult (or just different), and the versions of our products and services developed for these devices may not be compatible or compelling to users, manufacturers, or distributors of alternative devices. Each manufacturer or distributor may establish unique technical standards for its devices, and our products and services may not be available on these devices as a result. Some manufacturers may also elect not to include our products on their devices. In addition, search queries are increasingly being undertaken via voice-activated speakers, apps, social media or other platforms, which could affect our search and advertising business over time. As new devices and platforms are continually being released, it is difficult to predict the challenges we may encounter in adapting our products and services and developing competitive new products and services. We expect to continue to devote significant resources to the creation, support, and maintenance of products and services across multiple platforms and devices. If we are unable to attract and retain a substantial number of alternative device manufacturers, suppliers, distributors, developers, and users to our products and services, or if we are slow to develop products and technologies that are more compatible with alternative devices and platforms, we may fail to capture the opportunities available as consumers and advertisers continue to exist in a dynamic, multi-platform environment. Our revenue growth rate could decline over time, and we anticipate downward pressure on our operating margin in the future. Our revenue growth rate could decline and/or vary over time as a result of a number of factors, including increasing competition and the continued expansion of our business into a variety of new fields. Within our advertising business, changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix and an increasing competition for advertising may also affect our revenue growth rate. We may also experience a decline in our revenue growth rate as our revenues increase to higher levels or if there is a decrease in the rate of adoption of our products, services, and technologies, among other factors. In addition to a decline in our revenue growth rate, we may also experience downward pressure on our operating margin resulting from a variety of factors, such as the continued expansion of our business into a variety of new fields, including through products and services such as Google Cloud, Google Play, and hardware products where margins have generally been lower than those we generate from advertising. We may also experience downward pressure on our operating margins from increasing competition and increased costs for many aspects of our business, including within advertising where changes such as device mix and property mix can affect margin. The margin we earn on Alphabet Inc. revenues generated from our Google Network Members could also decrease in the future if we pay a larger percentage of advertising fees to them. We may also pay increased TAC to our distribution partners due to a number of factors. Additionally, our spend to promote new products and services or distribute certain products or an increased investment in our innovation efforts across the Company (within Google as well as our Other Bets businesses) may affect our operating margins. Due to these factors and the evolving nature of our business, our historical revenue growth rate and historical operating margin may not be indicative of our future performance. Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations. Our operating results may fluctuate as a result of a number of factors, many outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly, year-to-date, and annual expenses as a percentage of our revenues may differ significantly from our historical rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this section in addition to the following factors may affect our operating results: Our ability to continue to attract and retain users and customers to our products and services. Our ability to attract user and/or customer adoption of and generate significant revenues from new products, services, and technologies in which we have invested considerable time and resources. Our ability to monetize (or generate revenues from) traffic on Google properties and our Google Network Members' properties across various devices. Revenue fluctuations in our advertising business caused by changes in device mix, geographic mix, ongoing product and policy changes, product mix, and property mix. The amount of revenues and expenses generated and incurred in currencies other than U.S. dollars, and our ability to manage the resulting risk through our foreign exchange risk management program. The amount and timing of operating costs and expenses and capital expenditures related to the maintenance and expansion of our businesses, operations, and infrastructure. Our focus on long-term goals over short-term results. The results of our acquisitions, divestitures, and our investments in risky projects, including new businesses, products, services, and technologies. Our ability to keep our products and services operational at a reasonable cost and without service interruptions. The seasonal fluctuations in internet usage, advertising spending, and underlying business trends such as traditional retail seasonality. Our rapid growth has tended to mask the cyclicality and seasonality of our business. As our growth rate has slowed, the cyclicality and seasonality in our business has become more pronounced and caused our operating results to fluctuate. Because our businesses are changing and evolving, our historical operating results may not be useful to you in predicting our future operating results. A variety of new and existing laws and/or interpretations could harm our business. We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations (or new interpretations of existing laws and regulations) may make our products and services less useful, require us to incur substantial costs, expose us to unanticipated civil or criminal liability, or cause us to change our business practices. For example, our products and services are closely scrutinized by competition authorities around the world, which may limit our ability to pursue certain business models or offer certain products or services. Current and new patent laws may also affect the ability of companies, including us, to protect their innovations and defend against claims of patent infringement. Similarly, the Directive on Copyright in the Digital Single Market (DSM) in Europe, if passed in its proposed form, will increase the liability of large hosted platforms with respect to content uploaded by their users. It will also create a new property right in news publications that will limit the ability of online services to interact with or present such content. In addition to the DSM, other changes to copyright laws being considered elsewhere, will, if passed, increase costs and require companies, including us, to change or cease offering certain existing services. Additionally, as the focus on data privacy and security increases globally, we are and will Alphabet Inc. continue to be subject to various and evolving laws. The costs of compliance with these laws and regulations are high and are likely to increase in the future. Furthermore, many of these laws do not contemplate or address the unique issues raised by a number of our new businesses, products, services and technologies. In addition, the applicability and scope of these laws, as interpreted by the courts, remain uncertain. Other recently passed laws and/or certain court decisions that could harm our business include, among others: We rely on statutory safe harbors, as set forth in the Digital Millennium Copyright Act in the United States and the E-Commerce Directive in Europe, against copyright liability for various linking, caching, and hosting activities. Any legislation or court rulings affecting these safe harbors may adversely affect us. Court decisions such as the judgment of the Court of Justice of the European Union on May 13, 2014 on the right to be forgotten, which allows individuals to demand that Google remove search results about them in certain instances, may limit the content we can show to our users and impose significant operational burdens. Court decisions that require Google to suppress content not just in the jurisdiction of the issuing court, but for all of our users worldwide, including locations where the content at issue is lawful. The Supreme Court of Canada issued such a decision against Google in June 2017, and others could treat its decision as persuasive. For instance, with respect to the right to be forgotten, a follow-up case is pending before the Court of Justice of the European Union, which could result in an order to apply delisting actions under the right to be forgotten worldwide. Various U.S. and international laws that govern the distribution of certain materials to children and regulate the ability of online services to collect information from minors. Various laws with regard to content removal and disclosure obligations, such as the Network Enforcement Act in Germany, which may affect our businesses and operations and may subject us to significant fines if such laws are interpreted and applied in a manner inconsistent with our practices. Data protection laws passed by many states within the U.S. and by certain countries regarding notification to data subjects and/or regulators when there is a security breach of personal data. The California Consumer Privacy Act of 2018 that comes into effect in January of 2020, and gives new data privacy rights to California residents and regulates the security of data in connection with internet connected devices. Data localization laws, which generally mandate that certain types of data collected in a particular country be stored and/or processed within that country. Privacy laws, which could be interpreted broadly thereby limiting product offerings and/or increasing costs. Any failure on our part to comply with laws and regulations can result in negative publicity and diversion of management time and effort and may subject us to significant liabilities and other penalties. We are regularly subject to claims, suits, government investigations, and other proceedings that may adversely affect our business and results of operations. We are regularly subject to claims, suits, and government investigations involving competition, intellectual property, data privacy and security, consumer protection, tax, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Due to our manufacturing and sale of an expanded suite of products, including hardware as well as our Google Cloud offerings, we may also be subject to a variety of claims including product warranty, product liability and consumer protection claims related to product defects, among other litigation. We may also be subject to claims involving health and safety, hazardous materials usage, other environmental concerns or if users or customers experience service disruptions, failures, or other issues. In addition, our businesses face intellectual property litigation, as discussed later, that exposes us to the risk of exclusion and cease and desist orders, which could limit our ability to sell products and services. Such claims, suits, and government investigations are inherently uncertain. Regardless of the outcome, any of these types of legal proceedings can have an adverse effect on us because of legal costs, diversion of management resources, negative publicity and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that requires significant judgment. The resolution of one or more such proceedings has resulted and may in the future result in additional substantial fines and penalties that could adversely affect our business, consolidated financial position, results of operations, or cash flows in a particular period. These proceedings could also result in Alphabet Inc. reputational harm, criminal sanctions, consent decrees, or orders preventing us from offering certain features, functionalities, products, or services, requiring a change in our business practices or product recalls or corrections, or requiring development of non-infringing or otherwise altered products or technologies. Any of these consequences could adversely affect our business and results of operations. We may be subject to legal liability associated with providing online services or content. We host and provide a wide variety of services and products that enable users to exchange information, advertise products and services, conduct business, and engage in various online activities both domestically and internationally. The law relating to the liability of providers of these online services and products for activities of their users is still somewhat unsettled both within the U.S. and internationally. Claims have been threatened and have been brought against us for defamation, negligence, breaches of contract, copyright or trademark infringement, unfair competition, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information that we publish or to which we provide links or that may be posted online or generated by us or by third parties, including our users. In addition, we are and have been and may again in the future be subject to domestic or international actions alleging that certain content we have generated or third-party content that we have made available within our products and services violates U.S. and international law. We also place advertisements which are displayed on third-party publishers and advertising networks properties, and we offer third-party products, services, or content. We may be subject to claims concerning these products, services, or content by virtue of our involvement in marketing, branding, broadcasting, or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services, or content. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, which may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner. Data privacy and security concerns relating to our technology and our practices could damage our reputation and deter current and potential users or customers from using our products and services. Bugs or defects in our products and services have occurred and may occur in the future, or our security measures could be breached, resulting in the improper use and/or disclosure of user data, and our services and systems are subject to attacks that could degrade or deny the ability of users and customers to access, or rely on information received about, our products and services. As a consequence, our products and services may be perceived as being insecure, users and customers may curtail or stop using our products and services, and we may incur significant legal, reputational, and financial exposure. From time to time, concerns are expressed about whether our products, services, or processes compromise the privacy of users, customers, and others. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other data privacy related matters, even if unfounded, could damage our reputation and adversely affect our operating results. Our policies and practices may change over time as users and customers expectations regarding privacy and their data changes. Our products and services involve the storage and transmission of users and customers proprietary information, and bugs, theft, misuse, defects, vulnerabilities in our products and services, and security breaches expose us to a risk of loss of this information, improper use and disclosure of such information, litigation, and other potential liability. Systems failures, compromises of our security, failure to abide by our privacy policies, inadvertent disclosure that results in the release of our users data, or in our or our users inability to access such data, could result in government investigations and other liability, legislation or regulation, seriously harm our reputation and brand and, therefore, our business, and impair our ability to attract and retain users. We expect to continue to expend significant resources to maintain state-of-the-art security protections that shield against bugs, theft, misuse or security vulnerabilities or breaches. We experience cyber attacks of varying degrees and other attempts to gain unauthorized access to our systems on a regular basis. Our security measures may in the future be breached due to employee error, malfeasance, system errors or vulnerabilities, including vulnerabilities of our vendors, suppliers, their products, or otherwise. Such breach or other unauthorized access, increased government surveillance, or attempts by outside parties to fraudulently induce employees, users, or customers to disclose sensitive information in order to gain access to our data or our users or customers data could result in significant legal and financial exposure, damage to our reputation, and a loss of confidence in the security of our products and services that could potentially have an adverse effect on our business. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, become more sophisticated, and often are not recognized until launched against a target, we may be unable to anticipate or detect these techniques or to implement adequate preventative measures. Cyber attacks could also compromise trade secrets and other sensitive information and result in such information being disclosed to others and becoming less valuable, which could negatively affect our business. If an actual or perceived breach of our security Alphabet Inc. occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose users and customers. While we have dedicated significant resources to privacy and security incident response, including dedicated worldwide incident response teams, our response process may not be adequate, may fail to accurately assess the severity of an incident, may not respond quickly enough, or may fail to sufficiently remediate an incident, among other issues. As a result, we may suffer significant legal, reputational, or financial exposure, which could adversely affect our business and results of operations. Our business is subject to complex and rapidly evolving U.S. and international laws and regulations regarding privacy and data protection. Many of these laws and regulations are subject to change and uncertain interpretation and could result in claims, changes to our business practices, penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. Companies are under increased regulatory scrutiny relating to data privacy and security. Authorities around the world are considering a number of legislative and regulatory proposals concerning data protection, including measures to ensure that encryption of users data does not hinder law enforcement agencies access to that data. In addition, the interpretation and application of consumer and data protection laws in the U.S., Europe and elsewhere are often uncertain and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices. These legislative and regulatory proposals, if adopted, and such interpretations could, in addition to the possibility of fines, result in an order requiring that we change our data practices, which could have an adverse effect on our business and results of operations. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. Recent legal developments in Europe have created compliance uncertainty regarding certain transfers of personal data from Europe to the United States. For example, the General Data Protection Regulation (GDPR), became effective in the European Union (EU) beginning on May 25, 2018, and applies to all of our activities conducted from an establishment in the EU or related to products and services that we offer to EU users or customers, or the monitoring of their behavior in the EU. The GDPR subjects us to a range of new compliance obligations. Ensuring compliance with the GDPR is an ongoing commitment which involves substantial costs, and it is possible that despite our efforts, governmental authorities or third parties will assert that our business practices fail to comply. We have been and may in the future be, subject to lawsuits alleging violations of the GDPR. If our operations are found to be in violation of the GDPRs requirements, we may be required to change our business practices and/or be subject to significant civil penalties, business disruption, and reputational harm, any of which could have a material adverse effect on our business. In particular, serious breaches of the GDPR can result in administrative fines of up to the higher of 4% of annual worldwide revenues or 20 million. Fines of up to the higher of 2% of annual worldwide revenues or 10 million can be levied for other specified violations. In addition, the European Commission in July 2016 and the Swiss Government in January 2017 approved the EU-U.S. and the Swiss-U.S. Privacy Shield frameworks, respectively, which are designed to allow U.S. companies that self-certify to the U.S. Department of Commerce and publicly commit to comply with the Privacy Shield requirements to freely import personal data from the EU and Switzerland. However, these frameworks face a number of legal challenges and their validity remains subject to legal, regulatory and political developments in both Europe and the U.S. This has resulted in some uncertainty, and compliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business. We are, and may in the future be, subject to intellectual property or other claims, which are costly to defend, could result in significant damage awards, and could limit our ability to use certain technologies in the future. Many companies, in particular those in internet, technology and media own large numbers of patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. In addition, patent holding companies may continue to seek to monetize patents they have purchased or otherwise obtained by bringing claims against us, whether such claims are meritorious or not. As we have grown, the number of intellectual property claims against us has increased and may continue to increase as we develop new products, services, and technologies. We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Third parties have also sought broad injunctive relief against us by filing claims in U.S. and international courts and the U.S. International Trade Commission (ITC) for exclusion and cease and desist orders, which could limit our ability to sell our products or services in the U.S. or elsewhere if our products or services or those of our customers or suppliers are found to Alphabet Inc. infringe the intellectual property subject to the claims. Adverse results in any of these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements (if licenses are available at all), or orders preventing us from offering certain features, functionalities, products, or services, and may also cause us to change our business practices and require development of non-infringing products, services or technologies, which could result in a loss of revenues for us and otherwise harm our business. Many of our agreements with our customers and partners, including certain suppliers, require us to defend against certain intellectual property infringement claims and/or indemnify them for certain intellectual property infringement claims against them, which could result in increased costs for defending such claims or significant damages if there were an adverse ruling in any such claims. Such customers and partners may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. Moreover, intellectual property indemnities provided to us by our suppliers, when obtainable, may not cover all damages and losses suffered by us and our customers arising from intellectual property infringement claims brought against us. Furthermore, in connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, including those associated with intellectual property claims. Regardless of their merits, intellectual property claims are often time consuming, expensive to litigate or settle, and cause significant diversion of management attention. To the extent such claims are successful, they may have an adverse effect on our business, including our product and service offerings, consolidated financial position, results of operations, or cash flows. Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand as well as affect our ability to compete. Our patents, trademarks, trade secrets, copyrights, and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights, as well as to our products, services and technologies. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. Moreover, we may not have adequate patent or copyright protection for certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We also seek to maintain certain intellectual property as trade secrets. The secrecy of such trade secrets and other sensitive information could be compromised by outside parties, or by our employees, which could cause us to lose the competitive advantage resulting from these trade secrets. We also face risks associated with our trademarks. For example, there is a risk that the word Google could become so commonly used that it becomes synonymous with the word search. Some courts have ruled that ""Google"" is a protectable trademark, however it is possible that other courts, particularly those outside of the United States, may reach a different determination. If this happens, we could lose protection for this trademark, which could result in other people using the word Google to refer to their own products, thus diminishing our brand. Any significant impairment of our intellectual property rights could harm our business and our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results. Acquisitions, joint ventures, investments, and divestitures could result in operating difficulties, dilution, and other consequences that may adversely affect our business and results of operations. Acquisitions, joint ventures, investments and divestitures are important elements of our overall corporate strategy and use of capital, and these transactions could be material to our financial condition and results of operations. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions. Effecting these strategic transactions could create unforeseen operating difficulties and expenditures. The areas where we face risks include, among others: Diversion of management time and focus from operating our business to challenges related to acquisitions and other strategic transactions. Failure to successfully further develop the acquired business or technology. Implementation or remediation of controls, procedures, and policies at the acquired company. Alphabet Inc. Integration of the acquired company's accounting, human resource, and other administrative systems, and coordination of product, engineering, and sales and marketing functions. Transition of operations, users, and customers onto our existing platforms. Failure to obtain required approvals on a timely basis, if at all, from governmental authorities, or conditions placed upon approval that could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of an acquisition or other strategic transaction. In the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Cultural challenges associated with integrating employees from the acquired company into our organization, and retention of employees from the businesses we acquire. Liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, privacy issues, violations of laws, commercial disputes, tax liabilities, and other known and unknown liabilities. Litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former stockholders, or other third parties. Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and other strategic transactions could cause us to fail to realize their anticipated benefits, incur unanticipated liabilities, and harm our business generally. Our acquisitions and other strategic transactions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or impairment of goodwill and/or purchased long-lived assets, and restructuring charges, any of which could harm our financial condition or results. Also, the anticipated benefits or value of our acquisitions and other strategic transactions may not materialize. In connection with our divestitures, we have agreed, and may in the future agree, to provide indemnification for certain potential liabilities, which may adversely affect our financial condition or results. Our business depends on strong brands, and failing to maintain and enhance our brands would hurt our ability to expand our base of users, advertisers, customers, content providers, and other partners. Our strong brands have significantly contributed to the success of our business. Maintaining and enhancing the brands within Google and Other Bets increases our ability to enter new categories and launch new and innovative products that better serve the needs of our users, advertisers, customers, content providers, and other partners. Our brands may be negatively affected by a number of factors, including, among others, reputational issues, third-party content shared on our platforms, data privacy issues and developments, and product or technical performance failures. For example, if we fail to appropriately respond to the sharing of objectionable content on our services or objectionable practices by advertisers, or to otherwise adequately address user concerns, our users may lose confidence in our brands. Our brands may also be negatively affected by the use of our products or services to disseminate information that is deemed to be false or misleading. Furthermore, if we fail to maintain and enhance equity in our brands, our business, operating results, and financial condition may be materially and adversely affected. Our success will depend largely on our ability to remain a technology leader and continue to provide high-quality, innovative products and services that are truly useful and play a meaningful role in peoples everyday lives. We face a number of manufacturing and supply chain risks that, if not properly managed, could adversely affect our financial results and prospects. We face a number of risks related to manufacturing and supply chain management. These manufacturing and supply chain risks could affect our ability to supply both our products and our internet-based services. We rely on third parties to manufacture many of our assemblies and finished products, third-party arrangements for the design of some components and parts, and third party distributors, including cellular network carriers. Our business could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of our arrangements with them. Alphabet Inc. We may experience supply shortages and price increases driven by raw material availability, manufacturing capacity, labor shortages, industry allocations, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), and significant changes in the financial or business condition of our suppliers. We may experience shortages or other supply chain disruptions in the future that could negatively affect our operations. In addition, some of the components we use in our technical infrastructure and products are available only from a single source or limited sources, and we may not be able to find replacement vendors on favorable terms or at all in the event of a supply chain disruption. In addition, a significant hardware supply interruption could delay critical data center upgrades or expansions. We may enter into long term contracts that commit us to significant terms and conditions of supply. We may be liable for material and product that is not consumed due to market acceptance, technological change, obsolescences, quality, product recalls, and warranty issues. For instance, because many of our hardware supply contracts have volume-based pricing or minimum purchase requirements, if the volume of our hardware sales decreases or does not reach projected targets, we could face increased materials and manufacturing costs or other financial liabilities that could make our products more costly per unit to manufacture and therefore less competitive and negatively affect our financial results. Furthermore, certain of our competitors may negotiate more favorable contractual terms based on volume and other commitments that may provide them with competitive advantages and may affect our supply. The products and services we sell or offer may have quality issues resulting from the design or manufacture of the product, or from the software used. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our products and services does not meet our users and/or customers expectations or our products or services are found to be defective, then our sales and operating earnings, and ultimately our reputation, could be negatively affected. We also require our suppliers and business partners to comply with law and, where applicable, our company policies, such as the Google Supplier Code of Conduct, regarding workplace and employment practices, data security, environmental compliance and intellectual property licensing, but we do not control them or their practices. If any of them violates laws or implements practices regarded as unethical, we could experience supply chain disruptions, canceled orders, terminations of or damage to key relationships, and damage to our reputation. If any of them fails to procure necessary license rights to third-party intellectual property, legal action could ensue that could affect the saleability of our products and expose us to financial obligations to third parties. Web spam, including content farms, and other violations of our guidelines could affect the quality of our services, which could damage our reputation and deter our current and potential users from using our products and services. Web spam refers to websites that violate or attempt to violate our guidelines or that otherwise seek to inappropriately rank higher in search results than our search engine's assessment of their relevance and utility would rank them. Web spam may also affect the quality of content posted on our platforms and may manipulate them to display false, misleading or undesirable content. Although English-language web spam in our search results has been significantly reduced, and web spam in most other languages is limited, we expect web spammers will continue to seek ways to improve their rankings inappropriately. We continuously combat web spam in our search results, including through indexing technology that makes it harder for spam-like, less useful web content to rank highly. We also continue to invest in and deploy proprietary technology to detect and prevent web spam from abusing our platforms. We also face other challenges from web spam such as low-quality and irrelevant content websites, including content farms, which are websites that generate large quantities of low-quality content to help them improve their search rankings. We are continually launching algorithmic changes focused on low-quality websites. We, like others in the industry, face other violations of our guidelines, including sophisticated attempts by bad actors to manipulate our advertising systems to fraudulently generate revenues for themselves or others, or to otherwise generate traffic that does not represent genuine user interest or intent. While we invest significantly in efforts to detect and prevent invalid traffic, including attempts by bad actors to generate income fraudulently, we may be unable to adequately detect and prevent such abuses in the future. If we are subject to an increasing number of web spam, including content farms or other violations of our guidelines, this could hurt our reputation for delivering relevant information or reduce user traffic to our websites or their use of our platforms, which may adversely affect our financial condition or results. Interruption, interference with or failure of our information technology and communications systems could hurt our ability to effectively provide our products and services, which could damage our reputation and harm our operating results. Alphabet Inc. The availability of our products and services depends on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage, interference or interruption from terrorist attacks, natural disasters, the effects of climate change (such as sea level rise, drought, flooding, wildfires, and increased storm severity), power loss, telecommunications failures, computer viruses, computer denial of service attacks, or other attempts to harm or access our systems. Some of our data centers are located in areas with a high risk of major earthquakes or other natural disasters. Our data centers are also subject to break-ins, sabotage, and intentional acts of vandalism, and to potential disruptions if the operators of certain of these facilities have financial difficulties. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using, or other unanticipated problems at our data centers could result in lengthy interruptions in our service. In addition, our products and services are highly technical and complex and may contain errors or vulnerabilities, which could result in interruptions in our services or the failure of our systems. Our international operations expose us to additional risks that could harm our business, operating results, and financial condition. Our international operations are significant to our revenues and net income, and we plan to continue to grow internationally. International revenues accounted for approximately 54% of our consolidated revenues in 2018 . In addition to risks described elsewhere in this section, our international operations expose us to other risks, including the following: Restrictions on foreign ownership and investments, and stringent foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S. Import and export requirements, tariffs, trade disputes and barriers, and customs classifications that may prevent us from offering products or providing services to a particular market and may increase our operating costs. Longer payment cycles in some countries, increased credit risk, and higher levels of payment fraud. Evolving foreign laws and legal systems, including those that may occur as a result of the United Kingdom's potential withdrawal from the European Union (""Brexit""). Brexit may adversely affect global economic and market conditions and could contribute to volatility in the foreign exchange markets, which we may be unable to effectively manage through our foreign exchange risk management program. Brexit may also adversely affect our revenues and could subject us to new regulatory costs and challenges, in addition to other adverse effects that we are unable to effectively anticipate. Uncertainty regarding liability for services and content, including uncertainty as a result of local laws and lack of legal precedent. Different employee/employer relationships, existence of workers' councils and labor unions, and other challenges caused by distance, language, and cultural differences, making it harder to do business in certain jurisdictions. Changes in international local political, economic, regulatory, tax, social, and labor conditions may also harm our business, and compliance with complex international and U.S. laws and regulations that apply to our international operations increases our cost of doing business. These numerous and sometimes conflicting laws and regulations include, among others, internal control and disclosure rules, privacy and data protection requirements, anti-corruption laws, such as the U.S. Foreign Corrupt Practices Act, and other local laws prohibiting certain payments to governmental officials, and competition regulations, among others. Violations of these laws and regulations could result in fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business and on our ability to offer our products and services in one or more countries, and could also materially affect our brand, our international growth efforts, our ability to attract and retain employees, our business, and our operating results. Although we have implemented policies and procedures designed to ensure compliance with these laws and regulations, there can be no assurance that our employees, contractors, or agents will not violate our policies. Since we conduct business in currencies other than U.S. dollars but report our financial results in U.S. dollars, we face exposure to fluctuations in foreign currency exchange rates. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues and earnings. Hedging programs are also inherently risky and could expose us to additional risks that could adversely affect our financial condition and results of operations. If we were to lose the services of key personnel, we may not be able to execute our business strategy. Alphabet Inc. Our future success depends in a large part upon the continued service of key members of our senior management team. In particular, Larry Page and Sergey Brin are critical to the overall management of Alphabet and its subsidiaries, and they, along with Sundar Pichai, the Chief Executive Officer of Google, play an important role in the development of our technology. They also play a key role in maintaining our culture and setting our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of key personnel could seriously harm our business. We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture, we may not be able to grow effectively. Our performance largely depends on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate, and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and certain of our competitors have directly targeted our employees. In addition, our compensation arrangements, such as our equity award programs, may not always be successful in attracting new employees and retaining and motivating our existing employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees. In addition, we believe that our corporate culture fosters innovation, creativity, and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, particularly in light of our holding company structure, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively affect our future success. Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to restrict, block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers. Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take measures, including legal actions, that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings. Some jurisdictions have adopted regulations prohibiting certain forms of discrimination by Internet access providers; however, substantial uncertainty exists in the United States and elsewhere regarding such protections. For example, in the United States the Federal Communications Commission repealed net neutrality rules effective June 11, 2018, which could lead internet access providers to restrict, block, degrade, or charge for access to certain of our products and services. In addition, in some jurisdictions, our products and services have been subject to government-initiated restrictions or blockages. Such interference could result in a loss of existing users, customers and advertisers, goodwill, and increased costs, and could impair our ability to attract new users, customers and advertisers, thereby harming our revenues and growth. New and existing technologies could affect our ability to customize ads and/or could block ads online, which would harm our business. Technologies have been developed to make customizable ads more difficult or to block the display of ads altogether and some providers of online services have integrated technologies that could potentially impair the core functionality of third-party digital advertising. Most of our Google revenues are derived from fees paid to us in connection with the display of ads online. As a result, such technologies and tools could adversely affect our operating results. We are exposed to fluctuations in the market values of our investments. Given the global nature of our business, we have investments both domestically and internationally. Market values of these investments can be negatively affected by liquidity, credit deterioration or losses, financial results, foreign exchange rates, changes in interest rates, including changes that may result from the implementation of new benchmark rates that replace LIBOR, the effect of new or changing regulations, or other factors. Due to the adoption of ASU 2016-01 Financial Instruments; Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities in January 2018, we adjust the carrying value of our non-marketable equity securities to fair value for observable transactions of identical or similar investments of the same issuer and impairment. All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), which increases the volatility of our other income (expense). Alphabet Inc. As a result of these factors, the value or liquidity of our cash equivalents, as well as our marketable and non-marketable securities could decline and result in a material impairment, which could materially adversely affect our financial condition and operating results. We could be subject to changes in tax rates, the adoption of new U.S. or international tax legislation, or exposure to additional tax liabilities. Our future income taxes could be adversely affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. In addition, we are subject to regular review and audit by both domestic and foreign tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions on various tax-related assertions, examples include transfer pricing adjustments or permanent establishment. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws or rates in various jurisdictions may be subject to significant change, which could materially affect our financial position and results of operations. Risks Related to Ownership of Our Stock The trading price for our Class A common stock and non-voting Class C capital stock may continue to be volatile. The trading price of our stock has at times experienced substantial price volatility and may continue to be volatile. For example, from January 1, 2018 through December 31, 2018, the closing price of our Class A common stock ranged from $984.66 per share to $1,285.50 per share, and the closing price of our Class C capital stock ranged from $976.21 to $1,268.32 per share. In addition to the factors discussed in this report, the trading price of our Class A common stock and Class C capital stock may fluctuate widely in response to various factors, many of which are beyond our control, including, among others: Quarterly variations in our results of operations or those of our competitors. Announcements by us or our competitors of acquisitions, divestitures, investments, new products, significant contracts, commercial relationships, or capital commitments. Recommendations by securities analysts or changes in earnings estimates. Announcements about our earnings that are not in line with analyst expectations, the risk of which is enhanced because it is our policy not to give guidance on earnings. Announcements by our competitors of their earnings that are not in line with analyst expectations. Commentary by industry and market professionals about our products, strategies, and other matters affecting our business and results, regardless of its accuracy. The volume of shares of Class A common stock and Class C capital stock available for public sale. Sales of Class A common stock and Class C capital stock by us or by our stockholders (including sales by our directors, executive officers, and other employees). Short sales, hedging, and other derivative transactions on shares of our Class A common stock and Class C capital stock. The perceived values of Class A common stock and Class C capital stock relative to one another. Any share repurchase program. In addition, the stock market in general, which can be affected by various factors, including overall economic and political conditions, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Alphabet Inc. These broad market and industry factors may harm the market price of our Class A common stock and our Class C capital stock regardless of our actual operating performance. We cannot guarantee that any share repurchase program will be fully consummated or that any share repurchase program will enhance long-term stockholder value, and share repurchases could increase the volatility of the price of our stock and could diminish our cash reserves. In 2016 and 2018, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion and $8.6 billion of its Class C capital stock, respectively. The 2016 authorization was completed in 2018. As of December 31, 2018 , $1.7 billion remains available for repurchase. In January 2019, our board of directors authorized the repurchase of up to an additional $12.5 billion of our Class C capital stock. Our repurchase program does not have an expiration date and does not obligate Alphabet to repurchase any specific dollar amount or to acquire any specific number of shares. Our share repurchase program could affect the price of our stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our stock. The concentration of our stock ownership limits our stockholders ability to influence corporate matters. Our Class B common stock has 10 votes per share, our Class A common stock has one vote per share, and our Class C capital stock has no voting rights. As of December 31, 2018, Larry Page, Sergey Brin, and Eric E. Schmidt beneficially owned approximately 92.8% of our outstanding Class B common stock, which represented approximately 56.5% of the voting power of our outstanding common stock. Larry, Sergey, and Eric therefore have significant influence over management and affairs and over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets, for the foreseeable future. In addition, because our Class C capital stock carries no voting rights (except as required by applicable law), the issuance of the Class C capital stock, including in future stock-based acquisition transactions and to fund employee equity incentive programs, could prolong the duration of Larry, Sergey and Erics current relative ownership of our voting power and their ability to elect all of our directors and to determine the outcome of most matters submitted to a vote of our stockholders. This concentrated control limits or severely restricts our stockholders ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. As a result, the market price of our Class A common stock and our Class C capital stock could be adversely affected. Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable. Provisions in Alphabets certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following: Our certificate of incorporation provides for a tri-class capital stock structure. As a result of this structure, Larry, Sergey, and Eric have significant influence over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets. This concentrated control could discourage others from initiating any potential merger, takeover, or other change of control transaction that other stockholders may view as beneficial. As noted above, the issuance of the Class C capital stock could have the effect of prolonging the influence of Larry, Sergey, and Eric. Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death, or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors. Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders' meeting. Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates. Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders meeting. These provisions may discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer's own slate of directors or otherwise attempting to obtain control of our company. Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us. Alphabet Inc. As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its outstanding voting stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us. Risk Related to Our Holding Company Reorganization As a holding company, Alphabet is dependent on the operations and funds of its subsidiaries. Alphabet is a holding company with no business operations of its own. Alphabets most significant assets are the outstanding equity interests in its subsidiaries, including Google, that are each separate and distinct legal entities. As a result of our holding company structure, we rely on cash flows from subsidiaries to meet our obligations, including to service any debt obligations of Alphabet. Our subsidiaries may be restricted in their ability to pay cash dividends or to make other distributions to Alphabet and therefore, our ability to meet our obligations may be adversely affected by such restrictions. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our headquarters are located in Mountain View, California. We also own and lease office and building space in the surrounding areas near our headquarters, which in the aggregate (including our headquarters) represent approximately 11.2 million square feet of office/building space and approximately fifty-nine acres of developable land to accommodate anticipated future growth. In addition, we own and lease office/building space and research and development sites around the world, primarily in North America, Europe, South America, and Asia. We own and operate data centers in the U.S., Europe, South America, and Asia. We believe our existing facilities, both owned and leased, are in good condition and suitable for the conduct of our business. "," ITEM 3. LEGAL PROCEEDINGS For a description of our material pending legal proceedings, please see Note 9 Commitments and Contingencies - Legal Matters of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES As of October 2, 2015, Alphabet Inc. became the successor issuer of Google Inc. pursuant to Rule 12g-3(a) under the Exchange Act. Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since August 19, 2004 and under the symbol ""GOOGL"" since April 3, 2014. Prior to August 19, 2004, there was no public market for our stock. Our Class B common stock is neither listed nor traded. Our Class C capital stock has been listed on the Nasdaq Global Select Market under the symbol GOOG since April 3, 2014. Holders of Record As of December 31, 2018 , there were approximately 2,026 and 2,195 stockholders of record of our Class A common stock and Class C capital stock, respectively. Because many of our shares of Class A common stock and Class C capital stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018 , there were approximately 65 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common or capital stock. We do not expect to pay any cash dividends in the foreseeable future. Issuer Purchases of Equity Securities The following table presents information with respect to Alphabet's repurchases of Class C capital stock during the quarter ended December 31, 2018 : Period Total Number of Shares Purchased (in thousands) (1) Average Price Paid per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (in thousands) (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program (in millions) October 1 - 31 $ 1,115.81 $ 3,412 November 1 - 30 $ 1,054.22 $ 2,506 December 1 - 31 $ 1,048.23 $ 1,688 Total 2,470 $ 1,073.02 2,470 (1) In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. See Note 10 in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to share repurchases. (2) Average price paid per share includes costs associated with the repurchases. Alphabet Inc. Stock Performance Graphs The graph below matches Alphabet Inc. Class A's cumulative 5-Year total shareholder return on common stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each index (with the reinvestment of all dividends) from December 31, 2013 to December 31, 2018 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS A COMMON STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on December 31, 2013 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2015 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. The graph below matches Alphabet Inc. Class C's cumulative 57-Month total shareholder return on capital stock with the cumulative total returns of the SP 500 index, the NASDAQ Composite index, and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our Class C capital stock and in each index (with the reinvestment of all dividends) from April 3, 2014 to December 31, 2018 . The returns shown are based on historical results and are not intended to suggest future performance. COMPARISON OF CUMULATIVE TOTAL RETURN* ALPHABET INC. CLASS C CAPITAL STOCK Among Alphabet Inc., the SP 500 Index, the NASDAQ Composite Index, and the RDG Internet Composite Index *$100 invested on April 3, 2014 in stock or in index, including reinvestment of dividends. Fiscal year ending December 31. Copyright 2015 SP, a division of The McGraw-Hill Companies Inc. All rights reserved. Alphabet Inc. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Please read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included under Part II, Item 8 of this Annual Report on Form 10-K. Trends in Our Business The following trends have contributed to the results of our consolidated operations, and we anticipate that they will continue to affect our future results: Users' behaviors and advertising continue to shift online as the digital economy evolves. The continuing shift from an offline to online world has contributed to the growth of our business since inception, contributing to revenue growth, and we expect that this online shift will continue to benefit our business. As online advertising evolves, we continue to expand our product offerings which may affect our monetization. As interactions between users and advertisers change and as online user behavior evolves, we continue to expand and evolve our product offerings to serve their changing needs. Over time, we expect our monetization trends to fluctuate. For example, we have seen an increase in YouTube engagement ads, which monetize at a lower rate than traditional desktop search ads. Additionally, we continue to see a shift to programmatic buying which presents opportunities for advertisers to connect with the right user, in the right moment, in the right context. Programmatic buying has a different monetization profile than traditional advertising buying on Google properties. Users are increasingly using diverse devices and modalities to access our products and services, and our advertising revenues are increasingly coming from mobile and other new formats. Our users are accessing the Internet via diverse devices and modalities and want to feel connected no matter where they are or what they are doing. We seek to expand our products and services to stay in front of this shift in order to maintain and grow our business. We generate our advertising revenues increasingly from mobile and newer advertising formats, and the margins from the advertising revenues from these sources have generally been lower than those from traditional desktop search. Accordingly, we expect TAC paid to our distribution partners to increase due to changes in device mix between mobile, desktop, and tablet, partner mix, partner agreement terms, and the percentage of queries channeled through paid access points. We expect these trends to continue to put pressure on our overall margins. As users in developing economies increasingly come online, our revenues from international markets continue to increase and movements in foreign exchange rates affect such revenues. The shift to online, as well as the advent of the multi-device world, has brought opportunities outside of the U.S., including in emerging markets, and we continue to develop localized versions of our products and relevant advertising programs useful to our users in these markets. This has led to a trend of increased revenues from international markets over time and we expect that our results will continue to be affected by our performance in these markets, particularly as low-cost mobile devices become more available. Our international revenues represent a significant portion of our revenues and are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. While we have a foreign exchange risk management program designed to reduce our exposure to these fluctuations, this program does not fully offset their effect on our revenues and earnings. The portion of our revenues that we derive from non-advertising revenues is increasing and may affect margins. Non-advertising revenues have grown over time. We expect this trend to continue as we focus on expanding our offerings to our users through products and services like Google Cloud, Google Play, hardware products, and YouTube subscriptions. Across these initiatives, we currently derive non-advertising revenues primarily from sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings. The margins on these non-advertising businesses vary significantly and may be lower than the margins on our advertising business. A number of our Other Bets initiatives are in their initial development stages, and as such, the sources of revenues from these businesses could change over time and the revenues could be volatile. Alphabet Inc. As we continue to look for new ways to serve our users and expand our businesses, we will invest heavily in RD and capital expenditures. We continue to make significant RD investments in areas of strategic focus such as advertising, cloud, machine learning, and search, as well as in new products and services. Our capital expenditures have grown over time. We expect this trend to continue in the long term as we invest heavily in data centers, real estate and facilities, and information technology infrastructure. In addition, acquisitions remain an important part of our strategy and use of capital, and we expect to continue to spend cash on acquisitions and other investments. These acquisitions generally enhance the breadth and depth of our offerings, as well as expand our expertise in engineering and other functional areas. Our employees are critical to our success and we expect to continue investing in them. Our employees are among our best assets and are critical for our continued success. We expect to continue hiring talented employees around the globe and to provide competitive compensation programs to our employees. Executive Overview of Results Below are our key financial results for the fiscal year ended December 31, 2018 (consolidated unless otherwise noted): Revenues of $136.8 billion and revenue growth of 23% year over year, constant currency revenue growth of 22% year over year. Google segment revenues of $136.2 billion with revenue growth of 23% year over year and Other Bets revenues of $595 million with revenue growth of 25% year over year. Revenues from the United States , EMEA , APAC , and Other Americas were $63.3 billion , $44.6 billion , $21.4 billion , and $7.6 billion , respectively. Cost of revenues was $59.5 billion , consisting of TAC of $26.7 billion and other cost of revenues of $32.8 billion . Our TAC as a percentage of advertising revenues was 23% . Operating expenses (excluding cost of revenues) were $50.9 billion . Income from operations was $26.3 billion . Other income (expense), net, was $8.6 billion . Effective tax rate was 12% . Net income was $30.7 billion with diluted net income per share of $43.70 . Operating cash flow was $48.0 billion . Capital expenditures were $25.1 billion . Number of employees was 98,771 as of December 31, 2018 . Information about Segments We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as Ads, Android, Chrome, Google Cloud, Google Maps, Google Play, Hardware (including Nest), Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes businesses such as Access, Calico, CapitalG, GV, Verily, Waymo, and X. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. In Q1 2018, Nest joined Googles hardware team. Consequently, the financial results of Nest are reported in the Google segment, with Nest revenues reflected in Google other revenues. Prior period segment information has been recast to conform to the current period segment presentation. Consolidated financial results are not affected. Alphabet Inc. Please refer to Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Revenues The following table presents our revenues, by segment and revenue source (in millions): Year Ended December 31, Google segment Google properties revenues $ 63,785 $ 77,788 $ 96,336 Google Network Members' properties revenues 15,598 17,587 19,982 Google advertising revenues 79,383 95,375 116,318 Google other revenues 10,601 15,003 19,906 Google segment revenues $ 89,984 $ 110,378 $ 136,224 Other Bets Other Bets revenues $ $ $ Revenues $ 90,272 $ 110,855 $ 136,819 Google segment The following table presents our Google segment revenues (in millions): Year Ended December 31, Google segment revenues $ 89,984 $ 110,378 $ 136,224 Google segment revenues as a percentage of total revenues 99.7 % 99.6 % 99.6 % Use of Monetization Metrics When assessing our advertising revenues performance, historically we presented the percentage change in the number of paid clicks and cost-per-click for both our Google properties and our Google Network Members properties (Network) revenues. As our impression-based revenues have become a more significant driver of Network revenues growth, the percentage change in paid clicks and cost-per-click cover less of our total Network revenues. As a result, in Q1 2018, we transitioned our Network revenue metrics from the percentage change in paid clicks and cost-per-click to the percentage change in impressions and cost-per-impression. Click-based revenues generated by our Network business are included in impression-based metrics, so that these metrics cover nearly all of our Network business. The monetization metrics for Google properties revenues remain unchanged. Paid clicks for our Google properties represent engagement by users and include clicks on advertisements by end-users related to searches on Google.com, clicks related to advertisements on other owned and operated properties including Gmail, Google Maps, and Google Play; and viewed YouTube engagement ads. Impressions for our Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in AdMob, AdSense for Content, AdSense for Search, and Google Ad Manager (includes what was formerly DoubleClick AdExchange). Cost-per-click is defined as click-driven revenues divided by our total number of paid clicks and represents the average amount we charge advertisers for each engagement by users. Cost-per-impression is defined as impression-based and click-based revenues divided by our total number of impressions and represents the average amount we charge advertisers for each impression displayed to users. As our business evolves, we periodically review, refine and update our methodologies for monitoring, gathering, and counting the number of paid clicks on our Google properties and the number of impressions on Google Network Members properties and for identifying the revenues generated by click activity on our Google properties and the revenues generated by impression activity on Google Network Members properties. Our advertising revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members' properties and the correlation between these items, have fluctuated and may continue to fluctuate because of various factors, including: Alphabet Inc. advertiser competition for keywords; changes in advertising quality or formats; changes in device mix; changes in foreign currency exchange rates; fees advertisers are willing to pay based on how they manage their advertising costs; general economic conditions; growth rates of revenues within Google properties; seasonality; and traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels. Our advertising revenue growth rate has fluctuated over time as a result of a number of factors, including challenges in maintaining our growth rate as revenues increase to higher levels, changes in our product mix, increasing competition, query growth rates, our investments in new business strategies, shifts in the geographic mix of our revenues, and the evolution of the online advertising market. We also expect that our revenue growth rate will continue to be affected by evolving user preferences, the acceptance by users of our products and services as they are delivered on diverse devices and modalities, our ability to create a seamless experience for both users and advertisers, and movements in foreign currency exchange rates. Google properties The following table presents our Google properties revenues (in millions), and changes in our paid clicks and cost-per-click (expressed as a percentage): Year Ended December 31, Google properties revenues $ 63,785 $ 77,788 $ 96,336 Google properties revenues as a percentage of Google segment revenues 70.9 % 70.5 % 70.7 % Paid clicks change % % Cost-per-click change (21 )% (25 )% Google properties revenues consist primarily of advertising revenues that are generated on: Google search properties which includes revenues from traffic generated by search distribution partners who use Google.com as their default search in browsers, toolbars, etc.; and Other Google owned and operated properties like Gmail, Google Maps, Google Play, and YouTube. Our Google properties revenues increased $18,548 million from 2017 to 2018 and increased $14,003 million from 2016 to 2017 . The growth during both periods was primarily driven by increases in mobile search resulting from ongoing growth in user adoption and usage, as well as continued growth in advertiser activity. We also experienced growth in YouTube driven primarily by video advertising, as well as growth in desktop search due to improvements in ad formats and delivery. Additionally, revenue growth from 2017 to 2018 was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. The growth from 2016 to 2017 was partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. The number of paid clicks through our advertising programs on Google properties increased from 2017 to 2018 and from 2016 to 2017 due to growth in YouTube engagement ads, increases in mobile search queries, improvements we have made in ad formats and delivery, and continued global expansion of our products, advertisers and user base. The positive effect on our revenues from an increase in paid clicks was partially offset by a decrease in the cost-per-click paid by our advertisers from 2017 to 2018 and from 2016 to 2017 . The decreases in cost-per-click were primarily driven by continued growth in YouTube engagement ads where cost-per-click remains lower than on our other advertising platforms. Cost-per-click was also affected by changes in device mix, geographic mix, ongoing product changes, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Alphabet Inc. Google Network Members' properties The following table presents our Google Network Members' properties revenues (in millions) and changes in our impressions and cost-per-impression (expressed as a percentage): Year Ended December 31, Google Network Members' properties revenues $ 15,598 $ 17,587 $ 19,982 Google Network Members' properties revenues as a percentage of Google segment revenues 17.3 % 15.9 % 14.7 % Impressions change % % Cost-per-impression change % % Google Network Members' properties revenues consist primarily of advertising revenues generated from advertisements served on Google Network Members' properties participating in: AdMob; AdSense (such as AdSense for Content, AdSense for Search, etc.); and Google Ad Manager . Our Google Network Members' properties revenues increased $2,395 million from 2017 to 2018 . The growth was primarily driven by strength in both AdMob and programmatic advertising buying, offset by a decline in our traditional AdSense businesses. Additionally, the growth was favorably affected by the general weakening of the U.S. dollar compared to certain foreign currencies. The increase in impressions from 2017 to 2018 resulted primarily from growth in AdMob offset by a decrease from AdSense for Content due to ongoing product changes. The increase in cost-per-impression was primarily due to ongoing product and policy changes and improvements we have made in ad formats and delivery and was also affected by changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Our Google Network Members' properties revenues increased $1,989 million from 2016 to 2017 . The growth was primarily driven by strength in both programmatic advertising buying and AdMob, offset by a decline in our traditional AdSense businesses and the general strengthening of the U.S. dollar compared to certain foreign currencies. The increase in impressions from 2016 to 2017 resulted primarily from growth in programmatic advertising and AdMob, partially offset by a decrease from AdSense for Search. The increase in cost-per-impression from 2016 to 2017 was primarily due to ongoing product and policy changes and improvements we have made in ad formats and delivery and was also affected by changes in device mix, geographic mix, product mix, property mix, and fluctuations of the U.S. dollar compared to certain foreign currencies. Google other revenues The following table presents our Google other revenues (in millions): Year Ended December 31, Google other revenues $ 10,601 $ 15,003 $ 19,906 Google other revenues as a percentage of Google segment revenues 11.8 % 13.6 % 14.6 % Google other revenues consist primarily of revenues from: Apps, in-app purchases, and digital content in the Google Play store; Google Cloud offerings; and Hardware. Our Google other revenues increased $4,903 million from 2017 to 2018 . The increase was primarily driven by revenues from Google Cloud offerings, revenues from Google Play, largely relating to in-app purchases (revenues which we recognize net of payout to developers), and hardware sales. Our Google other revenues increased $4,402 million from 2016 to 2017 . The increase was primarily driven by revenues from Google Cloud offerings, hardware sales, and revenues from Google Play, largely relating to in-app purchases (revenues which we recognize net of payout to developers). Alphabet Inc. Other Bets The following table presents our Other Bets revenues (in millions): Year Ended December 31, Other Bets revenues $ $ $ Other Bets revenues as a percentage of total revenues 0.3 % 0.4 % 0.4 % Other Bets revenues consist primarily of revenues and sales from internet and TV services as well as licensing and RD services. Our Other Bets revenues increased $118 million from 2017 to 2018 and increased $189 million from 2016 to 2017 . These increases were primarily driven by revenues from sales of Access internet and TV services and revenues from Verily licensing and RD services. Revenues by Geography The following table presents our revenues by geography as a percentage of revenues, determined based on the addresses of our customers: Year Ended December 31, United States % % % EMEA % % % APAC % % % Other Americas % % % For the amounts of revenues by geography, please refer to Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Use of Constant Currency Revenues and Constant Currency Revenue Growth The effect of currency exchange rates on our business is an important factor in understanding period to period comparisons. Our international revenues are favorably affected as the U.S. dollar weakens relative to other foreign currencies, and unfavorably affected as the U.S. dollar strengthens relative to other foreign currencies. Our international revenues are also favorably affected by net hedging gains and unfavorably affected by net hedging losses. We use non-GAAP constant currency revenues and constant currency revenue growth for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of results on a constant currency basis in addition to GAAP results helps improve the ability to understand our performance because they exclude the effects of foreign currency volatility that are not indicative of our core operating results. Constant currency information compares results between periods as if exchange rates had remained constant period over period. We define constant currency revenues as total revenues excluding the effect of foreign exchange rate movements and hedging activities, and use it to determine the constant currency revenue growth on a year-on-year basis. Constant currency revenues are calculated by translating current period revenues using prior period exchange rates, as well as excluding any hedging effects realized in the current period. Constant currency revenue growth (expressed as a percentage) is calculated by determining the increase in current period revenues over prior period revenues where current period foreign currency revenues are translated using prior period exchange rates and hedging effects are excluded from revenues of both periods. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP. Alphabet Inc. The following table presents the foreign exchange effect on our international revenues and total revenues (in millions): Year Ended December 31, EMEA revenues $ 30,304 $ 36,046 $ 44,567 Exclude foreign exchange effect on current period revenues using prior year rates 1,291 (5 ) (1,325 ) Exclude hedging effect recognized in current period (479 ) EMEA constant currency revenues $ 31,116 $ 36,231 $ 43,414 Prior period EMEA revenues, excluding hedging effect $ 25,379 $ 29,825 $ 36,236 EMEA revenue growth % % EMEA constant currency revenue growth % % APAC revenues $ 12,559 $ 16,235 $ 21,374 Exclude foreign exchange effect on current period revenues using prior year rates (362 ) (49 ) Exclude hedging effect recognized in current period (31 ) (43 ) (33 ) APAC constant currency revenues $ 12,166 $ 16,218 $ 21,292 Prior period APAC revenues, excluding hedging effect $ 9,564 $ 12,528 $ 16,192 APAC revenue growth % % APAC constant currency revenue growth % % Other Americas revenues $ 4,628 $ 6,125 $ 7,609 Exclude foreign exchange effect on current period revenues using prior year rates (148 ) Exclude hedging effect recognized in current period (29 ) (1 ) Other Americas constant currency revenues $ 4,943 $ 5,999 $ 8,012 Prior period Other Americas revenues, excluding hedging effect $ 3,836 $ 4,599 $ 6,147 Other Americas revenue growth % % Other Americas constant currency revenue growth % % United States revenues $ 42,781 $ 52,449 $ 63,269 United States revenue growth % % Total revenues $ 90,272 $ 110,855 $ 136,819 Total constant currency revenues $ 91,006 $ 110,897 $ 135,987 Total revenue growth % % Total constant currency revenue growth % % Our EMEA revenues and revenue growth from 2017 to 2018 were favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Euro and British pound. Our EMEA revenues and revenue growth from 2016 to 2017 were unfavorably affected by hedging losses. Our APAC revenues and revenue growth from 2017 to 2018 were favorably affected by changes in foreign currency exchange rates, as well as hedging benefits, primarily due to the U.S. dollar weakening relative to the Japanese yen, offset by the U.S. dollar strengthening relative to the Australian dollar. Our APAC revenues and revenue growth from 2016 to 2017 were slightly affected by hedging benefits and changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Japanese yen, offset by the U.S. dollar weakening relative to the Australian dollar, Indian rupee, South Korean won, and Taiwanese dollar. Alphabet Inc. Our Other Americas revenues and revenue growth from 2017 to 2018 were unfavorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar strengthening relative to the Brazilian real and Argentine peso. Our Other Americas revenues and revenue growth from 2016 to 2017 were favorably affected by changes in foreign currency exchange rates, primarily due to the U.S. dollar weakening relative to the Brazilian real and Canadian dollar, offset by the U.S. dollar strengthening relative to the Argentine peso. Costs and Expenses Cost of Revenues Cost of revenues consists of TAC which are paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. The cost of revenues related to revenues generated from ads placed on Google Network Members' properties are significantly higher than the cost of revenues related to revenues generated from ads placed on Google properties because most of the advertiser revenues from ads served on Google Network Members properties are paid as TAC to our Google Network Members. Additionally, other cost of revenues (which is the cost of revenues excluding TAC) includes the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expenses (including stock-based compensation (SBC)), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. The following tables present our cost of revenues, including TAC (in millions): Year Ended December 31, TAC $ 16,793 $ 21,672 $ 26,726 Other cost of revenues 18,345 23,911 32,823 Total cost of revenues $ 35,138 $ 45,583 $ 59,549 Total cost of revenues as a percentage of revenues 38.9 % 41.1 % 43.5 % Year Ended December 31, TAC to distribution partners $ 5,894 $ 9,031 $ 12,572 TAC to distribution partners as a percentage of Google properties revenues (1) (Google properties TAC rate) 9.2 % 11.6 % 13.1 % TAC to Google Network Members $ 10,899 $ 12,641 $ 14,154 TAC to Google Network Members as a percentage of Google Network Members' properties revenues (1) (Network Members TAC rate) 69.9 % 71.9 % 70.8 % TAC $ 16,793 $ 21,672 $ 26,726 TAC as a percentage of advertising revenues (1) (Aggregate TAC rate) 21.2 % 22.7 % 23.0 % (1) Revenues include hedging gains (losses) which affect TAC rates. Cost of revenues increased $13,966 million from 2017 to 2018 . The increase was due to increases in TAC and other cost of revenues of $5,054 million and $8,912 million , respectively. The increase in TAC to distribution partners from 2017 to 2018 was a result of an increase in Google properties revenues and the associated TAC rate. The increase in the Google properties TAC rate was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are Alphabet Inc. channeled through paid access points. The increase in TAC to Google Network Members from 2017 to 2018 was a result of an increase in Google Network Members' properties revenues offset by a decrease in the associated TAC rate. The decrease in the Network Members TAC rate was primarily due to a shift to lower TAC products within programmatic advertising buying. The increase in the aggregate TAC rate from 2017 to 2018 was a result of an increase in Google properties TAC rate, partially offset by a favorable revenue mix shift from Google Network Members' properties to Google properties. Other cost of revenues increased $8,912 million from 2017 to 2018 . The increase was due to an increase in data center and other operations costs, which was affected by increased allocations primarily from general and administrative expenses; content acquisition costs as a result of increased activities related to YouTube; and hardware costs associated with new hardware launches. Cost of revenues increased $10,445 million from 2016 to 2017 . The increase was due to an increase in TAC of $4,879 million . The increase in TAC to distribution partners was a result of an increase in Google properties revenues and the associated TAC rate. The increase in TAC to Google Network Members was a result of an increase in Google Network Members' properties revenues and the associated TAC rate. The increase in the Google properties TAC rate was driven by changes in partner agreements and the ongoing shift to mobile, which carries higher TAC because more mobile searches are channeled through paid access points. The increase in the Network Members TAC rate was driven by the continued underlying shift in advertising buying from our traditional network business to programmatic advertising buying. The increase in the aggregate TAC rate was also partially offset by a favorable revenue mix shift from Google Network Members' properties to Google properties. Other cost of revenues increased $5,566 million from 2016 to 2017. The increase was due to various factors, including an increase in data center and other operations costs, which include depreciation, compensation expenses (including SBC), energy, bandwidth, and other equipment costs as a result of business growth; hardware costs associated with new hardware launches; and content acquisition costs as a result of increased activities related to YouTube. We expect cost of revenues to increase in dollar amount and as a percentage of total revenues in future periods based on a number of factors, including the following: Google Network Members TAC rates, which are affected by a combination of factors such as geographic mix, product mix, revenue share terms, and fluctuations of the U.S. dollar compared to certain foreign currencies ; Google properties TAC rates, which are affected by changes in device mix between mobile, desktop, and tablet, partner mix, partner agreement terms such as revenue share arrangements, and the percentage of queries channeled through paid access points; Growth rates of expenses associated with our data centers and other operations, content acquisition costs, as well as our hardware inventory and related costs; Higher cost of revenues associated with the increased proportion of non-advertising revenues relative to our advertising revenues; and Relative revenue growth rates of Google properties and our Google Network Members' properties. Research and Development The following table presents our RD expenses (in millions): Year Ended December 31, Research and development expenses $ 13,948 $ 16,625 $ 21,419 Research and development expenses as a percentage of revenues 15.5 % 15.0 % 15.7 % RD expenses consist primarily of: Compensation expenses (including SBC) and facilities-related costs for engineering and technical employees responsible for RD of our existing and new products and services; Depreciation expenses; Equipment-related expenses; and Professional services fees primarily related to consulting and outsourcing services. RD expenses increased $4,794 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $3,518 million, largely resulting from a 24% increase in headcount. In addition, there was an increase in depreciation and equipment-related expenses of $499 Alphabet Inc. million and $318 million, respectively, as well as an increase in professional services fees of $305 million due to additional expenses incurred for outsourced services and consulting. RD expenses increased $2,677 million from 2016 to 2017 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,886 million, largely resulting from a 16% increase in headcount. In addition, there was an increase in depreciation expenses of $323 million and equipment-related expenses of $246 million. We expect that RD expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. Sales and Marketing The following table presents our sales and marketing expenses (in millions): Year Ended December 31, Sales and marketing expenses $ 10,485 $ 12,893 $ 16,333 Sales and marketing expenses as a percentage of revenues 11.6 % 11.6 % 11.9 % Sales and marketing expenses consist primarily of: Advertising and promotional expenditures related to our products and services; and Compensation expenses (including SBC) and facilities-related costs for employees engaged in sales and marketing, sales support, and certain customer service functions. Sales and marketing expenses increased $3,440 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,418 million, largely resulting from a 12% increase in headcount. In addition, there was an increase in advertising and promotional expenses of $1,233 million, largely resulting from increases in marketing and promotion-related expenses for our Cloud offerings and the Google Assistant. Sales and marketing expenses increased $2,408 million from 2016 to 2017 . The increase was primarily due to an increase in advertising and promotional expenses of $1,266 million, largely resulting from increases in marketing and promotion-related expenses for our hardware products, Cloud offerings, and YouTube. In addition, there was an increase in compensation expenses (including SBC) and facilities-related costs of $853 million, largely resulting from a 6% increase in headcount. We expect that sales and marketing expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. General and Administrative The following table presents our general and administrative expenses (in millions): Year Ended December 31, General and administrative expenses $ 6,985 $ 6,872 $ 8,126 General and administrative expenses as a percentage of revenues 7.7 % 6.2 % 5.9 % General and administrative expenses consist primarily of: Compensation expenses (including SBC and accrued performance fees related to gains on securities) and facilities-related costs for employees in our facilities, finance, human resources, information technology, and legal organizations; Depreciation; Equipment-related expenses; and Professional services fees primarily related to audit, information technology consulting, outside legal, and outsourcing services. General and administrative expenses increased $1,254 million from 2017 to 2018 . The increase was primarily due to an increase in compensation expenses (including SBC) and facilities-related costs of $1,660 million, largely resulting from accrued performance fees primarily related to gains on equity securities. The increase was offset by reduced allocations (with a corresponding net increase primarily in cost of revenues). Alphabet Inc. General and administrative expenses decreased $113 million from 2016 to 2017 . The decrease was primarily from reduced allocations to general and administrative expenses with an offsetting increase to cost of revenues and other operating expenses. The decrease was partially offset by an increase in compensation expenses (including SBC) and facilities-related costs of $271 million, largely resulting from a 9% increase in headcount. Additionally, there was an increase in professional service fees of $253 million due to additional expenses incurred for outsourced services and consulting services. We expect general and administrative expenses will increase in dollar amount and may fluctuate as a percentage of revenues in future periods. European Commission Fines In June 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ($2.7 billion as of June 27, 2017) fine, which was accrued in the second quarter of 2017. In July 2018, the EC announced its decision that certain provisions in Google's Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ($5.1 billion as of June 30, 2018) fine, which was accrued in the second quarter of 2018. Please refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Other Income (Expense), Net The following table presents other income (expense), net, (in millions): Year Ended December 31, Other income (expense), net $ $ 1,047 $ 8,592 Other income (expense), net, as a percentage of revenues 0.5 % 0.9 % 6.3 % Other income (expense), net, increased $7,545 million from 2017 to 2018 . This increase was primarily driven by unrealized gains on equity securities resulting from the adoption of a new accounting standard and the modification of the terms of a non-marketable debt security resulting in a recognized unrealized gain. Other income (expense), net, increased $613 million from 2016 to 2017 . This increase was primarily driven by reduced costs of our foreign currency hedging activities, decreased losses on marketable securities and an increase in interest income. We expect other income (expense), net, will fluctuate in dollar amount and percentage of revenues in future periods as it is largely driven by market dynamics. Beginning in 2018, changes in the value of marketable and non-marketable equity security investments are reflected in OIE. Equity values generally change daily for marketable equity securities and upon the occurrence of observable price changes or upon impairment of non-marketable equity securities. In addition, volatility in the global economic climate and financial markets could result in a significant change in the value of our equity securities. Fluctuations in the value of these investments could contribute to the volatility of OIE in future periods. For additional information about equity investments, please see Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Provision for Income Taxes The following table presents our provision for income taxes (in millions) and effective tax rate: Year Ended December 31, Provision for income taxes $ 4,672 $ 14,531 $ 4,177 Effective tax rate 19.3 % 53.4 % 12.0 % Our provision for income taxes and our effective tax rate decreased from 2017 to 2018 , due to the U.S. Tax Cuts and Jobs Act (Tax Act) which was enacted in December 2017. Please refer to Note 13 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Alphabet Inc. Our provision for income taxes and our effective tax rate increased from 2016 to 2017 , due to the effects of the Tax Act related to the one time-transition tax on accumulated foreign subsidiary earnings not previously subject to U.S. income tax. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21% and creates new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax and the base erosion tax, respectively. Our future effective tax rate could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Part II, Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2018 . This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our consolidated financial position and operating results for the quarters presented. Both seasonal fluctuations in internet usage, advertising expenditures and underlying business trends such as traditional retail seasonality have affected, and are likely to continue to affect, our business. Commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, 2017 Jun 30, 2017 Sept 30, 2017 Dec 31, 2017 Mar 31, 2018 Jun 30, 2018 Sept 30, 2018 Dec 31, 2018 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues $ 24,750 $ 26,010 $ 27,772 $ 32,323 $ 31,146 $ 32,657 $ 33,740 $ 39,276 Costs and expenses: Cost of revenues 9,795 10,373 11,148 14,267 13,467 13,883 14,281 17,918 Research and development 3,942 4,172 4,205 4,306 5,039 5,114 5,232 6,034 Sales and marketing 2,644 2,897 3,042 4,310 3,604 3,780 3,849 5,100 General and administrative 1,801 1,700 1,595 1,776 2,035 2,002 2,068 2,021 European Commission fines 2,736 5,071 Total costs and expenses 18,182 21,878 19,990 24,659 24,145 29,850 25,430 31,073 Income from operations 6,568 4,132 7,782 7,664 7,001 2,807 8,310 8,203 Other income (expense), net 3,542 1,408 1,773 1,869 Income from continuing operations before income taxes 6,819 4,377 7,979 8,018 10,543 4,215 10,083 10,072 Provision for income taxes 1,393 1,247 11,038 1,142 1,020 1,124 Net income (loss) $ 5,426 $ 3,524 $ 6,732 $ (3,020 ) $ 9,401 $ 3,195 $ 9,192 $ 8,948 Basic net income (loss) per share of Class A and B common stock and Class C capital stock $ 7.85 $ 5.09 $ 9.71 $ (4.35 ) $ 13.53 $ 4.60 $ 13.21 $ 12.87 Diluted net income (loss) per share of Class A and B common stock and Class C capital stock $ 7.73 $ 5.01 $ 9.57 $ (4.35 ) $ 13.33 $ 4.54 $ 13.06 $ 12.77 Capital Resources and Liquidity As of December 31, 2018 , we had $109.1 billion in cash, cash equivalents, and marketable securities. Ca sh equivalents and marketable securities a re comprised of time deposits, money market funds, highly liquid government bonds, corporate debt securities, mortgage-backed and asset-backed securities. From time to time, we may hold Alphabet Inc. marketable equity securities obtained through acquisitions or strategic investments in private companies that subsequently go public. In December 2017, the Tax Act was enacted and resulted in a one-time transition tax on accumulated foreign subsidiary earnings. After 2017, our foreign earnings held by foreign subsidiaries are no longer subject to U.S. tax upon repatriation to the U.S. As of December 31, 2018 , the remaining long-term tax payable related to the Tax Act of $7.4 billion is presented within income tax payable, non-current on our Consolidated Balance Sheets. As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. During the years ended December 31, 2017 and 2018, the EC announced decisions that certain actions taken by Google infringed European competition law and imposed fines of 2.4 billion ($2.7 billion as of June 27, 2017) and 4.3 billion ($5.1 billion as of June 30, 2018), respectively. While under appeal, EC fines are included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the respective fines. Please refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for further information. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. We have a short-term debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2018 . We have $4.0 billion of revolving credit facilities expiring in July 2023 with no amounts outstanding. The interest rate for the credit facilities is determined based on a formula using certain market rates. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. As of December 31, 2018 , we have senior unsecured notes outstanding due in 2021, 2024, and 2026 with a total carrying value of $4.0 billion . In 2016 and 2018, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion and $8.6 billion of its Class C capital stock, respectively. The 2016 authorization was completed in 2018. As of December 31, 2018 , $1.7 billion remains available for repurchase. In January 2019, our board of directors authorized the repurchase of up to an additional $12.5 billion of our Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. Please refer to Note 10 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to stock repurchases. The following table presents our cash flows (in millions): Year Ended December 31, Net cash provided by operating activities $ 36,036 $ 37,091 $ 47,971 Net cash used in investing activities $ (31,165 ) $ (31,401 ) $ (28,504 ) Net cash used in financing activities $ (8,332 ) $ (8,298 ) $ (13,179 ) Cash Provided by Operating Activities Our largest source of cash provided by our operations are advertising revenues generated by Google properties and Google Network Members' properties. Additionally, we generate cash through sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees including fees received for Google Cloud offerings . Our primary uses of cash from our operating activities include payments to our Google Network Members and distribution partners, and payments for content acquisition costs. In addition, uses of cash from operating activities include compensation and related costs, hardware inventory costs, other general corporate expenditures, and income taxes. Net cash provided by operating activities increased from 2017 to 2018 primarily due to increases in cash received from advertising revenues and Google other revenues (net of payouts to app developers), offset by increases in cash paid for cost of revenues and operating expenses. Alphabet Inc. Net cash provided by operating activities increased from 2016 to 2017 primarily due to increases in cash received from advertising revenues and Google other revenues (net of payouts to app developers), offset by increases in cash paid for cost of revenues, operating expenses, and income taxes. Cash Used in Investing Activities Cash provided by or used in investing activities primarily consists of purchases of property and equipment; purchases, maturities, and sales of marketable and non-marketable securities; and payments for acquisitions. Net cash used in investing activities decreased from 2017 to 2018 primarily due to a decrease in purchases of marketable securities. The decrease was partially offset by higher investments in land and buildings for offices and data centers, as well as, servers to provide capacity for the growth of our businesses. Generally, our investment in office facilities is driven by workforce needs; and our investment in data centers is driven by our compute and storage requirements and has a lead time of up to three years. Further, the decrease was partially offset by an increase in payments for acquisitions and a decrease in maturities and sales of marketable securities. Net cash used in investing activities increased slightly from 2016 to 2017 primarily due to an increase in purchases of marketable securities and an increase in purchases of property and equipment, partially offset by an increase in the maturities and sales of marketable securities, a decrease in cash collateral paid related to securities lending, and an increase in proceeds received from collections of notes receivables. Cash Used in Financing Activities Cash provided by or used in financing activities consists primarily of net proceeds or payments from stock-based award activities, repurchases of capital stock, and net proceeds or payments from issuance or repayments of debt. Net cash used in financing activities increased from 2017 to 2018 primarily due to higher cash payments for repurchases of capital stock and stock-based award activities. Net cash used in financing activities decreased slightly from 2016 to 2017 primarily due to lower net cash payments from repayments and issuance of debt, partially offset by higher cash payments for repurchases of capital stock. Contractual Obligations as of December 31, 2018 The following summarizes our contractual obligations as of December 31, 2018 (in millions): Payments Due By Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Operating lease obligations, net of sublease income amounts (1) $ 10,047 $ 1,303 $ 2,711 $ 2,122 $ 3,911 Purchase obligations (2) 7,433 5,132 1,407 Long-term debt obligations (3) 4,689 1,220 3,181 Tax payable (4) 7,440 2,029 5,411 Other long-term liabilities reflected on our balance sheet (5) 2,443 1,048 Total contractual obligations $ 32,052 $ 6,910 $ 8,005 $ 8,473 $ 8,664 (1) For further information, refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (2) Represents non-cancelable contractual obligations primarily related to information technology assets and data center operation costs; purchases of inventory; and digital media content licensing arrangements. The amounts included above represent the non-cancelable portion of agreements or the minimum cancellation fee. For those agreements with variable terms, we do not estimate the non-cancelable obligation beyond any minimum quantities and/or pricing as of December 31, 2018 . Excluded from the table above are open orders for purchases that support normal operations. (3) Represents our principal and interest payments. For further information on long-term debt, refer to Note 5 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. (4) Represents one-time transition tax payable incurred as a result of the Tax Act. For further information, refer to Note 13 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Excluded from the table above are long-term taxes payable of $3.9 billion as of December 31, 2018 primarily related to uncertain tax positions, for which we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. (5) Represents cash obligations recorded on our Consolidated Balance Sheets, including the short-term portion of these long-term liabilities, primarily for the construction of offices and certain commercial agreements. These amounts do not include the EC fines which are classified as current liabilities on our Consolidated Balance Sheets. For further information regarding the Alphabet Inc. EC fines, refer to Note 9 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As of December 31, 2018 , we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, expenses, gains and losses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Please see Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. Revenues For the sale of third-party goods and services, we evaluate whether we are the principal, and report revenues on a gross basis, or an agent, and report revenues on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. Income Taxes We are subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes and the effective tax rate in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Services (IRS) and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, non-income taxes, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a regular basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both the likelihood of there being, and the estimated amount of, a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any Alphabet Inc. of our estimates and assumptions change or prove to have been incorrect, it could have a material effect on our business, consolidated financial position, results of operations, or cash flows. Long-lived Assets Long-lived assets, including property and equipment, long-term prepayments, and intangible assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows independent of other assets. An impairment loss would be recognized when estimated undiscounted future cash flows generated from the assets are less than their carrying amount. Measurement of an impairment loss would be based on the excess of the carrying amount of the asset group over its fair value. Valuation of Non-marketable Equity Securities Beginning on January 1, 2018, our non-marketable equity securities not accounted for under the equity method are carried either at fair value or under the measurement alternative upon the adoption of ASU 2016-01. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Determining whether an observed transaction is similar to a security within our portfolio requires judgment based on the rights and obligations of the securities. Recording upward and downward adjustments to the carrying value of our equity securities as a result of observable price changes requires quantitative assessments of the fair value of our securities using various valuation methodologies and involves the use of estimates. Non-marketable equity securities are also subject to periodic impairment reviews. Our quarterly impairment analysis considers both qualitative and quantitative factors that may have a significant effect on the investment's fair value. Qualitative factors considered include industry and market conditions, financial performance, business prospects, and other relevant events and factors. When indicators of impairment exist, we prepare quantitative assessments of the fair value of our equity investments using both the market and income approaches which require judgment and the use of estimates, including discount rates, investee revenues and costs, and comparable market data of private and public companies, among others. When our assessment indicates that an impairment exists, we measure our non-marketable securities at fair value. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to financial market risks, including changes in foreign currency exchange rates, interest rates, and equity investment risks. Foreign Currency Exchange Risk We transact business globally in multiple currencies. Our international revenues, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Principal currencies hedged included the Australian dollar, British pound, Canadian dollar, Euro and Japanese yen. For the purpose of analyzing foreign currency exchange risk, we considered the historical trends in foreign currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% could be experienced in the near term. We use foreign exchange forward contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the local currency of the subsidiary. These forward contracts reduce, but do not entirely eliminate, the effect of foreign currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on the assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on the forward contracts. If an adverse 10% foreign currency exchange rate change was applied to total monetary assets and liabilities denominated in currencies other than the local currencies at the balance sheet dates, it would have resulted in an adverse effect on income before income taxes of approximately $52 million and $1 million as of December 31, 2017 and 2018 , respectively. The adverse effect as of December 31, 2017 and 2018 is after consideration of the offsetting effect of approximately $374 million for both periods from foreign exchange contracts in place for the months ended December 31, 2017 and December 31, 2018 . We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options) to protect our forecasted U.S. dollar-equivalent earnings from changes in foreign currency exchange rates. When the U.S. dollar strengthens, gains from foreign currency options and forwards reduce the foreign currency losses related to our earnings. When the U.S. dollar weakens, losses from foreign currency collars and forwards offset the foreign currency gains related to our earnings. These hedging contracts reduce, but do Alphabet Inc. not entirely eliminate, the effect of foreign currency exchange rate movements. We designate these contracts as cash flow hedges for accounting purposes. We reflect the gains or losses of foreign currency spot rate changes as a component of AOCI and subsequently reclassify them into revenues to offset the hedged exposures as they occur. If the U.S. dollar weakened by 10% as of December 31, 2017 and December 31, 2018 , the amount recorded in AOCI related to our foreign exchange contracts before tax effect would have been approximately $950 million and $772 million lower as of December 31, 2017 and December 31, 2018 , respectively. The change in the value recorded in AOCI would be expected to offset a corresponding foreign currency change in forecasted hedged revenues when recognized. During 2018, we entered into foreign exchange forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. These forward contracts serve to offset the foreign currency translation risk from our foreign operations. If the U.S. dollar weakened by 10%, the amount recorded in cumulative translation adjustment (CTA) within AOCI related to our net investment hedge would have been approximately $635 million lower as of December 31, 2018. The change in value recorded in CTA would be expected to offset a corresponding foreign currency translation gain or loss from our investment in foreign subsidiaries. Interest Rate Risk Our investment strategy is to achieve a return that will allow us to preserve capital and maintain liquidity requirements. We invest primarily in debt securities including those of the U.S. government and its agencies, corporate debt securities, mortgage-backed securities, money market and other funds, municipal securities, time deposits, asset backed securities, and debt instruments issued by foreign governments. By policy, we limit the amount of credit exposure to any one issuer. Our investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Unrealized gains or losses on our marketable debt securities are primarily due to interest rate fluctuations as a result of higher market interest rates compared to interest rates at the time of purchase. We account for both fixed and variable rate securities at fair value with gains and losses recorded in AOCI until the securities are sold. We use value-at-risk (VaR) analysis to determine the potential effect of fluctuations in interest rates on the value of our marketable debt security portfolio. The VaR is the expected loss in fair value, for a given confidence interval, for our investment portfolio due to adverse movements in interest rates. We use a variance/covariance VaR model with 95% confidence interval. The estimated one-day loss in fair value of our marketable debt securities as of December 31, 2017 and 2018 are shown below (in millions): As of December 31, 12-Month Average As of December 31, Risk Category - Interest Rate $ $ $ $ Actual future gains and losses associated with our marketable debt security portfolio may differ materially from the sensitivity analyses performed as of December 31, 2017 and 2018 due to the inherent limitations associated with predicting the timing and amount of changes in interest rates and our actual exposures and positions. VaR analysis is not intended to represent actual losses but is used as a risk estimation. Equity Investment Risk Our marketable and non-marketable equity securities are subject to a wide variety of marketrelated risks that could substantially reduce or increase the fair value of our holdings. Our marketable equity securities are publicly traded stocks or funds and our non-marketable equity securities are investments in privately held companies, some of which are in the startup or development stages. We record our marketable equity securities not accounted for under the equity method at fair value based on readily determinable market values, of which publicly traded stocks and mutual funds are subject to market price volatility, and represent $1.2 billion of our investments as of December 31, 2018. A hypothetical adverse price change of 10%, which could be experienced in the near term, would decrease the fair value of our marketable equity securities by $120 million . Our non-marketable equity securities not accounted for under the equity method are adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the Alphabet Inc. measurement alternative). The fair value is measured at the time of the observable transaction, which is not necessarily an indication of the current fair value as of the balance sheet date. These investments, especially those that are in the early stages, are inherently risky because the technologies or products these companies have under development are typically in the early phases and may never materialize and they may experience a decline in financial condition, which could result in a loss of a substantial part of our investment in these companies. The success of our investment in any private company is also typically dependent on the likelihood of our ability to realize value in our investments through liquidity events such as public offerings, acquisitions, private sales or other favorable market events reflecting appreciation to the cost of our initial investment. As of December 31, 2018, the carrying value of our non-marketable equity securities, which were accounted for under the measurement alternative, was $12.3 billion . Valuations of our equity investments in private companies are inherently more complex due to the lack of readily available market data. Volatility in the global economic climate and financial markets could result in a significant impairment charge on our non-marketable equity securities. The carrying values of our equity method investments generally do not fluctuate based on market price changes, however these investments could be impaired if the carrying value exceeds the fair value. For further information about our equity investments, please refer to Note 1 and Note 3 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form 10-K. Alphabet Inc. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Alphabet Inc. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Ernst Young LLP, Independent Registered Public Accounting Firm Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8 is included in Item 7 under the caption Quarterly Results of Operations. Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Alphabet Inc. (the Company) as of December 31, 2017 and 2018, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedule listed in the Index at Item 15(a)2 (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 4, 2019 expressed an unqualified opinion thereon. Adoption of New Accounting Standard As discussed in Note 1 to the consolidated financial statements, the Company changed its method for accounting for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Company's auditor since 1999. San Jose, California February 4, 2019 Alphabet Inc. REPORT OF ERNST YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Alphabet Inc. Opinion on Internal Control over Financial Reporting We have audited Alphabet Inc.s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Alphabet Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2018 consolidated financial statements of the Company and our report dated February 4, 2019 expressed an unqualified opinion thereon that included an explanatory paragraph regarding the Companys adoption of a new accounting standard for the recognition, measurement, presentation and disclosure of certain equity securities in the year ended December 31, 2018. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitation of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Jose, California February 4, 2019 Alphabet Inc. Alphabet Inc. CONSOLIDATED BALANCE SHEETS (In millions, except share amounts which are reflected in thousands, and par value per share amounts) As of December 31, 2017 As of December 31, 2018 Assets Current assets: Cash and cash equivalents $ 10,715 $ 16,701 Marketable securities 91,156 92,439 Total cash, cash equivalents, and marketable securities 101,871 109,140 Accounts receivable, net of allowance of $674 and $729 18,336 20,838 Income taxes receivable, net Inventory 1,107 Other current assets 2,983 4,236 Total current assets 124,308 135,676 Non-marketable investments 7,813 13,859 Deferred income taxes Property and equipment, net 42,383 59,719 Intangible assets, net 2,692 2,220 Goodwill 16,747 17,888 Other non-current assets 2,672 2,693 Total assets $ 197,295 $ 232,792 Liabilities and Stockholders Equity Current liabilities: Accounts payable $ 3,137 $ 4,378 Accrued compensation and benefits 4,581 6,839 Accrued expenses and other current liabilities 10,177 16,958 Accrued revenue share 3,975 4,592 Deferred revenue 1,432 1,784 Income taxes payable, net Total current liabilities 24,183 34,620 Long-term debt 3,969 4,012 Deferred revenue, non-current Income taxes payable, non-current 12,812 11,327 Deferred income taxes 1,264 Other long-term liabilities 3,059 3,545 Total liabilities 44,793 55,164 Commitments and Contingencies (Note 9) Stockholders equity: Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding Class A and Class B common stock, and Class C capital stock and additional paid-in capital, $0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000, Class C 3,000,000); 694,783 (Class A 298,470, Class B 46,972, Class C 349,341) and 695,556 (Class A 299,242, Class B 46,636, Class C 349,678) shares issued and outstanding 40,247 45,049 Accumulated other comprehensive loss (992 ) (2,306 ) Retained earnings 113,247 134,885 Total stockholders equity 152,502 177,628 Total liabilities and stockholders equity $ 197,295 $ 232,792 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenues $ 90,272 $ 110,855 $ 136,819 Costs and expenses: Cost of revenues 35,138 45,583 59,549 Research and development 13,948 16,625 21,419 Sales and marketing 10,485 12,893 16,333 General and administrative 6,985 6,872 8,126 European Commission fines 2,736 5,071 Total costs and expenses 66,556 84,709 110,498 Income from operations 23,716 26,146 26,321 Other income (expense), net 1,047 8,592 Income before income taxes 24,150 27,193 34,913 Provision for income taxes 4,672 14,531 4,177 Net income $ 19,478 $ 12,662 $ 30,736 Basic net income per share of Class A and B common stock and Class C capital stock $ 28.32 $ 18.27 $ 44.22 Diluted net income per share of Class A and B common stock and Class C capital stock $ 27.85 $ 18.00 $ 43.70 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 19,478 $ 12,662 $ 30,736 Other comprehensive income (loss): Change in foreign currency translation adjustment (599 ) 1,543 (781 ) Available-for-sale investments: Change in net unrealized gains (losses) (314 ) Less: reclassification adjustment for net (gains) losses included in net income (911 ) Net change (net of tax effect of $0, $0, and $156) (93 ) (823 ) Cash flow hedges: Change in net unrealized gains (losses) (638 ) Less: reclassification adjustment for net (gains) losses included in net income (351 ) Net change (net of tax effect of $64, $247, and $103) (545 ) Other comprehensive income (loss) (528 ) 1,410 (1,216 ) Comprehensive income $ 18,950 $ 14,072 $ 29,520 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (In millions, except share amounts which are reflected in thousands) Class A and Class B Common Stock, Class C Capital Stock and Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders Equity Shares Amount Balance as of December 31, 2015 687,348 $ 32,982 $ (1,874 ) $ 89,223 $ 120,331 Cumulative effect of accounting change (133 ) Common and capital stock issued 9,106 Stock-based compensation expense 6,700 6,700 Tax withholding related to vesting of restricted stock units (3,597 ) (3,597 ) Repurchases of capital stock (5,161 ) (256 ) (3,437 ) (3,693 ) Net income 19,478 19,478 Other comprehensive loss (528 ) (528 ) Balance as of December 31, 2016 691,293 36,307 (2,402 ) 105,131 139,036 Cumulative effect of accounting change (15 ) (15 ) Common and capital stock issued 8,652 Stock-based compensation expense 7,694 7,694 Tax withholding related to vesting of restricted stock units (4,373 ) (4,373 ) Repurchases of capital stock (5,162 ) (315 ) (4,531 ) (4,846 ) Sale of subsidiary shares Net income 12,662 12,662 Other comprehensive income 1,410 1,410 Balance as of December 31, 2017 694,783 40,247 (992 ) 113,247 152,502 Cumulative effect of accounting change (98 ) (599 ) (697 ) Common and capital stock issued 8,975 Stock-based compensation expense 9,353 9,353 Tax withholding related to vesting of restricted stock units and other (4,782 ) (4,782 ) Repurchases of capital stock (8,202 ) (576 ) (8,499 ) (9,075 ) Sale of subsidiary shares Net income 30,736 30,736 Other comprehensive loss (1,216 ) (1,216 ) Balance as of December 31, 2018 695,556 $ 45,049 $ (2,306 ) $ 134,885 $ 177,628 See accompanying notes. Alphabet Inc. Alphabet Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Operating activities Net income $ 19,478 $ 12,662 $ 30,736 Adjustments: Depreciation and impairment of property and equipment 5,267 6,103 8,164 Amortization and impairment of intangible assets Stock-based compensation expense 6,703 7,679 9,353 Deferred income taxes (38 ) (Gain) loss on debt and equity securities, net (6,650 ) Other (189 ) Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable (2,578 ) (3,768 ) (2,169 ) Income taxes, net 3,125 8,211 (2,251 ) Other assets (2,164 ) (1,207 ) Accounts payable 1,067 Accrued expenses and other liabilities 1,515 4,891 8,614 Accrued revenue share Deferred revenue Net cash provided by operating activities 36,036 37,091 47,971 Investing activities Purchases of property and equipment (10,212 ) (13,184 ) (25,139 ) Proceeds from disposals of property and equipment Purchases of marketable securities (84,509 ) (92,195 ) (50,158 ) Maturities and sales of marketable securities 66,895 73,959 48,507 Purchases of non-marketable investments (1,109 ) (1,745 ) (2,073 ) Maturities and sales of non-marketable investments 1,752 Cash collateral related to securities lending (2,428 ) Investments in reverse repurchase agreements Acquisitions, net of cash acquired, and purchases of intangible assets (986 ) (287 ) (1,491 ) Proceeds from collection of notes receivable 1,419 Net cash used in investing activities (31,165 ) (31,401 ) (28,504 ) Financing activities Net payments related to stock-based award activities (3,304 ) (4,166 ) (4,993 ) Repurchases of capital stock (3,693 ) (4,846 ) (9,075 ) Proceeds from issuance of debt, net of costs 8,729 4,291 6,766 Repayments of debt (10,064 ) (4,377 ) (6,827 ) Proceeds from sale of subsidiary shares Net cash used in financing activities (8,332 ) (8,298 ) (13,179 ) Effect of exchange rate changes on cash and cash equivalents (170 ) (302 ) Net increase (decrease) in cash and cash equivalents (3,631 ) (2,203 ) 5,986 Cash and cash equivalents at beginning of period 16,549 12,918 10,715 Cash and cash equivalents at end of period $ 12,918 $ 10,715 $ 16,701 Supplemental disclosures of cash flow information Cash paid for taxes, net of refunds $ 1,643 $ 6,191 $ 5,671 Cash paid for interest, net of amounts capitalized $ $ $ See accompanying notes. Alphabet Inc. Alphabet Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (Alphabet) became the successor issuer to Google. We generate revenues primarily by delivering relevant, cost-effective online advertising. Basis of Consolidation The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. Noncontrolling interests are not presented separately as the amounts are not material. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the bad debt allowance, sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Revenue Recognition We recognize revenues when we transfer control of promised goods or services to our customers in an amount that reflects the consideration to which we expect to be entitled to in exchange for those goods or services. See Note 2 for further discussion on Revenues. Cost of Revenues Cost of revenues consists of TAC and other costs of revenues. TAC represents the amounts paid to Google Network Members primarily for ads displayed on their properties and amounts paid to our distribution partners who make available our search access points and services. Our distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. Other costs of revenues (which is the cost of revenues excluding TAC) include the following: Content acquisition costs primarily related to payments to content providers from whom we license video and other content for distribution on YouTube and Google Play (we pay fees to these content providers based on revenues generated or a flat fee); Expenses associated with our data centers and other operations (including bandwidth, compensation expense (including SBC), depreciation, energy, and other equipment costs); and Inventory related costs for hardware we sell. Stock-based Compensation Stock-based compensation primarily consists of Alphabet restricted stock units (RSUs). RSUs are equity classified and measured at the fair market value of the underlying stock at the grant date. We recognize RSU expense using the straight-line attribution method over the requisite service period and account for forfeitures as they occur. For RSUs, shares are issued on the vesting dates net of the applicable statutory tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are issued than the number of RSUs outstanding. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital. Additionally, stock-based compensation includes other types of stock-based awards that may be settled in the stock of certain of our Other Bets or in cash. Awards that are liability classified are remeasured at fair value through settlement or maturity. The fair value of such awards is based on the valuation of equity of the respective Other Bet. Alphabet Inc. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts. Certain Risks and Concentrations Our revenues are primarily derived from online advertising, the market for which is highly competitive and rapidly changing. In addition, our revenues are generated from a multitude of vertical market segments in countries around the world. Significant changes in this industry or changes in customer buying or advertiser spending behavior could adversely affect our operating results. We are subject to concentrations of credit risk principally from cash and cash equivalents, marketable securities, foreign exchange contracts, and accounts receivable. Cash equivalents and marketable securities consist primarily of time deposits, money market and other funds, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate debt securities, mortgage-backed securities, and asset-backed securities. Foreign exchange contracts are transacted with various financial institutions with high credit standing. Accounts receivable are typically unsecured and are derived from revenues earned from customers located around the world. We perform ongoing evaluations to determine customer credit and we limit the amount of credit we extend. We generally do not require collateral from our customers. We maintain reserves for estimated credit losses and these losses have generally been within our expectations. No individual customer or groups of affiliated customers represented more than 10% of our revenues in 2016 , 2017 , or 2018 . In 2016 , 2017 , and 2018 , we generated approximately 47% , 47% , and 46% of our revenues, respectively, from customers based in the U.S. See Note 2 for further details. Fair Value of Financial Instruments Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets that are measured at fair value on a nonrecurring basis include non-marketable equity securities measured at fair value when observable price changes are identified or when non-marketable equity securities are impaired . Other financial assets and liabilities are carried at cost with fair value disclosed, if required. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value: Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - Inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings. Level 3 - Unobservable inputs that are supported by little or no market activities. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Cash, Cash Equivalents, and Marketable Securities We invest all excess cash primarily in government bonds, corporate debt securities, mortgage-backed and asset-backed securities, time deposits, and money market funds. We classify all investments that are readily convertible to known amounts of cash and have stated maturities of three months or less from the date of purchase as cash equivalents and those with stated maturities of greater than three months as marketable securities. We determine the appropriate classification of our investments in marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. We have classified and accounted for our marketable debt securities as available-for-sale. After consideration of our risk versus reward objectives, as well as our liquidity requirements, we may sell these debt securities prior to their stated maturities. As we view these securities as available Alphabet Inc. to support current operations, we classify highly liquid securities with maturities beyond 12 months as current assets under the caption marketable securities on the Consolidated Balance Sheets. We carry these securities at fair value, and report the unrealized gains and losses, net of taxes, as a component of stockholders equity, except for unrealized losses determined to be other-than-temporary, which we record within other income (expense), net. We determine any realized gains or losses on the sale of marketable debt securities on a specific identification method, and we record such gains and losses as a component of other income (expense), net. Non-Marketable Investments We account for non-marketable equity investments through which we exercise significant influence but do not have control over the investee under the equity method. Beginning on January 1, 2018, our non-marketable equity securities not accounted for under the equity method are either carried at fair value or under the measurement alternative upon the adoption of ASU 2016-01. Under the measurement alternative, the carrying value is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Adjustments are determined primarily based on a market approach as of the transaction date. We classify our non-marketable investments as non-current assets on the Consolidated Balance Sheets as those investments do not have stated contractual maturity dates. We account for our non-marketable investments that meet the definition of a debt security as available-for-sale securities. Impairment of Investments We periodically review our debt and equity investments for impairment. For debt securities we consider the duration, severity and the reason for the decline in security value; whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or if the amortized cost basis cannot be recovered as a result of credit losses. If any impairment is considered other-than-temporary, we will write down the security to its fair value and record the corresponding charge as other income (expense), net. For equity securities we consider impairment indicators such as negative changes in industry and market conditions, financial performance, business prospects, and other relevant events and factors. If indicators exist and the fair value of the security is below the carrying amount, we write down the security to fair value. Variable Interest Entities We determine at the inception of each arrangement whether an entity in which we have made an investment or in which we have other variable interests in is considered a variable interest entity (VIE). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE; and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in our interest or relationship with the entity affect our determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interests in a VIE in accordance with applicable GAAP. Accounts Receivable We record accounts receivable at the invoiced amount. We maintain an allowance for doubtful accounts to reserve for potentially uncollectible receivables. We review the accounts receivable by amounts due from customers that are past due to identify specific customers with known disputes or collectability issues. In determining the amount of the reserve, we make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Property and Equipment Property and equipment includes the following categories: land and buildings, information technology assets, construction in progress, leasehold improvements, and furniture and fixtures. Land and buildings include land, offices, data centers and related building improvements. Information technology assets include servers and network equipment. We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets. We depreciate buildings over periods of seven to 25 years. We generally depreciate information technology assets over periods of three to five years (specifically, three years for servers and three to five years for network equipment). We depreciate leasehold improvements over the shorter of the remaining lease term or the estimated useful lives of the assets. Construction in progress is the construction or development of property and equipment that have not yet been placed in service for our intended use. Depreciation for equipment, buildings, and leasehold improvements commences once they are ready for our intended use. Land is not depreciated. Alphabet Inc. Inventory Inventory consists primarily of finished goods and is stated at the lower of cost and net realizable value. Cost is computed using the first-in, first-out method. Software Development Costs We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented. Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Costs capitalized for developing such software applications were not material for the periods presented. Business Combinations We include the results of operations of the businesses that we acquire as of the acquisition date. We allocate the purchase price of the acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of identifiable assets and liabilities is recorded as goodwill. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. Long-Lived Assets, Goodwill and Other Acquired Intangible Assets We review property and equipment, long-term prepayments and intangible assets, excluding goodwill, for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or the asset group are expected to generate. If the carrying value of the assets are not recoverable, the impairment recognized is measured as the amount by which the carrying value of the asset exceeds its fair value. Impairments were not material for the periods presented. We allocate goodwill to reporting units based on the expected benefit from the business combination. We evaluate our reporting units when changes in our operating structure occur, and if necessary, reassign goodwill using a relative fair value allocation approach. We test our goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the asset may be impaired. Goodwill impairments were not material for the periods presented. Intangible assets with definite lives are amortized over their estimated useful lives. We amortize intangible assets on a straight-line basis with definite lives over periods ranging from one to twelve years. Income Taxes We account for income taxes using the asset and liability method, under which we recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in our financial statements or tax returns. We measure current and deferred tax assets and liabilities based on provisions of enacted tax law. We evaluate the realization of our deferred tax assets based on all available evidence and establish a valuation allowance to reduce deferred tax assets when it is more likely than not that they will not be realized. We recognize the financial statement effects of a tax position when it is more likely than not that, based on technical merits, the position will be sustained upon examination. The tax benefits of the position recognized in the financial statements are then measured based on the largest amount of benefit that is greater than 50% likely to be realized upon settlement with a taxing authority. In addition, we recognize interest and penalties related to unrecognized tax benefits as a component of the income tax provision. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end exchange rates for assets and liabilities, and average rates for the annual period derived from month-end exchange rates for revenues, costs, and expenses. We record translation gains and losses in accumulated other comprehensive income (AOCI) as a component of stockholders equity. We reflect net foreign exchange transaction gains and losses resulting from the conversion of the transaction currency to functional currency as a component of foreign currency exchange losses in other income (expense), net. Alphabet Inc. Advertising and Promotional Expenses We expense advertising and promotional costs in the period in which they are incurred. For the years ended December 31, 2016 , 2017 and 2018 , advertising and promotional expenses totaled approximately $3.9 billion , $5.1 billion , and $6.4 billion , respectively. Recent Accounting Pronouncements Recently issued accounting pronouncements not yet adopted In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02 (Topic 842) ""Leases."" Topic 842 supersedes the lease requirements in Accounting Standards Codification (ASC) Topic 840, ""Leases."" Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases will continue to be classified as either finance or operating. We will adopt Topic 842 effective January 1, 2019 using a modified retrospective method and will not restate comparative periods. As permitted under the transition guidance, we will carry forward the assessment of whether our contracts contain or are leases, classification of our leases and remaining lease terms. Based on our portfolio of leases as of December 31, 2018, approximately $9 billion of lease assets and liabilities will be recognized on our balance sheet upon adoption, primarily relating to real estate. We are substantially complete with our implementation efforts. In June 2016, the FASB issued Accounting Standards Update No. 2016-13 (ASU 2016-13) ""Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"" which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model which requires the use of forward-looking information to calculate credit loss estimates. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. We will adopt ASU 2016-13 effective January 1, 2020. We are currently evaluating the effect of the adoption of ASU 2016-13 on our consolidated financial statements. The effect will largely depend on the composition and credit quality of our investment portfolio and the economic conditions at the time of adoption. Recently adopted accounting pronouncements In January 2016, the FASB issued Accounting Standards Update No. 2016-01 (ASU 2016-01) ""Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,"" which amends various aspects of the recognition, measurement, presentation, and disclosure of financial instruments. We adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective method for our marketable equity securities and the prospective method for our non-marketable equity securities. This resulted in a $98 million reclassification of net unrealized gains from AOCI to opening retained earnings. We have elected to use the measurement alternative for our non-marketable equity securities, defined as cost adjusted for changes from observable transactions for identical or similar investments of the same issuer, less impairment. The adoption of ASU 2016-01 increases the volatility of our other income (expense), net, as a result of the unrealized gain or loss from the remeasurement of our equity securities. For further information on unrealized gains from equity securities, see Note 3 . In October 2016, the FASB issued Accounting Standards Update No. 2016-16 (ASU 2016-16) ""Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory."" ASU 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. We adopted ASU 2016-16 as of January 1, 2018 using a modified retrospective transition method, resulting in a $701 million reclassification of prepaid income taxes related to asset transfers that occurred prior to adoption from other current and non-current assets to opening retained earnings. Prior Period Reclassifications Certain amounts in prior periods have been reclassified to conform with current period presentation. Note 2. Revenues Adoption of ASC Topic 606, ""Revenue from Contracts with Customers"" On January 1, 2017 , we adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2017 . Results for reporting periods beginning after January 1, 2017 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605. The effect from the adoption of ASC 606 was not material to our financial statements. Alphabet Inc. Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. The following table presents our revenues disaggregated by revenue source (in millions). Sales and usage-based taxes are excluded from revenues. Year Ended December 31, 2016 (1) Google properties $ 63,785 $ 77,788 $ 96,336 Google Network Members' properties 15,598 17,587 19,982 Google advertising revenues 79,383 95,375 116,318 Google other revenues 10,601 15,003 19,906 Other Bets revenues Total revenues (2) $ 90,272 $ 110,855 $ 136,819 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. (2) Revenues include hedging gains (losses) of $539 million , $(169) million , and $(138) million for the years ended December 31, 2016 , 2017 , and 2018 , respectively, which do not represent revenues recognized from contracts with customers. The following table presents our revenues disaggregated by geography, based on the addresses of our customers (in millions): Year Ended December 31, United States $ 42,781 % $ 52,449 % $ 63,269 % EMEA (1) 30,304 36,046 44,567 APAC (1) 12,559 16,235 21,374 Other Americas (1) 4,628 6,125 7,609 Total revenues (2) $ 90,272 % $ 110,855 % $ 136,819 % (1) Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (Other Americas). (2) Revenues include hedging gains (losses) for the years ended December 31, 2016 , 2017 , and 2018 . Advertising Revenues We generate revenues primarily by delivering advertising on Google properties and Google Network Members properties. Google properties revenues consist primarily of advertising revenues generated on Google.com, the Google Search app, and other Google owned and operated properties like Gmail, Google Maps, Google Play, and YouTube. Google Network Members properties revenues consist primarily of advertising revenues generated on Google Network Members properties. Our customers generally purchase advertising inventory through Google Ads (formerly AdWords), Google Ad Manager as part of the Authorized Buyers marketplace (formerly DoubleClick AdExchange), and Google Marketing Platform (includes what was formerly DoubleClick Bid Manager), among others. We offer advertising on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on an ad on Google properties or Google Network Members' properties or when a user views certain YouTube engagement ads. For these customers, we recognize revenue each time a user clicks on the ad or when a user views the ad for a specified period of time. We also offer advertising on other bases such as cost-per-impression, which means an advertiser pays us based on the number of times their ads are displayed on Google properties or Google Network Members properties. For these customers, we recognize revenue each time an ad is displayed. For ads placed on Google Network Members properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network Members properties on a gross basis, that is, the amounts billed to our customers Alphabet Inc. are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing. Other Revenues Google other revenues and Other Bets revenues consist primarily of revenues from: Apps, in-app purchases, and digital content in the Google Play store; Google Cloud offerings; Hardware; and Other miscellaneous products and services. As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues. Arrangements with Multiple Performance Obligations Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin. Customer Incentives and Credits Certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues recognized. We believe that there will not be significant changes to our estimates of variable consideration. Deferred Revenues We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. The increase in the deferred revenue balance for the twelve months ended December 31, 2018 is primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $1.5 billion of revenues recognized that were included in the deferred revenue balance as of December 31, 2017 . Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Note 3. Financial Instruments Debt Securities We classify our marketable debt securities within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. In January 2018, we reclassified our U.S. government notes included in marketable debt securities from Level 1 to Level 2 within the fair value hierarchy as these securities are priced based on a combination of quoted prices for identical or similar instruments in active markets and models with significant observable market inputs. Prior period amounts have been reclassified to conform with current period presentation. The vast majority of our government bond holdings are highly liquid U.S. government notes. We classify our non-marketable debt securities within Level 3 in the fair value hierarchy because they are preferred stock and convertible notes issued by private companies without quoted market prices. To estimate the fair value of Alphabet Inc. our non-marketable debt securities, we use a combination of valuation methodologies, including market and income approaches based on prior transaction prices; estimated timing, probability, and amount of cash flows; and illiquidity considerations. Financial information of private companies may not be available and consequently we estimate the fair value based on the best available information at the measurement date. The following tables summarize our debt securities by significant investment categories as of December 31, 2017 and 2018 (in millions): As of December 31, 2017 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Non-Marketable Securities Level 2: Time deposits (1) $ $ $ $ $ $ $ Government bonds (2) 51,548 (406 ) 51,152 1,241 49,911 Corporate debt securities 24,269 (135 ) 24,155 24,029 Mortgage-backed and asset-backed securities 16,789 (180 ) 16,622 16,622 92,965 (721 ) 92,288 1,724 90,564 Level 3: Non-marketable debt securities 1,083 1,894 1,894 Total $ 94,048 $ $ (721 ) $ 94,182 $ 1,724 $ 90,564 $ 1,894 As of December 31, 2018 Adjusted Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents Marketable Securities Non-Marketable Securities Level 2: Time deposits (1) $ 2,202 $ $ $ 2,202 $ 2,202 $ $ Government bonds (2) 53,634 (414 ) 53,291 3,717 49,574 Corporate debt securities 25,383 (316 ) 25,082 25,038 Mortgage-backed and asset-backed securities 16,918 (324 ) 16,605 16,605 98,137 (1,054 ) 97,180 5,963 91,217 Level 3: Non-marketable debt securities Total $ 98,284 $ $ (1,054 ) $ 97,443 $ 5,963 $ 91,217 $ (1) As of December 31, 2017, the majority of our time deposits were foreign deposits. As of December 31, 2018, the majority of our time deposits are domestic deposits. (2) Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds, and municipal securities. We determine realized gains or losses on the sale or extinguishment of debt securities on a specific identification method. We recognized gross realized gains of $251 million , $185 million , and $1.3 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. We recognized gross realized losses of $304 million , $295 million , and $143 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. We reflect these gains and losses as a component of other income (expense), net, in the Consolidated Statements of Income. The following table summarizes the estimated fair value of our investments in marketable debt securities with stated contractual maturity dates, accounted for as available-for-sale securities and classified by the contractual maturity date of the securities (in millions): Alphabet Inc. As of December 31, 2018 Due in 1 year $ 23,669 Due in 1 year through 5 years 54,504 Due in 5 years through 10 years 2,236 Due after 10 years 10,808 Total $ 91,217 The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2017 and 2018 , aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions): As of December 31, 2017 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds (1) $ 28,836 $ (211 ) $ 17,660 $ (195 ) $ 46,496 $ (406 ) Corporate debt securities 18,300 (114 ) 1,710 (21 ) 20,010 (135 ) Mortgage-backed and asset-backed securities 11,061 (105 ) 3,449 (75 ) 14,510 (180 ) Total $ 58,197 $ (430 ) $ 22,819 $ (291 ) $ 81,016 $ (721 ) As of December 31, 2018 Less than 12 Months 12 Months or Greater Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss Government bonds (1) $ 12,019 $ (85 ) $ 23,877 $ (329 ) $ 35,896 $ (414 ) Corporate debt securities 10,171 (107 ) 11,545 (209 ) 21,716 (316 ) Mortgage-backed and asset-backed securities 5,534 (75 ) 8,519 (249 ) 14,053 (324 ) Total $ 27,724 $ (267 ) $ 43,941 $ (787 ) $ 71,665 $ (1,054 ) (1) Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds, and municipal securities. During the years ended December 31, 2016 , 2017 and 2018 , we did not recognize any significant other-than-temporary impairment losses. Losses on impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net. The following table presents a reconciliation for our non-marketable debt securities measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) (in millions): Year Ended December 31, Beginning balance $ 1,165 $ 1,894 Total net gains (losses) Included in earnings (10 ) Included in other comprehensive income (1 ) Purchases Sales (2 ) (52 ) Settlements (1) (54 ) (2,228 ) Ending balance $ 1,894 $ (1) During the year ended December 31, 2018 the terms of a non-marketable debt security were modified resulting in an unrealized $1.3 billion gain recognized in other income (expense), net and a reclassification of the security to non-marketable equity securities. Alphabet Inc. Equity Investments The following discusses our marketable equity securities, non-marketable equity securities, realized and unrealized gains and losses on marketable and non-marketable equity securities, as well as our equity securities accounted for under the equity method. Marketable equity securities Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets. Prior to January 1, 2018, we accounted for the majority of our marketable equity securities at fair value with unrealized gains and losses recognized in accumulated other comprehensive income on the balance sheet. Realized gains and losses on marketable equity securities sold or impaired were recognized in other income (expense), net. Starting January 1, 2018, upon our adoption of ASU 2016-01, unrealized gains and losses during the year are recognized in other income (expense), net. Upon adoption, we reclassified $98 million net unrealized gains related to marketable equity securities from accumulated other comprehensive income to opening retained earnings. The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2017 and 2018 (in millions): As of December 31, 2017 Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 1,833 $ Marketable equity securities 1,833 Level 2: Mutual funds (1) Total $ 1,833 $ (1) The fair value option was elected for mutual funds with gains (losses) recognized in other income (expense), net. As of December 31, 2018 Cash and Cash Equivalents Marketable Securities Level 1: Money market funds $ 3,493 $ Marketable equity securities 3,493 Level 2: Mutual funds Total $ 3,493 $ 1,222 Non-marketable equity securities Our non-marketable equity securities are investments in privately held companies without readily determinable market values. Prior to January 1, 2018, we accounted for our non-marketable equity securities at cost less impairment. Realized gains and losses on non-marketable securities sold or impaired were recognized in other income (expense), net. As of December 31, 2017, non-marketable equity securities accounted for under the cost method had a carrying value of $ 4.5 billion and a fair value of approximately $ 8.8 billion . On January 1, 2018, we adopted ASU 2016-01 which changed the way we account for non-marketable securities. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Because we adopted ASU 2016-01 prospectively, we recognize unrealized gains that occurred in prior Alphabet Inc. periods in the first period after January 1, 2018 when there is an observable transaction for our securities. Non-marketable equity securities remeasured during the year ended December 31, 2018 are classified within Level 3 in the fair value hierarchy because we estimate the value based on valuation methods using the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities held as of December 31, 2018 (in millions): Twelve Months Ended December 31, 2018 Upward adjustments $ 4,285 Downward adjustments (including impairment) (178 ) Total unrealized gain (loss) for non-marketable equity securities $ 4,107 The following table summarizes the total carrying value of our non-marketable equity securities held as of December 31, 2018 including cumulative unrealized upward and downward adjustments made to the initial cost basis of the securities (in millions): Initial cost basis (1) $ 8,168 Upward adjustments 4,285 Downward adjustments (including impairment) (178 ) Total carrying value at the end of the period $ 12,275 (1) Includes $2.2 billion for a non-marketable equity security reclassified from a non-marketable debt security during 2018. During the year ended December 31, 2018 , included in the $12.3 billion of non-marketable equity securities, $6.9 billion were measured at fair value based on observable market transactions, resulting in a net unrealized gain of $4.1 billion . Gains and losses on marketable and non-marketable equity securities Realized and unrealized gains and losses for our marketable and non-marketable equity securities for the year ended December 31, 2018 are summarized below (in millions): Twelve Months Ended December 31, 2018 Realized gain (loss) for equity securities sold during the period $ 1,458 Unrealized gain (loss) on equity securities held as of the end of the period (1) 4,002 Total gain (loss) recognized in other income (expense), net $ 5,460 (1) Includes $4,107 million related to non-marketable equity securities for the year ended December 31, 2018 . Equity securities accounted for under the Equity Method As of December 31, 2017 and 2018 , equity securities accounted for under the equity method had a carrying value of approximately $1.4 billion and $1.3 billion , respectively. Our share of gains and losses including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net. Derivative Financial Instruments We classify our foreign currency and interest rate derivative contracts primarily within Level 2 in the fair value hierarchy as the valuation inputs are based on quoted prices and market observable data of similar instruments. We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. As a result of our adoption of Accounting Standard Update No. 2017-12 (ASU 2017-12) ""Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,"" the components excluded from the assessment of hedge effectiveness are recognized in the same income statement line as the hedged item beginning January 1, 2018. Alphabet Inc. We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows, earnings, and investment in foreign subsidiaries will be adversely affected by foreign currency exchange rate fluctuations. We also use interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and debt issuances. Our program is not used for trading or speculative purposes. We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. As of December 31, 2017 and 2018 , we received cash collateral related to the derivative instruments under our collateral security arrangements of $15 million and $327 million , respectively, which was included in other current assets. Cash Flow Hedges We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written options), designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $11.7 billion and $11.8 billion as of December 31, 2017 and 2018 , respectively. These contracts have maturities of 24 months or less. For forwards and option contracts, we exclude the change in the forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI and subsequently reclassify these gains and losses to revenues when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are immediately reclassified to other income (expense), net. As of December 31, 2018 , the net gain or loss of our foreign currency cash flow hedges before tax effect was a net accumulated gain of $247 million , of which a net gain of $247 million is expected to be reclassified from AOCI into earnings within the next 12 months. Fair Value Hedges We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $2.9 billion and $2.0 billion as of December 31, 2017 and 2018 , respectively. Gains and losses on these forward contracts are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items. Net Investment Hedges During the year ended December 31, 2018 , we entered into forward contracts designated as net investment hedges to hedge the foreign currency risks related to our investment in foreign subsidiaries. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $6.7 billion as of December 31, 2018 . Gains and losses on these forward contracts are recognized in AOCI as part of the foreign currency translation adjustment. Other Derivatives Other derivatives not designated as hedging instruments consist of foreign currency forward contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of the outstanding foreign exchange contracts was $15.2 billion and $20.1 billion as of December 31, 2017 and 2018 , respectively. Alphabet Inc. The fair values of our outstanding derivative instruments were as follows (in millions): As of December 31, 2017 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ As of December 31, 2018 Balance Sheet Location Fair Value of Derivatives Designated as Hedging Instruments Fair Value of Derivatives Not Designated as Hedging Instruments Total Fair Value Derivative Assets: Level 2: Foreign exchange contracts Other current and non-current assets $ $ $ Total $ $ $ Derivative Liabilities: Level 2: Foreign exchange contracts Accrued expenses and other liabilities, current and non-current $ $ $ Total $ $ $ The gains (losses) on derivatives in cash flow hedging and net investment hedging relationships recognized in other comprehensive income (OCI) are summarized below (in millions): Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect Year Ended December 31, Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness $ $ (955 ) $ Amount excluded from the assessment of effectiveness Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount included in the assessment of effectiveness Total $ $ (955 ) $ Alphabet Inc. The effect of derivative instruments on income is summarized below (in millions): Gains (Losses) Recognized in Income Year Ended December 31, Revenues Other income (expense), net Revenues Other income (expense), net Revenues Other income (expense), net Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded $ 90,272 $ $ 110,855 $ 1,047 $ 136,819 $ 8,592 Gains (Losses) on Derivatives in Cash Flow Hedging Relationship: Foreign exchange contracts Amount of gains (losses) reclassified from AOCI to income $ $ $ (169 ) $ $ (139 ) $ Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach Amount excluded from the assessment of effectiveness (381 ) Gains (Losses) on Derivatives in Fair Value Hedging Relationship: Foreign exchange contracts Hedged items (139 ) (96 ) Derivatives designated as hedging instruments (197 ) Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives in Net Investment Hedging Relationship: Foreign exchange contracts Amount excluded from the assessment of effectiveness Gains (Losses) on Derivatives Not Designated as Hedging Instruments: Foreign exchange contracts Derivatives not designated as hedging instruments (230 ) Total gains (losses) $ $ (245 ) $ (169 ) $ (124 ) $ (138 ) $ Offsetting of Derivatives We present our forwards and purchased options at gross fair values in the Consolidated Balance Sheets. For foreign currency collars, we present at net fair values where both purchased and written options are with the same counterparty. Our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2017 and 2018 , information related to these offsetting arrangements were as follows (in millions): Alphabet Inc. Offsetting of Assets As of December 31, 2017 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ (22 ) $ $ (64 ) (1) $ (4 ) $ (2 ) $ As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Assets Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Received Non-Cash Collateral Received Net Assets Exposed Derivatives $ $ (56 ) $ $ (90 ) (1) $ (307 ) $ (14 ) $ (1) The balances as of December 31, 2017 and 2018 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements. Offsetting of Liabilities As of December 31, 2017 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ (22 ) $ $ (64 ) (2) $ $ $ As of December 31, 2018 Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset Gross Amounts of Recognized Liabilities Gross Amounts Offset in the Consolidated Balance Sheets Net Presented in the Consolidated Balance Sheets Financial Instruments Cash Collateral Pledged Non-Cash Collateral Pledged Net Liabilities Derivatives $ $ (56 ) $ $ (90 ) (2) $ $ $ (2) The balances as of December 31, 2017 and 2018 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements. Note 4. Variable Interest Entities (VIEs) Consolidated VIEs We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. We are the primary beneficiary because we have the power to direct activities that most significantly affect their economic performance and have the obligation to absorb the majority of their losses or benefits. The results of operations and financial position of these VIEs are included in our consolidated financial statements. For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2017 and 2018 , assets that can only be used to settle obligations of these VIEs were $1.7 billion and $2.4 billion , respectively, and the liabilities for which creditors only have recourse to the VIEs were $997 million and $909 million , respectively. Calico Calico is a life science company with a mission to harness advanced technologies to increase our understanding of the biology that controls lifespan. Alphabet Inc. In September 2014, AbbVie Inc. (AbbVie) and Calico entered into a research and development collaboration agreement intended to help both companies discover, develop, and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. In the second quarter of 2018, AbbVie and Calico amended the collaboration agreement resulting in an increase in total commitments. As of December 31, 2018 , AbbVie has contributed $750 million to fund the collaboration pursuant to the agreement and is committed to an additional $500 million which will be paid by the fourth quarter of 2019. As of December 31, 2018 , Calico has contributed $500 million and has committed up to an additional $750 million . Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market. Both companies share costs and profits for projects covered under this agreement equally. AbbVie's contribution has been recorded as a liability on Calico's financial statements, which is reduced and reflected as a reduction to research and development expense as eligible research and development costs are incurred by Calico. As of December 31, 2018 , we have contributed $480 million to Calico in exchange for Calico convertible preferred units and are committed to fund up to an additional $750 million on an as-needed basis and subject to certain conditions. Verily Verily is a life science company with a mission to make the world's health data useful so that people enjoy healthier lives. In 2017, Temasek, a Singapore-based investment company, purchased a noncontrolling interest in Verily for an aggregate of $800 million in cash. In December 2018, Verily received $900 million in cash from a $1.0 billion investment round. The remaining $100 million is expected to be received in the first quarter of 2019. These transactions were accounted for as equity transactions and no gain or loss was recognized. Unconsolidated VIEs Certain renewable energy investments included in our non-marketable equity investments accounted for under the equity method are VIEs. These entities' activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance such as setting operating budgets. Therefore, we do not consolidate these VIEs in our consolidated financial statements. The carrying value and maximum exposure of these VIEs were $896 million and $705 million as of December 31, 2017 and 2018 , respectively. The maximum exposure is based on current investments to date. We have determined the single source of our exposure to these VIEs is our capital investment in them. Other unconsolidated VIEs were not material as of December 31, 2017 and 2018 . Note 5. Debt Short-Term Debt We have a debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2017 and 2018 . Long-Term Debt Google issued $3.0 billion of senior unsecured notes in three tranches (collectively, 2011 Notes) in May 2011, due in 2014, 2016, and 2021, as well as $1.0 billion of senior unsecured notes (2014 Notes) in February 2014 due in 2024. In April 2016, we completed an exchange offer with eligible holders of Googles 2011 Notes due 2021 and 2014 Notes due 2024 (collectively, the Google Notes). An aggregate principal amount of approximately $1.7 billion of the Google Notes was exchanged for approximately $1.7 billion of Alphabet notes with identical interest rate and maturity. Because the exchange was between a parent and the subsidiary company and for substantially identical notes, the change was treated as a debt modification for accounting purposes with no gain or loss recognized. In August 2016, Alphabet issued $2.0 billion of senior unsecured notes (2016 Notes) due 2026. The net proceeds from the issuance of the 2016 Notes were used for general corporate purposes, including the repayment of outstanding Alphabet Inc. commercial paper. The Alphabet notes due in 2021, 2024, and 2026 rank equally with each other and are structurally subordinate to the outstanding Google Notes. The total outstanding long-term debt is summarized below (in millions): As of December 31, 2017 As of December 31, 2018 3.625% Notes due on May 19, 2021 $ 1,000 $ 1,000 3.375% Notes due on February 25, 2024 1,000 1,000 1.998% Notes due on August 15, 2026 2,000 2,000 Unamortized discount for the Notes above (57 ) (50 ) Subtotal (1) 3,943 3,950 Capital lease obligation Total long-term debt $ 3,969 $ 4,012 (1) Includes the outstanding (and unexchanged) Google Notes issued in 2011 and 2014 and the Alphabet notes exchanged in 2016. The effective interest yields based on proceeds received from the outstanding notes due in 2021, 2024, and 2026 were 3.734% , 3.377% , and 2.231% , respectively, with interest payable semi-annually. We may redeem these notes at any time in whole or in part at specified redemption prices. The total estimated fair value of all outstanding notes was approximately $4.0 billion and $3.9 billion as of December 31, 2017 and 2018 , respectively. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. As of December 31, 2018 , the aggregate future principal payments for long-term debt including long-term capital leases for each of the next five years and thereafter are as follows (in millions): $ 2020 2021 1,003 2023 Thereafter 3,039 Total $ 4,062 Credit Facility As of December 31, 2018 , we have $4.0 billion of revolving credit facilities which expire in July 2023. The interest rate for the credit facilities is determined based on a formula using certain market rates. No amounts were outstanding under the credit facilities as of December 31, 2017 and 2018 . Note 6. Supplemental Financial Statement Information Property and Equipment, Net Property and equipment, net, consisted of the following (in millions): As of December 31, 2017 As of December 31, 2018 Land and buildings $ 23,183 $ 30,179 Information technology assets 21,429 30,119 Construction in progress 10,491 16,838 Leasehold improvements 4,496 5,310 Furniture and fixtures Property and equipment, gross 59,647 82,507 Less: accumulated depreciation (17,264 ) (22,788 ) Property and equipment, net $ 42,383 $ 59,719 Alphabet Inc. As of December 31, 2017 and 2018 , assets under capital lease with a cost basis of $390 million and $648 million , respectively, were included in property and equipment. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following (in millions): As of December 31, 2017 As of December 31, 2018 European Commission fines (1) $ 2,874 $ 7,754 Accrued customer liabilities 1,489 1,810 Other accrued expenses and current liabilities 5,814 7,394 Accrued expenses and other current liabilities $ 10,177 $ 16,958 (1) Includes the effects of foreign exchange and interest. See Note 9 for further details Accumulated Other Comprehensive Income (Loss) The components of AOCI, net of tax, were as follows (in millions): Foreign Currency Translation Adjustments Unrealized Gains (Losses) on Available-for-Sale Investments Unrealized Gains (Losses) on Cash Flow Hedges Total Balance as of December 31, 2015 $ (2,047 ) $ (86 ) $ $ (1,874 ) Other comprehensive income (loss) before reclassifications (599 ) (314 ) (398 ) Amounts reclassified from AOCI (351 ) (130 ) Other comprehensive income (loss) (599 ) (93 ) (528 ) Balance as of December 31, 2016 $ (2,646 ) $ (179 ) $ $ (2,402 ) Other comprehensive income (loss) before reclassifications 1,543 (638 ) 1,212 Amounts reclassified from AOCI Other comprehensive income (loss) 1,543 (545 ) 1,410 Balance as of December 31, 2017 $ (1,103 ) $ $ (122 ) $ (992 ) Other comprehensive income (loss) before reclassifications (1) (781 ) (10 ) (527 ) Amounts excluded from the assessment of hedge effectiveness recorded in AOCI Amounts reclassified from AOCI (911 ) (813 ) Other comprehensive income (loss) (781 ) (921 ) (1,314 ) Balance as of December 31, 2018 $ (1,884 ) $ (688 ) $ $ (2,306 ) (1) The change in unrealized gains (losses) on available-for-sale investments included a $98 million adjustment of net unrealized gains related to marketable equity securities from AOCI to opening retained earnings as a result of the adoption of ASU 2016-01 on January 1, 2018. Alphabet Inc. The effects on net income of amounts reclassified from AOCI were as follows (in millions): Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income Year Ended December 31, AOCI Components Location Unrealized gains (losses) on available-for-sale investments Other income (expense), net $ (221 ) $ (105 ) $ 1,190 Provision for income taxes (279 ) Net of tax $ (221 ) $ (105 ) $ Unrealized gains (losses) on cash flow hedges Foreign exchange contracts Revenue $ $ (169 ) $ (139 ) Interest rate contracts Other income (expense), net Benefit (provision) for income taxes (193 ) Net of tax $ $ (93 ) $ (98 ) Total amount reclassified, net of tax $ $ (198 ) $ Other Income (Expense), Net The components of other income (expense), net, were as follows (in millions): Year Ended December 31, Interest income $ 1,220 $ 1,312 $ 1,878 Interest expense (1) (124 ) (109 ) (114 ) Foreign currency exchange losses, net (2) (475 ) (121 ) (80 ) Gain (loss) on debt securities, net (3) (53 ) (110 ) 1,190 Gain (loss) on equity securities, net (20 ) 5,460 Loss and impairment from equity method investments, net (202 ) (156 ) (120 ) Other Other income (expense), net $ $ 1,047 $ 8,592 (1) Interest expense is net of interest capitalized of $0 million , $48 million , and $92 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. (2) Our foreign currency exchange losses, net, are related to the option premium costs and forwards points for our foreign currency hedging contracts, our foreign exchange transaction gains and losses from the conversion of the transaction currency to the functional currency, offset by the foreign currency hedging contract losses and gains. The net foreign currency transaction losses were $112 million , $226 million , and $195 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. (3) During the year ended December 31, 2018, the terms of a non-marketable debt security were modified resulting in an unrealized $1.3 billion gain. Note 7. Acquisitions 2018 Acquisitions HTC Corporation (HTC) In January 2018, we completed the acquisition of a team of engineers and a non-exclusive license of intellectual property from HTC for $1.1 billion in cash. In aggregate, $10 million was cash acquired, $165 million was attributed to intangible assets, $934 million was attributed to goodwill, and $9 million was attributed to net liabilities assumed. Goodwill, which was included in the Google segment, is not deductible for tax purposes. We expect this transaction to accelerate Googles ongoing hardware efforts. The transaction was accounted for as a business combination. Other Acquisitions During the year ended December 31, 2018 , we completed other acquisitions and purchases of intangible assets for total consideration of approximately $573 million . In aggregate, $10 million was cash acquired, $295 million was attributed to intangible assets, $293 million was attributed to goodwill, and $25 million was attributed to net liabilities Alphabet Inc. assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. The amount of goodwill expected to be deductible for tax purposes is approximately $81 million . Pro forma results of operations for these acquisitions, including HTC, have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2018 , patents and developed technology have a weighted-average useful life of 3.7 years, customer relationships have a weighted-average useful life of 2.3 years, and trade names and other have a weighted-average useful life of 3.7 years. 2017 Acquisitions During the year ended December 31, 2017 , we completed various acquisitions and purchases of intangible assets for total consideration of approximately $322 million . In aggregate, $12 million was cash acquired, $117 million was attributed to intangible assets, $221 million was attributed to goodwill, and $28 million was attributed to net liabilities assumed . These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. The amount of goodwill expected to be deductible for tax purposes is approximately $60 million . Pro forma results of operations for these acquisitions have not been presented because they are not material to the consolidated results of operations, either individually or in aggregate. For all intangible assets acquired and purchased during the year ended December 31, 2017 , patents and developed technology have a weighted-average useful life of 3.7 years, customer relationships have a weighted-average useful life of 2.0 years, and trade names and other have a weighted-average useful life of 8.8 years. Note 8. Goodwill and Other Intangible Assets Goodwill Changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2018 were as follows (in millions): Google Other Bets Total Consolidated Balance as of December 31, 2016 $ 16,027 $ $ 16,468 Acquisitions Foreign currency translation and other adjustments Balance as of December 31, 2017 16,295 16,747 Acquisitions 1,227 1,227 Transfers (80 ) Foreign currency translation and other adjustments (81 ) (5 ) (86 ) Balance as of December 31, 2018 $ 17,521 $ $ 17,888 Other Intangible Assets Information regarding purchased intangible assets were as follows (in millions): As of December 31, 2017 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents and developed technology $ 5,260 $ 3,040 $ 2,220 Customer relationships Trade names and other Total $ 6,163 $ 3,471 $ 2,692 Alphabet Inc. As of December 31, 2018 Gross Carrying Amount Accumulated Amortization Net Carrying Value Patents and developed technology $ 5,125 $ 3,394 $ 1,731 Customer relationships Trade names and other Total $ 6,177 $ 3,957 $ 2,220 Patents and developed technology, customer relationships, and trade names and other have weighted-average remaining useful lives of 3.0 years, 0.5 years, and 3.8 years, respectively. Amortization expense relating to purchased intangible assets was $833 million , $796 million , and $865 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. As of December 31, 2018 , expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in millions): $ 2020 2021 2022 2023 Thereafter $ 2,220 Note 9. Commitments and Contingencies Operating Leases We have entered into various non-cancelable operating lease agreements for data centers and land and offices throughout the world with lease periods expiring between 2019 and 2063 . We are committed to pay a portion of the actual operating expenses under certain of these lease agreements. These operating expenses are not included in the table below. Certain of these arrangements have free or escalating rent payment provisions. We recognize rent expense on a straight-line basis. As of December 31, 2018 , future minimum payments under operating leases having initial or remaining non-cancelable lease terms in excess of one year, net of sublease income amounts, were as follows (in millions): Operating Leases (1) Sub-lease Income Net Operating Leases $ 1,319 $ $ 1,303 1,397 1,384 1,337 1,327 1,153 1,145 980 Thereafter 3,916 3,911 Total minimum payments $ 10,102 $ $ 10,047 (1) Includes future minimum payments for leases which have not yet commenced. We have entered into certain non-cancelable lease agreements with lease periods expiring between 2021 and 2044 where we are the deemed owner for accounting purposes of new construction projects. Excluded from the table above are future minimum lease payments under such leases totaling approximately $3.5 billion , for which a $1.5 billion liability is included on the Consolidated Balance Sheets as of December 31, 2018 . Rent expense under operating leases was $897 million , $1.1 billion , and $1.3 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. Alphabet Inc. Purchase Obligations As of December 31, 2018 , we had $7.4 billion of other non-cancelable contractual obligations, primarily related to data center operations and build-outs, digital media content licensing, and purchases of inventory. Indemnifications In the normal course of business, to facilitate transactions in our services and products, we indemnify certain parties, including advertisers, Google Network Members, and lessors with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. Several of these agreements limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents. It is not possible to make a reasonable estimate of the maximum potential amount under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement. Additionally, we have a limited history of prior indemnification claims and the payments we have made under such agreements have not had a material adverse effect on our results of operations, cash flows, or financial position. However, to the extent that valid indemnification claims arise in the future, future payments by us could be significant and could have a material adverse effect on our results of operations or cash flows in a particular period. As of December 31, 2018 , we did not have any material indemnification claims that were probable or reasonably possible. Legal Matters Antitrust Investigations On November 30, 2010, the EC's Directorate General for Competition opened an investigation into various antitrust-related complaints against us. On April 15, 2015, the EC issued a Statement of Objections (SO) regarding the display and ranking of shopping search results and ads, to which we responded on August 27, 2015. On July 14, 2016, the EC issued a Supplementary SO regarding shopping search results and ads. On June 27, 2017, the EC announced its decision that certain actions taken by Google regarding its display and ranking of shopping search results and ads infringed European competition law. The EC decision imposed a 2.4 billion ( $2.7 billion as of June 27, 2017) fine. On September 11, 2017, we appealed the EC decision and on September 27, 2017, we implemented product changes to bring shopping ads into compliance with the EC's decision. We recognized a charge of $2.7 billion for the fine in the second quarter of 2017. While under appeal, the fine is included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the fine. On April 20, 2016, the EC issued an SO regarding certain Android distribution practices. We responded to the SO and the EC's informational requests. On July 18, 2018, the EC announced its decision that certain provisions in Googles Android-related distribution agreements infringed European competition law. The EC decision imposed a 4.3 billion ( $5.1 billion as of June 30, 2018) fine and directed the termination of the conduct at issue. On October 9, 2018, we appealed the EC decision and implemented changes to certain of our Android distribution practices. We recognized a charge of $5.1 billion for the fine in the second quarter of 2018. While under appeal, the fine is included in accrued expenses and other current liabilities on our Consolidated Balance Sheets as we provided bank guarantees in lieu of a cash payment for the fine. On July 14, 2016, the EC issued an SO regarding the syndication of AdSense for Search. We responded to the SO and continue to respond to the EC's informational requests. There is significant uncertainty as to the outcome of this investigation; however, an adverse decision could result in fines and directives to alter or terminate certain conduct. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any. We remain committed to working with the EC to resolve these matters. The Comision Nacional de Defensa de la Competencia in Argentina, the Competition Commission of India (CCI), Brazil's Administrative Council for Economic Defense (CADE), and the Korean Fair Trade Commission have also opened investigations into certain of our business practices. In November 2016, we responded to the CCI Director General's report with interim findings of competition law infringements regarding search and ads. On February 8, 2018, the CCI issued its final decision, including a fine of approximately $21 million , finding no violation of competition law infringement on most of the issues it investigated, but finding violations, including in the display of the flights unit in search results, and a contractual provision in certain direct search intermediation agreements. We have appealed the CCI decision. The fine was accrued for in 2018. Alphabet Inc. Patent and Intellectual Property Claims We have had patent, copyright, trade secret, and trademark infringement lawsuits filed against us claiming that certain of our products, services, and technologies infringe the intellectual property rights of others. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, or orders preventing us from offering certain features, functionalities, products, or services, and may also cause us to change our business practices, and require development of non-infringing products or technologies, which could result in a loss of revenues for us and otherwise harm our business. In addition, the U.S. International Trade Commission (ITC) has increasingly become an important forum to litigate intellectual property disputes because an ultimate loss for a company or its suppliers in an ITC action could result in a prohibition on importing infringing products into the U.S. Because the U.S. is an important market, a prohibition on importation could have an adverse effect on us, including preventing us from importing many important products into the U.S. or necessitating workarounds that may limit certain features of our products. Furthermore, many of our agreements with our customers and partners require us to indemnify them for certain intellectual property infringement claims against them, which would increase our costs as a result of defending such claims, and may require that we pay significant damages if there were an adverse ruling in any such claims. Our customers and partners may discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely affect our business. In 2010, Oracle America, Inc. (Oracle) brought a copyright lawsuit against Google in the Northern District of California, alleging that Google's Android operating system infringes Oracle's copyrights related to certain Java application programming interfaces. After trial, final judgment was entered by the district court in favor of Google on June 8, 2016, and the court decided post-trial motions in favor of Google. Oracle appealed and on March 27, 2018, the appeals court reversed and remanded the case for a trial on damages. On May 29, 2018, we filed a petition for an en banc rehearing at the Federal Circuit, and on August 28, 2018, the Federal Circuit denied the petition. On January 24, 2019, we filed a petition to the Supreme Court of the United States to review this case. We believe this lawsuit is without merit and are defending ourselves vigorously. Given the nature of this case, we are unable to estimate the reasonably possible loss or range of loss, if any, arising from this matter. Other We are also regularly subject to claims, suits, regulatory and government investigations, and other proceedings involving competition (such as the pending EC investigations described above), intellectual property, privacy, tax and related compliance, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, personal injury, consumer protection, and other matters. Such claims, suits, regulatory and government investigations, and other proceedings could result in fines, civil or criminal penalties, or other adverse consequences. Certain of these outstanding matters include speculative, substantial or indeterminate monetary amounts. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We evaluate developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related reasonably possible losses disclosed, and make adjustments as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. With respect to our outstanding matters, based on our current knowledge, we believe that the amount or range of reasonably possible loss will not, either individually or in aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of such matters is inherently unpredictable and subject to significant uncertainties. We expense legal fees in the period in which they are incurred. Non-Income Taxes We are under audit by various domestic and foreign tax authorities with regards to non-income tax matters. The subject matter of non-income tax audits primarily arises from disputes on the tax treatment and tax rate applied to the sale of our products and services in these jurisdictions and the tax treatment of certain employee benefits. We accrue non-income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities when a loss is probable and reasonably estimable. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the reasonably possible loss. We believe these matters are without merit and we are defending ourselves vigorously. Due to the inherent complexity and uncertainty of these matters and judicial process in certain jurisdictions, the final outcome may be materially different from our expectations. Alphabet Inc. For information regarding income tax contingencies, see Note 13 . Note 10. Stockholders Equity Convertible Preferred Stock Our board of directors has authorized 100 million shares of convertible preferred stock, $0.001 par value, issuable in series. As of December 31, 2017 and 2018 , no shares were issued or outstanding. Class A and Class B Common Stock and Class C Capital Stock Our board of directors has authorized three classes of stock, Class A and Class B common stock, and Class C capital stock. The rights of the holders of each class of our common and capital stock are identical, except with respect to voting. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share. Class C capital stock has no voting rights, except as required by applicable law. Shares of Class B common stock may be converted at any time at the option of the stockholder and automatically convert upon sale or transfer to Class A common stock. Share Repurchases In October 2016, the board of directors of Alphabet authorized the company to repurchase up to $7.0 billion of its Class C capital stock, which was completed during 2018. In January 2018, the board of directors of Alphabet authorized the company to repurchase up to $8.6 billion of its Class C capital stock. The repurchases are being executed from time to time, subject to general business and market conditions and other investment opportunities, through open market purchases or privately negotiated transactions, including through Rule 10b5-1 plans. The repurchase program does not have an expiration date. During the years ended December 31, 2017 and 2018 , we repurchased and subsequently retired 5.2 million shares of Alphabet Class C capital stock for an aggregate amount of $4.8 billion and 8.2 million shares of Alphabet Class C capital stock for an aggregate amount of $9.1 billion , respectively. Note 11. Net Income Per Share We compute net income per share of Class A and Class B common stock and Class C capital stock using the two-class method. Basic net income per share is computed using the weighted-average number of shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares and the effect of potentially dilutive securities outstanding during the period. Potentially dilutive securities consist of restricted stock units and other contingently issuable shares. The dilutive effect of outstanding restricted stock units and other contingently issuable shares is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares. The rights, including the liquidation and dividend rights, of the holders of our Class A and Class B common stock and Class C capital stock are identical, except with respect to voting. Furthermore, there are a number of safeguards built into our certificate of incorporation, as well as Delaware law, which preclude our board of directors from declaring or paying unequal per share dividends on our Class A and Class B common stock and Class C capital stock. Specifically, Delaware law provides that amendments to our certificate of incorporation which would have the effect of adversely altering the rights, powers, or preferences of a given class of stock must be approved by the class of stock adversely affected by the proposed amendment. In addition, our certificate of incorporation provides that before any such amendment may be put to a stockholder vote, it must be approved by the unanimous consent of our board of directors. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares and Class C capital stock as if the earnings for the year had been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. In the years ended December 31, 2016 , 2017 and 2018 , the net income per share amounts are the same for Class A and Class B common stock and Class C capital stock because the holders of each class are entitled to equal per share dividends or distributions in liquidation in accordance with the Amended and Restated Certificate of Incorporation of Alphabet Inc. Alphabet Inc. The following tables set forth the computation of basic and diluted net income per share of Class A and Class B common stock and Class C capital stock (in millions, except share amounts which are reflected in thousands and per share amounts): Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 8,332 $ 1,384 $ 9,762 Denominator Number of shares used in per share computation 294,217 48,859 344,702 Basic net income per share $ 28.32 $ 28.32 $ 28.32 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 8,332 $ 1,384 $ 9,762 Effect of dilutive securities in equity method investments and subsidiaries (9 ) (2 ) (10 ) Allocation of undistributed earnings for diluted computation 8,323 1,382 9,752 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 1,382 Reallocation of undistributed earnings (94 ) (21 ) Allocation of undistributed earnings $ 9,611 $ 1,361 $ 9,846 Denominator Number of shares used in basic computation 294,217 48,859 344,702 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 48,859 Restricted stock units and other contingently issuable shares 2,055 8,873 Number of shares used in per share computation 345,131 48,859 353,575 Diluted net income per share $ 27.85 $ 27.85 $ 27.85 Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 5,438 $ $ 6,362 Denominator Number of shares used in per share computation 297,604 47,146 348,151 Basic net income per share $ 18.27 $ 18.27 $ 18.27 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 5,438 $ $ 6,362 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares Reallocation of undistributed earnings (74 ) (14 ) Allocation of undistributed earnings $ 6,226 $ $ 6,436 Denominator Number of shares used in basic computation 297,604 47,146 348,151 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 47,146 Restricted stock units and other contingently issuable shares 1,192 9,491 Number of shares used in per share computation 345,942 47,146 357,642 Diluted net income per share $ 18.00 $ 18.00 $ 18.00 Alphabet Inc. Year Ended December 31, Class A Class B Class C Basic net income per share: Numerator Allocation of undistributed earnings $ 13,200 $ 2,072 $ 15,464 Denominator Number of shares used in per share computation 298,548 46,864 349,728 Basic net income per share $ 44.22 $ 44.22 $ 44.22 Diluted net income per share: Numerator Allocation of undistributed earnings for basic computation $ 13,200 $ 2,072 $ 15,464 Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares 2,072 Reallocation of undistributed earnings (146 ) (24 ) Allocation of undistributed earnings $ 15,126 $ 2,048 $ 15,610 Denominator Number of shares used in basic computation 298,548 46,864 349,728 Weighted-average effect of dilutive securities Add: Conversion of Class B to Class A common shares outstanding 46,864 Restricted stock units and other contingently issuable shares 7,456 Number of shares used in per share computation 346,101 46,864 357,184 Diluted net income per share $ 43.70 $ 43.70 $ 43.70 Note 12. Compensation Plans Stock Plans Under our 2012 Stock Plan, RSUs or stock options may be granted. An RSU award is an agreement to issue shares of our publicly traded stock at the time the award vests. Incentive and non-qualified stock options, or rights to purchase common stock, are generally granted for a term of 10 years. RSUs granted to participants under the 2012 Stock Plan generally vest over four years contingent upon employment or service with us on the vesting date. As of December 31, 2018 , there were 31,848,134 shares of stock reserved for future issuance under our Stock Plan. Stock-Based Compensation For the years ended December 31, 2016 , 2017 and 2018 , total stock-based compensation expense was $6.9 billion , $7.9 billion and $10.0 billion , including amounts associated with awards we expect to settle in Alphabet stock of $6.7 billion , $7.7 billion , and $9.4 billion , respectively. For the years ended December 31, 2016 , 2017 and 2018 , we recognized tax benefits on total stock-based compensation expense, which are reflected in the provision for income taxes in the Consolidated Statements of Income, of $1.5 billion , $1.6 billion , and $1.5 billion , respectively. For the years ended December 31, 2016 , 2017 and 2018 , tax benefit realized related to awards vested or exercised during the period was $2.1 billion , $2.7 billion and $2.1 billion , respectively. These amounts do not include the indirect effects of stock-based awards, which primarily relate to the research and development tax credit. Alphabet Inc. Stock-Based Award Activities The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2018 : Unvested Restricted Stock Units Number of Shares Weighted- Average Grant-Date Fair Value Unvested as of December 31, 2017 20,077,346 $ 712.45 Granted 12,669,251 $ 1,095.89 Vested (12,847,910 ) $ 756.45 Forfeited/canceled (1,431,009 ) $ 814.19 Unvested as of December 31, 2018 18,467,678 $ 936.96 The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2016 and 2017 , was $713.89 and $845.06 , respectively. Total fair value of RSUs, as of their respective vesting dates, during the years ended December 31, 2016 , 2017 , and 2018 were $9.0 billion , $11.3 billion , and $14.1 billion , respectively. As of December 31, 2018 , there was $16.2 billion of unrecognized compensation cost related to unvested employee RSUs. This amount is expected to be recognized over a weighted-average period of 2.5 years . 401(k) Plans We have two 401(k) Savings Plans that qualify as deferred salary arrangements under Section 401(k) of the Internal Revenue Code. Under these 401(k) Plans, matching contributions are based upon the amount of the employees contributions subject to certain limitations. We recognized expense of approximately $385 million , $448 million , and $691 million for the years ended December 31, 2016 , 2017 , and 2018 , respectively. Performance Fees We have compensation arrangements with payouts based on realized investment returns. We recognize compensation expense based on the estimated payouts, which may result in expense recognized before investment returns are realized. For the year ended December 31, 2018 , performance fees of $1.2 billion primarily related to gains on equity securities (for further information on gains on equity securities, see Note 3 ) were accrued and recorded as a component of general and administrative expenses. Note 13. Income Taxes Income from continuing operations before income taxes included income from domestic operations of $12.0 billion , $10.7 billion , and $15.8 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively, and income from foreign operations of $12.1 billion , $16.5 billion , and $19.1 billion for the years ended December 31, 2016 , 2017 , and 2018 , respectively. The provision for income taxes consists of the following (in millions): Year Ended December 31, 2017 Current: Federal and state $ 3,826 $ 12,608 $ 2,153 Foreign 1,746 1,251 Total 4,792 14,354 3,404 Deferred: Federal and state (70 ) Foreign (50 ) (43 ) (134 ) Total (120 ) Provision for income taxes $ 4,672 $ 14,531 $ 4,177 The Tax Act enacted on December 22, 2017 introduced significant changes to U.S. income tax law. Effective 2018, the Tax Act reduced the U.S. statutory tax rate from 35% to 21% and created new taxes on certain foreign-sourced earnings and certain related-party payments. Alphabet Inc. Due to the timing of the enactment and the complexity involved in applying the provisions of the Tax Act, we made reasonable estimates of the effects and recorded provisional amounts in our consolidated financial statements as of December 31, 2017. As we collected and prepared necessary data, and interpreted the additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we made adjustments, over the course of the year, to the provisional amounts including refinements to deferred taxes. The accounting for the tax effects of the Tax Act has been completed as of December 31, 2018. One-time transition tax The Tax Act required us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion as of December 31, 2017. Deferred tax effects Due to the change in the statutory tax rate from the Tax Act, we remeasured our deferred taxes as of December 31, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized. We recognized a deferred tax benefit of $376 million to reflect the reduced U.S. tax rate and other effects of the Tax Act as of December 31, 2017. The reconciliation of federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, U.S. federal statutory tax rate 35.0 % 35.0 % 21.0 % Foreign income taxed at different rates (11.0 ) (14.2 ) (4.9 ) Effect of the Tax Act One-time transition tax 0.0 37.6 (0.1 ) Deferred tax effects 0.0 (1.4 ) (1.2 ) Federal research credit (2.0 ) (1.8 ) (2.4 ) Stock-based compensation expense (3.4 ) (4.5 ) (2.2 ) European Commission fine 0.0 3.5 3.1 Deferred tax asset valuation allowance 0.1 0.9 (2.0 ) Other adjustments 0.6 (1.7 ) 0.7 Effective tax rate 19.3 % 53.4 % 12.0 % Our effective tax rate for each of the years presented was affected by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. Substantially all of the income from foreign operations was earned by an Irish subsidiary. Beginning in 2018, earnings realized in foreign jurisdictions are subject to U.S. tax in accordance with the Tax Act. On July 27, 2015, the United States Tax Court, in an opinion in Altera Corp. v. Commissioner, invalidated the portion of the Treasury regulations issued under IRC Section 482 requiring related-party participants in a cost sharing arrangement to share stock-based compensation costs. The U.S. Tax Court issued the final decision on December 28, 2015. The IRS served a Notice of Appeal on February 22, 2016 and the case is being heard by the Ninth Circuit Court of Appeals. The Ninth Circuit Court of Appeals overturned the Tax Courts decision in an opinion issued on July 24, 2018, but withdrew that opinion in an order issued on August 7, 2018 to allow time for a reconstituted panel to confer on the appeal. At this time, the Ninth Circuit Court of Appeals has not issued a final decision, and the U.S. Treasury has not withdrawn the requirement to include stock-based compensation from its regulations. We have evaluated the opinion and continue to record a tax benefit related to reimbursement of cost share payments for the previously shared stock-based compensation costs. In accordance with the Tax Act, the Altera tax benefit was remeasured from 35% to 21%. We also remeasured the tax benefit expected to be realized upon settlement including the expected future new taxes enacted by the Tax Act due upon resolution of the matter. The tax liability recorded as of December 31, 2016 for the U.S. tax cost of the potential repatriation associated with the contingent foreign earnings was reversed due to the Tax Act introducing a territorial tax system and providing a 100% dividend received deduction on certain qualified dividends from foreign subsidiaries. We will continue to monitor developments related to the case and the potential effect on our consolidated financial statements. Alphabet Inc. Deferred Income Taxes Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We recorded a provisional adjustment to our U.S. deferred income taxes as of December 31, 2017 to reflect the reduction in the U.S. statutory tax rate from 35% to 21% resulting from the Tax Act. Significant components of our deferred tax assets and liabilities are as follows (in millions): As of December 31, Deferred tax assets: Stock-based compensation expense $ $ Accrued employee benefits Accruals and reserves not currently deductible 1,062 Tax credits 1,187 1,979 Basis difference in investment in Arris Prepaid cost sharing Net operating losses Other Total deferred tax assets 4,351 5,781 Valuation allowance (2,531 ) (2,817 ) Total deferred tax assets net of valuation allowance 1,820 2,964 Deferred tax liabilities: Property and equipment (551 ) (1,382 ) Identified intangibles (419 ) (229 ) Renewable energy investments (531 ) (500 ) Investment gains/losses (22 ) (1,143 ) Other (47 ) (237 ) Total deferred tax liabilities (1,570 ) (3,491 ) Net deferred tax assets (liabilities) $ $ (527 ) As of December 31, 2018 , our federal and state net operating loss carryforwards for income tax purposes were approximately $1.2 billion and $1.4 billion , respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2021 and the state net operating loss carryforwards will begin to expire in 2019. It is more likely than not that certain federal net operating loss carryforwards and our state net operating loss carryforwards will not be realized; therefore, we have recorded a valuation allowance against them. The net operating loss carryforwards are subject to various annual limitations under the tax laws of the different jurisdictions. Our foreign net operating loss carryforwards for income tax purposes were $950 million that will begin to expire in 2021. As of December 31, 2018 , our California research and development credit carryforwards for income tax purposes were approximately $2.4 billion that can be carried over indefinitely. We believe the state tax credit is not likely to be realized. As of December 31, 2018 , we maintained a valuation allowance with respect to California deferred tax assets, certain federal net operating losses, and certain foreign net operating losses that we believe are not likely to be realized. Due to gains from equity securities recognized in 2018, we released the valuation allowance against the deferred tax asset for the book-to-tax basis difference in our investments in Arris shares received from the sale of the Motorola Home business to Arris in 2013. We continue to reassess the remaining valuation allowance quarterly and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly. For further information on the unrealized gains related to marketable equity securities recognized in other income (expenses), see Note 1. Alphabet Inc. Uncertain Tax Positions The following table summarizes the activity related to our gross unrecognized tax benefits from January 1, 2016 to December 31, 2018 (in millions): Beginning gross unrecognized tax benefits $ 4,167 $ 5,393 $ 4,696 Increases related to prior year tax positions Decreases related to prior year tax positions (157 ) (257 ) (623 ) Decreases related to settlement with tax authorities (196 ) (1,875 ) (191 ) Increases related to current year tax positions Ending gross unrecognized tax benefits $ 5,393 $ 4,696 $ 4,652 The total amount of gross unrecognized tax benefits was $5.4 billion , $4.7 billion , and $4.7 billion as of December 31, 2016 , 2017 , and 2018 , respectively, of which, $4.3 billion , $3.0 billion , and $2.9 billion , if recognized, would affect our effective tax rate, respectively. The decrease in gross unrecognized tax benefits in 2017 was primarily as a result of the resolution of a multi-year U.S. audit. As of December 31, 2017 and 2018 , we had accrued $362 million and $490 million in interest and penalties in provision for income taxes, respectively. We file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions, our two major tax jurisdictions are the U.S. federal and Ireland. We are subject to the continuous examination of our income tax returns by the IRS and other tax authorities. The IRS is currently examining our 2013 through 2015 tax returns. We have also received tax assessments in multiple foreign jurisdictions asserting transfer pricing adjustments or permanent establishment. We continue to defend any and all such claims as presented. Our 2016 and 2017 tax years remain subject to examination by the IRS for U.S. federal tax purposes, and our 2011 through 2017 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. There are other ongoing audits in various other jurisdictions that are not material to our financial statements. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We continue to monitor the progress of ongoing discussions with tax authorities and the effect, if any, of the expected expiration of the statute of limitations in various taxing jurisdictions. We believe that an adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax audits cannot be predicted with certainty. If any issues addressed in our tax audits are resolved in a manner not consistent with management's expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs. Although the timing of resolution, settlement, and closure of audits is not certain, it is reasonably possible that certain U.S. federal and non-U.S. tax audits may be concluded within the next 12 months, which could significantly increase or decrease the balance of our gross unrecognized tax benefits. We estimate that our unrecognized tax benefits as of December 31, 2018 could possibly decrease by approximately $600 million in the next 12 months. Positions that may be resolved include various U.S. and non-U.S. matters. Note 14. Information about Segments and Geographic Areas We operate our business in multiple operating segments. Google is our only reportable segment. None of our other segments meet the quantitative thresholds to qualify as reportable segments; therefore, the other operating segments are combined and disclosed as Other Bets. Our reported segments are: Google Google includes our main products such as Ads, Android, Chrome, Google Cloud, Google Maps, Google Play, Hardware (including Nest), Search, and YouTube. Our technical infrastructure is also included in Google. Google generates revenues primarily from advertising; sales of apps, in-app purchases, digital content products, and hardware; and licensing and service fees, including fees received for Google Cloud offerings. Other Bets Other Bets is a combination of multiple operating segments that are not individually material. Other Bets includes businesses such as Access, Calico, CapitalG, GV, Verily, Waymo, and X. Revenues from the Other Bets are derived primarily through the sales of internet and TV services through Access as well as licensing and RD services through Verily. Alphabet Inc. Revenues, cost of revenues, and operating expenses are generally directly attributed to our segments. Inter-segment revenues are not presented separately, as these amounts are immaterial. Our Chief Operating Decision Maker does not evaluate operating segments using asset information. In Q1 2018, Nest joined Googles hardware team. Consequently, the financial results of Nest are reported in the Google segment, with Nest revenues reflected in Google other revenues. Prior period segment information has been recast to conform to the current period segment presentation. Consolidated financial results are not affected. Information about segments during the periods presented were as follows (in millions): Year Ended December 31, Revenues: Google $ 89,984 $ 110,378 $ 136,224 Other Bets Total revenues $ 90,272 $ 110,855 $ 136,819 Year Ended December 31, Operating income (loss): Google $ 27,055 $ 32,287 $ 36,517 Other Bets (2,741 ) (2,734 ) (3,358 ) Reconciling items (1) (598 ) (3,407 ) (6,838 ) Total income from operations $ 23,716 $ 26,146 $ 26,321 (1) Reconciling items are primarily comprised of the European Commission fines for the years ended December 31, 2017 and 2018, and performance fees for the year ended December 31, 2018, as well as corporate administrative costs and other miscellaneous items that are not allocated to individual segments for all periods presented. Year Ended December 31, Capital expenditures: Google $ 9,437 $ 12,619 $ 25,460 Other Bets 1,365 Reconciling items (2) (590 ) (502 ) Total capital expenditures as presented on the Consolidated Statements of Cash Flows $ 10,212 $ 13,184 $ 25,139 (2) Reconciling items are related to timing differences of payments as segment capital expenditures are on accrual basis while total capital expenditures shown on the Consolidated Statements of Cash Flow are on cash basis and other miscellaneous differences. Alphabet Inc. Stock-based compensation (SBC) and depreciation, amortization, and impairment are included in segment operating income (loss) as shown below (in millions): Year Ended December 31, Stock-based compensation: Google $ 6,201 $ 7,168 $ 8,755 Other Bets Reconciling items (3) Total stock-based compensation (4) $ 6,703 $ 7,679 $ 9,353 Depreciation, amortization, and impairment: Google $ 5,882 $ 6,608 $ 8,708 Other Bets Reconciling items (5) Total depreciation, amortization, and impairment as presented on the Consolidated Statements of Cash Flows $ 6,144 $ 6,915 $ 9,035 (3) Reconciling items represent corporate administrative costs that are not allocated to individual segments. (4) For purposes of segment reporting, SBC represents awards that we expect to settle in Alphabet stock. (5) Reconciling items are primarily related to corporate administrative costs and other miscellaneous items that are not allocated to individual segments. The following table presents our long-lived assets by geographic area (in millions): As of December 31, 2017 As of December 31, 2018 Long-lived assets: United States $ 55,113 $ 74,882 International 17,874 22,234 Total long-lived assets $ 72,987 $ 97,116 For revenues by geography, see Note 2 . "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2018 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Alphabet Inc. Managements Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2018 . Management reviewed the results of its assessment with our Audit Committee. The effectiveness of our internal control over financial reporting as of December 31, 2018 has been audited by Ernst Young LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K. Limitations on Effectiveness of Controls and Procedures In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. " diff --git a/datasets/raw/coca-cola.csv b/datasets/raw/coca-cola.csv new file mode 100644 index 0000000..2dfcffe --- /dev/null +++ b/datasets/raw/coca-cola.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,ko-2,20211231," ITEM 1. BUSINESS In this report, the terms The Coca-Cola Company, Company, we, us and our mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to the Company account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. We are guided by our purpose, which is to refresh the world and make a difference, and rooted in our strategy to drive net operating revenue growth and generate long-term value. Our vision for growth has three connected pillars: Loved Brands. We craft meaningful brands and a choice of drinks that people love and that refresh them in body and spirit. Done Sustainably. We use our leadership to be part of the solution to achieve positive change in the world and to build a more sustainable future for our planet. For A Better Shared Future. We invest to improve peoples lives, from our employees to all those who touch our business system, to our investors, to the broad communities we call home. Effective January 1, 2021, we transformed our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace by building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We created new operating units, which are focused on regional and local execution. The operating units, which sit under four geographic operating segments, as discussed below, are highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units work closely with five global marketing category leadership teams to rapidly scale ideas while staying close to the consumer. The global marketing category leadership teams primarily focus on innovation as well as marketing efficiency and effectiveness. Our organizational structure also includes a center and a platform services organization, as discussed below. The Coca-Cola Company was incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Companys operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments: Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focusing on strategic initiatives, policy, governance and scaling global initiatives; and (2) a platform services organization supporting the operating units, global marketing category leadership teams and the center by providing efficient and scaled global services and capabilities including, but not limited to, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. For additional information about our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: concentrates means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes powders/minerals for purified water products; syrups means intermediate products in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); fountain syrups means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; Company Trademark Beverages means beverages bearing our trademarks and certain other beverages bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive an economic benefit; and Trademark Coca-Cola Beverages or Trademark Coca-Cola means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word Trademark together with the name of one of our other beverage products (such as Trademark Fanta, Trademark Sprite or Trademark Simply), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that Trademark Fanta includes Fanta Orange, Fanta Zero Orange, Fanta Zero Sugar, Fanta Apple, etc.; Trademark Sprite includes Sprite, Sprite Zero Sugar, etc.; and Trademark Simply includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa Limited (Costa). These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading Our Business General set forth in Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (Coca-Cola system), refer to the heading Operations Review Beverage Volume set forth in Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations of this report. We own and market numerous valuable beverage brands, including the following: sparkling soft drinks: Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, 1 Sprite and Thums Up; hydration, sports, coffee and tea: Aquarius, Ayataka, BODYARMOR, Ciel, Costa, doadan, Dasani, FUZE TEA, Georgia, glacau smartwater, glacau vitaminwater, Gold Peak, Ice Dew, I LOHAS, Powerade and Topo Chico; and nutrition, juice, dairy and plant-based beverages: AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy and Simply. 1 Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other beverage brands through licenses, joint ventures and strategic partnerships. For example, certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (Monster), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Our Company continually seeks to further optimize its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to the Company at a rate of 2.1 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 31.3 billion and 29.0 billion unit cases of our products in 2021 and 2020, respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume in both 2021 and 2020. Trademark Coca-Cola accounted for 47 percent of our worldwide unit case volume in both 2021 and 2020. In 2021, unit case volume in the United States represented 17 percent of the Companys worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 42 percent of U.S. unit case volume. Unit case volume outside the United States represented 83 percent of the Companys worldwide unit case volume in 2021. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2021 were as follows: Coca-Cola FEMSA, S.A.B. de C.V. (Coca-Cola FEMSA), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (a major part of the states of So Paulo and Minas Gerais, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois and part of the state of Rio de Janeiro), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola Europacific Partners plc (CCEP), which has bottling and distribution operations in Andorra, Australia, Belgium, Fiji, continental France, Germany, Great Britain, Iceland, Indonesia, Luxembourg, Monaco, the Netherlands, New Zealand, Norway, Papua New Guinea, Portugal, Samoa, Spain and Sweden; Coca-Cola HBC AG (Coca-Cola Hellenic), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan and territories in 13 states in the western United States. In 2021, these five bottling partners combined represented 41 percent of our total worldwide unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottlers Agreements We have separate contracts, to which we generally refer as bottlers agreements, with our bottling partners under which our bottling partners are granted certain authorizations by us. Subject to specified terms and conditions and certain variations, the bottlers agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers. However, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottlers agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Companys ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. However, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model in most markets. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrates are sold, and package mix. As further discussed below, our bottlers agreements for territories outside the United States differ in some respects from our bottlers agreements for territories within the United States. Bottlers Agreements Outside the United States Bottlers agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottlers agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottlers agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottlers Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a Comprehensive Beverage Agreement (CBA) that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottlers agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. In all instances, the bottlers agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers have been granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage brands (as defined by the CBAs). We refer to these bottlers as expanding participating bottlers or EPBs. EPBs operate under CBAs (EPB CBAs) under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. Each EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company has also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights, which we refer to as participating bottlers, converted their legacy bottlers agreements to CBAs, to which we refer as participating bottler CBAs, each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottlers agreements that include pricing formulas that generally provide for a baseline price for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume prepared, packaged, sold and distributed under these legacy bottlers agreements is not material. Under the terms of the bottlers agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups, or deliver them on our behalf, to restaurants and other retailers. Promotional and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottlers agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing support and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers and other customers of our Companys products, principally for participation in promotional and marketing programs, was $4.7 billion in 2021. Investments in Bottling Operations Most of our branded beverage products are prepared, packaged, distributed and sold by independent bottling partners. However, from time to time we acquire or take control of a bottling operation, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning a bottling operation enables us to compensate for limited local resources; help focus the bottlers sales and marketing programs; assist in the development of the bottlers business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a consolidated bottling operation, typically by selling all or a portion of our interest in the bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell a consolidated bottling operation to an independent bottling partner in which we have an equity method investment, our Company continues to participate in the bottlers results of operations through our share of the equity method investees earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola systems production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Companys concentrate operations. When our equity investment provides us with the ability to exercise significant influence over the investee bottlers operating and financial policies, we account for the investment under the equity method. Seasonality Sales of our ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The commercial beverage industry is highly competitive and consists of numerous companies, ranging from small or emerging to very large and well established. These include companies that, like our Company, compete globally in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; water products, including flavored and enhanced waters; juices, juice drinks and nectars; dilutables (including syrups and powders); coffees; teas; energy drinks; sports drinks; milk and other dairy-based drinks; plant-based beverages; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive products are sold to consumers in both ready-to-drink and non-ready-to-drink form. The Company has directly entered the alcohol beverage segment in numerous markets outside the United States. In the United States, the Company has authorized alcohol-licensed third parties to use certain of our brands on alcohol beverages. Competitive products include all flavored alcohol beverages of varying alcohol bases. In many of the countries in which we do business, PepsiCo, Inc. is a primary competitor. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Danone S.A., Suntory Beverage Food Limited, Unilever, AB InBev, Kirin Holdings, Heineken N.V., Diageo and Red Bull GmbH. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing microbrands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private-label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, digital marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging as well as new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.), and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer recognition and loyalty; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated employees. Our competitive challenges include strong competitors in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers own store or private-label beverage brands; new industry entrants; and dramatic shifts in consumer shopping methods and patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (HFCS), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers requirements with the assistance of Coca-Cola Bottlers Sales Services Company LLC (CCBSS). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our North American operations and to our U.S. bottling partners for the purchase of various goods and services, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Companys standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions that can impact the quality and supply of orange juice and orange juice concentrate. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. We generate most of our coffee revenues through Costa. Costa purchases Rainforest Alliance Certified green coffee through multiple suppliers. While most of Costas coffee is sourced as readily available bulked commercial grade from Brazil, Vietnam and Colombia, many of Costas suppliers have vertically integrated supply chains with direct access to yields from cooperatives and producer groups. Our consolidated bottling operations and our non-bottling finished product operations also purchase various other raw materials including, but not limited to, polyethylene terephthalate (PET) resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and beverage gases, including carbon dioxide and liquid nitrogen. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as technology. This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulas are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottlers agreements, we authorize our bottlers to use applicable Company trademarks in connection with their preparation, packaging, distribution and sale of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Companys products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under the Safe Drinking Water and Toxic Enforcement Act of 1986 (Proposition 65) of the state of California, if the state has determined that a substance causes cancer or harms human reproduction or development, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a safe harbor threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. However, the state of California and other parties have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer, among other beverage containers, nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at federal, state and local levels, both in the United States and elsewhere around the world. All of our Companys facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance will have, any material adverse effect on our Companys capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (GDPR) as well as the California Consumer Privacy Act of 2018 (CCPA), which became effective on January 1, 2020, and its extension, the California Privacy Rights Act (CPRA), which will take effect on January 1, 2023. The interpretation and application of data privacy, cross-border data transfers and data protection laws and regulations are often uncertain and are evolving in the United States and internationally, such as in the European Union, China and other jurisdictions. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Globally, we see a growing trend toward data protection laws and regulations increasing in complexity and number, and we anticipate that our obligations will expand commensurately. Human Capital Management Our people and culture agendas are critical business priorities. Our Board of Directors, through the Talent and Compensation Committee, provides oversight of the Companys policies and strategies relating to talent, leadership and culture, including diversity, equity and inclusion, as well as the Companys compensation philosophy and programs. The Talent and Compensation Committee also evaluates and approves the Companys compensation plans, policies and programs applicable to our senior executives. In addition, the Committee on Directors and Corporate Governance of the Board of Directors oversees succession planning and talent development for our senior executives. Employees We believe people are our most important asset, and we strive to attract and retain high-performing talent. As of December 31, 2021 and 2020, our Company had approximately 79,000 and 80,300 employees, respectively, of which approximately 9,400 and 9,300, respectively, were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2021, approximately 700 employees in North America were covered by collective bargaining agreements. These agreements typically have terms of three to five years. We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. Diversity, Equity and Inclusion We believe that a diverse, equitable and inclusive workplace that mirrors the markets we serve is a strategic business priority and critical to the Companys success. We take a comprehensive view of diversity, equity and inclusion across different races, ethnicities, tribes, religions, socioeconomic backgrounds, generations, abilities, and expressions of gender and sexual identity. As of December 31, 2021, we had approximately 8,400 employees located in the United States, excluding the employees of the Global Ventures operating segment, fairlife, LLC and BA Sports Nutrition, LLC. Of these employees, 39 percent and 46 percent were female and people of color, respectively. We are focused on social justice issues, including racial and gender equity, both in the United States and around the world. In 2021, we announced our 2030 aspirations to be 50 percent led by women globally, and in the United States, to reflect the U.S. Census racial and ethnic representation at all job grade levels. Each of our operating units outside the United States has developed locally relevant diversity, equity and inclusion aspirations. Diversity and inclusion metrics, which highlight progress and help drive accountability, are shared with our senior leaders on a quarterly basis. Our Global Womens Leadership Council, composed of eight executives, focuses on accelerating the development and promotion of women into roles of increasing responsibility and influence. We conduct annual pay equity analyses, with regard to gender globally and race/ethnicity in the United States, to help ensure our base pay structures are fair and to identify and address potential issues or disparities. We make adjustments to base pay, where appropriate. Also, as permitted by local law, during the annual rewards cycle, we perform an adverse impact analysis on base pay, annual incentives and long-term incentives to help ensure fairness. We support many employee-led inclusion networks, which are an integral part of our diversity, equity and inclusion strategy. Our inclusion networks are regionally structured in order to meet relevant local needs, and they provide employees with the opportunity to engage with colleagues globally based on common interests or backgrounds. Compensation and Benefits Through comprehensive and competitive compensation and benefits, ongoing employee learning and development, and a focus on health and well-being, we strive to support our employees in all aspects of their lives. Our compensation programs are designed to reinforce our growth agenda and our talent strategy as well as to drive a strong connection between the contributions of our employees and their pay. We believe the structure of our compensation packages provides the appropriate incentives to attract, retain and motivate our employees. We provide base pay that is competitive and that aligns with employee positions, skill levels, experience and geographic location. In addition to base pay, we seek to reward employees with annual incentive awards, recognition programs, and equity awards for employees at certain job levels. We also offer competitive employee benefits packages, which vary by country and region. These employee benefits packages may include: 401(k) plan, pension plan, core and supplemental life insurance, financial courses and advisors, employee assistance programs, tuition assistance, commuter assistance, adoption assistance, medical and dental insurance, vision insurance, health savings accounts, health reimbursement and flexible spending accounts, well-being rewards programs, vacation pay, holiday pay, and parental and adoption leave . Culture and Engagement As our employees work together to achieve our purpose to Refresh the World and Make a Difference, they collectively build and reinforce our culture. Our culture is rooted in our growth mindset, which expects each employee, leader and function to be curious, empowered, inclusive and agile. We use a variety of practices to measure and support progress against these growth behaviors and to ensure that our employees are engaged and fulfilled at work. For example, our Performance Enablement and Culture Engagement Pulse platforms provide regular opportunities for employees across the organization to provide feedback on how their leaders, teammates and work experiences support the growth behaviors. Data from questionnaires are anonymized and plotted against historical results to inform teams and functions on areas of strength and opportunities for improvement. We also encourage regular, live communication across the organization and host quarterly global town halls with our senior leadership that include employee question-and-answer sessions. In addition, function-level town halls are held on a regular basis. Leadership, Training and Development We focus on investing in inspirational leadership, learning opportunities and capabilities to equip our global workforce with the skills they need while improving engagement and retention. We provide a range of formal and informal learning programs, which are designed to help our employees continuously grow and strengthen their skills throughout their careers. We offer a variety of programs that contribute to our leadership, training and development goals, including: Coca-Cola University, a robust catalog of digital content, including courseware from Harvard, eCornell, and LinkedIn Learning; Opportunity Marketplace, a people-centered technology solution that helps connect project opportunities to interested employees who have the capacity, skills and interest in short-term experiences and assignments; and comprehensive enterprise-wide coaching and mentoring programs that support leadership and employee development. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Companys website is not incorporated by reference in this report. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (SEC) in accordance with the Securities Exchange Act of 1934, as amended (Exchange Act). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the Investors page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the Investors page of our website and review the information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition and results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. RISKS RELATED TO OUR OPERATIONS The COVID-19 pandemic and related ongoing impacts may have a material adverse effect on our results of operations, financial condition and cash flows. The COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus have negatively impacted, and could continue to negatively impact, our business globally. Our recovery has been asynchronous and the full extent to which theCOVID-19 pandemic will affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted, including, among others, new information which may emerge concerning the pandemic, vaccine adoption rates (including boosters) and the effectiveness of vaccines in limiting or stopping the spread of COVID-19, either over the long term or against new, emerging variants of COVID-19, and any related actions by governments. The extent and nature of government actions related to the COVID-19 pandemic varied throughout 2020 and 2021 based upon the then-current extent and severity of the COVID-19 pandemic within the respective markets. At times we experienced a decrease in sales of certain of our products in markets around the world, including consumer demand shifting to more at-home consumption versus away-from-home consumption. While in 2021 we have experienced improved trends in away-from-home channels and improved margins, if COVID-19 infection rates increase, the pandemic intensifies or expands geographically, or continued efforts to curb the pandemic are ineffective, the negative impacts of the pandemic on our sales could be more prolonged and may become more severe than we are currently experiencing. In addition, continuing economic and political uncertainties, such as increased unemployment, decreases in disposable income, declines in consumer confidence, or economic slowdowns or recessions in any of our major markets, may slow down or prevent the recovery of the demand for our products or may erode such demand. The COVID-19 pandemic has disrupted and could continue to disrupt our global supply chain . We and our bottling partners have experienced temporary disruptions in certain of our operations; delays in delivery of concentrates, ingredients, packaging and equipment; temporary plant closures; production slowdowns; and difficulty or delays in sourcing key ingredients and beverage containers. We and our bottling partners may face similar disruptions in the future, which may increase supply chain and packaging costs, or may result in an inability to secure key ingredients and inputs, which could cause delays in delivering our products to our customers and consumers. Although we are unable to predict the impact on our ability to source materials in the future, we expect supply chain pressures to continue into 2022. In addition to the above risks, the COVID-19 pandemic may exacerbate other risks related to our business, including risks related to changes in the retail landscape or the loss of key retail or foodservice customers; fluctuations in input costs, inflation rates, and foreign currency exchange rates; and the ability of third-party service providers and business partners to fulfill their respective commitments and responsibilities to us in a timely manner and in accordance with the agreed-upon terms. The continuing evolution of the pandemic may also present risks not currently known to us. Increased competition could hurt our business. We operate in the highly competitive commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading Competition set forth in Part I, Item 1. Business of this report. Our ability to maintain or gain share of sales in the global market or in local markets may be limited as a result of actions by competitors. Competitive pressures may cause the Company and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers ability to increase prices, as may be necessary in response to commodity and other cost increases. Such pressures may also increase marketing costs along with in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain consumer interest, brand loyalty and market share while we selectively expand into other profitable categories in the commercial beverage industry, our business could be negatively affected. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial results. Our industry is being affected by the trend toward consolidation in, and the blurring of the lines between, retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private-label brands, any of which could negatively affect the Coca-Cola systems profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we and our bottling partners build e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumer demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. If we do not successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. Consequently, we continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Companys and the Coca-Cola systems ability to attract, hire, develop, motivate and retain a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Companys purpose and work that matters most. Competition and compensation expectations for existing and prospective personnel have increased. In addition, the broader labor market is experiencing a shortage of qualified workers which has further increased the competition we face for qualified employees. We may not be able to successfully compete for, attract or retain the highly skilled and diverse workforce that we want and that our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled employees due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Failure to attract, hire, develop, motivate and retain highly skilled and diverse talent; to meet our goals related to fostering an inclusive and diverse culture, including increasing the number of underrepresented employees in the United States to develop and implement an adequate succession plan for our management team; to maintain a corporate culture that fosters innovation, collaboration and inclusion; or to design and successfully implement flexible work models that meet the expectations of employees and prospective employees could disrupt our operations and adversely affect our business and our future success. Increases in the cost, disruption of supply or shortages of energy or fuel could affect our profitability. Our consolidated bottling operations operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our production plants and the bottling plants and distribution facilities operated by our consolidated bottling operations. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries where we have production plants, or in markets where our consolidated bottling operations operate, which may be caused by increasing demand, by events such as natural disasters, power outages and extreme weather, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners operating costs and thus could indirectly negatively impact our results of operations. Increases in the cost, disruption of supply or shortages of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as coffee, orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading Raw Materials set forth in Part I, Item 1. Business of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions, governmental actions, climate change and other factors beyond our control, including the COVID-19 pandemic. Substantial increases in the prices of our or our bottling partners ingredients, other raw materials, packaging materials, aluminum cans and other containers, to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce our or our bottling partners sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are only available from one source. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredients that are available from a limited number of suppliers or from only one source. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS. The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply and quality of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. We may not be able to increase prices to fully offset inflationary pressures on various costs, such as our costs for materials and labor, which may adversely impact our financial condition or results of operations. In connection with our manufacturing and bottling operations, we are dependent upon, among other things, raw materials, packaging materials, plant labor and transportation providers. In 2021 and the early part of 2022, the costs of raw materials, packaging materials, labor, energy, fuel, transportation and other inputs necessary for the production and distribution of our products have rapidly increased. In addition, many of these items are subject to price fluctuations from a number of factors, including, but not limited to, market conditions, geopolitical developments, demand for raw materials, weather, growing and harvesting conditions, climate change, energy costs, currency fluctuations, supplier capacities, governmental actions, import and export requirements (including tariffs), and other factors beyond our control. We expect the inflationary pressures on input and other costs to continue to impact our business in 2022. Our attempts to offset these cost pressures, such as through price increases of some of our products, may not be successful. Higher product prices may result in reductions in sales volume. Consumers may be less willing to pay a price differential for our branded products and may increasingly purchase lower-priced offerings, or may forgo some purchases altogether. To the extent that price increases are not sufficient to offset higher costs adequately or in a timely manner, and/or if they result in significant decreases in sales volume, our financial condition or results of operations may be adversely affected. Furthermore, we may not be able to offset cost increases through productivity initiatives or through our commodity hedging activity. If we do not successfully integrate and manage our acquired businesses, brands or bottling operations, our financial results could suffer. We routinely evaluate opportunities to acquire businesses or brands to expand our beverage portfolio and capabilities. Additionally, from time to time, we have acquired or taken control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. We may incur unforeseen liabilities and obligations in connection with acquiring businesses, brands or bottling operations. The expected benefits of business or brand acquisitions, including cost and growth synergies associated with such acquisitions, may take longer to realize than expected or may not be realized at all. Moreover, we may encounter challenges to successfully integrating the operations, technologies, services, products and systems of any acquired businesses in an effective, timely and cost-efficient manner. We may also encounter unexpected difficulties, costs or delays in restructuring and integrating acquired businesses, brands or bottling operations into our Companys operating and internal control structures, including extending our Companys internal control over financial reporting to newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our quality management program, which is designed to ensure product quality and safety, may not be sufficiently robust to effectively manage the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing various supply chain models as we expand our product offerings. Our financial performance is impacted by how well we can integrate and manage acquired businesses, brands and bottling operations, and we may not be able to achieve our strategic and financial objectives for acquired businesses, brands or bottling operations. If we incur unforeseen liabilities or costs in connection with acquiring or integrating businesses, brands or bottling operations, experience internal control or product quality failures, or are unable to achieve our strategic and financial objectives for acquired businesses, brands or bottling operations, our consolidated results could be negatively affected. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed-upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. If we are unable to renew collective bargaining agreements on satisfactory terms, or if we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our employees at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with employees and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our employees. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations or our major bottlers plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Companys overall reputation and brand image, which in turn could have a negative impact on our products acceptance by consumers. RISKS RELATED TO CONSUMER DEMAND FOR OUR PRODUCTS Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental, social and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained in, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners periodically have not met, and may not always meet, these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as synthetic colors, non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (4-MEI), a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-flavored beverages; or substances used in packaging materials, such as bisphenol A (BPA), an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans, may affect consumers preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our efforts to digitize the Coca-Cola system, our financial results could be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the Coca-Cola systems retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up the brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights have not always had, and may not in the future always have, the desired impact on our products brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or spurious products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives have engaged, and may in the future engage, in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates have been, and could in the future be, the subject of backlash from advocacy groups or others that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships have subjected us in the past, and could subject us in the future, to negative publicity as a result of actual or alleged misconduct by individuals, hosts or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, have in the past, and could in the future, generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, the Guiding Principles on Business and Human Rights, endorsed by the United Nations Human Rights Council, outline how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations Protect, Respect and Remedy framework on human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Companys overall reputation and brand image, which in turn could have a negative impact on our products acceptance by consumers. In addition, if we fail to protect our employees and our supply chain employees human rights, or inadvertently discriminate against any group of employees or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Unfavorable general economic and political conditions could negatively impact our financial results. Many of the jurisdictions in which our products are sold have experienced and could continue to experience unfavorable general economic conditions, such as a recession or economic slowdown, which could negatively affect the affordability of, and consumer demand for, our beverages. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private-label brands, which could reduce our profitability and could negatively affect our overall financial performance. Other financial uncertainties in our major markets and unstable political conditions in certain markets, including civil unrest and governmental changes, could undermine global consumer confidence and reduce consumers purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. If we are unable to successfully manage new product launches, our business and financial results could be adversely affected. Due to the highly competitive nature of the commercial beverage industry, the Company continually introduces new products and evolves existing products to stimulate consumer demand. For instance, the Company has directly entered the ready-to-drink alcohol beverages segment in numerous markets outside the United States, and in the United States, the Company has authorized alcohol-licensed third parties to use certain of its brands on ready-to-drink alcohol beverages. The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance. Such endeavors may also involve significant risks and uncertainties, including greater execution risks, higher costs, distraction of management from current operations, inadequate return on investments, increased competitive pressures, exposure to additional regulations and reliance on the performance of third parties. If we become subject to additional government regulations, including alcohol regulations related to licensing, trade and pricing practices, labeling, advertising, promotion and marketing practices, and relationships with distributors, we may become exposed to the risk of increased compliance costs and disruption to our core business. RISKS RELATED TO THE COCA-COLA SYSTEM We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, some of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to maintain operating and strategic alignment or agree on appropriate pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their resources to business opportunities or products other than those of the Company. Such actions could, in the long term, have an adverse effect on our profitability. If our bottling partners financial condition deteriorates, our business and financial results could be affected. In the vast majority of our markets, our products are sold and distributed by independent bottling partners, and we therefore derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners. Accordingly, the success of our business depends in part on our bottling partners financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners income or loss. Our bottling partners financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions; the availability of capital and other financing resources on reasonable terms; loss of major customers; changes in or additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our equity method investee bottling partners, it could also result in a decrease in our equity income and/or impairments of our equity method investments. We may from time to time engage in refranchising activities or divestitures of certain brands or businesses, which could adversely affect our business and results of operations. As part of our strategic initiative to focus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise our consolidated bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on terms and conditions favorable to us, or if our refranchising partners are not efficient or not aligned with our long-term vision for the Coca-Cola system, our business and results of operations could be adversely affected. Additionally, we have divested and may in the future divest certain brands or businesses. These divestitures may adversely impact our business, results of operations, cash flows and financial condition if we are unable to offset impacts from the loss of revenue associated with the divested brands or businesses, or if we are otherwise unable to achieve the anticipated benefits or cost savings from such divestitures. RISKS RELATED TO REGULATORY AND LEGAL MATTERS Increases in income tax rates, changes in income tax laws, regulations or unfavorable resolutions of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates in the jurisdictions in which we operate, tax treaties between such jurisdictions, and the geographic mix of our income before income taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix or foreign exchange rates could reduce our net income. Tax laws and regulations, including rates of taxation, are subject to revision by individual taxing jurisdictions which may result from multilateral agreements. Many jurisdictions have enacted legislation and adopted policies resulting from the Organization for Economic Co-operation and Developments (OECD) anti-Base Erosion and Profit Shifting project. The OECD is currently coordinating a project on behalf of the G20 and other participating countries which would grant additional taxing rights over profits earned by multinational enterprises to the countries in which their products are sold and services rendered. A second pillar would establish a global per-country minimum tax of 15 percent. It is possible that the adoption of these or other proposals could have a material impact on our net income and cash flows. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions, estimates and accruals. The results of audits or related disputes could have a material adverse effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (IRS) is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. The Company firmly believes that the IRS claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. On November 18, 2020, the U.S. Tax Court (Tax Court) issued an opinion (Opinion) predominantly siding with the IRS. Although the Company disagrees with the unfavorable portions of the Opinion and intends to vigorously defend its position, considering all avenues of appeal, there is no assurance that the courts will ultimately rule in the Companys favor. It is therefore possible that all or some of the unfavorable portions of the Opinion could ultimately be upheld. In that event, the Company would be subject to significant additional liabilities for the years at issue and potentially also for the subsequent years if the unfavorable portions of the Opinion were to be applied to the foreign licensees covered within the scope of the Opinion. Moreover, the IRS could successfully appeal the portions of the Opinion that are favorable to the Company and/or assert new claims for additional tax relating to the subsequent years by broadening the scope to cover additional foreign licensees. These adjustments could have a material adverse impact on the Companys financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or thereafter, may also have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (Tax Reform Act). For additional information regarding the tax litigation, refer to the heading Legal Proceedings set forth in Part I, Item 3. Legal Proceedings of this report. Increased or new indirect taxes could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as indirect taxes, including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers offer, among other beverage containers, nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, recycling content, tethered bottle caps, ecotax and/or product stewardship, or even prohibitions on certain types of plastic products, packages and cups, have been introduced and/or adopted in various jurisdictions, and we anticipate that similar legislation or regulations may be proposed in the future at federal, state and local levels, both in the United States and elsewhere. Consumers increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions have adopted and may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction or development, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading Governmental Regulation set forth in Part I, Item 1. Business of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, those arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our employees and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our employees and agents with all applicable legal requirements. Improper conduct by our employees or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulas and other intellectual property rights could harm our business. Our trademarks, formulas and other intellectual property rights (refer to the heading Patents, Copyrights, Trade Secrets and Trademarks in Part I, Item 1. Business of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading Governmental Regulation set forth in Part I, Item 1. Business of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change; to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns; or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with various laws and regulations, such as U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and the Office of Foreign Assets Control trade sanction regulations and anti-boycott regulations, antitrust and competition laws, anti-modern slavery laws, anti-bribery and anti-corruption laws, data privacy laws, including the European Union General Data Protection Regulation, tax laws and regulations and a variety of other applicable local, national and multinational regulations and laws could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners facilities, as well as damage to our or our bottling partners image and reputation, all of which could harm our or our bottling partners profitability. RISKS RELATED TO FINANCE, ACCOUNTING AND INVESTMENTS Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using many currencies other than the U.S. dollar. In 2021, we used 70 functional currencies in addition to the U.S. dollar and derived $25.6 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. Because of the geographic diversity of our operations, weakness in some currencies may be offset by strength in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. On December 31, 2021, the United Kingdoms Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (LIBOR), ceased to publish certain LIBOR reference rates. However, other LIBOR reference rates, including U.S. dollar overnight, 1-month, 3-month, 6-month and 12-month maturities, will continue to be published through June 2023. In preparation for the discontinuation of LIBOR, we have amended, or will amend, our LIBOR-referencing agreements to either reference the Secured Overnight Financing Rate or include mechanics for selecting an alternative rate, but it is possible that these changes may have an adverse impact on our financing costs as compared to LIBOR in the long term. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners financial performance; changes in the credit rating agencies methodology in assessing our credit strength; the credit agencies perception of the impact of credit market conditions on our or our major bottling partners current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners interest expense could increase, which would reduce our equity income. If we are unable to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives are based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterpartys liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial results could be adversely affected. We have a long-term strategic relationship in the global energy drink category with Monster. If we are unable to successfully manage our relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. RISKS RELATED TO INFORMATION TECHNOLOGY AND DATA PRIVACY If we are unable to protect our information systems against service interruption, misappropriation of data or cybersecurity incidents, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (information systems), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company employees and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Companys operating activities, our business may be impacted by system shutdowns, service disruptions or cybersecurity incidents. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by hackers, criminal groups or nation-state organizations (which may include social engineering, business email compromise, cyber extortion, denial of service, or attempts to exploit vulnerabilities), geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated personal data. If our information systems or third-party information systems on which we rely suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrates or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data protection laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands, and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight, including governmental investigations, enforcement actions and regulatory fines. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems. These risks also may be present to the extent any of our bottling partners, distributors, joint venture partners or suppliers using separate information systems, not integrated with the information systems of the Company, suffers a cybersecurity incident and could result in increased costs related to involvement in investigations or notifications conducted by these third parties. These risks may also be present to the extent a business we have acquired, but which does not use our information systems, experiences a system shutdown, service disruption, or cybersecurity incident. Like most major corporations, the Companys information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners, suppliers or acquired businesses that use separate information systems, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date, as well as those reported to us by our third-party partners, have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies and training. Data protection laws and regulations around the world often require reasonable, appropriate or adequate technical and organizational security measures, and the interpretation and application of those laws and regulations are often uncertain and evolving; there can be no assurance that our security measures will be deemed adequate, appropriate or reasonable by a regulator or court. Moreover, even security measures that are deemed appropriate, reasonable or in accordance with applicable legal requirements may not be able to protect the information we maintain. In addition to potential fines, we could be subject to mandatory corrective action due to a cybersecurity incident, which could adversely affect our business operations and result in substantial costs for years to come. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks, as well as the Companys plans and strategies to address them, are regularly presented to senior management and the Audit Committee of the Board of Directors. While we have purchased cybersecurity insurance, there are no assurances that the coverage would be adequate in relation to any incurred losses. Moreover, as cyberattacks increase in frequency and magnitude, we may be unable to obtain cybersecurity insurance in amounts and on terms we view as appropriate for our operations. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (personal data), primarily employees, former employees and consumers with whom we interact. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. These laws impose operational requirements for companies receiving or processing personal data, and many provide for significant penalties for noncompliance. Some laws and regulations also impose obligations regarding cross-border data transfers of personal data. These requirements with respect to personal data have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and information security systems, policies, procedures and practices. In addition, some countries are considering or have enacted data localization laws requiring that certain data in their country be maintained, stored and/or processed in their country. Maintaining local data centers in individual countries could increase our operating costs significantly. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data by us or the third-party service providers and vendors whose technology, systems and services we use in connection with the receipt, storage and transmission of personal data. Unauthorized access to or improper disclosure of personal data in violation of personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to regulatory enforcement actions (including penalties, fines and investigations), and result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. We have incurred, and will continue to incur, expenses to comply with privacy and data protection standards and protocols imposed by law, regulation, industry standards and contractual obligations. Increased regulation of data collection, use, and retention practices, including self-regulation and industry standards, changes in existing laws and regulations, enactment of new laws and regulations, increased enforcement activity, and changes in interpretation of laws, could increase our cost of compliance and operation, limit our ability to grow our business or otherwise harm our business. RISKS RELATED TO ENVIRONMENTAL AND SOCIAL FACTORS Our ability to achieve our environmental, social and governance goals are subject to risks, many of which are outside of our control, and our reputation and brands could be harmed if we fail to meet such goals. Companies across all industries are facing increasing scrutiny from stakeholders related to environmental, social and governance (ESG) matters, including practices and disclosures related to environmental stewardship; social responsibility; diversity, equity and inclusion; and workplace rights. Our ability to achieve our ESG goals and objectives and to accurately and transparently report our progress presents numerous operational, financial, legal and other risks, and are dependent on the actions of our bottling partners, suppliers and other third parties, all of which are outside of our control. If we are unable to meet our ESG goals or evolving stakeholder expectations and industry standards, or if we are perceived to have not responded appropriately to the growing concern for ESG issues, our reputation, and therefore our ability to sell products, could be negatively impacted. In addition, in recent years, investor advocacy groups and certain institutional investors have placed increasing importance on ESG matters. If, as a result of their assessment of our ESG practices, certain investors are unsatisfied with our actions or progress, they may reconsider their investment in our Company. As the nature, scope and complexity of ESG reporting, diligence and disclosure requirements expand, we may have to undertake additional costs to control, assess and report on ESG metrics. Any failure or perceived failure, whether or not valid, to pursue or fulfill our ESG goals, targets and objectives or to satisfy various ESG reporting standards within the timelines we announce, or at all, could increase the risk of litigation. Increasing concerns about the environmental impact of plastic bottles and other packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the accumulation of plastic bottles and other packaging materials in the environment, particularly in the worlds waterways, lakes and oceans, as well as inefficient use of resources when packaging materials are not included in a circular economy. We and our bottling partners sell certain of our beverage products in plastic bottles and use other packaging materials that, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola systems impact on the environment by increasing our use of recycled content in our packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; expanding our use of reusable packaging (including refillable or returnable glass and plastic bottles, as well as dispensed and fountain delivery models where consumers use refillable containers for our beverages); participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted, or are considering adopting, regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase in recycling rates and/or recycled content minimums, or, in some cases, restrict or even prohibit the use of certain plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us or our bottling partners to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Water scarcity and poor quality could negatively impact the Coca-Cola systems costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve and the ecosystems in which we operate. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability. Increased demand for food products and decreased agricultural productivity may negatively affect our business. As part of the manufacture of our beverage products, we and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products; decreased agricultural productivity in certain regions of the world as a result of changing weather patterns; increased agricultural regulations; and other factors have in the past, and may in the future, limit the availability and/or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola systems bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola systems carbon footprint by increasing our use of recycled packaging materials, expanding our renewable energy usage, and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industrywide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre complex in Atlanta, Georgia. The complex includes several office buildings which are used by Corporate employees and North America operating segment employees. In addition, the complex includes technical and engineering facilities along with a reception center. We own or lease additional facilities, real estate and office space throughout the world, which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our Costa retail stores, which are included in the Global Ventures operating segment, and facilities related to our consolidated bottling and distribution operations, which are included in the Bottling Investments operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2021: Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Facilities Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa 5 2 7 27 13 Latin America 5 2 3 North America 11 7 4 23 Asia Pacific 7 2 1 Global Ventures 1 2 8 1,587 Bottling Investments 82 3 105 99 Corporate 3 5 Total 32 93 7 116 166 1,600 Management believes that our Companys facilities used for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of our production facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in U.S. Federal Income Tax Dispute below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (Georgia Case), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (Aqua-Chem), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Companys filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (Wisconsin Case). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chems general and product liability claims arising from occurrences prior to the Companys sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chems asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chems losses up to policy limits. The courts judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (Chartis insurers) would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Companys interpretation of the courts judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial courts summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (Notice) from the IRS seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arms-length pricing of transactions between related parties such as the Companys U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arms-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (Closing Agreement). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Companys compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Companys matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS designation of the Companys matter for litigation, the Company was forced to either accept the IRS newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the Tax Court in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Companys case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Companys foreign licensees to increase the Companys U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors, and we reviewed and considered relevant laws, rules, and regulations, including, but not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Companys tax positions, that it is more likely than not the Companys tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (Tax Court Methodology), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Companys analysis. The Companys conclusion that it is more likely than not the Companys tax positions will ultimately be sustained on appeal is unchanged as of December 31, 2021. However, we updated our calculation of the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of the application of the required probability analysis to these updated calculations and the accrual of interest through the current reporting period, we updated our tax reserve as of December 31, 2021 to $ 400 million. While the Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for tax years 2007 through 2009, and potentially also for subsequent years, which could have a material adverse impact on the Companys financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology were to be ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2021 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 through 2021. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the 2017 Tax Cuts and Jobs Act. The Company estimates that the potential aggregate incremental tax and interest liability could be approximately $ 13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. We currently project the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2021, would result in an incremental annual tax liability that would increase the Companys effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Companys Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax years. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax years, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Companys common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is KO. While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 18, 2022, there were 191,391 shareowner accounts of record. This figure does not include a substantially greater number of street name holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading Equity Compensation Plan Information under the principal heading Compensation in the Companys definitive Proxy Statement for the 2022 Annual Meeting of Shareowners (Companys 2022 Proxy Statement), to be filed with the SEC, is incorporated herein by reference. During the year ended December 31, 2021, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2021 by the Company or any affiliated purchaser of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act: Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 October 2, 2021 through October 29, 2021 9,480 $ 54.48 161,029,667 October 30, 2021 through November 26, 2021 161,029,667 November 27, 2021 through December 31, 2021 106,605 53.64 161,029,667 Total 116,085 $ 53.71 1 The total number of shares purchased includes: (i) shares purchased, if any, pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (2012 Plan) for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (2019 Plan) for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Shareowner Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Shareowner Return Stock Price Plus Reinvested Dividends December 31, 2016 2017 2018 2019 2020 2021 The Coca-Cola Company $ 100 $ 114 $ 122 $ 147 $ 151 $ 168 Peer Group Index 100 111 90 112 121 139 SP 500 Index 100 122 116 153 181 233 The total shareowner return is based on a $100 investment on December 31, 2016 and assumes that dividends were reinvested on the day of issuance. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, ConAgra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., Freshpet Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrims Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2021, the Dow Jones Food Beverage Index and the Peer Group Index included Freshpet Inc., which was not included in the indices in 2020. Additionally, in 2021 these indices do not include Jefferies Financial Group Inc. and TreeHouse Foods, Inc., which were included in the indices in 2020. ITEM 6. INTENTIONALLY OMITTED "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto contained in Item 8. Financial Statements and Supplementary Data of this report. MDA includes the following sections: Our Business a general description of our business and its challenges and risks. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our consolidated results of operations for 2021 and 2020 and year-to-year comparisons between 2021 and 2020. An analysis of our consolidated results of operations for 2020 and 2019 and year-to-year comparisons between 2020 and 2019 can be found in MDA in Part II, Item 7 of the Companys Form 10-K for the year ended December 31, 2020. Liquidity, Capital Resources and Financial Position an analysis of cash flows, contractual obligations, foreign exchange, and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Companys consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to us account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa. These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 Concentrate operations 56 % 56 % Finished product operations 44 44 Total 100 % 100 % The following table sets forth the percentage of total worldwide unit case volume attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 Concentrate operations 83 % 82 % Finished product operations 17 18 Total 100 % 100 % We operate in the highly competitive commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climates, local and national laws and regulations, foreign currency fluctuations, fuel prices, weather patterns and the COVID-19 pandemic. Throughout 2021, the effects of the COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus continued to impact our business globally. In particular, the number of people contracting COVID-19 and the preventive measures taken to contain COVID-19, including the spread of new variants, negatively impacted our unit case volume and increased our costs to manufacture and distribute our products. Our price, product and geographic mix was also negatively impacted, primarily due to unfavorable channel and product mix as consumer demand shifted to more at-home consumption versus away-from-home consumption. However, the timing and number of people receiving vaccinations, the governmental actions to reopen certain economies around the world, and the substance and pace of the economic recovery favorably impacted our business when compared to 2020. While uncertainties caused by the COVID-19 pandemic remain, and factors such as the state of the supply chain, labor shortages and the inflationary environment are likely to impact the pace of the economic recovery, we expect to continue to see improvements in our business as we continue to learn and adapt to the ever-changing environment. The Companys priorities during the COVID-19 pandemic and related business disruptions are ensuring the health and safety of our employees; supporting and making a difference in the communities we serve; keeping our brands in supply; maintaining the quality and safety of our products; and serving our customers across all channels as they adapt to the shifting demands of consumers during the pandemic. Throughout the pandemic, business continuity and adapting to the needs of our customers have been critical. We have developed systemwide knowledge-sharing routines and processes, which include the management of any supply chain challenges. As of the date of this filing, while we have experienced some temporary supply chain disruptions, there has been no material impact, and we do not foresee a material impact, on our and our bottling partners ability to manufacture or distribute our products. Despite the pandemic, we are not losing sight of long-term opportunities for our business. The pandemic helped us realize we could be much bolder in our efforts to change. We identified the following key objectives to navigate the pandemic and position us to capture growth: winning more consumers; gaining market share; maintaining strong system economics; strengthening stakeholder impact; and equipping the organization to win. In order to deliver against these objectives, we focused on the following priorities: unlocking the potential of our portfolio of strong global, regional and scaled local brands; developing a robust innovation pipeline focusing on scalable initiatives; increasing consumer-centric marketing effectiveness and efficiency; winning in the marketplace with aligned data-driven revenue growth management and execution capabilities; and further embedding ESG goals into our operations. In August 2020, the Company announced strategic steps to transform our organizational structure to better enable us to capture growth in the fast-changing marketplace. The Company has transformed into a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information about our strategic realignment initiatives. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of our Company and the commercial beverage industry. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers lifestyles and dietary choices. Therefore, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Product Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more beverage choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating growth through our evolving portfolio of beverage brands and products (including numerous low- and no-calorie products), selectively expanding into other profitable categories of the commercial beverage industry, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to the planet. Evolving Competitive Landscape and Competing in the Digital Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce in many markets has led to dramatic shifts in consumer shopping habits and patterns. Consumers are rapidly embracing shopping via mobile device applications, e-commerce retailers and e-commerce websites or platforms, which presents new challenges to maintain the competitiveness and relevancy of our brands. As a result, we must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share. In addition, we are increasing our investments in e-commerce to support retail and meal delivery services, offering more package sizes that are fit-for-purpose for online sales, and shifting more consumer and trade promotions to digital. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to satisfy consumers evolving needs and preferences. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management program also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Environmental and Social Matters As investors and stakeholders increasingly focus on ESG issues, our Company and companies across all industries are facing challenges and risks related to, among other things, environmental stewardship; social responsibility; diversity, equity and inclusion; and workplace rights. Where these challenges and risks relate to our business, we acknowledge that we have a role to play in developing and implementing solutions related to these important challenges. We have established specific ESG goals related to water quality and scarcity; packaging materials used for our products; reduction of added sugar in our beverages; reduction of carbon dioxide and other greenhouse gas emissions; sustainable agriculture; diversity, equity and inclusion; and human and workplace rights. Our ability to achieve our ESG goals is dependent on many factors, including, but not limited to, our actions along with the actions of various stakeholders, such as our bottling partners, suppliers, governments, nongovernmental organizations, communities, and other third parties, all of which are outside of our control. See Item 1A. Risk Factors in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Companys Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Companys significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entitys voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which another entity holds a variable interest is referred to as a VIE. An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether the VIEs are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over the operating and financial policies of the investee. Our consolidated net income includes our Companys proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading Our Business Challenges and Risks above and Item 1A. Risk Factors in Part I of this report. As a result, management must make numerous assumptions, which involve a significant amount of judgment, when performing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The performance of recoverability and impairment tests of current and noncurrent assets involves critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, the impact of any supply chain disruptions, inflation, long-term growth rates, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers financial condition. These factors are even more difficult to estimate as a result of uncertainties associated with the scope, severity and duration of the global COVID-19 pandemic and any resurgences of the pandemic, including, but not limited to, the number of people contracting the virus; the impact of shelter-in-place and social distancing requirements; the impact of governmental actions across the globe to contain the virus; vaccine availability, rates of vaccination and effectiveness of vaccines against existing and new variants of the virus; governmental or other vaccine mandates and any associated business and supply chain disruptions; and the substance and pace of the economic recovery. The estimates we use when performing recoverability tests of assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using managements best assumptions, which we believe are consistent with those a market participant would use. The variability of these factors depends on a number of conditions, including uncertainties associated with the COVID-19 pandemic, and thus our accounting estimates may change from period to period. While uncertainties still exist, we expect to see continued improvements in our business as vaccines become more widely available, as vaccination rates increase, and as consumers return to many of their previous work routines as well as socializing and traveling. The Company has certain intangible and other long-lived assets that are more dependent on cash flows generated in the away-from-home channels and/or that generate cash flows in geographic areas that are more heavily impacted by the COVID-19 pandemic and are therefore more susceptible to impairment. In addition, intangible and other long-lived assets we acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions at the time of acquisition. If we had used other assumptions and estimates when tests of these assets were performed, impairment charges could have resulted. Furthermore, if management uses different assumptions in future periods, or if different conditions exist in future periods, impairment charges could result. The total future impairment charges we may be required to record could be material. Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion of recent acquisitions. Refer to Note 16 of Notes to Consolidated Financial Statements for the discussion of impairment charges. Refer to the heading Operations Review below for additional information related to our present business environment. As of December 31, 2021, the carrying value of our investment in Coca-Cola Bottlers Japan Holdings Inc. (CCBJHI) exceeded its fair value by $87 million, or 18 percent. Based on the length of time and the extent to which the fair value has been less than our carrying value and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge related to the investment. Our equity method investees also perform such recoverability and impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charge may be impacted by items such as basis differences, deferred taxes and deferred gains. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of accumulated other comprehensive income (loss), except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Companys investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, managements assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe a market participant would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Managements assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses and/or projected future losses. When such events or changes in circumstances are present and a recoverability test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, recoverability tests must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, impairment tests must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The performance of recoverability and impairment tests of intangible assets involves critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, the impact of any supply chain disruptions, inflation, long-term growth rates, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers financial condition. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when performing recoverability tests of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using managements best assumptions, which we believe are consistent with those a market participant would use. The estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions in future periods or if different conditions exist in future periods, impairment charges could result. Refer to the heading Operations Review below for additional information related to our present business environment. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, we are required to ensure that the assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Companys actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is generally one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are generally subdivided into smaller geographic regions. These geographic regions are our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting units fair value. However, the impairment charge recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management performs a recoverability test of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment tests of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees in the United States. In addition, our Company and its subsidiaries have various pension plans outside the United States. Management is required to make certain critical estimates related to the actuarial assumptions used to determine our net periodic pension cost or income and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. Our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost or income and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic pension cost or income by applying the specific spot rates along the yield curve to the plans projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our expected long-term rates of return on plan assets. Our investment objective for our pension assets is to ensure all funded pension plans have sufficient assets to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to seek to improve returns and manage risk. In 2021, the Companys total income related to defined benefit pension plans was $61 million, which included net periodic pension income of $180 million and net charges of $119 million related to settlements, curtailments and special termination benefits. In 2022, we expect our net periodic pension income to be approximately $188 million. The increase in 2022 expected net periodic pension income is primarily due to an increase in the weighted-average discount rate at December 31, 2021 compared to December 31, 2020, favorable asset performance in 2021 and a reduction in the number of plan participants arising from our strategic realignment initiatives, partially offset by a decrease in the expected weighted-average long-term rate of return on plan assets assumption. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $17 million decrease in our 2022 net periodic pension income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $26 million decrease in our 2022 net periodic pension income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2021, the Companys primary U.S. pension plan represented 61 percent and 57 percent of the Companys consolidated projected benefit obligation and pension plan assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrates are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained, but for a lesser amount; or (3) the tax position is more likely than not to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading Operations Review Income Taxes below and Note 14 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 11 of Notes to Consolidated Financial Statements. Tax laws require certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the book basis and tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Companys local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of a center and a platform services organization. For additional information regarding our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Companys operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands and their related operations or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Companys performance. Unit case volume growth is a metric used by management to evaluate the Companys performance because it measures demand for our products at the consumer level. The Companys unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading Beverage Volume below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of beverages, primarily measured in number of transactions (in all instances expressed in unit case equivalents), sold by the Company to customers or consumers. Refer to the heading Beverage Volume below. When we analyze our net operating revenues, we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading Net Operating Revenues below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we do not recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party, regardless of our ownership interest in the bottling partner, if any. We generally refer to acquisitions and divestitures of bottling operations as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Companys unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Companys acquisitions and divestitures. Acquired brands refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to an acquired brand are incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. Licensed brands refers to brands not owned by the Company but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to a licensed brand in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to a licensed brand are incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2021, the Company acquired the remaining ownership interest in BA Sports Nutrition, LLC (BodyArmor). The impact of this acquisition has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. In 2020, the Company discontinued our Odwalla juice business. The impact of discontinuing our Odwalla juice business has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, unit case means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings), with the exception of unit case equivalents for Costa non-ready-to-drink beverage products, which are primarily measured in number of transactions; and unit case volume means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers. Unit case volume consists primarily of beverage products bearing Company trademarks. Also included in unit case volume are certain brands licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive an economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an ownership interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of beverages, primarily measured in number of transactions (in all instances expressed in unit case equivalents), sold by the Company to customers or consumers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to these items, the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2021 versus 2020 Unit Cases 1,2 Concentrate Sales Worldwide 8 % 9 % Europe, Middle East Africa 9 % 12 % Latin America 6 6 North America 5 7 Asia Pacific 10 11 Global Ventures 17 20 Bottling Investments 11 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic and Global Ventures operating segment data reflect unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. Global Ventures operating segment data also reflects unit case volume growth for Costa retail stores. Unit Case Volume Sparkling soft drinks represented 69 percent of our worldwide unit case volume in both 2021 and 2020. Trademark CocaCola accounted for 47 percent of our worldwide unit case volume in both 2021 and 2020. In 2021, unit case volume in the United States represented 17 percent of the Companys worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 42 percent of U.S. unit case volume. Unit case volume outside the United States represented 83 percent of the Companys worldwide unit case volume in 2021. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. The Coca-Cola system sold 31.3 billion and 29.0 billion unit cases of our products in 2021 and 2020, respectively. The increase was primarily a result of the gradual recovery in away-from-home channels in many markets throughout 2021, along with the larger impact of shelter-in-place and social distancing requirements in 2020. Unit case volume in Europe, Middle East and Africa increased 9 percent, which included 9 percent growth in both Trademark Coca-Cola and sparkling flavors, 17 percent growth in nutrition, juice, dairy and plant-based beverages, and 6 percent growth in hydration, sports, coffee and tea. The operating segment reported growth in unit case volume of 7 percent in the Europe operating unit, 12 percent in the Eurasia and Middle East operating unit and 10 percent in the Africa operating unit. In Latin America, unit case volume increased 6 percent, which included 5 percent growth in Trademark Coca-Cola, 7 percent growth in hydration, sports, coffee and tea, 6 percent growth in sparkling flavors and 10 percent growth in nutrition, juice, dairy and plant-based beverages. The operating segments volume performance included 3 percent growth in Mexico, 14 percent growth in Argentina and 3 percent growth in Brazil. Unit case volume in North America increased 5 percent, which included 9 percent growth in sparkling flavors, 6 percent growth in hydration, sports, coffee and tea, 2 percent growth in Trademark Coca-Cola, and 7 percent growth in nutrition, juice, dairy and plant-based beverages. In Asia Pacific, unit case volume increased 10 percent, which included 11 percent growth in both Trademark Coca-Cola and sparkling flavors, 6 percent growth in hydration, sports, coffee and tea, and 18 percent growth in nutrition, juice, dairy and plant-based beverages. The operating segment reported growth in unit case volume of 11 percent in the Greater China and Mongolia operating unit, 33 percent in the India and Southwest Asia operating unit, 3 percent in the ASEAN and South Pacific operating unit and 2 percent in the Japan and South Korea operating unit. Unit case volume for Global Ventures increased 17 percent, driven by 16 percent growth in hydration, sports, coffee and tea, along with growth in energy drinks, partially offset by a decline of 3 percent in nutrition, juice, dairy and plant-based beverages. Unit case volume for Bottling Investments increased 11 percent, which primarily reflects growth in India, South Africa and the Philippines. Concentrate Sales Volume In 2021, worldwide concentrate sales volume increased 9 percent and unit case volume increased 8 percent compared to 2020. The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments and the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. The timing of concentrate shipments was primarily a result of certain bottlers building inventory due to concerns associated with potential supply chain disruptions. Net Operating Revenues Net operating revenues were $38,655 million in 2021, compared to $33,014 million in 2020, an increase of $5,641 million, or 17 percent. The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2021 versus 2020 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated 9 % 6 % 1 % % 17 % Europe, Middle East Africa 12 % 6 % 1 % % 19 % Latin America 6 12 18 North America 7 7 15 Asia Pacific 11 (2) 3 12 Global Ventures 20 13 7 41 Bottling Investments 11 2 2 15 Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in unit case equivalents) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes, if any. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only after considering the impact of structural changes, if any. Refer to the heading Beverage Volume above. 2 Includes structural changes, if any. Refer to the heading Structural Changes, Acquired Brands and Newly Licensed Brands above. Refer to the heading Beverage Volume above for additional information related to changes in our unit case and concentrate sales volumes. Price, product and geographic mix refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Companys net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) changes in the mix of products and packages sold; (3) changes in the mix of channels where products were sold; and (4) changes in the mix of geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Price, product and geographic m ix had a 6 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable channel and package mix, partially offset by unfavorable geographic mix; Latin America favorable pricing initiatives, inflationary pricing in Argentina, and favorable channel and package mix; North America favorable pricing initiatives and favorable channel and category mix; Asia Pacific unfavorable geographic mix, partially offset by favorable product and package mix; Global Ventures favorable channel mix primarily due to the reopening of Costa retail stores, partially offset by unfavorable product mix; and Bottling Investments favorable price, category and package mix, partially offset by unfavorable geographic mix. The favorable channel and package mix for the year ended December 31, 2021 in all applicable operating segments was primarily a result of the gradual recovery in away-from-home channels in many markets throughout 2021 and the larger impact of shelter-in-place and social distancing requirements in 2020. Foreign currency fluctuations increased our consolidated net operating revenues by 1 percent. This favorable impact was primarily due to a weaker U.S. dollar compared to certain foreign currencies, including the British pound sterling, South African rand, euro, Chinese yuan and Mexican peso, which had a favorable impact on our Europe, Middle East and Africa; Asia Pacific; Latin America; Global Ventures; and Bottling Investments operating segments. The favorable impact of a weaker U.S. dollar compared to the currencies listed above was partially offset by the impact of a stronger U.S. dollar compared to certain other foreign currencies, including the Argentine peso, Brazilian real, Turkish lira, Ethiopian birr and Japanese yen, which had an unfavorable impact on our Latin America; Europe, Middle East and Africa; Asia Pacific; and Bottling Investments operating segments. Refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. Acquisitions and divestitures generally refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or a divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Companys net operating revenues provides investors with useful information to enhance their understanding of the Companys net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Companys performance. Refer to the heading Structural Changes, Acquired Brands and Newly Licensed Brands above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. Based on current spot rates and our hedging coverage in place, we expect foreign currency fluctuations will have a negative impact on our full year 2022 net operating revenues. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, 2021 2020 Europe, Middle East Africa 17.0 % 16.8 % Latin America 10.7 10.6 North America 34.1 34.7 Asia Pacific 12.1 12.8 Global Ventures 7.3 6.0 Bottling Investments 18.6 19.0 Corporate 0.2 0.1 Total 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in some operating segments growing at a faster rate compared to other operating segments. For additional information about the impact of foreign currency fluctuations, refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Our gross profit margin increased to 60.3 percent in 2021 from 59.3 percent in 2020. This increase was primarily due to the impact of favorable pricing initiatives and favorable channel and package mix as well as the gradual recovery in away-from-home channels in many markets throughout 2021, partially offset by the impact of increased commodity and transportation costs. We expect commodity and transportation costs to continue to increase in 2022, and we will continue to proactively take actions in an effort to mitigate the impact of these incremental costs. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2021 2020 Selling and distribution expenses $ 2,574 $ 2,638 Advertising expenses 4,098 2,777 Stock-based compensation expense 337 126 Other operating expenses 5,135 4,190 Selling, general and administrative expenses $ 12,144 $ 9,731 Selling, general and administrative expenses increased $2,413 million, or 25 percent, in 2021. This increase was primarily due to higher annual incentive and stock-based compensation expense, increased charitable donations and increased marketing spending, which was reduced in 2020 as a result of uncertainties associated with the COVID-19 pandemic. The increase in annual incentive and stock-based compensation expense was primarily due to improved financial performance in 2021 and a more favorable outlook of our future financial performance, which resulted in higher payout assumptions as compared to 2020. In 2021, foreign currency exchange rate fluctuations increased selling, general and administrative expenses by 2 percent. The decrease in selling and distribution expenses was primarily due to the continued impact of the COVID-19 pandemic on away-from-home channels, partially offset by the impact of foreign currency exchange rate fluctuations. As of December 31, 2021, we had $335 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2021 2020 Europe, Middle East Africa $ 141 $ 73 Latin America 11 29 North America 39 379 Asia Pacific 12 31 Global Ventures 4 Bottling Investments 34 Corporate 643 303 Total $ 846 $ 853 In 2021, the Company recorded other operating charges of $846 million. These charges primarily consisted of $369 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition, $146 million related to the Companys strategic realignment initiatives, $119 million related to the BodyArmor acquisition, which includes various transition and transaction costs, distributor termination fees, employee retention costs and the amortization of noncompete agreements, and $115 million related to the Companys productivity and reinvestment program. In addition, other operating charges included an impairment charge of $78 million related to a trademark in Europe, which was driven by a change in the long-term outlook on the licensing arrangement for a certain brand, charges of $15 million related to tax litigation and a net charge of $4 million related to the restructuring of our manufacturing operations in the United States. In 2020, the Company recorded other operating charges of $853 million. These charges primarily consisted of $413 million related to the Companys strategic realignment initiatives and $99 million related to the Companys productivity and reinvestment program. In addition, other operating charges included impairment charges of $160 million related to the Odwalla trademark and charges of $33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $55 million related to a trademark in North America, which was driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Companys portfolio. In addition, other operating charges included $51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and $16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the BodyArmor and fairlife acquisitions. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Companys strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2021 2020 Europe, Middle East Africa 36.2 % 36.8 % Latin America 24.6 23.5 North America 32.3 27.5 Asia Pacific 22.6 23.7 Global Ventures 2.8 (1.4) Bottling Investments 4.6 3.4 Corporate (23.1) (13.5) Total 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Companys performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2021 2020 Consolidated 26.7 % 27.3 % Europe, Middle East Africa 56.9 59.9 Latin America 61.2 60.5 North America 25.3 21.5 Asia Pacific 49.7 50.6 Global Ventures 10.5 (6.2) Bottling Investments 6.6 4.9 Corporate * * * Calculation is not meaningful. Operating income was $10,308 million in 2021, compared to $8,997 million in 2020, an increase of $1,311 million, or 15 percent. The increase in operating income was primarily driven by concentrate sales volume growth of 9 percent, favorable channel and package mix, effective cost management and a favorable currency exchange rate impact, partially offset by higher annual incentive and stock-based compensation expense, increased charitable donations and increased marketing spending. In 2021, fluctuations in foreign currency exchange rates favorably impacted consolidated operating income by 2 percent due to a weaker U.S. dollar compared to certain foreign currencies, including the Mexican peso, Chinese yuan and British pound sterling, which had a favorable impact on our Latin America; Asia Pacific; Europe, Middle East and Africa; and Global Ventures operating segments. The favorable impact of a weaker U.S. dollar compared to the currencies listed above was partially offset by the impact of a stronger U.S. dollar compared to certain other foreign currencies, including the Argentine peso, Brazilian real, Turkish lira and Japanese yen, which had an unfavorable impact on our Latin America; Europe, Middle East and Africa; and Asia Pacific operating segments. Refer to the heading Liquidity, Capital Resources and Financial Position Foreign Exchange below. The Companys Europe, Middle East and Africa operating segment reported operating income of $3,735 million and $3,313 million for the years ended December 31, 2021 and 2020, respectively. The increase in operating income was primarily driven by a 12 percent increase in concentrate sales volume, favorable channel and package mix, and a favorable foreign currency exchange rate impact of 2 percent, partially offset by higher annual incentive expense, increased marketing spending and higher other operating charges. Latin America reported operating income of $2,534 million and $2,116 million for the years ended December 31, 2021 and 2020, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 6 percent, favorable pricing initiatives, favorable channel and package mix, and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Operating income for North America for the years ended December 31, 2021 and 2020 was $3,331 million and $2,471 million, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 7 percent, favorable pricing initiatives, favorable channel and category mix, effective cost management and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Asia Pacifics operating income for the years ended December 31, 2021 and 2020 was $2,325 million and $2,133 million, respectively. The increase in operating income was primarily driven by concentrate sales volume growth of 11 percent, a favorable foreign currency exchange rate impact of 4 percent and lower other operating charges, partially offset by higher annual incentive expense and increased marketing spending. Global Ventures operating income for the year ended December 31, 2021 was $293 million, while the operating segments operating loss for the year ended December 31, 2020 was $123 million. The change in operating income was primarily driven by revenue growth as a result of the reopening of Costa retail stores in the United Kingdom and a favorable foreign currency exchange rate impact of 6 percent. Bottling Investments operating income for the years ended December 31, 2021 and 2020 was $473 million and $308 million, respectively. The increase in operating income was primarily driven by volume growth of 11 percent, lower other operating charges and favorable price, category and package mix, partially offset by an unfavorable foreign currency exchange rate impact of 1 percent. Corporates operating loss for the years ended December 31, 2021 and 2020 was $2,383 million and $1,221 million, respectively. Operating loss in 2021 increased primarily as a result of higher annual incentive and stock-based compensation expense, increased marketing spending, increased charitable donations and higher other operating charges. Interest Income Interest income was $276 million in 2021, compared to $370 million in 2020, a decrease of $94 million, or 25 percent. This decrease was primarily driven by lower interest rates in certain of our international locations as well as lower investment balances. Interest Expense Interest expense was $1,597 million in 2021, compared to $1,437 million in 2020, an increase of $160 million, or 11 percent. This increase was primarily due to charges of $650 million in 2021 versus charges of $484 million in 2020 associated with the extinguishment of long-term debt. Refer to Note 10 of Notes to Consolidated Financial Statements. Equity Income (Loss) Net Equity income (loss) net represents our Companys proportionate share of net income or loss from each of our equity method investees. In 2021, equity income was $1,438 million, compared to equity income of $978 million in 2020, an increase of $460 million, or 47 percent. This increase reflects, among other items, the impact of more favorable operating results reported by most of our equity method investees in 2021, as results in 2020 were more negatively impacted by the COVID-19 pandemic, along with a favorable foreign currency exchange rate impact. In addition, the Company recorded net charges of $13 million and $216 million during the years ended December 31, 2021 and 2020, respectively, which represent the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost or income for pension and other postretirement benefit plans; other charges and credits related to pension and other postretirement benefit plans; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; other-than-temporary impairment charges; and net foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2021, other income (loss) net was income of $2,000 million. The Company recognized a gain of $834 million in conjunction with the BodyArmor acquisition, a net gain of $695 million related to the sale of our ownership interest in Coca-Cola Amatil Limited (CCA), an equity method investee, to CCEP, also an equity method investee, and a net gain of $114 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Additionally, the Company recognized a net gain of $467 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Additionally, other income (loss) net included income of $277 million related to the non-service cost components of net periodic benefit income and dividend income of $73 million. Other income (loss) net also included charges of $266 million related to the restructuring of our manufacturing operations in the United States, pension plan settlement charges of $117 million related to our strategic realignment initiatives and net foreign currency exchange losses of $61 million. In 2020, other income (loss) net was income of $841 million. The Company recognized a gain of $902 million in conjunction with the fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value, a net gain of $148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, and a net gain of $35 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee . These gains were partially offset by an other-than-temporary impairment charge of $252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $38 million related to one of our equity method investees in Latin America, an impairment charge of $26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $55 million related to economic hedging activities. The Company also recorded net charges of $25 million related to the restructuring of our manufacturing operations in the United States and charges of $14 million for pension and other postretirement benefit plan settlements and curtailments related to the Companys strategic realignment initiatives. Other income (loss) net also included income of $171 million related to the non-service cost components of net periodic benefit income, $72 million of dividend income and net foreign currency exchange losses of $64 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the sale of our ownership interest in CCA and the BodyArmor and fairlife acquisitions. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on our economic hedging activities. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the restructuring of our manufacturing operations in the United States and the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Companys strategic realignment initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Eswatini. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $381 million and $317 million for the years ended December 31, 2021 and 2020, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2021 2020 Statutory U.S. federal tax rate 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 2.3 1 0.9 3 Equity income or loss (2.0) (1.4) Excess tax benefits on stock-based compensation (0.5) (0.8) Other net (0.8) 2 (0.5) 4,5 Effective tax rate 21.1 % 20.3 % 1 Includes net tax charges of $375 million (or a 3.0 percent impact on our effective tax rate) related to changes in tax laws in certain foreign jurisdictions, amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other discrete items. 2 Includes a tax benefit of $14 million (or a 1.5 percent impact on our effective tax rate) associated with the $834 million gain recorded upon the acquisition of the remaining ownership interest in BodyArmor. Refer to Note 2 of Notes to Consolidated Financial Statements. 3 Includes net tax charges of $110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 4 Includes net tax expense of $431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 5 Includes a tax benefit of $40 million (or a 2.4 percent impact on our effective tax rate) associated with the $902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements. On November 18, 2020, the Tax Court issued the Opinion regarding the Companys 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11 of Notes to Consolidated Financial Statements. As of December 31, 2021, the gross amount of unrecognized tax benefits was $906 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $600 million, exclusive of any benefits related to interest and penalties. The remaining $306 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2021 2020 Balance of unrecognized tax benefits at beginning of year $ 915 $ 392 Increase related to prior period tax positions 9 528 Decrease related to prior period tax positions (50) (1) Increase related to current period tax positions 37 26 Decrease related to settlements with taxing authorities (4) (19) Effect of foreign currency translation (1) (11) Balance of unrecognized tax benefits at end of year $ 906 $ 915 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11 of Notes to Consolidated Financial Statements. The Company recognizes interest and penalties related to unrecognized tax benefits in the line item income taxes on our consolidated statement of income. The Company had $453 million and $391 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2021 and 2020, respectively. Of these amounts, expense of $62 million and $190 million was recognized in 2021 and 2020, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Companys effective tax rate. Based on current tax laws, the Companys effective tax rate in 2022 is expected to be approximately 20 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of the fundamental strengths of our business. Refer to the heading Cash Flows from Operating Activities below. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners equity. Refer to the heading Cash Flows from Financing Activities below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to continue to borrow funds at reasonable rates over the long term. Our debt financing also includes the use of a commercial paper program. We currently have the ability to borrow funds in this market at levels that are consistent with our debt financing strategy and expect to continue to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and, as a result of this review, during 2021 we issued U.S. dollar- and euro-denominated long-term notes of $6.0 billion and 3.2 billion, respectively, across various maturities. We used a portion of the proceeds from these issuances to extinguish certain tranches of our previously issued long-term debt. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information on these issuances and extinguishments. The Companys cash, cash equivalents, short-term investments and marketable securities totaled $12.6 billion as of December 31, 2021. In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $8.1 billion in unused backup lines of credit for general corporate purposes as of December 31, 2021. These backup lines of credit expire at various times from 2022 through 2027. While uncertainties caused by the COVID-19 pandemic remain, we expect to continue to see improvements in our business as vaccines become more widely available. The timing and availability of vaccines will be different around the world, and therefore we believe the pace of the recovery will vary by geography depending on vaccine availability, rates of vaccination and the effectiveness of vaccines against existing and new variants of the virus, along with other macroeconomic factors. We will remain flexible so that we can adjust to uncertainties resulting from the COVID-19 pandemic. Our current capital allocation priorities are as follows: investing wisely to support our business operations, continuing to grow our dividend payment, enhancing our beverage portfolio and capabilities through opportunistic and disciplined acquisitions, and using excess cash to repurchase shares over time. We currently expect 2022 capital expenditures to be approximately $1.5 billion. During 2022, we also expect to repurchase approximately $500 million of shares in addition to repurchasing shares equivalent to the proceeds from the issuances of stock under our stock-based compensation plans. We are currently in litigation with the IRS for tax years 2007 through 2009. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS; however, a final decision is still pending and the timing of such decision is not currently known. The Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions and intends to vigorously defend our positions utilizing every available avenue of appeal. While the Company believes that it is more likely than not that we will ultimately prevail in this litigation upon appeal, it is possible that all, or some portion of, the adjustments proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In the event that all of the adjustments proposed by the IRS are ultimately upheld for tax years 2007 through 2009 and the IRS, with the consent of the federal courts, were to decide to apply the Tax Court Methodology to the subsequent years up to and including 2021, the Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. Once the Tax Court renders a final decision, the Company will have 90 days to file a notice of appeal and pay the portion of the potential aggregate incremental tax and interest liability related to the 2007 through 2009 tax years, which we currently estimate to be approximately $4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information on the tax litigation. While we believe it is more likely than not that we will prevail in the tax litigation discussed above, we are confident that, between our ability to generate cash flows from operating activities and our ability to borrow funds at reasonable interest rates, we can manage the range of possible outcomes in the final resolution of the matter. Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities As part of our continued efforts to improve our working capital efficiency, we have worked with our suppliers over the past several years to revisit terms and conditions, including the extension of payment terms. Our current payment terms with the majority of our suppliers are 120 days. Additionally, two global financial institutions offer a voluntary supply chain finance (SCF) program which enables our suppliers, at their sole discretion, to sell their receivables from the Company to these financial institutions on a non-recourse basis at a rate that leverages our credit rating and thus may be more beneficial to them. The SCF program is available to suppliers of goods and services included in cost of goods sold as well as suppliers of goods and services included in selling, general and administrative expenses in our consolidated statement of income. The Company and our suppliers agree on the contractual terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. The suppliers sell goods or services, as applicable, to the Company and issue the associated invoices to the Company based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. Our suppliers voluntary inclusion of invoices in the SCF program has no bearing on our payment terms. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. We have no economic interest in a suppliers decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable and accrued expenses in our consolidated balance sheet. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected within the operating activities section of our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2021 and 2020, suppliers had elected to sell $882 million and $703 million, respectively, of our outstanding payment obligations to the financial institutions. The amounts settled through the SCF program were $3,237 million and $2,810 million during the years ended December 31, 2021 and 2020, respectively. We do not believe there is a risk that our payment terms will be shortened in the near future. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company collects customer payments related to the factored receivables and remits those payments to the financial institutions. The Company sold $6,266 million and $185 million of trade accounts receivables under this program during the years ended December 31, 2021 and 2020, respectively, and the costs of factoring such receivables were not material. The cash received from the financial institutions is classified within the operating activities section in our consolidated statement of cash flows. Net cash provided by operating activities for the years ended December 31, 2021 and 2020 was $12,625 million and $9,844 million, respectively, an increase of $2,781 million, or 28 percent. This increase was primarily driven by increased operating income, which includes a benefit from our trade accounts receivable factoring program, a favorable impact of foreign currency exchange rate fluctuations, lower annual incentive payments in 2021 as a result of the impact of the COVID-19 pandemic on our operating performance in 2020, lower payments in 2021 of prior year-end marketing accruals due to lower spending in 2020 as a result of the COVID-19 pandemic, and lower prepayments to customers in 2021. These items were partially offset by higher payments related to our strategic realignment initiatives along with higher tax payments in 2021. Cash Flows from Investing Activities Net cash used in investing activities was $2,765 million and $1,477 million in 2021 and 2020, respectively. Purchases of Investments and Proceeds from Disposals of Investments In 2021, purchases of investments were $6,030 million and proceeds from disposals of investments were $7,059 million, resulting in a net cash inflow of $1,029 million. In 2020, purchases of investments were $13,583 million and proceeds from disposals of investments were $13,835 million, resulting in a net cash inflow of $252 million. This activity primarily represents the purchases of, and proceeds from the disposals of, investments in marketable securities and short-term investments that were made as part of the Companys overall cash management strategy. Also included in this activity are purchases of, and proceeds from the disposals of, investments held by our captive insurance companies. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2021, the Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $4,766 million, which primarily related to the acquisition of the remaining ownership interest in BodyArmor. In 2020, the Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions. Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2021, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $2,180 million, which primarily related to the sale of our ownership interest in CCA, an equity method investee, to CCEP, also an equity method investee. In 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals. Purchases of Property, Plant and Equipment Purchases of property, plant and equipment during the years ended December 31, 2021 and 2020 were $1,367 million and $1,177 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2021 2020 Capital expenditures $ 1,367 $ 1,177 Europe, Middle East Africa 2.6 % 2.3 % Latin America 0.1 0.5 North America 16.7 15.5 Asia Pacific 4.8 1.7 Global Ventures 20.8 22.2 Bottling Investments 41.0 40.3 Corporate 14.0 17.6 Cash Flows from Financing Activities Net cash used in financing activities was $6,786 million and $8,070 million in 2021 and 2020, respectively. Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2021, our long-term debt was rated A+ by Standard Poors and A1 by Moodys. Our commercial paper program was rated A-1 by Standard Poors and P-1 by Moodys. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Companys business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers financial performance, changes in the credit rating agencies methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers credit ratings were to decline, the Companys equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to borrow funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt as well as our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. During 2021, the Company had issuances of debt of $13,094 million, which included $3,391 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $80 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Companys total long-term debt issuances were $9,623 million, net of related discounts and issuance costs. During 2021, the Company made payments of debt of $12,866 million, which consisted of $2,357 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $10,509 million. During 2020, the Company had issuances of debt of $26,934 million, which included $8,260 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $18,674 million, net of related discounts and issuance costs. During 2020, the Company made payments of debt of $28,796 million, which included $15,292 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $1,768 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Companys total payments of long-term debt were $11,736 million. On December 31, 2021, the United Kingdoms Financial Conduct Authority, the governing body responsible for regulating LIBOR, ceased to publish certain LIBOR reference rates. However, other LIBOR reference rates, including U.S. dollar overnight, 1-month, 3-month, 6-month and 12-month maturities will continue to be published through June 2023. In preparation for the discontinuation of LIBOR, we have amended, or will amend, our LIBOR-referencing agreements to either reference the Secured Overnight Financing Rate or include mechanics for selecting an alternative rate. We do not plan to enter into variable-rate agreements that reference LIBOR after December 31, 2021. Issuances of Stock The issuances of stock in 2021 and 2020 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Companys common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. During 2021 and 2020, the Company did not repurchase common stock under the share repurchase plan authorized by our Board of Directors. Since the inception of our share repurchase program in 1984, we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Companys treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. The Companys treasury stock activity during 2021 resulted in a cash outflow of $111 million. Dividends The Company paid dividends of $7,252 million and $7,047 million during the years ended December 31, 2021 and 2020, respectively. At its February 2022 meeting, our Board of Directors increased our regular quarterly dividend to $0.44 per share, equivalent to a full year dividend of $1.76 per share in 2022. This is our 60 th consecutive annual increase. Our annualized common stock dividend was $1.68 per share and $1.64 per share in 2021 and 2020, respectively. Contractual Obligations As of December 31, 2021, the Companys contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2022 2023-2024 2025-2026 2027 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 2,462 $ 2,462 $ $ $ Lines of credit and other short-term borrowings 845 845 Current maturities of long-term debt 2 1,333 1,333 Long-term debt, net of current maturities 2 37,846 2,192 1,732 33,922 Estimated interest payments 3 10,648 620 1,125 1,059 7,844 Accrued income taxes 4 3,594 686 1,709 1,199 Purchase obligations 5 21,118 12,569 2,316 1,617 4,616 Marketing obligations 6 3,589 2,331 623 326 309 Lease obligations 1,688 330 526 351 481 Acquisition obligations 7 1,716 795 564 357 Held-for-sale obligations 8 264 238 15 3 8 Total contractual obligations $ 85,103 $ 22,209 $ 9,070 $ 6,644 $ 47,180 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives for settling this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2021 rate for all periods presented. We expect to fund such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,294 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $1,347 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. Currently, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms. These agreements include long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these purchase obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents obligations related to our acquisitions of fairlife and BodyArmor. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. 8 Represents liabilities and contractual obligations of the Companys bottling operations that are classified as held for sale. The total accrued liability for pension and other postretirement benefit plans recognized as of December 31, 2021 was $1,497 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost or income, plan funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the table above. We expect to make all contributions to our pension trusts with cash flows from operating activities. Our pension plans are generally funded in accordance with local laws and tax regulations. The Company expects to contribute $26 million in 2022 to our pension trusts, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension trusts in the table above. As of December 31, 2021, the projected benefit obligation of the U.S. qualified pension plans was $5,486 million, and the fair value of the plans assets was $5,383 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,094 million, and the fair value of the plans assets was $3,522 million. The Company sponsors various unfunded pension plans outside the United States as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain employees, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be approximately $63 million for 2022 through 2027. Thereafter, the expected annual benefit payments will decrease. Refer to Note 13 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Companys risk of catastrophic loss. Our reserves for the Companys self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. As of December 31, 2021, our self-insurance reserves totaled $229 million. Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2021 were $2,821 million. Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the table above because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the underlying assets or liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future years. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. As of December 31, 2021, we were contingently liable for guarantees of indebtedness owed by third parties of $440 million, of which $93 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers and vendors and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2021, we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in currencies. In 2021, we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2021 and 2020, the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, 2021 2020 All operating currencies 2 % (4) % Australian dollar 10 % (2) % Brazilian real (4) (23) British pound sterling 3 1 Euro 5 1 Japanese yen (2) 2 Mexican peso 6 (10) South African rand 6 (18) The percentages in the table above do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was an increase of 1 percent in 2021 and a decrease of 2 percent in 2020. The total currency impact on income before income taxes, including the effect of our hedging activities, was an increase of 2 percent in 2021 and a decrease of 6 percent in 2020. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are recorded in the line item other income (loss) net in our consolidated statement of income. Refer to the heading Operations Review Other Income (Loss) Net above. The Company recorded net foreign currency exchange losses of $61 million and $64 million during the years ended December 31, 2021 and 2020, respectively. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instruments and the underlying exposures, fluctuations in the values of the instruments are generally offset by reciprocal changes in the values of the underlying exposures. We monitor our exposure to market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2021, we used 70 functional currencies in addition to the U.S. dollar and generated $25.6 billion of our net operating revenues from operations outside the United States; therefore, weakness in some currencies may be offset by strength in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $13,691 million and $16,663 million as of December 31, 2021 and 2020, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of foreign currency derivatives that qualify for hedge accounting resulted in a net unrealized gain of $174 million as of December 31, 2021, and we estimate that a 10 percent weakening of the U.S. dollar would have decreased the net unrealized gain to $172 million. The fair value of the foreign currency derivatives that do not qualify for hedge accounting resulted in a net unrealized gain of $10 million as of December 31, 2021, and we estimate that a 10 percent weakening of the U.S. dollar would have resulted in a $58 million increase in fair value. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Companys variable-rate debt and derivative instruments outstanding as of December 31, 2021, we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $125 million in 2021. However, this increase in interest expense would have been partially offset by the increase in interest income due to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Companys investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would have resulted in a $52 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements, which enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to further manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $918 million and $726 million as of December 31, 2021 and 2020, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. There were no significant commodity derivatives that qualify for hedge accounting as of December 31, 2021 . The fair value of the commodity derivatives that do not qualify for hedge accounting resulted in a net gain of $127 million as of December 31, 2021, and we estimate that a 10 percent decrease in underlying commodity prices would have resulted in a $71 million decrease in fair value. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Fir m (PCAOB ID: 42 ) Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting 59 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2021 2020 2019 Net Operating Revenues $ 38,655 $ 33,014 $ 37,266 Cost of goods sold 15,357 13,433 14,619 Gross Profit 23,298 19,581 22,647 Selling, general and administrative expenses 12,144 9,731 12,103 Other operating charges 846 853 458 Operating Income 10,308 8,997 10,086 Interest income 276 370 563 Interest expense 1,597 1,437 946 Equity income (loss) net 1,438 978 1,049 Other income (loss) net 2,000 841 34 Income Before Income Taxes 12,425 9,749 10,786 Income taxes 2,621 1,981 1,801 Consolidated Net Income 9,804 7,768 8,985 Less: Net income (loss) attributable to noncontrolling interests 33 21 65 Net Income Attributable to Shareowners of The Coca-Cola Company $ 9,771 $ 7,747 $ 8,920 Basic Net Income Per Share 1 $ 2.26 $ 1.80 $ 2.09 Diluted Net Income Per Share 1 $ 2.25 $ 1.79 $ 2.07 Average Shares Outstanding Basic 4,315 4,295 4,276 Effect of dilutive securities 25 28 38 Average Shares Outstanding Diluted 4,340 4,323 4,314 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2021 2020 2019 Consolidated Net Income $ 9,804 $ 7,768 $ 8,985 Other Comprehensive Income: Net foreign currency translation adjustments ( 699 ) ( 911 ) 74 Net gains (losses) on derivatives 214 15 ( 54 ) Net change in unrealized gains (losses) on available-for-sale debt securities ( 90 ) ( 47 ) 18 Net change in pension and other postretirement benefit liabilities 712 ( 267 ) ( 159 ) Total Comprehensive Income 9,941 6,558 8,864 Less: Comprehensive income (loss) attributable to noncontrolling interests ( 101 ) ( 132 ) 110 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 10,042 $ 6,690 $ 8,754 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2021 2020 ASSETS Current Assets Cash and cash equivalents $ 9,684 $ 6,795 Short-term investments 1,242 1,771 Total Cash, Cash Equivalents and Short-Term Investments 10,926 8,566 Marketable securities 1,699 2,348 Trade accounts receivable, less allowances of $ 516 and $ 526 , respectively 3,512 3,144 Inventories 3,414 3,266 Prepaid expenses and other current assets 2,994 1,916 Total Current Assets 22,545 19,240 Equity method investments 17,598 19,273 Other investments 818 812 Other noncurrent assets 6,731 6,184 Deferred income tax assets 2,129 2,460 Property, plant and equipment net 9,920 10,777 Trademarks with indefinite lives 14,465 10,395 Goodwill 19,363 17,506 Other intangible assets 785 649 Total Assets $ 94,354 $ 87,296 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 14,619 $ 11,145 Loans and notes payable 3,307 2,183 Current maturities of long-term debt 1,338 485 Accrued income taxes 686 788 Total Current Liabilities 19,950 14,601 Long-term debt 38,116 40,125 Other noncurrent liabilities 8,607 9,453 Deferred income tax liabilities 2,821 1,833 The Coca-Cola Company Shareowners Equity Common stock, $ 0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 18,116 17,601 Reinvested earnings 69,094 66,555 Accumulated other comprehensive income (loss) ( 14,330 ) ( 14,601 ) Treasury stock, at cost 2,715 and 2,738 shares, respectively ( 51,641 ) ( 52,016 ) Equity Attributable to Shareowners of The Coca-Cola Company 22,999 19,299 Equity attributable to noncontrolling interests 1,861 1,985 Total Equity 24,860 21,284 Total Liabilities and Equity $ 94,354 $ 87,296 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Operating Activities Consolidated net income $ 9,804 $ 7,768 $ 8,985 Depreciation and amortization 1,452 1,536 1,365 Stock-based compensation expense 337 126 201 Deferred income taxes 894 ( 18 ) ( 280 ) Equity (income) loss net of dividends ( 615 ) ( 511 ) ( 421 ) Foreign currency adjustments 86 ( 88 ) 91 Significant (gains) losses net ( 1,365 ) ( 914 ) ( 467 ) Other operating charges 506 556 127 Other items 201 699 504 Net change in operating assets and liabilities 1,325 690 366 Net Cash Provided by Operating Activities 12,625 9,844 10,471 Investing Activities Purchases of investments ( 6,030 ) ( 13,583 ) ( 4,704 ) Proceeds from disposals of investments 7,059 13,835 6,973 Acquisitions of businesses, equity method investments and nonmarketable securities ( 4,766 ) ( 1,052 ) ( 5,542 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 2,180 189 429 Purchases of property, plant and equipment ( 1,367 ) ( 1,177 ) ( 2,054 ) Proceeds from disposals of property, plant and equipment 108 189 978 Other investing activities 51 122 ( 56 ) Net Cash Provided by (Used in) Investing Activities ( 2,765 ) ( 1,477 ) ( 3,976 ) Financing Activities Issuances of debt 13,094 26,934 23,009 Payments of debt ( 12,866 ) ( 28,796 ) ( 24,850 ) Issuances of stock 702 647 1,012 Purchases of stock for treasury ( 111 ) ( 118 ) ( 1,103 ) Dividends ( 7,252 ) ( 7,047 ) ( 6,845 ) Other financing activities ( 353 ) 310 ( 227 ) Net Cash Provided by (Used in) Financing Activities ( 6,786 ) ( 8,070 ) ( 9,004 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents ( 159 ) 76 ( 72 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 2,915 373 ( 2,581 ) Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 7,110 6,737 9,318 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 10,025 7,110 6,737 Less: Restricted cash and restricted cash equivalents at end of year 341 315 257 Cash and Cash Equivalents at End of Year $ 9,684 $ 6,795 $ 6,480 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS EQUITY (In millions except per share data) Year Ended December 31, 2021 2020 2019 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,302 4,280 4,268 Treasury stock issued to employees related to stock-based compensation plans 23 22 33 Purchases of stock for treasury ( 21 ) Balance at end of year 4,325 4,302 4,280 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 17,601 17,154 16,520 Stock issued to employees related to stock-based compensation plans 216 307 433 Stock-based compensation expense 299 141 201 Other activities ( 1 ) Balance at end of year 18,116 17,601 17,154 Reinvested Earnings Balance at beginning of year 66,555 65,855 63,234 Adoption of accounting standards 1 19 546 Net income attributable to shareowners of The Coca-Cola Company 9,771 7,747 8,920 Dividends (per share $ 1.68 , $ 1.64 and $ 1.60 in 2021, 2020 and 2019, respectively) ( 7,251 ) ( 7,047 ) ( 6,845 ) Balance at end of year 69,094 66,555 65,855 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 14,601 ) ( 13,544 ) ( 12,814 ) Adoption of accounting standards 1 ( 564 ) Net other comprehensive income (loss) 271 ( 1,057 ) ( 166 ) Balance at end of year ( 14,330 ) ( 14,601 ) ( 13,544 ) Treasury Stock Balance at beginning of year ( 52,016 ) ( 52,244 ) ( 51,719 ) Treasury stock issued to employees related to stock-based compensation plans 375 228 501 Purchases of stock for treasury ( 1,026 ) Balance at end of year ( 51,641 ) ( 52,016 ) ( 52,244 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 22,999 $ 19,299 $ 18,981 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 1,985 $ 2,117 $ 2,077 Net income attributable to noncontrolling interests 33 21 65 Net foreign currency translation adjustments ( 132 ) ( 153 ) 45 Dividends paid to noncontrolling interests ( 43 ) ( 18 ) ( 48 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests 20 17 3 Net change in pension and other postretirement benefit liabilities ( 2 ) Business combinations 1 59 Total Equity Attributable to Noncontrolling Interests $ 1,861 $ 1,985 $ 2,117 1 The 2021 amount represents the adoption of Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes , effective January 1, 2021. For information regarding the 2019 amounts, refer to Note 1 and Note 5. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms The Coca-Cola Company, Company, we, us and our mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is a total beverage company. We own or license and market numerous beverage brands, which we group into the following categories: Trademark Coca-Cola; sparkling flavors; hydration, sports, coffee and tea; nutrition, juice, dairy and plant-based beverages; and emerging beverages. We own and market five of the worlds top six nonalcoholic sparkling soft drink brands: Coca-Cola, Sprite, Fanta, Diet Coke and Coca-Cola Zero Sugar. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Companys consolidated bottling and distribution operations. Beverages bearing trademarks owned by or licensed to us account for 2.1 billion of the approximately 63 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entitys voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a VIE. An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entitys economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs economic performance. Our Companys investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 1,980 million and $ 2,567 million as of December 31, 2021 and 2020, respectively, representing our maximum exposures to loss. The Companys investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Companys consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Companys investments, plus any loans and guarantees, related to these VIEs totaled $ 103 million and $ 74 million as of December 31, 2021 and 2020, respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Companys consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Companys proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Our Company recognizes revenue when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Refer to Note 3. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 4 billion, $ 3 billion and $ 4 billion in 2021, 2020 and 2019, respectively. As of December 31, 2021 and 2020, advertising and production costs of $ 57 million and $ 83 million, respectively, were primarily recorded in the line item prepaid expenses and other current assets in our consolidated balance sheets. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our consolidated bottlers to our customers, which are included in the line item selling, general and administrative expenses in our consolidated statement of income. Our customers generally do not pay us separately for shipping and handling costs. We recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. We exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 6 million stock options were excluded from the computation of diluted net income per share in both 2021 and 2020 because the stock options would have been antidilutive. The number of stock options excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other noncurrent assets on our consolidated balance sheet. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in our consolidated statements of cash flows (in millions): December 31, 2021 2020 2019 Cash and cash equivalents $ 9,684 $ 6,795 $ 6,480 Restricted cash and restricted cash equivalents included in other noncurrent assets 1,2 341 315 257 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 10,025 $ 7,110 $ 6,737 1 Amounts represent restricted cash and restricted cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4. 2 As of December 31, 2021, restricted cash and restricted cash equivalents includes amounts related to assets held for sale. Refer to Note 2. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any expected loss on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on available relevant information, in addition to historical loss information, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company collects customer payments related to the factored receivables and remits those payments to the financial institutions. The Company sold $ 6,266 million and $ 185 million of trade accounts receivables under this program during the years ended December 31, 2021 and 2020, respectively, and the costs of factoring such receivables were not material. The Company accounts for this program as a sale, and accordingly, the trade receivables sold are excluded from trade accounts receivable on our consolidated balance sheet. The cash received from the financial institutions is classified within the operating activities section in our consolidated statement of cash flows. Inventories Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2021 2020 Raw materials and packaging $ 2,133 $ 2,106 Finished goods 982 791 Other 299 369 Total inventories $ 3,414 $ 3,266 Derivative Instruments When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other current assets; other noncurrent assets; accounts payable and accrued expenses; and other noncurrent liabilities. The cash flow impact of the Companys derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 5. Leases We determine if a contract contains a lease at its inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating lease right-of-use (ROU) assets represent our right to use an underlying asset for the lease term and are included in the line item other noncurrent assets on our consolidated balance sheet. Operating lease liabilities represent our obligation to make lease payments arising from the lease and are included in the line items accounts payable and accrued expenses and other noncurrent liabilities on our consolidated balance sheet. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. When determining the lease term, we include renewal or termination options that we are reasonably certain to exercise. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 9. We have various contracts for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewal options that we are reasonably certain to exercise, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,262 million, $ 1,301 million and $ 1,208 million in 2021, 2020 and 2019, respectively. Amortization expense for leasehold improvements totaled $ 15 million, $ 18 million and $ 18 million in 2021, 2020 and 2019, respectively. The following table summarizes our property, plant and equipment (in millions): December 31, 2021 2020 Land $ 652 $ 676 Buildings and improvements 4,349 4,782 Machinery and equipment 13,861 14,242 Property, plant and equipment cost 18,862 19,700 Less: Accumulated depreciation 8,942 8,923 Property, plant and equipment net $ 9,920 $ 10,777 Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and a recoverability test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Companys long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally less than 20 years. Refer to Note 7. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management performs a recoverability test of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment charge. The impairment charge recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment tests of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is generally one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are generally subdivided into smaller geographic regions. These geographic regions are our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (Costa), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (Monster), each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the impairment charge recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the impairment testing discussed above. Otherwise, the Company does not need to perform any further assessment. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11. Stock-Based Compensation Our Company grants long-term equity awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, performance share units, restricted stock and restricted stock units. The fair value of stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option award is earned by the employee, which is generally four years . The fair value of restricted stock, restricted stock units and certain performance share units is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the vesting period. The Company included a relative total shareowner return (TSR) modifier for most performance share unit awards granted from 2014 through 2017 as well as for performance share unit awards granted to executives from 2018 through 2021. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of performance share units that include a TSR modifier is determined using a Monte Carlo valuation model. In the reporting period it becomes probable that the minimum performance threshold specified in the performance share unit award will be achieved, we recognize compensation expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the performance share units expected to vest. The remaining fair value of the performance share units expected to vest is expensed on a straight-line basis over the remainder of the vesting period. In the event the Company determines it is no longer probable that the minimum performance threshold specified in the award will be achieved, we reverse all of the previously recognized compensation expense in the reporting period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that will ultimately vest to determine the amount of compensation expense recognized each reporting period. Forfeiture estimates are trued-up at the end of the vesting period in order to ensure that compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12. Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the book basis and the tax basis of assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained, but for a lesser amount; or (3) the tax position is more likely than not to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14. Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying values of these assets and liabilities attributable to fluctuations in spot rates are recognized in net foreign currency translation adjustments, a component of accumulated other comprehensive income (loss) (AOCI). Refer to Note 15. Accounts in our consolidated statement of income are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entitys functional currency must first be remeasured from the applicable currency to the legal entitys functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5. Recently Adopted Accounting Guidance In February 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (Tax Reform Act) on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as stranded tax effects. The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019. We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. NOTE 2: ACQUISITIONS AND DIVESTITURES Acquisitions During 2021, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 4,766 million, which primarily related to the acquisition of the remaining ownership interest in BA Sports Nutrition, LLC (BodyArmor). During 2020, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife, LLC (fairlife). During 2019, our Companys acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million, which primarily related to the acquisitions of Costa, the remaining ownership interest in C.H.I. Limited (CHI) and controlling interests in bottling operations in Zambia, Kenya and Eswatini. BA Sports Nutrition, LLC In November 2021, the Company acquired the remaining 85 percent ownership interest in, and now owns 100 percent of, BodyArmor, which offers a line of sports performance and hydration beverages in the United States. We acquired the remaining ownership interest in exchange for approximately $ 5,600 million of cash, of which $ 4,745 million was paid at close, net of cash acquired. The purchase price reflected the contractual discount included in the purchase option we obtained with our initial investment in 2018. The remaining $ 860 million of the purchase price was held back related to indemnification obligations, of which $ 540 million was included in the line item accounts payable and accrued expenses and $ 320 million was included in the line item other noncurrent liabilities in our consolidated balance sheet. Upon consolidation, we recognized a gain of $ 834 million resulting from the remeasurement of our previously held equity interest in BodyArmor to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. As of December 31, 2021, $ 4.2 billion of the purchase price was preliminarily allocated to the BodyArmor trademark and $ 2.2 billion was preliminarily allocated to goodwill, of which $ 1.2 billion is tax deductible. The goodwill recognized as part of this acquisition is primarily related to the synergistic value created from leveraging the capabilities, assets and scale of the Company and the opportunity for international expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. Of the total amount preliminarily allocated to goodwill, $ 1.9 billion has been assigned to the North America operating segment and $ 0.3 billion has been assigned to our other geographic operating segments. The preliminary allocation of the purchase price is subject to refinement when valuations are finalized. As of December 31, 2021, the valuations that have not been finalized primarily relate to other intangible assets and operating lease ROU assets and operating lease liabilities. The final purchase price allocation will be completed no later than the fourth quarter of 2022. fairlife, LLC In January 2020, the Company acquired the remaining 57.5 percent ownership interest in, and now owns 100 percent of, fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. Upon consolidation, we recognized a gain of $ 902 million resulting from the remeasurement of our previously held equity interest in fairlife to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. We acquired the remaining ownership interest in exchange for $ 979 million of cash, net of cash acquired, and effectively settled our $ 306 million note receivable from fairlife at the recorded amount. Under the terms of the agreement, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlifes operating results, the resulting values of which are not subject to a ceiling. Under the applicable accounting guidance, we recorded a $ 270 million liability representing our best estimate of the fair value of this contingent consideration as of the acquisition date. The fair value of this contingent consideration was determined using a Monte Carlo valuation model based on Level 3 inputs, including managements latest estimates of future operating results. We are required to remeasure this liability to fair value quarterly with any changes in the fair value recorded in income until the final milestone payment is made. Upon finalization of purchase accounting, $ 1.3 billion of the purchase price was allocated to the fairlife trademark and $ 0.8 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the North America operating segment. During the years ended December 31, 2021 and 2020, we recorded charges of $ 369 million and $ 51 million, respectively. These charges related to the remeasurement of the contingent consideration liability to fair value and were recorded in the line item other operating charges in our consolidated statements of income. During the year ended December 31, 2021, we made the first milestone payment of $ 100 million based on fairlife meeting its financial targets in 2020. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail stores in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market, as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. Upon finalization of purchase accounting, $ 2.4 billion of the purchase price was allocated to the Costa trademark and $ 2.5 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million which was assigned to the Europe, Middle East and Africa operating segment. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent ownership interest in CHI, a Nigerian producer of value-added dairy and juice beverages and iced tea, in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net loss was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2021, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 2,180 million, which primarily related to the sale of our ownership interest in Coca-Cola Amatil Limited (CCA), an equity method investee, to Coca-Cola Europacific Partners plc (CCEP), also an equity method investee. We received cash proceeds of $ 1,738 million and recognized a net gain of $ 695 million as a result of the sale and the related reversal of cumulative translation adjustments. Also included were the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. We received cash proceeds of $ 293 million and recognized a net gain of $ 114 million as a result of these sales. During 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. We received cash proceeds of $ 100 million and recognized a net loss of $ 2 million as a result of this sale. Also included were the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. We received cash proceeds of $ 62 million and recognized a net gain of $ 35 million as a result of these sales. During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million, which primarily related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (Andina) and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million, respectively. We continue to account for our remaining ownership interest in Andina as an equity method investment as a result of our representation on Andinas Board of Directors and other governance rights. Coca-Cola Beverages Africa Proprietary Limited Due to the Companys original intent to refranchise Coca-Cola Beverages Africa Proprietary Limited (CCBA), it was accounted for as held for sale and as a discontinued operation from October 2017 through the first quarter of 2019. Additionally, CCBAs property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized during this period. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans with the intent to maintain its controlling stake in CCBA, which resulted in CCBA no longer qualifying as held for sale or as a discontinued operation. As a result of this change, we recorded a $ 160 million adjustment to reduce the carrying value of CCBAs property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million, respectively, to reflect additional depreciation and amortization that would have been recognized during the period CCBA was held for sale. This adjustment was recorded in the line item other income (loss) net in our consolidated statement of income. Assets and Liabilities Held for Sale As of December 31, 2021, the Company had certain bottling operations in Asia Pacific that met the criteria to be classified as held for sale. As a result, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As the fair value less any costs to sell exceeded the carrying value, the related assets and liabilities were recorded at their carrying value. These assets and liabilities were included in the Bottling Investments operating segment. The Company expects these bottling operations to be refranchised during 2022. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale and were included in the line items prepaid expenses and other current assets and accounts payable and accrued expenses, respectively, in our consolidated balance sheet (in millions): December 31, 2021 Cash, cash equivalents and short-term investments $ 228 Trade accounts receivable, less allowances 21 Inventories 55 Prepaid expenses and other current assets 36 Other noncurrent assets 9 Deferred income tax assets 6 Property, plant and equipment net 282 Goodwill 37 Assets held for sale $ 674 Accounts payable and accrued expenses $ 139 Accrued income taxes 4 Other noncurrent liabilities 9 Deferred income tax liabilities 5 Liabilities held for sale $ 157 NOTE 3: REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as beverage bases, and syrups, including fountain syrups (we refer to this part of our business as our concentrate operations); and finished sparkling soft drinks and other beverages (we refer to this part of our business as our finished product operations). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our bottlers or our bottling partners). Our bottling partners either combine concentrates with still or sparkling water and sweeteners (depending on the product), or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished beverages to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Companys bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail stores operated by Costa. These sales are included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrates they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2021 related to performance obligations satisfied in prior periods was immaterial. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2021 Concentrate operations $ 6,551 $ 15,248 $ 21,799 Finished product operations 6,459 10,397 16,856 Total $ 13,010 $ 25,645 $ 38,655 Year Ended December 31, 2020 Concentrate operations $ 5,443 $ 13,139 $ 18,582 Finished product operations 5,838 8,594 14,432 Total $ 11,281 $ 21,733 $ 33,014 Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Refer to Note 19 for additional revenue disclosures by operating segment and Corporate. NOTE 4: INVESTMENTS We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair values of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Refer to Note 5 for additional information related to the Companys fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Companys investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, managements assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe a market participant would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Managements assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities The carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2021 Marketable securities $ 376 $ Other investments 771 47 Other noncurrent assets 1,576 Total equity securities $ 2,723 $ 47 December 31, 2020 Marketable securities $ 330 $ Other investments 762 50 Other noncurrent assets 1,282 Total equity securities $ 2,374 $ 50 The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2021 2020 Net gains (losses) recognized during the year related to equity securities $ 509 $ 146 Less: Net gains (losses) recognized during the year related to equity securities sold during the year 71 ( 22 ) Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ 438 $ 168 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2021 Trading securities $ 39 $ 1 $ $ 40 Available-for-sale securities 1,648 33 ( 132 ) 1,549 Total debt securities $ 1,687 $ 34 $ ( 132 ) $ 1,589 December 31, 2020 Trading securities $ 36 $ 2 $ $ 38 Available-for-sale securities 2,227 51 ( 13 ) 2,265 Total debt securities $ 2,263 $ 53 $ ( 13 ) $ 2,303 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2021 December 31, 2020 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Marketable securities $ 40 $ 1,283 $ 38 $ 1,980 Other noncurrent assets 266 285 Total debt securities $ 40 $ 1,549 $ 38 $ 2,265 The contractual maturities of these available-for-sale debt securities as of December 31, 2021 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 28 $ 28 After 1 year through 5 years 1,355 1,241 After 5 years through 10 years 88 98 After 10 years 177 182 Total $ 1,648 $ 1,549 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2021 2020 2019 Gross gains $ 6 $ 20 $ 39 Gross losses ( 10 ) ( 13 ) ( 8 ) Proceeds 1,197 1,559 3,956 Captive Insurance Companies In accordance with local insurance regulations, our consolidated captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of our consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the obligations of certain of our European and Canadian pension plans. This captives solvency capital funds included total equity and debt securities of $ 1,670 million and $ 1,389 million as of December 31, 2021 and 2020, respectively, which were classified in the line item other noncurrent assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5: HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Companys financial performance and are referred to as market risks. When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheet, primarily in the following line items, as applicable: prepaid expenses and other current assets; other noncurrent assets; accounts payable and accrued expenses; and other noncurrent liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized in earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in other comprehensive income (OCI). No components of the Companys hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019, we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019, we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million, net of taxes. The following table presents the fair values of the Companys derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2021 December 31, 2020 Assets: Foreign currency contracts Prepaid expenses and other current assets $ 151 $ 26 Foreign currency contracts Other noncurrent assets 27 74 Commodity contracts Prepaid expenses and other current assets 2 Interest rate contracts Prepaid expenses and other current assets 1 Interest rate contracts Other noncurrent assets 282 659 Total assets $ 461 $ 761 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 15 $ 29 Foreign currency contracts Other noncurrent liabilities 17 Interest rate contracts Accounts payable and accrued expenses 5 Interest rate contracts Other noncurrent liabilities 14 Total liabilities $ 46 $ 34 1 All of the Companys derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Companys derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Companys derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2021 December 31, 2020 Assets: Foreign currency contracts Prepaid expenses and other current assets $ 53 $ 28 Foreign currency contracts Other noncurrent assets 1 Commodity contracts Prepaid expenses and other current assets 131 76 Commodity contracts Other noncurrent assets 3 9 Other derivative instruments Prepaid expenses and other current assets 9 20 Other derivative instruments Other noncurrent assets 3 Total assets $ 196 $ 137 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 34 $ 41 Foreign currency contracts Other noncurrent liabilities 9 Commodity contracts Accounts payable and accrued expenses 6 15 Commodity contracts Other noncurrent liabilities 1 1 Total liabilities $ 50 $ 57 1 All of the Companys derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Companys derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Companys master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by fluctuations in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that were designated and qualified for the Companys foreign currency cash flow hedging program were $ 7,399 million and $ 7,785 million as of December 31, 2021 and 2020, respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company recognizes in earnings each period the changes in carrying values of these foreign currency denominated assets and liabilities due to fluctuations in exchange rates. The changes in fair values of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the changes in fair values attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that were designated as cash flow hedges for the Companys foreign currency denominated assets and liabilities were $ 1,994 million and $ 2,700 million as of December 31, 2021 and 2020, respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments were designated as part of the Companys commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that were designated and qualified for this program were $ 10 million and $ 11 million as of December 31, 2021 and 2020, respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Companys interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Companys future interest payments. The total notional value of these interest rate swap agreements that were designated and qualified for the Companys interest rate cash flow hedging program was $ 1,233 million as of December 31, 2020. As of December 31, 2021, we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on OCI, AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income Gain (Loss) Reclassified from AOCI into Income 2021 Foreign currency contracts $ 36 Net operating revenues $ ( 77 ) Foreign currency contracts ( 2 ) Cost of goods sold ( 10 ) Foreign currency contracts Interest expense ( 13 ) Foreign currency contracts 19 Other income (loss) net 74 Interest rate contracts 110 Interest expense ( 90 ) Commodity contracts ( 1 ) Cost of goods sold Total $ 162 $ ( 116 ) 2020 Foreign currency contracts $ ( 93 ) Net operating revenues $ ( 73 ) Foreign currency contracts 4 Cost of goods sold 9 Foreign currency contracts Interest expense ( 16 ) Foreign currency contracts 37 Other income (loss) net 60 Interest rate contracts 15 Interest expense ( 54 ) Commodity contracts 2 Cost of goods sold Total $ ( 35 ) $ ( 74 ) 2019 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) Foreign currency contracts 1 Cost of goods sold 11 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts 1 Cost of goods sold Total $ ( 200 ) $ ( 162 ) As of December 31, 2021, the Company estimates that it will reclassify into earnings during the next 12 months net gains of $ 36 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that result from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to fluctuations in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured or has been extinguished. The total notional values of derivatives that were designated and qualified as fair value hedges of this type were $ 12,113 million and $ 10,215 million as of December 31, 2021 and 2020, respectively. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 2021 Interest rate contracts Interest expense $ ( 67 ) Fixed-rate debt Interest expense 66 Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) 2020 Interest rate contracts Interest expense $ 275 Fixed-rate debt Interest expense ( 274 ) Net impact to interest expense $ 1 Foreign currency contracts Other income (loss) net $ ( 4 ) Available-for-sale securities Other income (loss) net 5 Net impact to other income (loss) net $ 1 Net impact of fair value hedging instruments $ 2 2019 Interest rate contracts Interest expense $ 368 Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) The following table summarizes the amounts recorded in our consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Cumulative Amount of Fair Value Hedging Adjustments 1 Carrying Values of Hedged Items Included in the Carrying Values of Hedged Items Remaining for Which Hedge Accounting Has Been Discontinued Balance Sheet Location of Hedged Items December 31, 2021 December 31, 2020 December 31, 2021 December 31, 2020 December 31, 2021 December 31, 2020 Current maturities of long-term debt $ 200 $ $ 1 $ $ $ Long-term debt 12,353 11,129 255 646 228 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rate fluctuations. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the fair values of the derivative financial instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the carrying values of the designated portions of the non-derivative financial instruments due to fluctuations in foreign currency exchange rates are recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2021 2020 2021 2020 2019 Foreign currency contracts $ 40 $ 451 $ ( 10 ) $ ( 5 ) $ 51 Foreign currency denominated debt 12,812 13,336 928 ( 1,089 ) 144 Total $ 12,852 $ 13,787 $ 918 $ ( 1,094 ) $ 195 The Company reclassified a loss of $ 4 million related to net investment hedges from AOCI into earnings during the year ended December 31, 2021. The Company did not reclassify any gains or losses related to net investment hedges from AOCI into earnings during the years ended December 31, 2020 and 2019. In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2021, 2020 and 2019. The cash inflows and outflows associated with the Companys derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in the fair values of economic hedges are immediately recognized in earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in the fair values of economic hedges used to offset those monetary assets and liabilities are immediately recognized in earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in the fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are immediately recognized in earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 4,258 million and $ 5,727 million as of December 31, 2021 and 2020, respectively. The Company uses interest rate contracts as economic hedges to minimize exposure to changes in the fair value of fixed-rate debt that result from fluctuations in benchmark interest rates. The total notional value of derivatives related to our economic hedges of this type was $ 200 million as of both December 31, 2021 and 2020. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and vehicle fuel. The changes in the fair values of these economic hedges are immediately recognized in earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 908 million and $ 715 million as of December 31, 2021 and 2020, respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, 2021 2020 2019 Foreign currency contracts Net operating revenues $ 6 $ 58 $ ( 4 ) Foreign currency contracts Cost of goods sold ( 10 ) 6 1 Foreign currency contracts Other income (loss) net ( 84 ) ( 13 ) ( 66 ) Commodity contracts Cost of goods sold 171 54 ( 23 ) Interest rate contracts Interest expense ( 187 ) 6 Other derivative instruments Selling, general and administrative expenses 34 21 47 Other derivative instruments Other income (loss) net ( 3 ) ( 55 ) 48 Total $ ( 73 ) $ 77 $ 3 NOTE 6: EQUITY METHOD INVESTMENTS Our consolidated net income includes our Companys proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. The Companys proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value of those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity method investees AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Companys equity method investments include, but are not limited to, our ownership interests in CCEP, Monster, AC Bebidas, S. de R.L. de C.V., Coca-Cola FEMSA, S.A.B. de C.V., Coca-Cola HBC AG and Coca-Cola Bottlers Japan Holdings Inc. (CCBJHI). As of December 31, 2021, we owned approximately 19 percent, 19 percent, 20 percent, 28 percent, 21 percent and 19 percent, respectively, of these companies outstanding shares. As of December 31, 2021, our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 7,298 million. This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 2021 2020 2019 Net operating revenues $ 79,934 $ 69,384 $ 75,980 Cost of goods sold 47,847 41,139 44,881 Gross profit $ 32,087 $ 28,245 $ 31,099 Operating income $ 9,089 $ 7,056 $ 7,748 Consolidated net income $ 6,050 $ 4,176 $ 4,597 Less: Net income attributable to noncontrolling interests 91 54 63 Net income attributable to common shareowners $ 5,959 $ 4,122 $ 4,534 Company equity income (loss) net $ 1,438 $ 978 $ 1,049 1 The financial information represents the results of the equity method investees during the Companys period of ownership. December 31, 2021 2020 Current assets $ 30,992 $ 29,431 Noncurrent assets 72,064 67,900 Total assets $ 103,056 $ 97,331 Current liabilities $ 21,362 $ 20,033 Noncurrent liabilities 37,353 33,613 Total liabilities $ 58,715 $ 53,646 Equity attributable to shareowners of investees $ 43,422 $ 42,622 Equity attributable to noncontrolling interests 919 1,063 Total equity $ 44,341 $ 43,685 Company equity method investments $ 17,598 $ 19,273 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,471 million, $ 13,041 million and $ 14,832 million in 2021, 2020 and 2019, respectively. Total payments, primarily related to marketing, made to equity method investees were $ 516 million, $ 547 million and $ 897 million in 2021, 2020 and 2019, respectively. The increase in net sales to equity method investees in 2021 was primarily due to recovery from the COVID-19 pandemic. In addition, purchases of beverage products from equity method investees were $ 496 million, $ 452 million and $ 426 million in 2021, 2020 and 2019, respectively. The increase in purchases of beverage products in 2021 was primarily due to increased purchases of Monster products as a result of international expansion and category growth. The following table presents the difference between calculated fair value, based on quoted closing prices of publicly traded shares, and our Companys carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2021 Fair Value Carrying Value Difference Monster Beverage Corporation $ 9,808 $ 4,323 $ 5,485 Coca-Cola Europacific Partners plc 4,919 3,578 1,341 Coca-Cola FEMSA, S.A.B. de C.V. 3,182 1,568 1,614 Coca-Cola HBC AG 2,705 1,115 1,590 Coca-Cola Consolidated, Inc. 1,537 224 1,313 Coca-Cola Bottlers Japan Holdings Inc. 1 387 474 ( 87 ) Coca-Cola ecek A.. 340 123 217 Embotelladora Andina S.A. 130 98 32 Total $ 23,008 $ 11,503 $ 11,505 1 The carrying value of our investment in CCBJHI exceeded its fair value as of December 31, 2021 by $ 87 million. Based on the length of time and the extent to which the fair value has been less than our carrying value and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge related to the investment. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 882 million and $ 1,025 million as of December 31, 2021 and 2020, respectively. The total amount of dividends received from equity method investees was $ 823 million, $ 467 million and $ 628 million for the years ended December 31, 2021, 2020 and 2019, respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2021 was $ 6,143 million. NOTE 7: INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2021 2020 Trademarks 1 $ 14,465 $ 10,395 Goodwill 19,363 17,506 Other 211 225 Indefinite-lived intangible assets $ 34,039 $ 28,126 1 For information related to the Companys acquisitions, refer to Note 2. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total 2020 Balance at beginning of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 Effect of foreign currency translation 40 ( 6 ) 7 84 ( 216 ) ( 91 ) Acquisitions 1 775 775 Purchase accounting adjustments 1,2 ( 26 ) 74 24 2 ( 2 ) 72 Impairments ( 14 ) ( 14 ) Balance at end of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 2021 Balance at beginning of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 Effect of foreign currency translation ( 83 ) ( 8 ) ( 6 ) 46 ( 285 ) ( 336 ) Acquisitions 1 55 44 1,886 227 45 2,257 Impairments ( 7 ) ( 7 ) Divestitures, deconsolidations and other 3 ( 13 ) ( 7 ) ( 37 ) ( 57 ) Balance at end of year $ 1,280 $ 200 $ 10,665 $ 422 $ 2,976 $ 3,820 $ 19,363 1 For information related to the Companys acquisitions, refer to Note 2. 2 Includes the allocation of goodwill from the Europe, Middle East and Africa segment to other reporting units expected to benefit from the CHI acquisition as well as purchase accounting adjustments related to fairlife. Refer to Note 2. 3 The decrease in the Bottling Investments segment was a result of certain bottling operations in Asia Pacific being classified as held for sale. Refer to Note 2. Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2021 December 31, 2020 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ 336 1 $ ( 86 ) $ 250 $ 195 $ ( 61 ) $ 134 Trademarks 189 ( 87 ) 102 245 ( 77 ) 168 Other 273 2 ( 51 ) 222 332 ( 210 ) 122 Total $ 798 $ ( 224 ) $ 574 $ 772 $ ( 348 ) $ 424 1 Includes $ 150 million related to the BodyArmor acquisition. Refer to Note 2. 2 Includes $ 102 million for BodyArmor noncompete agreements. Refer to Note 2. Total amortization expense for intangible assets subject to amortization was $ 165 million, $ 203 million and $ 120 million in 2021, 2020 and 2019, respectively. The increase in amortization expense in 2020 was due to the recognition of a full year of intangible amortization related to CCBA versus seven months in 2019. Based on the carrying value of definite-lived intangible assets as of December 31, 2021, we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense 2022 $ 106 2023 81 2024 66 2025 59 2026 47 NOTE 8: ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, 2021 2020 Accounts payable $ 4,602 $ 3,517 Accrued marketing expenses 2,830 1,930 Variable consideration payable 1,118 1,137 Accrued compensation 1,051 609 Other accrued expenses 5,018 3,952 Accounts payable and accrued expenses $ 14,619 $ 11,145 NOTE 9: LEASES We have operating leases primarily for real estate, aircraft, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2021 2020 Operating lease ROU assets 1 $ 1,418 $ 1,548 Current portion of operating lease liabilities 2 $ 310 $ 322 Noncurrent portion of operating lease liabilities 3 1,161 1,300 Total operating lease liabilities $ 1,471 $ 1,622 1 Operating lease ROU assets are included in the line item other noncurrent assets in our consolidated balance sheets. 2 The current portion of operating lease liabilities is included in the line item accounts payable and accrued expenses in our consolidated balance sheets. 3 The noncurrent portion of operating lease liabilities is included in the line item other noncurrent liabilities in our consolidated balance sheets. We had operating lease costs of $ 342 million and $ 353 million for the years ended December 31, 2021 and 2020, respectively. During 2021 and 2020, cash paid for amounts included in the measurement of operating lease liabilities was $ 352 million and $ 365 million, respectively. Operating lease ROU assets obtained in exchange for operating lease obligations were $ 194 million and $ 528 million for the years ended December 31, 2021 and 2020, respectively. Information associated with the measurement of our operating lease obligations as of December 31, 2021 is as follows: Weighted-average remaining lease term 8 years Weighted-average discount rate 2.7 % Our leases have remaining lease terms of 1 year to 43 years, inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturities of our operating lease liabilities as of December 31, 2021 (in millions): Maturities of Operating Lease Liabilities 2022 $ 324 2023 284 2024 231 2025 190 2026 142 Thereafter 476 Total operating lease payments 1,647 Less: Imputed interest 176 Total operating lease liabilities $ 1,471 NOTE 10: DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2021 and 2020, we had $ 2,462 million and $ 1,329 million, respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 0.1 percent and 1.3 percent as of December 31, 2021 and 2020, respectively. As of December 31, 2021 and 2020, the Company also had $ 845 million and $ 854 million, respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were related to our international operations. In addition, we had $ 9,972 million in unused lines of credit and other short-term credit facilities as of December 31, 2021, of which $ 8,060 million was in corporate backup lines of credit for general purposes. These backup lines of credit expire at various times from 2022 through 2027. There were no borrowings under these corporate backup lines of credit during 2021. These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2021, the Company issued fixed interest rate U.S. dollar- and euro-denominated notes of $ 5,950 million and 3,150 million, respectively, with maturity dates ranging from 2028 to 2051 and interest rates ranging from 0.125 percent to 3.000 percent. The carrying value of these notes as of December 31, 2021 was $ 9,410 million. During 2021, the Company retired upon maturity variable interest rate euro-denominated notes of 371 million with an interest rate equal to the three-month Euro Interbank Offered Rate (EURIBOR) plus 0.200 percent. During 2021, the Company also extinguished prior to maturity fixed interest rate U.S. dollar- and euro-denominated notes of $ 6,500 million and 2,430 million, respectively, with maturity dates ranging from 2023 to 2026 and interest rates ranging from 0.750 percent to 3.200 percent. These extinguishments resulted in associated charges of $ 559 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying value of the notes extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 91 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. During 2020, the Company issued fixed interest rate U.S. dollar- and euro-denominated notes of $ 15,600 million and 2,600 million, respectively, with maturity dates ranging from 2025 to 2060 and interest rates ranging from 0.125 percent to 4.200 percent. The carrying value of these notes as of December 31, 2020 was $ 17,616 million. During 2020, the Company retired upon maturity fixed interest rate Australian dollar- and U.S. dollar-denominated notes of AUD 450 million and $ 3,750 million, respectively, with interest rates ranging from 1.875 percent to 3.150 percent. Additionally, the Company retired upon maturity U.S. dollar zero coupon notes of $ 171 million. During 2020, the Company also extinguished prior to maturity fixed interest rate U.S. dollar- and euro-denominated notes of $ 3,815 million and 2,300 million, respectively, with maturity dates ranging from 2021 to 2050 and interest rates ranging from 0.000 percent to 4.200 percent. Additionally, the Company extinguished prior to maturity variable interest rate euro-denominated notes of 379 million with a maturity date in 2021 and an interest rate equal to the three-month EURIBOR plus 0.200 percent. These extinguishments resulted in associated charges of $ 459 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying value of the notes extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 25 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. During 2019, the Company issued fixed interest rate euro- and U.S. dollar-denominated notes of 2,750 million and $ 2,000 million, respectively, with maturity dates ranging from 2022 to 2031 and interest rates ranging from 0.125 percent to 2.125 percent. Additionally, the Company issued variable interest rate euro-denominated notes of 750 million maturing in 2021 with an interest rate equal to the three-month EURIBOR plus 0.200 percent. The carrying value of these notes as of December 31, 2019 was $ 5,891 million. During 2019, the Company retired upon maturity variable interest rate euro-denominated notes of 3,500 million with interest rates equal to the three-month EURIBOR plus 0.230 percent and the three-month EURIBOR plus 0.250 percent. Additionally, the Company retired upon maturity fixed interest rate U.S. dollar-denominated notes of $ 1,000 million with an interest rate of 1.375 percent. The Companys long-term debt consisted of the following (in millions except average rate data): December 31, 2021 December 31, 2020 Amount Average Rate 1 Amount Average Rate 1 Fixed interest rate long-term debt: U.S. dollar notes due 2023-2093 $ 21,953 2.2 % $ 22,550 2.0 % U.S. dollar debentures due 2022-2098 1,316 5.2 1,342 5.1 Australian dollar notes due 2024 398 2.5 400 2.5 Euro notes due 2023-2041 13,249 0.4 13,369 0.3 Swiss franc notes due 2022-2028 1,234 2.3 1,236 2.7 Variable interest rate long-term debt: Euro notes due 2021 452 0.0 Other, due through 2098 2 821 6.0 615 5.2 Fair value adjustments 3 483 N/A 646 N/A Total 4,5 39,454 1.7 % 40,610 1.6 % Less: Current portion 1,338 485 Long-term debt $ 38,116 $ 40,125 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 As of December 31, 2021, the amount shown includes $ 690 million of debt instruments and finance leases that are due through 2046. 3 Amounts represent the changes in fair values due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 4 As of December 31, 2021 and 2020, the fair value of our long-term debt, including the current portion, was $ 40,311 million and $ 43,218 million, respectively. 5 The above notes and debentures include various restrictions, none of which is presently significant to our Company. Total interest paid was $ 738 million, $ 935 million and $ 921 million in 2021, 2020 and 2019, respectively. The following table summarizes the maturities of long-term debt for the five years succeeding December 31, 2021 (in millions): Maturities of Long-Term Debt 2022 $ 1,338 2023 177 2024 2,023 2025 18 2026 1,733 NOTE 11: COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2021, we were contingently liable for guarantees of indebtedness owed by third parties of $ 440 million, of which $ 93 million was related to VIEs. Refer to Note 1 for additional information related to the Companys maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers and vendors and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings (excluding tax audit claims) will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an ownership interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not more likely than not to be sustained; (2) the tax position is more likely than not to be sustained but for a lesser amount; or (3) the tax position is more likely than not to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities, such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the more likely than not recognition threshold would be recognized in income tax expense in the quarter in which the uncertainty disappears under any one of the following conditions: (1) the tax position is more likely than not to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (Notice) from the U.S. Internal Revenue Service (IRS) seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $ 9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arms-length pricing of transactions between related parties such as the Companys U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arms-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (Closing Agreement). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Companys income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Companys compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $ 9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Companys matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS designation of the Companys matter for litigation, the Company was forced to either accept the IRS newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the U.S. Tax Court (Tax Court) in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued an opinion (Opinion) in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Companys case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Companys foreign licensees to increase the Companys U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors and we reviewed and considered relevant laws, rules, and regulations, including, but not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Companys tax positions, that it is more likely than not the Companys tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (Tax Court Methodology), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Companys analysis. The Companys conclusion that it is more likely than not the Companys tax positions will ultimately be sustained on appeal is unchanged as of December 31, 2021. However, we updated our calculation of the methodologies we believe the federal courts could ultimately order to be used in calculating the Companys tax. As a result of the application of the required probability analysis to these updated calculations and the accrual of interest through the current reporting period, we updated our tax reserve as of December 31, 2021 to $ 400 million. While the Company strongly disagrees with the IRS positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for tax years 2007 through 2009, and potentially also for subsequent years, which could have a material adverse impact on the Companys financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology were to be ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2021 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 through 2021. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the 2017 Tax Cuts and Jobs Act. The Company estimates that the potential aggregate incremental tax and interest liability could be approximately $ 13 billion as of December 31, 2021. Additional income tax and interest would continue to accrue until the time any such potential liability, or portion thereof, were to be paid. We currently project the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2021, would result in an incremental annual tax liability that would increase the Companys effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Companys licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Companys Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the U.S. Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax years. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax years, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.9 billion (including interest accrued through December 31, 2021), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Companys risk of catastrophic loss. Our reserves for the Companys self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. Our self-insurance reserves totaled $ 229 million and $ 265 million as of December 31, 2021 and 2020, respectively. NOTE 12: STOCK-BASED COMPENSATION PLANS Our Company grants long-term equity awards under its stock-based compensation plans to certain employees of the Company. The Coca-Cola Company 2014 Equity Plan (2014 Equity Plan) was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued through the grant of equity awards. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock, restricted stock units and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2021, there were approximately 329 million shares available to be granted under the 2014 Equity Plan. In addition, there were approximately 3 million shares available for stock option and restricted stock award grants under plans approved by shareowners prior to 2014. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance-based cash awards. Employees who received these performance-based cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for employees previously eligible for the performance-based cash award. These employees no longer participate in the long-term incentive program and were granted a final restricted stock unit award that vests ratably over five years . Total stock-based compensation expense was $ 337 million, $ 141 million and $ 201 million in 2021, 2020 and 2019, respectively. In 2020, for certain employees who accepted voluntary separation from the Company as a result of our strategic realignment initiatives, the Company modified their outstanding equity awards granted prior to 2020 so that the employees retained all or some of their awards, whereas otherwise the awards would have been forfeited. The incremental stock-based compensation expense in 2020 arising from the modifications was $ 15 million, which was recorded in the line item other operating charges in our consolidated statement of income. Refer to Note 18 for additional information on the Companys strategic realignment initiatives. The remainder of stock-based compensation expense in 2020 of $ 126 million and all stock-based compensation expense in 2021 and 2019 were recorded in the line item selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to total stock-based compensation expense was $ 60 million, $ 32 million and $ 43 million in 2021, 2020 and 2019, respectively. As of December 31, 2021, we had $ 335 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Stock Option Awards Stock option awards are generally granted with an exercise price equal to the average of the high and low market prices per share of the Companys stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is expensed on a straight-line basis over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2021, 2020 and 2019 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, 2021 2020 2019 Fair value of stock options on grant date $ 5.08 $ 6.44 $ 4.94 Dividend yield 1 3.3 % 2.7 % 3.5 % Expected volatility 2 18.0 % 16.0 % 15.5 % Risk-free interest rate 3 0.9 % 1.4 % 2.6 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the closing market price per share of the Companys stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Companys stock, historical volatility of the Companys stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Stock option awards generally expire 10 years after the date of grant. The shares of common stock to be issued and/or sold upon the exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. Since 2007, the Company has issued common stock under its stock-based compensation plans from treasury shares. Stock option activity during the year ended December 31, 2021 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2021 88 $ 40.55 Granted 7 50.59 Exercised ( 19 ) 36.32 Forfeited/expired ( 1 ) 54.18 Outstanding on December 31, 2021 75 $ 42.43 4.2 years $ 1,264 Expected to vest 74 $ 42.32 4.1 years $ 1,256 Exercisable on December 31, 2021 59 $ 40.08 3.1 years $ 1,138 The total intrinsic value of the stock options exercised was $ 358 million, $ 453 million and $ 609 million in 2021, 2020 and 2019, respectively. The total number of stock options exercised was approximately 19 million, 23 million and 34 million in 2021, 2020 and 2019, respectively. Performance-Based Share Unit Awards Performance share unit awards require achievement of certain performance criteria, which are predefined by the Talent and Compensation Committee of the Board of Directors at the time of grant. For performance share unit awards granted from 2015 through 2017, the performance criteria were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved by the Audit Committee of the Companys Board of Directors (Audit Committee). The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These awards included a relative TSR modifier to determine the final number of performance share units earned. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria was reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share unit awards granted from 2015 through 2017 were subject to a one-year holding period after the performance period before the shares were released. For performance share unit awards granted from 2018 through 2021, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. For purposes of these performance criteria, earnings per share is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved by the Audit Committee. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Performance share unit awards granted to executives include a relative TSR modifier to determine the final number of performance share units earned. The fair value of performance share units that include a TSR modifier is determined using a Monte Carlo valuation model. For these awards, the number of performance share units earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Companys total shareowner return over the performance period relative to a predefined compensation comparator group of companies fell outside of a predefined range. The fair value of performance share units that do not include a TSR modifier is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the performance period. The performance share unit awards will generally vest at the end of the respective performance period. During 2021, in addition to granting performance share unit awards with a three-year performance period, the Company granted emerging stronger performance share unit awards with a predefined performance period of two years. The awards performance criterion is earnings per share, and the award includes a relative TSR modifier. Earnings per share for these purposes is diluted net income per share adjusted for certain items, which are approved by the Audit Committee. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the performance criterion. The performance share unit awards will generally vest at the end of the two-year performance period. For performance share unit awards, in the event the certified results equal the predefined performance criteria, the number of performance share units earned will be equal to the target award. In the event the certified results exceed the predefined performance criteria, additional performance share units up to the maximum award will be earned. In the event the certified results fall below the predefined performance criteria but are at or above the minimum threshold, a reduced number of performance share units will be earned. If the certified results fall below the minimum threshold, no performance share units will be earned. Performance share unit awards do not entitle participants to vote or receive dividends until the performance share units are settled in stock. In the reporting period it becomes probable that the minimum performance threshold specified in the award will be achieved, we recognize compensation expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the performance share units expected to vest. The remaining fair value of the performance share units expected to vest is expensed on a straight-line basis over the remainder of the vesting period. In the event the Company determines it is no longer probable that the minimum performance threshold specified in the award will be achieved, we reverse all previously recognized compensation expense in the reporting period such a determination is made. Performance share units earned are generally settled in stock, except for certain circumstances such as death or disability, in which case beneficiaries or employees are provided cash payments. As of December 31, 2021, nonvested performance share units of approximately 1,587,000 , 578,000 and 2,021,000 were outstanding for the 2020-2022, 2021-2022 and 2021-2023 performance periods, respectively, based on the target award amounts. The following table summarizes information about outstanding nonvested performance share units based on the target award levels: Performance Share Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2021 3,771 $ 48.29 Granted 2,728 47.04 Vested 1 ( 1,846 ) 40.29 Forfeited ( 467 ) 49.18 Nonvested on December 31, 2021 2 4,186 $ 50.90 1 Represents the target level of performance share units vested at December 31, 2021 for the 2019-2021 performance period. Upon certification in February 2022 of the financial results for the performance period, the final number of shares earned will be determined and released. 2 The outstanding nonvested performance share units as of December 31, 2021 at the threshold award and maximum award levels were approximately 1,725,000 and 9,759,000 , respectively. The weighted-average grant date fair value of performance share unit awards granted in 2021, 2020 and 2019 was $ 47.04 , $ 57.00 and $ 40.29 , respectively. The following table summarizes information about vested performance share units based on the certified award level: 2017-2020 Award 2018-2020 Award Performance Share Units (In thousands) Weighted- Average Grant Date Fair Value Performance Share Units (In thousands) Weighted- Average Grant Date Fair Value Certified 3,728 $ 35.30 1,014 $ 41.02 Released during 2021 ( 3,720 ) 36.31 ( 1,008 ) 41.72 Forfeited during 2021 ( 8 ) 35.30 ( 6 ) 41.02 The total intrinsic value of performance share units that were released was $ 237 million, $ 191 million and $ 118 million in 2021, 2020 and 2019, respectively. Time-Based Restricted Stock and Restricted Stock Unit Awards Time-based restricted stock and restricted stock unit awards granted under the 2014 Equity Plan do not entitle recipients to vote or receive dividends during the vesting period and will be forfeited in the event of the recipients termination of employment, except for certain circumstances such as death or disability. The fair value of restricted stock and restricted stock units is the closing market price per share of the Companys stock on the grant date less the present value of the expected dividends not received during the vesting period. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2021, the Company had outstanding nonvested time-based restricted stock and restricted stock units totaling approximately 3,394,000 . The following table summarizes information about outstanding nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2021 4,162 $ 44.18 Granted 1,242 46.20 Vested and released ( 1,495 ) 41.91 Forfeited ( 515 ) 46.46 Nonvested on December 31, 2021 3,394 $ 46.56 NOTE 13: PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the primary U.S. plan. As of December 31, 2021, the primary U.S. plan represented 61 percent and 57 percent of the Companys consolidated projected benefit obligation and pension plan assets, respectively. Obligations and Funded Status The following table sets forth the changes in the benefit obligations and the fair value of plan assets for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2021 2020 Benefit obligation at beginning of year 1 $ 9,414 $ 8,757 $ 769 $ 757 Service cost 97 112 9 11 Interest cost 183 235 15 21 Participant contributions 5 1 13 12 Foreign currency exchange rate changes ( 33 ) 67 ( 1 ) ( 1 ) Amendments 3 ( 13 ) Net actuarial loss (gain) 2 ( 226 ) 746 ( 28 ) 22 Benefits paid ( 375 ) ( 485 ) ( 67 ) ( 59 ) Settlements 3 ( 491 ) ( 81 ) Curtailments 3 ( 15 ) ( 1 ) 6 Special termination benefits 3 2 Other 3 72 Benefit obligation at end of year 1 $ 8,580 $ 9,414 $ 696 $ 769 Fair value of plan assets at beginning of year $ 8,639 $ 8,080 $ 396 $ 339 Actual return on plan assets 1,003 830 15 51 Employer contributions 33 30 Participant contributions 6 1 8 7 Foreign currency exchange rate changes ( 42 ) 97 Benefits paid ( 315 ) ( 419 ) ( 1 ) Settlements 3 ( 421 ) ( 53 ) Other 2 73 Fair value of plan assets at end of year $ 8,905 $ 8,639 $ 419 $ 396 Net asset (liability) recognized $ 325 $ ( 775 ) $ ( 277 ) $ ( 373 ) 1 For pension plans, the benefit obligation is the projected benefit obligation. For other postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 8,431 million and $ 9,263 million as of December 31, 2021 and 2020, respectively. 2 A change in the weighted-average discount rate was the primary driver of net actuarial loss (gain) during 2021 and 2020. For our primary U.S. pension plan, an increase in the discount rate resulted in an actuarial gain of $ 197 million during 2021, and a decrease in the discount rate resulted in an actuarial loss of $ 491 million during 2020. Other drivers of net actuarial loss (gain) included assumption updates, plan experience and our strategic realignment initiatives. Refer to Note 18. 3 Settlements and curtailments were primarily related to our strategic realignment initiatives. Refer to Note 18. Pension and other postretirement benefit plan amounts recognized in our consolidated balance sheets were as follows (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Other noncurrent assets $ 1,545 $ 1,151 $ $ Accounts payable and accrued expenses ( 70 ) ( 116 ) ( 18 ) ( 19 ) Other noncurrent liabilities ( 1,150 ) ( 1,810 ) ( 259 ) ( 354 ) Net asset (liability) recognized $ 325 $ ( 775 ) $ ( 277 ) $ ( 373 ) Certain of our pension plans have a projected benefit obligation in excess of the fair value of plan assets. For these plans, the projected benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2021 2020 Projected benefit obligation $ 6,862 $ 7,722 Fair value of plan assets 5,641 5,796 Certain of our pension plans have an accumulated benefit obligation in excess of the fair value of plan assets. For these plans, the accumulated benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2021 2020 Accumulated benefit obligation $ 6,689 $ 7,553 Fair value of plan assets 5,584 5,745 All of our other postretirement benefit plans have an accumulated postretirement benefit obligation in excess of the fair value of plan assets. Pension Plan Assets The following table presents total assets by asset class for our U.S. and non-U.S. pension plans (in millions): U.S. Pension Plans Non-U.S. Pension Plans December 31, 2021 2020 2021 2020 Cash and cash equivalents $ 272 $ 279 $ 233 $ 399 Equity securities: U.S.-based companies 1,463 1,382 968 757 International-based companies 876 988 830 738 Fixed-income securities: Government bonds 182 220 495 417 Corporate bonds and debt securities 899 926 124 116 Mutual, pooled and commingled funds 1 290 301 560 513 Hedge funds/limited partnerships 682 588 38 34 Real estate 381 326 8 6 Derivative financial instruments ( 1 ) ( 1 ) ( 8 ) ( 14 ) Other 339 364 274 300 Total pension plan assets 2 $ 5,383 $ 5,373 $ 3,522 $ 3,266 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. pension plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2021, no investment manager was responsible for more than 8 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small-cap and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 5 percent of total global equities and approximately 3 percent of total U.S. pension plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small-cap and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans The long-term target allocation for 70 percent of our international subsidiaries pension plan assets, primarily certain of our European and Canadian plans, was 66 percent equity securities, 4 percent fixed-income securities and 30 percent other investments. The actual allocation for the remaining 30 percent of the Companys international subsidiaries pension plan assets consisted of 44 percent mutual, pooled and commingled funds; 21 percent fixed-income securities; 1 percent equity securities and 34 percent other investments. The investment strategies for our international subsidiaries pension plans vary greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (VEBA), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets by asset class for our other postretirement benefit plans (in millions): December 31, 2021 2020 Cash and cash equivalents $ 33 $ 30 Equity securities: U.S.-based companies 184 170 International-based companies 12 12 Fixed-income securities: Government bonds 3 3 Corporate bonds and debt securities 82 80 Mutual, pooled and commingled funds 87 86 Hedge funds/limited partnerships 9 7 Real estate 5 4 Other 4 4 Total other postretirement benefit plan assets 1 $ 419 $ 396 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost or income for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2019 2021 2020 2019 Service cost $ 97 $ 112 $ 104 $ 9 $ 11 $ 9 Interest cost 183 235 291 15 21 28 Expected return on plan assets 1 ( 606 ) ( 587 ) ( 552 ) ( 17 ) ( 16 ) ( 13 ) Amortization of prior service cost (credit) 3 ( 4 ) ( 2 ) ( 3 ) ( 2 ) Amortization of net actuarial loss 2 146 171 151 4 5 2 Net periodic benefit cost (income) ( 180 ) ( 66 ) ( 10 ) 9 18 24 Settlement charges 3 117 23 6 Curtailment charges (credits) ( 1 ) 1 ( 1 ) 6 ( 2 ) Special termination benefits 3 2 1 Other ( 4 ) 1 Total cost (income) $ ( 61 ) $ ( 44 ) $ ( 2 ) $ 8 $ 24 $ 22 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlement charges were primarily related to our strategic realignment initiatives. Refer to Note 18 . All of the amounts in the table above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the pretax changes in AOCI for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2021 2020 Balance in AOCI at beginning of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) Recognized prior service cost (credit) 1 3 ( 2 ) ( 3 ) Recognized net actuarial loss 261 195 3 11 Prior service credit (cost) occurring during the year ( 3 ) 13 Net actuarial (loss) gain occurring during the year 623 ( 488 ) 27 7 Net foreign currency translation adjustments 2 ( 41 ) 2 ( 3 ) Balance in AOCI at end of year $ ( 2,125 ) $ ( 3,012 ) $ ( 4 ) $ ( 47 ) 1 Includes $ 117 million of recognized net actuarial loss due to the impact of settlements, which were primarily related to our strategic realignment initiatives. Refer to Note 18. 2 Includes $ 23 million of recognized net actuarial loss due to the impact of settlements, which were primarily related to our strategic realignment initiatives. Refer to Note 18. 3 Includes $ 15 million of net actuarial loss occurring during the year due to the impact of curtailments. The following table sets forth the pretax amounts in AOCI for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Prior service credit (cost) $ ( 9 ) $ ( 10 ) $ 28 $ 17 Net actuarial loss ( 2,116 ) ( 3,002 ) ( 32 ) ( 64 ) Balance in AOCI at end of year $ ( 2,125 ) $ ( 3,012 ) $ ( 4 ) $ ( 47 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations for our pension and other postretirement benefit plans were as follows: Pension Plans Other Postretirement Benefit Plans December 31, 2021 2020 2021 2020 Discount rate 3.00 % 2.50 % 3.25 % 2.75 % Interest crediting rate 3.00 % 3.00 % N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost or income were as follows: Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2021 2020 2019 2021 2020 2019 Discount rate 2.50 % 3.25 % 4.00 % 2.75 % 3.50 % 4.25 % Interest crediting rate 3.00 % 3.50 % 3.75 % N/A N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % 3.75 % N/A N/A N/A Expected long-term rate of return on plan assets 7.25 % 7.50 % 7.75 % 4.25 % 4.50 % 4.50 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2021 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate assumption on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost or income for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The current cash balance interest crediting rate for the primary U.S. pension plan is the yield on six-month U.S. Treasury bills on the last day of September of the previous plan year, plus 150 basis points. The Company assumes that the current cash balance interest crediting rate will grow linearly over 10 years to the ultimate interest crediting rate assumption. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2021 net periodic benefit income for the U.S. pension plans was 7.25 percent. As of December 31, 2021, the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 10.7 percent, 9.7 percent and 6.8 percent, respectively. The annualized return since inception was 10.6 percent. The weighted-average assumptions for health care cost trend rates were as follows: December 31, 2021 2020 Health care cost trend rate assumed for next year 6.75 % 6.75 % Rate to which the trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.25 % Year that the trend rate reaches the ultimate trend rate 2027 2025 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Companys U.S. postretirement benefit plans are primarily defined-dollar benefit plans that limit the effects of health care inflation because the plans have established dollar limits for determining our contributions. Cash Flows The expected benefit payments for our pension and other postretirement benefit plans for the 10 years succeeding December 31, 2021 are as follows (in millions): Year Ended December 31, 2022 2023 2024 2025 2026 2027-2031 Benefit payments for pension plans $ 486 $ 454 $ 464 $ 470 $ 471 $ 2,390 Benefit payments for other postretirement benefit plans 59 56 53 51 48 211 Total $ 545 $ 510 $ 517 $ 521 $ 519 $ 2,601 The Company anticipates making contributions to our pension trusts in 2022 of $ 26 million, all of which will be allocated to our international plans. These contributions are generally made in accordance with local laws and tax regulations. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants contributions up to a maximum of 3.5 percent of compensation, subject to an IRS limit on compensation. The Companys expense for the U.S. plans totaled $ 32 million, $ 43 million and $ 43 million in 2021, 2020 and 2019, respectively. We also sponsor defined contribution plans in certain locations outside the United States. The Companys expense for these plans totaled $ 79 million, $ 63 million and $ 64 million in 2021, 2020 and 2019, respectively. Multi-Employer Retirement Plans The Company participates in various multi-employer retirement plans. Multi-employer retirement plans are designed to provide benefits to or on behalf of employees of multiple employers. These plans are typically established under collective bargaining agreements. Multi-employer retirement plans are generally governed by a board of trustees composed of representatives of both management and labor and are generally funded through employer contributions. The Companys expense for multi-employer retirement plans totaled $ 1 million, $ 2 million and $ 5 million in 2021, 2020 and 2019, respectively. The plans we currently participate in have contractual arrangements that extend into 2025. If, in the future, we choose to withdraw from any of the multi-employer retirement plans in which we currently participate, we would record the appropriate withdrawal liability, if any, at that time . NOTE 14: INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, 2021 2020 2019 United States $ 3,538 $ 3,149 $ 3,249 International 8,887 6,600 7,537 Total $ 12,425 $ 9,749 $ 10,786 Income taxes consisted of the following (in millions): United States State and Local International Total 2021 Current $ 243 $ 106 $ 1,378 $ 1,727 Deferred 229 ( 10 ) 675 894 2020 Current $ 296 $ 396 $ 1,307 $ 1,999 Deferred ( 220 ) 21 181 ( 18 ) 2019 Current $ 508 $ 94 $ 1,479 $ 2,081 Deferred ( 65 ) 52 ( 267 ) ( 280 ) 1 Includes net tax expense of $ 195 million related to the changes in tax laws in certain foreign jurisdictions. We made income tax payments of $ 2,168 million, $ 1,268 million and $ 2,126 million in 2021, 2020 and 2019, respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Eswatini. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 381 million, $ 317 million and $ 335 million for the years ended December 31, 2021, 2020 and 2019, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2021 2020 2019 Statutory U.S. federal tax rate 21.0 % 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 1.1 0.9 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 2.3 0.9 1.1 6,7,8 Equity income or loss ( 2.0 ) ( 1.4 ) ( 1.6 ) Excess tax benefits on stock-based compensation ( 0.5 ) ( 0.8 ) ( 0.9 ) Other net ( 0.8 ) ( 0.5 ) 4,5 ( 3.8 ) Effective tax rate 21.1 % 20.3 % 16.7 % 1 Includes net tax charges of $ 375 million (or a 3.0 percent impact on our effective tax rate) related to changes in tax laws in certain foreign jurisdictions, amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other discrete items. 2 Includes a tax benefit of $ 14 million (or a 1.5 percent impact on our effective tax rate) associated with the $ 834 million gain recorded upon the acquisition of the remaining ownership interest in BodyArmor. Refer to Note 2. 3 Includes net tax charges of $ 110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 4 Includes net tax expense of $ 431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $ 107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 5 Includes a tax benefit of $ 40 million (or a 2.4 percent impact on our effective tax rate) associated with the $ 902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2. 6 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon audit issues. 7 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 8 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 9 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon audit issues. As of December 31, 2021, we have not recorded incremental income taxes for any additional outside basis differences of approximately $ 5.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (GILTI) provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiarys earnings in excess of an allowable return on the foreign subsidiarys tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company and its subsidiaries file income tax returns in all applicable jurisdictions, including the U.S. federal jurisdiction, U.S. state jurisdictions and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007. With respect to U.S. state jurisdictions and foreign jurisdictions, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years prior to 2006. For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of CocaCola Enterprises Inc.s former North America business that were generated from the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for in accordance with the applicable accounting guidance. On November 18, 2020, the Tax Court issued the Opinion regarding the Companys 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11. As of December 31, 2021, the gross amount of unrecognized tax benefits was $ 906 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 600 million, exclusive of any benefits related to interest and penalties. The remaining $ 306 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2021 2020 2019 Balance of unrecognized tax benefits at beginning of year $ 915 $ 392 $ 336 Increase related to prior period tax positions 9 528 204 Decrease related to prior period tax positions ( 50 ) ( 1 ) Increase related to current period tax positions 37 26 29 Decrease related to settlements with taxing authorities ( 4 ) ( 19 ) ( 174 ) Effect of foreign currency translation ( 1 ) ( 11 ) ( 3 ) Balance of unrecognized tax benefits at end of year $ 906 $ 915 $ 392 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11. 2 The increase was primarily related to a change in judgment about the Companys tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Companys tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes interest and penalties related to unrecognized tax benefits in the line item income taxes on our consolidated statement of income. The Company had $ 453 million, $ 391 million and $ 201 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2021, 2020 and 2019, respectively. Of these amounts, expense of $ 62 million, $ 190 million and $ 11 million was recognized in 2021, 2020 and 2019, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Companys effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect any changes will have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. Currently, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, 2021 2020 Deferred tax assets: Property, plant and equipment $ 36 $ 44 Trademarks and other intangible assets 1,910 2,214 Equity method investments (including net foreign currency translation adjustments) 595 580 Derivative financial instruments 215 523 Other liabilities 1,255 1,401 Benefit plans 670 893 Net operating/capital loss carryforwards 280 320 Other 377 391 Gross deferred tax assets 5,338 6,366 Valuation allowances ( 401 ) ( 406 ) Total deferred tax assets $ 4,937 $ 5,960 Deferred tax liabilities: Property, plant and equipment $ ( 721 ) $ ( 837 ) Trademarks and other intangible assets ( 1,783 ) ( 1,661 ) Equity method investments (including net foreign currency translation adjustments) ( 1,619 ) ( 1,533 ) Derivative financial instruments ( 500 ) ( 435 ) Other liabilities ( 315 ) ( 402 ) Benefit plans ( 527 ) ( 321 ) Other ( 164 ) ( 144 ) Total deferred tax liabilities $ ( 5,629 ) $ ( 5,333 ) Net deferred tax assets (liabilities) $ ( 692 ) $ 627 As of December 31, 2021 and 2020, we had net deferred tax assets of $ 0.7 billion and $ 1.4 billion, respectively, located in countries outside the United States. As of December 31, 2021, we had $ 2,313 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 849 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, 2021 2020 2019 Balance at beginning of year $ 406 $ 303 $ 419 Additions 25 240 148 Deductions ( 30 ) ( 137 ) ( 264 ) Balance at end of year $ 401 $ 406 $ 303 The Companys deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards and foreign tax credit carryforwards from operations in various jurisdictions and basis differences in certain equity investments. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2021, the Company recognized a net decrease of $ 5 million in its valuation allowances. The decrease was primarily due to net decreases in the deferred tax assets and related valuation allowances on certain equity investments and the changes in net operating losses in the normal course of business. In 2020, the Company recognized a net increase of $ 103 million in its valuation allowances. The increase was primarily due to net increases in the deferred tax assets and related valuation allowances on certain equity investments. The increase was also due to the increase of valuation allowances after considering significant negative evidence on the utilization of certain net operating losses and excess foreign tax credits. In 2019, the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be nondeductible and the changes in net operating losses in the normal course of business. The decrease was partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. NOTE 15: OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Companys shareowners equity, which also includes our proportionate share of equity method investees AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, 2021 2020 Net foreign currency translation adjustments $ ( 12,595 ) $ ( 12,028 ) Accumulated net gains (losses) on derivatives 20 ( 194 ) Unrealized net gains (losses) on available-for-sale debt securities ( 62 ) 28 Adjustments to pension and other postretirement benefit liabilities ( 1,693 ) ( 2,407 ) Accumulated other comprehensive income (loss) $ ( 14,330 ) $ ( 14,601 ) The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2021 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 9,771 $ 33 $ 9,804 Other comprehensive income: Net foreign currency translation adjustments ( 567 ) ( 132 ) ( 699 ) Net gains (losses) on derivatives 1 214 214 Net change in unrealized gains (losses) on available-for-sale debt securities 2 ( 90 ) ( 90 ) Net change in pension and other postretirement benefit liabilities 3 714 ( 2 ) 712 Total comprehensive income $ 10,042 $ ( 101 ) $ 9,941 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Companys pension and other postretirement benefit liabilities. The following tables present OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees OCI (in millions): Before-Tax Amount Income Tax After-Tax Amount 2021 Foreign currency translation adjustments: Translation adjustments arising during the year $ 263 $ 19 $ 282 Reclassification adjustments recognized in net income 257 257 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,798 ) ( 1,798 ) Gains (losses) on net investment hedges arising during the year 1 918 ( 230 ) 688 Reclassification adjustments for net investment hedges recognized in net income 1 4 4 Net foreign currency translation adjustments $ ( 356 ) $ ( 211 ) $ ( 567 ) Derivatives: Gains (losses) arising during the year $ 160 $ ( 41 ) $ 119 Reclassification adjustments recognized in net income 124 ( 29 ) 95 Net gains (losses) on derivatives 1 $ 284 $ ( 70 ) $ 214 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 141 ) $ 48 $ ( 93 ) Reclassification adjustments recognized in net income 4 ( 1 ) 3 Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 137 ) $ 47 $ ( 90 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ 653 $ ( 138 ) $ 515 Reclassification adjustments recognized in net income 265 ( 66 ) 199 Net change in pension and other postretirement benefit liabilities 3 $ 918 $ ( 204 ) $ 714 Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ 709 $ ( 438 ) $ 271 2020 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 2,223 ) $ 150 $ ( 2,073 ) Reclassification adjustments recognized in net income 3 3 Gains (losses) on intra-entity transactions that are of a long-term investment nature 2,133 2,133 Gains (losses) on net investment hedges arising during the year 1 ( 1,094 ) 273 ( 821 ) Net foreign currency translation adjustments $ ( 1,181 ) $ 423 $ ( 758 ) Derivatives: Gains (losses) arising during the year $ ( 54 ) $ 13 $ ( 41 ) Reclassification adjustments recognized in net income 74 ( 18 ) 56 Net gains (losses) on derivatives 1 $ 20 $ ( 5 ) $ 15 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 64 ) $ 22 $ ( 42 ) Reclassification adjustments recognized in net income ( 7 ) 2 ( 5 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 71 ) $ 24 $ ( 47 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 560 ) $ 138 $ ( 422 ) Reclassification adjustments recognized in net income 206 ( 51 ) 155 Net change in pension and other postretirement benefit liabilities 3 $ ( 354 ) $ 87 $ ( 267 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,586 ) $ 529 $ ( 1,057 ) Before-Tax Amount Income Tax After-Tax Amount 2019 Foreign currency translation adjustments: Translation adjustments arising during the year $ 52 $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income 192 192 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 195 ( 49 ) 146 Net foreign currency translation adjustments $ 132 $ ( 103 ) $ 29 Derivatives: Gains (losses) arising during the year $ ( 225 ) $ 49 $ ( 176 ) Reclassification adjustments recognized in net income 163 ( 41 ) 122 Net gains (losses) on derivatives 1 $ ( 62 ) $ 8 $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ 47 $ ( 4 ) $ 43 Reclassification adjustments recognized in net income ( 31 ) 6 ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ 16 $ 2 $ 18 Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 379 ) $ 105 $ ( 274 ) Reclassification adjustments recognized in net income 151 ( 36 ) 115 Net change in pension and other postretirement benefit liabilities 3 $ ( 228 ) $ 69 $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Companys pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2021 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ 261 Income before income taxes 261 Income taxes Consolidated net income $ 261 Derivatives: Foreign currency contracts Net operating revenues $ 77 Foreign currency and commodity contracts Cost of goods sold 10 Foreign currency contracts Other income (loss) net ( 74 ) Divestitures, deconsolidations and other 1 Other income (loss) net 8 Foreign currency and interest rate contracts Interest expense 103 Income before income taxes 124 Income taxes ( 29 ) Consolidated net income $ 95 Available-for-sale debt securities: Sale of debt securities Other income (loss) net $ 4 Income before income taxes 4 Income taxes ( 1 ) Consolidated net income $ 3 Pension and other postretirement benefit liabilities: Settlement charges 2 Other income (loss) net $ 117 Curtailment charges (credits) 2 Other income (loss) net ( 2 ) Recognized net actuarial loss Other income (loss) net 150 Recognized prior service cost (credit) Other income (loss) net ( 2 ) Divestitures, deconsolidations and other 1 Other income (loss) net 2 Income before income taxes 265 Income taxes ( 66 ) Consolidated net income $ 199 1 Refer to Note 2. 2 The settlement charges and curtailment credits were related to our strategic realignment initiatives. Refer to Note 13 and Note 18. NOTE 16: FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale, derivative financial instruments and our contingent consideration liability. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Companys fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract prices as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (CDS) rates applied to each contract, by counterparty. We use our counterpartys CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2021 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,372 $ 230 $ 17 $ 104 $ $ 2,723 Debt securities 1 1,556 33 1,589 Derivatives 2 69 588 ( 459 ) 198 Total assets $ 2,441 $ 2,374 $ 50 $ 104 $ ( 459 ) $ 4,510 Liabilities: Contingent consideration liability $ $ $ 590 5 $ $ $ 590 Derivatives 2 96 ( 82 ) 14 Total liabilities $ $ 96 $ 590 $ $ ( 82 ) $ 604 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 331 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Companys derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 198 million in the line item other noncurrent assets and $ 14 million in the line item other noncurrent liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2020 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,049 $ 210 $ 12 $ 103 $ $ 2,374 Debt securities 1 4 2,267 32 2,303 Derivatives 2 63 835 ( 669 ) 229 Total assets $ 2,116 $ 3,312 $ 44 $ 103 $ ( 669 ) $ 4,906 Liabilities: Contingent consideration liability $ $ $ 321 $ $ $ 321 Derivatives 2 91 ( 81 ) 10 Total liabilities $ $ 91 $ 321 $ $ ( 81 ) $ 331 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 546 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Companys derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 229 million in the line item other noncurrent assets, $ 9 million in the line item accounts payable and accrued expenses and $ 1 million in the line item other noncurrent liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2021 and 2020. The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2021 and 2020. Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, 2021 2020 Assets held for sale $ ( 266 ) $ Other-than-temporary impairment charges ( 290 ) Impairment of intangible assets ( 78 ) ( 215 ) Impairment of equity investment without a readily determinable fair value ( 26 ) Total $ ( 344 ) $ ( 531 ) 1 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. The Company recorded charges of $ 266 million in the line item other income (loss) net in our consolidated statement of income related to the restructuring of our manufacturing operations in the United States. These charges, which were calculated based on Level 3 inputs, primarily impacted the line item property, plant and equipment in our consolidated balance sheet. 2 The Company recorded an impairment charge of $ 78 million related to a trademark in Europe, which was driven by a change in the long-term outlook on the licensing arrangement for a certain brand. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 3 During the year ended December 31, 2020, the Company recorded an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee. Based on the length of time and the extent to which the market value of our investment in CCBJHI was less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. This impairment charge was determined using the quoted market price (a Level 1 measurement) of CCBJHI. The Company also recorded an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 4 The Company recorded impairment charges of $ 160 million related to its Odwalla trademark in North America, as the Company decided in June 2020 to discontinue its Odwalla juice business. The Company also recorded an impairment charge of $ 55 million related to a trademark in North America, which was driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Companys portfolio. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recorded an impairment charge of $ 26 million related to an investment in an equity security without a readily determinable fair value. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheet but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Companys future net periodic benefit cost or income as well as amounts recognized in our consolidated balance sheet. Refer to Note 13. The Company uses the fair value hierarchy to measure the fair value of assets held by our pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2021 December 31, 2020 Level 1 Level 2 Level 3 Other Total Level 1 Level 2 Level 3 Other Total Cash and cash equivalents $ 479 $ 26 $ $ $ 505 $ 558 $ 120 $ $ $ 678 Equity securities: U.S.-based companies 2,382 22 27 2,431 2,123 12 4 2,139 International-based companies 1,684 22 1,706 1,694 32 1,726 Fixed-income securities: Government bonds 677 677 637 637 Corporate bonds and debt securities 994 29 1,023 1,011 31 1,042 Mutual, pooled and commingled funds 36 283 531 850 44 268 502 814 Hedge funds/limited partnerships 720 720 622 622 Real estate 389 389 332 332 Derivative financial instruments ( 9 ) ( 9 ) ( 15 ) ( 15 ) Other 283 330 613 302 3 362 664 Total $ 4,581 $ 2,015 $ 339 $ 1,970 $ 8,905 $ 4,419 $ 2,065 $ 337 $ 1,818 $ 8,639 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 This class of assets includes investments in credit contracts. 3 Includes purchased annuity insurance contracts. 4 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developing and emerging markets. There are no liquidity restrictions on these investments. 5 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semiannually, with a redemption notice period of up to one year and/or initial lock-up periods of up to three years, and private equity funds that are primarily closed-end funds in which the Companys investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 6 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation and can be subject to redemption restrictions, ranging from quarterly to semiannually, with a redemption notice period of up to 90 days. 7 Primarily includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semiannual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Other Total 2020 Balance at beginning of year $ 21 $ 40 $ 273 $ 334 Actual return on plan assets 1 6 7 Purchases, sales and settlements net ( 18 ) ( 17 ) 4 ( 31 ) Transfers into Level 3 net 1 7 8 Net foreign currency translation adjustments 19 19 Balance at end of year $ 4 $ 31 $ 302 $ 337 2021 Balance at beginning of year $ 4 $ 31 $ 302 $ 337 Actual return on plan assets 21 ( 3 ) ( 6 ) 12 Purchases, sales and settlements net 2 7 ( 2 ) 7 Transfers into Level 3 net ( 6 ) ( 6 ) Net foreign currency translation adjustments ( 11 ) ( 11 ) Balance at end of year $ 27 $ 29 $ 283 $ 339 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2021 December 31, 2020 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ 32 $ 1 $ $ 33 $ 29 $ 1 $ $ 30 Equity securities: U.S.-based companies 183 1 184 169 1 170 International-based companies 12 12 12 12 Fixed-income securities: Government bonds 3 3 3 3 Corporate bonds and debt securities 82 82 80 80 Mutual, pooled and commingled funds 85 2 87 84 2 86 Hedge funds/limited partnerships 9 9 7 7 Real estate 5 5 4 4 Other 4 4 4 4 Total $ 227 $ 172 $ 20 $ 419 $ 210 $ 169 $ 17 $ 396 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13 . Other Fair Value Disclosures The carrying values of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2021, the carrying value and fair value of our long-term debt, including the current portion, were $ 39,454 million and $ 40,311 million, respectively. As of December 31, 2020, the carrying value and fair value of our long-term debt, including the current portion, were $ 40,610 million and $ 43,218 million, respectively. NOTE 17: SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2021, the Company recorded other operating charges of $ 846 million. These charges primarily consisted of $ 369 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition, $ 146 million related to the Companys strategic realignment initiatives, $ 119 million related to the BodyArmor acquisition, which includes various transition and transaction costs, distributor termination fees, employee retention costs and the amortization of noncompete agreements, and $ 115 million related to the Companys productivity and reinvestment program. In addition, other operating charges included an impairment charge of $ 78 million related to a trademark in Europe, charges of $ 15 million related to tax litigation and a net charge of $ 4 million related to the restructuring of our manufacturing operations in the United States. In 2020, the Company recorded other operating charges of $ 853 million. These charges primarily consisted of $ 413 million related to the Companys strategic realignment initiatives and $ 99 million related to the Companys productivity and reinvestment program. In addition, other operating charges included impairment charges of $ 160 million related to the Odwalla trademark and net charges of $ 33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $ 55 million related to a trademark in North America. In addition, other operating charges included $ 51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and net charges of $ 16 million related to the restructuring of our manufacturing operations in the United States. In 2019, the Company recorded other operating charges of $ 458 million. These charges included $ 264 million related to the Companys productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisitions of BodyArmor, fairlife and Costa. Refer to Note 11 for additional information related to the tax litigation. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Companys strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the years ended December 31, 2021 and 2020, the Company recorded charges of $ 650 million and $ 484 million, respectively, related to the extinguishment of long-term debt. Refer to Note 10. Equity Income (Loss) Net The Company recorded net charges of $ 13 million, $ 216 million and $ 100 million in equity income (loss) net during the years ended December 31, 2021, 2020 and 2019, respectively. These amounts represent the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net During 2021, the Company recognized a gain of $ 834 million in conjunction with the BodyArmor acquisition, a net gain of $ 695 million related to the sale of our ownership interest in CCA, an equity method investee, and a net gain of $ 114 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Additionally, the Company recognized a net gain of $ 467 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. The Company also recorded charges of $ 266 million related to the restructuring of our manufacturing operations in the United States and pension plan settlement charges of $ 117 million related to our strategic realignment initiatives. During 2020, the Company recognized a gain of $ 902 million in conjunction with the fairlife acquisition, a net gain of $ 148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, and a net gain of $ 35 million related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee . These gains were partially offset by an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America, an impairment charge of $ 26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $ 55 million related to economic hedging activities. The Company also recorded net charges of $ 25 million related to the restructuring of our manufacturing operations in the United States and pension and other postretirement benefit plan settlement and curtailment charges of $ 14 million related to the Companys strategic realignment initiatives. During 2019, the Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBAs fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recorded net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America. Refer to Note 2 for additional information on the acquisitions of BodyArmor, fairlife and CHI, the sale of our ownership interest in CCA, the sale of a portion of our ownership interest in Andina, the refranchising activity in India, and the CCBA asset adjustment. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 5 for additional information on our economic hedging activities. Refer to Note 16 for additional information on the impairment charges and charges related to the restructuring of our manufacturing operations in the United States. Refer to Note 18 for additional information on the Companys strategic realignment initiatives. Refer to Note 19 for the impact these items had on our operating segments and Corporate. NOTE 18: RESTRUCTURING Strategic Realignment In August 2020, the Company announced strategic steps to transform our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace. The Company has transformed into a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We created new operating units effective January 1, 2021, which are focused on regional and local execution. The operating units, which sit under the four existing geographic operating segments, are highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units work closely with five global marketing category leadership teams to rapidly scale ideas while staying close to the consumer. The global marketing category leadership teams primarily focus on innovation as well as marketing efficiency and effectiveness. The organizational structure also includes a center and a platform services organization. Refer to Note 19 for additional information on our organizational structure. The Company has incurred total pretax expenses of $ 690 million related to these strategic realignment initiatives since they commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these expenses had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal and consulting activities. These initiatives were substantially complete as of December 31, 2021. The following table summarizes the balance of accrued expenses related to these strategic realignment initiatives (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2020 Costs incurred $ 386 $ 37 $ 4 $ 427 Payments ( 170 ) ( 36 ) ( 1 ) ( 207 ) Noncash and exchange ( 35 ) ( 35 ) Accrued balance at end of year $ 181 $ 1 $ 3 $ 185 2021 Accrued balance at beginning of year $ 181 $ 1 $ 3 $ 185 Costs incurred 224 37 2 263 Payments ( 265 ) ( 35 ) ( 3 ) ( 303 ) Noncash and exchange ( 120 ) ( 2 ) ( 122 ) Accrued balance at end of year $ 20 $ 1 $ 2 $ 23 1 Includes stock-based compensation modifications, pension settlement charges, and other postretirement benefit plan curtailment charges. Refer to Note 12 and Note 13. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program was expanded multiple times, with the last expansion occurring in April 2017. While we expect most of the remaining initiatives included in this program, which are primarily designed to further simplify and standardize our organization, to be completed by the end of 2023, certain initiatives may extend into 2024. The Company has incurred total pretax expenses of $ 4,044 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily include costs associated with outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2019 Accrued balance at beginning of year $ 76 $ 10 $ 4 $ 90 Costs incurred 36 87 141 264 Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 3 2 ( 19 ) ( 14 ) Accrued balance at end of year $ 58 $ 1 $ 7 $ 66 2020 Accrued balance at beginning of year $ 58 $ 1 $ 7 $ 66 Costs incurred ( 12 ) 69 42 99 Payments ( 29 ) ( 70 ) ( 36 ) ( 135 ) Noncash and exchange ( 2 ) ( 11 ) ( 13 ) Accrued balance at end of year $ 15 $ $ 2 $ 17 2021 Accrued balance at beginning of year $ 15 $ $ 2 $ 17 Costs incurred 4 97 14 115 Payments ( 6 ) ( 97 ) ( 14 ) ( 117 ) Noncash and exchange ( 1 ) 3 2 Accrued balance at end of year $ 12 $ $ 5 $ 17 NOTE 19: OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focusing on strategic initiatives, policy, governance and scaling global initiatives; and (2) a platform services organization supporting operating units, global marketing category leadership teams and the center by providing efficient and scaled global services and capabilities including, but not limited to, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. Segment Products and Services The business of our Company is primarily nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investees. Our consolidated bottling operations derive the majority of their revenues from the manufacture and sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins than concentrate operations. Refer to Note 3. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2021 2020 2019 Concentrate operations 56 % 56 % 55 % Finished product operations 44 44 45 Total 100 % 100 % 100 % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and interest expense, on a global basis within Corporate. We evaluate operating segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2021 2020 2019 United States $ 13,010 $ 11,281 $ 11,715 International 25,645 21,733 25,551 Net operating revenues $ 38,655 $ 33,014 $ 37,266 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2021 2020 2019 United States $ 3,420 $ 3,988 $ 4,062 International 6,500 6,789 6,776 Property, plant and equipment net $ 9,920 $ 10,777 $ 10,838 Information about our Companys operations by operating segment and Corporate is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated As of and for the Year Ended December 31, 2021 Net operating revenues: Third party $ 6,564 $ 4,143 $ 13,184 $ 4,682 $ 2,805 $ 7,194 $ 83 $ $ 38,655 Intersegment 629 6 609 9 2 ( 1,255 ) Total net operating revenues 7,193 4,143 13,190 5,291 2,805 7,203 85 ( 1,255 ) 38,655 Operating income (loss) 3,735 2,534 3,331 2,325 293 473 ( 2,383 ) 10,308 Interest income 40 10 226 276 Interest expense 1,597 1,597 Depreciation and amortization 76 39 388 49 135 529 236 1,452 Equity income (loss) net 33 9 22 8 ( 6 ) 1,071 301 1,438 Income (loss) before income taxes 3,821 2,542 3,140 2,350 310 1,596 ( 1,334 ) 12,425 Identifiable operating assets 7,908 1,720 25,730 2,355 3 7,949 10,312 2,3 19,964 75,938 Investments 1 436 594 21 230 12,669 4,466 18,416 Capital expenditures 35 2 228 65 285 560 192 1,367 As of and for the Year Ended December 31, 2020 Net operating revenues: Third party $ 5,534 $ 3,499 $ 11,473 $ 4,213 $ 1,991 $ 6,258 $ 46 $ $ 33,014 Intersegment 523 4 509 7 ( 1,043 ) Total net operating revenues 6,057 3,499 11,477 4,722 1,991 6,265 46 ( 1,043 ) 33,014 Operating income (loss) 3,313 2,116 2,471 2,133 ( 123 ) 308 ( 1,221 ) 8,997 Interest income 64 11 295 370 Interest expense 1,437 1,437 Depreciation and amortization 86 45 439 47 122 551 246 1,536 Equity income (loss) net 31 ( 72 ) 8 ( 9 ) 779 241 978 Income (loss) before income taxes 3,379 2,001 2,500 2,158 ( 120 ) 898 ( 1,067 ) 9,749 Identifiable operating assets 8,098 1,597 19,444 2,073 3 7,575 10,521 2,3 17,903 67,211 Investments 1 517 603 345 240 4 14,183 4,193 20,085 Capital expenditures 27 6 182 20 261 474 207 1,177 Year Ended December 31, 2019 Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ 94 $ $ 37,266 Intersegment 624 9 604 2 9 ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 94 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 334 358 ( 1,408 ) 10,086 Interest income 65 12 486 563 Interest expense 946 946 Depreciation and amortization 86 35 439 31 117 446 211 1,365 Equity income (loss) net 35 ( 32 ) ( 6 ) 11 ( 3 ) 836 208 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 343 716 ( 824 ) 10,786 Capital expenditures 108 140 392 47 209 836 322 2,054 1 Principally equity method investments and other investments in bottling companies. 2 Property, plant and equipment net in South Africa represented 16 percent and 15 percent of consolidated property, plant and equipment net as of December 31, 2021 and 2020, respectively. 3 Property, plant and equipment net in the Philippines represented 10 percent of consolidated property, plant and equipment net as of December 31, 2021 and 2020. During 2021, 2020 and 2019, our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2021, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 369 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for Corporate due to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 98 million for Corporate and $ 21 million for North America related to various costs incurred in conjunction with our acquisition of BodyArmor. Refer to Note 2 and Note 17. Operating income (loss) and income (loss) before income taxes were reduced by $ 78 million for Europe, Middle East and Africa related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 63 million and $ 61 million, respectively, for Europe, Middle East and Africa, $ 46 million and $ 160 million, respectively, for Corporate, $ 12 million and $ 14 million, respectively, for Asia Pacific, and $ 11 million and $ 12 million, respectively, for Latin America due to the Companys strategic realignment initiatives. In addition, operating income (loss) and income (loss) before income taxes were both reduced by $ 14 million for North America and income (loss) before income taxes was reduced by $ 2 million for Bottling Investments due to the Companys strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 52 million and $ 316 million, respectively, for North America, and income (loss) before income taxes was reduced by $ 2 million for Corporate related to the restructuring of our manufacturing operations in the United States. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 15 million for Corporate related to tax litigation expense. Refer to Note 11. Income (loss) before income taxes was increased by $ 834 million for Corporate in conjunction with our acquisition of BodyArmor, which resulted from the remeasurement of our previously held equity interest in BodyArmor to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 695 million for Corporate related to the sale of our ownership interest in CCA, an equity method investee. Refer to Note 2. Income (loss) before income taxes was increased by $ 467 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 114 million for Corporate related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Refer to Note 2. Income (loss) before income taxes was reduced by $ 650 million for Corporate related to charges associated with the extinguishment of long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 45 million for Bottling Investments and was increased by $ 32 million for Corporate due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2020, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes for North America were reduced by $ 160 million related to the impairment of the Odwalla trademark and $ 33 million related to the cost of discontinuing the Odwalla juice business. Operating income (loss) and income (loss) before income taxes were reduced by $ 145 million and $ 153 million, respectively, for Corporate, $ 31 million and $ 30 million, respectively, for Asia Pacific, $ 21 million and $ 26 million, respectively, for Bottling Investments, and $ 19 million and $ 21 million, respectively, for Latin America due to the Companys strategic realignment initiatives. Additionally, operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for North America, $ 78 million for Europe, Middle East and Africa and $ 4 million for Global Ventures due to the Companys strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 104 million for Corporate due to the Companys productivity and reinvestment program. Operating income (loss) and income (loss) before income taxes were increased by $ 5 million for Europe, Middle East and Africa due to the refinement of previously established accruals related to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 59 million and $ 84 million, respectively, for North America related to the restructuring of our manufacturing operations in the United States. Operating income (loss) and income (loss) before income taxes were reduced by $ 55 million for North America related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 51 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Income (loss) before income taxes was increased by $ 902 million for Corporate in conjunction with our fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 148 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 35 million for Corporate related to the sale of our ownership interest in an equity method investee and the sale of a portion of our ownership interest in another equity method investee. Refer to Note 2. Income (loss) before income taxes was reduced by $ 484 million for Corporate related to charges associated with the extinguishment of long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 252 million for Bottling Investments and $ 38 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 145 million for Bottling Investments, $ 70 million for Latin America and $ 1 million for North America due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 26 million for Corporate due to an impairment charge associated with an investment in an equity security without a readily determinable fair value. Refer to Note 16. In 2019, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Companys productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2. Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our ownership interest in Andina. Refer to Note 2. Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2. Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Refer to Note 2. Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Companys proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. NOTE 20: NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities was composed of the following (in millions): Year Ended December 31, 2021 2020 2019 (Increase) decrease in trade accounts receivable 1 $ ( 225 ) $ 882 $ ( 158 ) (Increase) decrease in inventories ( 135 ) 99 ( 183 ) (Increase) decrease in prepaid expenses and other current assets ( 241 ) 78 ( 87 ) Increase (decrease) in accounts payable and accrued expenses 2 2,843 ( 860 ) 1,318 Increase (decrease) in accrued income taxes 3 ( 566 ) ( 16 ) 96 Increase (decrease) in other noncurrent liabilities 4 ( 351 ) 507 ( 620 ) Net change in operating assets and liabilities $ 1,325 $ 690 $ 366 1 The increase in trade accounts receivable in 2021 was primarily due to improved business performance. The decrease in trade accounts receivable in 2020 was primarily due to the impact of the COVID-19 pandemic and the start of a trade accounts receivable factoring program. Refer to Note 1 for additional information on the factoring program. 2 The increase in accounts payable and accrued expenses in 2021 was primarily driven by an increase in trade accounts payable, higher marketing accruals, BodyArmor acquisition-related accruals and higher annual incentive accruals. The decrease in accounts payable and accrued expenses in 2020 was primarily driven by the impact of the COVID-19 pandemic and lower annual incentive accruals. Refer to Note 2 for information regarding the BodyArmor acquisition. 3 The decrease in accrued income taxes in 2021 was primarily driven by increased tax payments in 2021. Refer to Note 14. 4 The increase in other noncurrent liabilities in 2020 was primarily due to the increase in income tax reserves related to the litigation with the IRS. Refer to Note 11 . REPORT OF MANAGEMENT Managements Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this report is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Companys Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Companys Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Managements Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (Exchange Act). Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (COSO) in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2021. The Companys independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of our Companys Board of Directors, subject to ratification by our Companys shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Companys internal control over financial reporting. The reports of the independent auditors are contained in this report. Audit Committees Responsibility The Audit Committee of our Companys Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Companys Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committees Report can be found in the Companys 2022 Proxy Statement. James R. Quincey John Murphy Chairman of the Board of Directors and Chief Executive Officer February 22, 2022 Executive Vice President and Chief Financial Officer February 22, 2022 Kathy Loveless Mark Randazza Vice President and Controller February 22, 2022 Vice President, Assistant Controller and Chief Accounting Officer February 22, 2022 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 11 and Note 14 to the Companys consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2021, the gross amount of unrecognized tax benefits was $906 million. As described in Note 11, on September 17, 2015 the Company received a Statutory Notice of Deficiency from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period. On November 18, 2020, the U.S. Tax Court issued an opinion predominantly siding with the IRS related to the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates for tax years 2007 through 2009. While the Company continues to disagree with the IRS positions and the portions of the opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS could ultimately be upheld. As a result of the application of ASC 740, Accounting for Income Taxes , the Company has recorded a tax reserve of $400 million for this matter as of December 31, 2021. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS notice and opinion, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of managements assessment of the opinion, including inquiries of tax counsel, inspection of technical memos, and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 11 and Note 14. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 to the Companys consolidated financial statements, the Company performs an annual impairment test of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment test may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $14.5 billion and $19.4 billion, respectively, as of December 31, 2021. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, royalty rates, long-term growth rates, and cost of capital, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment tests for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative test and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment tests of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of certain significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment tests included in Note 1. /s/ Ernst Young LLP We have served as the Companys auditor since 1921. Atlanta, Georgia February 22, 2022 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, shareowners equity, and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 22, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 22, 2022 "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Companys disclosure controls and procedures were effective as of December 31, 2021. Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2021 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, Item 8. Financial Statements and Supplementary Data in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Companys internal control over financial reporting during the quarter ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. " +1,ko-2,20201231," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to the Company account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. We are guided by our purpose, which is to refresh the world and make a difference, and rooted in our strategy to drive net operating revenue growth and generate long-term value. We are determined to emerge from the COVID-19 pandemic a better and stronger company. The vision for our next stage of growth has three connected pillars: Loved Brands. We craft meaningful brands and a choice of drinks that people love and that refresh them in body and spirit. Done Sustainably. We use our leadership to be part of the solution to achieve positive change in the world and to build a more sustainable future for our planet. For A Better Shared Future. We invest to improve peoples lives, from our employees to all those who touch our business system, to our investors, to the broad communities we call home. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For additional information about our operating segments and Corporate, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes powders/minerals for purified water products; ""syrups"" means an intermediate product in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa Limited (""Costa""), which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We own and market numerous valuable beverage brands, including the following: sparkling soft drinks: Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, * Sprite, and Thums Up; water, enhanced water and sports drinks: Aquarius, Ciel, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade, and Topo Chico; juice, dairy and plant-based beverages: AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy, and Simply; and tea and coffee: Ayataka, Costa, doadan, FUZE TEA, Georgia, Gold Peak, HONEST TEA, and Kochakaden. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further optimize its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as our consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of 1.9 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 29.0 billion, 30.3 billion and 29.6 billion unit cases of our products in 2020, 2019 and 2018, respectively. In 2019, with the exception of ready-to-drink products, the Company did not report unit case volume for Costa, a component of the Global Ventures operating segment. However, unit case volume reported in 2020 includes both Costa ready-to-drink and non-ready-to-drink products. Sparkling soft drinks represented 69 percent of our worldwide unit case volume in 2020, 2019 and 2018. Trademark Coca-Cola accounted for 47 percent, 45 percent and 45 percent of our worldwide unit case volume in 2020, 2019 and 2018, respectively. In 2020, unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2020. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 32 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2020 were as follows: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2020, these five bottling partners combined represented 40 percent of our total worldwide unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners under which our bottling partners are granted certain authorizations by us. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a ""Comprehensive Beverage Agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. In all instances, the bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers have been granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage brands (as defined by the CBAs). We refer to these bottlers as expanding participating bottlers or ""EPBs."" EPBs operate under CBAs (""EPB CBAs"") under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights, which we refer to as participating bottlers (""PBs""), converted their legacy bottler's agreements to CBAs, to which we refer as ""PB CBAs,"" each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume prepared, packaged, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups, or deliver them on our behalf, to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing support and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers and other customers of our Company's products, principally for participation in promotional and marketing programs, was $4.1 billion in 2020. Investments in Bottling Operations Most of our branded beverage products are prepared, packaged, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of a bottling operation, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning a bottling operation enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a consolidated bottling operation, typically by selling all or a portion of our interest in the bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell a consolidated bottling operation to an independent bottling partner in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method. Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic and alcoholic beverage segments of the commercial beverage industry are highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete globally in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy drinks; sports and other performance-enhancing hydration beverages; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive products are sold to consumers in both ready-to-drink and non-ready-to-drink form. The Company has directly entered the alcoholic beverage segment in numerous markets outside the United States. In the United States, the Company has chosen to authorize alcohol-licensed third parties to use certain of its brands on alcoholic beverages. Competitive products include all flavored alcoholic beverages of varying alcoholic bases. In many of the countries in which we do business, PepsiCo, Inc., is a primary competitor. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, The Kraft Heinz Company, Suntory Beverage Food Limited, Unilever, AB InBev, Constellation Brands, Kirin Holdings, Heineken Holdings and Diageo. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private-label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, digital marking, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer recognition and loyalty; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition across both nonalcoholic and alcoholic beverages in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private-label beverage brands; new industry entrants; and dramatic shifts in consumer shopping methods and patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions that can impact the quality and supply of orange juice and orange juice concentrate. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our consolidated bottling operations and our non-bottling finished product operations also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere around the world. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (""GDPR"") as well as the California Consumer Privacy Act of 2018 (""CCPA""), which became effective on January 1, 2020. The interpretation and application of data privacy and data protection laws and regulations are often uncertain and are evolving in the United States and internationally. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Human Capital Management Our people and culture agendas are critical business priorities. Our Board of Directors, through the Talent and Compensation Committee, provides oversight of the Company's policies and strategies relating to talent, leadership and culture, including diversity and inclusion, as well as the Company's compensation philosophy and programs. The Talent and Compensation Committee also evaluates and approves the Company's compensation plans, policies and programs applicable to our senior executives. In addition, the Management Development Committee of our Board of Directors oversees succession planning and talent development for our senior executives. Employees We believe people are our most important asset, and we strive to attract high-performing talent. As of December 31, 2020 and 2019, our Company had approximately 80,300 and 86,200 employees, respectively, of which approximately 9,300 and 10,100, respectively, were located in the United States. The decrease in the total number of employees was primarily due to the Company's strategic realignment initiatives and the impact of the COVID-19 pandemic on our Costa retail stores, partially offset by the January 2020 acquisition of fairlife, LLC (""fairlife""). Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2020, approximately 900 employees in North America were covered by collective bargaining agreements. These agreements typically have terms of three to five years. We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. Diversity, Equity and Inclusion We believe that a diverse, equitable and inclusive workplace that mirrors the markets we serve is a strategic business priority and critical to the Company's success. We take a comprehensive view of diversity and inclusion across different races, ethnicities, tribes, religions, socioeconomic backgrounds, generations, abilities, and expressions of gender and sexual identity. As of December 31, 2020, we had approximately 8,900 employees located in the United States, excluding the employees of fairlife. Of these employees, 38 percent and 43 percent were female and people of color, respectively. We are focused on social justice issues, including racial and gender equity, both in the United States and around the world. In 2020, we started implementing a multifaceted racial equity plan in the United States, which set 10-year employee representation goals that reflect the country's racial and ethnic diversity. We also strive to be 50 percent led by women, in addition to growing and developing our female workforce overall. Diversity and inclusion metrics, which highlight progress and drive accountability, are shared with our senior leaders on a quarterly basis, and our Global Women's Leadership Council, composed of 15 female and male executives, focuses on accelerating the development and promotion of women into roles of increasing responsibility and influence. We also periodically conduct pay equity analyses to help identify any unsupported distinctions in pay between employees of different races, gender and/or age, as permitted by local law. We make adjustments to base pay, where appropriate. Also, during the annual rewards cycle, we perform an adverse impact analysis on base pay, annual incentives and long-term incentives to help ensure fairness. We support a number of employee business resource groups (""BRGs"") that are an integral part of our diversity, equity and inclusion strategy. Our BRGs provide employees with the opportunity to engage with colleagues based on shared interests in ethnic backgrounds, gender, sexual orientation, military service and work roles. Compensation and Benefits Through comprehensive and competitive compensation and benefits, ongoing employee learning and development, and a focus on health and well-being, we strive to support our employees in all aspects of their lives. Our compensation programs are designed to reinforce our growth agenda and our talent strategy as well as to drive a strong connection between the contributions of our employees and their pay. We believe the structure of our compensation packages provides the appropriate incentives to attract, retain and motivate our employees. We provide base pay that is competitive and that aligns with employee positions, skill levels, experience and geographic location. In addition to base pay, we seek to reward employees with annual incentive awards, recognition programs, and equity awards for employees at certain job grades. We also offer competitive employee benefits packages, which vary by country and region. These employee benefits packages may include: 401(k) plan, pension plan, core and supplemental life insurance, financial courses and advisors, employee assistance programs, tuition assistance, commuter assistance, adoption assistance, medical and dental insurance, vision insurance, health savings accounts, health reimbursement and flexible spending accounts, well-being rewards programs, vacation pay, holiday pay, and parental and adoption leave . Leadership, Training and Development We focus on investing in inspirational leadership, learning opportunities and capabilities to equip our global workforce with the skills they need while improving engagement and retention. We provide a range of formal and informal learning programs, which are designed to help our employees continuously grow and strengthen their skills throughout their careers . We offer a variety of programs that contribute to our leadership, training and development goals, including: (1) Coca-Cola U Digital Classroom, a hybrid space, equal parts classroom, studio, and online experience that combines the engaged learning environment of a traditional classroom with the flexibility, efficiency and scalability of digital delivery; (2) LinkedIn Learning, an online learning platform that provides relevant content of more than 16,000 expert-led courses; (3) Opportunity Marketplace, a people-centered technology solution that helps connect project opportunities to interested employees who have the capacity, skills and interest in short-term experiences and assignments; and (4) Emerging Stronger Coaching Program, a customized virtual coaching application that offers access to professional development coaches to support leadership development. COVID-19 Health Measures In response to the COVID-19 pandemic, we implemented measures to help ensure the health, safety and security of our employees, while constantly monitoring the rapidly evolving situation and adapting our efforts and responses. Around the world, we are endeavoring to follow guidance from authorities and health officials. This includes having the majority of our office-based employees work remotely, imposing travel restrictions and implementing safety measures for employees continuing critical on-site work including, but not limited to, social distancing practices, temperature checks, health symptom attestations when entering our facilities, and the use of personal protective equipment as appropriate and in accordance with local laws and regulations. Our system and production facilities have also implemented additional cleaning and sanitization routines and split shifts to ensure that we can continue to keep our brands in supply. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this report. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the ""Investors"" page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the ""Investors"" page of our website and review the information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. RISKS RELATED TO OUR OPERATIONS The COVID-19 pandemic has had, and we expect will continue to have, certain negative impacts on our business, and such impacts have had, and may continue to have, a material adverse effect on our results of operations, financial condition and cash flows. The public health crisis caused by theCOVID-19 pandemic and the measures that have been taken or that may be taken in the future by governments, businesses, including us and our bottling partners, and the public at large to limitthe spread of COVID-19 have had, and we expect will continue to have, certain negative impacts on our business including, without limitation, the following: We have experienced a decrease in sales of certain of our products in markets around the world as a result of the COVID-19 pandemic. In particular, sales of our products in the away-from-home channels have been significantly negatively affected by shelter-in-place regulations or recommendations, closings of restaurants and cancellations of major sporting and other events that were imposed as a result of the initial COVID-19 outbreak. While some of these restrictions have been lifted or eased in many jurisdictions as the rates of COVID-19 infections have decreased or stabilized, resurgence of the pandemic in some markets has slowed the reopening process. If COVID-19 infection trends increase, the pandemic intensifies or expands geographically or efforts to curb the pandemic are ineffective, the negative impacts of the pandemic on our sales could be more prolonged and may become more severe. While we initially experienced increased sales in the at-home channels from pantry loading as consumers stocked up on certain of our products with the expectation of spending more time at home during the crisis, such increased sales levels have not, and we expect will not, fully offset the sales pressures we have experienced, and we expect will continue to experience, in the away-from-home channels while shelter-in-place and social distancing mandates or recommendations are in effect. In certain COVID-19 affected markets, consumer demand has shifted away from some of our more profitable beverages and away-from-home consumption to lower-margin products and at-home consumption, and this shift in consumer purchasing patterns is likely to continue while shelter-in-place and social distancing behaviors are mandated or encouraged. We are accelerating our business strategy and are taking certain actions to address challenges posed by the COVID-19 pandemic and deliver on our commitment to emerge stronger from this crisis. These actions include focusing investments on a defined growth portfolio by prioritizing brands best positioned for consumer reach; streamlining the innovation pipeline through initiatives that are scalable regionally or globally, as well as maintaining a disciplined approach to local experimentation; refreshing our marketing approach, with a focus on improving our marketing investment effectiveness and efficiency; and investing in new capabilities to capitalize on emerging shifts in consumer behaviors that we anticipate may last beyond this crisis. These actions, which may require substantial additional investment of management time and financial resources, may not be sufficient to accomplish our goals. We have experienced temporary disruptions in certain of our concentrate production operations. We have taken measures to protect our employees and facilities around the world, which efforts have included, but have not been limited to, checking the temperature of employees when they enter our facilities, requiring employees to wear masks and other protective clothing as appropriate, and implementing additional cleaning and sanitization routines. These measures may not be sufficient to prevent the spread of COVID-19 among our employees and, therefore, we may face additional concentrate production disruptions in the future, which may place constraints on our ability to supply concentrates to our bottling partners in a timely manner or may increase our concentrate supply costs. We have faced, and may continue to face, delays in the delivery of concentrates to our bottling partners as a result of shipping delays due to, among other things, additional safety requirements imposed by port authorities, closures of or congestion at ports, and capacity constraints experienced by our transportation contractors. Some of our bottling partners have experienced, and may experience in the future, temporary plant closures, production slowdowns and disruptions in distribution operations as a result of the impact of the COVID-19 pandemic on their respective businesses. Disruptions in supply chains have placed, and may continue to place, constraints on our and our bottling partners' ability to source beverage containers, such as glass bottles and cans, which has increased, and in the future may increase, our and their packaging costs. As a result of the COVID-19 pandemic, including related governmental guidance or directives, we have required most office-based employees, including most employees based at our global headquarters in Atlanta, to work remotely. We may experience reductions in productivity and disruptions to our business routines while our remote work policy remains in place. Actions we have taken or may take, or decisions we have made or may make, as a consequence of the COVID-19 pandemic may result in legal claims or litigation against us. Deteriorating economic and political conditions in many of our major markets affected by the COVID-19 pandemic, such as increased unemployment, decreases in disposable income, declines in consumer confidence, or economic slowdowns or recessions, have caused a decrease in demand for our products. Continuing economic and political uncertainties in such markets may slow down or prevent the recovery of the demand for our products or may even further erode such demand. Governmental authorities in the United States and throughout the world may increase or impose new income taxes or indirect taxes, or revise interpretations of existing tax rules and regulations, as a means of financing the costs of stimulus and other measures enacted or taken, or that may be enacted or taken in the future, to protect populations and economies from the impact of the COVID-19 pandemic. Such actions could have an adverse effect on our results of operations and/or cash flows. We may be required to record significant impairment charges with respect to noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments, and other long-lived assets whose fair values may be negatively affected by the effects of the COVID-19 pandemic on our operations. In addition, we are required to record impairment charges related to our proportionate share of impairment charges that may be recorded by equity method investees, and such charges may be significant. In addition to the above risks, the COVID-19 pandemic may exacerbate existing risks related to our business including risks related to changes in the retail landscape or the loss of key retail or foodservice customers, fluctuations in foreign currency exchange rates; the ability of third-party service providers and business partners to fulfill their respective commitments and responsibilities to us in a timely manner and in accordance with the agreed-upon terms; and failure of or default by one or more of our counterparty financial institutions on their obligations to us. The resumption of normal business operations after the disruptions caused by the COVID-19 pandemic may be delayed or constrained by the pandemic's lingering effects on our bottling partners, consumers, suppliers and/or third-party service providers. Any of the negative impacts of the COVID-19 pandemic, including those described above, alone or in combination with others, may have a material adverse effect on our results of operations, financial condition and cash flows. The full extent to which theCOVID-19 pandemic will negatively affect our results of operations, financial condition and cash flows will depend on future developments that are highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the duration of the various shelter-in-place orders and reopening plans across the globe, and actions taken, or that may be taken in the future, by governmental authorities and other third parties in response to the pandemic. If we do not realize the economic benefits we anticipate from our productivity initiatives, including our recently announced reorganization and related strategic realignment initiatives, or are unable to successfully manage their possible negative consequences, our business operations could be adversely affected. Over the last three years, we worked to develop the strategies and evolve our culture to equip us to grow and become a total beverage company, while improving efficiency. In late 2020, we took a series of strategic steps to transform our organizational structure and to reallocate certain resources aimed at emerging stronger from the pandemic, including voluntary and involuntary reductions in employees. We have incurred and expect we will incur in future periods significant expenses in connection with the reorganization and related reduction in employees. If we are unable to timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these actions, our results of operations in future periods could be negatively affected. In addition, the reorganization and related reduction in employees may become a distraction for our managers and employees remaining with the Company; disrupt our ongoing business operations; cause deterioration in employee morale, which may make it more difficult for us to retain or attract qualified managers and employees in the future; disrupt or weaken our internal control and financial reporting structures; and/or give rise to negative publicity, which could affect our corporate reputation. If we are unable to successfully manage these possible negative consequences of our reorganization and reduction in employees, our business operations could be adversely affected. In addition, we believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may give rise to the same risks described above. If we are unable to successfully manage the possible negative consequences of our future productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Company's and the Coca-Cola system's ability to attract, develop, retain and motivate a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Company's purpose and work that matters most. We may not be able to successfully compete for, attract and/or retain the high-quality and diverse employee talent that we want and that our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic and alcoholic beverage segments of the global beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to maintain or gain share of sales in the global market or in various local markets and segments may be limited as a result of actions by competitors. Competitive pressures may cause the Company and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices, as may be necessary in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain consumer interest and brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic and alcoholic beverage segments of the commercial beverage industry, our business could be negatively affected. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial results. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private-label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. Increases in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our consolidated bottling operations operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our consolidated bottling operations. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our consolidated bottling operations operate, which may be caused by increasing demand, by events such as natural disasters, power outages and the like, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increases in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers, to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source. The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply and quality of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS. An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners' relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs that may be caused by the United Kingdom's withdrawal from the European Union, commonly referred to as ""Brexit""; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. If we are unable to successfully manage new product launches, our business and financial results could be adversely affected. Due to the highly competitive nature of the global beverage industry, the Company continually introduces new products and evolves existing products to stimulate customer demand. For instance, the Company has directly entered the alcoholic beverages segment in numerous markets outside the United States, and in the United States, the Company has authorized alcohol-licensed third parties to use certain of its brands on alcoholic beverages. The success of new and evolved products depends on a number of factors, including timely and successful development and consumer acceptance. Such endeavors may also involve significant risks and uncertainties, including distraction of management from current operations, greater than expected liabilities and expenses, inadequate return on capital, exposure to additional regulations and reliance on the performance of third parties. If we become subject to additional government regulations, including alcohol regulations related to licensing, trade and pricing practices, labeling, advertising, promotion and marketing practices, and relationships with distributors, we may become exposed to the risk of increased compliance costs and disruption to our core business. RISKS RELATED TO CONSUMER DEMAND FOR OUR PRODUCTS Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and potential delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained by, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; dramatic shifts in consumer shopping patterns as a result of the rapidly evolving digital landscape; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI""), a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages; or substances used in packaging materials, such as bisphenol A (""BPA""), an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans, may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, the Guiding Principles on Business and Human Rights, endorsed by the United Nations Human Rights Council, outline how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. RISKS RELATED TO THE COCA-COLA SYSTEM We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity method investee bottling partners, it could also result in a decrease in our equity income and/or impairments of our equity method investments. If we do not successfully integrate and manage our consolidated bottling operations or other acquired businesses or brands, our financial results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or consolidated bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our product quality and safety programs and controls may not be sufficiently robust to effectively cope with the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing the various supply chain models as we expand our product offerings and seek to manage acquired businesses in a more independent, less integrated manner. Our financial performance depends in large part on how well we can manage and improve the performance of consolidated bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations, businesses or brands. If we incur unforeseen liabilities, obligations and costs in connection with acquiring or integrating bottling operations or other businesses, experience internal control or product quality failures, or are unable to achieve our strategic and financial objectives for consolidated bottling operations and other acquired businesses or brands, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise consolidated bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. RISKS RELATED TO REGULATORY AND LEGAL MATTERS Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates in the jurisdictions in which we operate, tax treaties between such jurisdictions, and the geographic mix of our income before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix or foreign exchange rates could reduce our after-tax income. Tax laws, including rates of taxation, are subject to revision by individual taxing jurisdictions which may result from multilateral agreements. Many jurisdictions have enacted legislation and adopted policies resulting from the Organization for Economic Co-operation and Developments (""OECD"") anti-Base Erosion and Profit Shifting project. The OECD is currently considering proposals that could expand the jurisdictional scope and level of taxation of certain cross-border income and potentially impose some form of global minimum tax. It is possible that the adoption of these or other proposals could have a material impact on our after-tax income and cash flows. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions, estimates and accruals. The results of audits or related disputes could have a material adverse effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open . For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. On November 18, 2020, the U.S. Tax Court (""Tax Court"") issued an opinion (""Opinion"") predominantly siding with the IRS. Although the Company disagrees with the unfavorable portions of the Opinion and intends to vigorously defend its position, considering all avenues of appeal, there is no assurance that the courts will ultimately rule in the Company's favor. It is therefore possible that all or some of the unfavorable portions of the Opinion could ultimately be upheld. In that event, the Company would be subject to significant additional liabilities for the years at issue and potentially also for the subsequent years if the unfavorable portions of the Opinion were to be applied to the foreign licensees covered within the scope of the Opinion. Moreover, the IRS could successfully appeal the portions of the Opinion that are favorable to the Company and/or assert new claims for additional tax relating to the subsequent years by broadening the scope to cover additional foreign licensees. These adjustments could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or thereafter, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act""). Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship or even prohibitions on certain types of plastic products, packages and cups have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. RISKS RELATED TO FINANCE, ACCOUNTING AND INVESTMENTS Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2020, we used 70 functional currencies in addition to the U.S. dollar and derived $21.7 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2020 and 2019, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weakness in some currencies may be offset by strength in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. In addition, in July 2017, the United Kingdom's Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (""LIBOR""), announced that it will no longer compel or persuade financial institutions and panel banks to submit rates for the calculation of LIBOR after 2021. This decision is expected to result in the discontinuance of the use of LIBOR as a reference rate for commercial loans and other indebtedness. Although the impact of the possible discontinuance of LIBOR publication and transition to alternative reference rates remains unclear, it is possible that these changes may have an adverse impact on our financing costs. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottling partners' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners' interest expense could increase, which would reduce our equity income. Unfavorable general economic and political conditions in the United States and international markets could negatively impact our financial results. In 2020, our net operating revenues in the United States were $11.3 billion, or 34 percent, of our total net operating revenues, and our operations outside the United States accounted for $21.7 billion, or 66 percent, of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, could negatively affect the affordability of, and consumer demand for, our beverages. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private-label brands, which could reduce our profitability and could negatively affect our overall financial performance. Other financial uncertainties in our major markets, including uncertainties related to Brexit implementation and unstable political conditions, including civil unrest and governmental changes, could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. In connection with our long-term strategic planning, in 2020 a cross-functional, networked team reviewed the Company's total portfolio, earmarking thriving global, regional and local brands with track records of sequential and incremental growth. Following this exercise, the Company expects to offer a portfolio of approximately 200 master brands, an approximate 50 percent reduction from the current number. The portfolio optimization is intended to free up resources to invest in growing trademarks and better position the Company to nurture promising local innovations, and graduate regional wins to the global stage. If we are unsuccessful in implementing this portfolio optimization, our long-term growth may be adversely affected. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial results could be adversely affected. In June 2015, we entered into a long-term strategic relationship in the global energy drink category with Monster. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. RISKS RELATED TO INFORMATION TECHNOLOGY, DATA PRIVACY AND DIGITIZATION If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems. Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees, former employees and consumers with whom we interact. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. These laws impose operational requirements for companies receiving or processing personal data, and many provide for significant penalties for noncompliance. These requirements with respect to personal data have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and information security systems, policies, procedures and practices. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data by us or the third-party service providers and vendors whose technology, systems and services we use in connection with the receipt, storage and transmission of personal data. Unauthorized access or improper disclosure of personal data in violation of personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to regulatory enforcement actions (including fines), and result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial results could be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed-upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. RISKS RELATED TO ENVIRONMENTAL AND SOCIAL FACTORS Increasing concerns about the environmental impact of plastic bottles and other plastic packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the proliferation and accumulation of plastic bottles and other packaging materials in the environment, particularly in the world's waterways, lakes and oceans. We and our bottling partners sell certain of our beverage products in plastic bottles and use other plastic packaging materials that are not biodegradable and, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's impact on the environment by increasing our use of recycled plastic and other packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted or are considering adopting regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase of recycling rates or, in some cases, restricting or even prohibiting the use of plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our beverage products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. As part of the manufacture of our beverage products, we and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's carbon footprint by increasing our use of recycled packaging materials and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industrywide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The office complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The office complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities, and a reception center. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world, which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our Costa retail stores, which are included in the Global Ventures operating segment, and facilities related to our consolidated bottling and distribution operations, which are included in the Bottling Investments operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2020: Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Facilities Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa 6 7 26 12 Latin America 5 2 5 North America 11 9 4 17 Asia Pacific 6 2 Global Ventures 1 1 1 1,731 Bottling Investments 87 8 109 99 Corporate 3 6 Total 32 97 12 120 154 1,743 Management believes that our Company's facilities used for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of our production facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment or, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in ""U.S. Federal Income Tax Dispute"" below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Company's transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arm's-length pricing of transactions between related parties such as the Company's U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arm's-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (""Closing Agreement""). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Company's income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987 through 1995 tax years. The IRS audited and confirmed the Company's compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years, in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Company's matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS' designation of the Company's matter for litigation, the Company was forced either to accept the IRS' newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS' litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the Tax Court in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS' potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Company's case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Company's foreign licensees to increase the Company's U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by Accounting Standards Codification 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors, and we reviewed and considered relevant laws, rules, and regulations, including, though not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Company's tax positions, that it is more likely than not the Company's tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (""Tax Court Methodology""), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Company's tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020 related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Company's analysis. While the Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for the years at issue, and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology is ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2020 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 to 2020. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the Tax Cuts and Jobs Act of 2017. The Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $12 billion. Additional interest would continue to accrue until the time any such potential liability, or portion thereof, is paid. The Company currently projects that the impact of the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2020, would result in an incremental annual tax liability that would increase the Company's effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Company's Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the United States Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax period. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax period, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 22, 2021, there were 197,226 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 20, 2021 (""Company's 2021 Proxy Statement""), to be filed with the SEC, is incorporated herein by reference. During the year ended December 31, 2020, no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2020 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act: Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 September 26, 2020 through October 23, 2020 11,879 $ 50.02 161,029,667 October 24, 2020 through November 20, 2020 1,966,820 54.00 161,029,667 November 21, 2020 through December 31, 2020 127,023 53.32 161,029,667 Total 2,105,722 $ 53.93 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (""2019 Plan"") for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Shareowner Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Shareowner Return Stock Price Plus Reinvested Dividends December 31, 2015 2016 2017 2018 2019 2020 The Coca-Cola Company $ 100 $ 100 $ 114 $ 122 $ 147 $ 150 Peer Group Index 100 111 123 100 123 133 SP 500 Index 100 112 136 130 171 203 The total shareowner return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2015. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. ITEM 6. INTENTIONALLY OMITTED "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. MDA includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our progress toward emerging stronger from the COVID-19 pandemic; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our consolidated results of operations for 2020 and 2019 and year-to-year comparisons between 2020 and 2019. An analysis of our consolidated results of operations for 2019 and 2018 and year-to-year comparisons between 2019 and 2018 can be found in MDA in Part II, Item 7 of the Company's Form 10-K for the year ended December 31, 2019. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is a total beverage company, and beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Company's consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa, which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 Concentrate operations 56 % 55 % Finished product operations 44 45 Total 100 % 100 % The following table sets forth the percentage of total worldwide unit case volume attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 Concentrate operations 82 % 83 % Finished product operations 18 17 Total 100 % 100 % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Emerging Stronger from the COVID-19 Pandemic Throughout 2020, the effects of the COVID-19 pandemic and the related actions by governments around the world to attempt to contain the spread of the virus have significantly impacted our business. In particular, the outbreak and preventive measures taken to contain COVID-19 negatively impacted our unit case volume and our price, product and geographic mix in all of our operating segments, primarily due to unfavorable channel and product mix as consumer demand shifted to more at-home versus away-from-home consumption. The Company's priorities during the COVID-19 pandemic and related business disruption are ensuring the health and safety of our employees; supporting and making a difference in the communities we serve; keeping our brands in supply and maintaining the quality and safety of our products; serving our customers across all channels as they adapt to the shifting demands of consumers during the crisis; and positioning ourselves to emerge stronger when this crisis ends. We deployed global and regional teams to monitor the rapidly evolving situation in each of our local markets and recommended risk mitigation actions; we implemented travel restrictions; and we are following social distancing practices. Around the world, we are endeavoring to follow guidance from authorities and health officials including, but not limited to, checking the temperature of associates when entering our facilities, requiring associates to wear masks and other protective clothing as appropriate, and implementing additional cleaning and sanitization routines at system facilities. In addition, most office-based employees around the world are required to work remotely. During times of crisis, business continuity and adapting to the needs of our customers are critical. We have developed systemwide knowledge-sharing routines and processes, which include the management of any supply chain challenges. As of the date of this filing, there has been no material impact, and we do not foresee a material impact, on our and our bottling partners' ability to manufacture or distribute our products. We are moving with speed to best serve our customers impacted by COVID-19. In partnership with our bottlers and retail customers, we are working to ensure adequate inventory levels in key channels while prioritizing core brands, key packages and consumer affordability. We are increasing investments in e-commerce to support retailer and meal delivery services, shifting toward package sizes that are fit-for-purpose for online sales, and shifting more consumer and trade promotions to digital. Although we are experiencing a time of crisis, we are not losing sight of long-term opportunities for our business. The pandemic helped us realize we could be much bolder in our efforts to change. We believe that we will come out of this situation a better and stronger company. We identified the following key objectives to navigate the pandemic and position us to emerge stronger: winning more consumers; gaining market share; maintaining strong system economics; strengthening stakeholder impact; and equipping the organization to win. We leveraged the crisis as a catalyst to accelerate our strategy and to begin to deliver against these objectives by focusing on the following priorities: optimizing our portfolio of strong global, regional and scaled local brands; establishing a disciplined innovation framework; increasing consumer-centric marketing effectiveness and efficiency; strengthening data-driven revenue growth management and execution capabilities; enhancing system collaboration and capturing supply chain efficiencies; and evolving our organization and investing in new capabilities to support the accelerated strategy. In August 2020, the Company announced strategic steps to transform our organizational structure to better enable us to capture growth in the fast-changing marketplace. The Company is building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information about our strategic realignment initiatives. Core Capabilities To support our ability to emerge stronger from the COVID-19 pandemic, we must continue to enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising, sales promotions and digital marketing. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets, and grow net operating revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to create enhanced value for themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Product and Shopping Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our evolving portfolio of beverage brands and products (including numerous low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to the planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share, while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies, and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. We believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part will help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over the operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending, proceeds from the sale of assets and customers' financial condition. These factors are even more difficult to estimate as a result of uncertainties associated with the scope, severity and duration of the global COVID-19 pandemic and any resurgences of the pandemic including, but not limited to, the number of people contracting the virus, the impact of shelter-in-place and social distancing requirements, the impact of governmental actions across the globe to contain the virus, the timing and number of people receiving vaccinations, and the substance and pace of the post-pandemic economic recovery. The estimates we use when assessing the recoverability of assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe are consistent with those a market participant would use. The variability of these factors depends on a number of conditions, including uncertainties associated with the COVID-19 pandemic, and thus our accounting estimates may change from period to period. Our current estimates reflect our belief that we expect COVID-19 to impact our business for the better part of 2021, with the first half of the year likely to be more challenging than the second half. We expect to see improvements in our business as vaccines become more widely available throughout the year and consumers begin to return to many of their previous routines of socializing, work and travel. The Company has certain intangible and other long-lived assets that are more dependent on cash flows generated in the away-from-home channels and/or that generate cash flows in geographic areas that are more heavily impacted by the COVID-19 pandemic and are therefore more susceptible to impairment. In addition, intangible and other long-lived assets we acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions at the time of acquisition. If we had used other assumptions and estimates when tests of these assets were performed, impairment charges could have resulted. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. The total future impairment charges we may be required to record could be material. Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion of recent acquisitions. Refer to Note 16 of Notes to Consolidated Financial Statements for the discussion of impairment charges. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, royalty rates, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe are consistent with those a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, because they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all of our consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models. These models include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees and participate in multi-employer retirement plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. Management is required to make certain critical estimates related to the actuarial assumptions used to determine our net periodic pension cost and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our investment objective for our pension plan assets is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to seek to improve returns and manage risk. In 2020, the Company's total income related to defined benefit pension plans was $44 million, which included $66 million of net periodic benefit income and net charges of $22 million, primarily due to settlements, curtailments and special termination benefits. In 2021, we expect our net periodic benefit income related to defined benefit pension plans to be approximately $146 million. We currently expect to incur settlement charges in 2021 related to our strategic realignment initiatives. The increase in 2021 expected net periodic benefit income is primarily due to favorable asset performance in 2020 and a reduction in the number of plan participants arising from our strategic realignment initiatives, partially offset by a decrease in the weighted-average discount rate at December 31, 2020 compared to December 31, 2019. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $17 million decrease in our 2021 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $26 million decrease in our 2021 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2020, the Company's primary U.S. pension plan represented 61 percent and 59 percent of the Company's consolidated projected benefit obligation and pension plan assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 14 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 11 of Notes to Consolidated Financial Statements. Tax law requires certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of coffee beans and finished beverages (in all instances expressed in unit case equivalents) sold by the Company to customers or consumers. Refer to the heading ""Beverage Volume"" below. When we analyze our net operating revenues we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading ""Net Operating Revenues"" below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party or independent customer regardless of our ownership interest in the bottling partner. We generally refer to acquisitions and divestitures of bottling operations as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to these brands is incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to the brand is incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2020, the Company acquired the remaining ownership interest in fairlife. The impact on revenues for fairlife products not previously sold by the Company has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. Also in 2020, the Company discontinued our Odwalla juice business. The impact of discontinuing our Odwalla juice business has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the North America operating segment. In 2019, the Company acquired the remaining ownership interest in C.H.I. Limited (""CHI""). The impact of this acquisition has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Other acquisitions by the Company included controlling interests in bottling operations in Zambia, Kenya and Eswatini. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2019, the Company refranchised certain of its bottling operations in India. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings), with the exception of unit case equivalents for Costa non-ready-to-drink beverage products, which are primarily measured in number of transactions; and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers or consumers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an ownership interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in unit case equivalents) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. For Costa non-ready-to-drink beverage products, concentrate sales volume represents the amount of coffee beans and finished beverages (in all instances expressed in unit case equivalents) sold by the Company to customers or consumers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to these items, the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2020 versus 2019 Unit Cases 1,2 Concentrate Sales Worldwide (6) % 3 (7) % Europe, Middle East Africa (6) % (8) % Latin America (2) (2) North America (7) (7) Asia Pacific (9) (9) Global Ventures (13) 3 (13) Bottling Investments (15) 4 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic and Global Ventures operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. Global Ventures operating segment data also reflects unit case volume growth for Costa retail stores. 3 In 2019, with the exception of ready-to-drink products, the Company did not report unit case volume for Costa, a component of the Global Ventures operating segment. However, unit case volume in 2020 includes both Costa ready-to-drink and non-ready-to-drink products. The Company adjusted 2019 to include Costa non-ready-to-drink unit case volume when calculating 2020 versus 2019 volume growth rates. 4 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2020 declined 13 percent. 5 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2020 declined 10 percent. Unit Case Volume Sparkling soft drinks represented 69 percent of our worldwide unit case volume in 2020 and 2019. Trademark CocaCola accounted for 47 percent and 45 percent of our worldwide unit case volume in 2020 and 2019, respectively. In 2020, unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 61 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2020. The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 32 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 48 percent of non-U.S. unit case volume. The Coca-Cola system sold 29.0 billion and 30.3 billion unit cases of our products in 2020 and 2019, respectively. The decline was primarily due to the COVID-19 pandemic. Unit case volume in Europe, Middle East and Africa declined 6 percent, which included a 4 percent decline in sparkling soft drinks, an 18 percent decline in both water, enhanced water and sports drinks and tea and coffee, and a 9 percent decline in juice, dairy and plant-based beverages. The group's sparkling soft drinks volume performance reflected a decline of 2 percent in Trademark Coca-Cola. The group reported declines in unit case volume in all business units with the exception of the West Africa business unit, which reported a 3 percent increase in unit case volume. In Latin America, unit case volume declined 2 percent, which included a 1 percent decline in sparkling soft drinks, a 4 percent decline in water, enhanced water and sports drinks, a 6 percent decline in juice, dairy and plant-based beverages and a 1 percent decline in tea and coffee. Trademark Coca-Cola grew 1 percent. The group reported declines in unit case volume of 4 percent in the Mexico business unit and 6 percent in the South Latin business unit, which were partially offset by a 3 percent increase in unit case volume in the Brazil business unit and even volume in the Latin Center business unit. Unit case volume in North America declined 7 percent, which included a 15 percent decline in tea and coffee and a 4 percent decline in both water, enhanced water and sports drinks and juice, dairy and plant-based beverages. The group's sparkling soft drinks volume declined 7 percent, which included a 5 percent decline in Trademark Coca-Cola. In Asia Pacific, unit case volume declined 9 percent, which included a 16 percent decline in both water, enhanced water and sports drinks and juice, dairy and plant-based beverages, a 5 percent decline in sparkling soft drinks and an 8 percent decline in tea and coffee. The group's sparkling soft drinks volume performance included growth of 2 percent in Trademark Coca-Cola. The group reported declines in unit case volume of 27 percent in the India South West Asia business unit, 7 percent in both the ASEAN and Japan business units, 4 percent in the South Pacific business unit and 3 percent in the Greater China Korea business unit. Unit case volume for Global Ventures declined 13 percent, driven by a 29 percent decrease in tea and coffee, partially offset by growth in energy drinks. Performance was even in juice, dairy and plant-based beverages. Unit case volume for Bottling Investments declined 15 percent. Through early February 2021, the Company has experienced a volume decline of mid single digits globally. Concentrate Sales Volume In 2020, worldwide concentrate sales volume declined 7 percent and unit case volume declined 6 percent compared to 2019. The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an ownership interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. Net Operating Revenues Net operating revenues were $33,014 million in 2020, compared to $37,266 million in 2019, a decrease of $4,252 million, or 11 percent. The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2020 versus 2019 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated (7) % (2) % (2) % % (11) % Europe, Middle East Africa (8) % (5) % (2) % % (14) % Latin America (2) 2 (14) (15) North America (7) 2 2 (4) Asia Pacific (10) (2) (11) Global Ventures (13) (9) 1 (22) Bottling Investments (13) 2 (4) (2) (16) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Company's net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) the change in the mix of products and packages sold; (3) the change in the mix of channels where products were sold; and (4) the change in the mix of geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Price, product and geographic m ix had a 2 percent unfavorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa unfavorable channel, package and geographic mix; Latin America favorable pricing initiatives in Mexico and the impact of inflationary environments in certain markets, partially offset by unfavorable channel and package mix; North America favorable product mix, partially offset by unfavorable channel and package mix; Asia Pacific unfavorable channel and package mix across a majority of the business units, partially offset by favorable geographic mix; Global Ventures unfavorable product and channel mix primarily due to the impact of the COVID-19 pandemic on the Costa retail stores; and Bottling Investments favorable pricing and geographic mix, partially offset by unfavorable channel and package mix. The unfavorable channel and package mix for the year ended December 31, 2020 in all operating segments was primarily a result of the shift in consumer demand due to the impact of the COVID-19 pandemic. Consumers were purchasing more products in the at-home channels and fewer in the away-from-home channels. We expect any shift in consumer demand back to the away-from-home channels to be closely correlated with the timing and availability of COVID-19 vaccines and consumers returning to many of their previous routines of socializing, work and travel. Foreign currency fluctuations decreased our consolidated net operating revenues by 2 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Mexican peso, Brazilian real, South African rand, Turkish lira and Indian rupee, which had an unfavorable impact on our Latin America, Europe, Middle East and Africa, Asia Pacific and Bottling Investments operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and Philippine peso, which had a favorable impact on our Europe, Middle East and Africa, Global Ventures, Asia Pacific and Bottling Investments operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Company's net operating revenues provides investors with useful information to enhance their understanding of the Company's net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Company's performance. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. Based on current spot rates and our hedging coverage in place, we expect foreign currency fluctuations will have a slightly favorable impact on our full year 2021 net operating revenues. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, 2020 2019 Europe, Middle East Africa 16.8 % 17.3 % Latin America 10.6 11.0 North America 34.7 31.9 Asia Pacific 12.8 12.7 Global Ventures 6.0 6.9 Bottling Investments 19.0 19.9 Corporate 0.1 0.3 Total 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below, and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Our gross profit margin decreased to 59.3 percent in 2020 from 60.8 percent in 2019. This decrease was primarily driven by unfavorable channel and package mix, the unfavorable impact of foreign currency exchange rate fluctuations, and unfavorable manufacturing overhead variances, partially offset by the impact of acquisitions and divestitures . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2020 2019 Stock-based compensation expense $ 126 $ 201 Advertising expenses 2,777 4,246 Selling and distribution expenses 2,638 2,873 Other operating expenses 4,190 4,783 Selling, general and administrative expenses $ 9,731 $ 12,103 Selling, general and administrative expenses decreased $2,372 million, or 20 percent, in 2020. This decrease was primarily due to effective cost management and a reduction in marketing spending as a result of uncertainties related to the impact of the COVID-19 pandemic, the impact of savings from our productivity initiatives, the impact of a reduction in stock-based compensation expense resulting from a change in estimated payout, and a foreign currency exchange rate impact of 1 percent. The decrease in selling and distribution expenses was primarily due to volume declines, effective cost management as a result of uncertainties related to the COVID-19 pandemic and a foreign currency exchange rate impact of 2 percent, partially offset by amortization and depreciation expense in the current year for Coca-Cola Beverages Africa Proprietary Limited (""CCBA""). During the first five months of 2019, CCBA was classified as held for sale, and therefore amortization and depreciation expense were not recorded. As of December 31, 2020, we had $180 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2020 2019 Europe, Middle East Africa $ 73 $ 2 Latin America 29 1 North America 379 62 Asia Pacific 31 42 Global Ventures 4 Bottling Investments 34 100 Corporate 303 251 Total $ 853 $ 458 In 2020, the Company recorded other operating charges of $853 million. These charges primarily consisted of $413 million related to the Company's strategic realignment initiatives and $99 million related to the Company's productivity and reinvestment program. In addition, other operating charges included impairment charges of $160 million related to the Odwalla trademark and charges of $33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $55 million related to a trademark in North America, which was primarily driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Company's portfolio. In addition, other operating charges included $51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and $16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the fairlife acquisition. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2019, the Company recorded other operating charges of $458 million. These charges primarily consisted of $264 million related to the Company's productivity and reinvestment program and $42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the acquisition of Costa and refranchising of our bottling operations. Refer to Note 16 of Notes to Consolidated Financial Statements for information on the trademark impairment charge. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2020 2019 Europe, Middle East Africa 36.8 % 35.2 % Latin America 23.5 23.6 North America 27.5 25.7 Asia Pacific 23.7 22.6 Global Ventures (1.4) 3.3 Bottling Investments 3.4 3.6 Corporate (13.5) (14.0) Total 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2020 2019 Consolidated 27.3 % 27.1 % Europe, Middle East Africa 59.9 55.2 Latin America 60.5 57.7 North America 21.5 21.8 Asia Pacific 50.6 48.3 Global Ventures (6.2) 13.1 Bottling Investments 4.9 4.8 Corporate * * * Calculation is not meaningful. Operating income was $8,997 million in 2020, compared to $10,086 million in 2019, a decrease of $1,089 million, or 11 percent. The decrease in operating income was primarily driven by a decline in net operating revenues due to the impact of the COVID-19 pandemic, an unfavorable foreign currency exchange rate impact and higher other operating charges, partially offset by lower selling, general and administrative expenses. Operating income for each operating segment and Corporate was impacted by a decline in net operating revenues due to the impact of the COVID-19 pandemic. In addition, operating income for each operating segment and Corporate was impacted by the following: Europe, Middle East and Africa lower selling, general and administrative expenses, partially offset by higher other operating charges and an unfavorable foreign currency exchange rate impact of 3 percent; Latin America lower selling, general and administrative expenses, partially offset by higher other operating charges and an unfavorable foreign currency exchange rate impact of 21 percent; North America lower selling, general and administrative expenses, partially offset by higher other operating charges; Asia Pacific lower selling, general and administrative expenses and lower other operating charges, partially offset by an unfavorable foreign currency exchange rate impact of 1 percent; Global Ventures operating loss in 2020 was primarily due to the temporary closures and gradual reopenings of the Costa retail stores; Bottling Investments lower selling, general and administrative expenses, lower other operating charges and a favorable foreign currency exchange rate impact of 1 percent; and Corporate operating loss in 2020 decreased primarily as a result of lower stock-based compensation expense, lower annual incentive expense and savings from productivity initiatives, partially offset by higher other operating charges and unfavorable manufacturing overhead variances due to lower volume. In 2020, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Mexican peso, Brazilian real, Chilean peso and Turkish lira, which had an unfavorable impact on our Latin America and Europe, Middle East and Africa operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the British pound sterling, Japanese yen and Philippine peso, which had a favorable impact on our Europe, Middle East and Africa, Global Ventures, Asia Pacific and Bottling Investments operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Interest Income Interest income was $370 million in 2020, compared to $563 million in 2019, a decrease of $193 million, or 34 percent. This decrease was primarily driven by lower returns in certain of our international locations, as well as the unfavorable impact of fluctuations in foreign currency exchange rates. Interest Expense Interest expense was $1,437 million in 2020, compared to $946 million in 2019, an increase of $491 million, or 52 percent. This increase was primarily due to charges of $484 million associated with the extinguishment of certain long-term debt. The increase in interest expense was also driven by higher average balances resulting from long-term debt issuances in 2020, partially offset by lower short-term U.S. interest rates and balances. Refer to Note 10 of Notes to Consolidated Financial Statements. Equity Income (Loss) Net Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2020, equity income was $978 million, compared to equity income of $1,049 million in 2019, a decrease of $71 million, or 7 percent. This decrease reflects the impact of the COVID-19 pandemic on operating results reported by our equity method investees and the unfavorable impact of foreign currency exchange rate fluctuations. In addition, the Company recorded net charges of $216 million and $100 million in the line item equity income (loss) net during the years ended December 31, 2020 and 2019, respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost for pension and other postretirement benefit plans; other charges and credits related to pension and other postretirement benefit plans; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; other-than-temporary impairment charges; and net foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2020, other income (loss) net was income of $841 million. The Company recognized a gain of $902 million in conjunction with the fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value, a net gain of $148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a net gain of $18 million related to the sale of a portion of our ownership interest in one of our equity method investees and a gain of $17 million related to the sale of our ownership interest in an equity method investee in North America . These gains were partially offset by an other-than-temporary impairment charge of $252 million related to Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""), an equity method investee, an other-than-temporary impairment charge of $38 million related to one of our equity method investees in Latin America, an impairment charge of $26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $55 million related to economic hedging activities. The Company also recorded net charges of $25 million related to the restructuring of our manufacturing operations in the United States and charges of $14 million for pension and other postretirement benefit plan settlements and curtailments related to the Company's strategic realignment initiatives. Other income (loss) net also included income of $171 million related to the non-service cost components of net periodic benefit cost, $72 million of dividend income and net foreign currency exchange losses of $64 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the fairlife acquisition. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on our economic hedging activities. Refer to Note 16 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's strategic realignment initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2019, other income (loss) net was income of $34 million. The Company recognized a gain of $739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $73 million related to the refranchising of certain bottling operations in India and a gain of $39 million related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (""Andina""). These gains were partially offset by other-than-temporary impairment charges of $406 million related to CCBJHI, an equity method investee, $255 million related to certain equity method investees in the Middle East, $57 million related to one of our equity method investees in North America and $49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million and recognized a $118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recognized net charges of $105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Other income (loss) net also included income of $99 million related to the non-service cost components of net periodic benefit cost, $62 million of dividend income and net foreign currency exchange losses of $120 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining ownership interest in CHI and the sale of a portion of our ownership interest in Andina. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $317 million and $335 million for the years ended December 31, 2020 and 2019, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2020 2019 Statutory U.S. federal tax rate 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 0.9 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 0.9 1 1.1 4,5,6 Equity income or loss (1.4) (1.6) Excess tax benefits on stock-based compensation (0.8) (0.9) Other net (0.5) 2,3 (3.8) 7 Effective tax rate 20.3 % 16.7 % 1 Includes net tax charges of $110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes net tax expense of $431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 3 Includes a tax benefit of $40 million (or a 2.4 percent impact on our effective tax rate) associated with the $902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes net tax charges of $199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 6 Includes a tax benefit of $199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2 of Notes to Consolidated Financial Statements. 7 Includes a net tax benefit of $184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. On November 18, 2020, the Tax Court issued the Opinion regarding the Company's 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11 of Notes to Consolidated Financial Statements. As of December 31, 2020, the gross amount of unrecognized tax benefits was $915 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $588 million, exclusive of any benefits related to interest and penalties. The remaining $327 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2020 2019 Balance of unrecognized tax benefits at beginning of year $ 392 $ 336 Increase related to prior period tax positions 528 204 Decrease related to prior period tax positions (1) Increase related to current period tax positions 26 29 Decrease related to settlements with taxing authorities (19) (174) Increase (decrease) due to effect of foreign currency exchange rate changes (11) (3) Balance of unrecognized tax benefits at end of year $ 915 $ 392 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11 of Notes to Consolidated Financial Statements. 2 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $391 million and $201 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2020 and 2019, respectively. Of these amounts, $190 million and $11 million of expense were recognized in income tax expense in 2020 and 2019, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2021 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of the fundamental strengths of our business. Refer to the heading ''Cash Flows from Operating Activities'' below. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to continue to borrow funds at reasonable rates over the long term. Our debt financing also includes the use of a commercial paper program. While the COVID-19 pandemic initially caused a disruption in the commercial paper market, we currently have the ability to borrow funds in this market at levels that are consistent with our debt financing strategy and expect to continue to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and, as a result of this review, during 2020 we issued U.S. dollar- and euro-denominated long-term debt of $15.6 billion and 2.6 billion, respectively, across various maturities with certain tranches having a longer duration than other recent long-term debt issuances. We used a portion of the proceeds from the long-term debt issuances to extinguish certain tranches of our previously issued long-term debt which had either near-term maturity dates and/or high coupon rates. While we intend to remain active in the commercial paper market, we also used a portion of the proceeds from the long-term debt issuances to reduce our commercial paper balance. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information on the debt issuances and extinguishments. The Company's cash, cash equivalents, short-term investments and marketable securities totaled $10.9 billion as of December 31, 2020. In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $7.5 billion in lines of credit for general corporate purposes as of December 31, 2020. These backup lines of credit expire at various times from 2021 through 2025. While near-term uncertainty caused by the COVID-19 pandemic remains, we expect to see improvements in our business as vaccines become more widely available. The timing and availability of vaccines will be different around the world, and therefore we believe the pace of the recovery will vary by geography depending on both vaccine distribution and other macroeconomic factors. We will remain flexible so that we can adjust to near-term uncertainties while we continue to move forward on the initiatives we implemented to emerge stronger from the COVID-19 pandemic. In 2021, we plan to increase marketing spending behind our brands to drive increased net operating revenues. We expect the return on that spend to become more favorable as mobility stabilizes and away-from-home channels regain momentum. While many of the operating expenses that were significantly reduced in 2020 are likely to return in 2021, we will continue to focus on cash flow generation. Our current capital allocation priorities are focused on investing wisely to support our business operations and continuing to grow our dividend payment. We currently expect 2021 capital expenditures to be approximately $1.5 billion. In addition, we do not intend to repurchase shares under our Board of Directors' authorized plan during the year ending December 31, 2021, and we do not intend to change our approach toward paying dividends. We are currently in litigation with the IRS for tax years 2007 through 2009. On November 18, 2020, the Tax Court issued the Opinion in which it predominantly sided with the IRS; however, a final decision is still pending and the timing of such decision is currently not known. The Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions and intends to vigorously defend our positions utilizing every available avenue of appeal. While the Company believes that it is more likely than not that we will ultimately prevail in this litigation upon appeal, it is possible that all, or some portion of, the adjustments proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In the event that all of the adjustments proposed by the IRS are ultimately upheld for the years at issue and the IRS, with the consent of the federal court, were to decide to apply the underlying methodology to the subsequent years up to and including 2020, the Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $12 billion. Once the Tax Court renders a final decision, the Company will have 90 days to file a notice of appeal and pay the portion of the potential aggregate incremental tax and interest liability related to the 2007 through 2009 litigation period, which we currently estimate to be approximately $4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information on the tax litigation. While we believe it is more likely than not that we will prevail in the tax litigation discussed above, we are confident that, between our ability to generate cash flow from operations and our ability to borrow funds at reasonable interest rates, we can manage the range of possible outcomes in the final resolution of the matter. Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities As part of our continued efforts to improve our working capital efficiency, we have worked with our suppliers over the past several years to revisit terms and conditions, including the extension of payment terms. Our current payment terms with the majority of our suppliers are 120 days. Additionally, two global financial institutions offer a voluntary supply chain finance (""SCF"") program which enables our suppliers, at their sole discretion, to sell their receivables from the Company to these financial institutions on a non-recourse basis at a rate that leverages our credit rating and thus may be more beneficial to them. The SCF program is available to suppliers of goods and services included in cost of goods sold as well as suppliers of goods and services included in selling, general and administrative expenses in our consolidated statement of income. The Company and our suppliers agree on the contractual terms for the goods and services we procure, including prices, quantities and payment terms, regardless of whether the supplier elects to participate in the SCF program. The suppliers sell goods or services, as applicable, to the Company and issue the associated invoices to the Company based on the agreed-upon contractual terms. Then, if they are participating in the SCF program, our suppliers, at their sole discretion, determine which invoices, if any, they want to sell to the financial institutions. Our suppliers' voluntary inclusion of invoices in the SCF program has no bearing on our payment terms. No guarantees are provided by the Company or any of our subsidiaries under the SCF program. We have no economic interest in a supplier's decision to participate in the SCF program, and we have no direct financial relationship with the financial institutions, as it relates to the SCF program. Accordingly, amounts due to our suppliers that elected to participate in the SCF program are included in the line item accounts payable and accrued expenses in our consolidated balance sheet. All activity related to amounts due to suppliers that elected to participate in the SCF program is reflected in the line item cash flows from operating activities in our consolidated statement of cash flows. We have been informed by the financial institutions that as of December 31, 2020 and 2019, suppliers had elected to sell $703 million and $784 million, respectively, of our outstanding payment obligations to the financial institutions. The amount settled through the SCF program was $2,810 million and $2,883 million during the years ended December 31, 2020 and 2019, respectively. Net cash provided by operating activities for the years ended December 31, 2020 and 2019 was $9,844 million and $10,471 million, respectively, a decrease of $627 million, or 6 percent. This decrease was primarily driven by the decline in operating income, the extension of payment terms with certain of our suppliers in the prior year and the unfavorable impact of foreign currency exchange rate fluctuations. Net cash provided by operating activities included estimated benefits of $869 million for the year ended December 31, 2019 from the extension of payment terms with certain of our suppliers. We do not believe there is a risk that our payment terms will be shortened in the near future, and we do not currently expect our net cash provided by operating activities to be significantly impacted by additional extensions of payment terms in the foreseeable future. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables and remit those payments to the financial institutions. The Company sold $185 million of trade accounts receivables under this program during the year ended December 31, 2020, and the costs of factoring such receivables were not material. The Company classifies the cash received from the financial institutions within the operating activities section in the consolidated statement of cash flows. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, 2020 2019 Purchases of investments $ (13,583) $ (4,704) Proceeds from disposals of investments 13,835 6,973 Acquisitions of businesses, equity method investments and nonmarketable securities (1,052) (5,542) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 189 429 Purchases of property, plant and equipment (1,177) (2,054) Proceeds from disposals of property, plant and equipment 189 978 Other investing activities 122 (56) Net cash provided by (used in) investing activities $ (1,477) $ (3,976) Purchases of Investments and Proceeds from Disposals of Investments Purchases of investments and proceeds from disposals of investments resulted in net cash inflows of $252 million and $2,269 million in 2020 and 2019, respectively. This activity primarily represents the purchases of, and proceeds from the disposals of, investments in marketable securities and short-term investments that were made as part of the Company's overall cash management strategy. Also included in this activity are purchases of, and proceeds from the disposals of, investments held by our captive insurance companies. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2020, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife. In 2019, the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $5,542 million, which primarily related to the acquisitions of Costa and the remaining ownership interest in CHI. During 2019, the Company also acquired controlling interests in bottling operations in Zambia, Kenya and Eswatini. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2020 and 2019. Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee. In 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities were $429 million, which primarily related to the sale of a portion of our ownership interest in Andina and the refranchising of certain of our bottling operations in India. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2020 and 2019. Purchases of Property, Plant and Equipment Purchases of property, plant and equipment for the years ended December 31, 2020 and 2019 were $1,177 million and $2,054 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2020 2019 Capital expenditures $ 1,177 $ 2,054 Europe, Middle East Africa 2.3 % 5.2 % Latin America 0.5 6.8 North America 15.5 19.1 Asia Pacific 1.7 2.3 Global Ventures 22.2 10.2 Bottling Investments 40.3 40.7 Corporate 17.6 15.7 Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, 2020 2019 Issuances of debt $ 26,934 $ 23,009 Payments of debt (28,796) (24,850) Issuances of stock 647 1,012 Purchases of stock for treasury (118) (1,103) Dividends (7,047) (6,845) Other financing activities 310 (227) Net cash provided by (used in) financing activities $ (8,070) $ (9,004) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2020, our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to borrow funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2020, the Company had issuances of debt of $26,934 million, which included $8,260 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $18,674 million, net of related discounts and issuance costs. During 2020, the Company made payments of debt of $28,796 million, which included $15,292 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $1,768 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $11,736 million. In 2019, the Company had issuances of debt of $23,009 million, which included $16,842 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $6,167 million, net of related discounts and issuance costs. During 2019, the Company made payments of debt of $24,850 million, which included $17,577 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $2,244 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $5,029 million. Issuances of Stock The issuances of stock in 2020 and 2019 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Company's common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. During 2020, the Company did not repurchase common stock under the share repurchase plan authorized by our Board of Directors. In 2019, the Company repurchased 21 million shares of our common stock at an average price per share of $48.86 under the share repurchase plan authorized by our Board of Directors. Since the inception of our share repurchase program in 1984 through December 31, 2020, we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. The Company's treasury stock activity during 2020 resulted in a cash outflow of $118 million. Dividends The Company paid dividends of $7,047 million and $6,845 million during the years ended December 31, 2020 and 2019, respectively. At its February 2021 meeting, our Board of Directors increased our regular quarterly dividend to $0.42 per share, equivalent to a full year dividend of $1.68 per share in 2021. This is our 59 th consecutive annual increase. Our annualized common stock dividend was $1.64 per share and $1.60 per share in 2020 and 2019, respectively. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative financial instruments; and any obligation arising out of a material variable interest held by the Registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Registrant, or engages in leasing, hedging or research and development services with the Registrant. As of December 31, 2020, we were contingently liable for guarantees of indebtedness owed by third parties of $431 million, of which $109 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2020, we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivative financial instruments as either assets or liabilities at fair value in our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2020, the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2021 2022-2023 2024-2025 2026 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 1,329 $ 1,329 $ $ $ Lines of credit and other short-term borrowings 854 854 Current maturities of long-term debt 2 485 485 Long-term debt, net of current maturities 2 39,591 5,604 4,816 29,171 Estimated interest payments 3 9,452 681 1,358 1,117 6,296 Accrued income taxes 4 4,042 788 1,091 2,163 Purchase obligations 5 17,592 10,867 1,455 950 4,320 Marketing obligations 6 4,106 2,091 758 472 785 Lease obligations 1,876 349 562 397 568 Total contractual obligations $ 79,327 $ 17,444 $ 10,828 $ 9,915 $ 41,140 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2020 rate for all years presented. We typically expect to fund such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,639 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $1,296 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms. These agreements include long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these purchase obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2020 was $2,299 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost or income, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the table above. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. The Company expects to contribute $25 million in 2021 to our pension trusts, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension trusts in the table above. As of December 31, 2020, the projected benefit obligation of the U.S. qualified pension plans was $6,019 million, and the fair value of the plans' assets was $5,373 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,395 million, and the fair value of the plans' assets was $3,266 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain employees, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $108 million in 2021, $57 million in 2022 and increasing to $64 million by 2025. Thereafter, the annual benefit payments will decrease. Refer to Note 13 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. As of December 31, 2020, our self-insurance reserves totaled $265 million. Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2020 were $1,833 million. Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the table above because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the underlying assets or liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future years. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. In connection with our acquisition of the remaining ownership interest in fairlife, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting values of which are not subject to a ceiling. Based on fairlife's operating results in 2020, we anticipate making the first milestone payment of $100 million during the first quarter of 2021. As of December 31, 2020, we have accrued $321 million, which represents our best estimate of the present value of these milestone payments. These estimated milestone payments are not included in the table above. As of December 31, 2020, the Company had entered into a lease agreement for a production facility, which commences in the first quarter of 2021. Under the agreement, the Company will make future payments of approximately $540 million over the expected term, assuming we do not exercise any of the contractual purchase options. These future payments are not included in the table above. Additionally, under the terms of the agreement for our investment in BA Sports Nutrition, LLC (""BodyArmor""), the Company has an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreed-upon formula. The Company intends on exercising its option; however, the acquisition is subject to regulatory approval. Any potential payments related to this potential acquisition are not included in the table above. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in currencies. In 2020, we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2020 and 2019, the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, 2020 2019 All operating currencies (4) % (5) % Australian dollar (2) % (7) % Brazilian real (23) (10) British pound sterling 1 (4) Euro 1 (5) Japanese yen 2 1 Mexican peso (10) (1) South African rand (18) (10) The percentages in the table above do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 2 percent and 4 percent in 2020 and 2019, respectively. The total currency impact on income before income taxes, including the effect of our hedging activities, was a decrease of 6 percent and 10 percent in 2020 and 2019, respectively. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statement of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $64 million and $120 million during the years ended December 31, 2020 and 2019, respectively. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instruments and the underlying exposures, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposures. We monitor our exposure to market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2020, we used 70 functional currencies in addition to the U.S. dollar and generated $21.7 billion of our net operating revenues from operations outside the United States; therefore, weakness in some currencies may be offset by strength in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $16,663 million and $14,276 million as of December 31, 2020 and 2019, respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of foreign currency derivatives that qualify for hedge accounting resulted in a net unrealized gain of $117 million as of December 31, 2020, and we estimate that a 10 percent weakening of the U.S. dollar would have increased the net unrealized gain to $140 million. The fair value of the foreign currency derivatives that do not qualify for hedge accounting resulted in a net unrealized loss of $12 million as of December 31, 2020, and we estimate that a 10 percent weakening of the U.S. dollar would have resulted in a $143 million increase in fair value. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2020, we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $104 million in 2020. However, this increase in interest expense would have been partially offset by the increase in interest income due to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $53 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements, which enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to further manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $726 million and $427 million as of December 31, 2020 and 2019, respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the commodity derivatives that qualify for hedge accounting resulted in a net unrealized gain of $2 million as of December 31, 2020, and we estimate that a 10 percent decrease in underlying commodity prices would reduce the net unrealized gain to $1 million. The fair value of the commodity derivatives that do not qualify for hedge accounting resulted in a net gain of $69 million as of December 31, 2020, and we estimate that a 10 percent decrease in underlying commodity prices would have resulted in a $64 million decrease in fair value. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting 63 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2020 2019 2018 Net Operating Revenues $ 33,014 $ 37,266 $ 34,300 Cost of goods sold 13,433 14,619 13,067 Gross Profit 19,581 22,647 21,233 Selling, general and administrative expenses 9,731 12,103 11,002 Other operating charges 853 458 1,079 Operating Income 8,997 10,086 9,152 Interest income 370 563 689 Interest expense 1,437 946 950 Equity income (loss) net 978 1,049 1,008 Other income (loss) net 841 34 ( 1,674 ) Income Before Income Taxes 9,749 10,786 8,225 Income taxes 1,981 1,801 1,749 Consolidated Net Income 7,768 8,985 6,476 Less: Net income (loss) attributable to noncontrolling interests 21 65 42 Net Income Attributable to Shareowners of The Coca-Cola Company $ 7,747 $ 8,920 $ 6,434 Basic Net Income Per Share 1 $ 1.80 $ 2.09 $ 1.51 Diluted Net Income Per Share 1 $ 1.79 $ 2.07 $ 1.50 Average Shares Outstanding Basic 4,295 4,276 4,259 Effect of dilutive securities 28 38 40 Average Shares Outstanding Diluted 4,323 4,314 4,299 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2020 2019 2018 Consolidated Net Income $ 7,768 $ 8,985 $ 6,476 Other Comprehensive Income: Net foreign currency translation adjustments ( 911 ) 74 ( 2,035 ) Net gains (losses) on derivatives 15 ( 54 ) ( 7 ) Net change in unrealized gains (losses) on available-for-sale debt securities ( 47 ) 18 ( 34 ) Net change in pension and other postretirement benefit liabilities ( 267 ) ( 159 ) 29 Total Comprehensive Income 6,558 8,864 4,429 Less: Comprehensive income attributable to noncontrolling interests ( 132 ) 110 95 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 6,690 $ 8,754 $ 4,334 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2020 2019 ASSETS Current Assets Cash and cash equivalents $ 6,795 $ 6,480 Short-term investments 1,771 1,467 Total Cash, Cash Equivalents and Short-Term Investments 8,566 7,947 Marketable securities 2,348 3,228 Trade accounts receivable, less allowances of $ 526 and $ 524 , respectively 3,144 3,971 Inventories 3,266 3,379 Prepaid expenses and other assets 1,916 1,886 Total Current Assets 19,240 20,411 Equity method investments 19,273 19,025 Other investments 812 854 Other assets 6,184 6,075 Deferred income tax assets 2,460 2,412 Property, plant and equipment net 10,777 10,838 Trademarks with indefinite lives 10,395 9,266 Goodwill 17,506 16,764 Other intangible assets 649 736 Total Assets $ 87,296 $ 86,381 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 11,145 $ 11,312 Loans and notes payable 2,183 10,994 Current maturities of long-term debt 485 4,253 Accrued income taxes 788 414 Total Current Liabilities 14,601 26,973 Long-term debt 40,125 27,516 Other liabilities 9,453 8,510 Deferred income tax liabilities 1,833 2,284 The Coca-Cola Company Shareowners' Equity Common stock, $ 0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 17,601 17,154 Reinvested earnings 66,555 65,855 Accumulated other comprehensive income (loss) ( 14,601 ) ( 13,544 ) Treasury stock, at cost 2,738 and 2,760 shares, respectively ( 52,016 ) ( 52,244 ) Equity Attributable to Shareowners of The Coca-Cola Company 19,299 18,981 Equity attributable to noncontrolling interests 1,985 2,117 Total Equity 21,284 21,098 Total Liabilities and Equity $ 87,296 $ 86,381 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Operating Activities Consolidated net income $ 7,768 $ 8,985 $ 6,476 Depreciation and amortization 1,536 1,365 1,086 Stock-based compensation expense 126 201 225 Deferred income taxes ( 18 ) ( 280 ) ( 413 ) Equity (income) loss net of dividends ( 511 ) ( 421 ) ( 457 ) Foreign currency adjustments ( 88 ) 91 ( 50 ) Significant (gains) losses net ( 914 ) ( 467 ) 743 Other operating charges 556 127 558 Other items 699 504 699 Net change in operating assets and liabilities 690 366 ( 1,240 ) Net Cash Provided by Operating Activities 9,844 10,471 7,627 Investing Activities Purchases of investments ( 13,583 ) ( 4,704 ) ( 7,789 ) Proceeds from disposals of investments 13,835 6,973 14,977 Acquisitions of businesses, equity method investments and nonmarketable securities ( 1,052 ) ( 5,542 ) ( 1,263 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 189 429 1,362 Purchases of property, plant and equipment ( 1,177 ) ( 2,054 ) ( 1,548 ) Proceeds from disposals of property, plant and equipment 189 978 248 Other investing activities 122 ( 56 ) ( 60 ) Net Cash Provided by (Used in) Investing Activities ( 1,477 ) ( 3,976 ) 5,927 Financing Activities Issuances of debt 26,934 23,009 27,605 Payments of debt ( 28,796 ) ( 24,850 ) ( 30,600 ) Issuances of stock 647 1,012 1,476 Purchases of stock for treasury ( 118 ) ( 1,103 ) ( 1,912 ) Dividends ( 7,047 ) ( 6,845 ) ( 6,644 ) Other financing activities 310 ( 227 ) ( 272 ) Net Cash Provided by (Used in) Financing Activities ( 8,070 ) ( 9,004 ) ( 10,347 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents 76 ( 72 ) ( 262 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 373 ( 2,581 ) 2,945 Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 6,737 9,318 6,373 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 7,110 6,737 9,318 Less: Restricted cash and restricted cash equivalents at end of year 315 257 241 Cash and Cash Equivalents at End of Year $ 6,795 $ 6,480 $ 9,077 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (In millions except per share data) Year Ended December 31, 2020 2019 2018 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,280 4,268 4,259 Treasury stock issued to employees related to stock-based compensation plans 22 33 48 Purchases of stock for treasury ( 21 ) ( 39 ) Balance at end of year 4,302 4,280 4,268 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 17,154 16,520 15,864 Stock issued to employees related to stock-based compensation plans 307 433 467 Stock-based compensation expense 141 201 225 Other activities ( 1 ) ( 36 ) Balance at end of year 17,601 17,154 16,520 Reinvested Earnings Balance at beginning of year 65,855 63,234 60,430 Adoption of accounting standards 1 546 3,014 Net income attributable to shareowners of The Coca-Cola Company 7,747 8,920 6,434 Dividends (per share $ 1.64 , $ 1.60 and $ 1.56 in 2020, 2019 and 2018, respectively) ( 7,047 ) ( 6,845 ) ( 6,644 ) Balance at end of year 66,555 65,855 63,234 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 13,544 ) ( 12,814 ) ( 10,305 ) Adoption of accounting standards 1 ( 564 ) ( 409 ) Net other comprehensive income (loss) ( 1,057 ) ( 166 ) ( 2,100 ) Balance at end of year ( 14,601 ) ( 13,544 ) ( 12,814 ) Treasury Stock Balance at beginning of year ( 52,244 ) ( 51,719 ) ( 50,677 ) Treasury stock issued to employees related to stock-based compensation plans 228 501 704 Purchases of stock for treasury ( 1,026 ) ( 1,746 ) Balance at end of year ( 52,016 ) ( 52,244 ) ( 51,719 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 19,299 $ 18,981 $ 16,981 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 2,117 $ 2,077 $ 1,905 Net income attributable to noncontrolling interests 21 65 42 Net foreign currency translation adjustments ( 153 ) 45 53 Dividends paid to noncontrolling interests ( 18 ) ( 48 ) ( 31 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests 17 3 Business combinations 1 59 101 Other activities 7 Total Equity Attributable to Noncontrolling Interests $ 1,985 $ 2,117 $ 2,077 1 Refer to Note 1 and Note 5. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market numerous nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as the Company's consolidated bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 1.9 billion of the approximately 62 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 2,567 million and $ 3,179 million as of December 31, 2020 and 2019, respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 74 million and $ 51 million as of December 31, 2020 and 2019, respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Our Company recognizes revenue when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Refer to Note 3. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 3 billion in 2020 and $ 4 billion in 2019 and 2018. As of December 31, 2020 and 2019, advertising and production costs of $ 83 million and $ 55 million, respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our consolidated bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. We recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. We exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 6 million and 5 million stock option awards were excluded from the computations of diluted net income per share in 2020 and 2018, respectively, because the awards would have been antidilutive for the years presented. The number of stock option awards excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheet. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2020 2019 2018 Cash and cash equivalents $ 6,795 $ 6,480 $ 9,077 Restricted cash and restricted cash equivalents included in other assets 1 315 257 241 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 7,110 $ 6,737 $ 9,318 1 Amounts represent restricted cash and restricted cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any expected loss on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on available relevant information, in addition to historical loss information, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. In the fourth quarter of 2020, the Company started a trade accounts receivable factoring program in certain countries. Under this program we can elect to sell trade accounts receivables to unaffiliated financial institutions at a discount. In these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables and remit those payments to the financial institutions. The Company sold $ 185 million of trade accounts receivables under this program during the year ended December 31, 2020, and the costs of factoring such receivables were not material. The Company accounts for this program as a sale, and accordingly, the trade receivables sold are excluded from trade accounts receivable on our consolidated balance sheet. The cash received from the financial institutions is classified within the operating activities section in the consolidated statement of cash flows. Inventories Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2020 2019 Raw materials and packaging $ 2,106 $ 2,180 Finished goods 791 851 Other 369 348 Total inventories $ 3,266 $ 3,379 Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 5. Leases Effective January 1, 2019, we adopted Accounting Standards Codification (""ASC"") 842, Leases . We determine if an arrangement contains a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in the line items other assets, accounts payable and accrued expenses, and other liabilities in our consolidated balance sheet. Operating lease right-of-use (""ROU"") assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 9. We have various arrangements for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,301 million, $ 1,208 million and $ 999 million in 2020, 2019 and 2018, respectively. Amortization expense for leasehold improvements totaled $ 18 million in 2020, 2019 and 2018. The following table summarizes our property, plant and equipment (in millions): December 31, 2020 2019 Land $ 676 $ 659 Buildings and improvements 4,782 4,576 Machinery and equipment 14,242 13,686 Property, plant and equipment cost 19,700 18,921 Less: Accumulated depreciation 8,923 8,083 Property, plant and equipment net $ 10,777 $ 10,838 Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models. These appraisals and models include assumptions we believe are consistent with those a market participant would use. Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally less than 25 years. Refer to Note 7. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which include assumptions we believe are consistent with those a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (""Costa""), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""), each of which is its own reporting unit. The Bottling Investments operating segment includes all consolidated bottling operations, regardless of geographic location. Generally, each consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11. Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performance-based share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, which is generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018, 2019 and 2020, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12. Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14. Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying values of these assets and liabilities attributable to fluctuations in spot rates are recognized in net foreign currency translation adjustments, a component of AOCI. Refer to Note 15. Accounts in our consolidated statement of income are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 5. Recently Adopted Accounting Guidance In August 2017, the Financial Accounting Standards Board (""FASB"") issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (""ASU 2017-12""), which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments in this update include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2019 by $ 12 million, net of tax. Refer to Note 5 for additional disclosures required by this ASU. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (""ASU 2018-02""), which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act"") on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019. We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers . ASU 2014-09, and its amendments, were primarily included in ASC 606, Revenue from Contracts with Customers , which we adopted effective January 1, 2018 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $ 257 million, net of tax. In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $ 409 million, net of tax. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $ 2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Reform Act. The amendments also require any provisional amounts or subsequent adjustments to be included in net income. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018. Refer to Note 14. NOTE 2: ACQUISITIONS AND DIVESTITURES Acquisitions During 2020, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,052 million, which primarily related to the acquisition of the remaining ownership interest in fairlife, LLC (""fairlife""). During 2019, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million, which primarily related to the acquisitions of Costa, the remaining ownership interest in C.H.I. Limited (""CHI"") and controlling interests in bottling operations in Zambia, Kenya, and Eswatini. During 2018, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million, which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. fairlife, LLC In January 2020, the Company acquired the remaining 57.5 percent ownership interest in, and now owns 100 percent of, fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. A significant portion of fairlife's revenues was already reflected in our consolidated financial statements, as we have operated as the sales and distribution organization for certain fairlife products. Upon consolidation, we recognized a gain of $ 902 million resulting from the remeasurement of our previously held equity interest in fairlife to fair value. The fair value of our previously held equity interest was determined using a discounted cash flow model based on Level 3 inputs. The gain was recorded in the line item other income (loss) net in our consolidated statement of income. We acquired the remaining ownership interest in exchange for $ 979 million of cash, net of cash acquired, and effectively settled our $ 306 million note receivable from fairlife at the recorded amount. Under the terms of the agreement, we are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024 and, if achieved, are payable in 2021, 2023 and 2025. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting values of which are not subject to a ceiling. Under the applicable accounting guidance, we recorded a $ 270 million liability representing our best estimate of the fair value of this contingent consideration. The fair value of this contingent consideration was determined using a Monte Carlo valuation model based on Level 3 inputs. We will be required to remeasure this liability to fair value quarterly with any changes in the fair value recorded in income until the final milestone payment is made. During the year ended December 31, 2020, we recorded charges of $ 51 million related to this remeasurement in the line item other operating charges in our consolidated statement of income. Upon finalization of purchase accounting, $ 1.3 billion of the purchase price was allocated to the fairlife trademark and $ 0.8 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the North America operating segment. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail outlets in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market, as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. Upon finalization of purchase accounting, $ 2.4 billion of the purchase price was allocated to the Costa trademark and $ 2.5 billion was allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million, which was allocated to the Europe, Middle East and Africa operating segment. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent ownership interest in CHI, a Nigerian producer of value-added dairy and juice beverages and iced tea, in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net loss was recorded in the line item other income (loss) net in our consolidated statement of income. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $ 715 million of cash. The acquired business had $ 345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $ 32 million, which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2020, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 189 million, which primarily related to the sale of our ownership interest in Piedmont Coca-Cola Bottling Partnership to Coca-Cola Consolidated, Inc., an equity method investee, for cash proceeds of $ 100 million. Also included was the sale of our ownership interest in an equity method investee in North America and the sale of a portion of our ownership interest in one of our other equity method investees. We recognized a net loss of $ 2 million, a gain of $ 17 million, and a net gain of $ 18 million, respectively, as a result of these sales, which were recorded in the line item other income (loss) net in our consolidated statement of income. During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million, which primarily related to the sale of a portion of our ownership interest in Embotelladora Andina S.A. (""Andina"") and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million, respectively, which were recorded in the line item other income (loss) net in our consolidated statement of income. We continue to account for our remaining ownership interest in Andina as an equity method investment as a result of our representation on Andina's Board of Directors and other governance rights. During 2018, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 1,362 million, which primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the sale of our ownership interest in Corporacin Lindley S.A. (""Lindley""). Latin America Bottling Operations During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $ 289 million as a result of these sales and recognized a net gain of $ 47 million, which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018, we sold our ownership interest in Lindley to AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), an equity method investee. We received net cash proceeds of $ 507 million and recognized a net gain of $ 296 million during the year ended December 31, 2018, which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018, the Company completed its North America refranchising, which began in 2014, with the sale of its Canadian bottling operations. We received initial net cash proceeds of $ 518 million and recognized a net charge of $ 385 million during the year ended December 31, 2018. During the year ended December 31, 2019, we recognized a charge of $ 122 million, primarily related to post-closing adjustments as contemplated by the related agreements. These charges were included in the line item other income (loss) net in our consolidated statements of income. North America Refranchising United States In 2018, the Company completed the refranchising of all of our bottling territories in the United States to certain of our unconsolidated bottling partners. We recognized a net gain of $ 17 million during the year ended December 31, 2019 and recognized net charges of $ 91 million during the year ended December 31, 2018, primarily related to post-closing adjustments as contemplated by the related agreements. Included in these amounts is a net gain of $ 5 million during the year ended December 31, 2019 and a net charge of $ 21 million during the year ended December 31, 2018 from transactions with equity method investees or former management. During the years ended December 31, 2019 and 2018, the Company recorded charges of $ 4 million and $ 34 million, respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single new form of bottling agreement with additional requirements. The net gain and charges were included in the line item other income (loss) net in our consolidated statements of income. Coca-Cola Beverages Africa Proprietary Limited Due to the Company's original intent to refranchise Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), it was accounted for as held for sale and a discontinued operation from October 2017 through the first quarter of 2019. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As a result, during the year ended December 31, 2018, we recorded an impairment charge of $ 554 million, reflecting management's view of the proceeds that were expected to be received upon sale based on revised projections of future operating results and foreign currency exchange rate fluctuations. This charge was previously reflected in the line item income (loss) from discontinued operations in our consolidated statement of income and the corresponding reduction to assets was reflected as an allowance for reduction of assets held for sale discontinued operations in our consolidated balance sheet. Additionally, CCBA's property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans for CCBA and now intends to maintain its controlling stake in CCBA for the foreseeable future. As a result, CCBA no longer qualifies as held for sale or as a discontinued operation, and CCBA's financial results are now presented within the Company's continuing operations for all periods presented. As a result of this change in presentation, the Company reflected the impairment charge in other income (loss) net in our consolidated statement of income for the year ended December 31, 2018 and reallocated the allowance for reduction of assets held for sale discontinued operations balance to reduce the carrying value of CCBA's property, plant and equipment by $ 225 million and CCBA's definite-lived intangible assets by $ 329 million based on the relative amount of depreciation and amortization that would have been recognized during the period CCBA was held for sale. We also recorded a $ 160 million adjustment to reduce the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million, respectively, during the year ended December 31, 2019. These additional adjustments were included in the line item other income (loss) net in our consolidated statement of income. NOTE 3: REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Our concentrate operations typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrates, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers, or to distributors and wholesalers who in turn sell the beverages to retailers. These operations consist primarily of our consolidated bottling and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. Additionally, we sell directly to consumers through retail outlets operated by Costa, which is included in our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who in turn sell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrates they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above represent variable consideration, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2020 related to performance obligations satisfied in prior periods was immaterial. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2020 Concentrate operations $ 5,443 $ 13,139 $ 18,582 Finished product operations 5,838 8,594 14,432 Total $ 11,281 $ 21,733 $ 33,014 Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,323 $ 19,894 Finished product operations 6,773 7,633 14,406 Total $ 11,344 $ 22,956 $ 34,300 Refer to Note 19 for additional revenue disclosures by operating segment and Corporate. NOTE 4: INVESTMENTS We measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value with the change in fair value included in net income. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the changes in fair values attributable to the currency risk being hedged, if applicable, which are included in net income. Refer to Note 5 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities The carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2020 Marketable securities $ 330 $ Other investments 762 50 Other assets 1,282 Total equity securities $ 2,374 $ 50 December 31, 2019 Marketable securities $ 329 $ Other investments 772 82 Other assets 1,118 Total equity securities $ 2,219 $ 82 The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2020 2019 Net gains (losses) recognized during the year related to equity securities $ 146 $ 218 Less: Net gains (losses) recognized during the year related to equity securities sold during the year ( 22 ) 27 Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ 168 $ 191 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2020 Trading securities $ 36 $ 2 $ $ 38 Available-for-sale securities 2,227 51 ( 13 ) 2,265 Total debt securities $ 2,263 $ 53 $ ( 13 ) $ 2,303 December 31, 2019 Trading securities $ 46 $ 1 $ $ 47 Available-for-sale securities 3,172 113 ( 4 ) 3,281 Total debt securities $ 3,218 $ 114 $ ( 4 ) $ 3,328 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2020 December 31, 2019 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ 123 Marketable securities 38 1,980 47 2,852 Other assets 285 306 Total debt securities $ 38 $ 2,265 $ 47 $ 3,281 The contractual maturities of these available-for-sale debt securities as of December 31, 2020 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 701 $ 720 After 1 year through 5 years 1,236 1,237 After 5 years through 10 years 90 103 After 10 years 200 205 Total $ 2,227 $ 2,265 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2020 2019 2018 Gross gains $ 20 $ 39 $ 22 Gross losses ( 13 ) ( 8 ) ( 27 ) Proceeds 1,559 3,956 13,710 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $ 1,389 million and $ 1,266 million as of December 31, 2020 and 2019, respectively, which were classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5: HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in OCI. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019, we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019, we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million, net of taxes. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2020 December 31, 2019 Assets: Foreign currency contracts Prepaid expenses and other assets $ 26 $ 24 Foreign currency contracts Other assets 74 91 Commodity contracts Prepaid expenses and other assets 2 Interest rate contracts Prepaid expenses and other assets 10 Interest rate contracts Other assets 659 427 Total assets $ 761 $ 552 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 29 $ 40 Foreign currency contracts Other liabilities 48 Interest rate contracts Accounts payable and accrued expenses 5 Interest rate contracts Other liabilities 21 Total liabilities $ 34 $ 109 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2020 December 31, 2019 Assets: Foreign currency contracts Prepaid expenses and other assets $ 28 $ 13 Foreign currency contracts Other assets 1 Commodity contracts Prepaid expenses and other assets 76 8 Commodity contracts Other assets 9 2 Other derivative instruments Prepaid expenses and other assets 20 12 Other derivative instruments Other assets 3 1 Total assets $ 137 $ 36 Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ 41 $ 39 Commodity contracts Accounts payable and accrued expenses 15 13 Commodity contracts Other liabilities 1 1 Total liabilities $ 57 $ 53 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 7,785 million and $ 6,957 million as of December 31, 2020 and 2019, respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the changes in carrying values of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair values of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the changes in fair values attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 2,700 million and $ 3,028 million as of December 31, 2020 and 2019, respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 11 million and $ 2 million as of December 31, 2020 and 2019, respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional value of these interest rate swap agreements that were designated and qualified for the Company's interest rate cash flow hedging program was $ 1,233 million as of December 31, 2020. As of December 31, 2019, we did not have any interest rate swaps designated as a cash flow hedge. During the year ended December 31, 2018, we discontinued a cash flow hedge relationship related to these types of swaps. We reclassified a loss of $ 8 million into earnings as a result of the discontinuance. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on OCI, AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) 2 2020 Foreign currency contracts $ ( 93 ) Net operating revenues $ ( 73 ) $ Foreign currency contracts 4 Cost of goods sold 9 Foreign currency contracts Interest expense ( 16 ) Foreign currency contracts 37 Other income (loss) net 60 Interest rate contracts 15 Interest expense ( 54 ) Commodity contracts 2 Cost of goods sold Total $ ( 35 ) $ ( 74 ) $ 2019 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) $ Foreign currency contracts 1 Cost of goods sold 11 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts 1 Cost of goods sold Total $ ( 200 ) $ ( 162 ) $ 2018 Foreign currency contracts $ 9 Net operating revenues $ 136 $ 1 Foreign currency contracts 15 Cost of goods sold 8 ( 3 ) Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts 23 Other income (loss) net ( 5 ) ( 4 ) Interest rate contracts 22 Interest expense ( 40 ) ( 8 ) Commodity contracts ( 1 ) Cost of goods sold ( 5 ) Total $ 68 $ 90 $ ( 19 ) 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and the ineffective portion, if any, to the same line items in our consolidated statement of income. 2 Effective January 1, 2019, ASU 2017-12 eliminated the requirement to separately measure and report hedge ineffectiveness for cash flow hedges. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. As of December 31, 2020, the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 68 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured or has been extinguished. The total notional values of derivatives related to our fair value hedges of this type were $ 10,215 million and $ 12,523 million as of December 31, 2020 and 2019, respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair values of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in the fair values of derivatives designated as fair value hedges and the offsetting changes in the fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. As of December 31, 2020 and 2019, we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 2020 Interest rate contracts Interest expense $ 275 Fixed-rate debt Interest expense ( 274 ) Net impact to interest expense $ 1 Foreign currency contracts Other income (loss) net $ ( 4 ) Available-for-sale securities Other income (loss) net 5 Net impact to other income (loss) net $ 1 Net impact of fair value hedging instruments $ 2 2019 Interest rate contracts Interest expense $ 368 Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) 2018 Interest rate contracts Interest expense $ 34 Fixed-rate debt Interest expense ( 38 ) Net impact to interest expense $ ( 4 ) Foreign currency contracts Other income (loss) net $ ( 6 ) Available-for-sale securities Other income (loss) net 6 Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ ( 4 ) The following table summarizes the amounts recorded in the consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Carrying Values of Hedged Items Cumulative Amount of Fair Value Hedging Adjustments Included in the Carrying Values of Hedged Items 1 Balance Sheet Location of Hedged Items December 31, 2020 December 31, 2019 December 31, 2020 December 31, 2019 Current maturities of long-term debt $ $ 1,004 $ $ 5 Long-term debt 11,129 12,087 646 448 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rate fluctuations. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the carrying values of the designated portions of the non-derivative financial instruments due to changes in foreign currency exchange rates are recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2020 2019 2020 2019 2018 Foreign currency contracts $ 451 $ $ ( 5 ) $ 51 $ ( 14 ) Foreign currency denominated debt 13,336 12,334 ( 1,089 ) 144 653 Total $ 13,787 $ 12,334 $ ( 1,094 ) $ 195 $ 639 The Company did not reclassify any gains or losses related to net investment hedges from AOCI into earnings during the years ended December 31, 2020, 2019 and 2018. In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2020, 2019 and 2018. The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in the fair values of economic hedges are immediately recognized in earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in the fair values of economic hedges used to offset those monetary assets and liabilities are immediately recognized in earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in the fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are immediately recognized in earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 5,727 million and $ 4,291 million as of December 31, 2020 and 2019, respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and vehicle fuel. The changes in the fair values of these economic hedges are immediately recognized in earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 715 million and $ 425 million as of December 31, 2020 and 2019, respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, 2020 2019 2018 Foreign currency contracts Net operating revenues $ 58 $ ( 4 ) $ 22 Foreign currency contracts Cost of goods sold 6 1 9 Foreign currency contracts Other income (loss) net ( 13 ) ( 66 ) ( 264 ) Commodity contracts Cost of goods sold 54 ( 23 ) ( 25 ) Interest rate contracts Interest expense 6 ( 1 ) Other derivative instruments Selling, general and administrative expenses 21 47 ( 18 ) Other derivative instruments Other income (loss) net ( 55 ) 48 ( 22 ) Total $ 77 $ 3 $ ( 299 ) NOTE 6: EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statement of income and our carrying value of that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value of those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity method investees' AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in Coca-Cola European Partners plc (""CCEP""), Monster, AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic"") and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2020, we owned approximately 19 percent, 19 percent, 20 percent, 28 percent, 23 percent and 19 percent, respectively, of these companies' outstanding shares. As of December 31, 2020, our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 8,762 million. This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 2020 2019 2018 Net operating revenues $ 69,384 $ 75,980 $ 75,482 Cost of goods sold 41,139 44,881 44,933 Gross profit $ 28,245 $ 31,099 $ 30,549 Operating income $ 7,056 $ 7,748 $ 7,511 Consolidated net income $ 4,176 $ 4,597 $ 4,646 Less: Net income attributable to noncontrolling interests 54 63 101 Net income attributable to common shareowners $ 4,122 $ 4,534 $ 4,545 Company equity income (loss) net $ 978 $ 1,049 $ 1,008 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, 2020 2019 Current assets $ 29,431 $ 25,654 Noncurrent assets 67,900 68,269 Total assets $ 97,331 $ 93,923 Current liabilities $ 20,033 $ 20,271 Noncurrent liabilities 33,613 31,321 Total liabilities $ 53,646 $ 51,592 Equity attributable to shareowners of investees $ 42,622 $ 41,203 Equity attributable to noncontrolling interests 1,063 1,128 Total equity $ 43,685 $ 42,331 Company equity method investments $ 19,273 $ 19,025 Net sales to equity method investees, the majority of which are located outside the United States, were $ 13,041 million, $ 14,832 million and $ 14,799 million in 2020, 2019 and 2018, respectively. Total payments, primarily related to marketing, made to equity method investees were $ 547 million, $ 897 million and $ 1,131 million in 2020, 2019 and 2018, respectively. The decrease in net sales to, and payments made to, equity method investees in 2020 was primarily due to the impact of the COVID-19 pandemic. The decrease in payments made to equity method investees in 2019 was primarily due to changes in bottler funding arrangements. In addition, purchases of beverage products from equity method investees were $ 452 million, $ 426 million and $ 536 million in 2020, 2019 and 2018, respectively. The decrease in purchases of beverage products in 2019 was primarily due to reduced purchases of Monster products as a result of the North America refranchising activities. Refer to Note 2. The following table presents the difference between calculated fair value, based on quoted closing prices of publicly traded shares, and our Company's carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2020 Fair Value Carrying Value Difference Monster Beverage Corporation $ 9,444 $ 4,020 $ 5,424 Coca-Cola European Partners plc 4,383 3,959 424 Coca-Cola FEMSA, S.A.B. de C.V. 2,657 1,632 1,025 Coca-Cola HBC AG 2,657 1,282 1,375 Coca-Cola Amatil Limited 2,222 707 1,515 Coca-Cola Consolidated, Inc. 661 169 492 Coca-Cola Bottlers Japan Holdings Inc. 522 522 Coca-Cola ecek A.. 440 197 243 Embotelladora Andina S.A. 143 116 27 Total $ 23,129 $ 12,604 $ 10,525 Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,025 million and $ 1,707 million as of December 31, 2020 and 2019, respectively. The total amount of dividends received from equity method investees was $ 467 million, $ 628 million and $ 551 million for the years ended December 31, 2020, 2019 and 2018, respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2020 was $ 5,498 million. NOTE 7: INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2020 2019 Trademarks 1 $ 10,395 $ 9,266 Goodwill 17,506 16,764 Other 225 219 Indefinite-lived intangible assets $ 28,126 $ 26,249 1 For information related to the Company's acquisitions, refer to Note 2. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total 2019 Balance at beginning of year $ 1,051 $ 168 $ 7,943 $ 152 $ 414 $ 4,381 $ 14,109 Effect of foreign currency translation ( 8 ) 2 1 1 79 75 Acquisitions 1 141 2,505 173 2,819 Purchase accounting adjustments 1,2 110 17 ( 114 ) ( 252 ) ( 239 ) Balance at end of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 2020 Balance at beginning of year $ 1,294 $ 170 $ 7,943 $ 170 $ 2,806 $ 4,381 $ 16,764 Effect of foreign currency translation 40 ( 6 ) 7 84 ( 216 ) ( 91 ) Acquisitions 1 775 775 Purchase accounting adjustments 1,3 ( 26 ) 74 24 2 ( 2 ) 72 Impairments ( 14 ) ( 14 ) Balance at end of year $ 1,308 $ 164 $ 8,792 $ 201 $ 2,892 $ 4,149 $ 17,506 1 For information related to the Company's acquisitions, refer to Note 2. 2 Includes the allocation of goodwill from the Global Ventures segment to other reporting units expected to benefit from the Costa acquisition as well as the finalization of purchase accounting related to CCBA and the Philippine bottling operations. Refer to Note 2. 3 Includes the allocation of goodwill from the Europe, Middle East and Africa segment to other reporting units expected to benefit from the CHI acquisition as well as purchase accounting adjustments related to fairlife. Refer to Note 2. Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2020 December 31, 2019 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ 195 $ ( 61 ) $ 134 $ 344 $ ( 177 ) $ 167 Trademarks 245 ( 77 ) 168 177 ( 99 ) 78 Other 332 ( 210 ) 122 396 ( 124 ) 272 Total $ 772 $ ( 348 ) $ 424 $ 917 $ ( 400 ) $ 517 Total amortization expense for intangible assets subject to amortization was $ 203 million, $ 120 million and $ 49 million in 2020, 2019 and 2018, respectively. The increase in amortization expense in 2020 was due to the recognition of a full year of intangible amortization related to CCBA versus seven months in 2019. Based on the carrying value of definite-lived intangible assets as of December 31, 2020, we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense 2021 $ 163 2022 74 2023 43 2024 31 2025 25 NOTE 8: ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, 2020 2019 Accounts payable $ 3,517 $ 3,804 Accrued marketing expenses 1,930 2,059 Variable consideration payable 1,137 979 Other accrued expenses 3,352 2,856 Accrued compensation 609 1,021 Accrued sales, payroll and other taxes 443 442 Container deposits 157 151 Accounts payable and accrued expenses $ 11,145 $ 11,312 NOTE 9: LEASES We have operating leases primarily for real estate, aircraft, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2020 2019 Operating lease ROU assets 1 $ 1,548 $ 1,372 Current portion of operating lease liabilities 2 $ 322 $ 281 Noncurrent portion of operating lease liabilities 3 1,300 1,111 Total operating lease liabilities $ 1,622 $ 1,392 1 Operating lease ROU assets are recorded in the line item other assets in our consolidated balance sheet. 2 The current portion of operating lease liabilities is recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet. 3 The noncurrent portion of operating lease liabilities is recorded in the line item other liabilities in our consolidated balance sheet. We had operating lease costs of $ 353 million and $ 327 million for the years ended December 31, 2020 and 2019, respectively. During 2020 and 2019, cash paid for amounts included in the measurement of operating lease liabilities was $ 365 million and $ 339 million, respectively. Operating lease ROU assets obtained in exchange for operating lease obligations were $ 528 million and $ 308 million for the years ended December 31, 2020 and 2019, respectively. Information associated with the measurement of our remaining operating lease obligations as of December 31, 2020 is as follows: Weighted-average remaining lease term 9 years Weighted-average discount rate 3 % Our leases have remaining lease terms of 1 year to 44 years, inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturities of our operating lease liabilities as of December 31, 2020 (in millions): 2021 $ 340 2022 299 2023 252 2024 207 2025 170 Thereafter 565 Total operating lease payments 1,833 Less: Imputed interest 211 Total operating lease liabilities $ 1,622 NOTE 10: DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2020 and 2019, we had $ 1,329 million and $ 10,007 million, respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 1.3 percent and 2.0 percent per year as of December 31, 2020 and 2019, respectively. As of December 31, 2020 and 2019, the Company also had $ 854 million and $ 987 million, respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were primarily related to our international operations. In addition, we had $ 10,467 million in unused lines of credit and other short-term credit facilities as of December 31, 2020, of which $ 7,490 million was in backup lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2021 through 2025. There were no borrowings under these corporate backup lines of credit during 2020. These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2020, the Company issued U.S. dollar- and euro-denominated debt of $ 15,600 million and 2,600 million, respectively. The carrying value of this debt as of December 31, 2020 was $ 17,616 million. The general terms of the notes issued are as follows: $ 1,000 million total principal amount of notes due March 25, 2025, at a fixed interest rate of 2.950 percent; $ 1,000 million total principal amount of notes due March 25, 2027, at a fixed interest rate of 3.375 percent; $ 1,500 million total principal amount of notes due June 1, 2027, at a fixed interest rate of 1.450 percent; $ 1,300 million total principal amount of notes due March 15, 2028, at a fixed interest rate of 1.000 percent; 1,000 million total principal amount of notes due March 15, 2029, at a fixed interest rate of 0.125 percent; $ 1,250 million total principal amount of notes due March 25, 2030, at a fixed interest rate of 3.450 percent; $ 1,500 million total principal amount of notes due June 1, 2030, at a fixed interest rate of 1.650 percent; $ 1,300 million total principal amount of notes due March 15, 2031, at a fixed interest rate of 1.375 percent; 750 million total principal amount of notes due March 15, 2033, at a fixed interest rate of 0.375 percent; 850 million total principal amount of notes due March 15, 2040, at a fixed interest rate of 0.800 percent; $ 500 million total principal amount of notes due March 25, 2040, at a fixed interest rate of 4.125 percent; $ 1,000 million total principal amount of notes due June 1, 2040, at a fixed interest rate of 2.500 percent; $ 1,250 million total principal amount of notes due March 25, 2050, at a fixed interest rate of 4.200 percent; $ 1,500 million total principal amount of notes due June 1, 2050, at a fixed interest rate of 2.600 percent; $ 1,500 million total principal amount of notes due March 15, 2051, at a fixed interest rate of 2.500 percent; and $ 1,000 million total principal amount of notes due June 1, 2060, at a fixed interest rate of 2.750 percent. During 2020, the Company retired upon maturity Australian dollar- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.600 percent; $ 171 million total principal amount of zero coupon notes due June 20, 2020; $ 1,500 million total principal amount of notes due October 27, 2020, at a fixed interest rate of 1.875 percent; $ 1,250 million total principal amount of notes due November 1, 2020, at a fixed interest rate of 2.450 percent; and $ 1,000 million total principal amount of notes due November 15, 2020, at a fixed interest rate of 3.150 percent. During 2020, the Company also extinguished prior to maturity U.S. dollar- and euro-denominated debt of $ 3,815 million and 2,679 million, respectively, resulting in associated charges of $ 459 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationships. We also incurred charges of $ 25 million as a result of the reclassification of related cash flow hedging balances from AOCI into income. The general terms of the notes that were extinguished are as follows: 379 million total principal amount of notes due March 8, 2021, at a variable interest rate equal to the three-month Euro Interbank Offered Rate (""EURIBOR"") plus 0.200 percent; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.000 percent; $ 1,324 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 3.300 percent; $ 1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.550 percent; $ 500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.200 percent; 1,000 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 0.125 percent; 800 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 1.125 percent; $ 282 million total principal amount of notes due March 25, 2040, at a fixed interest rate of 4.125 percent; and $ 709 million total principal amount of notes due March 25, 2050, at a fixed interest rate of 4.200 percent. During 2019, the Company issued euro- and U.S. dollar-denominated debt of 3,500 million and $ 2,000 million, respectively. The carrying value of this debt as of December 31, 2019 was $ 5,891 million. The general terms of the notes issued are as follows: 750 million total principal amount of notes due March 8, 2021, at a variable interest rate equal to the three-month EURIBOR plus 0.200 percent; 1,000 million total principal amount of notes due September 22, 2022, at a fixed interest rate of 0.125 percent; 1,000 million total principal amount of notes due September 22, 2026, at a fixed interest rate of 0.750 percent; 750 million total principal amount of notes due March 8, 2031, at a fixed interest rate of 1.250 percent; $ 1,000 million total principal amount of notes due September 6, 2024, at a fixed interest rate of 1.750 percent; and $ 1,000 million total principal amount of notes due September 6, 2029, at a fixed interest rate of 2.125 percent. During 2019, the Company retired upon maturity euro- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three-month EURIBOR plus 0.250 percent; 2,000 million total principal amount of notes due September 9, 2019, at a variable interest rate equal to the three-month EURIBOR plus 0.230 percent; and $ 1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent. During 2018, the Company retired upon maturity U.S. dollar-denominated notes and debentures. The general terms of the notes and debentures retired are as follows: $ 26 million total principal amount of debentures due January 29, 2018, at a fixed interest rate of 9.660 percent; $ 750 million total principal amount of notes due March 14, 2018, at a fixed interest rate of 1.650 percent; $ 1,250 million total principal amount of notes due April 1, 2018, at a fixed interest rate of 1.150 percent; and $ 1,250 million total principal amount of notes due November 1, 2018, at a fixed interest rate of 1.650 percent. The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $ 94 million that was due to mature on May 15, 2098, at a fixed interest rate of 7.000 percent. Related to this extinguishment, the Company recorded a net gain of $ 27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018. The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2020 December 31, 2019 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20232093 $ 22,550 2.0 % $ 14,621 2.4 % U.S. dollar debentures due 20222098 1,342 5.1 1,366 4.9 U.S. dollar zero coupon notes due 2020 2 168 8.4 Australian dollar notes due 20202024 400 2.5 677 2.4 Euro notes due 20212040 13,821 0.3 12,807 0.5 Swiss franc notes due 20222028 1,236 2.7 1,129 3.7 Other, due through 2098 3 615 5.2 548 6.2 Fair value adjustments 4 646 N/A 453 N/A Total 5,6 40,610 1.6 % 31,769 1.9 % Less: Current portion 485 4,253 Long-term debt $ 40,125 $ 27,516 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 As of December 31, 2019, the amount shown is net of an unamortized discount of $ 3 million. 3 As of December 31, 2020, the amount shown includes $ 473 million of debt instruments and finance leases that are due through 2031. 4 Amounts represent the changes in fair values due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 5 As of December 31, 2020 and 2019, the fair value of our long-term debt, including the current portion, was $ 43,218 million and $ 32,725 million, respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. Total interest paid was $ 935 million, $ 921 million and $ 903 million in 2020, 2019 and 2018, respectively. Maturities of long-term debt for the five years succeeding December 31, 2020 are as follows (in millions): Maturities of Long-Term Debt 2021 $ 485 2022 1,391 2023 4,272 2024 2,061 2025 2,753 NOTE 11: COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2020, we were contingently liable for guarantees of indebtedness owed by third parties of $ 431 million, of which $ 109 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings (excluding tax audit claims) will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an ownership interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities, such as legislation and statutes, legislative intent, regulations, rulings and caselaw and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") seeking approximately $ 3.3 billion of additional federal income tax for years 2007 through 2009. In the Notice, the IRS stated its intent to reallocate over $ 9 billion of income to the U.S. parent company from certain of its foreign affiliates that the U.S. parent company licensed to manufacture, distribute, sell, market and promote its products in certain non-U.S. markets. The Notice concerned the Company's transfer pricing between its U.S. parent company and certain of its foreign affiliates. IRS rules governing transfer pricing require arm's-length pricing of transactions between related parties such as the Company's U.S. parent and its foreign affiliates. To resolve the same transfer pricing issue for the tax years 1987 through 1995, the Company and the IRS had agreed in 1996 on an arm's-length methodology for determining the amount of U.S. taxable income that the U.S. parent company would report as compensation from its foreign licensees. The Company and the IRS memorialized this accord in a closing agreement resolving that dispute (""Closing Agreement""). The Closing Agreement provided that, absent a change in material facts or circumstances or relevant federal tax law, in calculating the Company's income taxes going forward, the Company would not be assessed penalties by the IRS for using the agreed-upon tax calculation methodology that the Company and the IRS agreed would be used for the 1987-1995 tax years. The IRS audited and confirmed the Company's compliance with the agreed-upon Closing Agreement methodology in five successive audit cycles for tax years 1996 through 2006. The September 17, 2015 Notice from the IRS retroactively rejected the previously agreed-upon methodology for the 2007 through 2009 tax years, in favor of an entirely different methodology, without prior notice to the Company. Using the new tax calculation methodology, the IRS reallocated over $ 9 billion of income to the U.S. parent company from its foreign licensees for tax years 2007 through 2009. Consistent with the Closing Agreement, the IRS did not assert penalties, and it has yet to do so. The IRS designated the Company's matter for litigation on October 15, 2015. Litigation designation is an IRS determination that forecloses to a company any and all alternative means for resolution of a tax dispute. As a result of the IRS' designation of the Company's matter for litigation, the Company was forced either to accept the IRS' newly imposed tax assessment and pay the full amount of the asserted tax or litigate the matter in the federal courts. The matter remains subject to the IRS' litigation designation, preventing the Company from any attempt to settle or otherwise mutually resolve the matter with the IRS. The Company consequently initiated litigation by filing a petition in the U.S. Tax Court (""Tax Court"") in December 2015, challenging the tax adjustments enumerated in the Notice. Prior to trial, the IRS increased its transfer pricing adjustment by $ 385 million, resulting in an additional tax adjustment of $ 135 million. The Company obtained a summary judgment in its favor on a different matter related to Mexican foreign tax credits, which thereafter effectively reduced the IRS' potential tax adjustment by approximately $ 138 million. The trial was held in the Tax Court from March through May 2018, and final post-trial briefs were filed and exchanged in April 2019. On November 18, 2020, the Tax Court issued an opinion (""Opinion"") in which it predominantly sided with the IRS but agreed with the Company that dividends previously paid by the foreign licensees to the U.S. parent company in reliance upon the Closing Agreement should continue to be allowed to offset royalties, including those that would become payable to the Company in accordance with the Opinion. The Tax Court reserved ruling on the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil until after the Tax Court issues its opinion in the separate case of 3M Co. Subs. v. Commissioner, T.C. Docket No. 5816-13 (filed March 11, 2013). Once the Tax Court issues its opinion in 3M Co. Subs. v. Commissioner, the Company expects the Tax Court thereafter to render another opinion, and ultimately a final decision, in the Company's case. The Company believes that the IRS and the Tax Court misinterpreted and misapplied the applicable regulations in reallocating income earned by the Company's foreign licensees to increase the Company's U.S. tax. Moreover, the Company believes that the retroactive imposition of such tax liability using a calculation methodology different from that previously agreed upon by the IRS and the Company, and audited by the IRS for over a decade, is unconstitutional. The Company intends to assert its claims on appeal and vigorously defend its position. In determining the amount of tax reserve to be recorded as of December 31, 2020, the Company completed the required two-step evaluation process prescribed by ASC 740, Accounting for Income Taxes . In doing so, we consulted with outside advisors and we reviewed and considered relevant laws, rules, and regulations, including, though not limited to, the Opinion and relevant caselaw. We also considered our intention to vigorously defend our positions and assert our various well-founded legal claims via every available avenue of appeal. We concluded, based on the technical and legal merits of the Company's tax positions, that it is more likely than not the Company's tax positions will ultimately be sustained on appeal. In addition, we considered a number of alternative transfer pricing methodologies, including the methodology asserted by the IRS and affirmed in the Opinion (""Tax Court Methodology""), that could be applied by the courts upon final resolution of the litigation. Based on the required probability analysis, we determined the methodologies we believe the federal courts could ultimately order to be used in calculating the Company's tax. As a result of this analysis, we recorded a tax reserve of $ 438 million during the year ended December 31, 2020, related to the application of the resulting methodologies as well as the different tax treatment applicable to dividends originally paid to the U.S. parent company by its foreign licensees, in reliance upon the Closing Agreement, that would be recharacterized as royalties in accordance with the Opinion and the Company's analysis. While the Company strongly disagrees with the IRS' positions and the portions of the Opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS and sustained by the Tax Court could ultimately be upheld. In that event, the Company would likely be subject to significant additional liabilities for the years at issue, and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. The Company calculated the potential impact of applying the Tax Court Methodology to reallocate income from foreign licensees potentially covered within the scope of the Opinion, assuming such methodology was ultimately upheld by the courts, and the IRS were to decide to apply that methodology to subsequent years, with consent of the federal courts. This impact would include taxes and interest accrued through December 31, 2020 for the 2007 through 2009 litigated tax years and for subsequent tax years from 2010 to 2020. The calculations incorporated the estimated impact of correlative adjustments to the previously accrued transition tax payable under the Tax Reform Act. The Company currently estimates that the potential aggregate incremental tax and interest liability could be approximately $ 12 billion. Additional interest would continue to accrue until the time any such potential liability, or portion thereof, is paid. The Company currently projects that the impact of the continued application of the Tax Court Methodology in future years, assuming similar facts and circumstances as of December 31, 2020, would result in an incremental annual tax liability that would increase the Company's effective tax rate by approximately 3.5 percent. The Company does not know when the Tax Court will issue its opinion regarding the effect of Brazilian legal restrictions on the payment of royalties by the Company's licensee in Brazil for the 2007 through 2009 tax years. After the Tax Court issues its opinion on the Company's Brazilian licensee, the Company and the IRS will be provided time to agree on the tax impact, if any, of both opinions, after which the Tax Court would render a final decision in the case. The Company will have 90 days thereafter to file a notice of appeal to the United States Court of Appeals for the Eleventh Circuit and pay the tax liability and interest related to the 2007 through 2009 tax period. The Company currently estimates that the payment to be made at that time related to the 2007 through 2009 tax period, which is included in the above estimate of the potential aggregate incremental tax and interest liability, would be approximately $ 4.6 billion (including interest accrued through December 31, 2020), plus any additional interest accrued through the time of payment. Some or all of this amount would be refunded if the Company were to prevail on appeal. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claims history. Our self-insurance reserves totaled $ 265 million and $ 301 million as of December 31, 2020 and 2019, respectively . NOTE 12: STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued through the grant of equity awards to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2020, there were 345.3 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available for grants of stock option and restricted stock awards. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were granted a final restricted stock unit award that vests ratably over five years . Total stock-based compensation expense was $ 141 million, $ 201 million and $ 225 million in 2020, 2019 and 2018, respectively. In 2020, for certain employees who accepted voluntary separation from the Company as a result of our strategic realignment initiatives, the Company modified their outstanding equity awards granted prior to 2020 so that the employees retained all or some of their awards, whereas otherwise the awards would have been forfeited. The incremental stock-based compensation expense arising from the modifications was $ 15 million, which was recorded in the line item other operating charges in our consolidated statement of income. Refer to Note 18 for additional information on the Company's strategic realignment initiatives. The remainder of stock-based compensation expense in 2020 of $ 126 million as well as all stock-based compensation expense in 2019 and 2018 were included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to total stock-based compensation expense was $ 32 million, $ 43 million and $ 47 million in 2020, 2019 and 2018, respectively. As of December 31, 2020, we had $ 180 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans, which we expect to recognize over a weighted-average period of 1.9 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Stock Option Awards Stock options are generally granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2020, 2019 and 2018 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, 2020 2019 2018 Fair value of stock options on grant date $ 6.44 $ 4.94 $ 4.97 Dividend yield 1 2.7 % 3.5 % 3.5 % Expected volatility 2 16.0 % 15.5 % 15.5 % Risk-free interest rate 3 1.4 % 2.6 % 2.8 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from treasury shares. Stock option activity during the year ended December 31, 2020 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2020 105 $ 38.43 Granted 7 59.38 Exercised ( 23 ) 35.67 Forfeited/expired ( 1 ) 53.82 Outstanding on December 31, 2020 88 $ 40.55 4.16 years $ 1,289 Expected to vest 87 $ 40.44 4.11 years $ 1,283 Exercisable on December 31, 2020 72 $ 38.43 3.29 years $ 1,188 The total intrinsic value of the stock options exercised was $ 453 million, $ 609 million and $ 721 million in 2020, 2019 and 2018, respectively. The total number of stock options exercised was 23 million, 34 million and 47 million in 2020, 2019 and 2018, respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share units granted from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are vested and released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018, 2019 and 2020, the performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include a TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018, 2019 and 2020 will be vested and released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends until the shares are vested and released. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case former employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2020, growth share units of approximately 1,872,000 , 1,983,000 and 1,788,000 were outstanding for the 2018-2020, 2019-2021 and 2020-2022 performance periods, respectively, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2020 6,831 $ 38.57 Granted 1,983 57.00 Conversions into restricted stock units 1 ( 2,662 ) 35.30 Paid in cash equivalent ( 5 ) 38.20 Canceled/forfeited ( 504 ) 46.36 Outstanding on December 31, 2020 2 5,643 $ 45.89 1 Represents the target amount of performance share units converted into restricted stock units for the 2017-2019 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding growth share units as of December 31, 2020 at the threshold award and maximum award levels were approximately 2,384,000 and 12,950,000 , respectively. The weighted-average grant date fair value of growth share units granted in 2020, 2019 and 2018 was $ 57.00 , $ 40.29 and $ 41.02 , respectively. The Company converted performance share units and growth share units of approximately 5,000 in 2020 and approximately 1,000 in 2019 into cash equivalent payments of $ 0.2 million and $ 0.1 million, respectively, to former employees or their beneficiaries due to certain circumstances such as death or disability. The Company did not convert any performance share units or growth share units into cash equivalent payments in 2018. The following table summarizes information about performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2020 3,195 $ 39.70 Conversions from performance share units 3,785 35.30 Vested and released ( 3,189 ) 39.72 Canceled/forfeited ( 63 ) 35.71 Nonvested on December 31, 2020 3,728 $ 35.30 The total intrinsic value of restricted shares that were vested and released was $ 191 million, $ 118 million and $ 305 million in 2020, 2019 and 2018, respectively. Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle recipients to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle recipients to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2020, the Company had outstanding nonvested time-based restricted stock and restricted stock units totaling approximately 4,162,000 , most of which do not have voting rights or pay dividends. The following table summarizes information about time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2020 4,054 $ 40.73 Granted 1,354 53.90 Vested and released ( 735 ) 41.52 Canceled/forfeited ( 511 ) 46.30 Nonvested on December 31, 2020 4,162 $ 44.18 NOTE 13: PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain employees. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement benefit arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2020, the primary U.S. plan represented 61 percent and 59 percent of the Company's consolidated projected benefit obligation and pension plan assets, respectively. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our pension and other postretirement benefit plans (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2020 2019 Benefit obligation at beginning of year 1 $ 8,757 $ 8,015 $ 757 $ 719 Service cost 112 104 11 9 Interest cost 235 291 21 28 Participant contributions 1 1 12 20 Foreign currency exchange rate changes 67 ( 28 ) ( 1 ) ( 2 ) Amendments 3 ( 1 ) Net actuarial loss 2 746 931 22 71 Benefits paid ( 485 ) ( 537 ) ( 59 ) ( 86 ) Settlements 3 ( 81 ) ( 19 ) Curtailments 3 ( 15 ) ( 2 ) 6 ( 2 ) Special termination benefits 2 1 Other 72 1 Benefit obligation at end of year 1 $ 9,414 $ 8,757 $ 769 $ 757 Fair value of plan assets at beginning of year $ 8,080 $ 7,429 $ 339 $ 289 Actual return on plan assets 830 1,111 51 38 Employer contributions 30 36 Participant contributions 1 1 7 15 Foreign currency exchange rate changes 97 ( 26 ) Benefits paid ( 419 ) ( 453 ) ( 1 ) ( 3 ) Settlements 3 ( 53 ) ( 18 ) Other 73 Fair value of plan assets at end of year $ 8,639 $ 8,080 $ 396 $ 339 Net liability recognized $ ( 775 ) $ ( 677 ) $ ( 373 ) $ ( 418 ) 1 For pension plans, the benefit obligation is the projected benefit obligation. For other postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 9,263 million and $ 8,607 million as of December 31, 2020 and 2019, respectively. 2 A decrease in the weighted-average discount rate was the primary driver of net actuarial loss during 2020 and 2019. For our primary U.S. pension plan, a decrease in the discount rate resulted in actuarial loss of $ 491 million and $ 611 million during 2020 and 2019, respectively. Other drivers of net actuarial loss included assumption updates, plan experience, our strategic realignment initiatives and our productivity and reinvestment program. Refer to Note 18. 3 Settlements and curtailments were primarily related to our strategic realignment initiatives and our productivity and reinvestment program. Refer to Note 18. Pension and other postretirement benefit plan amounts recognized in our consolidated balance sheets were as follows (in millions): Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Other assets $ 1,151 $ 998 $ $ Accounts payable and accrued expenses ( 116 ) ( 72 ) ( 19 ) ( 21 ) Other liabilities ( 1,810 ) ( 1,603 ) ( 354 ) ( 397 ) Net liability recognized $ ( 775 ) $ ( 677 ) $ ( 373 ) $ ( 418 ) Certain of our pension plans have a projected benefit obligation in excess of the fair value of plan assets. For these plans, the projected benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2020 2019 Projected benefit obligation $ 7,722 $ 7,194 Fair value of plan assets 5,796 5,515 Certain of our pension plans have an accumulated benefit obligation in excess of the fair value of plan assets. For these plans, the accumulated benefit obligation and the fair value of plan assets were as follows (in millions): December 31, 2020 2019 Accumulated benefit obligation $ 7,553 $ 7,052 Fair value of plan assets 5,745 5,485 All of our other postretirement benefit plans have an accumulated postretirement benefit obligation in excess of the fair value of plan assets. Pension Plan Assets The following table presents total assets by asset class for our U.S. and non-U.S. pension plans (in millions): U.S. Pension Plans Non-U.S. Pension Plans December 31, 2020 2019 2020 2019 Cash and cash equivalents $ 279 $ 364 $ 399 $ 377 Equity securities: U.S.-based companies 1,382 1,231 757 673 International-based companies 988 770 738 617 Fixed-income securities: Government bonds 220 263 417 273 Corporate bonds and debt securities 926 899 116 65 Mutual, pooled and commingled funds 1 301 279 513 619 Hedge funds/limited partnerships 588 652 34 37 Real estate 326 337 6 5 Derivative financial instruments ( 1 ) ( 14 ) Other 364 354 300 265 Total pension plan assets 2 $ 5,373 $ 5,149 $ 3,266 $ 2,931 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. pension plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2020, no investment manager was responsible for more than 9 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 4 percent of our total global equities and approximately 3 percent of total U.S. pension plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2020, the long-term target allocation for 69 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, was 64 percent equity securities, 4 percent fixed-income securities and 32 percent other investments. The actual allocation for the remaining 31 percent of the Company's international subsidiaries' pension plan assets consisted of 42 percent mutual, pooled and commingled funds; 21 percent fixed-income securities; 1 percent equity securities and 36 percent other investments. The investment strategies for our international subsidiaries' pension plans vary greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets by asset class for our other postretirement benefit plans (in millions): December 31, 2020 2019 Cash and cash equivalents $ 30 $ 57 Equity securities: U.S.-based companies 170 124 International-based companies 12 9 Fixed-income securities: Government bonds 3 3 Corporate bonds and debt securities 80 47 Mutual, pooled and commingled funds 86 84 Hedge funds/limited partnerships 7 7 Real estate 4 4 Other 4 4 Total other postretirement benefit plan assets 1 $ 396 $ 339 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16. Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2018 2020 2019 2018 Service cost $ 112 $ 104 $ 124 $ 11 $ 9 $ 11 Interest cost 235 291 296 21 28 25 Expected return on plan assets 1 ( 587 ) ( 552 ) ( 650 ) ( 16 ) ( 13 ) ( 13 ) Amortization of prior service cost (credit) 3 ( 4 ) ( 3 ) ( 3 ) ( 2 ) ( 14 ) Amortization of net actuarial loss 2 171 151 128 5 2 3 Net periodic benefit cost (income) ( 66 ) ( 10 ) ( 105 ) 18 24 12 Settlement charges 3 23 6 240 Curtailment charges (credits) 3 1 5 6 ( 2 ) ( 4 ) Special termination benefits 3 2 1 7 Other ( 4 ) 1 ( 1 ) Total cost (income) recognized in consolidated statements of income $ ( 44 ) $ ( 2 ) $ 147 $ 24 $ 22 $ 7 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to our strategic realignment initiatives, our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 18 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our pension and other postretirement benefit plans (in millions, pretax): Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2020 2019 Balance in AOCI at beginning of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) Recognized prior service cost (credit) 3 ( 4 ) ( 3 ) ( 4 ) Recognized net actuarial loss 195 157 11 2 Prior service credit (cost) occurring during the year ( 3 ) 1 Net actuarial (loss) gain occurring during the year ( 488 ) ( 370 ) 7 ( 44 ) Net foreign currency translation adjustments ( 41 ) 20 ( 3 ) 2 Balance in AOCI at end of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) 1 Includes $ 23 million of recognized net actuarial loss due to the impact of settlements. 2 Includes $ 15 million of net actuarial loss occurring during the year due to the impact of curtailments . The following table sets forth the amounts in AOCI for our pension and other postretirement benefit plans (in millions, pretax): Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Prior service credit (cost) $ ( 10 ) $ ( 12 ) $ 17 $ 23 Net actuarial loss ( 3,002 ) ( 2,666 ) ( 64 ) ( 82 ) Balance in AOCI at end of year $ ( 3,012 ) $ ( 2,678 ) $ ( 47 ) $ ( 59 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations for our pension and other postretirement benefit plans were as follows: Pension Plans Other Postretirement Benefit Plans December 31, 2020 2019 2020 2019 Discount rate 2.50 % 3.25 % 2.75 % 3.50 % Interest crediting rate 3.00 % 3.50 % N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost (income) were as follows: Pension Plans Other Postretirement Benefit Plans Year Ended December 31, 2020 2019 2018 2020 2019 2018 Discount rate 3.25 % 4.00 % 3.50 % 3.50 % 4.25 % 3.50 % Interest crediting rate 3.50 % 3.75 % 3.25 % N/A N/A N/A Rate of increase in compensation levels 3.75 % 3.75 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 7.50 % 7.75 % 8.00 % 4.50 % 4.50 % 4.50 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2020 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate assumption on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The current cash balance interest crediting rate for the primary U.S. pension plan is the yield on six-month U.S. Treasury bills on the last day of September of the previous plan year, plus 150 basis points. The Company assumes that the current cash balance interest crediting rate will grow linearly over 10 years to the ultimate interest crediting rate assumption. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2020 net periodic pension cost for the U.S. pension plans was 7.50 percent. As of December 31, 2020, the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 10.2 percent, 8.4 percent and 6.9 percent, respectively. The annualized return since inception was 10.5 percent. The weighted-average assumptions for health care cost trend rates were as follows: December 31, 2020 2019 Health care cost trend rate assumed for next year 6.75 % 6.75 % Rate to which the trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.25 % Year that the trend rate reaches the ultimate trend rate 2025 2025 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of health care inflation because the plans have established dollar limits for determining our contributions. Cash Flows The estimated future benefit payments for our pension and other postretirement benefit plans are as follows (in millions): Year Ended December 31, 2021 2022 2023 2024 2025 20262030 Benefit payments for pension plans $ 657 1 $ 437 $ 472 $ 483 $ 491 $ 2,492 Benefit payments for other postretirement benefit plans 2 60 56 54 51 50 226 Total estimated benefit payments $ 717 $ 493 $ 526 $ 534 $ 541 $ 2,718 1 The estimated benefit payments in 2021 are higher due to our strategic realignment initiatives. Refer to Note 18. 2 The estimated benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $ 2 million for the period 20212025 and $ 2 million for the period 20262030. The Company anticipates making contributions to our pension trusts in 2021 of $ 25 million, all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or laws. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limits. The Company's expense for the U.S. plans totaled $ 43 million, $ 43 million and $ 39 million in 2020, 2019 and 2018, respectively. We also sponsor defined contribution plans in certain locations outside the United States. The Company's expense for these plans totaled $ 63 million, $ 64 million and $ 59 million in 2020, 2019 and 2018, respectively. Multi-Employer Retirement Plans The Company participates in various multi-employer retirement plans. Multi-employer retirement plans are designed to provide benefits to or on behalf of employees of multiple employers. These plans are typically established under collective bargaining agreements. Multi-employer retirement plans are generally governed by a board of trustees composed of representatives of both management and labor and are generally funded through employer contributions. The Company's expense for multi-employer retirement plans totaled $ 2 million, $ 5 million and $ 6 million in 2020, 2019 and 2018, respectively. The plans we currently participate in have contractual arrangements that extend into 2025. If, in the future, we choose to withdraw from any of the multi-employer retirement plans in which we currently participate, we would record the appropriate withdrawal liability, if any, at that time . NOTE 14: INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, 2020 2019 2018 United States $ 3,149 $ 3,249 $ 888 International 6,600 7,537 7,337 Total $ 9,749 $ 10,786 $ 8,225 Income taxes consisted of the following (in millions): United States State and Local International Total 2020 Current $ 296 $ 396 $ 1,307 $ 1,999 Deferred ( 220 ) 21 181 ( 18 ) 2019 Current $ 508 $ 94 $ 1,479 $ 2,081 Deferred ( 65 ) 52 ( 267 ) ( 280 ) 2018 Current $ 591 $ 145 $ 1,426 $ 2,162 Deferred ( 386 ) ( 81 ) 54 ( 413 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). We made income tax payments of $ 1,268 million, $ 2,126 million and $ 2,120 million in 2020, 2019 and 2018, respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036. We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 317 million, $ 335 million and $ 318 million for the years ended December 31, 2020, 2019 and 2018, respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2020 2019 2018 Statutory U.S. federal tax rate 21.0 % 21.0 % 21.0 % State and local income taxes net of federal benefit 1.1 0.9 1.5 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 0.9 1.1 4,5,6 3.1 8,9 Equity income or loss ( 1.4 ) ( 1.6 ) ( 2.5 ) Tax Reform Act 0.1 10 Excess tax benefits on stock-based compensation ( 0.8 ) ( 0.9 ) ( 1.3 ) Other net ( 0.5 ) 2,3 ( 3.8 ) ( 0.6 ) Effective tax rate 20.3 % 16.7 % 21.3 % 1 Includes net tax charges of $ 110 million (or a 1.1 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes net tax expense of $ 431 million (or a 4.4 percent impact on our effective tax rate) primarily related to changes in judgment on specific tax positions due to the Opinion and amounts required to be recorded for changes to other uncertain tax positions, including interest and penalties. Also includes a tax benefit of $ 107 million (or a 1.1 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 135 million (or a 1.4 percent impact on our effective tax rate) related to domestic return to provision adjustments and other tax items. 3 Includes a tax benefit of $ 40 million (or a 2.4 percent impact on our effective tax rate) associated with the $ 902 million gain recorded upon the acquisition of the remaining ownership interest in fairlife. Refer to Note 2. 4 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 6 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 7 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 8 Includes the impact of pretax charges of $ 591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $ 554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. 9 Includes net tax expense of $ 28 million on net pretax charges of $ 403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. 10 Includes net tax expense of $ 8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits of approximately $ 41 billion. Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017, following enactment of the Tax Reform Act, we recorded a provisional $ 4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $ 0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $ 0.3 billion in tax for our one-time transition tax and a tax benefit of $ 0.3 billion, primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. As of December 31, 2020, we have not recorded incremental income taxes for any additional outside basis differences of approximately $ 5.7 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiary's earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007. With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years prior to 2006. For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for in accordance with the applicable accounting guidance. On November 18, 2020, the Tax Court issued the Opinion regarding the Company's 2015 litigation with the IRS involving transfer pricing tax adjustments in which the court predominantly sided with the IRS. The Company disagrees with the Opinion and intends to vigorously defend its position. Refer to Note 11. As of December 31, 2020, the gross amount of unrecognized tax benefits was $ 915 million. If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 588 million, exclusive of any benefits related to interest and penalties. The remaining $ 327 million primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2020 2019 2018 Balance of unrecognized tax benefits at beginning of year $ 392 $ 336 $ 331 Increase related to prior period tax positions 528 204 11 Decrease related to prior period tax positions ( 1 ) ( 2 ) Increase related to current period tax positions 26 29 17 Decrease related to settlements with taxing authorities ( 19 ) ( 174 ) ( 4 ) Increase (decrease) due to effect of foreign currency exchange rate changes ( 11 ) ( 3 ) ( 17 ) Balance of unrecognized tax benefits at end of year $ 915 $ 392 $ 336 1 The increase was primarily related to a change in judgment on certain tax positions due to the Opinion. Refer to Note 11. 2 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 3 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 391 million, $ 201 million and $ 190 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2020, 2019 and 2018, respectively. Of these amounts, $ 190 million, $ 11 million and $ 13 million of expense were recognized in income tax expense in 2020, 2019 and 2018, respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, 2020 2019 Deferred tax assets: Property, plant and equipment $ 44 $ 53 Trademarks and other intangible assets 2,214 2,267 Equity method investments (including net foreign currency translation adjustments) 580 372 Derivative financial instruments 523 389 Other liabilities 1,401 1,066 Benefit plans 893 880 Net operating/capital loss carryforwards 320 259 Other 391 311 Gross deferred tax assets 6,366 5,597 Valuation allowances ( 406 ) ( 303 ) Total deferred tax assets $ 5,960 $ 5,294 Deferred tax liabilities: Property, plant and equipment $ ( 837 ) $ ( 877 ) Trademarks and other intangible assets ( 1,661 ) ( 1,533 ) Equity method investments (including net foreign currency translation adjustments) ( 1,533 ) ( 1,667 ) Derivative financial instruments ( 435 ) ( 348 ) Other liabilities ( 402 ) ( 351 ) Benefit plans ( 321 ) ( 286 ) Other ( 144 ) ( 104 ) Total deferred tax liabilities $ ( 5,333 ) $ ( 5,166 ) Net deferred tax assets $ 627 $ 128 As of December 31, 2020 and 2019, we had net deferred tax assets of $ 1.4 billion and $ 1.3 billion, respectively, located in countries outside the United States. As of December 31, 2020, we had $ 2,669 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 687 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, 2020 2019 2018 Balance at beginning of year $ 303 $ 419 $ 519 Additions 240 148 83 Deductions ( 137 ) ( 264 ) ( 183 ) Balance at end of year $ 406 $ 303 $ 419 The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions and basis differences in certain equity investments. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2020, the Company recognized a net increase of $ 103 million in its valuation allowances. The increase was primarily due to net increases in the deferred tax assets and related valuation allowances on certain equity investments. The increase was also due to the increase of valuation allowances after considering significant negative evidence on the utilization of certain net operating losses and excess foreign tax credits. In 2019, the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be nondeductible and the changes in net operating losses in the normal course of business. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. In 2018, the Company recognized a net decrease of $ 100 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. NOTE 15: OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, 2020 2019 Net foreign currency translation adjustments $ ( 12,028 ) $ ( 11,270 ) Accumulated net gains (losses) on derivatives ( 194 ) ( 209 ) Unrealized net gains (losses) on available-for-sale debt securities 28 75 Adjustments to pension and other postretirement benefit liabilities ( 2,407 ) ( 2,140 ) Accumulated other comprehensive income (loss) $ ( 14,601 ) $ ( 13,544 ) T he following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2020 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 7,747 $ 21 $ 7,768 Other comprehensive income: Net foreign currency translation adjustments ( 758 ) ( 153 ) ( 911 ) Net gains (losses) on derivatives 1 15 15 Net change in unrealized gains (losses) on available-for-sale debt securities 2 ( 47 ) ( 47 ) Net change in pension and other postretirement benefit liabilities 3 ( 267 ) ( 267 ) Total comprehensive income $ 6,690 $ ( 132 ) $ 6,558 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2020, 2019 and 2018 was as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount 2020 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 2,223 ) $ 150 $ ( 2,073 ) Reclassification adjustments recognized in net income 3 3 Gains (losses) on intra-entity transactions that are of a long-term investment nature 2,133 2,133 Gains (losses) on net investment hedges arising during the year 1 ( 1,094 ) 273 ( 821 ) Net foreign currency translation adjustments $ ( 1,181 ) $ 423 $ ( 758 ) Derivatives: Gains (losses) arising during the year $ ( 54 ) $ 13 $ ( 41 ) Reclassification adjustments recognized in net income 74 ( 18 ) 56 Net gains (losses) on derivatives 1 $ 20 $ ( 5 ) $ 15 Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 64 ) $ 22 $ ( 42 ) Reclassification adjustments recognized in net income ( 7 ) 2 ( 5 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 71 ) $ 24 $ ( 47 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 560 ) $ 138 $ ( 422 ) Reclassification adjustments recognized in net income 206 ( 51 ) 155 Net change in pension and other postretirement benefit liabilities 3 $ ( 354 ) $ 87 $ ( 267 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,586 ) $ 529 $ ( 1,057 ) 2019 Foreign currency translation adjustments: Translation adjustments arising during the year $ 52 $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income 192 192 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 195 ( 49 ) 146 Net foreign currency translation adjustments $ 132 $ ( 103 ) $ 29 Derivatives: Gains (losses) arising during the year $ ( 225 ) $ 49 $ ( 176 ) Reclassification adjustments recognized in net income 163 ( 41 ) 122 Net gains (losses) on derivatives 1 $ ( 62 ) $ 8 $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ 47 $ ( 4 ) $ 43 Reclassification adjustments recognized in net income ( 31 ) 6 ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ 16 $ 2 $ 18 Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 379 ) $ 105 $ ( 274 ) Reclassification adjustments recognized in net income 151 ( 36 ) 115 Net change in pension and other postretirement benefit liabilities 3 $ ( 228 ) $ 69 $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) Before-Tax Amount Income Tax After-Tax Amount 2018 Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,728 ) $ 59 $ ( 1,669 ) Reclassification adjustments recognized in net income 398 398 Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,296 ) ( 1,296 ) Gains (losses) on net investment hedges arising during the year 1 639 ( 160 ) 479 Net foreign currency translation adjustments $ ( 1,987 ) $ ( 101 ) $ ( 2,088 ) Derivatives: Gains (losses) arising during the year $ 59 $ ( 16 ) $ 43 Reclassification adjustments recognized in net income ( 68 ) 18 ( 50 ) Net gains (losses) on derivatives 1 $ ( 9 ) $ 2 $ ( 7 ) Available-for-sale securities: Unrealized gains (losses) arising during the year $ ( 50 ) $ 11 $ ( 39 ) Reclassification adjustments recognized in net income 5 5 Net change in unrealized gains (losses) on available-for-sale securities 2 $ ( 45 ) $ 11 $ ( 34 ) Pension and other postretirement benefit liabilities: Net pension and other postretirement benefit liabilities arising during the year $ ( 299 ) $ 75 $ ( 224 ) Reclassification adjustments recognized in net income 341 ( 88 ) 253 Net change in pension and other postretirement benefit liabilities 3 $ 42 $ ( 13 ) $ 29 Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,999 ) $ ( 101 ) $ ( 2,100 ) 1 Refer to Note 5 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2020 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ 3 Income before income taxes 3 Income taxes Consolidated net income $ 3 Derivatives: Foreign currency contracts Net operating revenues $ 73 Foreign currency and commodity contracts Cost of goods sold ( 9 ) Foreign currency contracts Other income (loss) net ( 60 ) Foreign currency and interest rate contracts Interest expense 70 Income before income taxes 74 Income taxes ( 18 ) Consolidated net income $ 56 Available-for-sale securities: Sale of securities Other income (loss) net $ ( 7 ) Income before income taxes ( 7 ) Income taxes 2 Consolidated net income $ ( 5 ) Pension and other postretirement benefit liabilities: Settlement charges 2 Other income (loss) net $ 23 Curtailment charges 2 Other income (loss) net 7 Recognized net actuarial loss Other income (loss) net 176 Recognized prior service cost (credit) Other income (loss) net Income before income taxes 206 Income taxes ( 51 ) Consolidated net income $ 155 1 Related to the sale of a portion of our ownership interest in one of our equity method investees. Refer to Note 2. 2 The settlement and curtailment charges were related to our strategic realignment initiatives. Refer to Note 13 and Note 18. NOTE 16: FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2020 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 2,049 $ 210 $ 12 $ 103 $ $ 2,374 Debt securities 1 4 2,267 32 2,303 Derivatives 2 63 835 ( 669 ) 229 Total assets $ 2,116 $ 3,312 $ 44 $ 103 $ ( 669 ) $ 4,906 Liabilities: Contingent consideration liability $ $ $ 321 5 $ $ $ 321 Derivatives 2 91 ( 81 ) 10 Total liabilities $ $ 91 $ 321 $ $ ( 81 ) $ 331 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 Refer to Note 2 for additional information related to the contingent consideration liability resulting from the fairlife acquisition. 6 The Company is obligated to return $ 546 million in cash collateral it has netted against its derivative position. 7 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 229 million in the line item other assets, $9 million in the line item accounts payable and accrued expenses and $ 1 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2019 Level 1 Level 2 Level 3 Other 3 Netting Adjustment Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,877 $ 219 $ 14 $ 109 $ $ 2,219 Debt securities 1 3,291 37 3,328 Derivatives 2 9 579 ( 392 ) 196 Total assets $ 1,886 $ 4,089 $ 51 $ 109 $ ( 392 ) $ 5,743 Liabilities: Derivatives 2 $ $ 162 $ $ $ ( 130 ) $ 32 Total liabilities $ $ 162 $ $ $ ( 130 ) $ 32 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4. 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5. 5 The Company is obligated to return $ 261 million in cash collateral it has netted against its derivative position. 6 The Company does not have the right to reclaim any cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 196 million in the line item other assets and $ 32 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2020 and 2019. The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2020 and 2019. Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, 2020 2019 Other-than-temporary impairment charges $ ( 290 ) $ ( 767 ) Impairment of intangible assets ( 215 ) ( 42 ) Impairment of equity investment without a readily determinable fair value ( 26 ) CCBA asset adjustments ( 160 ) Total $ ( 531 ) $ ( 969 ) 1 During the years ended December 31, 2020 and 2019, the Company recorded other-than-temporary impairment charges of $ 252 million and $ 406 million, respectively, related to CCBJHI, an equity method investee. Based on the length of time and the extent to which the market value of our investment in CCBJHI was less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. These impairment charges were determined using the quoted market prices (a Level 1 measurement) of CCBJHI. The Company also recorded other-than-temporary impairment charges of $ 38 million and $ 49 million, respectively, related to certain equity method investees in Latin America. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results. During the year ended December 31, 2019, the Company recognized other-than-temporary impairment charges of $ 255 million related to certain equity method investees in the Middle East. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results largely related to instability in the region and changes in local excise taxes. The Company also recognized an other-than-temporary impairment charge of $ 57 million related to one of our equity method investees in North America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 2 The Company recorded impairment charges of $ 160 million related to its Odwalla trademark in North America, as the Company decided in June 2020 to discontinue its Odwalla juice business. The Company also recorded an impairment charge of $ 55 million related to a trademark in North America, which was primarily driven by the impact of the COVID-19 pandemic, revised projections of future operating results and a change in brand focus in the Company's portfolio. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 3 The Company recorded an impairment charge of $ 26 million related to an investment in an equity security without a readily determinable fair value. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. 4 The Company recorded an impairment charge of $ 42 million related to a trademark in Asia Pacific, which was primarily driven by revised projections of future operating results for the trademark. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 As a result of CCBA no longer being classified as held for sale, the Company was required to measure CCBA's property, plant and equipment and definite-lived intangible assets at the lower of their current fair values or their carrying amounts before they were classified as held for sale, adjusted for depreciation and amortization expense that would have been recognized had the business been classified as held and used during the period that CCBA was classified as held for sale. As a result, we reduced the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by $ 34 million and $ 126 million, respectively, based on Level 3 inputs. Refer to Note 2. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost as well as amounts recognized in our consolidated balance sheets. Refer to Note 13. The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2020 December 31, 2019 Level 1 Level 2 Level 3 Other Total Level 1 Level 2 Level 3 Other Total Cash and cash equivalents $ 558 $ 120 $ $ $ 678 $ 597 $ 144 $ $ $ 741 Equity securities: U.S.-based companies 2,123 12 4 2,139 1,876 7 21 1,904 International-based companies 1,694 32 1,726 1,354 33 1,387 Fixed-income securities: Government bonds 637 637 536 536 Corporate bonds and debt securities 1,011 31 1,042 924 40 964 Mutual, pooled and commingled funds 44 268 502 814 40 258 600 898 Hedge funds/limited partnerships 622 622 689 689 Real estate 332 332 342 342 Derivative financial instruments ( 15 ) ( 15 ) Other 302 362 664 273 3 346 619 Total $ 4,419 $ 2,065 $ 337 $ 1,818 $ 8,639 $ 3,867 $ 1,902 $ 334 $ 1,977 $ 8,080 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 This class of assets includes investments in credit contracts. 3 Includes purchased annuity insurance contracts. 4 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developing and emerging markets. There are no liquidity restrictions on these investments. 5 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semiannually, with a redemption notice period of up to one year and/or initial lock-up periods of up to three years, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 6 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semiannually, with a redemption notice period of up to 90 days. 7 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semiannual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Other Total 2019 Balance at beginning of year $ 17 $ 16 $ 270 $ 303 Actual return on plan assets 1 10 11 Purchases, sales, and settlements net 1 21 1 23 Transfers into Level 3 net 2 3 5 Net foreign currency translation adjustments ( 8 ) ( 8 ) Balance at end of year $ 21 $ 40 $ 273 $ 334 2020 Balance at beginning of year $ 21 $ 40 $ 273 $ 334 Actual return on plan assets 1 6 7 Purchases, sales, and settlements net ( 18 ) ( 17 ) 4 ( 31 ) Transfers into Level 3 net 1 7 8 Net foreign currency translation adjustments 19 19 Balance at end of year $ 4 $ 31 $ 302 $ 337 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2020 December 31, 2019 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ 29 $ 1 $ $ 30 $ 56 $ 1 $ $ 57 Equity securities: U.S.-based companies 169 1 170 124 124 International-based companies 12 12 9 9 Fixed-income securities: Government bonds 3 3 3 3 Corporate bonds and debt securities 80 80 47 47 Mutual, pooled and commingled funds 84 2 86 2 82 84 Hedge funds/limited partnerships 7 7 7 7 Real estate 4 4 4 4 Other 4 4 4 4 Total $ 210 $ 169 $ 17 $ 396 $ 189 $ 53 $ 97 $ 339 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2020, the carrying amount and fair value of our long-term debt, including the current portion, were $ 40,610 million and $ 43,218 million, respectively. As of December 31, 2019, the carrying amount and fair value of our long-term debt, including the current portion, were $ 31,769 million and $ 32,725 million, respectively. NOTE 17: SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2020, the Company recorded other operating charges of $ 853 million. These charges primarily consisted of $ 413 million related to the Company's strategic realignment initiatives and $ 99 million related to the Company's productivity and reinvestment program. In addition, other operating charges included impairment charges of $ 160 million related to the Odwalla trademark and net charges of $ 33 million related to discontinuing the Odwalla juice business. Other operating charges also included an impairment charge of $ 55 million related to a trademark in North America. In addition, other operating charges included $ 51 million related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition and net charges of $ 16 million related to the restructuring of our manufacturing operations in the United States. Refer to Note 2 for additional information on the fairlife acquisition. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Company's strategic realignment initiatives and productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. In 2019, the Company recorded other operating charges of $ 458 million. These charges included $ 264 million related to the Company's productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs included, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisition of Costa and the refranchising of our bottling operations. Refer to Note 16 for additional information on the trademark impairment charge. Refer to Note 18 for additional information on the Company's productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $ 1,079 million. These charges primarily consisted of $ 450 million of North America bottling operations' asset impairments and $ 440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $ 33 million related to tax litigation expense and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 11 for additional information related to the tax litigation. Refer to Note 18 for additional information on the Company's productivity and reinvestment program. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2020, the Company recorded charges of $ 484 million related to the extinguishment of certain long-term debt. Refer to Note 10. During the year ended December 31, 2018, the Company recorded a net gain of $ 27 million related to the extinguishment of certain long-term debt. Refer to Note 10. Equity Income (Loss) Net The Company recorded net charges of $ 216 million, $ 100 million and $ 111 million in equity income (loss) net during the years ended December 31, 2020, 2019 and 2018, respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2020, other income (loss) net was income of $ 841 million. The Company recognized a gain of $ 902 million in conjunction with the fairlife acquisition, a net gain of $ 148 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a net gain of $ 18 million related to the sale of a portion of our ownership interest in one of our equity method investees and a gain of $ 17 million related to the sale of our ownership interest in an equity method investee in North America . These gains were partially offset by an other-than-temporary impairment charge of $ 252 million related to CCBJHI, an equity method investee, an other-than-temporary impairment charge of $ 38 million related to one of our equity method investees in Latin America, an impairment charge of $ 26 million associated with an investment in an equity security without a readily determinable fair value and a net loss of $ 55 million related to economic hedging activities. The Company also recorded net charges of $ 25 million related to the restructuring of our manufacturing operations in the United States and pension and other postretirement benefit plan settlement and curtailment charges of $ 14 million related to the Company's strategic realignment initiatives. Refer to Note 2 for additional information on the fairlife acquisition. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 5 for additional information on our economic hedging activities. Refer to Note 16 for additional information on the impairment charges. Refer to Note 18 for additional information on the Company's strategic realignment initiatives. Refer to Note 19 for the impact these items had on our operating segments and Corporate. In 2019, other income (loss) net was income of $ 34 million. The Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Additionally, the Company recognized net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $ 4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Refer to Note 2 for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining ownership interest in CHI and the sale of a portion of our ownership interest in Andina. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 19 for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $ 1,674 million. The Company recorded other-than-temporary impairment charges of $ 591 million related to certain of our equity method investees, an impairment charge of $ 554 million related to assets held by CCBA and net charges of $ 476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $ 278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $ 240 million related to pension settlements, and a net loss of $ 79 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Additionally, we recorded charges of $ 34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements, a net loss of $ 33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $ 32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $ 296 million related to the sale of our equity ownership in Lindley and a net gain of $ 47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley, our acquisition of the controlling interest in the Philippine bottling operations and our acquisition of Costa. Refer to Note 5 for additional information on our hedging activities. Refer to Note 19 for the impact these items had on our operating segments and Corporate. NOTE 18: RESTRUCTURING Strategic Realignment In August 2020, the Company announced strategic steps to transform our organizational structure in an effort to better enable us to capture growth in the fast-changing marketplace. The Company is building a networked global organization designed to combine the power of scale with the deep knowledge required to win locally. We are creating new operating units effective January 1, 2021, which will be focused on regional and local execution. The operating units, which will sit under the four existing geographic segments, will be highly interconnected, with more consistency in their structure and a focus on eliminating duplication of resources and scaling new products more quickly. The operating units will work closely with five global marketing category leadership teams to rapidly scale ideas. The global marketing category leadership teams will primarily focus on innovation, marketing efficiency and effectiveness. The organizational structure will also include our existing center that will provide strategy, governance and scale for global initiatives. The operating units, global marketing category leadership teams and the center will be supported by a platform services organization, which will focus on providing efficient and scaled global services and capabilities including, but not limited to, governance, transactional work, data management, consumer analytics, digital commerce and social/digital hubs. The expenses related to these strategic realignment initiatives were recorded in the line items other operating charges and other income (loss) net in our consolidated statement of income. Refer to Note 19 for the impact these expenses had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal and consulting activities. The Company currently expects the total cost of the strategic realignment initiatives will be up to $ 550 million. We expect the new networked organization to be established and functioning at the beginning of 2021, and the platform services activities will be integrated, standardized and scaled over the course of 2021. The following table summarizes the balance of accrued expenses related to these strategic realignment initiatives (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2020 Costs incurred $ 386 $ 37 $ 4 $ 427 Payments ( 170 ) ( 36 ) ( 1 ) ( 207 ) Noncash and exchange ( 35 ) ( 35 ) Accrued balance at end of year $ 181 $ 1 $ 3 $ 185 1 Includes stock-based compensation modification and other postretirement benefit plan curtailment charges. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focused on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units are supported by an enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The enabling services organization focuses on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Certain productivity initiatives included in the April 2017 expansion, primarily related to our enabling services organization, will continue beyond 2020. The Company has incurred total pretax expenses of $ 3,929 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total 2018 Accrued balance at beginning of year $ 190 $ 1 $ 15 $ 206 Costs incurred 164 92 252 508 Payments ( 209 ) ( 83 ) ( 211 ) ( 503 ) Noncash and exchange ( 69 ) ( 52 ) ( 121 ) Accrued balance at end of year $ 76 $ 10 $ 4 $ 90 2019 Accrued balance at beginning of year $ 76 $ 10 $ 4 $ 90 Costs incurred 36 87 141 264 Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 3 2 ( 19 ) ( 14 ) Accrued balance at end of year $ 58 $ 1 $ 7 $ 66 2020 Accrued balance at beginning of year $ 58 $ 1 $ 7 $ 66 Costs incurred ( 12 ) 69 42 99 Payments ( 29 ) ( 70 ) ( 36 ) ( 135 ) Noncash and exchange ( 2 ) ( 11 ) ( 13 ) Accrued balance at end of year $ 15 $ $ 2 $ 17 1 Includes pension settlement charges. Refer to Note 13. NOTE 19: OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investees. Our consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3. The following table sets forth the percentage of total net operating revenues attributable to concentrate operations and finished product operations: Year Ended December 31, 2020 2019 2018 Concentrate operations 56 % 55 % 58 % Finished product operations 44 45 42 Total 100 % 100 % 100 % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2020 2019 2018 United States $ 11,281 $ 11,715 $ 11,344 International 21,733 25,551 22,956 Net operating revenues $ 33,014 $ 37,266 $ 34,300 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2020 2019 2018 United States $ 3,988 $ 4,062 $ 4,154 International 6,789 6,776 5,444 Property, plant and equipment net $ 10,777 $ 10,838 $ 9,598 Information about our Company's operations by operating segment and Corporate as of and for the years ended December 31, 2020, 2019 and 2018 is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated 2020 Net operating revenues: Third party $ 5,534 $ 3,499 $ 11,473 $ 4,213 $ 1,991 $ 6,258 $ 46 $ $ 33,014 Intersegment 523 4 509 7 ( 1,043 ) Total net operating revenues 6,057 3,499 11,477 4,722 1,991 6,265 46 ( 1,043 ) 33,014 Operating income (loss) 3,313 2,116 2,471 2,133 ( 123 ) 308 ( 1,221 ) 8,997 Interest income 64 11 295 370 Interest expense 1,437 1,437 Depreciation and amortization 86 45 439 47 122 551 246 1,536 Equity income (loss) net 31 ( 72 ) 8 ( 9 ) 779 241 978 Income (loss) before income taxes 3,379 2,001 2,500 2,158 ( 120 ) 898 ( 1,067 ) 9,749 Identifiable operating assets 8,098 1,597 19,444 2,073 3 7,575 10,521 2,3 17,903 67,211 Investments 1 517 603 345 240 4 14,183 4,193 20,085 Capital expenditures 27 6 182 20 261 474 207 1,177 2019 Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ 94 $ $ 37,266 Intersegment 624 9 604 2 9 ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 94 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 334 358 ( 1,408 ) 10,086 Interest income 65 12 486 563 Interest expense 946 946 Depreciation and amortization 86 35 439 31 117 446 211 1,365 Equity income (loss) net 35 ( 32 ) ( 6 ) 11 ( 3 ) 836 208 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 343 716 ( 824 ) 10,786 Identifiable operating assets 8,143 1,801 17,687 2,060 7,265 11,170 18,376 66,502 Investments 1 543 716 358 224 14 14,093 3,931 19,879 Capital expenditures 108 140 392 47 209 836 322 2,054 2018 Net operating revenues: Third party $ 6,535 $ 3,971 $ 11,370 $ 4,797 $ 767 $ 6,768 $ 92 $ $ 34,300 Intersegment 564 39 260 388 3 19 ( 1,273 ) Total net operating revenues 7,099 4,010 11,630 5,185 770 6,787 92 ( 1,273 ) 34,300 Operating income (loss) 3,693 2,318 2,318 2,271 152 ( 197 ) ( 1,403 ) 9,152 Interest income 57 13 619 689 Interest expense 950 950 Depreciation and amortization 77 30 422 58 8 239 252 1,086 Equity income (loss) net 2 ( 19 ) ( 2 ) 12 828 187 1,008 Income (loss) before income taxes 3,386 2,243 2,345 2,298 165 ( 159 ) ( 2,053 ) 8,225 Capital expenditures 66 90 429 31 11 517 404 1,548 1 Principally equity method investments and other investments in bottling companies. 2 Property, plant and equipment net in South Africa represented 15 percent and 16 percent of consolidated property, plant and equipment net in 2020 and 2019, respectively. 3 Property, plant and equipment net in the Philippines represented 10 percent of consolidated property, plant and equipment net in 2020. During 2020, 2019 and 2018, our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2020, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes for North America were reduced by $ 160 million related to the impairment of the Odwalla trademark and $ 33 million related to the cost of discontinuing the Odwalla juice business. Operating income (loss) and income (loss) before income taxes were reduced by $ 145 million and $ 153 million, respectively, for Corporate, $ 31 million and $ 30 million, respectively, for Asia Pacific, $ 21 million and $ 26 million, respectively, for Bottling Investments and $ 19 million and $ 21 million, respectively, for Latin America due to the Company's strategic realignment initiatives. Additionally, operating income (loss) and income (loss) before income taxes were reduced by $ 115 million for North America, $ 78 million for Europe, Middle East and Africa and $ 4 million for Global Ventures due to the Company's strategic realignment initiatives. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 104 million for Corporate due to the Company's productivity and reinvestment program. Operating income (loss) and income (loss) before income taxes were increased by $ 5 million for Europe, Middle East and Africa due to the refinement of previously established accruals related to the Company's productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 59 million and $ 84 million, respectively, for North America related to the restructuring of our manufacturing operations in the United States. Operating income (loss) and income (loss) before income taxes were reduced by $ 55 million for North America related to the impairment of a trademark. Refer to Note 16. Operating income (loss) and income (loss) before income taxes were reduced by $ 51 million for Corporate related to the remeasurement of our contingent consideration liability to fair value in conjunction with the fairlife acquisition. Refer to Note 2. Income (loss) before income taxes was increased by $ 902 million for Corporate in conjunction with our fairlife acquisition, which resulted from the remeasurement of our previously held equity interest in fairlife to fair value. Refer to Note 2. Income (loss) before income taxes was increased by $ 148 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 18 million for Corporate related to the sale of a portion of our ownership interest in one of our equity method investees. Income (loss) before income taxes was increased by $ 17 million for Corporate related to the sale of our ownership interest in one of our equity method investees. Income (loss) before income taxes was reduced by $ 484 million for Corporate related to charges associated with the extinguishment of certain long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 252 million for Bottling Investments and $ 38 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 145 million for Bottling Investments, $ 70 million for Latin America and $ 1 million for North America due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 26 million for Corporate due to an impairment charge associated with an investment in an equity security without a readily determinable fair value. Refer to Note 16. In 2019, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2. Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Refer to Note 16. Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2. Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our ownership interest in Andina. Refer to Note 2. Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 16. Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2. Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining ownership interest in CHI. Refer to Note 2. Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2. Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2018, the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 4 million for Latin America, $ 175 million for North America, $ 31 million for Bottling Investments and $ 237 million for Corporate, and were increased by $ 3 million for Europe, Middle East and Africa and $ 4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) before income taxes was reduced by $ 64 million for Corporate and $ 4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 13 and Note 18. Operating income (loss) and income (loss) before income taxes were reduced by $ 450 million for Bottling Investments due to asset impairment charges. Operating income (loss) and income (loss) before income taxes were reduced by $ 139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 33 million for Corporate due to tax litigation expense. Refer to Note 11. Operating income (loss) and income (loss) before income taxes were reduced by $ 19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) before income taxes was increased by $ 296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2. Income (loss) before income taxes was increased by $ 47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2. Income (loss) before income taxes was increased by $ 27 million for Corporate related to a net gain on the extinguishment of certain long-term debt. Refer to Note 10. Income (loss) before income taxes was reduced by $ 554 million for Corporate as a result of an impairment charge related to assets held by CCBA. Refer to Note 2. Income (loss) before income taxes was reduced by $ 476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2. Income (loss) before income taxes was reduced by $ 334 million for Europe, Middle East and Africa, $ 205 million for Bottling Investments and $ 52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Income (loss) before income taxes was reduced by $ 278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4. Income (loss) before income taxes was reduced by $ 124 million for Bottling Investments and was increased by $ 13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 149 million for Bottling Investments due to pension settlements related to the refranchising of certain of our North America bottling operations. Refer to Note 13. Income (loss) before income taxes was reduced by $ 79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Income (loss) before income taxes was reduced by $ 34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single new form of bottling agreement with additional requirements. Refer to Note 2. Income (loss) before income taxes was reduced by $ 33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) before income taxes was reduced by $ 32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2. NOTE 20: NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities was composed of the following (in millions): Year Ended December 31, 2020 2019 2018 (Increase) decrease in trade accounts receivable 1 $ 882 $ ( 158 ) $ 27 (Increase) decrease in inventories 99 ( 183 ) ( 203 ) (Increase) decrease in prepaid expenses and other assets 78 ( 87 ) ( 221 ) Increase (decrease) in accounts payable and accrued expenses 2 ( 860 ) 1,318 ( 251 ) Increase (decrease) in accrued income taxes ( 16 ) 96 ( 17 ) Increase (decrease) in other liabilities 3 507 ( 620 ) ( 575 ) Net change in operating assets and liabilities $ 690 $ 366 $ ( 1,240 ) 1 The decrease in trade accounts receivable in 2020 was primarily due to the impacts of the COVID-19 pandemic and the start of a trade accounts receivable factoring program. Refer to Note 1 for additional information on the factoring program. 2 The decrease in accounts payable and accrued expenses in 2020 was primarily driven by the impacts of the COVID-19 pandemic and incentive payments related to prior year exceeding current year incentive accruals. The increase in accounts payable and accrued expenses in 2019 was primarily due to extending payment terms with our suppliers. 3 The increase in other liabilities in 2020 was primarily due to the increase in tax reserves related to IRS litigation. Refer to Note 11. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this report is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2021 Proxy Statement. James R. Quincey Kathy Loveless Chairman of the Board of Directors and Chief Executive Officer February 25, 2021 Vice President and Controller February 25, 2021 John Murphy Mark Randazza Executive Vice President and Chief Financial Officer February 25, 2021 Vice President, Assistant Controller and Chief Accounting Officer February 25, 2021 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 25, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 11 and Note 14 to the consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2020, the gross amount of unrecognized tax benefits was $915 million. As described in Note 11, on September 17, 2015 the Company received a Statutory Notice of Deficiency from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period, plus interest. On November 18, 2020, the U.S. Tax Court issued an opinion predominantly siding with the IRS related to the Companys transfer pricing between its U.S. parent company and certain of its foreign affiliates for tax years 2007 through 2009. While the Company continues to disagree with the IRS positions and the portions of the opinion affirming such positions, it is possible that some portion or all of the adjustment proposed by the IRS could ultimately be upheld. As a result of the application of ASC 740, Accounting for Income Taxes, the Company recorded a tax reserve of $438 million for this matter for the year ended December 31, 2020. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS notice and opinion, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. How We Addressed the Matter in Our Audit Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of managements assessment of the opinion, including inquiries of tax counsel, inspection of technical memos, and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 11 and Note 14. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 of the Companys consolidated financial statements, the Company performs an annual impairment assessment of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment assessment may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $10.4 billion and $17.5 billion, respectively, at December 31, 2020. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, royalty rates, cost of raw materials, inflation, cost of capital, marketing spending, foreign currency exchange rates, and tax rates, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment assessments for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative assessment and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment assessments of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment assessments included in Note 1. /s/ Ernst Young LLP We have served as the Company's auditor since 1921. Atlanta, Georgia February 25, 2021 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 25, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 25, 2021 "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2020. Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2020 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +2,a201,123110-k," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to execute our growth strategy centered around disciplined portfolio growth; an aligned and engaged bottling system; and winning with our stakeholders all supported by revenue growth management and brand-building initiatives to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. Our operating structure includes the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For additional information about our operating segments and Corporate, refer to Note 21 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavorings and other ingredients which, when combined with water and, depending on the product, sweeteners (nutritive or non-nutritive) are used to prepare syrups or finished beverages, and includes minerals and other powders for purified water products; ""syrups"" means an intermediate product in the beverage manufacturing process produced by combining concentrates with water and, depending on the product, sweeteners (nutritive or non-nutritive); ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We own and market numerous valuable nonalcoholic beverage brands, including the following: sparkling soft drinks : Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Fresca, Schweppes, * Sprite, Thums Up; water, enhanced water and sports drinks : Aquarius, Ciel, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade, Topo Chico; juice, dairy and plant-based beverages : AdeS, Del Valle, fairlife, innocent, Minute Maid, Minute Maid Pulpy, Simply, ZICO; and tea and coffee : Ayataka, Costa, doadan, FUZE TEA, Georgia, Gold Peak, HONEST TEA, Kochakaden. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of 2.0 billion servings each day. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to consumers throughout the world. The Coca-Cola system sold 30.3 billion , 29.6 billion and 29.2 billion unit cases of our products in 2019 , 2018 and 2017 , respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for each of 2019 , 2018 and 2017 . Trademark Coca-Cola accounted for 45 percent of our worldwide unit case volume for each of 2019 , 2018 and 2017 . In 2019 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2019 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2019 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, North Macedonia, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2019 , these five bottling partners combined represented 40 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) prepare and package Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a contract to which we generally refer as a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. A small number of bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. In all instances, the bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers, which were granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) in connection with the refranchising of bottler territories that had previously been managed by Coca-Cola Refreshments (""CCR"") (we refer to these bottlers as ""expanding participating bottlers"" or ""EPBs""), operate under CBAs (to which we refer as ""EPB CBAs"") under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements, and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The EPB CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain EPBs that have executed EPB CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights (to which we refer as ""participating bottlers"" or ""PBs"") converted their legacy bottler's agreements to CBAs, to which we refer as ""PB CBAs,"" each of which has a term of 10 years, is renewable by the bottler indefinitely for successive additional terms of 10 years each, and is substantially similar in most material respects to the EPB CBAs, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the EPB CBAs. Those bottlers that have not signed CBAs continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 4.4 billion in 2019 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc., is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, The Kraft Heinz Company, Suntory Beverage Food Limited and Unilever. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions; in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands; new industry entrants; and dramatic shifts in consumer shopping patterns due to a rapidly evolving digital landscape. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners. Our supply chain for non-nutritive sweeteners and certain other ingredients for our products includes suppliers in China. As a result of the outbreak of the novel coronavirus COVID-19, beginning in January 2020, our suppliers in China have experienced some delays in the production and export of these ingredients. We have initiated contingency supply plans and do not foresee a short-term impact due to these delays. However, we may see tighter supplies of some of these ingredients in the longer term should production or export operations in China deteriorate. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the conditions of an exemption (described below) can be met. The state maintains lists of these substances and periodically adds other substances to these lists. The detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. We are also subject to various federal, state and international laws and regulations related to privacy and data protection, including the European Unions General Data Protection Regulation (""GDPR""), which became effective in May 2018, and the California Consumer Privacy Act of 2018 (""CCPA""), which became effective on January 1, 2020. The interpretation and application of data privacy and data protection laws and regulations are often uncertain and are evolving in the United States and internationally. We monitor pending and proposed legislation and regulatory initiatives to ascertain their relevance to and potential impact on our business and develop strategies to address regulatory trends and developments, including any required changes to our privacy and data protection compliance programs and policies. Employees As of December 31, 2019 and 2018 , our Company had approximately 86,200 and 62,600 employees, respectively, of which approximately 10,100 and 11,400 , respectively, were located in the United States. The increase in the total number of employees was primarily due to the acquisition of Costa Limited (""Costa""). Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2019 , approximately 1,100 employees in North America were covered by collective bargaining agreements. These agreements have terms of three years to five years . We currently anticipate that we will be able to successfully renegotiate such agreements when they expire. The Company believes that its relations with its employees are generally satisfactory. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. In addition, we routinely post on the ""Investors"" page of our website news releases, announcements and other statements about our business and results of operations, some of which may contain information that may be deemed material to investors. Therefore, we encourage investors to monitor the ""Investors"" page of our website and review information we post on that page. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options and potential delivery methods; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of ingredient sources and the product manufacturing process; consumer emphasis on transparency related to ingredients we use in our products and collection and recyclability of, and amount of recycled content contained by, our packaging containers and other materials; concerns about the health and welfare of animals in our dairy supply chain; dramatic shifts in consumer shopping patterns as a result of the rapidly evolving digital landscape; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, do not successfully anticipate and prepare for future changes in such preferences, or are ineffective or slow in developing and implementing appropriate digital transformation initiatives, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. Competitive pressures may cause us and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping, and could potentially threaten the value of some of our legacy route-to-market strategies and thus negatively affect revenues. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution and emerging awareness of potential contaminants, poor management, lack of physical or financial access to water, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use in the manufacture of our beverage products a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the advertising, marketing, labeling, packaging or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions, and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, such incidents could have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection and privacy laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees and former employees but also some consumers. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. In the European Union (""EU""), the GDPR, which became effective on May 25, 2018 for all EU member states, includes operational requirements for companies receiving or processing personal data of EU residents and provides for significant penalties for noncompliance. In the United States, the CCPA, which became effective on January 1, 2020, provides for a private right of action for data breaches and requires companies that process information about California residents to make disclosures to consumers about their data collection, use and sharing practices and to allow consumers to opt out of certain data sharing with third parties. The changes introduced by the GDPR and the CCPA, as well as any other changes to existing personal data protection or privacy laws and the introduction of such laws in other jurisdictions, have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and security systems, policies, procedures and practices. Our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future may not prevent the improper disclosure of personal data. Improper disclosure of personal data in violation of the GDPR, the CCPA and/or of other personal data protection or privacy laws could harm our reputation, cause loss of consumer confidence, subject us to government enforcement actions (including fines), or result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial performance will be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity of, or heavy competition for, talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, our products may not be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2019 , we used 70 functional currencies in addition to the U.S. dollar and derived $25.6 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2019 and 2018, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies may be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. In addition, in July 2017, the United Kingdom's Financial Conduct Authority, the governing body responsible for regulating the London Interbank Offered Rate (""LIBOR""), announced that it will no longer compel or persuade financial institutions and panel banks to submit rates for the calculation of LIBOR after 2021. This decision is expected to result in the discontinuance of the use of LIBOR as a reference rate for commercial loans and other indebtedness. Although the impact of the possible discontinuance of LIBOR publication and transition to alternative reference rates remains unclear, it is possible that these changes may have an adverse impact on our financing costs. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottling partners. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottling partners' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottling partners' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottling partners in which we have equity method investments were to be downgraded, such bottling partners' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. If this income tax dispute were to be ultimately determined adversely to us, any additional taxes, interest and potential penalties in the litigated or subsequent years could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act""). For additional information regarding this income tax dispute, refer to Note 13 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, packaging taxes, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. Consequently, we continuously search for productivity opportunities in our business. Some of the actions we may take from time to time in pursuing these opportunities may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our Company's and the Coca-Cola system's ability to attract, develop, retain and motivate a highly skilled and diverse workforce as well as on our success in nurturing a culture that supports our growth and aligns employees around the Company purpose and work that matters most. We may not be able to successfully compete for, attract and/or retain the high-quality and diverse employee talent we want and our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills, and/or digital and analytics capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to an increase in aggressive recruiting for best-in-class talent could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, which may be caused by increasing demand, by events such as natural disasters, power outages and the like, or by government regulations, taxes, policies or programs designed to reduce greenhouse gas emissions to address climate change, could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices of these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, and saccharin, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by changes in or the enactment of new laws and regulations; a deterioration of our or our bottling partners' relationships with suppliers; supplier quality and reliability issues; trade disruptions; changes in supply chain; and increases in tariffs that may be caused by the United Kingdom's withdrawal from the European Union, commonly referred to as ""Brexit""; or events such as natural disasters, widespread outbreaks of infectious diseases (such as the recent outbreak of the novel coronavirus COVID-19), power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Increasing concerns about the environmental impact of plastic bottles and other plastic packaging materials could result in reduced demand for our beverage products and increased production and distribution costs. There are increasing concerns among consumers, governments and other stakeholders about the damaging impact of the proliferation and accumulation of plastic bottles and other packaging materials in the environment, particularly in the world's waterways, lakes and oceans. We and our bottling partners sell certain of our beverage products in plastic bottles and use other plastic packaging materials that are not biodegradable and, while largely recyclable, may not be regularly recovered and recycled due to low economic value or lack of collection and recycling infrastructure. If we and our bottling partners do not, or are perceived not to, act responsibly to address plastic materials recoverability and recycling concerns, our corporate image and brand reputation could be damaged, which may cause some consumers to reduce or discontinue consumption of some of our beverage products. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's impact on the environment by increasing our use of recycled plastic and other packaging materials; increasing our use of packaging materials that are made in part of plant-based renewable materials; participating in programs and initiatives to reclaim or recover plastic bottles and other packaging materials that are already in the environment; and taking other actions and participating in other programs and initiatives organized or sponsored by nongovernmental organizations and other groups. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our announced environmental goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. In addition, in response to environmental concerns, governmental entities in the United States and in many other jurisdictions around the world have adopted or are considering adopting regulations and policies designed to mandate or encourage plastic packaging waste reduction and an increase of recycling rates or, in some cases, restricting or even prohibiting the use of plastic containers or packaging materials. These regulations and policies, whatever their scope or form, could increase the cost of our beverage products or otherwise put the Company at a competitive disadvantage. In addition, our increased focus on reducing plastic containers and other packaging materials waste may require us to incur additional expenses and to increase our capital expenditures. A reduction in consumer demand for our beverage products and/or an increase in costs and expenditures relating to production and distribution as a result of these environmental concerns regarding plastic bottles and other packaging materials could have an adverse effect on our business and results of operations. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship or even prohibitions on certain types of plastic products, packages and cups have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of additional such legislation or regulations in the future. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level or another exemption is applicable. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2019 , our net operating revenues in the United States were $11.7 billion , or 31 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2019 , our operations outside the United States accounted for $25.6 billion , or 69 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties related to Brexit implementation, and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitations on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, tax disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change and legal or regulatory responses thereto may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. Increasing concern over climate change also may result in additional legal or regulatory requirements designed to reduce or mitigate the effects of carbon dioxide and other greenhouse gas emissions on the environment. Increased energy or compliance costs and expenses due to increased legal or regulatory requirements may cause disruptions in, or an increase in the costs associated with, the manufacturing and distribution of our beverage products. The effects of climate change and legal or regulatory initiatives to address climate change could have a long-term adverse impact on our business and results of operations. In addition, from time to time we establish and publicly announce goals and commitments to reduce the Coca-Cola system's carbon footprint by increasing our use of recycled packaging materials and participating in environmental and sustainability programs and initiatives organized or sponsored by nongovernmental organizations and other groups to reduce greenhouse gas emissions industry-wide. If we and our bottling partners fail to achieve or improperly report on our progress toward achieving our carbon footprint reduction goals and commitments, the resulting negative publicity could adversely affect consumer preference for our beverage products. If negative publicity, whether or not warranted, concerning product safety or quality, workplace and human rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with workplace and human rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable workplace and labor laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, occupational health and safety, employment and labor practices, personal data protection and privacy, and data security. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic materials, including regulations relating to recovery and/or disposal of plastic bottles and other packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. We may not be able to realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative impacts on employee morale and work performance, result in escalation of grievances and adversely affect the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, bottler franchise rights, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021 . If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. In addition, our product quality and safety programs and controls may not be sufficiently robust to effectively cope with the expanded range of product offerings introduced through newly acquired businesses or brands, which may increase our costs or subject us to negative publicity. Also, we may not be able to successfully manage the additional complexities involved with overseeing the various supply chain models as we expand our product offerings and seek to manage acquired businesses in a more independent, less integrated manner. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations, businesses or brands. If we incur unforeseen liabilities, obligations and costs in connection with acquiring or integrating bottling operations or other businesses, experience internal control or product quality failures or are unable to achieve our strategic and financial objectives for Company-owned or -controlled bottling operations and other acquired businesses or brands, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise Company-owned or -controlled bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases such as the recent outbreak of the novel coronavirus COVID-19. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located, with the exception of our retail stores which are primarily included in the Global Ventures operating segment. The following table summarizes our principal production facilities, distribution and storage facilities, and retail stores by operating segment and Corporate as of December 31, 2019 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Principal Distribution and Storage Warehouses Principal Retail Stores Owned Leased Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures 1,718 Bottling Investments Corporate Total 1,730 Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in ""U.S. Federal Income Tax Dispute"" below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit (The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit (Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 15,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit (Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (the ""Notice"") from the IRS for the tax years 2007 through 2009 after a five-year audit. In the Notice, the IRS claimed that the Company's U.S. taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in certain foreign markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement (the ""Closing Agreement"") that applied back to 1987. The Closing Agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent a change in material facts or circumstances or relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the Closing Agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the Closing Agreement. The IRS designated the matter for litigation on October 15, 2015. Due to the fact that the matter remains designated, the Company is prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million , resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in April 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's opinion. In the interim, or subsequent to the court's opinion, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations, and cash flows. Environmental Matter In April 2019, the Company received a Finding and Notice of Violation (""NOV"") from the United States Environmental Protection Agency (""EPA"") alleging that the Company violated the California Truck and Bus Regulation and the California Drayage Truck Regulation by failing to verify compliance with such regulations by certain diesel-fueled vehicles owned by third parties that the Company caused to be operated in California. The Company reached a settlement with the EPA regarding this matter under which it paid a civil penalty of $145,000. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 19, 2020 , there were 200,770 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 22, 2020 (""Company's 2020 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the year ended December 31, 2019 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2019 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under Publicly Announced Plans 3 September 28, 2019 through October 25, 2019 955,091 $ 54.22 945,000 167,390,321 October 26, 2019 through November 22, 2019 3,769,586 52.92 3,770,300 163,620,021 November 23, 2019 through December 31, 2019 4,131,840 54.16 2,590,354 161,029,667 Total 8,856,517 $ 53.64 7,305,654 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). 3 On February 21, 2019, the Company publicly announced that our Board of Directors had authorized a new plan (""2019 Plan"") for the Company to purchase up to 150 million shares of our common stock following the completion of the 2012 Plan. This column discloses the number of shares available for purchase under the 2012 Plan and the number of shares authorized for purchase under the 2019 Plan. Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2015 2017 2019 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 113 139 140 SP 500 Index 101 138 174 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2014. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, Beyond Meat, Inc., The Boston Beer Company, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, The Kraft Heinz Company, Keurig Dr Pepper Inc., Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2019, the Dow Jones Food Beverage Index and the Peer Group Index included Beyond Meat, Inc. and The Boston Beer Company, Inc., which were not included in the indices in 2018. Additionally, in 2019, these indices do not include BG Foods, Inc., which was included in the indices in 2018. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our platform for sustained performance; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; and the impact of inflation and changing prices. Our Business General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our independent network of bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 42 Total % % % The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 18 Total % % % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Platform for Sustained Performance We have established a platform for sustained performance centered around disciplined portfolio growth; an aligned and engaged bottling system; and winning with our stakeholders all supported by revenue growth management and brand-building initiatives. Disciplined Portfolio Growth Continuous innovation to offer consumers more personalized product solutions that match their tastes and lifestyles Leveraging the Coca-Cola system to lift, shift and scale leading brands and winning concepts quickly and efficiently around the world Utilizing mergers and acquisitions opportunities that strike the right balance between strategic rationale, financial returns and risk profile as an enabler to further our growth strategy An Aligned and Engaged Bottling System Strategically aligned bottling partners with a sharper focus on value growth rather than volume growth Gaining efficiencies through scale and improved supply chains Strong marketplace execution across the bottling system A winning culture Winning with Our Stakeholders Succeeding as a company by empowering our employees, satisfying consumers with a wide variety of beverage options, and providing solutions to grow our customers' beverage businesses Making a positive difference in the communities where we operate Helping to create value for all of our stakeholders for a better shared future Underpinning our platform for sustained performance are three enablers: digitizing the enterprise; fostering a growth culture; and growing sustainably. Digitizing the Enterprise The digital evolution is changing consumers' behaviors, influencing the way consumers think, interact and ultimately how they shop. We believe this evolution impacts every aspect of the Coca-Cola system and creates an opportunity to partner in different ways with our customers and re-engineer our supply chain and route-to-market. Fostering a Growth Culture We believe that sustainable and profitable growth is the product of a strong culture, with a focus on our employees, customers and consumers worldwide. As we move our business into the future, we will continue to drive a growth culture centered around curiosity, empowerment, inclusion and agility. Our belief is that focusing on these behaviors will enhance our associates' work performance and help us become a more growth-minded company. Growing Sustainably We are focused on giving people the drinks they want while trying to improve the world we all share, turning our passion for consumers into brands people love and creating shared opportunities through growth. We act in ways which we believe will create a more sustainable and better shared future for all of our stakeholders. We attempt to make a positive difference in peoples' lives, communities and our planet by doing business the right way. Core Capabilities To support our platform for sustained performance, we must continue to enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net operating revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to create enhanced value for themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,700 beverage products (including more than 1,600 low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to our planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment and maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part will help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. Coronavirus Impact Beginning in January 2020, concerns related to the spread of the novel coronavirus COVID-19 have caused a disruption to our business, primarily in China. While we currently expect this business disruption to be temporary, there is uncertainty around its duration and its broader impact, and therefore the effects it will have on our business. However, based on our current expectations, we believe this disruption will negatively impact our unit case volume and financial results for the first quarter of 2020. At this time, we do not expect this disruption to have a significant impact on our full year 2020 unit case volume or financial results. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 13 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charge may be impacted by items such as basis differences, deferred taxes and deferred gains. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Property, Plant and Equipment Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic lives of the assets, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a market participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a market participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our geographic operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster, each of which is its own reporting unit. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When events or circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe a market participant would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our net periodic pension cost and pension obligations. We believe the most critical assumptions are (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our net periodic pension cost and pension obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future benefit payments we anticipate making under the plans. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. In 2019 , the Company's total income related to defined benefit pension plans was $2 million , which included $10 million of net periodic benefit income and $8 million of settlement charges and special termination benefit costs. In 2020, we expect our net periodic benefit income related to defined benefit pension plans to be approximately $69 million. We currently do not expect to incur any settlement charges or special termination benefit costs in 2020. The increase in 2020 expected net periodic benefit income is primarily due to favorable asset performance in 2019 and a reduction in the number of plan participants in the primary U.S. pension plan, partially offset by a decrease in the weighted-average discount rate at December 31, 2019 compared to December 31, 2018 . The estimated impact of a 50 basis-point decrease in the discount rate would result in a $19 million decrease in our 2020 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $25 million decrease in our 2020 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2019 , the Company's primary U.S. pension plan represented 61 percent of both the Company's consolidated projected benefit obligation and plan assets. Refer to Note 15 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Refer to Note 3 of Notes to Consolidated Financial Statements. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. Refer to Note 3 of Notes to Consolidated Financial Statements. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 16 of Notes to Consolidated Financial Statements. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Refer to Note 13 of Notes to Consolidated Financial Statements. Tax law requires certain items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and for the manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 16 of Notes to Consolidated Financial Statements. Operations Review Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures; and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 21 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. When we analyze our net operating revenues we generally consider the following factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) changes in price, product and geographic mix; (3) foreign currency fluctuations; and (4) acquisitions and divestitures (including structural changes defined below), as applicable. Refer to the heading ""Net Operating Revenues"" below. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. We typically report unit case volume when finished products manufactured from the concentrates or syrups are sold to a third party or independent customer regardless of our ownership interest in the bottling partner. We generally refer to acquisitions and divestitures of bottling partners as structural changes, which are a component of acquisitions and divestitures. Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products, with the exception of Costa non-ready-to-drink products, regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume related to these brands is incremental to prior year volume. We generally do not consider the acquisition of a brand to be a structural change. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when the products are sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that a license agreement is entered into, the unit case volume and concentrate sales volume related to the brand is incremental to prior year volume. We generally do not consider the licensing of a brand to be a structural change. In 2019, the Company acquired Costa and the remaining equity interest in C.H.I. Limited (""CHI""). The impact of these acquisitions has been included in acquisitions and divestitures in our analysis of net operating revenues on a consolidated basis as well as for the Global Ventures and Europe, Middle East and Africa operating segments. Other acquisitions by the Company included controlling interests in bottling operations in Zambia, Kenya and Eswatini. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2019, the Company refranchised certain of its bottling operations in India. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. In 2018, the Company acquired a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. The Company also acquired a controlling interest in the franchise bottler in Oman. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Other acquisitions by the Company included controlling interests in bottling operations in Zambia and Botswana. The impact of these acquisitions has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Europe, Middle East and Africa operating segments. Also in 2018, the Company refranchised our Canadian and Latin American bottling operations. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America, Latin America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the Canadian refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the base year when calculating 2018 versus 2017 volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. Refer to the headings ""Beverage Volume"" and ""Net Operating Revenues"" below. In 2017, Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") was transitioned to the Company, resulting in CCBA's consolidation. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa and Bottling Investments operating segments. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals, may give rise to differences between unit case volume and concentrate sales volume growth rates. With the exception of ready-to-drink products, the Company does not report unit case volume or concentrate sales volume for Costa, a component of the Global Ventures operating segment. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2019 versus 2018 2018 versus 2017 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % 4 % % Europe, Middle East Africa % % % % 8 Latin America North America (1 ) 5 (2 ) 9 Asia Pacific 6 10 Global Ventures Bottling Investments 3 N/A (15 ) 7 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2019 grew 6 percent. 4 After considering the impact of acquisitions and divestitures, worldwide concentrate sales volume for the year ended December 31, 2019 grew 1 percent. 5 After considering the impact of acquisitions and divestitures, concentrate sales volume for North America for the year ended December 31, 2019 was even. 6 After considering the impact of acquisitions and divestitures, concentrate sales volume for Asia Pacific for the year ended December 31, 2019 grew 5 percent. 7 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2018 grew 12 percent. 8 After considering the impact of acquisitions and divestitures, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2018 grew 4 percent. 9 After considering the impact of acquisitions and divestitures, concentrate sales volume for North America for the year ended December 31, 2018 was even. 10 After considering the impact of acquisitions and divestitures, concentrate sales volume for Asia Pacific for the year ended December 31, 2018 grew 5 percent. Unit Case Volume The Coca-Cola system sold 30.3 billion , 29.6 billion and 29.2 billion unit cases of our products in 2019 , 2018 and 2017 , respectively. The unit case volume for 2019 , 2018 and 2017 reflects the impact of brands acquired or licensed during the applicable year. The unit case volume for 2019 , 2018 and 2017 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2019 versus 2018 and 2018 versus 2017 unit case volume growth rates. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for 2019 , 2018 and 2017 . Trademark CocaCola accounted for 45 percent of our worldwide unit case volume for 2019 , 2018 and 2017 . In 2019 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2019 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and India, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks, 3 percent in water, enhanced water and sports drinks and 3 percent in tea and coffee. Growth in sparkling soft drinks was primarily driven by 4 percent growth in Trademark Coca-Cola. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; South East Africa; West Africa; and Western Europe business units. The unit case volume in the Middle East North Africa business unit was even. In Latin America, unit case volume grew 1 percent, which included growth of 5 percent in water, enhanced water and sports drinks and 6 percent in tea and coffee, with even performance in sparkling soft drinks, partially offset by a 1 percent decline in juice, dairy and plant-based beverages. Trademark Coca-Cola grew 1 percent. The group's volume reflected growth of 5 percent in both the Brazil and Latin Center business units and 1 percent in the Mexico business unit, partially offset by a 5 percent decline in the South Latin business unit. Unit case volume in North America was even, with even performance in both sparkling soft drinks and juice, dairy and plant-based beverages. Unit case volume in water, enhanced water and sports drinks grew 1 percent, driven by 7 percent growth in sports drinks. Growth in this category cluster was offset by a 1 percent decline in tea and coffee. In Asia Pacific, unit case volume grew 5 percent, reflecting 8 percent growth in sparkling soft drinks, 1 percent growth in water, enhanced water and sports drinks, and 2 percent growth in both juice, dairy and plant-based beverages and tea and coffee. Growth in sparkling soft drinks volume included 9 percent growth in Trademark Coca-Cola and 5 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 2 percent in packaged water. The group's volume reflects growth of 11 percent in the India South West Asia business unit, 10 percent in the ASEAN business unit, 3 percent in the Greater China Korea business unit and 1 percent in the South Pacific business unit. The growth in these business units was partially offset by a decline of 2 percent in the Japan business unit. Unit case volume for Global Ventures grew 7 percent, which included growth of 8 percent in juice, dairy and plant-based beverages and growth in energy drinks, partially offset by a decline in tea. Unit case volume for Bottling Investments grew 24 percent. This increase primarily reflects the impact of the acquisition of a controlling interest in the Philippine bottling operations as well as growth in India and South Africa. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks and 3 percent in water, enhanced water and sports drinks. Growth in sparkling soft drinks was primarily driven by 2 percent growth in Trademark Coca-Cola and 3 percent growth in Trademark Fanta. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; and Middle East North Africa business units. The unit case volume growth in these business units was partially offset by a decline in the West Africa business unit. Volume in the South East Africa and Western Europe business units was even. In Latin America, unit case volume was even, which included growth of 4 percent in juice, dairy and plant-based beverages and 1 percent in water, enhanced water and sports drinks. Sparkling soft drinks volume was even. The group's volume reflected growth of 1 percent in each of the Mexico, Brazil and Latin Center business units, offset by a 4 percent decline in the South Latin business unit. The growth in Mexico's volume was primarily driven by 1 percent growth in sparkling soft drinks and 8 percent growth in juice, dairy and plant-based beverages. The decline in South Latin's volume was driven by a 4 percent decline in sparkling soft drinks. Unit case volume in North America was even. Sparkling soft drinks grew 1 percent, which included growth of 3 percent in Trademark Sprite and 1 percent in Trademark CocaCola. Unit case volume in water, enhanced water and sports drinks grew 2 percent, primarily driven by 2 percent growth in packaged water and 1 percent growth in sports drinks. Growth in these category clusters was offset by a 3 percent decline in juice, dairy and plant-based beverages. In Asia Pacific, unit case volume grew 4 percent, reflecting 4 percent growth in sparkling soft drinks, 5 percent growth in water, enhanced water and sports drinks, and 4 percent growth in tea and coffee. Growth in sparkling soft drinks volume included 5 percent growth in Trademark Coca-Cola and 6 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 7 percent in packaged water. The group's volume reflects growth of 6 percent in the Greater China Korea business unit, 10 percent in the India South West Asia business unit and 1 percent in the Japan business unit. Volume in the South Pacific and ASEAN business units was even. Unit case volume for Global Ventures grew 8 percent, which included growth of 8 percent in juice, dairy and plant-based beverages and growth in energy drinks, partially offset by a decline in tea. Unit case volume for Bottling Investments declined 15 percent. This decrease primarily reflects the impact of refranchising activities, partially offset by growth in India as well as the impact of bottler acquisitions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Concentrate Sales Volume In 2019 , worldwide concentrate sales volume and unit case sales volume both grew 2 percent compared to 2018 . In 2018 , worldwide concentrate sales volume grew 3 percent and unit case sales volume grew 2 percent compared to 2017 . The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, source waters or powders/minerals. Net Operating Revenues Year Ended December 31, 2019 versus Year Ended December 31, 2018 Net operating revenues were $37,266 million in 2019, compared to $34,300 million in 2018, an increase of $2,966 million , or 9 percent . The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2019 versus 2018 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Total Consolidated % % (4 )% % % Europe, Middle East Africa % % (9 )% % (1 )% Latin America 13 (10 ) North America Asia Pacific (1 ) (1 ) Global Ventures (1 ) (16 ) 233 Bottling Investments 3 (5 ) 10 Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (excluding Costa non-ready-to-drink products) (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. The impact of price, product and geographic mix is calculated by subtracting the change in net operating revenues resulting from volume increases or decreases, changes in foreign currency exchange rates, and acquisitions and divestitures from the total change in net operating revenues. Management believes that providing investors with price, product and geographic mix enhances their understanding about the combined impact that the following items had on the Company's net operating revenues: (1) pricing actions taken by the Company and, where applicable, our bottling partners; (2) the change in the mix of products and packages sold; and (3) the change in the mix of channels and geographic territories where products were sold. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Price, product and geographic m ix had a 5 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix across a majority of the business units; Latin America favorable price mix across all business units and the impact of inflationary environments in certain markets; North America favorable price mix driven by revenue growth management initiatives across the beverage categories; Asia Pacific favorable price mix in all business units offset by unfavorable geographic mix; Global Ventures unfavorable product mix; and Bottling Investments favorable price, product and package mix in certain bottling operations, partially offset by unfavorable geographic mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 4 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the euro, British pound sterling, Mexican peso, Brazilian real, South African rand and Australian dollar, which had an unfavorable impact on all of our operating segments, except for our North America operating segment. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. The impact of acquisitions and divestitures is the difference between the change in net operating revenues and the change in what our net operating revenues would have been if we removed the net operating revenues associated with an acquisition or divestiture from either the current year or the prior year, as applicable. Management believes that quantifying the impact that acquisitions and divestitures had on the Company's net operating revenues provides investors with useful information to enhance their understanding of the Company's net operating revenue performance by improving their ability to compare our year-to-year results. Management considers the impact of acquisitions and divestitures when evaluating the Company's performance. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to acquisitions and divestitures. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; and acquisitions and divestitures. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a slightly favorable impact on full year 2020 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect foreign currencies will have a slightly unfavorable impact on our full year 2020 net operating revenues. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Net operating revenues were $34,300 million in 2018, compared to $36,212 million in 2017, a decrease of $1,912 million , or 5 percent . The following table illustrates, on a percentage basis, the estimated impact of the factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2018 versus 2017 Volume 1 Price, Product Geographic Mix Foreign Currency Fluctuations Acquisitions Divestitures 2 Accounting Changes Total Consolidated % % (1 )% (11 )% % (5 )% Europe, Middle East Africa % % (2 )% % (3 )% % Latin America 10 (9 ) (3 ) North America (1 ) 9 Asia Pacific (1 ) (5 ) Global Ventures (1 ) Bottling Investments 1 (55 ) (40 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments and our Global Ventures operating segment (expressed in equivalent unit cases) after considering the impact of acquisitions and divestitures. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. 2 Includes structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above. Price, product and geographic m ix had a 2 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix in all of the segment's business units as well as favorable product and package mix; Latin America favorable price mix and the impact of inflationary environments in certain markets; North America favorable pricing initiatives, offset by incremental freight costs; Asia Pacific favorably impacted as a result of pricing initiatives as well as product and package mix, offset by geographic mix; Global Ventures unfavorable product mix; and Bottling Investments favorable geographic mix, partially offset by unfavorable price, product and package mix in certain bottling operations. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. ""Accounting changes"" refers to the impact of our adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 17.3 % 19.1 % 18.7 % Latin America 11.0 11.6 10.9 North America 31.9 33.1 24.0 1 Asia Pacific 12.7 14.0 13.1 Global Ventures 6.9 2.2 2.0 Bottling Investments 19.9 19.7 31.0 1 Corporate 0.3 0.3 0.3 Total 100.0 % 100.0 % 100.0 % 1 Amounts have been adjusted to reflect the reclassification of certain revenue streams from the Bottling Investments operating segment to the North America operating segment effective January 1, 2018. The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; price, product and geographic mix; foreign currency fluctuations; acquisitions and divestitures; and accounting changes. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below, and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin Gross profit margin is a ratio calculated by dividing gross profit by net operating revenues. Management believes gross profit margin provides investors with useful information related to the profitability of our business prior to considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Our gross profit margin decreased to 60.8 percent in 2019 from 61.9 percent in 2018 . The decrease was primarily due to the impact of structural changes as well as the unfavorable impact of foreign currency exchange rate fluctuations. Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Our gross profit margin decreased to 61.9 percent in 2018 from 62.1 percent in 2017 . The decrease was primarily due to the consolidation of CCBA, the unfavorable impact of foreign currency exchange rate fluctuations and the impact of accounting changes related to the new revenue recognition accounting standard, partially offset by the impact of divestitures. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information on the adoption of the new revenue recognition accounting standard. Selling, General and Administrative Expenses The following table sets forth the components of selling, general and administrative expenses (in millions): Year Ended December 31, 2018 Stock-based compensation expense $ $ $ Advertising expenses 4,246 4,113 3,958 Selling and distribution expenses 2,873 2,182 3,402 Other operating expenses 4,783 4,482 5,255 Selling, general and administrative expenses $ 12,103 $ 11,002 $ 12,834 Year Ended December 31, 2019 versus Year Ended December 31, 2018 Selling, general and administrative expenses increased $1,101 million , or 10 percent . This increase was primarily the result of acquisitions, partially offset by the impact of divestitures and a foreign currency exchange rate impact of 4 percent. The increase in advertising costs also reflects the Company's increased investments to strengthen our brands. Other operating expenses also reflect the impact of savings from our productivity initiatives. As of December 31, 2019 , we had $258 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.0 years as stock-based compensation expense, and it does not include the impact of any future stock-based compensation awards. Refer to Note 14 of Notes to Consolidated Financial Statements. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Selling, general and administrative expenses decreased $1,832 million , or 14 percent . The decrease in selling and distribution expenses during 2018 reflects the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017, partially offset by the impact of the consolidation of CCBA. The decrease in other operating expenses during 2018 reflects savings from our productivity initiatives, the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, 2018 Europe, Middle East Africa $ $ (3 ) $ Latin America 4 North America 175 Asia Pacific (4 ) Global Ventures Bottling Investments 617 1,079 Corporate 290 Total $ $ 1,079 $ 1,902 In 2019, the Company recorded other operating charges of $458 million . These charges primarily consisted of $264 million related to the Company's productivity and reinvestment program and $42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $95 million for costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the acquisition of Costa and refranchising of our bottling operations. Refer to Note 18 of Notes to Consolidated Financial Statements for information on the trademark impairment charge. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 18 of Notes to Consolidated Financial Statements for information on the asset impairment charges. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 20 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, 2018 Europe, Middle East Africa 35.2 % 40.4 % 46.2 % Latin America 23.6 25.3 28.6 North America 25.7 25.3 31.9 Asia Pacific 22.6 24.8 27.5 Global Ventures 3.3 1.7 2.1 Bottling Investments 3.6 (2.2 ) (10.4 ) Corporate (14.0 ) (15.3 ) (25.9 ) Total 100.0 % 100.0 % 100.0 % Operating margin is a ratio calculated by dividing operating income by net operating revenues. Management believes operating margin provides investors with useful information related to the profitability of our business after considering all of the operating costs incurred. Management uses this measure in making financial, operating and planning decisions and in evaluating the Company's performance. Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, 2018 Consolidated 27.1 % 26.7 % 21.4 % Europe, Middle East Africa 55.2 56.5 52.9 Latin America 57.7 58.4 56.0 North America 21.8 20.4 28.5 Asia Pacific 48.3 47.3 44.9 Global Ventures 13.1 19.8 22.3 Bottling Investments 4.8 (2.9 ) (7.2 ) Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2019 versus Year Ended December 31, 2018 Operating income was $10,086 million in 2019 , compared to $9,152 million in 2018 , an increase of $934 million , or 10 percent . The increase in operating income was driven by concentrate sales volume growth of 2 percent, favorable price and product mix, savings from our productivity initiatives, lower other operating charges and a benefit from acquisitions. These favorable impacts were partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. In 2019, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 9 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the euro, British pound sterling, Mexican peso, Brazilian real, South African rand and Australian dollar, which had an unfavorable impact on all of our operating segments, except for our North America operating segment. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2019 and 2018 was $3,551 million and $3,693 million , respectively. The decrease in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 12 percent, partially offset by favorable price and product mix and concentrate sales volume growth of 1 percent. Operating income for the Latin America segment for the years ended December 31, 2019 and 2018 was $2,375 million and $2,318 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 14 percent. North America's operating income for the years ended December 31, 2019 and 2018 was $2,594 million and $2,318 million , respectively. Operating income growth for this segment was primarily driven by favorable price mix and lower other operating charges. These favorable impacts were partially offset by a decline in concentrate sales volume of 1 percent and the impact of prior year structural changes. Operating income for Asia Pacific for the years ended December 31, 2019 and 2018 was $2,282 million and $2,271 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent, partially offset by higher other operating charges, an unfavorable foreign currency exchange rate impact of 1 percent and the impact of structural changes. Operating income for Global Ventures for the years ended December 31, 2019 and 2018 was $334 million and $152 million , respectively. Operating income growth was primarily due to the acquisition of Costa, partially offset by an unfavorable foreign currency exchange rate impact of 4 percent. Operating income for our Bottling Investments segment for the year ended December 31, 2019 was $358 million compared to an operating loss of $197 million for the year ended December 31, 2018 . Operating income growth in 2019 was impacted by strong performance in India and South Africa, the favorable impact of the acquisition of a controlling interest in the Philippine bottling operations in December 2018 and lower other operating charges, partially offset by an unfavorable foreign currency exchange rate impact. Corporate's operating loss for the years ended December 31, 2019 and 2018 was $1,408 million and $1,403 million , respectively. The operating loss in 2019 was unfavorably impacted by mark-to-market adjustments related to our economic hedging activities, partially offset by lower other operating charges and savings from our productivity initiatives. Based on current spot rates and our hedging coverage in place, we expect foreign currencies will have an unfavorable impact on our full year 2020 operating income. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Operating income was $9,152 million in 2018 , compared to $7,755 million in 2017 , an increase of $1,397 million , or 18 percent . The increase in operating income was driven by concentrate sales volume growth of 3 percent, favorable price mix and lower other operating charges. Additionally, operating income was favorably impacted by savings from our productivity initiatives. These favorable impacts were partially offset by the unfavorable impact of refranchising activities and foreign currency exchange rate fluctuations. In 2018, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar, which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand, which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2018 and 2017 was $3,693 million and $3,585 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 6 percent, favorable price, product and geographic mix, and lower other operating charges, partially offset by increased marketing investments primarily related to key product launches and an unfavorable foreign currency exchange rate impact of 5 percent. Operating income for the Latin America segment for the years ended December 31, 2018 and 2017 was $2,318 million and $2,215 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 12 percent. North America's operating income for the years ended December 31, 2018 and 2017 was $2,318 million and $2,472 million , respectively. The decrease in operating income was driven by higher freight costs and the impact of structural changes, partially offset by lower other operating charges. The operating margin decrease in 2018 was primarily related to the adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Operating income for Asia Pacific for the years ended December 31, 2018 and 2017 was $2,271 million and $2,136 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent. Foreign currency exchange rates had a nominal impact. Operating income for Global Ventures for the years ended December 31, 2018 and 2017 was $152 million and $159 million , respectively. The operating income decline for the segment reflects concentrate sales volume growth of 7 percent offset by unfavorable product mix and an unfavorable foreign currency exchange rate impact of 1 percent. Our Bottling Investments segment's operating loss for the years ended December 31, 2018 and 2017 was $197 million and $806 million , respectively. The decrease in operating loss reflects lower other operating charges, partially offset by the unfavorable impact of divestitures. Corporate's operating loss for the years ended December 31, 2018 and 2017 was $1,403 million and $2,006 million , respectively. The operating loss in 2018 was favorably impacted by lower selling, general and administrative expenses as a result of productivity initiatives, lower other operating charges and mark-to-market adjustments related to our economic hedging activities. Interest Income Year Ended December 31, 2019 versus Year Ended December 31, 2018 Interest income was $ 563 million in 2019 , compared to $ 689 million in 2018 , a decrease of $126 million , or 18 percent . This decrease was primarily driven by the liquidation of a portion of our short-term investments in connection with the acquisition of Costa, partially offset by higher cash balances in certain of our international locations. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest income was $ 689 million in 2018 , compared to $ 679 million in 2017 , an increase of $10 million , or 1 percent . The increase primarily reflects higher interest rates earned on certain investments, partially offset by lower investment balances in certain of our international locations. Interest Expense Year Ended December 31, 2019 versus Year Ended December 31, 2018 Interest expense was $946 million in 2019 , compared to $950 million in 2018 , a decrease of $4 million , or less than 1 percent. This decrease was primarily due to lower short-term U.S. debt balances, partially offset by higher average short-term U.S. debt interest rates and higher long-term debt balances. In addition, prior year interest expense included a net gain of $27 million related to the extinguishment of certain long-term debt. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest expense was $ 950 million in 2018 , compared to $ 853 million in 2017 , an increase of $97 million , or 11 percent . This increase was primarily due to the impact of higher short-term U.S. interest rates, partially offset by a net gain of $27 million related to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 12 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2019 versus Year Ended December 31, 2018 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2019 , equity income was $1,049 million , compared to equity income of $1,008 million in 2018 , an increase of $41 million , or 4 percent . This increase reflects, among other things, the impact of more favorable operating results reported by several of our equity method investees and a decrease in the Company's proportionate share of significant operating and nonoperating charges recorded by certain of our equity method investees. These favorable impacts were partially offset by the sale of our equity ownership interest in Corporacin Lindley S.A. (""Lindley""), the sale of a portion of our equity ownership interest in Embotelladora Andina S.A. (""Andina""), and the acquisition of a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee, as well as the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2018 versus Year Ended December 31, 2017 In 2018 , equity income was $ 1,008 million , compared to equity income of $ 1,072 million in 2017 , a decrease of $64 million , or 6 percent . This decrease reflects, among other things, the dissolution of our Beverage Partners Worldwide joint venture and the consolidation of CCBA. In addition, the Company recorded net charges of $111 million and $92 million in the line item equity income (loss) net during the years ended December 31, 2018 and 2017 , respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Other Income (Loss) Net Other income (loss) net includes, among other things, dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to acquisitions and divestitures; non-service cost components of net periodic benefit cost for pension and postretirement benefit plans; other benefit plan charges and credits; realized and unrealized gains and losses on equity securities and trading debt securities; realized gains and losses on available-for-sale debt securities; and the impact of foreign currency exchange gains and losses. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 of Notes to Consolidated Financial Statements. In 2019 , other income (loss) net was income of $34 million . The Company recognized a gain of $739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $73 million related to the refranchising of certain bottling operations in India and a gain of $39 million related to the sale of a portion of our equity ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $406 million related to Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""), an equity method investee, $255 million related to certain equity method investees in the Middle East, $57 million related to one of our equity method investees in North America, and $49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million and recognized a $118 million net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Additionally, the Company recognized net charges of $105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Other income (loss) net also included income of $99 million related to the non-service cost components of net periodic benefit cost, $62 million of dividend income and net foreign currency exchange losses of $120 million . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the CCBA asset adjustment, impairment charges and the loss recognized in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $1,674 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees, an impairment charge of $554 million related to assets held by CCBA and charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Lindley and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Other income (loss) net also included a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, net foreign currency exchange losses of $143 million , charges of $240 million related to pension settlements, income of $228 million related to the non-service cost components of net periodic benefit cost and $72 million of dividend income. Refer to Note 1 and Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $1,763 million . The Company recognized net charges of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $56 million . Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 21 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the statutory U.S. rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 335 million , $ 318 million and $ 221 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 21.0 % 21.0 % 35.0 % State and local income taxes net of federal benefit 0.9 1.5 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.1 1,2,3 3.1 5,6 (9.5 ) Equity income or loss (1.6 ) (2.5 ) (3.3 ) Tax Reform Act 0.1 7 52.4 8 Excess tax benefits on stock-based compensation (0.9 ) (1.3 ) (1.9 ) Other net (3.8 ) 4 (0.6 ) 7.6 9,10 Effective tax rate 16.7 % 21.3 % 81.4 % 1 Includes net tax charges of $199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes the impact of pretax charges of $710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 3 Includes a tax benefit of $199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes a net tax benefit of $184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. Refer to Note 18 of Notes to Consolidated Financial Statements. 6 Includes net tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 7 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 8 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 9 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 9.9 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""). The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 10 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. As of December 31, 2019 , the gross amount of unrecognized tax benefits was $ 392 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 173 million , exclusive of any benefits related to interest and penalties. The remaining $ 219 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, 2017 Balance of unrecognized tax benefits at beginning of year $ $ $ Increase related to prior period tax positions 1 18 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (174 ) 2 (4 ) Increase (decrease) due to effect of foreign currency exchange rate changes (3 ) (17 ) Balance of unrecognized tax benefits at end of year $ $ $ 1 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 2 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 201 million , $ 190 million and $ 177 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2019 , 2018 and 2017 , respectively. Of these amounts, $11 million , $13 million and $35 million of expense were recognized through income tax expense in 2019 , 2018 and 2017 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2020 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2020 . As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds both domestically and internationally at reasonable interest rates, and we expect to be able to do so in the future. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. The Company's cash, cash equivalents, short-term investments and marketable securities totaled $11.2 billion as of December 31, 2019 . In addition to these funds, our commercial paper program and our ability to issue long-term debt, we had $ 8.9 billion in lines of credit for general corporate purposes as of December 31, 2019 . These backup lines of credit expire at various times from 2020 through 2024 . Based on all of the aforementioned factors, the Company believes its current liquidity position is strong and will continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities for the foreseeable future. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2019 , 2018 and 2017 was $ 10,471 million , $ 7,627 million and $ 7,041 million , respectively. Net cash provided by operating activities increased $2,844 million , or 37 percent , in 2019 compared to 2018 . This increase was primarily driven by operating income growth, the acquisition of Costa in January 2019, the efficient management of working capital, primarily due to the extension of payment terms with our suppliers, and lower payments related to the Company's productivity and reinvestment program, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Net cash provided by operating activities increased $586 million , or 8 percent , in 2018 compared to 2017 . This increase was primarily driven by operating income growth, the efficient management of working capital and the consolidation of CCBA, partially offset by the impact of refranchising bottling operations and higher interest and tax payments. Refer to Note 12 and Note 16 of Notes to Consolidated Financial Statements for additional information on interest payments and tax payments, respectively. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, 2018 Purchases of investments $ (4,704 ) $ (7,789 ) $ (17,296 ) Proceeds from disposals of investments 6,973 14,977 16,694 Acquisitions of businesses, equity method investments and nonmarketable securities (5,542 ) (1,263 ) (3,809 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 Purchases of property, plant and equipment (2,054 ) (1,548 ) (1,750 ) Proceeds from disposals of property, plant and equipment 248 Other investing activities (56 ) (60 ) (80 ) Net cash provided by (used in) investing activities $ (3,976 ) $ 5,927 $ (2,312 ) Purchases of Investments and Proceeds from Disposals of Investments Purchases of investments and proceeds from disposals of investments resulted in net cash inflows of $2,269 million and $7,188 million in 2019 and 2018, respectively, and a net cash outflow of $602 million in 2017. The investments purchased in all three years include time deposits that had maturities greater than three months but less than one year and were classified in the line item short-term investments in our consolidated balance sheets. The remaining activity primarily represents the purchases of, and proceeds from the disposals of, short-term investments that were made as part of the Company's overall cash management strategy as well as our insurance captive investments. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2019 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $5,542 million , which primarily related to the acquisitions of Costa and the remaining interest in CHI. During 2019 , the Company also acquired controlling interests in bottling operations in Zambia, Kenya, and Eswatini. In 2018 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million , which was primarily related to the acquisition of a controlling interest in the Philippine bottling operations and an equity interest in BA Sports Nutrition, LLC (""BodyArmor""). Additionally, the Company acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity was primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2019 , 2018 and 2017 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2019 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $429 million , primarily related to the sale of a portion of our equity method investment in Andina and the refranchising of certain of our bottling operations in India. In 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 1,362 million , primarily related to the proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the the sale of our equity ownership in Lindley. In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2019 , 2018 and 2017 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment for the years ended December 31, 2019 , 2018 and 2017 were $2,054 million , $1,548 million and $1,750 million , respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, Capital expenditures $ 2,054 $ 1,548 $ 1,750 Europe, Middle East Africa 5.2 % 4.3 % 4.4 % Latin America 6.8 5.8 3.1 North America 19.1 27.7 30.9 Asia Pacific 2.3 2.0 2.9 Global Ventures 10.2 0.7 0.2 Bottling Investments 40.7 33.4 42.1 Corporate 15.7 26.1 16.4 We expect our full year 2020 capital expenditures to be approximately $2.0 billion . Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 23,009 $ 27,605 $ 29,926 Payments of debt (24,850 ) (30,600 ) (28,871 ) Issuances of stock 1,012 1,476 1,595 Purchases of stock for treasury (1,103 ) (1,912 ) (3,682 ) Dividends (6,845 ) (6,644 ) (6,320 ) Other financing activities (227 ) (272 ) (95 ) Net cash provided by (used in) financing activities $ (9,004 ) $ (10,347 ) $ (7,447 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2019 , our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both rating agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, certain rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc., Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that these rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2019 , the Company had issuances of debt of $23,009 million , which included $16,842 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $6,167 million , net of related discounts and issuance costs. During 2019 , the Company made payments of debt of $24,850 million , which included $17,577 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and $2,244 million net issuances related to commercial paper and short-term debt with maturities of 90 days or less. The Company's total payments of long-term debt were $5,029 million . In 2018, the Company had issuances of debt of $27,605 million , which primarily included $24,510 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $3,093 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. During 2018, the Company made payments of debt of $30,600 million , which included $27,281 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,319 million . In 2017, the Company had issuances of debt of $29,926 million , which included issuances of $26,287 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million , net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,871 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,259 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million . The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Coca-Cola Enterprises Inc.'s former North America business. Issuances of Stock The issuances of stock in 2019 , 2018 and 2017 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase plan of up to 500 million shares of the Company's common stock. In 2019, our Board of Directors authorized a new plan for the Company to purchase up to an additional 150 million shares of our common stock. The following table presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 48.86 $ 45.09 $ 44.09 Since the inception of our share repurchase program in 1984 through December 31, 2019 , we have purchased 3.5 billion shares of our common stock at an average price per share of $17.25. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2019 , we repurchased $1.1 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2019 resulted in a net cash outflow of $0.1 billion . After investing for growth and paying dividends, we intend to use excess cash to repurchase shares over time. Dividends The Company paid dividends of $6,845 million , $6,644 million and $6,320 million during the years ended December 31, 2019 , 2018 and 2017 , respectively. At its February 2020 meeting, our Board of Directors increased our regular quarterly dividend to $0.41 per share, equivalent to a full year dividend of $1.64 per share in 2020. This is our 58 th consecutive annual increase. Our annualized common stock dividend was $ 1.60 per share, $ 1.56 per share and $ 1.48 per share in 2019 , 2018 and 2017 , respectively. Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2019 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 621 million , of which $ 249 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees. However, management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2019 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2019 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2021-2022 2023-2024 2025 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 10,007 $ 10,007 $ $ $ Lines of credit and other short-term borrowings 987 Current maturities of long-term debt 2 4,255 4,255 Long-term debt, net of current maturities 2 27,017 7,507 6,035 13,475 Estimated interest payments 3 3,613 733 1,893 Accrued income taxes 4 4,143 838 1,686 1,205 Purchase obligations 5 16,100 10,008 1,450 1,008 3,634 Marketing obligations 6 5,015 2,404 1,090 896 Lease obligations 1,710 533 485 Total contractual obligations $ 72,847 $ 28,876 $ 12,151 $ 10,232 $ 21,588 1 Refer to Note 12 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 12 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2019 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 16 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,986 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $584 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2019 was $2,093 million . Refer to Note 15 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, net periodic benefit cost, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. The Company expects to contribute $28 million in 2020 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 15 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our pension plans in the table above. As of December 31, 2019 , the projected benefit obligation of the U.S. qualified pension plans was $5,623 million , and the fair value of the related plan assets was $5,149 million . The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,134 million , and the fair value of the related plan assets was $2,931 million . The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $67 million in 2020, increasing to $69 million by 2025 and then decreasing annually thereafter. Refer to Note 15 of Notes to Consolidated Financial Statements. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2019 , our self-insurance reserves totaled $ 301 million . Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2019 were $2,284 million . Refer to Note 16 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, in January 2020, the Company acquired the remaining 57.5 percent stake in fairlife, LLC for $1.0 billion, which is not included in the table above. Refer to Note 23 of Notes to Consolidated Financial Statements. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2019 , we used 70 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weakness in some of these currencies may be offset by strength in others. In 2019 and 2018 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies (5 )% (1 )% Australian dollar (7 )% (2 )% Brazilian real (10 ) (12 ) British pound sterling (4 ) Euro (5 ) Japanese yen Mexican peso (1 ) (2 ) South African rand (10 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 4 percent and 1 percent in 2019 and 2018 , respectively. The total currency impact on income before income taxes, including the effect of our hedging activities, was a decrease of 10 percent and 7 percent in 2019 and 2018 , respectively. Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statement of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $120 million , $143 million and $56 million during the years ended December 31, 2019 , 2018 and 2017 , respectively. Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. We have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of the impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 48 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2019 , we used 70 functional currencies in addition to the U.S. dollar and generated $25.6 billion of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies may be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $14,276 million and $17,142 million as of December 31, 2019 and 2018 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $6 million as of December 31, 2019 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $84 million . The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $26 million as of December 31, 2019 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the unrealized loss and created a net unrealized gain of $31 million . Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2019 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $241 million in 2019 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $47 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. The total notional values of our commodity derivatives were $427 million and $382 million as of December 31, 2019 and 2018 , respectively. These values included derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of less than $1 million as of December 31, 2019 , and we estimate that a 10 percent decrease in underlying commodity prices would have an insignificant impact. The fair value of the contracts that do not qualify for hedge accounting resulted in a net loss of $4 million as of December 31, 2019 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $38 million . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 67 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In millions except per share data) Year Ended December 31, 2018 Net Operating Revenues $ 37,266 $ 34,300 $ 36,212 Cost of goods sold 14,619 13,067 13,721 Gross Profit 22,647 21,233 22,491 Selling, general and administrative expenses 12,103 11,002 12,834 Other operating charges 1,079 1,902 Operating Income 10,086 9,152 7,755 Interest income 689 Interest expense 950 Equity income (loss) net 1,049 1,008 1,072 Other income (loss) net ( 1,674 ) ( 1,763 ) Income Before Income Taxes 10,786 8,225 6,890 Income taxes 1,801 1,749 5,607 Consolidated Net Income 8,985 6,476 1,283 Less: Net income (loss) attributable to noncontrolling interests 42 Net Income Attributable to Shareowners of The Coca-Cola Company $ 8,920 $ 6,434 $ 1,248 Basic Net Income Per Share 1 $ 2.09 $ 1.51 $ 0.29 Diluted Net Income Per Share 1 $ 2.07 $ 1.50 $ 0.29 Average Shares Outstanding Basic 4,276 4,259 4,272 Effect of dilutive securities 40 Average Shares Outstanding Diluted 4,314 4,299 4,324 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2018 Consolidated Net Income $ 8,985 $ 6,476 $ 1,283 Other comprehensive income: Net foreign currency translation adjustments ( 2,035 ) Net gains (losses) on derivatives ( 54 ) ( 7 ) ( 433 ) Net change in unrealized gains (losses) on available-for-sale securities ( 34 ) Net change in pension and other benefit liabilities ( 159 ) 322 Total Comprehensive Income 8,864 4,429 2,221 Less: Comprehensive income attributable to noncontrolling interests 95 Total Comprehensive Income Attributable to Shareowners of The Coca-Cola Company $ 8,754 $ 4,334 $ 2,148 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions except par value) December 31, 2018 ASSETS Current Assets Cash and cash equivalents $ 6,480 $ 9,077 Short-term investments 1,467 2,025 Total Cash, Cash Equivalents and Short-Term Investments 7,947 11,102 Marketable securities 3,228 5,013 Trade accounts receivable, less allowances of $524 and $501, respectively 3,971 3,685 Inventories 3,379 3,071 Prepaid expenses and other assets 1,886 2,059 Total Current Assets 20,411 24,930 Equity method investments 19,025 19,412 Other investments 867 Other assets 6,075 4,148 Deferred income tax assets 2,412 2,674 Property, plant and equipment net 10,838 9,598 Trademarks with indefinite lives 9,266 6,682 Bottlers' franchise rights with indefinite lives 51 Goodwill 16,764 14,109 Other intangible assets 745 Total Assets $ 86,381 $ 83,216 LIABILITIES AND EQUITY Current Liabilities Accounts payable and accrued expenses $ 11,312 $ 9,533 Loans and notes payable 10,994 13,835 Current maturities of long-term debt 4,253 5,003 Accrued income taxes 411 Total Current Liabilities 26,973 28,782 Long-term debt 27,516 25,376 Other liabilities 8,510 7,646 Deferred income tax liabilities 2,284 2,354 The Coca-Cola Company Shareowners' Equity Common stock, $0.25 par value; authorized 11,200 shares; issued 7,040 shares 1,760 1,760 Capital surplus 17,154 16,520 Reinvested earnings 65,855 63,234 Accumulated other comprehensive income (loss) ( 13,544 ) ( 12,814 ) Treasury stock, at cost 2,760 and 2,772 shares, respectively ( 52,244 ) ( 51,719 ) Equity Attributable to Shareowners of The Coca-Cola Company 18,981 16,981 Equity attributable to noncontrolling interests 2,117 2,077 Total Equity 21,098 19,058 Total Liabilities and Equity $ 86,381 $ 83,216 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2018 Operating Activities Consolidated net income $ 8,985 $ 6,476 $ 1,283 Depreciation and amortization 1,365 1,086 1,260 Stock-based compensation expense 225 Deferred income taxes ( 280 ) ( 413 ) ( 1,252 ) Equity (income) loss net of dividends ( 421 ) ( 457 ) ( 628 ) Foreign currency adjustments ( 50 ) Significant (gains) losses net ( 467 ) 1,459 Other operating charges 558 1,218 Other items 699 ( 252 ) Net change in operating assets and liabilities ( 1,240 ) 3,442 Net Cash Provided by Operating Activities 10,471 7,627 7,041 Investing Activities Purchases of investments ( 4,704 ) ( 7,789 ) ( 17,296 ) Proceeds from disposals of investments 6,973 14,977 16,694 Acquisitions of businesses, equity method investments and nonmarketable securities ( 5,542 ) ( 1,263 ) ( 3,809 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 Purchases of property, plant and equipment ( 2,054 ) ( 1,548 ) ( 1,750 ) Proceeds from disposals of property, plant and equipment 248 Other investing activities ( 56 ) ( 60 ) ( 80 ) Net Cash Provided by (Used in) Investing Activities ( 3,976 ) 5,927 ( 2,312 ) Financing Activities Issuances of debt 23,009 27,605 29,926 Payments of debt ( 24,850 ) ( 30,600 ) ( 28,871 ) Issuances of stock 1,012 1,476 1,595 Purchases of stock for treasury ( 1,103 ) ( 1,912 ) ( 3,682 ) Dividends ( 6,845 ) ( 6,644 ) ( 6,320 ) Other financing activities ( 227 ) ( 272 ) ( 95 ) Net Cash Provided by (Used in) Financing Activities ( 9,004 ) ( 10,347 ) ( 7,447 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents ( 72 ) ( 262 ) Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year ( 2,581 ) 2,945 ( 2,477 ) Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 9,318 6,373 8,850 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents at End of Year 6,737 9,318 6,373 Less: Restricted cash and restricted cash equivalents at end of year 241 Cash and Cash Equivalents at End of Year $ 6,480 $ 9,077 $ 6,102 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (In millions except per share data) Year Ended December 31, 2018 Equity Attributable to Shareowners of The Coca-Cola Company Number of Common Shares Outstanding Balance at beginning of year 4,268 4,259 4,288 Treasury stock issued to employees related to stock-based compensation plans 48 Purchases of stock for treasury ( 21 ) ( 39 ) ( 82 ) Balance at end of year 4,280 4,268 4,259 Common Stock $ 1,760 $ 1,760 $ 1,760 Capital Surplus Balance at beginning of year 16,520 15,864 14,993 Stock issued to employees related to stock-based compensation plans 467 Stock-based compensation expense 225 Other activities ( 36 ) ( 3 ) Balance at end of year 17,154 16,520 15,864 Reinvested Earnings Balance at beginning of year 63,234 60,430 65,502 Adoption of accounting standards 1 3,014 Net income attributable to shareowners of The Coca-Cola Company 8,920 6,434 1,248 Dividends (per share $1.60, $1.56 and $1.48 in 2019, 2018 and 2017, respectively) ( 6,845 ) ( 6,644 ) ( 6,320 ) Balance at end of year 65,855 63,234 60,430 Accumulated Other Comprehensive Income (Loss) Balance at beginning of year ( 12,814 ) ( 10,305 ) ( 11,205 ) Adoption of accounting standards 1 ( 564 ) ( 409 ) Net other comprehensive income (loss) ( 166 ) ( 2,100 ) Balance at end of year ( 13,544 ) ( 12,814 ) ( 10,305 ) Treasury Stock Balance at beginning of year ( 51,719 ) ( 50,677 ) ( 47,988 ) Treasury stock issued to employees related to stock-based compensation plans 704 Purchases of stock for treasury ( 1,026 ) ( 1,746 ) ( 3,598 ) Balance at end of year ( 52,244 ) ( 51,719 ) ( 50,677 ) Total Equity Attributable to Shareowners of The Coca-Cola Company $ 18,981 $ 16,981 $ 17,072 Equity Attributable to Noncontrolling Interests Balance at beginning of year $ 2,077 $ 1,905 $ Net income attributable to noncontrolling interests 42 Net foreign currency translation adjustments 53 Dividends paid to noncontrolling interests ( 48 ) ( 31 ) ( 15 ) Acquisition of interests held by noncontrolling owners ( 84 ) Contributions by noncontrolling interests Business combinations 101 1,805 Deconsolidation of certain entities ( 157 ) Other activities 41 Total Equity Attributable to Noncontrolling Interests $ 2,117 $ 2,077 $ 1,905 1 Refer to Note 1 , Note 3 , Note 4 , Note 6 and Note 16 . Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest nonalcoholic beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for 2.0 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 13 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,179 million and $ 3,916 million as of December 31, 2019 and 2018 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 51 million and $ 49 million as of December 31, 2019 and 2018 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. Refer to Note 3 . Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $ 4 billion in 2019 , 2018 and 2017 . As of December 31, 2019 and 2018 , advertising and production costs of $ 55 million and $ 54 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statement of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statement of income, except for costs incurred to distribute goods sold by our Company-owned bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. Effective January 1, 2018, we adopted ASC 606. Upon adoption, we made a policy election to recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Refer to Note 3 for additional information regarding revenue recognition. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. Upon adoption of ASC 606, we made a policy election to exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Refer to Note 3 for additional information regarding revenue recognition. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 5 million stock option awards were excluded from the computations of diluted net income per share in both 2018 and 2017 because the awards would have been antidilutive for the years presented. The number of stock option awards excluded from the computation of diluted net income per share in 2019 was insignificant. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheets, and amounts classified in assets held for sale. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2018 Cash and cash equivalents $ 6,480 $ 9,077 $ 6,102 Cash and cash equivalents included in assets held for sale Cash and cash equivalents included in other assets 1 241 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 6,737 $ 9,318 $ 6,373 1 Amounts represent cash and cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4 . Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") 2016-01 Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments, which includes our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheet in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statement of cash flows in net cash provided by operating activities. Refer to Note 6 . Leases Effective January 1, 2019 , we adopted Accounting Standards Codification 842, Leases (""ASC 842""). We determine if an arrangement contains a lease at inception based on whether or not the Company has the right to control the asset during the contract period and other facts and circumstances. We are the lessee in a lease contract when we obtain the right to control the asset. Operating leases are included in the line items other assets, accounts payable and accrued expenses, and other liabilities in our consolidated balance sheet. Operating lease right-of-use (""ROU"") assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease, both of which are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Leases with a lease term of 12 months or less at inception are not recorded on our consolidated balance sheet and are expensed on a straight-line basis over the lease term in our consolidated statement of income. We determine the lease term by assuming the exercise of renewal options that are reasonably certain. As most of our leases do not provide an implicit interest rate, we use our local incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. When our contracts contain lease and non-lease components, we account for both components as a single lease component. Refer to Note 11 . We have various arrangements for certain fountain equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery and equipment: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under finance leases, totaled $ 1,208 million , $ 999 million and $ 1,131 million in 2019 , 2018 and 2017 , respectively. Amortization expense for leasehold improvements totaled $ 18 million , $ 18 million and $ 19 million in 2019 , 2018 and 2017 , respectively. Refer to Note 8 . Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe market participants would use. Refer to Note 18 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 9 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe a market participant would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe market participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. Our Global Ventures operating segment includes the results of our Costa Limited (""Costa""), innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""), each of which is its own reporting unit. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a market participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statement of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 13 . Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performance-based share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, which is generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018 and 2019, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 14 . Income Taxes Income tax expense includes U.S., state, local and international income taxes. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 13 and Note 16 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 17 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statement of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheet. Refer to Note 6 . Recently Adopted Accounting Guidance ASC 842 requires lessees to recognize operating lease ROU assets, representing their right to use the underlying asset for the lease term, and operating lease liabilities on the balance sheet for all leases with lease terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted ASC 842 using the modified retrospective method and utilized the optional transition method under which we continue to apply the legacy guidance in ASC 840, Leases , including its disclosure requirements, in the comparative periods presented. In addition, we elected the package of practical expedients permitted under the transition guidance which permits us to carry forward the historical lease classification, among other things. As a result of the adoption, our operating lease ROU assets and operating lease liabilities were $ 1,372 million and $ 1,392 million , respectively, as of December 31, 2019 . The adoption of this standard did not impact our consolidated statement of income or our consolidated statement of cash flows. Refer to Note 11 . In August 2017, the Financial Accounting Standards Board (""FASB"") issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments in this update include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2019 by $ 12 million , net of tax. Refer to Note 6 for additional disclosures required by this ASU. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , which permits entities to reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017 (""Tax Reform Act"") on items within AOCI to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" The amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income is not affected by this update. We adopted ASU 2018-02 effective January 1, 2019 . We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2019 by $ 558 million related to the effect that the change in the income tax rate had on the gross deferred tax amounts of items remaining in AOCI. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , which replaces most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. ASU 2014-09 and its amendments were included primarily in ASC 606. The core principle of ASC 606 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASC 606 also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. We adopted ASC 606 effective January 1, 2018 using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $ 257 million , net of tax. The Company has changed our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data for the reporting process. Refer to Note 3 . In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $ 409 million , net of tax. Refer to Note 4 for additional disclosures required by this ASU. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $ 2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. Refer to Note 16 . In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Reform Act. The amendments also require any provisional amounts or subsequent adjustments to be included in net income. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018 . Refer to Note 16 . NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2019, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 5,542 million , which primarily related to the acquisitions of Costa, the remaining equity ownership interest in C.H.I. Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages and iced tea, and controlling interests in bottling operations in Zambia, Kenya, and Eswatini. Refer to the ""Costa Limited"" and ""C.H.I. Limited"" sections within this note below for further details. During 2018, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,263 million , which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Refer to the ""Philippine Bottling Operations"" section within this note below for further details. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor can exercise an option on behalf of the other equity owners to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2018, the Company also acquired controlling interests in bottling operations in Zambia and Botswana. During 2017, our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , of which $ 3,150 million related to the transition of Anheuser-Busch InBev's (""ABI"") 54.5 percent controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company, resulting in its consolidation in October 2017. Refer to the ""Coca-Cola Beverages Africa Proprietary Limited"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for noncash consideration. Refer to the ""North America Refranchising United States"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. Costa Limited In January 2019, the Company acquired Costa in exchange for $ 4.9 billion of cash, net of cash acquired. Costa is a coffee business with retail outlets in more than 30 countries, the Costa Express vending system and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverage market as Costa has a scalable platform across multiple formats and channels, including opportunities to introduce ready-to-drink products. As of December 31, 2019 , $ 2.4 billion of the purchase price was preliminarily allocated to the Costa trademark and $ 2.5 billion was preliminarily allocated to goodwill. The goodwill recognized as part of this acquisition is primarily related to synergistic value created from the opportunity for additional expansion as well as our ability to market and distribute Costa in ready-to-drink form throughout our bottling system. It also includes certain other intangible assets that do not qualify for separate recognition, such as an assembled workforce. The goodwill is not tax deductible and has been assigned to the Global Ventures operating segment, except for $ 108 million , which was allocated to the Europe, Middle East and Africa operating segment. The preliminary allocation of the purchase price is subject to refinement when valuations are finalized. As of December 31, 2019 , the valuations that have not been finalized primarily relate to operating lease ROU assets, operating lease liabilities and certain fixed assets. The final purchase price allocation will be completed in the first quarter of 2020. C.H.I. Limited In January 2019, the Company acquired the remaining 60 percent interest in CHI in exchange for $ 257 million of cash, net of cash acquired, under the terms of the agreement for our original investment in CHI. Upon consolidation, we recognized a net loss of $ 118 million , which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $ 715 million of cash. The acquired business had $ 345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $ 32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Coca-Cola Beverages Africa Proprietary Limited In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $ 3,150 million . Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $ 150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those market participants would use. We recorded $ 1,805 million for the noncontrolling interests of CCBA. The fair value of the noncontrolling interests was determined in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $ 4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. As a result, upon finalization of purchase accounting $ 411 million of the final goodwill balance of $ 4,186 million was allocated to other reporting units expected to benefit from this transaction. Due to the Company's original intent to refranchise CCBA, it was accounted for as held for sale and a discontinued operation from October 2017 through the first quarter of 2019. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell. As a result, during the year ended December 31, 2018 , we recorded an impairment charge of $ 554 million , reflecting management's view of the proceeds that were expected to be received upon sale based on revised projections of future operating results and foreign currency exchange rate fluctuations. This charge was previously reflected in the line item income (loss) from discontinued operations in our consolidated statement of income and the corresponding reduction to assets was reflected as an allowance for reduction of assets held for sale discontinued operations in our consolidated balance sheet. Refer to Note 18 . Additionally, CCBA's property, plant and equipment was not depreciated and its definite-lived intangible assets were not amortized. While the Company had discussions with a number of potential partners throughout the period CCBA was held for sale, during the second quarter of 2019 the Company updated its plans for CCBA and now intends to maintain its controlling stake in CCBA for the foreseeable future. As a result, CCBA no longer qualifies as held for sale or as a discontinued operation, and CCBA's financial results are now presented within the Company's continuing operations for all periods presented. As a result of this change in presentation, the Company reflected the impairment charge in other income (loss) net in our consolidated statement of income for the year ended December 31, 2018 and reallocated the allowance for reduction of assets held for sale discontinued operations balance to reduce the carrying value of CCBA's property, plant and equipment by $ 225 million and CCBA's definite-lived intangible assets by $ 329 million based on the relative amount of depreciation and amortization that would have been recognized during the period CCBA was held for sale. We also recorded a $ 160 million adjustment to reduce the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by an additional $ 34 million and $ 126 million , respectively, during the year ended December 31, 2019 . These additional adjustments were included in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2019, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 429 million , primarily related to the sale of a portion of our equity method investment in Embotelladora Andina S.A. (""Andina"") and the refranchising of certain of our bottling operations in India. As a result of these transactions, we recognized gains of $ 39 million and $ 73 million , respectively, which were recorded in the line item other income (loss) net in our consolidated statement of income. We continue to account for our remaining interest in Andina as an equity method investment as a result of our representation on Andina's Board of Directors and other governance rights. During 2018, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 1,362 million , primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations, as well as the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley""). During 2017, proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $ 3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. Latin America Bottling Operations During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $ 289 million as a result of these sales and recognized a net gain of $ 47 million , which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018 , we sold our equity ownership in Lindley to AC Bebidas, an equity method investee. We received net cash proceeds of $ 507 million and recognized a net gain of $ 296 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018 , the Company completed its North America refranchising with the sale of its Canadian bottling operations. We received initial net cash proceeds of $ 518 million and recognized a net charge of $ 385 million during the year ended December 31, 2018 . During the year ended December 31, 2019 , we recognized an additional charge of $ 122 million primarily related to post-closing adjustments as contemplated by the related agreements. These charges were included in the line item other income (loss) net in our consolidated statements of income. North America Refranchising United States In 2018, the Company completed the refranchising of all of our bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas, as well as the CBA entered into with Liberty Coca-Cola Beverages, the bottlers make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories to the respective bottlers in exchange for cash, except for the territory included in the Southwest Transaction. As discussed further below, we did not receive cash in the Southwest Transaction for these items. During the years ended December 31, 2018 and 2017 , cash proceeds from these sales totaled $ 3 million and $ 2,860 million , respectively. Included in the cash proceeds for the year ended December 31, 2017 was $ 336 million from Coca-Cola Bottling Co. Consolidated now known as Coca-Cola Consolidated, Inc., an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017 was $ 220 million from AC Bebidas and $ 39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized a net gain of $ 17 million during the year ended December 31, 2019 and recognized net charges of $ 91 million and $ 3,177 million during the years ended December 31, 2018 and 2017 , respectively. Included in these amounts is a net gain of $ 5 million during the year ended December 31, 2019 and net charges of $ 21 million and $ 1,104 million during the years ended December 31, 2018 and 2017 , respectively, from transactions with equity method investees or former management. The net gain in 2019 and net charges in 2018 were primarily related to post-closing adjustments as contemplated by the related agreements. The net charges in 2017 were primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The net charges in 2017 included $ 236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain refranchised territories participate. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the statement of income only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the statement of income as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2019 , 2018 and 2017 , the Company recorded charges of $ 4 million , $ 34 million and $ 313 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, as well as consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The charges related to these payments were included in the line item other income (loss) net in our consolidated statements of income. On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. CCR also made cash payments of $ 144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $ 1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $ 2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refranchising of China Bottling Operations In 2017, the Company sold its bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and sold a related cost method investment to one of the franchise bottlers. We received net cash proceeds of $ 963 million as a result of these sales and recognized a gain of $ 88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. NOTE 3 : REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine concentrates with sweeteners (depending on the product), still water or sparkling water, or combine syrups with still or sparkling water, to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments and our Global Ventures operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers or Company-owned Costa retail outlets. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments or our Global Ventures operating segment. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We adopted ASC 606 effective January 1, 2018 using the modified retrospective method. We have applied this standard to all contracts at the effective date and contracts entered into thereafter. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates, syrups or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates, syrups or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Upon transfer of control to the customer, which completes our performance obligation, revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In most markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we have implemented an incidence-based concentrate pricing model. Under this model, the price we charge bottlers for concentrate they use to prepare and package finished products is impacted by a number of factors, including, but not limited to, the prices charged by the bottlers for such finished products, the channels in which they are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606, an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2019 related to performance obligations satisfied in prior periods was immaterial. In addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification of certain costs relating to revenue arrangements with customers. As a result, during the years ended December 31, 2019 and 2018 , we recorded certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also re-evaluated the principal versus agent considerations pertaining to certain of its arrangements with third-party manufacturers and co-packers. We recorded certain costs in net operating revenues which were previously recorded in cost of goods sold related to arrangements in which we concluded we did not control the goods before they were delivered to our customers. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2019 Concentrate operations $ 5,252 $ 15,247 $ 20,499 Finished product operations 6,463 10,304 16,767 Total $ 11,715 $ 25,551 $ 37,266 Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,323 $ 19,894 Finished product operations 6,773 7,633 14,406 Total $ 11,344 $ 22,956 $ 34,300 Refer to Note 21 for additional revenue disclosures by operating segment and Corporate. NOTE 4 : INVESTMENTS Effective January 1, 2018, we adopted ASU 2016-01, which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $ 409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to AOCI as of January 1, 2018 in connection with the adoption of ASU 2016-01. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. The cost basis is determined by the specific identification method. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Refer to Note 6 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe market participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Equity Securities T he carrying values of our equity securities were included in the following line items in our consolidated balance sheets (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value December 31, 2019 Marketable securities $ $ Other investments 82 Other assets 1,118 Total equity securities $ 2,219 $ December 31, 2018 Marketable securities $ $ Other investments 80 Other assets Total equity securities $ 1,934 $ The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at the end of the year is as follows (in millions): Year Ended December 31, 2018 Net gains (losses) recognized during the year related to equity securities $ $ ( 250 ) Less: Net gains (losses) recognized during the year related to equity securities sold during the year 8 Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ $ ( 258 ) The sale and/or maturity of available-for-sale equity securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ Gross losses ( 19 ) Proceeds 86 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses December 31, 2019 Trading securities $ $ $ $ Available-for-sale securities 3,172 ( 4 ) 3,281 Total debt securities $ 3,218 $ $ ( 4 ) $ 3,328 December 31, 2018 Trading securities $ $ $ ( 1 ) $ Available-for-sale securities 4,901 ( 27 ) 4,993 Total debt securities $ 4,946 $ $ ( 28 ) $ 5,037 The carrying values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2019 December 31, 2018 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ Marketable securities 2,852 4,691 Other assets Total debt securities $ $ 3,281 $ $ 4,993 The contractual maturities of these available-for-sale debt securities as of December 31, 2019 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 1,943 $ 1,982 After 1 year through 5 years 1,022 After 5 years through 10 years 84 After 10 years 193 Total $ 3,172 $ 3,281 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2018 Gross gains $ $ $ Gross losses ( 8 ) ( 27 ) ( 13 ) Proceeds 3,956 13,710 13,930 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $ 1,266 million as of December 31, 2019 and $ 1,056 million as of December 31, 2018 , which are classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, 2018 Raw materials and packaging $ 2,180 $ 2,025 Finished goods 773 Other 273 Total inventories $ 3,379 $ 3,071 NOTE 6 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign currency denominated third-party debt, in hedging relationships. All derivative instruments are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 18 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We adopted ASU 2017-12 effective January 1, 2019 using the modified retrospective method. For highly effective cash flow hedges, this ASU requires the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness to be recorded in other comprehensive income. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. To reflect the adoption of the new hedging standard on our cash flow hedging relationships at January 1, 2019 , we recorded a $ 6 million increase, net of taxes, to the opening balance of reinvested earnings and a corresponding decrease to AOCI. For fair value hedges of interest rate risk, this ASU allows entities to elect to use the benchmark interest rate component of the contractual coupon cash flows to calculate the change in fair value of the hedged item attributable to changes in the benchmark interest rate. As a result of applying the new hedging standard to our fair value hedges on January 1, 2019 , we recorded a $ 24 million increase to our hedged long-term debt balances, with a corresponding decrease to the opening balance of reinvested earnings of $ 18 million , net of taxes. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2019 December 31, 2018 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Prepaid expenses and other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Commodity contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 18 for the net presentation of the Company's derivative instruments. 2 Refer to Note 18 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2019 December 31, 2018 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Other derivative instruments Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Other derivative instruments Accounts payable and accrued expenses Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 18 for the net presentation of the Company's derivative instruments. 2 Refer to Note 18 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically four years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 6,957 million and $ 3,175 million as of December 31, 2019 and 2018 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. As of December 31, 2019 and 2018 , the total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $ 3,028 million . The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 2 million and $ 9 million as of December 31, 2019 and 2018 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. During the year ended December 31, 2018 , we discontinued the cash flow hedge relationship related to these swaps. We reclassified a loss of $ 8 million into earnings as a result of the discontinuance. As of December 31, 2019 and 2018 , we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) 2 Foreign currency contracts $ ( 58 ) Net operating revenues $ ( 3 ) $ Foreign currency contracts Cost of goods sold Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts ( 97 ) Other income (loss) net ( 119 ) Interest rate contracts ( 47 ) Interest expense ( 42 ) Commodity contracts Cost of goods sold Total $ ( 200 ) $ ( 162 ) $ Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold ( 3 ) Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts Other income (loss) net ( 5 ) ( 4 ) Interest rate contracts Interest expense ( 40 ) ( 8 ) Commodity contracts ( 1 ) Cost of goods sold ( 5 ) Total $ $ $ ( 19 ) Foreign currency contracts $ ( 226 ) Net operating revenues $ $ Foreign currency contracts ( 26 ) Cost of goods sold ( 2 ) 3 Foreign currency contracts Interest expense ( 9 ) Foreign currency contracts Other income (loss) net Interest rate contracts ( 22 ) Interest expense ( 37 ) Commodity contracts ( 6 ) Cost of goods sold ( 1 ) Total $ ( 188 ) $ $ 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and the ineffective portion, if any, to the same line items in our consolidated statement of income. 2 Effective January 1, 2019, ASU 2017-12 eliminated the requirement to separately measure and report hedge ineffectiveness for cash flow hedges. No components of the Company's hedging instruments were excluded from the assessment of hedge effectiveness. 3 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2019 , the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 72 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives related to our fair value hedges of this type were $ 12,523 million and $ 8,023 million as of December 31, 2019 and 2018 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. As of December 31, 2019 and 2018 , we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Interest rate contracts Interest expense $ Fixed-rate debt Interest expense ( 369 ) Net impact to interest expense $ ( 1 ) Net impact of fair value hedging instruments $ ( 1 ) Interest rate contracts Interest expense $ Fixed-rate debt Interest expense ( 38 ) Net impact to interest expense $ ( 4 ) Foreign currency contracts Other income (loss) net $ ( 6 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ ( 4 ) Interest rate contracts Interest expense $ ( 69 ) Fixed-rate debt Interest expense Net impact to interest expense $ ( 6 ) Foreign currency contracts Other income (loss) net $ ( 37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ The following table summarizes the amounts recorded in the consolidated balance sheets related to hedged items in fair value hedging relationships (in millions): Carrying Value of the Hedged Item Cumulative Amount of Fair Value Hedging Adjustments Included in the Carrying Value of the Hedged Item 1 Balance Sheet Location of Hedged Item December 31, 2019 December 31, 2018 December 31, 2019 December 31, 2018 Current maturities of long-term debt $ 1,004 $ $ $ Long-term debt 12,087 8,043 62 1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rates. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the change in the carrying value of the designated portion of the non-derivative financial instrument due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2018 2018 Foreign currency contracts $ $ $ $ ( 14 ) $ ( 7 ) Foreign currency denominated debt 12,334 12,494 653 ( 1,505 ) Total $ 12,334 $ 12,494 $ $ $ ( 1,512 ) The Company did not reclassify any gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2019 , 2018 and 2017 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2019 , 2018 and 2017 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 4,291 million and $ 10,939 million as of December 31, 2019 and 2018 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 425 million and $ 373 million as of December 31, 2019 and 2018 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ ( 4 ) $ $ ( 30 ) Foreign currency contracts Cost of goods sold ( 1 ) Foreign currency contracts Other income (loss) net ( 66 ) ( 264 ) Commodity contracts Net operating revenues Commodity contracts Cost of goods sold ( 23 ) ( 25 ) Commodity contracts Selling, general and administrative expenses Interest rate contracts Interest expense ( 1 ) Other derivative instruments Selling, general and administrative expenses ( 18 ) Other derivative instruments Other income (loss) net ( 22 ) Total $ $ ( 299 ) $ NOTE 7 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statement of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statement of income and our carrying value in those investments. Refer to Note 19 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in Coca-Cola European Partners plc (""CCEP""), Monster, AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic"") and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2019 , we owned approximately 19 percent , 19 percent , 20 percent , 28 percent , 23 percent and 19 percent , respectively, of these companies' outstanding shares. As of December 31, 2019 , our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 8,679 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 75,980 $ 75,482 $ 73,343 Cost of goods sold 44,881 44,933 42,871 Gross profit $ 31,099 $ 30,549 $ 30,472 Operating income $ 7,748 $ 7,511 $ 7,577 Consolidated net income $ 4,597 $ 4,646 $ 4,545 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,534 $ 4,545 $ 4,425 Company equity income (loss) net $ 1,049 $ 1,008 $ 1,072 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, 2018 Current assets $ 25,654 $ 23,249 Noncurrent assets 68,269 66,733 Total assets $ 93,923 $ 89,982 Current liabilities $ 20,271 $ 18,100 Noncurrent liabilities 31,321 29,144 Total liabilities $ 51,592 $ 47,244 Equity attributable to shareowners of investees $ 41,203 $ 41,558 Equity attributable to noncontrolling interests 1,128 1,180 Total equity $ 42,331 $ 42,738 Company equity method investments $ 19,025 $ 19,412 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,832 million , $ 14,799 million and $ 14,144 million in 2019 , 2018 and 2017 , respectively. Total payments, primarily marketing, made to equity method investees were $ 897 million , $ 1,131 million and $ 930 million in 2019 , 2018 and 2017 , respectively. The decrease in payments made to equity method investees in 2019 was primarily due to changes in bottler funding arrangements. In addition, purchases of beverage products from equity method investees were $ 426 million , $ 536 million and $ 1,299 million in 2019 , 2018 and 2017 , respectively. The decrease in purchases of beverage products in 2019 and 2018 was primarily due to reduced purchases of Monster products as a result of the North America refranchising activities. Refer to Note 2. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's carrying value in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2019 Fair Value Carrying Value Difference Monster Beverage Corporation $ 6,490 $ 3,781 $ 2,709 Coca-Cola European Partners plc 4,475 3,604 Coca-Cola FEMSA, S.A.B. de C.V. 3,461 1,758 1,703 Coca-Cola HBC AG 2,801 1,109 1,692 Coca-Cola Amatil Limited 1,674 1,063 Coca-Cola Bottlers Japan Holdings Inc. Coca-Cola Consolidated, Inc. Coca-Cola ecek A.. Embotelladora Andina S.A. Total $ 20,982 $ 12,089 $ 8,893 Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,707 million and $ 1,564 million as of December 31, 2019 and 2018 , respectively. The total amount of dividends received from equity method investees was $ 628 million , $ 551 million and $ 443 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2019 was $ 4,983 million . NOTE 8 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, 2018 Land $ $ Buildings and improvements 4,576 4,322 Machinery and equipment 13,686 12,804 Property, plant and equipment cost 18,921 17,611 Less: Accumulated depreciation 8,083 8,013 Property, plant and equipment net $ 10,838 $ 9,598 NOTE 9 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, 2018 Trademarks 1 $ 9,266 $ 6,682 Bottlers' franchise rights 51 Goodwill 1 16,764 14,109 Other 106 Indefinite-lived intangible assets $ 26,249 $ 20,948 1 Refer to Note 2 for information related to the Company's acquisitions and divestitures. The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Total Balance at beginning of year $ $ $ 7,954 $ $ $ 4,302 $ 13,649 Effect of foreign currency translation ( 58 ) ( 9 ) ( 4 ) ( 202 ) ( 273 ) Acquisitions 1 798 Purchase accounting adjustments 1,2 27 ( 11 ) ( 487 ) ( 60 ) Divestitures, deconsolidations and other 1 ( 5 ) ( 5 ) Balance at end of year $ 1,051 $ $ 7,943 $ $ $ 4,381 $ 14,109 Balance at beginning of year $ 1,051 $ $ 7,943 $ $ $ 4,381 $ 14,109 Effect of foreign currency translation ( 8 ) 1 75 Acquisitions 1 2,505 2,819 Purchase accounting adjustments 1,3 ( 114 ) ( 252 ) ( 239 ) Balance at end of year $ 1,294 $ $ 7,943 $ $ 2,806 $ 4,381 $ 16,764 1 For information related to the Company's acquisitions and divestitures, refer to Note 2 . 2 Includes the allocation of goodwill from the Bottling Investments segment to other reporting units expected to benefit from the consolidation of CCBA. Refer to Note 2 . 3 Includes the allocation of goodwill from the Global Ventures segment to other reporting units expected to benefit from the Costa acquisition as well as the finalization of purchase accounting related to CCBA and the Philippine bottling operations. Refer to Note 2 . Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2019 December 31, 2018 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ $ ( 177 ) $ $ $ ( 151 ) $ Bottlers' franchise rights ( 94 ) ( 18 ) Trademarks ( 99 ) ( 91 ) Other ( 30 ) ( 61 ) Total $ $ ( 400 ) $ $ $ ( 321 ) $ Total amortization expense for intangible assets subject to amortization was $ 120 million , $ 49 million and $ 68 million in 2019 , 2018 and 2017 , respectively. The increase in amortization expense in 2019 was due to the amortization of CCBA's definite-lived intangible assets that were previously classified as held for sale. Based on the carrying value of definite-lived intangible assets as of December 31, 2019 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2021 2022 2023 2024 NOTE 10 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accounts payable $ 3,804 1 $ 2,719 Accrued marketing expenses 2,059 1,787 Other accrued expenses 3,835 3,560 Accrued compensation 1,021 Accrued sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 11,312 $ 9,533 1 The increase in accounts payable in 2019 was primarily driven by extending payment terms with our suppliers. NOTE 11 : LEASES We have operating leases primarily for real estate, vehicles, and manufacturing and other equipment. Balance sheet information related to operating leases is as follows (in millions): December 31, 2019 Operating lease ROU assets 1 $ 1,372 Current portion of operating lease liabilities 2 $ Noncurrent portion of operating lease liabilities 3 1,111 Total operating lease liabilities $ 1,392 1 Operating lease ROU assets are recorded in the line item other assets in our consolidated balance sheet. 2 The current portion of operating lease liabilities is recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet. 3 The noncurrent portion of operating lease liabilities is recorded in the line item other liabilities in our consolidated balance sheet. We had operating lease costs of $ 327 million for the year ended December 31, 2019 . During 2019, cash paid for amounts included in the measurement of operating lease liabilities was $ 339 million . Operating lease ROU assets obtained in exchange for operating lease obligations were $ 308 million for the year ended December 31, 2019 . Information associated with the measurement of our remaining operating lease obligations as of December 31, 2019 is as follows: Weighted-average remaining lease term 7 years Weighted-average discount rate % Our leases have remaining lease terms of 1 year to 25 years , inclusive of renewal or termination options that we are reasonably certain to exercise. The following table summarizes the maturity of our operating lease liabilities as of December 31, 2019 (in millions): $ 2021 2022 2023 2024 Thereafter Total operating lease payments $ 1,545 Less: Imputed interest Total operating lease liabilities $ 1,392 The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2018 (in millions): $ 2020 2021 2022 2023 Thereafter Total minimum operating lease payments $ 99 NOTE 12 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2019 and 2018 , we had $ 10,007 million and $ 13,063 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 2.0 percent and 2.6 percent per year as of December 31, 2019 and 2018 , respectively. As of December 31, 2019 and 2018 , the Company also had $ 987 million and $ 772 million , respectively, in lines of credit, short-term credit facilities and other short-term borrowings that were primarily related to our international operations. In addition, we had $ 11,911 million in unused lines of credit and other short-term credit facilities as of December 31, 2019 , of which $ 8,940 million was in backup lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2020 through 2024 . There were no borrowings under these corporate backup lines of credit during 2019 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2019 , the Company issued euro- and U.S. dollar-denominated debt of 3,500 million and $ 2,000 million , respectively. The carrying value of this debt as of December 31, 2019 was $ 5,891 million . The general terms of the notes issued are as follows: 750 million total principal amount of notes due March 8, 2021 , at a variable interest rate equal to the three month Euro Interbank Offered Rate (""EURIBOR"") plus 0.20 percent ; 1,000 million total principal amount of notes due September 22, 2022 , at a fixed interest rate of 0.125 percent ; 1,000 million total principal amount of notes due September 22, 2026 , at a fixed interest rate of 0.75 percent ; 750 million total principal amount of notes due March 8, 2031 , at a fixed interest rate of 1.25 percent ; $ 1,000 million total principal amount of notes due September 6, 2024 , at a fixed interest rate of 1.75 percent ; and $ 1,000 million total principal amount of notes due September 6, 2029 , at a fixed interest rate of 2.125 percent . During 2019 , the Company retired upon maturity euro- and U.S. dollar-denominated notes. The general terms of the notes retired are as follows: 1,500 million total principal amount of notes due March 8, 2019 , at a variable interest rate equal to the three month EURIBOR plus 0.25 percent ; 2,000 million total principal amount of notes due September 9, 2019 , at a variable interest rate equal to the three month EURIBOR plus 0.23 percent ; and $ 1,000 million total principal amount of notes due May 30, 2019 , at a fixed interest rate of 1.375 percent . During 2018 , the Company retired upon maturity U.S. dollar-denominated notes and debentures. The general terms of the notes and debentures retired are as follows: $ 26 million total principal amount of debentures due January 29, 2018 , at a fixed interest rate of 9.66 percent ; $ 750 million total principal amount of notes due March 14, 2018 , at a fixed interest rate of 1.65 percent ; $ 1,250 million total principal amount of notes due April 1, 2018 , at a fixed interest rate of 1.15 percent ; and $ 1,250 million total principal amount of notes due November 1, 2018 , at a fixed interest rate of 1.65 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $ 94 million that was due to mature on May 15, 2098 , at a fixed interest rate of 7.00 percent . Related to this extinguishment, the Company recorded a net gain of $ 27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018 . During 2017 , the Company issued U.S. dollar- and euro-denominated debt of $ 1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 was $ 3,974 million . The general terms of the notes issued are as follows: $ 500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $ 500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three month EURIBOR plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017 , the Company retired upon maturity euro-, U.S. dollar-, and Swiss franc-denominated notes. The general terms of the notes retired are as follows: 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three month EURIBOR plus 0.15 percent ; $ 206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent ; $ 750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent ; and $ 225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent ; and SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent . In 2017 , the Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of Old CCE. The extinguished notes had a carrying value of $ 417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $ 95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $ 38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $ 11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $ 36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $ 9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $ 53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $ 41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $ 32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $ 3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $ 24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $ 4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $ 38 million related to the early extinguishment of long-term debt in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017 . The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2019 December 31, 2018 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20202093 $ 14,621 2.4 % $ 13,619 2.6 % U.S. dollar debentures due 20222098 1,366 4.9 1,390 5.2 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.4 2.2 Euro notes due 20212036 12,807 0.5 12,994 0.6 Swiss franc notes due 20222028 1,129 3.7 1,128 3.6 Other, due through 2098 3 6.2 4.0 Fair value adjustments 4 N/A N/A Total 5,6 31,769 1.9 % 30,379 1.9 % Less: Current portion 4,253 5,003 Long-term debt $ 27,516 $ 25,376 1 Rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 6 for a more detailed discussion on interest rate management. 2 Amount is shown net of unamortized discounts of $ 3 million and $ 8 million as of December 31, 2019 and 2018 , respectively. 3 As of December 31, 2019 , the amount shown includes $ 409 million of debt instruments and finance leases that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 6 for additional information about our fair value hedging strategy. 5 As of December 31, 2019 and 2018 , the fair value of our long-term debt, including the current portion, was $ 32,725 million and $ 30,456 million , respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE in 2010 of $ 186 million and $ 212 million as of December 31, 2019 and 2018 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2019 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 921 million , $ 903 million and $ 803 million in 2019 , 2018 and 2017 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2019 are as follows (in millions): Maturities of Long-Term Debt $ 4,253 3,767 3,788 4,097 1,974 NOTE 13 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2019 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 621 million , of which $ 249 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 16 . On September 17, 2015, the Company received a Statutory Notice of Deficiency (the ""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009 after a five-year audit. In the Notice, the IRS claimed that the Company's U.S. taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $ 3.3 billion for the period plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing, and promotion of products in certain foreign markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement (the ""Closing Agreement"") that applied back to 1987. The Closing Agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent a change in material facts or circumstances or relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the Closing Agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the Closing Agreement. The IRS designated the matter for litigation on October 15, 2015. Due to the fact that the matter remains designated, the Company is prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $ 385 million resulting in an additional tax adjustment of $ 135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $ 138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in April 2019. It is not known how much time will elapse thereafter prior to the issuance of the court's opinion. In the interim, or subsequent to the court's opinion, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the Notice ultimately could be sustained. In that event, the Company may be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Reform Act. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 301 million and $ 362 million as of December 31, 2019 and 2018 , respectively . NOTE 14 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 201 million , $ 225 million and $ 219 million in 2019 , 2018 and 2017 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 43 million , $ 47 million and $ 44 million in 2019 , 2018 and 2017 , respectively. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2019 , we had $ 258 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.0 years as stockbased compensation expense, and it does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2019 , there were 367.8 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available for grants of stock option and restricted stock awards. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, which is generally four years . The weighted-average fair value of stock options granted during the years ended December 31, 2019 , 2018 and 2017 and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, Fair value of stock options on grant date $ 4.94 $ 4.97 $ 3.98 Dividend yield 1 3.5 % 3.5 % 3.6 % Expected volatility 2 15.5 % 15.5 % 15.5 % Risk-free interest rate 3 2.6 % 2.8 % 2.2 % Expected term of stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock on the grant date. 2 The expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the stock options is based on the U.S. Treasury yield curve in effect on the grant date. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued common stock or from treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from treasury shares. Stock option activity for all plans for the year ended December 31, 2019 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2019 $ 36.74 Granted 45.46 Exercised ( 34 ) 33.29 Forfeited/expired ( 2 ) 42.88 Outstanding on December 31, 2019 $ 38.43 4.41 years $ 1,785 Expected to vest $ 38.37 4.37 years $ 1,773 Exercisable on December 31, 2019 $ 37.33 3.69 years $ 1,599 The total intrinsic value of the stock options exercised was $ 609 million , $ 721 million and $ 744 million in 2019 , 2018 and 2017 , respectively. The total number of stock options exercised was 34 million , 47 million and 53 million in 2019 , 2018 and 2017 , respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share units granted from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are vested and released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018 and 2019, performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include the TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018 and 2019 will be vested and released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends until the shares are vested and released. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2019 , performance share units of approximately 2,662,000 were outstanding for the 2017-2019 performance period and growth share units of approximately 1,949,000 and 2,220,000 were outstanding for the 2018-2020 and 2019-2021 performance periods, respectively, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2019 7,698 $ 38.45 Granted 2,348 40.29 Conversions into restricted stock units 1 ( 2,756 ) 39.70 Paid in cash equivalent ( 1 ) 40.62 Canceled/forfeited ( 458 ) 38.53 Outstanding on December 31, 2019 2 6,831 $ 38.57 1 Represents the target amount of performance share units converted into restricted stock units for the 2016-2018 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units and growth share units as of December 31, 2019 at the threshold award and maximum award levels were 2.6 million and 14.2 million , respectively. The weighted-average grant date fair value of growth share units granted in 2019 and 2018 was $ 40.29 and $ 41.02 , respectively. The weighted-average grant date fair value of performance share units granted in 2017 was $ 34.75 . The Company converted performance share units of 1,418 in 2019 and 11,052 in 2017 into cash equivalent payments of $ 0.1 million and $ 0.4 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The Company did not convert any performance share units into cash equivalent payments in 2018 . The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2019 2,591 $ 36.24 Conversions from performance share units 3,355 39.70 Vested and released ( 2,575 ) 36.12 Canceled/forfeited ( 176 ) 39.37 Nonvested on December 31, 2019 3,195 $ 39.70 The total intrinsic value of restricted shares that were vested and released in 2019 was $ 118 million . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2019 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of approximately 4,054,000 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2019 3,422 $ 40.31 Granted 1,615 42.31 Vested and released ( 528 ) 42.35 Forfeited/expired ( 455 ) 41.41 Nonvested on December 31, 2019 4,054 $ 40.73 NOTE 15 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2019 , the primary U.S. plan represented 61 percent of both the Company's consolidated projected benefit obligation and pension assets. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Benefit obligation at beginning of year 1 $ 8,015 $ 9,469 $ $ Service cost 124 11 Interest cost 296 25 Participant contributions 2 1 9 Foreign currency exchange rate changes ( 28 ) ( 112 ) ( 2 ) ( 7 ) Amendments ( 1 ) ( 8 ) Net actuarial loss (gain) ( 470 ) ( 35 ) Benefits paid 3 ( 537 ) ( 358 ) ( 86 ) ( 70 ) Business combinations 4 Divestitures ( 11 ) Settlements 5 ( 19 ) ( 932 ) Curtailments 5 ( 2 ) ( 63 ) ( 2 ) Special termination benefits 5 7 Other 3 ( 2 ) Benefit obligation at end of year 1 $ 8,757 $ 8,015 $ $ Fair value of plan assets at beginning of year $ 7,429 $ 8,866 $ $ Actual return on plan assets 1,111 ( 269 ) ( 5 ) Employer contributions 107 Participant contributions 2 1 9 Foreign currency exchange rate changes ( 26 ) ( 131 ) Benefits paid ( 453 ) ( 287 ) ( 3 ) ( 3 ) Business combinations 4 Divestitures ( 1 ) Settlements 5 ( 18 ) ( 892 ) Other Fair value of plan assets at end of year $ 8,080 $ 7,429 $ $ Net liability recognized $ ( 677 ) $ ( 586 ) $ ( 418 ) $ ( 430 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $ 8,607 million and $ 7,867 million as of December 31, 2019 and 2018 , respectively. 2 In prior year disclosures, participant contributions were included in the Other line item. 3 Benefits paid to pension plan participants during 2019 and 2018 included $ 84 million and $ 71 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2019 and 2018 included $ 83 million and $ 67 million , respectively, that were paid from Company assets. 4 Business combinations were primarily related to the acquisition of a controlling interest in the Philippine bottling operations in 2018. Refer to Note 2 . 5 Settlements, curtailments and special termination benefits were primarily related to our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 20 . Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, 2018 2018 Other assets $ $ $ $ Accounts payable and accrued expenses ( 72 ) ( 70 ) ( 21 ) ( 21 ) Other liabilities ( 1,603 ) ( 1,329 ) ( 397 ) ( 409 ) Net liability recognized $ ( 677 ) $ ( 586 ) $ ( 418 ) $ ( 430 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, 2018 Projected benefit obligations $ 7,194 $ 6,562 Fair value of plan assets 5,515 5,163 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, 2018 Accumulated benefit obligations $ 7,052 $ 6,451 Fair value of plan assets 5,485 5,157 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, 2018 2018 Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,231 1,116 644 International-based companies 659 462 Fixed-income securities: Government bonds 192 271 Corporate bonds and debt securities 745 90 Mutual, pooled and commingled funds 1 238 637 Hedge funds/limited partnerships 785 43 Real estate 385 6 Other 412 261 Total pension plan assets 2 $ 5,149 $ 4,842 $ 2,931 $ 2,587 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 18 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the s ervices of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2019 , no investment manager was responsible for more than 11 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in our common stock accounted for approximately 5 percent of our total global equities and approximately 3 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. Our target allocation for alternative investments is 28 percent . These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2019 , the long-term target allocation for 68 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 64 percent equity securities, 4 percent fixed-income securities and 32 percent other investments. The actual allocation for the remaining 32 percent of the Company's international subsidiaries' plan assets consisted of 57 percent mutual, pooled and commingled funds; 7 percent fixed-income securities; 1 percent equity securities and 35 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, 2018 Cash and cash equivalents $ $ Equity securities: U.S.-based companies 93 International-based companies 7 Fixed-income securities: Government bonds 2 Corporate bonds and debt securities 16 Mutual, pooled and commingled funds 82 Hedge funds/limited partnerships 8 Real estate 4 Other 4 Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 18 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Service cost $ $ $ $ $ $ Interest cost 296 25 Expected return on plan assets 1 ( 552 ) ( 650 ) ( 650 ) ( 13 ) ( 13 ) ( 12 ) Amortization of prior service credit ( 4 ) ( 3 ) ( 2 ) ( 14 ) ( 18 ) Amortization of net actuarial loss 2 128 3 Net periodic benefit cost (income) ( 10 ) ( 105 ) 12 Settlement charges 3 240 Curtailment charges (credits) 3 4 ( 2 ) ( 4 ) ( 79 ) Special termination benefits 3 7 Other ( 1 ) Total cost (income) recognized in consolidated statements of income $ ( 2 ) $ $ $ $ $ ( 55 ) 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to our productivity and reinvestment program and the refranchising of certain of our North America bottling operations. Refer to Note 2 and Note 20 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ ( 2,482 ) $ ( 2,493 ) $ ( 15 ) $ ( 26 ) Recognized prior service cost (credit) ( 4 ) 3 ( 4 ) 5 ( 18 ) 6 Recognized net actuarial loss 1 4 Prior service credit (cost) occurring during the year ( 1 ) Net actuarial (loss) gain occurring during the year ( 370 ) 2 ( 386 ) 3 ( 44 ) 5 Impact of divestitures Foreign currency translation gain Balance in AOCI at end of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) 1 Includes $ 6 million of recognized net actuarial loss due to the impact of settlements. 2 Includes $ 2 million of net actuarial gain occurring during the year due to the impact of curtailments . 3 Includes $ 4 million of recognized prior service cost and $ 63 million of net actuarial gain occurring during the year due to the impact of curtailments. 4 Includes $ 240 million of recognized net actuarial loss due to the impact of settlements. 5 Includes $ 2 million of recognized prior service credit and $ 2 million of net actuarial gain occurring during the year due to the impact of curtailments. 6 Includes $ 4 million of recognized prior service credit due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, 2018 2018 Prior service credit (cost) $ ( 12 ) $ ( 12 ) $ $ Net actuarial loss ( 2,666 ) ( 2,470 ) ( 82 ) ( 43 ) Balance in AOCI at end of year $ ( 2,678 ) $ ( 2,482 ) $ ( 59 ) $ ( 15 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2020 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service credit $ $ ( 2 ) Amortization of net actuarial loss 5 Total $ $ 112 Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, 2018 2018 Discount rate 3.25 % 4.00 % 3.50 % 4.25 % Rate of increase in compensation levels 3.75 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost (income) are as follows: Pension Benefits Other Benefits Year Ended December 31, 2018 2018 Discount rate 4.00 % 3.50 % 4.00 % 4.25 % 3.50 % 4.00 % Rate of increase in compensation levels 3.75 % 3.50 % 3.75 % N/A N/A N/A Expected long-term rate of return on plan assets 7.75 % 8.00 % 8.00 % 4.50 % 4.50 % 4.75 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2019 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2019 net periodic pension cost for the U.S. plans was 7.75 percent . As of December 31, 2019 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 7.4 percent , 8.9 percent and 6.7 percent , respectively. The annualized return since inception was 10.5 percent . The weighted-average assumptions for health care cost trend rates are as follows : December 31, 2018 Health care cost trend rate assumed for next year 6.75 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.25 % 5.00 % Year that the rate reaches the ultimate trend rate 2023 We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 2021 2023 20252029 Pension benefit payments $ $ $ $ $ $ 2,543 Other benefit payments 1 58 54 240 Total estimated benefit payments $ $ $ $ $ $ 2,783 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $ 3 million for the period 20202024 and $ 2 million for the period 20252029. The Company anticipates making pension contributions in 2020 of $ 28 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limits. Company costs related to the U.S. plans were $ 43 million , $ 39 million and $ 61 million in 2019 , 2018 and 2017 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $ 64 million , $ 59 million and $ 42 million in 2019 , 2018 and 2017 , respectively. Multi-Employer Pension Plans The Company participates in various multi-employer pension plans. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for multi-employer pension plans totaled $ 5 million , $ 6 million and $ 35 million in 2019 , 2018 and 2017 , respectively. The decrease in 2018 was primarily driven by the refranchising of certain bottling territories in the United States during 2017. The plans we currently participate in have contractual arrangements that extend into 2021 . If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. Refer to Note 2 for additional information on North America refranchising. NOTE 16 : INCOME TAXES Income before income taxes consisted of the following (in millions): Year Ended December 31, United States $ 3,249 $ $ ( 690 ) 1 International 7,537 7,337 7,580 Total $ 10,786 $ 8,225 $ 6,890 1 Includes net charges of $ 2,140 million related to refranchising certain bottling territories in North America in 2017 . Refer to Note 2 . Income taxes consisted of the following (in millions): United States State and Local International Total Current $ $ $ 1,479 $ 2,081 Deferred ( 65 ) ( 267 ) ( 280 ) Current $ 1 $ $ 1,426 $ 2,162 Deferred ( 386 ) 1 ( 81 ) 1 1 ( 413 ) Current $ 5,438 2 $ $ 1,300 $ 6,859 Deferred ( 1,783 ) 2,3 2 ( 1,252 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). 2 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017 . The provisional amount as of December 31, 2017 related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $ 4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated at that time to be $ 42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $ 1.0 billion . 3 Includes the net tax benefit from net charges related to refranchising certain bottling territories in North America. Refer to Note 2 . We made income tax payments of $ 2,126 million , $ 2,120 million and $ 1,950 million in 2019 , 2018 and 2017 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2023 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 335 million , $ 318 million and $ 221 million for the years ended December 31, 2019 , 2018 and 2017 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 21.0 % 21.0 % 35.0 % State and local income taxes net of federal benefit 0.9 1.5 1.1 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.1 1,2,3 3.1 5,6 ( 9.5 ) Equity income or loss ( 1.6 ) ( 2.5 ) ( 3.3 ) Tax Reform Act 0.1 7 52.4 8 Excess tax benefits on stock-based compensation ( 0.9 ) ( 1.3 ) ( 1.9 ) Other net ( 3.8 ) 4 ( 0.6 ) 7.6 9,10 Effective tax rate 16.7 % 21.3 % 81.4 % 1 Includes net tax charges of $ 199 million (or a 1.9 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in various international jurisdictions, as well as other agreed-upon tax matters. 2 Includes the impact of pretax charges of $ 710 million (or a 1.2 percent impact on our effective tax rate) related to the impairment of certain of our equity method investees. 3 Includes a tax benefit of $ 199 million (or a 1.5 percent impact on our effective tax rate) recorded as a result of CCBA no longer qualifying as a discontinued operation. Refer to Note 2. 4 Includes a net tax benefit of $ 184 million (or a 1.7 percent impact on our effective tax rate) related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, a tax benefit of $ 145 million (or a 1.4 percent impact on our effective tax rate) related to changes in our assessment of certain valuation allowances and a net tax benefit of $ 89 million (or a 0.8 percent impact on our effective tax rate) related to domestic return to provision adjustments as well as other agreed-upon tax matters. 5 Includes the impact of pretax charges of $ 591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees and the impact of a pretax charge of $ 554 million (or a 1.9 percent impact on our effective tax rate) related to an impairment of assets held by CCBA. Refer to Note 18 . 6 Includes net tax expense of $ 28 million on net pretax charges of $ 403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 . 7 Includes net tax expense of $ 8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 8 Includes net tax expense of $ 3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 9 Includes net tax expense of $ 1,048 million on a pretax gain of $ 1,037 million (or a 9.9 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment, and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 . 10 Includes a $ 156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits of approximately $ 41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $ 4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $ 0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $ 0.3 billion in tax for our one-time transition tax and a tax benefit of $ 0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $ 13.4 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return each foreign subsidiary's earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2006 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 13 . As of December 31, 2019 , the gross amount of unrecognized tax benefits was $ 392 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 173 million , exclusive of any benefits related to interest and penalties. The remaining $ 219 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Balance of unrecognized tax benefits at the beginning of year $ $ $ Increase related to prior period tax positions 1 18 Decrease related to prior period tax positions ( 2 ) ( 13 ) Increase related to current period tax positions 17 Decrease related to settlements with taxing authorities ( 174 ) 2 ( 4 ) Increase (decrease) due to effect of foreign currency exchange rate changes ( 3 ) ( 17 ) Balance of unrecognized tax benefits at the end of year $ $ $ 1 The increase was primarily related to a change in judgment about the Company's tax positions with several foreign jurisdictions. 2 The decrease was primarily related to a change in judgment about one of the Company's tax positions that became certain as a result of settlement of a matter in the United States. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 201 million , $ 190 million and $ 177 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2019 , 2018 and 2017 , respectively. Of these amounts, $ 11 million , $ 13 million and $ 35 million of expense were recognized through income tax expense in 2019 , 2018 and 2017 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets 2,267 2,540 Equity method investments (including foreign currency translation adjustments) Derivative financial instruments Other liabilities 1,066 Benefit plans Net operating/capital loss carryforwards Other Gross deferred tax assets 5,597 5,484 Valuation allowances ( 303 ) ( 419 ) Total deferred tax assets $ 5,294 $ 5,065 Deferred tax liabilities: Property, plant and equipment $ ( 877 ) $ ( 922 ) Trademarks and other intangible assets ( 1,533 ) ( 1,179 ) Equity method investments (including foreign currency translation adjustments) ( 1,667 ) ( 1,707 ) Derivative financial instruments ( 348 ) ( 162 ) Other liabilities ( 351 ) ( 67 ) Benefit plans ( 286 ) ( 255 ) Other ( 104 ) ( 453 ) Total deferred tax liabilities $ ( 5,166 ) $ ( 4,745 ) Net deferred tax assets $ $ As of December 31, 2019 and 2018 , we had net deferred tax assets of $ 1.3 billion and $ 1.6 billion , respectively, located in countries outside the United States. As of December 31, 2019 , we had $ 2,396 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 472 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Deductions ( 264 ) ( 183 ) ( 213 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2019 , the Company recognized a net decrease of $ 116 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance after considering significant positive evidence on the utilization of certain net operating losses. This decrease was also due to the reversal of a valuation allowance in our U.S. operations related to expenses that were previously determined to be non-deductible and the changes in net operating losses in the normal course of business. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax assets and related valuation allowances on certain equity method investments and an increase due to the acquisition of foreign operations. In 2018 , the Company recognized a net decrease of $ 100 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. In 2017 , the Company recognized a net decrease of $ 11 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity method investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity method investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. NOTE 17 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheet as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheet as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments 1 $ ( 11,270 ) $ ( 11,045 ) Accumulated derivative net gains (losses) 1,2 ( 209 ) ( 126 ) Unrealized net gains (losses) on available-for-sale securities 1 Adjustments to pension and other benefit liabilities 1 ( 2,140 ) ( 1,693 ) Accumulated other comprehensive income (loss) $ ( 13,544 ) $ ( 12,814 ) 1 The change in the balance from December 31, 2018 includes a portion of a $ 558 million reclassification to reinvested earnings from AOCI upon the adoption of ASU 2018-02. Refer to Note 1 . 2 The change in the balance from December 31, 2018 includes a $ 6 million reclassification to reinvested earnings from AOCI upon the adoption of ASU 2017-12. Refer to Note 6 . The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2019 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 8,920 $ $ 8,985 Other comprehensive income: Net foreign currency translation adjustments 45 Net gains (losses) on derivatives 1 ( 54 ) ( 54 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 Net change in pension and other benefit liabilities 3 ( 159 ) ( 159 ) Total comprehensive income $ 8,754 $ $ 8,864 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2019 , 2018 and 2017 is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ $ ( 54 ) $ ( 2 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 307 ) ( 307 ) Gains (losses) on net investment hedges arising during the year 1 ( 49 ) Net foreign currency translation adjustments $ $ ( 103 ) $ Derivatives: Gains (losses) arising during the year $ ( 225 ) $ $ ( 176 ) Reclassification adjustments recognized in net income ( 41 ) Net gains (losses) on derivatives 1 $ ( 62 ) $ $ ( 54 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ $ ( 4 ) $ Reclassification adjustments recognized in net income ( 31 ) ( 25 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ $ $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ ( 379 ) $ $ ( 274 ) Reclassification adjustments recognized in net income ( 36 ) Net change in pension and other benefit liabilities 3 $ ( 228 ) $ $ ( 159 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 142 ) $ ( 24 ) $ ( 166 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,728 ) $ $ ( 1,669 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature ( 1,296 ) ( 1,296 ) Gains (losses) on net investment hedges arising during the year 1 ( 160 ) Net foreign currency translation adjustments $ ( 1,987 ) $ ( 101 ) $ ( 2,088 ) Derivatives: Gains (losses) arising during the year $ $ ( 16 ) $ Reclassification adjustments recognized in net income ( 68 ) ( 50 ) Net gains (losses) on derivatives 1 $ ( 9 ) $ $ ( 7 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year $ ( 50 ) $ $ ( 39 ) Reclassification adjustments recognized in net income Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ ( 45 ) $ $ ( 34 ) Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ ( 299 ) $ $ ( 224 ) Reclassification adjustments recognized in net income ( 88 ) Net change in pension and other benefit liabilities 3 $ $ ( 13 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ ( 1,999 ) $ ( 101 ) $ ( 2,100 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ ( 1,350 ) $ ( 242 ) $ ( 1,592 ) Reclassification adjustments recognized in net income ( 6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year 1 ( 1,512 ) ( 934 ) Net foreign currency translation adjustments $ $ $ Derivatives: Gains (losses) arising during the year $ ( 184 ) $ $ ( 119 ) Reclassification adjustments recognized in net income ( 506 ) ( 314 ) Net gains (losses) on derivatives 1 $ ( 690 ) $ $ ( 433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year $ $ ( 136 ) $ Reclassification adjustments recognized in net income ( 123 ) ( 81 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ ( 94 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year $ $ ( 7 ) $ Reclassification adjustments recognized in net income ( 116 ) Net change in pension and other benefit liabilities 3 $ $ ( 123 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 15 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2019 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ Income before income taxes Income taxes Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ Foreign currency and commodity contracts Cost of goods sold ( 11 ) Foreign currency contracts Other income (loss) net Divestitures, deconsolidations and other Other income (loss) net Foreign currency and interest rate contracts Interest expense Income before income taxes Income taxes ( 41 ) Consolidated net income $ Available-for-sale securities: Sale of securities Other income (loss) net $ ( 31 ) Income before income taxes ( 31 ) Income taxes Consolidated net income $ ( 25 ) Pension and other benefit liabilities: Settlement charges 2 Other income (loss) net $ Curtailment charges 2 Other income (loss) net ( 2 ) Recognized net actuarial loss Other income (loss) net Recognized prior service cost (credit) Other income (loss) net ( 6 ) Income before income taxes Income taxes ( 36 ) Consolidated net income $ 1 Primarily related to our previously held equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . 2 The settlement and curtailment charges were primarily related to our productivity and reinvestment program. Refer to Note 15 and Note 20 . NOTE 18 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity securities with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair values of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2019 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,877 $ $ $ $ $ 2,219 Debt securities 1 3,291 3,328 Derivatives 2 579 ( 392 ) 5 6 Total assets $ 1,886 $ 4,089 $ $ $ ( 392 ) $ 5,743 Liabilities: Derivatives 2 $ $ ( 162 ) $ $ $ $ ( 32 ) 6 Total liabilities $ $ ( 162 ) $ $ $ $ ( 32 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $ 261 million in cash collateral it has netted against its derivative position. 6 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 196 million in the line item other assets and $ 32 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. December 31, 2018 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,681 $ $ $ $ $ 1,934 Debt securities 1 5,018 5,037 Derivatives 2 313 ( 261 ) 5 7 Total assets $ 1,683 $ 5,517 $ $ $ ( 261 ) $ 7,025 Liabilities: Derivatives 2 $ ( 14 ) $ ( 221 ) $ $ $ 6 $ ( 53 ) 7 Total liabilities $ ( 14 ) $ ( 221 ) $ $ $ $ ( 53 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $ 96 million in cash collateral it has netted against its derivative position. 6 The Company has the right to reclaim $ 4 million in cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 54 million in the line item other assets; $ 3 million in the line item accounts payable and accrued expenses; and $ 50 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2019 and 2018 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2019 and 2018 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges, or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the following table (in millions): Gains (Losses) Year Ended December 31, Other-than-temporary impairment charges $ ( 767 ) 1 $ ( 591 ) 1 CCBA asset adjustments ( 160 ) 2 ( 554 ) 2 Investment in former equity method investee ( 118 ) 3 ( 32 ) 3 Other long-lived asset impairment charges ( 312 ) 5 Intangible asset impairment charges ( 42 ) 4 ( 138 ) 5 Total $ ( 1,087 ) $ ( 1,627 ) 1 During the year ended December 31, 2019 , the Company recorded other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee. Based on the extent to which the market value of our investment in CCBJHI has been less than our carrying value and the financial condition and near-term prospects of the issuer, management determined that the decline in fair value was other than temporary in nature. These impairment charges were determined using the quoted market prices (a Level 1 measurement) of CCBJHI. During the year ended December 31, 2019 , we also recorded other-than-temporary impairment charges of $ 255 million related to certain equity method investees in the Middle East. These impairment charges were derived using Level 3 inputs and were primarily driven by revised projections of future operating results largely related to instability in the region and changes in local excise taxes. During the year ended December 31, 2019 , we recorded an other-than-temporary impairment charge of $ 57 million related to one of our equity method investees in North America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. During the year ended December 31, 2019 , we also recorded an other-than-temporary impairment charge of $ 49 million related to one of our equity method investees in Latin America. This impairment charge was derived using Level 3 inputs and was primarily driven by revised projections of future operating results. During the year ended December 31, 2018 , we recognized other-than-temporary impairment charges of $ 334 million related to certain equity method investees in the Middle East. These impairments were primarily driven by revised projections of future operating results largely related to instability in the region, which include sanctions imposed locally. During the year ended December 31, 2018 , we recognized an other-than-temporary impairment charge of $ 205 million related to our equity method investee in Indonesia. This impairment was primarily driven by revised projections of future operating results reflecting unfavorable macroeconomic conditions and foreign currency exchange rate fluctuations. This impairment charge was derived using discounted cash flow analyses based on Level 3 inputs. During the year ended December 31, 2018 , we recognized an other-than-temporary impairment charge of $ 52 million related to one of our equity method investees in Latin America. This impairment was primarily driven by revised projections of future operating results. This impairment charge was derived using discounted cash flow analyses based on Level 3 inputs. 2 During the year ended December 31, 2018 , the Company recorded an impairment charge of $ 554 million related to assets held by CCBA. This charge was incurred primarily as a result of management's view of the proceeds that were expected to be received upon the sale of CCBA based on revised projections of future operating results and foreign currency exchange rate fluctuations. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. As a result of CCBA no longer being classified as held for sale, during the year ended December 31, 2019 , the Company was required to measure CCBA's property, plant and equipment and definite-lived intangible assets at the lower of their current fair values or their carrying amounts before they were classified as held for sale, adjusted for depreciation and amortization expense that would have been recognized had the business been classified as held and used during the period that CCBA was classified as held for sale. As a result, we reduced the carrying value of CCBA's property, plant and equipment and definite-lived intangible assets by $ 34 million and $ 126 million , respectively, based on Level 3 inputs. Refer to Note 2 . 3 During the year ended December 31, 2019 , the Company recognized a net loss of $ 118 million in conjunction with our acquisition of the remaining equity ownership interest in CHI, which included the remeasurement of our previously held equity interest in CHI to fair value and the reversal of the related cumulative translation adjustments. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. During the year ended December 31, 2018 , the Company recognized a loss of $ 32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. Refer to Note 2 . 4 The Company recorded an impairment charge of $ 42 million related to a trademark in Asia Pacific, which was primarily driven by revised projections of future operating results for the trademark. The fair value of this trademark was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recognized charges of $ 312 million related to CCR's property, plant and equipment and $ 138 million related to CCR's intangible assets. These charges were a result of management's revised estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 15 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The f ollowing table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2019 December 31, 2018 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 1,876 21 1,904 1,728 17 1,760 International-based companies 1,354 1,387 1,098 1,121 Fixed-income securities: Government bonds Corporate bonds and debt securities 40 16 Mutual, pooled and commingled funds 258 3 130 3 Hedge funds/limited partnerships 4 4 Real estate 5 5 Other 2 6 2 6 Total $ 3,867 $ 1,902 $ $ 1,977 $ 8,080 $ 3,333 $ 1,472 $ $ 2,321 $ 7,429 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 15 . 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to semi-annually, with a redemption notice period of up to 180 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually, with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The f ollowing table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date ( 2 ) ( 1 ) Purchases, sales and settlements net ( 7 ) ( 2 ) ( 5 ) Transfers into (out of) Level 3 net Foreign currency translation adjustments ( 13 ) ( 13 ) Balance at end of year $ $ $ $ 1 $ 2019 Actual return on plan assets held at the reporting date Purchases, sales and settlements net 21 Transfers into (out of) Level 3 net 3 Foreign currency translation adjustments ( 8 ) ( 8 ) Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The f ollowing table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2019 December 31, 2018 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 82 82 Hedge funds/limited partnerships 7 8 Real estate 4 4 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 15 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2019 , the carrying amount and fair value of our long-term debt, including the current portion, were $ 31,769 million and $ 32,725 million , respectively. As of December 31, 2018 , the carrying amount and fair value of our long-term debt, including the current portion, were $ 30,379 million and $ 30,456 million , respectively. NOTE 19 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2019, the Company recorded other operating charges of $ 458 million . These charges included $ 264 million related to the Company's productivity and reinvestment program and $ 42 million related to the impairment of a trademark in Asia Pacific. In addition, other operating charges included $ 46 million of transaction costs associated with the purchase of Costa, which we acquired in January 2019, and $ 95 million for costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Refer to Note 2 for additional information on the acquisition of Costa and the refranchising of our bottling operations. Refer to Note 18 for additional information on the trademark impairment charge. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. In 2018, the Company recorded other operating charges of $ 1,079 million . These charges primarily consisted of $ 450 million of CCR asset impairments and $ 440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 139 million related to costs incurred to refranchise certain of our North America bottling operations. Other operating charges also included $ 33 million related to tax litigation expense and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 13 for additional information related to the tax litigation. Refer to Note 18 for additional information on the impairment charges. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $ 1,902 million . These charges primarily consisted of $ 737 million of CCR asset impairments and $ 534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $ 280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $ 225 million related to a cash contribution we made to The Coca-Cola Foundation, $ 67 million related to tax litigation expense, $ 34 million related to impairments of Venezuelan intangible assets and $ 19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 20 for additional information on the Company's productivity and reinvestment program. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2018 , the Company recorded a net gain of $ 27 million related to the early extinguishment of long-term debt. Refer to Note 12 . During the year ended December 31, 2017, the Company recorded a net charge of $ 38 million related to the early extinguishment of long-term debt. Refer to Note 12 . Equity Income (Loss) Net The Company recorded net charges of $ 100 million , $ 111 million and $ 92 million in equity income (loss) net during the years ended December 31, 2019 , 2018 and 2017 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2019, other income (loss) net was income of $ 34 million . The Company recognized a gain of $ 739 million on the sale of a retail and office building in New York City. The Company also recognized a net gain of $ 250 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, a gain of $ 73 million related to the refranchising of certain bottling operations in India and a gain of $ 39 million related to the sale of a portion of our equity ownership interest in Andina. These gains were partially offset by other-than-temporary impairment charges of $ 406 million related to CCBJHI, an equity method investee, $ 255 million related to certain equity method investees in the Middle East, $ 57 million related to one of our equity method investees in North America, and $ 49 million related to one of our equity method investees in Latin America. The Company also recorded an adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $ 160 million and recognized a $ 118 million net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Additionally, the Company recognized net charges of $ 105 million primarily related to post-closing adjustments as contemplated by the related agreements associated with the refranchising of certain bottling territories in North America and charges of $ 4 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 for additional information on the CCBA asset adjustment, refranchising activities, the North America conversion payments, the acquisition of the remaining equity ownership interest in CHI and the sale of a portion of our equity ownership interest in Andina. Refer to Note 4 for additional information on equity and debt securities. Refer to Note 18 for additional information on the CCBA asset adjustment, impairment charges and the loss recognized in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 21 for the impact these items had on our operating segments and Corporate. In 2018, other income (loss) net was a loss of $ 1,674 million . The Company recorded other-than-temporary impairment charges of $ 591 million related to certain of our equity method investees, an impairment charge of $ 554 million related to assets held by CCBA and net charges of $ 476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $ 278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $ 240 million related to pension settlements, and a net loss of $ 79 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Additionally, we recorded charges of $ 34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $ 33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and a $ 32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $ 296 million related to the sale of our equity ownership in Lindley and a net gain of $ 47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley, our acquisition of the controlling interest in the Philippine bottling operations and our acquisition of Costa. Refer to Note 6 for additional information on our hedging activities. Refer to Note 18 for additional information on the impairment charges. Refer to Note 21 for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $ 1,763 million . The Company recognized net charges of $ 2,140 million due to the refranchising of certain bottling territories in North America and charges of $ 313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $ 255 million resulting from settlements, special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $ 50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $ 26 million related to our former German bottling operations. These charges were partially offset by a gain of $ 445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $ 150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $ 88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $ 25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 21 for the impact these items had on our operating segments and Corporate. NOTE 20 : PRODUCTIVITY AND REINVESTMENT PROGRAM In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focuses on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Certain productivity initiatives included in this program, primarily related to our enabling services organization, will continue beyond 2019. The Company has incurred total pretax expenses of $ 3,830 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 21 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 181 ) ( 83 ) ( 267 ) ( 531 ) Noncash and exchange ( 62 ) 1 ( 1 ) ( 1 ) ( 64 ) Accrued balance at end of year $ $ $ $ 2018 Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 209 ) ( 83 ) ( 211 ) ( 503 ) Noncash and exchange ( 69 ) 1 ( 52 ) ( 121 ) Accrued balance at end of year $ $ $ $ 2019 Accrued balance at beginning of year $ $ $ $ Costs incurred Payments ( 57 ) ( 98 ) ( 119 ) ( 274 ) Noncash and exchange 1 ( 19 ) ( 14 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 15 . NOTE 21 : OPERATING SEGMENTS Our organizational structure consists of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Global Ventures and Bottling Investments. Our operating structure also includes Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance; and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Global Ventures operating segment includes the results of our Costa, innocent and doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3 . The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2018 Concentrate operations % % % Finished product operations 42 Total % % % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based primarily on net operating revenues and operating income (loss). Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, 2018 United States $ 11,715 $ 11,344 $ 14,727 International 25,551 22,956 21,485 Net operating revenues $ 37,266 $ 34,300 $ 36,212 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, 2018 United States $ 4,062 $ 4,154 $ 4,163 International 6,776 5,444 5,475 Property, plant and equipment net $ 10,838 $ 9,598 $ 9,638 Information about our Company's operations by operating segment and Corporate as of and for the years ended December 31, 2019 , 2018 and 2017 is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Global Ventures Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 6,434 $ 4,118 $ 11,906 $ 4,723 $ 2,560 $ 7,431 $ $ $ 37,266 Intersegment ( 1,248 ) Total net operating revenues 7,058 4,118 11,915 5,327 2,562 7,440 ( 1,248 ) 37,266 Operating income (loss) 3,551 2,375 2,594 2,282 ( 1,408 ) 10,086 Interest income Interest expense Depreciation and amortization 1,365 Equity income (loss) net ( 32 ) ( 6 ) ( 3 ) 1,049 Income (loss) before income taxes 3,361 2,288 2,592 2,310 ( 824 ) 10,786 Identifiable operating assets 8,143 1 1,801 17,687 2,060 7,265 11,170 1 18,376 66,502 Investments 2 14,093 3,931 19,879 Capital expenditures 2,054 Net operating revenues: Third party $ 6,535 $ 3,971 $ 11,370 $ 4,797 $ $ 6,768 $ $ $ 34,300 Intersegment ( 1,273 ) Total net operating revenues 7,099 4,010 11,630 5,185 6,787 ( 1,273 ) 34,300 Operating income (loss) 3,693 2,318 2,318 2,271 ( 197 ) ( 1,403 ) 9,152 Interest income Interest expense Depreciation and amortization 1,086 Equity income (loss) net ( 19 ) ( 2 ) 1,008 Income (loss) before income taxes 3,386 2,243 2,345 2,298 ( 159 ) ( 2,053 ) 8,225 Identifiable operating assets 7,414 1 1,715 17,519 1,996 10,525 1 22,800 62,937 Investments 2 14,372 3,718 20,279 Capital expenditures 1,548 Net operating revenues: Third party $ 6,780 $ 3,953 $ 8,678 $ 4,753 $ $ 11,223 $ $ $ 36,212 Intersegment 1,951 ( 2,561 ) Total net operating revenues 6,822 4,026 10,629 5,162 11,306 ( 2,561 ) 36,212 Operating income (loss) 3,585 2,215 2,472 2,136 ( 806 ) ( 2,006 ) 7,755 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net ( 3 ) ( 3 ) 1,072 Income (loss) before income taxes 3,666 2,209 2,192 2,168 ( 2,202 ) ( 1,310 ) 6,890 Capital expenditures 1,750 1 Property, plant and equipment net in South Africa represented 16 percent and 14 percent of consolidated property, plant and equipment net in 2019 and 2018, respectively. 2 Principally equity method investments and other investments in bottling companies. During 2019 , 2018 and 2017 , our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2 . In 2019 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 2 million for Europe, Middle East and Africa, $ 1 million for Latin America, $ 62 million for North America, $ 5 million for Bottling Investments and $ 194 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 95 million for Bottling Investments due to costs incurred to refranchise certain of our North America bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 46 million for Corporate related to transaction costs associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 2 . Operating income (loss) and income (loss) before income taxes were reduced by $ 42 million for Asia Pacific due to an impairment charge related to a trademark. Refer to Note 18 . Income (loss) before income taxes was increased by $ 739 million for Corporate as a result of the sale of a retail and office building in New York City. Income (loss) before income taxes was increased by $ 250 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) before income taxes was increased by $ 73 million for Bottling Investments due to the refranchising of certain bottling operations in India. Refer to Note 2 . Income (loss) before income taxes was increased by $ 39 million for Corporate related to the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 406 million for Bottling Investments, $ 255 million for Europe, Middle East and Africa, $ 57 million for North America and $ 49 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 160 million for Corporate as a result of CCBA asset adjustments. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 118 million for Corporate resulting from a net loss in conjunction with our acquisition of the remaining equity ownership interest in CHI. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 105 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 98 million for Bottling Investments and $ 2 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In 2018 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 4 million for Latin America, $ 175 million for North America, $ 31 million for Bottling Investments and $ 237 million for Corporate, and increased by $ 3 million for Europe, Middle East and Africa and $ 4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) before income taxes was reduced by $ 64 million for Corporate and $ 4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 15 and Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 450 million for Bottling Investments due to asset impairment charges. Refer to Note 18 . Operating income (loss) and income (loss) before income taxes were reduced by $ 139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) before income taxes were reduced by $ 33 million for Corporate due to tax litigation expense. Refer to Note 13 . Operating income (loss) and income (loss) before income taxes were reduced by $ 19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) before income taxes was increased by $ 296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2 . Income (loss) before income taxes was increased by $ 47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2 . Income (loss) before income taxes was increased by $ 27 million for Corporate related to a net gain on the extinguishment of long-term debt. Refer to Note 12 . Income (loss) before income taxes was reduced by $ 554 million for Corporate as a result of an impairment charge related to assets held by CCBA. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 334 million for Europe, Middle East and Africa, $ 205 million for Bottling Investments and $ 52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 18 . Income (loss) before income taxes was reduced by $ 278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) before income taxes was reduced by $ 124 million for Bottling Investments and increased by $ 13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) before income taxes was reduced by $ 149 million for Bottling Investments due to pension settlements related to the refranchising of certain of our North America bottling operations. Refer to Note 15 . Income (loss) before income taxes was reduced by $ 79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Income (loss) before income taxes was reduced by $ 34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) before income taxes was reduced by $ 32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . In 2017 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) before income taxes were reduced by $ 26 million for Europe, Middle East and Africa, $ 7 million for Latin America, $ 241 million for North America, $ 10 million for Asia Pacific, $ 57 million for Bottling Investments and $ 193 million for Corporate due to the Company's productivity and reinvestment program. Income (loss) before income taxes was also reduced by $ 116 million for Corporate due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 15 and Note 20 . Operating income (loss) and income (loss) before income taxes were reduced by $ 737 million for Bottling Investments and $ 34 million for Corporate due to asset impairment charges. Operating income (loss) was reduced by $ 280 million and income (loss) before income taxes was reduced by $ 419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 . Operating income (loss) and income (loss) before income taxes were reduced by $ 225 million for Corporate as a result of a cash contribution we made to The Coca-Cola Foundation. Operating income (loss) and income (loss) before income taxes were reduced by $ 67 million for Corporate due to tax litigation expense. Refer to Note 13 . Income (loss) before income taxes was increased by $ 445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 19 . Income (loss) before income taxes was increased by $ 150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) before income taxes was increased by $ 88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and selling a related cost method investment. Refer to Note 2 . Income (loss) before income taxes was increased by $ 25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Income (loss) before income taxes was reduced by $ 2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) before income taxes was reduced by $ 50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Income (loss) before income taxes was reduced by $ 38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 12 . Income (loss) before income taxes was reduced by $ 26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) before income taxes was reduced by $ 4 million for Europe, Middle East and Africa, $ 2 million for North America, $ 70 million for Bottling Investments and $ 16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. NOTE 22 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, 2018 (Increase) decrease in trade accounts receivable $ ( 158 ) $ $ ( 108 ) (Increase) decrease in inventories ( 183 ) ( 203 ) ( 276 ) (Increase) decrease in prepaid expenses and other assets ( 87 ) ( 221 ) Increase (decrease) in accounts payable and accrued expenses 1 1,318 ( 251 ) ( 573 ) Increase (decrease) in accrued income taxes ( 17 ) ( 159 ) Increase (decrease) in other liabilities 2 ( 620 ) ( 575 ) 4,052 Net change in operating assets and liabilities $ $ ( 1,240 ) $ 3,442 1 The increase in accounts payable and accrued expenses in 2019 was primarily due to extending payment terms with our suppliers. 2 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 16 . NOTE 23 : SUBSEQUENT EVENT In January 2020, the Company acquired the remaining 57.5 percent stake in fairlife, LLC (""fairlife"") and now owns 100 percent of fairlife. fairlife offers a broad portfolio of products in the value-added dairy category across North America. Value-added dairy products have been one of the fastest-growing nonalcoholic beverage categories in the United States, with fairlife being a large contributor to sales growth. fairlife's success has been supported by new product innovations, ranging from lactose-free, ultra-filtered milk with less sugar and more protein than competing brands, to high-protein recovery and nutrition shakes and drinkable snacks. A significant portion of fairlife's revenues is already reflected in our consolidated financial statements, as we have operated as the sales and distribution organization for certain fairlife products. Under the terms of the agreement, we paid $ 1.0 billion upon the close of the transaction and are subject to making future milestone payments which are contingent on fairlife achieving certain financial targets through 2024. These milestone payments are based on agreed-upon formulas related to fairlife's operating results, the resulting value of which is not subject to a ceiling. We are currently in the process of finalizing the accounting for this transaction, including the valuation of the expected milestone payments and the remeasurement of our previously held equity interest. We expect to complete these valuations, as well as our preliminary allocation of the purchase consideration to the assets acquired and liabilities assumed, by the end of the first quarter of 2020. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2019 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2019 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls along with auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2020 Proxy Statement. James R. Quincey Larry M. Mark Chairman of the Board of Directors and Chief Executive Officer February 24, 2020 Vice President and Controller February 24, 2020 John Murphy Mark Randazza Executive Vice President and Chief Financial Officer February 24, 2020 Vice President, Assistant Controller and Chief Accounting Officer February 24, 2020 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2020 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Accounting for uncertain tax positions Description of the Matter As described in Note 13 and Note 16 to the consolidated financial statements, the Company is involved in various income tax matters for which the ultimate outcomes are uncertain. As of December 31, 2019, the gross amount of unrecognized tax benefits was $392 million. Additionally, as described in Note 13, on September 17, 2015 the Company received a Statutory Notice of Deficiency (Notice) from the Internal Revenue Service for the tax years 2007 through 2009 in the amount of $3.3 billion for the period, plus interest. While the Company continues to disagree strongly with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. Auditing managements evaluation of uncertain tax positions, including the uncertain tax position associated with the IRS Notice, was especially challenging due to the level of subjectivity and significant judgment associated with the recognition and measurement of the tax positions that are more likely than not to be sustained. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the effectiveness of controls over the Companys accounting process for uncertain tax positions. Our procedures included testing controls addressing the completeness of uncertain tax positions, controls relating to the identification and recognition of the uncertain tax positions, controls over the measurement of the unrecognized tax benefit, and controls over the identification of developments related to existing uncertain tax positions. Our audit procedures included, among others, evaluating the assumptions the Company used to assess its uncertain tax positions and related unrecognized tax benefit amounts by jurisdiction. We also tested the completeness and accuracy of the underlying data used in the identification and measurement of uncertain tax positions. We evaluated evidence of the status of the litigation with the IRS, including inquiries of tax counsel and written representations of management. We involved professionals with specialized skill and knowledge to assist in our evaluation of the tax technical merits of the Companys assessment, including the assessment of whether the tax positions are more likely than not to be sustained, the amount of the potential benefits to be realized, and the application of relevant tax law. We also assessed the Companys disclosure of uncertain tax positions included in Note 13 and Note 16. Valuation of trademarks with indefinite lives and goodwill Description of the Matter As described in Note 1 of the Companys consolidated financial statements, the Company performs an annual impairment assessment of its indefinite-lived intangible assets, including trademarks with indefinite lives and goodwill, or more frequently if events or circumstances indicate that assets might be impaired. Each impairment assessment may be qualitative or quantitative. Trademarks with indefinite lives and goodwill were $9,266 million and $16,764 million, respectively, at December 31, 2019. Auditing the valuation of trademarks with indefinite lives and reporting units with goodwill involved complex judgment due to the significant estimation required in determining the fair value of the trademarks with indefinite lives and related reporting units with goodwill, respectively. Specifically, the fair value estimates were sensitive to significant assumptions about future market and economic conditions. Significant assumptions used in the Companys fair value estimates included sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, and tax rates, as applicable. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Companys annual impairment assessments for trademarks with indefinite lives and reporting units with goodwill. For example, we tested managements risk assessment process to determine whether to perform a quantitative or qualitative assessment and managements review controls over the valuation models and underlying assumptions used to develop such estimates. For impairment assessments of reporting units with goodwill, we also tested controls over the determination of the carrying value of the reporting units. We tested the estimated fair values of the trademarks with indefinite lives and reporting units with goodwill based on our risk assessments. Our audit procedures included, among others, comparing significant judgmental inputs to observable third party and industry sources, considering other observable market transactions, and evaluating the reasonableness of managements projected financial information by comparing to third party industry projections, third party economic growth projections, and other internal and external data. We performed sensitivity analyses of significant assumptions to evaluate the change in the fair value of the trademarks with indefinite lives and reporting units with goodwill and also assessed the historical accuracy of managements estimates. In addition, we involved specialists to assist in our evaluation of certain significant assumptions used in the Companys discounted cash flow analyses. We also assessed the Companys disclosure of its annual impairment assessments included in Note 1. /s/ Ernst Young LLP We have served as the Company's auditor since 1921. Atlanta, Georgia February 24, 2020 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated February 24, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Atlanta, Georgia February 24, 2020 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 8,694 $ 9,997 $ 9,507 $ 9,068 $ 37,266 Gross profit 5,329 6,076 5,740 5,502 22,647 Net income attributable to shareowners of The Coca-Cola Company 1,678 2,607 2,593 2,042 8,920 Basic net income per share $ 0.39 $ 0.61 $ 0.61 $ 0.48 $ 2.09 Diluted net income per share $ 0.39 $ 0.61 $ 0.60 $ 0.47 $ 2.07 Net operating revenues $ 8,298 $ 9,421 $ 8,775 $ 7,806 $ 34,300 Gross profit 5,222 5,878 5,429 4,704 21,233 Net income attributable to shareowners of The Coca-Cola Company 1,368 2,316 1,880 6,434 Basic net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.51 1 Diluted net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.50 1 The sum of the quarterly net income per share amounts does not agree to the full year net income per share amounts. We calculate net income per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2019 and 2018 , our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2019 results were impacted by one less day compared to the first quarter of 2018 . Furthermore, the Company recorded the following transactions which impacted results: An other-than-temporary impairment charge of $286 million related to CCBJHI, an equity method investee. Refer to Note 18 . A net gain of $149 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net loss of $121 million related to acquiring a controlling interest in CHI. Refer to Note 2 . Charges of $68 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An other-than-temporary impairment charge of $57 million related to one of our equity method investees in North America. Refer to Note 18 . Charges of $46 million for transaction costs associated with the purchase of Costa. Refer to Note 2 . Net charges of $42 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A gain of $39 million related to the sale of a portion of our equity ownership interest in Andina. Refer to Note 2 . Charges of $11 million related to costs incurred to refranchise certain of our North America bottling operations. Charges of $4 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . In the second quarter of 2019 , the Company recorded the following transactions which impacted results: An adjustment to reduce the carrying amount of CCBA's fixed assets and definite-lived intangible assets by $160 million as a result of the Company's change in plans for CCBA. Refer to Note 2 . Charges of $55 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An other-than-temporary impairment charge of $49 million related to one of our equity method investees in Latin America. Refer to Note 18 . Charges of $29 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $26 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $10 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . In the third quarter of 2019 , the Company recorded the following transactions which impacted results: A gain of $739 million on the sale of a retail and office building in New York City. Other-than-temporary impairment charges of $255 million related to certain of our equity method investees in the Middle East. Refer to Note 18 . An other-than-temporary impairment charge of $120 million related to CCBJHI, an equity method investee. Refer to Note 18 . Charges of $103 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $61 million due to the Company's productivity and reinvestment program. Refer to Note 20 . An impairment charge of $42 million related to a trademark in Asia Pacific. Refer to Note 18 . A net charge of $39 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $38 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $21 million related to costs incurred to refranchise certain of our North America bottling operations. The Company's fourth quarter 2019 results were impacted by one additional day compared to the fourth quarter of 2018 . Furthermore, the Company recorded the following transactions which impacted results: Charges of $80 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net gain of $73 million related to the refranchising of certain of our bottling operations in India. Refer to Note 2 . A net gain of $53 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $7 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net gain of $3 million related to acquiring a controlling interest in CHI. Refer to Note 2 . A net gain of $2 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . In the first quarter of 2018 , the Company recorded the following transactions which impacted results: Charges of $390 million related to the impairment of certain CCR assets. Refer to Note 18 . Charges of $95 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net loss of $85 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net charge of $51 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $45 million related to costs incurred to refranchise certain of our North America bottling operations. A net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Charges of $19 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In the second quarter of 2018 , the Company recorded the following transactions which impacted results: Charges of $150 million due to the Company's productivity and reinvestment program. Refer to Note 20 . Charges of $102 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $60 million related to the impairment of certain assets. Refer to Note 18 . An other-than-temporary impairment charge of $52 million related to one of our Latin American equity method investees. Refer to Note 18 . Charges of $47 million related to pension settlements as a result of North America refranchising. Refer to Note 15 . A net gain of $36 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . A net gain of $36 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $33 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $22 million related to tax litigation expense. Refer to Note 13 . In the third quarter of 2018 , the Company recorded the following transactions which impacted results: An impairment charge of $554 million related to assets held by CCBA. Refer to Note 2 . A net gain of $370 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . Charges of $275 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . An other-than-temporary impairment charge of $205 million related to our equity method investee in Indonesia. Refer to Note 18 . Charges of $132 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net gain of $64 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A gain of $41 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 6 . Charges of $38 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 12 . A net gain of $19 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $12 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . A gain of $11 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . In the fourth quarter of 2018 , the Company recorded the following transactions which impacted results: Other-than-temporary impairment charges of $334 million related to certain of our equity method investees in the Middle East. Refer to Note 18 . A net loss of $293 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $131 million due to the Company's productivity and reinvestment program. Refer to Note 20 . A net loss of $120 million related to economic hedging activity associated with the purchase of Costa, which we acquired in January 2019. Refer to Note 6 . Charges of $102 million related to pension settlements as a result of North America refranchising. Refer to Note 15 . Charges of $97 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . A loss of $74 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . A net charge of $46 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net loss of $32 million related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Charges of $22 million related to costs incurred to refranchise certain of our North America bottling operations. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2019 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2019 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +3,a201,123110-k," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. As of December 31, 2018 , our operating structure included the following operating segments, which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Bottling Investments Our operating structure as of December 31, 2018 also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. In January 2019, we established a new operating segment, Global Ventures, which includes the results of Costa Limited (""Costa""), which we acquired on January 3, 2019, and the results of our innocent and Doadan businesses as well as fees earned pursuant to distribution coordination agreements between the Company and Monster Beverage Corporation (""Monster""). Refer to Note 22 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report for information regarding the Costa acquisition. Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. Products and Brands As used in this report: ""concentrates"" means flavoring ingredients and, depending on the product, sweeteners used to prepare syrups or finished beverages and includes powders or minerals for purified water products; ""syrups"" means beverage ingredients produced by combining concentrates and, depending on the product, sweeteners and added water; ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners, who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. For information regarding how we measure the volume of Company beverage products sold by the Company and our bottling partners (""Coca-Cola system""), refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. We own and market numerous valuable nonalcoholic beverage brands, including the following: sparkling soft drinks : Coca-Cola, Diet Coke/Coca-Cola Light, Coca-Cola Zero Sugar, Fanta, Schweppes, * Sprite, Thums Up; water, enhanced water and sports drinks : Aquarius, Dasani, glacau smartwater, glacau vitaminwater, Ice Dew, I LOHAS, Powerade; juice, dairy and plant-based beverages : AdeS, Del Valle, innocent, Minute Maid, Minute Maid Pulpy, Simply, ZICO; and tea and coffee : Ayataka, Costa, FUZE TEA, Georgia, Gold Peak, HONEST TEA. * Schweppes is owned by the Company in certain countries other than the United States. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: Certain Coca-Cola system bottlers distribute certain brands of Monster, primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Coca-Cola system bottlers. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. We and certain of our bottling partners distribute products of fairlife, LLC (""fairlife""), our joint venture with Select Milk Producers, Inc., a dairy cooperative, including fairlife ultra-filtered milk and Core Power, a high-protein milk shake, in the United States and Canada. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries and territories through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of more than 1.9 billion servings each day. We continue to expand our marketing presence in an effort to increase our unit case volume and net operating revenues in developed, developing and emerging markets. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to our consumers throughout the world. The Coca-Cola system sold 29.6 billion , 29.2 billion and 29.3 billion unit cases of our products in 2018 , 2017 and 2016 , respectively. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for each of 2018 , 2017 and 2016 . Trademark Coca-Cola accounted for 45 percent of our worldwide unit case volume for each of 2018 , 2017 and 2016 . In 2018 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2018 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2018 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (nationwide), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and Uruguay (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, continental France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, the Former Yugoslav Republic of Macedonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru, and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, Hong Kong, Taiwan, and territories in 13 states in the western United States. In 2018 , these five bottling partners combined represented 40 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare, package, distribute and sell Company Trademark Beverages in authorized containers in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory; (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law); and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production and distribution rights to the bottlers. In such instances, we have authorized certain bottlers to (1) manufacture Company Trademark Beverages for sale to other bottlers or (2) purchase Company Trademark Beverages from other bottlers for sale and distribution throughout their respective designated territories, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. Certain bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. The bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. Certain U.S. bottlers, which were granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) in connection with the refranchising of bottler territories that had previously been managed by Coca-Cola Refreshments (""CCR""), operate under ""expanding bottler CBAs,"" under which the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The expanding bottler CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain expanding bottlers that have executed expanding bottler CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights converted or agreed to convert their legacy bottler's agreements to a form of CBA to which we sometimes refer as ""non-expanding bottler CBA."" This form of CBA has a term of 10 years and is renewable by the bottler indefinitely for successive additional terms of 10 years each and is substantially similar in most material respects to the expanding bottler CBA, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the expanding bottler CBA. Those bottlers that have not signed a CBA continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 4.3 billion in 2018 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc., is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A., Keurig Dr Pepper Inc., Groupe Danone, Mondelz International, Inc., The Kraft Heinz Company, Suntory Beverage Food Limited and Unilever. We also compete against numerous regional and local companies and, increasingly, against smaller companies that are developing micro brands and selling them directly to consumers through e-commerce retailers and other e-commerce platforms. In addition, in some markets, we compete against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, contracting with marketing assets (theaters, sports arenas, universities, etc.) and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions and, in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company and to our bottling partners for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. We purchase sucralose, which we consider a critical raw material, from suppliers in the United States and China. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners, and we do not anticipate such difficulties in the future. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets and other know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to beverage products and the processes for their production; packages and packaging materials; design and operation of processes and equipment useful for our business; and certain software. Some of the technology is licensed to suppliers and other parties. Trade secrets are an important aspect of our technology, and our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; privacy and personal data protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. The state maintains lists of these substances and periodically adds other substances to these lists. Proposition 65 exposes all food and beverage producers to the possibility of having to provide warnings on their products in California because it does not provide for any generally applicable quantitative threshold below which the presence of a listed substance is exempt from the warning requirement. Consequently, the detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. Employees As of December 31, 2018 and 2017 , our Company had approximately 62,600 and 61,800 employees, respectively, of which approximately 11,400 and 12,400 , respectively, were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2018 , approximately 900 employees in North America were covered by collective bargaining agreements. These agreements have terms of three years to five years . We currently anticipate that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its employees are generally satisfactory. Available Information The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at the following address: http://www.sec.gov. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. If we do not address evolving consumer product and shopping preferences, our business could suffer. Consumer product preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, including concerns regarding caloric intake associated with sugar-sweetened beverages and the perceived undesirability of artificial ingredients; shifting consumer demographics; changes in consumer tastes and needs coupled with a rapid expansion of beverage options; changes in consumer lifestyles; concerns regarding location of origin or source of ingredients and raw materials and the environmental and sustainability impact of the product manufacturing process; consumer emphasis on transparency related to our products and packaging; and competitive product and pricing pressures. In addition, in many of our markets, shopping patterns are being affected by the digital evolution, with consumers rapidly embracing shopping by way of mobile device applications, e-commerce retailers and e-commerce websites or platforms. If we fail to address past changes in consumer product and shopping preferences, or do not successfully anticipate and prepare for future changes in such preferences, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. Competitive pressures may cause us and our bottling partners to reduce prices we charge customers or may restrict our and our bottlers' ability to increase such prices in response to commodity and other cost increases. Such pressures may also increase marketing costs and in-store placement and slotting fees. In addition, the rapid growth of ecommerce may create additional consumer price deflation by, among other things, facilitating comparison shopping. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution, poor management, sociopolitical tensions due to lack of public infrastructure in certain areas of the world and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints and the possibility of reputational damage, which could adversely affect our profitability or net operating revenues in the long run. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use in the manufacture of our beverage products a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns and other factors may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, our ability to source raw materials for use in our manufacturing processes and the affordability of our products and ultimately our business and results of operations could be negatively impacted. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, despite our strong commitment to product safety and quality, we or our bottling partners may not always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the marketing, labeling or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends; obtain, maintain and enforce necessary intellectual property protections; and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. In addition, third-party providers of data hosting or cloud services, as well as our bottling partners, distributors, joint venture partners or suppliers, may experience cybersecurity incidents that may involve data we share with them. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, there can be no assurance that such incidents will not have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. If we fail to comply with personal data protection laws, we could be subject to adverse publicity, government enforcement actions and/or private litigation, which could negatively affect our business and operating results. In the ordinary course of our business, we receive, process, transmit and store information relating to identifiable individuals (""personal data""), primarily employees and former employees. As a result, we are subject to various U.S. federal and state and foreign laws and regulations relating to personal data. These laws have been subject to frequent changes, and new legislation in this area may be enacted in other jurisdictions at any time. In the European Union (""EU""), the General Data Protection Regulation (""GDPR"") became effective on May 25, 2018 for all member states. The GDPR includes operational requirements for companies receiving or processing personal data of EU residents that are partially different from those that had previously been in place and includes significant penalties for noncompliance. The changes introduced by the GDPR, as well as any other changes to existing personal data protection laws and the introduction of such laws in other jurisdictions, have subjected and may continue in the future to subject the Company to, among other things, additional costs and expenses and have required and may in the future require costly changes to our business practices and security systems, policies, procedures and practices. There is no assurance that our security controls over personal data, the training of employees and vendors on data privacy and data security, and the policies, procedures and practices we implemented or may implement in the future will prevent the improper disclosure of personal data. Improper disclosure of personal data in violation of the GDPR and/or of other personal data protection laws could harm our reputation, cause loss of consumer confidence, subject us to government enforcement actions (including fines), or result in private litigation against us, which could result in loss of revenue, increased costs, liability for monetary damages, fines and/or criminal prosecution, all of which could negatively affect our business and operating results. If we are not successful in our efforts to digitize the Coca-Cola system, our financial performance will be negatively affected. The digital evolution is affecting how we interact with consumers, customers, suppliers, bottlers and other business partners and stakeholders. We believe that our future success will depend in part on our ability to adapt to and thrive in the digital environment. Therefore, one of our top priorities is to digitize the Coca-Cola system by, among other things, creating more relevant and more personalized experiences wherever our system interacts with consumers, whether in a digital environment or through digital devices in an otherwise physical environment; finding ways to create more powerful digital tools and capabilities for the CocaCola system's retail customers to enable them to grow their businesses; and digitizing operations through the use of data, artificial intelligence, automation, robotics and digital devices to increase efficiency and productivity. If we are not successful in our efforts to digitize the Coca-Cola system, our ability to increase sales and reduce costs may be negatively affected and the cost and expenses we have incurred or may incur in connection with our digitization initiatives may adversely impact our financial performance. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in and blurring of the lines between retail channels, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets discounters and value stores are growing at a rapid pace, while in emerging and developing markets modern trade is growing at a faster pace than traditional trade outlets. Our industry is also being affected by the rapid growth in sales through e-commerce retailers, e-commerce websites, mobile commerce applications and subscription services, which may result in a shift away from physical retail operations to digital channels. As we build the Coca-Cola system's e-commerce capabilities, we may not be able to develop and maintain successful relationships with existing and new e-commerce retailers without experiencing a deterioration of our relationships with key customers operating physical retail channels. If we are unable to successfully adapt to the rapidly changing retail landscape, including the rapid growth in digital commerce, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and employees to establish and manage our operations in these markets. Scarcity or heavy competition for talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, there can be no assurance that our products will be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2018 , we used 72 functional currencies in addition to the U.S. dollar and derived $20.5 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2018 and 2017, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies may be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, could materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. However, our financial risk management program may not be successful in reducing the risks inherent in exposures to interest rate fluctuations. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottlers. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottlers' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottlers' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottlers in which we have equity method investments were to be downgraded, such bottlers' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income from continuing operations before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for that period, plus interest. If this income tax dispute were to be ultimately determined adversely to us, any additional taxes, interest and potential penalties in the litigated or subsequent years could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017 (the ""Tax Reform Act""). For additional information regarding this income tax dispute, refer to Note 12 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. The Tax Reform Act, which was signed into law on December 22, 2017, significantly affected U.S. income tax law by changing how the United States imposes income tax on multinational corporations. As permitted by Staff Accounting Bulletin No. 118 (""SAB 118""), we recorded an original provisional estimate of the effect of the Tax Reform Act in our 2017 consolidated financial statements and have subsequently finalized our accounting analysis based on the guidance, interpretations and data available as of December 31, 2018. For additional information regarding the Tax Reform Act and the final tax amounts recorded in our consolidated financial statements, refer to the heading ""Critical Accounting Policies and Estimates Income Taxes"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, tariffs, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not realize the economic benefits we anticipate from our productivity and reinvestment program or are unable to successfully manage its possible negative consequences, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. For information regarding our productivity and reinvestment program, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. We have incurred, and we expect will continue to incur, significant costs and expenses in connection with our productivity and reinvestment program and associated initiatives. If we are unable to implement some or all of these productivity and reinvestment initiatives fully or in the envisioned timeframe, or we otherwise do not timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these initiatives, our results of operations for future periods could be negatively affected. In addition, some of the actions we are taking in furtherance of our productivity and reinvestment initiatives may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity and reinvestment initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our ability to attract, train, develop and retain a highly skilled and diverse workforce. We may not be able to successfully compete for, attract and retain the high-quality and diverse employee talent we want and our future business needs may require, such as employees with e-commerce, social media and digital marketing and advertising skills and capabilities. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to insecurity resulting from our ongoing productivity initiatives, organizational changes and changes in compensation structure could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, that may be caused by increasing demand or by events such as natural disasters, power outages, or the like could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET, bio-based PET and recycled PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices for these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, sucralose, saccharin and ascorbic acid, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We and our bottling partners may not be able to maintain favorable arrangements and relationships with these suppliers, and our contingency plans may not be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States or in other major corn-producing areas of the world may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by a deterioration of our or our bottling partners' relationships with suppliers; by supplier quality and reliability issues; by trade disruptions, changes in supply chain and increases in tariffs that may be caused by the United Kingdom's impending withdrawal from the European Union, commonly referred to as ""Brexit;"" or by events such as natural disasters, power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable recyclable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, tethered bottle caps, ecotax and/or product stewardship have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of such legislation or regulations. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance, unless the exposure falls under an established safe harbor level. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2018 , our net operating revenues in the United States were $11.3 billion , or 36 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2018 , our operations outside the United States accounted for $20.5 billion , or 64 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties surrounding Brexit, and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitation on profits, retaliatory tariffs, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability, deterioration of economic relations between countries or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. Actual outcomes or losses may differ materially from our current assessments and estimates. We conduct business in markets with high-risk legal compliance environments, which exposes us to increased legal and reputational risk. We have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, our policies, procedures and related training programs may not always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. If our third-party service providers and business partners do not satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. In the conduct of our business, we rely on relationships with third parties, including cloud data storage and other information technology service providers, suppliers, distributors, contractors, joint venture partners and other external business partners, for certain functions or for services in support of key portions of our operations. These third-party service providers and business partners are subject to similar risks as we are relating to cybersecurity, privacy violations, business interruption, and systems and employee failures, and are subject to legal, regulatory and market risks of their own. Our third-party service providers and business partners may not fulfill their respective commitments and responsibilities in a timely manner and in accordance with the agreed upon terms. In addition, while we have procedures in place for selecting and managing our relationships with third-party service providers and other business partners, we do not have control over their business operations or governance and compliance systems, practices and procedures, which increases our financial, legal, reputational and operational risk. If we are unable to effectively manage our third-party relationships, or for any reason our third-party service providers or business partners fail to satisfactorily fulfill their commitments and responsibilities, our financial results could suffer. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations. If negative publicity, whether or not warranted, concerning product safety or quality, human and workplace rights, obesity or other issues damages our brand image, corporate reputation and social license to operate, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions, and maintain our corporate reputation and social license to operate. However, our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights may not have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with human and workplace rights issues, whether actual or perceived, could adversely impact our corporate image and reputation. Additionally, negative postings or comments on social media or networking websites about the Company or one of its brands, even if inaccurate or malicious, could generate adverse publicity that could damage the reputation of our brands or the Company. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable labor and workplace rights laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, and employment and labor practices. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic, including regulations relating to recovery and/or disposal of plastic packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in litigation, the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. There can be no assurance that we will realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative impacts on employee morale, work performance, escalation of grievances and the negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our noncurrent assets, including trademarks, bottler franchise rights, goodwill and other intangible assets, equity method investments and other long-lived assets, as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform similar recoverability and impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our net income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021. If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other newly acquired businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. However, we may not be able to achieve our strategic and financial objectives for such bottling operations or other acquisitions. If we are unable to achieve such objectives, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we continue to seek opportunities to refranchise Company-owned or -controlled bottling operations. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. We also own an office and retail building at 711 Fifth Avenue in New York, New York. These properties, except for the North America group's main offices, are included in Corporate. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located. The following table summarizes our principal production, distribution and storage facilities by operating segment and Corporate as of December 31, 2018 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Distribution and Storage Warehouses Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Total 1 1 Does not include 36 owned and 2 leased principal beverage manufacturing/bottling plants and 23 owned and 30 leased distribution and storage warehouses related to our discontinued operations. Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that, except as disclosed in U.S. Federal Income Tax Dispute below, the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit ( The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50 ) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit ( Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit ( Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Companys continued adherence to the prescribed methodology absent change in material facts or circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Reform Act. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange and the corresponding trading symbol is ""KO."" While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 15, 2019 , there were 206,575 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the subheading ""Equity Compensation Plan Information"" under the principal heading ""Compensation"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 24, 2019 (""Company's 2019 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the year ended December 31, 2018 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2018 by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under the Publicly Announced Plan September 29, 2018 through October 26, 2018 2,584,881 $ 45.93 2,584,800 35,604,612 October 27, 2018 through November 23, 2018 4,499,050 49.25 3,584,201 32,020,411 November 24, 2018 through December 31, 2018 186,525 48.48 32,020,411 Total 7,270,456 $ 48.05 6,169,001 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2014 2016 2018 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 113 142 128 SP 500 Index 114 129 150 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2013. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer Daniels Midland Company, BG Foods, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Nutrition Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion Incorporated, Jefferies Financial Group Inc., Kellogg Company, The Kraft Heinz Company, Keurig Dr Pepper Inc., Lamb Weston Holdings, Inc., Lancaster Colony Corporation, McCormick Company, Incorporated, Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, National Beverage Corp., PepsiCo, Inc., Performance Food Group Company, Philip Morris International Inc., Pilgrim's Pride Corporation, Post Holdings, Inc., Seaboard Corporation, The J.M. Smucker Company, TreeHouse Foods, Inc., Tyson Foods, Inc. and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2018, the indices included Jefferies Financial Group Inc., Keurig Dr Pepper Inc., National Beverage Corp., Performance Food Group Company, Pilgrim's Pride Corporation and Seaboard Corporation, which were not included in the indices in 2017. Additionally, the indices do not include Dean Foods Company, Dr Pepper Snapple Group, Inc., Leucadia National Corporation, Pinnacle Foods Inc. and Snyder's-Lance, Inc., which were included in the indices in 2017. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our objective; our strategic priorities; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; the impact of inflation and changing prices; and an overview of financial position. Our Business General The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2017 Concentrate operations % % % Finished product operations 49 Total % % % The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2017 Concentrate operations % % % Finished product operations 22 Total % % % The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Objective Our objective is to use our formidable assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to achieve long-term sustainable growth. To accomplish our objective, we are focused on: Disciplined growth Turning our passion for consumers into drinks people come back to again and again, whether that means less sugar, more vitamins, or exciting new flavors Building relevant brands people love and scaling them around the world quickly and consistently Using the Coca-Cola system advantage to put our drinks in more hands in more places more quickly than anyone else Doing business the right way, not just the easy way Being leaders in responsible water use and giving back to nature and communities Contributing to the elimination of waste, including through package innovation, sharing of package innovation and recycling initiatives Caring for people and communities, with a special focus on womens economic empowerment Tapping into the passion of our people Building an inclusive culture of curiosity and empowerment where diverse perspectives are essential as we strive for progress, not perfection Strategic Priorities We have five strategic priorities designed to help us achieve our objective. These strategic priorities are accelerating growth of a consumer-centric brand portfolio; driving our revenue growth algorithm; strengthening the Coca-Cola system; digitizing the enterprise; and unlocking the power of our people. In order to execute on these strategic priorities, we must further enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Core Capabilities Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to deliver enhanced value to themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, five key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- and no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles and consumers who are empowered with more information than ever. As a consequence of these changes, many consumers want more choices, personalization, a focus on sustainability and recyclability, and transparency related to our products and packaging. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,300 beverage products (including more than 1,400 low- and no-calorie products), new product offerings, innovative and sustainable packaging, and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers and to providing options that reflect consumer concerns about impacts to our planet. Increased Competition and Capabilities in the Marketplace Our Company faces strong competition from well-established, global companies as well as numerous regional and local companies. Additionally, the rapidly evolving digital landscape and growth of e-commerce has led to dramatic shifts in consumer shopping patterns and presents new challenges to competitively maintain the relevancy of our brands. We must continuously strengthen our capabilities in marketing and innovation in order to compete in a digital environment, maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality We strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with consumers around the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions, and we engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries and territories where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Ingredient Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a critical natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part to help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. In addition, increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and ingredient quality and quantity have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Certain prior year amounts in Management's Discussion and Analysis of Financial Condition and Results of Operations have been revised to conform to the current year presentation as a result of the adoption of certain accounting standards that became effective January 1, 2018 , as applicable. Refer to Note 1 of Notes to Consolidated Financial Statements for further details. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 12 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,916 million and $ 4,523 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 49 million and $ 1 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charges may be impacted by items such as basis differences, deferred taxes and deferred gains. The assessment of recoverability and the performance of impairment tests of current and noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair values of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to accumulated other comprehensive income (loss) (""AOCI"") as of January 1, 2018 in connection with the adoption of ASU 2016-01. Refer to Note 1 of Notes to Consolidated Financial Statements. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. The following table presents the carrying values of our investments in equity and debt securities (in millions): December 31, 2018 Carrying Value Percentage of Total Assets Equity method investments $ 19,407 % Debt securities classified as available-for-sale 4,993 Equity securities with readily determinable fair values 1,934 Debt securities classified as trading * Equity securities without readily determinable fair values * Total $ 26,458 % * Accounts for less than 1 percent of the Company's total assets. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01 equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. During 2018 and 2017 , we recognized other-than-temporary impairment charges related to certain of our equity method investees of $591 million and $50 million , respectively. Refer to Note 17 of Notes to Consolidated Financial Statements. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's cost basis in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2018 Fair Value Carrying Value Difference Monster Beverage Corporation $ 5,026 $ 3,573 $ 1,453 Coca-Cola European Partners plc 4,033 3,551 Coca-Cola FEMSA, S.A.B. de C.V. 3,401 1,714 1,687 Coca-Cola HBC AG 2,681 1,260 1,421 Coca-Cola Amatil Limited 1,325 Coca-Cola Bottlers Japan Holdings Inc. 1 1,142 (164 ) Embotelladora Andina S.A. CocaCola Consolidated, Inc. 2 Coca-Cola ecek A.. Total $ 18,680 $ 12,471 $ 6,209 1 The carrying value of our investment in Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI"") exceeded its fair value as of December 31, 2018 . Based on the length of time and the extent to which the market value has been less than our cost basis and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. 2 Formerly known as Coca-Cola Bottling Co. Consolidated. Other Assets Our Company invests in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. Additionally, our Company advances payments to certain customers for distribution rights as well as to fund future marketing activities intended to generate profitable volume, and we expense such payments over the periods benefited. Payments under these programs are generally capitalized and reported in the line item prepaid expenses and other assets or other assets, as appropriate, in our consolidated balance sheet. When facts and circumstances indicate that the carrying value of these assets or asset groups may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. During the year ended December 31, 2017 , the Company recorded an impairment charge of $19 million related to CCR's other assets. Refer to Note 17 of Notes to Consolidated Financial Statements. Property, Plant and Equipment As of December 31, 2018 , the carrying value of our property, plant and equipment, net of depreciation, was $ 8,232 million , or 10 percent of our total assets. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe a hypothetical marketplace participant would use. During the year ended December 31, 2018 and December 31, 2017 , the Company recorded impairment charges of $312 million and $310 million , respectively, related to CCR's property, plant and equipment. Refer to Note 17 of Notes to Consolidated Financial Statements. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into one of three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The following table presents the carrying values of intangible assets included in our consolidated balance sheet (in millions): December 31, 2018 Carrying Value Percentage of Total Assets Goodwill $ 10,263 % Trademarks with indefinite lives 6,682 Bottlers' franchise rights with indefinite lives * Definite-lived intangible assets, net * Other intangible assets not subject to amortization * Total $ 17,270 % * Accounts for less than 1 percent of the Company's total assets. The assessment of recoverability and the performance of impairment tests of intangible assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of intangible assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions exist in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions that we believe a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further assessment. When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test indefinite-lived intangible assets, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. During 2018, the Company recorded impairment charges of $138 million related to certain intangible assets. These charges included $100 million related to bottlers' franchise rights with indefinite lives and $38 million related to definite-lived intangible assets. Refer to Note 17 of Notes to Consolidated Financial Statements. During 2017, the Company recorded impairment charges of $457 million related to certain intangible assets. These charges included $390 million related to goodwill and $33 million related to bottlers' franchise rights with indefinite lives. As a result of these charges, the carrying value of CCR's goodwill is zero. Additionally, we recorded impairment charges of $34 million related to Venezuelan intangible assets. As a result of these charges, the carrying value of these assets is zero. Refer to Note 17 of Notes to Consolidated Financial Statements. During 2016, the Company recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights and $10 million related to the impairment of goodwill. Refer to Note 17 of Notes to Consolidated Financial Statements. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our pension expense and obligations. We believe the most critical assumptions are related to (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our pension expense and obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future payments we anticipate making under the plans. As of December 31, 2018 and 2017 , the weighted-average discount rate used to compute our pension obligations was 4.00 percent and 3.50 percent , respectively. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. The weighted-average expected long-term rate of return used to calculate our pension expense was 8.00 percent , 8.00 percent and 8.25 percent in 2018, 2017 and 2016, respectively. In 2018 , the Company's total pension expense related to defined benefit plans was $145 million , which included $107 million of net periodic benefit income and $252 million of settlement charges, curtailment charges and special termination benefit costs. In 2019, we expect our total pension income to be approximately $11 million. We currently do not expect to incur any settlement charges or special termination benefit costs in 2019. The decrease in 2019 expected net periodic benefit income is primarily due to unfavorable asset performance in 2018, partially offset by an increase in the weighted-average discount rate at December 31, 2018 compared to December 31, 2017. The estimated impact of a 50 basis-point decrease in the discount rate would result in a $19 million decrease in our 2019 net periodic benefit income. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets would result in a $23 million decrease in our 2019 net periodic benefit income. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2018 , the Company's primary U.S. pension plan represented 62 percent of both the Company's consolidated projected benefit obligation and plan assets. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Refer to Note 3 of Notes to Consolidated Financial Statements. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Once control is transferred to the customer, we have completed our performance obligation, and revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volumebased incentive programs, support for infrastructure programs and other similar programs. In some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we work with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606 and an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 15 of Notes to Consolidated Financial Statements. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent change in material facts and circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. As of December 31, 2018 , the Company's valuation allowances on deferred tax assets were $ 399 million and were primarily related to uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards generated in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes it will generate sufficient future taxable income to realize the tax benefits related to the remaining deferred tax assets in our consolidated balance sheet. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference, which primarily results from earnings, meets the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 15 of Notes to Consolidated Financial Statements. The Tax Reform Act was signed into law on December 22, 2017. Among other things, the Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017 , transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") of approximately $41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $0.3 billion in tax for our one-time transition tax and a tax benefit of $0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $8.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. Based on current tax laws, the Company's effective tax rate in 2019 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Operations Review Our organizational structure as of December 31, 2018 consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; and Bottling Investments. Our operating structure also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. For further information regarding our operating segments, refer to Note 20 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. Our Bottling Investments operating segment and our other finished product operations typically generate net operating revenues by selling sparkling soft drinks and a variety of other beverages, such as juices, juice drinks, sports drinks, waters, teas and coffees, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. For these consolidated finished product operations, we recognize the associated concentrate sales volume at the time the unit case or unit case equivalent is sold to the customer. Our concentrate operations typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations. For these concentrate operations, we recognize concentrate revenue and concentrate sales volume when we sell concentrate and syrups to the authorized unconsolidated bottling operations, and we typically report unit case volume when finished products manufactured from the concentrates and syrups are sold to the customer. When we analyze our net operating revenues we generally consider the following five factors: (1) volume growth (concentrate sales volume or unit case volume, as applicable); (2) acquisitions and divestitures (including structural changes defined below), as applicable; (3) changes in price, product and geographic mix; (4) foreign currency fluctuations; and (5) the impact of our adoption of the new revenue recognition accounting standard. Refer to the heading ""Net Operating Revenues"" below. We generally refer to acquisitions and divestitures of bottling and distribution operations as structural changes, which are a component of acquisitions and divestitures (""structural changes""). Typically, structural changes do not impact the Company's unit case volume or concentrate sales volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider acquired brands to be structural changes. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when these brands are ultimately sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that the licenses are entered into, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider newly licensed brands to be structural changes. In 2018, the Company acquired a controlling interest in the Philippine bottling operations, which was previously accounted for as an equity method investee. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments and Asia Pacific operating segments. The Company also acquired a controlling interest in the franchise bottler in Oman. The impact of this acquisition has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments operating segment. In 2018, the Company refranchised our Canadian and Latin American bottling operations. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America, Latin America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the Canadian refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the base year when calculating 2018 versus 2017 volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. Refer to the headings ""Beverage Volume"" and ""Net Operating Revenues"" below. In 2017, Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") was transitioned to the Company, resulting in its consolidation. The results of CCBA have been recorded as discontinued operations. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017 and 2016, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed brands sold in the refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the applicable base year when calculating volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. During 2016, the Company deconsolidated its South African bottling operations and disposed of its related equity method investment in exchange for equity method investments in CCBA and CCBA's South African subsidiary. As part of the transaction, the Company also acquired and licensed several brands. The impacts of the deconsolidation, the disposal of the related equity method investment, and the new equity method investments have been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The brands and licenses that the Company acquired impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. During 2016, the Company also deconsolidated our German bottling operations as a result of their being combined to create CCEP. As a result of the transaction, the Company now owns an equity method investment in CCEP. Accordingly, the impact of the deconsolidation and new equity method investment has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The Company also changed our funding arrangement with our bottling partners in China, which resulted in a reduction in net operating revenues with an offsetting reduction in direct marketing expense. The impact of the change in the arrangement has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific operating segment. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a third party or independent customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions to the extent of our ownership interest until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can impact unit case volume and concentrate sales volume and can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest but to which the Company does not sell concentrates, syrups, beverage bases, source waters or powders/minerals may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2018 versus 2017 2017 versus 2016 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % % % Europe, Middle East Africa % % 4 % % 8 Latin America (2 ) (3 ) North America (1 ) 5 9 Asia Pacific 6 10 Bottling Investments (15 ) 3 N/A (41 ) 7 N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2018 grew 11 percent. 4 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2018 grew 4 percent. 5 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2018 grew 1 percent. 6 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2018 grew 5 percent. 7 After considering the impact of structural changes, unit case volume for Bottling Investments for the year ended December 31, 2017 declined 3 percent. 8 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2017 grew 2 percent. 9 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2017 was even. 10 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2017 grew 1 percent. Unit Case Volume The Coca-Cola system sold 29.6 billion , 29.2 billion and 29.3 billion unit cases of our products in 2018 , 2017 and 2016 , respectively. The unit case volume for 2018 , 2017 and 2016 reflects the impact of brands acquired and licensed during the applicable year. The unit case volume for 2018 , 2017 and 2016 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2018 versus 2017 and 2017 versus 2016 unit case volume growth rates. Sparkling soft drinks represented 69 percent of our worldwide unit case volume for 2018 , 2017 and 2016 . Trademark CocaCola accounted for 45 percent of our worldwide unit case volume for 2018 , 2017 and 2016 . In 2018 , unit case volume in the United States represented 18 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume for 2018 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 70 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 46 percent of non-U.S. unit case volume. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Unit case volume in Europe, Middle East and Africa grew 2 percent, which included growth of 2 percent in sparkling soft drinks and 3 percent in water, enhanced water and sports drinks. Growth in sparkling soft drinks was primarily driven by 2 percent growth in Trademark Coca-Cola and 3 percent growth in Trademark Fanta. The group reported increases in unit case volume in the Central Eastern Europe; Turkey, Caucasus Central Asia; and Middle East North Africa business units. The unit case volume growth in these business units was partially offset by a decline in the West Africa business unit. Volume in the South East Africa and Western Europe business units was even. In Latin America, unit case volume was even, which included growth of 4 percent in juice, dairy and plant-based beverages and 1 percent in water, enhanced water and sports drinks. Sparkling soft drinks volume was even. The group's volume reflected growth of 1 percent in each of the Mexico, Brazil and Latin Center business units, offset by a 4 percent decline in the South Latin business unit. The growth in Mexico's volume was primarily driven by 1 percent growth in sparkling soft drinks and 8 percent growth in juice, dairy and plant-based beverages. The decline in South Latin's volume was driven by a 4 percent decline in sparkling soft drinks. Unit case volume in North America grew 1 percent. Sparkling soft drinks grew 1 percent, which included growth of 3 percent in Trademark Sprite and 1 percent in Trademark CocaCola. Unit case volume in water, enhanced water and sports drinks grew 2 percent, primarily driven by 2 percent growth in packaged water and 1 percent growth in sports drinks. Growth in these category clusters was partially offset by a 3 percent decline in juice, dairy and plant-based beverages. In Asia Pacific, unit case volume grew 4 percent, reflecting 4 percent growth in sparkling soft drinks, 5 percent growth in water, enhanced water and sports drinks, and 4 percent growth in tea and coffee. Growth in sparkling soft drinks volume included 5 percent growth in Trademark Coca-Cola and 6 percent growth in Trademark Sprite. Volume within the water, enhanced water and sports drinks category cluster included growth of 7 percent in packaged water. The group's volume reflects growth of 6 percent in the Greater China Korea business unit, 10 percent in the India South West Asia business unit and 1 percent in the Japan business unit. Volume in the South Pacific and ASEAN business units was even. Unit case volume for Bottling Investments declined 15 percent. This decrease primarily reflects the impact of refranchising activities, partially offset by growth in India as well as the impact of bottler acquisitions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In Europe, Middle East and Africa, unit case volume grew 1 percent, reflecting an 8 percent increase in tea and coffee, a 5 percent increase in water, enhanced water and sports drinks and a 1 percent increase in sparkling soft drinks. These increases were partially offset by a decrease of 3 percent in juice, dairy and plant-based beverages. The group reported increases in unit case volume in our Central Eastern Europe, Turkey, Caucasus Central Asia, South East Africa and West Africa business units. The increases in these business units were partially offset by even results in both our Middle East North Africa and Western Europe business units. Unit case volume in Latin America decreased 2 percent, which included declines of 3 percent in sparkling soft drinks and 1 percent in water, enhanced water and sports drinks. The group's volume reflected declines of 10 percent in the Latin Center business unit and 6 percent in the Brazil business unit. These declines were partially offset by 1 percent growth in the Mexico business unit, which included 1 percent growth in water, enhanced water and sports drinks, and even performance in sparkling soft drinks. In North America, unit case volume was even, reflecting even volume for sparkling soft drinks, a 2 percent decline in water, enhanced water and sports drinks, and growth in energy drinks. North America's volume performance in sparkling soft drinks included 4 percent growth in Trademark Sprite and 5 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. Unit case volume in Asia Pacific increased 1 percent, reflecting a 2 percent increase in both sparkling soft drinks and juice, dairy and plant-based beverages. The increase in sparkling soft drinks included 4 percent growth in Trademark Coca-Cola. The group's unit case volume reflected an increase of 2 percent in both the ASEAN and Greater China Korea business units and a 1 percent increase in the India South West Asia business unit, partially offset by a 2 percent decline in the South Pacific business unit. Unit case volume in the Japan business unit was even. Unit case volume for Bottling Investments decreased 41 percent. This decrease primarily reflects the North America refranchising activities and the refranchising of our China bottling operations. Concentrate Sales Volume In 2018 , worldwide unit case sales volume grew 2 percent and concentrate sales volume grew 3 percent compared to 2017 . In 2017 , worldwide concentrate sales volume and unit case volume were both even compared to 2016 . The differences between concentrate sales volume and unit case volume growth rates on a consolidated basis and for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, beverage bases or powders. The difference between the unit case volume and concentrate sales volume growth rates in 2018 for both worldwide and Europe, Middle East and Africa included the impact of the dissolution of Beverage Partners Worldwide (""BPW""), a former tea joint venture to whom we did not sell concentrate. The BPW joint venture was replaced by the launch of Fuze Tea, for which the Company produces and sells the related concentrate. Analysis of Consolidated Statements of Income Percent Change Year Ended December 31, 2018 vs. 2017 2017 vs. 2016 (In millions except percentages and per share data) NET OPERATING REVENUES $ 31,856 $ 35,410 $ 41,863 (10)% (15)% Cost of goods sold 11,770 13,255 16,465 (11) (19) GROSS PROFIT 20,086 22,155 25,398 (9) (13) GROSS PROFIT MARGIN 63.1 % 62.6 % 60.7 % Selling, general and administrative expenses 10,307 12,654 15,370 (19) (18) Other operating charges 1,079 1,902 1,371 (43) OPERATING INCOME 8,700 7,599 8,657 (12) OPERATING MARGIN 27.3 % 21.5 % 20.7 % Interest income Interest expense Equity income (loss) net 1,008 1,071 (6) Other income (loss) net (1,121 ) (1,764 ) (1,265 ) (39) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 8,350 6,742 8,136 (17) Income taxes from continuing operations 1,623 5,560 1,586 (71) Effective tax rate 19.4 % 82.5 % 19.5 % NET INCOME FROM CONTINUING OPERATIONS 6,727 1,182 6,550 (82) Income (loss) from discontinued operations (net of income taxes of $126, $47 and $0, respectively) (251 ) * * CONSOLIDATED NET INCOME 6,476 1,283 6,550 (80) Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 6,434 $ 1,248 $ 6,527 416% (81)% * Calculation is not meaningful. Net Operating Revenues Year Ended December 31, 2018 versus Year Ended December 31, 2017 The Company's net operating revenues decreased $3,554 million, or 10 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2018 versus 2017 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Accounting Changes Total Consolidated % (16 )% % (1 )% % (10 )% Europe, Middle East Africa % % % (1 )% (3 )% % Latin America (9 ) (3 ) North America (1 ) 9 Asia Pacific (1 ) (5 ) Bottling Investments (78 ) (64 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. ""Price, product and geographic mix"" refers to the change in net operating revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. ""Accounting changes"" refers to the impact of our adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Price, product and geographic m ix had a 2 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable price mix in all of the segment's business units as well as favorable product and package mix; Latin America favorable price mix and the impact of inflationary environments in certain markets; North America favorable pricing initiatives, offset by incremental freight costs; Asia Pacific favorably impacted as a result of pricing initiatives as well as product and package mix, offset by geographic mix; and Bottling Investments unfavorable price, product and package mix in certain bottling operations, offset by geographic mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a favorable impact of 8 percent to 9 percent on full year 2019 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect currencies will have an unfavorable impact on our full year 2019 net operating revenues. Year Ended December 31, 2017 versus Year Ended December 31, 2016 The Company's net operating revenues decreased $6,453 million, or 15 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2017 vs. 2016 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (17 )% % (1 )% (15 )% Europe, Middle East Africa % (2 )% % (2 )% % Latin America (3 ) North America Asia Pacific (1 ) (4 ) (2 ) Bottling Investments (3 ) (48 ) (47 ) Note: Certain rows may not add due to rounding. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorably impacted as a result of pricing initiatives and product and package mix, partially offset by geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets; North America favorably impacted as a result of pricing initiatives and product and package mix; Asia Pacific unfavorably impacted by geographic mix, partially offset by the favorable impact of pricing initiatives and product and package mix; and Bottling Investments favorably impacted as a result of pricing initiatives and product and package mix in North America. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the British pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Information about our net operating revenues by operating segment and Corporate as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 22.8 % 20.7 % 16.8 % Latin America 12.7 11.2 8.9 North America 36.7 24.9 1 15.8 1 Asia Pacific 15.4 13.5 11.4 Bottling Investments 12.1 29.3 1 46.8 1 Corporate 0.3 0.4 0.3 Total 100.0 % 100.0 % 100.0 % 1 Amounts have been adjusted to reflect the reclassification of certain revenue streams from the Bottling Investments operating segment to the North America operating segment effective January 1, 2018. The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; foreign currency fluctuations and accounting changes. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin As a result of our finished goods operations, which are primarily included in our North America and Bottling Investments operating segments, the following inputs represent a substantial portion of the Company's total cost of goods sold: (1) sweeteners, (2) metals, (3) juices and (4) PET. The Company enters into hedging activities related to certain commodities in order to mitigate a portion of the price risk associated with forecasted purchases. Many of the derivative financial instruments used by the Company to mitigate the risk associated with these commodity exposures, including any related foreign currency exposure, do not qualify for hedge accounting. As a result, the changes in fair value of these derivative instruments have been, and will continue to be, included as a component of net income in each reporting period. The Company recorded a net loss related to these derivatives of $20 million during the year December 31, 2018 and recorded net gains of $14 million and $79 million during the years ended December 31, 2017 and December 31, 2016 , respectively, in the line item cost of goods sold in our consolidated statements of income. Refer to Note 6 of Notes to Consolidated Financial Statements. Year Ended December 31, 2018 versus Year Ended December 31, 2017 Our gross profit margin increased to 63.1 percent in 2018 from 62.6 percent in 2017. The increase was primarily due to the impact of divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations and the impact of accounting changes related to the new revenue recognition accounting standard. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Refer to Note 3 of Notes to Consolidated Financial Statements for additional information on the adoption of the new revenue recognition accounting standard. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Our gross profit margin increased to 62.6 percent in 2017 from 60.7 percent in 2016. The increase was primarily due to the impact of divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the significant components of selling, general and administrative expenses (in millions): Year Ended December 31, Stock-based compensation expense $ $ $ Advertising expenses 4,113 3,958 4,004 Selling and distribution expenses 1,701 3,266 5,189 Other operating expenses 4,268 5,211 5,919 Selling, general and administrative expenses $ 10,307 $ 12,654 $ 15,370 Year Ended December 31, 2018 versus Year Ended December 31, 2017 Selling, general and administrative expenses decreased $2,347 million, or 19 percent. The decrease in selling and distribution expenses during 2018 reflects the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. The decrease in other operating expenses during 2018 reflects savings from our productivity and reinvestment initiatives and the impact of refranchising activities throughout 2018 and the full year effect of refranchising activities that occurred during 2017. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. As of December 31, 2018 , we had $ 271 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.5 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 13 of Notes to Consolidated Financial Statements. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Selling, general and administrative expenses decreased $2,716 million, or 18 percent. During the year ended December 31, 2017, fluctuations in foreign currency exchange rates had a nominal impact on selling, general and administrative expenses. The decrease in selling and distribution expenses and advertising expenses during 2017 reflects the impact of divestitures. Additionally, advertising expenses during 2017 decreased 1 percent as a result of foreign currency exchange rate fluctuations. The decrease in other operating expenses during 2017 reflects savings from our productivity and reinvestment initiatives. Foreign currency exchange rate fluctuations had a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they were generally transacted in local currency. Our selling and distribution expenses were primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and were primarily denominated in U.S. dollars. Other Operating Charges Other operating charges incurred by operating segment and Corporate were as follows (in millions): Year Ended December 31, Europe, Middle East Africa $ (3 ) $ $ Latin America North America Asia Pacific (4 ) Bottling Investments 1,079 Corporate Total $ 1,079 $ 1,902 $ 1,371 In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 12 of Notes to Consolidated Financial Statements for additional information related to the tax litigation. Refer to Note 17 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information about the Venezuelan intangible assets. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 17 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity and reinvestment program. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. In 2016, the Company recorded other operating charges of $1,371 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $276 million related to costs incurred to refranchise certain of our bottling operations. The Company also recorded a charge of $200 million related to cash contributions we made to The CocaCola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. In 2016, the Company also recorded impairment charges of $153 million related to certain intangible assets. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan exchange rates. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 17 of Notes to Consolidated Financial Statements for additional information on the impairment charges. Refer to Note 19 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments and Corporate. Operating Income and Operating Margin Information about our operating income contribution by operating segment and Corporate on a percentage basis is as follows: Year Ended December 31, Europe, Middle East Africa 42.7 % 47.7 % 42.4 % Latin America 26.7 29.2 22.6 North America 28.2 34.1 30.2 Asia Pacific 26.2 28.3 25.5 Bottling Investments (7.5 ) (12.7 ) 0.0 Corporate (16.3 ) (26.6 ) (20.7 ) Total 100.0 % 100.0 % 100.0 % Information about our operating margin on a consolidated basis and by operating segment and Corporate is as follows: Year Ended December 31, Consolidated 27.3 % 21.5 % 20.7 % Europe, Middle East Africa 48.2 49.2 52.3 Latin America 58.4 56.1 52.1 North America 21.3 29.5 39.7 Asia Pacific 47.4 45.0 46.2 Bottling Investments (17.2 ) (9.3 ) 0.0 Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2018 versus Year Ended December 31, 2017 In 2018, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 6 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the Argentine peso, Mexican peso, Brazilian real and Australian dollar, which had an unfavorable impact on our Latin America and Asia Pacific operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, British pound sterling, Japanese yen and South African rand, which had a favorable impact on our Europe, Middle East and Africa and Asia Pacific operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2018 and 2017 was $3,714 million and $3,625 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 6 percent and favorable price, product and geographic mix and lower other operating charges, partially offset by increased marketing investments primarily related to key product launches and an unfavorable foreign currency exchange rate impact of 5 percent. Operating income for the Latin America segment for the years ended December 31, 2018 and 2017 was $2,321 million and $2,218 million , respectively. Operating income growth for the segment reflects favorable price and product mix and growth in concentrate sales volume of 1 percent, partially offset by an unfavorable foreign currency exchange rate impact of 12 percent. North America's operating income for the years ended December 31, 2018 and 2017 was $2,453 million and $2,591 million , respectively. The decrease in operating income was driven by higher freight costs and the impact of structural changes, partially offset by lower other operating charges. The operating margin decrease in 2018 was primarily related to the adoption of the new revenue recognition accounting standard. Refer to Note 3 of Notes to Consolidated Financial Statements. Operating income for Asia Pacific for the years ended December 31, 2018 and 2017 was $2,278 million and $2,147 million , respectively. Operating income growth for the segment reflects concentrate sales volume growth of 4 percent. Foreign currency exchange rates had a nominal impact. Our Bottling Investments segment's operating loss for the years ended December 31, 2018 and 2017 was $649 million and $962 million , respectively. The decrease in operating loss reflects lower other operating charges, partially offset by the unfavorable impact of divestitures. Corporate's operating loss for the years ended December 31, 2018 and 2017 was $1,417 million and $2,020 million , respectively. The operating loss in 2018 was favorably impacted by lower selling, general and administrative expenses as a result of productivity initiatives, lower other operating charges and mark-to-market adjustments related to our economic hedging activities. Based on current spot rates and our hedging coverage in place, we expect currencies will have an unfavorable impact on operating income in 2019. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 3 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the British pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2017 and 2016 was $3,625 million and $3,668 million , respectively. Operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 3 percent, partially offset by favorable price, product and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2017 and 2016 was $2,218 million and $1,953 million , respectively. Operating income for the segment reflects favorable price mix, a reduction in other operating charges and a nominal impact from foreign currency exchange rate fluctuations. North America's operating income for the years ended December 31, 2017 and 2016 was $2,591 million and $2,614 million , respectively. The decrease in the segment's operating income was due to higher other operating charges and an unfavorable foreign currency exchange rate impact of 1 percent, partially offset by favorable price and product and package mix. Operating income for Asia Pacific for the years ended December 31, 2017 and 2016 was $2,147 million and $2,210 million , respectively. The decline in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 6 percent and unfavorable price, product and geographic mix. Our Bottling Investments segment's operating loss for the year ended December 31, 2017 was $962 million , compared to operating income for the year ended December 31, 2016 of $1 million . The Bottling Investments segment was unfavorably impacted by acquisitions and divestitures and $737 million of asset impairment charges related to CCR in 2017. Corporate's operating loss for the years ended December 31, 2017 and 2016 was $2,020 million and $1,789 million , respectively. The operating loss in 2017 was unfavorably impacted by higher other operating charges. Interest Income Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest income was $ 682 million in 2018 , compared to $ 677 million in 2017 , an increase of $5 million, or 1 percent. The increase primarily reflects higher interest rates earned on certain investments, partially offset by lower investment balances in certain of our international locations. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest income was $ 677 million in 2017 , compared to $ 642 million in 2016 , an increase of $35 million, or 6 percent. The increase primarily reflects higher investment balances in certain of our international locations, partially offset by lower interest rates earned on certain investments. Interest Expense Year Ended December 31, 2018 versus Year Ended December 31, 2017 Interest expense was $ 919 million in 2018 , compared to $ 841 million in 2017 , an increase of $78 million, or 9 percent. This increase was primarily due to the impact of higher short-term U.S. interest rates, which was partially offset by a net gain of $27 million related to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest expense was $ 841 million in 2017 , compared to $ 733 million in 2016 , an increase of $108 million, or 15 percent. The increase primarily reflects the impact of short-term U.S. interest rates and longer debt maturities, both of which resulted in higher interest rates on the Company's debt portfolio. Additionally, interest expense during the year ended December 31, 2017 included a net charge of $38 million due to the early extinguishment of certain long-term debt. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2018 versus Year Ended December 31, 2017 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2018 , equity income was $ 1,008 million , compared to equity income of $ 1,071 million in 2017 , a decrease of $63 million, or 6 percent. This decrease reflects, among other things, the dissolution of our BPW joint venture and the consolidation of CCBA. In addition, the Company recorded net charges of $111 million and $92 million in the line item equity income (loss) net during the years ended December 31, 2018 and December 31, 2017 , respectively. These amounts represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017 , equity income was $ 1,071 million , compared to equity income of $ 835 million in 2016 , an increase of $236 million, or 28 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees. Additionally, the increase was attributable to the impact of the equity investment in CCEP acquired in 2016 and the impact of the equity investment in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas"") that was acquired in 2017. The favorable impact of these items was partially offset by the derecognition of the Company's former equity method investment in South Africa in 2016. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Other Income (Loss) Net Other income (loss) net includes, among other things, the impact of foreign currency exchange gains and losses; dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to business combinations and disposals; non-service cost components of net periodic benefit cost for pension and postretirement benefit plans; other benefit plan charges and credits; realized and unrealized gains and losses on equity securities and trading debt securities; and realized gains and losses on available-for-sale debt securities. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. In 2018, other income (loss) net was a loss of $1,121 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees and charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities and charges of $240 million related to pension settlements. Other income (loss) net also included net foreign currency exchange losses of $144 million. Additionally, we recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley"") and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 of Notes to Consolidated Financial Statements for additional information on equity and debt securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information on our hedging activities. Refer to Note 17 of Notes to Consolidated Financial Statements for information on the impairment charges. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2017, other income (loss) net was a loss of $1,764 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $57 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America and China bottling refranchising, the conversion payments and our consolidation of CCBA. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. In 2016, other income (loss) net was a loss of $1,265 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a net charge of $139 million resulting from special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. The Company also recorded a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred net foreign currency exchange losses of $246 million, including a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These losses were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations, dividend income of $55 million and net gains of $83 million related to trading securities and the sale of available-for-sale securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising, the deconsolidation of our South African bottling operations, the conversion payments and the deconsolidation of our German bottling operations. Refer to Note 20 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments and Corporate. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2019 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 318 million , $ 221 million and $ 105 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2017 Statutory U.S. federal tax rate 21.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.5 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.2 1,2 (9.7 ) (17.5 ) 7 Equity income or loss (2.4 ) (3.4 ) (3.0 ) Tax Reform Act 0.1 3 53.5 4 Excess tax benefits on stock-based compensation (1.2 ) (2.0 ) Other net (0.8 ) 7.9 5,6 3.8 8 Effective tax rate 19.4 % 82.5 % 19.5 % 1 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees. Refer to Note 17 of Notes to Consolidated Financial Statements. 2 Includes tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 3 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 4 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 5 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 6 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 7 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 8 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. As of December 31, 2018 , the gross amount of unrecognized tax benefits was $ 336 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 182 million , exclusive of any benefits related to interest and penalties. The remaining $ 154 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 18 1 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (4 ) (40 ) 1 Decrease due to lapse of the applicable statute of limitations Increase (decrease) due to effect of foreign currency exchange rate changes (17 ) (6 ) Ending balance of unrecognized tax benefits $ $ $ 1 The net increase was primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 190 million , $ 177 million and $ 142 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2018 , 2017 and 2016 , respectively. Of these amounts, $13 million , $35 million and $31 million of expense were recognized through income tax expense in 2018 , 2017 and 2016 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2019 is expected to be approximately 19.5 percent before considering the potential impact of any significant operating and nonoperating items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2019. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates. In addition, our domestic entities have recently borrowed and continue to have the ability to borrow funds in international markets at reasonable interest rates. Our debt financing includes the use of an extensive commercial paper program as part of our overall cash management strategy. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. In addition to the Company's cash balances, commercial paper program, and our ability to issue long-term debt, we also had $ 7,895 million in lines of credit for general corporate purposes as of December 31, 2018 . These backup lines of credit expire at various times from 2019 through 2022 . We have significant operations outside the United States. Unit case volume outside the United States represented 82 percent of the Company's worldwide unit case volume in 2018. We earn a substantial amount of our consolidated operating income and income from continuing operations before income taxes from foreign subsidiaries that either sell concentrates and syrups to our local bottling partners or, in certain instances, sell finished products directly to our customers to fulfill the demand for Company beverage products outside the United States. A significant portion of these foreign earnings was previously considered to be indefinitely reinvested in foreign jurisdictions where the Company has made, and will continue to make, substantial investments to support the ongoing development and growth of our international operations. Accordingly, no U.S. federal and state income taxes were previously provided on the portion of our foreign earnings that was considered to be indefinitely reinvested in foreign jurisdictions. On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017, transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. As a result, the Company recognized a provisional tax charge related to the one-time transition tax in the amount of $4.6 billion in 2017. During 2018, we recognized $0.3 billion of additional provisional transition tax expense. The Company's cash, cash equivalents, short-term investments and marketable securities held by our foreign subsidiaries totaled $14.4 billion as of December 31, 2018 . Net operating revenues in the United States were $11.3 billion in 2018, or 36 percent of the Company's consolidated net operating revenues. We expect existing domestic cash, cash equivalents, short-term investments, marketable securities, cash flows from operations, the repatriation of foreign earnings and the issuance of debt to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities. In addition, we expect foreign cash, cash equivalents, short-term investments and marketable securities remaining after repatriation, as well as cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities. Based on all the aforementioned factors, the Company believes its current liquidity position is strong, and we will continue to meet all of our financial commitments for the foreseeable future. These obligations and anticipated cash outflows include, but are not limited to, regular quarterly dividends, debt maturities, capital expenditures, share repurchases and obligations included under the heading ""Off-Balance Sheet Arrangements and Aggregate Contractual Obligations"" below. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2018 , 2017 and 2016 was $ 7,320 million , $ 6,930 million and $ 8,792 million , respectively. Net cash provided by operating activities increased $390 million , or 6 percent, in 2018 compared to 2017 . This increase was primarily driven by operating income growth and the efficient management of working capital partially offset by the impact of refranchising bottling operations and higher interest and tax payments. Refer to Note 11 and Note 15 of Notes to Consolidated Financial Statements for additional information on interest payments and tax payments. Net cash provided by operating activities decreased $1,862 million, or 21 percent, in 2017 compared to 2016 . This decrease was primarily driven by the refranchising of certain bottling operations, the unfavorable impact of foreign currency exchange rate fluctuations, one less day in 2017, and increased payments related to income taxes and restructuring. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 15 of Notes to Consolidated Financial Statements for additional information on the tax payments. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, Purchases of investments $ (7,789 ) $ (17,296 ) $ (16,626 ) Proceeds from disposals of investments 14,977 16,694 17,842 Acquisitions of businesses, equity method investments and nonmarketable securities (1,040 ) (3,809 ) (838 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 1,035 Purchases of property, plant and equipment (1,347 ) (1,675 ) (2,262 ) Proceeds from disposals of property, plant and equipment Other investing activities (60 ) (93 ) (305 ) Net cash provided by (used in) investing activities $ 6,348 $ (2,254 ) $ (1,004 ) Purchases of Investments and Proceeds from Disposals of Investments In 2018 , purchases of investments were $ 7,789 million and proceeds from disposals of investments were $ 14,977 million . This activity resulted in a net cash inflow of $7,188 million during 2018 . In 2017 , purchases of investments were $ 17,296 million and proceeds from disposals of investments were $ 16,694 million , resulting in a net cash outflow of $602 million . In 2016 , purchases of investments were $ 16,626 million and proceeds from disposals of investments were $ 17,842 million , resulting in a net cash inflow of $1,216 million . The investments purchased in all three years include time deposits that had maturities greater than three months but less than one year and were classified in the line item short-term investments in our consolidated balance sheets. The disposals in 2016 included proceeds from the disposal of the Company's investment in Keurig Green Mountain, Inc. (""Keurig"") of $2,380 million. The remaining activity primarily represents the purchases of and proceeds from short-term investments that were made as part of the Company's overall cash management strategy as well as our insurance captive investments. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in Keurig. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2018 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 1,040 million , which was primarily related to the acquisition of a controlling interest in the Philippine bottling operations and an equity interest in BA Sports Nutrition, LLC (""BodyArmor""). Additionally, the Company acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,809 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity was primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. In 2016 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $838 million , which was primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd., a maker of plant-based protein beverages in China, and a minority investment in CHI Limited, a Nigerian producer of value-added dairy and juice beverages. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2018 , 2017 and 2016 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 1,362 million , primarily related to the proceeds from the refranchising of our Canadian and Latin American bottling operations as well as the the sale of our equity ownership in Lindley. In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. In 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $1,035 million , primarily related to proceeds from the refranchising of certain bottling territories in North America. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2018 , 2017 and 2016 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment net of disposals for the years ended December 31, 2018 , 2017 and 2016 were $1,102 million , $1,571 million and $2,112 million , respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment and Corporate were as follows (in millions): Year Ended December 31, Capital expenditures $ 1,347 $ 1,675 $ 2,262 Europe, Middle East Africa 5.7 % 4.8 % 2.7 % Latin America 6.7 3.3 2.0 North America 31.8 32.3 19.4 Asia Pacific 2.3 3.0 4.7 Bottling Investments 23.5 39.5 58.8 Corporate 30.0 17.1 12.4 We expect our annual 2019 capital expenditures to be approximately $2.0 billion as we continue to make investments to enable growth in our business and further enhance our operational effectiveness. The increase in 2019 is primarily the result of the acquisition of Costa in January 2019 and the acquisition of a controlling interest in the Philippine bottling operations in December 2018. Other Investing Activities In 2016, cash used in other investing activities was primarily related to the cash flow impact of the Company's derivative contracts designated as net investment hedges and the purchases of trademarks. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information on the Company's derivative contracts designated as net investment hedges. Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 27,339 $ 29,857 $ 27,281 Payments of debt (30,568 ) (28,768 ) (25,615 ) Issuances of stock 1,476 1,595 1,434 Purchases of stock for treasury (1,912 ) (3,682 ) (3,681 ) Dividends (6,644 ) (6,320 ) (6,043 ) Other financing activities (243 ) (91 ) Net cash provided by (used in) financing activities $ (10,552 ) $ (7,409 ) $ (6,545 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2018 , our long-term debt was rated ""A+"" by Standard Poor's and ""A1"" by Moody's. Our commercial paper program was rated ""A-1"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Consolidated, Inc. (formerly Coca-Cola Bottling Co. Consolidated), Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2018, the Company had issuances of debt of $27,339 million , which primarily included $24,253 million of issuances related to commercial paper and short-term debt with maturities greater than 90 days and $3,083 million of net issuances related to commercial paper and short-term debt with maturities of 90 days or less. During 2018, the Company made payments of debt of $30,568 million , which included $27,249 million of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,319 million. In 2017, the Company had issuances of debt of $29,857 million , which included issuances of $26,218 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million, net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,768 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,156 of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million. The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Coca-Cola Enterprises Inc.'s former North America business (""Old CCE""). This resulted in a net charge of $38 million that was recorded in the line item interest expense in our consolidated statement of income. This net charge reflects the difference between the reacquisition price and the net carrying amount of the debt extinguished. In 2016, the Company had issuances of debt of $27,281 million , which included net issuances of $773 million of commercial paper and short-term debt with maturities of 90 days or less and $21,525 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $4,983 million, net of related discounts and issuance costs. During 2016, the Company made payments of debt of $25,615 million , which included $22,920 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $2,695 million. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE of $ 212 million and $ 263 million as of December 31, 2018 and 2017 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2018 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 871 million , $ 757 million and $ 663 million in 2018 , 2017 and 2016 , respectively. Refer to Note 11 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt balances. Issuances of Stock The issuances of stock in 2018 , 2017 and 2016 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase program of up to 500 million shares of the Company's common stock. The table below presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 45.09 $ 44.09 $ 43.62 Since the inception of our initial share repurchase program in 1984 through our current program as of December 31, 2018 , we have purchased 3.5 billion shares of our Company's common stock at an average price per share of $17.06. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2018, we repurchased $1.9 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2018 resulted in a net cash outflow of $0.4 billion . In 2019, we expect to repurchase shares to offset dilution resulting from employee stock-based compensation plans. Dividends The Company paid dividends of $6,644 million , $6,320 million and $6,043 million during the years ended December 31, 2018 , 2017 and 2016 , respectively. At its February 2019 meeting, our Board of Directors increased our regular quarterly dividend by 2.6 percent, raising it to $0.40 per share, equivalent to a full year dividend of $1.60 per share in 2019. This is our 57 th consecutive annual increase. Our annualized common stock dividend was $ 1.56 per share, $ 1.48 per share and $ 1.40 per share in 2018 , 2017 and 2016 , respectively. The 2018 dividend represented a 5 percent increase from 2017 , and the 2017 dividend represented a 6 percent increase from 2016 . Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2018 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 600 million , of which $ 247 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. Management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2018 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2018 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2020-2021 2022-2023 2024 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 13,063 $ 13,063 $ $ $ Lines of credit and other short-term borrowings Current maturities of long-term debt 2 4,999 4,999 Long-term debt, net of current maturities 2 25,230 7,203 6,463 11,564 Estimated interest payments 3 3,907 2,105 Accrued income taxes 4 4,364 1,128 2,206 Purchase obligations 5 14,840 8,344 1,512 1,066 3,918 Marketing obligations 6 4,260 2,333 1,035 Lease obligations Held-for-sale obligations 7 1,722 1,722 Total contractual obligations $ 73,211 $ 31,612 $ 11,369 $ 9,842 $ 20,388 1 Refer to Note 11 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 11 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be made by the Company in future periods and excludes the noncash portion of debt, including any fair market value adjustments, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2018 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 15 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes include $3,986 million related to the one-time transition tax required by the Tax Reform Act. Liabilities of $522 million for unrecognized tax benefits plus accrued interest and penalties were not included in the total above. At this time, the settlement period for these liabilities cannot be determined. In addition, any payments related to unrecognized tax benefits may be partially or fully offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents liabilities and contractual obligations of the Company's bottling operations that are classified as held for sale. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2018 was $1,817 million . Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, pension expense, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. As of December 31, 2018 , the projected benefit obligation of the U.S. qualified pension plans was $5,170 million, and the fair value of the related plan assets was $4,842 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $2,834 million, and the fair value of the related plan assets was $2,567 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $66 million in 2019, increasing to $70 million by 2025 and then decreasing annually thereafter. Refer to Note 14 of Notes to Consolidated Financial Statements. The Company expects to contribute $32 million in 2019 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 14 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our various plans in the table above. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2018 , our self-insurance reserves totaled $ 362 million . Refer to Note 12 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2018 were $1,933 million . Refer to Note 15 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, on January 3, 2019, the Company completed the acquisition of Costa for $4.9 billion , which is not included in the table above. Refer to Note 22 of Notes to Consolidated Financial Statements. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2018 , we used 72 functional currencies in addition to the U.S. dollar. Due to the geographic diversity of our operations, weaknesses in some of these currencies may be offset by strengths in others. In 2018 and 2017 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies (1 )% % Brazilian real (12 )% % Mexican peso (2 ) (2 ) Australian dollar (2 ) South African rand British pound sterling (6 ) Euro Japanese yen (3 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the potentially unfavorable impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 1 percent in 2018 and 2017 . The total currency impact on income from continuing operations before income taxes, including the effect of our hedging activities, was a decrease of 7 percent in 2018 and was nominal in 2017 . Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated statements of income. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded net foreign currency exchange losses of $144 million, $57 million and $246 million during the years ended December 31, 2018 , 2017 and 2016 , respectively. Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. During the year ended December 31, 2016 the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the former open market exchange rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. We sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the year ended December 31, 2016 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expected to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded a write-down of $76 million , which was recorded in the line item other operating charges in our consolidated statement of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of the impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. Overview of Financial Position The following table illustrates the change in the individual line items of the Company's consolidated balance sheet (in millions): December 31, Increase (Decrease) Percent Change Cash and cash equivalents $ 8,926 $ 6,006 $ 2,920 % Short-term investments 2,025 9,352 (7,327 ) (78 ) Marketable securities 5,013 5,317 (304 ) (6 ) Trade accounts receivable net 3,396 3,667 (271 ) (7 ) Inventories 2,766 2,655 Prepaid expenses and other assets 1,962 2,000 (38 ) (2 ) Assets held for sale (219 ) (100 ) Assets held for sale discontinued operations 6,546 7,329 (783 ) (11 ) Equity method investments 19,407 20,856 (1,449 ) (7 ) Other investments 1,096 (229 ) (21 ) Other assets 4,139 4,230 (91 ) (2 ) Deferred income tax assets 2,667 2,337 Property, plant and equipment net 8,232 8,203 Trademarks with indefinite lives 6,682 6,729 (47 ) (1 ) Bottlers' franchise rights with indefinite lives (87 ) (63 ) Goodwill 10,263 9,401 Other intangible assets (94 ) (26 ) Total assets $ 83,216 $ 87,896 $ (4,680 ) (5 )% Accounts payable and accrued expenses $ 8,932 $ 8,748 $ % Loans and notes payable 13,194 13,205 (11 ) Current maturities of long-term debt 4,997 3,298 1,699 Accrued income taxes (32 ) (8 ) Liabilities held for sale (37 ) (100 ) Liabilities held for sale discontinued operations 1,722 1,496 Long-term debt 25,364 31,182 (5,818 ) (19 ) Other liabilities 7,638 8,021 (383 ) (5 ) Deferred income tax liabilities 1,933 2,522 (589 ) (23 ) Total liabilities $ 64,158 $ 68,919 $ (4,761 ) (7 )% Net assets $ 19,058 $ 18,977 $ 1 % 1 Includes a decrease in net assets of $2,035 million resulting from foreign currency translation adjustments in various balance sheet line items. The increases (decreases) in the table above include the impact of the following transactions and events: Assets held for sale discontinued operations decreased primarily due to a $554 million impairment charge and a $411 million allocation of goodwill to other reporting units. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements. Equity method investments decreased primarily due to the derecognition of our equity method interest in the Philippine bottling operations as well as other-than-temporary impairment charges of $591 million related to certain of our equity method investees. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements. Deferred income tax assets increased primarily as a result of our adoption of ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory , which required us to record a deferred tax asset of $2.9 billion during the year ended December 31, 2018 . Refer to Note 1 and Note 15 of Notes to Consolidated Financial Statements. Goodwill increased primarily due to the acquisition of the Philippine bottling operations and the allocation of goodwill from CCBA to other reporting units. Refer to Note 2 and Note 9 of Notes to Consolidated Financial Statements. Current maturities of long-term debt increased and long-term debt decreased primarily due to a portion of the Company's long-term debt maturing within the next 12 months and being reclassified as current. Current maturities of long-term debt were reduced by payments. Refer to the heading ""Cash Flows from Financing Activities"" above for additional information. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 6 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2018 , we used 72 functional currencies in addition to the U.S. dollar and generated $20,512 million of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies may be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options (principally euros, British pounds sterling and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $17,142 million and $13,057 million as of December 31, 2018 and 2017 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $83 million as of December 31, 2018 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $191 million. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $40 million as of December 31, 2018 , and we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized loss and created a net unrealized gain of $217 million. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2018 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $251 million in 2018 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid debt securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $100 million decrease in the fair value of our portfolio of highly liquid debt securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution operations. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases and transportation of materials used in our manufacturing processes. Open commodity derivatives that qualify for hedge accounting had notional values of $9 million and $35 million as of December 31, 2018 and 2017 , respectively. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of $1 million as of December 31, 2018 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $2 million. Open commodity derivatives that do not qualify for hedge accounting had notional values of $373 million and $357 million as of December 31, 2018 and 2017 , respectively. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $44 million as of December 31, 2018 , and we estimate that a 10 percent decrease in underlying commodity prices would have increased the net unrealized loss to $69 million. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 70 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, (In millions except per share data) NET OPERATING REVENUES $ 31,856 $ 35,410 $ 41,863 Cost of goods sold 11,770 13,255 16,465 GROSS PROFIT 20,086 22,155 25,398 Selling, general and administrative expenses 10,307 12,654 15,370 Other operating charges 1,079 1,902 1,371 OPERATING INCOME 8,700 7,599 8,657 Interest income Interest expense Equity income (loss) net 1,008 1,071 Other income (loss) net (1,121 ) (1,764 ) (1,265 ) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 8,350 6,742 8,136 Income taxes from continuing operations 1,623 5,560 1,586 NET INCOME FROM CONTINUING OPERATIONS 6,727 1,182 6,550 Income (loss) from discontinued operations (net of income taxes of $126, $47 and $0, respectively) (251 ) CONSOLIDATED NET INCOME 6,476 1,283 6,550 Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 6,434 $ 1,248 $ 6,527 Basic net income per share from continuing operations 1 $ 1.58 $ 0.28 $ 1.51 Basic net income (loss) per share from discontinued operations 2 (0.07 ) 0.02 BASIC NET INCOME PER SHARE $ 1.51 $ 0.29 3 $ 1.51 Diluted net income per share from continuing operations 1 $ 1.57 $ 0.27 $ 1.49 Diluted net income (loss) per share from discontinued operations 2 (0.07 ) 0.02 DILUTED NET INCOME PER SHARE $ 1.50 $ 0.29 $ 1.49 AVERAGE SHARES OUTSTANDING BASIC 4,259 4,272 4,317 Effect of dilutive securities AVERAGE SHARES OUTSTANDING DILUTED 4,299 4,324 4,367 1 Calculated based on net income from continuing operations less net income from continuing operations attributable to noncontrolling interests. 2 Calculated based on net income (loss) from discontinued operations less net income from discontinued operations attributable to noncontrolling interests. 3 Per share amounts do not add due to rounding. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, (In millions) CONSOLIDATED NET INCOME $ 6,476 $ 1,283 $ 6,550 Other comprehensive income: Net foreign currency translation adjustments (2,035 ) (626 ) Net gains (losses) on derivatives (7 ) (433 ) (382 ) Net unrealized gains (losses) on available-for-sale securities (34 ) Net change in pension and other benefit liabilities (53 ) TOTAL COMPREHENSIVE INCOME 4,429 2,221 5,506 Less: Comprehensive income attributable to noncontrolling interests TOTAL COMPREHENSIVE INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 4,334 $ 2,148 $ 5,496 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions except par value) ASSETS CURRENT ASSETS Cash and cash equivalents $ 8,926 $ 6,006 Short-term investments 2,025 9,352 TOTAL CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS 10,951 15,358 Marketable securities 5,013 5,317 Trade accounts receivable, less allowances of $489 and $477, respectively 3,396 3,667 Inventories 2,766 2,655 Prepaid expenses and other assets 1,962 2,000 Assets held for sale Assets held for sale discontinued operations 6,546 7,329 TOTAL CURRENT ASSETS 30,634 36,545 EQUITY METHOD INVESTMENTS 19,407 20,856 OTHER INVESTMENTS 1,096 OTHER ASSETS 4,139 4,230 DEFERRED INCOME TAX ASSETS 2,667 PROPERTY, PLANT AND EQUIPMENT net 8,232 8,203 TRADEMARKS WITH INDEFINITE LIVES 6,682 6,729 BOTTLERS' FRANCHISE RIGHTS WITH INDEFINITE LIVES GOODWILL 10,263 9,401 OTHER INTANGIBLE ASSETS TOTAL ASSETS $ 83,216 $ 87,896 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 8,932 $ 8,748 Loans and notes payable 13,194 13,205 Current maturities of long-term debt 4,997 3,298 Accrued income taxes Liabilities held for sale Liabilities held for sale discontinued operations 1,722 1,496 TOTAL CURRENT LIABILITIES 29,223 27,194 LONG-TERM DEBT 25,364 31,182 OTHER LIABILITIES 7,638 8,021 DEFERRED INCOME TAX LIABILITIES 1,933 2,522 THE COCA-COLA COMPANY SHAREOWNERS' EQUITY Common stock, $0.25 par value; Authorized 11,200 shares; Issued 7,040 and 7,040 shares, respectively 1,760 1,760 Capital surplus 16,520 15,864 Reinvested earnings 63,234 60,430 Accumulated other comprehensive income (loss) (12,814 ) (10,305 ) Treasury stock, at cost 2,772 and 2,781 shares, respectively (51,719 ) (50,677 ) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY 16,981 17,072 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS 2,077 1,905 TOTAL EQUITY 19,058 18,977 TOTAL LIABILITIES AND EQUITY $ 83,216 $ 87,896 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (In millions) OPERATING ACTIVITIES Consolidated net income $ 6,476 $ 1,283 $ 6,550 (Income) loss from discontinued operations (101 ) Net income from continuing operations 6,727 1,182 6,550 Depreciation and amortization 1,086 1,260 1,787 Stock-based compensation expense Deferred income taxes (450 ) (1,256 ) (856 ) Equity (income) loss net of dividends (457 ) (628 ) (449 ) Foreign currency adjustments (38 ) Significant (gains) losses on sales of assets net 1,459 1,146 Other operating charges 1,218 Other items (269 ) (224 ) Net change in operating assets and liabilities (1,202 ) 3,464 (225 ) Net cash provided by operating activities 7,320 6,930 8,792 INVESTING ACTIVITIES Purchases of investments (7,789 ) (17,296 ) (16,626 ) Proceeds from disposals of investments 14,977 16,694 17,842 Acquisitions of businesses, equity method investments and nonmarketable securities (1,040 ) (3,809 ) (838 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 1,362 3,821 1,035 Purchases of property, plant and equipment (1,347 ) (1,675 ) (2,262 ) Proceeds from disposals of property, plant and equipment Other investing activities (60 ) (93 ) (305 ) Net cash provided by (used in) investing activities 6,348 (2,254 ) (1,004 ) FINANCING ACTIVITIES Issuances of debt 27,339 29,857 27,281 Payments of debt (30,568 ) (28,768 ) (25,615 ) Issuances of stock 1,476 1,595 1,434 Purchases of stock for treasury (1,912 ) (3,682 ) (3,681 ) Dividends (6,644 ) (6,320 ) (6,043 ) Other financing activities (243 ) (91 ) Net cash provided by (used in) financing activities (10,552 ) (7,409 ) (6,545 ) CASH FLOWS FROM DISCONTINUED OPERATIONS Net cash provided by (used in) operating activities from discontinued operations Net cash provided by (used in) investing activities from discontinued operations (421 ) (58 ) Net cash provided by (used in) financing activities from discontinued operations (38 ) Net cash provided by (used in) discontinued operations EFFECT OF EXCHANGE RATE CHANGES ON CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS (262 ) (5 ) CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents during the year 2,945 (2,477 ) 1,238 Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of year 6,373 8,850 7,612 Cash, cash equivalents, restricted cash and restricted cash equivalents at end of year 9,318 6,373 8,850 Less: Restricted cash and restricted cash equivalents at end of year Cash and cash equivalents at end of year $ 8,926 $ 6,006 $ 8,555 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY Year Ended December 31, (In millions except per share data) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year 4,259 4,288 4,324 Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (39 ) (82 ) (86 ) Balance at end of year 4,268 4,259 4,288 COMMON STOCK $ 1,760 $ 1,760 $ 1,760 CAPITAL SURPLUS Balance at beginning of year 15,864 14,993 14,016 Stock issued to employees related to stock compensation plans Tax benefit (charge) from stock compensation plans Stock-based compensation expense Other activities (36 ) (3 ) Balance at end of year 16,520 15,864 14,993 REINVESTED EARNINGS Balance at beginning of year 60,430 65,502 65,018 Adoption of accounting standards 1 3,014 Net income attributable to shareowners of The Coca-Cola Company 6,434 1,248 6,527 Dividends (per share $1.56, $1.48 and $1.40 in 2018, 2017 and 2016, respectively) (6,644 ) (6,320 ) (6,043 ) Balance at end of year 63,234 60,430 65,502 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year (10,305 ) (11,205 ) (10,174 ) Adoption of accounting standards 1 (409 ) Net other comprehensive income (loss) (2,100 ) (1,031 ) Balance at end of year (12,814 ) (10,305 ) (11,205 ) TREASURY STOCK Balance at beginning of year (50,677 ) (47,988 ) (45,066 ) Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (1,746 ) (3,598 ) (3,733 ) Balance at end of year (51,719 ) (50,677 ) (47,988 ) TOTAL EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 16,981 $ 17,072 $ 23,062 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS Balance at beginning of year $ 1,905 $ $ Net income attributable to noncontrolling interests Net foreign currency translation adjustments (13 ) Dividends paid to noncontrolling interests (31 ) (15 ) (25 ) Contributions by noncontrolling interests Business combinations 1,805 Deconsolidation of certain entities (157 ) (34 ) Other activities (4 ) TOTAL EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS $ 2,077 $ 1,905 $ 1 Refer to Note 1 , Note 3 , Note 4 and Note 15 . Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES When used in these notes, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. Description of Business The Coca-Cola Company is the world's largest nonalcoholic beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries and territories. We make our branded beverage products available to consumers throughout the world through our network of independent bottling partners, distributors, wholesalers and retailers as well as Company-owned or -controlled bottling and distribution operations the world's largest beverage distribution system (""Coca-Cola system""). Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 61 billion servings of all beverages consumed worldwide every day. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Certain prior year amounts in the consolidated financial statements and accompanying notes have been revised to conform to the current year presentation as a result of the adoption of certain accounting standards that became effective January 1, 2018 , as applicable. Refer to the ""Recently Adopted Accounting Guidance"" section within this note below for further details. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 12 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 3,916 million and $ 4,523 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 49 million and $ 1 million as of December 31, 2018 and 2017 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Assets and Liabilities Held for Sale Our Company classifies long-lived assets or disposal groups to be sold as held for sale in the period in which all of the following criteria are met: (1) management, having the authority to approve the action, commits to a plan to sell the asset or disposal group; (2) the asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets or disposal groups; (3) an active program to locate a buyer and other actions required to complete the plan to sell the asset or disposal group have been initiated; (4) the sale of the asset or disposal group is probable, and transfer of the asset or disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond our control extend the period of time required to sell the asset or disposal group beyond one year; (5) the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (6) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We initially measure a long-lived asset or disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held-for-sale criteria are met. Conversely, gains are not recognized on the sale of a long-lived asset or disposal group until the date of sale. We assess the fair value of a long-lived asset or disposal group less any costs to sell each reporting period it remains classified as held for sale and report any subsequent changes as an adjustment to the carrying value of the asset or disposal group, as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. Upon determining that a long-lived asset or disposal group meets the criteria to be classified as held for sale, the Company ceases depreciation and reports long-lived assets and/or the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale, respectively, in our consolidated balance sheet. Refer to Note 2 . Discontinued Operations A disposal group is classified as a discontinued operation when the following criteria are met: (1) the disposal group is a component of an entity; (2) the component of the entity meets the held-for-sale criteria in accordance with our policy described above; and (3) the component of the entity represents a strategic shift in the entity's operating and financial results. Alternatively, if a business meets the criteria for held for sale on the acquisition date, the business is accounted for as a discontinued operation. In October 2017, the Company and Anheuser-Busch InBev (""ABI"") completed the transition of ABI's controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company for $3,150 million , resulting in its consolidation. As CCBA met the criteria for held for sale upon consolidation, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. Revenue Recognition Effective January 1, 2018, we adopted Accounting Standards Codification 606, Revenue from Contracts with Customers (""ASC 606""). Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. Refer to Note 3 . Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $4 billion in 2018 , 2017 and 2016 . As of December 31, 2018 and 2017 , advertising and production costs of $ 54 million and $ 95 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of goods from our manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statements of income. Shipping and handling costs incurred to move goods from our manufacturing locations or sales distribution centers to our customers are also included in the line item cost of goods sold in our consolidated statements of income, except for costs incurred to distribute goods sold by our Company-owned bottlers to our customers, which are included in the line item selling, general and administrative expenses. Our customers generally do not pay us separately for shipping and handling costs. Effective January 1, 2018, we adopted ASC 606. Upon adoption, we made a policy election to recognize the cost of shipping and handling activities that are performed after a customer obtains control of the goods as costs to fulfill our promise to provide goods to the customer. As a result of this election, the Company does not evaluate whether shipping and handling activities are services promised to customers. If revenue is recognized for the related goods before the shipping and handling activities occur, the related costs of those shipping and handling activities are accrued. Refer to Note 3 for additional information regarding revenue recognition. Sales, Use, Value-Added and Excise Taxes The Company collects taxes imposed directly on its customers related to sales, use, value-added, excise and other similar taxes. The Company then remits such taxes on behalf of its customers to the applicable governmental authorities. Upon adoption of ASC 606, we made a policy election to exclude from net operating revenues the tax amounts imposed on revenue-producing transactions that were collected from our customers to be remitted to governmental authorities. Accordingly, such tax amounts are recorded in the line item trade accounts receivable in our consolidated balance sheet when collection of taxes from the customer has not yet occurred and are recorded in the line item accounts payable and accrued expenses in our consolidated balance sheet until they are remitted to the applicable governmental authorities. Taxes imposed directly on the Company, whether based on receipts from sales, inventory procurement costs or manufacturing activities, are recorded in the line item cost of goods sold in our consolidated statement of income. Refer to Note 3 for additional information regarding revenue recognition. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 51 million , 47 million and 51 million stock option awards were excluded from the computations of diluted net income per share in 2018 , 2017 and 2016 , respectively, because the awards would have been antidilutive for the years presented. The following table presents information related to net income from continuing operations and net income from discontinued operations (in millions): Year Ended December 31, 2017 CONTINUING OPERATIONS Net income from continuing operations $ 6,727 $ 1,182 $ 6,550 Less: Net income (loss) from continuing operations attributable to noncontrolling interests (7 ) Net income from continuing operations attributable to shareowners of The Coca-Cola Company $ 6,734 $ 1,181 $ 6,527 DISCONTINUED OPERATIONS Net income (loss) from discontinued operations $ (251 ) $ $ Less: Net income from discontinued operations attributable to noncontrolling interests Net income (loss) from discontinued operations attributable to shareowners of The Coca-Cola Company $ (300 ) $ $ CONSOLIDATED Consolidated net income $ 6,476 $ 1,283 $ 6,550 Less: Net income attributable to noncontrolling interests Net income attributable to shareowners of The Coca-Cola Company $ 6,434 $ 1,248 $ 6,527 Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents or restricted cash equivalents, as applicable. Restricted cash and restricted cash equivalents generally consist of amounts held by our captive insurance companies, which are included in the line item other assets on our consolidated balance sheets, and amounts classified in assets held for sale and assets held for sale discontinued operations. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our concentrations of credit risk. The following table provides a summary of cash, cash equivalents, restricted cash and restricted cash equivalents that constitute the total amounts shown in the consolidated statements of cash flows (in millions): December 31, 2018 December 31, 2017 December 31, 2016 Cash and cash equivalents $ 8,926 $ 6,006 $ 8,555 Cash and cash equivalents included in assets held for sale 49 Cash and cash equivalents included in assets held for sale discontinued operations 97 Cash and cash equivalents included in other assets 1 257 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 9,318 $ 6,373 $ 8,850 1 Amounts represent cash and cash equivalents in our solvency capital portfolio set aside primarily to cover pension obligations in certain of our European and Canadian pension plans. Refer to Note 4 . Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities Effective January 1, 2018, we adopted Accounting Standards Update (""ASU"") 2016-01 Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (""ASU 2016-01""), which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in accumulated other comprehensive income (loss) (""AOCI""), net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Refer to Note 4 for additional information on our policy for investments which include our assessment of impairments. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Activity in the allowance for doubtful accounts was as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Net charges to costs and expenses 1 Write-offs (4 ) (10 ) (10 ) Other 2 (13 ) (11 ) (2 ) Balance at end of year $ $ $ 1 The 2016 amount was primarily related to concentrate sales receivables from our bottling partner in Venezuela. See ""Hyperinflationary Economies"" discussion below for additional information. 2 Other includes foreign currency translation adjustments and the impact of reclassifying certain assets to assets held for sale. Refer to Note 2. A significant portion of our net operating revenues and corresponding accounts receivable is derived from sales of our products in international markets. Refer to Note 3 and Note 20 . We also generate a significant portion of our net operating revenues by selling concentrates and syrups to bottlers in which we have a noncontrolling interest. Refer to Note 7 . Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheets in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statements of cash flows in net cash provided by operating activities. Refer to Note 6 . Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery, equipment and vehicle fleet: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under capital lease, totaled $ 999 million , $ 1,131 million and $ 1,575 million in 2018 , 2017 and 2016 , respectively. Amortization expense for leasehold improvements totaled $ 18 million , $ 19 million and $ 22 million in 2018 , 2017 and 2016 , respectively. Refer to Note 8 . Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment test is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. Refer to Note 17 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 9 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment tests as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statements of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 12 . Stock-Based Compensation Our Company grants awards under its stock-based compensation plans to certain employees of the Company. These awards include stock options, restricted stock units, restricted stock and performancebased share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the stock option grant is earned by the employee, generally four years . The fair value of our restricted stock units, restricted stock and certain performance-based share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance-based share units granted from 2014 to 2017 and for performance-based share units granted to executives in 2018, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance-based share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance threshold specified in the performance-based share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of stock-based compensation awards that are expected to vest to determine the amount of compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 13 . Income Taxes Income tax expense includes U.S., state, local and international income taxes, plus a provision for U.S. taxes on undistributed earnings of foreign subsidiaries and other prescribed foreign entities not deemed to be indefinitely reinvested. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company records taxes that are collected from customers and remitted to governmental authorities on a net basis in our consolidated statements of income. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 12 and Note 15 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 16 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statements of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 6 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the former open market exchange rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. We sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the year ended December 31, 2016 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expected to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded a write-down of $76 million , which was recorded in the line item other operating charges in our consolidated statement of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized an impairment charge of $34 million during the year ended December 31, 2017 , which was recorded in the line item other operating charges in our consolidated statement of income. As a result of this impairment charge, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Recently Adopted Accounting Guidance In May 2014, the Financial Accounting Standards Board (""FASB"") issued ASU 2014-09, Revenue from Contracts with Customers , which replaces most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. ASU 2014-09 and its amendments were included primarily in ASC 606. The core principle of ASC 606 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASC 606 also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. We adopted ASC 606 effective January 1, 2018, using the modified retrospective method. We recognized a cumulative effect adjustment to decrease the opening balance of reinvested earnings as of January 1, 2018 by $257 million , net of tax. The Company has changed our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data for the reporting process. Refer to Note 3 . In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 was effective for the Company beginning January 1, 2018, and we are now recognizing any changes in the fair value of certain equity investments in net income as prescribed by the new standard rather than in other comprehensive income (""OCI""). We recognized a cumulative effect adjustment to increase the opening balance of reinvested earnings as of January 1, 2018 by $409 million , net of tax. Refer to Note 4 for additional disclosures required by this ASU. In March 2016, the FASB issued ASU 2016-09, Compensation Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The Company adopted ASU 2016-09 on January 1, 2017 by prospectively recognizing excess tax benefits and tax deficiencies in our consolidated statement of income as the awards vested or were settled. Effective January 1, 2017, the Company also prospectively presented excess tax benefits as an operating activity, rather than a financing activity, in our consolidated statement of cash flows. Had these changes been required to be adopted retrospectively, during the year ended December 31, 2016 , the Company would have recognized an additional $130 million of excess tax benefits in our consolidated statement of income. Additionally, during the year ended December 31, 2016 , the Company would have reduced our financing activities and increased our operating activities by $130 million in our consolidated statement of cash flows. The Company has elected, consistent with past practice, to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments , which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 was effective for the Company beginning January 1, 2018 and was adopted using the retrospective transition approach to all periods presented. The impact of the adoption of ASU 2016-15 on our consolidated statement of cash flows was a change in presentation related to our proceeds from the settlement of corporate-owned life insurance policies. We revised our consolidated statement of cash flows to reflect these proceeds in the line item other investing activities, which were previously presented in the line item net change in operating assets and liabilities. During the years ended December 31, 2017 and 2016 , the amount of proceeds received from the settlement of corporate-owned life insurance policies was $65 million and $3 million , respectively. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (""ASU 2016-16""), which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings, with the majority of the offset being recorded in the line item deferred income tax assets in our consolidated balance sheet. Refer to Note 15 . In November 2016, the FASB issued ASU 2016-18, Restricted Cash . The amendments in this update address diversity in practice that exists in the classification and presentation of changes in amounts generally described as restricted cash and require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts that an entity defines as restricted cash for purposes of this standard or otherwise does not present in the line item cash and cash equivalents on its balance sheet. ASU 2016-18 was effective for the Company beginning January 1, 2018 and was adopted using the retrospective transition method to all periods presented. Prior to the adoption of ASU 2016-18, we presented the transfer of cash and cash equivalents into or out of our captive insurance companies in the line items purchases of investments and proceeds from disposals of investments in our consolidated statement of cash flows. We did not present the purchases of investments and proceeds from disposals of investments within our captive insurance companies. Cash flows related to cash and cash equivalents included in our insurance captives are now presented in the line items purchases of investments and proceeds from disposals of investments within the investing activities section of our consolidated statement of cash flows. During the year ended December 31, 2017 , the purchases of investments and proceeds from disposals of investments within our captive insurance companies were $777 million and $773 million , respectively. During the year ended December 31, 2016 , the purchases of investments and proceeds from disposals of investments within our captive insurance companies were $1,388 million and $1,304 million , respectively. Prior to the adoption of ASU 2016-18, we treated the change in cash and cash equivalents included in assets held for sale as an adjustment to the line item other investing activities within our consolidated statement of cash flows. With the adoption of this ASU, we no longer make this adjustment and we revised the prior year to remove this adjustment. During the year ended December 31, 2017 , the change in cash and cash equivalents included in assets held for sale was $36 million . During the year ended December 31, 2016 , the change in cash and cash equivalents included in assets held for sale was $94 million . Refer to the heading ""Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents"" above for additional disclosures required by this ASU. In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost , which requires that the service cost component of the Company's net periodic pension cost and net periodic postretirement benefit cost be included in the same line item as other compensation costs arising from services rendered by employees, with the non-service cost components of net periodic benefit cost and other benefit plan charges and credits being classified outside of a subtotal of income from operations. ASU 2017-07 was effective for the Company beginning January 1, 2018 and was adopted retrospectively for the presentation of the other components of net periodic benefit cost and other benefit plan charges and credits in our consolidated statements of income. As part of our adoption, we elected to use a practical expedient which allows us to use information previously disclosed in our note on pension and other postretirement benefit plans as the estimation basis for applying the retrospective presentation requirements of this ASU. During the years ended December 31, 2017 and December 31, 2016 , we reclassified $98 million and $31 million of expense, respectively, related to our non-service cost components of net periodic benefit cost and other benefit plan charges and credits from operating income to other income (loss) net in our consolidated statements of income. Refer to Note 14 for additional disclosures required by this ASU. In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Cuts and Jobs Act (""Tax Reform Act""). The amendments also require any provisional amounts or subsequent adjustments to be included in net income from continuing operations. Additionally, this ASU discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company adopted this standard and subsequently finalized the accounting based on the guidance, interpretations and data available as of December 31, 2018 . Refer to Note 15 for additional information on the Tax Reform Act. Accounting Guidance Not Yet Adopted In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize right-of-use assets, representing their right to use the underlying asset for the lease term, and lease liabilities on the balance sheet for all leases with terms greater than 12 months. The guidance also modifies the classification criteria and the accounting for sales-type and direct financing leases by lessors. Additionally, the guidance requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The Company has substantially completed its preparation for the adoption of this new accounting standard. This included assessing the completeness of our lease arrangements, evaluating practical expedients and accounting policy elections, executing changes to our business process, which include our systems and controls, and implementing software to meet the reporting requirements of this standard. ASU 2016-02 is effective for the Company beginning January 1, 2019 . The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. The Company expects to elect certain practical expedients, including the package of practical expedients to not reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs, and is evaluating the other practical expedients available under the guidance. The Company also plans to elect the optional transition method that will give companies the option to use the effective date as the date of initial application on transition, and as a result, we will not adjust our comparative period financial information or make the new required lease disclosures for periods before the effective date. The Company anticipates the adoption of this new standard will result in an increase of approximately 1 percent of total assets and liabilities on our consolidated balance sheet. This estimate does not include transactions that closed in the first quarter of 2019, such as Costa Limited (""Costa""). While we are substantially complete with the process of quantifying the impacts that will result from applying the new guidance, our assessment will be finalized during the first quarter of 2019. We do not expect the new standard to have a material impact on the Company's consolidated statement of income. As the impact of this standard is noncash in nature, we do not anticipate its adoption having an impact on the Company's consolidated statement of cash flows. In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same line item in the statement of income where the hedged item resides. The amendments include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. Finally, the standard introduces new alternatives that permit companies to reduce the risk of material error if the shortcut method is misapplied. ASU 2017-12 is effective for the Company beginning January 1, 2019 and is required to be applied prospectively. The adoption of this ASU is not expected to have a material impact on our consolidated balance sheet, statement of income or statement of cash flows. In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income , which permits entities to reclassify the disproportionate income tax effects of the Tax Reform Act on items within accumulated other comprehensive income (loss) (""AOCI"") to reinvested earnings. These disproportionate income tax effect items are referred to as ""stranded tax effects."" Amendments in this update only relate to the reclassification of the income tax effects of the Tax Reform Act. Other accounting guidance that requires the effect of changes in tax laws or rates to be included in net income from continuing operations is not affected by this update. ASU 2018-02 is effective for the Company beginning January 1, 2019 and should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Reform Act is recognized. We have elected to apply this standard in the period of adoption and will recognize a cumulative effect adjustment to the opening balance of reinvested earnings as of January 1, 2019 . We expect this cumulative effect adjustment to increase reinvested earnings by approximately $500 million . NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2018 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $1,040 million , which included the acquisition of the 51 percent controlling interest in the Philippine bottling operations from Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), an equity method investee. Refer to the ""Philippine Bottling Operations"" section within this note below for further details. Additionally, we acquired a minority interest in BA Sports Nutrition, LLC (""BodyArmor""). We account for our minority interest in BodyArmor as an equity method investment based on our equity ownership percentage and our representation on their Management Committee. We obtained an option to acquire the remaining ownership interests in BodyArmor based on an agreed-upon formula, which becomes exercisable in 2021. Upon the expiration of the Company's option, BodyArmor has the option to sell their remaining interests to the Company based on the same agreedupon formula. The Company also acquired additional ownership interests in the Company's franchise bottlers in the United Arab Emirates and in Oman, both of which were previously equity method investees of the Company. As a result of the additional interest acquired in the Oman bottler, we obtained a controlling interest, resulting in its consolidation. During 2017 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $3,809 million , of which $3,150 million related to the transition of ABI's 54.5 percent controlling interest in CCBA to the Company, resulting in its consolidation in October 2017. The financial position and results of operations of CCBA are being accounted for as a discontinued operation. Refer to the ""Discontinued Operations"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for noncash consideration. Refer to the ""North America Refranchising United States"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. During 2016 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 838 million , which primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd. (""China Green""), a maker of plant-based protein beverages in China, and a minority investment in CHI Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages, which is accounted for under the equity method of accounting. Under the terms of the agreement for our investment in CHI, the Company acquired the remaining ownership interest from the existing shareowners in January 2019. Philippine Bottling Operations In December 2018, the Company acquired the 51 percent controlling interest in the Philippine bottling operations held by CocaCola FEMSA, an equity method investee, in exchange for $715 million of cash. The acquired business had $345 million of cash on hand upon acquisition. The acquisition was a result of Coca-Cola FEMSA exercising the option to sell its ownership interest to the Company. Coca-Cola FEMSA obtained this option when it originally acquired the controlling interest from the Company in 2013. As a result of this acquisition, we now own 100 percent of the Philippine bottling operations. Upon consolidation, we recognized a net charge of $32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. The net charge was recorded in the line item other income (loss) net in our consolidated statement of income. Divestitures During 2018 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,362 million , primarily related to proceeds from the refranchising of our Canadian and Latin American bottling operations, as well as the sale of our equity ownership in Corporacin Lindley S.A. (""Lindley""). During 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. During 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,035 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America. Latin America Bottling Operations As of December 31, 2017 , certain of the Company's bottling operations in Latin America were classified as held for sale. During 2018, the Company sold its bottling operations in Latin America to Coca-Cola FEMSA, an equity method investee. We received net cash proceeds of $289 million as a result of these sales and recognized a net gain of $47 million , which was included in the line item other income (loss) net in our consolidated statement of income. Corporacin Lindley S.A. In September 2018 , we sold our equity ownership in Lindley to AC Bebidas, an equity method investee. We received net cash proceeds of $507 million and recognized a net gain of $296 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising Canada In September 2018 , the Company completed its North America refranchising with the sale of its Canadian bottling operations. We received initial net cash proceeds of $518 million and recognized a net charge of $385 million during the year ended December 31, 2018 , which was included in the line item other income (loss) net in our consolidated statement of income. North America Refranchising United States In conjunction with implementing a new beverage partnership model in North America, the Company refranchised bottling territories in the United States that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas as well as the CBA entered into with Liberty Coca-Cola Beverages, the bottlers make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories to the respective bottlers in exchange for cash, except for the territory included in the Southwest Transaction. As discussed further below, we did not receive cash in the Southwest Transaction for these items. In 2016, the Company formed a new National Product Supply System (""NPSS"") to facilitate optimal operation of the U.S. product supply system. Under the NPSS, the Company and several of its independent producing bottlers administer key national product supply activities for these bottlers. Additionally, CCR sold production assets to these independent producing bottlers in exchange for cash, excluding production facilities included in the Southwest Transaction. During the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , cash proceeds from these sales totaled $3 million , $2,860 million and $1,017 million , respectively. Included in the cash proceeds for the years ended December 31, 2017 and December 31, 2016 was $336 million and $279 million , respectively, from Coca-Cola Bottling Co. Consolidated now known as Coca-Cola Consolidated, Inc. (""CCCI""), an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017 was $220 million from AC Bebidas and $39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized net charges of $91 million , $3,177 million and $2,456 million during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , respectively. Included in these amounts are net charges from transactions with equity method investees or former management of $21 million , $1,104 million and $492 million , during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , respectively. The net charges in 2018 were primarily related to post-closing adjustments as contemplated by the related agreements. The net charges in 2017 and 2016 were primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The net charges in 2017 included $236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain refranchised territories participate. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the statement of income only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the statement of income as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 , the Company recorded charges of $34 million , $313 million and $31 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, as well as consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The charges related to these payments were included in the line item other income (loss) net in our consolidated statements of income during the years ended December 31, 2018 , December 31, 2017 and December 31, 2016 . On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. CCR also made cash payments of $144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Refranchising of China Bottling Operations In 2017, the Company sold its bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and sold a related cost method investment to one of the franchise bottlers. We received net cash proceeds of $963 million as a result of these sales and recognized a gain of $88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. Coca-Cola European Partners In May 2016, the Company merged our German bottling operations with Coca-Cola Enterprises, Inc. (""CCE"") and Coca-Cola Iberian Partners, S.A.U., formerly known as Coca-Cola Iberian Partners, S.A. (""CCIP""), to create Coca-Cola European Partners plc (""CCEP""). In exchange for our German bottling operations, we received an 18 percent interest in CCEP. As a result of recording our interest in CCEP at fair value based on its quoted market price (a Level 1 measurement), the deconsolidation of our German bottling operations, and the related reversal of its cumulative translation adjustments, we recognized a gain of $1,400 million . This gain was partially offset by a $77 million charge incurred as a result of reclassifying losses related to our net investment hedges of our German bottling operations from AOCI into earnings as well as transaction costs incurred resulting in a net gain of $1,287 million during the year ended December 31, 2016. Refer to Note 16 . With the exception of the transaction costs, the net gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in CCEP as an equity method investment based on our equity ownership percentage, our representation on CCEP's Board of Directors, material intercompany transactions and other governance rights. Coca-Cola Beverages Africa Proprietary Limited In July 2016, the Company, SABMiller plc and Gutsche Family Investments combined the bottling operations of each of the parties' nonalcoholic ready-to-drink beverage businesses in Southern and East Africa to form a new bottler, which is called CCBA. The Company: (1) contributed its South African bottling operations to CCBA, which included certain wholly owned subsidiaries and an equity method investment; (2) paid $150 million in cash; (3) obtained a 12 percent interest in CCBA and a 3 percent interest in CCBA's South African subsidiary; and (4) acquired several trademarks that are generally indefinite-lived. As a result of recording our interests in CCBA and its South African subsidiary at fair value, the deconsolidation of our South African bottling operations, the derecognition of the equity method investment, and the reversal of related cumulative translation adjustments, we recognized a charge of $21 million . The fair values of the equity investments in CCBA and CCBA's South African subsidiary, along with the acquired trademarks, were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. The loss recognized resulted primarily from the reversal of the related cumulative translation adjustments. This loss was recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016. Based on the level of equity ownership, the Company's representation on CCBA's Board of Directors (two of its ten members) and other governance rights, the Company accounted for its interests in CCBA and CCBA's South African subsidiary as equity method investments. The Company's interest in CCBA provided it with a call option to acquire the ownership interest of SABMiller plc at fair value upon the occurrence of certain events, including upon a change in control of SABMiller plc. In October 2016, ABI acquired SABMiller plc, including its 54.5 percent controlling interest in CCBA, and as a result, we exercised our call option. In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of acquisition. Refer to the ""Discontinued Operations"" section within this note below for further discussion. Keurig Green Mountain, Inc. In March 2016, a JAB Holding Company-led investor group acquired Keurig Green Mountain, Inc. (""Keurig""). As a result, the Company received proceeds of $2,380 million , which were recorded in the line item proceeds from disposals of investments in our consolidated statement of cash flows, and recorded a gain of $18 million related to the disposal of our shares of Keurig in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016. Assets and Liabilities Held for Sale As of December 31, 2017 , the Company had certain bottling operations in North America and Latin America that met the criteria to be classified as held for sale, which requires us to present the related assets and liabilities as separate line items in our consolidated balance sheet. As these bottling territories met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price and present the related assets and liabilities as separate line items in our consolidated balance sheet. These operations were refranchised in 2018. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale in our consolidated balance sheet (in millions): December 31, 2017 Cash, cash equivalents and short-term investments $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Other assets Property, plant and equipment net Bottlers' franchise rights with indefinite lives Goodwill Other intangible assets Allowance for reduction of assets held for sale (28 ) Assets held for sale $ 1 Accounts payable and accrued expenses $ Other liabilities Deferred income taxes Liabilities held for sale $ 2 1 Consists of total assets relating to North America refranchising of $9 million and Latin America bottling operations of $210 million , which are included in the Bottling Investments operating segment. 2 Consists of total liabilities relating to North America refranchising of $5 million and Latin America bottling operations of $32 million , which are included in the Bottling Investments operating segment. We determined that the operations included in the table above did not meet the criteria to be classified as discontinued operations under the applicable guidance. Discontinued Operations In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold a controlling interest in CCBA temporarily. We anticipate that we will divest a portion of our ownership interest in 2019, which will result in the Company no longer having a controlling interest in CCBA. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. As CCBA met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell and present the related assets and liabilities as separate line items in our consolidated balance sheet. During the year ended December 31, 2018 , we recorded an impairment charge of $554 million , reflecting management's view of the proceeds that are expected to be received based on revised projections of future operating results and foreign currency exchange rate fluctuations. Refer to Note 17 . Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. We recorded $1,805 million for the noncontrolling interests of CCBA. The fair value of the noncontrolling interests was determined in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. As a result, upon finalization of purchase accounting $411 million of the final goodwill balance of $4,186 million was allocated to other reporting units expected to benefit from this transaction. During 2018, the Company acquired additional bottling operations in Zambia and Botswana, which have also been included in assets held for sale discontinued operations and liabilities held for sale discontinued operations. The following table presents information related to the major classes of assets and liabilities of CCBA that were classified as held for sale discontinued operations in our consolidated balance sheets (in millions): December 31, 2018 December 31, 2017 Cash, cash equivalents and short-term investments $ $ Trade accounts receivable, less allowances 299 Inventories 299 Prepaid expenses and other assets 52 Equity method investments 7 Other assets 29 Property, plant and equipment net 1,587 1,436 Goodwill 3,847 4,248 Other intangible assets 862 Allowance for reduction of assets held for sale (546 ) Assets held for sale discontinued operations $ 6,546 $ 7,329 Accounts payable and accrued expenses $ $ Loans and notes payable 404 Current maturities of long-term debt 6 Accrued income taxes 40 Long-term debt 19 Other liabilities 10 Deferred income taxes 419 Liabilities held for sale discontinued operations $ 1,722 $ 1,496 NOTE 3 : REVENUE RECOGNITION Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our domestic and international concentrate operations, we typically generate net operating revenues by selling concentrates, syrups and certain finished beverages to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers, such as cans and refillable and nonrefillable glass and plastic bottles, bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. In addition, outside the United States, our bottling partners are typically authorized to manufacture fountain syrups, using our concentrate, which they sell to fountain retailers for use in producing beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our concentrate operations are included in our geographic operating segments. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other finished nonalcoholic beverages, such as water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors and wholesalers who distribute them to retailers. These operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, which are included in our Bottling Investments operating segment. In certain markets, the Company also operates non-bottling finished product operations in which we sell finished beverages to distributors and wholesalers that are generally not one of the Company's bottling partners. These operations are generally included in one of our geographic operating segments. In the United States, we manufacture fountain syrups and sell them to fountain retailers, who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. We adopted ASC 606 effective January 1, 2018 , using the modified retrospective method. We have applied this standard to all contracts at the effective date and contracts entered into thereafter. Revenue is recognized when performance obligations under the terms of the contracts with our customers are satisfied. Our performance obligation generally consists of the promise to sell concentrates or finished products to our bottling partners, wholesalers, distributors or retailers. Control of the concentrates or finished products is transferred upon shipment to, or receipt at, our customers' locations, as determined by the specific terms of the contract. Once control is transferred to the customer, we have completed our performance obligation, and revenue is recognized. Our sales terms generally do not allow for a right of return except for matters related to any manufacturing defects on our part. After completion of our performance obligation, we have an unconditional right to consideration as outlined in the contract. Our receivables will generally be collected in less than six months, in accordance with the underlying payment terms. All of our performance obligations under the terms of contracts with our customers have an original duration of one year or less. Our customers and bottling partners may be entitled to cash discounts, funds for promotional and marketing activities, volume-based incentive programs, support for infrastructure programs and other similar programs. In some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned financial objectives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products produced from the concentrate are sold, and package mix. The amounts associated with the arrangements described above are defined as variable consideration under ASC 606 and an estimate of which is included in the transaction price as a component of net operating revenues in our consolidated statement of income upon completion of our performance obligations. The total revenue recorded, including any variable consideration, cannot exceed the amount for which it is probable that a significant reversal will not occur when uncertainties related to variability are resolved. As a result, we are recognizing revenue based on our faithful depiction of the consideration that we expect to receive. In making our estimates of variable consideration, we consider past results and make significant assumptions related to: (1) customer sales volumes; (2) customer ending inventories; (3) customer selling price per unit; (4) selling channels; and (5) discount rates, rebates and other pricing allowances, as applicable. In gathering data to estimate our variable consideration, we generally calculate our estimates using a portfolio approach at the country and product line level rather than at the individual contract level. The result of making these estimates will impact the line items trade accounts receivable and accounts payable and accrued expenses in our consolidated balance sheet. The actual amounts ultimately paid and/or received may be different from our estimates. The change in the amount of variable consideration recognized during the year ended December 31, 2018 related to performance obligations satisfied in prior periods was immaterial. In addition to changes in the timing of when we record variable consideration, ASC 606 provided clarification about the classification of certain costs relating to revenue arrangements with customers. As a result, during the year ended December 31, 2018 , we recorded certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also re-evaluated the principal versus agent considerations pertaining to certain of its arrangements with third-party manufacturers and co-packers. We recorded certain costs in net operating revenues which were previously recorded in cost of goods sold related to arrangements in which we concluded we did not control the goods before they were delivered to our customers. Prior to the adoption of ASC 606, we recognized revenue when persuasive evidence of an arrangement existed, delivery of products had occurred, the sales price was fixed or determinable and collectibility was reasonably assured. For our Company, this generally meant that we recognized revenue when title to our products was transferred to our bottling partners, resellers or other customers. Title usually transferred upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms did not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers could earn certain incentives which were included in deductions from revenue, a component of net operating revenues in our consolidated statement of income. These incentives included, but were not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. In preparing the financial statements, management made estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considered past results in making such estimates. The actual amounts ultimately paid may have been different from our estimates. Such differences were recorded once they were determined and historically were not significant. The following tables compare the amounts reported in the consolidated statement of income and consolidated balance sheet to the amounts had the previous revenue recognition guidance been in effect (in millions): Year Ended December 31, 2018 As Reported Balances without Adoption of ASC 606 Increase (Decrease) Due to Adoption Net operating revenues $ 31,856 $ 31,191 $ 1 Cost of goods sold 11,770 10,930 1 Gross profit 20,086 20,261 (175 ) Selling, general and administrative expenses 10,307 10,488 (181 ) Operating income 8,700 8,694 Income from continuing operations before income taxes 8,350 8,344 Income taxes from continuing operations 1,623 1,626 Net income from continuing operations 6,727 6,718 Income (loss) from discontinued operations (251 ) (253 ) Consolidated net income 6,476 6,465 Net income attributable to shareowners of The Coca-Cola Company 6,434 6,423 1 The increase was primarily due to the reclassification of shipping and handling costs. December 31, 2018 As Reported Balances without Adoption of ASC 606 Increase (Decrease) Due to Adoption ASSETS Trade accounts receivable $ 3,396 $ 3,302 $ 1 Prepaid expenses and other assets 1,962 1,970 (8 ) Total current assets 30,634 30,548 Deferred income tax assets 2,667 2,649 Total assets 83,216 83,112 LIABILITIES AND EQUITY Accounts payable and accrued expenses $ 8,932 $ 8,513 $ 2 Total current liabilities 29,223 28,804 Deferred income tax liabilities 1,933 2,002 (69 ) Reinvested earnings 63,234 63,480 (246 ) Total equity 19,058 19,304 (246 ) Total liabilities and equity 83,216 83,112 1 The increase was primarily due to incremental estimated variable consideration receivables from third-party customers. 2 The increase was primarily due to incremental estimated variable consideration payables due to third-party customers. The following table presents net operating revenues disaggregated between the United States and International and further by line of business (in millions): United States International Total Year Ended December 31, 2018 Concentrate operations $ 4,571 $ 15,886 $ 20,457 Finished product operations 6,773 4,626 11,399 Total $ 11,344 $ 20,512 $ 31,856 Refer to Note 20 for additional revenue disclosures by operating segment and Corporate. NOTE 4 : INVESTMENTS Equity Securities Effective January 1, 2018, we adopted ASU 2016-01, which requires us to measure all equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in earnings. We use quoted market prices to determine the fair value of equity securities with readily determinable fair values. For equity securities without readily determinable fair values, we have elected the measurement alternative under which we measure these investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Management assesses each of these investments on an individual basis. We recognized a cumulative effect adjustment of $409 million , net of tax, to increase the opening balance of reinvested earnings with an offset to AOCI as of January 1, 2018 in connection with the adoption of ASU 2016-01. Prior to the adoption of ASU 2016-01, marketable equity securities not accounted for under the equity method were classified as either trading or available-for-sale. Both realized and unrealized gains and losses on equity securities classified as trading securities were recognized in net income. For equity securities classified as available-for-sale, realized gains and losses were included in net income. Unrealized gains and losses on equity securities classified as available-for-sale were recognized in AOCI, net of tax. Equity securities without readily determinable fair values were recorded at cost. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. The cost basis is determined by the specific identification method. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading debt securities as well as realized gains and losses on available-for-sale debt securities are included in net income. Unrealized gains and losses, net of tax, on available-for-sale debt securities are included in our consolidated balance sheet as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Refer to Note 6 for additional information related to the Company's fair value hedges of available-for-sale debt securities. Equity securities with readily determinable fair values that are not accounted for under the equity method and debt securities classified as trading are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. Similarly, prior to the adoption of ASU 2016-01, equity investments classified as trading were not tested for impairment. Equity method investments, equity securities without readily determinable fair values and debt securities classified as available-for-sale or held-to-maturity are, and prior to the adoption of ASU 2016-01, equity securities classified as available-for-sale and cost method investments were, reviewed each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As of December 31, 2018 , the carrying values of our equity securities were included in the following line items in our consolidated balance sheet (in millions): Fair Value with Changes Recognized in Income Measurement Alternative No Readily Determinable Fair Value Marketable securities $ $ Other investments 80 Other assets Total equity securities $ 1,934 $ The calculation of net unrealized gains and losses recognized during the year related to equity securities still held at December 31, 2018 is as follows (in millions): Year Ended December 31, 2018 Net gains (losses) recognized during the year related to equity securities $ (250 ) Less: Net gains (losses) recognized during the year related to equity securities sold during the year Net unrealized gains (losses) recognized during the year related to equity securities still held at the end of the year $ (258 ) As of December 31, 2017 , our equity securities consisted of the following (in millions): Gross Unrealized Estimated Cost Gains Losses Fair Value Trading securities $ $ $ (4 ) $ Available-for-sale securities 1,276 (66 ) 1,895 Total equity securities $ 1,600 $ $ (70 ) $ 2,290 As of December 31, 2017 , the fair values of our equity securities were included in the following line items in our consolidated balance sheet (in millions): Trading Securities Available-for-Sale Securities Marketable securities $ $ Other investments Other assets 890 Total equity securities $ $ 1,895 The sale and/or maturity of available-for-sale equity securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ Gross losses (19 ) Proceeds 95 Debt Securities Our debt securities consisted of the following (in millions): Gross Unrealized Estimated Cost Gains Losses Fair Value December 31, 2018 Trading securities $ $ $ (1 ) $ Available-for-sale securities 4,901 (27 ) 4,993 Total debt securities $ 4,946 $ $ (28 ) $ 5,037 December 31, 2017 Trading securities $ $ $ $ Available-for-sale securities 5,782 (27 ) 5,912 Total debt securities $ 5,794 $ $ (27 ) $ 5,924 The fair values of our debt securities were included in the following line items in our consolidated balance sheets (in millions): December 31, 2018 December 31, 2017 Trading Securities Available-for-Sale Securities Trading Securities Available-for-Sale Securities Cash and cash equivalents $ $ $ $ Marketable securities 4,691 4,970 Other assets Total debt securities $ $ 4,993 $ $ 5,912 The contractual maturities of these available-for-sale debt securities as of December 31, 2018 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ $ After 1 year through 5 years 3,871 3,948 After 5 years through 10 years 122 After 10 years 241 Total $ 4,901 $ 4,993 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. The sale and/or maturity of available-for-sale debt securities resulted in the following realized activity (in millions): Year Ended December 31, 2017 Gross gains $ $ Gross losses (27 ) (13 ) Proceeds 13,710 13,930 Captive Insurance Companies In accordance with local insurance regulations, our captive insurance companies are required to meet and maintain minimum solvency capital requirements. The Company elected to invest a majority of its solvency capital in a portfolio of marketable equity and debt securities. These securities are included in the disclosures above. The Company uses one of its consolidated captive insurance companies to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. This captive's solvency capital funds included equity and debt securities of $1,056 million as of December 31, 2018 and $1,159 million as of December 31, 2017 , which are classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. NOTE 5 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, Raw materials and packaging $ 1,862 $ 1,729 Finished goods Other Total inventories $ 2,766 $ 2,655 NOTE 6 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign-denominated third-party debt, in hedging relationships. All derivatives are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statements of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statements of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the values of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a financial instrument's change in fair value is immediately recognized into earnings. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 17 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2018 December 31, 2017 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Liabilities held for sale discontinued operations Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 17 for the net presentation of the Company's derivative instruments. 2 Refer to Note 17 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2018 December 31, 2017 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Commodity contracts Liabilities held for sale discontinued operations Other derivative instruments Accounts payable and accrued expenses Other derivative instruments Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 17 for the net presentation of the Company's derivative instruments. 2 Refer to Note 17 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statements of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 3,175 million and $ 4,068 million as of December 31, 2018 and 2017 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $3,028 million and $1,851 million as of December 31, 2018 and 2017 , respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional value of derivatives that have been designated and qualify for this program were $ 9 million and $ 35 million as of December 31, 2018 and 2017 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional values of these interest rate swap agreements that was designated and qualified for the Company's interest rate cash flow hedging program was $ 500 million as of December 31, 2017 . During the year ended December 31, 2018 , we discontinued the cash flow hedge relationship related to these swaps. We reclassified a loss of $8 million into earnings as a result of the discontinuance. As of December 31, 2018, we did not have any interest rate swaps designated as a cash flow hedge. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (5 ) (4 ) Foreign currency contracts Income (loss) from discontinued operations (3 ) Interest rate contracts Interest expense (40 ) (8 ) Commodity contracts (1 ) Cost of goods sold Commodity contracts Income (loss) from discontinued operations (5 ) Total $ $ $ (19 ) Foreign currency contracts $ (226 ) Net operating revenues $ $ Foreign currency contracts (23 ) Cost of goods sold (2 ) 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net Foreign currency contracts (3 ) Income (loss) from discontinued operations Interest rate contracts (22 ) Interest expense (37 ) Commodity contracts (1 ) Cost of goods sold (1 ) Commodity contracts (5 ) Income (loss) from discontinued operations Total $ (188 ) $ $ Foreign currency contracts $ Net operating revenues $ $ (3 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (3 ) (3 ) Interest rate contracts (126 ) Interest expense (17 ) (2 ) Commodity contracts (1 ) Cost of goods sold (1 ) Total $ (37 ) $ $ (9 ) 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and ineffective portion, if any, to the same line items in our consolidated statements of income. 2 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2018 , the Company estimates that it will reclassify into earnings during the next 12 months net losses of $ 29 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. The ineffective portions of these hedges are immediately recognized into earnings. As of December 31, 2018 , such adjustments had cumulatively increased the carrying value of our long-term debt by $ 42 million . When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives related to our fair value hedges of this type were $ 8,023 million and $ 8,121 million as of December 31, 2018 and 2017 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. The total notional value of derivatives related to fair value hedges of this type was $ 311 million as of December 31, 2017 . As of December 31, 2018 , we did not have any fair value hedges of this type. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 1 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (38 ) Net impact to interest expense $ (4 ) Foreign currency contracts Other income (loss) net $ (6 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ (4 ) Interest rate contracts Interest expense $ (69 ) Fixed-rate debt Interest expense Net impact to interest expense $ (6 ) Foreign currency contracts Other income (loss) net $ (37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ 2016 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (152 ) Net impact to interest expense $ Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (73 ) Net impact to other income (loss) net $ (4 ) Net impact of fair value hedging instruments $ 1 The net impacts represent the ineffective portions of the hedge relationships and the amounts excluded from the assessment of hedge effectiveness. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustment, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the change in the carrying value of the designated portion of the non-derivative financial instrument due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustment. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. During the years ended December 31, 2018 , 2017 and 2016 , the Company designated a portion of its euro-denominated debt as a hedge of a net investment in our European operations. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2017 2017 Foreign currency contracts $ $ $ (14 ) $ (7 ) $ (237 ) Foreign currency denominated debt 12,494 13,147 (1,505 ) Total $ 12,494 $ 13,147 $ $ (1,512 ) $ The Company did not reclassify any deferred gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2018 and 2017 . The Company reclassified net deferred losses of $77 million related to the deconsolidation of our German bottling operations from AOCI into earnings during the year ended December 31, 2016 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2018 , 2017 and 2016 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statements of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statements of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues, cost of goods sold or other income (loss) net in our consolidated statements of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 10,939 million and $ 6,827 million as of December 31, 2018 and 2017 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statements of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 373 million and $ 357 million as of December 31, 2018 and 2017 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ $ (30 ) $ (45 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Other income (loss) net (264 ) (168 ) Commodity contracts Net operating revenues Commodity contracts Cost of goods sold (29 ) Commodity contracts Selling, general and administrative expenses Commodity contracts Income (loss) from discontinued operations Interest rate contracts Interest expense (1 ) (39 ) Other derivative instruments Selling, general and administrative expenses (18 ) Other derivative instruments Other income (loss) net (22 ) (15 ) Total $ (299 ) $ $ (156 ) NOTE 7 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statements of income and our carrying value in those investments. Refer to Note 18 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions to the extent of our ownership interest, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in CCEP, Monster Beverage Corporation (""Monster""), AC Bebidas, Coca-Cola FEMSA, Coca-Cola HBC AG (""Coca-Cola Hellenic""), and Coca-Cola Bottlers Japan Holdings Inc. (""CCBJHI""). As of December 31, 2018 , we owned approximately 19 percent , 19 percent , 20 percent , 28 percent , 23 percent and 18 percent , respectively, of these companies' outstanding shares. As of December 31, 2018 , our investments in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 9,071 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 75,462 $ 73,339 $ 58,054 Cost of goods sold 44,914 42,867 34,338 Gross profit $ 30,548 $ 30,472 $ 23,716 Operating income $ 7,511 $ 7,577 $ 5,652 Consolidated net income $ 4,645 $ 4,545 $ 2,967 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,544 $ 4,425 $ 2,889 Equity income (loss) net $ 1,008 $ 1,071 $ 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, Current assets $ 23,239 $ 25,023 Noncurrent assets 66,731 66,578 Total assets $ 89,970 $ 91,601 Current liabilities $ 18,097 $ 17,890 Noncurrent liabilities 29,143 29,986 Total liabilities $ 47,240 $ 47,876 Equity attributable to shareowners of investees $ 41,550 $ 41,773 Equity attributable to noncontrolling interests 1,180 1,952 Total equity $ 42,730 $ 43,725 Company equity investment $ 19,407 $ 20,856 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,799 million , $ 14,144 million and $ 10,495 million in 2018 , 2017 and 2016 , respectively. The increase in net sales to equity method investees in 2017 was primarily due to our acquisition of equity method investments in CCEP and AC Bebidas, as well as the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJHI in 2017 . Refer to Note 2. Total payments, primarily marketing, made to equity method investees were $ 1,131 million , $ 930 million and $ 946 million in 2018 , 2017 and 2016 , respectively. In addition, purchases of beverage products from equity method investees were $ 533 million , $ 1,298 million and $ 1,857 million in 2018 , 2017 and 2016 , respectively. The decrease in purchases of beverage products in 2018 was primarily due to reduced purchases of Monster products as a result of North America refranchising activities. Refer to Note 2. If valued at the December 31, 2018 quoted closing prices of shares actively traded on stock markets, the value of our equity method investments in publicly traded bottlers would have exceeded our carrying value by $ 6,209 million . However, the carrying value of our investment in CCBJHI exceeded the fair value of the investment as of December 31, 2018 by $164 million . Based on the length of time and the extent to which the market value has been less than our cost basis and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 1,563 million and $ 2,053 million as of December 31, 2018 and 2017 , respectively. The total amount of dividends received from equity method investees was $ 551 million , $ 443 million and $ 386 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2018 was $4,546 million . NOTE 8 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, Land $ $ Buildings and improvements 3,838 3,917 Machinery, equipment and vehicle fleet 11,922 12,198 Property, plant and equipment cost 16,245 16,449 Less accumulated depreciation 8,013 8,246 Property, plant and equipment net $ 8,232 $ 8,203 NOTE 9 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table presents the carrying values of indefinite-lived intangible assets included in our consolidated balance sheets (in millions): December 31, Trademarks $ 6,682 $ 6,729 Bottlers' franchise rights Goodwill 10,263 9,401 Other Indefinite-lived intangible assets $ 17,102 $ 16,374 The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Total Balance at beginning of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Effect of foreign currency translation (1 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment charges (390 ) (390 ) Divestitures, deconsolidations and other 1,2 (999 ) (999 ) Balance at end of year $ $ $ 8,349 $ $ $ 9,401 Balance at beginning of year $ $ $ 8,349 $ $ $ 9,401 Effect of foreign currency translation (58 ) (9 ) (4 ) (2 ) (73 ) Acquisitions 1,3 Adjustments related to the finalization of purchase accounting 1,4 (11 ) Divestitures, deconsolidations and other 1 (5 ) (5 ) Balance at end of year $ 1,068 $ $ 8,338 $ $ $ 10,263 1 Refer to Note 2 for information related to the Company's acquisitions and divestitures. 2 The 2017 decrease in the Bottling Investments segment was primarily a result of North America bottling operations being refranchised. Refer to Note 2 . 3 The increase in 2018 was primarily due to the acquisition of the Philippine bottling operations. Refer to Note 2 . 4 The increase in 2018 was primarily due to the allocation of goodwill from CCBA to other reporting units expected to benefit from the acquisition of CCBA. Refer to Note 2 . Definite-Lived Intangible Assets The following table provides information related to definite-lived intangible assets (in millions): December 31, 2018 December 31, 2017 Gross Carrying Value Accumulated Amortization Net Carrying Value Gross Carrying Value Accumulated Amortization Net Carrying Value Customer relationships $ $ (151 ) $ $ $ (143 ) $ Bottlers' franchise rights (18 ) (152 ) Trademarks (91 ) (73 ) Other (61 ) (64 ) Total $ $ (321 ) $ $ $ (432 ) $ Total amortization expense for intangible assets subject to amortization was $ 49 million , $ 68 million and $ 139 million in 2018 , 2017 and 2016 , respectively. Based on the carrying value of definite-lived intangible assets as of December 31, 2018 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2020 2021 2022 2023 NOTE 10 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accrued marketing $ 1,787 $ 2,108 Trade accounts payable 2,498 2,288 Other accrued expenses 3,352 1 3,071 Accrued compensation Sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 8,932 $ 8,748 1 The increase in other accrued expenses is primarily due to incremental estimated variable consideration due to third-party customers. Refer to Note 1 and Note 3 for additional information on our adoption of ASC 606 that became effective on January 1, 2018 . NOTE 11 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2018 and 2017 , we had $ 13,063 million and $ 12,931 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 2.6 percent and 1.4 percent per year as of December 31, 2018 and 2017 , respectively. In addition, we had $ 10,483 million in lines of credit and other short-term credit facilities as of December 31, 2018 . The Company's total lines of credit included $ 131 million that was outstanding and primarily related to our international operations. Included in the credit facilities discussed above, the Company had $ 7,895 million in lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2019 through 2022 . There were no borrowings under these backup lines of credit during 2018 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2018, the Company retired upon maturity $3,276 million total principal amount of notes and debentures. The general terms of the notes and debentures retired are as follows: $26 million total principal amount of debentures due January 29, 2018 , at a fixed interest rate of 9.66 percent ; $750 million total principal amount of notes due March 14, 2018 , at a fixed interest rate of 1.65 percent ; $1,250 million total principal amount of notes due April 1, 2018 , at a fixed interest rate of 1.15 percent ; and $1,250 million total principal amount of notes due November 1, 2018 , at a fixed interest rate of 1.65 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CocaCola Enterprises Inc.'s former North America business (""Old CCE""). The extinguished debentures had a total principal amount of $94 million that was due to mature on May 15, 2098 , at a fixed interest rate of 7.00 percent . Related to this extinguishment, the Company recorded a net gain of $27 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2018. During 2017, the Company issued U.S. dollar- and euro-denominated debt of $1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 was $3,974 million . The general terms of the notes issued are as follows: $500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three -month Euro Interbank Offered Rate (""EURIBOR"") plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017, the Company retired upon maturity 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent , $206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent , SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent , $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent , and $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of Old CCE. The extinguished notes had a carrying value of $417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $38 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017. During 2016, the Company issued Australian dollar-, euro- and U.S. dollar-denominated debt of AUD 1,000 million , 500 million and $3,725 million , respectively. The general terms of the notes issued are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.60 percent ; AUD 550 million total principal amount of notes due June 11, 2024, at a fixed interest rate of 3.25 percent ; 500 million total principal amount of notes due September 2, 2036, at a fixed interest rate of 1.10 percent ; $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month LIBOR plus 0.05 percent ; $1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent ; $1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.55 percent ; $500 million total principal amount of notes due June 1, 2026, at a fixed interest rate of 2.55 percent ; and $1,000 million total principal amount of notes due September 1, 2026, at a fixed interest rate of 2.25 percent . During 2016, the Company retired upon maturity $1,654 million total principal amount of notes due September 1, 2016 at a fixed interest rate of 1.80 percent , $500 million total principal amount of notes due November 1, 2016 at a fixed interest rate of 0.75 percent and $500 million total principal amount of notes due November 1, 2016 at a variable interest rate equal to the three -month LIBOR plus 0.10 percent . The Company's long-term debt consisted of the following (in millions except average rate data): December 31, 2018 December 31, 2017 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20192093 $ 13,619 2.6 % $ 16,854 2.3 % U.S. dollar debentures due 20202098 1,390 5.2 1,559 5.5 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.2 2.1 Euro notes due 20192036 12,994 0.6 13,663 0.7 Swiss franc notes due 20222028 1,128 3.6 1,148 3.0 Other, due through 2098 3 3.4 3.4 Fair value adjustments 4 N/A N/A Total 5,6 30,361 1.9 % 34,480 1.8 % Less current portion 4,997 3,298 Long-term debt $ 25,364 $ 31,182 1 These rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 6 for a more detailed discussion on interest rate management. 2 Amount is shown net of unamortized discounts of $ 8 million and $ 13 million as of December 31, 2018 and 2017 , respectively. 3 As of December 31, 2018 , the amount shown includes $ 136 million of debt instruments that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 6 for additional information about our fair value hedging strategy. 5 As of December 31, 2018 and 2017 , the fair value of our long-term debt, including the current portion, was $ 30,438 million and $ 35,169 million , respectively. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE's former North America business in 2010 of $ 212 million and $ 263 million as of December 31, 2018 and 2017 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2018 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 19 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 871 million , $ 757 million and $ 663 million in 2018 , 2017 and 2016 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2018 are as follows (in millions): Maturities of Long-Term Debt $ 4,997 4,265 2,929 2,414 4,099 NOTE 12 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2018 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 600 million , of which $ 247 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees is individually significant. These amounts represent the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities of the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained; (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount; or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved. The number of years subject to tax audits or tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained; (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation; or (3) the statute of limitations for the tax position has expired. Refer to Note 15 . On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claimed that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection conditioned on the Company's continued adherence to the prescribed methodology absent change in material facts or circumstances and relevant federal tax law. Although the IRS subsequently asserted, without explanation, that material facts and circumstances and relevant federal tax law had changed, it has not asserted penalties. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and is pursuing, and will continue to pursue, all available administrative and judicial remedies necessary to vigorously defend its position. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The U.S. Tax Court trial was held from March 8, 2018 through May 11, 2018. The Company and the IRS filed and exchanged final post-trial briefs in February 2019. It is not known how much time will elapse thereafter prior to the issuance of the Court's decision. In the interim, or subsequent to the Tax Court's decision, the IRS may propose similar adjustments for years subsequent to the 2007-2009 litigation period. While the Company continues to strongly disagree with the IRS' position, there is no assurance that the U.S. Tax Court will rule in the Company's favor, and it is possible that all or some portion of the adjustment proposed by the IRS Notice ultimately could be sustained. In that event, the Company will be subject to significant additional liabilities for the years at issue and potentially also for subsequent periods, which could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company regularly assesses the likelihood of adverse outcomes resulting from tax disputes such as this and other examinations for all open years to determine the adequacy of its tax reserves. Any such adjustments related to years prior to 2018, either in the litigation period or later, may have an impact on the transition tax payable as part of the Tax Cuts and Jobs Act of 2017. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 362 million and $ 480 million as of December 31, 2018 and 2017 , respectively. Operating Leases The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2018 (in millions): Operating Lease Payments $ 2020 2021 2022 2023 Thereafter Total minimum operating lease payments 1 $ 1 Income associated with sublease arrangements is not significant. NOTE 13 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 225 million , $ 219 million and $ 258 million in 2018 , 2017 and 2016 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 47 million , $ 44 million and $ 71 million in 2018 , 2017 and 2016 , respectively. From 2015 to 2017, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who received these performance cash awards did not receive equity awards as part of the long-term incentive program. In 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2018 , we had $ 271 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 2.5 years as stockbased compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. As of December 31, 2018 , there were 391.9 million shares available to be granted under the 2014 Equity Plan. In addition, there were 2.9 million shares from plans approved by shareowners prior to 2014 available to be granted under stock option and restricted stock award plans. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, generally four years . The weighted-average fair value of stock options granted during the past three years and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Year Ended December 31, Fair value of stock options at grant date $ 4.97 $ 3.98 $ 4.17 Dividend yield 1 3.5 % 3.6 % 3.2 % Expected volatility 2 15.5 % 15.5 % 16.0 % Risk-free interest rate 3 2.8 % 2.2 % 1.5 % Expected term of the stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock at the time of the grant. 2 Expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expired 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued Company common stock or from the Company's treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from the Company's treasury shares. Stock option activity for all plans for the year ended December 31, 2018 was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2018 $ 35.02 Granted 44.49 Exercised (47 ) 31.51 Forfeited/expired (1 ) 41.22 Outstanding on December 31, 2018 1 $ 36.74 4.59 years $ 1,407 Expected to vest $ 36.69 4.56 years $ 1,402 Exercisable on December 31, 2018 $ 35.74 4.02 years $ 1,327 1 Includes 0.1 million stock option replacement awards in connection with our acquisition of Old CCE in 2010. These options had a weighted-average exercise price of $ 17.35 and generally vest over 3 years and expire 10 years from the original date of grant. The total intrinsic value of the stock options exercised was $ 721 million , $ 744 million and $ 787 million in 2018 , 2017 and 2016 , respectively. The total shares exercised were 47 million , 53 million and 50 million in 2018 , 2017 and 2016 , respectively. Performance-Based Share Unit Awards Performance-based share unit awards require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. For performance share unit grants from 2015 through 2017, the performance criteria used were economic profit and net operating revenues over a predefined performance period of three years. Economic profit is our net operating profit after tax less the cost of the capital used in our business. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. These grants include a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of these performance share units was determined using a Monte Carlo valuation model. The performance share units granted from 2015 through 2017 are subject to a one-year holding period after the performance period before the shares are released. In 2018, the Company renamed our performance share unit awards to growth share unit awards. For growth share units granted in 2018, performance criteria were equally weighted among net operating revenues, earnings per share and free cash flow over a predefined performance period of three years. Earnings per share for these purposes is diluted net income per share from continuing operations and free cash flow is net cash provided by operating activities less purchases of property, plant and equipment. Net operating revenues, earnings per share and free cash flow are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. Growth share units granted to executives include a relative TSR modifier to determine the number of shares earned at the end of the performance period. The fair value of growth share unit grants that include a TSR modifier is determined using a Monte Carlo valuation model. The fair value of growth share units that do not include the TSR modifier is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the performance period. Growth share units granted in 2018 will be released at the end of the performance period if the predefined performance criteria are achieved. For all performance-based share unit awards, in the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria but above the minimum threshold, a reduced number of shares will be granted. If the certified results fall below the minimum threshold, no shares will be granted. Performance-based share unit awards do not entitle participants to vote or receive dividends. In the period it becomes probable that the minimum threshold specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance-based share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum threshold specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units and growth share units are generally settled in stock, except for certain circumstances such as death or disability, in which case employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2018 , performance share units of 2,756,000 and 2,837,000 were outstanding for the 2016-2018 and 2017-2019 performance periods, respectively, and growth share units of 2,105,000 were outstanding for the 2018-2020 performance period, based on the target award amounts. The following table summarizes information about performance share units and growth share units based on the target award amounts: Performance Share Units and Growth Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2018 8,212 $ 37.14 Granted 2,183 41.02 Conversions to restricted stock units 1 (2,111 ) 36.24 Canceled/forfeited (586 ) 37.58 Outstanding on December 31, 2018 2 7,698 $ 38.45 1 Represents the target amount of performance share units converted to restricted stock units for the 20152017 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units and growth share units as of December 31, 2018 at the threshold award and maximum award levels were 2.4 million and 15.3 million , respectively. The weightedaverage grant date fair value of growth share units granted in 2018 was $41.02 . The weightedaverage grant date fair value of performance share units granted in 2017 and 2016 was $34.75 and $39.70 , respectively. The Company did not convert any performance share units into cash equivalent payments in 2018. The Company converted performance share units of 11,052 in 2017 and 52,545 in 2016 to cash equivalent payments of $0.4 million and $ 1.9 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2018 6,748 $ 32.35 Conversions from performance share units 2,692 36.24 Vested and released (6,747 ) 32.34 Canceled/forfeited (102 ) 36.18 Nonvested on December 31, 2018 2,591 $ 36.24 The total intrinsic value of restricted shares that were vested and released in 2018 was $305 million . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2018 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of 3,422,323 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock and restricted stock units: Restricted Stock and Restricted Stock Units (In thousands) Weighted-Average Grant Date Fair Value Nonvested on January 1, 2018 3,535 $ 40.99 Granted 1,457 40.12 Vested and released (1,015 ) 41.80 Forfeited/expired (555 ) 41.32 Nonvested on December 31, 2018 3,422 $ 40.31 NOTE 14 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining agreements as the ""primary U.S. plan."" As of December 31, 2018 , the primary U.S. plan represented 62 percent of both the Company's consolidated projected benefit obligation and pension assets. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, Benefit obligation at beginning of year 1 $ 9,455 $ 9,428 $ $ Service cost Interest cost Foreign currency exchange rate changes (110 ) (5 ) Amendments (8 ) (21 ) Net actuarial loss (gain) (469 ) (33 ) (28 ) Benefits paid 2 (356 ) (341 ) (70 ) (71 ) Business combinations 3 Divestitures (11 ) (7 ) (66 ) Settlements 4 (932 ) (832 ) Curtailments 4 (63 ) (10 ) (48 ) Special termination benefits 4 Other Benefit obligation at end of year 1 $ 8,004 $ 9,455 $ $ Fair value of plan assets at beginning of year $ 8,843 $ 8,371 $ $ Actual return on plan assets (271 ) 1,139 (5 ) Employer contributions Foreign currency exchange rate changes (128 ) Benefits paid (285 ) (285 ) (3 ) (3 ) Business combinations 3 Divestitures (1 ) Settlements 4 (892 ) (794 ) Other Fair value of plan assets at end of year $ 7,409 $ 8,843 $ $ Net liability recognized $ (595 ) $ (612 ) $ (419 ) $ (494 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $7,856 million and $9,175 million as of December 31, 2018 and 2017 , respectively. 2 Benefits paid to pension plan participants during 2018 and 2017 included $71 million and $56 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2018 and 2017 included $67 million and $68 million , respectively, that were paid from Company assets. 3 Business combinations primarily related to the acquisition of a controlling interest in the Philippine bottling operations. Refer to Note 2 . 4 Settlements, curtailments and special termination benefits were primarily related to productivity, integration and restructuring initiatives and the refranchising of our North America bottling operations. Refer to Note 2 and Note 19 . Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, Other assets $ $ $ $ Accounts payable and accrued expenses (70 ) (72 ) (21 ) (21 ) Other liabilities (1,328 ) (1,461 ) (398 ) (473 ) Net liability recognized $ (595 ) $ (612 ) $ (419 ) $ (494 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Projected benefit obligations $ 6,561 $ 7,833 Fair value of plan assets 5,163 6,330 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Accumulated benefit obligations $ 6,450 $ 7,614 Fair value of plan assets 5,157 6,305 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,116 1,427 International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 1 Hedge funds/limited partnerships Real estate Other Total pension plan assets 2 $ 4,842 $ 6,028 $ 2,567 $ 2,815 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension plan assets are included in Note 17 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension plan assets. Investment Strategy for U.S. Pension Plans The Company utilizes the services of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2018 , no investment manager was responsible for more than 9 percent of total U.S. pension plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in the common stock of our Company accounted for approximately 5 percent of our total global equities and approximately 3 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. In addition to equity investments and fixed-income investments, we have a target allocation of 28 percent in alternative investments. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that which is typically available from publicly traded equity securities. Alternative investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2018 , the long-term target allocation for 68 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 65 percent equity securities, 10 percent fixed-income securities and 25 percent other investments. The actual allocation for the remaining 32 percent of the Company's international subsidiaries' plan assets consisted of 54 percent mutual, pooled and commingled funds; 7 percent fixed-income securities; 1 percent global equities and 38 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, Cash and cash equivalents $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds Hedge funds/limited partnerships Real estate Other Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 17 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost (Income) Net periodic benefit cost (income) for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets 1 (650 ) (650 ) (653 ) (13 ) (12 ) (11 ) Amortization of prior service credit (3 ) (2 ) (14 ) (18 ) (19 ) Amortization of net actuarial loss 2 Net periodic benefit cost (income) (107 ) Settlement charges 3 Curtailment charges (credits) 3 (4 ) (79 ) Special termination benefits 3 Other (3 ) (1 ) Total cost (income) recognized in consolidated statements of income $ $ $ $ $ (55 ) $ 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 Settlements, curtailments and special termination benefits were primarily related to productivity, integration and restructuring initiatives and the refranchising of our North America bottling operations. Refer to Note 2 and Note 19 . All of the amounts in the tables above, other than service cost, were recorded in the line item other income (loss) net in our consolidated statements of income. Impact on Accumulated Other Comprehensive Income The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) Recognized prior service cost (credit) 1 (18 ) 4 (54 ) 5 Recognized net actuarial loss (gain) 2 3 (36 ) 5 Prior service credit (cost) occurring during the year (1 ) (1 ) Net actuarial (loss) gain occurring during the year (389 ) 1 5 Impact of divestitures Foreign currency translation gain (loss) (42 ) (1 ) Balance in AOCI at end of year $ (2,482 ) $ (2,493 ) $ (15 ) $ (26 ) 1 Includes $4 million of recognized prior service cost and $63 million of actuarial gains occurring during the year due to the impact of curtailments. 2 Includes $240 million of recognized net actuarial losses due to the impact of settlements. 3 Includes $228 million of recognized net actuarial losses due to the impact of settlements. 4 Includes $4 million of recognized prior service credit due to the impact of curtailments. 5 Includes $36 million of recognized prior service credit, $43 million of recognized net actuarial gains and $45 million of actuarial gains occurring during the year due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, Prior service credit (cost) $ (12 ) $ (10 ) $ $ Net actuarial loss (2,470 ) (2,483 ) (44 ) (62 ) Balance in AOCI at end of year $ (2,482 ) $ (2,493 ) $ (15 ) $ (26 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2019 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service credit $ (4 ) $ (2 ) Amortization of net actuarial loss Total $ $ Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, Discount rate 4.00 % 3.50 % 4.25 % 3.50 % Rate of increase in compensation levels 3.75 % 3.50 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost are as follows: Pension Benefits Other Benefits Year Ended December 31, Discount rate 3.50 % 4.00 % 4.25 % 3.50 % 4.00 % 4.25 % Rate of increase in compensation levels 3.50 % 3.75 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 8.00 % 8.00 % 8.25 % 4.50 % 4.75 % 4.75 % The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2018 were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The Company measures the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The rate of compensation increase assumption is determined by the Company based upon annual reviews. The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2018 net periodic pension cost for the U.S. plans was 8.00 percent . As of December 31, 2018 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 5.5 percent , 9.2 percent and 6.4 percent , respectively. The annualized return since inception was 10.3 percent . The assumed health care cost trend rates are as follows: December 31, Health care cost trend rate assumed for next year 7.00 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 20242028 Pension benefit payments $ $ $ $ $ $ 2,517 Other benefit payments 1 Total estimated benefit payments $ $ $ $ $ $ 2,767 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $3 million for the period 20192023 and $2 million for the period 20242028. The Company anticipates making pension contributions in 2019 of $32 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limitations. Company costs related to the U.S. plans were $39 million , $61 million and $82 million in 2018 , 2017 and 2016 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $33 million , $35 million and $37 million in 2018 , 2017 and 2016 , respectively. Multi-Employer Pension Plans The Company participates in various multi-employer pension plans. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for multi-employer pension plans totaled $6 million , $35 million and $41 million in 2018 , 2017 and 2016 , respectively. The decrease in 2018 was primarily driven by the refranchising of certain bottling territories in the United States during 2017. The plans we currently participate in have contractual arrangements that extend into 2021. If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. Refer to Note 2 for additional information on North America refranchising. NOTE 15 : INCOME TAXES Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, United States $ 1 $ (690 ) 1 $ 1 International 7,462 1 7,432 8,023 Total $ 8,350 $ 6,742 $ 8,136 1 Includes charges of $476 million , $2,140 million and $2,456 million related to refranchising certain bottling territories in North America in 2018 , 2017 and 2016 , respectively. Refer to Note 2 . Income taxes from continuing operations consisted of the following (in millions): United States State and Local International Total Current $ 1 $ $ 1,337 $ 2,073 Deferred (386 ) 1,3 (81 ) 1,3 1,3 (450 ) Current $ 5,438 2 $ $ 1,257 $ 6,816 Deferred (1,783 ) 2,3 2 (1,256 ) Current $ 1,147 $ $ 1,182 $ 2,442 Deferred (838 ) 3 (91 ) (856 ) 1 Includes the tax impact that resulted from changes to our original provisional estimates of the impact of the Tax Reform Act as permitted by Staff Accounting Bulletin No. 118 (""SAB 118""). 2 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017 . The provisional amount as of December 31, 2017 , related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated at that time to be $42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $1.0 billion . 3 Includes the benefit from charges related to refranchising certain bottling territories in North America. Refer to Note 2 . Income taxes from discontinued operations consisted of $87 million and $55 million of current expense and $38 million of deferred tax expense and $8 million of deferred tax benefit for the years ended December 31, 2018 and 2017 , respectively. We made income tax payments of $ 2,037 million , $ 1,904 million and $ 1,554 million in 2018 , 2017 and 2016 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate. As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2019 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 318 million , $ 221 million and $ 105 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, 2017 Statutory U.S. federal tax rate 21.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.5 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal tax rate 1.2 1,2 (9.7 ) (17.5 ) 7 Equity income or loss (2.4 ) (3.4 ) (3.0 ) Tax Reform Act 0.1 3 53.5 4 Excess tax benefits on stock-based compensation (1.2 ) (2.0 ) Other net (0.8 ) 7.9 5,6 3.8 8 Effective tax rate 19.4 % 82.5 % 19.5 % 1 Includes the impact of pretax charges of $591 million (or a 1.5 percent impact on our effective tax rate) related to other-than-temporary impairments of certain of our equity method investees. Refer to Note 17 . 2 Includes tax expense of $28 million on net pretax charges of $403 million (or a 1.4 percent impact on our effective tax rate) primarily related to the refranchising of certain foreign bottling operations. Refer to Note 2 . 3 Includes net tax expense of $8 million (or a 0.1 percent impact on our effective tax rate) related to the finalization of our accounting related to the Tax Reform Act. 4 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 5 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 . 6 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 7 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 . 8 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") of approximately $41 billion . Most of this amount comprises unremitted foreign earnings, upon which no U.S. federal or state income tax had been accrued, because they were considered to have been indefinitely reinvested. At December 31, 2017 , following enactment of the Tax Reform Act, we recorded a provisional $4.6 billion tax reflecting our best estimate of the one-time deemed repatriation tax liability as of December 31, 2017, and a $0.6 billion provisional deferred tax liability related to foreign withholding taxes and state income taxes on earnings no longer considered to be indefinitely reinvested. During 2018, we recorded a net tax expense from the impact of the Tax Reform Act. As permitted by SAB 118, we had recorded provisional adjustments to our reasonable estimate of the impact of the Tax Reform Act during the 2018 measurement period pursuant to our analysis of contemporaneous guidance, interpretations and data, and we have finalized that analysis based on such information available as of December 31, 2018. As such, we recorded an additional $0.3 billion in tax for our one-time transition tax and a tax benefit of $0.3 billion , primarily related to a reduction in deferred taxes on related withholding taxes and state income taxes in 2018. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. This adjustment was not significant. We have not recorded incremental income taxes for any additional outside basis differences of approximately $8.1 billion in our investments in foreign subsidiaries, as these amounts continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities is not practicable. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. An accounting policy election is available to either account for the tax effects of GILTI in the period that is subject to such taxes or to provide deferred taxes for book and tax basis differences that upon reversal may be subject to such taxes. We have elected to account for the tax effects of these provisions in the period that is subject to such tax and the impact is reflected in our full year provision. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2004 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 12 . As of December 31, 2018 , the gross amount of unrecognized tax benefits was $ 336 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 182 million , exclusive of any benefits related to interest and penalties. The remaining $ 154 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 18 1 Decrease related to prior period tax positions (2 ) (13 ) Increase related to current period tax positions 13 Decrease related to settlements with taxing authorities (4 ) (40 ) 1 Increase (decrease) due to effect of foreign currency exchange rate changes (17 ) (6 ) Ending balance of unrecognized tax benefits $ $ $ 1 The net increase was primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 190 million , $ 177 million and $ 142 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2018 , 2017 and 2016 , respectively. Of these amounts, $13 million , $ 35 million and $31 million of expense were recognized through income tax expense in 2018 , 2017 and 2016 , respectively. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consisted of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets 2,540 2 Equity method investments (including foreign currency translation adjustment) Derivative financial instruments Other liabilities Benefit plans Net operating/capital loss carryforwards Other Gross deferred tax assets 5,452 3,405 Valuation allowances (399 ) (501 ) Total deferred tax assets 1 $ 5,053 $ 2,904 Deferred tax liabilities: Property, plant and equipment $ (724 ) $ (819 ) Trademarks and other intangible assets (951 ) (978 ) Equity method investments (including foreign currency translation adjustment) (1,707 ) (1,835 ) Derivative financial instruments (162 ) (436 ) Other liabilities (67 ) (50 ) Benefit plans (255 ) (289 ) Other (453 ) (688 ) Total deferred tax liabilities $ (4,319 ) $ (5,095 ) Net deferred tax assets (liabilities) $ $ (2,191 ) 1 Noncurrent deferred tax assets of $2,667 million and $330 million were included in the line item Deferred income tax assets in our consolidated balance sheets as of December 31, 2018 and 2017 , respectively. 2 The increase was primarily the result of a $2.9 billion cumulative effect adjustment related to our adoption of ASU 2016-16. In October 2016, the FASB issued ASU 2016-16, which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was adopted using a modified retrospective basis. We recorded a $2.9 billion cumulative effect adjustment to increase the opening balance of reinvested earnings with the majority of the offset being recorded as a deferred tax asset. This amount is primarily related to trademarks and other intangible assets and was recorded in the line item deferred income tax assets in our consolidated balance sheet. As of December 31, 2018 , we had net deferred tax assets of $ 2.0 billion and as of December 31, 2017 , we had net deferred tax liabilities of $ 539 million located in countries outside the United States. As of December 31, 2018 , we had $ 2,906 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 372 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Decrease due to reclassification to assets held for sale (9 ) Deductions (183 ) (213 ) (6 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2018, the Company recognized a net decrease of $102 million in its valuation allowances. This decrease was primarily due to changes to deferred tax assets and related valuation allowances on certain equity investments. In addition, the changes in net operating losses in the normal course of business contributed to the net decrease in valuation allowance. The decreases were partially offset by an increase due to the acquisition of a controlling interest in one of our foreign bottling operations. In 2017, the Company recognized a net decrease of $29 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. In 2016, the Company recognized a net increase of $53 million in its valuation allowances. This increase was primarily due to the increase in non-deductible expenses incurred during the normal course of business operations. NOTE 16 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheets as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheets as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments $ (11,045 ) $ (8,957 ) Accumulated derivative net gains (losses) (126 ) (119 ) Unrealized net gains (losses) on available-for-sale securities 1 Adjustments to pension and other benefit liabilities (1,693 ) (1,722 ) Accumulated other comprehensive income (loss) $ (12,814 ) $ (10,305 ) 1 The change in the balance from December 31, 2017 includes the $409 million reclassification to reinvested earnings upon the adoption of ASU 2016-01. Refer to Note 1 and Note 4 . The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2018 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 6,434 $ $ 6,476 Other comprehensive income: Net foreign currency translation adjustments (2,088 ) (2,035 ) Net gains (losses) on derivatives 1 (7 ) (7 ) Net change in unrealized gains (losses) on available-for-sale debt securities 2 (34 ) (34 ) Net change in pension and other benefit liabilities 3 Total comprehensive income $ 4,334 $ $ 4,429 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2018 , 2017 and 2016 is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,728 ) $ $ (1,669 ) Reclassification adjustments recognized in net income Gains (losses) on intra-entity transactions that are of a long-term investment nature (1,296 ) (1,296 ) Gains (losses) on net investment hedges arising during the year 1 (160 ) Net foreign currency translation adjustments $ (1,987 ) $ (101 ) $ (2,088 ) Derivatives: Gains (losses) arising during the year (16 ) Reclassification adjustments recognized in net income (68 ) (50 ) Net gains (losses) on derivatives 1 $ (9 ) $ $ (7 ) Available-for-sale debt securities: Unrealized gains (losses) arising during the year (50 ) (39 ) Reclassification adjustments recognized in net income Net change in unrealized gains (losses) on available-for-sale debt securities 2 $ (45 ) $ $ (34 ) Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (299 ) (224 ) Reclassification adjustments recognized in net income (88 ) Net change in pension and other benefit liabilities 3 $ $ (13 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,999 ) $ (101 ) $ (2,100 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale debt securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,350 ) $ (242 ) $ (1,592 ) Reclassification adjustments recognized in net income (6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year 1 (1,512 ) (934 ) Net foreign currency translation adjustments $ $ $ Derivatives: Gains (losses) arising during the year (184 ) (119 ) Reclassification adjustments recognized in net income (506 ) (314 ) Net gains (losses) on derivatives 1 $ (690 ) $ $ (433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (136 ) Reclassification adjustments recognized in net income (123 ) (81 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ (94 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (7 ) Reclassification adjustments recognized in net income (116 ) Net change in pension and other benefit liabilities 3 $ $ (123 ) $ Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,103 ) $ $ (1,052 ) Reclassification adjustments recognized in net income (18 ) Gains (losses) on net investment hedges arising during the year (25 ) Reclassification adjustments for net investment hedges recognized in net income (30 ) Net foreign currency translation adjustments $ (591 ) $ (22 ) $ (613 ) Derivatives: Gains (losses) arising during the year (43 ) (32 ) Reclassification adjustments recognized in net income (563 ) (350 ) Net gains (losses) on derivatives 1 $ (606 ) $ $ (382 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (28 ) Reclassification adjustments recognized in net income (105 ) (79 ) Net change in unrealized gains (losses) on available-for-sale securities 2 $ $ (2 ) $ Pension and other benefit liabilities: Net pension and other benefit liabilities arising during the year (374 ) (275 ) Reclassification adjustments recognized in net income (120 ) Net change in pension and other benefit liabilities 3 $ (32 ) $ (21 ) $ (53 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,210 ) $ $ (1,031 ) 1 Refer to Note 6 for additional information related to the net gains or losses on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 4 for additional information related to the net unrealized gains or losses on available-for-sale securities. 3 Refer to Note 14 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statement of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2018 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1,2 Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ (137 ) Foreign currency contracts Cost of goods sold (8 ) Foreign currency contracts Other income (loss) net Divestitures, deconsolidations and other Other income (loss) net Foreign currency and interest rate contracts Interest expense Income from continuing operations before income taxes $ (76 ) Income taxes from continuing operations Net income from continuing operations $ (56 ) Foreign currency and commodity contracts Income from discontinued operations (net of income taxes) $ Consolidated net income $ (50 ) Available-for-sale securities: Sale of securities Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations Consolidated net income $ Pension and other benefit liabilities: Settlement charges 3 Other income (loss) net $ Curtailment charges 3 Other income (loss) net Recognized net actuarial loss Other income (loss) net Recognized prior service cost (credit) Other income (loss) net (17 ) Divestitures, deconsolidations and other 2 Other income (loss) net (14 ) Income from continuing operations before income taxes $ Income taxes from continuing operations (88 ) Consolidated net income $ 1 Primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and the deconsolidation of our Canadian bottling operations. 2 Primarily related to our previously held equity method investment in the Philippine bottling operations and the refranchising of our Latin American bottling operations. 3 The settlement and curtailment charges were primarily related to productivity, restructuring and integration initiatives and the refranchising of our North America bottling operations. Refer to Note 14 and Note 19 . NOTE 17 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity with readily determinable fair values, debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Debt and Equity Securities The fair values of our investments in debt and equity securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in debt and equity securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair value of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair values of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2018 Level 1 Level 2 Level 3 Other 3 Netting Adjustment 4 Fair Value Measurements Assets: Equity securities with readily determinable values 1 $ 1,681 $ $ $ $ $ 1,934 Debt securities 1 5,018 5,037 Derivatives 2 (261 ) 5 7 Total assets $ 1,683 $ 5,517 $ $ $ (261 ) $ 7,025 Liabilities: Derivatives 2 $ (14 ) $ (221 ) $ $ $ 6 $ (53 ) 7 Total liabilities $ (14 ) $ (221 ) $ $ $ $ (53 ) 1 Refer to Note 4 for additional information related to the composition of our equity securities with readily determinable values and debt securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 4 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 5 The Company is obligated to return $96 million in cash collateral it has netted against its derivative position. 6 The Company has the right to reclaim $4 million in cash collateral it has netted against its derivative position. 7 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $54 million in the line item other assets; $3 million in the line item liabilities held for sale discontinued operations and $50 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. December 31, 2017 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,899 5,739 3 7,807 Derivatives 2 (198 ) 6 8 Total assets $ 2,118 $ 6,116 $ $ $ (198 ) $ 8,273 Liabilities: Derivatives 2 $ (3 ) $ (262 ) $ $ $ 7 $ (118 ) 8 Total liabilities $ (3 ) $ (262 ) $ $ $ $ (118 ) 1 Refer to Note 4 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 6 for additional information related to the composition of our derivative portfolio. 3 Primarily related to debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 4 . 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 6 . 6 The Company is obligated to return $55 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $2 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $59 million in the line item other assets; $28 million in the line item accounts payable and accrued expenses; $12 million in the line item liabilities held for sale discontinued operations and $78 million in the line item other liabilities. Refer to Note 6 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2018 and 2017 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2018 and 2017 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges, or as a result of observable changes in equity securities using the measurement alternative. The gains and losses on assets measured at fair value on a nonrecurring basis are summarized in the table below (in millions): Gains (Losses) Year Ended December 31, Other-than-temporary impairment charges $ (591 ) 1 $ (50 ) 5 Assets held for sale discontinued operations (554 ) 2 Other long-lived assets (312 ) 3 (329 ) 6 Intangible assets (138 ) 3 (442 ) 7 Assets held for sale (1,819 ) 8 Investment in formerly unconsolidated subsidiary (32 ) 4 9 Valuation of shares in equity method investee 10 Total $ (1,627 ) $ (2,465 ) 1 The Company recognized other-than-temporary impairment charges of $334 million related to certain equity method investees in the Middle East. These impairments were primarily driven by revised projections of future operating results largely related to instability in the region, which include recent sanctions imposed locally. The Company also recognized an other-than-temporary impairment charge of $205 million related to an equity method investee in Indonesia. This impairment was primarily driven by revised projections of future operating results reflecting unfavorable macroeconomic conditions and foreign currency exchange rate fluctuations. Additionally, the Company recognized an other-than-temporary impairment charge of $52 million related to one of our equity method investees in Latin America. This impairment was primarily driven by revised projections of future operating results. The fair value of each of these investments was derived using discounted cash flow analyses based on Level 3 inputs. 2 The Company recorded impairment charges of $554 million related to assets held by CCBA. These charges were incurred primarily as a result of management's view of the proceeds that are expected to be received based on revised projections of future operating results and foreign currency exchange rate fluctuations. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. We recorded these impairment charges in the line item income (loss) from discontinued operations in our consolidated statements of income. 3 The Company recognized charges of $312 million related to CCR's property, plant and equipment and $138 million related to CCR's intangible assets. These charges were a result of management's revised estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. Refer to Note 18 . 4 The Company recognized a loss of $32 million , which included the remeasurement of our previously held equity interest in the Philippine bottling operations to fair value and the reversal of the related cumulative translation adjustments. The fair value of our previously held equity investment was determined using a discounted cash flow model based on Level 3 inputs. 5 The Company recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. 6 The Company recognized impairment charges of $310 million related to CCR's property, plant and equipment and $19 million related to CCR's other assets primarily as a result of refranchising activities in North America. The fair value of these assets was derived using management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. 7 The Company recognized an impairment charge of $375 million related to CCR's goodwill. This impairment charge was determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. The Company also recognized an impairment charge of $33 million related to certain U.S. bottlers' franchise rights. This charge was determined by comparing the fair value of the asset to its current carrying value. Each of these impairment charges was primarily a result of refranchising activities in North America and management's estimates of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. Additionally, the Company recorded impairment charges of $34 million related to Venezuelan intangible assets due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. 8 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. These losses related to refranchising activities in North America. The charges were calculated based on Level 3 inputs. Refer to Note 2 . 9 The Company recognized a gain of $150 million on our previously held equity interests in CCBA and its South African subsidiary, which were accounted for under the equity method of accounting prior to our consolidation of the bottler in October 2017. U.S. GAAP requires the acquirer to remeasure its previously held noncontrolling equity interest in the acquired entity to fair value as of the acquisition date and recognize any gains or losses in earnings. The Company remeasured our equity interests in CCBA and its South African subsidiary based on Level 3 inputs. Refer to Note 2 . 10 The Company recognized a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock at a per share amount greater than the carrying value of the Company's per share investment. Accordingly, the Company is required to treat this type of transaction as if the Company had sold a proportionate share of its investment in Coca-Cola FEMSA. This gain was determined using Level 1 inputs. Fair Value Measurements for Pension and Other Postretirement Benefit Plan Assets The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 14 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets (in millions): December 31, 2018 December 31, 2017 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 1,728 17 1,760 2,080 14 2,097 International-based companies 1,098 1,121 1,465 1,465 Fixed-income securities: Government bonds Corporate bonds and debt securities 16 24 Mutual, pooled and commingled funds 130 3 42 3 Hedge funds/limited partnerships 4 4 Real estate 5 5 Other 2 6 2 6 Total $ 3,313 $ 1,472 $ $ 2,321 $ 7,409 $ 4,410 $ 1,287 $ $ 2,843 $ 8,843 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 14 . 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to tri-annually, with a redemption notice period of up to 120 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually, with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date (3 ) Purchases, sales and settlements net (9 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments Balance at end of year $ $ $ $ 1 $ 2018 Balance at beginning of year $ $ $ $ $ Actual return on plan assets held at the reporting date (2 ) (1 ) Purchases, sales and settlements net (7 ) (2 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments (13 ) (13 ) Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets (in millions): December 31, 2018 December 31, 2017 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 82 80 Hedge funds/limited partnerships 8 8 Real estate 4 5 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 14 . Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivable; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. As of December 31, 2018 , the carrying amount and fair value of our long-term debt, including the current portion, were $30,361 million and $ 30,438 million , respectively. As of December 31, 2017 , the carrying amount and fair value of our long-term debt, including the current portion, were $34,480 million and $ 35,169 million , respectively. NOTE 18 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2018, the Company recorded other operating charges of $1,079 million . These charges primarily consisted of $450 million of CCR asset impairments and $440 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $139 million related to costs incurred to refranchise certain of our North America bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $33 million related to tax litigation expense and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 12 for additional information related to the tax litigation. Refer to Note 17 for additional information on the impairment charges. Refer to Note 19 for additional information on the Company's productivity and reinvestment program. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. In 2017, the Company recorded other operating charges of $1,902 million . These charges primarily consisted of $737 million of CCR asset impairments and $534 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $280 million related to costs incurred to refranchise certain of our bottling operations. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information about the Venezuelan intangible assets. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 17 for information on how the Company determined the asset impairment charges. Refer to Note 19 for additional information on the Company's productivity and reinvestment program. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. In 2016, the Company recorded other operating charges of $1,371 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $276 million related to costs incurred to refranchise certain of our bottling operations. The Company also recorded a charge of $200 million related to cash contributions we made to The CocaCola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates, and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. In 2016, the Company also recorded impairment charges of $153 million related to certain intangible assets. Refer to Note 1 for additional information on the Venezuelan exchange rates. Refer to Note 2 for additional information on the refranchising of our bottling operations. Refer to Note 17 for additional information on the impairment charges. Refer to Note 19 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Other Nonoperating Items Interest Expense During the year ended December 31, 2018, the Company recorded a net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 11 for additional information. During the year ended December 31, 2017, the Company recorded a net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 11 for additional information. Equity Income (Loss) Net The Company recorded net charges of $111 million , $ 92 million and $ 61 million in equity income (loss) net during the years ended December 31, 2018 , 2017 and 2016 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Other Income (Loss) Net In 2018, other income (loss) net was a loss of $1,121 million . The Company recorded other-than-temporary impairment charges of $591 million related to certain of our equity method investees and net charges of $476 million due to the refranchising of certain bottling territories in North America. The Company also recorded a net loss of $278 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities, charges of $240 million related to pension settlements, and a net loss of $79 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Additionally, we recorded charges of $34 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements, a net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations, and a $32 million loss related to acquiring a controlling interest in the Philippine bottling operations. These charges were partially offset by a net gain of $296 million related to the sale of our equity ownership in Lindley and a net gain of $47 million related to the refranchising of our Latin American bottling operations. Refer to Note 1 and Note 4 for additional information on equity and debt securities. Refer to Note 2 for additional information on refranchising activities, North America conversion payments, the sale of our equity ownership in Lindley and our acquisition of the controlling interest in the Philippine bottling operations. Refer to Note 6 for additional information on our hedging activities. Refer to Note 17 for information on how the Company determined the impairment charges. Refer to Note 20 for the impact these items had on our operating segments and Corporate. Refer to Note 22 for additional information on the acquisition of Costa. In 2017, other income (loss) net was a loss of $1,764 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded net charges of $255 million resulting from settlements, special termination benefits and curtailment credits primarily related to North America refranchising and the Company's productivity and reinvestment program. Additionally, the Company recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company also incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of CCW and CCEJ to establish CCBJHI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJHI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and the sale of a related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on our North America and China refranchising activities, the conversion payments and our consolidation of CCBA. Refer to Note 20 for the impact these items had on our operating segments and Corporate. In 2016, other income (loss) net was a loss of $1,265 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a net charge of $139 million resulting from settlements and special termination benefits primarily related to North America refranchising. The Company also recorded a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These charges were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations, the deconsolidation of our South African bottling operations, the North America refranchising and the conversion payments. Refer to Note 20 for the impact these items had on our operating segments and Corporate. NOTE 19 : PRODUCTIVITY, INTEGRATION AND RESTRUCTURING INITIATIVES Productivity and Reinvestment In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives focuses on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced another expansion of our productivity and reinvestment program. This expansion is focused on achieving additional efficiencies in both our supply chain and our marketing expenditures as well as transitioning to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,566 million related to our productivity and reinvestment program since it commenced. These expenses were recorded in the line items other operating charges and other income (loss) net in our consolidated statements of income. Refer to Note 20 for the impact these charges had on our operating segments and Corporate. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments (114 ) (30 ) (205 ) (349 ) Noncash and exchange (2 ) (55 ) (56 ) Accrued balance at end of year $ $ $ $ 2017 Costs incurred $ $ $ $ Payments (181 ) (83 ) (267 ) (531 ) Noncash and exchange (62 ) 1 (1 ) (1 ) (64 ) Accrued balance at end of year $ $ $ $ 2018 Costs incurred $ $ $ $ Payments (209 ) (83 ) (211 ) (503 ) Noncash and exchange (69 ) 1 (52 ) (121 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 14 . Integration Initiatives Integration of Our German Bottling Operations In 2008, the Company began an integration initiative related to our German bottling operations acquired in 2007. The Company incurred $ 240 million of expenses related to this initiative in 2016 and has incurred total pretax expenses of $ 1,367 million related to this initiative since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income and impacted the Bottling Investments operating segment. The expenses recorded in connection with these integration activities have been primarily due to involuntary terminations. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Therefore, there was no remaining accrual balance as of December 31, 2016. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations. NOTE 20 : OPERATING SEGMENTS As of December 31, 2018 , our organizational structure consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; and Bottling Investments. Our operating structure also included Corporate, which consists of two components: (1) a center focused on strategic initiatives, policy and governance, and (2) an enabling services organization focused on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, with the exception of those that are classified as discontinued operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. Refer to Note 3 . The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, Concentrate operations % % % Finished product operations 49 Total % % % Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes from continuing operations and certain treasury-related items, such as interest income and expense, on a global basis within Corporate. We evaluate segment performance based on income or loss from continuing operations before income taxes. Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, United States $ 11,344 $ 14,727 $ 19,899 International 20,512 20,683 21,964 Net operating revenues $ 31,856 $ 35,410 $ 41,863 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, United States $ 4,154 $ 4,163 $ 6,784 International 4,078 4,040 3,851 Property, plant and equipment net $ 8,232 $ 8,203 $ 10,635 Information about our Company's continuing operations by operating segment and Corporate as of and for the years ended December 31, 2018 , 2017 and 2016 , is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 7,138 $ 3,975 $ 11,505 $ 4,809 $ 3,760 $ $ $ 31,292 Intersegment (701 ) 4 Total net operating revenues 7,702 4,014 11,768 5,197 3,771 (701 ) 31,856 Operating income (loss) 3,714 2,321 2,453 2,278 (649 ) (1,417 ) 8,700 Interest income Interest expense Depreciation and amortization 1,086 Equity income (loss) net (19 ) (2 ) 1,008 Income (loss) from continuing operations before income taxes 3,406 2,247 2,494 2,305 (612 ) (1,490 ) 8,350 Identifiable operating assets 1 7,985 1,715 17,913 1,999 2 4,135 2 22,649 56,396 5 Investments 3 14,367 3,718 20,274 Capital expenditures 1,347 Net operating revenues: Third party $ 7,332 $ 3,956 $ 8,796 $ 4,767 $ 10,379 $ $ $ 35,368 Intersegment 1,954 (2,517 ) 4 Total net operating revenues 7,374 4,029 10,750 5,176 10,460 (2,517 ) 35,410 Operating income (loss) 3,625 2,218 2,591 2,147 (962 ) (2,020 ) 7,599 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net (3 ) (3 ) 1,071 Income (loss) from continuing operations before income taxes 3,706 2,211 2,320 2,179 (2,358 ) (1,316 ) 6,742 Identifiable operating assets 1 5,475 1,896 17,619 2,072 2 4,493 2 27,060 58,615 5 Investments 3 1,238 15,998 3,536 21,952 Capital expenditures 1,675 Net operating revenues: Third party $ 7,014 $ 3,746 $ 6,587 $ 4,788 $ 19,601 $ $ $ 41,863 Intersegment 3,738 (4,720 ) Total net operating revenues 7,278 3,819 10,325 5,294 19,735 (4,720 ) 41,863 Operating income (loss) 3,668 1,953 2,614 2,210 (1,789 ) 8,657 Interest income Interest expense Depreciation and amortization 1,013 1,787 Equity income (loss) net (17 ) Income (loss) from continuing operations before income taxes 3,749 1,966 2,592 2,238 (1,955 ) (454 ) 8,136 Capital expenditures 1,329 2,262 1 Principally cash and cash equivalents, short-term investments, marketable securities, trade accounts receivable, inventories, goodwill, trademarks and other intangible assets, and property, plant and equipment net. 2 Property, plant and equipment net in India represented 10 percent and 11 percent of consolidated property, plant and equipment net in 2018 and 2017, respectively. 3 Principally equity method investments and other investments in bottling companies. 4 Intersegment revenues do not eliminate on a consolidated basis in the table above due to intercompany sales to our discontinued operations. 5 Identifiable operating assets excludes $6,546 million and $7,329 million of assets held for sale discontinued operations as of December 31, 2018 and December 31, 2017 , respectively. During 2018 , 2017 and 2016 , our operating segments and Corporate were impacted by acquisition and divestiture activities. Refer to Note 2. In 2018 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $4 million for Latin America, $175 million for North America, $31 million for Bottling Investments and $237 million for Corporate, and increased by $3 million for Europe, Middle East and Africa and $4 million for Asia Pacific due to the Company's productivity and reinvestment program, including refinements to prior period accruals. In addition, income (loss) from continuing operations before income taxes was reduced by $64 million for Corporate and $4 million for Latin America due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 14 and Note 19 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $450 million for Bottling Investments due to asset impairment charges. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $139 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $33 million for Corporate due to tax litigation expense. Refer to Note 12 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $19 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) from continuing operations before income taxes was reduced by $476 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $334 million for Europe, Middle East and Africa, $205 million for Bottling Investments and $52 million for Latin America due to other-than-temporary impairment charges related to certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $278 million for Corporate related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Income (loss) from continuing operations before income taxes was reduced by $124 million for Bottling Investments and increased by $13 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $149 million for Bottling Investments due to pension settlements related to the refranchising of North America bottling operations. Refer to Note 14 . Income (loss) from continuing operations before income taxes was reduced by $79 million for Corporate related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 and Note 22 . Income (loss) from continuing operations before income taxes was reduced by $34 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $33 million for Bottling Investments primarily due to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Income (loss) from continuing operations before income taxes was reduced by $32 million for Corporate related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $296 million for Corporate related to the sale of our equity ownership in Lindley. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $47 million for Corporate related to the refranchising of our Latin American bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $27 million for Corporate related to a net gain on the extinguishment of long-term debt. Refer to Note 11 . In 2017 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $26 million for Europe, Middle East and Africa, $7 million for Latin America, $241 million for North America, $10 million for Asia Pacific, $57 million for Bottling Investments and $193 million for Corporate due to the Company's productivity and reinvestment program. Income (loss) from continuing operations before income taxes was also reduced by $116 million for Corporate due to pension settlements related to the Company's productivity and reinvestment program. Refer to Note 14 and Note 19 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $737 million for Bottling Investments and $34 million for Corporate due to asset impairment charges. Refer to Note 17 . Operating income (loss) was reduced by $280 million and income (loss) from continuing operations before income taxes was reduced by $419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $225 million for Corporate as a result of a cash contribution we made to The Coca-Cola Foundation. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $67 million for Corporate due to tax litigation expense. Refer to Note 12 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa, $2 million for North America, $70 million for Bottling Investments and $16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 18 . Income (loss) from continuing operations before income taxes was reduced by $313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and selling a related cost method investment. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 11 . Income (loss) from continuing operations before income taxes was reduced by $26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) from continuing operations before income taxes was increased by $25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 17 . In 2016 , the results of our operating segments and Corporate were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $32 million for Europe, Middle East and Africa, $134 million for North America, $1 million for Asia Pacific, $322 million for Bottling Investments and $105 million for Corporate and increased by $2 million for Latin America due to the Company's productivity and reinvestment program, including refinements to prior period accruals. Refer to Note 19 . Operating income (loss) was reduced by $276 million and income (loss) from continuing operations before income taxes was reduced by $297 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $200 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $153 million for Bottling Investments due to impairment charges recorded on certain of the Company's intangible assets. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $76 million for Latin America due to the write-down we recorded related to our receivables from our bottling partner in Venezuela due to changes in exchange rates. Refer to Note 1 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $9 million for Bottling Investments and $32 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Income (loss) from continuing operations before income taxes was reduced by $118 million for Bottling Investments due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 14 . Income (loss) from continuing operations before income taxes was reduced by $52 million for Bottling Investments and $9 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Income (loss) from continuing operations before income taxes was reduced by $2,456 million for Bottling Investments primarily due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $1,323 million for Corporate as a result of the deconsolidation of our German bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $72 million for Corporate as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 18 . Income (loss) from continuing operations before income taxes was reduced by $31 million for North America related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . NOTE 21 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, (Increase) decrease in trade accounts receivable $ $ (141 ) $ (28 ) (Increase) decrease in inventories (171 ) (355 ) (142 ) (Increase) decrease in prepaid expenses and other assets (221 ) Increase (decrease) in accounts payable and accrued expenses (289 ) (445 ) (540 ) Increase (decrease) in accrued income taxes (12 ) (153 ) Increase (decrease) in other liabilities 1 (575 ) 4,052 (544 ) Net change in operating assets and liabilities $ (1,202 ) $ 3,464 $ (225 ) 1 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 15 . NOTE 22 : SUBSEQUENT EVENT On January 3, 2019, the Company acquired Costa in exchange for $4.9 billion of cash. Costa is a coffee company with retail outlets in over 30 countries, a coffee vending operation, for-home coffee formats and a state-of-the-art roastery. We believe this acquisition will allow us to increase our presence in the hot beverages market platform. We are currently in the process of finalizing the accounting for this transaction and expect to complete our preliminary allocation of the purchase consideration to the assets acquired and liabilities assumed by the end of the first quarter of 2019. REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2018 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2018 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls and auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2019 Proxy Statement. James R. Quincey Larry M. Mark Chief Executive Officer February 21, 2019 Vice President and Controller February 21, 2019 Kathy N. Waller Mark Randazza Executive Vice President and Chief Financial Officer February 21, 2019 Vice President, Assistant Controller and Chief Accounting Officer February 21, 2019 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, shareowners equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with US generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal controls over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 21, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company's auditor since 1921. Atlanta, Georgia February 21, 2019 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated February 21, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Atlanta, Georgia February 21, 2019 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 7,626 $ 8,927 $ 8,245 $ 7,058 $ 31,856 Gross profit 4,888 5,675 5,186 4,337 20,086 Net income attributable to shareowners of The Coca-Cola Company 1,368 2,316 1,880 6,434 Basic net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.51 1 Diluted net income per share $ 0.32 $ 0.54 $ 0.44 $ 0.20 $ 1.50 Net operating revenues $ 9,118 $ 9,702 $ 9,078 $ 7,512 $ 35,410 Gross profit 5,605 6,043 5,684 4,823 22,155 Net income (loss) attributable to shareowners of The Coca-Cola Company 1,182 1,371 1,447 (2,752 ) 1,248 Basic net income (loss) per share $ 0.28 $ 0.32 $ 0.34 $ (0.65 ) $ 0.29 Diluted net income (loss) per share $ 0.27 $ 0.32 $ 0.33 $ (0.65 ) $ 0.29 1 1 The sum of the quarterly net income (loss) per share amounts does not agree to the full year net income per share amounts. We calculate net income (loss) per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2018 and 2017, our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2018 results were impacted by one less day compared to the first quarter of 2017. Furthermore, the Company recorded the following transactions which impacted results: Charges of $390 million related to the impairment of certain assets. Refer to Note 17 . Charges of $95 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net loss of $85 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A net charge of $51 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $45 million related to costs incurred to refranchise certain of our North America bottling operations. A net loss of $33 million primarily related to the reversal of the cumulative translation adjustments resulting from the substantial liquidation of the Company's former Russian juice operations. Charges of $19 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In the second quarter of 2018, the Company recorded the following transactions which impacted results: Charges of $150 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $102 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $60 million related to the impairment of certain assets. Refer to Note 17 . A n other-than-temporary impairment charge of $52 million related to one of our international equity method investees. Refer to Note 17 . Charges of $47 million related to pension settlements as a result of North America refranchising. Refer to Note 14 . A net gain of $36 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . A net gain of $36 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $34 million related to costs incurred to refranchise certain of our North America bottling operations. A net charge of $33 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $22 million related to tax litigation expense. Refer to Note 12 . In the third quarter of 2018, the Company recorded the following transactions which impacted results: A net gain of $370 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . Charges of $275 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . An other-than-temporary impairment charge of $205 million related to our equity method investee in Indonesia. Refer to Note 17 . Charges of $132 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net gain of $64 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . A gain of $41 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 . Charges of $38 million related to costs incurred to refranchise certain of our North America bottling operations. A net gain of $27 million related to the early extinguishment of long-term debt. Refer to Note 11 . A net gain of $19 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $12 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . A gain of $11 million related to the refranchising of our Latin American bottling operations. Refer to Note 2 . The Company's fourth quarter 2018 results were impacted by one additional day compared to the fourth quarter of 2017. Furthermore, the Company recorded the following transactions which impacted results: Other-than-temporary impairment charges of $334 million related to certain of our equity method investees in the Middle East. Refer to Note 17 . A net loss of $293 million related to realized and unrealized gains and losses on equity securities and trading debt securities as well as realized gains and losses on available-for-sale debt securities. Refer to Note 4 . Charges of $131 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A net loss of $120 million related to economic hedging activity associated with the purchase of Costa, which we acquired on January 3, 2019. Refer to Note 6 . Charges of $102 million related to pension settlements as a result of North America refranchising. Refer to Note 14 . Charges of $97 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . A loss of $74 million related to the sale of our equity ownership in Lindley. Refer to Note 2 . A net charge of $46 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A net loss of $32 million related to acquiring a controlling interest in the Philippine bottling operations. Refer to Note 2 . Charges of $22 million related to costs incurred to refranchise certain of our North America bottling operations. In the first quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $497 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $139 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $106 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Charges of $104 million related to the impairment of certain intangible assets. Refer to Note 17 . A net charge of $58 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $60 million related to costs incurred to refranchise certain of our bottling operations. In the second quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $667 million related to the impairment of certain intangible assets. Refer to Note 17 . A gain of $445 million related to the integration of CCW and CCEJ to establish CCBJHI. Refer to Note 18 . Charges of $214 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $109 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Charges of $87 million due to the Company's productivity and reinvestment program. Refer to Note 19 . Charges of $44 million related to costs incurred to refranchise certain of our bottling operations. A net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 11 . A net gain of $37 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. A gain of $9 million related to refranchising a substantial portion of our China bottling operations. Refer to Note 2 . In the third quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $762 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $213 million related to costs incurred to refranchise certain of our bottling operations. Charges of $129 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A gain of $79 million related to the refranchising of our remaining China bottling operations and related cost method investment. Refer to Note 2 . Charges of $72 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . An other-than-temporary impairment charge of $50 million related to one of our international equity method investees. Refer to Note 17 . A net charge of $16 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. In the fourth quarter of 2017, the Company recorded the following transactions which impacted results: A net provisional tax charge of $3,610 million as a result of the Tax Reform Act that was signed into law on December 22, 2017. Refer to Note 15 . Charges of $667 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Charges of $295 million due to the Company's productivity and reinvestment program. Refer to Note 19 . A charge of $225 million as a result of a cash contribution we made to The Coca-Cola Foundation. A gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Charges of $105 million related to costs incurred to refranchise certain of our bottling operations. A net charge of $55 million related to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Charges of $26 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2018 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2018 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Changes in Internal Control Over Financial Reporting There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. " +4,a201,123110-k," ITEM 1. BUSINESS In this report, the terms ""The Coca-Cola Company,"" ""Company,"" ""we,"" ""us"" and ""our"" mean The Coca-Cola Company and all entities included in our consolidated financial statements. General The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations as well as independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage options to meet their desires, needs and lifestyles. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. We were incorporated in September 1919 under the laws of the State of Delaware and succeeded to the business of a Georgia corporation with the same name that had been organized in 1892. Operating Segments The Company's operating structure is the basis for our internal financial reporting. As of December 31, 2017 , our operating structure included the following operating segments, the first five of which are sometimes referred to as ""operating groups"" or ""groups"": Europe, Middle East and Africa Latin America North America Asia Pacific Bottling Investments Corporate Except to the extent that differences among operating segments are material to an understanding of our business taken as a whole, the description of our business in this report is presented on a consolidated basis. For financial information about our operating segments and geographic areas, refer to Note 19 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report, incorporated herein by reference. For certain risks attendant to our non-U.S. operations, refer to ""Item 1A. Risk Factors"" below. Products and Brands As used in this report: ""concentrates"" means flavoring ingredients and, depending on the product, sweeteners used to prepare syrups or finished beverages and includes powders or minerals for purified water products such as Dasani; ""syrups"" means beverage ingredients produced by combining concentrates and, depending on the product, sweeteners and added water; ""fountain syrups"" means syrups that are sold to fountain retailers, such as restaurants and convenience stores, which use dispensing equipment to mix the syrups with sparkling or still water at the time of purchase to produce finished beverages that are served in cups or glasses for immediate consumption; ""Company Trademark Beverages"" means beverages bearing our trademarks and certain other beverage products bearing trademarks licensed to us by third parties for which we provide marketing support and from the sale of which we derive economic benefit; and ""Trademark Coca-Cola Beverages"" or ""Trademark Coca-Cola"" means beverages bearing the trademark Coca-Cola or any trademark that includes Coca-Cola or Coke (that is, Coca-Cola, Coca-Cola Life, Diet Coke/Coca-Cola Light and Coca-Cola Zero Sugar and all their variations and any line extensions, including caffeine free Diet Coke, Cherry Coke, etc.). Likewise, when we use the capitalized word ""Trademark"" together with the name of one of our other beverage products (such as ""Trademark Fanta,"" ""Trademark Sprite"" or ""Trademark Simply""), we mean beverages bearing the indicated trademark (that is, Fanta, Sprite or Simply, respectively) and all its variations and line extensions (such that ""Trademark Fanta"" includes Fanta Orange, Fanta Zero Orange, Fanta Apple, etc.; ""Trademark Sprite"" includes Sprite, Diet Sprite, Sprite Zero, Sprite Light, etc.; and ""Trademark Simply"" includes Simply Orange, Simply Apple, Simply Grapefruit, etc.). Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. In our finished product operations, we typically generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, including water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. These finished product operations consist primarily of our Company-owned or -controlled bottling, sales and distribution operations which are included in our Bottling Investments operating segment. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers, such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. Our finished product business also includes juice and other still beverage production operations in North America. Our fountain syrup sales in the United States and the juice and other still beverage production operations in North America are included in our North America operating segment. For information regarding net operating revenues and unit case volume related to our concentrate operations and finished product operations, refer to the heading ""Our Business General"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. For information regarding how we measure the volume of Company beverage products sold by the Coca-Cola system, refer to the heading ""Operations Review Beverage Volume"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report, which is incorporated herein by reference. We own numerous valuable nonalcoholic beverage brands, including the following: Coca-Cola Georgia 2 Dasani Ice Dew 10 Diet Coke/Coca-Cola Light Powerade Simply 6 I LOHAS 11 Coca-Cola Zero Sugar 1 Del Valle 3 Glacau Vitaminwater Ayataka 12 Fanta Schweppes 4 Gold Peak 7 Sprite Aquarius FUZE TEA 8 Minute Maid Minute Maid Pulpy 5 Glacau Smartwater 9 1 Including Coca-Cola No Sugar and Coca-Cola Zero. 2 Georgia is primarily a coffee brand sold mainly in Japan. 3 Del Valle is a juice and juice drink brand sold in Latin America. In Mexico and Brazil, we manufacture, market and sell Del Valle beverage products through joint ventures with our bottling partners. 4 Schweppes is owned by the Company in certain countries other than the United States. 5 Minute Maid Pulpy is a juice drink brand sold primarily in Asia Pacific. 6 Simply is a juice and juice drink brand sold in North America. 7 Gold Peak is primarily a tea brand sold in North America. 8 FUZE TEA is a brand sold outside of North America. 9 Glacau Smartwater is a vapor-distilled water with added electrolytes which is sold mainly in North America and Great Britain. 10 Ice Dew is a water brand sold in China. 11 I LOHAS is a water brand sold primarily in Japan. 12 Ayataka is a green tea brand sold primarily in Japan. In addition to the beverage brands we own, we also provide marketing support and otherwise participate in the sales of other nonalcoholic beverage brands through licenses, joint ventures and strategic partnerships, including, but not limited to, the following: We and certain of our bottlers distribute certain brands of Monster Beverage Corporation (""Monster""), primarily Monster Energy, in designated territories in the United States, Canada and other international territories pursuant to distribution coordination agreements between the Company and Monster and related distribution agreements between Monster and Company-owned or -controlled bottling operations and independent bottling and distribution partners. We have a strategic partnership with Aujan Industries Company J.S.C. (""Aujan""), one of the largest independent beverage companies in the Middle East. We own 50 percent of the entity that holds the rights in certain territories to brands produced and distributed by Aujan, including Rani, a juice brand, and Barbican, a flavored malt beverage brand. fairlife, LLC (fairlife), our joint venture with Select Milk Producers, Inc., a dairy cooperative, is a health and wellness dairy company whose products include fairlife ultra-filtered milk and Core Power, a high-protein milkshake. We and certain of our bottling partners distribute fairlife products in the United States and Canada. Consumer demand determines the optimal menu of Company product offerings. Consumer demand can vary from one market to another and can change over time within a single market. Employing our business strategy, our Company seeks to further build its existing brands and, at the same time, to broaden its portfolio of brands, products and services in order to create and satisfy consumer demand in every market. Distribution System We make our branded beverage products available to consumers in more than 200 countries through our network of Company-owned or -controlled bottling and distribution operations, independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Consumers enjoy finished beverage products bearing trademarks owned by or licensed to us at a rate of more than 1.9 billion servings each day. We continue to expand our marketing presence in an effort to increase our unit case volume and net operating revenues in developed, developing and emerging markets. Our strong and stable bottling and distribution system helps us to capture growth by manufacturing, distributing and selling existing, enhanced and new innovative products to our consumers throughout the world. The Coca-Cola system sold 29.2 billion , 29.3 billion and 29.2 billion unit cases of our products in 2017 , 2016 and 2015 , respectively. Sparkling soft drinks represented 69 percent , 69 percent and 70 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. Trademark Coca-Cola accounted for 45 percent , 45 percent and 46 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. In 2017 , unit case volume in the United States represented 19 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume for 2017 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 45 percent of non-U.S. unit case volume. Our five largest independent bottling partners based on unit case volume in 2017 were: Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), which has bottling and distribution operations in Mexico (a substantial part of central Mexico, including Mexico City, as well as southeast and northeast Mexico), Guatemala (Guatemala City and surrounding areas), Nicaragua (nationwide), Costa Rica (nationwide), Panama (nationwide), Colombia (most of the country), Venezuela (nationwide), Brazil (greater So Paulo, Campias, Santos, the state of Mato Grosso do Sul, the state of Paran, the state of Santa Catarina, part of the state of Rio Grande do Sul, part of the state of Gois, part of the state of Rio de Janeiro and part of the state of Minas Gerais), Argentina (federal capital of Buenos Aires and surrounding areas) and the Philippines (nationwide); Coca-Cola European Partners plc (""CCEP""), which has bottling and distribution operations in Andorra, Belgium, France, Germany, Great Britain, Iceland, Luxembourg, Monaco, the Netherlands, Norway, Portugal, Spain and Sweden; Coca-Cola HBC AG (""Coca-Cola Hellenic""), which has bottling and distribution operations in Armenia, Austria, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Cyprus, the Czech Republic, Estonia, the Former Yugoslav Republic of Macedonia, Greece, Hungary, Italy, Latvia, Lithuania, Moldova, Montenegro, Nigeria, Northern Ireland, Poland, Republic of Ireland, Romania, the Russian Federation, Serbia, Slovakia, Slovenia, Switzerland and Ukraine; Arca Continental, S.A.B. de C.V., which has bottling and distribution operations in northern and western Mexico, northern Argentina, Ecuador, Peru and the state of Texas and parts of the states of New Mexico, Oklahoma and Arkansas in the United States; and Swire Beverages, which has bottling and distribution operations in Hong Kong, Taiwan, 11 provinces and the Shanghai Municipality in the eastern and southern areas of mainland China, and territories in 13 states in the western United States. In 2017 , these five bottling partners combined represented 41 percent of our total unit case volume. Being a bottler does not create a legal partnership or joint venture between us and our bottlers. Our bottlers are independent contractors and are not our agents. Bottler's Agreements We have separate contracts, to which we generally refer as ""bottler's agreements,"" with our bottling partners regarding the manufacture and sale of Company products. Subject to specified terms and conditions and certain variations, the bottler's agreements generally authorize the bottlers to prepare specified Company Trademark Beverages, to package the same in authorized containers, and to distribute and sell the same in (but, subject to applicable local law, generally only in) an identified territory. The bottler is obligated to purchase its entire requirement of concentrates or syrups for the designated Company Trademark Beverages from the Company or Company-authorized suppliers. We typically agree to refrain from selling or distributing, or from authorizing third parties to sell or distribute, the designated Company Trademark Beverages throughout the identified territory in the particular authorized containers; however, we typically reserve for ourselves or our designee the right (1) to prepare and package such Company Trademark Beverages in such containers in the territory for sale outside the territory, (2) to prepare, package, distribute and sell such Company Trademark Beverages in the territory in any other manner or form (territorial restrictions on bottlers vary in some cases in accordance with local law), and (3) to handle certain key accounts (accounts that cover multiple territories). While under most of our bottler's agreements we generally have complete flexibility to determine the price and other terms of sale of the concentrates and syrups we sell to our bottlers, as a practical matter, our Company's ability to exercise its contractual flexibility to determine the price and other terms of sale of concentrates and syrups is subject, both outside and within the United States, to competitive market conditions. In addition, in some instances we have agreed or may in the future agree with a bottler with respect to concentrate pricing on a prospective basis for specified time periods. Also, in some markets, in an effort to allow our Company and our bottling partners to grow together through shared value, aligned incentives and the flexibility necessary to meet consumers' always changing needs and tastes, we worked with our bottling partners to develop and implement an incidence-based concentrate pricing model. Under this model, the concentrate price we charge is impacted by a number of factors, including, but not limited to, bottler pricing, the channels in which the finished products are sold and package mix. As further discussed below, our bottler's agreements for territories outside the United States differ in some respects from our bottler's agreements for territories within the United States. Bottler's Agreements Outside the United States Bottler's agreements between us and our authorized bottlers outside the United States generally are of stated duration, subject in some cases to possible extensions or renewals. Generally, these bottler's agreements are subject to termination by the Company following the occurrence of certain designated events, including defined events of default and certain changes in ownership or control of the bottlers. Most of the bottler's agreements in force between us and bottlers outside the United States authorize the bottlers to manufacture and distribute fountain syrups, usually on a nonexclusive basis. In certain parts of the world outside the United States, we have not granted comprehensive beverage production rights to the bottlers. In such instances, we or our authorized suppliers sell Company Trademark Beverages to the bottlers for sale and distribution throughout the designated territory, often on a nonexclusive basis. Bottler's Agreements Within the United States In the United States, most bottlers operate under a ""comprehensive beverage agreement"" (""CBA"") that is of stated duration, subject in most cases to renewal rights of bottlers and in some cases to renewal rights of the Company. Certain bottlers continue to operate under legacy bottler's agreements with no stated expiration date for Trademark Coca-Cola Beverages and other cola-flavored beverages. The bottler's agreements in the United States are subject to termination by the Company for nonperformance or upon the occurrence of certain defined events of default that may vary from contract to contract. In conjunction with implementing a new beverage partnership model in North America, the Company granted certain additional exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products (as defined by the CBAs) to certain U.S. bottlers. These expanding bottlers entered into new CBAs, to which we sometimes refer as ""expanding bottler CBAs,"" which apply to newly granted territories as well as any legacy territories, and provide consistency across each such bottler's respective territory and consistency with other U.S. bottlers that have executed an expanding bottler CBA. Under the expanding bottler CBAs, the Company generally retained the rights to produce the applicable beverage products for territories not covered by specific manufacturing agreements and such bottlers purchase from the Company (or from Company-authorized manufacturing bottlers) substantially all of the finished beverage products needed in order to service the customers in these territories. The expanding bottler CBA has a term of 10 years and is renewable, in most cases by the bottler, and in some cases by the Company, indefinitely for successive additional terms of 10 years each, and includes additional requirements that provide for, among other things, a binding national governance model, mandatory incidence pricing and certain core performance requirements. The Company also entered into manufacturing agreements that authorize certain expanding bottlers that have executed expanding bottler CBAs to manufacture certain beverage products for their own account and for supply to other bottlers. In addition, certain U.S. bottlers that were not granted additional exclusive territory rights converted or agreed to convert their legacy bottler's agreements to a form of CBA to which we sometimes refer as ""non-expanding bottler CBA."" This form of CBA has a term of 10 years and is renewable by the bottler indefinitely for successive additional terms of 10 years each and is substantially similar in most material respects to the expanding bottler CBA, including with respect to requirements for a binding national governance model and mandatory incidence pricing, but includes core performance requirements that vary in certain respects from those in the expanding bottler CBA. Those bottlers that have not signed a CBA continue to operate under legacy bottler's agreements that include pricing formulas that generally provide for a baseline price for certain Trademark Coca-Cola Beverages and other cola-flavored Company Trademark Beverages. This baseline price may be adjusted periodically by the Company, up to a maximum indexed ceiling price, and is adjusted quarterly based upon changes in certain sugar or sweetener prices, as applicable. The U.S. unit case volume manufactured, sold and distributed under these legacy bottler's agreements is not material. Under the terms of the bottler's agreements, bottlers in the United States generally are not authorized to manufacture fountain syrups. Rather, the Company manufactures and sells fountain syrups to authorized fountain wholesalers (including certain authorized bottlers) and some fountain retailers. These wholesalers in turn sell the syrups or deliver them on our behalf to restaurants and other retailers. Promotions and Marketing Programs In addition to conducting our own independent advertising and marketing activities, we may provide promotional and marketing support and/or funds to our bottlers. In most cases, we do this on a discretionary basis under the terms of commitment letters or agreements, even though we are not obligated to do so under the terms of the bottler's or distribution agreements between our Company and the bottlers. Also, on a discretionary basis in most cases, our Company may develop and introduce new products, packages and equipment to assist the bottlers. Likewise, in many instances, we provide promotional and marketing services and/or funds and/or dispensing equipment and repair services to fountain and bottle/can retailers, typically pursuant to marketing agreements. The aggregate amount of funds provided by our Company to bottlers, resellers or other customers of our Company's products, principally for participation in promotional and marketing programs, was $ 6.2 billion in 2017 . Investments in Bottling Operations Most of our branded beverage products are manufactured, sold and distributed by independent bottling partners. However, from time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. Owning such a controlling interest enables us to compensate for limited local resources; help focus the bottler's sales and marketing programs; assist in the development of the bottler's business and information systems; and establish an appropriate capital structure for the bottler. In line with our long-term bottling strategy, we may periodically consider options for divesting or reducing our ownership interest in a Company-owned or -controlled bottler, typically by selling our interest in a particular bottling operation to an independent bottler to improve Coca-Cola system efficiency. When we sell our interest in a bottling operation to one of our other bottling partners in which we have an equity method investment, our Company continues to participate in the bottler's results of operations through our share of the equity method investee's earnings or losses. In addition, from time to time we make equity investments representing noncontrolling interests in selected bottling operations with the intention of maximizing the strength and efficiency of the Coca-Cola system's production, marketing, sales and distribution capabilities around the world by providing expertise and resources to strengthen those businesses. These investments are intended to result in increases in unit case volume, net revenues and profits at the bottler level, which in turn generate increased sales for our Company's concentrate business. When our equity investment provides us with the ability to exercise significant influence over the investee bottler's operating and financial policies, we account for the investment under the equity method, and we sometimes refer to such a bottler as an ""equity method investee bottler"" or ""equity method investee."" Seasonality Sales of our nonalcoholic ready-to-drink beverages are somewhat seasonal, with the second and third calendar quarters accounting for the highest sales volumes. The volume of sales in the beverage business may be affected by weather conditions. Competition The nonalcoholic beverage segment of the commercial beverage industry is highly competitive, consisting of numerous companies ranging from small or emerging to very large and well established. These include companies that, like our Company, compete in multiple geographic areas, as well as businesses that are primarily regional or local in operation. Competitive products include numerous nonalcoholic sparkling soft drinks; various water products, including flavored and enhanced waters; juices and nectars; fruit drinks and dilutables (including syrups and powdered drinks); coffees and teas; energy, sports and other performance-enhancing drinks; filtered milk and other dairy-based drinks; functional beverages, including vitamin-based products and relaxation beverages; and various other nonalcoholic beverages. These competitive beverages are sold to consumers in both ready-to-drink and other than ready-to-drink form. In many of the countries in which we do business, including the United States, PepsiCo, Inc. (""PepsiCo""), is one of our primary competitors. Other significant competitors include, but are not limited to, Nestl S.A. (""Nestl""), Dr Pepper Snapple Group, Inc. (""DPSG""), Groupe Danone, Mondelz International, Inc. (""Mondelz""), The Kraft Heinz Company (""Kraft""), Suntory Beverage Food Limited (""Suntory"") and Unilever. We also compete against numerous regional and local companies and, in some markets, against retailers that have developed their own store or private label beverage brands. Competitive factors impacting our business include, but are not limited to, pricing, advertising, sales promotion programs, in-store displays and point-of-sale marketing, product and ingredient innovation, increased efficiency in production techniques, the introduction of new packaging, new vending and dispensing equipment, and brand and trademark development and protection. Our competitive strengths include leading brands with high levels of consumer acceptance; a worldwide network of bottlers and distributors of Company products; sophisticated marketing capabilities; and a talented group of dedicated associates. Our competitive challenges include strong competition in all geographic regions and, in many countries, a concentrated retail sector with powerful buyers able to freely choose among Company products, products of competitive beverage suppliers and individual retailers' own store or private label beverage brands. Raw Materials Water is a main ingredient in substantially all of our products. While historically we have not experienced significant water supply difficulties, water is a limited natural resource in many parts of the world, and our Company recognizes water availability, quality and sustainability, for both our operations and also the communities where we operate, as one of the key challenges facing our business. In addition to water, the principal raw materials used in our business are nutritive and non-nutritive sweeteners. In the United States, the principal nutritive sweetener is high fructose corn syrup (""HFCS""), which is nutritionally equivalent to sugar. HFCS is available from numerous domestic sources and has historically been subject to fluctuations in its market price. The principal nutritive sweetener used by our business outside the United States is sucrose, i.e., table sugar, which is also available from numerous sources and has historically been subject to fluctuations in its market price. Our Company generally has not experienced any difficulties in obtaining its requirements for nutritive sweeteners. In the United States, we purchase HFCS to meet our and our bottlers' requirements with the assistance of Coca-Cola Bottlers' Sales Services Company LLC (""CCBSS""). CCBSS is a limited liability company that is owned by authorized Coca-Cola bottlers doing business in the United States. Among other things, CCBSS provides procurement services to our Company for the purchase of various goods and services in the United States, including HFCS. The principal non-nutritive sweeteners we use in our business are aspartame, acesulfame potassium, sucralose, saccharin, cyclamate and steviol glycosides. Generally, these raw materials are readily available from numerous sources. However, our Company purchases aspartame, an important non-nutritive sweetener that is used alone or in combination with other important non-nutritive sweeteners such as saccharin or acesulfame potassium in our low- and no-calorie sparkling beverage products, primarily from Ajinomoto Co., Inc. and SinoSweet Co., Ltd., which we consider to be our primary sources for the supply of this product. In addition, we purchase sucralose, which we consider a critical raw material, from a limited number of suppliers in the United States and China. We work closely with our primary sucralose suppliers to maintain continuity of supply. However, global demand for sucralose has increased in recent years as consumer products companies are reformulating food and beverages to replace high-intensity sweeteners with non-nutritive sweeteners, primarily sucralose. In addition, the Chinese sucralose industry has been impacted by the imposition of stringent environmental requirements that have reduced or closed production. To mitigate the impact of the increase in demand and tightening of supply of sucralose, we are working with our existing suppliers to secure additional volume and are expanding our sucralose supplier base as well as assessing additional internal contingency plans to address any potential shortages. Our Company generally has not experienced major difficulties in obtaining its requirements for non-nutritive sweeteners and we do not anticipate such difficulties in the future. Juice and juice concentrate from various fruits, particularly orange juice and orange juice concentrate, are the principal raw materials for our juice and juice drink products. We source our orange juice and orange juice concentrate primarily from Florida and the Southern Hemisphere (particularly Brazil). We work closely with Cutrale Citrus Juices U.S.A., Inc., our primary supplier of orange juice from Florida and Brazil, to ensure an adequate supply of orange juice and orange juice concentrate that meets our Company's standards. However, the citrus industry is impacted by greening disease and the variability of weather conditions. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of trees and increasing grower costs and prices. Our Company-owned or consolidated bottling operations and our finished product business also purchase various other raw materials including, but not limited to, polyethylene terephthalate (""PET"") resin, preforms and bottles; glass and aluminum bottles; aluminum and steel cans; plastic closures; aseptic fiber packaging; labels; cartons; cases; postmix packaging; and carbon dioxide. We generally purchase these raw materials from multiple suppliers and historically have not experienced significant shortages. Patents, Copyrights, Trade Secrets and Trademarks Our Company owns numerous patents, copyrights and trade secrets, as well as substantial know-how and technology, which we collectively refer to in this report as ""technology."" This technology generally relates to our Company's products and the processes for their production; the packages used for our products; and the design and operation of various processes and equipment used in our business. Some of the technology is licensed to suppliers and other parties. Our sparkling beverage and other beverage formulae are among the important trade secrets of our Company. We own numerous trademarks that are very important to our business. Depending upon the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained. Pursuant to our bottler's agreements, we authorize our bottlers to use applicable Company trademarks in connection with their manufacture, sale and distribution of Company products. In addition, we grant licenses to third parties from time to time to use certain of our trademarks in conjunction with certain merchandise and food products. Governmental Regulation Our Company is required to comply, and it is our policy to comply, with all applicable laws in the numerous countries throughout the world in which we do business. In many jurisdictions, compliance with competition laws is of special importance to us, and our operations may come under special scrutiny by competition law authorities due to our competitive position in those jurisdictions. In the United States, the safety, production, transportation, distribution, advertising, labeling and sale of our Company's products and their ingredients are subject to the Federal Food, Drug, and Cosmetic Act; the Federal Trade Commission Act; the Lanham Act; state consumer protection laws; competition laws; federal, state and local workplace health and safety laws; various federal, state and local environmental protection laws; and various other federal, state and local statutes and regulations. Outside the United States, our business is subject to numerous similar statutes and regulations, as well as other legal and regulatory requirements. Under a California law known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. The state maintains lists of these substances and periodically adds other substances to these lists. Proposition 65 exposes all food and beverage producers to the possibility of having to provide warnings on their products in California because it does not provide for any generally applicable quantitative threshold below which the presence of a listed substance is exempt from the warning requirement. Consequently, the detection of even a trace amount of a listed substance can subject an affected product to the requirement of a warning label. However, Proposition 65 does not require a warning if the manufacturer of a product can demonstrate that the use of that product exposes consumers to a daily quantity of a listed substance that is: below a ""safe harbor"" threshold that may be established; naturally occurring; the result of necessary cooking; or subject to another applicable exemption. One or more substances that are currently on the Proposition 65 lists, or that may be added in the future, can be detected in certain Company products at low levels that are safe. With respect to substances that have not yet been listed under Proposition 65, the Company takes the position that listing is not scientifically justified. With respect to substances that are already listed, the Company takes the position that the presence of each such substance in Company products is subject to an applicable exemption from the warning requirement or that the product is otherwise in compliance with Proposition 65. The state of California and other parties, however, have in the past taken a contrary position and may do so in the future. Bottlers of our beverage products presently offer and use nonrefillable recyclable containers in the United States and various other markets around the world. Some of these bottlers also offer and use refillable containers, which are also recyclable. Legal requirements apply in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. The precise requirements imposed by these measures vary. Other types of statutes and regulations relating to beverage container deposits, recycling, ecotaxes and/or product stewardship also apply in various jurisdictions in the United States and overseas. We anticipate that additional such legal requirements may be proposed or enacted in the future at local, state and federal levels, both in the United States and elsewhere. All of our Company's facilities and other operations in the United States and elsewhere around the world are subject to various environmental protection statutes and regulations, including those relating to the use of water resources and the discharge of wastewater. Our policy is to comply with all such legal requirements. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect on our Company's capital expenditures, net income or competitive position. Employees As of December 31, 2017 and 2016 , our Company had approximately 61,800 and 100,300 employees, respectively, of which approximately 2,900 were employed by consolidated variable interest entities (""VIEs"") as of December 31, 2016. There were no employees employed by consolidated VIEs as of December 31, 2017. The decrease in the total number of employees in 2017 was primarily due to the refranchising of certain bottling territories that were previously managed by Coca-Cola Refreshments (""CCR""), the refranchising of our China bottling operations, and our productivity initiatives. This decrease was partially offset by an increase in the number of employees due to the transition of Anheuser-Busch InBev's (""ABI"") controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company in October 2017. For additional information about the North America and China refranchising transactions, as well as the transition of ABI's controlling interest in CCBA, refer to Note 2 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. As of December 31, 2017 and 2016, our Company had approximately 12,400 and 51,000 employees, respectively, located in the United States, of which zero and approximately 400, respectively, were employed by consolidated VIEs. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2017 , approximately 3,700 employees, excluding seasonal hires, in North America were covered by collective bargaining agreements. These agreements typically have terms of three years to five years . We currently expect that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its employees are generally satisfactory. Securities Exchange Act Reports The Company maintains a website at the following address: www.coca-colacompany.com. The information on the Company's website is not incorporated by reference in this Annual Report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (""SEC"") in accordance with the Securities Exchange Act of 1934, as amended (""Exchange Act""). These include our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. "," ITEM 1A. RISK FACTORS In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks facing our Company. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations in future periods. Obesity and other health-related concerns may reduce demand for some of our products. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. Increasing public concern about obesity; other health-related public concerns surrounding consumption of sugar-sweetened beverages; possible new or increased taxes on sugar-sweetened beverages by government entities to reduce consumption or to raise revenue; additional governmental regulations concerning the marketing, labeling, packaging or sale of our sugar-sweetened beverages; and negative publicity resulting from actual or threatened legal actions against us or other companies in our industry relating to the marketing, labeling or sale of sugar-sweetened beverages may reduce demand for, or increase the cost of, our sugar-sweetened beverages, which could adversely affect our profitability. Water scarcity and poor quality could negatively impact the Coca-Cola system's costs and capacity. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited resource in many parts of the world, facing unprecedented challenges from overexploitation, increasing demand for food and other consumer and industrial products whose manufacturing processes require water, increasing pollution, poor management and the effects of climate change. As the demand for water continues to increase around the world, and as water becomes scarcer and the quality of available water deteriorates, the Coca-Cola system may incur higher costs or face capacity constraints that could adversely affect our profitability or net operating revenues in the long run. If we do not address evolving consumer preferences, our business could suffer. Consumer preferences have evolved and continue to evolve as a result of, among other things, health, wellness and nutrition considerations, especially the perceived undesirability of artificial ingredients and obesity concerns; shifting consumer demographics, including aging populations; changes in consumer tastes and needs; changes in consumer lifestyles; location of origin or source of products and ingredients; and competitive product and pricing pressures. If we fail to address these changes, or do not successfully anticipate future changes in consumer preferences, our share of sales, revenue growth and overall financial results could be negatively affected. Increased competition could hurt our business. We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. For additional information regarding the competitive environment in which we operate, including the names of certain of our significant competitors, refer to the heading ""Competition"" set forth in Part I, ""Item 1. Business"" of this report. Our ability to gain or maintain share of sales in the global market or in various local markets may be limited as a result of actions by competitors. If we do not continuously strengthen our capabilities in marketing and innovation to maintain our brand loyalty and market share while we selectively expand into other profitable categories in the nonalcoholic beverage segment of the commercial beverage industry, our business could be negatively affected. Product safety and quality concerns could negatively affect our business. Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of all of our products. We have rigorous product safety and quality standards, which we expect our operations as well as our bottling partners to meet. However, we cannot assure you that despite our strong commitment to product safety and quality we or all of our bottling partners will always meet these standards, particularly as we expand our product offerings through innovation or acquisitions into beverage categories, such as value-added dairy and plant-based beverages, that are beyond our traditional range of beverage products. If we or our bottling partners fail to comply with applicable product safety and quality standards, or if our beverage products taken to the market are or become contaminated or adulterated by any means, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our business to suffer. Public debate and concern about perceived negative health consequences of certain ingredients, such as non-nutritive sweeteners and biotechnology-derived substances, and of other substances present in our beverage products or packaging materials, may reduce demand for our beverage products. Public debate and concern about perceived negative health consequences of certain ingredients in our beverage products, such as non-nutritive sweeteners and biotechnology-derived substances; substances that are present in our beverage products naturally or that occur as a result of the manufacturing process, such as 4-methylimidazole (""4-MEI,"" a chemical compound that is formed during the manufacturing of certain types of caramel coloring used in cola-type beverages); or substances used in packaging materials, such as bisphenol A (""BPA,"" an odorless, tasteless food-grade chemical commonly used in the food and beverage industries as a component in the coating of the interior of cans), may affect consumers' preferences and cause them to shift away from some of our beverage products. In addition, increasing public concern about actual or perceived health consequences of the presence of such ingredients or substances in our beverage products or in packaging materials, whether or not justified, could result in additional governmental regulations concerning the marketing, labeling or sale of our beverages; possible new or increased taxes on our beverages by government entities; and negative publicity, or actual or threatened legal actions against us or other companies in our industry, all of which could damage the reputation of, and may reduce demand for, our beverage products. If we are not successful in our innovation activities, our financial results may be negatively affected. Achieving our business growth objectives depends in part on our ability to evolve and improve our existing beverage products through innovation and to successfully develop, introduce and market new beverage products. The success of our innovation activities in turn depends on our ability to correctly anticipate customer and consumer acceptance and trends, obtain, maintain and enforce necessary intellectual property protections and avoid infringing on the intellectual property rights of others. If we are not successful in our innovation activities, we may not be able to achieve our growth objectives, which may have a negative impact on our financial results. Increased demand for food products and decreased agricultural productivity may negatively affect our business. We and our bottling partners use a number of key ingredients that are derived from agricultural commodities such as sugarcane, corn, sugar beets, citrus, coffee and tea in the manufacture and packaging of our beverage products. Increased demand for food products and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of such agricultural commodities and could impact the food security of communities around the world. If we are unable to implement programs focused on economic opportunity and environmental sustainability to address these agricultural challenges and fail to make a strategic impact on food security through joint efforts with bottlers, farmers, communities, suppliers and key partners, as well as through our increased and continued investment in sustainable agriculture, the affordability of our products and ultimately our business and results of operations could be negatively impacted. If we are unable to protect our information systems against service interruption, misappropriation of data or breaches of security, our operations could be disrupted, we may suffer financial losses and our reputation may be damaged. We rely on networks and information systems and other technology (""information systems""), including the Internet and third-party hosted services, to support a variety of business processes and activities, including procurement and supply chain, manufacturing, distribution, invoicing and collection of payments, employee processes, consumer marketing, mergers and acquisitions and research and development. We use information systems to process financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting and legal and tax requirements. In addition, we depend on information systems for digital marketing activities and electronic communications among our locations around the world and between Company personnel and our bottlers and other customers, suppliers and consumers. Because information systems are critical to many of the Company's operating activities, our business may be impacted by system shutdowns, service disruptions or security breaches. These incidents may be caused by failures during routine operations such as system upgrades or by user errors, as well as network or hardware failures, malicious or disruptive software, unintentional or malicious actions of employees or contractors, cyberattacks by common hackers, criminal groups or nation-state organizations or social-activist (hacktivist) organizations, geopolitical events, natural disasters, failures or impairments of telecommunications networks, or other catastrophic events. In addition, such incidents could result in unauthorized or accidental disclosure of material confidential information or regulated individual personal data. If our information systems suffer severe damage, disruption or shutdown and our business continuity plans do not effectively resolve the issues in a timely manner, we could experience delays in reporting our financial results, and we may lose revenue and profits as a result of our inability to timely manufacture, distribute, invoice and collect payments for concentrate or finished products. Unauthorized or accidental access to, or destruction, loss, alteration, disclosure, falsification or unavailability of, information could result in violations of data privacy laws and regulations, damage to the reputation and credibility of the Company, loss of opportunities to acquire or divest of businesses or brands and loss of ability to commercialize products developed through research and development efforts and, therefore, could have a negative impact on net operating revenues. In addition, we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us, our current or former employees, our bottling partners, other customers or suppliers, or consumers or other data subjects, and may become exposed to legal action and increased regulatory oversight. The Company could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and information systems . Like most major corporations, the Company's information systems are a target of attacks. Although the incidents that we have experienced to date have not had a material effect on our business, financial condition or results of operations, there can be no assurance that such incidents will not have a material adverse effect on us in the future. In order to address risks to our information systems, we continue to make investments in personnel, technologies, cyber insurance and training of Company personnel. The Company maintains an information risk management program which is supervised by information technology management and reviewed by a cross-functional committee. As part of this program, reports that include analysis of emerging risks as well as the Company's plans and strategies to address them are regularly prepared and presented to senior management and the Audit Committee of the Board of Directors. Changes in the retail landscape or the loss of key retail or foodservice customers could adversely affect our financial performance. Our industry is being affected by the trend toward consolidation in the retail channel, particularly in Europe and the United States. Larger retailers may seek lower prices from us and our bottling partners, may demand increased marketing or promotional expenditures, and may be more likely to use their distribution networks to introduce and develop private label brands, any of which could negatively affect the Coca-Cola system's profitability. In addition, in developed markets, discounters and value stores, as well as the volume of transactions through e-commerce, are growing at a rapid pace. The nonalcoholic beverage retail landscape is also very dynamic and constantly evolving in emerging and developing markets, where modern trade is growing at a faster pace than traditional trade outlets. If we are unable to successfully adapt to the rapidly changing environment and retail landscape, our share of sales, volume growth and overall financial results could be negatively affected. In addition, our success depends in part on our ability to maintain good relationships with key retail and foodservice customers. The loss of one or more of our key retail or foodservice customers could have an adverse effect on our financial performance. If we are unable to expand our operations in emerging and developing markets, our growth rate could be negatively affected. Our success depends in part on our ability to grow our business in emerging and developing markets, which in turn depends on economic and political conditions in those markets and on our ability to work with local bottlers to make necessary infrastructure enhancements to production facilities, distribution networks, sales equipment and technology. Additionally, we rely on local availability of talented management and staff to establish and manage our operations in these markets. Scarcity or heavy competition for talented employee resources could impede our abilities in such markets. Moreover, the supply of our products in emerging and developing markets must match consumers' demand for those products. Due to product price, limited purchasing power and cultural differences, there can be no assurance that our products will be accepted in any particular emerging or developing market. Fluctuations in foreign currency exchange rates could have a material adverse effect on our financial results. We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar, including the euro, the Japanese yen, the Brazilian real and the Mexican peso. In 2017, we used 73 functional currencies in addition to the U.S. dollar and derived $20.7 billion of net operating revenues from operations outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our net operating revenues, operating income and the value of balance sheet items denominated in foreign currencies. For information regarding the estimated impact of currency fluctuations on our consolidated and operating segment net operating revenues for 2017 and 2016, refer to the heading ""Operations Review Net Operating Revenues"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. Because of the geographic diversity of our operations, weaknesses in some currencies might be offset by strengths in others over time. We also use derivative financial instruments to further reduce our net exposure to foreign currency exchange rate fluctuations. However, we cannot assure you that fluctuations in foreign currency exchange rates, particularly the strengthening of the U.S. dollar against major currencies or the currencies of large developing countries, would not materially affect our financial results. If interest rates increase, our net income could be negatively affected. We maintain levels of debt that we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. When and to the extent appropriate, we use derivative financial instruments to reduce our exposure to interest rate risks. We cannot assure you, however, that our financial risk management program will be successful in reducing the risks inherent in exposures to interest rate fluctuations. Our interest expense may also be affected by our credit ratings. In assessing our credit strength, credit rating agencies consider our capital structure and financial policies as well as the consolidated balance sheet and other financial information of the Company. In addition, some credit rating agencies also consider financial information of certain of our major bottlers. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure; our major bottlers' financial performance; changes in the credit rating agencies' methodology in assessing our credit strength; the credit agencies' perception of the impact of credit market conditions on our or our major bottlers' current or future financial performance and financial condition; or for any other reason, our cost of borrowing could increase. Additionally, if the credit ratings of certain bottlers in which we have equity method investments were to be downgraded, such bottlers' interest expense could increase, which would reduce our equity income. We rely on our bottling partners for a significant portion of our business. If we are unable to maintain good relationships with our bottling partners, our business could suffer. We generate a significant portion of our net operating revenues by selling concentrates and syrups to independent bottling partners. As independent companies, our bottling partners, some of which are publicly traded companies, make their own business decisions that may not always align with our interests. In addition, many of our bottling partners have the right to manufacture or distribute their own products or certain products of other beverage companies. If we are unable to provide an appropriate mix of incentives to our bottling partners through a combination of pricing and marketing and advertising support, or if our bottling partners are not satisfied with our brand innovation and development efforts, they may take actions that, while maximizing their own short-term profits, may be detrimental to our Company or our brands, or they may devote more of their energy and resources to business opportunities or products other than those of the Company. Such actions could, in the long run, have an adverse effect on our profitability. If our bottling partners' financial condition deteriorates, our business and financial results could be affected. We derive a significant portion of our net operating revenues from sales of concentrates and syrups to independent bottling partners and, therefore, the success of our business depends on our bottling partners' financial strength and profitability. While under our agreements with our bottling partners we generally have the right to unilaterally change the prices we charge for our concentrates and syrups, our ability to do so may be materially limited by our bottling partners' financial condition and their ability to pass price increases along to their customers. In addition, we have investments in certain of our bottling partners, which we account for under the equity method, and our operating results include our proportionate share of such bottling partners' income or loss. Our bottling partners' financial condition is affected in large part by conditions and events that are beyond our and their control, including competitive and general market conditions in the territories in which they operate; the availability of capital and other financing resources on reasonable terms; loss of major customers; additional regulations; or disruptions of bottling operations that may be caused by strikes, work stoppages, labor unrest, natural disasters or other catastrophic events. A deterioration of the financial condition or results of operations of one or more of our major bottling partners could adversely affect our net operating revenues from sales of concentrates and syrups; and, if such deterioration involves one or more of our major equity investee bottling partners, could also result in a decrease in our equity income and/or impairments of our equity method investments. Increases in income tax rates, changes in income tax laws or unfavorable resolution of tax matters could have a material adverse impact on our financial results. We are subject to income tax in the United States and numerous other jurisdictions in which we generate profits. Our overall effective income tax rate is a function of applicable local tax rates and the geographic mix of our income from continuing operations before taxes, which is itself impacted by currency movements. Consequently, the isolated or combined effects of unfavorable movements in tax rates, geographic mix, or foreign exchange rates could reduce our after-tax income. Our annual tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual income tax expense and in evaluating our tax positions. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related disputes could be materially different from our historical income tax provisions and accruals. The results of audits or related disputes could have a material effect on our financial statements for the period or periods for which the applicable final determinations are made and for periods for which the statute of limitations is open. For instance, the United States Internal Revenue Service (""IRS"") is seeking to increase our U.S. taxable income for tax years 2007 through 2009 by an amount that creates a potential additional U.S. federal income tax liability of approximately $3.3 billion for the period, plus interest. For additional information regarding this income tax dispute, refer to Note 11 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. If this income tax dispute were to be ultimately determined adversely to us, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Tax Cuts and Jobs Act (""Tax Reform Act""), which was signed into law on December 22, 2017, significantly affected U.S. income tax law by changing how the United States imposes income tax on multinational corporations. We have recorded in our consolidated financial statements provisional amounts based on our current estimates of the effects of the Tax Reform Act in accordance with our current understanding of the Tax Reform Act and currently available guidance. For additional information regarding the Tax Reform Act and the provisional tax amounts recorded in our consolidated financial statements, refer to the heading ""Critical Accounting Policies and Estimates Income Taxes"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. The final amounts may be significantly affected by regulations and interpretive guidance expected to be issued by the tax authorities, clarifications of the accounting treatment of various items, our additional analysis, and our refinement of our estimates of the effects of the Tax Reform Act and, therefore, such final amounts may be materially different than our current provisional amounts, which could materially affect our tax obligations and effective tax rate. Increased or new indirect taxes in the United States and throughout the world could negatively affect our business. Our business operations are subject to numerous duties or taxes that are not based on income, sometimes referred to as ""indirect taxes,"" including import duties, excise taxes, sales or value-added taxes, taxes on sugar-sweetened beverages, property taxes and payroll taxes, in many of the jurisdictions in which we operate, including indirect taxes imposed by state and local governments. In addition, in the past, the U.S. Congress considered imposing a federal excise tax on beverages sweetened with sugar, HFCS or other nutritive sweeteners and may consider similar proposals in the future. As federal, state and local governments in the United States and throughout the world experience significant budget deficits, some lawmakers have singled out beverages among a plethora of revenue-raising items and have imposed or increased, or proposed to impose or increase, sales or similar taxes on beverages, particularly sugar-sweetened beverages. Increases in or the imposition of new indirect taxes on our business operations or products would increase the cost of products or, to the extent levied directly on consumers, make our products less affordable, which may negatively impact our net operating revenues and profitability. If we do not realize the economic benefits we anticipate from our productivity initiatives or are unable to successfully manage their possible negative consequences, our business operations could be adversely affected. We believe that improved productivity is essential to achieving our long-term growth objectives and, therefore, a leading priority of our Company is to design and implement the most effective and efficient business model possible. For information regarding our productivity initiatives, refer to the heading ""Operations Review Other Operating Charges Productivity and Reinvestment Program"" set forth in Part II, ""Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations"" of this report. We have incurred, and we expect will continue to incur, significant costs and expenses with the programs and activities associated with our productivity initiatives. If we are unable to implement some or all of these actions fully or in the envisioned timeframe, or we otherwise do not timely capture the efficiencies, cost savings and revenue growth opportunities we anticipate from these actions, our results of operations for future periods could be negatively affected. In addition, some of the actions we are taking in furtherance of our productivity initiatives may become a distraction for our managers and employees and may disrupt our ongoing business operations; cause deterioration in employee morale which may make it more difficult for us to retain or attract qualified managers and employees; disrupt or weaken the internal control structures of the affected business operations; and give rise to negative publicity which could affect our corporate reputation. If we are unable to successfully manage the possible negative consequences of our productivity initiatives, our business operations could be adversely affected. If we are unable to attract or retain a highly skilled and diverse workforce, our business could be negatively affected. The success of our business depends on our ability to attract, train, develop and retain a highly skilled and diverse workforce. We may not be able to successfully compete for and attract the high-quality and diverse employee talent we want and our future business needs may require. Changes in immigration laws and policies could also make it more difficult for us to recruit or relocate highly skilled technical, professional and management personnel to meet our business needs. In addition, the unexpected loss of experienced and highly skilled associates due to insecurity resulting from our ongoing productivity initiatives, refranchising transactions and organizational changes could deplete our institutional knowledge base and erode our competitiveness. Any of the foregoing could have a negative impact on our business. Increase in the cost, disruption of supply or shortage of energy or fuel could affect our profitability. Our Company-owned or -controlled bottlers operate a large fleet of trucks and other motor vehicles to distribute and deliver beverage products to customers. In addition, we use a significant amount of electricity, natural gas and other energy sources to operate our concentrate, syrup and juice production plants and the bottling plants and distribution facilities operated by our Company-owned or -controlled bottlers. An increase in the price, disruption of supply or shortage of fuel and other energy sources in countries in which we have concentrate plants, or in any of the major markets in which our Company-owned or -controlled bottlers operate, that may be caused by increasing demand or by events such as natural disasters, power outages, or the like could increase our operating costs and negatively impact our profitability. Our independent bottling partners also operate large fleets of trucks and other motor vehicles to distribute and deliver beverage products to their own customers and use a significant amount of electricity, natural gas and other energy sources to operate their own bottling plants and distribution facilities. An increase in the price, disruption of supply or shortage of fuel and other energy sources in any of the major markets in which our independent bottling partners operate could increase the affected independent bottling partners' operating costs and thus indirectly negatively impact our results of operations. Increase in the cost, disruption of supply or shortage of ingredients, other raw materials, packaging materials, aluminum cans and other containers could harm our business. We and our bottling partners use various ingredients in our business, including HFCS, sucrose, aspartame, acesulfame potassium, sucralose, saccharin, cyclamate, steviol glycosides, ascorbic acid, citric acid, phosphoric acid, caffeine and caramel color; other raw materials such as orange and other fruit juice and juice concentrates; packaging materials such as PET for bottles; and aluminum cans and other containers. For additional information regarding ingredients, other raw materials, packaging materials and containers we use in our business, refer to the heading ""Raw Materials"" set forth in Part I, ""Item 1. Business"" of this report. The prices for these ingredients, other raw materials, packaging materials, aluminum cans and other containers fluctuate depending on market conditions. Substantial increases in the prices of our or our bottling partners' ingredients, other raw materials, packaging materials, aluminum cans and other containers to the extent they cannot be recouped through increases in the prices of finished beverage products, could increase our and our bottling partners' operating costs and reduce our profitability. Increases in the prices of our finished products resulting from a higher cost of ingredients, other raw materials, packaging materials, aluminum cans and other containers could affect affordability in some markets and reduce Coca-Cola system sales. In addition, some of our ingredients, such as aspartame, acesulfame potassium, sucralose, saccharin and ascorbic acid, as well as some packaging containers, such as aluminum cans, are available from a limited number of suppliers, and certain other ingredients are available from only one source each. Furthermore, some of our suppliers are located in countries experiencing political or other risks. We cannot assure you that we and our bottling partners will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans will be effective in preventing disruptions that may arise from shortages of any ingredient that is available from a limited number of suppliers or from only one source . The citrus industry is impacted by the variability of weather conditions and by greening disease, which affect the supply of orange juice and orange juice concentrate, which are important raw materials for our business. In particular, freezing weather or hurricanes in central Florida may result in shortages and higher prices for orange juice and orange juice concentrate throughout the industry. In addition, greening disease is reducing the number of citrus trees and increasing grower costs and prices. Adverse weather conditions may affect the supply of other agricultural commodities from which key ingredients for our products are derived. For example, drought conditions in certain parts of the United States may negatively affect the supply of corn, which in turn may result in shortages of and higher prices for HFCS . An increase in the cost, a sustained interruption in the supply, or a shortage of some of these ingredients, other raw materials, packaging materials, aluminum cans and other containers that may be caused by a deterioration of our or our bottling partners' relationships with suppliers; by supplier quality and reliability issues; or by events such as natural disasters, power outages, labor strikes, political uncertainties or governmental instability, or the like could negatively impact our net operating revenues and profits. Changes in laws and regulations relating to beverage containers and packaging could increase our costs and reduce demand for our products. We and our bottlers currently offer nonrefillable recyclable containers in the United States and in various other markets around the world. Legal requirements have been enacted in various jurisdictions in the United States and overseas requiring that deposits or certain ecotaxes or fees be charged in connection with the sale, marketing and use of certain beverage containers. Other proposals relating to beverage container deposits, recycling, ecotax and/or product stewardship have been introduced in various jurisdictions in the United States and overseas, and we anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and elsewhere. Consumers' increased concerns and changing attitudes about solid waste streams and environmental responsibility and the related publicity could result in the adoption of such legislation or regulations. If these types of requirements are adopted and implemented on a large scale in any of the major markets in which we operate, they could affect our costs or require changes in our distribution model, which could reduce our net operating revenues and profitability. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may inhibit sales of affected products. Various jurisdictions may seek to adopt significant additional product labeling or warning requirements or limitations on the marketing or sale of our products as a result of what they contain or allegations that they cause adverse health effects. If these types of requirements become applicable to one or more of our major products under current or future environmental or health laws or regulations, they may inhibit sales of such products. For example, under one such law in California, known as Proposition 65, if the state has determined that a substance causes cancer or harms human reproduction, a warning must be provided for any product sold in the state that exposes consumers to that substance. For additional information regarding Proposition 65, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. If we were required to add Proposition 65 warnings on the labels of one or more of our beverage products produced for sale in California, the resulting consumer reaction to the warnings and possible adverse publicity could negatively affect our sales both in California and in other markets. Unfavorable general economic conditions in the United States could negatively impact our financial performance. In 2017 , our net operating revenues in the United States were $14.7 billion , or 42 percent , of our total net operating revenues. Unfavorable general economic conditions, such as a recession or economic slowdown, in the United States could negatively affect the affordability of, and consumer demand for, our beverages in our flagship market. Under difficult economic conditions, consumers may seek to reduce discretionary spending by forgoing purchases of our products or by shifting away from our beverages to lower-priced products offered by other companies, including private label brands. Softer consumer demand for our beverages in the United States could reduce our profitability and could negatively affect our overall financial performance. Unfavorable economic and political conditions in international markets could hurt our business. We derive a significant portion of our net operating revenues from sales of our products in international markets. In 2017 , our operations outside the United States accounted for $20.7 billion , or 58 percent , of our total net operating revenues. Unfavorable economic conditions and financial uncertainties in our major international markets, including uncertainties surrounding the United Kingdom's impending withdrawal from the European Union, commonly referred to as ""Brexit,"" and unstable political conditions, including civil unrest and governmental changes, in certain of our other international markets could undermine global consumer confidence and reduce consumers' purchasing power, thereby reducing demand for our products. Product boycotts resulting from political activism could reduce demand for our products, while restrictions on our ability to transfer earnings or capital across borders, price controls, limitation on profits, import authorization requirements and other restrictions on business activities which have been or may be imposed or expanded as a result of political and economic instability or otherwise, could impact our profitability. In addition, U.S. trade sanctions against countries designated by the U.S. government as state sponsors of terrorism and/or financial institutions accepting transactions for commerce within such countries could increase significantly, which could make it impossible for us to continue to make sales to bottlers in such countries. The imposition of retaliatory sanctions against U.S. multinational corporations by countries that are or may become subject to U.S. trade sanctions, or the delisting of our branded products by retailers in various countries in reaction to U.S. trade sanctions or other governmental action or policy, could also negatively affect our business. Litigation or legal proceedings could expose us to significant liabilities and damage our reputation. We are party to various litigation claims and legal proceedings in the ordinary course of business, including, but not limited to, litigation claims and legal proceedings arising out of our advertising and marketing practices, product claims and labels, intellectual property and commercial disputes, and environmental and employment matters. We evaluate these litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. We caution you that actual outcomes or losses may differ materially from those envisioned by our current assessments and estimates. In addition, we have bottling and other business operations in markets with high-risk legal compliance environments. Our policies and procedures require strict compliance by our associates and agents with all United States and local laws and regulations and consent orders applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, we cannot assure you that our policies, procedures and related training programs will always ensure full compliance by our associates and agents with all applicable legal requirements. Improper conduct by our associates or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines as well as disgorgement of profits. Failure to adequately protect, or disputes relating to, trademarks, formulae and other intellectual property rights could harm our business. Our trademarks, formulae and other intellectual property rights (refer to the heading ""Patents, Copyrights, Trade Secrets and Trademarks"" in Part I, ""Item 1. Business"" of this report) are essential to the success of our business. We cannot be certain that the legal steps we are taking around the world are sufficient to protect our intellectual property rights or that, notwithstanding legal protection, others do not or will not infringe or misappropriate our intellectual property rights. If we fail to adequately protect our intellectual property rights, or if changes in laws diminish or remove the current legal protections available to them, the competitiveness of our products may be eroded and our business could suffer. In addition, we could come into conflict with third parties over intellectual property rights, which could result in disruptive and expensive litigation. Any of the foregoing could harm our business. Adverse weather conditions could reduce the demand for our products. The sales of our products are influenced to some extent by weather conditions in the markets in which we operate. Unusually cold or rainy weather during the summer months may have a temporary effect on the demand for our products and contribute to lower sales, which could have an adverse effect on our results of operations for such periods. Climate change may have a long-term adverse impact on our business and results of operations. There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products, and could impact the food security of communities around the world. Climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for the Coca-Cola system's bottling operations. Increased frequency or duration of extreme weather conditions could also impair production capabilities, disrupt our supply chain or impact demand for our products. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations. If negative publicity, whether or not warranted, concerning product safety or quality, human and workplace rights, obesity or other issues damages our brand image and corporate reputation, our business may suffer. Our success depends in large part on our ability to maintain the brand image of our existing products, build up brand image for new products and brand extensions and maintain our corporate reputation. We cannot assure you, however, that our continuing investment in advertising and marketing and our strong commitment to product safety and quality and human rights will have the desired impact on our products' brand image and on consumer preferences. Product safety or quality issues, actual or perceived, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products. In some emerging markets, the production and sale of counterfeit or ""spurious"" products, which we and our bottling partners may not be able to fully combat, may damage the image and reputation of our products. In addition, from time to time, we and our executives engage in public policy endeavors that are either directly related to our products and packaging or to our business operations and the general economic climate affecting the Company. These engagements in public policy debates can occasionally be the subject of backlash from advocacy groups that have a differing point of view and could result in adverse media and consumer reaction, including product boycotts. Similarly, our sponsorship relationships could subject us to negative publicity as a result of actual or alleged misconduct by individuals or entities associated with organizations we sponsor or support financially or through in-kind contributions. Likewise, campaigns by activists connecting us, or our bottling system or supply chain, with human and workplace rights issues could adversely impact our corporate image and reputation. Furthermore, in June 2011, the United Nations Human Rights Council endorsed the Guiding Principles on Business and Human Rights, which outlines how businesses should implement the corporate responsibility to respect human rights principles included in the United Nations ""Protect, Respect and Remedy"" framework on human rights. Through our Human Rights Policy, Code of Business Conduct and Supplier Guiding Principles, and our participation in the United Nations Global Compact, as well as our active participation in the Global Business Initiative on Human Rights, we made a number of commitments to respect all human rights. Allegations, even if untrue, that we are not respecting one or more of the 30 human rights found in the United Nations Universal Declaration of Human Rights; actual or perceived failure by our suppliers or other business partners to comply with applicable labor and workplace rights laws, including child labor laws, or their actual or perceived abuse or misuse of migrant workers; and adverse publicity surrounding obesity and health concerns related to our products, water usage, environmental impact, labor relations or the like could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. In addition, if we fail to protect our associates' and our supply chain employees' human rights, or inadvertently discriminate against any group of associates or hiring prospects, our ability to hire and retain the best talent will be diminished, which could have an adverse impact on our overall business. Changes in, or failure to comply with, the laws and regulations applicable to our products or our business operations could increase our costs or reduce our net operating revenues. Our Company's business is subject to various laws and regulations in the numerous countries throughout the world in which we do business, including laws and regulations relating to competition, product safety, advertising and labeling, container deposits, recycling and product stewardship, the protection of the environment, and employment and labor practices. For additional information regarding laws and regulations applicable to our business, refer to the heading ""Governmental Regulation"" set forth in Part I, ""Item 1. Business"" of this report. Changes in applicable laws or regulations or evolving interpretations thereof, including increased or additional regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, to discourage the use of plastic, including regulations relating to recovery and/or disposal of plastic packaging materials due to environmental concerns, or to limit or impose additional costs on commercial water use due to local water scarcity concerns, may result in increased compliance costs, capital expenditures and other financial obligations for us and our bottling partners, which could affect our profitability, or may impede the production, distribution, marketing and sale of our products, which could affect our net operating revenues. In addition, failure to comply with environmental, health or safety requirements, privacy laws and regulations, U.S. trade sanctions, the U.S. Foreign Corrupt Practices Act and other applicable laws or regulations could result in the assessment of damages, the imposition of penalties, suspension of production or distribution, costly changes to equipment or processes due to required corrective action, or a cessation or interruption of operations at our or our bottling partners' facilities, as well as damage to our or our bottling partners' image and reputation, all of which could harm our or our bottling partners' profitability. Changes in accounting standards could affect our reported financial results. New accounting standards or pronouncements that may become applicable to our Company from time to time, or changes in the interpretation of existing standards and pronouncements, could have a significant effect on our reported financial results for the affected periods. If we are not able to achieve our overall long-term growth objectives, the value of an investment in our Company could be negatively affected. We have established and publicly announced certain long-term growth objectives. These objectives were based on, among other things, our evaluation of our growth prospects, which are generally driven by the sales potential of our many beverage products, some of which are more profitable than others, and on an assessment of the potential price and product mix. There can be no assurance that we will realize the sales potential and the price and product mix necessary to achieve our long-term growth objectives. If global credit market conditions deteriorate, our financial performance could be adversely affected. The cost and availability of credit vary by market and are subject to changes in the global or regional economic environment. If conditions in major credit markets deteriorate, our and our bottling partners' ability to obtain debt financing on favorable terms may be negatively affected, which could affect our and our bottling partners' profitability as well as our share of the income of bottling partners in which we have equity method investments. A decrease in availability of consumer credit resulting from unfavorable credit market conditions, as well as general unfavorable economic conditions, may also cause consumers to reduce their discretionary spending, which could reduce the demand for our beverages and negatively affect our and our bottling partners' financial performance. Default by or failure of one or more of our counterparty financial institutions could cause us to incur significant losses. As part of our hedging activities, we enter into transactions involving derivative financial instruments, including forward contracts, commodity futures contracts, option contracts, collars and swaps, with various financial institutions. In addition, we have significant amounts of cash, cash equivalents and other investments on deposit or in accounts with banks or other financial institutions in the United States and abroad. As a result, we are exposed to the risk of default by or failure of counterparty financial institutions. The risk of counterparty default or failure may be heightened during economic downturns and periods of uncertainty in the financial markets. If one of our counterparties were to become insolvent or file for bankruptcy, our ability to recover losses incurred as a result of default or to retrieve our assets that are deposited or held in accounts with such counterparty may be limited by the counterparty's liquidity or the applicable laws governing the insolvency or bankruptcy proceedings. In the event of default by or failure of one or more of our counterparties, we could incur significant losses, which could negatively impact our results of operations and financial condition. If we are unable to renew collective bargaining agreements on satisfactory terms, or we or our bottling partners experience strikes, work stoppages or labor unrest, our business could suffer. Many of our associates at our key manufacturing locations and bottling plants are covered by collective bargaining agreements. While we generally have been able to renegotiate collective bargaining agreements on satisfactory terms when they expire and regard our relations with associates and their representatives as generally satisfactory, negotiations may nevertheless be challenging, as the Company must have competitive cost structures in each market while meeting the compensation and benefits needs of our associates. If we are unable to renew collective bargaining agreements on satisfactory terms, our labor costs could increase, which could affect our profit margins. In addition, many of our bottling partners' employees are represented by labor unions. Strikes, work stoppages or other forms of labor unrest at any of our major manufacturing facilities or at our bottling operations' or our major bottlers' plants could impair our ability to supply concentrates and syrups to our bottling partners or our bottlers' ability to supply finished beverages to customers, which could reduce our net operating revenues and could expose us to customer claims. Furthermore, from time to time we and our bottling partners restructure manufacturing and other operations to improve productivity. Restructuring activities and the announcement of plans for future restructuring activities may result in a general increase in insecurity among some Company associates and some employees in other parts of the Coca-Cola system, which may have negative implications on employee morale, work performance, escalation of grievances and successful negotiation of collective bargaining agreements. If these labor relations are not effectively managed at the local level, they could escalate in the form of corporate campaigns supported by the labor organizations and could negatively affect our Company's overall reputation and brand image, which in turn could have a negative impact on our products' acceptance by consumers. We may be required to recognize impairment charges that could materially affect our financial results. We assess our trademarks, bottler franchise rights, goodwill and other intangible assets as well as our other long-lived assets as and when required by accounting principles generally accepted in the United States to determine whether they are impaired and, if they are, we record appropriate impairment charges. Our equity method investees also perform impairment tests, and we record our proportionate share of impairment charges recorded by them adjusted, as appropriate, for the impact of items such as basis differences, deferred taxes and deferred gains. It is possible that we may be required to record significant impairment charges or our proportionate share of significant impairment charges recorded by equity method investees in the future and, if we do so, our operating or equity income could be materially adversely affected. We may incur multi-employer pension plan withdrawal liabilities in the future, which could negatively impact our financial performance. We currently participate, and have in the past participated, in certain multi-employer pension plans in the United States. Our U.S. multi-employer pension plan expense totaled $35 million in 2017. The U.S. multi-employer pension plans in which we currently participate have contractual arrangements that extend into 2021. If in the future we choose to withdraw, or are deemed to have withdrawn, from any of the multi-employer pension plans in which we currently participate, or in which we have participated in the past, we would need to record the appropriate withdrawal liabilities, which could negatively impact our financial performance in the applicable periods. If we do not successfully integrate and manage our Company-owned or -controlled bottling operations or other acquired businesses or brands, our results could suffer. From time to time we acquire or take control of bottling operations, often in underperforming markets where we believe we can use our resources and expertise to improve performance. In addition, we routinely evaluate opportunities to acquire other businesses or brands to expand our beverage portfolio and capabilities. We may incur unforeseen liabilities and obligations in connection with acquiring, taking control of or managing acquired bottling operations, other businesses or brands and may encounter unexpected difficulties and costs in restructuring and integrating them into our Company's operating and internal control structures. We may also experience delays in extending our Company's internal control over financial reporting to newly acquired or controlled bottling operations or other businesses, which may increase the risk of failure to prevent misstatements in their financial records and in our consolidated financial statements. Our financial performance depends in large part on how well we can manage and improve the performance of Company-owned or -controlled bottling operations and other acquired businesses or brands. We cannot assure you, however, that we will be able to achieve our strategic and financial objectives for such bottling operations or other acquisitions. If we are unable to achieve such objectives, our consolidated results could be negatively affected. If we do not successfully manage our refranchising activities, our business and results of operations could be adversely affected. As part of our strategic initiative to refocus on our core business of building brands and leading our system of bottling partners, we have refranchised substantially all of our Company-owned or -controlled bottling operations in the United States and all such bottling operations in China, and are continuing the process of refranchising Company-owned or -controlled bottling operations in Canada and Africa. Our refranchising activities require significant attention and effort on the part of, and therefore may be a distraction for, senior management. If we are unable to complete future refranchising transactions on our expected timetable and on terms and conditions favorable to us; our refranchising partners are not efficient and aligned with our long-term vision for the Coca-Cola system; or we are unable to maintain good relationships with the refranchised bottling operations, our business and results of operations could be adversely affected. If we fail to realize a significant portion of the anticipated benefits of our strategic relationship with Monster, our financial performance could be adversely affected. In June 2015, we and Monster entered into a long-term strategic relationship in the global energy drink category. For information regarding our relationship with Monster and related transactions, refer to Note 2 of Notes to Consolidated Financial Statements set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" of this report. If we are unable to successfully manage our complex relationship with Monster, or if for any other reason we fail to realize all or a significant part of the benefits we expect from this strategic relationship and the related investment, our financial performance could be adversely affected. Global or regional catastrophic events could impact our operations and financial results. Because of our global presence and worldwide operations, our business could be affected by large-scale terrorist acts, cyber-strikes and radiological attacks, especially those directed against the United States or other major industrialized countries; the outbreak or escalation of armed hostilities; major natural disasters; or widespread outbreaks of infectious diseases. Such events could impair our ability to manage our business around the world, could disrupt our supply of raw materials and ingredients, and could impact production, transportation and delivery of concentrates, syrups and finished products. In addition, such events could cause disruption of regional or global economic activity, which could affect consumers' purchasing power in the affected areas and, therefore, reduce demand for our products. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES Our worldwide headquarters is located on a 35-acre office complex in Atlanta, Georgia. The complex includes our 621,000 square foot headquarters building and an 870,000 square foot building in which our North America group's main offices are located. The complex also includes several other buildings, including our 264,000 square foot Coca-Cola Plaza building, technical and engineering facilities and a reception center. We also own an office and retail building at 711 Fifth Avenue in New York, New York. These properties, except for the North America group's main offices, are included in the Corporate operating segment. The North America group's main offices are included in the North America operating segment. We own or lease additional facilities, real estate and office space throughout the world which we use for administrative, manufacturing, processing, packaging, storage, warehousing, distribution and retail operations. These properties are generally included in the geographic operating segment in which they are located. The following table summarizes our principal production, distribution and storage facilities by operating segment as of December 31, 2017 : Principal Concentrate and/or Syrup Plants Principal Beverage Manufacturing/Bottling Plants Distribution and Storage Warehouses Owned Leased Owned Leased Owned Leased Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Total 1 1 Does not include 34 owned and 1 leased principal beverage manufacturing/bottling plants and 28 owned and 17 leased distribution and storage warehouses related to our discontinued operations. Management believes that our Company's facilities for the production of our products are suitable and adequate, that they are being appropriately utilized in line with past experience, and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies based upon seasonal demand for our products. However, management believes that additional production can be achieved at the existing facilities by adding personnel and capital equipment and, at some facilities, by adding shifts of personnel or expanding the facilities. We continuously review our anticipated requirements for facilities and, on the basis of that review, may from time to time acquire or lease additional facilities and/or dispose of existing facilities. "," ITEM 3. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, including the proceedings specifically discussed below. Management believes that the total liabilities to the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Aqua-Chem Litigation On December 20, 2002, the Company filed a lawsuit ( The Coca-Cola Company v. Aqua-Chem, Inc., Civil Action No. 2002CV631-50 ) in the Superior Court of Fulton County, Georgia (""Georgia Case""), seeking a declaratory judgment that the Company has no obligation to its former subsidiary, Aqua-Chem, Inc., now known as Cleaver-Brooks, Inc. (""Aqua-Chem""), for any past, present or future liabilities or expenses in connection with any claims or lawsuits against Aqua-Chem. Subsequent to the Company's filing but on the same day, Aqua-Chem filed a lawsuit ( Aqua-Chem, Inc. v. The Coca-Cola Company, Civil Action No. 02CV012179 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin (""Wisconsin Case""). In the Wisconsin Case, Aqua-Chem sought a declaratory judgment that the Company is responsible for all liabilities and expenses not covered by insurance in connection with certain of Aqua-Chem's general and product liability claims arising from occurrences prior to the Company's sale of Aqua-Chem in 1981, and a judgment for breach of contract in an amount exceeding $9 million for costs incurred by Aqua-Chem to date in connection with such claims. The Wisconsin Case initially was stayed, pending final resolution of the Georgia Case, and later was voluntarily dismissed without prejudice by Aqua-Chem. The Company owned Aqua-Chem from 1970 to 1981. During that time, the Company purchased over $400 million of insurance coverage, which also insures Aqua-Chem for some of its prior and future costs for certain product liability and other claims. The Company sold Aqua-Chem to Lyonnaise American Holding, Inc., in 1981 under the terms of a stock sale agreement. The 1981 agreement, and a subsequent 1983 settlement agreement, outlined the parties' rights and obligations concerning past and future claims and lawsuits involving Aqua-Chem. Cleaver-Brooks, a division of Aqua-Chem, manufactured boilers, some of which contained asbestos gaskets. Aqua-Chem was first named as a defendant in asbestos lawsuits in or around 1985 and currently has approximately 40,000 active claims pending against it. The parties agreed in 2004 to stay the Georgia Case pending the outcome of insurance coverage litigation filed by certain Aqua-Chem insurers on March 26, 2004. In the coverage action, five plaintiff insurance companies filed suit ( Century Indemnity Company, et al. v. Aqua-Chem, Inc., The Coca-Cola Company, et al., Case No. 04CV002852 ) in the Circuit Court, Civil Division of Milwaukee County, Wisconsin, against the Company, Aqua-Chem and 16 insurance companies. Several of the policies that were the subject of the coverage action had been issued to the Company during the period (1970 to 1981) when the Company owned Aqua-Chem. The complaint sought a determination of the respective rights and obligations under the insurance policies issued with regard to asbestos-related claims against Aqua-Chem. The action also sought a monetary judgment reimbursing any amounts paid by the plaintiffs in excess of their obligations. Two of the insurers, one with a $15 million policy limit and one with a $25 million policy limit, asserted cross-claims against the Company, alleging that the Company and/or its insurers are responsible for Aqua-Chem's asbestos liabilities before any obligation is triggered on the part of the cross-claimant insurers to pay for such costs under their policies. Aqua-Chem and the Company filed and obtained a partial summary judgment determination in the coverage action that the insurers for Aqua-Chem and the Company were jointly and severally liable for coverage amounts, but reserving judgment on other defenses that might apply. During the course of the Wisconsin insurance coverage litigation, Aqua-Chem and the Company reached settlements with several of the insurers, including plaintiffs, who paid funds into escrow accounts for payment of costs arising from the asbestos claims against Aqua-Chem. On July 24, 2007, the Wisconsin trial court entered a final declaratory judgment regarding the rights and obligations of the parties under the insurance policies issued by the remaining defendant insurers, which judgment was not appealed. The judgment directs, among other things, that each insurer whose policy is triggered is jointly and severally liable for 100 percent of Aqua-Chem's losses up to policy limits. The court's judgment concluded the Wisconsin insurance coverage litigation. The Company and Aqua-Chem continued to pursue and obtain coverage agreements for the asbestos-related claims against Aqua-Chem with those insurance companies that did not settle in the Wisconsin insurance coverage litigation. The Company anticipated that a final settlement with three of those insurers (""Chartis insurers"") would be finalized in May 2011, but the Chartis insurers repudiated their settlement commitments and, as a result, Aqua-Chem and the Company filed suit against them in Wisconsin state court to enforce the coverage-in-place settlement or, in the alternative, to obtain a declaratory judgment validating Aqua-Chem and the Company's interpretation of the court's judgment in the Wisconsin insurance coverage litigation. In February 2012, the parties filed and argued a number of cross-motions for summary judgment related to the issues of the enforceability of the settlement agreement and the exhaustion of policies underlying those of the Chartis insurers. The court granted defendants' motions for summary judgment that the 2011 Settlement Agreement and 2010 Term Sheet were not binding contracts, but denied their similar motions related to plaintiffs' claims for promissory and/or equitable estoppel. On or about May 15, 2012, the parties entered into a mutually agreeable settlement/stipulation resolving two major issues: exhaustion of underlying coverage and control of defense. On or about January 10, 2013, the parties reached a settlement of the estoppel claims and all of the remaining coverage issues, with the exception of one disputed issue relating to the scope of the Chartis insurers' defense obligations in two policy years. The trial court granted summary judgment in favor of the Company and Aqua-Chem on that one open issue and entered a final appealable judgment to that effect following the parties' settlement. On January 23, 2013, the Chartis insurers filed a notice of appeal of the trial court's summary judgment ruling. On October 29, 2013, the Wisconsin Court of Appeals affirmed the grant of summary judgment in favor of the Company and Aqua-Chem. On November 27, 2013, the Chartis insurers filed a petition for review in the Supreme Court of Wisconsin, and on December 11, 2013, the Company filed its opposition to that petition. On April 16, 2014, the Supreme Court of Wisconsin denied the Chartis insurers' petition for review. The Georgia Case remains subject to the stay agreed to in 2004. U.S. Federal Income Tax Dispute On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. A trial date has been set for March 5, 2018. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal United States market in which the Company's common stock is listed and traded is the New York Stock Exchange. The following table sets forth, for the quarterly reporting periods indicated, the high and low market prices per share for the Company's common stock, as reported on the New York Stock Exchange composite tape, and dividend per share information: Common Stock Market Prices High Low Dividends Declared Fourth quarter $ 47.48 $ 44.75 $ 0.37 Third quarter 46.98 44.15 0.37 Second quarter 46.06 42.27 0.37 First quarter 42.70 40.22 0.37 Fourth quarter $ 43.03 $ 39.88 $ 0.35 Third quarter 45.94 41.85 0.35 Second quarter 47.13 42.87 0.35 First quarter 46.88 40.75 0.35 While we have historically paid dividends to holders of our common stock on a quarterly basis, the declaration and payment of future dividends will depend on many factors, including, but not limited to, our earnings, financial condition, business development needs and regulatory considerations, and are at the discretion of our Board of Directors. As of February 16, 2018 , there were 212,331 shareowner accounts of record. This figure does not include a substantially greater number of ""street name"" holders or beneficial holders of our common stock, whose shares are held of record by banks, brokers and other financial institutions. The information under the heading ""EQUITY COMPENSATION PLAN INFORMATION"" in the Company's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on April 25, 2018 (""Company's 2018 Proxy Statement""), to be filed with the Securities and Exchange Commission, is incorporated herein by reference. During the fiscal year ended December 31, 2017 , no equity securities of the Company were sold by the Company that were not registered under the Securities Act of 1933, as amended. The following table presents information with respect to purchases of common stock of the Company made during the three months ended December 31, 2017 , by the Company or any ""affiliated purchaser"" of the Company as defined in Rule 10b-18(a)(3) under the Exchange Act. Period Total Number of Shares Purchased 1 Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plan 2 Maximum Number of Shares That May Yet Be Purchased Under the Publicly Announced Plan September 30, 2017 through October 27, 2017 5,256,426 $ 46.00 5,255,817 78,256,636 October 28, 2017 through November 24, 2017 1,660,944 45.84 1,660,597 76,596,039 November 25, 2017 through December 31, 2017 5,878,681 45.84 5,845,920 70,750,119 Total 12,796,051 $ 45.91 12,762,334 1 The total number of shares purchased includes: (i) shares purchased pursuant to the 2012 Plan described in footnote 2 below, and (ii) shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees, totaling 609 shares, 347 shares and 32,761 shares for the fiscal months of October, November and December 2017, respectively. 2 On October 18, 2012, the Company publicly announced that our Board of Directors had authorized a plan (""2012 Plan"") for the Company to purchase up to 500 million shares of our Company's common stock. This column discloses the number of shares purchased pursuant to the 2012 Plan during the indicated time periods (including shares purchased pursuant to the terms of preset trading plans meeting the requirements of Rule 10b5-1 under the Exchange Act). Performance Graph Comparison of Five-Year Cumulative Total Return Among The Coca-Cola Company, the Peer Group Index and the SP 500 Index Total Return Stock Price Plus Reinvested Dividends December 31, 2013 2015 2017 The Coca-Cola Company $ $ $ $ $ $ Peer Group Index 126 163 200 SP 500 Index 132 153 208 The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2012. The Peer Group Index is a self-constructed peer group of companies that are included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index, from which the Company has been excluded. The Peer Group Index consists of the following companies: Altria Group, Inc., Archer-Daniels-Midland Company, BG Foods, Inc., Brown-Forman Corporation, Bunge Limited, Campbell Soup Company, Conagra Brands, Inc., Constellation Brands, Inc., Darling Ingredients Inc., Dean Foods Company, Dr Pepper Snapple Group, Inc., Flowers Foods, Inc., General Mills, Inc., The Hain Celestial Group, Inc., Herbalife Ltd., The Hershey Company, Hormel Foods Corporation, Ingredion, Incorporated, The J.M. Smucker Company, Kellogg Company, The Kraft Heinz Company, Lamb Weston Holdings, Inc., Lancaster Colony Corporation, Leucadia National Corporation, McCormick Company, Incorporated., Molson Coors Brewing Company, Mondelz International, Inc., Monster Beverage Corporation, PepsiCo, Inc., Philip Morris International Inc., Pinnacle Foods Inc., Post Holdings, Inc., Snyder's-Lance, Inc., TreeHouse Foods, Inc., Tyson Foods, Inc., and US Foods Holding Corp. Companies included in the Dow Jones Food Beverage Index and the Dow Jones Tobacco Index change periodically. In 2017, the indices included US Foods Holding Corp., which was not included in the indices in 2016. Additionally, the indices do not include Mead Johnson Nutrition Company, Reynolds American Inc. and The WhiteWave Foods Company, which were included in the indices in 2016. "," ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (""MDA"") is intended to help the reader understand The Coca-Cola Company, our operations and our present business environment. MDA is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the accompanying notes thereto contained in ""Item 8. Financial Statements and Supplementary Data"" of this report. This overview summarizes the MDA, which includes the following sections: Our Business a general description of our business and the nonalcoholic beverage segment of the commercial beverage industry; our objective; our strategic priorities; our core capabilities; and challenges and risks of our business. Critical Accounting Policies and Estimates a discussion of accounting policies that require critical judgments and estimates. Operations Review an analysis of our Company's consolidated results of operations for the three years presented in our consolidated financial statements. Except to the extent that differences among our operating segments are material to an understanding of our business as a whole, we present the discussion on a consolidated basis. Liquidity, Capital Resources and Financial Position an analysis of cash flows; off-balance sheet arrangements and aggregate contractual obligations; foreign exchange; the impact of inflation and changing prices; and an overview of financial position. Our Business General The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations, bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. We believe our success depends on our ability to connect with consumers by providing them with a wide variety of beverage choices to meet their desires, needs and lifestyle choices. Our success further depends on the ability of our people to execute effectively, every day. Our objective is to use our Company's assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to become more competitive and to accelerate growth in a manner that creates value for our shareowners. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our finished product operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations, including CCR's bottling and associated supply chain operations in the United States and Canada, and are included in our Bottling Investments operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, such as water and sports drinks; juice, dairy and plantbased beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, 2016 Concentrate operations 1 % % % Finished product operations 2 60 Total % % % 1 Includes concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. The following table sets forth the percentage of total worldwide unit case volume related to concentrate operations and finished product operations: Year Ended December 31, 2016 Concentrate operations 1 % % % Finished product operations 2 24 Total % % % 1 Includes unit case volume related to concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes unit case volume related to fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. The Nonalcoholic Beverage Segment of the Commercial Beverage Industry We operate in the highly competitive nonalcoholic beverage segment of the commercial beverage industry. We face strong competition from numerous other general and specialty beverage companies. We, along with other beverage companies, are affected by a number of factors, including, but not limited to, cost to manufacture and distribute products, consumer spending, economic conditions, availability and quality of water, consumer preferences, inflation, political climate, local and national laws and regulations, foreign currency fluctuations, fuel prices and weather patterns. Our Objective Our objective is to use our formidable assets our brands, financial strength, unrivaled distribution system, global reach, and the talent and strong commitment of our management and associates to achieve long-term sustainable growth. Our vision for sustainable growth includes the following: People: Being a great place to work where people are inspired to be the best they can be. Portfolio: Bringing to the world a portfolio of beverage brands that anticipates and satisfies people's desires and needs. Partners: Nurturing a winning network of partners and building mutual loyalty. Planet: Being a responsible global citizen that makes a difference. Profit: Maximizing return to shareowners while being mindful of our overall responsibilities. Productivity: Managing our people, time and money for greatest effectiveness. Strategic Priorities We have five strategic priorities designed to help us achieve our objective. These strategic priorities are accelerating growth of a consumer-centric brand portfolio; driving our revenue growth algorithm; strengthening the Coca-Cola system; digitizing the enterprise; and unlocking the power of our people. In order to execute on these strategic priorities, we must further enhance our core capabilities of consumer marketing, commercial leadership and franchise leadership. Core Capabilities Consumer Marketing Marketing investments are designed to enhance consumer awareness of, and increase consumer preference for, our brands. Successful marketing investments produce long-term growth in unit case volume, per capita consumption and our share of worldwide nonalcoholic beverage sales. Through our relationships with our bottling partners and those who sell our products in the marketplace, we create and implement integrated marketing programs, both globally and locally, that are designed to heighten consumer awareness of and product appeal for our brands. In developing a strategy for a Company brand, we conduct product and packaging research, establish brand positioning, develop precise consumer communications and solicit consumer feedback. Our integrated marketing activities include, but are not limited to, advertising, point-of-sale merchandising and sales promotions. We are focusing on marketing strategies to drive volume growth in emerging markets, increase our brand value in developing markets and grow net revenues and profit in our developed markets. In emerging markets, we are investing in infrastructure programs that drive volume through increased access to consumers. In developing markets, where consumer access has largely been established, our focus is on differentiating our brands. In our developed markets, we continue to invest in brands and infrastructure programs but generally at a slower rate than gross profit growth. Commercial Leadership The Coca-Cola system has millions of customers around the world who sell or serve our products directly to consumers. We focus on enhancing value for our customers and providing solutions to grow their beverage businesses. Our approach includes understanding each customer's business and needs whether that customer is a sophisticated retailer in a developed market or a kiosk owner in an emerging market. We focus on ensuring that our customers have the right product and package offerings and the right promotional tools to deliver enhanced value to themselves and the Company. We are constantly looking to build new beverage consumption occasions in our customers' outlets through unique and innovative consumer experiences, product availability and delivery systems, and beverage merchandising and displays. We participate in joint brand-building initiatives with our customers in order to drive consumer preference for our brands. Through our commercial leadership initiatives, we embed ourselves further into our retail customers' businesses while developing strategies for better execution at the point of sale. Franchise Leadership We must continue to improve our franchise leadership capabilities to give our Company and our bottling partners the ability to grow together through shared values, aligned incentives and a sense of urgency and flexibility that supports consumers' always changing needs and tastes. The financial health and success of our bottling partners are critical components of the Company's success. We work with our bottling partners to identify processes that enable us to quickly achieve scale and efficiencies, and we share best practices throughout the bottling system. With our bottling partners, we work to produce differentiated beverages and packages that are appropriate for the right channels and consumers. We also design business models in specific markets to ensure that we appropriately share the value created by our beverages with our bottling partners. We must also continue to build a supply chain network that leverages the size and scale of the Coca-Cola system to gain a competitive advantage. Challenges and Risks Being global provides unique opportunities for our Company. Challenges and risks accompany those opportunities. Our management has identified certain challenges and risks that demand the attention of the nonalcoholic beverage segment of the commercial beverage industry and our Company. Of these, six key challenges and risks are discussed below. Obesity The rates of obesity affecting communities, cultures and countries worldwide continue to be too high. There is growing concern among consumers, public health professionals and government agencies about the health problems associated with obesity. This concern represents a significant challenge to our industry. We understand and recognize that obesity is a complex public health challenge and are committed to being a part of the solution. We recognize the uniqueness of consumers' lifestyles and dietary choices. Commercially, we continue to: offer reduced-, low- or no-calorie beverage options; provide transparent nutrition information, featuring calories on the front of most of our packages; provide our beverages in a range of packaging sizes; and market responsibly, including no advertising targeted to children under 12. The heritage of our Company is to lead, and innovation is critical for leadership. As such, we are resolute in continuing to innovate and are committed to partnering to find winning solutions in the area of noncaloric sweeteners. This includes working to reduce sugar and calories in many of our beverages. We want to be a more helpful and credible partner in the fight against obesity. Across the Coca-Cola system, we are mobilizing our assets in marketing and in community outreach to increase awareness and spur action. Water Quality and Quantity Water quality and quantity is an issue that requires our Company's sustained attention and collaboration with other companies, suppliers, governments, nongovernmental organizations and communities where we operate. Water is a main ingredient in substantially all of our products, is vital to the production of the agricultural ingredients on which our business relies and is needed in our manufacturing process. It also is critical to the prosperity of the communities we serve. Water is a limited natural resource facing unprecedented challenges from overexploitation, increased food demand, increasing pollution, poor management and the effects of climate change. Our Company regularly assesses the specific water-related risks that we and many of our bottling partners face and has implemented a formal water risk management program. Mitigation of water risk forms the basis of our water stewardship strategic framework. This strategy is executed at the local level where we operate and includes the following elements: water use efficiency and wastewater treatment in manufacturing operations; shared watershed protection efforts; engaging local communities; and addressing water resource management in our agricultural ingredient supply chain. Such efforts are conducted in collaboration and partnership with others and are intended to help address local needs. Many of these efforts help us in achieving our goal of replenishing the water that we and our bottling partners source and use in our finished products. We are also collaborating with other companies, governments, nongovernmental organizations and communities to advocate for needed water policy reforms and action to protect water availability and quality around the world. Through these integrated programs, we believe that our Company can leverage the water-related knowledge we have developed in the communities we serve through source water availability assessments and planning, water resource management, water treatment, wastewater treatment systems and models for working with communities and partners in addressing water and sanitation needs. As demand for water continues to increase around the world, we expect continued action on our part to help with the successful long-term stewardship of this critical natural resource, both for our business and the communities we serve. Evolving Consumer Preferences We are impacted by shifting consumer demographics and needs, on-the-go lifestyles, aging populations and consumers who are empowered with more information than ever. As a consequence of these changes, consumers want more choices. We are committed to meeting their needs and to generating new growth through our portfolio of more than 500 brands and more than 4,100 beverage products, including nearly 1,300 low- and no-calorie products, new product offerings, innovative packaging and ingredient education efforts. We are also committed to continuing to expand the variety of choices we provide to consumers to meet their ever-changing needs, desires and lifestyles. Increased Competition and Capabilities in the Marketplace Our Company is facing strong competition from some well-established global companies and numerous regional and local companies. We must continuously strengthen our capabilities in marketing and innovation in order to maintain our brand loyalty and market share while we selectively expand into other profitable categories of the nonalcoholic beverage segment of the commercial beverage industry. Product Safety and Quality As the world's largest beverage company, we strive to meet the highest standards in both product safety and product quality. We are aware that some consumers have concerns and negative viewpoints regarding certain ingredients used in our products. The Coca-Cola system works every day to share safe and refreshing beverages with the world. We have rigorous product and ingredient safety and quality standards designed to ensure safety and quality in each of our products, and we drive innovation that provides new beverage options to meet consumers' evolving needs and preferences. Across the Coca-Cola system, we take great care in an effort to ensure that every one of our beverages meets the highest standards for safety and quality. We work to ensure consistent safety and quality through strong governance and compliance with applicable regulations and standards. We stay current with new regulations, industry best practices and marketplace conditions and engage with standard-setting and industry organizations. Additionally, we manufacture and distribute our products according to strict policies, requirements and specifications set forth in an integrated quality management program that continually measures all operations within the Coca-Cola system against the same stringent standards. Our quality management system also identifies and mitigates risks and drives improvement. In our quality laboratories, we stringently measure the quality attributes of ingredients as well as samples of finished products collected from the marketplace. We perform due diligence to ensure that product and ingredient safety and quality standards are maintained in the more than 200 countries where our products are sold. We regularly assess the relevance of our requirements and standards and continually work to improve and refine them across our entire supply chain. Food Security Increased demand for commodities and decreased agricultural productivity in certain regions of the world as a result of changing weather patterns may limit the availability or increase the cost of key agricultural commodities, such as sugarcane, corn, sugar beets, citrus, coffee and tea, which are important sources of ingredients for our products and could impact the food security of communities around the world. We are dedicated to implementing our sustainable sourcing commitment, which is founded on principles that protect the environment, uphold workplace rights and help build more sustainable communities. To support this commitment, our programs focus on economic opportunity, with an emphasis on female farmers, and environmental sustainability designed to help address these agricultural challenges. Through joint efforts with farmers, communities, bottlers, suppliers and key partners, as well as our increased and continued investment in sustainable agriculture, we can together help make a positive strategic impact on food security. All of these challenges and risks obesity; water quality and quantity; evolving consumer preferences; increased competition and capabilities in the marketplace; product safety and quality; and food security have the potential to have a material adverse effect on the nonalcoholic beverage segment of the commercial beverage industry and on our Company; however, we believe our Company is well positioned to appropriately address these challenges and risks. See also ''Item 1A. Risk Factors'' in Part I of this report for additional information about risks and uncertainties facing our Company. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""), which require management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe our most critical accounting policies and estimates relate to the following: Principles of Consolidation Recoverability of Current and Noncurrent Assets Pension Plan Valuations Revenue Recognition Income Taxes Management has discussed the development, selection and disclosure of critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors. While our estimates and assumptions are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. For a discussion of the Company's significant accounting policies, refer to Note 1 of Notes to Consolidated Financial Statements. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance, and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 of Notes to Consolidated Financial Statements. Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 4,523 million and $ 3,709 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 1 million and $ 203 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Recoverability of Current and Noncurrent Assets Our Company faces many uncertainties and risks related to various economic, political and regulatory environments in the countries in which we operate, particularly in developing and emerging markets. Refer to the heading ""Our Business Challenges and Risks"" above and ""Item 1A. Risk Factors"" in Part I of this report. As a result, management must make numerous assumptions which involve a significant amount of judgment when completing recoverability and impairment tests of current and noncurrent assets in various regions around the world. We perform recoverability and impairment tests of current and noncurrent assets in accordance with U.S. GAAP. For certain assets, recoverability and/or impairment tests are required only when conditions exist that indicate the carrying value may not be recoverable. For other assets, impairment tests are required at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. Our equity method investees also perform such recoverability and/or impairment tests. If an impairment charge is recorded by one of our equity method investees, the Company records its proportionate share of such charge as a reduction of equity income (loss) net in our consolidated statement of income. However, the actual amount we record with respect to our proportionate share of such charges may be impacted by items such as basis differences, deferred taxes and deferred gains. Management's assessments of the recoverability and impairment tests of noncurrent assets involve critical accounting estimates. These estimates require significant management judgment, include inherent uncertainties and are often interdependent; therefore, they do not change in isolation. Factors that management must estimate include, among others, the economic life of the asset, sales volume, pricing, cost of raw materials, delivery costs, inflation, cost of capital, marketing spending, foreign currency exchange rates, tax rates, capital spending and proceeds from the sale of assets. These factors are even more difficult to predict when global financial markets are highly volatile. The estimates we use when assessing the recoverability of current and noncurrent assets are consistent with those we use in our internal planning. When performing impairment tests, we estimate the fair values of the assets using management's best assumptions, which we believe would be consistent with what a hypothetical marketplace participant would use. Estimates and assumptions used in these tests are evaluated and updated as appropriate. The variability of these factors depends on a number of conditions, including uncertainty about future events, and thus our accounting estimates may change from period to period. If other assumptions and estimates had been used when these tests were performed, impairment charges could have resulted. As mentioned above, these factors do not change in isolation and, therefore, we do not believe it is practicable or meaningful to present the impact of changing a single factor. Furthermore, if management uses different assumptions or if different conditions occur in future periods, future impairment charges could result. Refer to the heading ""Operations Review"" below for additional information related to our present business environment. Certain factors discussed above are impacted by our current business environment and are discussed throughout this report, as appropriate. Investments in Equity and Debt Securities The carrying values of our investments in equity securities are determined using the equity method, the cost method or the fair value method. We account for investments in companies that we do not control or account for under the equity method either at fair value or under the cost method, as applicable. Investments in equity securities, other than investments accounted for under the equity method, are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as either trading or available-for-sale securities. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in net income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in net income. Trading securities are reported as either marketable securities or other assets in our consolidated balance sheets. Securities classified as available-for-sale are reported as either cash and cash equivalents, marketable securities, other investments or other assets in our consolidated balance sheets. Investments in equity securities that do not qualify for fair value accounting or equity method accounting are accounted for under the cost method. In accordance with the cost method, our initial investment is recorded at cost and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets. The following table presents the carrying values of our investments in equity and debt securities (in millions): December 31, 2017 Carrying Value Percentage of Total Assets Equity method investments $ 20,856 % Securities classified as available-for-sale 7,807 Securities classified as trading * Cost method investments * Total $ 29,213 % * Accounts for less than 1 percent of the Company's total assets. Investments classified as trading securities are not assessed for impairment, since they are carried at fair value with the change in fair value included in net income. We review our investments in equity and debt securities that are accounted for using the equity method or cost method or that are classified as available-for-sale or held-to-maturity each reporting period to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis has exceeded the fair value. The fair values of most of our Company's investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. The ability to accurately predict future cash flows, especially in emerging and developing markets, may impact the determination of fair value. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. During 2017, we recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The Company will adopt Accounting Standards Update (""ASU"") 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities , on January 1, 2018. Adoption of this standard will require us to revise our policy to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income. Refer to Note 1 of Notes to Consolidated Financial Statements. The following table presents the difference between calculated fair values, based on quoted closing prices of publicly traded shares, and our Company's cost basis in investments in publicly traded companies accounted for under the equity method (in millions): December 31, 2017 Fair Value Carrying Value Difference Monster Beverage Corporation $ 6,463 $ 3,382 $ 3,081 Coca-Cola FEMSA, S.A.B. de C.V. 4,065 1,865 2,200 Coca-Cola European Partners plc 1 3,505 3,701 (196 ) Coca-Cola HBC AG 2,754 1,315 1,439 Coca-Cola Amatil Limited 1,449 Coca-Cola Bottlers Japan Inc. 1,251 1,151 Embotelladora Andina S.A. Coca-Cola Bottling Co. Consolidated Coca-Cola ecek A.. Corporacin Lindley S.A. Total $ 21,400 $ 12,896 $ 8,504 1 The carrying value of our investment in Coca-Cola European Partners plc (""CCEP"") exceeded its fair value as of December 31, 2017 . Based on the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Other Assets Our Company invests in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. Additionally, our Company advances payments to certain customers for distribution rights as well as to fund future marketing activities intended to generate profitable volume and expenses such payments over the periods benefited. Payments under these programs are generally capitalized and reported in the line item prepaid expenses and other assets or other assets, as appropriate, in our consolidated balance sheets. When facts and circumstances indicate that the carrying value of these assets or asset groups may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. During 2017, the Company recorded an impairment charge of $19 million related to CCR's other assets as a result of current year refranchising activities in North America and management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. This charge was recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and was determined by comparing the fair value of the asset to its carrying value. Property, Plant and Equipment As of December 31, 2017 , the carrying value of our property, plant and equipment, net of depreciation, was $ 8,203 million , or 9 percent of our total assets. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount or remaining useful life of property, plant and equipment should be assessed, including, among others, the manner or length of time in which the Company intends to use the asset, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present and an impairment review is performed, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. During 2017, the Company recorded impairment charges of $310 million related to CCR's property, plant and equipment as a result of current year refranchising activities in North America and management's estimate of the proceeds (a Level 3 measurement) that were expected to be received for the remaining bottling territories upon their refranchising. These charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the assets to their carrying value. Refer to Note 16 of Notes to Consolidated Financial Statements. Goodwill, Trademarks and Other Intangible Assets Intangible assets are classified into one of three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually, or more frequently if events or circumstances indicate that an asset may be impaired. The following table presents the carrying values of intangible assets included in our consolidated balance sheet (in millions): December 31, 2017 Carrying Value Percentage of Total Assets Goodwill $ 9,401 % Trademarks with indefinite lives 6,729 Bottlers' franchise rights with indefinite lives * Definite-lived intangible assets, net * Other intangible assets not subject to amortization * Total $ 16,636 % * Accounts for less than 1 percent of the Company's total assets. When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting gross profit and cash flows. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset or asset group, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment reviews as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. Intangible assets acquired in recent transactions are naturally more susceptible to impairment, primarily due to the fact that they are recorded at fair value based on recent operating plans and macroeconomic conditions present at the time of acquisition. Consequently, if operating results and/or macroeconomic conditions deteriorate shortly after an acquisition, it could result in the impairment of the acquired assets. A deterioration of macroeconomic conditions may not only negatively impact the estimated operating cash flows used in our cash flow models but may also negatively impact other assumptions used in our analyses, including, but not limited to, the estimated cost of capital and/or discount rates. Additionally, as discussed above, in accordance with U.S. GAAP, we are required to ensure that assumptions used to determine fair value in our analyses are consistent with the assumptions a hypothetical marketplace participant would use. As a result, the cost of capital and/or discount rates used in our analyses may increase or decrease based on market conditions and trends, regardless of whether our Company's actual cost of capital has changed. Therefore, if the cost of capital and/or discount rates change, our Company may recognize an impairment of an intangible asset in spite of realizing actual cash flows that are approximately equal to, or greater than, our previously forecasted amounts. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. During 2017, the Company recorded impairment charges of $457 million related to certain intangible assets. These charges included $390 million related to goodwill and $33 million related to bottlers' franchise rights with indefinite lives. The impairment charges related to goodwill were determined by comparing the fair values of the reporting units, based on Level 3 inputs, to their carrying values. As a result of these charges, the carrying value of CCR's goodwill is zero. The impairment charge related to bottlers' franchise rights with indefinite lives was determined by comparing the fair value of the assets, based on Level 3 inputs, to the current carrying value. These impairment charges were incurred primarily as a result of current year refranchising activities in North America and management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. These charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income. Additionally, we recorded impairment charges related to Venezuelan intangible assets of $34 million. The Venezuelan intangible assets were written down due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. These charges were recorded in Corporate in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to the respective carrying values. During 2016, the Company recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's view of the proceeds that would be ultimately received upon refranchising. The remaining charge of $10 million was related to the impairment of goodwill and resulted from management's revised outlook on market conditions. These impairment charges were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to their respective carrying values. During 2015, the Company recorded a charge of $55 million related to the impairment of a Venezuelan trademark. The Venezuelan trademark impairment was due to the Company's revised expectations regarding the convertibility of the local currency. In 2015, the Company also closed a transaction with Monster. Under the terms of the transaction, the Company was required to discontinue selling energy products under one of the trademarks included in the glacau portfolio. During the year ended December 31, 2015, the Company recognized impairment charges of $418 million, primarily as a result of discontinuing these products. The charges for the impairment of these trademarks were recorded in Corporate in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the trademarks, derived using discounted cash flow analyses, to the respective carrying values. Pension Plan Valuations Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Management is required to make certain critical estimates related to actuarial assumptions used to determine our pension expense and obligations. We believe the most critical assumptions are related to (1) the discount rate used to determine the present value of the liabilities and (2) the expected long-term rate of return on plan assets. All of our actuarial assumptions are reviewed annually, or more frequently to the extent that a settlement or curtailment occurs. Changes in these assumptions could have a material impact on the measurement of our pension expense and obligations. At each measurement date, we determine the discount rate primarily by reference to rates of high-quality, long-term corporate bonds that mature in a pattern similar to the future payments we anticipate making under the plans. As of December 31, 2017 and 2016 , the weighted-average discount rate used to compute our pension obligations was 3.50 percent and 4.00 percent , respectively. Effective January 1, 2016, the Company changed its method of measuring the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans by applying the specific spot rates along the yield curve to the plans' projected cash flows. The Company believes the approach adopted in 2016 provides a more precise measurement of these components by improving the correlation between projected cash flows and the corresponding spot rates. The change does not affect the measurement of the Company's pension and other postretirement benefit obligations for those plans. During the year ended December 31, 2015, for plans using the yield curve approach, the Company measured the service cost and interest cost components utilizing the single weighted-average discount rate derived from the yield curve. The expected long-term rate of return on plan assets is based upon the long-term outlook of our investment strategy as well as our historical returns and volatilities for each asset class. We also review current levels of interest rates and inflation to assess the reasonableness of our long-term rates. Our pension plan investment objective is to ensure all of our plans have sufficient funds to meet their benefit obligations when they become due. As a result, the Company periodically revises asset allocations, where appropriate, to improve returns and manage risk. The weighted-average expected long-term rate of return used to calculate our pension expense was 8.00 percent and 8.25 percent in 2017 and 2016, respectively. In 2017 , the Company's total pension expense related to defined benefit plans was $368 million , which included $28 million of net periodic benefit cost and $340 million of settlement charges, curtailment charges and special termination benefit costs. In 2018, we expect our total pension expense to be approximately $17 million, which includes $108 million of net periodic benefit income and $125 million of estimated settlement charges and special termination benefit costs expected to be incurred. The decrease in 2018 expected net periodic benefit cost is primarily due to 2017 North America refranchising activities, which decreased the size of the active workforce and, therefore, the number of employees earning pension benefits. Favorable asset performance in 2017 further decreased expected 2018 expense, although this was partially offset by a decrease in the weighted-average discount rate at December 31, 2017 compared to December 31, 2016. The estimated impact of a 50 basis-point decrease in the discount rate on our 2018 net periodic benefit cost would be an increase to our pension expense of $25 million. Additionally, the estimated impact of a 50 basis-point decrease in the expected long-term rate of return on plan assets on our 2018 net periodic benefit cost would be an increase to our pension expense of $29 million. The sensitivity information provided above is based only on changes to the actuarial assumptions used for our U.S. pension plans. As of December 31, 2017 , the Company's primary U.S. plan represented 64 percent and 65 percent of the Company's consolidated projected pension benefit obligation and pension assets, respectively. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information about our pension plans and related actuarial assumptions. The Company will adopt ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, on January 1, 2018. In accordance with this standard, we will record the service cost component of net periodic benefit cost in selling, general and administrative expenses, and we will record the non-service cost components in other income (loss) net. We expect to record service cost of $128 million and record a benefit of $111 million related to our non-service cost components of net periodic benefit cost and other benefit plan charges. Refer to Note 1 of Notes to Consolidated Financial Statements. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. For our Company, this generally means that we recognize revenue when title to our products is transferred to our bottling partners, resellers or other customers. Title usually transfers upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers can earn certain incentives which are included in deductions from revenue, a component of net operating revenues in our consolidated statements of income. These incentives include, but are not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. Refer to Note 1 of Notes to Consolidated Financial Statements. The aggregate deductions from revenue recorded by the Company in relation to these programs, including amortization expense on infrastructure programs, were $ 6.2 billion , $ 6.6 billion and $ 6.8 billion in 2017 , 2016 and 2015 , respectively. In preparing the financial statements, management must make estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considers past results in making such estimates. The actual amounts ultimately paid may be different from our estimates. Such differences are recorded once they have been determined and have historically not been significant. The Company will adopt ASU 2014-09, Revenue from Contracts with Customers , and its amendments on January 1, 2018. Adoption of this standard will result in a change in our revenue recognition policy. Refer to Note 1 of Notes to Consolidated Financial Statements. Income Taxes Our annual effective tax rate is based on our income and the tax laws in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax positions. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that the position becomes uncertain based upon one of the following: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information, (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position, and (3) each tax position is evaluated without considerations of the possibility of offset or aggregation with other tax positions taken. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. Refer to the heading ""Operations Review Income Taxes"" below and Note 14 of Notes to Consolidated Financial Statements. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million. A trial date has been set for March 5, 2018. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million. The Company regularly assesses the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of its tax reserves. The Company believes that the final adjudication of this matter will not have a material impact on its consolidated financial position, results of operations or cash flows. However, the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail in any material respect on its assertions, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. A number of years may elapse before a particular matter for which we have established a reserve is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Settlement of any particular issue would usually require the use of cash. Tax law requires items to be included in the tax return at different times than when these items are reflected in the consolidated financial statements. As a result, the annual effective tax rate reflected in our consolidated financial statements is different from that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year and manner in which the differences are expected to reverse. Based on the evaluation of all available information, the Company recognizes future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results; the reversal of existing taxable temporary differences; taxable income in prior carryback years (if permitted); and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that the Company will ultimately realize the tax benefit associated with a deferred tax asset. As of December 31, 2017 , the Company's valuation allowances on deferred tax assets were $ 501 million and were primarily related to uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards generated in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. The Company does not record a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in foreign subsidiaries to the extent that the basis difference results from earnings that meet the indefinite reversal criteria. These criteria are met if the foreign subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings that the Company intends to maintain in non-U.S. subsidiaries takes into account items including, but not limited to, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans, and planned loans to other non-U.S. subsidiaries. The Company also evaluates its expected cash requirements in the United States. Other factors that can influence that determination are local restrictions on remittances (for example, in some countries a central bank application and approval are required in order for the Company's local country subsidiary to pay a dividend), economic stability and asset risk. Refer to Note 14 of Notes to Consolidated Financial Statements. The Tax Reform Act was signed into law on December 22, 2017. Among other things, the Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017 , transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017 . At December 31, 2017 , we have not yet finalized the calculations of the tax effects of the Tax Reform Act; however, we have calculated a reasonable estimate of the effects on our year end income tax provision in accordance with our current understanding of the Tax Reform Act and the available guidance. As a result, the Company recognized a net provisional tax charge in the amount of $3.6 billion in 2017, which is included as a component of income taxes from continuing operations on our consolidated statement of income. We will continue to refine our calculations as additional analysis is completed. In addition, our estimates may also be affected as we gain a more thorough understanding of the Tax Reform Act as a result of potential legislative or regulatory provisions or interpretive guidance. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") estimated to be $42 billion , the majority of which was previously considered to be indefinitely reinvested and, accordingly, no U.S. federal and state income taxes had been provided. We recorded a provisional tax amount of $4.6 billion as a reasonable estimate for our one-time transition tax liability and a $0.6 billion provisional deferred tax for the related withholding taxes and state income taxes. Because of the complexities of the Tax Reform Act, we are still finalizing our calculation of the total accumulated post-1986 prescribed EP for the applicable foreign entities. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of post-1986 prescribed foreign EP and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any additional outside basis differences inherent in these entities, as these amounts continue to be provisionally indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities (i.e., basis differences in excess of that subject to the one-time transition tax) is not practicable. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent. However, we are still analyzing certain aspects of the Tax Reform Act and refining our calculations, which could affect the measurement of these balances or give rise to new deferred tax amounts. The provisional amount recorded related to the remeasurement and adjustments of our deferred tax balance was a tax benefit of $1.6 billion. On December 22, 2017, Staff Accounting Bulletin No. 118 (""SAB 118"") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to finalize the calculations for certain income tax effects of the Tax Reform Act. In accordance with SAB 118, the Company has determined that the net tax charge of $3.6 billion recorded in connection with the Tax Reform Act is a provisional amount and a reasonable estimate as of December 31, 2017 . Additional work is necessary to finalize the calculations for certain income tax effects of the Tax Reform Act. Additionally, certain of our equity method investees are impacted by the Tax Reform Act and have recorded provisional tax amounts. To the extent their provisional amounts are refined in 2018, we will record our proportionate share in the line item equity income (loss) net in our consolidated statement of income. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The Company has not yet elected an accounting policy related to how it will account for GILTI and therefore has not provided any deferred tax impacts of GILTI in its consolidated financial statements for the year ended December 31, 2017 . The Company's effective tax rate is expected to be approximately 21.0 percent in 2018. This estimated tax rate does not reflect the potential impact of further clarification of certain matters related to the Tax Reform Act and any unusual or special items that may affect our tax rate in 2018. Operations Review Our organizational structure as of December 31, 2017 consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Bottling Investments; and Corporate. For further information regarding our operating segments, refer to Note 19 of Notes to Consolidated Financial Statements. Structural Changes, Acquired Brands and Newly Licensed Brands In order to continually improve upon the Company's operating performance, from time to time, we engage in buying and selling ownership interests in bottling partners and other manufacturing operations. In addition, we also acquire brands or enter into license agreements for certain brands to supplement our beverage offerings. These items impact our operating results and certain key metrics used by management in assessing the Company's performance. Unit case volume growth is a metric used by management to evaluate the Company's performance because it measures demand for our products at the consumer level. The Company's unit case volume represents the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers and, therefore, reflects unit case volume for both consolidated and unconsolidated bottlers. Refer to the heading ""Beverage Volume"" below. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished products sold by, the Company to its bottling partners or other customers. Refer to the heading ""Beverage Volume"" below. Our Bottling Investments operating segment and our other finished product operations typically generate net operating revenues by selling sparkling soft drinks and a variety of other beverages, such as juices, juice drinks, sports drinks, waters, teas and coffees, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. For these consolidated finished product operations, we recognize the associated concentrate sales volume at the time the unit case or unit case equivalent is sold to the customer. Our concentrate operations typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations. For these concentrate operations, we recognize concentrate revenue and concentrate sales volume when we sell concentrate and syrups to the authorized unconsolidated bottling operations, and we typically report unit case volume when finished products manufactured from the concentrates and syrups are sold to the customer. When we analyze our net operating revenues we generally consider the following four factors: (1) volume growth (concentrate sales volume or unit case volume, as appropriate), (2) acquisitions and divestitures (including structural changes defined below), as applicable, (3) changes in price, product and geographic mix and (4) foreign currency fluctuations. Refer to the heading ""Net Operating Revenues"" below. We generally refer to acquisitions and divestitures of bottling and distribution operations and consolidation or deconsolidation of bottling and distribution entities for accounting purposes as structural changes, which are a component of acquisitions and divestitures (""structural changes""). Typically, structural changes do not impact the Company's unit case volume on a consolidated basis or at the geographic operating segment level. We recognize unit case volume for all sales of Company beverage products regardless of our ownership interest in the bottling partner, if any. However, the unit case volume reported by our Bottling Investments operating segment is generally impacted by structural changes because it only includes the unit case volume of our consolidated bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Company's acquisitions and divestitures. ""Acquired brands"" refers to brands acquired during the past 12 months. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to acquired brands in periods prior to the closing of a transaction. Therefore, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider acquired brands to be structural changes. ""Licensed brands"" refers to brands not owned by the Company, but for which we hold certain rights, generally including, but not limited to, distribution rights, and from which we derive an economic benefit when these brands are ultimately sold. Typically, the Company has not reported unit case volume or recognized concentrate sales volume related to these brands in periods prior to the beginning of the term of a license agreement. Therefore, in the year that the licenses are entered into, the unit case volume and concentrate sales volume from the sale of these brands is incremental to prior year volume. We do not generally consider newly licensed brands to be structural changes. In 2017, ABI's controlling interest in CCBA was transitioned to the Company, resulting in its consolidation. The results of CCBA have been recorded as discontinued operations. The impact of this transaction has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Europe, Middle East and Africa operating segment. Also in 2017, the Company refranchised its bottling operations in China to the two local franchise bottlers. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific and Bottling Investments operating segments. Throughout 2017, 2016 and 2015, the Company refranchised bottling territories in North America that were previously managed by CCR to certain of our unconsolidated bottling partners. The impact of these refranchising activities has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our North America and Bottling Investments operating segments. In addition, for non-Company-owned and licensed beverage products sold in the refranchised territories for which the Company no longer reports unit case volume, we have eliminated the unit case volume from the applicable base year when calculating volume growth rates on a consolidated basis as well as for the North America and Bottling Investments operating segments. During 2016, the Company deconsolidated its South African bottling operations and disposed of its related equity method investment in exchange for equity method investments in CCBA and CCBA's South African subsidiary. As part of the transaction, the Company also acquired and licensed several brands. The impacts of the deconsolidation, the disposal of the related equity method investment and the new equity method investments have been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The brands and licenses that the Company acquired impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. During 2016, the Company also deconsolidated our German bottling operations as a result of their being combined to create CCEP. As a result of the transaction, the Company now owns an equity method investment in CCEP. Accordingly, the impact of the deconsolidation and new equity method investment has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Europe, Middle East and Africa and Bottling Investments operating segments. The Company also changed our funding arrangement with our bottling partners in China, which resulted in a reduction in net operating revenues with an offsetting reduction in direct marketing expense. The impact of the change in the arrangement has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for our Asia Pacific operating segment. In 2015, the Company closed a transaction with Monster (""Monster Transaction""), which has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for each of the Company's operating segments. This transaction consisted of multiple elements including, but not limited to, the acquisition of Monster's non-energy brands and the expansion of our distribution territories for Monster's energy brands. These elements of the transaction impacted the Company's unit case volume and concentrate sales volume and therefore, in addition to being included as a structural change, they are also considered acquired brands. Also during 2015, the Company acquired a South African bottler, which has been included as a structural change in our analysis of net operating revenues on a consolidated basis as well as for the Bottling Investments operating segment. The Company sells concentrates and syrups to both consolidated and unconsolidated bottling partners. The ownership structure of our bottling partners impacts the timing of recognizing concentrate revenue and concentrate sales volume. When we sell concentrates or syrups to our consolidated bottling partners, we are not able to recognize the concentrate revenue or concentrate sales volume until the bottling partner has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. When we sell concentrates or syrups to our unconsolidated bottling partners, we recognize the concentrate revenue and concentrate sales volume when the concentrates or syrups are sold to the bottling partner. The subsequent sale of the finished products manufactured from the concentrates or syrups to a customer does not impact the timing of recognizing the concentrate revenue or concentrate sales volume. When we account for an unconsolidated bottling partner as an equity method investment, we eliminate the intercompany profit related to these transactions until the equity method investee has sold finished products manufactured from the concentrates or syrups to a third party or independent customer. Beverage Volume We measure the volume of Company beverage products sold in two ways: (1) unit cases of finished products and (2) concentrate sales. As used in this report, ""unit case"" means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings); and ""unit case volume"" means the number of unit cases (or unit case equivalents) of Company beverage products directly or indirectly sold by the Company and its bottling partners to customers. Unit case volume primarily consists of beverage products bearing Company trademarks. Also included in unit case volume are certain products licensed to, or distributed by, our Company, and brands owned by Coca-Cola system bottlers for which our Company provides marketing support and from the sale of which we derive economic benefit. In addition, unit case volume includes sales by certain joint ventures in which the Company has an equity interest. We believe unit case volume is one of the measures of the underlying strength of the Coca-Cola system because it measures trends at the consumer level. The unit case volume numbers used in this report are derived based on estimates received by the Company from its bottling partners and distributors. Concentrate sales volume represents the amount of concentrates, syrups, beverage bases, source waters, and powders/minerals (in all instances expressed in equivalent unit cases) sold by, or used in finished beverages sold by, the Company to its bottling partners or other customers. Unit case volume and concentrate sales volume growth rates are not necessarily equal during any given period. Factors such as seasonality, bottlers' inventory practices, supply point changes, timing of price increases, new product introductions and changes in product mix can impact unit case volume and concentrate sales volume and can create differences between unit case volume and concentrate sales volume growth rates. In addition to the items mentioned above, the impact of unit case volume from certain joint ventures in which the Company has an equity interest but to which the Company does not sell concentrates, syrups, beverage bases, source waters, or powders/minerals may give rise to differences between unit case volume and concentrate sales volume growth rates. Information about our volume growth worldwide and by operating segment is as follows: Percent Change 2017 versus 2016 2016 versus 2015 Year Ended December 31, Unit Cases 1,2 Concentrate Sales Unit Cases 1,2 Concentrate Sales Worldwide % % % % 6 Europe, Middle East Africa % % 3 % % Latin America (2 ) (3 ) (1 ) (1 ) North America 4 6 Asia Pacific 5 Bottling Investments (41 ) N/A (16 ) N/A 1 Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. 2 Geographic operating segment data reflects unit case volume growth for all bottlers, both consolidated and unconsolidated, and distributors in the applicable geographic areas. 3 After considering the impact of structural changes, concentrate sales volume for Europe, Middle East and Africa for the year ended December 31, 2017 grew 2 percent. 4 After considering the impact of structural changes, concentrate sales volume for North America for the year ended December 31, 2017 was even. 5 After considering the impact of structural changes, concentrate sales volume for Asia Pacific for the year ended December 31, 2017 grew 1 percent. 6 After considering the impact of structural changes, concentrate sales volume both worldwide and for North America for the year ended December 31, 2016 grew 1 percent. Unit Case Volume The Coca-Cola system sold 29.2 billion , 29.3 billion and 29.2 billion unit cases of our products in 2017 , 2016 and 2015 , respectively. The unit case volume for 2017, 2016 and 2015 reflects the impact of brands acquired and licensed during the applicable year. The unit case volume for 2017, 2016 and 2015 also reflects the impact of the transfer of distribution rights with respect to non-Company-owned brands that were previously licensed to us in North American bottling territories that have since been refranchised. The Company eliminated the unit case volume related to these structural changes from the base year, as applicable, when calculating 2017 versus 2016 and 2016 versus 2015 unit case volume growth rates. Sparkling soft drinks represented 69 percent, 69 percent and 70 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. Trademark Coca-Cola accounted for 45 percent, 45 percent and 46 percent of our worldwide unit case volume for 2017 , 2016 and 2015 , respectively. In 2017 , unit case volume in the United States represented 19 percent of the Company's worldwide unit case volume. Of the U.S. unit case volume, 62 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 43 percent of U.S. unit case volume. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume for 2017 . The countries outside the United States in which our unit case volumes were the largest were Mexico, China, Brazil and Japan, which together accounted for 31 percent of our worldwide unit case volume. Of the non-U.S. unit case volume, 71 percent was attributable to sparkling soft drinks. Trademark Coca-Cola accounted for 45 percent of non-U.S. unit case volume. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In Europe, Middle East and Africa, unit case volume grew 1 percent, reflecting an 8 percent increase in tea and coffee, a 5 percent increase in water, enhanced water and sports drinks and a 1 percent increase in sparkling soft drinks. These increases were partially offset by a decrease of 3 percent in juice, dairy and plant-based beverages. The group reported increases in unit case volume in our Central Eastern Europe, Turkey, Caucasus Central Asia, South East Africa and West Africa business units. The increases in these business units were partially offset by even results in both our Middle East North Africa and Western Europe business units. Unit case volume in Latin America decreased 2 percent, which included declines of 3 percent in sparkling soft drinks and 1 percent in water, enhanced water and sports drinks. The group's volume reflected declines of 10 percent in the Latin Center business unit and 6 percent in the Brazil business unit. These declines were partially offset by 1 percent growth in the Mexico business unit, which included 1 percent growth in water, enhanced water and sports drinks, and even performance in sparkling soft drinks. In North America, unit case volume was even, reflecting even volume for sparkling soft drinks, a 2 percent decline in water, enhanced water and sports drinks and growth in energy drinks. North America's volume performance in sparkling soft drinks included 4 percent growth in Trademark Sprite and 5 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. Unit case volume in Asia Pacific increased 1 percent, reflecting a 2 percent increase in both sparkling soft drinks and juice, dairy and plant-based beverages. The increase in sparkling soft drinks included 4 percent growth in Trademark Coca-Cola. The group's unit case volume reflected an increase of 2 percent in both the ASEAN and Greater China Korea business units and a 1 percent increase in the India South West Asia business unit, partially offset by a 2 percent decline in the South Pacific business unit. Unit case volume in the Japan business unit was even. Unit case volume for Bottling Investments decreased 41 percent. This decrease primarily reflects the North America refranchising activities and the refranchising of our China bottling operations. Year Ended December 31, 2016 versus Year Ended December 31, 2015 In Europe, Middle East and Africa, unit case volume grew 1 percent, which included even volume in sparkling soft drinks. The group's sparkling soft drinks performance included a 1 percent decline in Trademark Coca-Cola, offset by an increase of 4 percent in Trademark Sprite and an increase of 1 percent in Trademark Fanta. The group had unit case volume growth in water, tea and sports drinks, while volume for juice and juice drinks declined. The group reported increases in unit case volume in our Western Europe, Middle East North Africa, West Africa and South East Africa business units. The increases in these business units were partially offset by declines in unit case volume in both our Central Eastern Europe and Turkey, Caucasus Central Asia business units. Unit case volume in Latin America decreased 1 percent, which included a decline of 2 percent in sparkling soft drinks. Unit case volume growth was reported for water, tea and sports drinks. The group's volume reflected a decline of 7 percent in both the Brazil and Latin Center business units and a decline of 3 percent in the South Latin business unit. These declines were partially offset by unit case volume growth of 5 percent in the Mexico business unit, which reflected 5 percent growth in sparkling soft drinks. Mexico's sparkling soft drinks unit case growth was led by 4 percent growth in Trademark Coca-Cola. In North America, unit case volume grew 1 percent. Sparkling soft drinks volume was even, which included 3 percent growth in Trademark Sprite and 6 percent growth in Trademark Fanta offset by a 5 percent decline in Diet Coke. The group had unit case growth in water, sports drinks, juice and juice drinks and dairy. Unit case volume for vitaminwater grew 6 percent. Unit case volume in Asia Pacific increased 2 percent. Volume for sparkling soft drinks was even, which included 2 percent growth in Trademark Coca-Cola offset by a 4 percent decline in Trademark Sprite. The group had unit case volume growth in water, teas and coffee, while volume for juice and juice drinks declined. The group's unit case volume reflected an increase of 6 percent in the ASEAN business unit and an increase of 3 percent in both the India South West Asia and Japan business units. The growth in these business units was partially offset by a unit case volume decline of 1 percent in the Greater China Korea business unit. Unit case volume for Bottling Investments decreased 16 percent. This decrease primarily reflects the deconsolidation of our German bottling operations in May 2016, a decline in CCR's unit case volume of 14 percent as well as a decline in China. The decline in CCR's unit case volume was primarily driven by North America refranchising activities. The unfavorable impact of these items on the group's unit case volume results was partially offset by growth in India and other markets where we own or otherwise consolidate bottling operations. The Company's consolidated bottling operations accounted for 33 percent and 67 percent of the unit case volume in China and India, respectively. CCR accounted for 51 percent of the total bottlerdistributed unit case volume in North America. Concentrate Sales Volume In 2017 , worldwide concentrate sales volume and unit case volume were both even compared to 2016 . In 2016 , worldwide unit case sales volume grew 1 percent and concentrate sales volume was even compared to 2015 . After considering the impact of structural changes, concentrate sales volume grew 1 percent during the year ended December 31, 2016. The differences between concentrate sales volume and unit case volume growth rates for the operating segments were primarily due to the timing of concentrate shipments, structural changes and the impact of unit case volume from certain joint ventures in which the Company has an equity interest, but to which the Company does not sell concentrates, syrups, beverage bases or powders. Analysis of Consolidated Statements of Income Percent Change Year Ended December 31, 2017 vs. 2016 2016 vs. 2015 (In millions except percentages and per share data) NET OPERATING REVENUES $ 35,410 $ 41,863 $ 44,294 (15 )% (5 )% Cost of goods sold 13,256 16,465 17,482 (19 ) (6 ) GROSS PROFIT 22,154 25,398 26,812 (13 ) (5 ) GROSS PROFIT MARGIN 62.6 % 60.7 % 60.5 % Selling, general and administrative expenses 12,496 15,262 16,427 (18 ) (7 ) Other operating charges 2,157 1,510 1,657 (9 ) OPERATING INCOME 7,501 8,626 8,728 (13 ) (1 ) OPERATING MARGIN 21.2 % 20.6 % 19.7 % Interest income Interest expense (14 ) Equity income (loss) net 1,071 Other income (loss) net (1,666 ) (1,234 ) (35 ) * INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 6,742 8,136 9,605 (17 ) (15 ) Income taxes from continuing operations 5,560 1,586 2,239 (29 ) Effective tax rate 82.5 % 19.5 % 23.3 % NET INCOME FROM CONTINUING OPERATIONS 1,182 6,550 7,366 (82 ) (11 ) Income from discontinued operations (net of income taxes of $47, $0 and $0, respectively) * * CONSOLIDATED NET INCOME 1,283 6,550 7,366 (80 ) (11 ) Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 1,248 $ 6,527 $ 7,351 (81 )% (11 )% BASIC NET INCOME PER SHARE 1 $ 0.29 $ 1.51 $ 1.69 (81 )% (11 )% DILUTED NET INCOME PER SHARE 1 $ 0.29 $ 1.49 $ 1.67 (81 )% (10 )% * Calculation is not meaningful. 1 Calculated based on net income attributable to shareowners of The Coca-Cola Company. Net Operating Revenues Year Ended December 31, 2017 versus Year Ended December 31, 2016 The Company's net operating revenues decreased $6,453 million, or 15 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2017 vs. 2016 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (17 )% % (1 )% (15 )% Europe, Middle East Africa % (2 )% % (2 )% % Latin America (3 ) North America Asia Pacific (1 ) (4 ) (2 ) Bottling Investments (3 ) (48 ) (47 ) Corporate * * * * * Note: Certain rows may not add due to rounding. * Calculation is not meaningful. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. ""Price, product and geographic mix"" refers to the change in revenues caused by factors such as price changes, the mix of products and packages sold, and the mix of channels and geographic territories where the sales occurred. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorably impacted as a result of pricing initiatives and product and package mix, partially offset by geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets; North America favorably impacted as a result of pricing initiatives and product and package mix; Asia Pacific unfavorably impacted by geographic mix, partially offset by the favorable impact of pricing initiatives and product and package mix; and Bottling Investments favorably impacted as a result of pricing initiatives and product and package mix in North America. Foreign currency fluctuations decreased our consolidated net operating revenues by 1 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the U.K. pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. The size and timing of acquisitions and divestitures are not consistent from period to period. The Company currently expects acquisitions and divestitures to have a 17 percent unfavorable impact on full year 2018 net operating revenues. Based on current spot rates and our hedging coverage in place, we expect currencies will have a slight favorable impact on our full year 2018 net operating revenues. Year Ended December 31, 2016 versus Year Ended December 31, 2015 The Company's net operating revenues decreased $2,431 million, or 5 percent. The following table illustrates, on a percentage basis, the estimated impact of key factors resulting in the increase (decrease) in net operating revenues on a consolidated basis and for each of our operating segments: Percent Change 2016 vs. 2015 Volume 1 Acquisitions Divestitures Price, Product Geographic Mix Currency Fluctuations Total Consolidated % (6 )% % (3 )% (5 )% Europe, Middle East Africa % (4 )% % (3 )% (4 )% Latin America (1 ) (18 ) (6 ) North America Asia Pacific (2 ) (2 ) Bottling Investments (13 ) (1 ) (14 ) Corporate * * * * * Note: Certain rows may not add due to rounding. * Calculation is not meaningful. 1 Represents the percent change in net operating revenues attributable to the increase (decrease) in concentrate sales volume for our geographic operating segments (expressed in equivalent unit cases) after considering the impact of structural changes. For our Bottling Investments operating segment, this represents the percent change in net operating revenues attributable to the increase (decrease) in unit case volume after considering the impact of structural changes. Our Bottling Investments operating segment data reflects unit case volume growth for consolidated bottlers only. Refer to the heading ""Beverage Volume"" above. Refer to the heading ""Beverage Volume"" above for additional information related to changes in our unit case and concentrate sales volumes. ""Acquisitions and Divestitures"" refers to acquisitions and divestitures of brands or businesses, some of which the Company considers to be structural changes. Refer to the heading ""Structural Changes, Acquired Brands and Newly Licensed Brands"" above for additional information related to the structural changes. The acquisitions and divestitures percent change for 2016 versus 2015 in the table above consisted entirely of structural changes. Price, product and geographic m ix had a 3 percent favorable impact on our consolidated net operating revenues. Price, product and geographic mix was impacted by a variety of factors and events including, but not limited to, the following: Europe, Middle East and Africa favorable product and geographic mix; Latin America favorable price mix in all four of the segment's business units and the impact of inflationary environments in certain markets, partially offset by unfavorable geographic mix; North America favorably impacted as a result of pricing initiatives and product and package mix; and Asia Pacific unfavorable product and channel mix. Foreign currency fluctuations decreased our consolidated net operating revenues by 3 percent. This unfavorable impact was primarily due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Argentine peso, Mexican peso and Australian dollar, which had an unfavorable impact on our Europe, Middle East and Africa, Latin America, Asia Pacific and Bottling Investments operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Net Operating Revenues by Operating Segment Information about our net operating revenues by operating segment as a percentage of Company net operating revenues is as follows: Year Ended December 31, Europe, Middle East Africa 20.7 % 16.8 % 15.7 % Latin America 11.2 8.9 9.0 North America 24.4 15.4 12.6 Asia Pacific 13.5 11.4 10.6 Bottling Investments 29.8 47.2 51.7 Corporate 0.4 0.3 0.4 Total 100.0 % 100.0 % 100.0 % The percentage contribution of each operating segment fluctuates over time due to net operating revenues in certain operating segments growing at a faster rate compared to other operating segments. Net operating revenue growth rates are impacted by sales volume; acquisitions and divestitures; price, product and geographic mix; and foreign currency fluctuations. For additional information about the impact of foreign currency fluctuations, refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and for additional information about acquisitions and divestitures, refer to Note 2 of Notes to Consolidated Financial Statements. Gross Profit Margin As a result of our finished goods operations, which are primarily included in our North America and Bottling Investments operating segments, the following inputs represent a substantial portion of the Company's total cost of goods sold: (1) sweeteners, (2) metals, (3) juices and (4) PET. The Company enters into hedging activities related to certain commodities in order to mitigate a portion of the price risk associated with forecasted purchases. Many of the derivative financial instruments used by the Company to mitigate the risk associated with these commodity exposures, including any related foreign currency exposure, do not qualify for hedge accounting. As a result, the changes in fair value of these derivative instruments have been, and will continue to be, included as a component of net income in each reporting period. The Company recorded gains related to these derivatives of $14 million and $79 million during the years ended December 31, 2017 and December 31, 2016 , respectively, and recorded a loss of $206 million during the year ended December 31, 2015 in the line item cost of goods sold in our consolidated statements of income. Refer to Note 5 of Notes to Consolidated Financial Statements. We do not currently expect changes in commodity costs to have a significant impact on our 2018 gross profit margin as compared to 2017. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Our gross profit margin increased to 62.6 percent in 2017 from 60.7 percent in 2016. The increase was primarily due to the impact of acquisitions and divestitures, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Our gross profit margin increased to 60.7 percent in 2016 from 60.5 percent in 2015. The increase was primarily due to the impact of positive price mix and lower commodity costs, partially offset by the unfavorable impact of foreign currency exchange rate fluctuations and acquisitions and divestitures. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to acquisitions and divestitures. Selling, General and Administrative Expenses The following table sets forth the significant components of selling, general and administrative expenses (in millions): Year Ended December 31, Stock-based compensation expense $ $ $ Advertising expenses 3,958 4,004 3,976 Selling and distribution expenses 1 3,257 5,177 6,025 Other operating expenses 5,062 5,823 6,190 Selling, general and administrative expenses $ 12,496 $ 15,262 $ 16,427 1 Includes operating expenses as well as general and administrative expenses primarily related to our Bottling Investments operating segment. Year Ended December 31, 2017 versus Year Ended December 31, 2016 Selling, general and administrative expenses decreased $2,766 million, or 18 percent. During the year ended December 31, 2017, fluctuations in foreign currency exchange rates had a nominal impact on selling, general and administrative expenses. The decrease in selling and distribution expenses and advertising expenses during 2017 reflects the impact of divestitures. Additionally, advertising expenses during 2017 decreased 1 percent as a result of foreign currency exchange rate fluctuations. The decrease in other operating expenses during 2017 reflects savings from our productivity and reinvestment initiatives and a reduction in net periodic benefit cost. Foreign currency exchange rate fluctuations have a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they are generally transacted in local currency. Our selling and distribution expenses are primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and are primarily denominated in U.S. dollars. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. As of December 31, 2017 , we had $ 286 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our plans. This cost is expected to be recognized over a weighted-average period of 3.0 years years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. Refer to Note 12 of Notes to Consolidated Financial Statements. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Selling, general and administrative expenses decreased $1,165 million, or 7 percent. During the year ended December 31, 2016, fluctuations in foreign currency decreased selling, general and administrative expenses by 2 percent. The increase in advertising expenses reflects the Company's increased investments to strengthen our brands, partially offset by a foreign currency exchange impact of 3 percent. The decrease in selling and distribution expenses reflects the impact of divestitures. The decrease in other operating expenses reflects the shift of the Company's marketing spending to more consumer-facing advertising expenses as well as savings from our productivity and reinvestment initiatives. Foreign currency exchange rate fluctuations have a more significant impact on both advertising and other operating expenses as compared to our selling and distribution expenses since they are generally transacted in local currency. Our selling and distribution expenses are primarily related to our Company-owned bottling operations, of which the majority of expenses are attributable to CCR and are primarily denominated in U.S. dollars. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to divestitures. Other Operating Charges Other operating charges incurred by operating segment were as follows (in millions): Year Ended December 31, Europe, Middle East Africa $ $ $ (9 ) Latin America North America Asia Pacific Bottling Investments 1,218 Corporate Total $ 2,157 $ 1,510 $ 1,657 In 2017, the Company recorded other operating charges of $2,157 million . These charges primarily consisted of $737 million of CCR asset impairments and $650 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $419 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information about the Venezuelan intangible assets. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the refranchising of our bottling operations. Refer to Note 16 of Notes to Consolidated Financial Statements for information on how the Company determined the asset impairment charges. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. In 2016, the Company recorded other operating charges of $1,510 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $415 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. The Company also recorded a charge of $200 million related to cash contributions we made to The Coca-Cola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan exchange rates. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. In 2015, the Company incurred other operating charges of $1,657 million . These charges included $ 691 million due to the Company's productivity and reinvestment program and $ 292 million due to the integration of our German bottling operations. In addition, the Company recorded impairment charges of $418 million primarily due to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction and incurred a charge of $100 million due to a cash contribution we made to The Coca-Cola Foundation. The Company also incurred a charge of $ 111 million due to the write-down we recorded related to receivables from our bottling partner in Venezuela and an impairment of a Venezuelan trademark primarily due to changes in exchange rates as a result of the establishment of the new open market exchange system. Refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Venezuelan currency change. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these charges had on our operating segments. Productivity and Reinvestment Program In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Coca-Cola Enterprises Inc.'s (""Old CCE"") former North America bottling operations. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives will focus on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. The Company expects that the expanded productivity initiatives will generate an incremental $2.0 billion in annualized productivity. This productivity will enable the Company to fund marketing initiatives and innovation required to deliver sustainable net revenue growth and will also support margin expansion and increased returns on invested capital over time. We expect to achieve total annualized productivity of approximately $ 3.0 billion by 2019 as a result of initiatives implemented under the 2014 expansions of the program. In April 2017, the Company announced that we were expanding the current productivity and reinvestment program, with planned initiatives that are expected to generate an incremental $800 million in annualized savings by 2019. We expect to achieve these savings through additional efficiencies in both our supply chain and our marketing expenditures as well as the transition to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,058 million related to this program since it began in 2012. Refer to Note 18 of Notes to Consolidated Financial Statements for additional information. Integration of Our German Bottling Operations In 2008, the Company began the integration of our German bottling operations acquired in 2007. The Company incurred total pretax expenses of $ 1,367 million as a result of this initiative, primarily related to involuntary terminations. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Refer to Note 2 and Note 18 of Notes to Consolidated Financial Statements for additional information. Operating Income and Operating Margin Information about our operating income contribution by operating segment on a percentage basis is as follows: Year Ended December 31, Europe, Middle East Africa 48.6 % 42.6 % 44.4 % Latin America 29.5 22.6 24.9 North America 34.4 30.0 27.1 Asia Pacific 28.8 25.8 25.1 Bottling Investments (14.9 ) (1.6 ) 1.4 Corporate (26.4 ) (19.4 ) (22.9 ) Total 100.0 % 100.0 % 100.0 % Information about our operating margin on a consolidated basis and by operating segment is as follows: Year Ended December 31, Consolidated 21.2 % 20.6 % 19.7 % Europe, Middle East Africa 49.7 % 52.4 % 55.6 % Latin America 56.0 52.1 54.3 North America 29.8 40.1 42.4 Asia Pacific 45.4 46.5 46.5 Bottling Investments (10.6 ) (0.7 ) 0.5 Corporate * * * * Calculation is not meaningful. Year Ended December 31, 2017 versus Year Ended December 31, 2016 In 2017, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 3 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the U.K. pound sterling, Japanese yen, Argentine peso and Mexican peso, which had an unfavorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the euro, South African rand, Australian dollar and Brazilian real, which had a favorable impact on our Europe, Middle East and Africa, Asia Pacific and Latin America operating segments. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2017 and 2016 was $3,646 million and $3,676 million , respectively. Operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 3 percent, partially offset by favorable price, product and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2017 and 2016 was $2,214 million and $1,951 million , respectively. Operating income for the segment reflects favorable price mix, a reduction in other operating charges and a nominal impact from foreign currency exchange rate fluctuations. North America's operating income for the years ended December 31, 2017 and 2016 was $2,578 million and $2,582 million , respectively. The decrease in the segment's operating income was due to higher other operating charges and an unfavorable foreign currency exchange rate impact of 1 percent, partially offset by favorable price and product and package mix. Operating income for Asia Pacific for the years ended December 31, 2017 and 2016 was $2,163 million and $2,224 million , respectively. The decline in operating income for the segment reflects an unfavorable foreign currency exchange rate impact of 6 percent and unfavorable price, product and geographic mix. Our Bottling Investments segment's operating loss for the year ended December 31, 2017 was $1,117 million , compared to an operating loss for the year ended December 31, 2016 of $137 million . The Bottling Investments segment was unfavorably impacted by acquisitions and divestitures and $737 million of asset impairment charges related to CCR. The Corporate segment's operating loss for the years ended December 31, 2017 and 2016 was $1,983 million and $1,670 million , respectively. The operating loss in 2017 was unfavorably impacted by higher other operating charges. Year Ended December 31, 2016 versus Year Ended December 31, 2015 During the years ended December 31, 2016 and 2015, the Company's operating income was unfavorably impacted by the refranchising of certain bottling territories in North America, which unfavorably impacted our Bottling Investments operating segment. During the year ended December 31, 2016, the Company's operating income was unfavorably impacted by the sale of the Company's energy brands as part of the Monster Transaction which closed on June 12, 2015. The sale of the energy brands unfavorably impacted our Europe, Middle East and Africa, Latin America, North America, Asia Pacific and Bottling Investments operating segments. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising and the Monster Transaction. In 2016, fluctuations in foreign currency exchange rates unfavorably impacted consolidated operating income by 8 percent due to a stronger U.S. dollar compared to certain foreign currencies, including the South African rand, euro, U.K. pound sterling, Brazilian real, Argentine peso, Mexican peso and Australian dollar, which had an unfavorable impact on our Europe, Middle East and Africa, Latin America, Asia Pacific, Bottling Investments and Corporate operating segments. The unfavorable impact of a stronger U.S. dollar compared to the currencies listed above was partially offset by the impact of a weaker U.S. dollar compared to certain other foreign currencies, including the Japanese yen, which had a favorable impact on our Asia Pacific operating segment. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below. Operating income for Europe, Middle East and Africa for the years ended December 31, 2016 and 2015 was $3,676 million and $3,875 million , respectively. Foreign currency exchange rate fluctuations unfavorably impacted operating income by 3 percent and the segment was also unfavorably impacted by an increase in other operating charges and the impact of acquisitions and divestitures. The impact of these items was partially offset by favorable product mix and geographic mix. Operating income for the Latin America segment for the years ended December 31, 2016 and 2015 was $1,951 million and $2,169 million , respectively. Foreign currency exchange rate fluctuations unfavorably impacted operating income by 27 percent and the segment was also unfavorably impacted by an increase in other operating charges. The impact of these items was partially offset by favorable price mix in all of the segment's business units. North America's operating income for the years ended December 31, 2016 and 2015 was $2,582 million and $2,366 million , respectively. The increase in the segment's operating income was due to price increases and favorable package mix and a decrease in other operating charges, partially offset by the impact of acquisitions and divestitures. Operating income in Asia Pacific for the years ended December 31, 2016 and 2015 was $2,224 million and $2,189 million , respectively. Operating income for the segment reflects an increase in concentrate sales partially offset by the unfavorable impact of acquisitions and divestitures. Our Bottling Investments segment's operating loss for the year ended December 31, 2016 was $137 million , compared to operating income for the year ended December 31, 2015 of $124 million . The Bottling Investments segment was unfavorably impacted by an increase in other operating charges and the impact of acquisitions and divestitures, partially offset by a favorable impact of 1 percent due to fluctuations in foreign currency exchange rates. The Corporate segment's operating loss for the years ended December 31, 2016 and 2015 was $1,670 million and $1,995 million , respectively. Operating loss in 2016 was favorably impacted by a decrease in other operating charges, partially offset by an unfavorable impact of 2 percent due to fluctuations in foreign currency exchange rates. Interest Income Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest income was $ 677 million in 2017 , compared to $ 642 million in 2016 , an increase of $35 million, or 6 percent. The increase primarily reflects higher investment balances in certain of our international locations, partially offset by lower interest rates earned on certain investments. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Interest income was $ 642 million in 2016 , compared to $ 613 million in 2015 , an increase of $29 million, or 5 percent. The increase primarily reflects higher cash balances and higher average interest rates in certain of our international locations, partially offset by the unfavorable impact of fluctuations in foreign currency exchange rates due to a stronger U.S. dollar against most major currencies. Interest Expense Year Ended December 31, 2017 versus Year Ended December 31, 2016 Interest expense was $ 841 million in 2017 , compared to $ 733 million in 2016 , an increase of $108 million, or 15 percent. The increase primarily reflects the impact of short-term U.S. interest rates and longer debt maturities, both of which resulted in higher interest rates on the Company's debt portfolio. Additionally, interest expense during the year ended December 31, 2017 included a net charge of $38 million due to the early extinguishment of certain long-term debt. This net charge included the difference between the reacquisition price and the net carrying amount of the debt extinguished. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Year Ended December 31, 2016 versus Year Ended December 31, 2015 Interest expense was $ 733 million in 2016 , compared to $ 856 million in 2015 , a decrease of $123 million, or 14 percent. Interest expense during the year ended December 31, 2016 included the impact of recently issued long-term debt and interest rate swaps on our fixed-rate debt. Interest expense during the year ended December 31, 2015 included charges of $320 million the Company recorded on the early extinguishment of certain long-term debt. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information related to the Company's hedging program. Refer to the heading ""Liquidity, Capital Resources and Financial Position Cash Flows from Financing Activities Debt Financing"" below and Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt. Equity Income (Loss) Net Year Ended December 31, 2017 versus Year Ended December 31, 2016 Equity income (loss) net represents our Company's proportionate share of net income or loss from each of our equity method investees. In 2017 , equity income was $ 1,071 million , compared to equity income of $ 835 million in 2016 , an increase of $236 million, or 28 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees. Additionally, the increase was attributable to the impact of the equity investment in CCEP acquired in 2016 and the impact of the equity investment in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas"") that was acquired in 2017. The favorable impact of these items was partially offset by the derecognition of the Company's former equity method investment in South Africa in 2016. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in AC Bebidas and former investments in CCBA and CCBA's South African subsidiary. Year Ended December 31, 2016 versus Year Ended December 31, 2015 In 2016 , equity income was $ 835 million , compared to equity income of $ 489 million in 2015 , an increase of $346 million, or 71 percent. This increase reflects, among other items, more favorable operating results reported by several of our equity method investees, the impact of the June 2015 investment in Monster, as well as our investments in CCEP, CCBA and CCBA's South African subsidiary, which were acquired in 2016. The favorable impact of these items was partially offset by the unfavorable impact of fluctuations in foreign currency exchange rates due to a stronger U.S. dollar against most major currencies and the derecognition of the Company's former equity method investment in South Africa. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction and our investments in CCEP, CCBA and CCBA's South African subsidiary. Other Income (Loss) Net Other income (loss) net includes, among other things, the impact of foreign currency exchange gains and losses; dividend income; rental income; gains and losses related to the disposal of property, plant and equipment; gains and losses related to business combinations and disposals; realized and unrealized gains and losses on trading securities; realized gains and losses on available-for-sale securities; and other-than-temporary impairments of available-for-sale securities. The foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. In 2017, other income (loss) net was a loss of $1,666 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Additionally, the Company incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish Coca-Cola Bottlers Japan Inc. (""CCBJI""). In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJI. The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value upon consolidation of CCBA. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Other income (loss) net also included net gains of $88 million related to trading securities and the sale of available-for-sale securities and $71 million of dividend income, partially offset by net foreign currency exchange losses of $57 million. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America and China bottling refranchising, the conversion payments and our consolidation of CCBA. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. In 2016, other income (loss) net was a loss of $1,234 million . This loss included losses of $2,456 million due to the refranchising of certain bottling territories in North America and a loss of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred net foreign currency exchange losses of $246 million, including a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These losses were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations, dividend income of $55 million and net gains of $83 million related to trading securities and the sale of available-for-sale securities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the North America refranchising, the deconsolidation of our South African bottling operations, the conversion payments and the deconsolidation of our German bottling operations. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. In 2015, other income (loss) net was income of $631 million. This income included a net gain of $ 1,403 million as a result of the Monster Transaction, primarily due to the difference in the recorded carrying value of the assets transferred, including an allocated portion of goodwill, compared to the value of the total assets and business acquired. Other income (loss) net also included net foreign currency exchange gains of $149 million and dividend income of $83 million. This income was partially offset by losses of $1,006 million due to refranchising activities in North America. The net foreign currency exchange gains included a gain of $300 million associated with our foreign-denominated debt partially offset by a charge of $27 million due to the initial remeasurement of the net monetary assets of our Venezuelan subsidiary using the SIMADI exchange rate. The Company determined that based on its economic circumstances, the SIMADI rate best represented the applicable rate at which future transactions could be settled, including the payment of dividends. As such, the Company remeasured the net assets related to its operations in Venezuela using the current SIMADI rate. Refer to the heading ""Liquidity, Capital Resources and Financial Position Foreign Exchange"" below and Note 1 of Notes to Consolidated Financial Statements for additional information related to the charge due to the change in Venezuelan exchange rates. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to the Monster Transaction and North America refranchising. Refer to Note 19 of Notes to Consolidated Financial Statements for the impact these items had on our operating segments. Income Taxes Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate of 35.0 percent . As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2018 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 221 million , $ 105 million and $ 223 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 35.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.2 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal rate (9.7 ) (17.5 ) 5 (12.7 ) Equity income or loss (3.4 ) (3.0 ) (1.7 ) Tax Reform Act 53.5 1 Other net 5.9 2,3,4 3.8 6 1.5 Effective tax rate 82.5 % 19.5 % 23.3 % 1 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. Refer to Note 14 of Notes to Consolidated Financial Statements. 2 Includes excess tax benefits of $132 million (or a 2 percent impact on our effective tax rate) recognized as awards issued under the Company's share-based compensation arrangements vested or were settled. 3 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the refranchising of CCR's Southwest operating unit (""Southwest Transaction""), in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2 of Notes to Consolidated Financial Statements. 4 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book-to-tax adjustments. 5 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2 of Notes to Consolidated Financial Statements. 6 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. As of December 31, 2017 , the gross amount of unrecognized tax benefits was $ 331 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 205 million , exclusive of any benefits related to interest and penalties. The remaining $ 126 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 1 Decrease related to prior period tax positions (13 ) (9 ) Increase related to current period tax positions Decrease related to settlements with taxing authorities (40 ) 1 (5 ) Decrease due to lapse of the applicable statute of limitations (23 ) Increase (decrease) due to effect of foreign currency exchange rate changes (6 ) (15 ) Ending balance of unrecognized tax benefits $ $ $ 1 The increase is primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 177 million , $ 142 million and $ 111 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2017 , 2016 and 2015 , respectively. Of these amounts, $35 million and $31 million of expense were recognized through income tax expense in 2017 and 2016 , respectively. An insignificant amount of interest and penalties was recognized through income tax expense for the year ended December 31, 2015. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. Based on current tax laws, the Company's effective tax rate in 2018 is expected to be approximately 21.0 percent before considering the potential impact of further clarification of certain matters related to the Tax Reform Act and any unusual or special items that may affect our effective tax rate. Liquidity, Capital Resources and Financial Position We believe our ability to generate cash flows from operating activities is one of our fundamental financial strengths. Refer to the heading ""Cash Flows from Operating Activities"" below. The near-term outlook for our business remains strong, and we expect to generate substantial cash flows from operations in 2018. As a result of our expected cash flows from operations, we have significant flexibility to meet our financial commitments. The Company does not typically raise capital through the issuance of stock. Instead, we use debt financing to lower our overall cost of capital and increase our return on shareowners' equity. Refer to the heading ""Cash Flows from Financing Activities"" below. We have a history of borrowing funds domestically and continue to have the ability to borrow funds domestically at reasonable interest rates. In addition, our domestic entities have recently borrowed and continue to have the ability to borrow funds in international markets at reasonable interest rates. Our debt financing includes the use of an extensive commercial paper program as part of our overall cash management strategy. The Company reviews its optimal mix of short-term and long-term debt regularly and may replace certain amounts of commercial paper, short-term debt and current maturities of long-term debt with new issuances of long-term debt in the future. In addition to the Company's cash balances, commercial paper program, and our ability to issue long-term debt, we also had $ 7,295 million in lines of credit for general corporate purposes as of December 31, 2017 . These backup lines of credit expire at various times from 2018 through 2022 . We have significant operations outside the United States. Unit case volume outside the United States represented 81 percent of the Company's worldwide unit case volume in 2017. We earn a substantial amount of our consolidated operating income and income from continuing operations before income taxes from foreign subsidiaries that either sell concentrates and syrups to our local bottling partners or, in certain instances, sell finished products directly to our customers to fulfill the demand for Company beverage products outside the United States. A significant portion of these foreign earnings was previously considered to be indefinitely reinvested in foreign jurisdictions where the Company has made, and will continue to make, substantial investments to support the ongoing development and growth of our international operations. Accordingly, no U.S. federal and state income taxes were previously provided on the portion of our foreign earnings that was considered to be indefinitely reinvested in foreign jurisdictions. On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act reduces the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent effective for tax years beginning after December 31, 2017, transitions the U.S. method of taxation from a worldwide tax system to a modified territorial system and requires companies to pay a one-time transition tax over a period of eight years on the mandatory deemed repatriation of prescribed foreign earnings as of December 31, 2017. As a result, the Company recognized a provisional tax charge related to the one-time transition tax in the amount of $4.6 billion in 2017. The Company's cash, cash equivalents, short-term investments and marketable securities held by our foreign subsidiaries totaled $19.6 billion as of December 31, 2017 . Net operating revenues in the United States were $14.7 billion in 2017, or 42 percent of the Company's consolidated net operating revenues. We expect existing domestic cash, cash equivalents, short-term investments, marketable securities, cash flows from operations, the repatriation of foreign earnings and the issuance of debt to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities. In addition, we expect foreign cash, cash equivalents, short-term investments, marketable securities remaining after repatriation and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities. Based on all the aforementioned factors, the Company believes its current liquidity position is strong, and we will continue to meet all of our financial commitments for the foreseeable future. These obligations and anticipated cash outflows include, but are not limited to, regular quarterly dividends, debt maturities, capital expenditures, share repurchases and obligations included under the heading ""Off-Balance Sheet Arrangements and Aggregate Contractual Obligations"" below. Cash Flows from Operating Activities Net cash provided by operating activities for the years ended December 31, 2017 , 2016 and 2015 was $ 6,995 million , $ 8,796 million and $ 10,528 million , respectively. Net cash provided by operating activities decreased $1,801 million, or 20 percent, in 2017 compared to 2016 . This decrease was primarily driven by the refranchising of certain bottling operations, the unfavorable impact of foreign currency exchange rate fluctuations, one less day in the current year, and increased payments related to income taxes and restructuring. Net cash provided by operating activities in 2018 will be impacted by a tax payment of $370 million related to the one-time transition tax resulting from the Tax Reform Act. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information on the tax payments. Net cash provided by operating activities decreased $1,732 million, or 16 percent, in 2016 compared to 2015 . This decrease included the unfavorable impact of foreign currency exchange rate fluctuations, the impact of $471 million in incremental contributions made to the Company's pension plans and the impact of acquisitions and divestitures. The impact of these items was partially offset by lower income tax payments. Refer to the heading ""Operations Review Net Operating Revenues"" above for additional information on the impact of foreign currency fluctuations. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information on the tax payments. Cash Flows from Investing Activities Net cash provided by (used in) investing activities is summarized as follows (in millions): Year Ended December 31, Purchases of investments $ (16,520 ) $ (15,499 ) $ (15,831 ) Proceeds from disposals of investments 15,911 16,624 14,079 Acquisitions of businesses, equity method investments and nonmarketable securities (3,900 ) (838 ) (2,491 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 3,821 1,035 Purchases of property, plant and equipment (1,675 ) (2,262 ) (2,553 ) Proceeds from disposals of property, plant and equipment Other investing activities (126 ) (209 ) (40 ) Net cash provided by (used in) investing activities $ (2,385 ) $ (999 ) $ (6,186 ) Purchases of Investments and Proceeds from Disposals of Investments In 2017 , purchases of investments were $ 16,520 million and proceeds from disposals of investments were $ 15,911 million . This activity resulted in a net cash outflow of $609 million during 2017 . In 2016 , purchases of investments were $ 15,499 million and proceeds from disposals of investments were $ 16,624 million , resulting in a net cash inflow of $1,125 million. In 2015 , purchases of investments were $ 15,831 million and proceeds from disposals of investments were $ 14,079 million , resulting in a net cash outflow of $1,752 million. These investments include time deposits that have maturities greater than three months but less than one year and are classified in the line item short-term investments in our consolidated balance sheets. The disposals in 2016 include proceeds from the disposal of the Company's investment in Keurig of $2,380 million. The purchases in 2015 include our investment in Keurig of $830 million. The remaining activity primarily represents the purchases of and proceeds from short-term investments that were made as part of the Company's overall cash management strategy. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on our investment in Keurig. Acquisitions of Businesses, Equity Method Investments and Nonmarketable Securities In 2017 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 3,900 million , which was primarily related to the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . Additionally, in conjunction with the Southwest Transaction, we obtained an equity interest in AC Bebidas. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. In 2016 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 838 million , which was primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd., a maker of plant-based protein beverages in China, and a minority investment in CHI Limited, a Nigerian producer of value-added dairy and juice beverages. Under the terms of the agreement related to our investment in CHI Limited, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. In 2015 , the Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 2,491 million , which primarily included our equity investments in Monster and in Indonesian bottling operations and the acquisition of a controlling interest in a South African bottling operation. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our acquisitions during the years ended December 31, 2017 , 2016 and 2015 . Proceeds from Disposals of Businesses, Equity Method Investments and Nonmarketable Securities In 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $ 3,821 million , primarily related to proceeds from the refranchising of certain bottling territories in North America and the refranchising of our China bottling operations and related cost method investment. In 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $1,035 million , primarily related to proceeds from the refranchising of certain bottling territories in North America. In 2015 , proceeds from disposals of businesses, equity method investments and nonmarketable securities were $565 million , which included cash received as a result of a Brazilian bottling entity's majority interest owners exercising their option to acquire from us an additional equity interest. The proceeds from disposals of businesses, equity method investments and nonmarketable securities during 2015 also included the proceeds from the refranchising of certain of our bottling territories in North America. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information related to our disposals during the years ended December 31, 2017 , 2016 and 2015 . Purchases of Property, Plant and Equipment Purchases of property, plant and equipment net of disposals for the years ended December 31, 2017 , 2016 and 2015 were $1,571 million, $2,112 million and $2,468 million, respectively. Total capital expenditures for property, plant and equipment and the percentage of such totals by operating segment were as follows (in millions): Year Ended December 31, Capital expenditures $ 1,675 $ 2,262 $ 2,553 Europe, Middle East Africa 4.8 % 2.7 % 2.1 % Latin America 3.3 2.0 2.7 North America 32.3 19.4 14.8 Asia Pacific 3.0 4.7 3.2 Bottling Investments 39.5 58.8 66.5 Corporate 17.1 12.4 10.7 We expect our annual 2018 capital expenditures to be approximately $1.9 billion as we continue to make investments to enable growth in our business and further enhance our operational effectiveness. Other Investing Activities In 2016, cash used in other investing activities was primarily related to the cash flow impact of the Company's derivative contracts designated as net investment hedges and the purchases of trademarks. In 2015, cash used in other investing activities included a $530 million payment related to the Monster Transaction, partially offset by the cash flow impact of the Company's derivative contracts designated as net investment hedges. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information on the Monster Transaction and Note 5 of Notes to Consolidated Financial Statements for additional information on the Company's derivative contracts designated as net investment hedges. Cash Flows from Financing Activities Net cash provided by (used in) financing activities is summarized as follows (in millions): Year Ended December 31, Issuances of debt $ 29,857 $ 27,281 $ 40,434 Payments of debt (28,768 ) (25,615 ) (37,738 ) Issuances of stock 1,595 1,434 1,245 Purchases of stock for treasury (3,682 ) (3,681 ) (3,564 ) Dividends (6,320 ) (6,043 ) (5,741 ) Other financing activities (91 ) Net cash provided by (used in) financing activities $ (7,409 ) $ (6,545 ) $ (5,113 ) Debt Financing Our Company maintains debt levels we consider prudent based on our cash flows, interest coverage ratio and percentage of debt to capital. We use debt financing to lower our overall cost of capital, which increases our return on shareowners' equity. This exposes us to adverse changes in interest rates. Our interest expense may also be affected by our credit ratings. As of December 31, 2017, our long-term debt was rated ""AA-"" by Standard Poor's and ""Aa3"" by Moody's. Our commercial paper program was rated ""A-1+"" by Standard Poor's and ""P-1"" by Moody's. In assessing our credit strength, both agencies consider our capital structure (including the amount and maturity dates of our debt) and financial policies as well as the aggregated balance sheet and other financial information of the Company. In addition, some rating agencies also consider the financial information of certain bottlers, including CCEP, Coca-Cola Amatil Limited, Coca-Cola Bottling Co. Consolidated, Coca-Cola FEMSA and Coca-Cola Hellenic. While the Company has no legal obligation for the debt of these bottlers, the rating agencies believe the strategic importance of the bottlers to the Company's business model provides the Company with an incentive to keep these bottlers viable. It is our expectation that the credit rating agencies will continue using this methodology. If our credit ratings were to be downgraded as a result of changes in our capital structure, our major bottlers' financial performance, changes in the credit rating agencies' methodology in assessing our credit strength, or for any other reason, our cost of borrowing could increase. Additionally, if certain bottlers' credit ratings were to decline, the Company's equity income could be reduced as a result of the potential increase in interest expense for those bottlers. We monitor our financial ratios and, as indicated above, the rating agencies consider these ratios in assessing our credit ratings. Each rating agency employs a different aggregation methodology and has different thresholds for the various financial ratios. These thresholds are not necessarily permanent, nor are they always fully disclosed to our Company. Our global presence and strong capital position give us access to key financial markets around the world, enabling us to raise funds at a low effective cost. This posture, coupled with active management of our mix of short-term and long-term debt and our mix of fixed-rate and variable-rate debt, results in a lower overall cost of borrowing. Our debt management policies, in conjunction with our share repurchase program and investment activity, can result in current liabilities exceeding current assets. Issuances and payments of debt included both short-term and long-term financing activities. In 2017, the Company had issuances of debt of $29,857 million , which included net issuances of $26,218 million of commercial paper and short-term debt with maturities greater than 90 days and long-term debt issuances of $3,639 million, net of related discounts and issuance costs. During 2017, the Company made payments of debt of $28,768 million , which included $636 million of payments related to commercial paper and short-term debt with maturities of 90 days or less and $24,156 of payments related to commercial paper and short-term debt with maturities greater than 90 days. The Company's total payments of long-term debt were $3,976 million. The long-term debt payments included the early extinguishment of long-term debt with a carrying value of $417 million , a portion of which was assumed in connection with our acquisition of Old CCE's former North America business. This resulted in a net charge of $38 million that was recorded in the line item interest expense in our consolidated statement of income. This net charge included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including fair value adjustments recorded as part of purchase accounting. In 2016, the Company had issuances of debt of $27,281 million , which included net issuances of $773 million of commercial paper and short-term debt with maturities of 90 days or less and $21,525 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $4,983 million, net of related discounts and issuance costs. Refer below for additional details on our long-term debt issuances. During 2016, the Company made payments of debt of $25,615 million , which included $22,920 million of payments related to commercial paper and short-term debt with maturities greater than 90 days and payments of long-term debt of $2,695 million. In 2015, the Company had issuances of debt of $40,434 million, which included net issuances of $25,923 million of commercial paper and short-term debt with maturities greater than 90 days. The Company's total issuances of debt also included long-term debt issuances of $14,511 million, net of related discounts, premiums and issuance costs. During 2015, the Company made payments of debt of $37,738 million, which included net payments of $208 million of commercial paper and short-term debt with maturities of 90 days or less, $31,711 million of payments of commercial paper and short-term debt with maturities greater than 90 days and long-term debt payments of $5,819 million. The long-term debt payments included the extinguishment of $2,039 million of long-term debt prior to maturity, which resulted in associated charges of $320 million that were recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE of $ 263 million and $ 361 million as of December 31, 2017 and 2016 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2017 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 24 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 757 million , $ 663 million and $ 515 million in 2017 , 2016 and 2015 , respectively. Refer to Note 10 of Notes to Consolidated Financial Statements for additional information related to the Company's long-term debt balances. Issuances of Stock The issuances of stock in 2017 , 2016 and 2015 were related to the exercise of stock options by Company employees. Share Repurchases In 2012, the Board of Directors authorized a share repurchase program of up to 500 million shares of the Company's common stock. The table below presents annual shares repurchased and average price per share: Year Ended December 31, Number of shares repurchased (in millions) Average price per share $ 44.09 $ 43.62 $ 41.33 Since the inception of our initial share repurchase program in 1984 through our current program as of December 31, 2017 , we have purchased 3.4 billion shares of our Company's common stock at an average price per share of $16.74. In addition to shares repurchased under the share repurchase program authorized by our Board of Directors, the Company's treasury stock activity also includes shares surrendered to the Company to pay the exercise price and/or to satisfy tax withholding obligations in connection with so-called stock swap exercises of employee stock options and/or the vesting of restricted stock issued to employees. In 2017, we repurchased $3.7 billion of our stock. The net impact of the Company's treasury stock issuance and purchase activities in 2017 resulted in a net cash outflow of $2.1 billion. We currently expect to repurchase approximately $1.0 billion of our stock during 2018, net of proceeds from the issuance of treasury stock due to the exercise of employee stock options. Dividends The Company paid dividends of $6,320 million , $6,043 million and $5,741 million during the years ended December 31, 2017 , 2016 and 2015 , respectively. At its February 2018 meeting, our Board of Directors increased our quarterly dividend by 5 percent, raising it to $0.39 per share, equivalent to a full year dividend of $1.56 per share in 2018. This is our 56 th consecutive annual increase. Our annual common stock dividend was $ 1.48 per share, $ 1.40 per share and $ 1.32 per share in 2017 , 2016 and 2015 , respectively. The 2017 dividend represented a 6 percent increase from 2016 , and the 2016 dividend represented a 6 percent increase from 2015 . Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements In accordance with the definition under SEC rules, the following qualify as off-balance sheet arrangements: any obligation under certain guarantee contracts; a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; any obligation under certain derivative instruments; and any obligation arising out of a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or research and development services with the registrant. As of December 31, 2017 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 609 million , of which $ 256 million was related to VIEs. These guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees was individually significant. The amount represents the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. Management has concluded that the likelihood of any significant amounts being paid by our Company under these guarantees is not probable. As of December 31, 2017 , we were not directly liable for the debt of any unconsolidated entity, and we did not have any retained or contingent interest in assets as defined above. Our Company recognizes all derivatives as either assets or liabilities at fair value in our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. Aggregate Contractual Obligations As of December 31, 2017 , the Company's contractual obligations, including payments due by period, were as follows (in millions): Payments Due by Period Total 2019-2020 2021-2022 2023 and Thereafter Short-term loans and notes payable: 1 Commercial paper borrowings $ 12,931 $ 12,931 $ $ $ Lines of credit and other short-term borrowings Current maturities of long-term debt 2 3,300 3,300 Long-term debt, net of current maturities 2 31,082 9,501 5,398 16,183 Estimated interest payments 3 5,064 2,960 Accrued income taxes 4 4,663 2,773 Purchase obligations 5 14,582 8,132 1,464 4,154 Marketing obligations 6 4,629 2,439 1,033 Lease obligations Held-for-sale obligations 7 1,592 1,591 Total contractual obligations $ 78,934 $ 29,778 $ 13,853 $ 8,467 $ 26,836 1 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding short-term loans and notes payable. Upon payment of outstanding commercial paper, we typically issue new commercial paper. Lines of credit and other short-term borrowings are expected to fluctuate depending upon current liquidity needs, especially at international subsidiaries. 2 Refer to Note 10 of Notes to Consolidated Financial Statements for information regarding long-term debt. We will consider several alternatives to settle this long-term debt, including the use of cash flows from operating activities, issuance of commercial paper or issuance of other long-term debt. The table above shows expected cash payments to be paid by the Company in future periods and excludes the noncash portion of debt, including the fair market value markup, unamortized discounts and premiums. 3 We calculated estimated interest payments for our long-term debt based on the applicable rates and payment dates. For our variable-rate debt, we have assumed the December 31, 2017 rate for all years presented. We typically expect to settle such interest payments with cash flows from operating activities and/or short-term borrowings. 4 Refer to Note 14 of Notes to Consolidated Financial Statements for information regarding income taxes. Accrued income taxes includes $4,623 million related to the one-time transition tax required by the Tax Reform Act. Unrecognized tax benefits, including accrued interest and penalties of $505 million, were not included in the total above. At this time, the settlement period for the unrecognized tax benefits cannot be determined. In addition, any payments related to unrecognized tax benefits would be partially offset by reductions in payments in other jurisdictions. 5 Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including long-term contractual obligations, open purchase orders, accounts payable and certain accrued liabilities. We expect to fund these obligations with cash flows from operating activities. 6 We expect to fund these marketing obligations with cash flows from operating activities. 7 Represents liabilities and contractual obligations of the Company's bottling operations that are classified as held for sale. The total accrued benefit liability for pension and other postretirement benefit plans recognized as of December 31, 2017 , was $2,027 million. Refer to Note 13 of Notes to Consolidated Financial Statements. This amount is impacted by, among other items, pension expense, funding levels, plan amendments, changes in plan demographics and assumptions, and the investment return on plan assets. Because the accrued liability does not represent expected liquidity needs, we did not include this amount in the contractual obligations table. We generally expect to fund all future pension contributions with cash flows from operating activities. Our international pension plans are generally funded in accordance with local laws and income tax regulations. As of December 31, 2017 , the projected benefit obligation of the U.S. qualified pension plans was $6,384 million, and the fair value of the related plan assets was $6,028 million. The projected benefit obligation of all pension plans other than the U.S. qualified pension plans was $3,071 million, and the fair value of the related plan assets was $2,815 million. The majority of this underfunding is attributable to an international pension plan for certain non-U.S. employees that is unfunded due to tax law restrictions, as well as certain unfunded U.S. nonqualified pension plans. These U.S. nonqualified pension plans provide, for certain associates, benefits that are not permitted to be funded through a qualified plan because of limits imposed by the Internal Revenue Code of 1986. The expected benefit payments for these unfunded pension plans are not included in the table above. However, we anticipate annual benefit payments for these unfunded pension plans to be $67 million in 2018, increasing to $72 million by 2024 and then decreasing annually thereafter. Refer to Note 13 of Notes to Consolidated Financial Statements. The Company expects to contribute $59 million in 2018 to our global pension plans, all of which will be allocated to our international plans. Refer to Note 13 of Notes to Consolidated Financial Statements. We did not include our estimated contributions to our various plans in the table above. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for our specific expectations based on our claim history. As of December 31, 2017 , our self-insurance reserves totaled $ 480 million . Refer to Note 11 of Notes to Consolidated Financial Statements. We did not include estimated payments related to our self-insurance reserves in the table above. Deferred income tax liabilities as of December 31, 2017 were $2,522 million . Refer to Note 14 of Notes to Consolidated Financial Statements. This amount is not included in the total contractual obligations table because we believe that presentation would not be meaningful. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs. Additionally, as of December 31, 2017, the Company had entered into agreements related to the following future investing activities which are not included in the table above: Under the terms of the agreement for our investment in CHI Limited, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. The Company has also agreed in principle to acquire ABI's interest in bottling operations in Zambia, Zimbabwe, Botswana, Swaziland, Lesotho, El Salvador and Honduras. We plan to hold all of these bottling operations temporarily until they can be refranchised to other partners. The Company will negotiate the terms of these transactions with ABI according to the contractual parameters. The transactions are subject to the relevant regulatory approvals. Foreign Exchange Our international operations are subject to certain opportunities and risks, including currency fluctuations and governmental actions. We closely monitor our operations in each country and seek to adopt appropriate strategies that are responsive to changing economic and political environments as well as to fluctuations in foreign currencies. In 2017 , we used 74 functional currencies. Due to the geographic diversity of our operations, weakness in some of these currencies might be offset by strength in others. In 2017 , 2016 and 2015 , the weighted-average exchange rates for foreign currencies in which the Company conducted operations (all operating currencies), and for certain individual currencies, strengthened (weakened) against the U.S. dollar as follows: Year Ended December 31, All operating currencies % (5 )% (15 )% Brazilian real % (9 )% (27 )% Mexican peso (2 ) (14 ) (16 ) Australian dollar (1 ) (17 ) South African rand (13 ) (15 ) British pound (6 ) (11 ) (8 ) Euro (17 ) Japanese yen (3 ) (14 ) These percentages do not include the effects of our hedging activities and, therefore, do not reflect the actual impact of fluctuations in foreign currency exchange rates on our operating results. Our foreign currency management program is designed to mitigate, over time, a portion of the impact of exchange rate changes on our net income and earnings per share. The total currency impact on net operating revenues, including the effect of our hedging activities, was a decrease of 1 percent and 3 percent in 2017 and 2016 , respectively. The total currency impact on income from continuing operations before income taxes, including the effect of our hedging activities, was nominal in 2017 and was a decrease of 12 percent in 2016 . Foreign currency exchange gains and losses are primarily the result of the remeasurement of monetary assets and liabilities from certain currencies into functional currencies. The effects of the remeasurement of these assets and liabilities are partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 of Notes to Consolidated Financial Statements. Foreign currency exchange gains and losses are included as a component of other income (loss) net in our consolidated financial statements. Refer to the heading ""Operations Review Other Income (Loss) Net"" above. The Company recorded foreign currency exchange losses of $57 million in 2017 , foreign currency exchange losses of $246 million in 2016 and foreign currency exchange gains of $149 million in 2015 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. In February 2015, the Venezuelan government introduced a new open market exchange rate system, SIMADI. As a result, we remeasured the net monetary assets of our Venezuelan subsidiary, resulting in a charge of $27 million recorded in the line item other income (loss) net in our consolidated statement of income. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the SIMADI rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. In addition, we sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the years ended December 31, 2016 and December 31, 2015 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expect to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded write-downs of $76 million and $56 million , respectively. These write-downs were recorded in the line item other operating charges in our consolidated statements of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized impairment charges of $34 million and $55 million during the years ended December 31, 2017 and December 31, 2015 , respectively. These charges were recorded in the line item other operating charges in our consolidated statements of income. As a result of these impairment charges, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Impact of Inflation and Changing Prices Inflation affects the way we operate in many markets around the world. In general, we believe that, over time, we will be able to increase prices to counteract the majority of the inflationary effects of increasing costs and to generate sufficient cash flows to maintain our productive capability. Overview of Financial Position The following table illustrates the change in the individual line items of the Company's consolidated balance sheet (in millions): December 31, Increase (Decrease) Percent Change Cash and cash equivalents $ 6,006 $ 8,555 $ (2,549 ) (30 )% Short-term investments 9,352 9,595 (243 ) (3 ) Marketable securities 5,317 4,051 1,266 Trade accounts receivable net 3,667 3,856 (189 ) (5 ) Inventories 2,655 2,675 (20 ) (1 ) Prepaid expenses and other assets 2,000 2,481 (481 ) (19 ) Assets held for sale 2,797 (2,578 ) (92 ) Assets held for sale discontinued operations 7,329 7,329 Equity method investments 20,856 16,260 4,596 Other investments 1,096 Other assets 4,560 4,248 Property, plant and equipment net 8,203 10,635 (2,432 ) (23 ) Trademarks with indefinite lives 6,729 6,097 Bottlers' franchise rights with indefinite lives 3,676 (3,538 ) (96 ) Goodwill 9,401 10,629 (1,228 ) (12 ) Other intangible assets (358 ) (49 ) Total assets $ 87,896 $ 87,270 $ % Accounts payable and accrued expenses $ 8,748 $ 9,490 $ (742 ) (8 )% Loans and notes payable 13,205 12,498 Current maturities of long-term debt 3,298 3,527 (229 ) (6 ) Accrued income taxes Liabilities held for sale (673 ) (95 ) Liabilities held for sale discontinued operations 1,496 1,496 Long-term debt 31,182 29,684 1,498 Other liabilities 8,021 4,081 3,940 Deferred income taxes 2,522 3,753 (1,231 ) (33 ) Total liabilities $ 68,919 $ 64,050 $ 4,869 % Net assets $ 18,977 $ 23,220 $ (4,243 ) 1 (18 )% 1 Includes an increase in net assets of $861 million resulting from foreign currency translation adjustments in various balance sheet line items. The increases (decreases) in the table above include the impact of the following transactions and events: Assets held for sale and liabilities held for sale decreased primarily due to the North America and China bottling refranchising activities. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Assets held for sale discontinued operations and liabilities held for sale discontinued operations increased as a result of CCBA meeting the criteria to be classified as held for sale. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information. Equity method investments increased primarily due to our new investments in AC Bebidas and CCBJI. Refer to Note 2 and Note 17 of Notes to Consolidated Financial Statements for additional information. Property, plant and equipment, bottlers' franchise rights with indefinite lives and goodwill decreased primarily as a result of additional North America bottling territories being refranchised as well as impairment charges recorded. Refer to Note 2 and Note 16 of Notes to Consolidated Financial Statements for additional information. Other liabilities increased and deferred income taxes decreased primarily due to the Tax Reform Act signed into law on December 22, 2017. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our Company uses derivative financial instruments primarily to reduce our exposure to adverse fluctuations in foreign currency exchange rates, interest rates, commodity prices and other market risks. We do not enter into derivative financial instruments for trading purposes. As a matter of policy, all of our derivative positions are used to reduce risk by hedging an underlying economic exposure. Because of the high correlation between the hedging instrument and the underlying exposure, fluctuations in the value of the instruments are generally offset by reciprocal changes in the value of the underlying exposure. The Company generally hedges anticipated exposures up to 36 months in advance; however, the majority of our derivative instruments expire within 24 months or less. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. We monitor our exposure to financial market risks using several objective measurement systems, including a sensitivity analysis to measure our exposure to fluctuations in foreign currency exchange rates, interest rates and commodity prices. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information about our hedging transactions and derivative financial instruments. Foreign Currency Exchange Rates We manage most of our foreign currency exposures on a consolidated basis, which allows us to net certain exposures and take advantage of any natural offsets. In 2017 , we used 74 functional currencies and generated $20,683 million of our net operating revenues from operations outside the United States; therefore, weaknesses in some currencies might be offset by strengths in other currencies over time. We use derivative financial instruments to further reduce our net exposure to foreign currency fluctuations. Our Company enters into forward exchange contracts and purchases foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. Additionally, we enter into forward exchange contracts to offset the earnings impact related to foreign currency fluctuations on certain monetary assets and liabilities. We also enter into forward exchange contracts as hedges of net investments in foreign operations. The total notional values of our foreign currency derivatives were $13,057 million and $14,464 million as of December 31, 2017 and 2016 , respectively. These values include derivative instruments that are designated and qualify for hedge accounting as well as economic hedges. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized gain of $22 million as of December 31, 2017 . At the end of 2017 , we estimate that a 10 percent weakening of the U.S. dollar would have eliminated the net unrealized gain and created a net unrealized loss of $253 million. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized loss of $50 million, and we estimate that a 10 percent weakening of the U.S. dollar would have increased the net unrealized loss to $105 million. Interest Rates The Company is subject to interest rate volatility with regard to existing and future issuances of debt. We monitor our mix of fixed-rate and variable-rate debt as well as our mix of short-term debt and long-term debt. From time to time, we enter into interest rate swap agreements to manage our exposure to interest rate fluctuations. Based on the Company's variable-rate debt and derivative instruments outstanding as of December 31, 2017 , we estimate that a 1 percentage point increase in interest rates would have increased interest expense by $252 million in 2017 . However, this increase in interest expense would have been partially offset by the increase in interest income related to higher interest rates. The Company is subject to interest rate risk related to its investments in highly liquid securities. These investments are primarily managed by external managers within the guidelines of the Company's investment policy. Our policy requires these investments to be investment grade, with the primary objective of minimizing the potential risk of principal loss. In addition, our policy limits the amount of credit exposure to any one issuer. We estimate that a 1 percentage point increase in interest rates would result in a $97 million decrease in the fair value of our portfolio of highly liquid securities. Commodity Prices The Company is subject to market risk with respect to commodity price fluctuations, principally related to our purchases of sweeteners, metals, juices, PET and fuels. We manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing and distribution business. When deemed appropriate, we use derivative financial instruments to manage our exposure to commodity risks. Certain of these derivatives do not qualify for hedge accounting, but they are effective economic hedges that help the Company mitigate the price risk associated with the purchases of materials used in our manufacturing processes and the fuel used to operate our extensive vehicle fleet. Open commodity derivatives that qualify for hedge accounting had notional values of $35 million and $12 million as of December 31, 2017 and 2016 , respectively. The fair value of the contracts that qualify for hedge accounting resulted in a net unrealized loss of $5 million. The potential change in fair value of these commodity derivative instruments, assuming a 10 percent decrease in underlying commodity prices, would have increased the net unrealized loss to $6 million. Open commodity derivatives that do not qualify for hedge accounting had notional values of $357 million and $447 million as of December 31, 2017 and 2016 , respectively. The fair value of the contracts that do not qualify for hedge accounting resulted in a net unrealized gain of $20 million. The potential change in fair value of these commodity derivative instruments, assuming a 10 percent decrease in underlying commodity prices, would have eliminated the net unrealized gain and created a net unrealized loss of $18 million. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Shareowners' Equity Notes to Consolidated Financial Statements Report of Management Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Quarterly Data (Unaudited) 71 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, (In millions except per share data) NET OPERATING REVENUES $ 35,410 $ 41,863 $ 44,294 Cost of goods sold 13,256 16,465 17,482 GROSS PROFIT 22,154 25,398 26,812 Selling, general and administrative expenses 12,496 15,262 16,427 Other operating charges 2,157 1,510 1,657 OPERATING INCOME 7,501 8,626 8,728 Interest income Interest expense Equity income (loss) net 1,071 Other income (loss) net (1,666 ) (1,234 ) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 6,742 8,136 9,605 Income taxes from continuing operations 5,560 1,586 2,239 NET INCOME FROM CONTINUING OPERATIONS 1,182 6,550 7,366 Income from discontinued operations (net of income taxes of $47, $0 and $0, respectively) CONSOLIDATED NET INCOME 1,283 6,550 7,366 Less: Net income attributable to noncontrolling interests NET INCOME ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 1,248 $ 6,527 $ 7,351 Basic net income per share from continuing operations 1 $ 0.28 $ 1.51 $ 1.69 Basic net income per share from discontinued operations 2 0.02 BASIC NET INCOME PER SHARE $ 0.29 3 $ 1.51 $ 1.69 Diluted net income per share from continuing operations 1 $ 0.27 $ 1.49 $ 1.67 Diluted net income per share from discontinued operations 2 0.02 DILUTED NET INCOME PER SHARE $ 0.29 $ 1.49 $ 1.67 AVERAGE SHARES OUTSTANDING BASIC 4,272 4,317 4,352 Effect of dilutive securities AVERAGE SHARES OUTSTANDING DILUTED 4,324 4,367 4,405 1 Calculated based on net income from continuing operations less net income from continuing operations attributable to noncontrolling interests. 2 Calculated based on net income from discontinued operations less net income from discontinued operations attributable to noncontrolling interests. 3 Per share amounts do not add due to rounding. Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, (In millions) CONSOLIDATED NET INCOME $ 1,283 $ 6,550 $ 7,366 Other comprehensive income: Net foreign currency translation adjustment (626 ) (3,959 ) Net gain (loss) on derivatives (433 ) (382 ) Net unrealized gain (loss) on available-for-sale securities (684 ) Net change in pension and other benefit liabilities (53 ) TOTAL COMPREHENSIVE INCOME (LOSS) 2,221 5,506 2,951 Less: Comprehensive income (loss) attributable to noncontrolling interests (3 ) TOTAL COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 2,148 $ 5,496 $ 2,954 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions except par value) ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,006 $ 8,555 Short-term investments 9,352 9,595 TOTAL CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS 15,358 18,150 Marketable securities 5,317 4,051 Trade accounts receivable, less allowances of $477 and $466, respectively 3,667 3,856 Inventories 2,655 2,675 Prepaid expenses and other assets 2,000 2,481 Assets held for sale 2,797 Assets held for sale discontinued operations 7,329 TOTAL CURRENT ASSETS 36,545 34,010 EQUITY METHOD INVESTMENTS 20,856 16,260 OTHER INVESTMENTS 1,096 OTHER ASSETS 4,560 4,248 PROPERTY, PLANT AND EQUIPMENT net 8,203 10,635 TRADEMARKS WITH INDEFINITE LIVES 6,729 6,097 BOTTLERS' FRANCHISE RIGHTS WITH INDEFINITE LIVES 3,676 GOODWILL 9,401 10,629 OTHER INTANGIBLE ASSETS TOTAL ASSETS $ 87,896 $ 87,270 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses $ 8,748 $ 9,490 Loans and notes payable 13,205 12,498 Current maturities of long-term debt 3,298 3,527 Accrued income taxes Liabilities held for sale Liabilities held for sale discontinued operations 1,496 TOTAL CURRENT LIABILITIES 27,194 26,532 LONG-TERM DEBT 31,182 29,684 OTHER LIABILITIES 8,021 4,081 DEFERRED INCOME TAXES 2,522 3,753 THE COCA-COLA COMPANY SHAREOWNERS' EQUITY Common stock, $0.25 par value; Authorized 11,200 shares; Issued 7,040 and 7,040 shares, respectively 1,760 1,760 Capital surplus 15,864 14,993 Reinvested earnings 60,430 65,502 Accumulated other comprehensive income (loss) (10,305 ) (11,205 ) Treasury stock, at cost 2,781 and 2,752 shares, respectively (50,677 ) (47,988 ) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY 17,072 23,062 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS 1,905 TOTAL EQUITY 18,977 23,220 TOTAL LIABILITIES AND EQUITY $ 87,896 $ 87,270 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (In millions) OPERATING ACTIVITIES Consolidated net income $ 1,283 $ 6,550 $ 7,366 (Income) loss from discontinued operations (101 ) Net income from continuing operations 1,182 6,550 7,366 Depreciation and amortization 1,260 1,787 1,970 Stock-based compensation expense Deferred income taxes (1,256 ) (856 ) Equity (income) loss net of dividends (628 ) (449 ) (122 ) Foreign currency adjustments (137 ) Significant (gains) losses on sales of assets net 1,459 1,146 (374 ) Other operating charges 1,218 Other items (269 ) (224 ) Net change in operating assets and liabilities 3,529 (221 ) (157 ) Net cash provided by operating activities 6,995 8,796 10,528 INVESTING ACTIVITIES Purchases of investments (16,520 ) (15,499 ) (15,831 ) Proceeds from disposals of investments 15,911 16,624 14,079 Acquisitions of businesses, equity method investments and nonmarketable securities (3,900 ) (838 ) (2,491 ) Proceeds from disposals of businesses, equity method investments and nonmarketable securities 3,821 1,035 Purchases of property, plant and equipment (1,675 ) (2,262 ) (2,553 ) Proceeds from disposals of property, plant and equipment Other investing activities (126 ) (209 ) (40 ) Net cash provided by (used in) investing activities (2,385 ) (999 ) (6,186 ) FINANCING ACTIVITIES Issuances of debt 29,857 27,281 40,434 Payments of debt (28,768 ) (25,615 ) (37,738 ) Issuances of stock 1,595 1,434 1,245 Purchases of stock for treasury (3,682 ) (3,681 ) (3,564 ) Dividends (6,320 ) (6,043 ) (5,741 ) Other financing activities (91 ) Net cash provided by (used in) financing activities (7,409 ) (6,545 ) (5,113 ) CASH FLOWS FROM DISCONTINUED OPERATIONS Net cash provided by (used in) operating activities from discontinued operations Net cash provided by (used in) investing activities from discontinued operations (65 ) Net cash provided by (used in) financing activities from discontinued operations (38 ) Net cash provided by (used in) discontinued operations EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (6 ) (878 ) CASH AND CASH EQUIVALENTS Net increase (decrease) during the year (2,549 ) 1,246 (1,649 ) Balance at beginning of year 8,555 7,309 8,958 Balance at end of year $ 6,006 $ 8,555 $ 7,309 Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY Year Ended December 31, (In millions except per share data) EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year 4,288 4,324 4,366 Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (82 ) (86 ) (86 ) Balance at end of year 4,259 4,288 4,324 COMMON STOCK $ 1,760 $ 1,760 $ 1,760 CAPITAL SURPLUS Balance at beginning of year 14,993 14,016 13,154 Stock issued to employees related to stock compensation plans Tax benefit (charge) from stock compensation plans Stock-based compensation expense Other activities (3 ) Balance at end of year 15,864 14,993 14,016 REINVESTED EARNINGS Balance at beginning of year 65,502 65,018 63,408 Net income attributable to shareowners of The Coca-Cola Company 1,248 6,527 7,351 Dividends (per share $1.48, $1.40 and $1.32 in 2017, 2016 and 2015, respectively) (6,320 ) (6,043 ) (5,741 ) Balance at end of year 60,430 65,502 65,018 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year (11,205 ) (10,174 ) (5,777 ) Net other comprehensive income (loss) (1,031 ) (4,397 ) Balance at end of year (10,305 ) (11,205 ) (10,174 ) TREASURY STOCK Balance at beginning of year (47,988 ) (45,066 ) (42,225 ) Treasury stock issued to employees related to stock compensation plans Purchases of stock for treasury (3,598 ) (3,733 ) (3,537 ) Balance at end of year (50,677 ) (47,988 ) (45,066 ) TOTAL EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY $ 17,072 $ 23,062 $ 25,554 EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS Balance at beginning of year $ $ $ Net income attributable to noncontrolling interests Net foreign currency translation adjustment (13 ) (18 ) Dividends paid to noncontrolling interests (15 ) (25 ) (31 ) Contributions by noncontrolling interests Business combinations 1,805 (3 ) Deconsolidation of certain entities (157 ) (34 ) Other activities (4 ) TOTAL EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS $ 1,905 $ $ Refer to Notes to Consolidated Financial Statements. THE COCA-COLA COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 : BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business The Coca-Cola Company is the world's largest beverage company. We own or license and market more than 500 nonalcoholic beverage brands, which we group into the following category clusters: sparkling soft drinks; water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks. We own and market four of the world's top five nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta and Sprite. Finished beverage products bearing our trademarks, sold in the United States since 1886, are now sold in more than 200 countries. We make our branded beverage products available to consumers throughout the world through our network of Company-owned or -controlled bottling and distribution operations, as well as independent bottling partners, distributors, wholesalers and retailers the world's largest beverage distribution system. Beverages bearing trademarks owned by or licensed to us account for more than 1.9 billion of the approximately 60 billion servings of all beverages consumed worldwide every day. Our Company markets, manufactures and sells: beverage concentrates, sometimes referred to as ""beverage bases,"" and syrups, including fountain syrups (we refer to this part of our business as our ""concentrate business"" or ""concentrate operations""); and finished sparkling soft drinks and other nonalcoholic beverages (we refer to this part of our business as our ""finished product business"" or ""finished product operations""). Generally, finished product operations generate higher net operating revenues but lower gross profit margins than concentrate operations. In our concentrate operations, we typically generate net operating revenues by selling concentrates and syrups to authorized bottling operations (to which we typically refer as our ""bottlers"" or our ""bottling partners""). Our bottling partners either combine the concentrates with sweeteners (depending on the product), still water and/or sparkling water, or combine the syrups with sparkling water to produce finished beverages. The finished beverages are packaged in authorized containers such as cans and refillable and nonrefillable glass and plastic bottles bearing our trademarks or trademarks licensed to us and are then sold to retailers directly or, in some cases, through wholesalers or other bottlers. Outside the United States, we also sell concentrates for fountain beverages to our bottling partners who are typically authorized to manufacture fountain syrups, which they sell to fountain retailers such as restaurants and convenience stores which use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers who in turn sell and distribute the fountain syrups to fountain retailers. Our finished product operations consist primarily of Company-owned or -controlled bottling, sales and distribution operations which are included in our Bottling Investments operating segment. Our finished product operations generate net operating revenues by selling sparkling soft drinks and a variety of other nonalcoholic beverages, including water, enhanced water and sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks, to retailers or to distributors, wholesalers and bottling partners who distribute them to retailers. In addition, in the United States, we manufacture fountain syrups and sell them to fountain retailers, such as restaurants and convenience stores who use the fountain syrups to produce beverages for immediate consumption, or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. These fountain syrup sales are included in our North America operating segment. We authorize these wholesalers to resell our fountain syrups through nonexclusive appointments that neither restrict us in setting the prices at which we sell fountain syrups to the wholesalers nor restrict the territories in which the wholesalers may resell in the United States. Summary of Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (""U.S. GAAP""). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements and accompanying notes. Although these estimates are based on our knowledge of current events and actions we may undertake in the future, actual results may ultimately differ from these estimates and assumptions. Furthermore, when testing assets for impairment in future periods, if management uses different assumptions or if different conditions occur, impairment charges may result. Certain amounts in the prior years' consolidated financial statements and accompanying notes have been revised to conform to the current year presentation. Principles of Consolidation Our Company consolidates all entities that we control by ownership of a majority voting interest. Additionally, there are situations in which consolidation is required even though the usual condition of consolidation (ownership of a majority voting interest) does not apply. Generally, this occurs when an entity holds an interest in another business enterprise that was achieved through arrangements that do not involve voting interests, which results in a disproportionate relationship between such entity's voting interests in, and its exposure to the economic risks and potential rewards of, the other business enterprise. This disproportionate relationship results in what is known as a variable interest, and the entity in which we have the variable interest is referred to as a ""VIE."" An enterprise must consolidate a VIE if it is determined to be the primary beneficiary of the VIE. The primary beneficiary has both (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance, and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were not determined to be the primary beneficiary. Our variable interests in these VIEs primarily relate to equity investments, profit guarantees or subordinated financial support. Refer to Note 11 . Although these financial arrangements resulted in our holding variable interests in these entities, they did not empower us to direct the activities of the VIEs that most significantly impact the VIEs' economic performance. Our Company's investments, plus any loans and guarantees, and other subordinated financial support related to these VIEs totaled $ 4,523 million and $ 3,709 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The Company's investments, plus any loans and guarantees, related to these VIEs were not individually significant to the Company's consolidated financial statements. In addition, our Company holds interests in certain VIEs, primarily bottling and container manufacturing operations, for which we were determined to be the primary beneficiary. As a result, we have consolidated these entities. Our Company's investments, plus any loans and guarantees, related to these VIEs totaled $ 1 million and $ 203 million as of December 31, 2017 and 2016 , respectively, representing our maximum exposures to loss. The assets and liabilities of VIEs for which we are the primary beneficiary were not significant to the Company's consolidated financial statements. Creditors of our VIEs do not have recourse against the general credit of the Company, regardless of whether they are accounted for as consolidated entities. We use the equity method to account for investments in companies if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investee includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions, other commercial arrangements and material intercompany transactions. We eliminate from our financial results all significant intercompany transactions, including the intercompany transactions with consolidated VIEs and the intercompany portion of transactions with equity method investees. Assets and Liabilities Held for Sale Our Company classifies long-lived assets or disposal groups to be sold as held for sale in the period in which all of the following criteria are met: management, having the authority to approve the action, commits to a plan to sell the asset or disposal group; the asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets or disposal groups; an active program to locate a buyer and other actions required to complete the plan to sell the asset or disposal group have been initiated; the sale of the asset or disposal group is probable, and transfer of the asset or disposal group is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond our control extend the period of time required to sell the asset or disposal group beyond one year; the asset or disposal group is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. We initially measure a long-lived asset or disposal group that is classified as held for sale at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held-for-sale criteria are met. Conversely, gains are not recognized on the sale of a long-lived asset or disposal group until the date of sale. We assess the fair value of a long-lived asset or disposal group less any costs to sell each reporting period it remains classified as held for sale and report any subsequent changes as an adjustment to the carrying value of the asset or disposal group, as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. Upon determining that a long-lived asset or disposal group meets the criteria to be classified as held for sale, the Company ceases depreciation and reports long-lived assets and/or the assets and liabilities of the disposal group, if material, in the line items assets held for sale and liabilities held for sale, respectively, in our consolidated balance sheet. Refer to Note 2. Discontinued Operations When the following criteria are met: the disposal group is a component of an entity, the component of the entity meets the held for sale criteria in accordance with our policy described above and the component of the entity represents a strategic shift in the entity's operating and financial results, the disposal group is classified as a discontinued operation. Alternatively, if a business meets the criteria for held for sale on the acquisition date, the business is accounted for as a discontinued operation. In October 2017, the Company and Anheuser-Busch InBev (""ABI"") completed the transition of ABI's controlling interest in Coca-Cola Beverages Africa Proprietary Limited (""CCBA"") to the Company for $3,150 million , resulting in its consolidation. As CCBA met the criteria for held for sale upon consolidation, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements. Revenue Recognition Our Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price charged is fixed or determinable, and collectibility is reasonably assured. For our Company, this generally means that we recognize revenue when title to our products is transferred to our bottling partners, resellers or other customers. In particular, title usually transfers upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of the transactions. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part. Deductions from Revenue Our customers can earn certain incentives including, but not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. The costs associated with these incentives are included in deductions from revenue, a component of net operating revenues in our consolidated statements of income. For customer incentives that must be earned, management must make estimates related to the contractual terms, customer performance and sales volume to determine the total amounts earned and to be recorded in deductions from revenue. In making these estimates, management considers past results. The actual amounts ultimately paid may be different from our estimates. In some situations, the Company may determine it to be advantageous to make advance payments to specific customers to fund certain marketing activities intended to generate profitable volume and/or invest in infrastructure programs with our bottlers that are directed at strengthening our bottling system and increasing unit case volume. The Company also makes advance payments to certain customers for distribution rights. The advance payments made to customers are initially capitalized and included in our consolidated balance sheets in prepaid expenses and other assets and noncurrent other assets, depending on the duration of the agreements. The assets are amortized over the applicable periods and included in deductions from revenue. The duration of these agreements typically ranges up to 10 years. Amortization expense for infrastructure programs was $ 36 million , $ 45 million and $ 61 million in 2017 , 2016 and 2015 , respectively. The aggregate deductions from revenue recorded by the Company in relation to these programs, including amortization expense on infrastructure programs, were $ 6.2 billion , $ 6.6 billion and $ 6.8 billion in 2017 , 2016 and 2015 , respectively. Advertising Costs Our Company expenses production costs of print, radio, television and other advertisements as of the first date the advertisements take place. All other marketing expenditures are expensed in the annual period in which the expenditure is incurred. Advertising costs included in the line item selling, general and administrative expenses in our consolidated statements of income were $4 billion in 2017 , 2016 and 2015 . As of December 31, 2017 and 2016 , advertising and production costs of $ 95 million and $ 113 million , respectively, were primarily recorded in the line item prepaid expenses and other assets in our consolidated balance sheets. For interim reporting purposes, we allocate our estimated full year marketing expenditures that benefit multiple interim periods to each of our interim reporting periods. We use the proportion of each interim period's actual unit case volume to the estimated full year unit case volume as the basis for the allocation. This methodology results in our marketing expenditures being recognized at a standard rate per unit case. At the end of each interim reporting period, we review our estimated full year unit case volume and our estimated full year marketing expenditures in order to evaluate if a change in estimate is necessary. The impact of any changes in these full year estimates is recognized in the interim period in which the change in estimate occurs. Our full year marketing expenditures are not impacted by this interim accounting policy. Shipping and Handling Costs Shipping and handling costs related to the movement of finished goods from manufacturing locations to our sales distribution centers are included in the line item cost of goods sold in our consolidated statements of income. Shipping and handling costs incurred to move finished goods from our sales distribution centers to customer locations are included in the line item selling, general and administrative expenses in our consolidated statements of income. During the years ended December 31, 2017 , 2016 and 2015 , the Company recorded shipping and handling costs of $ 1.1 billion , $2.0 billion and $2.5 billion , respectively, in the line item selling, general and administrative expenses. Our customers do not pay us separately for shipping and handling costs related to finished goods. Net Income Per Share Basic net income per share is computed by dividing net income attributable to shareowners of The Coca-Cola Company by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per share is computed similarly to basic net income per share, except that it includes the potential dilution that could occur if dilutive securities were exercised. Approximately 47 million , 51 million and 27 million stock option awards were excluded from the computations of diluted net income per share in 2017 , 2016 and 2015 , respectively, because the awards would have been antidilutive for the years presented. The following table presents information related to net income from continuing operations and net income from discontinued operations attributable to shareowners of The Coca-Cola Company (in millions): Year Ended December 31, CONTINUING OPERATIONS Net income from continuing operations $ 1,182 $ 6,550 $ 7,366 Less: Net income from continuing operations attributable to noncontrolling interests Net income from continuing operations attributable to shareowners of The Coca-Cola Company $ 1,181 $ 6,527 $ 7,351 DISCONTINUED OPERATIONS Net income from discontinued operations $ $ $ Less: Net income from discontinued operations attributable to noncontrolling interests Net income from discontinued operations attributable to shareowners of The Coca-Cola Company $ $ $ CONSOLIDATED Consolidated net income $ 1,283 $ 6,550 $ 7,366 Less: Net income attributable to noncontrolling interests Net income attributable to shareowners of The Coca-Cola Company $ 1,248 $ 6,527 $ 7,351 Cash Equivalents We classify time deposits and other investments that are highly liquid and have maturities of three months or less at the date of purchase as cash equivalents. We manage our exposure to counterparty credit risk through specific minimum credit standards, diversification of counterparties and procedures to monitor our credit risk concentrations. Short-Term Investments We classify time deposits and other investments that have maturities of greater than three months but less than one year as short-term investments. Investments in Equity and Debt Securities We use the equity method to account for our investments in equity securities if our investment gives us the ability to exercise significant influence over operating and financial policies of the investee. We include our proportionate share of earnings and/or losses of our equity method investees in equity income (loss) net in our consolidated statements of income. The carrying value of our equity investments is reported in equity method investments in our consolidated balance sheets. Refer to Note 6 . We account for investments in companies that we do not control or account for under the equity method either at fair value or under the cost method, as applicable. Investments in equity securities, other than investments accounted for under the equity method, are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as either trading or available-for-sale securities with their cost basis determined by the specific identification method. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in other income (loss) net in our consolidated statements of income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of accumulated other comprehensive income (loss) (""AOCI""), except for the change in fair value attributable to the currency risk being hedged, if applicable, which is included in other income (loss) net in our consolidated statements of income. Trading securities are reported as either marketable securities or other assets in our consolidated balance sheets. Securities classified as available-for-sale are reported as either cash and cash equivalents, marketable securities, other investments or other assets in our consolidated balance sheets, depending on the length of time we intend to hold the investment. Refer to Note 3 . Investments in equity securities that we do not control or account for under the equity method and do not have readily determinable fair values for are accounted for under the cost method. Cost method investments are originally recorded at cost, and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets, and dividend income from cost method investments is reported in the line item other income (loss) net in our consolidated statements of income. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Each reporting period we review all of our investments in equity and debt securities, except for those classified as trading, to determine whether a significant event or change in circumstances has occurred that may have an adverse effect on the fair value of each investment. When such events or changes occur, we evaluate the fair value compared to our cost basis in the investment. We also perform this evaluation every reporting period for each investment for which our cost basis exceeded the fair value. The fair values of most of our investments in publicly traded companies are often readily available based on quoted market prices. For investments in nonpublicly traded companies, management's assessment of fair value is based on valuation methodologies including discounted cash flows, estimates of sales proceeds, and appraisals, as appropriate. We consider the assumptions that we believe hypothetical marketplace participants would use in evaluating estimated future cash flows when employing the discounted cash flow or estimates of sales proceeds valuation methodologies. In the event the fair value of an investment declines below our cost basis, management is required to determine if the decline in fair value is other than temporary. If management determines the decline is other than temporary, an impairment charge is recorded. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. Trade Accounts Receivable We record trade accounts receivable at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. We calculate this allowance based on our history of write-offs, the level of past-due accounts based on the contractual terms of the receivables, and our relationships with, and the economic status of, our bottling partners and customers. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Activity in the allowance for doubtful accounts was as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Net charges to costs and expenses 1 Write-offs (10 ) (10 ) (10 ) Other 2 (11 ) (2 ) (14 ) Balance at end of year $ $ $ 1 The increases in 2016 were primarily related to concentrate sales receivables from our bottling partner in Venezuela. See Hyperinflationary Economies discussion below for additional information. 2 Other includes foreign currency translation adjustments and the impact of reclassifying certain assets to assets held for sale. Refer to Note 2. A significant portion of our net operating revenues and corresponding accounts receivable is derived from sales of our products in international markets. Refer to Note 19 . We also generate a significant portion of our net operating revenues by selling concentrates and syrups to bottlers in which we have a noncontrolling interest. Refer to Note 6 . Inventories Inventories consist primarily of raw materials and packaging (which includes ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Refer to Note 4 . Derivative Instruments Our Company, when deemed appropriate, uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. All derivatives are carried at fair value in our consolidated balance sheets in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The cash flow impact of the Company's derivative instruments is primarily included in our consolidated statements of cash flows in net cash provided by operating activities. Refer to Note 5 . Property, Plant and Equipment Property, plant and equipment are stated at cost. Repair and maintenance costs that do not improve service potential or extend economic life are expensed as incurred. Depreciation is recorded principally by the straight-line method over the estimated useful lives of our assets, which are reviewed periodically and generally have the following ranges: buildings and improvements: 40 years or less; and machinery, equipment and vehicle fleet: 20 years or less. Land is not depreciated, and construction in progress is not depreciated until ready for service. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, including renewals that are deemed to be reasonably assured, or the estimated useful life of the improvement. Depreciation is not recorded during the period in which a long-lived asset or disposal group is classified as held for sale, even if the asset or disposal group continues to generate revenue during the period. Depreciation expense, including the depreciation expense of assets under capital lease, totaled $ 1,131 million , $ 1,575 million and $ 1,735 million in 2017 , 2016 and 2015 , respectively. Amortization expense for leasehold improvements totaled $ 19 million , $ 22 million and $ 18 million in 2017 , 2016 and 2015 , respectively. Certain events or changes in circumstances may indicate that the recoverability of the carrying amount of property, plant and equipment should be assessed, including, among others, a significant decrease in market value, a significant change in the business climate in a particular market, or a current period operating or cash flow loss combined with historical losses or projected future losses. When such events or changes in circumstances are present, we estimate the future cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount exceeds the fair value. We use a variety of methodologies to determine the fair value of property, plant and equipment, including appraisals and discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. Refer to Note 7 . Goodwill, Trademarks and Other Intangible Assets We classify intangible assets into three categories: (1) intangible assets with definite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. We determine the useful lives of our identifiable intangible assets after considering the specific facts and circumstances related to each intangible asset. Factors we consider when determining useful lives include the contractual term of any agreement related to the asset, the historical performance of the asset, the Company's long-term strategy for using the asset, any laws or other local regulations which could impact the useful life of the asset, and other economic factors, including competition and specific market conditions. Intangible assets that are deemed to have definite lives are amortized, primarily on a straight-line basis, over their useful lives, generally ranging from 1 to 20 years. Refer to Note 8 . When facts and circumstances indicate that the carrying value of definite-lived intangible assets may not be recoverable, management assesses the recoverability of the carrying value by preparing estimates of sales volume and the resulting profit and cash flows expected to result from the use of the asset or asset group and its eventual disposition. These estimated future cash flows are consistent with those we use in our internal planning. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount, we recognize an impairment loss. The impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the fair value. We use a variety of methodologies to determine the fair value of these assets, including discounted cash flow models, which are consistent with the assumptions we believe hypothetical marketplace participants would use. We test intangible assets determined to have indefinite useful lives, including trademarks, franchise rights and goodwill, for impairment annually, or more frequently if events or circumstances indicate that assets might be impaired. Our Company performs these annual impairment reviews as of the first day of our third fiscal quarter. We use a variety of methodologies in conducting impairment assessments of indefinite-lived intangible assets, including, but not limited to, discounted cash flow models, which are based on the assumptions we believe hypothetical marketplace participants would use. For indefinite-lived intangible assets, other than goodwill, if the carrying amount exceeds the fair value, an impairment charge is recognized in an amount equal to that excess. The Company has the option to perform a qualitative assessment of indefinite-lived intangible assets, other than goodwill, rather than completing the impairment test. The Company must assess whether it is more likely than not that the fair value of the intangible asset is less than its carrying amount. If the Company concludes that this is the case, it must perform the testing described above. Otherwise, the Company does not need to perform any further assessment. We perform impairment tests of goodwill at our reporting unit level, which is one level below our operating segments. Our operating segments are primarily based on geographic responsibility, which is consistent with the way management runs our business. Our operating segments are subdivided into smaller geographic regions or territories that we sometimes refer to as ""business units."" These business units are also our reporting units. The Bottling Investments operating segment includes all Company-owned or consolidated bottling operations, regardless of geographic location. Generally, each Company-owned or consolidated bottling operation within our Bottling Investments operating segment is its own reporting unit. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination. In order to test for goodwill impairment, the Company compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is lower than its carrying amount, goodwill is written down for the amount by which the carrying amount exceeds the fair value. However, the loss recognized cannot exceed the carrying amount of goodwill. We typically use discounted cash flow models to determine the fair value of a reporting unit. The assumptions used in these models are consistent with those we believe a hypothetical marketplace participant would use. The Company has the option to perform a qualitative assessment of goodwill in order to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill and other intangible assets. If the Company concludes that this is the case, it must perform the testing discussed above. Otherwise, the Company does not need to perform any further testing. Impairment charges related to intangible assets, including goodwill, are generally recorded in the line item other operating charges or, to the extent they relate to equity method investees, in the line item equity income (loss) net in our consolidated statements of income. Contingencies Our Company is involved in various legal proceedings and tax matters. Due to their nature, such legal proceedings and tax matters involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Refer to Note 11 . Stock-Based Compensation Our Company sponsors equity plans that provide for the grant of awards including stock options, restricted stock units, restricted stock and performance share units. The fair value of our stock option grants is estimated on the grant date using a Black-Scholes-Merton option-pricing model. The Company recognizes compensation expense on a straight-line basis over the period the grant is earned by the employee, generally four years . The fair value of our restricted stock units, restricted stock and certain performance share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. For most performance share units granted beginning in 2014, the Company includes a relative total shareowner return (""TSR"") modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance share units that include the TSR modifier is determined using a Monte Carlo valuation model. In the period it becomes probable that the minimum performance criteria specified in the performance share award will be achieved, we recognize expense for the proportionate share of the total fair value of the award related to the vesting period that has already lapsed. The remaining fair value of the award is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance criteria specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. The Company has made a policy election to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. Forfeiture estimates are trued-up through the vesting date, in order to ensure that total compensation expense is recognized only for those awards that ultimately vest. Refer to Note 12 . Pension and Other Postretirement Benefit Plans Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates and participate in multi-employer pension plans in the United States. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. Refer to Note 13 . Income Taxes Income tax expense includes U.S., state, local and international income taxes, plus a provision for U.S. taxes on undistributed earnings of foreign subsidiaries and other prescribed foreign entities not deemed to be indefinitely reinvested. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the financial reporting basis and the tax basis of existing assets and liabilities. The tax rate used to determine the deferred tax assets and liabilities is the enacted tax rate for the year and manner in which the differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets to the amount that will more likely than not be realized. The Company records taxes that are collected from customers and remitted to governmental authorities on a net basis in our consolidated statements of income. The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 11 and Note 14 . Translation and Remeasurement We translate the assets and liabilities of our foreign subsidiaries from their respective functional currencies to U.S. dollars at the appropriate spot rates as of the balance sheet date. Generally, our foreign subsidiaries use the local currency as their functional currency. Changes in the carrying value of these assets and liabilities attributable to fluctuations in spot rates are recognized in foreign currency translation adjustment, a component of AOCI. Refer to Note 15 . Income statement accounts are translated using the monthly average exchange rates during the year. Monetary assets and liabilities denominated in a currency that is different from a reporting entity's functional currency must first be remeasured from the applicable currency to the legal entity's functional currency. The effect of this remeasurement process is recognized in the line item other income (loss) net in our consolidated statements of income and is partially offset by the impact of our economic hedging program for certain exposures on our consolidated balance sheets. Refer to Note 5 . Hyperinflationary Economies A hyperinflationary economy is one that has cumulative inflation of 100 percent or more over a three-year period. In accordance with U.S. GAAP, local subsidiaries in hyperinflationary economies are required to use the U.S. dollar as their functional currency and remeasure the monetary assets and liabilities not denominated in U.S. dollars using the rate applicable to conversion of a currency for purposes of dividend remittances. All exchange gains and losses resulting from remeasurement are recognized currently in income. Venezuela has been designated as a hyperinflationary economy. In February 2015, the Venezuelan government introduced a new open market exchange rate system, SIMADI. As a result, we remeasured the net monetary assets of our Venezuelan subsidiary, resulting in a charge of $27 million recorded in the line item other income (loss) net in our consolidated statement of income. During the year ended December 31, 2016 , the Venezuelan government devalued its currency and changed its official and most preferential exchange rate, which should be used for purchases of certain essential goods, to 10 bolivars per U.S. dollar from 6.3 . The official and most preferential rate is now known as DIPRO and the former official rate has been eliminated. The Venezuelan government replaced the SIMADI rate with the DICOM rate, which is allowed to float freely and is expected to fluctuate based on supply and demand. As a result, management determined that the DICOM rate was the most appropriate legally available rate to remeasure the net monetary assets of our Venezuelan subsidiary. In addition, we sell concentrate to our bottling partner in Venezuela from outside the country. These sales are denominated in U.S. dollars. During the years ended December 31, 2016 and December 31, 2015 , as a result of the continued lack of liquidity and our revised assessment of the U.S. dollar value we expect to realize upon the conversion of Venezuelan bolivars into U.S. dollars by our bottling partner to pay our concentrate sales receivables, we recorded write-downs of $76 million and $56 million , respectively. These write-downs were recorded in the line item other operating charges in our consolidated statements of income. We also have certain U.S. dollar-denominated intangible assets associated with products sold in Venezuela. As a result of weaker sales, the volatility of foreign currency exchange rates resulting from continued instability and the Company's revised expectations regarding the convertibility of the local currency, we recognized impairment charges of $34 million and $55 million during the years ended December 31, 2017 and December 31, 2015 , respectively. These charges were recorded in the line item other operating charges in our consolidated statements of income. As a result of these impairment charges, the remaining carrying value of all U.S. dollar-denominated intangible assets associated with products sold in Venezuela is zero. Refer to Note 19 for the impact these items had on our operating segments. Recently Issued Accounting Guidance In May 2014, the Financial Accounting Standards Board (""FASB"") issued Accounting Standards Update (""ASU"") 2014-09, Revenue from Contracts with Customers , which will replace most existing revenue recognition guidance in U.S. GAAP and is intended to improve and converge with international standards the financial reporting requirements for revenue from contracts with customers. The core principle of ASU 2014-09 is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. ASU 2014-09 also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments. ASU 2014-09 allows for adoption either on a full retrospective basis to each prior reporting period presented or on a modified retrospective basis with the cumulative effect of initially applying the new guidance recognized at the date of initial application, which will be effective for the Company beginning January 1, 2018. The Company will adopt ASU 2014-09 and its amendments on a modified retrospective basis. We have closely assessed the new guidance, including the interpretations by the FASB Transition Resource Group for Revenue Recognition, throughout 2017. We have concluded that ASU 2014-09's broad definition of variable consideration will require the Company to estimate and record certain variable payments resulting from collaborative funding arrangements, rebates and other pricing allowances earlier than it currently does. While we do not expect this change to have a material impact on our net operating revenues on an annual basis, as revenue recognized from the sale of concentrate and finished goods occurs at a point in time when goods are transferred to the customer and the transfer of control is determined, we do expect that it will have an impact on our revenue in interim periods. The cumulative-effect adjustment upon adoption of the new revenue recognition standard as of January 1, 2018 is comprised primarily of the Company's estimated variable consideration and is expected to decrease the opening balance of retained earnings by less than $350 million , net of tax. As a result of electing certain of the practical expedients available under the ASU, the Company expects there will be some reclassifications to or from net operating revenues, cost of goods sold, and selling, general and administrative expenses, primarily related to the classification of shipping and handling costs. Additionally, the provisions of the new guidance provided clarification relating to the classification of certain costs incurred relating to revenue arrangements with customers. As a result, we will be classifying certain amounts in cost of goods sold or selling, general and administrative expenses that were previously classified as reductions in net operating revenues. The Company also evaluated the principal versus agent considerations as it relates to certain of its arrangements with third-party manufacturers and co-packers. We concluded that certain costs from these arrangements will be reflected in net operating revenues rather than in cost of goods sold. These changes will have no impact on the Company's consolidated operating income. The Company has also identified and implemented changes to our accounting policies and practices, business processes, systems and controls, as well as designed and implemented specific controls over our evaluation of the impact of the new guidance on the Company, including the cumulative effect calculation, disclosure requirements and the collection of relevant data into the reporting process. While we are substantially complete with the process of quantifying the impacts that will result from applying the new guidance, our assessment will be finalized during the first quarter of 2018. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes . The amendments in this update are intended to simplify the presentation of deferred income taxes and require that deferred tax liabilities and assets be classified as noncurrent in a consolidated statement of financial position. The standard was prospectively adopted by the Company on January 1, 2017. Had the Company retrospectively adopted the standard as of December 31, 2016, the line items prepaid expenses and other assets and accounts payable and accrued expenses in our consolidated balance sheet would have been reduced by $80 million and $692 million , respectively, as a result of reclassifying the current deferred tax assets and liabilities. The offsetting impact for the reclassifications as of December 31, 2016 would have increased the noncurrent line items other assets and deferred income taxes in our consolidated balance sheet by $54 million and $666 million , respectively. In January 2016, the FASB issued ASU 2016-01, Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities , which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. The amendment will be effective for the Company beginning January 1, 2018 and will require us to recognize any changes in the fair value of certain equity investments in net income. These changes are currently recognized in other comprehensive income (""OCI""). We have evaluated the impact of this standard and will recognize a cumulative effect adjustment to the opening balance of retained earnings as of January 1, 2018. We expect this cumulative effect adjustment to increase retained earnings by approximately $425 million . In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize right-of-use assets, representing their right to use the underlying asset for the lease term, and lease liabilities on the balance sheet for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The Company has initiated its plan for the adoption and implementation of this new accounting standard, including assessing our lease arrangements, evaluating practical expedient and accounting policy elections, and implementing software to meet the reporting requirements of this standard. The Company is also in the process of identifying changes to our business processes and controls to support adoption of the new standard. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019. The Company anticipates the adoption of this new standard to result in a significant increase in lease-related assets and liabilities on our consolidated balance sheets. The impact on the Company's consolidated statements of income is being evaluated. As the impact of this standard is non-cash in nature, we do not anticipate its adoption having an impact on the Company's consolidated statement of cash flows. In March 2016, the FASB issued ASU 2016-09, Compensation Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. The Company adopted ASU 2016-09 on January 1, 2017 by prospectively recognizing excess tax benefits and tax deficiencies in our consolidated statement of income as the awards vested or were settled. Effective January 1, 2017, the Company also prospectively presented excess tax benefits as an operating activity, rather than a financing activity, in our consolidated statement of cash flows. Had these changes been required to be adopted retrospectively, during the years ended December 31, 2016 and December 31, 2015 , the Company would have recognized an additional $130 million and $95 million , respectively, of excess tax benefits in our consolidated statements of income. Additionally, during the years ended December 31, 2016 and December 31, 2015 , the Company would have reduced our financing activities and increased our operating activities by $130 million and $95 million , respectively, in our consolidated statements of cash flows. The Company has elected, consistent with past practice, to estimate the number of awards that are expected to vest to determine the amount of stock-based compensation expense recognized in earnings. In June 2016, the FASB issued ASU 2016-13, Financial Instruments Measurement of Credit Losses on Financial Instruments , which requires measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for the Company beginning January 1, 2020 and we are currently evaluating the impact that it will have on our consolidated financial statements. In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments , which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 is effective for the Company beginning January 1, 2018 and will be applied using the retrospective transition approach to all periods presented. We expect that the only impact of the adoption of ASU 2016-15 on our consolidated statement of cash flows will be the change in presentation related to our proceeds from the settlement of corporate-owned life insurance policies. We currently reflect these proceeds in operating activities, however upon adoption of the new standard, we will reflect these proceeds in investing activities. In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory , which requires the Company to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for the Company beginning January 1, 2018 and will be applied using a modified retrospective basis. We currently expect the cumulative-effect adjustment will result in a net deferred tax asset of approximately $2.8 billion . This amount will primarily be recorded as a deferred tax asset in the line item other assets in our consolidated balance sheet. In November 2016, the FASB issued ASU 2016-18, Restricted Cash . The amendments in this update address diversity in practice that exists in the classification and presentation of changes in restricted cash and require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts that an entity defines as restricted cash for purposes of this standard or otherwise does not present in the line item cash and cash equivalents on its balance sheet. ASU 2016-18 is effective for the Company beginning January 1, 2018 and is required to be applied using a retrospective transition method to all periods presented. We expect that adoption of ASU 2016-18 will change how we report changes in cash within our insurance captives and assets held for sale in our consolidated statement of cash flows. In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business , which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is required to be applied prospectively and will be effective for the Company beginning January 1, 2018. The impact on our consolidated financial statements will depend on the facts and circumstances of any specific future transactions. In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost , which requires that the service cost component of the Company's net periodic pension cost and net periodic postretirement benefit cost be included in the same line item as other compensation costs arising from services rendered by employees, with the non-service cost components of net periodic benefit cost being classified outside of a subtotal of income from operations. Of the components of net periodic benefit cost, only the service cost component will be eligible for asset capitalization. ASU 2017-07 is effective for the Company beginning January 1, 2018 and is required to be applied retrospectively for all periods presented. We will elect to use the practical expedient which allows entities to use information previously disclosed in their pension and other postretirement benefit plans note as the estimation basis to apply the retrospective presentation requirements in this ASU. For the years ended December 31, 2017 and 2016 , we expect to reclassify $99 million and $31 million , respectively, related to our non-service cost components of net periodic benefit cost and other benefit plan charges from operating income to other income (loss) net in our consolidated statements of income. In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities , which eliminates the requirement to separately measure and report hedge ineffectiveness and requires companies to recognize all elements of hedge accounting that impact earnings in the same income statement line item where the hedged item resides. The amendments include new alternatives for measuring the hedged item for fair value hedges of interest rate risk and ease the requirements for effectiveness testing, hedge documentation and applying the critical terms match method. Finally, the standard introduces new alternatives that permit companies to reduce the risk of material error if the shortcut method is misapplied. ASU 2017-12 is effective for the Company beginning January 1, 2019 and is required to be applied prospectively. The Company is currently evaluating the impact that ASU 2017-12 will have on our consolidated financial statements. NOTE 2 : ACQUISITIONS AND DIVESTITURES Acquisitions During 2017 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $3,900 million , of which $3,150 million related to the transition of ABI's 54.5 percent controlling interest in CCBA to the Company, resulting in its consolidation in October 2017. The financial position and results of operations of CCBA are being accounted for as a discontinued operation. Refer to the ""Discontinued Operations"" section within this note below for further details. Additionally, in conjunction with the refranchising of Coca-Cola Refreshments' (""CCR"") Southwest operating unit (""Southwest Transaction""), we obtained an equity interest in AC Bebidas, S. de R.L. de C.V. (""AC Bebidas""), a subsidiary of Arca Continental, S.A.B. de C.V. (""Arca""), primarily for non-cash consideration. Refer to the ""North America Refranchising"" section within this note below for further details. The remaining activity primarily related to the acquisition of AdeS, a plant-based beverage business, by the Company and several of its bottling partners in Latin America, and the acquisition of the U.S. rights to the Topo Chico premium sparkling water brand from AC Bebidas, an equity method investee. During 2016 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $838 million , which primarily related to our acquisition of Xiamen Culiangwang Beverage Technology Co., Ltd. (""China Green""), a maker of plant-based protein beverages in China, and a minority investment in CHI Limited (""CHI""), a Nigerian producer of value-added dairy and juice beverages, which is accounted for under the equity method of accounting. Under the terms of the agreement for our investment in CHI, the Company is obligated to acquire the remaining ownership interest from the existing shareowners in 2019 based on an agreed-upon formula. During 2015 , our Company's acquisitions of businesses, equity method investments and nonmarketable securities totaled $ 2,491 million , which primarily related to our strategic partnership with Monster Beverage Corporation (""Monster"") and an investment in a bottling partner in Indonesia that is accounted for under the equity method of accounting. The bottling partner in Indonesia is a subsidiary of Coca-Cola Amatil Limited, an equity method investee. We also acquired the remaining outstanding shares of a bottling partner in South Africa (""South African bottler""), which was previously accounted for as an equity method investment. We remeasured our previously held equity interest in the South African bottler to fair value upon the close of the transaction and recorded a loss on the remeasurement of $19 million during the year ended December 31, 2015. This bottler was deconsolidated in conjunction with the Coca-Cola Beverages Africa Proprietary Limited transaction discussed further below. Monster Beverage Corporation In June 2015, the Company and Monster entered into a long-term strategic relationship in the global energy drink category (""Monster Transaction""). As a result of the Monster Transaction, (1) the Company purchased newly issued shares of Monster common stock representing approximately 17 percent of the outstanding shares of Monster common stock (after giving effect to the new issuance); (2) the Company sold its global energy drink business (including NOS, Full Throttle, Burn, Mother, Play and Power Play, and Relentless) to Monster, and the Company acquired Monster's non-energy drink business (including Hansen's Natural Sodas, Peace Tea, Hubert's Lemonade and Hansen's Juice Products); and (3) the parties amended their distribution coordination agreements to expand distribution of Monster products into additional territories pursuant to long-term agreements with the Company's existing network of Company-owned or -controlled bottling operations and independent distribution partners. The Company and its bottling partners (""Coca-Cola system"") also became Monster's preferred global distribution partner. The Company made a net cash payment of $2,150 million to Monster, of which $125 million was originally held in escrow, subject to release upon achievement of milestones relating to the transfer of Monster's domestic distribution rights to our distribution network. The $125 million originally held in escrow was transferred to Monster in 2017 upon achievement of the related milestones. The Monster Transaction consisted of multiple elements including the purchase of common stock, the acquisition and divestiture of businesses and the expansion of distribution territories. When consideration transferred is not solely in the form of cash, measurement is based on either the cost to the acquiring entity (the fair value of the assets given) or the fair value of the assets acquired, whichever is more clearly evident and, thus, more reliably measurable. As the majority of the consideration transferred was cash, we believe the fair value of the consideration transferred is more reliably measurable. The consideration transferred consists of $2,150 million of cash (including $125 million initially held in escrow) and the fair value of our global energy business of $2,046 million , which we determined using discounted cash flow analyses, resulting in total consideration transferred of $4,196 million . As such, we have allocated the total consideration transferred to the individual assets and business acquired based on a relative fair value basis, using the closing date fair values of each element, as follows (in millions): June 12, 2015 Equity investment in Monster $ 3,066 Expansion of distribution territories 1,035 Monster non-energy drink business Total assets and business acquired $ 4,196 In addition to our ownership interest in Monster's outstanding common stock, the Company is represented by two directors on Monster's 10 member Board of Directors. Based on our equity ownership percentage, the significance that our expanded distribution and coordination agreements have on Monster's operations, and our representation on Monster's Board of Directors, the Company is accounting for its interest in Monster as an equity method investment. As a result of the Monster Transaction, the North America Coca-Cola system obtained the right to distribute Monster products in territories for which it was not previously the authorized distributor (""expanded territories""). These distribution rights are governed by an agreement with an initial term of 20 years , after which it will continue to remain in effect unless otherwise terminated by either party, and there are no future costs of renewal. As such, these rights were determined to be indefinite-lived intangible assets and were classified in the line item bottlers' franchise rights with indefinite lives on our consolidated balance sheet. At the time of the Monster Transaction, CCR was the distributor in the majority of the expanded territories. The remainder of the territories were serviced by independent bottling partners. Of the $1,035 million allocated to the expanded distribution rights, the Company derecognized $341 million related to the expanded territories serviced by the independent bottling partners upon the close of the transaction. As consideration for these rights, the Company received an upfront payment of $28 million related to these territories, and we will receive a payment per case on all future sales made by these independent bottlers for the duration of the distribution agreements. As these payments are dependent on future sales, they are a form of contingent consideration. We elected to account for this consideration in the same manner as the contingent consideration to be received in the North America refranchising, discussed below. This resulted in a net loss of $313 million recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2015. During the year ended December 31, 2015, the Company recognized a gain of $1,715 million on the sale of our global energy drink business, primarily due to the difference in the recorded carrying value of the assets transferred, including an allocated portion of goodwill, compared to the value of the total assets and business acquired. After considering the loss resulting from the derecognition of the expanded territory rights serviced by the independent bottling partners, the net gain recognized on the Monster Transaction was $1,403 million , which was recorded in the line item other income (loss) net in our consolidated statement of income. Additionally, under the terms of the Monster Transaction, we were required to discontinue selling energy products under certain trademarks, including one trademark in the glacau portfolio. The Company recognized an impairment charge of $380 million upon closing, primarily related to the discontinuation of the energy products in the glacau portfolio, which was recorded in the line item other operating charges in our consolidated statement of income. During the year ended December 31, 2015, based on the relative fair values of the total assets and business acquired, $1,620 million of the $2,150 million cash payment made was classified in the line item acquisitions of businesses, equity method investments and nonmarketable securities in our consolidated statement of cash flows. The remaining $530 million was classified in the line item other investing activities in our consolidated statement of cash flows. Divestitures During 2017 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $3,821 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America and our China bottling operations. During 2016 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $1,035 million , primarily related to proceeds from the refranchising of certain of our bottling territories in North America. During 2015 , proceeds from disposals of businesses, equity method investments and nonmarketable securities totaled $565 million , which included proceeds from the refranchising of certain of our bottling territories in North America and proceeds from the sale of a 10 percent interest in a Brazilian bottling partner as a result of the majority owners exercising their right to acquire additional shares from us. North America Refranchising In conjunction with implementing a new beverage partnership model in North America, the Company refranchised bottling territories that were previously managed by CCR to certain of our unconsolidated bottling partners. These territories generally border these bottlers' existing territories, allowing each bottler to better service local customers and provide more efficient execution. By entering into comprehensive beverage agreements (""CBAs"") with each of the bottlers, we granted certain exclusive territory rights for the distribution, promotion, marketing and sale of Company-owned and licensed beverage products as defined by the CBA. Each CBA generally has a term of 10 years and is renewable, in most cases by the bottler and in some cases by the Company, indefinitely for successive additional terms of 10 years each. Under the CBA, except for the CBA entered into in conjunction with the Southwest Transaction and for additional territories sold to AC Bebidas, the bottlers will make ongoing quarterly payments to the Company based on their gross profit in the refranchised territories throughout the term of the CBA, including renewals, in exchange for the grant of the exclusive territory rights. Liberty Coca-Cola Beverages, the co-owners of which are former management of CCR, will make ongoing quarterly payments based on the gross profit in its refranchised territories upon the earlier of reaching a predefined level of profitability, or the 41 st quarter following the closing date. Contemporaneously with the grant of these rights, the Company sold the distribution assets, certain working capital items, and the exclusive rights to distribute certain beverage brands not owned by the Company, but distributed by CCR, in each of these territories, excluding the territory included in the Southwest Transaction, to the respective bottlers in exchange for cash. In 2016, the Company formed a new National Product Supply System (""NPSS"") to facilitate optimal operation of the U.S. product supply system. Under the NPSS, the Company and several of its existing independent producing bottlers administer key national product supply activities for these bottlers. Additionally, we have sold certain production facilities from CCR to these independent producing bottlers in exchange for cash, excluding production facilities included in the Southwest Transaction. During the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , cash proceeds from these sales totaled $2,860 million , $1,017 million and $362 million , respectively. Included in the cash proceeds for the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 was $336 million , $279 million and $83 million , respectively, from Coca-Cola Bottling Co. Consolidated (""CCBCC""), an equity method investee. Also included in the cash proceeds for the year ended December 31, 2017, was $220 million from AC Bebidas, and $39 million from Liberty Coca-Cola Beverages. Under the applicable accounting guidance, we were required to derecognize all of the tangible assets sold as well as the intangible assets transferred, including distribution rights, customer relationships and an allocated portion of goodwill related to these territories. We recognized losses of $3,177 million , $2,456 million and $1,006 million during the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , respectively. Included in these amounts are losses from transactions with equity method investees or former management of $1,104 million , $492 million and $379 million , during the years ended December 31, 2017 , December 31, 2016 and December 31, 2015 , respectively. These losses primarily related to the derecognition of the intangible assets transferred or reclassified as held for sale and were included in the line item other income (loss) net in our consolidated statements of income. The losses in 2017 included $236 million of expense associated with an indemnification liability related to an underfunded multi-employer benefit plan in which employees of certain of its refranchised territories participate. As of December 31, 2017, CCR had completed the refranchising of its U.S. bottling operations, with the exception of its operations in the U.S. Virgin Islands, which are classified as held for sale. See further discussion of assets and liabilities held for sale below. In total, we expect to recover the value of the intangible assets transferred to the bottlers under the CBAs through the future quarterly payments; however, as the payments for the territory rights are dependent on the bottlers' future gross profit in these territories, they are considered a form of contingent consideration. There is diversity in practice as it relates to the accounting for contingent consideration by the seller. The seller can account for the future contingent payments received as a gain contingency, recognizing the amounts in the income statement only after the related contingencies are resolved and the gain is realized, which in this arrangement will be quarterly as the bottlers earn gross profit in the transferred territories. Alternatively, the seller can record a receivable for the contingent consideration at fair value on the date of sale and record any future differences between the payments received and this receivable in the income statement as they occur. We elected the gain contingency treatment since the quarterly payments will be received throughout the terms of the CBAs, including all subsequent renewals, regardless of the cumulative amount received as compared to the value of the intangible assets transferred. During the years ended December 31, 2017 and December 31, 2016 , the Company incurred losses of $313 million and $31 million , respectively, primarily related to payments made to certain of our unconsolidated bottling partners in order to convert the bottling agreements for their legacy territories and any previously refranchised territories to a single form of CBA with additional requirements. The additional requirements generally include a binding national governance model, mandatory incidence pricing and additional core performance requirements, among other things. As a result of these conversions, the legacy territories and any previously refranchised territories for each of the related bottling partners will be governed under similar CBAs, which will provide consistency across each such bottler's respective territory, and consistency with other U.S. bottlers that have been granted or converted to this form of CBA. The losses related to these payments were included in the line item other income (loss) net in our consolidated statements of income during the years ended December 31, 2017 and December 31, 2016 . On April 1, 2017, the Company refranchised the Southwest operating unit of CCR, which includes Texas and parts of Oklahoma, New Mexico and Arkansas, in the Southwest Transaction. In conjunction with the Southwest Transaction, Arca contributed its existing beverage business to AC Bebidas. CCR contributed its Southwest operating unit, including all of its assets and liabilities, to AC Bebidas in exchange for an approximate 20 percent interest in AC Bebidas. Arca owns the remaining interest in AC Bebidas. Additionally, CCR made cash payments of $144 million , net of cash received. As a result of the Southwest Transaction, the Company recognized a gain of $1,037 million due to the difference in the recorded carrying value of the net assets transferred compared to the value of the interest it obtained in AC Bebidas of $2,960 million , which was determined using an income and market approach (a Level 3 measurement). This gain was recorded in the line item other income (loss) net in our consolidated statement of income. AC Bebidas will participate in the NPSS as it relates to its U.S. territory. The Company accounts for its interest in AC Bebidas as an equity method investment based on our equity ownership percentage, our representation on AC Bebidas' Board of Directors, material intercompany transactions and other governance rights. Refer to Note 19 for the impact these items had on our operating segments. Refranchising of China Bottling Operations In November 2016, the Company entered into definitive agreements for the sale of the Company-owned bottling operations in China to the two existing local franchise bottlers, one of which is an equity method investee, and to sell a related cost method investment to one of the franchise bottlers. As a result, the Company's bottling operations in China and a related cost method investment were classified as held for sale as of December 31, 2016. We received net proceeds of $963 million as a result of these sales and recognized a gain of $88 million during the year ended December 31, 2017, which was included in the line item other income (loss) net in our consolidated statement of income. Coca-Cola European Partners In May 2016, the Company merged our German bottling operations with Coca-Cola Enterprises, Inc. (""CCE"") and Coca-Cola Iberian Partners, S.A.U., formerly known as Coca-Cola Iberian Partners, S.A. (""CCIP""), to create Coca-Cola European Partners plc (""CCEP""). In exchange for our German bottling operations, we received an 18 percent interest in CCEP. As a result of recording our interest in CCEP at fair value based on its quoted market price (a Level 1 measurement), the deconsolidation of our German bottling operations, and the related reversal of its cumulative translation adjustments, we recognized a gain of $1,400 million . This gain was partially offset by a $77 million loss incurred as a result of reclassifying losses related to our net investment hedges of our German bottling operations from AOCI into earnings as well as transaction costs incurred resulting in a net gain of $1,287 million during the year ended December 31, 2016 . Refer to Note 15. With the exception of the transaction costs, the net gain was recorded in the line item other income (loss) net in our consolidated statement of income. The Company accounts for its interest in CCEP as an equity method investment based on our equity ownership percentage, our representation on CCEP's Board of Directors, material intercompany transactions and other governance rights. Coca-Cola Beverages Africa Proprietary Limited In July 2016, the Company, SABMiller plc and Gutsche Family Investments combined the bottling operations of each of the parties' nonalcoholic ready-to-drink beverage businesses in Southern and East Africa to form a new bottler, which is called CCBA. The Company: (1) contributed its South African bottling operations to CCBA, which included certain wholly owned subsidiaries and an equity method investment, (2) paid $150 million in cash, (3) obtained a 12 percent interest in CCBA and a 3 percent interest in CCBA's South African subsidiary and (4) acquired several trademarks that are generally indefinite-lived. As a result of recording our interests in CCBA and its South African subsidiary at fair value, the deconsolidation of our South African bottling operations, the derecognition of the equity method investment, and the reversal of related cumulative translation adjustments, we recognized a loss of $21 million . The fair values of the equity investments in CCBA and CCBA's South African subsidiary, along with the acquired trademarks, were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. The loss recognized resulted primarily from the reversal of the related cumulative translation adjustments. This loss is recorded in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016 . Based on the level of equity ownership, the Company's representation on CCBA's Board of Directors (two of its ten members) and other governance rights, the Company accounted for its interests in CCBA and CCBA's South African subsidiary as equity method investments. The Company's interest in CCBA provided it with a call option to acquire the ownership interest of SABMiller plc at fair value upon the occurrence of certain events, including upon a change in control of SABMiller plc. In October 2016, ABI acquired SABMiller plc, including its 54.5 percent controlling interest in CCBA. In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily and are currently in discussions with several potential buyers. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of acquisition. See further discussion of discontinued operations below. Keurig Green Mountain, Inc. In 2014, the Company purchased a 12 percent equity position in Keurig Green Mountain, Inc. (""Keurig"") for $1,567 million . In February 2015, the Company purchased an additional 4 percent ownership interest from Credit Suisse Capital LLC under an agreement for a total purchase price of $830 million . As this agreement qualified as a derivative, we recognized a loss of $58 million in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2015. The purchases of the shares were included in the line item purchases of investments in our consolidated statement of cash flows, net of any related derivative impact. The Company accounted for the investment in Keurig as an available-for-sale security. In March 2016, a JAB Holding Company-led investor group acquired Keurig. The Company received proceeds of $2,380 million , which were recorded in the line item proceeds from disposals of investments in our consolidated statement of cash flows, and recorded a gain of $18 million related to the disposal of our shares of Keurig in the line item other income (loss) net in our consolidated statement of income during the year ended December 31, 2016 . Brazilian Bottling Operations In January 2015, the owners of the majority interest in a Brazilian bottling operation exercised their option to acquire from us shares representing a 10 percent interest in the entity's outstanding shares. We recorded a loss of $6 million as a result of the exercise price being lower than our carrying value of these shares. As a result of this transaction, the Company's ownership was reduced to 34 percent of the entity's outstanding shares. The owners of the majority interest have a remaining option to acquire an additional 14 percent interest of the entity's outstanding shares at any time through December 31, 2019, based on an agreed-upon formula. Assets and Liabilities Held for Sale As of December 31, 2017 , the Company had entered into agreements to refranchise its U.S. Virgin Islands bottling territories. As these bottling territories met the criteria to be classified as held for sale, we were required to record their assets and liabilities at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price and present the related assets and liabilities as separate line items in our consolidated balance sheet. These bottling territories were refranchised in January 2018. In addition, the Company had certain bottling operations in Latin America that met the criteria to be classified as held for sale, which requires us to present the related assets and liabilities as separate line items in our consolidated balance sheet. We were not required to record these assets and liabilities at fair value less any costs to sell because their fair value approximates their carrying value. The Company expects these operations to be refranchised during 2018. The following table presents information related to the major classes of assets and liabilities that were classified as held for sale in our consolidated balance sheets (in millions): December 31, 2017 December 31, 2016 Cash, cash equivalents and short-term investments $ $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Equity method investments Other investments Other assets Property, plant and equipment net 1,780 Bottlers' franchise rights with indefinite lives 1,388 Goodwill Other intangible assets Allowance for reduction of assets held for sale (28 ) (1,342 ) Assets held for sale $ 1 $ 2,797 3 Accounts payable and accrued expenses $ $ Accrued income taxes Other liabilities Deferred income taxes Liabilities held for sale $ 2 $ 4 1 Consists of total assets relating to North America refranchising of $9 million and Latin America bottling operations of $210 million , which are included in the Bottling Investments operating segment. 2 Consists of total liabilities relating to North America refranchising of $5 million and Latin America bottling operations of $32 million , which are included in the Bottling Investments operating segment. 3 Consists of total assets relating to North America refranchising of $1,247 million , China bottling operations of $1,533 million and other assets held for sale of $17 million , which are included in the Bottling Investments and Corporate operating segments. 4 Consists of total liabilities relating to North America refranchising of $224 million , China bottling operations of $483 million and other liabilities held for sale of $3 million , which are included in the Bottling Investments and Corporate operating segments. We determined that the operations included in the table above did not meet the criteria to be classified as discontinued operations under the applicable guidance. Discontinued Operations In October 2017, the Company and ABI completed the transition of ABI's controlling interest in CCBA to the Company for $3,150 million . We plan to hold our controlling interest in CCBA temporarily and are currently in discussions with several potential buyers, and anticipate divesting of this interest in 2018. Accordingly, we have presented the financial position and results of operations of CCBA as discontinued operations in the accompanying consolidated financial statements from its date of consolidation. Upon consolidation of CCBA, we remeasured our previously held equity interests in CCBA and its South African subsidiary to fair value and recorded a gain on the remeasurement of $150 million . The fair values in our previously held equity investments in CCBA and its South African subsidiary were determined using income approaches, including discounted cash flow models (a Level 3 measurement), and the Company believes the inputs and assumptions used are consistent with those hypothetical marketplace participants would use. We recorded the noncontrolling interests of CCBA at an estimated fair value of $1,805 million . The fair value of the noncontrolling interests was assessed in a manner similar to our previously held equity investments. The preliminary goodwill recorded at the time of the transaction was $4,262 million , none of which is tax deductible. This goodwill is in part due to the significant synergies that are expected from the consolidation of the bottling system in Southern and East Africa, especially within the country of South Africa. The initial accounting for the business combination is currently incomplete, although preliminary purchase accounting entries have been recorded. The disclosures that are expected to be impacted by the completion of purchase accounting are the classification of assets held for sale discontinued operations and liabilities held for sale discontinued operations in the notes to the consolidated financial statements. The following table presents information related to the major classes of assets and liabilities of CCBA that were classified as held for sale discontinued operations in our consolidated balance sheet (in millions): December 31, 2017 Cash, cash equivalents and short-term investments $ Trade accounts receivable, less allowances Inventories Prepaid expenses and other assets Equity method investments Other assets Property, plant and equipment net 1,436 Goodwill 4,248 Other intangible assets Assets held for sale discontinued operations $ 7,329 Accounts payable and accrued expenses $ Loans and notes payable Current maturities of long-term debt Accrued income taxes Long-term debt Other liabilities Deferred income taxes Liabilities held for sale discontinued operations $ 1,496 NOTE 3 : INVESTMENTS Investments in debt and marketable securities, other than investments accounted for under the equity method, are classified as trading, available-for-sale or held-to-maturity. Our marketable equity investments are classified as either trading or available-for-sale with their cost basis determined by the specific identification method. Our investments in debt securities are carried at either amortized cost or fair value. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are carried at amortized cost and classified as held-to-maturity. Investments in debt securities that are not classified as held-to-maturity are carried at fair value and classified as either trading or available-for-sale. Realized and unrealized gains and losses on trading securities and realized gains and losses on available-for-sale securities are included in net income. Unrealized gains and losses, net of deferred taxes, on available-for-sale securities are included in our consolidated balance sheets as a component of AOCI, except for the change in fair value attributable to the currency risk being hedged. Refer to Note 5 for additional information related to the Company's fair value hedges of available-for-sale securities. Trading Securities As of December 31, 2017 and 2016 , our trading securities had a fair value of $ 407 million and $ 384 million , respectively, and consisted primarily of equity securities. The Company had net unrealized gains on trading securities of $ 67 million , $ 39 million and $ 19 million as of December 31, 2017 , 2016 and 2015 , respectively. The Company's trading securities were included in the following line items in our consolidated balance sheets (in millions): December 31, Marketable securities $ $ Other assets Total $ $ 94 Available-for-Sale and Held-to-Maturity Securities As of December 31, 2017 and 2016 , the Company did not have any held-to-maturity securities. Available-for-sale securities consisted of the following (in millions): Gross Unrealized Estimated Fair Value Cost Gains Losses Available-for-sale securities: 1 Equity securities $ 1,276 $ $ (66 ) $ 1,895 Debt securities 5,782 (27 ) 5,912 Total $ 7,058 $ $ (93 ) $ 7,807 Available-for-sale securities: 1 Equity securities $ 1,252 $ $ (22 ) $ 1,655 Debt securities 4,700 (31 ) 4,758 Total $ 5,952 $ $ (53 ) $ 6,413 1 Refer to Note 16 for additional information related to the estimated fair value. The sale and/or maturity of available-for-sale securities resulted in the following realized activity (in millions): Year Ended December 31, Gross gains $ $ $ Gross losses (32 ) (51 ) (42 ) Proceeds 14,205 11,540 4,043 As of December 31, 2017 and 2016 , the Company had investments classified as available-for-sale securities in which our cost basis exceeded the fair value of our investment. Management assessed each of these investments on an individual basis to determine if the decline in fair value was other than temporary. Management's assessment as to the nature of a decline in fair value is based on, among other things, the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. As a result of these assessments, management determined that the decline in fair value of these investments was not other than temporary and did not record any impairment charges. The Company uses two of its consolidated insurance captives to reinsure group annuity insurance contracts that cover the pension obligations of certain of our European and Canadian pension plans. In accordance with local insurance regulations, our insurance captives are required to meet and maintain minimum solvency capital requirements. The Company elected to invest its solvency capital in a portfolio of available-for-sale securities, which have been classified in the line item other assets in our consolidated balance sheets because the assets are not available to satisfy our current obligations. As of December 31, 2017 and 2016 , the Company's available-for-sale securities included solvency capital funds of $ 1,159 million and $ 985 million , respectively. As of December 31, 2017 and 2016 , the Company did not have any held-to-maturity securities. The Company's available-for-sale securities were included in the following line items in our consolidated balance sheets (in millions): December 31, Cash and cash equivalents $ $ Marketable securities 5,022 3,769 Other investments Other assets 1,165 1,113 Total $ 7,807 $ 6,413 The contractual maturities of these available-for-sale securities as of December 31, 2017 were as follows (in millions): Cost Estimated Fair Value Within 1 year $ 1,433 $ 1,491 After 1 year through 5 years 3,929 3,983 After 5 years through 10 years After 10 years Equity securities 1,276 1,895 Total $ 7,058 $ 7,807 The Company expects that actual maturities may differ from the contractual maturities above because borrowers have the right to call or prepay certain obligations. Cost Method Investments Cost method investments are initially recorded at cost, and we record dividend income when applicable dividends are declared. Cost method investments are reported as other investments in our consolidated balance sheets, and dividend income from cost method investments is reported in other income (loss) net in our consolidated statements of income. We review all of our cost method investments quarterly to determine if impairment indicators are present; however, we are not required to determine the fair value of these investments unless impairment indicators exist. When impairment indicators exist, we generally use discounted cash flow analyses to determine the fair value. We estimate that the fair values of our cost method investments approximated or exceeded their carrying values as of December 31, 2017 and 2016 . Our cost method investments had a carrying value of $ 143 million and $ 140 million as of December 31, 2017 and 2016 , respectively. NOTE 4 : INVENTORIES Inventories consist primarily of raw materials and packaging (which include ingredients and supplies) and finished goods (which include concentrates and syrups in our concentrate operations and finished beverages in our finished product operations). Inventories are valued at the lower of cost or net realizable value. We determine cost on the basis of the average cost or first-in, first-out methods. Inventories consisted of the following (in millions): December 31, Raw materials and packaging $ 1,729 $ 1,565 Finished goods Other Total inventories $ 2,655 $ 2,675 NOTE 5 : HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS The Company is directly and indirectly affected by changes in certain market conditions. These changes in market conditions may adversely impact the Company's financial performance and are referred to as ""market risks."" When deemed appropriate, our Company uses derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary market risks managed by the Company through the use of derivative and non-derivative financial instruments are foreign currency exchange rate risk, commodity price risk and interest rate risk. The Company uses various types of derivative instruments including, but not limited to, forward contracts, commodity futures contracts, option contracts, collars and swaps. Forward contracts and commodity futures contracts are agreements to buy or sell a quantity of a currency or commodity at a predetermined future date, and at a predetermined rate or price. An option contract is an agreement that conveys the purchaser the right, but not the obligation, to buy or sell a quantity of a currency or commodity at a predetermined rate or price during a period or at a time in the future. A collar is a strategy that uses a combination of options to limit the range of possible positive or negative returns on an underlying asset or liability to a specific range, or to protect expected future cash flows. To do this, an investor simultaneously buys a put option and sells (writes) a call option, or alternatively buys a call option and sells (writes) a put option. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. We do not enter into derivative financial instruments for trading purposes. The Company may also designate certain non-derivative instruments, such as our foreign-denominated debt, in hedging relationships. All derivatives are carried at fair value in our consolidated balance sheets, primarily in the following line items, as applicable: prepaid expenses and other assets; other assets; accounts payable and accrued expenses; and other liabilities. The carrying values of the derivatives reflect the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. These master netting agreements allow the Company to net settle positive and negative positions (assets and liabilities) arising from different transactions with the same counterparty. The accounting for gains and losses that result from changes in the fair values of derivative instruments depends on whether the derivatives have been designated and qualify as hedging instruments and the type of hedging relationships. Derivatives can be designated as fair value hedges, cash flow hedges or hedges of net investments in foreign operations. The changes in the fair values of derivatives that have been designated and qualify for fair value hedge accounting are recorded in the same line item in our consolidated statement of income as the changes in the fair values of the hedged items attributable to the risk being hedged. The changes in the fair values of derivatives that have been designated and qualify as cash flow hedges or hedges of net investments in foreign operations are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. Due to the high degree of effectiveness between the hedging instruments and the underlying exposures being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the fair values or cash flows of the underlying exposures being hedged. The changes in the fair values of derivatives that were not designated and/or did not qualify as hedging instruments are immediately recognized into earnings. For derivatives that will be accounted for as hedging instruments, the Company formally designates and documents, at inception, the financial instrument as a hedge of a specific underlying exposure, the risk management objective and the strategy for undertaking the hedge transaction. In addition, the Company formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments used in hedging transactions are effective at offsetting changes in either the fair values or cash flows of the related underlying exposures. Any ineffective portion of a financial instrument's change in fair value is immediately recognized into earnings. The Company determines the fair values of its derivatives based on quoted market prices or pricing models using current market rates. Refer to Note 16 . The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the financial risks described above. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the derivatives, such as interest rates, foreign currency exchange rates, commodity rates or other financial indices. The Company does not view the fair values of its derivatives in isolation but rather in relation to the fair values or cash flows of the underlying hedged transactions or other exposures. Virtually all of our derivatives are straightforward over-the-counter instruments with liquid markets. The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions): Fair Value 1,2 Derivatives Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2017 December 31, 2016 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Interest rate contracts Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Foreign currency contracts Liabilities held for sale discontinued operations Commodity contracts Accounts payable and accrued expenses Commodity contracts Liabilities held for sale discontinued operations Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions): Fair Value 1,2 Derivatives Not Designated as Hedging Instruments Balance Sheet Location 1 December 31, 2017 December 31, 2016 Assets: Foreign currency contracts Prepaid expenses and other assets $ $ Foreign currency contracts Other assets Commodity contracts Prepaid expenses and other assets Commodity contracts Other assets Other derivative instruments Prepaid expenses and other assets Other derivative instruments Other assets Total assets $ $ Liabilities: Foreign currency contracts Accounts payable and accrued expenses $ $ Foreign currency contracts Other liabilities Commodity contracts Accounts payable and accrued expenses Commodity contracts Other liabilities Interest rate contracts Accounts payable and accrued expenses Interest rate contracts Other liabilities Other derivative instruments Accounts payable and accrued expenses Other derivative instruments Other liabilities Total liabilities $ $ 1 All of the Company's derivative instruments are carried at fair value in our consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 16 for the net presentation of the Company's derivative instruments. 2 Refer to Note 16 for additional information related to the estimated fair value. Credit Risk Associated with Derivatives We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal. Cash Flow Hedging Strategy The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in AOCI and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically three years . The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by changes in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options (principally euros and Japanese yen) and collars to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that have been designated and qualify for the Company's foreign currency cash flow hedging program were $ 4,068 million and $ 6,074 million as of December 31, 2017 and 2016 , respectively. The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt due to changes in foreign currency exchange rates. For this hedging program, the Company records the change in carrying value of the foreign currency denominated debt due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. During the year ended December 31, 2015 , the Company discontinued the cash flow hedge relationships related to these swaps. Upon discontinuance, the Company recognized a loss of $92 million in other comprehensive income, which will be reclassified from AOCI into interest expense over the remaining life of the debt, a weighted-average period of approximately 10 years . The Company did not discontinue any cross-currency swaps designated as a cash flow hedge during the years ended December 31, 2017 and 2016 . The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated debt were $1,851 million as of December 31, 2017 and 2016 , respectively. The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that have been designated and qualify for this program were $ 35 million and $ 12 million as of December 31, 2017 and 2016 , respectively. Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. The total notional values of these interest rate swap agreements that were designated and qualified for the Company's interest rate cash flow hedging program were $ 500 million and $ 1,500 million as of December 31, 2017 and 2016 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on AOCI and earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Gain (Loss) Recognized in OCI Location of Gain (Loss) Recognized in Income 1 Gain (Loss) Reclassified from AOCI into Income (Effective Portion) Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing) Foreign currency contracts $ (226 ) Net operating revenues $ $ Foreign currency contracts (23 ) Cost of goods sold (2 ) 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net Foreign currency contracts (3 ) Income from discontinued operations Interest rate contracts (22 ) Interest expense (37 ) Commodity contracts (1 ) Cost of goods sold (1 ) Commodity contracts (5 ) Income from discontinued operations Total $ (188 ) $ $ Foreign currency contracts $ Net operating revenues $ $ (3 ) Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Interest expense (9 ) Foreign currency contracts Other income (loss) net (3 ) (3 ) Interest rate contracts (126 ) Interest expense (17 ) (2 ) Commodity contracts (1 ) Cost of goods sold (1 ) Total $ (37 ) $ $ (9 ) Foreign currency contracts $ Net operating revenues $ $ Foreign currency contracts Cost of goods sold 2 Foreign currency contracts Interest expense (9 ) Foreign currency contracts (38 ) Other income (loss) net (40 ) Interest rate contracts (153 ) Interest expense (3 ) Commodity contracts (1 ) Cost of goods sold (3 ) Total $ $ $ 1 The Company records gains and losses reclassified from AOCI into income for the effective portion and ineffective portion, if any, to the same line items in our consolidated statements of income. 2 Includes a de minimis amount of ineffectiveness in the hedging relationship. As of December 31, 2017 , the Company estimates that it will reclassify into earnings during the next 12 months net gains of $ 93 million from the pretax amount recorded in AOCI as the anticipated cash flows occur. Fair Value Hedging Strategy The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items are recognized in earnings. The ineffective portions of these hedges are immediately recognized into earnings. As of December 31, 2017 , such adjustments had cumulatively increased the carrying value of our long-term debt by $ 4 million . When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured. The total notional values of derivatives that related to our fair value hedges of this type were $ 8,121 million and $ 6,158 million as of December 31, 2017 and 2016 , respectively. The Company also uses fair value hedges to minimize exposure to changes in the fair value of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in fair values of derivatives designated as fair value hedges and the offsetting changes in fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. The total notional values of derivatives that related to our fair value hedges of this type were $ 311 million and $ 1,163 million as of December 31, 2017 and 2016 , respectively. The following table summarizes the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss) Recognized in Income 1 Interest rate contracts Interest expense $ (69 ) Fixed-rate debt Interest expense Net impact to interest expense $ (6 ) Foreign currency contracts Other income (loss) net $ (37 ) Available-for-sale securities Other income (loss) net Net impact to other income (loss) net $ Net impact of fair value hedging instruments $ 2016 Interest rate contracts Interest expense $ Fixed-rate debt Interest expense (152 ) Net impact to interest expense $ Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (73 ) Net impact to other income (loss) net $ (4 ) Net impact of fair value hedging instruments $ 2015 Interest rate contracts Interest expense $ (172 ) Fixed-rate debt Interest expense Net impact to interest expense $ (3 ) Foreign currency contracts Other income (loss) net $ Available-for-sale securities Other income (loss) net (131 ) Net impact to other income (loss) net $ (21 ) Net impact of fair value hedging instruments $ (24 ) 1 The net impacts represent the ineffective portions of the hedge relationships and the amounts excluded from the assessment of hedge effectiveness. Hedges of Net Investments in Foreign Operations Strategy The Company uses forward contracts and non-derivative financial instruments to protect the value of our net investments in a number of foreign operations. During the years ended December 31, 2017 , 2016 and 2015, the Company designated a portion of its euro-denominated debt as a hedge of a net investment in our European operations. The change in the carrying value of the designated portion of the euro-denominated debt due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustment, a component of AOCI. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in fair values of the derivative instruments are recognized in net foreign currency translation adjustment to offset the changes in the values of the net investments being hedged. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change. The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions): Notional Amount Gain (Loss) Recognized in OCI as of December 31, Year Ended December 31, 2016 2016 Foreign currency contracts $ $ $ (7 ) $ (237 ) $ Foreign currency denominated debt 13,147 11,113 (1,505 ) (24 ) Total $ 13,147 $ 11,213 $ (1,512 ) $ $ The Company reclassified net deferred losses of $77 million related to the deconsolidation of our German bottling operations from AOCI into earnings during the year ended December 31, 2016 . The Company did not reclassify any deferred gains or losses related to net investment hedges from AOCI to earnings during the years ended December 31, 2017 and 2015 . In addition, the Company did not have any ineffectiveness related to net investment hedges during the years ended December 31, 2017 , 2016 and 2015 . The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statements of cash flows. Economic (Non-Designated) Hedging Strategy In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in fair value of economic hedges are immediately recognized into earnings. The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in fair value of economic hedges used to offset those monetary assets and liabilities are immediately recognized into earnings in the line item other income (loss) net in our consolidated statements of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates. The changes in fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized into earnings in the line items net operating revenues or cost of goods sold in our consolidated statements of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $ 6,827 million and $ 5,276 million as of December 31, 2017 and 2016 , respectively. The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and for vehicle fuel. The changes in fair values of these economic hedges are immediately recognized into earnings in the line items net operating revenues, cost of goods sold, and selling, general and administrative expenses in our consolidated statements of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $ 357 million and $ 447 million as of December 31, 2017 and 2016 , respectively. The following table presents the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings during the years ended December 31, 2017 , 2016 and 2015 (in millions): Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Year Ended December 31, Foreign currency contracts Net operating revenues $ (30 ) $ (45 ) $ Foreign currency contracts Cost of goods sold (1 ) Foreign currency contracts Other income (loss) net (168 ) (92 ) Commodity contracts Net operating revenues (16 ) Commodity contracts Cost of goods sold (209 ) Commodity contracts Selling, general and administrative expenses (25 ) Interest rate contracts Interest expense (39 ) Other derivative instruments Selling, general and administrative expenses Other derivative instruments Other income (loss) net (15 ) (37 ) Total $ $ (156 ) $ (334 ) NOTE 6 : EQUITY METHOD INVESTMENTS Our consolidated net income includes our Company's proportionate share of the net income or loss of our equity method investees. When we record our proportionate share of net income, it increases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. Conversely, when we record our proportionate share of a net loss, it decreases equity income (loss) net in our consolidated statements of income and our carrying value in that investment. The Company's proportionate share of the net income or loss of our equity method investees includes significant operating and nonoperating items recorded by our equity method investees. These items can have a significant impact on the amount of equity income (loss) net in our consolidated statements of income and our carrying value in those investments. Refer to Note 17 for additional information related to significant operating and nonoperating items recorded by our equity method investees. The carrying values of our equity method investments are also impacted by our proportionate share of items impacting the equity investee's AOCI. We eliminate from our financial results all significant intercompany transactions, including the intercompany portion of transactions with equity method investees. The Company's equity method investments include, but are not limited to, our ownership interests in CCEP, Monster, AC Bebidas, Coca-Cola FEMSA, S.A.B. de C.V. (""Coca-Cola FEMSA""), Coca-Cola HBC AG (""Coca-Cola Hellenic""), and Coca-Cola Bottlers Japan Inc. (""CCBJI""). As of December 31, 2017 , we owned approximately 18 percent , 18 percent , 20 percent , 28 percent , 23 percent , and 17 percent , respectively, of these companies' outstanding shares. As of December 31, 2017 , our investment in our equity method investees in the aggregate exceeded our proportionate share of the net assets of these equity method investees by $ 9,932 million . This difference is not amortized. A summary of financial information for our equity method investees in the aggregate is as follows (in millions): Year Ended December 31, 1 Net operating revenues $ 73,339 $ 58,054 $ 47,498 Cost of goods sold 42,867 34,338 28,749 Gross profit $ 30,472 $ 23,716 $ 18,749 Operating income $ 7,577 $ 5,652 $ 4,483 Consolidated net income $ 4,545 $ 2,967 $ 2,299 Less: Net income attributable to noncontrolling interests Net income attributable to common shareowners $ 4,425 $ 2,889 $ 2,234 Equity income (loss) net $ 1,071 $ $ 1 The financial information represents the results of the equity method investees during the Company's period of ownership. December 31, Current assets $ 25,023 $ 19,586 Noncurrent assets 66,578 58,529 Total assets $ 91,601 $ 78,115 Current liabilities $ 17,890 $ 16,125 Noncurrent liabilities 29,986 25,610 Total liabilities $ 47,876 $ 41,735 Equity attributable to shareowners of investees $ 41,773 $ 35,204 Equity attributable to noncontrolling interests 1,952 1,176 Total equity $ 43,725 $ 36,380 Company equity investment $ 20,856 $ 16,260 Net sales to equity method investees, the majority of which are located outside the United States, were $ 14,144 million , $ 10,495 million and $ 8,984 million in 2017 , 2016 and 2015 , respectively. The increase in net sales to equity method investees in 2017 was primarily due to our acquisition of equity method investments in CCEP and AC Bebidas, as well as the integration of Coca-Cola West Co., Ltd. (""CCW"") and Coca-Cola East Japan Co., Ltd. (""CCEJ"") to establish CCBJI in 2017 . Refer to Note 2. Total payments, primarily marketing, made to equity method investees were $ 930 million , $ 946 million and $ 1,380 million in 2017 , 2016 and 2015 , respectively. In addition, purchases of beverage products from equity method investees were $ 1,298 million , $ 1,857 million and $ 1,131 million in 2017 , 2016 and 2015 , respectively. The decrease in purchases of beverage products in 2017 was primarily due to reduced purchases of Monster products as a result of North America refranchising activities. Refer to Note 2. If valued at the December 31, 2017 quoted closing prices of shares actively traded on stock markets, the value of our equity method investments in publicly traded bottlers would have exceeded our carrying value by $ 8,504 million . However, the carrying value of our investment in CCEP exceeded the fair value of the investment as of December 31, 2017 by $196 million . Based on the length of time and the extent to which the market value has been less than our cost basis; the financial condition and near-term prospects of the issuer; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, management determined that the decline in fair value was temporary in nature. Therefore, we did not record an impairment charge. Net Receivables and Dividends from Equity Method Investees Total net receivables due from equity method investees were $ 2,053 million and $ 1,696 million as of December 31, 2017 and 2016 , respectively. The total amount of dividends received from equity method investees was $ 443 million , $ 386 million and $ 367 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. The amount of consolidated reinvested earnings that represents undistributed earnings of investments accounted for under the equity method as of December 31, 2017 was $4,471 million . NOTE 7 : PROPERTY, PLANT AND EQUIPMENT The following table summarizes our property, plant and equipment (in millions): December 31, Land $ $ Buildings and improvements 3,917 4,574 Machinery, equipment and vehicle fleet 12,198 16,093 16,449 21,256 Less accumulated depreciation 8,246 10,621 Property, plant and equipment net $ 8,203 $ 10,635 NOTE 8 : INTANGIBLE ASSETS Indefinite-Lived Intangible Assets The following table summarizes information related to indefinite-lived intangible assets (in millions): December 31, Trademarks 1 $ 6,729 $ 6,097 Bottlers' franchise rights 2 3,676 Goodwill 9,401 10,629 Other Indefinite-lived intangible assets $ 16,374 $ 20,530 1 The increase in 2017 was primarily due to the acquisitions of AdeS and the U.S. rights to Topo Chico. Refer to Note 2 . 2 The decrease in 2017 was primarily the result of additional North America bottling territories being refranchised. Refer to Note 2 . The following table provides information related to the carrying value of our goodwill by operating segment (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Total Balance at beginning of year $ $ $ 8,311 $ $ 2,084 $ 11,289 Effect of foreign currency translation (10 ) (6 ) (11 ) (6 ) (33 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment (10 ) (10 ) Divestitures, deconsolidations and other 1 (633 ) (633 ) Balance at end of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Balance at beginning of year $ $ $ 8,321 $ $ 1,435 $ 10,629 Effect of foreign currency translation (1 ) Acquisitions 1 Adjustments related to the finalization of purchase accounting 1 Impairment (390 ) (390 ) Divestitures, deconsolidations and other 1,2 (999 ) (999 ) Balance at end of year $ $ $ 8,349 $ $ $ 9,401 Refer to Note 2 for information related to the Company's acquisitions and divestitures. 2 The 2017 decrease in the Bottling Investments segment was primarily a result of additional North America bottling territories being refranchised. Refer to Note 2 . Definite-Lived Intangible Assets The following table summarizes information related to definite-lived intangible assets (in millions): December 31, 2017 December 31, 2016 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Customer relationships 1 $ $ (143 ) $ $ $ (185 ) $ Bottlers' franchise rights 1 (152 ) (381 ) Trademarks (73 ) (64 ) Other (64 ) (58 ) Total $ $ (432 ) $ $ 1,286 $ (688 ) $ 1 The decrease in 2017 was primarily due to the derecognition of intangible assets as a result of the North America refranchising. Refer to Note 2 . Total amortization expense for intangible assets subject to amortization was $ 68 million , $ 139 million and $ 156 million in 2017 , 2016 and 2015 , respectively. Based on the carrying value of definite-lived intangible assets as of December 31, 2017 , we estimate our amortization expense for the next five years will be as follows (in millions): Amortization Expense $ 2019 2020 2021 2022 NOTE 9 : ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following (in millions): December 31, Accrued marketing $ 2,108 $ 2,186 Trade accounts payable 2,288 2,682 Other accrued expenses 3,071 2,593 Accrued compensation Deferred tax liabilities 1 Sales, payroll and other taxes Container deposits Accounts payable and accrued expenses $ 8,748 $ 9,490 1 As a result of our adoption of ASU 2015-17, all deferred tax liabilities are now recorded in noncurrent liabilities. Refer to Note 1. NOTE 10 : DEBT AND BORROWING ARRANGEMENTS Short-Term Borrowings Loans and notes payable consist primarily of commercial paper issued in the United States. As of December 31, 2017 and 2016 , we had $ 12,931 million and $ 12,330 million , respectively, in outstanding commercial paper borrowings. Our weighted-average interest rates for commercial paper outstanding were approximately 1.4 percent and 0.8 percent per year as of December 31, 2017 and 2016 , respectively. In addition, we had $ 9,199 million in lines of credit and other short-term credit facilities as of December 31, 2017 . The Company's total lines of credit included $ 274 million that was outstanding and primarily related to our international operations. Included in the credit facilities discussed above, the Company had $ 7,295 million in lines of credit for general corporate purposes. These backup lines of credit expire at various times from 2018 through 2022 . There were no borrowings under these backup lines of credit during 2017 . These credit facilities are subject to normal banking terms and conditions. Some of the financial arrangements require compensating balances, none of which is presently significant to our Company. Long-Term Debt During 2017 , the Company issued U.S. dollar- and euro-denominated debt of $1,000 million and 2,500 million , respectively. The carrying value of this debt as of December 31, 2017 , was $3,974 million . The general terms of the notes issued are as follows: $500 million total principal amount of notes due May 25, 2022, at a fixed interest rate of 2.20 percent ; $500 million total principal amount of notes due May 25, 2027, at a fixed interest rate of 2.90 percent ; 1,500 million total principal amount of notes due March 8, 2019, at a variable interest rate equal to the three -month Euro Interbank Offered Rate (""EURIBOR"") plus 0.25 percent ; 500 million total principal amount of notes due March 9, 2021, at a fixed interest rate of 0.00 percent ; and 500 million total principal amount of notes due March 8, 2024, at a fixed interest rate of 0.50 percent . D uring 2017, the Company retired upon maturity 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent , $206 million total principal amount of notes due August 1, 2017, at a fixed interest rate of 7.125 percent , SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent , $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent , and $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month London Interbank Offered Rate (""LIBOR"") plus 0.05 percent . The Company also extinguished a portion of the long-term debt that was assumed in connection with our acquisition of CCE's former North America business (""Old CCE""). The extinguished notes had a carrying value of $417 million , which included fair value adjustments recorded as part of purchase accounting. The general terms of the notes extinguished were as follo ws: $95.6 million total principal amount of notes due August 15, 2019, at a fixed interest rate of 4.50 percent ; $38.6 million total principal amount of notes due February 1, 2022, at a fixed interest rate of 8.50 percent ; $11.7 million total principal amount of notes due September 15, 2022, at a fixed interest rate of 8.00 percent ; $36.5 million total principal amount of notes due September 15, 2023, at a fixed interest rate of 6.75 percent ; $9.9 million total principal amount of notes due October 1, 2026, at a fixed interest rate of 7.00 percent ; $53.8 million total principal amount of notes due November 15, 2026, at a fixed interest rate of 6.95 percent ; $41.3 million total principal amount of notes due September 15, 2028, at a fixed interest rate of 6.75 percent ; $32.0 million total principal amount of notes due October 15, 2036, at a fixed interest rate of 6.70 percent ; $3.4 million total principal amount of notes due March 18, 2037, at a fixed interest rate of 5.71 percent ; $24.3 million total principal amount of notes due January 15, 2038, at a fixed interest rate of 6.75 percent ; and $4.7 million total principal amount of notes due May 15, 2098, at a fixed interest rate of 7.00 percent . The Company recorded a net charge of $38 million in the line item interest expense in our consolidated statement of income during the year ended December 31, 2017 . This net charge was due to the early extinguishment of long-term debt described above. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished. During 2016 , the Company issued Australian dollar-, euro- and U.S. dollar-denominated debt of AUD 1,000 million , 500 million and $3,725 million , respectively. The general terms of the notes issued are as follows: AUD 450 million total principal amount of notes due June 9, 2020, at a fixed interest rate of 2.60 percent ; AUD 550 million total principal amount of notes due June 11, 2024, at a fixed interest rate of 3.25 percent ; $225 million total principal amount of notes due November 16, 2017, at a variable interest rate equal to the three -month LIBOR plus 0.05 percent ; $1,000 million total principal amount of notes due May 30, 2019, at a fixed interest rate of 1.375 percent ; $1,000 million total principal amount of notes due September 1, 2021, at a fixed interest rate of 1.55 percent ; $500 million total principal amount of notes due June 1, 2026, at a fixed interest rate of 2.55 percent ; $1,000 million total principal amount of notes due September 1, 2026, at a fixed interest rate of 2.25 percent ; and 500 million total principal amount of notes due September 2, 2036, at a fixed interest rate of 1.10 percent . During 2016 , the Company retired upon maturity $1,654 million total principal amount of notes due September 1, 2016, at a fixed interest rate of 1.80 percent , $500 million total principal amount of notes due November 1, 2016 at a fixed interest rate of 0.75 percent and $500 million total principal amount of notes due November 1, 2016 at a variable interest rate equal to the three -month LIBOR plus 0.10 percent . During 2015 , the Company issued SFr 1,325 million , 8,500 million and $4,000 million of long-term debt. The general terms of the notes issued are as follows: SFr 200 million total principal amount of notes due October 2, 2017, at a fixed interest rate of 0.00 percent ; SFr 550 million total principal amount of notes due December 22, 2022, at a fixed interest rate of 0.25 percent ; SFr 575 million total principal amount of notes due October 2, 2028, at a fixed interest rate of 1.00 percent ; 2,000 million total principal amount of notes due March 9, 2017, at a variable interest rate equal to the three -month EURIBOR plus 0.15 percent ; 2,000 million total principal amount of notes due September 9, 2019, at a variable interest rate equal to the three -month EURIBOR plus 0.23 percent ; 1,500 million total principal amount of notes due March 9, 2023, at a fixed interest rate of 0.75 percent ; 1,500 million total principal amount of notes due March 9, 2027, at a fixed interest rate of 1.125 percent ; 1,500 million total principal amount of notes due March 9, 2035, at a fixed interest rate of 1.625 percent ; $750 million total principal amount of notes due October 27, 2017, at a fixed interest rate of 0.875 percent ; $1,500 million total principal amount of notes due October 27, 2020, at a fixed interest rate of 1.875 percent ; and $1,750 million total principal amount of notes due October 27, 2025, at a fixed interest rate of 2.875 percent . During 2015 , the Company retired $3,500 million of long-term debt upon maturity. The Company also extinguished $2,039 million of long-term debt prior to maturity, incurring associated charges of $320 million recorded in the line item interest expense in our consolidated statement of income. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. The general terms of the notes that were extinguished were as follows: $1,148 million total principal amount of notes due November 15, 2017, at a fixed interest rate of 5.35 percent ; and $891 million total principal amount of notes due March 15, 2019, at a fixed interest rate of 4.875 percent . The Company's long-term debt consisted of the following (in millions, except average rate data): December 31, 2017 December 31, 2016 Amount Average Rate 1 Amount Average Rate 1 U.S. dollar notes due 20182093 $ 16,854 2.3 % $ 16,922 2.0 % U.S. dollar debentures due 20182098 1,559 5.5 2,111 4.1 U.S. dollar zero coupon notes due 2020 2 8.4 8.4 Australian dollar notes due 20202024 2.1 1.2 Euro notes due 20192036 13,663 0.7 11,567 0.7 Swiss franc notes due 20222028 1,148 3.0 1,304 2.5 Other, due through 2098 3 3.4 3.5 Fair value adjustment 4 N/A N/A Total 5,6 34,480 1.8 % 33,211 1.7 % Less current portion 3,298 3,527 Long-term debt $ 31,182 $ 29,684 1 These rates represent the weighted-average effective interest rate on the balances outstanding as of year end, as adjusted for the effects of interest rate swap agreements, cross-currency swap agreements and fair value adjustments, if applicable. Refer to Note 5 for a more detailed discussion on interest rate management. 2 This amount is shown net of unamortized discounts of $ 13 million and $ 18 million as of December 31, 2017 and 2016 , respectively. 3 As of December 31, 2017 , the amount shown includes $ 165 million of debt instruments that are due through 2031 . 4 Amount represents changes in fair value due to changes in benchmark interest rates. Refer to Note 5 for additional information about our fair value hedging strategy. 5 As of December 31, 2017 and 2016 , the fair value of our long-term debt, including the current portion, was $ 35,169 million and $ 33,752 million , respectively. The fair value of our long-term debt is estimated based on quoted prices for those or similar instruments. 6 The above notes and debentures include various restrictions, none of which is presently significant to our Company. The carrying value of the Company's long-term debt included fair value adjustments related to the debt assumed from Old CCE's former North America business in 2010 of $ 263 million and $ 361 million as of December 31, 2017 and 2016 , respectively. These fair value adjustments are being amortized over the number of years remaining until the underlying debt matures. As of December 31, 2017 , the weighted-average maturity of the assumed debt to which these fair value adjustments relate was approximately 24 years. The amortization of these fair value adjustments will be a reduction of interest expense in future periods, which will typically result in our interest expense being less than the actual interest paid to service the debt. Total interest paid was $ 757 million , $ 663 million and $ 515 million in 2017 , 2016 and 2015 , respectively. Maturities of long-term debt for the five years succeeding December 31, 2017 , are as follows (in millions): Maturities of Long-Term Debt $ 3,298 5,209 4,298 2,930 2,480 NOTE 11 : COMMITMENTS AND CONTINGENCIES Guarantees As of December 31, 2017 , we were contingently liable for guarantees of indebtedness owed by third parties of $ 609 million , of which $ 256 million was related to VIEs. Refer to Note 1 for additional information related to the Company's maximum exposure to loss due to our involvement with VIEs. Our guarantees are primarily related to third-party customers, bottlers, vendors and container manufacturing operations and have arisen through the normal course of business. These guarantees have various terms, and none of these guarantees was individually significant. The amount represents the maximum potential future payments that we could be required to make under the guarantees; however, we do not consider it probable that we will be required to satisfy these guarantees. We believe our exposure to concentrations of credit risk is limited due to the diverse geographic areas covered by our operations. Legal Contingencies The Company is involved in various legal proceedings. We establish reserves for specific legal proceedings when we determine that the likelihood of an unfavorable outcome is probable and the amount of loss can be reasonably estimated. Management has also identified certain other legal matters where we believe an unfavorable outcome is reasonably possible and/or for which no estimate of possible losses can be made. Management believes that the total liabilities to the Company that may arise as a result of currently pending legal proceedings will not have a material adverse effect on the Company taken as a whole. Indemnifications At the time we acquire or divest an interest in an entity, we sometimes agree to indemnify the seller or buyer for specific contingent liabilities. Management believes that any liability to the Company that may arise as a result of any such indemnification agreements will not have a material adverse effect on the Company taken as a whole. Refer to Note 2 . Tax Audits The Company is involved in various tax matters, with respect to some of which the outcome is uncertain. We establish reserves to remove some or all of the tax benefit of any of our tax positions at the time we determine that it becomes uncertain based upon one of the following conditions: (1) the tax position is not ""more likely than not"" to be sustained, (2) the tax position is ""more likely than not"" to be sustained, but for a lesser amount, or (3) the tax position is ""more likely than not"" to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, (1) we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; (2) the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and (3) each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. A number of years may elapse before a particular uncertain tax position is audited and finally resolved or when a tax assessment is raised. The number of years subject to tax assessments varies depending on the tax jurisdiction. The tax benefit that has been previously reserved because of a failure to meet the ""more likely than not"" recognition threshold would be recognized in our income tax expense in the first interim period when the uncertainty disappears under any one of the following conditions: (1) the tax position is ""more likely than not"" to be sustained, (2) the tax position, amount, and/or timing is ultimately settled through negotiation or litigation, or (3) the statute of limitations for the tax position has expired. Refer to Note 14. On September 17, 2015, the Company received a Statutory Notice of Deficiency (""Notice"") from the Internal Revenue Service (""IRS"") for the tax years 2007 through 2009, after a five-year audit. In the Notice, the IRS claims that the Company's United States taxable income should be increased by an amount that creates a potential additional federal income tax liability of approximately $3.3 billion for the period, plus interest. No penalties were asserted in the Notice. The disputed amounts largely relate to a transfer pricing matter involving the appropriate amount of taxable income the Company should report in the United States in connection with its licensing of intangible property to certain related foreign licensees regarding the manufacturing, distribution, sale, marketing and promotion of products in overseas markets. During the 2007-2009 audit period, the Company followed the same transfer pricing methodology for these licenses that had consistently been followed since the methodology was agreed with the IRS in a 1996 closing agreement that applied back to 1987. The closing agreement provided prospective penalty protection as long as the Company followed the prescribed methodology and material facts and circumstances and relevant federal tax law have not changed. On February 11, 2016, the IRS notified the Company, without further explanation, that the IRS had determined that material facts and circumstances and relevant federal tax law had changed permitting it to assert penalties. The Company does not agree with this determination. The Company's compliance with the closing agreement was audited and confirmed by the IRS in five successive audit cycles covering the subsequent 11 years through 2006, with the last audit concluding as recently as 2009. The Notice represents a repudiation of the methodology previously adopted in the 1996 closing agreement. The IRS designated the matter for litigation on October 15, 2015. To the extent the matter remains designated, the Company will be prevented from pursuing any administrative settlement at IRS Appeals or under the IRS Advance Pricing and Mutual Agreement Program. The Company firmly believes that the IRS' claims are without merit and plans to pursue all available administrative and judicial remedies necessary to resolve this matter. To that end, the Company filed a petition in the U.S. Tax Court on December 14, 2015, and the IRS filed its answer on February 12, 2016. On October 4, 2017, the IRS filed an amended answer to the Company's petition in which it increased its transfer pricing adjustment by $385 million resulting in an additional tax adjustment of $135 million . A trial date has been set for March 5, 2018. The Company intends to vigorously defend its position and is confident in its ability to prevail on the merits. On June 20, 2017, the Company filed a motion for summary judgment on the portion of the IRS' adjustments related to our licensee in Mexico. On December 14, 2017, the U.S. Tax Court issued a decision on the summary judgment motion in favor of the Company. This decision effectively reduced the IRS' potential tax adjustment by approximately $138 million . The Company regularly assesses the likelihood of adverse outcomes resulting from examinations such as this to determine the adequacy of its tax reserves. The Company believes that the final adjudication of this matter will not have a material impact on its consolidated financial position, results of operations or cash flows. However, the ultimate outcome of disputes of this nature is uncertain, and if the IRS were to prevail in any material respect on its assertions, the additional tax, interest and any potential penalties could have a material adverse impact on the Company's financial position, results of operations and cash flows. Risk Management Programs The Company has numerous global insurance programs in place to help protect the Company from the risk of loss. In general, we are self-insured for large portions of many different types of claims; however, we do use commercial insurance above our self-insured retentions to reduce the Company's risk of catastrophic loss. Our reserves for the Company's self-insured losses are estimated using actuarial methods and assumptions of the insurance industry, adjusted for our specific expectations based on our claim history. Our self-insurance reserves totaled $ 480 million and $ 527 million as of December 31, 2017 and 2016 , respectively. Workforce (Unaudited) We refer to our employees as ""associates."" As of December 31, 2017 , our Company had approximately 61,800 associates, of which approximately 12,400 associates were located in the United States. Our Company, through its divisions and subsidiaries, is a party to numerous collective bargaining agreements. As of December 31, 2017 , approximately 3,700 associates, excluding seasonal hires, in North America were covered by collective bargaining agreements. These agreements typically have terms of three years to five years years. We currently expect that we will be able to renegotiate such agreements on satisfactory terms when they expire. The Company believes that its relations with its associates are generally satisfactory. Operating Leases The following table summarizes our minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year as of December 31, 2017 (in millions): Year Ended December 31, Operating Lease Payments $ 2019 2020 2021 2022 Thereafter Total minimum operating lease payments 1 $ 1 Income associated with sublease arrangements is not significant. NOTE 12 : STOCK-BASED COMPENSATION PLANS Our Company grants awards under its stock-based compensation plans to certain employees of the Company. Total stock-based compensation expense was $ 219 million , $ 258 million and $ 236 million in 2017 , 2016 and 2015 , respectively, and was included as a component of selling, general and administrative expenses in our consolidated statements of income. The total income tax benefit recognized in our consolidated statements of income related to awards under these plans was $ 44 million , $ 71 million and $ 65 million in 2017 , 2016 and 2015 , respectively. Beginning in 2015, certain employees who had previously been eligible for long-term equity awards received long-term performance cash awards. Employees who receive these performance cash awards do not receive equity awards as part of the long-term incentive program. In late 2017, the Company changed the long-term incentive program for certain employees previously eligible for the performance cash award. These employees no longer participate in the long-term incentive program and were issued a final restricted stock unit award that vests ratably over five years . As of December 31, 2017 , we had $ 286 million of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our plans. This cost is expected to be recognized over a weighted-average period of 3.0 years as stock-based compensation expense. This expected cost does not include the impact of any future stock-based compensation awards. The Coca-Cola Company 2014 Equity Plan (""2014 Equity Plan"") was approved by shareowners in April 2014. Under the 2014 Equity Plan, a maximum of 500 million shares of our common stock was approved to be issued, through the grant of equity awards, to certain employees. The 2014 Equity Plan allows for grants of stock options, performance share units, restricted stock units, restricted stock and other specified award types, including cash awards with performance-based vesting criteria. Beginning in 2015, the 2014 Equity Plan was the primary plan in use for equity awards and performance cash awards. There were no grants made from the 2014 Equity Plan prior to 2015. As of December 31, 2017 , there were 413.6 million shares available to be granted under the 2014 Equity Plan. In addition to the 2014 Equity Plan, there were 2.7 million shares available to be granted under stock option plans approved by shareowners in 1999 and 2008 and 0.2 million shares available to be granted under a restricted stock award plan approved by shareowners in 1989. Stock Option Awards Stock options have generally been granted with an exercise price equal to the average of the high and low market prices per share for the Company's stock on the date of grant. The fair value of each stock option award is estimated using a Black-Scholes-Merton option-pricing model and is amortized over the vesting period, generally four years . The weighted-average fair value of stock options granted during the past three years and the weighted-average assumptions used in the Black-Scholes-Merton option-pricing model for such grants were as follows: Fair value of stock options at grant date $ 3.98 $ 4.17 $ 4.38 Dividend yield 1 3.6 % 3.2 % 3.1 % Expected volatility 2 15.5 % 16.0 % 16.0 % Risk-free interest rate 3 2.2 % 1.5 % 1.8 % Expected term of the stock options 4 6 years 6 years 6 years 1 The dividend yield is the calculated yield on the Company's stock at the time of the grant. 2 Expected volatility is based on implied volatilities from traded options on the Company's stock, historical volatility of the Company's stock and other factors. 3 The risk-free interest rate for the period matching the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. 4 The expected term of the stock options represents the period of time that options granted are expected to be outstanding and is derived by analyzing historical exercise behavior. Generally, stock options granted from 1999 through July 2003 expire 15 years from the date of grant, and stock options granted in December 2003 and thereafter expire 10 years from the date of grant. The shares of common stock to be issued and/or sold upon exercise of stock options are made available from either authorized and unissued Company common stock or from the Company's treasury shares. In 2007, the Company began issuing common stock under its stock-based compensation plans from the Company's treasury shares. Stock option activity for all plans for the year ended December 31, 2017 , was as follows: Shares (In millions) Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life Aggregate Intrinsic Value (In millions) Outstanding on January 1, 2017 $ 33.70 Granted 40.89 Exercised (53 ) 30.28 Forfeited/expired (3 ) 38.34 Outstanding on December 31, 2017 1 $ 35.02 4.84 years $ 1,879 Expected to vest $ 34.96 4.81 years $ 1,869 Exercisable on December 31, 2017 $ 33.89 4.27 years $ 1,700 1 Includes 0.3 million stock option replacement awards in connection with our acquisition of Old CCE's North America business in 2010. These options had a weighted-average exercise price of $ 12.86 and generally vest over 3 years and expire 10 years from the original date of grant. The total intrinsic value of the stock options exercised was $ 744 million , $ 787 million and $ 594 million in 2017 , 2016 and 2015 , respectively. The total shares exercised were 53 million , 50 million and 44 million in 2017 , 2016 and 2015 , respectively. Performance Share Unit Awards Performance share units require achievement of certain performance criteria, which are predefined by the Compensation Committee of the Board of Directors at the time of grant. The primary performance criterion used is compound annual growth in economic profit over a predefined performance period, which is generally three years . Economic profit is our net operating profit after tax less the cost of the capital used in our business. Beginning in 2015, the Company added net operating revenues as an additional performance criterion. Economic profit and net operating revenues are adjusted for certain items, which are approved and certified by the Audit Committee of the Board of Directors. The purpose of these adjustments is to ensure a consistent year-to-year comparison of the specific performance criteria. In the event the certified results equal the predefined performance criteria, the Company will grant the number of shares equal to the target award. In the event the certified results exceed the predefined performance criteria, additional shares up to the maximum award will be granted. In the event the certified results fall below the predefined performance criteria, a reduced number of shares will be granted. If the certified results fall below the threshold award performance level, no shares will be granted. The performance share units granted under this program are then generally subject to a holding period of one year before the shares are released. Performance share units generally do not entitle participants to vote or receive dividends. For most performance share units granted beginning in 2014, the Company includes a relative TSR modifier to determine the number of shares earned at the end of the performance period. For these awards, the number of shares earned based on the certified achievement of the predefined performance criteria will be reduced or increased if the Company's total shareowner return over the performance period relative to a predefined compensation comparator group of companies falls outside of a defined range. The fair value of performance share units that include the TSR modifier is determined using a Monte Carlo valuation model. For the remaining awards that do not include the TSR modifier, the fair value of the performance share units is the quoted market value of the Company's stock on the grant date less the present value of the expected dividends not received during the relevant period. In the period it becomes probable that the minimum performance criteria specified in the award will be achieved, we recognize expense for the proportionate share of the total fair value of the performance share units related to the vesting period that has already lapsed for the shares expected to vest and be released. The remaining fair value of the shares expected to vest and be released is expensed on a straight-line basis over the balance of the vesting period. In the event the Company determines it is no longer probable that we will achieve the minimum performance criteria specified in the award, we reverse all of the previously recognized compensation expense in the period such a determination is made. Performance share units are generally settled in stock, except for certain circumstances such as death or disability, in which case former employees or their beneficiaries are provided a cash equivalent payment. As of December 31, 2017 , performance share units of 2,088,000 , 2,985,000 and 3,139,000 were outstanding for the 20152017, 20162018 and 20172019 performance periods, respectively, based on the target award amounts in the performance share unit agreements. The following table summarizes information about performance share units based on the target award amounts in the performance share unit agreements: Performance Share Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2017 9,773 $ 35.77 Granted 4,133 34.75 Conversions to restricted stock units 1 (4,851 ) 32.35 Paid in cash equivalent (11 ) 34.15 Canceled/forfeited (832 ) 37.20 Outstanding on December 31, 2017 2 8,212 $ 37.14 1 Represents the target amount of performance share units converted to restricted stock units for the 20142016 performance period. The vesting of restricted stock units is subject to the terms of the performance share unit agreements. 2 The outstanding performance share units as of December 31, 2017 , at the threshold award and maximum award levels were 2.2 million and 15.4 million , respectively. The weighted-average grant date fair value of performance share units granted was $34.75 in 2017 , $39.70 in 2016 and $37.99 in 2015 . The Company did not convert any performance share units into cash equivalent payments in 2015. The Company converted performance share units of 11,052 in 2017 and 52,545 in 2016 to cash equivalent payments of $0.4 million and $ 1.9 million , respectively, to former employees or their beneficiaries due to certain events such as death or disability. The following table summarizes information about nonvested performance-based restricted stock units based on the performance share units' certified award level: Restricted Stock Units (In thousands) Weighted- Average Grant Date Fair Value Nonvested on January 1, 2017 $ Conversions from performance share units 7,181 32.33 Vested and released (3 ) 32.35 Canceled/forfeited (430 ) 32.30 Nonvested on December 31, 2017 6,748 $ 32.35 The total intrinsic value of restricted shares that were vested and released was less than $1 million in both 2017 and 2016 and $ 5 million in 2015 . The total restricted share units vested and released were 3,037 in 2017 , 7,101 in 2016 and 130,017 in 2015 . Time-Based Restricted Stock and Restricted Stock Unit Awards Prior to the release date, time-based restricted stock and restricted stock units granted from the 2014 Equity Plan do not entitle participants to vote or receive dividends and will be forfeited in the event of the recipient's termination of employment, except for reasons such as death or disability. Certain other time-based restricted stock awards entitle participants to vote and receive dividends. The fair value of the restricted stock and restricted stock units expected to vest and be released is expensed on a straight-line basis over the vesting period. As of December 31, 2017 , the Company had outstanding nonvested time-based restricted stock, including restricted stock units, of 3,534,660 , most of which do not pay dividends or have voting rights. The following table summarizes information about nonvested time-based restricted stock awards: Restricted Stock and Stock Units (In thousands) Weighted-Average Grant Date Fair Value Outstanding on January 1, 2017 $ 37.54 Granted 2,994 41.62 Vested and released (179 ) 37.36 Forfeited/expired (50 ) 38.35 Outstanding on December 31, 2017 3,535 $ 40.99 NOTE 13 : PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Our Company sponsors and/or contributes to pension and postretirement health care and life insurance benefit plans covering substantially all U.S. employees. We also sponsor nonqualified, unfunded defined benefit pension plans for certain associates. In addition, our Company and its subsidiaries have various pension plans and other forms of postretirement arrangements outside the United States. We refer to the funded defined benefit pension plan in the United States that is not associated with collective bargaining organizations as the ""primary U.S. plan."" As of December 31, 2017 , the primary U.S. plan represented 64 percent and 65 percent of the Company's consolidated projected benefit obligation and pension assets, respectively. Obligations and Funded Status The following table sets forth the changes in benefit obligations and the fair value of plan assets for our benefit plans (in millions): Pension Benefits Other Benefits Year Ended December 31, Benefit obligation at beginning of year 1 $ 9,428 $ 9,159 $ $ Service cost Interest cost Foreign currency exchange rate changes (38 ) (2 ) Amendments (21 ) (4 ) Actuarial loss (gain) (28 ) Benefits paid 2 (341 ) (346 ) (71 ) (64 ) Divestitures 3 (7 ) (16 ) (66 ) (2 ) Settlements 4 (832 ) (384 ) Curtailments 4 (10 ) (48 ) (17 ) Special termination benefits 4 Other Benefit obligation at end of year 1 $ 9,455 $ 9,428 $ $ Fair value of plan assets at beginning of year $ 8,371 $ 7,689 $ $ Actual return on plan assets 1,139 Employer contributions Foreign currency exchange rate changes (70 ) Benefits paid (285 ) (270 ) (3 ) (3 ) Divestitures 3 (16 ) Settlements 4 (794 ) (374 ) Other Fair value of plan assets at end of year $ 8,843 $ 8,371 $ $ Net liability recognized $ (612 ) $ (1,057 ) $ (494 ) $ (707 ) 1 For pension benefit plans, the benefit obligation is the projected benefit obligation. For other benefit plans, the benefit obligation is the accumulated postretirement benefit obligation. The accumulated benefit obligation for our pension plans was $9,175 million and $9,141 million as of December 31, 2017 and 2016 , respectively. 2 Benefits paid to pension plan participants during 2017 and 2016 included $56 million and $76 million , respectively, in payments related to unfunded pension plans that were paid from Company assets. Benefits paid to participants of other benefit plans during 2017 and 2016 included $68 million and $61 million , respectively, that were paid from Company assets. 3 Divestitures were primarily related to the deconsolidation of the Company's German bottling operations in May 2016 and the Company's North America refranchising in 2017. Refer to Note 2. 4 Settlements, curtailments and special termination benefits were primarily related to the Company's North America refranchising and productivity, restructuring and integration initiatives. Refer to Note 2 and Note 18. Pension and other benefit amounts recognized in our consolidated balance sheets are as follows (in millions): Pension Benefits Other Benefits December 31, Noncurrent asset $ $ $ $ Current liability (72 ) (71 ) (21 ) (23 ) Long-term liability (1,461 ) (1,558 ) (473 ) (684 ) Net liability recognized $ (612 ) $ (1,057 ) $ (494 ) $ (707 ) Certain of our pension plans have projected benefit obligations in excess of the fair value of plan assets. For these plans, the projected benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Projected benefit obligation $ 7,833 $ 7,907 Fair value of plan assets 6,330 6,303 Certain of our pension plans have accumulated benefit obligations in excess of the fair value of plan assets. For these plans, the accumulated benefit obligations and the fair value of plan assets were as follows (in millions): December 31, Accumulated benefit obligation $ 7,614 $ 7,668 Fair value of plan assets 6,305 6,257 Pension Plan Assets The following table presents total assets for our U.S. and non-U.S. pension plans (in millions): U.S. Plans Non-U.S. Plans December 31, Cash and cash equivalents $ $ $ $ Equity securities: U.S.-based companies 1,427 1,208 International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 1 Hedge funds/limited partnerships 1,172 Real estate Other Total pension plan assets 2 $ 6,028 $ 6,061 $ 2,815 $ 2,310 1 Mutual, pooled and commingled funds include investments in equity securities, fixed-income securities and combinations of both. There are a significant number of mutual, pooled and commingled funds from which investors can choose. The selection of the type of fund is dictated by the specific investment objectives and needs of a given plan. These objectives and needs vary greatly between plans. 2 Fair value disclosures related to our pension assets are included in Note 16 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall; a reconciliation of the beginning and ending balances of Level 3 assets; and information about the valuation techniques and inputs used to measure the fair value of our pension assets. Investment Strategy for U.S. Pension Plans The Company utilizes the services of investment managers to actively manage the assets of our U.S. pension plans. We have established asset allocation targets and investment guidelines with each investment manager. Our asset allocation targets promote optimal expected return and volatility characteristics given the long-term time horizon for fulfilling the obligations of the plans. Selection of the targeted asset allocation for U.S. plan assets was based upon a review of the expected return and risk characteristics of each asset class, as well as the correlation of returns among asset classes. Our target allocation is a mix of 42 percent equity investments, 30 percent fixed-income investments and 28 percent alternative investments. We believe this target allocation will enable us to achieve the following long-term investment objectives: (1) optimize the long-term return on plan assets at an acceptable level of risk; (2) maintain a broad diversification across asset classes and among investment managers; and (3) maintain careful control of the risk level within each asset class. The guidelines that have been established with each investment manager provide parameters within which the investment managers agree to operate, including criteria that determine eligible and ineligible securities, diversification requirements and credit quality standards, where applicable. Unless exceptions have been approved, investment managers are prohibited from buying or selling commodities, futures or option contracts, as well as from short selling of securities. Additionally, investment managers agree to obtain written approval for deviations from stated investment style or guidelines. As of December 31, 2017 , no investment manager was responsible for more than 9 percent of total U.S. plan assets. Our target allocation of 42 percent equity investments is composed of 60 percent global equities, 16 percent emerging market equities and 24 percent domestic small- and mid-cap equities. Optimal returns through our investments in global equities are achieved through security selection as well as country and sector diversification. Investments in the common stock of our Company accounted for approximately 4 percent of our total global equities and approximately 2 percent of total U.S. plan assets. Our investments in global equities are intended to provide diversified exposure to both U.S. and non-U.S. equity markets. Our investments in both emerging market equities and domestic small- and mid-cap equities may experience large swings in their market value. Our investments in these asset classes are selected based on capital appreciation potential. Our target allocation of 30 percent fixed-income investments is composed of 33 percent long-duration bonds and 67 percent with multi-strategy alternative credit managers. Long-duration bonds are intended to provide a stable rate of return through investments in high-quality publicly traded debt securities. Our investments in long-duration bonds are diversified in order to mitigate duration and credit exposure. Multi-strategy alternative credit managers invest in a combination of high-yield bonds, bank loans, structured credit and emerging market debt. These investments are in lower-rated and non-rated debt securities, which generally produce higher returns compared to long-duration bonds and also help to diversify our overall fixed-income portfolio. In addition to equity investments and fixed-income investments, we have a target allocation of 28 percent in alternative investments. These alternative investments include hedge funds, reinsurance, private equity limited partnerships, leveraged buyout funds, international venture capital partnerships and real estate. The objective of investing in alternative investments is to provide a higher rate of return than that available from publicly traded equity securities. These investments are inherently illiquid and require a long-term perspective in evaluating investment performance. Investment Strategy for Non-U.S. Pension Plans As of December 31, 2017 , the long-term target allocation for 73 percent of our international subsidiaries' pension plan assets, primarily certain of our European and Canadian plans, is 71 percent equity securities, 10 percent fixed-income securities and 19 percent other investments. The actual allocation for the remaining 27 percent of the Company's international subsidiaries' plan assets consisted of 55 percent mutual, pooled and commingled funds; 5 percent fixed-income securities; and 40 percent other investments. The investment strategies for our international subsidiaries' plans differ greatly, and in some instances are influenced by local law. None of our pension plans outside the United States is individually significant for separate disclosure. Other Postretirement Benefit Plan Assets Plan assets associated with other postretirement benefits primarily represent funding of one of the U.S. postretirement benefit plans through a Voluntary Employee Beneficiary Association (""VEBA""), a tax-qualified trust. The VEBA assets are primarily invested in liquid assets due to the level and timing of expected future benefit payments. The following table presents total assets for our other postretirement benefit plans (in millions): December 31, Cash and cash equivalents $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds Hedge funds/limited partnerships Real estate Other Total other postretirement benefit plan assets 1 $ $ 1 Fair value disclosures related to our other postretirement benefit plan assets are included in Note 16 . Fair value disclosures include, but are not limited to, the levels within the fair value hierarchy in which the fair value measurements in their entirety fall and information about the valuation techniques and inputs used to measure the fair value of our other postretirement benefit plan assets. Components of Net Periodic Benefit Cost Net periodic benefit cost for our pension and other postretirement benefit plans consisted of the following (in millions): Pension Benefits Other Benefits Year Ended December 31, Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets 1 (650 ) (653 ) (705 ) (12 ) (11 ) (11 ) Amortization of prior service credit (2 ) (2 ) (18 ) (19 ) (19 ) Amortization of actuarial loss 2 Net periodic benefit cost Settlement charges 3 Curtailment charge (credit) 3 (79 ) Special termination benefits 3 Other (3 ) Total cost (income) recognized in consolidated statements of income $ $ $ $ (55 ) $ $ 1 The Company has elected to use the actual fair value of plan assets as the market-related value of assets in the determination of the expected return on plan assets. 2 Actuarial gains and losses are amortized using a corridor approach. The gain/loss corridor is equal to 10 percent of the greater of the benefit obligation and the market-related value of assets. Gains and losses in excess of the corridor are generally amortized over the average future working lifetime of the plan participants. 3 The settlement charges, curtailment charge (credit) and special termination benefits were primarily related to the Company's North America refranchising and productivity, restructuring and integration initiatives. Refer to Note 2 and Note 18 . The following table sets forth the changes in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits Year Ended December 31, Balance in AOCI at beginning of year $ (2,932 ) $ (2,907 ) $ (48 ) $ (26 ) Recognized prior service cost (credit) (2 ) (54 ) 4 (28 ) 5 Recognized net actuarial loss (gain) 2 3 (36 ) 4 Prior service credit (cost) arising in current year (1 ) (17 ) Net actuarial (loss) gain arising in current year (404 ) 4 (6 ) 5 Impact of divestitures 1 Foreign currency translation gain (loss) (42 ) (1 ) Balance in AOCI at end of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) 1 Related to the deconsolidation of our German bottling operations. Refer to Note 2 . 2 Includes $228 million of recognized net actuarial losses due to the impact of settlements. 3 Includes $118 million of recognized net actuarial losses due to the impact of settlements. 4 Includes $36 million of recognized prior service credit, $43 million of recognized net actuarial gains and $45 million of actuarial gains arising in the current year due to the impact of curtailments. 5 Includes $9 million of recognized prior service credit and $17 million of actuarial gains arising in the current year due to the impact of curtailments. The following table sets forth amounts in AOCI for our benefit plans (in millions, pretax): Pension Benefits Other Benefits December 31, Prior service credit (cost) $ (10 ) $ (14 ) $ $ Net actuarial loss (2,483 ) (2,918 ) (62 ) (117 ) Balance in AOCI at end of year $ (2,493 ) $ (2,932 ) $ (26 ) $ (48 ) Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2018 are as follows (in millions, pretax): Pension Benefits Other Benefits Amortization of prior service cost (credit) $ (3 ) $ (14 ) Amortization of actuarial loss Total $ $ (10 ) Assumptions Certain weighted-average assumptions used in computing the benefit obligations are as follows: Pension Benefits Other Benefits December 31, Discount rate 3.50 % 4.00 % 3.50 % 4.00 % Rate of increase in compensation levels 3.50 % 3.75 % N/A N/A Certain weighted-average assumptions used in computing net periodic benefit cost are as follows: Pension Benefits Other Benefits Year Ended December 31, Discount rate 4.00 % 4.25 % 3.75 % 4.00 % 4.25 % 3.75 % Rate of increase in compensation levels 3.75 % 3.50 % 3.50 % N/A N/A N/A Expected long-term rate of return on plan assets 8.00 % 8.25 % 8.25 % 4.75 % 4.75 % 4.75 % The expected long-term rate of return assumption for U.S. pension plan assets is based upon the target asset allocation and is determined using forward-looking assumptions in the context of historical returns and volatilities for each asset class, as well as correlations among asset classes. We evaluate the rate of return assumption on an annual basis. The expected long-term rate of return assumption used in computing 2017 net periodic pension cost for the U.S. plans was 8.00 percent . As of December 31, 2017 , the 5-year, 10-year and 15-year annualized return on plan assets for the primary U.S. plan was 8.8 percent , 5.4 percent and 8.5 percent , respectively. The annualized return since inception was 10.7 percent . The assumed health care cost trend rates are as follows: December 31, Health care cost trend rate assumed for next year 7.00 % 7.00 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate The Company's U.S. postretirement benefit plans are primarily defined dollar benefit plans that limit the effects of medical inflation because the plans have established dollar limits for determining our contributions. As a result, the effect of a 1 percentage point change in the assumed health care cost trend rate would not be significant to the Company. The discount rate assumptions used to account for pension and other postretirement benefit plans reflect the rates at which the benefit obligations could be effectively settled. Rates for U.S. and certain non-U.S. plans at December 31, 2017 , were determined using a cash flow matching technique whereby the rates of a yield curve, developed from high-quality debt securities, were applied to the benefit obligations to determine the appropriate discount rate. For other non-U.S. plans, we base the discount rate on comparable indices within each of the countries. The rate of compensation increase assumption is determined by the Company based upon annual reviews. We review external data and our own historical trends for health care costs to determine the health care cost trend rate assumptions. Effective January 1, 2016, for benefit plans using the yield curve approach, the Company changed the method used to calculate the service cost and interest cost components of net periodic benefit cost for pension and other postretirement benefit plans and is measuring these components by applying the specific spot rates along the yield curve to the plans' projected cash flows. The Company believes the new approach provides a more precise measurement of service and interest costs by improving the correlation between projected cash flows and the corresponding spot rates. The change did not affect the measurement of the Company's pension and other postretirement benefit obligations for those plans and was accounted for as a change in accounting estimate, which was applied prospectively. Cash Flows Our estimated future benefit payments for funded and unfunded plans are as follows (in millions): Year Ended December 31, 20232027 Pension benefit payments $ $ $ $ $ $ 2,642 Other benefit payments 1 Total estimated benefit payments $ $ $ $ $ $ 2,900 1 The expected benefit payments for our other postretirement benefit plans are net of estimated federal subsidies expected to be received under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. Federal subsidies are estimated to be $4 million for the period 20182022, and $3 million for the period 20232027. The Company anticipates making pension contributions in 2018 of $59 million , all of which will be allocated to our international plans. The majority of these contributions are required by funding regulations or law. Defined Contribution Plans Our Company sponsors qualified defined contribution plans covering substantially all U.S. employees. Under the largest U.S. defined contribution plan, we match participants' contributions up to a maximum of 3.5 percent of compensation, subject to certain limitations. Company costs related to the U.S. plans were $61 million , $82 million and $94 million in 2017 , 2016 and 2015 , respectively. We also sponsor defined contribution plans in certain locations outside the United States. Company costs associated with those plans were $35 million , $37 million and $35 million in 2017 , 2016 and 2015 , respectively. Multi-Employer Pension Plans As a result of our acquisition of Old CCE's North America business in 2010, the Company participates in various multi-employer pension plans in the United States. Multi-employer pension plans are designed to cover employees from multiple employers and are typically established under collective bargaining agreements. These plans allow multiple employers to pool their pension resources and realize efficiencies associated with the daily administration of the plan. Multi-employer plans are generally governed by a board of trustees composed of management and labor representatives and are funded through employer contributions. The Company's expense for U.S. multi-employer pension plans totaled $35 million , $ 41 million and $40 million in 2017 , 2016 and 2015 , respectively. The plans we currently participate in have contractual arrangements that extend into 2021. If, in the future, we choose to withdraw from any of the multi-employer pension plans in which we currently participate, we would need to record the appropriate withdrawal liabilities at that time. NOTE 14 : INCOME TAXES Income from continuing operations before income taxes consisted of the following (in millions): Year Ended December 31, United States $ (690 ) 1 $ 1 $ 1,801 1 International 7,432 8,023 7,804 Total $ 6,742 $ 8,136 $ 9,605 1 Includes charges of $2,140 million , $2,456 million and $1,006 million related to refranchising certain bottling territories in North America in 2017, 2016 and 2015, respectively. Refer to Note 2. Income taxes from continuing operations consisted of the following for the years ended December 31, 2017 , 2016 and 2015 (in millions): United States State and Local International Total Current $ 5,438 1 $ $ 1,257 $ 6,816 Deferred (1,783 ) 1,2 1 (1,256 ) Current $ 1,147 $ $ 1,182 $ 2,442 Deferred (838 ) 2 (91 ) (856 ) Current $ $ $ 1,386 $ 2,166 Deferred (92 ) 1 Includes our reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax resulting from the Tax Cuts and Jobs Act (""Tax Reform Act"") that was signed into law on December 22, 2017 . The provisional amount related to the one-time transition tax on the mandatory deemed repatriation of prescribed foreign earnings was $4.6 billion of tax expense based on cumulative prescribed foreign earnings estimated to be $42 billion . The provisional amount that was primarily related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was a net deferred tax benefit of $1.0 billion . 2 Includes the benefit from charges related to refranchising certain bottling territories in North America. Refer to Note 2. Income taxes from discontinued operations consisted of $55 million of current expense and $8 million of deferred tax benefit for the year ended December 31, 2017 . We made income tax payments of $ 1,904 million , $ 1,554 million and $ 2,357 million in 2017 , 2016 and 2015 , respectively. Our effective tax rate reflects the tax benefits of having significant operations outside the United States, which are generally taxed at rates lower than the U.S. statutory rate of 35.0 percent . As a result of employment actions and capital investments made by the Company, certain tax jurisdictions provide income tax incentive grants, including Brazil, Costa Rica, Singapore and Swaziland. The terms of these grants expire from 2018 to 2036 . We anticipate that we will be able to extend or renew the grants in these locations. Tax incentive grants favorably impacted our income tax expense by $ 221 million , $ 105 million and $ 223 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. In addition, our effective tax rate reflects the benefits of having significant earnings generated in investments accounted for under the equity method of accounting, which are generally taxed at rates lower than the U.S. statutory rate. A reconciliation of the statutory U.S. federal tax rate and our effective tax rate is as follows: Year Ended December 31, Statutory U.S. federal tax rate 35.0 % 35.0 % 35.0 % State and local income taxes net of federal benefit 1.2 1.2 1.2 Earnings in jurisdictions taxed at rates different from the statutory U.S. federal rate (9.7 ) (17.5 ) 5 (12.7 ) Equity income or loss (3.4 ) (3.0 ) (1.7 ) Tax Reform Act 53.5 1 Other net 5.9 2,3,4 3.8 6 1.5 Effective tax rate 82.5 % 19.5 % 23.3 % 1 Includes net tax expense of $3,610 million primarily related to our reasonable estimate of the one-time transition tax resulting from the Tax Reform Act that was signed into law on December 22, 2017, partially offset by the impact of the lower rate introduced by the Tax Reform Act on our existing deferred tax balances. 2 Includes excess tax benefits of $132 million (or a 2 percent impact on our effective tax rate) recognized as awards issued under the Company's share-based compensation arrangements vested or were settled. 3 Includes net tax expense of $1,048 million on a pretax gain of $1,037 million (or a 10.2 percent impact on our effective tax rate) related to the Southwest Transaction, in conjunction with which we obtained an equity interest in AC Bebidas. The Company accounts for its interest in AC Bebidas as an equity method investment and the net tax expense was primarily the result of the deferred tax recorded on the basis difference in this investment. Refer to Note 2. 4 Includes a $156 million net tax benefit related to the impact of manufacturing incentives and permanent book to tax adjustments. 5 Includes tax expense of $97 million related to a pretax gain of $1,323 million (or a 4.5 percent impact on our effective tax rate) related to the deconsolidation of our German bottling operations. Refer to Note 2. 6 Includes tax expense of $157 million (or a 1.9 percent impact on our effective tax rate) primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties, in certain domestic jurisdictions. The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. U.S. tax authorities have completed their federal income tax examinations for all years prior to 2007 . With respect to state and local jurisdictions and countries outside the United States, with limited exceptions, the Company and its subsidiaries are no longer subject to income tax audits for years before 2003 . For U.S. federal and state tax purposes, the net operating losses and tax credit carryovers acquired in connection with our acquisition of Old CCE's North America business that were generated between the years of 1990 through 2010 are subject to adjustments until the year in which they are actually utilized is no longer subject to examination. Although the outcome of tax audits is always uncertain, the Company believes that adequate amounts of tax, including interest and penalties, have been provided for any adjustments that are expected to result from those years. On September 17, 2015, the Company received a Notice from the IRS for the tax years 2007 through 2009 , after a five-year audit. Refer to Note 11. As of December 31, 2017 , the gross amount of unrecognized tax benefits was $ 331 million . If the Company were to prevail on all uncertain tax positions, the net effect would be a benefit of $ 205 million , exclusive of any benefits related to interest and penalties. The remaining $ 126 million , which was recorded as a deferred tax asset, primarily represents tax benefits that would be received in different tax jurisdictions in the event the Company did not prevail on all uncertain tax positions. A reconciliation of the changes in the gross amount of unrecognized tax benefits is as follows (in millions): Year Ended December 31, Beginning balance of unrecognized tax benefits $ $ $ Increase related to prior period tax positions 1 Decrease related to prior period tax positions (13 ) (9 ) Increase related to current period tax positions Decrease related to settlements with taxing authorities (40 ) 1 (5 ) Decrease due to lapse of the applicable statute of limitations (23 ) Increase (decrease) due to effect of foreign currency exchange rate changes (6 ) (15 ) Ending balance of unrecognized tax benefits $ $ $ 1 The increase is primarily related to a change in judgment about one of the Company's tax positions as a result of receiving notification of a preliminary settlement of a Competent Authority matter with a foreign jurisdiction, a portion of which became certain later in the year. This change in position did not have a material impact on the Company's consolidated statement of income during the year ended December 31, 2016, as it was partially offset by refunds to be received from the foreign jurisdiction. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company had $ 177 million , $ 142 million and $ 111 million in interest and penalties related to unrecognized tax benefits accrued as of December 31, 2017 , 2016 and 2015 , respectively. Of these amounts, $35 million and $ 31 million of expense were recognized through income tax expense in 2017 and 2016 , respectively. An insignificant amount of interest and penalties was recognized through income tax expense for the year ended December 31, 2015. If the Company were to prevail on all uncertain tax positions, the reversal of this accrual would also be a benefit to the Company's effective tax rate. It is expected that the amount of unrecognized tax benefits will change in the next 12 months; however, we do not expect the change to have a significant impact on our consolidated statement of income or consolidated balance sheet. These changes may be the result of settlements of ongoing audits, statute of limitations expiring or final settlements in transfer pricing matters that are the subject of litigation. At this time, an estimate of the range of the reasonably possible outcomes cannot be made. The one-time transition tax is based on our total accumulated post-1986 prescribed foreign earnings and profits (""EP"") estimated to be $42 billion , the majority of which was previously considered to be indefinitely reinvested and, accordingly, no U.S. federal and state income taxes were provided. We recorded a provisional tax amount of $4.6 billion as a reasonable estimate for our one-time transition tax liability and a $0.6 billion provisional deferred tax of related withholding taxes and state income taxes. Because of the complexities of the Tax Reform Act, we are still finalizing our calculation of the total accumulated post-1986 prescribed EP for the applicable foreign entities. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of accumulated post-1986 prescribed foreign EP and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any additional outside basis differences inherent in these entities, as these amounts continue to be provisionally indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any additional outside basis differences in these entities (i.e., basis differences in excess of that subject to the one-time transition tax) is not practicable. We also remeasured and adjusted certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21.0 percent . On December 22, 2017, Staff Accounting Bulletin No. 118 (""SAB 118"") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to finalize the calculations for certain income tax effects of the Tax Reform Act. In accordance with SAB 118, the Company has determined that the net tax charge of $3.6 billion recorded in connection with the tax effect of the Tax Reform Act is a provisional amount and a reasonable estimate as of December 31, 2017 . Additional work is necessary to finalize the calculation for certain income tax effects of the Tax Reform Act. Additionally, certain of our equity method investees are impacted by the Tax Reform Act and have recorded provisional tax amounts. To the extent their provisional amounts are refined in 2018, we will record our proportionate share in the line item equity income (loss) net in our consolidated statement of income. The Global Intangible Low-Taxed Income (""GILTI"") provisions of the Tax Reform Act require the Company to include in its U.S. income tax return foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary's tangible assets. The Company has not yet elected an accounting policy related to how it will account for GILTI and therefore has not provided any deferred tax impacts of GILTI in its consolidated financial statements for the year ended December 31, 2017 . The tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities consist of the following (in millions): December 31, Deferred tax assets: Property, plant and equipment $ $ Trademarks and other intangible assets Equity method investments (including foreign currency translation adjustment) Derivative financial instruments Other liabilities 1,141 Benefit plans 1,599 Net operating/capital loss carryforwards Other Gross deferred tax assets 3,405 4,471 Valuation allowances (501 ) (530 ) Total deferred tax assets 1,2 $ 2,904 $ 3,941 Deferred tax liabilities: Property, plant and equipment $ (819 ) $ (1,176 ) Trademarks and other intangible assets (978 ) (2,694 ) Equity method investments (including foreign currency translation adjustment) (1,835 ) (1,718 ) Derivative financial instruments (436 ) (1,121 ) Other liabilities (50 ) (149 ) Benefit plans (289 ) (487 ) Other (688 ) (635 ) Total deferred tax liabilities 3 (5,095 ) (7,980 ) Net deferred tax liabilities 4 $ (2,191 ) $ (4,039 ) 1 Current deferred tax assets of $80 million were included in the line item prepaid expenses and other assets in our consolidated balance sheet as of December 31, 2016 . 2 Noncurrent deferred tax assets of $331 million and $326 million were included in the line item other assets in our consolidated balance sheets as of December 31, 2017 and 2016 , respectively. 3 Current deferred tax liabilities of $692 million were included in the line item accounts payable and accrued expenses in our consolidated balance sheet as of December 31, 2016 . 4 The decrease in the net deferred tax liabilities was primarily the result of the remeasurement in accordance with the Tax Reform Act and the impact of refranchising certain bottling territories in North America. Refer to Note 2 . As of December 31, 2017 , we had net deferred tax liabilities of $ 539 million and as of December 31, 2016 , we had net deferred tax assets of $ 83 million located in countries outside the United States. As of December 31, 2017 , we had $ 4,893 million of loss carryforwards available to reduce future taxable income. Loss carryforwards of $ 335 million must be utilized within the next five years, and the remainder can be utilized over a period greater than five years. An analysis of our deferred tax asset valuation allowances is as follows (in millions): Year Ended December 31, Balance at beginning of year $ $ $ Additions Decrease due to reclassification to assets held for sale (9 ) (163 ) Deductions (213 ) (6 ) (51 ) Balance at end of year $ $ $ The Company's deferred tax asset valuation allowances are primarily the result of uncertainties regarding the future realization of recorded tax benefits on tax loss carryforwards from operations in various jurisdictions. Current evidence does not suggest we will realize sufficient taxable income of the appropriate character within the carryforward period to allow us to realize these deferred tax benefits. If we were to identify and implement tax planning strategies to recover these deferred tax assets or generate sufficient income of the appropriate character in these jurisdictions in the future, it could lead to the reversal of these valuation allowances and a reduction of income tax expense. The Company believes that it will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets in our consolidated balance sheet. In 2017, the Company recognized a net decrease of $29 million in its valuation allowances. This decrease was primarily due to the reversal of a valuation allowance in a foreign jurisdiction related to expenses incurred in the normal course of business that were previously determined to be non-deductible. In addition, the decrease in value of certain deferred tax assets and related valuation allowance due to the reduction in the U.S. corporate tax rate and changes to deferred tax assets and related valuation allowances on certain equity investments contributed to the net decrease in the valuation allowance. The decreases were partially offset by an increase in the valuation allowance due to increases in the deferred tax asset and related valuation allowances on certain equity investments and recognizing a valuation allowance on deferred tax assets related to net operating losses at certain foreign bottling operations after considering recent negative evidence as to the realizability of those deferred tax assets. In 2016, the Company recognized a net increase of $53 million in its valuation allowances. This increase was primarily due to the increase in non-deductible expenses incurred during the normal course of business operations. In 2015, the Company recognized a net decrease of $172 million in its valuation allowances. As a result of our German bottling operations meeting the criteria to be classified as held for sale, the Company was required to present the related assets and liabilities as separate line items in our consolidated balance sheets. In addition, the changes in net operating losses during the normal course of business and changes in deferred tax assets and related valuation allowances on certain equity investments also contributed to a decrease in the valuation allowances. These decreases were partially offset by an increase in the valuation allowances primarily due to the impact of currency devaluations in Venezuela on certain receivables. NOTE 15 : OTHER COMPREHENSIVE INCOME AOCI attributable to shareowners of The Coca-Cola Company is separately presented in our consolidated balance sheets as a component of The Coca-Cola Company's shareowners' equity, which also includes our proportionate share of equity method investees' AOCI. OCI attributable to noncontrolling interests is allocated to, and included in, our consolidated balance sheets as part of the line item equity attributable to noncontrolling interests. AOCI attributable to shareowners of The Coca-Cola Company consisted of the following, net of tax (in millions): December 31, Foreign currency translation adjustments $ (8,957 ) $ (9,780 ) Accumulated derivative net gain (loss) (119 ) Unrealized net gain (loss) on available-for-sale securities Adjustments to pension and other benefit liabilities (1,722 ) (2,044 ) Accumulated other comprehensive income (loss) $ (10,305 ) $ (11,205 ) The following table summarizes the allocation of total comprehensive income between shareowners of The Coca-Cola Company and noncontrolling interests (in millions): Year Ended December 31, 2017 Shareowners of The Coca-Cola Company Noncontrolling Interests Total Consolidated net income $ 1,248 $ $ 1,283 Other comprehensive income: Net foreign currency translation adjustment 38 Net gain (loss) on derivatives 1 (433 ) (433 ) Net change in unrealized gain (loss) on available-for-sale securities 2 Net change in pension and other benefit liabilities 3 Total comprehensive income $ 2,148 $ $ 2,221 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. Refer to Note 3 for additional information related to the net unrealized gain or loss on available-for-sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. OCI attributable to shareowners of The Coca-Cola Company, including our proportionate share of equity method investees' OCI, for the years ended December 31, 2017 , 2016 and 2015 , is as follows (in millions): Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,350 ) $ (242 ) $ (1,592 ) Reclassification adjustments recognized in net income (6 ) Gains (losses) on intra-entity transactions that are of a long-term investment nature 3,332 3,332 Gains (losses) on net investment hedges arising during the year (1,512 ) (934 ) Net foreign currency translation adjustments Derivatives: Gains (losses) arising during the year (184 ) (119 ) Reclassification adjustments recognized in net income (506 ) (314 ) Net gain (loss) on derivatives 1 (690 ) (433 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (136 ) Reclassification adjustments recognized in net income (123 ) (81 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (94 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (7 ) Reclassification adjustments recognized in net income (116 ) Net change in pension and other benefit liabilities 3 (123 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ $ $ 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (1,103 ) $ $ (1,052 ) Reclassification adjustments recognized in net income (18 ) Gains (losses) on net investment hedges arising during the year (25 ) Reclassification adjustments for net investment hedges recognized in net income (30 ) Net foreign currency translation adjustments (591 ) (22 ) (613 ) Derivatives: Gains (losses) arising during the year (43 ) (32 ) Reclassification adjustments recognized in net income (563 ) (350 ) Net gain (loss) on derivatives 1 (606 ) (382 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (28 ) Reclassification adjustments recognized in net income (105 ) (79 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (2 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (374 ) (275 ) Reclassification adjustments recognized in net income (120 ) Net change in pension and other benefit liabilities 3 (32 ) (21 ) (53 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (1,210 ) $ $ (1,031 ) 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. Before-Tax Amount Income Tax After-Tax Amount Foreign currency translation adjustments: Translation adjustments arising during the year $ (4,626 ) $ $ (4,383 ) Reclassification adjustments recognized in net income (14 ) Unrealized gains (losses) on net investment hedges arising during the year (244 ) Net foreign currency translation adjustments (3,926 ) (15 ) (3,941 ) Derivatives: Unrealized gains (losses) arising during the year (314 ) Reclassification adjustments recognized in net income (638 ) (397 ) Net gain (loss) on derivatives 1 (73 ) Available-for-sale securities: Unrealized gains (losses) arising during the year (973 ) (645 ) Reclassification adjustments recognized in net income (61 ) (39 ) Net change in unrealized gain (loss) on available-for-sale securities 2 (1,034 ) (684 ) Pension and other benefit liabilities: Net pension and other benefits arising during the year (169 ) (126 ) Reclassification adjustments recognized in net income (125 ) Net change in pension and other benefit liabilities 3 (82 ) Other comprehensive income (loss) attributable to shareowners of The Coca-Cola Company $ (4,577 ) $ $ (4,397 ) 1 Refer to Note 5 for additional information related to the net gain or loss on derivative instruments designated and qualifying as cash flow hedging instruments. 2 Refer to Note 3 for additional information related to the net unrealized gain or loss on available for sale securities. 3 Refer to Note 13 for additional information related to the Company's pension and other postretirement benefit liabilities. The following table presents the amounts and line items in our consolidated statements of income where adjustments reclassified from AOCI into income were recorded during the year ended December 31, 2017 (in millions): Description of AOCI Component Financial Statement Line Item Amount Reclassified from AOCI into Income Foreign currency translation adjustments: Divestitures, deconsolidations and other 1 Other income (loss) net $ Income from continuing operations before income taxes $ Income taxes from continuing operations (6 ) Consolidated net income $ Derivatives: Foreign currency contracts Net operating revenues $ (444 ) Foreign currency and commodity contracts Cost of goods sold Foreign currency and interest rate contracts Interest expense Foreign currency contracts Other income (loss) net (110 ) Divestitures, deconsolidations and other 2 Other income (loss) net Income from continuing operations before income taxes $ (506 ) Income taxes from continuing operations Consolidated net income $ (314 ) Available-for-sale securities: Divestitures, deconsolidations and other 2 Other income (loss) net $ (87 ) Sale of securities Other income (loss) net (36 ) Income from continuing operations before income taxes $ (123 ) Income taxes from continuing operations Consolidated net income $ (81 ) Pension and other benefit liabilities: Curtailment charges (credits) 3 Other operating charges $ (75 ) Settlement charges (credits) 3 Other operating charges Divestitures, deconsolidations and other 2 Other income (loss) net Recognized net actuarial loss (gain) * Recognized prior service cost (credit) * (18 ) Income from continuing operations before income taxes $ Income taxes from continuing operations (116 ) Consolidated net income $ 1 Includes a $104 million loss related to the integration of CCW and CCEJ to establish CCBJI and an $80 million gain related to the derecognition of our previously held equity interests in CCBA and its South African subsidiary upon the consolidation of CCBA. Refer to Note 2 and Note 17 . 2 Primarily related to the integration of CCW and CCEJ to establish CCBJI. Refer to Note 17 . 3 The curtailment charges (credits) and settlement charges (credits) were primarily related to North America refranchising and the Company's productivity, restructuring and integration initiatives. Refer to Note 13 and Note 18 . * This component of AOCI is included in the Company's computation of net periodic benefit cost and is not reclassified out of AOCI into a single line item in our consolidated statements of income in its entirety. Refer to Note 13 . NOTE 16 : FAIR VALUE MEASUREMENTS U.S. GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 2 Observable inputs other than quoted prices included in Level 1. We value assets and liabilities included in this level using dealer and broker quotations, certain pricing models, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. Recurring Fair Value Measurements In accordance with U.S. GAAP, certain assets and liabilities are required to be recorded at fair value on a recurring basis. For our Company, the only assets and liabilities that are adjusted to fair value on a recurring basis are investments in equity and debt securities classified as trading or available-for-sale and derivative financial instruments. Additionally, the Company adjusts the carrying value of certain long-term debt as a result of the Company's fair value hedging strategy. Investments in Trading and Available-for-Sale Securities The fair values of our investments in trading and available-for-sale securities using quoted market prices from daily exchange traded markets are based on the closing price as of the balance sheet date and are classified as Level 1. The fair values of our investments in trading and available-for-sale securities classified as Level 2 are priced using quoted market prices for similar instruments or nonbinding market prices that are corroborated by observable market data. Inputs into these valuation techniques include actual trade data, benchmark yields, broker/dealer quotes and other similar data. These inputs are obtained from quoted market prices, independent pricing vendors or other sources. Derivative Financial Instruments The fair values of our futures contracts are primarily determined using quoted contract prices on futures exchange markets. The fair values of these instruments are based on the closing contract price as of the balance sheet date and are classified as Level 1. The fair values of our derivative instruments other than futures are determined using standard valuation models. The significant inputs used in these models are readily available in public markets, or can be derived from observable market transactions, and therefore have been classified as Level 2. Inputs used in these standard valuation models for derivative instruments other than futures include the applicable exchange rates, forward rates, interest rates, discount rates and commodity prices. The standard valuation model for options also uses implied volatility as an additional input. The discount rates are based on the historical U.S. Deposit or U.S. Treasury rates, and the implied volatility specific to options is based on quoted rates from financial institutions. Included in the fair value of derivative instruments is an adjustment for nonperformance risk. The adjustment is based on current credit default swap (""CDS"") rates applied to each contract, by counterparty. We use our counterparty's CDS rate when we are in an asset position and our own CDS rate when we are in a liability position. The adjustment for nonperformance risk did not have a significant impact on the estimated fair value of our derivative instruments. The following tables summarize those assets and liabilities measured at fair value on a recurring basis (in millions): December 31, 2017 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,899 5,739 3 7,807 Derivatives 2 (198 ) 6 8 Total assets $ 2,118 $ 6,116 $ $ $ (198 ) $ 8,273 Liabilities: Derivatives 2 $ (3 ) $ (262 ) $ $ $ 7 $ (118 ) 8 Total liabilities $ (3 ) $ (262 ) $ $ $ $ (118 ) 1 Refer to Note 3 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Primarily related to debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 3. 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5 . 6 The Company is obligated to return $55 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $2 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 59 million in the line item other assets; $28 million in the line item accounts payable and accrued expenses; $12 million in the line item liabilities held for sale discontinued operations and $ 78 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. December 31, 2016 Level 1 Level 2 Level 3 Other 4 Netting Adjustment 5 Fair Value Measurements Assets: Trading securities 1 $ $ $ $ $ $ Available-for-sale securities 1 1,655 4,619 3 6,413 Derivatives 2 (369 ) 6 8 Total assets $ 1,861 $ 5,612 $ $ $ (369 ) $ 7,310 Liabilities: Derivatives 2 $ $ $ $ $ (192 ) 7 $ 8 Total liabilities $ $ $ $ $ (192 ) $ 1 Refer to Note 3 for additional information related to the composition of our trading securities and available-for-sale securities. 2 Refer to Note 5 for additional information related to the composition of our derivative portfolio. 3 Primarily related to long-term debt securities that mature in 2018. 4 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 3. 5 Amounts represent the impact of legally enforceable master netting agreements that allow the Company to settle net positive and negative positions and also cash collateral held or placed with the same counterparties. There are no amounts subject to legally enforceable master netting agreements that management has chosen not to offset or that do not meet the offsetting requirements. Refer to Note 5 . 6 The Company is obligated to return $ 201 million in cash collateral it has netted against its derivative position. 7 The Company has the right to reclaim $ 17 million in cash collateral it has netted against its derivative position. 8 The Company's derivative financial instruments are recorded at fair value in our consolidated balance sheet as follows: $ 347 million in the line item prepaid expenses and other assets; $ 166 million in the line item other assets; $42 million in the line item accounts payable and accrued expenses; and $ 53 million in the line item other liabilities. Refer to Note 5 for additional information related to the composition of our derivative portfolio. Gross realized and unrealized gains and losses on Level 3 assets and liabilities were not significant for the years ended December 31, 2017 and 2016 . The Company recognizes transfers between levels within the hierarchy as of the beginning of the reporting period. Gross transfers between levels within the hierarchy were not significant for the years ended December 31, 2017 and 2016 . Nonrecurring Fair Value Measurements In addition to assets and liabilities that are recorded at fair value on a recurring basis, the Company records assets and liabilities at fair value on a nonrecurring basis as required by U.S. GAAP. Generally, assets are recorded at fair value on a nonrecurring basis as a result of impairment charges. The gains or losses on assets measured at fair value on a nonrecurring basis are summarized in the table below (in millions): Gains (Losses) December 31, Assets held for sale 1 $ (1,819 ) $ (2,264 ) Intangible assets (442 ) 2 (153 ) 7 Other long-lived assets (329 ) 3 Other-than-temporary impairment charge (50 ) 4 Investment in formerly unconsolidated subsidiary 5 Valuation of shares in equity method investee 6 Total $ (2,465 ) $ (2,417 ) 1 The Company is required to record assets and liabilities that are held for sale at the lower of carrying value or fair value less any costs to sell based on the agreed-upon sale price. These losses related to refranchising activities in North America. The charges were calculated based on Level 3 inputs. Refer to Note 2. 2 The Company recognized an impairment charge of $375 million related to CCR's goodwill. This impairment charge was determined by comparing the fair value of the reporting unit, based on Level 3 inputs, to its carrying value. The Company also recognized an impairment charge of $33 million related to certain U.S. bottlers' franchise rights. This charge was determined by comparing the fair value of the asset to its current carrying value. Each of these impairment charges was primarily a result of refranchising activities in North America and management's estimates of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. Additionally, the Company recorded impairment charges of $34 million related to Venezuelan intangible assets due to weaker sales and the volatility of foreign currency exchange rates resulting from continued political instability. The fair value of these assets was derived using discounted cash flow analyses based on Level 3 inputs. 3 The Company recognized impairment charges of $310 million related to CCR's property, plant and equipment and $19 million related to CCR's other assets primarily as a result of refranchising activities in North America. The fair value of these assets was derived using management's estimate of the proceeds that were expected to be received for the remaining bottling territories upon their refranchising. 4 The Company recognized an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. The fair value of this investment was derived using discounted cash flow analyses based on Level 3 inputs. 5 The Company recognized a gain of $150 million on our previously held equity interests in CCBA and its South African subsidiary, which were accounted for under the equity method of accounting prior to our consolidation of the bottler in October 2017. U.S. GAAP requires the acquirer to remeasure its previously held noncontrolling equity interest in the acquired entity to fair value as of the acquisition date and recognize any gains or losses in earnings. The Company remeasured our equity interests in CCBA and its South African subsidiary based on Level 3 inputs. Refer to Note 2. 6 The Company recognized a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock at a per share amount greater than the carrying value of the Company's per share investment. Accordingly, the Company is required to treat this type of transaction as if the Company had sold a proportionate share of its investment in Coca-Cola FEMSA. This gain was determined using Level 1 inputs. 7 The Company recognized losses of $153 million during the year ended December 31, 2016 due to impairment charges related to certain intangible assets. The charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights. This charge was related to a number of factors, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's estimates of the proceeds that were expected to be received upon refranchising the territories. The losses also included a $10 million goodwill impairment charge, primarily the result of management's revised outlook on market conditions. The charges were determined by comparing the fair value of the assets to the current carrying value. The fair value of the assets was derived using discounted cash flow analyses based on Level 3 inputs. Refer to Note 17. Fair Value Measurements for Pension and Other Postretirement Benefit Plans The fair value hierarchy discussed above is not only applicable to assets and liabilities that are included in our consolidated balance sheets but is also applied to certain other assets that indirectly impact our consolidated financial statements. For example, our Company sponsors and/or contributes to a number of pension and other postretirement benefit plans. Assets contributed by the Company become the property of the individual plans. Even though the Company no longer has control over these assets, we are indirectly impacted by subsequent fair value adjustments to these assets. The actual return on these assets impacts the Company's future net periodic benefit cost, as well as amounts recognized in our consolidated balance sheets. Refer to Note 13 . The Company uses the fair value hierarchy to measure the fair value of assets held by our various pension and other postretirement benefit plans. Pension Plan Assets The following table summarizes the levels within the fair value hierarchy for our pension plan assets as of December 31, 2017 and 2016 (in millions): December 31, 2017 December 31, 2016 Level 1 Level 2 Level 3 Other 1 Total Level 1 Level 2 Level 3 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies 2,080 14 2,097 1,812 14 1,827 International-based companies 1,465 1,465 4 Fixed-income securities: Government bonds 1 Corporate bonds and debt securities 24 18 Mutual, pooled and commingled funds 42 3 20 1,022 3 1,133 Hedge funds/limited partnerships 4 1,213 4 1,213 Real estate 5 5 Other 2 6 211 2 6 Total $ 4,410 $ 1,287 $ $ 2,843 $ 8,843 $ 3,211 $ 1,560 $ $ 3,354 $ 8,371 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. 2 Includes purchased annuity insurance contracts. 3 This class of assets includes actively managed emerging markets equity funds and a collective trust fund for qualified plans, invested primarily in equity securities of companies in developed and emerging markets. There are no liquidity restrictions on these investments. 4 This class of assets includes hedge funds that can be subject to redemption restrictions, ranging from monthly to tri-annually with a redemption notice period of up to 120 days and/or initial lock-up periods of up to one year, and private equity funds that are primarily closed-end funds in which the Company's investments are generally not eligible for redemption. Distributions from these private equity funds will be received as the underlying assets are liquidated or distributed. 5 This class of assets includes funds invested in real estate, including a privately held real estate investment trust, a real estate commingled pension trust fund, infrastructure limited partnerships and commingled investment funds. These funds seek current income and capital appreciation through the investments and can be subject to redemption restrictions, ranging from quarterly to semi-annually with a redemption notice period of up to 90 days. 6 This class of assets includes segregated portfolios of private investment funds that are invested in a portfolio of insurance-linked securities. These assets can be subject to a semi-annual redemption, with a redemption notice period of 90 days, subject to certain gate restrictions. The following table provides a reconciliation of the beginning and ending balance of Level 3 assets for our U.S. and non-U.S. pension plans for the years ended December 31, 2017 and 2016 (in millions): Equity Securities Fixed-Income Securities Real Estate Other Total Balance at beginning of year $ $ $ $ $ Actual return on plan assets: Related to assets held at the reporting date Related to assets sold during the year (2 ) Purchases, sales and settlements net (23 ) (11 ) Transfers into/(out of) Level 3 net (1 ) Foreign currency translation adjustments (2 ) (2 ) Balance at end of year $ $ $ $ 1 $ 2017 Balance at beginning of year $ $ $ $ $ Actual return on plan assets: Related to assets held at the reporting date (3 ) Purchases, sales and settlements net (9 ) (5 ) Transfers into/(out of) Level 3 net Foreign currency translation adjustments Balance at end of year $ $ $ $ 1 $ 1 Includes purchased annuity insurance contracts. Other Postretirement Benefit Plan Assets The following table summarizes the levels within the fair value hierarchy for our other postretirement benefit plan assets as of December 31, 2017 and 2016 (in millions): December 31, 2017 December 31, 2016 Level 1 Level 2 Other 1 Total Level 1 Level 2 Other 1 Total Cash and cash equivalents $ $ $ $ $ $ $ $ Equity securities: U.S.-based companies International-based companies Fixed-income securities: Government bonds Corporate bonds and debt securities Mutual, pooled and commingled funds 80 103 Hedge funds/limited partnerships 8 9 Real estate 5 4 Other 4 4 Total $ $ $ $ $ $ $ $ 1 Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy but are included to reconcile to the amounts presented in Note 13. Other Fair Value Disclosures The carrying amounts of cash and cash equivalents; short-term investments; trade accounts receivables; accounts payable and accrued expenses; and loans and notes payable approximate their fair values because of the relatively short-term maturities of these financial instruments. The fair value of our long-term debt is estimated using Level 2 inputs based on quoted prices for those instruments. Where quoted prices are not available, fair value is estimated using discounted cash flows and market-based expectations for interest rates, credit risk and the contractual terms of the debt instruments. As of December 31, 2017 , the carrying amount and fair value of our long-term debt, including the current portion, were $34,480 million and $ 35,169 million , respectively. As of December 31, 2016 , the carrying amount and fair value of our long-term debt, including the current portion, were $33,211 million and $ 33,752 million , respectively. NOTE 17 : SIGNIFICANT OPERATING AND NONOPERATING ITEMS Other Operating Charges In 2017, the Company recorded other operating charges of $2,157 million . These charges primarily consisted of $737 million of CCR asset impairments and $650 million related to the Company's productivity and reinvestment program. In addition, other operating charges included $419 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. Other operating charges also included $225 million related to a cash contribution we made to The Coca-Cola Foundation, $67 million related to tax litigation expense, $34 million related to impairments of Venezuelan intangible assets and $19 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information about the Venezuelan intangible assets and Note 16 for information on how the Company determined the CCR asset impairment charges. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. In 2016, the Company recorded other operating charges of $1,510 million . These charges primarily consisted of $352 million due to the Company's productivity and reinvestment program and $240 million due to the integration of our German bottling operations. In addition, the Company recorded charges of $415 million related to costs incurred to refranchise certain of our bottling operations. These costs include, among other items, internal and external costs for individuals directly working on the refranchising efforts, severance, pension settlement charges and costs associated with the implementation of information technology systems to facilitate consistent data standards and availability throughout our bottling systems. The Company also recorded a charge of $200 million related to cash contributions we made to The Coca-Cola Foundation, a charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela as a result of changes in exchange rates and charges of $41 million related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 1 for additional information on the Venezuelan exchange rates. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. In 2016, the Company also recorded charges of $153 million related to certain intangible assets. These charges included $143 million related to the impairment of certain U.S. bottlers' franchise rights recorded in our Bottling Investments operating segment. This charge was related to a number of factors, primarily as a result of lower operating performance compared to previously modeled results as well as a revision in management's view of the proceeds that may be ultimately received upon refranchising the territories. The remaining charge of $10 million was related to the impairment of goodwill recorded in our Bottling Investments operating segment. This charge was primarily the result of management's revised outlook on market conditions. The total impairment charges of $153 million were recorded in our Bottling Investments operating segment in the line item other operating charges in our consolidated statement of income and were determined by comparing the fair value of the intangible assets, derived using discounted cash flow analyses, to their respective carrying values. In 2015, the Company incurred other operating charges of $1,657 million . These charges included $ 691 million due to the Company's productivity and reinvestment program and $ 292 million due to the integration of our German bottling operations. In addition, the Company recorded impairment charges of $418 million primarily due to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction and incurred a charge of $100 million due to a cash contribution we made to The Coca-Cola Foundation. The Company also incurred a charge of $ 111 million due to the write-down we recorded related to receivables from our bottling partner in Venezuela and an impairment of a Venezuelan trademark primarily due to changes in exchange rates as a result of the establishment of the new open market exchange system. Refer to Note 1 for additional information on the Venezuelan currency change. Refer to Note 2 for additional information on the Monster Transaction. Refer to Note 18 for additional information on the Company's productivity, integration and restructuring initiatives. Refer to Note 19 for the impact these charges had on our operating segments. Other Nonoperating Items Interest Expense During the year ended December 31, 2017 , the Company recorded a net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 10 for additional information and Note 19 for the impact this charge had on our operating segments.. During the year ended December 31, 2015, the Company recorded charges of $ 320 million due to the early extinguishment of certain long-term debt. These charges included the difference between the reacquisition price and the net carrying amount of the debt extinguished, including the impact of the related fair value hedging relationship. Refer to Note 10 for additional information and Note 19 for the impact these charges had on our operating segments. Equity Income (Loss) Net The Company recorded net charges of $92 million , $ 61 million and $ 87 million in equity income (loss) net during the years ended December 31, 2017 , 2016 and 2015 , respectively. These amounts primarily represent the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 19 for the impact these charges had on our operating segments. Other Income (Loss) Net In 2017, other income (loss) net was a loss of $1,666 million . The Company recognized a net charge of $2,140 million due to the refranchising of certain bottling territories in North America and charges of $313 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. The Company also recorded an other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Additionally, the Company incurred a charge of $26 million related to our former German bottling operations. These charges were partially offset by a gain of $445 million related to the integration of CCW and CCEJ to establish CCBJI. In exchange for our previously existing equity interests in CCW and CCEJ, we received an approximate 17 percent equity interest in CCBJI. The fair value of our equity investment in CCBJI was based on its quoted market price (a Level 1 measurement). The Company also recognized a gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Additionally, the Company recognized a gain of $88 million related to the refranchising of our China bottling operations and related cost method investment and a gain of $25 million as a result of Coca-Cola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. Refer to Note 2 for additional information on our North America and China refranchising activities and our consolidation of CCBA. Refer to Note 19 for the impact these items had on our operating segments. In 2016, other income (loss) net was a loss of $1,234 million . This loss included a net charge of $2,456 million due to the refranchising of certain bottling territories in North America and a charge of $21 million due to the deconsolidation of our South African bottling operations and disposal of the related equity method investment in exchange for investments in CCBA and CCBA's South African subsidiary. The Company incurred charges of $31 million related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Additionally, the Company incurred a charge of $72 million as a result of remeasuring its net monetary assets denominated in Egyptian pounds. The Egyptian pound devalued as a result of the central bank allowing its currency, which was previously pegged to the U.S. dollar, to float freely. These charges were partially offset by a gain of $1,323 million due to the deconsolidation of our German bottling operations. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations, the deconsolidation of our South African bottling operations, the North America refranchising and the conversion payments. Refer to Note 19 for the impact these items had on our operating segments. In 2015, the Company recorded a net gain of $ 1,403 million as a result of the Monster Transaction and a net charge of $ 1,006 million due to the refranchising of certain bottling territories in North America. In addition, the Company recognized a foreign currency exchange gain of $ 300 million associated with our foreign-denominated debt partially offset by a charge of $ 27 million due to the remeasurement of the net monetary assets of our Venezuelan subsidiary using the SIMADI exchange rate. Refer to Note 1 for additional information related to the charge due to the remeasurement in Venezuela. Refer to Note 2 for additional information related to the Monster Transaction and North America refranchising. Refer to Note 19 for the impact these items had on our operating segments. NOTE 18 : PRODUCTIVITY, INTEGRATION AND RESTRUCTURING INITIATIVES Productivity and Reinvestment In February 2012, the Company announced a productivity and reinvestment program designed to further enable our efforts to strengthen our brands and reinvest our resources to drive long-term profitable growth. This program is focused on the following initiatives: global supply chain optimization; global marketing and innovation effectiveness; operating expense leverage and operational excellence; data and information technology systems standardization; and the integration of Old CCE's North American bottling operations. In February 2014, the Company announced the expansion of our productivity and reinvestment program to drive incremental productivity that will primarily be redirected into increased media investments. Our incremental productivity goal consists of two relatively equal components. First, we will expand savings through global supply chain optimization, data and information technology systems standardization, and resource and cost reallocation. Second, we will increase the effectiveness of our marketing investments by transforming our marketing and commercial model to redeploy resources into more consumer-facing marketing investments to accelerate growth. In October 2014, the Company announced that we were further expanding our productivity and reinvestment program and extending it through 2019. The expansion of the productivity initiatives will focus on four key areas: restructuring the Company's global supply chain; implementing zero-based work, an evolution of zero-based budget principles, across the organization; streamlining and simplifying the Company's operating model; and further driving increased discipline and efficiency in direct marketing investments. In April 2017, the Company announced its plans to transition to a new, more agile operating model to enable growth. Under this operating model, our business units will be supported by an expanded enabling services organization and a corporate center focused on a few strategic initiatives, policy and governance. The expanded enabling services organization will focus on both simplifying and standardizing key transactional processes and providing support to business units through global centers of excellence. The Company has incurred total pretax expenses of $3,058 million related to this program since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income. Refer to Note 19 for the impact these charges had on our operating segments. Outside services reported in the table below primarily relate to expenses in connection with legal, outplacement and consulting activities. Other direct costs reported in the table below include, among other items, internal and external costs associated with the development, communication, administration and implementation of these initiatives; accelerated depreciation on certain fixed assets; contract termination fees; and relocation costs. The following table summarizes the balance of accrued expenses related to these productivity and reinvestment initiatives and the changes in the accrued amounts (in millions): Severance Pay and Benefits Outside Services Other Direct Costs Total Accrued balance at beginning of year $ $ $ $ Costs incurred Payments (200 ) (47 ) (265 ) (512 ) Noncash and exchange (185 ) 1 (5 ) (70 ) (260 ) Accrued balance at end of year $ $ $ $ 2016 Costs incurred $ $ $ $ Payments (114 ) (30 ) (205 ) (349 ) Noncash and exchange (2 ) (55 ) (56 ) Accrued balance at end of year $ $ $ $ 2017 Costs incurred $ $ $ $ Payments (181 ) (83 ) (267 ) (531 ) Noncash and exchange (62 ) 1 (1 ) (1 ) (64 ) Accrued balance at end of year $ $ $ $ 1 Includes pension settlement charges. Refer to Note 13. Integration Initiatives Integration of Our German Bottling Operations In 2008, the Company began an integration initiative related to our German bottling operations acquired in 2007. The Company incurred $ 240 million and $ 292 million of expenses related to this initiative in 2016 and 2015 , respectively and has incurred total pretax expenses of $ 1,367 million related to this initiative since it commenced. These expenses were recorded in the line item other operating charges in our consolidated statements of income and impacted the Bottling Investments operating segment. The expenses recorded in connection with these integration activities have been primarily due to involuntary terminations. The Company had $122 million accrued related to these integration costs as of December 31, 2015. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Therefore, there was no remaining accrual balance as of December 31, 2016. Refer to Note 2 for additional information on the deconsolidation of our German bottling operations. NOTE 19 : OPERATING SEGMENTS As of December 31, 2017 , our organizational structure consisted of the following operating segments: Europe, Middle East and Africa; Latin America; North America; Asia Pacific; Bottling Investments; and Corporate. Segment Products and Services The business of our Company is nonalcoholic beverages. Our geographic operating segments (Europe, Middle East and Africa; Latin America; North America; and Asia Pacific) derive a majority of their revenues from the manufacture and sale of beverage concentrates and syrups and, in some cases, the sale of finished beverages. Our Bottling Investments operating segment is composed of our Company-owned or consolidated bottling operations, with the exception of those that are classified as discontinued operations, regardless of the geographic location of the bottler. Our Bottling Investments operating segment also includes equity income from the majority of our equity method investments. Company-owned or consolidated bottling operations derive the majority of their revenues from the sale of finished beverages. Generally, finished product operations produce higher net operating revenues but lower gross profit margins compared to concentrate operations. The following table sets forth the percentage of total net operating revenues related to concentrate operations and finished product operations: Year Ended December 31, Concentrate operations 1 % % % Finished product operations 2 60 Total % % % 1 Includes concentrates sold by the Company to authorized bottling partners for the manufacture of fountain syrups. The bottlers then typically sell the fountain syrups to wholesalers or directly to fountain retailers. 2 Includes fountain syrups manufactured by the Company, including consolidated bottling operations, and sold to fountain retailers or to authorized fountain wholesalers or bottling partners who resell the fountain syrups to fountain retailers. Method of Determining Segment Income or Loss Management evaluates the performance of our operating segments separately to individually monitor the different factors affecting financial performance. Our Company manages income taxes from continuing operations and certain treasury-related items, such as interest income and expense, on a global basis within the Corporate operating segment. We evaluate segment performance based on income or loss from continuing operations before income taxes. Geographic Data The following table provides information related to our net operating revenues (in millions): Year Ended December 31, United States $ 14,727 $ 19,899 $ 20,360 International 20,683 21,964 23,934 Net operating revenues $ 35,410 $ 41,863 $ 44,294 The following table provides information related to our property, plant and equipment net (in millions): Year Ended December 31, United States $ 4,163 $ 6,784 $ 8,266 International 4,040 3,851 4,305 Property, plant and equipment net $ 8,203 $ 10,635 $ 12,571 Information about our Company's continuing operations by operating segment as of and for the years ended December 31, 2017 , 2016 and 2015 , is as follows (in millions): Europe, Middle East Africa Latin America North America Asia Pacific Bottling Investments Corporate Eliminations Consolidated Net operating revenues: Third party $ 7,332 $ 3,956 $ 8,651 $ 4,767 $ 10,524 $ $ $ 35,368 Intersegment 1,986 (2,549 ) 4 Total net operating revenues 7,374 4,029 10,637 5,176 10,605 (2,549 ) 35,410 Operating income (loss) 3,646 2,214 2,578 2,163 (1,117 ) (1,983 ) 7,501 Interest income Interest expense Depreciation and amortization 1,260 Equity income (loss) net (3 ) (3 ) 1,071 Income (loss) from continuing operations before income taxes 3,706 2,211 2,307 2,179 (2,345 ) (1,316 ) 6,742 Identifiable operating assets 1 5,475 1,896 17,619 2,072 2 4,493 2 27,060 58,615 5 Investments 3 1,238 15,998 3,536 21,952 Capital expenditures 1,675 Net operating revenues: Third party $ 7,014 $ 3,746 $ 6,437 $ 4,788 $ 19,751 $ $ $ 41,863 Intersegment 3,773 (4,755 ) Total net operating revenues 7,278 3,819 10,210 5,294 19,885 (4,755 ) 41,863 Operating income (loss) 3,676 1,951 2,582 2,224 (137 ) (1,670 ) 8,626 Interest income Interest expense Depreciation and amortization 1,013 1,787 Equity income (loss) net (17 ) Income (loss) from continuing operations before income taxes 3,749 1,966 2,560 2,238 (1,923 ) (454 ) 8,136 Identifiable operating assets 1 4,067 1,785 16,566 2,024 15,973 29,606 70,021 Investments 3 1,302 11,456 3,414 17,249 Capital expenditures 1,329 2,262 Net operating revenues: Third party $ 6,966 $ 3,999 $ 5,581 $ 4,707 $ 22,885 $ $ $ 44,294 Intersegment 4,259 (5,688 ) Total net operating revenues 7,587 4,074 9,840 5,252 23,063 (5,688 ) 44,294 Operating income (loss) 3,875 2,169 2,366 2,189 (1,995 ) 8,728 Interest income Interest expense Depreciation and amortization 1,211 1,970 Equity income (loss) net (7 ) (18 ) Income (loss) from continuing operations before income taxes 3,923 2,164 2,356 2,207 (427 ) (618 ) 9,605 Identifiable operating assets 1 4,156 2 1,627 16,396 1,639 22,688 2 27,702 74,208 Investments 3 1,138 8,084 5,644 15,788 Capital expenditures 1,699 2,553 1 Principally cash and cash equivalents, short-term investments, marketable securities, trade accounts receivable, inventories, goodwill, trademarks and other intangible assets, and property, plant and equipment net. 2 Property, plant and equipment net in India represented 11 percent of consolidated property, plant and equipment net in 2017. Property, plant and equipment net in Germany represented 10 percent of consolidated property, plant and equipment net in 2015. The 2015 amount includes property, plant and equipment net classified as held for sale. During the year ended December 31, 2016, the Company deconsolidated our German bottling operations. Refer to Note 2 . 3 Principally equity method investments and other investments in bottling companies. 4 Intersegment revenues do not eliminate on a consolidated basis in the table above due to intercompany sales to our discontinued operations. 5 Identifiable operating assets excludes $7,329 million of assets held for sale discontinued operations. During 2017, 2016 and 2015, our operating segments were impacted by acquisition and divestiture activities. Refer to Note 2. In 2017 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $26 million for Europe, Middle East and Africa, $7 million for Latin America, $241 million for North America, $10 million for Asia Pacific, $57 million for Bottling Investments and $309 million for Corporate due to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $737 million for Bottling Investments and $34 million for Corporate due to asset impairment charges. Refer to Note 1 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $419 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $225 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $67 million for Corporate due to tax litigation expense. Refer to Note 11 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa, $2 million for North America, $70 million for Bottling Investments and $16 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $2,140 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $445 million for Corporate due to a gain recognized resulting from the merger of CCW and CCEJ. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $313 million for North America primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $150 million for Corporate related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 . Income (loss) from continuing operations before income taxes was increased by $88 million for Corporate due to a gain recognized upon refranchising our China bottling operations and related cost method investment. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $50 million for Corporate due to an other-than-temporary impairment charge related to one of our international equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $38 million for Corporate due to the early extinguishment of long-term debt. Refer to Note 10 . Income (loss) from continuing operations before income taxes was reduced by $26 million for Corporate due to a charge related to our former German bottling operations. Income (loss) from continuing operations before income taxes was increased by $25 million for Corporate due to CocaCola FEMSA, an equity method investee, issuing additional shares of its stock during the period at a per share amount greater than the carrying value of the Company's per share investment. In 2016 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $32 million for Europe, Middle East and Africa, $134 million for North America, $1 million for Asia Pacific, $322 million for Bottling Investments and $105 million for Corporate due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Operating income (loss) and income (loss) from continuing operations before income taxes were increased by $2 million for Latin America due to the refinement of previously established accruals related to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $297 million for Bottling Investments due to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $200 million for Corporate as a result of cash contributions to The Coca-Cola Foundation. Refer to Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $153 million for Bottling Investments due to impairment charges recorded on certain of the Company's intangible assets. Refer to Note 17. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $118 million for Bottling Investments due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 17. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $76 million for Latin America due to the write-down we recorded related to our receivables from our bottling partner in Venezuela due to changes in exchange rates. Refer to Note 1. Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $9 million for Bottling Investments and $32 million for Corporate related to noncapitalizable transaction costs associated with pending and closed transactions. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $52 million for Bottling Investments and $9 million for Corporate due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $2,456 million for Bottling Investments primarily due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was increased by $1,323 million for Corporate as a result of the deconsolidation of our German bottling operations. Refer to Note 2 . Income (loss) from continuing operations before income taxes was reduced by $72 million for Corporate as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $31 million for North America related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 . In 2015 , the results of our operating segments were impacted by the following items: Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $ 7 million for Latin America, $ 141 million for North America, $ 2 million for Asia Pacific, $ 596 million for Bottling Investments and $ 246 million for Corporate due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Operating income (loss) and income (loss) from continuing operations before income taxes were increased by $ 9 million for Europe, Middle East and Africa due to the refinement of previously established accruals, partially offset by additional charges related to the Company's productivity and reinvestment program. Refer to Note 18 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $418 million for Corporate primarily due to an impairment charge primarily related to the discontinuation of the energy products in the glacau portfolio as a result of the Monster Transaction. Refer to Note 2 and Note 17 . Operating income (loss) and income (loss) from continuing operations before income taxes were reduced by $100 million for Corporate as a result of a cash contribution to The Coca-Cola Foundation. Refer to Note 17 . Income (loss) from continuing operations before income taxes was reduced by $4 million for Europe, Middle East and Africa and $83 million for Bottling Investments due to the Company's proportionate share of significant operating and nonoperating items recorded by certain of our equity method investees. Refer to Note 17 . Income (loss) from continuing operations before income taxes was increased by $1,403 million for Corporate as a result of the Monster Transaction. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $1,006 million for Bottling Investments due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $320 million for Corporate due to charges the Company recognized on the early extinguishment of certain long-term debt. Refer to Note 10 and Note 17 . Income (loss) from continuing operations before income taxes was reduced by $33 million for Latin America and $105 million for Corporate due to the remeasurement of the net monetary assets of our local Venezuelan subsidiary into U.S. dollars using the SIMADI exchange rate, an impairment of a Venezuelan trademark, and a write-down the Company recorded on receivables from our bottling partner in Venezuela. Refer to Note 1 and Note 17 . NOTE 20 : NET CHANGE IN OPERATING ASSETS AND LIABILITIES Net cash provided by (used in) operating activities attributable to the net change in operating assets and liabilities is composed of the following (in millions): Year Ended December 31, (Increase) decrease in trade accounts receivable $ (141 ) $ (28 ) $ (212 ) (Increase) decrease in inventories (355 ) (142 ) (250 ) (Increase) decrease in prepaid expenses and other assets Increase (decrease) in accounts payable and accrued expenses (445 ) (540 ) 1,004 Increase (decrease) in accrued income taxes (153 ) (306 ) Increase (decrease) in other liabilities 1 4,052 (544 ) (516 ) Net change in operating assets and liabilities $ 3,529 $ (221 ) $ (157 ) 1 The increase in other liabilities in 2017 was primarily due to the one-time transition tax required by the Tax Reform Act signed into law on December 22, 2017 . Refer to Note 14 . REPORT OF MANAGEMENT Management's Responsibility for the Financial Statements Management of the Company is responsible for the preparation and integrity of the consolidated financial statements appearing in our Annual Report on Form 10-K. The financial statements were prepared in conformity with accounting principles generally accepted in the United States appropriate in the circumstances and, accordingly, include certain amounts based on our best judgments and estimates. Financial information in this Annual Report on Form 10-K is consistent with that in the financial statements. Management of the Company is responsible for establishing and maintaining a system of internal controls and procedures to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements. Our internal control system is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Business Conduct adopted by our Company's Board of Directors, applicable to all officers and employees of our Company and subsidiaries. In addition, our Company's Board of Directors adopted a written Code of Business Conduct for Non-Employee Directors which reflects the same principles and values as our Code of Business Conduct for officers and employees but focuses on matters of relevance to non-employee Directors. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and, even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management's Report on Internal Control Over Financial Reporting Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 (""Exchange Act""). Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2017 . In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (""COSO"") in Internal Control Integrated Framework . Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017 . The Company's independent auditors, Ernst Young LLP, a registered public accounting firm, are appointed by the Audit Committee of the Company's Board of Directors, subject to ratification by our Company's shareowners. Ernst Young LLP has audited and reported on the consolidated financial statements of The Coca-Cola Company and subsidiaries and the Company's internal control over financial reporting. The reports of the independent auditors are contained in this annual report. Audit Committee's Responsibility The Audit Committee of our Company's Board of Directors, composed solely of Directors who are independent in accordance with the requirements of the New York Stock Exchange listing standards, the Exchange Act, and the Company's Corporate Governance Guidelines, meets with the independent auditors, management and internal auditors periodically to discuss internal controls and auditing and financial reporting matters. The Audit Committee reviews with the independent auditors the scope and results of the audit effort. The Audit Committee also meets periodically with the independent auditors and the chief internal auditor without management present to ensure that the independent auditors and the chief internal auditor have free access to the Audit Committee. Our Audit Committee's Report can be found in the Company's 2018 Proxy Statement. James R. Quincey Larry M. Mark President and Chief Executive Officer February 23, 2018 Vice President and Controller February 23, 2018 Kathy N. Waller Mark Randazza Executive Vice President, Chief Financial Officer and President, Enabling Services February 23, 2018 Vice President, Assistant Controller and Chief Accounting Officer February 23, 2018 Report of Independent Registered Public Accounting Firm Board of Directors and Shareowners The Coca-Cola Company Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of The Coca-Cola Company and subsidiaries (the Company) as of December 31, 2017 and 2016 , the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations for the Treadway Commission (2013 framework) and our report dated February 23, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company's auditor since 1921. Atlanta, Georgia February 23, 2018 Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting Board of Directors and Shareowners The Coca-Cola Company Opinion on Internal Control over Financial Reporting We have audited The Coca-Cola Company and subsidiaries' internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, The Coca-Cola Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria. As indicated in the accompanying Management's Report on Internal Control Over Financial Reporting, management's assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Coca-Cola Beverages Africa Proprietary Limited (CCBA), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of the Company and constituted 8 percent of the total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of CCBA. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, shareowners' equity, and cash flows, for each of the three years in the period ended December 31, 2017, and related notes and our report dated February 23, 2018 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Atlanta, Georgia February 23, 2018 Quarterly Data (Unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter Full Year (In millions except per share data) Net operating revenues $ 9,118 $ 9,702 $ 9,078 $ 7,512 $ 35,410 Gross profit 5,605 6,043 5,683 4,823 22,154 Net income (loss) attributable to shareowners of The Coca-Cola Company 1,182 1,371 1,447 (2,752 ) 1,248 Basic net income (loss) per share $ 0.28 $ 0.32 $ 0.34 $ (0.65 ) $ 0.29 Diluted net income (loss) per share $ 0.27 $ 0.32 $ 0.33 $ (0.65 ) $ 0.29 1 Net operating revenues $ 10,282 $ 11,539 $ 10,633 $ 9,409 $ 41,863 Gross profit 6,213 7,068 6,502 5,615 25,398 Net income attributable to shareowners of The Coca-Cola Company 1,483 3,448 1,046 6,527 Basic net income per share $ 0.34 $ 0.80 $ 0.24 $ 0.13 $ 1.51 Diluted net income per share $ 0.34 $ 0.79 $ 0.24 $ 0.13 $ 1.49 1 1 The sum of the quarterly net income per share amounts does not agree to the full year net income per share amounts. We calculate net income per share based on the weighted-average number of outstanding shares during the reporting period. The average number of shares fluctuates throughout the year and can therefore produce a full year result that does not agree to the sum of the individual quarters. Our first quarter, second quarter and third quarter reporting periods end on the Friday closest to the last day of the applicable quarterly calendar period. Our fourth quarter and fiscal year end on December 31 regardless of the day of the week on which December 31 falls. During 2017 and 2016, our quarterly operating results were impacted by acquisition and divestiture activities. Refer to Note 2. The Company's first quarter 2017 results were impacted by two fewer days compared to the first quarter of 2016. Furthermore, the Company recorded the following transactions which impacted results: Charges of $497 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $139 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $106 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. Charges of $104 million related to the impairment of certain intangible assets. Refer to Note 17. A net charge of $58 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. Charges of $60 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the second quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $667 million related to the impairment of certain intangible assets. Refer to Note 17. A gain of $445 million related to the integration of CCW and CCEJ to establish CCBJI. Refer to Note 17. Charges of $214 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $109 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. Charges of $87 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $44 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. A net charge of $38 million related to the early extinguishment of long-term debt. Refer to Note 10 . A net gain of $37 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. A gain of $9 million related to refranchising a substantial portion of our China bottling operations. Refer to Note 2 and Note 17. In the third quarter of 2017, the Company recorded the following transactions which impacted results: Charges of $762 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $213 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $129 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. A gain of $79 million related to the refranchising of our remaining China bottling operations and related cost method investment. Refer to Note 2 and Note 17. Charges of $72 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. A n other-than-temporary impairment charge of $50 million related to one of our international equity method investees, primarily driven by foreign currency exchange rate fluctuations. Refer to Note 16 and Note 17. A net charge of $16 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17 The Company's fourth quarter 2017 results were impacted by one additional day compared to the fourth quarter of 2016. Furthermore, the Company recorded the following transactions which impacted results: A net provisional tax charge of $3,610 million as a result of the Tax Reform Act that was signed into law on December 22, 2017. Refer to Note 14. Charges of $667 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $295 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. A charge of $225 million as a result of a cash contribution to The Coca-Cola Foundation. Refer to Note 17. A gain of $150 million related to the remeasurement of our previously held equity interests in CCBA and its South African subsidiary to fair value. Refer to Note 2 and Note 17. Charges of $105 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. A net charge of $55 million related to the Company's proportionate share of unusual or infrequent items recorded by certain of our equity method investees. Refer to Note 17. Charges of $26 million primarily related to payments made to convert the bottling agreements for certain North America bottling partners' territories to a single form of CBA with additional requirements. Refer to Note 2 and Note 17. In the first quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $369 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $262 million due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Refer to Note 17 and Note 18. Charges of $45 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the second quarter of 2016, the Company recorded the following transactions which impacted results: A benefit of $1,292 million, net of transaction costs, as a result of the deconsolidation of our German bottling operations. Refer to Note 2 and Note 17. Charges of $199 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $106 million due to the Company's productivity and reinvestment program as well as other restructuring initiatives. Refer to Note 17 and Note 18. A charge of $100 million as a result of a cash donation to The Coca-Cola Foundation. Refer to Note 17. A net tax charge of $83 million primarily related to amounts required to be recorded for changes to our uncertain tax positions, including interest and penalties. Refer to Note 14. Charges of $52 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. In the third quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $1,089 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. A charge of $80 million resulting from the accrual of tax on temporary differences related to the investment in foreign subsidiaries that are now expected to reverse in the foreseeable future. Refer to Note 14. A charge of $76 million due to the write-down we recorded related to our receivables from our bottling partner in Venezuela. Refer to Note 1 and Note 17. Charges of $73 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $59 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. In the fourth quarter of 2016, the Company recorded the following transactions which impacted results: Charges of $799 million due to the refranchising of certain bottling territories in North America. Refer to Note 2 and Note 17. Charges of $165 million due to the Company's productivity and reinvestment program. Refer to Note 17 and Note 18. Charges of $153 million related to the impairment of certain intangible assets. Refer to Note 17. Charges of $127 million related to costs incurred to refranchise certain of our bottling operations. Refer to Note 2 and Note 17. Charges of $118 million due to pension settlement charges primarily as a result of our refranchising activities. Refer to Note 2 and Note 17. A charge of $100 million as a result of a cash donation to The Coca-Cola Foundation. Refer to Note 17. A charge of $72 million as a result of remeasuring our net monetary assets denominated in Egyptian pounds. Refer to Note 17. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's ""disclosure controls and procedures"" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (""Exchange Act"")) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2017 . Report of Management on Internal Control Over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm The report of management on our internal control over financial reporting as of December 31, 2017 and the attestation report of our independent registered public accounting firm on our internal control over financial reporting are set forth in Part II, ""Item 8. Financial Statements and Supplementary Data"" in this report. Management has excluded from the scope of its assessment of internal control over financial reporting the operations and related assets of Coca-Cola Beverages Africa Proprietary Limited (""CCBA""), which the Company began consolidating in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . Changes in Internal Control Over Financial Reporting Except as described below, there have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company began consolidating the operations and related assets of CCBA in October 2017. The operations and related assets of CCBA were included in the consolidated financial statements of The Coca-Cola Company and subsidiaries and constituted 8 percent of total assets and 8 percent of consolidated net income as of and for the year ended December 31, 2017 . " diff --git a/datasets/raw/costco.csv b/datasets/raw/costco.csv new file mode 100644 index 0000000..26d1bec --- /dev/null +++ b/datasets/raw/costco.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,cost,20210829," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 815, 795, and 782 warehouses worldwide at August 29, 2021, August 30, 2020, and September 1, 2019, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. General We operate membership warehouses and e-commerce websites based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. For our e- commerce operations we ship merchandise through our depots, our logistics operations for big and bulky items, as well as through drop-ship and other delivery arrangements with our suppliers. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, Executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit most items to fast-selling models, sizes, and colors. We carry less than 4,000 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. We average anywhere from 9,000 to 11,000 SKUs online, some of which are also available in our warehouses. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise and services in the following categories: Core Merchandise Categories (or core business): Foods and Sundries (including sundries, dry grocery, candy, cooler, freezer, deli, liquor, and tobacco) Non-Foods (previously Hardlines and Softlines; including major appliances, electronics, health and beauty aids, hardware, garden and patio, sporting goods, tires, toys and seasonal, office supplies, automotive care, postage, tickets, apparel, small appliances, furniture, domestics, housewares, special order kiosk, and jewelry) Fresh Foods (including meat, produce, service deli, and bakery) Warehouse Ancillary (includes gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and Other Businesses (includes e-commerce, business centers, travel, and other) Warehouse ancillary businesses operate primarily within or next to our warehouses, encouraging members to shop more frequently. The number of warehouses with gas stations varies significantly by country, and we have no gasoline business in Korea or China. We operated 636 gas stations at the end of 2021. Net sales for our gasoline business represented approximately 9% of total net sales in 2021. Our other businesses sell products and services that complement our warehouse operations (core and warehouse ancillary businesses). Our e-commerce operations give members convenience and a broader selection of goods and services. Net sales for e-commerce represented approximately 7% of total net sales in 2021. This figure does not consider other services we offer online in certain countries such as business delivery, travel, same-day grocery, and various other services. Our business centers carry items tailored specifically for food services, convenience stores and offices, and offer walk-in shopping and deliveries. Business centers are included in our total warehouse count. Costco Travel offers vacation packages, hotels, cruises, and other travel products exclusively for Costco members (offered in the U.S., Canada, and the U.K.). We have direct buying relationships with many producers of brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. The COVID-19 pandemic created unprecedented supply constraints, including disruptions and delays that have impacted and could continue to impact the flow and availability of certain products. When sources of supply become unavailable, we seek alternative sources. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 12 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at all of our warehouses and websites. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 89% worldwide at the end of 2021. The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. At the end of 2020, we standardized our membership count methodology globally to be consistent with the U.S. and Canada, which resulted in the addition to the count of approximately 2.0 million total cardholders for 2020, of which 1.3 million were paid members. The change did not impact 2019. Membership fee income and the renewal rate calculations were not affected. Our membership was made up of the following (in thousands): 2021 2020 2019 Gold Star 50,200 46,800 42,900 Business, including affiliates 11,500 11,300 11,000 Total paid members 61,700 58,100 53,900 Household cards 49,900 47,400 44,600 Total cardholders 111,600 105,500 98,500 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., Japan, Korea, and Taiwan, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (generally up to a maximum reward of $1,000 per year), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members totaled 25.6 million and represented 55% of paid members (excluding affiliates) in the U.S. and Canada and 17% of paid members (excluding affiliates) in our Other International operations at the end of 2021. They generally shop more frequently and spend more than other members. Human Capital Our Code of Ethics requires that we Take Care of Our Employees, which is fundamental to the obligation to Take Care of Our Members. We must also carefully control our selling, general and administrative (SGA) expenses, so that we can sell high quality goods and services at low prices. Compensation and benefits for employees is our largest expense after the cost of merchandise and is carefully monitored. At the end of 2021, we employed 288,000 employees worldwide. The large majority (approximately 95%) is employed in our membership warehouses and distribution channels and approximately 17,000 employees are represented by unions. We also utilize seasonal employees during peak periods. The total number of employees by segment is: Number of Employees 2021 2020 2019 United States 192,000 181,000 167,000 Canada 47,000 46,000 42,000 Other International 49,000 46,000 45,000 Total employees 288,000 273,000 254,000 We believe that our warehouses are among the most productive in the retail industry, owing in substantial part to the commitment and efficiency of our employees. We seek to provide them not merely with employment but careers. Many attributes of our business contribute to the objective; the more significant include: competitive compensation and benefits for those working in our membership warehouses and distributions channels; a commitment to promoting from within; and maintaining a ratio of at least 50% of our employee base being full-time employees. These attributes contribute to what we consider, especially for the industry, a high retention rate. In 2021, in the U.S. that rate was above 90% for employees who have been with us for at least one year. The commitment to Take Care of Our Employees is also the foundation of our approach to diversity, equity and inclusion and creating an inclusive and respectful workplace. In 2021, we added training and communication for managers on topics of race, bias and equity, and greater visibility of our employee demographics. Embracing differences is important to the growth of our Company. It leads to more opportunities, innovation, and employee satisfaction and connects us to the communities where we do business. Costco is firmly committed to helping protect the health and safety of our members and employees and to serving our communities. In response to the COVID-19 pandemic and its associated challenges, we began providing premium pay to the majority of our hourly employees in March 2020 and continued for a full year through February 2021, at which time a portion of the premium was built permanently into our hourly wage scales in the U.S. In fall 2020, we also began offering employees additional paid time off to attend to child care and schooling needs through the 2021 school year. As the global effect of coronavirus (COVID-19) continues to evolve, we are closely monitoring the changing situation and complying with public health guidance. For more detailed information regarding our programs and initiatives, see Employees within our Sustainability Commitment (located on our website). This report and other information on our website are not incorporated by reference into and do not form any part of this Annual Report. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon are among our significant general merchandise retail competitors in the U.S. We also compete with other warehouse clubs including Walmarts Sams Club and BJs Wholesale Club, and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple clubs. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature. We believe that Kirkland Signature products are high quality, offered at prices that are generally lower than national brands, and help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers, pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 1995 69 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 1993 65 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non-Foods and E-commerce Merchandise, from 2013 to January 2018. 2018 59 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 2019 59 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 2018 64 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 2011 68 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 1994 69 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Foods and Sundries and Private Label, from 1995 to December 2012. 2013 69 Yoram Rubanenko Executive Vice President, Northeast and Southeast Regions. Mr. Rubanenko was Senior Vice President and General Manager, Southeast Region, from 2013 to September 2021, and Vice President, Regional Operations Manager for the Northeast Region, from 1998 to 2013. 2021 57 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 2016 56 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 86% and 81% of net sales and operating income in 2021, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 28% of U.S. net sales in 2021. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and future profitability could be delayed or otherwise materially adversely affected. We have made and may continue to make investments and acquisitions to improve the speed, accuracy and efficiency of our supply chains and delivery channels. The effectiveness of these investments can be less predictable than opening new locations and might not provide the anticipated benefits or desired rates of return. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive membership, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes, pandemics or other extreme weather conditions or catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. Our e-commerce business depends heavily on third-party and in-house logistics providers and that business is negatively affected when these providers are unable to provide services in a timely fashion. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to environmental, social and governance practices) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns, or we may experience out-of-stock positions and delivery delays, which could result in higher costs, both of which would reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. Availability and performance of our information technology (IT) systems are vital to our business. Failure to successfully execute IT projects and have IT systems available to our business would adversely impact our operations. IT systems play a crucial role in conducting our business. These systems are utilized to process a very high volume of transactions, conduct payment transactions, track and value our inventory and produce reports critical for making business decisions. Failure or disruption of these systems could have an adverse impact on our ability to buy products and services from our suppliers, produce goods in our manufacturing plants, move the products in an efficient manner to our warehouses and sell products to our members. We are undertaking large technology and IT transformation projects. The failure of these projects could adversely impact our business plans and potentially impair our day to day business operations. Given the high volume of transactions we process, it is important that we build strong digital resiliency to prevent disruption from events such as power outages, computer and telecommunications failures, viruses, internal or external security breaches, errors by employees, and catastrophic events such as fires, earthquakes, tornadoes and hurricanes. Any debilitating failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services and may cause serious impairment in our business operations including loss of business services, increased cost of moving merchandise and failure to provide service to our members. We are currently making substantial investments in maintaining and enhancing our digital resiliency and failure or delay in these projects could be costly and harmful to our business. Failure to deliver IT transformation efforts efficiently and effectively could result in the loss of our competitive position and adversely impact our financial condition and results of operations. We are required to maintain the privacy and security of personal and business information amidst multiplying threat landscapes and in compliance with privacy and data protection regulations globally. Failure to do so could damage our business, including our reputation with members, suppliers and employees, cause us to incur substantial additional costs, and become subject to litigation and regulatory action. Increased security threats and more sophisticated cyber misconduct pose a risk to our systems, networks, products and services. We rely upon IT systems and networks, some of which are managed by third parties, in connection with virtually all of our business activities. Additionally, we collect, store and process sensitive information relating to our business, members, suppliers and employees. Operating these IT systems and networks, and processing and maintaining this data, in a secure manner, is critical to our business operations and strategy. Increased remote work due to the COVID-19 pandemic has also increased the possible attack surfaces. Threats designed to gain unauthorized access to systems, networks and data, both ours and third parties with whom we work, are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crimes and advanced persistent threats. Phishing attacks have emerged as particularly prominent, including as vectors for ransomware attacks, which have increased in breadth and frequency. While we train our employees as part of our security efforts, that training cannot be completely effective. These threats pose a risk to the security of our systems and networks and the confidentiality, integrity, and availability of our data. It is possible that our IT systems and networks, or those managed by third parties such as cloud providers or suppliers that otherwise host confidential information, could have vulnerabilities, which could go unnoticed for a period of time. While our cybersecurity and compliance efforts seek to mitigate such risks, there can be no guarantee that the actions and controls we and our third-party service providers have implemented and are implementing, will be sufficient to protect our systems, information or other property. The potential impacts of a material cybersecurity attack include reputational damage, litigation, government enforcement actions, penalties, disruption to systems, unauthorized release of confidential or otherwise protected information, corruption of data, diminution in the value of our investment in IT systems and increased cybersecurity protection and remediation costs. This could adversely affect our competitiveness, results of operations and financial condition and, critically in light of our business model, loss of member confidence. Further, the insurance coverage we maintain and indemnification arrangements with third-parties may be inadequate to cover claims, costs, and liabilities relating to cybersecurity incidents. In addition, data we collect, store and process is subject to a variety of U.S. and international laws and regulations, such as the European Union's General Data Protection Regulation, California Consumer Privacy Act, Health Insurance Portability and Accountability Act, and other emerging privacy and cybersecurity laws across the various states and around the globe, which may carry significant potential penalties for noncompliance. We are subject to payment-related risks. We accept payments using a variety of methods, including select credit and debit cards, cash and checks, co-brand cardholder rebates, Executive member 2% reward certificates, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these parties become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, including food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety or labeling standards or our members ' expectations, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long-term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media, particularly in the wake of COVID-19. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of our employees, including members of our senior management and other key operations, IT, merchandising and administrative personnel. Failure to identify and implement a succession plan for senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including the continuing impacts of the pandemic, regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear a significant portion of the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets or customer expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, pandemics and other health crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China, the United States and the United Kingdom, have raised the cost of many items and created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin is influenced in part by our merchandising and pricing strategies in response to potential cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, inflationary pressures, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Inflationary factors such as increases in merchandise costs may adversely affect our business, financial condition and results of operations. If inflation on merchandise increases beyond our ability to control we may not be able to adjust prices to sufficiently offset the effect of the various cost increases without negatively impacting consumer demand. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years due to, among other things, the continuing impacts of the pandemic and uncertain economic environment. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions causing a loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, natural disasters, extreme weather conditions, public health emergencies, supply constraints and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, packaging, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2021, our international operations, including Canada, generated 28% and 36% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our merchandise costs and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters, extreme weather conditions, public health emergencies or other catastrophic events could negatively affect our business, financial condition, and results of operations. Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes, wildfires, droughts; acts of terrorism or violence, including active shooter situations; energy shortages; public health issues, including pandemics and quarantines, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, limitations on store operating hours, less frequent visits by members to physical locations, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, disruptions to our IT systems, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. The COVID-19 pandemic continues to affect our business, financial condition and results of operations in many respects. The continuing impacts of the COVID-19 pandemic are highly unpredictable and volatile and are affecting certain business operations, demand for our products and services, in-stock positions, costs of doing business, availability of labor, access to inventory, supply chain operations, our ability to predict future performance, exposure to litigation, and our financial performance, among other things. The pandemic has resulted in widespread and continuing impacts on the global economy and on our employees, members, suppliers and other people and entities with which we do business. There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders, and business and government shutdowns. The pandemic and any preventative or protective actions that governments or we may take may result in business disruption, reduced member traffic and reduced sales in certain merchandise categories, and increased operating expenses. The pandemic is continuing to impact the global supply chain, with restrictions and limitations on business activities causing disruption and delay, which have strained certain domestic and international supply chains, and could continue to negatively affect the flow or availability of certain products. Member demand for certain products has and may continue to fluctuate as the pandemic progresses and member behaviors change, which may challenge our ability to anticipate and/or adjust inventory levels to meet that demand. Similarly, increased demand for online purchases of products has impacted our fulfillment operations, resulting in delays in deliveries and lost sales from being out of stock for certain SKUs. Failure to appropriately respond, or the perception of an inadequate response to evolving events around the pandemic, could cause reputational harm to our brand and subject us to lost sales, as well as claims from employees, members, suppliers, regulators or other parties. Additionally, a future outbreak of confirmed cases of COVID-19 in our facilities could result in temporary or sustained workforce shortages or facility closures, which would negatively impact our business and results of operations. Some jurisdictions have taken measures intended to expand the availability of workers compensation or to change the presumptions applicable to workers compensation measures. These actions may increase our exposure to claims and increase our costs. Other factors and uncertainties include, but are not limited to: The severity and duration of the pandemic, including future mutations or related variants of the virus in areas in which we operate; Evolving macroeconomic factors, including general economic uncertainty, unemployment rates, and recessionary pressures; Changes in labor markets affecting us and our suppliers; Unknown consequences on our business performance and initiatives stemming from the substantial investment of time and other resources to the pandemic response; The pace of recovery when the pandemic subsides. The long-term impact of the pandemic on our business, including consumer behaviors; and Disruption and volatility within the financial and credit markets. To the extent that COVID-19 continues to adversely affect the U.S. and global economy, our business, results of operations, cash flows, or financial condition, it may also heighten other risks described in this section, including but not limited to those related to consumer behavior and expectations, competition, brand reputation, implementation of strategic initiatives, cybersecurity threats, payment-related risks, technology systems disruption, supply chain disruptions, labor availability and cost, litigation, operational risk as a result of remote work arrangements and regulatory requirements. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. Government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change, extreme weather conditions, wildfires, droughts and rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the price of our stock to decline. Legal and Regulatory Risks We are subject to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2021, we operated 251 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the withdrawal of the U.K. from the European Union, and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act of 2002 requires management assessments of the effectiveness of internal control over financial reporting and disclosure controls and procedures. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. Changes in tax rates, new U.S. or foreign tax legislation, and exposure to additional tax liabilities could adversely affect our financial condition and results of operations. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide and increasingly broad array of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. Operations at our facilities require the treatment and disposal of wastewater, stormwater and agricultural and food processing wastes, the use and maintenance of refrigeration systems, including ammonia-based chillers, noise, odor and dust management, the operation of mechanized processing equipment, and other operations that potentially could affect the environment and public health and safety. Failure to comply with current and future environmental, health and safety standards could result in the imposition of fines and penalties, illness or injury of our employees, and claims or lawsuits related to such illnesses or injuries, and temporary closures or limits on the operations of facilities. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At August 29, 2021, we operated 815 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 454 110 564 Canada 89 16 105 Other International 101 45 146 Total 644 171 815 _______________ (1) 121 of the 171 leases are land-only leases, where Costco owns the building. At the end of 2021, our warehouses contained approximately 118.9 million square feet of operating floor space: 83.2 million in the U.S.; 14.9 million in Canada; and 20.8 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 31.4 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 28, 2021, we had 9,958 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2021 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 10June 6, 2021 102,000 $ 381.50 102,000 $ 3,338 June 7July 4, 2021 108,000 387.32 108,000 3,296 July 5August 1, 2021 63,000 412.73 63,000 3,270 August 2August 29, 2021 45,000 446.15 45,000 3,250 Total fourth quarter 318,000 $ 398.76 318,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 28, 2016, through August 29, 2021. The following graph provides information concerning average sales per warehouse over a 10 year period. Average Sales Per Warehouse* (Sales In Millions) Year Opened # of Whses 2021 20 $ 140 2020 13 $ 132 152 2019 20 $ 129 138 172 2018 21 $ 116 119 141 172 2017 26 $ 121 142 158 176 206 2016 29 $ 87 97 118 131 145 173 2015 23 $ 83 85 94 112 122 136 163 2014 30 $ 108 109 115 125 140 144 155 182 2013 26 $ 99 109 113 116 124 137 144 158 186 2012 Before 607 $ 155 163 169 170 169 175 188 195 205 232 Totals 815 155 160 164 162 159 163 176 182 192 217 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Fiscal Year *First year sales annualized. 2017 was a 53-week fiscal year "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to promote understanding of the results of operations and financial condition. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of operations for 2021 compared to 2020. For discussion related to the results of operations and changes in financial condition for 2020 compared to 2019 refer to Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2020 Form 10-K, which was filed with the United States Securities and Exchange Commission (SEC) on October 7, 2020. In 2021, we combined the hardlines and softlines merchandise categories into non-foods. This change did not have a material impact on the discussion of our results of operations. Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (foods and sundries, non-foods, and fresh foods), warehouse ancillary (includes gasoline, pharmacy, optical, food court, hearing aids, and tire installation) and other businesses (includes e-commerce, business centers, travel and other). We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales-related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business draws members, but it generally has a lower gross margin percentage relative to our non-gasoline business. It also has lower SGA expenses as a percent of net sales compared to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China, the United States and the United Kingdom, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years. The impact to our net sales and gross margin is influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve net sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of operating floor space square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse operations. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business operates on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canadian, and Other International operating segments (see Note 12 to the consolidated financial statements included in Item 8 of this Report). Certain operations in the Other International segment have relatively higher rates of square footage growth, lower wage and benefit costs as a percentage of sales, less or no direct membership warehouse competition, or lack an e-commerce business. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for 2021 included: We opened 22 new warehouses, including 2 relocations: 12 net new in the U.S., 4 net new in our Canadian segment, and 4 new in our Other International segment, compared to 16 new warehouses, including 3 relocations in 2020; Net sales increased 18% to $192,052 driven by a 16% increase in comparable sales and sales at new warehouses opened in 2020 and 2021; Membership fee revenue increased 9% to $3,877, driven by sign-ups and upgrades to Executive membership; Gross margin percentage decreased seven basis points, driven primarily by a shift in sales penetration from our core merchandise categories to our warehouse ancillary and other businesses; SGA expenses as a percentage of net sales decreased 40 basis points, primarily due to leveraging increased sales and decreased incremental wages related to COVID-19; The effective tax rate in 2021 was 24.0% compared to 24.4% in 2020; Net income increased 25% to $5,007, or $11.27 per diluted share compared to $4,002, or $9.02 per diluted share in 2020; We paid a special cash dividend of $10.00 per share in December 2020 and in April 2021, increased the quarterly cash dividend from $0.70 to $0.79 per share totaling $5,748. COVID-19 During 2021, our sales mix began returning to pre-pandemic levels. This included sales increases in non-foods and in many of our warehouse ancillary and other businesses, certain of which experienced closures or restrictions in 2020. COVID-related supply and logistics constraints have adversely affected some merchandise categories and are expected to do so for the foreseeable future. We paid $515 in incremental wages during 2021 related to COVID-19. The incremental wage and benefit costs associated with COVID-19, which began on March 1, 2020 and ended on February 28, 2021, totaled approximately $825. Effective March 1, 2021, we permanently increased wages for hourly and most salaried warehouse employees. The estimated annualized pre-tax cost is approximately $400. Additionally, in certain areas in the United States governments have mandated or are considering mandating extra pay for classes of employees that include our employees, which has and will result in higher costs. RESULTS OF OPERATIONS Net Sales 2021 2020 2019 Net Sales $ 192,052 $ 163,220 $ 149,351 Increases in net sales: U.S. 16 % 9 % 9 % Canada 22 % 5 % 3 % Other International 23 % 13 % 5 % Total Company 18 % 9 % 8 % Increases in comparable sales: U.S. 15 % 8 % 8 % Canada 20 % 5 % 2 % Other International 19 % 9 % 2 % Total Company 16 % 8 % 6 % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. 14 % 9 % 6 % Canada 12 % 7 % 5 % Other International 13 % 11 % 6 % Total Company 13 % 9 % 6 % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019. Net Sales Net sales increased $28,832 or 18% during 2021. The improvement was attributable to an increase in comparable sales of 16%, and sales at new warehouses opened in 2020 and 2021. While sales in all core merchandise categories increased, sales were particularly strong in non-foods. Sales increases were also strong in our warehouse ancillary and other businesses, predominantly e-commerce and gasoline. Certain merchandise categories were impacted by inflation higher than what we have experienced in recent years. Changes in foreign currencies relative to the U.S. dollar positively impacted net sales by approximately $2,759, or 169 basis points, compared to 2020, attributable to our Canadian and Other International operations. Changes in gasoline prices positively impacted net sales by $1,636, or 100 basis points, compared to 2020, due to a 12% increase in the average price per gallon. The volume of gasoline sold increased approximately 10%, positively impacting net sales by $1,469, or 90 basis points. Comparable Sales Comparable sales increased 16% during 2021 and were positively impacted by increases in shopping frequency and average ticket. There was an increase of 44% in e-commerce comparable sales in 2021, driven by an increase of 80% in the first half of the year. Membership Fees 2021 2020 2019 Membership fees $ 3,877 $ 3,541 $ 3,352 Membership fees increase 9 % 6 % 7 % Membership fees increased 9% in 2021, driven by sign-ups and upgrades to Executive membership. Excluding the positive impact of changes in foreign currencies relative to the U.S. dollar, membership fees increased 8%. At the end of 2021, our member renewal rates were 91% in the U.S. and Canada and 89% worldwide. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. Gross Margin 2021 2020 2019 Net sales $ 192,052 $ 163,220 $ 149,351 Less merchandise costs 170,684 144,939 132,886 Gross margin $ 21,368 $ 18,281 $ 16,465 Gross margin percentage 11.13 % 11.20 % 11.02 % The gross margin of our core merchandise categories (foods and sundries, non-foods and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased 23 basis points. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. The increase was across all categories, most significantly in non-foods. Total gross margin percentage decreased seven basis points compared to 2020. Excluding the impact of gasoline price inflation on net sales in 2021, gross margin percentage was 11.22%, an increase of two basis points. This increase was due to a two basis point improvement in our core merchandise categories, predominantly non-foods, and in our warehouse ancillary and other businesses, largely e-commerce. The comparison was also positively impacted by a three basis point reserve on inventory recorded in 2020 with no such reserve this year. Gross margin percentage was negatively impacted three basis points due to increased 2% rewards and two basis points due to a LIFO charge for higher merchandise costs. Changes in foreign currencies relative to the U.S. dollar positively impacted gross margin by approximately $301 in 2021. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), decreased in our U.S. segment, due to our warehouse ancillary and other businesses, our core merchandise categories, and the LIFO charge, partially offset by the reserve for certain inventory in 2020. Our Canadian and Other International segments increased, primarily due to our warehouse ancillary and other businesses and certain of our core merchandise categories. These increases were partially offset by increased 2% rewards. Selling, General and Administrative Expenses 2021 2020 2019 SGA expenses $ 18,461 $ 16,332 $ 14,994 SGA expenses as a percentage of net sales 9.61 % 10.01 % 10.04 % SGA expenses as a percentage of net sales decreased 40 basis points compared to 2020. SGA expenses as a percentage of net sales excluding the impact of gasoline price inflation was 9.69%, a decrease of 32 basis points. Warehouse operations and other businesses were lower by 24 basis points, largely attributable to payroll leveraging increased sales. Incremental wages as a result of COVID-19, which ended on February 28, 2021, were lower by eight basis points. Central operating costs were lower by five basis points. Stock compensation expense was lower by three basis points, and costs associated with the acquisition of Innovel were lower by one basis point. These decreases were offset by an increase of five basis points related to a partial reversal of a product tax assessment in 2020, as well as an increase of four basis points related to a write-off of certain information technology assets in the fourth quarter of 2021 that are no longer expected to be utilized as part of the modernization of our information systems. Changes in foreign currencies relative to the U.S. dollar increased our SGA expenses by approximately $228 in 2021. Preopening 2021 2020 2019 Preopening expenses $ 76 $ 55 $ 86 Warehouse openings, including relocations United States 13 9 18 Canada 5 4 3 Other International 4 3 4 Total warehouse openings, including relocations 22 16 25 Preopening expenses include startup costs for new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and corporate facilities. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new or international market. Interest Expense 2021 2020 2019 Interest expense $ 171 $ 160 $ 150 Interest expense primarily relates to Senior Notes. For more information on our debt arrangements, refer to the consolidated financial statements included in Item 8 of this Report. Interest Income and Other, Net 2021 2020 2019 Interest income $ 41 $ 89 $ 126 Foreign-currency transaction gains, net 56 7 27 Other, net 46 (4) 25 Interest income and other, net $ 143 $ 92 $ 178 The decrease in interest income in 2021 was primarily due to lower interest rates in the U.S. and Canada, partially offset by higher average cash and investment balances. Foreign-currency transaction gains, net include mark-to-market adjustments for forward foreign-exchange contracts and revaluation or settlement of monetary assets and liabilities by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Note 1 to the consolidated financial statements included in Item 8 of this Report. During 2020, other, net was impacted by a $36 charge related to the repayment of certain Senior Notes. Provision for Income Taxes 2021 2020 2019 Provision for income taxes $ 1,601 $ 1,308 $ 1,061 Effective tax rate 24.0 % 24.4 % 22.3 % The effective tax rate for 2021 included discrete net tax benefits of $163, including a benefit of $75 due to excess benefits from stock compensation, $70 related to the special dividend payable through our 401(k) plan, and $19 related to a reduction in the valuation allowance against certain deferred tax assets. Excluding these benefits, the tax rate was 26.4% for 2021. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: 2021 2020 2019 Net cash provided by operating activities $ 8,958 $ 8,861 $ 6,356 Net cash used in investing activities (3,535) (3,891) (2,865) Net cash used in financing activities (6,488) (1,147) (1,147) Our primary sources of liquidity are cash flows generated from our operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $12,175 and $13,305 at the end of 2021 and 2020, respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,816 and $1,636 at the end of 2021 and 2020, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by a change in exchange rates of $46 and $70 in 2021 and 2020, respectively, and negatively impacted by $15 in 2019. Material contractual obligations arising in the normal course of business primarily consist of purchase obligations, long-term debt and related interest payments, leases, and construction and land purchase obligations. See Notes 5 and 6 to the consolidated financial statements included in Item 8 of this Report for amounts outstanding on August 29, 2021, related to debt and leases. Purchase obligations consist of contracts primarily related to merchandise, equipment, and third-party services, the majority of which are due in the next 12 months. Construction and land purchase obligations consist of contracts primarily related to the development and opening of new and relocated warehouses, the majority of which (other than leases) are due in the next 12 months. Management believes that our cash and investment position and operating cash flows as well as capacity under existing and available credit agreements will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. Cash Flows from Operating Activities Net cash provided by operating activities totaled $8,958 in 2021, compared to $8,861 in 2020. Our cash flow provided by operations is primarily from net sales and membership fees. Cash flow used in operations generally consists of payments to merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, the forward deployment of inventory to accelerate delivery times, payment terms with our suppliers, and early payments to obtain discounts from suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $3,535 in 2021, compared to $3,891 in 2020, and is primarily related to capital expenditures. In 2020, we acquired Innovel (Costco Wholesale Logistics) and a minority interest in Navitus. Net cash flows from investing activities also includes purchases and maturities of short-term investments. Capital Expenditures Our primary requirements for capital are acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations, and working capital. In 2021, we spent $3,588 on capital expenditures, and it is our current intention to spend approximat ely $3,800 to $4,200 d uring fiscal 2022. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 22 new warehous es, including two relocations, in 2021, and plan to open approximately up to 35 additional new warehouses, including five relocations, in 2022. We have experienced delays in real estate and construction activities due to COVID-19. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs or based on the current economic environment. Cash Flows from Financing Activities Net cash used in financing activities totaled $6,488 in 2021, compared to $1,147 in 2020. Cash flows used in financing activities primarily related to the payment of dividends, repurchases of common stock, and withholding taxes on stock-based awards. In 2020, we issued $4,000 in aggregate principal amount of Senior Notes and repaid $3,200 of Senior Notes. Stock Repurchase Programs During 2021 and 2020, we repurchased 1,358,000 and 643,000 shares of common stock, at average prices of $364.39 and $308.45, respectively, totaling approximately $495 and $198, respectively. These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. The remaining amount available to be purchased under our approved plan was $3,250 at the end of 2021. Dividends Cash dividends declared in 2021 totaled $12.98 per share, as compared to $2.70 per share in 2020. Dividends in 2021 included a special dividend of $10.00 per share, resulting in an aggregate payment of approximately $4,430. In April 2021, the Board of Directors increased our quarterly cash dividend from $0.70 to $0.79 per share. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At August 29, 2021, we had borrowing capacity under these facilities of $1,050. Our international operations maintain $574 of the total borrowing capacity under bank credit facilities, of which $201 is guaranteed by the Company. Short-term borrowings outstanding under the bank credit facilities at the end of 2021 were immaterial, and there were none outstanding at the end of 2020. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $235. The outstanding commitments under these facilities at the end of 2021 totaled $197, most of which were standby letters of credit which do not expire or have expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities Claims for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Recent Accounting Pronouncements We do not expect that any recently issued accounting pronouncements will have a material effect on our financial statements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2021 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2021, long-term debt with fixed interest rates was $7,531. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 29, 2021, would have decreased the fair value of the contracts by $149 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to some of the fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 29, 2021 and August 30, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 29, 2021 and August 30, 2020, and the results of its operations and its cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 5, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle The Company changed its method of accounting for leases as of September 2, 2019, due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of workers' compensation self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated self-insurance liabilities as of August 29, 2021 were $1,257 million, a portion of which related to workers compensation self-insurance liabilities for the United States operations. We identified the evaluation of the Companys workers compensation self-insurance liabilities for the United States operations as a critical audit matter because of the extent of specialized skill and knowledge needed to evaluate the underlying assumptions and judgments made by the Company in the actuarial models. Specifically, subjective auditor judgment was required to evaluate the Company's selected loss rates and initial expected losses used in the actuarial models. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys self-insurance workers' compensation process. This included controls related to the development and selection of the assumptions listed above used in the actuarial calculation and review of the actuarial report. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards Evaluating the Companys ability to estimate self-insurance workers' compensation liabilities by comparing its historical estimates with actual incurred losses and paid losses Evaluating the above listed assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance workers' compensation liabilities and comparing them to the amounts recorded by the Company /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 5, 2021 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 29, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of August 29, 2021 and August 30, 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 29, 2021, August 30, 2020 and September 1, 2019 , and the related notes (collectively, the consolidated financial statements), and our report dated October 5, 2021 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 5, 2021 COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 REVENUE Net sales $ 192,052 $ 163,220 $ 149,351 Membership fees 3,877 3,541 3,352 Total revenue 195,929 166,761 152,703 OPERATING EXPENSES Merchandise costs 170,684 144,939 132,886 Selling, general and administrative 18,461 16,332 14,994 Preopening expenses 76 55 86 Operating income 6,708 5,435 4,737 OTHER INCOME (EXPENSE) Interest expense ( 171 ) ( 160 ) ( 150 ) Interest income and other, net 143 92 178 INCOME BEFORE INCOME TAXES 6,680 5,367 4,765 Provision for income taxes 1,601 1,308 1,061 Net income including noncontrolling interests 5,079 4,059 3,704 Net income attributable to noncontrolling interests ( 72 ) ( 57 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 5,007 $ 4,002 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 11.30 $ 9.05 $ 8.32 Diluted $ 11.27 $ 9.02 $ 8.26 Shares used in calculation (000s) Basic 443,089 442,297 439,755 Diluted 444,346 443,901 442,923 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 5,079 $ 4,059 $ 3,704 Foreign-currency translation adjustment and other, net 181 162 ( 245 ) Comprehensive income 5,260 4,221 3,459 Less: Comprehensive income attributable to noncontrolling interests 93 80 37 COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 5,167 $ 4,141 $ 3,422 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) August 29, 2021 August 30, 2020 ASSETS CURRENT ASSETS Cash and cash equivalents $ 11,258 $ 12,277 Short-term investments 917 1,028 Receivables, net 1,803 1,550 Merchandise inventories 14,215 12,242 Other current assets 1,312 1,023 Total current assets 29,505 28,120 OTHER ASSETS Property and equipment, net 23,492 21,807 Operating lease right-of-use assets 2,890 2,788 Other long-term assets 3,381 2,841 TOTAL ASSETS $ 59,268 $ 55,556 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 16,278 $ 14,172 Accrued salaries and benefits 4,090 3,605 Accrued member rewards 1,671 1,393 Deferred membership fees 2,042 1,851 Current portion of long-term debt 799 95 Other current liabilities 4,561 3,728 Total current liabilities 29,441 24,844 OTHER LIABILITIES Long-term debt, excluding current portion 6,692 7,514 Long-term operating lease liabilities 2,642 2,558 Other long-term liabilities 2,415 1,935 TOTAL LIABILITIES 41,190 36,851 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $ 0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $ 0.01 par value; 900,000,000 shares authorized; 441,825,000 and 441,255,000 shares issued and outstanding 4 4 Additional paid-in capital 7,031 6,698 Accumulated other comprehensive loss ( 1,137 ) ( 1,297 ) Retained earnings 11,666 12,879 Total Costco stockholders equity 17,564 18,284 Noncontrolling interests 514 421 TOTAL EQUITY 18,078 18,705 TOTAL LIABILITIES AND EQUITY $ 59,268 $ 55,556 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT SEPTEMBER 2, 2018 438,189 $ 4 $ 6,107 $ ( 1,199 ) $ 7,887 $ 12,799 $ 304 $ 13,103 Net income 3,659 3,659 45 3,704 Foreign-currency translation adjustment and other, net ( 237 ) ( 237 ) ( 8 ) ( 245 ) Stock-based compensation 598 598 598 Release of vested restricted stock units (RSUs), including tax effects 2,533 ( 272 ) ( 272 ) ( 272 ) Repurchases of common stock ( 1,097 ) ( 16 ) ( 231 ) ( 247 ) ( 247 ) Cash dividends declared and other ( 1,057 ) ( 1,057 ) ( 1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 4 6,417 ( 1,436 ) 10,258 15,243 341 15,584 Net income 4,002 4,002 57 4,059 Foreign-currency translation adjustment and other, net 139 139 23 162 Stock-based compensation 621 621 621 Release of vested RSUs, including tax effects 2,273 ( 330 ) ( 330 ) ( 330 ) Repurchases of common stock ( 643 ) ( 10 ) ( 188 ) ( 198 ) ( 198 ) Cash dividends declared ( 1,193 ) ( 1,193 ) ( 1,193 ) BALANCE AT AUGUST 30, 2020 441,255 4 6,698 ( 1,297 ) 12,879 18,284 421 18,705 Net income 5,007 5,007 72 5,079 Foreign-currency translation adjustment and other, net 160 160 21 181 Stock-based compensation 668 668 668 Release of vested RSUs, including tax effects 1,928 ( 312 ) ( 312 ) ( 312 ) Repurchases of common stock ( 1,358 ) ( 23 ) ( 472 ) ( 495 ) ( 495 ) Cash dividends declared ( 5,748 ) ( 5,748 ) ( 5,748 ) BALANCE AT AUGUST 29, 2021 441,825 $ 4 $ 7,031 $ ( 1,137 ) $ 11,666 $ 17,564 $ 514 $ 18,078 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 29, 2021 August 30, 2020 September 1, 2019 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 5,079 $ 4,059 $ 3,704 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,781 1,645 1,492 Non-cash lease expense 286 194 Stock-based compensation 665 619 595 Other non-cash operating activities, net 85 42 9 Deferred income taxes 59 104 147 Changes in operating assets and liabilities: Merchandise inventories ( 1,892 ) ( 791 ) ( 536 ) Accounts payable 1,838 2,261 322 Other operating assets and liabilities, net 1,057 728 623 Net cash provided by operating activities 8,958 8,861 6,356 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments ( 1,331 ) ( 1,626 ) ( 1,094 ) Maturities and sales of short-term investments 1,446 1,678 1,231 Additions to property and equipment ( 3,588 ) ( 2,810 ) ( 2,998 ) Acquisitions ( 1,163 ) Other investing activities, net ( 62 ) 30 ( 4 ) Net cash used in investing activities ( 3,535 ) ( 3,891 ) ( 2,865 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding 188 137 210 Proceeds from short-term borrowings 41 Proceeds from issuance of long-term debt 3,992 298 Repayments of long-term debt ( 94 ) ( 3,200 ) ( 89 ) Tax withholdings on stock-based awards ( 312 ) ( 330 ) ( 272 ) Repurchases of common stock ( 496 ) ( 196 ) ( 247 ) Cash dividend payments ( 5,748 ) ( 1,479 ) ( 1,038 ) Other financing activities, net ( 67 ) ( 71 ) ( 9 ) Net cash used in financing activities ( 6,488 ) ( 1,147 ) ( 1,147 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 46 70 ( 15 ) Net change in cash and cash equivalents ( 1,019 ) 3,893 2,329 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 12,277 8,384 6,055 CASH AND CASH EQUIVALENTS END OF YEAR $ 11,258 $ 12,277 $ 8,384 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 149 $ 124 $ 141 Income taxes, net $ 1,527 $ 1,052 $ 1,187 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ $ 286 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At August 29, 2021, Costco operated 815 warehouses worldwide: 564 in the United States (U.S.) located in 46 states, Washington, D.C., and Puerto Rico, 105 in Canada, 39 in Mexico, 30 in Japan, 29 in the United Kingdom (U.K.), 16 in Korea, 14 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, U.K., Mexico, Korea, Taiwan, Japan, and Australia. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53-week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2021, 2020, and 2019 relate to the 52-week fiscal years ended August 29, 2021, August 30, 2020, and September 1, 2019, respectively. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions take into account historical and forward-looking factors that the Company believes are reasonable, including but not limited to the potential impacts arising from the novel coronavirus (COVID-19) and related public and private sector policies and initiatives. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,816 and $ 1,636 at the end of 2021 and 2020, respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2021 and 2020, are $ 999 and $ 810 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. Short-Term Investments Short-term investments generally consist of debt securities (U.S. Government and Agency Notes), with maturities at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. These available-for-sale investments have a low level of inherent credit risk given they are issued by the U.S. Government and Agencies. Changes in their fair value are primarily attributable to changes in interest rates and market liquidity. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for credit impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be impaired as the result of a credit loss, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 3 , 4 , and 5 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and LIBOR or Secured Overnight Financing Rate and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include discounts and volume rebates. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for credit losses which considers creditworthiness of vendors and third parties, historical experience and current economic trends. Write-offs of receivables were immaterial in 2021, 2020, and 2019. Merchandise Inventories Merchandise inventories consist of the following: 2021 2020 United States $ 10,248 $ 8,871 Canada 1,456 1,310 Other International 2,511 2,061 Merchandise inventories $ 14,215 $ 12,242 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. An immaterial charge was recorded to merchandise costs to increase the cumulative LIFO valuation on merchandise inventories at August 29, 2021. As of August 30, 2020, U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts using estimates based on experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment, Net Property and equipment are stated at cost. Depreciation and amortization expense is computed primarily using the straight-line method over estimated useful lives. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably certain at the date the leasehold improvements are made. The Company capitalizes certain computer software and costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. To the extent that the assets become ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over their estimated useful lives. In the fourth quarter of 2021, the Company recognized an $ 84 write-off of certain information technology assets, which was recorded in selling, general and administrative expenses, in the consolidated statements of income. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2021 and 2020 were immaterial. The following table summarizes the Company's property and equipment balances at the end of 2021 and 2020: Estimated Useful Lives 2021 2020 Land N/A $ 7,507 $ 6,696 Buildings and improvements 5-50 years 19,139 17,982 Equipment and fixtures 3-20 years 9,505 8,749 Construction in progress N/A 1,507 1,276 37,658 34,703 Accumulated depreciation and amortization ( 14,166 ) ( 12,896 ) Property and equipment, net $ 23,492 $ 21,807 The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. Impairment charges recognized in 2021 were immaterial. There were no impairment charges recognized in 2020 or 2019. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities. Leases generally contain one or more of the following options, which the Company can exercise at the end of the initial term: (a) renew the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase the property at the then-fair market value; or (c) a right of first refusal in the event of a third-party offer. Some leases include free-rent periods and step-rent provisions, which are recognized on a straight-line basis over the original term of the lease and any extension options that the Company is reasonably certain to exercise from the date the Company has control of the property. Certain leases provide for periodic rent increases based on price indices or the greater of minimum guaranteed amounts or sales volume. Our leases do not contain any material residual value guarantees or material restrictive covenants. The Company determines at inception whether a contract is or contains a lease. The Company initially records right-of-use (ROU) assets and lease obligations for its finance and operating leases based on the discounted future minimum lease payments over the term. The lease term is defined as the noncancelable period of the lease plus any options to extend when it is reasonably certain that the Company will exercise the option. As the rate implicit in the Company's leases is not easily determinable, the present value of the sum of the lease payments is calculated using the Company's incremental borrowing rate. The rate is determined using a portfolio approach based on the rate of interest the Company would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. The Company uses quoted interest rates from financial institutions to derive the incremental borrowing rate. Impairment of ROU assets is evaluated in a similar manner as described in Property and Equipment, net above. The Company's asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability, with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases are included in other liabilities in the accompanying consolidated balance sheet. Goodwill and Acquired Intangible Assets Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired and is not subject to amortization. The Company reviews goodwill annually in the fourth quarter for impairment or when circumstances indicate carrying value may exceed the fair value. This evaluation is performed at the reporting unit level. If a qualitative assessment indicates that it is more likely than not that the fair value is less than carrying value, a quantitative analysis is completed using either the income or market approach, or a combination of both. The income approach estimates fair value based on expected discounted future cash flows, while the market approach uses comparable public companies and transactions to develop metrics to be applied to historical and expected future operating results. Goodwill is included in other long-term assets in the consolidated balance sheets. The following table summarizes goodwill by reportable segment: United States Operations Canadian Operations Other International Operations Total Balance at September 1, 2019 $ 13 $ 27 $ 13 $ 53 Changes in currency translation 1 1 Acquisition 934 934 Balance at August 30, 2020 $ 947 $ 27 $ 14 $ 988 Changes in currency translation and other (1) 6 1 1 8 Balance at August 29, 2021 $ 953 $ 28 $ 15 $ 996 ____________ (1) Other consists of changes to the purchase price allocation. See Note 2 . Definite-lived intangible assets, which are not material, are included in other long-term assets on the consolidated balance sheets and are amortized on a straight-line basis over their estimated lives, which approximates the pattern of expected economic benefit. Insurance/Self-insurance Liabilities Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained for certain risks to limit exposures arising from very large losses. The Company uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2021 and 2020, these insurance liabilities were $ 1,257 and $ 1,188 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. There were no derivative instruments in a net liability position at the end of 2021 and for those in a net liability position at the end of 2020, the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered was immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 1,331 and $ 1,036 at the end of 2021 and 2020, respectively. See Note 4 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2021 and 2020. The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2021, 2020 and 2019. The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial in 2021, 2020, and 2019. Revenue Recognition The Company adopted Accounting Standards Update (ASU) 2014-09 in 2019, which provided for changes in the recognition of revenue from contracts with customers. The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and member returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. The Company offers merchandise in the following core merchandise categories: foods and sundries, non-foods (previously hardlines and softlines), and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is generally recognized upon shipment to the member. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2021 and 2020 were $ 2,042 and $ 1,851 , respectively. In most countries, the Company's Executive members qualify for a 2% reward on qualified purchases, subject to an annual maximum value, which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2021, 2020, and 2019, the net reduction in sales was $ 2,047 , $ 1,707 , and $ 1,537 respectively. The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Shop card liabilities are included in other current liabilities in the consolidated balance sheets. Citibank, N.A. became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot, fulfillment and manufacturing operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans, which are not material. Amounts expensed under all plans were $ 748 , $ 676 , and $ 614 for 2021, 2020, and 2019, respectively, and are predominantly included in selling, general and administrative expenses in the consolidated statements of income. Stock-Based Compensation RSUs granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 8 for additional information on the Companys stock-based compensation plans. Preopening Expenses Preopening expenses include startup costs for new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and corporate facilities and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 7 for additional information. Note 2Acquisition of Innovel On March 17, 2020, the Company acquired Innovel Solutions for $ 999 , using existing cash and cash equivalents. Innovel (now known as Costco Wholesale Logistics or CWL) provides final-mile delivery, installation and white-glove capabilities for big and bulky products in the United States and Puerto Rico. Its financial results have been included in the Company's consolidated financial statements from the date of acquisition. The net purchase price of $ 999 has been allocated to the tangible and intangible assets of $ 294 and liabilities assumed of $ 235 , based on fair values on the acquisition date. The remaining unallocated net purchase price of $ 940 was recorded as goodwill. Goodwill represents the acquisition's benefits to the Company, which include the ability to serve more members and improve delivery times, enabling growth in certain segments of our U.S. e-commerce operations. The Company assigned this goodwill, which is deductible for tax purposes, to reporting units within the U.S. segment. Changes to the purchase price allocation originally recorded in 2020 were not material. Note 3Investments The Companys investments were as follows: 2021: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 375 $ 6 $ 381 Held-to-maturity: Certificates of deposit 536 536 Total short-term investments $ 911 $ 6 $ 917 2020: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 436 $ 12 $ 448 Held-to-maturity: Certificates of deposit 580 580 Total short-term investments $ 1,016 $ 12 $ 1,028 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended August 29, 2021, and August 30, 2020. At the end of 2021 and 2020, there were no available-for-sale securities in a continuous unrealized-loss position. There were no sales of available-for-sale securities during 2021 or 2020. The maturities of available-for-sale and held-to-maturity securities at the end of 2021 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ 190 $ 191 $ 536 Due after one year through five years 185 190 Total $ 375 $ 381 $ 536 Note 4Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The table below presents information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. Level 2 2021 2020 Investment in government and agency securities (1) $ 393 $ 508 Forward foreign-exchange contracts, in asset position (2) 17 1 Forward foreign-exchange contracts, in (liability) position (2) ( 2 ) ( 21 ) Total $ 408 $ 488 ____________ (1) At August 29, 2021, $ 12 cash and cash equivalents and $ 381 short-term investments are included in the accompanying consolidated balance sheets. At August 30, 2020, $ 60 cash and cash equivalents and $ 448 short-term investments are included in the consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the consolidated balance sheets. At August 29, 2021, and August 30, 2020, the Company did not hold any Level 1 or 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers between levels during 2021 or 2020. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. Fair value adjustments to nonfinancial assets during 2021 were immaterial and there were no fair value adjustments to these items during 2020. Note 5Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $ 1,050 and $ 967 , in 2021 and 2020, respectively. Borrowings on these short-term facilities were immaterial during 2021 and 2020. Short-term borrowings outstanding were $ 41 at the end of 2021. There were no outstanding balances at the end of 2020. Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100 % of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, the holder has the right to require the Company to purchase this security at a price of 101 % of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary, valued using Level 3 inputs. In June 2021, the Japanese subsidiary repaid approximately $ 94 of its Guaranteed Senior Notes. In April 2020, the Company issued $ 4,000 in aggregate principal amount of Senior Notes as follows: $ 1,250 of 1.375 % due June 2027; $ 1,750 of 1.600 % due April 2030; and $ 1,000 of 1.750 % due April 2032. In May 2020, a portion of the proceeds from the issuance were used to repay, prior to maturity, the outstanding $ 1,000 and $ 500 principal balances and interest on the 2.150 % and 2.250 % Senior Notes, respectively. The early redemption resulted in a $ 36 charge which was recorded in interest income and other, net in 2020. At the end of 2021 and 2020, the fair value of the Company's long-term debt, including the current portion, was approximately $ 7,692 and $ 7,987 , respectively. The carrying value of long-term debt consisted of the following: 2021 2020 2.300% Senior Notes due May 2022 $ 800 $ 800 2.750% Senior Notes due May 2024 1,000 1,000 3.000% Senior Notes due May 2027 1,000 1,000 1.375% Senior Notes due June 2027 1,250 1,250 1.600% Senior Notes due April 2030 1,750 1,750 1.750% Senior Notes due April 2032 1,000 1,000 Other long-term debt 731 857 Total long-term debt 7,531 7,657 Less unamortized debt discounts and issuance costs 40 48 Less current portion (1) 799 95 Long-term debt, excluding current portion $ 6,692 $ 7,514 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: 2022 $ 800 2023 91 2024 1,109 2025 136 2026 100 Thereafter 5,295 Total $ 7,531 Note 6Leases The tables below present information regarding the Company's lease assets and liabilities. 2021 2020 Assets Operating lease right-of-use assets $ 2,890 $ 2,788 Finance lease assets (1) 1,000 592 Total lease assets $ 3,890 $ 3,380 Liabilities Current Operating lease liabilities (2) $ 222 $ 231 Finance lease liabilities (2) 72 31 Long-term Operating lease liabilities 2,642 2,558 Finance lease liabilities (3) 980 657 Total lease liabilities $ 3,916 $ 3,477 _______________ (1) Included in other long-term assets in the consolidated balance sheets. (2) Included in other current liabilities in the consolidated balance sheets. (3) Included in other long-term liabilities in the consolidated balance sheets. 2021 2020 Weighted-average remaining lease term (years) Operating leases 21 21 Finance leases 22 20 Weighted-average discount rate Operating leases 2.16 % 2.23 % Finance leases 4.91 % 6.34 % The components of lease expense, excluding short-term lease costs and sublease income (which were not material), were as follows: 2021 2020 Operating lease costs (1) $ 296 $ 252 Finance lease costs: Amortization of lease assets (1) 50 31 Interest on lease liabilities (2) 37 33 Variable lease costs (3) 151 87 Total lease costs $ 534 $ 403 _______________ (1) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. (2) Included in interest expense in the consolidated statements of income. (3) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. Supplemental cash flow information related to leases was as follows: 2021 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows operating leases $ 282 $ 258 Operating cash flows finance leases 37 33 Financing cash flows finance leases 67 49 Leased assets obtained in exchange for operating lease liabilities 350 354 Leased assets obtained in exchange for finance lease liabilities 399 317 As of August 29, 2021, future minimum payments during the next five fiscal years and thereafter are as follows: Operating Leases (1) Finance Leases 2022 $ 260 $ 107 2023 273 92 2024 232 87 2025 191 159 2026 192 74 Thereafter 2,507 1,070 Total (2) 3,655 1,589 Less amount representing interest 791 537 Present value of lease liabilities $ 2,864 $ 1,052 _______________ (1) Operating lease payments have not been reduced by future sublease income of $ 99 . (2) Excludes $ 665 of lease payments for leases that have been signed but not commenced. Note 7Equity Dividends Cash dividends declared in 2021 totaled $ 12.98 per share, as compared to $ 2.70 per share in 2020. Dividends in 2021 included a special dividend of $ 10.00 per share, resulting in an aggregate payment of approximately $ 4,430 . The Company's current quarterly dividend rate is $ 0.79 per share. Stock Repurchase Programs The Company's stock repurchase program is conducted under a $ 4,000 authorization by the Board of Directors, which expires in April 2023. As of the end of 2021, the remaining amount available under the approved plan was $ 3,250 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 2021 1,358 $ 364.39 $ 495 2020 643 308.45 198 2019 1,097 225.16 247 These amounts may differ from repurchases of common stock in the consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time to time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Note 8Stock-Based Compensation The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are generally performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant and the future forfeited shares from grants under the previous plan, up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. In conjunction with a special cash dividend paid in the second quarter of 2021, and in accordance with the plans, the number of shares subject to outstanding RSUs was increased on the dividend record date to preserve their value. They were adjusted by multiplying the number of outstanding shares by a factor of 1.019 (rounded up to a whole share), representing the ratio of the Nasdaq closing price of $ 391.77 on November 30, 2020, which was the last trading day immediately prior to the ex-dividend date, to the Nasdaq opening price of $ 384.50 on the ex-dividend date, December 1, 2020. The outstanding RSUs increased by approximately 94,000 . The adjustment did not result in additional stock-based compensation expense, as the fair value of the awards did not change. As further required by the plans, the maximum number of shares issuable was proportionally adjusted, which resulted in an additional 220,000 RSU shares available to be granted. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on unvested and undelivered shares. At the end of 2021, 12,001,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2021: 4,218,000 time-based RSUs, which vest upon continued employment or service over specified periods of time; and 131,000 performance-based RSUs, of which 104,000 were granted to executive officers subject to the determination of the attainment of performance targets for 2021. This determination occurred in September 2021, at which time at least 33% of the units vested, as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2021: Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2020 5,174 $ 207.55 Granted 1,982 369.15 Vested and delivered ( 2,764 ) 235.64 Forfeited ( 137 ) 253.53 Special cash dividend 94 N/A Outstanding at the end of 2021 4,349 $ 257.88 The weighted-average grant date fair value of RSUs granted was $ 369.15 , $ 294.08 , and $ 224.00 in 2021, 2020, and 2019, respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2021 was $ 728 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2021 were approximately 1,516,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits: 2021 2020 2019 Stock-based compensation expense $ 665 $ 619 $ 595 Less recognized income tax benefit 140 128 128 Stock-based compensation expense, net $ 525 $ 491 $ 467 Note 9 Taxes Income Taxes Income before income taxes is comprised of the following: 2021 2020 2019 Domestic $ 4,931 $ 4,204 $ 3,591 Foreign 1,749 1,163 1,174 Total $ 6,680 $ 5,367 $ 4,765 The provisions for income taxes are as follows: 2021 2020 2019 Federal: Current $ 718 $ 616 $ 328 Deferred 84 77 222 Total federal 802 693 550 State: Current 265 230 178 Deferred 11 8 26 Total state 276 238 204 Foreign: Current 557 372 405 Deferred ( 34 ) 5 ( 98 ) Total foreign 523 377 307 Total provision for income taxes $ 1,601 $ 1,308 $ 1,061 Except for certain provisions, the Tax Cuts and Jobs Act (2017 Tax Act) was effective for tax years beginning on or after January 1, 2018. Most provisions became effective for the Company for 2019, including limitations on the ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of 2018 and throughout 2019 included: a lower U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The lower U.S. tax rate of 21.0 % was effective for all of 2021, 2020, and 2019. The reconciliation between the statutory tax rate and the effective rate for 2021, 2020, and 2019 is as follows: 2021 2020 2019 Federal taxes at statutory rate $ 1,403 21.0 % $ 1,127 21.0 % $ 1,001 21.0 % State taxes, net 243 3.6 190 3.6 171 3.6 Foreign taxes, net 92 1.4 92 1.7 ( 1 ) Employee stock ownership plan (ESOP) ( 91 ) ( 1.3 ) ( 24 ) ( 0.5 ) ( 18 ) ( 0.4 ) 2017 Tax Act ( 123 ) ( 2.6 ) Other ( 46 ) ( 0.7 ) ( 77 ) ( 1.4 ) 31 0.7 Total $ 1,601 24.0 % $ 1,308 24.4 % $ 1,061 22.3 % During 2019, the Company recognized net tax benefits of $ 123 related to the 2017 Tax Act. This benefit included $ 105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. The Company recognized total net tax benefits of $ 163 , $ 81 and $ 221 in 2021, 2020 and 2019, respectively. These include benefits of $ 75 , $ 77 and $ 59 , respectively, related to the stock-based compensation accounting standard adopted in 2018, in addition to the impacts of the 2017 Tax Act noted above. During 2021, there was a net tax benefit of $ 70 related to the portion of the special dividend paid through our 401(k) plan. The components of the deferred tax assets (liabilities) are as follows: 2021 2020 Deferred tax assets: Equity compensation $ 72 $ 80 Deferred income/membership fees 161 144 Foreign tax credit carry forward 146 101 Operating lease liabilities 769 832 Accrued liabilities and reserves 681 639 Other 62 Total deferred tax assets 1,891 1,796 Valuation allowance ( 214 ) ( 105 ) Total net deferred tax assets 1,677 1,691 Deferred tax liabilities: Property and equipment ( 935 ) ( 800 ) Merchandise inventories ( 216 ) ( 228 ) Operating lease right-of-use assets ( 744 ) ( 801 ) Foreign branch deferreds ( 92 ) ( 81 ) Other ( 40 ) Total deferred tax liabilities ( 1,987 ) ( 1,950 ) Net deferred tax liabilities $ ( 310 ) $ ( 259 ) The deferred tax accounts at the end of 2021 and 2020 include deferred income tax assets of $ 444 and $ 406 , respectively, included in other long-term assets; and deferred income tax liabilities of $ 754 and $ 665 , respectively, included in other long-term liabilities. In 2021 and 2020, the Company had valuation allowances of $ 214 and $ 105 , respectively, primarily related to foreign tax credits that the Company believes will not be realized due to carry forward limitations. The foreign tax credit carry forwards are set to expire beginning in fiscal 2030. The Company no longer considers fiscal year earnings of non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested (other than China) and has recorded the estimated incremental foreign withholding taxes (net of available foreign tax credits) and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries, which totaled $ 3,070 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2021 and 2020 is as follows: 2021 2020 Gross unrecognized tax benefit at beginning of year $ 30 $ 27 Gross increasescurrent year tax positions 2 1 Gross increasestax positions in prior years 2 8 Gross decreasestax positions in prior years ( 3 ) Lapse of statute of limitations ( 1 ) ( 3 ) Gross unrecognized tax benefit at end of year $ 33 $ 30 The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2021 and 2020, these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that if recognized would favorably affect the effective income tax rate in future periods is $ 30 and $ 28 at the end of 2021 and 2020, respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Accrued interest and penalties recognized during 2021 and 2020, and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and abroad. Some audits may conclude in the next 12 months, and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2017. The Company is currently subject to examination in California for fiscal years 2013 to present. Other Taxes The Company is subject to multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. In the fourth quarter of 2020, the Company reached an agreement on a product tax audit resulting in a benefit of $ 84 . The Company recorded a charge of $ 123 in 2019 regarding this matter. Other possible losses or range of possible losses associated with these examinations are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 10Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): 2021 2020 2019 Net income attributable to Costco $ 5,007 $ 4,002 $ 3,659 Weighted average basic shares 443,089 442,297 439,755 RSUs 1,257 1,604 3,168 Weighted average diluted shares 444,346 443,901 442,923 Note 11Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigations arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in an action commenced in August 2013 under the California Labor Code Private Attorneys General Act (PAGA) alleging violation of California Wage Order 7-2001 for failing to provide seating to employees who work at entrance and exit doors in California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 2013-1-CV-248813; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or reasonably comfortable workplace temperature conditions. Lane v. Costco Wholesale Corp. (Case No. CIVDS 1908816; San Bernardino Superior Court). The Company filed an answer denying the material allegations of the complaint. In October 2019, the parties reached an agreement to settle for an immaterial amount the seating claims on a representative basis, which received court approval in February 2020. The workplace temperature claims continue in litigation. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In October 2019, the parties reached an agreement on a class settlement for an immaterial amount, which received court approval in January 2021. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez v. Costco Wholesale Corp. (Case No. 2:19-cv-03454; C.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In December 2019, the court issued an order denying class certification. In January 2020, the plaintiffs dismissed their Labor Code claims without prejudice, and the court remanded the action to state court. The remand was appealed; the appeal is in abeyance due to a pending settlement for an immaterial amount that was agreed upon in February 2021. The preliminary approval hearing of the settlement is scheduled for October 2021. In May 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340; E.D. Cal.). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The Company has moved for partial summary judgement, and the parties have filed competing motions regarding class certification. In August 2019, the plaintiff filed a companion case in state court seeking penalties under PAGA. Rough v. Costco Wholesale Corp. (Case No. FCS053454; Sonoma County Superior Court). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The state court action has been stayed pending resolution of the federal action. In June 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp . (Case No. 3:19-cv-05624-EMC; N.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In June 2021, the plaintiff agreed to dismiss his claims for failure to provide meal and rest breaks and to pay minimum wages. In July 2021, the parties reached an agreement settling for an immaterial amount the remaining claim and related derivative claims. In April 2020, an employee, alleging underpayment of sick pay, filed a class and representative action against the Company, alleging claims under California law for failure to pay all wages at termination and for Labor Code penalties under PAGA. Kristy v. Costco Wholesale Corp. (Case No. 5:20-cv-04119; N.D. Cal.). The case was stayed due to the plaintiff's bankruptcy, and his individual claim was settled for an immaterial amount. A request for dismissal of the class and representative action is pending. In July 2020, an employee filed an action under PAGA on behalf of all California non-exempt employees alleging violations of California Labor Code provisions regarding meal and rest periods, minimum wage, overtime, wage statements, reimbursement of expenses, and payment of wages at termination. Schwab v. Costco Wholesale Corporation (Case No. 37-2020-00023551-CU-OE-CTL; San Diego County Superior Court). In August 2020, the Company filed a motion to strike portions of the complaint, which was denied, and an answer has been filed denying the material allegations of the complaint. In December 2020, a former employee filed suit against the Company asserting collective and class claims on behalf of non-exempt employees under the Fair Labor Standards Act and New York Labor Law for failure to pay for all hours worked on a weekly basis and failure to provide proper wage statements and notices. The plaintiff also asserts individual retaliation claims. Cappadora v. Costco Wholesale Corp. (Case No. 1:20-cv-06067; E.D.N.Y.). An amended complaint was filed, and the Company has denied the material allegations of the amended complaint. In August 2021, a former employee filed a similar suit, asserting collective and class claims on behalf of non-exempt employees under the FLSA and New York law. Umadat v. Costco Wholesale Corp. (Case No. 2:21-cv-4814; E.D.N.Y.). The Company has not yet responded to the complaint. In February 2021, a former employee filed a class action against the Company alleging violations of California Labor Code regarding payment of wages, meal and rest periods, wage statements, reimbursement of expenses, payment of final wages to terminated employees, and for unfair business practices. Edwards v. Costco Wholesale Corp. (Case No. 5:21-cv-00716: C.D. Cal.). In May 2021, the Company filed a motion to dismiss the complaint, which was granted with leave to amend. In June 2021, the plaintiff filed an amended complaint, which the Company moved to dismiss later that month. The court granted the motion in part in July 2021 with leave to amend. In August 2021, the plaintiff filed a second amended complaint and filed a separate representative action under PAGA asserting the same Labor Code claims and seeking civil penalties and attorneys' fees. The Company has filed an answer to the second amended class action complaint denying the material allegations. In July 2021, a former temporary staffing employee filed a class action against the Company and a staffing company alleging violations of the California Labor Code regarding payment of wages, meal and rest periods, wage statements, the timeliness of wages and final wages, and for unfair business practices. Dimas v. Costco Wholesale Corp. (Case No. STK-CV-UOE-2021-0006024; San Joaquin Superior Court). The Company has not yet responded to the complaint. Beginning in December 2017, the United States Judicial Panel on Multidistrict Litigation has consolidated numerous cases concerning the impacts of opioid abuses filed against various defendants by counties, cities, hospitals, Native American tribes, third-party payors, and others. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and a hospital in Texas, class actions filed on behalf of infants born with opioid-related medical conditions in 40 states, and class actions and individual actions filed on behalf of individuals seeking to recover alleged increased insurance costs associated with opioid abuse in 43 states and American Samoa. Claims against the Company in state courts in New Jersey, Oklahoma, Utah, and Arizona have been dismissed. The Company is defending all of the pending matters. The Company and its CEO and CFO were defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Dec. 11, 2018). The complaints alleged violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. A consolidated amended complaint was filed on April 16, 2019. On November 26, 2019, the court entered an order dismissing the consolidated amended complaint and granting the plaintiffs leave to file a further amended complaint. A further amended complaint was filed on March 9, which the court dismissed with prejudice on August 19, 2020. On July 20, 2021, the Ninth Circuit affirmed the dismissal. Members of the Board of Directors, one other individual, and the Company were defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash.; filed Dec. 11, 2018). Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1), and June 12, 2019, Rahul Modi v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-15514-1). In light of the dismissal in Johnson noted above, the plaintiffs in the derivative actions agreed voluntarily to dismiss their complaints. On June 23, 2020, a putative class action was filed against the Company, the Board of Directors, the Costco Benefits Committee and others under the Employee Retirement Income Security Act, in the United States District Court for the Eastern District of Wisconsin. Dustin S. Soulek v. Costco Wholesale, et al. , Case No. 1:20-cv-937. The class is alleged to be beneficiaries of the Costco 401(k) plan from June 23, 2014, and the claims are that the defendants breached their fiduciary duties in the operation and oversight of the plan. The complaint seeks injunctive relief, damages, interest, costs, and attorneys' fees. On September 11, 2020, the defendants filed a motion to dismiss the complaint, and on September 21 the plaintiffs filed an amended complaint, which the defendants have also moved to dismiss. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 12Segment Reporting The Company is principally engaged in the operation of membership warehouses through wholly owned subsidiaries in the U.S., Canada, Mexico, Japan, U.K., Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. The following table provides information for the Company's reportable segments: United States Operations Canadian Operations Other International Operations Total 2021 Total revenue $ 141,398 $ 27,298 $ 27,233 $ 195,929 Operating income 4,262 1,176 1,270 6,708 Depreciation and amortization 1,339 177 265 1,781 Additions to property and equipment 2,612 272 704 3,588 Property and equipment, net 15,993 2,317 5,182 23,492 Total assets 39,589 5,962 13,717 59,268 2020 Total revenue $ 122,142 $ 22,434 $ 22,185 $ 166,761 Operating income 3,633 860 942 5,435 Depreciation and amortization 1,248 155 242 1,645 Additions to property and equipment 2,060 258 492 2,810 Property and equipment, net 14,916 2,172 4,719 21,807 Total assets 38,366 5,270 11,920 55,556 2019 Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 924 750 4,737 Depreciation and amortization 1,126 143 223 1,492 Additions to property and equipment 2,186 303 509 2,998 Property and equipment, net 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 Disaggregated Revenue The following table summarizes net sales by merchandise category; sales from e-commerce websites and business centers have been allocated to their respective merchandise categories: 2021 2020 2019 Foods and Sundries $ 77,277 $ 68,659 $ 59,672 Non-Foods 55,966 44,807 41,160 Fresh Foods 27,183 23,204 19,948 Warehouse Ancillary and Other Businesses 31,626 26,550 28,571 Total net sales $ 192,052 $ 163,220 $ 149,351 "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of August 29, 2021 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of August 29, 2021, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control Integrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of August 29, 2021. The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2021 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. " +1,cost,20200830," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 795, 782, and 762 warehouses worldwide at August 30, 2020, September 1, 2019, and September 2, 2018, respectively. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally-branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit most items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. We average anywhere from 8,000 to 10,000 SKUs online, some of which are also available in our warehouses. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations varies significantly by country, and we do not currently operate our gasoline business in Korea or China. We operated 615 gas stations at the end of 2020. Net sales for our gasoline business represented approximately 9% of total net sales in 2020. Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. Net sales for e-commerce represented approximately 6% of total net sales in 2020. This figure does not consider other services we offer online in certain countries such as business delivery, travel, same-day grocery, and various other services. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. The COVID-19 pandemic created unprecedented supply constraints including disruptions and delays that have impacted and could continue to impact the flow and availability of certain products. When sources of supply become unavailable, we seek alternative sources. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 12 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 88% on a worldwide basis at the end of 2020. The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. At the end of 2020, we standardized our membership count methodology globally to be consistent with the U.S. and Canada, which resulted in the addition to the count of approximately 2.0 million total cardholders for 2020, of which 1.3 million were paid members. The change did not impact 2019 or 2018. Membership fee income and the renewal rate calculations were not affected. Our membership was made up of the following (in thousands): 2020 2019 2018 Gold Star 46,800 42,900 40,700 Business, including affiliates 11,300 11,000 10,900 Total paid members 58,100 53,900 51,600 Household cards 47,400 44,600 42,700 Total cardholders 105,500 98,500 94,300 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., Japan, Korea, and Taiwan, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (generally up to a maximum reward of $1,000 per year), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico, Japan, and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members, who totaled 22.6 million and represented 39% of paid members at the end of 2020, generally shop more frequently and spend more than other members. Labor Our employee count was as follows: 2020 2019 2018 Full-time employees 156,000 149,000 143,000 Part-time employees 117,000 105,000 102,000 Total employees 273,000 254,000 245,000 Approximately 17,100 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon are among our significant general merchandise retail competitors. We also compete with other warehouse clubs (primarily Walmarts Sams Club and BJs Wholesale Club), and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple clubs. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered at prices that are generally lower than national brands, and help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 1995 68 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 1993 64 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce Merchandise, from 2013 to January 2018. 2018 58 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 2019 58 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 2018 63 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 2001 69 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 2011 67 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 1994 68 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 2013 68 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 2016 55 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2020, respectively. Within the U.S., we are highly dependent on our California operations, which comprised 29% of U.S. net sales in 2020. Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, and integrating acquisitions, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. We have made and may continue to make investments and acquisitions to improve the speed, accuracy and efficiency of our supply chains. The effectiveness of these investments can be less predictable than opening new locations and might not provide the anticipated benefits or desired rates of return. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes, pandemics or other extreme weather conditions or catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. Our e-commerce business depends heavily on third-party logistics providers and that business is negatively affected when these providers are unable to provide services in a timely fashion. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns, or we may experience out-of-stock positions and delivery delays, which could result in higher costs, both of which would reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. Availability and performance of our information technology (IT) systems are vital for our business to operate efficiently. Failure to execute complex IT projects, and have these IT systems available to our business will adversely impact our operations. IT systems play a crucial role in conducting our business on a daily basis. These systems are utilized to process a very high volume of transactions, conduct payment transactions, track and value our inventory and produce reports which are critical for making business decisions on a daily, weekly and periodic basis. Failure or disruption of these IT systems could have an adverse impact on our ability to buy products from our suppliers, produce goods in our manufacturing plants, move the products in an efficient manner to our warehouses and sell products to our members. We are undertaking large technology and IT transformation projects. The failure of these projects could adversely impact our business plans and potentially impair our day to day business operations. Given the high volume of transactions we process, it is important that we build strong digital resiliency for our business-critical systems to prevent disruption from events such as power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, errors by employees, and catastrophic events such as fires, earthquakes tornadoes and hurricanes. Any debilitating failure of our critical IT systems, data centers and backup systems would require significant investments in resources to restore IT services and may cause serious impairment in our business operations including loss of business services, increased cost of moving merchandise and failure to provide service to our members. We are currently making significant investments in enhancing our digital resiliency and failure or delay in execution of these projects could delay our ability to be resilient to disruptive events. Failure to deliver our IT transformation efforts efficiently and effectively could result in the loss of our competitive position and adversely impact our financial condition and results of operations. We are required to maintain the privacy and security of personal and business information amidst evolving threat landscapes and in compliance with emerging privacy and data protection regulations globally. Failure to meet the requirements could damage our reputation with members, suppliers and employees, cause us to incur substantial additional costs, and become subject to litigation. Increased IT security threats and more sophisticated computer crime pose a risk to our systems, networks, products and services. We rely upon IT systems and networks, some of which are managed by third parties, in connection with a variety of business activities. Additionally, we collect, store and process sensitive information relating to our business, members, suppliers and employees. Operating these IT systems and networks, and processing and maintaining this data, in a secure manner, is critical to our business operations and strategy. The increased use of remote work infrastructure due to the COVID-19 pandemic has also increased the possible attack surfaces. Security threats designed to gain unauthorized access to our systems, networks and data, are increasing in frequency and sophistication. Cybersecurity attacks may range from random attempts to coordinated and targeted attacks, including sophisticated computer crimes and advanced persistent threats. These threats pose a risk to the security of our systems and networks and the confidentiality, integrity, and availability of our data. It is possible that our IT systems and networks, or those managed by third parties such as cloud providers, could have vulnerabilities, which could go unnoticed for a period of time. While our cybersecurity and compliance posture seeks to mitigate such risks, there can be no guarantee that the actions and controls we and our third-party service providers have implemented and are implementing, will be sufficient to protect our systems, information or other property. The potential impacts of a future material cybersecurity attack includes reputational damage, litigation, government enforcement actions, penalties, disruption to systems, unauthorized release of confidential or otherwise protected information, corruption of data, diminution in the value of our investment in IT systems and increased cybersecurity protection and remediation costs. This could adversely affect our competitiveness, results of operations and financial condition and loss of member confidence. Further, the amount of insurance coverage we maintain may be inadequate to cover claims or liabilities relating to a cybersecurity attack. In addition, data we collect, store and process is subject to a variety of U.S. and international laws and regulations, such as the European Union's General Data Protection Regulation, California Consumer Privacy Act, Health Insurance Portability and Accountability Act, China cybersecurity law and other emerging privacy and cybersecurity laws across the various states and around the globe, which may carry significant potential penalties for noncompliance. We are subject to payment-related risks. We accept payments using a variety of methods, including select credit and debit cards, cash and checks, co-brand cardholder rebates, executive member 2% reward certificates, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these parties become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards, which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, including food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long-term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media, particularly in the wake of COVID-19. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of our employees, including members of our senior management and other key operations, IT, merchandising and administrative personnel. Failure to identify and implement a succession plan for senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear a significant portion of the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and customer expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, pandemics and other health crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China and the United States, have raised the cost of many items and created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our business, including net sales and gross margin, will be influenced in part by merchandising and pricing strategies in response to potential cost increases by us and our competitors. While these potential impacts are uncertain, they could have an adverse impact on our financial results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions causing a loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, natural disasters, extreme weather conditions, public health emergencies, supply constraints and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2020, our international operations, including Canada, generated 27% and 33% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters, extreme weather conditions, public health emergencies or other catastrophic events could negatively affect our business, financial condition, and results of operations. Natural disasters and extreme weather conditions, such as hurricanes, typhoons, floods, earthquakes; acts of terrorism or violence, including active shooter situations; public health issues, including pandemics and quarantines, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, limitations on store operating hours, less frequent visits by members to physical locations, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, disruptions to our IT systems, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. The COVID-19 pandemic is affecting our business, financial condition and results of operations in many respects. The continuing impacts of the COVID-19 pandemic are highly unpredictable and volatile, and are affecting certain business operations, demand for our products and services, in-stock positions, costs of doing business, availability of labor, access to inventory, supply chain operations, our ability to predict future performance, exposure to litigation, and our financial performance, among other things. The COVID-19 pandemic has resulted in widespread and continuing impacts on the global economy and on our employees, members, suppliers and other people and entities with which we do business. There is considerable uncertainty regarding the extent to which COVID-19 will continue to spread and the extent and duration of measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders and business and government shutdowns. We are taking precautionary measures intended to help minimize the risk of the virus to our employees, including temporarily requiring some employees to work remotely. To reward our employees for exemplary service in difficult times we temporarily increased compensation levels and otherwise incurred increased spending for wages and benefits, including overtime pay. The pandemic and any preventative or protective actions that governments or we may take are likely to result in a period of business disruption, reduced member traffic and reduced sales in certain merchandise categories, and increased operating expenses. The pandemic has significantly impacted the global supply chain, with restrictions and limitations on business activities causing disruption and delay. These disruptions and delays have strained certain domestic and international supply chains, which have affected and could continue to negatively affect the flow or availability of certain products. Member demand for certain products has also fluctuated as the pandemic has progressed and member behaviors have changed, which has challenged our ability to anticipate and/or adjust inventory levels to meet that demand. These factors have resulted in higher out-of-stock positions in certain products, as well as delays in delivering those products. Even if we are able to find alternate sources for certain products, they may cost more or require us to incur higher transportation costs, adversely impacting our profitability and financial condition. Similarly, increased demand for online purchases of products has impacted our fulfillment operations, resulting in delays in delivering products to members. If we do not respond appropriately to the pandemic, or if our members do not participate in social distancing and other safety measures, the well-being of our employees and members could be at risk, and a failure to appropriately respond, or the perception of an inadequate response, could cause reputational harm to our brand and subject us to lost sales and claims from employees, members, suppliers, regulators or other parties. Additionally, a future outbreak of confirmed cases of COVID-19 in our facilities could result in temporary or sustained workforce shortages or facility closures, which would negatively impact our business and results of operations. Some jurisdictions have taken measures intended to expand the availability of workers compensation or to change the presumptions applicable to workers compensation measures. These actions may increase our exposure to claims and increase our costs. In an effort to strengthen our liquidity position, during the year we issued $4,000 million Senior Notes, a portion of which was used to repay, prior to maturity, $1,500 million of our 2.150% and 2.250% Senior Notes. Financial and credit markets have experienced and may continue to experience significant volatility and turmoil. Our continued access to external sources of liquidity depends on multiple factors, including the condition of debt capital markets, our operating performance, and maintaining strong credit ratings. If the impacts of the pandemic continue to disrupt the financial markets, or if rating agencies lower our credit ratings, it could adversely affect our ability to access the debt markets, our cost of funds, and other terms for new debt or other sources of external liquidity, if needed. Other factors and uncertainties include, but are not limited to: The severity and duration of the pandemic, including whether there is a second wave caused by additional periods of increases or spikes in the number of COVID-19 cases, future mutations or related strains of the virus in areas in which we operate; Evolving macroeconomic factors, including general economic uncertainty, unemployment rates, and recessionary pressures; Unknown consequences on our business performance and initiatives stemming from the substantial investment of time and other resources to the pandemic response; The pace of recovery when the pandemic subsides; and The long-term impact of the pandemic on our business, including consumer behaviors. To the extent that COVID-19 continues to adversely affect the U.S. and global economy, our business, results of operations, cash flows, or financial condition, it may also heighten other risks described in this section, including but not limited to those related to consumer behavior and expectations, competition, brand reputation, implementation of strategic initiatives, cybersecurity threats, payment-related risks, technology systems disruption, supply chain disruptions, labor availability and cost, litigation, operational risk as a result of remote work arrangements and regulatory requirements. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. Government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change, extreme weather conditions, and rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks We are subject to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2020, we operated 243 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the withdrawal of the U.K. from the European Union, and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act of 2002 requires management assessments of the effectiveness of internal control over financial reporting and disclosure controls and procedures. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional tax liabilities. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide and increasingly broad array of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. Operations at our facilities require the treatment and disposal of wastewater, stormwater and agricultural and food processing wastes, the use and maintenance of refrigeration systems, including ammonia-based chillers, noise, odor and dust management, the operation of mechanized processing equipment, and other operations that potentially could affect the environment and public health and safety. Failure to comply with current and future environmental, health and safety standards could result in the imposition of fines and penalties, illness or injury of our employees, and claims or lawsuits related to such illnesses or injuries, and temporary closures or limits on the operations of facilities. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At August 30, 2020, we operated 795 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico 443 109 552 Canada 87 14 101 Other International 99 43 142 Total 629 166 795 _______________ (1) 119 of the 166 leases are land-only leases, where Costco owns the building. At the end of 2020, our warehouses contained approximately 116.1 million square feet of operating floor space: 81.4 million in the U.S.; 14.3 million in Canada; and 20.4 million in Other International. Total square feet associated with distribution and logistics facilities were approximately 28.0 million. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 11 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On September 29, 2020, we had 9,690 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2020 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 11June 7, 2020 $ $ 3,833 June 8July 5, 2020 94,000 301.79 94,000 3,805 July 6August 2, 2020 93,000 324.51 93,000 3,775 August 3August 30, 2020 88,000 340.17 88,000 3,745 Total fourth quarter 275,000 $ 321.73 275,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 30, 2015, through August 30, 2020. "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is increasing net sales, particularly comparable sales growth. Net sales includes our core merchandise categories (food and sundries, hardlines, softlines, and fresh foods), warehouse ancillary and other businesses. We define comparable sales as net sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative (SGA) expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long-term. Another substantial factor in net sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Net sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and merchandise mix, including increasing the penetration of our private-label items and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short-term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe our gasoline business draws members, but it generally has a lower gross margin percentage relative to our non-gasoline business. It also has lower SGA expenses as a percent of net sales compared to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our SGA expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin will be influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve net sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of operating floor space square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales but it generally has a lower gross margin percentage relative to our warehouse business. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business operates on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 12 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wage and benefit costs as a percentage of country sales, less or no direct membership warehouse competition, and may lack an e-commerce business. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. For discussion related to the results of operations and changes in financial condition for 2019 compared to 2018 refer to Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations in our fiscal year 2019 Form 10-K, which was filed with the United States Securities and Exchange Commission on October 11, 2019. Highlights for 2020 included: We opened 16 new warehouses, including 3 relocations: 9 new in the U.S., 3 new in our Other International segment, and 1 net new location in our Canadian segment, compared to 25 new warehouses, including 5 relocations in 2019; Net sales increased 9% to $163,220 driven by a 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020; Membership fee revenue increased 6% to $3,541, primarily due to membership sign-ups at existing and new warehouses; Gross margin percentage increased 18 basis points, driven primarily by certain core merchandise categories, partially offset by certain ancillary and other businesses, which were negatively impacted by COVID-19 related closures or restrictions; SGA expenses as a percentage of net sales decreased three basis points primarily due to leveraging increased sales and partial reversal of a previous year tax assessment. These benefits were partially offset by incremental wage and sanitation costs as a result of COVID-19; The effective tax rate in 2020 was 24.4% compared to 22.3% in 2019; Net income increased 9% to $4,002, or $9.02 per diluted share compared to $3,659, or $8.26 per diluted share in 2019; In February 2020, we acquired a 35% interest in Navitus Health Solutions, a pharmacy benefit manager. In March 2020, we acquired Innovel Solutions, a company that provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico; In April 2020, we issued $4,000 in aggregate principal amount of Senior Notes, some proceeds of which were used to repay $1,500 of Senior Notes; and In April 2020, the Board of Directors approved an increase in the quarterly cash dividend from $0.65 to $0.70 per share. COVID-19 On March 11, 2020, the World Health Organization announced that COVID-19 infections had become a pandemic, and shortly afterward the U.S. declared a National Emergency. The outbreak has led to widespread and continuing impacts on the global economy and is affecting many aspects of our business and the operations of others with which we do business. In our response to the pandemic and in an effort to protect our members and employees, we have taken several measures, as described in Item 1A Risk Factors, and their implications on our results of operations have impacted us across all our reportable segments to varying degrees. Throughout the pandemic our warehouses have largely remained open as a result of being deemed an essential business in most markets and resulted in strong sales increases in our food and sundries and fresh foods merchandise categories compared to pre-pandemic time periods. This growth in certain of our core business categories has led to improved gross margin and SGA percentages as we leveraged these sales to achieve greater efficiency. Our e-commerce business has also benefited, as more members have shopped online during the pandemic. Conversely, we have experienced decreases in both the sales and profitability of many of our ancillary and other businesses due to temporary closures or limited demand. Additionally, we paid $564 in incremental wage and sanitation costs during 2020 related to COVID-19. RESULTS OF OPERATIONS Net Sales 2020 2019 2018 Net Sales $ 163,220 $ 149,351 $ 138,434 Changes in net sales: U.S. 9 % 9 % 9 % Canada 5 % 3 % 10 % Other International 13 % 5 % 14 % Total Company 9 % 8 % 10 % Changes in comparable sales: U.S. 8 % 8 % 9 % Canada 5 % 2 % 9 % Other International 9 % 2 % 11 % Total Company 8 % 6 % 9 % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. 9 % 6 % 7 % Canada 7 % 5 % 4 % Other International 11 % 6 % 7 % Total Company 9 % 6 % 7 % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019. Net Sales Net sales increased $13,869 or 9% during 2020, primarily due to an 8% increase in comparable sales and sales at new warehouses opened in 2019 and 2020. During the second half of 2020, we experienced a significant sales shift from certain of our ancillary and other businesses to our core merchandise categories, primarily food and sundries and fresh foods, as a result of COVID-19. This shift was largely driven by price deflation and lower volume in our gasoline business; temporary closures of most of our optical, hearing aid and photo departments; limited service in our food courts; and minimal demand in our travel business. Changes in gasoline prices negatively impacted net sales by $1,504, or 101 basis points, compared to 2019, due to a 10% decrease in the average price per gallon. The volume of gasoline sold decreased approximately 4%, negatively impacting net sales by $699, or 47 basis points. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $663, or 44 basis points, compared to 2019, attributable to our Canadian and Other International Operations. Comparable Sales Comparable sales increased 8% during 2020 and were positively impacted by increases in average ticket. While traffic increased slightly in 2020, it decreased in the second half of the year due to capacity restrictions and regulations related to COVID-19. There was an increase of 50% in e-commerce comparable sales in 2020, with an increase of 80% in the second half of the year. Membership Fees 2020 2019 2018 Membership fees $ 3,541 $ 3,352 $ 3,142 Membership fees increase 6 % 7 % 10 % Membership fees as a percentage of net sales 2.17 % 2.24 % 2.27 % The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses. At the end of 2020, our member renewal rates were 91% in the U.S. and Canada and 88% worldwide. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. Our membership counts include active memberships as well as memberships that have not renewed within the 12 months prior to the reporting date. Gross Margin 2020 2019 2018 Net sales $ 163,220 $ 149,351 $ 138,434 Less merchandise costs 144,939 132,886 123,152 Gross margin $ 18,281 $ 16,465 $ 15,282 Gross margin percentage 11.20 % 11.02 % 11.04 % The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased 16 basis points, primarily due to increases in fresh foods and softlines, partially offset by a decrease in hardlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Fresh foods gross margin increased as a result of efficiencies from increased sales, partially offset by operating losses from our poultry complex. Total gross margin percentage increased 18 basis points compared to 2019. Excluding the impact of gasoline price deflation on net sales, gross margin percentage was 11.10%, an increase of eight basis points. This increase was primarily due to a 32 basis point increase in our core merchandise categories, predominantly fresh foods and food and sundries, partially offset by a decrease in softlines and hardlines. This increase was also positively impacted by our co-branded credit card program, which included an adjustment in 2019 to our estimate of breakage on rewards earned. These increases were partially offset by a decrease of 14 basis points in our warehouse ancillary and other businesses, predominantly certain ancillary businesses that were negatively impacted by COVID-19 related closures or restrictions. However, certain of our ancillary and other businesses, such as tire shop, gasoline and e-commerce businesses, did improve. Gross margin was also negatively impacted by incremental wage and sanitation costs related to COVID-19 of six basis points, a reserve for certain inventory of three basis points, and increased spending by members under the Executive Membership 2% reward program of one basis point. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $68 in 2020. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), was impacted by increases in fresh foods and food and sundries and decreases in softlines and hardlines in each of our U.S., Canadian, and Other International segments. Each of our segments were also negatively impacted by the incremental wage and sanitation costs as a result of COVID-19. The segment gross margin percentage increased in our U.S. operations, predominantly in our core merchandise categories which includes the impact from our co-branded credit card program, as discussed above, partially offset by certain ancillary businesses that were negatively impacted by COVID-19 related closures or restrictions. Our Canadian segment gross margin percentage decreased primarily due to certain of our warehouse ancillary and other businesses that were negatively impacted by COVID-19 related closures or restrictions. The segment gross margin percentage increased in our Other International operations primarily due to core merchandise categories, as discussed above, and was also positively impacted by certain warehouse ancillary and other businesses, predominantly e-commerce. These increases were partially offset by increased spending by members under the Executive Membership 2% reward program. Selling, General and Administrative Expenses 2020 2019 2018 SGA expenses $ 16,332 $ 14,994 $ 13,876 SGA expenses as a percentage of net sales 10.01 % 10.04 % 10.02 % SGA expenses as a percentage of net sales decreased three basis points compared to 2019. SGA expenses as a percentage of net sales, excluding the impact of gasoline price deflation, was 9.91%, a decrease of 13 basis points. SGA expenses were negatively impacted by approximately $456, or 28 basis points, due to incremental wage and sanitation costs as a result of COVID-19, and approximately $24 or one basis point due to costs associated with the acquisition of Innovel (see Note 2 to the consolidated financial statements). Operating costs related to warehouse operations and other businesses, which include e-commerce and travel, were lower by 26 basis points, primarily due to leveraging increased sales. SGA expenses were also benefited by 13 basis points related to a product tax assessment charge in 2019 which was partially reversed in 2020. Stock compensation was lower by two basis points, and central operating costs were lower by one basis point. Our Canadian segment SGA percentage was higher compared to 2019 due primarily to the incremental wage and sanitation costs related to COVID as outlined above. Changes in foreign currencies relative to the U.S. dollar positively impacted SGA expenses by approximately $58. Preopening 2020 2019 2018 Preopening expenses $ 55 $ 86 $ 68 Warehouse openings, including relocations United States 9 18 17 Canada 4 3 3 Other International 3 4 5 Total warehouse openings, including relocations 16 25 25 Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether a warehouse is owned or leased, and whether openings are in an existing, new, or international market. In 2020, operations commenced at our new poultry processing plant, and in 2019, we opened our first warehouse in China. Interest Expense 2020 2019 2018 Interest expense $ 160 $ 150 $ 159 Interest expense primarily relates to Senior Notes. In December 2019 and February 2020, we repaid $1,200 and $500 in total outstanding principal of the 1.700% and 1.750% Senior Notes, respectively. In April 2020, we issued $4,000 in aggregate principal amount of long-term debt consisting of $ 1,250 of 1.375 % Senior Notes due June 2027; $ 1,750 of 1.600 % Senior Notes due April 2030; and $ 1,000 of 1.750 % Senior Notes due April 2032. A portion of the proceeds was used to repay, prior to maturity, $1,000 and $500 of the 2.150% and 2.250% Senior Notes. For more information on our debt arrangements refer to Note 5 to the consolidated financial statements. Interest Income and Other, Net 2020 2019 2018 Interest income $ 89 $ 126 $ 75 Foreign-currency transaction gains, net 7 27 23 Other, net (4) 25 23 Interest income and other, net $ 92 $ 178 $ 121 The decrease in interest income in 2020 was primarily due to lower interest rates in the U.S. and Canada, partially offset by higher average cash and investment balances. Foreign-currency transaction gains, net include the revaluation and settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Note 1 to the consolidated financial statements. Other, net was impacted by a $36 charge related to the repayment of certain Senior Notes, as discussed above and in Note 5 . Provision for Income Taxes 2020 2019 2018 Provision for income taxes $ 1,308 $ 1,061 $ 1,263 Effective tax rate 24.4 % 22.3 % 28.4 % The effective tax rate for 2020 included discrete net tax benefits of $81, including a benefit of $77 due to excess tax benefits from stock compensation. Excluding these benefits, the tax rate was 25.9% for 2020. The effective tax rate for 2019 included discrete net tax benefits of $221, including a benefit of $59 due to excess tax benefits from stock compensation. This also included a tax benefit of $105 related to U.S. taxation of deemed foreign dividends, offset by losses of foreign tax credits, which impacted the effective tax rate. Excluding these benefits, the tax rate was 26.9% for 2019. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: 2020 2019 2018 Net cash provided by operating activities $ 8,861 $ 6,356 $ 5,774 Net cash used in investing activities (3,891) (2,865) (2,947) Net cash used in financing activities (1,147) (1,147) (1,281) Our primary sources of liquidity are cash flows generated from our operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $13,305 and $9,444 at the end of 2020 and 2019, respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,636 and $1,434 at the end of 2020 and 2019, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by a change in exchange rates of $70 in 2020, and negatively impacted by $15 and $37 in 2019 and 2018, respectively. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. We no longer consider earnings after 2017 of our non-U.S. consolidated subsidiaries to be indefinitely reinvested. Cash Flows from Operating Activities Net cash provided by operating activities totaled $8,861 in 2020, compared to $6,356 in 2019. Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, payment terms with our suppliers, and the amount of payables paid early to obtain discounts from our suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $3,891 in 2020, compared to $2,865 in 2019, and primarily related to capital expenditures. In 2020, we acquired Innovel and a minority interest in Navitus. For more information see Notes 1 and 2 to the consolidated financial statements. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations, and working capital. In 2020, we spent $2,810 on capital expenditures, and it is our current intention to spend approximat ely $3,000 to $3,200 d uring fiscal 2021. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 16 new warehous es, including three relocations, in 2020, and plan to open approximately 23 additional new warehouses, including three relocations, in 2021. We have experienced delays in real estate and construction activities due to COVID-19. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs or based on the current economic environment. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,147 in both 2020 and 2019. In April 2020, we issued $4,000 in aggregate principal amount of Senior Notes as follows: $1,250 of 1.375% due June 2027; $1,750 of 1.600% due April 2030; and $1,000 of 1.750% due April 2032. A portion of the proceeds was used to repay, prior to maturity, the outstanding $1,000 and $500 principal balances on the 2.150% and 2.250% Senior Notes, respectively, at a redemption price plus accrued interest as specified in the Notes' agreements. The remaining funds are intended for general corporate purposes. Financing activities also included $1,200 and $500 repayment of our 1.700% and 1.750% Senior Notes, respectively, payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. Stock Repurchase Programs During 2020 and 2019, we repurchased 643,000 and 1,097,000 shares of common stock, at average prices of $308.45 and $225.16, respectively, totaling approximately $198 and $247, respectively. These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. The remaining amount available to be purchased under our approved plan was $3,745 at the end of 2020. Dividends Cash dividends declared in 2020 totaled $2.70 per share, as compared to $2.44 per share in 2019. Dividends totaling $1,479 were paid during 2020, of which $286 related to the dividend declared in August 2019. In April 2020, the Board of Directors increased our quarterly cash dividend from $0.65 to $0.70 per share. In July 2020, the Board of Directors declared a quarterly cash dividend in the amount of $0.70 per share, which was paid on August 14, 2020. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At August 30, 2020, we had borrowing capacity under these facilities of $967. Our international operations maintain $500 of the total borrowing capacity under bank credit facilities, of which $204 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2020 and 2019. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $183. The outstanding commitments under these facilities at the end of 2020 totaled $166, most of which were standby letters of credit which do not expire or have expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Contractual Obligations At August 30, 2020, our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 2022 to 2023 2024 to 2025 2026 and thereafter Total Purchase obligations (1) $ 12,575 $ 9 $ $ $ 12,584 Long-term debt (2) 241 1,163 1,475 5,776 8,655 Operating leases (3) (4) 273 499 388 2,410 3,570 Construction and land obligations 979 35 1,014 Finance lease obligations (4) 61 128 197 742 1,128 Purchase obligations (equipment, services and other) (5) 674 205 72 187 1,138 Other (6) 60 36 28 108 232 Total $ 14,863 $ 2,075 $ 2,160 $ 9,223 $ 28,321 _______________ (1) Includes open purchase orders primarily related to merchandise and supplies. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Operating lease payments have not been reduced by future sublease income of $101. (4) Includes amounts representing interest. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations and deferred compensation obligations. The amount excludes $25 of non-current unrecognized tax contingencies and $48 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities Claims for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis point change in interest rates as of the end of 2020 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2020, long-term debt with fixed interest rates was $7,657. Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 5 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 4 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at August 30, 2020, would have decreased the fair value of the contracts by $111 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to some of the fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of August 30, 2020 and September 1, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of August 30, 2020 and September 1, 2019, and the results of its operations and its cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 6, 2020 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases as of September 2, 2019 due to the adoption of Accounting Standards Update 2016-02 Leases (ASC 842). Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated insurance/self-insurance liabilities as of August 30, 2020 were $1,188 million, a portion of which related to workers compensation and general liability self-insurance liabilities for the United States and Canadian operations. We identified the evaluation of the Companys workers compensation and general liability self-insurance liabilities for the United States and Canadian operations as a critical audit matter because of the extent of specialized skill and knowledge needed to evaluate the Companys actuarial models and the judgments required to assess the underlying assumptions made by the Company. Specifically, subjective auditor judgment was required to evaluate certain assumptions underlying the Companys actuarial estimates, including reporting and payment patterns used in the projections of the ultimate loss; loss and exposure trends; the selected loss rates and initial expected losses used in the Paid and Incurred Bornhuetter-Ferguson methods; and the selection of the ultimate loss derived from the various methods. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested operating effectiveness of certain internal controls over the Companys self-insurance process. This included controls related to the development and selection of the assumptions listed above used in the actuarial calculation and review of the actuarial report. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards Evaluating the Companys ability to estimate self-insurance liabilities by comparing its historical estimate with actual incurred losses and paid losses Evaluating the above listed assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance liabilities and comparing them to the amounts recorded by the Company /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 6, 2020 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of August 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of August 30, 2020 and September 1, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week periods ended August 30, 2020, September 1, 2019 and September 2, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated October 6, 2020 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 6, 2020 COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 REVENUE Net sales $ 163,220 $ 149,351 $ 138,434 Membership fees 3,541 3,352 3,142 Total revenue 166,761 152,703 141,576 OPERATING EXPENSES Merchandise costs 144,939 132,886 123,152 Selling, general and administrative 16,332 14,994 13,876 Preopening expenses 55 86 68 Operating income 5,435 4,737 4,480 OTHER INCOME (EXPENSE) Interest expense ( 160 ) ( 150 ) ( 159 ) Interest income and other, net 92 178 121 INCOME BEFORE INCOME TAXES 5,367 4,765 4,442 Provision for income taxes 1,308 1,061 1,263 Net income including noncontrolling interests 4,059 3,704 3,179 Net income attributable to noncontrolling interests ( 57 ) ( 45 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 4,002 $ 3,659 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 9.05 $ 8.32 $ 7.15 Diluted $ 9.02 $ 8.26 $ 7.09 Shares used in calculation (000s) Basic 442,297 439,755 438,515 Diluted 443,901 442,923 441,834 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 4,059 $ 3,704 $ 3,179 Foreign-currency translation adjustment and other, net 162 ( 245 ) ( 192 ) Comprehensive income 4,221 3,459 2,987 Less: Comprehensive income attributable to noncontrolling interests 80 37 38 COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 4,141 $ 3,422 $ 2,949 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) August 30, 2020 September 1, 2019 ASSETS CURRENT ASSETS Cash and cash equivalents $ 12,277 $ 8,384 Short-term investments 1,028 1,060 Receivables, net 1,550 1,535 Merchandise inventories 12,242 11,395 Other current assets 1,023 1,111 Total current assets 28,120 23,485 OTHER ASSETS Property and equipment, net 21,807 20,890 Operating lease right-of-use assets 2,788 Other long-term assets 2,841 1,025 TOTAL ASSETS $ 55,556 $ 45,400 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 14,172 $ 11,679 Accrued salaries and benefits 3,605 3,176 Accrued member rewards 1,393 1,180 Deferred membership fees 1,851 1,711 Current portion of long-term debt 95 1,699 Other current liabilities 3,728 3,792 Total current liabilities 24,844 23,237 OTHER LIABILITIES Long-term debt, excluding current portion 7,514 5,124 Long-term operating lease liabilities 2,558 Other long-term liabilities 1,935 1,455 TOTAL LIABILITIES 36,851 29,816 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 441,255,000 and 439,625,000 shares issued and outstanding 4 4 Additional paid-in capital 6,698 6,417 Accumulated other comprehensive loss ( 1,297 ) ( 1,436 ) Retained earnings 12,879 10,258 Total Costco stockholders equity 18,284 15,243 Noncontrolling interests 421 341 Total equity 18,705 15,584 TOTAL LIABILITIES AND EQUITY $ 55,556 $ 45,400 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT SEPTEMBER 3, 2017 437,204 $ 4 $ 5,800 $ ( 1,014 ) $ 5,988 $ 10,778 $ 301 $ 11,079 Net income 3,134 3,134 45 3,179 Foreign-currency translation adjustment and other, net ( 185 ) ( 185 ) ( 7 ) ( 192 ) Stock-based compensation 547 547 547 Release of vested restricted stock units (RSUs), including tax effects 2,741 ( 217 ) ( 217 ) ( 217 ) Repurchases of common stock ( 1,756 ) ( 26 ) ( 296 ) ( 322 ) ( 322 ) Cash dividends declared and other 3 ( 939 ) ( 936 ) ( 35 ) ( 971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 4 6,107 ( 1,199 ) 7,887 12,799 304 13,103 Net income 3,659 3,659 45 3,704 Foreign-currency translation adjustment and other, net ( 237 ) ( 237 ) ( 8 ) ( 245 ) Stock-based compensation 598 598 598 Release of vested RSUs, including tax effects 2,533 ( 272 ) ( 272 ) ( 272 ) Repurchases of common stock ( 1,097 ) ( 16 ) ( 231 ) ( 247 ) ( 247 ) Cash dividends declared and other ( 1,057 ) ( 1,057 ) ( 1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 4 6,417 ( 1,436 ) 10,258 15,243 341 15,584 Net income 4,002 4,002 57 4,059 Foreign-currency translation adjustment and other, net 139 139 23 162 Stock-based compensation 621 621 621 Release of vested RSUs, including tax effects 2,273 ( 330 ) ( 330 ) ( 330 ) Repurchases of common stock ( 643 ) ( 10 ) ( 188 ) ( 198 ) ( 198 ) Cash dividends declared ( 1,193 ) ( 1,193 ) ( 1,193 ) BALANCE AT AUGUST 30, 2020 441,255 $ 4 $ 6,698 $ ( 1,297 ) $ 12,879 $ 18,284 $ 421 $ 18,705 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended August 30, 2020 September 1, 2019 September 2, 2018 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 4,059 $ 3,704 $ 3,179 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,645 1,492 1,437 Non-cash lease expense 194 Stock-based compensation 619 595 544 Other non-cash operating activities, net 42 9 ( 6 ) Deferred income taxes 104 147 ( 49 ) Changes in operating assets and liabilities: Merchandise inventories ( 791 ) ( 536 ) ( 1,313 ) Accounts payable 2,261 322 1,561 Other operating assets and liabilities, net 728 623 421 Net cash provided by operating activities 8,861 6,356 5,774 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments ( 1,626 ) ( 1,094 ) ( 1,060 ) Maturities and sales of short-term investments 1,678 1,231 1,078 Additions to property and equipment ( 2,810 ) ( 2,998 ) ( 2,969 ) Acquisitions ( 1,163 ) Other investing activities, net 30 ( 4 ) 4 Net cash used in investing activities ( 3,891 ) ( 2,865 ) ( 2,947 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding 137 210 80 Proceeds from issuance of long-term debt 3,992 298 Repayments of long-term debt ( 3,200 ) ( 89 ) ( 86 ) Tax withholdings on stock-based awards ( 330 ) ( 272 ) ( 217 ) Repurchases of common stock ( 196 ) ( 247 ) ( 328 ) Cash dividend payments ( 1,479 ) ( 1,038 ) ( 689 ) Other financing activities, net ( 71 ) ( 9 ) ( 41 ) Net cash used in financing activities ( 1,147 ) ( 1,147 ) ( 1,281 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 70 ( 15 ) ( 37 ) Net change in cash and cash equivalents 3,893 2,329 1,509 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 8,384 6,055 4,546 CASH AND CASH EQUIVALENTS END OF YEAR $ 12,277 $ 8,384 $ 6,055 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 124 $ 141 $ 143 Income taxes, net $ 1,052 $ 1,187 $ 1,204 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ 286 $ 250 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At August 30, 2020, Costco operated 795 warehouses worldwide: 552 in the United States (U.S.) located in 45 states, Washington, D.C., and Puerto Rico, 101 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 27 in Japan, 16 in Korea, 13 in Taiwan, 12 in Australia, three in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, Taiwan, Japan, and Australia. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. In February 2020, the Company acquired a 35 % interest in Navitus Health Solutions, a pharmacy benefit manager. This investment is included in other long-term assets and is accounted for using the equity-method with earnings/losses recorded in other income in the consolidated statement of income. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2020, 2019, and 2018 relate to the 52-week fiscal years ended August 30, 2020, September 1, 2019, and September 2, 2018, respectively. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions take into account historical and forward looking factors that the Company believes are reasonable, including but not limited to the potential impacts arising from the novel coronavirus (COVID-19) and related public and private sector policies and initiatives. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,636 and $ 1,434 at the end of 2020 and 2019, respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2020 and 2019 are $ 810 and $ 673 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. Short-Term Investments Short-term investments generally consist of debt securities (U.S. Government and Agency Notes), with maturities at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 3 , 4 , and 5 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include discounts and volume rebates. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial in 2020, 2019, and 2018. Merchandise Inventories Merchandise inventories consist of the following: 2020 2019 United States $ 8,871 $ 8,415 Canada 1,310 1,123 Other International 2,061 1,857 Merchandise inventories $ 12,242 $ 11,395 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. As of August 30, 2020, and September 1, 2019, U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts using estimates based on experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment, Net Property and equipment are stated at cost. Depreciation and amortization expense is computed primarily using the straight-line method over estimated useful lives. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably certain at the date the leasehold improvements are made. The Company capitalizes certain computer software and costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. When the assets are ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over their estimated useful lives. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2020 and 2019 were immaterial. The following table summarizes the Company's property and equipment balances at the end of 2020 and 2019: Estimated Useful Lives 2020 2019 Land N/A $ 6,696 $ 6,417 Buildings and improvements 5-50 years 17,982 17,136 Equipment and fixtures 3-20 years 8,749 7,801 Construction in progress N/A 1,276 1,272 34,703 32,626 Accumulated depreciation and amortization ( 12,896 ) ( 11,736 ) Property and equipment, net $ 21,807 $ 20,890 The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2020, 2019 or 2018. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities. Leases generally contain one or more of the following options, which the Company can exercise at the end of the initial term: (a) renew the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase the property at the then-fair market value; or (c) a right of first refusal in the event of a third-party offer. Some leases include free-rent periods and step-rent provisions, which are recognized on a straight-line basis over the original term of the lease and any extension options that the Company is reasonably certain to exercise from the date the Company has control of the property. Certain leases provide for periodic rent increases based on price indices or the greater of minimum guaranteed amounts or sales volume. Our leases do not contain any material residual value guarantees or material restrictive covenants. The Company determines at inception whether a contract is or contains a lease. The Company initially records right-of-use (ROU) assets and lease obligations for its finance and operating leases based on the discounted future minimum lease payments over the term. As the rate implicit in the Company's leases is not easily determinable, the present value of the sum of the lease payments is calculated using the Company's incremental borrowing rate. The rate is determined using a portfolio approach based on the rate of interest the Company would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. The Company uses quoted interest rates from financial institutions to derive the incremental borrowing rate. The lease term is defined as the noncancelable period of the lease plus any options to extend when it is reasonably certain that the Company will exercise the option. Impairment of ROU assets is evaluated in a similar manner as described in Property and Equipment, Net above. The Company's asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability, with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases are included in other liabilities in the accompanying consolidated balance sheet. Goodwill and Acquired Intangible Assets Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired and is not subject to amortization. The Company reviews goodwill annually in the fourth quarter for impairment or when circumstances indicate carrying value may exceed the fair value. This evaluation is performed at the reporting unit level. If a qualitative assessment indicates that it is more likely than not that the fair value is less than carrying value, a quantitative analysis is completed using either the income or market approach, or a combination of both. The income approach estimates fair value based on expected discounted future cash flows, while the market approach uses comparable public companies and transactions to develop metrics to be applied to historical and expected future operating results. Goodwill is included in other long-term assets in the consolidated balance sheets. The following table summarizes goodwill by reportable segment: United States Operations Canadian Operations Other International Operations Total Balance at September 1, 2019 $ 13 $ 27 $ 13 $ 53 Changes in currency translation 1 1 Acquisition 934 934 Balance at August 30, 2020 $ 947 $ 27 $ 14 $ 988 Definite-lived intangible assets, which are not material, are included in other long-term assets on the consolidated balance sheets and are amortized on a straight-line basis over their estimated lives, which approximates the pattern of expected economic benefit. Insurance/Self-insurance Liabilities Claims for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, inventory loss, and other exposures are funded predominantly through self-insurance. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. It uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2020 and 2019, these insurance liabilities were $ 1,188 and $ 1,222 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. The aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial at the end of 2020 and 2019. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 1,036 and $ 704 at the end of 2020 and 2019, respectively. See Note 4 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2020 and 2019. The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2020, 2019 and 2018. The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial in 2020, 2019, and 2018. Revenue Recognition The Company adopted Accounting Standards Update (ASU) 2014-09 in 2019, which provided for changes in the recognition of revenue from contracts with customers. The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and member returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. The Company offers merchandise in the following core merchandise categories: food and sundries, hardlines, softlines, and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is generally recognized upon shipment to the member. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2020 and 2019 were $ 1,851 and $ 1,711 , respectively. In most countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum of approximately $1,000 per year), which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2020, 2019 and 2018, the net reduction in sales was $ 1,707 , $ 1,537 , and $ 1,394 respectively. The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Citibank, N.A. (Citi) became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot, fulfillment and manufacturing operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $ 676 , $ 614 , and $ 578 for 2020, 2019, and 2018, respectively, and are predominantly included in selling, general and administrative expenses in the consolidated statements of income. Stock-Based Compensation RSUs granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 8 for additional information on the Companys stock-based compensation plans. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 7 for additional information. Recent Accounting Pronouncements Adopted In February 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02 - Leases (ASC 842), which required recognition on the balance sheet for the rights and obligations created by leases with terms greater than 12 months. The Company adopted ASC 842, using the modified retrospective transition method and used September 2, 2019, as the date of initial application. Consequently, the comparative periods presented continue to be in accordance with ASC 840, Leases, previously in effect. The Company elected the package of practical expedients permitted under the transition guidance, allowing the Company to carry forward conclusions related to: (a) whether expired or existing contracts contain leases; (b) lease classification; and (c) initial direct costs for existing leases. The Company has elected not to record operating lease right-of-use assets or lease liabilities associated with leases with durations of 12 months or less. The Company elected the practical expedient allowing aggregation of non-lease components with related lease components when evaluating the accounting treatment for all classes of underlying assets. Adoption of the new standard resulted in an initial increase to assets and liabilities of $ 2,632 , related to recognition of operating lease right-of-use assets and operating lease obligations as of September 2, 2019. Other impacts in the Company's consolidated balance sheet were not material. The standard did not materially impact the consolidated statements of income and cash flows. For more information on the Company's lease arrangements refer to Note 6 . Note 2Acquisition of Innovel On March 17, 2020, the Company acquired Innovel Solutions for $ 998 , using existing cash and cash equivalents. Cash paid excludes the final settlement of certain holdbacks and provisional amounts, discussed below. As part of the acquisition, in the fourth quarter of 2020, a payment of $ 25 was made relating to certain holdbacks. Innovel provides final-mile delivery, installation and white-glove capabilities for big and bulky products across the United States and Puerto Rico. Its financial results have been included in the Company's consolidated financial statements from the date of acquisition. Innovel's results of operations were not material to the Company's consolidated results during 2020. Pro forma results are thus not considered meaningful. As of August 30, 2020, the initial accounting for the acquisition was incomplete, pending determination of the final purchase price, working capital adjustments, the fair value of operating lease right-of-use assets, operating lease liabilities, and other assumed obligations. The net purchase price of $ 998 was allocated to tangible and intangible assets of $ 283 and liabilities assumed of $ 219 , based on their preliminary fair values on the acquisition date. The remaining unallocated net purchase price of $ 934 was recorded as goodwill. Goodwill represents the acquisition's benefits to the Company, which include the ability to serve more members and improve delivery times, enabling growth in certain segments of our U.S. e-commerce operations. The Company assigned this goodwill, which is deductible for tax purposes, to reporting units within the U.S. segment. The changes to the purchase price allocation originally recorded in the third quarter of 2020 were not material. As additional information becomes available, the provisional fair value estimates will be refined. Note 3Investments The Companys investments were as follows: 2020: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 436 $ 12 $ 448 Held-to-maturity: Certificates of deposit 580 580 Total short-term investments $ 1,016 $ 12 $ 1,028 2019: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ 716 $ 6 $ 722 Held-to-maturity: Certificates of deposit 338 338 Total short-term investments $ 1,054 $ 6 $ 1,060 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended August 30, 2020, and September 1, 2019. At the end of 2020, there were no available-for-sale securities in a continuous unrealized-loss position. At the end of 2019, available-for-sale securities that were in a continuous unrealized-loss position were not material. There were no sales of available-for-sale securities during 2020 or 2019. The maturities of available-for-sale and held-to-maturity securities at the end of 2020 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ 172 $ 173 $ 580 Due after one year through five years 264 275 Total $ 436 $ 448 $ 580 Note 4Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The table below presents information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. Level 2 2020 2019 Investment in government and agency securities (1) $ 508 $ 766 Forward foreign-exchange contracts, in asset position (2) 1 15 Forward foreign-exchange contracts, in (liability) position (2) ( 21 ) ( 4 ) Total $ 488 $ 777 ____________ (1) At August 30, 2020, $ 60 cash and cash equivalents and $ 448 short-term investments are included in the accompanying consolidated balance sheets. At September 1, 2019, $ 44 cash and cash equivalents and $ 722 short-term investments are included in the consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the consolidated balance sheets. At August 30, 2020, and September 1, 2019, the Company did not hold any Level 1 or 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers between levels during 2020 or 2019. Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2020 or 2019. Note 5Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $ 967 and $ 865 , in 2020 and 2019, respectively. Borrowings on these short-term facilities were immaterial during 2020 and 2019, and there were no outstanding borrowings at the end of 2020 and 2019. Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100 % of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, the holder has the right to require the Company to purchase this security at a price of 101 % of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. In April 2020, the Company issued $4,000 in aggregate principal amount of Senior Notes as follows: $ 1,250 of 1.375 % due June 2027; $ 1,750 of 1.600 % due April 2030; and $ 1,000 of 1.750 % due April 2032. In May 2020, a portion of the proceeds from the issuance were used to repay, prior to maturity, the outstanding $ 1,000 and $ 500 principal balances and interest on the 2.150 % and 2.250 % Senior Notes, respectively. The early redemption resulted in a $36 charge which was recorded in interest income and other, net in 2020. The remaining funds are intended for general corporate purposes. In December 2019, the Company paid the outstanding $ 1,200 principal balance and interest on the 1.700 % Senior Notes, with existing sources of cash and cash equivalents and short-term investments. In February 2020, the Company paid the outstanding $ 500 principal balance and interest on the 1.750 % Senior Notes, with existing sources of cash and cash equivalents and short-term investments. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary, valued using Level 3 inputs. In August 2019, the Company's Japanese subsidiary issued approximately $ 200 and $ 100 of Guaranteed Senior Notes at fixed interest rates of 0.28 % and 0.42 %, respectively. Interest is payable semi-annually, and principal is due in August 2029 and August 2034, respectively. At the end of 2020 and 2019, the fair value of the Company's long-term debt, including the current portion, was approximately $ 7,987 and $ 6,997 , respectively. The carrying value of long-term debt consisted of the following: 2020 2019 1.700% Senior Notes due December 2019 $ $ 1,200 1.750% Senior Notes due February 2020 500 2.150% Senior Notes due May 2021 1,000 2.250% Senior Notes due February 2022 500 2.300% Senior Notes due May 2022 800 800 2.750% Senior Notes due May 2024 1,000 1,000 3.000% Senior Notes due May 2027 1,000 1,000 1.375% Senior Notes due June 2027 1,250 1.600% Senior Notes due April 2030 1,750 1.750% Senior Notes due April 2032 1,000 Other long-term debt 857 852 Total long-term debt 7,657 6,852 Less unamortized debt discounts and issuance costs 48 29 Less current portion (1) 95 1,699 Long-term debt, excluding current portion $ 7,514 $ 5,124 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: 2021 $ 95 2022 800 2023 95 2024 1,114 2025 142 Thereafter 5,411 Total $ 7,657 Note 6Leases The tables below present information regarding the Company's lease assets and liabilities. 2020 Assets Operating lease right-of-use assets $ 2,788 Finance lease assets (1) 592 Total lease assets $ 3,380 Liabilities Current Operating lease liabilities (2) $ 231 Finance lease liabilities (2) 31 Long-term Operating lease liabilities 2,558 Finance lease liabilities (3) 657 Total lease liabilities $ 3,477 _______________ (1) Included in other long-term assets in the consolidated balance sheets. (2) Included in other current liabilities in the consolidated balance sheets. (3) Included in other long-term liabilities in the consolidated balance sheets. 2020 Weighted-average remaining lease term (years) Operating leases 21 Finance leases 20 Weighted-average discount rate Operating leases 2.23 % Finance leases 6.34 % The components of lease expense, excluding short-term lease costs and sublease income (which were not material), were as follows: Operating lease costs (1) $ 252 Finance lease costs: Amortization of lease assets (1) 31 Interest on lease liabilities (2) 33 Variable lease costs (3) 87 Total lease costs $ 403 _______________ (1) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. (2) Included in interest expense in the consolidated statements of income. (3) Included in selling, general and administrative expenses and merchandise costs in the consolidated statements of income. Amount excludes property taxes, which were immaterial. Supplemental cash flow information related to leases was as follows: 2020 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows operating leases $ 258 Operating cash flows finance leases 33 Financing cash flows finance leases 49 Leased assets obtained in exchange for operating lease liabilities 354 Leased assets obtained in exchange for finance lease liabilities 317 As of August 30, 2020, future minimum payments during the next five fiscal years and thereafter are as follows: Operating Leases (1) Finance Leases 2021 $ 273 $ 61 2022 253 62 2023 246 66 2024 212 63 2025 176 134 Thereafter 2,410 742 Total (2) 3,570 1,128 Less amount representing interest 781 440 Present value of lease liabilities $ 2,789 $ 688 _______________ (1) Operating lease payments have not been reduced by future sublease income of $ 101 . (2) Excludes $ 280 of lease payments for leases that have been signed but not commenced. As of September 1, 2019, future minimum payments, net of sub-lease income of $ 105 , under noncancelable operating leases with terms of at least one year and capital leases reported under ASC 840 were as follows: Operating Leases Capital Leases 2020 $ 239 $ 51 2021 229 53 2022 202 38 2023 193 39 2024 181 39 Thereafter 2,206 544 Total $ 3,250 764 Less amount representing interest 343 Net present value of minimum lease payments $ 421 Note 7Stockholders Equity Dividends Cash dividends declared in 2020 totaled $ 2.70 per share, as compared to $ 2.44 per share in 2019. The Company's current quarterly dividend rate is $ 0.70 per share. Stock Repurchase Programs The Company's stock repurchase program is conducted under a $ 4,000 authorization by the Board of Directors, which expires in April 2023. As of the end of 2020, the remaining amount available under the approved plan was $ 3,745 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 2020 643 $ 308.45 $ 198 2019 1,097 225.16 247 2018 1,756 183.13 322 These amounts may differ from repurchases of common stock in the consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time to time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Note 8Stock-Based Compensation Plans The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant and the future forfeited shares from grants under the previous plan, up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on unvested and undelivered shares. At the end of 2020, 13,624,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2020: 5,021,000 time-based RSUs that vest upon continued employment over specified periods of time; 153,000 performance-based RSUs, of which 123,000 were granted to executive officers subject to the determination of the attainment of performance targets for 2020. This determination occurred in September 2020, at which time at least 33% of the units vested, as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2020: Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2019 6,496 $ 167.55 Granted 2,252 294.08 Vested and delivered ( 3,374 ) 188.92 Forfeited ( 200 ) 197.45 Outstanding at the end of 2020 5,174 $ 207.55 The weighted-average grant date fair value of RSUs granted was $ 294.08 , $ 224.00 , and $ 156.19 in 2020, 2019, and 2018, respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2020 was $ 697 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2020 were approximately 1,733,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: 2020 2019 2018 Stock-based compensation expense $ 619 $ 595 $ 544 Less recognized income tax benefit 128 128 116 Stock-based compensation expense, net $ 491 $ 467 $ 428 Note 9 Taxes Income Taxes Income before income taxes is comprised of the following: 2020 2019 2018 Domestic $ 4,204 $ 3,591 $ 3,182 Foreign 1,163 1,174 1,260 Total $ 5,367 $ 4,765 $ 4,442 The provisions for income taxes are as follows: 2020 2019 2018 Federal: Current $ 616 $ 328 $ 636 Deferred 77 222 ( 35 ) Total federal 693 550 601 State: Current 230 178 190 Deferred 8 26 22 Total state 238 204 212 Foreign: Current 372 405 487 Deferred 5 ( 98 ) ( 37 ) Total foreign 377 307 450 Total provision for income taxes $ 1,308 $ 1,061 $ 1,263 Except for certain provisions, the Tax Cuts and Jobs Act (2017 Tax Act) is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions became effective for fiscal 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of fiscal 2018 and throughout fiscal 2019 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0 % was effective for all of 2020 and 2019 and resulted in a blended rate for the Company of 25.6 % for 2018. The reconciliation between the statutory tax rate and the effective rate for 2020, 2019, and 2018 is as follows: 2020 2019 2018 Federal taxes at statutory rate $ 1,127 21.0 % $ 1,001 21.0 % $ 1,136 25.6 % State taxes, net 190 3.6 171 3.6 154 3.4 Foreign taxes, net 92 1.7 ( 1 ) 32 0.7 Employee stock ownership plan (ESOP) ( 24 ) ( 0.5 ) ( 18 ) ( 0.4 ) ( 14 ) ( 0.3 ) 2017 Tax Act ( 123 ) ( 2.6 ) 19 0.4 Other ( 77 ) ( 1.4 ) 31 0.7 ( 64 ) ( 1.4 ) Total $ 1,308 24.4 % $ 1,061 22.3 % $ 1,263 28.4 % During 2019, the Company recognized net tax benefits of $ 123 related to the 2017 Tax Act. This benefit primarily included $ 105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. During 2018, the Company recognized a net tax expense of $ 19 related to the 2017 Tax Act. This expense included $ 142 for the estimated tax on deemed repatriation of foreign earnings, and $ 43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $ 166 for the remeasurement of certain deferred tax liabilities. The Company recognized total net tax benefits of $ 81 , $ 221 and $ 57 in 2020, 2019 and 2018, respectively. These amounts include a benefit of $ 77 , $ 59 and $ 33 , respectively, related to the stock-based compensation accounting standard adopted in 2018 in addition to the impacts of the 2017 Tax Act noted above. The components of the deferred tax assets (liabilities) are as follows: 2020 2019 Deferred tax assets: Equity compensation $ 80 $ 74 Deferred income/membership fees 144 180 Foreign tax credit carry forward 101 65 Operating lease liabilities 832 Accrued liabilities and reserves 639 566 Total deferred tax assets 1,796 885 Valuation allowance ( 105 ) ( 76 ) Total net deferred tax assets 1,691 809 Deferred tax liabilities: Property and equipment ( 800 ) ( 677 ) Merchandise inventories ( 228 ) ( 187 ) Operating lease right-of-use assets ( 801 ) Foreign branch deferreds ( 81 ) ( 69 ) Other ( 40 ) ( 21 ) Total deferred tax liabilities $ ( 1,950 ) $ ( 954 ) Net deferred tax liabilities $ ( 259 ) $ ( 145 ) The deferred tax accounts at the end of 2020 and 2019 include deferred income tax assets of $ 406 and $ 398 , respectively, included in other long-term assets; and deferred income tax liabilities of $ 665 and $ 543 , respectively, included in other long-term liabilities. In 2020 and 2019, the Company recorded valuation allowances of $ 105 and $ 76 , respectively, primarily related to foreign tax credits that the Company believes will not be realized due to limitations on the ability to claim the credits during the carry forward period. The foreign tax credit carry forwards are set to expire beginning in fiscal 2030. The Company no longer considers fiscal year earnings of non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to 2018, which totaled $ 2,955 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2020 and 2019 is as follows: 2020 2019 Gross unrecognized tax benefit at beginning of year $ 27 $ 36 Gross increasescurrent year tax positions 1 5 Gross increasestax positions in prior years 8 2 Gross decreasestax positions in prior years ( 3 ) Settlements ( 4 ) Lapse of statute of limitations ( 3 ) ( 12 ) Gross unrecognized tax benefit at end of year $ 30 $ 27 The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2020 and 2019, these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $ 28 and $ 24 at the end of 2020 and 2019, respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Accrued interest and penalties recognized during 2020 and 2019 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2017. The Company is currently subject to examination in California for fiscal years 2013 to present. Other Taxes The Company is subject to multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. Subsequent to the end of 2019, the Company received an assessment related to a product tax audit covering multiple years. The Company recorded a charge of $ 123 in 2019. In the fourth quarter of 2020, the Company reached an agreement with the tax authority on this matter, resulting in a benefit of $84. Other possible losses or range of possible losses associated with these matters are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 10Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): 2020 2019 2018 Net income attributable to Costco $ 4,002 $ 3,659 $ 3,134 Weighted average basic shares 442,297 439,755 438,515 RSUs 1,604 3,168 3,319 Weighted average diluted shares 443,901 442,923 441,834 Note 11Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in an action under the California Labor Code Private Attorneys General Act (PAGA) alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 5:13-CV-03598; N.D. Cal.; filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The action has been remanded to state court. In January 2019, an employee brought similar claims for relief concerning Costco employees engaged at member services counters in California. Rodriguez v. Costco Wholesale Corp. (Case No. RG19001310; Alameda Superior Court). The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or appropriate workplace temperature conditions. Lane v. Costco Wholesale Corp. (Dec. 6, 2018 Notice to California Labor and Workforce Development Agency). The Company filed an answer denying the material allegations of the complaint. In October 2019, the parties reached an agreement to settle the seating claims on a representative basis, which received court approval in February 2020. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438; Santa Clara Superior Court). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In October 2019, the parties reached an agreement on a class settlement, which received preliminary court approval in July 2020. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez v. Costco Wholesale Corp. (Case No. 2:19-cv-03454; C.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In December 2019, the court issued an order denying class certification. In January 2020, the plaintiffs dismissed their Labor Code claims without prejudice, and the court remanded the action to state court. The remand is being appealed. In May 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340; E.D. Cal.). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In August 2019, Rough filed a companion case in state court seeking penalties under PAGA. Rough v. Costco Wholesale Corp. (Case No. FCS053454; Sonoma County Superior Court). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. The state court action has been stayed pending resolution of the federal action. In June 2019, an employee filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp . (Case No. 3:19-cv-05624; N.D. Cal.). The Company filed an answer denying the material allegations of the complaint. In April 2020, an employee, alleging underpayment of sick pay, filed a class and representative action against the Company, alleging claims under California law for failure to pay all wages at termination and for Labor Code penalties under PAGA. Kristy v. Costco Wholesale Corp. (Case No. 20CV366341; Santa Clara County Superior Court). A motion to dismiss was filed as to plaintiff's amended complaint, the case has been stayed due to the plaintiff's bankruptcy. In July 2020, an employee filed an action under PAGA on behalf of all California non-exempt employees alleging violations of California Labor Code provisions regarding meal and rest periods, minimum wage, overtime, wage statements, reimbursement of expenses, and payment of wages at termination. Schwab v. Costco Wholesale Corporation (Case No. 37-2020-00023551-CU-OE-CTL; San Diego County Superior Court). In August 2020, the Company filed a motion to strike portions of the complaint. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases concerning the impacts of opioid abuses filed against various defendants by counties, cities, hospitals, Native American tribes, third-party payors, and others. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and class actions filed on behalf of infants born with opioid-related medical conditions in 40 states, and class actions and individual actions filed on behalf of individuals seeking to recover alleged increased insurance costs associated with opioid abuse in 43 states and American Samoa. In 2019, similar actions were commenced against the Company in state court in Utah. Claims against the Company in state courts in New Jersey, Oklahoma, and Arizona have been dismissed. The Company is defending all of these matters. The Company and its CEO and CFO are defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash.; filed Dec. 11, 2018). The complaints allege violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. They seek unspecified damages, equitable relief, interest, and costs and attorneys fees. On January 30, 2019, an order was entered consolidating the actions, and a consolidated amended complaint was filed on April 16, 2019. On November 26, 2019, the court entered an order dismissing the consolidated amended complaint and granting the plaintiffs leave to file a further amended complaint. A further amended complaint was filed on March 9, which the court dismissed with prejudice on August 19, 2020. Plaintiffs filed a notice of appeal in September 2020. Members of the Board of Directors, one other individual, and the Company are defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash.; filed Dec. 11, 2018). The complaint seeks unspecified damages, disgorgement of compensation, corporate governance changes, and costs and attorneys' fees. Because the complaint is derivative in nature, it does not seek monetary damages from the Company, which is a nominal defendant. By agreement among the parties the action has been stayed pending further proceedings in the class action. Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1), and June 12, 2019, Rahul Modi v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-15514-1). These actions have also been stayed. On June 23, 2020, a putative class action was filed against the Company, the ""Board of Directors,"" the ""Costco Benefits Committee"" and others under the Employee Retirement Income Security Act, in the United States District Court for the Eastern District of Wisconsin. Dustin S. Soulek v. Costco Wholesale, et al. , Case No. 20-cv-937. The class is alleged to be beneficiaries of the Costco 401(k) plan from June 23, 2014, and the claims are that the defendants breached their fiduciary duties in the operation and oversight of the plan. The complaint seeks injunctive relief, damages, interest, costs, and attorneys' fees. On September 11, the defendants filed a motion to dismiss the complaint, and on September 21 the plaintiffs filed an amended complaint. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 12Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. The following table provides information for the Company's reportable segments: United States Operations Canadian Operations Other International Operations Total 2020 Total revenue $ 122,142 $ 22,434 $ 22,185 $ 166,761 Operating income 3,633 860 942 5,435 Depreciation and amortization 1,248 155 242 1,645 Additions to property and equipment 2,060 258 492 2,810 Property and equipment, net 14,916 2,172 4,719 21,807 Total assets 38,366 5,270 11,920 55,556 2019 Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 924 750 4,737 Depreciation and amortization 1,126 143 223 1,492 Additions to property and equipment 2,186 303 509 2,998 Property and equipment, net 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 2018 Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 939 754 4,480 Depreciation and amortization 1,078 135 224 1,437 Additions to property and equipment 2,046 268 655 2,969 Property and equipment, net 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Disaggregated Revenue The following table summarizes net sales by merchandise category; sales from business centers and e-commerce websites have been allocated to their respective categories: 2020 2019 2018 Food and sundries $ 68,659 $ 59,672 $ 56,073 Hardlines 27,729 24,570 22,620 Fresh foods 23,204 19,948 18,879 Softlines 17,078 16,590 15,387 Ancillary and other 26,550 28,571 25,475 Total net sales $ 163,220 $ 149,351 $ 138,434 Note 13Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2020 and 2019. 52 Weeks Ended August 30, 2020 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 36,236 $ 38,256 $ 36,451 $ 52,277 $ 163,220 Membership fees 804 816 815 1,106 3,541 Total revenue 37,040 39,072 37,266 53,383 166,761 OPERATING EXPENSES Merchandise costs (1) 32,233 34,056 32,249 46,401 144,939 Selling, general and administrative (2) 3,732 3,743 3,830 5,027 (3) 16,332 Preopening expenses 14 7 8 26 55 Operating income 1,061 1,266 1,179 1,929 5,435 OTHER INCOME (EXPENSE) Interest expense ( 38 ) ( 34 ) ( 37 ) ( 51 ) ( 160 ) Interest income and other, net 35 45 21 ( 9 ) 92 INCOME BEFORE INCOME TAXES 1,058 1,277 1,163 1,869 5,367 Provision for income taxes 202 330 311 465 1,308 Net income including noncontrolling interests 856 947 852 1,404 4,059 Net income attributable to noncontrolling interests ( 12 ) ( 16 ) ( 14 ) ( 15 ) ( 57 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 844 $ 931 $ 838 $ 1,389 $ 4,002 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.91 $ 2.10 $ 1.90 $ 3.14 $ 9.05 Diluted $ 1.90 $ 2.10 $ 1.89 $ 3.13 $ 9.02 Shares used in calculation (000s) Basic 441,818 442,021 442,322 442,843 442,297 Diluted 443,680 443,727 443,855 444,231 443,901 _______________ (1) Includes $ 108 of incremental wage and sanitation costs as a result of COVID-19 of which $ 44 and $ 64 were recorded in the third and fourth quarters, respectively. (2) Includes $ 456 of incremental wage and sanitation costs as a result of COVID-19 of which $ 239 and $ 217 were recorded in the third and fourth quarters, respectively. (3) Includes a $ 84 benefit due to a partial reversal of an accrual for a product tax assessment in 2019. 52 Weeks Ended September 1, 2019 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 34,311 $ 34,628 $ 33,964 $ 46,448 $ 149,351 Membership fees 758 768 776 1,050 3,352 Total revenue 35,069 35,396 34,740 47,498 152,703 OPERATING EXPENSES Merchandise costs 30,623 30,720 30,233 41,310 132,886 Selling, general and administrative 3,475 3,464 3,371 4,684 (1) 14,994 Preopening expenses 22 9 14 41 86 Operating income 949 1,203 1,122 1,463 4,737 OTHER INCOME (EXPENSE) Interest expense ( 36 ) ( 34 ) ( 35 ) ( 45 ) ( 150 ) Interest income and other, net 22 46 36 74 178 INCOME BEFORE INCOME TAXES 935 1,215 1,123 1,492 4,765 Provision for income taxes 158 314 207 382 1,061 Net income including noncontrolling interests 777 901 916 1,110 3,704 Net income attributable to noncontrolling interests ( 10 ) ( 12 ) ( 10 ) ( 13 ) ( 45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 767 $ 889 $ 906 $ 1,097 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.75 $ 2.02 $ 2.06 $ 2.49 $ 8.32 Diluted $ 1.73 $ 2.01 $ 2.05 $ 2.47 $ 8.26 Shares used in calculation (000s) Basic 439,157 440,284 439,859 439,727 439,755 Diluted 442,749 442,337 442,642 443,400 442,923 _______________ (1) Includes a $ 123 charge for a product tax assessment. "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of August 30, 2020 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of August 30, 2020, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control Integrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of August 30, 2020. The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +2,cost,t10k9119," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, China, and through a majority-owned subsidiary in Taiwan. Costco operated 782 , 762 , and 741 warehouses worldwide at September 1, 2019 , September 2, 2018 , and September 3, 2017 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 146,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit cards, including Costco co-branded cards, debit cards, cash, checks, and our proprietary stored-value card (shop card). Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations varies significantly by country, and we do not currently operate our gasoline business in Korea, France or China. We operated 593 gas stations at the end of 2019 . Net sales for our gasoline business represented approximately 11% of total net sales in 2019. Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. At the end of 2019, we operated e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Net sales for e-commerce represented approximately 4% of total net sales in 2019 . Additionally, we offer business delivery, travel and various other services online in certain countries. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase and manufacture private-label merchandise, as long as quality and member demand are high and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable document. Business members may add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 91% in the U.S. and Canada and 88% on a worldwide basis at the end of 2019 . The majority of members renew within six months following their renewal date. Our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 42,900 40,700 38,600 Business, including affiliates 11,000 10,900 10,800 Total paid members 53,900 51,600 49,400 Household cards 44,600 42,700 40,900 Total cardholders 98,500 94,300 90,300 Paid cardholders (except affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada, for an additional annual fee of $60. Executive memberships are also available in Mexico, the U.K., and Korea, for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (up to a maximum reward of $1,000 per year in the U.S. and Canada and varies in Mexico, the U.K. and Korea), which can be redeemed only at Costco warehouses. This program also offers (except in Mexico and Korea), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing. These services are generally provided by third parties and vary by state and country. Executive members, who represented 39% of paid members at the end of 2019 , generally shop more frequently and spend more than other members. Labor Our employee count was as follows: Full-time employees 149,000 143,000 133,000 Part-time employees 105,000 102,000 98,000 Total employees 254,000 245,000 231,000 Approximately 16,000 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with other warehouse clubs (primarily Walmarts Sams Club and BJs Wholesale Club), and many of the major metropolitan areas in the U.S. and certain of our Other International locations have multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered to our members at prices that are generally lower than national brands, and that they help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private-label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The SEC maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Information about our Executive Officers The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 67 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 63 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce merchandise, from 2013 to January 2018. 57 Patrick J. Callans Executive Vice President, Administration. Mr. Callans was Senior Vice President, Human Resources and Risk Management, from 2013 to December 2018. 57 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 62 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 68 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 66 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 67 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 67 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 54 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 84% of net sales and operating income in 2019 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2019 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets, including China. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lesser familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new e-commerce websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. We rely extensively on information technology to process transactions, compile results, and manage our business. Failure or disruption of our primary and back-up systems could adversely affect our business. A failure to adequately update our existing systems and implement new systems could harm our business and adversely affect our results of operations. Given the very high volume of transactions we process it is important that we maintain uninterrupted operation of our business-critical systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors or misfeasance by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making and will continue to make investments to improve or advance critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace could be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process should mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. The potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. We previously identified a material weakness in our internal control related to ineffective information technology general controls and if we fail to maintain an effective system of internal control in the future, this could result in loss of investor confidence and adversely impact our stock price. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. We reported in our Annual Report on Form 10-K as of September 2, 2018, a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology systems that support the Companys financial reporting processes. During 2019, we completed the remediation measures related to the material weakness and concluded that our internal control over financial reporting was effective as of September 1, 2019 . Completion of remediation does not provide assurance that our remediation or other controls will continue to operate properly. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. If we do not maintain the privacy and security of personal and business information, we could damage our reputation with members and employees, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and employees and entrust that information to third-party business associates, including cloud service-providers that perform activities for us. Our warehouse and online businesses depend upon the secure transmission of confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or defects within our hardware or software, or those of our business associates, that results in our members' or employees' information being obtained by unauthorized persons could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation, government actions, or the imposition of penalties. In addition, a breach could require expending significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is highly regulated in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to, among other things, systems changes and the development of new processes. If we or those with whom we share information fail to comply with laws and regulations, such as the General Data Protection Regulation (GDPR) and California Consumer Privacy Act (CCPA), our reputation could be damaged, possibly resulting in lost business, and we could be subjected to additional legal risk or financial losses as a result of non-compliance. We have security measures and controls to protect personal and business information and continue to make investments to secure access to our information technology network. These measures may be undermined, however, due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business and results of operations. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, select credit and debit cards, and our shop card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services for credit and debit cards and our shop card. It could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to evolving payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. If our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, such as food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our suppliers are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with safety and other standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury or that we will not be subject to claims, lawsuits, or government investigations relating to such matters, resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact our business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Although we maintain specific coverages for catastrophic property losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flows and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to tariff impacts on the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our business, including net sales and gross margin, will be influenced in part by merchandising and pricing strategies in response to potential cost increases by us and our competitors. While these potential impacts are uncertain, they could have an adverse impact on our financial results. Prices of certain commodities, including gasoline and consumable goods used in manufacturing and our warehouse retail operations, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by events like the outbreak of war or acts of terrorism. Suppliers may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any supplier has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions leading to loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key suppliers could negatively affect us. We may not be able to develop relationships with new suppliers, and products from alternative sources, if any, may be of a lesser quality or more expensive. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volumes we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. One or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2019 , our international operations, including Canada, generated 27% and 35% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to our properties, the temporary closure of warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may increase compliance and merchandise costs, and other regulation affecting energy inputs could materially affect our profitability. Climate change and extreme weather conditions, such as hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels could affect our ability to procure commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. At the end of 2019 , we operated 239 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs and trade sanctions), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities and income taxes, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional tax liabilities. We are subject to a variety of taxes and tax collection and remittance obligations in the U.S. and numerous foreign jurisdictions. Additionally, at any point in time, we may be under examination for value added, sales-based, payroll, product, import or other non-income taxes. We may recognize additional tax expense, be subject to additional tax liabilities, or incur losses and penalties, due to changes in laws, regulations, administrative practices, principles, assessments by authorities and interpretations related to tax, including tax rules in various jurisdictions. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates or adverse outcomes in tax audits, including transfer pricing disputes, could have a material adverse effect on our financial condition and results of operations. Significant changes in or failure to comply with regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are or may become involved in a number of legal proceedings and audits, including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 1, 2019 , we operated 782 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France China Total _______________ (1) 114 of the 162 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2019 : United States Canada Other International Total Total Warehouses in Operation 2015 and prior 2016 2017 2018 2019 2020 (expected through 12/31/2019) Total At the end of 2019 , our warehouses contained approximately 113.9 million square feet of operating floor space: 79.9 million in the U.S.; 14.0 million in Canada; and 20.0 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the distribution of most merchandise shipments to the warehouses. Additionally, we operate various fulfillment, processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 19 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 3, 2019 , we had 9,115 stockholders of record. Payment of dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase activity for the fourth quarter of 2019 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 13June 9, 2019 39,000 $ 246.12 39,000 $ 3,985 June 10July 7, 2019 36,000 263.30 36,000 3,976 July 8August 4, 2019 54,000 278.15 54,000 3,961 August 5September 1, 2019 65,000 275.37 65,000 3,943 Total fourth quarter 194,000 $ 268.08 194,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2019, which expires in April 2023. This authorization revoked previously authorized but unused amounts, totaling $2,237 . Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation and the reinvestment of dividends) on an investment of $100 in Costco common stock, SP 500 Index, and the SP 500 Retail Index over the five years from August 31, 2014 , through September 1, 2019 . "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, and sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); changes in the cost of gasoline and associated competitive conditions; and changes from the revenue recognition standard. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private-label items, and through online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing may include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. Additionally, actions in various countries, particularly China and the United States, have created uncertainty with respect to how tariffs will affect the costs of some of our merchandise. The degree of our exposure is dependent on (among other things) the type of goods, rates imposed, and timing of the tariffs. The impact to our net sales and gross margin will be influenced in part by our merchandising and pricing strategies in response to cost increases. While these potential impacts are uncertain, they could have an adverse impact on our results. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales. The membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets as compared to new markets. Our financial performance depends heavily on controlling costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low margins, modest changes in various items in the consolidated statements of income, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefits costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for 2019 included: We opened 25 new warehouses, including 5 relocations: 16 net new locations in the U.S. and 4 in our Other International segment, including our first warehouse in China, compared to 25 new warehouses, including 4 relocations in 2018 ; Net sales increased 8% to $149,351 driven by a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019; Membership fee revenue increased 7% to $3,352 , primarily due to membership sign-ups at existing and new warehouses and the annual fee increase in the U.S. and Canada in June 2017. Gross margin percentage decreased two basis points. Excluding the impact of the new revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales increased eight basis points; Selling, general administrative (SGA) expenses as a percentage of net sales increased two basis points. Excluding the impact of the new revenue recognition standard on net sales, SGA as a percentage of adjusted net sales increased 11 basis points, primarily related to a $123 charge for a product tax assessment; Effective March 2019, starting and supervisor wages were increased and paid bonding leave was made available for hourly employees in the U.S. and Canada. The estimated annualized pre-tax cost of these increases is approximately $50-$60; The effective tax rate in 2019 was 22.3% compared to 28.4% in 2018. Both years were favorably impacted by the Tax Cuts and Jobs Act (2017 Tax Act) and other net tax benefits; Net income increased 17% to $3,659 , or $8.26 per diluted share compared to $3,134 , or $7.09 per diluted share in 2018 ; and In April 2019 , the Board of Directors approved an increase in the quarterly cash dividend from $0.57 to $0.65 per share and authorized a new share repurchase program in the amount of $4,000. Results of operations Net Sales Net Sales $ 149,351 $ 138,434 $ 126,172 Changes in net sales: U.S. % % % Canada % % % Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % % % Other International % % % Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices (1) : U.S. % % % Canada % % % Other International % % % Total Company % % % _______________ (1) Excluding the impact of the revenue recognition standard for the year ended September 1, 2019 . See Note 1 in Item 8. Net Sales Net sales increased $10,917 or 8% during 2019 , primarily due to a 6% increase in comparable sales and sales at new warehouses opened in 2018 and 2019. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $1,463, or 106 basis points, compared to 2018, attributable to our Canadian and Other International Operations. The revenue recognition standard positively impacted net sales by $1,332, or 96 basis points. Changes in gasoline prices did not have a material impact on net sales. Comparable Sales Comparable sales increased 6% during 2019 and were positively impacted by increases in both shopping frequency and average ticket. Comparable sales were negatively impacted by cannibalization (established warehouses losing sales to our newly opened locations). Membership Fees Membership fees $ 3,352 $ 3,142 $ 2,853 Membership fees increase % % % Membership fees as a percentage of net sales 2.24 % 2.27 % 2.26 % The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses and the annual fee increase. Changes in foreign currencies relative to the U.S. dollar negatively impacted membership fees by approximately $30 in 2019. At the end of 2019 , our member renewal rates were 91% in the U.S. and Canada and 88% worldwide. As reported in 2017, we increased our annual membership fees in the U.S. and Canada and in certain of our Other International operations. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact of approximately $178 in 2018 and positively impacted 2019, primarily the first two quarters, by approximately $73. Gross Margin Net sales $ 149,351 $ 138,434 $ 126,172 Less merchandise costs 132,886 123,152 111,882 Gross margin $ 16,465 $ 15,282 $ 14,290 Gross margin percentage 11.02 % 11.04 % 11.33 % The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased seven basis points primarily due to increases in food and sundries and fresh foods partially offset by decreases in softlines and hardlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased two basis points compared to 2018. Excluding the impact of the revenue recognition standard on net sales, gross margin as a percentage of adjusted net sales was 11.12%, an increase of eight basis points. This increase was primarily due to a 19 basis point increase in our warehouse ancillary and other businesses, predominantly our gasoline business. This increase was partially offset by decreases of four basis points in our core merchandise categories, four basis points due to an adjustment to our estimate of breakage on rewards earned under our co-branded credit card program and three basis points due to increased spending by members under the Executive Membership 2% reward program. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $155 in 2019. The segment gross margin percentage, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), increased in our U.S. operations, predominantly in our warehouse ancillary and other businesses, primarily our gasoline business. This increase was partially offset by decreases in our core merchandise categories and the breakage adjustment noted above. The segment gross margin percentage in our Canadian operations decreased predominantly in hardlines and softlines and certain of our warehouse ancillary and other businesses, partially offset by an increase in fresh foods. The segment gross margin percentage in our Other International operations decreased primarily in our core merchandise categories and due to the introduction of the Executive Membership 2% reward program in Korea. This decrease was partially offset by an increase in our gasoline business. Selling, General and Administrative Expenses SGA expenses $ 14,994 $ 13,876 $ 12,950 SGA expenses as a percentage of net sales 10.04 % 10.02 % 10.26 % SGA expenses as a percentage of net sales increased two basis points compared to 2018 . Excluding the impact of the revenue recognition standard on net sales, SGA expenses as a percentage of adjusted net sales were 10.13%, an increase of 11 basis points. This increase is largely due to a $123 charge, or eight basis points, recorded in the U.S. related to a product tax assessment. Central operating costs were higher by two basis points and stock compensation expense was higher by one basis point. Operating costs as a percent of adjusted net sales related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were flat despite the wage increases and bonding leave benefits for U.S. and Canadian hourly employees effective in March 2019. Changes in foreign currencies relative to the U.S. dollar positively impacted SGA expenses by approximately $124 in 2019. Preopening Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse and facility openings, the timing of the opening relative to our year-end, whether a warehouse is owned or leased, and whether openings are in an existing, new, or international market. In 2019, we opened our first warehouse in China. Subsequent to year end, operations commenced at our new poultry processing plant. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company. Interest expense decreased in 2019 largely due to an increase in capitalized interest associated with our new poultry processing plant. Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ The increase in interest income in 2019 was primarily due to higher interest rates earned on higher average cash and investment balances. Foreign-currency transaction gains (losses), net include the revaluation and settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. Provision for Income Taxes Provision for income taxes $ 1,061 $ 1,263 $ 1,325 Effective tax rate 22.3 % 28.4 % 32.8 % Our effective tax rate for 2019 was favorably impacted by the reduction in the U.S. federal corporate tax rate in December 2017 from 35% to 21%, which was in effect for all of 2019, and compared to a higher blended rate effective for 2018. Net discrete tax benefits of $221 in 2019 included a benefit of $59 related to the stock-based compensation accounting standard adopted in the first quarter of 2018. This also included a tax benefit of $105 related to U.S. taxation of deemed foreign dividends, offset by losses of foreign tax credits, which impacted the effective tax rate. The tax rate for 2019 was 26.9%, excluding the net discrete tax benefits. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 6,356 $ 5,774 $ 6,726 Net cash used in investing activities (2,865 ) (2,947 ) (2,366 ) Net cash used in financing activities (1,147 ) (1,281 ) (3,218 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $9,444 and $7,259 at the end of 2019 and 2018 , respectively. Of these balances, unsettled credit and debit card receivables represented approximately $1,434 and $1,348 at the end of 2019 and 2018, respectively. These receivables generally settle within four days. Cash and cash equivalents were negatively impacted by a change in exchange rates of $15 and $37 in 2019 and 2018 , respectively, and positively impacted by $25 in 2017. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements. We no longer consider earnings after 2017 of our non-U.S. consolidated subsidiaries to be indefinitely reinvested. Cash Flows from Operating Activities Net cash provided by operating activities totaled $6,356 in 2019 , compared to $5,774 in 2018 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise suppliers, warehouse operating costs, including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. Changes in our net investment in merchandise inventories (the difference between merchandise inventories and accounts payable) is impacted by several factors, including how fast inventory is sold, payment terms with our suppliers, and the amount of payables paid early to obtain discounts from our suppliers. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,865 in 2019 , compared to $2,947 in 2018 , and primarily related to capital expenditures. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations and working capital. In 2019 , we spent $2,998 on capital expenditures, and it is our current intention to spend approximat ely $3,000 to $3,200 d uring fiscal 2020. These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. We opened 25 new warehous es, including five relocations, in 2019 , and plan to open approximately 22 additional new warehouses, including three relocations, in 2020. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,147 in 2019 , compared to $1,281 in 2018 . Cash flows used in financing activities primarily related to the payment of dividends, withholding taxes on stock-based awards, and repurchases of common stock. Dividends totaling $ 1,038 were paid during 2019, of which $250 related to the dividend declared in August 2018. In August 2019, approximately $200 and $100 of Guaranteed Senior Notes were issued by our Japanese subsidiary at fixed interest rates of 0.28% and 0.42%, respectively. Stock Repurchase Programs In April 2019, the Board of Directors authorized a new share repurchase program in the amount of $4,000, which expires in April 2023. This authorization revoked previously authorized but unused amounts, totaling $2,237 . During 2019 and 2018 , we repurchased 1,097,000 and 1,756,000 shares of common stock, at average prices of $225.16 and $183.13 , respectively, totaling approximately $247 and $322 , respectively. The remaining amount available to be purchased under our approved plan was $3,943 at the end of 2019 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends declared in 2019 totaled $2.44 per share, as compared to $2.14 per share in 2018 . In April 2019 , the Board of Directors increased our quarterly cash dividend from $0.57 to $0.65 per share. In August 2019 , the Board of Directors declared a quarterly cash dividend in the amount of $0.65 per share, which was paid subsequent to the end of 2019. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 1, 2019 , we had borrowing capacity under these facilities of $865, including a $400 revolving line of credit, which expires in June 2020. The Company currently has no plans to draw upon this facility. Our international operations maintain $355 of the total borrowing capacity under bank credit facilities, of which $150 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2019 and 2018 . The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $219. The outstanding commitments under these facilities at the end of 2019 totaled $145, most of which were standby letters of credit with expiration dates within one year. The bank credit facilities have various expiration dates, most of which are within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit outstanding. Contractual Obligations At September 1, 2019 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2021 to 2022 2023 to 2024 2025 and thereafter Total Purchase obligations (merchandise) (1) $ 8,752 $ $ $ $ 8,756 Long-term debt (2) 1,828 2,594 1,330 1,651 7,403 Operating leases (3) 2,206 3,250 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 12,032 $ 3,332 $ 1,838 $ 4,562 $ 21,764 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Excludes common area maintenance, taxes, and insurance and have been reduced by $105 related to sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations and deferred compensation obligations. The amount excludes $27 of non-current unrecognized tax contingencies and $36 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition or financial statements, other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-insurance Liabilities The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to seek to limit exposures arising from very large losses. We use different risk management mechanisms, including a wholly-owned captive insurance subsidiary, and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims over time. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. The 2017 Tax Act includes various provisions that significantly altered U.S. tax law, many of which impact our business (see Note 8 to the consolidated financial statements for further discussion). Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, U.S. government and government agency money market funds, and insured bank balances. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2019 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2019 , long-term debt with fixed interest rates was $6,852 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency Risk Our foreign subsidiaries conduct certain transactions in non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 1, 2019 , would have decreased the fair value of the contracts by $79 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodities used in retail and manufacturing operations, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases and normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 1, 2019 and September 2, 2018 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 1, 2019 and September 2, 2018 , and the results of its operations and its cash flows for the 52-week period ended September 1, 2019 , the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 10, 2019 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of self-insurance liabilities As discussed in Note 1 to the consolidated financial statements, the Company estimates its self-insurance liabilities by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated self-insurance liabilities as of September 1, 2019 were $ 1,222 million. We identified the evaluation of the Companys self-insurance liabilities as a critical audit matter because of the specialized skills necessary to evaluate the Companys actuarial models and the judgments required to assess the underlying assumptions made by the Company. Key assumptions underlying the Companys actuarial estimates include: reporting and payment patterns used in the projections of the ultimate loss; loss and exposure trends; the selected loss rates and initial expected losses used in the Paid and Incurred Bornhuetter-Ferguson methods; and the selection of the ultimate loss derived from the various methods. The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys self-insurance process. Such controls included controls over the (a) evaluation of claims information sent to the actuary, (b) development and selection of the key assumptions used in the actuarial calculation, and (c) review of the actuarial report and evaluation of the external actuarial experts qualifications, competency, and objectivity. We tested the claims data used in the actuarial calculation by selecting a sample and checking key attributes such as date of loss. We involved actuarial professionals with specialized skills and knowledge who assisted in: Assessing the actuarial models used by the Company for consistency with generally accepted actuarial standards; Evaluating the Companys ability to estimate self-insurance liabilities by comparing its historical estimates with actual loss payments; Evaluating the key assumptions underlying the Companys actuarial estimates by developing an independent expectation of the self-insurance liabilities and comparing them to the amounts recorded by the Company; and Evaluating the qualifications of the Companys actuaries by assessing their certifications, and determining whether they met the Qualification Standards of the American Academy of Actuaries to render the statements of actuarial opinion implicit in their analyses. Performance of incremental audit procedures over IT financial reporting processes As of September 2, 2018, the Company identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. Automated and manual business process controls that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. While our report dated October 10, 2019 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting as of September 1, 2019, during a portion of the 52-week period ended September 1, 2019, the ITGCs were ineffective and the information or system generated reports produced by the affected financial reporting systems could not be relied upon without further testing. We identified the performance of the necessary incremental audit procedures over the financial information reliant on the impacted IT systems as a critical audit matter. Significant auditor judgment was required to design and execute the incremental audit procedures and to assess the sufficiency of the procedures performed and evidence obtained due to ineffective controls and the complexity of the Companys IT environment. The primary procedures we performed to address this critical audit matter included the following. We involved IT professionals with specialized skills and knowledge to assist in the identification and design of the incremental procedures. We modified the types of procedures that were performed, which included: Testing the underlying records of selected transaction data obtained from the impacted IT systems to support the use of the information in the conduct of the audit; and Involving forensic professionals with specialized skills and knowledge in data analysis to perform an evaluation of the journal entry data, including assessing that the entire population of automated and manual transactions has been identified. Forensic professionals also assisted with the identification of certain entries that required additional testing and for all such entries, we agreed the journal entry data to source documents. We evaluated the collective results of the incremental audit procedures performed to assess the sufficiency of audit evidence obtained related to the information produced by the impacted IT systems. Evaluation of the impact of the 2017 Tax Act As discussed in Note 8 to the consolidated financial statements, H.R. 1, the ""Tax Cuts and Jobs Act"" (2017 Tax Act) contains numerous provisions impacting the computation of the Companys U.S. federal and state corporate income tax provision, including the Global Intangible Low Tax Income (GILTI), Foreign Derived Intangibles Income (FDII) and Foreign Tax Credit (FTC) provisions. For the year ended September 1, 2019, the Company recognized net tax benefits of $123 million related to the 2017 Tax Act. We identified the evaluation of the Companys implementation of the provisions of the 2017 Tax Act as a critical audit matter. A high degree of judgment was required to interpret the impact of the new tax law on the Company, especially given the complexity of the 2017 Tax Act and related Treasury Regulations. Further, evaluating the Companys application of the GILTI, FDII and FTC provisions of the 2017 Tax Act required complex auditor judgment. The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys income tax process, including controls over the (a) identification and interpretation of the relevant provisions of the 2017 Tax Act and related Treasury Regulations and (b) calculation of the impact of the GILTI, FDII and FTC provisions. We involved tax professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation and application of the 2017 Tax Act. They developed an independent assessment of the impact of the GILTI, FDII and FTC provisions based on our understanding and interpretation, and compared it to the net tax benefits the Company recognized related to the 2017 Tax Act. /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 10, 2019 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 1, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 1, 2019 and September 2, 2018, the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 1, 2019, the 52-week period ended September 2, 2018 and the 53-week period ended September 3, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated October 10, 2019 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting ( Item 9A ). Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 10, 2019 COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) September 1, 2019 September 2, 2018 ASSETS CURRENT ASSETS Cash and cash equivalents $ 8,384 $ 6,055 Short-term investments 1,060 1,204 Receivables, net 1,535 1,669 Merchandise inventories 11,395 11,040 Other current assets 1,111 Total current assets 23,485 20,289 PROPERTY AND EQUIPMENT Land 6,417 6,193 Buildings and improvements 17,136 16,107 Equipment and fixtures 7,801 7,274 Construction in progress 1,272 1,140 32,626 30,714 Less accumulated depreciation and amortization (11,736 ) (11,033 ) Net property and equipment 20,890 19,681 OTHER ASSETS 1,025 TOTAL ASSETS $ 45,400 $ 40,830 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 11,679 $ 11,237 Accrued salaries and benefits 3,176 2,994 Accrued member rewards 1,180 1,057 Deferred membership fees 1,711 1,624 Current portion of long-term debt 1,699 Other current liabilities 3,792 2,924 Total current liabilities 23,237 19,926 LONG-TERM DEBT, excluding current portion 5,124 6,487 OTHER LIABILITIES 1,455 1,314 Total liabilities 29,816 27,727 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 439,625,000 and 438,189,000 shares issued and outstanding Additional paid-in capital 6,417 6,107 Accumulated other comprehensive loss (1,436 ) (1,199 ) Retained earnings 10,258 7,887 Total Costco stockholders equity 15,243 12,799 Noncontrolling interests Total equity 15,584 13,103 TOTAL LIABILITIES AND EQUITY $ 45,400 $ 40,830 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 REVENUE Net sales $ 149,351 $ 138,434 $ 126,172 Membership fees 3,352 3,142 2,853 Total revenue 152,703 141,576 129,025 OPERATING EXPENSES Merchandise costs 132,886 123,152 111,882 Selling, general and administrative 14,994 13,876 12,950 Preopening expenses Operating income 4,737 4,480 4,111 OTHER INCOME (EXPENSE) Interest expense (150 ) (159 ) (134 ) Interest income and other, net INCOME BEFORE INCOME TAXES 4,765 4,442 4,039 Provision for income taxes 1,061 1,263 1,325 Net income including noncontrolling interests 3,704 3,179 2,714 Net income attributable to noncontrolling interests (45 ) (45 ) (35 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 3,659 $ 3,134 $ 2,679 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 8.32 $ 7.15 $ 6.11 Diluted $ 8.26 $ 7.09 $ 6.08 Shares used in calculation (000s) Basic 439,755 438,515 438,437 Diluted 442,923 441,834 440,937 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 3,704 $ 3,179 $ 2,714 Foreign-currency translation adjustment and other, net (245 ) (192 ) Comprehensive income 3,459 2,987 2,812 Less: Comprehensive income attributable to noncontrolling interests COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 3,422 $ 2,949 $ 2,764 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT AUGUST 28, 2016 437,524 $ $ 5,490 $ (1,099 ) $ 7,686 $ 12,079 $ $ 12,332 Net income 2,679 2,679 2,714 Foreign-currency translation adjustment and other, net Stock-based compensation Release of vested restricted stock units (RSUs), including tax effects 2,673 (165 ) (165 ) (165 ) Conversion of convertible notes Repurchases of common stock (2,998 ) (41 ) (432 ) (473 ) (473 ) Cash dividends declared and other (2 ) (3,945 ) (3,945 ) (3,945 ) BALANCE AT SEPTEMBER 3, 2017 437,204 5,800 (1,014 ) 5,988 10,778 11,079 Net income 3,134 3,134 3,179 Foreign-currency translation adjustment and other, net (185 ) (185 ) (7 ) (192 ) Stock-based compensation Release of vested RSUs, including tax effects 2,741 (217 ) (217 ) (217 ) Repurchases of common stock (1,756 ) (26 ) (296 ) (322 ) (322 ) Cash dividends declared and other (939 ) (936 ) (35 ) (971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 6,107 (1,199 ) 7,887 12,799 13,103 Net income 3,659 3,659 3,704 Foreign-currency translation adjustment and other, net (237 ) (237 ) (8 ) (245 ) Stock-based compensation Release of vested RSUs, including tax effects 2,533 (272 ) (272 ) (272 ) Repurchases of common stock (1,097 ) (16 ) (231 ) (247 ) (247 ) Cash dividends declared and other (1,057 ) (1,057 ) (1,057 ) BALANCE AT SEPTEMBER 1, 2019 439,625 $ $ 6,417 $ (1,436 ) $ 10,258 $ 15,243 $ $ 15,584 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended September 1, 2019 September 2, 2018 September 3, 2017 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 3,704 $ 3,179 $ 2,714 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,492 1,437 1,370 Stock-based compensation Other non-cash operating activities, net (6 ) (14 ) Deferred income taxes (49 ) (29 ) Changes in operating assets and liabilities: Merchandise inventories (536 ) (1,313 ) (894 ) Accounts payable 1,561 2,258 Other operating assets and liabilities, net Net cash provided by operating activities 6,356 5,774 6,726 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments (1,094 ) (1,060 ) (1,279 ) Maturities and sales of short-term investments 1,231 1,078 1,385 Additions to property and equipment (2,998 ) (2,969 ) (2,502 ) Other investing activities, net (4 ) Net cash used in investing activities (2,865 ) (2,947 ) (2,366 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank payments outstanding (236 ) Proceeds from issuance of long-term debt 3,782 Repayments of long-term debt (89 ) (86 ) (2,200 ) Tax withholdings on stock-based awards (272 ) (217 ) (202 ) Repurchases of common stock (247 ) (328 ) (469 ) Cash dividend payments (1,038 ) (689 ) (3,904 ) Other financing activities, net (9 ) (41 ) Net cash used in financing activities (1,147 ) (1,281 ) (3,218 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (15 ) (37 ) Net change in cash and cash equivalents 2,329 1,509 1,167 CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 6,055 4,546 3,379 CASH AND CASH EQUIVALENTS END OF YEAR $ 8,384 $ 6,055 $ 4,546 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ $ $ Income taxes, net $ 1,187 $ 1,204 $ 1,185 SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Cash dividend declared, but not yet paid $ $ $ COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At September 1, 2019 , Costco operated 782 warehouses worldwide: 543 in the United States (U.S.) located in 44 states, Washington, D.C., and Puerto Rico, 100 in Canada, 39 in Mexico, 29 in the United Kingdom (U.K.), 26 in Japan, 16 in Korea, 13 in Taiwan, 11 in Australia, two in Spain, and one each in Iceland, France and China. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Basis of Presentation The consolidated financial statements include the accounts of Costco, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018, the Company purchased its former joint-venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the year ending on the Sunday closest to August 31. References to 2019 and 2018 relate to the 52-week fiscal years ended September 1, 2019 , and September 2, 2018 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,434 and $ 1,348 at the end of 2019 and 2018 , respectively. The Company provides for the daily replenishment of major bank accounts as payments are presented. Included in accounts payable at the end of 2019 and 2018 are $ 673 and $ 463 , respectively, representing the excess of outstanding payments over cash on deposit at the banks on which the payments were drawn. The accompanying notes are an integral part of these consolidated financial statements. Short-Term Investments In general, short-term investments have a maturity at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 2 , 3 , and 4 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include volume rebates or other discounts. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial in 2019 , 2018 , and 2017 . Merchandise Inventories Merchandise inventories consist of the following: United States $ 8,415 $ 8,081 Canada 1,123 1,189 Other International 1,857 1,770 Merchandise inventories $ 11,395 $ 11,040 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels have been determined. As of September 1, 2019 and September 2, 2018 , U.S. merchandise inventories valued at LIFO approximated first-in, first-out (FIFO) after considering the lower of cost or market principle. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the FIFO basis. The Company provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on the Companys experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment Property and equipment are stated at cost. In general, new building additions are classified into components, each with an estimated useful life, generally five to fifty years for buildings and improvements and three to twenty years for equipment and fixtures. Depreciation and amortization expense is computed using the straight-line method over estimated useful lives or the lease term, if shorter. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably assured at the date the leasehold improvements are made. The Company capitalizes certain computer software and software development costs incurred in developing or obtaining software for internal use. During development, these costs are included in construction in progress. When the assets are ready for their intended use, these costs are included in equipment and fixtures and amortized on a straight-line basis over the estimated useful lives of the software, generally three to seven years. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2019 and 2018 were immaterial. The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2019 , 2018 or 2017 . Insurance/Self-insurance Liabilities The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit exposures arising from very large losses. It uses different risk management mechanisms, including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2019 and 2018 , these insurance liabilities were $ 1,222 and $ 1,148 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. At the end of 2019 and 2018 , the aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 704 and $ 717 at the end of 2019 and 2018 , respectively. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2019 and 2018 . The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2019 , 2018 , and 2017 . The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, and other commodity products used in retail and manufacturing operations, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial for 2019 , 2018 , and 2017 . Revenue Recognition The Company recognizes sales for the amount of consideration collected from the member, which includes gross shipping fees where applicable, and is net of sales taxes collected and remitted to government agencies and returns. The Company reserves for estimated returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The Company records, on a gross basis, a refund liability and an asset for recovery, which are included in other current liabilities and other current assets, respectively, in the consolidated balance sheets. Merchandise Sales - The Company offers merchandise in the following core merchandise categories: food and sundries, hardlines, softlines, and fresh foods. The Company also provides expanded products and services through warehouse ancillary and other businesses. The majority of revenue from merchandise sales is recognized at the point of sale. Revenue generated through e-commerce or special orders is recognized upon shipment to the member to the extent there is no installation provided as a part of the contract. For merchandise shipped directly to the member, shipping and handling costs are expensed as incurred as fulfillment costs and included in merchandise costs in the consolidated statements of income. In certain ancillary businesses, revenue is deferred until the member picks up merchandise at the warehouse. Deferred sales are included in other current liabilities in the consolidated balance sheets. Principal Versus Agent - The Company is the principal for the majority of its transactions and recognizes revenue on a gross basis. The Company is the principal when it has control of the merchandise or service before it is transferred to the member, which generally is established when Costco is primarily responsible for merchandising decisions, maintains the relationship with the member, including assurance of member service and satisfaction, and has pricing discretion. Membership Fees - The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership period. Deferred membership fees at the end of 2019 and 2018 were $1,711 and $1,624 , respectively. In certain countries, the Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum of approximately $1,000 per year), which does not expire and can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales, net of the estimated impact of non-redemptions (breakage), with the corresponding liability classified as accrued member rewards in the consolidated balance sheets. Estimated breakage is computed based on redemption data. For 2019 , 2018 and 2017, the net reduction in sales was $1,537 , $1,394 , and $1,281 respectively. Shop Cards - The Company sells and otherwise provides proprietary shop cards that do not expire and are redeemable at the warehouse or online for merchandise or membership. Revenue from shop cards is recognized upon redemption, and estimated breakage is recognized based on redemption data. The Company accounts for outstanding shop card balances as a shop card liability, net of estimated breakage. Previously, the shop cards were branded as cash cards. Co-Branded Credit Card Program - Citibank, N.A. (Citi) became the exclusive issuer of co-branded credit cards to U.S. members in June 2016. The Company receives various forms of consideration, including a royalty on purchases made on the card outside of Costco, a portion of which, after giving rise to estimated breakage, is used to fund the rebate that cardholders receive. The rebates are issued in February and expire on December 31. Breakage is estimated based on redemption data. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot and fulfillment operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for discounts and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses which are reflected in merchandise costs) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, credit and debit card processing fees, utilities, as well as other operating costs incurred to support warehouse and e-commerce website operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees over the age of 18 who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $614 , $578 , and $543 for 2019 , 2018 , and 2017 , respectively, and are predominantly included in selling, general and administrative expenses in the accompanying consolidated statements of income. Stock-Based Compensation Restricted stock units (RSUs) granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting of a portion of outstanding shares based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 7 for additional information on the Companys stock-based compensation plans. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2068 , with the exception of one lease in the U.K., which expires in 2151 . These leases generally contain one or more of the following options, which the Company can exercise at the end of the initial lease term: (a) renewal for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume. The Company has capital leases for certain warehouse locations, expiring at various dates through 2059 . Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income. The Company records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent the Company is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, the Company assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, it accounts for the arrangement as a financing lease. The Companys asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are generally recorded as a discounted liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the improvements. These liabilities are accreted over time to the projected future value of the obligation. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2019 and 2018 , respectively, and are included in other liabilities in the accompanying consolidated balance sheets. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 6 for additional information. Recent Accounting Pronouncements Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, providing for changes in the recognition of revenue from contracts with customers. The guidance requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows. The Company adopted the standard in the first quarter of 2019, using the modified retrospective approach, and recorded a cumulative effect adjustment of $16 as an increase to retained earnings, which is included in cash dividend declared and other in the consolidated statements of equity. The standard impacted the presentation and timing of certain revenue transactions. Specifically, the changes included gross presentation of the Companys estimate of merchandise returns reserve and the related recoverable assets, recognizing shop card breakage over the period of redemption, and accelerating the recognition of certain e-commerce and special-order sales. Additionally, the Companys evaluation under the standard of its status as a principal in certain revenue arrangements resulted in the recognition of additional sales on a gross basis. The effect of the standard on the Company's consolidated balance sheet was an increase to other current liabilities and other current assets of $649 and $698 at adoption and at the end of 2019 , respectively, related to the estimate of merchandise returns reserve and the related recoverable assets. The effect of the adoption of this standard on the Company's consolidated statement of income is as follows: As Reported ASU 2014-09 Effect Excluding ASU 2014-09 Effect 52 Weeks Ended September 1, 2019 Net Sales $ 149,351 $ 1,332 $ 148,019 Merchandise Costs 132,886 1,324 131,562 Gross Margin (1) 16,465 16,457 ______________ (1) Net sales less merchandise costs. For related disaggregated revenue disclosures, see Note 11 . Recent Accounting Pronouncements Not Yet Adopted In February 2016, the FASB issued ASU 2016-02, which requires recognition on the balance sheet of rights and obligations created by leases with terms greater than twelve months. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and utilize the transition option, which allows for a cumulative-effect adjustment in the period of adoption and does not require application of the guidance to comparative periods. The primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. The Company has substantially completed its assessment of the new standard and estimates total assets and liabilities will increase by approximately $2,400 upon adoption. The adoption is not expected to have a material impact to the Company's consolidated statements of income or cash flows. The Company continues to evaluate the related disclosure requirements. Note 2Investments The Companys investments were as follows: 2019: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ $ $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,054 $ $ 1,060 2018: Cost Basis Unrealized Losses, Net Recorded Basis Available-for-sale: Government and agency securities $ $ (14 ) $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,218 $ (14 ) $ 1,204 Gross unrecognized holding gains and losses on available-for-sale securities were not material for the years ended September 1, 2019 , and September 2, 2018 . At the end of 2019 and 2018 , the Company's available-for-sale securities that were in a continuous unrealized-loss position were not material. There were no sales of available-for-sale securities in 2019. Proceeds from sales of available-for-sale securities were $39 and $202 during 2018 , and 2017 , respectively. Gross realized gains or losses from sales of available-for-sale securities were not material in 2018 and 2017 . The maturities of available-for-sale and held-to-maturity securities at the end of 2019 are as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ $ $ Due after one year through five years Due after five years Total $ $ $ 48 Note 3Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The tables below present information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. 2019: Level 1 Level 2 Investment in government and agency securities (1) $ $ Forward foreign-exchange contracts, in asset position (2) Forward foreign-exchange contracts, in (liability) position (2) (4 ) Total $ $ 2018: Level 1 Level 2 Money market mutual funds (3) $ $ Investment in government and agency securities (1) Forward foreign-exchange contracts, in asset position (2) Forward foreign-exchange contracts, in (liability) position (2) (2 ) Total $ $ ______________ (1) At September 1, 2019 , $44 cash and cash equivalents and $722 short-term investments are included in the accompanying consolidated balance sheets. At September 2, 2018 , immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying consolidated balance sheets. (2) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying consolidated balance sheets. (3) Included in cash and cash equivalents in the accompanying balance sheet. During and at the end of both 2019 and 2018 , the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during 2019 and 2018 . Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2019 and 2018 . Note 4Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities, with a borrowing capacity of $865 and $857 , in 2019 and 2018 , respectively. Borrowings on these short-term facilities were immaterial during 2019 and 2018 , and there were no outstanding borrowings at the end of 2019 and 2018 . Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, which have various principal balances, interest rates, and maturity dates as described below. The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100% of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, as defined by the terms of the Senior Notes, the holder has the right to require the Company to purchase this security at a price of 101% of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary and are valued using Level 3 inputs. In October 2018, the Company's Japanese subsidiary repaid a Guaranteed Senior Note and in August 2019, issued approximately $200 and $100 of Guaranteed Senior Notes at fixed interest rates of 0.28% and 0.42% , respectively. Interest is payable semi-annually, and principal is due in August 2029 and August 2034 , respectively. At the end of 2019 and 2018 , the fair value of the Company's long-term debt, including the current portion, was approximately $6,997 and $6,492 , respectively. The carrying value of long-term debt consisted of the following: 1.70% Senior Notes due December 2019 $ 1,200 $ 1,200 1.75% Senior Notes due February 2020 2.15% Senior Notes due May 2021 1,000 1,000 2.25% Senior Notes due February 2022 2.30% Senior Notes due May 2022 2.75% Senior Notes due May 2024 1,000 1,000 3.00% Senior Notes due May 2027 1,000 1,000 Other long-term debt Total long-term debt 6,852 6,613 Less unamortized debt discounts and issuance costs Less current portion (1) 1,699 Long-term debt, excluding current portion $ 5,124 $ 6,487 _______________ (1) Net of unamortized debt discounts and issuance costs. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: $ 1,700 1,094 1,300 94 1,113 Thereafter 1,551 Total $ 6,852 Note 5Leases Operating Leases The aggregate rental expense for 2019 , 2018 , and 2017 was $268 , $265 , and $258 , respectively. Sub-lease income and contingent rent were not material in 2019 , 2018 , or 2017 . Capital and Build-to-Suit Leases Gross assets recorded under capital and build-to-suit leases were $457 and $427 at the end of 2019 and 2018 , respectively. These assets are recorded net of accumulated amortization of $106 and $94 at the end of 2019 and 2018 , respectively. At the end of 2019 , future minimum payments, net of sub-lease income of $105 for all years combined, under non-cancelable operating leases with terms of at least one year and capital leases were as follows: Operating Leases Capital Leases (1) $ $ 2021 2022 2023 2024 Thereafter 2,206 Total $ 3,250 Less amount representing interest (343 ) Net present value of minimum lease payments Less current installments (2) (26 ) Long-term capital lease obligations less current installments (3) $ _______________ (1) Includes build-to-suit lease obligations. (2) Included in other current liabilities in the accompanying consolidated balance sheets. (3) Included in other liabilities in the accompanying consolidated balance sheets. Note 6Stockholders Equity Dividends The Companys current quarterly dividend rate is $0.65 per share. In August 2019, the Board of Directors declared a quarterly cash dividend in the amount of $0.65 per share, which was paid subsequent to the end of 2019. Stock Repurchase Programs In April 2019 , the Board of Directors authorized a new share repurchase program in the amount of $4,000 , which expires in April 2023 . This authorization revoked previously authorized but unused amounts, totaling $2,237 . As of the end of 2019 , the remaining amount available for stock repurchases under the approved plan was $3,943 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 1,097 $ 225.16 $ 2018 1,756 183.13 2017 2,998 157.87 These amounts may differ from repurchases of common stock in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Note 7Stock-Based Compensation Plans The Company grants stock-based compensation, primarily to employees and non-employee directors. Grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain at least 25 years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date. On January 24, 2019, shareholders approved the adoption of the 2019 Incentive Plan, which replaced the Seventh Restated 2002 Stock Incentive Plan (Seventh Plan). The 2019 Incentive Plan authorized the issuance of 17,500,000 shares ( 10,000,000 RSUs) of common stock for future grants, plus the remaining shares that were available for grant under the Seventh Plan on January 24, 2019 and future forfeited shares from grants under the Seventh Plan up to a maximum aggregate of 27,800,000 shares ( 15,885,000 RSUs). The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of shares withheld for taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on non-vested and undelivered shares. At the end of 2019 , 15,676,000 shares were available to be granted as RSUs under the 2019 Incentive Plan. The following awards were outstanding at the end of 2019 : 6,268,000 time-based RSUs that vest upon continued employment over specified periods of time; 228,000 performance-based RSUs, of which 150,000 were granted to executive officers subject to the certification of the attainment of specified performance targets for 2019. This certification occurred in September 2019, at which time a portion vested as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2019 : Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2018 7,578 $ 140.85 Granted 2,792 224.00 Vested and delivered (3,719 ) 155.65 Forfeited (155 ) 164.75 Outstanding at the end of 2019 6,496 $ 167.55 The weighted-average grant date fair value of RSUs granted was $224.00 , $156.19 , and $144.12 in 2019 , 2018 , and 2017 , respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2019 was $ 694 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2019 were approximately 2,194,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: Stock-based compensation expense before income taxes $ $ $ Less income tax benefit (1) (128 ) (116 ) (167 ) Stock-based compensation expense, net of income taxes $ $ $ _______________ (1) In 2019 and 2018, the income tax benefit reflects the reduction in the U.S. federal statutory income tax rate from 35% to 21% . Note 8 Taxes Income Taxes Income before income taxes is comprised of the following: Domestic $ 3,591 $ 3,182 $ 2,988 Foreign 1,174 1,260 1,051 Total $ 4,765 $ 4,442 $ 4,039 The provisions for income taxes are as follows: Federal: Current $ $ $ Deferred (35 ) Total federal State: Current Deferred Total state Foreign: Current Deferred (98 ) (37 ) (42 ) Total foreign Total provision for income taxes $ 1,061 $ 1,263 $ 1,325 In December 2017, the 2017 Tax Act was signed into law. Except for certain provisions, the 2017 Tax Act is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions became effective for 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of 2018 and throughout 2019 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0% was effective for all of 2019 and resulted in a blended rate for the Company of 25.6% for 2018. The reconciliation between the statutory tax rate and the effective rate is as follows: Federal taxes at statutory rate $ 1,001 21.0 % $ 1,136 25.6 % $ 1,414 35.0 % State taxes, net 3.6 3.4 2.9 Foreign taxes, net (1 ) 0.0 0.7 (64 ) (1.6 ) Employee stock ownership plan (ESOP) (18 ) (0.4 ) (14 ) (0.3 ) (104 ) (2.6 ) 2017 Tax Act (123 ) (2.6 ) 0.4 Other 0.7 (64 ) (1.4 ) (37 ) (0.9 ) Total $ 1,061 22.3 % $ 1,263 28.4 % $ 1,325 32.8 % During 2019, the Company recognized net tax benefits of $123 related to the 2017 Tax Act. This benefit primarily included $105 related to U.S. taxation of deemed foreign dividends, partially offset by losses of current year foreign tax credits. During 2018, the Company recognized a net tax expense of $19 related to the 2017 Tax Act. This expense included $142 for the estimated tax on deemed repatriation of foreign earnings, and $43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $166 for the remeasurement of certain deferred tax liabilities. In 2019 and 2018, the Company recognized total net tax benefits of $221 and $57 , which included a benefit of $59 and $33 , respectively, related to the stock-based compensation accounting standard adopted in 2018 in addition to the impacts of the 2017 Tax Act noted above. In 2017, the Company s provision for income taxes was favorably impacted by a net tax benefit of $104 , primarily due to the $82 tax benefit recorded in connection with the May 2017 special cash dividends paid by the Company to employees through the Company's 401(k) retirement plan. Dividends on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2019 or 2018. The components of the deferred tax assets (liabilities) are as follows: Deferred tax assets: Equity compensation $ $ Deferred income/membership fees Foreign tax credit carry forward Accrued liabilities and reserves Total deferred tax assets Valuation allowance (76 ) Total net deferred tax assets Deferred tax liabilities: Property and equipment (677 ) (478 ) Merchandise inventories (187 ) (175 ) Foreign branch deferreds (69 ) Other (21 ) (40 ) Total deferred tax liabilities $ (954 ) $ (693 ) Net deferred tax (liabilities)/assets $ (145 ) $ (1 ) The deferred tax accounts at the end of 2019 and 2018 include deferred income tax assets of $398 and $316 , respectively, included in other assets; and deferred income tax liabilities of $543 and $317 , respectively, included in other liabilities. In 2019, the Company recorded a valuation allowance of $76 primarily related to foreign tax credits that we believe will not be realized due to limitations on the Company's ability to claim the credits during the carry forward period. The foreign tax credit carry forwards are set to expire beginning in fiscal 2027. The Company no longer considers fiscal year earnings of our non-U.S. consolidated subsidiaries after 2017 to be indefinitely reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to 2018, which totaled $2,924 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2019 and 2018 is as follows: Gross unrecognized tax benefit at beginning of year $ $ Gross increasescurrent year tax positions Gross increasestax positions in prior years Gross decreasestax positions in prior years (17 ) Settlements (4 ) (1 ) Lapse of statute of limitations (12 ) (10 ) Gross unrecognized tax benefit at end of year $ $ The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2019 and 2018 , these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $24 and $32 at the end of 2019 and 2018 , respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized during 2019 and 2018 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2014. Other Taxes The Company is undergoing multiple examinations for value added, sales-based, payroll, product, import or other non-income taxes in various jurisdictions. In certain cases, the Company has received assessments from the authorities. Subsequent to the end of 2019, the Company received an assessment related to a product tax audit covering multiple years. The Company recorded a charge of $123 in 2019, but plans to protest the assessment. Other possible losses or range of possible losses associated with these matters are either immaterial or an estimate of the possible loss or range of loss cannot be made at this time. If certain matters or a group of matters were to be decided adversely to the Company, it could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 9Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of basic and of potentially dilutive common shares outstanding (shares in 000s): Net income attributable to Costco $ 3,659 $ 3,134 $ 2,679 Weighted average basic shares 439,755 438,515 438,437 RSUs and other 3,168 3,319 2,500 Weighted average diluted shares 442,923 441,834 440,937 Note 10Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded immaterial accruals with respect to certain matters described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. ( Case No. 5:13-CV-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The action has been stayed pending review by the Ninth Circuit of the order certifying a class. In January 2019, an employee brought similar claims for relief concerning Costco employees engaged at member services counters in California. Rodriguez v. Costco Wholesale Corp. (Case No. RG19001310, Alameda Superior Court filed Jan. 4, 2019). The Company filed an answer denying the material allegations of the complaint. In December 2018, a depot employee raised similar claims, alleging that depot employees in California did not receive suitable seating or appropriate workplace temperature conditions. Lane v. Costco Wholesale Corp. (Dec. 6, 2018 Notice to California Labor and Workforce Development Agency). The Company filed an answer denying the material allegations of the complaint. In January 2019, a former seasonal employee filed a class action, alleging failure to provide California seasonal employees meal and rest breaks, proper wage statements, and appropriate wages. Jadan v. Costco Wholesale Corp. (Case No. 19-CV-340438 Santa Clara Superior Court filed Jan. 3, 2019). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. In March 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. Nevarez, et ano., v. Costco Wholesale Corp., et al. (Case No. 2:19-cv-03454 C.D. Cal. Filed Mar. 25, 2019). The Company filed an answer denying the material allegations of the complaint. In May 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Rough v. Costco Wholesale Corp . (Case No. 2:19-cv-01340 E.D. Cal. filed May 28, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In June 2019, employees filed a class action against the Company alleging claims under California law for failure to pay overtime, to provide meal and rest periods, itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Martinez v. Costco Wholesale Corp ., (Case No. 3:19-cv-05624 (N.D. Cal. filed June 11, 2019). The Company filed an answer denying the material allegations of the complaint. In August 2019, Rough filed a companion case in state court seeking penalties under the California Labor Code Private Attorneys General Act. Rough v. Costco (Case No. FCS053454, Sonoma County Superior Court, filed August 23, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In September 2019, an employee re-filed a class action against the Company alleging claims under California law for failure to pay wages, to provide meal and rest periods and itemized wage statements, to timely pay wages due to terminating employees, to pay minimum wages, and for unfair business practices. Mosley v. Costco Wholesale Corp. (Case No. 2:19-cv-07935, C.D. Cal. filed Sept. 12, 2019). Relief is sought under the California Labor Code, including civil penalties and attorneys' fees. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes, and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal cases that name the Company, including actions filed by counties and cities in Michigan, New Jersey, Oregon, Virginia and South Carolina, a third-party payor in Ohio, and class actions filed in thirty-eight states on behalf of infants born with opioid-related medical conditions. In 2019 similar actions were commenced against the Company in state courts in Utah. Claims against the Company in state courts in New Jersey and Oklahoma have been dismissed. The Company is defending all of these matters. The Company and its CEO and CFO are defendants in putative class actions brought on behalf of shareholders who acquired Company stock between June 6 and October 25, 2018. Johnson v. Costco Wholesale Corp., et al. (W.D. Wash. filed Nov. 5, 2018); Chen v. Costco Wholesale Corp., et al. (W.D. Wash. filed Dec. 11, 2018). The complaints allege violations of the federal securities laws stemming from the Companys disclosures concerning internal control over financial reporting. They seek unspecified damages, equitable relief, interest, and costs and attorneys fees. On January 30, 2019, an order was entered consolidating the actions and a consolidated amended complaint was filed on April 16, 2019. A motion to dismiss the complaint was filed on June 7. Members of the Board of Directors, one other individual, and the Company are defendants in a shareholder derivative action related to the internal controls and related disclosures identified in the putative class actions, alleging that the individual defendants breached their fiduciary duties. Wedekind v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (W.D. Wash. filed Dec. 11, 2018). The complaint seeks unspecified damages, disgorgement of compensation, corporate governance changes, and costs and attorneys' fees. Because the complaint is derivative in nature, it does not seek monetary damages from the Company, which is a nominal defendant. By agreement among the parties the action has been stayed pending further proceedings in the class actions. Similar actions were filed in King County Superior Court on February 20, 2019, Elliott v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, Richard Libenson, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-04824-7), and April 16, 2019, Brad Shuman, et ano. v. Hamilton James, Susan Decker, Kenneth Denman, Richard Galanti, Craig Jelinek, John Meisenbach, Charles Munger, Jeffrey Raikes, John Stanton, Mary Agnes Wilderotter, and Costco Wholesale Corp. (Case No. 19-2-10460-1). These actions have also been stayed. In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. The relief to be sought is not known at this time. The Company is seeking to cooperate concerning the resolution of these notices. On February 13, 2019, the Company's affiliate in Spain received notice from the General Directorate on Environment and Sustainability of the Regional Government of Madrid that the Directorate was investigating issues concerning rain, sewage and hydrocarbon drainage related to the Company's warehouse in Getafe. In August the Company was advised that no fines would be sought in this matter. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter or year. Note 11Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, France, and China and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1 . Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. United States Operations Canadian Operations Other International Operations Total Total revenue $ 111,751 $ 21,366 $ 19,586 $ 152,703 Operating income 3,063 4,737 Depreciation and amortization 1,126 1,492 Additions to property and equipment 2,186 2,998 Net property and equipment 14,367 2,044 4,479 20,890 Total assets 32,162 4,369 8,869 45,400 Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 4,480 Depreciation and amortization 1,078 1,437 Additions to property and equipment 2,046 2,969 Net property and equipment 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Total revenue $ 93,889 $ 18,775 $ 16,361 $ 129,025 Operating income 2,644 4,111 Depreciation and amortization 1,044 1,370 Additions to property and equipment 1,714 2,502 Net property and equipment 12,339 1,820 4,002 18,161 Total assets 24,068 4,471 7,808 36,347 Disaggregated Revenue The following table summarizes net sales by merchandise category: Food and Sundries $ 59,672 $ 56,073 $ 52,362 Hardlines 24,570 22,620 20,583 Fresh Foods 19,948 18,879 17,849 Softlines 16,590 15,387 14,537 Ancillary 28,571 25,475 20,841 Total Net Sales $ 149,351 $ 138,434 $ 126,172 Note 12Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2019 and 2018 . 52 Weeks Ended September 1, 2019 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 34,311 $ 34,628 $ 33,964 $ 46,448 $ 149,351 Membership fees 1,050 3,352 Total revenue 35,069 35,396 34,740 47,498 152,703 OPERATING EXPENSES Merchandise costs 30,623 30,720 30,233 41,310 132,886 Selling, general and administrative 3,475 3,464 3,371 4,684 (1 ) 14,994 Preopening expenses Operating income 1,203 1,122 1,463 4,737 OTHER INCOME (EXPENSE) Interest expense (36 ) (34 ) (35 ) (45 ) (150 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,215 1,123 1,492 4,765 Provision for income taxes 1,061 Net income including noncontrolling interests 1,110 3,704 Net income attributable to noncontrolling interests (10 ) (12 ) (10 ) (13 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,097 $ 3,659 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.75 $ 2.02 $ 2.06 $ 2.49 $ 8.32 Diluted $ 1.73 $ 2.01 $ 2.05 $ 2.47 $ 8.26 Shares used in calculation (000s) Basic 439,157 440,284 439,859 439,727 439,755 Diluted 442,749 442,337 442,642 443,400 442,923 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.57 $ 0.57 $ 0.65 $ 0.65 $ 2.44 _______________ (1) Includes a $123 charge for a product tax assessment. 52 Weeks Ended September 2, 2018 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 31,117 $ 32,279 $ 31,624 $ 43,414 $ 138,434 Membership fees 3,142 Total revenue 31,809 32,995 32,361 44,411 141,576 OPERATING EXPENSES Merchandise costs 27,617 28,733 28,131 38,671 123,152 Selling, general and administrative 3,224 3,234 3,155 4,263 13,876 Preopening expenses Operating income 1,016 1,067 1,446 4,480 OTHER INCOME (EXPENSE) Interest expense (37 ) (37 ) (37 ) (48 ) (159 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,071 1,449 4,442 Provision for income taxes 1,263 Net income including noncontrolling interests 1,053 3,179 Net income attributable to noncontrolling interests (11 ) (12 ) (12 ) (10 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,043 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.46 $ 1.60 $ 1.71 $ 2.38 $ 7.15 Diluted $ 1.45 $ 1.59 $ 1.70 $ 2.36 $ 7.09 Shares used in calculation (000s) Basic 437,965 439,022 438,740 438,379 438,515 Diluted 440,851 441,568 441,715 442,427 441,834 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.50 $ 0.50 $ 0.57 $ 0.57 $ 2.14 "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of September 1, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 1, 2019 , using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework (2013). As disclosed in Part II Item 9A Controls and Procedures in our Annual Report on Form 10-K for the fiscal year ended September 2, 2018 , during the fourth quarter of fiscal 2018 we identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. During 2019 , management implemented our previously disclosed remediation plan that included: (i) creating and filling an IT Compliance Oversight function; (ii) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over IT systems impacting financial reporting; (iii) developing and maintaining documentation underlying ITGCs to promote knowledge transfer upon personnel and function changes; (iv) developing enhanced risk assessment procedures and controls related to changes in IT systems; (v) implementing an IT management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board of Directors. During the fourth quarter of 2019 , we completed our testing of the operating effectiveness of the implemented controls and found them to be effective. As a result we have concluded the material weakness has been remediated as of September 1, 2019 . Changes in Internal Control Over Financial Reporting Except for the changes in connection with our implementation of the remediation plan discussed above, there have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +3,cost,t10k9218," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Korea, Australia, Spain, France, Iceland, and through a majority-owned subsidiary in Taiwan. Costco operated 762 , 741, and 715 warehouses worldwide at September 2, 2018 , September 3, 2017 , and August 28, 2016 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018 , and August 28, 2016 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to warehouses. This process creates freight volume and handling efficiencies, lowering costs associated with traditional multiple-step distribution channels. Our average warehouse space is approximately 145,000 square feet, with newer units being slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits and using a membership format, we believe our inventory losses (shrinkage) are well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,700 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Food and Sundries (including dry foods, packaged foods, groceries, snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gasoline and pharmacy businesses) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include gas stations, pharmacies, optical dispensing centers, food courts, and hearing-aid centers. The number of warehouses with gas stations vary significantly by country, and we do not operate our gasoline business in Korea or France. We operated 567 gas stations at the end of 2018 . Our e-commerce operations allow us to connect with our members online and provide additional products and services, many not found in our warehouses. We operate e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Net sales for e-commerce represented approximately 4% of total net sales in 2018 . Additionally, we offer business delivery, travel and various other services online in certain countries. We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase and manufacture private-label merchandise, as long as quality and member demand are comparable and the value to our members is significant. Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable evidence. Business members have the ability to add additional cardholders (affiliates), to which the same annual fee applies. Affiliates are not available for Gold Star members. Our annual fee for these memberships is $60 in our U.S. and Canadian operations and varies in other countries. All paid memberships include a free household card. Our member renewal rate was 90% in the U.S. and Canada and 88% on a worldwide basis at the end of 2018 . The majority of members renew within six months following their renewal date. Therefore, our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 40,700 38,600 36,800 Business, including affiliates 10,900 10,800 10,800 Total paid members 51,600 49,400 47,600 Household cards 42,700 40,900 39,100 Total cardholders 94,300 90,300 86,700 Paid cardholders (except Business affiliates) are eligible to upgrade to an Executive membership in the U.S. and Canada for an additional annual fee of $60. Executive memberships are also available in Mexico and the U.K., for which the additional annual fee varies. Executive members earn a 2% reward on qualified purchases (up to a maximum reward of $1,000 per year in U.S. and Canada and varies in Mexico and the U.K.), and can be redeemed only at Costco warehouses. This program also offers (except in Mexico), access to additional savings and benefits on various business and consumer services, such as auto and home insurance, the Costco auto purchase program, and check printing services. These services are generally provided by third parties and vary by state and country. Executive members, who represented 37% of paid members at the end of 2018 , generally shop more frequently and spend more than other members. Labor Our employee count was as follows: Full-time employees 143,000 133,000 126,000 Part-time employees 102,000 98,000 92,000 Total employees 245,000 231,000 218,000 Approximately 15,900 employees are union employees. We consider our employee relations to be very good. Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Walmart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with warehouse club operations (primarily Walmarts Sams Club and BJs Wholesale Club), and nearly every major U.S. and Mexico metropolitan area has multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, patents, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality, offered to our members at prices that are generally lower than national brands, and that they help lower costs, differentiate our merchandise offerings, and generally earn higher margins. We expect to continue to increase the sales penetration of our private label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and registrations are properly maintained. Available Information Our U.S. website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with or furnishing such documents to the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. The public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, from this code to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Executive Officers of the Registrant The executive officers of Costco, their position, and ages are listed below. All executive officers have over 25 years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 66 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 62 Jim C. Klauer Executive Vice President, Chief Operating Officer, Northern Division. Mr. Klauer was Senior Vice President, Non Foods and E-commerce merchandise, from 2013 to January 2018. 56 Franz E. Lazarus Executive Vice President, Administration. Mr. Lazarus was Senior Vice President, Administration-Global Operations, from 2006 to September 2012. 71 Russ D. Miller Executive Vice President, Chief Operating Officer, Southern Division and Mexico. Mr. Miller was Senior Vice President, Western Canada Region, from 2001 to January 2018. 61 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development, from 2001 until March 2010. 67 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 65 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994 and has been the Chief Diversity Officer since 2010. 66 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label, from 1995 to December 2012. 66 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region, from 2010 to July 2015. 53 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 83% of net sales and operating income in 2018 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2018 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations and increase the cost of sites and of constructing, leasing and operating warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance, member traffic, and profitability. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lack of familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new websites will be profitable and, as a result, future profitability could be delayed or otherwise materially adversely affected. Our failure to maintain membership growth, loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce member renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution or processing, packaging, manufacturing, and other facilities could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. We also rely upon processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Although we believe that our operations are efficient, disruptions due to fires, tornadoes, hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the production and delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services, and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. We rely extensively on information technology to process transactions, compile results, and manage our businesses. Failure or disruption of our primary and back-up systems could adversely affect our businesses. A failure to adequately update our existing systems and implement new systems could harm our businesses and adversely affect our results of operations. Given the very high volume of transactions we process each year it is important that we maintain uninterrupted operation of our business-critical computer systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making, and will continue to make, investments to improve or advance critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace would be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process will mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. The potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. We identified a material weakness in our internal control related to ineffective information technology general controls which, if not remediated appropriately or timely, could result in loss of investor confidence and adversely impact our stock price. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. As disclosed in Part II, Item 9A, during the fourth quarter of fiscal 2018, management identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. As a result, management concluded that our internal control over financial reporting was not effective as of September 2, 2018. We are implementing remedial measures and, while there can be no assurance that our efforts will be successful, we plan to remediate the material weakness prior to the end of fiscal 2019. These measures will result in additional technology and other expenses. If we are unable to remediate the material weakness, or are otherwise unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods, could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price. If we do not maintain the privacy and security of personal and business information, we could damage our reputation with members and employees, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and employees and entrust that information to third-party business associates, including cloud service-providers that perform activities for us. Our warehouse and online businesses depend upon the secure transmission of encrypted confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or defects within our hardware or software, or those of our business associates, that results in our members' or employees' information being obtained by unauthorized persons, could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation, government actions, or the imposition of penalties. In addition, a breach could require that we expend significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is regulated at the national and state or local level in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to, among other things, systems changes and the development of new processes. If we or those with whom we share information fail to comply with these laws and regulations, our reputation could be damaged, possibly resulting in lost future business, and we could be subjected to additional legal risk as a result of non-compliance, including fines of up to 4% of our global revenue in the case of the General Data Protection Regulation (GDPR). We do not maintain cyber-insurance for these risks. We have security measures and controls to protect personal and business information and continue to make investments to secure access to our information technology network. These measures may be undermined, however, due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business and results of operations. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, a select variety of credit and debit cards, and our proprietary cash card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related card acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services, including the processing of credit and debit cards, and our proprietary cash card, and it could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. In addition, if our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise, such as food and prepared food products for human consumption, drugs, children ' s products, pet products and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our vendors are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with all safety standards. While we are subject to governmental inspection and regulations and work to comply in all material respects with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause illness or injury in the future or that we will not be subject to claims, lawsuits, or government investigations relating to such matters resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. If we do not successfully develop and maintain a relevant omnichannel experience for our members, our results of operations could be adversely impacted. Omnichannel retailing is rapidly evolving, and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making technology investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact the business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. Significant claims or events, regulatory changes, a substantial rise in costs of health care or costs to maintain our insurance, or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. We are primarily self-insured as it relates to property damage. Although we maintain specific coverages for catastrophic losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flow and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse-club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores and operators selling a single category or narrow range of merchandise. Such retailers and warehouse club operators compete in a variety of ways, including merchandise pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop with digital devices, which has enhanced competition. Some competitors may have greater financial resources and technology capabilities, better access to merchandise, and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including changes in tax rates, duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Prices of certain commodity products, including gasoline and other food products, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by significant events like the outbreak of war or acts of terrorism. Vendors may be unable to timely supply us with quality merchandise at competitive prices or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any vendor has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions of our merchandise leading to loss of sales and profits. We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key vendors could negatively affect us. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality or more expensive than those from existing vendors. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volume we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. For these or other reasons, one or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation and otherwise damage our reputation and our brands, increase our costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2018 , our international operations, including Canada, generated 28% and 38% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we translate the financial statements of our international operations from local currencies into U.S. dollars using current exchange rates. Future fluctuations in exchange rates that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. A portion of the products we purchase for sale in our warehouses around the world is paid for in a currency other than the local currency of the country in which the goods are sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to one or more of our properties, the temporary closure of one or more warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots within the countries in which we operate, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may result in increased compliance and merchandise costs, and legislation or regulation affecting energy inputs that could materially affect our profitability. Climate change and extreme weather conditions, such as intense hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels could affect our ability to procure needed commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Failure to meet financial market expectations could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate, which could adversely affect our business, financial condition and results of operations. During 2018 , we operated 235 warehouses outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade (including tariffs), monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities in locations which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including self-insurance liabilities and income taxes, are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in rules or interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance and have a material impact on our consolidated financial statements. We could be subject to additional income tax liabilities. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates, adverse outcomes in tax audits, including transfer pricing disputes, or any change in the pronouncements relating to accounting for income taxes could have a material adverse effect on our financial condition and results of operations. Significant changes in, or failure to comply with, federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 2, 2018 , we operated 762 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea (2) Taiwan Australia Spain Iceland France Total _______________ (1) 106 of the 157 leases are land-only leases, where Costco owns the building. (2) In fiscal 2018, Costco purchased the remaining equity interest and three formerly leased locations from its former joint-venture partner in Korea. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2018 : United States Canada Other International Total Total Warehouses in Operation 2014 and prior 2015 2016 2017 2018 2019 (expected through 12/31/2018) Total At the end of fiscal 2018 , our warehouses contained approximately 110.7 million square feet of operating floor space: 77.5 million in the U.S.; 13.9 million in Canada; and 19.3 million in Other International. We operate 24 depots, with approximately 11.0 million square feet, for the consolidation and distribution of most merchandise shipments to the warehouses. Additionally, we operate various processing, packaging, manufacturing and other facilities to support our business, which includes the production of certain private-label items. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 18, 2018 , we had 8,829 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2018: Fourth Quarter $ 233.13 $ 195.48 $ 0.570 Third Quarter 197.16 180.84 0.570 Second Quarter 198.91 172.61 0.500 First Quarter 173.42 154.61 0.500 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2018 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 14June 10, 2018 96,000 $ 198.61 96,000 $ 2,497 June 11July 8, 2018 134,000 208.49 134,000 2,469 July 9August 5, 2018 111,000 216.06 111,000 2,445 August 6September 2, 2018 78,000 225.20 78,000 2,427 Total fourth quarter 419,000 $ 211.35 419,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019. Performance Graph The following graph compares the cumulative total shareholder return (stock price appreciation plus dividends) on our common stock for the last five years with the cumulative total return of the SP 500 Index, the SP 500 Retail Index, and a peer group previously selected by the Company. The SP 500 Retail Index is intended to replace the previously selected peer group to allow for a more broad representation of industry performance. The transition to a larger retail index provides a better representation of total retail market performance. For the year ended September 2, 2018 , the cumulative total return of the previous peer group is provided pursuant to SEC rules requiring presentation in the year of change, and consists of: Amazon.com Inc.; The Home Depot Inc.; Lowe's Companies; Best Buy Co., Inc.; Staples Inc.; Target Corporation; Kroger Company; and Walmart Stores, Inc. This group will not be presented in future periods. The information provided is from September 1, 2013 , through September 2, 2018 . The graph assumes the investment of $100 in Costco common stock, the SP 500 Index, the SP 500 Retail Index, and the previously selected peer group on September 1, 2013, and reinvestment of all dividends. "," Item 7Management's Discussion and Analysis of Financial Conditions and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) Overview We believe that the most important driver of our profitability is sales growth, particularly comparable warehouse sales (comparable sales) growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions. The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, including the effects of inflation or deflation, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers, including those with e-commerce operations. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items, and through our online offerings. Our philosophy is to provide our members with quality goods and services at competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority on quality goods consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are continuing to decline in significance as they relate to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth, domestically and internationally, has also increased our sales. Our membership format is an integral part of our business and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates, materially influences our profitability. Our paid membership growth rate may be adversely impacted when warehouse openings occur in existing markets. Our financial performance depends heavily on our ability to control costs. While we believe that we have achieved successes in this area, some significant costs are partially outside our control, most particularly health care and utility expenses. With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low margins, modest changes in various items in the income statement, particularly merchandise costs and selling, general and administrative expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefits costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. Fiscal year 2018 and 2016 were 52-week fiscal years ending on September 2, 2018 and August 28, 2016 , respectively, and 2017 was a 53-week fiscal year ending on September 3, 2017 . Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for fiscal year 2018 included: We opened 25 new warehouses, including 4 relocations, in 2018 : 13 net new locations in the U.S., three in Canada, and five in our Other International segment, compared to 28 new warehouses, including 2 relocations in 2017 ; Net sales increased 10% to 138,434 driven by a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by one additional week of sales in 2017 ; Membership fee revenue increased 10% to $3,142 , primarily due to the annual fee increase in the U.S. and Canada in June 2017, and membership sign-ups at existing and new warehouses; Gross margin percentage decreased 29 basis points due to the impact of gasoline price inflation on net sales and a shift in sales penetration to certain lower margin warehouse ancillary businesses from our core merchandise categories; Selling, general administrative (SGA) expenses as a percentage of net sales decreased 24 basis points, due to the impact of gasoline price inflation and leveraging increased sales; The effective tax rate in 2018 was 28.4% and was favorably impacted by the 2017 Tax Act and net tax benefits of $57. The effective tax rate in 2017 was 32.8% and was favorably impacted by net tax benefits of $104; Net income increased 17% to $3,134 , or $7.09 per diluted share compared to $2,679 , or $6.08 per diluted share in 2017 ; and In April 2018, the Board of Directors approved an increase in the quarterly cash dividend from $0.50 to $0.57 per share. Results of operations Net Sales Net Sales $ 138,434 $ 126,172 $ 116,073 Changes in net sales: U.S. % % % Canada % % (2 )% Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % % (3 )% Other International % % (3 )% Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices: U.S. % % % Canada % % % Other International % % % Total Company % % % 2018 vs. 2017 Net Sales Net sales increased $12,262 or 10% during 2018 , primarily due to a 9% increase in comparable sales and sales at new warehouses opened in 2017 and 2018 , partially offset by the impact of one additional week of sales in 2017. Changes in gasoline prices positively impacted net sales by approximately $2,267, or 180 basis points, due to a 19% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar positively impacted net sales by approximately $1,156, or 92 basis points, compared to 2017 . The positive impact was driven by both our Canadian and Other International operations. Comparable Sales Comparable sales increased 9% during 2018 and were positively impacted by increases in both shopping frequency and the average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices and exchange rates in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). 2017 vs. 2016 Net Sales Net sales increased $10,099 or 9% during 2017, primarily due to a 4% increase in comparable sales, new warehouses opened in 2016 and 2017, and the benefit of one additional week of sales in 2017. Changes in gasoline prices positively impacted net sales by approximately $785, or 68 basis points, due to an 8% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $295, or 25 basis points, compared to 2016. The negative impact was driven by Other International operations, partially offset by positive impacts attributable to our Canadian operations. Comparable Sales Comparable sales increased 4% during 2017 and were positively impacted by an increase in shopping frequency and, to a lesser extent, an increased average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices, offset by decreases in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization. Membership Fees Membership fees $ 3,142 $ 2,853 $ 2,646 Membership fees increase % % % Membership fees as a percentage of net sales 2.27 % 2.26 % 2.28 % 2018 vs. 2017 The increase in membership fees was primarily due to the annual fee increase and membership sign-ups at existing and new warehouses. These increases were partially offset by the impact of one additional week of membership fees in 2017. At the end of 2018 , our member renewal rates were 90% in the U.S. and Canada and 88% worldwide. As reported in fiscal 2017, we increased our annual membership fees in the U.S. and Canada and in certain of our Other International operations. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact of approximately $178 in fiscal 2018 and will positively impact fiscal 2019, primarily the first two quarters, by approximately $70. 2017 vs. 2016 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fee revenue, the annual fee increase, and an increased number of upgrades to our higher-fee Executive Membership program. Fee increases had a positive impact on membership fee revenues during 2017 of approximately $23. Gross Margin Net sales $ 138,434 $ 126,172 $ 116,073 Less merchandise costs 123,152 111,882 102,901 Gross margin $ 15,282 $ 14,290 $ 13,172 Gross margin percentage 11.04 % 11.33 % 11.35 % 2018 vs. 2017 The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased one basis point primarily due to increases in food and sundries and hardlines partially offset by decreases in fresh foods and softlines. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased 29 basis points compared to 2017. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.22%, a decrease of 11 basis points. This decrease was primarily due to a shift in sales penetration to certain lower margin warehouse ancillary and other businesses, which contributed to a 13 basis point decrease in our core merchandise categories, except hardlines which was flat. Gross margin percentage was also negatively impacted by 10 basis points due to a non-recurring legal settlement benefiting 2017 and costs related to our centralized return centers in the U.S. These decreases were partially offset by a 13 basis point increase in our warehouse ancillary and other businesses, predominantly our gasoline business. Changes in foreign currencies relative to the U.S. dollar positively impacted gross margin by approximately $124 in 2018. The segment gross margin percentage, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), decreased in our U.S. operations, predominantly in our core merchandise categories, and as a result of the non-recurring legal settlement in 2017, and the costs related to our centralized return centers mentioned above. The segment gross margin percentage in our Canadian operations increased, due to warehouse ancillary and other businesses, primarily our gasoline business. The segment gross margin percentage in our Other International operations decreased, predominantly in food and sundries and softlines, partially offset by an increase in our gasoline business. 2017 vs. 2016 The gross margin of our core merchandise categories, when expressed as a percentage of core merchandise sales, increased eight basis points due to increases in these categories other than fresh foods. Total gross margin percentage decreased two basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.40%, an increase of five basis points. This increase was primarily due to amounts earned under the co-branded credit card arrangement in the U.S. of 15 basis points and a benefit of three basis points from non-recurring legal settlements and other matters. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. These increases were partially offset by a six basis point decrease in our core merchandise categories, primarily due to food and sundries as a result of a decrease in sales penetration. The gross margin percentage was also negatively impacted by five basis points due to a LIFO benefit in 2016 and one basis point in warehouse ancillary and other businesses. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact on gross margin in 2017. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales, increased in our U.S. operations, due to amounts earned under the co-branded credit card arrangement and non-recurring legal settlements and other matters as discussed above. These increases were partially offset by a decrease in core merchandise categories, predominantly food and sundries as a result of a decrease in sales penetration, and a LIFO benefit in 2016. The segment gross margin percentage in our Canadian operations increased, primarily due to increases in warehouse ancillary and other businesses, primarily our pharmacy business, partially offset by a decrease in our core merchandise categories, largely fresh foods. The segment gross margin percentage increased in our Other International operations due to increases across all core merchandise categories, except fresh foods. Selling, General and Administrative Expenses SGA expenses $ 13,876 $ 12,950 $ 12,068 SGA expenses as a percentage of net sales 10.02 % 10.26 % 10.40 % 2018 vs. 2017 SGA expenses as a percentage of net sales decreased 24 basis points compared to 2017. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.19%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were lower by six basis points, predominantly in our U.S. and Other International operations, due to leveraging increased sales. Charges related to certain non-recurring legal and other matters in 2017 positively impacted SGA expense by two basis points. Stock compensation expense was also lower by one basis point. Central operating costs were higher by two basis points. Changes in foreign currencies relative to the U.S. dollar increased our SGA expenses by approximately $98 in 2018. Effective in June 2018, a portion of the savings generated from the Tax Cuts and Jobs Act (the 2017 Tax Act) were used to increase wages for the majority of our U.S. hourly employees. The impact in fiscal 2018 was two basis points and the estimated annualized pre-tax cost of these increases is approximately $120. 2017 vs. 2016 SGA expenses as a percentage of net sales decreased 14 basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.33%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, were lower by nine basis points, primarily due to lower costs associated with the co-branded credit card arrangement in the U.S. of 18 basis points. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. This was partially offset by higher payroll and employee benefit expenses of 11 basis points, primarily in our U.S. operations. Central operating costs were higher by one basis point, primarily due to increased costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations. Stock compensation expense was also higher by one basis point. Preopening Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses. Preopening expenses vary due to the number of warehouse openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new, or international market. In 2017, we entered into two new international markets, Iceland and France. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. In March and June 2017, we repaid $2,200 in total outstanding principal of the 5.5% and 1.125% Senior Notes, respectively. Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ 2018 vs. 2017 The increase in interest income in 2018 as compared to 2017 was primarily due to higher interest rates earned on higher average cash and investment balances. Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. In 2018, the increase was primarily due to a strengthening U.S. dollar relative to certain foreign currencies on forward foreign-exchange contracts. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. 2017 vs. 2016 Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. Provision for Income Taxes Provision for income taxes $ 1,263 $ 1,325 $ 1,243 Effective tax rate 28.4 % 32.8 % 34.3 % Our effective tax rate for 2018 was favorably impacted by the 2017 Tax Act, which included a reduction in the U.S. federal corporate rate from 35% to 21%. Due to the timing of our fiscal year relative to the effective date of the rate change, our U.S. corporate rate for 2018 resulted in a blended rate of 25.6%. Other impacts from the 2017 Tax Act consisted of tax expense of $142 for the estimated tax on deemed repatriation of unremitted earnings and $43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $166 for the provisional remeasurement of certain deferred tax liabilities. In 2018, we also recognized net tax benefits of $76, which was largely driven by the adoption of an accounting standard related to stock-based compensation and other immaterial net benefits. In 2017, our provision was favorably impacted by net tax benefits of $104, primarily due to a tax benefit recorded in connection with the May 2017 special dividend paid to employees through our 401(k) retirement plan of $82. This dividend was deductible for U.S. income tax purposes. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 5,774 $ 6,726 $ 3,292 Net cash used in investing activities (2,947 ) (2,366 ) (2,345 ) Net cash used in financing activities (1,281 ) (3,218 ) (2,419 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents, and short-term investments. Cash and cash equivalents and short-term investments were $7,259 and $5,779 at the end of 2018 and 2017 , respectively. Of these balances, approximately $ 1,348 and $ 1,255 represented unsettled credit and debit card receivables, respectively. These receivables generally settle within four days. Cash and cash equivalents were negatively impacted by a change in exchange rates of $ 37 in 2018 and positively impacted by $ 25 and $ 50 in 2017 and 2016 , respectively. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. While we believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements, beginning in the second quarter of fiscal 2018, we no longer consider current fiscal year and future earnings of our non-U.S. consolidated subsidiaries to be permanently reinvested. We recorded the estimated incremental foreign withholding (net of available foreign tax credits) and state income taxes payable on current fiscal year earnings assuming a hypothetical repatriation to the U.S. We continue to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to fiscal 2018 to be indefinitely reinvested and have not provided for withholding or state taxes. In fiscal 2018, we recorded a one-time charge of $142 for the estimated tax on deemed repatriation of unremitted earnings under the 2017 Tax Act. The 2017 Tax Act provides for the payment of the federal tax over an eight-year period. Because of the availability of foreign tax credits, the amount payable is $97, of which $89 is classified as long-term and included in other liabilities on our consolidated balance sheet. Cash Flows from Operating Activities Net cash provided by operating activities totaled $ 5,774 in 2018 , compared to $ 6,726 in 2017 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise vendors, warehouse operating costs including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. The decrease in net cash provided by operating activities for 2018 when compared to 2017 was primarily due to accelerated vendor payments of approximately $1,700 made in the last week of fiscal 2016, which positively impacted cash flows in 2017. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,947 in 2018 , compared to $2,366 in 2017 , and primarily related to capital expenditures. Net cash flows from investing activities also includes maturities and purchases of short-term investments. Capital Expenditures We opened 21 net new warehous es and relocated 4 warehouses in 2018 and plan to open approximately 20 net new warehouses and relocate up to 4 warehouses in 2019 . Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. Capital is also required for information systems, manufacturing and distribution facilities, initial warehouse operations and working capital. In 2018 , we spent $2,969 on capital expenditures, and it is our current intention to spend approximately $2,800 to $3,100 during fiscal 2019 . These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $1,281 in 2018 , compared to $3,218 in 2017 . The primary uses of cash in 2018 were related to dividend payments and repurchases of common stock. Net cash used in financing activities in 2017 primarily related to dividend payments, predominantly the special dividend paid in May 2017, and the repayments of debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. The proceeds received were net of a discount and used to pay the special dividend and a portion of the redemption of the 1.125% Senior Notes. Stock Repurchase Programs During 2018 and 2017 , we repurchased 1,756,000 and 2,998,000 shares of common stock, at average prices of $183.13 and $157.87 , totaling approximately $322 and $473 , respectively. The remaining amount available to be purchased under our approved plan was $2,427 at the end of 2018 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends declared in 2018 totaled $ 2.14 per share, as compared to $ 8.90 per share in 2017 , which included a special cash dividend of $7.00 per share. In April 2018 , our Board of Directors increased our quarterly cash dividend from $0.50 to $0.57 per share. Subsequent to the end of 2018, our Board of Directors declared a quarterly cash dividend in the amount of $0.57 per share, which is payable on November 23, 2018. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 2, 2018 , we had borrowing capacity under these facilities of $857, including a $400 revolving line of credit renewed by the U.S., which expires in June 2019. The Company currently has no plans to draw upon this facility. Our international operations maintain $344 of the total borrowing capacity under bank credit facilities, of which $163 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2018 and 2017. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $220. The outstanding standby letters of credit under these facilities at the end of 2018 totaled $149 and expire within one year. The bank credit facilities and commercial paper programs have various expiration dates, all within one year, and we generally intend to renew these facilities. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit then outstanding. Contractual Obligations At September 2, 2018 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2020 to 2021 2022 to 2023 2024 and thereafter Total Purchase obligations (merchandise) (1) $ 9,029 $ $ $ $ 9,031 Long-term debt (2) 3,029 1,537 2,496 7,294 Operating leases (3) 2,215 3,207 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 10,862 $ 3,745 $ 2,070 $ 5,502 $ 22,179 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Excludes common area maintenance, taxes, and insurance and have been reduced by $105 related to sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) Excludes certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations, deferred compensation obligations and current liabilities for unrecognized tax contingencies. The total amount excludes $36 of non-current unrecognized tax contingencies and $30 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had, or are reasonably likely to have, a material current or future effect on our financial condition or financial statements other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Insurance/Self-Insurance Liabilities The Company is predominantly self-insured for employee health-care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. We use different mechanisms, including a wholly-owned captive insurance subsidiary and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated by using historical claims experience, demographic factors, severity factors and other actuarial assumptions. The costs of claims are highly unpredictable and can fluctuate as a result of inflation rates, regulatory or legal changes, and unforeseen developments in claims of an extended nature. While we believe our estimates are reasonable and provide for a certain degree of coverage to account for these variables, actual claims and costs could differ significantly from recorded liabilities. Historically, adjustments to our estimates have not been material. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. In December 2017, the 2017 Tax Act was signed into law and our effective tax rate for fiscal 2018 reflects the provisional impact (see Note 8 to our Consolidated Financial Statements). Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents, as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest-rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2018 would have had an immaterial incremental change in fair market value. For those investments that are classified as available-for-sale, the unrealized gains or losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income in the consolidated balance sheets. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2018 , long-term debt with fixed interest rates was $6,577 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. For additional information related to the Company's forward foreign-exchange contracts, see Notes 1 and 3 to the consolidated financial statements included in Item 8 of this Report. A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 2, 2018 , would have decreased the fair value of the contracts by $80 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Costco Wholesale Corporation and subsidiaries (the Company) as of September 2, 2018 and September 3, 2017 , the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 2, 2018 and September 3, 2017 , and the results of its operations and its cash flows for the 52-week period ended September 2, 2018 , the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated October 25, 2018 expressed an adverse opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ KPMG LLP We have served as the Companys auditor since 2002. Seattle, Washington October 25, 2018 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Costco Wholesale Corporation: Opinion on Internal Control Over Financial Reporting We have audited Costco Wholesale Corporation and subsidiaries (the Company) internal control over financial reporting as of September 2, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, because of the effect of the material weakness, described below, on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of September 2, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of September 2, 2018 and September 3, 2017, and the related consolidated statements of income, comprehensive income, equity, and cash flows for the 52-week period ended September 2, 2018, the 53-week period ended September 3, 2017 and the 52-week period ended August 28, 2016, and the related notes (collectively, the consolidated financial statements), and our report dated October 25, 2018 expressed an unqualified opinion on those consolidated financial statements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the companys annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in managements assessment: There were ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. As a result, business process automated and manual controls that were dependent on the affected ITGCs were ineffective because they could have been adversely impacted. These control deficiencies were a result of: IT control processes lacked sufficient documentation; insufficient knowledge and training of certain individuals with IT expertise; and risk-assessment processes inadequate to identify and assess changes in IT environments and personnel that could impact internal control over financial reporting. The material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the fiscal year 2018 consolidated financial statements, and this report does not affect our report on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting (Item 9A). Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Seattle, Washington October 25, 2018 COSTCO WHOLESALE CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in millions, except par value and share data) September 2, 2018 September 3, 2017 ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,055 $ 4,546 Short-term investments 1,204 1,233 Receivables, net 1,669 1,432 Merchandise inventories 11,040 9,834 Other current assets Total current assets 20,289 17,317 PROPERTY AND EQUIPMENT Land 6,193 5,690 Buildings and improvements 16,107 15,127 Equipment and fixtures 7,274 6,681 Construction in progress 1,140 30,714 28,341 Less accumulated depreciation and amortization (11,033 ) (10,180 ) Net property and equipment 19,681 18,161 OTHER ASSETS TOTAL ASSETS $ 40,830 $ 36,347 LIABILITIES AND EQUITY CURRENT LIABILITIES Accounts payable $ 11,237 $ 9,608 Accrued salaries and benefits 2,994 2,703 Accrued member rewards 1,057 Deferred membership fees 1,624 1,498 Other current liabilities 3,014 2,725 Total current liabilities 19,926 17,495 LONG-TERM DEBT, excluding current portion 6,487 6,573 OTHER LIABILITIES 1,314 1,200 Total liabilities 27,727 25,268 COMMITMENTS AND CONTINGENCIES EQUITY Preferred stock $0.01 par value; 100,000,000 shares authorized; no shares issued and outstanding Common stock $0.01 par value; 900,000,000 shares authorized; 438,189,000 and 437,204,000 shares issued and outstanding Additional paid-in capital 6,107 5,800 Accumulated other comprehensive loss (1,199 ) (1,014 ) Retained earnings 7,887 5,988 Total Costco stockholders equity 12,799 10,778 Noncontrolling interests Total equity 13,103 11,079 TOTAL LIABILITIES AND EQUITY $ 40,830 $ 36,347 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (amounts in millions, except per share data) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 REVENUE Net sales $ 138,434 $ 126,172 $ 116,073 Membership fees 3,142 2,853 2,646 Total revenue 141,576 129,025 118,719 OPERATING EXPENSES Merchandise costs 123,152 111,882 102,901 Selling, general and administrative 13,876 12,950 12,068 Preopening expenses Operating income 4,480 4,111 3,672 OTHER INCOME (EXPENSE) Interest expense (159 ) (134 ) (133 ) Interest income and other, net INCOME BEFORE INCOME TAXES 4,442 4,039 3,619 Provision for income taxes 1,263 1,325 1,243 Net income including noncontrolling interests 3,179 2,714 2,376 Net income attributable to noncontrolling interests (45 ) (35 ) (26 ) NET INCOME ATTRIBUTABLE TO COSTCO $ 3,134 $ 2,679 $ 2,350 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 7.15 $ 6.11 $ 5.36 Diluted $ 7.09 $ 6.08 $ 5.33 Shares used in calculation (000s) Basic 438,515 438,437 438,585 Diluted 441,834 440,937 441,263 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 2.14 $ 8.90 $ 1.70 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (amounts in millions) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 NET INCOME INCLUDING NONCONTROLLING INTERESTS $ 3,179 $ 2,714 $ 2,376 Foreign-currency translation adjustment and other, net (192 ) Comprehensive income 2,987 2,812 2,402 Less: Comprehensive income attributable to noncontrolling interests COMPREHENSIVE INCOME ATTRIBUTABLE TO COSTCO $ 2,949 $ 2,764 $ 2,372 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY (amounts in millions) Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Costco Stockholders Equity Noncontrolling Interests Total Equity Shares (000s) Amount BALANCE AT AUGUST 30, 2015 437,952 $ $ 5,218 $ (1,121 ) $ 6,518 $ 10,617 $ $ 10,843 Net income 2,350 2,350 2,376 Foreign-currency translation adjustment and other, net Stock-based compensation Stock options exercised, including tax effects Release of vested restricted stock units (RSUs), including tax effects 2,749 (146 ) (146 ) (146 ) Conversion of convertible notes Repurchases of common stock (3,184 ) (41 ) (436 ) (477 ) (477 ) Cash dividends declared and other (746 ) (746 ) (3 ) (749 ) BALANCE AT AUGUST 28, 2016 437,524 5,490 (1,099 ) 7,686 12,079 12,332 Net income 2,679 2,679 2,714 Foreign-currency translation adjustment and other, net Stock-based compensation Release of vested RSUs, including tax effects 2,673 (165 ) (165 ) (165 ) Conversion of convertible notes Repurchases of common stock (2,998 ) (41 ) (432 ) (473 ) (473 ) Cash dividends declared and other (2 ) (3,945 ) (3,945 ) (3,945 ) BALANCE AT SEPTEMBER 3, 2017 437,204 5,800 (1,014 ) 5,988 10,778 11,079 Net income 3,134 3,134 3,179 Foreign-currency translation adjustment and other, net (185 ) (185 ) (7 ) (192 ) Stock-based compensation Release of vested RSUs, including tax effects 2,741 (217 ) (217 ) (217 ) Repurchases of common stock (1,756 ) (26 ) (296 ) (322 ) (322 ) Cash dividends declared and other (939 ) (936 ) (35 ) (971 ) BALANCE AT SEPTEMBER 2, 2018 438,189 $ $ 6,107 $ (1,199 ) $ 7,887 $ 12,799 $ $ 13,103 The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (amounts in millions) 52 Weeks Ended 53 Weeks Ended 52 Weeks Ended September 2, 2018 September 3, 2017 August 28, 2016 CASH FLOWS FROM OPERATING ACTIVITIES Net income including noncontrolling interests $ 3,179 $ 2,714 $ 2,376 Adjustments to reconcile net income including noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 1,437 1,370 1,255 Stock-based compensation Other non-cash operating activities, net (6 ) (14 ) (57 ) Deferred income taxes (49 ) (29 ) Changes in operating assets and liabilities: Merchandise inventories (1,313 ) (894 ) (25 ) Accounts payable 1,561 2,258 (1,532 ) Other operating assets and liabilities, net Net cash provided by operating activities 5,774 6,726 3,292 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of short-term investments (1,060 ) (1,279 ) (1,432 ) Maturities and sales of short-term investments 1,078 1,385 1,709 Additions to property and equipment (2,969 ) (2,502 ) (2,649 ) Other investing activities, net Net cash used in investing activities (2,947 ) (2,366 ) (2,345 ) CASH FLOWS FROM FINANCING ACTIVITIES Change in bank checks outstanding (236 ) Repayments of short-term borrowings (106 ) Proceeds from short-term borrowings Proceeds from issuance of long-term debt 3,782 Repayments of long-term debt (86 ) (2,200 ) (1,288 ) Tax withholdings on stock-based awards (217 ) (202 ) (220 ) Repurchases of common stock (328 ) (469 ) (486 ) Cash dividend payments (689 ) (3,904 ) (746 ) Other financing activities, net (41 ) Net cash used in financing activities (1,281 ) (3,218 ) (2,419 ) EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (37 ) Net change in cash and cash equivalents 1,509 1,167 (1,422 ) CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 4,546 3,379 4,801 CASH AND CASH EQUIVALENTS END OF YEAR $ 6,055 $ 4,546 $ 3,379 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest (reduced by $19, $16, and $19, interest capitalized in 2018, 2017, and 2016, respectively) $ $ $ Income taxes, net $ 1,204 $ 1,185 $ SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Property and equipment acquired, but not yet paid $ $ $ Cash dividend declared, but not yet paid $ $ $ The accompanying notes are an integral part of these consolidated financial statements. COSTCO WHOLESALE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in millions, except share, per share, and warehouse count data) Note 1Summary of Significant Accounting Policies Description of Business Costco Wholesale Corporation (Costco or the Company), a Washington corporation, and its subsidiaries operate membership warehouses based on the concept that offering members low prices on a limited selection of nationally-branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. At September 2, 2018 , Costco operated 762 warehouses worldwide: 527 United States (U.S.) locations (in 44 U.S. states, Washington, D.C., and Puerto Rico), 100 Canada locations, 39 Mexico locations, 28 United Kingdom (U.K.) locations, 26 Japan locations, 15 Korea locations, 13 Taiwan locations, 10 Australia locations, two Spain locations, one Iceland location, and one France location. The Company operates e-commerce websites in the U.S., Canada, Mexico, U.K., Korea, and Taiwan. Basis of Presentation The consolidated financial statements include the accounts of Costco Wholesale Corporation, its wholly-owned subsidiaries, and subsidiaries in which it has a controlling interest. The Company reports noncontrolling interests in consolidated entities as a component of equity separate from the Companys equity. All material inter-company transactions between and among the Company and its consolidated subsidiaries have been eliminated in consolidation. The Companys net income excludes income attributable to the noncontrolling interest in Taiwan. During the first quarter of 2018 , Costco purchased its former joint-venture partner's remaining equity interest in its Korean operations. Unless otherwise noted, references to net income relate to net income attributable to Costco. Fiscal Year End The Company operates on a 52/53 week fiscal year basis with the fiscal year ending on the Sunday closest to August 31. References to 2018 and 2016 relate to the 52-week fiscal years ended September 2, 2018 , and August 28, 2016 , respectively. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. Cash and Cash Equivalents The Company considers as cash and cash equivalents all cash on deposit, highly liquid investments with a maturity of three months or less at the date of purchase, and proceeds due from credit and debit card transactions with settlement terms of up to four days. Credit and debit card receivables were $ 1,348 and $ 1,255 at the end of 2018 and 2017 , respectively. The Company provides for the daily replenishment of major bank accounts as checks are presented. Included in accounts payable at the end of 2018 and 2017 are $ 463 and $ 383 , respectively, representing the excess of outstanding checks over cash on deposit at the banks on which the checks were drawn. Short-Term Investments In general, short-term investments have a maturity at the date of purchase of three months to five years. Investments with maturities beyond five years may be classified, based on the Companys determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest income and other, net in the consolidated statements of income. Short-term investments classified as held-to-maturity are financial instruments that the Company has the intent and ability to hold to maturity and are reported net of any related amortization and are not remeasured to fair value on a recurring basis. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the loss in interest income and other, net in the consolidated statements of income. Fair Value of Financial Instruments The Company accounts for certain assets and liabilities at fair value. The carrying value of the Companys financial instruments, including cash and cash equivalents, receivables and accounts payable, approximate fair value due to their short-term nature or variable interest rates. See Notes 2, 3, and 4 for the carrying value and fair value of the Companys investments, derivative instruments, and fixed-rate debt, respectively. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying a fair value hierarchy, which requires maximizing the use of observable inputs when measuring fair value. The three levels of inputs are: Level 1: Quoted market prices in active markets for identical assets or liabilities. Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data. Level 3: Significant unobservable inputs that are not corroborated by market data. The Companys valuation techniques used to measure the fair value of money market mutual funds are based on quoted market prices, such as quoted net asset values published by the fund as supported in an active market. Valuation methodologies used to measure the fair value of all other non-derivative financial instruments are based on independent external valuation information. The pricing process uses data from a variety of independent external valuation information providers, including trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to treasury benchmarks and Libor and swap curves, discount rates, and market data feeds. All are observable in the market or can be derived principally from or corroborated by observable market data. The Company reports transfers in and out of Levels 1, 2, and 3, as applicable, using the fair value of the individual securities as of the beginning of the reporting period in which the transfer(s) occurred. Current financial liabilities have fair values that approximate their carrying values. Long-term financial liabilities include the Company's long-term debt, which are recorded on the balance sheet at issuance price and adjusted for unamortized discounts or premiums and debt issuance costs, and are being amortized to interest expense over the term of the loan. The estimated fair value of the Company's long-term debt is based primarily on reported market values, recently completed market transactions, and estimates based upon interest rates, maturities, and credit. Receivables, Net Receivables consist primarily of vendor, reinsurance, credit card incentive, third-party pharmacy and other receivables. Vendor receivables include coupons, volume rebates or other purchase discounts. Balances are generally presented on a gross basis, separate from any related payable due. In certain circumstances, these receivables may be settled against the related payable to that vendor, in which case the receivables are presented on a net basis. Reinsurance receivables are held by the Companys wholly-owned captive insurance subsidiary and primarily represent amounts ceded through reinsurance arrangements gross of the amounts assumed under reinsurance, which are presented within other current liabilities in the consolidated balance sheets. Credit card incentive receivables primarily represent amounts earned under the co-branded credit card arrangement in the U.S. Third-party pharmacy receivables generally relate to amounts due from members insurers. Other receivables primarily consist of amounts due from governmental entities, mostly tax-related items. Receivables are recorded net of an allowance for doubtful accounts. The allowance is based on historical experience and application of the specific identification method. Write-offs of receivables were immaterial for fiscal years 2018 , 2017 , and 2016 . Merchandise Inventories Merchandise inventories consist of the following: United States $ 8,081 $ 7,091 Canada 1,189 1,040 Other International 1,770 1,703 Merchandise inventories $ 11,040 $ 9,834 Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation or deflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis. As of September 2, 2018 and September 3, 2017 , U.S. merchandise inventories valued at LIFO approximated FIFO after considering the lower of cost or market principle. Due to net deflation, a benefit of $64 was recorded to merchandise costs in 2016 . The Company provides for estimated inventory losses between physical inventory counts as a percentage of net sales, using estimates based on the Companys experience. The provision is adjusted periodically to reflect physical inventory counts, which generally occur in the second and fourth fiscal quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as the Company progresses towards earning those rebates, provided that they are probable and reasonably estimable. Property and Equipment Property and equipment are stated at cost. In general, new building additions are classified into components, each with an estimated useful life, generally five to fifty years for buildings and improvements and three to twenty years for equipment and fixtures. Depreciation and amortization expense is computed using the straight-line method over estimated useful lives or the lease term, if shorter. Leasehold improvements made after the beginning of the initial lease term are depreciated over the shorter of the estimated useful life of the asset or the remaining term of the initial lease plus any renewals that are reasonably assured at the date the leasehold improvements are made. The Company capitalizes certain computer software and software development costs incurred in developing or obtaining computer software for internal use. These costs are included in equipment and fixtures and amortized on a straight-line basis over the estimated useful lives of the software, generally three to seven years. Repair and maintenance costs are expensed when incurred. Expenditures for remodels, refurbishments and improvements that add to or change the way an asset functions or that extend the useful life are capitalized. Assets that were removed during the remodel, refurbishment or improvement are retired. Assets classified as held-for-sale at the end of 2018 and 2017 were immaterial. The Company evaluates long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances may indicate the carrying amount of the asset group, generally an individual warehouse, may not be fully recoverable. For asset groups held and used, including warehouses to be relocated, the carrying value of the asset group is considered recoverable when the estimated future undiscounted cash flows generated from the use and eventual disposition of the asset group exceed the respective carrying value. In the event that the carrying value is not considered recoverable, an impairment loss is recognized for the asset group to be held and used equal to the excess of the carrying value above the estimated fair value of the asset group. For asset groups classified as held-for-sale (disposal group), the carrying value is compared to the disposal groups fair value less costs to sell. The Company estimates fair value by obtaining market appraisals from third party brokers or using other valuation techniques. There were no impairment charges recognized in 2018 , 2017 or 2016 . Insurance/Self-Insurance Liabilities The Company is predominantly self-insured for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. Insurance coverage is maintained in certain instances to limit the exposure arising from catastrophic events. It uses different mechanisms including a wholly-owned captive insurance subsidiary (the captive) and participates in a reinsurance program. Liabilities associated with the risks that are retained by the Company are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. At the end of 2018 and 2017 , these insurance liabilities were $ 1,148 and $ 1,059 in the aggregate, respectively, and were included in accrued salaries and benefits and other current liabilities in the consolidated balance sheets, classified based on their nature. The captive receives direct premiums, which are netted against the Companys premium costs in selling, general and administrative expenses, in the consolidated statements of income. The captive participates in a reinsurance program that includes other third-party participants. The reinsurance agreement is one year in duration, and new agreements are entered into by each participant at their discretion at the commencement of the next calendar year. The participant agreements and practices of the reinsurance program limit a participating members individual risk. Income statement adjustments related to the reinsurance program and related impacts to the consolidated balance sheets are recognized as information becomes known. In the event the Company leaves the reinsurance program, the Company retains its primary obligation to the policyholders for prior activity. Derivatives The Company is exposed to foreign-currency exchange-rate fluctuations in the normal course of business. It manages these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of fluctuations of foreign exchange on known future expenditures denominated in a non-functional foreign-currency. The contracts relate primarily to U.S. dollar merchandise inventory expenditures made by the Companys international subsidiaries with functional currencies other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. The Company seeks to mitigate risk with the use of these contracts and does not intend to engage in speculative transactions. Some of these contracts contain credit-risk-related contingent features that require settlement of outstanding contracts upon certain triggering events. At the end of 2018 and 2017 , the aggregate fair value amounts of derivative instruments in a net liability position and the amount needed to settle the instruments immediately if the credit-risk-related contingent features were triggered were immaterial. The aggregate notional amounts of open, unsettled forward foreign-exchange contracts were $ 717 and $ 637 at the end of 2018 and 2017 , respectively. See Note 3 for information on the fair value of unsettled forward foreign-exchange contracts at the end of 2018 and 2017 . The unrealized gains or losses recognized in interest income and other, net in the accompanying consolidated statements of income relating to the net changes in the fair value of unsettled forward foreign-exchange contracts were immaterial in 2018 , 2017 , and 2016 . The Company is exposed to fluctuations in prices for energy, particularly electricity and natural gas, which it seeks to partially mitigate through the use of fixed-price contracts for certain of its warehouses and other facilities, primarily in the U.S. and Canada. The Company also enters into variable-priced contracts for some purchases of natural gas, in addition to fuel for its gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. Foreign Currency The functional currencies of the Companys international subsidiaries are the local currency of the country in which the subsidiary is located. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Translation adjustments are recorded in accumulated other comprehensive loss. Revenues and expenses of the Companys consolidated foreign operations are translated at average exchange rates prevailing during the year. The Company recognizes foreign-currency transaction gains and losses related to revaluing or settling monetary assets and liabilities denominated in currencies other than the functional currency in interest income and other, net in the accompanying consolidated statements of income. Generally, these include the U.S. dollar cash and cash equivalents and the U.S. dollar payables of consolidated subsidiaries revalued to their functional currency. Also included are realized foreign-currency gains or losses from settlements of forward foreign-exchange contracts. These items were immaterial for 2018 and 2017 and resulted in net gains of $38 for 2016 . Revenue Recognition The Company generally recognizes sales, which include gross shipping fees where applicable, net of returns, at the time the member takes possession of merchandise or receives services. When the Company collects payments from members prior to the transfer of ownership of merchandise or the performance of services, the amounts received are generally recorded as deferred sales, included in other current liabilities in the consolidated balance sheets, until the sale or service is completed. The Company reserves for estimated sales returns based on historical trends in merchandise returns and reduces sales and merchandise costs accordingly. The sales returns reserve is based on an estimate of the net realizable value of merchandise inventories expected to be returned. Amounts collected from members for sales or value added taxes are recorded on a net basis. Generally, when Costco is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, can influence product or service specifications, or has several but not all of these indicators, revenue is recorded on a gross basis. It otherwise records the net amounts earned, which is reflected in net sales. The Company accounts for membership fee revenue, net of refunds, on a deferred basis, ratably over the one-year membership. The Company's Executive members qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $ 1,000 per year), which can be redeemed only at Costco warehouses. The Company accounts for this reward as a reduction in sales. The sales reduction and corresponding liability (classified as accrued member rewards in the consolidated balance sheets) are computed after giving effect to the estimated impact of non-redemptions, based on historical data. The net reduction in sales was $ 1,394 , $ 1,281 , and $ 1,172 in 2018 , 2017 , and 2016 , respectively. Merchandise Costs Merchandise costs consist of the purchase price or manufacturing costs of inventory sold, inbound and outbound shipping charges and all costs related to the Companys depot operations, including freight from depots to selling warehouses, and are reduced by vendor consideration. Merchandise costs also include salaries, benefits, depreciation, and utilities in fresh foods and certain ancillary departments. Vendor Consideration The Company has agreements to receive funds from vendors for coupons and a variety of other programs. These programs are evidenced by signed agreements that are reflected in the carrying value of the inventory when earned or as the Company progresses towards earning the rebate or discount, and as a component of merchandise costs as the merchandise is sold. Other vendor consideration is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of the related agreement, or by another systematic approach. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries, benefits and workers compensation costs for warehouse employees (other than fresh foods departments and certain ancillary businesses) as well as all regional and home office employees, including buying personnel. Selling, general and administrative expenses also include substantially all building and equipment depreciation, stock compensation expense, utilities, credit and debit card processing fees, as well as other operating costs incurred to support warehouse operations. Retirement Plans The Company's 401(k) retirement plan is available to all U.S. employees who have completed 90 days of employment. The plan allows participants to make wage deferral contributions, a portion of which the Company matches. In addition, the Company provides each eligible participant an annual discretionary contribution. The Company also has a defined contribution plan for Canadian employees and contributes a percentage of each employee's wages. Certain subsidiaries in the Company's Other International operations have defined benefit and defined contribution plans that are not material. Amounts expensed under all plans were $578 , $543 , and $489 for 2018 , 2017 , and 2016 , respectively, and are predominantly included in selling, general and administrative expenses in the accompanying consolidated statements of income. Stock-Based Compensation Restricted stock units (RSUs) granted to employees generally vest over five years and allow for quarterly vesting of the pro-rata number of stock-based awards that would vest on the next anniversary of the grant date in the event of retirement or voluntary termination. Actual forfeitures are recognized as they occur. Compensation expense for stock-based awards is predominantly recognized using the straight-line method over the requisite service period for the entire award. Awards for employees and non-employee directors provide for accelerated vesting of a portion of outstanding shares based on cumulative years of service with the Company. Compensation expense for the accelerated shares is recognized upon achievement of the long-service term. The cumulative amount of compensation cost recognized at any point in time equals at least the portion of the grant-date fair value of the award that is vested at that date. The fair value of RSUs is calculated as the market value of the common stock on the measurement date less the present value of the expected dividends forgone during the vesting period. Stock-based compensation expense is predominantly included in selling, general and administrative expenses in the consolidated statements of income. Certain stock-based compensation costs are capitalized or included in the cost of merchandise. See Note 7 for additional information on the Companys stock-based compensation plans. Leases The Company leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2064 , with the exception of one lease in the U.K., which expires in 2151 . These leases generally contain one or more of the following options, which the Company can exercise at the end of the initial lease term: (a) renewal of the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer. The Company accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that the Company more likely than not expects to exercise, from the date the Company has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume. The Company has capital leases for certain warehouse locations, expiring at various dates through 2059 . Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income. The Company records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent the Company is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, the Company assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If the Company continues to be the deemed owner, it accounts for the arrangement as a financing lease. The Companys asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are recorded as a liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the leasehold improvements. These liabilities are accreted over time to the projected future value of the obligation using the Companys incremental borrowing rate. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2018 and 2017 , respectively, and are included in other liabilities in the accompanying consolidated balance sheets. Preopening Expenses Preopening expenses include costs for startup operations related to new warehouses and relocations, developments in new international markets, new manufacturing and distribution facilities, and expansions at existing warehouses and are expensed as incurred. Income Taxes The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts that are more likely than not expected to be realized. The timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions requires significant judgment. The benefits of uncertain tax positions are recorded in the Companys consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax positions will withstand challenge from tax authorities. When facts and circumstances change, the Company reassesses these probabilities and records any changes as appropriate. Net Income per Common Share Attributable to Costco The computation of basic net income per share uses the weighted average number of shares that were outstanding during the period. The computation of diluted net income per share uses the weighted average number of shares in the basic net income per share calculation plus the number of common shares that would be issued assuming vesting of all potentially dilutive common shares outstanding using the treasury stock method for shares subject to RSUs. Stock Repurchase Programs Repurchased shares of common stock are retired, in accordance with the Washington Business Corporation Act. The par value of repurchased shares is deducted from common stock and the excess repurchase price over par value is deducted by allocation to additional paid-in capital and retained earnings. The amount allocated to additional paid-in capital is the current value of additional paid-in capital per share outstanding and is applied to the number of shares repurchased. Any remaining amount is allocated to retained earnings. See Note 6 for additional information. Recent Accounting Pronouncements Adopted In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09 related to the accounting for share-based payment transactions. The guidance relates to income taxes, forfeitures, and minimum statutory tax withholding requirements. The new standard was effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance at the beginning of its first quarter of fiscal year 2018. As a result, the Company recognized a net tax benefit in fiscal 2018 of $ 33 as part of its income tax provision in the accompanying consolidated statements of income, which includes the impact of the lower tax rate from the 2017 Tax Act. Previously, tax benefits associated with the release of employee RSUs were reflected in equity. These amounts are now reflected as cash flows from operations instead of cash flows from financing activities in the consolidated statements of cash flows on a prospective basis. Adoption of this guidance did not have a material impact on the consolidated balance sheets, consolidated statements of cash flows, or related disclosures. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the FASB issued ASU 2014-09 providing for changes in the recognition of revenue from contracts with customers. The guidance converges the requirements for reporting revenue and requires disclosures sufficient to describe the nature, amount, timing, and uncertainty of revenue and cash flows arising from these contracts. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2017. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2019, using the modified retrospective approach through a cumulative effect adjustment to retained earnings. The Company has substantially completed its assessment of the new standard and it does not believe the impacts to be material to the Company's consolidated financial statements. The Company continues to evaluate the disclosure requirements related to the new standard. In February 2016, the FASB issued ASU 2016-02 which will require recognition on the balance sheet for the rights and obligations created by leases with terms greater than twelve months. The new standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. The Company plans to adopt this guidance at the beginning of its first quarter of fiscal 2020 and plans to utilize the transition option which does not require application of the guidance to comparative periods in the year of adoption. While the Company continues to evaluate this standard and the effect on related disclosures, the primary effect of adoption will be recording right-of-use assets and corresponding lease obligations for current operating leases. The adoption is expected to have a material impact on the Company's consolidated balance sheets, but not on the consolidated statements of income or cash flows. Additionally, the Company is in the process of reviewing current accounting policies, changes to business processes, systems and controls to support adoption of the new standard, which includes implementing a new lease accounting system. Note 2Investments The Companys investments were as follows: 2018: Cost Basis Unrealized Losses, Net Recorded Basis Available-for-sale: Government and agency securities $ $ (14 ) $ Held-to-maturity: Certificates of deposit Total short-term investments $ 1,218 $ (14 ) $ 1,204 2017: Cost Basis Unrealized Gains, Net Recorded Basis Available-for-sale: Government and agency securities $ $ $ Mortgage-backed securities Total available-for-sale Held-to-maturity: Certificates of deposit Total short-term investments $ 1,233 $ $ 1,233 Gross unrealized gains and losses on available-for-sale securities were not material in 2018 , 2017 , and 2016 . At the end of 2018 and 2017 , the Company's available-for-sale securities that were in a continuous unrealized-loss position were not material. The Company had no available-for-sale securities in a continuous unrealized-loss position in 2016. Gross unrealized gains and losses on cash equivalents were not material at the end of 2018 , and there were no gross unrealized gains and losses on cash equivalents at the end of 2017 or 2016 . The proceeds from sales of available-for-sale securities were $39 , $202 , and $291 during 2018 , 2017 , and 2016 , respectively. Gross realized gains or losses from sales of available-for-sale securities were not material in 2018 , 2017 , and 2016 . The maturities of available-for-sale and held-to-maturity securities at the end of 2018 were as follows: Available-For-Sale Held-To-Maturity Cost Basis Fair Value Due in one year or less $ $ $ Due after one year through five years Due after five years Total $ $ $ Note 3Fair Value Measurement Assets and Liabilities Measured at Fair Value on a Recurring Basis The tables below present information regarding the Companys financial assets and financial liabilities that are measured at fair value on a recurring basis and indicate the level within the hierarchy reflecting the valuation techniques utilized to determine such fair value. 2018: Level 1 Level 2 Money market mutual funds (1) $ $ Investment in government and agency securities (2) Forward foreign-exchange contracts, in asset position (3) Forward foreign-exchange contracts, in (liability) position (3) (2 ) Total $ $ 2017: Level 1 Level 2 Money market mutual funds (1) $ $ Investment in government and agency securities (2) Investment in mortgage-backed securities Forward foreign-exchange contracts, in asset position (3) Forward foreign-exchange contracts, in (liability) position (3) (8 ) Total $ $ ______________ (1) Included in cash and cash equivalents in the accompanying consolidated balance sheets. (2) At September 2, 2018, immaterial cash and cash equivalents and $898 short-term investments are included in the accompanying condensed consolidated balance sheets. At September 3, 2017, there were no securities included in cash and cash equivalents and $947 included in short-term investments in the accompanying condensed consolidated balance sheets. (3) The asset and the liability values are included in other current assets and other current liabilities, respectively, in the accompanying consolidated balance sheets. See Note 1 for additional information on derivative instruments. During and at the end of both 2018 and 2017 , the Company did not hold any Level 3 financial assets or liabilities that were measured at fair value on a recurring basis. There were no transfers in or out of Level 1 or 2 during 2018 and 2017 . Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis Assets and liabilities recognized and disclosed at fair value on a nonrecurring basis include items such as financial assets measured at amortized cost and long-lived nonfinancial assets. These assets are measured at fair value if determined to be impaired. There were no fair value adjustments to these items during 2018 and 2017 . Note 4Debt Short-Term Borrowings The Company maintains various short-term bank credit facilities with a borrowing capacity of $857 and $833 , in 2018 and 2017 , respectively. Borrowings on these short-term facilities were immaterial during 2018 and 2017, and there were no outstanding borrowings at the end of 2018 and 2017 . Long-Term Debt The Company's long-term debt consists primarily of Senior Notes, which have various principal balances, interest rates, and maturity dates as described below. In May 2017, the Company issued $3,800 in aggregate principal amount of Senior Notes, with maturity dates between May 2021 and May 2027. Additionally, in 2017 the Company repaid long-term debt totaling $2,200 . The Company at its option may redeem the Senior Notes at any time, in whole or in part, at a redemption price plus accrued interest. The redemption price is equal to the greater of 100% of the principal amount or the sum of the present value of the remaining scheduled payments of principal and interest to maturity. Additionally, upon certain events, as defined by the terms of the Senior Notes, the holder has the right to require the Company to purchase this security at a price of 101% of the principal amount plus accrued and unpaid interest to the date of the event. Interest on all outstanding long-term debt is payable semi-annually. The estimated fair value of Senior Notes is valued using Level 2 inputs. Other long-term debt consists of Guaranteed Senior Notes issued by the Company's Japanese subsidiary and are valued using Level 3 inputs. At the end of 2018 and 2017 , the fair value of the Company's long-term debt, including the current portion, was approximately $6,492 and $6,753 , respectively. The carrying value of long-term debt consisted of the following: 1.70% Senior Notes due December 2019 $ 1,199 $ 1,198 1.75% Senior Notes due February 2020 2.15% Senior Notes due May 2021 2.25% Senior Notes due February 2022 2.30% Senior Notes due May 2022 2.75% Senior Notes due May 2024 3.00% Senior Notes due May 2027 Other long-term debt Total long-term debt 6,577 6,659 Less current portion (1) Long-term debt, excluding current portion $ 6,487 $ 6,573 _______________ (1) Included in other current liabilities in the consolidated balance sheets. Maturities of long-term debt during the next five fiscal years and thereafter are as follows: $ 2020 1,700 1,091 1,300 90 Thereafter 2,343 Total $ 6,614 Note 5Leases Operating Leases The aggregate rental expense for 2018 , 2017 , and 2016 was $ 265 , $ 258 , and $ 250 , respectively. Sub-lease income and contingent rent were not material in 2018 , 2017 , or 2016 . Capital and Build-to-Suit Leases Gross assets recorded under capital and build-to-suit leases were $ 427 and $ 404 at the end of 2018 and 2017 , respectively. These assets are recorded net of accumulated amortization of $ 94 and $ 78 at the end of 2018 and 2017 , respectively. At the end of 2018 , future minimum payments, net of sub-lease income of $ 105 for all years combined, under non-cancelable operating leases with terms of at least one year and capital leases were as follows: Operating Leases Capital Leases (1) $ $ 2020 2021 2022 2023 Thereafter 2,215 Total $ 3,207 Less amount representing interest (427 ) Net present value of minimum lease payments Less current installments (2) (7 ) Long-term capital lease obligations less current installments (3) $ _______________ (1) Includes build-to-suit lease obligations. (2) Included in other current liabilities in the accompanying consolidated balance sheets. (3) Included in other liabilities in the accompanying consolidated balance sheets. Note 6Stockholders Equity Dividends The Companys current quarterly dividend rate is $0.57 per share. In May 2017, the Company paid a special cash dividend of $7.00 per share. The aggregate payment was approximately $3,100 . Subsequent to the end of 2018, the Board of Directors declared a quarterly cash dividend in the amount of $0.57 per share, which is payable on November 23, 2018. Stock Repurchase Programs The Companys stock repurchase program is conducted under a $4,000 authorization by the Board of Directors, which expires April 17, 2019 . As of the end of 2018 , the remaining amount available for stock repurchases under the approved plan was $2,427 . The following table summarizes the Companys stock repurchase activity: Shares Repurchased (000s) Average Price per Share Total Cost 1,756 $ 183.13 $ 2017 2,998 157.87 2016 3,184 149.90 These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Note 7Stock-Based Compensation Plans The Company grants stock-based compensation primarily to employees and non-employee directors. RSU grants to all executive officers are performance-based. Through a series of shareholder approvals, there have been amended and restated plans and new provisions implemented by the Company. RSUs are subject to quarterly vesting upon retirement or voluntary termination. Employees who attain certain years of service with the Company receive shares under accelerated vesting provisions on the annual vesting date rather than upon retirement. The Seventh Restated 2002 Stock Incentive Plan (Seventh Plan) is the Companys only stock-based compensation plan with shares available for grant at the end of 2018 . Each share issued in respect of stock awards is counted as 1.75 shares toward the limit of shares made available under the Seventh Plan. The Seventh Plan authorized the issuance of 23,500,000 shares ( 13,429,000 RSUs) of common stock for future grants in addition to the shares authorized under the previous plan. The Company issues new shares of common stock upon vesting of RSUs. Shares for vested RSUs are generally delivered to participants annually, net of statutory withholding taxes. Summary of Restricted Stock Unit Activity RSUs granted to employees and to non-employee directors generally vest over five and three years, respectively. Additionally, the terms of the RSUs, including performance-based awards, provide for accelerated vesting for employees and non-employee directors who have attained 25 or more and five or more years of service with the Company, respectively. Recipients are not entitled to vote or receive dividends on non-vested and undelivered shares. At the end of 2018 , 8,313,000 shares were available to be granted as RSUs under the Seventh Plan. The following awards were outstanding at the end of 2018: 7,246,000 time-based RSUs that vest upon continued employment over specified periods of time; 332,000 performance-based RSUs, of which 205,000 were granted to executive officers subject to the certification of the attainment of specified performance targets for 2018 . This certification occurred in October 2018 , at which time a portion vested as a result of the long service of all executive officers. The remaining awards vest upon continued employment over specified periods of time. The following table summarizes RSU transactions during 2018 : Number of Units (in 000s) Weighted-Average Grant Date Fair Value Outstanding at the end of 2017 8,199 $ 128.15 Granted 3,722 156.19 Vested and delivered (4,088 ) 129.49 Forfeited (255 ) 138.57 Outstanding at the end of 2018 7,578 $ 140.85 The weighted-average grant date fair value of RSUs granted was $156.19 , $144.12 , and $153.46 in 2018 , 2017 , and 2016 , respectively. The remaining unrecognized compensation cost related to non-vested RSUs at the end of 2018 was $ 693 and the weighted-average period of time over which this cost will be recognized is 1.6 years. Included in the outstanding balance at the end of 2018 were approximately 2,658,000 RSUs vested but not yet delivered. Summary of Stock-Based Compensation The following table summarizes stock-based compensation expense and the related tax benefits under the Companys plans: Stock-based compensation expense before income taxes $ $ $ Less income tax benefit (1) (116 ) (167 ) (150 ) Stock-based compensation expense, net of income taxes $ $ $ _______________ (1) In 2018, the income tax benefit reflects the reduction in the U.S. federal statutory income tax rate from 35% to 21% . Note 8Income Taxes Income before income taxes is comprised of the following: Domestic $ 3,182 $ 2,988 $ 2,622 Foreign 1,260 1,051 Total $ 4,442 $ 4,039 $ 3,619 The provisions for income taxes are as follows: Federal: Current $ $ $ Deferred (35 ) Total federal State: Current Deferred Total state Foreign: Current Deferred (37 ) (42 ) Total foreign Total provision for income taxes $ 1,263 $ 1,325 $ 1,243 In December 2017, the 2017 Tax Act was signed into law. Except for certain provisions, the 2017 Tax Act is effective for tax years beginning on or after January 1, 2018. The Company is a fiscal-year taxpayer, so most provisions will become effective for fiscal 2019, including limitations on the Companys ability to claim foreign tax credits, repeal of the domestic manufacturing deduction, and limitations on certain business deductions. Provisions with significant impacts that were effective starting in the second quarter of fiscal 2018 and throughout the remainder of fiscal 2018 included: a decrease in the U.S. federal income tax rate, remeasurement of certain net deferred tax liabilities, and a transition tax on deemed repatriation of certain foreign earnings. The decrease in the U.S. federal statutory income tax rate to 21.0% resulted in a blended rate for the Company of 25.6% for fiscal 2018. The reconciliation between the statutory tax rate and the effective rate is as follows: Federal taxes at statutory rate $ 1,136 25.6 % $ 1,414 35.0 % $ 1,267 35.0 % State taxes, net 3.4 2.9 2.5 Foreign taxes, net 0.7 (64 ) (1.6 ) (21 ) (0.6 ) Employee stock ownership plan (ESOP) (14 ) (0.3 ) (104 ) (2.6 ) (17 ) (0.5 ) 2017 Tax Act 0.4 Other (64 ) (1.4 ) (37 ) (0.9 ) (77 ) (2.1 ) Total $ 1,263 28.4 % $ 1,325 32.8 % $ 1,243 34.3 % During fiscal 2018, the Company recognized a net tax expense of $19 related to the 2017 Tax Act. This expense included $ 142 for the estimated tax on deemed repatriation of foreign earnings, and $ 43 for the reduction in foreign tax credits and other immaterial items, largely offset by a tax benefit of $ 166 for the provisional remeasurement of certain deferred tax liabilities. These items were predominantly recorded in the second quarter as provisional amounts and reflect the Company's current interpretations and estimates that it believes are reasonable. As the Company continues to evaluate the 2017 Tax Act and available data, it anticipates that adjustments may be made in future periods up to and including the second quarter of fiscal 2019 in accordance with Staff Accounting Bulletin 118. In fiscal 2018, we also recognized net tax benefits of $ 76 , which was largely driven by the adoption of an accounting standard related to stock-based compensation and other immaterial net benefits. In fiscal 2017, the Company s provision for income taxes was favorably impacted by a net tax benefit of $ 104 , primarily due to tax benefits recorded in connection with the May 2017 special cash dividends paid by the Company to employees through the Company's 401(k) retirement plan of $ 82 . Dividends on these shares are deductible for U.S. income tax purposes. There was no similar special cash dividend in 2018 or 2016. The components of the deferred tax assets (liabilities) are as follows: Equity compensation $ $ Deferred income/membership fees Accrued liabilities and reserves Property and equipment (478 ) (747 ) Merchandise inventories (175 ) (252 ) Other (1) (40 ) Net deferred tax (liabilities)/assets $ (1 ) $ (58 ) _______________ (1) Includes foreign tax credits of $36 for 2017. There were no foreign tax credits in 2018. The deferred tax accounts at the end of fiscal 2018 and 2017 include deferred income tax assets of $316 and $254 , respectively, included in other assets; and deferred income tax liabilities of $317 and $312 , respectively, included in other liabilities. The Company no longer considers current fiscal 2018 and future earnings of our non-U.S. consolidated subsidiaries to be permanently reinvested and has recorded the estimated incremental foreign withholding (net of available foreign tax credits) on current fiscal year earnings and state income taxes payable assuming a hypothetical repatriation to the U.S. The Company continues to consider undistributed earnings of certain non-U.S. consolidated subsidiaries prior to fiscal 2018, which totaled $ 3,071 , to be indefinitely reinvested and has not provided for withholding or state taxes. A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2018 and 2017 is as follows: Gross unrecognized tax benefit at beginning of year $ $ Gross increasescurrent year tax positions Gross increasestax positions in prior years Gross decreasestax positions in prior years (17 ) Settlements (1 ) (11 ) Lapse of statute of limitations (10 ) (9 ) Gross unrecognized tax benefit at end of year $ $ The gross unrecognized tax benefit includes tax positions for which the ultimate deductibility is highly certain but there is uncertainty about the timing of such deductibility. At the end of 2018 and 2017 , these amounts were immaterial. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of these tax positions would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority. The total amount of such unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods is $32 and $29 at the end of 2018 and 2017 , respectively. Accrued interest and penalties related to income tax matters are classified as a component of income tax expense. Interest and penalties recognized during 2018 and 2017 and accrued at the end of each respective period were not material. The Company is currently under audit by several jurisdictions in the United States and in several foreign countries. Some audits may conclude in the next 12 months and the unrecognized tax benefits recorded in relation to the audits may differ from actual settlement amounts. It is not practical to estimate the effect, if any, of any amount of such change during the next 12 months to previously recorded uncertain tax positions in connection with the audits. The Company does not anticipate that there will be a material increase or decrease in the total amount of unrecognized tax benefits in the next 12 months. The Company files income tax returns in the United States, various state and local jurisdictions, in Canada, and in several other foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state or local examination for years before fiscal 2014. The Company is currently subject to examination in California for fiscal years 2007 to present. No other examinations are believed to be material. Note 9Net Income per Common and Common Equivalent Share The following table shows the amounts used in computing net income per share and the weighted average number of shares of potentially dilutive common shares outstanding (shares in 000s): Net income attributable to Costco $ 3,134 $ 2,679 $ 2,350 Weighted average number of common shares used in basic net income per common share 438,515 438,437 438,585 RSUs and other 3,319 2,500 2,678 Weighted average number of common shares and dilutive potential of common stock used in diluted net income per share 441,834 440,937 441,263 Note 10Commitments and Contingencies Legal Proceedings The Company is involved in a number of claims, proceedings and litigation arising from its business and property ownership. In accordance with applicable accounting guidance, the Company establishes an accrual for legal proceedings if and when those matters reach a stage where they present loss contingencies that are both probable and reasonably estimable. There may be exposure to loss in excess of any amounts accrued. The Company monitors those matters for developments that would affect the likelihood of a loss (taking into account where applicable indemnification arrangements concerning suppliers and insurers) and the accrued amount, if any, thereof, and adjusts the amount as appropriate. As of the date of this Report, the Company has recorded an immaterial accrual with respect to one matter described below, in addition to other immaterial accruals for matters not described below. If the loss contingency at issue is not both probable and reasonably estimable, the Company does not establish an accrual, but will continue to monitor the matter for developments that will make the loss contingency both probable and reasonably estimable. In each case, there is a reasonable possibility that a loss may be incurred, including a loss in excess of the applicable accrual. For matters where no accrual has been recorded, the possible loss or range of loss (including any loss in excess of the accrual) cannot, in the Company's view, be reasonably estimated because, among other things: (i) the remedies or penalties sought are indeterminate or unspecified; (ii) the legal and/or factual theories are not well developed; and/or (iii) the matters involve complex or novel legal theories or a large number of parties. The Company is a defendant in a class action alleging violation of California Wage Order 7-2001 for failing to provide seating to member service assistants who act as greeters and exit attendants in the Companys California warehouses. Canela v. Costco Wholesale Corp., et al. (Case No. 5:13-cv-03598, N.D. Cal. filed July 1, 2013). The complaint seeks relief under the California Labor Code, including civil penalties and attorneys fees. The Company filed an answer denying the material allegations of the complaint. The plaintiff has since indicated that exit attendants are no longer a subject of the litigation. The action in the district court has been stayed pending review by the Ninth Circuit of the order certifying a class. On September 6, 2018, counsel claiming to represent an employee notified the California Labor and Workforce Development agency of an intention to bring similar claims concerning Costco employees engaged at member services counters. On November 23, 2016, the Companys Canadian subsidiary received from the Ontario Ministry of Health and Long Term Care a request for an inspection and information concerning compliance with the anti-rebate provisions in the Ontario Drug Benefit Act and the Drug Interchangeability and Dispensing Fee Act. The Company is seeking to cooperate with the request. The Ministry has indicated it has reason to believe the Company received payments in violation of these laws and is seeking disgorgement of these sums. In December 2017, the United States Judicial Panel on Multidistrict Litigation consolidated numerous cases filed against various defendants by counties, cities, hospitals, Native American tribes and third-party payors concerning the impacts of opioid abuse. In re National Prescription Opiate Litigation (MDL No. 2804) (N.D. Ohio). Included are federal court cases that name the Company, including actions filed by a number of counties and cities in Michigan, New Jersey and Ohio, and a third-party payor in Ohio. Similar cases that name the Company have been filed in state courts in New Jersey and Oklahoma. The Company is defending these matters. In November 2016 and September 2017, the Company received notices of violation from the Connecticut Department of Energy and Environmental Protection regarding hazardous waste practices at its Connecticut warehouses, primarily concerning unsalable pharmaceuticals. The Company is seeking to cooperate concerning the resolution of these notices. The Company does not believe that any pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Companys financial position, results of operations or cash flows; however, it is possible that an unfavorable outcome of some or all of the matters, however unlikely, could result in a charge that might be material to the results of an individual fiscal quarter. Note 11Segment Reporting The Company and its subsidiaries are principally engaged in the operation of membership warehouses in the U.S., Canada, Mexico, U.K., Japan, Korea, Australia, Spain, Iceland, and France and through a majority-owned subsidiary in Taiwan. Reportable segments are largely based on managements organization of the operating segments for operational decisions and assessments of financial performance, which considers geographic locations. The material accounting policies of the segments are as described in Note 1. Inter-segment net sales and expenses have been eliminated in computing total revenue and operating income. Certain operating expenses, predominantly stock-based compensation, incurred on behalf of the Company's Canadian and Other International operations, are included in the U.S. operations because those costs generally come under the responsibility of U.S. management. United States Operations Canadian Operations Other International Operations Total Total revenue $ 102,286 $ 20,689 $ 18,601 $ 141,576 Operating income 2,787 4,480 Depreciation and amortization 1,078 1,437 Additions to property and equipment 2,046 2,969 Net property and equipment 13,353 1,900 4,428 19,681 Total assets 28,207 4,303 8,320 40,830 Total revenue $ 93,889 $ 18,775 $ 16,361 $ 129,025 Operating income 2,644 4,111 Depreciation and amortization 1,044 1,370 Additions to property and equipment 1,714 2,502 Net property and equipment 12,339 1,820 4,002 18,161 Total assets 24,068 4,471 7,808 36,347 Total revenue $ 86,579 $ 17,028 $ 15,112 $ 118,719 Operating income 2,326 3,672 Depreciation and amortization 1,255 Additions to property and equipment 1,823 2,649 Net property and equipment 11,745 1,628 3,670 17,043 Total assets 22,511 3,480 7,172 33,163 The following table summarizes the percentage of net sales by merchandise category: Food and Sundries % % % Hardlines % % % Fresh Foods % % % Softlines % % % Ancillary % % % Note 12Quarterly Financial Data (Unaudited) The two tables that follow reflect the unaudited quarterly results of operations for 2018 and 2017 . 52 Weeks Ended September 2, 2018 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (16 Weeks) Total (52 Weeks) REVENUE Net sales $ 31,117 $ 32,279 $ 31,624 $ 43,414 $ 138,434 Membership fees 3,142 Total revenue 31,809 32,995 32,361 44,411 141,576 OPERATING EXPENSES Merchandise costs 27,617 28,733 28,131 38,671 123,152 Selling, general and administrative 3,224 3,234 3,155 4,263 13,876 Preopening expenses Operating income 1,016 1,067 1,446 4,480 OTHER INCOME (EXPENSE) Interest expense (37 ) (37 ) (37 ) (48 ) (159 ) Interest income and other, net INCOME BEFORE INCOME TAXES 1,071 1,449 4,442 Provision for income taxes 1,263 Net income including noncontrolling interests 1,053 3,179 Net income attributable to noncontrolling interests (11 ) (12 ) (12 ) (10 ) (45 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ 1,043 $ 3,134 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.46 $ 1.60 $ 1.71 $ 2.38 $ 7.15 Diluted $ 1.45 $ 1.59 $ 1.70 $ 2.36 $ 7.09 Shares used in calculation (000s) Basic 437,965 439,022 438,740 438,379 438,515 Diluted 440,851 441,568 441,715 442,427 441,834 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.50 $ 0.50 $ 0.57 $ 0.57 $ 2.14 53 Weeks Ended September 3, 2017 First Quarter (12 Weeks) Second Quarter (12 Weeks) Third Quarter (12 Weeks) Fourth Quarter (17 Weeks) Total (53 Weeks) REVENUE Net sales $ 27,469 $ 29,130 $ 28,216 $ 41,357 $ 126,172 Membership fees 2,853 Total revenue 28,099 29,766 28,860 42,300 129,025 OPERATING EXPENSES Merchandise costs 24,288 25,927 24,970 36,697 111,882 Selling, general and administrative 2,940 2,980 2,907 4,123 12,950 Preopening expenses Operating income 1,450 4,111 OTHER INCOME (EXPENSE) Interest expense (29 ) (31 ) (21 ) (53 ) (134 ) Interest income and other, net (4 ) INCOME BEFORE INCOME TAXES 1,419 4,039 Provision for income taxes (1) 1,325 Net income including noncontrolling interests 2,714 Net income attributable to noncontrolling interests (10 ) (6 ) (6 ) (13 ) (35 ) NET INCOME ATTRIBUTABLE TO COSTCO $ $ $ $ $ 2,679 NET INCOME PER COMMON SHARE ATTRIBUTABLE TO COSTCO: Basic $ 1.24 $ 1.17 $ 1.59 $ 2.10 $ 6.11 Diluted $ 1.24 $ 1.17 $ 1.59 $ 2.08 $ 6.08 Shares used in calculation (000s) Basic 438,007 439,127 438,817 437,987 438,437 Diluted 440,525 440,657 441,056 441,036 440,937 CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.45 $ 0.45 $ 7.50 (2) $ 0.50 $ 8.90 _______________ (1) Includes an $82 tax benefit recorded in the third quarter in connection with the special cash dividend paid to employees through the Company's 401(k) Retirement Plan. (2) Includes the special cash dividend of $7.00 per share paid in May 2017. "," Item 9AControls and Procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our principal executive and financial officers, to allow timely decisions regarding disclosure. The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of September 2, 2018 and, based on their evaluation, have concluded that the disclosure controls and procedures were not effective as of such date due to a material weakness in internal control over financial reporting, described below. Management's Annual Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness for future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision of and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 2, 2018, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework (2013). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We identified a material weakness in internal control related to ineffective information technology general controls (ITGCs) in the areas of user access and program change-management over certain information technology (IT) systems that support the Companys financial reporting processes. Our business process controls (automated and manual) that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted. We believe that these control deficiencies were a result of: IT control processes lacking sufficient documentation such that the successful operation of ITGCs was overly dependent upon knowledge and actions of certain individuals with IT expertise, which led to failures resulting from changes in IT personnel; insufficient training of IT personnel on the importance of ITGCs; and risk-assessment processes inadequate to identify and assess changes in IT environments that could impact internal control over financial reporting. The material weakness did not result in any identified misstatements to the financial statements, and there were no changes to previously released financial results. Based on this material weakness, the Companys management concluded that at September 2, 2018, the Companys internal control over financial reporting was not effective. The Companys independent registered public accounting firm, KPMG LLP has issued an adverse audit report on the effectiveness of the Companys internal control over financial reporting as of September 2, 2018, which appears in Item 8 of this Form 10-K. Following identification of the material weakness and prior to filing this Annual Report on Form 10-K, we completed substantive procedures for the year ended September 2, 2018. Based on these procedures, management believes that our consolidated financial statements included in this Form 10-K have been prepared in accordance with U.S. GAAP. Our CEO and CFO have certified that, based on their knowledge, the financial statements, and other financial information included in this Form 10-K, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this Form 10-K. KPMG LLP has issued an unqualified opinion on our financial statements, which is included in Item 8 of this Form 10-K. Remediation Management has been implementing and continues to implement measures designed to ensure that control deficiencies contributing to the material weakness are remediated, such that these controls are designed, implemented, and operating effectively. The remediation actions include: (i) creating and filling an IT Compliance Oversight function; (ii) developing a training program addressing ITGCs and policies, including educating control owners concerning the principles and requirements of each control, with a focus on those related to user access and change-management over IT systems impacting financial reporting; (iii) developing and maintaining documentation underlying ITGCs to promote knowledge transfer upon personnel and function changes; (iv) developing enhanced risk assessment procedures and controls related to changes in IT systems; (v) implementing an IT management review and testing plan to monitor ITGCs with a specific focus on systems supporting our financial reporting processes; and (vi) enhanced quarterly reporting on the remediation measures to the Audit Committee of the Board of Directors. We believe that these actions will remediate the material weakness. The weakness will not be considered remediated, however, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2019. Changes in Internal Control Over Financial Reporting Except for the material weakness identified during the quarter, as of September 2, 2018, there have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that occurred during the fourth quarter of fiscal 2018 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " +4,cost,10k90317," Item 1Business Costco Wholesale Corporation and its subsidiaries (Costco or the Company) began operations in 1983, in Seattle, Washington. We are principally engaged in the operation of membership warehouses in the United States (U.S.) and Puerto Rico, Canada, United Kingdom (U.K.), Mexico, Japan, Australia, Spain, France, Iceland and through majority-owned subsidiaries in Taiwan and Korea. Costco operated 741 , 715, and 686 warehouses worldwide at September 3, 2017 , August 28, 2016 , and August 30, 2015 , respectively. Our common stock trades on the NASDAQ Global Select Market, under the symbol COST. We report on a 52/53-week fiscal year, consisting of thirteen, four-week periods and ending on the Sunday nearest the end of August. The first three quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). The material seasonal impact in our operations is increased net sales and earnings during the winter holiday season. References to 2017 relate to the 53-week fiscal year ended September 3, 2017 . References to 2016 and 2015 relate to the 52-week fiscal years ended August 28, 2016 , and August 30, 2015 , respectively. General We operate membership warehouses based on the concept that offering our members low prices on a limited selection of nationally branded and private-label products in a wide range of merchandise categories will produce high sales volumes and rapid inventory turnover. When combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, these volumes and turnover enable us to operate profitably at significantly lower gross margins (net sales less merchandise costs) than most other retailers. We generally sell inventory before we are required to pay for it, even while taking advantage of early payment discounts when available. We buy most of our merchandise directly from manufacturers and route it to cross-docking consolidation points (depots) or directly to our warehouses. Our depots receive large shipments from manufacturers and quickly ship these goods to individual warehouses. This process creates freight volume and handling efficiencies, eliminating many costs associated with traditional multiple-step distribution channels. Item 1Business (Continued) Our average warehouse space is approximately 145,000 square feet, with newer units slightly larger. Floor plans are designed for economy and efficiency in the use of selling space, the handling of merchandise, and the control of inventory. Because shoppers are attracted principally by the quality of merchandise and low prices, our warehouses are not elaborate. By strictly controlling the entrances and exits of our warehouses and using a membership format, we have inventory losses (shrinkage) well below those of typical retail operations. Our warehouses on average operate on a seven-day, 70-hour week. Gasoline operations generally have extended hours. Because the hours of operation are shorter than other retailers, and due to other efficiencies inherent in a warehouse-type operation, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities, reducing labor required. In general, with variations by country, our warehouses accept certain credit, including the Costco co-branded card, and debit cards, cash, and checks. Our strategy is to provide our members with a broad range of high-quality merchandise at prices we believe are consistently lower than elsewhere. We seek to limit items to fast-selling models, sizes, and colors. We carry an average of approximately 3,800 active stock keeping units (SKUs) per warehouse in our core warehouse business, significantly less than other broadline retailers. Many consumable products are offered for sale in case, carton, or multiple-pack quantities only. In keeping with our policy of member satisfaction, we generally accept returns of merchandise. On certain electronic items, we typically have a 90-day return policy and provide, free of charge, technical support services, as well as an extended warranty. Additional third-party warranty coverage is sold on certain electronic items. We offer merchandise in the following categories: Foods (including dry foods, packaged foods, and groceries) Sundries (including snack foods, candy, alcoholic and nonalcoholic beverages, and cleaning supplies) Hardlines (including major appliances, electronics, health and beauty aids, hardware, and garden and patio) Fresh Foods (including meat, produce, deli, and bakery) Softlines (including apparel and small appliances) Ancillary (including gas stations and pharmacy) Ancillary businesses within or next to our warehouses provide expanded products and services, encouraging members to shop more frequently. These businesses include our gas stations, pharmacy, optical dispensing centers, food courts, and hearing-aid centers. We sell gasoline in all countries except Korea and France, with the number of warehouses with gas stations varying significantly by country. We operated 536, 508, and 472 gas stations at the end of 2017 , 2016 , and 2015 , respectively. Our online businesses, which include e-commerce, business delivery, and travel, vary by country. In the U.S. and Canada, we offer all of our online businesses. We operate e-commerce websites in all countries except Japan, Australia, Spain, Iceland, and France. Online businesses provide our members additional products and services, many not found in our warehouses. Net sales for our online business were approximately 4% of our total net sales in 2017 and 2016 , respectively, and 3% in 2015 . We have direct buying relationships with many producers of national brand-name merchandise. We do not obtain a significant portion of merchandise from any one supplier. We generally have not experienced difficulty in obtaining sufficient quantities of merchandise and believe that if one or more of our current sources of supply became unavailable, we would be able to obtain alternative sources without substantial disruption of our business. We also purchase private-label merchandise, as long as quality and member demand are comparable and the value to our members is significant. Item 1Business (Continued) Certain financial information for our segments and geographic areas is included in Note 11 to the consolidated financial statements included in Item 8 of this Report. Membership Our members may utilize their memberships at any of our warehouses worldwide. Gold Star memberships are available to individuals; Business memberships are limited to businesses, including individuals with a business license, retail sales license or comparable evidence. Business members have the ability to add additional cardholders (add-ons). Add-ons are not available for Gold Star members. Effective June 1, 2017, we increased our annual membership fees in the U.S. and Canada for Gold Star (individual), Business and Business add-on by $5 to $60 per year. The Executive membership fee increased from $110 to $120 (annual membership fee of $60, plus Executive upgrade of $60), and the maximum annual 2% reward, which is earned on qualified purchases and can be redeemed only at Costco warehouses, increased from $750 to $1,000. Our annual membership fees in our Other International operations vary by country. All paid memberships include a free household card. Our member renewal rate was 90% in the U.S. and Canada and 87% on a worldwide basis in 2017 . The majority of members renew within six months following their renewal date. Therefore, our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. Our membership was made up of the following (in thousands): Gold Star 38,600 36,800 34,000 Business, including add-ons 10,800 10,800 10,600 Total paid members 49,400 47,600 44,600 Household cards 40,900 39,100 36,700 Total cardholders 90,300 86,700 81,300 Paid cardholders (except Business add-ons) are eligible to upgrade to an Executive membership in the U.S., Canada, Mexico and the U.K. for an additional annual fee, which varies by country. Executive members have access to additional savings and benefits on various business and consumer services (except in Mexico), such as auto and home insurance, the Costco auto purchase program and check printing services. The services are generally provided by third-parties and vary by state and country. Executive members represented 38% of paid members at the end of 2017 . Executive members generally spend more than other members, and the percentage of our net sales attributable to these members continues to increase. Labor Our employee count was as follows: Full-time employees 133,000 126,000 117,000 Part-time employees 98,000 92,000 88,000 Total employees 231,000 218,000 205,000 Approximately 15,600 employees are union employees. We consider our employee relations to be very good. Item 1Business (Continued) Competition Our industry is highly competitive, based on factors such as price, merchandise quality and selection, location, convenience, distribution strategy, and customer service. We compete on a worldwide basis with global, national, and regional wholesalers and retailers, including supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, department and specialty stores, and operators selling a single category or narrow range of merchandise. Wal-Mart, Target, Kroger, and Amazon.com are among our significant general merchandise retail competitors. We also compete with warehouse club operations (primarily Wal-Marts, Sams Club and BJs Wholesale Club), and nearly every major U.S. and Mexico metropolitan area has multiple club operations. Intellectual Property We believe that, to varying degrees, our trademarks, trade names, copyrights, proprietary processes, trade secrets, patents, trade dress, domain names and similar intellectual property add significant value to our business and are important to our success. We have invested significantly in the development and protection of our well-recognized brands, including the Costco Wholesale trademarks and our private-label brand, Kirkland Signature . We believe that Kirkland Signature products are high quality products, offered to our members at prices that are generally lower than those for similar national brand products and that they help lower costs, differentiate our merchandise offerings from other retailers, and generally earn higher margins. We expect to continue to increase the sales penetration of our private label items. We rely on trademark and copyright laws, trade-secret protection, and confidentiality, license and other agreements with our suppliers, employees and others to protect our intellectual property rights. The availability and duration of trademark registrations vary by country; however, trademarks are generally valid and may be renewed indefinitely as long as they are in use and their registrations are properly maintained. Available Information Our U.S. internet website is www.costco.com. We make available through the Investor Relations section of that site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements and Forms 3, 4 and 5, and any amendments to those reports, as soon as reasonably practicable after filing such materials with, or furnishing such documents to, the Securities and Exchange Commission (SEC). The information found on our website is not part of this or any other report filed with or furnished to the SEC. In addition, the public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers, such as the Company, that file electronically with the SEC at www.sec.gov. We have adopted a code of ethics for senior financial officers pursuant to Section 406 of the Sarbanes-Oxley Act. Copies of the code are available free of charge by writing to Secretary, Costco Wholesale Corporation, 999 Lake Drive, Issaquah, WA 98027. If the Company makes any amendments to this code (other than technical, administrative, or non-substantive amendments) or grants any waivers, including implicit waivers, from this code to the CEO, chief financial officer or principal accounting officer and controller, we will disclose (on our website or in a Form 8-K report filed with the SEC) the nature of the amendment or waiver, its effective date, and to whom it applies. Item 1Business (Continued) Executive Officers of the Registrant The executive officers of Costco, their position, and ages are listed below. All executive officers have 25 or more years of service with the Company. Name Position Executive Officer Since Age W. Craig Jelinek President and Chief Executive Officer. Mr. Jelinek has been President and Chief Executive Officer since January 2012 and a director since February 2010. He was President and Chief Operating Officer from February 2010 to December 2011. Prior to that he was Executive Vice President, Chief Operating Officer, Merchandising since 2004. 65 Richard A. Galanti Executive Vice President and Chief Financial Officer. Mr. Galanti has been a director since January 1995. 61 Franz E. Lazarus Executive Vice President, Administration. Mr. Lazarus was Senior Vice President, Administration-Global Operations from 2006 to September 2012. 70 John D. McKay Executive Vice President, Chief Operating Officer, Northern Division. Mr. McKay was Senior Vice President, General Manager, Northwest Region from 2000 to March 2010. 60 Paul G. Moulton Executive Vice President, Chief Information Officer. Mr. Moulton was Executive Vice President, Real Estate Development from 2001 until March 2010. 66 James P. Murphy Executive Vice President, Chief Operating Officer, International. Mr. Murphy was Senior Vice President, International, from 2004 to October 2010. 64 Joseph P. Portera Executive Vice President, Chief Operating Officer, Eastern and Canadian Divisions. Mr. Portera has held these positions since 1994, and has been the Chief Diversity Officer since 2010. 65 Timothy L. Rose Executive Vice President, Ancillary Businesses, Manufacturing, and Business Centers. Mr. Rose was Senior Vice President, Merchandising, Food and Sundries and Private Label from 1995 to December 2012. 65 Ron M. Vachris Executive Vice President, Chief Operating Officer, Merchandising. Mr. Vachris was Senior Vice President, Real Estate Development, from August 2015 to June 2016, and Senior Vice President, General Manager, Northwest Region from 2010 to July 2015. 52 Dennis R. Zook Executive Vice President, Chief Operating Officer, Southwest Division and Mexico. 68 "," Item 1ARisk Factors The risks described below could materially and adversely affect our business, financial condition and results of operations. We could also be affected by additional risks that apply to all companies operating in the U.S. and globally, as well as other risks that are not presently known to us or that we currently consider to be immaterial. These Risk Factors should be carefully reviewed in conjunction with Management ' s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements and related notes in Item 8 of this Report. Business and Operating Risks We are highly dependent on the financial performance of our U.S. and Canadian operations. Our financial and operational performance is highly dependent on our U.S. and Canadian operations, which comprised 87% and 85% of net sales and operating income in 2017 , respectively. Within the U.S., we are highly dependent on our California operations, which comprised 30% of U.S. net sales in 2017 . Our California market, in general, has a larger percentage of higher volume warehouses as compared to our other domestic markets. Any substantial slowing or sustained decline in these operations could materially adversely affect our business and financial results. Declines in financial performance of our U.S. operations, particularly in California, and our Canadian operations could arise from, among other things: slow growth or declines in comparable warehouse sales (comparable sales); negative trends in operating expenses, including increased labor, healthcare and energy costs; failing to meet targets for warehouse openings; cannibalizing existing locations with new warehouses; shifts in sales mix toward lower gross margin products; changes or uncertainties in economic conditions in our markets, including higher levels of unemployment and depressed home values; and failing to consistently provide high quality and innovative new products to retain our existing member base and attract new members. We may be unsuccessful implementing our growth strategy, including expanding our business in existing markets and new markets, which could have an adverse impact on our business, financial condition and results of operations. Our growth is dependent, in part, on our ability to acquire property and build or lease new warehouses and regional depots. We compete with other retailers and businesses for suitable locations. Local land use and other regulations restricting the construction and operation of our warehouses and depots, as well as local community actions opposed to the location of our warehouses or depots at specific sites and the adoption of local laws restricting our operations and environmental regulations, may impact our ability to find suitable locations, and increase the cost of sites and of constructing, leasing and operating our warehouses and depots. We also may have difficulty negotiating leases or purchase agreements on acceptable terms. In addition, certain jurisdictions have enacted or proposed laws and regulations that would prevent or restrict the operation or expansion plans of certain large retailers and warehouse clubs, including us, within their jurisdictions. Failure to effectively manage these and other similar factors may affect our ability to timely build or lease and operate new warehouses and depots, which could have a material adverse effect on our future growth and profitability. We seek to expand in existing markets to attain a greater overall market share. A new warehouse may draw members away from our existing warehouses and adversely affect their comparable sales performance and member traffic. We intend to continue to open warehouses in new markets. Associated risks include difficulties in attracting members due to a lack of familiarity with us, attracting members of other wholesale club operators, our lack of familiarity with local member preferences, and seasonal differences in the market. Entry into new markets may bring us into competition with new competitors or with existing competitors with a large, established market presence. We cannot ensure that new warehouses and new websites will be profitably deployed and, as a result, future profitability could be delayed or otherwise materially adversely affected. Item 1ARisk Factors (Continued) Our failure to maintain membership loyalty and brand recognition could adversely affect our results of operations. Membership loyalty and growth are essential to our business model. The extent to which we achieve growth in our membership base, increase the penetration of our Executive members, and sustain high renewal rates materially influences our profitability. Damage to our brands or reputation may negatively impact comparable sales, diminish member trust, and reduce member renewal rates and, accordingly, net sales and membership fee revenue, negatively impacting our results of operations. We sell many products under our Kirkland Signature brand. Maintaining consistent product quality, competitive pricing, and availability of these products is essential to developing and maintaining member loyalty. These products also generally carry higher margins than national brand products carried in our warehouses and represent a growing portion of our overall sales. If the Kirkland Signature brand experiences a loss of member acceptance or confidence, our sales and gross margin results could be adversely affected. Disruptions in our merchandise distribution could adversely affect sales and member satisfaction. We depend on the orderly operation of the merchandise receiving and distribution process, primarily through our depots. Although we believe that our receiving and distribution process is efficient, unforeseen disruptions in operations due to fires, tornadoes and hurricanes, earthquakes or other catastrophic events, labor issues or other shipping problems may result in delays in the delivery of merchandise to our warehouses, which could adversely affect sales and the satisfaction of our members. We rely extensively on information technology to process transactions, compile results, and manage our businesses. Failure or disruption of our primary and back-up systems could adversely affect our businesses. A failure to adequately update our existing systems and implement new systems could harm our businesses and adversely affect our results of operations. Given the very high volume of transactions we process each year it is important that we maintain uninterrupted operation of our business-critical computer systems. Our systems, including our back-up systems, are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, catastrophic events such as fires, earthquakes, tornadoes and hurricanes, and errors by our employees. If our systems are damaged or cease to function properly, we may have to make significant investments to fix or replace them, and we may suffer interruptions in our operations in the interim. Any material interruption in these systems could have a material adverse effect on our business and results of operations. We are currently making, and will continue to make, significant technology investments to improve or replace critical information systems and processing capabilities. Failure to monitor and choose the right investments and implement them at the right pace would be harmful. The risk of system disruption is increased when significant system changes are undertaken, although we believe that our change management process will mitigate this risk. Excessive technological change could impact the effectiveness of adoption, and could make it more difficult for us to realize benefits. Targeting the wrong opportunities, failing to make the best investments, or making an investment commitment significantly above or below our needs could result in the loss of our competitive position and adversely impact our financial condition and results of operations. Additionally, the potential problems and interruptions associated with implementing technology initiatives could disrupt or reduce the efficiency of our operations. These initiatives might not provide the anticipated benefits or may provide them on a delayed schedule or at a higher cost. If we do not maintain the privacy and security of member-related and other business information, we could damage our reputation with members, incur substantial additional costs, and become subject to litigation. We receive, retain, and transmit personal information about our members and entrust that information to third-party business associates, including cloud service providers that perform activities for us. Our Item 1ARisk Factors (Continued) warehouse and online businesses depend upon the secure transmission of encrypted confidential information over public networks, including information permitting cashless payments. A compromise of our security systems or those of our business associates, that results in our members ' information being obtained by unauthorized persons, could adversely affect our reputation with our members and others, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of penalties. In addition, a breach could require that we expend significant additional resources related to the security of information systems and could disrupt our operations. The use of data by our business and our business associates is regulated at the national and state or local level in all of our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to necessary systems changes and the development of new processes. If we or those with whom we share information fail to comply with these laws and regulations, our reputation could be damaged, possibly resulting in lost future business, and we could be subjected to additional legal risk as a result of non-compliance. Our security measures may be undermined due to the actions of outside parties, employee error, internal or external malfeasance, or otherwise, and, as a result an unauthorized party may obtain access to our data systems and misappropriate business and personal information. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and may not immediately produce signs of intrusion, we may be unable to anticipate these techniques, timely discover or counter them, or implement adequate preventative measures. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and potentially have an adverse effect on our business. We are subject to payment-related risks. We accept payments using a variety of methods, including cash and checks, a select variety of credit and debit cards, and our proprietary cash card. As we offer new payment options to our members, we may be subject to additional rules, regulations, compliance requirements, and higher fraud losses. For certain payment methods, we pay interchange and other related card acceptance fees, along with additional transaction processing fees. We rely on third parties to provide payment transaction processing services, including the processing of credit and debit cards, and our proprietary cash card, and it could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to payment card association and network operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change over time. For example, we are subject to Payment Card Industry Data Security Standards (PCI DSS), which contain compliance guidelines and standards with regard to our security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. In addition, if our internal systems are breached or compromised, we may be liable for card re-issuance costs, subject to fines and higher transaction fees and lose our ability to accept credit and/or debit card payments from our members, and our business and operating results could be adversely affected. We might sell products that cause unexpected illness or injury to our members, harm to our reputation, and expose us to litigation. If our merchandise offerings, such as food and prepared food products for human consumption, drugs, children ' s products, pet products, and durable goods, do not meet or are perceived not to meet applicable safety standards or our members ' expectations regarding safety, we could experience lost sales, increased costs, litigation or reputational harm. The sale of these items involves the risk of health-related illness or injury to our members. Such illnesses or injuries could result from tampering by unauthorized third parties, product contamination or spoilage, including the presence of foreign objects, substances, chemicals, other agents, or residues introduced during the growing, manufacturing, storage, handling and transportation phases, or faulty design. Our vendors are generally contractually required to comply with product safety laws, and we are dependent on them to ensure that the products we buy comply with all safety standards. While we are subject to governmental inspection and regulations and work to comply in all material respects Item 1ARisk Factors (Continued) with applicable laws and regulations, we cannot be sure that consumption or use of our products will not cause a health-related illness or injury in the future or that we will not be subject to claims, lawsuits, or government investigations relating to such matters resulting in costly product recalls and other liabilities that could adversely affect our business and results of operations. Even if a product liability claim is unsuccessful or is not fully pursued, negative publicity could adversely affect our reputation with existing and potential members and our corporate and brand image, and these effects could be long term. We may not timely identify or effectively respond to consumer trends, which could negatively affect our relationship with our members, the demand for our products and services, and our market share. It is difficult to consistently and successfully predict the products and services that our members will desire. Our success depends, in part, on our ability to identify and respond to trends in demographics and consumer preferences. Failure to identify timely or effectively respond to changing consumer tastes, preferences (including those relating to sustainability of product sources and animal welfare) and spending patterns could negatively affect our relationship with our members, the demand for our products and services and our market share. If we are not successful at predicting our sales trends and adjusting our purchases accordingly, we may have excess inventory, which could result in additional markdowns and reduce our operating performance. This could have an adverse effect on net sales, gross margin and operating income. If we do not successfully develop and maintain a relevant multichannel experience for our members, our results of operations could be adversely impacted. Multichannel retailing is rapidly evolving and we must keep pace with changing member expectations and new developments by our competitors. Our members are increasingly using mobile phones, tablets, computers, and other devices to shop and to interact with us through social media. We are making technology investments in our websites and mobile applications. If we are unable to make, improve, or develop relevant member-facing technology in a timely manner, our ability to compete and our results of operations could be adversely affected. Inability to attract, train and retain highly qualified employees could adversely impact our business, financial condition and results of operations. Our success depends on the continued contributions of members of our senior management and other key operations, merchandising and administrative personnel. Failure to identify and implement a succession plan for key senior management could negatively impact the business. We must attract, train and retain a large and growing number of qualified employees, while controlling related labor costs and maintaining our core values. Our ability to control labor and benefit costs is subject to numerous internal and external factors, including regulatory changes, prevailing wage rates, and healthcare and other insurance costs. We compete with other retail and non-retail businesses for these employees and invest significant resources in training and motivating them. There is no assurance that we will be able to attract or retain highly qualified employees in the future, which could have a material adverse effect on our business, financial condition and results of operations. We may incur property, casualty or other losses not covered by our insurance. We are predominantly self-insured, with insurance coverage for certain catastrophic risks, for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability and inventory loss. The types and amounts of insurance may vary from time to time based on our decisions with respect to risk retention and regulatory requirements. The occurrence of significant claims, a substantial rise in costs to maintain our insurance or the failure to maintain adequate insurance coverage could have an adverse impact on our financial condition and results of operations. Item 1ARisk Factors (Continued) We are primarily self-insured as it relates to property damage, due to the substantial premiums required for insurance coverage over physical losses caused by certain natural disasters, as well as the limitations on available coverage for such losses. Although we maintain specific coverages for losses from physical damages in excess of certain amounts to guard against catastrophic losses, we still bear the risk of losses incurred as a result of any physical damage to, or the destruction of, any warehouses, depots, manufacturing or home office facilities, loss or spoilage of inventory, and business interruption caused by any such events to the extent they are below catastrophic levels of coverage, as well as any losses to the extent they exceed our aggregate limits of applicable coverages. Such losses could materially impact our cash flow and results of operations. Market and Other External Risks We face strong competition from other retailers and warehouse club operators, which could adversely affect our business, financial condition and results of operations. The retail business is highly competitive. We compete for members, employees, sites, products and services and in other important respects with a wide range of local, regional and national wholesalers and retailers, both in the United States and in foreign countries, including other warehouse club operators, supermarkets, supercenters, internet retailers, gasoline stations, hard discounters, and department and specialty stores. Such retailers and warehouse club operators compete in a variety of ways, including merchandise pricing, selection and availability, services, location, convenience, store hours, and the attractiveness and ease of use of websites and mobile applications. The evolution of retailing in online and mobile channels has improved the ability of customers to comparison shop with digital devices, which has enhanced competition. Some competitors may have greater financial resources, better access to merchandise and greater market penetration than we do. Our inability to respond effectively to competitive pressures, changes in the retail markets and member expectations could result in lost market share and negatively affect our financial results. General economic factors, domestically and internationally, may adversely affect our business, financial condition, and results of operations. Higher energy and gasoline costs, inflation, levels of unemployment, healthcare costs, consumer debt levels, foreign-currency exchange rates, unsettled financial markets, weaknesses in housing and real estate markets, reduced consumer confidence, changes and uncertainties related to government fiscal and tax policies including increased duties, tariffs, or other restrictions, sovereign debt crises, and other economic factors could adversely affect demand for our products and services, require a change in product mix, or impact the cost of or ability to purchase inventory. Prices of certain commodity products, including gasoline and other food products, are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations, taxes and periodic delays in delivery. Rapid and significant changes in commodity prices and our ability and desire to pass them through to our members may affect our sales and profit margins. These factors could also increase our merchandise costs and selling, general and administrative expenses, and otherwise adversely affect our operations and financial results. General economic conditions can also be affected by significant events like the outbreak of war or acts of terrorism. Vendors may be unable to supply us with quality merchandise at competitive prices in a timely manner or may fail to adhere to our high standards, resulting in adverse effects on our business, merchandise inventories, sales, and profit margins. We depend heavily on our ability to purchase quality merchandise in sufficient quantities at competitive prices. As the quantities we require continue to grow, we have no assurances of continued supply, appropriate pricing or access to new products, and any vendor has the ability to change the terms upon which they sell to us or discontinue selling to us. Member demands may lead to out-of-stock positions of our merchandise leading to loss of sales and profits. Item 1ARisk Factors (Continued) We buy from numerous domestic and foreign manufacturers and importers. Our inability to acquire suitable merchandise on acceptable terms or the loss of key vendors could negatively affect us. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality or more expensive than those from existing vendors. Because of our efforts to adhere to high quality standards for which available supply may be limited, particularly for certain food items, the large volume we demand may not be consistently available. Our suppliers (and those they depend upon for materials and services) are subject to risks, including labor disputes, union organizing activities, financial liquidity, inclement weather, natural disasters, supply constraints, and general economic and political conditions that could limit their ability to timely provide us with acceptable merchandise. For these or other reasons, one or more of our suppliers might not adhere to our quality control, legal, regulatory, labor, environmental or animal welfare standards. These deficiencies may delay or preclude delivery of merchandise to us and might not be identified before we sell such merchandise to our members. This failure could lead to recalls and litigation, and otherwise damage our reputation and our brands, increase our costs, and otherwise adversely impact our business. Fluctuations in foreign exchange rates may adversely affect our results of operations. During 2017 , our international operations, including Canada, generated 27% and 36% of our net sales and operating income, respectively. Our international operations have accounted for an increasing portion of our warehouses, and we plan to continue international growth. To prepare our consolidated financial statements, we must translate the financial statements of our international operations from local currencies into U.S. dollars using exchange rates for the current period. Future fluctuations in currency exchange rates over time that are unfavorable to us may adversely affect the financial performance of our Canadian and Other International operations and have a corresponding adverse period-over-period effect on our results of operations. As we continue to expand internationally, our exposure to fluctuations in foreign exchange rates may increase. We may pay for products we purchase for sale in our warehouses around the world with a currency other than the local currency of the country in which the goods will be sold. Currency fluctuations may increase our cost of goods and may not be passed on to members. Consequently, fluctuations in currency exchange rates may adversely affect our results of operations. Natural disasters or other catastrophes could negatively affect our business, financial condition, and results of operations. Natural disasters, such as hurricanes, typhoons or earthquakes, particularly in California or Washington state, where our centralized operating systems and administrative personnel are located, could negatively affect our operations and financial performance. Such events could result in physical damage to one or more of our properties, the temporary closure of one or more warehouses, depots, manufacturing or home office facilities, the temporary lack of an adequate work force in a market, the temporary or long-term disruption in the supply of products from some local or overseas suppliers, the temporary disruption in the transport of goods to or from overseas, delays in the delivery of goods to our warehouses or depots within the countries in which we operate, and the temporary reduction in the availability of products in our warehouses. Public health issues, whether occurring in the U.S. or abroad, could disrupt our operations, disrupt the operations of suppliers or members, or have an adverse impact on consumer spending and confidence levels. These events could also reduce demand for our products or make it difficult or impossible to procure products. We may be required to suspend operations in some or all of our locations, which could have a material adverse effect on our business, financial condition and results of operations. Factors associated with climate change could adversely affect our business. We use natural gas, diesel fuel, gasoline, and electricity in our distribution and warehouse operations. U.S. and foreign government regulations limiting carbon dioxide and other greenhouse gas emissions may result in increased compliance costs and legislation or regulation affecting energy inputs that could materially affect Item 1ARisk Factors (Continued) our profitability. Climate change could affect our ability to procure needed commodities at costs and in quantities we currently experience. We also sell a substantial amount of gasoline, the demand for which could be impacted by concerns about climate change and which could face increased regulation. Climate change may be associated with extreme weather conditions, such as more intense hurricanes, thunderstorms, tornadoes, and snow or ice storms, as well as rising sea levels. Failure to meet market expectations for our financial performance could adversely affect the market price and volatility of our stock. We believe that the price of our stock currently reflects high market expectations for our future operating results. Any failure to meet or delay in meeting these expectations, including our warehouse and e-commerce comparable sales growth rates, membership renewal rates, new member sign-ups, gross margin, earnings, earnings per share, new warehouse openings, or dividend or stock repurchase policies could cause the market price of our stock to decline. Legal and Regulatory Risks Our international operations subject us to risks associated with the legislative, judicial, accounting, regulatory, political and economic factors specific to the countries or regions in which we operate which could adversely affect our business, financial condition and results of operations. During 2017 , we operated 227 warehouses in 10 countries outside of the U.S., and we plan to continue expanding our international operations. Future operating results internationally could be negatively affected by a variety of factors, many similar to those we face in the U.S., certain of which are beyond our control. These factors include political and economic conditions, regulatory constraints, currency regulations, policy changes such as the U.K.'s vote to withdraw from the European Union, commonly known as ""Brexit"", and other matters in any of the countries or regions in which we operate, now or in the future. Other factors that may impact international operations include foreign trade, monetary and fiscal policies and the laws and regulations of the U.S. and foreign governments, agencies and similar organizations, and risks associated with having major facilities located in countries which have been historically less stable than the U.S. Risks inherent in international operations also include, among others, the costs and difficulties of managing international operations, adverse tax consequences, and greater difficulty in enforcing intellectual property rights. Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial condition and results of operations. Accounting principles and related pronouncements, implementation guidelines, and interpretations we apply to a wide range of matters that are relevant to our business, including, but not limited to, revenue recognition, merchandise inventories, vendor rebates and other vendor consideration, impairment of long-lived assets, self-insurance liabilities, and income taxes are highly complex and involve subjective assumptions, estimates and judgments by our management. Changes in these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported or expected financial performance. Provisions for losses related to self-insured risks are generally based upon independent actuarially determined estimates. The assumptions underlying the ultimate costs of existing claim losses can be highly unpredictable, which can affect the liability recorded for such claims. For example, variability in health care cost inflation rates inherent in these claims can affect the amounts recognized. Similarly, changes in legal trends and interpretations, as well as changes in the nature and method of how claims are settled can impact ultimate costs. Although our estimates of liabilities incurred do not anticipate significant changes in historical trends for these variables, any changes could have a considerable effect upon future claim costs and currently recorded liabilities and could materially impact our consolidated financial statements. Item 1ARisk Factors (Continued) We could be subject to additional income tax liabilities. We compute our income tax provision based on enacted tax rates in the countries in which we operate. As tax rates vary among countries, a change in earnings attributable to the various jurisdictions in which we operate could result in an unfavorable change in our overall tax provision. Additionally, changes in the enacted tax rates, adverse outcomes in tax audits, including transfer pricing disputes, or any change in the pronouncements relating to accounting for income taxes could have a material adverse effect on our financial condition and results of operations. Significant changes in, or failure to comply with, federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters could adversely impact our business, financial condition and results of operations. We are subject to a wide variety of federal, state, regional, local and international laws and regulations relating to the use, storage, discharge and disposal of hazardous materials, hazardous and non-hazardous wastes and other environmental matters. Failure to comply with these laws could result in harm to our members, employees or others, significant costs to satisfy environmental compliance, remediation or compensatory requirements, or the imposition of severe penalties or restrictions on operations by governmental agencies or courts that could adversely affect our business, financial condition and results of operations. We are involved in a number of legal proceedings and audits and some of these outcomes could adversely affect our business, financial condition and results of operations. Our business requires compliance with many laws and regulations. Failure to achieve compliance could subject us to lawsuits and other proceedings, and lead to damage awards, fines, penalties, and remediation costs. We are, or may become involved, in a number of legal proceedings and audits including grand jury investigations, government and agency investigations, and consumer, employment, tort, unclaimed property laws, and other litigation. We cannot predict with certainty the outcomes of these proceedings and other contingencies, including environmental remediation and other proceedings commenced by governmental authorities. The outcome of some of these proceedings, audits, unclaimed property laws, and other contingencies could require us to take, or refrain from taking, actions which could negatively affect our operations or could require us to pay substantial amounts of money, adversely affecting our financial condition and results of operations. Additionally, defending against these lawsuits and proceedings may involve significant expense and diversion of management ' s attention and resources. ", Item 1BUnresolved Staff Comments None. ," Item 2Properties Warehouse Properties At September 3, 2017 we operated 741 membership warehouses: Own Land and Building Lease Land and/or Building (1) Total United States and Puerto Rico Canada Mexico United Kingdom Japan Korea Taiwan Australia Spain Iceland France Total _______________ (1) 102 of the 154 leases are land-only leases, where Costco owns the building. The following schedule shows warehouse openings, net of closings and relocations, and expected openings through December 31, 2017 : United States Canada Other International Total Total Warehouses in Operation 2013 and prior 2014 2015 2016 2017 2018 (expected through 12/31/2017) Total At the end of fiscal 2017 , our warehouses contained approximately 107.3 million square feet of operating floor space: 75.4 million in the U.S.; 13.5 million in Canada; and 18.4 million in Other International. We operate depots for the consolidation and distribution of most merchandise shipments to the warehouses, and various processing, packaging, and other facilities to support ancillary and other businesses, including our online business. We operate 24 depots, consisting of approximately 11.0 million square feet. Our executive offices are located in Issaquah, Washington, and we maintain 18 regional offices in the U.S., Canada and Other International locations. ", Item 3Legal Proceedings See discussion of Legal Proceedings in Note 10 to the consolidated financial statements included in Item 8 of this Report. ," Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information and Dividend Policy Our common stock is traded on the NASDAQ Global Select Market under the symbol COST. On October 10, 2017 , we had 8,629 stockholders of record. The following table shows the quarterly high and low closing prices of our common stock as reported by NASDAQ for each quarter during the last two fiscal years and the quarterly cash dividend declared per share. Price Range Cash Dividends Declared High Low 2017: Fourth Quarter $ 182.20 $ 150.44 $ 0.500 Third Quarter 182.45 164.55 7.500 (1) Second Quarter 172.00 150.11 0.450 First Quarter 163.98 142.24 0.450 2016: Fourth Quarter 169.04 141.29 0.450 Third Quarter 158.25 146.44 0.450 Second Quarter 168.87 143.28 0.400 First Quarter 163.10 138.30 0.400 _______________ (1) Includes a special cash dividend of $7.00 per share. Payment of future dividends is subject to declaration by the Board of Directors. Factors considered in determining dividends include our profitability and expected capital needs. Subject to these qualifications, we presently expect to continue to pay dividends on a quarterly basis. Issuer Purchases of Equity Securities The following table sets forth information on our common stock repurchase program activity for the fourth quarter of fiscal 2017 (dollars in millions, except per share data): Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Program (1) Maximum Dollar Value of Shares that May Yet be Purchased under the Program May 8June 4, 2017 92,000 $171.87 92,000 $2,973 June 5July 2, 2017 573,000 162.00 573,000 $2,881 July 3July 30, 2017 451,000 155.06 451,000 $2,811 July 31September 3, 2017 396,000 156.95 396,000 $2,749 Total fourth quarter 1,512,000 $159.21 1,512,000 _______________ (1) The repurchase program is conducted under a $4,000 authorization approved by our Board of Directors in April 2015, which expires in April 2019. "," Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) OVERVIEW We believe that the most important driver of our profitability is sales growth, particularly comparable sales growth. We define comparable sales as sales from warehouses open for more than one year, including remodels, relocations and expansions, as well as online sales related to e-commerce websites operating for more than one year. Comparable sales growth is achieved through increasing shopping frequency from new and existing members and the amount they spend on each visit (average ticket). Sales comparisons can also be particularly influenced by certain factors that are beyond our control: fluctuations in currency exchange rates (with respect to the consolidation of the results of our international operations); and changes in the cost of gasoline and associated competitive conditions (primarily impacting our U.S. and Canadian operations). The higher our comparable sales exclusive of these items, the more we can leverage certain of our selling, general and administrative expenses, reducing them as a percentage of sales and enhancing profitability. Generating comparable sales growth is foremost a question of making available to our members the right merchandise at the right prices, a skill that we believe we have repeatedly demonstrated over the long term. Another substantial factor in sales growth is the health of the economies in which we do business, especially the United States. Sales growth and gross margins are also impacted by our competition, which is vigorous and widespread, across a wide range of global, national and regional wholesalers and retailers. While we cannot control or reliably predict general economic health or changes in competition, we believe that we have been successful historically in adapting our business to these changes, such as through adjustments to our pricing and to our merchandise mix, including increasing the penetration of our private label items. Our philosophy is to provide our members with quality goods and services at the most competitive prices. We do not focus in the short term on maximizing prices charged, but instead seek to maintain what we believe is a perception among our members of our pricing authority consistently providing the most competitive values. Our investments in merchandise pricing can, from time to time, include reducing prices on merchandise to drive sales or meet competition and holding prices steady despite cost increases instead of passing the increases on to our members, all negatively impacting near-term gross margin as a percentage of net sales (gross margin percentage). We believe that our gasoline business draws members but it generally has a significantly lower gross margin percentage relative to our non-gasoline business. A higher penetration of gasoline sales will generally lower our gross margin percentage. Rapidly changing gasoline prices may significantly impact our near-term net sales growth. Generally, rising gasoline prices benefit net sales growth which, given the higher sales base, negatively impacts our gross margin percentage but decreases our selling, general and administrative (SGA) expenses as a percentage of net sales. A decline in gasoline prices has the inverse effect. We operate our lower-margin gasoline business in all countries except Korea and France. We also achieve sales growth by opening new warehouses. As our warehouse base grows, available and desirable potential sites become more difficult to secure, and square footage growth becomes a comparatively less substantial component of growth. The negative aspects of such growth, however, including lower initial operating profitability relative to existing warehouses and cannibalization of sales at existing warehouses when openings occur in existing markets, are increasingly less significant relative to the results of our total operations. Our rate of square footage growth is generally higher in foreign markets, due to the smaller base in those markets, and we expect that to continue. Our e-commerce business growth both domestically and internationally has also increased our sales. Our membership format is an integral part of our business model and has a significant effect on our profitability. This format is designed to reinforce member loyalty and provide continuing fee revenue. The extent to which we achieve growth in our membership base, increase penetration of our Executive members, and sustain high renewal rates, materially influences our profitability. Our financial performance depends heavily on our ability to control costs. While we believe that we have achieved successes in this area historically, some significant costs are partially outside our control, most Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) particularly health care and utility expenses. With respect to expenses relating to the compensation of our employees, our philosophy is not to seek to minimize their wages and benefits. Rather, we believe that achieving our longer-term objectives of reducing employee turnover and enhancing employee satisfaction requires maintaining compensation levels that are better than the industry average for much of our workforce. This may cause us, for example, to absorb costs that other employers might seek to pass through to their workforces. Because our business is operated on very low gross margins, modest changes in various items in the income statement, particularly merchandise costs and SGA expenses, can have substantial impacts on net income. Our operating model is generally the same across our U.S., Canada, and Other International operating segments (see Note 11 to the consolidated financial statements included in Item 8 of this Report). Certain countries in the Other International segment have relatively higher rates of square footage growth, lower wages and benefit costs as a percentage of country sales, and/or less or no direct membership warehouse competition. In discussions of our consolidated operating results, we refer to the impact of changes in foreign currencies relative to the U.S. dollar, which are references to the differences between the foreign-exchange rates we use to convert the financial results of our international operations from local currencies into U.S. dollars for financial reporting purposes. This impact of foreign-exchange rate changes is calculated based on the difference between the current period's currency exchange rates and that of the comparable prior period. The impact of changes in gasoline prices on net sales is calculated based on the difference between the current period's average price per gallon sold and that of the comparable prior period. Our fiscal year ends on the Sunday closest to August 31. Fiscal year 2017 was a 53-week fiscal year ending on September 3, 2017 , while 2016 and 2015 were 52-week fiscal years ending on August 28, 2016 , and August 30, 2015 , respectively. Certain percentages presented are calculated using actual results prior to rounding. Unless otherwise noted, references to net income relate to net income attributable to Costco. Highlights for fiscal year 2017 included: We opened 26 net new warehouses in 2017 : 13 in the U.S., six in Canada, and seven in our Other International segment, compared to 29 net new warehouses in 2016 ; Net sales increased 9% to $126,172 , driven by a 4% increase in comparable sales, sales at new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017; Membership fee revenue increased 8% to $2,853 , primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fees in 2017 , the annual fee increase, and executive membership upgrades; Gross margin percentage decreased two basis points; SGA expenses as a percentage of net sales decreased 14 basis points, driven by lower costs associated with the co-branded credit card arrangement in the U.S.; Net income increased 14% to $2,679 , or $6.08 per diluted share compared to $2,350 , or $5.33 per diluted share in 2016 . The 2017 results were positively impacted by a $82 tax benefit, or $0.19 per diluted share, in connection with the special cash dividend paid to the Company's 401(k) Plan participants and other net benefits of approximately $51, or $0.07 per diluted share, for non-recurring net legal and other matters; In 2017, we re-paid long-term debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes; we issued $3,800 in aggregate principal amount of Senior Notes which funded a special cash dividend of $7.00 per share paid in May 2017 (approximately $3,100); and In April 2017, the Board of Directors approved an increase in the quarterly cash dividend from $0.45 to $0.50 per share. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) RESULTS OF OPERATIONS Net Sales Net Sales $ 126,172 $ 116,073 $ 113,666 Changes in net sales: U.S. % % % Canada % (2 )% (3 )% Other International % % % Total Company % % % Changes in comparable sales: U.S. % % % Canada % (3 )% (5 )% Other International % (3 )% (3 )% Total Company % % % Increases in comparable sales excluding the impact of changes in foreign currency and gasoline prices: U.S. % % % Canada % % % Other International % % % Total Company % % % 2017 vs. 2016 Net Sales Net sales increased $10,099 or 9% during 2017 , primarily due to a 4% increase in comparable sales, new warehouses opened in 2016 and 2017 , and the benefit of one additional week of sales in 2017 . Changes in gasoline prices positively impacted net sales by approximately $785, or 68 basis points, due to an 8% increase in the average sales price per gallon. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $295, or 25 basis points, compared to 2016 . The negative impact was driven by Other International operations, partially offset by positive impacts attributable to our Canadian operations. Comparable Sales Comparable sales increased 4% during 2017 and were positively impacted by an increase in shopping frequency and, to a lesser extent, an increased average ticket. The average ticket and comparable sales results were positively impacted by an increase in gasoline prices, offset by decreases in foreign currencies relative to the U.S. dollar. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). 2016 vs. 2015 Net Sales Net sales increased $2,407 or 2% during 2016. This was attributable to sales at new warehouses opened in 2015 and 2016. Comparable sales were flat. Changes in foreign currencies relative to the U.S. dollar negatively impacted net sales by approximately $2,690, or 237 basis points, compared to 2015. The negative impact was primarily attributable to our Canadian operations and within certain of our Other International Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) operations. Changes in gasoline prices negatively impacted net sales by approximately $2,194, or 193 basis points, due to a 19% decrease in the average sales price per gallon. Comparable Sales Comparable sales were flat during 2016, with an increase in shopping frequency offset by a decrease in the average ticket. The average ticket and comparable sales results were negatively impacted by changes in foreign currencies relative to the U.S. dollar and a decrease in gasoline prices. Changes in comparable sales includes the negative impact of cannibalization (established warehouses losing sales to our newly opened locations). Membership Fees Membership fees $ 2,853 $ 2,646 $ 2,533 Membership fees increase % % % Membership fees as a percentage of net sales 2.26 % 2.28 % 2.23 % 2017 vs. 2016 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses, an extra week of membership fee revenue, the annual fee increase (discussed below), and an increased number of upgrades to our higher-fee Executive Membership program. At the end of 2017 , our member renewal rates were 90% in the U.S. and Canada and 87% worldwide. In the first fiscal quarter of 2017, we increased our annual membership fees in certain of our Other International operations. Effective June 1, 2017, we also increased our annual membership fees in the U.S. and Canada for Gold Star (individual), Business and Business add-on by $5 to $60 and for Executive Membership from$110 to $120 (annual membership fee of $60, plus the Executive upgrade of $60); and the maximum 2% reward associated with Executive Membership increased from $750 to $1,000 annually. We account for membership fee revenue on a deferred basis, recognized ratably over the one-year membership period. These fee increases had a positive impact on membership fee revenues during 2017 of approximately $23 and will positively impact the next several quarters. We expect these increases to positively impact membership fee revenue by approximately $175 in fiscal 2018. 2016 vs. 2015 The increase in membership fees was primarily due to membership sign-ups at existing and new warehouses and increased upgrades to our higher-fee Executive Membership program. These increases were partially offset by changes in foreign currencies relative to the U.S. dollar, which negatively impacted fees by approximately $52 in 2016. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Gross Margin Net sales $ 126,172 $ 116,073 $ 113,666 Less merchandise costs 111,882 102,901 101,065 Gross margin $ 14,290 $ 13,172 $ 12,601 Gross margin percentage 11.33 % 11.35 % 11.09 % 2017 vs. 2016 The gross margin of our core merchandise categories (food and sundries, hardlines, softlines and fresh foods), when expressed as a percentage of core merchandise sales (rather than total net sales), increased eight basis points due to increases in these categories other than fresh foods. This measure eliminates the impact of changes in sales penetration and gross margins from our warehouse ancillary and other businesses. Total gross margin percentage decreased two basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, gross margin as a percentage of adjusted net sales was 11.40%, an increase of five basis points. This increase was primarily due to amounts earned under the co-branded credit card arrangement in the U.S. of 15 basis points and a benefit of three basis points from non-recurring legal settlements and other matters. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. Changes of comparable magnitude will not occur in subsequent years. These increases were partially offset by a six basis point decrease in our core merchandise categories, primarily due to food and sundries as a result of a decrease in sales penetration. The gross margin percentage was also negatively impacted by five basis points due to a LIFO benefit in 2016 and one basis point in warehouse ancillary and other businesses. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact on gross margin in 2017. Gross margin on a segment basis, when expressed as a percentage of the segment's own sales and excluding the impact of changes in gasoline prices on net sales (segment gross margin percentage), increased in our U.S. operations, due to amounts earned under the co-branded credit card arrangement and non-recurring legal settlements and other matters as discussed above. These increases were partially offset by a decrease in core merchandise categories, predominantly food and sundries as a result of a decrease in sales penetration, and a LIFO benefit in 2016. The segment gross margin percentage in our Canadian operations increased, primarily due to increases in warehouse ancillary and other businesses, primarily our pharmacy business, partially offset by a decrease in our core merchandise categories, largely fresh foods. The segment gross margin percentage increased in our Other International operations due to increases across all core merchandise categories, except fresh foods. 2016 vs. 2015 The gross margin of our core merchandise categories, when expressed as a percentage of core merchandise sales, increased 13 basis points, primarily due to increases in these categories other than fresh foods. Total gross margin percentage increased 26 basis points compared to 2015. Excluding the impact of gasoline price deflation on net sales, gross margin as a percentage of adjusted net sales was 11.14%, an increase of five basis points. A larger LIFO benefit in 2016 compared to 2015 positively contributed three basis points. The LIFO benefit resulted largely from lower costs for merchandise inventories, primarily in food and sundries and gasoline. Our core merchandise categories positively contributed one basis point, primarily due to an increase in hardlines, partially offset by food and sundries due to a decrease in sales penetration. Warehouse ancillary and other business gross margin positively contributed one basis point, primarily due to hearing aids and e-commerce businesses, partially offset by our gasoline business. Changes in foreign currencies relative to the U.S. dollar negatively impacted gross margin by approximately $286 in 2016. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Segment gross margin percentage increased in our U.S. operations predominantly due to a positive contribution from our core merchandise categories, primarily hardlines and softlines, and the LIFO benefit discussed above. The segment gross margin percentage in our Canadian operations decreased, primarily due to a decrease in all core merchandise categories, except hardlines, partially offset by increases in warehouse ancillary and other businesses, primarily pharmacy and e-commerce businesses. The segment gross margin percentage in Other International operations decreased in all merchandise categories, except fresh foods, which was higher. Selling, General and Administrative Expenses SGA expenses $ 12,950 $ 12,068 $ 11,445 SGA expenses as a percentage of net sales 10.26 % 10.40 % 10.07 % 2017 vs. 2016 SGA expenses as a percentage of net sales decreased 14 basis points compared to 2016. Excluding the impact of gasoline price inflation on net sales, SGA expenses as a percentage of adjusted net sales was 10.33%, a decrease of seven basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were lower by nine basis points, primarily due to lower costs associated with the co-branded credit card arrangement in the U.S. of 18 basis points. The improvement in terms in our current co-brand agreement as compared to the prior co-brand arrangement led to substantial year over year benefits in fiscal 2017. Changes of comparable magnitude will not occur in subsequent years. This was partially offset by higher payroll and employee benefit expenses of 11 basis points, primarily in our U.S. operations. Central operating costs were higher by one basis point, primarily due to increased costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations. Stock compensation expense was also higher by one basis point. Changes in foreign currencies relative to the U.S. dollar had an immaterial impact in 2017. 2016 vs. 2015 SGA expenses as a percentage of net sales increased 33 basis points compared to 2015. Excluding the negative impact of gasoline price deflation on net sales, SGA expenses as a percentage of adjusted net sales were 10.20%, an increase of 13 basis points. This was largely due to: higher central operating costs of six basis points, predominantly due to costs associated with our information systems modernization, including increased depreciation for projects placed in service, incurred by our U.S. operations; and higher stock compensation expense of four basis points, due to appreciation in the trading price of our stock at the time of grant. Charges for non-recurring legal and regulatory matters during 2016 negatively impacted SGA expenses by two basis points. Operating costs related to warehouses, ancillary, and other businesses, which includes e-commerce and travel, were higher by one basis point due to higher payroll and employee benefit costs, primarily health care, i n our U.S. operations. This increase was partially offset by lower payroll expense as a percentage of net sales in our Canadian operations. Changes in foreign currencies relative to the U.S. dollar decreased our SGA expenses by approximately $211 in 2016. Preopening Expenses Preopening expenses $ $ $ Warehouse openings, including relocations United States Canada Other International Total warehouse openings, including relocations 24 Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Preopening expenses include costs for startup operations related to new warehouses, including relocations, development in new international markets, and expansions at existing warehouses. In 2017, we entered into two new international markets, Iceland and France. Preopening expenses vary due to the number of warehouse openings, the timing of the opening relative to our year-end, whether the warehouse is owned or leased, and whether the opening is in an existing, new, or international market. Interest Expense Interest expense $ $ $ Interest expense primarily relates to Senior Notes issued by the Company (described in further detail under the heading Cash Flows from Financing Activities and in Note 4 to the consolidated financial statements included in Item 8 of this Report). Interest Income and Other, Net Interest income $ $ $ Foreign-currency transaction gains (losses), net (5 ) Other, net Interest income and other, net $ $ $ 2017 vs. 2016 Foreign-currency transaction gains (losses), net include the revaluation or settlement of monetary assets and liabilities and mark-to-market adjustments for forward foreign-exchange contracts by our Canadian and Other International operations. See Derivatives and Foreign Currency sections in Item 8, Note 1 of this Report. 2016 vs. 2015 The decrease in interest income in 2016 is attributable to lower average cash and investment balances, due in part to the payment of the outstanding principal balance and interest on the 0.65% Senior Notes in the second quarter of 2016. Provision for Income Taxes Provision for income taxes $ 1,325 $ 1,243 $ 1,195 Effective tax rate 32.8 % 34.3 % 33.2 % In 2017 and 2015, our provision was favorably impacted by net tax benefits of $104 and $68, respectively, primarily due to tax benefits recorded in connection with the May 2017 and February 2015 special cash dividends paid to employees through our 401(K) Retirement Plan of $82 and $57, respectively. These dividends are deductible for U.S. income tax purposes. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) LIQUIDITY AND CAPITAL RESOURCES The following table summarizes our significant sources and uses of cash and cash equivalents: Net cash provided by operating activities $ 6,726 $ 3,292 $ 4,285 Net cash used in investing activities (2,366 ) (2,345 ) (2,480 ) Net cash used in financing activities (3,218 ) (2,419 ) (2,324 ) Our primary sources of liquidity are cash flows generated from warehouse operations, cash and cash equivalents and short-term investments. Cash and cash equivalents and short-term investments were $5,779 and $4,729 at the end of 2017 and 2016 , respectively. Of these balances, approximately $1,255 and $1,071 represented unsettled credit and debit card receivables, respectively. These receivables generally settle within four days. Cash and cash equivalents were positively impacted by changes in exchange rates of $25 and $50 in 2017 and 2016, respectfully, and negatively impacted by $418 in 2015. We have not provided for U.S. deferred taxes on cumulative undistributed earnings of certain non-U.S. consolidated subsidiaries, including the remaining undistributed earnings of our Canadian operations, because our subsidiaries have invested or will invest the undistributed earnings indefinitely, or the earnings if repatriated would not result in an adverse tax consequence. Although we have historically asserted that certain non-U.S. undistributed earnings will be permanently reinvested, we may repatriate such earnings to the extent we can do so without an adverse tax consequence. If we determine that such earnings are no longer indefinitely reinvested, deferred taxes, to the extent required and applicable, are recorded at that time. During 2017, we changed our position regarding an additional portion of the undistributed earnings of our Canadian operations, as we determined such earnings could be repatriated without adverse tax consequences. Subsequent to the end of 2017, we repatriated a portion of our undistributed earnings in our Canadian operations without adverse tax consequences. Management believes that our cash position and operating cash flows will be sufficient to meet our liquidity and capital requirements for the foreseeable future. We believe that our U.S. current and projected asset position is sufficient to meet our U.S. liquidity requirements and have no current plans to repatriate for use in the U.S. cash and cash equivalents and short-term investments held by non-U.S. consolidated subsidiaries whose earnings are considered indefinitely reinvested. Cash and cash equivalents and short-term investments held at these subsidiaries with earnings considered to be indefinitely reinvested totaled $1,463 at September 3, 2017. Cash Flows from Operating Activities Net cash provided by operating activities totaled $6,726 in 2017 , compared to $3,292 in 2016 . Our cash flow provided by operations is primarily derived from net sales and membership fees. Cash flow used in operations generally consists of payments to our merchandise vendors, warehouse operating costs including payroll and employee benefits, utilities, and credit and debit card processing fees. Cash used in operations also includes payments for income taxes. The increase in net cash provided by operating activities for 2017 when compared to 2016 was primarily due to accelerated vendor payments of approximately $1,700 made in the last week of fiscal 2016, in advance of implementing our modernized accounting system. Cash Flows from Investing Activities Net cash used in investing activities totaled $2,366 in 2017 , compared to $2,345 in 2016 . Cash flow used in investing activities is primarily related to funding warehouse expansion and remodeling. Net cash flows from investing activities also includes purchases and maturities of short-term investments. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Capital Expenditure Plans Our primary requirement for capital is acquiring land, buildings, and equipment for new and remodeled warehouses. To a lesser extent, capital is required for initial warehouse operations, our information systems, and working capital. We opened 26 new warehous es and relocated 2 warehouses in 2017 and plan to open up to 24 new warehouses and relocate up to six warehouses in 2018 . In 2017 we spent $2,502 on capital expenditures, and it is our current intention to spend approximately $2,500 to $2,700 during fiscal 2018 . These expenditures are expected to be financed with cash from operations, existing cash and cash equivalents, and short-term investments. There can be no assurance that current expectations will be realized and plans are subject to change upon further review of our capital expenditure needs. Cash Flows from Financing Activities Net cash used in financing activities totaled $3,218 in 2017 , compared to $2,419 in 2016 . The primary uses of cash in 2017 were related to dividend payments, predominantly the special dividend paid in May 2017, and the repayments of debt totaling $2,200 representing the aggregate principal balances of the 5.5% and 1.125% Senior Notes. Net cash used in financing activities in 2016 includes a $1,200 repayment of our 0.65% Senior Notes in December 2015. In May 2017, we issued $3,800 in aggregate principal amount of Senior Notes. The proceeds received were net of a discount and used to pay the special cash dividend and a portion of the redemption of the 1.125% Senior Notes. Stock Repurchase Programs During 2017 and 2016 , we repurchased 2,998,000 and 3,184,000 shares of common stock, at average prices of $157.87 and $149.90 , totaling approximately $473 and $477 , respectively. The remaining amount available to be purchased under our approved plan was $2,749 at the end of 2017 . These amounts may differ from the stock repurchase balances in the accompanying consolidated statements of cash flows due to changes in unsettled stock repurchases at the end of each fiscal year. Purchases are made from time-to-time, as conditions warrant, in the open market or in block purchases and pursuant to plans under SEC Rule 10b5-1. Repurchased shares are retired, in accordance with the Washington Business Corporation Act. Dividends Cash dividends paid in 2017 totaled $8.90 per share, which included a special cash dividend of $7.00 per share, as compared to $1.70 per share in 2016 . In April 2017 , our Board of Directors increased our quarterly cash dividend from $0.45 to $0.50 per share. Bank Credit Facilities and Commercial Paper Programs We maintain bank credit facilities for working capital and general corporate purposes. At September 3, 2017, we had borrowing capacity under these facilities of $833, including a $400 revolving line of credit entered into by our U.S. operations in June 2017 with an expiration date of one year. The Company currently has no plans to draw upon the new revolving line of credit. Our international operations maintain $349 of the total borrowing capacity under bank credit facilities, of which $166 is guaranteed by the Company. There were no outstanding short-term borrowings under the bank credit facilities at the end of 2017 and 2016. The Company has letter of credit facilities, for commercial and standby letters of credit, totaling $181. The outstanding standby letters of credit under these facilities at the end of 2017 totaled $103 and expire within one year. The bank credit facilities have various expiration dates, all within one year, and we generally intend to renew these facilities prior to their expiration. The amount of borrowings available at any time under our bank credit facilities is reduced by the amount of standby and commercial letters of credit then outstanding. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Contractual Obligations At September 3, 2017 , our commitments to make future payments under contractual obligations were as follows: Payments Due by Fiscal Year Contractual obligations 2019 to 2020 2021 to 2022 2023 and thereafter Total Purchase obligations (merchandise) (1) $ 8,029 $ $ $ $ 8,035 Long-term debt (2) 2,060 2,588 2,650 7,528 Operating leases (3) 2,123 3,113 Construction and land obligations Capital lease obligations (4) Purchase obligations (equipment, services and other) (5) Other (6) Total $ 9,670 $ 2,774 $ 3,058 $ 5,427 $ 20,929 _______________ (1) Includes only open merchandise purchase orders. (2) Includes contractual interest payments and excludes deferred issuance costs. (3) Operating lease obligations exclude amounts for common area maintenance, taxes, and insurance and have been reduced by $112 to reflect sub-lease income. (4) Includes build-to-suit lease obligations and contractual interest payments. (5) The amounts exclude certain services negotiated at the individual warehouse or regional level that are not significant and generally contain clauses allowing for cancellation without significant penalty. (6) Includes asset retirement obligations, deferred compensation obligations and current liabilities for unrecognized tax contingencies. The total amount excludes $35 of non-current unrecognized tax contingencies and $29 of other obligations due to uncertainty regarding the timing of future cash payments. Off-Balance Sheet Arrangements In the opinion of management, we have no off-balance sheet arrangements that have had, or are reasonably likely to have, a material current or future effect on our financial condition or financial statements other than operating leases, included in the table above and discussed in Note 1 and Note 5 to the consolidated financial statements included in Item 8 of this Report. Critical Accounting Estimates The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (U.S. GAAP) requires that we make estimates and judgments, including those related to revenue recognition, merchandise inventory valuation, impairment of long-lived assets, insurance/self-insurance liabilities, and income taxes. We base our estimates on historical experience and on assumptions that we believe to be reasonable, and we continue to review and evaluate these estimates. For further information on significant accounting policies, see discussion in Note 1 to the consolidated financial statements included in Item 8 of this Report. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Revenue Recognition We generally recognize sales, which includes gross shipping fees where applicable, net of returns, at the time the member takes possession of merchandise or receives services. When we collect payment from members prior to the transfer of ownership of merchandise or the performance of services, the amount is generally recorded as deferred sales in the consolidated balance sheets until the sale or service is completed. We provide for estimated sales returns based on historical trends and reduce sales and merchandise costs accordingly. Our sales returns reserve is based on an estimate of the net realizable value of merchandise inventories to be returned. Amounts collected from members for sales and value added taxes are recorded on a net basis. We evaluate whether it is appropriate to record the gross amount of merchandise sales and related costs or a net amount. Generally, when we are the primary obligor, subject to inventory risk, have latitude in establishing prices and selecting suppliers, influence product or service specifications, or have several but not all of these indicators, revenue is recorded on a gross basis. If we are not the primary obligor and do not possess other indicators of gross reporting as noted above, we record a net amount, which is reflected in net sales. We account for membership fee revenue, net of refunds, on a deferred basis, whereby revenue is recognized ratably over one year. Our Executive members qualify for a 2% reward on qualified purchases (up to a maximum reward of approximately $1,000 per year in the U.S. and Canada and varies in our Other International operations), which can be redeemed only at Costco warehouses. We account for this reward as a reduction in sales. The sales reduction and corresponding liability are computed after giving effect to the estimated impact of non-redemptions, based on historical data. Merchandise Inventories Merchandise inventories are stated at the lower of cost or market. U.S. merchandise inventories are valued by the cost method of accounting, using the last-in, first-out (LIFO) basis. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. The Company records an adjustment each quarter, if necessary, for the projected annual effect of inflation or deflation, and these estimates are adjusted to actual results determined at year-end, after actual inflation rates and inventory levels for the year have been determined. Canadian and Other International merchandise inventories are predominantly valued using the cost and retail inventory methods, respectively, using the first-in, first-out (FIFO) basis. We provide for estimated inventory shrinkage between physical inventory counts as a percentage of net sales. The provision is adjusted to reflect results of the actual physical inventory counts, which generally occur in the second and fourth quarters. Inventory cost, where appropriate, is reduced by estimates of vendor rebates when earned or as we progress toward earning those rebates, provided they are probable and reasonably estimable. Other consideration received from vendors is generally recorded as a reduction of merchandise costs upon completion of contractual milestones, terms of agreement, or using other systematic approaches. Impairment of Long-Lived Assets We evaluate our long-lived assets for impairment on an annual basis, when relocating or closing a facility, or when events or changes in circumstances occur that may indicate the carrying amount may not be fully recoverable. Our judgments are based on existing market and operational conditions. Future events could cause us to conclude that impairment factors exist, requiring a downward adjustment of these assets to their then-current fair value. Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations (amounts in millions, except per share, share, membership fee, and warehouse count data) (Continued) Insurance/Self-Insurance Liabilities We are predominantly self-insured, with insurance coverage for certain catastrophic risks, for employee health care benefits, workers compensation, general liability, property damage, directors and officers liability, vehicle liability, and inventory loss. We use different mechanisms including a wholly-owned captive insurance subsidiary and participate in a reinsurance program. Liabilities associated with the risks that we retain are not discounted and are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. Income Taxes The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Significant judgment also is required in assessing the timing and amounts of deductible and taxable items and the probability of sustaining uncertain tax positions. The benefits associated with uncertain tax positions are recorded only after determining a more-likely-than-not probability that the positions will withstand challenge from tax authorities. When facts and circumstances change, we reassess these positions and record any changes in the consolidated financial statements as appropriate. Our cumulative foreign undistributed earnings, except the additional portion of earnings in Canada, were considered indefinitely reinvested as of September 3, 2017 . These earnings would be subject to U.S. income tax if we changed our position and could result in a U.S. deferred tax liability. Although we have historically asserted that certain non-U.S. undistributed earnings will be permanently reinvested, we may repatriate such earnings to the extent we can do so without an adverse tax consequence. Recent Accounting Pronouncements See Note 1 to the consolidated financial statements included in Item 8 of this Report for a detailed description of recent accounting pronouncements. "," Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) Our exposure to financial market risk results from fluctuations in interest rates and foreign currency exchange rates. We do not engage in speculative or leveraged transactions or hold or issue financial instruments for trading purposes. Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our investment holdings that are diversified among various instruments considered to be cash equivalents as defined in Note 1 to the consolidated financial statements included in Item 8 of this Report, as well as short-term investments in government and agency securities, and asset and mortgage-backed securities with effective maturities of generally three months to five years at the date of purchase. The primary objective of our investment activities is to preserve principal and secondarily to generate yields. The majority of our short-term investments are in fixed interest rate securities. These securities are subject to changes in fair value due to interest rate fluctuations. Our policy limits investments in the U.S. to direct U.S. government and government agency obligations, repurchase agreements collateralized by U.S. government and government agency obligations, and U.S. government and government agency money market funds. Our wholly-owned captive insurance subsidiary invests in U.S. government and government agency obligations and U.S. government and government agency money market funds. Our Canadian and Other International subsidiaries investments are primarily in money market funds, bankers acceptances, and bank certificates of deposit, generally denominated in local currencies. A 100 basis-point change in interest rates as of the end of 2017 would have an incremental change in fair market value of $20. For those investments that are classified as available-for-sale, the unrealized gains or Item 7AQuantitative and Qualitative Disclosures About Market Risk (amounts in millions) (Continued) losses related to fluctuations in market volatility and interest rates are reflected within stockholders equity in accumulated other comprehensive income. The nature and amount of our long-term debt may vary as a result of business requirements, market conditions, and other factors. As of the end of 2017 , the majority of our long-term debt has fixed interest rates and is carried at $6,632 . Fluctuations in interest rates may affect the fair value of the fixed-rate debt. See Note 4 to the consolidated financial statements included in Item 8 of this Report for more information on our long-term debt. Foreign Currency-Exchange Risk Our foreign subsidiaries conduct certain transactions in their non-functional currencies, which exposes us to fluctuations in exchange rates. We manage these fluctuations, in part, through the use of forward foreign-exchange contracts, seeking to economically hedge the impact of these fluctuations on known future expenditures denominated in a non-functional foreign-currency. The contracts are intended primarily to economically hedge exposure to U.S. dollar merchandise inventory expenditures made by our international subsidiaries whose functional currency is other than the U.S. dollar. Currently, these contracts do not qualify for derivative hedge accounting. We seek to mitigate risk with the use of these contracts and do not intend to engage in speculative transactions. These contracts do not contain any credit-risk-related contingent features. We seek to manage counterparty risk associated with these contracts by limiting transactions to counterparties with which we have established banking relationships. There can be no assurance that this practice is effective. These contracts are limited to less than one year. See Note 1 and Note 3 to the consolidated financial statements included in Item 8 of this Report for additional information on the fair value of unsettled forward foreign-exchange contracts at the end of 2017 and 2016 . A hypothetical 10% strengthening of the functional currency compared to the non-functional currency exchange rates at September 3, 2017 would have decreased the fair value of the contracts by $69 and resulted in an unrealized loss in the consolidated statements of income for the same amount. Commodity Price Risk We are exposed to fluctuations in prices for energy that we consume, particularly electricity and natural gas, which we seek to partially mitigate through fixed-price contracts for certain of our warehouses and other facilities, predominantly in the U.S. and Canada. We also enter into variable-priced contracts for some purchases of electricity and natural gas, in addition to fuel for our gas stations, on an index basis. These contracts meet the characteristics of derivative instruments, but generally qualify for the normal purchases or normal sales exception under authoritative guidance and require no mark-to-market adjustment. "," Item 8Financial Statements and Supplementary Data The following documents are filed as part of Item 8 of this Report on the pages listed below: Page Reports of Independent Registered Public Accounting Firm Consolidated Balance Sheets, as of September 3, 2017 and August 28, 2016 Consolidated Statements of Income, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Comprehensive Income, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Equity, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Consolidated Statements of Cash Flows, for the 53 weeks ended September 3, 2017 and 52 weeks ended August 28, 2016 and August 30, 2015 Notes to Consolidated Financial Statements Managements Report on the Consolidated Financial Statements Costcos management is responsible for the preparation, integrity and objectivity of the accompanying consolidated financial statements and the related financial information. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (U.S. GAAP) and necessarily include certain amounts that are based on estimates and informed judgments. The Companys management is also responsible for the preparation of the related financial information included in this Annual Report on Form 10-K and its accuracy and consistency with the consolidated financial statements. The consolidated financial statements have been audited by KPMG LLP, an independent registered public accounting firm, who conducted their audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). The independent registered public accounting firms responsibility is to express an opinion as to the fairness with which such consolidated financial statements present our financial position, results of operations and cash flows in accordance with U.S. GAAP. "," Item 9AControls and Procedures Disclosure Controls and Procedures As of the end of the period covered by this Annual Report on Form 10-K, we performed an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities and Exchange Act of 1934 (the Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Annual Report, our disclosure controls and procedures are effective. There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) during our fiscal quarter ended September 3, 2017 , that has materially affected or is reasonably likely to materially affect our internal control over financial reporting. Managements Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting Item 9AControls and Procedures (Continued) is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and the dispositions of our assets; (2) provide reasonable assurance that our transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that our receipts and expenditures are being made only in accordance with appropriate authorizations; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Under the supervision and with the participation of our management, we assessed the effectiveness of our internal control over financial reporting as of September 3, 2017 , using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework (2013). Based on its assessment, management has concluded that our internal control over financial reporting was effective as of September 3, 2017 . The attestation of KPMG LLP, our independent registered public accounting firm, on the effectiveness of our internal control over financial reporting is included with the consolidated financial statements in Item 8 of this Report. /s/ W. C RAIG J ELINEK W. Craig Jelinek President, Chief Executive Officer and Director /s/ R ICHARD A. G ALANTI Richard A. Galanti Executive Vice President, Chief Financial Officer and Director " diff --git a/datasets/raw/mastercard.csv b/datasets/raw/mastercard.csv new file mode 100644 index 0000000..08d5374 --- /dev/null +++ b/datasets/raw/mastercard.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,ma-2,20211231," ITEM 1. BUSINESS Item 1. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through our unique and proprietary core global payments network, we switch (authorize, clear and settle) payment transactions. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, we offer integrated payment products and services and capture new payment flows. Our value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on our principled use of consumer and merchant data . Our franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. Our payment solutions are designed to ensure safety and security for the global payments ecosystem. For a full discussion of our business, please see page 9. Our Performance The following are our key financial and operational highlights for 2021, including growth rates over the prior year: GAAP Net revenue Net income Diluted EPS $18.9B $8.7B $8.76 up 23% up 35% up 38% Non-GAAP 1 (currency-neutral) Net revenue Adjusted net income Adjusted diluted EPS $18.9B $8.3B $8.40 up 22% up 28% up 30% $7.6B $5.9B Repurchased shares $9.5B in capital returned to stockholders $1.7B Dividends paid cash flows from operations Gross dollar volume (growth on a local currency basis) Cross-border volume growth (on a local currency basis) Switched transactions $7.7T up 32% 112.1B up 21% up 25% 1 Non-GAAP results exclude the impact of gains and losses on equity investments, Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. For a full discussion of our results of operations, including impacts of the COVID-19 pandemic, see Managements Discussion and Analysis of Financial Condition and Results of Operations in Item II, Part 7. 6 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Strategy We remain committed to our strategy to grow our core payments network, diversify our customers and geographies and build new capabilities through a combination of organic and inorganic strategic initiatives. We are executing on this strategy through a focus on three key priorities: expand in payments for consumers, businesses and governments extend our services to enhance transactions and drive customer value embrace new network opportunities to enable open banking, digital identity and other adjacent network capabilities Each of our priorities supports and builds upon each other and are fundamentally interdependent. Our Key Strategic Priorities Expand in payments. We continue to focus on expanding upon our core payments network to enable payment flows for consumers, businesses, governments and others, providing them with choice and flexibility to transact across multiple payment rails (including cards, real-time payments and account-to-account) while ensuring that all payments are done safely, securely and seamlessly. We do so by: Driving growth in consumer purchases with a focus on accelerating digitization, growing acceptance and pursuing an expanded set of use cases, including through partnerships MASTERCARD 2021 FORM 10-K 7 PART I ITEM 1. BUSINESS Capturing new payment flows by expanding our multi-rail capabilities and applications to penetrate key flows such as disbursements and remittances (through Mastercard Send and Cross-Border Services), business-to-business (B2B) (including Mastercard Track Business Payment Service (Track BPS) and areas beyond payments such as enablement of supply chain financing) and consumer bill payments Leaning into new payment innovations such as our planned launch in 2022 of Mastercard Installments, our buy-now-pay-later solution, and developing solutions that support digital currencies and blockchain applications Extend our services. Our services drive value for our customers and the broader payments ecosystem. We continue to do that as well as diversify our business, by extending our services, which include cyber and intelligence solutions, insights and analytics, test and learn, consulting, managed services, loyalty, processing and payment gateway solutions for e-commerce merchants. As we drive value, our services help accelerate our top-line financial performance by supporting revenue growth in our core payments network. We extend our services by: Enhancing the value of payments by making payments safe, secure, intelligent and seamless Expanding services to new segments and use cases to address the needs of a larger set of customers, including financial institutions, merchants, governments, digital players and others, while expanding our geographic reach Supporting and strengthening new network capabilities, including expanding services associated with digital identities and deploying our expertise in open banking and open data, including with improved analytics Embrace new network opportunities. We are building and managing new adjacent network capabilities to power commerce, creating new opportunities to develop and embed services. We do so by: Applying our open banking solutions to help institutions and individuals exchange data securely and easily, by enabling the reliable access, transmission and management of consumer data (including for opening new accounts, securing loans, increasing credit scores and enabling consumer choice in money movement and personal finance management) Enabling digital identity solutions , including device intelligence, document proofing, internet protocol (IP) intelligence, biometrics, transaction fraud data, location, identity attributes and payment authorization to make transactions across individual devices and accounts efficient, safe and secure Each of our priorities supports and builds upon each other and are fundamentally interdependent: Payments provide data and distribution to drive scale and differentiation in services and enable the development and adoption of new network capabilities Services improve the security, efficiency and intelligence of payments, improve portfolio performance, differentiate our offerings and strengthen our customer relationships. They also power our open banking and digital identity platforms New network opportunities strengthen our digital payments value proposition, including improved authentication with digital identity, and new opportunities to develop and embed services in our expanding product offerings Powering Our Success These priorities are supported by six key drivers: People. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries. Our people and our winning culture is based on decency, respect and inclusion where people have opportunities to perform purpose-driven work that impacts communities, customers and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Brand. Our brands and brand identities (including our sonic brand identity) serve as a differentiator for our business, representing our values and enabling us to accelerate growth in new areas. Data. We use our data assets, infrastructure and platforms to create a range of products and services for our customers, while incorporating our data principles in how we design, implement and deliver those solutions. Our Privacy by Design and Data by Design processes have been developed to ensure we embed privacy, security and data controls in all of our products and services, keeping a clear focus on protecting customers and individuals data. Technology. Our technology provides resiliency, scalability and flexibility in how we serve customers. It enables broader reach to scale digital payment services to multiple channels, including mobile devices. Our technology standards, services and governance model help us to serve as the connection that allows financial institutions, financial technology companies (fintechs) and others to interoperate and enable consumers, businesses, governments and merchants to engage through digital channels. 8 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Franchise. We manage an ecosystem of stakeholders who participate in our network. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We provide a balanced ecosystem where all participants benefit from the availability, innovation and safety and security of our network and platforms. Our franchise enables the scale of our payments network and helps ensure our multiple payment capabilities operate under a single governance structure, which can be extended to new opportunities. Doing Well by Doing Good. We apply the full breadth of our technology, insights, partnerships and people to build a more financially inclusive and sustainable digital economy, with a commitment to diversity, equity and inclusion and a focus on a sustainable future. We are committed to our core values of operating ethically, responsibly and with decency. This commitment is directly connected to our continuing success as a business. We refer you to our most recently published Sustainability Report and Proxy Statement (each located on our website) for our efforts and initiatives in the area of sustainability. Our Business Our Multi-Rail Network and Payment Capabilities We enable a wide variety of payment capabilities (including integrated products and value-added service solutions) over our multi-rail network among account holders, merchants, financial institutions, businesses, governments and others, offering our customers one partner for their payment needs. Core Network Our core network links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at tens of millions of acceptance locations worldwide. This network facilitates an efficient, safe and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We enable transactions for our customers through our core network in more than 150 currencies and in more than 210 countries and territories. MASTERCARD 2021 FORM 10-K 9 PART I ITEM 1. BUSINESS Core Network Transactions. Our core network supports what is often referred to as a four-party payments network and includes the following participants: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. The following graphic depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below) and other applicable fees, and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs and benefits that consumers and merchants derive. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for the customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate. Issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and settle the transaction by facilitating the exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and country of issuance are different (cross-border transactions), providing account holders with the ability to use, and merchants 10 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the country of issuance are the same (domestic transactions). We switch over 60% of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers or the availability of unspent prepaid account holder account balances. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture that enables the network to adapt to the needs of each transaction. The network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring, tokenization services, etc.) to appropriate transactions in real time. This architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Additional Payment Capabilities ACH Batch and Real-Time Account-Based Payments Infrastructure and Applications. We offer ACH batch and real-time account-based payments capabilities, enabling payments for ACH transactions between bank accounts in real-time. These capabilities provide consumers and businesses the ability to make instant (faster) payments while providing enhanced data and messaging capabilities. We build, implement, enhance and operate real-time clearing and settlement infrastructure, payment platforms and direct debit systems for jurisdictions globally. As of December 31, 2021, we either operated or were implementing real-time payments infrastructure in 12 of the top 50 markets as measured by GDP. We also apply our real-time payments capabilities to new payment flows, such as consumer bill payments using our real-time bill pay solutions. Account to Account. We enable consumers, businesses, governments and merchants to send and receive money directly from account to account. We apply these capabilities to help these stakeholders with various disbursements and remittances. We discuss below under Our Payment Products and Applications the ways in which we apply our real-time account-based and account to account payment capabilities to capture new payment flows. Security and Franchise Payments System Security. We have a multi-layered approach to protect the global payments ecosystem. As part of this approach, we have a robust program to protect our network from cyber and information security threats. Our network and platforms incorporate multiple layers of protection, providing greater resiliency and best-in-class security protection. Our programs are assessed by third parties and incorporate benchmarking and other data from peer companies and consultants. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, an enterprise resilience program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. Through the combined efforts of our Security Operations Centers, Fusion Centers and the Mastercard Intelligence Center, we work with experts across the organization (as well as through other sources such as public-private partnerships) to monitor and respond quickly to a range of cyber and physical threats. As another feature of our multi-layered approach to protect the global payments ecosystem, we work with issuers, acquirers, merchants, governments and payments industry associations to develop and put in place technical standards (such as EMV standards for chips and smart payment cards) for safe and secure transactions and we provide solutions and products that are designed to ensure safety and security for the global payments ecosystem. We discuss specific cyber and intelligence solutions that we offer to our customers in Our Value-Added Services. Our Franchise. We manage an ecosystem of stakeholders that participate in our network and payments platforms. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We ensure a balanced ecosystem where all participants benefit from the availability, innovation, safety and security of our network. We achieve this through the following key activities: Participant Onboarding. We ensure the capability of new customers to use our network and define the roles and responsibilities for their operations once on the network Safety and Security. We establish the core principles, including ensuring consumer protections and integrity, so participants feel confident to transact on the network Operating Standards. We define the operational, technical and financial policies to which network participants are required to adhere MASTERCARD 2021 FORM 10-K 11 PART I ITEM 1. BUSINESS Responsible Stewardship. We establish performance standards to support ecosystem growth and optimization and establish proactive monitoring to ensure participant performance Issue Resolution. We operate a framework to enable the resolution of disputes for both customers and consumers Our Payment Products and Applications We provide a wide variety of integrated products and services that support payment products that customers can offer to consumers and merchants. These offerings facilitate transactions across our multi-rail payments network and platforms among account holders, merchants, financial institutions, digital partners, businesses, governments and other organizations in markets globally. Core Payment Products Consumer Credit. We offer a number of products that enable issuers to provide consumers with credit, allowing them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. How We Benefit Consumers We enable our customers to benefit consumers by: making electronic payments more convenient, secure and efficient delivering better, seamless consumer experiences providing consumers choice, empowering them to make and receive payments in the ways that best meet their daily needs protecting consumers and all other participants in a transaction, as well as consumer data providing loyalty rewards Consumer Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid accounts are a type of electronic payment that enables consumers to pay in advance whether or not they previously had a bank account or a credit history. These accounts can be tailored to meet specific program, customer or consumer needs, such as paying bills, sending person-to-person payments or withdrawing cash from an ATM. Our focus ranges from digital accounts (such as fintech and gig economy platforms) to business programs such as employee payroll, health savings accounts and solutions for small business owners. Our prepaid programs also offer opportunities in the private and public sectors to drive financial inclusion of previously unbanked individuals through social security payments, unemployment benefits and salary cards. We also provide prepaid program management services, primarily outside of the United States, that provide processing and end-to-end services on behalf of issuers or distributor partners such as airlines, foreign exchange bureaus and travel agents. Commercial Credit and Debit. We offer commercial credit and debit payment products and solutions that meet the payment needs of large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our point of sale offerings include small business (debit and credit), travel and entertainment, purchasing cards and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our virtual card offerings, supported by our Mastercard In Control platform, generate virtual account numbers which provide businesses with enhanced controls, more security and better data. 12 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS The following chart provides gross dollar volume (GDV) and number of cards featuring our brands in 2021 for select programs and solutions: Year Ended December 31, 2021 As of December 31, 2021 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2020 Mastercard-branded Programs 1,2 Consumer Credit $ 2,899 18 % 38 % 968 9 % Consumer Debit and Prepaid 3,953 22 % 51 % 1,509 13 % Commercial Credit and Debit 867 25 % 11 % 111 11 % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. New Payment Flows We offer platforms that apply our payment capabilities to support and capture new payment flows beyond cards. Disbursements and Remittances. We offer applications that enable consumers, businesses, governments and merchants to send and receive money domestically and across borders with greater speed and ease. Using Mastercard Send, we partner with digital messaging and payment platforms to enable consumers to send and receive money directly within applications. We partner with central banks, fintechs and financial institutions to help governments and nonprofits more efficiently enable, as applicable, distribution of social and economic assistance and business-to-consumer (B2C) disbursements. Mastercard Cross-Border Services enables a wide range of payment flows and use cases to customers, including trade payments, remittances and disbursements. These flows are enabled via a distribution network with a single point of access that allows financial institutions, fintechs and digital partners to send and receive money globally through multiple channels, including bank accounts, mobile wallets, cards and cash payouts. B2B Payments. We continue to focus on developing solutions to address ways that businesses move money, building on our point of sale capabilities to capture B2B payments. We offer B2B solutions globally that optimize customer choice, enabling payments through card, ACH and real-time payment rails. Mastercard Track BPS, our two-sided open-loop commercial service platform, is aimed at improving the way businesses pay and get paid by simplifying and automating payments between suppliers and buyers. It provides a single connection enabling access to multiple payment rails, providing greater control, richer data and working capital optimization capabilities to enhance B2B transactions for both buyers and suppliers. Track BPS leverages multiple payment options, including both real-time payments and batch ACH, as well as our core network. Consumer Bill Payments. We offer applications including those that make it easier for consumers and small businesses to present, view, manage and pay their bills through their online or mobile banking apps. Payments can be made in a variety of ways, using cards, real-time payments or batch ACH payments through a digital interface, providing a convenient, secure and paperless means to manage household bills in one place. Our bill pay solutions, which include Bill Pay Exchange, provide an open, Application Programming Interface (API) based bill pay network that leverages real-time messaging to connect consumers with billers and merchants through the home banking channel. We also provide real-time bill pay solutions as well as clearing and instant payment services. Our solutions enable enhanced biller setup and expanded bill presentment. They facilitate payment choice using multiple payment rails (including real-time account-based payments) and deliver immediate payment confirmation, providing an experience that benefits consumers, financial institutions and billers. MASTERCARD 2021 FORM 10-K 13 PART I ITEM 1. BUSINESS Innovation and Technology Our innovation capabilities and our technology provide resiliency, scalability and flexibility in how we serve customers. They enable broader reach to scale digital payment services across multiple channels, including mobile devices. Our technology standards, services and governance model help us to serve as the connection that allows financial institutions, fintechs and technology companies to interoperate and enable consumers, businesses, governments and merchants to engage through digital channels. Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base. Our contactless payment solutions help deliver a simple and intuitive way to pay, as well as health and safety benefits when consumers are looking for low-touch options Key 2021 Developments During 2021, we announced the expansion of several programs that enabled consumers to either use their cards to purchase cryptocurrencies or to convert their cryptocurrencies back into fiat currencies at their respective financial institutions. During 2021, we announced Mastercard Installments, our new open loop solution to deliver buy-now-pay-later installments capabilities at scale. The solution connects lenders with merchants across our acceptance network to provide buy-now-pay-later options for consumers. The program is expected to launch in 2022. Our Click to Pay checkout experience is designed to provide consumers the same convenience and security in a digital environment that they have when paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. This experience is based on the EMV Secure Remote Commerce industry standard that enables a faster, more secure checkout experience across web and mobile sites, mobile apps and connected devices Our Digital First Card program enables customers to offer their cardholders a fully digital payment experience with an optional physical card, meeting cardholder expectations of immediacy, safety and convenience during card application, authentication and instant card access, securing purchases (whether contactless, in-store, in-app or via the web) and managing alerts, controls and benefits Our Digital Doors program helps small businesses establish and protect an online presence, including accepting digital payments Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class APIs across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Foundry (formerly known as Mastercard Labs), we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. 14 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Value-Added Services Our services encompass a wide-ranging portfolio of value-added and differentiating capabilities that: instill trust in the ecosystem to allow parties to transact and operate with confidence provide actionable insights to our customers to assist in their decision making enable our customers to strengthen their engagement with their own end-users enable connectivity and access for a fragmented and diverse set of parties Cyber and Intelligence Solutions As part of the security we bring to the payments ecosystem, we offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer is designed to protect against attacks on infrastructure, devices and data. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Our solutions include SafetyNet, which protects financial institutions by helping to stop real-time attacks that are visible in the network, but not easily detected by financial institutions. The Identify layer allows us to help banks and merchants verify the authenticity of consumers during the payment process using various biometric technologies, including fingerprint, face and iris scanning, and behavioral user data assessment technology to verify online purchases on mobile devices, as well as a card with biometric technology built in. Key 2021 Developments We acquired CipherTrace, a leading digital currency intelligence platform that can map and trace blockchain-based transactions between entities, providing greater transparency and helping manage regulatory and compliance obligations. We became the first company to announce the retirement of legacy magnetic stripe technology enabling us to focus on technologies, such as chip and contactless, which provide increased security. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Our offerings in this space include alerts when accounts are exposed to data breaches or security incidents, fraud scoring technology that scans billions of dollars of money flows each day while increasing approvals and reducing false declines, and network-level monitoring on a global scale to help detect the occurrence of widespread fraud attacks when the customer (or their processor) may be unable to detect or defend against them. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions (enhancing approvals for online and card-on-file payments) to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include solutions for consumer alerts and controls and a suite of digital token services. We also offer an e-commerce fraud and dispute management network that enables merchants to stop delivery when a fraudulent or disputed transaction is identified, and issuers to refund the cardholder to avoid the chargeback process. The Network layer extends the services we provide to transactions in the payments ecosystem and across all of our rails, including decision intelligence and tokenization capabilities, to help secure our customers and transactions on a real-time basis. Moreover, we use our artificial intelligence (AI) and data analytics, along with our cyber risk assessment capabilities, to help financial institutions, merchants, corporations and governments secure their digital assets across each of these five layers. We have also worked with our customers to provide products to consumers globally with increased confidence through the benefit of zero liability, where the consumer bears no responsibility for counterfeit or lost card losses in the event of fraud. MASTERCARD 2021 FORM 10-K 15 PART I ITEM 1. BUSINESS Insights, Analytics and Test and Learn Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. We offer business intelligence to monitor key performance indicators (KPIs) and benchmark performance through self-service digital platforms, tools, and reports for financial institutions, merchants and others. We enable clients to better understand consumer behavior and improve segmentation and targeting by using our anonymized and aggregated data assets, third-party data and AI technologies. Through our Test Learn software as a service platform, we can help our customers accurately measure the impact of their decisions and improve them by leveraging data analytics to conduct disciplined business experiments for in-market tests to drive more profitable decision making. Consulting and Innovation We provide advisory services that help clients make better decisions and improve performance. By observing patterns of payments behavior based on billions of transactions switched globally, we are able to leverage anonymized and aggregated information to provide advice based on data. We also utilize our expertise, digital technology, innovation tools, methodologies and processes to collaborate with, and increasingly drive innovation at, financial institutions, merchants and governments. Through our global innovation and development arm, Mastercard Foundry, we offer Launchpad, a five-day app prototyping workshop, as well as other customized innovation programs such as in-lab usability testing and concept design. Managed Services We deliver marketing services, digital implementation and program management with performance-based solutions at every stage of the consumer lifecycle to assist our customers in implementing actions based on insights and driving adoption and usage. These services include developing messaging, targeting key groups, launching campaigns and training staff, all of which help our customers drive engagement and portfolio profitability. Issuer and Merchant Loyalty We have built a scalable rewards platform that enables issuers to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. We also provide a loyalty platform that enables stronger relationships with retailers, restaurants, airlines and consumer packaged goods companies by creating experiences that drive loyalty and impactful consumer engagement. Processing and Gateway We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions 16 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Our Expanded Network Capabilities Open Banking We offer an open banking platform that enables data providers and third parties, on a permissioned basis, to reliably access, securely transmit and confidently manage consumer data to improve the customer experience. Our platform enables consumers to have choice of financial services, providing them the ability to access, control and benefit from the use of their data, as well as an improved payment experience. Our platform is also used to serve the needs of the lending market, including through streamlining loan application processes and improving credit decisioning, thereby driving further financial inclusion. The network connections that underpin this platform leverage our data principles (including data usage guardrails, consumer protection and consent management), as well as API technology. Digital Identity We enable digital identity solutions, which provide smooth digital experiences and strengthen and secure digital payments across individuals, devices and accounts. Our digital identity capabilities focus on the identity of people, devices and transactions. They embody privacy by design principles and are consent-centric. Our solutions include device intelligence and behavioral biometrics (to determine whether the user is genuine or a fraudulent device), document proofing, IP intelligence, biometrics, transaction fraud data (from which we derive insights that can be used to significantly improve the global approval rate of transactions), location, identity attributes and payment authorization. Key 2021 Developments We acquired Ekata, Inc., a leader in digital identity verification solutions, broadening our fraud prevention and digital identity verification programs by adding Ekata's identity verification data, machine learning technology and global experience. Our People As of December 31, 2021, we employed approximately 24,000 persons globally. Our employee base is predominantly full-time and approximately 65% were employed outside of the United States in more than 80 countries around the world. We also had approximately 3,900 contractors which we used to supplement our employee base in order to meet specific needs. Our voluntary workforce turnover (rolling 12-month attrition) was 11% as of December 31, 2021. The total cost of our workforce for the year ended December 31, 2021 was $4.5 billion, which primarily consists of compensation, benefits and other personnel- and contractor-related costs. We provide more detailed information regarding our employees, including additional workforce demographics such as gender and racial/ethnic representation, in our Sustainability Report, our Proxy Statement, our Global Inclusion Report and our U.S. Consolidated EEO-1 Report, all of which are located on our website. We continue to support our employees during the ongoing global COVID-19 pandemic. We have extended a variety of global COVID-related employee benefits through 2022, including flexible hybrid working arrangements and additional paid time off due to illness, to get vaccinated, or to tend to childcare or eldercare-related demands. Our focus remains on the safety and well-being of our employees while maintaining health and safety protocols at each office location. Management reviews our people strategy and culture, as well as related risks, with our Human Resources and Compensation Committee on a quarterly basis, and annually with our Board of Directors. Additionally, our Board of Directors and our Board committees are tasked with overseeing other human capital management matters on a regular basis, such as ensuring processes are in place for maintaining an ethical corporate culture, overseeing key diversity initiatives, policies and practices, and monitoring governance trends in areas such as human rights. Our ability to attract, retain and engage top talent and build a culture centered around decency, with an overall focus on diversity, equity and inclusion (DEI), is critical to our business strategy. Specifically, to enable our business strategy effectively, our aim is to: attract talent with the key skills needed develop and retain an agile workforce that is able to compete in a fast-paced, digitally native and innovative environment and build on our DEI efforts to support our employees MASTERCARD 2021 FORM 10-K 17 PART I ITEM 1. BUSINESS Attract talent. Leveraging the strength of our brand, we attract talent through acquisitions, workforce planning and recruitment that incorporates a variety of sources. Develop and retain talent. Our efforts to develop and retain our employees include: An annual cycle that is focused on objective setting, performance assessment, talent evaluation, skill development, opportunities and career progression Succession planning for key roles, including talent and leadership programs across various levels. These programs embed our culture principles, include diverse populations and aim to develop talent and managerial skills through personalized coaching and group executive development Learning opportunities, such as Learning Academies that support our corporate business strategy and priorities and offer programs aligned to regional priorities Mentorship programs that give mentees tools and resources to help build and enhance their skills, inspire personal growth, overcome dilemmas, foster inclusion and support well-being A competitive compensation approach under which eligible employees across multiple job levels can receive long-term incentive equity awards Holistic physical, mental, professional and other benefits to our employees and their families to provide support when and where they need it Contributions to employees financial well-being as they plan for retirement. All employees globally are entitled to receive a matching Company contribution of $1.67 for every $1 contributed to a 401(k) or other retirement plan on the first 6% of base pay Support for charitable contributions of our employees time and money. We support employee charitable donations with matching Company gifts of up to $15,000 per employee annually and permit full-time employees to use five paid days per year for eligible volunteer work A culture of high ethical business practices and compliance standards, grounded in honesty, decency, trust and personal accountability. It is driven by tone at the top, reinforced with regular training, fostered in a speak-up environment, and measured by periodic employee surveys and other metrics that are designed to enable our Board of Directors to gauge the health of our culture Diversity, equity and inclusion underpin everything we do: We monitor our recruitment, development, succession and retention practices with a focus on gender, race (in the U.S.) and generational mix of our employee population We have developed regional and functional action plans to identify priorities and actions that will help us make more progress for DEI, including appropriate balance and inclusion in gender and racial representation We remain committed to our In Solidarity initiative through alignment of our DEI plans, introduction of new training programs and partnerships with historically Black colleges and universities (HBCUs) and other schools with diverse talent We introduced a modifier to our 2021 executive compensation plan that includes quantitative goals for gender pay and other key environmental, social and governance (ESG) items We expect to provide additional updates in 2022 on our diversity, equity and inclusion efforts, including the executive compensation modifier, in our upcoming Sustainability Report, Proxy Statement and Global Inclusion Report, all of which will be located on our website. 18 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands and brand identities (including our sonic brand identity) through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, preference and overall usage among account holders globally. Our Priceless advertising campaign, which has run in more than 50 languages and in more than 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Data We use our data assets, infrastructure and platforms to create a range of products and services for our customers, including the majority of our value-added services, which help reduce fraud, increase security, provide actionable insights to our customers to assist in their decision making and enable our customers to increase their engagement with consumers. We do all this while incorporating our data principles in how we design, implement and deliver those solutions. Our Privacy by Design and Data by Design processes have been developed to ensure we embed privacy, security and data controls in all of our products and services, keeping a clear focus on protecting customers and individuals data. We do this in a number of ways: Practicing data minimization. We collect and retain only the data that is needed for a given product or service, and limit the amount and type of personal information shared with third parties Being transparent and providing control. We explain how we use personal information and give individuals access and control over how their data is used and shared Working with trusted partners. We select partners and service providers who share our principled-approach to protecting data Addressing data bias. We ensure our use of advanced analytics, including AI and Machine Learning, utilizes diverse data sets to create fair and inclusive solutions that reflect individual, group and societal interests Advancing positive social impact. We utilize our data sets to create innovative solutions to societal challenges, promoting inclusive financial, social, climate, health and education growth Revenue Sources We generate revenue primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 and Note 3, Revenue for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other technologies, which are important to our business operations. These patents expire at varying times depending on the jurisdiction and filing date. MASTERCARD 2021 FORM 10-K 19 PART I ITEM 1. BUSINESS Competition We face a number of competitors both within and outside of the global payments industry and compete in all categories of payment, including paper-based payments and all forms of electronic payments. Among electronic payments, we face the following competition: General Purpose Payments Networks. We compete worldwide with payments networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. These competitors tend to offer a range of card-based payment products. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. Globally, financial institutions may issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express, China UnionPay and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. Debit and Local Networks. We compete with ATM and point of sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Real-time Account-based Payments Systems. We face competition in the real-time account-based payments space from other companies that provide infrastructure, applications and services to support these payment solutions. Alternative Payments Systems and New Entrants. As the global payments industry becomes more complex, we face increasing competition from alternative payments systems and emerging payments providers. Many of these providers, who in many circumstances can also be our partners or customers, have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payments networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), point of sale financing/buy-now-pay-later providers (such as Klarna), mobile operator services, mobile phone-based money transfer and microfinancing services (such as M-PESA) and handset manufacturers. We also compete with merchants and governments. National (Government-Backed) Networks. Governments have been increasingly creating regional payments structures, such as the newly established European Payments Initiative (EPI). Backed by numerous Eurozone banks and acquirers, EPI is aimed at creating a unified pan-European payments system, offering card, digital wallet and person-to-person (P2P) payment solutions for consumers and merchants. EPI is being positioned as an alternative to existing international payment solutions and schemes such as ours. In addition to regional networks, more than 80 national governments are exploring the use of central bank digital currencies (CBDCs). Digital Currencies. Stablecoins and floating cryptocurrencies may become more popular as they are increasingly viewed as providing immediacy, 24/7 accessibility, immutability and efficiency. Such currencies are starting to be accepted by person-to-merchant (P2M) players (such as Square). These currencies are also introducing into the payments ecosystem an emerging set of providers referred to as crypto natives, who have the ability to disrupt traditional financial markets. The increased prominence of digital currencies could compete with our products and services. Value-Added Service Providers and Adjacent Network Capabilities Players. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, merchants and governments and technology companies that provide cyber and fraud solutions, as well as companies that compete against us as providers of loyalty and program management solutions. We also face competition from companies that provide alternatives to our open banking and digital identity solutions. Regulatory initiatives could also lead to increased competition in this space. Mastercard plays a valuable role as a trusted intermediary in a complex system, creating value for individual stakeholders and the payments ecosystem overall. Our competitive advantages include our: globally recognized and trusted brands highly adaptable global acceptance network built over more than 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance 20 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS settlement guarantee backed by our strong credit standing expertise in real-time account-based payments and open banking development and adoption of innovative products and digital solutions safety and security solutions offered on our network, which reduce fraud and increase security for the payments ecosystem analytics insights and consulting services that help issuers and merchants optimize their payments and related businesses loyalty solutions that enhance the payments value proposition for issuers and merchants ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent and culture, with a focus on inclusion and being a force for good Collectively, the capabilities that we have created organically, and those that we have obtained through acquisitions, continue to enhance the total proposition we offer our customers. They enable us to partner with many participants in the broader payments ecosystem and provide choice, security and services to improve the value we provide to our customers. Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. We are committed to comply with all applicable laws and regulations and implement policies, procedures and programs designed to promote compliance. We coordinate globally while acting locally and leverage our relationships to manage the effects of regulation on us. See Risk Factors in Part I, Item 1A for more detail and examples of the regulation to which we are subject. Payments Oversight and Regulation. Central banks and other regulators in several jurisdictions around the world either have, or are seeking to establish, formal oversight over the payments industry, as well as authority to regulate certain aspects of the payments systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, Mastercard is subject to systemic importance regulation, which includes various requirements we must meet, including obligations related to governance and risk management. In the U.K., the Bank of England designated Vocalink, our real-time account-based payments network platform, as a specified service provider, and Mastercard Europe as a recognized payment system, which includes supervisions and examination requirements. In addition, European Union legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switching activities and other processing in terms of how we go to market, make decisions and organize our structure. Certain of our subsidiaries are regulated as payments institutions, including as money transmitters. This regulation subjects us to licensing obligations and regulatory supervision, as well as various business conduct and risk management requirements. Interchange Fees. Interchange fees that support the function and value of four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities, our settlement with the European Commission resolving its investigation into our interregional interchange fees and the European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the European Economic Area (the EEA). For more detail, see Risk Factors - Other Regulation in Part I, Item 1A and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Some jurisdictions are currently considering adopting or have adopted data localization requirements, which mandate the collection, processing, and/or storage of data within their borders. This is the case, for instance, in India, China, Saudi Arabia and South Africa. Various forms of data localization requirements or data transfer restrictions are also under consideration in other countries and jurisdictions, including the European Union. Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter-financing of terrorism (CFT) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CFT program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payments MASTERCARD 2021 FORM 10-K 21 PART I ITEM 1. BUSINESS network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in these countries and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer and Acquirer Practices Legislation and Regulation. Our issuers and acquirers are subject to numerous regulations and investigations applicable to banks, financial institutions and other licensed entities, impacting us as a consequence. Additionally, regulations such as the revised Payment Services Directive (commonly referred to as PSD2) in the EEA require financial institutions to provide third-party payment processors access to consumer payment accounts, enabling them to route transactions away from Mastercard products and provide payment initiation and account information services directly to consumers who use our products. PSD2 also requires a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Regulation of Internet, Digital Transactions and High-Risk Merchant Categories. Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports, as well as certain legally permissible but high-risk merchant categories, such as alcohol, tobacco, firearms and adult content. Privacy, Data and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the General Data Protection Regulation (the GDPR), which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California, Virginia and Colorado), Argentina, Brazil, Canada (Quebec), Chile, China, India, Indonesia, Kenya and Saudi Arabia. Due to increasing data collection and data flows, numerous data breaches and security incidents as well as the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to regulate data and protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Sustainability. Various jurisdictions are increasingly considering or adopting laws and regulations that would impact us pertaining to ESG performance, transparency and reporting. Regulations being considered include mandated corporate reporting on sustainability matters generally (such as the European Union Corporate Sustainability Reporting Directive) as well as in specific areas such as mandated reporting on climate-related financial disclosures. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. 22 MASTERCARD 2021 FORM 10-K PART I ITEM 1. BUSINESS Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website, including, but not limited to, our Sustainability Report, our Global Inclusion Report and our U.S. Consolidated EEO-1 Report, is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. "," Item 1A. Risk factors RISK HIGHLIGHTS Legal and Regulatory Business and Operations Payments Industry Regulation COVID-19 Global Economic and Political Environment Preferential or Protective Government Actions Competition and Technology Brand and Reputational Impact Privacy, Data and Security Information Security and Service Disruptions Talent and Culture Other Regulation Stakeholder Relationships Acquisitions Litigation Settlement and Third-Party Obligations Class A Common Stock and Governance Structure Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations, establishing, and potentially further expanding, obligations or restrictions with respect to the types of products and services that we may offer, the countries in which our integrated products and services MASTERCARD 2021 FORM 10-K 23 PART I ITEM 1A. RISK FACTORS may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). Several jurisdictions have also inquired about the network fees we charge to our customers (typically as part of broader market reviews of retail payments). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. In several jurisdictions, we have been designated as a systemically important payment system, and other regulators are considering designating us as systemically important or in a similar category resulting in heightened regulatory oversight. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payments systems. Moreover, as regulators around the world increasingly look to replicate similar regulation of payments and other industries, efforts in any one jurisdiction may influence approaches in other jurisdictions. Similarly, new initiatives within a jurisdiction involving one product may lead to regulation of similar or related products (for example, debit regulations could lead to regulation of credit products). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. The expansion of our products and services as part of our multi-rail strategy have also created the need for us to obtain new types and increasing numbers of regulatory licenses, resulting in increased supervision and additional compliance burdens distinct from those imposed on our core network activities. For example, certain of our subsidiaries maintain money transfer licenses to support certain activities. These licenses typically impose supervisory and examination requirements, as well as capital, safeguarding, risk management and other business obligations. Increased regulation and oversight of payments systems, as well as increased exposure to regulation resulting from changes to our products and services, have resulted and may continue to result in costly compliance burdens or otherwise increase our costs. As a result, issuers, acquirers and other customers could be less willing to participate in our payments system and/or use our other products or services, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. In addition, any regulation that is enacted related to the type and level of network fees we charge our customers could also materially and adversely impact our results of operations. Regulators could also require us to obtain prior approval for changes to our system rules, procedures or operations, or could require customization with regard to such changes, which could negatively impact us. Such changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Business - Government Regulation in Part I, Item 1 and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are required to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek a fee reduction from us to decrease the expense of their payment programs, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. 24 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries have implemented, or may implement, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. Some jurisdictions have implemented, or are considering, requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications as well as increased compliance burdens and other costs. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead affected jurisdictions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. In addition, to the extent a jurisdiction determines us not to be in compliance with regulatory requirements (including those related to data localization), we have, and may continue to be, subject to resource and time pressures in order to come back into compliance. Our inability to effect change in, or work with, these jurisdictions could adversely affect our ability to maintain or increase our revenues and extend our global brand. Additionally, some jurisdictions have implemented, or may implement, foreign ownership restrictions, which could potentially have the effect of forcing or inducing the transfer of our technology and proprietary information as a condition of access to their markets. Such restrictions could adversely impact our ability to compete in these markets. Privacy, Data and Security Regulation of privacy, data, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated and personalized products and services to meet the needs of a changing marketplace, and acquire new companies, we have expanded our information profile through the collection of additional data from additional sources and across multiple channels. This expansion has amplified the impact of these regulations on our business. Regulation of privacy, data and information security requires monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information, as well as increased care in our data management, governance and quality practices. While we make every effort to comply with all regulatory requirements and we deploy a privacy-by-design and data-by-design approach to all of our product development, the speed and pace of change may not allow us to meet rapidly evolving expectations. We are also MASTERCARD 2021 FORM 10-K 25 PART I ITEM 1A. RISK FACTORS subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions have implemented or are otherwise considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions have adopted or are otherwise considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements, as well as regulations on artificial intelligence and data governance, that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or changing interpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and/or restrict our ability to leverage data for innovation. This could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the need for improved data management, governance and quality practices, the development of information-based products and solutions, and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity and increasing cyberattacks have encouraged legislative and regulatory intervention, and could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer personal information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to legislative or regulatory intervention, such as enhanced security requirements and liabilities, as well as damage to our reputation. Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption - We are subject to AML and CFT laws and regulations globally. Economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies, and persons and entities. We are also subject to anti-corruption laws and regulations globally, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. Account-based Payments Systems - In the U.K., aspects of our Vocalink business are subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer and Acquirer Practices Legislation and Regulation - Certain regulations (such as PSD2 in the EEA) may impact various aspects of our business. For example, PSD2s strong authentication requirement could increase the number of transactions that consumers abandon if we are unable to secure a frictionless authentication experience under the new standards. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, 26 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS amplifying any potential compliance burden. Additionally, our compliance with new economic sanctions and related laws with respect to particular jurisdictions or customers could result in a loss of business, which could be significant. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. In particular, a violation and subsequent judgment or settlement against us, or those with whom we may be associated, under economic sanctions and AML, CFT, and anti-corruption laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Each instance may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective income tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective income tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective income tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant in a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations COVID-19 The global COVID-19 pandemic and measures taken in response have adversely impacted our business, results of operations and financial condition, and may continue to do so depending on future developments, which are uncertain. The global COVID-19 pandemic continues to have negative effects on the global economy. The pandemic has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. Variants of the virus have emerged, resulting in a resurgence of infections that have affected regions at different times. New variants may emerge with similar results. The extent to which the resurgence and severity of infections has affected, and may in the future affect, regions is impacted by the ongoing global administration of vaccines and the availability of therapeutic treatments in those locations. Governments, businesses and consumers continue to react to the changing conditions, tightening or loosening safety measures or voluntarily making personal safety decisions, as applicable, based on the current environment of their location. The pandemic has caused us to modify our business practices (including employee travel, employee work locations, and working in remote or hybrid environments). We continue to monitor the effects of the pandemic and may take further actions as required that are in the best interests of our employees, customers and business partners and which otherwise meet the responses by MASTERCARD 2021 FORM 10-K 27 PART I ITEM 1A. RISK FACTORS governments, businesses and consumers. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or otherwise be satisfactory to government authorities or voluntary actions taken by the public. The COVID-19 pandemic has adversely impacted our business, results of operations and financial condition. There are no comparable recent events which may provide guidance as to the effect of a global pandemic such as COVID-19, and, as a result, the ultimate impact of this pandemic or a similar health epidemic in the future is highly uncertain and subject to change. The full extent to which the COVID-19 pandemic, and measures taken in response, further impacts our business, results of operations and financial condition will depend on future developments, which are uncertain, including, but not limited to, the duration of the pandemic and its impact on the global economy, including how quickly and to what extent we can continue to progress toward more consistent economic and operating conditions. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business and our result of operations as a result of its global economic impact, including any recession that has occurred or may occur in the future. Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against competitors both within and outside of the global payments industry and compete in all categories of payment, including paper-based payments and all forms of electronic payments. We compete against general purpose payments networks, debit and local networks, ACH and real-time account-based payments systems, alternative payments systems and new entrants (focused on online activity across various channels and processing payments using in-house capabilities), national networks and digital currencies. We also face competition from companies that provide alternatives to our value-added services and adjacent network capabilities (including open banking and digital identity). Our traditional competitors may have substantially greater financial and other resources than we have, may offer a wider range of programs, services, and payment capabilities than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition and merchant acceptance than we have. They may also introduce their own innovative programs, value-added services and capabilities that adversely impact our growth. Certain of our competitors to our core network operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business - Competition in Part I, Item 1. New entrants against whom we compete have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on technology to support their services that provides cost advantages, and as a result may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our ability to compete may also be affected by regulatory and legislative initiatives, as well as the outcomes of litigation, competition-related regulatory proceedings and central bank activity and legislative activity. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Industry participants continue to invest in and develop alternative capabilities, such as account to account payments, which could facilitate P2M transactions that compete with our core payments network. 28 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Regulation (such as PSD2 in the EEA) may disintermediate issuers by enabling third-party providers opportunities to route payment transactions away from our network and products and towards other forms of payment by offering account information or payment initiation services directly to those who currently use our products. Such regulation may also provide these processors with the opportunity to commoditize the data that are included in the transactions they are servicing. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. Although we partner with fintechs and technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. When we do partner with fintechs and technology companies, we face a heightened risk when those relationships involve sharing Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data standards, without proper oversight we could give the partner a competitive advantage. Competitors, customers, fintechs, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop or encourage the creation of national payments platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets, or require us to compete differently. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our products and services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. We continue to experience pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. MASTERCARD 2021 FORM 10-K 29 PART I ITEM 1A. RISK FACTORS Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with fintechs, technology companies (such as digital players and mobile providers) and traditional customers that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. Regulatory or government requirements could require us to host and deliver certain products and services on-soil in certain markets, which would require us to alter our technology and delivery model, potentially resulting in additional expenses. Various central banks are experimenting with digital currencies called Central Bank Digital Currencies (CBDC). CBDCs may be launched with their own networks to transfer money between participants. Policy and design considerations that governments adopt could impact the extent of our role in facilitating CBDC-based payment transactions, potentially impacting the transactions that we may process over our network. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payments network presents risks that could materially affect our business. U.K. regulators have designated Vocalink, our real-time account-based payments network platform, to be a specified service provider and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payments systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payments platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payments network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our multi-rail solutions and integrated products and services can present operational and onboarding challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments markets, we are continually involved in developing complex multi-rail solutions and diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users other than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. These new customers are typically less regulated, and as a result, enhanced infrastructure and monitoring is required. Our failure to effectively design and deliver these multi-rail solutions and integrated products and services could make our other offerings less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, or we are unable to adequately anticipate 30 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS risks related to new types of customers, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code (including ransomware), phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. The advent of the global COVID-19 pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce working from home in a mostly remote environment. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information and technology in our computer systems and networks, as well as the systems of our third-party providers. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks, as well as the systems of our third-party providers, have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems (including third-party provider systems) or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the MASTERCARD 2021 FORM 10-K 31 PART I ITEM 1A. RISK FACTORS trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings have experienced in limited instances and may continue to experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events (including those related to climate change). Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a enterprise resiliency program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Stakeholder Relationships Losing a significant portion of business from one or more of our largest customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Many of our customer relationships are not exclusive. Our customers can reassess their future commitments to us subject to the terms of our contracts, and they separately may develop their own services that compete with ours. Our business agreements with these customers may not ultimately reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. While we have exclusive, or nearly-exclusive, relationships with certain of our customers to issue payment products, other customers have similar exclusive, or nearly-exclusive, relationships with our competitors. These relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with these customers to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation amongst our customers could materially and adversely affect our overall business and results of operations. Our customers industries have undergone substantial, accelerated consolidation in the past. These consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. 32 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments, fintechs and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. Some merchants are increasingly asking regulators to review and potentially regulate our own network fees, in addition to interchange. See our risk factor in Risk Factors Other Regulation in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination, of the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. MASTERCARD 2021 FORM 10-K 33 PART I ITEM 1A. RISK FACTORS Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us Consumers and businesses lowering spending, which could impact domestic and cross-border spend Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity has, and may continue to be, adversely affected by world geopolitical, economic, health, weather and other conditions. These include COVID-19, as well as the threat of terrorism and separate outbreaks of flu, viruses and other diseases (any of which could result in future epidemics or pandemics), as well as major environmental and extreme weather events, including those related to climate change. As governments, investors and other stakeholders face pressure to address climate change and other sustainability matters, these stakeholders may express new expectations, focus investments and require additional disclosures in ways that cause significant shifts in commerce and consumption behaviors. The impact of and uncertainty that could result from any of these events or factors could ultimately decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. Our operations as a global payments network rely in part on global interoperable standards to help facilitate safe and simple payments. To the extent geopolitical events result in jurisdictions no longer participating in the creation or adoption of these standards, or the creation of competing standards, the products and services we offer could be negatively impacted. Any of these developments could have a material adverse impact on our overall business and results of operations. 34 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2021, approximately 68% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers or other companies and organizations that use our products and services (including certain legally permissible but high- risk merchant categories, such as alcohol, tobacco, firearms and adult content) may also, by association, impair our reputation, or result in greater public, regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. To the extent any of our published sustainability metrics are subsequently viewed as inaccurate or we are unable to execute on our sustainability initiatives, we may be viewed negatively by consumers, investors and other stakeholders concerned about these matters. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Any of the above issues could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments ecosystem, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. MASTERCARD 2021 FORM 10-K 35 PART I ITEM 1A. RISK FACTORS Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and visa regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Moreover, as a result of the global COVID-19 pandemic, a significant portion of our workforce is working in either a remote or hybrid environment. Such environments may continue after the pandemic due to potential resulting trends, and could impact the quality of our corporate culture, as well as our ability to attract and retain talent. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity and decency. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Our efforts to enter into acquisitions, strategic investments or entry into new businesses could be impacted or prevented by regulatory scrutiny and could otherwise result in issues that could disrupt our business and harm our results of operations or reputation. We continue to evaluate our strategic acquisitions of complementary businesses, products or technologies, as well as acquiring interests in related joint ventures or other entities. As we do so, we face increasing regulatory scrutiny with respect to antitrust and other considerations that could impact these efforts. We also face competition for acquisition targets due to the nature of the market for technology companies. As a result, we could be prevented from successfully completing such acquisitions in the future. If we are not successful in these efforts, we could lose strategic opportunities that are dependent, in part, on inorganic growth. To the extent we do make these acquisitions, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations, both directly as a result of the new business as well as in the other existing parts of our business, with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Additionally, targets that we acquire may have data practices that do not initially conform to our privacy and data protection standards and data governance model, which could lead to regulatory scrutiny and reputational harm. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent 36 MASTERCARD 2021 FORM 10-K PART I ITEM 1A. RISK FACTORS any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 8, 2022, Mastercard Foundation owned 105,091,311 shares of Class A common stock, representing approximately 10.8% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted and have occurred. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", Item 1B. Unresolved staff comments Not applicable. ," Item 2. Properties We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center, located in OFallon, Missouri. As of December 31, 2021, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries around the world, consisting of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business and address climate-related impacts, or consolidate and dispose of facilities that are no longer required. "," Item 3. Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF EQUITY SECURITIES Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 8, 2022, we had 71 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 240 holders of record of our non-voting Class B common stock as of February 8, 2022, constituting approximately 0.8% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 and the SP 500 Financials for the five-year period ended December 31, 2021. The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index 2016 2017 2018 2019 2020 2021 Mastercard $ 100.00 $ 147.68 $ 185.07 $ 294.55 $ 353.98 $ 358.07 SP 500 100.00 121.83 116.49 153.17 181.35 233.41 SP 500 Financials 100.00 122.18 106.26 140.40 138.02 186.38 42 MASTERCARD 2021 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF EQUITY SECURITIES Dividend Declaration and Policy On November 30, 2021, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of record on January 7, 2022 of our Class A common stock and Class B common stock. On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share payable on May 9, 2022 to holders of record on April 8, 2022 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities During the fourth quarter of 2021, we repurchased a total of 3.7 million shares for $1.3 billion at an average price of $342.86 per share of Class A common stock. See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion with respect to our share repurchase programs. The following table presents our repurchase activity on a cash basis during the fourth quarter of 2021: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 1,282,075 $ 351.18 1,282,075 $ 4,752,404,601 November 1 30 1,126,537 340.52 1,126,537 12,368,795,391 December 1 31 1,312,321 336.75 1,312,321 11,926,866,431 Total 3,720,933 342.86 3,720,933 1 Dollar value of shares that may yet be purchased under the share repurchase programs is as of the end of the period. 2 In November 2021 and December 2020, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion and $6.0 billion respectively, of our Class A common stock under each plan. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2020. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through our unique and proprietary core global payments network, we switch (authorize, clear and settle) payment transactions. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, we offer integrated payment products and services and capture new payment flows. Our value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on our principled use of consumer and merchant data. Our franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. Our payment solutions are designed to ensure safety and security for the global payments ecosystem. Mastercard is not a financial institution. We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. COVID-19 In 2021, our growth rates, which are at various stages of recovery, increased as compared to the respective year ago period as consumer and business spend recovers and we lap the initial effects of the COVID-19 pandemic. The following tables provide a summary of trends in our key metrics for 2021 and 2020 as compared to the respective year ago periods: 2021 Quarter ended Year ended December 31, 2021 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % 33 % 20 % 23 % 21 % Cross-border volume (local currency basis) (17) % 58 % 52 % 53 % 32 % Switched transactions 9 % 41 % 25 % 27 % 25 % 2020 Quarter ended Year ended December 31, 2020 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % (10) % 1 % 1 % % Cross-border volume (local currency basis) (1) % (45) % (36) % (29) % (29) % Switched transactions 13 % (10) % 5 % 4 % 3 % The impact of the COVID-19 pandemic, which began in the first quarter of 2020, continues to have negative effects on the global economy. The pandemic has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. Variants of the virus have emerged, resulting in a resurgence of infections that have affected regions at different times. New variants may emerge with similar results. The extent to which the resurgence and severity of infections has affected regions is impacted by the ongoing global administration of vaccines and the availability of therapeutic 44 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS treatments in those locations. Governments, businesses and consumers continue to react to the changing conditions, tightening or loosening safety measures or voluntarily making personal safety decisions, as applicable, based on the current environment of their location. We continue to monitor the effects of the pandemic and the related impact on our business. The full extent to which the pandemic, and measures and actions taken by stakeholders in response, affect our business, results of operations and financial condition will depend on future developments, including the duration of the pandemic and its impact on the global economy, which are uncertain, and cannot be predicted at this time. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2021 Increase/ (Decrease) 2020 Increase/ (Decrease) 2021 2020 2019 ($ in millions, except per share data) Net revenue $ 18,884 $ 15,301 $ 16,883 23% (9)% Operating expenses $ 8,802 $ 7,220 $ 7,219 22% % Operating income $ 10,082 $ 8,081 $ 9,664 25% (16)% Operating margin 53.4 % 52.8 % 57.2 % 0.6 ppt (4.4) ppt Income tax expense $ 1,620 $ 1,349 $ 1,613 20% (16)% Effective income tax rate 15.7 % 17.4 % 16.6 % (1.7) ppt 0.8 ppt Net income $ 8,687 $ 6,411 $ 8,118 35% (21)% Diluted earnings per share $ 8.76 $ 6.37 $ 7.94 38% (20)% Diluted weighted-average shares outstanding 992 1,006 1,022 (1)% (2)% The following table provides a summary of our key non-GAAP operating results 1 , adjusted to exclude the impact of gains and losses on our equity investments, Special Items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, 2021 Increase/(Decrease) 2020 Increase/(Decrease) 2021 2020 2019 As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 18,884 $ 15,301 $ 16,883 23% 22% (9)% (8)% Adjusted operating expenses $ 8,627 $ 7,147 $ 7,219 21% 19% (1)% (1)% Adjusted operating margin 54.3 % 53.3 % 57.2 % 1.0 ppt 1.2 ppt (4.0) ppt (3.7) ppt Adjusted effective income tax rate 15.4 % 17.2 % 17.0 % (1.8) ppt (1.8) ppt 0.2 ppt 0.3 ppt Adjusted net income $ 8,333 $ 6,463 $ 7,937 29% 28% (19)% (17)% Adjusted diluted earnings per share $ 8.40 $ 6.43 $ 7.77 31% 30% (17)% (16)% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. MASTERCARD 2021 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Key highlights for 2021 as compared to 2020 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue increased 22% on a currency-neutral basis, which includes 2 percentage points of growth from acquisitions. The remaining increase was primarily due to: up 23% up 22% - Gross dollar volume growth of 21% on a local currency basis - Cross-border volume growth of 32% on a local currency basis - Switched transactions growth of 25% - Other revenues increased 32%, or 31% on a currency-neutral basis, which includes 8 percentage points of growth due to acquisitions. The remaining growth was driven primarily by our Cyber Intelligence and Data Services solutions. These increases to net revenue were partially offset by: - Rebates and incentives growth of 32%, or 31% on a currency-neutral basis, primarily due to increased volumes and transactions and new and renewed deals. Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expenses increased 19% on a currency-neutral basis, which includes 7 percentage points of growth due to acquisitions. The remaining increase was primarily due to higher personnel costs, increased spending on advertising and marketing and increased data processing costs. up 22% up 19% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) The adjusted effective income tax rate of 15.4% was lower than prior year, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rate. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. 15.7% 15.4% Other 2021 financial highlights were as follows: We generated net cash flows from operations of $9.5 billion. We completed the acquisitions of businesses for total consideration of $4.7 billion. We repurchased 16.5 million shares of our common stock for $5.9 billion and paid dividends of $1.7 billion. We completed debt offerings for an aggregate principal amount of $2.1 billion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of gains and losses on our equity investments which includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. Our non-GAAP financial measures also exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2021, 2020 and 2019, we recorded net gains of $645 million ($497 million after tax, or $0.50 per diluted share), $30 million ($15 million after tax, or $0.01 per diluted share) and $167 million ($124 million after tax, or $0.12 per diluted share), respectively. These net gains were primarily related to unrealized fair market value adjustments on marketable and nonmarketable equity securities. In addition, in 2021, net gains also included realized gains on sales of marketable equity securities. 46 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Items Litigation provisions During 2021, we recorded pre-tax charges of $94 million ($74 million after tax, or $0.07 per diluted share) related to litigation settlements and estimated attorneys fees with U.K. and Pan-European merchants. During 2020, we recorded pre-tax charges of $73 million ($67 million after tax, or $0.07 per diluted share) related to litigation provisions which included pre-tax charges of: $45 million related to a legal matter associated with our prepaid cards in the U.K., and $28 million related to estimated attorneys fees and litigation settlements with U.K. and Pan-European merchants. Indirect tax matter During 2021, we recorded a pre-tax charge of $88 million ($69 million after tax, or $0.07 per diluted share) to resolve a foreign indirect tax matter for 2015 through the current period and the related interest. Tax act During 2019, we recorded a $57 million net tax benefit ($0.06 per diluted share), which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the transition tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. See Note 7 (Investments), Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and non-recurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Currency-neutral Growth Rates We present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency of the entity. The impact of the related realized gains and losses resulting from our foreign exchange derivative contracts designated as cash flow hedging instruments is recognized in the respective financial statement line item on the statement of operations when the underlying forecasted transactions impact earnings. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. The translational and transactional impact of currency and the related impact of our foreign exchange derivative contracts designated as cash flow hedging instruments (Currency impact) has been excluded from our currency-neutral growth rates and has been identified in our drivers of change impact tables. See Foreign Currency - Currency Impact for further information on our currency impacts and Financial Results - Revenue and Operating Expenses for our drivers of change impact tables. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. MASTERCARD 2021 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2021 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 8,802 53.4 % $ 225 15.7 % $ 8,687 $ 8.76 (Gains) losses on equity investments ** ** (645) (0.5) % (497) (0.50) Litigation provisions (94) 0.5 % ** 0.1 % 74 0.07 Indirect tax matter (82) 0.4 % 6 0.1 % 69 0.07 Non-GAAP $ 8,627 54.3 % $ (413) 15.4 % $ 8,333 $ 8.40 Year ended December 31, 2020 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,220 52.8 % $ (321) 17.4 % $ 6,411 $ 6.37 (Gains) losses on equity investments ** ** (30) (0.1) % (15) (0.01) Litigation provisions (73) 0.5 % ** (0.1) % 67 0.07 Non-GAAP $ 7,147 53.3 % $ (351) 17.2 % $ 6,463 $ 6.43 Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 67 16.6 % $ 8,118 7.94 (Gains) losses on equity investments ** ** (167) (0.2) % (124) (0.12) Tax act ** ** ** 0.6 % (57) (0.06) Non-GAAP $ 7,219 57.2 % $ (100) 17.0 % $ 7,937 $ 7.77 Note: Tables may not sum due to rounding. ** Not applicable 48 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2021 as compared to the Year Ended December 31, 2020 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP 23 % 22 % 0.6 ppt (1.7) ppt 35 % 38 % (Gains) losses on equity investments ** ** ** (0.4) ppt (7) % (8) % Litigation provisions ** % ppt 0.1 ppt % % Indirect tax matter ** (1) % 0.4 ppt 0.1 ppt 1 % 1 % Non-GAAP 23 % 21 % 1.0 ppt (1.8) ppt 29 % 31 % Currency impact 1 (1) % (2) % 0.2 ppt ppt (1) % (1) % Non-GAAP - currency-neutral 22 % 19 % 1.2 ppt (1.8) ppt 28 % 30 % Year Ended December 31, 2020 as compared to the Year Ended December 31, 2019 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP (9) % % (4.4) ppt 0.8 ppt (21) % (20) % (Gains) losses on equity investments ** ** ** ppt 1 % 1 % Litigation provisions ** (1) % 0.5 ppt (0.1) ppt 1 % 1 % Tax act ** ** ** (0.6) ppt 1 % 1 % Non-GAAP (9) % (1) % (4.0) ppt 0.2 ppt (19) % (17) % Currency impact 1 1 % % 0.3 ppt 0.2 ppt 1 % 1 % Non-GAAP - currency-neutral (8) % (1) % (3.7) ppt 0.3 ppt (17) % (16) % Note: Tables may not sum due to rounding. ** Not applicable 1 See Non-GAAP Financial Information for further information on Currency impact. Key Metrics In addition to the financial measures described above in Financial Results Overview, we review the following metrics to evaluate and identify trends in our business, measure our performance, prepare financial projections and make strategic decisions. We believe that the key metrics presented facilitate an understanding of our operating and financial performance and provide a meaningful comparison of our results between periods. Gross Dollar Volume (GDV) 1 measures dollar volume of activity on cards carrying our brands during the period, on a local currency basis and U.S. dollar-converted basis. GDV represents purchase volume plus cash volume and includes the impact of balance transfers and convenience checks; purchase volume means the aggregate dollar amount of purchases made with Mastercard-branded cards for the relevant period; and cash volume means the aggregate dollar amount of cash disbursements and includes the impact of balance transfers and convenience checks obtained with Mastercard-branded cards for the relevant period. Information denominated in U.S. dollars relating to GDV is calculated by applying an established U.S. dollar/local currency exchange rate for each local currency in which our volumes are reported. These exchange rates are calculated on a quarterly basis using the average exchange rate for each quarter. We report period-over-period rates of change in purchase volume and cash volume on the basis of local currency information, in order to eliminate the impact of changes in the value of currencies against the U.S. dollar in calculating such rates of change. Cross-border Volume 2 measures cross-border dollar volume initiated and switched through our network during the period, on a local currency basis and U.S. dollar-converted basis, for all Mastercard-branded programs. Switched Transactions 2 measures the number of transactions switched by Mastercard, which is defined as the number of transactions initiated and switched through our network during the period. MASTERCARD 2021 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating Margin measures how much profit we make on each dollar of sales after our operating costs but before other income (expense) and income tax expense. Operating margin is calculated by dividing our operating income by net revenue. 1 Data used in the calculation of GDV is provided by Mastercard customers and is subject to verification by Mastercard and partial cross-checking against information provided by Mastercards transaction switching systems. All data is subject to revision and amendment by Mastercard or Mastercards customers. 2 Growth rates are normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the Company does not clear and settle are processed. In the fourth quarter of 2021, we began clearing and settling transactions and volumes on a daily basis. Foreign Currency Currency Impact Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results are also impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and certain volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, certain of our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2021, GDV on a U.S. dollar-converted basis increased 21.9%, while GDV on a local currency basis increased 20.5% versus 2020. In 2020, GDV on a U.S. dollar-converted basis decreased 1.9%, while GDV on a local currency basis increased 0.1% versus 2019. Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items is different than the functional currency of the entity. Through December 31, 2020, our approach to managing transactional currency exposure consisted of hedging a portion of anticipated revenues impacted by transactional currencies by entering into foreign exchange derivative contracts, and recording the related changes in fair value in general and administrative expenses on the consolidated statement of operations. During the first quarter of 2021, we started to formally designate certain newly-executed foreign exchange derivative contracts, which meet the established accounting criteria, as cash flow hedges. Gains and losses resulting from changes in fair value of these designated contracts are deferred in accumulated other comprehensive income (loss) and subsequently recognized in the respective component of net revenue when the underlying forecasted transactions impact earnings. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities, including settlement assets and obligations, that are denominated in a currency other than the functional currency of the entity. To manage this foreign exchange risk, we may enter into foreign exchange derivative contracts to economically hedge the foreign currency exposure of a portion of our nonfunctional monetary assets and liabilities. The gains or losses resulting from changes in fair value of these contracts are intended to reduce the potential effect of the underlying hedged exposure and are recorded net within general and administrative expenses on the consolidated statement of operations. The impact of this foreign exchange activity, including the related hedging activities, has not been eliminated in our currency-neutral results. Our foreign exchange risk management activities are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. 50 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Results Revenue Primary drivers of net revenue, versus the prior year, were as follows: Gross revenue increased 26%, or 25% on a currency-neutral basis, which includes growth of 2 percentage points from acquisitions. The remaining increase was primarily driven by transaction and volume growth and an increase in our Cyber Intelligence and Data Services solutions within other revenue. Rebates and incentives increased 32%, or 31% on a currency-neutral basis, primarily due to increased volumes and transactions and new and renewed deals. Net revenue increased 23%, or 22% on a currency-neutral basis, and includes 2 percentage points of growth from acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Domestic assessments $ 8,158 $ 6,656 $ 6,781 23% (2)% Cross-border volume fees 4,664 3,512 5,606 33% (37)% Transaction processing 10,799 8,731 8,469 24% 3% Other revenues 6,224 4,717 4,124 32% 14% Gross revenue 29,845 23,616 24,980 26% (5)% Rebates and incentives (contra-revenue) (10,961) (8,315) (8,097) 32% 3% Net revenue $ 18,884 $ 15,301 $ 16,883 23% (9)% The following table summarizes the drivers of change in net revenue: For the Years Ended December 31, Operational Acquisitions Currency Impact 3 Total 2021 2020 2021 2020 2021 2020 2021 2020 Domestic assessments 22% 1 1% 1 % % % (3)% 23 % (2) % Cross-border volume fees 30% 1 (37)% 1 % % 3% % 33 % (37) % Transaction processing 22% 1,2 3% 1,2 % % 1% % 24 % 3 % Other revenues 23% 2 12% 2 8% 3% 1% (1)% 32 % 14 % Rebates and incentives (contra-revenue) 31% 4% % % 1% (2)% 32 % 3 % Net revenue 20% (9)% 2% 1% 1% (1)% 23 % (9) % Note: Table may not sum due to rounding 1 Includes impacts from our key metrics, other non-volume based fees, pricing and mix. 2 Includes impacts from our cyber and intelligence solution fees, data analytics and consulting fees and other value-added services. 3 Includes the translational and transactional impact of currency and the related impact of our foreign exchange derivative contracts designated as cash flow hedging instruments. MASTERCARD 2021 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables provide a summary of the trend in volumes and transactions. For the Years Ended December 31, 2021 2020 Increase/(Decrease) USD Local USD Local Mastercard-branded GDV 1 22 % 21 % (2) % % United States 23 % 23 % 2 % 2 % Worldwide less United States 22 % 20 % (4) % (1) % Cross-border volume 1 32 % (29) % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Increase/(Decrease) 2021 2020 Switched transactions 25 % 3 % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2021, the net revenue from these customers was approximately $4.2 billion, or 23%, of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses increased 22% in 2021 versus the prior year. Adjusted operating expenses increased 21%, or 19% on a currency-neutral basis, versus the prior year. Current year results include growth of approximately 7 percentage points from acquisitions. Excluding acquisitions, expenses increased 12% primarily due to higher personnel costs to support our continued investment in our strategic initiatives, increased spending on advertising and marketing and increased data processing costs. The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) General and administrative $ 7,087 $ 5,910 $ 5,763 20 % 3 % Advertising and marketing 895 657 934 36 % (30) % Depreciation and amortization 726 580 522 25 % 11 % Provision for litigation 94 73 ** ** Total operating expenses 8,802 7,220 7,219 22 % % Special Items 1 (176) (73) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 8,627 $ 7,147 $ 7,219 21 % (1) % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 52 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 1 Acquisitions Currency Impact 2 Total 2021 2020 2021 2020 2021 2020 2021 2020 2021 2020 General and administrative 11% (1) % 1 % ** 6 % 4 % 2 % % 20 % 3 % Advertising and marketing 35% (30) % ** ** 1 % % 1 % (1) % 36 % (30) % Depreciation and amortization 3% 5 % ** ** 20 % 6 % 2 % % 25 % 11 % Provision for litigation ** ** ** ** ** ** ** ** ** ** Total operating expenses 12% (5) % 1 % 1 % 7 % 4 % 2 % % 22 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 Represents the translational and transactional impact of currency. General and Administrative General and administrative expenses increased 20%, or 18% on a currency-neutral basis, in 2021 versus the prior year. Current year results include growth of 6 percentage points from acquisitions and 1 percentage point from Special Items. The remaining increase was primarily due to higher personnel costs to support our continued investment in our strategic initiatives and increased data processing costs. The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Personnel $ 4,489 $ 3,787 $ 3,537 19% 7% Professional fees 433 384 447 13% (14)% Data processing and telecommunications 898 756 666 19% 14% Foreign exchange activity 1 51 9 32 ** ** Other 2 1,216 974 1,081 25% (10)% Total general and administrative expenses $ 7,087 $ 5,910 $ 5,763 20% 3% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Includes a special item related to a foreign indirect tax matter of $82 million, pre-tax, recorded during 2021. See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. Advertising and Marketing Advertising and marketing expenses increased 36%, on both an as reported and currency-neutral basis, in 2021 versus the prior year, primarily due to an increase in spending on certain marketing campaigns and an increase in advertising and sponsorship spend driven by the reinstatement of sponsored events as the effects of the pandemic recede. Depreciation and Amortization Depreciation and amortization expenses increased 25%, or 23% on a currency-neutral basis, in 2021 versus the prior year, which includes growth of 20 percentage points from acquisitions due to the amortization of acquired intangible assets. Provision for Litigation In 2021 and 2020, we recorded $ 94 million and $73 million, respectively, related to various litigation settlements and legal costs. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2021 FORM 10-K 53 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Other Income (Expense) Other income (expense) was favorable $546 million in 2021 versus the prior year, primarily due to higher net gains in the current period versus the prior period related to unrealized fair market value adjustments on marketable and nonmarketable equity securities and realized gains on sales of marketable equity securities. Adjusted other income (expense) was unfavorable $62 million versus the prior year, primarily due to increased interest expense related to our recent debt issuances and a decrease in our investment income. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) 2021 2020 2019 2021 2020 ($ in millions) Investment Income $ 11 $ 24 $ 97 (52) % (75) % Gains (losses) on equity investments, net 645 30 167 ** ** Interest expense (431) (380) (224) 13 % 70 % Other income (expense), net 5 27 ** ** Total other income (expense) 225 (321) 67 ** ** (Gains) losses on equity investments 1 (645) (30) (167) ** ** Special Items 1 6 ** ** Adjusted total other income (expense) 1 $ (413) $ (351) $ (100) 18 % ** Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. Income Taxes The effective income tax rates for the years ended December 31, 2021 and 2020 were 15.7% and 17.4%, respectively. The adjusted effective income tax rates for the years ended December 31, 2021 and 2020 were 15.4% and 17.2%, respectively. Both the as reported and as adjusted effective income tax rates in 2021 were lower than the prior year, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to our lower effective tax rates. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31: 2021 2020 (in billions) Cash, cash equivalents and investments 1 $ 7.9 $ 10.6 Unused line of credit 6.0 6.0 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.5 billion and $2.3 billion at December 31, 2021 and 2020, respectively. We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations which include litigation provisions and credit and settlement exposure. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; 54 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities: For the Years Ended December 31, 2021 2020 2019 (in millions) Net cash provided by operating activities $ 9,463 $ 7,224 $ 8,183 Net cash used in investing activities (5,272) (1,879) (1,640) Net cash used in financing activities (6,555) (2,152) (5,867) Net cash provided by operating activities increased $2.2 billion in 2021 versus the prior year, primarily due to higher net income adjusted for non-cash items and the timing of customer incentive payments, partially offset by higher outstanding receivables in the current period due to increased volumes and timing of settlement with customers. Net cash used in investing activities increased $3.4 billion in 2021 versus the prior year, primarily due to increased acquisition activity in the current year. Net cash used in financing activities increased $4.4 billion in 2021 versus the prior year, primarily due to lower proceeds from debt issuances, higher repurchases of our Class A common stock and repayment of debt in the current year. Debt and Credit Availability In March 2021, we issued $600 million principal amount of notes due March 2031 and $700 million principal amount of notes due March 2051 and in November 2021, we issued $750 million principal amount of notes due November 2031 (collectively the 2021 USD Notes). Additionally, during 2021, $650 million of principal related to the 2016 USD Notes was redeemed. Our total debt outstanding was $13.9 billion at December 31, 2021, with the earliest maturity of 700 million (approximately $793 million as of December 31, 2021) of principal occurring in December 2022. The proceeds of the 2021 USD Notes due March 2031 are to be used to fund eligible green and social projects, examples of which are described in the Use of Proceeds section of the Prospectus Supplement filed on March 4, 2021. All other notes are to be used for general corporate purposes. As of December 31, 2021, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which now expires in November 2026. Borrowings under the Commercial Paper Program and the Credit Facility are to be used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2021. See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. MASTERCARD 2021 FORM 10-K 55 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, 2021 2020 2019 (in millions, except per share data) Cash dividend, per share $ 1.76 $ 1.60 $ 1.32 Cash dividends paid $ 1,741 $ 1,605 $ 1,345 On November 30, 2021, our Board of Directors declared a quarterly cash dividend of $0.49 per share paid on February 9, 2022 to holders of record on January 7, 2022 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $479 million. On February 8, 2022, our Board of Directors declared a quarterly cash dividend of $0.49 per share payable on May 9, 2022 to holders of record on April 8, 2022 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $479 million. Repurchased shares of our common stock are considered treasury stock. In November 2021, December 2020 and December 2019, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion, $6.0 billion and $8.0 billion, respectively, of our Class A common stock. The program approved in 2021 will become effective after completion of the share repurchase program approved in 2020. The timing and actual number of additional shares repurchased will depend on a variety of factors, including cash requirements to meet the operating needs of the business, legal requirements, as well as the share price and economic and market conditions. The following table summarizes our share repurchase activity of our Class A common stock through December 31, 2021, under the plans approved in 2020 and 2019: (in millions, except per share data) Remaining authorization at December 31, 2020 $ 9,831 Dollar-value of shares repurchased in 2021 $ 5,904 Remaining authorization at December 31, 2021 $ 11,927 Shares repurchased in 2021 16.5 Average price paid per share in 2021 $ 356.82 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates and incentives when customers meet certain volume thresholds or other incentives tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction- based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. 56 MASTERCARD 2021 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. Income Taxes In calculating our effective income tax rate, estimates are required regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. In assessing the need for a valuation allowance, we consider all sources of taxable income, including projected future taxable income, reversing taxable temporary differences and ongoing tax planning strategies. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price, including contingent consideration, if any, is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. MASTERCARD 2021 FORM 10-K 57 PART II "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $70 million and $58 million on our foreign exchange derivative contracts outstanding at December 31, 2021 and 2020, respectively, before considering the offsetting effect of the underlying hedged activity. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into short duration foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with our customers. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $1 million and $23 million on our short duration foreign exchange derivative contracts outstanding at December 31, 2021 and 2020, respectively. We are further exposed to foreign exchange rate risk related to translation of our foreign operating results where the functional currency is different than our U.S. dollar reporting currency. To manage this risk, we may enter into foreign exchange derivative contracts to hedge a portion of our net investment in foreign subsidiaries. The effect of a hypothetical 10% adverse change in the value of the U.S. dollar could result in a fair value loss of approximately $165 million on our foreign exchange derivative contracts designated as a net investment hedge at December 31, 2021, before considering the offsetting effect of the underlying hedged activity. We did not have similar foreign exchange derivative contracts outstanding as of December 31, 2020. Interest Rate Risk Our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact to the fair value of our investments at December 31, 2021 and 2020. We are also exposed to interest rate risk related to our fixed-rate debt. To manage this risk, we may enter into interest rate derivative contracts to hedge a portion of our fixed-rate debt that is exposed to changes in fair value attributable to changes in a benchmark interest rate. The effect of a hypothetical 100 basis point adverse change in interest rates could result in a fair value loss of $49 million on our interest rate derivative contracts designated as a fair value hedge of our fixed-rate debt at December 31, 2021, before considering the offsetting effect of the underlying hedged activity. We did not have similar interest rate derivative contracts outstanding as of December 31, 2020. 58 MASTERCARD 2021 FORM 10-K PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2021 and 2020 and for the years ended December 31, 2021, 2020 and 2019 Managements report on internal control over financial reporting Report of independent registered public accounting firm (PCAOB ID 238 ) Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements MASTERCARD 2021 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2021. In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2021. The effectiveness of Mastercards internal control over financial reporting as of December 31, 2021 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. 60 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on internal control over financial reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. MASTERCARD 2021 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates and incentives which totaled $11.0 billion for the year ended December 31, 2021. The Company has business agreements with certain customers that provide for rebates and incentives that could be either fixed or variable-based. Variable rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Variable rebates and incentives are calculated based upon estimated customer performance, such as volume thresholds, and the terms of the related business agreements. As disclosed by management, various factors are considered in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter are (i) the significant judgment by management when developing estimates related to rebates and incentives based on customer performance; and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance, including the reasonableness of the various applicable factors considered by management in the estimate. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to rebates and incentives, including controls over evaluating estimated customer performance. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating the agreements to identify whether all rebates and incentives are identified and recorded accurately; (ii) testing managements process for developing estimated customer performance, including evaluating the reasonableness of the various applicable factors considered by management; and (iii) evaluating estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 11, 2022 We have served as the Companys auditor since 1989. 62 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, 2021 2020 2019 (in millions, except per share data) Net Revenue $ 18,884 $ 15,301 $ 16,883 Operating Expenses: General and administrative 7,087 5,910 5,763 Advertising and marketing 895 657 934 Depreciation and amortization 726 580 522 Provision for litigation 94 73 Total operating expenses 8,802 7,220 7,219 Operating income 10,082 8,081 9,664 Other Income (Expense): Investment income 11 24 97 Gains (losses) on equity investments, net 645 30 167 Interest expense ( 431 ) ( 380 ) ( 224 ) Other income (expense), net 5 27 Total other income (expense) 225 ( 321 ) 67 Income before income taxes 10,307 7,760 9,731 Income tax expense 1,620 1,349 1,613 Net Income $ 8,687 $ 6,411 $ 8,118 Basic Earnings per Share $ 8.79 $ 6.40 $ 7.98 Basic weighted-average shares outstanding 988 1,002 1,017 Diluted Earnings per Share $ 8.76 $ 6.37 $ 7.94 Diluted weighted-average shares outstanding 992 1,006 1,022 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, 2021 2020 2019 (in millions) Net Income $ 8,687 $ 6,411 $ 8,118 Other comprehensive income (loss): Foreign currency translation adjustments ( 442 ) 345 10 Income tax effect 55 ( 59 ) 13 Foreign currency translation adjustments, net of income tax effect ( 387 ) 286 23 Translation adjustments on net investment hedges 269 ( 177 ) 36 Income tax effect ( 60 ) 40 ( 8 ) Translation adjustments on net investment hedges, net of income tax effect 209 ( 137 ) 28 Cash flow hedges 6 ( 189 ) 14 Income tax effect ( 1 ) 42 ( 3 ) Reclassification adjustment for cash flow hedges 5 4 Income tax effect ( 1 ) ( 1 ) Cash flow hedges, net of income tax effect 9 ( 144 ) 11 Defined benefit pension and other postretirement plans 57 ( 12 ) ( 21 ) Income tax effect ( 14 ) 2 3 Reclassification adjustment for defined benefit pension and other postretirement plans ( 2 ) ( 1 ) ( 1 ) Income tax effect Defined benefit pension and other postretirement plans, net of income tax effect 41 ( 11 ) ( 19 ) Investment securities available-for-sale ( 1 ) ( 1 ) 3 Income tax effect ( 1 ) Investment securities available-for-sale, net of income tax effect ( 1 ) ( 1 ) 2 Other comprehensive income (loss), net of income tax effect ( 129 ) ( 7 ) 45 Comprehensive Income $ 8,558 $ 6,404 $ 8,163 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, 2021 2020 (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 7,421 $ 10,113 Restricted cash for litigation settlement 586 586 Investments 473 483 Accounts receivable 3,006 2,646 Settlement assets 1,319 1,706 Restricted security deposits held for customers 1,873 1,696 Prepaid expenses and other current assets 2,271 1,883 Total current assets 16,949 19,113 Property, equipment and right-of-use assets, net 1,907 1,902 Deferred income taxes 486 491 Goodwill 7,662 4,960 Other intangible assets, net 3,671 1,753 Other assets 6,994 5,365 Total Assets $ 37,669 $ 33,584 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ 738 $ 527 Settlement obligations 913 1,475 Restricted security deposits held for customers 1,873 1,696 Accrued litigation 840 842 Accrued expenses 6,642 5,430 Current portion of long-term debt 792 649 Other current liabilities 1,364 1,228 Total current liabilities 13,162 11,847 Long-term debt 13,109 12,023 Deferred income taxes 395 86 Other liabilities 3,591 3,111 Total Liabilities 30,257 27,067 Commitments and Contingencies Redeemable Non-controlling Interests 29 29 Stockholders Equity Class A common stock, $ 0.0001 par value; authorized 3,000 shares, 1,397 and 1,396 shares issued and 972 and 987 shares outstanding, respectively Class B common stock, $ 0.0001 par value; authorized 1,200 shares, 8 shares issued and outstanding Additional paid-in-capital 5,061 4,982 Class A treasury stock, at cost, 425 and 409 shares, respectively ( 42,588 ) ( 36,658 ) Retained earnings 45,648 38,747 Accumulated other comprehensive income (loss) ( 809 ) ( 680 ) Mastercard Incorporated Stockholders' Equity 7,312 6,391 Non-controlling interests 71 97 Total Equity 7,383 6,488 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 37,669 $ 33,584 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2018 $ $ $ 4,580 $ ( 25,750 ) $ 27,283 $ ( 718 ) $ 5,395 $ 23 $ 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests 1 1 Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) 45 45 45 Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments 207 8 215 215 Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 Net income 6,411 6,411 6,411 Activity related to non-controlling interests 73 73 Redeemable non-controlling interest adjustments ( 7 ) ( 7 ) ( 7 ) Other comprehensive income (loss) ( 7 ) ( 7 ) ( 7 ) Dividends ( 1,641 ) ( 1,641 ) ( 1,641 ) Purchases of treasury stock ( 4,459 ) ( 4,459 ) ( 4,459 ) Share-based payments 195 6 201 201 Balance at December 31, 2020 4,982 ( 36,658 ) 38,747 ( 680 ) 6,391 97 6,488 66 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2020 4,982 ( 36,658 ) 38,747 ( 680 ) 6,391 97 6,488 Net income 8,687 8,687 8,687 Activity related to non-controlling interests ( 9 ) ( 9 ) Acquisition of non-controlling interest ( 122 ) ( 122 ) ( 17 ) ( 139 ) Redeemable non-controlling interest adjustments ( 5 ) ( 5 ) ( 5 ) Other comprehensive income (loss) ( 129 ) ( 129 ) ( 129 ) Dividends ( 1,781 ) ( 1,781 ) ( 1,781 ) Purchases of treasury stock ( 5,934 ) ( 5,934 ) ( 5,934 ) Share-based payments 201 4 205 205 Balance at December 31, 2021 $ $ $ 5,061 $ ( 42,588 ) $ 45,648 $ ( 809 ) $ 7,312 $ 71 $ 7,383 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2021 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, 2021 2020 2019 (in millions) Operating Activities Net income $ 8,687 $ 6,411 $ 8,118 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,371 1,072 1,141 Depreciation and amortization 726 580 522 (Gains) losses on equity investments, net ( 645 ) ( 30 ) ( 167 ) Share-based compensation 273 254 250 Deferred income taxes ( 69 ) 73 ( 7 ) Other 36 14 24 Changes in operating assets and liabilities: Accounts receivable ( 397 ) ( 86 ) ( 246 ) Income taxes receivable ( 87 ) ( 2 ) ( 202 ) Settlement assets 390 1,288 ( 444 ) Prepaid expenses ( 2,087 ) ( 1,552 ) ( 1,661 ) Accrued litigation and legal settlements ( 1 ) ( 73 ) ( 662 ) Restricted security deposits held for customers 177 326 290 Accounts payable 100 26 ( 42 ) Settlement obligations ( 568 ) ( 1,242 ) 477 Accrued expenses 1,355 ( 114 ) 657 Long-term taxes payable ( 52 ) ( 37 ) 2 Net change in other assets and liabilities 254 316 133 Net cash provided by operating activities 9,463 7,224 8,183 Investing Activities Purchases of investment securities available-for-sale ( 389 ) ( 220 ) ( 643 ) Purchases of investments held-to-maturity ( 294 ) ( 198 ) ( 215 ) Proceeds from sales of investment securities available-for-sale 83 361 1,098 Proceeds from maturities of investment securities available-for-sale 291 140 376 Proceeds from maturities of investments held-to-maturity 296 121 383 Purchases of property and equipment ( 407 ) ( 339 ) ( 422 ) Capitalized software ( 407 ) ( 369 ) ( 306 ) Purchases of equity investments ( 228 ) ( 214 ) ( 467 ) Proceeds from sales of equity investments 186 Acquisition of businesses, net of cash acquired ( 4,436 ) ( 989 ) ( 1,440 ) Settlement of interest rate derivative contracts ( 175 ) Other investing activities 33 3 ( 4 ) Net cash used in investing activities ( 5,272 ) ( 1,879 ) ( 1,640 ) Financing Activities Purchases of treasury stock ( 5,904 ) ( 4,473 ) ( 6,497 ) Dividends paid ( 1,741 ) ( 1,605 ) ( 1,345 ) Proceeds from debt, net 2,024 3,959 2,724 Payment of debt ( 650 ) ( 500 ) Acquisition of redeemable non-controlling interests ( 49 ) Acquisition of non-controlling interest ( 133 ) Contingent consideration paid ( 64 ) ( 199 ) Tax withholdings related to share-based payments ( 133 ) ( 150 ) ( 161 ) Cash proceeds from exercise of stock options 61 97 126 Other financing activities ( 15 ) 69 ( 15 ) Net cash used in financing activities ( 6,555 ) ( 2,152 ) ( 5,867 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents ( 153 ) 257 ( 44 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents ( 2,517 ) 3,450 632 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 12,419 8,969 8,337 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 9,902 $ 12,419 $ 8,969 The accompanying notes are an integral part of these consolidated financial statements. 68 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known and trusted brands, including Mastercard, Maestro and Cirrus. The Company operates a multi-rail payments network that provides choice and flexibility for consumers and merchants. Through its unique and proprietary core global payments network, the Company switches (authorizes, clears and settles) payment transactions. The Company has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). Using these capabilities, the Company offers integrated payment products and services and captures new payment flows. The Companys value-added services include, among others, cyber and intelligence solutions to allow all parties to transact easily and with confidence, as well as other services that provide proprietary insights, drawing on Mastercards principled use of consumer and merchant data. The Companys franchise model sets the standards and ground-rules that balance value and risk across all stakeholders and allows for interoperability among them. The Companys payment solutions are designed to ensure safety and security for the global payments ecosystem. Mastercard is not a financial institution. The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as marketable, equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2021 and 2020, there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date on which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2021, 2020 and 2019, net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. These financial statements were prepared using information reasonably available as of December 31, 2021 and through the date of this Report. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated from assessing customers based on the dollar volume of activity, or gross dollar volume (GDV), on the products that carry the Companys brands, from fees to issuers, acquirers and other stakeholders for providing switching services, as well as from value-added products and services that are often integrated and sold with the Companys payment offerings. MASTERCARD 2021 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is primarily based on the related volume generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. For services provided to customers where delivery involves the use of a third-party, the Company recognizes revenue on a gross basis if it acts as the principal, controlling the service to the customer and on a net basis if it acts as the agent, arranging for the service to be provided. Mastercard has business agreements with certain customers that provide for rebates and incentives that could be either fixed or variable-based. Fixed incentives typically represent payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis as a reduction of gross revenue. Variable rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Variable rebates and incentives are calculated based upon estimated customer performance, such as volume thresholds, and the terms of the related business agreements. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payments network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, any non-controlling interest in the acquiree and contingent consideration at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses on the consolidated statement of operations. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date are recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy (as defined in Fair value subsection below). Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. 70 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires certain customers to enter into risk mitigation arrangements, including cash collateral and/or other forms of credit enhancement such as letters of credit and guarantees, for settlement of their transactions. Certain risk mitigation arrangements for settlement, such as standby letters of credit and bank guarantees, are not recorded on the consolidated balance sheet. The Company also holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. MASTERCARD 2021 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company also measures certain financial and non-financial assets and liabilities at fair value on a non-recurring basis, when a change in fair value or impairment is evidenced. The Company classifies these recurring and non-recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data The Companys financial assets and liabilities measured at fair value on a recurring basis include investment securities available for sale, marketable securities, derivative instruments and deferred compensation. The Companys financial assets and liabilities measured at fair value on a non-recurring basis include nonmarketable securities, debt and other financial instruments. The Companys non-financial assets measured at fair value on a non-recurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions are recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Investments in debt securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment is recognized as an allowance and recorded in other income (expense), net on the consolidated statement of operations while the non-credit related loss remains in accumulated other comprehensive income (loss) until realized from a sale or subsequent impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as other assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. 72 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gains (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the measurement alternative method or equity method. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operations of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gains (losses) on equity investments, net on the consolidated statement of operations. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the operations of the investee, generally when it holds between 20 % and 50 % ownership in the entity. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the operations of the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The Companys share of net earnings or losses for these investments are included in gains (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. The Company does not enter into derivative instruments for trading or speculative purposes. For derivatives that are not designated as hedging instruments, realized and unrealized gains and losses from the change in fair value of the derivatives are recognized in current earnings. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. The Company may designate derivative instruments as cash flow, fair value and net investment hedges, as follows: Cash flow hedges - Fair value adjustments to derivative instruments are recorded, net of tax, in other comprehensive income (loss) on the consolidated statement of comprehensive income. Any gains and losses deferred in accumulated other comprehensive income (loss) are subsequently reclassified to the corresponding line item on the consolidated statement of operations when the underlying hedged transactions impact earnings. For hedges that are no longer deemed highly effective, hedge accounting is discontinued prospectively, and any gains and losses remaining in accumulated other comprehensive income (loss) are reclassified to earnings when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, the associated gains or losses in accumulated other comprehensive income (loss) are reclassified to the corresponding line item on the consolidated statement of operations in current earnings. MASTERCARD 2021 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair value hedges - Changes in the fair value of derivative instruments are recorded in current-period earnings, along with the gain or loss on the hedged asset or liability (hedged item) that is attributable to the hedged risk. All amounts recognized in earnings are recorded to the corresponding line item on the consolidated statement of operations as the earnings effect of the hedged item. Hedged items are measured on the consolidated balance sheet at their carrying amount adjusted for any changes in fair value attributable to the hedged risk (basis adjustments). The Company defers the amortization of any basis adjustments until the end of the derivative instruments term. If the hedge designation is discontinued for reasons other than derecognition of the hedged item, the remaining basis adjustments are amortized in accordance with applicable GAAP for the hedged item. Net investment hedges - The Company has numerous investments in foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company may use foreign currency denominated debt and/or derivative instruments to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the hedging instruments are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as a cumulative translation adjustment component of equity. Gains and losses in accumulated other comprehensive income (loss) are reclassified to earnings only if the Company sells or substantially liquidates its net investments in foreign subsidiaries. Amounts excluded from effectiveness testing of net investment hedges are recognized in earnings over the life of the hedging instrument. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement assets/obligations - The Company operates systems for settling payment transactions among participants in the payments ecosystem in which the Company operates. Settlement is generally completed on a same-day basis, however, in some circumstances, funds may not settle until subsequent business days. In addition, the Company may receive or post funds in advance of transactions related to certain payment capabilities over its multi-rail payments network. The Company classifies the balances arising from these various activities as settlement assets and settlement obligations. Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. 74 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense), net on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. MASTERCARD 2021 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Accounting pronouncements not yet adopted Accounting for contract assets and contract liabilities in a business combination - In October 2021, the Financial Accounting Standards Board issued accounting guidance that requires contract assets and contract liabilities (i.e., deferred revenue) acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers . The guidance is effective for periods beginning after December 15, 2022 with early adoption permitted. The Company will early adopt this guidance effective January 1, 2022 and does not expect the impacts to be material. Note 2. Acquisitions In 2021, 2020 and 2019, the Company acquired several businesses for total consideration of $ 4.7 billion, $ 1.1 billion and $ 1.5 billion, respectively, representing both cash and contingent consideration. These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations and contingent consideration. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a majority of the goodwill is not expected to be deductible for local tax purposes. On March 5, 2021, Mastercard acquired a majority of the Corporate Services business of Nets Denmark A/S (Nets) for 3.0 billion (approximately $ 3.6 billion as of the date of acquisition) in cash consideration based on a 2.85 billion enterprise value, adjusted for cash and net working capital at closing. The business acquired is primarily comprised of clearing and instant payment services and e-billing solutions. In relation to this acquisition, the Companys preliminary estimate of net assets acquired primarily relates to intangible assets, including goodwill of $ 2.1 billion, of which $ 0.8 billion is expected to be deductible for local tax purposes. The goodwill arising from this acquisition is primarily attributable to the synergies expected to arise through geographic, product and customer expansion, the underlying technology and workforce acquired. On June 9, 2021, Mastercard acquired a 100 % equity interest in Ekata, Inc. (Ekata) for cash consideration of $ 861 million, based on an $ 850 million enterprise value, adjusted for cash and net working capital at closing. The acquisition of Ekata is expected to broaden the Companys digital identity verification capabilities. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and none of the goodwill is expected to be deductible for local tax purposes. Mastercard acquired additional businesses in 2021 for consideration of $ 272 million. These businesses were not considered individually material to Mastercard. Among the businesses acquired in 2020, the largest acquisition relates to Finicity Corporation (Finicity), an open-banking provider, headquartered in Salt Lake City, Utah. On November 18, 2020, Mastercard acquired 100 % equity interest in Finicity for cash consideration of $ 809 million. In addition, the Finicity sellers earned additional contingent consideration of $ 64 million upon meeting 2021 revenue targets in accordance with terms of the purchase agreement. The additional businesses acquired in 2020 and the businesses acquired in 2019 were not considered individually material to Mastercard. 76 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is evaluating and finalizing the purchase accounting for the businesses acquired during 2021. In 2021, the Company finalized the purchase accounting for businesses acquired during 2020. The estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for the years ended December 31. 2021 2020 2019 (in millions) Assets: Cash and cash equivalents $ 253 $ 6 $ 54 Other current assets 41 14 143 Other intangible assets 2,071 237 395 Goodwill 2,842 844 1,076 Other assets 15 11 48 Total assets 5,222 1,112 1,716 Liabilities: Other current liabilities 112 15 121 Deferred income taxes 398 23 52 Other liabilities 12 8 32 Total liabilities 522 46 205 Net assets acquired $ 4,700 $ 1,066 $ 1,511 The following table summarizes the identified intangible assets acquired during the years ended December 31: 2021 2020 2019 2021 2020 2019 Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ 433 $ 122 $ 199 11.7 6.3 7.7 Customer relationships 1,614 114 178 19.2 12.0 12.6 Other 24 1 18 7.1 1.0 5.0 Other intangible assets $ 2,071 $ 237 $ 395 17.5 9.0 9.7 Proforma information related to these acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. Pending Acquisition As of December 31, 2021, Mastercard has entered into a definitive agreement to acquire Dynamic Yield LTD. This acquisition is expected to close in the second quarter of 2022. Note 3. Revenue Mastercards core network involves four participants in addition to the Company: account holders (a person or entity who holds a card or uses another device enabled for payment), issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payments network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or GDV, on the products that carry the Companys brands. Revenue is generally derived from information accumulated by Mastercards systems or reported by customers. In addition, the Company generates other revenues from value-added products and services, often integrated and sold with the Companys payment offerings, that are recognized as revenue in the period in which the related transactions occur or services are performed. MASTERCARD 2021 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates switched or not switched by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization, which is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing, which is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement, which facilitates the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions, payment gateways for e-commerce merchants, mobile gateways for mobile-initiated transactions, and safety and security. Other revenues consist of value-added products and services that are often sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Cyber and intelligence solutions fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Data analytics and consulting fees are for insights, analytics, and test and learn capabilities as well as Mastercards advisory and managed services. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services and platforms, including account and transaction enhancement services, open banking and digital identity solutions, rules compliance and publications. 78 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Rebates and incentives (contra-revenue) are provided to customers and can be either fixed or variable-based. Fixed incentives typically represent payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis as a reduction of gross revenue. Variable rebates and incentives are typically tied to customer performance, such as volume thresholds, and are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31: 2021 2020 2019 (in millions) Revenue by source: Domestic assessments $ 8,158 $ 6,656 $ 6,781 Cross-border volume fees 4,664 3,512 5,606 Transaction processing 10,799 8,731 8,469 Other revenues 6,224 4,717 4,124 Gross revenue 29,845 23,616 24,980 Rebates and incentives (contra-revenue) ( 10,961 ) ( 8,315 ) ( 8,097 ) Net revenue $ 18,884 $ 15,301 $ 16,883 Net revenue by geographic region: North American Markets $ 6,594 $ 5,424 $ 5,843 International Markets 12,068 9,701 10,869 Other 1 222 176 171 Net revenue $ 18,884 $ 15,301 $ 16,883 1 Includes revenues managed by corporate functions. The Companys customers are generally billed weekly, however the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. The following table sets forth the location of the amounts recognized on the consolidated balance sheet from contracts with customers at December 31: 2021 2020 (in millions) Receivables from contracts with customers Accounts receivable $ 2,829 $ 2,505 Contract assets Prepaid expenses and other current assets 134 59 Other assets 487 245 Deferred revenue 1 Other current liabilities 482 355 Other liabilities 180 143 1 Revenue recognized from performance obligations satisfied in 2021, 2020 and 2019 was $ 1.5 billion, $ 1.1 billion and $ 994 million, respectively. The Companys remaining performance periods for its contracts with customers for its payments network services are typically long-term in nature (generally up to 10 years). As a payments network service provider, the Company provides its customers with continuous access to its global payments network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates volume- and transaction-based revenues from assessing its customers current period activity. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payments network services. The Company also earns revenues primarily from other value-added services comprised of both batch and real-time account-based payments services, cyber and intelligence solutions, consulting fees, loyalty programs, gateway services, processing, and other payment-related products and services. At December 31, 2021, the estimated MASTERCARD 2021 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion, which is expected to be recognized through 2024. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: 2021 2020 2019 (in millions, except per share data) Numerator Net income $ 8,687 $ 6,411 $ 8,118 Denominator Basic weighted-average shares outstanding 988 1,002 1,017 Dilutive stock options and stock units 4 4 5 Diluted weighted-average shares outstanding 1 992 1,006 1,022 Earnings per Share Basic $ 8.79 $ 6.40 $ 7.98 Diluted $ 8.76 $ 6.37 $ 7.94 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31: 2021 2020 (in millions) Cash and cash equivalents $ 7,421 $ 10,113 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement 586 586 Restricted security deposits held for customers 1,873 1,696 Prepaid expenses and other current assets 22 24 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 9,902 $ 12,419 80 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: 2021 2020 2019 (in millions) Cash paid for income taxes, net of refunds $ 1,820 $ 1,349 $ 1,644 Cash paid for interest 399 311 199 Cash paid for legal settlements 98 149 668 Non-cash investing and financing activities Dividends declared but not yet paid 479 439 403 Accrued property, equipment and right-of-use assets 15 154 468 Fair value of assets acquired, net of cash acquired 4,969 1,106 1,662 Fair value of liabilities assumed related to acquisitions 522 46 205 Note 7. Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity debt securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31: 2021 2020 (in millions) Available-for-sale securities 1 $ 314 $ 321 Held-to-maturity securities 2 159 162 Total investments $ 473 $ 483 1 See Available-for-Sale Securities section below for further detail. 2 The cost of these securities approximates fair value. Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2021 December 31, 2020 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ 2 $ $ $ 2 $ 10 $ $ $ 10 Government and agency securities 98 98 64 64 Corporate securities 214 214 246 1 247 Total $ 314 $ $ $ 314 $ 320 $ 1 $ $ 321 The Companys corporate and municipal available-for-sale investment securities held at December 31, 2021 and 2020, primarily carried a credit rating of A- or better. Corporate securities are comprised of commercial paper and corporate bonds. Municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds which are denominated in the national currency of the issuing country. Unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. MASTERCARD 2021 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys available-for-sale investment securities at December 31, 2021 was as follows: Amortized Cost Fair Value (in millions) Due within 1 year $ 132 $ 132 Due after 1 year through 5 years 182 182 Total $ 314 $ 314 Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits and available-for-sale investment securities, as well as realized gains and losses on the Companys available-for-sale investment securities. The realized gains and losses from the sales of available-for-sale securities for 2021, 2020 and 2019 were not material. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are equity interests in publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (Measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2020 Purchases Sales Changes in Fair Value 1 Other 2 Balance at December 31, 2021 (in millions) Marketable securities $ 476 $ $ ( 165 ) $ 91 $ 225 $ 627 Nonmarketable securities 696 228 ( 21 ) 554 ( 250 ) 1,207 Total equity investments $ 1,172 $ 228 $ ( 186 ) $ 645 $ ( 25 ) $ 1,834 1 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations. 2 Includes translational impact of currency and $ 227 million of transfers between equity investment categories due to changes to the existence of readily determinable fair values. The following table sets forth the components of the Companys Nonmarketable securities at December 31: 2021 2020 (in millions) Measurement alternative $ 952 $ 539 Equity method 255 157 Total Nonmarketable securities $ 1,207 $ 696 82 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the total carrying value of the Companys Measurement alternative investments, including cumulative unrealized gains and losses, at December 31: 2021 (in millions) Initial cost basis $ 448 Adjustments: Upward adjustments 514 Downward adjustments (including impairment) ( 10 ) Carrying amount, end of period $ 952 Unrealized gains and losses included in the carrying value of the Companys Measurement alternative investments still held as of December 31, 2021 and 2020, were as follows: For the Years Ended December 31, 2021 2020 (in millions) Upward adjustments $ 468 $ 21 Downward adjustments (including impairment) $ ( 2 ) $ ( 3 ) Note 8. Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy (the Valuation Hierarchy). Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. MASTERCARD 2021 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2021 December 31, 2020 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available-for-sale 1 : Municipal securities $ $ 2 $ $ 2 $ $ 10 $ $ 10 Government and agency securities 35 63 98 26 38 64 Corporate securities 214 214 247 247 Derivative instruments 2 : Foreign exchange contracts 8 8 19 19 Interest rate contracts 6 6 Marketable securities 3 : Equity securities 627 627 476 476 Deferred compensation plan 4 : Deferred compensation assets 89 89 78 78 Liabilities Derivative instruments 2 : Foreign exchange contracts $ $ 15 $ $ 15 $ $ 28 $ $ 28 Interest rate contracts 8 8 Deferred compensation plan 5 : Deferred compensation liabilities 89 89 81 81 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, non-U.S. government and agency securities and corporate securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign exchange for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . 84 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt securities are classified as Level 2 of the Valuation Hierarchy as they are not traded in active markets. At December 31, 2021, the carrying value and fair value of total long-term debt (including the current portion) was $ 13.9 billion and $ 15.3 billion, respectively. At December 31, 2020, the carrying value and fair value of long-term debt (including the current portion) was $ 12.7 billion and $ 14.8 billion, respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain other financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement assets, restricted security deposits held for customers, accounts payable, settlement obligations and other accrued liabilities. Note 9. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 1,326 $ 1,086 Prepaid income taxes 92 78 Other 853 719 Total prepaid expenses and other current assets $ 2,271 $ 1,883 Other assets consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 3,798 $ 3,220 Equity investments 1,834 1,172 Income taxes receivable 645 553 Other 717 420 Total other assets $ 6,994 $ 5,365 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Payments directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. MASTERCARD 2021 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31: 2021 2020 (in millions) Building, building equipment and land $ 615 $ 522 Equipment 1,456 1,321 Furniture and fixtures 96 99 Leasehold improvements 371 380 Operating lease right-of-use assets 983 970 Property, equipment and right-of-use assets 3,521 3,292 Less: Accumulated depreciation and amortization ( 1,614 ) ( 1,390 ) Property, equipment and right-of-use assets, net $ 1,907 $ 1,902 Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 424 million, $ 400 million and $ 336 million for 2021, 2020 and 2019, respectively. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows at December 31: 2021 2020 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ 671 $ 748 Other current liabilities 127 125 Other liabilities 645 726 Operating lease amortization expense for 2021, 2020 and 2019 was $ 122 million, $ 123 million and $ 99 million, respectively. As of December 31, 2021 and 2020, the weighted-average remaining lease term of operating leases was 8.8 years and 9.1 years and the weighted-average discount rate for operating leases was 2.6 % and 2.7 %, respectively. The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2021 based on lease term: Operating Leases (in millions) 2022 $ 145 2023 130 2024 109 2025 83 2026 75 Thereafter 322 Total operating lease payments 864 Less: Interest ( 92 ) Present value of operating lease liabilities $ 772 86 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: 2021 2020 (in millions) Beginning balance $ 4,960 $ 4,021 Additions 2,842 844 Foreign currency translation ( 140 ) 95 Ending balance $ 7,662 $ 4,960 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2021 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2021. Note 12. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: 2021 2020 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 2,929 $ ( 1,288 ) $ 1,641 $ 2,276 $ ( 1,126 ) $ 1,150 Customer relationships 2,272 ( 429 ) 1,843 743 ( 322 ) 421 Other 59 ( 38 ) 21 44 ( 41 ) 3 Total 5,260 ( 1,755 ) 3,505 3,063 ( 1,489 ) 1,574 Indefinite-lived intangible assets Customer relationships 166 166 179 179 Total $ 5,426 $ ( 1,755 ) $ 3,671 $ 3,242 $ ( 1,489 ) $ 1,753 The increase in the gross carrying amount of amortized intangible assets in 2021 was primarily related to businesses acquired in 2021 and software additions. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2021, it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $ 424 million, $ 303 million and $ 285 million in 2021, 2020 and 2019, respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2021 for the years ending December 31: (in millions) 2022 $ 429 2023 378 2024 355 2025 347 2026 and thereafter 1,996 Total $ 3,505 MASTERCARD 2021 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: 2021 2020 (in millions) Customer and merchant incentives $ 4,730 $ 3,998 Personnel costs 980 727 Income and other taxes 337 208 Other 595 497 Total accrued expenses $ 6,642 $ 5,430 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2021 and 2020, long-term customer and merchant incentives included in other liabilities were $ 1,835 million and $ 1,215 million, respectively. As of December 31, 2021 and 2020, the Companys provision for litigation was $ 840 million and $ 842 million, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 175 million, $ 150 million and $ 127 million in 2021, 2020 and 2019, respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 20 million as of December 31, 2021) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). 88 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, on the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized on the Companys consolidated balance sheet at December 31: Pension Plans Postretirement Plan 2021 2020 2021 2020 ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ 604 $ 531 $ 70 $ 64 Service cost 14 13 1 1 Interest cost 9 9 2 2 Actuarial (gain) loss ( 6 ) 43 ( 7 ) 7 Benefits paid ( 17 ) ( 18 ) ( 4 ) ( 4 ) Transfers in 4 3 Foreign currency translation ( 12 ) 23 Benefit obligation at end of year 596 604 62 70 Change in plan assets Fair value of plan assets at beginning of year 617 518 Actual gain on plan assets 63 56 Employer contributions 32 34 4 4 Benefits paid ( 17 ) ( 18 ) ( 4 ) ( 4 ) Transfers in 4 5 Foreign currency translation ( 11 ) 22 Fair value of plan assets at end of year 688 617 Funded status at end of year $ 92 $ 13 $ ( 62 ) $ ( 70 ) Amounts recognized on the consolidated balance sheet consist of: Noncurrent assets $ 105 $ 28 $ $ Other liabilities, short-term ( 3 ) ( 4 ) Other liabilities, long-term ( 13 ) ( 15 ) ( 59 ) ( 66 ) $ 92 $ 13 $ ( 62 ) $ ( 70 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ ( 38 ) $ 12 $ 2 $ 9 Prior service credit 1 1 ( 2 ) ( 4 ) Balance at end of year $ ( 37 ) $ 13 $ $ 5 Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.90 % 0.70 % * * Vocalink Plan 1.75 % 1.55 % * * Postretirement Plan * * 2.75 % 2.50 % Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % * * Vocalink Plan 3.20 % 2.75 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD 2021 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2021 and 2020, the Companys aggregated Pension Plan assets exceed the benefit obligations. For plans where the benefit obligations exceeded plan assets, the projected benefit obligation was $ 116 million and $ 112 million, the accumulated benefit obligation was $ 115 million and $ 111 million and plan assets were $ 104 million and $ 97 million at December 31, 2021 and 2020, respectively. Information on the Pension Plans were as follows as of December 31: 2021 2020 (in millions) Projected benefit obligation $ 596 $ 604 Accumulated benefit obligation 592 601 Fair value of plan assets 688 617 For the year ended December 31, 2021, the Companys projected benefit obligation related to its Pension Plans decreased $ 8 million, primarily attributable to actuarial gains related to higher discount rate assumptions. For the year ended December 31, 2020, the Companys projected benefit obligation related to its Pension Plans increased $ 73 million, primarily attributable to actuarial losses related to lower discount rate assumptions. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 (in millions) Service cost $ 14 $ 13 $ 11 $ 1 $ 1 $ 1 Interest cost 9 9 13 2 2 2 Expected return on plan assets ( 19 ) ( 18 ) ( 18 ) Amortization of actuarial loss ( 1 ) 1 Amortization of prior service credit ( 1 ) ( 1 ) ( 1 ) Net periodic benefit cost $ 3 $ 4 $ 7 $ 2 $ 2 $ 2 The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 (in millions) Current year actuarial loss (gain) $ ( 50 ) $ 5 $ 12 $ ( 7 ) $ 7 $ 9 Amortization of prior service credit 2 1 1 Total other comprehensive loss (income) $ ( 50 ) $ 5 $ 12 $ ( 5 ) $ 8 $ 10 Total net periodic benefit cost and other comprehensive loss (income) $ ( 47 ) $ 9 $ 19 $ ( 3 ) $ 10 $ 12 90 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31: Pension Plans Postretirement Plan 2021 2020 2019 2021 2020 2019 Discount rate Non-U.S. Plans 0.70 % 0.70 % 1.80 % * * * Vocalink Plan 1.55 % 1.55 % 2.00 % * * * Postretirement Plan * * * 2.50 % 3.25 % 4.25 % Expected return on plan assets Non-U.S. Plans 1.60 % 1.60 % 2.10 % * * * Vocalink Plan 3.20 % 3.20 % 3.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % 1.50 % * * * Vocalink Plan 2.75 % 2.75 % 2.50 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: 2021 2020 Healthcare cost trend rate assumed for next year 6.75 % 7.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate 7 8 Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed with the following target asset allocations: cash and cash equivalents 42 %, U.K. government securities 18 %, fixed income 17 %, equity 15 % and real estate 8 %. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. MASTERCARD 2021 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2021 December 31, 2020 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ 246 $ $ $ 246 $ 59 $ $ $ 59 Mutual funds 2 185 102 287 270 117 387 Insurance contracts 3 104 104 96 96 Total $ 431 $ 206 $ $ 637 $ 329 $ 213 $ $ 542 Investments at Net Asset Value (NAV) 4 51 75 Total Plan Assets $ 688 $ 617 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 3 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 4 Investments at NAV include mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) and are valued using the net asset value provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2021) through 2031 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) 2022 $ 27 $ 3 2023 18 3 2024 21 3 2025 21 4 2026 19 4 2027 - 2031 124 19 92 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15. Debt Long-term debt consisted of the following at December 31: 2021 2020 Effective Interest Rate (in millions) 2021 USD Notes 2.000 % Senior Notes due November 2031 $ 750 $ 2.112 % 1.900 % Senior Notes due March 2031 600 1.981 % 2.950 % Senior Notes due March 2051 700 3.013 % 2020 USD Notes 3.300 % Senior Notes due March 2027 1,000 1,000 3.420 % 3.350 % Senior Notes due March 2030 1,500 1,500 3.430 % 3.850 % Senior Notes due March 2050 1,500 1,500 3.896 % 2019 USD Notes 2.950 % Senior Notes due June 2029 1,000 1,000 3.030 % 3.650 % Senior Notes due June 2049 1,000 1,000 3.689 % 2.000 % Senior Notes due March 2025 750 750 2.147 % 2018 USD Notes 3.500 % Senior Notes due February 2028 500 500 3.598 % 3.950 % Senior Notes due February 2048 500 500 3.990 % 2016 USD Notes 2.000 % Senior Notes due November 2021 650 2.236 % 2.950 % Senior Notes due November 2026 750 750 3.044 % 3.800 % Senior Notes due November 2046 600 600 3.893 % 2015 EUR Notes 1 1.100 % Senior Notes due December 2022 793 859 1.265 % 2.100 % Senior Notes due December 2027 906 982 2.189 % 2.500 % Senior Notes due December 2030 170 184 2.562 % 2014 USD Notes 3.375 % Senior Notes due April 2024 1,000 1,000 3.484 % 14,019 12,775 Less: Unamortized discount and debt issuance costs ( 116 ) ( 103 ) Less: Cumulative hedge accounting fair value adjustments 2 ( 2 ) Total debt outstanding 13,901 12,672 Less: Current portion 3 ( 792 ) ( 649 ) Long-term debt $ 13,109 $ 12,023 1 1.650 billion euro-denominated debt issued in December 2015. 2 In 2021, the Company entered into an interest rate swap which is accounted for as a fair value hedge. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 2015 EUR Notes due December 2022 and 2016 USD Notes due November 2021 are classified as current portion of long-term debt on the consolidated balance sheet as of December 31, 2021 and 2020, respectively. In March 2021, the Company issued $ 600 million principal amount of notes due March 2031 and $ 700 million principal amount of notes due March 2051. In November 2021, the Company also issued $ 750 million principal amount of notes due November 2031. The two issuances in 2021 are collectively referred to as the 2021 USD Notes. The net proceeds from the issuance of the 2021 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.024 billion. In March 2020, the Company issued $ 1 billion principal amount of notes due March 2027, $ 1.5 billion principal amount of notes due March 2030 and $ 1.5 billion principal amount notes due March 2050 (collectively the 2020 USD Notes). The net proceeds from the issuance of the 2020 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 3.959 billion. MASTERCARD 2021 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049. In December 2019, the Company also issued $ 750 million principal amount of notes due March 2025. The two issuances in 2019 are collectively referred to as the 2019 USD Notes. The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion. The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2021 are summarized below. (in millions) 2022 $ 793 2023 2024 1,000 2025 750 2026 750 Thereafter 10,726 Total $ 14,019 As of December 31, 2021, the Company has a commercial paper program (the Commercial Paper Program) under which the Company is authorized to issue up to $ 6 billion in unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company has a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility). The Credit Facility, which previously expired on November 13, 2025, was amended and extended on November 13, 2021 for an additional year and now expires on November 12, 2026. The amendment and extension did not result in material changes to the terms and conditions of the Credit Facility. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2021 and 2020. Borrowings under the Commercial Paper Program and the Credit Facility are to be used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2021 and 2020. Note 16. Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 300 No shares issued or outstanding at December 31, 2021 and 2020. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. 94 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2021, 2020 and 2019. The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2021 2020 2019 (in millions, except per share data) Dividends declared per share $ 1.81 $ 1.64 $ 1.39 Total dividends declared $ 1,781 $ 1,641 $ 1,408 Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31: 2021 2020 Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.4 % 89.2 % 88.2 % 88.9 % Principal or Affiliate Customers (Class B stockholders) 0.8 % % 0.8 % % Mastercard Foundation (Class A stockholders) 10.8 % 10.8 % 11.0 % 11.1 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements pursuant to Canadian tax law. Under such current law, Mastercard Foundation must annually disburse at least 3.5 % of its assets not used in its charitable activities and administration in the previous eight quarters (Disbursement Quota). However, Mastercard Foundation obtained permission from the Canada Revenue Agency to, until December 31, 2021, meet its cumulative Disbursement Quota obligations over a period of time that, on average, demonstrates compliance with the requirement for such established time period. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. MASTERCARD 2021 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Common Stock Activity The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31: Outstanding Shares Class A Class B (in millions) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 Purchases of treasury stock ( 14.3 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.9 ( 2.9 ) Balance at December 31, 2020 986.9 8.3 Purchases of treasury stock ( 16.5 ) Share-based payments 1.2 Conversion of Class B to Class A common stock 0.5 ( 0.5 ) Balance at December 31, 2021 972.1 7.8 The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. The following table summarizes the Companys share repurchase authorizations of its Class A common stock for the years ended December 31: 2021 2020 2019 (In millions, except per share data) Board authorization $ 8,000 $ 6,000 $ 8,000 Dollar-value of shares repurchased $ 5,904 $ 4,473 $ 6,497 Shares repurchased 16.5 14.3 26.4 Average price paid per share $ 356.82 $ 312.68 $ 245.89 As of December 31, 2021, the remaining authorization under the share repurchase programs approved by the Companys Board of Directors was $ 11.9 billion. 96 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2021 and 2020 were as follows: December 31, 2020 Increase / (Decrease) Reclassifications December 31, 2021 (in millions) Foreign currency translation adjustments 1 $ ( 352 ) $ ( 387 ) $ $ ( 739 ) Translation adjustments on net investment hedges 2 ( 175 ) 209 34 Cash flow hedges Foreign exchange contracts 3 5 ( 1 ) 4 Interest rate contracts 4 ( 133 ) 5 ( 128 ) Defined benefit pension and other postretirement plans 5 ( 20 ) 43 ( 2 ) 21 Investment securities available-for-sale ( 1 ) ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 680 ) $ ( 131 ) $ 2 $ ( 809 ) December 31, 2019 Increase / (Decrease) Reclassifications December 31, 2020 (in millions) Foreign currency translation adjustments 1 $ ( 638 ) $ 286 $ $ ( 352 ) Translation adjustments on net investment hedges 2 ( 38 ) ( 137 ) ( 175 ) Cash flow hedges Interest rate contracts 4 11 ( 147 ) 3 ( 133 ) Defined benefit pension and other postretirement plans 5 ( 9 ) ( 10 ) ( 1 ) ( 20 ) Investment securities available-for-sale 1 ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 673 ) $ ( 9 ) $ 2 $ ( 680 ) 1 During 2021, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily b y the depreciation of the euro against the U.S. dollar. During 2020, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro and British pound partially offset by the depreciation of the Brazilian real. 2 During 2021, t he increase in the accumulated other comprehensive income related to the net investment hedges was driven by the depreciation of the euro against the U.S. dollar. During 2020, the increase in the accumulated other comprehensive loss related to the net investment hedge was driven by the appreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 Beginning in 2021, certain foreign exchange derivative contracts are designated as cash flow hedging instruments. Gains and losses resulting from changes in the fair value of these contracts are deferred in accumulated other comprehensive income (loss) and subsequently reclassified to the consolidated statement of operations when the underlying hedged transactions impact earnings. See Note 23 (Derivative and Hedging Instruments) for additional information. 4 In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled for a loss of $ 175 million, or $ 136 million net of tax, recorded in accumulated other comprehensive income (loss). The cumulative loss will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. See Note 23 (Derivative and Hedging Instruments) for additional information. 5 During 2021, the increase in the accumulated other comprehensive income related to the Plans was driven primarily by a net actuarial gain within the Pension Plans. During 2020, the increase in the accumulated other comprehensive loss related to the Plans was driven primarily by an actuarial loss within the Postretirement Plan. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. MASTERCARD 2021 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18. Share-Based Payments In May 2006, the Company granted the following awards under the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, however, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per Option granted for the years ended December 31: 2021 2020 2019 Risk-free rate of return 0.9 % 1.0 % 2.6 % Expected term (in years) 6.00 6.00 6.00 Expected volatility 26.1 % 19.3 % 19.6 % Expected dividend yield 0.5 % 0.6 % 0.6 % Weighted-average fair value per Option granted $ 91.70 $ 80.92 $ 53.09 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2021: Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2021 5.7 $ 137 Granted 0.3 $ 363 Exercised ( 0.6 ) $ 96 Forfeited/expired $ 259 Outstanding at December 31, 2021 5.4 $ 152 5.3 $ 1,109 Exercisable at December 31, 2021 4.2 $ 122 4.6 $ 986 Options vested and expected to vest at December 31, 2021 5.3 $ 152 5.3 $ 1,109 As of December 31, 2021, there was $ 26 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 1.9 years. 98 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restricted Stock Units For RSUs granted on or after March 1, 2020, the awards generally vest ratably over four years . For RSUs granted before March 1, 2020, the awards generally vest after three years . A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than seven months . The following table summarizes the Companys RSU activity for the year ended December 31, 2021: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2021 2.5 $ 231 Granted 0.8 $ 358 Converted ( 1.0 ) $ 199 Forfeited ( 0.1 ) $ 282 Outstanding at December 31, 2021 2.2 $ 291 $ 781 RSUs expected to vest at December 31, 2021 2.1 $ 289 $ 751 The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2021, there was $ 283 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 2.6 years. Performance Stock Units PSUs vest after three years , however, awards granted on or after March 1, 2019 are subject to a mandatory one-year post-vest hold. A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. The following table summarizes the Companys PSU activity for the year ended December 31, 2021: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2021 0.4 $ 259 Granted 0.2 $ 385 Converted ( 0.1 ) $ 226 Other ( 0.1 ) $ 231 Outstanding at December 31, 2021 0.4 $ 334 $ 128 PSUs expected to vest at December 31, 2021 0.4 $ 334 $ 128 Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. MASTERCARD 2021 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Compensation expense for PSUs is recognized over the requisite service period, or the date the individual becomes eligible to retire but not less than seven months , if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. During the year ended December 31, 2020, performance targets related to PSU awards granted in 2018 (2018 PSU Awards) were adjusted to exclude certain pandemic-related financial impacts deemed outside of the Companys control. The adjustment during the year ended December 31, 2020 required the Company to apply modification accounting to the 2018 PSU Awards which had an immaterial impact on compensation expense. As of December 31, 2021, there was $ 34 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.5 years. Additional Information The following table includes additional share-based payment information for each of the years ended December 31: 2021 2020 2019 (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ 273 $ 254 $ 250 Income tax benefit recognized for equity awards 57 53 53 Income tax benefit realized related to Options exercised 36 68 69 Options: Total intrinsic value of Options exercised 169 317 317 RSUs: Weighted-average grant-date fair value of awards granted 358 288 226 Total intrinsic value of RSUs converted into shares of Class A common stock 360 330 394 PSUs: Weighted-average grant-date fair value of awards granted 385 291 231 Total intrinsic value of PSUs converted into shares of Class A common stock 32 92 85 Note 19. Commitments At December 31, 2021, the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements. The Company has accrued $ 17 million of these future payments as of December 31, 2021. (in millions) 2022 $ 424 2023 202 2024 114 2025 48 2026 3 Thereafter 1 Total $ 792 100 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 20. Income Taxes Components of Income and Income Tax Expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: 2021 2020 2019 (in millions) United States $ 4,261 $ 3,304 $ 4,213 Foreign 6,046 4,456 5,518 Income before income taxes $ 10,307 $ 7,760 $ 9,731 The total income tax provision for the years ended December 31 is comprised of the following components: 2021 2020 2019 (in millions) Current Federal $ 663 $ 439 $ 642 State and local 51 56 81 Foreign 976 781 897 1,690 1,276 1,620 Deferred Federal ( 31 ) 106 40 State and local ( 4 ) 9 Foreign ( 35 ) ( 42 ) ( 47 ) ( 70 ) 73 ( 7 ) Income tax expense $ 1,620 $ 1,349 $ 1,613 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: 2021 2020 2019 Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 10,307 $ 7,760 $ 9,731 Federal statutory tax 2,164 21.0 % 1,630 21.0 % 2,044 21.0 % State tax effect, net of federal benefit 60 0.6 % 57 0.7 % 65 0.7 % Foreign tax effect ( 283 ) ( 2.7 ) % ( 193 ) ( 2.5 ) % ( 208 ) ( 2.1 ) % U.S. tax benefits 1 ( 132 ) ( 1.3 ) % % % Windfall benefit ( 67 ) ( 0.7 ) % ( 119 ) ( 1.5 ) % ( 129 ) ( 1.3 ) % Other, net 2 ( 122 ) ( 1.2 ) % ( 26 ) ( 0.3 ) % ( 159 ) ( 1.7 ) % Income tax expense $ 1,620 15.7 % $ 1,349 17.4 % $ 1,613 16.6 % 1 Refer to the description below for the components that represent U.S. tax benefits. 2 Included within the impact of other is $ 27 million of tax benefits for 2019 relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2021, 2020 and 2019 were 15.7 %, 17.4 % and 16.6 %, respectively. The effective income tax rate for 2021 was lower than the effective income tax rate for 2020, primarily due to the recognition of U.S. tax benefits, the majority of which were discrete, resulting from a higher foreign derived intangible income deduction and greater utilization of foreign tax credits in the U.S. In addition, a more favorable geographic mix of earnings in 2021 contributed to the Companys lower effective tax rate. These benefits were partially offset by a lower discrete tax benefit related to share-based payments in 2021. MASTERCARD 2021 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effective income tax rate for 2020 was higher than the effective income tax rate for 2019, primarily due to higher discrete tax benefits in 2019, partially offset by a more favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S. tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2021, 2020 and 2019, the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 300 million, or $ 0.30 per diluted share, $ 260 million, or $ 0.26 per diluted share, and $ 300 million, or $ 0.29 per diluted share, respectively. Indefinite Reinvestment As of December 31, 2021 the Company had immaterial deferred tax liabilities related to the tax effect of the estimated foreign exchange impact on unremitted earnings. The Company expects that foreign withholding taxes associated with future repatriation of these earnings will not be material. Earnings of approximately $ 1.1 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax benefits would result, primarily from foreign exchange, if these earnings were to be repatriated. 102 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: 2021 2020 (in millions) Deferred Tax Assets Accrued liabilities $ 497 $ 324 Compensation and benefits 260 218 State taxes and other credits 40 47 Net operating and capital losses 136 147 Unrealized gain/loss - 2015 EUR Notes 24 58 U.S. foreign tax credits 333 276 Intangible assets 206 182 Other items 137 142 Less: Valuation allowance ( 415 ) ( 353 ) Total Deferred Tax Assets 1,218 1,041 Deferred Tax Liabilities Prepaid expenses and other accruals 114 78 Gains on equity investments 153 60 Goodwill and intangible assets 571 216 Property, plant and equipment 174 183 Previously taxed earnings and profits 3 61 Other items 112 38 Total Deferred Tax Liabilities 1,127 636 Net Deferred Tax Assets $ 91 $ 405 The valuation allowance balance at December 31, 2021 and 2020 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current and prior periods and certain foreign losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is dependent on the timing and character of future taxable income in such jurisdictions. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31, is as follows: 2021 2020 2019 (in millions) Beginning balance $ 388 $ 203 $ 164 Additions: Current year tax positions 17 19 22 Prior year tax positions 4 192 37 Reductions: Prior year tax positions ( 31 ) ( 10 ) ( 11 ) Settlements with tax authorities ( 15 ) ( 12 ) ( 2 ) Expired statute of limitations ( 3 ) ( 4 ) ( 7 ) Ending balance $ 360 $ 388 $ 203 MASTERCARD 2021 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2021, the amount of unrecognized tax benefit was $ 360 million. This amount, if recognized, would reduce the effective income tax rate. The Companys unrecognized tax benefits increased in 2020 primarily due to a prior year tax issue resulting from a refund claim filed in 2020. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2021 and 2020, the Company had a net income tax-related interest payable of $ 20 million and $ 24 million, respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2021, 2020 and 2019 was not material. In addition, as of December 31, 2021 and 2020, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 21. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services, resulting in merchants paying excessive costs for the acceptance of Mastercard and Visa credit and debit cards. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. 104 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the merchant litigation cases. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed and oral argument on the appeal is scheduled for March 2022. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. Briefing on summary judgment motions in the Rules Relief Class and opt-out merchant cases was completed in December 2020. In September 2021, the district court granted the Rules Relief Classs motion for class certification. As of December 31, 2021 and 2020, Mastercard had accrued a liability of $ 783 million as a reserve for both the Damages Class litigation and the opt-out merchant cases. As of December 31, 2021 and 2020, Mastercard had $ 586 million in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. The reserve as of December 31, 2021 for both the Damages Class litigation and the opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Europe. Since May 2012, a number of United Kingdom (U.K.) merchants filed claims or threatened litigation against Mastercard seeking damages for excessive costs paid for acceptance of Mastercard credit and debit cards arising out of alleged anti-competitive conduct with respect to, among other things, Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). Mastercard has resolved a substantial amount of these damages claims through settlement or judgment. Approximately 1 billion (approximately $ 1.2 billion as of December 31, 2021) of unresolved damages claims remain. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court heard the appeals of MASTERCARD 2021 FORM 10-K 105 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the four merchant claimants and ruled against both Mastercard and Visa on two of the three legal issues being considered. The parties appealed the rulings to the U.K. Supreme Court. In June 2020, the U.K. Supreme Court ruled against Mastercard and Visa with respect to one of the liability issues being considered by the Court related to U.K domestic interchange fees. Additionally, the U.K Supreme Court set out the legal standard that should be applied by lower trial courts with respect to determining whether interchange was exemptible under applicable law, and provided guidance to lower courts with regard to the legal standard that should be applied in assessing merchants damages claims. The U.K. Supreme Court sent three of the merchant cases back to the trial court solely for the purpose of determining damages issues which is scheduled to commence in January 2023. Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. The majority of these merchant claims generally had been stayed pending the decision of the U.K. Supreme Court, and a number of those matters are now progressing with motion practice and discovery. In one of the actions involving multiple merchant plaintiff claims, in November 2021 the trial court denied the plaintiffs motion for summary judgment on certain liability issues. The plaintiffs were granted permission to appeal that ruling. In 2021 and 2020, Mastercard incurred charges of $ 94 million and $ 28 million, respectively, to reflect both the litigation settlements and estimated attorneys fees with a number of U.K. merchants as well as settlements with a number of Pan-European merchants. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 19 billion as of December 31, 2021). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. In December 2020, the U.K. Supreme Court rejected Mastercards appeal of this ruling. In March 2021, the trial court held a re-hearing on the plaintiffs collective action application, during which Mastercard sought to narrow the scope of the proposed class. In August 2021, the trial court issued a decision in which it granted class certification but agreed with Mastercards argument and narrowed the scope of the class. The plaintiffs did not appeal the trial courts decision narrowing the class. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. In August 2021, the trial court issued an order granting the plaintiffs request for class certification. Visa and Mastercards request for permission to appeal the certification decision to the appellate court was granted. Briefing on the appeal is expected to take place over the course of 2022. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims. 106 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the district court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the district court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. In August 2020, the district court issued an order granting the plaintiffs request for class certification. In January 2021, the Network Defendants request for permission to appeal the district courts certification decision to the appellate court was denied. The plaintiffs have submitted expert reports that allege aggregate damages in excess of $ 1 billion against the four Network Defendants. The Network Defendants have submitted expert reports rebutting both liability and damages. Briefing on summary judgment is expected to occur in 2022. Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the district court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. In January 2021, the magistrate judge serving on the district court issued an opinion recommending that the district court judge deny plaintiffs class certification motion. In light of an appellate court decision, issued subsequent to the magistrates recommendation, the district court judge instructed the parties to re-brief the motion for class certification, and the motion has been fully briefed. In December 2021, the trial court narrowed the scope of the potential class as it denied the plaintiffs motion for class certification of a class of all fax recipients (both stand-alone faxes and online faxes sent via email). However, the court granted class certification for a narrower class of online fax recipients only. Mastercard has filed a motion for reconsideration of the part of the trial courts order granting partial certification. U.S. Federal Trade Commission Investigation In June 2020, the U.S. Federal Trade Commissions Bureau of Competition (FTC) informed Mastercard that it has initiated a formal investigation into compliance with the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In particular, the investigation focuses on Mastercards compliance with the debit routing provisions of the Durbin Amendment. The FTC has issued a subpoena and Mastercard is cooperating with it in the investigation. U.K. Prepaid Cards Matter In 2019, Mastercard was informed by the U.K. Payment Systems Regulator (PSR) that Mastercard was a target of its investigation into alleged anti-competitive conduct by public sector prepaid card program managers in the U.K. This matter focused exclusively on historic behavior. In March 2021, the PSR announced the resolution and settlement of this investigation. As part of the resolution, Mastercard agreed to pay a maximum fine of 32 million. This matter has no prospective impact on Mastercards on-going business. In connection with this matter, in the fourth quarter of 2020, Mastercard recorded a litigation charge of $ 45 million. In January 2022, the PSR issued a decision which concludes the matter and which requires that Mastercard pay its previously agreed fine in March 2022. Note 22. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months prior to period end multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which MASTERCARD 2021 FORM 10-K 107 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to enter into risk mitigation arrangements, including cash collateral and/or other forms of credit enhancement such as letters of credit and guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio and the adequacy of its risk mitigation arrangements on a regular basis. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31: 2021 2020 (in millions) Gross settlement exposure $ 59,571 $ 52,360 Risk mitigation arrangements applied to settlement exposure ( 7,710 ) ( 6,021 ) Net settlement exposure $ 51,861 $ 46,339 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 361 million and $ 370 million at December 31, 2021 and 2020, respectively, of which the Company has risk mitigation arrangements for $ 287 million and $ 294 million at December 31, 2021 and 2020, respectively. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 23. Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts and foreign currency denominated debt. In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances. Cash Flow Hedges The Company may enter into foreign exchange derivative contracts, including forwards and options, to manage the impact of foreign currency variability on anticipated revenues and expenses, which fluctuate based on currencies other than the functional currency of the entity. The objective of these hedging activities is to reduce the effect of movement in foreign exchange rates for a portion of revenues and expenses forecasted to occur. As these contracts are designated as cash flow hedging instruments, gains and losses resulting from changes in fair value of these contracts are deferred in accumulated other comprehensive income (loss) and subsequently reclassified to the consolidated statement of operations when the underlying hedged transactions impact earnings. In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances, and designate such derivatives as hedging instruments in a cash flow hedging relationship. In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled at a loss of $ 136 million, after tax, in accumulated other comprehensive income (loss). As of December 31, 2021, a cumulative loss of $ 128 million, after tax, remains in accumulated other comprehensive income (loss) associated with these contracts and will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes due in March 2030 and March 2050. 108 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value Hedges The Company may enter into interest rate derivative contracts, including interest rate swaps, to manage the effects of interest rate movements on the fair value of the Company's fixed-rate debt and designate such derivatives as hedging instruments in a fair value hedging relationship. Changes in fair value of these contracts and changes in fair value of fixed-rate debt attributable to changes in the hedged benchmark interest rate generally offset each other and are recorded in interest expense on the consolidated statement of operations. Gains or losses related to the net settlements of interest rate swaps are also recorded in interest expense on the consolidated statement of operations. The periodic cash settlements are included in operating activities on the consolidated statement of cash flows. During the fourth quarter of 2021, the Company entered into an interest rate swap designated as a fair value hedge related to $ 1.0 billion of the 3.850 % Senior Notes due March 2050. In effect, the interest rate swap synthetically converts the fixed interest rate on this debt to a variable interest rate based on the Secured Overnight Financing Rate (SOFR) Overnight Index Swap Rate. The net impact to interest expense for the year ended December 31, 2021 was not material. Net Investment Hedges The Company may use foreign currency denominated debt and/or foreign exchange derivative contracts to hedge a portion of its net investment in foreign subsidiaries against adverse movements in exchange rates. The effective portion of the net investment hedge is recorded as a currency translation adjustment in accumulated other comprehensive income (loss). Forward points are designated as an excluded component and recognized in general and administrative expenses on the consolidated statement of operations over the hedge period. The amounts recognized in earnings related to forward points for 2021 were not material. In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in its European operations. During 2021, 2020 and 2019 the Company recorded a pre-tax net foreign currency gain of $ 155 million, loss of $ 177 million and gain of $ 36 million, respectively, in other comprehensive income (loss). As of December 31, 2021 and 2020, the Company had a net foreign currency gain of $ 34 million and loss of $ 175 million, after tax, respectively, in accumulated other comprehensive income (loss) associated with this hedging activity. Non-designated Derivatives The Company may also enter into foreign exchange derivative contracts to serve as economic hedges, such as to offset possible changes in the value of monetary assets and liabilities due to foreign exchange fluctuations, without designating these derivative contracts as hedging instruments. In addition, the Company is subject to foreign exchange risk as part of its daily settlement activities. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with customers. To manage this risk, the Company may enter into short duration foreign exchange derivative contracts based upon anticipated receipts and disbursements for the respective currency position. The objective of these activities is to reduce the Companys exposure to volatility arising from gains and losses resulting from fluctuations of foreign currencies against its functional currencies. Gains and losses resulting from changes in fair value of these contracts are recorded in general and administrative expenses on the consolidated statement of operations, net, along with the foreign currency gains and losses on monetary assets and liabilities. MASTERCARD 2021 FORM 10-K 109 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the fair value of the Companys derivative financial instruments and the related notional amounts: December 31, 2021 December 31, 2020 Notional Fair Value Notional Fair Value (in millions) Derivative assets: Derivatives designated as hedging instruments Foreign exchange contracts in a cash flow hedge 1 $ 102 $ 7 $ $ Interest rate contracts in a fair value hedge 2 ** 6 Derivatives not designated as hedging instruments Foreign exchange contracts 1 124 1 483 19 Total Derivative Assets $ 226 $ 14 $ 483 $ 19 Derivative liabilities: Derivatives designated as hedging instruments Foreign exchange contracts in a cash flow hedge 1 $ 104 $ 3 $ $ Interest rate contracts in a fair value hedge 2 1,000 8 Foreign exchange contracts in a net investment hedge 1 1,473 4 Derivatives not designated as hedging instruments Foreign exchange contracts 1 406 8 1,016 28 Total Derivative Liabilities $ 2,983 $ 23 $ 1,016 $ 28 1 Foreign exchange derivative assets and liabilities are recorded at fair value and are included within prepaid expenses and other current assets and other current liabilities, respectively, on the consolidated balance sheet. 2 Interest rate derivative assets and liabilities are recorded at fair value and are included within prepaid and other current assets and other liabilities, respectively, on the consolidated balance sheet. ** As of December 31, 2021, the total notional of interest rate contracts in a fair value hedge is $ 1.0 billion. The pre-tax gain (loss) related to the Company's derivative financial instruments designated as hedging instruments are as follows: Gain (Loss) Recognized in OCI Gain (Loss) Reclassified from AOCI Year ended December 31, Location of Gain (Loss) Reclassified from AOCI into Earnings Year ended December 31, 2021 2020 2019 2021 2020 2019 (in millions) (in millions) Derivative financial instruments in a cash flow hedge relationship: Foreign exchange contracts $ 6 $ $ Net revenue $ 1 $ $ Interest rate contracts $ $ ( 189 ) $ 14 Interest expense $ ( 6 ) $ ( 4 ) $ Derivative financial instruments in a net investment hedge relationship: Foreign exchange contracts $ 114 $ $ The Company estimates that $ 1 million, pre-tax, of the net deferred loss on cash flow hedges recorded in accumulated other comprehensive income (loss) at December 31, 2021 will be reclassified into the consolidated statement of operations within the next 12 months. The term of the foreign exchange derivative contracts designated in hedging relationships are generally less than 18 months. 110 MASTERCARD 2021 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The amount of gain (loss) recognized on the consolidated statement of operations for non-designated derivative contracts is summarized below: Year ended December 31, Derivatives not designated as hedging instruments: 2021 2020 2019 (in millions) Foreign exchange derivative contracts General and administrative $ ( 10 ) $ 40 $ ( 39 ) The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. The Companys derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Note 24. Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, the location of the merchant acquirer where the card is being used or the location of the customer receiving services. Revenue generated in the U.S. was approximately 32 % of total revenue in 2021, 33 % in 2020 and 32 % in 2019. No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2021, 2020 or 2019. The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31: 2021 2020 2019 (in millions) United States $ 1,117 $ 1,185 $ 1,147 Other countries 790 717 681 Total $ 1,907 $ 1,902 $ 1,828 MASTERCARD 2021 FORM 10-K 111 PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2021 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2021. Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2021 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +1,ma-2,20201231," ITEM 1. BUSINESS Item 1. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction switching and from other payment-related products and services. For a full discussion of our business, please see page 8. Our Performance The following are our key financial and operational highlights for 2020, including growth rates over the prior year: GAAP Net revenue Net income Diluted EPS $15.3B $6.4B $6.37 down 9% down 21% down 20% Non-GAAP 1 (currency-neutral) Net revenue Adjusted net income Adjusted diluted EPS $15.3B $6.5B $6.43 down 8% down 17% down 16% $6.1B $4.5B Repurchased shares $7.2B in capital returned to stockholders $1.6B Dividends paid cash flows from operations Gross dollar volume (growth on a local currency basis) Cross-border volume growth (on a local currency basis) Switched transactions $6.3T down 29% 90.1B flat up 3% 1 Non-GAAP results exclude the impact of gains and losses on equity investments, Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. 6 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS The coronavirus (COVID-19) outbreak and its negative impact on the global economy affected our 2020 performance, during which we saw unfavorable trends compared to historical periods. For a full discussion of this impact, see Managements Discussion and Analysis of Financial Condition and Results of Operation in Item II, Part 7. Our Strategy We grow, diversify and build our business through a combination of organic and inorganic strategic initiatives. Our ability to grow our business is influenced by: personal consumption expenditure (PCE) growth driving cash and check transactions toward electronic forms of payment increasing our share in the payments space providing integrated value-added products and services providing enhanced payment capabilities to capture new payment flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government payments. GROW DIVERSIFY BUILD CORE CUSTOMERS AND GEOGRAPHIES NEW AREAS Credit Debit Commercial Prepaid Digital-Physical Convergence Acceptance Financial Inclusion New Markets Businesses Governments Merchants Digital Players Local Schemes/Switches Data Analytics Consulting Marketing Services Loyalty Cyber and Intelligence Processing New Payment Flows Open Banking ENABLED BY BRAND, DATA, TECHNOLOGY AND PEOPLE Grow. We focus on growing our core business globally, including growing our consumer and commercial products and solutions, as well as increasing the number of payment transactions we switch. We also look to provide effective and efficient payments solutions that cater to the evolving ways people interact and transact in the growing digital economy. This includes expanding merchant access to electronic payments through new technologies in an effort to deliver a better consumer experience, while creating greater efficiencies and security. Diversify. We diversify our business by: working with new customers, including governments, merchants, financial technology companies (fintechs), digital players, mobile providers and other corporate businesses scaling our capabilities and business into new geographies, including growing acceptance in markets with limited electronic payments acceptance today broadening financial inclusion for the unbanked and underbanked Build. We build our business by: creating and acquiring differentiated products and platforms to provide unique, innovative solutions that we bring to market to support new payment flows and related applications, such as real-time account-based payments and the Mastercard Track suite of products providing services across data analytics, consulting, marketing services, loyalty, cyber and intelligence, and processing providing open banking capabilities to enable the reliable access, transmission and management of consumer-consented data Strategic Partners. We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for our products and services. We help merchants, financial institutions, governments, and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer MASTERCARD 2020 FORM 10-K 7 PART I ITEM 1. BUSINESS experiences. We partner with technology companies such as digital players, fintechs and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments improve financial inclusion and efficiencies, reduce costs, increase transparency of financial transactions and data to reduce crime and corruption and advance social programs. For consumers, we provide faster, safer and more convenient ways to pay and transfer funds and exchange information to enable services. Talent and Culture. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries by building a world-class culture based on decency, respect and inclusion where people have opportunities to perform purpose-driven work that impacts customers, communities and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Our Business Our Operations and Network We operate a multi-rail network that offers our customers one partner to turn to for their domestic and cross-border needs. Our core network links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We enable transactions for our customers through our core network in more than 150 currencies and in more than 210 countries and territories. Our range of capabilities extend beyond our core network into real-time account-based payments and open banking. Core Network Transactions. Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs and benefits that consumers and merchants derive. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for the customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. 8 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate. Issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and country of issuance are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the country of issuance are the same (domestic transactions). We switch over 55% of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture with an intelligent edge that enables the network to adapt to the needs of each transaction. Our core network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring, tokenization services, etc.) to appropriate transactions in real time. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Infrastructure and Applications. Augmenting our core network, we offer real-time account-based payment capabilities, enabling payments between bank accounts in real-time in countries in which it has been deployed. Open Banking. We offer a platform that enables data providers and third parties to reliably access, securely transmit and confidently manage customer-consented data to improve the customer experience. Payments System Security. Our payment solutions and products are designed to ensure safety and security for the global payments system. Our core network and additional platforms incorporate multiple layers of protection, providing greater resiliency and best-in-class security protection. Our programs are assessed by third parties and incorporate benchmarking and other data from peer companies and consultants. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, an enterprise resilience program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. Through the combined efforts of our Security Operations Centers, Fusion Centers and Mastercard Intelligence Center, we work with experts across the organization (as well as through other sources such as public-private partnerships), to monitor and respond quickly to a range of cyber and physical threats. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our network supports and enables our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. For a full discussion of the ways our innovation capabilities enable digital payments, see Our Products and Services - Digital Enablement below. Customer Risk. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers or the availability of unspent prepaid account holder account balances. Our Franchise. We manage an ecosystem of stakeholders who participate in our network. Our franchise creates and sustains a comprehensive series of value exchanges across our ecosystem. We ensure a balanced ecosystem where all participants benefit from the availability, innovation and safety and security of our network. We achieve this through the following key activities: Participant Onboarding. We ensure the capability of new customers to use our network, and define the roles and responsibilities for their operations once on the network MASTERCARD 2020 FORM 10-K 9 PART I ITEM 1. BUSINESS Safety and Security. We establish the core principles, including ensuring consumer protections and integrity, so participants feel confident to transact on the network. Operating Standards. We define the operational, technical and financial policies to which network participants are required to adhere. Responsible Stewardship. We establish performance standards to support ecosystem growth and optimization and establish proactive monitoring to ensure participant performance. Issue Resolution. We operate a framework to enable the resolution of disputes for both customers and consumers. Our Products and Services We provide a wide variety of integrated products and services that support products that customers can offer to their account holders and merchants. These offerings facilitate transactions across our multi-rail payment network among account holders, merchants, financial institutions, businesses, governments and other organizations in markets globally. Core Payment Products Consumer Credit. We offer a number of products that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Consumer Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid accounts are a type of electronic payment that enables consumers to pay in advance whether or not they previously had a bank account or a credit history. These accounts can be tailored to meet specific program, customer or consumer needs, such as paying bills, sending person-to-person payments or withdrawing cash from an ATM. Our focus ranges from digital accounts (such as fintech and gig economy platforms) to business programs such as employee payroll, health savings accounts and solutions for small business owners). Our prepaid programs also offer opportunities in the private and public sectors to drive financial inclusion of previously unbanked individuals through social security payments, unemployment benefits and salary cards. 10 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS We also provide prepaid program management services, primarily outside of the United States, that provide processing and end-to-end services on behalf of issuers or distributor partners such as airlines, foreign exchange bureaus and travel agents. Commercial Credit and Debit. We offer commercial credit and debit payment products and solutions that meet the payment needs of large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our card offerings include travel, small business (debit and credit), purchasing and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our Mastercard In Control platform generates virtual account numbers which provide businesses with enhanced controls, more security and better data. Our Mastercard Track Business Payment Service (Track BPS) is aimed at improving the way businesses pay and get paid by providing a single connection enabling access to multiple payment rails, greater control and richer data to optimize B2B transactions for both buyers and suppliers. The following chart provides GDV and number of cards featuring our brands in 2020 for select programs and solutions: Year Ended December 31, 2020 As of December 31, 2020 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2019 Mastercard-branded Programs 1,2 Consumer Credit $ 2,425 (7) % 38 % 894 2 % Consumer Debit and Prepaid 3,230 8 % 51 % 1,338 11 % Commercial Credit and Debit 682 (6) % 11 % 102 22 % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. New Payment Products and Open Banking In addition to the switching capabilities of our core network, we offer platforms with payment capabilities that support new payment flows and related applications: We offer real-time account-based payments for ACH transactions. This platform enables payments between bank accounts in real time and provides enhanced data and messaging capabilities. We offer applications including those that make it easier for consumers to view, manage and pay their bills either with cards or real-time and batch ACH payments from their bank accounts, and that enable consumers, businesses, governments and merchants to send and receive money beyond borders with greater speed and ease. We offer an open banking platform that allows data providers and third parties to reliably access, securely transmit and confidently manage customer-consented data to improve the customer experience. Value-Added Products and Services Cyber and Intelligence. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number of EMV cards issued and the transaction volume on EMV cards. The Identify layer allows us to help banks and merchants verify the authenticity of consumers during the payment process using various biometric technologies, including fingerprint, face and iris scanning technology to verify online purchases on mobile devices, as well as a card with biometric technology built in. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Our offerings in this space include alerts when accounts are exposed to data breaches or security incidents, fraud scoring technology that scans billions of dollars of money flows each day while increasing approvals and reducing false declines, and network-level monitoring on a global scale to help identify the occurrence of widespread fraud attacks when the customer (or their processor) may be unable to detect or defend against them. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, enhancing approvals for online and card-on-file payments, to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include solutions for consumer alerts and controls and a suite of digital token services. We also offer an e- MASTERCARD 2020 FORM 10-K 11 PART I ITEM 1. BUSINESS commerce fraud and dispute management network that enables merchants to stop delivery when a fraudulent or disputed transaction is identified, and issuers to refund the cardholder to avoid the chargeback process. Moreover, we use our AI and data analytics, along with our cyber risk assessment capabilities, to help financial institutions, merchants, corporations and governments secure their digital assets We have also worked with our customers to provide products to consumers globally with increased confidence through the benefit of zero liability, where the consumer bears no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards. We have built a scalable rewards platform that enables customers to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. We also provide a loyalty platform that enables stronger relationships with retailers, restaurants, airlines and consumer packaged goods companies by creating experiences that drive loyalty and impactful consumer engagement. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions. Data Analytics and Consulting. We provide proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and program management allow us to assist customers to implement actions based on these insights. We utilize our expertise and tools to collaborate with, and increasingly drive, innovation at financial institutions, merchants and governments. Through our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five-day app prototyping workshop, as well as other customized innovation programs such as in-lab usability testing and concept design. Through our Test Learn software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests to drive more profitable decision making. Digital Enablement Our innovation capabilities enable broader reach to scale digital payment services beyond cards to multiple channels, including mobile devices, and our standards, services and governance model help us to serve as the connection that allows financial institutions, fintechs and technology companies to interoperate and enable consumers to engage through digital channels: Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base, as well as products and practices to facilitate acceptance via mobile devices. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. We provide solutions that enable our customers to offer consumers the ability to send and receive money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and often in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. 12 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands and brand identities (including our sonic brand identity) through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, preference and overall usage among account holders globally. Our Priceless advertising campaign, which has run in more than 50 languages and in more than 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Human Capital Management As of December 31, 2020, we employed approximately 21,000 persons globally. We are dedicated to supporting our workforce during the global COVID-19 pandemic: We had no COVID-19 related layoffs in 2020 We introduced a COVID-19 global employee benefit providing up to 10 business days of additional paid leave for sick, childcare or eldercare related needs We covered 100% of the costs associated with COVID-19 testing for all employees and provided access to free COVID-related telemedicine consultations for our U.S. employees We provided employees with flexibility for how and where they get work done and put precautionary health and safety measures in place at each office location Management regularly reviews our people strategy and culture, as well as related risks, with our Human Resources and Compensation Committee, and reviews this annually with our Board of Directors. Our strategy focuses on recruitment, development, succession and retention, including: Attracting top talent with the strength of our talent brand, which includes our culture of being a force for good Developing our depth of talent through acquisitions and recruitment Strong development and succession planning for key roles, including talent and leadership programs across various levels that: Embed our culture principles Focus on diverse populations and Aim to develop talent and people managers through personalized and group executive development programs Using learning to drive innovation and growth, including a focus on scaling digital fluency globally, product training certification, creating an environment for employees to drive their own learning, and focusing on developing capability in key skill areas Retaining and growing an inclusive workforce, including: Ongoing development conversations and personalized development plans A focus on talent movement, including career moves and rotations and Competitive and differentiated pay and benefits, including pay equity on the basis of gender and (in the U.S.) race and ethnicity, as well as a flexible work model As an organization, we are focused on maintaining a world-class culture, built on a foundation of decency: We are mindful of the health of our culture, looking at retention of critical roles, our external brand reputation, internal levels of engagement, and diverse representation MASTERCARD 2020 FORM 10-K 13 PART I ITEM 1. BUSINESS We are committed to providing a safe and respectful workplace built on a culture of decency and a focus on the well-being of our employees, as well as monitoring for potential disruptions to our culture and reputation - especially with respect to such events as the COVID-19 pandemic We are focused on providing and supporting a culture of volunteering We have established a culture of high ethical business practices and compliance standards, grounded in honesty, decency, trust and personal accountability. It is driven by tone at the top, reinforced with regular training, fostered in a speak-up environment, and measured by a risk culture and climate survey Diversity and inclusion underpin everything we do: We look at our recruitment, development, succession and retention practices (including global attrition rates) with a focus on gender, race (in the U.S.) and generational mix of our employee population We have developed regional and functional action plans to identify priorities and actions that will help us make more progress for diversity and inclusion, including balance and inclusion in gender and racial representation As part of our commitment to racial justice, we have committed to our In Solidarity initiative, which focuses on people, market and society to harness our culture of decency and build on our efforts to advance inclusion and equality We encourage you to review our Sustainability Report (located on our website) for more detailed information regarding our people strategy. Recent Developments We are focused on helping individuals and businesses weather the challenges presented by the COVID-19 pandemic by ensuring our network remains secure, resilient and reliable. We are applying our technology, philanthropy, and data and cybersecurity expertise to help rebuild communities, ensure that economic growth is inclusive and help address new challenges facing governments, small businesses and consumers. Consumer While technology has increasingly changed the way people get information, interact, shop and make purchases, consumers continue to expect a seamless experience where their payment is simple and secure. Our teams are creating innovative solutions that meet the needs of consumers and merchants in a digital environment by applying emerging technologies. During the global COVID-19 pandemic, we have seen continued trends toward a preference for contactless and the rapid adoption of e-commerce. These trends are further accelerating the secular shift to digital forms of payment. In 2020, we: expanded click to pay, the activation of the EMV Secure Remote Commerce industry standard that enables a faster, more secure checkout experience across web and mobile sites, mobile apps and connected devices. This checkout experience is designed to provide consumers the same convenience and security in a digital environment that they have when paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. continued our focus on contactless payments technology to help deliver a simple and intuitive way to pay, as well as health and safety benefits when consumers are looking for low-touch options. These efforts include raising contactless purchase limits in virtually all geographies. announced a suite of frictionless solutions in various markets designed to deliver low-touch high engagement experiences for retailers and the consumer. For example, our Shop Anywhere platform enables merchants to create simple, personalized shopping experiences in store, offering consumers no wait, no checkout lines and a secure way to pay. expanded our Digital First Card Program to each of our regions to provide our customers with foundational guidelines that will enable them to offer their cardholders a fully digital payment experience with an optional physical card. This solution enables our customers to meet cardholder expectations of immediacy, safety, and convenience, including during card application, authentication and instant card access, making secure purchases (whether contactless in-store, in-app, or via the web), and managing alerts, controls, and benefits. 14 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Commercial and B2B Building on our corporate TE, fleet, purchasing card and small business capabilities, we have been increasingly focused on developing solutions to address other ways that businesses move money. In 2020, we: added account-to-account payment functionality to Mastercard Track BPS, our open-loop commercial service platform built to simplify and automate payments between suppliers and buyers. With this launch, businesses in the United States can now have a similar experience within this service for account-to-account payments as they do for card payments - exchanging data with greater efficiency and facilitating payments across multiple payment rails including real-time and batch ACH payments. launched Digital Doors, a dedicated program to help small businesses successfully adapt to the changing needs of their customers by establishing and protecting an online presence, including accepting digital payments. We have also created a free Small Business Digital Readiness Diagnostic to identify the first steps needed in this transition. New Payment Products and Open Banking In order to help grow our business and offer more electronic payment options to consumers, businesses and governments, Mastercard has developed and enhanced solutions beyond the principal switching capabilities available on our core network. We believe this will allow us to capture more payment flows, including B2B, P2P, B2C and government disbursements. In 2020, we: continued to expand our support of real-time payments globally, including being selected to build and operate a new real-time clearing and settlement platform in Canada and partnering with the Saudi Arabian Monetary Authority to enable instant account-to-account payments in the country for the first time. These developments build on other recent achievements, including our selection to enhance the InstaPay real-time retail payment system in the Philippines (including operating the infrastructure for and providing anti-money laundering tools to the its national clearing switch). As of December 31, 2020, we either operated or were implementing real-time payments infrastructure in 12 of the top 50 markets as measured by GDP. positioned ourselves to add to our real-time payments solutions, including our pending acquisition of the majority of the Corporate Services business of Nets Denmark A/S. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of the business. strengthened Mastercards open-banking platform with our acquisition of Finicity, a leading North American provider of real-time access to financial data and insights. The acquisition enables a greater choice of financial services, reinforcing our long-standing partnerships with and commitment to financial institutions and fintechs across the globe. This acquisition also enables us to expand our capabilities across North America and globally, and in particular accelerate the adoption of Finicitys services in North America. Together with Finicity, we will be able to focus on serving the needs of the lending market, including through helping to streamline loan application processes and improve credit decisioning, thereby helping to drive further financial inclusion. further extended Mastercard Cross-Border Services to customers, including financial institutions and fintechs, in every region across the globe. These services enable a wide range of payment flows and use cases, including trade, remittances and disbursements. These flows are enabled via a distribution network that continues to evolve across multiple channels, including account, card, and wallets. In particular, these services have enabled inbound B2B payments into China. extended our blockchain initiatives, providing additional transparency and efficiencies to the cross-border B2B payments space and proof of provenance - innovative, secure solutions across the global supply chain. Value-Added Products and Services We provide products and services including cyber and intelligence, loyalty, processing, data analytics and consulting that meet evolving requirements and the expectations of our stakeholders. We recently: extended our investments in Artificial Intelligence (AI) by: launching Mastercard ThreatScan, an AI-powered solution that helps banks proactively identify potential vulnerabilities in their authorization systems. The service works alongside an issuers existing fraud tools, imitating known criminal transaction behavior to identify potential weaknesses and prompt action before fraud potentially occurs. MASTERCARD 2020 FORM 10-K 15 PART I ITEM 1. BUSINESS scaling Decision Intelligence, our fraud scoring technology, to score billions of transactions in real time every day while increasing approvals and reducing false declines. scaled digital services in our Loyalty and Engagement capabilities to support customers in their response to the accelerated demand of digital services from consumers during the pandemic. This scaling includes additional capabilities for real-time promotions and cash back offers, digital acquisition, digital training and online offers to bring a full suite of digital loyalty and marketing solutions to merchants and financial institutions. enhanced the services we are able to offer to customers based on account-to-account flows, including data insights we are providing U.K. and U.S. customers to help them with anti-money laundering compliance and identification and prevention of other financial crimes. launched Recovery Insights, a set of data, tech and research tools that can help airlines, restaurants, consumer packaged goods companies, banks, governments and others navigate the rise in e-commerce, fine-tune operations, and prioritize investments. Key Initiatives In light of the digital inequality gaps being exacerbated by COVID-19, we have expanded our worldwide commitment to financial inclusion, pledging to bring a total of 1 billion people and 50 million micro and small businesses into the digital economy by 2025. As part of this effort, we are focused on providing 25 million women entrepreneurs with solutions that can help them grow their businesses. Engaged with several hundred national and local governments around the world to support their efforts to respond to the pandemic crisis, including facilitating electronic disbursements of vital benefits and providing access to data-driven insights in order to assess the impact of COVID-19 on their communities and optimize their recovery plans. We have committed $250 million in financial, technology, product and insight assets over the next five years to support the financial security and vitality of small businesses and their workers, including supporting the transition of low-income entrepreneurs to digital banking and helping small businesses access federal relief. We began to implement our In Solidarity initiative, which focuses on people, market and society to harness our culture of decency and build on our efforts to advance inclusion and equality. We launched the Priceless Planet Coalition, a platform to unite corporate sustainability efforts and make meaningful investments to preserve the environment. Together with partners who share a commitment to doing well by doing good, the coalition is pledging to plant 100 million trees over five years. We announced the expansion of Start Path, our startup engagement program, adding new seed businesses and more technology partners. Through this program, we provide entrepreneurs access to expert engineers and specialists that can help them deploy new services quickly and efficiently and help them grow their businesses and scale sustainably. Revenue Sources We generate revenue primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 and Note 3, Revenue for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other technologies, which are important to our business operations. These patents expire at varying times depending on the jurisdiction and filing date. 16 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS Competition We face competition in all categories of payment, including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments and wire transfers We face a number of competitors both within and outside of the global payments industry: Cash, Check and Legacy ACH. Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. General Purpose Payment Networks. We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. Globally, financial institutions may issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Real-time Account-based Payment Systems. We face competition in the real-time account-based payment space from other companies that provide infrastructure, applications and services to support these payment solutions. Alternative Payments Systems and New Entrants. As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers, who in many circumstances can also be our partners or customers, have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), POS financing/buy now pay later providers (such as Klarna), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. We also compete with merchants and governments. Value-Added Products and Service Providers. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, merchants and governments and technology companies that provide cyber and fraud solutions, as well as companies that compete against us as providers of loyalty and program management solutions. Regulatory initiatives could also lead to increased competition in this space. Mastercard is a trusted intermediary in a complex system. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over more than 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance expertise in real-time account-based payments and open banking development and adoption of innovative products and digital solutions safety and security solutions embedded in our networks analytics insights and consulting services that help issuers and merchants optimize their payments and related businesses loyalty solutions that enhance the payments value proposition for issuers and merchants MASTERCARD 2020 FORM 10-K 17 PART I ITEM 1. BUSINESS ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent and culture, with a focus on inclusion and being a force for good Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. We are committed to comply with all applicable laws and regulations and implement policies, procedures and programs designed to promote compliance. We coordinate globally while acting locally and leverage our relationships to manage the effects of regulation on us. See Risk Factors in Part I, Item 1A for more detail and examples of the regulation to which we are subject. Payments Oversight and Regulation. Central banks and other regulators in several jurisdictions around the world either have, or are seeking to establish, formal oversight over the payments industry, as well as authority to regulate certain aspects of the payment systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, Mastercard is subject to systemic importance regulation, which includes various requirements we must meet, including obligations related to governance and risk management. In the U.K., the Bank of England designated Vocalink, our real-time account-based payment network platform, to be a specified service provider, which includes supervisions and examination requirements. In addition, European Union legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switching activities and other processing in terms of how we go to market, make decisions and organize our structure. Interchange Fees. Interchange fees that support the function and value of four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities, our settlement with the European Commission resolving its investigation into our interregional interchange fees and the European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the European Economic Area (the EEA). For more detail, see Risk Factors - Other Regulation in Part I, Item 1A and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter-financing of terrorism (CFT) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CFT program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in these countries and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with 18 MASTERCARD 2020 FORM 10-K PART I ITEM 1. BUSINESS oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks, financial institutions and others in their capacity as issuers and otherwise, impacting us as a consequence. Additionally, regulations such as the revised Payment Services Directive (commonly referred to as PSD2) in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to route transactions away from Mastercard products and provide payment initiation and account information services directly to consumers who use our products. PSD2 also requires a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Regulation of Internet and Digital Transactions. Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security and copyright and trademark infringement. Privacy, Data and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the General Data Protection Regulation (the GDPR), which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California), Argentina, Brazil, Canada, Chile, India, Indonesia and Kenya. Some jurisdictions, such as India, are currently considering adopting or have adopted data localization requirements, which mandate the collection, processing, and/or storage of data within their borders. We believe that various forms of data localization requirements are under consideration in other countries and jurisdictions, including the European Union. Due to increasing data collection and data flows, numerous data breaches and security incidents as well as the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to regulate data and protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. MASTERCARD 2020 FORM 10-K 19 PART I "," ITEM 1A. RISK FACTORS Item 1A. Risk factors RISK HIGHLIGHTS Legal and Regulatory Business and Operations Payments Industry Regulation COVID-19 Global Economic and Political Environment Preferential or Protective Government Actions Competition and Technology Brand and Reputational Impact Privacy, Data and Security Information Security and Service Disruptions Talent and Culture Other Regulation Stakeholder Relationships Acquisitions Litigation Settlement and Third-Party Obligations Class A Common Stock and Governance Structure Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations, establishing, and potentially further expanding, obligations or restrictions with respect to the types of products and services that we may offer, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). Several jurisdictions have also inquired about the network fees we charge to our customers (typically as part of broader market reviews of retail payments). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. In some cases, we have been designated as a systemically important payment system, and other regulators may consider designating us as systemically important or in a similar category resulting in heightened regulatory oversight. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. Moreover, as regulators around the world increasingly look to replicate similar regulation of payments and other industries, efforts in any one jurisdiction may influence approaches in other jurisdictions. Similarly, new initiatives within a jurisdiction involving one product may lead to regulation of similar or related products (for example, debit regulations could lead to regulation of credit products). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. Increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. As a result, issuers and acquirers could be less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. In addition, any regulation that is enacted related to the type and level of network fees we charge our customers could also materially and adversely 20 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS impact our results of operations. Regulators could also require us to obtain prior approval for changes to our system rules, procedures or operations, or could require customization with regard to such changes, which could negatively impact us. Such changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Business - Government Regulation in Part I, Item 1 and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, changes to interregional interchange fees as a result of the resolution of the European Commissions investigation could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek a fee reduction from us to decrease the expense of their payment programs, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries have implemented, or may implement, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. MASTERCARD 2020 FORM 10-K 21 PART I ITEM 1A. RISK FACTORS Some jurisdictions are considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our inability to effect change in, or work with, these jurisdictions could adversely affect our ability to maintain or increase our revenues and extend our global brand. Additionally, some jurisdictions have implemented, or may implement, foreign ownership restrictions, which could potentially have the effect of forcing or inducing the transfer of our technology and proprietary information as a condition of access to their markets. Such restrictions could adversely impact our ability to compete in these markets. Privacy, Data and Security Regulation of privacy, data, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated and personalized products and services to meet the needs of a changing marketplace, as well as acquire new companies, we have expanded our information profile through the collection of additional data from additional sources and across multiple channels. This expansion has amplified the impact of these regulations on our business. Regulation of privacy and data and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information, as well as increased care in our data management, governance and quality practices. While we make every effort to comply with all regulatory requirements and we deploy a privacy-by-design and data-by-design approach to all of our product development, the speed and pace of change may not allow us to meet rapidly evolving expectations. We are also subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions are also considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions are considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or interpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and/or restrict our ability to leverage data for innovation. This could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the need for improved data management, governance and quality practices, the development of information-based products and solutions, and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity and increasing cyberattacks have encouraged legislative and regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer personal information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to legislative or regulatory intervention, such as enhanced security requirements and liabilities, as well as damage to our reputation. 22 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Financing of Terrorism, Economic Sanctions and Anti-Corruption - We are subject to AML and CFT laws and regulations globally. Economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies, and persons and entities. We are also subject to anti-corruption laws and regulations globally, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. Account-based Payment Systems - In the U.K., aspects of our Vocalink business are subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Certain regulations (such as PSD2 in the EEA) may impact various aspects of our business. For example, PSD2s strong authentication requirement could increase the number of transactions that consumers abandon if we are unable to secure a frictionless authentication experience under the new standards. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. In particular, a violation and subsequent judgment or settlement against us, or those with whom we may be associated, under economic sanctions and AML, CFT, and anti-corruption laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Each instance may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective income tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective income tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective income tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. MASTERCARD 2020 FORM 10-K 23 PART I ITEM 1A. RISK FACTORS Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations COVID-19 The global COVID-19 pandemic and containment measures taken in response to it have adversely impacted our business, results of operations and financial condition, and may continue to do so depending on future developments, which are uncertain. Global health concerns relating to the COVID-19 outbreak have impacted the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The outbreak resulted in governments in countries across the globe implementing measures to try to contain the virus, such as travel restrictions, social distancing, and restrictions on business operations which have impacted consumers and businesses. These measures have adversely impacted and may further impact our workforce and operations and the operations of our customers, suppliers and business partners. While some of these measures have eased in certain jurisdictions, others have remained in place. The extent to which current measures are removed or new measures are put in place will depend how the pandemic evolves, as well as the progress of the global roll-out of vaccines. The spread of COVID-19 has caused us to modify our business practices (including employee travel, employee work locations, and working in a remote environment), and we may take further actions as required by government authorities or that are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus or otherwise be satisfactory to government authorities. The COVID-19 pandemic has adversely impacted our business, results of operations and financial condition. There are no comparable recent events which may provide guidance as to the effect of the spread of COVID-19 and a global pandemic, and, as a result, the ultimate impact of COVID-19 or a similar health epidemic is highly uncertain and subject to change. The extent to which COVID-19 further impacts our business, results of operations and financial condition will depend on future developments, which are uncertain, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business and our result of operations as a result of its global economic impact, including any recession that has occurred or may occur in the future. Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business - Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also introduce their own innovative programs and services that adversely impact our growth. Beyond our traditional competitors, we also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our 24 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation (such as PSD2 in the EEA) may disintermediate issuers by enabling third-party providers opportunities to route payment transactions away from our network and products and towards other forms of payment by offering account information or payment initiation services directly to those who currently use our products. This may also allow these processors to commoditize the data that are included in the transactions. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. Although we partner with fintechs and technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data standards, without proper oversight we could give the partner a competitive advantage. Competitors, customers, fintechs, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop or encourage the creation of national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets, or require us to compete differently. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our products and services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. We continue to experience pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. MASTERCARD 2020 FORM 10-K 25 PART I ITEM 1A. RISK FACTORS Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with fintechs and technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. Regulatory or government requirements could require us to host and deliver certain products and services on-soil in certain markets, which would require us to alter our technology and delivery model, potentially resulting in additional expenses. Various central banks are experimenting with digital currencies called Central Bank Digital Currencies (CBDC). CBDCs may be launched with their own networks to transfer money between participants. Policy and design considerations that governments adopt could impact the extent of our role in facilitating CBDC-based payment transactions, potentially impacting the transactions that we may process over our network. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payment network presents risks that could materially affect our business. U.K. regulators have designated Vocalink, our real-time account-based payment network platform, to be a specified service provider and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payment systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payment platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payment network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our integrated products and services can present operational and onboarding challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the 26 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS payments markets, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users other than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. These new customers are typically less regulated, and as a result, enhanced infrastructure and monitoring is required. Our failure to deliver these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, or we are unable to adequately anticipate risks related to new types of customers, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. The advent of the global COVID-19 pandemic has resulted in a significant rise in these types of threats due to a significant portion of our workforce working from home in a mostly remote environment. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information and technology in our computer systems and networks, as well as the systems of our third-party providers. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks, as well as the systems of our third-party providers, have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems (including third-party provider systems) or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks MASTERCARD 2020 FORM 10-K 27 PART I ITEM 1A. RISK FACTORS from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings have experienced in limited instances and may continue to experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a enterprise resiliency program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Stakeholder Relationships Losing a significant portion of business from one or more of our largest customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. 28 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments, fintechs and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. Some merchants are increasingly asking regulators to review and potentially regulate our own network fees, in addition to interchange. See our risk factor in Risk Factors Other Regulation in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. MASTERCARD 2020 FORM 10-K 29 PART I ITEM 1A. RISK FACTORS Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination, of the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us Consumers and businesses lowering spending, which could impact domestic and cross-border spend Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity has, and may continue to be, adversely affected by world geopolitical, economic, health, weather and other conditions. These include COVID-19, as well as the threat of terrorism and separate outbreaks of flu, viruses and other diseases, as well as major environmental events (including those related to climate change). The uncertainty that could result from such events could decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. 30 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Our operations as a global payments network rely in part on global interoperable standards to help facilitate safe and simple payments. To the extent geopolitical events result in jurisdictions no longer participating in the creation or adoption of these standards, or the creation of competing standards, the products and services we offer could be negatively impacted. Any of these developments could have a material adverse impact on our overall business and results of operations. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2020, approximately 67% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers or other companies and organizations that use our products and services (including certain legally permissible but high risk merchant categories, such as alcohol, tobacco, fire-arms and adult content) may also, by association, impair our reputation, or result in greater public, regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. To the extent any of our published sustainability metrics are subsequently viewed as inaccurate or we are unable to execute on our sustainability initiatives, we may be viewed negatively by consumers, investors and other stakeholders concerned about these matters. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Any of the above issues could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments system, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. MASTERCARD 2020 FORM 10-K 31 PART I ITEM 1A. RISK FACTORS Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and visa regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Moreover, as a result of the global COVID-19 pandemic, a significant portion of our workforce is working in a mostly remote environment. This remote environment may continue after the pandemic due to potential resulting trends, and could impact the quality of our corporate culture. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity and decency. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Acquisitions, strategic investments or entry into new businesses could be impacted by regulatory scrutiny, and if successful, could disrupt our business and harm our results of operations or reputation. As we continue to evaluate our strategic acquisitions of, or acquiring interests in joint ventures or other entities related to, complementary businesses, products or technologies, we face increasing regulatory scrutiny with respect to antitrust and other considerations. Such scrutiny could prevent us from successfully completing such acquisitions in the future. To the extent we do make these acquisitions, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations, both directly as a result of the new business as well as in the other existing parts of our business, with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors 32 MASTERCARD 2020 FORM 10-K PART I ITEM 1A. RISK FACTORS Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 9, 2021, Mastercard Foundation owned 108,210,635 shares of Class A common stock, representing approximately 11.0% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted and have occurred. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", Item 1B. Unresolved staff comments Not applicable. ," Item 2. Properties We own our corporate headquarters, located in Purchase, New York, and our principal technology and operations center, located in OFallon, Missouri. As of December 31, 2020, Mastercard and its subsidiaries owned or leased commercial properties throughout the U.S. and other countries around the world, consisting of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," Item 3. Legal proceedings Refer to Note 13 (Accrued Expenses and Accrued Litigation) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 9, 2021, we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 257 holders of record of our non-voting Class B common stock as of February 9, 2021, constituting approximately 0.8% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 and the SP 500 Financials for the five-year period ended December 31, 2020. The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index 2015 2016 2017 2018 2019 2020 Mastercard $ 100.00 $ 106.91 $ 157.88 $ 197.86 $ 314.91 $ 378.44 SP 500 100.00 111.96 136.40 130.42 171.49 203.04 SP 500 Financials 100.00 122.80 150.04 130.49 172.41 169.49 38 MASTERCARD 2020 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Dividend Declaration and Policy On December 8, 2020, our Board of Directors declared a quarterly cash dividend of $0.44 per share paid on February 9, 2021 to holders of record on January 8, 2021 of our Class A common stock and Class B common stock. On February 8, 2021, our Board of Directors declared a quarterly cash dividend of $0.44 per share payable on May 7, 2021 to holders of record on April 9, 2021 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities During the fourth quarter of 2020, we repurchased a total of approximately 3.1 million shares for $1.03 billion at an average price of $330.34 per share of Class A common stock. See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion with respect to our share repurchase programs. The following table presents our repurchase activity on a cash basis during the fourth quarter of 2020: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 1,552,273 $ 335.39 1,552,273 $ 4,340,730,451 November 1 30 779,892 314.13 779,892 4,095,745,017 December 1 31 785,846 336.44 785,846 9,831,351,292 Total 3,118,011 330.34 3,118,011 1 Dollar value of shares that may yet be purchased under the share repurchase programs are as of the end of each period presented. MASTERCARD 2020 FORM 10-K 39 PART II "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2019 compared to the year ended December 31, 2018, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We operate a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our customers. COVID-19 The coronavirus (COVID-19) pandemic has spread rapidly across the globe and has had significant negative effects on the global economy. This outbreak has affected business activity, adversely impacting consumers, our customers, suppliers and business partners, as well as our workforce. We continue to monitor the effects of the pandemic and actions taken by governments as they relate to travel restrictions, social distancing measures and restrictions on business operations, as well as the continued impact of these actions on consumers and businesses. While some of these measures have eased in certain jurisdictions, others have remained in place. The extent to which current measures are removed or new measures are put in place will depend upon how the pandemic evolves, as well as the progress of the global roll-out of vaccines. The COVID-19 outbreak affected our 2020 performance, during which we noted unfavorable trends compared to historical periods. The following table provides a summary of trends in our key metrics for 2020 as compared to the respective periods in 2019: Quarter ended Year ended December 31 March 31 June 30 September 30 December 31 Increase/(Decrease) Gross dollar volume (local currency basis) 8 % (10) % 1 % 1 % % Cross-border volume (local currency basis) (1) % (45) % (36) % (29) % (29) % Switched transactions 13 % (10) % 5 % 4 % 3 % The impact of this outbreak started in the first quarter of 2020 as we experienced declines in our key metrics compared to historical periods, primarily due to travel restrictions and stay-at-home orders implemented by governments in many regions and countries across the globe. Our key metrics continued to be impacted throughout 2020 as follows: Gross dollar volumes were flat in 2020 as compared to 2019, recovering gradually in the second half of the year from a decline during the second quarter in part due to the global relaxation of both restrictions on business operations and social distancing measures. MASTERCARD 2020 FORM 10-K 41 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Cross-border volumes were negatively impacted by the pandemic during 2020 due to a significant decrease in global travel as a result of compliance with travel restrictions and quarantine requirements. While cross-border volumes are still lower compared to prior year periods, these volumes have improved throughout the second half of 2020. Switched transactions were negatively impacted by the pandemic primarily in the second quarter. Subsequently, switched transactions improved during the third quarter in part due to the global relaxation of both restrictions on business operations and social distancing measures. During the fourth quarter, switched transactions growth slowed slightly as compared to the third quarter. The full extent to which the pandemic, and measures taken in response, affect our business, results of operations and financial condition will depend on future developments, including the duration of the pandemic and its impact on the global economy, which are uncertain, and cannot be predicted at this time. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2020 Increase/ (Decrease) 2019 Increase/ (Decrease) 2020 2019 2018 ($ in millions, except per share data) Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% 13% Operating expenses $ 7,220 $ 7,219 $ 7,668 % (6)% Operating income $ 8,081 $ 9,664 $ 7,282 (16)% 33% Operating margin 52.8 % 57.2 % 48.7 % (4.4) ppt 8.5 ppt Income tax expense $ 1,349 $ 1,613 $ 1,345 (16)% 20% Effective income tax rate 17.4 % 16.6 % 18.7 % 0.8 ppt (2.1) ppt Net income $ 6,411 $ 8,118 $ 5,859 (21)% 39% Diluted earnings per share $ 6.37 $ 7.94 $ 5.60 (20)% 42% Diluted weighted-average shares outstanding 1,006 1,022 1,047 (2)% (2)% The following table provides a summary of our key non-GAAP operating results 1 , adjusted to exclude the impact of gains and losses on our equity investments, special items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, 2020 Increase/(Decrease) 2019 Increase/(Decrease) 2020 2019 2018 As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% (8)% 13% 16% Adjusted operating expenses $ 7,147 $ 7,219 $ 6,540 (1)% (1)% 10% 12% Adjusted operating margin 53.3 % 57.2 % 56.2 % (4.0) ppt (3.7) ppt 1.0 ppt 1.3 ppt Adjusted effective income tax rate 17.2 % 17.0 % 18.5 % 0.2 ppt 0.3 ppt (1.5) ppt (1.3) ppt Adjusted net income $ 6,463 $ 7,937 $ 6,792 (19)% (17)% 17% 20% Adjusted diluted earnings per share $ 6.43 $ 7.77 $ 6.49 (17)% (16)% 20% 23% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 42 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Key highlights for 2020 as compared to 2019 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue decreased 8% on a currency-neutral basis due to COVID-19 impacts, and includes a 1 percentage point benefit from acquisitions. Gross dollar volume was flat on a local currency basis. The primary drivers of net revenue were: down 9% down 8% - Cross-border volume decline of 29% on a local currency basis - Rebates and incentives growth of 3%, or 4% on a currency-neutral basis These decreases to net revenue were partially offset by: - Switched transactions growth of 3% - Other revenues growth of 14%, or 15% on a currency-neutral basis, which includes 3 percentage points of growth due to acquisitions Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expense decreased 1% on a currency-neutral basis, which included a 4 percentage point increase due to acquisitions. Excluding acquisitions, expenses declined 5 percentage points primarily due to reduced spending on advertising and marketing, travel and professional fees, partially offset by higher personnel and data processing costs to support continued investment in our strategic initiatives. flat down 1% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) Adjusted effective income tax rate of 17.2% was higher than prior year primarily due to a discrete tax benefit related to a favorable court ruling in 2019. 17.4% 17.2% Other 2020 financial highlights were as follows: We generated net cash flows from operations of $7.2 billion. We completed the acquisitions of businesses for total consideration of $1.1 billion. We repurchased 14.3 million shares of our common stock for $4.5 billion and paid dividends of $1.6 billion. We completed debt offerings for an aggregate principal amount of $4.0 billion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). Starting in 2019, our non-GAAP financial measures also exclude the impact of gains and losses on our equity investments which primarily includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. The 2018 amounts were not restated, as the impact of the change was immaterial in relation to our non-GAAP results. Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2020 and 2019, we recorded net gains of $30 million ($15 million after tax, or $0.01 per diluted share) and $167 million ($124 million after tax, or $0.12 per diluted share), respectively. The net gains were primarily related to unrealized fair market value adjustments on marketable and non-marketable equity securities. MASTERCARD 2020 FORM 10-K 43 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Items Litigation provisions During 2020, we recorded pre-tax charges of $73 million ($67 million after tax, or $0.07 per diluted share) related to litigation provisions which included pre-tax charges of: $45 million related to an ongoing confidential legal matter associated with our prepaid cards in the U.K., and $28 million related to estimated attorneys fees and litigation settlements with U.K. and Pan-European merchants. During 2018, we recorded pre-tax charges of $1,128 million ($1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission, $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases, and $237 million related to litigation settlements with U.K. and Pan-European merchants. Tax act During 2019, we recorded a $57 million net tax benefit ($0.06 per diluted share), which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. During 2018, we recorded a $75 million net tax benefit ($0.07 per diluted share), which included a $90 million benefit related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense primarily related to an increase to our Transition Tax. See Note 7 (Investments), Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and nonrecurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. In addition, we present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. 44 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2020 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,220 52.8 % $ (321) 17.4 % $ 6,411 $ 6.37 (Gains) losses on equity investments ** ** (30) (0.1) % (15) (0.01) Litigation provisions (73) 0.5 % ** (0.1) % 67 0.07 Non-GAAP $ 7,147 53.3 % $ (351) 17.2 % $ 6,463 $ 6.43 Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 67 16.6 % $ 8,118 $ 7.94 (Gains) losses on equity investments ** ** (167) (0.2) % (124) (0.12) Tax act ** ** ** 0.6 % (57) (0.06) Non-GAAP $ 7,219 57.2 % $ (100) 17.0 % $ 7,937 $ 7.77 Year ended December 31, 2018 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % $ (78) 18.7 % $ 5,859 5.60 Ligitation provisions (1,128) 7.5 % ** (1.1) % 1,008 0.96 Tax act ** ** ** 0.9 % (75) (0.07) Non-GAAP $ 6,540 56.2 % $ (78) 18.5 % $ 6,792 $ 6.49 Note: Tables may not sum due to rounding. ** Not applicable MASTERCARD 2020 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2020 as compared to the Year Ended December 31, 2019 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP (9) % % (4.4) ppt 0.8 ppt (21) % (20) % (Gains) losses on equity investments ** ** ** ppt 1 % 1 % Litigation provisions ** (1) % 0.5 ppt (0.1) ppt 1 % 1 % Tax act ** ** ** (0.6) ppt 1 % 1 % Non-GAAP (9) % (1) % (4.0) ppt 0.2 ppt (19) % (17) % Currency impact 2 1 % % 0.3 ppt 0.2 ppt 1 % 1 % Non-GAAP - currency-neutral (8) % (1) % (3.7) ppt 0.3 ppt (17) % (16) % Year Ended December 31, 2019 as compared to the Year Ended December 31, 2018 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP 13 % (6) % 8.5 ppt (2.1) ppt 39 % 42 % (Gains) losses on equity investments 1 ** ** ** (0.2) ppt (2) % (2) % Tax act ** ** ** (0.3) ppt 1 % 1 % Litigation provisions ** 16 % (7.5) ppt 1.1 ppt (20) % (21) % Non-GAAP 13 % 10 % 1.0 ppt (1.5) ppt 17 % 20 % Currency impact 2 3 % 2 % 0.3 ppt 0.2 ppt 3 % 3 % Non-GAAP - currency-neutral 16 % 12 % 1.3 ppt (1.3) ppt 20 % 23 % Note: Tables may not sum due to rounding. ** Not applicable 1 In 2019 we updated our non-GAAP methodology to prospectively exclude the impact of gains and losses on our equity investments. The 2018 period was not restated as the impact of the change was immaterial in relation to our non-GAAP results. 2 Represents the translational and transactional impact of currency. Key Metrics In addition to the financial measures described above in Financial Results Overview, we review the following metrics to evaluate and identify trends in our business, measure our performance, prepare financial projections and make strategic decisions. We believe that the key metrics presented facilitate an understanding of our operating and financial performance and provide a meaningful comparison of our results between periods. Gross Dollar Volume (GDV) 1 measures dollar volume of activity on cards carrying our brands during the period, on a local currency basis and U.S. dollar-converted basis. Dollar volume represents purchase volume plus cash volume and includes the impact of balance transfers and convenience checks; purchase volume means the aggregate dollar amount of purchases made with Mastercard-branded cards for the relevant period; and cash volume means the aggregate dollar amount of cash disbursements and includes the impact of balance transfers and convenience checks obtained with Mastercard-branded cards for the relevant period. Information denominated in U.S. dollars relating to GDV is calculated by applying an established U.S. dollar/local currency exchange rate for each local currency in which Mastercard volumes are reported. These exchange rates are calculated on a quarterly basis using the average exchange rate for each quarter. Mastercard reports period-over-period rates of change in purchase volume and cash volume on the basis of local currency information, in order to eliminate the impact of changes in the value of currencies against the U.S. dollar in calculating such rates of change. Cross-border Volume 2 measures cross-border dollar volume initiated and switched through our network during the period, on a local currency basis and U.S. dollar-converted basis, for all Mastercard-branded programs. 46 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Switched Transactions 2 measures the number of transactions switched by Mastercard. We define transactions switched as the number of transactions initiated and switched through our network during the period. Operating Margin measures how much profit we make on each dollar of sales after our operating costs but before other income (expense) and income tax expense. Operating margin is calculated by dividing our operating income by net revenue. 1 Data used in the calculation of GDV is provided by Mastercard customers and is subject to verification by Mastercard and partial cross-checking against information provided by Mastercards transaction switching systems. All data is subject to revision and amendment by Mastercard or Mastercards customers. 2 Normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. Foreign Currency Currency Impact Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results are also impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and certain volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, certain of our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2020, GDV on a U.S. dollar-converted basis decreased 2.0%, while GDV on a local currency basis increased 0.1% versus 2019. In 2019, GDV on a U.S. dollar-converted basis increased 9.8%, while GDV on a local currency basis increased 13.1% versus 2018. Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items is different than the functional currency of the entity. The translational and transactional impact of currency (Currency impact) has been identified in our drivers of change tables and has been excluded from our currency-neutral growth rates, which are non-GAAP financial measures. See Financial Results - Revenue and Operating Expenses for our drivers of change impact tables and Non-GAAP Financial Information for further information on our non-GAAP adjustments. 2021 Hedge Accounting Designation Through December 31, 2020, our approach to manage our transactional currency exposure consisted of hedging a portion of anticipated revenues impacted by transactional currencies by entering into foreign exchange derivative contracts, and recording the related changes in fair value in general and administrative expenses on the consolidated statement of operations. Beginning in January 2021, we started to formally designate certain newly-executed foreign exchange derivative contracts, which meet the established accounting criteria, as cash flow hedges. Starting in the first quarter of 2021, gains and losses resulting from changes in fair value of these designated contracts will be deferred in accumulated other comprehensive income (loss) and subsequently recognized in the respective component of net revenue when the underlying forecasted transactions impact earnings. The related impact of our foreign exchange cash flow hedging activities will be excluded from our currency-neutral growth rates as part of our Currency impact. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities, including settlement receivables and payables with our customers, that are denominated in a currency other than the functional currency of the entity. To manage this foreign exchange risk, we may enter into foreign exchange derivative contracts to economically hedge the foreign currency exposure of a portion of our nonfunctional monetary assets and liabilities. The gains or losses resulting from changes in fair value of these contracts are intended to reduce the potential effect of the underlying hedged exposure and are recorded net within general and MASTERCARD 2020 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS administrative expenses on the consolidated statement of operations. The impact of foreign exchange activity, including the related hedging activities, has not been eliminated in our currency-neutral results. Our foreign exchange risk management activities are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Financial Results Revenue Primary drivers of net revenue, versus the prior year, were as follows: Gross revenue decreased 5%, or 4% on a currency-neutral basis, driven by decreased cross-border volumes reflecting impacts of the COVID-19 outbreak, partially offset by increases in our value-added products and services and the number of switched transactions. Gross dollar volume of $6.3 trillion was flat. Rebates and incentives increased 3%, or 4% on a currency-neutral basis, due to new and renewed deals partially offset by a favorable mix of volume-based incentives. Net revenue decreased 9%, or 8% on a currency-neutral basis, including 1 percentage point of growth from our acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Domestic assessments $ 6,656 $ 6,781 $ 6,138 (2)% 10% Cross-border volume fees 3,512 5,606 4,954 (37)% 13% Transaction processing 8,731 8,469 7,391 3% 15% Other revenues 4,717 4,124 3,348 14% 23% Gross revenue 23,616 24,980 21,831 (5)% 14% Rebates and incentives (contra-revenue) (8,315) (8,097) (6,881) 3% 18% Net revenue $ 15,301 $ 16,883 $ 14,950 (9)% 13% 48 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of change in net revenue: For the Years Ended December 31, Volume Acquisitions Currency Impact 1 Other 2 Total 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 Domestic assessments % 13% % % (3)% (3)% 1 % 3 1 % 3 (2) % 10 % Cross-border volume fees (30)% 14% % % % (3)% (7) % 2 % (37) % 13 % Transaction processing 3% 14% % % % (2)% % 3 % 3 % 15 % Other revenues ** ** 3% 2% (1)% (1)% 12 % 4 22 % 4 14 % 23 % Rebates and incentives (6)% 5 9% 5 % % (2)% (3)% 10 % 6 11 % 6 3 % 18 % Net revenue (5)% 13% 1% 1% (1)% (3)% (4) % 2 % (9) % 13 % Note: Table may not sum due to rounding ** Not applicable 1 Represents the translational and transactional impact of currency. 2 Includes impact from pricing, other non-volume based fees and geographic mix. 3 Includes impact of the allocation of revenue to service deliverables, which are primarily recorded in other revenue when services are performed. 4 Includes impacts from cyber and intelligence fees, data analytics and consulting fees and other payment-related products and services. 5 Includes the impact from mix on volume-based incentives. 6 Includes the impact of new, renewed and expired agreements. The following tables provide a summary of the trend in volumes and transactions. For the Years Ended December 31, 2020 2019 Increase/(Decrease) USD Local USD Local Mastercard-branded GDV 1 (2) % % 10 % 13 % Asia Pacific/Middle East/Africa (3) % (2) % 8 % 12 % Canada (4) % (3) % 4 % 7 % Europe (2) % 1 % 12 % 18 % Latin America (17) % (2) % 9 % 15 % United States 2 % 2 % 10 % 10 % Cross-border volume 1 (29) % 16 % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Increase/(Decrease) 2020 2019 Switched transactions 3 % 19 % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2020, the net revenue from these customers was approximately $3.4 billion, or 22%, of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses were flat in 2020 versus the prior year. Adjusted operating expenses decreased 1% on both an as adjusted and a currency-neutral basis versus the prior year. Current year results include growth of approximately 4 percentage points from acquisitions. Excluding acquisitions, expenses declined 5% primarily due to reduced spending on advertising and marketing, travel and professional fees, partially offset by higher personnel and data processing costs to support continued investment in our strategic initiatives. MASTERCARD 2020 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) General and administrative $ 5,910 $ 5,763 $ 5,174 3 % 11 % Advertising and marketing 657 934 907 (30) % 3 % Depreciation and amortization 580 522 459 11 % 14 % Provision for litigation 73 1,128 ** ** Total operating expenses 7,220 7,219 7,668 % (6) % Special Items 1 (73) (1,128) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 7,147 $ 7,219 $ 6,540 (1) % 10 % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 1 Acquisitions Currency Impact 2 Total 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 General and administrative (1)% 11 % ** ** 4 % 2 % % (2) % 3 % 11 % Advertising and marketing (30)% 5 % ** ** % % (1) % (2) % (30) % 3 % Depreciation and amortization 5% 9 % ** ** 6 % 7 % % (2) % 11 % 14 % Provision for litigation ** ** ** ** ** ** ** ** ** ** Total operating expenses (5)% 10 % 1 % (16) % 4 % 2 % % (2) % % (6) % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 Represents the translational and transactional impact of currency. General and Administrative General and administrative expenses increased 3% on both an as reported and a currency-neutral basis in 2020 versus the prior year. Current year results include growth of approximately 4 percentage points from acquisitions. Excluding acquisitions, expenses declined 1% primarily due to reduced spending on travel and professional fees, partially offset by an increase in personnel and data processing costs to support continued investment in our strategic initiatives. 50 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Personnel $ 3,787 $ 3,537 $ 3,214 7% 10% Professional fees 384 447 377 (14)% 19% Data processing and telecommunications 756 666 600 14% 11% Foreign exchange activity 1 9 32 (36) ** ** Other 974 1,081 1,019 (10)% 6% Total general and administrative expenses 5,910 5,763 5,174 3% 11% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. Advertising and Marketing Advertising and marketing expenses decreased 30%, or 29% on a currency-neutral basis in 2020 versus the prior year, primarily due to lower advertising and sponsorship spend in response to COVID-19. Depreciation and Amortization Depreciation and amortization expenses increased 11% on both an as reported and a currency-neutral basis in 2020 versus the prior year. Current year results include growth of approximately 6 percentage points from acquisitions. The remaining increase was primarily due to higher depreciation from capital investments. Provision for Litigation In 2020, we recorded $73 million related to various litigation settlements and legal costs. There were no litigation charges in the prior year. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) was unfavorable in 2020 versus the prior year primarily due to increased interest expense related to our recent debt issuances, as well as lower net gains in the current year versus the prior year related to unrealized fair market value adjustments on marketable and non-marketable equity securities and a decrease in our investment income. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) 2020 2019 2018 2020 2019 ($ in millions) Investment Income $ 24 $ 97 $ 122 (75) % (21) % Gains (losses) on equity investments, net 30 167 (82) % ** Interest expense (380) (224) (186) 70 % 20 % Other income (expense), net 5 27 (14) (81) % ** Total other income (expense) (321) 67 (78) ** ** Note: Table may not sum due to rounding. ** Not meaningful Income Taxes The effective income tax rates for the years ended December 31, 2020 and 2019 were 17.4% and 16.6%, respectively. The effective income tax rate for 2020 was higher than the prior year, primarily due to discrete tax benefits in 2019, partially offset by a more MASTERCARD 2020 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. The adjusted effective income tax rates for the years ended December 31, 2020 and 2019 were 17.2% and 17.0%, respectively. The adjusted effective income tax rate was higher than the prior year, primarily due to a discrete tax benefit related to a favorable court ruling in 2019. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31: 2020 2019 (in billions) Cash, cash equivalents and investments 1 $ 10.6 $ 7.7 Unused line of credit 6.0 6.0 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.3 billion and $2.0 billion at December 31, 2020 and 2019, respectively. We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities: For the Years Ended December 31, 2020 2019 2018 (in millions) Net cash provided by operating activities $ 7,224 $ 8,183 $ 6,223 Net cash used in investing activities (1,879) (1,640) (506) Net cash used in financing activities (2,152) (5,867) (4,966) Net cash provided by operating activities decreased $1.0 billion in 2020 versus the prior year, primarily due to lower net income adjusted for non-cash items, partially offset by a decrease in litigation payments. Net cash used in investing activities increased $239 million in 2020 versus the prior year, primarily due to lower net proceeds from our investments in available-for-sale and held-to-maturity securities, partially offset by higher prior year acquisition payments. Net cash used in financing activities decreased $3.7 billion in 2020 versus the prior year, primarily due to lower repurchases of our Class A common stock, higher net debt proceeds in the current period and the repayment of debt that matured in the prior year. 52 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Debt and Credit Availability In March 2020, we issued $1 billion principal amount of notes due March 2027, $1.5 billion principal amount of notes due March 2030 and $1.5 billion principal amount notes due March 2050. Our total debt outstanding was $12.7 billion at December 31, 2020, with the earliest maturity of $650 million of principal occurring in November 2021. As of December 31, 2020, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which, in 2020, was extended for an additional year and now expires in November 2025. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2020. See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. The declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, 2020 2019 2018 (in millions, except per share data) Cash dividend, per share $ 1.60 $ 1.32 $ 1.00 Cash dividends paid $ 1,605 $ 1,345 $ 1,044 On December 8, 2020, our Board of Directors declared a quarterly cash dividend of $0.44 per share paid on February 9, 2021 to holders of record on January 8, 2021 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $439 million. On February 8, 2021, our Board of Directors declared a quarterly cash dividend of $0.44 per share payable on May 7, 2021 to holders of record on April 9, 2021 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $437 million. Repurchased shares of our common stock are considered treasury stock. In December 2020, 2019 and 2018, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $6.0 billion, $8.0 billion and $6.5 billion, respectively, of our Class A common stock. The program approved in 2020 will become effective after completion of the share repurchase program authorized in 2019. The timing and actual number of additional shares repurchased will depend on a variety of factors, including cash requirements to meet the operating needs of the business, legal requirements, as well as the share price and economic and market conditions. The following table summarizes our share repurchase activity of our Class A common stock through December 31, 2020, under the plans approved in 2019 and 2018: (in millions, except per share data) Remaining authorization at December 31, 2019 $ 8,304 Dollar-value of shares repurchased in 2020 $ 4,473 Remaining authorization at December 31, 2020 $ 9,831 Shares repurchased in 2020 14.3 Average price paid per share in 2020 $ 312.68 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2020 FORM 10-K 53 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates or support when customers meet certain volume thresholds as well as other support incentives, which are tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction- based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. Income Taxes In calculating our effective income tax rate, estimates are required regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. In assessing the need for a valuation allowance, we consider all sources of taxable income including, projected future taxable income, reversing taxable temporary differences and ongoing tax planning strategies. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price, including contingent consideration, is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization 54 MASTERCARD 2020 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. "," Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $58 million and $144 million on our foreign exchange derivative contracts outstanding at December 31, 2020 and 2019, respectively, before considering the offsetting effect of the underlying hedged activity. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into short duration foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with our customers. The effect of a hypothetical 10% adverse change in the value of the functional currencies could result in a fair value loss of approximately $23 million on our short duration foreign exchange derivative contracts outstanding at December 31, 2020. The Company did not have any outstanding short duration foreign exchange derivative contracts related to this activity at December 31, 2019. Interest Rate Risk Our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact to the fair value of our investments at December 31, 2020 and 2019. MASTERCARD 2020 FORM 10-K 55 PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019 and 2018 Managements report on internal control over financial reporting Report of independent registered public accounting firm Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements 56 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2020. In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2020. The effectiveness of Mastercards internal control over financial reporting as of December 31, 2020 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. MASTERCARD 2020 FORM 10-K 57 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2020 and 2019 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2020, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on internal control over financial reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. 58 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates or incentives which totaled $8.3 billion for the year ended December 31, 2020. The Company has business agreements with certain customers that provide for rebates or other support when customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. As disclosed by management, various factors are considered in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter are (i) the significant judgment by management when developing estimates related to rebates and incentives based on customer performance; and (ii) a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance, including the reasonableness of the various applicable factors considered by management in the estimate. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to rebates and incentives, including controls over evaluating estimated customer performance. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating rebate and incentive contracts to identify whether all incentives are identified and recorded accurately; (ii) testing managements process for developing estimated customer performance, including evaluating the reasonableness of the various applicable factors considered by management; and (iii) evaluating estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 12, 2021 We have served as the Companys auditor since 1989. MASTERCARD 2020 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, 2020 2019 2018 (in millions, except per share data) Net Revenue $ 15,301 $ 16,883 $ 14,950 Operating Expenses General and administrative 5,910 5,763 5,174 Advertising and marketing 657 934 907 Depreciation and amortization 580 522 459 Provision for litigation 73 1,128 Total operating expenses 7,220 7,219 7,668 Operating income 8,081 9,664 7,282 Other Income (Expense) Investment income 24 97 122 Gains (losses) on equity investments, net 30 167 Interest expense ( 380 ) ( 224 ) ( 186 ) Other income (expense), net 5 27 ( 14 ) Total other income (expense) ( 321 ) 67 ( 78 ) Income before income taxes 7,760 9,731 7,204 Income tax expense 1,349 1,613 1,345 Net Income $ 6,411 $ 8,118 $ 5,859 Basic Earnings per Share $ 6.40 $ 7.98 $ 5.63 Basic weighted-average shares outstanding 1,002 1,017 1,041 Diluted Earnings per Share $ 6.37 $ 7.94 $ 5.60 Diluted weighted-average shares outstanding 1,006 1,022 1,047 The accompanying notes are an integral part of these consolidated financial statements. 60 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, 2020 2019 2018 (in millions) Net Income $ 6,411 $ 8,118 $ 5,859 Other comprehensive income (loss): Foreign currency translation adjustments 345 10 ( 319 ) Income tax effect ( 59 ) 13 40 Foreign currency translation adjustments, net of income tax effect 286 23 ( 279 ) Translation adjustments on net investment hedge ( 177 ) 36 96 Income tax effect 40 ( 8 ) ( 21 ) Translation adjustments on net investment hedge, net of income tax effect ( 137 ) 28 75 Cash flow hedges ( 189 ) 14 Income tax effect 42 ( 3 ) Reclassification adjustment for cash flow hedges 4 Income tax effect ( 1 ) Cash flow hedges, net of income tax effect ( 144 ) 11 Defined benefit pension and other postretirement plans ( 12 ) ( 21 ) ( 16 ) Income tax effect 2 3 3 Reclassification adjustment for defined benefit pension and other postretirement plans ( 1 ) ( 1 ) ( 2 ) Income tax effect Defined benefit pension and other postretirement plans, net of income tax effect ( 11 ) ( 19 ) ( 15 ) Investment securities available-for-sale ( 1 ) 3 ( 3 ) Income tax effect ( 1 ) 1 Investment securities available-for-sale, net of income tax effect ( 1 ) 2 ( 2 ) Other comprehensive income (loss), net of income tax effect ( 7 ) 45 ( 221 ) Comprehensive Income $ 6,404 $ 8,163 $ 5,638 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2020 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, 2020 2019 (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 10,113 $ 6,988 Restricted cash for litigation settlement 586 584 Investments 483 688 Accounts receivable 2,646 2,514 Settlement due from customers 1,706 2,995 Restricted security deposits held for customers 1,696 1,370 Prepaid expenses and other current assets 1,883 1,763 Total current assets 19,113 16,902 Property, equipment and right-of-use assets, net 1,902 1,828 Deferred income taxes 491 543 Goodwill 4,960 4,021 Other intangible assets, net 1,753 1,417 Other assets 5,365 4,525 Total Assets $ 33,584 $ 29,236 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ 527 $ 489 Settlement due to customers 1,475 2,714 Restricted security deposits held for customers 1,696 1,370 Accrued litigation 842 914 Accrued expenses 5,430 5,489 Current portion of long-term debt 649 Other current liabilities 1,228 928 Total current liabilities 11,847 11,904 Long-term debt 12,023 8,527 Deferred income taxes 86 85 Other liabilities 3,111 2,729 Total Liabilities 27,067 23,245 Commitments and Contingencies Redeemable Non-controlling Interests 29 74 Stockholders Equity Class A common stock, $ 0.0001 par value; authorized 3,000 shares, 1,396 and 1,391 shares issued and 987 and 996 shares outstanding, respectively Class B common stock, $ 0.0001 par value; authorized 1,200 shares, 8 and 11 shares issued and outstanding, respectively Additional paid-in-capital 4,982 4,787 Class A treasury stock, at cost, 409 and 395 shares, respectively ( 36,658 ) ( 32,205 ) Retained earnings 38,747 33,984 Accumulated other comprehensive income (loss) ( 680 ) ( 673 ) Mastercard Incorporated Stockholders' Equity 6,391 5,893 Non-controlling interests 97 24 Total Equity 6,488 5,917 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 33,584 $ 29,236 The accompanying notes are an integral part of these consolidated financial statements. 62 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2017 $ $ $ 4,365 $ ( 20,764 ) $ 22,364 $ ( 497 ) $ 5,468 $ 29 $ 5,497 Adoption of revenue standard 366 366 366 Adoption of intra-entity asset transfers standard ( 183 ) ( 183 ) ( 183 ) Net income 5,859 5,859 5,859 Activity related to non-controlling interests ( 6 ) ( 6 ) Redeemable non-controlling interest adjustments ( 3 ) ( 3 ) ( 3 ) Other comprehensive income (loss) ( 221 ) ( 221 ) ( 221 ) Dividends ( 1,120 ) ( 1,120 ) ( 1,120 ) Purchases of treasury stock ( 4,991 ) ( 4,991 ) ( 4,991 ) Share-based payments 215 5 220 220 Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 23 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests 1 1 Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) 45 45 45 Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments 207 8 215 215 Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 MASTERCARD 2020 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2019 4,787 ( 32,205 ) 33,984 ( 673 ) 5,893 24 5,917 Net income 6,411 6,411 6,411 Activity related to non-controlling interests 73 73 Redeemable non-controlling interest adjustments ( 7 ) ( 7 ) ( 7 ) Other comprehensive income (loss) ( 7 ) ( 7 ) ( 7 ) Dividends ( 1,641 ) ( 1,641 ) ( 1,641 ) Purchases of treasury stock ( 4,459 ) ( 4,459 ) ( 4,459 ) Share-based payments 195 6 201 201 Balance at December 31, 2020 $ $ $ 4,982 $ ( 36,658 ) $ 38,747 $ ( 680 ) $ 6,391 $ 97 $ 6,488 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, 2020 2019 2018 (in millions) Operating Activities Net income $ 6,411 $ 8,118 $ 5,859 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,072 1,141 1,235 Depreciation and amortization 580 522 459 (Gains) losses on equity investments, net ( 30 ) ( 167 ) Share-based compensation 254 250 196 Deferred income taxes 73 ( 7 ) ( 244 ) Other 14 24 31 Changes in operating assets and liabilities: Accounts receivable ( 86 ) ( 246 ) ( 317 ) Income taxes receivable ( 2 ) ( 202 ) ( 120 ) Settlement due from customers 1,288 ( 444 ) ( 1,078 ) Prepaid expenses ( 1,552 ) ( 1,661 ) ( 1,769 ) Accrued litigation and legal settlements ( 73 ) ( 662 ) 869 Restricted security deposits held for customers 326 290 ( 6 ) Accounts payable 26 ( 42 ) 101 Settlement due to customers ( 1,242 ) 477 849 Accrued expenses ( 114 ) 657 439 Long-term taxes payable ( 37 ) 2 ( 20 ) Net change in other assets and liabilities 316 133 ( 261 ) Net cash provided by operating activities 7,224 8,183 6,223 Investing Activities Purchases of investment securities available-for-sale ( 220 ) ( 643 ) ( 1,300 ) Purchases of investments held-to-maturity ( 198 ) ( 215 ) ( 509 ) Proceeds from sales of investment securities available-for-sale 361 1,098 604 Proceeds from maturities of investment securities available-for-sale 140 376 379 Proceeds from maturities of investments held-to-maturity 121 383 929 Purchases of property and equipment ( 339 ) ( 422 ) ( 330 ) Capitalized software ( 369 ) ( 306 ) ( 174 ) Purchases of equity investments ( 214 ) ( 467 ) ( 91 ) Acquisition of businesses, net of cash acquired ( 989 ) ( 1,440 ) Settlement of interest rate derivative contracts ( 175 ) Other investing activities 3 ( 4 ) ( 14 ) Net cash used in investing activities ( 1,879 ) ( 1,640 ) ( 506 ) Financing Activities Purchases of treasury stock ( 4,473 ) ( 6,497 ) ( 4,933 ) Dividends paid ( 1,605 ) ( 1,345 ) ( 1,044 ) Proceeds from debt, net 3,959 2,724 991 Payment of debt ( 500 ) Acquisition of redeemable non-controlling interests ( 49 ) Contingent consideration paid ( 199 ) Tax withholdings related to share-based payments ( 150 ) ( 161 ) ( 80 ) Cash proceeds from exercise of stock options 97 126 104 Other financing activities 69 ( 15 ) ( 4 ) Net cash used in financing activities ( 2,152 ) ( 5,867 ) ( 4,966 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents 257 ( 44 ) ( 6 ) Net increase in cash, cash equivalents, restricted cash and restricted cash equivalents 3,450 632 745 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 8,969 8,337 7,592 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 12,419 $ 8,969 $ 8,337 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2020 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known brands, including Mastercard, Maestro and Cirrus. The Company operates a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through its unique and proprietary global payments network, which is referred to as the core network, the Company switches (authorizes, clears and settles) payment transactions and delivers related products and services. Mastercard has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). The Company also provides integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs, processing and open banking. The Companys payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2020 and 2019, there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date in which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2020, 2019 and 2018, net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty, including the potential impacts and duration of the COVID-19 pandemic, as well as other factors; accordingly, accounting estimates require the exercise of judgment. These financial statements were prepared using information reasonably available as of December 31, 2020 and through the date of this Report. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated from assessing customers based on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands, from fees to issuers, acquirers and other stakeholders for providing switching services, as well as from value-added products and services that are typically integrated and sold with the Companys payment offerings. 66 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is primarily based on the related volume generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. For services provided to customers where delivery involves the use of a third-party, the Company recognizes revenue on a gross basis if it acts as the principal, controlling the service to the customer and on a net basis if it acts as the agent, arranging for the service to be provided. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, any non-controlling interest in the acquiree and contingent consideration at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses on the consolidated statement of operations. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date are recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. MASTERCARD 2020 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets 68 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions are recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Investments in debt securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment is recognized as an allowance and recorded in other income (expense), net on the consolidated statement of operations while the non-credit related loss remains in accumulated other comprehensive income (loss) until realized from a sale or subsequent impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. MASTERCARD 2020 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gain (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the equity method or measurement alternative method. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20 % and 50 % ownership in the entity. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The Companys share of net earnings or losses for these investments are included in gains (losses) on equity investments, net on the consolidated statement of operations. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gain (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. The Company does not enter into derivative contracts for trading or speculative purposes. For derivative contracts that are not designated as hedging instruments, realized and unrealized gains and losses from the change in fair value of the contracts are recognized in current earnings. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. For cash flow hedges, the fair value adjustments are recorded, net of tax, in other comprehensive income (loss) on the consolidated statement of comprehensive income. Any gains and losses deferred in accumulated other comprehensive income (loss) are subsequently reclassified to the corresponding line item on the consolidated statement of operations when the underlying hedged transactions impact earnings. For hedging instruments that are no longer deemed highly effective, hedge accounting is discontinued prospectively, and any gains and losses remaining in accumulated other comprehensive income (loss) are reclassified to earnings when the underlying forecasted transaction occurs. If it is probable that the forecasted transaction will no longer occur, the associated gains or losses in accumulated other comprehensive income (loss) are reclassified to the corresponding line item on the consolidated statement of operations in current earnings. The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company may use foreign currency denominated debt and/or derivative instruments to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the hedging instruments are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as a cumulative translation adjustment component of equity. Amounts excluded from 70 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS effectiveness testing of net investment hedges are recognized in earnings over the life of the hedging instrument. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. MASTERCARD 2020 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. Accounting pronouncements not yet adopted Simplifying the accounting for income taxes - In December 2019, the FASB issued accounting guidance to simplify the accounting for income taxes. This guidance includes the removal of certain exceptions to the general income tax accounting principles and provides clarity and simplification to other areas of income tax accounting by amending the existing guidance. The guidance is effective for periods beginning after December 15, 2020. The Company will adopt this guidance effective January 1, 2021 and does not expect the impacts to be material. Reference Rate Reform - In March 2020, the FASB issued accounting guidance to provide temporary optional expedients and exceptions to the current contract modifications and hedge accounting guidance in light of the expected market transition from LIBOR to alternative rates. The new guidance provides optional expedients and exceptions to transactions affected by reference rate reform if certain criteria are met. The transactions primarily include (1) contract modifications, (2) hedging relationships, and (3) sale or transfer of debt securities classified as held-to-maturity. The amendments were effective immediately upon issuance of the update. Companies may elect to adopt the amendments prospectively to transactions existing as of or entered from the date of adoption through December 31, 2022. The Company does not expect the impacts to be material. 72 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 2. Acquisitions In 2020 and 2019, the Company acquired several businesses for total consideration of $ 1.1 billion and $ 1.5 billion, respectively, representing both cash and contingent consideration. There were no acquisitions in 2018. These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations and contingent consideration. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a majority of the goodwill is not expected to be deductible for local tax purposes. In 2020, the Company finalized the purchase accounting for businesses acquired during 2019 and $ 185 million of the businesses acquired in 2020. The Company is evaluating and finalizing the purchase accounting for the remainder of the businesses acquired during 2020. The preliminary estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for the years ended December 31. 2020 2019 (in millions) Assets: Cash and cash equivalents $ 6 $ 54 Other current assets 14 143 Other intangible assets 237 395 Goodwill 844 1,076 Other assets 11 48 Total assets 1,112 1,716 Liabilities: Other current liabilities 15 121 Deferred income taxes 23 52 Other liabilities 8 32 Total liabilities 46 205 Net assets acquired $ 1,066 $ 1,511 The following table summarizes the identified intangible assets acquired during the years ended December 31: 2020 2019 2020 2019 Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ 122 $ 199 6.3 7.7 Customer relationships 114 178 12.0 12.6 Other 1 18 1.0 5.0 Other intangible assets $ 237 $ 395 9.0 9.7 Pro forma information related to the acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. Among the businesses acquired in 2020, the largest acquisition relates to Finicity Corporation (Finicity), an open-banking provider, headquartered in Salt Lake City, Utah. On November 18, 2020, Mastercard acquired 100 % equity interest in Finicity for cash consideration of $ 809 million. In addition, the Finicity sellers have the potential to earn contingent consideration of up to $ 160 million if certain revenue targets are met in 2021. As of the acquisition date, the fair value of the contingent consideration was $ 71 million. The businesses acquired in 2019 were not individually significant to Mastercard. Pending Acquisition In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $ 3.5 billion as of December 31, 2020 ) after adjusting for cash and certain other MASTERCARD 2020 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS liabilities at closing. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of Nets Denmark A/Ss Corporate Services business. The Company has secured conditional approval from the European Commission and, subject to other closing conditions, anticipates completing the acquisition in the first quarter of 2021, or shortly thereafter. Note 3. Revenue Mastercards core network involves four participants in addition to the Company: account holders (a person or entity who holds a card or uses another device enabled for payment), issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from information accumulated by Mastercards systems or reported by customers. In addition, the Company generates other revenues from value-added products and services that are typically integrated and sold with the Companys payment offerings and are recognized as revenue in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile-initiated transactions; and safety and security. 74 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other revenues consist of value-added products and services that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Data analytics and consulting fees. Cyber and intelligence fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services and platforms, including account and transaction enhancement services, open banking solutions, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31: 2020 2019 2018 (in millions) Revenue by source: Domestic assessments $ 6,656 $ 6,781 $ 6,138 Cross-border volume fees 3,512 5,606 4,954 Transaction processing 8,731 8,469 7,391 Other revenues 4,717 4,124 3,348 Gross revenue 23,616 24,980 21,831 Rebates and incentives (contra-revenue) ( 8,315 ) ( 8,097 ) ( 6,881 ) Net revenue $ 15,301 $ 16,883 $ 14,950 Net revenue by geographic region: North American Markets $ 5,424 $ 5,843 $ 5,312 International Markets 9,701 10,869 9,514 Other 1 176 171 124 Net revenue $ 15,301 $ 16,883 $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $ 2.5 billion and $ 2.3 billion as of December 31, 2020 and 2019, respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are generally billed weekly, however, the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2020 in the amounts of $ 59 million and $ 245 million, respectively. The comparable amounts included in prepaid expenses and other current assets and other assets at December 31, 2019 were $ 48 million and $ 152 million, respectively. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2020 in the amounts of $ 355 million and $ 143 million, respectively. The comparable amounts included in other current liabilities and MASTERCARD 2020 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS other liabilities at December 31, 2019 were $ 238 million and $ 106 million, respectively. In 2020, 2019 and 2018 revenue recognized from the satisfaction of such performance obligations was $ 1.1 billion, $ 994 million and $ 904 million, respectively. The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years). As a payment network service provider, the Company provides its customers with continuous access to its global payments network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates volume- and transaction-based revenues from assessing its customers current period activity. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues primarily from other value-added services comprised of both batch and real-time account-based payment services, consulting fees, gateway services, processing, loyalty programs and other payment-related products and services. At December 31, 2020, the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion, which is expected to be recognized through 2023. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: 2020 2019 2018 (in millions, except per share data) Numerator Net income $ 6,411 $ 8,118 $ 5,859 Denominator Basic weighted-average shares outstanding 1,002 1,017 1,041 Dilutive stock options and stock units 4 5 6 Diluted weighted-average shares outstanding 1 1,006 1,022 1,047 Earnings per Share Basic $ 6.40 $ 7.98 $ 5.63 Diluted $ 6.37 $ 7.94 $ 5.60 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31: 2020 2019 (in millions) Cash and cash equivalents $ 10,113 $ 6,988 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement 586 584 Restricted security deposits held for customers 1,696 1,370 Prepaid expenses and other current assets 24 27 Cash, cash equivalents, restricted cash and restricted cash equivalents $ 12,419 $ 8,969 76 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: 2020 2019 2018 (in millions) Cash paid for income taxes, net of refunds $ 1,349 $ 1,644 $ 1,790 Cash paid for interest 311 199 153 Cash paid for legal settlements 149 668 260 Non-cash investing and financing activities Dividends declared but not yet paid 439 403 340 Accrued property, equipment and right-of-use assets 154 468 10 Fair value of assets acquired, net of cash acquired 1,106 1,662 Fair value of liabilities assumed related to acquisitions 46 205 Note 7. Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31: 2020 2019 (in millions) Available-for-sale securities $ 321 $ 591 Held-to-maturity securities 162 97 Total investments $ 483 $ 688 Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2020 December 31, 2019 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ 10 $ $ $ 10 $ 15 $ $ $ 15 Government and agency securities 64 64 108 108 Corporate securities 246 1 247 381 1 382 Asset-backed securities 85 1 86 Total $ 320 $ 1 $ $ 321 $ 589 $ 2 $ $ 591 The Companys available-for-sale investment securities held at December 31, 2020 and 2019, primarily carried a credit rating of A- or better with unrealized gains and losses recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. The municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. MASTERCARD 2020 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2020 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ 115 $ 115 Due after 1 year through 5 years 205 206 Total $ 320 $ 321 Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits, and realized gains and losses on the Companys debt securities. The realized gains and losses from the sale of available-for-sale securities for 2020, 2019 and 2018 were not significant. Held-to-Maturity Securities The Company classifies time deposits with maturities greater than three months but less than one year as held-to-maturity. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. The cost of these securities approximates fair value. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2019 Purchases (Sales), net Changes in Fair Value 1 Other 2 Balance at December 31, 2020 (in millions) Marketable securities $ 479 $ 1 $ ( 5 ) $ 1 $ 476 Nonmarketable securities 435 204 35 22 696 Total equity investments $ 914 $ 205 $ 30 $ 23 $ 1,172 1 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations 2 Includes translational impact of currency At December 31, 2020 , the total carrying value of Nonmarketable securities included $ 157 million of measurement alternative investments and $ 539 million of equity method investments. At December 31, 2019, the total carrying value of Nonmarketable securities included $ 317 million of measurement alternative investments and $ 118 million of equity method investments. Cumulative impairments and downward fair value adjustments on measurement alternative investments were $ 14 million and cumulative upward fair value adjustments were $ 86 million as of December 31, 2020 . Note 8. Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy within the Valuation Hierarchy. Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. There were no transfers made among the three levels in the Valuation Hierarchy for 2020 and 2019. 78 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2020 December 31, 2019 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ 10 $ $ 10 $ $ 15 $ $ 15 Government and agency securities 26 38 64 66 42 108 Corporate securities 247 247 382 382 Asset-backed securities 86 86 Derivative instruments 2 : Foreign exchange contracts 19 19 12 12 Interest rate contracts 14 14 Marketable securities 3 : Equity securities 476 476 479 479 Deferred compensation plan 4 : Deferred compensation assets 78 78 67 67 Liabilities Derivative instruments 2 : Foreign exchange derivative liabilities $ $ ( 28 ) $ $ ( 28 ) $ $ ( 32 ) $ $ ( 32 ) Deferred compensation plan 5 : Deferred compensation liabilities ( 81 ) ( 81 ) ( 67 ) ( 67 ) 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . MASTERCARD 2020 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2020, the carrying value and fair value of total long-term debt (including the current portion) was $ 12.7 billion and $ 14.8 billion, respectively. At December 31, 2019, the carrying value and fair value of long-term debt (including the current portion) was $ 8.5 billion and $ 9.2 billion, respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Note 9. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 1,086 $ 872 Prepaid income taxes 78 105 Other 719 786 Total prepaid expenses and other current assets $ 1,883 $ 1,763 Other assets consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 3,220 $ 2,838 Equity investments 1,172 914 Income taxes receivable 553 460 Other 420 313 Total other assets $ 5,365 $ 4,525 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. See Note 7 (Investments) for further information on the Companys equity investments. 80 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31: 2020 2019 (in millions) Building, building equipment and land $ 522 $ 505 Equipment 1,321 1,218 Furniture and fixtures 99 92 Leasehold improvements 380 303 Operating lease right-of-use assets 970 810 Property, equipment and right-of-use assets 3,292 2,928 Less: Accumulated depreciation and amortization ( 1,390 ) ( 1,100 ) Property, equipment and right-of-use assets, net $ 1,902 $ 1,828 Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 400 million, $ 336 million and $ 209 million for 2020, 2019 and 2018, respectively. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows at December 31: 2020 2019 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ 748 $ 711 Other current liabilities 125 106 Other liabilities 726 656 Operating lease amortization expense for 2020 and 2019 was $ 123 million and $ 99 million, respectively. As of December 31, 2020 and 2019, the weighted-average remaining lease term of operating leases was 9.1 years and 9.5 years and the weighted-average discount rate for operating leases was 2.7 % and 2.9 %, respectively. The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2020 based on lease term: Operating Leases (in millions) 2021 $ 137 2022 130 2023 108 2024 95 2025 72 Thereafter 383 Total operating lease payments 925 Less: Interest ( 74 ) Present value of operating lease liabilities $ 851 Prior to adoption of the lease accounting standard in 2019, consolidated rental expense for the Companys leased office space was $ 94 million for 2018. Consolidated lease expense for automobiles, computer equipment and office equipment was $ 20 million for 2018, respectively. MASTERCARD 2020 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 11. Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: 2020 2019 (in millions) Beginning balance $ 4,021 $ 2,904 Additions 844 1,076 Foreign currency translation 95 41 Ending balance $ 4,960 $ 4,021 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2020 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2020. Note 12. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: 2020 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 2,276 $ ( 1,126 ) $ 1,150 $ 1,884 $ ( 988 ) $ 896 Customer relationships 743 ( 322 ) 421 621 ( 264 ) 357 Other 44 ( 41 ) 3 44 ( 44 ) Total 3,063 ( 1,489 ) 1,574 2,549 ( 1,296 ) 1,253 Indefinite-lived intangible assets Customer relationships 179 179 164 164 Total $ 3,242 $ ( 1,489 ) $ 1,753 $ 2,713 $ ( 1,296 ) $ 1,417 The increase in the gross carrying amount of amortized intangible assets in 2020 was primarily related to software additions and businesses acquired in 2020. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2020, it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $ 303 million, $ 285 million and $ 250 million in 2020, 2019 and 2018, respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2020 for the years ending December 31: (in millions) 2021 $ 332 2022 260 2023 211 2024 194 2025 and thereafter 577 $ 1,574 82 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: 2020 2019 (in millions) Customer and merchant incentives $ 3,998 $ 3,892 Personnel costs 727 713 Income and other taxes 208 332 Other 497 552 Total accrued expenses $ 5,430 $ 5,489 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2020 and 2019, the Companys provision for litigation was $ 842 million and $ 914 million, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 150 million, $ 127 million and $ 98 million in 2020, 2019 and 2018, respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 20 million as of December 31, 2020) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD 2020 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31: Pension Plans Postretirement Plan 2020 2019 2020 2019 ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ 531 $ 438 $ 64 $ 57 Service cost 13 11 1 1 Interest cost 9 13 2 2 Actuarial (gain) loss 43 73 7 9 Benefits paid ( 18 ) ( 15 ) ( 4 ) ( 5 ) Transfers in 3 2 Foreign currency translation 23 9 Benefit obligation at end of year 604 531 70 64 Change in plan assets Fair value of plan assets at beginning of year 518 410 Actual (loss) gain on plan assets 56 79 Employer contributions 34 32 4 5 Benefits paid ( 18 ) ( 15 ) ( 4 ) ( 5 ) Transfers in 5 2 Foreign currency translation 22 10 Fair value of plan assets at end of year 617 518 Funded status at end of year $ 13 $ ( 13 ) $ ( 70 ) $ ( 64 ) Amounts recognized on the consolidated balance sheet consist of: Noncurrent assets $ 28 $ $ $ Other liabilities, short-term ( 4 ) ( 3 ) Other liabilities, long-term ( 15 ) ( 13 ) ( 66 ) ( 61 ) $ 13 $ ( 13 ) $ ( 70 ) $ ( 64 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ 12 $ 7 $ 9 $ 2 Prior service credit 1 1 ( 4 ) ( 5 ) Balance at end of year $ 13 $ 8 $ 5 $ ( 3 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.70 % 0.70 % * * Vocalink Plan 1.55 % 2.00 % * * Postretirement Plan * * 2.50 % 3.25 % Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % * * Vocalink Plan 2.75 % 2.50 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable 84 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2020, the Companys aggregated Pension Plan assets exceed the benefit obligations. For plans where the benefit obligations exceeded plan assets, the projected benefit obligation was $ 112 million, the accumulated benefit obligation was $ 111 million and plan assets were $ 97 million. At December 31, 2019, all of the Pension Plans had benefit obligations in excess of plan assets. Information on the Pension Plans were as follows as of December 31: 2020 2019 (in millions) Projected benefit obligation $ 604 $ 531 Accumulated benefit obligation 601 524 Fair value of plan assets 617 518 For the years ended December 31, 2020 and 2019, the Companys projected benefit obligation related to its Pension Plans increased $ 73 million and $ 93 million, respectively, primarily attributable to actuarial losses related to lower discount rate assumptions. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 (in millions) Service cost $ 13 $ 11 $ 9 $ 1 $ 1 $ 1 Interest cost 9 13 12 2 2 2 Expected return on plan assets ( 18 ) ( 18 ) ( 20 ) Amortization of actuarial loss 1 Amortization of prior service credit ( 1 ) ( 1 ) ( 2 ) Net periodic benefit cost $ 4 $ 7 $ 1 $ 2 $ 2 $ 1 The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 (in millions) Current year actuarial loss (gain) $ 5 $ 12 $ 17 $ 7 $ 9 $ ( 2 ) Current year prior service credit 1 Amortization of prior service credit 1 1 2 Total other comprehensive loss (income) $ 5 $ 12 $ 18 $ 8 $ 10 $ Total net periodic benefit cost and other comprehensive loss (income) $ 9 $ 19 $ 19 $ 10 $ 12 $ 1 MASTERCARD 2020 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31: Pension Plans Postretirement Plan 2020 2019 2018 2020 2019 2018 Discount rate Non-U.S. Plans 0.70 % 1.80 % 1.80 % * * * Vocalink Plan 1.55 % 2.00 % 2.80 % * * * Postretirement Plan * * * 3.25 % 4.25 % 3.50 % Expected return on plan assets Non-U.S. Plans 1.60 % 2.10 % 3.00 % * * * Vocalink Plan 3.20 % 3.75 % 4.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 1.50 % 2.60 % * * * Vocalink Plan 2.75 % 2.50 % 3.85 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: 2020 2019 Healthcare cost trend rate assumed for next year 7.00 % 6.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate 8 2 Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed with the following target asset allocations: fixed income 35 %, U.K. government securities 23 %, equity 22 %, cash and cash equivalents 12 % and real estate 8 %. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. 86 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2020 December 31, 2019 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ 59 $ $ $ 59 $ 16 $ $ $ 16 Mutual funds 2 270 117 387 153 193 346 Insurance contracts 3 96 96 75 75 Total $ 329 $ 213 $ $ 542 $ 169 $ 268 $ $ 437 Investments at Net Asset Value (NAV) 4 75 81 Total Plan Assets $ 617 $ 518 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 3 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 4 Investments at NAV include mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) and are valued using the net asset value provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2020 ) through 2030 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) 2021 $ 19 $ 4 2022 12 4 2023 14 4 2024 15 4 2025 15 4 2026 - 2030 77 20 MASTERCARD 2020 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15. Debt Long-term debt consisted of the following at December 31: 2020 2019 Effective Interest Rate (in millions) 2020 USD Notes 3.300 % Senior Notes due March 2027 $ 1,000 $ 3.420 % 3.350 % Senior Notes due March 2030 1,500 3.430 % 3.850 % Senior Notes due March 2050 1,500 3.896 % 2019 USD Notes 2.950 % Senior Notes due June 2029 1,000 1,000 3.030 % 3.650 % Senior Notes due June 2049 1,000 1,000 3.689 % 2.000 % Senior Notes due March 2025 750 750 2.147 % 2018 USD Notes 3.500 % Senior Notes due February 2028 500 500 3.598 % 3.950 % Senior Notes due February 2048 500 500 3.990 % 2016 USD Notes 2.000 % Senior Notes due November 2021 650 650 2.236 % 2.950 % Senior Notes due November 2026 750 750 3.044 % 3.800 % Senior Notes due November 2046 600 600 3.893 % 2015 EUR Notes 1 1.100 % Senior Notes due December 2022 859 785 1.265 % 2.100 % Senior Notes due December 2027 982 896 2.189 % 2.500 % Senior Notes due December 2030 184 169 2.562 % 2014 USD Notes 3.375 % Senior Notes due April 2024 1,000 1,000 3.484 % 12,775 8,600 Less: Unamortized discount and debt issuance costs ( 103 ) ( 73 ) Total debt outstanding 12,672 8,527 Less: Current portion 2 ( 649 ) Long-term debt $ 12,023 $ 8,527 1 Relates to euro-denominated debt issuance of 1.650 billion in December 2015 2 Relates to current portion of the 2016 USD Notes, due in November 2021, classified as current portion of long-term debt on the consolidated balance sheet In March 2020, the Company issued $ 1 billion principal amount of notes due March 2027, $ 1.5 billion principal amount of notes due March 2030 and $ 1.5 billion principal amount notes due March 2050 (collectively the 2020 USD Notes). The net proceeds from the issuance of the 2020 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 3.959 billion. In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049 and in December 2019, the Company issued $ 750 million principal amount of notes due March 2025 (collectively the 2019 USD Notes). The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion. The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2018 USD Notes were $ 991 million. 88 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2020 are summarized below. (in millions) 2021 $ 650 2022 859 2023 2024 1,000 2025 750 Thereafter 9,516 Total $ 12,775 On November 14, 2019, the Company increased its commercial paper program (the Commercial Paper Program) from $ 4.5 billion to $ 6 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility) on November 14, 2019. The Credit Facility, which previously expired on November 14, 2024, was extended on November 14, 2020 for an additional year and now expires on November 13, 2025. The extension did not result in material changes to the terms and conditions of the Credit Facility. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2020 and 2019. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2020 and 2019. Note 16. Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 300 No shares issued or outstanding at December 31, 2020 and 2019. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. MASTERCARD 2020 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2020, 2019 and 2018. The Company declared total per share dividends on its Class A and Class B Common Stock during the years ended December 31 as summarized below: 2020 2019 2018 (in millions, except per share data) Dividends declared per share $ 1.64 $ 1.39 $ 1.08 Total dividends declared $ 1,641 $ 1,408 $ 1,120 Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31: 2020 2019 Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.2 % 88.9 % 87.8 % 88.8 % Principal or Affiliate Customers (Class B stockholders) 0.8 % % 1.1 % % Mastercard Foundation (Class A stockholders) 11.0 % 11.1 % 11.1 % 11.2 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements pursuant to Canadian tax law. Under such current law, Mastercard Foundation must annually disburse at least 3.5 % of its assets not used in its charitable activities and administration in the previous eight quarters (Disbursement Quota). However, Mastercard Foundation obtained permission from the Canada Revenue Agency to, until December 31, 2021, meet its cumulative Disbursement Quota obligations over a period of time that, on average, demonstrates compliance with the requirement for such established time period. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. 90 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2020, as well as historical purchases: Board authorization dates December 2020 December 2019 December 2018 December 2017 December 2016 Date program became effective Not yet effective January 2020 January 2019 March 2018 April 2017 Total (in millions, except average price data) Board authorization $ 6,000 $ 8,000 $ 6,500 $ 4,000 $ 4,000 $ 28,500 Dollar-value of shares repurchased in 2018 $ $ $ $ 3,699 $ 1,234 $ 4,933 Remaining authorization at December 31, 2018 $ $ $ 6,500 $ 301 $ $ 6,801 Dollar-value of shares repurchased in 2019 $ $ $ 6,196 $ 301 $ $ 6,497 Remaining authorization at December 31, 2019 $ $ 8,000 $ 304 $ $ $ 8,304 Dollar-value of shares repurchased in 2020 $ $ 4,169 $ 304 $ $ $ 4,473 Remaining authorization at December 31, 2020 $ 6,000 $ 3,831 $ $ $ $ 9,831 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ $ $ 194.77 $ 171.11 $ 188.26 Shares repurchased in 2019 24.8 1.6 26.4 Average price paid per share in 2019 $ $ $ 249.58 $ 188.38 $ $ 245.89 Shares repurchased in 2020 13.3 1.0 14.3 Average price paid per share in 2020 $ $ 313.26 $ 304.89 $ $ $ 312.68 Cumulative shares repurchased through December 31, 2020 13.3 25.8 20.6 28.2 87.9 Cumulative average price paid per share $ $ 313.26 $ 251.72 $ 194.27 $ 141.99 $ 212.41 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31: Outstanding Shares Class A Class B (in millions) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock ( 26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 ( 2.3 ) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 Purchases of treasury stock ( 14.3 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.9 ( 2.9 ) Balance at December 31, 2020 986.9 8.3 MASTERCARD 2020 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2020 and 2019 were as follows: December 31, 2019 Increase / (Decrease) Reclassifications December 31, 2020 (in millions) Foreign currency translation adjustments 1 $ ( 638 ) $ 286 $ $ ( 352 ) Translation adjustments on net investment hedge 2 ( 38 ) ( 137 ) ( 175 ) Cash flow hedges Interest rate contracts 3 11 ( 147 ) 3 ( 133 ) Defined benefit pension and other postretirement plans 4 ( 9 ) ( 10 ) ( 1 ) ( 20 ) Investment securities available-for-sale 1 ( 1 ) Accumulated Other Comprehensive Income (Loss) $ ( 673 ) $ ( 9 ) $ 2 $ ( 680 ) December 31, 2018 Increase / (Decrease) Reclassifications December 31, 2019 (in millions) Foreign currency translation adjustments 1 $ ( 661 ) $ 23 $ $ ( 638 ) Translation adjustments on net investment hedge 2 ( 66 ) 28 ( 38 ) Cash flow hedges Interest rate contracts 3 11 11 Defined benefit pension and other postretirement plans 4 10 ( 17 ) ( 2 ) ( 9 ) Investment securities available-for-sale ( 1 ) 2 1 Accumulated Other Comprehensive Income (Loss) $ ( 718 ) $ 47 $ ( 2 ) $ ( 673 ) 1. During 2020, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the Euro and British pound partially offset by the depreciation of the Brazilian real. During 2019, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the British pound partially offset by the depreciation of the euro. 2. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. Changes in the value of the debt are recorded in accumulated other comprehensive income (loss). During 2020, the increase in the accumulated other comprehensive loss related to the net investment hedge was driven by the appreciation of the euro. During 2019, the decrease in the accumulated other comprehensive loss related to the net investment hedge was driven by the depreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3. In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. In the first quarter of 2020, in connection with the issuance of the 2020 USD Notes, these contracts were settled for a loss of $ 175 million, or $ 136 million net of tax, recorded in accumulated other comprehensive income (loss). The cumulative loss will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. See Note 23 (Derivative and Hedging Instruments) for additional information. 4. During 2020, the increase in the accumulated other comprehensive loss related to the Companys Plans was driven primarily by an actuarial loss within the Postretirement Plan. During 2019, the decrease in the accumulated other comprehensive gain related to the Companys Plans was primarily driven by actuarial losses within the Vocalink and non-U.S. Plans. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. Note 18. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. 92 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, however, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: 2020 2019 2018 Risk-free rate of return 1.0 % 2.6 % 2.7 % Expected term (in years) 6.00 6.00 6.00 Expected volatility 19.3 % 19.6 % 19.7 % Expected dividend yield 0.6 % 0.6 % 0.6 % Weighted-average fair value per Option granted $ 80.92 $ 53.09 $ 40.90 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2020: Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2020 6.6 $ 117 Granted 0.4 $ 263 Exercised ( 1.3 ) $ 75 Forfeited/expired $ 229 Outstanding at December 31, 2020 5.7 $ 137 6.0 $ 1,259 Exercisable at December 31, 2020 3.8 $ 106 5.1 $ 962 Options vested and expected to vest at December 31, 2020 5.7 $ 137 6.0 $ 1,257 As of December 31, 2020, there was $ 37 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.1 years. Restricted Stock Units For RSUs granted on or after March 1, 2020, the awards generally vest ratably over four years. For RSUs granted before March 1, 2020, the awards generally vest after three years . A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than seven months . MASTERCARD 2020 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys RSU activity for the year ended December 31, 2020: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2020 2.9 $ 166 Granted 0.9 $ 288 Converted ( 1.2 ) $ 116 Forfeited ( 0.1 ) $ 218 Outstanding at December 31, 2020 2.5 $ 231 $ 898 RSUs expected to vest at December 31, 2020 2.4 $ 230 $ 861 The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2020, there was $ 233 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 2.4 years. Performance Stock Units PSUs vest after three years , however, awards granted on or after March 1, 2019 are subject to a mandatory one-year post-vest hold. A participants unvested awards are forfeited upon termination of employment. In the event of termination due to job elimination (as defined by the Company), however, a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than seven months after receiving the award, the participant retains all of their awards without providing additional service to the Company. The following table summarizes the Companys PSU activity for the year ended December 31, 2020: Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2020 0.5 $ 167 Granted 0.2 $ 291 Converted ( 0.3 ) $ 126 Outstanding at December 31, 2020 0.4 $ 259 $ 148 PSUs expected to vest at December 31, 2020 0.4 $ 259 $ 148 Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expense for PSUs is recognized over the requisite service period, or the date the individual becomes eligible to retire but not less than seven months , if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. During the year ended December 31, 2020, performance targets related to PSU awards granted in 2018, and scheduled to vest in 2021 (2018 PSU Awards), were adjusted to exclude certain pandemic-related financial impacts deemed outside of the Companys control. The adjustment required the Company to apply modification accounting to the 2018 PSU Awards. The modification had an immaterial impact on compensation expense expected to be recognized over the remaining service period. As of December 31, 2020, there was $ 38 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.4 years. 94 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Additional Information The following table includes additional share-based payment information for each of the years ended December 31: 2020 2019 2018 (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ 254 $ 250 $ 196 Income tax benefit recognized for equity awards 53 53 41 Income tax benefit realized related to Options exercised 68 69 53 Options: Total intrinsic value of Options exercised 317 317 242 RSUs: Weighted-average grant-date fair value of awards granted 288 226 171 Total intrinsic value of RSUs converted into shares of Class A common stock 330 394 194 PSUs: Weighted-average grant-date fair value of awards granted 291 231 226 Total intrinsic value of PSUs converted into shares of Class A common stock 92 85 40 Note 19. Commitments At December 31, 2020, the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements and a commitment to purchase the remaining shares of a majority-owned joint venture. The Company has accrued $ 22 million of these future payments as of December 31, 2020. (in millions) 2021 $ 573 2022 255 2023 117 2024 78 2025 1 Thereafter Total $ 1,024 Note 20. Income Taxes Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: 2020 2019 2018 (in millions) United States $ 3,304 $ 4,213 $ 3,510 Foreign 4,456 5,518 3,694 Income before income taxes $ 7,760 $ 9,731 $ 7,204 MASTERCARD 2020 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The total income tax provision for the years ended December 31 is comprised of the following components: 2020 2019 2018 (in millions) Current Federal $ 439 $ 642 $ 649 State and local 56 81 69 Foreign 781 897 871 1,276 1,620 1,589 Deferred Federal 106 40 ( 228 ) State and local 9 ( 11 ) Foreign ( 42 ) ( 47 ) ( 5 ) 73 ( 7 ) ( 244 ) Income tax expense $ 1,349 $ 1,613 $ 1,345 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: 2020 2019 2018 Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 7,760 $ 9,731 $ 7,204 Federal statutory tax 1,630 21.0 % 2,044 21.0 % 1,513 21.0 % State tax effect, net of federal benefit 57 0.7 % 65 0.7 % 46 0.6 % Foreign tax effect ( 193 ) ( 2.5 ) % ( 208 ) ( 2.1 ) % ( 92 ) ( 1.3 ) % European Commission fine % % 194 2.7 % Foreign tax credits 1 % ( 32 ) ( 0.3 ) % ( 110 ) ( 1.5 ) % Windfall benefit ( 119 ) ( 1.5 ) % ( 129 ) ( 1.3 ) % ( 72 ) ( 1.0 ) % Other, net ( 26 ) ( 0.3 ) % ( 127 ) ( 1.4 ) % ( 134 ) ( 1.8 ) % Income tax expense $ 1,349 17.4 % $ 1,613 16.6 % $ 1,345 18.7 % 1 Included within the impact of the foreign tax credits is $ 27 million for 2019 and $ 90 million for 2018 of tax benefits relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2020, 2019 and 2018 were 17.4 %, 16.6 % and 18.7 %, respectively. The effective income tax rate for 2020 was higher than the effective income tax rate for 2019, primarily due to discrete tax benefits in 2019, partially offset by a more favorable geographic mix of earnings in 2020. The 2019 discrete tax benefits related to a favorable court ruling, a reduction to the Companys transition tax liability and additional foreign tax credits which can be carried back under U.S. tax reform transition rules issued by the Department of the Treasury and the Internal Revenue Service. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019. These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. 96 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2020, 2019 and 2018, the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 260 million, or $ 0.26 per diluted share, $ 300 million, or $ 0.29 per diluted share, and $ 212 million, or $ 0.20 per diluted share, respectively. Indefinite Reinvestment As of December 31, 2020 the Company had deferred tax liabilities of $ 61 million primarily related to the tax effect of the estimated foreign exchange impact on unremitted earnings. The Company expects that foreign withholding taxes associated with future repatriation of these earnings will not be material. Earnings of approximately $ 0.6 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax expense would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: 2020 2019 (in millions) Deferred Tax Assets Accrued liabilities $ 324 $ 354 Compensation and benefits 218 214 State taxes and other credits 47 41 Net operating and capital losses 147 119 Unrealized gain/loss - 2015 EUR Notes 58 20 U.S. foreign tax credits 276 145 Intangible assets 182 157 Other items 142 74 Less: Valuation allowance ( 353 ) ( 205 ) Total Deferred Tax Assets 1,041 919 Deferred Tax Liabilities Prepaid expenses and other accruals 78 83 Goodwill and intangible assets 216 187 Property, plant and equipment 183 128 Previously taxed earnings and profits 61 Other items 98 63 Total Deferred Tax Liabilities 636 461 Net Deferred Tax Assets $ 405 $ 458 The valuation allowance balance at December 31, 2020 and 2019 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current and prior periods and certain foreign net operating losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is MASTERCARD 2020 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31, is as follows: 2020 2019 2018 (in millions) Beginning balance $ 203 $ 164 $ 183 Additions: Current year tax positions 19 22 23 Prior year tax positions 192 37 5 Reductions: Prior year tax positions ( 10 ) ( 11 ) ( 17 ) Settlements with tax authorities ( 12 ) ( 2 ) ( 18 ) Expired statute of limitations ( 4 ) ( 7 ) ( 12 ) Ending balance $ 388 $ 203 $ 164 As of December 31, 2020, the amount of unrecognized tax benefit was $ 388 million. This amount, if recognized, would reduce the effective income tax rate. The Companys unrecognized tax benefits increased primarily due to a prior year tax issue resulting from a refund claim filed in 2020. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2020 and 2019, the Company had a net income tax-related interest payable of $ 24 million and $ 13 million, respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2020, 2019 and 2018 was not material. In addition, as of December 31, 2020 and 2019, the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 21. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. 98 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services, resulting in merchants paying excessive costs for the acceptance of Mastercard and Visa credit and debit cards. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $ 237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. In December 2020, the Rules Relief Class filed a motion for class certification. Briefing on summary judgment motions in the Rules Relief Class and opt-out merchant cases was completed in December 2020. MASTERCARD 2020 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2020 and 2019, Mastercard had accrued a liability of $ 783 million and $ 914 million, respectively, as a reserve for both the Damages Class litigation and the opt-out merchant cases. As of December 31, 2020 and 2019, Mastercard had $ 586 million and $ 584 million, respectively, in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. The reserve as of December 31, 2020 for both the Damages Class litigation and the opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $ 5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. All appellate courts have rejected the objectors appeals. In one of the appeals, the objectors have until April 2021 to request an appeal to the Supreme Court of Canada. For the remainder of the appeals, the Supreme Court has previously denied such requests. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The EC issued a decision accepting the settlement in April 2019, with changes to interregional interchange fees going into effect in the fourth quarter of 2019. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but included a fine of 571 million, which was paid in April 2019. Mastercard incurred a charge of $ 654 million in 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) merchants filed claims or threatened litigation against Mastercard seeking damages for merchants allegedly paying excessive costs for the acceptance of Mastercard credit and debit cards arising out of alleged anti-competitive conduct with respect to, among other things, Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $ 4.5 billion as of December 31, 2020). Mastercard has resolved over 2 billion (approximately $ 3 billion as of December 31, 2020) of these damages claims through settlement or judgment. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court heard the appeals of the four merchants and ruled against both Mastercard and Visa on two of the three legal issues being considered. The parties appealed the rulings to the U.K. Supreme Court. In June 2020, the U.K. Supreme Court ruled against Mastercard and Visa with respect to one of the liability issues being considered by the Court related to U.K domestic interchange fees. Additionally, the U.K Supreme Court set out the legal standard that should be applied by lower trial courts with respect to determining whether interchange was exemptible under applicable law, and provided guidance to lower courts with regard to the legal standard that should be applied in assessing merchants damages claims. The U.K. Supreme Court sent one of the four merchant cases back to the trial court for a determination of liability and damages issues and sent the remaining three merchant cases back to the trial court for a determination of damages issues only. A hearing in one of these merchant cases on liability and damages issues is expected to be scheduled for the fourth quarter of 2021, while a trial on damages for the other three merchant claims is not expected to occur until 2023. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $ 237 million in 2018. Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. The majority of these merchant claims 100 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS generally had been stayed pending the decision of the U.K. Supreme Court, and a number of those matters are now progressing with motion practice and discovery. Mastercard incurred charges of $ 22 million in 2020 to reflect both the estimated attorneys fees incurred by the four merchant claimants in the U.K. Supreme Court appeal, as well as settlements with a number of Pan-European merchants. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 19 billion as of December 31, 2020). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. In December 2020, the U.K. Supreme Court rejected Mastercards appeal of this ruling. The case has been sent back to the trial court for a re-hearing on the plaintiffs collective action application in light of the Supreme Court decision. The hearing is scheduled to occur in late March 2021. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims and has opposed class certification. Briefing on class certification is complete. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the district court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the district court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. In August 2020, the district court issued an order granting the plaintiffs request for class certification. In January 2021, the Network Defendants request for permission to appeal the district courts certification decision to the appellate court was denied. The case is proceeding with substantive expert discovery. MASTERCARD 2020 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the district court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. In January 2021, the magistrate judge serving on the district court issued a decision recommending that the district court judge deny plaintiffs class certification motion. The plaintiffs have the opportunity to file objections to this decision with the district court judge. U.S. Federal Trade Commission Investigation In June 2020, the U.S. Federal Trade Commissions Bureau of Competition (FTC) informed Mastercard that it has initiated a formal investigation into compliance with the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In particular, the investigation focuses on Mastercards compliance with the debit routing provisions of the Durbin Amendment. The FTC has issued a subpoena and Mastercard is cooperating with it in the investigation. U.K. Prepaid Cards Matter Mastercard is subject to an ongoing confidential legal matter related to prepaid cards in the U.K. This matter focuses exclusively on historic behavior, and has no prospective impact on Mastercards on-going business. In connection with this matter, in the fourth quarter of 2020, Mastercard recorded a litigation charge of $ 45 million. Note 22. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months prior to period end multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, such as cash, letters of credit, guarantees, or other risk mitigating arrangements. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31: 2020 2019 (in millions) Gross settlement exposure $ 52,360 $ 55,800 Collateral applied to settlement exposure ( 6,021 ) ( 4,772 ) Net uncollateralized settlement exposure $ 46,339 $ 51,028 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 370 million and $ 367 million at December 31, 2020 and 2019, respectively, of which $ 294 million and $ 290 million at December 31, 2020 and 2019, respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements 102 MASTERCARD 2020 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 23. Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances (Cash Flow Hedges). Foreign Exchange Risk Derivatives The Company enters into foreign exchange derivative contracts to manage currency exposure associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currency of the entity. The Company may also enter into foreign exchange derivative contracts to offset possible changes in value due to foreign exchange fluctuations of assets and liabilities. In addition, the Company is subject to foreign exchange risk as part of its daily settlement activities. This risk is typically limited to a few days between when a payment transaction takes place and the subsequent settlement with customers. To manage this risk, the Company enters into short duration foreign exchange derivative contracts based upon anticipated receipts and disbursements for the respective currency position. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. The Companys derivative contracts are summarized below: December 31, 2020 December 31, 2019 Notional Fair Value Notional Fair Value (in millions) Commitments to purchase foreign currency $ 389 $ 17 $ 185 $ 3 Commitments to sell foreign currency 1,110 ( 26 ) 1,506 ( 25 ) Options to sell foreign currency 21 2 Balance sheet location Prepaid expenses and other current assets 1 $ 19 $ 12 Other current liabilities 1 ( 28 ) ( 32 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, 2020 2019 2018 (in millions) Foreign exchange derivative contracts General and administrative $ 40 $ ( 39 ) $ 53 The fair value of the foreign exchange derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign exchange derivative contracts are generally less than 18 months. The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2020 and 2019, as these contracts were not designated as hedging instruments for accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as MASTERCARD 2020 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European operations. As of December 31, 2020, the Company had a net foreign currency transaction loss of $ 175 million after tax, in accumulated other comprehensive income (loss) associated with hedging activity. Interest Rate Risk Cash Flow Hedges During the fourth quarter of 2019, the Company entered into treasury rate locks for a total notional amount of $ 1 billion, which were accounted for as cash flow hedges. These contracts were entered into to hedge a portion of the Companys interest rate exposure attributable to changes in the treasury rates related to the forecasted debt issuance during 2020. The maximum length of time over which the Company had hedged its exposure was 30 years. In connection with the issuance of the 2020 USD Notes, these contracts were settled and the Company paid $ 175 million. As of December 31, 2020, a cumulative loss of $ 133 million, after tax, was recorded in accumulated other comprehensive income (loss) associated with these contracts and will be reclassified as an adjustment to interest expense over the respective terms of the 2020 USD Notes. As of December 31, 2019, the Company recorded a pre-tax net unrealized gain of $ 14 million ($ 11 million, after tax) in accumulated other comprehensive income (loss) associated with these contracts. In 2020, the Company reclassified $ 4 million, pre-tax, of the deferred loss on cash flow derivative contracts recorded in accumulated other comprehensive income (loss) to interest expense on the statement of operations. The Company estimates that $ 6 million, pre-tax, of the deferred loss will be reclassified into interest expense within the next 12 months. Note 24. Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 33 % of total revenue in 2020, 32 % in 2019 and 33 % in 2018. No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2020, 2019 or 2018. The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31: 2020 2019 2018 (in millions) United States $ 1,185 $ 1,147 $ 613 Other countries 717 681 308 Total $ 1,902 $ 1,828 $ 921 104 MASTERCARD 2020 FORM 10-K PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2020 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2020. Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2020 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +2,ma12,019-10xk, Item 1. Business , Item 1A. Risk factors , Item 1B. Unresolved staff comments , Item 2. Properties , Item 3. Legal proceedings ," ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Item 5. Market for registrants common equity, related stockholder matters and issuer purchases of equity securities Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 11, 2020 , we had 68 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 271 holders of record of our non-voting Class B common stock as of February 11, 2020 , constituting approximately 1.1% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 Financials and the SP 500 Index for the five-year period ended December 31, 2019 . The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Comparison of cumulative five-year total return Total returns to stockholders for each of the years presented were as follows: Base period Indexed Returns For the Years Ended December 31, Company/Index Mastercard $ 100.00 $ 113.80 $ 121.67 $ 179.67 $ 225.17 $ 358.38 SP 500 Financials 100.00 98.47 120.92 147.75 128.50 169.78 SP 500 Index 100.00 101.38 113.51 138.29 132.23 173.86 36 MASTERCARD 2019 FORM 10-K PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUES PURCHASES OF Dividend Declaration and Policy On December 3, 2019, our Board of Directors declared a quarterly cash dividend of $0.40 per share paid on February 7, 2020 to holders of record on January 9, 2020 of our Class A common stock and Class B common stock. On February 4, 2020, our Board of Directors declared a quarterly cash dividend of $0.40 per share payable on May 8, 2020 to holders of record on April 9, 2020 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 4, 2018, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $6.5 billion of our Class A common stock (the 2018 Share Repurchase Program). This program became effective in January 2019. On December 3, 2019, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $8.0 billion of our Class A common stock (the 2019 Share Repurchase Program). This program became effective in January 2020. During the fourth quarter of 2019 , we repurchased a total of approximately 3.6 million shares for $994 million at an average price of $275.00 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2019 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,128,776 $ 271.55 2,128,776 $ 719,951,874 November 1 30 1,363,616 278.93 1,363,616 339,605,253 December 1 31 121,837 291.38 121,837 8,304,104,890 Total 3,614,229 275.00 3,614,229 1 Dollar value of shares that may yet be purchased under the 2018 Share Repurchase Program and the 2019 Share Repurchase Program are as of the end of each period presented. MASTERCARD 2019 FORM 10-K 37 PART II "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7. Managements discussion and analysis of financial condition and results of operations The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. For discussion related to the results of operations for the year ended December 31, 2018 compared to the year ended December 31, 2017, please see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by providing a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through our unique and proprietary global payments network, which we refer to as our core network, we switch (authorize, clear and settle) payment transactions and deliver related products and services. We have additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). We also provide integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs and processing. Our payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. Financial Results Overview The following table provides a summary of our key GAAP operating results, as reported: Year ended December 31, 2019 Increase/ (Decrease) 2018 Increase/ (Decrease) ($ in millions, except per share data) Net revenue $ 16,883 $ 14,950 $ 12,497 13% 20% Operating expenses $ 7,219 $ 7,668 $ 5,875 (6)% 31% Operating income $ 9,664 $ 7,282 $ 6,622 33% 10% Operating margin 57.2 % 48.7 % 53.0 % 8.5 ppt (4.3) ppt Income tax expense $ 1,613 $ 1,345 $ 2,607 20% (48)% Effective income tax rate 16.6 % 18.7 % 40.0 % (2.1) ppt (21.3) ppt Net income $ 8,118 $ 5,859 $ 3,915 39% 50% Diluted earnings per share $ 7.94 $ 5.60 $ 3.65 42% 53% Diluted weighted-average shares outstanding 1,022 1,047 1,072 (2)% (2)% MASTERCARD 2019 FORM 10-K 39 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table provides a summary of key non-GAAP operating results 1, 2 , adjusted to exclude the impact of gains and losses on our equity investments, special items (which represent litigation judgments and settlements and certain one-time items) and the related tax impacts on our non-GAAP adjustments. In addition, we have presented growth rates, adjusted for the impact of currency: Year ended December 31, Increase/(Decrease) Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 16,883 $ 14,950 $ 12,497 13% 16% 20% 20% Adjusted operating expenses $ 7,219 $ 6,540 $ 5,693 10% 12% 15% 15% Adjusted operating margin 57.2 % 56.2 % 54.4 % 1.0 ppt 1.3 ppt 1.8 ppt 1.8 ppt Adjusted effective income tax rate 2 17.0 % 18.5 % 26.8 % (1.5) ppt (1.3) ppt (8.3) ppt (8.2) ppt Adjusted net income 2 $ 7,937 $ 6,792 $ 4,906 17% 20% 38% 38% Adjusted diluted earnings per share 2 $ 7.77 $ 6.49 $ 4.58 20% 23% 42% 41% Note: Tables may not sum due to rounding. 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. 2 For 2019 we updated our non-GAAP methodology to exclude the impact of gains and losses on our equity investments. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. Key highlights for 2019 as compared to 2018 were as follows: Net revenue GAAP Non-GAAP (currency-neutral) Net revenue increased 16% on a currency-neutral basis, which included growth of approximately 1 percentage point from acquisitions. The primary drivers of our up 13% up 16% net revenue growth were 1 : - Gross dollar volume growth of 13% on a local currency basis - Cross-border growth of 16% on a local currency basis - Switched transaction growth of 19% - Other revenues growth of 23%, or 24% on a currency-neutral basis. This includes 2 percentage points of growth due to acquisitions. The remaining growth was primarily driven by our Cyber Intelligence and Data Services solutions. - These increases were partially offset by higher rebates and incentives, which increased 18%, or 20% on a currency-neutral basis, primarily due to the impact from new and renewed agreements and increased volumes. 1 The cross-border volume and switched transactions growth rates have been normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. 40 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Operating expenses Adjusted operating expenses GAAP Non-GAAP (currency-neutral) Adjusted operating expenses on a currency-neutral basis included growth of approximately 2 percentage points from acquisitions and 1 percentage point related to the differential in hedging gains and losses versus the year-ago period. The remaining 9 percentage points of growth was primarily related to our continued investment in strategic initiatives. down 6% up 12% Effective income tax rate Adjusted effective income tax rate GAAP Non-GAAP (currency-neutral) Adjusted effective income tax rate of 17.0% primarily attributable to a more favorable geographic mix of earnings and discrete tax benefits including a favorable court ruling in the current period. 16.6% 17.0% Other 2019 financial highlights were as follows: We generated net cash flows from operations of $8.2 billion . We completed the acquisitions of businesses for total consideration of $1.5 billion . We repurchased 26 million shares of our common stock for $6.5 billion and paid dividends of $1.3 billion We completed debt offerings for an aggregate principal amount of $2.8 billion and separately repaid $500 million of principal that matured related to our 2014 USD Notes. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of special items, where applicable, which represent litigation judgments and settlements and certain one-time items, as well as the related tax impacts (Special Items). For 2019, our non-GAAP financial measures also exclude the impact of gains and losses on our equity investments which includes mark-to-market fair value adjustments, impairments and gains and losses upon disposition and the related tax impacts. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. Our non-GAAP financial measures for the comparable periods exclude the impact of the following: Gains and Losses on Equity Investments During 2019 , we recorded net gains of $167 million ( $124 million after tax, or $0.12 per diluted share), primarily related to unrealized fair market value adjustments on marketable and non-marketable equity securities. Special Items Tax act During 2019, we recorded a $57 million net tax benefit ( $0.06 per diluted share) which included a $30 million benefit related to a reduction to the 2017 one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) resulting from final tax regulations issued in 2019 and a $27 million benefit related to additional foreign tax credits which can be carried back under transition rules. During 2018, we recorded a $75 million net tax benefit ( $0.07 per diluted share) which included a $90 million benefit related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense primarily related to an increase to our Transition Tax. During 2017, we recorded additional tax expense of $873 million ( $0.81 per diluted share) which included $825 million of provisional charges attributable to the Transition Tax, the remeasurement of our net deferred tax asset in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million additional tax expense related to a foregone foreign tax credit benefit on 2017 repatriations. Litigation provisions During 2018, we recorded pre-tax charges of $1,128 million ( $1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission MASTERCARD 2019 FORM 10-K 41 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017, we recorded pre-tax charges of $15 million ( $10 million after tax, or $0.01 per diluted share) related to a litigation settlement with Canadian merchants. Venezuela charge During 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries. See Note 1 (Summary of Significant Accounting Policies) , Note 7 (Investments) , Note 20 (Income Taxes) and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these items because management evaluates the underlying operations and performance of the Company separately from these recurring and nonrecurring items. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. In addition, we present growth rates adjusted for the impact of currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of currency-neutral growth rates provides relevant information to facilitate an understanding of our operating results. Net revenue, operating expenses, operating margin, other income (expense), effective income tax rate, net income and diluted earnings per share adjusted for the impact of gains and losses on our equity investments, Special Items and/or the impact of currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. 42 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables reconcile our reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2019 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,219 57.2 % $ 16.6 % $ 8,118 $ 7.94 (Gains) losses on equity investments ** ** (167 ) (0.2 )% (124 ) (0.12 ) Tax act ** ** ** 0.6 % (57 ) (0.06 ) Non-GAAP $ 7,219 57.2 % $ (100 ) 17.0 % $ 7,937 $ 7.77 Year ended December 31, 2018 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % $ (78 ) 18.7 % $ 5,859 $ 5.60 Litigation provisions (1,128 ) 7.5 % ** (1.1 )% 1,008 0.96 Tax act ** ** ** 0.9 % (75 ) (0.07 ) Non-GAAP $ 6,540 56.2 % $ (78 ) 18.5 % $ 6,792 $ 6.49 Year ended December 31, 2017 Operating expenses Operating margin Other income (expense) Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % $ (100 ) 40.0 % $ 3,915 $ 3.65 Tax act ** ** ** (13.4 )% 0.81 Venezuela charge (167 ) 1.3 % ** 0.2 % 0.10 Litigation provisions (15 ) 0.1 % ** % 0.01 Non-GAAP $ 5,693 54.4 % $ (100 ) 26.8 % $ 4,906 $ 4.58 Note: Tables may not sum due to rounding. ** Not applicable MASTERCARD 2019 FORM 10-K 43 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables represent the reconciliation of our growth rates reported under GAAP to our non-GAAP growth rates: Year Ended December 31, 2019 as compared to the Year Ended December 31, 2018 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % (6 )% 8.5 (2.1) ppt % % (Gains) losses on equity investments 1 ** ** ** (0.2) ppt (2 )% (2 )% Tax act ** ** ** (0.3) ppt % % Litigation provisions ** % (7.5) ppt 1.1 ppt (20 )% (21 )% Non-GAAP % % 1.0 ppt (1.5) ppt % % Currency impact 2 % % 0.3 ppt 0.2 ppt % % Non-GAAP - currency-neutral % % 1.3 ppt (1.3) ppt % % Year Ended December 31, 2018 as compared to the Year Ended December 31, 2017 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (4.3) ppt (21.3) ppt % % Litigation provisions ** (19 )% 7.4 ppt (1.0) ppt % % Tax act ** ** ** 14.2 ppt (33 )% (34 )% Venezuela charge ** % (1.3) ppt (0.2) ppt (3 )% (3 )% Non-GAAP % % 1.8 ppt (8.3) ppt % % Currency impact 2 % % 0.1 ppt % % Non-GAAP - currency-neutral % % 1.8 ppt (8.2) ppt % % Note: Tables may not sum due to rounding. ** Not applicable 1 For 2019 we updated our non-GAAP methodology to exclude the impact of gains and losses on our equity investments. Prior year periods were not restated as the impact of the change was immaterial in relation to our non-GAAP results. 2 Represents the currency translational and transactional impact. 44 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Foreign Currency Currency Impact (Translation and Transactional) Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional currency. The impact of the transactional currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2019 , GDV on a U.S. dollar-converted basis increased 9.6% , while GDV on a local currency basis increased 13.0% versus 2018 . In 2018 , GDV on a U.S. dollar-converted basis increased 12.8% , while GDV on a local currency basis increased 13.8% versus 2017 . Further, the impact from transactional currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. The translational and transactional impact of currency (Currency impact) has been identified in our growth impact tables and has been excluded from our currency neutral growth rates, which are non-GAAP financial measures. See Non-GAAP Financial Information for further information on our non-GAAP adjustments. Foreign Exchange Activity We incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses on the consolidated statement of operations. We manage foreign currency balance sheet remeasurement and transactional currency exposure through our foreign exchange risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign exchange derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives immediately in current-period earnings, with the related hedged item being recognized as the exposures materialize. Risk of Currency Devaluation We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in 2017, due to foreign exchange regulations which were restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we transitioned to the cost method of accounting. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in 2017. We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. MASTERCARD 2019 FORM 10-K 45 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial Results Revenue Gross revenue increased 14% , or 17% on a currency-neutral basis in 2019 versus the prior year, primarily due to an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 18% , or 20% on a currency-neutral basis in 2019 versus the prior year, primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 13% , or 16% on a currency-neutral basis in 2019 versus the prior year, including growth of 1 percentage point from our acquisitions. See Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The components of net revenue were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Domestic assessments $ 6,781 $ 6,138 $ 5,130 10% 20% Cross-border volume fees 5,606 4,954 4,174 13% 19% Transaction processing 8,469 7,391 6,188 15% 19% Other revenues 4,124 3,348 2,853 23% 17% Gross revenue 24,980 21,831 18,345 14% 19% Rebates and incentives (contra-revenue) (8,097 ) (6,881 ) (5,848 ) 18% 18% Net revenue $ 16,883 $ 14,950 $ 12,497 13% 20% The following table summarizes the drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Revenue Standard 1 Currency Impact 2 Other 3 Total Domestic assessments 13% 14% % % ** 6% (3)% (1)% % 4 % 4 % % Cross-border volume fees 14% 17% % % ** 1% (3)% 1% % % % % Transaction processing 14% 14% % % ** % (2)% % % % % % Other revenues ** ** 2% 2% ** % (1)% (1)% % 5 % 5 % % Rebates and incentives 9% 10% % % ** (2)% (3)% (1)% % 6 % 6 % % Net revenue 13% 14% 1% 0.5% ** 4% (3)% % % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the impact of our adoption of the revenue guidance in 2018. For a more detailed discussion on the impact of the revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 2 Represents the currency translational and transactional impact. 3 Includes impact from pricing and other non-volume based fees. 4 Includes impact of the allocation of revenue to service deliverables, which are primarily recorded in other revenue when services are performed. 5 Includes impacts from cyber and intelligence fees, data analytics and consulting fees and other payment-related products and services. 6 Includes the impact of new, renewed and expired agreements. 46 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following tables provide a summary of the trend in volume and transaction growth. The cross-border volume and switched transactions growth rates have been normalized to eliminate the effects of differing switching and carryover days between periods. Carryover days are those where transactions and volumes from days where the company does not clear and settle are processed. Additionally, we adjusted the switched transactions growth rate in the prior period for the deconsolidation of our Venezuelan subsidiaries in 2017. For a more detailed discussion of the deconsolidation of our Venezuelan subsidiaries, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. For the Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border volume 1 % % 1 Excludes volume generated by Maestro and Cirrus cards. For the Years Ended December 31, Switched transactions % % No individual country, other than the United States, generated more than 10% of net revenue in any such period. A significant portion of our net revenue is concentrated among our five largest customers. In 2019 , the net revenue from these customers was approximately $3.5 billion , or 21% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses decreased 6% in 2019 versus the prior year. Adjusted operating expenses increased 10% , or 12% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 2 percentage points from acquisitions and 1 percentage point primarily from foreign exchange derivative contracts. The components of operating expenses were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 5,763 $ 5,174 $ 4,653 % % Advertising and marketing % % Depreciation and amortization % % Provision for litigation 1,128 ** ** Total operating expenses 7,219 7,668 5,875 (6 )% % Special Items 1 (1,128 ) (182 ) ** ** Adjusted operating expenses (excluding Special Items 1 ) $ 7,219 $ 6,540 $ 5,693 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts. MASTERCARD 2019 FORM 10-K 47 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the drivers of changes in operating expenses: For the Years Ended December 31, Operational Special Items 2 Acquisitions Revenue Standard 3 Currency Impact 4 Total General and administrative 11% % 1 ** (4 )% % % ** % (2 )% % % % Advertising and marketing 5% (4 )% ** ** % % ** % (2 )% % % % Depreciation and amortization 9% (5 )% ** ** % % ** % (2 )% % % % Provision for litigation ** ** ** ** ** ** ** ** ** ** ** ** Total operating expenses 10% % 1 (16 )% % % % ** % (2 )% % (6 )% % Note: Table may not sum due to rounding. ** Not meaningful 1 Includes a 2 percentage point impact to general and administrative and total operating expenses growth due to contributions made in 2018 to support inclusive growth efforts. Contributions made in 2019 were comparable to the prior year. 2 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts . 3 Represents the impact of our adoption of the revenue guidance in 2018. For a more detailed discussion on the impact of the revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 4 Represents the currency translational and transactional impact. General and Administrative General and administrative expenses increased 11% , or 13% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 2 percentage points from acquisitions and 1 percentage point primarily from foreign exchange derivative contracts. The remaining increase was primarily driven by an increase in personnel to support our continued investment in our strategic initiatives. The components of general and administrative expenses were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Personnel $ 3,537 $ 3,214 $ 2,687 10% 20% Professional fees 19% 6% Data processing and telecommunications 11% 19% Foreign exchange activity 1 (36 ) ** ** Other 1,081 1,019 1,001 6% 2% Total general and administrative expenses 5,763 5,174 4,653 11% 11% Special Items 2 (167 ) ** ** Adjusted general and administrative expenses (excluding Special Items 2 ) $ 5,763 $ 5,174 $ 4,486 11% 15% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 See Non-GAAP Financial Information for further information on our non-GAAP adjustments and the reconciliation to GAAP reported amounts . Advertising and Marketing Advertising and marketing expenses increased 3% , or 5% on a currency-neutral basis in 2019 versus the prior year, primarily due to higher spending on certain sponsorship initiatives. 48 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Depreciation and Amortization Depreciation and amortization expenses increased 14% , or 15% on a currency-neutral basis in 2019 versus the prior year. Current year results include growth of approximately 7 percentage points from acquisitions with the remaining increase primarily driven by amortization of certain intangible assets and depreciation on data center assets. Provision for Litigation Provision for litigation decreased in 2019 versus the prior year as there were no litigation charges in the current year. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) increased in 2019 versus the prior year primarily due to net gains of $167 million which were related to unrealized fair market value adjustments on marketable and non-marketable equity securities in the current period. The components of other income (expense) were as follows: For the Years Ended December 31, Increase (Decrease) ($ in millions) Investment Income $ $ $ (21 )% ** Gains (losses) on equity investments, net ** ** Interest expense (224 ) (186 ) (154 ) % % Other income (expense), net (14 ) (2 ) ** ** Total other income (expense) (78 ) (100 ) ** (22 )% Note: Table may not sum due to rounding. ** Not meaningful Income Taxes The effective income tax rates for the years ended December 31, 2019 and 2018 were 16.6% and 18.7% , respectively. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 , primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019 . These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. The adjusted effective income tax rates for the years ended December 31, 2019 and 2018 were 17.0% and 18.5% , respectively. The adjusted effective income tax rate was lower than the prior year primarily due to a more favorable geographic mix of earnings and discrete tax benefits including a favorable court ruling in 2019. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 7.7 $ 8.4 Unused line of credit 6.0 4.5 1 Investments include available-for-sale securities and held-to-maturity securities. This amount excludes restricted cash and restricted cash equivalents of $2.0 billion and $1.7 billion at December 31, 2019 and 2018 , respectively. MASTERCARD 2019 FORM 10-K 49 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. See Note 22 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors - Legal and Regulatory Risks and Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Net cash provided by operating activities $ 8,183 $ 6,223 $ 5,664 Net cash used in investing activities (1,640 ) (506 ) (1,781 ) Net cash used in financing activities (5,867 ) (4,966 ) (4,764 ) Net cash provided by operating activities increased $2.0 billion in 2019 versus the prior year, primarily due to higher net income as adjusted for non-cash items. Net cash used in investing activities increased $1.1 billion in 2019 versus the prior year, primarily due to acquisitions and purchases of equity investments, partially offset by higher net proceeds from our investments in available-for-sale and held-to-maturity securities. Net cash used in financing activities increased $901 million in 2019 versus the prior year, primarily due to higher repurchases of our Class A common stock, higher dividends paid and the settlement of the contingent consideration attributable to our 2017 acquisitions, partially offset by higher net debt proceeds in the current period. Debt and Credit Availability In May 2019, we issued $1.0 billion principal amount of notes due June 2029 and $1.0 billion principal amount of notes due June 2049 and in December 2019, we issued $750 million principal amount of notes due March 2025. Additionally, during 2019, $500 million of principal related to the 2014 USD Notes matured and was paid. Our total debt outstanding was $8.5 billion at December 31, 2019 , with the earliest maturity of $650 million of principal occurring in November 2021. As of December 31, 2019 , we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $6 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $6 billion revolving credit facility (the Credit Facility) which expires in November 2024. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2019 . See Note 15 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating 50 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: For the Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 1.32 $ 1.00 $ 0.88 Cash dividends paid $ 1,345 $ 1,044 $ On December 4, 2019, our Board of Directors declared a quarterly cash dividend of $0.40 per share paid on February 7, 2020 to holders of record on January 9, 2020 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $403 million . On February 4, 2020, our Board of Directors declared a quarterly cash dividend of $0.40 per share payable on May 8, 2020 to holders of record on April 9, 2020 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $402 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2019 , 2018 and 2017 , our Board of Directors approved share repurchase programs authorizing us to repurchase up to $8.0 billion , $6.5 billion and $4.0 billion , respectively, of our Class A common stock. The program approved in 2019 became effective in January 2020 after completion of the share repurchase program authorized in 2018. The following table summarizes our share repurchase authorizations of our Class A common stock through December 31, 2019 , under the plans approved in 2018 and 2017: (in millions, except per share data) Remaining authorization at December 31, 2018 $ 6,801 Dollar-value of shares repurchased in 2019 $ 6,497 Remaining authorization at December 31, 2019 $ 8,304 Shares repurchased in 2019 26.4 Average price paid per share in 2019 $ 245.89 See Note 16 (Stockholders' Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than the commitments presented in the Future Obligations table that follows. MASTERCARD 2019 FORM 10-K 51 PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Future Obligations The following table summarizes our obligations as of December 31, 2019 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period 2021 - 2022 2023 - 2024 2025 and thereafter Total (in millions) Debt $ $ 1,435 $ 1,000 $ 6,165 $ 8,600 Interest on debt 2,235 3,370 Operating leases 1 Other obligations Sponsorship, licensing and other Employee benefits 2 Transition Tax 3 Redeemable non-controlling interests 4 Total 5 $ $ 2,616 $ 1,926 $ 9,050 $ 14,488 1 Amounts relate to the maturity of our operating lease liabilities. See Note 10 (Property, Equipment and Right-of-Use Assets) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts relate to severance along with expected funding requirements for defined benefit pension and postretirement plans. 3 Amounts relate to the U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 4 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 The table does not include the following: Payment related to a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $3.19 billion as of December 31, 2019 ) as the transaction is subject to regulatory approval and other customary closing conditions. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liability for unrecognized tax benefits of $203 million as of December 31, 2019 . These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated and the timing of these payments will depend on the progress of tax examinations with the various authorities. See Note 20 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Litigation provision of $914 million as of December 31, 2019 as the timing of payments is not fixed and determinable. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Future cash payments that will become due to customers and merchants under business agreements as the amounts due are contingent on future performance. We have accrued $4.8 billion as of December 31, 2019 related to these customer and merchant agreements. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition - Rebates and Incentives We enter into business agreements with certain customers that provide for rebates or support when customers meet certain volume thresholds as well as other support incentives, which are tied to customer performance. We consider various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates primarily when volume- and transaction - based revenues are recognized over the contractual term. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. 52 MASTERCARD 2019 FORM 10-K PART II ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 21 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Business Combinations We account for our business combinations using the acquisition method of accounting. The acquisition purchase price is allocated to the underlying identified, tangible and intangible assets, liabilities assumed and any non-controlling interest in the acquiree, based on their respective estimated fair values on the acquisition date. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. The amounts and useful lives assigned to acquisition-related tangible and intangible assets impact the amount and timing of future amortization expense. We use various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty and multi-period excess earnings for estimating the value of intangible assets. These valuation techniques included comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. Determining the fair value of assets acquired, liabilities assumed, any non-controlling interest in the acquiree and the expected useful lives, requires managements judgment. The significance of managements estimates and assumptions is relative to the size of the acquisition. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. "," Item 7A. Quantitative and qualitative disclosures about market risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management monitors risk exposures on an ongoing basis and establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments to manage these risks. MASTERCARD 2019 FORM 10-K 53 PART II ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign currency and interest rate exposures are managed through our risk management activities, which are discussed further in Note 23 (Derivative and Hedging Instruments) to the consolidated financial statements included in Part II, Item 8. Foreign Exchange Risk We enter into foreign exchange derivative contracts to manage transactional currency exposure associated with anticipated receipts and disbursements occurring in a currency other than the functional currency of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value of assets and liabilities due to foreign exchange fluctuations. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $144 million and $113 million on our foreign exchange derivative contracts outstanding at December 31, 2019 and 2018 , respectively, related to the hedging program. We are also subject to foreign exchange risk as part of our daily settlement activities. To manage this risk, we enter into foreign exchange contracts based upon anticipated receipts and disbursements for the respective currency position. This risk is typically limited to a few days between the timing of when a payment transaction takes place and the subsequent settlement with our customers. Interest Rate Risk During the fourth quarter of 2019, we entered into interest rate derivative contracts that were designated as cash flow hedges in order to manage our exposure to interest rate changes on future forecasted debt issuances. At December 31, 2019 , the total notional amount of these contracts was $1 billion . The maximum length of time over which we have hedged our exposure to the variability in future cash flows is 30 years. The effect of a hypothetical 100 basis point adverse change in interest rates could result in a fair value loss of approximately $168 million on our interest rate derivative contracts outstanding at December 31, 2019 . There were no similar contracts outstanding as of December 31, 2018 . In addition, our available-for-sale debt investments include fixed and variable rate securities that are sensitive to interest rate fluctuations. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. A hypothetical 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2019 and 2018 . 54 MASTERCARD 2019 FORM 10-K PART II "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Item 8. Financial statements and supplementary data Mastercard Incorporated Index to consolidated financial statements Page As of December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 Managements report on internal control over financial reporting Report of independent registered public accounting firm Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to consolidated financial statements MASTERCARD 2019 FORM 10-K 55 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Managements report on internal control over financial reporting The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2019 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. 56 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2019 and 2018 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2019 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. MASTERCARD 2019 FORM 10-K 57 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Revenue Recognition - Rebates and Incentives As described in Notes 1 and 3 to the consolidated financial statements, the Company provides certain customers with rebates or incentives which totaled $8.1 billion for the year ended December 31, 2019. The Company has business agreements with certain customers that provide for rebates or other support when customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction to gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. Management considers various factors in estimating customer performance, including forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. The principal considerations for our determination that performing procedures relating to rebates and incentives is a critical audit matter was the significant judgment of management when developing estimates related to rebates and incentives based on customer performance. This in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating managements estimates related to customer performance and the reasonableness of assumptions related to the forecasted transactions, card issuance and card conversion volumes, expected payments and historical experience with that customer. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer rebates and incentives, including controls over evaluating customer performance based upon historical experience with that customer, forecasted transactions, card issuance and card conversion volumes and expected payments. These procedures also included, among others, evaluating the reasonableness of estimated customer performance for a sample of customer agreements, including (i) evaluating rebate and incentive contracts to identify whether all incentives are identified and recorded accurately; (ii) testing managements process for developing the estimated customer performance, including evaluating the reasonableness of the assumptions related to the forecasted transactions, card issuance and card conversion volumes, expected payments and historical customer experience; and (iii) evaluating the estimated customer performance as compared to actual results in the period the customer reports actual performance. /s/ PricewaterhouseCoopers LLP New York, New York February 14, 2020 We have served as the Companys auditor since 1989. 58 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Operations For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 16,883 $ 14,950 $ 12,497 Operating Expenses General and administrative 5,763 5,174 4,653 Advertising and marketing Depreciation and amortization Provision for litigation 1,128 Total operating expenses 7,219 7,668 5,875 Operating income 9,664 7,282 6,622 Other Income (Expense) Investment income Gains (losses) on equity investments, net Interest expense ( 224 ) ( 186 ) ( 154 ) Other income (expense), net ( 14 ) ( 2 ) Total other income (expense) ( 78 ) ( 100 ) Income before income taxes 9,731 7,204 6,522 Income tax expense 1,613 1,345 2,607 Net Income $ 8,118 $ 5,859 $ 3,915 Basic Earnings per Share $ 7.98 $ 5.63 $ 3.67 Basic weighted-average shares outstanding 1,017 1,041 1,067 Diluted Earnings per Share $ 7.94 $ 5.60 $ 3.65 Diluted weighted-average shares outstanding 1,022 1,047 1,072 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 59 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Comprehensive Income For the Years Ended December 31, (in millions) Net Income $ 8,118 $ 5,859 $ 3,915 Other comprehensive income (loss): Foreign currency translation adjustments ( 319 ) Income tax effect Foreign currency translation adjustments, net of income tax effect ( 279 ) Translation adjustments on net investment hedge ( 236 ) Income tax effect ( 8 ) ( 21 ) Translation adjustments on net investment hedge, net of income tax effect ( 153 ) Cash flow hedges Income tax effect ( 3 ) Cash flow hedges, net of income tax effect Defined benefit pension and other postretirement plans ( 22 ) ( 18 ) Income tax effect ( 1 ) Defined benefit pension and other postretirement plans, net of income tax effect ( 19 ) ( 15 ) Investment securities available-for-sale ( 3 ) ( 3 ) Income tax effect ( 1 ) Investment securities available-for-sale, net of income tax effect ( 2 ) ( 1 ) Other comprehensive income (loss), net of income tax effect ( 221 ) Comprehensive Income $ 8,163 $ 5,638 $ 4,342 The accompanying notes are an integral part of these consolidated financial statements. 60 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet December 31, (in millions, except per share data) Assets Current assets: Cash and cash equivalents $ 6,988 $ 6,682 Restricted cash for litigation settlement Investments 1,696 Accounts receivable 2,514 2,276 Settlement due from customers 2,995 2,452 Restricted security deposits held for customers 1,370 1,080 Prepaid expenses and other current assets 1,763 1,432 Total current assets 16,902 16,171 Property, equipment and right-of-use assets, net 1,828 Deferred income taxes Goodwill 4,021 2,904 Other intangible assets, net 1,417 Other assets 4,525 3,303 Total Assets $ 29,236 $ 24,860 Liabilities, Redeemable Non-controlling Interests and Equity Current liabilities: Accounts payable $ $ Settlement due to customers 2,714 2,189 Restricted security deposits held for customers 1,370 1,080 Accrued litigation 1,591 Accrued expenses 5,489 4,747 Current portion of long-term debt Other current liabilities Total current liabilities 11,904 11,593 Long-term debt 8,527 5,834 Deferred income taxes Other liabilities 2,729 1,877 Total Liabilities 23,245 19,371 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,391 and 1,387 shares issued and 996 and 1,019 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 11 and 12 issued and outstanding, respectively Additional paid-in-capital 4,787 4,580 Class A treasury stock, at cost, 395 and 368 shares, respectively ( 32,205 ) ( 25,750 ) Retained earnings 33,984 27,283 Accumulated other comprehensive income (loss) ( 673 ) ( 718 ) Mastercard Incorporated Stockholders' Equity 5,893 5,395 Non-controlling interests Total Equity 5,917 5,418 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 29,236 $ 24,860 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 61 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2016 $ $ $ 4,183 $ ( 17,021 ) $ 19,418 $ ( 924 ) $ 5,656 $ $ 5,684 Net income 3,915 3,915 3,915 Activity related to non-controlling interests Redeemable non-controlling interest adjustments ( 2 ) ( 2 ) ( 2 ) Other comprehensive income (loss) Dividends ( 967 ) ( 967 ) ( 967 ) Purchases of treasury stock ( 3,747 ) ( 3,747 ) ( 3,747 ) Share-based payments Balance at December 31, 2017 4,365 ( 20,764 ) 22,364 ( 497 ) 5,468 5,497 Adoption of revenue standard Adoption of intra-entity asset transfers standard ( 183 ) ( 183 ) ( 183 ) Net income 5,859 5,859 5,859 Activity related to non-controlling interests ( 6 ) ( 6 ) Redeemable non-controlling interest adjustments ( 3 ) ( 3 ) ( 3 ) Other comprehensive income (loss) ( 221 ) ( 221 ) ( 221 ) Dividends ( 1,120 ) ( 1,120 ) ( 1,120 ) Purchases of treasury stock ( 4,991 ) ( 4,991 ) ( 4,991 ) Share-based payments Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 5,418 62 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Changes in Equity (Continued) Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Mastercard Incorporated Stockholders' Equity Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2018 4,580 ( 25,750 ) 27,283 ( 718 ) 5,395 5,418 Net income 8,118 8,118 8,118 Activity related to non-controlling interests Redeemable non-controlling interest adjustments ( 9 ) ( 9 ) ( 9 ) Other comprehensive income (loss) Dividends ( 1,408 ) ( 1,408 ) ( 1,408 ) Purchases of treasury stock ( 6,463 ) ( 6,463 ) ( 6,463 ) Share-based payments Balance at December 31, 2019 $ $ $ 4,787 $ ( 32,205 ) $ 33,984 $ ( 673 ) $ 5,893 $ $ 5,917 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD 2019 FORM 10-K 63 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Statement of Cash Flows For the Years Ended December 31, (in millions) Operating Activities Net income $ 8,118 $ 5,859 $ 3,915 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,141 1,235 1,001 Depreciation and amortization (Gains) losses on equity investments, net ( 167 ) Share-based compensation Deferred income taxes ( 7 ) ( 244 ) Venezuela charge Other Changes in operating assets and liabilities: Accounts receivable ( 246 ) ( 317 ) ( 445 ) Income taxes receivable ( 202 ) ( 120 ) ( 8 ) Settlement due from customers ( 444 ) ( 1,078 ) ( 281 ) Prepaid expenses ( 1,661 ) ( 1,769 ) ( 1,402 ) Accrued litigation and legal settlements ( 662 ) ( 12 ) Restricted security deposits held for customers ( 6 ) Accounts payable ( 42 ) Settlement due to customers Accrued expenses Long-term taxes payable ( 20 ) Net change in other assets and liabilities ( 261 ) Net cash provided by operating activities 8,183 6,223 5,664 Investing Activities Purchases of investment securities available-for-sale ( 643 ) ( 1,300 ) ( 714 ) Purchases of investments held-to-maturity ( 215 ) ( 509 ) ( 1,145 ) Proceeds from sales of investment securities available-for-sale 1,098 Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property and equipment ( 422 ) ( 330 ) ( 300 ) Capitalized software ( 306 ) ( 174 ) ( 123 ) Purchases of equity investments ( 467 ) ( 91 ) ( 147 ) Acquisition of businesses, net of cash acquired ( 1,440 ) ( 1,175 ) Other investing activities ( 4 ) ( 14 ) ( 1 ) Net cash used in investing activities ( 1,640 ) ( 506 ) ( 1,781 ) Financing Activities Purchases of treasury stock ( 6,497 ) ( 4,933 ) ( 3,762 ) Dividends paid ( 1,345 ) ( 1,044 ) ( 942 ) Proceeds from debt 2,724 Payment of debt ( 500 ) ( 64 ) Contingent consideration paid ( 199 ) Tax withholdings related to share-based payments ( 161 ) ( 80 ) ( 47 ) Cash proceeds from exercise of stock options Other financing activities ( 15 ) ( 4 ) ( 6 ) Net cash used in financing activities ( 5,867 ) ( 4,966 ) ( 4,764 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents ( 44 ) ( 6 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents ( 681 ) Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 8,337 7,592 8,273 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 8,969 $ 8,337 $ 7,592 The accompanying notes are an integral part of these consolidated financial statements. 64 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Notes to consolidated financial statements Note 1 . Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by providing a wide range of payment solutions and services through its family of well-known brands, including Mastercard, Maestro and Cirrus. The Company is a multi-rail network that offers customers one partner to turn to for their domestic and cross-border payment needs. Through its unique and proprietary global payments network, which is referred to as the core network, the Company switches (authorizes, clears and settles) payment transactions and delivers related products and services. Mastercard has additional payment capabilities that include automated clearing house (ACH) transactions (both batch and real-time account-based payments). The Company also provides integrated value-added offerings such as cyber and intelligence products, information and analytics services, consulting, loyalty and reward programs and processing. The Companys payment solutions offer customers choice and flexibility and are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a person or entity who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or measurement alternative method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2019 and 2018 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. The Company consolidates acquisitions as of the date in which the Company has obtained a controlling financial interest. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2019 presentation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. In 2017, due to foreign exchange regulations restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar impacted the Companys ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the measurement alternative method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $ 167 million ( $ 108 million after tax or $ 0.10 per diluted share) that was recorded in general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2017. Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100 % of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2019, 2018 and 2017 , net losses from non-controlling interests were not material and, as a result, amounts are included on the consolidated statement of operations within other income (expense). Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is MASTERCARD 2019 FORM 10-K 65 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue (transaction processing) is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated customer performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed data analytic and consulting services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from data analytic and consulting services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed and any non-controlling interest in the acquiree, at fair value as of the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Measurement period adjustments, if any, to the preliminary estimated fair value of the intangibles assets as of the acquisition date will be recorded in goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years . Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment at the reporting unit level in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a qualitative assessment to determine whether it is more likely than not that goodwill is impaired. The qualitative factors may include, but are not limited to, macroeconomic conditions, industry and market conditions, operating environment, financial performance and other relevant events. If it is determined that it is more likely than not that goodwill is impaired, then the Company is required to perform a quantitative goodwill impairment test. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated 66 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. Loss contingencies are recorded in provision for litigation on the consolidated statement of operations. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with an original maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents which are included in the reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to the settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). MASTERCARD 2019 FORM 10-K 67 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, equipment and right-of-use assets, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. The changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments as available-for-sale or held-to-maturity at the date of acquisition. Available-for-sale debt securities: Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets and the securities that are not available for current operational needs are classified as non-current assets on the consolidated balance sheet. The investments in debt securities are carried at fair value, with unrealized gains and losses, net of tax, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. Held-to-maturity securities: Time deposits - The Company classifies time deposits with original maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets within investments on the consolidated balance sheet while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. 68 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity investments - The Company holds equity securities of publicly traded and privately held companies. Marketable equity securities - Marketable equity securities are strategic investments in publicly traded companies and are measured at fair value using quoted prices in their respective active markets with changes recorded through gain (losses) on equity investments, net on the consolidated statement of operations. Securities that are not for use in current operations are classified in other assets on the consolidated balance sheet. Nonmarketable equity investments - The Companys nonmarketable equity investments, which are reported in other assets on the consolidated balance sheet, include investments in privately held companies without readily determinable market values. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. The Companys nonmarketable equity investments are accounted for under the equity method or measurement alternative method. Equity method - The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20 % and 50 % ownership in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5 % of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense), net on the consolidated statement of operations. Measurement alternative method - The Company accounts for investments in common stock or in-substance common stock under the measurement alternative method of accounting when it does not exercise significant influence, generally when it holds less than 20 % ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5 % and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the measurement alternative method of accounting. Measurement alternative investments are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Fair value adjustments, as well as impairments, are included in gain (losses) on equity investments, net on the consolidated statement of operations. Derivative and hedging instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange and interest rate derivative contracts are included in Level 2 of the Valuation Hierarchy as the fair value of the contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. As the Company does not designate foreign exchange contracts as hedging instruments, realized and unrealized gains and losses from the change in fair value of the contracts are recognized immediately in current-period earnings. The Companys foreign exchange contracts are not entered into for trading or speculative purposes. The Companys derivatives that are designated as hedging instruments are required to meet established accounting criteria. In addition, an effectiveness assessment is required to demonstrate that the derivative is expected to be highly effective at offsetting changes in fair value or cash flows of the underlying exposure both at inception of the hedging relationship and on an ongoing basis. The method of assessing hedge effectiveness and measuring hedge results is formally documented at hedge inception and assessed at least quarterly throughout the designated hedge period. For cash flow hedges, the fair value adjustments are recorded, net of tax, in other comprehensive income (loss). Any gains and losses deferred in other comprehensive income (loss) are then recognized in current-period earnings when earnings are affected by the variability of cash flows of the hedged forecasted transaction. The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. MASTERCARD 2019 FORM 10-K 69 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property, equipment and right-of-use assets - Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of finance leases is included in depreciation and amortization expense on the consolidated statement of operations. Operating lease amortization expense is included in general and administrative expenses on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Right-of-use assets Shorter of life of the asset or lease term The Company determines if a contract is, or contains, a lease at contract inception. The Companys right-of-use (ROU) assets are primarily related to operating leases for office space, automobiles and other equipment. Leases are included in property, equipment and right-of-use assets, other current liabilities and other liabilities on the consolidated balance sheet. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. In addition, ROU assets include initial direct costs incurred by the lessee as well as any lease payments made at or before the commencement date, and exclude lease incentives. As most of the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The incremental borrowing rate is determined by using the rate of interest that the Company would pay to borrow on a collateralized basis an amount equal to the lease payments for a similar term and in a similar economic environment. Lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Leases with a term of one year or less are excluded from ROU assets and liabilities. The Company excludes variable lease payments in measuring ROU assets and lease liabilities, other than those that depend on an index, a rate or are in-substance fixed payments. Lease and nonlease components are generally accounted for separately. When available, consideration is allocated to the separate lease and nonlease components in a lease contract on a relative standalone price basis using observable standalone prices. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded as employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards brand, products and services are recognized in advertising and marketing on the consolidated statement of operations. The timing of recognition is dependent on the type of advertising or marketing expense . Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted- 70 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. The interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to the estimated redemption value. The adjustments to the redemption value are recorded to retained earnings or additional paid-in capital on the consolidated balance sheet. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. Accounting pronouncements adopted Leases - In February 2016, the Financial Accounting Standards Board (the FASB) issued accounting guidance that changed how companies account for and present lease arrangements. This guidance requires companies to recognize lease assets and liabilities for both finance and operating leases on the consolidated balance sheet. The Company adopted this guidance effective January 1, 2019, under the modified retrospective transition method with the available practical expedients. The following table summarizes the impact of the changes made to the January 1, 2019 consolidated balance sheet for the adoption of the new accounting standard pertaining to leases. The prior periods have not been restated and have been reported under the accounting standard in effect for those periods. Balance at December 31, 2018 Impact of lease standard Balance at January 1, 2019 (in millions) Assets Property, equipment and right-of-use assets, net $ $ $ 1,296 Liabilities Other current liabilities 1,021 Other liabilities 1,877 2,180 For a more detailed discussion on lease arrangements, refer to Note 10 (Property, Equipment and Right-of-Use Assets) . Comprehensive income - In February 2018, the FASB issued accounting guidance that allows for a one-time reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from U.S. tax reform. The Company adopted this guidance effective January 1, 2019, electing to retain the stranded tax effects in accumulated other comprehensive income (loss). The adoption did not result in a material impact on the Companys consolidated financial statements. MASTERCARD 2019 FORM 10-K 71 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted this guidance effective January 1, 2018 under the modified retrospective transition method, applying the standard to contracts not completed as of January 1, 2018 and considered the aggregate amount of modifications. This revenue guidance impacts the timing of certain customer incentives recognized in the Companys consolidated statement of operations, as they are recognized over the life of the contract. Previously, such incentives were recognized when earned by the customer. This revenue guidance also impacts the Companys accounting recognition for certain market development fund contributions and expenditures. Historically, these items were recorded on a net basis in net revenue and will now be recognized on a gross basis, resulting in an increase to both revenues and expenses. The following tables summarize the impact of the revenue standard on the Companys consolidated statement of operations and consolidated balance sheet: Year Ended December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Net Revenue $ 14,471 $ $ 14,950 Operating Expenses Advertising and marketing Income before income taxes 6,889 7,204 Income tax expense 1,278 1,345 Net Income 5,611 5,859 December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Assets Accounts receivable $ 2,214 $ $ 2,276 Prepaid expenses and other current assets 1,176 1,432 Deferred income taxes ( 96 ) Other assets 2,388 3,303 Liabilities Accounts payable ( 422 ) Accrued expenses 4,375 4,747 Other current liabilities 1,085 ( 136 ) Other liabilities 1,145 1,877 Equity Retained earnings 26,692 27,283 For a more detailed discussion on revenue recognition, refer to Note 3 (Revenue) . Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies are required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. 72 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cumulative effect of the 2018 adopted accounting pronouncements The following table summarizes the cumulative impact of the changes made to the January 1, 2018 consolidated balance sheet for the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers. The prior periods have not been restated and have been reported under the accounting standards in effect for those periods. Balance at December 31, 2017 Impact of revenue standard Impact of intra-entity asset transfers standard Balance at January 1, 2018 (in millions) Assets Accounts receivable $ 1,969 $ $ $ 2,013 Prepaid expenses and other current assets 1,040 ( 17 ) 1,204 Deferred income taxes ( 69 ) Other assets 2,298 ( 352 ) 2,636 Liabilities Accounts payable ( 495 ) Accrued expenses 3,931 4,322 Other current liabilities ( 44 ) Other liabilities 1,438 2,066 Equity Retained earnings 22,364 ( 183 ) 22,547 Accounting pronouncements not yet adopted Implementation costs incurred in a hosting arrangement that is a service contract - In August 2018, the FASB issued accounting guidance which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for periods beginning after December 15, 2019. Companies are required to adopt this guidance either retrospectively or by prospectively applying the guidance to all implementation costs incurred after the date of adoption. The Company will adopt this guidance effective January 1, 2020 by applying the prospective approach as of the date of adoption and this guidance will not have a material impact on its consolidated financial statements. Disclosure requirements for fair value measurement - In August 2018, the FASB issued accounting guidance which modifies disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for periods beginning after December 15, 2019. Companies are required to adopt the guidance for certain added disclosures prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption and all other amendments retrospectively to all periods presented upon their effective date. The Company will adopt this guidance effective January 1, 2020 and the impact will not be material. Note 2 . Acquisitions In 2019 and 2017 , the Company acquired several businesses in separate transactions for total consideration of $ 1.5 billion in each year, representing both cash and contingent consideration. There were no acquisitions in 2018 . These acquisitions align with the Companys strategy to grow, diversify and build the Companys business. Refer to Note 1 (Summary of Significant Accounting Policies) for the valuation techniques Mastercard utilizes to fair value the respective components of business combinations. The residual value allocated to goodwill is primarily attributable to the synergies expected to arise after the acquisition date and a portion of the goodwill is expected to be deductible for tax purposes. MASTERCARD 2019 FORM 10-K 73 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company is evaluating and finalizing the purchase accounting for businesses acquired during 2019 . In 2018 , the Company finalized the purchase accounting for businesses acquired during 2017 . The preliminary estimated and final fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below for 2019 and 2017 , respectively. There were no acquisitions in 2018. (in millions) Assets: Cash and cash equivalents $ $ Other current assets Other intangible assets Goodwill 1,076 1,135 Other assets Total assets 1,716 1,935 Liabilities: Other current liabilities Deferred income taxes Other liabilities Total liabilities Net assets acquired $ 1,511 $ 1,571 The following table summarizes the identified intangible assets acquired for 2019 and 2017: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (in years) Developed technologies $ $ 7.7 7.5 Customer relationships 12.6 9.9 Other 5.0 1.4 Other intangible assets $ $ 9.7 8.3 Pro forma information related to the acquisitions was not included because the impact on the Company's consolidated results of operations was not considered to be material. The businesses acquired in 2019 were not individually significant to Mastercard. For the businesses acquired in 2017, the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4 % controlling interest in Vocalink for cash consideration of 719 million ( $ 929 million ). In addition, the Vocalink sellers earned additional contingent consideration of 169 million ( $ 219 million ) upon meeting 2018 revenue targets in accordance with terms of the purchase agreement. Refer to Note 8 (Fair Value Measurements) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6 % ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $ 76 million as of December 31, 2019 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. 74 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Pending Acquisition In August 2019, Mastercard entered into a definitive agreement to acquire the majority of the Corporate Services business of Nets Denmark A/S, for 2.85 billion (approximately $ 3.19 billion as of December 31, 2019 ) after adjusting for cash and certain other liabilities at closing. The pending acquisition primarily comprises the clearing and instant payment services, and e-billing solutions of Nets Denmark A/Ss Corporate Services business. While the Company anticipates completing the acquisition in the first half of 2020, the transaction is subject to regulatory approval and other customary closing conditions. Note 3 . Revenue Mastercards business model involves four participants in addition to the Company: account holders, issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is primarily generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the products that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. In addition, the Company recognizes revenue from other payment-related products and services in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the merchant country and the country of issuance are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile-initiated transactions; and safety and security. MASTERCARD 2019 FORM 10-K 75 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other revenues consist of value-added service offerings that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Data analytics and consulting fees. Cyber and intelligence fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Batch and real-time account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of gross revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The Companys disaggregated net revenue by source and geographic region were as follows for the years ended December 31 : (in millions) Revenue by source: Domestic assessments $ 6,781 $ 6,138 Cross-border volume fees 5,606 4,954 Transaction processing 8,469 7,391 Other revenues 4,124 3,348 Gross revenue 24,980 21,831 Rebates and incentives (contra-revenue) ( 8,097 ) ( 6,881 ) Net revenue $ 16,883 $ 14,950 Net revenue by geographic region: North American Markets $ 5,843 $ 5,312 International Markets 10,869 9,514 Other 1 Net revenue $ 16,883 $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $ 2.3 billion and $ 2.1 billion as of December 31, 2019 and 2018 , respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are generally billed weekly, however the frequency is dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not typically offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2019 in the amounts of $ 48 million and $ 152 million , respectively. The comparable amounts included in prepaid expenses and other current assets and other assets at December 31, 2018 were $ 40 million and $ 92 million , respectively. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2019 in the amounts of $ 238 million and $ 106 million , respectively. The comparable amounts included in other current liabilities and other 76 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS liabilities at December 31, 2018 were $ 218 million and $ 101 million , respectively. In 2019 and 2018 , revenue recognized from the satisfaction of such performance obligations was $ 904 million in each year. The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years ). As a payment network service provider, the Company provides its customers with continuous access to its global payment processing network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable as the Company generates revenues from assessing its customers based on the GDV of activity on the products that carry the Companys brands. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues from other value-added services comprised of both batch and real-time account-based payment services, consulting fees, loyalty programs and other payment-related products and services. At December 31, 2019 , the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value-added services is $ 1.3 billion , which is expected to be recognized through 2022. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. Note 4 . Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 8,118 $ 5,859 $ 3,915 Denominator Basic weighted-average shares outstanding 1,017 1,041 1,067 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,022 1,047 1,072 Earnings per Share Basic $ 7.98 $ 5.63 $ 3.67 Diluted $ 7.94 $ 5.60 $ 3.65 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5 . Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows for the years ended December 31 : (in millions) Cash and cash equivalents $ 6,988 $ 6,682 $ 5,933 $ 6,721 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement Restricted security deposits held for customers 1,370 1,080 1,085 Prepaid expenses and other current assets Other assets Cash, cash equivalents, restricted cash and restricted cash equivalents $ 8,969 $ 8,337 $ 7,592 $ 8,273 MASTERCARD 2019 FORM 10-K 77 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6 . Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31 : (in millions) Cash paid for income taxes, net of refunds $ 1,644 $ 1,790 $ 1,893 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Accrued property, equipment and right-of-use assets Fair value of assets acquired, net of cash acquired 1,662 1,825 Fair value of liabilities assumed related to acquisitions Note 7 . Investments The Companys investments on the consolidated balance sheet include both available-for-sale and held-to-maturity securities (see Investments section below). The Company classifies its investments in equity securities of publicly traded and privately held companies within other assets on the consolidated balance sheet (see Equity Investments section below). Investments Investments on the consolidated balance sheet consisted of the following at December 31 : (in millions) Available-for-sale securities $ $ 1,432 Held-to-maturity securities Total investments $ $ 1,696 Available-for-Sale Securities The major classes of the Companys available-for-sale investment securities and their respective amortized cost basis and fair values were as follows: December 31, 2019 December 31, 2018 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,044 ( 2 ) 1,043 Asset-backed securities Total $ $ $ $ $ 1,433 $ $ ( 2 ) $ 1,432 The Companys available-for-sale investment securities held at December 31, 2019 and 2018 , primarily carried a credit rating of A- or better with unrealized gains and losses recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income. The municipal securities are comprised of state tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. 78 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2019 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years Total $ $ Investment income on the consolidated statement of operations primarily consists of interest income generated from cash, cash equivalents, time deposits, and realized gains and losses on the Companys debt securities. The realized gains and losses from the sale of available-for-sale securities for 2019 , 2018 and 2017 were not significant. Held-to-Maturity Securities The Company classifies time deposits with maturities greater than three months but less than one year as held-to-maturity. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. The cost of these securities approximates fair value. Equity Investments Included in other assets on the consolidated balance sheet are equity investments with readily determinable fair values (Marketable securities) and equity investments without readily determinable fair values (Nonmarketable securities). Marketable securities are publicly traded companies and are measured using unadjusted quoted prices in their respective active markets. Nonmarketable securities that do not qualify for equity method accounting are measured at cost, less any impairment and adjusted for changes resulting from observable price changes in orderly transactions for the identical or similar investments of the same issuer (measurement alternative). The following table is a summary of the activity related to the Companys equity investments: Balance at December 31, 2018 Purchases (Sales), net 1 Changes in Fair Value 2 Balance at December 31, 2019 (in millions) Marketable securities $ $ $ $ Nonmarketable securities Total equity investments $ $ $ $ 1 Includes impact of balance sheet foreign currency translation 2 Recorded in gains (losses) on equity investments, net on the consolidated statement of operations At December 31, 2019 , the total carrying value of Nonmarketable securities included $ 317 million of measurement alternative investments and $ 118 million of equity method investments. At December 31, 2018 , the total carrying value of Nonmarketable securities included $ 232 million of measurement alternative investments and $ 105 million of equity method investments. Note 8 . Fair Value Measurements The Company classifies its fair value measurements of financial instruments into a three-level hierarchy within the Valuation Hierarchy. Financial instruments are categorized for fair value measurement purposes as recurring or non-recurring in nature. There were no transfers made among the three levels in the Valuation Hierarchy for 2019 and 2018 . MASTERCARD 2019 FORM 10-K 79 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Recurring Measurements The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2019 December 31, 2018 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,043 1,043 Asset-backed securities Derivative instruments 2 : Foreign exchange contracts Interest rate contracts Marketable securities 3 : Equity securities Deferred compensation plan 4 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign exchange derivative liabilities $ $ ( 32 ) $ $ ( 32 ) $ $ ( 6 ) $ $ ( 6 ) Deferred compensation plan 5 : Deferred compensation liabilities ( 67 ) ( 67 ) ( 54 ) ( 54 ) 1 The Companys U.S. government securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign exchange and interest rate derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 23 (Derivative and Hedging Instruments) for further details. 3 The Companys Marketable securities are publicly held and classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices in their respective active markets. 4 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 5 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet . 80 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Financial Instruments - Non-Recurring Measurements Nonmarketable Securities The Companys Nonmarketable securities are recorded at fair value on a non-recurring basis in periods after initial recognition under the equity method or measurement alternative method. Nonmarketable securities are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity and unobservable inputs used to measure fair value that require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its Nonmarketable securities when certain events or circumstances indicate that impairment may exist. See Note 7 (Investments) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2019 , the carrying value and fair value of total long-term debt (including the current portion) was $ 8.5 billion and $ 9.2 billion , respectively. At December 31, 2018 , the carrying value and fair value of long-term debt (including the current portion) was $ 6.3 billion and $ 6.5 billion , respectively. See Note 15 (Debt) for further details. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost or amortized cost basis, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Contingent Consideration The contingent consideration attributable to acquisitions made in 2017 was primarily based on the achievement of 2018 revenue targets and was measured at fair value on a recurring basis. This contingent consideration liability of $ 219 million was included in other current liabilities on the consolidated balance sheet at December 31, 2018 . This liability was classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices and unobservable inputs used to measure fair value that require managements judgment. During 2019, the Company paid $ 219 million to settle the contingent consideration . Note 9 . Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,763 $ 1,432 Other assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 2,838 $ 2,458 Equity investments Income taxes receivable Other Total other assets $ 4,525 $ 3,303 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. See Note 7 (Investments) for further information on the Companys equity investments. MASTERCARD 2019 FORM 10-K 81 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10 . Property, Equipment and Right-of-Use Assets Property, equipment and right-of-use assets consisted of the following at December 31 : (in millions) Building, building equipment and land $ $ Equipment 1,218 Furniture and fixtures Leasehold improvements Operating lease right-of-use assets Property, equipment and right-of-use assets 2,928 1,768 Less accumulated depreciation and amortization ( 1,100 ) ( 847 ) Property, equipment and right-of-use assets, net $ 1,828 $ Depreciation and amortization expense for the above property, equipment and right-of-use assets was $ 336 million , $ 209 million and $ 185 million for 2019 , 2018 and 2017 , respectively. The increase in property, equipment and right-of-use assets at December 31, 2019 from December 31, 2018 was primarily due to the impact from the adoption of the new accounting standard pertaining to lease arrangements as of January 1, 2019 as well as leases that commenced in 2019 . See Note 1 (Summary of Significant Accounting Policies) for additional information of the accounting policy under the new leasing standard. Operating lease ROU assets and operating lease liabilities are recorded on the consolidated balance sheet as follows: December 31, 2019 (in millions) Balance sheet location Property, equipment and right-of-use assets, net $ Other current liabilities Other liabilities Operating lease amortization expense for 2019 was $ 99 million . As of December 31, 2019 , weighted-average remaining lease term of operating leases was 9.5 years and weighted-average discount rate for operating leases was 2.9 % . The following table summarizes the maturity of the Companys operating lease liabilities at December 31, 2019 based on lease term: Operating Leases (in millions) $ 2021 2022 2023 2024 Thereafter Total operating lease payments Less: Interest ( 111 ) Present value of operating lease liabilities $ As of December 31, 2019 , the Company has entered into additional operating leases as a lessee, primarily for real estate. These leases have not yet commenced and will result in ROU assets and corresponding lease liabilities of approximately $ 23 million . These operating leases are expected to commence in fiscal year 2020, with lease terms between one and ten years. 82 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following disclosures relate to periods prior to adoption of the new lease accounting standard, including those operating leases entered into during 2018, but not yet commenced: At December 31, 2018, the Company had the following future minimum payments due under noncancelable leases: Operating Leases (in millions) $ 2020 2021 2022 2023 Thereafter Total $ Consolidated rental expense for the Companys leased office space was $ 94 million and $ 77 million for 2018 and 2017 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $ 20 million and $ 22 million for 2018 and 2017 , respectively. Note 11 . Goodwill The changes in the carrying amount of goodwill for the years ended December 31 were as follows: (in millions) Beginning balance $ 2,904 $ 3,035 Additions 1,076 Foreign currency translation ( 133 ) Ending balance $ 4,021 $ 2,904 The Company performed its annual qualitative assessment of goodwill during the fourth quarter of 2019 and determined a quantitative assessment was not necessary. The Company concluded that goodwill was not impaired and had no accumulated impairment losses at December 31, 2019 . Note 12 . Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31 : Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 1,884 $ ( 988 ) $ $ 1,514 $ ( 898 ) $ Customer relationships ( 264 ) ( 232 ) Other ( 44 ) ( 45 ) Total 2,549 ( 1,296 ) 1,253 1,999 ( 1,175 ) Indefinite-lived intangible assets Customer relationships Total $ 2,713 $ ( 1,296 ) $ 1,417 $ 2,166 $ ( 1,175 ) $ The increase in the gross carrying amount of amortized intangible assets in 2019 was primarily related to the businesses acquired in 2019. See Note 2 (Acquisitions) for further details. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2019 , it was determined that the Companys indefinite-lived intangible assets were not impaired. MASTERCARD 2019 FORM 10-K 83 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amortization on the assets above amounted to $ 285 million , $ 250 million and $ 252 million in 2019, 2018 and 2017 , respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2019 for the years ending December 31 : (in millions) $ 2021 2022 2023 2024 and thereafter $ 1,253 Note 13 . Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 3,892 $ 3,275 Personnel costs Income and other taxes Other Total accrued expenses $ 5,489 $ 4,747 Customer and merchant incentives represent amounts to be paid to customers under business agreements. As of December 31, 2019 and 2018 , the Companys provision for litigation was $ 914 million and $ 1,591 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 21 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 14 . Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $ 127 million , $ 98 million and $ 84 million in 2019, 2018 and 2017 , respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. Additionally, Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $ 19 million as of December 31, 2019 ) annually until September 2022. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). 84 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Service cost Interest cost Actuarial (gain) loss ( 7 ) ( 2 ) Benefits paid ( 15 ) ( 22 ) ( 5 ) ( 5 ) Transfers in Foreign currency translation ( 23 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Actual (loss) gain on plan assets ( 8 ) Employer contributions Benefits paid ( 15 ) ( 23 ) ( 5 ) ( 5 ) Transfers in Foreign currency translation ( 21 ) Fair value of plan assets at end of year Funded status at end of year $ ( 13 ) $ ( 28 ) $ ( 64 ) $ ( 57 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term ( 3 ) ( 3 ) Other liabilities, long-term ( 13 ) ( 28 ) ( 61 ) ( 54 ) $ ( 13 ) $ ( 28 ) $ ( 64 ) $ ( 57 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ $ ( 5 ) $ $ ( 7 ) Prior service credit ( 5 ) ( 6 ) Balance at end of year $ $ ( 4 ) $ ( 3 ) $ ( 13 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 0.70 % 1.80 % * * Vocalink Plan 2.00 % 3.10 % * * Postretirement Plan * * 3.25 % 4.25 % Rate of compensation increase Non-U.S. Plans 1.50 % 2.60 % * * Vocalink Plan 2.50 % 4.00 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD 2019 FORM 10-K 85 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS All of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2019 and 2018 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets For the year ended December 31, 2019 , the Companys projected benefit obligation related to its Pension Plans increased $ 93 million primarily attributable to actuarial losses related to lower discount rate assumptions. For the year ended December 31, 2018 , the Companys projected benefit obligation related to its Pension Plans decreased $ 30 million primarily attributable to foreign currency translation and benefits paid. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets ( 18 ) ( 20 ) ( 13 ) Amortization of actuarial loss Amortization of prior service credit ( 1 ) ( 2 ) ( 2 ) Net periodic benefit cost $ $ $ $ $ $ The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Current year actuarial loss (gain) $ $ $ ( 22 ) $ $ ( 2 ) $ Current year prior service credit Amortization of prior service credit Total other comprehensive loss (income) $ $ $ ( 22 ) $ $ $ Total net periodic benefit cost and other comprehensive loss (income) $ $ $ ( 18 ) $ $ $ 86 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.80 % 1.80 % 1.60 % * * * Vocalink Plan 2.00 % 2.80 % 2.50 % * * * Postretirement Plan * * * 4.25 % 3.50 % 4.00 % Expected return on plan assets Non-U.S. Plans 2.10 % 3.00 % 3.25 % * * * Vocalink Plan 3.75 % 4.75 % 4.75 % * * * Rate of compensation increase Non-U.S. Plans 1.50 % 2.60 % 2.59 % * * * Vocalink Plan 2.50 % 3.85 % 3.95 % * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: Health care cost trend rate assumed for next year 6.00 % 6.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed within the following target asset allocations: fixed income 36 % , U.K. government securities 25 % , equity 25 % , real estate 9 % and cash and cash equivalents 5 % . For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. MASTERCARD 2019 FORM 10-K 87 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value: December 31, 2019 December 31, 2018 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents 1 $ $ $ $ $ $ $ $ Government and agency securities 2 Mutual funds 3 Insurance contracts 4 Asset-backed securities 5 Other 6 Total $ $ $ $ $ $ $ $ Investments at Net Asset Value (NAV) 7 Mutual funds Other Total Plan Assets $ $ 1 Cash and cash equivalents are valued at quoted market prices, which represent the net asset value of the shares held by the Plans. 2 Governmental and agency securities are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 3 Certain mutual funds are valued at quoted market prices, which represent the value of the shares held by the Plans, and are therefore included in Level 1. Certain other mutual funds are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 4 Insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors. 5 Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. These assets were sold during 2019. 6 Other represents hedge fund pooled vehicles which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2. 7 Mutual funds (comprised primarily of credit investments) and other investments (comprised primarily of real estate investments) are valued using the NAV provided by the administrator as a practical expedient, and therefore these investments are not included in the valuation hierarchy. These investments have quarterly redemption frequencies with redemption notice periods ranging from 60 to 90 days. The following table summarizes expected benefit payments (as of December 31, 2019 ) through 2029 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2021 2022 2023 2024 2025 - 2029 88 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15 . Debt Long-term debt consisted of the following at December 31 : Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2019 USD Notes May 2019 Semi-annually $ 1,000 2.950 % 3.030 % $ 1,000 $ 1,000 3.650 % 3.689 % 1,000 December 2019 Semi-annually 2.000 % 2.147 % $ $ 2,750 2018 USD Notes February 2018 Semi-annually $ 3.500 % 3.598 % 3.950 % 3.990 % $ 1,000 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 8,600 6,389 Less: Unamortized discount and debt issuance costs ( 73 ) ( 55 ) Total debt outstanding $ 8,527 $ 6,334 Less: Current portion 1 ( 500 ) Long-term debt $ 8,527 $ 5,834 1 Relates to the 2014 USD Notes, which was classified in current liabilities as of December 31, 2018 , matured and was paid during 2019 In May 2019, the Company issued $ 1 billion principal amount of notes due June 2029 and $ 1 billion principal amount of notes due June 2049 and in December 2019, the Company issued $ 750 million principal amount of notes due March 2025 (collectively the 2019 USD Notes). The net proceeds from the issuance of the 2019 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $ 2.724 billion . The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2018 USD Notes were $ 991 million . MASTERCARD 2019 FORM 10-K 89 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2019 are summarized below. (in millions) $ 2022 2023 1,000 Thereafter 6,165 Total $ 8,600 On November 14, 2019, the Company increased its commercial paper program (the Commercial Paper Program) from $ 4.5 billion to $ 6 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $ 6 billion revolving credit facility (the Credit Facility) on November 14, 2019. The Credit Facility, which expires on November 14, 2024, amended and restated the Companys prior $ 4.5 billion credit facility which was set to expire on November 15, 2023. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, affirmative and negative covenants, events of default and indemnification provisions. The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2019 and 2018 . Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2019 and 2018 . Note 16 . Stockholders' Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $ 0.0001 3,000 One vote per share Dividend rights B $ 0.0001 1,200 Non-voting Dividend rights Preferred $ 0.0001 No shares issued or outstanding at December 31, 2019 and 2018. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. 90 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Dividends The Company declared a quarterly cash dividend on its Class A and Class B Common Stock during each of the four quarters of 2019 , 2018 and 2017 . For the years ended December 31, 2019, 2018 and 2017 , the Company declared total per share dividends of $ 1.39 , $ 1.08 , and $ 0.91 , respectively, resulting in total annual dividends of $ 1,408 million , $ 1,120 million and $ 967 million , respectively. Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 87.8 % 88.8 % 88.0 % 89.0 % Principal or Affiliate Customers (Class B stockholders) 1.1 % % 1.1 % % Mastercard Foundation (Class A stockholders) 11.1 % 11.2 % 10.9 % 11.0 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5 % of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. MASTERCARD 2019 FORM 10-K 91 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2019 , as well as historical purchases: Board authorization dates December 2019 December 2018 December 2017 December 2016 December Date program became effective January 2020 January 2019 March 2018 April 2017 February 2016 Total (in millions, except average price data) Board authorization $ 8,000 $ 6,500 $ 4,000 $ 4,000 $ 4,000 $ 26,500 Dollar-value of shares repurchased in 2017 $ $ $ $ 2,766 $ $ 3,762 Remaining authorization at December 31, 2017 $ $ $ 4,000 $ 1,234 $ $ 5,234 Dollar-value of shares repurchased in 2018 $ $ $ 3,699 $ 1,234 $ $ 4,933 Remaining authorization at December 31, 2018 $ $ 6,500 $ $ $ $ 6,801 Dollar-value of shares repurchased in 2019 $ $ 6,196 $ $ $ $ 6,497 Remaining authorization at December 31, 2019 $ 8,000 $ $ $ $ $ 8,304 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ $ $ 131.97 $ 109.16 $ 125.05 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ $ 194.77 $ 171.11 $ $ 188.26 Shares repurchased in 2019 24.8 1.6 26.4 Average price paid per share in 2019 $ $ 249.58 $ 188.38 $ $ $ 245.89 Cumulative shares repurchased through December 31, 2019 24.8 20.6 28.2 40.4 114.0 Cumulative average price paid per share $ $ 249.58 $ 194.27 $ 141.99 $ 99.10 $ 159.68 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock ( 30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 ( 5.2 ) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock ( 26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 ( 2.3 ) Balance at December 31, 2018 1,018.6 11.8 Purchases of treasury stock ( 26.4 ) Share-based payments 3.2 Conversion of Class B to Class A common stock 0.6 ( 0.6 ) Balance at December 31, 2019 996.0 11.2 92 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 17 . Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2019 and 2018 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge 2 Cash Flow Hedges 3 Defined Benefit Pension and Other Postretirement Plans 4 Investment Securities Available-for-Sale 5 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2017 $ ( 382 ) $ ( 141 ) $ $ $ $ ( 497 ) Other comprehensive income (loss) ( 279 ) ( 15 ) ( 2 ) ( 221 ) Balance at December 31, 2018 ( 661 ) ( 66 ) ( 1 ) ( 718 ) Other comprehensive income (loss) ( 19 ) Balance at December 31, 2019 $ ( 638 ) $ ( 38 ) $ $ ( 9 ) $ $ ( 673 ) 1 During 2018, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the depreciation of the euro, British pound and Brazilian real. During 2019, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the British pound partially offset by the depreciation of the euro. 2 The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. Changes in the value of the debt are recorded in accumulated other comprehensive income (loss). During 2018 and 2019, the decreases in the accumulated other comprehensive loss related to the net investment hedge were driven by the depreciation of the euro. See Note 23 (Derivative and Hedging Instruments) for additional information. 3 In 2019, the Company entered into treasury rate locks which are accounted for as cash flow hedges. During 2019, in connection with these cash flow hedges, the Company recorded unrealized gains, net of tax, of $ 11 million in accumulated other comprehensive income (loss). See Note 23 (Derivative and Hedging Instruments) for additional information. 4 During 2018, the decrease in the accumulated other comprehensive gain related to the Companys Plans was driven primarily by an actuarial loss within the Vocalink Plan. During 2019, the decrease in the accumulated other comprehensive gain related to the Companys Plans was primarily driven by actuarial losses within the Vocalink and non-U.S. Plans. During 2018 and 2019, amounts reclassified from accumulated other comprehensive income (loss) to earnings, were not material. See Note 14 (Pension, Postretirement and Savings Plans) for additional information. 5 During 2018 and 2019, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not material. See Note 7 (Investments) for additional information. Note 18 . Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Company uses the straight-line method of attribution for expensing all equity awards. Compensation expense is recorded net of estimated forfeitures, with estimates adjusted as appropriate. There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. MASTERCARD 2019 FORM 10-K 93 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock Options Stock Options expire ten years from the date of grant and vest ratably over four years . For Options granted, a participants unvested awards are forfeited upon termination. However, in the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense continues to be recognized over the vesting period as stated in the LTIP. The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31 : Risk-free rate of return 2.6 % 2.7 % 2.0 % Expected term (in years) 6.00 6.00 5.00 Expected volatility 19.6 % 19.7 % 19.3 % Expected dividend yield 0.6 % 0.6 % 0.8 % Weighted-average fair value per Option granted $ 53.09 $ 40.90 $ 21.23 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2019 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2019 7.6 $ Granted 0.9 $ Exercised ( 1.8 ) $ Forfeited/expired ( 0.1 ) $ Outstanding at December 31, 2019 6.6 $ 6.2 $ 1,206 Exercisable at December 31, 2019 3.9 $ 5.1 $ Options vested and expected to vest at December 31, 2019 6.6 $ 6.2 $ 1,200 As of December 31, 2019 , there was $ 34 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.3 years . Restricted and Performance Stock Units RSUs and PSUs generally vest after three years . For all RSUs and PSUs granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all RSUs and PSUs granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). 94 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the Companys RSU activity for the year ended December 31, 2019 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2019 3.7 $ Granted 1.0 $ Converted ( 1.6 ) $ Forfeited ( 0.2 ) $ Outstanding at December 31, 2019 2.9 $ $ RSUs expected to vest at December 31, 2019 2.8 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2019 , there was $ 180 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . The following table summarizes the Companys PSU activity for the year ended December 31, 2019 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2019 0.6 $ Granted 0.1 $ Converted ( 0.4 ) $ Other 1 0.2 $ Outstanding at December 31, 2019 0.5 $ $ PSUs expected to vest at December 31, 2019 0.5 $ $ 1 Represents additional shares issued in March 2019 related to the 2016 PSU grant based on performance and market conditions achieved over the three-year measurement period. These shares vested upon issuance. Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2019 , there was $ 13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . MASTERCARD 2019 FORM 10-K 95 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Additional Information The following table includes additional share-based payment information for each of the years ended December 31 : (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock Note 19 . Commitments At December 31, 2019 , the Company had the following future minimum payments due under noncancelable agreements, primarily related to sponsorships to promote the Mastercard brand and licensing arrangements. The Company has accrued $ 20 million of these future payments as of December 31, 2019 . (in millions) $ 2021 2022 2023 2024 Thereafter Total $ Note 20 . Income Taxes Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 4,213 $ 3,510 $ 3,482 Foreign 5,518 3,694 3,040 Income before income taxes $ 9,731 $ 7,204 $ 6,522 96 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ $ $ 1,704 State and local Foreign 1,620 1,589 2,521 Deferred Federal ( 228 ) State and local ( 11 ) Foreign ( 47 ) ( 5 ) ( 49 ) ( 7 ) ( 244 ) Income tax expense $ 1,613 $ 1,345 $ 2,607 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 9,731 $ 7,204 $ 6,522 Federal statutory tax 2,044 21.0 % 1,513 21.0 % 2,283 35.0 % State tax effect, net of federal benefit 0.7 % 0.6 % 0.7 % Foreign tax effect ( 208 ) ( 2.1 )% ( 92 ) ( 1.3 )% ( 380 ) ( 5.8 )% European Commission fine % 2.7 % % Foreign tax credits 1 ( 32 ) ( 0.3 )% ( 110 ) ( 1.5 )% ( 27 ) ( 0.4 )% Transition Tax ( 30 ) ( 0.3 )% 0.3 % 9.6 % Remeasurement of deferred taxes % ( 7 ) ( 0.1 )% 2.4 % Windfall benefit ( 129 ) ( 1.3 )% ( 72 ) ( 1.0 )% ( 43 ) ( 0.7 )% Other, net ( 97 ) ( 1.1 )% ( 149 ) ( 2.0 )% ( 55 ) ( 0.8 )% Income tax expense $ 1,613 16.6 % $ 1,345 18.7 % $ 2,607 40.0 % 1 Included within the impact of the foreign tax credits is $ 27 million for 2019 and $ 90 million for 2018 of tax benefits relating to the carryback of certain foreign tax credits. The effective income tax rates for the years ended December 31, 2019, 2018 and 2017 were 16.6 % , 18.7 % and 40.0 % , respectively. The effective income tax rate for 2019 was lower than the effective income tax rate for 2018 , primarily due to the nondeductible nature of the fine issued by the European Commission in 2018 and a discrete tax benefit related to a favorable court ruling in 2019 . These 2019 benefits were partially offset by discrete tax benefits in 2018 primarily related to foreign tax credits generated in 2018 as a result of U.S. tax reform, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $ 873 million in 2017 attributable to U.S. tax reform (which included provisional amounts of $ 825 million related to the one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax), the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $ 48 million due to a foregone foreign tax credit benefit on 2017 repatriations). Additionally, the lower effective income tax rate in 2018 was due to a lower 2018 statutory tax rate in the U.S. and Belgium, a more favorable geographic mix of earnings and discrete tax benefits, relating primarily to $ 90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules issued by the Department of the Treasury and the Internal Revenue Service, along with provisions for legal matters in the United States. These benefits were partially offset by the MASTERCARD 2019 FORM 10-K 97 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS nondeductible nature of the fine issued by the European Commission. See Note 21 (Legal and Regulatory Proceedings) for further discussion of the European Commission fine and U.S. merchant class litigation. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2019, 2018 and 2017 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $ 300 million , or $ 0.29 per diluted share, $ 212 million , or $ 0.20 per diluted share, and $ 104 million , or $ 0.10 per diluted share, respectively. Indefinite Reinvestment During 2019 and 2018 , the Company repatriated approximately $ 2.5 billion and $ 3.3 billion , respectively. As of December 31, 2019 and 2018 the Company had approximately $ 3.5 billion and $ 2.5 billion , respectively, of accumulated earnings to be repatriated in the future, for which immaterial deferred tax benefits were recorded. The tax effect is primarily related to the estimated foreign exchange impact recognized when earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Earnings of approximately $ 0.8 billion remain permanently reinvested and the Company estimates that immaterial U.S. federal and state and local income tax benefit would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses U.S. foreign tax credits 1 Intangible assets Other items Less: Valuation allowance ( 205 ) ( 94 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Goodwill and intangible assets Property, plant and equipment Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ 1 A deferred tax asset has been established in 2019 for $ 145 million related to foreign taxes paid in the current period, which are not expected to be utilized as credits in the current or future period, with a corresponding full valuation allowance. The valuation allowance balance at December 31, 2019 primarily relates to the Companys ability to recognize future tax benefits associated with the carry forward of U.S. foreign tax credits generated in the current period and certain foreign net operating losses. The valuation allowance balance at December 31, 2018 relates primarily to the Companys ability to recognize tax benefits associated 98 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS with certain foreign net operating losses. The recognition of the foreign tax credits is dependent upon the realization of future foreign source income in the appropriate foreign tax credit basket in accordance with U.S. federal income tax law. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions ( 11 ) ( 17 ) ( 1 ) Settlements with tax authorities ( 2 ) ( 18 ) ( 4 ) Expired statute of limitations ( 7 ) ( 12 ) ( 11 ) Ending balance $ $ $ The unrecognized tax benefit of $ 203 million , if recognized, would reduce the effective income tax rate. In 2019, there was an increase to the Companys unrecognized tax benefits primarily due to various U.S. and non-U.S. tax issues, compared to a reduction in the prior year primarily due to a favorable court decision and settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2019 and 2018 , the Company had a net income tax-related interest payable of $ 13 million and $ 8 million , respectively, in its consolidated balance sheet. Tax-related interest income/(expense) in 2019 , 2018 and 2017 was not material. In addition, as of December 31, 2019 and 2018 , the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. MASTERCARD 2019 FORM 10-K 99 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21 . Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12 % of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36 % of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court 100 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $ 237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. The time period during which Damages Class members were permitted to opt out of the class settlement agreement ended in July 2019 with merchants representing slightly more than 25 % of the Damages Class interchange volume choosing to opt out of the settlement. The district court granted final approval of the settlement in December 2019. The district courts settlement approval order has been appealed. Mastercard has commenced settlement negotiations with a number of the opt-out merchants and has reached settlements and/or agreements in principle to settle a number of these claims. The Damages Class settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. As of December 31, 2019 and 2018 , Mastercard had accrued a liability of $ 914 million as a reserve for both the Damages Class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2019 and 2018 , Mastercard had $ 584 million and $ 553 million , respectively, in a qualified cash settlement fund related to the Damages Class litigation and classified as restricted cash on its consolidated balance sheet. During the first quarter of 2019, Mastercard increased its qualified cash settlement fund by $ 108 million in accordance with a January 2019 preliminary approval of the settlement. The Damages Class settlement agreement provided for a return to the defendants of a portion of the cash settlement fund, based upon the percentage of interchange volume represented by the opt out merchants. During the fourth quarter of 2019, $ 84 million of the qualified cash settlement fund was reclassified from restricted cash to cash and cash equivalents in accordance with the December 2019 final approval of the settlement. The reserve as of December 31, 2019 for both the Damages Class litigation and the filed opt-out merchants represents Mastercards best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the Damages Class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $ 5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. Certain appellate courts have rejected the objectors appeals, while outstanding appeals remain in a few provinces. In 2017, Mastercard recorded a provision for litigation of $ 15 million related to this matter. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The EC issued a decision accepting the settlement in April 2019, with changes to interregional interchange fees going into effect in the fourth quarter of 2019. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but included a fine of 571 million , which was paid in April 2019. Mastercard incurred a charge of $ 654 million in 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic MASTERCARD 2019 FORM 10-K 101 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $ 4 billion as of December 31, 2019 ). Mastercard has resolved over 2 billion (approximately $ 3 billion as of December 31, 2019 ) of these damages claims through settlement or judgment. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $ 237 million in 2018. As detailed below, Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court ruled against both Mastercard and Visa on two of the three legal issues being considered, concluding that U.K. interchange rates restricted competition and that they were not objectively necessary for the payment networks. The appellate court sent the cases back to trial for reconsideration on the remaining issue concerning the lawful level of interchange. The U.K. Supreme Court granted the parties permission to appeal the appellate courts rulings and oral argument on the appeals was heard in January 2020. Mastercard expects the litigation process to be delayed pending the decision of the U.K. Supreme Court on the appeals. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $ 17 billion as of December 31, 2019 ). In July 2017, the trial court denied the plaintiffs application for the case to proceed as a collective action. In April 2019, the U.K. appellate court granted the plaintiffs appeal of the trial courts decision and sent the case back to the trial court for a re-hearing on the plaintiffs collective action application. Mastercard has been granted permission to appeal the appellate court ruling to the U.K. Supreme Court and oral argument on that appeal is scheduled to occur in May 2020. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. In September 2019, the plaintiffs filed their motions for class certification in which the plaintiffs, in aggregate, allege over $ 1 billion in damages against all of the defendants. Mastercard intends to vigorously defend against both the plaintiffs liability and damages claims and to oppose class certification. Mastercard expects briefing on class certification to be completed in the second quarter of 2020. 102 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. The plaintiffs have filed a renewed motion for class certification, following the district courts denial of their initial motion. Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $ 500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the court granted Mastercards motion to stay the proceedings until the Federal Communications Commission (FCC) makes a decision on the application of the TCPA to online fax services. In December 2019, the FCC issued a declaratory ruling clarifying that the TCPA does not apply to faxes sent to online fax services that are received via e-mail. As a result of the ruling, the stay of the litigation was lifted in January 2020. Note 22 . Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months ended December 31, 2019 multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under the Companys rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, such as cash, letters of credit, or guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows at December 31 : (in millions) Gross settlement exposure $ 55,800 $ 49,666 Collateral held for settlement exposure ( 4,772 ) ( 4,711 ) Net uncollateralized settlement exposure $ 51,028 $ 44,955 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $ 367 million and $ 377 million at December 31, 2019 and 2018 , respectively, of which $ 290 million and $ 297 million at December 31, 2019 and 2018 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. MASTERCARD 2019 FORM 10-K 103 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 23 . Derivative and Hedging Instruments The Company monitors and manages its foreign currency and interest rate exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign exchange derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). In addition, the Company may enter into interest rate derivative contracts to manage the effects of interest rate movements on the Companys aggregate liability portfolio, including potential future debt issuances (Cash Flow Hedges). Foreign Exchange Risk Derivatives The Company enters into foreign exchange derivative contracts to manage transactional currency exposure associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currency of the entity. The Company may also enter into foreign exchange derivative contracts to offset possible changes in value due to foreign exchange fluctuations of assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. The Companys foreign exchange derivative contracts are summarized below: December 31, 2019 December 31, 2018 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ ( 1 ) Commitments to sell foreign currency 1,506 ( 25 ) 1,066 Options to sell foreign currency Balance sheet location Prepaid expenses and other current assets 1 $ $ Other current liabilities 1 ( 32 ) ( 6 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign exchange derivative contracts General and administrative $ ( 39 ) $ $ ( 75 ) The fair value of the foreign exchange derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign exchange derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2019 and 2018 , as these contracts were not designated as hedging instruments for accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. 104 MASTERCARD 2019 FORM 10-K PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European operations. As of December 31, 2019 , the Company had a net foreign currency transaction pre-tax loss of $ 84 million in accumulated other comprehensive income (loss) associated with hedging activity. Interest Rate Risk Cash Flow Hedges The Company is exposed to interest rate volatility on future debt issuances. To manage this risk, in the fourth quarter of 2019, the Company entered into treasury rate locks to lock the benchmark rate on a portion of the interest payments related to forecasted debt issuances. These locks are linked to future interest payments on anticipated U.S. dollar debt issuances forecasted to occur during 2020 and are accounted for as cash flow hedges. The maximum length of time over which the Company has hedged its exposure to the variability in future cash flows is 30 years. As of December 31, 2019 , the total notional amount of interest rate contracts outstanding was $ 1 billion . The Company did not have any derivative instruments relating to this program outstanding as of December 31, 2018. As of December 31, 2019 , in connection with these cash flow hedges, the Company recorded pre-tax net unrealized gains of $ 14 million in accumulated other comprehensive income. As of December 31, 2019 , the fair value of these contracts was $ 14 million and is included in prepaid expenses and other current assets on the consolidated balance sheet. Note 24 . Segment Reporting Mastercard has concluded it has one reportable operating segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 32 % of total revenue in 2019 , 33 % in 2018 and 35 % in 2017 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2019 , 2018 or 2017 . The following table reflects the geographical location of the Companys property, equipment and right-of-use assets, net, as of December 31 : (in millions) United States $ 1,147 $ $ Other countries Total $ 1,828 $ $ MASTERCARD 2019 FORM 10-K 105 PART II ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Note 25 . Summary of Quarterly Data (Unaudited) 2019 Quarter Ended March 31 June 30 September 30 December 31 2019 Total (in millions, except per share data) Net revenue $ 3,889 $ 4,113 $ 4,467 $ 4,414 $ 16,883 Operating income 2,213 2,397 2,655 2,399 9,664 Net income 1,862 2,048 2,108 2,100 8,118 Basic earnings per share $ 1.81 $ 2.01 $ 2.08 $ 2.08 $ 7.98 Basic weighted-average shares outstanding 1,026 1,020 1,013 1,008 1,017 Diluted earnings per share $ 1.80 $ 2.00 $ 2.07 $ 2.07 $ 7.94 Diluted weighted-average shares outstanding 1,032 1,025 1,019 1,013 1,022 2018 Quarter Ended March 31 June 30 September 30 December 31 2018 Total (in millions, except per share data) Net revenue $ 3,580 $ 3,665 $ 3,898 $ 3,807 $ 14,950 Operating income 1,825 1,936 2,287 1,234 7,282 Net income 1,492 1,569 1,899 5,859 Basic earnings per share $ 1.42 $ 1.50 $ 1.83 $ 0.87 $ 5.63 Basic weighted-average shares outstanding 1,051 1,043 1,037 1,032 1,041 Diluted earnings per share $ 1.41 $ 1.50 $ 1.82 $ 0.87 $ 5.60 Diluted weighted-average shares outstanding 1,057 1,049 1,043 1,038 1,047 Note: Tables may not sum due to rounding. 106 MASTERCARD 2019 FORM 10-K PART II "," Item 9A. Controls and procedures Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2019 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2019 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2019 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +3,ma12,018-10xk," ITEM 1. BUSINESS Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network. Through our core global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. With additional payment capabilities that include real-time account-based payments (including automated clearing house (ACH) transactions), we offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. We also provide value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. Our payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction switching and from other payment-related products and services. Our Performance The following are our key financial and operational results for 2018: 1 Non-GAAP results excludes the impact of Special Items and/or foreign currency. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results Overview in Part II, Item 7 for the reconciliation to the most direct comparable GAAP financial measures. 2 Adjusted to normalize for the effects of differing switching days between periods. 3 Adjusted for the deconsolidation of our Venezuelan subsidiaries in 2017. See Managements Discussion and Analysis of Financial Condition and Results of Operations - Financial Results- Revenue in Part II, Item 7. Our Strategy We grow, diversify and build our business through a combination of organic growth and strategic investments. Our ability to grow our business is influenced by personal consumption expenditure (PCE) growth, driving cash and check transactions toward electronic forms of payment, increasing our share in electronic payments and providing value-added products and services. In addition, growing our business includes supplementing our core network with enhanced payment capabilities to capture new payment flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government payments, through a combination of product offerings and expanded solutions for our customers. Grow . We focus on growing our core business globally, including growing our consumer credit, debit, prepaid and commercial products and solutions, as well as increasing the number of payment transactions we switch. We also look to take advantage of the opportunities presented by the evolving ways people interact and transact in the growing digital economy. This includes expanding merchant access to electronic payments through new technologies in an effort to deliver a better consumer experience, while creating greater efficiencies and security. Diversify . We diversify our business by: working with new customers, including governments, merchants, financial technology companies, digital players, mobile providers and other corporate businesses scaling our capabilities and business into new geographies, including growing acceptance in markets with limited electronic payments acceptance today broadening financial inclusion for the unbanked and underbanked Build . We build our business by: creating and acquiring differentiated products to provide unique, innovative solutions that we bring to market to support new payment flows, such as real-time account-based payment, Mastercard B2B Hub and Mastercard Send platforms providing services across data analytics, consulting, managed services, safety and security, loyalty and processing Strategic Partners . We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for Mastercard-branded products. We help merchants, financial institutions and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer experiences. We partner with technology companies such as digital players and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments drive increased financial inclusion and efficiency, reduce costs, increase transparency to reduce crime and corruption and advance social programs. For consumers, we provide faster, safer and more convenient ways to pay and transfer funds. Talent and Culture. Our success is driven by the skills, experience, integrity and mindset of the talent we hire. We attract and retain top talent from diverse backgrounds and industries by building a world-class culture based on decency, respect and inclusion in which people have opportunities to do purpose-driven work that impacts customers, communities and co-workers on a global scale. The diversity and skill sets of our people underpin everything we do. Recent Business and Legal/Regulatory Developments Digital Payments . Technology is increasingly changing the way people get information, interact with each other, shop and make purchases. As a result of these changes, digital commerce is growing significantly. In this digital environment, consumers continue to seek a seamless experience where their payment is simple, secure and familiar. These consumer demands are driving us to think and act differently. Our teams are innovating to create solutions that meet the needs of our consumers and merchants, and applying emerging technologies to maximize our opportunities from those needs. In 2018, we: supported the development and implementation of EMVCos global standards for a simple and unified digital experience for consumers, issuers and merchants in the form of a common checkout button. This button is designed to provide consumers the same convenience and security in a digital environment that they have when shopping and paying in a store, make it easier for merchants to implement secure digital payments and provide issuers with improved fraud detection and prevention capability. announced plans to enable token services on all cards, removing the primary account number from the transaction flow. Enabling these services will help make the payment process simpler, more seamless and more secure, while supporting our merchant partners in their card on file activities. reinforced our support for contactless payments across all markets, including in Europe, where we are working with issuers, acquirers and merchants to ensure availability and support of contactless payments across the continent by 2020. New payment flows. In order to help grow our business and offer more electronic payment options to consumers, businesses and governments, Mastercard has developed and enhanced solutions beyond the principal switching capabilities available on our core network. We believe this will allow us to capture more payment flows, including B2B, P2P, B2C and government disbursements. In 2018, we: advanced business development efforts around the world with our real-time account-based payments capabilities that we acquired with Vocalink in 2017. These efforts include the launch of a real-time payment service in the U.S. in conjunction with The Clearing House that enables consumers and businesses to send and receive immediate payments. combined our proprietary Mastercard Send assets with Vocalink strategic partnerships to enable financial institutions, financial technology companies (or fintechs), digital customers and other businesses to send real-time payments to U.K. bank accounts. Mastercard Send will connect to Faster Payments, enabling a variety of use cases such as P2P payments and B2C disbursements. This effort is part of our continued expansion of Mastercard Sends capabilities, connecting more people, businesses and governments to facilitate the transfer of funds quickly and securely both domestically and cross-border. expanded the reach of Vocalinks Pay by Bank application in the United Kingdom, enabling real-time payments directly from a consumers bank account using a mobile banking app, with real-time clearing and without the need for a card. continued to invest in and test proprietary permission-based Blockchain, with an initial focus on the cross-border B2B payments space. Safety and Security. As new technologies and cyber-security threats evolve, including organized cyber-crime and nation state attacks, there is a growing need to protect the security and resilience of the payments ecosystem for every stakeholder. It is critical to protect all transactional and personal data that is stored, processed or transmitted regardless of the device or channel used to make a purchase, while at the same time continuing to improve the payment experience for all stakeholders. We focus on security across networks, and it is embedded in our policies, products, systems and analytics to prevent fraud. In 2018, we: implemented EMVCos 3D Secure 2.0 specification as part of a new solution (launched with issuer and merchant partners globally) that supports app-based authentication, integration with digital wallets and browser-based e-commerce. This is complemented by biometrics, machine learning and artificial intelligence solutions, alongside incremental transaction data, to help merchants seamlessly verify a consumers identity. At the same time, the solution reduces friction during the checkout process, as well as reduces fraud while increasing payment approvals. continued to extend our investments in Artificial Intelligence (AI) by: introducing AI Express, a new accelerated technology implementation service to help issuers, acquirers and merchants develop AI models to solve priority problems, including anti-money laundering, fraud, risk management and cybersecurity. scaling Decision Intelligence, our fraud scoring technology, to score billions of transactions in real time every day while increasing approvals and reducing false declines. piloted biometric cards in multiple markets, placing fingerprint readers directly onto a card to authenticate a cardholders identity (as an alternative to a PIN or signature) using existing chip and contactless acceptance terminals. modified our rules so that signatures will no longer be required on either cards or receipts and merchants no longer need to capture or compare a signature at the point of sale, helping to provide a faster checkout and more advanced authentication methods. Inclusive Growth. We are dedicated to increasing the opportunity for individuals and micro and small merchants to achieve financial security and greater prosperity, with the benefits of economic growth shared among all segments of society. Together with our partners, we are more than two-thirds of the way toward an important initial step towards that goal by providing access to 500 million people previously excluded from financial services by 2020. We also help communities build the ecosystems that support usage. In 2018, we worked with governments and private sector partners across several geographies to develop and roll out electronic payments solutions, social payment distribution mechanisms and digital identity solutions. We organized a global network of cities to help city leaders address the challenges of urbanization and co-develop solutions to improve life for residents and visitors and promote economic growth. We also deployed our services, partnerships and technologies to develop platforms that help small business owners accept electronic payments, manage their records, access market information, build a financial footprint and use digital communications channels to receive training and business advice. In 2018, we made an initial $100 million contribution to the Mastercard Impact Fund (formerly referred to as Mastercards Center for Inclusive Growth Fund), a non-profit charitable organization. This contribution is part of a $500 million commitment to support initiatives that focus on inclusive growth, such as financial inclusion, economic development, the future of work and data science for social impact. Legal and Regulatory . We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny, expansion of local regulatory schemes and other legal challenges, particularly with respect to interchange fees (as discussed below under Our Operations and Network). These challenges create both risks and opportunities for our industry. Our recent legal and regulatory developments include: Payments Regulation In December 2018, we announced the anticipated resolution of an investigation by the European Commission (EC) related to the interregional interchange rates we set and our central acquiring rule within the European Economic Area (the EEA). With respect to interregional interchange fees, the proposed settlement included changes to those fees that, if accepted by the EC following market testing, would avoid prolonged litigation and gain certainty concerning our business practices. With respect to our historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification in 2015. The decision does not require any modification of our current business practices but includes a fine of 571 million . We recorded a charge of $654 million in the fourth quarter of 2018 in relation to this matter. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Several jurisdictions have implemented payments regulation or initiated payments reviews in 2018. In the U.K., the Payment Systems Regulator (the PSR) published draft terms of reference for a formal review of card-acquiring services provided by Mastercard, Visa and other card scheme operators that could lead to future regulation. The European Commission expects to issue proposals in 2020 to revise the E.U. Interchange Fee Regulation. In Australia, the Productivity Commission released a report recommending, among other things, that regulators ban interchange fees by the end of 2019 and consider regulating merchant service fees. In Brazil, the Central Bank implemented a weighted average and cap for domestic debit interchange. Jurisdictions around the globe continue to implement or consider open banking initiatives. Initiatives such as the EEAs revised Payment Services Directive (commonly referred to as PSD2) which went into effect in 2018, require financial institutions to provide third-party payment processors access to consumer payment accounts, as well as requiring additional verification information from consumers to complete transactions. Other jurisdictions considering open banking initiatives include Australia, Canada, Hong Kong, Japan, Singapore and the United States. The U.K. Treasury has extended the U.K. payment systems oversight to include our Vocalink business due to its role as a payment service provider. Privacy and Data Protection In 2018, the European Union General Data Protection Regulation (the GDPR) became effective. The GDPR is a data protection regulation that has increased our compliance burden for collecting, using and processing personal and sensitive data of EEA residents. We have reviewed our products, services and processes involving EEA personal data to ensure privacy and data protection requirements are embedded into their design. We have also launched online data portals to allow EEA residents to request a copy of their personal data, and to ask for their data to be updated, corrected or deleted as appropriate. In addition, we have taken steps to assist our customers with their compliance efforts. As part of our implementation approach, we co-founded with IBM a data trust called Truata to provide anonymization and analytics services in a GDPR-compliant manner. Some jurisdictions are currently considering adopting data localization requirements, which mandate the collection, processing, and/or storage of data within their borders, including India, Kenya and Vietnam. Litigation - In September 2018, we entered into an amended class settlement agreement with the merchant damages class plaintiffs to settle their monetary damages claims in a U.S. antitrust litigation that was brought against Mastercard, Visa and a number of financial institutions. Visa and the financial institutions are also parties to the agreement, which is subject to court approval. In addition to the monetary amounts that constituted the financial settlement under the original agreement, the agreement requires an additional payment from the defendants. We took a charge during 2018 to reflect our share of this payment. Under the agreement, Mastercard and its customer financial institutions will receive a release of all damages claims that were alleged, or could have been alleged by the merchant class members concerning our interchange and fee structure and merchant acceptance rules. This release covers all retrospective claims, as well as prospective claims for a period of five years after the resolution of all appeals relating to court approval of the agreement. In January 2019, the district court issued an order granting preliminary approval of the settlement. The agreement does not relate to the merchants' claims seeking changes to business practices. Separate settlement negotiations for those claims are ongoing. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Our Business Our Operations and Network We operate a unique and proprietary global payments network, our core network, that links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We authorize, clear and settle transactions through our core network for our issuer customers in more than 150 currencies and in more than 210 countries and territories. Vocalink expands our range of payment capabilities beyond our core network into real-time account-based payments. Typical Transaction . Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs consumers and merchants incur. We do not earn revenues from interchange fees. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for their customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate, and issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the determination and exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the acquirer country and issuer country are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the acquirer country and the issuer country are the same (domestic transactions). We switch more than half of all transactions for Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Outside of these countries, most domestic transactions on our products are switched without our involvement. Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It is based largely on a distributed (peer-to-peer) architecture with an intelligent edge that enables the network to adapt to the needs of each transaction. Our core network accomplishes this by performing intelligent routing and applying multiple value-added services (such as fraud scoring or rewards at the point of sale) to appropriate transactions in real time. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Systems. Augmenting our core network, we now offer real-time account-based payment capabilities through our acquisition of Vocalink, which enables payments between bank accounts in near real-time in countries in which it has been deployed. Payments System Security. Our payment solutions and products are designed to ensure safety and security for the global payments system. The core network and additional platforms incorporate multiple layers of protection, both for continuity purposes and to provide best-in-class security protection. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, a business continuity program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our networks support and enable our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. Customer Risk. We guarantee the settlement of many of the transactions from issuers to acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers, or the availability of unspent prepaid account holder account balances. Our Products and Services We provide a wide variety of integrated products and services that support payment products that customers can offer to their account holders. These offerings facilitate transactions on our core network among account holders, merchants, financial institutions, businesses, governments and other organizations in markets globally. Core Products Consumer Credit. We offer a number of programs that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid programs involve a balance that is funded prior to use and can be accessed via one of our payment products. We offer prepaid payment programs using any of our brands, which we support with processing products and services. Segments on which we focus include government programs such as Social Security payments, unemployment benefits and others; commercial programs such as payroll, health savings accounts, employee benefits and others; and reloadable programs for consumers without formal banking relationships and non-traditional users of electronic payments. We also provide prepaid program management services, primarily outside of the United States, that manage and enable switching and issuer processing for consumer and commercial prepaid travel cards for business partners such as financial institutions, retailers, telecommunications companies, travel agents, foreign exchange bureaus, colleges and universities, airlines and governments. Commercial. We offer commercial payment products and solutions that help large corporations, midsize companies, small businesses and government entities. Our solutions streamline procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our card offerings include travel, small business (debit and credit), purchasing and fleet cards. Our SmartData platform provides expense management and reporting capabilities. Our Mastercard In Control platform generates virtual account numbers which provide businesses with enhanced controls, more security and better data. The following chart provides GDV and number of cards featuring our brands in 2018 for select programs and solutions: Year Ended December 31, 2018 As of December 31, 2018 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2017 Mastercard Branded Programs 1,2 Consumer Credit $ 2,520 % % % Consumer Debit and Prepaid 2,724 % % 1,126 % Commercial Credit and Debit % % % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Prepaid includes both consumer and commercial prepaid. Additional Platforms. In addition to the switching capabilities of our core network, we offer additional platforms with payment capabilities that extend to new payment flows: We offer commercial payment products and solutions, such as the Mastercard B2B Hub, which enables small and midsized businesses to optimize their invoice and payment processes. With Vocalink, we offer real-time account-based payments for ACH transactions. This platform enables payments between bank accounts in real-time and provides enhanced data and messaging capabilities, making them particularly well-suited for B2B and bill payment flows. Value-Added Products and Services We provide additional integrated products and services to our customers and stakeholders, including financial institutions, retailers and governments that enhance the value proposition of our products and solutions. Safety and Security. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number of EMV cards issued and the transaction volume on EMV cards. While this technology is prevalent in Europe, the U.S. market has been adopting this technology in recent years. The Identify layer allows us to help banks and merchants verify genuine consumers during the payment process. Examples of solutions under this layer include Mastercard Identity Check, a fingerprint, face and iris scanning biometric technology to verify online purchases on mobile devices, and our recently launched Biometric Card which has a fingerprint scanner built in to the card and is compatible with existing EMV payment terminals. The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Examples of our capabilities under this layer include our Early Detection System, Decision Intelligence and Safety Net services and technologies. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, enhancing approvals for online and card-on-file payments, to the ability to differentiate legitimate consumers from fraudulent ones. Our offerings in this space include Mastercard In Control, for consumer alerts and controls and our suite of digital token services available through our Mastercard Digital Enablement Service (MDES). We have also worked with our financial institution customers to provide products to consumers globally with increased confidence through the benefit of zero liability, or no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards . We have built a scalable rewards platform that enables financial institutions to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions. Analytics Insights and Consulting . We provide proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Our capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and staff augmentation allow us to assist clients implement actions based on these insights. Increasingly, we have been helping financial institutions, retailers and governments innovate. Drawing on rapid prototyping methodologies from our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five day app prototyping workshop. Through our Applied Predictive Technology business, a software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests. Digital Enablement Leveraging our global innovations capability, we work to digitize payment services across all channels and devices: Delivering better digital experiences everywhere. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base and are developing products and practices to facilitate acceptance via mobile devices. The successful implementation of our loyalty and reward programs is an important part of enabling these digital purchasing experiences. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. We provide solutions that enable our customers to offer consumers the ability to send and receive money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best-in-class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, our global innovation and development arm, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Brand Our family of well-known brands includes Mastercard, Maestro and Cirrus. We manage and promote our brands through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, usage and overall preference among account holders globally. Our Priceless advertising campaign, which has run in 52 languages in 120 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. Revenue Sources We generate revenues primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessments, cross-border volume fees, transaction processing, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks on a royalty-free basis in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payment solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems, blockchain and other matters, many of which are important to our business operations. Patents are of varying duration depending on the jurisdiction and filing date. Competition We compete in the global payments industry against all forms of payment including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments, wire transfers, electronic benefits transfers and bill payments We face a number of competitors both within and outside of the global payments industry: Cash, Check and Legacy ACH . Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. General Purpose Payment Networks . We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a more detailed discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes focused mostly on debit (e.g., MIR in Russia). Competition for Customer Business . We compete intensely with other payments companies for customer business. Globally, financial institutions typically issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. We also compete for merchants, governments and mobile providers. Real-time Account-based Payment Systems. Through Vocalink, we face competition in the real-time account-based payment space from other companies that provide these payment solutions. In addition, real-time account-based payments face competition from other payment methods, such as cash and checks, cards, electronic, mobile and e-commerce payment platforms, cryptocurrencies and other payments networks. Alternative Payments Systems and New Entrants . As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. In some circumstances, these providers can be a partner or customer, as well as a competitor. Value-Added Products and Services. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, as well as companies that compete against us as providers of loyalty and program management solutions. In addition, our integrated products and services offerings face competition and potential displacement from transaction processors throughout the world, which are seeking to enhance their networks that link issuers directly with point-of-sale devices for payment transaction authorization and processing services. Regulatory initiatives could also lead to increased competition in this space. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over 50 years which can reach a variety of parties enabling payments global payments network with world-class operating performance expertise in real-time account-based payments through our Vocalink business adoption of innovative products and digital solutions safety and security solutions embedded in our networks analytics insights and consulting services dedicated solely to the payments industry ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. See Risk Factors in Part I, Item 1A for more detail and examples. Payments Oversight . Several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. Actions by these organizations could influence other organizations around the world to adopt or consider adopting similar oversight. As a result, Mastercard could be subject to new regulation, supervisions and examination requirements. For example, in the U.K., the Bank of England has expanded its oversight of systemically important payment systems to include service providers, as well. Also, in the EEA, the implementation of PSD2 will require financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. PSD2 will also require a new standard for authentication of transactions, which necessitates additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Interchange Fees. Interchange fees associated with four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities and European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the EEA. For more detail, see our risk factors in Risk Factors-Regulations Related to Our Participation in the Payments Industry in Part I, Item 1A. Also see Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. For example, governments in some countries mandate switching of domestic payments either entirely in that country or by only domestic companies. In China, we are currently excluded from domestic switching and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. We are in active discussions to explore different solutions. Payment Systems Regulation . Regulators in several countries around the world either have, or are seeking to establish, authority to regulate certain aspects of the payment systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switched transactions and other processing in terms of how we go to market, make decisions and organize our structure. Additionally, several jurisdictions have created or granted authority to create new regulatory bodies that either have or would have the authority to regulate payment systems, including the United Kingdoms PSR (Vocalink and Mastercard are both participants in the payments system and are therefore subject to the PSRs duties and powers), India (which has also designated us as a payments system subject to regulation), the National Bank of Belgium and regulators in Brazil, Hong Kong, Mexico and Russia. Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter terrorist financing (CTF) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks and other financial institutions in their capacity as issuers and otherwise, impacting us as a consequence. Such regulations and investigations have been related to payment card add-on products, campus cards, bank overdraft practices, fees issuers charge to account holders and the transparency of terms and conditions. Additionally, regulations such as PSD2 in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to provide payment initiation and account information services directly to consumers. Regulation of Internet and Digital Transactions . Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security and copyright and trademark infringement. Privacy, Data Protection and Information Security. Aspects of our operations or business are subject to increasingly complex privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we are subject to the GDPR, which requires a comprehensive privacy and data protection program to protect the personal and sensitive data of EEA residents. A number of regulators and policymakers around the globe are using the GDPR as a reference to adopt new or updated privacy and data protection laws, including in the U.S. (California), Argentina, Brazil, Chile, India, Indonesia and Kenya. Some jurisdictions are currently considering adopting data localization requirements, which mandate the collection, processing, and/or storage of data within their borders, including India, Kenya and Vietnam. Due to constant changes to the nature of data and the use of emerging technologies such as artificial intelligence, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world adopting proposals to protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, disclosure rules, security and marketing that would impact our customers directly. Seasonality We do not experience meaningful seasonality. Employees As of December 31, 2018 , we employed approximately 14,800 persons, of whom approximately 8,800 were employed outside of the United States. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated, a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 15 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. You can also visit Investor Alerts in the investor relations section to enroll your email address to automatically receive email alerts and other information about Mastercard. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. Our filings are also available electronically from the SEC at www.sec.gov. "," ITEM 1A. RISK FACTORS Legal and Regulatory Payments Industry Regulation Global regulatory and legislative activity directly related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate certain aspects of payments systems such as ours, or establish or expand their authority to do so. Many jurisdictions have enacted such regulations. These regulations have established, and could further expand, obligations or restrictions with respect to the types of products and services that we may offer to financial institutions for consumers, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). In addition, several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry and, in some cases, are considering designating certain payments networks as systemically important payment systems or critical infrastructure. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. Some enacted regulations require financial institutions to provide third party payment processors access to consumer payment accounts. This may enable these third party payment processors to route transactions away from Mastercard products by offering account information or payment initiation services directly to people who currently use our products. This may also allow these processors to commoditize the data that are included in the transactions. New authentication standards have been enacted requiring additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience. An increase in the rate of abandoned transactions could adversely impact our volumes or other operational metrics. Increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. Such laws or compliance burdens could result in issuers and acquirers being less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. Regulators could also require us to obtain prior approval for changes to its system rules, procedures or operations, or could require customization with regard to such changes, which could impact market participant risk and therefore risk to us. Such regulatory changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation. Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route debit transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking or low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. See Government Regulation and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, potential changes to interregional interchange fees as a result of the proposed resolution of the European Commissions investigation could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek to decrease the expense of their payment programs by seeking a reduction in the fees that we charge to them, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result (and in some cases has resulted) in us being fined and/or having to pay civil damages, the amount of which could be material. Current regulatory activity could be extended to additional jurisdictions or products, which could materially and adversely affect our overall business and results of operations. Regulators around the world increasingly replicate other regulators approaches with regard to the regulation of payments and other industries. Consequently, regulation in any one country, state or region may influence regulatory approaches in other countries, states or regions. Similarly, new laws and regulations within a country, state or region involving one product may lead to regulation of similar or related products. For example, regulations affecting debit transactions could lead to regulation of other products (such as credit). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. These include matters like interchange rates, potential direct regulation of our network fees and pricing, network standards and network exclusivity and routing agreements. Conversely, if widely varying regulations come into existence worldwide, we may have difficulty adjusting our products, services, fees and other important aspects of our business to meet the varying requirements. Either of these outcomes could materially and adversely affect our overall business and results of operations. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries are considering, or may consider, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. Some jurisdictions are considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our efforts to effect change in, or work with, these countries may not succeed. This could adversely affect our ability to maintain or increase our revenues and extend our global brand. Privacy, Data Protection and Security Regulation of privacy, data protection, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to increasingly complex regulations related to privacy, data protection and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated products and services to meet the needs of a changing marketplace, as well as acquire new companies, we may expand our information profile through the collection of additional data from additional sources and across multiple channels. This expansion could amplify the impact of these regulations on our business. Regulation of privacy and data protection and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage, transfer and/or security of personal and sensitive information. We are also subject to enhanced compliance and operational requirements in the European Union, and policymakers around the globe are using these requirements as a reference to adopt new or updated privacy laws that could result in similar or stricter requirements in other jurisdictions. Some jurisdictions are also considering requirements to collect, process and/or store data within their borders, as well as prohibitions on the transfer of data abroad, leading to technological and operational implications. Other jurisdictions are considering adopting sector-specific regulations for the payments industry, including forced data sharing requirements or additional verification requirements that overlap or conflict with, or diverge from, general privacy rules. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or reinterpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and could impact the products and services we offer and other aspects of our business, such as fraud monitoring, the development of information-based products and solutions and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events and privacy abuses by other companies, as well as the disclosure of monitoring activities by certain governmental agencies in combination with the use of artificial intelligence and new technologies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements and/or future enforcement. Those developments have also raised public attention on companies data practices and have changed consumer and societal expectations for enhanced privacy and data protection. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity could encourage regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer account information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to regulatory intervention, such as enhanced security requirements, as well as damage to our reputation. Other Regulation Regulations that directly or indirectly apply to Mastercard as a result of our participation in the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business - Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption - We are subject to AML and CTF laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by OFAC. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including the SDN List. Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. A violation and subsequent judgment or settlement against us, or those with whom we may be associated, under these laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Account-based Payment Systems In the U.K., the Treasury has expanded the Bank of Englands oversight of certain payment system providers that are systemically important to U.K.s payment network. As a result of these changes, aspects of our Vocalink business are now subject to the U.K. payment system oversight regime and are directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Our financial institution customers are subject to numerous regulations, which impact us as a consequence. In addition, certain regulations (such as PSD2 in the EEA) may disintermediate issuers. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. In addition, existing or new regulations in these or other areas may diminish the attractiveness of our products to our customers. Regulation of Internet and Digital Transactions - Proposed legislation in various jurisdictions relating to Internet gambling and other digital areas such as cyber-security and copyright and trademark infringement could impose additional compliance burdens on us and/or our customers, including requiring us or our customers to monitor, filter, restrict, or otherwise oversee various categories of payment transactions. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems, or may otherwise impact the competitiveness of our products. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. Each may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws, including future regulatory guidance, may impact our effective tax rate and tax payments. There can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective tax rate, tax payments, financial condition and results of operations. Litigation Liabilities we may incur or limitations on our business related to any litigation or litigation settlements could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business-Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also more effectively introduce their own innovative programs and services that adversely impact our growth. We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation in the EEA may disintermediate us by enabling third-party providers opportunities to route payment transactions away from our networks and towards other forms of payment. Although we partner with technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and privacy and data protection standards, without proper oversight we could inadvertently share too much data which could give the partner a competitive advantage. Competitors, customers, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment products and services that compete with our services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. Over the past several years, we have experienced continued pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to switch additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and products that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a real-time account-based payment network presents risks that could materially affect our business. Our acquisition of Vocalink in 2017 added real-time account-based payment technology to the suite of capabilities we offer. While expansion into this space presents business opportunities, there are also regulatory and operational risks associated with administering a real-time account-based payment network. British regulators have designated this platform to be critical national infrastructure and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payment systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payment platform, see our risk factor in Risk Factors - Payments Industry Regulation in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payment network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. Working with new customers and end users as we expand our integrated products and services can present operational challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments market, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. Our failure to render these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added services), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. Despite various mitigation efforts that we undertake, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, the cumulative impact of multiple account data compromise events could increase the impact of the fraud resulting from such events by, among other things, making it more difficult to identify consumers. Moreover, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings may experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a business continuity program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Financial Institution Customers and Other Stakeholder Relationships Losing a significant portion of business from one or more of our largest financial institution customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our financial institution customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest financial institution customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies, as well as regulation. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. See our risk factor in Risk Factors Risks Related to Our Participation in the Payments Industry in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination of, the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor, as well as other contractual obligations, expose us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of certain of our customers. In this capacity, we are exposed to credit and liquidity risk from these customers and certain service providers. We may incur significant losses in connection with transaction settlements if a customer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our results of operations. We have significant contractual indemnification obligations with certain customers. Should an event occur that triggers these obligations, such an event could materially and adversely affect our overall business and result of operations. Global Economic and Political Environment Global economic, political, financial and societal events or conditions could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends in key countries in which we operate may adversely affect our financial performance. Such impact may include, but is not limited to, the following: Customers mitigating their economic exposure by limiting the issuance of new Mastercard products and requesting greater incentive or greater cost stability from us. Consumers and businesses lowering spending, which could impact cross-border travel patterns (on which a significant portion of our revenues is dependent). Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, that may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products. Tightening of credit availability that could impact the ability of participating financial institutions to lend to us under the terms of our credit facility. Additionally, we switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity may be adversely affected by world geopolitical, economic, weather and other conditions. These include the threat of terrorism and outbreaks of flu, viruses and other diseases, as well as major environmental events. The uncertainty that could result from such events could decrease cross-border activity. Additionally, any regulation of interregional interchange fees could also negatively impact our cross-border activity. In each case, decreased cross-border activity could decrease the revenue we receive. Any of these developments could have a material adverse impact on our overall business and results of operations. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2018 , approximately 67% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. The United Kingdoms proposed withdrawal from the European Union could harm our business and financial results. In June 2016, voters in the United Kingdom approved the withdrawal of the U.K. from the E.U. (commonly referred to as Brexit). The U.K. government triggered Article 50 of the Lisbon Treaty on March 29, 2017, which commenced the official E.U. withdrawal process. Uncertainty over the terms of the U.K.s departure from the E.U. could cause political and economic uncertainty in the U.K. and the rest of Europe, which could harm our business and financial results. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations in the U.K. and E.U. We, as well as our clients who have significant operations in the U.K., may incur additional costs and expenses as we adapt to potentially divergent regulatory frameworks from the rest of the E.U. We may also face additional complexity with regard to immigration and travel rights for our employees located in the U.K. and the E.U. These factors may impact our ability to operate in the E.U. and U.K. seamlessly. Any of these effects of Brexit, among others, could harm our business and financial results. Brand and Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Moreover, adverse developments with respect to our industry or the industries of our customers may also, by association, impair our reputation, or result in greater regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Such perception and damage to our reputation could have a material and adverse effect to our overall business. Lack of visibility of our brand in our products and services, or in the products and services of our partners who use our technology, may materially and adversely affect our business. As more players enter the global payments system, the layers between our brand and consumers and merchants increase. In order to compete with other powerful consumer brands that are also becoming part of the consumer payment experience, we often partner with those brands on payment solutions. These brands include large digital companies and other technology companies who are our customers and use our networks to build their own acceptance brands. In some cases, our brand may not be featured in the payment solution or may be secondary to other brands. Additionally, as part of our relationships with some issuers, our payment brand is only included on the back of the card. As a result, our brand may either be invisible to consumers or may not be the primary brand with which consumers associate the payment experience. This brand invisibility, or any consumer confusion as to our role in the consumer payment experience, could decrease the value of our brand, which could adversely affect our business. Talent and Culture We may not be able to attract, hire and retain a highly qualified and diverse workforce, or maintain our corporate culture, which could impact our ability to grow effectively. Our performance largely depends on the talents and efforts of our employees, particularly our key personnel and senior management. We may be unable to retain or to attract highly qualified employees. The market for key personnel is highly competitive, particularly in technology and other skill areas significant to our business. Additionally, changes in immigration and work permit laws and regulations and related enforcement have made it difficult for employees to work in, or transfer among, jurisdictions in which we have operations and could impair our ability to attract and retain qualified employees. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employee talent, or to maintain a corporate culture that fosters innovation, creativity and teamwork could harm our overall business and results of operations. We rely on key personnel to lead with integrity. To the extent our leaders behave in a manner that is not consistent with our values, we could experience significant impact to our brand and reputation, as well as to our corporate culture. Acquisitions Acquisitions, strategic investments or entry into new businesses could disrupt our business and harm our results of operations or reputation. Although we may continue to evaluate and/or make strategic acquisitions of, or acquire interests in joint ventures or other entities related to, complementary businesses, products or technologies, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 8, 2019 , Mastercard Foundation owned 112,181,762 shares of Class A common stock, representing approximately 11.1% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027, subject to certain conditions. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2018 , Mastercard and its subsidiaries owned or leased 169 commercial properties. We own our corporate headquarters, located in Purchase, New York. The building is approximately 500,000 square feet. There is no outstanding debt on this building. Our principal technology and operations center, a leased facility located in OFallon, Missouri, is also approximately 500,000 square feet. Our leased properties in the United States are located in nine states and in the District of Columbia. We also lease and own properties in 74 other countries. These facilities primarily consist of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," ITEM 3. LEGAL PROCEEDINGS Refer to Note 12 (Accrued Expenses and Accrued Litigation) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Our Class A common stock trades on the New York Stock Exchange under the symbol MA. At February 8, 2019 , we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. There is currently no established public trading market for our Class B common stock. There were approximately 287 holders of record of our non-voting Class B common stock as of February 8, 2019 , constituting approximately 1.1% of our total outstanding equity. Stock Performance Graph The graph and table below compare the cumulative total stockholder return of Mastercards Class A common stock, the SP 500 Financials and the SP 500 Index for the five-year period ended December 31, 2018 . The graph assumes a $100 investment in our Class A common stock and both of the indices and the reinvestment of dividends. Mastercards Class B common stock is not publicly traded or listed on any exchange or dealer quotation system. Total returns to stockholders for each of the years presented were as follows: Indexed Returns Base period For the Years Ended December 31, Company/Index Mastercard $ 100.00 $ 103.73 $ 118.05 $ 126.20 $ 186.37 $ 233.56 SP 500 Financials 100.00 115.20 113.44 139.31 170.21 148.03 SP 500 Index 100.00 113.69 115.26 129.05 157.22 150.33 Dividend Declaration and Policy During the years ended December 31, 2018 and 2017 , we paid the following quarterly cash dividends per share on our Class A common stock and Class B common stock: Dividend per Share First Quarter $ 0.25 $ 0.22 Second Quarter 0.25 0.22 Third Quarter 0.25 0.22 Fourth Quarter 0.25 0.22 On December 4, 2018, our Board of Directors declared a quarterly cash dividend of $0.33 per share paid on February 8, 2019 to holders of record on January 9, 2019 of our Class A common stock and Class B common stock. On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.33 per share payable on May 9, 2019 to holders of record on April 9, 2019 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 4, 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the 2017 Share Repurchase Program). This program became effective in 2018. On December 4, 2018, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $6.5 billion of our Class A common stock (the 2018 Share Repurchase Program). This program became effective in January 2019. During the fourth quarter of 2018 , we repurchased a total of approximately 4.4 million shares for $888 million at an average price of $201.20 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2018 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,390,996 $ 206.39 2,390,996 $ 695,528,134 November 1 30 1,027,633 197.12 1,027,633 492,962,254 December 1 31 996,945 192.94 996,945 6,800,613,788 Total 4,415,574 201.20 4,415,574 1 Dollar value of shares that may yet be purchased under the 2017 Share Repurchase Program and the 2018 Share Repurchase Program are as of the end of each period presented. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. Certain prior period amounts have been reclassified to conform to the 2018 presentation. For 2017 and 2016, $127 million and $113 million , respectively, of expenses were reclassified from advertising and marketing expenses to general and administrative expenses. The reclassification had no impact on total operating expenses, operating income or net income. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro and Cirrus. We are a multi-rail network. Through our core global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. With additional payment capabilities that include real-time account based payments (including automated clearing house (ACH) transactions), we offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. We also provide value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. Our payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. Financial Results Overview The following tables provide a summary of our operating results: Year ended December 31, Increase/ (Decrease) Year ended December 31, Increase/ (Decrease) ($ in millions, except per share data) Net revenue $ 14,950 $ 12,497 20% $ 12,497 $ 10,776 16% Operating expenses $ 7,668 $ 5,875 31% $ 5,875 $ 5,015 17% Operating income $ 7,282 $ 6,622 10% $ 6,622 $ 5,761 15% Operating margin 48.7 % 53.0 % (4.3) ppt 53.0 % 53.5 % (0.5) ppt Income tax expense $ 1,345 $ 2,607 (48)% $ 2,607 $ 1,587 64% Effective income tax rate 18.7 % 40.0 % (21.3) ppt 40.0 % 28.1 % 11.9 ppt Net income $ 5,859 $ 3,915 50% $ 3,915 $ 4,059 (4)% Diluted earnings per share $ 5.60 $ 3.65 53% $ 3.65 $ 3.69 (1)% Diluted weighted-average shares outstanding 1,047 1,072 (2)% 1,072 1,101 (3)% Summary of Non-GAAP Results 1 : Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 14,950 $ 12,497 20% 20% $ 12,497 $ 10,776 16% 15% Adjusted operating expenses $ 6,540 $ 5,693 15% 15% $ 5,693 $ 4,898 16% 16% Adjusted operating margin 56.2 % 54.4 % 1.8 ppt 1.8 ppt 54.4 % 54.5 % (0.1) ppt (0.2) ppt Adjusted effective income tax rate 18.5 % 26.8 % (8.3) ppt (8.2) ppt 26.8 % 28.1 % (1.3) ppt (1.3) ppt Adjusted net income $ 6,792 $ 4,906 38% 38% $ 4,906 $ 4,144 18% 17% Adjusted diluted earnings per share $ 6.49 $ 4.58 42% 41% $ 4.58 $ 3.77 21% 21% Note: Tables may not sum due to rounding. 1 The Summary of Non-GAAP Results excludes the impact of Special Items (subsequently defined) and/or foreign currency. See Non-GAAP Financial Information for further information on the Special Items, the impact of foreign currency and the reconciliation to GAAP reported amounts. Key highlights for 2018 were as follows: Net revenue increased 20% both as reported and on a currency-neutral basis, in 2018 versus 2017 . Current year results include growth of 4 percentage points from the impact of the adoption of the new revenue standard and an additional 0.5 percentage points from our prior year acquisitions. The remaining 15 percentage points of growth was primarily driven by: Switched transaction growth of 17% , adjusted for the impact of the Venezuela deconsolidation 1 Cross-border growth of 18% on a local currency basis 1 1 Adjusted to normalize for the effects of differing switching days between periods. Gross dollar volume growth of 14% on a local currency basis These increases were partially offset by higher rebates and incentives, which increased 18% both as reported and on a currency-neutral basis. Operating expenses increased 31% in 2018 versus 2017 . Excluding the impact of Special Items (defined below), operating expenses increased 15% both as adjusted and on a currency-neutral basis, primarily driven by: 3 percentage point increase from the adoption of the new revenue guidance 2 percentage point increase from acquisitions 2 percentage point increase from the $100 million contribution to the Mastercard Impact Fund (formerly referred to as Mastercards Center for Inclusive Growth Fund), a non-profit charitable organization. The remaining 8 percentage points of growth was primarily related to our continued investment in strategic initiatives and higher operating costs. The effective income tax rate was 18.7% in 2018 versus 40.0% in 2017. The lower effective tax rate for the period was primarily due to additional tax expense in 2017 attributable to comprehensive U.S. tax legislation (U.S. Tax Reform) passed on December 22, 2017, a lower enacted statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate for the period was also attributable to discrete tax benefits, relating primarily to the carryback of foreign tax credits due to transition rules, along with provisions for legal matters in the United States. These benefits were partially offset by the non-deductible fine issued by the European Commission. Other financial highlights for 2018 were as follows: We generated net cash flows from operations of $6.2 billion . We completed a debt offering for an aggregate principal amount of $1.0 billion . We repurchased 26 million shares of our common stock for $4.9 billion and paid dividends of $1.0 billion . We recorded litigation provision charges of $1.1 billion . See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). Our non-GAAP financial measures exclude the impact of the following special items (Special Items). Litigation provisions During 2018, we recorded pre-tax charges of $1,128 million ( $1,008 million after tax, or $0.96 per diluted share) related to litigation provisions which included pre-tax charges of: $654 million related to a fine issued by the European Commission $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017, we recorded pre-tax charges of $15 million ( $10 million after tax, or $0.01 per diluted share) related to a litigation settlement with Canadian merchants. During 2016, we recorded pre-tax charges of $117 million ( $85 million after tax, or $0.08 per diluted share) related to litigation settlements with U.K. merchants. Tax act During 2018, we recorded a $75 million net tax benefit ( $0.07 per diluted share) which included a $90 million benefit ( $0.09 per diluted share) related to the carryback of foreign tax credits due to transition rules, offset by a net $15 million expense ( $0.01 per diluted share) primarily related to the true-up to our 2017 mandatory deemed repatriation tax on accumulated foreign earnings. During 2017, we recorded additional tax expense of $873 million ( $0.81 per diluted share) which includes $825 million of provisional charges attributable to a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax), the remeasurement of our net deferred tax asset in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million additional tax expense related to a foregone foreign tax credit benefit on 2017 repatriations. Venezuela charge During 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries. See Note 1 (Summary of Significant Accounting Policies) , Note 19 (Income Taxes) and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. We excluded these Special Items as management evaluates the underlying operations and performance of the Company separately from litigation judgments and settlements related to interchange and other one-time items, as well as the related tax impacts. In addition, we present growth rates adjusted for the impact of foreign currency, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of foreign currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. We believe the presentation of the impact of foreign currency provides relevant information. We believe that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. We use non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables reconcile our as-reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures: Year ended December 31, 2018 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 7,668 48.7 % 18.7 % $ 5,859 $ 5.60 Litigation provisions (1,128 ) 7.5 % (1.1 )% 1,008 0.96 Tax act ** ** 0.9 % (75 ) (0.07 ) Non-GAAP $ 6,540 56.2 % 18.5 % $ 6,792 $ 6.49 Year ended December 31, 2017 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % 40.0 % $ 3,915 $ 3.65 Tax act ** ** (13.4 )% 0.81 Venezuela charge (167 ) 1.3 % 0.2 % 0.10 Litigation provisions (15 ) 0.1 % % 0.01 Non-GAAP $ 5,693 54.4 % 26.8 % $ 4,906 $ 4.58 Year ended December 31, 2016 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,015 53.5 % 28.1 % $ 4,059 $ 3.69 Litigation provisions (117 ) 1.0 % % 0.08 Non-GAAP $ 4,898 54.5 % 28.1 % $ 4,144 $ 3.77 Note: Tables may not sum due to rounding. ** Not applicable Net revenue, operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items and/or the impact of foreign currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables represent the reconciliation of our growth rates reported under GAAP to our Non-GAAP growth rates: Year Ended December 31, 2018 as compared to the Year Ended December 31, 2017 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (4.3) ppt (21.3) ppt % % Litigation provisions ** (19 )% 7.4 ppt (1.0) ppt % % Tax act ** ** ** 14.2 ppt (33 )% (34 )% Venezuela charge ** % (1.3) ppt (0.2) ppt (3 )% (3 )% Non-GAAP % % 1.8 ppt (8.3) ppt % % Foreign currency 1 % % ppt 0.1 ppt % % Non-GAAP - currency-neutral % % 1.8 ppt (8.2) ppt % % Year Ended December 31, 2017 as compared to the Year Ended December 31, 2016 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (0.5) ppt 11.9 ppt (4 )% (1 )% Tax act ** ** ** (13.4) ppt % % Venezuela charge ** (3 )% 1.3 ppt 0.2 ppt % % Litigation provisions ** % (1.0) ppt ppt (2 )% (3 )% Non-GAAP % % (0.1) ppt (1.3) ppt % % Foreign currency 1 (1 )% (1 )% (0.1) ppt ppt (1 )% % Non-GAAP - currency-neutral % % (0.2) ppt (1.3) ppt % % Note: Tables may not sum due to rounding. ** Not applicable 1 Represents the foreign currency translational and transactional impact. Impact of Foreign Currency Rates Our primary revenue functional currencies are the U.S. dollar, euro, Brazilian real and the British pound. Our overall operating results are impacted by foreign currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional foreign currency. The impact of the transactional foreign currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in foreign currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The foreign currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2018 , GDV on a U.S. dollar-converted basis increased 13.0% , while GDV on a local currency basis increased 14.0% versus 2017 . In 2017 , GDV on a U.S. dollar-converted basis increased 8.5% , while GDV on a local currency basis increased 8.4% versus 2016 . Further, the impact from transactional foreign currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. We incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses. We manage foreign currency balance sheet remeasurement and cash flow risk through our foreign exchange risk management activities, which are discussed further in Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign currency derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives immediately in current-period earnings, with the related hedged item being recognized as the exposures materialize. We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in 2017, due to foreign exchange regulations which were restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we transitioned to the cost method of accounting. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in 2017. We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. Financial Results Revenue Gross revenue increased 19% and 18% , or 19% and 17% on a currency-neutral basis, in 2018 and 2017 , respectively, versus the prior year. The increase in both 2018 and 2017 was primarily driven by an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 18% and 22% in 2018 and 2017 , respectively, versus the prior year, both as reported and on a currency-neutral basis. The increases in rebates and incentives in 2018 and 2017 were primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 20% and 16% , or 20% and 15% on a currency-neutral basis, in 2018 and 2017 , respectively, versus the prior year. Current year results include growth of 4 percentage points from the impact of the adoption of the new revenue standard and an additional 0.5 percentage points from our prior year acquisitions. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for a further discussion of the new revenue guidance. Additionally, see Note 3 (Revenue) to the consolidated financial statements included in Part II, Item 8 for a further discussion of how we recognize revenue. The significant components of our net revenue were as follows: For the Years Ended December 31, Percent Increase (Decrease) ($ in millions) Domestic assessments $ 6,138 $ 5,130 $ 4,411 20% 16% Cross-border volume fees 4,954 4,174 3,568 19% 17% Transaction processing 7,391 6,188 5,143 19% 20% Other revenues 3,348 2,853 2,431 17% 17% Gross revenue 21,831 18,345 15,553 19% 18% Rebates and incentives (contra-revenue) (6,881 ) (5,848 ) (4,777 ) 18% 22% Net revenue $ 14,950 $ 12,497 $ 10,776 20% 16% The following table summarizes the primary drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Revenue Standard 1 Foreign Currency 2 Other 3 Total Domestic assessments % % % % % % (1 )% % % 4 % 4 % % Cross-border volume fees % % % % % % % % % % % % Transaction processing % % % % % % % % % % % % Other revenues ** ** % % % % (1 )% % % 5 % 5 % % Rebates and incentives % % % % (2 )% % (1 )% % % 6 % 6 % % Net revenue % % 0.5 % % % % % % % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the impact of our adoption of the new revenue guidance. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 2 Represents the foreign currency translational and transactional impact versus the prior year. 3 Includes impact from pricing and other non-volume based fees. 4 Includes impact of the allocation of revenue to service deliverables, which are recorded in other revenue when services are performed. 5 Includes impacts from Advisors fees, safety and security fees, loyalty and reward solution fees and other payment-related products and services. 6 Includes the impact from timing of new, renewed and expired agreements. The following table provides a summary of the trend in volume and transaction growth: Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border volume 1 % % Switched transactions % % 1 Excludes volume generated by Maestro and Cirrus cards. In 2016, our GDV was impacted by the EU Interchange Fee Regulation related to card payments which became effective in June 2016. The regulation requires that we no longer collect fees on domestic European Economic Area payment transactions that do not use our network brand. Prior to that, we collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non Mastercard co-badged volume is no longer being included. The following table reflects GDV growth rates for Europe and Worldwide Mastercard. For comparability purposes, we adjusted growth rates for the impact of Article 8 of the EU Interchange Fee Regulation related to card payments, to exclude the prior period co-badged volume processed by other networks. For the Years Ended December 31, Growth (Local) GDV 1 Worldwide as reported 14% 8% Worldwide as adjusted for EU Regulation 14% 10% Europe as reported 19% 10% Europe as adjusted for EU Regulation 19% 16% 1 Excludes volume generated by Maestro and Cirrus cards. The following table reflects cross-border volume and switched transactions growth rates. For comparability purposes, we normalized the growth rates for the effects of differing switching days between periods. Additionally, we adjusted the switched transactions growth rate for the deconsolidation of our Venezuelan subsidiaries in 2017. For a more detailed discussion of the deconsolidation of our Venezuelan subsidiaries, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. For the Years Ended December 31, Growth (Local) Cross-border volume as reported 19% 15% Cross-border volume, normalized 18% 15% Switched transactions as reported 13% 17% Switched transactions, normalized 1 17% 16% 1 Adjusted for the deconsolidation of Venezuela subsidiaries. No individual country, other than the United States, generated more than 10% of total net revenue in any such period. A significant portion of our revenue is concentrated among our five largest customers. In 2018 , the net revenue from these customers was approximately $3.1 billion , or 21% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. Operating Expenses Operating expenses increased 31% and 17% in 2018 and 2017 , respectively, versus the prior year. Excluding the impact of the Special Items, adjusted operating expenses increased 15% and 16% in 2018 and 2017 , respectively, versus the prior year, both as adjusted and on a currency-neutral basis. Acquisitions contributed 2 percentage points of growth in 2018 . The components of operating expenses were as follows: Year ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 5,174 $ 4,653 $ 3,827 % % Advertising and marketing % % Depreciation and amortization % % Provision for litigation 1,128 ** ** Total operating expenses 7,668 5,875 5,015 % % Special Items 1 (1,128 ) (182 ) (117 ) ** ** Adjusted total operating expenses (excluding Special Items 1 ) $ 6,540 $ 5,693 $ 4,898 % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on Special Items. The following table summarizes the primary drivers of changes in operating expenses in 2018 and 2017 : For the Years Ended December 31, Operational Special Items 1 Acquisitions Revenue Standard 2 Mastercard Impact Fund 3 Foreign Currency 4 Total General and administrative % % (4 )% % % % % % % % % % % % Advertising and marketing (4 )% % % % % % % % % % % % % % Depreciation and amortization (5 )% % % % % % % % % % % % % % Provision for litigation ** ** ** ** ** ** ** ** ** ** ** ** ** ** Total operating expenses % % % % % % % % % % % % % % Note: Table may not sum due to rounding. ** Not meaningful 1 See Non-GAAP Financial Information for further information on Special Items. 2 Represents the impact of our adoption of the new revenue guidance. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. 3 Represents contribution to a non-profit entity. 4 Represents the foreign currency translational and transactional impact versus the prior year. General and Administrative The significant components of our general and administrative expenses were as follows: For the Years Ended December 31, Percent Increase (Decrease) ($ in millions) Personnel $ 3,214 $ 2,687 $ 2,225 20% 21% Professional fees 6% 5% Data processing and telecommunications 19% 20% Foreign exchange activity 1 (36 ) ** ** Other 1,019 1,001 2% 23% General and administrative expenses 5,174 4,653 3,827 11% 22% Special Item 2 (167 ) ** ** Adjusted general and administrative expenses (excluding Special Item) 2 $ 5,174 $ 4,486 $ 3,827 15% 17% Note: Table may not sum due to rounding. ** Not meaningful 1 Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 See Non-GAAP Financial Information for further information on Special Items. The primary drivers of general and administrative expenses in 2018 and 2017, versus the prior year, were as follows: Personnel expenses increased 20% and 21% , or 19% and 20% on a currency-neutral basis, respectively. The 2018 and 2017 increases were driven by a higher number of employees to support our continued investment in the areas of real-time account-based payments, digital, services, data analytics and geographic expansion. The impact of acquisitions contributed 2 and 6 percentage points of growth for 2018 and 2017 , respectively. Data processing and telecommunication expenses increased 19% and 20% , respectively, both as reported and on a currency-neutral basis, due to capacity growth of our business. Acquisitions contributed 3 and 8 percentage points, respectively. Foreign exchange activity contributed a benefit of 3 percentage points in 2018 related to gains from our foreign exchange activity for derivative contracts primarily due to the strengthening of the U.S. dollar, partially offset by balance sheet remeasurement losses. In 2017, foreign exchange activity had a negative impact of 2 percentage points due to greater losses from foreign exchange derivative contracts. Other expenses increased 2% and 23% , or 2% and 25% on a currency-neutral basis, respectively. In 2018 , other expenses increased primarily due to the $100 million contribution to the Mastercard Impact Fund. The remaining increase was due to costs to support our strategic development efforts. These increases were primarily offset by the non-recurring Venezuela charge of $167 million recorded in 2017 which was the primary driver of growth for that period. Other expenses include costs to provide loyalty and rewards solutions, travel and meeting expenses and rental expense for our facilities and other costs associated with our business. Advertising and Marketing In 2018 , advertising and marketing expenses increased 18% both as reported and on a currency-neutral basis versus 2017 , primarily due to a change in accounting for certain marketing fund arrangements as a result of our adoption of the new revenue guidance, partially offset by a net decrease in spending on certain marketing campaigns. For a more detailed discussion on the impact of the new revenue guidance, refer to Note 1 (Summary of Significant Accounting Policies) . In 2017 , advertising and marketing expenses increased 11% , or 10% on a currency-neutral basis versus 2016 , mainly due to higher marketing spend primarily related to certain marketing campaigns. Depreciation and Amortization Depreciation and amortization expenses increased 5% and 17% in 2018 and 2017 , respectively, versus the prior year, both as reported and on a currency-neutral basis. The increase in 2018 was primarily due to the impact of acquisitions partially offset by the full amortization of certain intangible assets. In 2017 , the increase was primarily due to the impact of acquisitions. Provision for Litigation In 2018 , we recorded pre-tax charges of $1,128 million which includes $654 million related to a fine issued by the European Commission, $237 million related to both the U.S. merchant class litigation and the filed and anticipated opt-out U.S. merchant cases and $237 million related to litigation settlements with U.K. and Pan-European merchants. During 2017 and 2016 , we recorded pre-tax charges of $15 million and $117 million related to litigations with merchants in Canada and the U.K., respectively. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) is comprised primarily of investment income, interest expense, our share of income (losses) from equity method investments and other gains and losses. Total other expense decreased $22 million to $78 million in 2018 versus $100 million in 2017 due to higher investment income partially offset by higher interest expense related to our debt issuance in February 2018 and higher equity losses in the current year. Total other expense decreased $15 million to $100 million in 2017 versus $115 million in 2016 due to lower impairment charges taken on certain investments last year and a gain on an investment recorded in 2017, partially offset by higher interest expense from debt issued in the fourth quarter of 2017. Income Taxes On December 22, 2017, U.S. Tax Reform was enacted into law with the effective date for most provisions being January 1, 2018. U.S. Tax Reform represents significant changes to the U.S. internal revenue code and, among other things: lowered the corporate income tax rate from 35% to 21% imposed a one-time deemed repatriation tax on accumulated foreign earnings provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduced further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations and eliminates the domestic production activities deduction. While the effective date of the law for most provisions was January 1, 2018, GAAP requires the effects of changes in tax rates be accounted for in the reporting period of enactment, which was the 2017 reporting period. The effective tax rates for the years ended December 31, 2018, 2017 and 2016 were 18.7% , 40.0% and 28.1% , respectively. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $873 million attributable to U.S. Tax Reform in 2017, a lower 2018 statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate is also attributable to discrete tax benefits, relating primarily to $90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules in the proposed foreign tax credit regulations issued on November 28, 2018, along with provisions for legal matters in the United States. These benefits were partially offset by the nondeductible nature of the fine issued by the European Commission. Excluding the impact of Special Items, the 2018 adjusted effective income tax rate improved by 8.3 percentage points to 18.5% from 26.8% in 2017 primarily due to the lower tax rate in the U.S. and a more favorable geographical mix of earnings. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to U.S. Tax reform, which included provisional amounts of $825 million related to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of our foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on current year repatriations. Excluding the impact of U.S. Tax Reform and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of earnings, partially offset by a lower U.S. foreign tax credit benefit. The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 21% for 2018 and 35.0% for 2017 and 2016 to pretax income for the years ended December 31, as a result of the following: For the Years Ended December 31, Amount Percent Amount Percent Amount Percent ($ in millions) Income before income taxes $ 7,204 $ 6,522 $ 5,646 Federal statutory tax 1,513 21.0 % 2,283 35.0 % 1,976 35.0 % State tax effect, net of federal benefit 0.6 % 0.7 % 0.4 % Foreign tax effect (92 ) (1.3 )% (380 ) (5.8 )% (188 ) (3.3 )% European Commission fine 2.7 % % % Foreign tax credits 1 (110 ) (1.5 )% (27 ) (0.4 )% (141 ) (2.5 )% Transition Tax 0.3 % 9.6 % % Remeasurement of deferred taxes (7 ) (0.1 )% 2.4 % % Windfall benefit (72 ) (1.0 )% (43 ) (0.7 )% % Other, net (149 ) (2.0 )% (55 ) (0.8 )% (82 ) (1.5 )% Income tax expense $ 1,345 18.7 % $ 2,607 40.0 % $ 1,587 28.1 % 1 Included within the impact of the 2018 foreign tax credits is a $90 million tax benefit relating to the carry back of certain foreign tax credits. Additionally, included in 2016 is a $116 million benefit associated with the repatriation of 2016 foreign earnings. There was no benefit associated with the repatriation of foreign earnings in 2018 and 2017 due to the enactment of U.S. Tax Reform. Our GAAP effective income tax rates for 2018 , 2017 and 2016 were affected by the tax benefits related to the Special Items as previously discussed. Our unrecognized tax benefits related to positions taken during the current and prior periods were $164 million and $183 million , as of December 31, 2018 and 2017 , respectively, all of which would reduce our effective tax rate if recognized. Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local tax examinations is reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. In 2010, in connection with the expansion of our operations in the Asia Pacific, Middle East and Africa region, our subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL), received an incentive grant from the Singapore Ministry of Finance. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 8.4 $ 7.8 Unused line of credit 4.5 3.8 1 Investments include available-for-sale securities and short-term held-to-maturity securities. At December 31, 2018 and 2017 , this amount excludes restricted cash related to the U.S. merchant class litigation settlement of $553 million and $546 million , respectively. This amount also excludes restricted security deposits held for customers of $1.1 billion at both December 31, 2018 and 2017 . In 2017, as a result of U.S. Tax Reform, among other things, we changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates and recognized a provisional deferred tax liability of $36 million . In 2018, we completed our analysis of global working capital and cash needs. It is our present intention to indefinitely reinvest approximately $0.9 billion of our historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the U.S. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many of the transactions between our customers. See Note 21 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven significantly by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see our risk factor in Risk Factors - Legal and Regulatory Risks in Part I, Item 1A and Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Cash Flow Data: Net cash provided by operating activities $ 6,223 $ 5,664 $ 4,637 Net cash used in investing activities (506 ) (1,781 ) (1,163 ) Net cash used in financing activities (4,966 ) (4,764 ) (2,344 ) Net cash provided by operating activities increased $559 million in 2018 versus 2017 , primarily due to higher net income as adjusted for non-cash items, partially offset by deferred payments associated with U.S. Tax Reform in the prior year and the timing of settlement with customers. Net cash provided by operating activities in 2017 versus 2016 , increased by $1.0 billion , primarily due to higher net income as adjusted for non-cash items and deferred payments associated with U.S. Tax Reform. Net cash used in investing activities decreased $1.3 billion in 2018 versus 2017 , primarily due to 2017 acquisitions. Net cash used in investing activities increased $618 million in 2017 versus 2016 , primarily due to 2017 acquisitions and investments in nonmarketable equity investments, partially offset by higher net proceeds of investment securities. Net cash used in financing activities increased $202 million in 2018 versus 2017 , primarily due to higher repurchases of our Class A common stock and dividends paid, partially offset by the proceeds from debt issued in the current year. Net cash used in financing activities increased $2.4 billion in 2017 versus 2016 , primarily due to proceeds from debt issued in 2016, higher repurchases of our Class A common stock and dividends paid. The table below shows a summary of select balance sheet data at December 31 : (in millions) Balance Sheet Data: Current assets $ 16,171 $ 13,797 Current liabilities 11,593 8,793 Long-term liabilities 7,778 6,968 Equity 5,418 5,497 We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, our borrowing capacity and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Debt and Credit Availability In February 2018, we issued $500 million principal amount of notes due in 2028 and an additional $500 million principal amount of notes due in 2048. Our total debt outstanding (including the current portion) was $6.3 billion and $5.4 billion at December 31, 2018 and 2017 , respectively, with the earliest maturity of $500 million of principal occurring in April 2019. As of December 31, 2018, we have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $4.5 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have a committed unsecured $4.5 billion revolving credit facility (the Credit Facility) which expires in November 2023. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2018 and 2017 . In March 2018, we filed a universal shelf registration statement (replacing a previously filed shelf registration statement that was set to expire) to provide additional access to capital, if needed. Pursuant to the shelf registration statement, we may from time to time offer to sell debt securities, guarantees of debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. See Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on our debt, the Commercial Paper Program and the Credit Facility. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 1.00 $ 0.88 $ 0.76 Cash dividends paid $ 1,044 $ $ On December 4, 2018, our Board of Directors declared a quarterly cash dividend of $0.33 per share paid on February 8, 2019 to holders of record on January 9, 2019 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $340 million . On February 5, 2019, our Board of Directors declared a quarterly cash dividend of $0.33 per share payable on May 9, 2019 to holders of record on April 9, 2019 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $339 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2018, 2017 and 2016, our Board of Directors approved share repurchase programs authorizing us to repurchase up to $6.5 billion , $4 billion and $4 billion , respectively, of our Class A common stock. The program approved in 2018 became effective in January 2019 after completion of the share repurchase program authorized in 2017. The following table summarizes our share repurchase authorizations of our Class A common stock through December 31, 2018 , under the plans approved in 2018, 2017 and 2016: (in millions, except per share data) Board authorization $ 14,500 Remaining authorization at December 31, 2017 $ 5,234 Dollar-value of shares repurchased in 2018 $ 4,933 Remaining authorization at December 31, 2018 $ 6,801 Shares repurchased in 2018 26.2 Average price paid per share in 2018 $ 188.26 See Note 15 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than lease arrangements and other commitments as presented in the Future Obligations table that follows. Future Obligations The following table summarizes our obligations as of December 31, 2018 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period Total 2020 - 2021 2022 - 2023 2024 and thereafter (in millions) Debt $ 6,389 $ $ $ $ 4,438 Interest on debt 2,072 1,295 Capital leases Operating leases Other obligations 1 Sponsorship, licensing and other 2 Employee benefits 3 Transition Tax 4 Redeemable non-controlling interests 5 Total 6 $ 10,691 $ 1,164 $ 1,576 $ 1,479 $ 6,472 1 The table does not include the $1.6 billion provision as of December 31, 2018 related to litigation as the timing of payments is not fixed and determinable. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. The table also does not include the $219 million accrual as of December 31, 2018 related to the contingent consideration attributable to acquisitions made in 2017, which is pending our final assessment in accordance with the terms of the purchase agreement. This payment is expected to be completed in 2019. See Note 7 (Fair Value and Investment Securities) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts primarily relate to sponsorships to promote the Mastercard brand. Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance. We have accrued $4.1 billion as of December 31, 2018 related to customer and merchant agreements. 3 Amounts relate to severance liabilities along with expected funding requirements for defined benefit pension and postretirement plans. 4 Amounts relate to the U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 19 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 6 We have recorded a liability for unrecognized tax benefits of $164 million at December 31, 2018 . Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated. The timing of these payments will ultimately depend on the progress of tax examinations with the various authorities. Seasonality We do not experience meaningful seasonality. No individual quarter in 2018 , 2017 or 2016 accounted for more than 30% of net revenue. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. We have established detailed policies and control procedures to provide reasonable assurance that the methods used to make estimates and assumptions are well controlled and are applied consistently from period to period. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to our financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to our financial condition. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Domestic assessment revenue requires an estimate of our customers performance in order to recognize this revenue. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates. We consider various factors in estimating customer performance, including a review of specific transactions, historical experience with that customer and market and economic conditions. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assess its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise our estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 20 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. Deferred taxes are established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Valuation of Assets The valuation of assets acquired in a business combination and asset impairment reviews require the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired, liabilities assumed and any non-controlling interest in the acquiree to properly allocate purchase price consideration. Impairment testing for assets, other than goodwill and indefinite-lived intangible assets, requires the allocation of cash flows to those assets or group of assets and if required, an estimate of fair value for the assets or group of assets. We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis or sooner if indicators of impairment exist. Goodwill is tested for impairment at the reporting unit level utilizing a quantitative assessment. We use market capitalization for estimating the fair value of our reporting unit. If the fair value exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds the fair value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate all relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. In performing these qualitative assessments, we consider relevant events and conditions, including but not limited to, macroeconomic trends, industry and market conditions, overall financial performance, cost factors, company-specific events, and legal and regulatory factors. If the qualitative assessments indicate that it is more likely than not that the fair value of the indefinite-lived intangible assets is less than their carrying amounts, we must perform a quantitative impairment test. Our estimates in the valuation of these assets are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of managements assumptions, which would not reflect unanticipated events and circumstances that may occur. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as interest rates and foreign currency exchange rates. Our exposure to market risk from changes in interest rates and foreign exchange rates is limited. Management establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments. We monitor risk exposures on an ongoing basis. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $113 million on our foreign currency derivative contracts outstanding at December 31, 2018 related to the hedging program. In addition, a 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2018 and 2017 . Foreign Exchange Risk Our settlement activities are subject to foreign exchange risk resulting from foreign exchange rate fluctuations. This risk is typically limited to the one business day between setting the foreign exchange rates and clearing the financial transactions. We enter into foreign currency contracts to manage risk associated with anticipated receipts and disbursements which are either transacted in a non-functional currency or valued based on a currency other than the functional currencies of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities denominated in currencies other than the functional currency of the entity. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. Foreign currency exposures are managed together through our foreign exchange risk management activities, which are discussed further in Note 22 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. The terms of the forward contracts are generally less than 18 months . As of December 31, 2018 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with our customers. Our derivative contracts are summarized below: December 31, 2018 December 31, 2017 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ (1 ) $ $ Commitments to sell foreign currency 1,066 (26 ) Options to sell foreign currency We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates, with changes in the translated value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations. Our euro-denominated debt is vulnerable to changes in the euro to U.S. dollar exchange rates. The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8. Interest Rate Risk Our interest rate sensitive assets are our investments in fixed income securities, which we generally hold as available-for-sale investments. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows: Maturity Fair Market Value at December 31, 2018 2024 and there-after Financial Instrument Summary Terms (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest 1,043 Asset-backed securities Fixed / Variable Interest Total $ 1,432 $ $ $ $ $ $ Maturity Financial Instrument Summary Terms Fair Market Value at December 31, 2017 2023 and there-after (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,148 $ $ $ $ $ $ We also have time deposits that are classified as held-to-maturity securities. At December 31, 2018 and 2017 , the cost which approximates fair value, of our short-term held-to-maturity securities was $264 million and $700 million , respectively. At December 31, 2018 , we have U.S. dollar-denominated and euro-denominated debt, which is subject to interest rate risk. The principal amounts of this debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 14 (Debt) to the consolidated financial statements included in Part II, Item 8. See Future Obligations for estimated interest payments due by period relating to the U.S. dollar-denominated and euro-denominated debt. At December 31, 2018 , we have the Commercial Paper Program and the Credit Facility which provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. Borrowing rates under the Commercial Paper Program are based on market conditions. Borrowing rates under the Credit Facility are variable rates, which are applied to the borrowing based on terms and conditions set forth in the agreement. See Note 14 (Debt) to the consolidated financial statements in Part II, Item 8 for additional information on the Credit Facility and the Commercial Paper Program. We had no borrowings under the Commercial Paper Program or the Credit Facility at December 31, 2018 and 2017 . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MASTERCARD INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Mastercard Incorporated As of December 31, 2018 and 2017 and for the years ended December 31, 2018, 2017 and 2016 Managements Report on Internal Control over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheet Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 58 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2018 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries (the Company) as of December 31, 2018 and 2017 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2018 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York February 13, 2019 We have served as the Companys auditor since 1989. MASTERCARD INCORPORATED CONSOLIDATED BALANCE SHEET December 31, (in millions, except per share data) ASSETS Cash and cash equivalents $ 6,682 $ 5,933 Restricted cash for litigation settlement Investments 1,696 1,849 Accounts receivable 2,276 1,969 Settlement due from customers 2,452 1,375 Restricted security deposits held for customers 1,080 1,085 Prepaid expenses and other current assets 1,432 1,040 Total Current Assets 16,171 13,797 Property, plant and equipment, net Deferred income taxes Goodwill 2,904 3,035 Other intangible assets, net 1,120 Other assets 3,303 2,298 Total Assets $ 24,860 $ 21,329 LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS AND EQUITY Accounts payable $ $ Settlement due to customers 2,189 1,343 Restricted security deposits held for customers 1,080 1,085 Accrued litigation 1,591 Accrued expenses 4,747 3,931 Current portion of long-term debt Other current liabilities Total Current Liabilities 11,593 8,793 Long-term debt 5,834 5,424 Deferred income taxes Other liabilities 1,877 1,438 Total Liabilities 19,371 15,761 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,387 and 1,382 shares issued and 1,019 and 1,040 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 12 and 14 issued and outstanding, respectively Additional paid-in-capital 4,580 4,365 Class A treasury stock, at cost, 368 and 342 shares, respectively (25,750 ) (20,764 ) Retained earnings 27,283 22,364 Accumulated other comprehensive income (loss) (718 ) (497 ) Total Stockholders Equity 5,395 5,468 Non-controlling interests Total Equity 5,418 5,497 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 24,860 $ 21,329 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF OPERATIONS For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 14,950 $ 12,497 $ 10,776 Operating Expenses General and administrative 5,174 4,653 3,827 Advertising and marketing Depreciation and amortization Provision for litigation 1,128 Total operating expenses 7,668 5,875 5,015 Operating income 7,282 6,622 5,761 Other Income (Expense) Investment income Interest expense (186 ) (154 ) (95 ) Other income (expense), net (14 ) (2 ) (63 ) Total other income (expense) (78 ) (100 ) (115 ) Income before income taxes 7,204 6,522 5,646 Income tax expense 1,345 2,607 1,587 Net Income $ 5,859 $ 3,915 $ 4,059 Basic Earnings per Share $ 5.63 $ 3.67 $ 3.70 Basic weighted-average shares outstanding 1,041 1,067 1,098 Diluted Earnings per Share $ 5.60 $ 3.65 $ 3.69 Diluted weighted-average shares outstanding 1,047 1,072 1,101 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the Years Ended December 31, (in millions) Net Income $ 5,859 $ 3,915 $ 4,059 Other comprehensive income (loss): Foreign currency translation adjustments (319 ) (275 ) Income tax effect (11 ) Foreign currency translation adjustments, net of income tax effect (279 ) (286 ) Translation adjustments on net investment hedge (236 ) Income tax effect (21 ) (22 ) Translation adjustments on net investment hedge, net of income tax effect (153 ) Defined benefit pension and other postretirement plans (18 ) (2 ) Income tax effect (1 ) Defined benefit pension and other postretirement plans, net of income tax effect (15 ) (2 ) Investment securities available-for-sale (3 ) (3 ) Income tax effect (1 ) Investment securities available-for-sale, net of income tax effect (2 ) (1 ) Other comprehensive income (loss), net of income tax effect (221 ) (248 ) Comprehensive Income $ 5,638 $ 4,342 $ 3,811 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Stockholders Equity Common Stock Additional Paid-In Capital Class A Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Non- Controlling Interests Total Equity Class A Class B (in millions, except per share data) Balance at December 31, 2015 $ $ $ 4,004 $ (13,522 ) $ 16,222 $ (676 ) $ $ 6,062 Net income 4,059 4,059 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (248 ) (248 ) Cash dividends declared on Class A and Class B common stock, $0.79 per share (863 ) (863 ) Purchases of treasury stock (3,503 ) (3,503 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2016 4,183 (17,021 ) 19,418 (924 ) 5,684 Net income 3,915 3,915 Activity related to non-controlling interests Other comprehensive income (loss), net of tax Cash dividends declared on Class A and Class B common stock, $0.91 per share (969 ) (969 ) Purchases of treasury stock (3,747 ) (3,747 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2017 4,365 (20,764 ) 22,364 (497 ) 5,497 Adoption of revenue standard Adoption of intra-entity asset transfers standard (183 ) (183 ) Net income 5,859 5,859 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (221 ) (221 ) Cash dividends declared on Class A and Class B common stock, $1.08 per share (1,123 ) (1,123 ) Purchases of treasury stock (4,991 ) (4,991 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2018 $ $ $ 4,580 $ (25,750 ) $ 27,283 $ (718 ) $ $ 5,418 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS For the Years Ended December 31, (in millions) Operating Activities Net income $ 5,859 $ 3,915 $ 4,059 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,235 1,001 Depreciation and amortization Share-based compensation Tax benefit for share-based payments (48 ) Deferred income taxes (244 ) (20 ) Venezuela charge Other Changes in operating assets and liabilities: Accounts receivable (317 ) (445 ) (338 ) Income taxes receivable (120 ) (8 ) (1 ) Settlement due from customers (1,078 ) (281 ) (10 ) Prepaid expenses (1,769 ) (1,402 ) (1,073 ) Accrued litigation and legal settlements (12 ) Restricted security deposits held for customers (6 ) Accounts payable Settlement due to customers Accrued expenses Long-term taxes payable (20 ) Net change in other assets and liabilities (261 ) (187 ) Net cash provided by operating activities 6,223 5,664 4,637 Investing Activities Purchases of investment securities available-for-sale (1,300 ) (714 ) (957 ) Purchases of investments held-to-maturity (509 ) (1,145 ) (867 ) Proceeds from sales of investment securities available-for-sale Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property, plant and equipment (330 ) (300 ) (215 ) Capitalized software (174 ) (123 ) (167 ) Acquisition of businesses, net of cash acquired (1,175 ) Investment in nonmarketable equity investments (91 ) (147 ) (31 ) Other investing activities (14 ) (1 ) Net cash used in investing activities (506 ) (1,781 ) (1,163 ) Financing Activities Purchases of treasury stock (4,933 ) (3,762 ) (3,511 ) Proceeds from debt 1,972 Payment of debt (64 ) Dividends paid (1,044 ) (942 ) (837 ) Tax benefit for share-based payments Tax withholdings related to share-based payments (80 ) (47 ) (51 ) Cash proceeds from exercise of stock options Other financing activities (4 ) (6 ) (2 ) Net cash used in financing activities (4,966 ) (4,764 ) (2,344 ) Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents (6 ) (50 ) Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents (681 ) 1,080 Cash, cash equivalents, restricted cash and restricted cash equivalents - beginning of period 7,592 8,273 7,193 Cash, cash equivalents, restricted cash and restricted cash equivalents - end of period $ 8,337 $ 7,592 $ 8,273 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard, Maestro and Cirrus. The Company is a multi-rail network. Through its core global payments processing network, Mastercard facilitates the switching (authorization, clearing and settlement) of payment transactions, and delivers related products and services. With additional payment capabilities that include real-time account based payments (including automated clearing house (ACH) transactions), Mastercard offers customers one partner to turn to for their payment needs for both domestic and cross-border transactions across multiple payment flows. The Company also provides value-added offerings such as safety and security products, information and analytics services, consulting, loyalty and reward programs and issuer and acquirer processing. The Companys payment solutions are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (a consumer who holds a card or uses another device enabled for payment), issuer (the account holders financial institution), merchant and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys branded products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or cost method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2018 and 2017 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2018 presentation. For 2017 and 2016, $127 million and $113 million , respectively, of expenses were reclassified from advertising and marketing expenses to general and administrative expenses. The reclassification had no impact on total operating expenses, operating income or net income. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. In 2017, due to foreign exchange regulations restricting access to U.S. dollars in Venezuela, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar impacted the Companys ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax or $0.10 per diluted share) that was recorded in general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2017 . Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100% of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2018, 2017 and 2016 , losses from non-controlling interests were de minimis and, as a result, amounts are included on the consolidated statement of operations within other income (expense). The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5% of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense) on the consolidated statement of operations. The Company accounts for investments in common stock or in-substance common stock under the cost method of accounting when it does not exercise significant influence, generally when it holds less than 20% ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5% and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the cost method of accounting. These investments for which there is no readily determinable fair value and the cost method of accounting is used are adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. Investments for which the equity method or cost method of accounting is used are classified as nonmarketable equity investments and recorded in other assets on the consolidated balance sheet. Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those goods or services. Revenue is generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the cards and other devices that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue is primarily based on the number and type of transactions and is recognized as revenue in the same period in which the related transactions occur. Other payment-related products and services are recognized as revenue in the period in which the related services are performed or transactions occur. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives such as marketing, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. Rebates and incentives are calculated based upon estimated performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. Contract assets include unbilled consideration typically resulting from executed consulting, data analytic and research services performed for customers in connection with Mastercards payment network service arrangements. Collection for these services typically occurs over the contractual term. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet. The Company defers the recognition of revenue when consideration has been received prior to the satisfaction of performance obligations. As these performance obligations are satisfied, revenue is subsequently recognized. Deferred revenue is primarily derived from consulting, data analytic and research services. Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed and any non-controlling interest MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the acquiree, at their fair values at the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years. Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized but are tested annually for impairment in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a quantitative assessment. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the transactions between its customers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) records interest expense related to income tax matters as interest expense on the consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. The Company will recognize earnings of foreign affiliates that are determined to be global intangible low taxed income (GILTI) in the period it arises and it will not recognize deferred taxes for basis differences that may reverse as GILTI in future years. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with a maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when it is unavailable for withdrawal or use in its general operations. The Company has the following types of restricted cash and restricted cash equivalents: Restricted cash for litigation settlement - The Company has restricted cash for litigation within a qualified settlement fund related to a preliminary settlement agreement for the U.S. merchant class litigation. The funds continue to be restricted for payments until the litigation matter is resolved. Restricted security deposits held for customers - The Company requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, the Company holds cash deposits and certificates of deposit from certain customers as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. These security deposits are typically held for the duration of the agreement with the customers. Other restricted cash balances - The Company has other restricted cash balances which include contractually restricted deposits, as well as cash balances that are restricted based on the Companys intention with regard to usage. These funds are classified on the consolidated balance sheet within prepaid expenses and other current assets and other assets. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability. Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data. Certain assets are measured at fair value on a nonrecurring basis. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. The Company uses market capitalization for estimating the fair value of its reporting unit. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. Measurement period adjustments, if any, to the preliminary estimated fair value of contingent consideration as of the acquisition date will be recorded to goodwill, however, changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments in debt securities as available-for-sale. Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets. Available-for-sale securities that are not available to meet the Companys current operational needs are classified as non-current assets on the consolidated balance sheet. The investments in debt securities are carried at fair value, with unrealized gains and losses, net of applicable taxes, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. The Company classifies time deposits with maturities greater than three months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. Derivative financial instruments - The Companys derivative financial instruments are recorded as either assets or liabilities on the balance sheet and measured at fair value. The Companys foreign exchange forward and option contracts are included in Level 2 of the Valuation Hierarchy as the fair value of these contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. As the Company does not elect hedge accounting for any derivative instruments, realized and unrealized gains and losses from the change in fair value of these contracts are recognized immediately in current-period earnings. The Companys derivative contracts hedge foreign exchange risk and are not entered into for trading or speculative purposes. The Company did not have any derivative contracts accounted for under hedge accounting as of December 31, 2018 and 2017 . The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The ineffective portion, if any, is recognized in earnings in the current period. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Property, plant and equipment - Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Depreciation of leasehold improvements and amortization of capital leases is included in depreciation and amortization expense on the consolidated statement of operations. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Capital leases Shorter of life of the asset or lease term Leases - The Company enters into operating and capital leases for the use of premises and equipment. Rent expense related to lease agreements that contain lease incentives is recorded on a straight-line basis over the term of the lease. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans and postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the projected benefit obligation at December 31, the measurement date. Overfunded plans, if any, are aggregated and recorded in other assets, while underfunded plans are aggregated and recorded as accrued expenses and other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income), excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. These costs include interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Defined contribution plans - The Companys contributions to defined contribution plans are recorded when employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - Expenses incurred to promote Mastercards products, services and brand are recognized in advertising and marketing on the consolidated statement of operations. The cost of media advertising is expensed when the advertising takes place. Advertising production costs are expensed as incurred. Promotional items are expensed at the time the promotional event occurs. Sponsorship costs are recognized over the period of benefit. Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company to purchase additional interests in the subsidiary at their discretion. These interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to their estimated redemption value. These adjustments to the redemption value will impact retained earnings or additional paid-in capital on the consolidated balance sheet, but will not impact the consolidated statement of operations. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. For 2018 , 2017 and 2016 , there was no impact to EPS for adjustments related to redeemable non-controlling interests. Recently adopted accounting pronouncements Disclosure requirements for defined benefit plans - In August 2018, the Financial Accounting Standards Board (the FASB) issued accounting guidance which modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans by removing, modifying and adding certain disclosures. This guidance is required to be applied retrospectively and is effective for periods ending after December 15, 2020, with early adoption permitted. The Company adopted this guidance effective December 31, 2018, which did not result in a material impact on the Companys current year consolidated financial statements. Income taxes - In March 2018, the FASB incorporated the Securities and Exchange Commissions (the SECs) interpretive guidance from Staff Accounting Bulletin No. 118 (SAB 118), issued on December 22, 2017, into the income tax accounting codification under GAAP. The guidance allows for the recognition of provisional amounts related to 2017 U.S. tax reform (U.S. Tax Reform) during a one year measurement period with changes recorded as a component of income tax expense. This guidance was effective upon issuance. Refer to Note 19 (Income Taxes) for further discussion. Net periodic pension cost and net periodic postretirement benefit cost - In March 2017, the FASB issued accounting guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. Under this guidance, the service cost component is required to be reported in the same line item as other compensation costs arising from services rendered by employees during the period. The other components of the net periodic benefit costs are required to be presented on the consolidated statement of operations separately from the service cost component and outside of operating income. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018, which did not result in a material impact on the Companys current year consolidated financial statements. The Company did not apply this guidance retrospectively, as the impact was de minimis to the prior year consolidated financial statements. Refer to Note 13 (Pension, Postretirement and Savings Plans) for the components of the Companys net periodic pension cost and net periodic postretirement benefit costs. Restricted cash - In November 2016, the FASB issued accounting guidance to address diversity in the classification and presentation of changes in restricted cash on the consolidated statement of cash flows. Under this guidance, companies are required to present restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company adopted this guidance effective January 1, 2018. In accordance with the adoption of this standard, the Company includes restricted cash, which currently consists of restricted cash for litigation settlement, restricted security deposits held for customers and other restricted cash balances in its reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. Refer to Note 5 (Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents) for related disclosures. Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies are required to recognize MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. Refer to Note 19 (Income Taxes) for further discussion. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. Financial instruments - In January 2016, the FASB issued accounting guidance to amend certain aspects of recognition, measurement, presentation and disclosure of financial instruments, including the requirement to measure certain equity investments at fair value with changes in fair value recognized in income. This guidance is required to be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Amendments related to equity securities without readily determinable fair values should be applied prospectively to equity investments that exist as of the date of adoption. The guidance is effective for periods beginning after December 15, 2017. The Company adopted this guidance effective January 1, 2018. The cumulative effect of the adoption of the standard was de minimis to the Companys balance sheet upon adoption. For the year ended December 31, 2018, the Company recorded a gain on non-marketable equity investments, which resulted in a pre-tax increase of $12 million . Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted this guidance effective January 1, 2018 under the modified retrospective transition method, applying the standard to contracts not completed as of January 1, 2018 and considered the aggregate amount of modifications. See the section in this note entitled Cumulative Effect of the Adopted Accounting Pronouncements for a summary of the cumulative impact of adopting this standard as of January 1, 2018. This new revenue guidance impacts the timing of certain customer incentives recognized in the Companys consolidated statement of operations, as they are recognized over the life of the contract. Previously, such incentives were recognized when earned by the customer. The new revenue guidance also impacts the Companys accounting recognition for certain market development fund contributions and expenditures. Historically, these items were recorded on a net basis in net revenue and will now be recognized on a gross basis, resulting in an increase to both revenues and expenses. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following tables summarize the impact of the revenue standard on the Companys consolidated statement of operations for the year ended December 31, 2018 and consolidated balance sheet as of December 31, 2018 : Year Ended December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Net Revenue $ 14,471 $ $ 14,950 Operating Expenses Advertising and marketing Income before income taxes 6,889 7,204 Income tax expense 1,278 1,345 Net Income 5,611 5,859 December 31, 2018 Balances excluding revenue standard Impact of revenue standard As reported (in millions) Assets Accounts receivable $ 2,214 $ $ 2,276 Prepaid expenses and other current assets 1,176 1,432 Deferred income taxes (96 ) Other assets 2,388 3,303 Liabilities Accounts payable (422 ) Accrued expenses 4,375 4,747 Other current liabilities 1,085 (136 ) Other liabilities 1,145 1,877 Equity Retained earnings 26,692 27,283 For a more detailed discussion on revenue recognition, refer to Note 3 (Revenue) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Cumulative Effect of the Adopted Accounting Pronouncements The following table summarizes the cumulative impact of the changes made to the January 1, 2018 consolidated balance sheet for the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers. The prior periods have not been restated and have been reported under the accounting standards in effect for those periods. Balance at December 31, 2017 Impact of revenue standard Impact of intra-entity asset transfers standard Balance at January 1, 2018 (in millions) Assets Accounts receivable $ 1,969 $ $ $ 2,013 Prepaid expenses and other current assets 1,040 (17 ) 1,204 Deferred income taxes (69 ) Other assets 2,298 (352 ) 2,636 Liabilities Accounts payable (495 ) Accrued expenses 3,931 4,322 Other current liabilities (44 ) Other liabilities 1,438 2,066 Equity Retained earnings 22,364 (183 ) 22,547 Recent accounting pronouncements not yet adopted Implementation costs incurred in a hosting arrangement that is a service contract - In August 2018, the FASB issued accounting guidance which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This guidance is effective for periods beginning after December 15, 2019 and early adoption is permitted. Companies are required to adopt this guidance either retrospectively or by prospectively applying the guidance to all implementation costs incurred after the date of adoption. The Company is in the process of evaluating when it will adopt this guidance and the potential effects this guidance will have on its consolidated financial statements. Disclosure requirements for fair value measurement - In August 2018, the FASB issued accounting guidance which modifies disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This guidance is effective for periods beginning after December 15, 2019. Companies are permitted to early adopt the removed or modified disclosures and delay adoption of added disclosures until the effective date. Companies are required to adopt the guidance for certain added disclosures prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption and all other amendments retrospectively to all periods presented upon their effective date. The Company is in the process of evaluating when it will adopt this guidance and the potential effects this guidance will have on its disclosures. Comprehensive income - In February 2018, the FASB issued accounting guidance that allows for a one-time reclassification from accumulated other comprehensive income (loss) to retained earnings for stranded tax effects resulting from U.S. Tax Reform. The guidance is effective for periods beginning after December 15, 2018, with early adoption permitted. The Company will adopt this guidance effective January 1, 2019 and does not expect the impacts of this standard to be material. Derivatives and hedging - In August 2017, the FASB issued accounting guidance to improve and simplify existing guidance to allow companies to better reflect their risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, eliminates the requirement to separately measure and recognize hedge ineffectiveness and eases requirements of an entitys assessment of hedge effectiveness. This guidance is effective for periods beginning after December 15, 2018 and early adoption is permitted. The Company currently does not account for its foreign currency derivative contracts under hedge accounting. The Company will adopt this guidance effective January 1, 2019 and does not expect the impacts of this standard to be material. For a more detailed discussion of the Companys foreign exchange risk management activities, refer to Note 22 (Foreign Exchange Risk Management) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Credit losses - In June 2016, the FASB issued accounting guidance to amend the measurement of credit losses for financial instruments. The guidance requires all expected credit losses for most financial assets held at the reporting date to be measured based on historical experience, current conditions, and reasonable and supportable forecasts, generally resulting in the earlier recognition of allowance for losses. The guidance is effective for periods beginning after December 15, 2019, with early adoption permitted. The Company is required to apply the provisions of this guidance as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company will adopt this guidance effective January 1, 2020 and does not expect the impacts of this standard to be material. Leases - In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. This guidance requires companies to recognize leased assets and liabilities for both financing and operating leases. This guidance is effective for periods beginning after December 15, 2018. The Company will adopt this guidance effective January 1, 2019 using the modified retrospective approach as of the date of adoption with the available practical expedients. Upon adoption of the standard, the estimated impact on the Companys consolidated financial statements is expected to be an increase in non-current assets with a corresponding increase in current and non-current liabilities. The Company estimates that the increase in assets and liabilities will represent approximately 2% of the Companys total assets and total liabilities as of December 31, 2018 and expects no significant impact to retained earnings. Note 2. Acquisitions In 2017 , the Company acquired businesses for total consideration of $1.5 billion , representing both cash and contingent consideration. For the businesses acquired, Mastercard allocated the values associated with the assets, liabilities and redeemable non-controlling interests based on their respective fair values on the acquisition dates. Refer to Note 1 (Summary of Significant Accounting Policies) , for the valuation techniques Mastercard utilizes to fair value the assets and liabilities acquired in business combinations. The residual value allocated to goodwill is not expected to be deductible for local tax purposes. The Company has finalized the purchase accounting for businesses acquired during 2017. The final fair values of the purchase price allocations, as of the acquisition dates, are noted below: (in millions) Cash consideration $ 1,286 Contingent consideration Redeemable non-controlling interests Gain on previously held minority interest Total fair value of businesses acquired $ 1,571 Assets: Cash and cash equivalents $ Other current assets Other intangible assets Goodwill 1,135 Other assets Total assets 1,935 Liabilities: Short-term debt 1 Other current liabilities Net pension liability Other liabilities Total liabilities Net assets acquired $ 1,571 1 The short-term debt assumed through acquisitions was repaid during 2017. The following table summarizes the identified intangible assets acquired: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (Years) Developed technologies $ 7.5 Customer relationships 9.9 Other 1.4 Other intangible assets $ 8.3 For the businesses acquired in 2017, the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4% controlling interest in Vocalink for cash consideration of 719 million ( $929 million as of the acquisition date). In addition, the Vocalink sellers have the potential to earn additional contingent consideration of 169 million (approximately $214 million as of December 31, 2018 ), upon meeting 2018 revenue targets in accordance with terms of the purchase agreement. Refer to Note 7 (Fair Value and Investment Securities) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6% ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $73 million as of December 31, 2018 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. The consolidated financial statements include the operating results of the acquired businesses from the dates of their respective acquisition. Pro forma information related to the acquisitions was not included because the impact on the Companys consolidated results of operations was not considered to be material. Note 3. Revenue Mastercards business model involves four participants in addition to the Company: account holders, issuers (the account holders financial institutions), merchants and acquirers (the merchants financial institutions). Revenue from contracts with customers is recognized when services are performed in an amount that reflects the consideration to which the Company expects to be entitled to in exchange for those services. Revenue recognized from domestic assessments, cross-border volume fees and transaction processing are derived from Mastercards payment network services. Revenue is generated by charging fees to issuers, acquirers and other stakeholders for providing switching services, as well as by assessing customers based primarily on the dollar volume of activity, or gross dollar volume, on the cards and other devices that carry the Companys brands. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. In addition, the Company recognizes revenue from other payment-related products and services in the period in which the related transactions occur or services are performed. The price structure for Mastercards products and services is dependent on the nature of volumes, types of transactions and type of products and services offered to customers. Net revenue can be impacted by the following: domestic or cross-border transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by the Company amount of usage of the Companys other products or services amount of rebates and incentives provided to customers The Company classifies its net revenue into the following five categories: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry the Companys brands where the acquirer country and the issuer country are the same. Revenue from domestic assessments is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Cross-border volume fees are charged to issuers and acquirers based on the dollar volume of activity on cards and other devices that carry the Companys brands where the acquirer country and the issuer country are different. Revenue from cross-border volume is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards or other devices that carry the Companys brands. Transaction processing revenue is recognized for both domestic and cross-border transactions in the period in which the related transactions occur. Transaction processing includes the following: Switched transaction revenue is generated from the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others approve such transactions on behalf of the issuer in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. Transactions are cleared among customers through Mastercards central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to the Companys network. Other processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile initiated transactions; and safety and security. Other revenues consist of value added service offerings that are typically sold with the Companys payment service offerings and are recognized in the period in which the related services are performed or transactions occur. Other revenues include the following: Consulting, data analytic and research fees. Safety and security services fees are for products and services offered to prevent, detect and respond to fraud and to ensure the safety of transactions made primarily on Mastercard products. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. Loyalty and reward solution fees also include rewards campaigns and management services. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Bank account-based payment services relating to ACH transactions and other ACH related services. Other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. Rebates and incentives (contra-revenue) are provided to customers that meet certain volume targets and can be in the form of a rebate or other support incentives, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue primarily when volume- and transaction-based revenues are recognized over the contractual term. In addition, Mastercard may make incentive payments to a customer directly related to entering into an agreement, which are generally capitalized and amortized over the life of the agreement on a straight-line basis. The following table disaggregates the Companys net revenue by source and geographic region for the year ended December 31, 2018 : (in millions) Revenue by source: Domestic assessments $ 6,138 Cross-border volume fees 4,954 Transaction processing 7,391 Other revenues 3,348 Gross revenue 21,831 Rebates and incentives (contra-revenue) (6,881 ) Net revenue $ 14,950 Net revenue by geographic region: North American Markets $ 5,311 International Markets 9,441 Other 1 Net revenue $ 14,950 1 Includes revenues managed by corporate functions. Receivables from contracts with customers of $2.1 billion and $1.9 billion as of December 31, 2018 and 2017 , respectively, are recorded within accounts receivable on the consolidated balance sheet. The Companys customers are billed quarterly or more frequently dependent upon the nature of the performance obligation and the underlying contractual terms. The Company does not offer extended payment terms to customers. Contract assets are included in prepaid expenses and other current assets and other assets on the consolidated balance sheet at December 31, 2018 in the amounts of $40 million and $92 million , respectively. The Company did not have contract assets at December 31, 2017 . Deferred revenue is included in other current liabilities and other liabilities on the consolidated balance sheet at December 31, 2018 in the amounts of $218 million and $101 million , respectively. The comparable amounts included in other current liabilities and other liabilities at December 31, 2017 were $230 million and $17 million , respectively. Revenue recognized from such performance obligations satisfied during 2018 was $904 million . The Companys remaining performance periods for its contracts with customers for its payment network services are typically long-term in nature (generally up to 10 years ). As a payment network service provider, the Company provides its customers with continuous access to its global payment processing network and stands ready to provide transaction processing and related services over the contractual term. Consideration is variable based upon the number of transactions processed and volume activity on the cards and other devices that carry the Companys brands. The Company has elected the optional exemption to not disclose the remaining performance obligations related to its payment network services. The Company also earns revenues from other value added services comprised of bank account-based payment services, consulting and research fees, loyalty programs and other payment-related products and services. At December 31, 2018 , the estimated aggregate consideration allocated to unsatisfied performance obligations for these other value added services is $1.0 billion , which is expected to be recognized through 2022. The estimated remaining performance obligations related to these revenues are subject to change and are affected by several factors, including modifications and terminations and are not expected to be material to any future annual period. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 4. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 5,859 $ 3,915 $ 4,059 Denominator Basic weighted-average shares outstanding 1,041 1,067 1,098 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,047 1,072 1,101 Earnings per Share Basic $ 5.63 $ 3.67 $ 3.70 Diluted $ 5.60 $ 3.65 $ 3.69 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 5. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents The following table provides a reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents reported on the consolidated balance sheet that total to the amounts shown on the consolidated statement of cash flows. December 31, (in millions) Cash and cash equivalents $ 6,682 $ 5,933 $ 6,721 $ 5,747 Restricted cash and restricted cash equivalents Restricted cash for litigation settlement Restricted security deposits held for customers 1,080 1,085 Prepaid expenses and other current assets Other assets Cash, cash equivalents, restricted cash and restricted cash equivalents $ 8,337 $ 7,592 $ 8,273 $ 7,193 Note 6. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: (in millions) Cash paid for income taxes, net of refunds $ 1,790 $ 1,893 $ 1,579 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Capital leases and other Fair value of assets acquired, net of cash acquired 1,825 Fair value of liabilities assumed related to acquisitions MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 7. Fair Value and Investment Securities Financial Instruments - Recurring Measurements The Company classifies its fair value measurements of financial instruments within the Valuation Hierarchy. There were no transfers made among the three levels in the Valuation Hierarchy for 2018 . The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2018 December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,043 1,043 Asset-backed securities Equity securities Derivative instruments 2 : Foreign currency derivative assets Deferred compensation plan 3 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign currency derivative liabilities $ $ (6 ) $ $ (6 ) $ $ (30 ) $ $ (30 ) Deferred compensation plan 4 : Deferred compensation liabilities (54 ) (54 ) (54 ) (54 ) 1 The Companys U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign currency derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 22 (Foreign Exchange Risk Management) for further details. 3 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. 4 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. These are included in other liabilities on the consolidated balance sheet. Settlement and Other Guarantee Liabilities The Company estimates the fair value of its settlement and other guarantees using market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At December 31, 2018 and 2017 , the carrying value and fair value of settlement and other guarantee liabilities were not material MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) and accordingly are not included in the Valuation Hierarchy table above. Settlement and other guarantee liabilities are classified within Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not observable in the market. See Note 21 (Settlement and Other Risk Management) for additional information regarding the Companys settlement and other guarantee liabilities. Financial Instruments - Non-Recurring Measurements Held-to-Maturity Securities Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Held-to-maturity securities are not measured at fair value on a recurring basis and are not included in the Valuation Hierarchy table above. At December 31, 2018 and 2017 , the Company held $264 million and $700 million , respectively, of held-to-maturity securities due within one year. The cost of these securities approximates fair value. Nonmarketable Equity Investments The Companys nonmarketable equity investments are measured at fair value at initial recognition. In addition, nonmarketable equity investments accounted for under the cost method of accounting are adjusted for changes resulting from identifiable price changes in orderly transactions for the identical or similar investments of the same issuer. Nonmarketable equity investments are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity, and the fact that inputs used to measure fair value are unobservable and require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. These investments are included in other assets on the consolidated balance sheet. See Note 8 (Prepaid Expenses and Other Assets) for further details. Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2018 , the carrying value and fair value of total long-term debt (including the current portion) was $6.3 billion and $6.5 billion , respectively. At December 31, 2017 , the carrying value and fair value of long-term debt was $5.4 billion and $5.7 billion , respectively. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Contingent Consideration The contingent consideration attributable to acquisitions made in 2017 is primarily based on the achievement of 2018 revenue targets and is measured at fair value on a recurring basis. This contingent consideration liability is included in other current liabilities on the consolidated balance sheet and is classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices. The activity of the Companys contingent consideration liability for 2018 was as follows: (in millions) Balance at December 31, 2017 $ Net change in valuation Payments (5 ) Foreign currency translation (14 ) Balance at December 31, 2018 $ 82 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amortized Costs and Fair Values Available-for-Sale Investment Securities The major classes of the Companys available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of December 31, 2018 and 2017 were as follows: December 31, 2018 December 31, 2017 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities 1,044 (2 ) 1,043 (1 ) Asset-backed securities Equity securities Total $ 1,433 $ $ (2 ) $ 1,432 $ 1,147 $ $ (1 ) $ 1,149 The Companys available-for-sale investment securities held at December 31, 2018 and 2017 , primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. Investment Maturities: The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2018 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years 1,056 1,055 Due after 5 years through 10 years Total $ 1,433 $ 1,432 Investment Income Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Companys consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for 2018 , 2017 and 2016 were not significant. Note 8. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,432 $ 1,040 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Other assets consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 2,458 $ 1,434 Nonmarketable equity investments Prepaid income taxes Income taxes receivable Other Total other assets $ 3,303 $ 2,298 Customer and merchant incentives represent payments made to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. The increase in customer and merchant incentives and the decrease in prepaid income taxes at December 31, 2018 from December 31, 2017 are primarily due to the impact from the adoption of the new accounting standards pertaining to revenue recognition and intra-entity asset transfers, respectively. See Note 1 (Summary of Significant Accounting Policies) for additional information on the cumulative impact of the adoption of these accounting pronouncements. Note 9. Property, Plant and Equipment Property, plant and equipment consisted of the following at December 31 : (in millions) Building, building equipment and land $ $ Equipment Furniture and fixtures Leasehold improvements Property, plant and equipment 1,768 1,543 Less: accumulated depreciation and amortization (847 ) (714 ) Property, plant and equipment, net $ $ As of December 31, 2018 and 2017 , capital leases of $33 million and $32 million , respectively, were included in equipment. Accumulated amortization of these capital leases was $24 million and $18 million as of December 31, 2018 and 2017 , respectively. Depreciation and amortization expense for the above property, plant and equipment was $209 million , $185 million and $151 million for 2018 , 2017 and 2016 , respectively. Note 10. Goodwill The changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017 were as follows: (in millions) Beginning balance $ 3,035 $ 1,756 Additions 1,136 Foreign currency translation (133 ) Ending balance $ 2,904 $ 3,035 The Company had no accumulated impairment losses for goodwill at December 31, 2018 . Based on annual impairment testing, the Companys goodwill is not impaired. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 11. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31 : Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Finite-lived intangible assets Capitalized software $ 1,514 $ (898 ) $ $ 1,572 $ (888 ) $ Customer relationships (232 ) (214 ) Other (45 ) (55 ) Total 1,999 (1,175 ) 2,102 (1,157 ) Indefinite-lived intangible assets Customer relationships Total $ 2,166 $ (1,175 ) $ $ 2,277 $ (1,157 ) $ 1,120 The decrease in the gross carrying amount of amortized intangible assets in 2018 was primarily related to the retirement of fully amortized intangible assets, partially offset by additions to capitalized software. Certain intangible assets are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2018 , it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $250 million , $252 million and $221 million in 2018, 2017 and 2016 , respectively. The following table sets forth the estimated future amortization expense on finite-lived intangible assets on the consolidated balance sheet at December 31, 2018 for the years ending December 31 : (in millions) $ 2020 2021 2022 2023 and thereafter $ Note 12. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31 : (in millions) Customer and merchant incentives $ 3,275 $ 2,648 Personnel costs Advertising Income and other taxes Other Total accrued expenses $ 4,747 $ 3,931 Customer and merchant incentives represent amounts to be paid to customers under business agreements. The increase in customer and merchant incentives is due to the adoption of the new accounting standard pertaining to revenue recognition and timing of payments to customers. See Note 1 (Summary of Significant Accounting Policies) for additional information on the cumulative impact of the adoption of the revenue recognition guidance. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2018 and 2017 , the Companys provision for litigation was $1,591 million and $709 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 20 (Legal and Regulatory Proceedings) for additional information regarding the Companys accrued litigation. Note 13. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension and other postretirement plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $98 million , $84 million and $73 million in 2018, 2017 and 2016 , respectively. Defined Benefit and Other Postretirement Plans The Company sponsors pension and postretirement plans for certain non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. In 2017, the Company acquired a majority interest in Vocalink. Vocalink has a defined benefit pension plan (the Vocalink Plan) which was permanently closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $18 million as of December 31, 2018 ) annually until March 2020. The term Pension Plans includes the non-U.S. Plans and the Vocalink Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan ($ in millions) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Benefit obligation acquired during the year Service cost Interest cost Actuarial (gain) loss (7 ) (44 ) (2 ) Benefits paid (22 ) (12 ) (5 ) (4 ) Transfers in Foreign currency translation (23 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Fair value of plan assets acquired during the year Actual (loss) gain on plan assets (8 ) (4 ) Employer contributions Benefits paid (23 ) (12 ) (5 ) (4 ) Transfers in Foreign currency translation (21 ) Fair value of plan assets at end of year Funded status at end of year $ (28 ) $ (41 ) $ (57 ) $ (61 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term $ $ $ (3 ) $ (3 ) Other liabilities, long-term (28 ) (41 ) (54 ) (58 ) $ (28 ) $ (41 ) $ (57 ) $ (61 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ (5 ) $ (22 ) $ (7 ) $ (5 ) Prior service credit (6 ) (8 ) Balance at end of year $ (4 ) $ (22 ) $ (13 ) $ (13 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 1.80 % 1.80 % * * Vocalink Plan 3.10 % 2.80 % * * Postretirement Plan * * 4.25 % 3.50 % Rate of compensation increase Non-U.S. Plans 2.60 % 2.60 % * * Vocalink Plan 4.00 % 3.85 % * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Each of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2018 and 2017 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets For the year ended December 31, 2018, the Companys projected benefit obligation related to its Pension Plans decreased $30 million attributable primarily to foreign currency translation and benefits paid. For the year ended December 31, 2017, the Companys projected benefit obligation related to its Pension Plans increased $422 million attributable primarily to the acquisition of Vocalink. Components of net periodic benefit cost recorded in earnings were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets (20 ) (13 ) (1 ) Curtailment gain Amortization of actuarial loss Amortization of prior service credit (2 ) (2 ) (1 ) Pension settlement charge Net periodic benefit cost $ $ $ $ $ $ Net periodic benefit cost, excluding the service cost component, is recognized in other income (expense) on the consolidated statement of operations. The service cost component is recognized in general and administrative expenses on the consolidated statement of operations. Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Curtailment gain $ $ $ $ $ $ Current year actuarial loss (gain) (22 ) (2 ) Current year prior service credit Amortization of prior service credit Pension settlement charge Total other comprehensive loss (income) $ $ (22 ) $ $ $ $ Total net periodic benefit cost and other comprehensive loss (income) $ $ (18 ) $ $ $ $ 88 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.80 % 1.60 % 1.85 % * * * Vocalink Plan 2.80 % 2.50 % * * * * Postretirement Plan * * * 3.50 % 4.00 % 4.25 % Expected return on plan assets Non-U.S. Plans 3.00 % 3.25 % 3.25 % * * * Vocalink Plan 4.75 % 4.75 % * * * * Rate of compensation increase Non-U.S. Plans 2.60 % 2.59 % 2.64 % * * * Vocalink Plan 3.85 % 3.95 % * * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows of each respective plan. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plans assets and considering historical as well as expected returns on various classes of plan assets. The rates of compensation increases are determined by the Company, based upon its long-term plans for such increases. The following additional assumptions were used at December 31 in accounting for the Postretirement Plan: Health care cost trend rate assumed for next year 6.00 % 6.50 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate Assets Plan assets are managed taking into account the timing and amount of future benefit payments. The Vocalink Plan assets are managed within the following target asset allocations: non-government fixed income 39% , government securities (including U.K. governmental bonds) 28% , investment funds 25% and other 8% . The investment funds are currently comprised of approximately 44% derivatives, 28% equity, 16% fixed income and 12% other. For the non-U.S. Plans, the assets are concentrated primarily in insurance contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. Cash and cash equivalents and other public investment vehicles (including certain mutual funds and government and agency securities) are valued at quoted market prices, which represent the net asset value of the shares held by the Vocalink Plan, and are therefore included in Level 1 of the Valuation Hierarchy. Certain other mutual funds (including commingled funds), governmental and agency securities and insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2 of the Valuation Hierarchy. Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value as of December 31, 2018 and 2017 : December 31, 2018 December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents $ $ $ $ $ $ $ $ Government and agency securities Mutual funds Insurance contracts Asset-backed securities Other Total $ $ $ $ $ $ $ $ The following table summarizes expected benefit payments through 2028 for the Pension Plans and the Postretirement Plan, including those payments expected to be paid from the Companys general assets. Actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2020 2021 2022 2023 2024 - 2028 90 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 14. Debt Long-term debt consisted of the following at December 31: Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2018 USD Notes February 2018 Semi-annually $ 3.500 % 3.598 % $ $ $ 3.950 % 3.990 % $ 1,000 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 6,389 5,477 Less: Unamortized discount and debt issuance costs (55 ) (53 ) Total debt outstanding 6,334 5,424 Less: Current portion 1 (500 ) Long-term debt $ 5,834 $ 5,424 1 Relates to the current portion of the 2014 USD Notes, due in April 2019, classified as current portion of long-term debt on the consolidated balance sheet. In February 2018, the Company issued $500 million principal amount of notes due February 2028 and $500 million principal amount of notes due February 2048 (collectively the 2018 USD Notes). The net proceeds from the issuance of the 2018 USD Notes, after deducting the original issue discount, underwriting discount and offering expenses, were $991 million . The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2016 USD Notes, the 2015 Euro Notes and the 2014 USD Notes, were $1.969 billion , $1.723 billion and $1.484 billion , respectively. The outstanding debt, described above, is not subject to any financial covenants and it may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. These notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the notes are to be used for general corporate purposes. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2018 are summarized below. (in millions) $ 2020 650 801 Thereafter 4,438 Total $ 6,389 On November 15, 2018, the Company increased its commercial paper program (the Commercial Paper Program) from $3.75 billion to $4.5 billion under which the Company is authorized to issue unsecured commercial paper notes with maturities of up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed five-year unsecured $4.5 billion revolving credit facility (the Credit Facility) on November 15, 2018. The Credit Facility, which expires on November 15, 2023, amended and restated the Companys prior $3.75 billion credit facility which was set to expire in October 2022. Borrowings under the Credit Facility are available in U.S. dollars and/or euros. The facility fee under the Credit Facility is determined according to the Companys credit rating and is payable on the average daily commitment, regardless of usage, per annum. In addition to the facility fee, interest rates on borrowings under the Credit Facility would be based on prevailing market interest rates plus applicable margins that fluctuate based on the Companys credit rating. The Credit Facility contains customary representations, warranties, events of default and affirmative and negative covenants, including a financial covenant limiting the maximum level of consolidated debt to earnings before interest, taxes, depreciation and amortization (EBITDA). The Company was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2018 and 2017 . The majority of Credit Facility lenders are customers or affiliates of customers of Mastercard. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. The Company had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2018 and 2017 . In March 2018, the Company filed a universal shelf registration statement (replacing a previously filed shelf registration statement that was set to expire) to provide additional access to capital, if needed. Pursuant to the shelf registration statement, the Company may from time to time offer to sell debt securities, guarantees of debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Note 15. Stockholders Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $0.0001 3,000 One vote per share Dividend rights B $0.0001 1,200 Non-voting Dividend rights Preferred $0.0001 No shares issued or outstanding at December 31, 2018 and 2017, respectively. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.0 % 89.0 % 88.0 % 89.2 % Principal or Affiliate Customers (Class B stockholders) 1.1 % % 1.4 % % Mastercard Foundation (Class A stockholders) 10.9 % 11.0 % 10.6 % 10.8 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5% of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027, subject to certain conditions. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2018 , as well as historical purchases: Board authorization dates December 2018 December 2017 December 2016 December December Date program became effective January 2019 March 2018 April 2017 February 2016 January 2015 Total (in millions, except average price data) Board authorization $ 6,500 $ 4,000 $ 4,000 $ 4,000 $ 3,750 $ 22,250 Dollar-value of shares repurchased in 2016 $ $ $ $ 3,004 $ $ 3,511 Remaining authorization at December 31, 2016 $ $ $ 4,000 $ $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ $ 2,766 $ $ $ 3,762 Remaining authorization at December 31, 2017 $ $ 4,000 $ 1,234 $ $ $ 5,234 Dollar-value of shares repurchased in 2018 $ $ 3,699 $ 1,234 $ $ $ 4,933 Remaining authorization at December 31, 2018 $ 6,500 $ $ $ $ $ 6,801 Shares repurchased in 2016 31.2 5.7 36.9 Average price paid per share in 2016 $ $ $ $ 96.15 $ 89.76 $ 95.18 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ $ 131.97 $ 109.16 $ $ 125.05 Shares repurchased in 2018 19.0 7.2 26.2 Average price paid per share in 2018 $ $ 194.77 $ 171.11 $ $ $ 188.26 Cumulative shares repurchased through December 31, 2018 19.0 28.2 40.4 40.8 128.4 Cumulative average price paid per share $ $ 194.77 $ 141.99 $ 99.10 $ 92.03 $ 120.44 The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2015 1,095.0 21.3 Purchases of treasury stock (36.9 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.0 (2.0 ) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock (30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 (5.2 ) Balance at December 31, 2017 1,039.7 14.1 Purchases of treasury stock (26.2 ) Share-based payments 2.8 Conversion of Class B to Class A common stock 2.3 (2.3 ) Balance at December 31, 2018 1,018.6 11.8 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 16. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2018 and 2017 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge Defined Benefit Pension and Other Postretirement Plans 2 Investment Securities Available-for-Sale 3 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2016 $ (949 ) $ $ $ $ (924 ) Other comprehensive income (loss) (153 ) (1 ) Balance at December 31, 2017 (382 ) (141 ) (497 ) Other comprehensive income (loss) (279 ) (15 ) (2 ) (221 ) Balance at December 31, 2018 $ (661 ) $ (66 ) $ $ (1 ) $ (718 ) 1 During 2017, the decrease in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro. During 2018, the increase in the accumulated other comprehensive loss related to foreign currency translation adjustments was driven primarily by the devaluation of the euro, British pound and Brazilian real. 2 During 2017, the increase in the accumulated other comprehensive gain related to the Companys postretirement plans was driven primarily by the addition of the Vocalink Plan. Deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $2 million before tax and $1 million after tax. During 2018, the decrease in the accumulated other comprehensive gain related to the Companys postretirement plans was driven primarily by an actuarial loss related to the Vocalink Plan. Deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $1 million before and after tax. See Note 13 (Pension, Postretirement and Savings Plans) for additional information. 3 During 2017 and 2018, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant. Note 17. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. The Company has granted Options, RSUs and PSUs under the LTIP. The Options, which expire ten years from the date of grant, generally vest ratably over four years from the date of grant. The RSUs and PSUs generally vest after three years . The Company uses the straight-line method of attribution for expensing equity awards. Compensation expense is recorded net of estimated forfeitures. Estimates are adjusted as appropriate. For all awards granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all awards granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Stock Options The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: Risk-free rate of return 2.7 % 2.0 % 1.3 % Expected term (in years) 6.00 5.00 5.00 Expected volatility 19.7 % 19.3 % 23.3 % Expected dividend yield 0.6 % 0.8 % 0.8 % Weighted-average fair value per Option granted $ 40.90 $ 21.23 $ 18.58 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2018 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2018 8.6 $ Granted 0.9 $ Exercised (1.8 ) $ Forfeited/expired (0.1 ) $ Outstanding at December 31, 2018 7.6 $ 6.4 $ Exercisable at December 31, 2018 4.3 $ 5.2 $ Options vested and expected to vest at December 31, 2018 7.6 $ 6.4 $ As of December 31, 2018 , there was $34 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.1 years . Restricted Stock Units The following table summarizes the Companys RSU activity for the year ended December 31, 2018 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2018 4.1 $ Granted 0.9 $ Converted (1.1 ) $ Forfeited (0.2 ) $ Outstanding at December 31, 2018 3.7 $ $ RSUs expected to vest at December 31, 2018 3.6 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) common stock after the vesting period. As of December 31, 2018 , there was $153 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.7 years . Performance Stock Units The following table summarizes the Companys PSU activity for the year ended December 31, 2018 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2018 0.5 $ Granted 0.1 $ Converted (0.3 ) $ Other 1 0.3 $ Outstanding at December 31, 2018 0.6 $ $ PSUs expected to vest at December 31, 2018 0.6 $ $ 1 Represents additional shares issued in March 2018 related to the 2015 PSU grant based on performance and market conditions achieved over the three-year measurement period. These shares vested upon issuance. Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2018 , there was $13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.3 years . Additional Information The following table includes additional share-based payment information for each of the years ended December 31: (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 18. Commitments At December 31, 2018 , the Company had the following future minimum payments due under non-cancelable agreements: Total Capital Leases Operating Leases Sponsorship, Licensing Other (in millions) $ $ $ $ 2020 2021 2022 2023 Thereafter Total $ 1,375 $ $ $ Included in the table above are capital leases with a net present value of minimum lease payments of $8 million . In addition, at December 31, 2018 , $25 million of the future minimum payments in the table above for sponsorship, licensing and other agreements was accrued. Consolidated rental expense for the Companys leased office space was $94 million , $77 million and $62 million for 2018 , 2017 and 2016 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $20 million , $22 million and $19 million for 2018 , 2017 and 2016 , respectively. Note 19. Income Taxes On December 22, 2017, U.S. Tax Reform was enacted into law with the effective date for most provisions being January 1, 2018. U.S. Tax Reform represents significant changes to the U.S. internal revenue code and, among other things: lowered the corporate income tax rate from 35% to 21% imposed a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduced further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations and eliminates the domestic production activities deduction. While the effective date of the law for most provisions was January 1, 2018, GAAP requires the effects of changes in tax rates be accounted for in the reporting period of enactment, which was the 2017 reporting period. Components of Income and Income tax expense The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 3,510 $ 3,482 $ 3,736 Foreign 3,694 3,040 1,910 Income before income taxes $ 7,204 $ 6,522 $ 5,646 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ $ 1,704 $ 1,074 State and local Foreign 1,589 2,521 1,607 Deferred Federal (228 ) (6 ) State and local (11 ) (2 ) Foreign (5 ) (49 ) (12 ) (244 ) (20 ) Income tax expense $ 1,345 $ 2,607 $ 1,587 Effective Income Tax Rate A reconciliation of the effective income tax rate to the U.S. federal statutory income tax rate for the years ended December 31, is as follows: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 7,204 $ 6,522 $ 5,646 Federal statutory tax 1,513 21.0 % 2,283 35.0 % 1,976 35.0 % State tax effect, net of federal benefit 0.6 % 0.7 % 0.4 % Foreign tax effect (92 ) (1.3 )% (380 ) (5.8 )% (188 ) (3.3 )% European Commission fine 2.7 % % % Foreign tax credits 1 (110 ) (1.5 )% (27 ) (0.4 )% (141 ) (2.5 )% Transition Tax 0.3 % 9.6 % % Remeasurement of deferred taxes (7 ) (0.1 )% 2.4 % % Windfall benefit (72 ) (1.0 )% (43 ) (0.7 )% % Other, net (149 ) (2.0 )% (55 ) (0.8 )% (82 ) (1.5 )% Income tax expense $ 1,345 18.7 % $ 2,607 40.0 % $ 1,587 28.1 % 1 Included within the impact of the 2018 foreign tax credits is a $90 million tax benefit relating to the carryback of certain foreign tax credits. Additionally, included in 2016 is a $116 million benefit associated with the repatriation of 2016 foreign earnings. There was no benefit associated with the repatriation of foreign earnings in 2018 and 2017 due to the enactment of U.S. Tax Reform. The effective tax rates for the years ended December 31, 2018, 2017 and 2016 were 18.7% , 40.0% and 28.1% , respectively. The effective income tax rate for 2018 was lower than the effective income tax rate for 2017 primarily due to additional tax expense of $873 million attributable to U.S. Tax Reform in 2017, a lower 2018 statutory tax rate in the U.S. and Belgium and a more favorable geographic mix of earnings. The lower effective tax rate is also attributable to discrete tax benefits, relating primarily to $90 million of foreign tax credits generated in 2018, which can be carried back and utilized in 2017 under transition rules in the proposed foreign tax credit regulations issued on November 28, 2018, along with provisions for legal matters in the United States. These benefits were partially offset by the nondeductible nature of the fine issued by the European Commission. See Note 20 (Legal and Regulatory Proceedings) for further discussion of the European Commission fine and U.S. merchant class litigation. The impact of U.S. Tax Reform for the period ending December 31, 2018 resulted in a net $75 million non-recurring tax benefit due to the carry back of certain foreign tax credits, incremental transition tax and the remeasurement of deferred taxes. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to U.S. Tax reform, which included provisional amounts of $825 million related to the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on 2017 repatriations. In addition, the MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Companys 2017 effective income tax rate versus 2016 was impacted by a more favorable geographic mix of earnings in 2017, partially offset by a lower U.S. foreign tax credit benefit. SAB 118 The Company was able to make reasonable estimates at December 31, 2017 and had recorded a provisional charge of $629 million related to the Transition Tax, $157 million for the remeasurement of the Companys net deferred tax asset in the U.S. and $36 million related to the change in assertion regarding the indefinite reinvestment of foreign earnings. However, these amounts were adjusted during the measurement period due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and Treasury of Notices and regulations, discussions with the Department of Treasury (Treasury), as well as interpretations of how accounting for income taxes should be applied. At the close of the measurement period, the Company has finalized its assessment of the impact of U.S. Tax Reform resulting in a Transition Tax liability of $687 million and a $150 million charge related to the remeasurement of the Companys net deferred tax assets in the U.S. In 2018, the Company recorded an increase in the transition tax liability of $36 million , with an offsetting decrease to its deferred tax liabilities. The Company recorded additional Transition Tax expense of $22 million and has recorded a $7 million reduction to the charge for the remeasurement of its net deferred tax assets. The adjustments in 2018 were primarily the result of additional administrative guidance and proposed regulations issued by the IRS and Treasury. The Transition Tax will be paid over eight annual installments. The initial installment of $55 million was due and paid by April 15, 2018. Additionally, the overpayment appearing on the 2017 U.S. federal tax return has been applied against the Companys Transition Tax liability. Approximately $509 million of the remaining tax due is recorded in other liabilities on the consolidated balance sheet at December 31, 2018. At December 31, 2017 the Company had reflected a current liability of $52 million and an other liability of $577 million . Under U.S. Tax Reform, for purposes of IRS examination of the Transition Tax, the statute of limitations is extended to six years. Singapore Income Tax Rate In connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance in 2010. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2018, 2017 and 2016 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $212 million , or $0.20 per diluted share, $104 million , or $0.10 per diluted share, and $49 million , or $0.04 per diluted share, respectively. Intra-entity asset transfers During 2014, the Company implemented an initiative to better align its legal entity and tax structure with its operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property to a related foreign entity in the United Kingdom. The Company recorded a deferred charge related to the income tax expense on intercompany profits that resulted from the transfer. The tax associated with the transfer was deferred and amortized utilizing a 25 -year life. The deferred charge was included in other current assets and other assets on the consolidated balance sheet at December 31, 2017 in the amounts of $17 million and $352 million , respectively. The aforementioned deferred charge of $369 million at December 31, 2017 , was written off to retained earnings as a component of the cumulative-effect adjustment as of January 1, 2018. In addition, deferred taxes are a component of the cumulative-effect adjustment whereby the Company has recorded a $186 million deferred tax asset in this regard. See Note 1 (Summary of Significant Accounting Policies) for additional information related to this guidance. Indefinite Reinvestment In 2017, as a result of U.S. Tax Reform, among other things, the Company changed its assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates and recognized a provisional deferred tax liability of $36 million . In 2018, the Company completed its analysis of global working capital and cash needs. It is the Companys MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) present intention to indefinitely reinvest a portion of its historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the U.S. As part of its analysis, the Company determined that approximately $5.8 billion of the approximately $6.7 billion of unremitted foreign earnings as of December 31, 2017, were no longer permanently reinvested. Notwithstanding the fact that some earnings continue to be permanently reinvested, all historical earnings, approximately $7.0 billion , were taxed in the U.S. as part of transition tax pursuant to U.S. Tax Reform, of which $267 million was repatriated in 2017. Additionally, during 2018, the Company repatriated approximately $3.3 billion . As of December 31, 2018, the Company had approximately $2.5 billion of accumulated earnings to be repatriated in the future, for which $8 million of deferred tax benefit was recorded. The tax effect is primarily related to the estimated foreign exchange impact recognized when earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Earnings of approximately $0.9 billion remain permanently reinvested and the Company estimates that an immaterial U.S. federal and state and local income tax benefit would result, primarily from foreign exchange, if these earnings were to be repatriated. Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses Unrealized gain/loss - 2015 Euro Notes Recoverable basis of deconsolidated entities Intangible assets 1 Previously taxed earnings and profits Other items Less: Valuation allowance (94 ) (91 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Intangible assets Property, plant and equipment Previously taxed earnings and profits Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ 1 On January 1, 2018 a $186 million deferred tax asset was established related to intra-entity transfers as discussed above. Both the 2018 and 2017 valuation allowances relate primarily to the Companys ability to recognize tax benefits associated with certain foreign net operating losses. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions (17 ) (1 ) (28 ) Settlements with tax authorities (18 ) (4 ) (2 ) Expired statute of limitations (12 ) (11 ) (15 ) Ending balance $ $ $ The entire unrecognized tax benefit of $164 million , if recognized, would reduce the effective tax rate. During 2018, there was a reduction to the balance of the Companys unrecognized tax benefits. This was primarily due to a favorable court decision and settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the U.S., Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. At December 31, 2018 and 2017 , the Company had a net income tax-related interest payable of $8 million and $10 million , respectively, in its consolidated balance sheet. Tax-related interest income /(expense) in the periods 2018 , 2017 and 2016, were not material. In addition, as of December 31, 2018 and 2017 , the amounts the Company has recognized for penalties payable in its consolidated balance sheet were not material. Note 20. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory, legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12% of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36% of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. As a result of the appellate court ruling, the district court divided the merchants claims into two separate classes - monetary damages claims (the Damages Class) and claims seeking changes to business practices (the Rules Relief Class). The court appointed separate counsel for each class. Prior to the reversal of the settlement approval, merchants representing slightly more than 25% of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over 30 opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants motion to dismiss the opt-out merchant complaints for failure to state a claim. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In September 2018, the parties to the Damages Class litigation entered into a class settlement agreement to resolve the Damages Class claims. Mastercard increased its reserve by $237 million during 2018 to reflect both its expected financial obligation under the Damages Class settlement agreement and the filed and anticipated opt-out merchant cases. In January 2019, the district court issued an order granting preliminary approval of the settlement and authorized notice of the settlement to class members. Damages Class members will now have the opportunity to opt out of the class settlement agreement, after which the district court will schedule a hearing on final approval. The settlement agreement does not relate to the Rules Relief Class claims. Separate settlement negotiations with the Rules Relief Class are ongoing. As of December 31, 2018 and 2017 , Mastercard had accrued a liability of $915 million and $708 million , respectively, as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2018 and 2017 , Mastercard had $553 million and $546 million , respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted cash on its consolidated balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters. The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada . In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which requires Mastercard to make a cash payment and modify its no surcharge rule, has received court approval in each Canadian province. Objectors to the settlement have sought to appeal the approval orders. In 2017, Mastercard recorded a provision for litigation of $15 million related to this matter. Europe. In July 2015, the European Commission (EC) issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rule within the European Economic Area (the EEA). The Statement of Objections, which followed an investigation opened in 2013, included preliminary conclusions concerning the alleged anticompetitive effects of these practices. In December 2018, Mastercard announced the anticipated resolution of the ECs investigation. With respect to interregional interchange fees, Mastercard made a settlement proposal whereby it would make changes to its interregional interchange fees. The proposed settlement is subject to market testing by the EC before it is made binding in an EC decision. The EC has announced that Visa has entered into a parallel proposed settlement. In addition, with respect to Mastercards historic central acquiring rule, the EC issued a negative decision in January 2019. The ECs negative decision covers a period of time of less than two years before the rules modification. The rule was modified in late 2015 to comply with the requirements of the EEA Interchange Fee Regulation. The decision does not require any modification of Mastercards current business practices but includes a fine of 571 million . Mastercard incurred a charge of $654 million in the fourth quarter of 2018 in relation to this matter. Since May 2012, a number of United Kingdom (U.K.) retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants). In addition, Mastercard, has faced similar filed or threatened litigation by merchants with respect to interchange rates in other countries in Europe (the Pan-European Merchant claimants). In aggregate, the alleged damages claims from the U.K. and Pan-European Merchant claimants were in the amount of approximately 3 billion (approximately $4 billion as of December 31, 2018 ). Mastercard has resolved over 2 billion (approximately $3 billion as of December 31, 2018 ) of these damages claims through settlement or judgment. Since June 2015, Mastercard has recorded litigation provisions for settlements, judgments and legal fees relating to these claims, including charges of $237 million and $117 million in 2018 and 2016, respectively. There were no litigation charges relating to U.K. and Pan-European Merchant claimants in 2017. As detailed below, Mastercard continues to litigate with the remaining U.K. and Pan-European Merchant claimants and it has submitted statements of defense disputing liability and damages claims. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants. Three of the U.K. Merchant claimants appealed the judgment, and these appeals were MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) combined with Mastercards appeal of a 2016 judgment in favor of one U.K. merchant. In July 2018, the U.K. appellate court ruled against both Mastercard and Visa on two of the three legal issues being considered, concluding that U.K. interchange rates restricted competition and that they were not objectively necessary for the payment networks. The appellate court sent the cases back to trial for reconsideration on the remaining issue concerning the lawful level of interchange. Mastercard and Visa have been granted permission to appeal the appellate court ruling to the U.K. Supreme Court. Mastercard expects the litigation process to be delayed pending the resolution of its appeal to the U.K. Supreme Court. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $18 billion as of December 31, 2018 ). In July 2017, the court denied the plaintiffs application for the case to proceed as a collective action. The plaintiffs were granted permission to appeal the denial of their collective action application and the appellate court heard an oral argument on the appeal in February 2019. ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. The plaintiffs have filed a renewed motion for class certification, following the district courts denial of their initial motion. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Telephone Consumer Protection Class Action Mastercard is a defendant in a Telephone Consumer Protection Act (TCPA) class action pending in Florida. The plaintiffs are individuals and businesses who allege that approximately 381,000 unsolicited faxes were sent to them advertising a Mastercard co-brand card issued by First Arkansas Bank (FAB). The TCPA provides for uncapped statutory damages of $500 per fax. Mastercard has asserted various defenses to the claims, and has notified FAB of an indemnity claim that it has (which FAB has disputed). In June 2018, the court granted Mastercards motion to stay the proceedings until the Federal Communications Commission makes a decision on the application of the TCPA to online fax services. Note 21. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the transactions between its customers (settlement risk). Settlement exposure is the settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily payment volume during the three months ended December 31, 2018 multiplied by the estimated number of days of exposure. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk and exposure. In the event of a failed customer, Mastercard may pursue one or more remedies available under our rules to recover potential losses. Historically, the Company has experienced a low level of losses from customer failures. As part of its policies, Mastercard requires certain customers that are not in compliance with the Companys risk standards to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on a review of the individual risk circumstances for each customer. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure was as follows: December 31, 2018 December 31, 2017 (in millions) Gross settlement exposure $ 49,666 $ 47,002 Collateral held for settlement exposure (4,711 ) (4,360 ) Net uncollateralized settlement exposure $ 44,955 $ 42,642 Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $377 million and $395 million at December 31, 2018 and 2017 , respectively, of which $297 million and $313 million at December 31, 2018 and 2017 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 22. Foreign Exchange Risk Management The Company monitors and manages its foreign currency exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A primary objective of the Companys risk management strategies is to reduce the financial impact that may arise from volatility in foreign currency exchange rates principally through the use of both foreign currency derivative contracts (Derivatives) and foreign currency denominated debt (Net Investment Hedge). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Derivatives The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currencies of the entity. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. As of December 31, 2018 and 2017 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercards derivative contracts are summarized below: December 31, 2018 December 31, 2017 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ (1 ) $ $ Commitments to sell foreign currency 1,066 (26 ) Options to sell foreign currency Balance sheet location Accounts receivable 1 $ $ Prepaid expenses and other current assets 1 Other current liabilities 1 (6 ) (30 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized on the consolidated statement of operations for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign currency derivative contracts General and administrative $ $ (75 ) $ (6 ) The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2018 and 2017 , as these contracts were not accounted for under hedge accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. The effect of a hypothetical 10% adverse change in U.S. dollar forward rates could result in a fair value loss of approximately $113 million on the Companys foreign currency derivative contracts outstanding at December 31, 2018 . Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of December 31, 2018 , the Company had a net foreign currency transaction pre-tax loss of $120 million in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 23. Segment Reporting Mastercard has concluded it has one operating and reportable segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 33% of total revenue in 2018 , 35% in 2017 and 38% in 2016 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. Mastercard did not have any individual customer that generated greater than 10% of net revenue in 2018 , 2017 or 2016 . The following table reflects the geographical location of the Companys property, plant and equipment, net, as of December 31: (in millions) United States $ $ $ Other countries Total $ $ $ 108 MASTERCARD INCORPORATED SUMMARY OF QUARTERLY DATA (Unaudited) 2018 Quarter Ended March 31 June 30 September 30 December 31 2018 Total (in millions, except per share data) Net revenue $ 3,580 $ 3,665 $ 3,898 $ 3,807 $ 14,950 Operating income 1,825 1,936 2,287 1,234 7,282 Net income 1,492 1,569 1,899 5,859 Basic earnings per share $ 1.42 $ 1.50 $ 1.83 $ 0.87 $ 5.63 Basic weighted-average shares outstanding 1,051 1,043 1,037 1,032 1,041 Diluted earnings per share $ 1.41 $ 1.50 $ 1.82 $ 0.87 $ 5.60 Diluted weighted-average shares outstanding 1,057 1,049 1,043 1,038 1,047 2017 Quarter Ended March 31 June 30 September 30 December 31 2017 Total (in millions, except per share data) Net revenue $ 2,734 $ 3,053 $ 3,398 $ 3,312 $ 12,497 Operating income 1,506 1,653 1,941 1,522 6,622 Net income 1,081 1,177 1,430 3,915 Basic earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.67 Basic weighted-average shares outstanding 1,078 1,070 1,063 1,057 1,067 Diluted earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.65 Diluted weighted-average shares outstanding 1,082 1,075 1,068 1,063 1,072 Note: Tables may not sum due to rounding. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2018 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2018 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " +4,ma12,017-10xk," ITEM 1. BUSINESS Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. Through our global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro, Cirrus and Masterpass. Our recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded our capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, we now offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions. We also provide value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. Our networks are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our Strategy We grow, diversify and build our business through a combination of organic growth and strategic investments, including acquisitions. Our ability to grow our business is influenced by personal consumption expenditure (PCE) growth, driving cash and check transactions toward electronic forms of payment, increasing our share in electronic payments and providing value-added products and services. In addition, our ability to grow our business extends to other payments flows, such as business to business (B2B), person to person (P2P), business to consumer (B2C) and government disbursements, among others. We have enhanced our capabilities to capture these payment flows through a combination of product offerings and expanded solutions for our customers. As a result, the total market opportunity for our addressable payment flows is approximately $225 trillion. Grow . We focus on growing our core businesses globally, including growing our consumer credit, debit, prepaid and commercial products and solutions, thereby increasing the number of payment transactions we switch. We also look to take advantage of the opportunities presented by the evolving ways people interact and transact in the growing digital economy. Diversify . We diversify our business by: adding new players to our customer base in new and existing markets by working with partners such as governments, merchants, technology companies (such as digital players and mobile providers) and other businesses expanding capabilities based on our core network into new areas to provide opportunities for electronic payments and to capture more payment flows, such as B2C transfers, B2B transfers, P2P transfers, including in the areas of transit and government disbursements driving acceptance at merchants of all sizes broadening financial inclusion for the unbanked and underbanked Build . We build our business by: creating and acquiring differentiated products to provide unique, innovative solutions that we bring to market, such as real-time account-based payment, Mastercard B2B Hub and Mastercard Send platforms providing value-added services across safety and security, consulting, data analytics, processing and loyalty. Strategic Partners . We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue by driving preference for Mastercard-branded products. We help merchants, financial institutions and other organizations by delivering data-driven insights and other services that help them grow and create simple and secure customer experiences. We partner with technology companies such as digital players and mobile providers to deliver digital payment solutions powered by our technology, expertise and security protocols. We help national and local governments drive increased financial inclusion and efficiency, reduce costs, increase transparency to reduce crime and corruption and advance social programs. For consumers, we provide better, safer and more convenient ways to pay. Recent Business and Legal/Regulatory Developments Digital Payments . Numerous trends in the digital economy, such as demand for faster payments and the application of emerging technology, present opportunities for growth and impetus for change in our business. We have launched and extended products and platforms that take advantage of the growing digital economy, where consumers are increasingly using technology to interact with other consumers and merchants. Among our recent developments in 2017 we: expanded our use of Masterpass globally, which is live in dozens of markets around the world. Masterpass is a global digital payment service that allows consumers to make fast, simple and secure transactions on any device and across any channel. Over the last year, we have enhanced the browser and in-app checkout experience globally and made significant platform improvements to make it easier and faster for consumers to checkout. We have also launched a new merchant onboarding experience and a new package of software to make it easier for merchants to integrate with Masterpass. continued to expand and scale Mastercard Send capabilities, using HomeSend, to connect more people, businesses and governments to facilitate the transfer of funds quickly and securely both domestically and cross-border in over 100 markets. broadened our acceptance solutions to offer Quick Response (QR) codes under a common set of new global specifications developed in conjunction with EMVCo and other industry players. Masterpass QR provides people with mobile phones the ability to safely make in-person purchases without a card and avoids the need for expensive point of sale equipment. Real-time Account-based Payment Systems. In 2017, we completed the acquisition of a controlling interest in Vocalink. Vocalink operates systems for ACH payments and ATM processing platforms in the United Kingdom and other countries. ACH payments constitute a significant amount of all payments made by consumers, businesses and governments. Adding ACH payments to our core card-based business will expand our ability to offer more electronic payment options to consumers, businesses and governments, and help us capture more payment flows. Safety and Security. As new technologies and cyber-security threats evolve, including organized cyber-crime and nation state attacks, there is a growing need to protect transactions and peoples identities regardless of the device or channel used to make a purchase, while at the same time continuing to improve the payment experience for all stakeholders. Our focus on security is embedded in our products, our systems and our networks, as well as our analytics to prevent fraud. In 2017, we: acquired Brighterion, Inc., a software company specializing in Artificial Intelligence (AI), that enhances our networks, improves our existing product suite and helps us build the next generation of solutions to tackle fraud and cybersecurity threats. acquired NuData Security, a global technology company that helps businesses prevent online and mobile fraud using session and behavioral biometric indicators, to enhance security of the internet of things (the IoT), including device-level security and authentication. launched Early Detection System, a service that provides issuers with a unique predictive capability to identify accounts with a heightened risk of fraud based on their exposure to security incidents or data breaches. Early Detection System determines if an account is at risk and sends an alert to the issuer with a quantification of the level of risk. The issuer then uses the level of risk to more accurately prioritize what action to take; from monitoring transactions more closely to proactively issuing a replacement card. embedded AI across our network with Decision Intelligence, a comprehensive decision and fraud detection solution that utilizes our networks to increase approvals and reduce false declines. This solution now applies AI scoring to every processed transaction on our networks and is used by multiple issuers globally. expanded Safety Net, a technology that intelligently detects and blocks large scale fraud events resulting from cyber-attacks against our issuers. This technology now features new advanced detection capabilities, and acts as an extra layer of defense for every issuer we work with globally, monitoring every processed transaction on our networks. helped stakeholders to increase approvals and reduce declines for consumers with our account continuity solution, Automated Billing Updater. This solution automatically updates expired card numbers at merchant card-on-file locations and is increasingly used by major digital merchants. leveraged MDES to tokenize Masterpass and enable third-party token vaults compliant with EMV (the global standard for chip technology) to tokenize Mastercard-branded products and services and extended the utility of MDES to tokenize credentials-on-file. Commercial. Our market share in commercial products is growing globally, as we offer solutions with travel and entertainment, procurement, fleet and virtual cards. We estimate there is $120 trillion in addressable payment flows in B2B globally, of which approximately $100 trillion is related to accounts payable. To address this opportunity, we are expanding our capabilities to capture non-carded payment flows with new solutions, such as the Mastercard B2B Hub, Mastercard Send for cross-border payments, and real-time account-based payment systems for ACH transactions. We launched the innovative Mastercard B2B Hub platform in 2017 to enable small and midsized businesses to optimize their invoice and payment processes with automation tools that improve the speed, ease and security of their commercial payments. Financial Inclusion . We are focused on addressing financial inclusion, reaching people without access to an account that allows them to store and use money. In 2015, we made a commitment to reach 500 million people previously excluded from financial services by 2020. We are more than halfway to delivering on that commitment. In 2017, we worked with governments across several geographies to develop and roll out electronic payments solutions, social payment distribution mechanisms and digital identity solutions. We also worked with merchants globally to help drive acceptance necessary to support these inclusion efforts. Legal and Regulatory . We operate in a dynamic and rapidly evolving legal and regulatory environment, with heightened regulatory and legislative scrutiny, expansion of local regulatory schemes and other legal challenges, particularly with respect to interchange fees (as discussed below under Our Operations and Network). These create both risks and opportunities for our industry. See Part I, Item 1A for a more detailed discussion of our legal and regulatory developments and risks. Also see Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Our recent legal and regulatory developments include: European Union In 2015, the European Commission issued a statement of objections related to the interregional interchange rates we set and our central acquiring rules within the European Economic Area (the EEA). The statement of objections preliminarily concludes that these practices have anticompetitive effects, and the European Commission has indicated it intends to seek fines if it confirms these conclusions. We submitted a response in April 2016 and participated in a related oral hearing in May 2016. Since that time, we have remained in discussions with the European Commission and expect to obtain greater clarity with respect to these issues in the first half of 2018. E.U. member states were required to finish transposing the EEAs revised Payment Services Directive (commonly referred to as PSD2) into their national laws by January 2018. This directive requires financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. This directive also requires a new standard for authentication of transactions, which requires additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. In 2016, the European Parliament passed the General Data Protection Regulation (the GDPR), a new data protection regulation that will increase our compliance burden for using and processing personal and sensitive data of EEA residents. We have implemented an approach to achieve compliance by the May 2018 deadline. United States Merchant Class Litigation. In June 2016, the U.S. Court of Appeals for the Second Circuit reversed the approval of a settlement of an antitrust litigation among a class of merchants, Mastercard, Visa and a number of financial institutions. The court vacated the class action certification and sent the case back to the district court for further proceedings. The parties are proceeding with discovery while at the same time are involved in mediation. Tax Cuts and Jobs Act. On December 22, 2017, the U.S. passed a comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the TCJA). Among other things, the TCJA reduces the U.S. corporate income tax rate from 35% to 21% in 2018, puts into effect the migration towards a territorial tax system and imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax). The enactment of the tax legislation has resulted in additional tax expense of $873 million in the fourth quarter and year ended December 31, 2017, due primarily to provisional amounts recorded for the Transition Tax and the remeasurement of U.S. deferred tax assets and liabilities at lower enacted corporate tax rates. These provisional amounts are based on our initial analysis of the TCJA and may be adjusted in 2018. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. United Kingdom Beginning in May 2012, a number of retailers filed claims or threatened litigation against us seeking damages for alleged anti-competitive conduct with respect to our cross-border interchange fees and our U.K. and Ireland domestic interchange fees. In 2016, a tribunal in one of these cases issued a judgment against us for damages, and we entered into settlements with additional claimants. In January 2017, we received a favorable liability judgment on all significant matters in a separate action brought by ten of the claimants (who were seeking over $500 million in damages). Both the negative judgment and positive judgment for us are being appealed before the U.K. appellate court. In connection with the Vocalink part of our business, we expect to enter into a period of consultation with the U.K. Treasury regarding the possible extension of the U.K. payment systems oversight regime to include Vocalinks role as a service provider. China - In 2017, Peoples Bank of China issued the Service Guidelines for Market Access of Bank Card Clearing Institutions, providing more guidance and clarity in addition to the 2016 regulations on license application and operational requirements for network operators, including international networks such as ours, to process domestic payments in China. We have been engaged with regulators and other stakeholders in connection with steps required to advance an application. In the meantime, we continue to work to expand issuance and acceptance of Mastercard-branded products in the Chinese market to support our existing cross-border business and to prepare for potential domestic opportunities. Our Business Our Operations and Network We operate a unique and proprietary global payments network, our core network, that links issuers and acquirers around the globe to facilitate the switching of transactions, permitting account holders to use a Mastercard product at millions of acceptance locations worldwide. Our core network facilitates an efficient and secure means for receiving payments, a convenient, quick and secure payment method for consumers to access their funds and a channel for businesses to receive insight through information that is derived from our network. We authorize, clear and settle transactions through our core network for our issuer customers in more than 150 currencies and in more than 210 countries and territories. Our acquisition of Vocalink expands our range of payment capabilities beyond our core network. Typical Transaction . Our core network supports what is often referred to as a four-party payments network. The following diagram depicts a typical transaction on our core network, and our role in that transaction: In a typical transaction, an account holder purchases goods or services from a merchant using one of our payment products. After the transaction is authorized by the issuer, the issuer pays the acquirer an amount equal to the value of the transaction, minus the interchange fee (described below), and then posts the transaction to the account holders account. The acquirer pays the amount of the purchase, net of a discount (referred to as the merchant discount rate, as further described below), to the merchant. Interchange Fees. Interchange fees reflect the value merchants receive from accepting our products and play a key role in balancing the costs consumers and merchants incur. We do not earn revenues from interchange fees. Generally, interchange fees are collected from acquirers and paid to issuers to reimburse the issuers for a portion of the costs incurred. These costs are incurred by issuers in providing services that benefit all participants in the system, including acquirers and merchants, whose participation in the network enables increased sales to their existing and new customers, efficiencies in the delivery of existing and new products, guaranteed payments and improved experience for their customers. We (or, alternatively, financial institutions) establish default interchange fees that apply when there are no other established settlement terms in place between an issuer and an acquirer. We administer the collection and remittance of interchange fees through the settlement process. Additional Four-Party System Fees. The merchant discount rate is established by the acquirer to cover its costs of both participating in the four-party system and providing services to merchants. The rate takes into consideration the amount of the interchange fee which the acquirer generally pays to the issuer. Additionally, acquirers may charge merchants processing and related fees in addition to the merchant discount rate, and issuers may also charge account holders fees for the transaction, including, for example, fees for extending revolving credit. Switched Transactions Authorization, Clearing and Settlement. Through our core network, we enable the routing of a transaction to the issuer for its approval, facilitate the exchange of financial transaction information between issuers and acquirers after a successfully conducted transaction, and help to settle the transaction by facilitating the determination and exchange of funds between parties via settlement banks chosen by us and our customers. Cross-Border and Domestic. Our core network switches transactions throughout the world when the merchant country and issuer country are different (cross-border transactions), providing account holders with the ability to use, and merchants to accept, our products and services across country borders. We also provide switched transaction services to customers where the merchant country and the issuer country are the same (domestic transactions). We switch approximately half of all transactions using Mastercard and Maestro-branded cards, including nearly all cross-border transactions. We switch the majority of Mastercard and Maestro-branded domestic transactions in the United States, United Kingdom, Canada, Brazil and a select number of other countries. Outside of these countries, most domestic transactions on our products are switched without our involvement. Our Core Network Architecture. Our core network features a globally integrated structure that provides scale for our issuers, enabling them to expand into regional and global markets. It features an intelligent architecture that enables the network to adapt to the needs of each transaction by blending two distinct network structures: a distributed (peer-to-peer) switching structure for transactions that require fast, reliable switching to ensure they are switched close to where the transaction occurred; and a centralized (hub-and-spoke) switching structure for transactions that require value-added switching, such as real-time access to transaction data for fraud scoring or rewards at the point-of-sale. Our core networks architecture enables us to connect all parties regardless of where or how the transaction is occurring. It has 24-hour a day availability and world-class response time. Real-time Account-based Payment Systems. Augmenting our core network, we now offer real-time account-based payments through our acquisition of Vocalink, which enables payments between bank accounts in near real-time in countries in which it has been deployed. Payments System Security. Our networks and products are designed to ensure safety and security for the global payments system. The networks incorporate multiple layers of protection, both for continuity purposes and to provide best-in-class security protection. We engage in many efforts to mitigate information security challenges, including maintaining an information security program, a business continuity program and insurance coverage, as well as regularly testing our systems to address potential vulnerabilities. As part of our multi-layered approach to protect the global payments system, we also work with issuers, acquirers, merchants, governments and payments industry associations to help develop and put in place standards (e.g., EMV) for safe and secure transactions. Digital Payments. Our networks support and enable our digital payment platforms, products and solutions, reflecting the growing digital economy where consumers are increasingly seeking to use their payment accounts to pay when, where and how they want. Customer Risk. We guarantee the settlement of many of the transactions between our issuers and acquirers to ensure the integrity of our core network. We refer to the amount of this guarantee as our settlement exposure. We do not, however, guarantee payments to merchants by their acquirers, or the availability of unspent prepaid account holder account balances. Our Products and Services We provide a wide variety of integrated products and services that support payment products that customers can offer to their account holders. These services facilitate transactions on our core network among account holders, merchants, financial institutions, businesses, governments, and other organizations in markets globally. Core Products Consumer Credit and Charge. We offer a number of programs that enable issuers to provide consumers with credit that allow them to defer payment. These programs are designed to meet the needs of our customers around the world and address standard, premium and affluent consumer segments. Debit. We support a range of payment products and solutions that allow our customers to provide consumers with convenient access to funds in deposit and other accounts. Our debit and deposit access programs can be used to make purchases and to obtain cash in bank branches, at ATMs and, in some cases, at the point of sale. Our branded debit programs consist of Mastercard (including standard, premium and affluent offerings), Maestro (the only PIN-based solution that operates globally) and Cirrus (our primary global cash access solution). Prepaid. Prepaid programs involve a balance that is funded prior to use and can be accessed via one of our payment products. We offer prepaid payment programs using any of our brands, which we support with processing products and services. Segments on which we focus include government programs such as Social Security payments, unemployment benefits and others; commercial programs such as payroll, health savings accounts, employee benefits and others; and reloadable programs for consumers without formal banking relationships and non-traditional users of electronic payments. We also provide prepaid program management services, primarily outside of the United States, that manage and enable switching and issuer processing for consumer and commercial prepaid travel cards for business partners such as financial institutions, retailers, telecommunications companies, travel agents, foreign exchange bureaus, colleges and universities, airlines and governments. Commercial. We offer commercial payment products and solutions that help large corporations, midsized companies, small businesses and government entities streamline their procurement and payment processes, manage information and expenses (such as travel and entertainment) and reduce administrative costs. Our offerings and platforms include premium, travel, purchasing and fleet cards and programs; our SmartData tool that provides information reporting and expense management capabilities; and credit and debit programs targeted for small businesses. The following chart provides GDV and number of cards featuring our brands in 2017 for select programs and solutions: Year Ended December 31, 2017 As of December 31, 2017 GDV Cards (in billions) Growth (Local) % of Total GDV (in millions) Percentage Increase from December 31, 2016 Mastercard Branded Programs 1,2 Consumer Credit $ 2,289 % % % Consumer Debit and Prepaid 2,369 % % % Commercial Credit and Debit % % % 1 Excludes Maestro and Cirrus cards and volume generated by those cards. 2 Article 8 of the E.U. Interchange Fee Regulation related to card payments, which became effective in June 2016, states that a network can no longer charges fees on domestic EEA payment transactions that do not use its payment brand. Prior to that, Mastercard collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non-Mastercard co-badged volume is no longer being included. Please see Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations for a further discussion. Digital . Leveraging our global innovations capability, we are developing platforms, products and solutions in digital payments that help our customers and partners to offer digital solutions: Delivering better digital experiences everywhere. We work to enable digital payment services across all channels and devices. We are using our technologies and security protocols to develop solutions to make digital shopping and selling experiences, such as on smartphones and other connected devices, simpler, faster and safer for both consumers and merchants. We also offer products that make it easier for merchants to accept payments and expand their customer base and are developing products and practices to facilitate acceptance via mobile devices. The successful implementation of our loyalty and reward programs is an important part of enabling these digital purchasing experiences. Securing more transactions. We are leveraging tokenization, biometrics and machine learning technologies in our push to secure every transaction. These efforts include driving EMV-level security and benefits through all our payment channels. Digitizing personal and business payments. Through Mastercard Send, we provide money transfer and global remittance solutions to enable our customers to facilitate consumers sending and receiving money quickly and securely domestically and around the world. These solutions allow our customers to address new payment flows with the goal of enabling the movement of money from any funding source, such as cash, card, bank account or mobile money account, to any destination globally, securely and in real time. Simplifying access to, and integration of, our digital assets. Our Mastercard Developer platform makes it easy for customers and partners to leverage our many digital assets and services. By providing a single access point with tools and capabilities to find what we believe are some of the best in class Application Program Interfaces (APIs) across a broad range of Mastercard services, we enable easy integration of our services into new and existing solutions. Identifying and experimenting with future technologies, start-ups and trends. Through Mastercard Labs, our global innovation and development arm, we continue to bring customers and partners access to thought leadership, innovation methodologies, new technologies and relevant early-stage fintech players. Additional Platforms. We offer commercial payment products and solutions that utilize additional payment platforms that are in addition to our core network - for example, Mastercard B2B Hub, which enables small and midsized businesses to optimize their invoice and payment processes. In addition, through our acquisition of Vocalink, we offer real-time account-based payments for ACH transactions and will be able to offer commercial solutions utilizing these capabilities. These networks enable payments between bank accounts in near real-time and have key attributes, including enhanced data and messaging capabilities, making them particularly well-suited for B2B and bill payment flows. The real-time account-based payment landscape is rapidly evolving as more markets introduce real-time account-based payment infrastructure. Value-Added Products and Services We provide additional integrated products and services to our customers and stakeholders, including financial institutions, retailers and governments that enhance the value proposition of our products and networks. Safety and Security. We offer integrated products and services to prevent, detect and respond to fraud and cyber-attacks and to ensure the safety of transactions made using Mastercard products. We do this using a multi-layered safety and security strategy: The Prevent layer protects infrastructure, devices and data from attacks. We have continued to grow global usage of EMV chip and contactless security technology, helping to reduce fraud. Greater usage of this technology has increased the number EMV cards issued and the transaction volume on EMV cards. While this technology is prevalent in Europe, the U.S. market has been adopting this technology in recent years. The Identify layer allows us to help banks and merchants verify genuine consumers during the payment process. Examples of solutions under this layer include Mastercard Identity Check, a fingerprint, face and iris scanning biometric technology to verify online purchases on mobile devices, and our recently launched Biometric Card which has a fingerprint scanner built in to the card and is compatible with existing EMV payment terminals The Detect layer spots fraudulent behavior and cyber-attacks and takes action to stop these activities once detected. Examples of our capabilities under this layer include our Early Detection System, Decision Intelligence and Safety Net services and technologies. The Experience layer improves the security experience for our stakeholders in areas from the speed of transactions, improving approvals for online and card-on-file payments, to the ability to differentiate good consumers from fraudsters. Our offerings in this space include Mastercard In Control, for consumer alerts and controls and our suite of digital token services available through our Mastercard Digital Enablement Service (MDES). We have also worked with our financial institution customers to provide products to consumers globally with increased confidence through the benefit of zero liability, or no responsibility for counterfeit or lost card losses in the event of fraud. Loyalty and Rewards . We have built a scalable rewards platform that enables financial institutions to provide consumers with a variety of benefits and services, such as personalized offers and rewards, access to a global airline lounge network, concierge services, insurance services, emergency card replacement, emergency cash advances and a 24-hour account holder service center. For merchants, we provide campaigns with targeted offers and rewards, management services for publishing offers, and accelerated points programs for co-brand and rewards program members. Processing. We extend our processing capabilities in the payments value chain in various regions and across the globe with an expanded suite of offerings, including: Issuer solutions designed to provide customers with a complete processing solution to help them create differentiated products and services and allow quick deployment of payments portfolios across banking channels. Payment gateways that offer a single interface to provide e-commerce merchants with the ability to process secure online and in-app payments and offer value-added solutions, including outsourced electronic payments, fraud prevention and alternative payment options. Mobile gateways that facilitate transaction routing and processing for mobile-initiated transactions for our customers. Mastercard Advisors . Mastercard Advisors is our global professional services group that provides proprietary analysis, data-driven consulting and marketing services solutions to help clients optimize, streamline and grow their businesses, as well as deliver value to consumers. Mastercard Advisors capabilities incorporate payments expertise and analytical and executional skills to create end-to-end solutions which are increasingly delivered via platforms embedded in our customers day-to-day operations. By observing patterns of payments behavior based on billions of transactions switched globally, we leverage anonymized and aggregated information and a consultative approach to help our customers make better business decisions. Our executional skills such as marketing, digital implementation and staff augmentation allow us to assist clients implement actions based on these insights. Increasingly, Mastercard Advisors has been helping financial institutions, retailers and governments innovate. Drawing on rapid prototyping methodologies from our global innovation and development arm, Mastercard Labs, we offer Launchpad, a five day app prototyping workshop that is one of our fastest growing offerings globally. Through our Applied Predictive Technology business, a software as a service platform, we can help our customers conduct disciplined business experiments for in-market tests. Brand Our family of well-known brands includes Mastercard, Maestro, Cirrus and Masterpass. We manage and promote our brands through advertising, promotions and sponsorships, as well as digital, mobile and social media initiatives, in order to increase peoples preference for our brands and usage of our products. We sponsor a variety of sporting, entertainment and charity-related marketing properties to align with consumer segments important to us and our customers. Our advertising plays an important role in building brand visibility, usage and overall preference among account holders globally. Our Priceless advertising campaign, which has run in 54 languages in 119 countries worldwide, promotes Mastercard usage benefits and acceptance, markets Mastercard payment products and solutions and provides Mastercard with a consistent, recognizable message that supports our brand around the globe. We have extended Priceless to create experiences through four platforms to drive brand preference: Priceless Cities provides account holders across all of our regions with access to special experiences in various cities, Priceless Causes provides account holders with opportunities to support philanthropic causes, Priceless Specials TM provides account holders with merchant offers and discounts and Priceless Surprises provides account holders with unexpected and unique surprises. Our Revenue Sources We generate revenues primarily from assessing our customers based on GDV on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Our net revenues are classified into five categories: domestic assessment fees, cross-border volume fees, transaction processing fees, other revenues and rebates and incentives (contra-revenue). See Managements Discussion and Analysis of Financial Condition and Results of Operations - Revenue in Part II, Item 7 for more detail about our revenue, GDV, processed transactions and our other payment-related products and services. Intellectual Property We own a number of valuable trademarks that are essential to our business, including Mastercard, Maestro and Cirrus, through one or more affiliates. We also own numerous other trademarks covering various brands, programs and services offered by us to support our payment programs. Trademark and service mark registrations are generally valid indefinitely as long as they are used and/or properly maintained. Through license agreements with our customers, we authorize the use of our trademarks in connection with our customers issuing and merchant acquiring businesses. In addition, we own a number of patents and patent applications relating to payments solutions, transaction processing, smart cards, contactless, mobile, biometrics, AI, security systems and other matters, many of which are important to our business operations. Patents are of varying duration depending on the jurisdiction and filing date. Competition We compete in the global payments industry against all forms of payment including: cash and checks card-based payments, including credit, charge, debit, ATM and prepaid products, as well as limited-use products such as private label contactless, mobile and e-commerce payments, as well as cryptocurrency other electronic payments, including ACH payments, wire transfers, electronic benefits transfers and bill payments We face a number of competitors both within and outside of the global payments industry: Cash, Check and legacy ACH . Cash and checks continue to represent one of the most widely used forms of payment. However, an even larger share of payments on a U.S. dollar volume basis are made via legacy, or slow, ACH platforms. When combined, cash, checks and legacy ACH payments represent 90 percent of the $225 trillion of addressable payment flows. General Purpose Payment Networks . We compete worldwide with payment networks such as Visa, American Express, JCB, China UnionPay and Discover, among others. Some of the competitors have more market share than we do in certain jurisdictions. Some also have different business models that may provide an advantage in pricing, regulatory compliance burdens or otherwise. In addition, several governments are promoting, or considering promoting, local networks for domestic switching. See Risk Factors in Part I, Item 1A for a discussion of the risks related to payments system regulation and government actions that may prevent us from competing effectively for a more detailed discussion. Debit and Local Networks. We compete with ATM and point-of-sale debit networks in various countries. In addition, in many countries outside of the United States, local debit brands serve as the main domestic brands, while our brands are used mostly to enable cross-border transactions (typically representing a small portion of overall transaction volume). Certain jurisdictions have also created domestic card schemes that are focused mostly on debit (including MIR in Russia). Competition for Customer Business . We compete intensely with other payments networks for customer business. Globally, financial institutions typically issue both Mastercard and Visa-branded payment products, and we compete with Visa for business on the basis of individual portfolios or programs. In addition, a number of our customers issue American Express and/or Discover-branded payment cards in a manner consistent with a four-party system. We continue to face intense competitive pressure on the prices we charge our issuers and acquirers, and we seek to enter into business agreements with them through which we offer incentives and other support to issue and promote our payment products. We also compete for non-financial institution partners, such as merchants, governments and mobile providers. Real-time Account-based Payment Systems. Through our acquisition of Vocalink, we now face competition in the real-time account-based payment space from other companies that provide these payment solutions. In addition, real-time account-based payments face competition from other payment methods, such as cash and checks, credit cards, electronic, mobile and e-commerce payment platforms, cryptocurrencies and other payments networks. Alternative Payments Systems and New Entrants . As the global payments industry becomes more complex, we face increasing competition from alternative payment systems and emerging payment providers. Many of these providers have developed payments systems focused on online activity in e-commerce and mobile channels (in some cases, expanding to other channels), and may process payments using in-house account transfers, real-time account-based payment networks or global or local networks. Examples include digital wallet providers (such as Paytm, PayPal, Alipay and Amazon), mobile operator services, mobile phone-based money transfer and microfinancing services (such as mPesa), handset manufacturers and cryptocurrencies. In some circumstances, these providers can be a partner or customer, as well as a competitor. Value-Added Products and Services. We face competition from companies that provide alternatives to our value-added products and services, including information services and consulting firms that provide consulting services and insights to financial institutions, as well as companies that compete against us as providers of loyalty and program management solutions. In addition, our integrated products and services offerings face competition and potential displacement from transaction processors throughout the world, which are seeking to enhance their networks that link issuers directly with point-of-sale devices for payment transaction authorization and processing services. Regulatory initiatives could also lead to increased competition in this space. Our competitive advantages include our: globally recognized brands highly adaptable global acceptance network built over 50 years expertise in real-time account-based payments through our Vocalink acquisition adoption of innovative products and digital solutions Masterpass global digital payments ecosystem safety and security solutions embedded in our networks Mastercard Advisors group dedicated solely to the payments industry ability to serve a broad array of participants in global payments due to our expanded on-soil presence in individual markets and a heightened focus on working with governments world class talent Government Regulation General. Government regulation impacts key aspects of our business. We are subject to regulations that affect the payments industry in the many countries in which our integrated products and services are used. See Risk Factors in Part I, Item 1A for more detail and examples. Payments Oversight . Several central banks or similar regulatory bodies around the world have increased, or are seeking to increase, their formal oversight of the electronic payments industry. Actions by these organizations could influence other organizations around the world to adopt or consider adopting similar oversight. As a result, Mastercard could be subject to new regulation, supervisions and examination requirements. For example, in the U.K., the Bank of England has expanded its oversight of systemically important payment systems to include service providers, as well. Also, in the EEA, the implementation of the revised Payment Services Directive (PSD2) will require financial institutions to provide third party payment processors access to consumer payment accounts, which may enable these processors to route transactions away from Mastercard products by offering certain services directly to people who currently use our products. PSD2 will also require a new standard for authentication of transactions, which necessitate additional verification information from consumers to complete transactions. This may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience under the new standards. Interchange Fees. Interchange fees associated with four-party payments systems like ours are being reviewed or challenged in various jurisdictions around the world via legislation to regulate interchange fees, competition-related regulatory proceedings, central bank regulation and litigation. Examples include statutes in the United States that cap debit interchange for certain regulated activities and European Union legislation capping consumer credit and debit interchange fees on payments issued and acquired within the EEA. For more detail, see our risk factors in Risk Factors-Regulations Related to Our Participation in the Payments Industry in Part I, Item 1A. Also see Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. Preferential or Protective Government Actions. Some governments have taken action to provide resources, preferential treatment or other protection to selected domestic payments and processing providers, as well as to create their own national providers. Payments System Regulation . Regulators in several countries around the world either have, or are seeking to establish, authority to regulate certain aspects of the payments systems in their countries. Such authority has resulted in regulation of various aspects of our business. In the European Union, legislation requires us to separate our scheme activities (brand, products, franchise and licensing) from our switched transactions and other processing in terms of how we go to market, make decisions and organize our structure. Additionally, several jurisdictions have created or granted authority to create new regulatory bodies that either have or would have the authority to regulate payment systems, including the United Kingdoms Payments Systems Regulator (PSR) (which has designated us (including our Vocalink business) as a payments system subject to regulation) and the National Bank of Belgium. Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption. We are subject to anti-money laundering (AML) and counter terrorist financing (CTF) laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by the U.S. Office of Foreign Assets Control (OFAC). We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including its list of Specially Designated Nationals and Blocked Persons (the SDN List). We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist- sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. Financial Sector Oversight. We are or may be subject to regulations related to our role in the financial industry and our relationship with our financial institution customers. In addition, we are or may be subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. The regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. Issuer Practice Legislation and Regulation. Our customers are subject to numerous regulations and investigations applicable to banks and other financial institutions in their capacity as issuers and otherwise, impacting us as a consequence. Such regulations and investigations have been related to payment card add-on products, campus cards, bank overdraft practices, fees issuers charge to account holders and the transparency of terms and conditions. Additionally, regulations such as PSD2 in the EEA require financial institutions to provide third-party payment-processors access to consumer payment accounts, enabling them to provide payment initiation and account information services directly to consumers. Regulation of Internet and Digital Transactions . Various jurisdictions have enacted or have proposed regulation related to internet transactions. The legislation applies to payments system participants, including us and our U.S. customers, and is implemented through a federal regulation. We may also be impacted by evolving laws surrounding gambling, including fantasy sports. Certain jurisdictions are also considering regulatory initiatives in digital-related areas that could impact us, such as cyber-security, copyright and trademark infringement and privacy. Data Protection and Information Security. Aspects of our operations or business are subject to privacy and data protection laws in the United States, the European Union and elsewhere around the world. For example, in the United States, we and our customers are respectively subject to Federal Trade Commission and federal banking agency information safeguarding requirements under the Gramm-Leach-Bliley Act that require the maintenance of a written, comprehensive information security program. In the European Union, we will be subject to the pending GDPR which goes into effect in May of 2018. This law will require a comprehensive data protection and privacy program to protect the personal and sensitive data of European citizens and residents. Due to constant changes to the nature of data, regulations in this area are constantly evolving with regulatory and legislative authorities in numerous parts of the world considering proposals to protect information. In addition, the interpretation and application of these privacy and data protection laws are often uncertain and in a state of flux, thus requiring constant monitoring for compliance. Additional Regulatory Developments. Various regulatory agencies also continue to examine a wide variety of issues that could impact us, including evolving laws surrounding marijuana, prepaid payroll cards, virtual currencies, identity theft, account management guidelines, privacy, disclosure rules, security and marketing that would impact our customers directly. Seasonality See Managements Discussion and Analysis of Financial Condition and Results of Operations-Seasonality in Part II, Item 7. Financial Information About Geographic Areas See Note 21 (Segment Reporting) to the consolidated financial statements included in Part II, Item 8 for certain geographic financial information. Employees As of December 31, 2017 , we employed approximately 13,400 persons, of whom approximately 7,900 were employed outside of the United States. Additional Information Mastercard Incorporated was incorporated as a Delaware corporation in May 2001. We conduct our business principally through our principal operating subsidiary, Mastercard International Incorporated (Mastercard International), a Delaware non-stock (or membership) corporation that was formed in November 1966. For more information about our capital structure, including our Class A common stock (our voting stock) and Class B common stock (our non-voting stock), see Note 13 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8. Website and SEC Reports Our internet address is www.mastercard.com. From time to time, we may use our corporate website as a channel of distribution of material company information. Financial and other material information is routinely posted and accessible on the investor relations section of our corporate website. In addition, you may automatically receive email alerts and other information about Mastercard by enrolling your email address by visiting Investor Alerts in the investor relations section of our corporate website. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available for review, without charge, on the investor relations section of our corporate website as soon as reasonably practicable after they are filed with, or furnished to, the U.S. Securities and Exchange Commission (the SEC). The information contained on our corporate website is not incorporated by reference into this Report. You may also read and copy any materials that we file with the SEC at its Public Reference Room at 100 F Street N.E., Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, our filings are available electronically from the SEC at www.sec.gov. "," ITEM 1A. RISK FACTORS Legal and Regulatory Direct Regulation of the Payments Industry Global regulatory and legislative activity related to the payments industry may have a material adverse impact on our overall business and results of operations. Regulators increasingly seek to regulate, or establish or expand their authority to regulate, certain aspects of payments systems such as ours. Some recent examples of regulatory and legislative activity include: The European Unions adoption of its Interchange Fee Regulation in 2015 regulating electronic payments issued and acquired within the EEA, including caps on consumer credit and debit interchange fees (described in more detail in the risk factors below) and the separation of brand and switching (which Mastercard implemented in 2016) Several jurisdictions creation or grant of authority to create new regulations that either have or would enable the authority to regulate or increase formal oversight over payment systems, including the United Kingdom and India (both of which have designated us as a payments system subject to regulation), as well as Brazil, Hong Kong, Mexico and Russia The EEAs implementation of the revised PSD2, which requires: financial institutions to provide third party payment processors access to consumer payment accounts. This may enable these third party payment processors to route transactions away from Mastercard products by offering account information or payment initiation services directly to people who currently use our products. a different standard for authentication of transactions (strong customer authentication (SCA), as opposed to risk-based authentication). The new authentication standard requires additional verification information from consumers to complete transactions and may increase the number of transactions that consumers abandon if we are unable to ensure a frictionless authentication experience. An increase in the rate of abandoned transactions could adversely impact our volumes or other operations metrics. These regulations have established, and could further expand, obligations or restrictions with respect to the types of products and services that we may offer to financial institutions for consumers, the countries in which our integrated products and services may be used, the way we structure and operate our business and the types of consumers and merchants who can obtain or accept our products or services. New regulations and oversight could also relate to our clearing and settlement activities (including risk management policies and procedures, collateral requirements, participant default policies and procedures, the ability to complete timely switching of financial transactions, and capital and financial resource requirements). In addition, several central banks or similar regulatory bodies around the world that have increased, or are seeking to increase, their formal oversight of the electronic payments industry and, in some cases, are considering designating certain payments networks as systemically important payment systems or critical infrastructure. These obligations, designations and restrictions may further expand and could conflict with each other as more jurisdictions impose oversight of payment systems. As a result, increased regulation and oversight of payment systems may result in costly compliance burdens or otherwise increase our costs. Such laws or compliance burdens could result in issuers being less willing to participate in our payments system, reduce the benefits offered in connection with the use of our products (making our products less desirable to consumers), reduce the volume of domestic and cross-border transactions or other operational metrics, disintermediate us, impact our profitability and limit our ability to innovate or offer differentiated products and services, all of which could materially and adversely impact our financial performance. Regulators could also require us to obtain prior approval for changes to its system rules, procedures or operations, or could require customization with regard to such changes, which could impact market participant risk and therefore risk to us. Such regulatory changes could lead to new or different criteria for participation in and access to our payments system by financial institutions or other customers. Moreover, failure to comply with the laws and regulations to which we are subject could result in fines, sanctions, civil damages or other penalties, which could materially and adversely affect our overall business and results of operations, as well as have an impact on our brand and reputation Increased regulatory, legislative and litigation activity with respect to interchange rates could have an adverse impact on our business. Interchange rates are a significant component of the costs that merchants pay in connection with the acceptance of our products. Although we do not earn revenues from interchange, interchange rates can impact the volume of transactions we see on our payment products. If interchange rates are too high, merchants may stop accepting our products or route debit transactions away from our network. If interchange rates are too low, issuers may stop promoting our integrated products and services, eliminate or reduce loyalty rewards programs or other account holder benefits (e.g., free checking, low interest rates on balances), or charge fees to account holders (e.g., annual fees or late payment fees). Governments and merchant groups in a number of countries have implemented or are seeking interchange rate reductions through legislation, competition law, central bank regulation and litigation. Examples of regulatory and legislative activity include: A Statement of Objections issued by the European Commission in July 2015 related to our interregional interchange fees and central acquiring rules within the EEA, to which we have responded and remain in discussions. Legislation regulating the level of domestic interchange rates that has been enacted, or is being considered, in many jurisdictions (for example, debit interchange in the United States is capped by statute for certain regulated entities). Merchants and consumers are also seeking interchange fee reductions and acceptance rule changes through litigation. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details. If issuers cannot collect or we are forced to reduce interchange rates, issuers may be less willing to participate in our four-party payments system, or may reduce the benefits offered in connection with the use of our products, reducing the attractiveness of our products to consumers. In particular, any changes to interregional interchange fees as a result of the European Commissions Statement of Objections could impact our cross-border transaction activity disproportionately versus competitors that are not subject to similar reductions. These and other impacts could lower transaction volumes, and/or make proprietary three-party networks or other forms of payment more attractive. Issuers could reduce the benefits associated with our products or choose to charge higher fees to consumers to attempt to recoup a portion of the costs incurred for their services. In addition, issuers could seek to decrease the expense of their payment programs by seeking a reduction in the fees that we charge to them, particularly if regulation has a disproportionate impact on us as compared to our competitors in terms of the fees we can charge. This could make our products less desirable to consumers, reduce the volume of transactions and our profitability, and limit our ability to innovate or offer differentiated products. We are devoting substantial resources to defending our right to establish interchange rates in regulatory proceedings, litigation and legislative activity. The potential outcome of any of these activities could have a more positive or negative impact on us relative to our competitors. If we are ultimately unsuccessful in defending our ability to establish interchange rates, any resulting legislation, regulation and/or litigation may have a material adverse impact on our overall business and results of operations. In addition, regulatory proceedings and litigation could result in us being fined and/or having to pay civil damages, the amount of which could be material. Current regulatory activity could be extended to additional jurisdictions or products, which could materially and adversely affect our overall business and results of operations. Regulators around the world increasingly replicate other regulators approaches with regard to the regulation of payments and other industries. Consequently, regulation in any one country, state or region may influence regulatory approaches in other countries, states or regions. Similarly, new laws and regulations within a country, state or region involving one product may lead to regulation of similar or related products. For example, regulations affecting debit transactions could lead to regulation of other products (such as credit). As a result, the risks to our business created by any one new law or regulation are magnified by the potential it has to be replicated in other jurisdictions or involve other products within any particular jurisdiction. These include matters like interchange rates, potential direct regulation of our network fees and pricing, network standards and network exclusivity and routing agreements. Conversely, if widely varying regulations come into existence worldwide, we may have difficulty adjusting our products, services, fees and other important aspects of our business to meet the varying requirements. Either of these outcomes could materially and adversely affect our overall business and results of operations. Limitations on our ability to restrict merchant surcharging could materially and adversely impact our results of operations. We have historically implemented policies, referred to as no-surcharge rules, in certain jurisdictions, including the United States, that prohibit merchants from charging higher prices to consumers who pay using our products instead of other means. Authorities in several jurisdictions have acted to end or limit the application of these no-surcharge rules (or indicated interest in doing so). Additionally, we have modified our no-surcharge rules to permit U.S. merchants to surcharge credit cards, subject to certain limitations. It is possible that over time merchants in some or all merchant categories in these jurisdictions may choose to surcharge as permitted by the rule change. This could result in consumers viewing our products less favorably and/or using alternative means of payment instead of electronic products, which could result in a decrease in our overall transaction volumes, and which in turn could materially and adversely impact our results of operations. Preferential or Protective Government Actions Preferential and protective government actions related to domestic payment services could adversely affect our ability to maintain or increase our revenues. Governments in some countries have acted, or in the future may act, to provide resources, preferential treatment or other protection to selected national payment and switching providers, or have created, or may in the future create, their own national provider. This action may displace us from, prevent us from entering into, or substantially restrict us from participating in, particular geographies, and may prevent us from competing effectively against those providers. For example: Governments in some countries are considering, or may consider, regulatory requirements that mandate switching of domestic payments either entirely in that country or by only domestic companies. In particular, we are currently excluded from domestic switching in China and are seeking market access, which is uncertain and subject to a number of factors, including receiving regulatory approval. In 2017, Peoples Bank of China issued the Service Guidelines for Market Access of Bank Card Clearing Institutions, which provide some guidance on the 2016 regulations on license application and operational requirements for network operators to process domestic payments in China. We have been engaged with regulators, business partners and other stakeholders in connection with steps required to advance an application. Additionally, Russia has amended its National Payments Systems laws to require all payment systems to process domestic transactions through a government-owned payment switch. As a result, all of our domestic transactions in Russia are currently processed by that system instead of by us. Geopolitical events and resulting OFAC sanctions, adverse trade policies or other types of government actions could lead jurisdictions affected by those sanctions to take actions in response that could adversely affect our business. Regional groups of countries, such as the Gulf Cooperation Countries in the Middle East and a number of countries in South East Asia, are considering, or may consider, efforts to restrict our participation in the switching of regional transactions. Such developments prevent us from utilizing our global switching capabilities for domestic or regional customers. Our efforts to effect change in, or work with, these countries may not succeed. This could adversely affect our ability to maintain or increase our revenues and extend our global brand. Regulation Related to Our Participation in the Payments Industry Regulations that directly or indirectly affect the global payments industry may materially and adversely affect our overall business and results of operations. We are subject to regulations that affect the payments industry in the many jurisdictions in which our integrated products and services are used. Many of our customers are also subject to regulations applicable to banks and other financial institutions that, at times, consequently affect us. Regulation of the payments industry, including regulations applicable to us and our customers, has increased significantly in the last several years. See Business-Government Regulation in Part I, Item 1 for a detailed description of such regulation and related legislation. Examples include: Anti-Money Laundering, Counter Terrorist Financing, Economic Sanctions and Anti-Corruption - We are subject to AML and CTF laws and regulations globally, including the U.S. Bank Secrecy Act and the USA PATRIOT Act, as well as the various economic sanctions programs, including those imposed and administered by OFAC. We have implemented a comprehensive AML/CTF program, comprised of policies, procedures and internal controls, including the designation of a compliance officer, which is designed to prevent our payment network from being used to facilitate money laundering and other illicit activity and to address these legal and regulatory requirements and assist in managing money laundering and terrorist financing risks. The economic sanctions programs administered by OFAC restrict financial transactions and other dealings with certain countries and geographies (specifically Crimea, Cuba, Iran, North Korea and Syria) and with persons and entities included in OFAC sanctions lists including the SDN List. We take measures to prevent transactions that do not comply with OFAC and other applicable sanctions, including establishing a risk-based compliance program that has policies, procedures and controls designed to prevent us from having unlawful business dealings with prohibited countries, regions, individuals or entities. As part of this program, we obligate issuers and acquirers to comply with their local sanctions obligations and the U.S. sanctions programs, including requiring the screening of account holders and merchants, respectively, against OFAC sanctions lists (including the SDN List). Iran, Sudan and Syria have been identified by the U.S. State Department as terrorist-sponsoring states, and we have no offices, subsidiaries or affiliated entities located in any of these countries or geographies and do not license entities domiciled there. We are also subject to anti-corruption laws and regulations globally, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, which, among other things, generally prohibit giving or offering payments or anything of value for the purpose of improperly influencing a business decision or to gain an unfair business advantage. We have implemented policies, procedures and internal controls to proactively manage corruption risk. A violation and subsequent judgment or settlement against us, or those with whom we may be associated, under these laws could subject us to substantial monetary penalties, damages, and/or have a significant reputational impact. Financial Sector Oversight - In the United States, we are subject to regulation by a number of agencies charged with oversight of, among other things, consumer protection, financial and banking matters. These regulators have supervisory and independent examination authority as well as enforcement authority that we may be subject to because of the services we provide to financial institutions that issue and acquire our products. It is often not clear whether and/or to what extent these institutions will regulate broader aspects of payment networks. Real-time Account-based Payment Systems In 2017, we completed the acquisition of a controlling interest in Vocalink. In the U.K., the Bank of England has expanded its oversight of certain payment system providers that are systemically important to U.K.s payment network. As a result of these changes, aspects of our Vocalink business could become subject to the U.K. payment system oversight regime and be directly overseen by the Bank of England. Issuer Practice Legislation and Regulation - Our financial institution customers are subject to numerous regulations, which impact us as a consequence. In addition, certain regulations, such as PSD2 in the EEA, may disintermediate issuers. If our customers are disintermediated in their business, we could face diminished demand for our integrated products and services. In addition, existing or new regulations in these or other areas may diminish the attractiveness of our products to our customers. Regulation of Internet and Digital Transactions - Proposed legislation in various jurisdictions relating to Internet gambling and other digital areas such as cyber-security, copyright, trademark infringement and privacy could impose additional compliance burdens on us and/or our customers, including requiring us or our customers to monitor, filter, restrict, or otherwise oversee various categories of payment transactions. Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs. Similarly, increased regulatory focus on our customers may cause such customers to reduce the volume of transactions processed through our systems. Actions by regulators could influence other organizations around the world to enact or consider adopting similar measures, amplifying any potential compliance burden. Finally, failure to comply with the laws and regulations discussed above to which we are subject could result in fines, sanctions or other penalties. Each may individually or collectively materially and adversely affect our financial performance and/or our overall business and results of operations, as well as have an impact on our reputation. We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions. We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various non-U.S. jurisdictions. Potential changes in existing tax laws may impact our effective tax rate and tax payments. For example, the recent U.S. tax legislation enacted on December 22, 2017 represents a significant overhaul of the U.S. federal tax code. This tax legislation reduced the U.S. statutory corporate tax rate and made other changes that could have a favorable impact on our overall U.S. federal tax liability in a given period. However, the tax legislation also included a number of provisions that limit or eliminate various deductions, including interest expense, performance-based compensation for certain executives and the domestic production activities deduction, among others, that could affect our U.S. federal income tax position. We are continuing to evaluate the overall impact of this tax legislation on our operations and U.S. federal income tax position. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. While we expect the TCJA to be favorable to the Company overall, there can be no assurance that changes in tax laws or regulations, both within the U.S. and the other jurisdictions in which we operate, will not materially and adversely affect our effective tax rate, tax payments, financial condition and results of operations. Similarly, changes in tax laws and regulations that impact our customers and counterparties or the economy generally may also impact our financial condition and results of operations. In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to substantial penalties and liabilities. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective tax rate, tax payments, financial condition and results of operations. Privacy, Data Protection and Security Regulation of privacy, data protection, security and the digital economy could increase our costs, as well as negatively impact our growth. We are subject to regulations related to privacy, data protection and information security in the jurisdictions in which we do business. These regulations could result in negative impacts to our business. As we continue to develop integrated products and services to meet the needs of a changing marketplace, we may expand our information profile through the collection of additional data across multiple channels. This expansion could amplify the impact of these regulations on our business. Regulation of privacy and data protection and information security often times require monitoring of and changes to our data practices in regard to the collection, use, disclosure, storage and/or security of personal and sensitive information. In addition, due to the European Parliaments passage of the GDPR and the European Court of Justices invalidation of the Safe Harbor treaty, we are subject to enhanced compliance and operational requirements in the European Union. Failure to comply with these laws, regulations and requirements could result in fines, sanctions or other penalties, which could materially and adversely affect our results of operations and overall business, as well as have an impact on our reputation. New requirements or reinterpretations of existing requirements in these areas, or the development of new regulatory schemes related to the digital economy in general, may also increase our costs and could impact aspects of our business such as fraud monitoring, the development of information-based products and solutions and technology operations. In addition, these requirements may increase the costs to our customers of issuing payment products, which may, in turn, decrease the number of our payment products that they issue. Moreover, due to account data compromise events, as well as the disclosure of the monitoring activities by certain governmental agencies, there has been heightened legislative and regulatory scrutiny around the world that could lead to further regulation and requirements. Any of these developments could materially and adversely affect our overall business and results of operations. In addition, fraudulent activity could encourage regulatory intervention, which could damage our reputation and reduce the use and acceptance of our integrated products and services or increase our compliance costs. Criminals are using increasingly sophisticated methods to capture consumer account information to engage in illegal activities such as counterfeiting or other fraud. As outsourcing and specialization become common in the payments industry, there are more third parties involved in processing transactions using our payment products. While we are taking measures to make card and digital payments more secure, increased fraud levels involving our integrated products and services, or misconduct or negligence by third parties switching or otherwise servicing our integrated products and services, could lead to regulatory intervention, such as enhanced security requirements, as well as damage to our reputation. Litigation Liabilities we may incur for any litigation that has been or may be brought against us could materially and adversely affect our results of operations. We are a defendant on a number of civil litigations and regulatory proceedings and investigations, including among others, those alleging violations of competition and antitrust law and those involving intellectual property claims. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for more details regarding the allegations contained in these complaints and the status of these proceedings. In the event we are found liable in any material litigations or proceedings, particularly in the event we may be found liable in a large class-action lawsuit or on the basis of an antitrust claim entitling the plaintiff to treble damages or under which we were jointly and severally liable, we could be subject to significant damages, which could have a material adverse impact on our overall business and results of operations. Limitations on our business resulting from litigation or litigation settlements may materially and adversely affect our overall business and results of operations. Certain limitations have been placed on our business in recent years because of litigation and litigation settlements, such as changes to our no-surcharge rule in the United States. Any future limitations on our business resulting from litigation or litigation settlements could impact our relationships with our customers, including reducing the volume of business that we do with them, which may materially and adversely affect our overall business and results of operations. Business and Operations Competition and Technology Substantial and intense competition worldwide in the global payments industry may materially and adversely affect our overall business and results of operations. The global payments industry is highly competitive. Our payment programs compete against all forms of payment, including cash and checks; electronic, mobile and e-commerce payment platforms; cryptocurrencies; ACH payment services; and other payments networks, which can have several competitive impacts on our business: Within the global general purpose payments industry, we face substantial and increasingly intense competition worldwide. In certain jurisdictions, including the United States, Visa has greater volume, scale and market share than we do, which may provide significant competitive advantages. Some of our traditional competitors, as well as alternative payment service providers, may have substantially greater financial and other resources than we have, may offer a wider range of programs and services than we offer or may use more effective advertising and marketing strategies to achieve broader brand recognition or merchant acceptance than we have. Our ability to compete may also be affected by the outcomes of litigation, competition-related regulatory proceedings, central bank activity and legislative activity. Certain of our competitors, including American Express, Discover, private-label card networks and certain alternative payments systems, operate three-party payments systems with direct connections to both merchants and consumers and these competitors may derive competitive advantages from their business models. If we continue to attract more regulatory scrutiny than these competitors because we operate a four-party system, or we are regulated because of the system we operate in a way in which our competitors are not, we could lose business to these competitors. See Business-Competition in Part I, Item 1. If we are not able to differentiate ourselves from our competitors, drive value for our customers and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively against these threats. Our competitors may also more effectively introduce their own innovative programs and services that adversely impact our growth. We also compete against new entrants that have developed alternative payments systems, e-commerce payments systems and payments systems for mobile devices, as well as physical store locations. A number of these new entrants rely principally on the Internet to support their services and may enjoy lower costs than we do, which could put us at a competitive disadvantage. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Disintermediation from stakeholders both within and outside of the payments value chain could harm our business. As the payments industry continues to develop and change, we face disintermediation and related risks, including: Parties that process our transactions in certain countries may try to eliminate our position as an intermediary in the payment process. For example, merchants could switch (and in some cases are switching) transactions directly with issuers. Additionally, processors could process transactions directly between issuers and acquirers. Large scale consolidation within processors could result in these processors developing bilateral agreements or in some cases switching the entire transaction on their own network, thereby disintermediating us. Regulation in the EEA may disintermediate us by enabling third-party processors opportunities to route payment transactions away from our networks and towards other forms of payment. Although we partner with technology companies (such as digital players and mobile providers) that leverage our technology, platforms and networks to deliver their products, they could develop platforms or networks that disintermediate us from digital payments and impact our ability to compete in the digital economy. This risk is heightened when we have relationships with these entities where we share Mastercard data. While we share this data in a controlled manner subject to applicable anonymization and data privacy standards, without proper oversight we could inadvertently share too much data which could give the partner a competitive advantage. Competitors, customers, technology companies, governments and other industry participants may develop products that compete with or replace value-added products and services we currently provide to support our switched transaction and payment offerings. These products could replace our own switching and payments offerings or could force us to change our pricing or practices for these offerings. In addition, governments that develop national payment platforms may promote their platforms in such a way that could put us at a competitive disadvantage in those markets. Participants in the payments industry may merge, create joint ventures or form other business combinations that may strengthen their existing business services or create new payment services that compete with our services. Our failure to compete effectively against any of the foregoing competitive threats could materially and adversely affect our overall business and results of operations. Continued intense pricing pressure may materially and adversely affect our overall business and results of operations. In order to increase transaction volumes, enter new markets and expand our Mastercard-branded cards and enabled products and services, we seek to enter into business agreements with customers through which we offer incentives, pricing discounts and other support that promote our products. In order to stay competitive, we may have to increase the amount of these incentives and pricing discounts. Over the past several years, we have experienced continued pricing pressure. The demand from our customers for better pricing arrangements and greater rebates and incentives moderates our growth. We may not be able to continue our expansion strategy to process additional transaction volumes or to provide additional services to our customers at levels sufficient to compensate for such lower fees or increased costs in the future, which could materially and adversely affect our overall business and results of operations. In addition, increased pressure on prices increases the importance of cost containment and productivity initiatives in areas other than those relating to customer incentives. In the future, we may not be able to enter into agreements with our customers if they require terms that we are unable or unwilling to offer, and we may be required to modify existing agreements in order to maintain relationships and to compete with others in the industry. Some of our competitors are larger and have greater financial resources than we do and accordingly may be able to charge lower prices to our customers. In addition, to the extent that we offer discounts or incentives under such agreements, we will need to further increase transaction volumes or the amount of services provided thereunder in order to benefit incrementally from such agreements and to increase revenue and profit, and we may not be successful in doing so, particularly in the current regulatory environment. Our customers also may implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability. These factors could have a material adverse impact on our overall business and results of operations. Rapid and significant technological developments and changes could negatively impact our overall business and results of operations or limit our future growth. The payments industry is subject to rapid and significant technological changes, which can impact our business in several ways: Technological changes, including continuing developments of technologies in the areas of smart cards and devices, contactless and mobile payments, e-commerce, cryptocurrency and block chain technology, machine learning and AI, could result in new technologies that may be superior to, or render obsolete, the technologies we currently use in our programs and services. Moreover, these changes could result in new and innovative payment methods and programs that could place us at a competitive disadvantage and that could reduce the use of our products. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies. The inability of these companies to keep pace with technological developments, or the acquisition of these companies by competitors, could negatively impact our offerings. Our ability to develop and adopt new services and technologies may be inhibited by industry-wide solutions and standards (such as those related to EMV, tokenization or other safety and security technologies), and by resistance from customers or merchants to such changes. Our ability to develop evolving systems and products may be inhibited by any difficulty we may experience in attracting and retaining technology experts. Our ability to adopt these technologies can also be inhibited by intellectual property rights of third parties. We have received, and we may in the future receive, notices or inquiries from patent holders (for example, other operating companies or non-practicing entities) suggesting that we may be infringing certain patents or that we need to license the use of their patents to avoid infringement. Such notices may, among other things, threaten litigation against us or our customers or demand significant license fees. Our ability to develop new technologies and reflect technological changes in our payments offerings will require resources, which may result in additional expenses. We work with technology companies (such as digital players and mobile providers) that use our technology to enhance payment safety and security and to deliver their payment-related products and services quickly and efficiently to consumers. Our inability to keep pace technologically could negatively impact the willingness of these customers to work with us, and could encourage them to use their own technology and compete against us. We cannot predict the effect of technological changes on our business, and our future success will depend, in part, on our ability to anticipate, develop or adapt to technological changes and evolving industry standards. Failure to keep pace with these technological developments or otherwise bring to market products that reflect these technologies could lead to a decline in the use of our products, which could have a material adverse impact on our overall business and results of operations. Operating a new real-time account-based payments network in connection with our Vocalink acquisition presents risks that could materially affect our business. Our acquisition of Vocalink in 2017 added real-time account-based payment technology to the suite of capabilities we offer. While expansion into this space presents business opportunities, there are also regulatory and operational risks associated with administering a new type of payments network and with integrating this acquisition into our business. Operating a new type of payments system presents new regulatory and operational risks. English regulators have designated this platform to be critical national infrastructure and regulators in other countries may in the future expand their regulatory oversight of real-time account-based payments systems in similar ways. In addition, any prolonged service outage on this network could result in quickly escalating impacts, including potential intervention by the Bank of England and significant reputational risk to Vocalink and us. For a discussion of the regulatory risks related to our real-time account-based payments platform, see our risk factor in Risk Factors - Regulation Related to Our Participation in the Payments Industry in this Part I, Item 1A. Furthermore, the complexity of this payment technology requires careful management to address security vulnerabilities that are different from those faced on our core network. While we are leveraging Vocalinks talent and expertise, we may face challenges in adapting to the complex requirements of operating a new payments system. Operational difficulties, such as the temporary unavailability of our services or products, or security breaches on our real-time account-based payments network could cause a loss of business for these products and services, result in potential liability for us and adversely affect our reputation. We are also working to embed the new products and technology acquired from Vocalink into our existing markets. This product convergence requires tight working relationships and integration with the people and corporate culture of Vocalink as a critical success factor. Not managing the integration successfully could result in larger-than-expected integration costs, which could be significant. If we fail to successfully embed these new technologies, we may lose existing Vocalink business and may not remain competitive in our payment technology offerings as compared to our competitors. See our risk factor in Risk Factors - Acquisitions in this Part I, Item 1A for more information on risks relating to the integrating our acquisitions. Working with new customers and end users as we expand our integrated products and services can present operational challenges, be costly and result in reputational damage if the new products or services do not perform as intended. The payments markets in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer and consumer needs. In order to remain competitive and meet the needs of the payments market, we are continually involved in diversifying our integrated products and services. These efforts carry the risks associated with any diversification initiative, including cost overruns, delays in delivery and performance problems. These projects also carry risks associated with working with different types of customers, for example organizations such as corporations that are not financial institutions and non-governmental organizations (NGOs), and end users than those we have traditionally worked with. These differences may present new operational challenges in the development and implementation of our new products or services. Our failure to render these integrated products and services could make our other integrated products and services less desirable to customers, or put us at a competitive disadvantage. In addition, if there is a delay in the implementation of our products or services or if our products or services do not perform as anticipated, we could face additional regulatory scrutiny, fines, sanctions or other penalties, which could materially and adversely affect our overall business and results of operations, as well as negatively impact our brand and reputation. Information Security and Service Disruptions Information security incidents or account data compromise events could disrupt our business, damage our reputation, increase our costs and cause losses. Information security risks for payments and technology companies such as ours have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches and could lead to the misappropriation of consumer account and other information and identity theft. Our operations rely on the secure processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks. Our customers and other parties in the payments value chain, as well as account holders, rely on our digital technologies, computer systems, software and networks to conduct their operations. In addition, to access our integrated products and services, our customers and account holders increasingly use personal smartphones, tablet PCs and other mobile devices that may be beyond our control. We, like other financial technology organizations, routinely are subject to cyber-threats and our technologies, systems and networks have been subject to attempted cyber-attacks. Because of our position in the payments value chain, we believe that we are likely to continue to be a target of such threats and attacks. Additionally, geopolitical events and resulting government activity could also lead to information security threats and attacks by affected jurisdictions and their sympathizers. To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. However, future attacks or breaches could lead to security breaches of the networks, systems or devices that our customers use to access our integrated products and services, which in turn could result in the unauthorized disclosure, release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information (including account data information) or data security compromises. Such attacks or breaches could also cause service interruptions, malfunctions or other failures in the physical infrastructure or operations systems that support our businesses and customers (such as the lack of availability of our value-added systems), as well as the operations of our customers or other third parties. In addition, they could lead to damage to our reputation with our customers and other parties and the market, additional costs to us (such as repairing systems, adding new personnel or protection technologies or compliance costs), regulatory penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. We maintain an information security program, a business continuity program and insurance coverage (each reviewed by our Board of Directors and its Audit Committee), and our processing systems incorporate multiple levels of protection, in order to address or otherwise mitigate these risks. We also continually test our systems to discover and address any potential vulnerabilities. Despite these mitigation efforts, there can be no assurance that we will be immune to these risks and not suffer material breaches and resulting losses in the future, or that our insurance coverage would be sufficient to cover all losses. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, our prominent size and scale and our role in the global payments and technology industries, our plans to continue to implement our digital and mobile channel strategies and develop additional remote connectivity solutions to serve our customers and account holders when and how they want to be served, our global presence, our extensive use of third-party vendors and future joint venture and merger and acquisition opportunities. As a result, information security and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a priority for us. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations. In addition to information security risks for our systems, we also routinely encounter account data compromise events involving merchants and third-party payment processors that process, store or transmit payment transaction data, which affect millions of Mastercard, Visa, Discover, American Express and other types of account holders. These events, some of which have been high profile, typically involve external agents hacking the merchants or third-party processors systems and installing malware to compromise the confidentiality and integrity of those systems. Further events of this type may subject us to reputational damage and/or lawsuits involving payment products carrying our brands. Damage to our reputation or that of our brands resulting from an account data breach of either our systems or the systems of our customers, merchants and other third parties could decrease the use and acceptance of our integrated products and services. Such events could also slow or reverse the trend toward electronic payments. In addition to reputational concerns, while most of the lawsuits resulting from account data breaches do not involve direct claims against us and while we have releases from many issuers and acquirers, we could still face damage claims, which, if upheld, could materially and adversely affect our results of operations. Such events could have a material adverse impact on our transaction volumes, results of operations and prospects for future growth, or increase our costs by leading to additional regulatory burdens being imposed on us. Service disruptions that cause us to be unable to process transactions or service our customers could materially affect our overall business and results of operations. Our transaction switching systems and other offerings may experience interruptions as a result of technology malfunctions, fire, weather events, power outages, telecommunications disruptions, terrorism, workplace violence, accidents or other catastrophic events. Our visibility in the global payments industry may also put us at greater risk of attack by terrorists, activists, or hackers who intend to disrupt our facilities and/or systems. Additionally, we rely on third-party service providers for the timely transmission of information across our global data network. Inadequate infrastructure in lesser-developed markets could also result in service disruptions, which could impact our ability to do business in those markets. If one of our service providers fails to provide the communications capacity or services we require, as a result of natural disaster, operational disruptions, terrorism, hacking or any other reason, the failure could interrupt our services. Although we maintain a business continuity program to analyze risk, assess potential impacts, and develop effective response strategies, we cannot ensure that our business would be immune to these risks, because of the intrinsic importance of our switching systems to our business, any interruption or degradation could adversely affect the perception of the reliability of products carrying our brands and materially adversely affect our overall business and our results of operations. Financial Institution Customers and Other Stakeholder Relationships Losing a significant portion of business from one or more of our largest financial institution customers could lead to significant revenue decreases in the longer term, which could have a material adverse impact on our business and our results of operations. Most of our financial institution customer relationships are not exclusive and may be terminated by our customers. Our customers can reassess their commitments to us at any time in the future and/or develop their own competitive services. Accordingly, our business agreements with these customers may not reduce the risk inherent in our business that customers may terminate their relationships with us in favor of relationships with our competitors, or for other reasons, or might not meet their contractual obligations to us. In addition, a significant portion of our revenue is concentrated among our five largest financial institution customers. Loss of business from any of our large customers could have a material adverse impact on our overall business and results of operations. Exclusive/near exclusive relationships certain customers have with our competitors may have a material adverse impact on our business. Certain customers have exclusive, or nearly-exclusive, relationships with our competitors to issue payment products, and these relationships may make it difficult or cost-prohibitive for us to do significant amounts of business with them to increase our revenues. In addition, these customers may be more successful and may grow faster than the customers that primarily issue our payment products, which could put us at a competitive disadvantage. Furthermore, we earn substantial revenue from customers with nearly-exclusive relationships with our competitors. Such relationships could provide advantages to the customers to shift business from us to the competitors with which they are principally aligned. A significant loss of our existing revenue or transaction volumes from these customers could have a material adverse impact on our business. Consolidation in the banking industry could materially and adversely affect our overall business and results of operations. The banking industry has undergone substantial, accelerated consolidation in the past. Consolidations have included customers with a substantial Mastercard portfolio being acquired by institutions with a strong relationship with a competitor. If significant consolidation among customers were to continue, it could result in the substantial loss of business for us, which could have a material adverse impact on our business and prospects. In addition, one or more of our customers could seek to merge with, or acquire, one of our competitors, and any such transaction could also have a material adverse impact on our overall business. Consolidation could also produce a smaller number of large customers, which could increase their bargaining power and lead to lower prices and/or more favorable terms for our customers. These developments could materially and adversely affect our results of operations. Our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and, in many jurisdictions, their ability to effectively manage or help manage our brands. While we work directly with many stakeholders in the payments system, including merchants, governments and large digital companies and other technology companies, we are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their respective relationships with account holders and merchants to support our programs and services. Furthermore, we depend on our issuing partners and acquirers to continue to innovate to maintain competitiveness in the market. We do not issue cards or other payment devices, extend credit to account holders or determine the interest rates or other fees charged to account holders. Each issuer determines these and most other competitive payment program features. In addition, we do not establish the discount rate that merchants are charged for acceptance, which is the responsibility of our acquiring customers. As a result, our business significantly depends on the continued success and competitiveness of our issuing and acquiring customers and the strength of our relationships with them. In turn, our customers success depends on a variety of factors over which we have little or no influence, including economic conditions in global financial markets or their disintermediation by competitors or emerging technologies. If our customers become financially unstable, we may lose revenue or we may be exposed to settlement risk. See our risk factor in Risk Factors - Settlement and Third-Party Obligations in this Part I, Item 1A with respect to how we guarantee certain third-party obligations for further discussion. With the exception of the United States and a select number of other jurisdictions, most in-country (as opposed to cross-border) transactions conducted using Mastercard, Maestro and Cirrus cards are authorized, cleared and settled by our customers or other processors. Because we do not provide domestic switching services in these countries and do not, as described above, have direct relationships with account holders, we depend on our close working relationships with our customers to effectively manage our brands, and the perception of our payments system, among consumers in these countries. We also rely on these customers to help manage our brands and perception among regulators and merchants in these countries, alongside our own relationships with them. From time to time, our customers may take actions that we do not believe to be in the best interests of our payments system overall, which may materially and adversely impact our business. Merchants continued focus on acceptance costs may lead to additional litigation and regulatory proceedings and increase our incentive program costs, which could materially and adversely affect our profitability. Merchants are important constituents in our payments system. We rely on both our relationships with them, as well as their relationships with our issuer and acquirer customers, to continue to expand the acceptance of our integrated products and services. We also work with merchants to help them enable new sales channels, create better purchase experiences, improve efficiencies, increase revenues and fight fraud. In the retail industry, there is a set of larger merchants with increasingly global scope and influence. We believe that these merchants are having a significant impact on all participants in the global payments industry, including Mastercard. Some large merchants have supported the legal, regulatory and legislative challenges to interchange fees that Mastercard has been defending, including the U.S. merchant litigations. See our risk factor in Risk Factors Risks Related to Our Participation in the Payments Industry in this Part I, Item 1A with respect to payments industry regulation, including interchange fees. The continued focus of merchants on the costs of accepting various forms of payment, including in connection with the growth of digital payments, may lead to additional litigation and regulatory proceedings. Certain larger merchants are also able to negotiate incentives from us and pricing concessions from our issuer and acquirer customers as a condition to accepting our products. We also make payments to certain merchants to incentivize them to create co-branded payment programs with us. As merchants consolidate and become even larger, we may have to increase the amount of incentives that we provide to certain merchants, which could materially and adversely affect our results of operations. Competitive and regulatory pressures on pricing could make it difficult to offset the costs of these incentives. Additionally, if the rate of merchant acceptance growth slows our business could suffer. Our work with governments exposes us to unique risks that could have a material impact on our business and results of operations. As we increase our work with national, state and local governments, both indirectly through financial institutions and with them directly as our customers, we may face various risks inherent in associating or contracting directly with governments. These risks include, but are not limited to, the following: Governmental entities typically fund projects through appropriated monies. Changes in governmental priorities or other political developments, including disruptions in governmental operations, could impact approved funding and result in changes in the scope, or lead to the termination of, the arrangements or contracts we or financial institutions enter into with respect to our payment products and services. Our work with governments subjects us to U.S. and international anti-corruption laws, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act. A violation and subsequent judgment or settlement under these laws could subject us to substantial monetary penalties and damages and have a significant reputational impact. Working or contracting with governments, either directly or via our financial institution customers, can subject us to heightened reputational risks, including extensive scrutiny and publicity, as well as a potential association with the policies of a government as a result of a business arrangement with that government. Any negative publicity or negative association with a government entity, regardless of its accuracy, may adversely affect our reputation. Settlement and Third-Party Obligations Our role as guarantor exposes us to risk of loss or illiquidity. We are a guarantor of certain third-party obligations, including those of: principal customers, which are customers that participate directly in our programs and are responsible for their own settlement and other activities as well as those of their sponsored affiliate customers affiliate debit licensees In this capacity, we are exposed to risk of loss or illiquidity: We may incur obligations in connection with transaction settlements if an issuer or acquirer fails to fund its daily settlement obligations due to technical problems, liquidity shortfalls, insolvency or other reasons. If our principal customer or affiliate debit licensee is unable to fulfill its settlement obligations to other customers, we may bear the loss. Although we are not obligated to do so, we may elect to keep merchants whole if an acquirer defaults on its merchant payment obligations, or to keep prepaid cardholders whole if an issuer defaults on its obligation to safeguard unspent prepaid funds. Concurrent settlement failures of more than one of our larger customers or of several of our smaller customers either on a given day or over a condensed period of time may exceed our available resources and could materially and adversely affect our overall business and liquidity. Even if we have sufficient liquidity to cover a settlement failure, we may not be able to recover the cost of such a payment and may therefore be exposed to significant losses, which could materially and adversely affect our results of operations. Should an event occur that would trigger any significant indemnification obligation which we owe to any customers or other companies, such an obligation could materially and adversely affect our overall business and results of operations. We mitigate the contingent risk of a settlement failure using various strategies, including monitoring our customers financial condition, their economic and political operating environments and their compliance with our participation standards. For more information on our settlement exposure and risk assessment and mitigation practices, see Note 19 (Settlement and Other Risk Management) to the consolidated financial statements included in Part II, Item 8. Global Economic and Political Environment Global financial market activity could result in a material and adverse impact on our overall business and results of operations. Adverse economic trends (including distress in financial markets, turmoil in specific economies around the world and additional government intervention) have impacted the environment in which we operate. The condition of the economic environment may accelerate the timing of or increase the impact of risks to our financial performance. Such impact may include, but is not limited to, the following: Our customers may: restrict credit lines to account holders or limit the issuance of new Mastercard products to mitigate increasing account holder defaults implement cost reduction initiatives that reduce or eliminate payment product marketing or increase requests for greater incentives or greater cost stability default on their settlement obligations, including as a result of sovereign defaults, causing a liquidity crisis for our other customers Consumer spending can be negatively impacted by: declining economies, foreign currency fluctuations and the pace of economic recovery, which can change cross-border travel patterns, on which a significant portion of our revenues is dependent low levels of consumer and business confidence typically associated with recessionary environments and those markets experiencing relatively high unemployment Government intervention (including the effect of laws, regulations and/or government investments on or in our financial institution customers), as well as uncertainty due to changing political regimes in executive, legislative and/or judicial branches of government, may have potential negative effects on our business and our relationships with customers or otherwise alter their strategic direction away from our products. Tightening of credit availability could impact the ability of participating financial institutions to lend to us under the terms of our credit facility. Any of these developments could have a material adverse impact on our overall business and results of operations. A decline in cross-border activity could adversely affect our results of operations. We switch substantially all cross-border transactions using Mastercard, Maestro and Cirrus-branded cards and generate a significant amount of revenue from cross-border volume fees and fees related to switched transactions. Revenue from switching cross-border and currency conversion transactions for our customers fluctuates with the levels and destinations of cross-border travel and our customers need for transactions to be converted into their base currency. Cross-border activity may be adversely affected by world geopolitical, economic, weather and other conditions. These include the threat of terrorism and outbreaks of flu, viruses and other diseases. Additionally, any regulation of interregional interchange fees could negatively impact our cross-border activity, which could decrease the revenue we receive. Any such decline in cross-border activity could materially adversely affect our results of operations. Negative trends in spending could negatively impact our results of operations. The global payments industry depends heavily upon the overall level of consumer, business and government spending. General economic conditions (such as unemployment, housing and changes in interest rates) and other political conditions (such as devaluation of currencies and government restrictions on consumer spending) in key countries in which we operate may adversely affect our financial performance by reducing the number or average purchase amount of transactions involving our products. Adverse currency fluctuations and foreign exchange controls could negatively impact our results of operations. During 2017 , approximately 65% of our revenue was generated from activities outside the United States. This revenue (and the related expense) could be transacted in a non-functional currency or valued based on a currency other than the functional currency of the entity generating the revenues. Resulting exchange gains and losses are included in our net income. Our risk management activities provide protection with respect to adverse changes in the value of only a limited number of currencies and are based on estimates of exposures to these currencies. In addition, some of the revenue we generate outside the United States is subject to unpredictable currency fluctuations including devaluation of currencies where the values of other currencies change relative to the U.S. dollar. If the U.S. dollar strengthens compared to currencies in which we generate revenue, this revenue may be translated at a materially lower amount than expected. Furthermore, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our other revenue currencies into U.S. dollars, such as what we have experienced in Venezuela. The occurrence of currency fluctuations or exchange controls could have a material adverse impact on our results of operations. The United Kingdoms proposed withdrawal from the European Union could harm our business and financial results. In June 2016, voters in the United Kingdom approved the withdrawal of the U.K. from the E.U. (commonly referred to as Brexit). The U.K. government triggered Article 50 of the Lisbon Treaty on May 29, 2017, which commenced the official E.U. withdrawal process. Uncertainty over the terms of the U.K.s departure from the E.U. could cause political and economic uncertainty in the U.K. and the rest of Europe, which could harm our business and financial results. Brexit could lead to legal uncertainty and potentially divergent national laws and regulations in the U.K. and E.U. We, as well as our clients who have significant operations in the U.K., may incur additional costs and expenses as we adapt to potentially divergent regulatory frameworks from the rest of the E.U. In addition, because we conduct business in and have operations in the U.K., we may need to apply for regulatory authorization and permission in separate E.U. member states. We may also face additional complexity with regard to immigration and travel rights for our employees located in the U.K. and the E.U. These factors may impact our ability to operate in the E.U. and U.K. seamlessly. Any of these effects of Brexit, among others, could harm our business and financial results. Reputational Impact Negative brand perception may materially and adversely affect our overall business. Our brands and their attributes are key assets of our business. The ability to attract consumers to our branded products and retain them depends upon the external perception of us and our industry. Our business may be affected by actions taken by our customers, merchants or other organizations that impact the perception of our brands or the payments industry in general. From time to time, our customers may take actions that we do not believe to be in the best interests of our brands, such as creditor practices that may be viewed as predatory. Additionally, large digital companies and other technology companies who are our customers use our networks to build their own acceptance brands, which could cause consumer confusion and decrease the value of our brand. Moreover, adverse developments with respect to our industry or the industries of our customers may also, by association, impair our reputation, or result in greater regulatory or legislative scrutiny. We have also been pursuing the use of social media channels at an increasingly rapid pace. Under some circumstances, our use of social media, or the use of social media by others as a channel for criticism or other purposes, could also cause rapid, widespread reputational harm to our brands by disseminating rapidly and globally actual or perceived damaging information about us, our products or merchants or other end users who utilize our products. Also, as we are headquartered in the United States, a negative perception of the United States could impact the perception of our company, which could adversely affect our business. Such perception and damage to our reputation could have a material and adverse effect to our overall business. Acquisitions Acquisitions, strategic investments or entry into new businesses could disrupt our business and harm our results of operations or reputation. Although we may continue to evaluate and/or make strategic acquisitions of, or acquire interests in joint ventures or other entities related to, complementary businesses, products or technologies, we may not be able to successfully partner with or integrate them, despite original intentions and focused efforts. In addition, such an integration may divert managements time and resources from our core business and disrupt our operations. Moreover, we may spend time and money on acquisitions or projects that do not meet our expectations or increase our revenue. To the extent we pay the purchase price of any acquisition in cash, it would reduce our cash reserves available to us for other uses, and to the extent the purchase price is paid with our stock, it could be dilutive to our stockholders. Furthermore, we may not be able to successfully finance the business following the acquisition as a result of costs of operations, including any litigation risk which may be inherited from the acquisition. Any acquisition or entry into a new business could subject us to new regulations with which we would need to comply. This compliance could increase our costs, and we could be subject to liability or reputational harm to the extent we cannot meet any such compliance requirements. Our expansion into new businesses could also result in unanticipated issues which may be difficult to manage. Class A Common Stock and Governance Structure Provisions in our organizational documents and Delaware law could be considered anti-takeover provisions and have an impact on change-in-control. Provisions contained in our amended and restated certificate of incorporation and bylaws and Delaware law could be considered anti-takeover provisions, including provisions that could delay or prevent entirely a merger or acquisition that our stockholders consider favorable. These provisions may also discourage acquisition proposals or have the effect of delaying or preventing entirely a change in control, which could harm our stock price. For example, subject to limited exceptions, our amended and restated certificate of incorporation prohibits any person from beneficially owning more than 15% of any of the Class A common stock or any other class or series of our stock with general voting power, or more than 15% of our total voting power. In addition: our stockholders are not entitled to the right to cumulate votes in the election of directors our stockholders are not entitled to act by written consent a vote of 80% or more of all of the outstanding shares of our stock then entitled to vote is required for stockholders to amend any provision of our bylaws any representative of a competitor of Mastercard or of Mastercard Foundation is disqualified from service on our board of directors Mastercard Foundations substantial stock ownership, and restrictions on its sales, may impact corporate actions or acquisition proposals favorable to, or favored by, the other public stockholders. As of February 9, 2018 , Mastercard Foundation owned 112,181,762 shares of Class A common stock, representing approximately 10.8% of our general voting power. Mastercard Foundation may not sell or otherwise transfer its shares of Class A common stock prior to May 1, 2027, except to the extent necessary to satisfy its charitable disbursement requirements, for which purpose earlier sales are permitted. Mastercard Foundation is permitted to sell all of its remaining shares after May 1, 2027. The directors of Mastercard Foundation are required to be independent of us and our customers. The ownership of Class A common stock by Mastercard Foundation, together with the restrictions on transfer, could discourage or make more difficult acquisition proposals favored by the other holders of the Class A common stock. In addition, because Mastercard Foundation is restricted from selling its shares for an extended period of time, it may not have the same interest in short or medium-term movements in our stock price as, or incentive to approve a corporate action that may be favorable to, our other stockholders. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2017 , Mastercard and its subsidiaries owned or leased 167 commercial properties. We own our corporate headquarters, located in Purchase, New York. The building is approximately 500,000 square feet. There is no outstanding debt on this building. Our principal technology and operations center, a leased facility located in OFallon, Missouri, is also approximately 500,000 square feet. The term of the lease on this facility is 10 years, which commenced on March 1, 2009. Our leased properties in the United States are located in 10 states and in the District of Columbia. We also lease and own properties in 69 other countries. These facilities primarily consist of corporate and regional offices, as well as our operations centers. We believe that our facilities are suitable and adequate for the business that we currently conduct. However, we periodically review our space requirements and may acquire or lease new space to meet the needs of our business, or consolidate and dispose of facilities that are no longer required. "," ITEM 3. LEGAL PROCEEDINGS Refer to Notes 10 (Accrued Expenses and Accrued Litigation) and 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Price Range of Common Stock Our Class A common stock trades on the New York Stock Exchange under the symbol MA. The following table sets forth the intra-day high and low sale prices for our Class A common stock for the four quarterly periods in each of 2017 and 2016 . At February 9, 2018 , we had 73 stockholders of record for our Class A common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our Class A common stock is held in street name by brokers. High Low High Low First Quarter $ 113.50 $ 104.01 $ 95.83 $ 78.52 Second Quarter 126.19 111.01 100.00 87.59 Third Quarter 143.59 120.65 102.31 86.65 Fourth Quarter 154.65 140.61 108.93 99.51 There is currently no established public trading market for our Class B common stock. There were approximately 307 holders of record of our non-voting Class B common stock as of February 9, 2018 , constituting approximately 1.3% of our total outstanding equity. Dividend Declaration and Policy During the years ended December 31, 2017 and 2016 , we paid the following quarterly cash dividends per share on our Class A common stock and Class B Common stock: Dividend per Share First Quarter $ 0.22 $ 0.19 Second Quarter 0.22 0.19 Third Quarter 0.22 0.19 Fourth Quarter 0.22 0.19 On December 4, 2017, our Board of Directors declared a quarterly cash dividend of $0.25 per share paid on February 9, 2018 to holders of record on January 9, 2018 of our Class A common stock and Class B common stock. On February 5, 2018, our Board of Directors declared a quarterly cash dividend of $0.25 per share payable on May 9, 2018 to holders of record on April 9, 2018 of our Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend on our outstanding Class A common stock and Class B common stock. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. Issuer Purchases of Equity Securities On December 6, 2016, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the December 2016 Share Repurchase Program). This program became effective in April 2017. On December 4, 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock (the December 2017 Share Repurchase Program). This program will become effective after completion of the December 2016 Share Repurchase Program. During the fourth quarter of 2017 , we repurchased a total of approximately 6.9 million shares for $1.0 billion at an average price of $148.44 per share of Class A common stock. Our repurchase activity during the fourth quarter of 2017 consisted of open market share repurchases and is summarized in the following table: Period Total Number of Shares Purchased Average Price Paid per Share (including commission cost) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Dollar Value of Shares that may yet be Purchased under the Plans or Programs 1 October 1 31 2,276,450 $ 144.78 2,276,450 $ 1,935,087,778 November 1 30 2,314,860 150.22 2,314,860 1,587,353,507 December 1 31 2,353,069 150.22 2,353,069 5,233,867,141 Total 6,944,379 148.44 6,944,379 1 Dollar value of shares that may yet be purchased under the December 2016 Share Repurchase Program and the December 2017 Share Repurchase Program are as of the end of each period presented. "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the consolidated financial statements and notes of Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International) (together, Mastercard or the Company), included elsewhere in this Report. This change only relates to terminology; no previously reported amounts have changed. Percentage changes provided throughout Managements Discussion and Analysis of Financial Condition and Results of Operations were calculated on amounts rounded to the nearest thousand. Business Overview Mastercard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. Through our global payments processing network, we facilitate the switching (authorization, clearing and settlement) of payment transactions and deliver related products and services. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including Mastercard, Maestro, Cirrus and Masterpass. Our recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded our capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, we now offer customers one partner to turn to for their payment needs for both domestic and cross-border transactions. We also provide value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. Our networks are designed to ensure safety and security for the global payments system. A typical transaction on our core network involves four participants in addition to us: account holder (a consumer who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of our branded products. In most cases, account holder relationships belong to, and are managed by, our financial institution customers. We generate revenues from assessing our customers based on the gross dollar volume (the GDV) of activity on the products that carry our brands, from the fees we charge to our customers for providing transaction processing and from other payment-related products and services. Business Environment We authorize, clear and settle transactions in more than 210 countries and territories and in more than 150 currencies. Net revenue generated in the United States was 35% of total revenue in 2017 and 38% in 2016 and 39% in 2015 . No individual country, other than the United States, generated more than 10% of total net revenue in any such period, but differences in market growth, economic health and foreign exchange fluctuations in certain countries can have an impact on the proportion of revenue generated outside the United States over time. While the global nature of our business helps protect our operating results from adverse economic conditions in a single or a few countries, the significant concentration of our revenue generated in the United States makes our business particularly susceptible to adverse economic conditions in the United States. The competitive and evolving nature of the global payments industry provides both challenges to and opportunities for the continued growth of our business. Adverse economic trends (including distress in financial markets, currency fluctuations, turmoil in specific economies around the world and additional government intervention) have impacted the environment in which we operate. Certain of our customers, merchants that accept our brands and account holders who use our brands, have been directly impacted by these adverse economic conditions. Our financial results may be negatively impacted by actions taken by individual financial institutions or by governmental or regulatory bodies. In addition, political instability or a decline in economic conditions in the countries in which we operate may accelerate the timing of or increase the impact of risks to our financial performance. As a result, our revenue or results of operations may be negatively impacted. We continue to monitor political and economic conditions around the world to identify opportunities for the continued growth of our business and to evaluate the evolution of the global payments industry. Notwithstanding recent encouraging trends, the extent and pace of economic recovery in various regions remains uncertain and the overall business environment may present challenges for us to grow our business. For a full discussion of the various legal, regulatory and business risks that could impact our financial results, see Risk Factors in Part I, Item 1A. Financial Results Overview The following tables provide a summary of our operating results: Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) ($ in millions, except per share data) Net revenue $ 12,497 $ 10,776 16% $ 10,776 $ 9,667 11% Operating expenses $ 5,875 $ 5,015 17% $ 5,015 $ 4,589 9% Operating income $ 6,622 $ 5,761 15% $ 5,761 $ 5,078 13% Operating margin 53.0 % 53.5 % (0.5) ppt 53.5 % 52.5 % 0.9 ppt Income tax expense $ 2,607 $ 1,587 64% $ 1,587 $ 1,150 38% Effective income tax rate 40.0 % 28.1 % 11.9 ppt 28.1 % 23.2 % 4.9 ppt Net income $ 3,915 $ 4,059 (4)% $ 4,059 $ 3,808 7% Diluted earnings per share $ 3.65 $ 3.69 (1)% $ 3.69 $ 3.35 10% Diluted weighted-average shares outstanding 1,072 1,101 (3)% 1,101 1,137 (3)% Summary of Non-GAAP Results 1 : Year ended December 31, Increase/(Decrease) Year ended December 31, Increase/(Decrease) As adjusted Currency-neutral As adjusted Currency-neutral ($ in millions, except per share data) Net revenue $ 12,497 $ 10,776 16% 15% $ 10,776 $ 9,667 11% 13% Adjusted operating expenses $ 5,693 $ 4,898 16% 16% $ 4,898 $ 4,449 10% 12% Adjusted operating margin 54.4 % 54.5 % (0.1) ppt (0.2) ppt 54.5 % 54.0 % 0.6 ppt 0.6 ppt Adjusted effective income tax rate 26.8 % 28.1 % (1.3) ppt (1.3) ppt 28.1 % 23.4 % 4.6 ppt 4.7 ppt Adjusted net income $ 4,906 $ 4,144 18% 17% $ 4,144 $ 3,903 6% 7% Adjusted diluted earnings per share $ 4.58 $ 3.77 21% 21% $ 3.77 $ 3.43 10% 11% Note: Tables may not sum due to rounding. 1 The Summary of Non-GAAP Results excludes the impact of Special Items and/or foreign currency. See Non-GAAP Financial Information for further information on the Special Items, the impact of foreign currency and the reconciliation to GAAP reported amounts. Key highlights for 2017 were as follows: Net revenue increased 16% , or 15% on a currency-neutral basis, in 2017 versus 2016 , primarily driven by: Switched transaction growth of 17% Cross border growth of 15% on a local currency basis An increase of 10% in gross dollar volume, on a local currency basis and adjusted for the impact of the 2016 EU regulation change Acquisitions contributed 2 percentage points of growth These increases were partially offset by higher rebates and incentives Operating expenses increased 17% in 2017 versus 2016 . Excluding the impact of Special Items, adjusted operating expenses increased 16% , both as adjusted and on a currency-neutral basis, in 2017 versus 2016 . The impact of acquisitions contributed 6 percentage points of growth for the twelve months ended December 31, 2017 . Other factors contributing to the increase were continued investments in strategic initiatives as well as foreign exchange related charges. The effective income tax rate increased 11.9 percentage points to 40.0% in 2017 versus 28.1% in 2016 , primarily due to the Tax Cuts and Jobs Act (the TCJA). Excluding the impact of the TCJA and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of taxable earnings, partially offset by a lower U.S. foreign tax credit benefit. Other financial highlights for 2017 were as follows: We generated net cash flows from operations of $5.6 billion in 2017 , versus $4.5 billion in 2016 . We repurchased 30 million shares of our common stock for $3.8 billion and paid dividends of $942 million in 2017 . We acquired businesses for total consideration of $1.5 billion in 2017 , the largest of which was VocaLink Holdings Limited (Vocalink), which expanded our capability, among other things, to process real-time account-based payment transactions. The TCJA, enacted in 2017, will reduce the U.S. corporate income tax rate from 35% to 21% beginning in 2018, imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) and puts into effect the migration towards a territorial tax system. While the enactment of the TCJA resulted in additional tax expense of $873 million in 2017, it is expected to have a favorable impact on our effective tax rate in future periods. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA impact. Non-GAAP Financial Information Non-GAAP financial information is defined as a numerical measure of a companys performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (GAAP). These non-GAAP financial measures exclude the impact of the following special items (Special Items). We excluded these Special Items as management monitors significant changes in tax law, litigation judgments and settlements related to interchange and regulation, and significant one-time items separately from ongoing operations and evaluates ongoing performance without these amounts. In 2017, due to the passage of the TCJA, we incurred additional tax expense of $873 million , $0.81 per diluted share, which includes $825 million of provisional charges attributable to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding reinvestment of foreign earnings, as well as $48 million in additional tax expense related to a foregone foreign tax credit benefit on current year repatriations (collectively the Tax Act Impact). See Financial Results of this section and Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion of the TCJA. In 2017, we recorded a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) in general and administrative expenses related to the deconsolidation of our Venezuelan subsidiaries (the Venezuela Charge). See Impact of Foreign Currency of this section and Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion of the Venezuela Charge. In 2017, we recorded a pre-tax charge of $15 million ( $10 million after tax, or $0.01 per diluted share) in provision for litigation settlements expense, related to a litigation settlement with Canadian merchants (the Canadian Merchant Litigation Provision). In 2016 and 2015, we recorded a pre-tax charge of $117 million ( $85 million after tax, or $0.08 per diluted share) and $61 million ( $45 million after tax, or $0.04 per diluted share), respectively, in provision for litigation settlements expense, related to separate litigations with merchants in the U.K. (collectively the U.K. Merchant Litigation Provision). See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion of the Canadian Merchant Litigation Provision and the U.K. Merchant Litigation Provision. In 2015, we recorded a settlement charge of $79 million ( $50 million after tax, or $0.04 per diluted share) in general and administrative expenses, relating to the termination of our qualified U.S. defined benefit pension plan (the U.S. Employee Pension Plan Settlement Charge). See Note 11 (Pension, Postretirement and Savings Plans) to the consolidated financial statements included in Part II, Item 8 for further discussion of the U.S. Employee Pension Plan Settlement Charge. In addition, we present growth rates adjusted for the impact of foreign currency, which is a non-GAAP financial measure. For 2017 and 2016 , we present currency-neutral growth rates, which are calculated by remeasuring the prior periods results using the current periods exchange rates for both the translational and transactional impacts on operating results. The impact of foreign currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. Our management believes the presentation of the impact of foreign currency provides relevant information. Our management believes that the non-GAAP financial measures presented facilitate an understanding of our operating performance and provide a meaningful comparison of our results between periods. Our management uses non-GAAP financial measures to, among other things, evaluate our ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. Net revenue, operating expenses, operating margin, effective income tax rate, net income and diluted earnings per share, adjusted for Special Items and/or the impact of foreign currency, are non-GAAP financial measures and should not be relied upon as substitutes for measures calculated in accordance with GAAP. The following tables reconcile our as-reported financial measures calculated in accordance with GAAP to the respective non-GAAP adjusted financial measures. Year ended December 31, 2017 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,875 53.0 % 40.0 % $ 3,915 $ 3.65 Tax Act Impact ** ** (13.4 )% 0.81 Venezuela Charge (167 ) 1.3 % 0.2 % 0.10 Canadian Merchant Litigation Provision (15 ) 0.1 % % 0.01 Non-GAAP $ 5,693 54.4 % 26.8 % $ 4,906 $ 4.58 Year ended December 31, 2016 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 5,015 53.5 % 28.1 % $ 4,059 $ 3.69 U.K. Merchant Litigation Provision (117 ) 1.0 % % 0.08 Non-GAAP $ 4,898 54.5 % 28.1 % $ 4,144 $ 3.77 Year ended December 31, 2015 Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share ($ in millions, except per share data) Reported - GAAP $ 4,589 52.5 % 23.2 % $ 3,808 $ 3.35 U.S. Employee Pension Plan Settlement Charge (79 ) 0.8 % 0.1 % 0.04 U.K. Merchant Litigation Provision (61 ) 0.6 % 0.1 % 0.04 Non-GAAP $ 4,449 54.0 % 23.4 % $ 3,903 $ 3.43 The following tables represent the reconciliation of our growth rates reported under GAAP to our Non-GAAP growth rates, adjusted for Special Items and foreign currency: Year Ended December 31, 2017 as compared to the Year Ended December 31, 2016 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % (0.5) ppt 11.9 ppt (4 )% (1 )% Tax Act Impact ** ** ** (13.4) ppt % % Venezuela Charge ** (3 )% 1.3 ppt 0.2 ppt % % Canadian Merchant Litigation Provision ** % 0.1 ppt ppt % % U.K. Merchant Litigation Provision ** % (1.1) ppt ppt (2 )% (3 )% Non-GAAP % % (0.1) ppt (1.3) ppt % % Foreign currency 1 (1 )% (1 )% (0.1) ppt ppt (1 )% % Non-GAAP - currency-neutral % % (0.2) ppt (1.3) ppt % % Year Ended December 31, 2016 as compared to the Year Ended December 31, 2015 Increase/(Decrease) Net revenue Operating expenses Operating margin Effective income tax rate Net income Diluted earnings per share Reported - GAAP % % 0.9 ppt 4.9 ppt % % U.K. Merchant Litigation Provision ** (1 )% 0.5 ppt (0.1) ppt % % U.S. Employee Pension Plan Settlement Charge ** % (0.8) ppt (0.2) ppt (1 )% (1 )% Non-GAAP % % 0.6 ppt 4.6 ppt % % Foreign currency 1 % % ppt 0.1 ppt % % Non-GAAP - currency-neutral % % 0.6 ppt 4.7 ppt % % Note: Tables may not sum due to rounding. ** Not meaningful. 1 Represents the foreign currency translational and transactional impact. Impact of Foreign Currency Rates Our overall operating results are impacted by foreign currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. Our operating results can also be impacted by transactional foreign currency. The impact of the transactional foreign currency represents the effect of converting revenue and expense transactions occurring in a currency other than the functional currency. Changes in foreign currency exchange rates directly impact the calculation of gross dollar volume (GDV) and gross euro volume (GEV), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The foreign currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. In 2017 , GDV on a U.S. dollar-converted basis increased 8.7% , while GDV on a local currency basis increased 8.6% versus 2016 . In 2016 , GDV on a U.S. dollar-converted basis increased 5.5% , while GDV on a local currency basis increased 9.1% versus 2015 . Further, the impact from transactional foreign currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency. In addition, we incur foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (Foreign Exchange Activity). The impact of Foreign Exchange Activity has not been eliminated in our currency-neutral results (see Non-GAAP Financial Information) and is recorded in general and administrative expenses. We attempt to manage foreign currency balance sheet remeasurement and cash flow risk through our foreign exchange risk management activities, which are discussed further in Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. Since we do not designate foreign currency derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, we record gains and losses on foreign exchange derivatives on a current basis, with the associated offset being recognized as the exposures materialize. We are exposed to currency devaluation in certain countries. In addition, we are subject to exchange control regulations that restrict or prohibit the conversion of financial assets into U.S. dollars. While these revenues and assets are not material to us on a consolidated basis, we can be negatively impacted should there be a continued and sustained devaluation of local currencies relative to the U.S. dollar and/or a continued and sustained deterioration of economic conditions in these countries. Specifically, in Venezuela, due to increasing foreign exchange regulations restricting access to U.S. dollars, an other-than-temporary lack of exchangeability between the Venezuela bolivar and the U.S. dollar has impacted our ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to our Venezuelan operations. As a result of these factors, we concluded that, effective December 31, 2017, we did not meet the accounting criteria for consolidation of these subsidiaries, and therefore we would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share). We continue to operate and serve our Venezuelan issuers, acquirers, merchants and account holders with our products and services. We do not believe this accounting change will have a significant impact on our consolidated financial statements in future periods. See Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8 for further discussion. Financial Results Revenue Revenue Description Our business model involves four participants in addition to us: account holders, merchants, issuers (the account holders financial institutions) and acquirers (the merchants financial institutions). We generate revenues from assessing our customers based on the GDV of activity on the products that carry our brands, from the fees that we charge our customers for providing transaction processing and from other payment-related products and services. Our revenue is based upon transactional information accumulated by our systems or reported by our customers. Our primary revenue billing currencies are the U.S. dollar, euro, Brazilian real and the British pound. The price structure for our products and services is complex and is dependent on the nature of volumes, types of transactions and type of products and services we offer to our customers. Our net revenue can be significantly impacted by the following: domestic or cross-border transactions signature-based or PIN-based transactions geographic region or country in which the transaction occurs volumes/transactions subject to tiered rates processed or not processed by us amount of usage of our other products or services amount of rebates and incentives provided to customers We classify our net revenue into the following five categories: 1. Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are the same. Domestic assessments include items such as card assessments, which are fees charged on the number of cards issued or assessments for specific purposes, such as acceptance development or market development programs. 2. Cross-border volume fees are charged to issuers and acquirers based on the dollar volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are different. In general, a cross-border transaction generates higher revenue than a domestic transaction since cross-border fees are higher than domestic fees, and may include fees for currency conversion. 3. Transaction processing revenue is earned for both domestic and cross-border transactions and is primarily based on the number of transactions. Transaction processing includes the following: Switched transactions include the following products and services: Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances, such as when the issuers systems are unavailable or cannot be contacted, Mastercard or others, on behalf of the issuer approve in accordance with either the issuers instructions or applicable rules (also known as stand-in). Clearing is the determination and exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. We clear transactions among customers through our central and regional processing systems. Settlement is facilitating the exchange of funds between parties. Connectivity fees are charged to issuers, acquirers and other financial institutions for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted and the number of connections to our network. Other Processing fees include issuer and acquirer processing solutions; payment gateways for e-commerce merchants; mobile gateways for mobile initiated transactions; and safety and security. 4. Other revenues: Other revenues consist of other payment-related products and services and are primarily associated with the following: Consulting, data analytic and research fees are primarily generated by Mastercard Advisors, our professional advisory services group. Safety and security services fees are for products and services we offer to prevent, detect and respond to fraud and to ensure the safety of transactions made on our products. We work with issuers, merchants and governments to help deploy standards for safe and secure transactions for the global payments system. Loyalty and rewards solutions fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. For merchants, we provide targeted offers and rewards campaigns and management services for publishing offers, as well as opportunities for holders of co-brand or loyalty cards and rewards program members to obtain rewards points faster. Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees, and ATM withdrawal fees paid by cardholders on the sale and encashment of prepaid cards. Real-time account-based payment services relating to ACH and other ACH related services. We also charge for a variety of other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. 5. Rebates and incentives (contra-revenue): Rebates and incentives are provided to certain of our customers and are recorded as contra-revenue. Revenue Analysis Gross revenue increased 18% and 14% , or 17% and 15% on a currency neutral basis, in 2017 and 2016 , respectively, versus the prior year. The increase in both 2017 and 2016 was primarily driven by an increase in transactions, dollar volume of activity on cards carrying our brands for both domestic and cross-border transactions and other payment-related products and services. Rebates and incentives increased 22% and 20% in 2017 and 2016 , respectively, or 22% on a currency neutral basis in both periods. The increases in rebates and incentives in 2017 and 2016 were primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 16% and 11% , or 15% and 13% on a currency neutral basis, respectively, versus the prior year. The significant components of our net revenue were as follows: For the Years Ended December 31, Percent Increase (Decrease) (in millions, except percentages) Domestic assessments $ 5,130 $ 4,411 $ 4,086 16% 8% Cross-border volume 4,174 3,568 3,225 17% 11% Transaction processing 6,188 5,143 4,345 20% 18% Other revenues 2,853 2,431 1,991 17% 22% Gross revenue 18,345 15,553 13,647 18% 14% Rebates and incentives (contra-revenue) (5,848 ) (4,777 ) (3,980 ) 22% 20% Net revenue $ 12,497 $ 10,776 $ 9,667 16% 11% The following table summarizes the primary drivers of net revenue growth: For the Years Ended December 31, Volume Acquisitions Foreign Currency 1 Other 2 Total Domestic assessments % % % % % (2 )% % 3 (1 )% 3 % % Cross-border volume % % % % % (3 )% % % % % Transaction processing % % % % % % % % % % Other revenues ** ** % % % % % 4 % 4 % % Rebates and incentives % % % % % (2 )% % 5 % 5 % % Net revenue % % % % % (1 )% % % % % Note: Table may not sum due to rounding ** Not applicable 1 Represents the foreign currency translational and transactional impact versus the prior year. 2 Includes impact from pricing and other non-volume based fees. 3 Includes impact of the allocation of revenue to service deliverables, which are recorded in other revenue when services are performed. 4 Includes impacts from Advisor fees, safety and security fees, loyalty and reward solution fees and other payment-related products and services. 5 Includes the impact from timing of new, renewed and expired agreements. The following table provides a summary of the trend in volume and transaction growth: Years Ended December 31, Growth (USD) Growth (Local) Growth (USD) Growth (Local) Mastercard-branded GDV 1 % % % % Asia Pacific/Middle East/Africa % % % % Canada % % % % Europe % % % % Latin America % % % % United States % % % % Cross-border Volume 1 % % Switched Transactions Growth % % 1 Excludes volume generated by Maestro and Cirrus cards. In 2016, our GDV was impacted by the EU Interchange Fee Regulation related to card payments which became effective in June 2016. The regulation requires that we no longer collect fees on domestic European Economic Area payment transactions that do not use our network brand. Prior to that, we collected a de minimis assessment fee in a few countries, particularly France, on transactions with Mastercard co-badged cards if the brands of domestic networks (as opposed to Mastercard) were used. As a result, the non-Mastercard co-badged volume is no longer being included. The following table reflects GDV growth rates for Europe and Worldwide Mastercard. For comparability purposes, we adjusted growth rates for the impact of Article 8 of the EU Interchange Fee Regulation related to card payments, to exclude the prior period co-badged volume processed by other networks. For the Years Ended December 31, Growth (Local) GDV 1 Worldwide as reported 9% 9% Worldwide as adjusted for EU Regulation 10% 11% Europe as reported 10% 10% Europe as adjusted for EU Regulation 16% 18% 1 Excludes volume generated by Maestro and Cirrus cards. A significant portion of our revenue is concentrated among our five largest customers. In 2017 , the net revenue from these customers was approximately $2.9 billion , or 23% , of total net revenue. The loss of any of these customers or their significant card programs could adversely impact our revenue. In addition, as part of our business strategy, among other efforts, we enter into business agreements with customers. These agreements can be terminated in a variety of circumstances. See our risk factor in Risk Factor - Business Risks in Part I, Item 1A for further discussion. Operating Expenses Operating expenses increased 17% and 9% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of the Special Items, adjusted operating expenses increased 16% and 10% , or 16% and 12% on a currency neutral basis, in 2017 and 2016 , respectively. Acquisitions contributed 6 percentage points of growth in 2017 . The components of operating expenses were as follows: Year ended December 31, Increase (Decrease) ($ in millions) General and administrative $ 4,526 $ 3,714 $ 3,341 % % Advertising and marketing % (1 )% Depreciation and amortization % % Provision for litigation settlement ** ** Total operating expenses 5,875 5,015 4,589 % % Special Items 1 (182 ) (117 ) (140 ) (1 )% % Adjusted total operating expenses (excluding Special Items 1 ) $ 5,693 $ 4,898 $ 4,449 % % Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. The following table summarizes the primary drivers of changes in operating expenses in 2017 and 2016 : For the Years Ended December 31, Operational Special Items 1 Acquisitions Foreign Currency 2 Total General and administrative % % % (3 )% % % % (1 )% % % Advertising and marketing % % % % % % % (1 )% % (1 )% Depreciation and amortization % % % % % % % (2 )% % % Provision for litigation settlements ** ** ** ** ** ** ** ** ** ** Total operating expenses % % % (1 )% % % % (1 )% % % Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. 2. Represents the foreign currency translational and transactional impact versus the prior year. General and Administrative General and administrative expenses increased 22% and 11% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of Special Items, adjusted general and administrative expenses increased 17% and 14% in 2017 and 2016 , respectively, versus the prior year. Acquisitions contributed 6 percentage points and 1 percentage point of growth in 2017 and 2016 , respectively. The significant components of our general and administrative expenses were as follows: For the Years Ended December 31, Percent Increase (Decrease) (in millions, except percentages) Personnel $ 2,687 $ 2,225 $ 2,105 21% 6% Professional fees 5% 9% Data processing and telecommunications 20% 16% Foreign exchange activity (82 ) ** ** Other 25% 8% General and administrative expenses 4,526 3,714 3,341 22% 11% Special Item 1 (167 ) (79 ) (5)% 3% Adjusted general and administrative expenses (excluding Special Item) 1 $ 4,359 $ 3,714 $ 3,262 17% 14% Note: Table may not sum due to rounding. ** Not meaningful. 1 See Non-GAAP Financial Information for further information on Special Items. The primary drivers of changes in general and administrative expenses in 2017 and 2016 were: Personnel expenses increased 21% and 6% in 2017 and 2016 , respectively, versus the prior year. Excluding the impact of U.S. Employee Pension Plan Settlement Charge of $79 million recorded in 2015, personnel expense grew 10% for 2016 versus 2015 . The 2017 and 2016 increases were driven by a higher number of employees to support our continued investment in the areas of real-time account payments, digital, services, data analytics and geographic expansion. The impact of acquisitions contributed 6 and 1 percentage points of growth for 2017 and 2016 , respectively. Professional fees consist primarily of third-party services, legal costs to defend our outstanding litigation and the evaluation of regulatory developments that impact our industry and brand. The increase in 2017 was primarily due to merger and acquisition related consulting costs. The increase in 2016 was primarily due to higher legal costs to defend litigation. Data processing and telecommunication charges consist of expenses to support our global payments network infrastructure, expenses to operate and maintain our computer systems and other telecommunication systems. These expenses increased in both 2017 and 2016 due to capacity growth of our business and higher third-party processing costs. Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8 for further discussion. During 2017 , foreign exchange activity negatively impacted general and administrative expense growth by 2 percentage points versus the comparable period in 2016 , due to greater losses from foreign exchange derivative contracts versus the prior year. During 2016 , foreign exchange activity negatively impacted general and administrative expense growth by 4 percentage points versus the comparable period in 2015 , due to the impact from foreign exchange derivative contracts and the lapping of balance sheet remeasurement gains in the prior year. Other expenses include costs to provide loyalty and rewards solutions, travel and meeting expenses and rental expense for our facilities and other miscellaneous charges. Other expenses increased 25% and 8% in 2017 and 2016 , respectively, versus the prior year. In 2017 , other expenses increased due to the impact of the Venezuelan Charge of $167 million . In 2016 , other expenses increased primarily due to higher cardholder services and loyalty costs. Advertising and Marketing In 2017 , advertising and marketing expenses increased 11% versus 2016 , mainly due to higher marketing spend primarily related to Masterpass. Advertising and marketing expenses decreased 1% in 2016 , mainly due to lower sponsorship promotions compared to 2015 . Depreciation and Amortization Depreciation and amortization expenses increased 17% and 2% in 2017 and 2016 , respectively, versus the prior year. The increase in 2017 was primarily due to the impact of acquisitions. In 2016 , the increase was primarily due to higher depreciation from capital investments partially offset by certain intangibles becoming fully amortized. Provision for Litigation Settlements During 2017 and 2016 , we recorded pre-tax charges of $15 million and $117 million related to litigations with merchants in Canada and the U.K., respectively. During 2015 , we recorded a pre-tax charge of $61 million related to litigations with merchants in the U.K. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Other Income (Expense) Other income (expense) is comprised primarily of investment income, interest expense, our share of income (losses) from equity method investments and other gains and losses. Total other expense decreased $15 million to $100 million in 2017 versus $115 million in 2016 due to lower impairment charges taken on certain investments last year and a gain on an investment in the current year, partially offset by higher interest expense from debt issued in the fourth quarter of 2016 . Total other expense decreased $5 million to $115 million in 2016 versus $120 million in 2015 due to lower impairment charges taken on certain investments and higher investment income in 2016 , partially offset by higher interest expense from debt issued in 2015 and 2016 . Income Taxes On December 22, 2017, in the U.S., the TCJA was signed into law. The TCJA, represents significant changes to the U.S. internal revenue code and, among other things: lowers the corporate income tax rate from 35% to 21% imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduces further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations eliminates the domestic production activities deduction While the effective date of the law for most of the above provisions is January 1, 2018, GAAP requires the resulting tax effects be accounted for in the reporting period of enactment. The impact of the TCJA is discussed further below and in Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8. The effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were 40.0% , 28.1% and 23.2% , respectively. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to the TCJA, which includes $825 million of provisional charges related to the Transition Tax, the remeasurement of our net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the reinvestment of foreign earnings, as well as $48 million in additional tax expense due to a foregone foreign tax credit benefit on current year repatriations. Excluding the impact of the TCJA and other Special Items, the 2017 adjusted effective income tax rate improved by 1.3 percentage points to 26.8% from 28.1% in 2016 primarily due to a more favorable geographical mix of taxable earnings, partially offset by a lower U.S. foreign tax credit benefit. The effective income tax rate for 2016 was higher than the effective income tax rate for 2015 primarily due to benefits associated with the impact of settlements with tax authorities in multiple jurisdictions in 2015, the lapping of a discrete benefit relating to certain foreign taxes that became eligible to be claimed as credits in the United States in 2015, and a higher U.S. foreign tax credit benefit associated with the repatriation of current year foreign earnings in 2015. These items were partially offset by a more favorable geographic mix of taxable earnings in 2016. The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 35% to pretax income for the years ended December 31, as a result of the following: For the Years Ended December 31, Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 6,522 $ 5,646 $ 4,958 Federal statutory tax 2,283 35.0 % 1,976 35.0 % 1,735 35.0 % State tax effect, net of federal benefit 0.7 % 0.4 % 0.5 % Foreign earnings (380 ) (5.8 )% (188 ) (3.3 )% (144 ) (2.9 )% Impact of foreign tax credits 1 (27 ) (0.4 )% (141 ) (2.5 )% (281 ) (5.7 )% Impact of settlements with tax authorities % % (147 ) (2.9 )% Transition Tax 9.6 % % % Remeasurement of U.S. deferred taxes 2.4 % % % Other, net (98 ) (1.5 )% (82 ) (1.5 )% (40 ) (0.8 )% Income tax expense $ 2,607 40.0 % $ 1,587 28.1 % $ 1,150 23.2 % 1 Included within the impact of foreign tax credits are repatriation benefits of current year foreign earnings of $0 million , $116 million and $172 million , in addition to other foreign tax credit benefits which become eligible in the United States of $27 million , $25 million and $109 million for 2017 , 2016 and 2015 , respectively. Our GAAP effective income tax rates for 2017 , 2016 and 2015 were affected by the tax benefits related to the Special Items as previously discussed. As of December 31, 2017 , a provisional amount of the U.S. federal and state and local income taxes of $36 million has been provided on a substantial amount of our undistributed foreign earnings. This deferred tax charge has been established primarily on the estimated foreign exchange gain which will be recognized when such earnings are repatriated. We expect that foreign withholding taxes associated with these future repatriated earnings will not be material. Based upon the ongoing review of business requirements and capital needs of our non-U.S. subsidiaries, we believe a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, we will complete our analysis of global working capital and cash needs to determine the amount we consider indefinitely reinvested. We will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. Our unrecognized tax benefits related to positions taken during the current and prior periods were $183 million and $169 million , as of December 31, 2017 and 2016 , respectively, all of which would reduce our effective tax rate if recognized. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local tax examinations is reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. During 2015, our unrecognized tax benefits related to tax positions taken during the current and prior periods decreased by $183 million . This decrease was primarily due to settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. During 2014, we implemented an initiative to better align our legal entity and tax structure with our operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property to a related foreign entity in the United Kingdom. We believe this improved alignment has resulted in greater flexibility and efficiency with regard to the global deployment of cash, as well as ongoing benefits in our effective income tax rate. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. In 2010, in connection with the expansion of our operations in the Asia Pacific, Middle East and Africa region, our subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL), received an incentive grant from the Singapore Ministry of Finance. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. Liquidity and Capital Resources We rely on existing liquidity, cash generated from operations and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The following table summarizes the cash, cash equivalents, investments and credit available to us at December 31 : (in billions) Cash, cash equivalents and investments 1 $ 7.8 $ 8.3 Unused line of credit 3.8 3.8 1 Investments include available-for-sale securities and short-term held-to-maturity securities. At December 31, 2017 and 2016 , this amount excludes restricted cash related to the U.S. merchant class litigation settlement of $546 million and $543 million , respectively. This amount also excludes restricted security deposits held for customers of $1 billion at December 31, 2017 and 2016 . Cash, cash equivalents and investments held by our foreign subsidiaries was $4.8 billion and $3.8 billion at December 31, 2017 and 2016 , respectively, or 62% and 45% as of such dates. As described further in Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8, as a result of the enactment of the TCJA, among other things, we recorded a provisional amount of $629 million in tax expense due to the Transition Tax, which is payable over the next 8 years . In addition, we have changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates. As a result of this assertion change, we have recognized a provisional deferred tax liability of $36 million . It is our present intention to indefinitely reinvest a portion of our historic undistributed accumulated earnings associated with certain foreign subsidiaries outside of the United States. Based upon the ongoing review of business requirements and capital needs of our non-U.S. subsidiaries, we believe a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, we will complete our analysis of global working capital and cash needs to determine the amount we consider indefinitely reinvested. We will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. Our liquidity and access to capital could be negatively impacted by global credit market conditions. We guarantee the settlement of many Mastercard, Cirrus and Maestro-branded transactions between our issuers and acquirers. See Note 19 (Settlement and Other Risk Management) to the consolidated financial statements in Part II, Item 8 for a description of these guarantees. Historically, payments under these guarantees have not been significant; however, historical trends may not be an indication of potential future losses. The risk of loss on these guarantees is specific to individual customers, but may also be driven significantly by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see our risk factor in Risk Factors - Legal and Regulatory Risks in Part I, Item 1A and Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8; and Part II, Item 7 (Business Environment). Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the years ended December 31 : (in millions) Cash Flow Data: Net cash provided by operating activities $ 5,555 $ 4,535 $ 4,101 Net cash used in investing activities (1,779 ) (1,167 ) (715 ) Net cash used in financing activities (4,764 ) (2,344 ) (2,516 ) Net cash provided by operating activities increased $1.0 billion in 2017 versus 2016 , primarily due to higher net income as adjusted for non-cash items including deferred payments associated with the TCJA. Net cash provided by operating activities in 2016 versus 2015 , increased by $434 million , primarily due to higher net income as adjusted for non-cash items and accrued expenses, partially offset by higher prepaid taxes. Net cash used in investing activities increased $612 million in 2017 versus 2016 , primarily due to acquisitions and investments in nonmarketable equity investments, partially offset by higher net proceeds of investment securities. Net cash used in investing activities increased $452 million in 2016 versus 2015 , primarily due to lower sales and maturities of our investment securities, partially offset by cash used for acquisition activities in the prior year. Net cash used in financing activities increased $2.4 billion in 2017 versus 2016 , primarily due to proceeds from debt issued in the prior year, increased cash used in the repurchases of our Class A common stock and higher dividends paid. Net cash used in financing activities decreased $172 million in 2016 versus 2015 , primarily due to higher proceeds from debt, partially offset by higher dividends paid. The table below shows a summary of select balance sheet data at December 31 : (in millions) Balance Sheet Data: Current assets $ 13,797 $ 13,228 Current liabilities 8,793 7,206 Long-term liabilities 6,968 5,785 Equity 5,497 5,684 We believe that our existing cash, cash equivalents and investment securities balances, our cash flow generating capabilities, our borrowing capacity and our access to capital resources are sufficient to satisfy our future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with our existing operations and potential obligations. Debt and Credit Availability Our long-term debt was $5.4 billion and $5.2 billion at December 31, 2017 and 2016 , respectively, with the earliest maturity of principal occurring in 2019. We have a commercial paper program (the Commercial Paper Program), under which we are authorized to issue up to $3.75 billion in outstanding notes, with maturities up to 397 days from the date of issuance. In conjunction with the Commercial Paper Program, we have entered into a committed unsecured $3.75 billion revolving credit facility (the Credit Facility) which expires in October 2022. Borrowings under the Commercial Paper Program and the Credit Facility are to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. In addition, we may borrow and repay amounts under these facilities for business continuity purposes. We had no borrowings outstanding under the Commercial Paper Program or the Credit Facility at December 31, 2017 and 2016 . See Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8 for further discussion on the Notes, the Commercial Paper Program and the Credit Facility. In June 2015, we filed a universal shelf registration statement to provide additional access to capital, if needed. Pursuant to the shelf registration statement, we may from time to time offer to sell debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Dividends and Share Repurchases We have historically paid quarterly dividends on our outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. The following table summarizes the annual, per share dividends paid in the years reflected: Years Ended December 31, (in millions, except per share data) Cash dividend, per share $ 0.88 $ 0.76 $ 0.64 Cash dividends paid $ $ $ On December 4, 2017, our Board of Directors declared a quarterly cash dividend of $0.25 per share paid on February 9, 2018 to holders of record on January 9, 2018 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $263 million . On February 5, 2018, our Board of Directors declared a quarterly cash dividend of $0.25 per share payable on May 9, 2018 to holders of record on April 9, 2018 of our Class A common stock and Class B common stock. The aggregate amount of this dividend is estimated to be $263 million . Repurchased shares of our common stock are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2017, our Board of Directors approved a share repurchase program authorizing us to repurchase up to $4 billion of our Class A common stock. This program is effective after completion of the share repurchase program authorized in December 2016. The following table summarizes our share repurchase authorizations of its Class A common stock through December 31, 2017 , as well as historical purchases: Authorization Dates December 2017 December 2016 December 2015 Total (in millions, except average price data) Board authorization $ 4,000 $ 4,000 $ 4,000 $ 12,000 Remaining authorization at December 31, 2016 $ $ 4,000 $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ 2,766 $ $ 3,762 Remaining authorization at December 31, 2017 $ 4,000 $ 1,234 $ $ 5,234 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ 131.97 $ 109.16 $ 125.05 See Note 13 (Stockholders Equity) to the consolidated financial statements included in Part II, Item 8 for further discussion. Off-Balance Sheet Arrangements We have no off-balance sheet debt, other than lease arrangements and other commitments as presented in the Future Obligations table that follows. Future Obligations The following table summarizes our obligations as of December 31, 2017 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through cash generated from operations and our cash balances. Payments Due by Period Total 2019 - 2020 2021 - 2022 2023 and thereafter (in millions) Debt $ 5,477 $ $ $ 1,489 $ 3,488 Interest on debt 1,453 Capital leases Operating leases Other obligations 1 Sponsorship, licensing and other 2 Employee benefits 3 Transition Tax 4 Redeemable non-controlling interests 5 Total 6 $ 8,985 $ $ 1,450 $ 2,004 $ 4,804 1 The table does not include the $709 million provision as of December 31, 2017 related to litigation in the U.S. and the U.K. since the payments are not fixed and determinable. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. The table also does not include the $219 million provision as of December 31, 2017 related to the contingent consideration attributable to acquisitions made in 2017 (primarily based on the achievement of 2018 revenue targets) which are not fixed and determinable. See Note 5 (Fair Value and Investment Securities) to the consolidated financial statements included in Part II, Item 8 for further discussion. 2 Amounts primarily relate to sponsorships to promote the Mastercard brand. Future cash payments that will become due to our customers under agreements which provide pricing rebates on our standard fees and other incentives in exchange for transaction volumes are not included in the table because the amounts due are contingent on future performance. We have accrued $3.3 billion as of December 31, 2017 related to customer and merchant agreements. 3 Amounts relate to severance liabilities along with expected funding requirements for defined benefit pension and postretirement plans. 4 Amounts relate to the provisional U.S. tax liability on the Transition Tax on accumulated non-U.S. earnings of U.S entities. See Note 17 (Income Taxes) to the consolidated financial statements included in Part II, Item 8 for further discussion. 5 Amount relates to the fixed-price put option for the Vocalink remaining shareholders to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter. See Note 2 (Acquisitions) to the consolidated financial statements included in Part II, Item 8 for further discussion. 6 We have recorded a liability for unrecognized tax benefits of $183 million at December 31, 2017 . Within the next twelve months, we believe that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. It is not possible to provide a range of the potential change until the examinations progress further or the related statute of limitations expire. These amounts have been excluded from the table since the settlement period of this liability cannot be reasonably estimated. The timing of these payments will ultimately depend on the progress of tax examinations with the various authorities. Seasonality We do not experience meaningful seasonality. No individual quarter in 2017 , 2016 or 2015 accounted for more than 30% of net revenue. Critical Accounting Estimates The application of GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. We have established detailed policies and control procedures to provide reasonable assurance that the methods used to make estimates and assumptions are well controlled and are applied consistently from period to period. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to its financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to our financial condition. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Our significant accounting policies, including recent accounting pronouncements, are described in Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part II, Item 8. Revenue Recognition Application of the various accounting principles in GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Domestic assessment revenue requires an estimate of our customers performance in order to recognize this revenue. Rebates and incentives are recorded as a reduction to gross revenue based on these estimates. We consider various factors in estimating customer performance, including a review of specific transactions, historical experience with that customer and market and economic conditions. Differences between actual results and our estimates are adjusted in the period the customer reports actual performance. If our customers actual performance is not consistent with our estimates of their performance, net revenue may be materially different. Loss Contingencies We are currently involved in various claims and legal proceedings. We regularly review the status of each significant matter and assesses its potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and whether an exposure is reasonably estimable. Our judgments are subjective based on the status of the legal or regulatory proceedings, the merits of our defenses and consultation with in-house and outside legal counsel. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to its pending claims and litigation and may revise its estimates. Due to the inherent uncertainties of the legal and regulatory process in the multiple jurisdictions in which we operate, our judgments may be materially different than the actual outcomes. See Note 18 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part II, Item 8 for further discussion. Income Taxes In calculating our effective income tax rate, we need to make estimates regarding the timing and amount of taxable and deductible items which will adjust the pretax income earned in various tax jurisdictions. Through our interpretation of local tax regulations, adjustments to pretax income for income earned in various tax jurisdictions are reflected within various tax filings. Although we believe that our estimates and judgments discussed herein are reasonable, actual results may be materially different than the estimated amounts. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Significant judgment is required in determining the valuation allowance. We consider projected future taxable income and ongoing tax planning strategies in assessing the need for the valuation allowance. If it is determined that we are able to realize deferred tax assets in excess of the net carrying value or to the extent we are unable to realize a deferred tax asset, we would adjust the valuation allowance in the period in which such a determination is made, with a corresponding increase or decrease to earnings. We record tax liabilities for uncertain tax positions taken, or expected to be taken, which may not be sustained or may only be partially sustained, upon examination by the relevant taxing authorities. We consider all relevant facts and current authorities in the tax law in assessing whether any benefit resulting from an uncertain tax position is more likely than not to be sustained and, if so, how current law impacts the amount reflected within these financial statements. If upon examination, we realize a tax benefit which is not fully sustained or is more favorably sustained, this would decrease or increase earnings in the period. In certain situations, we will have offsetting tax credits or taxes in other jurisdictions. We have changed our assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain of our foreign affiliates. As a result of the TCJA and the one-time deemed repatriation tax on untaxed accumulated foreign earnings, a provisional amount of U.S. federal and state and local income taxes have been provided on all of our undistributed foreign earnings. Future distributions from foreign affiliates from earnings which have not already been taxed in the U.S. will be eligible for a 100% dividends received deduction. Beginning in 2018, deferred taxes will be established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. Ultimately, the working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. On December 22, 2017, SEC staff issued Staff Accounting Bulletin No. 118 - Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which allows registrants to record provisional amounts during a measurement period, which is not to extend beyond one year. Accordingly, amounts recorded may require further adjustments due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and The Department of Treasury (Treasury) of Notices, regulations and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied to the TCJA. Consistent with SAB 118, we were able to make reasonable estimates and we have incorporated provisional amounts for the impact of the Transition Tax. This tax is on previously untaxed accumulated and current earnings and profits of our foreign subsidiaries. To compute the tax, we must determine the amount of post-1986 earnings and profits of relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. Further, we were able to make reasonable estimates and have recorded provisional amounts related to the remeasurement of our net deferred tax asset in the U.S. and the change in assertion regarding the indefinite reinvestment of foreign earnings. As with the Transition Tax, these amounts may require further adjustments during the measurement period due to evolving analysis and interpretations of law, including issuance by the IRS and Treasury of Notices and regulations, and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied. Valuation of Assets The valuation of assets acquired in a business combination and asset impairment reviews require the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires us to estimate the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree to properly allocate purchase price consideration. Impairment testing for assets, other than goodwill and indefinite-lived intangible assets, requires the allocation of cash flows to those assets or group of assets and if required, an estimate of fair value for the assets or group of assets. We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis or sooner if indicators of impairment exist. Goodwill is tested for impairment at the reporting unit level utilizing a quantitative assessment. We use the market capitalization for estimating the fair value of its reporting unit. If the fair value exceeds the carrying value, goodwill is not impaired. If the carrying value exceeds the fair value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate all relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. In performing the qualitative assessment, we consider relevant events and conditions, including but not limited to, macroeconomic trends, industry and market conditions, overall financial performance, cost factors, company-specific events, and legal and regulatory factors. If the qualitative assessment indicates that it is more likely than not that the fair value of the indefinite-lived intangible asset is less than their carrying amounts, we must perform a quantitative impairment test. Our estimates in the valuation of these assets are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of managements assumptions, which would not reflect unanticipated events and circumstances that may occur. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as interest rates, foreign currency exchange rates and equity price risk. Our exposure to market risk from changes in interest rates, foreign exchange rates and equity price risk is limited. Management establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments. We monitor risk exposures on an ongoing basis. The effect of a hypothetical 10% adverse change in foreign exchange rates could result in a fair value loss of approximately $109 million on our foreign currency derivative contracts outstanding at December 31, 2017 related to the hedging program. A 100 basis point adverse change in interest rates would not have a material impact on our investments at December 31, 2017 and 2016 . In addition, there was no material equity price risk at December 31, 2017 or 2016 . Foreign Exchange Risk Our settlement activities are subject to foreign exchange risk resulting from foreign exchange rate fluctuations. This risk is typically limited to the one business day between setting the foreign exchange rates and clearing the financial transactions. We enter into foreign currency contracts to manage risk associated with anticipated receipts and disbursements which are either transacted in a non-functional currency or valued based on a currency other than the functional currencies of the entity. We may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities denominated in currencies other than the functional currency of the entity. The objective of these activities is to reduce our exposure to transaction gains and losses resulting from fluctuations of foreign currencies against our functional and reporting currencies, principally the U.S. dollar and euro. Foreign currency exposures are managed together through our foreign exchange risk management activities, which are discussed further in Note 20 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part II, Item 8. The terms of the forward contracts are generally less than 18 months . As of December 31, 2017 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with our customers. Our derivative contracts are summarized below: December 31, 2017 December 31, 2016 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ (2 ) Commitments to sell foreign currency (26 ) Options to sell foreign currency We also use foreign currency denominated debt to hedge a portion of our net investment in foreign operations against adverse movements in exchange rates, with changes in the translated value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). We have designated our euro-denominated debt as a net investment hedge for a portion of our net investment in European foreign operations. Our euro-denominated debt is vulnerable to changes in the euro to U.S. dollar exchange rates. The principal amounts of our euro-denominated debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8. Interest Rate Risk Our interest rate sensitive assets are our investments in fixed income securities, which we generally hold as available-for-sale investments. Our policy is to invest in high quality securities, while providing adequate liquidity and maintaining diversification to avoid significant exposure. The fair value and maturity distribution of our available-for-sale investments for fixed income securities as of December 31 was as follows: Maturity Fair Market Value at December 31, 2017 2023 and there-after Financial Instrument Summary Terms (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,148 $ $ $ $ $ $ Maturity Financial Instrument Summary Terms Fair Market Value at December 31, 2016 2022 and there-after (in millions) Municipal securities Fixed / Variable Interest $ $ $ $ $ $ $ Government and agency securities Fixed / Variable Interest Corporate securities Fixed / Variable Interest Asset-backed securities Fixed / Variable Interest Total $ 1,160 $ $ $ $ $ $ We also have time deposits that are classified as held-to-maturity securities. At December 31, 2017 and 2016 , the cost which approximates fair value, of our short-term held-to-maturity securities was $700 million and $452 million , respectively. In addition, at December 31, 2016 , we held $61 million of long-term held-to-maturity securities. We did not hold any long-term held-to-maturity securities at December 31, 2017 . At December 31, 2017 , we have U.S. dollar-denominated and euro-denominated debt, which is subject to interest rate risk. The principal amounts of this debt as well as the effective interest rates and scheduled annual maturities of the principal is included in Note 12 (Debt) to the consolidated financial statements included in Part II, Item 8. See Future Obligations for estimated interest payments due by period relating to the U.S. dollar-denominated and euro-denominated debt. At December 31, 2017 , we have the Commercial Paper Program and the Credit Facility which provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by our customers. Borrowing rates under the Commercial Paper Program are based on market conditions. Borrowing rates under the Credit Facility are variable rates, which are applied to the borrowing based on terms and conditions set forth in the agreement. See Note 12 (Debt) to the consolidated financial statements in Part II, Item 8 for additional information on the Credit Facility and the Commercial Paper Program. We had no borrowings under the Commercial Paper Program or the Credit Facility at December 31, 2017 and 2016 . Equity Price Risk We did not have significant equity price risk as of December 31, 2017 and 2016 . "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MASTERCARD INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Mastercard Incorporated As of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015 Managements Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Consolidated Balance Sheet Consolidated Statement of Operations Consolidated Statement of Comprehensive Income Consolidated Statement of Changes in Equity Consolidated Statement of Cash Flows Notes to Consolidated Financial Statements 57 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of Mastercard Incorporated (Mastercard) is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. As required by Section 404 of the Sarbanes-Oxley Act of 2002, management has assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 . In making its assessment, management has utilized the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Management has concluded that, based on its assessment, Mastercards internal control over financial reporting was effective as of December 31, 2017 . The effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears on the next page. REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Mastercard Incorporated: Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Mastercard Incorporated and its subsidiaries as of December 31, 2017 and 2016 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2017 , including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016 , and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control over Financial Reporting appearing in the 2017 Annual Report under Item 8 on page 58. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York February 14, 2018 We have served as the Companys auditor since 1989. MASTERCARD INCORPORATED CONSOLIDATED BALANCE SHEET December 31, (in millions, except per share data) ASSETS Cash and cash equivalents $ 5,933 $ 6,721 Restricted cash for litigation settlement Investments 1,849 1,614 Accounts receivable 1,969 1,416 Settlement due from customers 1,375 1,093 Restricted security deposits held for customers 1,085 Prepaid expenses and other current assets 1,040 Total Current Assets 13,797 13,228 Property, plant and equipment, net Deferred income taxes Goodwill 3,035 1,756 Other intangible assets, net 1,120 Other assets 2,298 1,929 Total Assets $ 21,329 $ 18,675 LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS AND EQUITY Accounts payable $ $ Settlement due to customers 1,343 Restricted security deposits held for customers 1,085 Accrued litigation Accrued expenses 3,931 3,318 Other current liabilities Total Current Liabilities 8,793 7,206 Long-term debt 5,424 5,180 Deferred income taxes Other liabilities 1,438 Total Liabilities 15,761 12,991 Commitments and Contingencies Redeemable Non-controlling Interests Stockholders Equity Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,382 and 1,374 shares issued and 1,040 and 1,062 outstanding, respectively Class B common stock, $0.0001 par value; authorized 1,200 shares, 14 and 19 issued and outstanding, respectively Additional paid-in-capital 4,365 4,183 Class A treasury stock, at cost, 342 and 312 shares, respectively (20,764 ) (17,021 ) Retained earnings 22,364 19,418 Accumulated other comprehensive income (loss) (497 ) (924 ) Total Stockholders Equity 5,468 5,656 Non-controlling interests Total Equity 5,497 5,684 Total Liabilities, Redeemable Non-controlling Interests and Equity $ 21,329 $ 18,675 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF OPERATIONS For the Years Ended December 31, (in millions, except per share data) Net Revenue $ 12,497 $ 10,776 $ 9,667 Operating Expenses General and administrative 4,526 3,714 3,341 Advertising and marketing Depreciation and amortization Provision for litigation settlements Total operating expenses 5,875 5,015 4,589 Operating income 6,622 5,761 5,078 Other Income (Expense) Investment income Interest expense (154 ) (95 ) (61 ) Other income (expense), net (2 ) (63 ) (84 ) Total other income (expense) (100 ) (115 ) (120 ) Income before income taxes 6,522 5,646 4,958 Income tax expense 2,607 1,587 1,150 Net Income $ 3,915 $ 4,059 $ 3,808 Basic Earnings per Share $ 3.67 $ 3.70 $ 3.36 Basic Weighted-Average Shares Outstanding 1,067 1,098 1,134 Diluted Earnings per Share $ 3.65 $ 3.69 $ 3.35 Diluted Weighted-Average Shares Outstanding 1,072 1,101 1,137 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the Years Ended December 31, (in millions) Net Income $ 3,915 $ 4,059 $ 3,808 Other comprehensive income (loss): Foreign currency translation adjustments (275 ) (460 ) Income tax effect (11 ) Foreign currency translation adjustments, net of income tax effect (286 ) (433 ) Translation adjustments on net investment hedge (236 ) (40 ) Income tax effect (22 ) Translation adjustments on net investment hedge, net of income tax effect (153 ) (26 ) Defined benefit pension and other postretirement plans (1 ) (19 ) Income tax effect (2 ) Defined benefit pension and other postretirement plans, net of income tax effect (1 ) (12 ) Reclassification adjustment for defined benefit pension and other postretirement plans (2 ) (1 ) Income tax effect (29 ) Reclassification adjustment for defined benefit pension and other postretirement plans, net of income tax effect (1 ) (1 ) Investment securities available-for-sale (3 ) (11 ) Income tax effect (1 ) Investment securities available-for-sale, net of income tax effect (1 ) (11 ) Reclassification adjustment for investment securities available-for-sale Income tax effect Reclassification adjustment for investment securities available-for-sale, net of income tax effect Other comprehensive income (loss), net of income tax effect (248 ) (416 ) Comprehensive Income $ 4,342 $ 3,811 $ 3,392 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Additional Paid-In Capital Class A Treasury Stock Non- Controlling Interests Total Class A Class B (in millions, except per share data) Balance at December 31, 2014 $ $ $ 13,169 $ (260 ) $ 3,876 $ (9,995 ) $ $ 6,824 Net income 3,808 3,808 Activity related to non-controlling interests Other comprehensive income (loss), net of tax (416 ) (416 ) Cash dividends declared on Class A and Class B common stock, $0.67 per share (755 ) (755 ) Purchases of treasury stock (3,532 ) (3,532 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2015 16,222 (676 ) 4,004 (13,522 ) 6,062 Net income 4,059 4,059 Activity related to non-controlling interests (6 ) (6 ) Other comprehensive income (loss), net of tax (248 ) (248 ) Cash dividends declared on Class A and Class B common stock, $0.79 per share (863 ) (863 ) Purchases of treasury stock (3,503 ) (3,503 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2016 19,418 (924 ) 4,183 (17,021 ) 5,684 Net income 3,915 3,915 Activity related to non-controlling interests Other comprehensive income (loss), net of tax Cash dividends declared on Class A and Class B common stock, $0.91 per share (969 ) (969 ) Purchases of treasury stock (3,747 ) (3,747 ) Share-based payments Conversion of Class B to Class A common stock Balance at December 31, 2017 $ $ $ 22,364 $ (497 ) $ 4,365 $ (20,764 ) $ $ 5,497 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS For the Years Ended December 31, (in millions) Operating Activities Net income $ 3,915 $ 4,059 $ 3,808 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of customer and merchant incentives 1,001 Depreciation and amortization Share-based compensation Tax benefit for share-based payments (48 ) (42 ) Deferred income taxes (20 ) (16 ) Venezuela charge Other (81 ) Changes in operating assets and liabilities: Accounts receivable (445 ) (338 ) (35 ) Settlement due from customers (281 ) (10 ) (98 ) Prepaid expenses (1,402 ) (1,073 ) (802 ) Accrued litigation and legal settlements (15 ) (63 ) Accounts payable Settlement due to customers (186 ) Accrued expenses Long-term taxes payable Net change in other assets and liabilities (194 ) (10 ) Net cash provided by operating activities 5,555 4,535 4,101 Investing Activities Purchases of investment securities available-for-sale (714 ) (957 ) (974 ) Purchases of investments held-to-maturity (1,145 ) (867 ) (918 ) Proceeds from sales of investment securities available-for-sale Proceeds from maturities of investment securities available-for-sale Proceeds from maturities of investments held-to-maturity 1,020 Purchases of property, plant and equipment (300 ) (215 ) (177 ) Capitalized software (123 ) (167 ) (165 ) Acquisition of businesses, net of cash acquired (1,175 ) (584 ) Investment in nonmarketable equity investments (147 ) (31 ) Other investing activities (2 ) (1 ) Net cash used in investing activities (1,779 ) (1,167 ) (715 ) Financing Activities Purchases of treasury stock (3,762 ) (3,511 ) (3,518 ) Proceeds from debt 1,972 1,735 Payment of debt (64 ) Dividends paid (942 ) (837 ) (727 ) Tax benefit for share-based payments Tax withholdings related to share-based payments (47 ) (51 ) (58 ) Cash proceeds from exercise of stock options Other financing activities (6 ) (2 ) (17 ) Net cash used in financing activities (4,764 ) (2,344 ) (2,516 ) Effect of exchange rate changes on cash and cash equivalents (50 ) (260 ) Net (decrease) increase in cash and cash equivalents (788 ) Cash and cash equivalents - beginning of period 6,721 5,747 5,137 Cash and cash equivalents - end of period $ 5,933 $ 6,721 $ 5,747 The accompanying notes are an integral part of these consolidated financial statements. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (Mastercard International and together with Mastercard Incorporated, Mastercard or the Company), is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments, digital partners, businesses and other organizations worldwide, enabling them to use electronic forms of payment instead of cash and checks. The Company facilitates the switching (authorization, clearing and settlement) of payment transactions, and delivers related products and services. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard, Maestro and Cirrus. The recent acquisition of VocaLink Holdings Limited (Vocalink) has expanded the Companys capability to process automated clearing house (ACH) transactions, among other things. As a multi-rail network, Mastercard now offers customers one partner to turn to for their payment needs for both domestic and cross-border transactions. The Company also provides value-added offerings such as safety and security products, information services and consulting, loyalty and reward programs and issuer and acquirer processing. The Companys networks are designed to ensure safety and security for the global payments system. A typical transaction on the Companys core network involves four participants in addition to the Company: account holder (an individual who holds a card or uses another device enabled for payment), merchant, issuer (the account holders financial institution) and acquirer (the merchants financial institution). The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to account holders by issuers, or establish the rates charged by acquirers in connection with merchants acceptance of the Companys branded products. In most cases, account holder relationships belong to, and are managed by, the Companys financial institution customers. Mastercard generates revenues from assessing its customers based on the gross dollar volume (GDV) of activity on the products that carry its brands, from the fees charged to customers for providing transaction processing and from other payment-related products and services. Significant Accounting Policies Consolidation and basis of presentation - The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (VIEs) for which the Company is the primary beneficiary. Investments in VIEs for which the Company is not considered the primary beneficiary are not consolidated and are accounted for as equity method or cost method investments and recorded in other assets on the consolidated balance sheet. At December 31, 2017 and 2016 , there were no significant VIEs which required consolidation and the investments were not considered material to the consolidated financial statements. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2017 presentation. The Company follows accounting principles generally accepted in the United States of America (GAAP). Prior to December 31, 2017, the Company included the financial results from its Venezuela subsidiaries in the consolidated financial statements using the consolidation method of accounting. Due to increasing foreign exchange regulations in Venezuela restricting access to U.S. dollars, an other-than-temporary lack of exchangeability between the Venezuelan bolivar and U.S. dollar has impacted the ability to manage risk, process cross-border transactions and satisfy U.S. dollar denominated liabilities related to operations in Venezuela. As a result of these factors, Mastercard concluded that effective December 31, 2017, it did not meet the accounting criteria for consolidation of these Venezuelan subsidiaries, and therefore would transition to the cost method of accounting as of December 31, 2017. This accounting change resulted in a pre-tax charge of $167 million ( $108 million after tax, or $0.10 per diluted share) included in general and administrative expenses in the consolidated statement of operations. Non-controlling interests represent the equity interest not owned by the Company and are recorded for consolidated entities in which the Company owns less than 100% of the interests. Changes in a parents ownership interest while the parent retains its controlling interest are accounted for as equity transactions, and upon loss of control, retained ownership interests are remeasured at fair value, with any gain or loss recognized in earnings. For 2017, 2016 and 2015 , losses from non-controlling interests were de minimis and, as a result, amounts are included on the consolidated statement of operations within other income (expense). The Company accounts for investments in common stock or in-substance common stock under the equity method of accounting when it has the ability to exercise significant influence over the investee, generally when it holds between 20% and 50% ownership MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) in the entity. In addition, investments in flow-through entities such as limited partnerships and limited liability companies are also accounted for under the equity method when the Company has the ability to exercise significant influence over the investee, generally when the investment ownership percentage is equal to or greater than 5% of the outstanding ownership interest. The excess of the cost over the underlying net equity of investments accounted for under the equity method is allocated to identifiable tangible and intangible assets and liabilities based on fair values at the date of acquisition. The amortization of the excess of the cost over the underlying net equity of investments and Mastercards share of net earnings or losses of entities accounted for under the equity method of accounting is included in other income (expense) on the consolidated statement of operations. The Company accounts for investments in common stock or in-substance common stock under the cost method of accounting when it does not exercise significant influence, generally when it holds less than 20% ownership in the entity or when the interest in a limited partnership or limited liability company is less than 5% and the Company has no significant influence over the operation of the investee. Investments in companies that Mastercard does not control, but that are not in the form of common stock or in-substance common stock, are also accounted for under the cost method of accounting. Investments for which the equity method or cost method of accounting is used are recorded in other assets on the consolidated balance sheet. Use of estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty; accordingly, accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of the Companys consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as the Companys operating environment changes. Actual results may differ from these estimates. Revenue recognition - Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectibility is reasonably assured. Revenue is generally derived from transactional information accumulated by Mastercards systems or reported by customers. The Companys revenue is based on the volume of activity on cards that carry the Companys brands, the number of transactions processed or the nature of other payment-related products and services. Volume-based revenue (domestic assessments and cross-border volume fees) is recorded as revenue in the period it is earned, which is when the related volume is generated on the cards. Certain volume-based revenue is based upon information reported by customers. Transaction-based revenue is primarily based on the number and type of transactions and is recognized as revenue in the same period as the related transactions occur. Other payment-related products and services are recognized as revenue in the same period as the related transactions occur or services are rendered. Mastercard has business agreements with certain customers that provide for rebates or other support when the customers meet certain volume hurdles as well as other support incentives such as marketing, which are tied to performance. Rebates and incentives are recorded as a reduction of revenue either when the revenue is recognized by the Company or at the time the rebate or incentive is earned by the customer. Rebates and incentives are calculated based upon estimated performance and the terms of the related business agreements. In addition, Mastercard may make payments to a customer directly related to entering into an agreement, which are generally deferred and amortized over the life of the agreement on a straight-line basis. Business combinations - The Company accounts for business combinations under the acquisition method of accounting. The Company measures the tangible and intangible identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree, at their fair values at the acquisition date. Acquisition-related costs are expensed as incurred and are included in general and administrative expenses. Any excess of purchase price over the fair value of net assets acquired, including identifiable intangible assets, is recorded as goodwill. Goodwill and other intangible assets - Indefinite-lived intangible assets consist of goodwill, which represents the synergies expected to arise after the acquisition date and the assembled workforce, and customer relationships. Finite-lived intangible assets consist of capitalized software costs, trademarks, tradenames, customer relationships and other intangible assets. Intangible assets with finite useful lives are amortized over their estimated useful lives, on a straight-line basis, which range from one to twenty years. Capitalized software includes internal and external costs incurred directly related to the design, development and testing phases of each capitalized software project. Impairment of assets - Goodwill and indefinite-lived intangible assets are not amortized and are tested annually for impairment in the fourth quarter, or sooner when circumstances indicate an impairment may exist. The impairment evaluation for goodwill utilizes a quantitative assessment. If the fair value of a reporting unit exceeds the carrying value, goodwill is not impaired. If the MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) fair value of the reporting unit is less than its carrying value, then goodwill is impaired and the excess of the reporting units carrying value over the fair value is recognized as an impairment charge. Impairment charges, if any, are recorded in general and administrative expenses on the consolidated statement of operations. The impairment test for indefinite-lived intangible assets consists of a qualitative assessment to evaluate relevant events and circumstances that could affect the significant inputs used to determine the fair value of indefinite-lived intangible assets. If the qualitative assessment indicates that it is more likely than not that indefinite-lived intangible assets are impaired, then a quantitative assessment is required. Long-lived assets, other than goodwill and indefinite-lived intangible assets, are tested for impairment whenever events or circumstances indicate that their carrying amount may not be recoverable. If the carrying value of the asset cannot be recovered from estimated future cash flows, undiscounted and without interest, the fair value of the asset is calculated using the present value of estimated net future cash flows. If the carrying amount of the asset exceeds its fair value, an impairment is recorded. Litigation - The Company is a party to certain legal and regulatory proceedings with respect to a variety of matters. The Company evaluates the likelihood of an unfavorable outcome of all legal or regulatory proceedings to which it is a party and accrues a loss contingency when the loss is probable and reasonably estimable. These judgments are subjective based on the status of the legal or regulatory proceedings, the merits of its defenses and consultation with in-house and external legal counsel. Legal costs are expensed as incurred and recorded in general and administrative expenses on the consolidated statement of operations. Settlement and other risk management - Mastercards rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro-branded transactions between its issuers and acquirers. Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during the ordinary course activities of the Company. The Company also enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. The Company accounts for each of its guarantees by recording the guarantee at its fair value at the inception or modification date through earnings. Income taxes - The Company follows an asset and liability based approach in accounting for income taxes as required under GAAP. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between the financial statement carrying amounts and income tax bases of assets and liabilities. Deferred income taxes are displayed separately as noncurrent assets and liabilities on the consolidated balance sheet. Valuation allowances are provided against assets which are not more likely than not to be realized. The Company recognizes all material tax positions, including uncertain tax positions in which it is more likely than not that the position will be sustained based on its technical merits and if challenged by the relevant taxing authorities. At each balance sheet date, unresolved uncertain tax positions are reassessed to determine whether subsequent developments require a change in the amount of recognized tax benefit. The allowance for uncertain tax positions is recorded in other current and noncurrent liabilities on the consolidated balance sheet. The Company records interest expense related to income tax matters as interest expense in its consolidated statement of operations. The Company includes penalties related to income tax matters in the income tax provision. On December 22, 2017, in the U.S., An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, a comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the TCJA), was enacted into law. Prior to the enactment of the TCJA, the Company did not historically provide for U.S. federal income tax and foreign withholding taxes on undistributed earnings from non-U.S. subsidiaries as such earnings were intended to be reinvested indefinitely outside of the U.S. The foreign earnings that the Company had repatriated to the United States, for periods prior to the enactment of the TCJA, were limited to the amount of current year foreign earnings and not made out of historic undistributed accumulated earnings. As of December 31, 2017, the Company has changed its assertion regarding the indefinite reinvestment of foreign earnings outside the U.S. for certain foreign affiliates. As a result of the TCJA and a one-time MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) deemed repatriation tax on untaxed accumulated foreign earnings, a provisional amount of U.S. federal and state and local income taxes have been provided on all undistributed foreign earnings. Future distributions from foreign affiliates from earnings which have not already been taxed in the U.S. will be eligible for a 100% dividends received deduction. Beginning in 2018, deferred taxes will be established on the estimated foreign exchange gains or losses for foreign earnings that are not considered permanently reinvested, which will be recognized through cumulative translation adjustments as incurred. The working capital requirements of foreign affiliates will determine the amount of cash to be remitted from respective jurisdictions. Cash and cash equivalents - Cash and cash equivalents include certain investments with daily liquidity and with a maturity of three months or less from the date of purchase. Cash equivalents are recorded at cost, which approximates fair value. Restricted cash - The Company classifies cash and cash equivalents as restricted when the cash is unavailable for withdrawal or usage for general operations. Restrictions may include legally restricted deposits, contracts entered into with others, or the Companys statements of intention with regard to particular deposits. Fair value - The Company measures certain financial assets and liabilities at fair value on a recurring basis by estimating the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. The Company classifies these recurring fair value measurements into a three-level hierarchy (Valuation Hierarchy). The Valuation Hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the Valuation Hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of the Valuation Hierarchy are as follows: Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in inactive markets and inputs that are observable for the asset or liability. Level 3 - inputs to the valuation methodology are unobservable and cannot be directly corroborated by observable market data. Certain assets are measured at fair value on a nonrecurring basis. The Companys assets measured at fair value on a nonrecurring basis include property, plant and equipment, nonmarketable equity investments, goodwill and other intangible assets. These assets are subject to impairment evaluation and if impaired, would be adjusted to fair value. The valuation methods for goodwill and other intangible assets acquired in business combinations involve assumptions concerning comparable company multiples, discount rates, growth projections and other assumptions of future business conditions. The Company uses various valuation techniques to determine fair value, primarily discounted cash flows analysis, relief-from-royalty, and multi-period excess earnings for estimating the fair value of its intangible assets. The Companys uses market capitalization for estimating the fair value of its reporting unit. As the assumptions employed to measure these assets are based on managements judgment using internal and external data, these fair value determinations are classified in Level 3 of the Valuation Hierarchy. Contingent consideration - Certain business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones. These liabilities are classified within Level 3 of the Valuation Hierarchy as the inputs used to measure fair value are unobservable and require managements judgment. The fair value of the contingent consideration at the acquisition date and subsequent periods is determined utilizing an income approach based on a Monte Carlo technique and is recorded in other current liabilities and other liabilities on the consolidated balance sheet. Changes to projected performance milestones of the acquired businesses could result in a higher or lower contingent consideration liability. Measurement period adjustments, if any, to the preliminary estimated fair value of contingent consideration as of the acquisition date will be recorded to goodwill, however, changes in fair value as a result of updated assumptions will be recorded in general and administrative expenses on the consolidated statement of operations. Investment securities - The Company classifies investments in debt and equity securities as available-for-sale. Available-for-sale securities that are available to meet the Companys current operational needs are classified as current assets. Available-for-sale securities that are not available to meet the Companys current operational needs are classified as non-current assets on the consolidated balance sheet. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The investments in debt and equity securities are carried at fair value, with unrealized gains and losses, net of applicable taxes, recorded as a separate component of accumulated other comprehensive income (loss) on the consolidated statement of comprehensive income. Net realized gains and losses on debt and equity securities are recognized in investment income on the consolidated statement of operations. The specific identification method is used to determine realized gains and losses. The Company evaluates its debt and equity securities for other-than-temporary impairment on an ongoing basis. When there has been a decline in fair value of a debt or equity security below the amortized cost basis, the Company recognizes an other-than-temporary impairment if: (1) it has the intent to sell the security; (2) it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis; or (3) it does not expect to recover the entire amortized cost basis of the security. The credit loss component of the impairment would be recognized in other income (expense), net on the consolidated statement of operations while the non-credit loss would remain in accumulated other comprehensive income (loss) until realized from a sale or an other-than-temporary impairment. The Company classifies time deposits with maturities greater than 3 months as held-to-maturity. Held-to-maturity securities that mature within one year are classified as current assets while held-to-maturity securities with maturities of greater than one year are classified as non-current assets. Time deposits are carried at amortized cost on the consolidated balance sheet and are intended to be held until maturity. Derivative financial instruments - The Company records all derivatives at fair value. The Companys foreign exchange forward and option contracts are included in Level 2 of the Valuation Hierarchy as the fair value of these contracts are based on inputs, which are observable based on broker quotes for the same or similar instruments. Changes in the fair value of derivative instruments are reported in current-period earnings. The Companys derivative contracts hedge foreign exchange risk and are not entered into for trading or speculative purposes. The Company did not have any derivative contracts accounted for under hedge accounting as of December 31, 2017 and 2016 . The Company has numerous investments in its foreign subsidiaries. The net assets of these subsidiaries are exposed to volatility in foreign currency exchange rates. The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates. The effective portion of the foreign currency gains and losses related to the foreign currency denominated debt are reported in accumulated other comprehensive income (loss) on the consolidated balance sheet as part of the cumulative translation adjustment component of equity. The ineffective portion, if any, is recognized in earnings in the current period. The Company evaluates the effectiveness of the net investment hedge each quarter. Settlement due from/due to customers - The Company operates systems for clearing and settling payment transactions among customers. Net settlements are generally cleared daily among customers through settlement cash accounts by wire transfer or other bank clearing means. However, some transactions may not settle until subsequent business days, resulting in amounts due from and due to customers. Restricted security deposits held for customers - Mastercard requires collateral from certain customers for settlement of their transactions. The majority of collateral for settlement is in the form of standby letters of credit and bank guarantees which are not recorded on the consolidated balance sheet. Additionally, Mastercard holds cash deposits and certificates of deposit from certain customers of Mastercard as collateral for settlement of their transactions, which are recorded as assets on the consolidated balance sheet. These assets are fully offset by corresponding liabilities included on the consolidated balance sheet. Property, plant and equipment - Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Depreciation of leasehold improvements and amortization of capital leases is included in depreciation and amortization expense on the consolidated balance sheet. The useful lives of the Companys assets are as follows: Asset Category Estimated Useful Life Buildings 30 years Building equipment 10 - 15 years Furniture and fixtures and equipment 3 - 5 years Leasehold improvements Shorter of life of improvement or lease term Capital leases Shorter of life of the asset or lease term MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Leases - The Company enters into operating and capital leases for the use of premises and equipment. Rent expense related to lease agreements that contain lease incentives is recorded on a straight-line basis over the term of the lease. Pension and other postretirement plans - The Company recognizes the funded status of its single-employer defined benefit pension plans or postretirement plans as assets or liabilities on its consolidated balance sheet and recognizes changes in the funded status in the year in which the changes occur through accumulated other comprehensive income (loss). The funded status is measured as the difference between the fair value of plan assets and the benefit obligation at December 31, the measurement date. The fair value of plan assets represents the current market value of the pension assets. Overfunded plans are aggregated and recorded in long-term other assets, while underfunded plans are aggregated and recorded as accrued expenses and long-term other liabilities on the consolidated balance sheet. Net periodic pension and postretirement benefit cost/(income) is recognized in general and administrative expenses on the consolidated statement of operations. These costs include service costs, interest cost, expected return on plan assets, amortization of prior service costs or credits and gains or losses previously recognized as a component of accumulated other comprehensive income (loss). Defined contribution plans - The Companys contributions to defined contribution plans are recorded when employees render service to the Company. The charge is recorded in general and administrative expenses on the consolidated statement of operations. Advertising and marketing - The cost of media advertising is expensed when the advertising takes place. Advertising production costs are expensed as incurred. Promotional items are expensed at the time the promotional event occurs. Sponsorship costs are recognized over the period of benefit. Foreign currency remeasurement and translation - Monetary assets and liabilities are remeasured to functional currencies using current exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are recorded at historical exchange rates. Revenue and expense accounts are remeasured at the weighted-average exchange rate for the period. Resulting exchange gains and losses related to remeasurement are included in general and administrative expenses on the consolidated statement of operations. Where a non-U.S. currency is the functional currency, translation from that functional currency to U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted-average exchange rate for the period. Resulting translation adjustments are reported as a component of accumulated other comprehensive income (loss). Treasury stock - The Company records the repurchase of shares of its common stock at cost on the trade date of the transaction. These shares are considered treasury stock, which is a reduction to stockholders equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. Share-based payments - The Company measures share-based compensation expense at the grant date, based on the estimated fair value of the award and uses the straight-line method of attribution, net of estimated forfeitures, for expensing awards over the requisite employee service period. The Company estimates the fair value of its non-qualified stock option awards (Options) using a Black-Scholes valuation model. The fair value of restricted stock units (RSUs) is determined and fixed on the grant date based on the Companys stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model is used to determine the grant date fair value of performance stock units (PSUs) granted. All share-based compensation expenses are recorded in general and administrative expenses on the consolidated statement of operations. Redeemable non-controlling interests - The Companys business combinations may include provisions allowing non-controlling equity owners the ability to require the Company purchase additional interests in the subsidiary at their discretion. These interests are initially recorded at fair value and in subsequent reporting periods are accreted or adjusted to their estimated redemption value. These adjustments to the redemption value will impact retained earnings or additional paid-in capital on the consolidated balance sheet, but will not impact the consolidated statement of operations. The redeemable non-controlling interests are considered temporary and reported outside of permanent equity on the consolidated balance sheet at the greater of the carrying amount adjusted for the non-controlling interests share of net income (loss) or its redemption value. Earnings per share - The Company calculates basic earnings per share (EPS) by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS is calculated by dividing net income by the weighted-average number of common shares outstanding during the year, adjusted for the potentially dilutive effect of stock options and unvested stock units using the treasury stock method. The Company may be required to calculate EPS using the two-class method as a MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) result of its redeemable non-controlling interests. If redemption value exceeds the fair value of the redeemable non-controlling interests, the excess would be a reduction to net income for the EPS calculation. For 2017, 2016 and 2015, there was no impact to EPS for adjustments related to redeemable non-controlling interests. Recent accounting pronouncements Derivatives and Hedging - In August 2017, the Financial Accounting Standards Board (the FASB) issued accounting guidance to improve and simplify existing guidance to allow companies to better reflect their risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, eliminates the requirement to separately measure and recognize hedge ineffectiveness and eases requirements of an entitys assessment of hedge effectiveness. This guidance is effective for periods beginning after December 15, 2018 and early adoption is permitted. The Company currently does not account for its foreign currency derivative contracts under hedge accounting and does not expect the standard to have an impact to the Company. For a more detailed discussion of the Companys foreign exchange risk management activities, refer to Note 20 (Foreign Exchange Risk Management). Net periodic pension cost and net periodic postretirement benefit cost - In March 2017, the FASB issued accounting guidance to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. Under this guidance, the service cost component is required to be reported in the same line item as other compensation costs arising from services rendered by employees during the period. The other components of the net periodic benefit costs are required to be presented in the consolidated statement of operations separately from the service cost component and outside of operating income. This guidance is required to be applied retrospectively. This guidance is effective for periods beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company will adopt this guidance effective January 1, 2018. The Company does not expect the impacts of this standard to be material. Refer to Note 11 (Pension, Postretirement and Savings Plans) for the components of the Companys net periodic pension cost and net periodic postretirement benefit costs. Goodwill impairment - In January 2017, the FASB issued accounting guidance to simplify how companies are required to test goodwill for impairment. Under this guidance, step 2 of the goodwill impairment test has been eliminated. Step 2 of the goodwill impairment test required companies to determine the implied fair value of the reporting units goodwill. Under this guidance, companies will perform their annual, or interim, goodwill impairment test by comparing the reporting units carrying value, including goodwill, to its fair value. An impairment charge would be recorded if the reporting units carrying value exceeds its fair value. This guidance is required to be applied prospectively and is effective for periods beginning after December 15, 2019, with early adoption permitted. The Company adopted this guidance effective January 1, 2017 and there was no impact from the adoption of the new accounting guidance on its consolidated financial statements. Restricted cash - In November 2016, the FASB issued accounting guidance to address diversity in the classification and presentation of changes in restricted cash on the consolidated statement of cash flows. Under this guidance, companies will be required to present restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. This guidance is required to be applied retrospectively and is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company will adopt this guidance effective January 1, 2018. Upon adoption of this standard, the Company will include restricted cash, which currently consists primarily of restricted cash for litigation settlement and restricted security deposits held for customers in its reconciliation of beginning-of-period and end-of-period amounts shown on the consolidated statement of cash flows. Intra-entity asset transfers - In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. This guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The guidance is effective for periods beginning after December 15, 2017 and early adoption is permitted. The Company will adopt this guidance effective January 1, 2018. The Company is in the process of evaluating the impacts this guidance will have on its consolidated financial statements. However, the Company expects that it will recognize a cumulative-effect adjustment to retained earnings upon adoption of the new guidance related to certain tax activity resulting from intra-entity asset transfers occurring before the date of adoption. For a more detailed discussion of an intra-entity transfer of intellectual property that occurred in 2014, refer to Note 17 (Income Taxes) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Share-based payments - In March 2016, the FASB issued accounting guidance related to share-based payments to employees. The Company adopted this guidance on January 1, 2017. The adoption had the following impacts on the consolidated financial statements: The Company is required to recognize the excess tax benefits and deficiencies from share-based awards on the consolidated statement of operations in the period in which they occurred rather than in additional paid-in-capital on the consolidated balance sheet. For the year ended December 31, 2017 , the Company recorded excess tax benefits of $49 million within income tax expense on the consolidated statement of operations. The Company is also required to revise its calculation of diluted weighted-average shares outstanding by excluding the tax effects from the assumed proceeds available to repurchase shares. For the year ended December 31, 2017 , diluted weighted-average shares outstanding included an additional 1 million shares as a result of the change in this calculation. For the year ended December 31, 2017 , the net impact of adoption resulted in an increase of $0.04 to diluted EPS. Lastly, the Company is required to change the classification of these tax effects on the consolidated statement of cash flows and classify them as an operating activity rather than as a financing activity. Each of these above items have been adopted prospectively. Retrospectively, the Company is required to change its classification of cash paid for employees withholding tax related to equity awards as a financing activity rather than as an operating activity on the consolidated statement of cash flows. As a result of this change in classification, cash provided by operating activities and cash used in financing activities on the consolidated statement of cash flows increased by $51 million and $58 million for the years ended December 31, 2016 and 2015 , respectively. This guidance allows a company-wide accounting policy election either to continue estimating forfeitures each period or to account for forfeitures as they occur. The Company elected to continue its existing practice to estimate the number of awards that will be forfeited. There was no impact on its consolidated financial statements. Leases - In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. This guidance requires companies to recognize leased assets and liabilities for both financing and operating leases. This guidance is effective for periods after December 15, 2018 and early adoption is permitted. Companies are required to adopt the guidance using a modified retrospective method. The Company expects to adopt this guidance effective January 1, 2019. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements. Revenue recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued accounting guidance that delayed the effective date of this standard by one year, making this guidance effective for fiscal years beginning after December 15, 2017. The Company will adopt this guidance effective January 1, 2018 under the modified retrospective transition method by recognizing the cumulative effect of initially applying the new standard as an increase to the opening balance of retained earnings. The comparative information will not be restated and will be reported under the accounting standards in effect for those periods. This new revenue guidance will primarily impact the timing of certain incentives which will be recognized over the life of the contract versus as earned by the customer. In addition, the Company will account for certain market development fund contributions and expenditures on a gross basis, instead of net, resulting in an increase to both revenues and expenses. Upon adoption of the standard, the estimated impact on the Companys consolidated financial statements is expected to be an increase of approximately $300 million in net revenue and $200 million in operating expenses in 2018. This estimate could change and is dependent upon how customer deals will be executed throughout 2018. Note 2. Acquisitions In 2017 , the Company acquired businesses for total consideration of $1.5 billion , representing both cash and contingent consideration. For the businesses acquired, Mastercard allocated the values associated with the assets, liabilities and redeemable non-controlling interests based on their respective fair values on the acquisition dates. Refer to Note 1 (Summary of Significant Accounting Policies), for the valuation techniques Mastercard utilizes to fair value the assets and liabilities acquired in business combinations. The residual value allocated to goodwill is not expected to be deductible for local tax purposes. For acquisitions occurring in 2017 , the Company is evaluating and finalizing the purchase price accounting; however, the preliminary estimated fair values of the purchase price allocations in aggregate, as of the acquisition dates, are noted below: (in millions) Cash consideration $ 1,286 Contingent consideration Redeemable non-controlling interests Gain on previously held minority interest Total fair value of businesses acquired $ 1,571 Assets: Cash and cash equivalents $ Other current assets Other intangible assets Goodwill 1,136 Other assets Total assets 1,936 Liabilities: Short-term debt 1 Other current liabilities Net pension liability Other liabilities Total liabilities Net assets acquired $ 1,571 1 The short-term debt assumed through acquisitions was repaid during the second quarter of 2017. The following table summarizes the identified intangible assets acquired: Acquisition Date Fair Value Weighted-Average Useful Life (in millions) (Years) Developed technologies $ 7.5 Customer relationships 9.9 Other 1.4 Other intangible assets $ 8.3 For the businesses acquired in 2017 , the largest acquisition relates to Vocalink, a payment systems and ATM switching platform operator, located principally in the U.K. On April 28, 2017, Mastercard acquired 92.4% controlling interest in Vocalink for cash consideration of 719 million ( $929 million as of the acquisition date). In addition, the Vocalink sellers have the potential to earn additional contingent consideration up to 169 million (approximately $228 million as of December 31, 2017 ) if certain revenue targets are met in 2018. Refer to Note 5 (Fair Value and Investment Securities) for additional information related to the fair value of contingent consideration. A majority of Vocalinks shareholders have retained a 7.6% ownership for at least three years , which is recorded as redeemable non-controlling interests on the consolidated balance sheet. These remaining shareholders have a put option to sell their ownership interest to Mastercard on the third and fifth anniversaries of the transaction and quarterly thereafter (the Third Anniversary Option and Fifth Anniversary Option, respectively). The Third Anniversary Option is exercisable at a fixed price of 58 million (approximately $78 million as of December 31, 2017 ) (Fixed Price). The Fifth Anniversary Option is exercisable at the greater of the Fixed Price or fair value. Additionally, Mastercard has a call option to purchase the remaining interest from Vocalinks shareholders on the fifth anniversary of the transaction and quarterly thereafter, which is exercisable at the greater of the Fixed Price or fair value. The fair value of the redeemable non-controlling interests was determined utilizing a market approach, which extrapolated the consideration transferred that was discounted for lack of control and marketability. The rollforward of redeemable non-controlling interests was not included as the activity was not considered to be material. In 2015 , the Company acquired two businesses for $609 million in cash. For these acquisitions, the Company recorded $481 million as goodwill representing the aggregate excess of the purchase consideration over the fair value of the net assets acquired. A portion of the goodwill related to the 2015 acquisitions is expected to be deductible for local tax purposes. The consolidated financial statements include the operating results of the acquired businesses from the dates of their respective acquisition. Pro forma information related to the acquisitions was not included because the impact on the Companys consolidated results of operations was not considered to be material. Note 3. Earnings Per Share The components of basic and diluted EPS for common shares for each of the years ended December 31 were as follows: (in millions, except per share data) Numerator Net income $ 3,915 $ 4,059 $ 3,808 Denominator Basic weighted-average shares outstanding 1,067 1,098 1,134 Dilutive stock options and stock units Diluted weighted-average shares outstanding 1 1,072 1,101 1,137 Earnings per Share Basic $ 3.67 $ 3.70 $ 3.36 Diluted $ 3.65 $ 3.69 $ 3.35 Note: Table may not sum due to rounding. 1 For the years presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards. Note 4. Supplemental Cash Flows The following table includes supplemental cash flow disclosures for each of the years ended December 31: (in millions) Cash paid for income taxes, net of refunds $ 1,893 $ 1,579 $ 1,097 Cash paid for interest Cash paid for legal settlements Non-cash investing and financing activities Dividends declared but not yet paid Capital leases and other Fair value of assets acquired, net of cash acquired 1,825 Fair value of liabilities assumed related to acquisitions Note 5. Fair Value and Investment Securities Financial Instruments - Recurring Measurements The Company classifies its fair value measurements of financial instruments within the Valuation Hierarchy. There were no transfers made among the three levels in the Valuation Hierarchy for 2017 . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The distribution of the Companys financial instruments measured at fair value on a recurring basis within the Valuation Hierarchy were as follows: December 31, 2017 December 31, 2016 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total (in millions) Assets Investment securities available for sale 1 : Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities Asset-backed securities Equity securities Derivative instruments 2 : Foreign currency derivative assets Deferred compensation plan 3 : Deferred compensation assets Liabilities Derivative instruments 2 : Foreign currency derivative liabilities $ $ (30 ) $ $ (30 ) $ $ (13 ) $ $ (13 ) Deferred compensation plan 4 : Deferred compensation liabilities (54 ) (54 ) (43 ) (43 ) 1 The Companys U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets. The fair value of the Companys available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on observable inputs such as quoted prices, benchmark yields and issuer spreads for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. 2 The Companys foreign currency derivative asset and liability contracts have been classified within Level 2 of the Valuation Hierarchy as the fair value is based on observable inputs such as broker quotes relating to foreign currency exchange rates for similar derivative instruments. See Note 20 (Foreign Exchange Risk Management) for further details. 3 The Company has a nonqualified deferred compensation plan where assets are invested primarily in mutual funds held in a rabbi trust, which is restricted for payments to participants of the plan. The Company has elected to use the fair value option for these mutual funds, which are measured using quoted prices of identical instruments in active markets and are included in prepaid expenses and other current assets on the consolidated balance sheet. The Company had previously invested in corporate-owned life insurance contracts that were recorded at cash surrender value. The contracts were terminated during the third quarter of 2017. 4 The deferred compensation liabilities are measured at fair value based on the quoted prices of identical instruments to the investment vehicles selected by the participants. They are included in other liabilities on the consolidated balance sheet. Settlement and Other Guarantee Liabilities The Company estimates the fair value of its settlement and other guarantees using market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At December 31, 2017 and 2016 , the carrying value and fair value of settlement and other guarantee liabilities were not material and accordingly are not included in the Valuation Hierarchy table above. Settlement and other guarantee liabilities are classified within Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not observable in the market. For additional information regarding the Companys settlement and other guarantee liabilities, see Note 19 (Settlement and Other Risk Management) . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Financial Instruments - Non-Recurring Measurements Held-to-Maturity Securities Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Held-to-maturity securities are not measured at fair value on a recurring basis and are not included in the Valuation Hierarchy table above. At December 31, 2017 and 2016 , the Company held $700 million and $452 million , respectively, of short-term held-to-maturity securities. In addition, at December 31, 2016 , the Company held $61 million of long-term held-to-maturity securities included in other assets on the consolidated balance sheet. The Company did not hold any long-term held-to-maturity securities at December 31, 2017 . The cost of these securities approximates fair value. Nonmarketable Equity Investments The Companys nonmarketable equity investments are measured at fair value at initial recognition and for impairment testing. These investments are classified within Level 3 of the Valuation Hierarchy due to the absence of quoted market prices, the inherent lack of liquidity, and the fact that inputs used to measure fair value are unobservable and require managements judgment. The Company uses discounted cash flows and market assumptions to estimate the fair value of its nonmarketable equity investments when certain events or circumstances indicate that impairment may exist. These investments are included in other assets on the consolidated balance sheet and in Note 6 (Prepaid Expenses and Other Assets) . Debt The Company estimates the fair value of its long-term debt based on market quotes. These debt instruments are not traded in active markets and are classified as Level 2 of the Valuation Hierarchy. At December 31, 2017 , the carrying value and fair value of long-term debt was $5.4 billion and $5.7 billion , respectively. At December 31, 2016 , the carrying value and fair value of long-term debt was $5.2 billion and $5.3 billion , respectively. Other Financial Instruments Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and other accrued liabilities. Non-Financial Instruments Certain assets are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing. The Companys non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment. The contingent consideration attributable to acquisitions made in 2017 is primarily based on the achievement of 2018 revenue targets. The activity of the Companys contingent consideration liability for 2017 was as follows: (in millions) Balance at December 31, 2016 $ Preliminary estimated fair value as of acquisition date for businesses acquired Net change in valuation Foreign currency translation Balance at December 31, 2017 $ 76 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Amortized Costs and Fair Values Available-for-Sale Investment Securities The major classes of the Companys available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income (loss) on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of December 31, 2017 and 2016 were as follows: December 31, 2017 December 31, 2016 Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Fair Value (in millions) Municipal securities $ $ $ $ $ $ $ $ Government and agency securities Corporate securities (1 ) (1 ) Asset-backed securities Equity securities Total $ 1,147 $ $ (1 ) $ 1,149 $ 1,159 $ $ (1 ) $ 1,162 The Companys available-for-sale investment securities held at December 31, 2017 and 2016 , primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables. Investment Maturities: The maturity distribution based on the contractual terms of the Companys investment securities at December 31, 2017 was as follows: Available-For-Sale Amortized Cost Fair Value (in millions) Due within 1 year $ $ Due after 1 year through 5 years Due after 5 years through 10 years Due after 10 years No contractual maturity 1 Total $ 1,147 $ 1,149 1 Equity securities have been included in the No contractual maturity category, as these securities do not have stated maturity dates. Investment Income Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Companys consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for 2017 , 2016 and 2015 were not significant. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 6. Prepaid Expenses and Other Assets Prepaid expenses and other current assets consisted of the following at December 31: (in millions) Customer and merchant incentives $ $ Prepaid income taxes Other Total prepaid expenses and other current assets $ 1,040 $ Other assets consisted of the following at December 31: (in millions) Customer and merchant incentives $ 1,434 $ 1,134 Nonmarketable equity investments Prepaid income taxes Income taxes receivable Other Total other assets $ 2,298 $ 1,929 Customer and merchant incentives represent payments made or amounts to be paid to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. Amounts to be paid for these incentives and the related liability were included in accrued expenses and other liabilities. Nonmarketable equity investments represent the Companys cost and equity method investments. For the year ended December 31, 2017 , the Company invested $147 million in nonmarketable cost method equity investments. Non-current prepaid income taxes, included in the other asset table above, primarily consists of taxes paid in 2014 relating to the deferred charge resulting from the reorganization of the Companys legal entity and tax structure to better align with its business footprint of its non-U.S. operations. See Note 17 (Income Taxes) for further discussion of this deferred charge. Note 7. Property, Plant and Equipment Property, plant and equipment consisted of the following at December 31: (in millions) Building, building equipment and land $ $ Equipment Furniture and fixtures Leasehold improvements Property, plant and equipment 1,543 1,336 Less: accumulated depreciation and amortization (714 ) (603 ) Property, plant and equipment, net $ $ As of December 31, 2017 and 2016 , capital leases of $32 million and $23 million , respectively, were included in equipment. Accumulated amortization of these capital leases was $18 million and $16 million as of December 31, 2017 and 2016 , respectively. Depreciation and amortization expense for the above property, plant and equipment was $185 million , $151 million and $131 million for 2017 , 2016 and 2015 , respectively. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 8. Goodwill The changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2016 were as follows: (in millions) Beginning balance $ 1,756 $ 1,891 Additions 1,136 Foreign currency translation (143 ) Ending balance $ 3,035 $ 1,756 The Company had no accumulated impairment losses for goodwill at December 31, 2017 . Based on annual impairment testing, the Companys goodwill is not impaired. Note 9. Other Intangible Assets The following table sets forth net intangible assets, other than goodwill, at December 31: Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount (in millions) Amortized intangible assets Capitalized software $ 1,572 $ (888 ) $ $ 1,210 $ (768 ) $ Trademarks and tradenames (29 ) (22 ) Customer relationships (214 ) (162 ) Other (26 ) (22 ) Total 2,102 (1,157 ) 1,542 (974 ) Unamortized intangible assets Customer relationships Total $ 2,277 $ (1,157 ) $ 1,120 $ 1,696 $ (974 ) $ The increase in the gross carrying amount of amortized intangible assets in 2017 was primarily related to the businesses acquired in 2017. See Note 2 (Acquisitions) for further details. Certain intangible assets, including amortizable and unamortizable customer relationships and trademarks and tradenames, are denominated in foreign currencies. As such, the change in intangible assets includes a component attributable to foreign currency translation. Based on the qualitative assessment performed in 2017 , it was determined that the Companys indefinite-lived intangible assets were not impaired. Amortization on the assets above amounted to $252 million , $221 million and $235 million in 2017, 2016 and 2015 , respectively. The following table sets forth the estimated future amortization expense on amortizable intangible assets on the consolidated balance sheet at December 31, 2017 for the years ending December 31: (in millions) $ 2019 2020 2021 2022 and thereafter $ 79 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 10. Accrued Expenses and Accrued Litigation Accrued expenses consisted of the following at December 31: (in millions) Customer and merchant incentives $ 2,648 $ 2,286 Personnel costs Advertising Income and other taxes Other Total accrued expenses $ 3,931 $ 3,318 As of December 31, 2017 and 2016 , the Companys provision for litigation was $709 million and $722 million , respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 18 (Legal and Regulatory Proceedings) for further discussion of the U.S. and Canadian merchant class litigations. Note 11. Pension, Postretirement and Savings Plans The Company and certain of its subsidiaries maintain various pension, postretirement, savings and other postemployment benefit plans that cover substantially all employees worldwide. Defined Contribution Plans The Company sponsors defined contribution retirement plans. The primary plan is the Mastercard Savings Plan, a 401(k) plan for substantially all of the Companys U.S. employees, which is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), as amended. In addition, the Company has several defined contribution plans outside of the U.S. The Companys total expense for its defined contribution plans was $84 million , $73 million and $61 million in 2017, 2016 and 2015 , respectively. Defined Benefit and Other Postretirement Plans In 2015, the Company terminated its non-contributory, qualified, U.S. defined benefit pension plan (the U.S. Employee Pension Plan). Participants had the option to receive a lump sum distribution or to participate in an annuity with a third-party insurance company. As a result of this termination, the Company settled its obligation for $287 million , which resulted in a pension settlement charge of $79 million recorded in general and administrative expense during 2015. The Company also sponsors pension and postretirement plans for non-U.S. employees (the non-U.S. Plans) that cover various benefits specific to their country of employment. In April 2017, the Company acquired a majority interest in Vocalink. Vocalink has a defined benefit pension plan (the Vocalink Plan) which is closed to new entrants and future accruals as of July 21, 2013, however, plan participants obligations are adjusted for future salary changes. The Company has agreed to make contributions of 15 million (approximately $20 million as of December 31, 2017 ) annually until March 2020. See Note 2 (Acquisitions) for additional information on the Vocalink acquisition. The term Pension Plans includes the non-U.S. Plans, the Vocalink Plan and the U.S. Employee Pension Plan. The Company maintains a postretirement plan providing health coverage and life insurance benefits for substantially all of its U.S. employees hired before July 1, 2007 (the Postretirement Plan). MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company uses a December 31 measurement date for the Pension Plans and its Postretirement Plan (collectively the Plans). The Company recognizes the funded status of its Plans, measured as the difference between the fair value of the plan assets and the projected benefit obligation, in the consolidated balance sheet. The following table sets forth the Plans funded status, key assumptions and amounts recognized in the Companys consolidated balance sheet at December 31 : Pension Plans Postretirement Plan (in millions, except percentages) Change in benefit obligation Benefit obligation at beginning of year $ $ $ $ Benefit obligation acquired during the year Service cost Interest cost Actuarial (gain) loss (44 ) Benefits paid (12 ) (2 ) (4 ) (4 ) Transfers in Foreign currency translation (2 ) Benefit obligation at end of year Change in plan assets Fair value of plan assets at beginning of year Fair value of plan assets acquired during the year Actual gain (loss) on plan assets (4 ) Employer contributions Benefits paid (12 ) (2 ) (4 ) (4 ) Transfers in Foreign currency translation (1 ) Fair value of plan assets at end of year Funded status at end of year $ (41 ) $ (13 ) $ (61 ) $ (59 ) Amounts recognized on the consolidated balance sheet consist of: Other liabilities, short-term $ $ $ (3 ) $ (3 ) Other liabilities, long-term (41 ) (13 ) (58 ) (56 ) $ (41 ) $ (13 ) $ (61 ) $ (59 ) Accumulated other comprehensive income consists of: Net actuarial (gain) loss $ (22 ) $ $ (5 ) $ (10 ) Prior service credit (8 ) (10 ) Balance at end of year $ (22 ) $ $ (13 ) $ (20 ) Weighted-average assumptions used to determine end of year benefit obligations Discount rate Non-U.S. Plans 1.80 % 1.60 % * * Vocalink Plan 2.80 % * * * Postretirement Plan * * 3.50 % 4.00 % Rate of compensation increase Non-U.S. Plans 2.60 % 2.59 % * * Vocalink Plan 3.85 % * * * Postretirement Plan * * 3.00 % 3.00 % * Not applicable MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Each of the Pension Plans had benefit obligations in excess of plan assets at December 31, 2017 and 2016 . Information on the Pension Plans were as follows: (in millions) Projected benefit obligation $ $ Accumulated benefit obligation Fair value of plan assets Components of net periodic benefit cost recorded in general and administrative expenses were as follows for the Plans for each of the years ended December 31 : Pension Plans Postretirement Plan (in millions) Service cost $ $ $ $ $ $ Interest cost Expected return on plan assets (13 ) (1 ) (1 ) Curtailment gain Amortization of actuarial loss Amortization of prior service credit (2 ) (1 ) Pension settlement charge Net periodic benefit cost $ $ $ $ $ $ Other changes in plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31 were as follows: Pension Plans Postretirement Plan (in millions) Curtailment gain $ $ $ (1 ) $ $ $ Current year actuarial (gain) loss (22 ) Current year prior service credit Amortization of prior service credit Pension settlement charge (79 ) Total recognized in other comprehensive income (loss) $ (22 ) $ $ (80 ) $ $ $ Total recognized in net periodic benefit cost and other comprehensive income (loss) $ (18 ) $ $ $ $ $ The estimated amounts that are expected to be amortized from accumulated other comprehensive income into net periodic benefit cost in 2018 are as follows: Pension Plans Postretirement Plan (in millions) Prior service credit $ $ (1 ) MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Assumptions Weighted-average assumptions used to determine net periodic benefit cost were as follows for the years ended December 31 : Pension Plans Postretirement Plan Discount rate Non-U.S. Plans 1.60 % 1.85 % 2.00 % * * * Vocalink Plan 2.50 % * * * * * Postretirement Plan * * * 4.00 % 4.25 % 4.00 % Expected return on plan assets Non-U.S. Plans 3.25 % 3.25 % 3.25 % * * * Vocalink Plan 4.75 % * * * * * Postretirement Plan * * * * * * Rate of compensation increase Non-U.S. Plans 2.59 % 2.64 % 2.92 % * * * Vocalink Plan 3.95 % * * * * * Postretirement Plan * * * 3.00 % 3.00 % 3.00 % * Not applicable The Companys discount rate assumptions are based on yield curves derived from high quality corporate bonds, which are matched to the expected cash flows to each of the respective Plans. The expected return on plan assets assumptions are derived using the current and expected asset allocations of the Pension Plan assets and considering historical as well as expected returns on various classes of plan assets. The assumed health care cost trend rates at December 31 for the Postretirement Plan were as follows: Health care cost trend rate assumed for next year 6.50 % 7.00 % Ultimate trend rate 5.00 % 5.00 % Year that the rate reaches the ultimate trend rate The assumed health care cost trend rates have a significant effect on the amounts reported for the Postretirement Plan. A one-percentage point change in assumed health care cost trend rates for 2017 would have a $5 million increase and $4 million decrease effect with a one-percentage point increase and decrease, respectively, in the benefit obligation. The effect on total service and interest cost components would be less than $1 million . Assets Plan assets are managed with a long-term perspective intended to ensure that there is an adequate level of assets to support benefit payments to participants over the life of the Pension Plans. The Vocalink Plan assets are managed within the following target asset allocations: non-government fixed income 37% , government securities (including U.K. governmental bonds) 28% , investment funds 25% and other 10% . The investment funds are currently comprised of approximately 40% derivatives, 30% equity, 15% fixed income and 15% other. For the non-U.S. Plans the assets are concentrated 100% in Insurance Contracts. The Valuation Hierarchy of the Pension Plans assets is determined using a consistent application of the categorization measurements for the Companys financial instruments. See Note 1 (Summary of Significant Accounting Policies) for additional information. Cash and cash equivalents and other public investment vehicles (including certain mutual funds and government and agency securities) are valued at quoted market prices, which represent the net asset value of the shares held by the Vocalink Plan, and are therefore included in Level 1 of the Valuation Hierarchy. Certain other mutual funds (including commingled funds), MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) governmental and agency securities and insurance contracts are valued at unit values provided by investment managers, which are based on the fair value of the underlying investments utilizing public information, independent external valuation from third-party services or third-party advisors, and are therefore included in Level 2 of the Valuation Hierarchy. Asset-backed securities are classified as Level 3 due to a lack of observable inputs in measuring fair value. A separate roll-forward of Level 3 plan assets measured at fair value is not presented as activities during 2017 and 2016 were immaterial. The following tables set forth by level, within the Valuation Hierarchy, the Pension Plans assets at fair value as of December 31, 2017 and 2016 : December 31, 2017 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Cash and cash equivalents $ $ $ $ Government and agency securities Mutual funds Insurance contracts Asset-backed securities Other Total $ $ $ $ December 31, 2016 Quoted Prices in Active Markets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fair Value (in millions) Insurance contracts $ $ $ $ Total $ $ $ $ The following table summarizes expected benefit payments through 2026 for the Pension Plans and the Postretirement Plans, including those payments expected to be paid from the Companys general assets. Since the majority of the benefit payments for the Pension Plans are made in the form of lump-sum distributions, actual benefit payments may differ from expected benefit payments. Pension Plans Postretirement Plan (in millions) $ $ 2019 2020 2021 2022 2023- 2026 84 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Note 12. Debt Long-term debt consisted of the following at December 31: Notes Issuance Date Interest Payment Terms Maturity Date Aggregate Principal Amount Stated Interest Rate Effective Interest Rate (in millions, except percentages) 2016 USD Notes November 2016 Semi-annually $ 2.000 % 2.236 % $ $ 2.950 % 3.044 % 3.800 % 3.893 % $ 2,000 2015 Euro Notes December 2015 Annually 1.100 % 1.265 % 2.100 % 2.189 % 2.500 % 2.562 % 1,650 2014 USD Notes March 2014 Semi-annually $ 2.000 % 2.178 % 1,000 3.375 % 3.484 % 1,000 1,000 $ 1,500 5,477 5,239 Less: Unamortized discount and debt issuance costs (53 ) (59 ) Long-term debt $ 5,424 $ 5,180 The net proceeds, after deducting the original issue discount, underwriting discount and offering expenses, from the issuance of the 2016 USD Notes, the 2015 Euro Notes and the 2014 USD Notes (collectively the Notes), were $1.969 billion , $1.723 billion and $1.484 billion , respectively. The Company is not subject to any financial covenants under the Notes. The Notes may be redeemed in whole, or in part, at the Companys option at any time for a specified make-whole amount. The Notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the Notes are to be used for general corporate purposes. Scheduled annual maturities of the principal portion of long-term debt outstanding at December 31, 2017 are summarized below. Amounts exclude capital lease obligations disclosed in Note 16 (Commitments) . (in millions) $ 500 650 839 Thereafter 3,488 Total $ 5,477 In November 2015, the Company established a commercial paper program (the Commercial Paper Program). Under which it is authorized to issue up to $3.75 billion in outstanding notes, with maturities up to 397 days from the date of issuance. The Commercial Paper Program is available in U.S. dollars. In conjunction with the Commercial Paper Program, the Company entered into a committed unsecured $3.75 billion revolving credit facility (the Credit Facility). Borrowings under the Credit Facility are available in U.S. dollars and/or euros. In October 2017, the Company extended the Credit Facility for an additional year to October 2022. The extension did not result in any material changes to the terms and conditions of the Credit Facility. The facility fee and borrowing cost under the Credit Facility MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) are based upon the Companys credit rating. At December 31, 2017 , the applicable facility fee was 8 basis points on the average daily commitment (whether or not utilized). In addition to the facility fee, interest on borrowings under the Credit Facility would be charged at the London Interbank Offered Rate (LIBOR) plus an applicable margin of 79.5 basis points, or an alternative base rate. The Credit Facility contains customary representations, warranties, events of default and affirmative and negative covenants, including a financial covenant limiting the maximum level of consolidated debt to earnings before interest, taxes, depreciation and amortization (EBITDA). Mastercard was in compliance in all material respects with the covenants of the Credit Facility at December 31, 2017 and 2016 . The majority of Credit Facility lenders are customers or affiliates of customers of Mastercard. Borrowings under the Commercial Paper Program and the Credit Facility are used to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Companys customers. The Company may borrow and repay amounts under the Commercial Paper Program and Credit Facility from time to time. Mastercard had no borrowings under the Credit Facility and the Commercial Paper Program at December 31, 2017 and 2016 . In June 2015, the Company filed a universal shelf registration statement to provide additional access to capital, if needed. Pursuant to the shelf registration statement, the Company may from time to time offer to sell debt securities, preferred stock, Class A common stock, depository shares, purchase contracts, units or warrants in one or more offerings. Note 13. Stockholders Equity Classes of Capital Stock Mastercards amended and restated certificate of incorporation authorizes the following classes of capital stock: Class Par Value Per Share Authorized Shares (in millions) Dividend and Voting Rights A $0.0001 3,000 One vote per share Dividend rights B $0.0001 1,200 Non-voting Dividend rights Preferred $0.0001 No shares issued or outstanding at December 31, 2017 and 2016, respectively. Dividend and voting rights are to be determined by the Board of Directors of the Company upon issuance. Ownership and Governance Structure Equity ownership and voting power of the Companys shares were allocated as follows as of December 31 : Equity Ownership General Voting Power Equity Ownership General Voting Power Public Investors (Class A stockholders) 88.0 % 89.2 % 87.7 % 89.3 % Principal or Affiliate Customers (Class B stockholders) 1.4 % % 1.8 % % Mastercard Foundation (Class A stockholders) 10.6 % 10.8 % 10.5 % 10.7 % Class B Common Stock Conversions Shares of Class B common stock are convertible on a one-for-one basis into shares of Class A common stock. Entities eligible to hold Mastercards Class B common stock are defined in the Companys amended and restated certificate of incorporation (generally the Companys principal or affiliate customers), and they are restricted from retaining ownership of shares of Class A common stock. Class B stockholders are required to subsequently sell or otherwise transfer any shares of Class A common stock received pursuant to such a conversion. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Mastercard Foundation In connection and simultaneously with its 2006 initial public offering (the IPO), the Company issued and donated 135 million newly authorized shares of Class A common stock to Mastercard Foundation. Mastercard Foundation is a private charitable foundation incorporated in Canada that is controlled by directors who are independent of the Company and its principal customers. Under the terms of the donation, Mastercard Foundation became able to resell the donated shares in May 2010 to the extent necessary to meet charitable disbursement requirements dictated by Canadian tax law. Under Canadian tax law, Mastercard Foundation is generally required to disburse at least 3.5% of its assets not used in administration each year for qualified charitable disbursements. However, Mastercard Foundation obtained permission from the Canadian tax authorities to defer the giving requirements until 2021. Mastercard Foundation, at its discretion, may decide to meet its disbursement obligations on an annual basis or to settle previously accumulated obligations during any given year. Mastercard Foundation will be permitted to sell all of its remaining shares beginning May 1, 2027. Stock Repurchase Programs The Companys Board of Directors have approved share repurchase programs authorizing the Company to repurchase shares of its Class A Common Stock. These programs become effective after the completion of the previously authorized share repurchase program. The following table summarizes the Companys share repurchase authorizations of its Class A common stock through December 31, 2017 , as well as historical purchases: Board authorization dates December 2017 December 2016 December December December Date program became effective N/A 1 April 2017 February 2016 January 2015 January 2014 Total (in millions, except average price data) Board authorization $ 4,000 $ 4,000 $ 4,000 $ 3,750 $ 3,500 $ 19,250 Dollar-value of shares repurchased in 2015 $ $ $ $ 3,243 $ $ 3,518 Remaining authorization at December 31, 2015 $ $ $ 4,000 $ $ $ 4,507 Dollar-value of shares repurchased in 2016 $ $ $ 3,004 $ $ $ 3,511 Remaining authorization at December 31, 2016 $ $ 4,000 $ $ $ $ 4,996 Dollar-value of shares repurchased in 2017 $ $ 2,766 $ $ $ $ 3,762 Remaining authorization at December 31, 2017 $ 4,000 $ 1,234 $ $ $ $ 5,234 Shares repurchased in 2015 35.1 3.2 38.3 Average price paid per share in 2015 $ $ $ $ 92.39 $ 84.31 $ 91.70 Shares repurchased in 2016 31.2 5.7 36.9 Average price paid per share in 2016 $ $ $ 96.15 $ 89.76 $ $ 95.18 Shares repurchased in 2017 21.0 9.1 30.1 Average price paid per share in 2017 $ $ 131.97 $ 109.16 $ $ $ 125.05 Cumulative shares repurchased through December 31, 2017 21.0 40.4 40.8 45.8 148.0 Cumulative average price paid per share $ $ 131.97 $ 99.10 $ 92.03 $ 76.42 $ 94.78 1 The December share repurchase program will become effective after completion of the December 2016 share repurchase program. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table presents the changes in the Companys outstanding Class A and Class B common stock for the years ended December 31 : Outstanding Shares Class A Class B (in millions) Balance at December 31, 2014 1,115.4 37.2 Purchases of treasury stock (38.3 ) Share-based payments 2.0 Conversion of Class B to Class A common stock 15.9 (15.9 ) Balance at December 31, 2015 1,095.0 21.3 Purchases of treasury stock (36.9 ) Share-based payments 2.3 Conversion of Class B to Class A common stock 2.0 (2.0 ) Balance at December 31, 2016 1,062.4 19.3 Purchases of treasury stock (30.1 ) Share-based payments 2.2 Conversion of Class B to Class A common stock 5.2 (5.2 ) Balance at December 31, 2017 1,039.7 14.1 Note 14. Accumulated Other Comprehensive Income (Loss) The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2017 and 2016 were as follows: Foreign Currency Translation Adjustments 1 Translation Adjustments on Net Investment Hedge Defined Benefit Pension and Other Postretirement Plans 2 Investment Securities Available-for-Sale 3 Accumulated Other Comprehensive Income (Loss) (in millions) Balance at December 31, 2015 $ (663 ) $ (26 ) $ $ $ (676 ) Other comprehensive income (loss) (286 ) (2 ) (248 ) Balance at December 31, 2016 (949 ) (924 ) Other comprehensive income (loss) (153 ) (1 ) Balance at December 31, 2017 $ (382 ) $ (141 ) $ $ $ (497 ) 1 During 2016, the increase in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the devaluation of the British pound and euro. During 2017, the decrease in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the appreciation of the euro. 2 During 2016, deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $1 million before and after tax. During 2017, the decrease in other comprehensive loss related to the Companys postretirement plan was driven by a tax deferred gain primarily related to a defined benefit pension plan, acquired as part of Vocalink. See Note 11 (Pension, Postretirement and Savings Plans) for additional information. In addition, deferred gains related to the Companys postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were $2 million before tax and $1 million after tax. 3 During 2016 and 2017, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant. Note 15. Share-Based Payments In May 2006, the Company implemented the Mastercard Incorporated 2006 Long Term Incentive Plan, which was amended and restated as of June 5, 2012 (the LTIP). The LTIP is a stockholder-approved plan that permits the grant of various types of equity awards to employees. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The Company has granted Options, RSUs and PSUs under the LTIP. The Options, which expire ten years from the date of grant, generally vest ratably over four years from the date of grant. The RSUs and PSUs generally vest after three years . The Company uses the straight-line method of attribution for expensing equity awards. Compensation expense is recorded net of estimated forfeitures. Estimates are adjusted as appropriate. For all awards granted prior to March 2017, a participants unvested awards are forfeited upon termination of employment. For all awards granted on or after March 1, 2017, in the event of termination due to job elimination (as defined by the Company), a participant will retain a pro-rata portion of the unvested awards for services performed through the date of termination. In the event a participant terminates employment due to disability or retirement more than six months ( seven months for those granted on or after March 1, 2017) after receiving the award, the participant retains all of their awards without providing additional service to the Company. Retirement eligibility is dependent upon age and years of service. Compensation expense is recognized over the shorter of the vesting periods stated in the LTIP or the date the individual becomes eligible to retire but not less than six months (or seven months for grants awarded on or after March 1, 2017). There are approximately 116 million shares of Class A common stock authorized for equity awards under the LTIP. Although the LTIP permits the issuance of shares of Class B common stock, no such shares have been authorized for issuance. Shares issued as a result of Option exercises and the conversions of RSUs and PSUs were funded primarily with the issuance of new shares of Class A common stock. Stock Options The fair value of each Option is estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted for the years ended December 31: Risk-free rate of return 2.0 % 1.3 % 1.5 % Expected term (in years) 5.00 5.00 5.00 Expected volatility 19.3 % 23.3 % 20.6 % Expected dividend yield 0.8 % 0.8 % 0.7 % Weighted-average fair value per Option granted $ 21.23 $ 18.58 $ 17.29 The risk-free rate of return was based on the U.S. Treasury yield curve in effect on the date of grant. The expected term and the expected volatility were based on historical Mastercard information. The expected dividend yields were based on the Companys expected annual dividend rate on the date of grant. The following table summarizes the Companys option activity for the year ended December 31, 2017 : Options Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in millions) (in years) (in millions) Outstanding at January 1, 2017 8.3 $ Granted 1.7 $ Exercised (1.3 ) $ Forfeited/expired (0.1 ) $ Outstanding at December 31, 2017 8.6 $ 6.6 $ Exercisable at December 31, 2017 4.6 $ 5.2 $ Options vested and expected to vest at December 31, 2017 8.5 $ 6.6 $ As of December 31, 2017 , there was $32 million of total unrecognized compensation cost related to non-vested Options. The cost is expected to be recognized over a weighted-average period of 2.2 years . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Restricted Stock Units The following table summarizes the Companys RSU activity for the year ended December 31, 2017 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2017 4.1 $ Granted 1.4 $ Converted (1.2 ) $ Forfeited (0.2 ) $ Outstanding at December 31, 2017 4.1 $ $ RSUs vested and expected to vest at December 31, 2017 4.0 $ $ The fair value of each RSU is the closing stock price on the New York Stock Exchange of the Companys Class A common stock on the date of grant, adjusted for the exclusion of dividend equivalents. Upon vesting, a portion of the RSU award may be withheld to satisfy the minimum statutory withholding taxes. The remaining RSUs will be settled in shares of the Companys Class A common stock after the vesting period. As of December 31, 2017 , there was $156 million of total unrecognized compensation cost related to non-vested RSUs. The cost is expected to be recognized over a weighted-average period of 1.8 years . Performance Stock Units The following table summarizes the Companys PSU activity for the year ended December 31, 2017 : Units Weighted-Average Grant-Date Fair Value Aggregate Intrinsic Value (in millions) (in millions) Outstanding at January 1, 2017 0.4 $ Granted 0.2 $ Converted (0.1 ) $ Outstanding at December 31, 2017 0.5 $ $ PSUs vested and expected to vest at December 31, 2017 0.5 $ $ Since 2013, PSUs containing performance and market conditions have been issued. Performance measures used to determine the actual number of shares that vest after three years include net revenue growth, EPS growth, and relative total shareholder return (TSR). Relative TSR is considered a market condition, while net revenue and EPS growth are considered performance conditions. The Monte Carlo simulation valuation model is used to determine the grant-date fair value. Compensation expenses for PSUs are recognized over the requisite service period if it is probable that the performance target will be achieved and subsequently adjusted if the probability assessment changes. As of December 31, 2017 , there was $13 million of total unrecognized compensation cost related to non-vested PSUs. The cost is expected to be recognized over a weighted-average period of 1.6 years . MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Additional Information The following table includes additional share-based payment information for each of the years ended December 31: (in millions, except weighted-average fair value) Share-based compensation expense: Options, RSUs and PSUs $ $ $ Income tax benefit recognized for equity awards Income tax benefit realized related to Options exercised Options: Total intrinsic value of Options exercised RSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of RSUs converted into shares of Class A common stock PSUs: Weighted-average grant-date fair value of awards granted Total intrinsic value of PSUs converted into shares of Class A common stock Note 16. Commitments At December 31, 2017 , the Company had the following future minimum payments due under non-cancelable agreements: Total Capital Leases Operating Leases Sponsorship, Licensing Other (in millions) $ $ $ $ 2019 2020 2021 2022 Thereafter Total $ 1,088 $ $ $ Included in the table above are capital leases with a net present value of minimum lease payments of $11 million . In addition, at December 31, 2017 , $20 million of the future minimum payments in the table above for sponsorship, licensing and other agreements was accrued. Consolidated rental expense for the Companys leased office space was $77 million , $62 million and $52 million for 2017 , 2016 and 2015 , respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $22 million , $19 million and $17 million for 2017 , 2016 and 2015 , respectively. Note 17. Income Taxes On December 22, 2017, in the U.S., the TCJA was enacted into law. The TCJA represents significant changes to the U.S. internal revenue code and, among other things: lowers the corporate income tax rate from 35% to 21% imposes a one-time deemed repatriation tax on accumulated foreign earnings (the Transition Tax) provides for a 100% dividends received deduction on dividends from foreign affiliates requires a current inclusion in U.S. federal taxable income of earnings of foreign affiliates that are determined to be global intangible low taxed income or GILTI creates the base erosion anti-abuse tax, or BEAT MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) provides for an effective tax rate of 13.125% for certain income derived from outside of the U.S. (referred to as foreign derived intangible income or FDII) introduces further limitations on the deductibility of executive compensation permits 100% expensing of qualifying fixed assets acquired after September 27, 2017 limits the deductibility of interest expense in certain situations eliminates the domestic production activities deduction While the effective date of the law for most provisions is January 1, 2018, GAAP requires the resulting tax effects be accounted for in the reporting period of enactment. This includes the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S., the dilution of foreign tax credit benefits on the repatriation of current year foreign earnings and the recognition of a deferred tax liability resulting from the change in the Companys indefinite reinvestment assertion for certain foreign affiliates. The impact of the TCJA is discussed further below. Also, on December 22, 2017, SEC staff issued Staff Accounting Bulletin No. 118 - Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which will allow registrants to record provisional amounts during a measurement period, which is not to extend beyond one year. Accordingly, amounts reflected below may require further adjustments due to evolving analysis and interpretations of law, including issuance by the Internal Revenue Service (the IRS) and The Department of Treasury (Treasury) of Notices, regulations and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied to the TCJA. The domestic and foreign components of income before income taxes for the years ended December 31 are as follows: (in millions) United States $ 3,482 $ 3,736 $ 3,399 Foreign 3,040 1,910 1,559 Income before income taxes $ 6,522 $ 5,646 $ 4,958 The total income tax provision for the years ended December 31 is comprised of the following components: (in millions) Current Federal $ 1,704 $ 1,074 $ State and local Foreign 2,521 1,607 1,166 Deferred Federal (6 ) State and local (2 ) (3 ) Foreign (49 ) (12 ) (17 ) (20 ) (16 ) Income tax expense $ 2,607 $ 1,587 $ 1,150 As of December 31, 2017 , a provisional amount of U.S. federal and state and local income taxes of $36 million has been provided on a substantial amount of the Companys undistributed foreign earnings. This deferred tax charge has been established primarily on the estimated foreign exchange gain which will be recognized when such earnings are repatriated. The Company expects that foreign withholding taxes associated with these future repatriated earnings will not be material. Based upon the ongoing review of business requirements and capital needs of the Companys non-U.S. subsidiaries, the Company believes a portion of these undistributed earnings that have already been subject to tax in the U.S. will be necessary to fund current and future growth of the related businesses and will remain indefinitely reinvested outside of the U.S. In 2018, the Company will complete its analysis of global working capital and cash needs to determine the amount it considers indefinitely reinvested. It will disclose such amount in the period in which such analysis is completed, as well as, if practicable, any potential tax cost that would arise if the amounts were remitted back to the U.S. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The provision for income taxes differs from the amount of income tax determined by applying the U.S. federal statutory income tax rate of 35% to pretax income for the years ended December 31, as a result of the following: Amount Percent Amount Percent Amount Percent (in millions, except percentages) Income before income taxes $ 6,522 $ 5,646 $ 4,958 Federal statutory tax 2,283 35.0 % 1,976 35.0 % 1,735 35.0 % State tax effect, net of federal benefit 0.7 % 0.4 % 0.5 % Foreign earnings (380 ) (5.8 )% (188 ) (3.3 )% (144 ) (2.9 )% Impact of foreign tax credits 1 (27 ) (0.4 )% (141 ) (2.5 )% (281 ) (5.7 )% Impact of settlements with tax authorities % % (147 ) (2.9 )% Transition Tax 9.6 % % % Remeasurement of U.S. deferred taxes 2.4 % % % Other, net (98 ) (1.5 )% (82 ) (1.5 )% (40 ) (0.8 )% Income tax expense $ 2,607 40.0 % $ 1,587 28.1 % $ 1,150 23.2 % 1 Included within the impact of foreign tax credits are repatriation benefits of current year foreign earnings of $0 million , $116 million and $172 million , in addition to other foreign tax credit benefits which become eligible in the United States of $27 million , $25 million and $109 million for 2017 , 2016 and 2015 , respectively. Effective Income Tax Rate The effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were 40.0% , 28.1% and 23.2% , respectively. The effective income tax rate for 2017 was higher than the effective income tax rate for 2016 primarily due to additional tax expense of $873 million attributable to the TCJA, which includes provisional amounts of $825 million related to the Transition Tax, the remeasurement of the Companys net deferred tax asset balance in the U.S. and the recognition of a deferred tax liability related to a change in assertion regarding the indefinite reinvestment of a substantial amount of the Companys foreign earnings, as well as $48 million due to a foregone foreign tax credit benefit on current year repatriations. In addition, the Companys effective income tax rate versus the prior year was impacted by a more favorable geographic mix of taxable earnings in 2017, partially offset by a lower U.S. foreign tax credit benefit. There are provisional current and noncurrent components of the Companys liability for the Transition Tax. The Transition Tax will be paid over 8 annual installments commencing April 15, 2018. Approximately $52 million and $577 million of the total amount due is recorded in other current liabilities and other liabilities, respectively, on the consolidated balance sheet at December 31, 2017. Under the TCJA, for purposes of IRS examination of the Transition Tax, the statute of limitations is extended to six years. Consistent with SAB 118, the Company was able to make reasonable estimates and has incorporated provisional amounts for the impact of the Transition Tax. This tax is on previously untaxed accumulated and current earnings and profits of the Companys foreign subsidiaries. To compute the tax, the Company must determine the amount of post-1986 earnings and profits of relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company was able to make reasonable estimates and has recorded provisional amounts of $629 million related to the Transition Tax, $157 million charge for the remeasurement of the Companys net deferred tax asset in the U.S. and $36 million related to the change in assertion regarding the indefinite reinvestment of foreign earnings. However, these amounts may require further adjustments during the measurement period due to evolving analysis and interpretations of law, including issuance by the IRS and Treasury of Notices and regulations, and, potentially, direct discussions with Treasury, as well as interpretations of how accounting for income taxes should be applied. The effective income tax rate for 2016 was higher than the effective income tax rate for 2015 primarily due to benefits associated with the impact of settlements with tax authorities in multiple jurisdictions in 2015 , the lapping of a discrete benefit relating to certain foreign taxes that became eligible to be claimed as credits in the United States in 2015 , and a higher U.S. foreign tax credit benefit associated with the repatriation of current year foreign earnings in 2015 . These items were partially offset by a more favorable geographic mix of taxable earnings in 2016 . During 2014, the Company implemented an initiative to better align its legal entity and tax structure with its operational footprint outside of the U.S. This initiative resulted in a one-time taxable gain in Belgium relating to the transfer of intellectual property MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) to a related foreign entity in the United Kingdom. Management believes this improved alignment has resulted in greater flexibility and efficiency with regard to the global deployment of cash, as well as ongoing benefits in the Companys effective income tax rate. The Company recorded a deferred charge related to the income tax expense on intercompany profits that resulted from the transfer. The tax associated with the transfer is deferred and amortized utilizing a 25 -year life. This deferred charge is included in other current assets and other assets on the consolidated balance sheet at December 31, 2017 in the amounts of $17 million and $352 million , respectively. The comparable amounts included in other current assets and other assets were $15 million and $325 million , respectively, at December 31, 2016 , with the difference driven by changes in foreign exchange rates and current period amortization. In October 2016, the FASB issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. The guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The Company will adopt this accounting guidance on January 1, 2018. The aforementioned deferred charge of $369 million at December 31, 2017 , will be written off to retained earnings as a component of the cumulative-effect adjustment. In addition, deferred taxes will also be a component of the cumulative-effect adjustment whereby the Company expects to record a $186 million deferred tax asset in this regard. See Note 1 (Summary of Significant Accounting Policies) for additional information related to this guidance. In 2010, in connection with the expansion of the Companys operations in the Asia Pacific, Middle East and Africa region, the Companys subsidiary in Singapore, Mastercard Asia Pacific Pte. Ltd. (MAPPL) received an incentive grant from the Singapore Ministry of Finance. The incentive had provided MAPPL with, among other benefits, a reduced income tax rate for the 10 -year period commencing January 1, 2010 on taxable income in excess of a base amount. The Company continued to explore business opportunities in this region, resulting in an expansion of the incentives being granted by the Ministry of Finance, including a further reduction to the income tax rate on taxable income in excess of a revised fixed base amount commencing July 1, 2011 and continuing through December 31, 2025. Without the incentive grant, MAPPL would have been subject to the statutory income tax rate on its earnings. For 2017, 2016 and 2015 , the impact of the incentive grant received from the Ministry of Finance resulted in a reduction of MAPPLs income tax liability of $104 million , or $0.10 per diluted share, $49 million , or $0.04 per diluted share, and $47 million , or $0.04 per diluted share, respectively. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Deferred Taxes Deferred tax assets and liabilities represent the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities. The components of deferred tax assets and liabilities at December 31 are as follows: (in millions) Deferred Tax Assets Accrued liabilities $ $ Compensation and benefits State taxes and other credits Net operating and capital losses Unrealized gain/loss - 2015 Euro Notes Recoverable basis of deconsolidated entities Other items Less: Valuation allowance (91 ) (91 ) Total Deferred Tax Assets Deferred Tax Liabilities Prepaid expenses and other accruals Intangible assets Property, plant and equipment Unrealized gain/loss - 2015 Euro Notes Previously taxed earnings and profits Other items Total Deferred Tax Liabilities Net Deferred Tax Assets $ $ As a result of the TCJA, the December 31, 2017 deferred tax balance has been reduced by $157 million during 2017 through the provisional remeasurement of the U.S. deferred tax assets and liabilities. Both the 2017 and 2016 valuation allowances relate primarily to the Companys ability to recognize tax benefits associated with certain foreign net operating losses. The net activity related to the valuation allowance balance at December 31, 2017 from the December 31, 2016 balance is attributable to an increase from additional foreign losses offset by a reduction, due to remeasurement of the deferred tax attribute, for capital loss and capital asset impairments in the United States. The recognition of the foreign losses is dependent upon the future taxable income in such jurisdictions and the ability under tax law in these jurisdictions to utilize net operating losses following a change in control. The recognition of losses with regard to capital loss and impairments is dependent upon the recognition of future capital gains in the United States. A reconciliation of the beginning and ending balance for the Companys unrecognized tax benefits for the years ended December 31 , is as follows: (in millions) Beginning balance $ $ $ Additions: Current year tax positions Prior year tax positions Reductions: Prior year tax positions (1 ) (28 ) (151 ) Settlements with tax authorities (4 ) (2 ) (53 ) Expired statute of limitations (11 ) (15 ) (9 ) Ending balance $ $ $ 95 MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The entire unrecognized tax benefit of $183 million , if recognized, would reduce the effective tax rate. During 2015, there was a reduction to the balance of the Companys unrecognized tax benefits. This was primarily due to settlements with tax authorities in multiple jurisdictions. Further, the information gained related to these matters was considered in measuring uncertain tax benefits recognized for the periods subsequent to the periods settled. The Company is subject to tax in the United States, Belgium, Singapore, the United Kingdom and various other foreign jurisdictions, as well as state and local jurisdictions. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitation. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local examinations are reasonably possible and that a change in estimate, reducing unrecognized tax benefits, may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2008, with the exception of transfer pricing issues which are settled through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2010. It is the Companys policy to account for interest expense related to income tax matters as interest expense in its consolidated statement of operations, and to include penalties related to income tax matters in the income tax provision. The Company recorded tax-related interest expense of $1 million in 2017 and tax-related interest income of $4 million and $3 million in 2016 and 2015 , respectively, in its consolidated statement of operations. At December 31, 2017 and 2016 , the Company had a net income tax-related interest payable of $10 million and $9 million , respectively, in its consolidated balance sheet. At December 31, 2017 and 2016 , the amounts the Company had recognized for penalties payable in its consolidated balance sheet were not material. Other Impacts of the TCJA As mentioned above, the TCJA imposes significant changes to U.S. tax law. The Company expects to pay a marginal amount of GILTI. However, in accordance with FASB guidance, the Companys policy will be to recognize GILTI in the period it arises and it will not recognize a deferred charge with regard to GILTI. The Company does not expect to be subject to the BEAT. The Company expects to recognize income in the U.S. that will qualify as FDII and be taxed at the lower 13.125% effective tax rate. The Company will be eligible to expense qualifying fixed assets acquired after September 27, 2017, will be impacted by the additional limitations imposed on the deductibility of executive compensation, and does not expect to be impacted by the limitations placed on the deductibility of interest expense. Finally, the Company will lose its domestic production activities deduction. Note 18. Legal and Regulatory Proceedings Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined, and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercards results of operations, financial condition and overall business. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Interchange Litigation and Regulatory Proceedings Mastercards interchange fees and other practices are subject to regulatory and/or legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Companys prospects for future growth and its overall results of operations, financial position and cash flows. United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages. In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercards initial public offering of its Class A Common Stock in May 2006 (the IPO) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercards right to assess them for Mastercards litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO. In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12% of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36% of the monetary portion of such settlement. In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its no surcharge rule. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement. Prior to the reversal of the settlement approval, merchants representing slightly more than 25% of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over 30 opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters (except for two state court actions) in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants motion to dismiss the opt-out merchant complaints for failure to state a claim. Deposition discovery commenced in December 2016 and the parties in the class action are in mediation. As of December 31, 2017 , Mastercard had accrued a liability of $708 million as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of December 31, 2017 and 2016 , Mastercard had $546 million and $543 million , respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) cash on its consolidated balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters at December 31, 2017 . The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur. Canada . In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. The suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercards favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the honor all cards and no surcharge rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit sought compensatory damages in unspecified amounts, and the Ontario suit sought compensatory damages of $5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. Additional purported class action complaints were commenced in Saskatchewan and Alberta with claims that largely mirror those in the other suits. In June 2017, Mastercard entered into a class settlement agreement to resolve all of the Canadian class action litigation. The settlement, which is subject to court approval in each applicable province, requires Mastercard to make a cash payment and modify its no surcharge rule. During the first quarter of 2017, the Company recorded a provision for litigation of $15 million related to this matter. Europe. In July 2015, the European Commission issued a Statement of Objections related to Mastercards interregional interchange fees and central acquiring rules within the European Economic Area. The Statement of Objections, which follows an investigation opened in 2013, includes preliminary conclusions concerning the alleged anticompetitive effects of these practices. The European Commission has indicated it intends to seek fines if these conclusions are subsequently confirmed. In April 2016, Mastercard submitted a response to the Statement of Objections disputing the European Commissions preliminary conclusions and participated in a related oral hearing in May 2016. Since that time, Mastercard has remained in discussions with the European Commission. Although the Statement of Objections does not quantify the level of fines, based upon recent interactions with the European Commission, it is possible that they could be substantial, potentially in excess of $1 billion if the European Commission were to issue a negative decision. Fines may be less than this amount in the event of a negotiated resolution. Due to the uncertainty of numerous legal issues, including the potential for a negotiated resolution, Mastercard cannot estimate a possible range of loss at this time, although Mastercard expects to obtain greater clarity with respect to these issues in the first half of 2018. In the United Kingdom, beginning in May 2012, a number of retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercards cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the U.K. Merchant claimants), with claimed purported damages exceeding $1 billion . The U.K. Merchant claimants (including all resolved matters) represent approximately 40% of Mastercards U.K. interchange volume over the relevant damages period. Additional merchants have filed or threatened litigation with respect to interchange rates in Europe (the Pan-European claimants) for purported damages exceeding $1 billion . Mastercard submitted statements of defense to the retailers claims disputing liability and damages. In June 2015, Mastercard entered into a settlement with one of the U.K. Merchant claimants for $61 million , recorded as a provision for litigation settlement. Following the conclusion of a trial for liability and damages for one of the U.K. merchant cases, in July 2016, the tribunal issued a judgment against Mastercard for damages. Mastercard recorded a litigation provision of $107 million in the second quarter of 2016 that includes the amount of the judgment and estimated legal fees and costs. Mastercard has been granted permission to appeal this judgment. In the fourth quarter of 2016, Mastercard recorded a charge of $10 million relating to settlements with multiple U.K. Merchant claimants. In January 2017, Mastercard received a liability judgment in its favor on all significant matters in a separate action brought by ten of the U.K. Merchant claimants, who had been seeking in excess of $500 million in damages. Subsequently, Mastercard settled with six of these claimants to resolve their claims, with no financial payments required by Mastercard. Three of the U.K. Merchant claimants are appealing the judgment. In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commissions 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds 14 billion (approximately $19 billion as of December 31, 2017 ). In July 2017, the court denied the plaintiffs application for the case to proceed as a collective action. The plaintiffs request for permission to appeal this decision was denied, which they have appealed. The plaintiffs have also filed a separate request for judicial review of the courts denial of their collective action. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ATM Non-Discrimination Rule Surcharge Complaints In October 2011, a trade association of independent Automated Teller Machine (ATM) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the ATM Operators Complaint). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercards and Visas respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the ATM Consumer Complaints). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars. In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercards motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district courts order in August 2015 and sent the case back for further proceedings. U.S. Liability Shift Litigation In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the Network Defendants), EMVCo, and a number of issuing banks (the Bank Defendants) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the EMV Liability Shift), in violation of the Sherman Act and California law. Plaintiffs allege damages equal to the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorneys fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. In May 2017, the court transferred the case to New York so that discovery could be coordinated with the U.S. merchant class interchange litigation described above. Note 19. Settlement and Other Risk Management Mastercards rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro branded transactions between its issuers and acquirers (settlement risk). Settlement exposure is the outstanding settlement risk to customers under Mastercards rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily card volume during the quarter multiplied by the estimated number of days to settle. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Companys settlement risk. Customer-reported transaction data and the transaction clearing data underlying the settlement exposure calculation may be revised in subsequent reporting periods. In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during the ordinary course activities of the Company. The Company has global risk management policies and procedures aimed at managing the settlement exposure. These risk management procedures include interaction with the bank regulators of countries in which it operates, requiring customers to make adjustments to settlement processes, and requiring collateral from customers. As part of its policies, Mastercard requires MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) certain customers that are not in compliance with the Companys risk standards in effect at the time of review to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on managements review of the individual risk circumstances for each customer that is out of compliance. In addition to these amounts, Mastercard holds collateral to cover variability and future growth in customer programs. The Company may also hold collateral to pay merchants in the event of an acquirer failure. Although the Company is not contractually obligated under its rules to effect such payments to merchants, the Company may elect to do so to protect brand integrity. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary. The Companys estimated settlement exposure from Mastercard, Cirrus and Maestro branded transactions was as follows: December 31, 2017 December 31, 2016 (in millions) Gross settlement exposure 1 $ 47,002 $ 39,523 Collateral held for settlement exposure (4,360 ) (3,734 ) Net uncollateralized settlement exposure $ 42,642 $ 35,789 1. In the second quarter of 2017, Mastercard adjusted the methodology for estimating gross settlement exposure for certain customers whose exposures are now reported before the impact of potential offsetting positions. The gross settlement exposure as of December 31, 2016 has been updated to conform to the current years methodology. General economic and political conditions in countries in which Mastercard operates affect the Companys settlement risk. Many of the Companys financial institution customers have been directly and adversely impacted by political instability and uncertain economic conditions. These conditions present increased risk that the Company may have to perform under its settlement guarantee. This risk could increase if political, economic and financial market conditions deteriorate further. The Companys global risk management policies and procedures are revised and enhanced from time to time. Historically, the Company has experienced a low level of losses from financial institution failures. Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $395 million and $397 million at December 31, 2017 and 2016 , respectively, of which $313 million and $312 million at December 31, 2017 and 2016 , respectively, is mitigated by collateral arrangements. In addition, the Company enters into agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Companys obligations under these agreements depends entirely upon the occurrence of future events, the Companys potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material. Note 20. Foreign Exchange Risk Management The Company monitors and manages its foreign currency exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A principal objective of the Companys risk management strategies is to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates principally through the use of derivative instruments. Derivatives The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than the functional currencies of the entity. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Companys exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2017 and 2016 , the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercards derivative contracts are summarized below: December 31, 2017 December 31, 2016 Notional Estimated Fair Value Notional Estimated Fair Value (in millions) Commitments to purchase foreign currency $ $ $ $ (2 ) Commitments to sell foreign currency (26 ) Options to sell foreign currency Balance sheet location Accounts receivable 1 $ $ Other current liabilities 1 (30 ) (13 ) 1 The derivative contracts are subject to enforceable master netting arrangements, which contain various netting and setoff provisions. The amount of gain (loss) recognized in income for the contracts to purchase and sell foreign currency is summarized below: Year Ended December 31, (in millions) Foreign currency derivative contracts General and administrative $ (75 ) $ (6 ) $ The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than 18 months . The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of December 31, 2017 and 2016 , as these contracts were not accounted for under hedge accounting. The Companys derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as foreign currency exchange rates, interest rates and other related variables. The effect of a hypothetical 10% adverse change in foreign currency forward rates could result in a fair value loss of approximately $109 million on the Companys foreign currency derivative contracts outstanding at December 31, 2017 . Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with a diversified group of selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties. Net Investment Hedge The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). In 2015, the Company designated its 1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of December 31, 2017 , the Company had a net foreign currency transaction pre-tax loss of $216 million in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period. Note 21. Segment Reporting Mastercard has concluded it has one operating and reportable segment, Payment Solutions. Mastercards President and Chief Executive Officer has been identified as the chief operating decision-maker. All of the Companys activities are interrelated, and each activity is dependent upon and supportive of the other. Accordingly, all significant operating decisions are based upon analysis of Mastercard at the consolidated level. Revenue by geographic market is based on the location of the Companys customer that issued the card, as well as the location of the merchant acquirer where the card is being used. Revenue generated in the U.S. was approximately 35% of total revenue in 2017 , 38% in 2016 and 39% in 2015 . No individual country, other than the U.S., generated more than 10% of total revenue in those periods. MASTERCARD INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Mastercard did not have any one customer that generated greater than 10% of net revenue in 2017 , 2016 or 2015 . The following table reflects the geographical location of the Companys property, plant and equipment, net, as of December 31: (in millions) United States $ $ $ Other countries Total $ $ $ 102 MASTERCARD INCORPORATED SUMMARY OF QUARTERLY DATA (Unaudited) 2017 Quarter Ended March 31 June 30 September 30 December 31 2017 Total (in millions, except per share data) Net revenue $ 2,734 $ 3,053 $ 3,398 $ 3,312 $ 12,497 Operating income 1,506 1,653 1,941 1,522 6,622 Net income 1,081 1,177 1,430 3,915 Basic earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.67 Basic weighted-average shares outstanding 1,078 1,070 1,063 1,057 1,067 Diluted earnings per share $ 1.00 $ 1.10 $ 1.34 $ 0.21 $ 3.65 Diluted weighted-average shares outstanding 1,082 1,075 1,068 1,063 1,072 2016 Quarter Ended March 31 June 30 September 30 December 31 2016 Total (in millions, except per share data) Net revenue $ 2,446 $ 2,694 $ 2,880 $ 2,756 $ 10,776 Operating income 1,348 1,380 1,670 1,363 5,761 Net income 1,184 4,059 Basic earnings per share $ 0.86 $ 0.89 $ 1.08 $ 0.86 $ 3.70 Basic weighted-average shares outstanding 1,109 1,098 1,096 1,087 1,098 Diluted earnings per share $ 0.86 $ 0.89 $ 1.08 $ 0.86 $ 3.69 Diluted weighted-average shares outstanding 1,112 1,101 1,099 1,090 1,101 Note: Tables may not sum due to rounding. "," ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding disclosure. The President and Chief Executive Officer and the Chief Financial Officer, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2017 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. Internal Control over Financial Reporting In addition, Mastercard Incorporateds management assessed the effectiveness of Mastercards internal control over financial reporting as of December 31, 2017 . Managements report on internal control over financial reporting is included in Part II, Item 8. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. Changes in Internal Control over Financial Reporting There was no change in Mastercards internal control over financial reporting that occurred during the three months ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, Mastercards internal control over financial reporting. " diff --git a/datasets/raw/merck.csv b/datasets/raw/merck.csv new file mode 100644 index 0000000..49a2959 --- /dev/null +++ b/datasets/raw/merck.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,mrk-,20211231," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off (the Spin-Off) of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. Table o f Contents Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) 2021 2020 2019 Total Sales $ 48,704 $ 41,518 $ 39,121 Pharmaceutical 42,754 36,610 34,100 Keytruda 17,186 14,380 11,084 Gardasil/Gardasil 9 5,673 3,938 3,737 Januvia/Janumet 5,288 5,276 5,524 ProQuad/M-M-R II /Varivax 2,135 1,878 2,275 Bridion 1,532 1,198 1,131 Alliance revenue - Lynparza (1) 989 725 444 Molnupiravir 952 Pneumovax 23 893 1,087 926 Simponi 825 838 830 RotaTeq 807 797 791 Isentress/Isentress HD 769 857 975 Alliance revenue - Lenvima (1) 704 580 404 Animal Health 5,568 4,703 4,393 Livestock 3,295 2,939 2,784 Companion Animals 2,273 1,764 1,609 Other Revenues (2) 382 205 628 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs. (2) Other revenues are primarily comprised of third-party manufacturing sales and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin Lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal or gastroesophageal junction (GEJ) carcinoma, head and neck squamous cell carcinoma (HNSCC), hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer (solid tumors), including MSI-H/dMMR colorectal cancer (CRC), primary mediastinal large B-cell lymphoma (PMBCL), tumor mutational burden-high (TMB-H) cancer (solid tumors), and urothelial carcinoma, including non-muscle invasive bladder cancer. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy for human epidermal growth factor 2 (HER2)-positive gastric or GEJ adenocarcinoma, in combination with platinum-and fluoropyrimidine-based chemotherapy for esophageal or GEJ carcinoma, in combination with chemotherapy, with or without bevacizumab, for cervical cancer, in combination with chemotherapy for triple-negative breast cancer (TNBC), in combination with axitinib for advanced renal cell carcinoma (RCC), and in combination with lenvatinib for endometrial carcinoma or RCC. Keytruda is also approved for certain patients with high-risk early-stage TNBC in combination with chemotherapy as neoadjuvant treatment, and then continued as a single agent as adjuvant treatment after surgery. Keytruda is also approved as a monotherapy for the adjuvant treatment of certain patients with RCC. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast, pancreatic, and prostate cancers; and Lenvima (lenvatinib) for certain types of Table o f Contents thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with RCC, and in combination with Keytruda for certain patients with endometrial carcinoma or RCC. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; MMR II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant; Primaxin (imipenem and cilastatin) for injection, an antibiotic for the treatment of certain bacterial infections; Noxafil (posaconazole), an antifungal agent for the prevention of certain invasive fungal infections; Cancidas (caspofungin acetate) for injection, an anti-fungal agent for the treatment of certain fungal infections; Invanz (ertapenem) for injection, an antibiotic for the treatment of certain bacterial infections; and Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, both of which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Molnupiravir, an investigational oral antiviral COVID-19 medicine; Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection. Cardiovascular Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension; Verquvo (vericiguat), a medicine to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in certain adults with symptomatic chronic heart failure and reduced ejection fraction. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory Table o f Contents drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto , a line of oral and topical parasitic control products, including the original Bravecto (fluralaner) products for dogs and cats that last up to 12 weeks; Bravecto (fluralaner) One-Month , a monthly product for dogs, and Bravecto Plus (fluralaner/moxidectin), a two-month product for cats; Sentinel, a line of oral parasitic products for dogs including Sentinel Spectrum (milbemycin oxime, lufenuron, and praziquantel) and Sentinel Flavor Tabs (milbemycin oxime, lufenuron); Optimmune (cyclosporine), an ophthalmic ointment; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies; and Sure Petcare products for companion animal identification and well-being, including the microchip and pet recovery system Home Again . For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2021 Product Approvals and Authorizations Set forth below is a summary of significant product approvals and authorizations received by the Company in 2021. Product Date Approval Keytruda January 2021 European Commission (EC) approved Keytruda as monotherapy for the first-line treatment of adult patients with MSI-H or dMMR CRC. March 2021 EC approved Keytruda as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed autologous stem cell transplant (ASCT) or following at least two prior therapies when ASCT is not a treatment option. March 2021 U.S. Food and Drug Administration (FDA) approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for the treatment of patients with locally advanced or metastatic esophageal or GEJ (tumors with epicenter 1 to 5 centimeters above the GEJ) carcinoma that is not amenable to surgical resection or definitive chemoradiation. May 2021 FDA approved Keytruda , in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy, for the first-line treatment of patients with locally advanced unresectable or metastatic HER2-positive gastric or GEJ adenocarcinoma. June 2021 Chinas National Medical Products Administration (NMPA) approved Keytruda as a monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR CRC that is KRAS, NRAS and BRAF all wild-type. Table o f Contents Keytruda June 2021 EC approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus or HER2-negative GEJ adenocarcinoma in adults whose tumors express PD-L1 (Combined Positive Score [CPS] 10). July 2021 FDA approved Keytruda as monotherapy for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation. July 2021 FDA approved Keytruda plus Lenvima for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR, who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation. July 2021 FDA approved Keytruda for the treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant treatment, then continued as single agent as adjuvant treatment after surgery. August 2021 FDA approved Keytruda for the treatment of patients with locally advanced or metastatic urothelial carcinoma who are not eligible for any platinum-containing chemotherapy. August 2021 Japan Pharmaceuticals and Medical Devices Agency (PMDA) approved Keytruda for the treatment of patients with PD-L1-positive, hormone receptor-negative and HER2-negative, inoperable or recurrent breast cancer. August 2021 PMDA approved Keytruda for the treatment of patients with unresectable, advanced or recurrent MSI-H CRC. August 2021 FDA approved Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC. September 2021 NMPA approved Keytruda in combination with platinum- and fluoropyrimidine-based chemotherapy for first-line treatment of patients with locally advanced, unresectable or metastatic carcinoma of the esophageal or GEJ. October 2021 FDA approved Keytruda in combination with chemotherapy, with or without bevacizumab, for the treatment of patients with persistent, recurrent or metastatic cervical cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. October 2021 EC approved Keytruda in combination with chemotherapy for the first-line treatment of locally recurrent unresectable or metastatic TNBC in adults whose tumors express PD-L1 (CPS 1) and who have not received prior chemotherapy for metastatic disease. November 2021 FDA approved Keytruda for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy, or following nephrectomy and resection of metastatic lesions. November 2021 EC approved Keytruda plus Lenvima as a first-line treatment for adult patients with advanced RCC. Table o f Contents Keytruda November 2021 EC approved Keytruda plus Lenvima for the treatment of advanced or recurrent endometrial carcinoma in adults who have disease progression on or following prior treatment with a platinumcontaining therapy in any setting and who are not candidates for curative surgery or radiation. November 2021 PMDA approved Keytruda in combination with chemotherapy (5-fluorouracil plus cisplatin) for the first-line treatment of patients with radically unresectable, advanced or recurrent esophageal carcinoma. December 2021 FDA approved Keytruda as a monotherapy for the adjuvant treatment of adult and pediatric (12 years and older) patients with stage IIB or IIC melanoma following complete resection. The FDA also expanded the indication for Keytruda as adjuvant treatment for stage III melanoma following complete resection to include pediatric patients (12 years and older). December 2021 Japans Ministry of Health, Labor and Welfare (MHLW) approved Keytruda in combination with Lenvima for the treatment of patients with unresectable, advanced or recurrent endometrial carcinoma that progressed after cancer chemotherapy. Lynparza (1) June 2021 NMPA approved Lynparza as monotherapy for the treatment of adult patients with germline or somatic BRCA -mutated metastatic castration-resistant prostate cancer who have progressed following prior treatment that included a new hormonal agent (abiraterone, enzalutamide). molnupiravir (2) December 2021 FDA granted Emergency Use Authorization (EUA) for molnupiravir to treat mild to moderate COVID-19 in adults with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death, and for whom alternative COVID-19 treatment options authorized by the FDA are not accessible or clinically appropriate. December 2021 MHLW granted molnupiravir Special Approval for Emergency for the treatment of infectious disease caused by SARS-CoV-2. Vaxneuvance July 2021 FDA approved Vaxneuvance for active immunization for the prevention of invasive disease caused by Streptococcus pneumoniae serotypes 1, 3, 4, 5, 6A, 6B, 7F, 9V, 14, 18C, 19A, 19F, 22F, 23F and 33F in adults 18 years of age and older. December 2021 EC approved Vaxneuvance for active immunization for the prevention of invasive disease and pneumonia caused by Streptococcus pneumoniae in individuals 18 years of age and older. Verquvo (3) January 2021 FDA approved Verquvo to reduce the risk of cardiovascular death and heart failure (HF) hospitalization following a hospitalization for heart failure or need for outpatient intravenous (IV) diuretics in adults with symptomatic chronic HF and ejection fraction less than 45%. July 2021 EC approved Verquvo for the treatment of symptomatic chronic heart failure in adult patients with reduced ejection fraction who are stabilized after a recent decompensation event requiring IV therapy. Welireg August 2021 FDA approved Welireg for adult patients with von Hippel-Lindau (VHL) disease who require therapy for associated RCC, central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. (1) Being jointly developed and commercialized in a worldwide collaboration with AstraZeneca . (2) Being jointly developed and commercialized in a worldwide collaboration with Ridgeback Biopharmaceuticals LP. Molnupiravir has not been approved by the FDA but has been authorized for emergency use. (3) Being jointly developed and commercialized in a worldwide collaboration with Bayer AG. Table o f Contents Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers, and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products as well as competitors products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. Changes to the U.S. health care system as part of health care reform enacted in prior years, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. United States The Company faces increasing pricing pressure from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins, including, through (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the Patient Protection and Affordable Care Act (ACA). In the U.S., federal and state governments for many years have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal and state laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for medicines purchased by certain state and federal entities such as the Department of Defense, Veterans Affairs, Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Table o f Contents Additionally in the U.S., consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers (PBMs) have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely affect revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been increasing the cost-sharing required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payor has taken the position that multiple branded products are therapeutically comparable. As the U.S. payor market concentrates further, pharmaceutical companies may face greater pricing pressure from private third-party payors. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the U.S. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2021, the Companys gross U.S. sales were reduced by 43.5% as a result of rebates, discounts and returns. Legislative Changes In 2021, Congress actively considered multiple versions of drug pricing legislation that could significantly impact branded pharmaceutical manufacturers. This legislation would implement a government negotiation plan for certain products covered by Medicare Parts B and D, institute financial penalties for price increases above inflation, and redesign the Medicare Part D program to include a cap on patients out of pocket costs and realign the liability for costs of the benefit among manufacturers, health plans, and the government. It is unclear when or if this legislation will be passed by Congress, and it remains very uncertain as to what other proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. Also in 2021, Congress passed the American Rescue Plan Act of 2021, which included a provision that eliminates the statutory cap on rebates drug manufacturers pay to Medicaid beginning in January 2024. These rebates act as a discount off the list price and eliminating the cap means that manufacturer discounts paid to Medicaid can increase. Prior to this change, manufacturers have not been required to pay more than 100% of the Average Manufacturer Price (AMP) in rebates to state Medicaid programs for Medicaid-covered drugs. As a result of this provision, beginning in 2024, it is possible that manufacturers may have to pay state Medicaid programs more in rebates than they received on sales of particular products. This change could present a risk to Merck in the future for drugs that have high Medicaid utilization and rebate exposure that is more than 100% of the AMP. The Company also faces increasing pricing pressure in the states, which are looking to exert greater influence over the price of prescription drugs. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical pricing and will increasingly shift to more aggressive price control tools such as Prescription Drug Affordability Boards that have the authority to conduct affordability reviews and establish upper payment limits. Regulatory Changes In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of AMP and Best Price, two metrics used to determine the rebates drug manufacturers are required to pay to state Medicaid programs. On December 21, 2020, CMS issued a final rule making significant changes to these requirements. Effective January 1, 2023, this final rule changes the way that manufacturers must calculate Best Price in relation to certain patient support programs, including coupons. PhRMA, a pharmaceutical industry trade group of which the Company is a member, filed a complaint challenging this rule as invalid asserting that it conflicts Table o f Contents with the plain language of the Medicaid drug rebate statute. Should this legal challenge fail, the impact of this and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. In November 2020, the Department of Health and Human Services Office of Inspector General issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to PBMs on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. This rulemaking also established, effective January 1, 2021, a new safe harbor for point of sale discounts at the pharmacy counter and a new safe harbor for certain service arrangements between pharmaceutical manufacturers and PBMs. Congress has delayed implementation of this Final Rule until January 1, 2026 and pending federal legislation would repeal it entirely. The pharmaceutical industry also could be considered a potential source of savings via other legislative and administrative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. European Union Efforts toward health care cost containment remain intense in the European Union (EU). The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in the EU attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs. Reference pricing may either compare a products prices in other markets (external reference pricing), or compare a products price with those of other products in a national class (internal reference pricing). The authorities then use the price data to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. Some EU Member States have established free-pricing systems, but regulate the pricing for drugs through profit control plans. Others seek to negotiate or set prices based on the cost-effectiveness of a product or an assessment of whether it offers a therapeutic benefit over other products in the relevant class. The downward pressure on health care costs in general, particularly prescription drugs, has become intense. As a result, increasingly high barriers are being erected to the entry of new products. In some EU Member States, cross-border imports from low-priced markets also exert competitive pressure that may reduce pricing within an EU Member State. Additionally, EU Member States have the power to restrict the range of pharmaceutical products for which their national health insurance systems provide reimbursement. In the EU, pricing and reimbursement plans vary widely from Member State to Member State. Some EU Member States provide that drug products may be marketed only after a reimbursement price has been agreed. Some EU Member States may require the completion of additional studies that compare the cost-effectiveness of a particular product candidate to already available therapies or so-called health technology assessments (HTA), in order to obtain reimbursement or pricing approval. The HTA of pharmaceutical products is becoming an increasingly common part of the pricing and reimbursement procedures in most EU Member States. The HTA process, which is governed by the national laws of these countries, involves the assessment of the cost-effectiveness, public health impact, therapeutic impact and/or the economic and social impact of use of a given pharmaceutical product in the national health care system of the individual country in which it is conducted. Ultimately, HTA measures the added value of a new health technology compared to existing ones. The outcome of HTAs regarding specific pharmaceutical products will often influence the pricing and reimbursement status granted to these pharmaceutical products by the regulatory authorities of individual EU Member States. A negative HTA of one of the Companys products may mean that the product is not reimbursable or may force the Company to reduce its reimbursement price or offer discounts or rebates. A negative HTA by a leading and recognized HTA body could also undermine the Companys ability to obtain reimbursement for the relevant product outside a jurisdiction. For example, EU Member States that have not yet developed HTA mechanisms may rely to some extent on the HTA performed in other countries with a developed HTA framework, to inform their pricing and reimbursement decisions. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. Table o f Contents To obtain reimbursement or pricing approval in some EU Member States, the Company may be required to conduct studies that compare the cost-effectiveness of the Companys product candidates to other therapies that are considered the local standard of care. There can be no assurance that any EU Member State will allow favorable pricing, reimbursement and market access conditions for any of the Companys products, or that it will be feasible to conduct additional cost-effectiveness studies, if required. Brexit In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period applied from January 31, 2020 until December 31, 2020, and during this period the EU and UK operated as if the UK was an EU Member State, and the UK continued to participate in the EU Customs Union allowing for the freedom of movement for people and goods. It was announced on December 24, 2020, that the EU and the UK agreed to a Trade and Cooperation Agreement (TCA). The TCA sets out the new arrangements for trade of goods, including medicines and vaccines, which allows goods to continue to flow between the EU and the UK. The TCA was signed on December 30, 2020, was applied provisionally as of January 1, 2021, and entered into force on May 1, 2021. As a result of the TCA, the Company believes that its operations will not be materially adversely affected by Brexit. Japan In Japan, the pharmaceutical industry is subject to government-mandated annual price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2022. China The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. While the mechanism for drugs being added to the governments National Reimbursement Drug List (NRDL) evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2021, drugs were added to the NRDL with an average of more than 60% price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the last five rounds of VBP had, on average, a price reduction of more than 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. Emerging Markets The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and measures impacting intellectual property, including in exceptional cases, threats of compulsory licenses (especially for COVID-19 vaccines and drugs), that aim to put pressure on the price of innovative pharmaceuticals or result in constrained market access to innovative medicine. The Company anticipates that pricing pressures and market access challenges will continue in the future to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing Table o f Contents availability of funding for health care, credit worthiness of health care partners, such as hospitals, due to COVID-19, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing global cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. Regulation The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the U.S., which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the U.S. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, approval for marketing, labeling, advertising, manufacturing, wholesale distribution, integrity of the supply chain, pharmacovigilance and safety monitoring of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU Member States. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that, in collaboration with key stakeholders, it has a role to play in helping to ensure that its science advances health care, and its products are accessible and affordable. The Company is committed to ensuring a reliable, safe global supply of its quality medicines and vaccines, and to developing, testing and implementing innovative solutions that address barriers to access and affordability of its medicines and vaccines. The Companys approach is designed to enable it to serve the greatest number of patients today, while Table o f Contents meeting the needs of patients in the future. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the U.S. who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. Merck has funded Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the EU General Data Protection Regulation (GDPR), which went into effect in May 2018 and imposes penalties of up to 4% of global revenue. The GDPR and related implementing laws in individual EU Member States govern the collection and use of personal health data and other personal data in the EU. The GDPR increased responsibility and liability in relation to personal data that the Company processes. It also imposes a number of strict obligations and restrictions on the ability to process (which includes collection, analysis and transfer of) personal data, including health data from clinical trials and adverse event reporting. The GDPR also includes requirements relating to the consent of the individuals to whom the personal data relates, the information provided to the individuals prior to processing their personal data or personal health data, notification of data processing obligations to the national data protection authorities, and the security and confidentiality of the personal data. Further, the GDPR prohibits the transfer of personal data to countries outside of the EU that are not considered by the EC to provide an adequate level of data protection, including to the U.S., except if the data controller meets very specific requirements. Following the Schrems II decision of the Court of Justice of the EU on July 16, 2020, there is considerable uncertainty as to the permissibility of international data transfers under the GDPR. In light of the implications of this decision, the Company may face difficulties regarding the transfer of personal data from the EU to third countries. Failure to comply with the requirements of the GDPR and the related national data protection laws of the EU Member States may result in significant monetary fines and other administrative penalties as well as civil liability claims from individuals whose personal data was processed. Data protection authorities from the different EU Member States may still implement certain variations, enforce the GDPR and national data protection laws differently, and introduce additional national regulations and guidelines, which adds to the complexity of processing personal data in the EU. Guidance developed at both the EU level and at the national level in individual EU Member States concerning implementation and compliance practices is often updated or otherwise revised. There is, moreover, a growing trend towards required public disclosure of clinical trial data in the EU which adds to the complexity of obligations relating to processing health data from clinical trials. Failing to comply with these obligations could lead to government enforcement actions and significant penalties against the Company, harm to its reputation, and adversely impact its business and operating results. The uncertainty regarding the interplay between different regulatory frameworks further adds to the complexity that the Company faces with regard to data protection regulation. On August 20, 2021, Chinas 13th National Peoples Congress passed the Personal Information Protection Law (PIPL) that aims to standardize the handling of personal information in China which became effective on November 1, 2021. The PIPL currently applies to the processing of personal information of natural persons in China, the processing of personal information outside China where the purpose is to provide products and services in China, and to analyze the activities of individuals in China. While similar to the GDPR, the PIPL contains unique requirements not found in the GDPR. Table o f Contents The Company has developed and implemented comprehensive plans to ensure compliance with the PIPL, with those relating to data localization and cross-border transfers yet to be completed pending forthcoming guidance from the Cyberspace Administration of China. Additional laws and regulations enacted in the U.S. (such as the California Consumer Privacy Act), Europe, Asia, and Latin America, have increased enforcement and litigation activity in the U.S. and other developed markets, as well as increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving requirements and risks and to facilitate the transfer of personal information across international borders. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, PBMs and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the U.S. and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the U.S. for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the U.S., the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Table o f Contents Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Januvia 2023 2022 2025-2026 2022 Janumet 2023 2022 N/A 2022 Janumet XR 2023 N/A N/A 2022 Isentress 2024 2023 (3) 2022-2026 (4) 2022 Simponi N/A (5) 2024 (6) N/A (5) N/A (5) Lenvima (7) 2025 (3) 2026 (3) (SPCs) 2026 Expired Bridion 2026 (3) 2023 2024 Expired Bravecto 2026 (with pending PTE) 2025 (patents), 2029 (SPCs) 2029 2025 Gardasil 2028 Expired Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A 2025 Keytruda 2028 2030 (3) 2032-2033 2028 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 2024 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Adempas (9) N/A (10) 2028 (3) 2027-2028 2023 Belsomra 2029 (3) N/A 2031 N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2029 N/A Segluromet (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (12) Steglatro (11) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A (12) Steglujan (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (12) Verquvo (8) 2035 (with pending PTE) N/A (13) N/A (13) N/A (13) Vaxneuvance 2031 (with pending PTE) No Patent N/A N/A Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A 2031 Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) 2036 2031 Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Welireg 2035 (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. (1) The EU date represents the expiration date for the following four countries: France, Germany, Italy, and Spain (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) Expiry date reflects the approved product and includes granted PTE for the 600 mg tablet in Japan. (5) The Company has no marketing rights in the U.S., Japan or China. (6) The distribution agreement with Janssen Pharmaceuticals, Inc. expires on October 1, 2024. (7) Part of a global strategic oncology collaboration with Eisai Co., Ltd. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized in a worldwide collaboration with Bayer AG. (10) The Company has no marketing rights in the U.S. (11) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. (12) The Company has no marketing rights in Japan. (13) The Company has no marketing rights in the EU, Japan or China. Table o f Contents The Company has the following key U.S. patent protection for drug candidates under review in the U.S. by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review in the U.S. Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-8591 (islatravir) MK-7962 (sotatercept) 2027 MK-8591A (doravirine + islatravir) 2032 (pending PTE for doravirine) MK-1308A (quavonlimab + pembrolizumab) MK-7684A (vibostolimab + pembrolizumab) MK-4280A (favezelimab + pembrolizumab) MK-1654 (clesrovimab) MK-4482 (molnupiravir) (1) (1) Received Emergency Use Authorization from the FDA for the treatment of high-risk adults with mild to moderate COVID-19. Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the U.S., the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a compound patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-expiring patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the U.S. and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the U.S. and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the U.S. and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Table o f Contents Royalty income in 2021 on patent and know-how licenses and other rights amounted to $286 million. Merck also incurred royalty expenses amounting to $2.4 billion in 2021 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2021, approximately 17,500 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, metabolic diseases, infectious diseases, neurosciences, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the U.S. and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the U.S., recorded data on pre-clinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Table o f Contents Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the U.S., the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. More than one of these special designations can be granted for a given application (i.e., a product designated as a Breakthrough Therapy may also be eligible for Priority Review). Due to the COVID-19 public health crisis, the U.S. Secretary of Health and Human Services has exercised statutory authority to determine that a public health emergency exists, and declared these circumstances justify the emergency use of drugs and biological products as authorized by the FDA. While in effect, this declaration enables the FDA to issue Emergency Use Authorizations (EUAs) permitting distribution and use of specific medical products absent NDA/BLA submission or approval, including products to treat or prevent diseases or conditions caused by the SARS-CoV-2 virus, subject to the terms of any such EUAs. The FDA must make certain findings to grant an EUA, including that it is reasonable to believe based on the totality of evidence that the drug or biologic may be effective, and that known or potential benefits when used under the terms of the EUA outweigh known or potential risks. Additionally, the FDA must find that there is no adequate, approved and available alternative to the emergency use. The FDA may revise or revoke an EUA if the circumstances justifying its issuance no longer exist, the criteria for its issuance are no longer met, or other circumstances make a revision or revocation appropriate to protect the public health or safety. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure Table o f Contents must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other EU Member States. Outside of the U.S. and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, the National Medical Products Administration in China, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, and the Therapeutic Goods Administration in Australia. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the U.S. or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the U.S. and internationally or in late-stage clinical development. MK-4482, molnupiravir, is an investigational oral antiviral medicine for the treatment of mild to moderate COVID-19 in adults who are at risk for progressing to severe disease. Merck is developing molnupiravir in collaboration with Ridgeback Biotherapeutics LP. The FDA granted Emergency Use Authorization (EUA) for molnupiravir in December 2021; as updated in February 2022, to authorize molnupiravir for the treatment of mild to moderate COVID-19 in adults with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death, and for whom alternative COVID-19 treatment options approved or authorized by the FDA are not accessible or clinically appropriate. The authorization is based on the Phase 3 MOVe-OUT trial. Molnupiravir is not approved for any use in the U.S. and is authorized only for the duration of the declaration that circumstances exist justifying the authorization of its emergency use under the Food, Drug and Cosmetic Act, unless the authorization is terminated or revoked sooner. Molnupiravir has also received conditional marketing authorization in the UK and Special Approval for Emergency in Japan. In November 2021, the EMA issued a positive scientific opinion for molnupiravir, which is intended to support national decision-making on the possible use of molnupiravir prior to marketing authorization. In October 2021, the EMA initiated a rolling review for molnupiravir for the treatment of COVID-19 in adults. Merck plans to work with the Committee for Medicinal Products for Human Use of the EMA to complete the rolling review process to facilitate initiating the formal review of the MAA. Applications to other regulatory bodies worldwide are underway. Molnupiravir is also being evaluated for post-exposure prophylaxis in the Phase 3 MOVe-AHEAD trial, which is evaluating the efficacy and safety of molnupiravir for the prevention of COVID-19 in adults who reside with a person with COVID-19. As previously announced, data from the MOVe-IN clinical trial indicated that molnupiravir is unlikely to demonstrate a clinical benefit in hospitalized patients, who generally had a longer duration of symptoms prior to study entry; therefore, the decision was made not to proceed to Phase 3. MK-7264, gefapixant, is an investigational, orally administered, selective P2X3 receptor antagonist, for the treatment of refractory chronic cough or unexplained chronic cough in adults under review by the FDA. The NDA for gefapixant is based on results from the COUGH-1 and COUGH-2 clinical trials. In January 2022, the FDA issued a Complete Response Letter (CRL) regarding Mercks NDA for gefapixant. In the CRL, the FDA requested additional information related to measurement of efficacy. The CRL was not related to the safety of gefapixant. Merck is reviewing the letter and considering next steps. Gefapixant is also under review in the EU, although the review period has been extended pending the receipt of additional information from the Company. V114 is an investigational 15-valent pneumococcal conjugate vaccine under review in Japan for use in adults. V114 was approved in the U.S. in 2021 for use in adults where it is marketed as Vaxneuvance . Vaxneuvance is also under priority review by the FDA for the prevention of invasive pneumococcal disease in children 6 weeks through 17 years of age. The FDA grants priority review to medicines and vaccines that, if approved, would provide a significant improvement in the safety or effectiveness of the treatment or prevention of a serious condition. The FDA set a PDUFA date of April 1, 2022. The supplemental BLA is supported by results from Phase 2 and Phase 3 clinical studies in pediatric populations including infants, children, and adolescents. Table o f Contents MK-3475, Keytruda , is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,650 clinical trials, including more than 1,250 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary, estrogen receptor positive breast cancer, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, gastric, glioblastoma, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, non-small-cell lung, small-cell lung, melanoma, mesothelioma, ovarian, prostate, renal, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU for the adjuvant treatment of adult and pediatric (12 years and older) patients with Stage IIB or IIC melanoma following complete resection based on data from the Phase 3 KEYNOTE-716 trial. Keytruda is under review in Japan for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy (surgical removal of a kidney) based on data from the Phase 3 KEYNOTE-564 trial. Keytruda is under review by the FDA for the treatment of patients with advanced endometrial cancer that is MSI-H or dMMR, who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation. This submission is based on data from the KEYNOTE-158 trial. The FDA set a PDUFA date of March 28, 2022. Keytruda is under review in the EU for the treatment of unresectable or metastatic MSI-H or dMMR colorectal, endometrial, gastric, small intestine, biliary, or pancreatic cancer in adults who have received prior therapy. The proposed indication is based on the results from the KEYNOTE-164 and KEYNOTE-158 trials. Keytruda in combination with chemotherapy is under review in the EU and Japan for the treatment of patients with high-risk, early-stage TNBC as neoadjuvant treatment, and then as a single agent as adjuvant treatment after surgery based on data from the KEYNOTE-522 trial. Keytruda is under review in Japan for treatment of adult patients with advanced or recurrent TMB-H solid tumors that have progressed after chemotherapy (limited to use when difficult to treat with standard of care) based on the KEYNOTE-158 trial. Keytruda in combination with chemotherapy with or without bevacizumab is also under review in the EU and Japan for the first-line treatment of patients with persistent, recurrent or metastatic cervical cancer based on the KEYNOTE-826 trial. In January 2021, Merck, the European Organisation for Research and Treatment of Cancer and the European Thoracic Oncology Platform announced that the Phase 3 KEYNOTE-091 trial investigating Keytruda met one of its dual primary endpoints of disease-free survival (DFS) for the adjuvant treatment of patients with stage IB-IIIA NSCLC following surgical resection regardless of PD-L1 expression. Based on an interim analysis review conducted by an independent Data Monitoring Committee, adjuvant treatment with Keytruda resulted in a statistically significant and clinically meaningful improvement in DFS compared with placebo in the all-comer population of patients with stage IB-IIIA NSCLC. At the interim analysis, there was also an improvement in DFS for patients whose tumors express PD-L1 (tumor proportion score [TPS] 50%) treated with Keytruda compared to placebo; however, this dual primary endpoint did not meet statistical significance per the pre-specified statistical plan. The trial will continue to analyze DFS in patients whose tumors express high levels of PD-L1 (TPS 50%) and evaluate overall survival, a key secondary endpoint. Results will be presented at an upcoming medical meeting and will be submitted to regulatory authorities. MK-7339, Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast, pancreatic and prostate cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca PLC. In November 2021, the FDA accepted for priority review a supplemental NDA for Lynparza for the adjuvant treatment of patients with BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative high-risk, early-stage breast cancer who have already been treated with chemotherapy either before or after surgery based on the results from the Phase 3 OlympiA trial. The FDA set a PDUFA date during the first quarter of 2022. Table o f Contents This indication is also under review in the EU. Lynparza is also under review in the EU for the treatment of certain patients with metastatic castration-resistant prostate cancer based on the PROpel clinical trial. MK-7902, Lenvima, is an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai Co., Ltd. (Eisai). Merck and Eisai are studying the Keytruda plus Lenvima combination through the LEAP (LEnvatinib And Pembrolizumab) clinical program that includes 17 Phase 3 studies across 14 different tumor types (biliary cancer, CRC, endometrial carcinoma, esophageal cancer, gastric cancer, glioblastoma, HCC, HNSCC, melanoma, pancreatic cancer, prostate cancer, NSCLC, SCLC and RCC). In July 2020, Merck and Eisai announced that the FDA issued a CRL regarding Mercks and Eisais applications seeking accelerated approval for the first-line treatment of patients with unresectable HCC based on the KEYNOTE-524/Study 116 trial. Ahead of the PDUFA action dates of Mercks and Eisais applications, another combination therapy was approved based on a randomized, controlled trial that demonstrated improvement in overall survival versus standard-of-care treatment. Consequently, the CRL stated that Mercks and Eisais applications do not provide evidence that Keytruda in combination with Lenvima represents a meaningful advantage over available therapies for the treatment of unresectable or metastatic HCC with no prior systemic therapy for advanced disease. Since the applications for KEYNOTE-524/Study 116 no longer meet the criteria for accelerated approval, both companies plan to work with the FDA to take appropriate next steps, which include conducting a well-controlled clinical trial that demonstrates substantial evidence of effectiveness and the clinical benefit of the combination. As such, LEAP-002, the Phase 3 trial evaluating the Keytruda plus Lenvima combination as a first-line treatment for advanced HCC, is currently underway and fully enrolled. The CRL does not impact the current approved indications for Keytruda or for Lenvima. Merck and Eisai have stopped LEAP-007, the Phase 3 study evaluating the first-line treatment of Lenvima in combination with Keytruda in participants with metastatic squamous or non-squamous NSCLC, whose tumors are PD-L1 positive with no EGFR or ALK genomic tumor aberrations. The trial has been discontinued following the recommendation of the external Data Monitoring Committee (eDMC) which met, as scheduled, to assess safety and futility. The eDMC determined that the study had met the criteria for declaring futility and the benefit/risk profile of the combination did not support continuing the trial. Merck and Eisai have closed LEAP-011 for further enrollment. LEAP-011 is a Phase 3 study evaluating Lenvima in combination with Keytruda for the first-line treatments of patients with platinum-ineligible urothelial carcinoma. Enrollment was closed following the recommendation of the eDMC, which met, as scheduled, to assess safety and futility. The eDMC determined that the benefit/risk profile of the combination did not support continuing the trial and improvements in outcomes in favor of the combination were unlikely to be as high as initially hypothesized. The Company also has several other programs in Phase 3 clinical development. MK-1308A is the coformulation of quavonlimab, Mercks novel investigational anti-CTLA-4 antibody, with pembrolizumab being evaluated for the treatment of RCC. Subcutaneous MK-3475, pembrolizumab, is being evaluated for comparability with the intravenous formulation in NSCLC. MK-4280A is the coformulation of favezelimab, Mercks novel investigational anti-LAG3 therapy, with pembrolizumab, being evaluated for the treatment of CRC. MK-6482, Welireg (belzutifan), is a hypoxia-inducible factor-2 (HIF-2) inhibitor being evaluated for a supplemental indication for the treatment of patients with RCC. MK-7119, Tukysa, is a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers in development for the treatment of breast cancer. In September 2020, Seagen granted Merck an exclusive license and entered into a co-development agreement with Merck to accelerate the global reach of Tukysa. MK-7684A is the coformulation of vibostolimab, an anti-TIGIT therapy, with pembrolizumab being evaluated for the treatment of NSCLC. In December 2021, Merck announced that the FDA had placed clinical holds on the investigational new drug applications for the oral and implant formulations of islatravir (MK-8591) for HIV-1 pre-exposure prophylaxis Table o f Contents (PrEP); the injectable formulation of islatravir for HIV-1 treatment and prophylaxis; and the oral doravirine/islatravir (MK-8591A) HIV-1 once-daily treatment regimen. The FDAs clinical hold is based on observations of decreases in total lymphocyte and CD4+ T-cell counts in some participants receiving islatravir in clinical studies. Merck previously announced it had stopped dosing in the Phase 2 IMAGINE-DR clinical trial of islatravir in combination with MK-8507 (MK-8591-013) and paused enrollment in the once-monthly Phase 3 PrEP studies, (MK-8591-022 and MK-8591-024). With the FDAs clinical hold, no new studies may be initiated. Additionally, Merck and Gilead have made the decision to stop all dosing of participants in the Phase 2 clinical study evaluating an oral-weekly combination treatment regimen of islatravir and Gileads investigational lenacapavir in people living with HIV who are virologically suppressed on antiretroviral therapy. This decision follows the joint announcement on November 23, 2021 of a temporary hold on further enrollment and screening in the study, which commenced in October 2021. The two companies will assess whether a different dosing of islatravir in combination with lenacapavir may provide a once-weekly oral therapy option for people living with HIV. Merck and Gilead remain committed to their collaboration, which aims to develop long-acting new treatment options to address the unmet needs for people living with HIV. MK-7962, sotatercept, is a potentially first-in-class therapy for the treatment of pulmonary arterial hypertension (PAH). Sotatercept is in clinical trials as an add-on to current standard of care for the treatment of PAH. Sotatercept was obtained in connection with Mercks acquisition of Acceleron Pharma Inc. in 2021. MK-1654, clesrovimab, is a respiratory syncytial virus (RSV) monoclonal antibody that is being evaluated for the prevention of RSV medically attended lower respiratory tract infection in infants and certain children over 2 years of age. In April 2021, Merck announced the discontinuation of development of MK-7110 which was being evaluated for the treatment of hospitalized patients with COVID-19. Merck obtained MK-7110 in December 2020 through its acquisition of OncoImmune, a privately held clinical-stage biopharmaceutical company. In 2021, Merck received feedback from the FDA that additional data would be needed to support a potential EUA application and therefore the Company did not expect MK-7110 would become available until the first half of 2022. Given this timeline and the technical, clinical and regulatory uncertainties, the availability of a number of medicines for patients hospitalized with COVID-19, and the need to concentrate Mercks resources on accelerating the development and manufacture of the most viable therapeutics and vaccines, Merck decided to discontinue development of MK-7110 for the treatment of COVID-19. In September 2021, the FDA approved updated labeling for Steglatro, Steglujan and Segluromet, medicines for adults with type 2 diabetes, to include the primary efficacy and safety results from the VERTIS CV trial, which assessed the effect of Steglatro compared with placebo on cardiovascular outcomes in adult patients with type 2 diabetes and established atherosclerotic cardiovascular disease. The FDA issued a CRL concerning the Companys application for a new indication, based on additional results from the VERTIS CV trial, to reduce the risk of hospitalization for heart failure. The Company has determined not to pursue the indication. The chart below reflects the Companys research pipeline as of February 22, 2022. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. Table o f Contents Phase 2 Phase 3 (Phase 3 entry date) Under Review Cancer MK-0482 (2) Non-Small-Cell Lung MK-1026 (nemtabrutinib) Hematological Malignancies MK-1308 (quavonlimab) (2) Non-Small-Cell Lung MK-1308A (quavonlimab+pembrolizumab) Advanced Solid Tumors Colorectal Hepatocellular Melanoma Small-Cell-Lung MK-2140 (zilovertamab vedotin) Breast Hematological Malignancies Non-Small-Cell Lung MK-3475 Keytruda Advanced Solid Tumors MK-4280 (favezelimab) (2) Hematological Malignancies Non-Small-Cell Lung MK-4280A (favezelimab+pembrolizumab) Renal Cell Small-Cell Lung MK-4830 (2) Non-Small-Cell Lung Renal Cell Small-Cell Lung MK-5890 (2) Non-Small-Cell Lung Small-Cell Lung MK-6440 (ladiratuzumab vedotin) (1)(3) Breast Esophageal Gastric Head and Neck Melanoma Non-Small-Cell Lung Prostate Small-Cell Lung MK-6482 Welireg (3) Biliary Colorectal Hepatocellular Pancreatic Rare cancers Von Hippel-Lindau Disease-Associated Tumors (EU) MK-7119 Tukysa (1) Advanced Solid Tumors Biliary Bladder Cervical Colorectal Endometrial Gastric Non-Small-Cell Lung MK-7339 Lynparza (1)(3) Advanced Solid Tumors MK-7684 (vibostolimab) (2) Melanoma MK-7684A (vibostolimab+pembrolizumab) Biliary Breast Cervical Endometrial Esophageal Head and Neck Hematological Malignancies Hepatocellular Prostate MK-7902 Lenvima (1)(2) Biliary Glioblastoma Pancreatic Prostate Small-Cell Lung V937 Breast Cutaneous Squamous Cell Head and Neck Melanoma Solid Tumors Cardiovascular MK-2060 Chikungunya Virus Vaccine V184 HIV-1 Infection MK-8591B (islatravir+MK-8507) (4) MK-8591D (islatravir+lenacapavir) (1)(4) Nonalcoholic Steatohepatitis (NASH) MK-3655 MK-6024 Overgrowth Syndrome MK-7075 (miransertib) Pneumococcal Vaccine Adult V116 Pulmonary Arterial Hypertension MK-5475 Schizophrenia MK-8189 Treatment Resistant Depression MK-1942 Antiviral COVID-19 MK-4482 (molnupiravir) (May 2021) (1)(5) (U.S) Cancer MK-1308A (quavonlimab+pembrolizumab) Renal Cell (April 2021) MK-3475 Keytruda Biliary (September 2019) Cutaneous Squamous Cell (August 2019) (EU) Gastric (May 2015) (EU) Hepatocellular (May 2016) (EU) Mesothelioma (May 2018) Ovarian (December 2018) Prostate (May 2019) Small-Cell Lung (May 2017) MK-3475 (pembrolizumab subcutaneous) Non-Small-Cell Lung (August 2021) MK-4280A (favezelimab+pembrolizumab) Colorectal (November 2021) MK-6482 Welireg (3) Renal Cell (February 2020) MK-7119 Tukysa (1) Breast (October 2019) MK-7339 Lynparza (1)(3) Colorectal (August 2020) Non-Small-Cell Lung (June 2019) Small-Cell Lung (December 2020) MK-7684A (vibostolimab+pembrolizumab) Non-Small-Cell Lung (April 2021) MK-7902 Lenvima (1)(2) Colorectal (April 2021) Esophageal (July 2021) Gastric (December 2020) Head and Neck (February 2020) Melanoma (March 2019) Non-Small-Cell Lung (March 2019) HIV-1 Infection MK-8591A (doravirine+islatravir) (February 2020) (4) HIV-1 Prevention MK-8591 (islatravir) (February 2021) (4) Pulmonary Arterial Hypertension MK-7962 (sotatercept) (January 2021) Respiratory Syncytial Virus MK-1654 (clesrovimab) (November 2021) New Molecular Entities/Vaccines Antiviral COVID-19 MK-4482 (molnupiravir) (1) (EU) Cough MK-7264 (gefapixant) (U.S.) (6) (EU) Pneumococcal Vaccine Adult V114 (JPN) Certain Supplemental Filings Cancer MK-3475 Keytruda Adjuvant Treatment of Stage IIB or IIC Melanoma (KEYNOTE-716) (EU) Adjuvent Renal Cell Cancer (KEYNOTE-564) (JPN) MSI-H or dMMR Endometrial Cancer (KEYNOTE-158) (U.S.) MSI-H or dMMR Six Tumor Basket (KEYNOTE-158) (EU) High-Risk Early-Stage Triple-Negative Breast Cancer (KEYNOTE-522) (EU) (JPN) Tumor Mutational Burden-High (KEYNOTE-158) (JPN) Cervical Cancer (KEYNOTE-826) (EU) (JPN) MK-7339 Lynparza (1) BRCA -Mutated HER2-Negative Adjuvant Breast Cancer (OlympiA) (U.S.) (EU) First-Line Metastatic Prostate Cancer (PROpel) (EU) MK-7902 Lenvima (1)(2) First-Line Metastatic Hepatocellular Carcinoma (KEYNOTE-524) (U.S.) (7) Advanced Unresectable Renal Cell Carcinoma (KEYNOTE-581) (JPN) (8) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda . (3) Being developed as monotherapy and/or in combination with Keytruda. (4) On FDA clinical hold. (5) Available in the U.S. under Emergency Use Authorization. (6) In January 2022, the FDA issued a CRL. Merck is reviewing the CRL and considering next steps. (7) In July 2020, the FDA issued a CRL for Mercks and Eisais applications. Merck and Eisai intend to submit additional data when available to the FDA. (8) Approved on February 25, 2022. Table o f Contents Human Capital As of December 31, 2021, the Company had approximately 68,000 employees worldwide, with approximately 27,000 employed in the U.S., including Puerto Rico, and, additionally, approximately 14,000 third-party contractors globally. (1) Approximately 67,000 of the Companys employees are full-time employees. Women and individuals from underrepresented ethnic groups comprise approximately 50% and 32% of its workforce (the Company defines workforce as its employees) in the U.S., respectively. Women comprise 46% of the members of the Board of Directors. Additionally, the Companys executive team is made up of 33% women. Approximately 23% of the Companys employees are represented by various collective bargaining groups. The Companys voluntary turnover rate was approximately 8.8% and 6.0%, respectively, in 2021 and 2020. The Company recognizes that its employees are critical to meet the needs of its patients and customers and that its ability to excel depends on the integrity, skill, and diversity of its employees. (1) Third party contractors include the Companys temporary workers, independent contractors, and freelancers who are viewed as full-time equivalent employees. They exclude outsourced service providers. Talent Acquisition The Company uses a comprehensive approach to ensure recruiting, retention and leadership development goals are systematically executed throughout the Company and that it hires talented leaders to achieve improved gender parity and representation across all dimensions of diversity. The Company provides training to its managers and external recruiting organizations on strategies to mitigate unconscious bias in the candidate selection and hiring process. In addition, the Company utilizes a comprehensive communications strategy, employee branding and marketing outreach, social media and strategic alliance partnerships to reach a broad pool of talent in its critical business areas. In 2021, the Company hired approximately 8,700 employees across the globe through various channels including the Companys external career site, direct passive candidate sourcing, diversity partnerships, employee referrals, universities and other external sources. Global Diversity and Inclusion Diversity and inclusion are fundamental to the Companys success and core to future innovation. The Company fosters a globally diverse and inclusive workforce for its employees by creating an environment of belonging, engagement, equity, and empowerment. The Company is proactive and intentional about diversity hiring and development programs to advance talent. The Company creates competitive advantages by leveraging diversity and inclusion to accelerate business performance. This includes fostering global supplier diversity, integrating diversity and inclusion into the Companys commercialization strategies and leveraging employee insights to improve performance. In addition to these efforts, the Company has ten Employee Business Resource Groups that provide opportunities for employees to take an active part in contributing to the Companys inclusive culture through their work in talent acquisition and development, business and customer insights and social and community outreach. The Companys diversity goals include increasing representation in senior management roles (1) by 2024 of (i) women globally to 40%, up from 31% in 2020, (ii) Black/African Americans in the U.S. to 10%, up from 3% in 2020, and (iii) Hispanics/Latinos in the U.S. to 10%, up from 5% in 2020. At December 31, 2021, representation in senior management roles at the Company for (i) women globally was 36%, (ii) Black/African Americans in the U.S. was 7%, and (iii) Hispanics/Latinos in the U.S. was 6%. In addition, by 2025, the Company seeks to maintain or exceed both its current inclusion index score and its current employee engagement index score. (2) (1) Senior management role is defined as an individual holding either a Vice President or Senior Vice President title. (2) The Inclusion Index is the average favorability score for employees responses to three items in the employee pulse survey (manager supports inclusion, sense of belonging, leaders value perspective). The Employee Engagement Index is the average favorability score for employees responses to items in the employee survey. Table o f Contents Gender and Ethnicity Performance Data (1)(2) 2021 2020 2019 Women in the workforce 50% 50% 49% Women in the workforce in the U.S. 50% 50% 50% Women on the Board of Directors 46% 46% 33% Women in executive roles (3) 33% 33% 20% Women in management roles (4) 44% 42% 42% Members of underrepresented ethnic groups on the Board of Directors 23% 23% 17% Members of underrepresented ethnic groups in executive roles (U.S.) 42% 25% 40% Members of underrepresented ethnic groups in the workforce (U.S.) 32% 30% 29% Members of underrepresented ethnic groups in management roles (U.S.) 26% 25% 23% New hires that were female 53% 50% 51% New hires that were members of underrepresented ethnic groups (U.S.) 46% 40% 35% (1) As of 12/31. As self-identified to the Company. (2) Prior period data has not been restated to adjust for the Organon Spin-Off. (3) Executive role is defined as an individual holding an Executive Vice President title. (4) Management role is defined as all managers with direct reports other than executives as defined in note 3. Compensation and Benefits The Company provides a valuable total rewards package reflecting its commitment to attract, retain and motivate its talent, and support its employees and their families in every stage of life. The Company continuously monitors and adjusts its compensation and benefit programs to ensure they are competitive, contemporary, helpful and engaging, and that they support strategic imperatives such as diversity and inclusion, equity, flexibility, quality, security and affordability. For example, the Company added a personal health care concierge service to assist U.S. employees participating in the Company medical plan with their health care needs. Aligned with its business and in support of its cancer care strategy, the Company also improved cancer screening benefits, added resources and provided immediate access to a leading cancer center of excellence for U.S. employees. Globally, the Company implemented a minimum standard of 12 weeks of paid parental leave, which inclusively applies to all parents. In the U.S., the Companys benefits rank in the top quartile of Fortune 100 companies under the Aon 2021 Benefits Index. The Company has been included in Seramount (previously the Working Mother) 100 Best Companies ranking for 35 consecutive years and was named a Seramount top ten Best Company for Dads in 2021. Employee Wellbeing The Company is committed to helping its employees and their families improve their own health and wellbeing. The Companys culture of wellbeing is referred to as Live it , which includes programs to support preventive health, emotional and financial wellbeing, physical fitness and nutrition. It is designed to inspire all employees to pursue, enjoy, and share healthy lifestyles. Live it was launched in the U.S. in 2011 and today is available in every country in which the Company has employees. In addition, many of the Companys larger sites offer onsite health clinics that provide an array of services to help its employees stay or get well, including vaccinations, cancer and biometric screenings, travel medicine and advice, diagnosis and treatment of non-occupational illnesses or injuries, health counseling and referrals. The Companys overall employee wellbeing program was recognized for excellence in health and wellbeing by receiving the most recent highest-level awards from the Business Group on Health and the American Heart Association. COVID-19 Response The Company recognizes that it has a unique responsibility to help in response to the COVID-19 pandemic and is committed to supporting and protecting its employees and their families, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches and supporting its health care providers and the communities in which they serve. The Company continues to provide employees with easy and regular access to information, including details regarding the Companys tracking process, guidance around hygiene measures and travel and best practices for working from home. Examples of pandemic support resources and programs available to the Companys employees include pay continuation for workers who have been sick or exposed, volunteer policy adjustment to enable employees with Table o f Contents medical backgrounds to volunteer in SARS-CoV-2-related activities, resources to prioritize physical and mental wellness, adjustments to medical plans to cover 100% of a COVID-19-related diagnosis, testing and treatment, backup childcare and more. Engaging Employees The Company strives to foster employee engagement by promoting a safe, positive, diverse and inclusive work environment that provides numerous opportunities for two-way communication with employees. Some of the Companys key programs and initiatives include promoting global employee engagement surveys, ongoing pulse checks to the organization for interim feedback on specific topics, fostering professional networking and collaboration, identifying and providing opportunities for volunteering and establishing positive, cooperative business relations with designated employee representatives. Talent Management and Development As the Company pursues its goal of becoming the worlds premier research-based biopharmaceutical company, there is a consistent focus on the importance of continuously developing its diverse and talented people. The Companys current talent management system supports company-wide performance management, leadership development, talent reviews and succession planning. Annual performance reviews help further the professional development of the Companys employees and ensure that the Companys workforce is aligned with the Companys objectives. The Company seeks to continuously build the skills and capabilities of its workforce to accelerate talent, improve performance and mitigate risk through relevant continuous learning experiences. This includes, but is not limited to, building leadership and management skills, as well as providing technical and functional training to all employees. Environmental Matters Environmental Sustainability The Company strives to be a strong environmental steward, and realizes that its strategy and efforts need to continuously improve for the Company to excel in an increasingly resource-constrained world. The Companys environmental sustainability strategy has three areas of focus: Driving efficiency in operations; Designing new products to minimize environmental impact; and Reducing any impacts in the Companys upstream and downstream value chain. The Company has recently adopted a set of new climate goals to address the rising expectations of its customers, investors, external stakeholders and employees regarding the environmental impact of its operations and supply chain. These goals include achieving carbon neutrality for greenhouse gas emissions across operations (Scopes 1 and 2) by 2025, reducing Scope 1 and 2 greenhouse gas emissions 46% by 2030 (from a 2019 baseline), reducing value chain (Scope 3) greenhouse gas emissions by 30% by 2030 (from a 2019 baseline), and sourcing 100% renewable energy for purchased electricity by 2025. The Companys absolute greenhouse gas reduction targets have been verified by the Science Based Target initiative. Other environmental sustainability initiatives of the Company include: Global water use and stewardship. The Companys global water strategy aims to achieve sustainable water management within its operations and its supply chain, as well as address water-related risk. Access to clean water is critical for human health, and water is a key input to the Companys manufacturing operations. The Companys sites employ a variety of technologies and techniques, such as closed-loop cooling systems and reused reverse osmosis reject water, to reduce the Companys water footprint and improve operational performance. Waste management and diversion. The Company continuously strives to reduce the amount of operational waste it generates and to maximize the use of environmentally beneficial disposal methods such as recycling, composting and waste-to-energy. Product stewardship and green and sustainable science. The Companys product stewardship program focuses on identifying and either preventing or minimizing potential safety and environmental hazards throughout a products life cycle. The Company is also committed to Table o f Contents understanding, managing and reducing the environmental impacts of its products and the materials associated with discovering and producing them. The Companys green and sustainable science program uses a green-by-design approach. By using more efficient and innovative processing methods and technologies, the Company is reducing the amount of energy, water and raw materials the Company uses to make the Companys products, thereby reducing the amount of waste the Company generates and lowering the Companys production costs. Animal conservation. The Company is a leading worldwide supplier of individual identification, real-time data access and advanced analytics for the animal conservation community. This enables the Company to produce actionable insights that inform recovery actions on a global scale, for species ranging from wild fish to penguins. The Company also provides wild fish conservation monitoring equipment and real-time video monitoring technology to advance fish health and welfare. Together, these technologies help to promote biodiversity and support the global need for reliable and safe sources of protein. Management does not believe that expenditures related to these initiatives should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. In December 2021, the Company completed its inaugural issuance of a $1.0 billion sustainability bond, which was part of an $8.0 billion underwritten bond offering. The Company intends to use the net proceeds from the sustainability bond offering to support projects and partnerships in the Companys priority environmental, social and governance (ESG) areas and contribute to the advancement of the United Nations Sustainable Development Goals. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy usage, water use and greenhouse gas emissions. Environmental Regulation and Remediation The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $12 million in 2021 and are estimated to be $24 million in the aggregate for the years 2022 through 2026. These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $40 million and $43 million at December 31, 2021 and 2020, respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $40 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Geographic Area Information The Companys operations outside the U.S. are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the U.S. as a percentage of total Company sales were 54% in 2021 and were 53% in both 2020 and 2019. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Table o f Contents Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is sec.gov . In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at merck.com/company-overview/leadership and all such information is available in print to any shareholder who requests it from the Company. The Companys 2020/2021 Environmental, Social Governance (ESG) Progress Report, which provides enhanced ESG disclosures, is available on the Companys website at merck.com/company-overview/responsibility/ . Information in the Companys ESG Progress Report is not incorporated by reference into this Form 10-K. "," Item 1A. Risk Factors. Summary Risk Factors The Company is subject to a number of risks that if realized could materially adversely affect its business, results of operations, cash flow, financial condition or prospects. The following is a summary of the principal risk factors facing the Company: The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. The Company faces continued pricing pressure with respect to its products. Unfavorable or uncertain economic conditions, together with cost-reduction measures being taken by certain governments, could negatively affect the Companys operating results. The Company faces intense competition from lower cost generic products. The Company faces intense competition from competitors products. In 2021 and 2020, COVID-19-related disruptions had an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the Table o f Contents COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. Climate change or legal, regulatory or market measures to address climate change may negatively affect the Companys business, results of operations, cash flows and prospects. Environmental, social and governance (ESG) matters may impact the Companys business and reputation. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Company may experience difficulties and delays in manufacturing certain of its products, including vaccines. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. Pharmaceutical products can develop unexpected safety or efficacy concerns. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The health care industry in the U.S. has been, and will continue to be, subject to increasing regulation and political action. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. Developments following regulatory approval may adversely affect sales of the Companys products. The Company is subject to a variety of U.S. and international laws and regulations. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. Adverse outcomes in current or future legal matters could negatively affect Mercks business. Product liability insurance for products may be limited, cost prohibitive or unavailable. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. Social media and mobile messaging platforms present risks and challenges. The above list is not exhaustive, and the Company faces additional challenges and risks. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. Table o f Contents Risk Factors The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations, cash flow or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. Risks Related to the Companys Business The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the U.S. and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to successfully assert and defend the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company asserts and defends its patents both within and outside the U.S., including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by asserting its patent with a lawsuit alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the U.S. and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and Table o f Contents rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Januvia and Janumet will lose market exclusivity in the U.S. in January 2023. Januvia and Janumet will lose market exclusivity in the EU in September 2022 and in China in July 2022. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of exclusivity. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Lynparza, Bravecto , and Bridion . In particular, in 2021, the Companys oncology portfolio, led by Keytruda, represented a substantial portion of the Companys revenue growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and financial condition. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. In order to remain competitive, the Company, like other major pharmaceutical companies, must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs and vaccines. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short Table o f Contents term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the U.S., these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment. Changes to the health care system enacted as part of health care reform in the U.S., as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the U.S. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2021, the Companys gross U.S. sales were reduced by 43.5% as a result of rebates, discounts and returns. Outside the U.S., numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated annual price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. Table o f Contents The Company expects pricing pressures to continue in the future. Unfavorable or uncertain economic conditions, together with cost-reduction measures being taken by certain governments, could negatively affect the Companys operating results. The Companys business may be adversely affected by local and global economic conditions, including with respect to inflation, interest rates, and costs of raw materials and packaging. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. In addition, the COVID-19 pandemic has caused some disruption and volatility in the Companys global supply chain network, and the Company may experience disruptions in availability and delays in shipments of raw materials and packaging, as well as related cost inflation. Any such disruptions, delays or costs may result in the Companys inability to meet demand for the Companys products. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the U.S. or in the EU. In the U.S. and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the U.S. and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in Table o f Contents connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. In 2021 and 2020, COVID-19-related disruptions had an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Companys business and financial results were negatively impacted by COVID-19-related disruptions in 2021 and 2020. The continued duration and severity of the COVID-19 pandemic is uncertain, rapidly changing and difficult to predict. The degree to which COVID-19-related disruptions impact the Companys results in 2022 will depend on future developments, beyond the Companys knowledge or control, including, but not limited to, the duration of the pandemic, its severity, the success of actions taken to contain or prevent the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In 2021, the COVID-19 pandemic impacted the Companys business in numerous ways. As expected, within the Companys human health business, which is comprised largely of physician-administered products, revenue was negatively impacted by social distancing measures and fewer well visits, which negatively affected vaccine and oncology sales in particular. The estimated negative impact of COVID-19-related disruptions to Mercks revenue for the full year 2021 was approximately $1.3 billion, attributable to the Pharmaceutical segment. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, however, roughly 75% of Mercks Pharmaceutical segment revenue is comprised of physician-administered products which could be adversely affected by the pandemic if its effects worsen. Despite the Companys efforts to manage the impacts of the COVID-19 pandemic, their ultimate effect will also depend on factors beyond the Companys knowledge or control, including the duration of the COVID-19 pandemic as well as governmental and third-party actions taken to contain or prevent the spread and treatment of the virus and mitigate its public health and economic effects. In addition, any future pandemic, epidemic or similar public health threat could present similar risks to the Companys business, cash flow, results of operations, financial condition and prospects. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the U.S. is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the U.S. or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. In particular, in February 2022, armed conflict escalated between Russia and Ukraine. It is not possible to predict the broader consequences of this conflict, which could include sanctions, embargoes, regional instability, geopolitical shifts and adverse effects on macroeconomic conditions, currency exchange rates and financial markets. Table o f Contents Climate change or legal, regulatory or market measures to address climate change may negatively affect the Companys business, results of operations, cash flows and prospects. The Company believes that climate change has the potential to negatively affect its business and results of operations, cash flows and prospects. The Company is exposed to physical risks (such as extreme weather conditions or rising sea levels), risks in transitioning to a low-carbon economy (such as additional legal or regulatory requirements, changes in technology, market risk and reputational risk) and social and human effects (such as population dislocations and harm to health and well-being) associated with climate change. These risks can be either acute (short-term) or chronic (long-term). The adverse impacts of climate change include increased frequency and severity of natural disasters and extreme weather events such as hurricanes, tornados, wildfires (exacerbated by drought), flooding, and extreme heat. Extreme weather and sea-level rise pose physical risks to the Companys facilities as well as those of its suppliers. Such risks include losses incurred as a result of physical damage to facilities, loss or spoilage of inventory, and business interruption caused by such natural disasters and extreme weather events. Other potential physical impacts due to climate change include reduced access to high-quality water in certain regions and the loss of biodiversity, which could impact future product development. These risks could disrupt the Companys operations and its supply chain, which may result in increased costs. New legal or regulatory requirements may be enacted to prevent, mitigate, or adapt to the implications of a changing climate and its effects on the environment. These regulations, which may differ across jurisdictions, could result in the Company being subject to new or expanded carbon pricing or taxes, increased compliance costs, restrictions on greenhouse gas emissions, investment in new technologies, increased carbon disclosure and transparency, upgrade of facilities to meet new building codes, and the redesign of utility systems, which could increase the Companys operating costs, including the cost of electricity and energy used by the Company. The Companys supply chain would likely be subject to these same transitional risks and would likely pass along any increased costs to the Company. Environmental, social and governance (ESG) matters may impact the Companys business and reputation. Governmental authorities, non-governmental organizations, customers, investors, external stakeholders and employees are increasingly sensitive to ESG concerns, such as diversity and inclusion, climate change, water use, recyclability or recoverability of packaging, and plastic waste. This focus on ESG concerns may lead to new requirements that could result in increased costs associated with developing, manufacturing and distributing the Companys products. The Companys ability to compete could also be affected by changing customer preferences and requirements, such as growing demand for more environmentally friendly products, packaging or supplier practices, or by failure to meet such customer expectations or demand. While the Company strives to improve its ESG performance, the Company risks negative stockholder reaction, including from proxy advisory services, as well as damage to its brand and reputation, if the Company does not act responsibly, or if the Company is perceived to not be acting responsibly in key ESG areas, including equitable access to medicines and vaccines, product quality and safety, diversity and inclusion, environmental stewardship, support for local communities, corporate governance and transparency, and addressing human capital factors in the Companys operations. If the Company does not meet the ESG expectations of its investors, customers and other stakeholders, the Company could experience reduced demand for its products, loss of customers, and other negative impacts on the Companys business and results of operations. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry, both in the U.S. and internationally, is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. Table o f Contents The Company may experience difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. For example, in 2020 the Company issued a product recall for Zerbaxa following the identification of product sterility issues. The Company may, in the future, experience other difficulties and delays in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including supply chain delays, shortages in raw materials, changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the U.S. has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Competition and the Health Care Environment, pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing health care reform that has led to the acceleration of generic substitution, where available. While the mechanism for drugs being added to the NRDL evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2021, drugs were added to the NRDL with an average of more than 60% price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the last five rounds of VBP had, on average, a price reduction of more than 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, at the same time macro-economic growth of selected emerging markets is expected to outpace Europe and even the U.S., leading to significant increased health care spending in those countries and access to innovative medicines for patients. A failure to maintain the Companys presence in emerging markets could therefore have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Table o f Contents The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which will cause LIBOR to cease to exist entirely in the future. While the Company has begun to implement alternative reference rates as alternatives to LIBOR, the Company cannot predict the consequences and timing of any additional or unexpected developments, which could include an increase in interest expense and will also require the amendment of contracts that reference LIBOR. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology (IT) systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt the manufacture of its animal health products at such sites or force the Company to incur substantial expenses in procuring raw materials or products elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. In addition, sales of Bravecto represent a significant portion of the Companys Animal Health segment sales. Any negative event with respect to Bravecto could have a material adverse effect on the Companys Animal Health sales. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Table o f Contents Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the U.S. and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the U.S., a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial human vaccine lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Risks Relating to Government Regulation and Legal Proceedings The health care industry in the U.S. has been, and will continue to be, subject to increasing regulation and political action. As discussed above in Competition and the Health Care Environment, the Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. On December 21, 2020, the CMS issued a final rule making significant changes to these requirements. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons. PhRMA, a pharmaceutical industry trade group, of which the Company is a member, filed a complaint challenging this rule as invalid asserting that it conflicts with the plain language of the Medicaid drug rebate statute. Should this legal Table o f Contents challenge fail, the impact of this and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. In 2021, Congress passed the American Rescue Plan Act of 2021, which included a provision that eliminates the statutory cap on rebates drug manufacturers pay to Medicaid beginning in January 2024. These rebates act as a discount off the list price and eliminating the cap means that manufacturer discounts paid to Medicaid can increase. Prior to this change, manufacturers have not been required to pay more than 100% of the Average Manufacturer Price (AMP) in rebates to state Medicaid programs for Medicaid-covered drugs. As a result of this provision, beginning in 2024, it is possible that manufacturers may have to pay state Medicaid programs more in rebates than they received on sales of particular products. This change could present a risk to Merck in the future for drugs that have high Medicaid utilization and rebate exposure that is more than 100% of the AMP. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company cannot predict what additional future changes in the health care industry in general, or the pharmaceutical industry in particular, will occur; however, any changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the U.S., including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the U.S., the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In some cases, the FDA requirements have increased the amount of time and resources necessary to develop new products and bring them to market in the U.S. Regulation outside the U.S. also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in the EU, Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; scrutiny of advertising and promotion; and the withdrawal of indications granted pursuant to accelerated approvals. In the past, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of Table o f Contents marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional health care reform initiatives in the U.S. or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU, the U.S., and China; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to health care professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are routinely examined by various tax authorities. In connection with the 2015 Organization for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in other countries. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions, including, among others, any potential changes to the existing U.S. tax law by the current U.S. Presidential administration and Congress, as well as any changes in tax law resulting from the implementation of the OECDs two-pillar solution to reform the international tax landscape . The Company has taken the position, based on the opinions of tax counsel, that its distribution of Organon common stock in connection with the 2021 Spin-Off of Organon qualifies as a transaction that is tax-free for U.S. federal income tax purposes. If any facts, assumptions, representations, and undertakings from the Company and Organon regarding the past and future conduct of their respective businesses and other matters are Table o f Contents incorrect or not otherwise satisfied, the Spin-Off may not qualify for tax-free treatment, which could result in significant U.S. federal income tax liabilities for the Company and its shareholders. Adverse outcomes in current or future legal matters could negatively affect Mercks business. Current or future litigation, claims, proceedings and government investigations could preclude or delay the commercialization of Mercks products or could adversely affect Mercks business, results of operations, cash flow, prospects and financial condition. Such legal matters may include, but are not limited to: (i) intellectual property disputes; (ii) adverse decisions in litigation, including product safety and liability, consumer protection and commercial cases; (iii) anti-bribery regulations, such as the U.S. Foreign Corrupt Practices Act, including compliance with ongoing reporting obligations to the government resulting from any settlements; (iv) recalls or withdrawals of pharmaceutical products or forced closings of manufacturing plants; (v) product pricing and promotional matters; (vi) lawsuits, claims and administrative proceedings asserting, or investigations into, violations of securities, antitrust, Federal and state pricing, consumer protection, data privacy and other laws and regulations; (vii) environmental, health, safety and sustainability matters, including regulatory actions in response to climate change; and (viii) tax liabilities resulting from assessments from tax authorities. See Item 8. Financial Statements and Supplementary Data, Note 11, Contingencies and Environmental Liabilities for more information on the Companys legal matters. In 2021, Merck informed the U.S. Department of Health and Human Services, Health Resources and Services Administration (HHS) that Merck was implementing an update to its Section 340b program integrity initiative, pursuant to which Merck required all hospital covered entities to provide 340b claims data for all claims originating from contract pharmacies. For those entities that declined to submit such claims data, Mercks new initiative provided that it would no longer voluntarily honor 340b discounts or chargebacks for contract pharmacy transactions, except for a single contract pharmacy of the hospital covered entitys choice. Also in 2021, HHS sent letters to numerous drug manufacturers stating that it had determined that those manufacturers actions restricting contract pharmacy transactions were in violation of the 340b statute and further stating that if those manufacturers did not cease their restrictions, HHS might seek both repayment of overcharges as well as civil monetary penalties. Those manufacturers are now in litigation with the U.S. government seeking to confirm the legality of the restrictions. Merck did not receive a similar letter from HHS. However, HHS could seek to implement administrative proceedings to recover overcharges and/or impose civil monetary penalties against Merck. If such proceedings were implemented against Merck a negative outcome could have a material adverse effect on Mercks business, results of operations, cash flow, prospects and financial condition. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Risks Related to Technology The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications, complex information technology systems, computing infrastructure, and cloud service providers (collectively, IT systems) to conduct Table o f Contents critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes, including data acquisition; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. Social media and mobile messaging platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media and mobile messaging channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there are internal Company Social Media and Mobile Messaging Policies that guide employees on appropriate personal and professional use of these platforms for communication about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as new communication tools expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs, environmental or other sustainability initiatives, and include Table o f Contents statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the U.S. and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. The impact of the global COVID-19 pandemic and any future pandemic, epidemic, or similar public health threat, on the Companys business, operations and financial performance. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the U.S., the EU, and China. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the U.S. requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Table o f Contents Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is currently located in Kenilworth, New Jersey. The Company has previously announced that it intends to consolidate its New Jersey campuses into a single corporate headquarters location in Rahway, New Jersey by the end of 2023. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey; Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey; West Point, Pennsylvania; Boston and Cambridge, Massachusetts; South San Francisco, California; and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the U.S. are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at seven locations in the U.S. and Puerto Rico. Outside the U.S., through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. A number of properties were transferred to Organon in the Spin-Off. Capital expenditures were $4.4 billion in 2021, $4.4 billion in 2020 and $3.4 billion in 2019. In the U.S., these amounted to $2.8 billion in 2021, $2.6 billion in 2020 and $1.9 billion in 2019. Abroad, such expenditures amounted to $1.6 billion in 2021, $1.8 billion in 2020, and $1.5 billion in 2019. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2022, there were approximately 99,932 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2021 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 246,194 $74.92 246,194 $5,047 November 1 November 30 $5,047 December 1 December 31 $5,047 Total 246,194 $74.92 246,194 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. Table o f Contents Performance Graph The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2021/2016 CAGR* MERCK $159 10% PEER GROUP** 201 15% SP 500 233 18% 2016 2017 2018 2019 2020 2021 MERCK 100.0 98.5 137.9 168.6 156.5 159.3 PEER GROUP 100.0 120.0 128.4 152.6 163.6 200.6 SP 500 100.0 121.8 116.5 153.1 181.3 233.3 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis as of December 31, 2016. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. Table o f Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify and has been treated as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off (see Note 3 to the consolidated financial statements). Table o f Contents Overview Financial Highlights ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Sales $ 48,704 17 % 16 % $ 41,518 6 % 8 % $ 39,121 Net Income from Continuing Operations Attributable to Merck Co., Inc.: GAAP $ 12,345 * * $ 4,519 (21) % (16) % $ 5,690 Non-GAAP (1) $ 15,282 33 % 31 % $ 11,506 20 % 23 % $ 9,617 Earnings per Common Share Assuming Dilution from Continuing Operations Attributable to Merck Co., Inc. Common Shareholders: GAAP $ 4.86 * * $ 1.78 (19) % (15) % $ 2.21 Non-GAAP (1) $ 6.02 33 % 32 % $ 4.53 21 % 25 % $ 3.73 * Calculation not meaningful. (1) Non-GAAP net income and non-GAAP earnings per share (EPS) exclude acquisition and divestiture-related costs, restructuring costs and certain other items. For further discussion and a reconciliation of GAAP to non-GAAP net income and EPS (see Non-GAAP Income and Non-GAAP EPS below) . Executive Summary During 2021, Merck delivered on its strategic priorities by executing commercially to drive strong revenue and earnings growth in the year, completing key business development transactions, accelerating its broad pipeline, and achieving notable regulatory milestones. Also, on June 2, 2021, Merck completed the spin-off of Organon. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off. Worldwide sales were $48.7 billion in 2021, an increase of 17% compared with 2020, or 16% excluding the favorable effect of foreign exchange. The sales increase was driven primarily by growth in oncology, vaccines, hospital acute care and animal health. Additionally, revenue in 2021 reflects the benefit of sales of molnupiravir, an investigational oral antiviral COVID-19 treatment. As discussed below, COVID-19-related disruptions negatively affected sales in 2021, but to a lesser extent than in 2020, which benefited year-over-year sales growth. Merck continues to execute scientifically compelling business development opportunities to augment its pipeline. In November 2021, Merck acquired Acceleron Pharma Inc. (Acceleron), a publicly traded biopharmaceutical company evaluating the transforming growth factor (TGF)-beta superfamily of proteins through the development of pulmonary and hematologic therapies. In April 2021, Merck acquired Pandion Therapeutics, Inc. (Pandion), a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases. Additionally, Merck entered into a collaboration with Gilead Sciences, Inc. (Gilead) to jointly develop and commercialize long-acting treatments in HIV. In 2021, Merck received over 30 approvals and filed over 20 New Drug Applications (NDAs) and supplemental Biologics License Applications (BLAs) across the U.S., the EU, Japan and China. During 2021, the Company received numerous regulatory approvals within oncology. Keytruda received approval for additional indications in the U.S. and/or internationally as monotherapy in the therapeutic areas of breast, colorectal, cutaneous squamous cell, esophageal, melanoma and renal cell cancers, as well as in combination with chemotherapy in the therapeutic areas of breast, cervical, gastric or gastroesophageal junction cancers. Keytruda was also approved in combination with Lenvima both for the treatment of certain adult patients with endometrial cancer and for the treatment of renal cell cancer. Lenvima is being developed in collaboration with Eisai Co., Ltd. (Eisai). Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received approval in China as monotherapy for the treatment of certain adult patients with metastatic castration resistant prostate cancer. Additionally, the U.S. Food and Drug Administration (FDA) approved Welireg (belzutifan), an oral hypoxia-inducible factor-2 alpha (HIF-2) inhibitor, for the treatment of adult patients with von Hippel-Lindau (VHL) Table o f Contents disease who require therapy for associated renal cell carcinoma (RCC), central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. Also in 2021, as updated in February 2022, the FDA granted Emergency Use Authorization (EUA) for molnupiravir, an investigational oral antiviral COVID-19 treatment being developed in a collaboration with Ridgeback Biotherapuetics LP (Ridgeback). Molnupiravir also received conditional marketing authorization in the United Kingdom (UK) and Special Approval for Emergency in Japan. Also in 2021, the FDA and the European Commission (EC) approved Vaxneuvance (Pneumococcal 15-valent Conjugate Vaccine), a pneumococcal conjugate vaccine for use in adults. Additionally, Verquvo, a medicine to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults was approved in the U.S., the EU and Japan. Verquvo is being jointly developed with Bayer AG (Bayer). In January 2022, the Japan Ministry of Health, Labor and Welfare (MHLW) approved Lyfnua (gefapixant) for adults with refractory or unexplained chronic cough. In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline with several regulatory submissions. Keytruda is under review in the U.S. and/or internationally for supplemental indications for the treatment of certain patients with triple negative breast, cervical, endometrial, melanoma, renal cell and tumor mutation burden-high (TMBH) cancers. Lynparza is under review for supplemental indications for the treatment of certain patients with breast and prostate cancers. Lenvima is under review in combination with Keytruda for a supplemental indication for the treatment of certain patients with hepatocellular carcinoma (HCC). MK-4482, molnupiravir, is under a rolling review by the European Medicines Agency (EMA); MK-7264, gefapixant, a selective, non-narcotic, orally-administered, investigational P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough is under review in the U.S. and the EU; and Vaxneuvance (V114), a 15-valent pneumococcal conjugate vaccine, is under priority review by the FDA for the prevention of invasive pneumococcal disease in pediatric patients. V114 is also under review in Japan for use in adults. The Companys Phase 3 oncology programs include: Keytruda in the therapeutic areas of biliary, cutaneous squamous cell, gastric, hepatocellular, mesothelioma, ovarian, prostate and small-cell lung cancers; Lynparza as monotherapy for colorectal cancer and in combination with Keytruda for non-small-cell lung and small-cell lung cancers; Lenvima in combination with Keytruda for colorectal, esophageal, gastric, head and neck, melanoma and non-small-cell lung cancers; Welireg for RCC; MK-1308A, the coformulation of quavonlimab, Mercks novel investigational anti-CTLA-4 antibody, and pembrolizumab for RCC; MK-3475, pembrolizumab subcutaneous for non-small-cell lung cancer (NSCLC); MK-7119, Tukysa (tucatinib), which is being developed in collaboration with Seagen Inc. (Seagen), for breast cancer; MK-4280A, the coformulation of favezelimab, Mercks novel investigational anti-LAG3 therapy, and pembrolizumab for colorectal cancer; and MK-7684A, the coformulation of vibostolimab, an anti-TIGIT therapy, and pembrolizumab for NSCLC. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas including: MK-7962, sotatercept, for the treatment of pulmonary arterial hypertension (PAH), which was obtained in the Acceleron acquisition; MK-1654, clesrovimab, for the prevention of respiratory syncytial virus; MK-8591, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) for the prevention of HIV-1 infection (which is on clinical hold); Table o f Contents MK-8591A, islatravir in combination with doravirine for the treatment of HIV-1 infection (which is on clinical hold); and MK-4482, molnupiravir, which is reflected in Phase 3 development in the U.S. as it remains investigational following EUA. The Company is allocating resources to support its commercial opportunities in the near term while investing heavily in research to support future innovations and long-term growth. Research and development expenses in 2021 reflect higher clinical development spending and increased investment in discovery research and early drug development. In November 2021, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.69 per share from $0.65 per share on the Companys outstanding common stock. During 2021, the Company returned $7.5 billion to shareholders through dividends and share repurchases. In December 2021, the Company completed its inaugural issuance of a $1.0 billion sustainability bond, which was part of an $8.0 billion underwritten bond offering. The Company intends to use the net proceeds from the sustainability bond offering to support projects and partnerships in the Companys priority environmental, social and governance (ESG) areas and contribute to the advancement of the United Nations Sustainable Development Goals. COVID-19 Update During the COVID-19 pandemic Merck has remained focused on protecting the safety of its employees, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of an antiviral therapy, supporting efforts to expand manufacturing capacity and supply of SARS-CoV-2/COVID-19 medicines and vaccines (see below), and supporting health care providers and Mercks communities. Although COVID-19-related disruptions negatively affected results in 2021 and 2020, Merck continues to experience strong global underlying demand across its business. In 2021, Mercks sales were unfavorably affected by COVID-19-related disruptions, which resulted in an estimated negative impact to Mercks Pharmaceutical segment sales of approximately $1.3 billion. Roughly 75% of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures and fewer well visits. Mercks sales were favorably affected by the authorization of molnupiravir in several markets as discussed further below, which resulted in sales of $952 million in 2021. In 2020, the estimated negative impact of COVID-19-related disruptions to Mercks sales was approximately $2.1 billion, of which approximately $2.0 billion was attributable to the Pharmaceutical segment and approximately $50 million was attributable to the Animal Health segment. In April 2021, Merck announced it was discontinuing the development of MK-7110 (formerly known as CD24Fc) for the treatment of hospitalized patients with COVID-19, which was obtained as part of Mercks acquisition of OncoImmune (see Note 4 to the consolidated financial statements). This decision resulted in charges of $207 million to Cost of sales in 2021. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $305 million in 2020, of which $260 million was reflected in Cost of sales and the remaining $45 million of costs were reflected in Research and development expenses. Operating expenses reflect a minor positive effect in 2021 as investments in COVID-19-related research largely offset the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Operating expenses were positively affected in 2020 by approximately $500 million primarily due to lower promotional and selling costs, as well as lower research and development expenses, net of investments in COVID-19-related antiviral and vaccine research programs. In addition, the COVID-19 pandemic has caused some disruption and volatility in the Companys global supply chain network, and the Company may in the future experience disruptions in availability and delays in shipments of raw materials and packaging, as well as related cost inflation. In December 2021, the FDA granted EUA for molnupiravir based on positive results from the Phase 3 MOVe-OUT clinical trial. Additionally, in December 2021, Japans MHLW granted Special Approval for Table o f Contents Emergency for molnupiravir. In November 2021, the UK Medicines and Healthcare products Regulatory Agency granted conditional marketing authorization for molnupiravir. In addition, in October 2021, the EMA initiated a rolling review for molnupiravir. Merck plans to work with the Committee for Medicinal Products for Human Use of the EMA to complete the rolling review process to facilitate initiating the formal review of the Marketing Authorization Application. Merck is developing molnupiravir in collaboration with Ridgeback. The companies are actively working with other regulatory agencies worldwide to submit applications for emergency use or marketing authorization. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets. See Note 5 to the consolidated financial statements for additional information related to the collaboration with Ridgeback. In March 2021, Merck announced it had entered into multiple agreements to support efforts to expand manufacturing capacity and supply of SARS-CoV-2/COVID-19 medicines and vaccines. The Biomedical Advanced Research and Development Authority (BARDA), a division of the Office of the Assistant Secretary for Preparedness and Response within the U.S. Department of Health and Human Services, is providing Merck with funding to adapt and make available a number of existing manufacturing facilities for the production of SARS-CoV-2/COVID-19 vaccines and medicines. Merck has also entered into agreements to support the manufacturing and supply of Johnson Johnsons SARS-CoV-2/COVID-19 vaccine. Merck is using certain of its facilities in the U.S. to produce drug substance, formulate and fill vials of Johnson Johnsons vaccine. Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform enacted in prior years, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2021 was negatively affected by other cost-reduction measures taken by governments and other third parties to lower health care costs. In the U.S., the Biden Administration and Congress continue to discuss legislation designed to control health care costs, including the cost of drugs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 United States $ 22,425 14 % 14 % $ 19,588 6 % 6 % $ 18,420 International 26,279 20 % 17 % 21,930 6 % 9 % 20,701 Total $ 48,704 17 % 16 % $ 41,518 6 % 8 % $ 39,121 Worldwide sales grew 17% in 2021 primarily due to higher sales in the oncology franchise largely driven by strong growth of Keytruda and increased alliance revenue from Lynparza and Lenvima, as well as higher sales in the vaccines franchise, primarily attributable to growth in Gardasil/Gardasil 9, Varivax and ProQuad . Also contributing to revenue growth in 2021 were higher sales in the virology franchise attributable to molnupiravir, higher sales in the hospital acute care franchise, reflecting growth in Bridion and Prevymis , as well as higher sales of animal health products. Additionally, sales in 2021 benefited from higher third-party manufacturing sales and the achievement of milestones for an out-licensed product that triggered contingent payments to Merck. As discussed above, COVID-19-related disruptions unfavorably affected sales in 2021, but to a lesser extent than in 2020, which benefited year-over-year sales growth. Sales growth in 2021 was partially offset by lower sales of Pneumovax 23, the suspension of sales in 2020 of hospital acute care product Zerbaxa , and lower sales of virology products Isentress/Isentress HD . Sales in the U.S. grew 14% in 2021 primarily driven by higher sales of Keytruda , sales of molnupiravir, higher sales of Bridion , Gardasil 9 , Varivax and ProQuad , increased alliance revenue from Lynparza and Lenvima, Table o f Contents as well as higher sales of animal health products. Lower sales of Pneumovax 23, Januvia/Janumet and Zerbaxa partially offset revenue growth in the U.S. in 2021. International sales increased 20% in 2021 primarily due to growth in Gardasil/Gardasil 9, Keytruda , sales of molnupiravir, increased alliance revenue from Lynparza and Lenvima, as well as higher sales of Januvia/Janumet , Bridion , Prevymis and animal health products. International sales growth in 2021 was partially offset by lower sales of Noxafil , Zerbaxa and Isentress/Isentress HD . International sales represented 54% and 53% of total sales in 2021 and 2020, respectively. Worldwide sales increased 6% in 2020 primarily due to higher sales in the oncology franchise, as well as growth in certain hospital acute care products and animal health. Growth in these areas was largely offset by the negative effects of the COVID-19 pandemic as discussed above, competitive pressure in the virology franchise and pricing pressure in the diabetes franchise. See Note 19 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Keytruda $ 17,186 20 % 18 % $ 14,380 30 % 30 % $ 11,084 Alliance Revenue - Lynparza (1) 989 36 % 35 % 725 63 % 62 % 444 Alliance Revenue - Lenvima (1) 704 21 % 20 % 580 44 % 43 % 404 Emend 127 (13) % (15) % 145 (63) % (62) % 388 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Keytruda is an anti-PD-1 (programmed death receptor-1) therapy that has been approved as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal or gastroesophageal junction (GEJ) carcinoma, head and neck squamous cell carcinoma (HNSCC), HCC, NSCLC, melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer (solid tumors) including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma, TMB-H cancer (solid tumors), and urothelial carcinoma including non-muscle invasive bladder cancer. Additionally, Keytruda is approved as monotherapy for the adjuvant treatment of certain patients with RCC. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and nonsquamous NSCLC, in combination with chemotherapy, with or without bevacizumab for cervical cancer, in combination with chemotherapy for esophageal cancer, in combination with chemotherapy for gastric cancer, in combination with chemotherapy for HNSCC, in combination with chemotherapy for triple-negative-breast cancer (TNBC), in combination with axitinib for advanced RCC, and in combination with Lenvima for both endometrial carcinoma and RCC. The Keytruda clinical development program includes studies across a broad range of cancer types. Global sales of Keytruda grew 20% in 2021 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally, although the COVID-19 pandemic had a dampening effect on growing demand by negatively affecting the number of new patients starting treatment. Sales in the U.S. continue to build across the multiple approved indications, in particular for the treatment of advanced NSCLC as monotherapy, and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with continued uptake in the TNBC, RCC, HNSCC, MSI-H cancer, and esophageal cancer indications. Keytruda sales growth in international markets reflects continued uptake predominately for the NSCLC, HNSCC and RCC indications, particularly in Europe. Sales growth in 2021 was partially offset by lower pricing in Europe, China and Japan. Global sales of Keytruda grew 30% in 2020 driven by higher demand globally, particularly in the U.S. and Europe, although the COVID-19 pandemic had an unfavorable effect on growing demand. Sales growth in 2020 was partially offset by lower pricing in Japan and Europe. Table o f Contents Keytruda received numerous regulatory approvals in 2021 summarized below. Date Approval January 2021 EC approval as a first-line treatment in adult patients with MSI-H or dMMR colorectal cancer based on the KEYNOTE-177 study. March 2021 EC approval of an expanded label as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed autologous stem cell transplant (ASCT) or following at least two prior therapies when ASCT is not a treatment option based on the KEYNOTE-204 and KEYNOTE-087 trials. March 2021 FDA approval in combination with platinum- and fluoropyrimidine-based chemotherapy for the treatment of certain patients with locally advanced or metastatic esophageal or GEJ carcinoma that is not amenable to surgical resection or definitive chemoradiation based on the KEYNOTE-590 trial. May 2021 FDA approval in combination with trastuzumab, fluoropyrimidine- and platinum-containing chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic human epidermal growth factor receptor 2 (HER2)-positive gastric or GEJ adenocarcinoma based on the KEYNOTE-811 trial. May 2021 EC approval of the 400 mg every six weeks (Q6W) dosing regimen to indications where Keytruda is administered in combination with other anticancer agents. June 2021 Chinas National Medical Products Administration (NMPA) approval as a first-line treatment of adult patients with MSI-H or dMMR colorectal cancer that is KRAS, NRAS and BRAF all wild-type based on the KEYNOTE-177 study. June 2021 EC approval in combination with chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus or HER2-negative GEJ adenocarcinoma in adults whose tumors express PD-L1 based on the KEYNOTE-590 trial. July 2021 FDA approval as monotherapy for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation based on the KEYNOTE-629 trial. July 2021 FDA approval of Keytruda plus Lenvima for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR who have disease progression following prior systemic therapy in any setting and are not candidates for curative surgery or radiation based on the KEYNOTE-775/Study 309 trial. July 2021 FDA approval of Keytruda for treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant treatment and then continued as single agent as adjuvant treatment after surgery based on the KEYNOTE-522 trial. August 2021 FDA approval of Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC based on the KEYNOTE-581 trial/Study 307 trial. August 2021 Japans Pharmaceuticals and Medical Devices Agency (PMDA) approval for the treatment of patients with unresectable, advanced or recurrent MSI-H colorectal cancer based on the KEYNOTE-177 trial. August 2021 Japans PMDA approval for the treatment of patients with PD-L1-positive, hormone receptor-negative and HER2-negative, inoperable or recurrent breast cancer based on the KEYNOTE-355 trial. September 2021 Chinas NMPA approval in combination with chemotherapy for the first-line treatment of patients with locally advanced, unresectable or metastatic carcinoma of the esophagus or GEJ based on the KEYNOTE-590 trial. October 2021 FDA approval in combination with chemotherapy, with or without bevacizumab, for the treatment of patients with persistent, recurrent or metastatic cervical cancer based on the KEYNOTE-826 trial. October 2021 EC approval in combination with chemotherapy for the first-line treatment of locally recurrent unresectable or metastatic TNBC in adults whose tumors express PD-L1 and who have not received prior chemotherapy for metastatic disease based on the KEYNOTE-355 trial. November 2021 FDA approval for the adjuvant treatment of patients with RCC at intermediate-high or high risk of recurrence following nephrectomy, or following nephrectomy and resection of metastatic lesions based on the KEYNOTE-564 trial. Table o f Contents November 2021 EC approval of Keytruda plus Lenvima for the first-line treatment of adult patients with advanced RCC based on the CLEAR (Study 307)/KEYNOTE-581 trial. November 2021 EC approval of Keytruda plus Lenvima for the treatment of advanced or recurrent endometrial carcinoma in adults who have disease progression on or following prior treatment with a platinumcontaining therapy in any setting and who are not candidates for curative surgery or radiation based on the KEYNOTE-775/Study 309 trial. November 2021 Japans PMDA approval in combination with chemotherapy (5-fluorouracil plus cisplatin) for the first-line treatment of patients with radically unresectable, advanced or recurrent esophageal carcinoma in combination with chemotherapy based on the KEYNOTE-590 trial. December 2021 FDA approval for the adjuvant treatment of adult and pediatric (12 years and older) patients with stage IIB or IIC melanoma following complete resection based on the KEYNOTE-716 trial; FDA expanded the indication for the adjuvant treatment of stage III melanoma following complete resection to include pediatric patients (12 years and older). December 2021 Japans MHLW approval of Keytruda in combination with Lenvima for the treatment of patients with unresectable, advanced or recurrent endometrial carcinoma that progressed after cancer chemotherapy based on the KEYNOTE-775/Study 309 trial. In March 2021, Merck announced it was voluntarily withdrawing the U.S. indication for Keytruda for the treatment of patients with metastatic small-cell lung cancer with disease progression on or after platinum-based chemotherapy and at least one other prior line of therapy. The withdrawal of this indication was done in consultation with the FDA and does not affect other indications for Keytruda . As announced in January 2020, KEYNOTE-604, the confirmatory Phase 3 trial for this indication, met one of its dual primary endpoints of progression-free survival but did not reach statistical significance for the other primary endpoint of overall survival. In 2022, Merck initiated the withdrawal of the U.S. accelerated approval indication for Keytruda for the treatment of patients with recurrent locally advanced or metastatic gastric or GEJ adenocarcinoma whose tumors express PD-L1, with disease progression on or after two or more prior lines of therapy. The decision was made in consultation with the FDA following the Oncologic Drugs Advisory Committee evaluation of this third-line gastric cancer indication for Keytruda as a monotherapy because it failed to meet its post-marketing requirement of demonstrating an overall survival benefit in a Phase 3 study. The withdrawal of this indication does not affect other indications for Keytruda . The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the U.S. in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca (see Note 5 to the consolidated financial statements). Lynparza is approved for the treatment of certain types of advanced ovarian, breast, pancreatic and prostate cancers. Alliance revenue related to Lynparza grew 36% in 2021 and 63% in 2020 due to continued uptake across the multiple approved indications in the U.S., Europe, Japan and China. In June 2021, Lynparza was granted conditional approval in China as monotherapy for the treatment of certain previously treated adult patients with germline or somatic BRCA -mutated metastatic castration-resistant prostate cancer based on the results of the PROfound trial. Lenvima is an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai (see Note 5 to the consolidated financial statements). Lenvima is approved for the treatment of certain types of thyroid cancer, HCC, in combination with everolimus for certain patients with RCC, and in combination with Keytruda both for the treatment of certain patients with endometrial carcinoma and for the treatment of certain patients with RCC. Alliance revenue related to Lenvima grew 21% in 2021 and 44% in 2020 primarily due to higher demand in the U.S. and China. Global sales of Emend (aprepitant), for the prevention of certain chemotherapy-induced nausea and vomiting, declined 13% in 2021 reflecting lower volumes in Europe and China. Worldwide sales of Emend Table o f Contents decreased 63% in 2020 primarily due to lower demand and pricing in the U.S. due to generic competition for Emend for Injection following U.S. patent expiry in September 2019. Also contributing to the Emend sales decline in 2020 was lower demand in Europe and Japan as a result of generic competition for the oral formulation of Emend following loss of market exclusivity in May 2019 and December 2019, respectively. In June 2021, Koselugo (selumetinib) was granted conditional approval in the EU for the treatment of pediatric patients three years of age and older with neurofibromatosis type 1 who have symptomatic, inoperable plexiform neurofibromas based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Stratum 1 trial. Koselugo was approved by the FDA in April 2020. Koselugo is part of the same collaboration with AstraZeneca referenced above that includes Lynparza. In August 2021, the FDA approved Welireg , an oral HIF-2 inhibitor, for the treatment of adult patients with VHL disease who require therapy for associated RCC, central nervous system hemangioblastomas, or pancreatic neuroendocrine tumors, not requiring immediate surgery. The approval was based on results from the open-label Study 004 trial. Welireg was obtained as part of Mercks 2019 acquisition of Peloton Therapeutics, Inc. (Peloton). See Note 4 to the consolidated financial statements. Vaccines ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Gardasil/Gardasil 9 $ 5,673 44 % 39 % $ 3,938 5 % 6 % $ 3,737 ProQuad 773 14 % 13 % 678 (10) % (10) % 756 M-M-R II 391 3 % 3 % 378 (31) % (31) % 549 Varivax 971 18 % 18 % 823 (15) % (15) % 970 Pneumovax 23 893 (18) % (19) % 1,087 17 % 18 % 926 Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of human papillomavirus (HPV), grew 44% in 2021 driven primarily by strong global demand, particularly in China, as well as increased supply. Higher pricing in China and the U.S. also contributed to sales growth in 2021. Sales growth in 2021 was unfavorably affected by the replenishment in 2020 of doses borrowed from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile, which favorably affected sales by $120 million in 2020. The timing of public sector purchases in the U.S. also partially offset sales growth in 2021. Global sales of Gardasil/Gardasil 9 grew 5% in 2020 primarily due to higher volumes in China and the replenishment in 2020 of doses borrowed from the CDC Pediatric Vaccine Stockpile in 2019. The replenishment resulted in the recognition of sales of $120 million in 2020, which, when combined with the reduction of sales of $120 million in 2019 due to the borrowing, resulted in a favorable impact to sales of $240 million in 2020 compared with 2019. Lower demand in the U.S. and Hong Kong, SAR, PRC attributable to the COVID-19 pandemic partially offset the increase in sales of Gardasil/Gardasil 9 in 2020. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (royalty obligations under this agreement expire in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the U.S. to another third party (these royalty obligations expire in December 2028). The royalties are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, grew 14% in 2021 due to higher sales in the U.S. reflecting higher demand driven by the ongoing COVID-19 pandemic recovery, as well as higher pricing. Worldwide sales of ProQuad declined 10% in 2020 driven primarily by lower demand in the U.S. resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic, partially offset by higher pricing. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, grew 3% in 2021 primarily due to higher sales in the U.S. reflecting the ongoing COVID-19 pandemic recovery inclusive of higher public sector mix of business. Lower demand in Europe partially offset MMR II sales growth in 2021. Global sales of M-M-R II declined 31% in 2020 driven primarily by lower demand in the U.S. resulting from fewer Table o f Contents measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic. Lower demand in Brazil also contributed to the M-M-R II sales decline in 2020. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), grew 18% in 2021 primarily reflecting the ongoing COVID-19 pandemic recovery and higher pricing in the U.S. Higher government tenders in Brazil also contributed to Varivax sales growth in 2021. Worldwide sales of Varivax declined 15% in 2020 driven primarily by lower demand in the U.S. resulting from the COVID-19 pandemic, partially offset by higher pricing. The Varivax sales decline in 2020 was also attributable to lower government tenders in Brazil. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, declined 18% in 2021 primarily due to lower sales in the U.S. attributable to lower demand reflecting prioritization of COVID-19 vaccination, partially offset by higher pricing. Global sales of Pneumovax 23 grew 17% in 2020 primarily due to higher volumes in Europe and the U.S. attributable in part to heightened awareness of pneumococcal vaccination. Higher pricing in the U.S. also contributed to Pneumovax 23 sales growth in 2020. In July 2021, the FDA approved Vaxneuvance for active immunization for the prevention of invasive disease caused by 15 Streptococcus pneumoniae serotypes in adults 18 years of age and older. In December 2021, Vaxneuvance was approved by the EC. These approvals were based on data from seven clinical studies assessing safety, tolerability, and immunogenicity in adults. In October 2021, the CDCs Advisory Committee on Immunization Practices (ACIP) voted to recommend vaccination either with a sequential regimen of Vaxneuvance followed by Pneumovax 23, or with a single dose of 20-valent pneumococcal conjugate vaccine both for adults 65 years and older and for adults ages 19 to 64 with certain underlying medical conditions. These recommendations subsequently were adopted by the director of the CDC and the U.S. Department of Health and Human Services and published in the CDCs Morbidity and Mortality Weekly Report . In September 2021, Merck announced a settlement and license agreement with Pfizer Inc. (Pfizer), resolving all worldwide patent infringement litigation related to the use of Mercks investigational and licensed pneumococcal conjugate vaccine (PCV) products, including Vaxneuvance . Under the terms of the agreement, Merck will make certain regulatory milestone payments to Pfizer, as well as royalty payments on the worldwide sales of its PCV products. The Company will pay royalties of 7.25% of net sales of all Merck PCV products through 2026; and 2.5% of net sales of all Merck PCV products from 2027 through 2035. Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis, Inactivated Poliovirus, Haemophilus b Conjugate and Hepatitis B Vaccine), developed as part of a U.S.-based partnership between Merck and Sanofi Pasteur, is now available in the U.S. for active immunization of children six weeks through four years of age to help prevent diphtheria, tetanus, pertussis, poliomyelitis, hepatitis B, and invasive disease due to Haemophilus influenzae type b. In February 2021, the CDCs ACIP included Vaxelis as a combination vaccine option in the CDCs Recommended Child and Adolescent Immunization Schedule. Sales of Vaxelis in the U.S. are made through the U.S.-based Merck/Sanofi Pasteur partnership, the results of which are reflected in equity income from affiliates included in Other (income) expense, net. Supply sales to the partnership are recorded within Sales . Vaxelis is also approved in the EU where it is marketed directly by Merck and Sanofi Pasteur. Hospital Acute Care ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Bridion $ 1,532 28 % 27 % $ 1,198 6 % 7 % $ 1,131 Prevymis 370 32 % 30 % 281 70 % 69 % 165 Noxafil 259 (21) % (23) % 329 (50) % (50) % 662 Zerbaxa (1) * * 130 8 % 10 % 121 * Calculation not meaningful. Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 28% in 2021 due to higher demand globally, particularly in the U.S. and Europe, attributable to the COVID-19 pandemic recovery, as well as increased usage of neuromuscular blockade reversal agents and Bridion s growing share within the class. Bridion was also approved by the FDA in June 2021 for pediatric patients aged 2 years and older undergoing surgery. Worldwide sales of Bridion grew 6% in 2020 due to higher demand globally, Table o f Contents particularly in the U.S. However, fewer elective surgeries as a result of the COVID-19 pandemic unfavorably affected demand in 2020. Worldwide sales of Prevymis , a medicine for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients of an allogenic hematopoietic stem cell transplant, grew 32% in 2021 and increased 70% in 2020 due to continued uptake since launch in several markets, particularly in Europe and the U.S. Worldwide sales of Noxafil , an antifungal agent for the prevention of certain invasive fungal infections, declined 21% in 2021 primarily due to generic competition in Europe, partially offset by higher demand in China. The patent that provided market exclusivity for Noxafil in a number of major European markets expired in December 2019. As a result, the Company is experiencing lower demand for Noxafil in these markets due to generic competition and expects the decline to continue. Global sales of Noxafil declined 50% in 2020 due to generic competition in the U.S. and in Europe. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. In December 2020, the Company temporarily suspended sales of Zerbaxa , a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections, and subsequently issued a product recall, following the identification of product sterility issues. As a result, the Company recorded an intangible asset impairment charge in 2020 related to Zerbaxa (see Note 9 to the consolidated financial statements). A phased resupply of Zerbaxa was initiated in the fourth quarter of 2021, which the Company expects to continue during 2022. Immunology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Simponi $ 825 (2) % (6) % $ 838 1 % 1 % $ 830 Remicade 299 (9) % (12) % 330 (20) % (20) % 411 Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 2% in 2021 and were nearly flat in 2020. Sales of Simponi are being unfavorably affected by biosimilar competition for competing products. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade , a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 9% in 2021 and decreased 20% in 2020 driven by ongoing biosimilar competition in the Companys marketing territories in Europe. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. on October 1, 2024. Virology ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Molnupiravir $ 952 $ $ Isentress/Isentress HD 769 (10) % (11) % 857 (12) % (11) % 975 Zepatier 128 (23) % (25) % 167 (55) % (54) % 370 Molnupiravir is an investigational oral antiviral COVID-19 medicine being developed in a collaboration with Ridgeback (see Note 5 to the consolidated financial statements). The FDA granted an EUA for molnupiravir in December 2021; as updated in February 2022, to authorize molnupiravir for the treatment of mild to moderate COVID-19 in high-risk adults for whom alternative FDA-approved or authorized treatment options are not Table o f Contents accessible or clinically appropriate. Also in December 2021, Japans MHLW granted Special Approval for Emergency for molnupiravir to treat infectious disease caused by SARS-CoV-2. In November 2021, the UKs MHRA granted conditional marketing authorization for molnupiravir to treat mild to moderate COVID-19 in adults at risk of developing severe illness. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets and Merck began shipping molnupiravir in the fourth quarter of 2021 to countries where it is approved or authorized. Sales of molnupiravir were $952 million in 2021 primarily consisting of sales in the U.S., the UK and Japan. Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 10% in 2021 and decreased 12% in 2020 primarily due to competitive pressure particularly in Europe and the U.S. The Company expects competitive pressure for Isentress/Isentress HD to continue. Global sales of Zepatier , a treatment for adult patients with chronic hepatitis C virus genotype (GT) 1 or GT4 infection, declined 23% in 2021 primarily due to lower demand from competitive pressure in the U.S. and Europe. Worldwide sales of Zepatier declined 55% in 2020 driven by lower demand globally due to competition and declining patient volumes, coupled with the impact of the COVID-19 pandemic. Cardiovascular ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Alliance revenue - Adempas/Verquvo (1) $ 342 22 % 22 % $ 281 38 % 38 % $ 204 Adempas 252 14 % 11 % 220 3 % 2 % 215 (1) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 5 to the consolidated financial statements). Adempas and Verquvo are part of a worldwide collaboration with Bayer to market and develop soluble guanylate cyclase (sGC) modulators (see Note 5 to the consolidated financial statements). Adempas is approved for the treatment of certain types of PAH. Verquvo was approved in the U.S. in January 2021 to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults with symptomatic chronic heart failure and reduced ejection fraction. Verquvo was also approved in Japan in June 2021 and in the EU in July 2021. These approvals were based on the results of the VICTORIA trial. Alliance revenue from the collaboration grew 22% in 2021 and rose 38% in 2020. Revenue from the collaboration also includes sales of Adempas and Verquvo in Mercks marketing territories. Sales of Adempas in Mercks marketing territories grew 14% in 2021 primarily reflecting higher demand in Europe. Diabetes ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Januvia/Janumet $ 5,288 % (2) % $ 5,276 (4) % (4) % $ 5,524 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were nearly flat in 2021 and declined 4% in 2020. Sales performance in both periods reflects continued pricing pressure and lower demand in the U.S., largely offset by higher demand in certain international markets, particularly in China. The Company expects U.S. pricing pressure to continue. Januvia and Janumet will lose market exclusivity in the U.S. in January 2023, in the EU in September 2022, and in China in July 2022. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of exclusivity. Combined sales of Januvia and Janumet in the U.S., Europe and China represented 33%, 24% and 9%, respectively, of total combined Januvia and Janumet sales in 2021. Table o f Contents Animal Health Segment ($ in millions) 2021 % Change % Change Excluding Foreign Exchange 2020 % Change % Change Excluding Foreign Exchange 2019 Livestock $ 3,295 12 % 10 % $ 2,939 6 % 9 % $ 2,784 Companion Animal 2,273 29 % 26 % 1,764 10 % 11 % 1,609 Sales of livestock products grew 12% in 2021 primarily due to higher demand for ruminant products, including animal health intelligence solutions for animal identification, monitoring and traceability, as well as higher demand for poultry and swine products. Sales of livestock products increased 6% in 2020 predominantly due to an additional five months of sales in 2020 related to the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 4 to the consolidated financial statements). Sales of companion animal products grew 29% in 2021 and rose 10% in 2020 primarily due to higher demand for parasiticides, including the Bravecto line of products, as well as higher demand for companion animal vaccines. Costs, Expenses and Other ($ in millions) 2021 % Change 2020 % Change 2019 Cost of sales $ 13,626 % $ 13,618 13 % $ 12,016 Selling, general and administrative 9,634 8 % 8,955 (5) % 9,455 Research and development 12,245 (9) % 13,397 38 % 9,724 Restructuring costs 661 15 % 575 (8) % 626 Other (income) expense, net (1,341) 51 % (890) * 129 $ 34,825 (2) % $ 35,655 12 % $ 31,950 * Calculation not meaningful. Cost of Sales Cost of sales was $13.6 billion in both 2021 and 2020 and was $12.0 billion in 2019. Cost of sales includes the amortization of intangible assets recorded in connection with acquisitions, collaborations, and licensing arrangements, which totaled $1.6 billion in 2021, $1.8 billion in 2020 and $1.7 billion in 2019. Costs in 2021 and 2020 also include charges of $225 million and $260 million, respectively, related to the discontinuation of COVID-19 development programs (see Note 4 to the consolidated financial statements). Additionally, costs in 2020 and 2019 include intangible asset impairment charges of $1.6 billion and $705 million related to marketed products and other intangibles (see Note 9 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business combinations and such charges could be material. Costs in 2020 also include inventory write-offs of $120 million related to a recall for Zerbaxa (see Note 9 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities, which amounted to $160 million in 2021, $175 million in 2020 and $251 million in 2019, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 72.0% in 2021 compared with 67.2% in 2020. The gross margin improvement in 2021 reflects lower impairments and amortization of intangible assets (noted above), as well as the favorable effects of product mix and lower inventory write-offs. Partially offsetting the gross margin improvement in 2021 were higher manufacturing costs, the impact of molnupiravir (which has a lower gross margin due to profit sharing with Ridgeback as discussed in Note 5 to the consolidated financial statements), and higher compensation and benefit costs. Gross margin was 67.2% in 2020 compared with 69.3% in 2019. The gross margin decline in 2020 reflects the unfavorable effects of higher impairments and amortization of intangible assets, pricing pressure, a charge related to the discontinuation of COVID-19 vaccine development programs, and higher inventory write-offs related to the recall of Zerbaxa (noted above), partially offset by the favorable effects of product mix and lower restructuring costs. Table o f Contents Selling, General and Administrative Selling, general and administrative (SGA) expenses were $9.6 billion in 2021, an increase of 8% compared with 2020. The increase was primarily due to higher administrative costs, including compensation and benefits, higher promotional expenses in support of the Companys key growth pillars, and higher acquisition-related costs, including costs related to the acquisition of Acceleron. The COVID-19 pandemic drove lower spending in 2020 which contributed to the increase in SGA expenses in 2021. These increases were partially offset by the favorable effects of foreign exchange and a contribution in 2020 to the Merck Foundation. SGA expenses were $9.0 billion in 2020, a decline of 5% compared with 2019. The decline was driven primarily by lower administrative, selling and promotional costs, including lower travel and meeting expenses, due in part to the COVID-19 pandemic, and the favorable effect of foreign exchange, partially offset by a contribution to the Merck Foundation. Research and Development Research and development (RD) expenses were $12.2 billion in 2021, a decline of 9% compared with 2020 primarily due to lower upfront payments related to acquisitions and collaborations. The decline was partially offset by higher clinical development spending and increased investment in discovery research and early drug development, net of the reimbursement of a portion of molnupiravir development costs through the partnership with Ridgeback. Higher compensation and benefit costs, higher in-process research and development (IPRD) impairment charges, as well as costs related to the acquisition of Acceleron also partially offset the decline in RD expenses in 2021. RD expenses were $13.4 billion in 2020, an increase of 38% compared with 2019. The increase was driven largely by higher upfront payments related to acquisitions and collaborations, higher clinical development spending and increased investment in discovery research and early drug development. Higher restructuring costs also contributed to the increase in RD expenses in 2020. The increase in RD expenses in 2020 was partially offset by lower IPRD impairment charges and lower costs resulting from the COVID-19 pandemic, net of spending on COVID-19-related vaccine and antiviral research programs. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $7.1 billion in 2021, $6.5 billion in 2020 and $6.0 billion in 2019. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $3.0 billion in 2021, $2.6 billion in 2020 and $2.6 billion in 2019. Additionally, RD expenses in 2021 include a $1.7 billion charge for the acquisition of Pandion. RD expenses in 2020 include a $2.7 billion charge for the acquisition of VelosBio Inc., a $462 million charge for the acquisition of OncoImmune and charges of $826 million related to transactions with Seagen. RD expenses in 2019 include a $993 million charge for the acquisition of Peloton. See Note 4 to the consolidated financial statements for more information on these transactions. RD expenses also include IPRD impairment charges of $275 million, $90 million and $172 million in 2021, 2020 and 2019, respectively (see Note 9 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business combinations and such charges could be material. In addition, RD expenses in 2021 and 2020 include $28 million and $83 million, respectively, of costs associated with restructuring activities, primarily relating to accelerated depreciation. RD expenses also include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business combinations. The Company recorded $35 million of expenses in 2021 compared with a net reduction in expenses of $95 million and $39 million in 2020 and 2019, respectively, related to changes in these estimates. Restructuring Costs In 2019, Merck approved a global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization and builds on prior restructuring programs. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program estimated to be approximately $3.5 billion. The Company expects to record charges of Table o f Contents approximately $400 million in 2022 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program will result in annual net cost savings of approximately $900 million by the end of 2023. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $661 million in 2021, $575 million in 2020 and $626 million in 2019. Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative expenses and Research and development costs. The Company recorded aggregate pretax costs of $868 million in 2021, $880 million in 2020 and $915 million in 2019 related to restructuring program activities (see Note 6 to the consolidated financial statements). Other (Income) Expense, Net Other (income) expense, net, was $1.3 billion of income in 2021 compared with $890 million of income in 2020 primarily due to higher income from investments in equity securities, net, largely related to higher realized and unrealized gains on certain investments including the disposition in 2021 of the Companys ownership interest in Preventice Solutions Inc. (Preventice) as a result of the acquisition of Preventice by Boston Scientific, partially offset by higher foreign exchange losses and pension settlement costs. Other (income) and expense, net, was $890 million of income in 2020 compared with $129 million of expense in 2019, primarily due to higher income from investments in equity securities, net, largely related to Moderna, Inc. For details on the components of Other (income) expense, net, see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) 2021 2020 2019 Pharmaceutical segment profits $ 30,977 $ 26,106 $ 23,448 Animal Health segment profits 1,950 1,669 1,612 Other non-reportable segment profits 1 (7) Other (19,048) (21,913) (17,882) Income from Continuing Operations Before Taxes $ 13,879 $ 5,863 $ 7,171 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, RD expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including the amortization of intangible assets and amortization of purchase accounting adjustments, intangible asset impairment charges, and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Beginning in 2021, the amortization of intangible assets previously included as part of the calculation of Table o f Contents segment profits is now included in unallocated non-segment corporate expenses. Prior period Pharmaceutical and Animal Health segment profits have been recast to reflect this change on a comparable basis. Pharmaceutical segment profits grew 19% in 2021 primarily due to higher sales and the favorable effect of foreign exchange, partially offset by higher administrative and promotional costs. Pharmaceutical segment profits increased 11% in 2020 driven primarily by higher sales, as well as lower selling and promotional costs. Animal Health segment profits grew 17% in 2021 reflecting higher sales, partially offset by higher promotional, selling and administrative costs. Animal Health segment profits increased 4% in 2020 driven primarily by higher sales and lower promotional and selling costs, partially offset by higher RD costs and the unfavorable effect of foreign exchange. Taxes on Income The effective income tax rates from continuing operations were 11.0% in 2021, 22.9% in 2020 and 21.8% in 2019. The full year effective income tax rate reflects a favorable mix of income and expense, as well as higher foreign tax credits from ordinary business operations that the Company was able to credit in 2021. The effective income tax rate from continuing operations in 2021 also reflects the beneficial impact of the settlement of a foreign tax matter, as well as a net tax benefit of $207 million related to the settlement of certain federal income tax matters (see Note 16 to the consolidated financial statements). The effective income tax rate from continuing operations in 2021 also reflects the unfavorable effect of a charge for the acquisition of Pandion for which no tax benefit was recognized. The effective income tax rate in 2020 reflects the unfavorable impact of a charge for the acquisition of VelosBio for which no tax benefit was recognized. The effective income tax rate in 2019 reflects the favorable impact of a $106 million net tax benefit related to the settlement of certain federal income tax matters (see Note 16 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impact of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 16 to the consolidated financial statements). Net Income (Loss) Attributable to Noncontrolling Interests Net income (loss) attributable to noncontrolling interests was $13 million in 2021, $4 million in 2020 and $(84) million in 2019. The loss in 2019 was driven primarily by the portion of goodwill impairment charges related to certain businesses in the Healthcare Services segment that were attributable to noncontrolling interests. Non-GAAP Income and Non-GAAP EPS from Continuing Operations Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs, income and losses from investments in equity securities and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the U.S. (GAAP). Table o f Contents A reconciliation between GAAP financial measures and non-GAAP financial measures (from continuing operations) is as follows: ($ in millions except per share amounts) 2021 2020 2019 Income from continuing operations before taxes as reported under GAAP $ 13,879 $ 5,863 $ 7,171 Increase (decrease) for excluded items: Acquisition and divestiture-related costs (1) 2,484 3,642 2,970 Restructuring costs 868 880 915 Income from investments in equity securities, net (1,884) (1,292) (132) Other items: Charge for the acquisition of Pandion 1,704 Charges for the discontinuation of COVID-19 development programs 225 305 Charge for the acquisition of VelosBio (43) 2,660 Charges for the formation of collaborations (2) 1,076 Charge for the acquisition of OncoImmune 462 Charge for the acquisition of Peloton 993 Other (4) (20) 55 Non-GAAP income from continuing operations before taxes 17,229 13,576 11,972 Taxes on income as reported under GAAP 1,521 1,340 1,565 Estimated tax benefit on excluded items (3) 206 793 710 Net tax benefit from the settlement of certain federal income tax matters 207 106 Adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition (67) Tax benefit from the reversal of tax reserves related to the divestiture of MCC 86 Net tax charge related to the finalization of treasury regulations related to the enactment of the TCJA (117) Non-GAAP taxes on income from continuing operations 1,934 2,066 2,350 Non-GAAP net income from continuing operations 15,295 11,510 9,622 Less: Net income (loss) attributable to noncontrolling interests as reported under GAAP 13 4 (84) Acquisition and divestiture-related costs attributable to noncontrolling interests (89) Non-GAAP net income from continuing operations attributable to noncontrolling interests 13 4 5 Non-GAAP net income attributable to Merck Co., Inc. $ 15,282 $ 11,506 $ 9,617 EPS assuming dilution from continuing operations as reported under GAAP $ 4.86 $ 1.78 $ 2.21 EPS difference 1.16 2.75 1.52 Non-GAAP EPS assuming dilution from continuing operations $ 6.02 $ 4.53 $ 3.73 (1) Amount in 2020 includes a $1.6 billion intangible asset impairment charge related to Zerbaxa . Amount in 2019 includes a $612 million intangible asset impairment charge related to Sivextro . See Note 9 to the consolidated financial statements. (2) Includes $826 million related to transactions with Seagen. See Note 4 to the consolidated financial statements. (3) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges, and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with acquisitions and divestitures. Non-GAAP income and non-GAAP EPS also exclude amortization of intangible assets related to collaborations and licensing arrangements. Table o f Contents Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 6 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Income and Losses from Investments in Equity Securities Non-GAAP income and non-GAAP EPS exclude realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS are charges for the acquisitions of Pandion, VelosBio, OncoImmune and Peloton, as well as charges related to collaborations, including transactions with Seagen (see Note 4 to the consolidated financial statements). Also excluded from non-GAAP income and non-GAAP EPS are charges related to the discontinuation of COVID-19 development programs (see Note 4 to the consolidated financial statements). Additionally, excluded from non-GAAP income and non-GAAP EPS are certain tax items, including net tax benefits related to the settlement of certain federal income tax matters, an adjustment to tax benefits recorded in conjunction with the 2015 acquisition of Cubist Pharmaceuticals, Inc., a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC, and a net tax charge related to the finalization of U.S. treasury regulations related to the TCJA (see Note 16 to the consolidated financial statements). Research and Development Research Pipeline The Company currently has several candidates under regulatory review in the U.S. and internationally, as well as in late-stage clinical development. A chart reflecting the Companys current research pipeline as of February 22, 2022 and related discussion is set forth in Item 1. Business Research and Development above. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are summarized below; additional details are included in Note 4 to the consolidated financial statements. Merck actively monitors the landscape for growth opportunities that meet the Companys strategic criteria. In March 2021, Merck and Gilead entered into an agreement to jointly develop and commercialize long-acting treatments in HIV that combine Mercks investigational NRTTI, islatravir, and Gileads investigational capsid inhibitor, lenacapavir. The collaboration will initially focus on long-acting oral formulations and long-acting injectable formulations of these combination products, with other formulations potentially added to the collaboration as mutually agreed. There was no upfront payment made by either party upon entering into the agreement. In April 2021, Merck acquired Pandion, a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases, for total consideration of $1.9 billion. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. In November 2021, Merck acquired Acceleron, a publicly traded biopharmaceutical company, for total consideration of $11.5 billion. Acceleron is evaluating the TGF-beta superfamily of proteins that is known to play a central role in the regulation of cell growth, differentiation and repair. Accelerons lead therapeutic candidate, Table o f Contents sotatercept (MK-7962), has a novel mechanism of action with the potential to improve short-term and/or long-term clinical outcomes in patients with PAH. Sotatercept is in Phase 3 trials as an add-on to current standard of care for the treatment of PAH. In addition to sotatercept, Accelerons portfolio includes Reblozyl (luspatercept), a first-in-class erythroid maturation recombinant fusion protein that is approved in the U.S., Europe, Canada and Australia for the treatment of anemia in certain rare blood disorders and is being evaluated in clinical trials for additional indications for hematology therapies. Reblozyl is being developed and commercialized through a global collaboration with Bristol Myers Squibb. Acquired In-Process Research and Development In connection with business combinations, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2021, the balance of IPRD was $9.3 billion (see Note 9 to the consolidated financial statements). The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if the IPRD programs require additional clinical trial data than previously anticipated, or if the programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges, which could be material. In 2021, 2020, and 2019 the Company recorded IPRD impairment charges within Research and development expenses of $275 million, $90 million and $172 million, respectively (see Note 9 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Capital Expenditures Capital expenditures were $4.4 billion in 2021, $4.4 billion in 2020 and $3.4 billion in 2019. Expenditures in the U.S. were $2.8 billion in 2021, $2.6 billion in 2020 and $1.9 billion in 2019. The Company plans to invest approximately $20 billion in capital projects from 2021-2025 including expanding manufacturing capacity for oncology, vaccine and animal health products. Depreciation expense was $1.6 billion in 2021, $1.7 billion in 2020 and $1.6 billion in 2019, of which $1.1 billion in 2021, $1.2 billion in 2020 and $1.2 billion in 2019, related to locations in the U.S. Total depreciation expense in 2021, 2020 and 2019 included accelerated depreciation of $91 million, $268 million and $233 million, respectively, associated with restructuring activities (see Note 6 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) 2021 2020 2019 Working capital $ 6,394 $ 437 $ 5,263 Total debt to total liabilities and equity 31.3 % 34.7 % 31.2 % Cash provided by operating activities of continuing operations to total debt 0.4:1 0.2:1 0.3:1 Table o f Contents The increase in working capital in 2021 compared with 2020 is primarily related to decreased short-term debt. Cash provided by operating activities of continuing operations was $13.1 billion in 2021 compared with $7.6 billion in 2020 and $8.9 billion in 2019. The higher cash provided by operating activities of continuing operations in 2021 reflects stronger operating performance. Cash provided by operating activities of continuing operations includes upfront and milestone payments related to collaborations of $435 million in 2021, $2.9 billion in 2020 and $805 million in 2019. Cash provided by operating activities of continuing operations continues to be the Companys source of funds to finance operating needs, with excess cash serving as the primary source of funds to finance capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities of continuing operations was $16.4 billion in 2021 compared with $9.2 billion in 2020. The higher use of cash in investing activities of continuing operations was primarily due to higher cash used for acquisitions, including for the acquisition of Acceleron, and lower proceeds from sales of securities and other investments, partially offset by the 2020 purchase of Seagen common stock. Cash used in investing activities of continuing operations was $9.2 billion in 2020 compared with $2.5 billion in 2019. The increase was driven primarily by lower proceeds from the sales of securities and other investments, higher use of cash for acquisitions, higher capital expenditures and the purchase of Seagen common stock, partially offset by lower purchases of securities and other investments. Cash provided by financing activities of continuing operations was $3.1 billion in 2021 compared with a use of cash in financing activities of continuing operations of $2.8 billion in 2020. The change was primarily driven by the cash distribution received from Organon in connection with the spin-off (see Note 3 to the consolidated financial statements), higher proceeds from the issuance of debt (see below) and lower purchases of treasury stock, partially offset by a net decrease in short-term borrowings in 2021 compared with a net increase in short-term borrowings in 2020, higher payments on debt (see below) and higher dividends paid to shareholders. Cash used in financing activities of continuing operations was $2.8 billion in 2020 compared with $8.9 billion in 2019. The lower use of cash in financing activities of continuing operations was driven primarily by a net increase in short-term borrowings in 2020 compared with a net decrease in short-term borrowing in 2019, as well as lower purchases of treasury stock, partially offset by higher payments on debt (see below), lower proceeds from the issuance of debt (see below), higher dividends paid to shareholders and lower proceeds from the exercise of stock options. In December 2021, the Company issued $8.0 billion principal amount of senior unsecured notes consisting of $1.5 billion of 1.70% notes due 2027, $1.0 billion of 1.90% notes due 2028, $2.0 billion of 2.15% notes due 2031, $2.0 billion of 2.75% notes due 2051 and $1.5 billion of 2.90% notes due 2061. Merck used the net proceeds from the offering of the 2027 notes, the 2031 notes, the 2051 notes and the 2061 notes for general corporate purposes, including the repayment of outstanding commercial paper borrowings (including commercial paper borrowings in connection with Mercks acquisition of Acceleron), and other indebtedness. Merck allocated an amount equal to the net proceeds of the offering of the notes due in 2028 to finance or refinance, in whole or in part, projects and partnerships in the Companys priority ESG areas. In June 2020, the Company issued $4.5 billion principal amount of senior unsecured notes consisting of $1.0 billion of 0.75% notes due 2026, $1.25 billion of 1.45% notes due 2030, $1.0 billion of 2.35% notes due 2040 and $1.25 billion of 2.45% notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings and other indebtedness. In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings. In February 2022, the Companys $1.25 billion, 2.35% notes matured in accordance with their terms and were repaid. In 2021, the Companys $1.15 billion, 3.875% notes and the Companys 1.0 billion, 1.125% notes matured in accordance with their terms and were repaid. In 2020, the Companys $1.25 billion, 1.85% notes and $700 million floating-rate notes matured in accordance with their terms and were repaid. Table o f Contents The Company has a $6.0 billion credit facility that matures in June 2026. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. The Company expects foreseeable liquidity and capital resource requirements to be met through existing cash and cash equivalents and anticipated cash flows from operations, as well as commercial paper borrowings and long-term borrowings if needed. Merck believes that its sources of financing will be adequate to meet its future requirements. The Companys material cash requirements arising in the normal course of business primarily include: Debt Obligations and Interest Payments See Note 10 to the consolidated financial statements for further detail of the Companys debt obligations and the timing of expected future principal and interest payments. Tax Liabilities In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA. Additionally, the Company has liabilities for unrecognized tax benefits, including interest and penalties. See Note 16 to the consolidated financial statements for further information pertaining to the transition tax and liabilities for unrecognized tax benefits. Operating Leases See Note 10 to consolidated financial statements for further details of the Companys lease obligations and the timing of expected future lease payments. Contingent Milestone Payments The Company has accrued liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca, Eisai, and Bayer where payment has been deemed probable, but remains subject to the achievement of the related sales milestone. See Note 5 to the consolidated financial statements for additional information related to these sales-based milestones. Purchase Obligations Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Purchase obligations also include future inventory purchases the Company has committed to in connection with certain divestitures. As of December 31, 2021, the Company had total purchase obligations of $5.3 billion, of which $1.6 billion is estimated to be payable in 2022. In March 2021, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company believes it maintains a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2021, Mercks Board of Directors increased the quarterly dividend, declaring a quarterly dividend of $0.69 per share on the Companys outstanding common stock that was paid in January 2022. In January 2022, the Board of Directors declared a quarterly dividend of $0.69 per share on the Companys common stock for the second quarter of 2022 payable in April 2022. In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. In May 2021, Merck restarted its share repurchase program, which the Company had temporarily suspended in March 2020. The Company spent $840 million to purchase 11 million shares of its common stock for its treasury during 2021 under this program. As of December 31, 2021, the Companys remaining share repurchase Table o f Contents authorization was $5.0 billion. The Company purchased $1.3 billion and $4.8 billion of its common stock during 2020 and 2019, respectively, under authorized share repurchase programs. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other Comprehensive Income (Loss) ( OCI) , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated Other Comprehensive Loss ( AOCL) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $648 million and $593 million at December 31, 2021 and 2020, respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro, Japanese yen, British pound, Canadian dollar and Swiss franc. For exposures in developing country currencies, including the Chinese renminbi, the Company will enter into forward contracts to offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the Table o f Contents hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2021 and 2020, Income from Continuing Operations Before Taxes would have declined by approximately $125 million and $99 million in 2021 and 2020, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCL until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2021, the Company was a party to nine pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) 2021 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 2.40% notes due 2022 $ 1,000 4 $ 1,000 2.35% notes due 2022 (1) 1,250 5 1,250 (1) These interest rate swaps matured in February 2022. Table o f Contents The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. See Note 2 to the consolidated financial statements for a discussion of the pending discontinuation of LIBOR as part of reference rate reform. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2021 and 2020 would have positively affected the net aggregate market value of these instruments by $3.2 billion and $2.6 billion, respectively. A one percentage point decrease at December 31, 2021 and 2020 would have negatively affected the net aggregate market value by $3.9 billion and $3.1 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Estimates The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. The fair values of intangible assets are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) Table o f Contents over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent and any related patent term extension, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each IPRD project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business combinations involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of Table o f Contents ownership transfer to the customer and the Company is entitled to payment. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the U.S., sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, if collection of accounts receivable is expected to be in excess of one year, sales are recorded net of time value of money discounts, which have not been material. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2021, 2020 or 2019. Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) 2021 2020 Balance January 1 $ 2,776 $ 2,078 Current provision 12,412 11,423 Adjustments to prior years (110) (24) Payments (12,234) (10,701) Balance December 31 $ 2,844 $ 2,776 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $207 million and $2.6 billion, respectively, at December 31, 2021 and were $208 million and $2.6 billion, respectively, at December 31, 2020. Outside of the U.S., variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 Table o f Contents months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic or other competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 0.9% in 2021, 0.5% in 2020 and 1.0% in 2019. Outside of the U.S., returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the U.S., payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2021 and 2020 were $256 million and $279 million, respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense Table o f Contents reserves as of December 31, 2021 and 2020 of approximately $230 million and $235 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $12 million in 2021 and are estimated to be $24 million in the aggregate for the years 2022 through 2026. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $40 million and $43 million at December 31, 2021 and 2020, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $40 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense from continuing operations was $479 million in 2021, $441 million in 2020 and $388 million in 2019. At December 31, 2021, there was $699 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted-average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $748 million in 2021, $450 million in 2020 and $134 million in 2019. Net periodic benefit credit for other postretirement benefit plans was $83 million in 2021, $59 million in 2020 and $49 million in 2019. Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations Table o f Contents and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are attributable to settlement charges incurred by certain plans, as well as changes in the discount rate. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 2.60% to 3.10% at December 31, 2021, compared with a range of 2.10% to 2.80% at December 31, 2020. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2022, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will be 6.70%, compared to a range of 6.50% to 6.70% in 2021. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $85 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2021. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $58 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2021. Required funding obligations for 2022 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which primarily reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCL . Expected returns for pension plans are based on a calculated market-related value of assets. Net loss amounts in AOCL in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Table o f Contents Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax Table o f Contents position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs, environmental or other sustainability initiatives, and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Table o f Contents ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2021 and 2020, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2021, the notes to consolidated financial statements, and the report dated February 25, 2022 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) 2021 2020 2019 Sales $ 48,704 $ 41,518 $ 39,121 Costs, Expenses and Other Cost of sales 13,626 13,618 12,016 Selling, general and administrative 9,634 8,955 9,455 Research and development 12,245 13,397 9,724 Restructuring costs 661 575 626 Other (income) expense, net ( 1,341 ) ( 890 ) 129 34,825 35,655 31,950 Income from Continuing Operations Before Taxes 13,879 5,863 7,171 Taxes on Income from Continuing Operations 1,521 1,340 1,565 Net Income from Continuing Operations 12,358 4,523 5,606 Less: Net Income (Loss) Attributable to Noncontrolling Interests 13 4 ( 84 ) Net Income from Continuing Operations Attributable to Merck Co., Inc. 12,345 4,519 5,690 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 704 2,548 4,153 Net Income Attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 4.88 $ 1.79 $ 2.22 Income from Discontinued Operations 0.28 1.01 1.62 Net Income $ 5.16 $ 2.79 $ 3.84 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 4.86 $ 1.78 $ 2.21 Income from Discontinued Operations 0.28 1.00 1.61 Net Income $ 5.14 $ 2.78 $ 3.81 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2021 2020 2019 Net Income Attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Other Comprehensive Income (Loss) Net of Taxes: Net unrealized gain (loss) on derivatives, net of reclassifications 410 ( 297 ) ( 135 ) Net unrealized (loss) gain on investments, net of reclassifications ( 18 ) 96 Benefit plan net gain (loss) and prior service credit (cost), net of amortization 1,769 ( 279 ) ( 705 ) Cumulative translation adjustment ( 423 ) 153 96 1,756 ( 441 ) ( 648 ) Comprehensive Income Attributable to Merck Co., Inc. $ 14,805 $ 6,626 $ 9,195 The accompanying notes are an integral part of these consolidated financial statements. Table o f Contents Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) 2021 2020 Assets Current Assets Cash and cash equivalents $ 8,096 $ 8,050 Accounts receivable (net of allowance for doubtful accounts of $ 62 in 2021 and $ 67 in 2020) 9,230 6,803 Inventories (excludes inventories of $ 2,194 in 2021 and $ 2,070 in 2020 classified in Other assets - see Note 8) 5,953 5,554 Other current assets 6,987 4,674 Current assets of discontinued operations 2,683 Total current assets 30,266 27,764 Investments 370 785 Property, Plant and Equipment (at cost) Land 326 336 Buildings 12,529 11,998 Machinery, equipment and office furnishings 16,303 15,860 Construction in progress 8,313 6,968 37,471 35,162 Less: accumulated depreciation 18,192 18,162 19,279 17,000 Goodwill 21,264 18,882 Other Intangibles, Net 22,933 14,101 Other Assets 11,582 9,881 Noncurrent Assets of Discontinued Operations 3,175 $ 105,694 $ 91,588 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 2,412 $ 6,431 Trade accounts payable 4,609 4,327 Accrued and other current liabilities 13,859 12,212 Income taxes payable 1,224 1,597 Dividends payable 1,768 1,674 Current liabilities of discontinued operations 1,086 Total current liabilities 23,872 27,327 Long-Term Debt 30,690 25,360 Deferred Income Taxes 3,441 1,005 Other Noncurrent Liabilities 9,434 12,306 Noncurrent Liabilities of Discontinued Operations 186 Merck Co., Inc. Stockholders Equity Common stock, $ 0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2021 and 2020 1,788 1,788 Other paid-in capital 44,238 39,588 Retained earnings 53,696 47,362 Accumulated other comprehensive loss ( 4,429 ) ( 6,634 ) 95,293 82,104 Less treasury stock, at cost: 1,049,499,023 shares in 2021 and 1,046,877,695 shares in 2020 57,109 56,787 Total Merck Co., Inc. stockholders equity 38,184 25,317 Noncontrolling Interests 73 87 Total equity 38,257 25,404 $ 105,694 $ 91,588 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2019 $ 1,788 $ 38,808 $ 42,579 $ ( 5,545 ) $ ( 50,929 ) $ 181 $ 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($ 2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) 759 611 Balance December 31, 2019 1,788 39,660 46,602 ( 6,193 ) ( 55,950 ) 94 26,001 Net income attributable to Merck Co., Inc. 7,067 7,067 Other comprehensive loss, net of taxes ( 441 ) ( 441 ) Cash dividends declared on common stock ($ 2.48 per share) ( 6,307 ) ( 6,307 ) Treasury stock shares purchased ( 1,281 ) ( 1,281 ) Net income attributable to noncontrolling interests 15 15 Distributions attributable to noncontrolling interests ( 22 ) ( 22 ) Share-based compensation plans and other ( 72 ) 444 372 Balance December 31, 2020 1,788 39,588 47,362 ( 6,634 ) ( 56,787 ) 87 25,404 Net income attributable to Merck Co., Inc. 13,049 13,049 Other comprehensive income, net of taxes 1,756 1,756 Cash dividends declared on common stock ($ 2.64 per share) ( 6,715 ) ( 6,715 ) Treasury stock shares purchased ( 840 ) ( 840 ) Spin-off of Organon Co. 4,643 449 ( 1 ) 5,091 Net income attributable to noncontrolling interests 16 16 Distributions attributable to noncontrolling interests ( 29 ) ( 29 ) Share-based compensation plans and other 7 518 525 Balance December 31, 2021 $ 1,788 $ 44,238 $ 53,696 $ ( 4,429 ) $ ( 57,109 ) $ 73 $ 38,257 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2021 2020 2019 Cash Flows from Operating Activities of Continuing Operations Net income from continuing operations $ 12,358 $ 4,523 $ 5,606 Adjustments to reconcile net income from continuing operations to net cash provided by operating activities of continuing operations: Amortization 1,636 1,817 1,695 Depreciation 1,578 1,669 1,615 Intangible asset impairment charges 302 1,718 1,040 Income from investments in equity securities, net ( 1,940 ) ( 1,338 ) ( 170 ) Charge for the acquisition of Pandion Therapeutics, Inc. 1,556 Charge for the acquisition of VelosBio Inc. 2,660 Charge for the acquisition of Peloton Therapeutics, Inc. 993 Deferred income taxes 187 ( 566 ) ( 560 ) Share-based compensation 479 441 388 Other 805 1,294 354 Net changes in assets and liabilities: Accounts receivable ( 2,033 ) ( 1,002 ) 92 Inventories ( 674 ) ( 895 ) ( 473 ) Trade accounts payable 405 684 443 Accrued and other current liabilities 277 ( 1,152 ) 413 Income taxes payable ( 540 ) 814 ( 1,889 ) Noncurrent liabilities 484 ( 617 ) ( 733 ) Other ( 1,758 ) ( 2,433 ) 70 Net Cash Provided by Operating Activities of Continuing Operations 13,122 7,617 8,884 Cash Flows from Investing Activities of Continuing Operations Capital expenditures ( 4,448 ) ( 4,429 ) ( 3,369 ) Purchase of Seagen Inc. common stock ( 1,000 ) Purchases of securities and other investments ( 1 ) ( 95 ) ( 3,202 ) Proceeds from sales of securities and other investments 1,026 2,812 8,622 Acquisition of Acceleron Pharma Inc., net of cash acquired ( 11,174 ) Acquisition of Pandion Therapeutics, Inc., net of cash acquired ( 1,554 ) Acquisition of VelosBio Inc., net of cash acquired ( 2,696 ) Acquisition of ArQule, Inc., net of cash acquired ( 2,545 ) Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 179 ) ( 1,365 ) ( 294 ) Other ( 91 ) 125 374 Net Cash Used in Investing Activities of Continuing Operations ( 16,421 ) ( 9,193 ) ( 2,529 ) Cash Flows from Financing Activities of Continuing Operations Net change in short-term borrowings ( 3,986 ) 2,549 ( 3,710 ) Payments on debt ( 2,319 ) ( 1,957 ) Proceeds from issuance of debt 7,936 4,419 4,958 Distribution from Organon Co. 9,000 Purchases of treasury stock ( 840 ) ( 1,281 ) ( 4,780 ) Dividends paid to stockholders ( 6,610 ) ( 6,215 ) ( 5,695 ) Proceeds from exercise of stock options 202 89 361 Other ( 286 ) ( 436 ) 5 Net Cash Provided by (Used in) Financing Activities of Continuing Operations 3,097 ( 2,832 ) ( 8,861 ) Discontinued Operations Net cash provided by operating activities 987 2,636 4,556 Net cash used in investing activities ( 134 ) ( 250 ) ( 100 ) Net cash used in financing activities ( 504 ) Net Cash Flows Provided by Discontinued Operations 349 2,386 4,456 Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash ( 133 ) 253 17 Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 14 ( 1,769 ) 1,967 Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $ 103 of restricted cash at January 1, 2021 included in Other Assets - see Note 7) 8,153 9,934 7,967 Less: Cash and cash equivalents related to discontinued operations 12 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $ 71 of restricted cash at December 31, 2021 included in Other Assets - see Note 7) $ 8,167 $ 8,153 $ 9,934 The accompanying notes are an integral part of this consolidated financial statement. Table o f Contents Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify and has been treated as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consisted of dermatology, non-opioid pain management, respiratory, select cardiovascular products, as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs continue to be owned and developed within Merck as planned. The historical results of the businesses that were contributed to Organon in the spin-off have been reflected as discontinued operations in the Companys consolidated financial statements through the date of the spin-off (see Note 3). 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is Table o f Contents defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive loss ( AOCL ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are not impairment related are reported net of taxes in Other Comprehensive Income (OCI) . The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the extent to which fair value is less than cost, whether an allowance for credit loss is required, as well as adverse factors that could affect the value of the securities. An impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the impairment recognized in earnings, recorded in Other (income) expense, net is limited to the portion attributed to credit loss. The remaining portion of the impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period. Gains and losses from ownership interests in investment funds, which are accounted for as equity method investments, are reported on a one quarter lag. Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical Table o f Contents or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. Some customers have bill-and-hold arrangements with the Company. Revenue for bill-and-hold arrangements is recognized when control transfers to the customer even though the customer does not yet have physical possession of the goods. Control transfers when the bill-and-hold arrangement has been requested by the customer, the product is identified as belonging to the customer and is ready for physical transfer, the product cannot be directed for use by anyone but the customer and, in certain circumstances, the customer has inspected and accepted the product at the Companys facility. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the U.S., sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, if collection of accounts receivable is expected to be in excess of one year, sales are recorded net of time value of money discounts, which have not been material. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 12.3 billion in 2021, $ 11.4 billion in 2020 and $ 9.9 billion in 2019. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 207 Table o f Contents million and $ 2.6 billion, respectively, at December 31, 2021 and were $ 208 million and $ 2.6 billion, respectively, at December 31, 2020. Outside of the U.S., variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic or other competition, changes in formularies or launch of over-the-counter products, among others. Outside of the U.S., returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the U.S., payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. See Note 19 for disaggregated revenue disclosures. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.6 billion in 2021, $ 1.7 billion in 2020 and $ 1.6 billion in 2019. Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.0 billion in 2021, $ 1.8 billion in 2020 and $ 1.9 billion in 2019. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are being amortized over periods ranging from 3 to 10 years, with the longer lives generally associated with enterprise-wide projects implemented over multiple years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, trade names and patents, licenses and other, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted Table o f Contents future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each IPRD project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as a business combination, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration associated with IPRD assets. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. Table o f Contents In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on Income from Continuing Operations . The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S. (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Table o f Contents Recently Adopted Accounting Standards In December 2019, the Financial Accounting Standards Board (FASB) issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In August 2020, the FASB issued amended guidance on the accounting for convertible instruments and contracts in an entitys own equity. The guidance removes the separation model for convertible debt instruments and preferred stock, amends requirements for conversion options to be classified in equity as well as amends diluted earnings per share (EPS) calculations for certain convertible debt instruments. The amended guidance is effective for interim and annual periods in 2022. The application of the amendments in the new guidance are to be applied either on a modified retrospective or a retrospective basis. There was no impact to the Companys consolidated financial statements upon adoption on January 1, 2022. Recently Issued Accounting Standards Not Yet Adopted In March 2020, the FASB issued optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting and subsequently issued clarifying amendments. The guidance provides optional expedients and exceptions for accounting for contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The optional guidance is effective upon issuance and can be applied on a prospective basis at any time between January 1, 2020 through December 31, 2022. The Company is currently evaluating the impact of adoption on its consolidated financial statements. The Company is progressing in its evaluation of LIBOR cessation exposures, including the review of debt-related contracts, leases, business development and licensing arrangements, royalty and other agreements. The Company has amended certain agreements and continues to review other agreements for potential impacts. With regard to debt-related exposures in particular, all existing interest rate swaps linked to LIBOR will mature in 2022. The Company is still evaluating the impact to its LIBOR-based debt. Based on its evaluation thus far, the Company does not anticipate a material impact to its consolidated financial statements as a result of reference rate reform. In October 2021, the FASB issued amended guidance that requires acquiring entities to recognize and measure contract assets and liabilities in a business combination in accordance with existing revenue recognition guidance. The amended guidance is effective for interim and annual periods in 2023 and is to be applied prospectively. Early adoption is permitted on a retrospective basis to the beginning of the fiscal year of adoption. The adoption of this guidance will not have a material impact on the Companys consolidated financial statements for prior acquisitions; however, the impact in future periods will be dependent upon the contract assets and contract liabilities acquired in future business combinations. In November 2021, the FASB issued new guidance to increase the transparency of transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy. The guidance requires annual disclosures of such transactions to include the nature of the transactions and the significant terms and conditions, the accounting treatment and the impact to the companys financial statements. The guidance is effective for annual periods beginning in 2022 and is to be applied on either a prospective or retrospective basis. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Spin-Off of Organon Co. On June 2, 2021, Merck completed the spin-off of Organon through a distribution of Organons publicly traded stock to Company shareholders. In connection with the spin-off, each Merck shareholder received one-tenth of a share of Organons common stock for each share of Merck common stock held by such shareholder. The Table o f Contents distribution is expected to qualify and has been treated as tax free to Merck and its shareholders for U.S. federal income tax purposes. Indebtedness of $ 9.5 billion principal amount, consisting of term loans and senior notes, was issued in 2021 in connection with the spin-off and assumed by Organon. Merck is no longer the obligor of any Organon debt or financing arrangements. Cash proceeds of $ 9.0 billion were distributed by Organon to Merck in connection with the spin-off. Also in connection with the spin-off, Merck and Organon entered into a separation and distribution agreement and also entered into various other agreements to effect the spin-off and provide a framework for the relationship between Merck and Organon after the spin-off, including a transition services agreement (TSA), manufacturing and supply agreements (MSAs), trademark license agreements, intellectual property license agreements, an employee matters agreement, a tax matters agreement and certain other commercial agreements. Under the TSA, Merck will provide Organon various services and, similarly, Organon will provide Merck various services. The provision of services under the TSA generally will terminate within 25 months following the spin-off. Merck and Organon also entered into a series of interim operating agreements pursuant to which in various jurisdictions where Merck held licenses, permits and other rights in connection with marketing, import and/or distribution of Organon products prior to the separation, Merck will continue to market, import and distribute such products until such time as the relevant licenses and permits are transferred to Organon. Under such interim operating agreements and in accordance with the separation and distribution agreement, Merck will continue operations in the affected markets on behalf of Organon, with Organon receiving all of the economic benefits and burdens of such activities. Additionally, Merck and Organon entered into a number of MSAs pursuant to which Merck will (a) manufacture and supply certain active pharmaceutical ingredients for Organon, (b) toll manufacture and supply certain formulated pharmaceutical products for Organon, and (c) package and label certain finished pharmaceutical products for Organon. Similarly, Organon and Merck entered into a number of MSAs pursuant to which Organon will (a) manufacture and supply certain formulated pharmaceutical products for Merck, and (b) package and label certain finished pharmaceutical products for Merck. The terms of the MSAs range in initial duration from four years to ten years . Amounts included in the consolidated statement of income for the above MSAs include sales of $ 219 million and related cost of sales of $ 195 million in 2021. Amounts included in the consolidated statement of income for the TSAs was immaterial in 2021. The amount due from Organon under the above agreements was $ 964 million at December 31, 2021 and is reflected in Other current assets . The amount due to Organon under these agreements was $ 400 million at December 31, 2021 and is included in A ccrued and other current liabilities . The results of the womens health, biosimilars and established brands businesses (previously included in the Pharmaceutical segment) that were contributed to Organon in the spin-off, as well as interest expense related to the debt issuance in 2021, have been reflected as discontinued operations in the Companys consolidated statement of income as Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests through June 2, 2021, the date of the spin-off. Prior periods have been recast to reflect this presentation. As a result of the spin-off of Organon, Merck incurred separation costs of $ 556 million in 2021 and $ 743 million in 2020, which are also included in Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests . These costs primarily relate to professional fees for separation activities within finance, tax, legal and information technology functions, as well as investment banking fees. As of December 31, 2020, the assets and liabilities associated with these businesses are classified as assets and liabilities of discontinued operations in the consolidated balance sheet. Table o f Contents Details of Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests are as follows: Years Ended December 31 2021 (1) 2020 2019 Sales $ 2,512 $ 6,476 $ 7,719 Costs, Expenses and Other Cost of sales 789 1,867 2,096 Selling, general and administrative 877 1,513 1,160 Research and development 103 161 148 Restructuring costs 1 3 12 Other (income) expense, net ( 15 ) 4 10 1,755 3,548 3,426 Income from discontinued operations before taxes 757 2,928 4,293 Tax provision 50 369 122 Income from discontinued operations, net of taxes 707 2,559 4,171 Less: Income of discontinued operations attributable to noncontrolling interests 3 11 18 Income from discontinued operations, net of taxes and amounts attributable to noncontrolling interests $ 704 $ 2,548 $ 4,153 (1) Reflects amounts through the June 2, 2021 spin-off date. Details of assets and liabilities of discontinued operations are as follows: December 31 2020 Cash and cash equivalents $ 12 Accounts receivable, less allowance for doubtful accounts 1,048 Inventories 756 Other current assets 867 Current assets of discontinued operations $ 2,683 Property, plant and equipment, net $ 986 Goodwill 1,356 Other intangibles, net 503 Other assets 330 Noncurrent Assets of Discontinued Operations $ 3,175 Trade accounts payable $ 267 Accrued and other current liabilities 841 Income taxes payable ( 22 ) Total current liabilities of discontinued operations $ 1,086 Deferred income taxes $ 10 Other noncurrent liabilities 176 Noncurrent Liabilities of Discontinued Operations $ 186 As a result of the spin-off of Organon, Merck distributed net liabilities of $ 5.1 billion as of June 2, 2021 consisting of debt of $ 9.4 billion (described above), goodwill of $ 1.4 billion, property, plant and equipment of $ 981 million, cash of $ 929 million, inventory of $ 815 million, other intangibles, net, of $ 519 million and other net liabilities of $ 328 million. The spin-off also resulted in a net decrease to AOCL of $ 449 million consisting of $ 421 million for the derecognition of net losses on foreign currency translation adjustments and $ 28 million associated with employee benefit plans. The distribution of the net liabilities and reduction to AOCL resulted in a net $ 4.6 billion increase to Other paid-in capital . Table o f Contents Expenses for curtailments, settlements and termination benefits provided to certain employees were incurred in connection with the spin-off (see Note 14). Additionally, all outstanding Merck stock options, restricted stock units (RSUs) and performance share units (PSUs) (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees (see Note 13). 4. Acquisitions, Research Collaborations and License Agreements The Company continues to pursue acquisitions and the establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. 2021 Transactions In November 2021, Merck acquired Acceleron Pharma Inc. (Acceleron), a publicly traded biopharmaceutical company, for total consideration of $ 11.5 billion. Acceleron is evaluating the transforming growth factor (TGF)-beta superfamily of proteins that is known to play a central role in the regulation of cell growth, differentiation and repair. Accelerons lead therapeutic candidate, sotatercept (MK-7962), has a novel mechanism of action with the potential to improve short-term and/or long-term clinical outcomes in patients with pulmonary arterial hypertension (PAH). Sotatercept is in Phase 3 trials as an add-on to current standard of care for the treatment of PAH. Under a previous agreement assumed by Merck, Bristol Myers Squibb (BMS) was granted an exclusive license to develop and commercialize sotatercept outside of the pulmonary hypertension (PH) field (for which Merck would be eligible to receive contingent milestones and royalty payments), however, Merck retains the worldwide exclusive rights to develop and commercialize sotatercept in the PH field. The agreement provides for Merck to pay 22 % royalties on future sales of sotatercept in the PH field to BMS. In addition to sotatercept, Accelerons portfolio includes Reblozyl (luspatercept), a first-in-class erythroid maturation recombinant fusion protein that is approved in the U.S., Europe, Canada and Australia for the treatment of anemia in certain rare blood disorders and is also being evaluated in Phase 2 and Phase 3 trials for additional indications for hematology therapies. Reblozyl is being developed and commercialized through a global collaboration with BMS. In connection with this ongoing collaboration, Merck receives a 20 % sales royalty from BMS which could increase to a maximum of 24 % based on sales levels. This royalty will be reduced by 50 % upon the earlier of patent expiry or generic entry on an indication-by-indication basis in each market. Merck is eligible to receive future contingent milestone payments including up to $ 20 million in regulatory milestones and up to $ 80 million in sales-based milestones. The transaction was accounted for as a business combination. The Company incurred $ 280 million of costs directly related to the acquisition of Acceleron, consisting primarily of share-based compensation payments to settle non-vested equity awards attributable to postcombination service, severance, as well as investment banking and legal fees. These costs were included in Selling, general and administrative expenses and Research and development costs in 2021. Table o f Contents The estimated fair value of assets acquired and liabilities assumed from Acceleron is as follows: November 19, 2021 Cash and cash equivalents $ 340 Investments 285 Identifiable intangible assets: (1) IPRD - sotatercept 6,380 Products and product rights - Reblozyl ( 12 year useful life) 3,830 Deferred income tax liabilities, net ( 1,832 ) Other assets and liabilities, net 89 Total identifiable net assets 9,092 Goodwill (2) 2,422 Consideration transferred $ 11,514 (1) The estimated fair value of the identifiable intangible assets related to sotatercept and Reblozyl were determined using an income approach, specifically the multi-period excess earnings method. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 7.5 % for sotatercept and 6.0 % for Reblozyl . Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes. In April 2021, Merck acquired Pandion Therapeutics, Inc. (Pandion), a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. Total consideration paid of $ 1.9 billion included $ 147 million of costs primarily comprised of share-based compensation payments to settle equity awards. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 156 million (primarily cash) and Research and development expenses of $ 1.7 billion in 2021 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2021, Merck and Gilead Sciences, Inc. (Gilead) entered into an agreement to jointly develop and commercialize long-acting treatments in HIV that combine Mercks investigational nucleoside reverse transcriptase translocation inhibitor, islatravir, and Gileads investigational capsid inhibitor, lenacapavir. The collaboration will initially focus on long-acting oral formulations and long-acting injectable formulations of these combination products, with other formulations potentially added to the collaboration as mutually agreed. There was no upfront payment made by either party upon entering into the agreement. Under the terms of the agreement, Merck and Gilead will share operational responsibilities, as well as development, commercialization and marketing costs, and any future revenues. Global development and commercialization costs will be shared 60 % Gilead and 40 % Merck across the oral and injectable formulation programs. For long-acting oral products, Gilead will lead commercialization in the U.S. and Merck will lead commercialization in the EU and the rest of the world. For long-acting injectable products, Merck will lead commercialization in the U.S. and Gilead will lead commercialization in the EU and the rest of the world. Gilead and Merck will co-promote in the U.S. and certain other major markets. Merck and Gilead will share global product revenues equally until product revenues surpass certain pre-agreed per formulation revenue tiers. Upon passing $ 2.0 billion a year in net product sales for the oral combination, the revenue split will adjust to 65 % Gilead and 35 % Merck for any revenues above the threshold. Upon passing $ 3.5 billion a year in net product sales for the injectable combination, the revenue split will adjust to 65 % Gilead and 35 % Merck for any revenues above the threshold. Beyond the potential combinations of investigational lenacapavir and investigational islatravir, Gilead will have the option to license certain of Mercks investigational oral integrase inhibitors to develop in combination with lenacapavir. Reciprocally, Merck will have the option to license certain of Gileads investigational oral integrase inhibitors to develop in combination with islatravir. Each company may exercise its option for an investigational oral integrase inhibitor of the other company following completion of the first Phase 1 clinical trial of that integrase inhibitor. Upon exercise of an option, the companies will split development costs and revenues, unless the non-exercising company decides to opt-out. In December 2021, the U.S. Food and Drug Administration (FDA) placed full or partial clinical holds on investigational new drug applications for certain oral, implant and injectable formulations of islatravir based on Table o f Contents observations of decreases in total lymphocyte and CD4+ T-cell counts in some participants receiving islatravir in clinical studies. As a result of these holds, Merck and Gilead made the decision to stop all dosing of participants in a Phase 2 clinical study evaluating islatravir and lenacapavir in people living with HIV who are virologically suppressed on antiretroviral therapy. The two companies are assessing whether a different dosing of islatravir in combination with lenacapavir may provide a once-weekly oral therapy option for people living with HIV. Merck and Gilead remain committed to their collaboration. In January 2021, Merck entered into an exclusive license and research collaboration agreement with Artiva Biotherapeutics, Inc. (Artiva) to discover, develop and manufacture CAR-NK cells that target certain solid tumors using Artivas proprietary platform. Merck and Artiva agreed to engage in up to three different research programs, each covering a collaboration target. Merck has sole responsibility for all development and commercialization activities (including regulatory filing and approval). Under the terms of the agreement, Merck made an upfront payment of $ 30 million, which was included in Research and development expenses in 2021, for license and other rights for the first two collaboration targets and agreed to make another upfront payment of $ 15 million for license and other rights for the third collaboration target when it is selected by Merck and accepted by Artiva. In addition, Artiva is eligible to receive future contingent milestone payments (which span all three collaboration targets), aggregating up to $ 217.5 million in developmental milestones, $ 570 million in regulatory milestones, and $ 1.05 billion in sales-based milestones. The agreement also provides for Merck to pay tiered royalties ranging from 7 % to 14 % on future sales. 2020 Transactions In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $ 423 million. OncoImmunes lead therapeutic candidate (MK-7110) was being evaluated for the treatment of patients hospitalized with COVID-19. The transaction was accounted for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $ 50 million for a 20 % ownership interest in the new entity, which was valued at $ 33 million resulting in a $ 17 million premium. Merck also recognized other net liabilities of $ 22 million. The Company recorded Research and development expenses of $ 462 million in 2020 related to this transaction. In 2021, Merck received feedback from the FDA that additional data would be needed to support a potential Emergency Use Authorization (EUA) application and therefore the Company did not expect MK-7110 would become available until the first half of 2022. Given this timeline and the technical, clinical and regulatory uncertainties, the availability of a number of medicines for patients hospitalized with COVID-19, and the need to concentrate Mercks resources on accelerating the development and manufacture of the most viable therapeutics and vaccines, Merck decided to discontinue development of MK-7110 for the treatment of COVID-19. Due to the discontinuation, the Company recorded charges of $ 207 million in 2021, which are reflected in Cost of sales and relate to fixed assets and materials written off, as well as the recognition of liabilities for purchase commitments. Also in December 2020, Merck acquired VelosBio Inc. (VelosBio), a privately held, clinical-stage biopharmaceutical company, for $ 2.8 billion. VelosBios lead investigational candidate is zilovertamab vedotin (MK-2140), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 180 million (primarily cash) and Research and development expenses of $ 2.7 billion in 2020 related to the transaction. During 2021, the Company recorded adjustments to these amounts which resulted in a reduction of Research and development expenses of $ 43 million, an increase to total consideration paid of $ 47 million, and an increase to net assets recorded of $ 90 million. In September 2020, Merck and Seagen Inc. (Seagen) announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda (pembrolizumab) in triple-negative breast cancer, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. The companies will equally share profits worldwide. Under the terms of the agreement, Table o f Contents Merck made an upfront payment of $ 600 million and a $ 1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $ 200 per share. Merck recorded $ 616 million in Research and development expenses in 2020 related to this transaction reflecting the upfront payment as well as a $ 16 million premium relating to the equity shares based on the price of Seagen common stock on the closing date. Seagen is also eligible to receive future contingent milestone payments of up to $ 2.6 billion, including $ 850 million in development milestones and $ 1.75 billion in sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of human epidermal growth factor receptor 2 (HER2)-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the U.S., Canada and Europe. Merck will be responsible for marketing applications seeking approval in its territories, supported by the positive results from the HER2CLIMB clinical trial. Merck will also co-fund a portion of the Tukysa global development plan, which encompasses several ongoing and planned trials across HER2-positive cancers, including breast, colorectal, gastric and other cancers set forth in a global product development plan. Merck will solely fund and conduct country-specific clinical trials necessary to support anticipated regulatory applications in its territories. Under the terms of the agreement, Merck made upfront payments aggregating $ 210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones of up to $ 65 million and will receive tiered royalties ranging from 20 % to 33 % based on annual sales levels of Tukysa in Mercks territories. Additionally in September 2020, Merck acquired a biologics manufacturing facility located in Dunboyne, Ireland from Takeda Pharmaceutical Company Limited for 256 million ($ 302 million). The transaction was accounted for as an acquisition of an asset. Merck recorded property, plant and equipment of $ 289 million and other net assets of $ 13 million. There are no future contingent payments associated with the acquisition. In July 2020, Merck acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews from Virbac Corporation for $ 410 million. Sentinel products provide protection against common parasites in dogs. The transaction was accounted for as an acquisition of an asset. Merck recognized intangible assets of $ 401 million related to currently marketed products and inventory of $ 9 million at the acquisition date. The estimated fair values of the identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products will be amortized over their estimated useful lives of 15 years. There are no future contingent payments associated with the acquisition. Also in July 2020, Merck and Ridgeback Biotherapeutics LP (Ridgeback), a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. See Note 5 for additional information related to this collaboration. In June 2020, Merck acquired privately held Themis Bioscience GmbH (Themis), a company focused on vaccines (including a COVID-19 vaccine candidate, V591) and immune-modulation therapies for infectious diseases and cancer for $ 366 million. The acquisition originally provided for Merck to make additional contingent payments of up to $ 740 million. The transaction was accounted for as a business combination. The Company determined the fair value of the contingent consideration was $ 85 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payments. Merck recognized intangible assets for IPRD of $ 113 million, cash of $ 59 million, deferred tax assets of $ 72 million and other net liabilities of $ 32 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 239 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In January 2021, the Company announced it was discontinuing development of V591 as discussed below. As a result, in 2020, the Company recorded an IPRD impairment charge of $ 90 million within Research and development expenses. The Company also recorded a reduction in Research and development expenses resulting from a decrease in the related liability for contingent consideration of $ 45 million since future contingent milestone payments have been reduced to $ 450 million in the aggregate, including up to $ 60 million for development milestones, up to $ 196 million for regulatory approval milestones, and up to $ 194 million for commercial milestones. Table o f Contents In May 2020, Merck and the International AIDS Vaccine Initiative, Inc. (IAVI), a nonprofit scientific research organization dedicated to addressing urgent, unmet global health challenges, announced a collaboration to develop V590, an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. The agreement provided for an upfront payment by Merck of $ 6.5 million and also provided for future contingent payments based on sales. Merck also signed an agreement with the Biomedical Advanced Research and Development Authority (BARDA), part of the office of the Assistant Secretary for Preparedness and Response within an agency of the U.S. Department of Health and Human Services, to provide initial funding support to Merck for this effort. In January 2021, the Company announced it was discontinuing development of V590 as discussed below. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $ 305 million in 2020, of which $ 260 million was reflected in Cost of sales and related to fixed assets and materials written off, as well as the recognition of liabilities for purchase commitments . The remaining $ 45 million of costs were reflected in Research and development expenses and represent amounts related to the Themis acquisition noted above (an IPRD impairment charge, partially offset by a reduction in the related liability for contingent consideration). In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases. Total consideration paid of $ 2.7 billion included $ 138 million of share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of ArQule. The Company incurred $ 95 million of costs directly related to the acquisition of ArQule, consisting almost entirely of share-based compensation payments to settle non-vested equity awards attributable to postcombination service. These costs were included in Selling, general and administrative expenses in 2020. ArQules lead investigational candidate, nemtabrutinib (MK-1026), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as a business combination. The estimated fair value of assets acquired and liabilities assumed from ArQule is as follows: January 16, 2020 Cash and cash equivalents $ 145 IPRD - nemtabrutinib (1) 2,280 Licensing arrangement for ARQ 087 80 Deferred income tax liabilities ( 361 ) Other assets and liabilities, net 34 Total identifiable net assets 2,178 Goodwill (2) 512 Consideration transferred $ 2,690 (1) The estimated fair value of nemtabrutinib was determined using an income approach. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 12.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill was allocated to the Pharmaceutical segment and is not deductible for tax purposes. In 2021, Merck recorded a $ 275 million intangible asset impairment charge related to nemtabrutinib (see Note 9). 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Merck made an upfront payment of $ 1.2 billion. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million, deferred tax liabilities of $ 52 million, and other net liabilities of $ 4 million at the acquisition Table o f Contents date, as well as Research and development expenses of $ 993 million in 2019 related to the transaction. Former Peloton shareholders received a $ 50 million milestone payment from Merck in 2021 upon first commercial sale of Pelotons lead candidate, Welireg (belzutifan), which was approved as monotherapy in the U.S. in August 2021. Former Peloton shareholders are also eligible to receive $ 50 million upon U.S. regulatory approval as a combination therapy, as well as up to $ 1.05 billion of sales-based milestones. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as a business combination. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: April 1, 2019 Cash and cash equivalents $ 31 Accounts receivable 73 Inventories 93 Property, plant and equipment 60 Identifiable intangible assets (useful lives ranging from 18 - 24 years) (1) 2,689 Deferred income tax liabilities ( 589 ) Other assets and liabilities, net ( 82 ) Total identifiable net assets 2,275 Goodwill (2) 1,376 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future probability-weighted net cash flows were discounted to present value utilizing a discount rate of 11.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as a business combination. Merck recognized intangible assets of $ 156 million, cash of $ 83 million and other net assets of $ 42 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 5. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies are also jointly developing and Table o f Contents commercializing AstraZenecas Koselugo (selumetinib) for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and Koselugo monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Profits from Lynparza and Koselugo product sales generated through monotherapies or combination therapies are shared equally. AstraZeneca is the principal on Lynparza and Koselugo sales transactions. Merck records its share of Lynparza and Koselugo product sales, net of cost of sales and commercialization costs, as alliance revenue, and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca and also made payments over a multi-year period for certain license options. In addition, the agreement provides for contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. Merck made sales-based milestone payments to AstraZeneca aggregating $ 550 million and $ 200 million in 2020 and 2019, respectively. As of December 31, 2021, sales-based milestone payments accrued but not yet paid totaled $ 400 million. Potential future sales-based milestone payments of $ 2.7 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020 and 2019, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 160 million and $ 60 million, respectively, in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.4 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 1.1 billion at December 31, 2021 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Lynparza $ 989 $ 725 $ 444 Alliance revenue - Koselugo 29 8 Total alliance revenue $ 1,018 $ 733 $ 444 Cost of sales (1) 167 247 148 Selling, general and administrative 178 160 138 Research and development 120 133 168 December 31 2021 2020 Receivables from AstraZeneca included in Other current assets $ 271 $ 215 Payables to AstraZeneca included in Trade a ccounts payable and Accrued and other current liabilities (2) 415 423 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone payments. Eisai In 2018, Merck and Eisai Co., Ltd. (Eisai) announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (lenvatinib), an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions) and Merck and Eisai share applicable profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development are shared by the two companies in accordance with the collaboration agreement and reflected in Research and development expenses. Certain expenses incurred solely by Merck or Eisai are not Table o f Contents shareable under the collaboration agreement, including costs incurred in excess of agreed upon caps and costs related to certain combination studies of Keytruda and Lenvima. Under the agreement, Merck made an upfront payment to Eisai and also made payments over a multi-year period for certain option rights (of which the final $ 125 million option payment was made in March 2021). In addition, the agreement provides for contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. Merck made sales-based milestone payments to Eisai aggregating $ 200 million, $ 500 million and $ 50 million in 2021, 2020 and 2019, respectively. As of December 31, 2021, sales-based milestone payments accrued but not yet paid totaled $ 600 million. Potential future sales-based milestone payments of $ 2.6 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2021 and 2020, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 75 million and $ 10 million, respectively, from Merck to Eisai. As of December 31, 2021, a regulatory approval milestone payment of $ 25 million was accrued but not yet paid. Potential future regulatory milestone payments of $ 25 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 1.0 billion at December 31, 2021 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Lenvima $ 704 $ 580 $ 404 Cost of sales (1) 195 271 206 Selling, general and administrative 127 73 80 Research and development 173 185 189 December 31 2021 2020 Receivables from Eisai included in Other current assets $ 200 $ 157 Payables to Eisai included in Accrued and other current liabilities (2) 625 335 Payables to Eisai included in Other Noncurrent Liabilities (3) 600 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone and future option payments. (3) Includes accrued milestone payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat). The two companies have implemented a joint development and commercialization strategy. The collaboration also includes development of Bayers Verquvo (vericiguat), which was approved in the U.S. in January 2021, in Japan in June 2021 and in the EU in July 2021. Under the agreement, Bayer commercializes Adempas in the Americas, while Merck commercializes in the rest of the world. For Verquvo, Merck commercializes in the U.S. and Bayer commercializes in the rest of the world. Both companies share in development costs and profits on sales. Merck records sales of Adempas and Verquvo in its marketing territories, as well as alliance revenue. Alliance revenue represents Mercks share of profits from sales of Adempas and Verquvo in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs. Cost of sales includes Bayers share of profits from sales in Mercks marketing territories. In addition, the agreement provided for contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. Merck made a sales-based milestone payment to Bayer of $ 375 million in 2020. In 2021, following the approval of Verquvo noted above, Merck determined it was probable that sales of Adempas and Verquvo in the future would trigger the remaining $ 400 million sales-based milestone Table o f Contents payment that was outstanding under this agreement. Accordingly, Merck recorded a liability of $ 400 million and a corresponding increase to the intangible assets related to this collaboration. Merck also recognized $ 153 million of cumulative amortization catch-up expense related to the recognition of this milestone in 2021. In January 2022, Merck made this final milestone payment to Bayer. The intangible asset balances related to Adempas (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments attributed to Adempas) and Verquvo (which reflects the portion of the final sales-based milestone payment that was attributed to Verquvo) were $ 806 million and $ 68 million, respectively, at December 31, 2021 and are included in Other Intangibles, Net . The assets are being amortized over their estimated useful lives (through 2027 for Adempas and through 2031 for Verquvo) as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 2019 Alliance revenue - Adempas/Verquvo $ 342 $ 281 $ 204 Net sales of Adempas recorded by Merck 252 220 215 Net sales of Verquvo recorded by Merck 7 Total sales $ 601 $ 501 $ 419 Cost of sales (1) 424 196 188 Selling, general and administrative 126 47 34 Research and development 53 63 126 December 31 2021 2020 Receivables from Bayer included in Other current assets $ 114 $ 65 Payables to Bayer included in Accrued and other current Liabilities (2) 472 (1) Includes amortization of intangible assets. Amount in 2021 includes $ 153 million of cumulative amortization catch-up expense as noted above. In addition, cost of sales in all periods now includes Bayers share of profits from sales in Mercks marketing territories. (2) Includes accrued milestone payment. Ridgeback Biotherapeutics LP In July 2020, Merck and Ridgeback, a closely held biotechnology company, entered into a collaboration agreement to develop molnupiravir (MK-4482), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback received an upfront payment and is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones. The agreement also provides for Merck to reimburse Ridgeback for a portion of certain third-party contingent milestone payments and royalties on net sales, which is part of the profit share calculation. Merck is the principal on sales transactions, recognizing sales and related costs, with profit sharing amounts recorded within Cost of sales . Profits from the collaboration are split equally between the partners. Reimbursements from Ridgeback for its share of research and development costs (deducted from Ridgebacks share of profits) are reflected as decreases to Research and development expenses. In December 2021, the FDA granted EUA for molnupiravir. Under a previously announced procurement agreement with the U.S. government, Merck agreed to supply 3.1 million courses of molnupiravir to the U.S. government upon EUA or approval from the FDA, of which approximately 888,000 courses were delivered in 2021. This procurement of molnupiravir is being supported in whole or in part with federal funds. Additionally, in December 2021, Japans Ministry of Health, Labor and Welfare granted Special Approval for Emergency in Japan for molnupiravir. Under a supply agreement, the Japanese government will purchase 1.6 million courses of molnupiravir, of which approximately 200,000 courses were delivered in 2021. Also, in November 2021, the Medicines and Healthcare products Regulatory Agency in the United Kingdom (UK) granted conditional marketing authorization for molnupiravir. The UK government has committed to purchase a total of 2.23 million courses of molnupiravir, of which approximately 152,000 courses were delivered in 2021. Merck has entered into advance purchase and supply agreements for molnupiravir in more than 30 markets. Table o f Contents Merck and Ridgeback are committed to providing timely access to molnupiravir globally through a comprehensive supply and access approach, which includes investing at risk to produce millions of courses of therapy; tiered pricing based on the ability of governments to finance health care; entering into supply agreements with governments as noted above; allocating up to 3 million courses of therapy to the United Nations Childrens Fund (UNICEF) for use in adults; and granting voluntary licenses to generic manufacturers and to the Medicines Patent Pool (MPP) to make generic molnupiravir available in more than 100 low- and middle-income countries following local regulatory authorizations or approvals. Merck, Ridgeback and Emory University will not receive royalties for sales of molnupiravir under the MPP agreement (molnupiravir was invented at Emory University and licensed to Ridgeback) for as long as COVID-19 remains classified as a Public Health Emergency of International Concern by the World Health Organization. Summarized financial information related to this collaboration is as follows: Years Ended December 31 2021 2020 Molnupiravir sales $ 952 $ Cost of sales (1) 494 13 Selling, general and administrative 33 6 Research and development (2) 60 323 December 31 2021 2020 Payables to Ridgeback included in Accrued and other current liabilities (3) $ 283 $ 3 (1) Includes royalty expense and amortization of capitalized milestone payments. (2) Amount in 2020 includes upfront payment. (3) Includes accrued royalty and milestone payments. 6. Restructuring In 2019, Merck approved a global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization and builds on prior restructuring programs. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program estimated to be approximately $ 3.5 billion. The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 30 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company recorded total pretax costs of $ 868 million in 2021, $ 880 million in 2020 and $ 915 million in 2019 related to restructuring program activities. Since inception of the Restructuring Program through December 31, 2021, Merck has recorded total pretax accumulated costs of approximately $ 2.7 billion. The Company expects to record charges of approximately $ 400 million in 2022 related to the Restructuring Program. For segment reporting, restructuring charges are unallocated expenses. Table o f Contents The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2021 Cost of sales $ $ 52 $ 108 $ 160 Selling, general and administrative 12 7 19 Research and development 27 1 28 Restructuring costs 451 210 661 $ 451 $ 91 $ 326 $ 868 Year Ended December 31, 2020 Cost of sales $ $ 143 $ 32 $ 175 Selling, general and administrative 44 3 47 Research and development 81 2 83 Restructuring costs 385 190 575 $ 385 $ 268 $ 227 $ 880 Year Ended December 31, 2019 Cost of sales $ $ 198 $ 53 $ 251 Selling, general and administrative 33 1 34 Research and development 2 2 4 Restructuring costs 572 54 626 $ 572 $ 233 $ 110 $ 915 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2021, 2020 and 2019 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2020 $ 690 $ $ 25 $ 715 Expenses 385 268 227 880 (Payments) receipts, net ( 508 ) ( 271 ) ( 779 ) Non-cash activity ( 268 ) 38 ( 230 ) Restructuring reserves December 31, 2020 567 19 586 Expenses 451 91 326 868 (Payments) receipts, net ( 422 ) ( 186 ) ( 608 ) Non-cash activity ( 91 ) ( 118 ) ( 209 ) Restructuring reserves December 31, 2021 (1) $ 596 $ $ 41 $ 637 (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. Table o f Contents 7. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in AOCL and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro, Japanese yen, British pound, Canadian dollar and Swiss franc. For exposures in developing country currencies, including the Chinese renminbi, the Company will enter into forward contracts to offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . Table o f Contents The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCL until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 2021 2020 2019 2021 2020 2019 Net Investment Hedging Relationships Foreign exchange contracts $ ( 49 ) $ 26 $ ( 10 ) $ ( 13 ) $ ( 19 ) $ ( 31 ) Euro-denominated notes ( 296 ) 385 ( 75 ) (1) No amounts were reclassified from AOCL into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In January 2021, five interest rate swaps with a total notional amount of $ 1.15 billion matured. These swaps effectively converted the Companys $ 1.15 billion, 3.875 % fixed-rate notes due 2021 to variable rate debt. At December 31, 2021, the Company was a party to nine pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below: 2021 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 2.40 % notes due 2022 $ 1,000 4 $ 1,000 2.35 % notes due 2022 (1) 1,250 5 1,250 (1) These interest rate swaps matured in February 2022. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark LIBOR swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. See Note 2 for a discussion of the pending discontinuation of LIBOR as part of reference rate reform. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Table o f Contents The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount 2021 2020 2021 2020 Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 2,263 $ 1,150 $ 13 $ Long-Term Debt 2,301 53 Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: 2021 2020 Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other current assets $ 14 $ $ 2,250 $ 1 $ $ 1,150 Interest rate swap contracts Other Assets 54 2,250 Foreign exchange contracts Other current assets 271 6,778 12 3,183 Foreign exchange contracts Other Assets 43 1,551 45 2,030 Foreign exchange contracts Accrued and other current liabilities 24 1,623 217 5,049 Foreign exchange contracts Other Noncurrent Liabilities 1 43 1 52 $ 328 $ 25 $ 12,245 $ 112 $ 218 $ 13,714 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ 221 $ $ 10,073 $ 70 $ $ 7,260 Foreign exchange contracts Accrued and other current liabilities 96 10,640 307 11,810 $ 221 $ 96 $ 20,713 $ 70 $ 307 $ 19,070 $ 549 $ 121 $ 32,958 $ 182 $ 525 $ 32,784 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: 2021 2020 Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ 549 $ 121 $ 182 $ 525 Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 110 ) ( 110 ) ( 156 ) ( 156 ) Cash collateral posted/received ( 164 ) ( 36 ) Net amounts $ 275 $ 11 $ 26 $ 333 Table o f Contents The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 48,704 $ 41,518 $ 39,121 $ ( 1,341 ) ( 890 ) 129 $ 1,756 $ ( 441 ) $ ( 648 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items ( 40 ) 40 95 Derivatives designated as hedging instruments 1 ( 76 ) ( 65 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives 333 ( 383 ) 87 (Decrease) increase in Sales as a result of AOCL reclassifications ( 194 ) ( 6 ) 255 194 6 ( 255 ) Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 2 ) ( 4 ) ( 4 ) Amount of loss recognized in OCI on derivatives ( 2 ) ( 4 ) ( 6 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 2021 2020 2019 Derivatives Not Designated as Hedging Instruments Income Statement Caption Foreign exchange contracts (1) Other (income) expense, net $ 313 $ ( 12 ) $ 174 Foreign exchange contracts (2) Sales 9 13 1 Interest rate contracts (3) Other (income) expense, net 9 Forward contract related to Seagen common stock Research and development expenses 15 (1) These derivative contracts primarily mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. Amount in 2021 includes a loss on forward exchange contracts entered into in conjunction with the spin-off of Organon. (2) These derivatives serve as economic hedges of forecasted transactions. (3) These derivatives serve as economic hedges against rising treasury rates. At December 31, 2021, the Company estimates $ 170 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCL to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Table o f Contents Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: 2021 2020 Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses U.S. government and agency securities $ 80 $ $ $ 80 $ 84 $ $ $ 84 Foreign government bonds 2 2 5 5 Corporate notes and bonds 4 4 Total debt securities 86 86 89 89 Publicly traded equity securities (1) 1,647 1,787 Total debt and publicly traded equity securities $ 1,733 $ 1,876 (1) Unrealized net losses recorded in Other (income) expense, net on equity securities still held at December 31, 2021 were $ 232 million during 2021. Unrealized net gains recorded in Other (income) expense, net on equity securities still held at December 31, 2020 were $ 163 million during 2020. At December 31, 2021 and 2020, the Company also had $ 596 million and $ 586 million, respectively, of equity investments without readily determinable fair values included in Other Assets . The Company records unrealized gains on these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee and records unrealized losses based on unfavorable observable price changes, which are included in Other (income) expense, net . During 2021, the Company recorded unrealized gains of $ 110 million and unrealized losses of $ 1 million related to certain of these equity investments still held at December 31, 2021. During 2020, the Company recorded unrealized gains of $ 62 million and unrealized losses of $ 3 million related to certain of these investments still held at December 31, 2020. Cumulative unrealized gains and cumulative unrealized losses based on observable price changes for investments in equity investments without readily determinable fair values still held at December 31, 2021 were $ 234 million and $ 7 million, respectively. At December 31, 2021 and 2020, the Company also had $ 1.7 billion and $ 800 million, respectively, recorded in Other Assets for equity securities held through ownership interests in investment funds. (Gains) losses recorded in Other (income) expense, net relating to these investment funds were $( 1.4 ) billion, $( 583 ) million and $ 113 million for the years ended December 31, 2021, 2020 and 2019, respectively. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Table o f Contents Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total 2021 2020 Assets Investments Foreign government bonds $ $ 2 $ $ 2 $ $ 5 $ $ 5 Publicly traded equity securities 368 368 780 780 368 2 370 780 5 785 Other assets (1) U.S. government and agency securities 80 80 84 84 Corporate notes and bonds 4 4 Publicly traded equity securities 1,279 1,279 1,007 1,007 1,363 1,363 1,091 1,091 Derivative assets (2) Forward exchange contracts 351 351 90 90 Purchased currency options 184 184 37 37 Interest rate swaps 14 14 55 55 549 549 182 182 Total assets $ 1,731 $ 551 $ $ 2,282 $ 1,871 $ 187 $ $ 2,058 Liabilities Other liabilities Contingent consideration $ $ $ 777 $ 777 $ $ $ 841 $ 841 Derivative liabilities (2) Forward exchange contracts 120 120 505 505 Written currency options 1 1 20 20 121 121 525 525 Total liabilities $ $ 121 $ 777 $ 898 $ $ 525 $ 841 $ 1,366 (1) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (2) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2021 and 2020, Cash and cash equivalents include cash equivalents of $ 6.8 billion (which would be considered Level 2 in the fair value hierarchy). Table o f Contents Contingent Consideration Summarized information about the changes in the fair value of liabilities for contingent consideration associated with business combinations is as follows: 2021 2020 Fair value January 1 $ 841 $ 767 Additions 97 Changes in estimated fair value (1) 57 83 Payments ( 109 ) ( 106 ) Other ( 12 ) Fair value December 31 (2)(3) $ 777 $ 841 (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2021 includes $ 151 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2021 and 2020, $ 620 million and $ 711 million, respectively, of the liabilities relate to the termination of the Sanofi Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows using a risk-adjusted discount rate of 8 % to present value the cash flows. The additions to contingent consideration in 2020 relate to the acquisition of Themis (see Note 4). The payments of contingent consideration in both years relate to the Sanofi Pasteur MSD liabilities described above. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2021, was $ 35.7 billion compared with a carrying value of $ 33.1 billion and at December 31, 2020, was $ 36.0 billion compared with a carrying value of $ 31.8 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the U.S., Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented approximately 20 %, 15 % and 10 %, respectively, of total accounts receivable at December 31, 2021. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $ 2.8 billion and $ 2.1 billion of accounts receivable as of December 31, 2021 and 2020, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2021 and 2020, the Company had collected $ 62 million and $ 102 million, Table o f Contents respectively, on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2022 and 2021, respectively. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $ 164 million at December 31, 2021. The obligation to return such collateral is recorded in Accrued and other current liabilities . Cash collateral advanced by the Company to counterparties was $ 36 million at December 31, 2020. 8. Inventories Inventories at December 31 consisted of: 2021 2020 Finished goods $ 1,747 $ 1,610 Raw materials and work in process 6,220 5,949 Supplies 196 146 Total (approximates current cost) 8,163 7,705 Decrease to LIFO cost ( 16 ) ( 81 ) $ 8,147 $ 7,624 Recognized as: Inventories $ 5,953 $ 5,554 Other assets 2,194 2,070 Inventories valued under the LIFO method comprised approximately $ 3.3 billion and $ 2.8 billion at December 31, 2021 and 2020, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2021 and 2020, these amounts included $ 1.9 billion and $ 1.8 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 256 million and $ 279 million at December 31, 2021 and 2020, respectively, of inventories produced in preparation for product launches. 9. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2020 $ 14,825 $ 3,192 $ 52 $ 18,069 Acquisitions 742 105 847 Divestitures ( 54 ) ( 54 ) Other (1) 47 ( 29 ) 2 20 Balance December 31, 2020 (2) 15,614 3,268 18,882 Acquisitions 2,431 5 2,436 Other (1) ( 48 ) ( 6 ) ( 54 ) Balance December 31, 2021 (2) $ 17,997 $ 3,267 $ $ 21,264 (1) Includes cumulative translation adjustments on goodwill balances. (2) Accumulated goodwill impairment losses were $ 531 million at both December 31, 2021 and 2020. The additions to goodwill in the Pharmaceutical segment in 2021 were primarily related to the acquisition of Acceleron. The additions to goodwill in the Pharmaceutical segment in 2020 were primarily related to the acquisitions of ArQule and Themis. See Note 4 for more information on these acquisitions. Table o f Contents Other acquired intangibles at December 31 consisted of: 2021 2020 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 23,671 $ 15,776 $ 7,895 $ 20,928 $ 16,138 $ 4,790 IPRD 9,281 9,281 3,228 3,228 Trade names 2,882 493 2,389 2,882 352 2,530 Licenses and other 6,604 3,236 3,368 6,199 2,646 3,553 $ 42,438 $ 19,505 $ 22,933 $ 33,237 $ 19,136 $ 14,101 Acquired intangibles include products and product rights, IPRD, trade names and patents, licenses and other, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2021 include Reblozyl , $ 3.8 billion; Zerbaxa , $ 478 million; Gardasil/Gardasil 9, $ 191 million; Bridion , $ 145 million; Dificid , $ 145 million; Sivextro , $ 138 million; and Simponi , $ 101 million. Additionally, the Company had $ 5.0 billion of net acquired intangibles related to animal health marketed products at December 31, 2021, of which $ 2.3 billion relate primarily to trade names obtained through the 2019 acquisition of Antelliq (see Note 4). At December 31, 2021, IPRD primarily relates to MK-7962 (sotatercept), $ 6.4 billion, obtained through the acquisition of Acceleron in 2021 (see Note 4); MK-1026 (nemtabrutinib), $ 2.0 billion, obtained through the acquisition of ArQule in 2020 (see below and Note 4); and MK-7264 (gefapixant) $ 832 million, obtained through the acquisition of Afferent Pharmaceuticals in 2016. Some of the more significant net intangible assets included in licenses and other above at December 31, 2021 include Lynparza, $ 1.1 billion, related to a collaboration with AstraZeneca; Lenvima, $ 1.0 billion, related to a collaboration with Eisai; Adempas, $ 806 million related to a collaboration with Bayer; and Verquvo, $ 68 million, also related to a collaboration with Bayer. See Note 5 for additional information related to the intangible assets associated with these collaborations. In 2020, the Company recorded an impairment charge of $ 1.6 billion within Cost of sales related to Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. In December 2020, the Company temporarily suspended sales of Zerbaxa , and subsequently issued a product recall, following the identification of product sterility issues. The recall constituted a triggering event requiring the evaluation of the Zerbaxa intangible asset for impairment. The Company revised its cash flow forecasts for Zerbaxa utilizing certain assumptions around the return to market timeline and anticipated uptake in sales thereafter. These revised cash flow forecasts indicated that the Zerbaxa intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Zerbaxa that, when compared with its related carrying value, resulted in the impairment charge noted above. The Company also wrote-off inventory of $ 120 million to Cost of sales in 2020 related to the Zerbaxa recall. A phased resupply of Zerbaxa was initiated in the fourth quarter of 2021. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million. Of this amount, $ 612 million related to Sivextro (tedizolid phosphate), a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced cash flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until Table o f Contents completion or abandonment of the projects. Upon successful completion of each IPRD project, the Company will make a separate determination as to the then-useful life of the asset and begin amortization. In 2021, the Company recorded a $ 275 million IPRD impairment charge within Research and development expenses related to nemtabrutinib (MK-1026), a novel, oral BTK inhibitor currently being evaluated for the treatment of B-cell malignancies, obtained in connection with the acquisition of ArQule (see Note 4). As part of Mercks annual impairment assessment of IPRD intangible assets, the Company estimated the current fair value of nemtabrutinib utilizing projected future cash flows. The market participant assumptions used to derive the forecasted cash flows were updated to reflect the current competitive landscape for nemtabrutinib, including increased expected development costs for additional clinical trial data needed to develop nemtabrutinib, as well as a delay in the anticipated launch date for nemtabrutinib, which collectively reduced the projected future cash flows and estimated fair value. Additionally, the discount rate utilized to determine the current fair value of the asset was reduced to 8.5 % to reflect the current risk profile of the asset. The revised estimated fair value of nemtabrutinib when compared with its related carrying value resulted in the IPRD impairment charge noted above. The remaining IPRD intangible asset related to nemtabrutinib is $ 2.0 billion. If the assumptions used to estimate the fair value of nemtabrutinib prove to be incorrect and the development of nemtabrutinib does not progress as anticipated thereby adversely affecting projected future cash flows, the Company may record an additional impairment charge in the future and such charge could be material. In 2020, the Company recorded a $ 90 million IPRD impairment charge related to a decision to discontinue the development program for COVID-19 vaccine candidate V591 following Mercks review of findings from a Phase 1 clinical study for the vaccine. In the study, V591 was generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The discontinuation of this development program also resulted in a reversal of the related liability for contingent consideration of $ 45 million. In 2019, the Company recorded $ 172 million of IPRD impairment charges. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 11 million. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $ 1.6 billion in 2021, $ 1.8 billion in 2020 and $ 1.7 billion in 2019. The estimated aggregate amortization expense for each of the next five years is as follows: 2022, $ 1.7 billion; 2023, $ 1.6 billion; 2024, $ 1.6 billion; 2025, $ 1.4 billion; 2026, $ 1.4 billion. 10. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2021 included $ 2.3 billion of notes due in 2022 and $ 149 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2020 included $ 2.3 billion of notes due in 2021, $ 4.0 billion of commercial paper borrowings and $ 73 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.08 % and 0.79 % for the years ended December 31, 2021 and 2020, respectively. Table o f Contents Long-Term Debt Long-term debt at December 31 consisted of: 2021 2020 2.75 % notes due 2025 $ 2,495 $ 2,493 2.15 % notes due 2031 1,986 2.75 % notes due 2051 1,979 3.70 % notes due 2045 1,977 1,976 2.80 % notes due 2023 1,749 1,748 3.40 % notes due 2029 1,736 1,734 1.70 % notes due 2027 1,493 2.90 % notes due 2061 1,484 4.00 % notes due 2049 1,470 1,469 4.15 % notes due 2043 1,239 1,238 1.45 % notes due 2030 1,235 1,233 2.45 % notes due 2050 1,212 1,211 1.875 % euro-denominated notes due 2026 1,123 1,218 1.90 % notes due 2028 994 0.75 % notes due 2026 993 991 3.90 % notes due 2039 984 983 2.35 % notes due 2040 983 982 2.90 % notes due 2024 748 746 6.50 % notes due 2033 715 719 0.50 % euro-denominated notes due 2024 563 611 1.375 % euro-denominated notes due 2036 559 606 2.50 % euro-denominated notes due 2034 558 605 3.60 % notes due 2042 491 491 6.55 % notes due 2037 409 411 5.75 % notes due 2036 338 338 5.95 % debentures due 2028 306 306 5.85 % notes due 2039 271 271 6.40 % debentures due 2028 250 250 6.30 % debentures due 2026 135 135 2.35 % notes due 2022 1,269 2.40 % notes due 2022 1,032 Other 215 294 $ 30,690 $ 25,360 Other (as presented in the table above) includes borrowings at variable rates that resulted in effective interest rates of zero and 0.45 % for 2021 and 2020, respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In December 2021, the Company issued $ 8.0 billion principal amount of senior unsecured notes consisting of $ 1.5 billion of 1.70 % notes due 2027, $ 1.0 billion of 1.90 % notes due 2028, $ 2.0 billion of 2.15 % notes due 2031, $ 2.0 billion of 2.75 % notes due 2051 and $ 1.5 billion of 2.90 % notes due 2061. Merck used the net proceeds from the offering of the 2027 notes, the 2031 notes, the 2051 notes and the 2061 notes for general corporate purposes, including the repayment of outstanding commercial paper borrowings (including commercial paper borrowings in connection with Mercks acquisition of Acceleron), and other indebtedness. Merck allocated an amount equal to the net proceeds of the offering of the notes due in 2028 to finance or refinance, in whole or in part, projects and partnerships in the Companys priority environmental, social and governance (ESG) areas. Table o f Contents Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2021, the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2022, $ 2.3 billion; 2023, $ 1.7 billion; 2024, $ 1.3 billion; 2025, $ 2.5 billion; 2026, $ 2.3 billion. Interest payments related to these debt obligations are as follows: 2022, $ 910 million; 2023, $ 875 million; 2024, $ 838 million; 2025, $ 771 million; 2026, $ 743 million. The Company has a $ 6.0 billion credit facility that matures in June 2026. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of seven years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company does not record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. The Company does not separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 343 million in 2021, $ 340 million in 2020 and $ 333 million in 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $ 340 million in 2021, $ 334 million in 2020 and $ 275 million in 2019. Operating lease assets obtained in exchange for lease obligations were $ 117 million in 2021, $ 473 million in 2020 and $ 125 million in 2019. Table o f Contents Supplemental balance sheet information related to operating leases is as follows: December 31 2021 2020 Assets Other Assets (1) $ 1,586 $ 1,688 Liabilities Accrued and other current liabilities 304 291 Other Noncurrent Liabilities 1,225 1,335 $ 1,529 $ 1,626 Weighted-average remaining lease term (years) 7.0 8.0 Weighted-average discount rate 2.6 % 2.8 % (1) Includes prepaid leases that have no related lease liability. Maturities of operating leases liabilities are as follows: 2022 $ 336 2023 292 2024 242 2025 178 2026 146 Thereafter 511 Total lease payments 1,705 Less: Imputed interest 176 $ 1,529 At December 31, 2021, the Company had entered into additional real estate operating leases that had not yet commenced; the obligations associated with these leases total $ 86 million. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Table o f Contents Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the U.S. involving Fosamax (Fosamax Litigation). As of December 31, 2021, approximately 3,470 cases are pending against Merck in either a federal multidistrict litigation (Femur Fracture MDL) or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax. In March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. In May 2019, the U.S. Supreme Court decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. In November 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. Briefing on the issue is closed, and the parties await the decision of the District Court. Discovery is presently stayed in the Femur Fracture MDL. As part of the spin-off of Organon, Organon is required to indemnify Merck for all liabilities relating to, arising from, or resulting from the Fosamax Litigation. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the U.S. involving Januvia and/or Janumet . As of December 31, 2021, Merck is aware of approximately 675 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). On March 9, 2021, the MDL Court issued an omnibus order granting defendants summary judgment motions based on preemption and failure to establish general causation, as well as granting defendants motions to exclude plaintiffs expert witnesses. The plaintiffs appealed that order. Since that time, more than half of these claims have been dismissed with prejudice as to Merck, and on October 5, 2021, the U.S. Court of Appeals for the Ninth Circuit dismissed the appeal as to Merck and two of its codefendants. Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). On April 6, 2021, the court in California issued an omnibus order granting defendants summary judgment motions and also granting defendants motions to exclude plaintiffs expert witnesses. As of December 31, 2021, six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided in September 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In May 2020, the Illinois Appellate Court issued a mandate to the state trial court, which, as of December 31, 2021, had not scheduled a case management conference or otherwise taken action. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against any remaining lawsuits. Table o f Contents Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, in May 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal health care programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, in April 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, in June 2020, Merck received a CID from the U.S. Department of Justice. The CID requests answers to interrogatories, as well as various documents, regarding temperature excursions at a third-party storage facility containing certain Merck products. Merck is cooperating with the governments investigation and intends to produce information and/or documents as necessary in response to the CID. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the U.S. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation, Schering-Plough Corporation, and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. In August 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, in June 2019, the representatives of the putative direct purchaser class filed an amended complaint, and in August 2019, retailer opt-out plaintiffs filed an amended complaint. In December 2019, the district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities Table o f Contents that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. In November 2019, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed motions for class certification. In August 2020, the district court granted in part the direct purchasers motion for class certification and certified a class of 35 direct purchasers. In August 2020, the Fourth Circuit vacated the district courts class certification order and remanded for further proceedings consistent with the courts ruling. In September 2021, the direct purchaser plaintiffs filed a renewed motion for class certification. On January 25, 2022, the magistrate judge recommended that the district court deny the motion for class certification. On February 8, 2022, the direct purchaser plaintiffs filed objections to the recommendation. Briefing on these objections is ongoing. In August 2020, the Merck Defendants filed a motion for summary judgment and other motions, and plaintiffs filed a motion for partial summary judgment, and other motions. Those motions are now fully briefed, and the court has heard argument on certain of the motions. The court may hold additional hearings on the other motions. Trial in this matter has been adjourned. Also, in August 2020, the magistrate judge recommended that the court grant the motion for class certification filed by the putative indirect purchaser class. In August 2021, the district court granted certification of a class of indirect purchasers. In September 2021, the Merck Defendants petitioned to appeal the class certification decision to the Fourth Circuit. The Fourth Circuit denied that petition on September 30, 2021. In September 2020, United Healthcare Services, Inc. filed a lawsuit in the U.S. District Court for the District of Minnesota against the Merck Defendants and others (the UHC Action). The UHC Action makes similar allegations as those made in the Zetia class action, as well as allegations about Vytorin. In September 2020, the U.S. Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. In December 2020, Humana Inc. filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against Merck and others, alleging defendants violated state antitrust laws in multiple states. Also, in December 2020, Centene Corporation and others filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana. Both lawsuits allege similar anticompetitive acts to those alleged in the Zetia class action. In July 2021, the California Court ruled on defendants Motion to Quash for lack of personal jurisdiction, granting the motion as to the out-of-state claims against defendants, and ordering limited jurisdictional discovery with regard to the California claims. Also, on July 16, 2021, Humana and Centene filed actions against the Merck Defendants in New Jersey in the Bergen County Superior Court, re-asserting the claims that were dismissed in their California action. In September 2021, the parties reached an agreement that Humana and Centene would file their claims in New Jersey federal court, seek a transfer of those claims to the multidistrict Zetia litigation already in progress, and subsequently dismiss the actions previously filed in California and New Jersey state courts. In June 2021, Kaiser Foundation Health Plan, Inc. similarly filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana and Centene. The Kaiser lawsuit alleges similar anticompetitive acts to those alleged in the Zetia class action. The Kaiser action was removed to the U.S. District Court for the Northern District of California on July 16, 2021. In September 2021, the U.S. Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. As of December 2021, all of the insurer plaintiffs (Kaiser, Humana, and Centene) are part of the multidistrict Zetia litigation, and are proceeding with discovery in that action. On February 9, 2022, United Healthcare, Kaiser, and Humana each filed an amended complaint. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. In January 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. In February 2019, MSD appealed the courts order on arbitration to the Third Circuit. In October 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of Table o f Contents arbitrability. On July 6, 2020, MSD filed a renewed motion to compel arbitration, and plaintiffs filed a cross motion for summary judgment as to arbitrability. On November 20, 2020, the district court denied MSDs motion and granted plaintiffs motion. On December 4, 2020, MSD filed a notice of appeal to the Third Circuit. MSDs appeal is fully briefed, and the Third Circuit heard argument on September 24, 2021. Bravecto Litigation As previously disclosed, in January 2020, the Company was served with a complaint in the U.S. District Court for the District of New Jersey. Following motion practice, the plaintiffs filed a second amended complaint on July 1, 2021, seeking to certify a nationwide class action of purchasers or users of Bravecto (fluralaner) products in the U.S. or its territories between May 1, 2014 and July 1, 2021. Plaintiffs contend Bravecto causes neurological events in dogs and cats and alleges violations of the New Jersey Consumer Fraud Act, Breach of Warranty, Product Liability, and related theories. The Company moved to dismiss or, alternatively, to strike the class allegations from the second amended complaint, and that motion is pending. A similar case was filed in Quebec, Canada in May 2019. The Superior Court certified a class of dog owners in Quebec who gave Bravecto Chew to their dogs between February 16, 2017 and November 2, 2018 whose dogs experienced one of the conditions in the post-marketing adverse reactions section of the labeling approved on November 2, 2018. The Company and plaintiffs each appealed the class certification decision. The Court of Appeal of Quebec heard the appeal on February 7, 2022 and took the matter under advisement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that had been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the court. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the U.S., the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the U.S., alleging it improperly uses the name Merck in the U.S. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, SAR, PRC, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, SAR, PRC, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the U.S. with no trial date set, and also ongoing in numerous jurisdictions outside of the U.S. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened Table o f Contents periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Bridion As previously disclosed, between January and November 2020, the Company received multiple Paragraph IV Certification Letters under the Hatch-Waxman Act notifying the Company that generic drug companies have filed applications to the FDA seeking pre-patent expiry approval to sell generic versions of Bridion (sugammadex) Injection. In March, April and December 2020, the Company filed patent infringement lawsuits in the U.S. District Courts for the District of New Jersey and the Northern District of West Virginia against those generic companies. All actions in the District of New Jersey have been consolidated. These lawsuits, which assert one or more patents covering sugammadex and methods of using sugammadex, automatically stay FDA approval of the generic applications until June 2023 or until adverse court decisions, if any, whichever may occur earlier. Mylan Pharmaceuticals Inc., Mylan API US LLC, and Mylan Inc. (Mylan) have filed motions to dismiss in the District of New Jersey for lack of venue and failure to state a claim against certain defendants, and in the Northern District of West Virginia for failure to state a claim against certain defendants. The New Jersey motion has not yet been decided, and the West Virginia action is stayed pending resolution of the New Jersey motion. The Company has settled with four generic companies providing that these generic companies can bring their generic versions of Bridion to the market in January 2026 (which may be delayed by any applicable pediatric exclusivity) or earlier under certain circumstances. The Company has agreed to stay the lawsuit filed against one generic company, which in exchange agreed to be bound by a judgment on the merits of the consolidated action in the District of New Jersey. One of the generic companies in the consolidated action requested dismissal of the action against it and the Company did not oppose this request, which was subsequently granted by the court. The Company does not expect this company to bring its generic version of Bridion to the market before January 2026 or later, depending on any applicable pediatric exclusivity, unless the Company receives an adverse court decision. Januvia, Janumet, Janumet XR As previously disclosed, the FDA has granted pediatric exclusivity with respect to Januvia , Janumet , and Janumet XR , which provides a further six months of exclusivity in the U.S. beyond the expiration of all patents listed in the FDAs Orange Book. Adding this exclusivity to the term of the key patent protection extends exclusivity on these products to January 2023. The Company currently anticipates that sales of Januvia and Janumet in the U.S. will decline significantly after this date. However, Januvia , Janumet , and Janumet XR contain sitagliptin phosphate monohydrate and the Company has another patent covering certain phosphate salt and polymorphic forms of sitagliptin (2027 salt/polymorph patent), which, if determined to be valid, would preclude generic manufacturers from making sitagliptin phosphate salt and polymorphic forms until 2027 with the expiration of that patent, plus pediatric exclusivity. In 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of the 2027 salt/polymorph patent. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection, but prior to the expiration of the 2027 salt/polymorph patent, and a later granted patent owned by the Company covering the Janumet formulation where its term plus the pediatric exclusivity, ends in 2029. The Company also filed a patent infringement lawsuit against Mylan in the Northern District of West Virginia. The Judicial Panel on Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. Prior to the beginning of the scheduled October 2021 trial in the U.S. District Court for the District of Delaware on invalidity issues, the Company settled with all defendants scheduled to participate in that trial. In the Companys case against Mylan, a bench trial was held in December 2021 in the U.S. District Court for the Northern District of West Virginia, with closing arguments scheduled for April 13, 2022. In total, the Company has settled with 21 generic companies providing that these generic companies can bring their generic versions of Januvia and Janumet to the market in May 2026 or earlier under certain circumstances, and their generic versions of Janumet XR to the market in July 2026 or earlier under certain circumstances. Table o f Contents Additionally, in 2019, Mylan filed a petition for Inter Partes Review (IPR) at the U.S. Patent and Trademark Office (USPTO) seeking invalidity of some, but not all, of the claims of the 2027 salt/polymorph patent. The USPTO instituted IPR proceedings in May 2020, finding a reasonable likelihood that the challenged claims are not valid. A trial was held in February 2021 and a final decision was rendered in May 2021, holding that all of the challenged claims were not invalid. Mylan has appealed the USPTOs decision to the U.S. Court of Appeals for the Federal Circuit. In March 2021, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Zydus Worldwide DMCC, Zydus Pharmaceuticals (USA) Inc., and Cadila Healthcare Ltd. (collectively, Zydus). In that lawsuit, the Company alleged infringement of the 2027 salt/polymorph patent based on the filing of Zyduss application seeking approval of its sitagliptin tablets. The U.S. District Court for the District of Delaware has set a three-day bench trial in this matter beginning on October 31, 2022. In Germany, generic companies have sought the revocation of the Supplementary Protection Certificate (SPC) for Janumet . If the generic companies are successful, Janumet could lose market exclusivity in Germany at the same time as the expiry of Januvia pediatric market exclusivity in September 2022. A hearing was held in June 2021 and the court decided that the SPC for Janumet is invalid, which decision the Company has appealed. Challenges to the Janumet SPC have also occurred in the following European countries: Austria, Czech Republic, Finland, France, Hungary, Italy, Portugal, Romania, Slovakia, and Sweden. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2021 and 2020 of approximately $ 230 million and $ 235 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which Table o f Contents would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 40 million and $ 43 million at December 31, 2021 and 2020, respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $ 40 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: 2021 2020 2019 Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 1,047 3,577 1,038 3,577 985 Purchases of treasury stock 11 16 66 Issuances (1) ( 9 ) ( 7 ) ( 13 ) Balance December 31 3,577 1,049 3,577 1,047 3,577 1,038 (1) Issuances primarily reflect activity under share-based compensation plans. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2021, 93 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years . RSU awards generally vest one-third each year over a three-year period. Table o f Contents Total pretax share-based compensation cost recorded in 2021, 2020 and 2019 was $ 498 million, $ 475 million and $ 417 million, respectively, including $ 479 million, $ 441 million and $ 388 million, respectively, related to continuing operations. Income tax benefits for share-based compensation expense recognized in 2021, 2020 and 2019 were $ 69 million, $ 65 million and $ 57 million, respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2021, 2020 and 2019 was $ 75.99 , $ 77.67 and $ 80.05 per option, respectively. The weighted average fair value of options granted in 2021, 2020 and 2019 was $ 9.80 , $ 9.93 and $ 10.63 per option, respectively, and were determined using the following assumptions: Years Ended December 31 2021 2020 2019 Expected dividend yield 3.1 % 3.1 % 3.2 % Risk-free interest rate 1.0 % 0.4 % 2.4 % Expected volatility 20.9 % 22.1 % 18.7 % Expected life (years) 5.9 5.8 5.9 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2021 (1) 19,446 $ 63.64 Granted (1) 4,781 75.99 Exercised (1) ( 3,728 ) 54.14 Forfeited (1) ( 626 ) 73.97 Awards transferred to Organon in the spin-off ( 1,947 ) 72.15 Adjustment to Merck awards related to the spin-off of Organon (2) 646 Outstanding December 31, 2021 18,572 $ 65.27 6.3 $ 213 Vested and expected to vest December 31, 2021 17,829 $ 64.90 6.2 $ 212 Exercisable December 31, 2021 12,136 $ 60.41 5.0 $ 198 (1) Activity prior to the Organon spin-off has not been restated. (2) In connection with the spin-off of Organon, all outstanding Merck stock options (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees. Such adjusted awards preserved the same intrinsic value and general terms and conditions (including vesting) as were in place immediately prior to the adjustments. Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 2021 2020 2019 Total intrinsic value of stock options exercised $ 106 $ 51 $ 295 Fair value of stock options vested 27 25 27 Cash received from the exercise of stock options 202 89 361 Table o f Contents A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2021 (1) 11,915 $ 74.17 2,100 $ 75.08 Granted (1) 7,897 76.16 1,487 69.33 Vested (1) ( 6,066 ) 70.25 ( 1,284 ) 57.14 Forfeited (1) ( 1,015 ) 76.62 ( 149 ) 79.33 Awards transferred to Organon in the spin-off ( 1,309 ) 76.99 ( 248 ) 77.39 Adjustment to Merck awards related to the spin-off of Organon (2) 368 60 Nonvested December 31, 2021 11,790 $ 74.88 1,966 $ 77.13 Expected to vest December 31, 2021 10,499 $ 74.93 1,832 $ 77.40 (1) Activity prior to the Organon spin-off has not been restated. (2) In connection with the spin-off of Organon, all outstanding Merck RSUs and PSUs (whether vested or unvested) were converted into adjusted Merck awards for current and former Merck employees or Organon awards for Organon employees. Such adjusted awards preserved the same intrinsic value and general terms and conditions (including vesting) as were in place immediately prior to the adjustments. At December 31, 2021, there was $ 699 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the U.S. and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans (including certain costs reported as part of discontinued operations) consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ 403 $ 360 $ 293 $ 328 $ 297 $ 235 $ 48 $ 52 $ 48 Interest cost 404 431 458 123 136 176 45 57 69 Expected return on plan assets ( 755 ) ( 774 ) ( 817 ) ( 416 ) ( 414 ) ( 425 ) ( 79 ) ( 75 ) ( 72 ) Amortization of unrecognized prior service cost ( 38 ) ( 49 ) ( 49 ) ( 16 ) ( 18 ) ( 12 ) ( 63 ) ( 73 ) ( 78 ) Net loss (gain) amortization 298 303 151 142 127 64 ( 42 ) ( 18 ) ( 10 ) Termination benefits 56 10 31 5 3 8 37 2 5 Curtailments 16 10 14 ( 26 ) 6 ( 29 ) ( 4 ) ( 11 ) Settlements 216 13 8 15 1 Net periodic benefit cost (credit) $ 600 $ 304 $ 81 $ 148 $ 146 $ 53 $ ( 83 ) $ ( 59 ) $ ( 49 ) Net periodic benefit cost (credit) for pension and other postretirement benefit plans in 2021 includes expenses for curtailments, settlements and termination benefits provided to certain employees in connection with the spin-off of Organon. In connection with restructuring actions (see Note 6), termination charges were recorded in 2021, 2020 and 2019 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments and settlements were recorded on Table o f Contents certain pension plans. An increase in lump sum payments to U.S. pension plan participants also contributed to the settlements recorded during 2021. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 15), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions or in Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests if related to the spin-off of Organon (each as noted above). Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International 2021 2020 2021 2020 2021 2020 Fair value of plan assets January 1 $ 12,672 $ 11,361 $ 12,009 $ 10,135 $ 1,221 $ 1,102 Actual return on plan assets 1,250 1,908 891 1,026 118 175 Company contributions 305 199 189 383 33 19 Effects of exchange rate changes ( 671 ) 743 Benefits paid ( 219 ) ( 751 ) ( 233 ) ( 214 ) ( 86 ) ( 93 ) Settlements ( 941 ) ( 45 ) ( 55 ) ( 117 ) Spin-off of Organon ( 55 ) Other 120 53 6 18 Fair value of plan assets December 31 $ 13,067 $ 12,672 $ 12,195 $ 12,009 $ 1,292 $ 1,221 Benefit obligation January 1 $ 14,613 $ 13,003 $ 12,458 $ 10,558 $ 1,607 $ 1,673 Service cost 403 360 328 297 48 52 Interest cost 404 431 123 136 45 57 Actuarial (gains) losses (1) ( 332 ) 1,594 ( 240 ) 1,032 ( 103 ) ( 98 ) Benefits paid ( 219 ) ( 751 ) ( 233 ) ( 214 ) ( 86 ) ( 93 ) Effects of exchange rate changes ( 678 ) 788 ( 1 ) ( 3 ) Plan amendments 4 ( 64 ) Curtailments 15 11 ( 38 ) ( 8 ) ( 12 ) ( 1 ) Termination benefits 56 10 5 3 37 2 Settlements ( 941 ) ( 45 ) ( 55 ) ( 117 ) Spin-off of Organon ( 118 ) Other 19 47 6 18 Benefit obligation December 31 $ 13,999 $ 14,613 $ 11,575 $ 12,458 $ 1,541 $ 1,607 Funded status December 31 $ ( 932 ) $ ( 1,941 ) $ 620 $ ( 449 ) $ ( 249 ) $ ( 386 ) Recognized as: Other Assets $ 9 $ $ 1,395 $ 941 $ $ Accrued and other current liabilities ( 64 ) ( 82 ) ( 22 ) ( 13 ) ( 8 ) ( 9 ) Other Noncurrent Liabilities ( 877 ) ( 1,859 ) ( 753 ) ( 1,377 ) ( 241 ) ( 377 ) (1) Actuarial (gains) losses primarily reflect changes in discount rates. At December 31, 2021 and 2020, the accumulated benefit obligation was $ 24.9 billion and $ 26.3 billion, respectively, for all pension plans, of which $ 13.8 billion and $ 14.4 billion, respectively, related to U.S. pension plans. Table o f Contents Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International 2021 2020 2021 2020 Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 13,013 $ 14,613 $ 2,507 $ 8,875 Fair value of plan assets 12,072 12,672 1,731 7,488 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 12,916 $ 13,489 $ 2,462 $ 4,234 Fair value of plan assets 12,072 11,685 1,723 2,995 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2021 and 2020, $ 943 million and $ 942 million, respectively, or approximately 4 % of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Table o f Contents The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2021 2020 U.S. Pension Plans Cash and cash equivalents $ 3 $ $ $ 289 $ 292 $ 5 $ $ $ 303 $ 308 Investment funds Developed markets equities 236 3,799 4,035 206 3,884 4,090 Emerging markets equities 919 919 169 927 1,096 Mortgage and asset-backed securities 89 89 Equity securities Developed markets 2,915 2,915 2,819 2,819 Fixed income securities Government and agency obligations 2,870 2,870 2,236 2,236 Corporate obligations 2,005 2,005 1,994 1,994 Mortgage and asset-backed securities 23 23 33 33 Other investments 2 6 8 7 7 Plan assets at fair value $ 3,156 $ 4,898 $ 6 $ 5,007 $ 13,067 $ 3,199 $ 4,352 $ 7 $ 5,114 $ 12,672 International Pension Plans Cash and cash equivalents $ 82 $ 10 $ $ 18 $ 110 $ 110 $ 1 $ $ 20 $ 131 Investment funds Developed markets equities 531 4,292 121 4,944 475 4,286 118 4,879 Government and agency obligations 240 4,025 171 4,436 1,516 2,614 172 4,302 Emerging markets equities 137 72 209 154 92 246 Corporate obligations 9 8 171 188 5 12 172 189 Other fixed income obligations 15 8 3 26 9 11 4 24 Real estate 1 16 17 1 15 16 Equity securities Developed markets 369 369 505 505 Fixed income securities Government and agency obligations 3 591 3 597 3 481 3 487 Corporate obligations 223 2 225 1 174 2 177 Mortgage and asset-backed securities 90 90 70 70 Other investments Insurance contracts (2) 44 937 1 982 42 935 1 978 Other 1 1 2 1 4 5 Plan assets at fair value $ 1,387 $ 9,293 $ 937 $ 578 $ 12,195 $ 2,779 $ 7,696 $ 935 $ 599 $ 12,009 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2021 and 2020. (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. Table o f Contents The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: 2021 2020 Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ 7 $ 7 $ $ $ 9 $ 9 Actual return on plan assets: Relating to assets still held at December 31 ( 5 ) ( 5 ) ( 5 ) ( 5 ) Relating to assets sold during the year 7 7 5 5 Purchases and sales, net ( 3 ) ( 3 ) ( 2 ) ( 2 ) Balance December 31 $ $ $ 6 $ 6 $ $ $ 7 $ 7 International Pension Plans Balance January 1 $ 935 $ $ $ 935 $ 851 $ $ $ 851 Actual return on plan assets: Relating to assets still held at December 31 ( 34 ) ( 34 ) 103 103 Purchases and sales, net ( 42 ) ( 42 ) ( 17 ) ( 17 ) Transfers in (out) of Level 3 78 78 ( 2 ) ( 2 ) Balance December 31 $ 937 $ $ $ 937 $ 935 $ $ $ 935 The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2021 2020 Cash and cash equivalents $ 11 $ $ $ 28 $ 39 $ 31 $ $ $ 28 $ 59 Investment funds Developed markets equities 24 378 402 19 355 374 Emerging markets equities 92 92 16 85 101 Government and agency obligations 1 1 1 1 Mortgage and asset-backed securities 8 8 Equity securities Developed markets 290 290 258 258 Fixed income securities Government and agency obligations 275 275 221 221 Corporate obligations 191 191 196 196 Mortgage and asset-backed securities 2 2 3 3 Plan assets at fair value $ 326 $ 468 $ $ 498 $ 1,292 $ 325 $ 428 $ $ 468 $ 1,221 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2021 and 2020. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11 %, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the Table o f Contents targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Contributions during 2022 are expected to be approximately $ 280 million for U.S. pension plans, approximately $ 150 million for international pension plans and approximately $ 50 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits 2022 $ 724 $ 289 $ 84 2023 745 275 85 2024 731 278 87 2025 748 280 89 2026 770 308 90 2027 2031 4,230 1,715 469 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 2021 2020 2019 2021 2020 2019 2021 2020 2019 Net gain (loss) arising during the period $ 1,048 $ ( 448 ) $ ( 816 ) $ 815 $ ( 407 ) $ ( 227 ) $ 144 $ 198 $ 112 Prior service (cost) credit arising during the period ( 3 ) ( 1 ) ( 4 ) ( 29 ) 62 ( 1 ) ( 17 ) ( 3 ) ( 11 ) $ 1,045 $ ( 449 ) $ ( 820 ) $ 786 $ ( 345 ) $ ( 228 ) $ 127 $ 195 $ 101 Net loss (gain) amortization included in benefit cost $ 298 $ 303 $ 151 $ 142 $ 127 $ 64 $ ( 42 ) $ ( 18 ) $ ( 10 ) Prior service credit amortization included in benefit cost ( 38 ) ( 49 ) ( 49 ) ( 16 ) ( 18 ) ( 12 ) ( 63 ) ( 73 ) ( 78 ) $ 260 $ 254 $ 102 $ 126 $ 109 $ 52 $ ( 105 ) $ ( 91 ) $ ( 88 ) Table o f Contents Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 2021 2020 2019 2021 2020 2019 Net periodic benefit cost Discount rate 2.70 % 3.40 % 4.40 % 1.10 % 1.50 % 2.20 % Expected rate of return on plan assets 6.70 % 7.30 % 8.10 % 3.80 % 4.40 % 4.90 % Salary growth rate 4.60 % 4.20 % 4.30 % 2.80 % 2.80 % 2.80 % Interest crediting rate 4.70 % 4.90 % 3.40 % 3.00 % 2.80 % 2.90 % Benefit obligation Discount rate 3.00 % 2.70 % 3.40 % 1.50 % 1.10 % 1.50 % Salary growth rate 4.60 % 4.60 % 4.20 % 2.90 % 2.80 % 2.80 % Interest crediting rate 5.00 % 4.70 % 4.90 % 3.00 % 3.00 % 2.80 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2022, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will be 6.70 %, as compared to a range of 6.50 % to 6.70 % in 2021. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 2021 2020 Health care cost trend rate assumed for next year 6.4 % 6.6 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate 2032 2032 Savings Plans The Company also maintains defined contribution savings plans in the U.S. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2021, 2020 and 2019 were $ 158 million, $ 158 million and $ 143 million, respectively. Table o f Contents 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 2021 2020 2019 Interest income $ ( 36 ) $ ( 59 ) $ ( 274 ) Interest expense 806 831 893 Exchange losses 297 145 187 Income from investments in equity securities, net (1) ( 1,940 ) ( 1,338 ) ( 170 ) Net periodic defined benefit plan (credit) cost other than service cost ( 212 ) ( 339 ) ( 545 ) Other, net ( 256 ) ( 130 ) 38 $ ( 1,341 ) $ ( 890 ) $ 129 (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period, while gains and losses from ownership interests in investment funds are accounted for on a one quarter lag. The Company estimates losses of approximately $ 500 million will be recorded in the first quarter of 2022 from ownership interests in investment funds. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment, which were fully divested by the first quarter of 2020. Interest paid was $ 779 million in 2021, $ 822 million in 2020 and $ 841 million in 2019. 16. Taxes on Income A reconciliation between the effective tax rate for income from continuing operations and the U.S. statutory rate is as follows: 2021 2020 2019 Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income from continuing operations before taxes $ 2,915 21.0 % $ 1,231 21.0 % $ 1,506 21.0 % Differential arising from: Foreign earnings ( 1,446 ) ( 10.4 ) ( 965 ) ( 16.5 ) ( 461 ) ( 6.4 ) GILTI and the foreign-derived intangible income deduction ( 75 ) ( 0.5 ) 349 6.0 323 4.5 Tax settlements ( 275 ) ( 2.0 ) ( 13 ) ( 0.2 ) ( 139 ) ( 1.9 ) RD tax credit ( 81 ) ( 0.6 ) ( 108 ) ( 1.8 ) ( 116 ) ( 1.6 ) Acquisition of VelosBio ( 9 ) ( 0.1 ) 559 9.5 Acquisition of Pandion 356 2.6 Valuation allowances 102 0.7 37 0.6 115 1.6 Restructuring 61 0.4 105 1.8 39 0.5 Acquisition-related costs, including amortization 8 0.1 38 0.6 70 1.0 State taxes 2 57 1.0 ( 12 ) ( 0.2 ) Acquisition of OncoImmune 97 1.7 Acquisition of Peloton 209 2.9 Tax Cuts and Jobs Act of 2017 117 1.6 Other ( 37 ) ( 0.2 ) ( 47 ) ( 0.8 ) ( 86 ) ( 1.2 ) $ 1,521 11.0 % $ 1,340 22.9 % $ 1,565 21.8 % The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017 and the Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA Table o f Contents remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized and resulted in additional income tax expense in 2018 and 2019. The Companys remaining transition tax liability under the TCJA, which has been reduced by payments and the utilization of foreign tax credits, was $ 2.6 billion at December 31, 2021, of which $ 390 million is included in Income taxes payable and the remainder of $ 2.2 billion is included in Other Noncurrent Liabilities . As a result of the transition tax under the TCJA, the Company is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for foreign withholding taxes that would apply. The Company remains indefinitely reinvested with respect to its financial statement basis in excess of tax basis of its foreign subsidiaries. A determination of the deferred tax liability with respect to this basis difference is not practicable. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the U.S., particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21%. Beginning in 2021, the Company has an additional tax incentive in the form of a tax holiday in Switzerland for a newly active legal entity which is effective through 2030. Income from continuing operations before taxes consisted of: Years Ended December 31 2021 2020 2019 Domestic $ 1,854 $ ( 3,814 ) $ ( 66 ) Foreign 12,025 9,677 7,237 $ 13,879 $ 5,863 $ 7,171 Taxes on income from continuing operations consisted of: Years Ended December 31 2021 2020 2019 Current provision Federal $ 74 $ 893 $ 642 Foreign 1,273 969 1,523 State ( 13 ) 44 ( 40 ) 1,334 1,906 2,125 Deferred provision Federal 240 ( 605 ) ( 328 ) Foreign ( 77 ) 64 ( 228 ) State 24 ( 25 ) ( 4 ) 187 ( 566 ) ( 560 ) $ 1,521 $ 1,340 $ 1,565 Table o f Contents Deferred income taxes at December 31 consisted of: 2021 2020 Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 2,933 $ 109 $ 1,250 Inventory related 119 370 43 315 Accelerated depreciation 589 587 Equity investments 335 175 Pensions and other postretirement benefits 487 338 826 248 Compensation related 301 235 Unrecognized tax benefits 75 117 Net operating losses and other tax credit carryforwards 867 764 Other 434 180 743 81 Subtotal 2,283 4,745 2,837 2,656 Valuation allowance ( 287 ) ( 404 ) Total deferred taxes $ 1,996 $ 4,745 $ 2,433 $ 2,656 Net deferred income taxes $ 2,749 $ 223 Recognized as: Other Assets $ 692 $ 782 Deferred Income Taxes $ 3,441 $ 1,005 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2021, $ 181 million of deferred tax assets on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 164 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 686 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards. Valuation allowances of $ 123 million have been established on these U.S. tax credit carryforwards and NOL carryforwards. Income taxes paid in 2021, 2020 and 2019 (including amounts attributable to discontinued operations) were $ 2.4 billion, $ 2.7 billion and $ 4.5 billion, respectively. Tax benefits relating to stock option exercises were $ 21 million in 2021, $ 12 million in 2020 and $ 65 million in 2019. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: 2021 2020 2019 Balance January 1 $ 1,537 $ 1,225 $ 1,893 Additions related to current year positions 306 298 199 Additions related to prior year positions 63 110 46 Reductions for tax positions of prior years (1) ( 230 ) ( 4 ) ( 454 ) Settlements (1) ( 46 ) ( 70 ) ( 356 ) Lapse of statute of limitations (2) ( 58 ) ( 22 ) ( 103 ) Spin-off of Organon ( 43 ) Balance December 31 $ 1,529 $ 1,537 $ 1,225 (1) Amounts in 2021 and 2019 reflect settlements with the IRS discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.5 billion at December 31, 2021, the income tax provision would reflect a favorable net impact of $ 1.5 billion. The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2021 could decrease by up to approximately $ 11 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys Table o f Contents examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to a (benefit) expense of $( 37 ) million in 2021, $ 16 million in 2020 and $( 53 ) million in 2019. These amounts reflect the beneficial impacts of various tax settlements, including the settlements discussed below. Liabilities for accrued interest and penalties were $ 192 million and $ 205 million as of December 31, 2021 and 2020, respectively. In 2021, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2015-2016 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 190 million (of which $ 172 million related to continuing operations and $ 18 million related to discontinued operations). The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 236 million net tax benefit in 2021 (of which $ 207 million related to continuing operations and $ 29 million related to discontinued operations). This net benefit reflects reductions in reserves for unrecognized tax benefits and other related liabilities for tax positions relating to the years that were under examination. In 2019, the IRS concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million (of which $ 142 million related to discontinued operations with an offsetting credit of $ 35 million related to continuing operations). The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019 (of which $ 106 million related to continuing operations and $ 258 million related to discontinued operations). This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. The IRS is currently conducting examinations of the Companys tax returns for the years 2017 and 2018. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2021. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 2021 2020 2019 Net Income from Continuing Operations Attributable to Merck Co., Inc. $ 12,345 $ 4,519 $ 5,690 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 704 2,548 4,153 Net income attributable to Merck Co., Inc. $ 13,049 $ 7,067 $ 9,843 Average common shares outstanding 2,530 2,530 2,565 Common shares issuable (1) 8 11 15 Average common shares outstanding assuming dilution 2,538 2,541 2,580 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders: Income from Continuing Operations $ 4.88 $ 1.79 $ 2.22 Income from Discontinued Operations 0.28 1.01 1.62 Net Income $ 5.16 $ 2.79 $ 3.84 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders: Income from Continuing Operations $ 4.86 $ 1.78 $ 2.21 Income from Discontinued Operations 0.28 1.00 1.61 Net Income $ 5.14 $ 2.78 $ 3.81 (1) Issuable primarily under share-based compensation plans. Table o f Contents In 2021, 2020 and 2019, 9 million, 5 million and 2 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in each component of other comprehensive income (loss) are as follows: Derivatives Investments Employee Benefit Plans Foreign Currency Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2019, net of taxes $ 166 $ ( 78 ) $ ( 3,556 ) $ ( 2,077 ) $ ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax 86 140 ( 948 ) 112 ( 610 ) Tax ( 15 ) 192 ( 16 ) 161 Other comprehensive income (loss) before reclassification adjustments, net of taxes 71 140 ( 756 ) 96 ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) 66 (3) ( 239 ) Tax 55 ( 15 ) 40 Reclassification adjustments, net of taxes ( 206 ) ( 44 ) 51 ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) 96 ( 705 ) 96 ( 648 ) Balance at December 31, 2019, net of taxes 31 18 ( 4,261 ) ( 1,981 ) ( 6,193 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 383 ) 3 ( 599 ) 64 ( 915 ) Tax 84 111 89 284 Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 299 ) 3 ( 488 ) 153 ( 631 ) Reclassification adjustments, pretax 2 (1) ( 21 ) (2) 272 (3) 253 Tax ( 63 ) ( 63 ) Reclassification adjustments, net of taxes 2 ( 21 ) 209 190 Other comprehensive income (loss), net of taxes ( 297 ) ( 18 ) ( 279 ) 153 ( 441 ) Balance at December 31, 2020, net of taxes ( 266 ) ( 4,540 ) (4) ( 1,828 ) ( 6,634 ) Other comprehensive income (loss) before reclassification adjustments, pretax 333 1,922 ( 304 ) 1,951 Tax ( 75 ) ( 374 ) ( 119 ) ( 568 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes 258 1,548 ( 423 ) 1,383 Reclassification adjustments, pretax 192 (1) 281 (3) 473 Tax ( 40 ) ( 60 ) ( 100 ) Reclassification adjustments, net of taxes 152 221 373 Other comprehensive income (loss), net of taxes 410 1,769 ( 423 ) 1,756 Spin-off of Organon (see Note 3) 28 421 449 Balance at December 31, 2021, net of taxes $ 144 $ $ ( 2,743 ) (4) $ ( 1,830 ) $ ( 4,429 ) (1) Primarily relates to foreign currency cash flow hedges that were reclassified from AOCL to Sales . (2) Represents net realized gains on the sales of available-for-sale debt securities that were reclassified from AOCL to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 3.6 billion and $ 5.4 billion at December 31, 2021 and 2020, respectively, and other postretirement benefit plan net gain of $ 473 million and $ 391 million at December 31, 2021 and 2020, respectively, as well as pension plan prior service credit of $ 190 million and $ 255 million at December 31, 2021 and 2020, respectively, and other postretirement benefit plan prior service credit of $ 181 million and $ 244 million at December 31, 2021 and 2020, respectively. Table o f Contents 19. Segment Reporting The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. Beginning in 2021, the amortization of intangible assets previously included as part of the calculation of segment profits is now included in unallocated non-segment corporate expenses. Prior period Pharmaceutical and Animal Health segment profits have been recast to reflect this change on a comparable basis. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment during the first quarter of 2020. Table o f Contents Sales of the Companys products were as follows: Years Ended December 31 2021 2020 2019 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 9,765 $ 7,421 $ 17,186 $ 8,352 $ 6,028 $ 14,380 $ 6,305 $ 4,779 $ 11,084 Alliance revenue - Lynparza (1) 515 473 989 417 308 725 269 176 444 Alliance revenue - Lenvima (1) 417 287 704 359 220 580 239 165 404 Vaccines Gardasil/Gardasil 9 1,881 3,792 5,673 1,755 2,184 3,938 1,831 1,905 3,737 ProQuad/M-M-R II/Varivax 1,629 506 2,135 1,378 500 1,878 1,683 592 2,275 Pneumovax 23 547 346 893 727 359 1,087 679 247 926 RotaTeq 473 334 807 486 311 797 506 284 791 Vaqta 100 79 179 103 67 170 130 108 238 Hospital Acute Care Bridion 762 770 1,532 583 615 1,198 533 598 1,131 Prevymis 153 218 370 119 162 281 84 81 165 Primaxin 2 258 259 2 248 251 2 271 273 Noxafil 60 199 259 42 287 329 282 380 662 Cancidas 4 208 212 7 207 213 6 242 249 Invanz ( 5 ) 207 202 9 202 211 30 233 263 Zerbaxa 4 ( 5 ) ( 1 ) 74 56 130 63 58 121 Immunology Simponi 825 825 838 838 830 830 Remicade 299 299 330 330 411 411 Neuroscience Belsomra 78 241 318 81 247 327 92 214 306 Virology Molnupiravir 632 320 952 Isentress/Isentress HD 294 474 769 326 531 857 398 576 975 Cardiovascular Alliance revenue - Adempas/Verquvo (2) 312 30 342 259 22 281 194 10 204 Adempas 252 252 220 220 215 215 Diabetes Januvia 1,404 1,920 3,324 1,470 1,836 3,306 1,724 1,758 3,482 Janumet 367 1,597 1,964 477 1,494 1,971 589 1,452 2,041 Other pharmaceutical (3) 1,007 1,302 2,310 984 1,328 2,312 1,215 1,661 2,873 Total Pharmaceutical segment sales 20,401 22,353 42,754 18,010 18,600 36,610 16,854 17,246 34,100 Animal Health: Livestock 667 2,628 3,295 612 2,327 2,939 582 2,201 2,784 Companion Animals 1,091 1,182 2,273 872 892 1,764 724 885 1,609 Total Animal Health segment sales 1,758 3,810 5,568 1,484 3,219 4,703 1,306 3,086 4,393 Other segment sales (4) 23 23 174 1 175 Total segment sales 22,159 26,163 48,322 19,517 21,819 41,336 18,334 20,333 38,668 Other (5) 266 116 382 71 111 182 86 368 453 $ 22,425 $ 26,279 $ 48,704 $ 19,588 $ 21,930 $ 41,518 $ 18,420 $ 20,701 $ 39,121 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 5). (2) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 5). (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents sales for the Healthcare Services segment. All the businesses in the Healthcare Services segment were fully divested by the first quarter of 2020. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales (including sales to Organon). Other for 2021 also includes $ 185 million related to the achievement of milestones for an out-licensed product that triggered contingent payments to Merck. Table o f Contents Consolidated sales by geographic area where derived are as follows: Years Ended December 31 2021 2020 2019 United States $ 22,425 $ 19,588 $ 18,420 Europe, Middle East and Africa 13,341 11,547 10,496 China 4,378 2,751 2,180 Japan 2,726 2,602 2,609 Asia Pacific (other than China and Japan) 2,407 2,113 2,126 Latin America 2,206 1,890 2,015 Other 1,221 1,027 1,275 $ 48,704 $ 41,518 $ 39,121 A reconciliation of segment profits to Income from Continuing Operations Before Taxes is as follows: Years Ended December 31 2021 2020 2019 Segment profits: Pharmaceutical segment $ 30,977 $ 26,106 $ 23,448 Animal Health segment 1,950 1,669 1,612 Other segments 1 ( 7 ) Total segment profits 32,927 27,776 25,053 Other profits 156 75 295 Unallocated: Interest income 36 59 274 Interest expense ( 806 ) ( 831 ) ( 893 ) Amortization ( 1,636 ) ( 1,817 ) ( 1,695 ) Depreciation ( 1,414 ) ( 1,519 ) ( 1,491 ) Research and development ( 11,692 ) ( 12,911 ) ( 9,351 ) Restructuring costs ( 661 ) ( 575 ) ( 626 ) Other unallocated, net ( 3,031 ) ( 4,394 ) ( 4,395 ) $ 13,879 $ 5,863 $ 7,171 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of intangible assets and purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net, includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration, and other miscellaneous income or expense items. Table o f Contents Equity loss from affiliates and depreciation included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2021 Included in segment profits: Equity loss from affiliates $ 11 $ $ $ 11 Depreciation 6 158 164 Year Ended December 31, 2020 Included in segment profits: Equity loss from affiliates $ 6 $ $ $ 6 Depreciation 6 143 1 150 Year Ended December 31, 2019 Included in segment profits: Equity loss from affiliates $ $ $ $ Depreciation 9 105 10 124 Property, plant and equipment, net, by geographic area where located is as follows: December 31 2021 2020 2019 United States $ 11,759 $ 10,394 $ 8,963 Europe, Middle East and Africa 6,081 5,314 4,129 Asia Pacific (other than China and Japan) 857 737 692 China 220 216 174 Latin America 199 169 180 Japan 159 166 152 Other 4 4 7 $ 19,279 $ 17,000 $ 14,297 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Table o f Contents Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2021 and 2020, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2021, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Table o f Contents Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. U.S. Rebate Accruals - Medicaid, Managed Care and Medicare Part D As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts representing a portion of the accrual take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The accrued balance relative to the provision for rebates included in accrued and other current liabilities was $2.6 billion as of December 31, 2021, of which the majority relates to U.S. rebate accruals Medicaid, Managed Care and Medicare Part D. The principal considerations for our determination that performing procedures relating to U.S. rebate accruals - Medicaid, Managed Care, and Medicare Part D is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the rebate accruals, as the accruals are based on assumptions developed using pricing information and historical customer segment utilization mix, and a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating evidence related to these assumptions. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to U.S. rebate accruals - Medicaid, Managed Care, and Medicare Part D, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others (i) developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., pricing information, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid, (ii) comparing the independent estimate to the rebate accruals recorded by management, and (iii) testing rebate claims paid, including evaluating those claims for consistency with the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 25, 2022 We have served as the Companys auditor since 2002. Table o f Contents (b) Supplementary Data Selected Quarterly Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q (3) 1st Q 2021 (4) Sales $ 13,521 $ 13,154 $ 11,402 $ 10,627 Gross Profit 9,648 9,704 8,298 7,428 Net Income from Continuing Operations Attributable to Merck Co., Inc. 3,820 4,567 1,213 2,745 (Loss) Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests (62) 332 434 Net Income Attributable to Merck Co., Inc. 3,758 4,567 1,545 3,179 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 1.51 $ 1.81 $ 0.48 $ 1.08 (Loss) Income from Discontinued Operations (0.02) 0.13 0.17 Net Income $ 1.49 $ 1.81 $ 0.61 $ 1.26 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders Income from Continuing Operations $ 1.51 $ 1.80 $ 0.48 $ 1.08 (Loss) Income from Discontinued Operations (0.02) 0.13 0.17 Net Income $ 1.48 $ 1.80 $ 0.61 $ 1.25 2020 (4) Sales $ 10,948 $ 10,929 $ 9,353 $ 10,288 Gross Profit 5,919 7,916 6,606 7,459 Net (Loss) Income from Continuing Operations Attributable to Merck Co., Inc. (2,617) 2,324 2,341 2,471 Income from Discontinued Operations, Net of Taxes and Amounts Attributable to Noncontrolling Interests 523 617 661 748 Net (Loss) Income Attributable to Merck Co., Inc. (2,094) 2,941 3,002 3,219 Basic (Loss) Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders (Loss) Income from Continuing Operations $ (1.03) $ 0.92 $ 0.93 $ 0.98 Income from Discontinued Operations 0.21 0.24 0.26 0.30 Net (Loss) Income $ (0.83) $ 1.16 $ 1.19 $ 1.27 (Loss) Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders (Loss) Income from Continuing Operations $ (1.03) $ 0.92 $ 0.92 $ 0.97 Income from Discontinued Operations 0.21 0.24 0.26 0.29 Net (Loss) Income $ (0.83) $ 1.16 $ 1.18 $ 1.26 (1) Amounts in the fourth quarter of 2020 include charges related to the acquisitions of VelosBio Inc. and OncoImmune (see Note 4) and an intangible asset impairment charge related to Zerbaxa (see Note 9). (2) Amounts in the third quarter of 2020 include charges related to transactions with Seagen Inc (see Note 4). (3) Amounts in the second quarter of 2021 include a charge related to the acquisition of Pandion Therapeutics, Inc. (see Note 4). (4) Reflects the results of the businesses that were spun-off to Organon on June 2, 2021 as discontinued operations for all periods presented (see Note 3). Table o f Contents "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2021, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2021. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Table o f Contents Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2021. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2021, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Robert M. Davis Caroline Litchfield Chief Executive Officer and President Executive Vice President and Chief Financial Officer " +1,mrk-,20201231," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off (the Spin-Off) products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia (ezetimibe) and Vytorin (ezetimibe/simvastatin), as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The Spin-Off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. See Risk Factors - Risks Related to the Proposed Spin-Off of Organon. s Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) 2020 2019 2018 Total Sales $ 47,994 $ 46,840 $ 42,294 Pharmaceutical 43,021 41,751 37,689 Keytruda 14,380 11,084 7,171 Januvia/Janumet 5,276 5,524 5,914 Gardasil/Gardasil 9 3,938 3,737 3,151 ProQuad/M-M-R II /Varivax 1,878 2,275 1,798 Bridion 1,198 1,131 917 Pneumovax 23 1,087 926 907 Isentress/Isentress HD 857 975 1,140 Simponi 838 830 893 RotaTeq 797 791 728 Alliance revenue - Lynparza (1) 725 444 187 Implanon/Nexplanon 680 787 703 Zetia/Vytorin 664 874 1,355 Alliance revenue - Lenvima (1) 580 404 149 Animal Health 4,703 4,393 4,212 Livestock 2,939 2,784 2,630 Companion Animals 1,764 1,609 1,582 Other Revenues (2) 270 696 393 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs. (2) Other revenues are primarily comprised of third-party manufacturing sales and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with cervical cancer, classical Hodgkin Lymphoma (cHL), cutaneous squamous cell carcinoma (cSCC), esophageal cancer, gastric or gastroesophageal junction adenocarcinoma, head and neck squamous cell carcinoma (HNSCC), hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) cancer, including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma (PMBCL), tumor mutational burden-high (TMB-H) cancer, and urothelial carcinoma, including non-muscle invasive bladder cancer. Keytruda is also approved for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with chemotherapy for triple-negative breast cancer, in combination with axitinib for renal cell carcinoma, and in combination with lenvatinib for endometrial carcinoma; and Emend (aprepitant) for the prevention of certain chemotherapy-induced nausea and vomiting. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast, pancreatic, and prostate cancers; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for certain patients with endometrial carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases s caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; MMR II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole), an antifungal agent for the prevention of certain invasive fungal infections; Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant; Primaxin (imipenem and cilastatin) for injection, an antibiotic for the treatment of certain bacterial infections; Cancidas (caspofungin acetate) for injection, an anti-fungal agent for the treatment of certain fungal infections; Invanz (ertapenem) for injection, an antibiotic for the treatment of certain bacterial infections; Cubicin (daptomycin for injection), an antibiotic for the treatment of certain bacterial infections; and Zerbaxa (ceftolozane and tazobactam) for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, both of which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant; and NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory s drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto , a line of oral and topical parasitic control products, including the original Bravecto (fluralaner) products for dogs and cats that last up to 12 weeks; Bravecto (fluralaner) One-Month , a monthly product for dogs, and Bravecto Plus (fluralaner/moxidectin), a two-month product for cats; Sentinel, a line of oral parasitic products for dogs including Sentinel Spectrum (milbemycin oxime, lufenuron, and praziquantel) and Sentinel Flavor Tabs (milbemycin oxime, lufenuron); Optimmune (cyclosporine), an ophthalmic ointment; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies; and Sure Petcare products for companion animal identification and well-being, including the microchip and pet recovery system Home Again . For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2020 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2020. Product Date Approval Dificid (1) January 2020 U.S. Food and Drug Administration (FDA) approved Dificid as an oral suspension, and Dificid tablets for the treatment of Clostridioides (formerly Clostridium) difficile-associated diarrhea in children aged six months and older. Gardasil November 2020 Chinas National Medical Products Administration (NMPA) granted expanded approval for Gardasil for use in girls and women from 9 to 45 years of age. Gardasil 9 December 2020 Japans Ministry of Health, Labour and Welfare (MHLW) approved additional indication, dosage and administrations of Gardasil 9 (marketed as Silgard 9) for the prevention of anal cancer (squamous cell cancer) and precursor lesions (anal intraepithelial neoplasia (AIN) grade 1/2/3) caused by HPV types 6, 11, 16 and 18 for individuals 9 years and older and for Genital Warts (condyloma acuminate) for men 9 years and older. July 2020 Japans Pharmaceuticals and Medical Devices Agency (PMDA) approved Gardasil 9 for use in girls and women 9 years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine. June 2020 FDA granted accelerated approval for an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by HPV Types 16, 18, 31, 33, 45, 52, and 58. s Keytruda December 2020 NMPA approved Keytruda as monotherapy for the first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC whose tumors express PD-L1 (Combined Positive Score CPS 20) as determined by a fully validated test. November 2020 FDA granted accelerated approval for Keytruda in combination with chemotherapy for patients with locally recurrent unresectable or metastatic triplenegative breast cancer whose tumors express PD-L1 (CPS 10). October 2020 FDA approved an expanded label for Keytruda , as monotherapy for the treatment of adult patients with relapsed or refractory cHL. August 2020 PMDA approved Keytruda for use at an additional recommended dosage of 400 mg every six weeks (Q6W) administered as an intravenous infusion over 30 minutes across all adult indications, including Keytruda monotherapy and combination therapy. August 2020 PMDA approved Keytruda for the treatment of patients whose tumors are PD-L1-positive, and have radically unresectable, advanced or recurrent esophageal squamous cell carcinoma (ESCC) who have progressed after chemotherapy. June 2020 FDA approved Keytruda as monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR colorectal cancer. June 2020 FDA approved Keytruda as monotherapy for the treatment of patients with recurrent or metastatic cSCC that is not curable by surgery or radiation. June 2020 NMPA approved Keytruda as monotherapy for the treatment of patients with locally advanced or metastatic ESCC whose tumors express PD-L1 (CPS 10) as determined by a fully validated test, following failure of one prior line of systemic therapy. June 2020 FDA granted accelerated approval for Keytruda as monotherapy for the treatment of adult and pediatric patients with unresectable or metastatic TMB-H [10 mutations/megabase (mut/Mb)] solid tumors, as determined by an FDA-approved test, that have progressed following prior treatment and who have no satisfactory alternative treatment options. April 2020 FDA granted accelerated approval for Keytruda for use at an additional recommended dose of 400 mg every six weeks (Q6W) for all approved adult indications. January 2020 FDA approved Keytruda for patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, non-muscle invasive bladder cancer with carcinoma in situ with or without papillary tumors who are ineligible for or have elected not to undergo cystectomy. Koselugo (2) April 2020 FDA approved the kinase inhibitor Koselugo for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN). Lenvima November 2020 NMPA approved Lenvima as a monotherapy for the treatment of differentiated thyroid cancer. s Lynparza (2) December 2020 PMDA approved Lynparza for the treatment of patients with BRCA gene-mutated ( BRCA m) castration-resistant prostate cancer with distant metastasis. December 2020 PMDA approved Lynparza as maintenance treatment after platinum-based chemotherapy for patients with BRCA m curatively unresectable pancreas cancer. December 2020 PMDA approved Lynparza as maintenance treatment after first-line chemotherapy containing bevacizumab (genetical recombination) in patients with homologous recombination repair deficient (HRD) ovarian cancer. November 2020 The European Commission (EC) approved Lynparza for the maintenance treatment of adult patients with advanced (FIGO stages III and IV) high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer who are in response (complete or partial) following completion of first-line platinum-based chemotherapy in combination with bevacizumab and whose cancer is associated with HRD-positive status defined by either a breast cancer susceptibility gene 1/2 ( BRCA 1/2) mutation and/or genomic instability. November 2020 EC approved Lynparza as monotherapy for the treatment of adult patients with metastatic castration-resistant prostate cancer (mCRPC) and BRCA1/2 mutations (germline and/or somatic) who have progressed following a prior therapy that included a new hormonal agent. July 2020 EC approved Lynparza as a monotherapy for the maintenance treatment of adult patients with germline BRCA 1/2 mutations who have metastatic adenocarcinoma of the pancreas and have not progressed after a minimum of 16 weeks of platinum treatment within a first-line chemotherapy regimen. May 2020 FDA approved Lynparza for the treatment of adult patients with deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene-mutated mCRPC, as determined by an FDA-approved test, who have progressed following prior treatment with enzalutamide or abiraterone. May 2020 FDA approved Lynparza in combination with bevacizumab as a first-line maintenance treatment of adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy and whose cancer is associated with HRD positive status defined by either a deleterious or suspected deleterious BRCA mutation, and/or genomic instability, as determined by an FDA-approved test. Recarbrio June 2020 FDA approved Recarbrio for the treatment of patients 18 years of age and older with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP). Steglatro (3) July 2020 NMPA approved Steglatro 5 mg tablets for the treatment of type 2 diabetes. (1) Dificid in the U.S. and Canada is a trademark of Cubist Pharmaceuticals LLC, an indirect wholly-owned subsidiary of Merck Sharp Dohme Corp. (2) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza and Koselugo . (3) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. s Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers, and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products as well as competitors products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. United States In the United States, federal and state governments for many years have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal and state laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for medicines purchased by certain state and federal entities such as the Department of Defense, Veterans Affairs, Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Health Care Programs The United States enacted major health care reform legislation in 2010 (the ACA). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay 70% of the cost of the medicine, including biosimilar products, when Medicare Part D beneficiaries are in the Medicare Part D coverage gap (i.e., the so-called donut hole), which increased from 50% beginning in 2019 as a result of the Balanced Budget Act of 2018. Merck recorded approximately $700 million, $615 million and $365 million as a reduction to revenue in 2020, 2019, and 2018, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. The total annual industry fee has been set at $2.8 billion. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded approximately $85 million, $112 million, and $124 million of costs within Selling, general and administrative s expenses in 2020, 2019 and 2018, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. More recently, although CMS previously declined to define what constitutes a product line extension (beyond the statutory definition), CMS issued a new rule on December 21, 2020 that will significantly expand the definition of the term line extension as of January 1, 2022 to include a broad range of products, including products reflecting new strengths, dosage forms, release mechanisms, and routes of administration. This expanded definition will increase the number of drugs subject to a higher Medicaid rebate. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons, which also may result in an increase in the Companys Medicaid rebates. The impact of these and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. The Patient Protection and Affordable Care Act There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. In December 2018, a Texas federal district court struck down the ACA on the grounds that the individual health insurance mandate is unconstitutional. The United States Supreme Court heard arguments in this case on November 10, 2020. The Company is participating in the health care debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any changes to the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Other Legislative Changes In addition, other legislative changes have been proposed and adopted in the United States since the ACA was enacted. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. Drug Pricing The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins, including, in the United States (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. In November 2020, the Department of Health and Human Services Office of Inspector General (OIG) issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to pharmacy benefit managers (PBMs) on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. This rulemaking also established, effective January 1, 2021, a new safe harbor for point of sale discounts at the pharmacy counter and a new safe harbor for certain services arrangements between pharmaceutical manufacturers and PBMs. CMS also recently issued an Interim Final Rule (the MFN Rule) that alters how physicians will be reimbursed under the Medicare program for physician administered drugs. Pursuant to the MFN Rule, which was intended to be effective January 1, 2021, rather than use the current Average Sales Price (ASP)-based payment framework for certain physician-administered drugs, the MFN Rule would institute a new pricing system for certain prescription drugs and biologic products covered by Medicare Part B in which Medicare would reimburse no more than the most favored nation price, meaning the lowest price after adjusting for volume and differences in gross domestic product, for the top 50 Part B reimbursed products, which includes Keytruda , sold in 22 member countries of the Organisation for Economic Co-operation and Development (OECD). Several organizations, including two s trade groups of which Merck is a member, have filed suit challenging this regulation. Those lawsuits remain pending with a preliminary injunction having been entered in one of the cases. At this time, the Company cannot predict with any certainty if or when the MFN Rule will go into effect. Implementation of the MFN Rule could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The FDA also recently issued rulemaking allowing the commercial importation of certain prescription drugs from Canada through FDA-authorized, time-limited programs sponsored by states or Native American tribes recognized under the rule, and, in certain future circumstances, pharmacists and wholesalers. The FDA also recently released final guidance for industry detailing procedures for drug manufacturers to import FDA-approved prescription drug, biological, and combination products that were manufactured abroad and authorized and intended for sale in a foreign country. A trade organization, in which Merck is a member, brought suit, which remains pending in federal district court, challenging the commercial importation rule. These proposed changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform has contributed to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. The pharmaceutical industry also could be considered a potential source of savings via other legislative and administrative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. There was active consideration of drug-pricing related legislation in the last Congress, and it remains very uncertain as to what proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and PBMs have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely affect revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payor has taken the position that multiple branded products are therapeutically comparable. As the U.S. payor market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payors. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2020, the Companys gross U.S. sales were reduced by 45.5% as a result of rebates, discounts and returns. European Union Efforts toward health care cost containment remain intense in the European Union (EU). The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in the EU attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs. Reference pricing may either compare a products prices in other markets (external reference pricing), or compare a products price with those of other products in a national class (internal reference pricing). The authorities then use the price data to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed s pursuant to local regulations. Some EU Member States have established free-pricing systems, but regulate the pricing for drugs through profit control plans. Others seek to negotiate or set prices based on the cost-effectiveness of a product or an assessment of whether it offers a therapeutic benefit over other products in the relevant class. The downward pressure on health care costs in general, particularly prescription drugs, has become intense. As a result, increasingly high barriers are being erected to the entry of new products. In some EU Member States, cross-border imports from low-priced markets also exert competitive pressure that may reduce pricing within an EU Member State. Additionally, EU Member States have the power to restrict the range of pharmaceutical products for which their national health insurance systems provide reimbursement. In the EU, pricing and reimbursement plans vary widely from Member State to Member State. Some EU Member States provide that drug products may be marketed only after a reimbursement price has been agreed. Some EU Member States may require the completion of additional studies that compare the cost-effectiveness of a particular product candidate to already available therapies or so-called health technology assessments (HTA), in order to obtain reimbursement or pricing approval. The HTA of pharmaceutical products is becoming an increasingly common part of the pricing and reimbursement procedures in most EU Member States. The HTA process, which is governed by the national laws of these countries, involves the assessment of the cost-effectiveness, public health impact, therapeutic impact and/or the economic and social impact of use of a given pharmaceutical product in the national health care system of the individual country is conducted. Ultimately, HTA measures the added value of a new health technology compared to existing ones. The outcome of HTAs regarding specific pharmaceutical products will often influence the pricing and reimbursement status granted to these pharmaceutical products by the regulatory authorities of individual EU Member States. A negative HTA of one of the Companys products may mean that the product is not reimbursable or may force the Company to reduce its reimbursement price or offer discounts or rebates. A negative HTA by a leading and recognized HTA body could also undermine the Companys ability to obtain reimbursement for the relevant product outside a jurisdiction. For example, EU Member States that have not yet developed HTA mechanisms may rely to some extent on the HTA performed in other countries with a developed HTA framework, to inform their pricing and reimbursement decisions. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. To obtain reimbursement or pricing approval in some EU Member States, the Company may be required to conduct studies that compare the cost-effectiveness of the Companys product candidates to other therapies that are considered the local standard of care. There can be no assurance that any EU Member State will allow favorable pricing, reimbursement and market access conditions for any of the Companys products, or that it will be feasible to conduct additional cost-effectiveness studies, if required. Brexit In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period applied from January 31, 2020 until December 31, 2020, and during this period the EU and UK operated as if the UK was an EU Member State, and the UK continued to participate in the EU Customs Union allowing for the freedom of movement for people and goods. It was announced on December 24, 2020, that the EU and the UK agreed to a Trade and Cooperation Agreement (TCA). The TCA sets out the new arrangements for trade of goods, including medicines and vaccines, which allows goods to continue to flow between the EU and the UK. On December 29, 2020, the Council of the EU adopted the decision to sign the TCA and for the TCA to be provisionally applied from January 1, 2021. The UK and EU signed the TCA on December 30, 2020. In order for the TCA to be ratified and formally come into effect, the Council of the EU must unanimously approve the TCA and the European Parliament must consent to it, which the Company believes will occur. As a result of the TCA, the Company believes that its operations will not be materially adversely affected by Brexit. s Japan In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2021 and is expected to impact many Company products. China The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. Additionally, in 2017, the Chinese government updated the National Reimbursement Drug List (NRDL) for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2020, drugs were added to the NRDL through double-digit price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first three rounds of VBP have had, on average, a price reduction of 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. Emerging Markets The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and measures impacting intellectual property, including in exceptional cases, threats of compulsory licenses, that aim to put pressure on the price of innovative pharmaceuticals or result in constrained market access to innovative medicine. The Company anticipates that pricing pressures and market access challenges will continue in the future to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, credit worthiness of health care partners, such as hospitals, due to COVID-19, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and s its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. Regulation The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, approval for marketing, labeling, advertising, manufacturing, wholesale distribution, integrity of the supply chain, pharmacovigilance and safety monitoring of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its medicines, vaccines, and to quality health care around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. Merck has funded Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the EU General Data Protection Regulation, (GDPR) which went into effect in May 2018 and imposes penalties of up to 4% of global revenue. s The GDPR and related implementing laws in individual EU Member States govern the collection and use of personal health data and other personal data in the EU. The GDPR increased responsibility and liability in relation to personal data that the Company processes. It also imposes a number of strict obligations and restrictions on the ability to process (which includes collection, analysis and transfer of) personal data, including health data from clinical trials and adverse event reporting. The GDPR also includes requirements relating to the consent of the individuals to whom the personal data relates, the information provided to the individuals prior to processing their personal data or personal health data, notification of data processing obligations to the national data protection authorities, and the security and confidentiality of the personal data. Further, the GDPR prohibits the transfer of personal data to countries outside of the EU that are not considered by the EC to provide an adequate level of data protection, including to the United States, except if the data controller meets very specific requirements. Following the Schrems II decision of the Court of Justice of the European Union on July 16, 2020, there is considerable uncertainty as to the permissibility of international data transfers under the GDPR. In light of the implications of this decision, the Company may face difficulties regarding the transfer of personal data from the EU to third countries. Failure to comply with the requirements of the GDPR and the related national data protection laws of the EU Member States may result in significant monetary fines and other administrative penalties as well as civil liability claims from individuals whose personal data was processed. Data protection authorities from the different EU Member States may still implement certain variations, enforce the GDPR and national data protection laws differently, and introduce additional national regulations and guidelines, which adds to the complexity of processing personal data in the EU. Guidance developed at both EU level and at the national level in individual EU Member States concerning implementation and compliance practices is often updated or otherwise revised. There is, moreover, a growing trend towards required public disclosure of clinical trial data in the EU which adds to the complexity of obligations relating to processing health data from clinical trials. Failing to comply with these obligations could lead to government enforcement actions and significant penalties against the Company, harm to its reputation, and adversely impact its business and operating results. The uncertainty regarding the interplay between different regulatory frameworks further adds to the complexity that the Company faces with regard to data protection regulation. Additional laws and regulations enacted in the United States (such as the California Consumer Privacy Act), Europe, Asia and Latin America, have increased enforcement and litigation activity in the United States and other developed markets, as well as increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks and facilitate the transfer of personal information across international borders. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, PBMs and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law s provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Januvia 2023 2022 2025-2026 2022 Janumet 2023 2023 N/A 2022 Janumet XR 2023 N/A N/A 2022 Isentress 2024 2023 (3) 2022-2026 2022 Simponi N/A (4) 2024 (5) N/A (4) N/A (4) Lenvima (6) 2025 (3) (with pending PTE) 2021 (patents), 2026 (3) (SPCs) 2026 2021 Adempas (7) 2026 (3) 2028 (3) 2027-2028 2023 Bridion 2026 (3) (with pending PTE) 2023 2024 Expired Nexplanon 2027 (device) 2025 (device) N/A 2025 Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) 2029 2033 Gardasil 2028 2021 (3) Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A 2025 Keytruda 2028 2028 (patents), 2030 (3) (SPCs) 2032-2033 2028 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 2024 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Sivextro 2028 2024 (patents), 2029 (SPCs) 2029 2024 Belsomra 2029 (3) N/A 2031 N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2029 N/A Segluromet (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (10) N/A Steglatro (9) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A (10) Steglujan (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A (10) N/A Verquvo (7) 2031 (with pending PTE) N/A (11) N/A (11) N/A (11) Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) 2036 2031 Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. s (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) The Company has no marketing rights in the U.S., Japan or China. (5) Expiration of the distribution agreement with Janssen Pharmaceuticals, Inc. (6) Part of a global strategic oncology collaboration with Eisai. (7) Being commercialized in a worldwide collaboration with Bayer AG. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. (10) The Company has no marketing rights in Japan. (11) The Company has no marketing rights in the EU, Japan or China. The Company also has the following key U.S. patent protection for drug candidates under review or in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) 2027 V114 (pneumoconjugate vaccine) 2031 (vaccine composition) MK-7110 (CD24Fc) 2031 MK-8591A (islatravir/doravirine) 2032 MK-6482 (belzutifan) Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. s Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2020 on patent and know-how licenses and other rights amounted to $185 million. Merck also incurred royalty expenses amounting to $2.0 billion in 2020 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2020, approximately 16,750 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, metabolic diseases, infectious diseases, neurosciences, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on pre-clinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can s be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. More than one of these special designations can be granted for a given application (i.e., a product designated as a Breakthrough Therapy may also be eligible for Priority Review). Due to the COVID-19 public health crisis, the United States Secretary of Health and Human Services has exercised statutory authority to determine that a public health emergency exists, and declare these circumstances justify the emergency use of drugs and biological products as authorized by the FDA. While in effect, this declaration enables the FDA to issue Emergency Use Authorizations (EUAs) permitting distribution and use of specific medical products absent NDA/BLA submission or approval, including products to treat or prevent diseases or conditions caused by the SARS-CoV-2 virus, subject to the terms of any such EUAs. The FDA must make certain findings to grant an EUA, including that it is reasonable to believe based on the totality of evidence that the drug or biologic may be effective, and that known or potential benefits when used under the terms of the EUA outweigh known or potential risks. Additionally, the FDA must find that there is no adequate, approved and available alternative to the emergency use. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in s particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other EU member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, the National Medical Products Administration in China, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, and the Therapeutic Goods Administration in Australia. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally or in late-stage clinical development. MK-7655A is combination of relebactum, a beta-lactamase inhibitor, and imipenem/cilastatin (a carbapenem antibiotic) under review in Japan for the treatment of bacterial infection. MK-7655A was approved by the FDA in 2019 and is marketed in the United States as Recarbrio . MK-1242, vericiguat, is an orally administered soluble guanylate cyclase (sGC) stimulator under review in the EU and in Japan to reduce the risk of cardiovascular death and heart failure hospitalization following a worsening heart failure event in patients with symptomatic chronic heart failure with reduced ejection fraction, in combination with other heart failure therapies. The applications are based on results from the Phase 3 VICTORIA trial. Vericiguat was approved by the FDA in January 2021 and will be marketed in the United States as Verquvo. Vericiguat is being jointly developed with Bayer. Bayer will commercialize vericiguat in territories outside the United States, if approved. MK-5618, selumetinib, is under review in the EU for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN) based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored Phase 2 SPRINT Stratum 1 trial. Selumetinib was approved by the FDA in April 2020 and is marketed in the United States as Koselugo. Selumetinib is being jointly developed and commercialized with AstraZeneca globally. V114 is an investigational 15-valent pneumococcal conjugate vaccine under priority review by the FDA for the prevention of invasive pneumococcal disease in adults 18 years of age and older. The FDA set a PDUFA date of July 18, 2021. The EMA is also reviewing an application for licensure of V114 in adults. Additionally, the Company has several ongoing Phase 3 trials evaluating V114 in pediatric patients. V114 previously received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease in pediatric patients 6 weeks to 18 years of age and adults 18 years of age and older. The Company is involved in litigation challenging the validity of several Pfizer Inc. patents that relate to pneumococcal vaccine technology in the United States and several foreign jurisdictions. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,400 clinical trials, including more than 1,000 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, estrogen receptor positive breast cancer, gastric, glioblastoma, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, non-small-cell lung, small-cell lung, melanoma, mesothelioma, ovarian, prostate, renal, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. s Keytruda in combination with chemotherapy is under review in the EU for the treatment of locally recurrent unresectable or metastatic triple negative breast cancer (TNBC) in adults whose tumors express PD-L1 with a CPS 10 and who have not received prior chemotherapy for metastatic disease based on the results of the KEYNOTE-355 trial. Keytruda was approved for this indication under accelerated approval based on progression-free survival (PFS) by the FDA in November 2020. Keytruda in combination with chemotherapy is also under review in Japan for the treatment of patients with locally recurrent unresectable or metastatic TNBC based on data from the KEYNOTE-355 trial. In July 2020, the FDA accepted for standard review a supplemental BLA for Keytruda for the treatment of patients with high-risk, early-stage TNBC in combination with chemotherapy as neoadjuvant (pre-operative) treatment, and then as a single agent as adjuvant (post-operative) treatment after surgery. The application was based on data from the first and second interim analyses of the KEYNOTE-522 trial. In February 2021, the FDAs Oncologic Drugs Advisory Committee (ODAC), which discussed the Companys supplemental BLA for Keytruda , voted that a regulatory decision should be deferred until further data are available from the Phase 3 KEYNOTE-522 trial. The study met one of the dual primary endpoints of pathological complete response and is continuing to evaluate event-free survival. The ODAC provides the FDA with independent, expert advice and recommendations on marketed and investigational medicines for use in the treatment of cancer. The FDA is not bound by the committees guidance but takes its advice into consideration. The PDUFA date for this application is March 29, 2021. The next interim analysis is calendar-driven, and data is expected in the third quarter of 2021. In February 2021, Merck announced that the Committee for Medicinal Products for Human Use (CHMP) of the EMA adopted a positive opinion recommending approval of an expanded label for Keytruda as monotherapy for the treatment of adult and pediatric patients aged 3 years and older with relapsed or refractory cHL who have failed an earlier line of therapy. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-204 trial, in which Keytruda monotherapy demonstrated a significant improvement in PFS compared with brentuximab vedotin, a commonly used treatment. The recommendation is also based on supportive data from an updated analysis of the KEYNOTE-087 trial, which supported EC approval of Keytruda for the treatment of adult patients with relapsed or refractory cHL. The CHMPs recommendation will now be reviewed by the EC for marketing authorization in the EU. Keytruda was approved for this indication by the FDA in October 2020. Keytruda is also under review as monotherapy for the first-line treatment of adult patients with metastatic MSI-H or dMMR colorectal cancer in Japan based on the result of the KEYNOTE-177 trial. Keytruda was approved for this indication by the FDA in June 2020 and by the EU in January 2021. In January 2021, the FDA accepted a supplemental BLA seeking use of Keytruda for the treatment of patients with locally advanced cSCC that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a PDUFA date of September 9, 2021. In December 2020, the FDA accepted and granted priority review for a supplemental BLA for Keytruda in combination with chemotherapy for the first-line treatment of patients with locally advanced unresectable or metastatic carcinoma of the esophagus and gastroesophageal junction. This supplemental BLA is based on data from the pivotal Phase 3 KEYNOTE-590 trial, in which Keytruda plus chemotherapy demonstrated significant improvements in the primary endpoints of overall survival (OS) and PFS versus chemotherapy in these patients regardless of PD-L1 expression status and tumor histology. These data were presented at the European Society of Medical Oncology (ESMO) Virtual Congress 2020. The FDA set a PDUFA date of April 13, 2021. In December 2020, the CHMP of the EMA announced the start of a procedure to extend the indication to include in combination with chemotherapy, first-line treatment of locally advanced unresectable or metastatic carcinoma of the esophagus or HER-2 negative gastroesophageal junction adenocarcinoma in adults for Keytruda , based on the results from KEYNOTE-590. Keytruda is also under review for this indication in Japan. Keytruda also received Breakthrough Therapy designation from the FDA in February 2020 for the combination of Keytruda with Padcev (enfortumab vedotin-ejfv), in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. s In January 2021, Merck announced first-time data from the Phase 3 KEYNOTE-598 study evaluating Keytruda in combination with ipilimumab (Yervoy) compared with Keytruda monotherapy as first-line treatment for patients with metastatic NSCLC without EGFR or ALK genomic tumor aberrations and whose tumors express PD-L1 (tumor proportion score 50%). Results of the study showed that the addition of ipilimumab to Keytruda did not improve OS or PFS but added toxicity compared with Keytruda monotherapy in these patients. These results were presented in the Presidential Symposium at the IASLC 2020 World Conference on Lung Cancer hosted by the International Association for the Study of Lung Cancer in January 2021 and published in the Journal of Clinical Oncology. As previously announced in November 2020, the study was discontinued due to futility based on the recommendation of an independent Data Monitoring Committee (DMC), which determined the benefit/risk profile of Keytruda in combination with ipilimumab did not support continuing the trial. The DMC also advised that patients in the study discontinue treatment with ipilimumab/placebo. In February 2021, Mercks announced that the Phase 3 KEYNOTE-122 trial evaluating Keytruda versus standard of care treatment (capecitabine, gemcitabine, or docetaxel) for the treatment of recurrent or metastatic nasopharyngeal cancer did not meet its primary endpoint of OS. Full results will be presented at a future medical meeting. In May 2020, Merck and Eisai presented data from analyses of two Phase 2 trials evaluating Keytruda plus Lenvima at the 2020 American Society of Clinical Oncology (ASCO) Annual Meeting in which the Keytruda plus Lenvima combination demonstrated clinically meaningful objective response rates (ORR): the KEYNOTE-524/Study 116 trial in patients with unresectable HCC with no prior systemic therapy; and the KEYNOTE-146/Study 111 trial in patients with metastatic clear cell renal cell carcinoma (ccRCC) who progressed following immune checkpoint inhibitor therapy. In July 2020, Merck and Eisai announced that the FDA issued a CRL regarding Mercks and Eisais applications seeking accelerated approval for the first-line treatment of patients with unresectable HCC based on this trial, which showed clinically meaningful efficacy in the single-arm setting. These data supported a Breakthrough Therapy designation granted by the FDA in July 2019. Ahead of the PDUFA action dates of Mercks and Eisais applications, another combination therapy was approved based on a randomized, controlled trial that demonstrated improvement in OS versus standard-of-care treatment. Consequently, the CRL stated that Mercks and Eisais applications do not provide evidence that Keytruda in combination with Lenvima represents a meaningful advantage over available therapies for the treatment of unresectable or metastatic HCC with no prior systemic therapy for advanced disease. Since the applications for KEYNOTE-524/Study 116 no longer meet the criteria for accelerated approval, both companies plan to work with the FDA to take appropriate next steps, which include conducting a well-controlled clinical trial that demonstrates substantial evidence of effectiveness and the clinical benefit of the combination. As such, LEAP-002, the Phase 3 trial evaluating the Keytruda plus Lenvima combination as a first-line treatment for advanced HCC, is currently underway and fully enrolled. The CRL does not impact the current approved indications for Keytruda or for Lenvima. In February 2021, Merck and Eisai announced the first presentation of new investigational data from the pivotal Phase 3 CLEAR study (KEYNOTE-581/Study 307) at the 2021 Genitourinary Cancers Symposium (ASCO GU) and published simultaneously in the New England Journal of Medicine . The trial evaluated the combinations of Keytruda plus Lenvima, and Lenvima plus everolimus versus sunitinib for the first-line treatment of patients with advanced RCC. Keytruda plus Lenvima demonstrated statistically significant and clinically meaningful improvements in PFS, OS and ORR versus sunitinib. Lenvima plus everolimus also showed significant improvements in PFS and ORR versus sunitinib. Merck and Eisai will discuss these data with regulatory authorities worldwide, with the intent to submit marketing authorization applications based on these results. In December 2020, Merck and Eisai announced that the pivotal Phase 3 KEYNOTE-775/Study 309 trial evaluating the investigational use of Keytruda plus Lenvima met its dual primary endpoints of OS and PFS and its secondary efficacy endpoint of ORR in patients with advanced endometrial cancer following at least one prior platinum-based regimen. These positive results were observed in the mismatch repair proficient (pMMR) subgroup and the ITT study population, which includes both patients with endometrial carcinoma that is pMMR as well as patients whose disease is MSI-H/dMMR. Based on an analysis conducted by an independent DMC, Keytruda plus Lenvima demonstrated a statistically significant and clinically meaningful improvement in OS, PFS and ORR versus chemotherapy. Merck and Eisai will discuss these data with regulatory authorities worldwide, with the intent to s submit marketing authorization applications based on these results, and plan to present these results at an upcoming medical meeting. KEYNOTE-775/Study 309 is the confirmatory trial for KEYNOTE-146/Study 111, which supported accelerated approval by the FDA in 2019 of the Keytruda plus Lenvima combination for the treatment of patients with advanced endometrial carcinoma that is not MSI-H or dMMR, who have disease progression following prior systemic therapy and are not candidates for curative surgery or radiation. Merck and Eisai are continuing to study the Keytruda plus Lenvima combination through the LEAP (LEnvatinib And Pembrolizumab) clinical program across 19 trials in 13 different tumor types (endometrial carcinoma, HCC, melanoma, NSCLC, RCC, squamous cell carcinoma of the head and neck, urothelial cancer, biliary tract cancer, colorectal cancer, gastric cancer, glioblastoma, ovarian cancer, and TNBC). MK-6482, belzutifan, is an investigational hypoxia-inducible factor-2 (HIF-2) inhibitor being evaluated for the treatment of patients with von Hippel-Lindau (V HL) disease-associated RCC with nonmetastatic RCC tumors less than three centimeters in size, unless immediate surgery is required. In July 2020, the FDA granted Breakthrough Therapy designation to belzutifan and has also granted orphan drug designation to belzutifan for VHL disease. These designations are based on data from a Phase 2 trial evaluating belzutifan in patients with VHL-associated ccRCC, which were presented at the 2020 ASCO Annual Meeting. Additionally, Phase 2 data showing anti-tumor responses in VHL disease patients with ccRCC and other tumors were presented at the ESMO Virtual Congress 2020 . In February 2021, Merck and Eisai began a Phase 3 trial examining Lenvima in combination with belzutifan in previously treated patients with metastatic RCC. MK-7119, Tukysa, is a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers. In September 2020, Seagen granted Merck an exclusive license and entered into a co-development agreement with Merck to accelerate the global reach of Tukysa. Merck and Seagen also announced a collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda in TNBC, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. MK-7339, Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast, pancreatic and prostate cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca. MK-7264, gefapixant, is an investigational, orally administered, selective P2X3 receptor antagonist, for the treatment of refractory or unexplained chronic cough. In September 2020, Merck announced the results from two ongoing pivotal Phase 3 trials (COUGH-1 and COUGH-2) evaluating the efficacy and safety of gefapixant. In these studies, adult patients treated with gefapixant 45 mg twice daily demonstrated a statistically significant reduction in 24-hour cough frequency versus placebo at 12 weeks (COUGH-1) and 24 weeks (COUGH-2). The gefapixant 15 mg twice daily treatment arms did not meet the primary efficacy endpoint in either Phase 3 study. These results were presented at the Virtual European Respiratory Society International Congress 2020. Merck plans to share data from COUGH-1 and COUGH-2 with regulatory authorities worldwide. MK-7110 (also known as CD24Fc) is an investigational treatment for patients hospitalized with COVID-19. Merck obtained MK-7110 through the acquisition of OncoImmune. In September 2020, OncoImmune reported topline findings from an interim efficacy analysis of a Phase 3 study evaluating MK-7110. An interim analysis of data from 203 participants (75% of the planned enrollment) indicated that selected hospitalized patients with COVID-19 treated with a single dose of MK-7110 showed a 60% higher probability of improvement in clinical status compared to placebo, as defined by the protocol. The risk of death or respiratory failure was reduced by more than 50%. Full results from this Phase 3 study, which were consistent with the topline results, were received in February 2021 and will be submitted for publication in the future. MK-7110 is also being studied in a Phase 3 trial for the treatment of graft versus host disease. Molnupiravir (also known as MK-4482) is an orally available antiviral candidate for the treatment of COVID-19 being developed in collaboration with Ridgeback Biotherapeutics LP. It is currently being evaluated in s Phase 2/3 clinical trials in both the hospital and outpatient settings. The primary completion date for the Phase 2/3 studies is June 2021. The Company anticipates interim efficacy data in the first quarter of 2021. MK-8591A is a combination of islatravir, the companys investigational oral nucleoside reverse transcriptase translocation inhibitor (NRTTI), and doravirine ( Pifeltro ) being evaluated for the treatment of HIV-1 infection. In October 2020, Merck announced Week 96 data from the Phase 2b trial (NCT03272347) evaluating the efficacy and safety of MK-8591A in treatment-nave adults with HIV-1 infection. Week 96 findings demonstrated that the combination of islatravir and doravirine maintained virologic suppression similar to Delstrigo (doravirine/lamivudine/tenofovir disoproxil fumarate), and the findings were consistent with Week 48 results. Additional Week 96 data from the study show low rates of participants meeting the definition of protocol-defined virologic failure in both the islatravir plus doravirine and the Delstrigo treatment arms, and no participants in either arm met the criteria for resistance testing. These data were presented at the virtual 2020 International Congress on Drug Therapy in HIV Infection (HIV Glasgow). In November 2020, Merck announced a collaboration with the Bill Melinda Gates Foundation (the foundation) where the foundation is committing to provide funding to support a pivotal Phase 3 study investigating a once-monthly oral pre-exposure prophylaxis (PrEP) option in women and adolescent girls at high risk for acquiring HIV-1 infection in sub-Saharan Africa. The study, IMPOWER 22, will evaluate the efficacy and safety of once-monthly islatravir and is anticipated to begin in early 2021. Merck will be funding the IMPOWER 22 clinical trial in the United States. Merck also plans to conduct additional studies in HIV prevention with islatravir in once-monthly oral PrEP. These studies will include IMPOWER 24, a global Phase 3 clinical trial to evaluate islatravir as a once-monthly oral agent for PrEP at sites across the world and among other key populations impacted by the epidemic, including men who have sex with men and transgender women. In January 2021, the FDA accepted for standard review a supplemental NDA for Steglatro (ertugliflozin) to incorporate the results of the Phase 3 VERTIS cardiovascular (CV) outcomes trial in the product labeling. The VERTIS CV trial evaluated Steglatro, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, versus placebo, added to background standard of care treatment, in patients with type 2 diabetes and atherosclerotic CV disease. The study met the primary endpoint of non-inferiority on major adverse CV events (MACE), which is a composite of CV death, nonfatal myocardial infarction or nonfatal stroke, compared to placebo. The key secondary endpoints of superiority for Steglatro versus placebo for time to the first occurrence of the composite of CV death or hospitalization for heart failure, time to CV death alone and time to the first occurrence of the composite of renal death, dialysis/transplant or doubling of serum creatinine from baseline were not met. While not a pre-specified hypothesis for statistical testing, a reduction in hospitalization for heart failure was observed with Steglatro. A supplemental application was also submitted to the EMA and is currently under review. In January 2021, the Company announced the discontinuation of the clinical development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The chart below reflects the Companys research pipeline as of February 22, 2021. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. s Phase 2 Phase 3 (Phase 3 entry date) Under Review Antiviral COVID-19 MK-4482 (molnupiravir) (1) Cancer MK-1026 Hematological Malignancies MK-1308 (quavonlimab) (2) Melanoma Non-Small-Cell Lung Solid Tumors MK-1454 (2) Head and Neck MK-2140 Advanced Solid Tumors MK-3475 Keytruda Advanced Solid Tumors MK-4280 (2) Hematological Malignancies Non-Small-Cell Lung MK-4830 Non-Small-Cell Lung MK-5890 (2) Non-Small-Cell Lung MK-6440 (ladiratuzumab vedotin) (1)(3) Advanced Solid Tumors Breast MK-7119 Tukysa (1) Advanced Solid Tumors Colorectal Gastric MK-7339 Lynparza (1)(3) Advanced Solid Tumors MK-7684 (vibostolimab) (2) Melanoma Non-Small-Cell Lung MK-7902 Lenvima (1)(2) Advanced Solid Tumors Biliary Tract Colorectal Glioblastoma V937 Breast Cutaneous Squamous Cell Head and Neck Melanoma Solid Tumors Chikungunya virus V184 Cytomegalovirus V160 HIV-1 Prevention MK-8591 (islatravir) Nonalcoholic Steatohepatitis NASH MK-3655 Overgrowth Syndrome MK-7075 (miransertib) Pneumococcal Vaccine Adult V116 Respiratory Syncytial Virus MK-1654 Schizophrenia MK-8189 Cancer MK-3475 Keytruda Biliary Tract (September 2019) Cervical (October 2018) (EU) Cutaneous Squamous Cell (August 2019) (EU) Endometrial (August 2019) (EU) Gastric (May 2015) (EU) Hepatocellular (May 2016) (EU) Mesothelioma (May 2018) Ovarian (December 2018) Prostate (May 2019) Small-Cell Lung (May 2017) (EU) MK-6482 (belzutifan) Renal Cell (February 2020) MK-7119 Tukysa (1) Breast (October 2019) MK-7339 Lynparza (1)(2) Colorectal (1) (August 2020) Non-Small-Cell Lung (2) (June 2019) Small-Cell Lung (2) (December 2020) MK-7902 Lenvima (1)(2) Bladder (May 2019) Endometrial (June 2018) (EU) Gastric (December 2020) Head and Neck (February 2020) Melanoma (March 2019) Non-Small-Cell Lung (March 2019) Cough MK-7264 (gefapixant) (March 2018) COVID-19 MK-7110 (December 2020) HIV-1 Infection MK-8591A (doravirine/islatravir) (February 2020) New Molecular Entities/Vaccines Bacterial Infection MK-7655A (relebactam+imipenem/cilastatin) (JPN) Heart Failure MK-1242 (vericiguat) (1) (EU) (JPN) Pediatric Neurofibromatosis Type 1 MK-5618 (selumetinib) (1) (EU) Pneumococcal Infection Adult V-114 (U.S.) (EU) Certain Supplemental Filings Cancer MK-3475 Keytruda Metastatic Triple-Negative Breast Cancer (KEYNOTE-355) (EU) (JPN) Early-Stage Triple-Negative Breast Cancer (KEYNOTE-522) (U.S.) Refractory Classical Hodgkin Lymphoma (KEYNOTE-204) (EU) Unresectable or Metastatic MSI-H or dMMR Colorectal Cancer (KEYNOTE-177) (JPN) Cutaneous Squamous Cell Cancer (KEYNOTE-629) (U.S.) Advanced Unresectable Metastatic Esophageal Cancer (KEYNOTE-590) (U.S.) (EU) (JPN) First-Line Metastatic HER2+ Gastric Cancer (KEYNOTE-811) (U.S.) MK-7902 Lenvima (1) First-Line Metastatic Hepatocellular Carcinoma (KEYNOTE-524) (U.S.) (2)(4) Thymic Carcinoma (NCCH1508/REMORA) (JPN) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda . (3) Being developed as monotherapy and in combination with Keytruda. (4) In July 2020, the FDA issued a CRL for Mercks and Eisais applications. Merck and Eisai intend to submit additional data when available to the FDA. Human Capital As of December 31, 2020, the Company had approximately 74,000 employees worldwide, with approximately 27,000 employed in the United States, including Puerto Rico, and approximately 26,000 third-party contractors globally. Approximately 73,000 of the Companys employees are full time-employees. Women and individuals with ethnically diverse backgrounds comprise approximately 50% and 31% of its workforce in the United States, respectively. Women comprise 46% of the members of the Board of Directors. Additionally, the Companys executive team, which includes individuals up to two structural levels below the Chief Executive s Officer, is made up of 34% women. Approximately 30% of the Companys employees are represented by various collective bargaining groups. The Company recognizes that its employees are critical to meet the needs of its patients and customers and that its ability to excel depends on the integrity, skill, and diversity of its employees. Talent Acquisition The Company uses a comprehensive approach to ensure recruiting, retention and leadership development goals are systematically executed throughout the Company and that it hires talented leaders to achieve improved gender parity and representation across all dimensions of diversity. The Company provides training to its managers and external recruiting organizations on strategies to mitigate unconscious bias in the candidate selection and hiring process. In addition, the Company utilizes a comprehensive communications strategy, marketing outreach, social media and strategic alliance partnerships to reach a broad pool of talent in its critical business areas. In 2020, the Company hired approximately 10,000 employees across the globe through various channels including the Companys external career site, diversity partnerships, employee referrals, universities and other external sources. Global Diversity and Inclusion Diversity and inclusion are fundamental to the Companys success and core to future innovation. The Company fosters a globally diverse and inclusive workforce for its employees by creating an environment of belonging, engagement, equity, and empowerment. The Company is proactive and intentional about diversity hiring and development programs to advance talent. The Company creates competitive advantages by leveraging diversity and inclusion to accelerate business performance. This includes fostering global supplier diversity, integrating diversity and inclusion into the Companys commercialization strategies and leveraging employee insights to improve performance. In addition to these efforts, the Company has ten Employee Business Resource Groups, that provide opportunities for employees to take an active part in contributing to the Companys inclusive culture through their work in talent acquisition and development, business and customer insights and social and community outreach. Gender and Ethnicity Performance Data (1) 2020 2019 2018 Women in the workforce 49% 49% 49% Women in the workforce in the U.S. 50% 50% NR Women on the Board of Directors 46% 33% 23% Women in executive roles (2) 34% 36% 32% Women in management roles (3) 43% 43% 41% Members of underrepresented ethnic groups on the Board of Directors 23% 17% 15% Members of underrepresented ethnic groups in executive roles (U.S.) 22% 26% 21% Members of underrepresented ethnic groups in the workforce (U.S.) 31% 29% 27% Members of underrepresented ethnic groups in management roles (U.S.) 29% 27% 25% New hires that were female 50% 50% 51% New hires that were members of underrepresented ethnic groups (U.S.) 42% 33% 36% NR: Not reported. (1) As of 12/31. (2) Executive is defined as the chief executive officer and two structur al levels below. (3) Management role is defined as all managers with direct reports other than executives defined in note 2. Compensation and Benefits The Company provides a valuable total rewards package reflecting its commitment to attract, retain and motivate its talent, and to supporting its employees and their families in every stage of life. The Company continuously monitors and adjusts its compensation and benefit programs to ensure they are competitive, contemporary, helpful and engaging, and that they support strategic imperatives such as diversity and inclusion, equity, flexibility, quality, security and affordability. For example, in 2020, the Company added a personal health care concierge service to assist U.S. employees participating in the Company medical plan with their health care s needs. Aligned with its business and in support of its cancer care strategy, the Company also improved cancer screening benefits, added resources and provided immediate access to a leading cancer center of excellence for U.S. employees. Globally, the Company implemented a minimum standard of 12 weeks of paid parental leave, which inclusively applies to all parents. In the United States, the Companys benefits rank in the top quartile of Fortune 100 companies under the Aon Hewitt 2019 Benefits Index. The Company has been included in the Working Mother 100 Best Companies ranking for 34 consecutive years and was named a Working Mother Best Company for Dads in 2020. Employee Wellbeing The Company is committed to helping its employees and their families improve their own health and wellbeing. The Companys culture of wellbeing is referred to as Live it , which includes programs to support preventive health, emotional and financial wellbeing, physical fitness and nutrition. It is designed to inspire all employees to pursue, enjoy, and share healthy lifestyles. Live it was launched in the United States in 2011 and today is available in every country in which the Company has employees. In addition, many of the Companys larger sites offer onsite health clinics that provide an array of services to help its employees stay or get well, including vaccinations, cancer and biometric screenings, travel medicine and advice, diagnosis and treatment of non-occupational illnesses or injuries, health counseling and referrals. The Companys overall employee wellbeing program was recognized for excellence in health and wellbeing by receiving the highest-level awards from the Business Group on Health (2019 and 2020), and the American Heart Association (2018-2020). COVID-19 Response The Company recognizes that it has a unique responsibility to help in response to the COVID-19 pandemic and is committed to supporting and protecting its employees and their families, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches and supporting its health care providers and the communities in which they serve. The Company continues to provide employees with easy and regular access to information, including details regarding the Companys tracking process, guidance around hygiene measures and travel and best practices for working from home. Examples of pandemic support resources and programs available to the Companys employees include pay continuation for workers who have been sick or exposed, volunteer policy adjustment to enable employees with medical backgrounds to volunteer in SARS-CoV-2-related activities, resources to prioritize physical and mental wellness, adjustments to medical plans to cover 100% of a COVID-19-related diagnosis, testing and treatment, backup childcare and more. Engaging Employees The Company strives to foster employee engagement by promoting a safe, positive, diverse and inclusive work environment that provides numerous opportunities for two-way communication with employees. Some of the Companys key programs and initiatives include promoting global employee engagement surveys, ongoing pulse checks to the organization for interim feedback on specific topics, fostering professional networking and collaboration, identifying and providing opportunities for volunteering and establishing positive, cooperative business relations with designated employee representatives. Talent Management and Development As the Company pursues its goal of becoming the worlds premier research-based biopharmaceutical company, it needs to continuously develop its diverse and talented people. The Companys current talent management system supports company-wide performance management, development, talent reviews and succession planning. Annual performance reviews help further the professional development of the Companys employees and ensure that the Companys workforce is aligned with the Companys objectives. The Company seeks to continuously build the skills and capabilities of its workforce to accelerate talent, improve performance and mitigate risk through relevant continuous learning experiences. This includes, but is not limited to, building leadership and management skills, as well as providing technical and functional training to all employees. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for s remediation and environmental liabilities were $11 million in 2020 and are estimated at $46 million in the aggregate for the years 2021 through 2025. These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million at both December 31, 2020 and 2019. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $65 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy usage, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 56% in both 2020 and 2019 and were 57% in 2018. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/company-overview/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Summary Risk Factors The Company is subject to a number of risks that if realized could materially adversely affect its business, results of operations, cash flow, financial condition or prospects. The following is a summary of the principal risk factors facing the Company: The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. s Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. The Company faces continued pricing pressure with respect to its products. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. The Company faces intense competition from lower cost generic products. The Company faces intense competition from competitors products. The global COVID-19 pandemic is having an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. Pharmaceutical products can develop unexpected safety or efficacy concerns. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. Developments following regulatory approval may adversely affect sales of the Companys products. The Company is subject to a variety of U.S. and international laws and regulations. s The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. Product liability insurance for products may be limited, cost prohibitive or unavailable. The Company is increasingly dependent on sophisticated software applications, computing infrastructure and cloud service providers. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. Social media platforms present risks and challenges. The proposed Spin-Off of Organon may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of Organon. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The above list is not exhaustive, and the Company faces additional challenges and risks. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. Risk Factors The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations, cash flow or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. Risks Related to the Companys Business The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent s infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the United States and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. For example, the patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company experienced a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. In addition, Januvia and Janumet will lose market exclusivity in the United States in January 2023. Januvia will lose market exclusivity in the EU in September 2022. Finally, the SPC that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after the loss of market exclusivity. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Januvia , Janumet , and Bridion . In particular, in 2020, the Companys oncology portfolio, led by Keytruda, represented the vast majority of the Companys revenue growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. s The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that lose patent protection. In order to remain competitive, the Company, like other major pharmaceutical companies, must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs and vaccines. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. s In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the United States, larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2020, the Companys gross U.S. sales were reduced by 45.5% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. The next government-mandated price reduction will occur in April 2021 and is expected to impact many Company products. The Company expects pricing pressures to continue in the future. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2020 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. s If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The global COVID-19 pandemic is having an adverse impact on the Companys business, operations and financial performance. The Company is unable to predict the full extent to which the COVID-19 pandemic or any future pandemic, epidemic or similar public health threat will adversely impact its business, operations, financial performance, results of operations, and financial condition. The Companys business and financial results were negatively impacted by the outbreak of COVID-19 in 2020. The continued duration and severity of the COVID-19 pandemic is uncertain, rapidly changing and difficult to predict. The degree to which COVID-19 impacts the Companys results in 2021 will depend on future developments, beyond the Companys knowledge or control, including, but not limited to, the duration of the outbreak, its severity, the success of actions taken to contain or prevent the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In 2020, the COVID-19 pandemic impacted the Companys business in numerous ways. As expected, within the Companys human health business, revenue was negatively impacted by reduced access to health care providers given social distancing measures, which negatively affected vaccine and oncology sales in particular. The estimated overall negative impact of the COVID-19 pandemic to Mercks revenue for the full year 2020 was approximately $2.5 billion, largely attributable to the Pharmaceutical segment, with approximately $50 million attributable to the Animal Health segment. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures, fewer well visits and delays in elective surgeries due to the COVID-19 pandemic. These impacts, as well as the prioritization of COVID-19 patients at health care providers, have resulted in reduced administration of many of the Companys human health products, in particular for its vaccines, including Gardasil 9, as well as for Keytruda and Implanon/ s Nexplanon . In addition, declines in elective surgeries negatively affected the demand for Bridion . However, sales of Pneumovax 23 have increased due to heightened awareness of pneumococcal vaccination. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, but the Companys assumption is that ongoing residual negative impacts will persist, particularly during the first half of 2021 and most notably with respect to vaccine sales, with the impact expected to be more acute in the United States. For the full year of 2021, Merck assumes an unfavorable impact to revenue of approximately 2% due to the COVID-19 pandemic, all of which relates to Pharmaceutical segment sales. In addition, for the full year of 2021, with respect to the COVID-19 pandemic, Merck expects a net negative impact to operating expenses, as spending on the development of its COVID-19 antiviral programs is expected to exceed the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Despite the Companys efforts to manage these impacts, their ultimate impact will also depend on factors beyond the Companys knowledge or control, including the duration of the COVID-19 virus as well as governmental and third-party actions taken to contain or prevent its spread, treat the virus and mitigate its public health and economic effects. In addition, any future pandemic, epidemic or similar public health threat could present similar risks to the Companys business, cash flow, results of operations, financial condition and prospects. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. For example, in 2020 the Company issued a product recall for Zerbaxa following the identification of product sterility issues. The Company may, in the future, experience other difficulties and delays in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to s manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Competition and the Health Care Environment, pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing health care reform that has led to the acceleration of generic substitution, where available. In 2017, the Chinese government updated the NRDL for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2020, drugs were added to the NRDL through double-digit price reductions. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first three rounds of VBP had, on average, a price reduction of 50%. The Company expects VBP to be a semi-annual process that will have a significant impact on mature products moving forward. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, at the same time macro-economic growth of selected emerging markets is expected to outpace Europe and even the United States, leading to significant increased headcount spending in those countries and access to innovative medicines for patients. A failure to maintain the Companys presence in emerging markets could therefore have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. s In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which will cause LIBOR to cease to exist entirely in the future. While the Company expects that reasonable alternatives to LIBOR will be implemented prior to its termination, the Company cannot predict the consequences and timing of these developments, which could include an increase in interest expense and may also require the amendment of contracts that reference LIBOR. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology (IT) systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt the manufacture of its animal health products at such sites or force the Company to incur substantial expenses in procuring raw materials or products elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. s The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Risks Relating to Government Regulation and Legal Proceedings The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. As discussed above Competition and the Health Care Environment, the Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. The ACA increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The ACA also requires pharmaceutical manufacturers to pay 70% of the cost of medicine, including biosimilar products, when Medicare Part D beneficiaries are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2020, the Companys revenue was reduced by approximately $700 million due to this requirement. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. In 2020, the Company recorded $85 million of costs for this annual fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implemented provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. More recently, although CMS previously declined to define what constitutes a product line extension (beyond the statutory definition), CMS issued a new rule on December 21, 2020 that will significantly expand the definition of the term line extension as of January 1, 2022 to include a broad range of products, including products reflecting new strengths, dosage forms, release mechanisms, and routes of administration. This expanded definition will increase the number of drugs subject to a higher Medicaid rebate. Effective January 1, 2023, this final rule also changes the way that manufacturers must calculate Best Price, in relation to certain patient support programs, including coupons, which also may result in an increase in s the Companys Medicaid rebates. The impact of these and other provisions in this final rule could adversely impact the Companys business, cash flow, results of operations, financial condition and prospects. As discussed above in Competition and the Health Care Environment, in November 2020, the Department of Health and Human Services Office of Inspector General (OIG) issued a Final Rule that would, effective January 1, 2023, eliminate the Anti-Kickback Statute safe harbor for rebates paid to Medicare Part D plans or to PBMs on behalf of such plans. While the Company cannot anticipate the effects of this change to the way it currently contracts, this new framework could significantly alter the way it does business with Part D Plan Sponsors and PBMs on behalf of such plans. On November 20, 2020, CMS also issued the MFN Rule, which was intended to be effective January 1, 2021, to institute a new pricing system for certain prescription drugs and biologic products covered by Medicare Part B in which Medicare would reimburse no more than the most favored nation price, meaning the lowest price after adjusting for volume and differences in gross domestic product, for the top fifty Part B reimbursed products, which includes Keytruda , sold in 22 member countries of the OECD, rather than use the current Average Sales Price (ASP)-based payment framework for certain physician-administered drugs. Implementation of the MFN Rule could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The FDA also recently issued rulemaking allowing the commercial importation of certain prescription drugs from Canada through FDA-authorized, time-limited programs sponsored by states or Native American tribes recognized under the rule, and, in certain future circumstances, pharmacists and wholesalers. The FDA also recently released a final guidance for industry detailing procedures for drug manufacturers to import FDA-approved prescription drug, biological, and combination products that were manufactured abroad and authorized and intended for sale in a foreign country. These changes, if they become effective, could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Several organizations, including two trade groups of which Merck is a member, have filed suit challenging the MFN Rule. Those lawsuits remain pending with a preliminary injunction having been entered in one of the cases. A trade organization in which Merck is a member brought suit, which is pending, in federal district court challenging the commercial importation rule. The Company cannot predict the likelihood of these regulations becoming effective or what additional future changes in the health care industry in general, or the pharmaceutical industry in particular, will occur, however, these changes could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. s Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; and scrutiny of advertising and promotion. In the past, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional health care reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to health care professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. s The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Risks Related to Technology The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications, complex information technology systems, computing infrastructure, and cloud service providers (collectively, IT systems) to conduct critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing s basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Risks Related to the Proposed Spin-Off of Organon The proposed Spin-Off of Organon may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. In February 2020, the Company announced its intention to Spin-Off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company, which has been named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The transaction is expected to be completed late in the second quarter of 2021. Completion of the Spin-Off will be subject to a number of factors and conditions, and there can be no assurances that the Company will be able to complete the Spin-Off on the terms or on the timeline that was announced, if at all. Unanticipated developments could delay, prevent or otherwise adversely affect the proposed Spin-Off, including but not limited to disruptions in general or financial market conditions or potential problems or delays in obtaining various regulatory and tax approvals or clearances. In addition, consummation of the proposed Spin-Off will require final approval from the Companys Board of Directors. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of Organon. The Company will incur significant expenses in connection with the Spin-Off. In addition, the Company may not be able to achieve the full strategic and financial benefits that are expected to result from the Spin-Off. The anticipated benefits of the Spin-Off are based on a number of assumptions, some of which may prove incorrect. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. The Company cannot predict the effect of the Spin-Off on the trading price of shares of its common stock, and the market value of shares of its common stock may be less than, equal to or greater than the market value of shares of its common stock prior to the Spin-Off. In addition, the price of Mercks common stock may be more volatile around the time of the Spin-Off. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The Company expects that prior to completion of the Spin-Off it will receive an opinion from its U.S. tax counsel that concludes, among other things, that the Spin-Off of all of the outstanding Organon shares to Merck s shareholders and certain related transactions will qualify as tax-free to Merck and its shareholders under Sections 355 and 368 of the U.S. Internal Revenue Code, except to the extent of any cash received in lieu of fractional shares of Organon common stock. Any such opinion is not binding on the Internal Revenue Service (IRS). Accordingly, while the Company believes the risk is low, the IRS may reach conclusions with respect to the Spin-Off that are different from the conclusions reached in the opinion. The opinion will rely on certain facts, assumptions, representations and undertakings from Merck and Organon regarding the past and future conduct of the companies respective businesses and other matters, which, if incomplete, incorrect or not satisfied, could alter the conclusions of the party giving such opinion. If the proposed Spin-Off ultimately is determined to be taxable, which the Company believes is unlikely, the Spin-Off could be treated as a taxable dividend to Mercks shareholders for U.S. federal income tax purposes, and Mercks shareholders could incur significant U.S. federal income tax liabilities. In addition, Merck would recognize a taxable gain to the extent that the fair market value of Organon common stock exceeds Mercks tax basis in such stock on the date of the Spin-Off. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. The impact of the global COVID-19 pandemic and any future pandemic, epidemic, or similar public health threat, on the Companys business, operations and financial performance. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. s Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. The proposed Spin-Off might be delayed or the costs to complete the Spin-Off might be more significant than expected. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is currently located in Kenilworth, New Jersey. The Company has previously announced that it intends to consolidate its New Jersey campuses into a single corporate headquarters location in Rahway, New Jersey by the end of 2023. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey; Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey; West Point, Pennsylvania; Boston, Massachusetts; South San Francisco, California; and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are currently headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. A number of properties will be transferred to Organon in the Spin-Off. Capital expenditures were $4.7 billion in 2020, $3.5 billion in 2019 and $2.6 billion in 2018. In the United States, these amounted to $2.7 billion in 2020, $1.9 billion in 2019 and $1.5 billion in 2018. Abroad, such expenditures amounted to $2.0 billion in 2020, $1.6 billion in 2019, and $1.1 billion in 2018. s The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2021, there were approximately 104,900 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2020 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 $0.00 $5,888 November 1 November 30 $0.00 $5,888 December 1 December 31 $0.00 $5,888 Total $0.00 $5,888 (1) The Company did not purchase any shares during the three months ended December 31, 2020 under the plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. s Performance Graph The following graph assumes a $100 investment on December 31, 2015, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2020/2015 CAGR* MERCK $180 12% PEER GRP.** 157 9% SP 500 203 15% 2015 2016 2017 2018 2019 2020 MERCK 100.0 115.1 113.4 158.9 194.3 180.1 PEER GRP. 100.0 96.9 116.1 124.1 147.2 157.2 SP 500 100.0 112.0 136.4 130.4 171.4 203.0 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. s "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. The following section of this Form 10-K generally discusses 2020 and 2019 results and year-to-year comparisons between 2020 and 2019. Discussion of 2018 results and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed on February 26, 2020. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. s Overview Financial Highlights ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 Sales $ 47,994 2 % 4 % $ 46,840 Net Income Attributable to Merck Co., Inc. 7,067 (28) % (25) % 9,843 Non-GAAP Net Income Attributable to Merck Co., Inc. (1) 15,082 13 % 16 % 13,382 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $2.78 (27) % (24) % $3.81 Non-GAAP Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders (1) $5.94 14 % 17 % $5.19 (1) Non-GAAP net income and non-GAAP earnings per share (EPS) exclude acquisition and divestiture-related costs, restructuring costs and certain other items. For further discussion and a reconciliation of GAAP to non-GAAP net income and EPS (see Non-GAAP Income and Non-GAAP EPS below) . Executive Summary Worldwide sales were $48.0 billion in 2020, an increase of 2% compared with 2019, or 4% excluding the unfavorable effect from foreign exchange. The sales increase was driven primarily by oncology, certain hospital acute care products and animal health. Growth in these areas was largely offset by the negative effects of the coronavirus disease 2019 (COVID-19) pandemic as discussed below, the effects of generic competition, particularly in the diversified brands and womens health franchises, competitive pressure in the virology franchise and pricing pressure in the diabetes franchise. During 2020, Merck continued executing on its strategic priorities reporting year-over-year sales growth despite the business challenges posed by the COVID-19 pandemic. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, sales of which were negatively affected in 2020 by patients inability to access health care providers, fewer well visits, and social distancing measures. However, in the latter part of the year, the Company experienced a partial recovery in the underlying demand for products across its key growth pillars. Despite the pandemic, Merck employees across the organization continued their important work, enrolling and maintaining clinical studies, progressing the pipeline and ensuring the supply of and patient access to the Companys portfolio of medically important medicines and vaccines. The Company also executed on Mercks capital allocation priorities by completing business development transactions and investing in its pipeline. Additionally, the Company remains on track to complete the spin-off of Organon late in the second quarter of 2021 thereby creating two companies, each focused on their strengths and portfolios allowing them to pursue their respective market opportunities and business strategies. In 2020, the products that will comprise Organon had total sales of $6.5 billion. Merck actively monitors the business development landscape for growth opportunities that meet the Companys strategic criteria. To expand its oncology presence, Merck completed the acquisitions of ArQule, Inc. (ArQule), a biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of cancer and other diseases; and VelosBio Inc. (VelosBio), a clinical-stage biopharmaceutical company committed to developing first-in-class cancer therapies targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. Additionally, Merck entered into strategic collaboration agreements with Seagen to gain access to ladiratuzumab vedotin, an investigational antibody-drug conjugate targeting LIV-1, and Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor for the treatment of human epidermal growth factor receptor 2 (HER2)-positive cancers. To augment Mercks animal health business, the Company acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews. As part of industry-wide efforts to develop solutions to the pandemic, the Company acquired OncoImmune, a company developing a therapeutic candidate for the treatment of patients hospitalized with COVID-19; and Themis Bioscience GmbH (Themis), a company focused on vaccines and immune-modulation therapies for infectious diseases, including a COVID-19 vaccine candidate. Additionally, Merck entered into s strategic collaborations with Ridgeback Biotherapeutics LP (Ridgeback Bio) to develop an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19; and with the International AIDS Vaccine Initiative, Inc. (IAVI) to develop an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. In January 2021, the Company announced it was discontinuing development of the COVID-19 vaccine candidates (see Note 3 to the consolidated financial statements). During 2020, the Company received numerous regulatory approvals within oncology. Keytruda received approval in the United States as monotherapy in the therapeutic areas of cutaneous squamous cell carcinoma (cSCC), metastatic microsatellite instability-high (MSI-H) or mismatch repair deficient (dMMR) colorectal cancer, non-muscle invasive bladder cancer (NMIBC) and tumor mutational burden-high (TMB-H) solid tumors, as well as in combination with chemotherapy for the treatment of triple-negative breast cancer (TNBC). Merck also received approval in the United States for an every six weeks (Q6W) dosing regimen across all adult indications. Additionally, Keytruda received approval in China for the treatment of certain patients with head and neck squamous cell carcinoma (HNSCC) and in both China and Japan for the treatment of certain patients with esophageal squamous cell carcinoma (ESCC). Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received approval in the United States: in combination with bevacizumab as a first-line maintenance treatment of certain adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy; and for the treatment of certain adult patients with metastatic castration-resistant prostate cancer (mCRPC) following progression on prior treatment. Additionally, Lynparza was approved in the European Union (EU): as monotherapy for the treatment of adult patients with mCRPC and BRCA 1/2 mutations who have progressed following a prior therapy; and for the maintenance treatment of certain adult patients with metastatic adenocarcinoma of the pancreas. Lynparza was also approved in Japan for the treatment of three types of advanced cancer: ovarian, prostate and pancreatic cancer. Lenvima, which is being developed in collaboration with Eisai Co., Ltd. (Eisai), received approval in China as monotherapy for the treatment of differentiated thyroid cancer. Also in 2020, Gardasil 9 was approved for use in women and girls in Japan where it is marketed as Silgard 9. Additionally, in 2020, the U.S. Food and Drug and Administration (FDA) granted accelerated approval for an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by certain HPV types. In January 2021, the Company received FDA approval for Verquvo (vericiguat), to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults. Verquvo is being jointly developed with Bayer AG (Bayer). In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline with several regulatory submissions. Keytruda is under review in United States and/or internationally for the treatment of certain patients with TNBC, classical Hodgkin Lymphoma (cHL), colorectal cancer, cSCC, esophageal and gastric cancer. Lenvima is under review in Japan as monotherapy for the treatment of thymic cancer. V114, an investigational 15-valent pneumococcal conjugate vaccine, is under priority review by the FDA for the prevention of invasive pneumococcal disease in adults 18 years of age and older. The European Medicines Agency (EMA) is also reviewing an application for licensure of V114 in adults. The Company is involved in litigation challenging the validity of several Pfizer Inc. patents that relate to pneumococcal vaccine technology in the United States and several foreign jurisdictions. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of biliary tract, cervical, cutaneous squamous cell, endometrial, gastric, hepatocellular, mesothelioma, ovarian, prostate and small-cell lung cancers; Lynparza as monotherapy for colorectal cancer and in combination with Keytruda for non-small-cell lung and small-cell lung cancers; and Lenvima in combination with Keytruda for bladder, endometrial, gastric, head and neck, melanoma and non-small-cell lung cancers. Also within oncology, MK-6482, belzutifan, an investigational hypoxia-inducible factor-2 alpha (HIF-2) inhibitor being evaluated for the treatment of patients with von Hippel-Lindau disease-associated renal cell carcinoma (RCC), received Breakthrough Therapy designation from the FDA . Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including MK-7264, gefapixant, a selective, non-narcotic, orally-administered, investigational P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough; MK-7110, an investigational treatment for patients hospitalized with COVID-19; MK-8591A, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) in combination with doravirine for the treatment of HIV-1 infection; and V114, which is being evaluated for the prevention of pneumococcal disease in pediatric patients. s The Company is allocating resources to support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2020 reflect higher costs related to business development activity, higher clinical development spending and increased investment in discovery research and early drug development. In November 2020, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.65 per share from $0.61 per share on the Companys outstanding common stock. During 2020, the Company returned $7.5 billion to shareholders through dividends and share repurchases. Management In February 2021, Merck announced that Kenneth C. Frazier, chairman and chief executive officer, will retire as chief executive officer, effective June 30, 2021. Mr. Frazier will continue to serve on Mercks Board of Directors as executive chairman, for a transition period to be determined by the board. The Merck Board of Directors has unanimously elected Robert M. Davis, Mercks current executive vice president, global services and chief financial officer, as chief executive officer, as well as a member of the board, effective July 1, 2021. Mr. Davis will become president of Merck, effective April 1, 2021, at which time the Companys operating divisionsHuman Health, Animal Health, Manufacturing, and Merck Research Laboratories (MRL)will begin reporting to Mr. Davis. COVID-19 Overall, in response to the COVID-19 pandemic, Merck remains focused on protecting the safety of its employees, ensuring that its supply of medicines and vaccines reaches its patients, contributing its scientific expertise to the development of antiviral approaches, and supporting health care providers and Mercks communities. Although COVID-19-related disruptions to patients ability to access health care providers negatively affected results in 2020, Merck remains confident in the fundamental underlying demand for its products and its prospects for long-term growth. In 2020, the estimated negative impact of the COVID-19 pandemic to Mercks sales was approximately $2.5 billion, largely attributable to the Pharmaceutical segment, with approximately $50 million attributable to the Animal Health segment. Roughly two-thirds of Mercks Pharmaceutical segment revenue is comprised of physician-administered products, which, despite strong underlying demand, have been affected by social distancing measures, fewer well visits and delays in elective surgeries due to the COVID-19 pandemic. These impacts, as well as the prioritization of COVID-19 patients at health care providers, have resulted in reduced administration of many of the Companys human health products, in particular for its vaccines, including Gardasil 9, as well as for Keytruda and Implanon/Nexplanon . In addition, declines in elective surgeries negatively affected the demand for Bridion . However, sales of Pneumovax 23 increased due to heightened awareness of pneumococcal vaccination. Operating expenses were positively affected in 2020 by approximately $600 million primarily due to lower promotional and selling costs, as well as lower research and development expenses, net of investments in COVID-19-related antiviral and vaccine research programs. Merck believes that global health systems and patients have largely adapted to the impacts of COVID-19, but the Companys assumption is that ongoing residual negative impacts will persist, particularly during the first half of 2021 and most notably with respect to vaccine sales, with the impact expected to be more acute in the United States. For the full year of 2021, Merck assumes an unfavorable impact to revenue of approximately 2% due to the COVID-19 pandemic, all of which relates to Pharmaceutical segment sales. In addition, for the full year of 2021, with respect to the COVID-19 pandemic, Merck expects a net negative impact to operating expenses, as spending on the development of its COVID-19 antiviral programs is expected to exceed the favorable impact of lower spending in other areas due to the COVID-19 pandemic. Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2020 was negatively s affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 United States $ 21,027 2 % 2 % $ 20,519 12 % 12 % $ 18,346 International 26,967 2 % 5 % 26,321 10 % 13 % 23,949 Total $ 47,994 2 % 4 % $ 46,840 11 % 13 % $ 42,294 U.S. plus international may not equal total due to rounding. Worldwide sales grew 2% in 2020 due to higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as increased alliance revenue from Lynparza and Lenvima. Also contributing to revenue growth were higher sales of certain vaccines, including Gardasil/Gardasil 9 and Pneumovax 23, as well as increased sales of certain hospital acute care products, including Prevymis and Bridion. Higher sales of animal health products also drove revenue growth in 2020. Sales growth in 2020 was partially offset by the effects of generic competition for certain products including womens health product NuvaRing , hospital acute care products Noxafil and Cubicin , oncology products Emend / Emend for Injection, cardiovascular products Zetia and Vytorin , and products within the diversified brands franchise, particularly Singulair. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Lower sales of pediatric vaccines, including ProQuad , M-M-R II, and Varivax , as well as lower sales of diabetes products Januvia and Janumet , and virology products Zepatier and Isentress/Isentress HD also partially offset revenue growth in 2020. As discussed above, the COVID-19 pandemic negatively affected sales in 2020. Sales in the United States grew 2% in 2020 primarily driven by higher sales of Keytruda , increased alliance revenue from Lynparza and Lenvima, and higher sales of animal health products. Revenue growth was largely offset by lower sales of NuvaRing , Januvia , Noxafil , Emend/Emend for Injection, M-M-R II, Janumet , Varivax and Implanon/Nexplanon . International sales grew 2% in 2020. The increase in international sales primarily reflects growth in Keytruda , Gardasil/Gardasil 9, increased alliance revenue from Lynparza, as well as higher sales of Pneumovax 23, Prevymis , Januvia and animal health products. Sales growth was partially offset by lower sales of Zepatier , Vytorin , Noxafil , Zetia , Remicade , Emend/Emend for Injection and products within the diversified brands franchise, particularly Singulair and Nasonex . International sales represented 56% of total sales in both 2020 and 2019. See Note 18 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Keytruda $ 14,380 30 % 30 % $ 11,084 55 % 58 % $ 7,171 Alliance Revenue - Lynparza (1) 725 63 % 62 % 444 137 % 141 % 187 Alliance Revenue - Lenvima (1) 580 44 % 43 % 404 171 % 173 % 149 Emend 145 (63) % (62) % 388 (26) % (24) % 522 (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). s Keytruda is an anti-PD-1 (programmed death receptor-1) therapy that has been approved as monotherapy for the treatment of certain patients with cervical cancer, cHL, cSCC, ESCC, gastric or gastroesophageal junction adenocarcinoma, HNSCC, hepatocellular carcinoma (HCC), non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), melanoma, Merkel cell carcinoma, MSI-H or dMMR cancer including MSI-H/dMMR colorectal cancer, primary mediastinal large B-cell lymphoma (PMBCL), TMB-H cancer, and urothelial carcinoma including NMIBC. Keytruda is also approved for the treatment of certain patients: in combination with chemotherapy for metastatic squamous and nonsquamous NSCLC, in combination with chemotherapy for HNSCC, in combination with chemotherapy for TNBC, in combination with axitinib for RCC, and in combination with Lenvima for endometrial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types. Global sales of Keytruda grew 30% in 2020 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally, although the COVID-19 pandemic had a dampening effect on growing demand. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of advanced NSCLC as monotherapy, and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with uptake in the RCC, adjuvant melanoma, HNSCC, bladder cancer and endometrial carcinoma indications. Uptake of the every six weeks (Q6W) adult dosing regimen in the United States benefited sales in 2020. Keytruda sales growth in international markets was driven by continued uptake in approved indications, particularly in the EU. Sales growth was partially offset by declines in Japan due to pricing. Pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda was subject to another price reduction of 20.9% in April 2020 under a provision of the Japanese pricing rules. In January 2020, the FDA approved Keytruda as monotherapy for the treatment of certain patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, NMIBC based on the results of the KEYNOTE-057 trial. In April 2020, the FDA granted accelerated approval for an additional recommended dosage of 400 mg every six weeks (Q6W) for Keytruda across all adult indications, including monotherapy and combination therapy. This new dosage option is available in addition to the current dose of 200 mg every three weeks (Q3W). In June 2020, the FDA granted accelerated approval for Keytruda as monotherapy for the treatment of adult and pediatric patients with unresectable or metastatic TMB-H solid tumors, as determined by an FDA-approved test, that have progressed following prior treatment and who have no satisfactory alternative treatment options based in part on the results of the KEYNOTE-158 trial. Also in June 2020, the FDA approved Keytruda as monotherapy for the treatment of patients with recurrent or metastatic cSCC that is not curable by surgery or radiation based on data from the KEYNOTE-629 trial. Additionally in June 2020, the FDA approved Keytruda as monotherapy for the first-line treatment of patients with unresectable or metastatic MSI-H or dMMR colorectal cancer based on results from the KEYNOTE-177 trial. In October 2020, the FDA approved an expanded label for Keytruda as monotherapy for the treatment of adult patients with relapsed or refractory cHL based on results from the KEYNOTE-204 trial. The FDA also approved an updated pediatric indication for Keytruda for the treatment of pediatric patients with refractory cHL or cHL that has relapsed after two or more lines of therapy. Keytruda was previously approved under the FDAs accelerated approval process for the treatment of adult and pediatric patients with refractory cHL, or who have relapsed after three or more prior lines of therapy based on data from the KEYNOTE-087 trial. In accordance with accelerated approval regulations, continued approval was contingent upon verification and description of clinical benefit; these accelerated approval requirements have been fulfilled with the data from KEYNOTE-204. In November 2020, the FDA granted accelerated approval for Keytruda in combination with chemotherapy for the treatment of patients with locally recurrent unresectable or metastatic TNBC whose tumors express PD-L1 (Combined Positive Score [CPS] 10) as determined by an FDA-approved test. The approval is based on results from the KEYNOTE-355 trial. In June 2020, Keytruda was approved by the National Medical Products Administration (NMPA) in China as monotherapy for the second-line treatment of patients with locally advanced or metastatic ESCC whose s tumors express PD-L1 (CPS 10). This indication was granted based on the KEYNOTE-181 trial, including data from an extension of the global study in Chinese patients. In December 2020, Chinas NMPA approved Keytruda as monotherapy for the first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC whose tumors express PD-L1 (CPS 20) as determined by a fully validated test. In August 2020, Keytruda was approved by Japans Pharmaceuticals and Medical Devices Agency (PMDA) as monotherapy for the treatment of patients whose tumors are PD-L1-positive, and have radically unresectable, advanced or recurrent ESCC who have progressed after chemotherapy. The approval was based on results from the KEYNOTE-181 trial. Additionally, Keytruda was approved by Japans PMDA for use at an additional recommended dosage of 400 mg Q6W, including monotherapy and combination therapy. This new dosage option is available in addition to the current dose of 200 mg Q3W. In January 2021, Keytruda was approved by the European Commission (EC) as a first-line treatment in adult patients with MSI-H or dMMR colorectal cancer based on the results of the KEYNOTE-177 study. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the United States in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of advanced ovarian, breast, pancreatic and prostate cancers. Alliance revenue related to Lynparza grew 63% in 2020 due to continued uptake across the multiple approved indications in the United States, the EU, China and Japan. In May 2020, the FDA approved Lynparza in combination with bevacizumab as a first-line maintenance treatment of certain adult patients with advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy. In November 2020, Lynparza was approved in the EU for the maintenance treatment of adult patients with advanced high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response following completion of first-line platinum-based chemotherapy in combination with bevacizumab and whose cancer is associated with homologous recombination deficiency (HRD)-positive status. These approvals were based on the results from the PAOLA-1 trial. Also in May 2020, the FDA approved Lynparza for the treatment of adult patients with deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene-mutated mCRPC who have progressed following prior treatment. In November 2020, Lynparza was approved in the EU as monotherapy for the treatment of adult patients with mCRPC and BRCA 1/2 mutations (germline and/or somatic) who have progressed following a prior therapy. These approvals were based on the results from the PROfound trial. In July 2020, Lynparza was approved in the EU as a monotherapy for the maintenance treatment of adult patients with germline BRCA 1/2 mutations who have metastatic adenocarcinoma of the pancreas and have not progressed after a first-line chemotherapy regimen. This approval was based on the results from the POLO trial. In December 2020, Lynparza was approved in Japan for the treatment of three types of advanced cancer: ovarian, prostate and pancreatic cancer. The three approvals authorize Lynparza for use as maintenance treatment after first-line chemotherapy containing bevacizumab (genetical recombination) in patients with HRD ovarian cancer; the treatment of patients with BRCA gene-mutated ( BRCA m) mCRPC; and maintenance treatment after platinum-based chemotherapy for patients with BRCA m curatively unresectable pancreas cancer. The concurrent approvals by the Japanese Ministry of Health, Labor, and Welfare are based on results from the PAOLA-1, PROfound and POLO trials. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of thyroid cancer, HCC, in combination with everolimus for certain patients with RCC, and in combination with Keytruda for the s treatment of certain patients with endometrial carcinoma. Alliance revenue related to Lenvima grew 44% in 2020 due to higher demand in the United States, China and the EU. In November 2020, Chinas NMPA approved Lenvima as a monotherapy for the treatment of differentiated thyroid cancer. Global sales of Emend , for the prevention of certain chemotherapy-induced nausea and vomiting, declined 63% in 2020 primarily due to lower demand and pricing in the United States due to generic competition for Emend for Injection following U.S. patent expiry in September 2019. Also contributing to the Emend sales decline was lower demand in the EU and Japan as a result of generic competition for the oral formulation of Emend following loss of market exclusivity in May 2019 and December 2019, respectively. U.S. market exclusivity for the oral formulation of Emend previously expired in 2015. In April 2020, the FDA approved Koselugo (selumetinib) for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 (NF1) who have symptomatic, inoperable plexiform neurofibromas (PN). The FDA approval is based on positive results from the National Cancer Institute (NCI) Cancer Therapy Evaluation Program (CTEP)-sponsored Phase 2 SPRINT Stratum 1 trial coordinated by the NCIs Center for Cancer Research, Pediatric Oncology Branch. This is the first regulatory approval of a medicine for the treatment of NF1 PN, a rare and debilitating genetic condition. Koselugo is being jointly developed and commercialized with AstraZeneca globally (see Note 4 to the consolidated financial statements). Vaccines ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Gardasil/Gardasil 9 $ 3,938 5 % 6 % $ 3,737 19 % 21 % $ 3,151 ProQuad 678 (10) % (10) % 756 27 % 29 % 593 M-M-R II 378 (31) % (31) % 549 28 % 29 % 430 Varivax 823 (15) % (15) % 970 25 % 28 % 774 Pneumovax 23 1,087 17 % 18 % 926 2 % 3 % 907 Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 5% in 2020 primarily due to higher volumes in China and the replenishment in 2020 of doses borrowed from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile in 2019. The replenishment resulted in the recognition of sales of $120 million in 2020, which, when combined with the reduction of sales of $120 million in 2019 due to the borrowing, resulted in a favorable impact to sales of $240 million in 2020. Lower demand in the United States and Hong Kong, SAR, PRC attributable to the COVID-19 pandemic partially offset the increase in sales of Gardasil/Gardasil 9. In June 2020, the FDA approved an expanded indication for Gardasil 9 for the prevention of oropharyngeal and other head and neck cancers caused by HPV Types 16, 18, 31, 33, 45, 52, and 58. The oropharyngeal and head and neck cancer indication was approved under accelerated approval based on effectiveness in preventing HPV-related anogenital disease. In July 2020, Gardasil 9 was approved by the PMDA in Japan for use in women and girls nine years and older for the prevention of cervical cancer, certain cervical, vaginal and vulvar precancers, and genital warts caused by the HPV types covered by the vaccine. In December 2020, Silgard 9 was also approved in Japan for the prevention of anal cancer and precursor lesions caused by HPV types 6, 11, 16 and 18 for individuals nine years and older and for genital warts for men nine years and older. Gardasil 9 is marketed in Japan as Silgard 9. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (royalty obligations under this agreement expire in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the United States to another third party (these royalty obligations expire in December 2028). The royalties are included in Cost of sales . s Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, declined 10% in 2020 driven primarily by lower demand in the United States resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic, partially offset by higher pricing. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, declined 31% in 2020 driven primarily by lower demand in the United States resulting from fewer measles outbreaks in 2020 compared with 2019, coupled with the unfavorable impact of the COVID-19 pandemic. Lower demand in Brazil also contributed to the M-M-R II sales decline in 2020. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), declined 15% in 2020 driven primarily by lower demand in the United States resulting from the COVID-19 pandemic, partially offset by higher pricing. The Varivax sales decline was also attributable to lower government tenders in Brazil. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, grew 17% in 2020 primarily due to higher volumes in the EU and in the United States attributable in part to heightened awareness of pneumococcal vaccination. Higher pricing in the United States also contributed to Pneumovax 23 sales growth in 2020. Hospital Acute Care ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Bridion $ 1,198 6 % 7 % $ 1,131 23 % 26 % $ 917 Noxafil 329 (50) % (50) % 662 (11) % (7) % 742 Prevymis 281 70 % 69 % 165 128 % 131 % 72 Cubicin 152 (41) % (40) % 257 (30) % (28) % 367 Zerbaxa 130 8 % 10 % 121 39 % 42 % 87 Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 6% in 2020 due to higher demand globally, particularly in the United States. However, fewer elective surgeries as a result of the COVID-19 pandemic unfavorably affected demand in 2020. Worldwide sales of Noxafil , an antifungal agent for the prevention of certain invasive fungal infections, declined 50% in 2020 due to generic competition in the United States and in the EU. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. Additionally, the patent for Noxafil expired in a number of major European markets in December 2019. As a result, the Company is experiencing volume and pricing declines in Noxafil sales in these markets as a result of generic competition and expects the declines to continue. Worldwide sales of Prevymis , a medicine for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients of an allogenic hematopoietic stem cell transplant, grew 70% in 2020 due to continued uptake since launch in the EU and in the United States. Prevymis was approved by the EC in January 2018 and by the FDA in November 2017. Global sales of Cubicin for injection, an antibiotic for the treatment of certain bacterial infections, declined 41% in 2020 primarily due to ongoing generic competition in the EU and in the United States. In December 2020, the Company temporarily suspended sales of Zerbaxa , a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections, and subsequently issued a product recall, following the identification of product sterility issues. As a result, the Company recorded an intangible asset impairment charge related to Zerbaxa (see Note 8 to the consolidated financial statements). The Company does not anticipate that Zerbaxa will return to the market before 2022. In June 2020, the FDA approved a supplemental New Drug Application (NDA) for Recarbrio (imipenem, cilastatin, and relebactam) for the treatment of patients 18 years of age and older with hospital-acquired s bacterial pneumonia and ventilator-associated bacterial pneumonia caused by certain susceptible Gram-negative microorganisms. Immunology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Simponi $ 838 1 % 1 % $ 830 (7) % (2) % $ 893 Remicade 330 (20) % (20) % 411 (29) % (25) % 582 Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were nearly flat in 2020. Sales of Simponi are being unfavorably affected by the launch of biosimilars for a competing product. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 20% in 2020 driven by ongoing biosimilar competition in the Companys marketing territories in Europe. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. in the second half of 2024. Virology ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Isentress/Isentress HD $ 857 (12) % (11) % $ 975 (15) % (10) % $ 1,140 Zepatier 167 (55) % (54) % 370 (19) % (16) % 455 Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 12% in 2020 primarily due to competitive pressure in the United States and in the EU. The Company expects competitive pressures for Isentress/Isentress HD to continue. Global sales of Zepatier , a treatment for adult patients with chronic hepatitis C virus genotype (GT) 1 or GT4 infection, declined 55% in 2020 driven by lower demand globally due to competition and declining patient volumes, coupled with the impact of the COVID-19 pandemic. Cardiovascular ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Zetia/Vytorin $ 664 (24) % (24) % $ 874 (35) % (34) % $ 1,355 Atozet 453 16 % 16 % 391 13 % 18 % 347 Rosuzet 130 8 % 9 % 120 107 % 115 % 58 Alliance revenue - Adempas (1) 281 38 % 38 % 204 47 % 47 % 139 Adempas 220 3 % 2 % 215 13 % 17 % 190 (1) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin (marketed outside the United States as Inegy ), medicines for lowering LDL cholesterol, declined 24% in 2020 driven primarily by lower sales of Ezetrol in Japan and Ezetrol and Inegy in the EU. The patent that provided market exclusivity for Ezetrol in Japan expired in September 2019 and generic competition began in June 2020. The s EU patents for Ezetrol and Inegy expired in April 2018 and April 2019, respectively. Accordingly, the Company is experiencing sales declines in these markets as a result of generic competition and expects the declines to continue. The sales decline in 2020 was also attributable to lower pricing following loss of exclusivity in Australia. Higher demand for Ezetrol in China partially offset the sales decline in 2020. Merck lost market exclusivity in the United States for Zetia in 2016 and Vytorin in 2017 and subsequently lost nearly all U.S. sales of these products as a result of generic competition. Sales of Atozet (marketed outside of the United States), a medicine for lowering LDL cholesterol, grew 16% in 2020, primarily driven by higher demand in most markets, particularly in the EU, Japan and other countries in the Asia Pacific region. Zetia , Vytorin , Atozet and Rosuze t will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide collaboration with Bayer to market and develop soluble guanylate cyclase (sGC) modulators including Adempas (see Note 4 to the consolidated financial statements). Revenue from Adempas includes Mercks share of profits from the sale of Adempas in Bayers marketing territories, which grew 38% in 2020, as well as sales in Mercks marketing territories, which grew 3% in 2020. In January 2021, the FDA approved Verquvo (vericiguat), an sGC stimulator, to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults with symptomatic chronic heart failure and reduced ejection fraction. The approval was based on the results of the pivotal Phase 3 VICTORIA trial and follows a priority regulatory review. Verquvo is part of the same worldwide clinical development collaboration with Bayer that includes Adempas referenced above. Diabetes ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Januvia/Janumet $ 5,276 (4) % (4) % $ 5,524 (7) % (4) % $ 5,914 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, declined 4% in 2020 as a result of continued pricing pressure in the United States, partially offset by higher demand in certain international markets, particularly in China. The Company expects U.S. pricing pressure to continue. Januvia and Janumet will lose market exclusivity in the United States in January 2023. The supplementary patent certificates that provide market exclusivity for Januvia and Janumet in the EU expire in September 2022 and April 2023, respectively. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after loss of market exclusivity. Womens Health ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Implanon/Nexplanon 680 (14) % (13) % 787 12 % 14 % 703 NuvaRing 236 (73) % (73) % 879 (3) % (2) % 902 Worldwide sales of Implanon/Nexplanon , a single-rod subdermal contraceptive implant, declined 14% in 2020, primarily driven by lower demand in the United States and in the EU resulting from the COVID-19 pandemic. Worldwide sales of NuvaRing , a vaginal contraceptive product, declined 73% in 2020 due to generic competition in the United States. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. Accordingly, the Company is experiencing a rapid and substantial decline in U.S. NuvaRing sales and expects the decline to continue. s Implanon/Nexplanon and NuvaRing will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Biosimilars ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Biosimilars $ 330 31 % 31 % $ 252 * * $ 64 * Calculation not meaningful. Biosimilar products are marketed by the Company pursuant to an agreement with Samsung Bioepis Co., Ltd. (Samsung) to develop and commercialize multiple pre-specified biosimilar candidates. Currently, the Company markets Renflexis (infliximab-abda), a biosimilar to Remicade (infliximab) for the treatment of certain inflammatory diseases; Ontruzant (trastuzumab-dttb), a biosimilar to Herceptin (trastuzumab) for the treatment of HER2-positive breast cancer and HER2 overexpressing gastric cancer; Brenzys (etanercept biosimilar), a biosimilar to Enbrel for the treatment of certain inflammatory diseases; and Aybintio (bevacizumab) for the treatment of certain types of cancer. Mercks commercialization territories under the agreement vary by product. Sales growth of biosimilars in 2020 was primarily due to continued post-launch uptake of Renflexis in the United States and Canada and the launch of Ontruzant in Brazil in 2020. In August 2020, the EC granted marketing authorization for Aybintio for the treatment of metastatic carcinoma of the colon or rectum, metastatic breast cancer, NSCLC, advanced and/or metastatic RCC, epithelial ovarian, fallopian tube and primary peritoneal cancer and cervical cancer. An application seeking approval of Aybintio in the United States was filed in September 2019. The above biosimilar products will be contributed to Organon in connection with the spin-off (see Note 1 to the consolidated financial statements). Animal Health Segment ($ in millions) 2020 % Change % Change Excluding Foreign Exchange 2019 % Change % Change Excluding Foreign Exchange 2018 Livestock $ 2,939 6 % 9 % $ 2,784 6 % 11 % $ 2,630 Companion Animal 1,764 10 % 11 % 1,609 2 % 5 % 1,582 Sales of livestock products grew 6% in 2020 predominantly due to an additional five months of sales in 2020 related to the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Sales of companion animal products grew 10% in 2020 driven primarily by higher demand for the Bravecto line of products for parasitic control, as well as higher demand for companion animal vaccines. Costs, Expenses and Other ($ in millions) 2020 % Change 2019 % Change 2018 Cost of sales $ 15,485 10 % $ 14,112 4 % $ 13,509 Selling, general and administrative 10,468 (1) % 10,615 5 % 10,102 Research and development 13,558 37 % 9,872 1 % 9,752 Restructuring costs 578 (9) % 638 1 % 632 Other (income) expense, net (886) * 139 * (402) $ 39,203 11 % $ 35,376 5 % $ 33,593 * Calculation not meaningful. s Cost of Sales Cost of sales was $15.5 billion in 2020 compared with $14.1 billion in 2019. Cost of sales includes the amortization of intangible assets recorded in connection with acquisitions, collaborations, and licensing arrangements, which totaled $1.8 billion in 2020 compared with $2.0 billion in 2019, respectively. Additionally, costs in 2020 and 2019 include intangible asset impairment charges of $1.6 billion and $705 million related to marketed products and other intangibles (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Costs in 2020 also include a charge of $260 million in connection with the discontinuation of COVID-19 vaccine development programs (see Note 3 to the consolidated financial statements) and inventory write-offs of $120 million related to a recall for Zerbaxa (see Note 8 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities which amounted to $175 million in 2020 compared with $251 million in 2019, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 67.7% in 2020 compared with 69.9% in 2019. The gross margin decline in 2020 reflects the unfavorable effects of higher impairment charges (noted above), pricing pressure, a charge related to the discontinuation of COVID-19 vaccine development programs, and higher inventory write-offs related to the recall of Zerbaxa (noted above), partially offset by the favorable effects of product mix, lower amortization of intangible assets and lower restructuring costs. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.5 billion in 2020, a decline of 1% compared with 2019. The decline was driven primarily by lower administrative, selling and promotional costs, including lower travel and meeting expenses, due in part to the COVID-19 pandemic, and the favorable effect of foreign exchange, partially offset by higher costs related to the spin-off of Organon and a contribution to the Merck Foundation. SGA expenses in 2020 include $710 million of costs related to the spin-off of Organon. SGA expenses in 2020 and 2019 include restructuring costs of $47 million and $34 million, respectively, related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. Research and Development Research and development (RD) expenses were $13.6 billion in 2020, an increase of 37% compared with 2019. The increase was driven primarily by higher upfront payments related to acquisitions and collaborations, including a $2.7 billion charge in 2020 related to the acquisition of VelosBio (see Note 3 to the consolidated financial statements), as well as higher expenses related to clinical development and increased investment in discovery research and early drug development. Higher restructuring costs also contributed to the increase in RD expenses in 2020. The increase in RD expenses in 2020 was partially offset by lower in-process research and development (IPRD) impairment charges and lower costs resulting from the COVID-19 pandemic, net of spending on COVID-19-related vaccine and antiviral research programs. RD expenses are comprised of the costs directly incurred by MRL, the Companys research and development division that focuses on human health-related activities, which were $6.6 billion in 2020 compared with $6.1 billion in 2019. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $2.7 billion in 2020 and $2.6 billion in 2019. Additionally, RD expenses in 2020 include a $2.7 billion charge for the acquisition of VelosBio (noted above), a $462 million charge for the acquisition of OncoImmune and charges of $826 million related to transactions with Seagen. RD expenses in 2019 include a $993 million charge for the acquisition of Peloton. See Note 3 to the consolidated financial statements for more information on these transactions. RD expenses also include IPRD impairment charges of $90 million and $172 million in 2020 and 2019, respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such s charges could be material. In addition, RD expenses in 2020 include $83 million of costs associated with restructuring activities, primarily relating to accelerated depreciation. RD expenses also include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business acquisitions. During 2020 and 2019, the Company recorded a net reduction in expenses of $95 million and $39 million, respectively, related to changes in these estimates. Restructuring Costs In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $3.0 billion. The Company expects to record charges of approximately $700 million in 2021 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program to result in annual net cost savings of approximately $900 million by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $578 million in 2020 and $638 million in 2019. Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative expenses and Research and development costs. The Company recorded aggregate pretax costs of $883 million in 2020 and $927 million in 2019 related to restructuring program activities (see Note 5 to the consolidated financial statements). Other (Income) Expense, Net Other (income) expense, net, was $886 million of income in 2020 compared with $139 million of expense in 2019, primarily due to higher income from investments in equity securities, net, largely related to Moderna, Inc. For details on the components of Other (income) expense, net, see Note 14 to the consolidated financial statements. Segment Profits ($ in millions) 2020 2019 2018 Pharmaceutical segment profits $ 29,722 $ 28,324 $ 24,871 Animal Health segment profits 1,650 1,609 1,659 Other non-reportable segment profits 1 (7) 103 Other (22,582) (18,462) (17,932) Income Before Taxes $ 8,791 $ 11,464 $ 8,701 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for s monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including the amortization of purchase accounting adjustments, intangible asset impairment charges, and changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Pharmaceutical segment profits grew 5% in 2020 compared with 2019 driven primarily by higher sales, as well as lower selling and promotional costs. Animal Health segment profits grew 3% in 2020 driven primarily by higher sales and lower promotional and selling costs, partially offset by higher RD costs and the unfavorable effect of foreign exchange. Taxes on Income The effective income tax rates of 19.4% in 2020 and 14.7% in 2019 reflect the impacts of acquisition and divestiture-related costs and restructuring costs, partially offset by the beneficial impact of foreign earnings, including product mix. The effective income tax rate in 2020 reflects the unfavorable impact of a charge for the acquisition of VelosBio for which no tax benefit was recognized. The effective income tax rate in 2019 reflects the favorable impact of a $364 million net tax benefit related to the settlement of certain federal income tax matters (see Note 15 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impacts of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 15 to the consolidated financial statements). Net Income (Loss) Attributable to Noncontrolling Interests Net income (loss) attributable to noncontrolling interests was $15 million in 2020 compared with $(66) million in 2019. The loss in 2019 was driven primarily by the portion of goodwill impairment charges related to certain businesses in the Healthcare Services segment that were attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $7.1 billion in 2020 and $9.8 billion in 2019. EPS was $2.78 in 2020 and $3.81 in 2019. Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). s A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) 2020 2019 2018 Income before taxes as reported under GAAP $ 8,791 $ 11,464 $ 8,701 Increase (decrease) for excluded items: Acquisition and divestiture-related costs (1) 3,704 2,681 3,066 Restructuring costs 883 927 658 Other items: Charge for the acquisition of VelosBio 2,660 Charges for the formation of collaborations (2) 1,076 1,400 Charge for the acquisition of OncoImmune 462 Charge for the discontinuation of COVID-19 vaccine development programs 305 Charge for the acquisition of Peloton 993 Charge related to the termination of a collaboration with Samsung 423 Charge for the acquisition of Viralytics Limited 344 Other (20) 55 (57) Non-GAAP income before taxes 17,861 16,120 14,535 Taxes on income as reported under GAAP 1,709 1,687 2,508 Estimated tax benefit on excluded items (3) 1,122 695 535 Adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition (67) Net tax benefit from the settlement of certain federal income tax matters 364 Tax benefit from the reversal of tax reserves related to the divestiture of MCC 86 Net tax charge related to the finalization of treasury regulations related to the enactment of the TCJA (117) (160) Non-GAAP taxes on income 2,764 2,715 2,883 Non-GAAP net income 15,097 13,405 11,652 Less: Net income (loss) attributable to noncontrolling interests as reported under GAAP 15 (66) (27) Acquisition and divestiture-related costs attributable to noncontrolling interests (89) (58) Non-GAAP net income attributable to noncontrolling interests 15 23 31 Non-GAAP net income attributable to Merck Co., Inc. $ 15,082 $ 13,382 $ 11,621 EPS assuming dilution as reported under GAAP $ 2.78 $ 3.81 $ 2.32 EPS difference 3.16 1.38 2.02 Non-GAAP EPS assuming dilution $ 5.94 $ 5.19 $ 4.34 (1) Amount in 2020 includes a $1.6 billion intangible asset impairment charge related to Zerbaxa . Amount in 2019 includes a $612 million intangible asset impairment charge related to Sivextro . See Note 8 to the consolidated financial statements. (2) Amount in 2020 includes $826 million related to transactions with Seagen (see Note 3 to the consolidated financial statements). Amount in 2018 represents charge for the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements). (3) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation s associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items These items are adjusted for after evaluating them on an individual basis considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2020 are charges for the acquisitions of VelosBio and OncoImmune, charges related to collaborations, including transactions with Seagen (see Note 3 to the consolidated financial statements), a charge for the discontinuation of COVID-19 vaccine development programs, and an adjustment to tax benefits recorded in conjunction with the 2015 Cubist Pharmaceuticals, Inc. acquisition. Excluded from non-GAAP income and non-GAAP EPS in 2019 is a charge for the acquisition of Peloton (see Note 3 to the consolidated financial statements), tax charges related to the finalization of U.S. treasury regulations related to the TCJA, a net tax benefit related to the settlement of certain federal income tax matters, and a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 15 to the consolidated financial statements). Beginning in 2021, the Company will be changing the treatment of certain items for the purposes of its non-GAAP reporting. Historically, Mercks non-GAAP results excluded the amortization of intangible assets recognized in connection with business acquisitions (reflected as part of acquisition and divestiture-related costs) but did not exclude the amortization of intangibles originating from collaborations, asset acquisitions or licensing arrangements. Beginning in 2021, Mercks non-GAAP results will no longer differentiate between the nature of the intangible assets being amortized and will exclude all amortization of intangible assets. Also, beginning in 2021, Mercks non-GAAP results will exclude gains and losses on investments in equity securities. Prior period amounts will be recast to conform to the new presentation. Research and Development Research Pipeline The Company currently has several candidates under regulatory review in the United States and internationally, as well as in late-stage clinical development. A chart reflecting the Companys current research pipeline as of February 22, 2021 and related discussion is set forth in Item 1. Business Research and Development above. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2020, the balance of IPRD was $3.2 billion (see Note 8 to the consolidated financial statements). The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of s the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2020, 2019, and 2018 the Company recorded IPRD impairment charges within Research and development expenses of $90 million, $172 million and $152 million, respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are summarized below; additional details are included in Note 3 to the consolidated financial statements. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In January 2020, Merck acquired ArQule, a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $2.7 billion. ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business. The Company recorded IPRD of $2.3 billion (related to MK-1026), goodwill of $512 million and other net liabilities of $102 million. In July 2020, Merck and Ridgeback Bio, a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Molnupiravir is currently being evaluated in Phase 2/3 clinical trials in both the hospital and outpatient settings. The primary completion date for the Phase 2/3 studies is June 2021. The Company anticipates interim efficacy data in the first quarter of 2021. In September 2020, Merck and Seagen announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. Under the terms of the agreement, Merck made an upfront payment of $600 million and a $1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $200 per share. Merck recorded $616 million in Research and development expenses in 2020 related to this transaction. Seagen is also eligible to receive future contingent milestone payments dependent upon the achievement of certain developmental and sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the United States, Canada and Europe. Under the terms of the agreement, Merck made upfront payments aggregating $210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones and tiered royalties based on annual sales levels of Tukysa in Mercks territories. In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $423 million. In addition, OncoImmune shareholders will be eligible to receive future contingent regulatory approval milestone payments and tiered royalties. OncoImmunes lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with COVID-19. Topline results from a pre-planned interim efficacy analysis from a Phase 3 study of MK-7110 were released in September 2020. Full results from this Phase 3 study, which were consistent with the topline results, were received in February 2021 and will be submitted for publication in the future. The transaction was accounted s for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $50 million for a 20% ownership interest in the new entity, which was valued at $33 million resulting in a $17 million premium. Merck also recognized other net liabilities of $22 million. The Company recorded Research and development expenses of $462 million in 2020 related to this transaction. In December 2020, Merck announced it had entered into an agreement with the U.S. Government to support the development, manufacture and initial distribution of MK-7110 upon approval or Emergency Use Authorization (EUA) from the FDA by June 30, 2021. Under the agreement, Merck was to receive up to approximately $356 million for manufacturing and supply of approximately 60,000-100,000 doses of MK-7110 to the U.S. government by June 30, 2021 to help meet the governments pandemic response goals. Following the execution of this agreement, Merck received feedback from the FDA that additional data, beyond the study conducted by OncoImmune, would be needed to support a potential EUA application. Based on this FDA feedback, Merck no longer expects to supply the U.S. government with MK-7110 in the first half of 2021. Merck is actively working with FDA to address the agencys comments. In December 2020, Merck acquired VelosBio, a privately held clinical-stage biopharmaceutical company, for $2.8 billion. VelosBios lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $180 million (primarily cash) and Research and development expenses of $2.7 billion in 2020 related to the transaction. In February 2021, Merck and Pandion Therapeutics, Inc. (Pandion) entered into a definitive agreement under which Merck will acquire Pandion, a clinical-stage biotechnology company developing novel therapeutics designed to address the unmet needs of patients living with autoimmune diseases, for $60 per share in cash representing an approximate total equity value of $1.85 billion. Pandion is advancing a pipeline of precision immune modulators targeting critical immune control nodes. Under the terms of the acquisition agreement, Merck, through a subsidiary, will initiate a tender offer to acquire all outstanding shares of Pandion. The closing of the tender offer is subject to certain conditions, including the tender of shares representing at least a majority of the total number of Pandions shares of fully-diluted common stock, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and other customary conditions. The transaction is expected to close in the first half of 2021. Capital Expenditures Capital expenditures were $4.7 billion in 2020, $3.5 billion in 2019 and $2.6 billion in 2018. Expenditures in the United States were $2.7 billion in 2020, $1.9 billion in 2019 and $1.5 billion in 2018. The increased capital expenditures in 2020 and 2019 reflect investment in new capital projects focused primarily on increasing manufacturing capacity for Mercks key products. The increased capital expenditures in 2020 also reflect the purchase of a manufacturing facility in Dunboyne, Ireland to support upcoming product launches (see Note 3 to the consolidated financial statements). The Company plans to invest more than $20 billion in new capital projects from 2020-2024. Depreciation expense was $1.7 billion in 2020, $1.7 billion in 2019 and $1.4 billion in 2018, of which $1.2 billion in 2020, $1.2 billion in 2019 and $1.0 billion in 2018, related to locations in the United States. Total depreciation expense in 2020 and 2019 included accelerated depreciation of $268 million and $233 million, respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). s Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) 2020 2019 2018 Working capital $ 437 $ 5,263 $ 3,669 Total debt to total liabilities and equity 34.7 % 31.2 % 30.4 % Cash provided by operations to total debt 0.3:1 0.5:1 0.4:1 The decline in working capital in 2020 compared with 2019 is primarily related to increased short-term debt supporting the funding of business development activities and capital expenditures. Cash provided by operating activities was $10.3 billion in 2020 compared with $13.4 billion in 2019, reflecting higher payments related to collaborations which were $2.9 billion in 2020 compared with $805 million in 2019. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities was $9.4 billion in 2020 compared with $2.6 billion in 2019. The increase was driven primarily by lower proceeds from the sales of securities and other investments, higher use of cash for acquisitions and higher capital expenditures, partially offset by lower purchases of securities and other investments. Cash used in financing activities was $2.8 billion in 2020 compared with $8.9 billion in 2019. The lower use of cash in financing activities was driven primarily by a net increase in short-term borrowings in 2020 compared with a net decrease in short-term borrowing in 2019, as well as lower purchases of treasury stock, partially offset by higher payments on debt (see below), lower proceeds from the issuance of debt (see below), higher dividends paid to shareholders and lower proceeds from the exercise of stock options. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable (see Note 6 to the consolidated financial statements). The Company factored $2.3 billion and $2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2020 and 2019 the Company had collected $102 million and $256 million, respectively, on behalf of the financial institutions, which was remitted to them in January 2021 and 2020, respectively. The net cash flows from these collections are reported as financing activities in the Consolidated Statement of Cash Flows. s The Companys contractual obligations as of December 31, 2020 are as follows: Payments Due by Period ($ in millions) Total 2021 20222023 20242025 Thereafter Purchase obligations (1) $ 3,458 $ 977 $ 1,232 $ 668 $ 581 Loans payable and current portion of long-term debt 6,432 6,432 Long-term debt 25,437 4,000 3,863 17,574 Interest related to debt obligations 10,779 759 1,431 1,254 7,335 Unrecognized tax benefits (2) 305 305 Transition tax related to the enactment of the TCJA (3) 3,006 390 736 1,880 Milestone payments related to collaborations (4) 200 200 Leases (5) 1,778 335 521 342 580 $ 51,395 $ 9,398 $ 7,920 $ 8,007 $ 26,070 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2020, the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, including interest and penalties, of $1.8 billion, including $305 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2021 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA (see Note 15 to the consolidated financial statements). (4) Reflects payments under collaborative agreements for sales-based milestones that were achieved in 2020 (and therefore deemed to be contractual obligations) but not paid until 2021 (see Note 4 to the consolidated financial statements). (5) Amounts exclude reasonably certain lease renewals that have not yet been executed (see Note 9 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts do not include contingent milestone payments related to collaborative arrangements or acquisitions as they are not considered contractual obligations until the successful achievement of developmental, regulatory approval or commercial milestones. At December 31, 2020, the Company has recognized liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca and Eisai where payment remains subject to the achievement of the related sales milestone aggregating $1.0 billion (see Note 4 to the consolidated financial statements). Excluded from research and development obligations are potential future funding commitments of up to approximately $52 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $73 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2021 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $300 million to its U.S. pension plans, $170 million to its international pension plans and $35 million to its other postretirement benefit plans during 2021. In June 2020, the Company issued $4.5 billion principal amount of senior unsecured notes consisting of $1.0 billion of 0.75% notes due 2026, $1.25 billion of 1.45% notes due 2030, $1.0 billion of 2.35% notes due 2040 and $1.25 billion of 2.45% notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities. In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering for general corporate purposes, including the repayment of outstanding commercial paper borrowings. The Company has a $6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. s In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2020, Mercks Board of Directors declared a quarterly dividend of $0.65 per share on the Companys outstanding common stock that was paid in January 2021. In January 2021, the Board of Directors declared a quarterly dividend of $0.65 per share on the Companys common stock for the second quarter of 2021 payable in April 2021. In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company spent $1.3 billion to purchase 16 million shares of its common stock for its treasury during 2020 under this program. In March 2020, the Company temporarily suspended its share repurchase program. As of December 31, 2020, the Companys remaining share repurchase authorization was $5.9 billion. The Company purchased $4.8 billion and $9.1 billion of its common stock during 2019 and 2018, respectively, under authorized share repurchase programs. In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers in 2018, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the s future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or Other Comprehensive Income (Loss) ( OCI) , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in Accumulated Other Comprehensive Income (Loss) ( AOCI) and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $593 million and $456 million at December 31, 2020 and 2019, respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2020 and 2019, Income before taxes would have declined by approximately $99 million and $110 million in 2020 and 2019, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative s instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2020, the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) 2020 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 3.875% notes due 2021 (1) $ 1,150 5 $ 1,150 2.40% notes due 2022 1,000 4 1,000 2.35% notes due 2022 1,250 5 1,250 (1) These interest rate swaps matured in January 2021. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2020 and 2019 would have positively affected the net aggregate market value of these instruments by $2.6 billion and $2.0 billion, respectively. A one percentage point decrease at December 31, 2020 and 2019 would have negatively affected the net aggregate market value by $3.1 billion and $2.2 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Estimates The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including s those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize s the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly s basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2020, 2019 or 2018. Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) 2020 2019 Balance January 1 $ 2,436 $ 2,630 Current provision 13,144 11,999 Adjustments to prior years (16) (230) Payments (12,454) (11,963) Balance December 31 $ 3,110 $ 2,436 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $249 million and $2.9 billion, respectively, at December 31, 2020 and were $233 million and $2.2 billion, respectively, at December 31, 2019. Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 0.6% in 2020, 1.1% in 2019 and 1.6% in 2018. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. s Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2020 and 2019 were $279 million and $168 million, respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 10 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2020 and 2019 of approximately $250 million and $240 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. s The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $11 million in 2020 and are estimated at $46 million in the aggregate for the years 2021 through 2025. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million at both December 31, 2020 and 2019. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $475 million in 2020, $417 million in 2019 and $348 million in 2018. At December 31, 2020, there was $678 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted-average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $454 million in 2020, $137 million in 2019 and $195 million in 2018. Net periodic benefit (credit) for other postretirement benefit plans was $(59) million in 2020, $(49) million in 2019 and $(45) million in 2018. Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 2.10% to 2.80% at December 31, 2020, compared with a range of 3.20% to 3.50% at December 31, 2019. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2021, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 6.50% to 6.70%, compared to a range of 7.00% to 7.30% in 2020. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard s deviation of returns of the target portfolio, which approximates 11%, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $80 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2020. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $40 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2020. Required funding obligations for 2021 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which primarily reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). s Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the s financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 15 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product approvals, product potential, development programs and include statements related to the expected impact of the COVID-19 pandemic. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. s ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2020 and 2019, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2020, the notes to consolidated financial statements, and the report dated February 25, 2021 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) 2020 2019 2018 Sales $ 47,994 $ 46,840 $ 42,294 Costs, Expenses and Other Cost of sales 15,485 14,112 13,509 Selling, general and administrative 10,468 10,615 10,102 Research and development 13,558 9,872 9,752 Restructuring costs 578 638 632 Other (income) expense, net ( 886 ) 139 ( 402 ) 39,203 35,376 33,593 Income Before Taxes 8,791 11,464 8,701 Taxes on Income 1,709 1,687 2,508 Net Income 7,082 9,777 6,193 Less: Net Income (Loss) Attributable to Noncontrolling Interests 15 ( 66 ) ( 27 ) Net Income Attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 2.79 $ 3.84 $ 2.34 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 2.78 $ 3.81 $ 2.32 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2020 2019 2018 Net Income Attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Other Comprehensive Loss Net of Taxes: Net unrealized (loss) gain on derivatives, net of reclassifications ( 297 ) ( 135 ) 297 Net unrealized (loss) gain on investments, net of reclassifications ( 18 ) 96 ( 10 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization ( 279 ) ( 705 ) ( 425 ) Cumulative translation adjustment 153 96 ( 223 ) ( 441 ) ( 648 ) ( 361 ) Comprehensive Income Attributable to Merck Co., Inc. $ 6,626 $ 9,195 $ 5,859 The accompanying notes are an integral part of these consolidated financial statements. s Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) 2020 2019 Assets Current Assets Cash and cash equivalents $ 8,062 $ 9,676 Short-term investments 774 Accounts receivable (net of allowance for doubtful accounts of $ 85 in 2020 and $ 86 in 2019) 7,851 6,778 Inventories (excludes inventories of $ 2,197 in 2020 and $ 1,480 in 2019 classified in Other assets - see Note 7) 6,310 5,978 Other current assets 5,541 4,277 Total current assets 27,764 27,483 Investments 785 1,469 Property, Plant and Equipment (at cost) Land 350 343 Buildings 12,645 11,989 Machinery, equipment and office furnishings 16,649 15,394 Construction in progress 7,324 5,013 36,968 32,739 Less: accumulated depreciation 18,982 17,686 17,986 15,053 Goodwill 20,238 19,425 Other Intangibles, Net 14,604 14,196 Other Assets 10,211 6,771 $ 91,588 $ 84,397 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 6,431 $ 3,610 Trade accounts payable 4,594 3,738 Accrued and other current liabilities 13,053 12,549 Income taxes payable 1,575 736 Dividends payable 1,674 1,587 Total current liabilities 27,327 22,220 Long-Term Debt 25,360 22,736 Deferred Income Taxes 1,015 1,470 Other Noncurrent Liabilities 12,482 11,970 Merck Co., Inc. Stockholders Equity Common stock, $ 0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2020 and 2019 1,788 1,788 Other paid-in capital 39,588 39,660 Retained earnings 47,362 46,602 Accumulated other comprehensive loss ( 6,634 ) ( 6,193 ) 82,104 81,857 Less treasury stock, at cost: 1,046,877,695 shares in 2020 and 1,038,087,496 shares in 2019 56,787 55,950 Total Merck Co., Inc. stockholders equity 25,317 25,907 Noncontrolling Interests 87 94 Total equity 25,404 26,001 $ 91,588 $ 84,397 The accompanying notes are an integral part of this consolidated financial statement. s Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2018 $ 1,788 $ 39,902 $ 41,350 $ ( 4,910 ) $ ( 43,794 ) $ 233 $ 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards 322 ( 274 ) 48 Other comprehensive loss, net of taxes ( 361 ) ( 361 ) Cash dividends declared on common stock ($ 1.99 per share) ( 5,313 ) ( 5,313 ) Treasury stock shares purchased ( 1,000 ) ( 8,091 ) ( 9,091 ) Net loss attributable to noncontrolling interests ( 27 ) ( 27 ) Distributions attributable to noncontrolling interests ( 25 ) ( 25 ) Share-based compensation plans and other ( 94 ) 956 862 Balance December 31, 2018 1,788 38,808 42,579 ( 5,545 ) ( 50,929 ) 181 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($ 2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) 759 611 Balance December 31, 2019 1,788 39,660 46,602 ( 6,193 ) ( 55,950 ) 94 26,001 Net income attributable to Merck Co., Inc. 7,067 7,067 Other comprehensive loss, net of taxes ( 441 ) ( 441 ) Cash dividends declared on common stock ($ 2.48 per share) ( 6,307 ) ( 6,307 ) Treasury stock shares purchased ( 1,281 ) ( 1,281 ) Net income attributable to noncontrolling interests 15 15 Distributions attributable to noncontrolling interests ( 22 ) ( 22 ) Share-based compensation plans and other ( 72 ) 444 372 Balance December 31, 2020 $ 1,788 $ 39,588 $ 47,362 $ ( 6,634 ) $ ( 56,787 ) $ 87 $ 25,404 The accompanying notes are an integral part of this consolidated financial statement. s Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) 2020 2019 2018 Cash Flows from Operating Activities Net income $ 7,082 $ 9,777 $ 6,193 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 1,899 1,973 3,103 Depreciation 1,726 1,679 1,416 Intangible asset impairment charges 1,718 1,040 296 Charge for the acquisition of VelosBio Inc. 2,660 Charge for the acquisition of Peloton Therapeutics, Inc. 993 Charge for future payments related to collaboration license options 650 Deferred income taxes ( 668 ) ( 556 ) ( 509 ) Share-based compensation 475 417 348 Other ( 49 ) 184 978 Net changes in assets and liabilities: Accounts receivable ( 1,002 ) 294 ( 418 ) Inventories ( 855 ) ( 508 ) ( 911 ) Trade accounts payable 724 399 230 Accrued and other current liabilities ( 1,138 ) 376 ( 341 ) Income taxes payable 560 ( 2,359 ) 827 Noncurrent liabilities ( 453 ) ( 237 ) ( 266 ) Other ( 2,426 ) ( 32 ) ( 674 ) Net Cash Provided by Operating Activities 10,253 13,440 10,922 Cash Flows from Investing Activities Capital expenditures ( 4,684 ) ( 3,473 ) ( 2,615 ) Purchase of Seagen Inc. common stock ( 1,000 ) Purchases of securities and other investments ( 95 ) ( 3,202 ) ( 7,994 ) Proceeds from sales of securities and other investments 2,812 8,622 15,252 Acquisition of VelosBio Inc., net of cash acquired ( 2,696 ) Acquisition of ArQule, Inc., net of cash acquired ( 2,545 ) Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 1,365 ) ( 294 ) ( 431 ) Other 130 378 102 Net Cash (Used in) Provided by Investing Activities ( 9,443 ) ( 2,629 ) 4,314 Cash Flows from Financing Activities Net change in short-term borrowings 2,549 ( 3,710 ) 5,124 Payments on debt ( 1,957 ) ( 4,287 ) Proceeds from issuance of debt 4,419 4,958 Purchases of treasury stock ( 1,281 ) ( 4,780 ) ( 9,091 ) Dividends paid to stockholders ( 6,215 ) ( 5,695 ) ( 5,172 ) Proceeds from exercise of stock options 89 361 591 Other ( 436 ) 5 ( 325 ) Net Cash Used in Financing Activities ( 2,832 ) ( 8,861 ) ( 13,160 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash 253 17 ( 205 ) Net (Decrease) Increase in Cash, Cash Equivalents and Restricted Cash ( 1,769 ) 1,967 1,871 Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $ 258 of restricted cash at January 1, 2020 included in Other Assets - see Note 6) 9,934 7,967 6,096 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $ 103 of restricted cash at December 31, 2020 included in Other Assets - see Note 6) $ 8,165 $ 9,934 $ 7,967 The accompanying notes are an integral part of this consolidated financial statement. s Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Biosimilars and Established Brands into a New Company In February 2020, Merck announced its intention to spin-off products from its womens health, biosimilars and established brands businesses into a new, independent, publicly traded company named Organon Co. (Organon) through a distribution of Organons publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The established brands included in the transaction consist of dermatology, non-opioid pain management, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. Organon will have development capabilities initially focused on late-stage development and life-cycle management and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed late in the second quarter of 2021, subject to market and certain other conditions. Subsequent to the spin-off, the historical results of the womens health, biosimilars and established brands businesses will be reflected as discontinued operations in the Companys consolidated financial statements. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates s over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related s to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 13.1 billion in 2020, $ 11.8 billion in 2019 and $ 10.7 billion in 2018. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 249 s million and $ 2.9 billion, respectively, at December 31, 2020 and were $ 233 million and $ 2.2 billion, respectively, at December 31, 2019. Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms, some of which are up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. See Note 18 for disaggregated revenue disclosures. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.7 billion in 2020, $ 1.7 billion in 2019 and $ 1.4 billion in 2018. Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.0 billion in 2020, $ 2.1 billion in 2019 and $ 2.1 billion in 2018. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are being amortized over periods ranging from 3 to 10 years, with the longer lives generally associated with enterprise-wide projects implemented over multiple years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted s future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as an acquisition of a business, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. s In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income . The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities (primarily IPRD, other intangible assets and contingent consideration), as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. s Recently Adopted Accounting Standards In June 2016, the Financial Accounting Standards Board (FASB) issued new guidance on the accounting for credit losses on financial instruments. The new guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The Company adopted the new guidance effective January 1, 2020. There was no impact to the Companys consolidated financial statements upon adoption. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under revenue recognition guidance (ASC 606). The Company retrospectively adopted the new guidance effective January 1, 2020, which resulted in minor changes to the presentation of information related to the Companys collaborative arrangements (see Note 4 and Note 18). In December 2019, the FASB issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the new guidance effective January 1, 2021. There was no impact to the Companys consolidated financial statements upon adoption. Recently Issued Accounting Standard Not Yet Adopted In March 2020, the FASB issued optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting and subsequently issued clarifying amendments. The guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued because of reference rate reform. The optional guidance is effective upon issuance and can be applied on a prospective basis at any time between January 1, 2020 through December 31, 2022. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue acquisitions and the establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. 2020 Transactions In December 2020, Merck acquired OncoImmune, a privately held, clinical-stage biopharmaceutical company, for an upfront payment of $ 423 million. In addition, OncoImmune shareholders will be eligible to receive up to $ 255 million of future contingent regulatory approval milestone payments and tiered royalties ranging from 10 % to 20 %. OncoImmunes lead therapeutic candidate MK-7110 (also known as CD24Fc) is being evaluated for the treatment of patients hospitalized with coronavirus disease 2019 (COVID-19). The transaction was accounted for as an acquisition of an asset. Under the agreement, prior to the completion of the acquisition, OncoImmune spun-out certain rights and assets unrelated to the MK-7110 program to a new entity owned by the existing shareholders of OncoImmune. In connection with the closing of the acquisition, Merck invested $ 50 million for a 20 % ownership interest in the new entity, which was valued at $ 33 million resulting in a $ 17 million premium. Merck also s recognized other net liabilities of $ 22 million. The Company recorded Research and development expenses of $ 462 million in 2020 related to this transaction. Also in December 2020, Merck acquired VelosBio Inc. (VelosBio), a privately held, clinical-stage biopharmaceutical company, for $ 2.8 billion. VelosBios lead investigational candidate is MK-2140 (formerly known as VLS-101), an antibody-drug conjugate targeting receptor tyrosine kinase-like orphan receptor 1 (ROR1) that is currently being evaluated for the treatment of patients with hematologic malignancies and solid tumors. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 180 million (primarily cash) and Research and development expenses of $ 2.7 billion in 2020 related to the transaction. In September 2020, Merck and Seagen Inc. (Seagen, formerly known as Seattle Genetics, Inc.) announced an oncology collaboration to globally develop and commercialize Seagens ladiratuzumab vedotin (MK-6440), an investigational antibody-drug conjugate targeting LIV-1, which is currently in Phase 2 clinical trials for breast cancer and other solid tumors. The collaboration will pursue a broad joint development program evaluating ladiratuzumab vedotin as monotherapy and in combination with Keytruda (pembrolizumab) in triple-negative breast cancer, hormone receptor-positive breast cancer and other LIV-1-expressing solid tumors. The companies will equally share profits worldwide. Under the terms of the agreement, Merck made an upfront payment of $ 600 million and a $ 1.0 billion equity investment in 5 million shares of Seagen common stock at a price of $ 200 per share. Merck recorded $ 616 million in Research and development expenses in 2020 related to this transaction reflecting the upfront payment as well as a $ 16 million premium relating to the equity shares based on the price of Seagen common stock on the closing date. Seagen is also eligible to receive future contingent milestone payments of up to $ 2.6 billion, including $ 850 million in development milestones and $ 1.75 billion in sales-based milestones. Concurrent with the above transaction, Seagen granted Merck an exclusive license to commercialize Tukysa (tucatinib), a small molecule tyrosine kinase inhibitor, for the treatment of HER2-positive cancers, in Asia, the Middle East and Latin America and other regions outside of the United States, Canada and Europe. Merck will be responsible for marketing applications seeking approval in its territories, supported by the positive results from the HER2CLIMB clinical trial. Merck will also co-fund a portion of the Tukysa global development plan, which encompasses several ongoing and planned trials across HER2-positive cancers, including breast, colorectal, gastric and other cancers set forth in a global product development plan. Merck will solely fund and conduct country-specific clinical trials necessary to support anticipated regulatory applications in its territories. Under the terms of the agreement, Merck made upfront payments aggregating $ 210 million, which were recorded as Research and development expenses in 2020. Seagen is also eligible to receive future contingent regulatory approval milestones of up to $ 65 million and will receive tiered royalties ranging from 20 % to 33 % based on annual sales levels of Tukysa in Mercks territories. Additionally in September 2020, Merck acquired a biologics manufacturing facility located in Dunboyne, Ireland from Takeda Pharmaceutical Company Limited for 256 million ($ 302 million). The transaction was accounted for as an acquisition of an asset. Merck recorded property, plant and equipment of $ 289 million and other net assets of $ 13 million. There are no future contingent payments associated with the acquisition. In July 2020, Merck acquired the U.S. rights to Sentinel Flavor Tabs and Sentinel Spectrum Chews from Virbac Corporation for $ 410 million. Sentinel products provide protection against common parasites in dogs. The transaction was accounted for as an acquisition of an asset. Merck recognized intangible assets of $ 401 million related to currently marketed products and inventory of $ 9 million at the acquisition date. The estimated fair values of the identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products will be amortized over their estimated useful lives of 15 years. There are no future contingent payments associated with the acquisition. Also in July 2020, Merck and Ridgeback Biotherapeutics LP (Ridgeback Bio), a closely held biotechnology company, closed a collaboration agreement to develop molnupiravir (MK-4482, also known as EIDD-2801), an orally available antiviral candidate in clinical development for the treatment of patients with COVID-19. Merck gained exclusive worldwide rights to develop and commercialize molnupiravir and related molecules. Under the terms of the agreement, Ridgeback Bio received an upfront payment and also is eligible to receive future contingent payments dependent upon the achievement of certain developmental and regulatory approval milestones, as well as a share of the net profits of molnupiravir and related molecules, if approved. Merck s and Ridgeback are committed to ensure that any medicines developed for SARS-CoV-2 (the causative agent of COVID-19) will be accessible and affordable globally. In June 2020, Merck acquired privately held Themis Bioscience GmbH (Themis), a company focused on vaccines (including a COVID-19 vaccine candidate, V591) and immune-modulation therapies for infectious diseases and cancer for $ 366 million. The acquisition originally provided for Merck to make additional contingent payments of up to $ 740 million. The transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $ 97 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payments. Merck recognized intangible assets for IPRD of $ 136 million, cash of $ 59 million, deferred tax assets of $ 70 million and other net liabilities of $ 32 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 230 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In January 2021, the Company announced it was discontinuing development of V591 as discussed below. As a result, in 2020, the Company recorded an IPRD impairment charge of $ 90 million within Research and development expenses. The Company also recorded a reduction in Research and development expenses resulting from a decrease in the related liability for contingent consideration of $ 45 million since future contingent milestone payments have been reduced to $ 450 million in the aggregate, including up to $ 60 million for development milestones, up to $ 196 million for regulatory approval milestones, and up to $ 194 million for commercial milestones. In May 2020, Merck and the International AIDS Vaccine Initiative, Inc. (IAVI), a nonprofit scientific research organization dedicated to addressing urgent, unmet global health challenges, announced a collaboration to develop V590, an investigational vaccine against SARS-CoV-2 being studied for the prevention of COVID-19. The agreement provided for an upfront payment by Merck of $ 6.5 million and also provided for future contingent payments based on sales. Merck also signed an agreement with the Biomedical Advanced Research and Development Authority (BARDA), part of the office of the Assistant Secretary for Preparedness and Response within an agency of the United States Department of Health and Human Services, to provide initial funding support to Merck for this effort. In January 2021, the Company announced it was discontinuing development of V590 as discussed below. In January 2021, the Company announced the discontinuation of the development programs for its COVID-19 vaccine candidates, V590 and V591, following Mercks review of findings from Phase 1 clinical studies for the vaccines. In these studies, both V590 and V591 were generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. Due to the discontinuation, the Company recorded a charge of $ 305 million in 2020, of which $ 260 million was reflected in Cost of sales and related to fixed-asset and materials write-offs, as well as the recognition of liabilities for purchase commitments . The remaining $ 45 million of costs were reflected in Research and development expenses and represent amounts related to the Themis acquisition noted above (an IPRD impairment charge, partially offset by a reduction in the related liability for contingent consideration). In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases. Total consideration paid of $ 2.7 billion included $ 138 million of share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of ArQule. The Company incurred $ 95 million of transaction costs directly related to the acquisition of ArQule, consisting almost entirely of share-based compensation payments to settle non-vested equity awards attributable to postcombination service. These costs were included in Selling, general and administrative expenses in 2020. ArQules lead investigational candidate, MK-1026 (formerly known as ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently being evaluated for the treatment of B-cell malignancies. The transaction was accounted for as an acquisition of a business. s The estimated fair value of assets acquired and liabilities assumed from ArQule is as follows: ($ in millions) January 16, 2020 Cash and cash equivalents $ 145 IPRD MK-1026 (formerly ARQ 531) (1) 2,280 Licensing arrangement for ARQ 087 80 Deferred income tax liabilities ( 361 ) Other assets and liabilities, net 34 Total identifiable net assets 2,178 Goodwill (2) 512 Consideration transferred $ 2,690 (1) The estimated fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 12.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill was allocated to the Pharmaceutical segment and is not deductible for tax purposes. 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly known as PT2977), is a novel investigational oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $ 1.2 billion; additionally, former Peloton shareholders will be eligible to receive $ 50 million upon U.S. regulatory approval, $ 50 million upon first commercial sale in the United States, and up to $ 1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million, deferred tax liabilities of $ 52 million, and other net liabilities of $ 4 million at the acquisition date, as well as Research and development expenses of $ 993 million in 2019 related to the transaction. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: ($ in millions) April 1, 2019 Cash and cash equivalents $ 31 Accounts receivable 73 Inventories 93 Property, plant and equipment 60 Identifiable intangible assets (useful lives ranging from 18 - 24 years) (1) 2,689 Deferred income tax liabilities ( 589 ) Other assets and liabilities, net ( 82 ) Total identifiable net assets 2,275 Goodwill (2) 1,376 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 11.5 %. Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. s The Companys results for 2019 include eight months of activity for Antelliq, while the Companys results in 2020 include 13 months of activity. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $ 156 million, cash of $ 83 million and other net assets of $ 42 million. The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 2018 Transactions In 2018, the Company recorded an aggregate charge of $ 423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $ 155 million, which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $ 137 million, inventory write-offs of $ 122 million, as well as other related costs of $ 9 million. The termination of this agreement had no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ($ 378 million). The transaction provided Merck with full rights to V937 (formerly known as CVA21), an investigational oncolytic immunotherapy. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 34 million (primarily cash) at the acquisition date and Research and development expenses of $ 344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. The Companys marketing rights with respect to these products will revert to Janssen Pharmaceuticals, Inc. in the second half of 2024. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of s advanced ovarian, breast, pancreatic and prostate cancers. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies are also jointly developing and commercializing AstraZenecas Koselugo (selumetinib), an oral, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, for multiple indications. In April 2020, Koselugo was approved by the U.S. Food and Drug Administration (FDA) for the treatment of pediatric patients two years of age and older with neurofibromatosis type 1 who have symptomatic, inoperable plexiform neurofibromas. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and Koselugo monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Profits from Lynparza and Koselugo product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or Koselugo. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or Koselugo. AstraZeneca is the principal on Lynparza and Koselugo sales transactions. Merck records its share of Lynparza and Koselugo product sales, net of cost of sales and commercialization costs, as alliance revenue and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.6 billion in 2017 and made payments of $ 750 million over a multi-year period for certain license options (of which $ 250 million was paid in December 2017, $ 400 million was paid in December 2018 and $ 100 million was paid in December 2019). The upfront payment and license option payments were reflected in Research and development expenses in 2017. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. In 2020, Merck determined it was probable that sales of Lynparza in the future would trigger $ 400 million of sales-based milestone payments from Merck to AstraZeneca. Accordingly, Merck recorded $ 400 million of liabilities and corresponding increases to the intangible asset related to Lynparza. Prior to 2020, Merck accrued sales-based milestone payments aggregating $ 1.0 billion related to Lynparza, of which $ 550 million, $ 200 million and $ 250 million was paid to AstraZeneca in 2020, 2019 and 2018, respectively. Potential future sales-based milestone payments of $ 2.7 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020, 2019 and 2018, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 160 million, $ 60 million and $ 140 million, respectively, in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.4 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 1.3 billion at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Lynparza $ 725 $ 444 $ 187 Alliance revenue - Koselugo 8 Total alliance revenue $ 733 $ 444 $ 187 Cost of sales (1) 247 148 93 Selling, general and administrative 160 138 48 Research and development 133 168 152 December 31 2020 2019 Receivables from AstraZeneca included in Other current assets $ 215 $ 128 Payables to AstraZeneca included in Accrued and other current liabilities (2) 423 577 (1) Represents amortization of capitalized milestone payments. (2) Includes accrued milestone payments. Eisai In March 2018, Merck and Eisai Co., Ltd. (Eisai) announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (lenvatinib), an orally available tyrosine kinase inhibitor discovered by Eisai. Lenvima is currently approved for the treatment of certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for the treatment of certain patients with endometrial carcinoma. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share applicable profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development are shared by the two companies in accordance with the collaboration agreement and reflected in Research and development expenses. Certain expenses incurred solely by Merck or Eisai are not shareable under the collaboration agreement, including costs incurred in excess of agreed upon caps and costs related to certain combination studies of Keytruda and Lenvima. Under the agreement, Merck made an upfront payment to Eisai of $ 750 million in 2018 and agreed to make payments of up to $ 650 million for certain option rights through 2021 (of which $ 325 million was paid in March 2019, $ 200 million was paid in March 2020 and $ 125 million is expected to be paid in March 2021). The Company recorded an aggregate charge of $ 1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for additional contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. In 2020, Merck determined it was probable that sales of Lenvima in the future would trigger sales-based milestone payments aggregating $ 400 million from Merck to Eisai. Accordingly, Merck recorded liabilities of $ 400 million and corresponding increases to the intangible asset related to Lenvima. Prior to 2020, Merck accrued sales-based milestone payments aggregating $ 950 million related to Lenvima, of which $ 500 million and $ 50 million was paid to Eisai in 2020 and 2019, respectively. Potential future sales-based milestone payments of $ 2.6 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2020 and 2018, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 10 million and $ 250 million, respectively, from Merck to Eisai. Potential future regulatory milestone payments of $ 125 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 1.1 billion at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Lenvima $ 580 $ 404 $ 149 Cost of sales (1) 271 206 39 Selling, general and administrative 73 80 13 Research and development (2) 185 189 1,489 December 31 2020 2019 Receivables from Eisai included in Other current assets $ 157 $ 150 Payables to Eisai included in Accrued and other current liabilities (3) 335 700 Payables to Eisai included in Other Noncurrent Liabilities (4) 600 525 (1) Represents amortization of capitalized milestone payments. (2) Amount for 2018 includes $ 1.4 billion related to the upfront payment and option payments. (3) Includes accrued milestone and future option payments. (4) Includes accrued milestone payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat), which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers Verquvo (vericiguat), which was approved by the FDA in January 2021 to reduce the risk of cardiovascular death and heart failure hospitalization following a hospitalization for heart failure or need for outpatient intravenous diuretics in adults. Verquvo is under review by regulatory authorities in other territories including the EU and Japan. Under the agreement, Bayer commercializes Adempas in the Americas, while Merck commercializes in the rest of the world. For Verquvo, Merck will commercialize in the United States and Bayer will commercialize in the rest of the world. Both companies share in development costs and profits on sales. Merck records sales of Adempas (and will record sales of Verquvo) in its marketing territories, as well as alliance revenue. Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs. In addition, the agreement provides for contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. Prior to 2020, Merck accrued $ 725 million of sales-based milestone payments for this collaboration, of which $ 375 million and $ 350 million was paid to Bayer in 2020 and 2018, respectively. Following the 2021 FDA approval of Verquvo noted above, Merck determined it was probable that sales of Adempas and Verquvo in the future would trigger the remaining $ 400 million sales-based milestone payment. Accordingly, Merck will record a liability of $ 400 million and a corresponding increase in intangible assets related to this collaboration in the first quarter of 2021. The intangible asset balance related to this collaboration (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $ 849 million at December 31, 2020 and is included in Other Intangibles, Net . The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. s Summarized financial information related to this collaboration is as follows: Years Ended December 31 2020 2019 2018 Alliance revenue - Adempas $ 281 $ 204 $ 139 Net sales of Adempas recorded by Merck 220 215 190 Total sales $ 501 $ 419 $ 329 Cost of sales (1) 115 113 216 Selling, general and administrative 61 41 35 Research and development 63 126 127 December 31 2020 2019 Receivables from Bayer included in Other current assets $ 65 $ 49 Payables to Bayer included in Other Noncurrent Liabilities (2) 375 (1) Includes amortization of intangible assets. (2) Represents accrued milestone payment. 5. Restructuring In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of Organon. As the Company continues to evaluate its global footprint and overall operating model, it subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $ 3.0 billion. The Company estimates that approximately 70 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 30 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects to record charges of approximately $ 700 million in 2021 related to the Restructuring Program. Actions under previous global restructuring programs have been substantially completed. The Company recorded total pretax costs of $ 883 million in 2020, $ 927 million in 2019 and $ 658 million in 2018 related to restructuring program activities. Since inception of the Restructuring Program through December 31, 2020, Merck has recorded total pretax accumulated costs of approximately $ 1.8 billion. For segment reporting, restructuring charges are unallocated expenses. s The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2020 Cost of sales $ $ 143 $ 32 $ 175 Selling, general and administrative 44 3 47 Research and development 81 2 83 Restructuring costs 385 193 578 $ 385 $ 268 $ 230 $ 883 Year Ended December 31, 2019 Cost of sales $ $ 198 $ 53 $ 251 Selling, general and administrative 33 1 34 Research and development 2 2 4 Restructuring costs 572 66 638 $ 572 $ 233 $ 122 $ 927 Year Ended December 31, 2018 Cost of sales $ $ 10 $ 11 $ 21 Selling, general and administrative 2 1 3 Research and development ( 13 ) 15 2 Restructuring costs 473 159 632 $ 473 $ ( 1 ) $ 186 $ 658 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2020, 2019 and 2018 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 13) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2019 $ 443 $ $ 91 $ 534 Expenses 572 233 122 927 (Payments) receipts, net ( 325 ) ( 136 ) ( 461 ) Non-cash activity ( 233 ) ( 8 ) ( 241 ) Restructuring reserves December 31, 2019 690 69 759 Expenses 385 268 230 883 (Payments) receipts, net ( 508 ) ( 301 ) ( 809 ) Non-cash activity ( 268 ) 38 ( 230 ) Restructuring reserves December 31, 2020 (1) $ 567 $ $ 36 $ 603 (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. s 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts are recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . s The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded components). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded components on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 2020 2019 2018 2020 2019 2018 Net Investment Hedging Relationships Foreign exchange contracts $ 26 $ ( 10 ) $ ( 18 ) $ ( 19 ) $ ( 31 ) $ ( 11 ) Euro-denominated notes 385 ( 75 ) ( 183 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In February 2020, five interest rate swaps with notional amounts of $ 250 million each matured. These swaps effectively converted the Companys $ 1.25 billion, 1.85 % fixed-rate notes due 2020 to variable rate debt. At December 31, 2020, the Company was a party to 14 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below: 2020 Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 3.875 % notes due 2021 (1) $ 1,150 5 $ 1,150 2.40 % notes due 2022 1,000 4 1,000 2.35 % notes due 2022 1,250 5 1,250 (1) These interest rate swaps matured in January 2021. The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark LIBOR swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. s The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount 2020 2019 2020 2019 Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 1,150 $ 1,249 $ $ ( 1 ) Long-Term Debt 2,301 3,409 53 14 Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: 2020 2019 Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other current assets $ 1 $ $ 1,150 $ $ $ Interest rate swap contracts Other Assets 54 2,250 15 3,400 Interest rate swap contracts Accrued and other current liabilities 1 1,250 Foreign exchange contracts Other current assets 12 3,183 152 6,117 Foreign exchange contracts Other Assets 45 2,030 55 2,160 Foreign exchange contracts Accrued and other current liabilities 217 5,049 22 1,748 Foreign exchange contracts Other Noncurrent Liabilities 1 52 1 53 $ 112 $ 218 $ 13,714 $ 222 $ 24 $ 14,728 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ 70 $ $ 7,260 $ 66 $ $ 7,245 Foreign exchange contracts Accrued and other current liabilities 307 11,810 73 8,693 $ 70 $ 307 $ 19,070 $ 66 $ 73 $ 15,938 $ 182 $ 525 $ 32,784 $ 288 $ 97 $ 30,666 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: 2020 2019 Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ 182 $ 525 $ 288 $ 97 Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 156 ) ( 156 ) ( 84 ) ( 84 ) Cash collateral posted/received ( 36 ) ( 34 ) Net amounts $ 26 $ 333 $ 170 $ 13 s The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 47,994 $ 46,840 $ 42,294 $ ( 886 ) 139 ( 402 ) $ ( 441 ) $ ( 648 ) $ ( 361 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items 40 95 ( 27 ) Derivatives designated as hedging instruments ( 76 ) ( 65 ) 50 Impact of cash flow hedging relationships Foreign exchange contracts Amount of (loss) gain recognized in OCI on derivatives ( 383 ) 87 228 (Decrease) increase in Sales as a result of AOCI reclassifications ( 6 ) 255 ( 160 ) 6 ( 255 ) 160 Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 4 ) ( 4 ) ( 4 ) Amount of loss recognized in OCI on derivatives ( 4 ) ( 6 ) ( 4 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 2020 2019 2018 Derivatives Not Designated as Hedging Instruments Income Statement Caption Foreign exchange contracts (1) Other (income) expense, net $ ( 12 ) $ 174 $ ( 260 ) Foreign exchange contracts (2) Sales 13 1 ( 8 ) Interest rate contracts (3) Other (income) expense, net 9 Forward contract related to Seagen common stock Research and development expenses 15 (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. (3) These derivatives serve as economic hedges against rising treasury rates. At December 31, 2020, the Company estimates $ 331 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. s Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: 2020 2019 Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses U.S. government and agency securities $ 84 $ $ $ 84 $ 266 $ 3 $ $ 269 Foreign government bonds 5 5 Commercial paper 668 668 Corporate notes and bonds 608 13 621 Asset-backed securities 226 1 227 Total debt securities 89 89 1,768 17 1,785 Publicly traded equity securities (1) 1,787 838 Total debt and publicly traded equity securities $ 1,876 $ 2,623 (1) Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2020 were $ 163 million during 2020. Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2019 were $ 160 million during 2019. At December 31, 2020 and 2019, the Company also had $ 586 million and $ 420 million, respectively, of equity investments without readily determinable fair values included in Other Assets . During 2020 and 2019, the Company recognized unrealized gains of $ 62 million and $ 20 million, respectively, in Other (income) expense, net , on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2020 and 2019, the Company recognized unrealized losses of $ 3 million and $ 13 million, respectively, in Other (income) expense, net , related to certain of these investments based on unfavorable observable price changes. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values were $ 169 million and $ 24 million, respectively. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. s Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total 2020 2019 Assets Investments Foreign government bonds $ $ 5 $ $ 5 $ $ $ $ Commercial paper 668 668 Corporate notes and bonds 621 621 Asset-backed securities 227 227 U.S. government and agency securities 209 209 Publicly traded equity securities 780 780 518 518 780 5 785 518 1,725 2,243 Other assets (1) U.S. government and agency securities 84 84 60 60 Publicly traded equity securities 1,007 1,007 320 320 1,091 1,091 380 380 Derivative assets (2) Forward exchange contracts 90 90 169 169 Interest rate swaps 55 55 15 15 Purchased currency options 37 37 104 104 182 182 288 288 Total assets $ 1,871 $ 187 $ $ 2,058 $ 898 $ 2,013 $ $ 2,911 Liabilities Other liabilities Contingent consideration $ $ $ 841 $ 841 $ $ $ 767 $ 767 Derivative liabilities (2) Forward exchange contracts 505 505 95 95 Written currency options 20 20 1 1 Interest rate swaps 1 1 525 525 97 97 Total liabilities $ $ 525 $ 841 $ 1,366 $ $ 97 $ 767 $ 864 (1) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (2) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2020 and 2019, Cash and cash equivalents include $ 6.8 billion and $ 8.9 billion, respectively, of cash equivalents (which would be considered Level 2 in the fair value hierarchy). s Contingent Consideration Summarized information about the changes in liabilities for contingent consideration associated with business acquisitions is as follows: 2020 2019 Fair value January 1 $ 767 $ 788 Additions 97 Changes in estimated fair value (1) 83 64 Payments ( 106 ) ( 85 ) Fair value December 31 (2)(3) $ 841 $ 767 (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2020 includes $ 148 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2020 and 2019, $ 711 million and $ 625 million, respectively, of the liabilities relate to the termination of the Sanofi Pasteur MSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8 % to present value the cash flows. The additions to contingent consideration in 2020 relate to the acquisition of Themis. The changes in the estimated fair value of liabilities for contingent consideration in 2020 and 2019 were largely attributable to increases in the liabilities recorded in connection with the termination of the Sanofi Pasteur MSD (SPMSD) joint venture in 2016. In 2020, the increase was partially offset by a decline related to the discontinuation of a COVID-19 vaccine program obtained through the acquisition of Themis. The payments of contingent consideration in both years relate to the SPMSD liabilities described above. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2020, was $ 36.0 billion compared with a carrying value of $ 31.8 billion and at December 31, 2019, was $ 28.8 billion compared with a carrying value of $ 26.3 billion. Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States, Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 45 % of total accounts receivable at December 31, 2020. The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. The Company factored $ 2.3 billion and $ 2.7 billion of accounts receivable in the fourth quarter of 2020 and 2019, respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the s Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2020 and 2019, the Company had collected $ 102 million and $ 256 million, respectively, on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2021 and 2020, respectively. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The cost of factoring such accounts receivable was de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral advanced by the Company to counterparties was $ 36 million at December 31, 2020. Cash collateral received by the Company from various counterparties was $ 34 million at December 31, 2019. The obligation to return such collateral is recorded in Accrued and other current liabilities . 7. Inventories Inventories at December 31 consisted of: 2020 2019 Finished goods $ 1,963 $ 1,772 Raw materials and work in process 6,420 5,650 Supplies 206 207 Total (approximates current cost) 8,589 7,629 Decrease to LIFO cost ( 82 ) ( 171 ) $ 8,507 $ 7,458 Recognized as: Inventories $ 6,310 $ 5,978 Other assets 2,197 1,480 Inventories valued under the LIFO method comprised approximately $ 2.9 billion and $ 2.6 billion at December 31, 2020 and 2019, respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2020 and 2019, these amounts included $ 1.9 billion and $ 1.3 billion, respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 279 million and $ 168 million at December 31, 2020 and 2019, respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2019 $ 16,162 $ 1,870 $ 221 $ 18,253 Acquisitions 19 1,322 1,341 Impairments ( 162 ) ( 162 ) Other (1) ( 7 ) ( 7 ) Balance December 31, 2019 (2) 16,181 3,192 52 19,425 Acquisitions 742 105 847 Divestitures ( 54 ) ( 54 ) Other (1) 47 ( 29 ) 2 20 Balance December 31, 2020 (2) $ 16,970 $ 3,268 $ $ 20,238 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses were $ 531 million at both December 31, 2020 and 2019. s The additions to goodwill in the Pharmaceutical segment in 2020 were primarily related to the acquisitions of ArQule and Themis (see Note 3). The additions to goodwill within the Animal Health segment in 2019 primarily relate to the acquisition of Antelliq (see Note 3). The impairments of goodwill within other non-reportable segments in 2019 relate to certain businesses within the Healthcare Services segment. The Healthcare Services segment was fully divested in the first quarter of 2020. Other intangibles at December 31 consisted of: 2020 2019 Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 45,087 $ 39,925 $ 5,162 $ 45,947 $ 38,852 $ 7,095 Licenses 4,177 1,387 2,790 3,185 824 2,361 IPRD 3,228 3,228 1,032 1,032 Trade names 2,882 352 2,530 2,899 217 2,682 Other 2,223 1,329 894 2,261 1,235 1,026 $ 57,597 $ 42,993 $ 14,604 $ 55,324 $ 41,128 $ 14,196 Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2020 include Zerbaxa , $ 551 million; Implanon/Nexplanon, $ 354 million; Gardasil/Gardasil 9, $ 276 million; Dificid , $ 228 million; Bridion , $ 185 million; Sivextro , $ 154 million; and Simponi , $ 132 million. Additionally, the Company had $ 5.4 billion of net acquired intangibles related to animal health marketed products at December 31, 2020, of which $ 2.5 billion relate primarily to trade names obtained through the 2019 acquisition of Antelliq (see Note 3). Some of the Companys more significant net intangible assets included in licenses above at December 31, 2020 include Lynparza, $ 1.3 billion and Lenvima, $ 1.1 billion as a result of collaborations with AstraZeneca and Eisai (see Note 4). At December 31, 2020, IPRD primarily relates to MK-1026 obtained through the acquisition of ArQule in 2020 (see Note 3) and MK-7264 (gefapixant) obtained through the acquisition of Afferent Pharmaceuticals in 2016. The Company has an intangible asset related to a collaboration with Bayer (see Note 4) that had a carrying value of $ 849 million at December 31, 2020 reflected in Other in the table above. In 2020, the Company recorded an impairment charge of $ 1.6 billion within Cost of sales related to Zerbaxa for injection, a combination antibacterial and beta-lactamase inhibitor for the treatment of certain bacterial infections. In December 2020, the Company temporarily suspended sales of Zerbaxa , and subsequently issued a product recall, following the identification of product sterility issues. The recall constituted a triggering event requiring the evaluation of the Zerbaxa intangible asset for impairment. The Company revised its cash flow forecasts for Zerbaxa utilizing certain assumptions around the return to market timeline and anticipated uptake in sales thereafter. These revised cash flow forecasts indicated that the Zerbaxa intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Zerbaxa that, when compared with its related carrying value, resulted in the impairment charge noted above. The Company also wrote-off inventory of $ 120 million to Cost of sales in 2020 related to the Zerbaxa recall. The remaining intangible asset balance related to Zerbaxa was $ 551 million at December 31, 2020. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million. Of this amount, $ 612 million related to Sivextro , a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced cash flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. s IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2020, the Company recorded a $ 90 million IPRD impairment charge within Research and development expenses related to a decision to discontinue the development program for COVID-19 vaccine candidate V591 following Mercks review of findings from a Phase 1 clinical study for the vaccine. In the study, V591 was generally well tolerated, but the immune responses were inferior to those seen following natural infection and those reported for other SARS-CoV-2/COVID-19 vaccines. The discontinuation of this development program also resulted in a reversal of the related liability for contingent consideration of $ 45 million (see Note 6). In 2019, the Company recorded $ 172 million of IPRD impairment charges. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 11 million. In 2018, the Company recorded $ 152 million of IPRD impairment charges. Of this amount, $ 139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The discontinuation of this clinical development program also resulted in a reversal of the related liability for contingent consideration of $ 60 million. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $ 1.9 billion in 2020, $ 2.0 billion in 2019 and $ 3.1 billion in 2018. The estimated aggregate amortization expense for each of the next five years is as follows: 2021, $ 1.5 billion; 2022, $ 1.5 billion; 2023, $ 1.4 billion; 2024, $ 1.3 billion; 2025, $ 1.2 billion. 9. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2020 included $ 2.3 billion of notes due in 2021, $ 4.0 billion of commercial paper and $ 73 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2019 included $ 1.9 billion of notes due in 2020, $ 1.4 billion of commercial paper and $ 226 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.79 % and 2.23 % for the years ended December 31, 2020 and 2019, respectively. s Long-Term Debt Long-term debt at December 31 consisted of: 2020 2019 2.75 % notes due 2025 $ 2,493 $ 2,492 3.70 % notes due 2045 1,976 1,975 2.80 % notes due 2023 1,748 1,747 3.40 % notes due 2029 1,734 1,732 4.00 % notes due 2049 1,469 1,468 2.35 % notes due 2022 1,269 1,248 4.15 % notes due 2043 1,238 1,238 1.45 % notes due 2030 1,233 1.875 % euro-denominated notes due 2026 1,218 1,107 2.45 % notes due 2050 1,211 2.40 % notes due 2022 1,032 1,010 0.75 % notes due 2026 991 3.90 % notes due 2039 983 982 2.35 % notes due 2040 982 2.90 % notes due 2024 746 745 6.50 % notes due 2033 719 722 0.50 % euro-denominated notes due 2024 611 555 1.375 % euro-denominated notes due 2036 606 551 2.50 % euro-denominated notes due 2034 605 550 3.60 % notes due 2042 491 490 6.55 % notes due 2037 411 412 5.75 % notes due 2036 338 338 5.95 % debentures due 2028 306 306 5.85 % notes due 2039 271 271 6.40 % debentures due 2028 250 250 6.30 % debentures due 2026 135 135 3.875 % notes due 2021 1,151 1.125 % euro-denominated notes due 2021 1,113 Other 294 148 $ 25,360 $ 22,736 Other (as presented in the table above) includes $ 294 million and $ 147 million at December 31, 2020 and 2019, respectively, of borrowings at variable rates that resulted in effective interest rates of 0.45 % and 2.54 % for 2020 and 2019, respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In June 2020, the Company issued $ 4.5 billion principal amount of senior unsecured notes consisting of $ 1.0 billion of 0.75 % notes due 2026, $ 1.25 billion of 1.45 % notes due 2030, $ 1.0 billion of 2.35 % notes due 2040 and $ 1.25 billion of 2.45 % notes due 2050. Merck used the net proceeds from the offering for general corporate purposes, including without limitation the repayment of outstanding commercial paper borrowings and other indebtedness with upcoming maturities. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2020, the Company was in compliance with these covenants. s The aggregate maturities of long-term debt for each of the next five years are as follows: 2021, $ 2.3 billion; 2022, $ 2.3 billion; 2023, $ 1.7 billion; 2024, $ 1.4 billion; 2025, $ 2.5 billion. The Company has a $ 6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of eight years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company does not record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. The Company does not separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to effectively account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 346 million in 2020 and $ 339 million in 2019. Rental expense under operating leases, net of sublease income, was $ 322 million in 2018. Cash paid for amounts included in the measurement of operating lease liabilities was $ 340 million in 2020 and $ 281 million in 2019. Operating lease assets obtained in exchange for lease obligations was $ 495 million in 2020 and $ 129 million in 2019. Supplemental balance sheet information related to operating leases is as follows: December 31 2020 2019 Assets Other Assets (1) $ 1,725 $ 1,073 Liabilities Accrued and other current liabilities 300 236 Other Noncurrent Liabilities 1,362 768 $ 1,662 $ 1,004 Weighted-average remaining lease term (years) 8.0 7.4 Weighted-average discount rate 2.8 % 3.2 % (1) Includes prepaid leases that have no related lease liability. s Maturities of operating leases liabilities are as follows: 2021 $ 336 2022 277 2023 252 2024 187 2025 162 Thereafter 665 Total lease payments 1,879 Less: Imputed interest 217 $ 1,662 At December 31, 2020, the Company had entered into additional real estate operating leases that had not yet commenced; the obligations associated with these leases total $ 475 million. 10. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2020, approximately 3,520 cases are pending against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . All federal cases involving allegations of Femur Fractures have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. s In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. In May 2019, the U.S. Supreme Court decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. In November 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. Briefing on the issue is closed, and the parties await the decision of the District Court. Accordingly, as of December 31, 2020, approximately 970 cases were actively pending in the Femur Fracture MDL. As of December 31, 2020, approximately 2,270 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of cases to be reviewed through fact discovery, and Merck has continued to select additional cases to be reviewed. As of December 31, 2020, approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is presently stayed in the Femur Fracture MDL and in the state court in California. Merck intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2020, Merck is aware of approximately 1,480 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court, in separate opinions, granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery. In November 2018, the California state appellate court reversed and remanded on similar grounds. In March 2019, the parties in the MDL and the California coordinated proceedings agreed to coordinate and adopt a schedule for completing discovery on general causation and preemption issues and for renewing summary judgment and expert motions. Briefing of those motions is complete and hearings before both the MDL and California State Court judges took place on October 20 and December 8, 2020, respectively. As of December 31, 2020, six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed s the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided in September 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In May 2020, the Illinois Appellate Court issued a mandate to the state trial court, which, as of December 31, 2020, had not scheduled a case management conference. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx Merck reached a settlement with the Attorney General of Utah to fully resolve the states previously disclosed civil lawsuit alleging that Merck misrepresented the safety of Vioxx . As part of the resolution, Merck paid the state $ 25 million. The settlement does not constitute an admission by Merck of any liability or wrongdoing. This agreement marks the final resolution of litigation involving Vioxx in the United States. There is ongoing Vioxx litigation in certain countries outside the United States. Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, in May 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal health care programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, in April 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, in June 2020, Merck received a CID from the U.S. Department of Justice. The CID requests answers to interrogatories, as well as various documents, regarding temperature excursions at a third-party storage facility containing certain Merck products. Merck is cooperating with the governments investigation and intends to produce information and/or documents as necessary in response to the CID. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. s Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. In August 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, in June 2019, the representatives of the putative direct purchaser class filed an amended complaint and, in August 2019, retailer opt-out plaintiffs filed an amended complaint. In December 2019, the district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. In November 2019, the direct purchaser plaintiffs and the indirect purchaser plaintiffs filed motions for class certification. On August 21, 2020, the district court granted in part the direct purchasers motion for class certification and certified a class of 35 direct purchasers, and on November 2, 2020, the U.S. Court of Appeals for the Fourth Circuit granted the Merck Defendants motion for permission to appeal the district courts order. Also, on August 14, 2020, the magistrate judge recommended that the court grant the motion for class certification filed by the putative indirect purchaser class. The Merck Defendants objected to this report and recommendation and are awaiting a decision from the district court. On August 10, 2020, the Merck Defendants filed a motion for summary judgment and other motions, and plaintiffs filed a motion for partial summary judgment, and other motions. Those motions are now fully briefed, and the court will likely hold a hearing on the competing motions. Trial in this matter has been adjourned. On September 4, 2020, United Healthcare Services, Inc. filed a lawsuit in the United States District Court for the District of Minnesota against Merck and others (the UHC Action). The UHC Action makes similar allegations as those made in the Zetia class action. On September 23, 2020, the United States Judicial Panel on Multidistrict Litigation transferred the case to the Eastern District of Virginia to proceed with the multidistrict Zetia litigation already in progress. On December 11, 2020, Humana Inc. filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against Merck and others, alleging defendants violated state antitrust laws in multiple states. Also, on December 11, 2020, Centene Corporation and others filed a lawsuit in the Superior Court of the State of California, County of San Francisco, against the same defendants as Humana. Both lawsuits allege similar anticompetitive acts to those alleged in the Zetia class action. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. In January 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. In February 2019, MSD appealed the courts order on arbitration to the Third Circuit. In October 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of arbitrability. On July 6, 2020, MSD filed a renewed motion to compel arbitration, and plaintiffs filed a cross motion for summary judgment as to arbitrability. On November 20, 2020, the district court denied MSDs motion and granted plaintiffs motion. On December 4, 2020, MSD filed a notice of appeal to the Third Circuit. Bravecto Litigation As previously disclosed, in January 2020, the Company was served with a complaint in the United States District Court for the District of New Jersey, seeking to certify a nationwide class action of purchasers or users of Bravecto (fluralaner) products in the United States or its territories between May 1, 2014 and December 27, 2019. The complaint contends Bravecto causes neurological events and alleges violations of the New Jersey Consumer s Fraud Act, Breach of Warranty, Product Liability, and related theories. A similar case was filed in Quebec, Canada in May 2019. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that had been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the Court. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the United States with no trial date set, and also ongoing in numerous jurisdictions outside of the United States; the Company is defending those suits in each jurisdiction. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Bridion Between January and November 2020, the Company received multiple Paragraph IV Certification Letters under the Hatch-Waxman Act notifying the Company that generic drug companies have filed applications to the FDA seeking pre-patent expiry approval to sell generic versions of Bridion (sugammadex) Injection. In March, April and December 2020, the Company filed patent infringement lawsuits in the U.S. District Courts for the District of New Jersey and the Northern District of West Virginia against those generic companies. All actions in the District of New Jersey have been consolidated. These lawsuits, which assert one or more patents covering sugammadex and methods of using sugammadex, automatically stay FDA approval of the generic applications until June 2023 or until adverse court decisions, if any, whichever may occur earlier. Mylan Pharmaceuticals Inc., Mylan API US LLC, and Mylan Inc. (Mylan) have filed motions to dismiss in the District of New Jersey for lack of venue and failure to state a claim against certain defendants, and in the Northern District of West Virginia for failure to state a claim against certain defendants. The New Jersey motion has not yet been decided, and the West Virginia action is stayed pending resolution of the New Jersey motion. s Januvia, Janumet, Janumet XR The FDA has granted pediatric exclusivity with respect to Januvia , Janumet , and Janumet XR , which provides a further six months of exclusivity in the United States beyond the expiration of all patents listed in the FDAs Orange Book. Including this exclusivity, key patent protection extends to January 2023. The Company anticipates that sales of Januvia and Janumet in the United States will decline significantly after this loss of market exclusivity. However, Januvia , Janumet , and Janumet XR contain sitagliptin phosphate monohydrate and the Company has another patent covering certain phosphate salt and polymorphic forms of sitagliptin, which, if determined to be valid, would preclude generic manufacturers from making sitagliptin phosphate salt and polymorphic forms before that patent, inclusive of pediatric exclusivity, expires in 2027 (2027 salt/polymorph patent). In 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of the 2027 salt/polymorph patent. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection, but prior to the expiration of the 2027 salt/polymorph patent, and a later granted patent owned by the Company covering the Janumet formulation which, inclusive of pediatric exclusivity, expires in 2029. The Company also filed a patent infringement lawsuit against Mylan in the Northern District of West Virginia. The Judicial Panel of Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. The U.S. District Court for the District of Delaware has scheduled the lawsuits for a single three-day trial on invalidity issues in October 2021. The Court has scheduled separate one-day trials on infringement issues in November 2021 through January 2022, to the extent such trials are necessary. In the Companys case against Mylan, the U.S. District Court for the Northern District of West Virginia has conditionally scheduled a three-day trial in December 2021 on all issues. The Company has settled with nine generic companies providing that these generic companies can bring their products to the market in May 2027 or earlier under certain circumstances. Additionally, in 2019, Mylan filed a petition for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking invalidity of some, but not all, of the claims of the 2027 salt/polymorph patent, which other manufacturers joined. The USPTO instituted IPR proceedings in May 2020, finding a reasonable likelihood that the challenged claims are not valid. A trial was held in February 2021 and a final decision is expected in May 2021. If the challenges are successful, the unchallenged claims of the 2027 salt/polymorph patent will remain valid, subject to the court proceedings described above. In Germany, two generic companies have sought the revocation of the Supplementary Protection Certificate (SPC) for Janumet . If the generic companies are successful, Janumet could lose market exclusivity in Germany as early as July 2022. Challenges to the Janumet SPC have also occurred in Portugal and Finland, and could occur in other European countries. Nexplanon In June 2017, Microspherix LLC (Microspherix) sued the Company in the U.S District Court for the District of New Jersey asserting that the manufacturing, use, sale and importation of Nexplanon infringed several of Microspherixs patents that claim radio-opaque, implantable drug delivery devices. Microspherix is claiming damages from September 2014 until those patents expire in May 2021. The Company brought IPR proceedings in the USPTO and successfully stayed the district court action. The USPTO invalidated some, but not all, of the claims asserted against the Company. The Company appealed the decisions finding claims valid, and the Court of Appeals for the Federal Circuit affirmed the USPTOs decisions. The matter is no longer stayed in the district court, and the Company is currently litigating the invalidity and non-infringement of the remaining asserted claims. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. s Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2020 and 2019 of approximately $ 250 million and $ 240 million, respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 67 million at both December 31, 2020 and 2019. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed approximately $ 65 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. s 11. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: 2020 2019 2018 Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 1,038 3,577 985 3,577 880 Purchases of treasury stock 16 66 122 Issuances (1) ( 7 ) ( 13 ) ( 17 ) Balance December 31 3,577 1,047 3,577 1,038 3,577 985 (1) Issuances primarily reflect activity under share-based compensation plans. In 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (the Dealers). Under the ASR agreements, Merck agreed to purchase $ 5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $ 5 billion made by Merck to the Dealers, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million. 12. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2020, 100 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three-year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years . RSU awards generally vest one-third each year over a three-year period. Total pretax share-based compensation cost recorded in 2020, 2019 and 2018 was $ 475 million, $ 417 million and $ 348 million, respectively, with related income tax benefits of $ 65 million, $ 57 million and $ 55 million, respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk- s free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2020, 2019 and 2018 was $ 77.67 , $ 80.05 and $ 58.15 per option, respectively. The weighted average fair value of options granted in 2020, 2019 and 2018 was $ 9.93 , $ 10.63 and $ 8.26 per option, respectively, and were determined using the following assumptions: Years Ended December 31 2020 2019 2018 Expected dividend yield 3.1 % 3.2 % 3.4 % Risk-free interest rate 0.4 % 2.4 % 2.9 % Expected volatility 22.1 % 18.7 % 19.1 % Expected life (years) 5.8 5.9 6.1 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2020 17,868 $ 59.88 Granted 3,564 77.67 Exercised ( 1,685 ) 52.73 Forfeited ( 301 ) 67.73 Outstanding December 31, 2020 19,446 $ 63.64 6.27 $ 353 Exercisable December 31, 2020 13,141 $ 58.30 5.13 $ 309 Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 2020 2019 2018 Total intrinsic value of stock options exercised $ 51 $ 295 $ 348 Fair value of stock options vested 25 27 29 Cash received from the exercise of stock options 89 361 591 A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2020 13,527 $ 67.58 1,972 $ 69.18 Granted 6,627 77.79 996 77.82 Vested ( 7,511 ) 65.70 ( 824 ) 64.01 Forfeited ( 728 ) 72.06 ( 44 ) 80.06 Nonvested December 31, 2020 11,915 $ 74.17 2,100 $ 75.08 At December 31, 2020, there was $ 678 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. s 13. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ 360 $ 293 $ 326 $ 301 $ 238 $ 238 $ 52 $ 48 $ 57 Interest cost 431 458 432 137 177 178 57 69 69 Expected return on plan assets ( 774 ) ( 817 ) ( 851 ) ( 415 ) ( 426 ) ( 431 ) ( 75 ) ( 72 ) ( 83 ) Amortization of unrecognized prior service cost ( 49 ) ( 49 ) ( 50 ) ( 18 ) ( 12 ) ( 13 ) ( 73 ) ( 78 ) ( 84 ) Net loss (gain) amortization 303 151 232 127 64 84 ( 18 ) ( 10 ) 1 Termination benefits 10 31 19 3 8 2 2 5 3 Curtailments 10 14 10 6 1 ( 4 ) ( 11 ) ( 8 ) Settlements 13 5 15 1 13 Net periodic benefit cost (credit) $ 304 $ 81 $ 123 $ 150 $ 56 $ 72 $ ( 59 ) $ ( 49 ) $ ( 45 ) The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2020, 2019 and 2018 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 14), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. s Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International 2020 2019 2020 2019 2020 2019 Fair value of plan assets January 1 $ 11,361 $ 9,648 $ 10,163 $ 8,580 $ 1,102 $ 968 Actual return on plan assets 1,908 2,165 1,026 1,505 175 203 Company contributions 199 130 387 262 19 14 Effects of exchange rate changes 746 31 Benefits paid ( 751 ) ( 582 ) ( 215 ) ( 230 ) ( 93 ) ( 104 ) Settlements ( 45 ) ( 117 ) ( 12 ) Other 59 27 18 21 Fair value of plan assets December 31 $ 12,672 $ 11,361 $ 12,049 $ 10,163 $ 1,221 $ 1,102 Benefit obligation January 1 $ 13,003 $ 10,620 $ 10,612 $ 9,083 $ 1,673 $ 1,615 Service cost 360 293 301 238 52 48 Interest cost 431 458 137 177 57 69 Actuarial losses (gains) (1) 1,594 2,165 1,036 1,313 ( 98 ) 21 Benefits paid ( 751 ) ( 582 ) ( 215 ) ( 230 ) ( 93 ) ( 104 ) Effects of exchange rate changes 794 4 ( 3 ) 1 Plan amendments ( 64 ) 1 Curtailments 11 18 ( 8 ) 3 ( 1 ) Termination benefits 10 31 3 8 2 5 Settlements ( 45 ) ( 117 ) ( 12 ) Other 55 27 18 18 Benefit obligation December 31 $ 14,613 $ 13,003 $ 12,534 $ 10,612 $ 1,607 $ 1,673 Funded status December 31 $ ( 1,941 ) $ ( 1,642 ) $ ( 485 ) $ ( 449 ) $ ( 386 ) $ ( 571 ) Recognized as: Other Assets $ $ $ 941 $ 837 $ $ Accrued and other current liabilities ( 82 ) ( 92 ) ( 13 ) ( 18 ) ( 9 ) ( 10 ) Other Noncurrent Liabilities ( 1,859 ) ( 1,550 ) ( 1,413 ) ( 1,268 ) ( 377 ) ( 561 ) (1) Actuarial losses (gains) primarily reflect changes in discount rates. At December 31, 2020 and 2019, the accumulated benefit obligation was $ 26.4 billion and $ 22.8 billion, respectively, for all pension plans, of which $ 14.4 billion and $ 12.8 billion, respectively, related to U.S. pension plans. s Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International 2020 2019 2020 2019 Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 14,613 $ 13,003 $ 8,951 $ 7,421 Fair value of plan assets 12,672 11,361 7,526 6,135 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 13,489 $ 12,009 $ 4,288 $ 2,476 Fair value of plan assets 11,685 10,484 3,033 1,501 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2020 and 2019, $ 942 million and $ 860 million, respectively, or approximately 4 % of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. s The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2020 2019 U.S. Pension Plans Cash and cash equivalents $ 5 $ $ $ 303 $ 308 $ 3 $ $ $ 236 $ 239 Investment funds Developed markets equities 206 3,884 4,090 205 3,542 3,747 Emerging markets equities 169 927 1,096 165 723 888 Mortgage and asset-backed securities 89 89 Government and agency obligations 173 173 Equity securities Developed markets 2,819 2,819 2,451 2,451 Fixed income securities Government and agency obligations 2,236 2,236 2,094 2,094 Corporate obligations 1,994 1,994 1,582 1,582 Mortgage and asset-backed securities 33 33 178 178 Other investments 7 7 9 9 Plan assets at fair value $ 3,199 $ 4,352 $ 7 $ 5,114 $ 12,672 $ 2,824 $ 3,854 $ 9 $ 4,674 $ 11,361 International Pension Plans Cash and cash equivalents $ 110 $ 1 $ $ 20 $ 131 $ 70 $ 1 $ $ 15 $ 86 Investment funds Developed markets equities 475 4,286 118 4,879 546 3,761 96 4,403 Government and agency obligations 1,516 2,614 172 4,302 462 2,534 207 3,203 Emerging markets equities 154 92 246 66 96 90 252 Corporate obligations 5 12 172 189 5 11 109 125 Other fixed income obligations 9 11 4 24 9 6 15 Real estate 1 15 16 1 1 Equity securities Developed markets 505 505 565 565 Fixed income securities Government and agency obligations 3 486 3 492 3 376 379 Corporate obligations 1 174 2 177 1 135 136 Mortgage and asset-backed securities 70 70 61 61 Other investments Insurance contracts (2) 76 935 1 1,012 65 851 916 Other 1 5 6 5 16 21 Plan assets at fair value $ 2,779 $ 7,736 $ 935 $ 599 $ 12,049 $ 1,727 $ 7,052 $ 851 $ 533 $ 10,163 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2020 and 2019. (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. s The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: 2020 2019 Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ 9 $ 9 $ $ $ 13 $ 13 Actual return on plan assets: Relating to assets still held at December 31 ( 5 ) ( 5 ) ( 8 ) ( 8 ) Relating to assets sold during the year 5 5 8 8 Purchases and sales, net ( 2 ) ( 2 ) ( 4 ) ( 4 ) Balance December 31 $ $ $ 7 $ 7 $ $ $ 9 $ 9 International Pension Plans Balance January 1 $ 851 $ $ $ 851 $ 811 $ 1 $ 1 $ 813 Actual return on plan assets: Relating to assets still held at December 31 103 103 54 54 Purchases and sales, net ( 17 ) ( 17 ) ( 14 ) ( 1 ) ( 1 ) ( 16 ) Transfers out of Level 3 ( 2 ) ( 2 ) Balance December 31 $ 935 $ $ $ 935 $ 851 $ $ $ 851 The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total 2020 2019 Cash and cash equivalents $ 31 $ $ $ 28 $ 59 $ 52 $ $ $ 22 $ 74 Investment funds Developed markets equities 19 355 374 19 324 343 Emerging markets equities 16 85 101 15 66 81 Government and agency obligations 1 1 1 16 17 Mortgage and asset-backed securities 8 8 Equity securities Developed markets 258 258 225 225 Fixed income securities Government and agency obligations 221 221 196 196 Corporate obligations 196 196 149 149 Mortgage and asset-backed securities 3 3 17 17 Plan assets at fair value $ 325 $ 428 $ $ 468 $ 1,221 $ 312 $ 362 $ $ 428 $ 1,102 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2020 and 2019. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11 %, reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the s targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2021 are approximately $ 300 million for U.S. pension plans, approximately $ 170 million for international pension plans and approximately $ 35 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits 2021 $ 816 $ 274 $ 85 2022 786 277 86 2023 781 284 87 2024 772 285 89 2025 782 287 91 2026 2030 4,271 1,688 474 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 2020 2019 2018 2020 2019 2018 2020 2019 2018 Net (loss) gain arising during the period $ ( 448 ) $ ( 816 ) $ ( 397 ) $ ( 407 ) $ ( 227 ) $ ( 505 ) $ 198 $ 112 $ 186 Prior service (cost) credit arising during the period ( 1 ) ( 4 ) ( 4 ) 62 ( 1 ) ( 10 ) ( 3 ) ( 11 ) 2 $ ( 449 ) $ ( 820 ) $ ( 401 ) $ ( 345 ) $ ( 228 ) $ ( 515 ) $ 195 $ 101 $ 188 Net loss (gain) amortization included in benefit cost $ 303 $ 151 $ 232 $ 127 $ 64 $ 84 $ ( 18 ) $ ( 10 ) $ 1 Prior service credit amortization included in benefit cost ( 49 ) ( 49 ) ( 50 ) ( 18 ) ( 12 ) ( 13 ) ( 73 ) ( 78 ) ( 84 ) $ 254 $ 102 $ 182 $ 109 $ 52 $ 71 $ ( 91 ) $ ( 88 ) $ ( 83 ) s Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 2020 2019 2018 2020 2019 2018 Net periodic benefit cost Discount rate 3.40 % 4.40 % 3.70 % 1.50 % 2.20 % 2.10 % Expected rate of return on plan assets 7.30 % 8.10 % 8.20 % 4.40 % 4.90 % 5.10 % Salary growth rate 4.20 % 4.30 % 4.30 % 2.80 % 2.80 % 2.90 % Interest crediting rate 4.90 % 3.40 % 3.30 % 2.80 % 2.90 % 2.80 % Benefit obligation Discount rate 2.70 % 3.40 % 4.40 % 1.10 % 1.50 % 2.20 % Salary growth rate 4.60 % 4.20 % 4.30 % 2.80 % 2.80 % 2.80 % Interest crediting rate 4.70 % 4.90 % 3.40 % 3.00 % 2.80 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2021, the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 6.50 % to 6.70 %, as compared to a range of 7.00 % to 7.30 % in 2020. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 2020 2019 Health care cost trend rate assumed for next year 6.6 % 6.8 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate 2032 2032 Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2020, 2019 and 2018 were $ 166 million, $ 149 million and $ 136 million, respectively. s 14. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 2020 2019 2018 Interest income $ ( 59 ) $ ( 274 ) $ ( 343 ) Interest expense 831 893 772 Exchange losses 145 187 145 Income from investments in equity securities, net (1) ( 1,338 ) ( 170 ) ( 324 ) Net periodic defined benefit plan (credit) cost other than service cost ( 339 ) ( 545 ) ( 512 ) Other, net ( 126 ) 48 ( 140 ) $ ( 886 ) $ 139 $ ( 402 ) (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Unrealized gains and losses from investments that are directly owned are determined at the end of the reporting period, while ownership interests in investment funds are accounted for on a one quarter lag. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8). Other, net in 2018 includes a gain of $ 115 million related to the settlement of certain patent litigation, income of $ 99 million related to AstraZenecas option exercise in 2014 in connection with the termination of the Companys relationship with AstraZeneca LP (AZLP), and a gain of $ 85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $ 144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $ 41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Interest paid was $ 822 million in 2020, $ 841 million in 2019 and $ 777 million in 2018. 15. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: 2020 2019 2018 Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 1,846 21.0 % $ 2,408 21.0 % $ 1,827 21.0 % Differential arising from: Foreign earnings ( 1,242 ) ( 14.1 ) ( 1,020 ) ( 8.9 ) ( 245 ) ( 2.8 ) GILTI and the foreign-derived intangible income deduction 364 4.1 336 2.9 ( 25 ) ( 0.3 ) RD tax credit ( 110 ) ( 1.3 ) ( 118 ) ( 1.0 ) ( 96 ) ( 1.1 ) Tax settlements ( 13 ) ( 0.2 ) ( 403 ) ( 3.5 ) ( 22 ) ( 0.3 ) Acquisition of VelosBio 559 6.3 Restructuring 105 1.2 39 0.3 56 0.6 Acquisition of OncoImmune 97 1.1 State taxes 67 0.8 ( 2 ) 201 2.3 Acquisition-related costs, including amortization 46 0.5 95 0.8 267 3.1 Valuation allowances 42 0.5 113 1.0 269 3.1 Acquisition of Peloton 209 1.8 Tax Cuts and Jobs Act of 2017 117 1.0 289 3.3 Other ( 52 ) ( 0.5 ) ( 87 ) ( 0.7 ) ( 13 ) ( 0.1 ) $ 1,709 19.4 % $ 1,687 14.7 % $ 2,508 28.8 % s The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017 and the Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized and resulted in additional income tax expense in 2018 and 2019. The Companys remaining transition tax liability under the TCJA, which has been reduced by payments and the utilization of foreign tax credits, was $ 3.0 billion at December 31, 2020, of which $ 390 million is included in Income taxes payable and the remainder of $ 2.6 billion is included in Other Noncurrent Liabilities . As a result of the transition tax under the TCJA, the Company is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for foreign withholding taxes that would apply. The Company remains indefinitely reinvested with respect to its financial statement basis in excess of tax basis of its foreign subsidiaries. A determination of the deferred tax liability with respect to this basis difference is not practicable. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21%. Towards the end of 2020, a new reduced tax rate arrangement was agreed to in Switzerland for certain newly active legal entities. Income before taxes consisted of: Years Ended December 31 2020 2019 2018 Domestic $ ( 3,492 ) $ 439 $ 3,717 Foreign 12,283 11,025 4,984 $ 8,791 $ 11,464 $ 8,701 Taxes on income consisted of: Years Ended December 31 2020 2019 2018 Current provision Federal $ 962 $ 514 $ 536 Foreign 1,362 1,806 2,281 State 53 ( 77 ) 200 2,377 2,243 3,017 Deferred provision Federal ( 605 ) ( 330 ) ( 402 ) Foreign ( 40 ) ( 240 ) ( 64 ) State ( 23 ) 14 ( 43 ) ( 668 ) ( 556 ) ( 509 ) $ 1,709 $ 1,687 $ 2,508 s Deferred income taxes at December 31 consisted of: 2020 2019 Assets Liabilities Assets Liabilities Product intangibles and licenses $ 141 $ 1,250 $ 442 $ 1,778 Inventory related 43 335 32 354 Accelerated depreciation 588 594 Equity investments 175 Pensions and other postretirement benefits 834 248 785 191 Compensation related 252 322 Unrecognized tax benefits 117 109 Net operating losses and other tax credit carryforwards 794 897 Other 808 81 764 84 Subtotal 2,989 2,677 3,351 3,001 Valuation allowance ( 433 ) ( 1,100 ) Total deferred taxes $ 2,556 $ 2,677 $ 2,251 $ 3,001 Net deferred income taxes $ 121 $ 750 Recognized as: Other Assets $ 894 $ 719 Deferred Income Taxes $ 1,015 $ 1,470 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2020, $ 464 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 433 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 330 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2020, 2019 and 2018 were $ 2.7 billion, $ 4.5 billion and $ 1.5 billion, respectively. Tax benefits relating to stock option exercises were $ 55 million in 2020, $ 65 million in 2019 and $ 77 million in 2018. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: 2020 2019 2018 Balance January 1 $ 1,225 $ 1,893 $ 1,723 Additions related to current year positions 298 199 221 Additions related to prior year positions 110 46 142 Reductions for tax positions of prior years (1) ( 4 ) ( 454 ) ( 73 ) Settlements (1) ( 70 ) ( 356 ) ( 91 ) Lapse of statute of limitations (2) ( 22 ) ( 103 ) ( 29 ) Balance December 31 $ 1,537 $ 1,225 $ 1,893 (1) Amounts in 2019 reflects the settlement with the IRS discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.5 billion at December 31, 2020, the income tax provision would reflect a favorable net impact of $ 1.5 billion. s The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2020 could decrease by up to approximately $ 160 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to an expense (benefit) of $ 27 million in 2020, $( 101 ) million in 2019 and $ 51 million in 2018. These amounts reflect the beneficial impacts of various tax settlements, including the settlement discussed below. Liabilities for accrued interest and penalties were $ 268 million and $ 243 million as of December 31, 2020 and 2019, respectively. In 2019, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million. The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. The IRS is currently conducting examinations of the Companys tax returns for the years 2015 and 2016. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2020. 16. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 2020 2019 2018 Net income attributable to Merck Co., Inc. $ 7,067 $ 9,843 $ 6,220 Average common shares outstanding 2,530 2,565 2,664 Common shares issuable (1) 11 15 15 Average common shares outstanding assuming dilution 2,541 2,580 2,679 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 2.79 $ 3.84 $ 2.34 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 2.78 $ 3.81 $ 2.32 (1) Issuable primarily under share-based compensation plans. In 2020, 2019 and 2018, 5 million, 2 million and 6 million, respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. s 17. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2018, net of taxes $ ( 108 ) $ ( 61 ) $ ( 2,787 ) $ ( 1,954 ) $ ( 4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax 228 ( 108 ) ( 728 ) ( 84 ) ( 692 ) Tax ( 55 ) 1 169 ( 139 ) ( 24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes 173 ( 107 ) ( 559 ) ( 223 ) ( 716 ) Reclassification adjustments, pretax 157 (1) 97 (2) 170 (3) 424 Tax ( 33 ) ( 36 ) ( 69 ) Reclassification adjustments, net of taxes 124 97 134 355 Other comprehensive income (loss), net of taxes 297 ( 10 ) ( 425 ) ( 223 ) ( 361 ) Adoption of ASU 2018-02 ( 23 ) 1 ( 344 ) 100 ( 266 ) Adoption of ASU 2016-01 ( 8 ) ( 8 ) Balance at December 31, 2018, net of taxes 166 ( 78 ) ( 3,556 ) ( 2,077 ) ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax 86 140 ( 948 ) 112 ( 610 ) Tax ( 15 ) 192 ( 16 ) 161 Other comprehensive income (loss) before reclassification adjustments, net of taxes 71 140 ( 756 ) 96 ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) 66 (3) ( 239 ) Tax 55 ( 15 ) 40 Reclassification adjustments, net of taxes ( 206 ) ( 44 ) 51 ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) 96 ( 705 ) 96 ( 648 ) Balance at December 31, 2019, net of taxes 31 18 ( 4,261 ) (4) ( 1,981 ) ( 6,193 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 383 ) 3 ( 599 ) 64 ( 915 ) Tax 84 111 89 284 Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 299 ) 3 ( 488 ) 153 ( 631 ) Reclassification adjustments, pretax 2 (1) ( 21 ) (2) 272 (3) 253 Tax ( 63 ) ( 63 ) Reclassification adjustments, net of taxes 2 ( 21 ) 209 190 Other comprehensive income (loss), net of taxes ( 297 ) ( 18 ) ( 279 ) 153 ( 441 ) Balance at December 31, 2020, net of taxes $ ( 266 ) $ $ ( 4,540 ) (4) $ ( 1,828 ) $ ( 6,634 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 13). (4) Includes pension plan net loss of $ 5.4 billion and $ 5.1 billion at December 31, 2020 and 2019, respectively, and other postretirement benefit plan net gain of $ 391 million and $ 247 million at December 31, 2020 and 2019, respectively, as well as pension plan prior service credit of $ 255 million and $ 263 million at December 31, 2020 and 2019, respectively, and other postretirement benefit plan prior service credit of $ 244 million and $ 305 million at December 31, 2020 and 2019, respectively. s 18. Segment Reporting The Companys operations are principally managed on a products basis and include two operating segments, which are the Pharmaceutical and Animal Health segments, both of which are reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Company previously had a Healthcare Services segment that provided services and solutions focused on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company divested the remaining businesses in this segment in the first quarter of 2020. The Company previously had an Alliances segment that primarily included activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. s Sales of the Companys products were as follows: Years Ended December 31 2020 2019 2018 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 8,352 $ 6,028 $ 14,380 $ 6,305 $ 4,779 $ 11,084 $ 4,150 $ 3,021 $ 7,171 Alliance revenue - Lynparza (1) 417 308 725 269 176 444 127 61 187 Alliance revenue - Lenvima (1) 359 220 580 239 165 404 95 54 149 Emend 18 127 145 183 205 388 312 210 522 Vaccines Gardasil/Gardasil 9 1,755 2,184 3,938 1,831 1,905 3,737 1,873 1,279 3,151 ProQuad/M-M-R II/Varivax 1,378 500 1,878 1,683 592 2,275 1,430 368 1,798 Pneumovax 23 727 359 1,087 679 247 926 627 281 907 RotaTeq 486 311 797 506 284 791 496 232 728 Vaqta 103 67 170 130 108 238 127 112 239 Hospital Acute Care Bridion 583 615 1,198 533 598 1,131 386 531 917 Noxafil 42 287 329 282 380 662 353 389 742 Prevymis 119 162 281 84 81 165 46 27 72 Primaxin 2 248 251 2 271 273 7 258 265 Cancidas 7 207 213 6 242 249 12 314 326 Invanz 9 202 211 30 233 263 253 243 496 Cubicin 46 106 152 92 165 257 191 176 367 Zerbaxa 74 56 130 63 58 121 42 45 87 Immunology Simponi 838 838 830 830 893 893 Remicade 330 330 411 411 582 582 Neuroscience Belsomra 81 247 327 92 214 306 96 164 260 Virology Isentress/Isentress HD 326 531 857 398 576 975 513 627 1,140 Zepatier 60 107 167 118 252 370 8 447 455 Cardiovascular Zetia ( 1 ) 483 482 14 575 590 45 813 857 Vytorin 12 171 182 16 269 285 10 487 497 Atozet 453 453 391 391 347 347 Alliance revenue - Adempas (2) 259 22 281 194 10 204 134 5 139 Adempas 220 220 215 215 190 190 Diabetes Januvia 1,470 1,836 3,306 1,724 1,758 3,482 1,969 1,718 3,686 Janumet 477 1,494 1,971 589 1,452 2,041 811 1,417 2,228 Womens Health Implanon/Nexplanon 488 192 680 568 219 787 495 208 703 NuvaRing 110 127 236 742 136 879 722 180 902 Diversified Brands Singulair 18 444 462 29 669 698 20 688 708 Cozaar/Hyzaar 21 365 386 24 418 442 23 431 453 Arcoxia 258 258 288 288 335 335 Nasonex 12 206 218 9 284 293 23 353 376 Follistim AQ 84 109 193 103 138 241 115 153 268 Other pharmaceutical (3) 1,555 3,152 4,709 1,416 3,204 4,615 1,231 3,308 4,546 Total Pharmaceutical segment sales 19,449 23,572 43,021 18,953 22,798 41,751 16,742 20,947 37,689 Animal Health: Livestock 612 2,327 2,939 582 2,201 2,784 528 2,102 2,630 Companion Animals 872 892 1,764 724 885 1,609 710 872 1,582 Total Animal Health segment sales 1,484 3,219 4,703 1,306 3,086 4,393 1,238 2,974 4,212 Other segment sales (4) 23 23 174 1 175 248 2 250 Total segment sales 20,956 26,791 47,747 20,433 25,885 46,319 18,228 23,923 42,151 Other (5) 71 176 247 86 436 521 118 26 143 $ 21,027 $ 26,967 $ 47,994 $ 20,519 $ 26,321 $ 46,840 $ 18,346 $ 23,949 $ 42,294 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4). (2) Alliance revenue represents Mercks share of profits from sales in Bayers marketing territories, which are product sales net of cost of sales and commercialization costs (see Note 4). (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents sales for the non-reportable segments of Healthcare Services (fully divested in the first quarter of 2020) and Alliances (which concluded in 2018). (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. s Consolidated sales by geographic area where derived are as follows: Years Ended December 31 2020 2019 2018 United States $ 21,027 $ 20,519 $ 18,346 Europe, Middle East and Africa 13,600 12,707 12,213 China 3,624 3,207 2,184 Japan 3,376 3,583 3,212 Asia Pacific (other than China and Japan) 2,864 2,943 2,909 Latin America 2,274 2,469 2,415 Other 1,229 1,412 1,015 $ 47,994 $ 46,840 $ 42,294 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 2020 2019 2018 Segment profits: Pharmaceutical segment $ 29,722 $ 28,324 $ 24,871 Animal Health segment 1,650 1,609 1,659 Other segments 1 ( 7 ) 103 Total segment profits 31,373 29,926 26,633 Other profits 140 363 6 Unallocated: Interest income 59 274 343 Interest expense ( 831 ) ( 893 ) ( 772 ) Depreciation and amortization ( 1,602 ) ( 1,593 ) ( 1,352 ) Research and development ( 13,072 ) ( 9,499 ) ( 9,432 ) Amortization of purchase accounting adjustments ( 1,168 ) ( 1,406 ) ( 2,664 ) Restructuring costs ( 578 ) ( 638 ) ( 632 ) Charge related to the termination of a collaboration with Samsung ( 423 ) Other unallocated, net ( 5,530 ) ( 5,070 ) ( 3,006 ) Income Before Taxes $ 8,791 $ 11,464 $ 8,701 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. s Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2020 Included in segment profits: Equity (income) loss from affiliates $ 6 $ $ $ 6 Depreciation and amortization 690 164 1 855 Year Ended December 31, 2019 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization 534 109 10 653 Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ 4 $ $ $ 4 Depreciation and amortization 411 82 10 503 Property, plant and equipment, net, by geographic area where located is as follows: December 31 2020 2019 2018 United States $ 10,526 $ 8,974 $ 8,306 Europe, Middle East and Africa 6,059 4,767 3,706 Asia Pacific (other than China and Japan) 761 714 684 Latin America 252 266 264 China 217 174 167 Japan 166 152 159 Other 5 6 5 $ 17,986 $ 15,053 $ 13,291 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. s Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2020, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. s Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Customer Discount Accruals in the U.S. - Medicaid, Managed Care and Medicare Part D Rebates As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts as of December 31, 2020 in the U.S. are $3.1 billion and are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The principal considerations for our determination that performing procedures relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates is a critical audit matter are the significant judgment by management due to the significant measurement uncertainty involved in developing the provisions, as the provisions include assumptions related to changes to price and historical customer segment utilization mix, pertaining to forecasted customer claims that may not be fully paid until a subsequent period. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions and in evaluating the evidence obtained from these procedures. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others, (i) developing an independent estimate of the rebate accruals by utilizing third party data on historical customer segment utilization mix in the U.S., changes to price, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid, (ii) comparing the independent estimate to the rebate accruals recorded by management and (iii) testing actual rebate claims paid, including evaluating those claims for consistency with the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 25, 2021 We have served as the Companys auditor since 2002. s "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2020, there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2020. PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated s Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2020. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2020, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +2,mrk1,1201910k," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. While the Company continues to look for investment opportunities in this area of health care, the approach to these investments has shifted toward venture capital investments in third parties as opposed to wholly-owned businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. The Company was incorporated in New Jersey in 1970. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into a New Company In February 2020, Merck announced its intention to spin-off (the Spin-Off) products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The Spin-Off is expected to be completed in the first half of 2021, subject to market and certain other conditions. See Risk Factors - Risks Related to the Proposed Spin-Off of NewCo. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) Total Sales $ 46,840 $ 42,294 $ 40,122 Pharmaceutical 41,751 37,689 35,390 Keytruda 11,084 7,171 3,809 Januvia/Janumet 5,524 5,914 5,896 Gardasil/Gardasil 9 3,737 3,151 2,308 ProQuad/M-M-R II /Varivax 2,275 1,798 1,676 Bridion 1,131 Isentress/Isentress HD 1,140 1,204 Pneumovax 23 NuvaRing Zetia/Vytorin 1,355 2,095 Simponi Animal Health 4,393 4,212 3,875 Livestock 2,784 2,630 2,484 Companion Animals 1,609 1,582 1,391 Other Revenues (1) (1) Other revenues are primarily comprised of Healthcare Services segment revenue, third-party manufacturing sales, and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with melanoma, non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), head and neck squamous cell carcinoma (HNSCC), classical Hodgkin Lymphoma (cHL), primary mediastinal large B-cell lymphoma (PMBCL), urothelial carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, gastric or gastroesophageal junction adenocarcinoma, esophageal cancer, cervical cancer, hepatocellular carcinoma, and merkel cell carcinoma. Keytruda is also used for the treatment of certain patients in combination with chemotherapy for metastatic squamous and non-squamous NSCLC, in combination with chemotherapy for HNSCC, in combination with axitinib for renal cell carcinoma, and in combination with lenvatinib for endometrial carcinoma; and Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of advanced ovarian, breast and pancreatic cancers; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, in combination with everolimus for certain patients with renal cell carcinoma, and in combination with Keytruda for certain patients with endometrial carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV); ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Vaqta (hepatitis A vaccine, inactivated) indicated for the prevention of disease caused by hepatitis A virus in persons 12 months of age and older. Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Primaxin (imipenem and cilastatin sodium) an anti-bacterial product; Invanz (ertapenem sodium) for the treatment of certain infections; Cubicin (daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; Cancidas (caspofungin acetate), an anti-fungal product; and Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product; and Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant. Animal Health The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceuticals, vaccines and health management solutions and services, as well as an extensive suite of digitally connected identification, traceability and monitoring products. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; Aquaflor (Florfenicol) antibiotic for farm-raised fish; and Allflex Livestock Intelligence solutions for animal identification, monitoring and traceability. Companion Animal Products Bravecto (fluralaner), a line of oral and topical parasitic control products for dogs and cats that last up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2019 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2019. Product Date Approval Ervebo December 2019 The U.S. Food and Drug Administration (FDA) approved Ervebo for the prevention of disease caused by Zaire ebolavirus in individuals 18 years of age and older. November 2019 The European Commission (EC) granted a conditional marketing authorization for Ervebo for active immunization of individuals 18 years of age or older to protect against Ebola Virus Disease caused by Zaire Ebola virus. Keytruda December 2019 The Japanese Ministry of Health, Labour and Welfare (MHLW) approved Keytruda for three new first-line indications across advanced renal cell carcinoma (RCC) and recurrent or distant metastatic head and neck cancer. November 2019 EC approved two new regimens of Keytruda as first-line treatment for metastatic or unresectable recurrent head and neck squamous cell carcinoma (HNSCC). November 2019 The China National Medical Products Administration (NMPA) approved Keytruda for first-line treatment of metastatic squamous non-small cell lung cancer (NSCLC) in combination with chemotherapy. October 2019 NMPA approved Keytruda as monotherapy for first-line treatment of certain patients with advanced NSCLC whose tumors express PD-L1. September 2019 FDA approved Keytruda plus Lenvima combination treatment for patients with certain types of endometrial carcinoma. September 2019 EC approved Keytruda in combination with axitinib as first-line treatment for patients with advanced RCC. July 2019 FDA approved Keytruda for recurrent locally advanced or metastatic squamous cell carcinoma of the esophagus in patients whose tumors express PD-L1 combined positive score [CPS] (CPS 10) with disease progression after one of more prior lines of systemic therapy. Keytruda June 2019 FDA approved Keytruda as monotherapy for patients with metastatic small-cell lung cancer (SCLC) with disease progression on or after platinum-based chemotherapy and at least one other prior line of therapy. June 2019 FDA approved two indications for Keytruda for first-line treatment of patients with metastatic or with unresectable, recurrent HNSCC as monotherapy for patients whose tumors express PD-L1 CPS 1 or in combination with platinum and fluorouracil regardless of PD-L1 expression. April 2019 FDA approved Keytruda in combination with axitinib for first-line treatment of patients with advanced RCC. April 2019 FDA approved an expanded label for Keytruda as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (tumor proportion score [TPS] 1%) as determined by an FDA-approved test, with no epidermal growth factor receptor (EGFR) or anaplastic lymphoma kinase positive (ALK) genomic tumor aberrations. April 2019 EC approved new extended dosing schedule for Keytruda for all approved monotherapy indications. April 2019 NMPA approved Keytruda for first-line treatment of metastatic nonsquamous NSCLC in combination with chemotherapy. March 2019 EC approved Keytruda in combination with chemotherapy for first-line treatment of adults with metastatic squamous NSCLC. February 2019 FDA approved Keytruda for the adjuvant treatment of patients with melanoma with involvement of lymph node(s) following complete resection. January 2019 MHLW approved Keytruda for five indications, including three expanded uses in advanced NSCLC, one in melanoma, as well as a new indication in advanced microsatellite instability-high tumors. Lynparza (1) December 2019 FDA approved Lynparza for first-line maintenance therapy for patients with germline BRCA -mutated (g BRCA -m) metastatic pancreatic cancer whose disease has not progressed for at least 16 weeks of a first-line, platinum-based chemotherapy regimen. December 2019 NMPA approved Lynparza as a first-line maintenance therapy in BRCA -m advanced ovarian cancer. July 2019 EC approved Lynparza as monotherapy for the maintenance treatment of adult patients with advanced BRCA -m, high-grade epithelial ovarian, fallopian tube or primary peritoneal cancer. June 2019 MHLW approved Lynparza as first-line maintenance therapy in patients with BRCA -m advanced ovarian cancer. June 2019 EC approved Lynparza for use as first-line maintenance therapy in patients with BRCA -m advanced ovarian cancer. April 2019 EC approved Lynparza for the treatment of g BRCA -m HER2-negative advanced breast cancer. Pifeltro and Delstrigo September 2019 FDA approved supplemental New Drug Applications (sNDAs) for Pifeltro (doravirine) in combination with other antiretroviral agents, and Delstrigo (doravirine, lamivudine, and tenofovir disoproxil fumarate) as a complete regimen, for use in appropriate adults with HIV-1 infection who are virologically suppressed on a stable antiretroviral regimen. Recarbrio July 2019 FDA approved Recarbrio (imipenem, cilastatin, and relebactam) for the treatment of adults with complicated urinary tract and complicated intra-abdominal bacterial infections where limited or no alternative treatment options are available. Zerbaxa August 2019 EC approved Zerbaxa for the treatment of adults with hospital-acquired pneumonia, including ventilator-associated pneumonia (to be used in combination with an antibacterial agent active against Gram-positive pathogens when these are known or suspected to be contributing to the infectious process.) June 2019 FDA approved Zerbaxa 3g dose for the treatment of patients 18 years and older with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP). Bravecto November 2019 FDA approved Bravecto Plus topical solution for cats indicated for both external and internal parasite infestations. (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also required pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). As a result of the Balanced Budget Act of 2018 and effective at the beginning of 2019, the 50% point of service discount increased to a 70% point of service discount in the coverage gap. In addition, this point of service discount was extended to biosimilar products. Merck recorded a reduction to revenue of approximately $615 million, $365 million and $385 million in 2019, 2018 and 2017, respectively, related to the donut hole provision. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and decreased to $2.8 billion in 2019 and is expected to remain at that amount for 2020. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $112 million, $124 million and $210 million of costs within Selling, general and administrative expenses in 2019, 2018 and 2017, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2022. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate, and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. Some laws also require manufacturers to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. The pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls. In addition, Congress and/or the administration may again consider proposals to allow international reference pricing or, under certain conditions, the importation of medicines from other countries. The administration has recently proposed a draft rule that would allow importation of certain lower-cost prescription drugs from Canada. If the rule is finalized as proposed, states or certain other non-federal governmental entities would be able to submit importation program proposals to the FDA for review and authorization of two-year programs (with the opportunity to extend for two more years). There will be a public comment period on the proposed rule which will expire on March 9, 2020. Following the comment period, the FDA will have to review and finalize its proposal before any states or other parties can submit their plans to comply with the federal rule. If the proposed rule is adopted, it likely will be some time before states or other parties can actually implement importation plans. In October 2018, the administration also issued an advance notice of proposed rulemaking to implement an International Pricing Index (IPI) model in the United States for products covered under Medicare Part B. The proposal would: (1) reduce Medicare Part B payments for drugs based on a market basket of international prices; (2) allow private sector vendors to negotiate prices for drugs, take title to drugs, and compete for physician and hospital business; and (3) change the physician reimbursement under Medicare Part B from the current model to eliminate the buy and bill system and instead pay physicians based on a flat fee that approximates the revenue they currently receive from drugs. Public comments on the IPI proposal were accepted through late 2018 and it is unclear when the agency may issue a proposed rule on the IPI model. Adoption of one or both of the proposed rules could have a material adverse effect on the Companys business, results of operations and financial condition. It remains uncertain as to what proposals, if any, may be included as part of future federal legislative proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price, net price increases, and average discounts across the Companys U.S. portfolio dating back to 2010. In 2019, the Companys gross U.S. sales were reduced by approximately 44% as a result of rebates, discounts and returns. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys drugs. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which occurred in 2018 and will occur again in 2020. Furthermore, the government can order re-pricings for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. Pursuant to those rules, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant increase in the number of new products being approved each year. Additionally, in 2017, the Chinese government updated the National Reimbursement Drug List for the first time in eight years. While the mechanism for drugs being added to the list evolves, inclusion may require a price negotiation which could impact the outlook in the market for selected brands. In 2019, drugs were added through two pathways, direct inclusion and price negotiations. For price negotiations, price reductions of approximately 60% on average were required for inclusion. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through volume based procurement (VBP). In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first two rounds of VBP have had, on average, a price reduction of 50%. The expansion of the VBP program remains to be seen. The Companys focus on emerging markets, in addition to China, has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2020 to varying degrees in the emerging markets, including China. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA). Examples include the UK, France, Germany, Ireland, Italy and Sweden. The HTA process is the procedure according to which the assessment of the public health impact, therapeutic impact, and the economic and social impact of use of a given medicinal product in the national health care system of the individual country is conducted. HTAs generally focus on the clinical efficacy and effectiveness, safety, cost, and cost-effectiveness of individual medicinal products as well as their potential implications for the health care system. Those elements of medicinal products are compared with other treatment options available on the market. The outcome of HTAs will often influence the pricing and reimbursement status granted to medicinal products by the regulatory authorities of individual European Union (EU) Member States. A negative HTA of one of the Companys products by a leading and recognized HTA body could undermine the Companys ability to obtain reimbursement for such product in the EU Member State in which such negative assessment was issued, and also in other EU Member States. HTA procedures require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The EU has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. In particular, EU regulators may approve products subject to a number of post-authorization conditions. Examples of typical post-authorization commitments include additional pharmacovigilance, the conduct of clinical trials, the establishment of patient registries, physician or patient education and controlled distribution and prescribing arrangements. Non-compliance with post-authorization conditions, pharmacovigilance and other obligations can lead to regulatory action, including the variation, suspension or withdrawal of the marketing authorizations, or other enforcement or regulatory actions, including the imposition of financial penalties. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its medicines, vaccines, and to quality health care around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, through innovative social investments, including philanthropic programs and impact investing, Merck is also helping to strengthen health systems and build capacity, particularly in under-resourced communities. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicines and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent grantmaking organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including both the EU General Data Protection Regulation, which went into effect on May 25, 2018 and imposes penalties of up to 4% of global revenue, and the California Consumer Privacy Act, which became effective January 1, 2020. Additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increased enforcement and litigation activity in the United States and other developed markets, and increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. and Swiss-U.S. Privacy Shield Programs, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for, or intermediates useful in, the manufacture of products, or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent term. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU, Japan and China (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (2) Year of Expiration (China) Emend for Injection Expired 2020 (3) N/A Januvia 2022 (3) 2022 (3) 2025-2026 Janumet 2022 (3) N/A Janumet XR 2022 (3) N/A N/A Isentress 2023 (3) 2022-2026 Simponi N/A (4) 2024 (5) N/A (4) N/A (4) Lenvima (6) 2025 (3) (with pending PTE) 2021 (patents), 2026 (3) (SPCs) 2021 Adempas (7) 2026 (3) 2028 (3) 2027-2028 Bridion 2026 (3) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) 2033 Gardasil 2021 (3) Expired N/A Gardasil 9 2025 (patents) , 2030 (3) (SPCs) N/A Keytruda 2028 (patents), 2030 (3) (SPCs) 2032-2033 Lynparza (8) 2028 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) 2028-2029 Zerbaxa 2028 (3) 2023 (patents), 2028 (3) (SPCs) 2028 (with pending PTE) N/A Belsomra 2029 (3) N/A N/A Prevymis 2029 (3) (with pending PTE) 2024 (patents), 2029 (3) (SPCs) N/A Steglatro (9) 2031 (3) (with pending PTE) 2029 (patents), 2034 (3) (SPCs) N/A Steglujan (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Segluromet (9) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Delstrigo 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Pifeltro 2032 (with pending PTE) 2031 (patents), 2033 (SPCs) N/A N/A Recarbrio 2033 (3) (with pending PTE) N/A N/A N/A Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. N/A: Currently no marketing approval. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (3) Eligible for 6 months Pediatric Exclusivity. (4) The Company has no marketing rights in the U.S., Japan or China. (5) Expiration of the distribution agreement with Janssen Pharmaceuticals, Inc. (6) Part of a global strategic oncology collaboration with Eisai. (7) Being commercialized in a worldwide collaboration with Bayer AG. (8) Part of a global strategic oncology collaboration with AstraZeneca. (9) Being commercialized and promoted in a worldwide, except Japan, collaboration with Pfizer Inc. The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-7264 (gefapixant) MK-1242 (vericiguat) (1) V114 (pneumoconjugate vaccine) MK-8591A (islatravir/doravirine) (1) Being developed in a worldwide collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent may be subject to a future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2019 on patent and know-how licenses and other rights amounted to $135 million. Merck also incurred royalty expenses amounting to $1.7 billion in 2019 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2019, approximately 15,600 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes and other metabolic diseases, infectious diseases, neurosciences, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through pre-clinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on pre-clinical and clinical experience are included in the NDA for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences pre-clinical testing with that compound. Pre-clinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable pre-clinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Pre-clinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Ministry of Health, Labour and Welfare in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and the National Medical Products Administration in China. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,000 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, non-small-cell lung, ovarian, PMBCL, prostate, renal, small-cell lung, triple-negative breast, and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (TPS 1%) with no EGFR or ALK genomic tumor aberrations based on results from the Phase 3 KEYNOTE-042 trial. Keytruda is under review in Japan as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma based on results from the pivotal Phase 3 KEYNOTE-062 trial. Keytruda is also under review in Japan as monotherapy for the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma based on the results of the Phase 3 KEYNOTE-181 trial. Merck has made the decision to withdraw its Type II variation application for Keytruda for this indication in the EU. In October 2019, the FDA accepted a supplemental BLA seeking use of Keytruda for the treatment of patients with recurrent and/or metastatic cutaneous squamous cell carcinoma (cSCC) that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a PDUFA date of June 29, 2020. In February 2020, Merck announced the FDA issued a Complete Response Letter (CRL) regarding Mercks supplemental BLAs seeking to update the dosing frequency for Keytruda to include a 400 mg dose infused over 30 minutes every-six-weeks (Q6W) option in multiple indications. The submitted applications are based on pharmacokinetic modeling and simulation data presented at the 2018 American Society of Clinical Oncology (ASCO) Annual Meeting. These data supported the EC approval of 400 mg Q6W dosing for Keytruda monotherapy indications in March 2019. Merck is reviewing the letter and will discuss next steps with the FDA. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with neoadjuvant chemotherapy for the treatment of high-risk early-stage triple-negative breast cancer (TNBC) and in combination with enfortumab vedotin, in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In September 2019, Merck announced results from the pivotal neoadjuvant/adjuvant Phase 3 KEYNOTE-522 trial in patients with early-stage TNBC. The trial investigated a regimen of neoadjuvant Keytruda plus chemotherapy, followed by adjuvant Keytruda as monotherapy (the Keytruda regimen) compared with a regimen of neoadjuvant chemotherapy followed by adjuvant placebo (the chemotherapy-placebo regimen). Interim findings were presented at the European Society for Medical Oncology (ESMO) 2019 Congress. In the neoadjuvant phase, Keytruda plus chemotherapy resulted in a statistically significant increase in pathological complete response (pCR) versus chemotherapy in patients with early-stage TNBC. The improvement seen when adding Keytruda to neoadjuvant chemotherapy was observed regardless of PD-L1 expression. In the other dual primary endpoint of event-free-survival (EFS), with a median follow-up of 15.5 months, the Keytruda regimen reduced the risk of progression in the neoadjuvant phase and recurrence in the adjuvant phase compared with the chemotherapy-placebo regimen. Merck continues to discuss interim analysis data from KEYNOTE-522 with regulatory authorities. The Keytruda breast cancer clinical development program encompasses several internal and external collaborative studies. In February 2020, Merck announced that the pivotal Phase 3 KEYNOTE-355 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of progression-free survival (PFS) in patients with metastatic triple-negative breast cancer (mTNBC) whose tumors expressed PD-L1 (CPS 10). Based on an interim analysis conducted by an independent Data Monitoring Committee (DMC), first-line treatment with Keytruda in combination with chemotherapy (nab-paclitaxel, paclitaxel or gemcitabine/carboplatin) demonstrated a statistically significant and clinically meaningful improvement in PFS compared to chemotherapy alone in these patients. Based on the recommendation of the DMC, the trial will continue without changes to evaluate the other dual primary endpoint of overall survival (OS). In May 2019, Merck announced that the Phase 3 KEYNOTE-119 trial evaluating Keytruda as monotherapy for the second- or third-line treatment of patients with metastatic TNBC did not meet its pre-specified primary endpoint of superior OS compared to chemotherapy. Other endpoints were not formally tested per the study protocol because the primary endpoint of OS was not met. In June 2019, Merck announced full results from the pivotal Phase 3 KEYNOTE-062 trial evaluating Keytruda as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma. In the monotherapy arm of the study, Keytruda met a primary endpoint by demonstrating noninferiority to chemotherapy, the current standard of care, for OS in patients whose tumors expressed PD-L1 (CPS 1). In the combination arm of KEYNOTE-062, Keytruda plus chemotherapy was not found to be statistically superior for OS (CPS 1 or CPS 10) or PFS (CPS 1) compared with chemotherapy alone. Results were presented at the 2019 American Society of Clinical Oncology (ASCO) Annual Meeting. In September 2017, the FDA approved Keytruda as a third-line treatment for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. KEYNOTE-062 was a potential confirmatory trial for this accelerated, third-line approval. In addition to KEYNOTE-062, additional first-line, Phase 3 studies in Mercks gastric clinical program include KEYNOTE-811 and KEYNOTE-859, as well as KEYNOTE-585 in the neoadjuvant and adjuvant treatment setting. In January 2020, Merck announced that the Phase 3 KEYNOTE-604 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of PFS in the first-line treatment of patients with extensive stage SCLC. At the final analysis of the study, there was also an improvement in OS for patients treated with Keytruda in combination with chemotherapy compared to chemotherapy alone; however, these OS results did not meet statistical significance per the pre-specified statistical plan. Results will be presented at an upcoming medical meeting and discussed with regulatory authorities. Lynparza, is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast and pancreatic cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca. Lynparza is under review in the EU as a first-line maintenance monotherapy for patients with g BRCA m metastatic pancreatic cancer whose disease has not progressed following first-line platinum-based chemotherapy. Lynparza was approved for this indication by the FDA in December 2019 based on results from the Phase 3 POLO trial. A decision from the EMA is expected in the second half of 2020. In January 2020, the FDA accepted a supplemental NDA for Lynparza in combination with bevacizumab for the maintenance treatment of women with advanced ovarian cancer whose disease showed a complete or partial response to first-line treatment with platinum-based chemotherapy and bevacizumab based on the results from the pivotal Phase 3 PAOLA-1 trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In January 2020, the FDA accepted for Priority Review a supplemental NDA for Lynparza for the treatment of patients with metastatic castration-resistant prostate cancer (mCRPC) and deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene mutations, who have progressed following prior treatment with a new hormonal agent based on positive results from the Phase 3 PROfound trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In June 2019, Merck and AstraZeneca presented full results from the Phase 3 SOLO-3 trial which evaluated Lynparza, compared to chemotherapy, for the treatment of platinum-sensitive relapsed patients with g BRCA m advanced ovarian cancer, who have received two or more prior lines of chemotherapy. The results from the trial showed a statistically-significant and clinically-meaningful improvement in objective response rate (ORR) in the Lynparza arm compared to the chemotherapy arm. The key secondary endpoint of PFS was also significantly increased in the Lynparza arm compared to the chemotherapy arm. The results were presented at the 2019 ASCO Annual Meeting. MK-5618, selumetinib, is a MEK 1/2 inhibitor being co-developed as part of a strategic collaboration with AstraZeneca. Selumetinib is under Priority Review with the FDA as a potential new medicine for pediatric patients aged three years and older with neurofibromatosis type 1 (NF1) and symptomatic, inoperable plexiform neurofibromas. This regulatory submission was based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Phase 2 Stratum 1 trial. A PDUFA date is set for the second quarter of 2020. V503 is under review in Japan for an initial indication in females for the prevention of certain HPV-related diseases and precursors. In February 2020, the FDA accepted for Priority Review a supplemental BLA for Gardasil 9 for the prevention of certain head and neck cancers caused by vaccine-type HPV in females and males 9 through 45 years of age. The FDA set a PDUFA date of June 2020. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. Lynparza, in addition to the indications under review discussed above, is in Phase 3 development in combination with Keytruda for the treatment of NSCLC. Lenvima is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, HCC, and in combination for certain patients with RCC being co-developed as part of a strategic collaboration with Eisai. Pursuant to the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination in six types of cancer (endometrial cancer, NSCLC, HCC, HNSCC, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima both for the potential treatment of patients with advanced and/or metastatic RCC and for the potential treatment of patients with unresectable HCC not amenable to locoregional treatment. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor antagonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. MK-1242, vericiguat, is a sGC stimulator for the potential treatment of patients with worsening chronic heart failure being developed as part of a worldwide strategic collaboration between Merck and Bayer. Vericiguat is being studied in patients suffering from chronic heart failure with reduced ejection fraction (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fraction (Phase 2 clinical trial). In November 2019, Merck announced that the Phase 3 VICTORIA study evaluating the efficacy and safety of vericiguat met the primary efficacy endpoint. Vericiguat reduced the risk of the composite endpoint of heart failure hospitalization or cardiovascular death in patients with worsening chronic heart failure with reduced ejection fraction compared to placebo when given in combination with available heart failure therapies. The results of the VICTORIA study will be presented at an upcoming medical meeting in 2020. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently six Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, eight studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. V114 has received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults. The chart below reflects the Companys research pipeline as of February 21, 2020. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 Entry Date) Under Review Cancer Cancer New Molecular Entities/Vaccines MK-3475 Keytruda MK-3475 Keytruda Pediatric Neurofibromatosis Type-1 Advanced Solid Tumors Biliary Tract (September 2019) MK-5618 (selumetinib) (1) (U.S.) MK-6482 Breast (October 2015) HPV Vaccine Renal Cell Carcinoma Cervical (October 2018) (EU) V503 Human Papillomavirus 9-valent Vaccine, MK-7123 (2) Colorectal (November 2015) Recombinant (JPN) Solid Tumors Cutaneous Squamous Cell Carcinoma Certain Supplemental Filings MK-7339 Lynparza (1) (August 2019) (EU) Cancer Advanced Solid Tumors Endometrial (August 2019) (EU) MK-3475 Keytruda MK-7690 (vicriviroc) (2) Esophageal (December 2015) (EU) First-Line Metastatic Non-Small-Cell Lung Colorectal Gastric (May 2015) (EU) Cancer (KEYNOTE-042) (EU) MK-7902 Lenvima (1) Hepatocellular (May 2016) (EU) First-Line Metastatic Gastric Cancer Biliary Tract Mesothelioma (May 2018) (KEYNOTE-062) (JPN) V937 Nasopharyngeal (April 2016) Recurrent Locally Advanced or Metastatic Melanoma Ovarian (December 2018) Esophageal Cancer (KEYNOTE-180/181) MK-7684 (2) Prostate (May 2019) (JPN) Non-Small-Cell Lung Small-Cell Lung (May 2017) (EU) Recurrent and/or Metastatic Cutaneous MK-1026 MK-7339 Lynparza (1,2) Squamous Cell Carcinoma Hematological Malignancies Non-Small-Cell Lung (June 2019) (KEYNOTE-629) (U.S.) MK-4280 (2) MK-7902 Lenvima (1,2) Alternative Dosing Regimen (3) Hematological Malignancies Bladder (May 2019) (Q6W) (U.S.) Non-Small-Cell Lung Endometrial (June 2018) (EU) MK-7339 Lynparza (1) MK-1308 (2) Head and Neck Squamous Cell Carcinoma First-Line g BRCA m Pancreatic Cancer Non-Small-Cell Lung (February 2020) (POLO) (EU) MK-5890 (2) Melanoma (March 2019) First-Line Maintenance Newly Diagnosed Non-Small-Cell Lung Non-Small-Cell Lung (March 2019) Advanced Ovarian Cancer (PAOLA) Cytomegalovirus Cough (U.S.) (EU) V160 MK-7264 (gefapixant) (March 2018) Metastatic Prostate Cancer (PROfound) HIV-1 Infection Heart Failure (U.S.) (EU) MK-8591 (islatravir) MK-1242 (vericiguat) (September 2016) (1) Footnotes: Overgrowth Syndrome HIV-1 Infection (1) Being developed in a collaboration. MK-7075 MK-8591A (islatravir/doravirine) (February 2020) (2) Being developed in combination with Pediatric Neurofibromatosis Type-1 Pneumoconjugate Vaccine Keytruda. MK-5618 (selumetinib) (1) (EU) V114 (June 2018) (3) The Company received a CRL in February Respiratory Syncytial Virus 2020. Merck is reviewing the letter and will MK-1654 discuss next steps with the FDA. Schizophrenia MK-8189 Employees As of December 31, 2019, the Company had approximately 71,000 employees worldwide, with approximately 26,000 employed in the United States, including Puerto Rico. Approximately 30% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $19 million in 2019 and are estimated at $47 million in the aggregate for the years 2020 through 2024 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million and $71 million at December 31, 2019 and 2018 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $58 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial condition, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in each of 2019 , 2018 and 2017 . The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business could be materially adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation in both the U.S. and certain foreign markets relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has launched commercially successful products that replace the lost sales. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. For example, the patents that provided U.S. and EU market exclusivity for certain forms of Noxafil expired in July 2019 and December 2019, respectively, and the Company anticipates a significant decline in U.S. and EU Noxafil sales. Also, the patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company anticipates a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. In addition, the patents that provide market exclusivity for Januvia and Janumet in the U.S. expire in July 2022 (although six-month pediatric exclusivity may extend this date). The patent that provides market exclusivity for Januvia in the EU expires in July 2022 (although pediatric exclusivity may extend this date to September 2022). Finally, the SPC that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material adverse effect on the Companys results of operations and financial condition. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Gardasil/Gardasil 9, Januvia , Janumet , and Bridion . In particular, in 2019, the Companys oncology portfolio, led by Keytruda, represented the majority of the Companys revenue and earnings growth. As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals. Therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial condition and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, pre-clinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities, including in Japan and China, have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy, quality or labeling changes; and scrutiny of advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA, Japans PMDA and Chinas NMPA have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. In addition, dissemination of promotional materials through evolving digital channels serves to increase visibility and scrutiny in the marketplace. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial condition and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial condition and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment Health Care Environment and Government Regulations. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the United States, larger customers have received higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. In 2019, the Companys gross U.S. sales were reduced by approximately 44% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. In Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which will occur again in 2020. Furthermore, the government can order re-pricing for specific products if it determines that use of such product will exceed certain thresholds defined under applicable re-pricing rules. For example, pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5%, effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. The Company expects pricing pressures to continue in the future. The health care industry in the United States has been, and will continue to be, subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. The ACA increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The ACA also requires pharmaceutical manufacturers to pay a point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole) which increased to 70% in 2019 and was extended to biosimilar products. In 2019, the Companys revenue was reduced by approximately $615 million due to this requirement. Also, pharmaceutical manufacturers are required to pay an annual non-tax deductible health care reform fee. In 2019, the Company recorded $112 million of costs for this annual fee. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2022. The Company will evaluate the financial impact of these two elements when they become effective. In addition, as discussed above in Competition and the Health Care Environment, the administration has recently proposed a draft rule that would allow importation of certain lower-cost prescription drugs from Canada. If the rule is finalized as proposed, states or certain other non-federal governmental entities would be able to submit importation program proposals to the FDA for review and authorization of two-year programs (with the opportunity to extend for two more years). There will be a public comment period on the proposed rule which will expire on March 9, 2020. Following the comment period, the FDA will have to review and finalize its proposal before any states or other parties can submit their plans to comply with the federal rule. If the proposed rule is adopted, it likely will be some time before states or other parties can actually implement importation plans. Also, in October 2018, the administration issued an advance notice of proposed rulemaking to implement an International Pricing Index (IPI) model in the United States for products covered under Medicare Part B. The proposal would: (1) reduce Medicare Part B payments for drugs based on a market basket of international prices; (2) allow private sector vendors to negotiate prices for drugs, take title to drugs, and compete for physician and hospital business; and (3) change the physician reimbursement under Medicare Part B from the current model to eliminate the buy and bill system and instead pay physicians based on a flat fee that approximates the revenue they currently receive from drugs. Public comments on the IPI proposal were accepted through late 2018 and it is unclear when the agency may issue a proposed rule on the IPI model. Adoption of one or both of the proposed rules could have a material adverse effect on the Companys business, results of operations and financial condition. The Company cannot predict the likelihood of additional future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Certain of these systems are managed, hosted, provided or used by third parties to assist in conducting the Companys business. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means by the Companys employees, third parties with authorized access or unauthorized third parties could adversely affect key business processes. Cyber-attacks against the Companys IT systems or third-party providers IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of any of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations, and resulting losses. The Company has insurance coverage insuring against losses resulting from cyber-attacks and has received proceeds in connection with the 2017 cyber-attack. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to the 2017 cyber-attack. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems or the efforts of third-party providers to protect their IT systems will be successful in preventing disruptions to the Companys operations, including its manufacturing, research and sales operations. Such disruptions have in the past and could in the future result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third-party providers databases or IT systems and have in the past and could in the future also result in financial, legal, business or reputational harm to the Company and substantial remediation costs. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial condition and prospects of the Company; these laws and regulations include (i) additional healthcare reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to healthcare professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2019 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions, and additional actions in the future, will continue to negatively affect revenue performance. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material adverse effect on the Companys results of operations and financial condition. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum and subsequent negotiations, the UK left the EU on January 31, 2020. A transitional period will apply from January 31, 2020 until December 31, 2020, and during this period the EU will treat the UK as if it were an EU Member State, and the UK will continue to participate in the EU Customs Union allowing for the freedom of movement for people and goods. During the transitional period the EU and the UK will continue to negotiate a trade agreement to formalize the terms of the UKs future relationship with the EU. The Company has taken actions and made certain contingency plans for scenarios in which the UK and the EU do not reach a mutually satisfactory understanding as to a future trade agreement. It is not possible at this time to predict whether there will be any such understanding before the end of 2020, or if such an understanding is reached, whether its terms will vary in ways that result in greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and/or cross border labor issues that could materially adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Health Care Environment and Government Regulation , pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing healthcare reform that has led to the acceleration of generic substitution, where available. While pricing pressure has always existed in China, health care reform has increased this pressure in part due to the acceleration of generic substitution through the governments VBP program. In 2019, the government implemented the VBP program through a tendering process for mature products which have generic substitutes with a Generic Quality Consistency Evaluation approval. Mature products that have entered into the first two rounds of VBP had, on average, a price reduction of 50%. The expansion of the VBP program remains to be seen. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. Also, in December 2019, a new Coronavirus, now known as COVID-19, which has proved to be highly contagious, emerged in Wuhan, China. The outbreak of the virus has caused material disruptions to the Chinese economy, including its health care system, which will have a negative effect on the Companys first quarter 2020 results which, at this time, is not expected to be material. Since the future course and duration of the COVID-19 outbreak are unknown, the Company is currently unable to determine whether the outbreak will have a further negative effect on the Companys results in 2020. The outbreak of COVID-19 currently has also had a limited effect on the Companys supply chain of drugs into and raw materials out of China. The outbreak has also negatively affected certain of the Companys clinical trials. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the Companys business, cash flow, results of operations, financial condition and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial condition and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. Certain of the Companys interest rate derivatives and investments are based on the London Interbank Offered Rate (LIBOR), and a portion of Mercks indebtedness bears interest at variable interest rates, primarily based on LIBOR. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform, which may cause LIBOR to cease to exist entirely after 2021. While the Company expects that reasonable alternatives to LIBOR will be implemented prior to the 2021 target date, the Company cannot predict the consequences and timing of these developments, which could include an increase in interest expense and may also require the amendment of contracts that reference LIBOR. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations and financial condition. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be negatively affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could materially adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its IT systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a material adverse effect on future results of operations and financial condition. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as African Swine Fever, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely affect the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a material adverse effect on the Companys future results of operations and financial condition. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties related to biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both pre-clinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost of such insurance has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain social media channels could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Risks Related to the Proposed Spin-Off of NewCo. The proposed Spin-Off of NewCo may not be completed on the terms or timeline currently contemplated, if at all, and may not achieve the expected results. In February 2020, the Company announced its intention to Spin-Off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The transaction is expected to be completed in the first half of 2021. Completion of the Spin-Off will be subject to a number of factors and conditions, and there can be no assurances that the Company will be able to complete the Spin-Off on the terms or on the timeline that was announced, if at all. Unanticipated developments could delay, prevent or otherwise adversely affect the proposed Spin-Off, including but not limited to disruptions in general or financial market conditions or potential problems or delays in obtaining various regulatory and tax approvals or clearances. In addition, consummation of the proposed Spin-Off will require final approval from the Companys Board of Directors. The costs to complete the proposed Spin-Off will be significant. In addition, the Company may be unable to achieve some or all of the strategic and financial benefits that it expects to achieve from the Spin-Off of NewCo. The Company will incur significant expenses in connection with the Spin-Off. In addition, the Company may not be able to achieve the full strategic and financial benefits that are expected to result from the Spin-Off. The anticipated benefits of the Spin-Off are based on a number of assumptions, some of which may prove incorrect. Following the Spin-Off, the price of shares of the Companys common stock may fluctuate significantly. The Company cannot predict the effect of the Spin-Off on the trading price of shares of its common stock, and the market value of shares of its common stock may be less than, equal to or greater than the market value of shares of its common stock prior to the Spin-Off. In addition, the price of Mercks common stock may be more volatile around the time of the Spin-Off. There could be significant income tax liability if the Spin-Off or certain related transactions are determined to be taxable for U.S. federal income tax purposes. The Company expects that prior to completion of the Spin-Off it will receive an opinion from its U.S. tax counsel that concludes, among other things, that the Spin-Off of all of the outstanding NewCo shares to Merck shareholders and certain related transactions will qualify as tax-free to Merck and its shareholders under Sections 355, 361 and 368 of the U.S. Internal Revenue Code, except to the extent of any cash received in lieu of fractional shares of NewCo common stock. Any such opinion is not binding on the Internal Revenue Service (IRS). Accordingly, while the Company believes the risk is low, the IRS may reach conclusions with respect to the Spin-Off that are different from the conclusions reached in the opinion. The opinion will rely on certain facts, assumptions, representations and undertakings from Merck and NewCo regarding the past and future conduct of the companies respective businesses and other matters, which, if incomplete, incorrect or not satisfied, could alter the conclusions of the party giving such opinion. If the proposed Spin-Off ultimately is determined to be taxable, which the Company believes is unlikely, the Spin-Off could be treated as a taxable dividend to Mercks shareholders for U.S. federal income tax purposes, and Mercks shareholders could incur significant U.S. federal income tax liabilities. In addition, Merck would recognize a taxable gain to the extent that the fair market value of NewCo common stock exceeds Mercks tax basis in such stock on the date of the Spin-Off. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys or third-party providers information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. The proposed Spin-Off might be delayed or the costs to complete the Spin-Off might be more significant than expected. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Company also maintains operational or divisional headquarters in Kenilworth, New Jersey, Madison, New Jersey and Upper Gwynedd, Pennsylvania. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, South San Francisco, California and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in the United Kingdom, Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $3.5 billion in 2019 , $2.6 billion in 2018 and $1.9 billion in 2017 . In the United States, these amounted to $1.9 billion in 2019 , $1.5 billion in 2018 and $1.2 billion in 2017 . Abroad, such expenditures amounted to $1.6 billion in 2019, $1.1 billion in 2018 and $728 million in 2017. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company believes that its plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities, including previously-disclosed capital expansion projects, that will be adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 10. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2020, there were approximately 109,500 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2019 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 5,064,526 $83.63 $7,796 November 1 November 30 4,182,277 $84.72 $7,441 December 1 December 31 3,053,800 $89.16 $7,169 Total 12,300,603 $85.37 $7,169 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in October 2018 to purchase up to $10 billion in Merck shares for its treasury. Performance Graph The following graph assumes a $100 investment on December 31, 2014, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2019/2014 CAGR* MERCK $187 13% PEER GRP.** 9% SP 500 12% 2015 2017 2019 MERCK 100.0 96.0 110.5 108.8 152.5 186.5 PEER GRP. 100.0 103.0 99.9 119.6 127.8 151.6 SP 500 100.0 101.4 113.5 138.3 132.2 173.8 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. The following section of this Form 10-K generally discusses 2019 and 2018 results and year-to-year comparisons between 2019 and 2018 . Discussion of 2017 results and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in Managements Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed on February 27, 2019. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. While the Company continues to look for investment opportunities in this area of health care, the approach to these investments has shifted toward venture capital investments in third parties as opposed to wholly-owned businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into New Company In February 2020, Merck announced its intention to spin-off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed in the first half of 2021, subject to market and certain other conditions. Overview Mercks performance during 2019 demonstrates execution in both commercial and research operations driven by a focus on key growth drivers and innovative pipeline investment reinforcing the Companys science-led strategy. In 2019, Merck enhanced its portfolio and pipeline with external innovation, increased investment in new capital projects focused primarily on expanding manufacturing capacity across Mercks key businesses, and returned capital to shareholders. Worldwide sales were $46.8 billion in 2019 , an increase of 11% compared with 2018 , including a 2% unfavorable effect from foreign exchange. The sales increase was driven primarily by Mercks growth pillars of oncology, human health vaccines, certain hospital acute care products, and animal health. Growth in these areas was partially offset by the ongoing effects of generic competition, particularly in the diversified brands and cardiovascular franchises, as well as by competitive pressure, particularly in the diabetes and virology franchises. Merck continued to prioritize business development aimed at enhancing its portfolio and strengthening its pipeline by executing several business development transactions in 2019. To expand its oncology presence, Merck completed the acquisitions of Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates for the treatment of cancer and other diseases, and Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease. Merck also announced an agreement to acquire ArQule, Inc. (ArQule), a biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of cancer and other diseases; the acquisition closed in January 2020. To augment Mercks animal health business, the Company acquired Antelliq Group (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. During 2019, the Company received numerous regulatory approvals and progressed many important pipeline candidates through clinical development. Within oncology, Keytruda received multiple additional approvals in the United States, European Union (EU), China and Japan as monotherapy in the therapeutic areas of non-small-cell lung cancer (NSCLC), small-cell lung cancer (SCLC), esophageal cancer and in combination with axitinib for the treatment of renal cell carcinoma (RCC), in combination with chemotherapy for head and neck squamous cell carcinoma (HNSCC), and in combination with Lenvima for endometrial carcinoma. Lynparza, which is being developed in collaboration with AstraZeneca PLC (AstraZeneca), received U.S. Food and Drug Administration (FDA) approval for the treatment of appropriate patients with germline BRCA -mutated (g BRCA m) pancreatic cancer and European Commission (EC) approval for use in certain patients with advanced ovarian cancer and advanced or metastatic breast cancer. In addition to oncology, the Company received regulatory approvals in the hospital acute care and vaccines therapeutic areas. The FDA approved Recarbrio (imipenem, cilastatin, and relebactam) for injection, a new combination antibacterial for the treatment of certain patients with complicated urinary tract infections caused by certain Gram-negative microorganisms. Recarbrio was approved by the EC in February 2020. The FDA and EC also approved expanded indications for Zerbaxa for the treatment of patients with hospital-acquired bacterial pneumonia and ventilator-associated bacterial pneumonia (HABP/VABP) caused by certain susceptible Gram-negative microorganisms. Additionally, Ervebo (Ebola Zaire Vaccine, Live), a vaccine for the prevention of disease caused by Zaire ebolavirus in adults, was approved in the United States and received conditional approval in the EU . In addition to the recent regulatory approvals discussed above, the Company advanced its late-stage pipeline, particularly in oncology, with several regulatory submissions for Keytruda , Lynparza and Lenvima in the United States and internationally. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of biliary tract, breast, cervical, colorectal, cutaneous squamous cell, endometrial, esophageal, gastric, hepatocellular, mesothelioma, nasopharyngeal, ovarian, prostate and small-cell lung cancers; Lynparza in combination with Keytruda for non-small cell lung cancer; and Lenvima in combination with Keytruda for bladder, endometrial, head and neck, melanoma and non-small-cell lung cancers. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including V114, an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease that received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults; MK-7264, gefapixant, a selective, non-narcotic, orally-administered P2X3-receptor antagonist being developed for the treatment of refractory, chronic cough; MK-8591A, islatravir, an investigational nucleoside reverse transcriptase translocation inhibitor (NRTTI) in combination with doravirine for the treatment of HIV-1 infection; and MK-1242, vericiguat, an investigational treatment for heart failure being developed in a collaboration (see Research and Development below). The Company is allocating resources to effectively support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2019 reflect higher clinical development spending and increased investment in discovery research and early drug development. In November 2019, Mercks Board of Directors approved an increase to the Companys quarterly dividend, raising it to $0.61 per share from $0.55 per share on the Companys outstanding common stock. During 2019 , the Company returned $10.5 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2019 were $3.81 compared with $2.32 in 2018 . EPS in both years reflects the impact of acquisition and divestiture-related costs, as well as restructuring costs and certain other items. Certain other items in 2019 include a charge related to the acquisition of Peloton and in 2018 include a charge related to the formation of a collaboration with Eisai Co., Ltd. (Eisai). Non-GAAP EPS, which excludes these items, was $5.19 in 2019 and $4.34 in 2018 (see Non-GAAP Income and Non-GAAP EPS below). Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2019 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions and additional actions in the future will continue to negatively affect revenue performance. Operating Results Sales ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange United States $ 20,325 % % $ 18,212 % % $ 17,424 International 26,515 % % 24,083 % % 22,698 Total $ 46,840 % % $ 42,294 % % $ 40,122 U.S. plus international may not equal total due to rounding. Worldwide sales grew 11% in 2019 driven primarily by higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as increased alliance revenue related to Lynparza and Lenvima. Also contributing to revenue growth were higher sales of vaccines, including Gardasil/Gardasil 9, Varivax , ProQuad and MMR II, as well as increased sales of certain hospital acute care products, including Bridion. Higher sales of animal health products also drove revenue growth in 2019 . Sales growth in 2019 was partially offset by the effects of generic competition for cardiovascular products Zetia and Vytorin , hospital acute care products Invanz , Cubicin and Noxafil , oncology product Emend , and products within the diversified brands franchise, as well as biosimilar competition for immunology product Remicade. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Lower sales of diabetes products Januvia and Janumet and HIV products Isentress/Isentress HD also partially offset revenue growth in 2019 . Sales in the United States grew 12% in 2019 driven primarily by higher sales of Keytruda , combined sales of ProQuad , M-M-R II and Varivax , and Bridion , as well as higher alliance revenue from Lenvima and Lynparza. Revenue growth was partially offset by lower sales of Januvia, Janumet , Invanz , Emend , Isentress/Isentress HD , Cubicin and Noxafil . International sales grew 10% in 2019 . Performance in international markets was led by China, which had total sales of $3.2 billion in 2019 , representing growth of 47% compared with 2018 , including a 7% unfavorable effect from foreign exchange. The increase in international sales primarily reflects growth in Keytruda , Gardasil/Gardasil 9, combined sales of ProQuad , M-M-R II and Varivax , as well as higher alliance revenue from Lynparza and Lenvima. Sales growth was partially offset by lower sales of Zetia , Vytorin , Zepatier, Remicade , and products within the diversified brands franchise. International sales represented 57% of total sales in both 2019 and 2018 . See Note 18 to the consolidated financial statements for details on sales of the Companys products. A discussion of performance for select products in the franchises follows. Pharmaceutical Segment Oncology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Keytruda $ 11,084 % % $ 7,171 % % $ 3,809 Alliance Revenue - Lynparza (1) % % * * Alliance Revenue - Lenvima (1) % % N/A N/A Emend (26 )% (24 )% (6 )% (7 )% * Calculation not meaningful. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4 to the consolidated financial statements). Keytruda is an anti-PD-1 therapy that has been approved for the treatment of multiple malignancies including cervical cancer, classical Hodgkin lymphoma (cHL), esophageal cancer, gastric or gastroesophageal junction adenocarcinoma, HNSCC, hepatocellular carcinoma (HCC), NSCLC, SCLC, melanoma, Merkel cell carcinoma, microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, primary mediastinal large B-cell lymphoma (PMBCL), RCC and urothelial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In January 2020, the FDA approved Keytruda as monotherapy for the treatment of certain patients with Bacillus Calmette-Guerin (BCG)-unresponsive, high-risk, non-muscle invasive bladder cancer (NMIBC) based on the results of the KEYNOTE-057 trial. In July 2019, the FDA approved Keytruda as monotherapy for the treatment of certain patients with recurrent locally advanced or metastatic squamous cell carcinoma of the esophagus whose tumors express PD-L1 (Combined Positive Score [CPS] 10) as determined by an FDA-approved test, based on the results of the KEYNOTE-181 and KEYNOTE-180 trials. In June 2019, the FDA approved Keytruda as monotherapy or in combination with chemotherapy for the first-line treatment of patients with metastatic or unresectable, recurrent HNSCC based on results from the pivotal Phase 3 KEYNOTE-048 trial. Keytruda was initially approved for HNSCC under the FDAs accelerated approval process based on data from the Phase 1b KEYNOTE-012 trial. In accordance with the accelerated approval process, continued approval was contingent upon verification and description of clinical benefit, which has now been demonstrated in KEYNOTE-048 and has resulted in the FDA converting the accelerated approval to a full (regular) approval. Keytruda was approved for these indications by the EC in November 2019 and by Japans Ministry of Health, Labour and Welfare (MHLW) in December 2019. Also in June 2019, the FDA approved Keytruda as monotherapy for the treatment of certain patients with metastatic SCLC based on pooled data from the KEYNOTE-158 (cohort G) and KEYNOTE-028 (cohort C1) clinical trials. In April 2019, the FDA approved Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced RCC, the most common type of kidney cancer, based on findings from the pivotal Phase 3 KEYNOTE-426 trial. Keytruda was approved for this indication by the EC in September 2019 and by Japans MHLW in December 2019. Also in April 2019, the FDA approved an expanded label for Keytruda as monotherapy for the first-line treatment of patients with NSCLC expressing PD-L1 (Tumor Proportion Score [TPS] 1%) as determined by an FDA-approved test, with no EGFR or ALK genomic tumor aberrations, in stage III disease where patients are not candidates for surgical resection or definitive chemoradiation, and in metastatic disease. The approval was based on results from the Phase 3 KEYNOTE-042 trial. In September 2019, the FDA approved the combination of Keytruda plus Lenvima for the treatment of certain patients with advanced endometrial carcinoma that is not MSI-H or mismatch repair deficient. In March 2019, the EC approved Keytruda in combination with carboplatin and either paclitaxel or nab-paclitaxel for the first-line treatment of adults with metastatic squamous NSCLC based on data from the Phase 3 KEYNOTE-407 trial. Keytruda was approved for this indication by the FDA in October 2018. In April 2019, the EC approved a new extended dosing schedule of 400 mg every six weeks (Q6W) delivered as an intravenous infusion over 30 minutes for all approved monotherapy indications in the EU. The Q6W dose is available in addition to the formerly approved dose of Keytruda 200 mg every three weeks (Q3W) infused over 30 minutes. Additionally, in 2019, Keytruda received the following approvals from Chinas National Medical Products Administration (NMPA): in combination with pemetrexed and platinum chemotherapy for the first-line treatment of patients with metastatic nonsquamous NSCLC, with no EGFR or ALK genomic tumor aberrations, based on data from the pivotal Phase 3 KEYNOTE-189 trial; as monotherapy for the first-line treatment of patients with locally advanced or metastatic NSCLC whose tumors express PD-L1 as determined by a NMPA-approved test, with no EGFR or ALK genomic tumor aberrations, based on the results from the Phase 3 KEYNOTE-042 trial; and in combination with carboplatin and paclitaxel for the first-line treatment of patients with metastatic squamous NSCLC based on findings from the pivotal Phase 3 KEYNOTE-407 trial. Global sales of Keytruda grew 55% in 2019 driven by higher demand as the Company continues to launch Keytruda with multiple new indications globally. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC as monotherapy and in combination with chemotherapy for both nonsquamous and squamous metastatic NSCLC, along with uptake in the recently launched RCC and adjuvant melanoma indications. Other indications contributing to U.S. sales growth include HNSCC, urothelial carcinoma, melanoma, and MSI-H cancer. Keytruda sales growth in international markets was driven primarily by performance in Europe, Japan and China reflecting increased use in the treatment of NSCLC, as well as for the more recently approved indications as described above. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Keytruda . Under the terms of the more significant of these agreements, Merck pays a royalty of 6.5% on worldwide sales of Keytruda through 2023 to one third party; this royalty will decline to 2.5% for 2024 through 2026 and will terminate thereafter. The Company pays an additional 2% royalty on worldwide sales of Keytruda to another third party, the termination date of which varies by country; this royalty will expire in the United States in 2024 and in major European markets in 2025. The royalties are included in Cost of sales . Pursuant to a re-pricing rule, the Japanese government reduced the price of Keytruda by 17.5% effective February 2020. Additionally, Keytruda will be subject to another significant price reduction in April 2020 under a provision of the Japanese pricing rules. Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca entered into in July 2017 (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of advanced ovarian, breast and pancreatic cancers. The increase in alliance revenue related to Lynparza in 2019 was driven primarily by expanded use in the United States, the EU, Japan and China reflecting in part the ongoing launch of new indications. Lynparza received approval for the treatment of certain types of advanced ovarian cancer in the United States in December 2018, in the EU and in Japan in June 2019, and in China in December 2019 based on the results of the Phase 3 SOLO-1 trial. Also, in April 2019, the EC approved Lynparza for the treatment of certain adult patients with advanced breast cancer based on the results of the Phase 3 OlympiAD trial. Additionally, in December 2019, the FDA approved Lynparza for the maintenance treatment of certain adult patients with advanced pancreatic cancer based on the results of the Phase 3 POLO trial. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai entered into in March 2018 (see Note 4 to the consolidated financial statements), is approved for the treatment of certain types of thyroid cancer, HCC, and in combination with evorolimus for certain patients with RCC. Additionally, in September 2019, the FDA approved the combination of Keytruda plus Lenvima for the treatment of certain patients with advanced endometrial carcinoma that is not MSI-H or mismatch repair deficient. This marks the first U.S. approval for the combination of Keytruda plus Lenvima. The increase in alliance revenue related to Lenvima in 2019 reflects strong performance in the treatment of HCC following recent worldwide launches, as well as a full year of collaboration activity in 2019. Global sales of Emend , for the prevention of chemotherapy-induced and post-operative nausea and vomiting, declined 26% in 2019 driven primarily by lower demand and pricing in the United States due to competition, including recent generic competition for Emend for Injection following U.S. patent expiry in September 2019. The patent that provided U.S. market exclusivity for Emend expired in 2015 and the patent that provided market exclusivity in most major European markets expired in May 2019. Additionally, Emend for Injection will lose market exclusivity in major European markets in August 2020. The Company anticipates that sales of Emend for Injection in these markets will decline significantly thereafter. Vaccines ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Gardasil/Gardasil 9 $ 3,737 % % $ 3,151 % % $ 2,308 ProQuad % % % % M-M-R II % % % % Varivax % % % % RotaTeq % % % % Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, grew 19% in 2019 driven primarily by higher demand in the Asia Pacific region, particularly in China, and higher demand in certain European markets reflecting increased vaccination rates for both boys and girls. Growth was partially offset by lower sales in the United States. The U.S. sales decline was driven by the borrowing of Gardasil 9 doses from the U.S. Centers for Disease and Control Prevention (CDC) Pediatric Vaccine Stockpile, offset in part by higher demand and pricing. In 2019, the Company borrowed doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile. The borrowing reduced sales in 2019 by approximately $120 million and the Company recognized a corresponding liability. During 2018, the Company replenished doses borrowed from the CDC Pediatric Vaccine Stockpile in 2017 resulting in the recognition of sales of $125 million in 2018 and a reversal of the liability related to that borrowing. The decision of Japans MHLW to suspend the active recommendation for HPV vaccination is still under review. The Company is a party to certain third-party license agreements pursuant to which the Company pays royalties on sales of Gardasil/Gardasil 9. Under the terms of the more significant of these agreements, Merck pays a 7% royalty on worldwide sales of Gardasil/Gardasil 9 to one third party (this agreement expires in December 2023) and an additional 7% royalty on sales of Gardasil/Gardasil 9 in the United States to another third party (this agreement expires in December 2028). The royalties are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, grew 27% in 2019 driven primarily by higher volumes and pricing in the United States, as well as volume growth in the EU largely reflecting a competitor supply issue. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, grew 28% in 2019 driven primarily by higher sales in the United Sates reflecting increased demand due to measles outbreaks, as well as higher pricing. The Company anticipates that U.S. sales of M-M-R II will decline in 2020 driven by lower expected demand related to fewer measles outbreaks. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), grew 25% in 2019 driven primarily by government tenders in Latin America, as well as higher pricing and volume growth in the United States. Varivax sales are expected to decline in 2020 due in part to the timing of government tenders and competition in select Latin American markets. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, grew 9% in 2019 driven primarily by continued uptake from the launch in China and higher volumes in the United States, partially offset by lower volumes in Latin America. In December 2019, the FDA approved Ervebo for the prevention of disease caused by Zaire ebolavirus in individuals 18 years of age and older. As previously announced, Merck is working to initiate manufacturing of licensed doses and expects these doses to start becoming available in approximately the third quarter of 2020. Merck is working closely with the U.S. government, the World Health Organization (WHO), UNICEF, and Gavi (the Vaccine Alliance) to plan for how eventual, licensed doses will support future public health preparedness and response efforts against Zaire ebolavirus disease. Merck is not seeking to profit from sales of this vaccine; rather, to ensure the vaccine is sustainable by recovering manufacturing and operational costs associated with the program. Ervebo was also granted a conditional marking authorization by the EC. Additionally, Merck has made submissions to African country national regulatory authorities in collaboration with the African Vaccine Regulatory Forum that will allow the vaccine to be registered in African countries considered to be at-risk for Ebola outbreaks by the WHO. In February 2020, Merck confirmed that four African countries have approved Ervebo . Approvals in additional countries in Africa are anticipated in the near future. Hospital Acute Care ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Bridion $ 1,131 % % $ % % $ Noxafil (11 )% (7 )% % % Invanz (47 )% (44 )% (18 )% (17 )% Cubicin (30 )% (28 )% (4 )% (5 )% Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, grew 23% in 2019 driven by higher demand globally, particularly in the United States. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, declined 11% in 2019 driven primarily by generic competition in the United States. The patent that provided U.S. market exclusivity for certain forms of Noxafil representing the majority of U.S. Noxafil sales expired in July 2019. Accordingly, the Company is experiencing a decline in U.S. Noxafil sales as a result of generic competition and expects the decline to continue. Additionally, the patent for Noxafil expired in a number of major European markets in December 2019. As a result, the Company anticipates sales of Noxafil in these markets will decline significantly in future periods. Global sales of Invanz , for the treatment of certain infections, declined 47% in 2019 driven by generic competition in the United States. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and generic competition began in the second half of 2018. The Company subsequently experienced a significant decline in Invanz sales in the United States as a result of this generic competition and has since lost most of its U.S. Invanz sales. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, declined 30% in 2019 resulting primarily from ongoing generic competition in the United States following expiration of the U.S. composition patent for Cubicin in 2016. In 2019, the FDA and EC approved expanded indications for Zerbaxa for the treatment of HABP/VABP caused by certain susceptible Gram-negative microorganisms based on the results of the pivotal Phase 3 ASPECT-NP trial. Zerbaxa was previously approved in the United States and EU for the treatment of adults with certain complicated urinary tract and intra-abdominal infections. In July 2019, the FDA approved Recarbrio for injection, a new combination antibacterial for the treatment of adults who have limited or no alternative treatment options with complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative microorganisms. Recarbrio was approved by the EC in February 2020. Merck anticipates making Recarbrio available in the first half of 2020. In January 2020, the FDA approved Dificid (fidaxomicin) for oral suspension and Dificid tablets for the treatment of Clostridioides (formerly Clostridium ) difficile -associated diarrhea in children aged six months and older. Immunology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Simponi $ (7 )% (2 )% $ % % $ Remicade (29 )% (25 )% (31 )% (33 )% Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 7% in 2019 driven by the unfavorable effect of foreign exchange and lower pricing in Europe. Sales of Simponi are being unfavorably affected by the launch of biosimilars for a competing product. The Company expects this competition will continue to unfavorably affect sales of Simponi . Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), declined 29% in 2019 driven by ongoing biosimilar competition in the Companys marketing territories. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Virology ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Isentress/Isentress HD $ (15 )% (10 )% $ 1,140 (5 )% (5 )% $ 1,204 Worldwide sales of Isentress/Isentress HD , an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, declined 15% in 2019 primarily reflecting lower demand in the United States and in the EU due to competitive pressure. In September 2019, the FDA approved supplemental New Drug Applications (NDA) for Pifeltro (doravirine) in combination with other antiretroviral agents, and for Delstrigo (doravirine/lamivudine/tenofovir disoproxil fumarate) as a complete regimen, that expand their indications to include adult patients with HIV-1 infection who are virologically suppressed on a stable antiretroviral regimen. Cardiovascular ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Zetia/Vytorin $ (35 )% (34 )% $ 1,355 (35 )% (38 )% $ 2,095 Atozet % % % % Rosuzet % % % % Adempas % % % % Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ) and Vytorin (marketed outside the United States as Inegy ), medicines for lowering LDL cholesterol, declined 35% in 2019 driven primarily by lower sales in the EU. The EU patents for Ezetrol and Inegy expired in April 2018 and April 2019, respectively. Accordingly, the Company is experiencing sales declines in these markets as a result of generic competition and expects the declines to continue. The sales decline was also attributable to loss of exclusivity in Australia. Merck lost market exclusivity in the United States for Zetia in 2016 and Vytorin in 2017 and subsequently lost nearly all U.S. sales of these products as a result of generic competition. Sales of Atozet (marketed outside of the United States), a medicine for lowering LDL cholesterol, grew 13% in 2019 , primarily driven by higher demand in the EU and in Korea. Sales of Rosuzet (marketed outside of the United States), a medicine for lowering LDL cholesterol, more than doubled in 2019 , primarily driven by the launch in Japan, as well as higher demand in Korea. Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, is part of a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Adempas (see Note 4 to the consolidated financial statements). The increase in alliance revenue of 27% in 2019 was driven both by higher profits from Bayer and higher sales of Adempas in Mercks marketing territories. Diabetes ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Januvia/Janumet $ 5,524 (7 )% (4 )% $ 5,914 % (1 )% $ 5,896 Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, declined 7% in 2019 as a result of continued pricing pressure in the United States, partially offset by higher demand in most international markets. The Company expects U.S. pricing pressure to continue. The patents that provide market exclusivity for Januvia and Janumet in the United States expire in July 2022 (although six-month pediatric exclusivity may extend this date). The patent that provides market exclusivity for Januvia in the EU expires in July 2022 (although pediatric exclusivity may extend this date to September 2022). The supplementary patent certificate that provides market exclusivity for Janumet in the EU expires in April 2023. The Company anticipates sales of Januvia and Janumet in these markets will decline substantially after these patent expiries. Womens Health ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange NuvaRing $ (3 )% (2 )% $ % % $ Implanon/Nexplanon % % % % Worldwide sales of NuvaRing , a vaginal contraceptive product, declined 3% in 2019 driven primarily by lower demand in the EU due to generic competition, largely offset by higher sales in the United States reflecting higher pricing that was partially offset by lower demand. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and generic competition began in December 2019. The Company anticipates a rapid and substantial decline in U.S. NuvaRing sales in 2020 as a result of this generic competition. Worldwide sales of Implanon/Nexplanon , a single-rod subdermal contraceptive implant, grew 12% in 2019 , primarily driven by higher demand and pricing in the United States. Biosimilars ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Biosimilars $ * * $ * * $ * Calculation not meaningful. Biosimilar products are marketed by the Company pursuant to an agreement with Samsung Bioepis Co., Ltd. (Samsung) to develop and commercialize multiple pre-specified biosimilar candidates. Currently, the Company markets Renflexis (infliximab-abda), a tumor necrosis factor (TNF) antagonist biosimilar to Remicade (infliximab) for the treatment of certain inflammatory diseases; Ontruzant (trastuzumab-dttb), a human epidermal growth factor receptor 2 (HER2)/ neu receptor antagonist biosimilar to Herceptin (trastuzumab) for the treatment of HER2-positive breast cancer and HER2 overexpressing gastric cancer; and Brenzys (etanercept biosimilar), a TNF antagonist biosimilar to Enbrel for the treatment of certain inflammatory diseases. Mercks commercialization territories under the agreement vary by product. Sale growth of biosimilars in 2019 was driven by continued uptake of Renflexis in United States since launch in 2017, continued uptake of Ontruzant in the EU since launch in 2018, and the launch of Brenzys in Brazil in 2019. Animal Health Segment ($ in millions) % Change % Change Excluding Exchange % Change % Change Excluding Exchange Livestock $ 2,784 % % $ 2,630 % % $ 2,484 Companion Animal 1,609 % % 1,582 % % 1,391 Sales of livestock products grew 6% in 2019 predominantly due to products obtained in the April 2019 acquisition of Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Growth in sales of livestock products was also driven by higher demand for aqua and swine products. Sales of companion animal products grew 2% in 2019 driven primarily by higher demand for the Bravecto line of products for parasitic control. Costs, Expenses and Other ($ in millions) Change Change Cost of sales $ 14,112 % $ 13,509 % $ 12,912 Selling, general and administrative 10,615 % 10,102 % 10,074 Research and development 9,872 % 9,752 % 10,339 Restructuring costs % % Other (income) expense, net * (402 ) % (500 ) $ 35,376 % $ 33,593 % $ 33,601 * Greater than 100%. Cost of Sales Cost of sales was $14.1 billion in 2019 compared with $13.5 billion in 2018 . Cost of sales includes the amortization of intangible assets recorded in connection with business acquisitions, which totaled $1.4 billion in 2019 compared with $2.7 billion in 2018. Cost of sales also includes the amortization of amounts capitalized in connection with collaborations of $464 million in 2019 compared with $347 million in 2018 (see Note 8 to the consolidated financial statements). Additionally, costs in 2019 include intangible asset impairment charges of $705 million related to marketed products recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Costs in 2018 include a $423 million charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements). Also included in cost of sales are expenses associated with restructuring activities which amounted to $251 million in 2019 compared with $21 million in 2018 , primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 69.9% in 2019 compared with 68.1% in 2018 . The gross margin improvement in 2019 reflects the charge recorded in 2018 in connection with the termination of the collaboration agreement with Samsung (noted above), favorable product mix, and lower amortization of intangible assets (noted above). These improvements in gross margin were partially offset by unfavorable manufacturing variances, inventory write-offs, pricing pressure, and higher restructuring costs. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.6 billion in 2019 , an increase of 5% compared with 2018 , driven primarily by higher administrative costs, acquisition and divestiture-related costs (largely related to the acquisition of Antelliq), promotional expenses primarily in support of strategic brands, and restructuring costs, partially offset by the favorable effect of foreign exchange and lower selling costs. SGA expenses in 2019 include restructuring costs of $34 million related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. SGA expenses include acquisition and divestiture-related costs of $126 million in 2019 compared with $32 million in 2018, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Research and Development Research and development (RD) expenses were $9.9 billion in 2019 , an increase of 1% compared with 2018 . The increase was driven primarily by a $993 million charge in 2019 for the acquisition of Peloton (see Note 3 to the consolidated financial statements), as well as higher expenses related to clinical development and increased investment in discovery research and early drug development. The increase in RD expenses in 2019 was partially offset by a $1.4 billion charge in 2018 related to the formation of an oncology collaboration with Eisai (see Note 4 to the consolidated financial statements), a $344 million charge in 2018 related to the acquisition of Viralytics Limited (Viralytics) (see Note 3 to the consolidated financial statements), and the favorable effect of foreign exchange. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $6.1 billion in 2019 compared with $5.6 billion in 2018. Also included in RD expenses are Animal Health research costs, licensing costs and costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, which in the aggregate were $2.6 billion in 2019 and $2.3 billion in 2018. RD expenses also include in-process research and development (IPRD) impairment charges of $172 million and $152 million in 2019 and 2018 , respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with business acquisitions. During 2019 and 2018, the Company recorded a net reduction in expenses of $39 million and $54 million, respectively, related to changes in these estimates. Restructuring Costs In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $2.5 billion . The Company expects to record charges of approximately $800 million in 2020 related to the Restructuring Program. The Company anticipates the actions under the Restructuring Program to result in annual net cost savings of approximately $900 million by the end of 2023. Actions under previous global restructuring programs have been substantially completed. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $638 million in 2019 and $632 million in 2018 . Separation costs incurred were associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Also included in restructuring costs are asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative and Research and development . The Company recorded aggregate pretax costs of $927 million in 2019 and $658 million in 2018 related to restructuring program activities (see Note 5 to the consolidated financial statements). Other (Income) Expense, Net For details on the components of Other (income) expense, net, see Note 14 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 28,324 $ 24,871 $ 23,018 Animal Health segment profits 1,609 1,659 1,552 Other non-reportable segment profits (7 ) Other (18,462 ) (17,932 ) (18,324 ) Income Before Taxes $ 11,464 $ 8,701 $ 6,521 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred by MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are costs related to restructuring activities and acquisition and divestiture-related costs, including amortization of purchase accounting adjustments, intangible asset impairment charges and changes in the estimated fair value measurement of liabilities for contingent consideration. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. During 2019, as a result of changes to the Companys internal reporting structure, certain costs that were previously included in the Pharmaceutical segment are now being included as part of non-segment expenses within MRL. Prior period Pharmaceutical segment profits have been recast to reflect these changes on a comparable basis. Pharmaceutical segment profits grew 14% in 2019 compared with 2018 driven primarily by higher sales, as well as lower selling costs. Animal Health segment profits declined 3% in 2019 driven primarily by unfavorable product mix, higher investments in selling and product development, and the unfavorable effect of foreign exchange, partially offset by higher sales. Taxes on Income The effective income tax rates of 14.7% in 2019 and 28.8% in 2018 reflect the impacts of acquisition and divestiture-related costs, restructuring costs and the beneficial impact of foreign earnings, including product mix. The effective income tax rate in 2019 also reflects the favorable impact of a $364 million net tax benefit related to the settlement of certain federal income tax matters (see Note 15 to the consolidated financial statements) and the reversal of tax reserves established in connection with the 2014 divestiture of Mercks Consumer Care (MCC) business due to the lapse in the statute of limitations. In addition, the effective income tax rate in 2019 reflects the unfavorable impacts of a charge for the acquisition of Peloton for which no tax benefit was recognized and charges of $117 million related to the finalization of treasury regulations for the transition tax associated with the 2017 enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 15 to the consolidated financial statements). The effective income tax rate in 2018 includes measurement-period adjustments to the provisional amounts recorded in 2017 associated with the enactment of the TCJA, including $124 million related to the transition tax. In addition, the effective income tax rate for 2018 reflects the unfavorable impacts of a charge recorded in connection with the formation of a collaboration with Eisai and a charge related to the termination of a collaboration agreement with Samsung for which no tax benefit was recognized. Net (Loss) Income Attributable to Noncontrolling Interests Net (loss) income attributable to noncontrolling interests was $(66) million in 2019 compared with $(27) million in 2018. The losses in 2019 and 2018 were driven primarily by the portion of goodwill impairment charges related to certain business in the Healthcare Services segment that are attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $9.8 billion in 2019 and $6.2 billion in 2018 . EPS was $3.81 in 2019 and $2.32 in 2018 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. In addition, senior managements annual compensation is derived in part using non-GAAP pretax income. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 11,464 $ 8,701 $ 6,521 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 2,681 3,066 3,760 Restructuring costs Other items: Charge for the acquisition of Peloton Charge related to the formation of an oncology collaboration with Eisai 1,400 Charge related to the termination of a collaboration with Samsung Charge for the acquisition of Viralytics Charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Other (57 ) (16 ) Non-GAAP income before taxes 16,120 14,535 13,542 Taxes on income as reported under GAAP 1,687 2,508 4,103 Estimated tax benefit on excluded items (1) Net tax charge related to the enactment of the TCJA and subsequent finalization of related treasury regulations (2) (117 ) (160 ) (2,625 ) Net tax benefit from the settlement of certain federal income tax matters Tax benefit from the reversal of tax reserves related to the divestiture of MCC Tax benefit related to the settlement of a state income tax matter Non-GAAP taxes on income 2,715 2,883 2,585 Non-GAAP net income 13,405 11,652 10,957 Less: Net (loss) income attributable to noncontrolling interests as reported under GAAP (66 ) (27 ) Acquisition and divestiture-related costs attributable to noncontrolling interests (89 ) (58 ) Non-GAAP net income attributable to noncontrolling interests 31 Non-GAAP net income attributable to Merck Co., Inc. $ 13,382 $ 11,621 $ 10,933 EPS assuming dilution as reported under GAAP $ 3.81 $ 2.32 $ 0.87 EPS difference 1.38 2.02 3.11 Non-GAAP EPS assuming dilution $ 5.19 $ 4.34 $ 3.98 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Amount in 2017 was provisional (see Note 15 to the consolidated financial statements). Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, facility shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items These items are adjusted for after they are evaluated on an individual basis considering their quantitative and qualitative aspects. Typically, these consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2019 is a charge for the acquisition of Peloton (see Note 3 to the consolidated financial statements), tax charges related to the finalization of U.S. treasury regulations related to the TCJA, a net tax benefit related to the settlement of certain federal income tax matters, and a tax benefit related to the reversal of tax reserves established in connection with the 2014 divestiture of MCC (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 15 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2017 is a charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), as well as a provisional net tax charge related to the enactment of the TCJA, a net tax benefit related to the settlement of certain federal income tax matters and a tax benefit related to the settlement of a state income tax matter (see Note 15 to the consolidated financial statements). Research and Development A chart reflecting the Companys current research pipeline as of February 21, 2020 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an anti-PD-1 therapy approved for the treatment of many cancers that is in clinical development for expanded indications. These approvals were the result of a broad clinical development program that currently consists of more than 1,000 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: biliary tract, cervical, colorectal, cutaneous squamous cell, endometrial, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, non-small-cell lung, ovarian, PMBCL, prostate, renal, small-cell lung, triple-negative breast and urothelial, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Keytruda is under review in the EU as monotherapy for the first-line treatment of patients with stage III NSCLC who are not candidates for surgical resection or definitive chemoradiation, or metastatic NSCLC, and whose tumors express PD-L1 (TPS 1%) with no EGFR or ALK genomic tumor aberrations based on results from the Phase 3 KEYNOTE-042 trial. Keytruda is under review in Japan as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma based on results from the pivotal Phase 3 KEYNOTE-062 trial. Keytruda is also under review in Japan as monotherapy for the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma based on the results of the Phase 3 KEYNOTE-181 trial. Merck has made the decision to withdraw its Type II variation application for Keytruda for this indication in the EU. In October 2019, the FDA accepted a supplemental Biologics License Application (BLA) seeking use of Keytruda for the treatment of patients with recurrent and/or metastatic cutaneous squamous cell carcinoma (cSCC) that is not curable by surgery or radiation based on the results of the KEYNOTE-629 trial. The FDA set a Prescription Drug User Fee Act (PDUFA) date of June 29, 2020. In February 2020, Merck announced the FDA issued a Complete Response Letter regarding Mercks supplemental BLAs seeking to update the dosing frequency for Keytruda to include a 400 mg dose infused over 30 minutes every-six-weeks (Q6W) option in multiple indications. The submitted applications are based on pharmacokinetic modeling and simulation data presented at the 2018 American Society of Clinical Oncology (ASCO) Annual Meeting. These data supported the EC approval of 400 mg Q6W dosing for Keytruda monotherapy indications in March 2019. Merck is reviewing the letter and will discuss next steps with the FDA. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with neoadjuvant chemotherapy for the treatment of high-risk, early-stage triple-negative breast cancer (TNBC) and in combination with enfortumab vedotin, in the first-line setting for the treatment of patients with unresectable locally advanced or metastatic urothelial cancer who are not eligible for cisplatin-containing chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In September 2019, Merck announced results from the pivotal neoadjuvant/adjuvant Phase 3 KEYNOTE-522 trial in patients with early-stage TNBC. The trial investigated a regimen of neoadjuvant Keytruda plus chemotherapy, followed by adjuvant Keytruda as monotherapy (the Keytruda regimen) compared with a regimen of neoadjuvant chemotherapy followed by adjuvant placebo (the chemotherapy-placebo regimen). Interim findings were presented at the European Society for Medical Oncology (ESMO) 2019 Congress. In the neoadjuvant phase, Keytruda plus chemotherapy resulted in a statistically significant increase in pathological complete response (pCR) versus chemotherapy in patients with early-stage TNBC. The improvement seen when adding Keytruda to neoadjuvant chemotherapy was observed regardless of PD-L1 expression. In the other dual primary endpoint of event-free-survival (EFS), with a median follow-up of 15.5 months, the Keytruda regimen reduced the risk of progression in the neoadjuvant phase and recurrence in the adjuvant phase compared with the chemotherapy-placebo regimen. Merck continues to discuss interim analysis data from KEYNOTE-522 with regulatory authorities. The Keytruda breast cancer clinical development program encompasses several internal and external collaborative studies. In February 2020, Merck announced that the pivotal Phase 3 KEYNOTE-355 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of progression-free survival (PFS) in patients with metastatic triple-negative breast cancer (mTNBC) whose tumors expressed PD-L1 (CPS 10). Based on an interim analysis conducted by an independent Data Monitoring Committee (DMC), first-line treatment with Keytruda in combination with chemotherapy (nab-paclitaxel, paclitaxel or gemcitabine/carboplatin) demonstrated a statistically significant and clinically meaningful improvement in PFS compared to chemotherapy alone in these patients. Based on the recommendation of the DMC, the trial will continue without changes to evaluate the other dual primary endpoint of overall survival (OS). In May 2019, Merck announced that the Phase 3 KEYNOTE-119 trial evaluating Keytruda as monotherapy for the second- or third-line treatment of patients with metastatic TNBC did not meet its pre-specified primary endpoint of superior OS compared to chemotherapy. Other endpoints were not formally tested per the study protocol because the primary endpoint of OS was not met. In June 2019, Merck announced full results from the pivotal Phase 3 KEYNOTE-062 trial evaluating Keytruda as monotherapy and in combination with chemotherapy for the first-line treatment of advanced gastric or gastroesophageal junction adenocarcinoma. In the monotherapy arm of the study, Keytruda met a primary endpoint by demonstrating noninferiority to chemotherapy, the current standard of care, for OS in patients whose tumors expressed PD-L1 (CPS 1). In the combination arm of KEYNOTE-062, Keytruda plus chemotherapy was not found to be statistically superior for OS (CPS 1 or CPS 10) or PFS (CPS 1) compared with chemotherapy alone. Results were presented at the 2019 ASCO Annual Meeting. In September 2017, the FDA approved Keytruda as a third-line treatment for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1 (CPS 1) as determined by an FDA-approved test. KEYNOTE-062 was a potential confirmatory trial for this accelerated, third-line approval. In addition to KEYNOTE-062, additional first-line, Phase 3 studies in Mercks gastric clinical program include KEYNOTE-811 and KEYNOTE-859, as well as KEYNOTE-585 in the neoadjuvant and adjuvant treatment setting. In January 2020, Merck announced that the Phase 3 KEYNOTE-604 trial investigating Keytruda in combination with chemotherapy met one of its dual primary endpoints of PFS in the first-line treatment of patients with extensive stage SCLC. At the final analysis of the study, there was also an improvement in OS for patients treated with Keytruda in combination with chemotherapy compared to chemotherapy alone; however, these OS results did not meet statistical significance per the pre-specified statistical plan. Results will be presented at an upcoming medical meeting and discussed with regulatory authorities. Lynparza is an oral PARP inhibitor currently approved for certain types of advanced ovarian, breast and pancreatic cancers being co-developed for multiple cancer types as part of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). Lynparza is under review in the EU as a first-line maintenance monotherapy for patients with g BRCA m metastatic pancreatic cancer whose disease has not progressed following first-line platinum-based chemotherapy. Lynparza was approved for this indication by the FDA in December 2019 based on results from the Phase 3 POLO trial. A decision from the European Medicines Agency (EMA) is expected in the second half of 2020. In January 2020, the FDA accepted a supplemental NDA for Lynparza in combination with bevacizumab for the maintenance treatment of women with advanced ovarian cancer whose disease showed a complete or partial response to first-line treatment with platinum-based chemotherapy and bevacizumab based on the results from the pivotal Phase 3 PAOLA-1 trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In January 2020, the FDA accepted for Priority Review a supplemental NDA for Lynparza for the treatment of patients with metastatic castration-resistant prostate cancer (mCRPC) and deleterious or suspected deleterious germline or somatic homologous recombination repair (HRR) gene mutations, who have progressed following prior treatment with a new hormonal agent based on positive results from the Phase 3 PROfound trial. A PDUFA date is set for the second quarter of 2020. This indication is also under review in the EU. In June 2019, Merck and AstraZeneca presented full results from the Phase 3 SOLO-3 trial which evaluated Lynparza, compared to chemotherapy, for the treatment of platinum-sensitive relapsed patients with g BRCA m advanced ovarian cancer, who have received two or more prior lines of chemotherapy. The results from the trial showed a statistically-significant and clinically-meaningful improvement in objective response rate (ORR) in the Lynparza arm compared to the chemotherapy arm. The key secondary endpoint of PFS was also significantly increased in the Lynparza arm compared to the chemotherapy arm. The results were presented at the 2019 ASCO Annual Meeting. MK-5618, selumetinib, is a MEK 1/2 inhibitor being co-developed as part of a strategic collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). Selumetinib is under Priority Review with the FDA as a potential new medicine for pediatric patients aged three years and older with neurofibromatosis type 1 (NF1) and symptomatic, inoperable plexiform neurofibromas. This regulatory submission was based on positive results from the National Cancer Institute Cancer Therapy Evaluation Program-sponsored SPRINT Phase 2 Stratum 1 trial. A PDUFA date is set for the second quarter of 2020. V503 is under review in Japan for an initial indication in females for the prevention of certain HPV-related diseases and precursors. In February 2020, the FDA accepted for Priority Review a supplemental BLA for Gardasil 9 for the prevention of certain head and neck cancers caused by vaccine-type HPV in females and males 9 through 45 years of age. The FDA set a PDUFA date of June 2020. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. Lynparza, in addition to the indications under review discussed above, is in Phase 3 development in combination with Keytruda for the treatment of NSCLC. Lenvima is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, HCC, and in combination for certain patients with RCC being co-developed as part of a strategic collaboration with Eisai (see Note 4 to the consolidated financial statements). Pursuant to the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination in six types of cancer (endometrial cancer, NSCLC, HCC, HNSCC, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima both for the potential treatment of patients with advanced and/or metastatic RCC and for the potential treatment of patients with unresectable HCC not amenable to locoregional treatment. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor antagonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. MK-1242, vericiguat, is a sGC stimulator for the potential treatment of patients with worsening chronic heart failure being developed as part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). Vericiguat is being studied in patients suffering from chronic heart failure with reduced ejection fraction (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fraction (Phase 2 clinical trial). In November 2019, Merck announced that the Phase 3 VICTORIA study evaluating the efficacy and safety of vericiguat met the primary efficacy endpoint. Vericiguat reduced the risk of the composite endpoint of heart failure hospitalization or cardiovascular death in patients with worsening chronic heart failure with reduced ejection fraction compared to placebo when given in combination with available heart failure therapies. The results of the VICTORIA study will be presented at an upcoming medical meeting in 2020. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently six Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, eight studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. V114 has received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients (6 weeks to 18 years of age) and in adults. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes and other metabolic diseases, infectious diseases, neurosciences, pain, respiratory diseases, and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2019 , the balance of IPRD was $1.0 billion . The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2019 , 2018 , and 2017 the Company recorded IPRD impairment charges within Research and development expenses of $172 million , $152 million and $483 million , respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets for IPRD of $156 million , cash of $83 million and other net assets of $42 million . The excess of the consideration transferred over the fair value of net assets acquired of $20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. In July 2019, Merck acquired Peloton, a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly PT2977), is a novel oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $1.2 billion in cash; additionally, former Peloton shareholders will be eligible to receive $50 million upon U.S. regulatory approval, $50 million upon first commercial sale in the United States, and up to $1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $157 million , deferred tax liabilities of $52 million , and other net liabilities of $4 million at the acquisition date and Research and development expenses of $993 million in 2019 related to the transaction. In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $2.7 billion . ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently in a Phase 2 dose expansion study for the treatment of B-cell malignancies. The Company is in the process of determining the preliminary fair value of assets acquired, liabilities assumed and total consideration transferred in this transaction, which will be accounted for as an acquisition of a business. Capital Expenditures Capital expenditures were $3.5 billion in 2019 , $2.6 billion in 2018 and $1.9 billion in 2017 . Expenditures in the United States were $1.9 billion in 2019 , $1.5 billion in 2018 and $1.2 billion in 2017 . The increased capital expenditures in 2019 reflect investment in new capital projects focused primarily on increasing manufacturing capacity for Mercks key products. As previously announced, the Company plans to invest more than $19 billion in new capital projects from 2019-2023. Depreciation expense was $1.7 billion in 2019 , $1.4 billion in 2018 and $1.5 billion in 2017 , of which $1.2 billion in 2019 , $1.0 billion in 2018 and $1.0 billion in 2017 , related to locations in the United States. Total depreciation expense in 2019 and 2017 included accelerated depreciation of $233 million and $60 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 5,263 $ 3,669 $ 6,152 Total debt to total liabilities and equity 31.2 % 30.4 % 27.8 % Cash provided by operations to total debt 0.5:1 0.4:1 0.3:1 Cash provided by operating activities was $13.4 billion in 2019 compared with $10.9 billion in 2018 , reflecting stronger operating performance and increased accounts receivable factoring as discussed below. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash used in investing activities was $2.6 billion in 2019 compared with cash provided by investing activities of $4.3 billion in 2018 . The change was driven primarily by lower proceeds from the sales of securities and other investments, the acquisitions of Antelliq and Peloton in 2019, and higher capital expenditures, partially offset by lower purchases of securities and other investments. Cash used in financing activities was $8.9 billion in 2019 compared with $13.2 billion in 2018 . The lower use of cash in financing activities was driven primarily by proceeds from the issuance of debt and lower purchases of treasury stock reflecting the accelerated share repurchase (ASR) program in 2018 as discussed below, as well as lower payments on debt, partially offset by the repayment of short-term borrowings, higher dividends paid to shareholders and lower proceeds from the exercise of stock options. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable (see Note 6 to the consolidated financial statements). The Company factored $2.7 billion and $1.1 billion of accounts receivable in the fourth quarter of 2019 and 2018 , respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2019 , the Company had collected $256 million on behalf of the financial institutions, which was remitted to them in January 2020. The net cash flows from these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The Companys contractual obligations as of December 31, 2019 are as follows: Payments Due by Period ($ in millions) Total 20212022 20232024 Thereafter Purchase obligations (1) $ 3,167 $ 1,097 $ 1,108 $ $ Loans payable and current portion of long-term debt 3,612 3,612 Long-term debt 22,779 4,515 3,058 15,206 Interest related to debt obligations 10,021 1,372 1,189 6,700 Unrecognized tax benefits (2) Transition tax related to the enactment of the TCJA (3) 3,397 1,181 1,045 Milestone payments related to collaborations (4) Leases (5) 1,012 $ 44,437 $ 6,562 $ 8,130 $ 6,051 $ 23,694 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2019 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $1.5 billion , including $49 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2020 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years through 2025 as permitted under the TCJA (see Note 15 to the consolidated financial statements). (4) Reflects payments under collaborative agreements for sales-based milestones that were achieved in 2019 (and therefore deemed to be contractual obligations) but not paid until January 2020 (see Note 4 to the consolidated financial statements). (5) Amounts exclude reasonably certain lease renewals that have not yet been executed (see Note 9 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts do not include contingent milestone payments related to collaborative arrangements or acquisitions as they are not considered contractual obligations until the successful achievement of developmental, regulatory approval or commercial milestones. At December 31, 2019 , the Company has recognized liabilities for contingent sales-based milestone payments related to collaborations with AstraZeneca, Eisai and Bayer where payment remains subject to the achievement of the related sales milestone aggregating $1.4 billion (see Note 4 to the consolidated financial statements). Excluded from research and development obligations are potential future funding commitments of up to approximately $60 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $226 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2020 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $100 million to its U.S. pension plans, $150 million to its international pension plans and $15 million to its other postretirement benefit plans during 2020 . In March 2019, the Company issued $5.0 billion principal amount of senior unsecured notes consisting of $750 million of 2.90% notes due 2024, $1.75 billion of 3.40% notes due 2029, $1.0 billion of 3.90% notes due 2039, and $1.5 billion of 4.00% notes due 2049. The Company used the net proceeds from the offering of $5.0 billion for general corporate purposes, including the repayment of outstanding commercial paper borrowings. In December 2018, the Company exercised a make-whole provision on its $1.25 billion, 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. The Company has a $6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2019, Mercks Board of Directors declared a quarterly dividend of $0.61 per share on the Companys outstanding common stock that was paid in January 2020. In January 2020 , the Board of Directors declared a quarterly dividend of $0.61 per share on the Companys common stock for the second quarter of 2020 payable in April 2020 . In October 2018, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company spent $4.8 billion to purchase 59 million shares of its common stock for its treasury during 2019 . In addition, the Company received 7.7 million shares in settlement of ASR agreements as discussed below. As of December 31, 2019 , the Companys remaining share repurchase authorization was $7.2 billion . The Company purchased $9.1 billion and $4.0 billion of its common stock during 2018 and 2017 , respectively, under authorized share repurchase programs. On October 25, 2018, the Company entered into ASR agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. Upon settlement of the ASR agreements in April 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million . Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives of the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $456 million and $441 million at December 31, 2019 and 2018 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2019 and 2018 , Income before taxes would have declined by approximately $110 million and $134 million in 2019 and 2018 , respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within Other Comprehensive Income (Loss) ( OCI ), and remain in Accumulated Other Comprehensive Income (Loss) ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2019 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2019 and 2018 would have positively affected the net aggregate market value of these instruments by $2.0 billion and $1.2 billion, respectively. A one percentage point decrease at December 31, 2019 and 2018 would have negatively affected the net aggregate market value by $2.2 billion and $1.4 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Revenue Recognition Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2019 , 2018 or 2017 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,630 $ 2,551 Current provision 11,999 10,837 Adjustments to prior years (230 ) (117 ) Payments (11,963 ) (10,641 ) Balance December 31 $ 2,436 $ 2,630 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $233 million and $2.2 billion , respectively, at December 31, 2019 and were $245 million and $2.4 billion , respectively, at December 31, 2018 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 1.1% in 2019, 1.6% in 2018 and 2.1% in 2017. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2019 and 2018 were $168 million and $7 million , respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters including governmental and environmental matters (see Note 10 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2019 and 2018 of approximately $240 million and $245 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $19 million in 2019 and are estimated at $47 million in the aggregate for the years 2020 through 2024 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $67 million and $71 million at December 31, 2019 and 2018 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $58 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $417 million in 2019 , $348 million in 2018 and $312 million in 2017 . At December 31, 2019 , there was $603 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $137 million in 2019 , $195 million in 2018 and $201 million in 2017 . Net periodic benefit (credit) for other postretirement benefit plans was $(49) million in 2019 , $(45) million in 2018 and $(60) million in 2017 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 3.20% to 3.50% at December 31, 2019 , compared with a range of 4.00% to 4.40% at December 31, 2018 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2020 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.00% to 7.30% , compared to a range of 7.70% to 8.10% in 2019 . The decrease reflects lower expected asset returns and a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 45% in U.S. equities, 15% to 30% in international equities, 35% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 10% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $70 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2019 . A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $50 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2019 . Required funding obligations for 2020 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 15 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2019 and 2018 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2019 , the notes to consolidated financial statements, and the report dated February 26, 2020 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 46,840 $ 42,294 $ 40,122 Costs, Expenses and Other Cost of sales 14,112 13,509 12,912 Selling, general and administrative 10,615 10,102 10,074 Research and development 9,872 9,752 10,339 Restructuring costs Other (income) expense, net ( 402 ) ( 500 ) 35,376 33,593 33,601 Income Before Taxes 11,464 8,701 6,521 Taxes on Income 1,687 2,508 4,103 Net Income 9,777 6,193 2,418 Less: Net (Loss) Income Attributable to Noncontrolling Interests ( 66 ) ( 27 ) Net Income Attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 3.84 $ 2.34 $ 0.88 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 3.81 $ 2.32 $ 0.87 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Other Comprehensive (Loss) Income Net of Taxes: Net unrealized (loss) gain on derivatives, net of reclassifications ( 135 ) ( 446 ) Net unrealized gain (loss) on investments, net of reclassifications ( 10 ) ( 58 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization ( 705 ) ( 425 ) Cumulative translation adjustment ( 223 ) ( 648 ) ( 361 ) Comprehensive Income Attributable to Merck Co., Inc. $ 9,195 $ 5,859 $ 2,710 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 9,676 $ 7,965 Short-term investments Accounts receivable (net of allowance for doubtful accounts of $86 in 2019 and $119 in 2018) 6,778 7,071 Inventories (excludes inventories of $1,480 in 2019 and $1,417 in 2018 classified in Other assets - see Note 7) 5,978 5,440 Other current assets 4,277 4,500 Total current assets 27,483 25,875 Investments 1,469 6,233 Property, Plant and Equipment (at cost) Land Buildings 11,989 11,486 Machinery, equipment and office furnishings 15,394 14,441 Construction in progress 5,013 3,355 32,739 29,615 Less: accumulated depreciation 17,686 16,324 15,053 13,291 Goodwill 19,425 18,253 Other Intangibles, Net 14,196 13,104 Other Assets 6,771 5,881 $ 84,397 $ 82,637 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 3,610 $ 5,308 Trade accounts payable 3,738 3,318 Accrued and other current liabilities 12,549 10,151 Income taxes payable 1,971 Dividends payable 1,587 1,458 Total current liabilities 22,220 22,206 Long-Term Debt 22,736 19,806 Deferred Income Taxes 1,470 1,702 Other Noncurrent Liabilities 11,970 12,041 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2019 and 2018 1,788 1,788 Other paid-in capital 39,660 38,808 Retained earnings 46,602 42,579 Accumulated other comprehensive loss ( 6,193 ) ( 5,545 ) 81,857 77,630 Less treasury stock, at cost: 1,038,087,496 shares in 2019 and 984,543,979 shares in 2018 55,950 50,929 Total Merck Co., Inc. stockholders equity 25,907 26,701 Noncontrolling Interests Total equity 26,001 26,882 $ 84,397 $ 82,637 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2017 $ 1,788 $ 39,939 $ 44,133 $ ( 5,226 ) $ ( 40,546 ) $ $ 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) ( 5,177 ) ( 5,177 ) Treasury stock shares purchased ( 4,014 ) ( 4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests ( 18 ) ( 18 ) Share-based compensation plans and other ( 37 ) Balance December 31, 2017 1,788 39,902 41,350 ( 4,910 ) ( 43,794 ) 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards ( 274 ) Other comprehensive loss, net of taxes ( 361 ) ( 361 ) Cash dividends declared on common stock ($1.99 per share) ( 5,313 ) ( 5,313 ) Treasury stock shares purchased ( 1,000 ) ( 8,091 ) ( 9,091 ) Net loss attributable to noncontrolling interests ( 27 ) ( 27 ) Distributions attributable to noncontrolling interests ( 25 ) ( 25 ) Share-based compensation plans and other ( 94 ) Balance December 31, 2018 1,788 38,808 42,579 ( 5,545 ) ( 50,929 ) 26,882 Net income attributable to Merck Co., Inc. 9,843 9,843 Other comprehensive loss, net of taxes ( 648 ) ( 648 ) Cash dividends declared on common stock ($2.26 per share) ( 5,820 ) ( 5,820 ) Treasury stock shares purchased 1,000 ( 5,780 ) ( 4,780 ) Net loss attributable to noncontrolling interests ( 66 ) ( 66 ) Distributions attributable to noncontrolling interests ( 21 ) ( 21 ) Share-based compensation plans and other ( 148 ) Balance December 31, 2019 $ 1,788 $ 39,660 $ 46,602 $ ( 6,193 ) $ ( 55,950 ) $ $ 26,001 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 9,777 $ 6,193 $ 2,418 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,652 4,519 4,676 Intangible asset impairment charges 1,040 Charge for the acquisition of Peloton Therapeutics, Inc. Charge for future payments related to collaboration license options Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Deferred income taxes ( 556 ) ( 509 ) ( 2,621 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable ( 418 ) Inventories ( 508 ) ( 911 ) ( 145 ) Trade accounts payable Accrued and other current liabilities ( 341 ) ( 922 ) Income taxes payable ( 2,359 ) ( 3,291 ) Noncurrent liabilities ( 237 ) ( 266 ) ( 123 ) Other ( 32 ) ( 674 ) ( 1,087 ) Net Cash Provided by Operating Activities 13,440 10,922 6,451 Cash Flows from Investing Activities Capital expenditures ( 3,473 ) ( 2,615 ) ( 1,888 ) Purchases of securities and other investments ( 3,202 ) ( 7,994 ) ( 10,739 ) Proceeds from sales of securities and other investments 8,622 15,252 15,664 Acquisition of Antelliq Corporation, net of cash acquired ( 3,620 ) Acquisition of Peloton Therapeutics, Inc., net of cash acquired ( 1,040 ) Other acquisitions, net of cash acquired ( 294 ) ( 431 ) ( 396 ) Other Net Cash (Used in) Provided by Investing Activities ( 2,629 ) 4,314 2,679 Cash Flows from Financing Activities Net change in short-term borrowings ( 3,710 ) 5,124 ( 26 ) Payments on debt ( 4,287 ) ( 1,103 ) Proceeds from issuance of debt 4,958 Purchases of treasury stock ( 4,780 ) ( 9,091 ) ( 4,014 ) Dividends paid to stockholders ( 5,695 ) ( 5,172 ) ( 5,167 ) Proceeds from exercise of stock options Other ( 325 ) ( 195 ) Net Cash Used in Financing Activities ( 8,861 ) ( 13,160 ) ( 10,006 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash ( 205 ) Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 1,967 1,871 ( 419 ) Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $2 million of restricted cash at January 1, 2019 included in Other Assets) 7,967 6,096 6,515 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $258 million of restricted cash at December 31, 2019 included in Other Assets - see Note 6) $ 9,934 $ 7,967 $ 6,096 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Planned Spin-Off of Womens Health, Legacy Brands and Biosimilars into New Company In February 2020, Merck announced its intention to spin-off products from its womens health, trusted legacy brands and biosimilars businesses into a new, yet-to-be-named, independent, publicly traded company (NewCo) through a distribution of NewCos publicly traded stock to Company shareholders. The distribution is expected to qualify as tax-free to the Company and its shareholders for U.S. federal income tax purposes. The legacy brands included in the transaction consist of dermatology, pain, respiratory, and select cardiovascular products including Zetia and Vytorin , as well as the rest of Mercks diversified brands franchise. Mercks existing research pipeline programs will continue to be owned and developed within Merck as planned. NewCo will have development capabilities initially focused on late-stage development and life-cycle management, and is expected over time to develop research capabilities in selected therapeutic areas. The spin-off is expected to be completed in the first half of 2021, subject to market and certain other conditions. Subsequent to the spin-off, the historical results of the womans health, legacy brands and biosimilars businesses will be reflected as discontinued operations in the Companys consolidated financial statements. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers , and subsequent amendments (ASC 606 or new guidance), using the modified retrospective method. Comparative information for prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $ 11.8 billion in 2019 , $ 10.7 billion in 2018 and $ 10.7 billion in 2017 . Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $ 233 million and $ 2.2 billion , respectively, at December 31, 2019 and were $ 245 million and $ 2.4 billion , respectively, at December 31, 2018 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically 36 days from receipt of invoice and for U.S. animal health customers are typically 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $ 1.7 billion in 2019 , $ 1.4 billion in 2018 and $ 1.5 billion in 2017 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $ 2.1 billion , $ 2.1 billion and $ 2.2 billion in 2019 , 2018 and 2017 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. These costs are included in Property, plant and equipment . In addition, the Company capitalizes certain costs incurred to implement a cloud computing arrangement that is considered a service agreement, which are included in Other Assets . Capitalized software costs are amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $ 548 million and $ 439 million , net of accumulated amortization at December 31, 2019 and 2018 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 24 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development IPRD that the Company acquires in conjunction with the acquisition of a business represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company evaluates IPRD for impairment at least annually, or more frequently if impairment indicators exist, by performing a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. If the transaction is accounted for as an acquisition of a business, the fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period until the contingency is resolved, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Significant events that increase or decrease the probability of achieving development and regulatory milestones or that increase or decrease projected cash flows will result in corresponding increases or decreases in the fair values of the related contingent consideration obligations. If the transaction is accounted for as an acquisition of an asset rather than a business, contingent consideration is not recognized at the acquisition date. In these instances, product development milestones are recognized upon achievement and sales-based milestones are recognized when the milestone is deemed probable by the Company of being achieved. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued and capitalized, subject to cumulative amortization catch-up, when probable of being achieved. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. The Company accounts for the tax effects of the tax on global intangible low-taxed income (GILTI) of certain foreign subsidiaries in the income tax provision in the period the tax arises. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Adopted Accounting Standards In February 2016, the Financial Accounting Standards Board (FASB) issued new accounting guidance for the accounting and reporting of leases (ASU 2016-02) and subsequently issued several updates to the new guidance (ASC 842 or new leasing guidance). The new leasing guidance requires that lessees recognize a right-of-use asset and a lease liability for each of its leases (other than leases that meet the definition of a short-term lease). Leases are classified as either operating or finance. Operating leases result in straight-line expense in the income statement (similar to previous operating leases), while finance leases result in more expense being recognized in the earlier years of the lease term (similar to previous capital leases). The Company adopted the new standard on January 1, 2019 using a modified retrospective approach. Merck elected the transition method that allows for application of the standard at the adoption date rather than at the beginning of the earliest comparative period presented in the financial statements. The Company also elected available practical expedients. Upon adoption, the Company recognized $ 1.1 billion of additional assets and related liabilities on its consolidated balance sheet (see Note 9). The adoption of the new leasing guidance did not impact the Companys consolidated statements of income or of cash flows. In April 2018, the FASB issued new guidance on the accounting for costs incurred to implement a cloud computing arrangement that is considered a service arrangement. The new guidance requires the capitalization of such costs, aligning it with the accounting for costs associated with developing or obtaining internal-use software. The Company adopted the new standard in the third quarter of 2019 using prospective application for eligible costs, which were immaterial. In August 2018, the FASB issued new guidance modifying the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The new guidance removes disclosures that no longer are considered cost beneficial, clarifies the specific requirements of certain disclosures, and adds disclosure requirements identified as relevant. The Company elected to early adopt the new guidance in 2019 on a retrospective basis resulting in minor changes to its employee benefit plan disclosures (see Note 13). Also, in August 2018, the FASB issued new guidance on fair value measurements that adds, removes, and modifies certain disclosure requirements. The Company elected to early adopt the new guidance in 2019 resulting in minor changes to its fair value disclosures (see Note 6). Recently Issued Accounting Standards Not Yet Adopted In June 2016, the FASB issued new guidance on the accounting for credit losses on financial instruments. The new guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The Company adopted the new guidance effective January 1, 2020. There was no impact to the Companys consolidated financial statements upon adoption. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under revenue recognition guidance (ASC 606). The Company adopted the new guidance effective January 1, 2020, which will result in minor changes to the footnote presentation of information related to the Companys collaborative arrangements. In December 2019, the FASB issued amended guidance on the accounting and reporting of income taxes. The guidance is intended to simplify the accounting for income taxes by removing exceptions related to certain intraperiod tax allocations and deferred tax liabilities; clarifying guidance primarily related to evaluating the step-up tax basis for goodwill in a business combination; and reflecting enacted changes in tax laws or rates in the annual effective tax rate. The amended guidance is effective for interim and annual periods in 2021. Early adoption is permitted. The application of the amendments in the new guidance are to be applied on a retrospective basis, on a modified retrospective basis through a cumulative-effect adjustment to retained earnings or prospectively, depending on the amendment. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In January 2020, the FASB issued new guidance intended to clarify certain interactions between accounting standards related to equity securities, equity method investments and certain derivatives. The guidance addresses accounting for the transition into and out of the equity method of accounting and measuring certain purchased options and forward contracts to acquire investments. The new guidance is effective for interim and annual periods in 2021 and is to be applied prospectively. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Completed Transaction In January 2020, Merck acquired ArQule, Inc. (ArQule), a publicly traded biopharmaceutical company focused on kinase inhibitor discovery and development for the treatment of patients with cancer and other diseases for $ 2.7 billion . ArQules lead investigational candidate, MK-1026 (formerly ARQ 531), is a novel, oral Brutons tyrosine kinase (BTK) inhibitor currently in a Phase 2 dose expansion study for the treatment of B-cell malignancies. The Company is in the process of determining the preliminary fair value of assets acquired, liabilities assumed and total consideration transferred in this transaction, which will be accounted for as an acquisition of a business. 2019 Transactions In July 2019, Merck acquired Peloton Therapeutics, Inc. (Peloton), a clinical-stage biopharmaceutical company focused on the development of novel small molecule therapeutic candidates targeting hypoxia-inducible factor-2 (HIF-2) for the treatment of patients with cancer and other non-oncology diseases. Pelotons lead candidate, MK-6482 (formerly PT2977), is a novel oral HIF-2 inhibitor in late-stage development for renal cell carcinoma. Merck made an upfront payment of $ 1.2 billion in cash; additionally, former Peloton shareholders will be eligible to receive $ 50 million upon U.S. regulatory approval, $ 50 million upon first commercial sale in the United States, and up to $ 1.05 billion of sales-based milestones. The transaction was accounted for as an acquisition of an asset. Merck recorded cash of $ 157 million , deferred tax liabilities of $ 52 million , and other net liabilities of $ 4 million at the acquisition date and Research and development expenses of $ 993 million in 2019 related to the transaction. On April 1, 2019, Merck acquired Antelliq Corporation (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck paid $ 2.3 billion to acquire all outstanding shares of Antelliq and spent $ 1.3 billion to repay Antelliqs debt. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Antelliq is as follows: ($ in millions) April 1, 2019 Cash and cash equivalents $ Accounts receivable Inventories Property, plant and equipment Identifiable intangible assets (useful lives ranging from 18-24 years) (1) 2,689 Deferred income tax liabilities ( 520 ) Other assets and liabilities, net ( 81 ) Total identifiable net assets 2,349 Goodwill (2) 1,302 Consideration transferred $ 3,651 (1) The estimated fair values of identifiable intangible assets relate primarily to trade names and were determined using an income approach. The future net cash flows were discounted to present value utilizing a discount rate of 11.5 % . Actual cash flows are likely to be different than those assumed. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Animal Health segment. The goodwill is not deductible for tax purposes. The Companys results for 2019 include eight months of activity for Antelliq. The Company incurred $ 47 million of transaction costs directly related to the acquisition of Antelliq, consisting largely of advisory fees, which are reflected in Selling, general and administrative expenses in 2019. Also in April 2019, Merck acquired Immune Design, a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease, for $ 301 million in cash. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets for IPRD of $ 156 million , cash of $ 83 million and other net assets of $ 42 million . The excess of the consideration transferred over the fair value of net assets acquired of $ 20 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. Actual cash flows are likely to be different than those assumed. 2018 Transactions In 2018, the Company recorded an aggregate charge of $ 423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $ 155 million , which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $ 137 million , inventory write-offs of $ 122 million , as well as other related costs of $ 9 million . The termination of this agreement has no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $ 378 million ). The transaction provided Merck with full rights to V937 (formerly CVA21), Viralyticss investigational oncolytic immunotherapy. V937 is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. V937 is currently being evaluated in multiple clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and V937 combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $ 34 million (primarily cash) at the acquisition date and Research and development expenses of $ 344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec), a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, MK-4621 (formerly RGT100), is in development for the treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $ 140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5 % of the shares of Valle for $ 358 million . Of the total purchase price, $ 176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $ 297 million related to currently marketed products, net deferred tax liabilities of $ 102 million , other net assets of $ 32 million and noncontrolling interest of $ 25 million . In addition, the Company recorded liabilities of $ 37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $ 37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $ 156 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5 % interest in Valle for $ 18 million , which reduced the noncontrolling interest related to Valle. Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZeneca is the principal on Lynparza sales transactions. Merck records its share of Lynparza product sales, net of cost of sales and commercialization costs, as alliance revenue and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $ 1.6 billion in 2017 and made payments of $ 750 million over a multi-year period for certain license options (of which $ 250 million was paid in December 2017, $ 400 million was paid in December 2018 and $ 100 million was paid in December 2019). The Company recorded an aggregate charge of $ 2.35 billion in Research and development expenses in 2017 related to the upfront payment and license option payments. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of sales-based and regulatory milestones. In 2019, Merck determined it was probable that annual sales of Lynparza in the future would trigger a $ 300 million sales-based milestone payment from Merck to AstraZeneca. Accordingly, in 2019, Merck recorded a $300 million liability and a corresponding increase to the intangible asset related to Lynparza. Prior to 2019, Merck accrued sales-based milestone payments aggregating $ 700 million , of which $ 200 million and $ 250 million was paid to AstraZeneca in 2019 and 2018, respectively, and the remainder of $ 250 million was paid in January 2020. Potential future sales-based milestone payments of $ 3.1 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2019, Lynparza received regulatory approval in the European Union (EU) both as a monotherapy for the treatment of certain adult patients with advanced breast cancer and as a monotherapy for the maintenance treatment of certain adult patients with BRCA -mutated advanced ovarian cancer. Each of these approvals triggered a $ 30 million capitalized milestone payment from Merck to AstraZeneca. In 2018, Lynparza received regulatory approvals triggering capitalized milestone payments of $ 140 million in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $ 1.7 billion remain under the agreement. The intangible asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $ 955 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 2,419 December 31 Receivables from AstraZeneca included in Other current assets $ $ Payables to AstraZeneca included in Accrued and other current liabilities (3) Payables to AstraZeneca included Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2017 includes $ 2.35 billion related to the upfront payment and license option payments. (3) Includes accrued milestone payments. Eisai In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share gross profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development, including for studies evaluating Lenvima as monotherapy, are shared equally by the two companies and reflected in Research and development expenses. Under the agreement, Merck made an upfront payment to Eisai of $ 750 million and will make payments of up to $ 650 million for certain option rights through 2021 (of which $ 325 million was paid in March 2019, $ 200 million is expected to be paid in March 2020 and $ 125 million is expected to be paid in March 2021). The Company recorded an aggregate charge of $ 1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for additional contingent payments from Merck to Eisai related to the successful achievement of sales-based and regulatory milestones. In 2019, Merck determined it was probable that annual sales of Lenvima in the future would trigger sales-based milestone payments from Merck to Eisai aggregating $ 682 million . Accordingly, in 2019, Merck recorded $ 682 million of liabilities and corresponding increases to the intangible asset related to Lenvima. In 2018, Merck accrued sales-based milestone payments aggregating $ 268 million related to Lenvima. Of these amounts, $ 50 million was paid to Eisai in 2019 and an additional $ 150 million was paid in January 2020. Potential future sales-based milestone payments of $ 3.0 billion have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lenvima received regulatory approvals triggering capitalized milestone payments of $ 250 million in the aggregate from Merck to Eisai. Potential future regulatory milestone payments of $ 135 million remain under the agreement. The intangible asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $ 956 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 1,489 December 31 Receivables from Eisai included in Other current assets $ $ Payables to Eisai included in Accrued and other current liabilities (3) Payables to Eisai included in Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2018 includes $ 1.4 billion related to the upfront payment and option payments. (3) Includes accrued milestone and future option payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas, which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. In addition, the agreement provides for additional contingent payments from Merck to Bayer related to the successful achievement of sales-based milestones. In 2018, Merck determined it was probable that annual worldwide sales of Adempas in the future would trigger a $ 375 million sales-based milestone payment from Merck to Bayer. Accordingly, Merck recorded a $ 375 million liability and a corresponding increase to the intangible asset related to Adempas. In 2018, the Company made a $ 350 million milestone payment to Bayer, which was accrued for in 2016 when Merck deemed the payment to be probable. There is an additional $ 400 million potential future sales-based milestone payment that has not yet been accrued as it is not deemed by the Company to be probable at this time. The intangible asset balance related to Adempas (which includes the acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $ 883 million at December 31, 2019 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. Summarized financial information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share from sales in Bayers marketing territories Total sales Cost of sales (1) Selling, general and administrative Research and development December 31 Receivables from Bayer included in Other current assets $ $ Payables to Bayer included in Other Noncurrent Liabilities (2) (1) Includes amortization of intangible assets. (2) Represents accrued milestone payment. 5. Restructuring In early 2019, Merck approved a new global restructuring program (Restructuring Program) as part of a worldwide initiative focused on further optimizing the Companys manufacturing and supply network, as well as reducing its global real estate footprint. This program is a continuation of the Companys plant rationalization, builds on prior restructuring programs and does not include any actions associated with the planned spin-off of NewCo. As the Company continues to evaluate its global footprint and overall operating model, it has subsequently identified additional actions under the Restructuring Program, and could identify further actions over time. The actions currently contemplated under the Restructuring Program are expected to be substantially completed by the end of 2023, with the cumulative pretax costs to be incurred by the Company to implement the program now estimated to be approximately $ 2.5 billion . The Company estimates that approximately 60 % of the cumulative pretax costs will result in cash outlays, primarily related to employee separation expense and facility shut-down costs. Approximately 40 % of the cumulative pretax costs will be non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company expects to record charges of approximately $ 800 million in 2020 related to the Restructuring Program. Actions under previous global restructuring programs have been substantially completed. The Company recorded total pretax costs of $ 927 million in 2019 , $ 658 million in 2018 and $ 927 million in 2017 related to restructuring program activities. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2019 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2018 Cost of sales $ $ $ $ Selling, general and administrative Research and development ( 13 ) Restructuring costs $ $ ( 1 ) $ $ Year Ended December 31, 2017 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows are sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2019 , 2018 and 2017 includes asset abandonment, facility shut-down and other related costs, as well as pretax gains and losses resulting from the sales of facilities and related assets. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 13) and share-based compensation. The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2018 $ $ $ $ Expenses ( 1 ) (Payments) receipts, net ( 649 ) ( 238 ) ( 887 ) Non-cash activity Restructuring reserves December 31, 2018 Expenses (Payments) receipts, net ( 325 ) ( 136 ) ( 461 ) Non-cash activity ( 233 ) ( 8 ) ( 241 ) Restructuring reserves December 31, 2019 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2023. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by changes in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro, Japanese yen and Chinese renminbi. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company also uses forward exchange contracts to hedge a portion of its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . The Company recognizes in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 Net Investment Hedging Relationships Foreign exchange contracts $ ( 10 ) $ ( 18 ) $ $ ( 31 ) $ ( 11 ) $ Euro-denominated notes ( 75 ) ( 183 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2019 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ 1,249 $ $ ( 1 ) $ Long-Term Debt 3,409 4,560 ( 82 ) Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other Assets $ $ $ 3,400 $ $ $ Interest rate swap contracts Accrued and other current liabilities 1,250 Interest rate swap contracts Other Noncurrent Liabilities 4,650 Foreign exchange contracts Other current assets 6,117 6,222 Foreign exchange contracts Other Assets 2,160 2,655 Foreign exchange contracts Accrued and other current liabilities 1,748 Foreign exchange contracts Other Noncurrent Liabilities $ $ $ 14,728 $ $ $ 14,390 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 7,245 $ $ $ 5,430 Foreign exchange contracts Accrued and other current liabilities 8,693 9,922 $ $ $ 15,938 $ $ $ 15,352 $ $ $ 30,666 $ $ $ 29,742 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amounts subject to offset in master netting arrangements not offset in the consolidated balance sheet ( 84 ) ( 84 ) ( 121 ) ( 121 ) Cash collateral received ( 34 ) ( 107 ) Net amounts $ $ $ $ 90 The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 46,840 $ 42,294 $ 40,122 $ ( 402 ) ( 500 ) $ ( 648 ) $ ( 361 ) $ (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items ( 27 ) ( 48 ) Derivatives designated as hedging instruments ( 65 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives ( 562 ) (Decrease) increase in Sales as a result of AOCI reclassifications ( 160 ) ( 255 ) ( 138 ) Interest rate contracts Amount of gain recognized in Other (income) expense, net on derivatives ( 4 ) ( 4 ) ( 3 ) Amount of loss recognized in OCI on derivatives ( 6 ) ( 4 ) ( 3 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 Income Statement Caption Derivatives Not Designated as Hedging Instruments Foreign exchange contracts (1) Other (income) expense, net $ $ ( 260 ) $ Foreign exchange contracts (2) Sales ( 8 ) ( 3 ) (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. At December 31, 2019 , the Company estimates $ 31 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Fair Value Gains Losses Gains Losses Commercial paper $ $ $ $ $ $ $ $ Corporate notes and bonds 4,985 ( 68 ) 4,920 U.S. government and agency securities ( 5 ) Asset-backed securities 1,285 ( 11 ) 1,275 Foreign government bonds ( 1 ) Mortgage-backed securities Total debt securities 1,768 1,785 7,340 ( 85 ) 7,261 Publicly traded equity securities (1) Total debt and publicly traded equity securities $ 2,623 $ 7,717 (1) Unrealized net gains recognized in Other (income) expense, net on equity securities still held at December 31, 2019 were $ 160 million during 2019. Unrealized net losses recognized in Other (income) expense, net on equity securities still held at December 31, 2018 were $ 35 million during 2018. At December 31, 2019 and 2018 , the Company also had $ 420 million and $ 568 million , respectively, of equity investments without readily determinable fair values included in Other Assets . During 2019 and 2018 , the Company recognized unrealized gains of $ 20 million and $ 167 million , respectively, in Other (income) expense, net , on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2019 and 2018 , the Company recognized unrealized losses of $ 13 million and $ 26 million , respectively, in Other (income) expense, net , related to certain of these investments based on unfavorable observable price changes. Cumulative unrealized gains and cumulative unrealized losses based on observable prices changes for investments in equity investments without readily determinable fair values were $ 109 million and $ 21 million , respectively. Available-for-sale debt securities included in Short-term investments totaled $ 749 million at December 31, 2019 . Of the remaining debt securities, $ 933 million mature within five years. At December 31, 2019 and 2018 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Assets Investments Commercial paper $ $ $ $ $ $ $ $ Corporate notes and bonds 4,835 4,835 Asset-backed securities (1) 1,253 1,253 U.S. government and agency securities Foreign government bonds Publicly traded equity securities 1,725 2,243 6,985 7,132 Other assets (2) U.S. government and agency securities Corporate notes and bonds Asset-backed securities (1) Mortgage-backed securities Publicly traded equity securities 364 Derivative assets (3) Forward exchange contracts Purchased currency options Interest rate swaps Total assets $ $ 2,013 $ $ 2,911 $ $ 7,660 $ $ 8,171 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (3) Forward exchange contracts Interest rate swaps Written currency options Total liabilities $ $ $ $ $ $ $ $ (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. (2) Investments included in other assets are restricted as to use, including for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. As of December 31, 2019 , Cash and cash equivalents of $ 9.7 billion include $ 8.9 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration associated with business acquisitions is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) Additions Payments ( 85 ) ( 244 ) Fair value December 31 (2)(3) $ $ (1) Recorded in Cost of sales, Research and development expenses, and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2019 includes $ 114 million recorded as a current liability for amounts expected to be paid within the next 12 months. (3) At December 31, 2019 and 2018 , $ 625 million and $ 614 million , respectively, of the liabilities relate to the termination of the SPMSD joint venture in 2016. As part of the termination, Merck recorded a liability for contingent future royalty payments of 11.5 % on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024. The fair value of this liability is determined utilizing the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8 % is used to present value the cash flows. The changes in the estimated fair value of liabilities for contingent consideration in 2019 and 2018 were largely attributable to increases in the liabilities recorded in connection with the termination of the Sanofi Pasteur MSD (SPMSD) joint venture in 2016. In 2018, these increases were partially offset by the reversal of a liability related to the discontinuation of a program obtained in connection with the acquisition of SmartCells (see Note 8). The payments of contingent consideration in both years relate to the SPMSD termination liabilities described above. The payments of contingent consideration in 2018 also include $ 175 million related to the achievement of a clinical development milestone for MK-7264 (gefapixant), a program obtained in connection with the acquisition of Afferent Pharmaceuticals. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2019 , was $ 28.8 billion compared with a carrying value of $ 26.3 billion and at December 31, 2018 , was $ 25.6 billion compared with a carrying value of $ 25.1 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States, Europe and China and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 35 % of total accounts receivable at December 31, 2019 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. The Company has accounts receivable factoring agreements with financial institutions in certain countries to sell accounts receivable. In 2019, the Company expanded its factoring arrangements in China and entered into factoring agreements to sell accounts receivable from the Companys major U.S. distributors. The Company factored $ 2.7 billion and $ 1.1 billion of accounts receivable in the fourth quarter of 2019 and 2018 , respectively, under these factoring arrangements, which reduced outstanding accounts receivable. The cash received from the financial institutions is reported within operating activities in the Consolidated Statement of Cash Flows. In certain of these factoring arrangements, for ease of administration, the Company will collect customer payments related to the factored receivables, which it then remits to the financial institutions. At December 31, 2019 , the Company had collected $ 256 million on behalf of the financial institutions, which is reflected as restricted cash in Other current assets and the related obligation to remit the cash within Accrued and other current liabilities . The Company remitted the cash to the financial institutions in January 2020. The net cash flows relating to these collections are reported as financing activities in the Consolidated Statement of Cash Flows. The costs of factoring such accounts receivable were de minimis . Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $ 34 million and $ 107 million at December 31, 2019 and 2018 , respectively. The obligation to return such collateral is recorded in Accrued and other current liabilities . No cash collateral was advanced by the Company to counterparties as of December 31, 2019 or 2018 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,772 $ 1,658 Raw materials and work in process 5,650 5,004 Supplies Total (approximates current cost) 7,629 6,856 (Decrease) increase to LIFO cost ( 171 ) $ 7,458 $ 6,857 Recognized as: Inventories $ 5,978 $ 5,440 Other assets 1,480 1,417 Inventories valued under the LIFO method comprised approximately $ 2.6 billion and $ 2.5 billion at December 31, 2019 and 2018 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2019 and 2018 , these amounts included $ 1.3 billion and $ 1.4 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $ 168 million and $ 7 million at December 31, 2019 and 2018 , respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2018 $ 16,066 $ 1,877 $ $ 18,284 Acquisitions Impairments ( 144 ) ( 144 ) Other (1) ( 24 ) Balance December 31, 2018 (2) 16,162 1,870 18,253 Acquisitions 1,322 1,341 Impairments ( 162 ) ( 162 ) Other (1) ( 7 ) ( 7 ) Balance December 31, 2019 (2) $ 16,181 $ 3,192 $ $ 19,425 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2019 and 2018 were $ 531 million and $ 369 million , respectively. The additions to goodwill within the Animal Health segment in 2019 primarily relate to the acquisition of Antelliq (see Note 3). The impairments of goodwill within other non-reportable segments in 2019 and 2018 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 45,947 $ 38,852 $ 7,095 $ 46,615 $ 37,585 $ 9,030 Licenses 3,185 2,361 2,081 1,673 IPRD 1,032 1,032 1,064 1,064 Trade names 2,899 2,682 Other 2,261 1,235 1,026 2,403 1,168 1,235 $ 55,324 $ 41,128 $ 14,196 $ 52,372 $ 39,268 $ 13,104 Acquired intangibles include products and product rights, licenses, trade names and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles, on a net basis, related to human health marketed products (included in products and product rights above) at December 31, 2019 include Zerbaxa , $ 2.4 billion ; Implanon/Nexplanon, $ 412 million ; Gardasil/Gardasil 9, $ 314 million ; Dificid , $ 312 million ; Bridion , $ 230 million ; Sivextro , $ 171 million ; and Simponi , $ 163 million . Additionally, the Company had $ 2.4 billion of acquired intangibles related to animal health marketed products at December 31, 2019 . Some of the Companys more significant intangible assets included in licenses above at December 31, 2019 include Lenvima, $ 956 million and Lynparza, $ 955 million as a result of collaborations with Eisai and AstraZeneca (see Note 4). The increase in trade names in 2019 reflects $ 2.7 billion of intangibles acquired in the Antelliq acquisition in 2019 (see Note 3). The Company has an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $ 883 million at December 31, 2019 reflected in Other in the table above. In 2019, the Company recorded impairment charges related to marketed products and other intangibles of $ 705 million within Cost of sales . Of this amount, $ 612 million related to Sivextro , a product for the treatment of acute bacterial skin and skin structure infections caused by designated susceptible Gram-positive organisms. As part of a reorganization and reprioritization of its internal sales force, the Company made the decision to cease promotion of Sivextro in the U.S. market by the end of 2019. This decision resulted in reduced ca sh flow projections for Sivextro , which indicated that the Sivextro intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Sivextro that, when compared with its related carrying value, resulted in the impairment charge noted above. In 2017, the Company recorded impairment charges related to marketed products and other intangibles of $ 58 million . Of this amount, $ 47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A were being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2019, the Company recorded $ 172 million of IPRD impairment charges within Research and development expenses. Of this amount, $ 155 million relates to the write-off of the intangible asset balance for programs obtained in connection with the acquisition of IOmet Pharma Ltd following a review of clinical trial results conducted by Merck, along with external clinical trial results for similar compounds. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $ 11 million . In 2018, the Company recorded $ 152 million of IPRD impairment charges. Of this amount, $ 139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $ 60 million (see Note 6). In 2017, the Company recorded $ 483 million of IPRD impairment charges. Of this amount, $ 240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The IPRD impairment charges in 2017 also include a charge of $ 226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense recorded within Cost of sales was $ 2.0 billion in 2019 , $ 3.1 billion in 2018 and $ 3.2 billion in 2017 . The estimated aggregate amortization expense for each of the next five years is as follows: 2020 , $ 1.6 billion ; 2021 , $ 1.5 billion ; 2022 , $ 1.5 billion ; 2023 , $ 1.5 billion ; 2024 , $ 1.4 billion . 9. Loans Payable, Long-Term Debt and Leases Loans Payable Loans payable at December 31, 2019 included $ 1.9 billion of notes due in 2020, $ 1.4 billion of commercial paper and $ 226 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2018 included $ 5.1 billion of commercial paper and $ 149 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 2.23 % and 2.09 % for the years ended December 31, 2019 and 2018 , respectively. Long-Term Debt Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,492 $ 2,490 3.70% notes due 2045 1,975 1,974 2.80% notes due 2023 1,747 1,745 3.40% notes due 2029 1,732 4.00% notes due 2049 1,468 2.35% notes due 2022 1,248 1,214 4.15% notes due 2043 1,238 1,237 3.875% notes due 2021 1,151 1,132 1.125% euro-denominated notes due 2021 1,113 1,134 1.875% euro-denominated notes due 2026 1,107 1,127 2.40% notes due 2022 1,010 3.90% notes due 2039 2.90% notes due 2024 6.50% notes due 2033 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 1.85% notes due 2020 1,231 Floating-rate notes due 2020 Other $ 22,736 $ 19,806 Other (as presented in the table above) includes $ 147 million and $ 223 million at December 31, 2019 and 2018 , respectively, of borrowings at variable rates that resulted in effective interest rates of 2.54 % and 2.27 % for 2019 and 2018 , respectively. With the exception of the 6.30 % debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In March 2019, the Company issued $ 5.0 billion principal amount of senior unsecured notes consisting of $ 750 million of 2.90 % notes due 2024, $ 1.75 billion of 3.40 % notes due 2029, $ 1.0 billion of 3.90 % notes due 2039, and $ 1.5 billion of 4.00 % notes due 2049. The Company used the net proceeds from the offering of $ 5.0 billion for general corporate purposes, including the repayment of outstanding commercial paper borrowings. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2019 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2020 , $ 1.9 billion ; 2021 , $ 2.3 billion ; 2022 , $ 2.3 billion ; 2023 , $ 1.7 billion ; 2024 , $ 1.3 billion . The Company has a $ 6.0 billion credit facility that matures in June 2024. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Leases As discussed in Note 1, on January 1, 2019, Merck adopted new guidance for the accounting and reporting of leases. The Company has operating leases primarily for manufacturing facilities, research and development facilities, corporate offices, employee housing, vehicles and certain equipment. As permitted under the transition guidance in ASC 842, the Company elected a package of practical expedients which, among other provisions, allowed the Company to carry forward historical lease classifications. The Company determines if an arrangement is a lease at inception. When evaluating contracts for embedded leases, the Company exercises judgment to determine if there is an explicit or implicit identified asset in the contract and if Merck controls the use of that asset. Embedded leases, primarily associated with contract manufacturing organizations, are immaterial. Under ASC 842 transition guidance, Merck elected the hindsight practical expedient to determine the lease term for existing leases, which permits companies to consider available information prior to the effective date of the new guidance as to the actual or likely exercise of options to extend or terminate the lease. The lease term includes options to extend or terminate the lease when it is reasonably certain that Merck will exercise that option. Real estate leases for facilities have an average remaining lease term of eight years , which include options to extend the leases for up to four years where applicable. Vehicle leases are generally in effect for four years . The Company has made an accounting policy election not to record short-term leases (leases with an initial term of 12 months or less) on the balance sheet; however, Merck currently has no short-term leases. Lease expense for operating lease payments is recognized on a straight-line basis over the term of the lease. Operating lease assets and liabilities are recognized based on the present value of lease payments over the lease term. Since the Companys leases do not have a readily determinable implicit discount rate, the Company uses its incremental borrowing rate to calculate the present value of lease payments by asset class. On a quarterly basis, an updated incremental borrowing rate is determined based on the average remaining lease term of each asset class and the Companys pretax cost of debt for that same term. The updated rates for each asset class are applied prospectively to new leases. As a practical expedient, the Company has made an accounting policy election for all asset classes not to separate lease components (e.g. payments for rent, real estate taxes and insurance costs) from non-lease components (e.g. common-area maintenance costs) in the event that the agreement contains both. Merck includes both the lease and non-lease components for purposes of calculating the right-of-use asset and related lease liability (if the non-lease components are fixed). For vehicle leases and employee housing, the Company applies a portfolio approach to effectively account for the operating lease assets and liabilities. Certain of the Companys lease agreements contain variable lease payments that are adjusted periodically for inflation or for actual operating expense true-ups compared with estimated amounts; however, these amounts are immaterial. Sublease income and activity related to sale and leaseback transactions are immaterial. Mercks lease agreements do not contain any material residual value guarantees or material restrictive covenants. Operating lease cost was $ 339 million in 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $ 281 million in 2019. Operating lease assets obtained in exchange for lease obligations was $ 129 million in 2019. Supplemental balance sheet information related to operating leases is as follows: December 31 Assets Other Assets (1) $ 1,073 Liabilities Accrued and other current liabilities Other Noncurrent Liabilities $ 1,004 Weighted-average remaining lease term (years) 7.4 Weighted-average discount rate 3.2 % (1) Includes prepaid leases that have no related lease liability. Maturities of operating leases liabilities are as follows: $ 2021 2022 2023 2024 Thereafter Total lease payments 1,131 Less: Imputed interest $ 1,004 At December 31, 2019 , the Company had entered into additional real estate operating leases that had not yet commenced. The obligations associated with these leases total $ 538 million , of which $ 221 million relates to a lease that will commence in April 2020 and has a lease term of 10 years . As of December 31, 2018, prior to the adoption of ASC 842, the minimum aggregate rental commitments under noncancellable leases were as follows: 2019, $ 188 million ; 2020, $ 198 million ; 2021, $ 150 million ; 2022, $ 134 million ; 2023, $ 84 million and thereafter, $ 243 million . 10. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial condition, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2019 , approximately 3,750 cases are pending against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . All federal cases involving allegations of Femur Fractures have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court in August 2017, seeking review of the Third Circuits decision. The Supreme Court granted Mercks petition in June 2018, and in May 2019, the Supreme Court issued its opinion and decided that the Third Circuit had incorrectly concluded that the issue of preemption should be resolved by a jury, and accordingly vacated the judgment of the Third Circuit and remanded the proceedings back to the Third Circuit to address the issue in a manner consistent with the Supreme Courts opinion. On November 15, 2019, the Third Circuit remanded the cases back to the District Court in order to allow that court to determine in the first instance whether the plaintiffs state law claims are preempted by federal law under the standards described by the Supreme Court in its opinion. On December 13, 2019, the District Court ordered Merck to serve its opening brief on or before February 21, 2020, and plaintiffs to file their responsive brief on or before April 22, 2020. Merck may then file a reply on or before May 22, 2020. Accordingly, as of December 31, 2019 , approximately 970 cases were actively pending in the Femur Fracture MDL. As of December 31, 2019 , approximately 2,510 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of cases to be reviewed through fact discovery, and Merck has continued to select additional cases to be reviewed. As of December 31, 2019 , approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is presently stayed in the Femur Fracture MDL and in the state court in California. Merck intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2019 , Merck is aware of approximately 1,380 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court-in separate opinions-granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery. In November 2018, the California state appellate court reversed and remanded on similar grounds. In March 2019, the parties in the MDL and the California coordinated proceeding agreed to coordinate and adopt a schedule for completing discovery on general causation and preemption issues and for renewing summary judgment and Daubert motions. Under the stipulated case management schedule, the hearings for Daubert and summary judgment motions are expected to take place in June 2020. As of December 31, 2019 , six product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck filed a petition for leave to appeal to the Illinois Supreme Court in February 2019. In April 2019, the Illinois Supreme Court stayed consideration of the pending petition to appeal until the U.S. Supreme Court issued its opinion in Merck Sharp Dohme Corp. v. Albrecht (relating to the Fosamax matter discussed above). Merck filed the opinion in Albrecht with the Illinois Supreme Court in June 2019. The petition for leave to appeal was decided on September 25, 2019, in which the Illinois Supreme Court directed the intermediate appellate court to reconsider its earlier ruling. The Illinois Appellate Court issued a favorable decision concluding, consistent with Albrecht , that preemption presents a legal question to be resolved by the court. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx As previously disclosed, Merck is a defendant in a lawsuit brought by the Attorney General of Utah alleging that Merck misrepresented the safety of Vioxx . The lawsuit is pending in Utah state court. Utah seeks damages and penalties under the Utah False Claims Act. A bench trial in this matter is currently scheduled for April 20, 2020. Governmental Proceedings As previously disclosed, in the fall of 2018, the Company received a records subpoena from the U.S. Attorneys Office for the District of Vermont (VT USAO) pursuant to Section 248 of the Health Insurance Portability and Accountability Act of 1996 (HIPAA) relating to an investigation of potential health care offenses. The subpoena sought information relating to any actual or potential business relationship or arrangement Merck has had with Practice Fusion, Inc. (PFI), a cloud-based, electronic health records (EHR) company that was acquired by Allscripts in January 2018. The Company cooperated with the government and responded to that subpoena. Subsequently, on May 21, 2019, Merck received a second records subpoena from the VT USAO that broadened the governments information request by seeking information relating to Mercks relationship with any EHR company. Shortly thereafter, the VT USAO served a Civil Investigation Demand (CID) upon Merck similarly seeking information on the Companys relationships with EHR vendors. The CID explains that the government is conducting a False Claims Act investigation concerning whether Merck and/or PFI submitted claims to federal healthcare programs that violate the Federal Anti-Kickback Statute. Merck is cooperating with the governments investigation. As previously disclosed, on April 15, 2019, Merck received a set of investigative interrogatories from the California Attorney Generals Office pursuant to its investigation of conduct and agreements that allegedly affected or delayed competition to Lantus in the insulin market. The interrogatories seek information concerning Mercks development of an insulin glargine product, and its subsequent termination, as well as Mercks patent litigation against Sanofi S.A. concerning Lantus and the resolution of that litigation. Merck is cooperating with the California Attorney Generals investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. In December 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. On August 9, 2019, the district court adopted in full the report and recommendation of the magistrate judge with respect to the Merck Defendants motions to dismiss on non-arbitration issues, thereby granting in part and denying in part Merck Defendants motions to dismiss. In addition, on June 27, 2019, the representatives of the putative direct purchaser class filed an amended complaint and, on August 1, 2019, retailer opt-out plaintiffs filed an amended complaint. The Merck Defendants moved to dismiss the new allegations in both complaints. On October 15, 2019, the magistrate judge issued a report and recommendation recommending that the district judge grant the motions in their entirety. On December 20, 2019, the district court adopted this report and recommendation in part. The district court granted the Merck Defendants motion to dismiss to the extent the motion sought dismissal of claims for overcharges paid by entities that purchased generic ezetimibe from Par Pharmaceutical, Inc. (Par Pharmaceutical) and dismissed any claims for such overcharges. Trial is currently scheduled to begin on October 28, 2020. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. On January 23, 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. On February 19, 2019, MSD appealed the courts order on arbitration to the Third Circuit. On October 28, 2019, the Third Circuit vacated the district courts order and remanded for limited discovery on the issue of arbitrability, after which MSD may file a renewed motion to compel arbitration. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In April 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals opted-in to this action; the opt-in period has closed. In August 2017, plaintiffs filed their motion to certify a Title VII pay discrimination class and also sought final collective action certification of plaintiffs Equal Pay Act claim. On October 1, 2018, the parties entered into an agreement to fully resolve the Smith sales force litigation. As part of the settlement and in exchange for a full and general release of all individual and class claims, the Company agreed to pay $ 8.5 million . On December 3, 2019, the court approved the settlement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is now complete, and the parties have filed and briefed cross-motions for summary judgment, which are currently pending before the Court. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. The litigation is ongoing in the United States with no trial date set, and also ongoing in numerous jurisdictions outside of the United States; the Company is defending those suits in each jurisdiction. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated New Drug Applications (NDAs) with the U.S. Food and Drug Administration (FDA) seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Januvia, Janumet, Janumet XR In February 2019, Par Pharmaceutical filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of a patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026, and a later granted patent owned by the Company covering the Janumet formulation which expires in 2028. Par Pharmaceutical dismissed its case in the U.S. District Court for the District of New Jersey against the Company and will litigate the action in the U.S. District Court for the District of Delaware. The Company filed a patent infringement lawsuit against Mylan Pharmaceuticals Inc. and Mylan Inc. (Mylan) in the Northern District of West Virginia. The Judicial Panel of Multidistrict Litigation entered an order transferring the Companys lawsuit against Mylan to the U.S. District Court for the District of Delaware for coordinated and consolidated pretrial proceedings with the other cases pending in that district. The U.S. District Court for the District of Delaware has scheduled the lawsuits for a single 3-day trial on invalidity issues in October 2021. The Court will schedule separate 1-day trials on infringement issues if necessary. In October 2019, Mylan filed a petition for Inter Partes Review (IPR) at the United States Patent and Trademark Office (USPTO) seeking invalidity of the 2026 patent. The USPTO has six months from filing to determine whether it will institute the requested IPR proceeding. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial condition, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2019 and 2018 of approximately $ 240 million and $ 245 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial condition, results of operations or liquidity of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $ 67 million and $ 71 million at December 31, 2019 and 2018 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $ 58 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial condition, results of operations or liquidity for any year. 11. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) ( 13 ) ( 17 ) ( 15 ) Balance December 31 3,577 1,038 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. On October 25, 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $ 5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $ 5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The payments to the Dealers were recorded as reductions to shareholders equity, consisting of a $ 4 billion increase in treasury stock, which reflected the value of the initial 56.7 million shares received on October 29, 2018, and a $ 1 billion decrease in other-paid-in capital, which reflected the value of the stock held back by the Dealers pending final settlement. Upon settlement of the ASR agreements in April 2019, Merck received an additional 7.7 million shares as determined by the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount, bringing the total shares received by Merck under this program to 64.4 million . 12. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2019 , 111 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards generally vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2019 , 2018 and 2017 was $ 417 million , $ 348 million and $ 312 million , respectively, with related income tax benefits of $ 57 million , $ 55 million and $ 57 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2019 , 2018 and 2017 was $ 80.05 , $ 58.15 and $ 63.88 per option, respectively. The weighted average fair value of options granted in 2019 , 2018 and 2017 was $ 10.63 , $ 8.26 and $ 7.04 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.2 % 3.4 % 3.6 % Risk-free interest rate 2.4 % 2.9 % 2.0 % Expected volatility 18.7 % 19.1 % 17.8 % Expected life (years) 5.9 6.1 6.1 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2019 23,807 $ 51.89 Granted 2,796 80.05 Exercised ( 8,119 ) 44.48 Forfeited ( 616 ) 45.48 Outstanding December 31, 2019 17,868 $ 59.88 6.48 $ Exercisable December 31, 2019 11,837 $ 55.40 5.45 $ Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2019 16,128 $ 58.85 2,039 $ 59.42 Granted 4,811 80.08 83.90 Vested ( 6,594 ) 55.70 ( 748 ) 57.87 Forfeited ( 818 ) 64.75 ( 82 ) 66.68 Nonvested December 31, 2019 13,527 $ 67.58 1,972 $ 69.18 At December 31, 2019 , there was $ 603 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 13. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets ( 817 ) ( 851 ) ( 862 ) ( 426 ) ( 431 ) ( 393 ) ( 72 ) ( 83 ) ( 78 ) Amortization of unrecognized prior service cost ( 49 ) ( 50 ) ( 53 ) ( 12 ) ( 13 ) ( 11 ) ( 78 ) ( 84 ) ( 98 ) Net loss amortization ( 10 ) Termination benefits Curtailments ( 4 ) ( 11 ) ( 8 ) ( 31 ) Settlements Net periodic benefit cost (credit) $ $ $ $ $ $ $ ( 49 ) $ ( 45 ) $ ( 60 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2019 , 2018 and 2017 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 14), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 9,648 $ 10,896 $ 8,580 $ 9,339 $ $ 1,114 Actual return on plan assets 2,165 ( 810 ) 1,505 ( 289 ) ( 72 ) Company contributions Effects of exchange rate changes ( 352 ) Benefits paid ( 582 ) ( 772 ) ( 230 ) ( 202 ) ( 104 ) ( 80 ) Settlements ( 44 ) ( 12 ) ( 106 ) Other Fair value of plan assets December 31 $ 11,361 $ 9,648 $ 10,163 $ 8,580 $ 1,102 $ Benefit obligation January 1 $ 10,620 $ 11,904 $ 9,083 $ 9,483 $ 1,615 $ 1,922 Service cost Interest cost Actuarial losses (gains) (1) 2,165 ( 1,258 ) 1,313 ( 154 ) ( 341 ) Benefits paid ( 582 ) ( 772 ) ( 230 ) ( 202 ) ( 104 ) ( 80 ) Effects of exchange rate changes ( 387 ) ( 6 ) Plan amendments ( 9 ) Curtailments ( 2 ) Termination benefits Settlements ( 44 ) ( 12 ) ( 106 ) Other Benefit obligation December 31 $ 13,003 $ 10,620 $ 10,612 $ 9,083 $ 1,673 $ 1,615 Funded status December 31 $ ( 1,642 ) $ ( 972 ) $ ( 449 ) $ ( 503 ) $ ( 571 ) $ ( 647 ) Recognized as: Other Assets $ $ $ $ $ $ Accrued and other current liabilities ( 92 ) ( 47 ) ( 18 ) ( 14 ) ( 10 ) ( 10 ) Other Noncurrent Liabilities ( 1,550 ) ( 925 ) ( 1,268 ) ( 1,148 ) ( 561 ) ( 637 ) (1) Actuarial losses (gains) primarily reflect changes in discount rates. At December 31, 2019 and 2018 , the accumulated benefit obligation was $ 22.8 billion and $ 19.0 billion , respectively, for all pension plans, of which $ 12.8 billion and $ 10.4 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 13,003 $ 10,620 $ 7,421 $ 6,251 Fair value of plan assets 11,361 9,648 6,135 5,089 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 12,009 $ 9,702 $ 2,476 $ 5,936 Fair value of plan assets 10,484 8,966 1,501 5,071 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2019 and 2018 , $ 860 million and $ 826 million , respectively, or approximately 4 % and 5 % , respectively, of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,542 3,747 3,021 3,190 Emerging markets equities Government and agency obligations Corporate obligations Equity securities Developed markets 2,451 2,451 2,172 2,172 Fixed income securities Government and agency obligations 2,094 2,094 1,509 1,509 Corporate obligations 1,582 1,582 1,246 1,246 Mortgage and asset-backed securities Other investments Plan assets at fair value $ 2,824 $ 3,854 $ $ 4,674 $ 11,361 $ 2,502 $ 3,017 $ $ 4,116 $ 9,648 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,761 4,403 3,071 3,607 Government and agency obligations 2,534 3,203 2,082 2,634 Emerging markets equities Corporate obligations Fixed income obligations Real estate Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (2) Other Plan assets at fair value $ 1,727 $ 7,052 $ $ $ 10,163 $ 1,497 $ 5,809 $ $ $ 8,580 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2019 and 2018 . (2) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 ( 8 ) ( 8 ) ( 3 ) ( 3 ) Relating to assets sold during the year Purchases and sales, net ( 4 ) ( 4 ) ( 3 ) ( 3 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 ( 32 ) ( 32 ) Purchases and sales, net ( 14 ) ( 1 ) ( 1 ) ( 16 ) ( 1 ) Transfers out of Level 3 ( 7 ) ( 7 ) Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Level 1 Level 2 Level 3 NAV (1) Total Level 1 Level 2 Level 3 NAV (1) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Corporate obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Plan assets at fair value $ $ $ $ $ 1,102 $ $ $ $ $ (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2019 and 2018 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30 % to 45 % in U.S. equities, 15 % to 30 % in international equities, 35 % to 45 % in fixed-income investments, and up to 5 % in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 10 % , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2020 are approximately $ 100 million for U.S. pension plans, approximately $ 150 million for international pension plans and approximately $ 15 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2021 2022 2023 2024 2025 2029 3,943 1,417 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ ( 816 ) $ ( 397 ) $ ( 19 ) $ ( 227 ) $ ( 505 ) $ $ $ $ Prior service (cost) credit arising during the period ( 4 ) ( 4 ) ( 13 ) ( 1 ) ( 10 ) ( 11 ) ( 31 ) $ ( 820 ) $ ( 401 ) $ ( 32 ) $ ( 228 ) $ ( 515 ) $ $ $ $ Net loss amortization included in benefit cost $ $ $ $ $ $ $ ( 10 ) $ $ Prior service credit amortization included in benefit cost ( 49 ) ( 50 ) ( 53 ) ( 12 ) ( 13 ) ( 11 ) ( 78 ) ( 84 ) ( 98 ) $ $ $ $ $ $ $ ( 88 ) $ ( 83 ) $ ( 97 ) Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 4.40 % 3.70 % 4.30 % 2.20 % 2.10 % 2.20 % Expected rate of return on plan assets 8.10 % 8.20 % 8.70 % 4.90 % 5.10 % 5.10 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.80 % 2.90 % 2.90 % Interest crediting rate 3.40 % 3.30 % 3.30 % 2.90 % 2.80 % 3.00 % Benefit obligation Discount rate 3.40 % 4.40 % 3.70 % 1.50 % 2.20 % 2.10 % Salary growth rate 4.20 % 4.30 % 4.30 % 2.80 % 2.80 % 2.90 % Interest crediting rate 4.90 % 3.40 % 3.30 % 2.80 % 2.90 % 2.80 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return for each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted-average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2020 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.00 % to 7.30 % , as compared to a range of 7.70 % to 8.10 % in 2019 . The decrease reflects lower expected asset returns and a modest shift in asset allocation. The change in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2017 to 2019 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 6.8 % 7.0 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2019 , 2018 and 2017 were $ 149 million , $ 136 million and $ 131 million , respectively. 14. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ ( 274 ) $ ( 343 ) $ ( 385 ) Interest expense Exchange losses (gains) ( 11 ) Income from investments in equity securities, net (1) ( 170 ) ( 324 ) ( 352 ) Net periodic defined benefit plan (credit) cost other than service cost ( 545 ) ( 512 ) ( 512 ) Other, net ( 140 ) $ $ ( 402 ) $ ( 500 ) (1) Includes net realized and unrealized gains and losses from investments in equity securities either owned directly or through ownership interests in investment funds. Other, net (as presented in the table above) in 2019 includes $ 162 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8). Other, net in 2018 includes a gain of $ 115 million related to the settlement of certain patent litigation, income of $ 99 million related to AstraZenecas option exercise in 2014 in connection with the termination of the Companys relationship with AstraZeneca LP (AZLP), and a gain of $ 85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $ 144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $ 41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Other, net in 2017 includes income of $ 232 million related to AstraZenecas option exercise and a $ 191 million loss on extinguishment of debt. Interest paid was $ 841 million in 2019 , $ 777 million in 2018 and $ 723 million in 2017 . 15. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 2,408 21.0 % $ 1,827 21.0 % $ 2,282 35.0 % Differential arising from: Foreign earnings ( 1,020 ) ( 8.9 ) ( 245 ) ( 2.8 ) ( 1,654 ) ( 25.4 ) GILTI and the foreign-derived intangible income deduction 2.9 ( 25 ) ( 0.3 ) Tax settlements ( 403 ) ( 3.5 ) ( 22 ) ( 0.3 ) ( 356 ) ( 5.5 ) RD tax credit ( 118 ) ( 1.0 ) ( 96 ) ( 1.1 ) ( 71 ) ( 1.1 ) State taxes ( 2 ) 2.3 1.2 Acquisition of Peloton 1.8 TCJA 1.0 3.3 2,625 40.3 Valuation allowances 1.0 3.1 9.7 Acquisition-related costs, including amortization 0.8 3.1 10.9 Restructuring 0.3 0.6 2.2 Other (1) ( 87 ) ( 0.7 ) ( 13 ) ( 0.1 ) ( 287 ) ( 4.4 ) $ 1,687 14.7 % $ 2,508 28.8 % $ 4,103 62.9 % (1) Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items. The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017. Among other provisions, the TCJA reduced the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, required companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and created new taxes on certain foreign sourced earnings. The Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA, which were since finalized as described below. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount in 2017 for its one-time transition tax liability of $ 5.3 billion . This provisional amount was reduced by the reversal of $ 2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. On the basis of revised calculations of post-1986 undistributed foreign EP and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $ 124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $ 5.5 billion . In 2019, the Company recorded additional charges of $ 117 million related to the finalization of treasury regulations associated with the TCJA. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years through 2025. The Companys remaining transition tax liability, which has been reduced by payments and the utilization of foreign tax credits, was $ 3.4 billion at December 31, 2019 , of which $ 390 million is included in Income taxes payable and the remainder of $ 3.0 billion is included in Other Noncurrent Liabilities . In 2017, the Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $ 779 million . On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $ 32 million related to deferred income taxes. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 21% in 2019 and 2018 and 35% in 2017. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate compared to the U.S. statutory rate. Income before taxes consisted of: Years Ended December 31 Domestic $ $ 3,717 $ 3,483 Foreign 11,025 4,984 3,038 $ 11,464 $ 8,701 $ 6,521 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ $ $ 5,585 Foreign 1,806 2,281 1,229 State ( 77 ) ( 90 ) 2,243 3,017 6,724 Deferred provision Federal ( 330 ) ( 402 ) ( 2,958 ) Foreign ( 240 ) ( 64 ) State ( 43 ) ( 556 ) ( 509 ) ( 2,621 ) $ 1,687 $ 2,508 $ 4,103 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 1,778 $ $ 1,640 Inventory related Accelerated depreciation Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other Subtotal 3,351 3,001 3,118 2,816 Valuation allowance ( 1,100 ) ( 1,348 ) Total deferred taxes $ 2,251 $ 3,001 $ 1,770 $ 2,816 Net deferred income taxes $ $ 1,046 Recognized as: Other Assets $ $ Deferred Income Taxes $ 1,470 $ 1,702 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2019 , $ 762 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $ 1.1 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $ 135 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2019 , 2018 and 2017 were $ 4.5 billion , $ 1.5 billion and $ 4.9 billion , respectively. Tax benefits relating to stock option exercises were $ 65 million in 2019 , $ 77 million in 2018 and $ 73 million in 2017 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 1,893 $ 1,723 $ 3,494 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) ( 454 ) ( 73 ) ( 1,038 ) Settlements (1) ( 356 ) ( 91 ) ( 1,388 ) Lapse of statute of limitations (2) ( 103 ) ( 29 ) ( 11 ) Balance December 31 $ 1,225 $ 1,893 $ 1,723 (1) Amounts reflect the settlements with the IRS as discussed below. (2) Amount in 2019 includes $ 78 million related to the divestiture of Mercks Consumer Care business in 2014. If the Company were to recognize the unrecognized tax benefits of $ 1.2 billion at December 31, 2019 , the income tax provision would reflect a favorable net impact of $ 1.1 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2019 could decrease by up to approximately $ 40 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Interest and penalties associated with uncertain tax positions amounted to a (benefit) expense of $( 101 ) million in 2019 , $ 51 million in 2018 and $ 183 million in 2017 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $ 243 million and $ 372 million as of December 31, 2019 and 2018 , respectively. In 2019, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2012-2014 U.S. federal income tax returns. As a result, the Company was required to make a payment of $ 107 million . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a $ 364 million net tax benefit in 2019. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for. In 2017, the IRS concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $ 2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $ 234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. The IRS is currently conducting examinations of the Companys tax returns for the years 2015 and 2016. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2019. 16. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 9,843 $ 6,220 $ 2,394 Average common shares outstanding 2,565 2,664 2,730 Common shares issuable (1) Average common shares outstanding assuming dilution 2,580 2,679 2,748 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 3.84 $ 2.34 $ 0.88 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 3.81 $ 2.32 $ 0.87 (1) Issuable primarily under share-based compensation plans. In 2019 , 2018 and 2017 , 2 million , 6 million and 5 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 17. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2017, net of taxes $ $ ( 3 ) $ ( 3,206 ) $ ( 2,355 ) $ ( 5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 561 ) Tax ( 35 ) ( 106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 354 ) Reclassification adjustments, pretax ( 141 ) (1) ( 291 ) (2) (3) ( 315 ) Tax ( 30 ) Reclassification adjustments, net of taxes ( 92 ) ( 235 ) ( 240 ) Other comprehensive income (loss), net of taxes ( 446 ) ( 58 ) Balance at December 31, 2017, net of taxes ( 108 ) ( 61 ) ( 2,787 ) ( 1,954 ) ( 4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 108 ) ( 728 ) ( 84 ) ( 692 ) Tax ( 55 ) ( 139 ) ( 24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 107 ) ( 559 ) ( 223 ) ( 716 ) Reclassification adjustments, pretax (1) (2) (3) Tax ( 33 ) ( 36 ) ( 69 ) Reclassification adjustments, net of taxes Other comprehensive income (loss), net of taxes ( 10 ) ( 425 ) ( 223 ) ( 361 ) Adoption of ASU 2018-02 ( 23 ) ( 344 ) ( 266 ) Adoption of ASU 2016-01 ( 8 ) ( 8 ) Balance at December 31, 2018, net of taxes ( 78 ) ( 3,556 ) (4) ( 2,077 ) ( 5,545 ) Other comprehensive income (loss) before reclassification adjustments, pretax ( 948 ) ( 610 ) Tax ( 15 ) ( 16 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes ( 756 ) ( 449 ) Reclassification adjustments, pretax ( 261 ) (1) ( 44 ) (2) (3) ( 239 ) Tax ( 15 ) Reclassification adjustments, net of taxes ( 206 ) ( 44 ) ( 199 ) Other comprehensive income (loss), net of taxes ( 135 ) ( 705 ) ( 648 ) Balance at December 31, 2019, net of taxes $ $ $ ( 4,261 ) (4) $ ( 1,981 ) $ ( 6,193 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . In 2017, these amounts included both investments in debt and equity securities; however, as a result of the adoption of ASU 2016-01 in 2018, these amounts relate only to investments in available-for-sale debt securities. (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 13). (4) Includes pension plan net loss of $ 5.1 billion and $ 4.4 billion at December 31, 2019 and 2018 , respectively, and other postretirement benefit plan net gain of $ 247 million and $ 170 million at December 31, 2019 and 2018 , respectively, as well as pension plan prior service credit of $ 263 million and $ 314 million at December 31, 2019 and 2018 , respectively, and other postretirement benefit plan prior service credit of $ 305 million and $ 375 million at December 31, 2019 and 2018 , respectively. 18. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. During 2019, as a result of changes to the Companys internal reporting structure, certain costs that were previously included in the Pharmaceutical segment are now being included as part of non-segment expenses within Merck Research Laboratories. Prior period Pharmaceutical segment profits have been recast to reflect these changes on a comparable basis. The Animal Health segment discovers, develops, manufactures and markets a wide range of veterinary pharmaceutical and vaccine products, as well as health management solutions and services, for the prevention, treatment and control of disease in all major livestock and companion animal species. The Company also offers an extensive suite of digitally connected identification, traceability and monitoring products. The Company sells its products to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company has recently sold certain businesses in the Healthcare Services segment and is in the process of divesting the remaining businesses. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 6,305 $ 4,779 $ 11,084 $ 4,150 $ 3,021 $ 7,171 $ 2,309 $ 1,500 $ 3,809 Alliance revenue - Lynparza (1) Alliance revenue - Lenvima (1) Emend Vaccines Gardasil/Gardasil 9 1,831 1,905 3,737 1,873 1,279 3,151 1,565 2,308 ProQuad/M-M-R II/Varivax 1,683 2,275 1,430 1,798 1,374 1,676 Pneumovax 23 RotaTeq Vaqta Hospital Acute Care Bridion 1,131 Noxafil Primaxin Invanz Cubicin Cancidas Immunology Simponi Remicade Neuroscience Belsomra Virology Isentress/Isentress HD 1,140 1,204 Zepatier 1,660 Cardiovascular Zetia 1,344 Vytorin Atozet Adempas Diabetes Januvia 1,724 1,758 3,482 1,969 1,718 3,686 2,153 1,584 3,737 Janumet 1,452 2,041 1,417 2,228 1,296 2,158 Womens Health NuvaRing Implanon/Nexplanon Diversified Brands Singulair Cozaar/Hyzaar Nasonex Arcoxia Follistim AQ Other pharmaceutical (2) 1,563 3,343 4,901 1,319 3,380 4,705 1,759 3,556 5,314 Total Pharmaceutical segment sales 18,759 22,992 41,751 16,608 21,081 37,689 15,854 19,536 35,390 Animal Health: Livestock 2,201 2,784 2,102 2,630 2,013 2,484 Companion Animals 1,609 1,582 1,391 Total Animal Health segment sales 1,306 3,086 4,393 1,238 2,974 4,212 1,090 2,785 3,875 Other segment sales (3) Total segment sales 20,239 26,079 46,319 18,094 24,057 42,151 17,340 22,322 39,662 Other (4) $ 20,325 $ 26,515 $ 46,840 $ 18,212 $ 24,083 $ 42,294 $ 17,424 $ 22,698 $ 40,122 U.S. plus international may not equal total due to rounding. (1) Alliance revenue represents Mercks share of profits, which are product sales net of cost of sales and commercialization costs (see Note 4). (2) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (3) Represents the non-reportable segments of Healthcare Services and Alliances. (4) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2019 , 2018 and 2017 also includes approximately $ 80 million , $ 95 million and $ 85 million , respectively, related to the sale of the marketing rights to certain products. Consolidated sales by geographic area where derived are as follows: Years Ended December 31 United States $ 20,325 $ 18,212 $ 17,424 Europe, Middle East and Africa 12,707 12,213 11,478 Japan 3,583 3,212 3,122 China 3,207 2,184 1,586 Asia Pacific (other than Japan and China) 2,943 2,909 2,751 Latin America 2,469 2,415 2,339 Other 1,606 1,149 1,422 $ 46,840 $ 42,294 $ 40,122 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 28,324 $ 24,871 $ 23,018 Animal Health segment 1,609 1,659 1,552 Other segments ( 7 ) Total segment profits 29,926 26,633 24,845 Other profits Unallocated: Interest income Interest expense ( 893 ) ( 772 ) ( 754 ) Depreciation and amortization ( 1,573 ) ( 1,334 ) ( 1,378 ) Research and development ( 9,499 ) ( 9,432 ) ( 10,004 ) Amortization of purchase accounting adjustments ( 1,419 ) ( 2,664 ) ( 3,056 ) Restructuring costs ( 638 ) ( 632 ) ( 776 ) Charge related to the termination of a collaboration with Samsung ( 423 ) Loss on extinguishment of debt ( 191 ) Other unallocated, net ( 5,077 ) ( 3,024 ) ( 2,576 ) Income Before Taxes $ 11,464 $ 8,701 $ 6,521 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2019 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2017 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Property, plant and equipment, net, by geographic area where located is as follows: December 31 United States $ 8,974 $ 8,306 $ 8,070 Europe, Middle East and Africa 4,767 3,706 3,151 Asia Pacific (other than Japan and China) Latin America China Japan Other $ 15,053 $ 13,291 $ 12,439 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheet of Merck Co., Inc. and its subsidiaries (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Customer Discount Accruals in the U.S. - Medicaid, Managed Care and Medicare Part D Rebates As described in Note 2 to the consolidated financial statements, the Company records certain variable consideration including discounts, which are estimated at the time of sale generally using the expected value method. Amounts accrued for aggregate customer discounts as of December 31, 2019 in the U.S. are $2.4 billion and are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. Certain of these discounts take the form of rebates, which are amounts owed based upon definitive contractual agreements or legal requirements with private sector (Managed Care) and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. Management uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. The principal considerations for our determination that performing procedures relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates is a critical audit matter are that there was significant judgment required by management with significant measurement uncertainty, as the calculation of the rebate accruals includes assumptions related to price and customer segment utilization, pertaining to forecasted customer claims that may not be fully paid until a subsequent period. This in turn led to a high degree of auditor judgment, subjectivity and effort in applying the procedures related to those assumptions. Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to customer discount accruals in the U.S. - Medicaid, Managed Care, and Medicare Part D rebates, including managements controls over the assumptions used to estimate the corresponding rebate accruals. These procedures also included, among others, developing an independent estimate of the rebate accruals by utilizing third party data on customer segment utilization, changes to price, the terms of the specific rebate programs, and the historical trend of actual rebate claims paid. The independent estimate was compared to the rebate accruals recorded by management to evaluate the reasonableness of the estimate. Additionally, these procedures included testing actual rebate claims paid and evaluating the contractual terms of the Companys rebate agreements. PricewaterhouseCoopers LLP Florham Park, New Jersey February 26, 2020 We have served as the Companys auditor since 2002. (b) Supplementary Data Selected quarterly financial data for 2019 and 2018 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q 3rd Q (1) 2nd Q 1st Q (2) 2019 (3) Sales $ 11,868 $ 12,397 $ 11,760 $ 10,816 Cost of sales 3,669 3,990 3,401 3,052 Selling, general and administrative 2,888 2,589 2,712 2,425 Research and development 2,548 3,204 2,189 1,931 Restructuring costs Other (income) expense, net (223 ) Income before taxes 2,792 2,347 3,259 3,067 Net income attributable to Merck Co., Inc. 2,357 1,901 2,670 2,915 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.93 $ 0.74 $ 1.04 $ 1.13 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.92 $ 0.74 $ 1.03 $ 1.12 2018 (3) Sales $ 10,998 $ 10,794 $ 10,465 $ 10,037 Cost of sales 3,289 3,619 3,417 3,184 Selling, general and administrative 2,643 2,443 2,508 2,508 Research and development 2,214 2,068 2,274 3,196 Restructuring costs Other (income) expense, net (172 ) (48 ) (291 ) Income before taxes 2,604 2,665 2,086 1,345 Net income attributable to Merck Co., Inc. 1,827 1,950 1,707 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.70 $ 0.73 $ 0.64 $ 0.27 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.69 $ 0.73 $ 0.63 $ 0.27 (1) Amounts for 2019 include a charge related to the acquisition of Peloton Therapeutics, Inc. (see Note 3). (2) Amounts for 2018 include a charge related to the formation of a collaboration with Eisai (see Note 4). (3) Amounts for 2019 and 2018 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2019 , there have been no changes in internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2019 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2019 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2019 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +3,mrk1,1201810k," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes results from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018. The Company was incorporated in New Jersey in 1970. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as sales of animal health products, were as follows: ($ in millions) Total Sales $ 42,294 $ 40,122 $ 39,807 Pharmaceutical 37,689 35,390 35,151 Keytruda 7,171 3,809 1,402 Januvia/Janumet 5,914 5,896 6,109 Gardasil/Gardasil 9 3,151 2,308 2,173 ProQuad/M-M-R II /Varivax 1,798 1,676 1,640 Zetia/Vytorin 1,355 2,095 3,701 Isentress/Isentress HD 1,140 1,204 1,387 Bridion Pneumovax 23 NuvaRing Simponi Animal Health 4,212 3,875 3,478 Livestock 2,630 2,484 2,287 Companion Animals 1,582 1,391 1,191 Other Revenues (1) 1,178 (1) Other revenues are primarily comprised of Healthcare Services segment revenue, third-party manufacturing sales, and miscellaneous corporate revenues, including revenue hedging activities. Pharmaceutical The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. Certain of the products within the Companys franchises are as follows: Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with non-small-cell lung cancer (NSCLC), melanoma, classical Hodgkin Lymphoma (cHL), urothelial carcinoma, head and neck squamous cell carcinoma (HNSCC), gastric or gastroesophageal junction adenocarcinoma, and microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, and in combination with chemotherapy in certain patients with NSCLC. Keytruda is also used in the United States for monotherapy treatment of certain patients with cervical cancer, primary mediastinal large B-cell lymphoma (PMBCL), hepatocellular carcinoma, and Merkel cell carcinoma, and in combination with chemotherapy for patients with squamous NSCLC; Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting; and Temodar (temozolomide) (marketed as Temodal outside the United States), a treatment for certain types of brain tumors. In addition, the Company recognizes alliance revenue related to sales of Lynparza (olaparib), an oral poly (ADP-ribose) polymerase (PARP) inhibitor, for certain types of ovarian and breast cancer; and Lenvima (lenvatinib) for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV) ; ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Zostavax (Zoster Vaccine Live), a vaccine to help prevent shingles (herpes zoster). Hospital Acute Care Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Invanz (ertapenem sodium) for the treatment of certain infections; Cubicin ( daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; Cancidas (caspofungin acetate), an anti-fungal product; Primaxin (imipenem and cilastatin sodium), an anti-bacterial product; and Zerbaxa ( ceftolozane and tazobactam ) is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. Immunology Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases; and Remicade (infliximab), a treatment for inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Neuroscience Belsomra (suvorexant), an orexin receptor antagonist indicated for the treatment of insomnia, characterized by difficulties with sleep onset and/or sleep maintenance. Virology Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection; and Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. Cardiovascular Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); Atozet (ezetimibe and atorvastatin) (marketed in certain countries outside of the United States) and Rosuzet (ezetimibe and rosuvastatin) (marketed in certain countries outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. Womens Health NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product; and Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant. Animal Health The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species. Principal products in this segment include: Livestock Products Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine; Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines; Exzolt , a systemic treatment for poultry red mite infestations; Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; and Aquaflor (Florfenicol) antibiotic for farm-raised fish. Companion Animal Products Bravecto (fluralaner), a line of oral and topical products that kills fleas and ticks in dogs and cats for up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2018 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2018. Product Date Approval Keytruda December 2018 The Japanese Ministry of Health, Labor and Welfare (JMHLW) approved Keytruda for three expanded uses in unresectable, advanced or recurrent NSCLC, one in malignant melanoma, as well as a new indication in high microsatellite instability solid tumors. December 2018 The U.S. Food and Drug Administration (FDA) approved Keytruda for the treatment of adult and pediatric patients with recurrent locally advanced or metastatic Merkel cell carcinoma. December 2018 The European Commission (EC) approved Keytruda for the adjuvant treatment of adults with stage III melanoma and lymph node involvement who have undergone complete resection. November 2018 FDA approved Keytruda for the treatment of patients with hepatocellular carcinoma who have been previously treated with sorafenib. October 2018 FDA approved Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of patients with metastatic squamous non-small cell lung cancer (NSCLC). September 2018 EC approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC in adults whose tumors have no EGFR or ALK positive mutations. September 2018 EC approved Keytruda for the treatment of recurrent or metastatic head and neck squamous cell carcinoma (HNSCC) in adults whose tumors express PD-L1 with a 50% TPS and progressing on or after platinum-containing chemotherapy. August 2018 FDA approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC patients with no EGFR or ALK genomic tumor aberrations. July 2018 The China National Drug Administration (CNDA) approved Keytruda for the treatment of adult patients with unresectable or metastatic melanoma following failure of one prior line of therapy. June 2018 FDA approved Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal large B-cell lymphoma (PMBCL), or who have relapsed after two or more prior lines of therapy. June 2018 FDA approved Keytruda for the treatment of patients with recurrent or metastatic cervical cancer with disease progression on or after chemotherapy whose tumors express PD-L1 as determined by an FDA-approved test. Lynparza (1) December 2018 FDA approved Lynparza for use as maintenance treatment of certain patients with advanced ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy. July 2018 JMHLW approved Lynparza for use in patients with unresectable or recurrent BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative breast cancer who have received prior chemotherapy. May 2018 EC approved Lynparza for use as a maintenance therapy in patients with platinum-sensitive relapsed high grade epithelial ovarian, fallopian tube, or primary peritoneal cancer, who are in response (complete or partial) to platinum based chemotherapy regardless of BRCA mutation status. January 2018 FDA approved Lynparza for use in patients with BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy. January 2018 JMHLW approved Lynparza for use as a maintenance therapy in patients with platinum-sensitive relapsed ovarian cancer, regardless of BRCA mutation status. Lenvima (2) September 2018 CNDA approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. August 2018 FDA approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. August 2018 EC approved Lenvima for the treatment of certain patients with hepatocellular carcinoma. March 2018 JMHLW approved Lenvima for the treatment of certain patients with unresectable hepatocellular carcinoma. Gardasil 9 October 2018 FDA approved Gardasil 9 for an expanded age indication for use in women and men ages 27 to 45 for the prevention of certain cancers and diseases caused by the nine HPV types covered by the vaccine. April 2018 CNDA approved Gardasil 9 for use in girls and women ages 16 to 26. Delstrigo November 2018 EC approved Delstrigo (doravirine, lamivudine, and tenofovir disoproxil fumarate) for the treatment of adults infected with human immunodeficiency virus (HIV-1) without past or present evidence of resistance to the non-nucleoside reverse transcriptase inhibitor (NNRTI) class, lamivudine, or tenofovir. August 2018 FDA approved Delstrigo for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Pifeltro November 2018 EC approved Pifeltro (doravirine), in combination with other antiretroviral medicinal products, for the treatment of adults infected with HIV-1 without past or present evidence of resistance to the NNRTI class. August 2018 FDA approved Pifeltro for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Isentress March 2018 EC approved Isentress for an extension to the existing indication to cover treatment of neonates. Isentress is now indicated in combination with other anti-retroviral medicinal products for the treatment of HIV-1 infection. Prevymis January 2018 EC approved Prevymis (letermovir) for the prophylaxis of cytomegalovirus (CMV) reactivation and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. Steglatro, Steglujan and Segluromet (3) March 2018 EC approved Steglatro (ertugliflozin), Steglujan (ertugliflozin and sitagliptin) and Segluromet (ertugliflozin and metformin hydrochloride) for the treatment of adults aged 18 years and older with type 2 diabetes mellitus as an adjunct to diet and exercise to improve glycaemic control (as monotherapy in patients for whom the use of metformin is considered inappropriate due to intolerance or contraindications, and in addition to other medicinal products for the treatment of diabetes). Vaxelis December 2018 FDA approved Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis Adsorbed, Inactivated Poliovirus, Haemophilus b Conjugate [Meningococcal Protein Conjugate] and Hepatitis B [Recombinant] Vaccine) for use in children from 6 weeks through 4 years of age (prior to the 5th birthday) (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza. (2) In March 2018, Merck and Eisai Co., Ltd. announced a strategic collaboration for the worldwide co-development and co-commercialization of Eisais Lenvima. (3) In 2013, Merck and Pfizer Inc. announced that they entered into a worldwide collaboration, except Japan, for the co-development and co-promotion of ertugliflozin. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well-positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). Approximately $365 million, $385 million and $415 million was recorded by Merck as a reduction to revenue in 2018, 2017 and 2016, respectively, related to the donut hole provision. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and will decrease to $2.8 billion in 2019 and is currently planned to remain at that amount thereafter. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $124 million, $210 million and $193 million of costs within Selling, general and administrative expenses in 2018, 2017 and 2016, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate, and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. A number of states have passed pharmaceutical price and cost transparency laws. These laws typically require manufacturers to report certain product price information or other financial data to the state. In the case of a California law, manufacturers also are required to provide advance notification of price increases. The Company expects that states will continue their focus on pharmaceutical price transparency and that this focus will continue to exert pressure on product pricing. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which occurred in 2018. Furthermore, the government can order repricings for classes of drugs if it determines that it is appropriate under applicable rules. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA), which require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. The Companys focus on emerging markets has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2019 to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, changes in trade sanctions and embargoes, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well-positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The FDA has also undertaken efforts to bring generic competition to market more efficiently and in a more timely manner. The European Union (EU) has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys current in-line products, and the absence of trade impediments or adverse pricing controls. In recent years, the Chinese government has introduced and implemented a number of structural reforms to accelerate the shift to innovative products and reduce costs. Since 2017, there have been multiple new policies introduced by the government to improve access to new innovation, reduce the complexity of regulatory filings, and accelerate the review and approval process. This has led to a significant expansion of the new products being approved each year. Additionally, in 2017, the government updated the National Reimbursement Drug List for the first time in eight years. While the mechanism for drugs being added to the list evolves, it is likely that in the future, inclusion will require a price negotiation which could impact the outlook in the market for selected brands. While pricing pressure has always existed in China, health care reform has led to the acceleration of generic substitution, through a pilot tendering process for mature products that have generic substitutes with a Generic Quality Consistency Evaluation approval. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, the Company has many far-reaching philanthropic programs. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicine and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including the new EU General Data Protection Regulation, which went into effect on May 25, 2018 and imposes penalties up to 4% of global revenue. Additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increases enforcement and litigation activity in the United States and other developed markets, and increases regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. Privacy Shield Program, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent rights. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU and Japan (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) (3) Emend Expired 2019 Emend for Injection 2020 (2) Noxafil 2019 N/A Vaxelis (4) 2020 (method of making) 2021 (5) (SPCs) Not Marketed Januvia 2022 (2) 2022 (2) 2025-2026 Janumet 2022 (2) N/A Janumet XR 2022 (2) N/A N/A Isentress 2022 (2) Simponi N/A (6) 2025 (7) N/A (6) Lenvima (8) 2025 (2) (with pending PTE) 2021 (patents), 2026 (2) (SPCs) Adempas (9) 2026 (2) 2028 (2) 2027-2028 Bridion 2026 (2) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) Gardasil 2021 (2) Expired Gardasil 9 2025 (patents) , 2030 (2) (SPCs) N/A Keytruda 2028 (patents), 2030 (2) (SPCs) Lynparza (10) 2028 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2028-2029 (with pending PTE) Zerbaxa 2028 (2) (with pending PTE) 2023 (patents), 2028 (2) (SPCs) N/A Sivextro 2028 (2) 2024 (patents), 2029 (2) (SPCs) 2029 (with pending PTE) Belsomra 2029 (2) N/A Prevymis 2029 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2029 (with pending PTE) Steglatro (11) 2031 (2) (with pending PTE) 2029 (patents), 2034 (2) (SPCs) N/A Steglujan (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Segluromet (11) 2031 (with pending PTE) 2029 (patents), 2034 (SPCs) N/A Delstrigo 2032 (with pending PTE) 2031 (12) N/A Pifeltro 2032 (with pending PTE) 2031 (12) N/A N/A: Currently no marketing approval. Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If SPC applications have been filed but have not been granted in all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) Eligible for 6 months Pediatric Exclusivity. (3) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (4) Being commercialized in a U.S.-based joint partnership with Sanofi Pasteur. (5) SPCs are granted in four Major EU Markets and pending in one, based on a patent that expired in 2016. (6) The Company has no marketing rights in the U.S. and Japan. (7) Includes Pediatric Exclusivity, which is granted in four Major EU Markets and pending in one. (8) Being developed and commercialized in a global strategic oncology collaboration with Eisai. (9) Being commercialized in a worldwide collaboration with Bayer AG. (10) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (11) Being developed and promoted in a worldwide, except Japan, collaboration with Pfizer. (12) SPC applications to be filed by May 2019. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. The Company has the following key U.S. patent protection for drug candidates under review in the United States by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review (in the U.S.) Currently Anticipated Year of Expiration (in the U.S.) V920 (ebola vaccine) MK-7655A (relebactam + imipenem/cilastatin) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) MK-1242 (vericiguat) (1) MK-7264 (gefapixant) V114 (pneumoconjugate vaccine) (1) Being developed in a worldwide clinical development collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent is subject to any future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2018 on patent and know-how licenses and other rights amounted to $135 million. Merck also incurred royalty expenses amounting to $1.3 billion in 2018 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2018, approximately 14,500 people were employed in the Companys research activities. The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on preclinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Preclinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Pharmaceuticals and Medical Devices Agency in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and China Food and Drug Administration. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma. This supplemental BLA is based on findings from the Phase 3 KEYNOTE-426 trial, which demonstrated that Keytruda in combination with axitinib, as compared to sunitinib, significantly improved overall survival (OS) and progression-free survival (PFS) in the first-line treatment of advanced renal cell carcinoma. These data were presented at the American Society for Clinical Oncology (ASCO) Genitourinary Cancers Symposium in February 2019. The supplemental BLA also included supporting data from the Phase 1b KEYNOTE-035 trial. The FDA set a PDUFA date of June 20, 2019. Merck has filed data from KEYNOTE-426 with regulatory authorities worldwide. In February 2019, the Committee for Medicinal Products for Human Use of the EMA adopted a positive opinion recommending Keytruda, in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of metastatic squamous NSCLC in adults. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-407 trial, which enrolled patients regardless of PD-L1 tumor expression status. The trial showed a significant improvement in OS and PFS for patients taking Keytruda in combination with chemotherapy (carboplatin and either paclitaxel or nab-paclitaxel) compared with chemotherapy alone. If approved, this would mark the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy for adults with metastatic squamous NSCLC. In October 2018, the FDA approved Keytruda in combination with carboplatin-paclitaxel or nab-paclitaxel as a first-line treatment for metastatic squamous NSCLC, regardless of PD-L1 expression. In December 2018, the FDA extended the action date for the supplemental BLA seeking approval for Keytruda as monotherapy for the first-line treatment of locally advanced or metastatic NSCLC in patients whose tumors express PD-L1 (TPS 1%) without EGFR or ALK genomic tumor aberrations. The supplemental BLA is based on results of the Phase 3 KEYNOTE-042 trial where Keytruda monotherapy demonstrated a significant improvement in OS compared with chemotherapy in this patient population. The Company submitted additional data and analyses to the FDA, which constituted a major amendment and extended the PDUFA date by three months to April 11, 2019. Merck continues to work closely with the FDA during the review of this supplemental BLA. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda as monotherapy for the treatment of patients with advanced small-cell lung cancer (SCLC) whose disease has progressed after two or more lines of prior therapy. This supplemental BLA, which is seeking accelerated approval for this new indication, is based on data from the SCLC cohorts of the Phase 2 KEYNOTE-158 and Phase 1b KEYNOTE-028 trials. The FDA set a PDUFA date of June 17, 2019. Keytruda is also being studied in combination with chemotherapy in the ongoing Phase 3 KEYNOTE-604 study in patients with newly diagnosed extensive stage SCLC. In February 2019, the FDA accepted a supplemental BLA for Keytruda as monotherapy or in combination with platinum and 5-fluorouracil chemotherapy for the first-line treatment of patients with recurrent or metastatic HNSCC. This supplemental BLA is based in part on data from the pivotal Phase 3 KEYNOTE-048 trial where Keytruda demonstrated a significant improvement in OS compared with the standard of care, as monotherapy in patients whose tumors expressed PD-L1 with Combined Positive Score (CPS)20 and CPS1 and in combination with chemotherapy in the total patient population. These data were presented at the European Society for Medical Oncology (ESMO) 2018 Congress. The FDA granted Priority Review to the supplemental BLA and set a PDUFA date of June 10, 2019. KEYNOTE-048 also serves as the confirmatory trial for KEYNOTE-012, a Phase 1b study which supported the previous accelerated approval for Keytruda as monotherapy for the treatment of patients with recurrent or metastatic HNSCC with disease progression on or after platinum-containing chemotherapy. In November 2018, Merck announced that the Phase 3 KEYNOTE-181 trial investigating Keytruda as monotherapy in the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma met a primary endpoint of OS in patients whose tumors expressed PD-L1 (CPS 10). In this pivotal study, treatment with Keytruda resulted in a statistically significant improvement in OS compared to chemotherapy (paclitaxel, docetaxel or irinotecan) in patients with CPS 10, regardless of histology. The primary endpoint of OS was also evaluated in patients with squamous cell histology and in the entire intention-to-treat study population. While directionally favorable, statistical significance for OS was not met in these two patient groups. Per the statistical analysis plan, the key secondary endpoints of PFS and objective response rate (ORR) were not formally tested, as OS was not reached in the full intention-to-treat study population. These results were presented in January 2019 at the ASCO Gastrointestinal Cancers Symposium and have been submitted for regulatory review. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In October 2018, Merck announced the first presentation of results from an interim analysis of KEYNOTE-057, a Phase 2 trial evaluating Keytruda for previously treated patients with high-risk non-muscle invasive bladder cancer. An interim analysis of the studys primary endpoint showed a complete response rate of nearly 40% at three months with Keytruda in patients whose disease was unresponsive to Bacillus Calmette-Gurin therapy, the current standard of care for this disease, and who were ineligible for or who refused to undergo radical cystectomy. These results, as well as other study findings, were presented at the ESMO 2018 Congress. In February 2019, Merck announced that the pivotal Phase 3 KEYNOTE-240 trial evaluating Keytruda , plus best supportive care, for the treatment of patients with advanced hepatocellular carcinoma who were previously treated with systemic therapy, did not meet its co-primary endpoints of OS and PFS compared with placebo plus best supportive care. In the final analysis of the study, there was an improvement in OS for patients treated with Keytruda compared to placebo, however these OS results did not meet statistical significance per the pre-specified statistical plan. Results for PFS were also directionally favorable in the Keytruda arm compared with placebo but did not reach statistical significance. The key secondary endpoint of ORR was not formally tested, since superiority was not reached for OS or PFS. Results will be presented at an upcoming medical meeting and have been shared with the FDA for discussion. The Keytruda clinical development program consists of more than 900 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, cervical, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Lynparza, is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. In April 2018, Merck and AstraZeneca announced that the EMA validated for review the MAA for Lynparza for use in patients with deleterious or suspected deleterious BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. This was the first regulatory submission for a PARP inhibitor in breast cancer in Europe. Lynparza tablets are also under review in the EU as a maintenance treatment in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response following first-line standard platinum-based chemotherapy. This submission was based on positive results from the pivotal Phase 3 SOLO-1 trial. The trial showed a statistically-significant and clinically-meaningful improvement in PFS for Lynparza compared to placebo, reducing the risk of disease progression or death by 70% in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response to platinum-based chemotherapy. In December 2018, Merck and AstraZeneca announced positive results from the randomized, open-label, controlled, Phase 3 SOLO-3 trial of Lynparza tablets in patients with relapsed ovarian cancer after two or more lines of treatment. The trial was conducted as a post-approval commitment in agreement with the FDA. Results from the trial showed BRCA -mutated advanced ovarian cancer patients treated with Lynparza following two or more prior lines of chemotherapy demonstrated a statistically significant and clinically meaningful improvement in the primary endpoint of ORR and the key secondary endpoint of PFS compared to chemotherapy. Merck and AstraZeneca plan to discuss these results with the FDA. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). In February 2019, Merck announced that the FDA accepted for Priority Review an NDA for MK-7655A for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. The PDUFA date is July 16, 2019. In April 2018, Merck announced that a pivotal Phase 3 study of MK-7655A demonstrated a favorable overall response in the treatment of certain imipenem-non-susceptible bacterial infections, the primary endpoint, with lower treatment-emergent nephrotoxicity (kidney toxicity), a secondary endpoint, compared to a colistin (colistimethate sodium) plus imipenem/cilastatin regimen. The FDA had previously designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital- acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. V920 (rVSVG-ZEBOV-GP, live attenuated), is an investigational Ebola Zaire disease vaccine candidate being studied in large scale Phase 2/3 clinical trials. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The WHO decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In November 2018, Merck announced that it has started the submission of a rolling BLA to the FDA for V920. This rolling submission was made pursuant to the FDAs Breakthrough Therapy designation. Merck expects the rolling submission of the BLA to be completed in 2019. The Company also intends to file V920 with the EMA in 2019. In February 2019, Merck announced that the FDA accepted for Priority Review a supplemental NDA for Zerbaxa to treat adult patients with nosocomial pneumonia, including ventilator-associated pneumonia, caused by certain susceptible Gram-negative microorganisms. The PDUFA date is June 3, 2019. Zerbaxa is also under review for this indication by the EMA. Zerbaxa is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor agonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. Lenvima, is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. In March 2018, Merck and Eisai entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Per the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination to support 11 potential indications in six types of cancer (endometrial cancer, NSCLC, hepatocellular carcinoma, head and neck cancer, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma and for the potential treatment of certain patients with advanced and/or metastatic non-microsatellite instability high/proficient mismatch repair endometrial carcinoma. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure with reduced ejection fracture (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fracture (Phase 2 clinical trial). The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer. V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently five Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, three studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. In January 2019, Merck announced that V114 received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age. As a result of changes in the herpes zoster vaccine environment, Merck is ending development of V212, its investigational vaccine for the prevention of shingles in immunocompromised patients. The chart below reflects the Companys research pipeline as of February 22, 2019. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to cancer and certain other indications) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 Entry Date) Under Review Cancer Cancer New Molecular Entities/Vaccines MK-3475 Keytruda MK-3475 Keytruda Bacterial Infection Advanced Solid Tumors Breast (October 2015) MK-7655A relebactam+imipenem/cilastatin Cutaneous Squamous Cell Carcinoma Cervical (October 2018) (EU) (U.S.) Prostate Colorectal (November 2015) Ebola Vaccine MK-7902 Lenvima (1) Esophageal (December 2015) V920 (4) (U.S.) Biliary Tract Gastric (May 2015) (EU) Non-Small-Cell Lung Hepatocellular (May 2016) (EU) Certain Supplemental Filings V937 Cavatak Mesothelioma (May 2018) Cancer Melanoma Nasopharyngeal (April 2016) MK-3475 Keytruda MK-7690 Ovarian (December 2018) First-Line Advanced Renal Cell Carcinoma Colorectal (2) Renal (October 2016) (EU) (KEYNOTE-426) (U.S.) MK-7339 Lynparza (1) Small-Cell Lung (May 2017) (EU) First-Line Metastatic Squamous Non-Small- Advanced Solid Tumors MK-7902 Lenvima (1,2) Cell Lung Cancer (KEYNOTE-407) (EU) Cytomegalovirus Vaccine Endometrial (June 2018) First-Line Metastatic Non-Small-Cell Lung V160 MK-7339 Lynparza (1) Cancer (KEYNOTE-042) (U.S.) (EU) Diabetes Mellitus Pancreatic (December 2014) Third-Line Advanced Small-Cell Lung MK-8521 (3) Prostate (April 2017) Cancer (KEYNOTE-158) (U.S.) HIV-1 Infection Cough First-Line Head and Neck Cancer MK-8591 MK-7264 (gefapixant) (March 2018) (KEYNOTE-048) (U.S.) Pediatric Neurofibromatosis Type-1 Heart Failure Alternative Dosing Regimen MK-5618 (selumetinib) (1) MK-1242 (vericiguat) (September 2016) (1) (Q6W) (EU) Respiratory Syncytial Virus Pneumoconjugate Vaccine MK-7339 Lynparza (1) MK-1654 V114 (June 2018) Second-Line Metastatic Breast Cancer (EU) Schizophrenia First-Line Advanced Ovarian Cancer (EU) MK-8189 HABP/VABP (5) MK-7625A Zerbaxa (U.S.) Footnotes: (1) Being developed in a collaboration. (2) Being developed in combination with Keytruda. (3) Development is currently on hold. (4) Rolling submission. (5) HABP - Hospital-Acquired Bacterial Pneumonia / VABP - Ventilator-Associated Bacterial Pneumonia Employees As of December 31, 2018, the Company had approximately 69,000 employees worldwide, with approximately 25,400 employed in the United States, including Puerto Rico. Approximately 30% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Since inception of the programs through December 31, 2018, Merck has eliminated approximately 45,510 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company has substantially completed the actions under these programs. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $16 million in 2018 , and are estimated at $57 million in the aggregate for the years 2019 through 2023 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in 2018 , 57% of sales in 2017 and 54% of sales in 2016 . The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). The address of that website is http://www.sec.gov. In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to the Office of the Secretary, Merck Co., Inc., 2000 Galloping Hill Road, K1-4157, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any shareholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health and animal health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively affect product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates under review and in Phase 3 clinical development is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. For example, pursuant to an agreement with a generic manufacturer, that manufacturer launched in the United States a generic version of Zetia in December 2016. In addition, the Company lost U.S. patent protection for Vytorin in April 2017. As a result, the Company experienced a significant and rapid loss of sales of Zetia and Vytorin in the United States in 2017, which continued in 2018. Furthermore, the patents that provide U.S. and EU market exclusivity for Noxafil will expire in July 2019 and December 2019, respectively, and the Company anticipates a significant decline in U.S. and EU Noxafil sales thereafter. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material and negative impact on results of operations and cash flows. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Keytruda, Januvia , Janumet , Gardasil/Gardasil 9 and Bridion . As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. For example, in 2018, sales of Zepatier were materially unfavorably affected by increasing competition and declining patient volumes. Sales of Zostavax were also materially unfavorably affected due to competition. The Company expects that competition will continue to adversely affect the sales of these products. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, or the anticipated labeling, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions or certain collaborations. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, preclinical testing, clinical trials and the manufacturing and marketing of its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU, Japan and China. In the United States, the FDA administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, reduction in the cost of drugs. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the products in that jurisdiction. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches the market, certain developments following regulatory approval may decrease demand for the Companys products, including the following: results in post-approval Phase 4 trials or other studies; the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy or labeling changes; and greater scrutiny in advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA and Japans Pharmaceutical and Medical Device Agency have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products that are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and, in particular, direct-to-consumer advertising. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial position and prospects. The Company faces intense competition from competitors products. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use, have better insurance coverage or reimbursement levels or be more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency, including new laws as noted above in Item 1. Competition and the Health Care Environment Health Care Environment and Government Regulations. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers may, in the future, ask for and receive higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company annually posts on its website its Pricing Transparency Report for the United States. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. Outside the United States, numerous major markets, including the EU, Japan and China have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. The Company expects pricing pressures to continue in the future. The health care industry in the United States will continue to be subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2018, the Companys revenue was reduced by $365 million due to this requirement. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.1 billion in 2018 and will be $2.8 billion in 2019. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. In 2018, the Company recorded $124 million of costs for this annual fee. In 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck, at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. The Company cannot predict the likelihood of future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys business, cash flow, results of operations, financial position and prospects. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means could impact key business processes. Cyber-attacks against the Companys IT systems could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. Due to the cyber-attack, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Cost of sales , as well as expenses related to remediation efforts in Selling, general and administrative expenses and Research and development expenses, which aggregated $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders, 2018 sales were unfavorably affected in certain markets by approximately $150 million from the cyber-attack. The Company has insurance coverage insuring against costs resulting from cyber-attacks and has received proceeds. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to the 2017 cyber-attack. The Company has implemented a variety of measures to further enhance and modernize its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems will be successful in preventing disruptions to its operations, including its manufacturing, research and sales operations. Any such disruption could result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third party providers databases or IT systems and could also result in financial, legal, business or reputational harm to the Company and potentially substantial remediation costs. The Company is subject to a variety of U.S. and international laws and regulations. The Company is currently subject to a number of government laws and regulations and, in the future, could become subject to new government laws and regulations. The costs of compliance with such laws and regulations, or the negative results of non-compliance, could adversely affect the business, cash flow, results of operations, financial position and prospects of the Company; these laws and regulations include (i) additional healthcare reform initiatives in the United States or in other countries, including additional mandatory discounts or fees; (ii) the U.S. Foreign Corrupt Practices Act or other anti-bribery and corruption laws; (iii) new laws, regulations and judicial or other governmental decisions affecting pricing, drug reimbursement, and access or marketing within or across jurisdictions; (iv) changes in intellectual property laws; (v) changes in accounting standards; (vi) new and increasing data privacy regulations and enforcement, particularly in the EU and the United States; (vii) legislative mandates or preferences for local manufacturing of pharmaceutical or vaccine products; (viii) emerging and new global regulatory requirements for reporting payments and other value transfers to healthcare professionals; (ix) environmental regulations; and (x) the potential impact of importation restrictions, embargoes, trade sanctions and legislative and/or other regulatory changes. The uncertainty in global economic conditions together with cost-reduction measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. The Company anticipates these pricing actions will continue to negatively affect revenue performance in 2019. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material negative impact on the Companys results of operations. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. In 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of that referendum, the British government has been in the process of negotiating the terms of the UKs future relationship with the EU. While the Company has taken actions and made certain contingency plans for scenarios in which the UK and the EU do not reach a mutually satisfactory understanding as to that relationship, it is not possible at this time to predict whether there will be any such understanding, or if such an understanding is reached, whether its terms will vary in ways that result in greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and/or cross border labor issues that could materially adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect the Companys ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. In addition, the Company could experience difficulties or delays in manufacturing its products caused by natural disasters, such as hurricanes. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. The Companys business in China has grown rapidly in the past few years, and the importance of China to the Companys overall pharmaceutical and vaccines business outside the United States has increased accordingly. Continued growth of the Companys business in China is dependent upon ongoing development of a favorable environment for innovative pharmaceutical products and vaccines, sustained access for the Companys currently marketed products, and the absence of trade impediments or adverse pricing controls. As noted above in Healthcare Environment , pricing pressure in China has increased as the Chinese government has been taking steps to reduce costs, including implementing healthcare reform that has led to the acceleration of generic substitution, where available. In addition, the Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into business development transactions, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates, interest rates and inflation could negatively affect the Companys business, cash flow, results of operations, financial position and prospects. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be affected by changes in tax laws, or new tax laws, affecting, for example, tax rates, and/or revised tax law interpretations in domestic or foreign jurisdictions. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third-party relationships and outsourcing arrangements could adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third-party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a negative impact on future results of operations. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as Bovine Spongiform Encephalopathy or mad cow disease, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely impact the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, complex, expensive and uncertain process. There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both preclinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004, including liability for legacy Merck products first sold after that date. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain media vehicles could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking platforms could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Companys U.S. commercial operations are headquartered in Upper Gwynedd, Pennsylvania. The Companys U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania and Kenilworth, New Jersey. The Companys vaccines business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania. Mercks Animal Health headquarters is located in Madison, New Jersey. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, South San Francisco, California and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $2.6 billion in 2018 , $1.9 billion in 2017 and $1.6 billion in 2016 . In the United States, these amounted to $1.5 billion in 2018 , $1.2 billion in 2017 and $1.0 billion in 2016 . Abroad, such expenditures amounted to $1.1 billion in 2018, $728 million in 2017 and $594 million in 2016. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. In addition, in October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022. The focus of this investment will primarily be on increasing manufacturing capacity across Mercks key businesses. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. As of January 31, 2019, there were approximately 115,320 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2018 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 59,154,075 $70.56 $12,709 (2) November 1 November 30 5,279,715 $74.64 $12,315 December 1 December 31 4,788,526 $76.30 $11,949 Total 69,222,316 $71.27 $11,949 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in November 2017 to purchase up to $10 billion in Merck shares. In October 2018, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. Shares are approximated. (2) Amount includes $1.0 billion being held back pending final settlement under the accelerated share repurchase agreements discussed below. Performance Graph The following graph assumes a $100 investment on December 31, 2013, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2018/2013 CAGR** MERCK $179 12% PEER GRP.** 7% SP 500 8% 2014 2016 2018 MERCK 100.00 117.10 112.40 129.40 127.40 178.70 PEER GRP. 100.00 111.40 114.80 111.20 133.00 142.20 SP 500 100.00 113.70 115.20 129.00 157.20 150.30 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. In 2017, Merck began recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9 to the consolidated financial statements). Overview The Companys performance during 2018 demonstrates execution of its innovation strategy, with revenue growth in oncology, vaccines, hospital acute care and animal health, focused investment in the research and development pipeline, and disciplined allocation of resources. Additionally, Merck completed several business development transactions, expanded its capital expenditures program primarily to increase future manufacturing capacity, and returned capital to shareholders. Worldwide sales were $42.3 billion in 2018 , an increase of 5% compared with 2017 . Strong growth in the oncology franchise reflects the performance of Keytruda , as well as alliance revenue related to Lynparza and Lenvima resulting from Mercks business development activities. Also contributing to revenue growth were higher sales of vaccines, driven primarily by Gardasil/Gardasil 9, and growth in the hospital acute care franchise, largely attributable to Bridion and Noxafil . Higher sales of animal health products, reflecting increases in companion animal and livestock products both from in-line and recently launched products, also contributed to revenue growth. Growth in these areas was partially offset by competitive pressures on Zepatier and Zostavax , as well as the ongoing effects of generic and biosimilar competition that resulted in sales declines for products including Zetia , Vytorin , and Remicade . Augmenting Mercks portfolio and pipeline with external innovation remains an important component of the Companys overall strategy. In 2018, Merck continued executing on this strategy by entering into a strategic collaboration with Eisai Co., Ltd. (Eisai) for the worldwide co-development and co-commercialization of Lenvima. Lenvima is an orally available tyrosine kinase inhibitor discovered by Eisai, which is approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . In addition, Merck acquired Viralytics Limited (Viralytics), a company focused on oncolytic immunotherapy treatments for a range of cancers. Also, the Company announced an agreement to acquire Antelliq Group (Antelliq), a leader in digital animal identification, traceability and monitoring solutions. During 2018, the Company advanced its leadership in oncology through focused commercial execution, the achievement of important regulatory milestones and the presentation of clinical data. Keytruda continues its global launch with multiple new indications across several tumor types, including approval from the U.S. Food and Drug Administration (FDA) for the treatment of certain patients with cervical cancer, primary mediastinal large B-cell lymphoma (PMBCL), a type of non-Hodgkin lymphoma, hepatocellular carcinoma, Merkel cell carcinoma, and in combination with chemotherapy for the treatment of certain patients with squamous non-small-cell lung cancer (NSCLC). Also during 2018, the European Commission (EC) approved Keytruda for the treatment of certain patients with head and neck squamous cell carcinoma (HNSCC), for the adjuvant treatment of melanoma, and in combination with chemotherapy for the first-line treatment of certain patients with nonsquamous NSCLC. This was the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy. Also in 2018, Keytruda was approved in China for the treatment of certain patients with melanoma. Additionally, Merck recently announced the receipt of five new approvals for Keytruda in Japan, including three expanded uses in advanced NSCLC, one in adjuvant melanoma, as well as a new indication in advanced microsatellite instability-high (MSI-H) tumors. Keytruda also continues to launch in many other international markets. In 2018, Lynparza, which is being developed in a collaboration with AstraZeneca PLC (AstraZeneca), received FDA approval for use in certain patients with metastatic breast cancer who have been previously treated with chemotherapy, and for use as maintenance treatment of adult patients with certain types of advanced ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to chemotherapy. Additionally, Lenvima was approved in the United States, European Union (EU), Japan and China for the treatment of certain patients with hepatocellular carcinoma. The FDA and EC also approved two new HIV-1 medicines: Delstrigo , a once-daily fixed-dose combination tablet of doravirine, lamivudine and tenofovir disoproxil fumarate; and Pifeltro (doravirine), a new non-nucleoside reverse transcriptase inhibitor to be administered in combination with other antiretroviral medicines. Merck continues to invest in its pipeline, with an emphasis on being a leader in immuno-oncology and expanding in other areas such as vaccines and hospital acute care. In addition to the recent regulatory approvals discussed above, the Company has continued to advance its late-stage pipeline with several regulatory submissions. Keytruda is under review in the United States in combination with axitinib, a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma for which it has been granted Priority Review by the FDA; in the EU for the first-line treatment of certain patients with metastatic squamous NSCLC; in the United States and in the EU as monotherapy for the first-line treatment of certain patients with locally advanced or metastatic NSCLC; in the United States as monotherapy for the treatment of certain patients with advanced small-cell lung cancer (SCLC); and in the United States as monotherapy or in combination with chemotherapy for the first-line treatment of certain patients with recurrent or metastatic HNSCC for which it has been granted Priority Review by the FDA. Additionally, MK-7655A, the combination of relebactam and imipenem/cilastatin, has been accepted for Priority Review by the FDA for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. Merck has also started the submission of a rolling Biologics License Application (BLA) to the FDA for V920, an investigational Ebola Zaire disease vaccine candidate. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of breast, cervical, colorectal, esophageal, gastric, hepatocellular, mesothelioma, nasopharyngeal, ovarian, renal and small-cell lung cancers; Lynparza for pancreatic and prostate cancer; and Lenvima in combination with Keytruda for endometrial cancer. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas, including V114, an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease that received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age; MK-7264, gefapixant, a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough; and MK-1242, vericiguat, an investigational treatment for heart failure being developed in a collaboration (see Research and Development below). The Company is allocating resources to effectively support its commercial opportunities in the near term while making the necessary investments to support long-term growth. Research and development expenses in 2018 reflect higher clinical development spending and investment in discovery and early drug development. In October 2018, Mercks Board of Directors approved a 15% increase to the Companys quarterly dividend, raising it to $0.55 per share from $0.48 per share on the Companys outstanding common stock. Also in October 2018, Mercks Board of Directors approved a $10 billion share repurchase program and the Company entered into $5 billion of accelerated share repurchase (ASR) agreements. During 2018 , the Company returned $14.3 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2018 were $2.32 compared with $0.87 in 2017 . EPS in both years reflect the impact of acquisition and divestiture-related costs, as well as restructuring costs and certain other items. Certain other items in 2018 include a charge related to the formation of the collaboration with Eisai and in 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation and a charge related to the formation of a collaboration with AstraZeneca. Non-GAAP EPS, which exclude these items, were $4.34 in 2018 and $3.98 in 2017 (see Non-GAAP Income and Non-GAAP EPS below). Pricing Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In the United States, pricing pressure continues on many of the Companys products. Changes to the U.S. health care system as part of health care reform, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, have contributed to pricing pressure. In several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, the Companys revenue performance in 2018 was negatively affected by other cost-reduction measures taken by governments and other third-parties to lower health care costs. The Company anticipates all of these actions will continue to negatively affect revenue performance in 2019 . Cyber-attack On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. Due to a backlog of orders for certain products as a result of the cyber-attack, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2018 and 2017 of approximately $150 million and $260 million, respectively. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Cost of sales , as well as expenses related to remediation efforts in Selling, general and administrative expenses and Research and development expenses, which aggregated approximately $285 million in 2017, net of insurance recoveries of approximately $45 million. Costs in 2018 were immaterial. As referenced above, the Company has insurance coverage insuring against costs resulting from cyber-attacks and has received insurance proceeds. However, there are disputes with certain of the insurers about the availability of some of the insurance coverage for claims related to this incident. Operating Results Sales Worldwide sales were $42.3 billion in 2018, an increase of 5% compared with 2017. Sales growth was driven primarily by higher sales in the oncology franchise reflecting strong growth of Keytruda , as well as alliance revenue related to Lynparza and Lenvima. Also contributing to revenue growth were higher sales of vaccines, driven primarily by human papillomavirus (HPV) vaccine Gardasil/Gardasil 9, as well as higher sales in the hospital acute care franchise, largely attributable to Bridion and Noxafil . Higher sales of animal health products also drove revenue growth in 2018. Sales growth in 2018 was partially offset by declines in the virology franchise driven primarily by lower sales of hepatitis C virus (HCV) treatment Zepatier , as well as lower sales of shingles (herpes zoster) vaccine Zostavax . The ongoing effects of generic and biosimilar competition for cardiovascular products Zetia and Vytorin , and immunology product Remicade , as well as lower sales of products within the diversified brands franchise also partially offset revenue growth in 2018. The diversified brands franchise includes certain products that are approaching the expiration of their marketing exclusivity or that are no longer protected by patents in developed markets. Sales in the United States were $18.2 billion in 2018 , growth of 5% compared with 2017 . The increase was driven primarily by higher sales of Keytruda , Gardasil/Gardasil 9, NuvaRing , and Bridion , as well as alliance revenue from Lynparza and Lenvima, and higher sales of animal health products. Growth was partially offset by lower sales of Zepatier , Zetia , Vytorin , Zostavax , Januvia , Janumet , Invanz , and products within the diversified brands franchise. International sales were $24.1 billion in 2018 , an increase of 6% compared with 2017 . The increase primarily reflects growth in Keytruda , Gardasil/Gardasil 9, Januvia, Janumet and Atozet , as well as higher sales of animal health products. Sales growth was partially offset by lower sales of Zepatier , Remicade , Zetia , Vytorin , and products within the diversified brands franchise. International sales represented 57% of total sales in both 2018 and 2017 . Worldwide sales were $40.1 billion in 2017, an increase of 1% compared with 2016. Sales growth in 2017 was driven primarily by higher sales of Keytruda , Zepatier and Bridion . Additionally, sales in 2017 benefited from the December 31, 2016 termination of SPMSD, which marketed vaccines in most major European markets. In 2017, Merck began recording vaccine sales in the markets that were previously part of the SPMSD joint venture resulting in incremental vaccine sales of approximately $400 million during 2017. Higher sales of Pneumovax 23, Adempas, and animal health products also contributed to revenue growth in 2017. These increases were largely offset by the effects of generic competition for certain products including Zetia , which lost U.S. market exclusivity in December 2016, Vytorin , which lost U.S. market exclusivity in April 2017, Cubicin due to U.S. patent expiration in June 2016, and Cancidas , which lost EU patent protection in April 2017. Revenue growth was also offset by continued biosimilar competition for Remicade and ongoing generic erosion for products including Singulair and Nasonex . Collectively, the sales decline attributable to the above products affected by generic and biosimilar competition was $3.3 billion in 2017. Lower sales of other products within the diversified brands franchise, as well as lower combined sales of the diabetes franchise of Januvia and Janumet , and declines in sales of Isentress/Isentress HD also partially offset revenue growth. Additionally, sales in 2017 were reduced by $125 million due to a borrowing the Company made from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile of doses of Gardasil 9 as discussed below. Also, the Company was unable to fulfill orders for certain products in certain markets due to the cyber-attack, which had an unfavorable effect on sales in 2017 of approximately $260 million. See Note 19 to the consolidated financial statements for details on sales of the Companys products. Pharmaceutical Segment Oncology Keytruda is approved in the United States and in the EU as monotherapy for the treatment of certain patients with NSCLC, melanoma, classical Hodgkin lymphoma (cHL), HNSCC and urothelial carcinoma, a type of bladder cancer, and in combination with chemotherapy for certain patients with nonsquamous NSCLC. Keytruda is also approved in the United States as monotherapy for the treatment of certain patients with gastric or gastroesophageal junction adenocarcinoma and MSI-H or mismatch repair deficient cancer. In addition, the FDA recently approved Keytruda for the treatment of certain patients with cervical cancer, PMBCL, hepatocellular carcinoma, Merkel cell carcinoma, and in combination with chemotherapy for patients with squamous NSCLC (see below). Keytruda is approved in Japan for the treatment of certain patients with NSCLC, both as monotherapy and in combination with chemotherapy, melanoma, cHL, MSI-H tumors, and urothelial carcinoma. Additionally, Keytruda has been approved in China for the treatment of certain patients with melanoma. Keytruda is also approved in many other international markets. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In August 2018, the FDA approved an expanded label for Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of patients with metastatic nonsquamous NSCLC, with no EGFR or ALK genomic tumor aberrations, based on results of the KEYNOTE-189 trial. Keytruda in combination with pemetrexed and carboplatin was first approved in 2017 under the FDAs accelerated approval process for the first-line treatment of patients with metastatic nonsquamous NSCLC, based on tumor response rates and progression-free survival (PFS) data from a Phase 2 study (KEYNOTE-021, Cohort G1). In accordance with the accelerated approval process, continued approval was contingent upon verification and description of clinical benefit, which was demonstrated in KEYNOTE-189 and resulted in the FDA converting the accelerated approval to full (regular) approval. Also, in September 2018, the EC approved Keytruda in combination with pemetrexed and platinum chemotherapy for the first-line treatment of metastatic nonsquamous NSCLC in adults whose tumors have no EGFR or ALK positive mutations. In June 2018, the FDA approved Keytruda for the treatment of patients with recurrent or metastatic cervical cancer with disease progression on or after chemotherapy whose tumors express PD-L1 as determined by an FDA- approved test. Also in June 2018, the FDA approved Keytruda for the treatment of adult and pediatric patients with refractory PMBCL, or who have relapsed after two or more prior lines of therapy. In September 2018, the EC approved Keytruda as monotherapy for the treatment of recurrent or metastatic HNSCC in adults whose tumors express PD-L1 with a tumor proportion score (TPS) of 50%, and who progressed on or after platinum-containing chemotherapy, based on data from the Phase 3 KEYNOTE-040 trial. In October 2018, the FDA approved Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of patients with metastatic squamous NSCLC based on results from the KEYNOTE-407 trial. This approval marks the first time an anti-PD-1 regimen has been approved for the first-line treatment of squamous NSCLC regardless of tumor PD-L1 expression status. In November 2018, the FDA approved Keytruda for the treatment of patients with hepatocellular carcinoma who have been previously treated with sorafenib based on data from the KEYNOTE-224 trial. In December 2018, the FDA approved Keytruda for the treatment of adult and pediatric patients with recurrent locally advanced or metastatic Merkel cell carcinoma, based on the results of the Cancer Immunotherapy Trials Networks CITN-09/KEYNOTE-017 trial. Also in December 2018, the EC approved Keytruda for the adjuvant treatment of adults with stage III melanoma and lymph node involvement who have undergone complete resection. Keytruda was approved for this indication by the FDA in February 2019. These approvals were based on data from the pivotal Phase 3 EORTC1325/KEYNOTE-054 trial, conducted in collaboration with the European Organisation for Research and Treatment of Cancer. Global sales of Keytruda were $7.2 billion in 2018 , $3.8 billion in 2017 and $1.4 billion in 2016 . The year-over-year increases were driven by volume growth as the Company continues to launch Keytruda with multiple new indications globally. Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC reflecting both the continued adoption of Keytruda in the first-line setting as monotherapy for patients with metastatic NSCLC whose tumors have high PD-L1 expression, as well as the uptake of Keytruda in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous NSCLC with or without PD-L1 expression. Other indications contributing to sales growth include HNSCC, bladder, and melanoma. Recently approved indications, including squamous NSCLC and MSI-H cancer, also contributed to growth in 2018. Sales growth in international markets reflects continued uptake for the treatment of NSCLC as the Company has secured reimbursement in most major markets. Sales growth in international markets in 2018 also includes contributions from the more recently approved indications as described above, including for the treatment of HNSCC, bladder cancer and in combination with chemotherapy for the treatment of NSCLC in the EU, multiple new indications in Japan, and for the treatment of melanoma in China. In January 2017, Merck entered into a settlement and license agreement to resolve worldwide patent infringement litigation related to Keytruda . Pursuant to the settlement, the Company will pay royalties of 6.5% on net sales of Keytruda in 2017 through 2023; and 2.5% on net sales of Keytruda in 2024 through 2026. Global sales of Emend , for the prevention of chemotherapy-induced and post-operative nausea and vomiting, were $522 million in 2018, a decline of 6% compared with 2017 including a 1% favorable effect from foreign exchange. The decline primarily reflects lower demand in the United States due to competition. Worldwide sales of Emend were $556 million in 2017, an increase of 1% compared with 2016. The patent that provided U.S. market exclusivity for Emend expired in 2015 and the patent that provides market exclusivity in most major European markets will expire in May 2019. The patent that provides U.S. market exclusivity for Emend for Injection expires in September 2019 and the patent that provides market exclusivity in major European markets expires in February 2020 (although six-month pediatric exclusivity may extend this date). The Company anticipates that sales of Emend in these markets will decline significantly after these patent expiries. Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor being developed as part of a collaboration with AstraZeneca entered into in July 2017 (see Note 4 to the consolidated financial statements), is currently approved for certain types of ovarian and breast cancer. Merck recorded alliance revenue of $187 million in 2018 and $20 million in 2017 related to Lynparza. The revenue increase reflects the approval of new indications, as well as a full year of activity in 2018. In January 2018, the FDA approved Lynparza for use in patients with BRCA -mutated, human epidermal growth factor receptor 2 (HER2)-negative metastatic breast cancer who have been previously treated with chemotherapy, triggering a $70 million capitalized milestone payment from Merck to AstraZeneca. Lynparza was also approved in Japan in July 2018 for use in patients with unresectable or recurrent BRCA -mutated, HER2-negative breast cancer who have received prior chemotherapy. Additionally, Lynparza was approved for use as a maintenance therapy in patients with platinum-sensitive relapsed ovarian cancer, regardless of BRCA mutation status in Japan in January 2018 and in the EU in May 2018. In December 2018, the FDA approved Lynparza for use as maintenance treatment of adult patients with deleterious or suspected deleterious germline or somatic BRCA -mutated advanced epithelial ovarian, fallopian tube or primary peritoneal cancer who are in complete or partial response to first-line platinum-based chemotherapy based on the results of the SOLO-1 clinical trial, triggering a $70 million capitalized milestone payment from Merck to AstraZeneca. Lenvima, an oral receptor tyrosine kinase inhibitor being developed as part of a collaboration with Eisai entered into in March 2018 (see Note 4 to the consolidated financial statements), is approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. Merck recorded alliance revenue of $149 million in 2018 related to Lenvima. In 2018, Lenvima was approved for the treatment of certain patients with hepatocellular carcinoma in the United States, the EU, Japan and China, triggering capitalized milestone payments of $250 million in the aggregate from Merck to Eisai. Vaccines On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which developed and marketed vaccines in Europe. Accordingly, vaccine sales in 2018 and 2017 include sales of Merck vaccines in the European markets that were previously part of the SPMSD joint venture, whereas sales in periods prior to 2017 do not. Prior to 2017, vaccine sales in these European markets were sold through the SPMSD joint venture, the results of which were reflected in equity income from affiliates included in Other (income) expense, net . Supply sales to SPMSD, however, are included in vaccine sales in periods prior to 2017. Incremental vaccine sales resulting from the termination of the SPMSD joint venture were approximately $400 million in 2017, of which approximately $215 million relate to Gardasil/Gardasil 9. Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and other diseases caused by certain types of HPV, were $3.2 billion in 2018, growth of 37% compared with 2017 including a 1% favorable effect from foreign exchange. Sales growth was driven primarily by higher sales in the Asia Pacific region, particularly in China reflecting continued uptake since launch, as well as higher demand in certain European markets. The sales increase was also attributable to the replenishment in 2018 of doses borrowed from the CDC Pediatric Vaccine Stockpile in 2017 as discussed below. In April 2018, Chinas Food and Drug Administration approved Gardasil 9 for use in girls and women ages 16 to 26. In October 2018, the FDA approved an expanded age indication for use in women and men ages 27 to 45 for the prevention of certain cancers and diseases caused by the nine HPV types covered by the vaccine. During 2017, the Company made a request to borrow doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile, which the CDC granted. The Companys decision to borrow the doses from the CDC was driven in part by the temporary shutdown resulting from the cyber-attack that occurred in June 2017, as well as by overall higher demand than expected. As a result of the borrowing, the Company reversed the sales related to the borrowed doses and recognized a corresponding liability. The Company subsequently replenished a portion of the doses borrowed from the stockpile. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company replenished the remaining borrowed doses in 2018 resulting in the recognition of sales of $125 million in 2018 and a reversal of the related liability. Global sales of Gardasil/Gardasil 9 were $2.3 billion in 2017, growth of 6% compared with 2016. Sales growth was driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture noted above, as well as higher demand in the Asia Pacific region due in part to the launch in China, partially offset by lower sales in the United States. Lower sales in the United States reflect the timing of public sector purchases and the CDC stockpile borrowing as described above. The Company is a party to certain third-party license agreements with respect to Gardasil/Gardasil 9 pursuant to which the Company pays royalties on worldwide Gardasil/Gardasil 9 sales. The royalties, which vary by country and range from 7% to 13%, are included in Cost of sales . Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, were $593 million in 2018, an increase of 12% compared with 2017, driven primarily by higher volumes and pricing in the United States and volume growth in certain European markets. Worldwide sales of ProQuad were $528 million in 2017, an increase of 7% compared with $495 million in 2016. Sales growth in 2017 was driven primarily by higher pricing and volumes in the United States, as well as volume growth in international markets, particularly in Europe. Foreign exchange favorably affected global sales performance by 1% in 2017. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, were $430 million in 2018, an increase of 13% compared with 2017, driven primarily by volume growth in Latin America. Global sales of M-M-R II were $382 million in 2017, an increase of 8% compared with $353 million in 2016. Sales growth in 2017 was largely attributable to higher sales in Europe resulting from the termination of the SPMSD joint venture. Foreign exchange favorably affected global sales performance by 1% in 2018 and unfavorably affected global sales performance by 1% in 2017. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), were $774 million in 2018, an increase of 1% compared with 2017, reflecting volume growth in Latin America and the Asia Pacific region, along with higher pricing in the United States, largely offset by volume declines in Turkey from the loss of a government tender due to competition. Worldwide sales of Varivax were $767 million in 2017, a decline of 3% compared with $792 million in 2016. The sales decline in 2017 was driven primarily by lower volumes in Brazil due to the loss of a government tender, as well as lower sales in the United States reflecting lower demand that was partially offset by higher pricing. Higher sales in Europe resulting from the termination of the SPMSD joint venture partially offset the sales decline in 2017. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, were $907 million in 2018, an increase of 10% compared with 2017. Sales growth was driven primarily by higher pricing in the United States and volume growth in Europe. Global sales of Pneumovax 23 were $821 million in 2017, an increase of 28% compared with 2016, driven primarily by higher demand and pricing in the United States, as well as higher sales in Europe resulting from the termination of the SPMSD joint venture. Foreign exchange unfavorably affected sales performance by 1% in 2017. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, were $728 million in 2018, an increase of 6% compared with 2017, driven primarily by the launch in China. Worldwide sales of RotaTeq were $686 million in 2017, an increase of 5% compared with 2016, driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture. Worldwide sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $217 million in 2018, a decline of 68% compared with 2017, driven by lower volumes in most markets, particularly in the United States. Lower demand in the United States reflects the launch of a competing vaccine that received a preferential recommendation from the CDCs Advisory Committee on Immunization Practices in October 2017 for the prevention of shingles over Zostavax . The declines were partially offset by higher demand in certain European markets. The Company anticipates competition will continue to have an adverse effect on sales of Zostavax in future periods. Global sales of Zostavax were $668 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States reflecting the approval of a competing vaccine as noted above, partially offset by growth in Europe resulting from the termination of the SPMSD joint venture and volume growth in the Asia Pacific region. In 2018, the FDA approved Vaxelis (Diphtheria and Tetanus Toxoids and Acellular Pertussis Adsorbed, Inactivated Poliovirus, Haemophilus b Conjugate [Meningococcal Protein Conjugate] and Hepatitis B [Recombinant] Vaccine) for use in children from 6 weeks through 4 years of age (prior to the 5th birthday). Vaxelis , which is currently being marketed in Europe, was developed as part of a joint-partnership between Merck and Sanofi. Merck and Sanofi are working to maximize production of Vaxelis to allow for a sustainable supply to meet anticipated U.S. demand. Commercial supply will not be available prior to 2020. Hospital Acute Care Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, were $917 million in 2018, growth of 30% compared with 2017, driven primarily by volume growth in the United States and certain European markets. Worldwide sales of Bridion were $704 million in 2017, growth of 46% compared with 2016, driven by strong global demand, particularly in the United States. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, were $742 million in 2018, an increase of 17% compared with 2017 including a 2% favorable effect from foreign exchange. Sales growth primarily reflects higher demand in the United States, certain European markets and China. Global sales of Noxafil were $636 million in 2017, an increase of 7% compared with 2016, primarily reflecting higher demand and pricing in the United States, as well as volume growth in Europe. The patent that provides U.S. market exclusivity for Noxafil expires in July 2019. Additionally, the patent for Noxafil will expire in a number of major European markets in December 2019. The Company anticipates sales of Noxafil in these markets will decline significantly thereafter. Global sales of Invanz , for the treatment of certain infections, were $496 million in 2018, a decline of 18% compared with 2017 including a 1% unfavorable effect from foreign exchange. The sales decline was driven by lower volumes in the United States. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and generic competition began in the second half of 2018. The Company is experiencing a significant decline in U.S. Invanz sales as a result of this generic competition and expects the decline to continue. Worldwide sales of Invanz were $602 million in 2017, an increase of 7% compared with 2016, driven primarily by higher sales in the United States, reflecting higher pricing that was partially offset by lower demand, as well as higher demand in Brazil. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, were $367 million in 2018, a decline of 4% compared with 2017 including a 1% favorable effect from foreign exchange. Worldwide sales of Cubicin were $382 million in 2017, a decline of 65% compared with 2016, resulting from generic competition in the United States following expiration of the U.S. composition patent for Cubicin in June 2016. Global sales of Cancidas , an anti-fungal product sold primarily outside of the United States, were $326 million in 2018, a decline of 23% compared with 2017, and were $422 million in 2017, a decline of 24% compared with 2016. Foreign exchange favorably affected global sales performance by 2% in 2018. The sales declines were driven primarily by generic competition in certain European markets. The EU compound patent for Cancidas expired in April 2017. Accordingly, the Company is experiencing a significant decline in Cancidas sales in these European markets and expects the decline to continue. Immunology Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $893 million in 2018, growth of 9% compared with 2017 including a 4% favorable effect from foreign exchange. Sales of Simponi were $819 million in 2017, growth of 7% compared with 2016 including a 1% favorable effect from foreign exchange. Sales growth in both years was driven by higher demand in Europe. The Company anticipates sales of Simponi will be unfavorably affected in future periods by the recent launch of biosimilars for a competing product. Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $582 million in 2018, a decline of 31% compared with 2017, and were $837 million in 2017, a decline of 34% compared with 2016. Foreign exchange favorably affected sales performance by 2% in 2018. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Virology Worldwide sales of Isentress/Isentress HD, an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, were $1.1 billion in 2018, a decline of 5% compared with 2017, and were $1.2 billion in 2017, a decline of 13% compared with 2016. Foreign exchange favorably affected global sales performance by 1% in 2017. The sales declines primarily reflect competitive pressure in the United States and Europe. In August 2018, the FDA approved two new HIV-1 medicines: Delstrigo , a once-daily fixed-dose combination tablet of doravirine, lamivudine and tenofovir disoproxil fumarate; and Pifeltro (doravirine), a new non-nucleoside reverse transcriptase inhibitor to be administered in combination with other antiretroviral medicines. Both Delstrigo and Pifeltro are indicated for the treatment of HIV-1 infection in adult patients with no prior antiretroviral treatment experience. Delstrigo and Pifeltro were also approved by the EC in November 2018 . In January 2019, the FDA accepted for review supplemental New Drug Applications (NDA) for Pifeltro and Delstrigo seeking approval for use in patients living with HIV-1 who are switching from a stable antiretroviral regimen and whose virus is suppressed. The Prescription Drug User Fee Act (PDUFA) date for the supplemental NDAs is September 20, 2019. Global sales of Zepatier , a treatment for adult patients with certain types of chronic hepatitis C virus (HCV) infection, were $455 million in 2018, a decline of 73% compared with 2017. The sales decline was driven primarily by the unfavorable effects of increasing competition and declining patient volumes, particularly in the United States, Europe and Japan. The Company anticipates that sales of Zepatier in the future will continue to be adversely affected by competition and lower patient volumes. Worldwide sales of Zepatier were $1.7 billion in 2017 compared with $555 million in 2016. Sales growth in 2017 was driven primarily by higher sales in Europe, the United States and Japan following product launch in 2016. Cardiovascular Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ), Vytorin (marketed outside the United States as Inegy ), as well as Atozet and Rosuzet (both marketed in certain countries outside of the United States), medicines for lowering LDL cholesterol, were $1.8 billion in 2018, a decline of 26% compared with 2017 including a 3% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States and Europe. Zetia and Vytorin lost market exclusivity in the United States in December 2016 and April 2017, respectively. Accordingly, the Company experienced a rapid and substantial decline in U.S. Zetia and Vytorin sales as a result of generic competition and has lost nearly all U.S. sales of these products. In addition, the Company lost market exclusivity in major European markets for Ezetrol in April 2018 and has also lost market exclusivity in certain European markets for Inegy (see Note 11 to the consolidated financial statements). Accordingly, the Company is experiencing significant sales declines in these markets as a result of generic competition and expects the declines to continue. These declines were partially offset by higher sales in Japan due in part to the launch of Atozet . Combined worldwide sales of the ezetimibe family were $2.4 billion in 2017, a decline of 39% compared with 2016. The sales decline was driven by lower volumes and pricing of Zetia and Vytorin in the United States as a result of generic competition due to the loss of U.S. market exclusivity as described above. Pursuant to a collaboration with Bayer AG (Bayer) (see Note 4 to the consolidated financial statements), Merck has lead commercial rights for Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, in countries outside the Americas while Bayer has lead rights in the Americas, including the United States. The companies share profits equally under the collaboration. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. Merck recorded revenue related to Adempas of $329 million in 2018, an increase of 10% compared with 2017, reflecting higher sales in Mercks marketing territories, partially offset by lower profit sharing from Bayer due in part to lower pricing in the United States. Revenue related to Adempas was $300 million in 2017, an increase of 78% compared with 2016, reflecting both higher sales in Mercks marketing territories, as well as the recognition of higher profit sharing from Bayer. Foreign exchange favorably affected global sales performance by 3% in 2018 and by 1% in 2017. Diabetes Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were $5.9 billion in 2018, essentially flat compared with 2017. Global combined sales of Januvia and Janumet were $5.9 billion in 2017, a decline of 3% compared with 2016. Foreign exchange favorably affected sales performance by 1% in both 2018 and 2017. Sales performance in both periods was driven primarily by ongoing pricing pressure, particularly in the United States, partially offset by higher demand in most international markets. The Company expects pricing pressure to continue. Womens Health Worldwide sales of NuvaRing , a vaginal contraceptive product, were $902 million in 2018, an increase of 19% compared with 2017 including a 1% favorable effect from foreign exchange. Sales growth was driven primarily by higher pricing in the United States. The patent that provided U.S. market exclusivity for NuvaRing expired in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales in future periods as a result of generic competition. Global sales of NuvaRing were $761 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower sales in the United States reflecting lower volumes that were partially offset by higher pricing, and lower demand in Europe. Animal Health Segment Global sales of Animal Health products were $4.2 billion in 2018, an increase of 9% compared with 2017, reflecting growth from both in-line and recently launched companion animal and livestock products. Higher sales of companion animal products reflect growth in the Bravecto line of products that kill fleas and ticks in dogs and cats for up to 12 weeks, as well as higher sales of companion animal vaccines. Growth in livestock products reflects higher sales of ruminant, poultry and swine products. Worldwide sales of Animal Health products were $3.9 billion in 2017, an increase of 11% compared with 2016, primarily reflecting higher sales of companion animal products, largely driven by growth in Bravecto , reflecting both growth in the oral formulation and continued uptake in the topical formulation, which was launched in 2016. Animal Health sales growth in 2017 was also driven by higher sales of ruminant, poultry and swine products. In December 2018, the Company signed an agreement to acquire Antelliq, a leader in digital animal identification, traceability and monitoring solutions (see Note 3 to the consolidated financial statements). Costs, Expenses and Other ($ in millions) Change Change Cost of sales $ 13,509 % $ 12,912 % $ 14,030 Selling, general and administrative 10,102 % 10,074 % 10,017 Research and development 9,752 % 10,339 % 10,261 Restructuring costs % % Other (income) expense, net (402 ) % (500 ) * $ 33,593 % $ 33,601 % $ 35,148 * Greater than 100%. Cost of Sales Cost of sales was $13.5 billion in 2018 , $12.9 billion in 2017 and $14.0 billion in 2016 . Costs in 2018 include a $423 million charge related to the termination of a collaboration agreement with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine (see Note 3 to the consolidated financial statements). Also in 2018, the Company recorded $188 million of cumulative amortization expense for amounts capitalized in connection with the recognition of liabilities for potential future milestone payments related to collaborations (see Note 4 to the consolidated financial statements). Cost of sales includes expenses for the amortization of intangible assets recorded in connection with business acquisitions which totaled $2.7 billion in 2018, $3.1 billion in 2017 and $3.7 billion in 2016. Costs in 2017 and 2016 also include intangible asset impairment charges of $58 million and $347 million , respectively, related to marketed products and other intangibles recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). Costs in 2017 also include a $76 million intangible asset impairment charge related to a licensing agreement. The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. Also included in cost of sales are expenses associated with restructuring activities which amounted to $21 million , $138 million and $181 million in 2018 , 2017 and 2016 , respectively, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 68.1% in 2018 compared with 67.8% in 2017 and 64.5% in 2016 . The year-over-year improvements in gross margin reflect a lower net impact from the amortization of intangible assets and intangible asset impairment charges related to business acquisitions, as well as restructuring costs as noted above, which reduced gross margin by 6.3 percentage points in 2018, 8.3 percentage points in 2017 and 10.6 percentage points in 2016. The gross margin improvement in 2018 compared with 2017 also reflects the favorable effects of product mix and amortization of unfavorable manufacturing variances recorded in 2017, resulting in part from the June 2017 cyber-attack. The gross margin improvement in 2018 was partially offset by a charge associated with the termination of a collaboration agreement with Samsung, as well as the unfavorable effects of pricing pressure and cumulative amortization expense for potential future milestone payments related to collaborations as noted above. The gross margin improvement in 2017 compared with 2016 also reflects the favorable effects of product mix. Manufacturing-related costs associated with the cyber-attack partially offset the gross margin improvement in 2017. Selling, General and Administrative Selling, general and administrative (SGA) expenses were $10.1 billion in 2018, essentially flat compared with 2017, reflecting higher administrative costs and the unfavorable effect of foreign exchange, offset by lower selling and promotional expenses. SGA expenses were $10.1 billion in 2017, an increase of 1% compared with 2016. Higher administrative costs, including costs associated with the Company operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, remediation costs related to the cyber-attack, and higher promotional expenses related to product launches, were partially offset by lower restructuring and acquisition and divestiture-related costs, lower selling expenses and the favorable effect of foreign exchange. SGA expenses in 2016 include restructuring costs of $95 million related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. SGA expenses also include acquisition and divestiture-related costs of $32 million, $44 million and $78 million in 2018, 2017 and 2016, respectively, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Research and Development Research and development (RD) expenses were $9.8 billion in 2018, a decline of 6% compared with 2017. The decrease primarily reflects lower expenses in 2018 for upfront and license option payments related to the formation of oncology collaborations, lower in-process research and development (IPRD) impairment charges, and a reduction in expenses associated with a decrease in the estimated fair value measurement of liabilities for contingent consideration, partially offset by higher clinical development spending and investment in discovery and early drug development, as well as higher expenses related to other business development activities, including a charge in 2018 for the acquisition of Viralytics. RD expenses were $10.3 billion in 2017, an increase of 1% compared with 2016. The increase was driven primarily by a charge in 2017 related to the formation of a collaboration with AstraZeneca, an unfavorable effect from changes in the estimated fair value measurement of liabilities for contingent consideration, and higher clinical development spending, largely offset by lower IPRD impairment charges and lower restructuring costs. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $5.1 billion in 2018, $4.6 billion in 2017 and $4.4 billion in 2016. Also included in RD expenses are costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, as well as licensing activity, and certain costs from operating segments, including the Pharmaceutical and Animal Health segments, which in the aggregate were $2.8 billion, $2.9 billion and $2.6 billion for 2018, 2017 and 2016, respectively. Additionally, RD expenses in 2018 include a $1.4 billion charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), as well as a $344 million charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements). RD expenses in 2017 include a $2.35 billion charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). RD expenses also include IPRD impairment charges of $152 million , $483 million and $3.6 billion in 2018 , 2017 and 2016 , respectively (see Note 8 to the consolidated financial statements). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with acquisitions. During 2018 and 2016, the Company recorded a net reduction in expenses of $54 million and $402 million, respectively, to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs (see Note 6 to the consolidated financial statements). During 2017, the Company recorded charges of $27 million to increase the estimated fair value of liabilities for contingent consideration. RD expenses in 2016 also reflect $142 million of accelerated depreciation and asset abandonment costs associated with restructuring activities. Restructuring Costs In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $632 million , $776 million and $651 million in 2018 , 2017 and 2016 , respectively. In 2018 , 2017 and 2016 , separation costs of $473 million , $552 million and $216 million , respectively, were incurred associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Merck eliminated approximately 2,160 positions in 2018 , 2,450 positions in 2017 and 2,625 positions in 2016 related to these restructuring activities. Also included in restructuring costs are asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Cost of sales , Selling, general and administrative and Research and development as discussed above. The Company recorded aggregate pretax costs of $658 million in 2018 , $927 million in 2017 and $1.1 billion in 2016 related to restructuring program activities (see Note 5 to the consolidated financial statements). The Company has substantially completed the actions under these programs. Other (Income) Expense, Net Other (income) expense, net, was $402 million of income in 2018 , $500 million of income in 2017 and $189 million of expense in 2016 . For details on the components of Other (income) expense, net, see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 24,292 $ 22,495 $ 22,141 Animal Health segment profits 1,659 1,552 1,357 Other non-reportable segment profits Other (17,353 ) (17,801 ) (18,985 ) Income before taxes $ 8,701 $ 6,521 $ 4,659 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as SGA and RD expenses directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as SGA and RD expenses directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in MRL, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are acquisition and divestiture-related costs (amortization of purchase accounting adjustments, intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration), restructuring costs, and a portion of equity income. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items, including a charge related to the termination of a collaboration agreement with Samsung for insulin glargine in 2018, a loss on the extinguishment of debt in 2017, and a charge related to the settlement of worldwide Keytruda patent litigation and gains on divestitures in 2016, are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. In the first quarter of 2018, the Company adopted a new accounting standard related to the classification of certain defined benefit plan costs, which resulted in a change to the measurement of segment profits (see Note 19 to the consolidated financial statements). Prior period amounts have been recast to conform to the new presentation. Pharmaceutical segment profits grew 8% in 2018 compared with 2017 primarily reflecting higher sales and lower selling and promotional costs. Pharmaceutical segment profits grew 2% in 2017 compared with 2016 primarily reflecting higher sales and the favorable effects of product mix. Animal Health segment profits grew 7% in 2018 and 14% in 2017 driven primarily by higher sales, partially offset by increased selling and promotional costs. Taxes on Income The effective income tax rates of 28.8% in 2018 , 62.9% in 2017 and 15.4% in 2016 reflect the impacts of acquisition and divestiture-related costs, restructuring costs and the beneficial impact of foreign earnings. The effective income tax rate in 2018 includes measurement-period adjustments to the provisional amounts recorded in 2017 associated with the enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA), including $124 million related to the transition tax (see Note 16 to the consolidated financial statements). In addition, the effective income tax rate for 2018 reflects the unfavorable impacts of a $1.4 billion pretax charge recorded in connection with the formation of a collaboration with Eisai and a $423 million pretax charge related to the termination of a collaboration agreement with Samsung for which no tax benefits were recognized. The effective income tax rate for 2017 includes a provisional net charge of $2.6 billion related to the enactment of the TCJA. The effective income tax rate for 2017 also reflects the unfavorable impact of a $2.35 billion pretax charge recorded in connection with the formation of a collaboration with AstraZeneca for which no tax benefit was recognized, partially offset by the favorable impact of a net tax benefit of $234 million related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), and a benefit of $88 million related to the settlement of a state income tax issue. Net (Loss) Income Attributable to Noncontrolling Interests Net (loss) income attributable to noncontrolling interests was $(27) million in 2018 compared with $24 million in 2017 and $21 million in 2016. The loss in 2018 primarily reflects the portion of goodwill impairment charges related to certain business in the Healthcare Services segment that are attributable to noncontrolling interests. Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $6.2 billion in 2018 , $2.4 billion in 2017 and $3.9 billion in 2016 . EPS was $2.32 in 2018 , $0.87 in 2017 and $1.41 in 2016 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. Senior managements annual compensation is derived in part using non-GAAP income and non-GAAP EPS. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 8,701 $ 6,521 $ 4,659 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 3,066 3,760 7,312 Restructuring costs 1,069 Other items: Charge related to the formation of an oncology collaboration with Eisai 1,400 Charge related to the termination of a collaboration with Samsung Charge for the acquisition of Viralytics Charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Charge related to the settlement of worldwide Keytruda patent litigation Other (57 ) (16 ) (67 ) Non-GAAP income before taxes 14,535 13,542 13,598 Taxes on income as reported under GAAP 2,508 4,103 Estimated tax benefit on excluded items (1) 2,321 Net tax charge related to the enactment of the TCJA (2) (160 ) (2,625 ) Net tax benefit from the settlement of certain federal income tax issues Tax benefit related to the settlement of a state income tax issue Non-GAAP taxes on income 2,883 2,585 3,039 Non-GAAP net income 11,652 10,957 10,559 Less: Net (loss) income attributable to noncontrolling interests as reported under GAAP (27 ) Acquisition and divestiture-related costs attributable to noncontrolling interests (58 ) Non-GAAP net income attributable to noncontrolling interests 24 Non-GAAP net income attributable to Merck Co., Inc. $ 11,621 $ 10,933 $ 10,538 EPS assuming dilution as reported under GAAP $ 2.32 $ 0.87 $ 1.41 EPS difference (3) 2.02 3.11 2.37 Non-GAAP EPS assuming dilution $ 4.34 $ 3.98 $ 3.78 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Amount in 2017 was provisional (see Note 16 to the consolidated financial statements). (3) Represents the difference between calculated GAAP EPS and calculated non-GAAP EPS, which may be different than the amount calculated by dividing the impact of the excluded items by the weighted-average shares for the applicable year . Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects, and typically consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2018 is a charge related to the formation of a collaboration with Eisai (see Note 4 to the consolidated financial statements), a charge related to the termination of a collaboration agreement with Samsung for insulin glargine (see Note 3 to the consolidated financial statements), a charge for the acquisition of Viralytics (see Note 3 to the consolidated financial statements), and measurement-period adjustments related to the provisional amounts recorded for the TCJA (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2017 is a charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), as well as a provisional net tax charge related to the enactment of the TCJA, a net tax benefit related to the settlement of certain federal income tax issues and a tax benefit related to the settlement of a state income tax issue (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2016 is a charge to settle worldwide patent litigation related to Keytruda . Research and Development A chart reflecting the Companys current research pipeline as of February 22, 2019 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda in combination with Inlyta (axitinib), a tyrosine kinase inhibitor, for the first-line treatment of patients with advanced renal cell carcinoma. This supplemental BLA is based on findings from the Phase 3 KEYNOTE-426 trial, which demonstrated that Keytruda in combination with axitinib, as compared to sunitinib, significantly improved overall survival (OS) and PFS in the first-line treatment of advanced renal cell carcinoma. These data were presented at the American Society for Clinical Oncology (ASCO) Genitourinary Cancers Symposium in February 2019. The supplemental BLA also included supporting data from the Phase 1b KEYNOTE-035 trial. The FDA set a PDUFA date of June 20, 2019. Merck has filed data from KEYNOTE-426 with regulatory authorities worldwide. In February 2019, the Committee for Medicinal Products for Human Use of the European Medicines Agency (EMA) adopted a positive opinion recommending Keytruda , in combination with carboplatin and either paclitaxel or nab-paclitaxel, for the first-line treatment of metastatic squamous NSCLC in adults. This recommendation is based on results from the pivotal Phase 3 KEYNOTE-407 trial, which enrolled patients regardless of PD-L1 tumor expression status. The trial showed a significant improvement in OS and PFS for patients taking Keytruda in combination with chemotherapy (carboplatin and either paclitaxel or nab-paclitaxel) compared with chemotherapy alone. If approved, this would mark the first approval in Europe for an anti-PD-1 therapy in combination with chemotherapy for adults with metastatic squamous NSCLC. In October 2018, the FDA approved Keytruda in combination with carboplatin-paclitaxel or nab-paclitaxel as a first-line treatment for metastatic squamous NSCLC, regardless of PD-L1 expression. In December 2018, the FDA extended the action date for the supplemental BLA seeking approval for Keytruda as monotherapy for the first-line treatment of locally advanced or metastatic NSCLC in patients whose tumors express PD-L1 (TPS 1%) without EGFR or ALK genomic tumor aberrations. The supplemental BLA is based on results of the Phase 3 KEYNOTE-042 trial where Keytruda monotherapy demonstrated a significant improvement in OS compared with chemotherapy in this patient population. The Company submitted additional data and analyses to the FDA, which constituted a major amendment and extended the PDUFA date by three months to April 11, 2019. Merck continues to work closely with the FDA during the review of this supplemental BLA. In February 2019, the FDA accepted and granted Priority Review for a supplemental BLA for Keytruda as monotherapy for the treatment of patients with advanced SCLC whose disease has progressed after two or more lines of prior therapy. This supplemental BLA, which is seeking accelerated approval for this new indication, is based on data from the SCLC cohorts of the Phase 2 KEYNOTE-158 and Phase 1b KEYNOTE-028 trials. The FDA set a PDUFA date of June 17, 2019. Keytruda is also being studied in combination with chemotherapy in the ongoing Phase 3 KEYNOTE-604 study in patients with newly diagnosed extensive stage SCLC. In February 2019, the FDA accepted a supplemental BLA for Keytruda as monotherapy or in combination with platinum and 5-fluorouracil chemotherapy for the first-line treatment of patients with recurrent or metastatic HNSCC. This supplemental BLA is based in part on data from the pivotal Phase 3 KEYNOTE-048 trial where Keytruda demonstrated a significant improvement in OS compared with the standard of care, as monotherapy in patients whose tumors expressed PD-L1 with Combined Positive Score (CPS)20 and CPS1 and in combination with chemotherapy in the total patient population. These data were presented at the European Society for Medical Oncology (ESMO) 2018 Congress. The FDA granted Priority Review to the supplemental BLA and set a PDUFA date of June 10, 2019. KEYNOTE-048 also serves as the confirmatory trial for KEYNOTE-012, a Phase 1b study which supported the previous accelerated approval for Keytruda as monotherapy for the treatment of patients with recurrent or metastatic HNSCC with disease progression on or after platinum-containing chemotherapy. In November 2018, Merck announced that the Phase 3 KEYNOTE-181 trial investigating Keytruda as monotherapy in the second-line treatment of advanced or metastatic esophageal or esophagogastric junction carcinoma met a primary endpoint of OS in patients whose tumors expressed PD-L1 (CPS 10). In this pivotal study, treatment with Keytruda resulted in a statistically significant improvement in OS compared to chemotherapy (paclitaxel, docetaxel or irinotecan) in patients with CPS 10, regardless of histology. The primary endpoint of OS was also evaluated in patients with squamous cell histology and in the entire intention-to-treat study population. While directionally favorable, statistical significance for OS was not met in these two patient groups. Per the statistical analysis plan, the key secondary endpoints of PFS and objective response rate (ORR) were not formally tested, as OS was not reached in the full intention-to-treat study population. These results were presented in January 2019 at the ASCO Gastrointestinal Cancers Symposium and have been submitted for regulatory review. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy. The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In October 2018, Merck announced the first presentation of results from an interim analysis of KEYNOTE-057, a Phase 2 trial evaluating Keytruda for previously treated patients with high-risk non-muscle invasive bladder cancer. An interim analysis of the studys primary endpoint showed a complete response rate of nearly 40% at three months with Keytruda in patients whose disease was unresponsive to Bacillus Calmette-Gurin therapy, the current standard of care for this disease, and who were ineligible for or who refused to undergo radical cystectomy. These results, as well as other study findings, were presented at the ESMO 2018 Congress. In February 2019, Merck announced that the pivotal Phase 3 KEYNOTE-240 trial evaluating Keytruda , plus best supportive care, for the treatment of patients with advanced hepatocellular carcinoma who were previously treated with systemic therapy, did not meet its co-primary endpoints of OS and PFS compared with placebo plus best supportive care. In the final analysis of the study, there was an improvement in OS for patients treated with Keytruda compared to placebo, however these OS results did not meet statistical significance per the pre-specified statistical plan. Results for PFS were also directionally favorable in the Keytruda arm compared with placebo but did not reach statistical significance. The key secondary endpoint of ORR was not formally tested, since superiority was not reached for OS or PFS. Results will be presented at an upcoming medical meeting and have been shared with the FDA for discussion. The Keytruda clinical development program consists of more than 900 clinical trials, including more than 600 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, cervical, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, mesothelioma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. Lynparza, is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4 to the consolidated financial statements). In April 2018, Merck and AstraZeneca announced that the EMA validated for review the Marketing Authorization Application for Lynparza for use in patients with deleterious or suspected deleterious BRCA -mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. This was the first regulatory submission for a PARP inhibitor in breast cancer in Europe. Lynparza tablets are also under review in the EU as a maintenance treatment in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response following first-line standard platinum-based chemotherapy. This submission was based on positive results from the pivotal Phase 3 SOLO-1 trial. The trial showed a statistically-significant and clinically-meaningful improvement in PFS for Lynparza compared to placebo, reducing the risk of disease progression or death by 70% in patients with newly-diagnosed, BRCA -mutated advanced ovarian cancer who were in complete or partial response to platinum-based chemotherapy. In December 2018, Merck and AstraZeneca announced positive results from the randomized, open-label, controlled, Phase 3 SOLO-3 trial of Lynparza tablets in patients with relapsed ovarian cancer after two or more lines of treatment. The trial was conducted as a post-approval commitment in agreement with the FDA. Results from the trial showed BRCA -mutated advanced ovarian cancer patients treated with Lynparza following two or more prior lines of chemotherapy demonstrated a statistically significant and clinically meaningful improvement in the primary endpoint of ORR and the key secondary endpoint of PFS compared to chemotherapy. Merck and AstraZeneca plan to discuss these results with the FDA. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). In February 2019, Merck announced that the FDA accepted for Priority Review an NDA for MK-7655A for the treatment of complicated urinary tract infections and complicated intra-abdominal infections caused by certain susceptible Gram-negative bacteria in adults with limited or no alternative therapies available. The PDUFA date is July 16, 2019. In April 2018, Merck announced that a pivotal Phase 3 study of MK-7655A demonstrated a favorable overall response in the treatment of certain imipenem-non-susceptible bacterial infections, the primary endpoint, with lower treatment-emergent nephrotoxicity (kidney toxicity), a secondary endpoint, compared to a colistin (colistimethate sodium) plus imipenem/cilastatin regimen. The FDA had previously designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. V920 (rVSVG-ZEBOV-GP, live attenuated), is an investigational Ebola Zaire disease vaccine candidate being studied in large scale Phase 2/3 clinical trials. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The WHO decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In November 2018, Merck announced that it has started the submission of a rolling BLA to the FDA for V920. This rolling submission was made pursuant to the FDAs Breakthrough Therapy designation. Merck expects the rolling submission of the BLA to be completed in 2019. The Company also intends to file V920 with the EMA in 2019. In February 2019, Merck announced that the FDA accepted for Priority Review a supplemental NDA for Zerbaxa to treat adult patients with nosocomial pneumonia, including ventilator-associated pneumonia, caused by certain susceptible Gram-negative microorganisms. The PDUFA date is June 3, 2019. Zerbaxa is also under review for this indication by the EMA. Zerbaxa is currently approved in the United States for the treatment of adult patients with complicated urinary tract infections caused by certain susceptible Gram-negative microorganisms, and is also indicated, in combination with metronidazole, for the treatment of adult patients with complicated intra-abdominal infections caused by certain susceptible Gram-negative and Gram-positive microorganisms. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7264, gefapixant, is a selective, non-narcotic, orally-administered P2X3-receptor agonist being investigated in Phase 3 trials for the treatment of refractory, chronic cough and in a Phase 2 trial for the treatment of women with endometriosis-related pain. Lenvima, is an orally available tyrosine kinase inhibitor currently approved for certain types of thyroid cancer, hepatocellular carcinoma, and in combination for certain patients with renal cell carcinoma. In March 2018, Merck and Eisai entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima (see Note 4 to the consolidated financial statements). Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Keytruda . Per the agreement, the companies will jointly initiate clinical studies evaluating the Keytruda /Lenvima combination to support 11 potential indications in six types of cancer (endometrial cancer, NSCLC, hepatocellular carcinoma, head and neck cancer, bladder cancer and melanoma), as well as a basket trial targeting multiple cancer types. The FDA granted Breakthrough Therapy designation for Keytruda in combination with Lenvima for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma and for the potential treatment of certain patients with advanced and/or metastatic non-microsatellite instability high/proficient mismatch repair endometrial carcinoma. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure with reduced ejection fracture (Phase 3 clinical trial) and from chronic heart failure with preserved ejection fracture (Phase 2 clinical trial). The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). V114 is an investigational polyvalent conjugate vaccine for the prevention of pneumococcal disease. In June 2018, Merck initiated the first Phase 3 study in the adult population for the prevention of invasive pneumococcal disease. Currently five Phase 3 adult studies are ongoing, including studies in healthy adults 50 years of age or older, adults with risk factors for pneumococcal disease, those infected with HIV, and those who are recipients of allogeneic hematopoietic stem cell transplant. In October 2018, Merck began the first Phase 3 study in the pediatric population. Currently, three studies are ongoing, including studies in healthy infants and in children afflicted with sickle cell disease. In January 2019, Merck announced that V114 received Breakthrough Therapy designation from the FDA for the prevention of invasive pneumococcal disease caused by the vaccine serotypes in pediatric patients 6 weeks to 18 years of age. As a result of changes in the herpes zoster vaccine environment, Merck is ending development of V212, its investigational vaccine for the prevention of shingles in immunocompromised patients. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2018 , the balance of IPRD was $1.1 billion . The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date, and the Company may also not recover the research and development expenditures made since the acquisition to further develop such programs. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2018, 2017, and 2016 the Company recorded IPRD impairment charges within Research and development expenses of $152 million , $483 million and $3.6 billion , respectively (see Note 8 to the consolidated financial statements). Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain of the more recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks anti-PD-1 therapy, Keytruda . Under the agreement, Merck made an upfront payment to Eisai of $750 million and will make payments of up to $650 million for certain option rights through 2021 (of which $325 million will be paid in March 2019, $200 million is expected to be paid in 2020 and $125 million is expected to be paid in 2021). The Company recorded a charge of $1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for Eisai to receive up to $385 million associated with the achievement of certain clinical and regulatory milestones and up to $3.97 billion for the achievement of milestones associated with sales of Lenvima (see Note 4 to the consolidated financial statements). In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $378 million ). The transaction provided Merck with full rights to Cavatak (V937, formerly CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatak is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatak is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatak combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $34 million (primarily cash) at the acquisition date and Research and development expenses of $344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In February 2019, Merck and Immune Design entered into a definitive agreement under which Merck will acquire Immune Design for $5.85 per share in cash for an approximate value of $300 million. Immune Design is a late-stage immunotherapy company employing next-generation in vivo approaches to enable the bodys immune system to fight disease. Immune Designs proprietary technologies, GLAAS and ZVex, are engineered to activate the immune systems natural ability to generate and/or expand antigen-specific cytotoxic immune cells to fight cancer and other chronic diseases. Under the terms of the acquisition agreement, Merck, through a subsidiary, will initiate a tender offer to acquire all outstanding shares of Immune Design. The closing of the tender offer will be subject to certain conditions, including the tender of shares representing at least a majority of the total number of Immune Designs outstanding shares, the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and other customary conditions. The transaction is expected to close early in the second quarter of 2019. Capital Expenditures Capital expenditures were $2.6 billion in 2018 , $1.9 billion in 2017 and $1.6 billion in 2016 . Expenditures in the United States were $1.5 billion in 2018 , $1.2 billion in 2017 and $1.0 billion in 2016 . In October 2018, the Company announced it plans to invest approximately $16 billion on new capital projects from 2018-2022. The focus of this investment will primarily be on increasing manufacturing capacity across Mercks key businesses. Depreciation expense was $1.4 billion in 2018 , $1.5 billion in 2017 and $1.6 billion in 2016 . In each of these years, $1.0 billion of the depreciation expense applied to locations in the United States. Total depreciation expense in 2017 and 2016 included accelerated depreciation of $60 million and $227 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 3,669 $ 6,152 $ 13,410 Total debt to total liabilities and equity 30.4 % 27.8 % 26.0 % Cash provided by operations to total debt 0.4:1 0.3:1 0.4:1 The decline in working capital in 2018 compared with 2017 reflects the utilization of cash and short-term borrowings to fund $5.0 billion of ASR agreements, a $1.25 billion payment to redeem debt in connection with the exercise of a make-whole provision as discussed below, as well as a $750 million upfront payment related to the formation of a collaboration with Eisai discussed above. The decline in working capital in 2017 compared with 2016 primarily reflects the reclassification of $3.0 billion of notes due in the first half of 2018 from long-term debt to short-term debt, $1.85 billion of upfront and option payments related to the formation of the AstraZeneca collaboration discussed above, as well as $810 million paid to redeem debt in connection with tender offers discussed below. Cash provided by operating activities was $10.9 billion in 2018 , $6.5 billion in 2017 and $10.4 billion in 2016 . The lower cash provided by operating activities in 2017 reflects a $2.8 billion payment related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), payments of $1.85 billion related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), and a $625 million payment made by the Company related to the previously disclosed settlement of worldwide Keytruda patent litigation. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash provided by investing activities was $4.3 billion in 2018 compared with $2.7 billion in 2017. The increase in cash provided by investing activities was driven primarily by lower purchases of securities and other investments, partially offset by higher capital expenditures, lower proceeds from the sales of securities and other investments, and a $350 million milestone payment in 2018 related to a collaboration with Bayer (see Note 4 to the consolidated financial statements). Cash provided by investing activities was $2.7 billion in 2017 compared with a use of cash in investing activities of $3.2 billion in 2016. The change was driven primarily by lower purchases of securities and other investments, higher proceeds from the sales of securities and other investments and a lower use of cash for the acquisitions of businesses. Cash used in financing activities was $13.2 billion in 2018 compared with $10.0 billion in 2017. The increase in cash used in financing activities was driven primarily by higher purchases of treasury stock (largely under ASR agreements as discussed below), higher payments on debt and payment of contingent consideration related to a prior year business acquisition, partially offset by an increase in short-term borrowings. Cash used in financing activities was $10.0 billion in 2017 compared with $9.0 billion in 2016. The increase in cash used in financing activities was driven primarily by proceeds from the issuance of debt in 2016, as well as higher purchases of treasury stock and lower proceeds from the exercise of stock options in 2017, partially offset by lower payments on debt in 2017. The Companys contractual obligations as of December 31, 2018 are as follows: Payments Due by Period ($ in millions) Total 20202021 20222023 Thereafter Purchase obligations (1) $ 2,349 $ $ 1,011 $ $ Loans payable and current portion of long-term debt 5,309 5,309 Long-term debt 19,882 4,237 4,000 11,645 Interest related to debt obligations 7,680 1,163 4,923 Unrecognized tax benefits (2) Transition tax related to the enactment of the TCJA (3) 4,899 1,217 2,534 Leases $ 41,160 $ 7,364 $ 7,632 $ 6,774 $ 19,390 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) As of December 31, 2018 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $2.3 billion , including $44 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2019 cannot be made. (3) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years as permitted under the TCJA (see Note 16 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts reflected for research and development obligations do not include contingent milestone payments related to collaborative arrangements and acquisitions. Contingent milestone payments are not considered contractual obligations as they are contingent upon the successful achievement of developmental, regulatory approval and commercial milestones. At December 31, 2018 , the Company has liabilities for milestone payments related to collaborations with AstraZeneca, Eisai and Bayer (see Note 4 to the consolidated financial statements). Also excluded from research and development obligations are potential future funding commitments of up to approximately $40 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $149 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2019 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $50 million to its U.S. pension plans, $150 million to its international pension plans and $15 million to its other postretirement benefit plans during 2019 . In December 2018, the Company exercised a make-whole provision on its $1.25 billion , 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. In November 2016, the Company issued 1.0 billion principal amount of senior unsecured notes consisting of 500 million principal amount of 0.50% notes due 2024 and 500 million principal amount of 1.375% notes due 2036. The Company used the net proceeds of the offering of $1.1 billion for general corporate purposes. The Company has a $6.0 billion credit facility that matures in June 2023. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In March 2018, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In October 2018, Merck announced that its Board of Directors approved a 15% increase to the Companys quarterly dividend, raising it to $0.55 per share from $0.48 per share on the Companys outstanding common stock. Payment was made in January 2019. In January 2019 , the Board of Directors declared a quarterly dividend of $0.55 per share on the Companys common stock for the second quarter of 2019 payable in April 2019 . In November 2017, Mercks Board of Directors authorized purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. In October 2018, Mercks Board of Directors authorized an additional $10 billion of treasury stock purchases with no time limit for completion and the Company entered into ASR agreements of $5 billion as discussed below. The Company spent $9.1 billion to purchase shares of its common stock for its treasury during 2018 . As of December 31, 2018 , the Companys remaining share repurchase authorization was $11.9 billion. The Company purchased $4.0 billion and $3.4 billion of its common stock during 2017 and 2016 , respectively, under authorized share repurchase programs. On October 25, 2018, the Company entered into ASR agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The number of shares of Mercks common stock that Merck may receive, or may be required to remit, upon final settlement under the ASR agreements will be based upon the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount. Final settlement of the transaction under the ASR agreements is expected to occur in the first half of 2019, but may occur earlier at the option of the Dealers, or later under certain circumstances. If Merck is obligated to make adjustment payments to the Dealers under the ASR agreements, Merck may elect to satisfy such obligations in cash or in shares of Mercks common stock. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $441 million and $400 million at December 31, 2018 and 2017 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2018 and 2017 , Income before taxes would have declined by approximately $134 million and $92 million in 2018 and 2017 , respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The economy of Argentina was determined to be hyperinflationary in 2018; consequently, in accordance with U.S. GAAP, the Company began remeasuring its monetary assets and liabilities for those operations in earnings. The impact to the Companys results was immaterial. The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within Other Comprehensive Income (Loss) ( OCI ), and remain in Accumulated Other Comprehensive Income (Loss) ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . In accordance with the new guidance adopted on January 1, 2018 (see Note 2 to the consolidated financial statements), the Company has elected to recognize in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In May 2018, four interest rate swaps with notional amounts aggregating $1.0 billion matured. These swaps effectively converted the Companys $1.0 billion , 1.30% fixed-rate notes due 2018 to variable rate debt. In December 2018, in connection with the early repayment of debt, the Company settled three interest rate swaps with notional amounts aggregating $550 million . These swaps effectively converted a portion of the Companys $1.25 billion , 5.00% notes due 2019 to variable rate debt. At December 31, 2018 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at December 31, 2018 and 2017 would have positively affected the net aggregate market value of these instruments by $1.2 billion and $1.3 billion, respectively. A one percentage point decrease at December 31, 2018 and 2017 would have negatively affected the net aggregate market value by $1.4 billion and $1.5 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a separate determination as to the then-useful life of the asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Revenue Recognition On January 1, 2018, the Company adopted a new standard on revenue recognition (see Note 2 to the consolidated financial statements). Changes to the Companys revenue recognition policy as a result of adopting the new guidance are described below. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. Certain Merck entities, including U.S. entities, have contract terms under which control of the goods passes to the customer upon shipment; however, either pursuant to the terms of the contract or as a business practice, Merck retains responsibility for goods lost or damaged in transit. Prior to the adoption of the new standard, Merck would recognize revenue for these entities upon delivery of the goods. Under the new guidance, the Company is now recognizing revenue at time of shipment for these entities. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2018 , 2017 or 2016 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,551 $ 2,945 Current provision 10,837 11,001 Adjustments to prior years (117 ) (286 ) Payments (10,641 ) (11,109 ) Balance December 31 $ 2,630 $ 2,551 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $245 million and $2.4 billion , respectively, at December 31, 2018 and were $198 million and $2.4 billion , respectively, at December 31, 2017 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 1.6% in 2018, 2.1% in 2017 and 1.4% in 2016. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically net 36 days from receipt of invoice and for U.S. animal health customers are typically net 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above-mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at December 31, 2018 and 2017 were $7 million and $80 million , respectively. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2018 and 2017 of approximately $245 million and $160 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $16 million in 2018 , and are estimated at $57 million in the aggregate for the years 2019 through 2023 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $348 million in 2018 , $312 million in 2017 and $300 million in 2016 . At December 31, 2018 , there was $560 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $195 million in 2018 , $201 million in 2017 and $144 million in 2016 . Net periodic benefit (credit) for other postretirement benefit plans was $(45) million in 2018 , $(60) million in 2017 and $(88) million in 2016 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 4.00% to 4.40% at December 31, 2018 , compared with a range of 3.20% to 3.80% at December 31, 2017 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2019 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.10% , compared to a range of 7.70% to 8.30% in 2018 . The decrease is primarily due to a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 50% in U.S. equities, 15% to 30% in international equities, 30% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $80 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2018 . A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $50 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2018 . Required funding obligations for 2019 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of AOCI . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing termination costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Cost of sales , Selling, general and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the project. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized within the Companys operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments in marketable debt securities for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. Changes in fair value that are considered temporary are reported net of tax in OCI . An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2018 and 2017 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2018 , the notes to consolidated financial statements, and the report dated February 27, 2019 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 42,294 $ 40,122 $ 39,807 Costs, Expenses and Other Cost of sales 13,509 12,912 14,030 Selling, general and administrative 10,102 10,074 10,017 Research and development 9,752 10,339 10,261 Restructuring costs Other (income) expense, net (402 ) (500 ) 33,593 33,601 35,148 Income Before Taxes 8,701 6,521 4,659 Taxes on Income 2,508 4,103 Net Income 6,193 2,418 3,941 Less: Net (Loss) Income Attributable to Noncontrolling Interests (27 ) Net Income Attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 2.34 $ 0.88 $ 1.42 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 2.32 $ 0.87 $ 1.41 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Other Comprehensive (Loss) Income Net of Taxes: Net unrealized gain (loss) on derivatives, net of reclassifications (446 ) (66 ) Net unrealized loss on investments, net of reclassifications (10 ) (58 ) (44 ) Benefit plan net (loss) gain and prior service (cost) credit, net of amortization (425 ) (799 ) Cumulative translation adjustment (223 ) (169 ) (361 ) (1,078 ) Comprehensive Income Attributable to Merck Co., Inc. $ 5,859 $ 2,710 $ 2,842 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 7,965 $ 6,092 Short-term investments 2,406 Accounts receivable (net of allowance for doubtful accounts of $119 in 2018 and $159 in 2017) 7,071 6,873 Inventories (excludes inventories of $1,417 in 2018 and $1,187 in 2017 classified in Other assets - see Note 7) 5,440 5,096 Other current assets 4,500 4,299 Total current assets 25,875 24,766 Investments 6,233 12,125 Property, Plant and Equipment (at cost) Land Buildings 11,486 11,726 Machinery, equipment and office furnishings 14,441 14,649 Construction in progress 3,355 2,301 29,615 29,041 Less: accumulated depreciation 16,324 16,602 13,291 12,439 Goodwill 18,253 18,284 Other Intangibles, Net 11,431 14,183 Other Assets 7,554 6,075 $ 82,637 $ 87,872 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 5,308 $ 3,057 Trade accounts payable 3,318 3,102 Accrued and other current liabilities 10,151 10,427 Income taxes payable 1,971 Dividends payable 1,458 1,320 Total current liabilities 22,206 18,614 Long-Term Debt 19,806 21,353 Deferred Income Taxes 1,702 2,219 Other Noncurrent Liabilities 12,041 11,117 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2018 and 2017 1,788 1,788 Other paid-in capital 38,808 39,902 Retained earnings 42,579 41,350 Accumulated other comprehensive loss (5,545 ) (4,910 ) 77,630 78,130 Less treasury stock, at cost: 984,543,979 shares in 2018 and 880,491,914 shares in 2017 50,929 43,794 Total Merck Co., Inc. stockholders equity 26,701 34,336 Noncontrolling Interests Total equity 26,882 34,569 $ 82,637 $ 87,872 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2016 $1,788 $ 40,222 $ 45,348 $ (4,148 ) $ (38,534 ) $ $ 44,767 Net income attributable to Merck Co., Inc. 3,920 3,920 Other comprehensive loss, net of taxes (1,078 ) (1,078 ) Cash dividends declared on common stock ($1.85 per share) (5,135 ) (5,135 ) Treasury stock shares purchased (3,434 ) (3,434 ) Acquisition of The StayWell Company LLC Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (16 ) (16 ) Share-based compensation plans and other (283 ) 1,422 1,139 Balance December 31, 2016 1,788 39,939 44,133 (5,226 ) (40,546 ) 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) (5,177 ) (5,177 ) Treasury stock shares purchased (4,014 ) (4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (18 ) (18 ) Share-based compensation plans and other (37 ) Balance December 31, 2017 1,788 39,902 41,350 (4,910 ) (43,794 ) 34,569 Net income attributable to Merck Co., Inc. 6,220 6,220 Adoption of new accounting standards (see Note 2) (274 ) Other comprehensive loss, net of taxes (361 ) (361 ) Cash dividends declared on common stock ($1.99 per share) (5,313 ) (5,313 ) Treasury stock shares purchased (1,000 ) (8,091 ) (9,091 ) Net loss attributable to noncontrolling interests (27 ) (27 ) Distributions attributable to noncontrolling interests (25 ) (25 ) Share-based compensation plans and other (94 ) Balance December 31, 2018 $ 1,788 $ 38,808 $ 42,579 $ (5,545 ) $ (50,929 ) $ $ 26,882 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 6,193 $ 2,418 $ 3,941 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,519 4,676 5,471 Intangible asset impairment charges 3,948 Charge for future payments related to collaboration license options Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Charge related to the settlement of worldwide Keytruda patent litigation Deferred income taxes (509 ) (2,621 ) (1,521 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable (418 ) (619 ) Inventories (911 ) (145 ) Trade accounts payable Accrued and other current liabilities (341 ) (922 ) (2,018 ) Income taxes payable (3,291 ) Noncurrent liabilities (266 ) (123 ) (809 ) Other (674 ) (1,087 ) Net Cash Provided by Operating Activities 10,922 6,451 10,376 Cash Flows from Investing Activities Capital expenditures (2,615 ) (1,888 ) (1,614 ) Purchases of securities and other investments (7,994 ) (10,739 ) (15,651 ) Proceeds from sales of securities and other investments 15,252 15,664 14,353 Acquisitions, net of cash acquired (431 ) (396 ) (780 ) Other Net Cash Provided by (Used in) Investing Activities 4,314 2,679 (3,210 ) Cash Flows from Financing Activities Net change in short-term borrowings 5,124 (26 ) Payments on debt (4,287 ) (1,103 ) (2,386 ) Proceeds from issuance of debt 1,079 Purchases of treasury stock (9,091 ) (4,014 ) (3,434 ) Dividends paid to stockholders (5,172 ) (5,167 ) (5,124 ) Proceeds from exercise of stock options Other (325 ) (195 ) (118 ) Net Cash Used in Financing Activities (13,160 ) (10,006 ) (9,044 ) Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash (205 ) (131 ) Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash 1,871 (419 ) (2,009 ) Cash, Cash Equivalents and Restricted Cash at Beginning of Year (includes $4 million of restricted cash at January 1, 2018 included in Other Assets) 6,096 6,515 8,524 Cash, Cash Equivalents and Restricted Cash at End of Year (includes $2 million of restricted cash at December 31, 2018 included in Other Assets) $ 7,967 $ 6,096 $ 6,515 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. In 2017, Merck began recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9). 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired in-process research and development (IPRD) with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or net realizable value. The cost of a substantial majority of U.S. pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments in marketable debt securities are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). The Company considers available evidence in evaluating potential impairments of its investments in marketable debt securities, including the duration and extent to which fair value is less than cost. An other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the marketable debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for debt securities are included in Other (income) expense, net . Investments in publicly traded equity securities are reported at fair value determined using quoted market prices in active markets for identical assets or quoted prices for similar assets or other inputs that are observable or can be corroborated by observable market data. Changes in fair value are included in Other (income) expense, net . Investments in equity securities without readily determinable fair values are recorded at cost, plus or minus subsequent observable price changes in orderly transactions for identical or similar investments, minus impairments. Such adjustments are recognized in Other (income) expense, net . Realized gains and losses for equity securities are included in Other (income) expense, net . Revenue Recognition On January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers , and subsequent amendments (ASC 606 or new guidance), using the modified retrospective method. Merck applied the new guidance to all contracts with customers within the scope of the standard that were in effect on January 1, 2018 and recognized the cumulative effect of initially applying the new guidance as an adjustment to the opening balance of retained earnings (see Recently Adopted Accounting Standards below). Comparative information for prior periods has not been restated and continues to be reported under the accounting standards in effect for those periods. The new guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services. The new guidance introduces a 5-step model to recognize revenue when or as control is transferred: identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when or as the performance obligations are satisfied. Changes to the Companys revenue recognition policy as a result of adopting ASC 606 are described below. See Note 19 for disaggregated revenue disclosures. Recognition of revenue requires evidence of a contract, probable collection of sales proceeds and completion of substantially all performance obligations. Merck acts as the principal in substantially all of its customer arrangements and therefore records revenue on a gross basis. The majority of the Companys contracts related to the Pharmaceutical and Animal Health segments have a single performance obligation - the promise to transfer goods. Shipping is considered immaterial in the context of the overall customer arrangement and damages or loss of goods in transit are rare. Therefore, shipping is not deemed a separately recognized performance obligation. The vast majority of revenues from sales of products are recognized at a point in time when control of the goods is transferred to the customer, which the Company has determined is when title and risks and rewards of ownership transfer to the customer and the Company is entitled to payment. Certain Merck entities, including U.S. entities, have contract terms under which control of the goods passes to the customer upon shipment; however, either pursuant to the terms of the contract or as a business practice, Merck retains responsibility for goods lost or damaged in transit. Prior to the adoption of the new standard, Merck would recognize revenue for these entities upon delivery of the goods. Under the new guidance, the Company is now recognizing revenue at time of shipment for these entities. The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. For businesses within the Companys Healthcare Services segment and certain services in the Animal Health segment, revenue is recognized over time, generally ratably over the contract term as services are provided. These service revenues are not material. The nature of the Companys business gives rise to several types of variable consideration including discounts and returns, which are estimated at the time of sale generally using the expected value method, although the most likely amount method is used for prompt pay discounts. In the United States, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. The U.S. provision for aggregate customer discounts covering chargebacks and rebates was $10.7 billion in 2018, $10.7 billion in 2017 and $9.7 billion in 2016. Chargebacks are discounts that occur when a contracted customer purchases through an intermediary wholesaler. The contracted customer generally purchases product from the wholesaler at its contracted price plus a mark-up. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision for rebates is based on expected patient usage, as well as inventory levels in the distribution channel to determine the contractual obligation to the benefit providers. The Company uses historical customer segment utilization mix, sales forecasts, changes to product mix and price, inventory levels in the distribution channel, government pricing calculations and prior payment history in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers, federal and state agencies, and other customers to the amounts accrued. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $245 million and $2.4 billion , respectively, at December 31, 2018 and were $198 million and $2.4 billion , respectively, at December 31, 2017 . Outside of the United States, variable consideration in the form of discounts and rebates are a combination of commercially-driven discounts in highly competitive product classes, discounts required to gain or maintain reimbursement, or legislatively mandated rebates. In certain European countries, legislatively mandated rebates are calculated based on an estimate of the governments total unbudgeted spending and the Companys specific payback obligation. Rebates may also be required based on specific product sales thresholds. The Company applies an estimated factor against its actual invoiced sales to represent the expected level of future discount or rebate obligations associated with the sale. The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of generic competition, changes in formularies or launch of over-the-counter products, among others. Outside of the United States, returns are only allowed in certain countries on a limited basis. Mercks payment terms for U.S. pharmaceutical customers are typically net 36 days from receipt of invoice and for U.S. animal health customers are typically net 30 days from receipt of invoice; however, certain products, including Keytruda , have longer payment terms up to 90 days. Outside of the United States, payment terms are typically 30 days to 90 days, although certain markets have longer payment terms. The following table provides the effects of adopting ASC 606 on the Consolidated Statement of Income: Year Ended December 31, 2018 As Reported Effects of Adopting ASC 606 Amounts Without Adoption of ASC 606 Sales $ 42,294 $ (2 ) $ 42,292 Cost of sales 13,509 (6 ) 13,503 Income before taxes 8,701 8,705 Taxes on income 2,508 2,509 Net income attributable to Merck Co., Inc. 6,220 6,223 The following table provides the effects of adopting ASC 606 on the Consolidated Balance Sheet: December 31, 2018 As Reported Effects of Adopting ASC 606 Amounts Without Adoption of ASC 606 Assets Accounts receivable $ 7,071 $ (13 ) $ 7,058 Inventories 5,440 5,447 Liabilities Accrued and other current liabilities 10,151 (3 ) 10,148 Income taxes payable 1,971 (1 ) 1,970 Equity Retained earnings 42,579 (2 ) 42,577 Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $1.4 billion in 2018 , $1.5 billion in 2017 and $1.6 billion in 2016 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.1 billion , $2.2 billion and $2.1 billion in 2018 , 2017 and 2016 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $439 million and $449 million , net of accumulated amortization at December 31, 2018 and 2017 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. If the carrying value of a reporting unit is greater than its fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). Acquired Intangibles Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development Acquired IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then-useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Research and development expenses also include upfront and milestone payments related to asset acquisitions and licensing transactions involving clinical development programs that have not yet received regulatory approval. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, cost of sales and selling, general and administrative expenses on a gross basis. Profit sharing amounts it pays to its collaborative partners are recorded within Cost of sales . When the collaborative partner is the principal on sales transactions with third parties, the Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ). Alliance revenue is recorded net of cost of sales and includes an adjustment to share commercialization costs between the partners in accordance with the collaboration agreement. The adjustment is determined by comparing the commercialization costs Merck has incurred directly and reported within Selling, general and administrative expenses with the costs the collaborative partner has incurred. Research and development costs Merck incurs related to collaborations are recorded within Research and development expenses. Cost reimbursements to the collaborative partner or payments received from the collaborative partner to share these costs pursuant to the terms of the collaboration agreements are recorded as increases or decreases to Research and development expenses. In addition, the terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Cost of sales provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Cost of sales over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities, accruals for contingent sales-based milestone payments and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Adopted Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition (ASU 2014-09) that applies to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard was effective as of January 1, 2018 and was adopted using the modified retrospective method. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million . In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments (ASU 2016-01) and in 2018 issued related technical corrections (ASU 2018-03). The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The Company has elected to measure equity investments without readily determinable fair values at cost, adjusted for subsequent observable price changes and less impairments, which will be recognized in net income. The new guidance also changed certain disclosure requirements. ASU 2016-01 was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million . ASU 2018-03 was also adopted as of January 1, 2018 on a prospective basis and did not result in any additional impacts upon adoption. In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory (ASU 2016-16). The new guidance requires the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs, replacing the prohibition against doing so. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The new standard was effective as of January 1, 2018 and was adopted using a modified retrospective approach. The Company recorded a cumulative-effect adjustment upon adoption increasing Retained earnings by $54 million with a corresponding decrease to Deferred Income Taxes . In August 2017, the FASB issued new guidance on hedge accounting (ASU 2017-12) that is intended to more closely align hedge accounting with companies risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The Company elected to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The new guidance was applied to all existing hedges as of the adoption date. For fair value hedges of interest rate risk outstanding as of the date of adoption, the Company recorded a cumulative-effect adjustment upon adoption to the basis adjustment on the hedged item resulting from applying the benchmark component of the coupon guidance. This adjustment decreased Retained earnings by $11 million . Also, in accordance with the transition provisions of ASU 2017-12, the Company was required to eliminate the separate measurement of ineffectiveness for its cash flow hedging instruments existing as of the adoption date through a cumulative-effect adjustment to retained earnings; however, all such amounts were de minimis . In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the Tax Cuts and Jobs Act of 2017 (TCJA) (ASU 2018-02). Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of the stranded tax effects resulting from the TCJA from accumulated other comprehensive income to retained earnings thereby eliminating these stranded tax effects. The Company elected to early adopt the new guidance in the first quarter of 2018 and reclassified the stranded income tax effects of the TCJA, increasing Accumulated other comprehensive loss in the amount of $266 million with a corresponding increase to Retained earnings (see Note 18). The Companys policy for releasing disproportionate income tax effects from Accumulated other comprehensive loss is to utilize the item-by-item approach. The impact of adopting the above standards is as follows: ($ in millions) ASU 2014-09 (Revenue) ASU 2016-01 (Financial Instruments) ASU 2016-16 (Intra-Entity Transfers of Assets Other than Inventory) ASU 2017-12 (Derivatives and Hedging) ASU 2018-02 (Reclassification of Certain Tax Effects) Total Assets - Increase (Decrease) Accounts receivable $ $ Liabilities - Increase (Decrease) Income Taxes Payable (3 ) (3 ) Debt Deferred Income Taxes (54 ) (54 ) Equity - Increase (Decrease) Retained earnings (11 ) Accumulated other comprehensive loss (8 ) (266 ) (274 ) In March 2017, the FASB issued amended guidance on retirement benefits (ASU 2017-07) related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. The Company adopted the new standard as of January 1, 2018 using a retrospective transition method as to the requirement for separate presentation in the income statement of service costs and other components, and a prospective transition method as to the requirement to limit the capitalization of benefit costs to the service cost component. The Company utilized a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. Upon adoption, net periodic benefit cost (credit) other than service cost of $(512) million and $(531) million for the years ended December 31, 2017 and 2016, respectively, was reclassified to Other (income) expense, net from the previous classification within Cost of sales , Selling, general and administrative expenses and Research and development expenses (see Note 15). In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The Company adopted the new standard effective as of January 1, 2018 using a retrospective application. There were no changes to the presentation of the Consolidated Statement of Cash Flows in the previous years presented as a result of adopting the new standard. In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard was effective as of January 1, 2018 and was adopted using a retrospective application. The adoption of the new guidance did not have a material effect on the Companys Consolidated Statement of Cash Flows. In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted the new standard effective as of January 1, 2018 and will apply the new guidance to future share-based payment award modifications should they occur. In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The Company adopted the new standard in the fourth quarter of 2018 and applied the new guidance for purposes of its fourth quarter goodwill impairment assessment. The adoption of the new guidance had an immaterial effect on its consolidated financial statements. Recently Issued Accounting Standards Not Yet Adopted In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases and subsequently issued several updates to the new guidance. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new standard is effective as of January 1, 2019 and will be adopted using a modified retrospective approach. Merck will elect the transition method that allows for application of the standard at the adoption date rather than at the beginning of the earliest comparative period presented in the financial statements. The Company intends to elect available practical expedients. Merck has implemented a lease accounting software application and has completed data validation of the Companys portfolio of leases, including its assessment of potential embedded leases. Upon adoption, the Company anticipates it will recognize approximately $1 billion of additional assets and corresponding liabilities on its consolidated balance sheet, subject to finalization. In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In April 2018, the FASB issued new guidance on the accounting for costs incurred to implement a cloud computing arrangement that is considered a service arrangement. The new guidance requires the capitalization of such costs, aligning it with the accounting for costs associated with developing or obtaining internal-use software. The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. Prospective adoption for eligible costs incurred on or after the date of adoption or retrospective adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements and may elect to early adopt this guidance. In November 2018, the FASB issued new guidance for collaborative arrangements intended to reduce diversity in practice by clarifying whether certain transactions between collaborative arrangement participants should be accounted for under the recently issued guidance on revenue recognition (ASC 606). The new guidance is effective for interim and annual periods beginning in 2020. Early adoption is permitted, including adoption in any interim period. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings. The Company is currently evaluating the impact of adoption on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Announced Transaction In December 2018, Merck and privately held Antelliq Group (Antelliq) signed a definitive agreement under which Merck will acquire Antelliq from funds advised by BC Partners. Antelliq is a leader in digital animal identification, traceability and monitoring solutions. These solutions help veterinarians, farmers and pet owners gather critical data to improve management, health and well-being of livestock and pets. Merck will make a cash payment of approximately 2.1 billion (approximately $2.4 billion based on exchange rates at the time of the announcement) to acquire all outstanding shares of Antelliq and will assume Antelliqs debt of 1.1 billion (approximately $1.3 billion ), which it intends to repay shortly after the closing of the acquisition. The transaction is subject to clearance by antitrust and competition law authorities and other customary closing conditions, and is expected to close in the second quarter of 2019. 2018 Transactions In 2018, the Company recorded an aggregate charge of $423 million within Cost of sales in conjunction with the termination of a collaboration agreement entered into in 2014 with Samsung Bioepis Co., Ltd. (Samsung) for insulin glargine. The charge reflects a termination payment of $155 million , which represents the reimbursement of all fees previously paid by Samsung to Merck under the agreement, plus interest, as well as the release of Mercks ongoing obligations under the agreement. The charge also included fixed asset abandonment charges of $137 million , inventory write-offs of $122 million , as well as other related costs of $9 million . The termination of this agreement has no impact on the Companys other collaboration with Samsung. In June 2018, Merck acquired Viralytics Limited (Viralytics), an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 502 million ( $378 million ). The transaction provided Merck with full rights to Cavatak (V937, formerly CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatak is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatak is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatak combination in melanoma, prostate, lung and bladder cancers. The transaction was accounted for as an acquisition of an asset. Merck recorded net assets of $34 million (primarily cash) at the acquisition date and Research and development expenses of $344 million in 2018 related to the transaction. There are no future contingent payments associated with the acquisition. In March 2018, Merck and Eisai Co., Ltd. (Eisai) entered into a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai (see Note 4). 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, MK-4621 (formerly RGT100), is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca PLC (AstraZeneca) entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Valle for $358 million . Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $297 million related to currently marketed products, net deferred tax liabilities of $102 million , other net assets of $32 million and noncontrolling interest of $25 million . In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $156 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5% . Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Valle for $18 million , which reduced the noncontrolling interest related to Valle. 2016 Transactions In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferents lead investigational candidate, MK-7264 (formerly AF-219), gefapixant, is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough and for the treatment of endometriosis-related pain. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPRD of $832 million , net deferred tax liabilities of $258 million , and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. In 2018, as a result of the achievement of a clinical development milestone, Merck made a $175 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6). In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Mercks Keytruda . Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million , which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda . Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents. In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provided Merck with IOmets preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5% . Merck recognized intangible assets for IPRD of $155 million and net deferred tax assets of $32 million . The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5% . Actual cash flows are likely to be different than those assumed. In 2017, as a result of the achievement of a clinical development milestone, Merck made a $100 million payment, which was accrued for at estimated fair value at the time of acquisition as noted above. The contingent consideration liability was then remeasured at current fair value at each subsequent reporting period until payment was made (see Note 6). Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda and Imfinzi. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies are shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZeneca is currently the principal on Lynparza sales transactions. Merck records its share of Lynparza product sales, net of cost of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and will make payments of up to $750 million over a multi-year period for certain license options (of which $250 million was paid in December 2017, $400 million was paid in December 2018 and $100 million is expected be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license option payments. In addition, the agreement provides for additional contingent payments from Merck to AstraZeneca related to the successful achievement of regulatory and sales-based milestones. In 2018, Merck determined it was probable that annual sales of Lynparza in the future would trigger three sales-based milestone payments from Merck to AstraZeneca aggregating $600 million . Accordingly, in 2018, Merck recorded $600 million of liabilities and a corresponding increase to the intangible asset related to Lynparza, and recognized $58 million of cumulative amortization expense within Cost of sales . During 2018, one of the sales-based milestones was triggered, resulting in a $150 million payment to AstraZeneca. In 2018, Merck made an additional $100 million sales-based milestone payment, which was accrued for in 2017 when the Company deemed to the payment to be probable. The remaining $3.4 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer and for use in the first-line maintenance setting for advanced ovarian cancer, triggering capitalized milestone payments of $140 million in the aggregate from Merck to AstraZeneca. Potential future regulatory milestone payments of $1.76 billion remain under the agreement. The asset balance related to Lynparza (which includes capitalized sales-based and regulatory milestone payments) was $743 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2028 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Years Ended December 31 Alliance revenue $ $ Cost of sales (1) Selling, general and administrative Research and development (2) 2,419 December 31 Receivables from AstraZeneca included in Other current assets $ $ Payables to AstraZeneca included in Accrued and other current liabilities (3) Payables to AstraZeneca included Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Amount for 2017 includes $2.35 billion related to the upfront payment and future license option payments. (3) Includes accrued milestone and license option payments. Eisai In March 2018, Merck and Eisai announced a strategic collaboration for the worldwide co-development and co-commercialization of Lenvima, an orally available tyrosine kinase inhibitor discovered by Eisai. Under the agreement, Merck and Eisai will develop and commercialize Lenvima jointly, both as monotherapy and in combination with Mercks anti-PD-1 therapy, Keytruda . Eisai records Lenvima product sales globally (Eisai is the principal on Lenvima sales transactions), and Merck and Eisai share gross profits equally. Merck records its share of Lenvima product sales, net of cost of sales and commercialization costs, as alliance revenue. Expenses incurred during co-development, including for studies evaluating Lenvima as monotherapy, are shared equally by the two companies and reflected in Research and development expenses. Under the agreement, Merck made an upfront payment to Eisai of $750 million and will make payments of up to $650 million for certain option rights through 2021 (of which $325 million will be paid in March 2019, $200 million is expected to be paid in 2020 and $125 million is expected to be paid in 2021). The Company recorded an aggregate charge of $1.4 billion in Research and development expenses in 2018 related to the upfront payment and future option payments. In addition, the agreement provides for Eisai to receive up to $385 million associated with the achievement of certain clinical and regulatory milestones and up to $3.97 billion for the achievement of milestones associated with sales of Lenvima. In 2018, Merck determined it was probable that annual sales of Lenvima in the future would trigger three sales-based milestone payments from Merck to Eisai aggregating $268 million . Accordingly, in 2018, Merck recorded $268 million of liabilities and a corresponding increase to the intangible asset related to Lenvima, and recognized $24 million of cumulative amortization expense within Cost of sales . The remaining $3.71 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. In 2018, Lenvima was approved for the treatment of patients with unresectable hepatocellular carcinoma in the United States, the European Union, Japan and China, triggering capitalized milestone payments to Eisai of $250 million in the aggregate. Potential future regulatory milestone payments of $135 million remain under the agreement. The asset balance related to Lenvima (which includes capitalized sales-based and regulatory milestone payments) was $479 million at December 31, 2018 and is included in Other Assets on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2026 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Year Ended December 31 Alliance revenue $ Cost of sales (1) Selling, general and administrative Research and development (2) 1,489 December 31 Receivables from Eisai included in Other current assets $ Payables to Eisai included in Accrued and other current liabilities (3) Payables to Eisai included in Other Noncurrent Liabilities (3) (1) Represents amortization of capitalized milestone payments. (2) Includes $1.4 billion related to the upfront payment and future option payments. (3) Includes accrued milestone and option payments. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas, which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies have implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Revenue from Adempas includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. In 2018, Merck determined it was probable that annual worldwide sales of Adempas in the future would trigger a $375 million sales-based milestone payment from Merck to Bayer. Accordingly, Merck recorded a $375 million noncurrent liability and a corresponding increase to the intangible asset related to Adempas, and recognized $106 million of cumulative amortization expense within Cost of sales . In 2018, the Company made a $350 million milestone payment to Bayer, which was accrued for in 2016 when Merck deemed the payment to be probable. There is an additional $400 million potential future sales-based milestone payment that has not yet been accrued as it is not deemed by the Company to be probable at this time. The intangible asset balance related to Adempas (which includes the remaining acquired intangible asset balance, as well as capitalized sales-based milestone payments) was $1.0 billion at December 31, 2018 and is included in Other Intangibles, Net on the Consolidated Balance Sheet. The amount is being amortized over its estimated useful life through 2027 as supported by projected future cash flows, subject to impairment testing. Summarized information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share from sales in Bayers marketing territories Total sales Cost of sales (1) Selling, general and administrative Research and development December 31 Receivables from Bayer included in Other current assets $ $ Payables to Bayer included in Accrued and other current liabilities (2) Payables to Bayer included in Other Noncurrent Liabilities (2) (1) Includes amortization of intangible assets. (2) Includes accrued milestone payments. Aggregate amortization expense related to capitalized license costs recorded within Cost of sales was $186 million in 2018 , $39 million in 2017 and $30 million in 2016 . The estimated aggregate amortization expense for each of the next five years is as follows: 2019 , $196 million ; 2020 , $193 million ; 2021 , $191 million ; 2022 , $187 million ; 2023 , $181 million . 5. Restructuring In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. The Company recorded total pretax costs of $658 million in 2018 , $927 million in 2017 and $1.1 billion in 2016 related to restructuring program activities. Since inception of the programs through December 31, 2018 , Merck has recorded total pretax accumulated costs of approximately $14.1 billion and eliminated approximately 45,510 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. The Company has substantially completed the actions under these programs. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2018 Cost of sales $ $ $ $ Selling, general and administrative Research and development (13 ) Restructuring costs $ $ (1 ) $ $ Year Ended December 31, 2017 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2016 Cost of sales $ $ $ $ Selling, general and administrative Research and development Restructuring costs $ $ $ $ 1,069 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,160 in 2018 , 2,450 in 2017 and 2,625 in 2016 . Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2018 , 2017 and 2016 includes $141 million , $267 million and $409 million , respectively, of asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $151 million in 2016 . The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2017 $ $ $ $ Expenses (Payments) receipts, net (328 ) (394 ) (722 ) Non-cash activity (60 ) Restructuring reserves December 31, 2017 Expenses (1 ) (Payments) receipts, net (649 ) (238 ) (887 ) Non-cash activity Restructuring reserves December 31, 2018 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2020. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company also uses forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations. The unrealized gains or losses on these contracts are recorded in foreign currency translation adjustment within OCI , and remain in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The Company excludes certain portions of the change in fair value of its derivative instruments from the assessment of hedge effectiveness (excluded component). Changes in fair value of the excluded components are recognized in OCI . In accordance with the new guidance adopted on January 1, 2018 (see Note 2), the Company has elected to recognize in earnings the initial value of the excluded component on a straight-line basis over the life of the derivative instrument, rather than using the mark-to-market approach. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . The effects of the Companys net investment hedges on OCI and the Consolidated Statement of Income are shown below: Amount of Pretax (Gain) Loss Recognized in Other Comprehensive Income (1) Amount of Pretax (Gain) Loss Recognized in Other (income) expense, net for Amounts Excluded from Effectiveness Testing Years Ended December 31 Net Investment Hedging Relationships Foreign exchange contracts $ (18 ) $ $ $ (11 ) $ $ (1 ) Euro-denominated notes (183 ) (193 ) (1) No amounts were reclassified from AOCI into income related to the sale of a subsidiary. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. In May 2018, four interest rate swaps with notional amounts aggregating $1.0 billion matured. These swaps effectively converted the Companys $1.0 billion , 1.30% fixed-rate notes due 2018 to variable rate debt. In December 2018, in connection with the early repayment of debt, the Company settled three interest rate swaps with notional amounts aggregating $550 million . These swaps effectively converted a portion of the Companys $1.25 billion , 5.00% notes due 2019 to variable rate debt. At December 31, 2018 , the Company was a party to 19 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.85% notes due 2020 $ 1,250 $ 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense along with the offsetting fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The table below presents the location of amounts recorded on the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges as of December 31: Carrying Amount of Hedged Liabilities Cumulative Amount of Fair Value Hedging Adjustment Increase (Decrease) Included in the Carrying Amount Balance Sheet Line Item in which Hedged Item is Included Loans payable and current portion of long-term debt $ $ $ $ (17 ) Long-Term Debt (1) 4,560 5,146 (82 ) (41 ) (1) Amounts include hedging adjustment gains related to discontinued hedging relationships of $11 million at December 31, 2017. Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other assets $ $ $ $ $ $ Interest rate swap contracts Accrued and other current liabilities 1,000 Interest rate swap contracts Other noncurrent liabilities 4,650 4,650 Foreign exchange contracts Other current assets 6,222 4,216 Foreign exchange contracts Other assets 2,655 1,936 Foreign exchange contracts Accrued and other current liabilities 2,014 Foreign exchange contracts Other noncurrent liabilities $ $ $ 14,390 $ $ $ 14,386 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 5,430 $ $ $ 3,778 Foreign exchange contracts Accrued and other current liabilities 9,922 7,431 $ $ $ 15,352 $ $ $ 11,209 $ $ $ 29,742 $ $ $ 25,595 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet (121 ) (121 ) (94 ) (94 ) Cash collateral received (107 ) (3 ) Net amounts $ $ $ $ 90 The table below provides information regarding the location and amount of pretax (gains) losses of derivatives designated in fair value or cash flow hedging relationships: Sales Other (income) expense, net (1) Other comprehensive income (loss) Years Ended December 31 Financial Statement Line Items in which Effects of Fair Value or Cash Flow Hedges are Recorded $ 42,294 $ 40,122 $ 39,807 $ (402 ) (500 ) $ (361 ) $ $ (1,078 ) (Gain) loss on fair value hedging relationships Interest rate swap contracts Hedged items (27 ) (48 ) (29 ) Derivatives designated as hedging instruments (35 ) Impact of cash flow hedging relationships Foreign exchange contracts Amount of gain (loss) recognized in OCI on derivatives (562 ) (Decrease) increase in Sales as a result of AOCI reclassifications (160 ) (138 ) (311 ) (1) Interest expense is a component of Other (income) expense, net. The table below provides information regarding the income statement effects of derivatives not designated as hedging instruments: Amount of Derivative Pretax (Gain) Loss Recognized in Income Years Ended December 31 Income Statement Caption Derivatives Not Designated as Hedging Instruments Foreign exchange contracts (1) Other (income) expense, net $ (260 ) $ $ Foreign exchange contracts (2) Sales (8 ) (3 ) (1) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. (2) These derivative contracts serve as economic hedges of forecasted transactions. At December 31, 2018 , the Company estimates $186 million of pretax net unrealized gains on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Fair Value Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Gains Losses Gains Losses Corporate notes and bonds $ 4,920 $ 4,985 $ $ (68 ) $ 9,806 $ 9,837 $ $ (40 ) Asset-backed securities 1,275 1,285 (11 ) 1,542 1,548 (7 ) U.S. government and agency securities (5 ) 2,042 2,059 (17 ) Foreign government bonds (1 ) (6 ) Mortgage-backed securities (9 ) Commercial paper Total debt securities 7,261 7,340 (85 ) 14,908 14,976 (79 ) Publicly traded equity securities (1) (6 ) Total debt and publicly traded equity securities $ 7,717 $ 15,183 $ 15,241 $ $ (85 ) (1) Pursuant to the adoption of ASU 2016-01 (see Note 2), beginning on January 1, 2018, changes in the fair value of publicly traded equity securities are recognized in net income. Unrealized net losses of $35 million were recognized in Other (income) expense, net during 2018 on equity securities still held at December 31, 2018 . At December 31, 2018 , the Company also had $568 million of equity investments without readily determinable fair values included in Other Assets . During 2018 , the Company recognized unrealized gains of $167 million in Other (income) expense, net on certain of these equity investments based on favorable observable price changes from transactions involving similar investments of the same investee. In addition, during 2018 , the Company recognized unrealized losses of $26 million in Other (income) expense, net related to certain of these investments based on unfavorable observable price changes. Available-for-sale debt securities included in Short-term investments totaled $894 million at December 31, 2018 . Of the remaining debt securities, $5.8 billion mature within five years. At December 31, 2018 and 2017 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Investments Corporate notes and bonds $ $ 4,835 $ $ 4,835 $ $ 9,678 $ $ 9,678 Asset-backed securities (1) 1,253 1,253 1,476 1,476 U.S. government and agency securities 1,767 1,835 Foreign government bonds Mortgage-backed securities Commercial paper Publicly traded equity securities 6,985 7,132 14,359 14,531 Other assets (2) U.S. government and agency securities Corporate notes and bonds Asset-backed securities (1) Mortgage-backed securities Foreign government bonds Publicly traded equity securities 221 171 Derivative assets (3) Forward exchange contracts Purchased currency options Interest rate swaps Total assets $ $ 7,660 $ $ 8,171 $ $ 14,970 $ $ 15,313 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (3) Interest rate swaps Forward exchange contracts Written currency options Total liabilities $ $ $ $ $ $ $ $ 1,152 (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. (2) Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. There were no transfers between Level 1 and Level 2 during 2018 . As of December 31, 2018 , Cash and cash equivalents of $8.0 billion include $7.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) Additions Payments (244 ) (100 ) Fair value December 31 (2) $ $ (1) Recorded in Research and development expenses, Cost of sales and Other (income) expense, net . Includes cumulative translation adjustments. (2) Balance at December 31, 2018 includes $89 million recorded as a current liability for amounts expected to be paid within the next 12 months. The changes in the estimated fair value of liabilities for contingent consideration in 2018 were largely attributable to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture in 2016 (see Note 9), partially offset by the reversal of a liability related to the discontinuation of a program obtained in connection with the acquisition of SmartCells (see Note 8). The changes in the estimated fair value of liabilities for contingent consideration in 2017 primarily relate to increases in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The payments of contingent consideration in 2018 include $175 million related to the achievement of a clinical milestone in connection with the acquisition of Afferent (see Note 3). The remaining payments in 2018 relate to liabilities recorded in connection with the termination of the SPMSD joint venture. The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3). Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2018 , was $25.6 billion compared with a carrying value of $25.1 billion and at December 31, 2017 , was $25.6 billion compared with a carrying value of $24.4 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation and Cardinal Health, Inc., which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2018 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. Cash collateral received by the Company from various counterparties was $107 million and $3 million at December 31, 2018 and 2017 , respectively. The obligation to return such collateral is recorded in Accrued and other current liabilities . No cash collateral was advanced by the Company to counterparties as of December 31, 2018 or 2017 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,658 $ 1,334 Raw materials and work in process 5,004 4,703 Supplies Total (approximates current cost) 6,856 6,238 Increase to LIFO costs $ 6,857 $ 6,283 Recognized as: Inventories $ 5,440 $ 5,096 Other assets 1,417 1,187 Inventories valued under the LIFO method comprised approximately $2.5 billion and $2.2 billion at December 31, 2018 and 2017 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2018 and 2017 , these amounts included $1.4 billion and $1.1 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $7 million and $80 million at December 31, 2018 and 2017 , respectively, of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical Animal Health All Other Total Balance January 1, 2017 $ 16,075 $ 1,708 $ $ 18,162 Acquisitions Impairments (38 ) (38 ) Other (1) (9 ) (8 ) (17 ) Balance December 31, 2017 (2) 16,066 1,877 18,284 Acquisitions Impairments (144 ) (144 ) Other (1) (24 ) Balance December 31, 2018 (2) $ 16,162 $ 1,870 $ $ 18,253 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2018 and 2017 were $369 million and $225 million , respectively. The additions to goodwill within the Animal Health segment in 2017 primarily relate to the acquisition of Valle (see Note 3). The impairments of goodwill within other non-reportable segments in 2018 and 2017 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 46,615 $ 37,585 $ 9,030 $ 46,693 $ 34,950 $ 11,743 IPRD 1,064 1,064 1,194 1,194 Tradenames Other 2,403 1,168 1,235 2,035 1,134 $ 50,291 $ 38,860 $ 11,431 $ 50,131 $ 35,948 $ 14,183 Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles related to marketed products (included in products and product rights above) at December 31, 2018 include Zerbaxa , $2.7 billion ; Sivextro , $833 million ; Implanon/Nexplanon $470 million ; Dificid , $395 million ; Gardasil/Gardasil 9, $384 million ; Bridion , $275 million ; and Simponi , $194 million . The Company has an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $1.0 billion at December 31, 2018 reflected in Other in the table above. During 2017 and 2016 , the Company recorded impairment charges related to marketed products and other intangibles of $58 million and $347 million , respectively, within Cost of sales . During 2017, the Company recorded an intangible asset impairment charge of $47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A are being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. In 2016, the Company lowered its cash flow projections for Zontivity, a product for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in an impairment charge of $252 million . Also during 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek, allergy immunotherapy tablets that, for business reasons, the Company returned to the licensor. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. In 2018, the Company recorded $152 million of IPRD impairment charges within Research and development expenses. Of this amount, $139 million relates to the write-off of the remaining intangible asset balance for a program obtained in connection with the SmartCells acquisition following a decision to terminate the program due to product development issues. The Company previously recorded an impairment charge in 2016 for the other programs obtained in connection with the acquisition of SmartCells as described below. The discontinuation of this clinical development program resulted in a reversal of the related liability for contingent consideration of $60 million (see Note 6). In 2017, the Company recorded $483 million of IPRD impairment charges. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion related to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million , resulting in the recognition of the impairment charge noted above. The IPRD impairment charges in 2016 also included charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM Biotherapeutics Ltd. and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million related to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also included $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily related to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration. The IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Cost of sales was $2.9 billion in 2018 , $3.2 billion in 2017 and $3.8 billion in 2016 . The estimated aggregate amortization expense for each of the next five years is as follows: 2019 , $1.5 billion ; 2020 , $1.2 billion ; 2021 , $1.1 billion ; 2022 , $1.1 billion ; 2023 , $1.1 billion . 9. Joint Ventures and Other Equity Method Affiliates Sanofi Pasteur MSD In 1994, Merck and Pasteur Mrieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture (SPMSD) to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.0 billion for 2016. On December 31, 2016, Merck and Sanofi Pasteur (Sanofi) terminated SPMSD and ended their joint vaccines operations in Europe. Under the terms of the termination, Merck acquired Sanofis 50% interest in SPMSD in exchange for consideration of $657 million comprised of cash, as well as future royalties of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $416 million on the date of termination. The Company accounted for this transaction as a step acquisition, which required that Merck remeasure its ownership interest (previously accounted for as an equity method investment) to fair value at the acquisition date. Merck in turn sold to Sanofi its intellectual property rights held by SPMSD in exchange for consideration of $596 million comprised of cash and future royalties of 11.5% on net sales of all Sanofi products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $302 million on the date of termination. Excluded from this arrangement are sales of Vaxelis (a jointly developed pediatric hexavalent combination vaccine that was approved by the European Commission in 2016 and by the U.S. Food and Drug Administration in 2018). The European marketing rights for Vaxelis were transferred to a separate equally-owned joint venture between Sanofi and Merck. The net impact of the termination of the SPMSD joint venture is as follows: Products and product rights (8-year useful life) $ Accounts receivable Income taxes payable (221 ) Deferred income tax liabilities (147 ) Other, net Net assets acquired Consideration payable to Sanofi, net (392 ) Derecognition of Mercks previously held equity investment in SPMSD (183 ) Increase in net assets Mercks share of restructuring costs related to the termination (77 ) Net gain on termination of SPMSD joint venture (1) $ (1) Recorded in Other (income) expense, net . The estimated fair values of identifiable intangible assets related to products and product rights were determined using an income approach through which fair value is estimated based on market participant expectations of each assets projected net cash flows. The projected net cash flows were then discounted to present value utilizing a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Of the amount recorded for products and product rights, $468 million related to Gardasil/Gardasil 9. The fair value of liabilities for contingent consideration related to Mercks future royalty payments to Sanofi of $416 million (reflected in the consideration payable to Sanofi, net, in the table above) was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% used to present value the cash flows. Changes in the inputs could result in a different fair value measurement. Based on an existing accounting policy election, Merck did not record the $302 million estimated fair value of contingent future royalties to be received from Sanofi on the sale of Sanofi products, but rather is recognizing such amounts as sales occur and the royalties are earned. The Company incurred $24 million of transaction costs related to the termination of SPMSD included in Selling, general and administrative expenses in 2016. Pro forma financial information for this transaction has not been presented as the results are not significant when compared with the Companys financial results. AstraZeneca LP In 1982, Merck entered into an agreement with Astra AB (Astra) to develop and market Astra products under a royalty-bearing license. In 1993, Mercks total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (AMI), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astras new prescription medicines in the United States. In 1998, Merck and Astra completed a restructuring of the ownership and operations of the joint venture whereby Merck acquired Astras interest in AMI, renamed KBI Inc. (KBI), and contributed KBIs operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (AZLP) upon Astras 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. Merck earned revenue based on sales of KBI products and earned certain Partnership returns from AZLP. On June 30, 2014, AstraZeneca exercised its option to purchase Mercks interest in KBI (and redeem Mercks remaining interest in AZLP). A portion of the exercise price, which remained subject to a true-up in 2018 based on actual sales of Nexium and Prilosec from closing in 2014 to June 2018, was deferred and recognized as income as the contingency was eliminated as sales occurred. Once the deferred income amount was fully recognized, in 2016, the Company began recognizing income and a corresponding receivable for amounts that would be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized income of $99 million in 2018, $232 million in 2017, and $98 million in 2016 (including $5 million of remaining deferred income) in Other (income) expense, net related to these amounts. In January 2019, the Company received $424 million from AstraZeneca in settlement of these amounts, which concludes the transactions related to the 2014 termination of Companys relationship with AZLP. 10. Loans Payable, Long-Term Debt and Other Commitments Loans payable at December 31, 2018 included $5.1 billion of commercial paper and $149 million of long-dated notes that are subject to repayment at the option of the holders. Loans payable at December 31, 2017 included $3.0 billion of notes due in 2018 and $73 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 2.09% and 0.85% for the years ended December 31, 2018 and 2017 , respectively. Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,490 $ 2,488 3.70% notes due 2045 1,974 1,973 2.80% notes due 2023 1,745 1,744 4.15% notes due 2043 1,237 1,237 1.85% notes due 2020 1,231 1,232 2.35% notes due 2022 1,214 1,220 1.125% euro-denominated notes due 2021 1,134 1,185 3.875% notes due 2021 1,132 1,140 1.875% euro-denominated notes due 2026 1,127 1,178 2.40% notes due 2022 6.50% notes due 2033 Floating-rate notes due 2020 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 5.00% notes due 2019 1,260 Other $ 19,806 $ 21,353 Other (as presented in the table above) includes $223 million and $300 million at December 31, 2018 and 2017 , respectively, of borrowings at variable rates that resulted in effective interest rates of 2.27% and 1.42% for 2018 and 2017 , respectively. With the exception of the 6.30% debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In December 2018, the Company exercised a make-whole provision on its $1.25 billion , 5.00% notes due 2019 and repaid this debt. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers and recognized a loss on extinguishment of debt of $191 million in 2017. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with covenants and, at December 31, 2018 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2019 , no maturities; 2020 , $1.9 billion ; 2021 , $2.3 billion ; 2022 , $2.2 billion ; 2023 , $1.7 billion . The Company has a $6.0 billion credit facility that matures in June 2023. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Rental expense under operating leases, net of sublease income, was $322 million in 2018 , $327 million in 2017 and $292 million in 2016 . The minimum aggregate rental commitments under noncancellable leases are as follows: 2019 , $188 million ; 2020 , $198 million ; 2021 , $150 million ; 2022 , $134 million ; 2023 , $84 million and thereafter, $243 million . The Company has no significant capital leases. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial position, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2018 , approximately 3,900 cases have been filed and either are pending or conditionally dismissed (as noted below) against Merck in either federal or state court. Plaintiffs in the vast majority of these cases generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . In March 2011, Merck submitted a Motion to Transfer to the Judicial Panel on Multidistrict Litigation (JPML) seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. All federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). In March 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court in August 2017, seeking review of the Third Circuits decision. In December 2017, the Supreme Court invited the Solicitor General to file a brief in the case expressing the views of the United States, and in May 2018, the Solicitor General submitted a brief stating that the Third Circuits decision was wrongly decided and recommended that the Supreme Court grant Mercks cert petition. The Supreme Court granted Mercks petition in June 2018, and an oral argument before the Supreme Court was held on January 7, 2019. The final decision on the Femur Fracture MDL courts preemption ruling is now pending before the Supreme Court. Accordingly, as of December 31, 2018 , nine cases were actively pending in the Femur Fracture MDL, and approximately 1,055 cases have either been dismissed without prejudice or administratively closed pending final resolution by the Supreme Court of the appeal of the Femur Fracture MDL courts preemption order. As of December 31, 2018 , approximately 2,555 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015, and Merck has continued to select additional cases to be reviewed through fact discovery from 2016 to the present. As of December 31, 2018 , approximately 275 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs selected, as the first trial. The Galper trial began in February 2015 and the jury returned a verdict in Mercks favor in April 2015, and plaintiff appealed that verdict to the California appellate court. In April 2017, the California appellate court issued a decision affirming the lower courts judgment in favor of Merck. The next Femur Fracture trial in California that was scheduled to begin in April 2016 was stayed at plaintiffs request and a new trial date has not been set. Additionally, there are four Femur Fracture cases pending in other state courts. Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2018 , Merck is aware of approximately 1,290 product users alleging that Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. Most claims have been filed in multidistrict litigation before the U.S. District Court for the Southern District of California (MDL). Outside of the MDL, the majority of claims have been filed in coordinated proceedings before the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court-in separate opinions-granted summary judgment to defendants on grounds of federal preemption. Plaintiffs appealed in both forums. In November 2017, the U.S. Court of Appeals for the Ninth Circuit vacated the judgment and remanded for further discovery, which is ongoing. In November 2018, the California state appellate court reversed and remanded on similar grounds. As of December 31, 2018 , eight product users have claims pending against Merck in state courts other than California, including Illinois. In June 2017, the Illinois trial court denied Mercks motion for summary judgment based on federal preemption. Merck appealed, and the Illinois appellate court affirmed in December 2018. Merck intends to appeal that ruling. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Vioxx As previously disclosed, Merck is a defendant in a lawsuit brought by the Attorney General of Utah alleging that Merck misrepresented the safety of Vioxx . The lawsuit is pending in Utah state court. Utah seeks damages and penalties under the Utah False Claims Act. A bench trial in this matter is currently scheduled for July 2019. Propecia/Proscar As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar . The lawsuits were filed in various federal courts and in state court in New Jersey. The federal lawsuits were then consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey were consolidated before Judge Hyland in Middlesex County (NJ Coordinated Proceedings). As previously disclosed, on April 9, 2018, Merck and the Plaintiffs Executive Committee in the Propecia MDL and the Plaintiffs Liaison Counsel in the NJ Coordinated Proceedings entered into an agreement to resolve the above mentioned Propecia/Proscar lawsuits for an aggregate amount of $4.3 million . The settlement was subject to certain contingencies, including 95% plaintiff participation and a per plaintiff clawback if the participation rate was less than 100%. The contingencies were satisfied and the settlement agreement was finalized. After the settlement, fewer than 25 cases remain pending in the United States. The Company intends to defend against any remaining unsettled lawsuits. Governmental Proceedings As previously disclosed, the Company has learned that the Prosecution Office of Milan, Italy is investigating interactions between the Companys Italian subsidiary, certain employees of the subsidiary and certain Italian health care providers. The Company understands that this is part of a larger investigation involving engagements between various health care companies and those health care providers. The Company is cooperating with the investigation. As previously disclosed, the United Kingdom (UK) Competition and Markets Authority (CMA) issued a Statement of Objections against the Company and MSD Sharp Dohme Limited (MSD UK) in May 2017. In the Statement of Objections, the CMA alleges that MSD UK abused a dominant position through a discount program for Remicade over the period from March 2015 to February 2016. The Company and MSD UK are contesting the CMAs allegations. As previously disclosed, the Company has received an investigative subpoena from the California Insurance Commissioners Fraud Bureau (Bureau) seeking information from January 1, 2007 to the present related to the pricing and promotion of Cubicin . The Bureau is investigating whether Cubist Pharmaceuticals, Inc., which the Company acquired in 2015, unlawfully induced the presentation of false claims for Cubicin to private insurers under the California Insurance Code False Claims Act. The Company is cooperating with the investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation Zetia Antitrust Litigation As previously disclosed, Merck, MSD, Schering Corporation and MSP Singapore Company LLC (collectively, the Merck Defendants) are defendants in putative class action and opt-out lawsuits filed in 2018 on behalf of direct and indirect purchasers of Zetia alleging violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. The cases have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Rebecca Beach Smith in the Eastern District of Virginia. On December 6, 2018, the court denied the Merck Defendants motions to dismiss or stay the direct purchaser putative class actions pending bilateral arbitration. On February 6, 2019, the magistrate judge issued a report and recommendation recommending that the district judge grant in part and deny in part defendants motions to dismiss on non-arbitration issues. On February 20, 2019, defendants and retailer opt-out plaintiffs filed objections to the report and recommendation. After responses are filed, the parties will await a decision from the district judge. Rotavirus Vaccines Antitrust Litigation As previously disclosed, MSD is a defendant in putative class action lawsuits filed in 2018 on behalf of direct purchasers of RotaTeq , alleging violations of federal antitrust laws. The cases were consolidated in the Eastern District of Pennsylvania. On January 23, 2019, the court denied MSDs motions to compel arbitration and to dismiss the consolidated complaint. On February 19, 2019, MSD appealed the courts order on arbitration to the Third Circuit, and on February 22, 2019, the court granted MSDs motion to vacate existing deadlines in the district court in light of the appeal. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. In October 2014, the court denied the Companys motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. In April 2016, the court granted plaintiffs motion for conditional certification but denied plaintiffs motions to extend the liability period for their Equal Pay Act claims back to June 2009. In April 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals opted-in to this action; the opt-in period has closed. In August 2017, plaintiffs filed their motion for class certification. This motion sought to certify a Title VII pay discrimination class and also sought final collective action certification of plaintiffs Equal Pay Act claim. On October 1, 2018, the parties entered into an agreement to fully resolve the Smith sales force litigation. As part of the settlement and in exchange for a full and general release of all individual and class claims, the Company agreed to pay $8.5 million . The settlement agreement, which contains an opt-out clause allowing Merck to pull out of the agreement if 30 or more individuals opt out, will be subject to court approval. On December 18, 2018, plaintiffs filed a motion with the court seeking preliminary approval of the settlement. Qui Tam Litigation As previously disclosed, in June 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery, which is ongoing. The Company continues to defend against these lawsuits. Merck KGaA Litigation As previously disclosed, in January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), historically operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, India, Australia, Singapore, Hong Kong, and China alleging, among other things, unfair competition, trademark infringement and/or corporate name infringement. In the UK, Australia, Singapore, Hong Kong, and India, KGaA also alleges breach of the parties coexistence agreement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe and constitute unfair competition. The Company and KGaA appealed the decision, and the appeal was heard in May 2017. In June 2017, the French appeals court held that certain of the activities by the Company directed to France constituted unfair competition or trademark infringement and, in December 2017, the Company decided not to pursue any further appeal. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaAs trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Companys use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal was heard in June 2017. In November 2017, the UK Court of Appeals affirmed the decision on the co-existence agreement and remitted for re-hearing issues of trademark infringement, the scope of KGaAs UK trademarks for pharmaceutical products, and the relief to which KGaA would be entitled. The re-hearing was held, and no decision has been handed down. In November 2018, the District Court in Hamburg, Germany dismissed all of KGaAs claims concerning KGaAs EU trademark with respect to the territory of the EU. In accordance with the Judgment of the Court of Justice of the EU delivered in October 2017, the District Court in Hamburg further held that it had no jurisdiction over the claim by KGaA insofar as the claim related to the territory of the UK. KGaA has appealed this decision. Further decisions from the District Court in Hamburg, Germany, in connection with claims concerning KGaAs EU trademark, German trademark and trade name rights as well as unfair competition law with respect to the territory of Germany are expected on February 28, 2019. In January 2019, the Mexican Trademark Office issued a decision on KGaAs action. The court found no trademark infringement by the Company and dismissed all of KGaAs claims for trademark infringement. The court ruled against the Company on KGaAs unfair competition claim. Both KGaA and the Company have appealed this decision. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Inegy The patents protecting Inegy in Europe have expired but supplemental protection certificates (SPCs) have been granted to the Company in many European countries that will expire in April 2019. There are multiple challenges to the SPCs related to Inegy throughout Europe and generic products have been launched in Austria, France, Italy, Ireland, Spain, Portugal, Germany, and the Netherlands. The Company has filed for preliminary injunctions in many countries that are still pending decision. Preliminary injunctions are presently in force in Austria, Czech Republic, Greece, Norway, Portugal, and Slovakia. Preliminary injunctions have been denied or revoked in Germany, Ireland, the Netherlands and Spain. The Company is appealing those decisions. In France and Belgium, preliminary injunctions were granted against some companies and denied against others, and appeals are pending. The SPC was held valid in merits proceedings in Portugal and France. The Company has filed and will continue to file actions for patent infringement seeking damages against those companies that launch generic products before April 2019. Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the district court held the patent valid and infringed. Actavis appealed this decision. While the appeal was pending, the parties reached a settlement, subject to certain terms of the agreement being met, whereby Actavis can launch its generic version prior to expiry of the patent and pediatric exclusivity under certain conditions. In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In November 2017, the parties reached a settlement whereby Roxane can launch its generic version prior to expiry of the patent under certain conditions. In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil injection. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions. In February 2018, the Company filed a lawsuit against Fresenius Kabi USA, LLC (Fresenius) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In November 2018, the Company reached a settlement with Fresenius, whereby Fresenius can launch its generic version of the intravenous product prior to expiry of the patent under certain conditions. In March 2018, the Company filed a lawsuit against Mylan Laboratories Limited in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . Nasonex Nasonex lost market exclusivity in the United States in 2016. Prior to that, in April 2015, the Company filed a patent infringement lawsuit against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotexs marketed product that the Company believed was infringing. In January 2018, the Company and Apotex settled this matter with Apotex agreeing to pay the Company $115 million plus certain other consideration. Januvia, Janumet, Janumet XR In February 2019, Par Pharmaceutical, Inc. (Par Pharmaceutical) filed suit against the Company in the U.S. District Court for the District of New Jersey, seeking a declaratory judgment of invalidity of a patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026. A judgment in its favor may allow Par Pharmaceutical to bring to market a generic version of Janumet XR following the expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent it is challenging. In response, the Company filed a patent infringement lawsuit in the U.S. District Court for the District of Delaware against Par Pharmaceutical and additional companies that also indicated an intent to market generic versions of Januvia , Janumet , and Janumet XR following expiration of key patent protection in 2022, but prior to the expiration of the later-granted patent owned by the Company covering certain salt and polymorphic forms of sitagliptin that expires in 2026, and a later granted patent owned by the Company covering the Janumet formulation which expires in 2028. No schedule for the cases has been set by the court. Gilead Patent Litigation and Opposition The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation against Gilead in the United States, Germany, and France based on different patent estates that would be infringed by Gileads sales of their two products, Sovaldi and Harvoni. Gilead opposed the European patent at the European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion . The Company submitted post-trial motions, including on the issues of enhanced damages and future royalties. Gilead submitted post-trial motions for judgment as a matter of law. A hearing on the motions was held in September 2017. Also, in September 2017, the court denied the Companys motion on enhanced damages, granted its motion on prejudgment interest and deferred its motion on future royalties. In February 2018, the court granted Gileads motion for judgment as a matter of law and found the patent was invalid for a lack of enablement. The Company appealed this decision. The appellate briefing is completed and the Company is waiting for the oral argument to be scheduled. The EPO opposition division revoked the European patent, and the Company appealed this decision. The cases in France and Germany have been stayed pending the final decision of the EPO. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial position, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2018 and 2017 of approximately $245 million and $160 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters As previously disclosed, Mercks facilities in Oss, the Netherlands, were inspected in 2012 by the Province of Brabant (Province) pursuant to the Dutch Hazards of Major Accidents Decree and the sites environmental permits. The Province issued penalties for alleged violations of regulations governing preventing and managing accidents with hazardous substances, and the government also issued a fine for alleged environmental violations at one of the Oss facilities, which together totaled $235 thousand . The Company was subsequently advised that a criminal investigation had been initiated based upon certain of the issues that formed the basis of the administrative enforcement action by the Province. As previously disclosed, the matter was settled, without any admission of liability, for an aggregate payment of 400 thousand . The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $71 million and $82 million at December 31, 2018 and 2017 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $60 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) (17 ) (15 ) (28 ) Balance December 31 3,577 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. On October 25, 2018, the Company entered into accelerated share repurchase (ASR) agreements with two third-party financial institutions (Dealers). Under the ASR agreements, Merck agreed to purchase $5 billion of Mercks common stock, in total, with an initial delivery of 56.7 million shares of Mercks common stock, based on the then-current market price, made by the Dealers to Merck, and payments of $5 billion made by Merck to the Dealers on October 29, 2018, which were funded with existing cash and investments, as well as short-term borrowings. The payments to the Dealers were recorded as reductions to shareholders equity, consisting of a $4 billion increase in treasury stock, which reflects the value of the initial 56.7 million shares received on October 29, 2018, and a $1 billion decrease in other-paid-in capital, which reflects the value of the stock held back by the Dealers pending final settlement. The number of shares of Mercks common stock that Merck may receive, or may be required to remit, upon final settlement under the ASR agreements will be based upon the average daily volume weighted-average price of Mercks common stock during the term of the ASR program, less a negotiated discount. Final settlement of the transaction under the ASR agreements is expected to occur in the first half of 2019, but may occur earlier at the option of the Dealers, or later under certain circumstances. If Merck is obligated to make adjustment payments to the Dealers under the ASR agreements, Merck may elect to satisfy such obligations in cash or in shares of Mercks common stock. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2018 , 111 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled primarily with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards generally vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2018 , 2017 and 2016 was $348 million , $312 million and $300 million , respectively, with related income tax benefits of $55 million , $57 million and $92 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2018 , 2017 and 2016 was $58.15 , $63.88 and $54.63 per option, respectively. The weighted average fair value of options granted in 2018 , 2017 and 2016 was $8.26 , $7.04 and $5.89 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.4 % 3.6 % 3.8 % Risk-free interest rate 2.9 % 2.0 % 1.4 % Expected volatility 19.1 % 17.8 % 19.6 % Expected life (years) 6.1 6.1 6.2 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2018 36,274 $ 46.77 Granted 3,520 58.15 Exercised (14,598 ) 40.51 Forfeited (1,389 ) 53.80 Outstanding December 31, 2018 23,807 $ 51.89 5.95 $ Exercisable December 31, 2018 16,184 $ 48.85 4.82 $ Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options 109 A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2018 13,609 $ 59.32 1,868 $ 60.03 Granted 7,270 58.46 1,081 57.17 Vested (3,766 ) 59.66 (758 ) 57.59 Forfeited (985 ) 59.30 (152 ) 60.06 Nonvested December 31, 2018 16,128 $ 58.85 2,039 $ 59.42 At December 31, 2018 , there was $560 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (851 ) (862 ) (831 ) (431 ) (393 ) (382 ) (83 ) (78 ) (107 ) Amortization of unrecognized prior service cost (50 ) (53 ) (55 ) (13 ) (11 ) (11 ) (84 ) (98 ) (106 ) Net loss amortization Termination benefits Curtailments (4 ) (1 ) (8 ) (31 ) (18 ) Settlements Net periodic benefit cost (credit) $ $ $ (1 ) $ $ $ $ (45 ) $ (60 ) $ (88 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. In connection with restructuring actions (see Note 5), termination charges were recorded in 2018 , 2017 and 2016 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. The components of net periodic benefit cost (credit) other than the service cost component are included in Other (income) expense, net (see Note 15), with the exception of certain amounts for termination benefits, curtailments and settlements, which are recorded in Restructuring costs if the event giving rise to the termination benefits, curtailment or settlement is related to restructuring actions as noted above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 10,896 $ 9,766 $ 9,339 $ 7,794 $ 1,114 $ 1,019 Actual return on plan assets (810 ) 1,723 (289 ) (72 ) Company contributions, net (4 ) Effects of exchange rate changes (352 ) Benefits paid (772 ) (651 ) (202 ) (198 ) (80 ) (62 ) Settlements (44 ) (106 ) (17 ) Other Fair value of plan assets December 31 $ 9,648 $ 10,896 $ 8,580 $ 9,339 $ $ 1,114 Benefit obligation January 1 $ 11,904 $ 10,849 $ 9,483 $ 8,372 $ 1,922 $ 1,922 Service cost Interest cost Actuarial (gains) losses (1) (1,258 ) (154 ) (7 ) (341 ) (87 ) Benefits paid (772 ) (651 ) (202 ) (198 ) (80 ) (62 ) Effects of exchange rate changes (387 ) (6 ) Plan amendments (22 ) (9 ) Curtailments (2 ) (3 ) Termination benefits Settlements (44 ) (106 ) (17 ) Other Benefit obligation December 31 $ 10,620 $ 11,904 $ 9,083 $ 9,483 $ 1,615 $ 1,922 Funded status December 31 $ (972 ) $ (1,008 ) $ (503 ) $ (144 ) $ (647 ) $ (808 ) Recognized as: Other assets $ $ $ $ $ $ Accrued and other current liabilities (47 ) (59 ) (14 ) (17 ) (10 ) (11 ) Other noncurrent liabilities (925 ) (949 ) (1,148 ) (955 ) (637 ) (797 ) (1) Actuarial (gains) losses in 2018 and 2017 primarily reflect changes in discount rates. At December 31, 2018 and 2017 , the accumulated benefit obligation was $19.0 billion and $20.5 billion , respectively, for all pension plans, of which $10.4 billion and $11.5 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 10,620 $ 11,904 $ 6,251 $ 3,323 Fair value of plan assets 9,648 10,896 5,089 2,352 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ 9,702 $ $ 5,936 $ 2,120 Fair value of plan assets 8,966 5,071 1,346 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2018 and 2017 , $826 million and $488 million , respectively, or approximately 5% and 2% , respectively, of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Equity securities Developed markets 2,172 2,172 2,743 2,743 Fixed income securities Government and agency obligations 1,509 1,509 Corporate obligations 1,246 1,246 Mortgage and asset-backed securities Other investments Net assets in fair value hierarchy $ 2,502 $ 3,017 $ $ 5,532 $ 3,277 $ 1,897 $ $ 5,189 Investments measured at NAV (1) 4,116 5,707 Plan assets at fair value $ 9,648 $ 10,896 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,071 3,532 3,326 3,888 Emerging markets equities Government and agency obligations 2,082 2,454 2,095 2,344 Corporate obligations Fixed income obligations Real estate (2) Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (3) Other Net assets in fair value hierarchy $ 1,497 $ 5,809 $ $ 8,119 $ 1,602 $ 6,462 $ $ 8,537 Investments measured at NAV (1) Plan assets at fair value $ 8,580 $ 9,339 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017 . (2) The plans Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds. (3) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (3 ) (3 ) (2 ) (2 ) Relating to assets sold during the year Purchases and sales, net (3 ) (3 ) (5 ) (5 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (32 ) (32 ) Purchases and sales, net (1 ) (2 ) Transfers into Level 3 (7 ) (7 ) Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Net assets in fair value hierarchy $ $ $ $ $ $ $ $ Investments measured at NAV (1) Plan assets at fair value $ $ 1,114 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2018 and 2017 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 30% to 50% in U.S. equities, 15% to 30% in international equities, 30% to 45% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 11% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2019 are approximately $50 million for U.S. pension plans, approximately $150 million for international pension plans and approximately $15 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2020 2021 2022 2023 2024 2028 3,805 1,349 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ (397 ) $ (19 ) $ (743 ) $ (505 ) $ $ (380 ) $ $ $ (45 ) Prior service (cost) credit arising during the period (4 ) (13 ) (10 ) (10 ) (2 ) (31 ) (19 ) $ (401 ) $ (32 ) $ (753 ) $ (515 ) $ $ (382 ) $ $ $ (64 ) Net loss amortization included in benefit cost $ $ $ $ $ $ $ $ $ Prior service (credit) cost amortization included in benefit cost (50 ) (53 ) (55 ) (13 ) (11 ) (11 ) (84 ) (98 ) (106 ) $ $ $ $ $ $ $ (83 ) $ (97 ) $ (103 ) The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net periodic benefit cost during 2019 are $204 million and $(62) million , respectively, for pension plans (of which $141 million and $(50) million , respectively, relates to U.S. pension plans) and $(7) million and $(78) million , respectively, for other postretirement benefit plans. Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 3.70 % 4.30 % 4.70 % 2.10 % 2.20 % 2.80 % Expected rate of return on plan assets 8.20 % 8.70 % 8.60 % 5.10 % 5.10 % 5.60 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.90 % 2.90 % 2.90 % Benefit obligation Discount rate 4.40 % 3.70 % 4.30 % 2.20 % 2.10 % 2.20 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.80 % 2.90 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return within each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2019 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.10% , as compared to a range of 7.70% to 8.30% in 2018 . The decrease is primarily due to a modest shift in asset allocation. The change in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2016 to 2018 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 7.0 % 7.2 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate A one percentage point change in the health care cost trend rate would have had the following effects: One Percentage Point Increase Decrease Effect on total service and interest cost components $ $ (9 ) Effect on benefit obligation (74 ) Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2018 , 2017 and 2016 were $136 million , $131 million and $126 million , respectively. 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ (343 ) $ (385 ) $ (328 ) Interest expense Exchange losses (gains) (11 ) Income on investments in equity securities, net (1) (324 ) (352 ) (43 ) Net periodic defined benefit plan (credit) cost other than service cost (512 ) (512 ) (531 ) Other, net (140 ) $ (402 ) $ (500 ) $ (1) Includes net realized and unrealized gains and losses on investments in equity securities either owned directly or through ownership interests in investment funds. Income on investments in equity securities, net, in 2018 reflects the recognition of unrealized net gains pursuant to the prospective adoption of ASU 2016-01 on January 1, 2018 (see Note 2). The increase in income on investments in equity securities, net, in 2017 was driven primarily by higher realized gains on sales. Other, net (as presented in the table above) in 2018 includes a gain of $115 million related to the settlement of certain patent litigation (see Note 11), income of $99 million related to AstraZenecas option exercise (see Note 9), and a gain of $85 million resulting from the receipt of a milestone payment for an out-licensed migraine clinical development program. Other, net in 2018 also includes $144 million of goodwill impairment charges related to certain businesses in the Healthcare Services segment (see Note 8), as well as $41 million of charges related to the write-down of assets held for sale to fair value in anticipation of the dissolution of the Companys joint venture with Supera Farma Laboratorios S.A. in Brazil. Other, net in 2017 includes income of $232 million related to AstraZenecas option exercise and a $191 million loss on extinguishment of debt (see Note 10). Other, net in 2016 includes a charge of $625 million related to the previously disclosed settlement of worldwide patent litigation related to Keytruda , a gain of $117 million related to the settlement of other patent litigation, gains of $100 million resulting from the receipt of milestone payments for out-licensed migraine clinical development programs, and $98 million of income related to AstraZenecas option exercise. Interest paid was $777 million in 2018 , $723 million in 2017 and $686 million in 2016 . 16. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 1,827 21.0 % $ 2,282 35.0 % $ 1,631 35.0 % Differential arising from: Impact of the TCJA 3.3 2,625 40.3 Valuation allowances 3.1 9.7 (5 ) (0.1 ) Impact of purchase accounting adjustments, including amortization 3.1 10.9 13.4 State taxes 2.3 1.2 3.7 Restructuring 0.6 2.2 3.1 Foreign earnings (245 ) (2.8 ) (1,654 ) (25.4 ) (1,546 ) (33.2 ) RD tax credit (96 ) (1.1 ) (71 ) (1.1 ) (58 ) (1.3 ) Tax settlements (22 ) (0.3 ) (356 ) (5.5 ) Other (1) (38 ) (0.4 ) (287 ) (4.4 ) (245 ) (5.2 ) $ 2,508 28.8 % $ 4,103 62.9 % $ 15.4 % (1) Other includes the tax effects of losses on foreign subsidiaries and miscellaneous items. The Companys 2017 effective tax rate reflected a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduced the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. The Company reflected the impact of the TCJA in its 2017 financial statements. However, since application of certain provisions of the TCJA remained subject to further interpretation, in certain instances the Company made reasonable estimates of the effects of the TCJA. In 2018, these amounts were finalized as described below. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount in 2017 for its one-time transition tax liability of $5.3 billion . This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. On the basis of revised calculations of post-1986 undistributed foreign EP and finalization of the amounts held in cash or other specified assets, the Company recognized a measurement-period adjustment of $124 million in 2018 related to the transition tax obligation, with a corresponding adjustment to income tax expense during the period, resulting in a revised transition tax obligation of $5.5 billion . The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment. As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. After payment of the amount due in 2018, the remaining transition tax liability at December 31, 2018, is $4.9 billion , of which $275 million is included in Income Taxes Payable and the remainder of $4.6 billion is included in Other Noncurrent Liabilities . As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply. In 2017, the Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million . On the basis of clarifications to the deferred tax benefit calculation, the Company recorded measurement-period adjustments in 2018 of $32 million related to deferred income taxes. Beginning in 2018, the TCJA includes a tax on global intangible low-taxed income (GILTI) as defined in the TCJA. The Company has made an accounting policy election to account for the tax effects of the GILTI tax in the income tax provision in future periods as the tax arises. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate compared with the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate compared to the U.S. statutory rate of 35% in 2017 and 2016 and 21% in 2018. Income before taxes consisted of: Years Ended December 31 Domestic $ 3,717 $ 3,483 $ Foreign 4,984 3,038 4,141 $ 8,701 $ 6,521 $ 4,659 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ $ 5,585 $ 1,166 Foreign 2,281 1,229 State (90 ) 3,017 6,724 2,239 Deferred provision Federal (402 ) (2,958 ) (1,255 ) Foreign (64 ) (225 ) State (43 ) (41 ) (509 ) (2,621 ) (1,521 ) $ 2,508 $ 4,103 $ 119 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Product intangibles and licenses $ $ 1,640 $ $ 2,256 Inventory related Accelerated depreciation Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other Subtotal 3,118 2,816 2,895 3,641 Valuation allowance (1,348 ) (900 ) Total deferred taxes $ 1,770 $ 2,816 $ 1,995 $ 3,641 Net deferred income taxes $ 1,046 $ 1,646 Recognized as: Other assets $ $ Deferred income taxes $ 1,702 $ 2,219 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2018 , $715 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $1.3 billion have been established on these foreign NOL carryforwards and other foreign deferred tax assets. The Company has no NOL carryforwards relating to U.S. jurisdictions. Income taxes paid in 2018 , 2017 and 2016 were $1.5 billion , $4.9 billion and $1.8 billion , respectively. Tax benefits relating to stock option exercises were $77 million in 2018 , $73 million in 2017 and $147 million in 2016 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 1,723 $ 3,494 $ 3,448 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) (73 ) (1,038 ) (90 ) Settlements (1) (91 ) (1,388 ) (92 ) Lapse of statute of limitations (29 ) (11 ) (43 ) Balance December 31 $ 1,893 $ 1,723 $ 3,494 (1) Amounts reflect the settlements with the IRS as discussed below. If the Company were to recognize the unrecognized tax benefits of $1.9 billion at December 31, 2018 , the income tax provision would reflect a favorable net impact of $1.8 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2018 could decrease by up to approximately $750 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Expenses for interest and penalties associated with uncertain tax positions amounted to $51 million in 2018 , $183 million in 2017 and $134 million in 2016 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $372 million and $341 million as of December 31, 2018 and 2017 , respectively. In 2017, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. The IRS is currently conducting examinations of the Companys tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress and for these jurisdictions, the Companys income tax returns are open for examination for the period 2003 through 2018. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 6,220 $ 2,394 $ 3,920 Average common shares outstanding 2,664 2,730 2,766 Common shares issuable (1) Average common shares outstanding assuming dilution 2,679 2,748 2,787 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 2.34 $ 0.88 $ 1.42 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 2.32 $ 0.87 $ 1.41 (1) Issuable primarily under share-based compensation plans. In 2018 , 2017 and 2016 , 6 million , 5 million and 13 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2016, net of taxes $ $ $ (2,407 ) $ (2,186 ) $ (4,148 ) Other comprehensive income (loss) before reclassification adjustments, pretax (38 ) (1,199 ) (150 ) (1,177 ) Tax (72 ) (19 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (836 ) (169 ) (889 ) Reclassification adjustments, pretax (314 ) (1) (31 ) (2) (3) (308 ) Tax Reclassification adjustments, net of taxes (204 ) (22 ) (189 ) Other comprehensive income (loss), net of taxes (66 ) (44 ) (799 ) (169 ) (1,078 ) Balance December 31, 2016, net of taxes (3 ) (3,206 ) (2,355 ) (5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax (561 ) Tax (35 ) (106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (354 ) Reclassification adjustments, pretax (141 ) (1) (291 ) (2) (3) (315 ) Tax (30 ) Reclassification adjustments, net of taxes (92 ) (235 ) (240 ) Other comprehensive income (loss), net of taxes (446 ) (58 ) Balance December 31, 2017, net of taxes (108 ) (61 ) (2,787 ) (4) (1,954 ) (4,910 ) Other comprehensive income (loss) before reclassification adjustments, pretax (108 ) (728 ) (84 ) (692 ) Tax (55 ) (139 ) (24 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (107 ) (559 ) (223 ) (716 ) Reclassification adjustments, pretax (1) (2) (3) Tax (33 ) (36 ) (69 ) Reclassification adjustments, net of taxes Other comprehensive income (loss), net of taxes (10 ) (425 ) (223 ) (361 ) Adoption of ASU 2018-02 (see Note 2) (23 ) (344 ) (266 ) Adoption of ASU 2016-01 (see Note 2) (8 ) (8 ) Balance December 31, 2018, net of taxes $ $ (78 ) $ (3,556 ) (4) $ (2,077 ) $ (5,545 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . In 2017 and 2016, these amounts included both investments in debt and equity securities; however, as a result of the adoption of ASU 2016-01 (see Note 2), in 2018, these amounts relate only to investments in available-for-sale debt securities. (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 4.4 billion and $3.5 billion at December 31, 2018 and 2017 , respectively, and other postretirement benefit plan net (gain) loss of $(170) million and $(16) million at December 31, 2018 and 2017 , respectively, as well as pension plan prior service credit of $314 million and $326 million at December 31, 2018 and 2017 , respectively, and other postretirement benefit plan prior service credit of $375 million and $383 million at December 31, 2018 and 2017 , respectively. 19. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical and Animal Health segments are the only reportable segments. The Animal Health segment met the criteria for separate reporting and became a reportable segment in 2018. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Companys SPMSD joint venture until its termination on December 31, 2016 (see Note 9). The Animal Health segment discovers, develops, manufactures and markets animal health products, including pharmaceutical and vaccine products, for the prevention, treatment and control of disease in all major livestock and companion animal species, which the Company sells to veterinarians, distributors and animal producers. The Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Alliances segment primarily includes activity from the Companys relationship with AstraZeneca LP related to sales of Nexium and Prilosec, which concluded in 2018 (see Note 9). Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Pharmaceutical: Oncology Keytruda $ 4,150 $ 3,021 $ 7,171 $ 2,309 $ 1,500 $ 3,809 $ $ $ 1,402 Emend Temodar Alliance revenue - Lynparza Alliance revenue - Lenvima Vaccines (1) Gardasil/Gardasil 9 1,873 1,279 3,151 1,565 2,308 1,780 2,173 ProQuad/M-M-R II/Varivax 1,430 1,798 1,374 1,676 1,362 1,640 Pneumovax 23 RotaTeq Zostavax Hospital Acute Care Bridion Noxafil Invanz Cubicin 1,087 Cancidas Primaxin Immunology Simponi Remicade 1,268 1,268 Neuroscience Belsomra Virology Isentress/Isentress HD 1,140 1,204 1,387 Zepatier 1,660 Cardiovascular Zetia 1,344 1,588 2,560 Vytorin 1,141 Atozet Adempas Diabetes Januvia 1,969 1,718 3,686 2,153 1,584 3,737 2,286 1,622 3,908 Janumet 1,417 2,228 1,296 2,158 1,217 2,201 Womens Health NuvaRing Implanon/Nexplanon Diversified Brands Singulair Cozaar/Hyzaar Nasonex Arcoxia Follistim AQ Dulera Fosamax Other pharmaceutical (2) 1,228 2,855 4,090 1,148 2,917 4,065 1,261 3,158 4,420 Total Pharmaceutical segment sales 16,608 21,081 37,689 15,854 19,536 35,390 17,073 18,077 35,151 Animal Health: Livestock 2,102 2,630 2,013 2,484 1,841 2,287 Companion Animals 1,582 1,391 1,191 Total Animal Health segment sales 1,238 2,974 4,212 1,090 2,785 3,875 2,489 3,478 Other segment sales (3) Total segment sales 18,094 24,057 42,151 17,340 22,322 39,662 18,447 20,566 39,014 Other (4) $ 18,212 $ 24,083 $ 42,294 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 U.S. plus international may not equal total due to rounding. (1) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2018 and 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 do, however, include supply sales to SPMSD. (2) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (3) Represents the non-reportable segments of Healthcare Services and Alliances. (4) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2018, 2017 and 2016 also includes approximately $95 million , $85 million and $170 million , respectively, related to the sale of the marketing rights to certain products. Consolidated revenues by geographic area where derived are as follows: Years Ended December 31 United States $ 18,212 $ 17,424 $ 18,478 Europe, Middle East and Africa 12,213 11,478 10,953 Japan 3,212 3,122 2,846 Asia Pacific (other than Japan and China) 2,909 2,751 2,483 Latin America 2,415 2,339 2,155 China 2,184 1,586 1,435 Other 1,149 1,422 1,457 $ 42,294 $ 40,122 $ 39,807 A reconciliation of segment profits to Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 24,292 $ 22,495 $ 22,141 Animal Health segment 1,659 1,552 1,357 Other segments Total segment profits 26,054 24,322 23,644 Other profits Unallocated: Interest income Interest expense (772 ) (754 ) (693 ) Depreciation and amortization (1,334 ) (1,378 ) (1,585 ) Research and development (8,853 ) (9,481 ) (9,218 ) Amortization of purchase accounting adjustments (2,664 ) (3,056 ) (3,692 ) Restructuring costs (632 ) (776 ) (651 ) Charge related to termination of collaboration agreement with Samsung (423 ) Loss on extinguishment of debt (191 ) Gain on sale of certain migraine clinical development programs Charge related to the settlement of worldwide Keytruda patent litigation (625 ) Other unallocated, net (3,024 ) (2,576 ) (3,430 ) $ 8,701 $ 6,521 $ 4,659 Pharmaceutical segment profits are comprised of segment sales less standard costs, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. Animal Health segment profits are comprised of segment sales, less all cost of sales, as well as selling, general and administrative expenses and research and development costs directly incurred by the segment. For internal management reporting presented to the chief operating decision maker, Merck does not allocate the remaining cost of sales not included in segment profits as described above, research and development expenses incurred in Merck Research Laboratories, the Companys research and development division that focuses on human health-related activities, or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of liabilities for contingent consideration, and other miscellaneous income or expense items. In 2018, the Company adopted a new accounting standard related to the classification of certain defined benefit plan costs (see Note 2), which resulted in a change to the measurement of segment profits. Net periodic benefit cost (credit) other than service cost is no longer included as a component of segment profits. Prior period amounts have been recast to conform to the new presentation. Equity (income) loss from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical Animal Health All Other Total Year Ended December 31, 2018 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2017 Included in segment profits: Equity (income) loss from affiliates $ $ $ $ Depreciation and amortization Year Ended December 31, 2016 Included in segment profits: Equity (income) loss from affiliates $ (105 ) $ $ $ (105 ) Depreciation and amortization Property, plant and equipment, net, by geographic area where located is as follows: December 31 United States $ 8,306 $ 8,070 $ 8,114 Europe, Middle East and Africa 3,706 3,151 2,732 Asia Pacific (other than Japan and China) Latin America China Japan Other $ 13,291 $ 12,439 $ 12,026 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Merck Co., Inc and its subsidiaries (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2018, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Change in Accounting Principle As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for retirement benefits in 2018. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Florham Park, New Jersey February 27, 2019 We have served as the Companys auditor since 2002. (b) Supplementary Data Selected quarterly financial data for 2018 and 2017 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q 1st Q (3) 2018 (4) Sales $ 10,998 $ 10,794 $ 10,465 $ 10,037 Cost of sales 3,289 3,619 3,417 3,184 Selling, general and administrative 2,643 2,443 2,508 2,508 Research and development 2,214 2,068 2,274 3,196 Restructuring costs Other (income) expense, net (172 ) (48 ) (291 ) Income before taxes 2,604 2,665 2,086 1,345 Net income attributable to Merck Co., Inc. 1,827 1,950 1,707 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.70 $ 0.73 $ 0.64 $ 0.27 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.69 $ 0.73 $ 0.63 $ 0.27 2017 (4) (5) Sales $ 10,433 $ 10,325 $ 9,930 $ 9,434 Cost of sales 3,440 3,307 3,116 3,049 Selling, general and administrative 2,643 2,459 2,500 2,472 Research and development 2,314 4,413 1,782 1,830 Restructuring costs Other (income) expense, net (149 ) (207 ) (73 ) (71 ) Income before taxes 1,879 2,439 2,003 Net (loss) income attributable to Merck Co., Inc. (1,046 ) (56 ) 1,946 1,551 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (1) Amounts for 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation (see Note 16). (2) Amounts for 2017 include a charge related to the formation of a collaboration with AstraZeneca (see Note 4). (3) Amounts for 2018 include a charge related to the formation of a collaboration with Eisai (see Note 4). (4) Amounts for 2018 and 2017 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). (5) Amounts have been recast as a result of the adoption, on January 1, 2018, of a new accounting standard related to the classification of certain defined benefit plan costs. There was no impact to net income as a result of adopting the new accounting standard (see Note 2). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the fourth quarter of 2018, there have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2018 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2018 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2018 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Global Services, and Chief Financial Officer " +4,mrk1,1201710k," Item 1. Business. Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. The Company was incorporated in New Jersey in 1970. For financial information and other information about the Companys segments, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data below. All product or service marks appearing in type form different from that of the surrounding text are trademarks or service marks owned, licensed to, promoted or distributed by Merck, its subsidiaries or affiliates, except as noted. All other trademarks or services marks are those of their respective owners. Product Sales Total Company sales, including sales of the Companys top pharmaceutical products, as well as total sales of animal health products, were as follows: ($ in millions) Total Sales $ 40,122 $ 39,807 $ 39,498 Pharmaceutical 35,390 35,151 34,782 Januvia/Janumet 5,896 6,109 6,014 Keytruda 3,809 1,402 Gardasil/Gardasil 9 2,308 2,173 1,908 Zetia/Vytorin 2,095 3,701 3,777 ProQuad/M-M-R II /Varivax 1,676 1,640 1,505 Zepatier 1,660 Isentress/Isentress HD 1,204 1,387 1,511 Remicade 1,268 1,794 Pneumovax 23 Simponi Animal Health 3,875 3,478 3,331 Other Revenues (1) 1,178 1,385 (1) Other revenues are primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, and third-party manufacturing sales. Pharmaceutical The Companys pharmaceutical products include therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. Certain of the products within the Companys franchises are as follows: Primary Care and Womens Health Cardiovascular: Zetia (ezetimibe) (marketed as Ezetrol in most countries outside the United States); Vytorin (ezetimibe/simvastatin) (marketed as Inegy outside the United States); and Atozet (ezetimibe and atorvastatin) (marketed in certain countries outside of the United States), cholesterol modifying medicines; and Adempas (riociguat), a cardiovascular drug for the treatment of pulmonary arterial hypertension. Diabetes: Januvia (sitagliptin) and Janumet (sitagliptin/metformin HCl) for the treatment of type 2 diabetes. General Medicine and Womens Health: NuvaRing (etonogestrel/ethinyl estradiol vaginal ring), a vaginal contraceptive product ; Implanon (etonogestrel implant), a single-rod subdermal contraceptive implant/ Nexplanon (etonogestrel implant), a single, radiopaque, rod-shaped subdermal contraceptive implant; and Follistim AQ (follitropin beta injection) (marketed as Puregon in most countries outside the United States), a fertility treatment. Hospital and Specialty Hepatitis: Zepatier (elbasvir and grazoprevir) for the treatment of adult patients with chronic hepatitis C virus (HCV) genotype (GT) 1 or GT4 infection, with ribavirin in certain patient populations. HIV: Isentress/Isentress HD (raltegravir), an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection. Hospital Acute Care: Bridion (sugammadex) Injection, a medication for the reversal of two types of neuromuscular blocking agents used during surgery; Noxafil (posaconazole) for the prevention of invasive fungal infections; Invanz (ertapenem sodium) for the treatment of certain infections; Cancidas (caspofungin acetate), an anti-fungal product; Cubicin ( daptomycin for injection), an I.V. antibiotic for complicated skin and skin structure infections or bacteremia, when caused by designated susceptible organisms; and Primaxin (imipenem and cilastatin sodium), an anti-bacterial product. Immunology: Remicade (infliximab), a treatment for inflammatory diseases; and Simponi (golimumab), a once-monthly subcutaneous treatment for certain inflammatory diseases, which the Company markets in Europe, Russia and Turkey. Oncology Keytruda (pembrolizumab), the Companys anti-PD-1 (programmed death receptor-1) therapy, as monotherapy for the treatment of certain patients with non-small-cell lunch cancer (NSCLC), melanoma, classical Hodgkin Lymphoma (cHL), urothelial carcinoma, head and neck squamous cell carcinoma (HNSCC), gastric or gastroesophageal junction adenocarcinoma, and microsatellite instability-high (MSI-H) or mismatch repair deficient cancer, and in combination with pemetrexed and carboplatin in certain patients with NSCLC; Emend (aprepitant) for the prevention of chemotherapy-induced and post-operative nausea and vomiting; and Temodar (temozolomide) (marketed as Temodal outside the United States), a treatment for certain types of brain tumors. Diversified Brands Respiratory: Singulair (montelukast), a medicine indicated for the chronic treatment of asthma and the relief of symptoms of allergic rhinitis; Nasonex (mometasone furoate monohydrate), an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms; and Dulera Inhalation Aerosol (mometasone furoate/formoterol fumarate dihydrate), a combination medicine for the treatment of asthma . Other: Cozaar (losartan potassium) and Hyzaar (losartan potassium and hydrochlorothiazide), treatments for hypertension; Arcoxia (etoricoxib) for the treatment of arthritis and pain, which the Company markets outside the United States; and Fosamax (alendronate sodium) (marketed as Fosamac in Japan) for the treatment and prevention of osteoporosis. Vaccines Gardasil (Human Papillomavirus Quadrivalent [Types 6, 11, 16 and 18] Vaccine, Recombinant)/ Gardasil 9 (Human Papillomavirus 9-valent Vaccine, Recombinant), vaccines to help prevent certain diseases caused by certain types of human papillomavirus (HPV) ; ProQuad (Measles, Mumps, Rubella and Varicella Virus Vaccine Live), a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella; M-M-R II (Measles, Mumps and Rubella Virus Vaccine Live), a vaccine to help prevent measles, mumps and rubella; Varivax (Varicella Virus Vaccine Live), a vaccine to help prevent chickenpox (varicella); Pneumovax 23 (pneumococcal vaccine polyvalent), a vaccine to help prevent pneumococcal disease; RotaTeq (Rotavirus Vaccine, Live Oral, Pentavalent), a vaccine to help protect against rotavirus gastroenteritis in infants and children; and Zostavax (Zoster Vaccine Live), a vaccine to help prevent shingles (herpes zoster). Animal Health The Animal Health segment discovers, develops, manufactures and markets animal health products, including vaccines. Principal products in this segment include: Livestock Products: Nuflor (Florfenicol) antibiotic range for use in cattle and swine; Bovilis / Vista vaccine lines for infectious diseases in cattle; Banamine (Flunixin meglumine) bovine and swine anti-inflammatory; Estrumate (cloprostenol sodium) for the treatment of fertility disorders in cattle; Matrix (altrenogest) fertility management for swine; Resflor (florfenicol and flunixin meglumine) , a combination broad-spectrum antibiotic and non-steroidal anti-inflammatory drug for bovine respiratory disease; Zuprevo (Tildipirosin) for bovine respiratory disease; Zilmax (zilpaterol hydrochloride) and Revalor (trenbolone acetate and estradiol) to improve production efficiencies in beef cattle; Safe-Guard (fenbendazole) de-wormer for cattle; M+Pac (Mycoplasma Hyopneumoniae Bacterin) swine pneumonia vaccine; and Porcilis (Lawsonia intracellularis baterin) and Circumvent (Porcine Circovirus Vaccine, Type 2, Killed Baculovirus Vector) vaccine lines for infectious diseases in swine. Poultry Products: Nobilis / Innovax (Live Mareks Disease Vector) , vaccine lines for poultry; Paracox and Coccivac coccidiosis vaccines and Exzolt , a systemic treatment for poultry red mite infestations. Companion Animal Products: Bravecto (fluralaner), a line of oral and topical products that kills fleas and ticks in dogs and cats for up to 12 weeks; Nobivac vaccine lines for flexible dog and cat vaccination; Otomax (Gentamicin sulfate, USP; Betamethasone valerate USP; and Clotrimazole USP ointment)/ Mometamax (Gentamicin sulfate, USP, Mometasone Furoate Monohydrate and Clotrimazole, USP, Otic Suspension)/ Posatex (Orbifloxacin, Mometasone Furoate Monohydrate and Posaconazole, Suspension) ear ointments for acute and chronic otitis; Caninsulin / Vetsulin (porcine insulin zinc suspension) diabetes mellitus treatment for dogs and cats; Panacur (fenbendazole)/ Safeguard (fenbendazole) broad-spectrum anthelmintic (de-wormer) for use in many animals; Regumate (altrenogest) fertility management for horses; Prestige vaccine line for horses; and Activyl (Indoxacrb) /Scalibor (Deltamethrin) /Exspot for protecting against bites from fleas, ticks, mosquitoes and sandflies. Aquaculture Products: Slice (Emamectin benzoate) parasiticide for sea lice in salmon; Aquavac (Avirulent Live Culture)/ Norvax vaccines against bacterial and viral disease in fish; Compact PD vaccine for salmon; and Aquaflor (Florfenicol) antibiotic for farm-raised fish. For a further discussion of sales of the Companys products, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations below. 2017 Product Approvals Set forth below is a summary of significant product approvals received by the Company in 2017. Product Date Approval Keytruda December 2017 Japanese Ministry of Health, Labour and Welfare approved Keytruda for the treatment of patients with radically unresectable urothelial carcinoma who progressed after cancer chemotherapy. September 2017 The U.S. Food and Drug Administration (FDA) approved Keytruda for previously treated patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction cancer whose tumors express PD-L1. September 2017 The European Commission (EC) approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. May 2017 FDA approved Keytruda for the treatment of adult and pediatric patients with previously treated unresectable or metastatic, microsatellite instability-high (MSI-H) or mismatch repair deficient, solid tumors. May 2017 FDA approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. May 2017 FDA approved Keytruda in combination with pemetrexed and carboplatin for the first-line treatment of patients with metastatic nonsquamous NSCLC. May 2017 EC approved Keytruda for the treatment of adult patients with relapsed or refractory classical Hodgkin Lymphoma (cHL) who have failed autologous stem cell transplant (ASCT) and brentuximab vedotin (BV), or who are transplant-eligible and have failed BV. March 2017 FDA approved Keytruda for the treatment of adult and pediatric patients with refractory cHL, or who have relapsed after three or more prior lines of therapy. January 2017 EC approved Keytruda for the first-line treatment of metastatic NSCLC in adults whose tumors have high PD-L1 expression with no EGFR or ALK positive tumor mutations. Lynparza (1) August 2017 FDA approved the oral poly (ADP-ribose) polymerase (PARP) inhibitor, Lynparza (olaparib), as follows: New use of Lynparza as a maintenance treatment for recurrent, epithelial ovarian, fallopian tube or primary peritoneal adult cancer who are in response to platinum-based chemotherapy, regardless of BRCA status; New use of Lynparza tablets (2 tablets twice daily) as opposed to capsules (8 capsules twice daily); Lynparza tablets also now indicated for the use in patients with deleterious or suspected deleterious germline BRCA-mutated advanced ovarian cancer, who have been treated with three or more prior lines of chemotherapy. Isentress November 2017 FDA approved Isentress for use in combination with other antiretroviral agents for the treatment of HIV-1 in neonates - newborn patients from birth to four weeks of age - weighing at least 2 kg. Isentress HD July 2017 EC approved Isentress 600 mg film-coated tablets, in combination with other anti-retroviral medicinal products, as a once-daily treatment of HIV-1 infection in patients who are treatment-nave or who are virologically suppressed on an initial regimen of Isentress 400 mg twice daily. May 2017 FDA approved Isentress HD , a once-daily dose of Isentress , in combination with other antiretroviral agents, for the treatment of HIV-1 infection patients who are treatment-nave or whose virus has been suppressed on an initial regimen of Isentress 400 mg given twice daily. Prevymis November 2017 FDA approved Prevymis (letermovir) for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant (HSCT). Steglatro/ Steglujan/ Segluromet (2) December 2017 FDA approved Steglatro (ertugliflozin) tablets, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, the fixed-dose combination Steglujan (ertugliflozin and sitagliptin) tablets, and the fixed-dose combination Segluromet (ertugliflozin and metformin hydrochloride) for the treatment of type 2 diabetes. (1) In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. (2) In 2013, Merck and Pfizer Inc. announced that they entered into a worldwide collaboration, except Japan, for the co-development and co-promotion of ertugliflozin. Competition and the Health Care Environment Competition The markets in which the Company conducts its business and the pharmaceutical industry in general are highly competitive and highly regulated. The Companys competitors include other worldwide research-based pharmaceutical companies, smaller research companies with more limited therapeutic focus, generic drug manufacturers and animal health care companies. The Companys operations may be adversely affected by generic and biosimilar competition as the Companys products mature, as well as technological advances of competitors, industry consolidation, patents granted to competitors, competitive combination products, new products of competitors, the generic availability of competitors branded products, and new information from clinical trials of marketed products or post-marketing surveillance. In addition, patent rights are increasingly being challenged by competitors, and the outcome can be highly uncertain. An adverse result in a patent dispute can preclude commercialization of products or negatively affect sales of existing products and could result in the payment of royalties or in the recognition of an impairment charge with respect to intangible assets associated with certain products. Competitive pressures have intensified as pressures in the industry have grown. Pharmaceutical competition involves a rigorous search for technological innovations and the ability to market these innovations effectively. With its long-standing emphasis on research and development, the Company is well positioned to compete in the search for technological innovations. Additional resources required to meet market challenges include quality control, flexibility to meet customer specifications, an efficient distribution system and a strong technical information service. The Company is active in acquiring and marketing products through external alliances, such as licensing arrangements and collaborations, and has been refining its sales and marketing efforts to further address changing industry conditions. However, the introduction of new products and processes by competitors may result in price reductions and product displacements, even for products protected by patents. For example, the number of compounds available to treat a particular disease typically increases over time and can result in slowed sales growth or reduced sales for the Companys products in that therapeutic category. The highly competitive animal health business is affected by several factors including regulatory and legislative issues, scientific and technological advances, product innovation, the quality and price of the Companys products, effective promotional efforts and the frequent introduction of generic products by competitors. Health Care Environment and Government Regulation Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, federal and state governments for many years also have pursued methods to reduce the cost of drugs and vaccines for which they pay. For example, federal laws require the Company to pay specified rebates for medicines reimbursed by Medicaid and to provide discounts for outpatient medicines purchased by certain Public Health Service entities and hospitals serving a disproportionate share of low income or uninsured patients. Against this backdrop, the United States enacted major health care reform legislation in 2010 (the Patient Protection and Affordable Care Act (ACA)). Various insurance market reforms have since advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). Approximately $385 million, $415 million and $550 million was recorded by Merck as a reduction to revenue in 2017, 2016 and 2015, respectively, related to the donut hole provision. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.0 billion in 2017 and will increase to $4.1 billion in 2018. The annual fee will decline to $2.8 billion in 2019 and is currently planned to remain at that amount thereafter. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. The Company recorded $210 million, $193 million and $173 million of costs within Marketing and administrative expenses in 2017, 2016 and 2015, respectively, for the annual health care reform fee. In February 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. There is significant uncertainty about the future of the ACA in particular and health care laws in general in the United States. The Company is participating in the debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys results of operations, financial condition or business. Also, during 2016, the Vermont legislature passed a pharmaceutical cost transparency law. The law requires manufacturers identified by the Vermont Green Mountain Care Board to report certain product price information to the Vermont Attorney General. The Attorney General is then required to submit a report to the legislature. During 2017, Nevada and California passed similar price transparency bills requiring manufacturers to disclose certain pricing information and to provide advance notification of price increases. A number of other states have introduced legislation of this kind and the Company expects that states will continue their focus on pharmaceutical price transparency. The extent to which these proposals will pass into law is unknown at this time. The Company also faces increasing pricing pressure globally from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care organizations, federal and state exchanges, and institutional and governmental purchasers, and (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 and the ACA. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. As an example, health care reform is contributing to an increase in the number of patients in the Medicaid program under which sales of pharmaceutical products are subject to substantial rebates. In addition, in the effort to contain the U.S. federal deficit, the pharmaceutical industry could be considered a potential source of savings via legislative proposals that have been debated but not enacted. These types of revenue generating or cost saving proposals include additional direct price controls in the Medicare prescription drug program (Part D). In addition, Congress may again consider proposals to allow, under certain conditions, the importation of medicines from other countries. It remains very uncertain as to what proposals, if any, may be included as part of future federal budget deficit reduction proposals that would directly or indirectly affect the Company. In the U.S. private sector, consolidation and integration among health care providers is a major factor in the competitive marketplace for pharmaceutical products. Health plans and pharmacy benefit managers have been consolidating into fewer, larger entities, thus enhancing their purchasing strength and importance. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain timely or adequate pricing or formulary placement for Mercks products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. These same utilization management tools are also used in treatment areas in which the payer has taken the position that multiple branded products are therapeutically comparable. As the U.S. payer market concentrates further and as more drugs become available in generic form, pharmaceutical companies may face greater pricing pressure from private third-party payers. In order to provide information about the Companys pricing practices, the Company recently posted on its website its Pricing Action Transparency Report for the United States for the years 2010 - 2017. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. The report shows that the Companys average annual net price increases (after taking sales deductions such as rebates, discounts and returns into account) across the U.S. human health portfolio have been in the low to mid-single digits from 2010 - 2016. In 2017, the average net price across the Companys portfolio declined by 1.9%, reflecting specific in-year dynamics, including the impact of loss of patent protection for three major Merck medicines. Additionally, the weighted average annual discount rate has been steadily increasing over time, reflecting the competitive market for branded medicines and the impact of the ACA. In 2017, the Companys gross U.S. sales were reduced by 45.1% as a result of rebates, discounts and returns. Efforts toward health care cost containment also remain intense in European countries. The Company faces competitive pricing pressure resulting from generic and biosimilar drugs. In addition, a majority of countries in Europe attempt to contain drug costs by engaging in reference pricing in which authorities examine pre-determined markets for published prices of drugs by brand. The authorities then use price data from those markets to set new local prices for brand-name drugs, including the Companys. Guidelines for examining reference pricing are usually set in local markets and can be changed pursuant to local regulations. In addition, in Japan, the pharmaceutical industry is subject to government-mandated biennial price reductions of pharmaceutical products and certain vaccines, which will occur again in 2018. Furthermore, the government can order repricings for classes of drugs if it determines that it is appropriate under applicable rules. Certain markets outside of the United States have also implemented other cost management strategies, such as health technology assessments (HTA), which require additional data, reviews and administrative processes, all of which increase the complexity, timing and costs of obtaining product reimbursement and exert downward pressure on available reimbursement. In the United States, HTAs are also being used by government and private payers. The Companys focus on emerging markets has continued. Governments in many emerging markets are also focused on constraining health care costs and have enacted price controls and related measures, such as compulsory licenses, that aim to put pressure on the price of pharmaceuticals and constrain market access. The Company anticipates that pricing pressures and market access challenges will continue in 2018 to varying degrees in the emerging markets. Beyond pricing and market access challenges, other conditions in emerging market countries can affect the Companys efforts to continue to grow in these markets, including potential political instability, significant currency fluctuation and controls, financial crises, limited or changing availability of funding for health care, and other developments that may adversely impact the business environment for the Company. Further, the Company may engage third-party agents to assist in operating in emerging market countries, which may affect its ability to realize continued growth and may also increase the Companys risk exposure. In addressing cost containment pressures, the Company engages in public policy advocacy with policymakers and continues to work to demonstrate that its medicines provide value to patients and to those who pay for health care. The Company advocates with government policymakers to encourage a long-term approach to sustainable health care financing that ensures access to innovative medicines and does not disproportionately target pharmaceuticals as a source of budget savings. In markets with historically low rates of health care spending, the Company encourages those governments to increase their investments and adopt market reforms in order to improve their citizens access to appropriate health care, including medicines. Operating conditions have become more challenging under the global pressures of competition, industry regulation and cost containment efforts. Although no one can predict the effect of these and other factors on the Companys business, the Company continually takes measures to evaluate, adapt and improve the organization and its business practices to better meet customer needs and believes that it is well positioned to respond to the evolving health care environment and market forces. The pharmaceutical industry is also subject to regulation by regional, country, state and local agencies around the world focused on standards and processes for determining drug safety and effectiveness, as well as conditions for sale or reimbursement. Of particular importance is the FDA in the United States, which administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling, and marketing of prescription pharmaceuticals. In some cases, the FDA requirements and practices have increased the amount of time and resources necessary to develop new products and bring them to market in the United States. At the same time, the FDA has committed to expediting the development and review of products bearing the breakthrough therapy designation, which has accelerated the regulatory review process for medicines with this designation. The European Union (EU) has adopted directives and other legislation concerning the classification, labeling, advertising, wholesale distribution, integrity of the supply chain, enhanced pharmacovigilance monitoring and approval for marketing of medicinal products for human use. These provide mandatory standards throughout the EU, which may be supplemented or implemented with additional regulations by the EU member states. The Companys policies and procedures are already consistent with the substance of these directives; consequently, it is believed that they will not have any material effect on the Companys business. The Company believes that it will continue to be able to conduct its operations, including launching new drugs, in this regulatory environment. (See Research and Development below for a discussion of the regulatory approval process.) Access to Medicines As a global health care company, Mercks primary role is to discover and develop innovative medicines and vaccines. The Company also recognizes that it has an important role to play in helping to improve access to its products around the world. The Companys efforts in this regard are wide-ranging and include a set of principles that the Company strives to embed into its operations and business strategies to guide the Companys worldwide approach to expanding access to health care. In addition, the Company has many far-reaching philanthropic programs. The Merck Patient Assistance Program provides medicines and adult vaccines for free to people in the United States who do not have prescription drug or health insurance coverage and who, without the Companys assistance, cannot afford their Merck medicine and vaccines. In 2011, Merck launched Merck for Mothers, a long-term effort with global health partners to end preventable deaths from complications of pregnancy and childbirth. Merck has also provided funds to the Merck Foundation, an independent organization, which has partnered with a variety of organizations dedicated to improving global health. Privacy and Data Protection The Company is subject to a significant number of privacy and data protection laws and regulations globally, many of which place restrictions on the Companys ability to transfer, access and use personal data across its business. The legislative and regulatory landscape for privacy and data protection continues to evolve. There has been increased attention to privacy and data protection issues in both developed and emerging markets with the potential to affect directly the Companys business, including a new EU General Data Protection Regulation, which will become effective in 2018 and impose penalties up to 4% of global revenue, additional laws and regulations enacted in the United States, Europe, Asia and Latin America, increased enforcement and litigation activity in the United States and other developed markets, and increased regulatory cooperation among privacy authorities globally. The Company has adopted a comprehensive global privacy program to manage these evolving risks which has been certified as compliant with and approved by the Asia Pacific Economic Cooperation Cross-Border Privacy Rules System, the EU-U.S. Privacy Shield Program, and the Binding Corporate Rules in the EU. Distribution The Company sells its human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers, such as health maintenance organizations, pharmacy benefit managers and other institutions. Human health vaccines are sold primarily to physicians, wholesalers, physician distributors and government entities. The Companys professional representatives communicate the effectiveness, safety and value of the Companys pharmaceutical and vaccine products to health care professionals in private practice, group practices, hospitals and managed care organizations. The Company sells its animal health products to veterinarians, distributors and animal producers. Raw Materials Raw materials and supplies, which are generally available from multiple sources, are purchased worldwide and are normally available in quantities adequate to meet the needs of the Companys business. Patents, Trademarks and Licenses Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of its products in the United States and in most major foreign markets. Patents may cover products per se , pharmaceutical formulations, processes for or intermediates useful in the manufacture of products or the uses of products. Protection for individual products extends for varying periods in accordance with the legal life of patents in the various countries. The protection afforded, which may also vary from country to country, depends upon the type of patent and its scope of coverage. The Food and Drug Administration Modernization Act includes a Pediatric Exclusivity Provision that may provide an additional six months of market exclusivity in the United States for indications of new or currently marketed drugs if certain agreed upon pediatric studies are completed by the applicant. Current U.S. patent law provides additional patent term for periods when the patented product was under regulatory review by the FDA. The EU also provides an additional six months of pediatric market exclusivity attached to a products Supplementary Protection Certificate (SPC). Japan provides the additional term for pediatric studies attached to market exclusivity unrelated to patent rights. Patent portfolios developed for products introduced by the Company normally provide market exclusivity. The Company has the following key patent protection in the United States, the EU and Japan (including the potential for patent term extensions (PTE) and SPCs where indicated) for the following marketed products: Product Year of Expiration (U.S.) Year of Expiration (EU) (1) Year of Expiration (Japan) Cancidas Expired Expired Zostavax Expired 2018 (use) N/A Zetia Expired 2019 Vytorin Expired 2019 Asmanex 2018 (formulation) 2018 (formulation) 2020 (formulation) NuvaRing 2018 (delivery system) 2018 (delivery system) N/A Emend for Injection 2019 (2) 2020 (2) Follistim AQ 2019 (formulation) 2019 (formulation) 2019 (formulation) Noxafil 2019 N/A RotaTeq Expired Expired Recombivax 2020 (method of making) Expired Expired Dulera 2020 (combination) N/A N/A Januvia 2022 (2) 2022 (2) 2025-2026 (3) Janumet 2022 (2) N/A Janumet XR 2022 (2) N/A N/A Isentress 2022 (2) Simponi N/A (4) N/A (4) Adempas (5) 2026 (2) 2023 (patents), 2028 (2) (SPCs) 2027-2028 (3) Bridion 2026 (2) (with pending PTE) 2024 Nexplanon 2027 (device) 2025 (device) Not Marketed Bravecto 2027 (with pending PTE) 2025 (patents), 2029 (SPCs) Gardasil 2021 (2) Gardasil 9 2025 (patents) , 2030 (2) (SPCs) N/A Keytruda 2028 (patents), 2030 (2) (SPCs) Lynparza (6) 2028 (2) (with pending PTE) 2024 (patents), 2029 (2) (SPCs) 2024 (7) Zerbaxa 2028 (2) (with pending PTE) 2023 (patents), 2028 (2) (SPCs) N/A Sivextro 2028 (2) 2024 (patents), 2029 (2) (SPCs) N/A Belsomra 2029 (2) N/A Prevymis 2029 (2) (with pending PTE) 2024 (8) N/A Steglatro (9) 2031 (2) (with pending PTE) N/A N/A Steglujan (9) 2031 (with pending PTE) N/A N/A Segluromet (9) 2031 (with pending PTE) N/A N/A Zepatier 2031 (2) 2030 (patents), 2031 (2) (SPCs) 2034 (with pending PTE) N/A: Currently no marketing approval. Note: Compound patent unless otherwise noted. Certain of the products listed may be the subject of patent litigation. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. (1) The EU date represents the expiration date for the following five countries: France, Germany, Italy, Spain and the United Kingdom (Major EU Markets). If an SPC has been granted in some but not all Major EU Markets, both the patent expiry date and the SPC expiry date are listed. (2) Eligible for 6 months Pediatric Exclusivity. (3) The PTE system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. (4) The Company has no marketing rights in the U.S. and Japan. (5) Being commercialized in a worldwide collaboration with Bayer AG. (6) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (7) PTE application to be filed by April 2018. Expected expiry 2029. (8) SPC applications to be filed by July 2018. Expected expiry 2029. Eligible for Pediatric Exclusivity. (9) Being developed and promoted in a worldwide, except Japan, collaboration with Pfizer. While the expiration of a product patent normally results in a loss of market exclusivity for the covered pharmaceutical product, commercial benefits may continue to be derived from: (i) later-granted patents on processes and intermediates related to the most economical method of manufacture of the active ingredient of such product; (ii) patents relating to the use of such product; (iii) patents relating to novel compositions and formulations; and (iv) in the United States and certain other countries, market exclusivity that may be available under relevant law. The effect of product patent expiration on pharmaceutical products also depends upon many other factors such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries. Additions to market exclusivity are sought in the United States and other countries through all relevant laws, including laws increasing patent life. Some of the benefits of increases in patent life have been partially offset by an increase in the number of incentives for and use of generic products. Additionally, improvements in intellectual property laws are sought in the United States and other countries through reform of patent and other relevant laws and implementation of international treaties. The Company has the following key U.S. patent protection for drug candidates under review in the United States by the FDA. Additional patent term may be provided for these pipeline candidates based on Patent Term Restoration and Pediatric Exclusivity. Under Review (in the U.S.) Currently Anticipated Year of Expiration (in the U.S.) V419 (pediatric hexavalent combination vaccine) 2020 (method of making) MK-1439 (doravirine) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) The Company also has the following key U.S. patent protection for drug candidates in Phase 3 development: Phase 3 Drug Candidate Currently Anticipated Year of Expiration (in the U.S.) V920 (ebola vaccine) MK-5618 (selumetinib) (1) MK-7655A (relebactam + imipenem/cilastatin) MK-1242 (vericiguat) (2) (1) Being developed and commercialized in a global strategic oncology collaboration with AstraZeneca. (2) Being developed in a worldwide clinical development collaboration with Bayer AG. Unless otherwise noted, the patents in the above charts are compound patents. Each patent is subject to any future patent term restoration of up to five years and six month pediatric market exclusivity, either or both of which may be available. In addition, depending on the circumstances surrounding any final regulatory approval of the compound, there may be other listed patents or patent applications pending that could have relevance to the product as finally approved; the relevance of any such application would depend upon the claims that ultimately may be granted and the nature of the final regulatory approval of the product. Also, regulatory exclusivity tied to the protection of clinical data is complementary to patent protection and, in some cases, may provide more effective or longer lasting marketing exclusivity than a compounds patent estate. In the United States, the data protection generally runs five years from first marketing approval of a new chemical entity, extended to seven years for an orphan drug indication and 12 years from first marketing approval of a biological product. For further information with respect to the Companys patents, see Item 1A. Risk Factors and Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. Worldwide, all of the Companys important products are sold under trademarks that are considered in the aggregate to be of material importance. Trademark protection continues in some countries as long as used; in other countries, as long as registered. Registration is for fixed terms and can be renewed indefinitely. Royalty income in 2017 on patent and know-how licenses and other rights amounted to $158 million. Merck also incurred royalty expenses amounting to $944 million in 2017 under patent and know-how licenses it holds. Research and Development The Companys business is characterized by the introduction of new products or new uses for existing products through a strong research and development program. At December 31, 2017, approximately 12,650 people were employed in the Companys research activities. Research and development expenses were $10.2 billion in 2017 , $10.1 billion in 2016 and $6.7 billion in 2015 (which included restructuring costs and acquisition and divestiture-related costs in all years). The Company prioritizes its research and development efforts and focuses on candidates that it believes represent breakthrough science that will make a difference for patients and payers. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases, and vaccines. In the development of human health products, industry practice and government regulations in the United States and most foreign countries provide for the determination of effectiveness and safety of new chemical compounds through preclinical tests and controlled clinical evaluation. Before a new drug or vaccine may be marketed in the United States, recorded data on preclinical and clinical experience are included in the New Drug Application (NDA) for a drug or the Biologics License Application (BLA) for a vaccine or biologic submitted to the FDA for the required approval. Once the Companys scientists discover a new small molecule compound or biologic that they believe has promise to treat a medical condition, the Company commences preclinical testing with that compound. Preclinical testing includes laboratory testing and animal safety studies to gather data on chemistry, pharmacology, immunogenicity and toxicology. Pending acceptable preclinical data, the Company will initiate clinical testing in accordance with established regulatory requirements. The clinical testing begins with Phase 1 studies, which are designed to assess safety, tolerability, pharmacokinetics, and preliminary pharmacodynamic activity of the compound in humans. If favorable, additional, larger Phase 2 studies are initiated to determine the efficacy of the compound in the affected population, define appropriate dosing for the compound, as well as identify any adverse effects that could limit the compounds usefulness. In some situations, the clinical program incorporates adaptive design methodology to use accumulating data to decide how to modify aspects of the ongoing clinical study as it continues, without undermining the validity and integrity of the trial. One type of adaptive clinical trial is an adaptive Phase 2a/2b trial design, a two-stage trial design consisting of a Phase 2a proof-of-concept stage and a Phase 2b dose-optimization finding stage. If data from the Phase 2 trials are satisfactory, the Company commences large-scale Phase 3 trials to confirm the compounds efficacy and safety. Another type of adaptive clinical trial is an adaptive Phase 2/3 trial design, a study that includes an interim analysis and an adaptation that changes the trial from having features common in a Phase 2 study (e.g. multiple dose groups) to a design similar to a Phase 3 trial. An adaptive Phase 2/3 trial design reduces timelines by eliminating activities which would be required to start a separate study. Upon completion of Phase 3 trials, if satisfactory, the Company submits regulatory filings with the appropriate regulatory agencies around the world to have the product candidate approved for marketing. There can be no assurance that a compound that is the result of any particular program will obtain the regulatory approvals necessary for it to be marketed. Vaccine development follows the same general pathway as for drugs. Preclinical testing focuses on the vaccines safety and ability to elicit a protective immune response (immunogenicity). Pre-marketing vaccine clinical trials are typically done in three phases. Initial Phase 1 clinical studies are conducted in normal subjects to evaluate the safety, tolerability and immunogenicity of the vaccine candidate. Phase 2 studies are dose-ranging studies. Finally, Phase 3 trials provide the necessary data on effectiveness and safety. If successful, the Company submits regulatory filings with the appropriate regulatory agencies. In the United States, the FDA review process begins once a complete NDA or BLA is submitted, received and accepted for review by the agency. Within 60 days after receipt, the FDA determines if the application is sufficiently complete to permit a substantive review. The FDA also assesses, at that time, whether the application will be granted a priority review or standard review. Pursuant to the Prescription Drug User Fee Act V (PDUFA), the FDA review period target for NDAs or original BLAs is either six months, for priority review, or ten months, for a standard review, from the time the application is deemed sufficiently complete. Once the review timelines are determined, the FDA will generally act upon the application within those timelines, unless a major amendment has been submitted (either at the Companys own initiative or the FDAs request) to the pending application. If this occurs, the FDA may extend the review period to allow for review of the new information, but by no more than three months. Extensions to the review period are communicated to the Company. The FDA can act on an application either by issuing an approval letter or by issuing a Complete Response Letter (CRL) stating that the application will not be approved in its present form and describing all deficiencies that the FDA has identified. Should the Company wish to pursue an application after receiving a CRL, it can resubmit the application with information that addresses the questions or issues identified by the FDA in order to support approval. Resubmissions are subject to review period targets, which vary depending on the underlying submission type and the content of the resubmission. The FDA has four program designations Fast Track, Breakthrough Therapy, Accelerated Approval, and Priority Review to facilitate and expedite development and review of new drugs to address unmet medical needs in the treatment of serious or life-threatening conditions. The Fast Track designation provides pharmaceutical manufacturers with opportunities for frequent interactions with FDA reviewers during the products development and the ability for the manufacturer to do a rolling submission of the NDA/BLA. A rolling submission allows completed portions of the application to be submitted and reviewed by the FDA on an ongoing basis. The Breakthrough Therapy designation provides manufacturers with all of the features of the Fast Track designation as well as intensive guidance on implementing an efficient development program for the product and a commitment by the FDA to involve senior managers and experienced staff in the review. The Accelerated Approval designation allows the FDA to approve a product based on an effect on a surrogate or intermediate endpoint that is reasonably likely to predict a products clinical benefit and generally requires the manufacturer to conduct required post-approval confirmatory trials to verify the clinical benefit. The Priority Review designation means that the FDAs goal is to take action on the NDA/BLA within six months, compared to ten months under standard review. In addition, under the Generating Antibiotic Incentives Now Act, the FDA may grant Qualified Infectious Disease Product (QIDP) status to antibacterial or antifungal drugs intended to treat serious or life threatening infections including those caused by antibiotic or antifungal resistant pathogens, novel or emerging infectious pathogens, or other qualifying pathogens. QIDP designation offers certain incentives for development of qualifying drugs, including Priority Review of the NDA when filed, eligibility for Fast Track designation, and a five-year extension of applicable exclusivity provisions under the Food, Drug and Cosmetic Act. The primary method the Company uses to obtain marketing authorization of pharmaceutical products in the EU is through the centralized procedure. This procedure is compulsory for certain pharmaceutical products, in particular those using biotechnological processes, and is also available for certain new chemical compounds and products. A company seeking to market an innovative pharmaceutical product through the centralized procedure must file a complete set of safety data and efficacy data as part of a Marketing Authorization Application (MAA) with the European Medicines Agency (EMA). After the EMA evaluates the MAA, it provides a recommendation to the EC and the EC then approves or denies the MAA. It is also possible for new chemical products to obtain marketing authorization in the EU through a mutual recognition procedure in which an application is made to a single member state and, if the member state approves the pharmaceutical product under a national procedure, the applicant may submit that approval to the mutual recognition procedure of some or all other member states. Outside of the United States and the EU, the Company submits marketing applications to national regulatory authorities. Examples of such are the Pharmaceuticals and Medical Devices Agency in Japan, Health Canada, Agncia Nacional de Vigilncia Sanatria in Brazil, Korea Food and Drug Administration in South Korea, Therapeutic Goods Administration in Australia and China Food and Drug Administration. Each country has a separate and independent review process and timeline. In many markets, approval times can be longer as the regulatory authority requires approval in a major market, such as the United States or the EU, and issuance of a Certificate of Pharmaceutical Product from that market before initiating their local review process. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In December 2017, the FDA accepted for review a supplemental BLA for Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal B-cell lymphoma (PMBCL), or who have relapsed after two or more prior lines of therapy. The FDA granted Priority Review status with a PDUFA, or target action, date of April 3, 2018. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with axitnib as a first-line treatment for patients with advanced or metastatic renal cell carcinoma; for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy; and for the treatment of Merkel cell carcinoma. Also, in January 2018, Merck and Eisai Co., Ltd. (Eisai) announced receipt of Breakthrough Therapy designation from the FDA for Eisais multiple receptor tyrosine kinase inhibitor Lenvima (lenvatinib) in combination with Keytruda for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma. The Lenvima and Keytruda combination therapy is being jointly developed by Eisai and Merck. This marks the 12 th Breakthrough Therapy designation granted to Keytruda . The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In January 2018, Merck announced that the pivotal Phase 3 KEYNOTE-189 trial investigating Keytruda in combination with pemetrexed (Alimta) and cisplatin or carboplatin, for the first-line treatment of patients with metastatic non-squamous NSCLC, met its dual primary endpoints of overall survival (OS) and progression-free survival (PFS). Based on an interim analysis conducted by the independent Data Monitoring Committee, treatment with Keytruda in combination with pemetrexed plus platinum chemotherapy resulted in significantly longer OS and PFS than pemetrexed plus platinum chemotherapy alone. Results from KEYNOTE-189 will be presented at an upcoming medical meeting and submitted to regulatory authorities. In 2017, the FDA placed a full clinical hold on KEYNOTE-183 and KEYNOTE-185 and a partial clinical hold on Cohort 1 of KEYNOTE-023, three combination studies of Keytruda with lenalidomide or pomalidomide versus lenalidomide or pomalidomide alone in the blood cancer multiple myeloma. This decision followed a review of data by the Data Monitoring Committee in which more deaths were observed in the Keytruda arms of KEYNOTE-183 and KEYNOTE-185. The FDA determined that the data available at the time indicated that the risks of Keytruda plus pomalidomide or lenalidomide outweighed any potential benefit for patients with multiple myeloma. All patients enrolled in KEYNOTE-183 and KEYNOTE-185 and those in the Keytruda /lenalidomide/dexamethasone cohort in KEYNOTE-023 have discontinued investigational treatment with Keytruda . This clinical hold does not apply to other studies with Keytruda . The Keytruda clinical development program consists of more than 700 clinical trials, including more than 400 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. MK-8835, ertugliflozin, an investigational oral SGLT-2 inhibitor in development to help improve glycemic control in adults with type 2 diabetes, and two fixed-dose combination products (MK-8835A, ertugliflozin and Januvia , and MK-8835B, ertugliflozin and metformin) are under review in the EU. In January 2018, the Committee for Medicinal Products for Human Use (CHMP) of the EMA adopted a positive opinion recommending approval of these medicines. The CHMP positive opinion will be considered by the EC. Ertugliflozin and the two fixed-dose combination products were approved by the FDA in December 2017. MK-0431J is an investigational fixed-dose combination of sitagliptin and ipragliflozin under review with the Japan Pharmaceuticals and Medical Devices Agency. MK-0431 is being developed for commercialization in Japan in collaboration with Astellas Pharma Inc. (Astellas). Ipragliflozin, an SGLT2 inhibitor, co-developed by Astellas and Kotobuki Pharmaceutical Co., Ltd. (Kotobuki), is approved for use in Japan and is being co-promoted with Merck and Kotobuki. MK-1439, doravirine, is an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection. In January 2018, Merck announced that the FDA accepted for review two NDAs for doravirine. The NDAs include data for doravirine as a once-daily tablet for use in combination with other antiretroviral agents, and for use of doravirine with lamivudine and tenofovir disoproxil fumarate in a once-daily fixed-dose combination single tablet as a complete regimen (MK-1439A). The PDUFA action date for both applications is October 23, 2018. V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, under review with the FDA that is being developed and, if approved, will be commercialized through a joint venture between Merck and Sanofi. This vaccine is designed to help protect against six important diseases - diphtheria, tetanus, pertussis (whooping cough), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b (Hib), and hepatitis B. In November 2015, the FDA issued a CRL with respect to the BLA for V419. Both companies are working to provide additional data requested by the FDA. V419 is being marketed as Vaxelis in the EU. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). The FDA has designated this combination a QIDP with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. MK-7339, Lynparza (olaparib), is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. MK-5618, selumetinib, is an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple cancer types. Additionally, in February 2018, the FDA granted Orphan Drug designation for selumetinib for the treatment of neurofibromatosis type 1. The development of selumetinib is part of the global strategic oncology collaboration between Merck and AstraZeneca reference above. V920 is an investigational rVSV-ZEBOV (Ebola) vaccine candidate being studied in large scale Phase 2/3 clinical trials. In November 2014, Merck and NewLink Genetics announced an exclusive licensing and collaboration agreement for the investigational Ebola vaccine. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In December 2016, end of study results from the WHO ring vaccination trial were reported in Lancet supporting the July 2015 interim assessment that V920 offers substantial protection against Ebola virus disease, with no reported cases among vaccinated individuals from 10 days after vaccination in both randomized and non-randomized clusters. Results from other ongoing studies to be included in the first regulatory filing are anticipated in the first half of 2018. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure. The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer. V212 is an inactivated varicella zoster virus (VZV) vaccine in development for the prevention of herpes zoster. The Company completed a Phase 3 trial in autologous hematopoietic cell transplant patients and another Phase 3 trial in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The study in autologous hematopoietic cell transplant patients met its primary endpoints and Merck presented the results from this study at the American Society for Blood and Marrow Transplantation Meetings in February 2017. The study in patients with solid tumor malignancies undergoing chemotherapy met its primary endpoints, but the primary efficacy endpoint was not met in patients with hematologic malignancies. Merck will present the results from this study at an upcoming scientific meeting. Due to the competitive environment, the development of V212 is currently on hold. MK-7264 is a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough. Merck plans to initiate a Phase 3 clinical trial in the first half of 2018. MK-7264 was originally developed by Afferent Pharmaceuticals, which was acquired by the Company in 2016. The Company also discontinued certain drug candidates. In February 2018, Merck announced that it will be stopping protocol 019, also known as the APECS study, a Phase 3 study evaluating verubecestat, MK-8931, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), in people with prodromal Alzheimers disease. The decision to stop the study follows a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during a recent interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. In 2017, Merck announced that it will not submit applications for regulatory approval for MK-0859, anacetrapib, the Companys investigational cholesteryl ester transfer protein (CETP) inhibitor. The decision followed a thorough review of the clinical profile of anacetrapib, including discussions with external experts. Also in 2017, Merck made a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. The chart below reflects the Companys research pipeline as of February 23, 2018. Candidates shown in Phase 3 include specific products and the date such candidate entered into Phase 3 development. Candidates shown in Phase 2 include the most advanced compound with a specific mechanism or, if listed compounds have the same mechanism, they are each currently intended for commercialization in a given therapeutic area. Small molecules and biologics are given MK-number designations and vaccine candidates are given V-number designations. Except as otherwise noted, candidates in Phase 1, additional indications in the same therapeutic area (other than with respect to Keytruda ) and additional claims, line extensions or formulations for in-line products are not shown. Phase 2 Phase 3 (Phase 3 entry date) Under Review Cancer MK-3475 Keytruda Advanced Solid Tumors Ovarian Prostate Chronic Cough MK-7264 Diabetes Mellitus MK-8521 (2) HIV Infection MK-8591 Pneumoconjugate Vaccine V114 Schizophrenia MK-8189 Bacterial Infection MK-7655A (relebactam+imipenem/cilastatin) (October 2015) Cancer MK-3475 Keytruda Breast (October 2015) Colorectal (November 2015) Esophageal (December 2015) Gastric (May 2015) (EU) Head and Neck (November 2014) (EU) Hepatocellular (May 2016) Nasopharyngeal (April 2016) Renal (October 2016) Small-Cell Lung (May 2017) MK-7339 Lynparza (1) Pancreatic (December 2014) Prostate (April 2017) MK-5618 (selumetinib) (1) Thyroid (June 2013) Ebola Vaccine V920 (March 2015) Heart Failure MK-1242 (vericiguat) (September 2016) (1) Herpes Zoster V212 (inactivated VZV vaccine) (December 2010) (2) HIV MK-1439 (doravirine) (December 2014) (EU) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) (June 2015) (EU) New Molecular Entities/Vaccines Diabetes Mellitus MK-0431J (sitagliptin+ipragliflozin) (Japan) (1) MK-8835 (ertugliflozin) (EU) (1) MK-8835A (ertugliflozin+sitagliptin) (EU) (1) MK-8835B (ertugliflozin+metformin) (EU) (1) HIV MK-1439 (doravirine) (U.S.) MK-1439A (doravirine/lamivudine/tenofovir disoproxil fumarate) (U.S.) Pediatric Hexavalent Combination Vaccine V419 (U.S.) (3) Certain Supplemental Filings MK-3475 Keytruda Relapsed or Refractory Primary Mediastinal BCell Lymphoma (PMBCL) (U.S.) MK-7339 Lynparza (1) Broader Approval for Ovarian Cancer (EU) Footnotes: (1) Being developed in a collaboration. (2) Development is currently on hold. (3) V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, that is being developed and, if approved, will be commercialized through a partnership of Merck and Sanofi. In November 2015, the FDA issued a CRL with respect to V419. Both companies are working to provide additional data requested by the FDA. Employees As of December 31, 2017, the Company had approximately 69,000 employees worldwide, with approximately 26,700 employed in the United States, including Puerto Rico. Approximately 29% of worldwide employees of the Company are represented by various collective bargaining groups. Restructuring Activities The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Since inception of the programs through December 31, 2017, Merck has eliminated approximately 43,350 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company has substantially completed the actions under these programs. Environmental Matters The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites. Expenditures for remediation and environmental liabilities were $11 million in 2017 , and are estimated at $56 million in the aggregate for the years 2018 through 2022 . These amounts do not consider potential recoveries from other parties. The Company has taken an active role in identifying and accruing for these costs and, in managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should have a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Merck believes that climate change could present risks to its business. Some of the potential impacts of climate change to its business include increased operating costs due to additional regulatory requirements, physical risks to the Companys facilities, water limitations and disruptions to its supply chain. These potential risks are integrated into the Companys business planning including investment in reducing energy, water use and greenhouse gas emissions. The Company does not believe these risks are material to its business at this time. Geographic Area Information The Companys operations outside the United States are conducted primarily through subsidiaries. Sales worldwide by subsidiaries outside the United States as a percentage of total Company sales were 57% of sales in 2017, 54% of sales in 2016 and 56% of sales in 2015. The Companys worldwide business is subject to risks of currency fluctuations, governmental actions and other governmental proceedings abroad. The Company does not regard these risks as a deterrent to further expansion of its operations abroad. However, the Company closely reviews its methods of operations and adopts strategies responsive to changing economic and political conditions. Merck has operations in countries located in Latin America, the Middle East, Africa, Eastern Europe and Asia Pacific. Business in these developing areas, while sometimes less stable, offers important opportunities for growth over time. Financial information about geographic areas of the Companys business is provided in Item 8. Financial Statements and Supplementary Data below. Available Information The Companys Internet website address is www.merck.com . The Company will make available, free of charge at the Investors portion of its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the U.S. Securities and Exchange Commission (SEC). In addition, the Company will provide without charge a copy of its Annual Report on Form 10-K, including financial statements and schedules, upon the written request of any shareholder to Merck Shareholder Services, Merck Co., Inc., 2000 Galloping Hill Road, K1-3049, Kenilworth, NJ 07033 U.S.A. The Companys corporate governance guidelines and the charters of the Board of Directors four standing committees are available on the Companys website at www.merck.com/about/leadership and all such information is available in print to any stockholder who requests it from the Company. "," Item 1A. Risk Factors. Investors should carefully consider all of the information set forth in this Form 10-K, including the following risk factors, before deciding to invest in any of the Companys securities. The risks below are not the only ones the Company faces. Additional risks not currently known to the Company or that the Company presently deems immaterial may also impair its business operations. The Companys business, financial condition, results of operations or prospects could be materially adversely affected by any of these risks. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. The Companys results could materially differ from those anticipated in these forward-looking statements as a result of certain factors, including the risks it faces described below and elsewhere. See Cautionary Factors that May Affect Future Results below. The Company is dependent on its patent rights, and if its patent rights are invalidated or circumvented, its business would be adversely affected. Patent protection is considered, in the aggregate, to be of material importance to the Companys marketing of human health products in the United States and in most major foreign markets. Patents covering products that it has introduced normally provide market exclusivity, which is important for the successful marketing and sale of its products. The Company seeks patents covering each of its products in each of the markets where it intends to sell the products and where meaningful patent protection is available. Even if the Company succeeds in obtaining patents covering its products, third parties or government authorities may challenge or seek to invalidate or circumvent its patents and patent applications. It is important for the Companys business to defend successfully the patent rights that provide market exclusivity for its products. The Company is often involved in patent disputes relating to challenges to its patents or claims by third parties of infringement against the Company. The Company defends its patents both within and outside the United States, including by filing claims of infringement against other parties. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below. In particular, manufacturers of generic pharmaceutical products from time to time file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned or licensed by the Company. The Company normally responds by defending its patent, including by filing lawsuits alleging patent infringement. Patent litigation and other challenges to the Companys patents are costly and unpredictable and may deprive the Company of market exclusivity for a patented product or, in some cases, third-party patents may prevent the Company from marketing and selling a product in a particular geographic area. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies or in other circumstances, which could diminish or eliminate sales and profits from those regions and negatively affect the Companys results of operations. Further, court decisions relating to other companies patents, potential legislation relating to patents, as well as regulatory initiatives may result in a more general weakening of intellectual property protection. If one or more important products lose patent protection in profitable markets, sales of those products are likely to decline significantly as a result of generic versions of those products becoming available. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Companys results of operations may be adversely affected by the lost sales unless and until the Company has successfully launched commercially successful replacement products. A chart listing the patent protection for certain of the Companys marketed products, and U.S. patent protection for candidates under review and Phase 3 candidates is set forth above in Item 1. Business Patents, Trademarks and Licenses. As the Companys products lose market exclusivity, the Company generally experiences a significant and rapid loss of sales from those products. The Company depends upon patents to provide it with exclusive marketing rights for its products for some period of time. Loss of patent protection for one of the Companys products typically leads to a significant and rapid loss of sales for that product, as lower priced generic versions of that drug become available. In the case of products that contribute significantly to the Companys sales, the loss of market exclusivity can have a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. For example, pursuant to an agreement with a generic manufacturer, that manufacturer launched in the United States a generic version of Zetia in December 2016. In addition, the Company lost U.S. patent protection for Vytorin in April 2017. As a result, the Company experienced a significant and rapid loss of sales of Zetia and Vytorin in the United States in 2017, which the Company expects will continue in 2018. In addition, the patent that provides U.S. market exclusivity for NuvaRing will expire in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales thereafter. Key products generate a significant amount of the Companys profits and cash flows, and any events that adversely affect the markets for its leading products could have a material and negative impact on results of operations and cash flows. The Companys ability to generate profits and operating cash flow depends largely upon the continued profitability of the Companys key products, such as Januvia , Janumet , Keytruda , Gardasil/Gardasil 9 and Isentress . As a result of the Companys dependence on key products, any event that adversely affects any of these products or the markets for any of these products could have a significant adverse impact on results of operations and cash flows. These events could include loss of patent protection, increased costs associated with manufacturing, generic or over-the-counter availability of the Companys product or a competitive product, the discovery of previously unknown side effects, results of post-approval trials, increased competition from the introduction of new, more effective treatments and discontinuation or removal from the market of the product for any reason. Such events could have a material adverse effect on the sales of any such products. For example, in 2018, the Company anticipates that sales of Zepatier will be materially unfavorably affected by increasing competition and declining patient volumes. The Company also anticipates that sales of Zostavax will be materially unfavorably affected due to competition. The Companys research and development efforts may not succeed in developing commercially successful products and the Company may not be able to acquire commercially successful products in other ways; in consequence, the Company may not be able to replace sales of successful products that have lost patent protection. Like other major pharmaceutical companies, in order to remain competitive, the Company must continue to launch new products each year. Expected declines in sales of products after the loss of market exclusivity mean that the Companys future success is dependent on its pipeline of new products, including new products that it may develop through collaborations and joint ventures and products that it is able to obtain through license or acquisition. To accomplish this, the Company commits substantial effort, funds and other resources to research and development, both through its own dedicated resources and through various collaborations with third parties. There is a high rate of failure inherent in the research and development process for new drugs. As a result, there is a high risk that funds invested by the Company in research programs will not generate financial returns. This risk profile is compounded by the fact that this research has a long investment cycle. To bring a pharmaceutical compound from the discovery phase to market may take a decade or more and failure can occur at any point in the process, including later in the process after significant funds have been invested. For a description of the research and development process, see Item 1. Business Research and Development above. Each phase of testing is highly regulated and during each phase there is a substantial risk that the Company will encounter serious obstacles or will not achieve its goals, therefore, the Company may abandon a product in which it has invested substantial amounts of time and resources. Some of the risks encountered in the research and development process include the following: pre-clinical testing of a new compound may yield disappointing results; competing products from other manufacturers may reach the market first; clinical trials of a new drug may not be successful; a new drug may not be effective or may have harmful side effects; a new drug may not be approved by the regulators for its intended use; it may not be possible to obtain a patent for a new drug; payers may refuse to cover or reimburse the new product; or sales of a new product may be disappointing. The Company cannot state with certainty when or whether any of its products now under development will be approved or launched; whether it will be able to develop, license or otherwise acquire compounds, product candidates or products; or whether any products, once launched, will be commercially successful. The Company must maintain a continuous flow of successful new products and successful new indications or brand extensions for existing products sufficient both to cover its substantial research and development costs and to replace sales that are lost as profitable products lose market exclusivity or are displaced by competing products or therapies. Failure to do so in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys success is dependent on the successful development and marketing of new products, which are subject to substantial risks. Products that appear promising in development may fail to reach the market or fail to succeed for numerous reasons, including the following: findings of ineffectiveness, superior safety or efficacy of competing products, or harmful side effects in clinical or pre-clinical testing; failure to receive the necessary regulatory approvals, including delays in the approval of new products and new indications, and uncertainties about the time required to obtain regulatory approvals and the benefit/risk standards applied by regulatory agencies in determining whether to grant approvals; failure in certain markets to obtain reimbursement commensurate with the level of innovation and clinical benefit presented by the product; lack of economic feasibility due to manufacturing costs or other factors; and preclusion from commercialization by the proprietary rights of others. In the future, if certain pipeline programs are cancelled or if the Company believes that their commercial prospects have been reduced, the Company may recognize material non-cash impairment charges for those programs that were measured at fair value and capitalized in connection with acquisitions. Failure to successfully develop and market new products in the short term or long term would have a material adverse effect on the Companys business, results of operations, cash flow, financial position and prospects. The Companys products, including products in development, cannot be marketed unless the Company obtains and maintains regulatory approval. The Companys activities, including research, preclinical testing, clinical trials and manufacturing and marketing its products, are subject to extensive regulation by numerous federal, state and local governmental authorities in the United States, including the FDA, and by foreign regulatory authorities, including in the EU and Japan. In the United States, the FDA is of particular importance to the Company, as it administers requirements covering the testing, approval, safety, effectiveness, manufacturing, labeling and marketing of prescription pharmaceuticals. In many cases, the FDA requirements have increased the amount of time and money necessary to develop new products and bring them to market in the United States. Regulation outside the United States also is primarily focused on drug safety and effectiveness and, in many cases, cost reduction. The FDA and foreign regulatory authorities have substantial discretion to require additional testing, to delay or withhold registration and marketing approval and to otherwise preclude distribution and sale of a product. Even if the Company is successful in developing new products, it will not be able to market any of those products unless and until it has obtained all required regulatory approvals in each jurisdiction where it proposes to market the new products. Once obtained, the Company must maintain approval as long as it plans to market its new products in each jurisdiction where approval is required. The Companys failure to obtain approval, significant delays in the approval process, or its failure to maintain approval in any jurisdiction will prevent it from selling the new products in that jurisdiction until approval is obtained, if ever. The Company would not be able to realize revenues for those new products in any jurisdiction where it does not have approval. Developments following regulatory approval may adversely affect sales of the Companys products. Even after a product reaches market, certain developments following regulatory approval, including results in post-approval Phase 4 trials or other studies, may decrease demand for the Companys products, including the following: the re-review of products that are already marketed; the recall or loss of marketing approval of products that are already marketed; changing government standards or public expectations regarding safety, efficacy or labeling changes; and greater scrutiny in advertising and promotion. In the past several years, clinical trials and post-marketing surveillance of certain marketed drugs of the Company and of competitors within the industry have raised concerns that have led to recalls, withdrawals or adverse labeling of marketed products. Clinical trials and post-marketing surveillance of certain marketed drugs also have raised concerns among some prescribers and patients relating to the safety or efficacy of pharmaceutical products in general that have negatively affected the sales of such products. In addition, increased scrutiny of the outcomes of clinical trials has led to increased volatility in market reaction. Further, these matters often attract litigation and, even where the basis for the litigation is groundless, considerable resources may be needed to respond. In addition, following in the wake of product withdrawals and other significant safety issues, health authorities such as the FDA, the EMA and Japans Pharmaceutical and Medical Device Agency have increased their focus on safety when assessing the benefit/risk balance of drugs. Some health authorities appear to have become more cautious when making decisions about approvability of new products or indications and are re-reviewing select products that are already marketed, adding further to the uncertainties in the regulatory processes. There is also greater regulatory scrutiny, especially in the United States, on advertising and promotion and, in particular, direct-to-consumer advertising. If previously unknown side effects are discovered or if there is an increase in negative publicity regarding known side effects of any of the Companys products, it could significantly reduce demand for the product or require the Company to take actions that could negatively affect sales, including removing the product from the market, restricting its distribution or applying for labeling changes. Further, in the current environment in which all pharmaceutical companies operate, the Company is at risk for product liability and consumer protection claims and civil and criminal governmental actions related to its products, research and/or marketing activities. The Company faces intense competition from lower cost generic products. In general, the Company faces increasing competition from lower-cost generic products. The patent rights that protect its products are of varying strengths and durations. In addition, in some countries, patent protection is significantly weaker than in the United States or in the EU. In the United States and the EU, political pressure to reduce spending on prescription drugs has led to legislation and other measures that encourage the use of generic and biosimilar products. Although it is the Companys policy to actively protect its patent rights, generic challenges to the Companys products can arise at any time, and the Companys patents may not prevent the emergence of generic competition for its products. Loss of patent protection for a product typically is followed promptly by generic substitutes, reducing the Companys sales of that product. Availability of generic substitutes for the Companys drugs may adversely affect its results of operations and cash flow. In addition, proposals emerge from time to time in the United States and other countries for legislation to further encourage the early and rapid approval of generic drugs. Any such proposal that is enacted into law could worsen this substantial negative effect on the Companys sales and, potentially, its business, cash flow, results of operations, financial position and prospects. The Company faces intense competition from competitors products which, in addition to other factors, could in certain circumstances lead to non-cash impairment charges. The Companys products face intense competition from competitors products. This competition may increase as new products enter the market. In such an event, the competitors products may be safer or more effective, more convenient to use or more effectively marketed and sold than the Companys products. Alternatively, in the case of generic competition, including the generic availability of competitors branded products, they may be equally safe and effective products that are sold at a substantially lower price than the Companys products. As a result, if the Company fails to maintain its competitive position, this could have a material adverse effect on its business, cash flow, results of operations, financial position and prospects. In addition, if products that were measured at fair value and capitalized in connection with acquisitions experience difficulties in the market that negatively impact product cash flows, the Company may recognize material non-cash impairment charges with respect to the value of those products. The Company faces continued pricing pressure with respect to its products. The Company faces continued pricing pressure globally and, particularly in mature markets, from managed care organizations, government agencies and programs that could negatively affect the Companys sales and profit margins. In the United States, these include (i) practices of managed care groups and institutional and governmental purchasers, (ii) U.S. federal laws and regulations related to Medicare and Medicaid, including the Medicare Prescription Drug Improvement and Modernization Act of 2003 and the ACA, and (iii) state activities aimed at increasing price transparency. Changes to the health care system enacted as part of health care reform in the United States, as well as increased purchasing power of entities that negotiate on behalf of Medicare, Medicaid, and private sector beneficiaries, could result in further pricing pressures. In addition, in the U.S., larger customers may, in the future, ask for and receive higher rebates on drugs in certain highly competitive categories. The Company must also compete to be placed on formularies of managed care organizations. Exclusion of a product from a formulary can lead to reduced usage in the managed care organization. In order to provide information about the Companys pricing practices, the Company recently posted on its website its Pricing Action Transparency Report for the United States for the years 2010 - 2017. The report provides the Companys average annual list price and net price increases across the Companys U.S. portfolio dating back to 2010. The report shows that the Companys average annual net price increases (after taking sales deductions such as rebates, discounts and returns into account) across the U.S. human health portfolio have been in the low to mid-single digits from 2010 - 2016. In 2017, the average net price across the Companys portfolio declined by 1.9%, reflecting specific in-year dynamics, including the impact of loss of patent protection for three major Merck medicines. Additionally, the weighted average annual discount rate has been steadily increasing over time, reflecting the competitive market for branded medicines and the impact of the ACA. In 2017, the Companys gross U.S. sales were reduced by 45.1% as a result of rebates, discounts and returns. Outside the United States, numerous major markets, including the EU and Japan, have pervasive government involvement in funding health care and, in that regard, fix the pricing and reimbursement of pharmaceutical and vaccine products. Consequently, in those markets, the Company is subject to government decision making and budgetary actions with respect to its products. The Company expects pricing pressures to continue in the future. The health care industry in the United States will continue to be subject to increasing regulation and political action. The Company believes that the health care industry will continue to be subject to increasing regulation as well as political and legal action, as future proposals to reform the health care system are considered by the Executive branch, Congress and state legislatures. In 2010, the United States enacted major health care reform legislation in the form of the ACA. Various insurance market reforms have advanced and state and federal insurance exchanges were launched in 2014. With respect to the effect of the law on the pharmaceutical industry, the law increased the mandated Medicaid rebate from 15.1% to 23.1%, expanded the rebate to Medicaid managed care utilization, and increased the types of entities eligible for the federal 340B drug discount program. The law also requires pharmaceutical manufacturers to pay a 50% point of service discount to Medicare Part D beneficiaries when they are in the Medicare Part D coverage gap (i.e., the so-called donut hole). In 2017, the Companys revenue was reduced by $385 million due to this requirement. Beginning in 2019, the 50% point of service discount will increase to a 70% point of service discount in the coverage gap, as a result of the Balanced Budget Act of 2018. In addition, the 70% point of service discount will be extended to biosimilar products. Also, pharmaceutical manufacturers are now required to pay an annual non-tax deductible health care reform fee. The total annual industry fee was $4.0 billion in 2017 and will be $4.1 billion in 2018. The fee is assessed on each company in proportion to its share of prior year branded pharmaceutical sales to certain government programs, such as Medicare and Medicaid. In 2017, the Company recorded $210 million of costs for this annual fee. On January 21, 2016, the Centers for Medicare Medicaid Services (CMS) issued the Medicaid rebate final rule that implements provisions of the ACA effective April 1, 2016. The rule provides comprehensive guidance on the calculation of Average Manufacturer Price and Best Price; two metrics utilized to determine the rebates drug manufacturers are required to pay to state Medicaid programs. The impact of changes resulting from the issuance of the rule is not material to Merck, at this time. However, the Company is still awaiting guidance from CMS on two aspects of the rule that were deferred for later implementation. These include a definition of what constitutes a product line extension and a delay in the participation of the U.S. Territories in the Medicaid Drug Rebate Program until April 1, 2020. The Company will evaluate the financial impact of these two elements when they become effective. The Company cannot predict the likelihood of future changes in the health care industry in general, or the pharmaceutical industry in particular, or what impact they may have on the Companys results of operations, financial condition or business. The Company is increasingly dependent on sophisticated software applications and computing infrastructure. In 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. The Company could be a target of future cyber-attacks. The Company is increasingly dependent on sophisticated software applications and complex information technology systems and computing infrastructure (collectively, IT systems) to conduct critical operations. Disruption, degradation, or manipulation of these IT systems through intentional or accidental means could impact key business processes. Cyber-attacks against the Companys IT systems could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Misuse of these IT systems could result in the disclosure of sensitive personal information or the theft of trade secrets, intellectual property, or other confidential business information. The Company continues to leverage new and innovative technologies across the enterprise to improve the efficacy and efficiency of its business processes; the use of which can create new risks. On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. All of the Companys manufacturing sites are now operational, manufacturing active pharmaceutical ingredient (API), formulating, packaging and shipping product. The Companys external manufacturing was not impacted. Throughout this time, Merck continued to fulfill orders and ship product. Due to the cyber-attack, as anticipated, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Materials and Production costs, as well as expenses related to remediation efforts in Marketing and Administrative expenses and Research and Development expenses, which aggregated $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders, the Company anticipates that in 2018 sales will be unfavorably affected in certain markets by approximately $200 million from the cyber-attack. Merck does not expect a significant impairment to the value of intangible assets related to marketed products or inventories as a result of the cyber-attack. The Company has insurance coverage insuring against costs resulting from cyber-attacks and has received proceeds. However, there may be disputes with the insurers about the availability of the insurance coverage for claims related to this incident. Additionally, the temporary production shut-down from the cyber-attack contributed to the Companys inability to meet higher than expected demand for Gardasil 9, which resulted in Mercks decision to borrow doses of Gardasil 9 from the U.S. Centers for Disease Control and Prevention Pediatric Vaccine Stockpile. The Company subsequently replenished a portion of the borrowed doses in 2017. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018. The Company has implemented a variety of measures to further enhance its systems to guard against similar attacks in the future, and also is pursuing an enterprise-wide effort to enhance the Company's resiliency against future cyber-attacks, including incidents similar to the June 2017 attack. The objective of these efforts is not only to protect against future cyber-attacks, but also to improve the speed of the Companys recovery from such attacks and enable continued business operations to the greatest extent possible during any recovery period. Although the aggregate impact of cyber-attacks and network disruptions, including the June 2017 cyber-attack, on the Companys operations and financial condition has not been material to date, the Company continues to be a target of events of this nature and expects them to continue. The Company monitors its data, information technology and personnel usage of Company IT systems to reduce these risks and continues to do so on an ongoing basis for any current or potential threats. There can be no assurance that the Companys efforts to protect its data and IT systems will be successful in preventing disruptions to its operations, including its manufacturing, research and sales operations. Any such disruption could result in loss of revenue, or the loss of critical or sensitive information from the Companys or the Companys third party providers databases or IT systems and could also result in financial, legal, business or reputational harm to the Company and potentially substantial remediation costs. Changes in laws and regulations could materially adversely affect the Companys business. All aspects of the Companys business, including research and development, manufacturing, marketing, pricing, sales, litigation and intellectual property rights, are subject to extensive legislation and regulation. Changes in applicable federal and state laws and agency regulations could have a material adverse effect on the Companys business. In particular, there is significant uncertainty about the future of the ACA and health care laws in general in the United States. The Company is participating in the debate and monitoring how any proposed changes could affect its business. The Company is unable to predict the likelihood of changes to the ACA. Depending on the nature of any repeal and replacement of the ACA, such actions could have a material adverse effect on the Companys results of operations, financial condition or business. The uncertainty in global economic conditions together with austerity measures being taken by certain governments could negatively affect the Companys operating results. Uncertainty in global economic and geopolitical conditions may result in a slowdown to the global economy that could affect the Companys business by reducing the prices that drug wholesalers and retailers, hospitals, government agencies and managed health care providers may be able or willing to pay for the Companys products or by reducing the demand for the Companys products, which could in turn negatively impact the Companys sales and result in a material adverse effect on the Companys business, cash flow, results of operations, financial position and prospects. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Companys revenue performance in 2017. The Company anticipates these pricing actions, including the biennial price reductions in Japan that will occur again in 2018, and other austerity measures will continue to negatively affect revenue performance in 2018. If credit and economic conditions worsen, the resulting economic and currency impacts in the affected markets and globally could have a material adverse effect on the Companys results. The Company has significant global operations, which expose it to additional risks, and any adverse event could have a material negative impact on the Companys results of operations. The extent of the Companys operations outside the United States is significant. Risks inherent in conducting a global business include: changes in medical reimbursement policies and programs and pricing restrictions in key markets; multiple regulatory requirements that could restrict the Companys ability to manufacture and sell its products in key markets; trade protection measures and import or export licensing requirements, including the imposition of trade sanctions or similar restrictions by the United States or other governments; foreign exchange fluctuations; diminished protection of intellectual property in some countries; and possible nationalization and expropriation. In addition, there may be changes to the Companys business and political position if there is instability, disruption or destruction in a significant geographic region, regardless of cause, including war, terrorism, riot, civil insurrection or social unrest; and natural or man-made disasters, including famine, flood, fire, earthquake, storm or disease. For example, in 2017, the Companys lone manufacturing plant in Puerto Rico was negatively affected by Hurricane Maria. On June 23, 2016, the United Kingdom (UK) held a referendum in which voters approved an exit from the EU, commonly referred to as Brexit. As a result of the referendum, the British government has begun negotiating the terms of the UKs future relationship with the EU. Although it is unknown what those terms will be, it is possible that there will be greater restrictions on imports and exports between the UK and EU countries, increased regulatory complexities, and cross boarder labor issues that could adversely impact the Companys business operations in the UK. Failure to attract and retain highly qualified personnel could affect its ability to successfully develop and commercialize products. The Companys success is largely dependent on its continued ability to attract and retain highly qualified scientific, technical and management personnel, as well as personnel with expertise in clinical research and development, governmental regulation and commercialization. Competition for qualified personnel in the pharmaceutical industry is intense. The Company cannot be sure that it will be able to attract and retain quality personnel or that the costs of doing so will not materially increase. In the past, the Company has experienced difficulties and delays in manufacturing certain of its products, including vaccines. Merck has, in the past, experienced difficulties in manufacturing certain of its products, including vaccines. In addition, the network cyber-attack experienced by the Company in June 2017 led to a disruption of the Companys operations, including its manufacturing operations. The Company may, in the future, experience difficulties and delays inherent in manufacturing its products, such as (i) failure of the Company or any of its vendors or suppliers to comply with Current Good Manufacturing Practices and other applicable regulations and quality assurance guidelines that could lead to manufacturing shutdowns, product shortages and delays in product manufacturing; (ii) construction delays related to the construction of new facilities or the expansion of existing facilities, including those intended to support future demand for the Companys products; and (iii) other manufacturing or distribution problems including changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, or physical limitations that could impact continuous supply. Manufacturing difficulties can result in product shortages, leading to lost sales and reputational harm to the Company. The Company may not be able to realize the expected benefits of its investments in emerging markets. The Company has been taking steps to increase its sales in emerging markets. However, there is no guarantee that the Companys efforts to expand sales in these markets will succeed. Some countries within emerging markets may be especially vulnerable to periods of global financial instability or may have very limited resources to spend on health care. In order for the Company to successfully implement its emerging markets strategy, it must attract and retain qualified personnel. The Company may also be required to increase its reliance on third-party agents within less developed markets. In addition, many of these countries have currencies that fluctuate substantially and, if such currencies devalue and the Company cannot offset the devaluations, the Companys financial performance within such countries could be adversely affected. In addition, in China, commercial and economic conditions may adversely affect the Companys growth prospects in that market. While the Company continues to believe that China represents an important growth opportunity, these events, coupled with heightened scrutiny of the health care industry, may continue to have an impact on product pricing and market access generally. The Company anticipates that the reported inquiries made by various governmental authorities involving multinational pharmaceutical companies in China may continue. For all these reasons, sales within emerging markets carry significant risks. However, a failure to maintain the Companys presence in emerging markets could have a material adverse effect on the business, financial condition or results of the Companys operations. The Company is exposed to market risk from fluctuations in currency exchange rates and interest rates. The Company operates in multiple jurisdictions and virtually all sales are denominated in currencies of the local jurisdiction. Additionally, the Company has entered and will enter into acquisition, licensing, borrowings or other financial transactions that may give rise to currency and interest rate exposure. Since the Company cannot, with certainty, foresee and mitigate against such adverse fluctuations, fluctuations in currency exchange rates and interest rates could negatively affect the Companys results of operations, financial position and cash flows as occurred with respect to Venezuela in 2015 and 2016. In order to mitigate against the adverse impact of these market fluctuations, the Company will from time to time enter into hedging agreements. While hedging agreements, such as currency options and forwards and interest rate swaps, may limit some of the exposure to exchange rate and interest rate fluctuations, such attempts to mitigate these risks may be costly and not always successful. The Company is subject to evolving and complex tax laws, which may result in additional liabilities that may affect results of operations. The Company is subject to evolving and complex tax laws in the jurisdictions in which it operates. Significant judgment is required for determining the Companys tax liabilities, and the Companys tax returns are periodically examined by various tax authorities. The Company believes that its accrual for tax contingencies is adequate for all open years based on past experience, interpretations of tax law, and judgments about potential actions by tax authorities; however, due to the complexity of tax contingencies, the ultimate resolution of any tax matters may result in payments greater or less than amounts accrued. In addition, the Company may be affected by changes in tax laws, such as tax rate changes, new tax laws, and revised tax law interpretations in domestic and foreign jurisdictions. Further, on December 22, 2017, the U.S. Tax Cuts and Jobs Act of 2017 (TCJA) became law. The final impact of the TCJA on the Company may differ from the estimates reported, possibly materially, due to such factors as changes in interpretations and assumptions made, additional guidance that may be issued, and actions taken by the Company as a result of the TCJA, among others. Pharmaceutical products can develop unexpected safety or efficacy concerns. Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals, or declining sales, as well as product liability, consumer fraud and/or other claims, including potential civil or criminal governmental actions. Reliance on third party relationships and outsourcing arrangements could adversely affect the Companys business. The Company depends on third parties, including suppliers, alliances with other pharmaceutical and biotechnology companies, and third party service providers, for key aspects of its business including development, manufacture and commercialization of its products and support for its information technology systems. Failure of these third parties to meet their contractual, regulatory and other obligations to the Company or the development of factors that materially disrupt the relationships between the Company and these third parties could have a material adverse effect on the Companys business. Negative events in the animal health industry could have a negative impact on future results of operations. Future sales of key animal health products could be adversely affected by a number of risk factors including certain risks that are specific to the animal health business. For example, the outbreak of disease carried by animals, such as Bovine Spongiform Encephalopathy or mad cow disease, could lead to their widespread death and precautionary destruction as well as the reduced consumption and demand for animals, which could adversely impact the Companys results of operations. Also, the outbreak of any highly contagious diseases near the Companys main production sites could require the Company to immediately halt production of vaccines at such sites or force the Company to incur substantial expenses in procuring raw materials or vaccines elsewhere. Other risks specific to animal health include epidemics and pandemics, government procurement and pricing practices, weather and global agribusiness economic events. As the Animal Health segment of the Companys business becomes more significant, the impact of any such events on future results of operations would also become more significant. Biologics and vaccines carry unique risks and uncertainties, which could have a negative impact on future results of operations. The successful development, testing, manufacturing and commercialization of biologics and vaccines, particularly human and animal health vaccines, is a long, expensive and uncertain process. There are unique risks and uncertainties with biologics and vaccines, including: There may be limited access to, and supply of, normal and diseased tissue samples, cell lines, pathogens, bacteria, viral strains and other biological materials. In addition, government regulations in multiple jurisdictions, such as the United States and the EU, could result in restricted access to, or transport or use of, such materials. If the Company loses access to sufficient sources of such materials, or if tighter restrictions are imposed on the use of such materials, the Company may not be able to conduct research activities as planned and may incur additional development costs. The development, manufacturing and marketing of biologics and vaccines are subject to regulation by the FDA, the EMA and other regulatory bodies. These regulations are often more complex and extensive than the regulations applicable to other pharmaceutical products. For example, in the United States, a BLA, including both preclinical and clinical trial data and extensive data regarding the manufacturing procedures, is required for human vaccine candidates, and FDA approval is generally required for the release of each manufactured commercial lot. Manufacturing biologics and vaccines, especially in large quantities, is often complex and may require the use of innovative technologies to handle living micro-organisms. Each lot of an approved biologic and vaccine must undergo thorough testing for identity, strength, quality, purity and potency. Manufacturing biologics requires facilities specifically designed for and validated for this purpose, and sophisticated quality assurance and quality control procedures are necessary. Slight deviations anywhere in the manufacturing process, including filling, labeling, packaging, storage and shipping and quality control and testing, may result in lot failures, product recalls or spoilage. When changes are made to the manufacturing process, the Company may be required to provide pre-clinical and clinical data showing the comparable identity, strength, quality, purity or potency of the products before and after such changes. Biologics and vaccines are frequently costly to manufacture because production ingredients are derived from living animal or plant material, and most biologics and vaccines cannot be made synthetically. In particular, keeping up with the demand for vaccines may be difficult due to the complexity of producing vaccines. The use of biologically derived ingredients can lead to variability in the manufacturing process and could lead to allegations of harm, including infections or allergic reactions, which allegations would be reviewed through a standard investigation process that could lead to closure of product facilities due to possible contamination. Any of these events could result in substantial costs. Product liability insurance for products may be limited, cost prohibitive or unavailable. As a result of a number of factors, product liability insurance has become less available while the cost has increased significantly. The Company is subject to a substantial number of product liability claims. See Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities below for more information on the Companys current product liability litigation. With respect to product liability, the Company self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for certain product liabilities effective August 1, 2004, including liability for legacy Merck products first sold after that date. The Company will continually assess the most efficient means to address its risk; however, there can be no guarantee that insurance coverage will be obtained or, if obtained, will be sufficient to fully cover product liabilities that may arise. Social media platforms present risks and challenges. The inappropriate and/or unauthorized use of certain media vehicles could cause brand damage or information leakage or could lead to legal implications, including from the improper collection and/or dissemination of personally identifiable information. In addition, negative or inaccurate posts or comments about the Company or its products on any social networking web site could damage the Companys reputation, brand image and goodwill. Further, the disclosure of non-public Company-sensitive information by the Companys workforce or others through external media channels could lead to information loss. Although there is an internal Company Social Media Policy that guides employees on appropriate personal and professional use of social media about the Company, the processes in place may not completely secure and protect information. Identifying new points of entry as social media continues to expand also presents new challenges. Cautionary Factors that May Affect Future Results (Cautionary Statements Under the Private Securities Litigation Reform Act of 1995) This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential, and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. The Company cautions you not to place undue reliance on these forward-looking statements. Although it is not possible to predict or identify all such factors, they may include the following: Competition from generic and/or biosimilar products as the Companys products lose patent protection. Increased brand competition in therapeutic areas important to the Companys long-term business performance. The difficulties and uncertainties inherent in new product development. The outcome of the lengthy and complex process of new product development is inherently uncertain. A drug candidate can fail at any stage of the process and one or more late-stage product candidates could fail to receive regulatory approval. New product candidates may appear promising in development but fail to reach the market because of efficacy or safety concerns, the inability to obtain necessary regulatory approvals, the difficulty or excessive cost to manufacture and/or the infringement of patents or intellectual property rights of others. Furthermore, the sales of new products may prove to be disappointing and fail to reach anticipated levels. Pricing pressures, both in the United States and abroad, including rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and health care reform, pharmaceutical reimbursement and pricing in general. Changes in government laws and regulations, including laws governing intellectual property, and the enforcement thereof affecting the Companys business. Efficacy or safety concerns with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales. Significant changes in customer relationships or changes in the behavior and spending patterns of purchasers of health care products and services, including delaying medical procedures, rationing prescription medications, reducing the frequency of physician visits and foregoing health care insurance coverage. Legal factors, including product liability claims, antitrust litigation and governmental investigations, including tax disputes, environmental concerns and patent disputes with branded and generic competitors, any of which could preclude commercialization of products or negatively affect the profitability of existing products. Cyber-attacks on the Companys information technology systems, which could disrupt the Companys operations. Lost market opportunity resulting from delays and uncertainties in the approval process of the FDA and foreign regulatory authorities. Increased focus on privacy issues in countries around the world, including the United States and the EU. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increasing amount of focus on privacy and data protection issues with the potential to affect directly the Companys business, including recently enacted laws in a majority of states in the United States requiring security breach notification. Changes in tax laws including changes related to the taxation of foreign earnings. Changes in accounting pronouncements promulgated by standard-setting or regulatory bodies, including the Financial Accounting Standards Board and the SEC, that are adverse to the Company. Economic factors over which the Company has no control, including changes in inflation, interest rates and foreign currency exchange rates. This list should not be considered an exhaustive statement of all potential risks and uncertainties. See Risk Factors above. ", Item 1B. Unresolved Staff Comments. None. ," Item 2. Properties. The Companys corporate headquarters is located in Kenilworth, New Jersey. The Companys U.S. commercial operations are headquartered in Upper Gwynedd, Pennsylvania. The Companys U.S. pharmaceutical business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania and Kenilworth, New Jersey. The Companys vaccines business is conducted through divisional headquarters located in Upper Gwynedd, Pennsylvania. Mercks Animal Health global headquarters is located in Madison, New Jersey. Principal U.S. research facilities are located in Rahway and Kenilworth, New Jersey, West Point, Pennsylvania, Palo Alto, California, Boston, Massachusetts, and Elkhorn, Nebraska (Animal Health). Principal research facilities outside the United States are located in Switzerland and China. Mercks manufacturing operations are headquartered in Whitehouse Station, New Jersey. The Company also has production facilities for human health products at nine locations in the United States and Puerto Rico. Outside the United States, through subsidiaries, the Company owns or has an interest in manufacturing plants or other properties in Japan, Singapore, South Africa, and other countries in Western Europe, Central and South America, and Asia. Capital expenditures were $1.9 billion in 2017 , $1.6 billion in 2016 and $1.3 billion in 2015 . In the United States, these amounted to $1.2 billion in 2017 , $1.0 billion in 2016 and $879 million in 2015 . Abroad, such expenditures amounted to $728 million in 2017, $594 million in 2016 and $404 million in 2015. The Company and its subsidiaries own their principal facilities and manufacturing plants under titles that they consider to be satisfactory. The Company believes that its properties are in good operating condition and that its machinery and equipment have been well maintained. Plants for the manufacture of products are suitable for their intended purposes and have capacities and projected capacities adequate for current and projected needs for existing Company products. Some capacity of the plants is being converted, with any needed modification, to the requirements of newly introduced and future products. "," Item 3. Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8. Financial Statements and Supplementary Data, Note 11. Contingencies and Environmental Liabilities. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal market for trading of the Companys Common Stock is the New York Stock Exchange (NYSE) under the symbol MRK. The Common Stock market price information set forth in the table below is based on historical NYSE market prices. The following table also sets forth, for the calendar periods indicated, the cash dividends paid per common share and the high and low sales prices of the Companys Common Stock as reported by the NYSE. Cash Dividends Paid per Common Share Year 4th Q 3rd Q 2nd Q 1st Q 2017 $ 1.88 $ 0.47 $ 0.47 $ 0.47 $ 0.47 2016 $ 1.84 $ 0.46 $ 0.46 $ 0.46 $ 0.46 Common Stock Market Prices 2017 4th Q 3rd Q 2nd Q 1st Q High 64.90 66.41 66.40 66.80 Low 53.63 61.16 61.87 59.05 2016 High $ 65.46 $ 64.00 $ 57.87 $ 53.60 Low $ 58.29 $ 57.18 $ 52.44 $ 47.97 As of January 31, 2018, there were approximately 121,125 shareholders of record of the Companys Common Stock. Issuer purchases of equity securities for the three months ended December 31, 2017 were as follows: Issuer Purchases of Equity Securities ($ in millions) Period Total Number of Shares Purchased (1) Average Price Paid Per Share Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs (1) October 1 October 31 2,172,335 $63.38 $2,605 November 1 November 30 11,850,338 $55.03 $1,953 December 1 December 31 16,285,000 $56.05 $11,040 Total 30,307,673 $56.17 $11,040 (1) All shares purchased during the period were made as part of a plan approved by the Board of Directors in March 2015 to purchase up to $10 billion in Merck shares. In November 2017, the Board of Directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. Shares are approximated. Performance Graph The following graph assumes a $100 investment on December 31, 2012, and reinvestment of all dividends, in each of the Companys Common Shares, the SP 500 Index, and a composite peer group of major pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca plc, Bristol-Myers Squibb Company, Johnson Johnson, Eli Lilly and Company, GlaxoSmithKline plc, Novartis AG, Pfizer Inc., Roche Holding AG, and Sanofi SA. Comparison of Five-Year Cumulative Total Return* Merck Co., Inc., Composite Peer Group and SP 500 Index End of Period Value 2017/2012 CAGR** MERCK $162 10% PEER GRP.** 13% SP 500 16% 2013 2015 2017 MERCK 100.00 126.90 148.70 142.70 164.30 161.80 PEER GRP. 100.00 134.60 150.20 154.70 151.60 184.70 SP 500 100.00 132.40 150.50 152.50 170.80 208.10 * Compound Annual Growth Rate ** Peer group average was calculated on a market cap weighted basis. This Performance Graph will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference. In addition, the Performance Graph will not be deemed to be soliciting material or to be filed with the SEC or subject to Regulation 14A or 14C, other than as provided in Regulation S-K, or to the liabilities of section 18 of the Securities Exchange Act of 1934, except to the extent that the Company specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. Description of Mercks Business Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. Overview During 2017, Merck continued to bring innovation to patients and physicians, expanding its focus in oncology and advancing other programs in its late-stage pipeline. Throughout 2017, Keytruda , the Companys anti-PD-1 (programmed death receptor-1) therapy, received approval for several additional indications globally, including U.S. Food and Drug Administration (FDA) approval in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous non-small-cell lung cancer (NSCLC), irrespective of PD-L1 expression. Keytruda is the only anti-PD-1 treatment approved in the first-line setting as both monotherapy and combination therapy for appropriate patients with metastatic NSCLC. In addition, Lynparza, an oral poly (ADP-ribose) polymerase (PARP) inhibitor, which is being developed in a collaboration, received FDA approval for the treatment of patients with germline BRCA-mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy. Additionally, in November 2017, the FDA approved Prevymis for prophylaxis (prevention) of cytomegalovirus (CMV) infection and disease, and in December 2017, the FDA approved Steglatro, Steglujan and Segluromet for the treatment of type 2 diabetes. In January 2018, Prevymis was also approved in the European Union (EU). Worldwide sales were $40.1 billion in 2017 , an increase of 1% compared with 2016 . Sales growth was driven primarily by the launches of Keytruda , Zepatier and Bridion , as well as positive performance from Mercks Animal Health business. In addition, revenue in 2017 benefited from the sale of vaccines in the markets that were previously part of the now-terminated SPMSD vaccines joint venture. Growth in these areas was largely offset by the effects of generic and biosimilar competition that resulted in sales declines for products including Zetia , Vytorin , Cubicin and Remicade . Augmenting Mercks portfolio and pipeline with external innovation remains an important component of the Companys overall strategy. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types. Lynparza is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. The companies will develop and commercialize Lynparza both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PDL1 medicines. The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. In addition, in October 2017, Merck acquired Rigontec GmbH (Rigontec), a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Also, in March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Merck continues to prioritize resources to maximize opportunities for ongoing and upcoming product launches. Keytruda is launching around the world in multiple indications. In 2017, Merck achieved multiple additional regulatory milestones for Keytruda , including approval from the FDA as combination therapy for appropriate patients with metastatic NSCLC as noted above, as well as monotherapy approval for the treatment of certain patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction adenocarcinoma; for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer; for the treatment of adult and pediatric patients with classical Hodgkin lymphoma (cHL); and for the treatment of adult and pediatric patients with unresectable or metastatic, microsatellite instability-high (MSI-H) or mismatch repair deficient solid tumors. During 2017, Keytruda also received approval in the EU for the treatment of certain patients with cHL and urothelial carcinoma. Merck continues to evaluate its pipeline, focusing its research efforts on the opportunities it believes have the greatest potential to address unmet medical needs. In addition to the recent regulatory approvals discussed above, the Company has continued to advance other programs in its late-stage pipeline with several regulatory submissions. MK-1439, doravirine, an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection, and MK-1439A, doravirine with lamivudine and tenofovir disoproxil fumarate, are currently under review with the FDA. In addition, the FDA accepted for review a supplemental Biologics License Application (BLA) for Keytruda for the treatment of adult and pediatric patients with refractory primary mediastinal B-cell lymphoma (PMBCL) that is refractory to or has relapsed after two prior lines of therapy. Additionally, Steglatro, Steglujan and Segluromet are under review in the EU. The Companys Phase 3 oncology programs include Keytruda in the therapeutic areas of breast, colorectal, esophageal, gastric, head and neck, hepatocellular, nasopharyngeal, renal and small-cell lung cancers; Lynparza for pancreatic and prostate cancer; and selumetinib for thyroid cancer. Additionally, the Company has candidates in Phase 3 clinical development in several other therapeutic areas (see Research and Development below). The Company continues to support its innovation strategy by remaining disciplined and prioritizing resources wherever possible to not only fund investment in the many opportunities in Mercks pipeline that it believes can help drive long-term growth, but also fund near-term opportunities to grow revenue. Research and development expenses in 2017 reflect increased clinical development spending as the Company continues to invest in the pipeline. In November 2017, Mercks Board of Directors raised the Companys quarterly dividend to $0.48 per share from $0.47 per share. During 2017 , the Company returned $9.2 billion to shareholders through dividends and share repurchases. Earnings per common share assuming dilution attributable to common shareholders (EPS) for 2017 were $0.87 compared with $1.41 in 2016 . EPS in both years reflect the impact of acquisition and divestiture-related costs, which in 2016 includes a charge related to the uprifosbuvir clinical development program, as well as restructuring costs and certain other items, which in 2017 include a provisional net tax charge related to the recent enactment of U.S. tax legislation and an aggregate charge related to the formation of a collaboration with AstraZeneca. Non-GAAP EPS, which exclude these items, were $3.98 in 2017 and $3.78 in 2016 (see Non-GAAP Income and Non-GAAP EPS below). Cyber-attack On June 27, 2017, the Company experienced a network cyber-attack that led to a disruption of its worldwide operations, including manufacturing, research and sales operations. All of the Companys manufacturing sites are now operational, manufacturing active pharmaceutical ingredient (API), formulating, packaging and shipping product. The Companys external manufacturing was not impacted. Throughout this time, Merck continued to fulfill orders and ship product. Due to the cyber-attack, as anticipated, the Company was unable to fulfill orders for certain products in certain markets, which had an unfavorable effect on sales in 2017 of approximately $260 million. In addition, the Company recorded manufacturing-related expenses, primarily unfavorable manufacturing variances, in Materials and production costs, as well as expenses related to remediation efforts in Marketing and administrative expenses and Research and development expenses, which aggregated approximately $285 million in 2017, net of insurance recoveries of approximately $45 million. Due to a residual backlog of orders for certain products, the Company anticipates that in 2018 sales will be unfavorably affected in certain markets by approximately $200 million from the cyber-attack. Merck does not expect a significant impairment to the value of intangible assets related to marketed products or inventories as a result of the cyber-attack. As referenced above, the Company has insurance coverage insuring against costs resulting from cyber-attacks and has received insurance proceeds. However, there may be disputes with the insurers about the availability of the insurance coverage for claims related to this incident. Additionally, the temporary production shut-down from the cyber-attack contributed to the Companys inability to meet higher than expected demand for Gardasil 9, which resulted in Mercks decision to borrow doses of Gardasil 9 from the U.S. Centers for Disease Control and Prevention (CDC) Pediatric Vaccine Stockpile. The Company subsequently replenished a portion of the borrowed doses in 2017. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018. Hurricane Maria In September 2017, Hurricane Maria made direct landfall on Puerto Rico. The Company has one plant in Puerto Rico that makes a limited number of its pharmaceutical products, and the Company also works with contract manufacturers on the island. Mercks plant did not sustain substantial damage, and production activities at the plant have resumed. While power has been restored to the facility, it is not yet fully reliable and the plant continues to be prepared to use alternative sources of power and water. The Company is making progress to fully restore normal operations despite the significant damage to the islands infrastructure. Supply chains within Puerto Rico are improving, but are not yet fully restored. There was an immaterial impact to sales in 2017 and the Company expects an immaterial impact to sales in 2018. Operating Results Sales Worldwide sales were $40.1 billion in 2017, an increase of 1% compared with 2016. Sales growth in 2017 was driven primarily by higher sales of recently launched products including Keytruda, Zepatier and Bridion . Additionally, sales in 2017 benefited from the December 31, 2016 termination of SPMSD, which marketed vaccines in most major European markets. In 2017, Merck began recording vaccine sales in the markets that were previously part of the SPMSD joint venture resulting in incremental vaccine sales of approximately $400 million during 2017. Higher sales of Pneumovax 23 and Adempas, as well as animal health products also contributed to revenue growth in 2017. These increases were largely offset by the effects of generic competition for certain products including Zetia , which lost U.S. market exclusivity in December 2016, Vytorin , which lost U.S. market exclusivity in April 2017, Cubicin due to U.S. patent expiration in June 2016, and Cancidas , which lost EU patent protection in April 2017. Revenue growth was also offset by continued biosimilar competition for Remicade and ongoing generic erosion for products including Singulair and Nasonex . Collectively, the sales decline attributable to the above products affected by generic and biosimilar competition was $3.3 billion in 2017. Lower sales of other products within the Diversified Brands franchise that includes certain products approaching the expiration of their marketing exclusivity or are no longer protected by patents in developed markets, including Dulera Inhalation Aerosol, as well as lower combined sales of the diabetes franchise of Januvia and Janumet , and declines in sales of Isentress/Isentress HD also partially offset revenue growth. Additionally, sales in 2017 were reduced by $125 million due to a borrowing the Company made from the CDC Pediatric Vaccine Stockpile of doses of Gardasil 9 as discussed below. Also, as anticipated, the Company was unable to fulfill orders for certain products in certain markets due to the cyber-attack, which had an unfavorable effect on sales in 2017 of approximately $260 million. Sales in the United States were $17.4 billion in 2017 , a decline of 6% compared with $18.5 billion in 2016 . The decrease was driven primarily by the effects of generic competition for Zetia and Vytorin , Cubicin , and declines of products within Diversified Brands including Nasonex and Dulera Inhalation Aerosol. Lower sales of Januvia/Janumet , Gardasil/Gardasil 9, Isentress/Isentress HD and Zostavax , also contributed to the U.S. sales decline in 2017. These declines were partially offset by higher sales of Keytruda , Zepatier , Bridion , and Pneumovax 23, along with higher sales of animal health products. International sales were $22.7 billion in 2017 , an increase of 6% compared with $21.3 billion in 2016 , primarily reflecting growth in Keytruda and Zepatier , and higher sales of vaccines due to the termination of the SPMSD joint venture, as well as higher sales of animal health products. Sales growth was partially offset by ongoing biosimilar competition for Remicade , as well as generic erosion for Cancidas and products within Diversified Brands. International sales represented 57% and 54% of total sales in 2017 and 2016 , respectively. Global efforts toward health care cost containment continue to exert pressure on product pricing and market access worldwide. In the United States, pricing pressures continue on many of the Companys products and, in several international markets, government-mandated pricing actions have reduced prices of generic and patented drugs. In addition, other austerity measures negatively affected the Companys revenue performance in 2017 . The Company anticipates these pricing actions, including the biennial price reductions in Japan that will occur again in 2018, and other austerity measures will continue to negatively affect revenue performance in 2018 . Worldwide sales were $39.8 billion in 2016, an increase of 1% compared with 2015. Foreign exchange unfavorably affected global sales performance by 2% in 2016, which includes a lower benefit from revenue hedging activities as compared with 2015. Revenue growth primarily reflects higher sales of Keytruda , the launch of the HCV treatment Zepatier, and growth in vaccine products, including Gardasil/Gardasil 9, Varivax and Pneumovax 23. Also contributing to sales growth in 2016 were higher sales of hospital acute care products including Bridion and Noxafil , growth within the diabetes franchise of Januvia and Janumet , as well as higher sales of animal health products, particularly Bravecto . These increases were largely offset by sales declines attributable to the ongoing effects of generic and biosimilar competition for certain products, including Remicade and Nasonex , along with other products within Diversified Brands. Declines in Isentress and Dulera Inhalation Aerosol also partially offset revenue growth in 2016. Sales performance in 2016 reflects a decline of approximately $625 million due to reduced operations by the Company in Venezuela as a result of the economic conditions and volatility in that country. Sales of the Companys products were as follows: ($ in millions) U.S. Intl Total U.S. Intl Total U.S. Intl Total Primary Care and Womens Health Cardiovascular Zetia $ $ $ 1,344 $ 1,588 $ $ 2,560 $ 1,612 $ $ 2,526 Vytorin 1,141 1,251 Atozet Adempas Diabetes Januvia 2,153 1,584 3,737 2,286 1,622 3,908 2,263 1,601 3,863 Janumet 1,296 2,158 1,217 2,201 1,175 2,151 General Medicine and Womens Health NuvaRing Implanon/Nexplanon Follistim AQ Hospital and Specialty Hepatitis Zepatier 1,660 HIV Isentress/Isentress HD 1,204 1,387 1,511 Hospital Acute Care Bridion Noxafil Invanz Cancidas Cubicin (1) 1,087 1,030 1,127 Primaxin Immunology Remicade 1,268 1,268 1,794 1,794 Simponi Oncology Keytruda 2,309 1,500 3,809 1,402 Emend Temodar Diversified Brands Respiratory Singulair Nasonex Dulera Other Cozaar/Hyzaar Arcoxia Fosamax Vaccines (2) Gardasil/Gardasil 9 1,565 2,308 1,780 2,173 1,520 1,908 ProQuad/M-M-R II /Varivax 1,374 1,676 1,362 1,640 1,290 1,505 Pneumovax 23 RotaTeq Zostavax Other pharmaceutical (3) 1,246 3,049 4,295 1,345 3,228 4,574 1,473 3,785 5,256 Total Pharmaceutical segment sales 15,854 19,536 35,390 17,073 18,077 35,151 16,238 18,544 34,782 Other segment sales (4) 1,486 2,785 4,272 1,374 2,489 3,862 1,213 2,454 3,667 Total segment sales 17,340 22,321 39,662 18,447 20,566 39,013 17,451 20,998 38,449 Other (5) 1,049 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 $ 17,519 $ 21,979 $ 39,498 U.S. plus international may not equal total due to rounding. (1) Sales of Cubicin in 2015 represent sales subsequent to the Cubist acquisition date. (2) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 and 2015 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 and 2015 do, however, include supply sales to SPMSD. (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents the non-reportable segments of Animal Health, Healthcare Services and Alliances. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2017 and 2016 also includes $85 million and $170 million, respectively, related to the sale of the marketing rights to certain products . Pharmaceutical Segment Primary Care and Womens Health Cardiovascular Combined global sales of Zetia (marketed in most countries outside the United States as Ezetrol ), Vytorin (marketed outside the United States as Inegy ), and Atozet (marketed in certain countries outside of the United States), medicines for lowering LDL cholesterol, were $2.3 billion in 2017, a decline of 40% compared with 2016. The sales decline was driven by lower volumes and pricing of Zetia and Vytorin in the United States as a result of generic competition. By agreement, a generic manufacturer launched a generic version of Zetia in the United States in December 2016. The U.S. patent and exclusivity periods for Zetia and Vytorin otherwise expired in April 2017. Accordingly, the Company is experiencing rapid and substantial declines in U.S. Zetia and Vytorin sales and expects the declines to continue. The Company will lose market exclusivity in major European markets for Ezetrol in April 2018 and for Inegy in April 2019 and anticipates sales declines in these markets thereafter. Sales of Ezetrol and Inegy in these markets were $552 million and $457 million, respectively, in 2017. Combined worldwide sales of Zetia , Vytorin and Atozet were $3.8 billion in 2016, growth of 1% compared with 2015, reflecting volume growth in Europe and higher pricing in the United States, largely offset by lower sales in Venezuela due to reduced operations by the Company in that country and lower volumes in the United States reflecting in part generic competition for Zetia . Pursuant to a collaboration with Bayer AG (Bayer) (see Note 4 to the consolidated financial statements), Merck has lead commercial rights for Adempas, a cardiovascular drug for the treatment of pulmonary arterial hypertension, in countries outside the Americas while Bayer has lead rights in the Americas, including the United States. The companies share profits equally under the collaboration. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. Merck recorded sales for Adempas of $300 million in 2017, $169 million in 2016 and $30 million in 2015, which includes sales in Mercks marketing territories, as well as Mercks share of profits from the sale of Adempas in Bayers marketing territories. Diabetes Worldwide combined sales of Januvia and Janumet , medicines that help lower blood sugar levels in adults with type 2 diabetes, were $5.9 billion in 2017, a decline of 3% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by ongoing pricing pressure partially offset by continued volume growth globally. Combined global sales of Januvia and Janumet were $6.1 billion in 2016, an increase of 2% compared with 2015. Sales growth was driven primarily by higher volumes in the United States, Europe and Canada, partially offset by pricing pressures in the United States and Europe, and lower sales in Venezuela due to the Companys reduced operations in that country. In April 2017, Merck announced that the FDA issued a Complete Response Letter (CRL) regarding Mercks supplemental New Drug Applications (NDA) for Januvia , Janumet and Janumet XR (sitagliptin and metformin HCl extended-release). With these applications, Merck is seeking to include data from TECOS (Trial Evaluating Cardiovascular Outcomes with Sitagliptin) in the prescribing information of sitagliptin-containing medicines. Merck is taking actions to respond to the CRL. In December 2017, the FDA approved Steglatro (ertugliflozin) tablets, an oral sodium-glucose cotransporter 2 (SGLT2) inhibitor, and the fixed-dose combination Steglujan (ertugliflozin and sitagliptin) tablets, the only fixed-dose combination of an SGLT2 inhibitor and dipeptidyl peptidase-4 inhibitor Januvia (sitagliptin). The FDA also approved the fixed-dose combination Segluromet (ertugliflozin and metformin hydrochloride). Steglatro , Steglujan and Segluromet are indicated to improve glycemic control in adults with type 2 diabetes mellitus. These products are part of a worldwide (except Japan) collaboration between Merck and Pfizer Inc. (Pfizer) for the co-development and co-promotion of ertugliflozin. As a result of FDA approval, Merck will make a $60 million payment to Pfizer, which was accrued for in the fourth quarter of 2017. The amount was capitalized and will be amortized over its estimated useful life, subject to impairment testing. Merck will exclusively promote Steglatro and the two fixed-dose combination products in the United States. Merck and Pfizer will share revenues and certain costs on a 60%/40% basis, with Merck having the 60% share, and Pfizer may be entitled to additional milestone payments. In January 2018, the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) adopted a positive opinion recommending approval of ertugliflozin and the two fixed-dose combination products. The CHMP positive opinion will be considered by the European Commission (EC). If approval of any of the products in the EU is received, Merck will make an additional $40 million milestone payment to Pfizer. General Medicine and Womens Health Worldwide sales of NuvaRing , a vaginal contraceptive product, were $761 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower sales in the United States reflecting lower volumes that were partially offset by higher pricing, and lower demand in Europe. Global sales of NuvaRing were $777 million in 2016, an increase of 6% compared with 2015 including a 1% unfavorable effect from foreign exchange. Sales growth largely reflects higher pricing in the United States, partially offset by volume declines in Europe. The patent that provides U.S. market exclusivity for NuvaRing will expire in April 2018 and the Company anticipates a significant decline in U.S. NuvaRing sales thereafter. Worldwide sales of Implanon/Nexplanon , single-rod subdermal contraceptive implants, grew to $686 million in 2017, an increase of 13% compared with 2016, primarily reflecting higher pricing and volume growth in the United States. Global sales of Implanon/Nexplanon were $606 million in 2016, an increase of 3% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales growth reflects higher demand in the United States, partially offset by declines in international markets, particularly in Venezuela. Hospital and Specialty Hepatitis Global sales of Zepatier , a treatment for chronic hepatitis C (HCV) infection, were $1.7 billion in 2017 and $555 million in 2016. Sales growth was driven primarily by higher sales in Europe, the United States and Japan following product launch in 2016. Merck has also launched Zepatier in other international markets. The Company is beginning to experience the unfavorable effects of increasing competition and declining patient volumes and anticipates that sales of Zepatier in the future will be materially adversely affected by these factors. HIV Worldwide sales of Isentress/Isentress HD, an HIV integrase inhibitor for use in combination with other antiretroviral agents for the treatment of HIV-1 infection, were $1.2 billion in 2017, a decline of 13% compared with 2016. The sales decline primarily reflects lower demand in the United States and Europe due to competitive pressures. In May 2017, the FDA approved Isentress HD , a once-daily dose of Isentress. In July 2017, the EC granted marketing authorization for the once-daily dose of Isentress (where it will be marketed as Isentress 600 mg). Global sales of Isentress were $1.4 billion in 2016, a decline of 8% compared with 2015 including a 2% unfavorable effect from foreign exchange. The sales decline was driven primarily by lower volumes in the United States, as well as lower demand and pricing in Europe due to competitive pressures, partially offset by a favorable adjustment to discount reserves in the United States. Hospital Acute Care Global sales of Bridion , for the reversal of two types of neuromuscular blocking agents used during surgery, were $704 million in 2017, growth of 46% compared with 2016, driven by strong global demand, particularly in the United States. Worldwide sales were $482 million in 2016, growth of 37% compared with 2015 including a 2% favorable effect from foreign exchange. Sales growth reflects volume growth in most markets, including in the United States where it was approved by the FDA in December 2015, partially offset by a decline in Venezuela due to reduced operations by the Company in this country. Worldwide sales of Noxafil , for the prevention of invasive fungal infections, were $636 million in 2017, an increase of 7% compared with 2016, primarily reflecting higher demand and pricing in the United States, as well as volume growth in Europe. Global sales of Noxafil grew 22% in 2016 to $595 million driven primarily by higher pricing in the United States, volume growth in Europe reflecting an ongoing positive impact from the approval of new formulations, and higher demand in the Asia Pacific region. Foreign exchange unfavorably affected global sales performance by 3% in 2016. Global sales of Invanz , for the treatment of certain infections, were $602 million in 2017, an increase of 7% compared with 2016, driven primarily by higher sales in the United States, reflecting higher pricing that was partially offset by lower demand, as well as higher demand in Brazil. Worldwide sales of Invanz were $561 million in 2016, a decline of 1% compared with 2015 including a 2% unfavorable effect from foreign exchange. Sales performance in 2016 reflects higher pricing in the United States, largely offset by a decline in Venezuela. The patent that provided U.S. market exclusivity for Invanz expired in November 2017 and the Company anticipates a significant decline in U.S. Invanz sales in future periods. Global sales of Cancidas , an anti-fungal product sold primarily outside of the United States, were $422 million in 2017, a decline of 24% compared with 2016, driven primarily by generic competition in certain European markets. The EU compound patent for Cancidas expired in April 2017. Accordingly, the Company is experiencing a significant decline in Cancidas sales in these European markets and expects the decline to continue. Worldwide sales of Cancidas were $558 million in 2016, a decline of 3% compared with 2015, reflecting a 4% unfavorable effect from foreign exchange and pricing declines in Europe that were offset by higher volumes in China. Global sales of Cubicin , an I.V. antibiotic for complicated skin and skin structure infections or bacteremia when caused by designated susceptible organisms, were $382 million in 2017, a decline of 65% compared with 2016, and were $1.1 billion in 2016, a decline of 4% compared with 2015. The U.S. composition patent for Cubicin expired in June 2016. Accordingly, the Company is experiencing a rapid and substantial decline in U.S. Cubicin sales as a result of generic competition and expects the decline to continue. The Company anticipates it will lose market exclusivity for Cubicin in some European markets in early 2018. In November 2017, Merck announced that the FDA approved Prevymis (letermovir) for prophylaxis (prevention) of CMV infection and disease in adult CMV-seropositive recipients [R+] of an allogeneic hematopoietic stem cell transplant. As a result of FDA approval, Merck made a 105 million ($125 million) milestone payment to AiCuris in 2017. This amount was capitalized and will be amortized over its estimated useful life, subject to impairment testing. In January 2018, Prevymis was approved by the EC and, as a result, Merck will make an additional 30 million milestone payment to AiCuris. Merck also has filed Prevymis for regulatory approval in other markets including Japan. Immunology Sales of Remicade, a treatment for inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $837 million in 2017, a decline of 34% compared with 2016, and were $1.3 billion in 2016, a decline of 29% compared with 2015. Foreign exchange unfavorably affected sales performance by 1% in 2016. The Company lost market exclusivity for Remicade in major European markets in 2015 and no longer has market exclusivity in any of its marketing territories. The Company is experiencing pricing and volume declines in these markets as a result of biosimilar competition and expects the declines to continue. Sales of Simponi , a once-monthly subcutaneous treatment for certain inflammatory diseases (marketed by the Company in Europe, Russia and Turkey), were $819 million in 2017, growth of 7% compared with 2016 including a 1% favorable effect from foreign exchange. Sales growth primarily reflects higher demand in Europe. Sales of Simponi were $766 million in 2016, an increase of 11% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales growth was driven primarily by higher volumes in Europe reflecting in part an ongoing positive impact from the ulcerative colitis indication. Oncology Sales of Keytruda , an anti-PD-1 therapy, were $3.8 billion in 2017 , $1.4 billion in 2016 and $566 million in 2015 . The year-over-year increases were driven by volume growth in all markets, particularly in the United States, Europe and Japan as the Company continues to launch Keytruda with multiple new indications globally. U.S. sales of Keytruda were $2.3 billion in 2017 , $792 million in 2016 and $393 million in 2015 . Sales in the United States continue to build across the multiple approved indications, in particular for the treatment of NSCLC reflecting both the continued adoption of Keytruda in the first-line setting as monotherapy for patients with metastatic NSCLC whose tumors have high PD-L1 expression, as well as the uptake of Keytruda in combination with pemetrexed and carboplatin, a commonly used chemotherapy regimen, for the first-line treatment of metastatic nonsquamous NSCLC with or without PD-L1 expression. Other indications, including melanoma, head and neck cancer, and bladder cancer, also contributed to growth in 2017. Sales growth in international markets reflects positive performance in the melanoma indications, as well as a greater contribution from the treatment of patients with NSCLC as reimbursement is established in additional markets in the first- and second-line settings. In March 2017, the FDA approved Keytruda for the treatment of adult and pediatric patients with cHL refractory to treatment, or who have relapsed after three or more prior lines of therapy. In May 2017, the EC approved Keytruda for the treatment of adult patients with relapsed or refractory cHL who have failed autologous stem cell transplant and brentuximab vedotin, or who are transplant-ineligible and have failed brentuximab vedotin. In May 2017, the FDA approved Keytruda in combination with pemetrexed and carboplatin for the first-line treatment of metastatic nonsquamous NSCLC, irrespective of PD-L1 expression. Keytruda is the only anti-PD-1 treatment approved in the first-line setting as both monotherapy and combination therapy for appropriate patients with metastatic NSCLC. In October 2016, Keytruda was approved by the FDA as monotherapy in the first-line setting for patients with metastatic NSCLC whose tumors have high PD-L1 expression, with no EGFR or ALK genomic tumor aberrations. Keytruda as monotherapy is also indicated for the second-line or greater treatment setting for patients with metastatic NSCLC whose tumors express PD-L1, with disease progression on or after platinum-containing chemotherapy. Patients with EGFR or ALK genomic tumor aberrations should have disease progression on FDA-approved therapy for these aberrations prior to receiving Keytruda . Additionally, in January 2017, the EC approved Keytruda for the first-line treatment of metastatic NSCLC in adults whose tumors have high PD-L1 expression with no EGFR or ALK positive tumor mutations. Also in May 2017, the FDA approved Keytruda for the treatment of certain patients with locally advanced or metastatic urothelial carcinoma, a type of bladder cancer. In the first-line setting, Keytruda is approved for the treatment of patients with locally advanced or metastatic urothelial carcinoma who are ineligible for cisplatin-containing chemotherapy. In the second-line setting, Keytruda is approved for the treatment of patients with locally advanced or metastatic urothelial carcinoma who have disease progression during or following platinum-containing chemotherapy or within 12 months of neoadjuvant or adjuvant treatment with platinum-containing chemotherapy. In September 2017, the EC approved Keytruda for use as monotherapy for the treatment of locally advanced or metastatic urothelial carcinoma in adults who have received prior platinum-containing chemotherapy, as well as adults who are not eligible for cisplatin-containing chemotherapy. Additionally in May 2017, the FDA approved Keytruda for a first-of-its-kind indication: the treatment of adult and pediatric patients with previously treated unresectable or metastatic MSI-H or mismatch repair deficient solid tumors. With this unique indication, Keytruda is the first cancer therapy approved for use based on a biomarker, regardless of tumor type. In September 2017, the FDA approved Keytruda for the treatment of patients with recurrent locally advanced or metastatic gastric or gastroesophageal junction adenocarcinoma whose tumors express PD-L1. In December 2017, Merck announced that the pivotal Phase 3 KEYNOTE-061 trial investigating Keytruda , as a second-line treatment for patients with advanced gastric or gastroesophageal junction adenocarcinoma, did not meet its primary endpoint of overall survival (OS) in patients whose tumors expressed PD-L1. Additionally, progression free survival (PFS) in the PD-L1 positive population did not show statistical significance. The safety profile observed in KEYNOTE-061 was consistent with that observed in previously reported studies of Keytruda ; no new safety signals were identified. The current indication remains unchanged and the Company continues to evaluate Keytruda for gastric or gastroesophageal junction adenocarcinoma through KEYNOTE-062, a Phase 3 clinical trial studying Keytruda as a monotherapy or in combination with chemotherapy as first-line treatment for patients with PD-L1 positive advanced gastric or gastroesophageal junction cancer, and with KEYNOTE-585, a Phase 3 trial studying Keytruda in combination with chemotherapy in a neoadjuvant/adjuvant setting. In August 2016, Merck announced that the FDA approved Keytruda for the treatment of patients with recurrent or metastatic head and neck squamous cell carcinoma (HNSCC) with disease progression on or after platinum-containing chemotherapy. In July 2017, Merck announced that the pivotal Phase 3 KEYNOTE-040 trial investigating Keytruda in previously treated patients with recurrent or metastatic HNSCC did not meet its pre-specified primary endpoint of OS. The safety profile observed in KEYNOTE-040 was consistent with that observed in previously reported studies of Keytruda ; no new safety signals were identified. The current indication remains unchanged and clinical trials continue, including KEYNOTE-048, a Phase 3 clinical trial of Keytruda in the first-line treatment of recurrent or metastatic HNSCC. As a result of the additional approvals received in 2017 as noted above, Keytruda is now approved in the United States and in the EU as monotherapy for the treatment of certain patients with NSCLC, melanoma, cHL and urothelial carcinoma. Keytruda is also approved in the United States as monotherapy for the treatment of certain patients with HNSCC, gastric or gastroesophageal junction adenocarcinoma and MSI-H or mismatch repair deficient cancer, and in combination with pemetrexed and carboplatin in certain patients with NSCLC. Keytruda is also approved in Japan for the treatment of radically unresectable melanoma, PD-L1-positive unresectable advanced or recurrent NSCLC, relapsed or refractory cHL, and radically unresectable urothelial carcinoma. The Keytruda clinical development program includes studies across a broad range of cancer types (see Research and Development below). In January 2017, Merck entered into a settlement and license agreement to resolve worldwide patent infringement litigation related to Keytruda (see Note 11 to the consolidated financial statements). Pursuant to the settlement, the Company will pay royalties of 6.5% on net sales of Keytruda in 2017 through 2023; and 2.5% on net sales of Keytruda in 2024 through 2026. Lynparza, an oral PARP inhibitor being developed as part of a collaboration formed in July 2017 with AstraZeneca (see Note 4 to the consolidated financial statements), is currently approved for certain types of ovarian and breast cancer. In January 2018, the FDA approved Lynparza for use in patients with BRCA-mutated, HER2-negative metastatic breast cancer who have been previously treated with chemotherapy in the neoadjuvant, adjuvant or metastatic setting. As a result of this approval, Merck will make a $70 million milestone payment to AstraZeneca (see Note 4 to the consolidated financial statements). Also in January 2018, the Japanese Ministry of Health, Labour and Welfare approved Lynparza for use as a maintenance therapy in patients for platinum-sensitive relapsed ovarian cancer, regardless of their BRCA mutation status, who responded to their last platinum-based chemotherapy. Lynparza is the first PARP inhibitor to be approved in Japan. Diversified Brands Mercks diversified brands include human health pharmaceutical products that are approaching the expiration of their marketing exclusivity or are no longer protected by patents in developed markets, but continue to be a core part of the Companys offering in other markets around the world. Respiratory Worldwide sales of Singulair, a once-a-day oral medicine for the chronic treatment of asthma and for the relief of symptoms of allergic rhinitis, were $732 million in 2017, a decline of 20% compared with 2016, and were $915 million in 2016, a decrease of 2% compared with 2015. Foreign exchange unfavorably affected global sales performance by 1% in 2017 and favorably affected global sales performance by 2% in 2016. The sales declines were driven by lower volumes in Japan as a result of generic competition. The patents that provided market exclusivity for Singulair in Japan expired in 2016. As a result, the Company is experiencing a significant decline in Singulair sales in Japan and expects the decline to continue. The Company no longer has market exclusivity for Singulair in any major market. Global sales of Nasonex , an inhaled nasal corticosteroid for the treatment of nasal allergy symptoms, were $387 million in 2017, a decline of 28% compared with 2016, and were $537 million in 2016, a decline of 37% compared with 2015. Foreign exchange favorably affected global sales performance by 1% in 2017. The Company is experiencing a substantial decline in U.S. Nasonex sales as a result of generic competition and expects the decline to continue. The decline in global Nasonex sales in 2016 was also driven by lower volumes and pricing in Europe from ongoing generic erosion and lower sales in Venezuela due to reduced operations by the Company in this country. Global sales of Dulera Inhalation Aerosol, a combination medicine for the treatment of asthma, were $287 million in 2017, a decline of 34% compared with 2016, driven by lower sales in the United States reflecting ongoing competitive pricing pressure, as well as lower demand. Worldwide sales of Dulera Inhalation Aerosol were $436 million in 2016, a decline of 19% compared with 2015 including a 1% unfavorable effect from foreign exchange. The decline was driven by lower sales in the United Sales reflecting competitive pricing pressure that was partially offset by higher demand. Vaccines On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which developed and marketed vaccines in Europe. Accordingly, vaccine sales in 2017 include sales of Merck vaccines in the European markets that were previously part of the SPMSD joint venture, whereas sales in periods prior to 2017 do not. Prior to 2017, vaccine sales in these European markets were sold through the SPMSD joint venture, the results of which are reflected in equity income from affiliates included in Other (income) expense, net (see Note 15 to the consolidated financial statements). Supply sales to SPMSD, however, are included in vaccine sales in periods prior to 2017. Incremental vaccine sales resulting from the termination of the SPMSD joint venture in 2017 were approximately $400 million, of which approximately $215 million relate to Gardasil/Gardasil 9 . Worldwide sales of Gardasil/Gardasil 9, vaccines to help prevent certain cancers and diseases caused by certain types of human papillomavirus (HPV), were $2.3 billion in 2017, growth of 6% compared with 2016. Sales growth was driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture noted above, as well as higher demand in Asia Pacific due in part to the launch in China, partially offset by lower sales in the United States. Lower sales in the United States reflect the timing of public sector purchases. In addition, during 2017, the Company made a request to borrow doses of Gardasil 9 from the CDC Pediatric Vaccine Stockpile, which the CDC granted. The Companys decision to borrow the doses from the CDC was driven in part by the temporary shutdown resulting from the cyber-attack that occurred in June, as well as by overall higher demand than expected. As a result of the borrowing, the Company reversed the sales related to the borrowed doses and recognized a corresponding liability. The Company subsequently replenished nearly half of the doses borrowed from the stockpile. The net effect of the borrowing and subsequent partial replenishment was a reduction in sales of $125 million in 2017. The Company anticipates it will replenish the remaining borrowed doses in the second half of 2018, which will result in the recognition of sales and a reversal of the remaining liability. Additionally, in October 2016, the FDA approved a 2-dose vaccination regimen for Gardasil 9, for use in girls and boys 9 through 14 years of age, and the CDCs Advisory Committee on Immunization Practices (ACIP) voted to recommend the 2-dose vaccination regimen for certain 9 through 14 year olds. The Company is experiencing an impact from the transition from a 3-dose vaccine regimen to a 2-dose vaccination regimen; however, increased patient starts are helping to offset the negative effects of the transition. Mercks sales of Gardasil/Gardasil 9 were $2.2 billion in 2016, growth of 14% compared with 2015. Sales growth was driven primarily by higher volumes and pricing in the United States, as well as higher demand in the Asia Pacific region, partially offset by a decline in government tenders in Brazil. The Company is a party to certain third-party license agreements with respect to Gardasil/Gardasil 9 (including a cross-license and settlement agreement with GlaxoSmithKline). As a result of these agreements, the Company pays royalties on worldwide Gardasil/Gardasil 9 sales of 10% to 18% which vary by country and are included in Materials and production costs. Global sales of ProQuad , a pediatric combination vaccine to help protect against measles, mumps, rubella and varicella, were $528 million in 2017, $495 million in 2016 and $454 million in 2015. The increase in 2017 as compared with 2016 was driven primarily by higher pricing and volumes in the United States, as well as volume growth in international markets, particularly in Europe. Sales growth in 2016 as compared with 2015 was driven primarily by higher demand and pricing in the United States. Worldwide sales of M-M-R II, a vaccine to help protect against measles, mumps and rubella, were $382 million in 2017, $353 million in 2016 and $365 million in 2015. Sales growth in 2017 as compared with 2016 was largely attributable to higher sales in Europe resulting from the termination of the SPMSD joint venture. Sales performance in 2016 as compared with 2015 was driven by higher demand in 2015 resulting from measles outbreaks in the United States. Global sales of Varivax, a vaccine to help prevent chickenpox (varicella), were $767 million in 2017, $792 million in 2016 and $686 million in 2015. The sales decline in 2017 as compared with 2016 was driven primarily by lower volumes in Brazil due to the loss of a government tender, as well as lower sales in the United States reflecting lower demand partially offset by higher pricing. Higher sales in Europe resulting from the termination of the SPMSD joint venture partially offset the decline. Sales growth in 2016 as compared with 2015 was driven primarily by higher sales in the United States reflecting the effects of public sector purchasing and higher pricing that were partially offset by lower demand. Volume growth in Brazil reflecting the timing of government tenders also contributed to the sales increase in 2016 as compared with 2015. Worldwide sales of Pneumovax 23, a vaccine to help prevent pneumococcal disease, were $821 million in 2017, an increase of 28% compared with 2016, driven primarily by higher demand and pricing in the United States, as well as higher sales in Europe resulting from the termination of the SPMSD joint venture. Mercks sales of Pneumovax 23 were $641 million in 2016, an increase of 18% compared with 2015, driven primarily by higher volumes and pricing in the United States and higher demand in the Asia Pacific region. Foreign exchange unfavorably affected sales performance by 1% in 2017 and favorably affected sales performance by 1% in 2016. Global sales of RotaTeq, a vaccine to help protect against rotavirus gastroenteritis in infants and children, were $686 million in 2017, an increase of 5% compared with 2016, driven primarily by higher sales in Europe resulting from the termination of the SPMSD joint venture. Mercks sales of RotaTeq were $652 million in 2016, an increase of 7% compared with 2015 including a 3% unfavorable effect from foreign exchange. Sales performance was driven primarily by the effects of public sector purchasing in the United States, as well as volume growth in several international markets. Worldwide sales of Zostavax, a vaccine to help prevent shingles (herpes zoster) in adults 50 years of age and older, were $668 million in 2017, a decline of 2% compared with 2016 including a 1% favorable effect from foreign exchange. The sales decline was driven primarily by lower demand in the United States reflecting the approval of a competitors vaccine that received a preferential recommendation from the ACIP in October 2017 for the prevention of shingles over Zostavax . The Company anticipates this competition will have a material adverse effect on sales of Zostavax in future periods. The U.S. sales decline was largely offset by growth in Europe resulting from the termination of the SPMSD joint venture and volume growth in the Asia Pacific region. Mercks sales of Zostavax were $685 million in 2016, a decline of 9% compared with 2015 including a 1% unfavorable effect from foreign exchange. The decline was driven primarily by lower volumes in the United States, partially offset by higher pricing in the United States and higher demand in the Asia Pacific region. Other Segments The Companys other segments are the Animal Health, Healthcare Services and Alliances segments, which are not material for separate reporting. Animal Health Animal Health includes pharmaceutical and vaccine products for the prevention, treatment and control of disease in all major farm and companion animal species. Animal Health sales are affected by competition and the frequent introduction of generic products. Worldwide sales of Animal Health products were $3.9 billion in 2017, $3.5 billion in 2016 and $3.3 billion in 2015. Global sales of Animal Health products grew 11% in 2017 compared with 2016 primarily reflecting higher sales of companion animal products, largely driven by growth in Bravecto , a line of products that kill fleas and ticks in dogs and cats for up to 12 weeks, reflecting both growth in the oral formulation and continued uptake in the topical formulation, which was launched in 2016. Animal Health sales growth was also driven by higher sales of ruminant, poultry and swine products. Worldwide sales of Animal Health products increased 4% in 2016 compared with 2015 including a 4% unfavorable effect from foreign exchange. Sales growth reflects volume growth across most species areas, particularly in products for companion animals, driven primarily by higher sales of Bravecto, as well as in poultry and swine products. In March 2017, Merck acquired a controlling interest in Valle, a leading privately held producer of animal health products in Brazil (see Note 3 to the consolidated financial statements). Costs, Expenses and Other ($ in millions) Change Change Materials and production $ 12,775 % $ 13,891 % $ 14,934 Marketing and administrative 9,830 % 9,762 % 10,313 Research and development 10,208 % 10,124 % 6,704 Restructuring costs % % Other (income) expense, net % % 1,527 $ 33,601 % $ 35,148 % $ 34,097 Materials and Production Materials and production costs were $12.8 billion in 2017 , $13.9 billion in 2016 and $14.9 billion in 2015 . Costs include expenses for the amortization of intangible assets recorded in connection with business acquisitions which totaled $3.1 billion in 2017, $3.7 billion in 2016 and $4.7 billion in 2015. Costs in 2017 , 2016 and 2015 also include intangible asset impairment charges of $58 million , $347 million and $45 million , respectively, related to marketed products and other intangibles recorded in connection with business acquisitions (see Note 8 to the consolidated financial statements). Costs in 2017 also include a $76 million intangible asset impairment charge related to a licensing agreement. The Company may recognize additional non-cash impairment charges in the future related to intangible assets that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, expenses for 2015 include $105 million of amortization of purchase accounting adjustments to Cubists inventories. Also included in materials and production costs are expenses associated with restructuring activities which amounted to $138 million , $181 million and $361 million in 2017 , 2016 and 2015 , respectively, primarily reflecting accelerated depreciation and asset write-offs related to the planned sale or closure of manufacturing facilities. Separation costs associated with manufacturing-related headcount reductions have been incurred and are reflected in Restructuring costs as discussed below. Gross margin was 68.2% in 2017 compared with 65.1% in 2016 and 62.2% in 2015 . The improvements in gross margin reflect a lower net impact from the amortization of intangible assets, intangible asset impairment charges and restructuring costs as noted above, which reduced gross margin by 8.2 percentage points in 2017, 10.6 percentage points in 2016 and 13.2 percentage points in 2015. The gross margin improvement in 2017 compared with 2016 also reflects the favorable effects of product mix. Manufacturing-related costs associated with the cyber-attack partially offset the gross margin improvement in 2017. The improvement in gross margin in 2016 as compared with 2015 was also driven by lower inventory write-offs and the favorable effects of foreign exchange. Marketing and Administrative Marketing and administrative (MA) expenses were $9.8 billion in 2017, an increase of 1% compared with 2016. Higher administrative costs, including costs associated with the Company operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, remediation costs related to the cyber-attack, and higher promotional expenses related to product launches were partially offset by lower restructuring and acquisition and divestiture-related costs, lower selling expenses and the favorable effect of foreign exchange. MA expenses were $9.8 billion in 2016, a decline of 5% compared with 2015, driven largely by lower acquisition and divestiture-related costs, the favorable effects of foreign exchange, lower administrative expenses, such as legal defense costs, as well as lower selling costs. Higher promotional spending largely related to product launches and higher restructuring costs partially offset the decline. MA expenses for 2017 , 2016 and 2015 include restructuring costs of $2 million , $95 million and $78 million , respectively, related primarily to accelerated depreciation for facilities to be closed or divested. Separation costs associated with sales force reductions have been incurred and are reflected in Restructuring costs as discussed below. MA expenses also include acquisition and divestiture-related costs of $44 million, $78 million and $436 million in 2017, 2016 and 2015, respectively, consisting of integration, transaction, and certain other costs related to business acquisitions and divestitures. Acquisition and divestiture-related costs in 2015 include costs related to the acquisition of Cubist (see Note 3 to the consolidated financial statements). Research and Development Research and development (RD) expenses were $10.2 billion in 2017, an increase of 1% compared with 2016. The increase was driven primarily by a charge in 2017 related to the formation of a collaboration with AstraZeneca, an unfavorable effect from changes in the estimated fair value measurement of liabilities for contingent consideration and higher clinical development spending, largely offset by lower in-process research and development (IPRD) impairment charges and lower restructuring costs. RD expenses were $10.1 billion in 2016 compared with $6.7 billion in 2015. The increase was driven primarily by higher IPRD impairment charges, increased clinical development spending, higher restructuring and licensing costs, partially offset by a reduction in expenses associated with a decrease in the estimated fair value measurement of liabilities for contingent consideration, as well as by the favorable effects of foreign exchange. RD expenses are comprised of the costs directly incurred by Merck Research Laboratories (MRL), the Companys research and development division that focuses on human health-related activities, which were $4.6 billion in 2017, $4.3 billion in 2016 and $4.0 billion in 2015. Also included in RD expenses are costs incurred by other divisions in support of RD activities, including depreciation, production and general and administrative, as well as licensing activity, and certain costs from operating segments, including the Pharmaceutical and Animal Health segments, which in the aggregate were $2.7 billion, $2.5 billion and $2.6 billion for 2017, 2016 and 2015, respectively. Additionally, RD expenses in 2017 include a $2.35 billion aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements). RD expenses also include IPRD impairment charges of $483 million , $3.6 billion and $63 million in 2017 , 2016 and 2015 , respectively (see Research and Development below). The Company may recognize additional non-cash impairment charges in the future related to the cancellation or delay of other pipeline programs that were measured at fair value and capitalized in connection with business acquisitions and such charges could be material. In addition, RD expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration recorded in connection with acquisitions. During 2017, the Company recorded charges of $27 million to increase the estimated fair value of liabilities for contingent consideration. During 2016 and 2015, the Company recorded a reduction in expenses of $402 million and $24 million, respectively, to decrease the estimated fair value of liabilities for contingent consideration related to the discontinuation or delay of certain programs (see Note 6 to the consolidated financial statements). RD expenses in 2017 , 2016 and 2015 also reflect $11 million , $142 million and $52 million , respectively, of accelerated depreciation and asset abandonment costs associated with restructuring activities. Restructuring Costs The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. Restructuring costs, primarily representing separation and other related costs associated with these restructuring activities, were $776 million , $651 million and $619 million in 2017 , 2016 and 2015 , respectively. In 2017 , 2016 and 2015 , separation costs of $552 million , $216 million and $208 million , respectively, were incurred associated with actual headcount reductions, as well as estimated expenses under existing severance programs for headcount reductions that were probable and could be reasonably estimated. Merck eliminated approximately 2,450 positions in 2017 , 2,625 positions in 2016 and 3,770 positions in 2015 related to these restructuring activities. Also included in restructuring costs are asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation plan costs. For segment reporting, restructuring costs are unallocated expenses. Additional costs associated with the Companys restructuring activities are included in Materials and production , Marketing and administrative and Research and development as discussed above. The Company recorded aggregate pretax costs of $927 million in 2017 , $1.1 billion in 2016 and $1.1 billion in 2015 related to restructuring program activities (see Note 5 to the consolidated financial statements). While the Company has substantially completed the actions under the programs, approximately $500 million of additional pretax costs are expected to be incurred in 2018 relating to anticipated employee separations and remaining asset-related costs. Other (Income) Expense, Net Other (income) expense, net was $12 million of expense in 2017 , $720 million of expense in 2016 and $1.5 billion of expense in 2015 . For details on the components of Other (income) expense, net , see Note 15 to the consolidated financial statements. Segment Profits ($ in millions) Pharmaceutical segment profits $ 22,586 $ 22,180 $ 21,658 Other non-reportable segment profits 1,834 1,507 1,573 Other (17,899 ) (19,028 ) (17,830 ) Income before taxes $ 6,521 $ 4,659 $ 5,401 Segment profits are comprised of segment sales less standard costs, certain operating expenses directly incurred by the segment, components of equity income or loss from affiliates and certain depreciation and amortization expenses. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. Also excluded from the determination of segment profits are acquisition and divestiture-related costs, including the amortization of purchase accounting adjustments, intangible asset impairment charges and changes in the estimated fair value measurement of liabilities for contingent consideration, restructuring costs, and a portion of equity income. Additionally, segment profits do not reflect other expenses from corporate and manufacturing cost centers and other miscellaneous income or expense. These unallocated items, including a loss on the extinguishment of debt in 2017, a charge related to the settlement of worldwide Keytruda patent litigation in 2016, gains on divestitures in 2016 and 2015, as well as a net charge related to the settlement of Vioxx shareholder class action litigation and foreign exchange losses related to the devaluation of the Companys net monetary assets in Venezuela in 2015, are reflected in Other in the above table. Also included in Other are miscellaneous corporate profits (losses), as well as operating profits (losses) related to third-party manufacturing sales. Pharmaceutical segment profits grew 2% in 2017 compared with 2016 primarily reflecting higher sales and the favorable effects of product mix. Pharmaceutical segment profits grew 2% in 2016 compared with 2015 primarily reflecting higher sales. Taxes on Income The effective income tax rates of 62.9% in 2017 , 15.4% in 2016 and 17.4% in 2015 reflect the impacts of acquisition and divestiture-related costs, which in 2016 include $3.6 billion of IPRD impairment charges, as well as restructuring costs and the beneficial impact of foreign earnings. In addition, the effective income tax rate for 2017 includes a provisional net charge of $2.6 billion related to the enactment of U.S. tax legislation known as the Tax Cuts and Jobs Act (TCJA) (see Note 16 to the consolidated financial statements). The effective income tax rate for 2017 also reflects the unfavorable impact of a $2.35 billion aggregate pretax charge recorded in connection with the formation of a collaboration with AstraZeneca for which no tax benefit was recognized, partially offset by the favorable impact of a net benefit of $234 million related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements) and a benefit of $88 million related to the settlement of a state income tax issue. The effective income tax rate for 2015 reflects the favorable impact of a net benefit of $410 million related to the settlement of certain federal income tax issues, the impact of a net charge related to the settlement of Vioxx shareholder class action litigation being fully deductible at combined U.S. federal and state tax rates and the favorable impact of tax legislation enacted in the fourth quarter of 2015, as well as the unfavorable effect of non-tax deductible foreign exchange losses related to Venezuela (see Note 15 to the consolidated financial statements). Net Income and Earnings per Common Share Net income attributable to Merck Co., Inc. was $2.4 billion in 2017 , $3.9 billion in 2016 and $4.4 billion in 2015 . EPS was $0.87 in 2017 , $1.41 in 2016 and $1.56 in 2015 . Non-GAAP Income and Non-GAAP EPS Non-GAAP income and non-GAAP EPS are alternative views of the Companys performance that Merck is providing because management believes this information enhances investors understanding of the Companys results as it permits investors to understand how management assesses performance. Non-GAAP income and non-GAAP EPS exclude certain items because of the nature of these items and the impact that they have on the analysis of underlying business performance and trends. The excluded items (which should not be considered non-recurring) consist of acquisition and divestiture-related costs, restructuring costs and certain other items. These excluded items are significant components in understanding and assessing financial performance. Non-GAAP income and non-GAAP EPS are important internal measures for the Company. Senior management receives a monthly analysis of operating results that includes non-GAAP EPS. Management uses these measures internally for planning and forecasting purposes and to measure the performance of the Company along with other metrics. Senior managements annual compensation is derived in part using non-GAAP income and non-GAAP EPS. Since non-GAAP income and non-GAAP EPS are not measures determined in accordance with GAAP, they have no standardized meaning prescribed by GAAP and, therefore, may not be comparable to the calculation of similar measures of other companies. The information on non-GAAP income and non-GAAP EPS should be considered in addition to, but not as a substitute for or superior to, net income and EPS prepared in accordance with generally accepted accounting principles in the United States (GAAP). A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows: ($ in millions except per share amounts) Income before taxes as reported under GAAP $ 6,521 $ 4,659 $ 5,401 Increase (decrease) for excluded items: Acquisition and divestiture-related costs 3,760 7,312 5,398 Restructuring costs 1,069 1,110 Other items: Aggregate charge related to the formation of an oncology collaboration with AstraZeneca 2,350 Charge related to the settlement of worldwide Keytruda patent litigation Foreign currency devaluation related to Venezuela Net charge related to the settlement of Vioxx shareholder class action litigation Gain on sale of certain migraine clinical development programs (250 ) Gain on divestiture of certain ophthalmic products (147 ) Other (16 ) (67 ) (34 ) Non-GAAP income before taxes 13,542 13,598 13,034 Taxes on income as reported under GAAP 4,103 Estimated tax benefit on excluded items (1) 2,321 1,470 Provisional net tax charge related to the enactment of the TCJA (2,625 ) Net tax benefits from the settlements of certain federal income tax issues Tax benefit related to the settlement of a state income tax issue Non-GAAP taxes on income 2,585 3,039 2,822 Non-GAAP net income 10,957 10,559 10,212 Less: Net income attributable to noncontrolling interests Non-GAAP net income attributable to Merck Co., Inc. $ 10,933 $ 10,538 $ 10,195 EPS assuming dilution as reported under GAAP $ 0.87 $ 1.41 $ 1.56 EPS difference (2) 3.11 2.37 2.03 Non-GAAP EPS assuming dilution $ 3.98 $ 3.78 $ 3.59 (1) The estimated tax impact on the excluded items is determined by applying the statutory rate of the originating territory of the non-GAAP adjustments. (2) Represents the difference between calculated GAAP EPS and calculated non-GAAP EPS, which may be different than the amount calculated by dividing the impact of the excluded items by the weighted-average shares for the applicable year . Acquisition and Divestiture-Related Costs Non-GAAP income and non-GAAP EPS exclude the impact of certain amounts recorded in connection with business acquisitions and divestitures. These amounts include the amortization of intangible assets and amortization of purchase accounting adjustments to inventories, as well as intangible asset impairment charges and expense or income related to changes in the estimated fair value measurement of contingent consideration. Also excluded are integration, transaction, and certain other costs associated with business acquisitions and divestitures. Restructuring Costs Non-GAAP income and non-GAAP EPS exclude costs related to restructuring actions (see Note 5 to the consolidated financial statements). These amounts include employee separation costs and accelerated depreciation associated with facilities to be closed or divested. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. Restructuring costs also include asset abandonment, shut-down and other related costs, as well as employee-related costs such as curtailment, settlement and termination charges associated with pension and other postretirement benefit plans and share-based compensation costs. Certain Other Items Non-GAAP income and non-GAAP EPS exclude certain other items. These items are adjusted for after evaluating them on an individual basis, considering their quantitative and qualitative aspects, and typically consist of items that are unusual in nature, significant to the results of a particular period or not indicative of future operating results. Excluded from non-GAAP income and non-GAAP EPS in 2017 is an aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), a provisional net tax charge related to the enactment of the TCJA, a net benefit related to the settlement of certain federal income tax issues and a benefit related to the settlement of a state income tax issue (see Note 16 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2016 is a charge to settle worldwide patent litigation related to Keytruda (see Note 11 to the consolidated financial statements). Excluded from non-GAAP income and non-GAAP EPS in 2015 are foreign exchange losses related to the devaluation of the Companys net monetary assets in Venezuela (see Note 15 to the consolidated financial statements), a net charge related to the previously disclosed settlement of Vioxx shareholder class action litigation, a gain on the sale of certain migraine clinical development programs (see Note 3 to the consolidated financial statements), a gain on the divestiture of the Companys remaining ophthalmics business in international markets (see Note 3 to the consolidated financial statements), as well as a net tax benefit related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements). Research and Development A chart reflecting the Companys current research pipeline as of February 23, 2018 is set forth in Item 1. Business Research and Development above. Research and Development Update The Company currently has several candidates under regulatory review in the United States and internationally. Keytruda is an approved anti-PD-1 therapy in clinical development for expanded indications in different cancer types. In December 2017, the FDA accepted for review a supplemental BLA for Keytruda for the treatment of adult and pediatric patients with refractory PMBCL, or who have relapsed after two or more prior lines of therapy. The FDA granted Priority Review status with a Prescription Drug User Fee Action (PDUFA), or target action, date of April 3, 2018. Additionally, Keytruda has received Breakthrough Therapy designation from the FDA in combination with axitnib as a first-line treatment for patients with advanced or metastatic renal cell carcinoma; for the treatment of high-risk early-stage triple-negative breast cancer in combination with neoadjuvant chemotherapy; and for the treatment of Merkel cell carcinoma. Also, in January 2018, Merck and Eisai Co., Ltd. (Eisai) announced receipt of Breakthrough Therapy designation from the FDA for Eisais multiple receptor tyrosine kinase inhibitor Lenvima (lenvatinib) in combination with Keytruda for the potential treatment of patients with advanced and/or metastatic renal cell carcinoma. The Lenvima and Keytruda combination therapy is being jointly developed by Eisai and Merck. This marks the 12 th Breakthrough Therapy designation granted to Keytruda . The FDAs Breakthrough Therapy designation is intended to expedite the development and review of a candidate that is planned for use, alone or in combination, to treat a serious or life-threatening disease or condition when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies on one or more clinically significant endpoints. In January 2018, Merck announced that the pivotal Phase 3 KEYNOTE-189 trial investigating Keytruda in combination with pemetrexed (Alimta) and cisplatin or carboplatin, for the first-line treatment of patients with metastatic non-squamous NSCLC, met its dual primary endpoints of OS and PFS. Based on an interim analysis conducted by the independent Data Monitoring Committee, treatment with Keytruda in combination with pemetrexed plus platinum chemotherapy resulted in significantly longer OS and PFS than pemetrexed plus platinum chemotherapy alone. Results from KEYNOTE-189 will be presented at an upcoming medical meeting and submitted to regulatory authorities. In 2017, the FDA placed a full clinical hold on KEYNOTE-183 and KEYNOTE-185 and a partial clinical hold on Cohort 1 of KEYNOTE-023, three combination studies of Keytruda with lenalidomide or pomalidomide versus lenalidomide or pomalidomide alone in the blood cancer multiple myeloma. This decision followed a review of data by the Data Monitoring Committee in which more deaths were observed in the Keytruda arms of KEYNOTE-183 and KEYNOTE-185. The FDA determined that the data available at the time indicated that the risks of Keytruda plus pomalidomide or lenalidomide outweighed any potential benefit for patients with multiple myeloma. All patients enrolled in KEYNOTE-183 and KEYNOTE-185 and those in the Keytruda /lenalidomide/dexamethasone cohort in KEYNOTE-023 have discontinued investigational treatment with Keytruda . This clinical hold does not apply to other studies with Keytruda . The Keytruda clinical development program consists of more than 700 clinical trials, including more than 400 trials that combine Keytruda with other cancer treatments. These studies encompass more than 30 cancer types including: bladder, colorectal, esophageal, gastric, head and neck, hepatocellular, Hodgkin lymphoma, non-Hodgkin lymphoma, melanoma, nasopharyngeal, NSCLC, ovarian, PMBCL, prostate, renal, small-cell lung and triple-negative breast, many of which are currently in Phase 3 clinical development. Further trials are being planned for other cancers. MK-8835, ertugliflozin, an investigational oral SGLT-2 inhibitor in development to help improve glycemic control in adults with type 2 diabetes, and two fixed-dose combination products (MK-8835A, ertugliflozin and Januvia , and MK-8835B, ertugliflozin and metformin) are under review in the EU. In January 2018, the CHMP of the EMA adopted a positive opinion recommending approval of these medicines. The CHMP positive opinion will be considered by the EC. Ertugliflozin and the two fixed-dose combination products were approved by the FDA in December 2017. MK-0431J is an investigational fixed-dose combination of sitagliptin and ipragliflozin under review with the Japan Pharmaceuticals and Medical Devices Agency. MK-0431 is being developed for commercialization in Japan in collaboration with Astellas Pharma Inc. (Astellas). Ipragliflozin, an SGLT2 inhibitor, co-developed by Astellas and Kotobuki Pharmaceutical Co., Ltd. (Kotobuki), is approved for use in Japan and is being co-promoted with Merck and Kotobuki. MK-1439, doravirine, is an investigational, non-nucleoside reverse transcriptase inhibitor for the treatment of HIV-1 infection. In January 2018, Merck announced that the FDA accepted for review two NDAs for doravirine. The NDAs include data for doravirine as a once-daily tablet for use in combination with other antiretroviral agents, and for use of doravirine with lamivudine and tenofovir disoproxil fumarate in a once-daily fixed-dose combination single tablet as a complete regimen (MK-1439A). The PDUFA action date for both applications is October 23, 2018. V419 is an investigational pediatric hexavalent combination vaccine, DTaP5-IPV-Hib-HepB, under review with the FDA that is being developed and, if approved, will be commercialized through a joint venture between Merck and Sanofi. This vaccine is designed to help protect against six important diseases - diphtheria, tetanus, pertussis (whooping cough), polio (poliovirus types 1, 2, and 3), invasive disease caused by Haemophilus influenzae type b (Hib), and hepatitis B. In 2015, the FDA issued a CRL with respect to the BLA for V419. Both companies are working to provide additional data requested by the FDA. V419 is being marketed as Vaxelis in the EU. In addition to the candidates under regulatory review, the Company has several drug candidates in Phase 3 clinical development in addition to the Keytruda programs discussed above. MK-7655A is a combination of relebactam, an investigational beta-lactamase inhibitor, and imipenem/cilastatin (an approved carbapenem antibiotic). The FDA has designated this combination a Qualified Infectious Disease Product with designated Fast Track status for the treatment of hospital-acquired bacterial pneumonia, ventilator-associated bacterial pneumonia, complicated intra-abdominal infections and complicated urinary tract infections. MK-7339, Lynparza (olaparib), is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza for multiple cancer types (see Note 4 to the consolidated financial statements). MK-5618, selumetinib, is an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple cancer types. Additionally, in February 2018, the FDA granted Orphan Drug designation for selumetinib for the treatment of neurofibromatosis type 1. The development of selumetinib is part of the global strategic oncology collaboration between Merck and AstraZeneca reference above. V920 is an investigational rVSV-ZEBOV (Ebola) vaccine candidate being studied in large scale Phase 2/3 clinical trials. In November 2014, Merck and NewLink Genetics announced an exclusive licensing and collaboration agreement for the investigational Ebola vaccine. In December 2015, Merck announced that the application for Emergency Use Assessment and Listing (EUAL) for V920 was accepted for review by the World Health Organization (WHO). According to the WHO, the EUAL process is designed to expedite the availability of vaccines needed for public health emergencies such as another outbreak of Ebola. The decision to grant V920 EUAL status will be based on data regarding quality, safety, and efficacy/effectiveness; as well as a risk/benefit analysis for emergency use. While EUAL designation allows for emergency use, the vaccine remains investigational and has not yet been licensed for commercial distribution. In July 2016, Merck announced that the FDA granted V920 Breakthrough Therapy designation, and that the EMA granted the vaccine candidate PRIME (PRIority MEdicines) status. In December 2016, end of study results from the WHO ring vaccination trial were reported in Lancet supporting the July 2015 interim assessment that V920 offers substantial protection against Ebola virus disease, with no reported cases among vaccinated individuals from 10 days after vaccination in both randomized and non-randomized clusters. Results from other ongoing studies to be included in the first regulatory filing are anticipated in the first half of 2018. MK-1242, vericiguat, is an investigational treatment for heart failure being studied in patients suffering from chronic heart failure. The development of vericiguat is part of a worldwide strategic collaboration between Merck and Bayer (see Note 4 to the consolidated financial statements). V212 is an inactivated varicella zoster virus vaccine in development for the prevention of herpes zoster. The Company completed a Phase 3 trial in autologous hematopoietic cell transplant patients and another Phase 3 trial in patients with solid tumor malignancies undergoing chemotherapy and hematological malignancies. The study in autologous hematopoietic cell transplant patients met its primary endpoints and Merck presented the results from this study at the American Society for Blood and Marrow Transplantation Meetings in February 2017. The study in patients with solid tumor malignancies undergoing chemotherapy met its primary endpoints, but the primary efficacy endpoint was not met in patients with hematologic malignancies. Merck will present the results from this study at an upcoming scientific meeting. Due to the competitive environment, development of V212 is currently on hold. MK-7264 is a selective, non-narcotic, orally-administered P2X3-receptor agonist being developed for the treatment of refractory, chronic cough. Merck plans to initiate a Phase 3 clinical trial in the first half of 2018. MK-7264 was originally developed by Afferent Pharmaceuticals (Afferent), which was acquired by the Company in 2016 (see Note 3 to the consolidated financial statements). Upon initiation of the Phase 3 clinical trial, Merck will make a $175 million milestone payment, which was accrued for at estimated fair value at the time of acquisition. The Company also discontinued certain drug candidates. In February 2018, Merck announced that it will be stopping protocol 019, also known as the APECS study, a Phase 3 study evaluating verubecestat, MK-8931, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), in people with prodromal Alzheimers disease. The decision to stop the study follows a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during a recent interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. As a result, the Company recorded an IPRD impairment charge as discussed below. In 2017, Merck announced that it will not submit applications for regulatory approval for MK-0859, anacetrapib, the Companys investigational cholesteryl ester transfer protein (CETP) inhibitor. The decision followed a thorough review of the clinical profile of anacetrapib, including discussions with external experts. Also in 2017, Merck made a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge as discussed below. The Company maintains a number of long-term exploratory and fundamental research programs in biology and chemistry as well as research programs directed toward product development. The Companys research and development model is designed to increase productivity and improve the probability of success by prioritizing the Companys research and development resources on candidates the Company believes are capable of providing unambiguous, promotable advantages to patients and payers and delivering the maximum value of its approved medicines and vaccines through new indications and new formulations. Merck is pursuing emerging product opportunities independent of therapeutic area or modality (small molecule, biologics and vaccines) and is building its biologics capabilities. The Company is committed to ensuring that externally sourced programs remain an important component of its pipeline strategy, with a focus on supplementing its internal research with a licensing and external alliance strategy focused on the entire spectrum of collaborations from early research to late-stage compounds, as well as access to new technologies. The Company also reviews its pipeline to examine candidates that may provide more value through out-licensing. The Company continues to evaluate certain late-stage clinical development and platform technology assets to determine their out-licensing or sale potential. The Companys clinical pipeline includes candidates in multiple disease areas, including cancer, cardiovascular diseases, diabetes, infectious diseases, neurosciences, obesity, pain, respiratory diseases and vaccines. Acquired In-Process Research and Development In connection with business acquisitions, the Company has recorded the fair value of in-process research projects which, at the time of acquisition, had not yet reached technological feasibility. At December 31, 2017 , the balance of IPRD was $1.2 billion . During 2017 , 2016 and 2015 , $14 million , $8 million and $280 million , respectively, of IPRD projects received marketing approval in a major market and the Company began amortizing these assets based on their estimated useful lives. All of the IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The time periods to receive approvals from the FDA and other regulatory agencies are subject to uncertainty. Significant delays in the approval process, or the Companys failure to obtain approval at all, would delay or prevent the Company from realizing revenues from these products. Additionally, if certain of the IPRD programs fail or are abandoned during development, then the Company will not realize the future cash flows it has estimated and recorded as IPRD as of the acquisition date, and the Company may also not recover the research and development expenditures made since the acquisition to further develop such programs. If such circumstances were to occur, the Companys future operating results could be adversely affected and the Company may recognize impairment charges and such charges could be material. In 2017, the Company recorded $483 million of IPRD impairment charges within Research and development expenses. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic HCV infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the eDMC, which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion relates to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million, resulting in the recognition of the pretax impairment charge noted above. The IPRD impairment charges in 2016 also include charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM Biotherapeutics Ltd. and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million relates to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also include $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily relate to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration (see Note 6 to the consolidated financial statements). During 2015, the Company recorded $63 million of IPRD impairment charges, of which $50 million related to the surotomycin clinical development program. In 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and the IPRD impairment charge noted above. Additional research and development will be required before any of the remaining programs reach technological feasibility. The costs to complete the research projects will depend on whether the projects are brought to their final stages of development and are ultimately submitted to the FDA or other regulatory agencies for approval. Acquisitions, Research Collaborations and License Agreements Merck continues to remain focused on pursuing opportunities that have the potential to drive both near- and long-term growth. Certain of the more recent transactions are described below. Merck is actively monitoring the landscape for growth opportunities that meet the Companys strategic criteria. In February 2018, Merck and Viralytics Limited (Viralytics) announced a definitive agreement pursuant to which Merck will acquire Viralytics, an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 1.75 per share. The proposed acquisition values the total issued shares in Viralytics at approximately AUD 502 million ($394 million). Upon completion of the transaction, Merck will gain full rights to Cavatax (CVA21), Viralyticss investigational oncolytic immunotherapy. Cavatax is based on Viralyticss proprietary formulation of an oncolytic virus (Coxsackievirus Type A21) that has been shown to preferentially infect and kill cancer cells. Cavatax is currently being evaluated in multiple Phase 1 and Phase 2 clinical trials, both as an intratumoral and intravenous agent, including in combination with Keytruda . Under a previous agreement between Merck and Viralytics, a study is investigating the use of the Keytruda and Cavatax combination in melanoma, prostate, lung and bladder cancers. The transaction remains subject to a Viralyticss shareholder vote and customary regulatory approvals. Merck anticipates the transaction will close in the second quarter of 2018. In October 2017, Merck acquired Rigontec. Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, RGT100, is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral PARP inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda (pembrolizumab) and Imfinzi (durvalumab). The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies will be shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and is making payments of $750 million over a multi-year period for certain license options ( $250 million was paid in December 2017, $400 million will be paid in 2018 and $100 million will be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license options payments. In addition, Merck will pay AstraZeneca up to an additional $6.15 billion contingent upon successful achievement of future regulatory and sales-based milestones for total aggregate consideration of up to $8.5 billion . Capital Expenditures Capital expenditures were $1.9 billion in 2017 , $1.6 billion in 2016 and $1.3 billion in 2015 . Expenditures in the United States were $1.2 billion in 2017 , $1.0 billion in 2016 and $879 million in 2015 . Merck plans to invest approximately $12.0 billion over five years in capital projects including approximately $8.0 billion in the United States. Depreciation expense was $1.5 billion in 2017 , $1.6 billion in 2016 and $1.6 billion in 2015 of which $1.0 billion, $1.0 billion and $1.1 billion, respectively, applied to locations in the United States. Total depreciation expense in 2017 , 2016 and 2015 included accelerated depreciation of $60 million , $227 million and $174 million , respectively, associated with restructuring activities (see Note 5 to the consolidated financial statements). Analysis of Liquidity and Capital Resources Mercks strong financial profile enables it to fund research and development, focus on external alliances, support in-line products and maximize upcoming launches while providing significant cash returns to shareholders. Selected Data ($ in millions) Working capital $ 6,152 $ 13,410 $ 10,550 Total debt to total liabilities and equity 27.8 % 26.0 % 26.0 % Cash provided by operations to total debt 0.3:1 0.4:1 0.5:1 The decline in working capital in 2017 as compared with 2016 primarily reflects the reclassification of $3.0 billion of notes due in the first half of 2018 from long-term debt to short-term debt, $1.85 billion of upfront and option payments related to the formation of the AstraZeneca collaboration discussed above, as well as $810 million paid to redeem debt in connection with tender offers discussed below. Cash provided by operating activities was $6.4 billion in 2017 , $10.4 billion in 2016 and $12.5 billion in 2015 . The decline in cash provided by operating activities in 2017 reflects a $2.8 billion payment related to the settlement of certain federal income tax issues (see Note 16 to the consolidated financial statements), payments of $1.85 billion related to the formation of a collaboration with AstraZeneca (see Note 4 to the consolidated financial statements), and a $625 million payment made by the Company related to the settlement of worldwide Keytruda patent litigation (see Note 11 to the consolidated financial statements). Cash provided by operating activities in 2016 reflects a net payment of approximately $680 million to fund the Vioxx shareholder class action litigation settlement not covered by insurance proceeds. Cash provided by operating activities continues to be the Companys primary source of funds to finance operating needs, capital expenditures, treasury stock purchases and dividends paid to shareholders. Cash provided by investing activities was $2.7 billion in 2017 compared with a use of cash in investing activities of $3.2 billion in 2016. The change was driven primarily by lower purchases of securities and other investments, higher proceeds from the sales of securities and other investments and a lower use of cash for the acquisitions of businesses. Cash used in investing activities was $3.2 billion in 2016 compared with $4.8 billion in 2015. The lower use of cash in 2016 was driven primarily by cash used in 2015 for the acquisition of Cubist, as well as lower purchases of securities and other investments in 2016, partially offset by lower proceeds from the sales of securities and other investments in 2016 and the use of cash in 2016 for the acquisitions of Afferent and The StayWell Company LLC. Cash used in financing activities was $10.0 billion in 2017 compared with $9.0 billion in 2016. The increase in cash used in financing activities was driven primarily by proceeds from the issuance of debt in 2016, as well as higher purchases of treasury stock and lower proceeds from the exercise of stock options in 2017, partially offset by lower payments on debt in 2017. Cash used in financing activities was $9.0 billion in 2016 compared with $5.4 billion in 2015 driven primarily by lower proceeds from the issuance of debt, partially offset by a decrease in short-term borrowings in 2015, lower payments on debt, lower purchases of treasury stock and higher proceeds from the exercise of stock options. During 2015, the Company recorded charges of $876 million related to the devaluation of its net monetary assets in Venezuela, the large majority of which was cash (see Note 15 to the consolidated financial statements). At December 31, 2017 , the total of worldwide cash and investments was $20.6 billion , including $8.5 billion of cash, cash equivalents and short-term investments, and $12.1 billion of long-term investments. A substantial majority of cash and investments are held by foreign subsidiaries that, prior to the enactment of the TCJA, would have been subject to significant tax payments if such cash and investments were repatriated in the form of dividends. In accordance with the TCJA, the Company has recorded a provisional amount for taxes on unremitted earnings through December 31, 2017 that were previously deemed to be indefinitely reinvested outside of the United States (see Note 16 to the consolidated financial statements). As a result of the TCJA, repatriation of foreign earnings in the future will have little to no incremental U.S. tax consequences. The Companys contractual obligations as of December 31, 2017 are as follows: Payments Due by Period ($ in millions) Total 20192020 20212022 Thereafter Purchase obligations (1) $ 2,226 $ $ $ $ Loans payable and current portion of long-term debt (2) 3,074 3,074 Long-term debt 21,400 3,200 4,589 13,611 Interest related to debt obligations 8,206 1,200 1,011 5,320 Unrecognized tax benefits (3) Transition tax related to the enactment of the TCJA (4) 5,057 1,194 2,465 Operating leases $ 40,882 $ 5,331 $ 6,446 $ 7,430 $ 21,675 (1) Includes future inventory purchases the Company has committed to in connection with certain divestitures. (2) In January 2018, $1.0 billion of notes matured and were repaid. (3) As of December 31, 2017 , the Companys Consolidated Balance Sheet reflects liabilities for unrecognized tax benefits, interest and penalties of $2.1 billion , including $67 million reflected as a current liability. Due to the high degree of uncertainty regarding the timing of future cash outflows of liabilities for unrecognized tax benefits beyond one year, a reasonable estimate of the period of cash settlement for years beyond 2018 cannot be made. (4) In connection with the enactment of the TCJA, the Company is required to pay a one-time transition tax, which the Company has elected to pay over a period of eight years as permitted under the TCJA (see Note 16 to the consolidated financial statements). Purchase obligations are enforceable and legally binding obligations for purchases of goods and services including minimum inventory contracts, research and development and advertising. Amounts reflected for research and development obligations do not include contingent milestone payments related to collaborative arrangements and acquisitions. Contingent milestone payments are not considered contractual obligations as they are contingent upon the successful achievement of developmental, regulatory approval and commercial milestones. At December 31, 2017, the Company has $635 million of accrued milestone payments related to collaborations with Pfizer, Bayer and AstraZeneca (see Note 4 to the consolidated financial statements), as well as in connection with certain licensing arrangements, that are payable in 2018. In addition, at December 31, 2017, the Company has $315 million of current liabilities for contingent consideration related to business acquisitions expected to be paid in 2018 (see Note 6 to the consolidated financial statements). Also excluded from research and development obligations are potential future funding commitments of up to approximately $60 million for investments in research venture capital funds. Loans payable and current portion of long-term debt reflects $73 million of long-dated notes that are subject to repayment at the option of the holders. Required funding obligations for 2018 relating to the Companys pension and other postretirement benefit plans are not expected to be material. However, the Company currently anticipates contributing approximately $60 million to its U.S. pension plans, $150 million to its international pension plans and $25 million to its other postretirement benefit plans during 2018 . In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers. In November 2016, the Company issued 1.0 billion principal amount of senior unsecured notes consisting of 500 million principal amount of 0.50% notes due 2024 and 500 million principal amount of 1.375% notes due 2036. The Company used the net proceeds of the offering of $1.1 billion for general corporate purposes. The Company has a $6.0 billion, five-year credit facility that matures in June 2022. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. In December 2015, the Company filed a securities registration statement with the U.S. Securities and Exchange Commission (SEC) under the automatic shelf registration process available to well-known seasoned issuers which is effective for three years. In February 2015, Merck issued $8.0 billion aggregate principal amount of senior unsecured notes. The Company used a portion of the net proceeds of the offering of $7.9 billion to repay commercial paper issued to substantially finance the Companys acquisition of Cubist. The remaining net proceeds were used for general corporate purposes, including for repurchases of the Companys common stock, and the repayment of outstanding commercial paper borrowings and debt maturities. Also in February 2015, the Company redeemed $1.9 billion of legacy Cubist debt acquired in the acquisition (see Note 3 to the consolidated financial statements). Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. The Company continues to maintain a conservative financial profile. The Company places its cash and investments in instruments that meet high credit quality standards, as specified in its investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issuer. The Company does not participate in any off-balance sheet arrangements involving unconsolidated subsidiaries that provide financing or potentially expose the Company to unrecorded financial obligations. In November 2017, the Board of Directors declared a quarterly dividend of $0.48 per share on the Companys common stock that was paid in January 2018. In January 2018, the Board of Directors declared a quarterly dividend of $0.48 per share on the Companys common stock for the second quarter of 2018 payable in April 2018. In November 2017, Mercks board of directors authorized additional purchases of up to $10 billion of Mercks common stock for its treasury. The treasury stock purchase authorization has no time limit and will be made over time in open-market transactions, block transactions, on or off an exchange, or in privately negotiated transactions. The Company purchased $4.0 billion of its common stock ( 67 million shares) for its treasury during 2017 . As of December 31, 2017 , the Companys share repurchase authorization was $11.0 billion, which includes $1.0 billion in authorized repurchases remaining under a program announced in March 2015. The Company purchased $3.4 billion and $4.2 billion of its common stock during 2016 and 2015 , respectively, under authorized share repurchase programs. Financial Instruments Market Risk Disclosures The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management, and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. Because Merck principally sells foreign currency in its revenue hedging program, a uniform weakening of the U.S. dollar would yield the largest overall potential loss in the market value of these hedge instruments. The market value of Mercks hedges would have declined by an estimated $400 million and $538 million at December 31, 2017 and 2016 , respectively, from a uniform 10% weakening of the U.S. dollar. The market value was determined using a foreign exchange option pricing model and holding all factors except exchange rates constant. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statements of Cash Flows. A sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives, investments and monetary assets and liabilities indicated that if the U.S. dollar uniformly weakened by 10% against all currency exposures of the Company at December 31, 2017 and 2016, Income before taxes would have declined by approximately $92 million and $26 million in 2017 and 2016, respectively. Because the Company was in a net short (payable) position relative to its major foreign currencies after consideration of forward contracts, a uniform weakening of the U.S. dollar will yield the largest overall potential net loss in earnings due to exchange. This measurement assumes that a change in one foreign currency relative to the U.S. dollar would not affect other foreign currencies relative to the U.S. dollar. Although not predictive in nature, the Company believes that a 10% threshold reflects reasonably possible near-term changes in Mercks major foreign currency exposures relative to the U.S. dollar. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. During 2015, upon evaluation of evolving economic conditions in Venezuela and volatility in the country, combined with a decline in transactions that were settled at the then official (CENCOEX) rate, the Company determined it was unlikely that all outstanding net monetary assets would be settled at the CENCOEX rate. Accordingly, during 2015, the Company recorded charges of $876 million within Other (income) expense, net to devalue its net monetary assets in Venezuela to an amount that represented the Companys estimate of the U.S. dollar amount that would ultimately be collected and recorded additional exchange losses of $138 million in the aggregate reflecting the ongoing effect of translating transactions and net monetary assets consistent with these rates. The Company may also use forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates that are recorded in Other (income) expense, net . The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within Other Comprehensive Income ( OCI ), and remains in Accumulated Other Comprehensive Income ( AOCI) until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2017 , the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. ($ in millions) Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.30% notes due 2018 $ 1,000 $ 1,000 5.00% notes due 2019 1,250 1.85% notes due 2020 1,250 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Companys investment portfolio includes cash equivalents and short-term investments, the market values of which are not significantly affected by changes in interest rates. The market value of the Companys medium- to long-term fixed-rate investments is modestly affected by changes in U.S. interest rates. Changes in medium- to long-term U.S. interest rates have a more significant impact on the market value of the Companys fixed-rate borrowings, which generally have longer maturities. A sensitivity analysis to measure potential changes in the market value of Mercks investments and debt from a change in interest rates indicated that a one percentage point increase in interest rates at both December 31, 2017 and 2016 would have positively affected the net aggregate market value of these instruments by $1.3 billion. A one percentage point decrease at December 31, 2017 and 2016 would have negatively affected the net aggregate market value by $1.5 billion and $1.6 billion, respectively. The fair value of Mercks debt was determined using pricing models reflecting one percentage point shifts in the appropriate yield curves. The fair values of Mercks investments were determined using a combination of pricing and duration models. Critical Accounting Policies The Companys consolidated financial statements are prepared in conformity with GAAP and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Application of the following accounting policies result in accounting estimates having the potential for the most significant impact on the financial statements. Acquisitions and Dispositions To determine whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses, the Company makes certain judgments, which include assessment of the inputs, processes, and outputs associated with the acquired set of activities. If the Company determines that substantially all of the fair value of gross assets included in a transaction is concentrated in a single asset (or a group of similar assets), the assets would not represent a business. To be considered a business, the assets in a transaction need to include an input and a substantive process that together significantly contribute to the ability to create outputs. In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are recognized at fair value if fair value can reasonably be estimated. If the acquisition date fair value of an asset acquired or liability assumed that arises from a contingency cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. The fair values of intangible assets, including acquired IPRD, are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. Given the considerable judgment involved in determining fair values, the Company typically obtains assistance from third-party valuation specialists for significant items. Amounts allocated to acquired IPRD are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a separate determination as to the then useful life of the asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Changes in any of the inputs may result in a significantly different fair value adjustment. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed in a business combination, as well as asset lives, can materially affect the Companys results of operations. The fair values of identifiable intangible assets related to currently marketed products and product rights are primarily determined by using an income approach through which fair value is estimated based on each assets discounted projected net cash flows. The Companys estimates of market participant net cash flows consider historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the time and investment that will be required to develop products and technologies; the ability to obtain marketing and regulatory approvals; the ability to manufacture and commercialize the products; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent, if any. The net cash flows are then probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product are then discounted to present value utilizing an appropriate discount rate. The fair values of identifiable intangible assets related to IPRD are also determined using an income approach, through which fair value is estimated based on each assets probability-adjusted future net cash flows, which reflect the different stages of development of each product and the associated probability of successful completion. The net cash flows are then discounted to present value using an appropriate discount rate. If the Company determines the transaction will not be accounted for as an acquisition of a business, the transaction will be accounted for as an asset acquisition rather than a business combination and, therefore, no goodwill will be recorded. In an asset acquisition, acquired IPRD with no alternative future use is charged to expense and contingent consideration is not recognized at the acquisition date. Revenue Recognition Revenues from sales of products are recognized when title and risk of loss passes to the customer, typically at time of delivery. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts for customers for which collection of accounts receivable is expected to be in excess of one year. The provision for aggregate customer discounts covers chargebacks and rebates. Chargebacks are discounts that occur when a contracted customer purchases directly through an intermediary wholesaler. The contracted customer generally purchases product at its contracted price plus a mark-up from the wholesaler. The wholesaler, in turn, charges the Company back for the difference between the price initially paid by the wholesaler and the contract price paid to the wholesaler by the customer. The provision for chargebacks is based on expected sell-through levels by the Companys wholesale customers to contracted customers, as well as estimated wholesaler inventory levels. Rebates are amounts owed based upon definitive contractual agreements or legal requirements with private sector and public sector (Medicaid and Medicare Part D) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. The provision is based on expected payments, which are driven by patient usage and contract performance by the benefit provider customers. The Company uses historical customer segment mix, adjusted for other known events, in order to estimate the expected provision. Amounts accrued for aggregate customer discounts are evaluated on a quarterly basis through comparison of information provided by the wholesalers, health maintenance organizations, pharmacy benefit managers and other customers to the amounts accrued. Adjustments are recorded when trends or significant events indicate that a change in the estimated provision is appropriate. The Company continually monitors its provision for aggregate customer discounts. There were no material adjustments to estimates associated with the aggregate customer discount provision in 2017 , 2016 or 2015 . Summarized information about changes in the aggregate customer discount accrual related to U.S. sales is as follows: ($ in millions) Balance January 1 $ 2,945 $ 2,798 Current provision 10,938 9,831 Adjustments to prior years (223 ) (169 ) Payments (11,109 ) (9,515 ) Balance December 31 $ 2,551 $ 2,945 Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates as current liabilities. The accrued balances relative to these provisions included in Accounts receivable and Accrued and other current liabilities were $198 million and $2.4 billion , respectively, at December 31, 2017 and were $196 million and $2.7 billion , respectively, at December 31, 2016 . The Company maintains a returns policy that allows its U.S. pharmaceutical customers to return product within a specified period prior to and subsequent to the expiration date (generally, three to six months before and 12 months after product expiration). The estimate of the provision for returns is based upon historical experience with actual returns. Additionally, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, whether products have been discontinued, entrance in the market of additional generic competition, changes in formularies or launch of over-the-counter products, among others. The product returns provision for U.S. pharmaceutical sales as a percentage of U.S. net pharmaceutical sales was 2.1% in 2017 , 1.4% in 2016 and 1.5% in 2015 . Through its distribution programs with U.S. wholesalers, the Company encourages wholesalers to align purchases with underlying demand and maintain inventories below specified levels. The terms of the programs allow the wholesalers to earn fees upon providing visibility into their inventory levels, as well as by achieving certain performance parameters such as inventory management, customer service levels, reducing shortage claims and reducing product returns. Information provided through the wholesaler distribution programs includes items such as sales trends, inventory on-hand, on-order quantity and product returns. Wholesalers generally provide only the above mentioned data to the Company, as there is no regulatory requirement to report lot level information to manufacturers, which is the level of information needed to determine the remaining shelf life and original sale date of inventory. Given current wholesaler inventory levels, which are generally less than a month, the Company believes that collection of order lot information across all wholesale customers would have limited use in estimating sales discounts and returns. Inventories Produced in Preparation for Product Launches The Company capitalizes inventories produced in preparation for product launches sufficient to support estimated initial market demand. Typically, capitalization of such inventory does not begin until the related product candidates are in Phase 3 clinical trials and are considered to have a high probability of regulatory approval. The Company monitors the status of each respective product within the regulatory approval process; however, the Company generally does not disclose specific timing for regulatory approval. If the Company is aware of any specific risks or contingencies other than the normal regulatory approval process or if there are any specific issues identified during the research process relating to safety, efficacy, manufacturing, marketing or labeling, the related inventory would generally not be capitalized. Expiry dates of the inventory are affected by the stage of completion. The Company manages the levels of inventory at each stage to optimize the shelf life of the inventory in relation to anticipated market demand in order to avoid product expiry issues. For inventories that are capitalized, anticipated future sales and shelf lives support the realization of the inventory value as the inventory shelf life is sufficient to meet initial product launch requirements. Inventories produced in preparation for product launches capitalized at both December 31, 2017 and 2016 were $80 million . Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property and commercial litigation, as well as certain additional matters (see Note 11 to the consolidated financial statements). The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2017 and 2016 of approximately $160 million and $185 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. When a legitimate claim for contribution is asserted, a liability is initially accrued based upon the estimated transaction costs to manage the site. Accruals are adjusted as site investigations, feasibility studies and related cost assessments of remedial techniques are completed, and as the extent to which other potentially responsible parties who may be jointly and severally liable can be expected to contribute is determined. The Company is also remediating environmental contamination resulting from past industrial activity at certain of its sites and takes an active role in identifying and accruing for these costs. In the past, Merck performed a worldwide survey to assess all sites for potential contamination resulting from past industrial activities. Where assessment indicated that physical investigation was warranted, such investigation was performed, providing a better evaluation of the need for remedial action. Where such need was identified, remedial action was then initiated. As definitive information became available during the course of investigations and/or remedial efforts at each site, estimates were refined and accruals were established or adjusted accordingly. These estimates and related accruals continue to be refined annually. The Company believes that there are no compliance issues associated with applicable environmental laws and regulations that would have a material adverse effect on the Company. Expenditures for remediation and environmental liabilities were $11 million in 2017 , and are estimated at $56 million in the aggregate for the years 2018 through 2022 . In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. Share-Based Compensation The Company expenses all share-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The Company determines the fair value of certain share-based awards using the Black-Scholes option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options. Total pretax share-based compensation expense was $312 million in 2017 , $300 million in 2016 and $299 million in 2015 . At December 31, 2017 , there was $469 million of total pretax unrecognized compensation expense related to nonvested stock option, restricted stock unit and performance share unit awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. Pensions and Other Postretirement Benefit Plans Net periodic benefit cost for pension plans totaled $201 million in 2017 , $144 million in 2016 and $277 million in 2015 . Net periodic benefit (credit) for other postretirement benefit plans was $(60) million in 2017 , $(88) million in 2016 and $(24) million in 2015 . Pension and other postretirement benefit plan information for financial reporting purposes is calculated using actuarial assumptions including a discount rate for plan benefit obligations and an expected rate of return on plan assets. The changes in net periodic benefit cost year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The increase in net periodic benefit (credit) for other postretirement benefit plans in 2017 and 2016 as compared with 2015 is largely attributable to changes in retiree medical benefits approved by the Company in December 2015, partially offset by lower returns on plan assets. The Company reassesses its benefit plan assumptions on a regular basis. For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The discount rates for the Companys U.S. pension and other postretirement benefit plans ranged from 3.20% to 3.80% at December 31, 2017 , compared with a range of 3.40% to 4.30% at December 31, 2016 . The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data, current market conditions and actual returns on the Companys plan assets. Using this reference information, the Company develops forward-looking return expectations for each asset category and a weighted-average expected long-term rate of return for a target portfolio allocated across these investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2018 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.30% , compared to a range of 8.00% to 8.75% in 2017 . The decrease is primarily due to a modest shift in asset allocation. The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 35% to 55% in U.S. equities, 20% to 35% in international equities, 20% to 35% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 13% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For non-U.S. pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Actuarial assumptions are based upon managements best estimates and judgment. A reasonably possible change of plus (minus) 25 basis points in the discount rate assumption, with other assumptions held constant, would have had an estimated $77 million favorable (unfavorable) impact on the Companys net periodic benefit cost in 2017. A reasonably possible change of plus (minus) 25 basis points in the expected rate of return assumption, with other assumptions held constant, would have had an estimated $44 million favorable (unfavorable) impact on Mercks net periodic benefit cost in 2017. Required funding obligations for 2018 relating to the Companys pension and other postretirement benefit plans are not expected to be material. The preceding hypothetical changes in the discount rate and expected rate of return assumptions would not impact the Companys funding requirements. Net loss amounts, which reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions, are recorded as a component of Accumulated Other Comprehensive Income (AOCI) . Expected returns for pension plans are based on a calculated market-related value of assets. Under this methodology, asset gains/losses resulting from actual returns that differ from the Companys expected returns are recognized in the market-related value of assets ratably over a five-year period. Also, net loss amounts in AOCI in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. Restructuring Costs Restructuring costs have been recorded in connection with restructuring programs designed to streamline the Companys cost structure. As a result, the Company has made estimates and judgments regarding its future plans, including future termination benefits and other exit costs to be incurred when the restructuring actions take place. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. In connection with these actions, management also assesses the recoverability of long-lived assets employed in the business. In certain instances, asset lives have been shortened based on changes in the expected useful lives of the affected assets. Severance and other related costs are reflected within Restructuring costs . Asset-related charges are reflected within Materials and production costs, Marketing and administrative expenses and Research and development expenses depending upon the nature of the asset. Impairments of Long-Lived Assets The Company assesses changes in economic, regulatory and legal conditions and makes assumptions regarding estimated future cash flows in evaluating the value of the Companys property, plant and equipment, goodwill and other intangible assets. The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its long-lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the assets fair value and its carrying value. If quoted market prices are not available, the Company will estimate fair value using a discounted value of estimated future cash flows approach. Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired and is assigned to reporting units. The Company tests its goodwill for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Some of the factors considered in the assessment include general macroeconomic conditions, conditions specific to the industry and market, cost factors which could have a significant effect on earnings or cash flows, the overall financial performance of the reporting unit, and whether there have been sustained declines in the Companys share price. Additionally, the Company evaluates the extent to which the fair value exceeded the carrying value of the reporting unit at the last date a valuation was performed. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. Other acquired intangible assets (excluding IPRD) are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. When events or circumstances warrant a review, the Company will assess recoverability from future operations using pretax undiscounted cash flows derived from the lowest appropriate asset groupings. Impairments are recognized in operating results to the extent that the carrying value of the intangible asset exceeds its fair value, which is determined based on the net present value of estimated future cash flows. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the project. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. For impairment testing purposes, the Company may combine separately recorded IPRD intangible assets into one unit of account based on the relevant facts and circumstances. Generally, the Company will combine IPRD intangible assets for testing purposes if they operate as a single asset and are essentially inseparable. If the fair value is less than the carrying amount, an impairment loss is recognized within the Companys operating results. The judgments made in evaluating impairment of long-lived intangibles can materially affect the Companys results of operations. Impairments of Investments The Company reviews its investments for impairments based on the determination of whether the decline in market value of the investment below the carrying value is other-than-temporary. The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Companys ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Taxes on Income The Companys effective tax rate is based on pretax income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates. An estimated effective tax rate for a year is applied to the Companys quarterly operating results. In the event that there is a significant unusual or one-time item recognized, or expected to be recognized, in the Companys quarterly operating results, the tax attributable to that item would be separately calculated and recorded at the same time as the unusual or one-time item. The Company considers the resolution of prior year tax matters to be such items. Significant judgment is required in determining the Companys tax provision and in evaluating its tax positions. The recognition and measurement of a tax position is based on managements best judgment given the facts, circumstances and information available at the reporting date. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. If the more likely than not threshold is not met in the period for which a tax position is taken, the Company may subsequently recognize the benefit of that tax position if the tax matter is effectively settled, the statute of limitations expires, or if the more likely than not threshold is met in a subsequent period (see Note 16 to the consolidated financial statements). Tax regulations require items to be included in the tax return at different times than the items are reflected in the financial statements. Timing differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in the tax return in future years for which the Company has already recorded the tax benefit in the financial statements. The Company establishes valuation allowances for its deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred or expense for which the Company has already taken a deduction on the tax return, but has not yet recognized as expense in the financial statements. Recently Issued Accounting Standards For a discussion of recently issued accounting standards, see Note 2 to the consolidated financial statements. Cautionary Factors That May Affect Future Results This report and other written reports and oral statements made from time to time by the Company may contain so-called forward-looking statements, all of which are based on managements current expectations and are subject to risks and uncertainties which may cause results to differ materially from those set forth in the statements. One can identify these forward-looking statements by their use of words such as anticipates, expects, plans, will, estimates, forecasts, projects and other words of similar meaning, or negative variations of any of the foregoing. One can also identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Companys growth strategy, financial results, product development, product approvals, product potential and development programs. One must carefully consider any such statement and should understand that many factors could cause actual results to differ materially from the Companys forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially. The Company does not assume the obligation to update any forward-looking statement. One should carefully evaluate such statements in light of factors, including risk factors, described in the Companys filings with the Securities and Exchange Commission, especially on this Form 10-K and Forms 10-Q and 8-K. In Item 1A. Risk Factors of this annual report on Form 10-K the Company discusses in more detail various important risk factors that could cause actual results to differ from expected or historic results. The Company notes these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. One should understand that it is not possible to predict or identify all such factors. Consequently, the reader should not consider any such list to be a complete statement of all potential risks or uncertainties. ", Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The information required by this Item is incorporated by reference to the discussion under Financial Instruments Market Risk Disclosures in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. ," Item 8. Financial Statements and Supplementary Data. (a) Financial Statements The consolidated balance sheet of Merck Co., Inc. and subsidiaries as of December 31, 2017 and 2016 , and the related consolidated statements of income, of comprehensive income, of equity and of cash flows for each of the three years in the period ended December 31, 2017 , the notes to consolidated financial statements, and the report dated February 27, 2018 of PricewaterhouseCoopers LLP, independent registered public accounting firm, are as follows: Consolidated Statement of Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Sales $ 40,122 $ 39,807 $ 39,498 Costs, Expenses and Other Materials and production 12,775 13,891 14,934 Marketing and administrative 9,830 9,762 10,313 Research and development 10,208 10,124 6,704 Restructuring costs Other (income) expense, net 1,527 33,601 35,148 34,097 Income Before Taxes 6,521 4,659 5,401 Taxes on Income 4,103 Net Income 2,418 3,941 4,459 Less: Net Income Attributable to Noncontrolling Interests Net Income Attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Basic Earnings per Common Share Attributable to Merck Co., Inc. Common Shareholders $ 0.88 $ 1.42 $ 1.58 Earnings per Common Share Assuming Dilution Attributable to Merck Co., Inc. Common Shareholders $ 0.87 $ 1.41 $ 1.56 Consolidated Statement of Comprehensive Income Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Net Income Attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Other Comprehensive Income (Loss) Net of Taxes: Net unrealized loss on derivatives, net of reclassifications (446 ) (66 ) (126 ) Net unrealized loss on investments, net of reclassifications (58 ) (44 ) (70 ) Benefit plan net gain (loss) and prior service credit (cost), net of amortization (799 ) Cumulative translation adjustment (169 ) (208 ) (1,078 ) Comprehensive Income Attributable to Merck Co., Inc. $ 2,710 $ 2,842 $ 4,617 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Balance Sheet Merck Co., Inc. and Subsidiaries December 31 ($ in millions except per share amounts) Assets Current Assets Cash and cash equivalents $ 6,092 $ 6,515 Short-term investments 2,406 7,826 Accounts receivable (net of allowance for doubtful accounts of $210 in 2017 and $195 in 2016) 6,873 7,018 Inventories (excludes inventories of $1,187 in 2017 and $1,117 in 2016 classified in Other assets - see Note 7) 5,096 4,866 Other current assets 4,299 4,389 Total current assets 24,766 30,614 Investments 12,125 11,416 Property, Plant and Equipment (at cost) Land Buildings 11,726 11,439 Machinery, equipment and office furnishings 14,649 14,053 Construction in progress 2,301 1,871 29,041 27,775 Less: accumulated depreciation 16,602 15,749 12,439 12,026 Goodwill 18,284 18,162 Other Intangibles, Net 14,183 17,305 Other Assets 6,075 5,854 $ 87,872 $ 95,377 Liabilities and Equity Current Liabilities Loans payable and current portion of long-term debt $ 3,057 $ Trade accounts payable 3,102 2,807 Accrued and other current liabilities 10,427 10,274 Income taxes payable 2,239 Dividends payable 1,320 1,316 Total current liabilities 18,614 17,204 Long-Term Debt 21,353 24,274 Deferred Income Taxes 2,219 5,077 Other Noncurrent Liabilities 11,117 8,514 Merck Co., Inc. Stockholders Equity Common stock, $0.50 par value Authorized - 6,500,000,000 shares Issued - 3,577,103,522 shares in 2017 and 2016 1,788 1,788 Other paid-in capital 39,902 39,939 Retained earnings 41,350 44,133 Accumulated other comprehensive loss (4,910 ) (5,226 ) 78,130 80,634 Less treasury stock, at cost: 880,491,914 shares in 2017 and 828,372,200 shares in 2016 43,794 40,546 Total Merck Co., Inc. stockholders equity 34,336 40,088 Noncontrolling Interests Total equity 34,569 40,308 $ 87,872 $ 95,377 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Equity Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions except per share amounts) Common Stock Other Paid-In Capital Retained Earnings Accumulated Other Comprehensive Loss Treasury Stock Non- controlling Interests Total Balance January 1, 2015 $1,788 $ 40,423 $ 46,021 $ (4,323 ) $ (35,262 ) $ $ 48,791 Net income attributable to Merck Co., Inc. 4,442 4,442 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.81 per share) (5,115 ) (5,115 ) Treasury stock shares purchased (4,186 ) (4,186 ) Changes in noncontrolling ownership interests (20 ) (55 ) (75 ) Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (15 ) (15 ) Share-based compensation plans and other (181 ) Balance December 31, 2015 1,788 40,222 45,348 (4,148 ) (38,534 ) 44,767 Net income attributable to Merck Co., Inc. 3,920 3,920 Other comprehensive loss, net of taxes (1,078 ) (1,078 ) Cash dividends declared on common stock ($1.85 per share) (5,135 ) (5,135 ) Treasury stock shares purchased (3,434 ) (3,434 ) Changes in noncontrolling ownership interests Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (16 ) (16 ) Share-based compensation plans and other (283 ) 1,422 1,139 Balance December 31, 2016 1,788 39,939 44,133 (5,226 ) (40,546 ) 40,308 Net income attributable to Merck Co., Inc. 2,394 2,394 Other comprehensive income, net of taxes Cash dividends declared on common stock ($1.89 per share) (5,177 ) (5,177 ) Treasury stock shares purchased (4,014 ) (4,014 ) Acquisition of Valle S.A. Net income attributable to noncontrolling interests Distributions attributable to noncontrolling interests (18 ) (18 ) Share-based compensation plans and other (37 ) Balance December 31, 2017 $ 1,788 $ 39,902 $ 41,350 $ (4,910 ) $ (43,794 ) $ $ 34,569 The accompanying notes are an integral part of this consolidated financial statement. Consolidated Statement of Cash Flows Merck Co., Inc. and Subsidiaries Years Ended December 31 ($ in millions) Cash Flows from Operating Activities Net income $ 2,418 $ 3,941 $ 4,459 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,637 5,441 6,375 Intangible asset impairment charges 3,948 Provisional charge for one-time transition tax related to the enactment of U.S. tax legislation 5,347 Charge for future payments related to AstraZeneca collaboration license options Charge related to the settlement of worldwide Keytruda patent litigation Foreign currency devaluation related to Venezuela Net charge related to the settlement of Vioxx shareholder class action litigation Equity income from affiliates (42 ) (86 ) (205 ) Dividends and distributions from equity method affiliates Deferred income taxes (2,621 ) (1,521 ) (764 ) Share-based compensation Other Net changes in assets and liabilities: Accounts receivable (619 ) (480 ) Inventories (145 ) Trade accounts payable (37 ) Accrued and other current liabilities (922 ) (2,018 ) (8 ) Income taxes payable (3,291 ) (266 ) Noncurrent liabilities (123 ) (809 ) (277 ) Other (1,091 ) (5 ) Net Cash Provided by Operating Activities 6,447 10,376 12,538 Cash Flows from Investing Activities Capital expenditures (1,888 ) (1,614 ) (1,283 ) Purchases of securities and other investments (10,739 ) (15,651 ) (16,681 ) Proceeds from sales of securities and other investments 15,664 14,353 20,413 Acquisition of Cubist Pharmaceuticals, Inc., net of cash acquired (7,598 ) Acquisitions of other businesses, net of cash acquired (396 ) (780 ) (146 ) Dispositions of businesses, net of cash divested Other Net Cash Provided by (Used in) Investing Activities 2,679 (3,210 ) (4,758 ) Cash Flows from Financing Activities Net change in short-term borrowings (26 ) (1,540 ) Payments on debt (1,103 ) (2,386 ) (2,906 ) Proceeds from issuance of debt 1,079 7,938 Purchases of treasury stock (4,014 ) (3,434 ) (4,186 ) Dividends paid to stockholders (5,167 ) (5,124 ) (5,117 ) Proceeds from exercise of stock options Other (195 ) (118 ) (61 ) Net Cash Used in Financing Activities (10,006 ) (9,044 ) (5,387 ) Effect of Exchange Rate Changes on Cash and Cash Equivalents (131 ) (1,310 ) Net (Decrease) Increase in Cash and Cash Equivalents (423 ) (2,009 ) 1,083 Cash and Cash Equivalents at Beginning of Year 6,515 8,524 7,441 Cash and Cash Equivalents at End of Year $ 6,092 $ 6,515 $ 8,524 The accompanying notes are an integral part of this consolidated financial statement. Notes to Consolidated Financial Statements Merck Co., Inc. and Subsidiaries ($ in millions except per share amounts) 1. Nature of Operations Merck Co., Inc. (Merck or the Company) is a global health care company that delivers innovative health solutions through its prescription medicines, vaccines, biologic therapies and animal health products. The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. On December 31, 2016, Merck and Sanofi Pasteur S.A. (Sanofi) terminated their equally-owned joint venture, Sanofi Pasteur MSD (SPMSD), which developed and marketed vaccines in Europe. Beginning in 2017, Merck is recording vaccine sales and incurring costs as a result of operating its vaccines business in the European markets that were previously part of the SPMSD joint venture, which was accounted for as an equity method affiliate. The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. 2. Summary of Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries in which a controlling interest is maintained. Intercompany balances and transactions are eliminated. Controlling interest is determined by majority ownership interest and the absence of substantive third-party participating rights or, in the case of variable interest entities, by majority exposure to expected losses, residual returns or both. For those consolidated subsidiaries where Merck ownership is less than 100%, the outside shareholders interests are shown as Noncontrolling interests in equity. Investments in affiliates over which the Company has significant influence but not a controlling interest, such as interests in entities owned equally by the Company and a third party that are under shared control, are carried on the equity basis. Acquisitions In a business combination, the acquisition method of accounting requires that the assets acquired and liabilities assumed be recorded as of the date of the acquisition at their respective fair values with limited exceptions. Assets acquired and liabilities assumed in a business combination that arise from contingencies are generally recognized at fair value. If fair value cannot be determined, the asset or liability is recognized if probable and reasonably estimable; if these criteria are not met, no asset or liability is recognized. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accordingly, the Company may be required to value assets at fair value measures that do not reflect the Companys intended use of those assets. Any excess of the purchase price (consideration transferred) over the estimated fair values of net assets acquired is recorded as goodwill. Transaction costs and costs to restructure the acquired company are expensed as incurred. The operating results of the acquired business are reflected in the Companys consolidated financial statements after the date of the acquisition. If the Company determines the assets acquired do not meet the definition of a business under the acquisition method of accounting, the transaction will be accounted for as an acquisition of assets rather than a business combination and, therefore, no goodwill will be recorded. Foreign Currency Translation The net assets of international subsidiaries where the local currencies have been determined to be the functional currencies are translated into U.S. dollars using current exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account, which is included in Accumulated other comprehensive income (loss) ( AOCI ) and reflected as a separate component of equity. For those subsidiaries that operate in highly inflationary economies and for those subsidiaries where the U.S. dollar has been determined to be the functional currency, non-monetary foreign currency assets and liabilities are translated using historical rates, while monetary assets and liabilities are translated at current rates, with the U.S. dollar effects of rate changes included in Other (income) expense, net . Cash Equivalents Cash equivalents are comprised of certain highly liquid investments with original maturities of less than three months. Inventories Inventories are valued at the lower of cost or market. The cost of a substantial majority of domestic pharmaceutical and vaccine inventories is determined using the last-in, first-out (LIFO) method for both financial reporting and tax purposes. The cost of all other inventories is determined using the first-in, first-out (FIFO) method. Inventories consist of currently marketed products, as well as certain inventories produced in preparation for product launches that are considered to have a high probability of regulatory approval. In evaluating the recoverability of inventories produced in preparation for product launches, the Company considers the likelihood that revenue will be obtained from the future sale of the related inventory together with the status of the product within the regulatory approval process. Investments Investments in marketable debt and equity securities classified as available-for-sale are reported at fair value. Fair values of the Companys investments are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Changes in fair value that are considered temporary are reported net of tax in Other Comprehensive Income ( OCI ). For declines in the fair value of equity securities that are considered other-than-temporary, impairment losses are charged to Other (income) expense, net . The Company considers available evidence in evaluating potential impairments of its investments, including the duration and extent to which fair value is less than cost and, for equity securities, the Companys ability and intent to hold the investments. For debt securities, an other-than-temporary impairment has occurred if the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company does not intend to sell the impaired debt security, and it is not more likely than not it will be required to sell the debt security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings, recorded in Other (income) expense, net , is limited to the portion attributed to credit loss. The remaining portion of the other-than-temporary impairment related to other factors is recognized in OCI . Realized gains and losses for both debt and equity securities are included in Other (income) expense, net . Revenue Recognition Revenues from sales of products are recognized when title and risk of loss passes to the customer, typically upon delivery. Recognition of revenue also requires reasonable assurance of collection of sales proceeds and completion of all performance obligations. Domestically, sales discounts are issued to customers at the point-of-sale, through an intermediary wholesaler (known as chargebacks), or in the form of rebates. Additionally, sales are generally made with a limited right of return under certain conditions. Revenues are recorded net of provisions for sales discounts and returns, which are established at the time of sale. In addition, revenues are recorded net of time value of money discounts if collection of accounts receivable is expected to be in excess of one year. Accruals for chargebacks are reflected as a direct reduction to accounts receivable and accruals for rebates are recorded as current liabilities. The accrued balances relative to the provisions for chargebacks and rebates included in Accounts receivable and Accrued and other current liabilities were $198 million and $2.4 billion , respectively, at December 31, 2017 and $196 million and $2.7 billion , respectively, at December 31, 2016 . The Company recognizes revenue from the sales of vaccines to the Federal government for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation , Commission Guidance Regarding Accounting for Sales of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile . This interpretation allows companies to recognize revenue for sales of vaccines into U.S. government stockpiles even though these sales might not meet the criteria for revenue recognition under other accounting guidance. Depreciation Depreciation is provided over the estimated useful lives of the assets, principally using the straight-line method. For tax purposes, accelerated tax methods are used. The estimated useful lives primarily range from 25 to 45 years for Buildings , and from 3 to 15 years for Machinery, equipment and office furnishings . Depreciation expense was $1.5 billion in 2017 , $1.6 billion in 2016 and $1.6 billion in 2015 . Advertising and Promotion Costs Advertising and promotion costs are expensed as incurred. The Company recorded advertising and promotion expenses of $2.2 billion , $2.1 billion and $2.1 billion in 2017 , 2016 and 2015 , respectively. Software Capitalization The Company capitalizes certain costs incurred in connection with obtaining or developing internal-use software including external direct costs of material and services, and payroll costs for employees directly involved with the software development. Capitalized software costs are included in Property, plant and equipment and amortized beginning when the software project is substantially complete and the asset is ready for its intended use. Capitalized software costs associated with projects that are being amortized over 6 to 10 years (including the Companys on-going multi-year implementation of an enterprise-wide resource planning system) were $449 million and $452 million , net of accumulated amortization at December 31, 2017 and 2016 , respectively. All other capitalized software costs are being amortized over periods ranging from 3 to 5 years. Costs incurred during the preliminary project stage and post-implementation stage, as well as maintenance and training costs, are expensed as incurred. Goodwill Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. Goodwill is assigned to reporting units and evaluated for impairment on at least an annual basis, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company concludes it is more likely than not that the fair value of a reporting unit is less than its carrying amount, a quantitative fair value test is performed. Acquired Intangibles Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives ranging from 2 to 20 years (see Note 8). The Company periodically evaluates whether current facts or circumstances indicate that the carrying values of its acquired intangibles may not be recoverable. If such circumstances are determined to exist, an estimate of the undiscounted future cash flows of these assets, or appropriate asset groupings, is compared to the carrying value to determine whether an impairment exists. If the asset is determined to be impaired, the loss is measured based on the difference between the carrying value of the intangible asset and its fair value, which is determined based on the net present value of estimated future cash flows. Acquired In-Process Research and Development Acquired in-process research and development (IPRD) that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. The amounts are capitalized and are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, Merck will make a determination as to the then useful life of the intangible asset, generally determined by the period in which the substantial majority of the cash flows are expected to be generated, and begin amortization. The Company tests IPRD for impairment at least annually, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that the fair value of the IPRD intangible asset is less than its carrying amount. If the Company concludes it is more likely than not that the fair value is less than the carrying amount, a quantitative test that compares the fair value of the IPRD intangible asset with its carrying value is performed. If the fair value is less than the carrying amount, an impairment loss is recognized in operating results. Contingent Consideration Certain of the Companys business acquisitions involve the potential for future payment of consideration that is contingent upon the achievement of performance milestones, including product development milestones and royalty payments on future product sales. The fair value of contingent consideration liabilities is determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at current fair value with changes (either expense or income) recorded in earnings. Research and Development Research and development is expensed as incurred. Nonrefundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity has been performed or when the goods have been received rather than when the payment is made. Research and development expenses include restructuring costs and IPRD impairment charges in all periods. In addition, research and development expenses include expense or income related to changes in the estimated fair value measurement of liabilities for contingent consideration. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Cost reimbursements between the collaborative partners are recognized as incurred and included in Materials and production costs, Marketing and administrative expenses and Research and development expenses based on the underlying nature of the related activities subject to reimbursement. When Merck is the principal on sales transactions with third parties, the Company recognizes sales, materials and production costs and marketing and administrative expenses on a gross basis. The Company records profit sharing amounts received from its collaborative partners as alliance revenue (within Sales ) and profit sharing amounts it pays to its collaborative partners within Materials and production costs. Terms of the collaboration agreements may require the Company to make payments based upon the achievement of certain developmental, regulatory approval or commercial milestones. Upfront and milestone payments payable by Merck to collaborative partners prior to regulatory approval are expensed as incurred and included in Research and development expenses. Payments due to collaborative partners upon or subsequent to regulatory approval are capitalized and amortized over the estimated useful life of the corresponding intangible asset to Materials and production costs provided that future cash flows support the amounts capitalized. Sales-based milestones payable by Merck to collaborative partners are accrued when probable of being achieved and capitalized, subject to cumulative amortization catch-up. The amortization catch-up is calculated either from the time of the first regulatory approval for indications that were unapproved at the time the collaboration was formed, or from time of the formation of the collaboration for approved products. The related intangible asset that is recognized is amortized to Materials and production costs over its remaining useful life, subject to impairment testing. Share-Based Compensation The Company expenses all share-based payments to employees over the requisite service period based on the grant-date fair value of the awards. Restructuring Costs The Company records liabilities for costs associated with exit or disposal activities in the period in which the liability is incurred. In accordance with existing benefit arrangements, employee termination costs are accrued when the restructuring actions are probable and estimable. When accruing these costs, the Company will recognize the amount within a range of costs that is the best estimate within the range. When no amount within the range is a better estimate than any other amount, the Company recognizes the minimum amount within the range. Costs for one-time termination benefits in which the employee is required to render service until termination in order to receive the benefits are recognized ratably over the future service period. Contingencies and Legal Defense Costs The Company records accruals for contingencies and legal defense costs expected to be incurred in connection with a loss contingency when it is probable that a liability has been incurred and the amount can be reasonably estimated. Taxes on Income Deferred taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting based on enacted tax laws and rates. The Company evaluates tax positions to determine whether the benefits of tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, the Company recognizes the largest amount of the benefit that is greater than 50% likely of being realized upon ultimate settlement in the financial statements. For tax positions that are not more likely than not of being sustained upon audit, the Company does not recognize any portion of the benefit in the financial statements. The Company recognizes interest and penalties associated with uncertain tax positions as a component of Taxes on income in the Consolidated Statement of Income. Use of Estimates The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States (GAAP) and, accordingly, include certain amounts that are based on managements best estimates and judgments. Estimates are used when accounting for amounts recorded in connection with acquisitions, including initial fair value determinations of assets and liabilities, primarily IPRD, other intangible assets and contingent consideration, as well as subsequent fair value measurements. Additionally, estimates are used in determining such items as provisions for sales discounts and returns, depreciable and amortizable lives, recoverability of inventories, including those produced in preparation for product launches, amounts recorded for contingencies, environmental liabilities and other reserves, pension and other postretirement benefit plan assumptions, share-based compensation assumptions, restructuring costs, impairments of long-lived assets (including intangible assets and goodwill) and investments, and taxes on income. Because of the uncertainty inherent in such estimates, actual results may differ from these estimates. Reclassifications Certain reclassifications have been made to prior year amounts to conform to the current year presentation. Recently Issued Accounting Standards In May 2014, the Financial Accounting Standards Board (FASB) issued amended accounting guidance on revenue recognition that will be applied to all contracts with customers. The objective of the new guidance is to improve comparability of revenue recognition practices across entities and to provide more useful information to users of financial statements through improved disclosure requirements. The new standard permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of adopting the guidance being recognized at the date of initial application (modified retrospective method). The new standard will be effective as of January 1, 2018 and will be adopted using the modified retrospective method. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $5 million in 2018. The adoption of the new guidance will also result in some additional disclosures. In January 2016, the FASB issued revised guidance for the accounting and reporting of financial instruments. The new guidance requires that equity investments with readily determinable fair values currently classified as available for sale be measured at fair value with changes in fair value recognized in net income. The new guidance also simplifies the impairment testing of equity investments without readily determinable fair values and changes certain disclosure requirements. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by $8 million in 2018. In August 2016, the FASB issued guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The Company does not anticipate any changes to the presentation of its Consolidated Statement of Cash Flows as a result of adopting the new standard. In October 2016, the FASB issued guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under existing guidance, the recognition of current and deferred income taxes for an intra-entity asset transfer is prohibited until the asset has been sold to a third party. The new guidance will require the recognition of the income tax consequences of an intra-entity transfer of an asset (with the exception of inventory) when the intra-entity transfer occurs. The new standard will be effective as of January 1, 2018 and will be adopted using a modified retrospective approach. The Company anticipates recording a cumulative-effect adjustment upon adoption increasing Retained earnings by approximately $60 million in 2018 with a corresponding increase to deferred tax assets, subject to finalization. In November 2016, the FASB issued guidance requiring that amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective as of January 1, 2018 and will be adopted using a retrospective application. The adoption of the new guidance will not have a material effect on the Companys Consolidated Statement of Cash Flows. In March 2017, the FASB amended the guidance related to net periodic benefit cost for defined benefit plans that requires entities to (1) disaggregate the current service cost component from the other components of net benefit cost and present it with other employee compensation costs in the income statement within operations if such a subtotal is presented; (2) present the other components of net benefit cost separately in the income statement and outside of income from operations; and (3) only capitalize the service cost component when applicable. Entities must use a retrospective transition method to adopt the requirement for separate presentation in the income statement of service costs and other components and a prospective transition method to adopt the requirement to limit the capitalization of benefit costs to the service cost component. The Company will utilize a practical expedient that permits it to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. The new standard is effective as of January 1, 2018. Net periodic benefit cost (credit) other than service cost was approximately $(510) million and $(530) million for the years ended December 31, 2017 and 2016 , respectively, (see Note 14). Upon adoption, these amounts will be reclassified to Other (income) expense, net from their current classification within Materials and production costs, Marketing and administrative expenses and Research and development costs. In May 2017, the FASB issued guidance clarifying when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The new standard is effective as of January 1, 2018 and will be applied to future share-based payment award modifications should they occur. In February 2016, the FASB issued new accounting guidance for the accounting and reporting of leases. The new guidance requires that lessees recognize a right-of-use asset and a lease liability recorded on the balance sheet for each of its leases (other than leases that meet the definition of a short-term lease). Leases will be classified as either operating or finance. Operating leases will result in straight-line expense in the income statement (similar to current operating leases) while finance leases will result in more expense being recognized in the earlier years of the lease term (similar to current capital leases). The new guidance will be effective for interim and annual periods beginning in 2019 and will be adopted using a modified retrospective approach which will require application of the new guidance at the beginning of the earliest comparative period presented. Early adoption is permitted. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In August 2017, the FASB issued new guidance on hedge accounting that is intended to more closely align hedge accounting with companies risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. The new guidance makes more financial and nonfinancial hedging strategies eligible for hedge accounting, amends the presentation and disclosure requirements, and changes how companies assess effectiveness. The new guidance is effective for interim and annual periods beginning in 2019 on a modified retrospective basis. Early application is permitted in any interim period. The Company intends to early adopt this guidance as of January 1, 2018 on a modified retrospective basis. The Company anticipates recording a cumulative-effect adjustment upon adoption decreasing Retained earnings by $11 million in 2018.The adoption of the new guidance will result in some additional disclosures. In February 2018, the FASB issued new guidance to address a narrow-scope financial reporting issue that arose as a consequence of the TCJA. Existing guidance requires that deferred tax liabilities and assets be adjusted for a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date. That guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income (rather than in net income), such as amounts related to benefit plans and hedging activity. As a result, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate (the difference is referred to as stranded tax effects). The new guidance allows for a reclassification of these amounts to retained earnings thereby eliminating these stranded tax effects. The new guidance is effective for interim and annual periods in 2019. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In June 2016, the FASB issued amended guidance on the accounting for credit losses on financial instruments. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for interim and annual periods beginning in 2020, with earlier application permitted in 2019. The new guidance is to be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings in the beginning of the period of adoption. The Company is currently evaluating the impact of adoption on its consolidated financial statements. In January 2017, the FASB issued guidance that provides for the elimination of Step 2 from the goodwill impairment test. Under the new guidance, impairment charges are recognized to the extent the carrying amount of a reporting unit exceeds its fair value with certain limitations. The new guidance is effective for interim and annual periods in 2020. Early adoption is permitted. The Company does not anticipate that the adoption of the new guidance will have a material effect on its consolidated financial statements. 3. Acquisitions, Divestitures, Research Collaborations and License Agreements The Company continues to pursue the acquisition of businesses and establishment of external alliances such as research collaborations and licensing agreements to complement its internal research capabilities. These arrangements often include upfront payments, as well as expense reimbursements or payments to the third party, and milestone, royalty or profit share arrangements, contingent upon the occurrence of certain future events linked to the success of the asset in development. The Company also reviews its marketed products and pipeline to examine candidates which may provide more value through out-licensing and, as part of its portfolio assessment process, may also divest certain assets. Pro forma financial information for acquired businesses is not presented if the historical financial results of the acquired entity are not significant when compared with the Companys financial results. Recently Announced Transaction In February 2018, Merck and Viralytics Limited (Viralytics) announced a definitive agreement pursuant to which Merck will acquire Viralytics, an Australian publicly traded company focused on oncolytic immunotherapy treatments for a range of cancers, for AUD 1.75 per share. The proposed acquisition values the total issued shares in Viralytics at approximately AUD 502 million ( $394 million ). Upon completion of the transaction, Merck will gain full rights to Cavatax (CVA21), Viralyticss investigational oncolytic immunotherapy. The transaction remains subject to a Viralyticss shareholder vote and customary regulatory approvals. Merck anticipates the transaction will close in the second quarter of 2018. 2017 Transactions In October 2017, Merck acquired Rigontec GmbH (Rigontec). Rigontec is a leader in accessing the retinoic acid-inducible gene I pathway, part of the innate immune system, as a novel and distinct approach in cancer immunotherapy to induce both immediate and long-term anti-tumor immunity. Rigontecs lead candidate, RGT100, is currently in Phase I development evaluating treatment in patients with various tumors. Under the terms of the agreement, Merck made an upfront cash payment of 119 million ( $140 million ) and may make additional contingent payments of up to 349 million (of which 184 million are related to the achievement of research milestones and regulatory approvals and 165 million are related to the achievement of commercial targets). The transaction was accounted for as an acquisition of an asset and the upfront payment is reflected within Research and development expenses in 2017. In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types (see Note 4). In March 2017, Merck acquired a controlling interest in Valle S.A. (Valle), a leading privately held producer of animal health products in Brazil. Valle has an extensive portfolio of products spanning parasiticides, anti-infectives and vaccines that include products for livestock, horses, and companion animals. Under the terms of the agreement, Merck acquired 93.5% of the shares of Valle for $358 million . Of the total purchase price, $176 million was placed into escrow pending resolution of certain contingent items. The transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $291 million related to currently marketed products, net deferred tax liabilities of $93 million , other net assets of $14 million and noncontrolling interest of $25 million . In addition, the Company recorded liabilities of $37 million for contingencies identified at the acquisition date and corresponding indemnification assets of $37 million , representing the amounts to be reimbursed to Merck if and when the contingent liabilities are paid. The excess of the consideration transferred over the fair value of net assets acquired of $171 million was recorded as goodwill. The goodwill was allocated to the Animal Health segment and is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The probability-adjusted future net cash flows of each product were discounted to present value utilizing a discount rate of 15.5% . Actual cash flows are likely to be different than those assumed. The intangible assets related to currently marketed products are being amortized over their estimated useful lives of 15 years. In the fourth quarter of 2017, Merck acquired an additional 4.5% interest in Valle for $18 million , which reduced noncontrolling interest related to Valle. 2016 Transactions In July 2016, Merck acquired Afferent Pharmaceuticals (Afferent), a privately held pharmaceutical company focused on the development of therapeutic candidates targeting the P2X3 receptor for the treatment of common, poorly-managed, neurogenic conditions. Afferents lead investigational candidate, MK-7264 (formerly AF-219), is a selective, non-narcotic, orally-administered P2X3 antagonist being evaluated for the treatment of refractory, chronic cough. Total consideration transferred of $510 million included cash paid for outstanding Afferent shares of $487 million , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Afferent. In addition, former Afferent shareholders are eligible to receive a total of up to an additional $750 million contingent upon the attainment of certain clinical development and commercial milestones for multiple indications and candidates, including MK-7264. This transaction was accounted for as an acquisition of a business. The Company determined the fair value of the contingent consideration was $223 million at the acquisition date utilizing a probability-weighted estimated cash flow stream using an appropriate discount rate dependent on the nature and timing of the milestone payment. Merck recognized an intangible asset for IPRD of $832 million , net deferred tax liabilities of $258 million , and other net assets of $29 million (primarily consisting of cash acquired). The excess of the consideration transferred over the fair value of net assets acquired of $130 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair value of the identifiable intangible asset related to IPRD was determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value using a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Also in July 2016, Merck, through its wholly owned subsidiary Healthcare Services Solutions, LLC, acquired a majority ownership interest in The StayWell Company LLC (StayWell), a portfolio company of Vestar Capital Partners (Vestar). StayWell is a health engagement company that helps its clients engage and educate people to improve health and business results. Under the terms of the transaction, Merck paid $150 million for a majority ownership interest. Additionally, Merck provided StayWell with a $150 million intercompany loan to pay down preexisting third-party debt. Merck has an option to buy, and Vestar has an option to require Merck to buy, some or all of Vestars remaining ownership interest at fair value beginning three years from the acquisition date. This transaction was accounted for as an acquisition of a business. Merck recognized intangible assets of $238 million , deferred tax liabilities of $84 million , other net liabilities of $5 million and noncontrolling interest of $124 million . The excess of the consideration transferred over the fair value of net assets acquired of $275 million was recorded as goodwill and is largely attributable to anticipated synergies expected to arise after the acquisition. The goodwill was allocated to the Healthcare Services segment and is not deductible for tax purposes. The intangible assets recognized primarily relate to customer relationships, which are being amortized over a 10 -year useful life, and medical information and solutions content, which are being amortized over a five -year useful life. In June 2016, Merck and Moderna Therapeutics (Moderna) entered into a strategic collaboration and license agreement to develop and commercialize novel messenger RNA (mRNA)-based personalized cancer vaccines. The development program will entail multiple studies in several types of cancer and include the evaluation of mRNA-based personalized cancer vaccines in combination with Mercks Keytruda . Pursuant to the terms of the agreement, Merck made an upfront cash payment to Moderna of $200 million , which was recorded in Research and development expenses. Following human proof of concept studies, Merck has the right to elect to make an additional payment to Moderna. If Merck exercises this right, the two companies will then equally share costs and profits under a worldwide collaboration for the development of personalized cancer vaccines. Moderna will have the right to elect to co-promote the personalized cancer vaccines in the United States. The agreement entails exclusivity around combinations with Keytruda . Moderna and Merck each have the ability to combine mRNA-based personalized cancer vaccines with other (non-PD-1) agents. In January 2016, Merck acquired IOmet Pharma Ltd (IOmet), a privately held UK-based drug discovery company focused on the development of innovative medicines for the treatment of cancer, with a particular emphasis on the fields of cancer immunotherapy and cancer metabolism. The acquisition provides Merck with IOmets preclinical pipeline of IDO (indoleamine-2,3-dioxygenase 1), TDO (tryptophan-2,3-dioxygenase), and dual-acting IDO/TDO inhibitors. The transaction was accounted for as an acquisition of a business. Total purchase consideration in the transaction included a cash payment of $150 million and future additional milestone payments of up to $250 million contingent upon certain clinical and regulatory milestones being achieved. The Company determined the fair value of the contingent consideration was $94 million at the acquisition date utilizing a probability-weighted estimated cash flow stream adjusted for the expected timing of each payment utilizing a discount rate of 10.5% . Merck recognized intangible assets for IPRD of $155 million and net deferred tax assets of $32 million . The excess of the consideration transferred over the fair value of net assets acquired of $57 million was recorded as goodwill that was allocated to the Pharmaceutical segment and is not deductible for tax purposes. The fair values of the identifiable intangible assets related to IPRD were determined using an income approach. The assets probability-adjusted future net cash flows were discounted to present value also using a discount rate of 10.5% . Actual cash flows are likely to be different than those assumed. In July 2017, Merck made a $100 million payment as a result of the achievement of a clinical development milestone, which was accrued for at estimated fair value at the time of acquisition as noted above. 2015 Transactions In December 2015, the Company divested its remaining ophthalmics portfolio in international markets to Mundipharma Ophthalmology Products Limited. Merck received consideration of approximately $170 million and recognized a gain of $147 million recorded in Other (income) expense, net in 2015. In July 2015, Merck acquired cCAM Biotherapeutics Ltd. (cCAM), a privately held biopharmaceutical company focused on the discovery and development of novel cancer immunotherapies. Total purchase consideration in the transaction included an upfront payment of $96 million in cash and potential future additional payments associated with the attainment of certain clinical development, regulatory and commercial milestones. The transaction was accounted for as an acquisition of a business. Merck recognized an intangible asset for IPRD of $180 million related to CM-24, a monoclonal antibody, as well as a liability for contingent consideration of $105 million , goodwill of $14 million and other net assets of $7 million . During 2016, as a result of unfavorable efficacy data, the Company determined that it would discontinue development of the pipeline program. Accordingly, the Company recorded an IPRD impairment charge of $180 million related to CM-24 and reversed the related liability for contingent consideration, which had a fair value of $116 million at the time of program discontinuation. Both the IPRD impairment charge and the income related to the reduction in the liability for contingent consideration were recorded in Research and development expenses in 2016. Also in July 2015, Merck and Allergan plc (Allergan) entered into an agreement pursuant to which Allergan acquired the exclusive worldwide rights to MK-1602 and MK-8031, Mercks investigational small molecule oral calcitonin gene-related peptide (CGRP) receptor antagonists, which are being developed for the treatment and prevention of migraine. Under the terms of the agreement, Allergan acquired these rights for upfront payments of $250 million , of which $125 million was paid in August 2015 upon closing of the transaction and the remaining $125 million was paid in April of 2016. The Company recorded a gain of $250 million within Other (income) expense, net in 2015 related to the transaction. Allergan is fully responsible for development of the CGRP programs, as well as manufacturing and commercialization upon approval and launch of the products. Under the agreement, Merck is entitled to receive potential development and commercial milestone payments and royalties at tiered double-digit rates based on commercialization of the programs. During 2016, Merck recognized gains of $100 million within Other (income) expense, net resulting from payments by Allergan for the achievement of research and development milestones. In February 2015, Merck and NGM Biopharmaceuticals, Inc. (NGM), a privately held biotechnology company, entered into a multi-year collaboration to research, discover, develop and commercialize novel biologic therapies across a wide range of therapeutic areas. Under the terms of the agreement, Merck made an upfront payment to NGM of $94 million , which was included in Research and development expenses, and purchased a 15% equity stake in NGM for $106 million . Merck committed up to $250 million to fund all of NGMs efforts under the initial five -year term of the collaboration, with the potential for additional funding if certain conditions are met. Prior to Merck initiating a Phase 3 study for a licensed program, NGM may elect to either receive milestone and royalty payments or, in certain cases, to co-fund development and participate in a global cost and revenue share arrangement of up to 50% . The agreement also provides NGM with the option to participate in the co-promotion of any co-funded program in the United States. Merck has the option to extend the research agreement for two additional two -year terms. In January 2015, Merck acquired Cubist Pharmaceuticals, Inc. (Cubist), a leader in the development of therapies to treat serious infections caused by a broad range of bacteria. Total consideration transferred of $8.3 billion included cash paid for outstanding Cubist shares of $7.8 billion , as well as share-based compensation payments to settle equity awards attributable to precombination service and cash paid for transaction costs on behalf of Cubist. Share-based compensation payments to settle non-vested equity awards attributable to postcombination service were recognized as transaction expense in 2015. In addition, the Company assumed all of the outstanding convertible debt of Cubist, which had a fair value of approximately $1.9 billion at the acquisition date. Merck redeemed this debt in February 2015. The transaction was accounted for as an acquisition of a business. The estimated fair value of assets acquired and liabilities assumed from Cubist is as follows: Estimated fair value at January 21, 2015 Cash and cash equivalents $ Accounts receivable Inventories Other current assets Property, plant and equipment Identifiable intangible assets: Products and product rights (11 year weighted-average useful life) 6,923 IPRD Other noncurrent assets Current liabilities (1) (233 ) Deferred income tax liabilities (2,519 ) Long-term debt (1,900 ) Other noncurrent liabilities (1) (122 ) Total identifiable net assets 3,661 Goodwill (2) 4,670 Consideration transferred $ 8,331 (1) Included in current liabilities and other noncurrent liabilities is contingent consideration of $73 million and $50 million , respectively. (2) The goodwill recognized is largely attributable to anticipated synergies expected to arise after the acquisition and was allocated to the Pharmaceutical segment. The goodwill is not deductible for tax purposes. The estimated fair values of identifiable intangible assets related to currently marketed products were determined using an income approach. The Companys estimates of projected net cash flows considered historical and projected pricing, margins and expense levels; the performance of competing products where applicable; relevant industry and therapeutic area growth drivers and factors; current and expected trends in technology and product life cycles; the extent and timing of potential new product introductions by the Companys competitors; and the life of each assets underlying patent. The net cash flows were probability-adjusted where appropriate to consider the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future net cash flows of each product were then discounted to present value utilizing a discount rate of 8% . Actual cash flows are likely to be different than those assumed. The Company recorded the fair value of incomplete research project surotomycin (MK-4261) which, at the time of acquisition, had not reached technological feasibility and had no alternative future use. During the second quarter of 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and an IPRD impairment charge (see Note 8). In connection with the Cubist acquisition, liabilities were recorded for potential future consideration that is contingent upon the achievement of future sales-based milestones. The fair value of contingent consideration liabilities was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and a risk-adjusted discount rate of 8% used to present value the probability-weighted cash flows. Changes in the inputs could result in a different fair value measurement. This transaction closed on January 21, 2015; accordingly, the results of operations of the acquired business have been included in the Companys results of operations beginning after that date. During 2015, the Company incurred $324 million of transaction costs directly related to the acquisition of Cubist including share-based compensation costs, severance costs, and legal and advisory fees which are reflected in Marketing and administrative expenses. The following unaudited supplemental pro forma data presents consolidated information as if the acquisition of Cubist had been completed on January 1, 2014: Years Ended December 31 Sales $ 39,584 Net income attributable to Merck Co., Inc. 4,640 Basic earnings per common share attributable to Merck Co., Inc. common shareholders 1.65 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders 1.63 The unaudited supplemental pro forma data reflects the historical information of Merck and Cubist adjusted to include additional amortization expense based on the fair value of assets acquired, additional interest expense that would have been incurred on borrowings used to fund the acquisition, transaction costs associated with the acquisition, and the related tax effects of these adjustments. The pro forma data should not be considered indicative of the results that would have occurred if the acquisition had been consummated on January 1, 2014, nor are they indicative of future results. Remicade/Simponi In 1998, a subsidiary of Schering-Plough entered into a licensing agreement with Centocor Ortho Biotech Inc. (Centocor), a Johnson Johnson (JJ) company, to market Remicade, which is prescribed for the treatment of inflammatory diseases. In 2005, Schering-Ploughs subsidiary exercised an option under its contract with Centocor for license rights to develop and commercialize Simponi , a fully human monoclonal antibody. The Company has marketing rights to both products throughout Europe, Russia and Turkey. Remicade lost market exclusivity in major European markets in February 2015 and the Company no longer has market exclusivity in any of its marketing territories . The Company continues to have market exclusivity for Simponi in all of its marketing territories. All profits derived from Mercks distribution of the two products in these countries are equally divided between Merck and JJ. 4. Collaborative Arrangements Merck has entered into collaborative arrangements that provide the Company with varying rights to develop, produce and market products together with its collaborative partners. Both parties in these arrangements are active participants and exposed to significant risks and rewards dependent on the commercial success of the activities of the collaboration. Mercks more significant collaborative arrangements are discussed below. AstraZeneca In July 2017, Merck and AstraZeneca entered into a global strategic oncology collaboration to co-develop and co-commercialize AstraZenecas Lynparza (olaparib) for multiple cancer types. Lynparza is an oral poly (ADP-ribose) polymerase (PARP) inhibitor currently approved for certain types of ovarian and breast cancer. The companies are jointly developing and commercializing Lynparza, both as monotherapy and in combination trials with other potential medicines. Independently, Merck and AstraZeneca will develop and commercialize Lynparza in combinations with their respective PD-1 and PD-L1 medicines, Keytruda (pembrolizumab) and Imfinzi (durvalumab). The companies will also jointly develop and commercialize AstraZenecas selumetinib, an oral, potent, selective inhibitor of MEK, part of the mitogen-activated protein kinase (MAPK) pathway, currently being developed for multiple indications including thyroid cancer. Under the terms of the agreement, AstraZeneca and Merck will share the development and commercialization costs for Lynparza and selumetinib monotherapy and non-PD-L1/PD-1 combination therapy opportunities. Gross profits from Lynparza and selumetinib product sales generated through monotherapies or combination therapies will be shared equally. Merck will fund all development and commercialization costs of Keytruda in combination with Lynparza or selumetinib. AstraZeneca will fund all development and commercialization costs of Imfinzi in combination with Lynparza or selumetinib. AstraZenca is currently the principal on Lynparza sales transactions. Merck is recording its share of product sales of Lynparza, net of costs of sales and commercialization costs, as alliance revenue within the Pharmaceutical segment and its share of development costs associated with the collaboration as part of Research and development expenses. Reimbursements received from AstraZeneca for research and development expenses are recognized as reductions to Research and development costs. As part of the agreement, Merck made an upfront payment to AstraZeneca of $1.6 billion and is making payments of $750 million over a multi-year period for certain license options ( $250 million was paid in December 2017, $400 million will be paid in 2018 and $100 million will be paid in 2019). The Company recorded an aggregate charge of $2.35 billion in Research and development expenses in 2017 related to the upfront payment and future license options payments. In addition, Merck will pay AstraZeneca up to an additional $6.15 billion contingent upon successful achievement of future regulatory milestones of $2.05 billion and sales-based milestones of $4.1 billion for total aggregate consideration of up to $8.5 billion . During the fourth quarter of 2017, based on the performance of Lynparza since the formation of the collaboration, Merck determined it was probable that annual sales of Lynparza in the future would exceed $250 million , which would trigger a $100 million sales-based milestone payment from Merck to AstraZeneca upon achievement of the sales milestone. Accordingly, in the fourth quarter of 2017, Merck recorded a $100 million liability and a corresponding intangible asset and also recognized $4 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset will be amortized over its remaining estimated useful life of 11 years , subject to impairment testing. The remaining $4.0 billion of potential future sales-based milestone payments have not yet been accrued as they are not deemed by the Company to be probable at this time. Also, in January 2018, Lynparza received approval in the United States for the treatment of certain patients with metastatic breast cancer, triggering a $70 million milestone payment from Merck to AstraZeneca. This milestone payment will be capitalized and amortized over the remaining useful life of Lynparza. Summarized information related to this collaboration is as follows: Year Ended December 31 Alliance revenues (net of commercialization costs) $ Materials and production costs Marketing and administrative expenses Research and development expenses 2,419 Receivables from AstraZeneca Payables to AstraZeneca Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets. Bayer AG In 2014, the Company entered into a worldwide clinical development collaboration with Bayer AG (Bayer) to market and develop soluble guanylate cyclase (sGC) modulators including Bayers Adempas (riociguat), which is approved to treat pulmonary arterial hypertension and chronic thromboembolic pulmonary hypertension. The two companies equally share costs and profits from the collaboration and implemented a joint development and commercialization strategy. The collaboration also includes clinical development of Bayers vericiguat, which is in Phase 3 trials for worsening heart failure, as well as opt-in rights for other early-stage sGC compounds in development by Bayer. Merck in turn made available its early-stage sGC compounds under similar terms. Under the agreement, Bayer leads commercialization of Adempas in the Americas, while Merck leads commercialization in the rest of the world. For vericiguat and other potential opt-in products, Bayer will lead commercialization in the rest of world and Merck will lead in the Americas. For all products and candidates included in the agreement, both companies will share in development costs and profits on sales and will have the right to co-promote in territories where they are not the lead. In 2016, Merck began promoting and distributing Adempas in Europe. Transition from Bayer in other Merck territories, including Japan, continued in 2017. In 2016, the Company determined it was probable that annual sales of Adempas would exceed $500 million triggering a $350 million payment from Merck to Bayer. Accordingly, in 2016, the Company recorded a $350 million liability and a corresponding intangible asset and also recognized $50 million of cumulative amortization expense within Materials and production costs. The remaining intangible asset is being amortized over its then- remaining estimated useful life, subject to impairment testing. In 2017, annual sales of Adempas exceeded $500 million triggering the $350 million milestone payment from Merck to Bayer, which will be paid in the first quarter of 2018. There are $775 million of additional potential future sales-based milestone payments that have not yet been accrued as they are not deemed by the Company to be probable at this time. Summarized information related to this collaboration is as follows: Years Ended December 31 Net product sales recorded by Merck $ $ $ Mercks profit share of sales in Bayer's marketing territories Total sales Materials and production costs Marketing and administrative expenses Research and development expenses Receivables from Bayer Payables to Bayer Expenses do not include all amounts attributed to activities related to the collaboration, rather only the amounts relating to payments between partners. Amounts in materials and production costs include amortization of related intangible assets. 5. Restructuring The Company incurs substantial costs for restructuring program activities related to Mercks productivity and cost reduction initiatives, as well as in connection with the integration of certain acquired businesses. In 2010 and 2013, the Company commenced actions under global restructuring programs designed to streamline its cost structure. The actions under these programs include the elimination of positions in sales, administrative and headquarters organizations, as well as the sale or closure of certain manufacturing and research and development sites and the consolidation of office facilities. The Company also continues to reduce its global real estate footprint and improve the efficiency of its manufacturing and supply network. The Company recorded total pretax costs of $927 million in 2017 , $1.1 billion in 2016 and $1.1 billion in 2015 related to restructuring program activities. Since inception of the programs through December 31, 2017 , Merck has recorded total pretax accumulated costs of approximately $13.5 billion and eliminated approximately 43,350 positions comprised of employee separations, as well as the elimination of contractors and vacant positions. The Company estimates that approximately two-thirds of the cumulative pretax costs are cash outlays, primarily related to employee separation expense. Approximately one-third of the cumulative pretax costs are non-cash, relating primarily to the accelerated depreciation of facilities to be closed or divested. While the Company has substantially completed the actions under these programs, approximately $500 million of additional pretax costs are expected to be incurred in 2018 relating to anticipated employee separations and remaining asset-related costs. For segment reporting, restructuring charges are unallocated expenses. The following table summarizes the charges related to restructuring program activities by type of cost: Separation Costs Accelerated Depreciation Other Total Year Ended December 31, 2017 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ Year Ended December 31, 2016 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ 1,069 Year Ended December 31, 2015 Materials and production $ $ $ $ Marketing and administrative Research and development Restructuring costs $ $ $ $ 1,110 Separation costs are associated with actual headcount reductions, as well as those headcount reductions which were probable and could be reasonably estimated. Positions eliminated under restructuring program activities were approximately 2,450 in 2017 , 2,625 in 2016 and 3,770 in 2015 . Accelerated depreciation costs primarily relate to manufacturing, research and administrative facilities and equipment to be sold or closed as part of the programs. Accelerated depreciation costs represent the difference between the depreciation expense to be recognized over the revised useful life of the asset, based upon the anticipated date the site will be closed or divested or the equipment disposed of, and depreciation expense as determined utilizing the useful life prior to the restructuring actions. All of the sites have and will continue to operate up through the respective closure dates and, since future undiscounted cash flows were sufficient to recover the respective book values, Merck is recording accelerated depreciation over the revised useful life of the site assets. Anticipated site closure dates, particularly related to manufacturing locations, have been and may continue to be adjusted to reflect changes resulting from regulatory or other factors. Other activity in 2017 , 2016 and 2015 includes $267 million , $409 million and $550 million , respectively, of asset abandonment, shut-down and other related costs. Additionally, other activity includes certain employee-related costs associated with pension and other postretirement benefit plans (see Note 14) and share-based compensation. Other activity also reflects net pretax losses resulting from sales of facilities and related assets of $6 million in 2017 , $151 million in 2016 and $117 million in 2015 . The following table summarizes the charges and spending relating to restructuring program activities: Separation Costs Accelerated Depreciation Other Total Restructuring reserves January 1, 2016 $ $ $ $ Expenses 1,069 (Payments) receipts, net (413 ) (347 ) (760 ) Non-cash activity (227 ) (186 ) (413 ) Restructuring reserves December 31, 2016 Expenses (Payments) receipts, net (328 ) (394 ) (722 ) Non-cash activity (60 ) Restructuring reserves December 31, 2017 (1) $ $ $ $ (1) The remaining cash outlays are expected to be substantially completed by the end of 2020. 6. Financial Instruments Derivative Instruments and Hedging Activities The Company manages the impact of foreign exchange rate movements and interest rate movements on its earnings, cash flows and fair values of assets and liabilities through operational means and through the use of various financial instruments, including derivative instruments. A significant portion of the Companys revenues and earnings in foreign affiliates is exposed to changes in foreign exchange rates. The objectives and accounting related to the Companys foreign currency risk management program, as well as its interest rate risk management activities are discussed below. Foreign Currency Risk Management The Company has established revenue hedging, balance sheet risk management and net investment hedging programs to protect against volatility of future foreign currency cash flows and changes in fair value caused by volatility in foreign exchange rates. The objective of the revenue hedging program is to reduce the variability caused by changes in foreign exchange rates that would affect the U.S. dollar value of future cash flows derived from foreign currency denominated sales, primarily the euro and Japanese yen. To achieve this objective, the Company will hedge a portion of its forecasted foreign currency denominated third-party and intercompany distributor entity sales (forecasted sales) that are expected to occur over its planning cycle, typically no more than two years into the future. The Company will layer in hedges over time, increasing the portion of forecasted sales hedged as it gets closer to the expected date of the forecasted sales. The portion of forecasted sales hedged is based on assessments of cost-benefit profiles that consider natural offsetting exposures, revenue and exchange rate volatilities and correlations, and the cost of hedging instruments. The Company manages its anticipated transaction exposure principally with purchased local currency put options, forward contracts, and purchased collar options. The fair values of these derivative contracts are recorded as either assets (gain positions) or liabilities (loss positions) in the Consolidated Balance Sheet. Changes in the fair value of derivative contracts are recorded each period in either current earnings or OCI , depending on whether the derivative is designated as part of a hedge transaction and, if so, the type of hedge transaction. For derivatives that are designated as cash flow hedges, the effective portion of the unrealized gains or losses on these contracts is recorded in AOCI and reclassified into Sales when the hedged anticipated revenue is recognized. The hedge relationship is highly effective and hedge ineffectiveness has been de minimis . For those derivatives which are not designated as cash flow hedges, but serve as economic hedges of forecasted sales, unrealized gains or losses are recorded in Sales each period. The cash flows from both designated and non-designated contracts are reported as operating activities in the Consolidated Statement of Cash Flows. The Company does not enter into derivatives for trading or speculative purposes. The Company manages operating activities and net asset positions at each local subsidiary in order to mitigate the effects of exchange on monetary assets and liabilities. The Company also uses a balance sheet risk management program to mitigate the exposure of net monetary assets that are denominated in a currency other than a subsidiarys functional currency from the effects of volatility in foreign exchange. In these instances, Merck principally utilizes forward exchange contracts to offset the effects of exchange on exposures denominated in developed country currencies, primarily the euro and Japanese yen. For exposures in developing country currencies, the Company will enter into forward contracts to partially offset the effects of exchange on exposures when it is deemed economical to do so based on a cost-benefit analysis that considers the magnitude of the exposure, the volatility of the exchange rate and the cost of the hedging instrument. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Monetary assets and liabilities denominated in a currency other than the functional currency of a given subsidiary are remeasured at spot rates in effect on the balance sheet date with the effects of changes in spot rates reported in Other (income) expense, net . The forward contracts are not designated as hedges and are marked to market through Other (income) expense, net . Accordingly, fair value changes in the forward contracts help mitigate the changes in the value of the remeasured assets and liabilities attributable to changes in foreign currency exchange rates, except to the extent of the spot-forward differences. These differences are not significant due to the short-term nature of the contracts, which typically have average maturities at inception of less than one year . The Company may also use forward exchange contracts to hedge its net investment in foreign operations against movements in exchange rates. The forward contracts are designated as hedges of the net investment in a foreign operation. The Company hedges a portion of the net investment in certain of its foreign operations and measures ineffectiveness based upon changes in spot foreign exchange rates that are recorded in Other (income) expense, net . The effective portion of the unrealized gains or losses on these contracts is recorded in foreign currency translation adjustment within OCI , and remains in AOCI until either the sale or complete or substantially complete liquidation of the subsidiary. The cash flows from these contracts are reported as investing activities in the Consolidated Statement of Cash Flows. Foreign exchange risk is also managed through the use of foreign currency debt. The Companys senior unsecured euro-denominated notes have been designated as, and are effective as, economic hedges of the net investment in a foreign operation. Accordingly, foreign currency transaction gains or losses due to spot rate fluctuations on the euro-denominated debt instruments are included in foreign currency translation adjustment within OCI . Included in the cumulative translation adjustment are pretax losses of $520 million in 2017 , and pretax gains of $193 million in 2016 and $304 million in 2015 from the euro-denominated notes. Interest Rate Risk Management The Company may use interest rate swap contracts on certain investing and borrowing transactions to manage its net exposure to interest rate changes and to reduce its overall cost of borrowing. The Company does not use leveraged swaps and, in general, does not leverage any of its investment activities that would put principal capital at risk. At December 31, 2017 , the Company was a party to 26 pay-floating, receive-fixed interest rate swap contracts designated as fair value hedges of fixed-rate notes in which the notional amounts match the amount of the hedged fixed-rate notes as detailed in the table below. Debt Instrument Par Value of Debt Number of Interest Rate Swaps Held Total Swap Notional Amount 1.30% notes due 2018 $ 1,000 $ 1,000 5.00% notes due 2019 1,250 1.85% notes due 2020 1,250 1,250 3.875% notes due 2021 1,150 1,150 2.40% notes due 2022 1,000 1,000 2.35% notes due 2022 1,250 1,250 The interest rate swap contracts are designated hedges of the fair value changes in the notes attributable to changes in the benchmark London Interbank Offered Rate (LIBOR) swap rate. The fair value changes in the notes attributable to changes in the LIBOR swap rate are recorded in interest expense and offset by the fair value changes in the swap contracts. The cash flows from these contracts are reported as operating activities in the Consolidated Statement of Cash Flows. Presented in the table below is the fair value of derivatives on a gross basis segregated between those derivatives that are designated as hedging instruments and those that are not designated as hedging instruments as of December 31: Fair Value of Derivative U.S. Dollar Notional Fair Value of Derivative U.S. Dollar Notional Balance Sheet Caption Asset Liability Asset Liability Derivatives Designated as Hedging Instruments Interest rate swap contracts Other assets $ $ $ $ $ $ 2,700 Interest rate swap contracts Accrued and other current liabilities 1,000 Interest rate swap contracts Other noncurrent liabilities 4,650 3,500 Foreign exchange contracts Other current assets 4,216 6,063 Foreign exchange contracts Other assets 1,936 2,075 Foreign exchange contracts Accrued and other current liabilities 2,014 Foreign exchange contracts Other noncurrent liabilities $ $ $ 14,386 $ $ $ 14,398 Derivatives Not Designated as Hedging Instruments Foreign exchange contracts Other current assets $ $ $ 3,778 $ $ $ 8,210 Foreign exchange contracts Accrued and other current liabilities 7,431 2,931 $ $ $ 11,209 $ $ $ 11,141 $ $ $ 25,595 $ $ $ 25,539 As noted above, the Company records its derivatives on a gross basis in the Consolidated Balance Sheet. The Company has master netting agreements with several of its financial institution counterparties (see Concentrations of Credit Risk below). The following table provides information on the Companys derivative positions subject to these master netting arrangements as if they were presented on a net basis, allowing for the right of offset by counterparty and cash collateral exchanged per the master agreements and related credit support annexes at December 31: Asset Liability Asset Liability Gross amounts recognized in the consolidated balance sheet $ $ $ $ Gross amount subject to offset in master netting arrangements not offset in the consolidated balance sheet (94 ) (94 ) (131 ) (131 ) Cash collateral (received) posted (3 ) (529 ) Net amounts $ $ $ $ 90 The table below provides information on the location and pretax gain or loss amounts for derivatives that are: (i) designated in a fair value hedging relationship, (ii) designated in a foreign currency cash flow hedging relationship, (iii) designated in a foreign currency net investment hedging relationship and (iv) not designated in a hedging relationship: Years Ended December 31 Derivatives designated in a fair value hedging relationship Interest rate swap contracts Amount of loss (gain) recognized in Other (income) expense, net on derivatives (1) $ $ $ (14 ) Amount of (gain) loss recognized in Other (income) expense, net on hedged item (1) (48 ) (29 ) Derivatives designated in foreign currency cash flow hedging relationships Foreign exchange contracts Amount of gain reclassified from AOCI to Sales (138 ) (311 ) (724 ) Amount of loss (gain) recognized in OCI on derivatives (210 ) (526 ) Derivatives designated in foreign currency net investment hedging relationships Foreign exchange contracts Amount of gain recognized in Other (income) expense, net on derivatives (2) (1 ) (4 ) Amount of loss (gain) recognized in OCI on derivatives (10 ) Derivatives not designated in a hedging relationship Foreign exchange contracts Amount of loss (gain) recognized in Other (income) expense, net on derivatives (3) (461 ) Amount of gain recognized in Sales (3 ) (1 ) (1) There was $5 million , $1 million and $7 million of ineffectiveness on the hedge during 2017 , 2016 and 2015 , respectively. (2) There was no ineffectiveness on the hedge. Represents the amount excluded from hedge effectiveness testing. (3) These derivative contracts mitigate changes in the value of remeasured foreign currency denominated monetary assets and liabilities attributable to changes in foreign currency exchange rates. At December 31, 2017 , the Company estimates $184 million of pretax net unrealized losses on derivatives maturing within the next 12 months that hedge foreign currency denominated sales over that same period will be reclassified from AOCI to Sales . The amount ultimately reclassified to Sales may differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity. Investments in Debt and Equity Securities Information on investments in debt and equity securities at December 31 is as follows: Fair Value Amortized Cost Gross Unrealized Fair Value Amortized Cost Gross Unrealized Gains Losses Gains Losses Corporate notes and bonds $ 9,806 $ 9,837 $ $ (40 ) $ 10,577 $ 10,601 $ $ (39 ) U.S. government and agency securities 2,042 2,059 (17 ) 2,232 2,244 (13 ) Asset-backed securities 1,542 1,548 (7 ) 1,376 1,380 (5 ) Foreign government bonds (6 ) (2 ) Mortgage-backed securities (9 ) (6 ) Commercial paper 4,330 4,330 Equity securities (6 ) (3 ) $ 15,183 $ 15,241 $ $ (85 ) $ 20,179 $ 20,158 $ $ (68 ) Available-for-sale debt securities included in Short-term investments totaled $2.4 billion at December 31, 2017 . Of the remaining debt securities, $11.1 billion mature within five years. At December 31, 2017 and 2016 , there were no debt securities pledged as collateral. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company uses a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. Level 3 assets or liabilities are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as assets or liabilities for which the determination of fair value requires significant judgment or estimation. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis Financial assets and liabilities measured at fair value on a recurring basis at December 31 are summarized below: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Investments Corporate notes and bonds $ $ 9,678 $ $ 9,678 $ $ 10,389 $ $ 10,389 U.S. government and agency securities 1,767 1,835 1,890 1,919 Asset-backed securities (1) 1,476 1,476 1,257 1,257 Foreign government bonds Mortgage-backed securities (1) Commercial paper 4,330 4,330 Equity securities 14,359 14,531 19,012 19,242 Other assets (2) U.S. government and agency securities Corporate notes and bonds Mortgage-backed securities (1) Asset-backed securities (1) Foreign government bonds Equity securities 481 148 Derivative assets (3) Purchased currency options Forward exchange contracts Interest rate swaps Total assets $ $ 14,970 $ $ 15,313 $ $ 20,796 $ $ 21,174 Liabilities Other liabilities Contingent consideration $ $ $ $ $ $ $ $ Derivative liabilities (2) Forward exchange contracts Interest rate swaps Written currency options Total liabilities $ $ $ $ 1,152 $ $ $ $ 1,025 (1) Primarily all of the asset-backed securities are highly-rated (Standard Poors rating of AAA and Moodys Investors Service rating of Aaa), secured primarily by auto loan, credit card and student loan receivables, with weighted-average lives of primarily 5 years or less. Mortgage-backed securities represent AAA-rated securities issued or unconditionally guaranteed as to payment of principal and interest by U.S. government agencies. (2) Investments included in other assets are restricted as to use, primarily for the payment of benefits under employee benefit plans. (3) The fair value determination of derivatives includes the impact of the credit risk of counterparties to the derivatives and the Companys own credit risk, the effects of which were not significant. There were no transfers between Level 1 and Level 2 during 2017 . As of December 31, 2017 , Cash and cash equivalents of $6.1 billion include $5.2 billion of cash equivalents (which would be considered Level 2 in the fair value hierarchy). Contingent Consideration Summarized information about the changes in liabilities for contingent consideration is as follows: Fair value January 1 $ $ Changes in estimated fair value (1) (407 ) Additions Payments (100 ) (25 ) Fair value December 31 (2) $ $ (1) Recorded in Research and development expenses, Materials and production costs and Other (income) expense, net . Includes cumulative translation adjustments. (2) Includes $315 million recorded as a current liability for amounts expected to be paid within the next 12 months. The changes in the estimated fair value of contingent consideration in 2017 primarily relate to changes in the liabilities recorded in connection with the termination of the SPMSD joint venture and the clinical progression of a program related to the Afferent acquisition. The changes in the estimated fair value of contingent consideration in 2016 were largely attributable to the reversal of liabilities related to programs obtained in connection with the acquisitions of cCAM, OncoEthix and SmartCells (see Note 8). The additions to contingent consideration reflected in the table above in 2016 relate to the termination of the SPMSD joint venture (see Note 9) and the acquisitions of IOmet and Afferent (see Note 3). The payments of contingent consideration in 2017 relate to the achievement of a clinical milestone in connection with the acquisition of IOmet (see Note 3) and in 2016 relate to the first commercial sale of Zerbaxa in the European Union. Other Fair Value Measurements Some of the Companys financial instruments, such as cash and cash equivalents, receivables and payables, are reflected in the balance sheet at carrying value, which approximates fair value due to their short-term nature. The estimated fair value of loans payable and long-term debt (including current portion) at December 31, 2017 , was $25.6 billion compared with a carrying value of $24.4 billion and at December 31, 2016 , was $25.7 billion compared with a carrying value of $24.8 billion . Fair value was estimated using recent observable market prices and would be considered Level 2 in the fair value hierarchy. Concentrations of Credit Risk On an ongoing basis, the Company monitors concentrations of credit risk associated with corporate and government issuers of securities and financial institutions with which it conducts business. Credit exposure limits are established to limit a concentration with any single issuer or institution. Cash and investments are placed in instruments that meet high credit quality standards, as specified in the Companys investment policy guidelines. The majority of the Companys accounts receivable arise from product sales in the United States and Europe and are primarily due from drug wholesalers and retailers, hospitals, government agencies, managed health care providers and pharmacy benefit managers. The Company monitors the financial performance and creditworthiness of its customers so that it can properly assess and respond to changes in their credit profile. The Company also continues to monitor global economic conditions, including the volatility associated with international sovereign economies, and associated impacts on the financial markets and its business. As of December 31, 2017 , the Companys total net accounts receivable outstanding for more than one year were approximately $130 million . The Company does not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on its financial position, liquidity or results of operations. The Companys customers with the largest accounts receivable balances are: McKesson Corporation, AmerisourceBergen Corporation, Cardinal Health, Inc. and Zuellig Pharma Ltd. (Asia Pacific), which represented, in aggregate, approximately 40% of total accounts receivable at December 31, 2017 . The Company monitors the creditworthiness of its customers to which it grants credit terms in the normal course of business. Bad debts have been minimal. The Company does not normally require collateral or other security to support credit sales. Derivative financial instruments are executed under International Swaps and Derivatives Association master agreements. The master agreements with several of the Companys financial institution counterparties also include credit support annexes. These annexes contain provisions that require collateral to be exchanged depending on the value of the derivative assets and liabilities, the Companys credit rating, and the credit rating of the counterparty. As of December 31, 2017 and 2016 , the Company had received cash collateral of $3 million and $529 million , respectively, from various counterparties and the obligation to return such collateral is recorded in Accrued and other current liabilities . The Company had not advanced any cash collateral to counterparties as of December 31, 2017 or 2016 . 7. Inventories Inventories at December 31 consisted of: Finished goods $ 1,334 $ 1,304 Raw materials and work in process 4,703 4,222 Supplies Total (approximates current cost) 6,238 5,681 Increase to LIFO costs $ 6,283 $ 5,983 Recognized as: Inventories $ 5,096 $ 4,866 Other assets 1,187 1,117 Inventories valued under the LIFO method comprised approximately $2.2 billion and $2.3 billion of inventories at December 31, 2017 and 2016 , respectively. Amounts recognized as Other assets are comprised almost entirely of raw materials and work in process inventories. At December 31, 2017 and 2016 , these amounts included $1.1 billion and $1.0 billion , respectively, of inventories not expected to be sold within one year. In addition, these amounts included $80 million at both December 31, 2017 and 2016 , of inventories produced in preparation for product launches. 8. Goodwill and Other Intangibles The following table summarizes goodwill activity by segment: Pharmaceutical All Other Total Balance January 1, 2016 $ 15,862 $ 1,861 $ 17,723 Acquisitions Impairments (47 ) (47 ) Other (1) (2 ) Balance December 31, 2016 (2) 16,075 2,087 18,162 Acquisitions Impairments (38 ) (38 ) Other (1) (9 ) (8 ) (17 ) Balance December 31, 2017 (2) $ 16,066 $ 2,218 $ 18,284 (1) Other includes cumulative translation adjustments on goodwill balances and certain other adjustments. (2) Accumulated goodwill impairment losses at December 31, 2017 and 2016 were $225 million and $187 million , respectively. In 2016, the additions to goodwill in the Pharmaceutical segment resulted primarily from the acquisitions of Afferent and IOmet (see Note 3). The additions to goodwill within other non-reportable segments in 2017 primarily relate to the acquisition of Valle, which is part of the Animal Health segment (see Note 3), and in 2016 relate to the acquisition of StayWell, which is part of the Healthcare Services segment (see Note 3). The impairments of goodwill within other non-reportable segments in 2017 and 2016 relate to certain businesses within the Healthcare Services segment. Other intangibles at December 31 consisted of: Gross Carrying Amount Accumulated Amortization Net Gross Carrying Amount Accumulated Amortization Net Products and product rights $ 46,693 $ 34,950 $ 11,743 $ 46,269 $ 31,919 $ 14,350 IPRD 1,194 1,194 1,653 1,653 Tradenames Other 2,035 1,134 1,947 1,176 $ 50,131 $ 35,948 $ 14,183 $ 50,084 $ 32,779 $ 17,305 Acquired intangibles include products and product rights, tradenames and patents, which are initially recorded at fair value, assigned an estimated useful life, and are amortized primarily on a straight-line basis over their estimated useful lives. Some of the Companys more significant acquired intangibles related to marketed products (included in product and product rights above) at December 31, 2017 include Zerbaxa , $3.0 billion ; Sivextro , $879 million ; Zetia , $756 million ; Implanon/Nexplanon $529 million ; Dificid , $478 million ; Gardasil/Gardasil 9, $468 million ; Vytorin , $375 million ; Bridion , $320 million ; and Simponi , $226 million . The Company recognized an intangible asset related to Adempas as a result of a collaboration with Bayer (see Note 4) that had a carrying value of $894 million at December 31, 2017 reflected in Other in the table above. During 2017 , 2016 and 2015 , the Company recorded impairment charges related to marketed products and other intangibles of $58 million , $347 million and $45 million , respectively, within Material and production costs. During 2017, the Company recorded an intangible asset impairment charge of $47 million related to Intron A , a treatment for certain types of cancers. Sales of Intron A are being adversely affected by the availability of new therapeutic options. In 2017, sales of Intron A in the United States eroded more rapidly than previously anticipated by the Company, which led to changes in the cash flow assumptions for Intron A. These revisions to cash flows indicated that the Intron A intangible asset value was not fully recoverable on an undiscounted cash flows basis. The Company utilized market participant assumptions to determine its best estimate of the fair value of the intangible asset related to Intron A that, when compared with its related carrying value, resulted in the impairment charge noted above. The intangible asset value for Intron A at December 31, 2017 was $13 million . The remaining charges in 2017 relate to the impairment of customer relationship, tradename and developed technology intangibles for certain businesses in the Healthcare Services segment. In 2016, the Company lowered its cash flow projections for Zontivity, a product for the reduction of thrombotic cardiovascular events in patients with a history of myocardial infarction or with peripheral arterial disease, following several business decisions that reduced sales expectations for Zontivity in the United States and Europe. The Company utilized market participant assumptions and considered several different scenarios to determine the fair value of the intangible asset related to Zontivity that, when compared with its related carrying value, resulted in an impairment charge of $252 million . Also during 2016, the Company wrote-off $95 million that had been capitalized in connection with in-licensed products Grastek and Ragwitek , allergy immunotherapy tablets that, for business reasons, the Company returned to the licensor. The charges in 2015 primarily relate to the impairment of customer relationship and tradename intangibles for certain businesses within in the Healthcare Services segment. IPRD that the Company acquires through business combinations represents the fair value assigned to incomplete research projects which, at the time of acquisition, have not reached technological feasibility. Amounts capitalized as IPRD are accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project, the Company will make a separate determination as to the then useful life of the asset and begin amortization. During 2017 , 2016 and 2015 , $14 million , $8 million and $280 million , respectively, of IPRD was reclassified to products and product rights upon receipt of marketing approval in a major market. In 2017, the Company recorded $483 million of IPRD impairment charges within Research and development expenses. Of this amount, $240 million resulted from a strategic decision to discontinue the development of the investigational combination regimens MK-3682B (grazoprevir/ruzasvir/uprifosbuvir) and MK-3682C (ruzasvir/uprifosbuvir) for the treatment of chronic hepatitis C virus (HCV) infection. This decision was made based on a review of available Phase 2 efficacy data and in consideration of the evolving marketplace and the growing number of treatment options available for patients with chronic HCV infection, including Zepatier , which is currently marketed by the Company for the treatment of adult patients with chronic HCV infection. As a result of this decision, the Company recorded an IPRD impairment charge to write-off the remaining intangible asset related to uprifosbuvir. The Company had previously recorded an impairment charge for uprifosbuvir in 2016 as described below. The IPRD impairment charges in 2017 also include a charge of $226 million to write-off the intangible asset related to verubecestat, an investigational small molecule inhibitor of the beta-site amyloid precursor protein cleaving enzyme 1 (BACE1), resulting from a decision in February 2018 to stop a Phase 3 study evaluating verubecestat in people with prodromal Alzheimers disease. The decision to stop the study followed a recommendation by the external Data Monitoring Committee (eDMC), which assessed overall benefit/risk during an interim safety analysis. The eDMC concluded that it was unlikely that positive benefit/risk could be established if the trial continued. During 2016, the Company recorded $3.6 billion of IPRD impairment charges. Of this amount, $2.9 billion relates to the clinical development program for uprifosbuvir, a nucleotide prodrug that was being evaluated for the treatment of HCV. The Company determined that changes to the product profile, as well as changes to Mercks expectations for pricing and the market opportunity, taken together constituted a triggering event that required the Company to evaluate the uprifosbuvir intangible asset for impairment. Utilizing market participant assumptions, and considering different scenarios, the Company concluded that its best estimate of the fair value of the intangible asset related to uprifosbuvir was $240 million , resulting in the recognition of the pretax impairment charge noted above. The IPRD impairment charges in 2016 also include charges of $180 million and $143 million related to the discontinuation of programs obtained in connection with the acquisitions of cCAM and OncoEthix, respectively, resulting from unfavorable efficacy data. An additional $72 million relates to programs obtained in connection with the SmartCells acquisition following a decision to terminate the lead compound due to a lack of efficacy and to pursue a back-up compound which reduced projected future cash flows. The IPRD impairment charges in 2016 also include $112 million related to an in-licensed program for house dust mite allergies that, for business reasons, was returned to the licensor. The remaining IPRD impairment charges in 2016 primarily relate to deprioritized pipeline programs that were deemed to have no alternative use during the period, including a $79 million impairment charge for an investigational candidate for contraception. The discontinuation or delay of certain of these clinical development programs resulted in a reduction of the related liabilities for contingent consideration (see Note 6). During 2015, the Company recorded $63 million of IPRD impairment charges, of which $50 million related to the surotomycin clinical development program. In 2015, the Company received unfavorable efficacy data from a clinical trial for surotomycin. The evaluation of this data, combined with an assessment of the commercial opportunity for surotomycin, resulted in the discontinuation of the program and the IPRD impairment charge noted above. All of the IPRD projects that remain in development are subject to the inherent risks and uncertainties in drug development and it is possible that the Company will not be able to successfully develop and complete the IPRD programs and profitably commercialize the underlying product candidates. The Company may recognize additional non-cash impairment charges in the future related to other marketed products or pipeline programs and such charges could be material. Aggregate amortization expense primarily recorded within Materials and production costs was $3.2 billion in 2017 , $3.8 billion in 2016 and $4.8 billion in 2015 . The estimated aggregate amortization expense for each of the next five years is as follows: 2018 , $2.8 billion ; 2019 , $1.5 billion ; 2020 , $1.2 billion ; 2021 , $1.1 billion ; 2022 , $1.1 billion . 9. Joint Ventures and Other Equity Method Affiliates Equity income from affiliates reflects the performance of the Companys joint ventures and other equity method affiliates including SPMSD (until termination on December 31, 2016) and certain investment funds. Equity income from affiliates was $42 million in 2017 , $86 million in 2016 and $205 million in 2015 and is included in Other (income) expense, net (see Note 15). Investments in affiliates accounted for using the equity method totaled $767 million at December 31, 2017 and $715 million at December 31, 2016 . Sanofi Pasteur MSD In 1994, Merck and Pasteur Mrieux Connaught (now Sanofi Pasteur S.A.) established an equally-owned joint venture (SPMSD) to market vaccines in Europe and to collaborate in the development of combination vaccines for distribution in Europe. Joint venture vaccine sales were $1.0 billion for 2016 and $923 million for 2015 . On December 31, 2016, Merck and Sanofi Pasteur (Sanofi) terminated SPMSD and ended their joint vaccines operations in Europe. Under the terms of the termination, Merck acquired Sanofis 50% interest in SPMSD in exchange for consideration of $657 million comprised of cash, as well as future royalties of 11.5% on net sales of all Merck products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $416 million on the date of termination. The Company accounted for this transaction as a step acquisition, which required that Merck remeasure its ownership interest (previously accounted for as an equity method investment) to fair value at the acquisition date. Merck in turn sold to Sanofi its intellectual property rights held by SPMSD in exchange for consideration of $596 million comprised of cash and future royalties of 11.5% on net sales of all Sanofi products that were previously sold by the joint venture through December 31, 2024, which the Company determined had a fair value of $302 million on the date of termination. Excluded from this arrangement are potential future sales of Vaxelis (a jointly developed investigational pediatric hexavalent combination vaccine that was approved by the European Commission in February 2016). The European marketing rights for Vaxelis were transferred to a separate equally-owned joint venture between Sanofi and Merck. The net impact of the termination of the SPMSD joint venture is as follows: Products and product rights (8 year useful life) $ Accounts receivable Income taxes payable (221 ) Deferred income tax liabilities (147 ) Other, net Net assets acquired Consideration payable to Sanofi, net (392 ) Derecognition of Mercks previously held equity investment in SPMSD (183 ) Increase in net assets Mercks share of restructuring costs related to the termination (77 ) Net gain on termination of SPMSD joint venture (1) $ (1) Recorded in Other (income) expense, net . The estimated fair values of identifiable intangible assets related to products and product rights were determined using an income approach through which fair value is estimated based on market participant expectations of each assets projected net cash flows. The projected net cash flows were then discounted to present value utilizing a discount rate of 11.5% . Actual cash flows are likely to be different than those assumed. Of the amount recorded for products and product rights, $468 million related to Gardasil/Gardasil 9. The fair value of liabilities for contingent consideration related to Mercks future royalty payments to Sanofi of $416 million (reflected in the consideration payable to Sanofi, net, in the table above) was determined at the acquisition date using unobservable inputs. These inputs include the estimated amount and timing of projected cash flows and a risk-adjusted discount rate of 8% used to present value the cash flows. Changes in the inputs could result in a different fair value measurement. Based on an existing accounting policy election, Merck did not record the $302 million estimated fair value of contingent future royalties to be received from Sanofi on the sale of Sanofi products, but rather is recognizing such amounts as sales occur and the royalties are earned. The Company incurred $24 million of transaction costs related to the termination of SPMSD included in Marketing and administrative expenses in 2016. Pro forma financial information for this transaction has not been presented as the results are not significant when compared with the Companys financial results. AstraZeneca LP In 1982, Merck entered into an agreement with Astra AB (Astra) to develop and market Astra products under a royalty-bearing license. In 1993, Mercks total sales of Astra products reached a level that triggered the first step in the establishment of a joint venture business carried on by Astra Merck Inc. (AMI), in which Merck and Astra each owned a 50% share. This joint venture, formed in 1994, developed and marketed most of Astras new prescription medicines in the United States. In 1998, Merck and Astra completed a restructuring of the ownership and operations of the joint venture whereby Merck acquired Astras interest in AMI, renamed KBI Inc. (KBI), and contributed KBIs operating assets to a new U.S. limited partnership, Astra Pharmaceuticals L.P. (the Partnership), in exchange for a 1% limited partner interest. Astra contributed the net assets of its wholly owned subsidiary, Astra USA, Inc., to the Partnership in exchange for a 99% general partner interest. The Partnership, renamed AstraZeneca LP (AZLP) upon Astras 1999 merger with Zeneca Group Plc, became the exclusive distributor of the products for which KBI retained rights. Merck earned revenue based on sales of KBI products and earned certain Partnership returns from AZLP. On June 30, 2014, AstraZeneca exercised its option to purchase Mercks interest in KBI (and redeem Mercks remaining interest in AZLP). A portion of the exercise price, which is subject to a true-up in 2018 based on actual sales of Nexium and Prilosec from closing in 2014 to June 2018, was deferred and recognized as income as the contingency was eliminated as sales occurred. Once the deferred income amount was fully recognized, in 2016, the Company began recognizing income and a corresponding receivable for amounts that will be due to Merck from AstraZeneca based on the sales performance of Nexium and Prilosec subject to the true-up in June 2018. The Company recognized income of $232 million , $98 million and $182 million in 2017, 2016 and 2015, respectively, in Other (income) expense, net related to these amounts. The receivable from AstraZeneca was $325 million at December 31, 2017. 10. Loans Payable, Long-Term Debt and Other Commitments Loans payable at December 31, 2017 included $3.0 billion of notes due in 2018 and $73 million of long-dated notes that are subject to repayment at the option of the holder. Loans payable at December 31, 2016 included $300 million of notes due in 2017 , $267 million of long-dated notes that are subject to repayment at the option of the holders. The weighted-average interest rate of commercial paper borrowings was 0.85% and 0.40% for the years ended December 31, 2017 and 2016 , respectively. Long-term debt at December 31 consisted of: 2.75% notes due 2025 $ 2,488 $ 2,487 3.70% notes due 2045 1,973 1,972 2.80% notes due 2023 1,744 1,743 5.00% notes due 2019 1,260 1,273 4.15% notes due 2043 1,237 1,236 1.85% notes due 2020 1,232 1,238 2.35% notes due 2022 1,220 1,228 1.125% euro-denominated notes due 2021 1,185 1,035 1.875% euro-denominated notes due 2026 1,178 1,028 3.875% notes due 2021 1,140 1,152 2.40% notes due 2022 1,003 6.50% notes due 2033 Floating-rate notes due 2020 0.50% euro-denominated notes due 2024 1.375% euro-denominated notes due 2036 2.50% euro-denominated notes due 2034 3.60% notes due 2042 6.55% notes due 2037 5.75% notes due 2036 5.95% debentures due 2028 5.85% notes due 2039 6.40% debentures due 2028 6.30% debentures due 2026 Floating-rate borrowing due 2018 1.10% notes due 2018 1.30% notes due 2018 Other $ 21,353 $ 24,274 Other (as presented in the table above) includes $300 million and $147 million at December 31, 2017 and 2016 , respectively, of borrowings at variable rates that resulted in effective interest rates of 1.42% and 0.89% for 2017 and 2016 , respectively. With the exception of the 6.30% debentures due 2026, the notes listed in the table above are redeemable in whole or in part, at Mercks option at any time, at varying redemption prices. In November 2017, the Company launched tender offers for certain outstanding notes and debentures. The Company paid $810 million in aggregate consideration (applicable purchase price together with accrued interest) to redeem $585 million principal amount of debt that was validly tendered in connection with the tender offers and recognized a loss on extinguishment of debt of $191 million in 2017. Effective as of November 3, 2009, the Company executed a full and unconditional guarantee of the then existing debt of its subsidiary Merck Sharp Dohme Corp. (MSD) and MSD executed a full and unconditional guarantee of the then existing debt of the Company (excluding commercial paper), including for payments of principal and interest. These guarantees do not extend to debt issued subsequent to that date. Certain of the Companys borrowings require that Merck comply with financial covenants including a requirement that the Total Debt to Capitalization Ratio (as defined in the applicable agreements) not exceed 60% . At December 31, 2017 , the Company was in compliance with these covenants. The aggregate maturities of long-term debt for each of the next five years are as follows: 2018 , $3.0 billion ; 2019 , $1.3 billion ; 2020 , $1.9 billion ; 2021 , $2.3 billion ; 2022 , $2.2 billion . The Company has a $6.0 billion , five -year credit facility that matures in June 2022. The facility provides backup liquidity for the Companys commercial paper borrowing facility and is to be used for general corporate purposes. The Company has not drawn funding from this facility. Rental expense under operating leases, net of sublease income, was $327 million in 2017 , $292 million in 2016 and $303 million in 2015 . The minimum aggregate rental commitments under noncancellable leases are as follows: 2018 , $255 million ; 2019 , $175 million ; 2020 , $126 million ; 2021 , $90 million ; 2022 , $68 million and thereafter, $138 million . The Company has no significant capital leases. 11. Contingencies and Environmental Liabilities The Company is involved in various claims and legal proceedings of a nature considered normal to its business, including product liability, intellectual property, and commercial litigation, as well as certain additional matters including governmental and environmental matters. In the opinion of the Company, it is unlikely that the resolution of these matters will be material to the Companys financial position, results of operations or cash flows. Given the nature of the litigation discussed below and the complexities involved in these matters, the Company is unable to reasonably estimate a possible loss or range of possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. For product liability claims, a portion of the overall accrual is actuarially determined and considers such factors as past experience, number of claims reported and estimates of claims incurred but not yet reported. Individually significant contingent losses are accrued when probable and reasonably estimable. Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. The Companys decision to obtain insurance coverage is dependent on market conditions, including cost and availability, existing at the time such decisions are made. The Company has evaluated its risks and has determined that the cost of obtaining product liability insurance outweighs the likely benefits of the coverage that is available and, as such, has no insurance for most product liabilities effective August 1, 2004. Product Liability Litigation Fosamax As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Fosamax ( Fosamax Litigation). As of December 31, 2017 , approximately 4,085 cases are filed and pending against Merck in either federal or state court. In approximately 15 of these actions, plaintiffs allege, among other things, that they have suffered osteonecrosis of the jaw (ONJ), generally subsequent to invasive dental procedures, such as tooth extraction or dental implants and/or delayed healing, in association with the use of Fosamax . In addition, plaintiffs in approximately 4,070 of these actions generally allege that they sustained femur fractures and/or other bone injuries (Femur Fractures) in association with the use of Fosamax . Cases Alleging ONJ and/or Other Jaw Related Injuries In August 2006, the Judicial Panel on Multidistrict Litigation (JPML) ordered that certain Fosamax product liability cases pending in federal courts nationwide should be transferred and consolidated into one multidistrict litigation ( Fosamax ONJ MDL) for coordinated pre-trial proceedings. In December 2013, Merck reached an agreement in principle with the Plaintiffs Steering Committee (PSC) in the Fosamax ONJ MDL to resolve pending ONJ cases not on appeal in the Fosamax ONJ MDL and in the state courts for an aggregate amount of $27.7 million . Merck and the PSC subsequently formalized the terms of this agreement in a Master Settlement Agreement (ONJ Master Settlement Agreement) that was executed in April 2014 and included over 1,200 plaintiffs. In July 2014, Merck elected to proceed with the ONJ Master Settlement Agreement at a reduced funding level of $27.3 million since the participation level was approximately 95% . Merck has fully funded the ONJ Master Settlement Agreement and the escrow agent under the agreement has been making settlement payments to qualifying plaintiffs. The ONJ Master Settlement Agreement has no effect on the cases alleging Femur Fractures discussed below. Discovery is currently ongoing in some of the approximately 15 remaining ONJ cases that are pending in various federal and state courts and the Company intends to defend against these lawsuits. Cases Alleging Femur Fractures In March 2011, Merck submitted a Motion to Transfer to the JPML seeking to have all federal cases alleging Femur Fractures consolidated into one multidistrict litigation for coordinated pre-trial proceedings. The Motion to Transfer was granted in May 2011, and all federal cases involving allegations of Femur Fracture have been or will be transferred to a multidistrict litigation in the District of New Jersey (Femur Fracture MDL). In the only bellwether case tried to date in the Femur Fracture MDL, Glynn v. Merck , the jury returned a verdict in Mercks favor. In addition, in June 2013, the Femur Fracture MDL court granted Mercks motion for judgment as a matter of law in the Glynn case and held that the plaintiffs failure to warn claim was preempted by federal law. The Glynn decision was not appealed by plaintiff. In August 2013, the Femur Fracture MDL court entered an order requiring plaintiffs in the Femur Fracture MDL to show cause why those cases asserting claims for a femur fracture injury that took place prior to September 14, 2010, should not be dismissed based on the courts preemption decision in the Glynn case. Pursuant to the show cause order, in March 2014, the Femur Fracture MDL court dismissed with prejudice approximately 650 cases on preemption grounds. Plaintiffs in approximately 515 of those cases appealed that decision to the U.S. Court of Appeals for the Third Circuit (Third Circuit). The Femur Fracture MDL court also dismissed without prejudice another approximately 510 cases pending plaintiffs appeal of the preemption ruling to the Third Circuit. On March 22, 2017, the Third Circuit issued a decision reversing the Femur Fracture MDL courts preemption ruling and remanding the appealed cases back to the Femur Fracture MDL court. On April 5, 2017, Merck filed a petition seeking a rehearing on the Third Circuits March 22, 2017 decision, which was denied on April 24, 2017. Merck filed a petition for a writ of certiorari to the U.S. Supreme Court on August 22, 2017, seeking review of the Third Circuits decision. On December 4, 2017, the Supreme Court invited the Solicitor General to file a brief in the case expressing the views of the United States. In addition, in June 2014, the Femur Fracture MDL court granted Merck summary judgment in the Gaynor v. Merck case and found that Mercks updates in January 2011 to the Fosamax label regarding atypical femur fractures were adequate as a matter of law and that Merck adequately communicated those changes. The plaintiffs in Gaynor did not appeal the Femur Fracture MDL courts findings with respect to the adequacy of the 2011 label change but did appeal the dismissal of their case based on preemption grounds, and the Third Circuit subsequently reversed that dismissal in its March 22, 2017 decision. In August 2014, Merck filed a motion requesting that the Femur Fracture MDL court enter a further order requiring all plaintiffs in the Femur Fracture MDL who claim that the 2011 Fosamax label is inadequate and the proximate cause of their alleged injuries to show cause why their cases should not be dismissed based on the courts preemption decision and its ruling in the Gaynor case. In November 2014, the court granted Mercks motion and entered the requested show cause order. No plaintiffs responded to or appealed the November 2014 show cause order. As of December 31, 2017 , approximately 530 cases were pending in the Femur Fracture MDL following the reinstatement of the cases that had been on appeal to the Third Circuit. The 510 cases dismissed without prejudice that were also pending the final resolution of the aforementioned appeal have not yet been reinstated. As of December 31, 2017 , approximately 2,750 cases alleging Femur Fractures have been filed in New Jersey state court and are pending before Judge James Hyland in Middlesex County. The parties selected an initial group of 30 cases to be reviewed through fact discovery. Two additional groups of 50 cases each to be reviewed through fact discovery were selected in November 2013 and March 2014, respectively. A further group of 25 cases to be reviewed through fact discovery was selected by Merck in July 2015, and Merck has continued to select additional cases to be reviewed through fact discovery during 2016 and 2017. As of December 31, 2017 , approximately 280 cases alleging Femur Fractures have been filed and are pending in California state court. All of the Femur Fracture cases filed in California state court have been coordinated before a single judge in Orange County, California. In March 2014, the court directed that a group of 10 discovery pool cases be reviewed through fact discovery and subsequently scheduled the Galper v. Merck case, which plaintiffs selected, as the first trial. The Galper trial began in February 2015 and the jury returned a verdict in Mercks favor in April 2015, and plaintiff appealed that verdict to the California appellate court. Oral argument on plaintiffs appeal in Galper was held in November 2016 and, on April 24, 2017, the California appellate court issued a decision affirming the lower courts judgment in favor of Merck. The next Femur Fracture trial in California that was scheduled to begin in April 2016 was stayed at plaintiffs request and a new trial date has not been set. Additionally, there are five Femur Fracture cases pending in other state courts. Discovery is ongoing in the Femur Fracture MDL and in state courts where Femur Fracture cases are pending and the Company intends to defend against these lawsuits. Januvia/Janumet As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Januvia and/or Janumet . As of December 31, 2017 , Merck is aware of approximately 1,235 product user claims alleging generally that use of Januvia and/or Janumet caused the development of pancreatic cancer and other injuries. These complaints were filed in several different state and federal courts. Most of the claims were filed in a consolidated multidistrict litigation proceeding in the U.S. District Court for the Southern District of California called In re Incretin-Based Therapies Products Liability Litigation (MDL). The MDL includes federal lawsuits alleging pancreatic cancer due to use of the following medicines: Januvia, Janumet , Byetta and Victoza, the latter two of which are products manufactured by other pharmaceutical companies. The majority of claims not filed in the MDL were filed in the Superior Court of California, County of Los Angeles (California State Court). In November 2015, the MDL and California State Court - in separate opinions - granted summary judgment to defendants on grounds of preemption. Of the approximately 1,235 product user claims, these rulings resulted in the dismissal of approximately 1,100 product user claims. Plaintiffs appealed the MDL and California State Court preemption rulings. On November 28, 2017, the U.S. Court of Appeals for the Ninth Circuit (Ninth Circuit) reversed the trial courts ruling in the MDL and remanded for further proceedings. The Ninth Circuit did not address the substance of defendants preemption argument but instead ruled that the district court made various errors during discovery. Jurisdiction returned to U.S. District Court for the Southern District of California on January 2, 2018. The preemption appeal in the California state court litigation has been fully briefed, but the court has not yet scheduled oral argument. As of December 31, 2017 , seven product users have claims pending against Merck in state courts other than California state court, including four active product user claims pending in Illinois state court. On June 30, 2017, the Illinois trial court denied Mercks motion for summary judgment on grounds of preemption. Merck sought permission to appeal that order on an interlocutory basis and was granted a stay of proceedings in the trial court. On September 19, 2017, an intermediate appellate court in Illinois denied Mercks petition for interlocutory review. On October 20, 2017, Merck filed a petition with the Illinois Supreme Court, seeking leave to appeal the appellate courts denial. The Illinois Supreme Court denied Mercks petition for certiorari review and, instead, directed the appellate court to answer the certified question. As a result, proceedings in the trial court remain stayed and trials for certain of the product users in Illinois have been delayed. In addition to the claims noted above, the Company has agreed to toll the statute of limitations for approximately 50 additional claims. The Company intends to continue defending against these lawsuits. Propecia/Proscar As previously disclosed, Merck is a defendant in product liability lawsuits in the United States involving Propecia and/or Proscar . As of December 31, 2017 , approximately 775 lawsuits have been filed by plaintiffs who allege that they have experienced persistent sexual side effects following cessation of treatment with Propecia and/or Proscar . Approximately 20 of the plaintiffs also allege that Propecia or Proscar has caused or can cause prostate cancer, testicular cancer or male breast cancer. The lawsuits have been filed in various federal courts and in state court in New Jersey. The federal lawsuits have been consolidated for pretrial purposes in a federal multidistrict litigation before Judge Brian Cogan of the Eastern District of New York. The matters pending in state court in New Jersey have been consolidated before Judge Hyland in Middlesex County. In addition, there is one matter pending in state court in California, one matter pending in state court in Ohio, and one matter on appeal in the Massachusetts Supreme Judicial Court. The Company intends to defend against these lawsuits. Governmental Proceedings As previously disclosed, the Company has learned that the Prosecution Office of Milan, Italy is investigating interactions between the Companys Italian subsidiary, certain employees of the subsidiary and certain Italian health care providers. The Company understands that this is part of a larger investigation involving engagements between various health care companies and those health care providers. The Company is cooperating with the investigation. As previously disclosed, the United Kingdom (UK) Competition and Markets Authority (CMA) issued a Statement of Objections against the Company and MSD Sharp Dohme Limited (MSD UK) on May 23, 2017. In the Statement of Objections, the CMA alleges that MSD UK abused a dominant position through a discount program for Remicade over the period from March 2015 to February 2016. The Company and MSD UK are contesting the CMAs allegations. As previously disclosed, the Company has received an investigative subpoena from the California Insurance Commissioners Fraud Bureau (Bureau) seeking information from January 1, 2007 to the present related to the pricing and promotion of Cubicin . The Bureau is investigating whether Cubist Pharmaceuticals, Inc., which the Company acquired in 2015, unlawfully induced the presentation of false claims for Cubicin to private insurers under the California Insurance Code False Claims Act. The Company is cooperating with the investigation. As previously disclosed, the Company has received a civil investigative demand from the U.S. Attorneys Office for the Southern District of New York that requests information relating to the Companys contracts with, services from and payments to pharmacy benefit managers with respect to Maxalt and Levitra from January 1, 2006 to the present. The Company is cooperating with the investigation. As previously disclosed, the Company has received a subpoena from the Office of Inspector General of the U.S. Department of Health and Human Services on behalf of the U.S. Attorneys Office for the District of Maryland and the Civil Division of the U.S. Department of Justice that requests information relating to the Companys marketing of Singulair and Dulera Inhalation Aerosol and certain of its other marketing activities from January 1, 2006 to the present. The Company is cooperating with the investigation. As previously disclosed, the Companys subsidiaries in China have received and may continue to receive inquiries regarding their operations from various Chinese governmental agencies. Some of these inquiries may be related to matters involving other multinational pharmaceutical companies, as well as Chinese entities doing business with such companies. The Companys policy is to cooperate with these authorities and to provide responses as appropriate. As previously disclosed, from time to time, the Company receives inquiries and is the subject of preliminary investigation activities from competition and other governmental authorities in markets outside the United States. These authorities may include regulators, administrative authorities, and law enforcement and other similar officials, and these preliminary investigation activities may include site visits, formal or informal requests or demands for documents or materials, inquiries or interviews and similar matters. Certain of these preliminary inquiries or activities may lead to the commencement of formal proceedings. Should those proceedings be determined adversely to the Company, monetary fines and/or remedial undertakings may be required. Commercial and Other Litigation K-DUR Antitrust Litigation In June 1997 and January 1998, Schering-Plough Corporation (Schering-Plough) settled patent litigation with Upsher-Smith, Inc. (Upsher-Smith) and ESI Lederle, Inc. (Lederle), respectively, relating to generic versions of Schering-Ploughs long-acting potassium chloride product supplement used by cardiac patients, for which Lederle and Upsher-Smith had filed abbreviated New DrugApplications (NDA). Putative class and non-class action suits were then filed on behalf of direct and indirect purchasers of K-DUR against Schering-Plough, Upsher-Smith and Lederle and were consolidated in a multidistrict litigation in the U.S. District Court for the District of New Jersey. In February 2016, the court denied the Companys motion for summary judgment relating to all of the direct purchasers claims concerning the settlement with Upsher-Smith and granted the Companys motion for summary judgment relating to all of the direct purchasers claims concerning the settlement with Lederle. As previously disclosed, in February 2017, Merck and Upsher-Smith reached a settlement in principle with the class of direct purchasers and the opt-outs to the class. Merck will contribute approximately $80 million in the aggregate towards the overall settlement. On April 5, 2017, the claims of the opt-outs were dismissed with prejudice pursuant to a written settlement agreement with those parties. On May 15, 2017, Merck and the class executed a settlement agreement, which received preliminary approval from the court on May 23, 2017. On October 5, 2017, the court entered a Final Judgment and Order of Dismissal approving the settlement agreement with the direct purchaser class and dismissing the claims of the class with prejudice. Zetia Antitrust Litigation In May 2010, Schering Corporation (Schering) and MSP Singapore Company LLC (MSP) settled patent litigation with Glenmark Pharmaceuticals Inc., USA, and Glenmark Pharmaceuticals Ltd. (together, Glenmark) relating to a generic version of Zetia , a pharmaceutical product containing ezetimibe used by patients with high cholesterol, for which Glenmark had filed an abbreviated NDA. In January and February 2018, putative class action suits were filed on behalf of direct and indirect purchasers of Zetia against Merck, MSD, Schering-Plough, Schering, MSP, and Glenmark in the U.S. District Courts for the Eastern District of Virginia and the Eastern District of New York. These suits claim violations of federal and state antitrust laws, as well as other state statutory and common law causes of action. These suits seek unspecified damages. Sales Force Litigation As previously disclosed, in May 2013, Ms. Kelli Smith filed a complaint against the Company in the U.S. District Court for the District of New Jersey on behalf of herself and a putative class of female sales representatives and a putative sub-class of female sales representatives with children, claiming (a) discriminatory policies and practices in selection, promotion and advancement, (b) disparate pay, (c) differential treatment, (d) hostile work environment and (e) retaliation under federal and state discrimination laws. Plaintiffs sought and were granted leave to file an amended complaint. In January 2014, plaintiffs filed an amended complaint adding four additional named plaintiffs. In October 2014, the court denied the Companys motion to dismiss or strike the class claims as premature. In September 2015, plaintiffs filed additional motions, including a motion for conditional certification under the Equal Pay Act; a motion to amend the pleadings seeking to add ERISA and constructive discharge claims and a Company subsidiary as a named defendant; and a motion for equitable relief. Merck filed papers in opposition to the motions. On April 27, 2016, the court granted plaintiffs motion for conditional certification but denied plaintiffs motions to extend the liability period for their Equal Pay Act claims back to June 2009. As a result, the liability period will date back to April 2012, at the earliest. On April 29, 2016, the Magistrate Judge granted plaintiffs request to amend the complaint to add the following: (i) a Company subsidiary as a corporate defendant; (ii) an ERISA claim and (iii) an individual constructive discharge claim for one of the named plaintiffs. Approximately 700 individuals have opted-in to this action; the opt-in period has closed. On August 1, 2017, plaintiffs filed their motion for class certification. This motion seeks to certify a Title VII pay discrimination class and also seeks final collective action certification of plaintiffs Equal Pay Act claim. The parties are currently engaged in motion practice before the court. Qui Tam Litigation As previously disclosed, on June 21, 2012, the U.S. District Court for the Eastern District of Pennsylvania unsealed a complaint that has been filed against the Company under the federal False Claims Act by two former employees alleging, among other things, that the Company defrauded the U.S. government by falsifying data in connection with a clinical study conducted on the mumps component of the Companys M-M-R II vaccine. The complaint alleges the fraud took place between 1999 and 2001. The U.S. government had the right to participate in and take over the prosecution of this lawsuit, but notified the court that it declined to exercise that right. The two former employees are pursuing the lawsuit without the involvement of the U.S. government. In addition, as previously disclosed, two putative class action lawsuits on behalf of direct purchasers of the MMR II vaccine, which charge that the Company misrepresented the efficacy of the M-M-R II vaccine in violation of federal antitrust laws and various state consumer protection laws, are pending in the Eastern District of Pennsylvania. In September 2014, the court denied Mercks motion to dismiss the False Claims Act suit and granted in part and denied in part its motion to dismiss the then-pending antitrust suit. As a result, both the False Claims Act suit and the antitrust suits have proceeded into discovery. The Company intends to defend against these lawsuits. Merck KGaA Litigation In January 2016, to protect its long-established brand rights in the United States, the Company filed a lawsuit against Merck KGaA, Darmstadt, Germany (KGaA), operating as the EMD Group in the United States, alleging it improperly uses the name Merck in the United States. KGaA has filed suit against the Company in France, the UK, Germany, Switzerland, Mexico, and India alleging breach of the parties co-existence agreement, unfair competition and/or trademark infringement. In December 2015, the Paris Court of First Instance issued a judgment finding that certain activities by the Company directed towards France did not constitute trademark infringement and unfair competition while other activities were found to infringe. The Company and KGaA appealed the decision, and the appeal was heard in May 2017. In June 2017, the French appeals court held that certain of the activities by the Company directed to France constituted unfair competition or trademark infringement and no further appeal was pursued. In January 2016, the UK High Court issued a judgment finding that the Company had breached the co-existence agreement and infringed KGaAs trademark rights as a result of certain activities directed towards the UK based on use of the word MERCK on promotional and information activity. As noted in the UK decision, this finding was not based on the Companys use of the sign MERCK in connection with the sale of products or any material pharmaceutical business transacted in the UK. The Company and KGaA have both appealed this decision, and the appeal was heard in June 2017. In November 2017, the UK Court of Appeals affirmed the decision on the co-existence agreement and remitted for re-hearing issues of trade mark infringement, validity and the relief to which KGaA would be entitled. Patent Litigation From time to time, generic manufacturers of pharmaceutical products file abbreviated NDAs with the FDA seeking to market generic forms of the Companys products prior to the expiration of relevant patents owned by the Company. To protect its patent rights, the Company may file patent infringement lawsuits against such generic companies. Certain products of the Company currently involved in such patent infringement litigation in the United States include Noxafil and NuvaRing . Similar lawsuits defending the Companys patent rights may exist in other countries. The Company intends to vigorously defend its patents, which it believes are valid, against infringement by companies attempting to market products prior to the expiration of such patents. As with any litigation, there can be no assurance of the outcomes, which, if adverse, could result in significantly shortened periods of exclusivity for these products and, with respect to products acquired through acquisitions, potentially significant intangible asset impairment charges. Noxafil In August 2015, the Company filed a lawsuit against Actavis Laboratories Fl, Inc. (Actavis) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the district court held the patent valid and infringed. Actavis has appealed this decision. In March 2016, the Company filed a lawsuit against Roxane Laboratories, Inc. (Roxane) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil . In October 2017, the parties reached a settlement whereby Roxane can launch its generic version upon expiry of the patent, or earlier under certain conditions. In February 2016, the Company filed a lawsuit against Par Sterile Products LLC, Par Pharmaceutical, Inc., Par Pharmaceutical Companies, Inc. and Par Pharmaceutical Holdings, Inc. (collectively, Par) in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of Noxafil injection. In October 2016, the parties reached a settlement whereby Par can launch its generic version in January 2023, or earlier under certain conditions. Nasonex Nasonex lost market exclusivity in the United States in 2016. Prior to that, in April 2015, the Company filed a patent infringement lawsuit against Apotex Inc. and Apotex Corp. (Apotex) in respect of Apotexs marketed product that the Company believed was infringing. In January 2018, the Company and Apotex settled this matter with Apotex agreeing to pay the Company $115 million plus certain other consideration. NuvaRing In December 2013, the Company filed a lawsuit against a subsidiary of Allergan plc in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing . The trial in this matter was held in January 2016. In August 2016, the district court ruled that the patent was invalid and the Company appealed this decision. In October 2017, the appellate court reversed the district court decision and found the patent to be valid. The case was remanded and the district court enjoined the defendant from marketing its generic version of NuvaRing until the patent expires. In September 2015, the Company filed a lawsuit against Teva Pharma in the United States in respect of that companys application to the FDA seeking pre-patent expiry approval to sell a generic version of NuvaRing . Based on its ruling in the Allergan plc matter, the district court dismissed the Companys lawsuit in December 2016. Following the appellate reversal in the Allergan plc matter, the defendant has agreed to be enjoined from marketing its generic version of NuvaRing until the patent expires. Anti-PD-1 Antibody Patent Oppositions and Litigation As previously disclosed, Ono Pharmaceutical Co. (Ono) has a European patent (EP 1 537 878) (878) that broadly claims the use of an anti-PD-1 antibody, such as the Companys immunotherapy, Keytruda , for the treatment of cancer. Ono has previously licensed its commercial rights to an anti-PD-1 antibody to Bristol-Myers Squibb (BMS) in certain markets. BMS and Ono also own European Patent EP 2 161 336 (336) that, as granted, broadly claimed anti-PD-1 antibodies that could include Keytruda . As previously disclosed, the Company and BMS and Ono were engaged in worldwide litigation, including in the United States, over the validity and infringement of the 878 patent, the 336 patent and their equivalents. In January 2017, the Company announced that it had entered into a settlement and license agreement with BMS and Ono resolving the worldwide patent infringement litigation related to the use of an anti-PD-1 antibody for the treatment of cancer, such as Keytruda . Under the settlement and license agreement, the Company made a one-time payment of $625 million (which was recorded as an expense in the Companys 2016 financial results) to BMS and will pay royalties on the worldwide sales of Keytruda for a non-exclusive license to market Keytruda in any market in which it is approved. For global net sales of Keytruda , the Company will pay royalties of 6.5% of net sales occurring from January 1, 2017 through and including December 31, 2023; and 2.5% of net sales occurring from January 1, 2024 through and including December 31, 2026. The parties also agreed to dismiss all claims worldwide in the relevant legal proceedings. In October 2015, PDL Biopharma (PDL) filed a lawsuit in the United States against the Company alleging that the manufacture of Keytruda infringed US Patent No. 5,693,761 (761 patent), which expired in December 2014. This patent claims platform technology used in the creation and manufacture of recombinant antibodies and PDL is seeking damages for pre-expiry infringement of the 761 patent. In April 2017, the parties reached a settlement pursuant to which, in exchange for a lump sum, PDL dismissed its lawsuit with prejudice and granted the Company a fully paid-up non-exclusive license to the 761 patent. In July 2016, the Company filed a declaratory judgment action in the United States against Genentech and City of Hope seeking a ruling that US Patent No. 7,923,221 (Cabilly III patent), which claims platform technology used in the creation and manufacture of recombinant antibodies, is invalid and that Keytruda and bezlotoxumab do not infringe the Cabilly III patent. In July 2016, the Company also filed a petition in the USPTO for Inter Partes Review (IPR) of certain claims of US Patent No. 6,331,415 (Cabilly II patent), which claims platform technology used in the creation and manufacture of recombinant antibodies and is also owned by Genentech and City of Hope, as being invalid. In December 2016, the USPTO denied the petition but allowed the Company to join an IPR filed previously by another party. In May 2017, the parties reached a settlement pursuant to which the Company dismissed its lawsuit with prejudice and moved to terminate the IPR and Genentech and City of Hope granted the Company a fully paid-up non-exclusive license to the Cabilly II and Cabilly III patent. Gilead Patent Litigation and Opposition In August 2013, Gilead Sciences, Inc. (Gilead) filed a lawsuit in the U.S. District Court for the Northern District of California seeking a declaration that two Company patents were invalid and not infringed by the sale of their two sofosbuvir containing products, Solvadi and Harvoni. The Company filed a counterclaim that the sale of these products did infringe these two patents and sought a reasonable royalty for the past, present and future sales of these products. In March 2016, at the conclusion of a jury trial, the patents were found to be not invalid and infringed. The jury awarded the Company $200 million as a royalty for sales of these products up to December 2015. After the conclusion of the jury trial, the court held a bench trial on the equitable defenses raised by Gilead. In June 2016, the court found for Gilead and determined that Merck could not collect the jury award and that the patents were unenforceable with respect to Gilead. The Company appealed the courts decision. Gilead also asked the court to overturn the jurys decision on validity. The court held a hearing on Gileads motion in August 2016, and the court subsequently rejected Gileads request, which Gilead appealed. A hearing on the combined appeals for this case was held on February 4, 2018. The Company will pay 20% , net of legal fees, of damages or royalties, if any, that it receives to Ionis Pharmaceuticals, Inc. The Company, through its Idenix Pharmaceuticals, Inc. subsidiary, has pending litigation against Gilead in the United States, the UK, Norway, Canada, Germany, France, and Australia based on different patent estates that would also be infringed by Gileads sales of these two products. Gilead opposed the European patent at the European Patent Office (EPO). Trial in the United States was held in December 2016 and the jury returned a verdict for the Company, awarding damages of $2.54 billion . The Company submitted post-trial motions, including on the issues of enhanced damages and future royalties. Gilead submitted post-trial motions for judgment as a matter of law. A hearing on the motions was held in September 2017. Also, in September 2017, the court denied the Companys motion on enhanced damages, granted its motion on prejudgment interest and deferred its motion on future royalties. In February 2018, the court granted Gileads motion for judgment as a matter of law and found the patent was invalid for a lack of enablement. The Company will appeal this decision. In Australia, the Company was initially unsuccessful and the Full Federal Court affirmed the lower court decision. The Company has sought leave to appeal to the High Court of Australia for further review. In Canada, the Company was initially unsuccessful and the Federal Court of Appeals affirmed the lower court decision The Company sought leave to the Supreme Court of Canada for further review. In the UK and Norway, the patent was held invalid and no further appeal was filed. The EPO opposition division revoked the European patent, and the Company appealed this decision. The cases in France and Germany have been stayed pending the final decision of the EPO. Other Litigation There are various other pending legal proceedings involving the Company, principally product liability and intellectual property lawsuits. While it is not feasible to predict the outcome of such proceedings, in the opinion of the Company, either the likelihood of loss is remote or any reasonably possible loss associated with the resolution of such proceedings is not expected to be material to the Companys financial position, results of operations or cash flows either individually or in the aggregate. Legal Defense Reserves Legal defense costs expected to be incurred in connection with a loss contingency are accrued when probable and reasonably estimable. Some of the significant factors considered in the review of these legal defense reserves are as follows: the actual costs incurred by the Company; the development of the Companys legal defense strategy and structure in light of the scope of its litigation; the number of cases being brought against the Company; the costs and outcomes of completed trials and the most current information regarding anticipated timing, progression, and related costs of pre-trial activities and trials in the associated litigation. The amount of legal defense reserves as of December 31, 2017 and December 31, 2016 of approximately $160 million and $185 million , respectively, represents the Companys best estimate of the minimum amount of defense costs to be incurred in connection with its outstanding litigation; however, events such as additional trials and other events that could arise in the course of its litigation could affect the ultimate amount of legal defense costs to be incurred by the Company. The Company will continue to monitor its legal defense costs and review the adequacy of the associated reserves and may determine to increase the reserves at any time in the future if, based upon the factors set forth, it believes it would be appropriate to do so. Environmental Matters As previously disclosed, Mercks facilities in Oss, the Netherlands, were inspected by the Province of Brabant (Province) pursuant to the Dutch Hazards of Major Accidents Decree and the sites environmental permits. The Province issued penalties for alleged violations of regulations governing preventing and managing accidents with hazardous substances, and the government also issued a fine for alleged environmental violations at one of the Oss facilities, which together totaled $235 thousand . The Company was subsequently advised that a criminal investigation had been initiated based upon certain of the issues that formed the basis of the administrative enforcement action by the Province. The Company intends to defend itself against any enforcement action that may result from this investigation. In May 2015, the Environmental Protection Agency (EPA) conducted an air compliance evaluation of the Companys pharmaceutical manufacturing facility in Elkton, Virginia. As a result of the investigation, the Company was issued a Notice of Noncompliance and Show Cause Notification relating to certain federally enforceable requirements applicable to the Elkton facility. The Company has been advised by the EPA that enforcement action is no longer being pursued. The Company and its subsidiaries are parties to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund, and other federal and state equivalents. These proceedings seek to require the operators of hazardous waste disposal facilities, transporters of waste to the sites and generators of hazardous waste disposed of at the sites to clean up the sites or to reimburse the government for cleanup costs. The Company has been made a party to these proceedings as an alleged generator of waste disposed of at the sites. In each case, the government alleges that the defendants are jointly and severally liable for the cleanup costs. Although joint and several liability is alleged, these proceedings are frequently resolved so that the allocation of cleanup costs among the parties more nearly reflects the relative contributions of the parties to the site situation. The Companys potential liability varies greatly from site to site. For some sites the potential liability is de minimis and for others the final costs of cleanup have not yet been determined. While it is not feasible to predict the outcome of many of these proceedings brought by federal or state agencies or private litigants, in the opinion of the Company, such proceedings should not ultimately result in any liability which would have a material adverse effect on the financial position, results of operations, liquidity or capital resources of the Company. The Company has taken an active role in identifying and accruing for these costs and such amounts do not include any reduction for anticipated recoveries of cleanup costs from former site owners or operators or other recalcitrant potentially responsible parties. In managements opinion, the liabilities for all environmental matters that are probable and reasonably estimable have been accrued and totaled $82 million and $83 million at December 31, 2017 and 2016 , respectively. These liabilities are undiscounted, do not consider potential recoveries from other parties and will be paid out over the periods of remediation for the applicable sites, which are expected to occur primarily over the next 15 years. Although it is not possible to predict with certainty the outcome of these matters, or the ultimate costs of remediation, management does not believe that any reasonably possible expenditures that may be incurred in excess of the liabilities accrued should exceed $63 million in the aggregate. Management also does not believe that these expenditures should result in a material adverse effect on the Companys financial position, results of operations, liquidity or capital resources for any year. 12. Equity The Merck certificate of incorporation authorizes 6,500,000,000 shares of common stock and 20,000,000 shares of preferred stock. Capital Stock A summary of common stock and treasury stock transactions (shares in millions) is as follows: Common Stock Treasury Stock Common Stock Treasury Stock Common Stock Treasury Stock Balance January 1 3,577 3,577 3,577 Purchases of treasury stock Issuances (1) (15 ) (28 ) (18 ) Balance December 31 3,577 3,577 3,577 (1) Issuances primarily reflect activity under share-based compensation plans. 13. Share-Based Compensation Plans The Company has share-based compensation plans under which the Company grants restricted stock units (RSUs) and performance share units (PSUs) to certain management level employees. In addition, employees and non-employee directors may be granted options to purchase shares of Company common stock at the fair market value at the time of grant. These plans were approved by the Companys shareholders. At December 31, 2017 , 118 million shares collectively were authorized for future grants under the Companys share-based compensation plans. These awards are settled primarily with treasury shares. Employee stock options are granted to purchase shares of Company stock at the fair market value at the time of grant. These awards generally vest one-third each year over a three -year period, with a contractual term of 7 - 10 years. RSUs are stock awards that are granted to employees and entitle the holder to shares of common stock as the awards vest. The fair value of the stock option and RSU awards is determined and fixed on the grant date based on the Companys stock price. PSUs are stock awards where the ultimate number of shares issued will be contingent on the Companys performance against a pre-set objective or set of objectives. The fair value of each PSU is determined on the date of grant based on the Companys stock price. For RSUs and PSUs, dividends declared during the vesting period are payable to the employees only upon vesting. Over the PSU performance period, the number of shares of stock that are expected to be issued will be adjusted based on the probability of achievement of a performance target and final compensation expense will be recognized based on the ultimate number of shares issued. RSU and PSU distributions will be in shares of Company stock after the end of the vesting or performance period, subject to the terms applicable to such awards. PSU awards generally vest after three years. Prior to 2018, RSU awards generally vested after three years; beginning with awards granted in 2018, RSU awards will vest one-third each year over a three -year period. Total pretax share-based compensation cost recorded in 2017 , 2016 and 2015 was $312 million , $300 million and $299 million , respectively, with related income tax benefits of $57 million , $92 million and $93 million , respectively. The Company uses the Black-Scholes option pricing model for determining the fair value of option grants. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its options. The Black-Scholes model requires several assumptions including expected dividend yield, risk-free interest rate, volatility, and term of the options. The expected dividend yield is based on historical patterns of dividend payments. The risk-free rate is based on the rate at grant date of zero-coupon U.S. Treasury Notes with a term equal to the expected term of the option. Expected volatility is estimated using a blend of historical and implied volatility. The historical component is based on historical monthly price changes. The implied volatility is obtained from market data on the Companys traded options. The expected life represents the amount of time that options granted are expected to be outstanding, based on historical and forecasted exercise behavior. The weighted average exercise price of options granted in 2017 , 2016 and 2015 was $63.88 , $54.63 and $59.73 per option, respectively. The weighted average fair value of options granted in 2017 , 2016 and 2015 was $7.04 , $5.89 and $6.46 per option, respectively, and were determined using the following assumptions: Years Ended December 31 Expected dividend yield 3.6 % 3.8 % 4.1 % Risk-free interest rate 2.0 % 1.4 % 1.7 % Expected volatility 17.8 % 19.6 % 19.9 % Expected life (years) 6.1 6.2 6.2 Summarized information relative to stock option plan activity (options in thousands) is as follows: Number of Options Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value Outstanding January 1, 2017 45,091 $ 44.47 Granted 4,232 63.88 Exercised (11,512 ) 43.38 Forfeited (1,537 ) 51.78 Outstanding December 31, 2017 36,274 $ 46.77 4.89 $ Exercisable December 31, 2017 26,778 $ 42.54 3.64 $ 110 Additional information pertaining to stock option plans is provided in the table below: Years Ended December 31 Total intrinsic value of stock options exercised $ $ $ Fair value of stock options vested Cash received from the exercise of stock options A summary of nonvested RSU and PSU activity (shares in thousands) is as follows: RSUs PSUs Number of Shares Weighted Average Grant Date Fair Value Number of Shares Weighted Average Grant Date Fair Value Nonvested January 1, 2017 13,266 $ 57.19 1,744 $ 59.24 Granted 5,014 63.85 1,008 63.62 Vested (3,795 ) 58.13 (833 ) 62.71 Forfeited (876 ) 58.22 (51 ) 60.24 Nonvested December 31, 2017 13,609 $ 59.32 1,868 $ 60.03 At December 31, 2017 , there was $469 million of total pretax unrecognized compensation expense related to nonvested stock options, RSU and PSU awards which will be recognized over a weighted average period of 1.9 years. For segment reporting, share-based compensation costs are unallocated expenses. 14. Pension and Other Postretirement Benefit Plans The Company has defined benefit pension plans covering eligible employees in the United States and in certain of its international subsidiaries. In addition, the Company provides medical benefits, principally to its eligible U.S. retirees and their dependents, through its other postretirement benefit plans. The Company uses December 31 as the year-end measurement date for all of its pension plans and other postretirement benefit plans. Net Periodic Benefit Cost The net periodic benefit cost (credit) for pension and other postretirement benefit plans consisted of the following components: Pension Benefits U.S. International Other Postretirement Benefits Years Ended December 31 Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (862 ) (831 ) (819 ) (393 ) (382 ) (379 ) (78 ) (107 ) (143 ) Amortization of unrecognized prior service cost (53 ) (55 ) (56 ) (11 ) (11 ) (14 ) (98 ) (106 ) (64 ) Net loss amortization Termination benefits Curtailments (12 ) (4 ) (1 ) (9 ) (31 ) (18 ) (19 ) Settlements Net periodic benefit cost (credit) $ $ (1 ) $ $ $ $ $ (60 ) $ (88 ) $ (24 ) The changes in net periodic benefit cost (credit) year over year for pension plans are largely attributable to changes in the discount rate affecting net loss amortization. The increase in net periodic benefit credit for other postretirement benefit plans in 2017 and 2016 as compared with 2015 is largely attributable to changes in retiree medical benefits approved by the Company in December 2015, partially offset by lower returns on plan assets. In connection with restructuring actions (see Note 5), termination charges were recorded in 2017 , 2016 and 2015 on pension and other postretirement benefit plans related to expanded eligibility for certain employees exiting Merck. Also, in connection with these restructuring activities, curtailments were recorded on pension and other postretirement benefit plans and settlements were recorded on certain U.S. and international pension plans as reflected in the table above. Obligations and Funded Status Summarized information about the changes in plan assets and benefit obligations, the funded status and the amounts recorded at December 31 is as follows: Pension Benefits Other Postretirement Benefits U.S. International Fair value of plan assets January 1 $ 9,766 $ 9,266 $ 7,794 $ 7,204 $ 1,019 $ 1,913 Actual return on plan assets 1,723 Company contributions, net (4 ) Effects of exchange rate changes (546 ) Benefits paid (651 ) (504 ) (198 ) (193 ) (62 ) (108 ) Settlements (17 ) (21 ) Assets no longer restricted to the payment of postretirement benefits (1) (992 ) Other Fair value of plan assets December 31 $ 10,896 $ 9,766 $ 9,339 $ 7,794 $ 1,114 $ 1,019 Benefit obligation January 1 $ 10,849 $ 9,723 $ 8,372 $ 7,733 $ 1,922 $ 1,810 Service cost Interest cost Actuarial losses (gains) (2) (7 ) (87 ) Benefits paid (651 ) (504 ) (198 ) (193 ) (62 ) (108 ) Effects of exchange rate changes (576 ) Plan amendments (22 ) Curtailments (3 ) (15 ) Termination benefits Settlements (17 ) (21 ) Other Benefit obligation December 31 $ 11,904 $ 10,849 $ 9,483 $ 8,372 $ 1,922 $ 1,922 Funded status December 31 $ (1,008 ) $ (1,083 ) $ (144 ) $ (578 ) $ (808 ) $ (903 ) Recognized as: Other assets $ $ $ $ $ $ Accrued and other current liabilities (59 ) (50 ) (17 ) (7 ) (11 ) (11 ) Other noncurrent liabilities (949 ) (1,033 ) (955 ) (1,022 ) (797 ) (892 ) (1) As a result of certain allowable administrative actions that occurred in June 2016, $992 million of plan assets previously restricted for the payment of other postretirement benefits became available to fund certain other health and welfare benefits. (2) Actuarial losses in 2017 and 2016 primarily reflect changes in discount rates. At December 31, 2017 and 2016 , the accumulated benefit obligation was $20.5 billion and $18.4 billion , respectively, for all pension plans, of which $11.5 billion and $10.5 billion , respectively, related to U.S. pension plans. Information related to the funded status of selected pension plans at December 31 is as follows: U.S. International Pension plans with a projected benefit obligation in excess of plan assets Projected benefit obligation $ 11,904 $ 10,849 $ 3,323 $ 5,486 Fair value of plan assets 10,896 9,766 2,352 4,457 Pension plans with an accumulated benefit obligation in excess of plan assets Accumulated benefit obligation $ $ 9,807 $ 2,120 $ 2,692 Fair value of plan assets 9,057 1,346 1,898 Plan Assets Entities are required to use a fair value hierarchy which maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. There are three levels of inputs used to measure fair value with Level 1 having the highest priority and Level 3 having the lowest: Level 1 Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Unobservable inputs that are supported by little or no market activity. The Level 3 assets are those whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques with significant unobservable inputs, as well as instruments for which the determination of fair value requires significant judgment or estimation. At December 31, 2017 and 2016 , $488 million and $435 million , respectively, or approximately 2% of the Companys pension investments were categorized as Level 3 assets. If the inputs used to measure the financial assets fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. The fair values of the Companys pension plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Equity securities Developed markets 2,743 2,743 2,521 2,521 Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Net assets in fair value hierarchy $ 3,277 $ 1,897 $ $ 5,189 $ 3,148 $ 1,376 $ $ 4,542 Investments measured at NAV (1) 5,707 5,224 Plan assets at fair value $ 10,896 $ 9,766 International Pension Plans Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities 3,326 3,888 2,846 3,033 Emerging markets equities Government and agency obligations 2,095 2,344 1,904 2,027 Corporate obligations Fixed income obligations Real estate (2) Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Other investments Insurance contracts (3) Other Net assets in fair value hierarchy $ 1,602 $ 6,462 $ $ 8,537 $ $ 5,637 $ $ 7,006 Investments measured at NAV (1) Plan assets at fair value $ 9,339 $ 7,794 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2017 and 2016 . (2) The plans Level 3 investments in real estate funds are generally valued by market appraisals of the underlying investments in the funds. (3) The plans Level 3 investments in insurance contracts are generally valued using a crediting rate that approximates market returns and invest in underlying securities whose market values are unobservable and determined using pricing models, discounted cash flow methodologies, or similar techniques. The table below provides a summary of the changes in fair value, including transfers in and/or out, of all financial assets measured at fair value using significant unobservable inputs (Level 3) for the Companys pension plan assets: Insurance Contracts Real Estate Other Total Insurance Contracts Real Estate Other Total U.S. Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (2 ) (2 ) (3 ) (3 ) Relating to assets sold during the year Purchases and sales, net (5 ) (5 ) (6 ) (6 ) Balance December 31 $ $ $ $ $ $ $ $ International Pension Plans Balance January 1 $ $ $ $ $ $ $ $ Actual return on plan assets: Relating to assets still held at December 31 (9 ) (8 ) Purchases and sales, net (2 ) (2 ) (1 ) (1 ) Transfers into Level 3 Balance December 31 $ $ $ $ $ $ $ $ The fair values of the Companys other postretirement benefit plan assets at December 31 by asset category are as follows: Fair Value Measurements Using Fair Value Measurements Using Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Quoted Prices In Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Assets Cash and cash equivalents $ $ $ $ $ $ $ $ Investment funds Developed markets equities Emerging markets equities Government and agency obligations Equity securities Developed markets Fixed income securities Government and agency obligations Corporate obligations Mortgage and asset-backed securities Net assets in fair value hierarchy $ $ $ $ $ $ $ $ Investments measured at NAV (1) Plan assets at fair value $ 1,114 $ 1,019 (1) Certain investments that were measured at net asset value (NAV) per share or its equivalent as a practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the fair value of plan assets at December 31, 2017 and 2016 . The Company has established investment guidelines for its U.S. pension and other postretirement plans to create an asset allocation that is expected to deliver a rate of return sufficient to meet the long-term obligation of each plan, given an acceptable level of risk. The target investment portfolio of the Companys U.S. pension and other postretirement benefit plans is allocated 35% to 55% in U.S. equities, 20% to 35% in international equities, 20% to 35% in fixed-income investments, and up to 5% in cash and other investments. The portfolios equity weighting is consistent with the long-term nature of the plans benefit obligations. The expected annual standard deviation of returns of the target portfolio, which approximates 13% , reflects both the equity allocation and the diversification benefits among the asset classes in which the portfolio invests. For international pension plans, the targeted investment portfolio varies based on the duration of pension liabilities and local government rules and regulations. Although a significant percentage of plan assets are invested in U.S. equities, concentration risk is mitigated through the use of strategies that are diversified within management guidelines. Expected Contributions Expected contributions during 2018 are approximately $60 million for U.S. pension plans, approximately $150 million for international pension plans and approximately $25 million for other postretirement benefit plans. Expected Benefit Payments Expected benefit payments are as follows: U.S. Pension Benefits International Pension Benefits Other Postretirement Benefits $ $ $ 2019 2020 2021 2022 2023 2027 3,760 1,326 Expected benefit payments are based on the same assumptions used to measure the benefit obligations and include estimated future employee service. Amounts Recognized in Other Comprehensive Income Net loss amounts reflect experience differentials primarily relating to differences between expected and actual returns on plan assets as well as the effects of changes in actuarial assumptions. Net loss amounts in excess of certain thresholds are amortized into net periodic benefit cost over the average remaining service life of employees. The following amounts were reflected as components of OCI : Pension Plans Other Postretirement Benefit Plans U.S. International Years Ended December 31 Net (loss) gain arising during the period $ (19 ) $ (743 ) $ $ $ (380 ) $ (66 ) $ $ (45 ) $ Prior service (cost) credit arising during the period (13 ) (10 ) (13 ) (2 ) (4 ) (31 ) (19 ) $ (32 ) $ (753 ) $ $ $ (382 ) $ (70 ) $ $ (64 ) $ Net loss amortization included in benefit cost $ $ $ $ $ $ $ $ $ Prior service (credit) cost amortization included in benefit cost (53 ) (55 ) (56 ) (11 ) (11 ) (14 ) (98 ) (106 ) (64 ) $ $ $ $ $ $ $ (97 ) $ (103 ) $ (59 ) The estimated net loss (gain) and prior service cost (credit) amounts that will be amortized from AOCI into net periodic benefit cost during 2018 are $314 million and $(64) million , respectively, for pension plans (of which $230 million and $(51) million , respectively, relates to U.S. pension plans) and $1 million and $(84) million , respectively, for other postretirement benefit plans. Actuarial Assumptions The Company reassesses its benefit plan assumptions on a regular basis. The weighted average assumptions used in determining U.S. pension and other postretirement benefit plan and international pension plan information are as follows: U.S. Pension and Other Postretirement Benefit Plans International Pension Plans December 31 Net periodic benefit cost Discount rate 4.30 % 4.70 % 4.20 % 2.20 % 2.80 % 2.70 % Expected rate of return on plan assets 8.70 % 8.60 % 8.50 % 5.10 % 5.60 % 5.70 % Salary growth rate 4.30 % 4.30 % 4.40 % 2.90 % 2.90 % 2.90 % Benefit obligation Discount rate 3.70 % 4.30 % 4.80 % 2.10 % 2.20 % 2.80 % Salary growth rate 4.30 % 4.30 % 4.30 % 2.90 % 2.90 % 2.90 % For both the pension and other postretirement benefit plans, the discount rate is evaluated on measurement dates and modified to reflect the prevailing market rate of a portfolio of high-quality fixed-income debt instruments that would provide the future cash flows needed to pay the benefits included in the benefit obligation as they come due. The expected rate of return for both the pension and other postretirement benefit plans represents the average rate of return to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid and is determined on a plan basis. The expected rate of return within each plan is developed considering long-term historical returns data, current market conditions, and actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category and a weighted average expected return for each plans target portfolio is developed, according to the allocation among those investment categories. The expected portfolio performance reflects the contribution of active management as appropriate. For 2018 , the expected rate of return for the Companys U.S. pension and other postretirement benefit plans will range from 7.70% to 8.30% , as compared to a range of 8.00% to 8.75% in 2017 . The decrease is primarily due to a modest shift in asset allocation. The increase in the weighted-average expected return on U.S. pension and other postretirement benefit plan assets from 2015 to 2017 is due to the relative weighting of the referenced plans assets. The health care cost trend rate assumptions for other postretirement benefit plans are as follows: December 31 Health care cost trend rate assumed for next year 7.2 % 7.4 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the trend rate reaches the ultimate trend rate A one percentage point change in the health care cost trend rate would have had the following effects: One Percentage Point Increase Decrease Effect on total service and interest cost components $ $ (11 ) Effect on benefit obligation (104 ) Savings Plans The Company also maintains defined contribution savings plans in the United States. The Company matches a percentage of each employees contributions consistent with the provisions of the plan for which the employee is eligible. Total employer contributions to these plans in 2017 , 2016 and 2015 were $131 million , $126 million and $125 million , respectively. 15. Other (Income) Expense, Net Other (income) expense, net, consisted of: Years Ended December 31 Interest income $ (385 ) $ (328 ) $ (289 ) Interest expense Exchange (gains) losses (11 ) 1,277 Equity income from affiliates (42 ) (86 ) (205 ) Other, net (304 ) $ $ $ 1,527 The exchange losses in 2015 were related primarily to the Venezuelan Bolvar. During 2015, upon evaluation of evolving economic conditions in Venezuela and volatility in the country, combined with a decline in transactions that were settled at the then official (CENCOEX) rate, the Company determined it was unlikely that all outstanding net monetary assets would be settled at the CENCOEX rate. Accordingly, during 2015, the Company recorded charges of $876 million to devalue its net monetary assets in Venezuela to amounts that represented the Companys estimate of the U.S. dollar amount that would ultimately be collected and recorded additional exchange losses of $138 million in the aggregate during 2015 reflecting the ongoing effect of translating transactions and net monetary assets consistent with these rates. Since January 2010, Venezuela has been designated hyperinflationary and, as a result, local foreign operations are remeasured in U.S. dollars with the impact recorded in results of operations. The decline in equity income from affiliates in 2017 as compared with 2016 was driven primarily by the termination of the SPMSD joint venture on December 31, 2016, partially offset by higher equity income from certain research investment funds. The decline in equity income from affiliates in 2016 as compared with 2015 was driven primarily by lower equity income from certain research investment funds. Other, net (as presented in the table above) in 2017 includes gains of $291 million on the sale of equity investments, income of $232 million related to AstraZenecas option exercise (see Note 9), and a $191 million loss on extinguishment of debt (see Note 10). Other, net in 2016 includes a charge of $625 million to settle worldwide patent litigation related to Keytruda (see Note 11), a gain of $117 million related to the settlement of other patent litigation, gains of $100 million resulting from the receipt of milestone payments for out-licensed migraine clinical development programs (see Note 3) and $98 million of income related to AstraZenecas option exercise. Other, net in 2015 includes a $680 million net charge related to the settlement of Vioxx shareholder class action litigation (which was paid in 2016) and an expense of $78 million for a contribution of investments in equity securities to the Merck Foundation, partially offset by a $250 million gain on the sale of certain migraine clinical development programs (see Note 3), a $147 million gain on the divestiture of Mercks remaining ophthalmics business in international markets (see Note 3), and the recognition of $182 million of income related to AstraZenecas option exercise. Interest paid was $723 million in 2017 , $686 million in 2016 and $653 million in 2015 . 16. Taxes on Income A reconciliation between the effective tax rate and the U.S. statutory rate is as follows: Amount Tax Rate Amount Tax Rate Amount Tax Rate U.S. statutory rate applied to income before taxes $ 2,282 35.0 % $ 1,631 35.0 % $ 1,890 35.0 % Differential arising from: Provisional impact of the TCJA 2,625 40.3 Impact of purchase accounting adjustments, including amortization 10.9 13.4 14.8 Valuation allowances 9.7 (5 ) (0.1 ) 0.7 Restructuring 2.2 3.1 3.1 State taxes 1.2 3.7 2.9 U.S. health care reform legislation 1.1 1.4 1.2 Foreign currency devaluation related to Venezuela 5.9 Foreign earnings (1,725 ) (26.5 ) (1,646 ) (35.3 ) (2,144 ) (39.7 ) Tax settlements (356 ) (5.5 ) (417 ) (7.7 ) Unremitted foreign earnings (30 ) (0.6 ) 4.8 Other (1) (361 ) (5.5 ) (241 ) (5.2 ) (196 ) (3.6 ) $ 4,103 62.9 % $ 15.4 % $ 17.4 % (1) Other includes the tax effect of contingency reserves, research credits, losses on foreign subsidiaries and miscellaneous items. The Companys 2017 effective tax rate reflects a provisional impact of 40.3% for the Tax Cuts and Jobs Act (TCJA), which was enacted on December 22, 2017. Among other provisions, the TCJA reduces the U.S. federal corporate statutory tax rate from 35% to 21% effective January 1, 2018, requires companies to pay a one-time transition tax on undistributed earnings of certain foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. The Company has reflected the impact of the TCJA in its financial statements as described below. However, application of certain provisions of the TCJA remains subject to further interpretation and in these instances the Company has made a reasonable estimate of the effects of the TCJA. The one-time transition tax is based on the Companys post-1986 undistributed earnings and profits (EP). For a substantial portion of these undistributed EP, the Company had not previously provided deferred taxes as these earnings were deemed by Merck to be retained indefinitely by subsidiary companies for reinvestment. The Company recorded a provisional amount for its one-time transition tax liability of $5.3 billion . Merck has not yet finalized its calculation of the total post-1986 undistributed EP for these foreign subsidiaries. The transition tax is based in part on the amount of undistributed EP held in cash and other specified assets; therefore, this amount may change when the Company finalizes its calculation of post-1986 undistributed foreign EP and finalizes the amounts held in cash or other specified assets. This provisional amount was reduced by the reversal of $2.0 billion of deferred taxes that were previously recorded in connection with the merger of Schering-Plough Corporation in 2009 for certain undistributed foreign EP. The Company anticipates that it will be able to utilize certain foreign tax credits to partially reduce the transition tax payment, resulting in a net transition tax payment of $5.1 billion . As permitted under the TCJA, the Company has elected to pay the one-time transition tax over a period of eight years. The current portion of the transition tax liability of $545 million is included as reduction to prepaid income taxes included in Other Current Assets and the remainder of $4.5 billion is included in Other Noncurrent Liabilities . As a result of the TCJA, the Company has made a determination it is no longer indefinitely reinvested with respect to its undistributed earnings from foreign subsidiaries and has provided a deferred tax liability for withholding tax that would apply. The Company remeasured its deferred tax assets and liabilities at the new federal statutory tax rate of 21%, which resulted in a provisional deferred tax benefit of $779 million . The deferred tax benefit calculation remains subject to certain clarifications, particularly related to executive compensation and benefits. Beginning in 2018, the TCJA includes a tax on global intangible low-taxed income (GILTI) as defined in the TCJA. The Company is allowed to make an accounting policy election to account for the tax effects of the GILTI tax either in the income tax provision in future periods as the tax arises, or as a component of deferred taxes on the related investments in foreign subsidiaries. The Company is currently evaluating the GILTI provisions of the TCJA and the implications on its tax provision and has not finalized the accounting policy election; therefore, the Company has not recorded deferred taxes for GILTI as of December 31, 2017. The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Ireland and Switzerland, as well as Singapore and Puerto Rico which operate under tax incentive grants (which begin to expire in 2022), where the earnings had been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments or restructuring costs. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35% U.S. statutory rate. The Companys 2015 effective tax rate reflects the impact of the Protecting Americans From Tax Hikes Act, which was signed into law on December 18, 2015, extending the research credit permanently and the controlled foreign corporation look-through provisions for five years. Income before taxes consisted of: Years Ended December 31 Domestic $ 3,483 $ $ 2,247 Foreign 3,038 4,141 3,154 $ 6,521 $ 4,659 $ 5,401 Taxes on income consisted of: Years Ended December 31 Current provision Federal $ 5,585 $ 1,166 $ Foreign 1,229 State (90 ) 6,724 2,239 1,706 Deferred provision Federal (2,958 ) (1,255 ) (552 ) Foreign (225 ) (163 ) State (41 ) (49 ) (2,621 ) (1,521 ) (764 ) $ 4,103 $ $ 120 Deferred income taxes at December 31 consisted of: Assets Liabilities Assets Liabilities Intangibles $ $ 2,435 $ $ 3,854 Inventory related Accelerated depreciation Unremitted foreign earnings 2,044 Pensions and other postretirement benefits Compensation related Unrecognized tax benefits Net operating losses and other tax credit carryforwards Other 1,088 1,248 Subtotal 3,074 3,820 3,377 7,640 Valuation allowance (900 ) (268 ) Total deferred taxes $ 2,174 $ 3,820 $ 3,109 $ 7,640 Net deferred income taxes $ 1,646 $ 4,531 Recognized as: Other assets $ $ Deferred income taxes $ 2,219 $ 5,077 The Company has net operating loss (NOL) carryforwards in several jurisdictions. As of December 31, 2017 , $630 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions. Valuation allowances of $900 million have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has $24 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry. Income taxes paid in 2017 , 2016 and 2015 were $4.9 billion , $1.8 billion and $1.8 billion , respectively. Tax benefits relating to stock option exercises were $73 million in 2017 , $147 million in 2016 and $109 million in 2015 . A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: Balance January 1 $ 3,494 $ 3,448 $ 3,534 Additions related to current year positions Additions related to prior year positions Reductions for tax positions of prior years (1) (1,038 ) (90 ) (59 ) Settlements (1) (1,388 ) (92 ) (184 ) Lapse of statute of limitations (11 ) (43 ) (94 ) Balance December 31 $ 1,723 $ 3,494 $ 3,448 (1) Amounts reflect the settlements with the IRS as discussed below. If the Company were to recognize the unrecognized tax benefits of $1.7 billion at December 31, 2017 , the income tax provision would reflect a favorable net impact of $1.6 billion . The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2017 could decrease by up to approximately $165 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Companys examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures. Expenses for interest and penalties associated with uncertain tax positions amounted to $183 million in 2017 , $134 million in 2016 and $102 million in 2015 . These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $341 million and $886 million as of December 31, 2017 and 2016 , respectively. In 2017, the Internal Revenue Service (IRS) concluded its examinations of Mercks 2006-2011 U.S. federal income tax returns. As a result, the Company was required to make a payment of approximately $2.8 billion . The Companys reserves for unrecognized tax benefits for the years under examination exceeded the adjustments relating to this examination period and therefore the Company recorded a net $234 million tax benefit in 2017. This net benefit reflects reductions in reserves for unrecognized tax benefits for tax positions relating to the years that were under examination, partially offset by additional reserves for tax positions not previously reserved for, as well as adjustments to reserves for unrecognized tax benefits relating to years which remain open to examination that are affected by this settlement. Although the IRSs examination of the Companys 2002-2005 federal tax returns was concluded prior to 2015, one issue relating to a refund claim remained open. During 2015, this issue was resolved and the Company received a refund of approximately $715 million , which exceeded the receivable previously recorded by the Company, resulting in a tax benefit of $410 million . The IRS is currently conducting examinations of the Companys tax returns for the years 2012 through 2014. In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Companys income tax returns are open for examination for the period 2003 through 2017. 17. Earnings per Share The calculations of earnings per share (shares in millions) are as follows: Years Ended December 31 Net income attributable to Merck Co., Inc. $ 2,394 $ 3,920 $ 4,442 Average common shares outstanding 2,730 2,766 2,816 Common shares issuable (1) Average common shares outstanding assuming dilution 2,748 2,787 2,841 Basic earnings per common share attributable to Merck Co., Inc. common shareholders $ 0.88 $ 1.42 $ 1.58 Earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ 0.87 $ 1.41 $ 1.56 (1) Issuable primarily under share-based compensation plans. In 2017 , 2016 and 2015 , 5 million , 13 million and 9 million , respectively, of common shares issuable under share-based compensation plans were excluded from the computation of earnings per common share assuming dilution because the effect would have been antidilutive. 18. Other Comprehensive Income (Loss) Changes in AOCI by component are as follows: Derivatives Investments Employee Benefit Plans Cumulative Translation Adjustment Accumulated Other Comprehensive Income (Loss) Balance January 1, 2015, net of taxes $ $ $ (2,986 ) $ (1,978 ) $ (4,323 ) Other comprehensive income (loss) before reclassification adjustments, pretax (9 ) (158 ) 1,069 Tax (177 ) (13 ) (272 ) (28 ) (490 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (186 ) Reclassification adjustments, pretax (731 ) (1) (73 ) (2) (3) (22 ) (623 ) Tax (62 ) Reclassification adjustments, net of taxes (475 ) (48 ) (22 ) (404 ) Other comprehensive income (loss), net of taxes (126 ) (70 ) (208 ) Balance December 31, 2015, net of taxes (2,407 ) (2,186 ) (4,148 ) Other comprehensive income (loss) before reclassification adjustments, pretax (38 ) (1,199 ) (150 ) (1,177 ) Tax (72 ) (19 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (22 ) (836 ) (169 ) (889 ) Reclassification adjustments, pretax (314 ) (1) (31 ) (2) (3) (308 ) Tax Reclassification adjustments, net of taxes (204 ) (22 ) (189 ) Other comprehensive income (loss), net of taxes (66 ) (44 ) (799 ) (169 ) (1,078 ) Balance December 31, 2016, net of taxes (3 ) (3,206 ) (4) (2,355 ) (5,226 ) Other comprehensive income (loss) before reclassification adjustments, pretax (561 ) Tax (35 ) (106 ) Other comprehensive income (loss) before reclassification adjustments, net of taxes (354 ) Reclassification adjustments, pretax (141 ) (1) (291 ) (2) (3) (315 ) Tax (30 ) Reclassification adjustments, net of taxes (92 ) (235 ) (240 ) Other comprehensive income (loss), net of taxes (446 ) (58 ) Balance December 31, 2017, net of taxes $ (108 ) $ (61 ) $ (2,787 ) (4) $ (1,954 ) $ (4,910 ) (1) Relates to foreign currency cash flow hedges that were reclassified from AOCI to Sales . (2) Represents net realized (gains) losses on the sales of available-for-sale investments that were reclassified from AOCI to Other (income) expense, net . (3) Includes net amortization of prior service cost and actuarial gains and losses included in net periodic benefit cost (see Note 14). (4) Includes pension plan net loss of $ 3.5 billion and $3.9 billion at December 31, 2017 and 2016 , respectively, and other postretirement benefit plan net (gain) loss of $(16) million and $115 million at December 31, 2017 and 2016 , respectively, as well as pension plan prior service credit of $326 million and $361 million at December 31, 2017 and 2016 , respectively, and other postretirement benefit plan prior service credit of $383 million and $466 million at December 31, 2017 and 2016 , respectively. 19. Segment Reporting The Companys operations are principally managed on a products basis and include four operating segments, which are the Pharmaceutical, Animal Health, Healthcare Services and Alliances segments. The Pharmaceutical segment is the only reportable segment. The Pharmaceutical segment includes human health pharmaceutical and vaccine products. Human health pharmaceutical products consist of therapeutic and preventive agents, generally sold by prescription, for the treatment of human disorders. The Company sells these human health pharmaceutical products primarily to drug wholesalers and retailers, hospitals, government agencies and managed health care providers such as health maintenance organizations, pharmacy benefit managers and other institutions. Vaccine products consist of preventive pediatric, adolescent and adult vaccines, primarily administered at physician offices. The Company sells these human health vaccines primarily to physicians, wholesalers, physician distributors and government entities. A large component of pediatric and adolescent vaccine sales are made to the U.S. Centers for Disease Control and Prevention Vaccines for Children program, which is funded by the U.S. government. Additionally, the Company sells vaccines to the Federal government for placement into vaccine stockpiles. Sales of vaccines in most major European markets were marketed through the Companys SPMSD joint venture until its termination on December 31, 2016 (see Note 9). The Company also has an Animal Health segment that discovers, develops, manufactures and markets animal health products, including vaccines, which the Company sells to veterinarians, distributors and animal producers. The Companys Healthcare Services segment provides services and solutions that focus on engagement, health analytics and clinical services to improve the value of care delivered to patients. Sales of the Companys products were as follows: Years Ended December 31 U.S. Intl Total U.S. Intl Total U.S. Intl Total Primary Care and Womens Health Cardiovascular Zetia $ $ $ 1,344 $ 1,588 $ $ 2,560 $ 1,612 $ $ 2,526 Vytorin 1,141 1,251 Atozet Adempas Diabetes Januvia 2,153 1,584 3,737 2,286 1,622 3,908 2,263 1,601 3,863 Janumet 1,296 2,158 1,217 2,201 1,175 2,151 General Medicine and Womens Health NuvaRing Implanon/Nexplanon Follistim AQ Hospital and Specialty Hepatitis Zepatier 1,660 HIV Isentress/Isentress HD 1,204 1,387 1,511 Hospital Acute Care Bridion Noxafil Invanz Cancidas Cubicin (1) 1,087 1,030 1,127 Primaxin Immunology Remicade 1,268 1,268 1,794 1,794 Simponi Oncology Keytruda 2,309 1,500 3,809 1,402 Emend Temodar Diversified Brands Respiratory Singulair Nasonex Dulera Other Cozaar/Hyzaar Arcoxia Fosamax Vaccines (2) Gardasil/Gardasil 9 1,565 2,308 1,780 2,173 1,520 1,908 ProQuad/M-M-R II/Varivax 1,374 1,676 1,362 1,640 1,290 1,505 Pneumovax 23 RotaTeq Zostavax Other pharmaceutical (3) 1,246 3,049 4,295 1,345 3,228 4,574 1,473 3,785 5,256 Total Pharmaceutical segment sales 15,854 19,536 35,390 17,073 18,077 35,151 16,238 18,544 34,782 Other segment sales (4) 1,486 2,785 4,272 1,374 2,489 3,862 1,213 2,454 3,667 Total segment sales 17,340 22,321 39,662 18,447 20,566 39,013 17,451 20,998 38,449 Other (5) 1,049 $ 17,424 $ 22,698 $ 40,122 $ 18,478 $ 21,329 $ 39,807 $ 17,519 $ 21,979 $ 39,498 U.S. plus international may not equal total due to rounding. (1) Sales of Cubicin in 2015 represent sales subsequent to the Cubist acquisition date. (2) On December 31, 2016, Merck and Sanofi terminated their equally-owned joint venture, SPMSD, which marketed vaccines in most major European markets (see Note 9). Accordingly, vaccine sales in 2017 include sales in the European markets that were previously part of SPMSD. Amounts for 2016 and 2015 do not include sales of vaccines sold through SPMSD, the results of which are reflected in equity income from affiliates included in Other (income) expense, net . Amounts for 2016 and 2015 do, however, include supply sales to SPMSD. (3) Other pharmaceutical primarily reflects sales of other human health pharmaceutical products, including products within the franchises not listed separately. (4) Represents the non-reportable segments of Animal Health, Healthcare Services and Alliances. (5) Other is primarily comprised of miscellaneous corporate revenues, including revenue hedging activities, as well as third-party manufacturing sales. Other in 2017 and 2016 also includes $85 million and $170 million , respectively, related to the sale of the marketing rights to certain products. Consolidated revenues by geographic area where derived are as follows: Years Ended December 31 United States $ 17,424 $ 18,478 $ 17,519 Europe, Middle East and Africa 11,478 10,953 10,677 Asia Pacific 4,337 3,918 3,825 Japan 3,122 2,846 2,673 Latin America 2,339 2,155 2,825 Other 1,422 1,457 1,979 $ 40,122 $ 39,807 $ 39,498 A reconciliation of total segment profits to consolidated Income before taxes is as follows: Years Ended December 31 Segment profits: Pharmaceutical segment $ 22,586 $ 22,180 $ 21,658 Other segments 1,834 1,507 1,573 Total segment profits 24,420 23,687 23,231 Other profits Unallocated: Interest income Interest expense (754 ) (693 ) (672 ) Equity income from affiliates (19 ) Depreciation and amortization (1,378 ) (1,585 ) (1,573 ) Research and development (9,355 ) (9,084 ) (5,871 ) Amortization of purchase accounting adjustments (3,056 ) (3,692 ) (4,816 ) Restructuring costs (776 ) (651 ) (619 ) Loss on extinguishment of debt (191 ) Gain on sale of certain migraine clinical development programs Charge related to the settlement of worldwide Keytruda patent litigation (625 ) Gain on divestiture of certain ophthalmic products Foreign currency devaluation related to Venezuela (876 ) Net charge related to the settlement of Vioxx shareholder class action litigation (680 ) Other unallocated, net (2,849 ) (3,588 ) (4,354 ) $ 6,521 $ 4,659 $ 5,401 Segment profits are comprised of segment sales less standard costs and certain operating expenses directly incurred by the segments. For internal management reporting presented to the chief operating decision maker, Merck does not allocate materials and production costs, other than standard costs, the majority of research and development expenses or general and administrative expenses, nor the cost of financing these activities. Separate divisions maintain responsibility for monitoring and managing these costs, including depreciation related to fixed assets utilized by these divisions and, therefore, they are not included in segment profits. In addition, costs related to restructuring activities, as well as the amortization of purchase accounting adjustments are not allocated to segments. Other profits are primarily comprised of miscellaneous corporate profits, as well as operating profits related to third-party manufacturing sales. Other unallocated, net includes expenses from corporate and manufacturing cost centers, goodwill and other intangible asset impairment charges, gains or losses on sales of businesses, expense or income related to changes in the estimated fair value of contingent consideration, and other miscellaneous income or expense items. Equity income from affiliates and depreciation and amortization included in segment profits is as follows: Pharmaceutical All Other Total Year Ended December 31, 2017 Included in segment profits: Equity income from affiliates $ (7 ) $ $ (7 ) Depreciation and amortization (125 ) (87 ) (212 ) Year Ended December 31, 2016 Included in segment profits: Equity income from affiliates $ $ $ Depreciation and amortization (160 ) (23 ) (183 ) Year Ended December 31, 2015 Included in segment profits: Equity income from affiliates $ $ $ Depreciation and amortization (82 ) (18 ) (100 ) Property, plant and equipment, net by geographic area where located is as follows: December 31 United States $ 8,070 $ 8,114 $ 8,467 Europe, Middle East and Africa 3,151 2,732 2,844 Asia Pacific Latin America Japan Other $ 12,439 $ 12,026 $ 12,507 The Company does not disaggregate assets on a products and services basis for internal management reporting and, therefore, such information is not presented. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Merck Co., Inc. Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Merck Co., Inc. and its subsidiaries as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes (collectively referred to as the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Managements Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Companys consolidated financial statements and on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP Florham Park, New Jersey February 27, 2018 We have served as the Companys auditor since 2002 (b) Supplementary Data Selected quarterly financial data for 2017 and 2016 are contained in the Condensed Interim Financial Data table below. Condensed Interim Financial Data (Unaudited) ($ in millions except per share amounts) 4th Q (1) 3rd Q (2) 2nd Q 1st Q 2017 (3) Sales $ 10,433 $ 10,325 $ 9,930 $ 9,434 Materials and production 3,406 3,274 3,080 3,015 Marketing and administrative 2,580 2,401 2,438 2,411 Research and development 2,281 4,383 1,749 1,796 Restructuring costs Other (income) expense, net (19 ) (86 ) Income before taxes 1,879 2,439 2,003 Net (loss) income attributable to Merck Co., Inc. (1,046 ) (56 ) 1,946 1,551 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.39 ) $ (0.02 ) $ 0.71 $ 0.56 2016 (3) Sales $ 10,115 $ 10,536 $ 9,844 $ 9,312 Materials and production 3,332 3,409 3,578 3,572 Marketing and administrative 2,593 2,393 2,458 2,318 Research and development 4,650 1,664 2,151 1,659 Restructuring costs Other (income) expense, net (Loss) income before taxes (1,356 ) 2,887 1,504 1,624 Net (loss) income attributable to Merck Co., Inc. (594 ) 2,184 1,205 1,125 Basic (loss) earnings per common share attributable to Merck Co., Inc. common shareholders $ (0.22 ) $ 0.79 $ 0.44 $ 0.41 (Loss) earnings per common share assuming dilution attributable to Merck Co., Inc. common shareholders $ (0.22 ) $ 0.78 $ 0.43 $ 0.40 (1) Amounts for 2017 include a provisional net tax charge related to the enactment of U.S. tax legislation (see Note 16). Amounts for 2016 include a charge to settle worldwide patent litigation related to Keytruda (see Note 11). (2) Amounts for 2017 include an aggregate charge related to the formation of a collaboration with AstraZeneca (see Note 4). (3) Amounts for 2017 and 2016 reflect acquisition and divestiture-related costs (see Note 8) and the impact of restructuring actions (see Note 5). "," Item 9A. Controls and Procedures. Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Based on their evaluation, as of the end of the period covered by this Form 10-K, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Act)) are effective. For the period covered by this report, there have been no changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Act. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2017 . PricewaterhouseCoopers LLP, an independent registered public accounting firm, has performed its own assessment of the effectiveness of the Companys internal control over financial reporting and its attestation report is included in this Form 10-K filing. Managements Report Managements Responsibility for Financial Statements Responsibility for the integrity and objectivity of the Companys financial statements rests with management. The financial statements report on managements stewardship of Company assets. These statements are prepared in conformity with generally accepted accounting principles and, accordingly, include amounts that are based on managements best estimates and judgments. Nonfinancial information included in the Annual Report on Form 10-K has also been prepared by management and is consistent with the financial statements. To assure that financial information is reliable and assets are safeguarded, management maintains an effective system of internal controls and procedures, important elements of which include: careful selection, training and development of operating and financial managers; an organization that provides appropriate division of responsibility; and communications aimed at assuring that Company policies and procedures are understood throughout the organization. A staff of internal auditors regularly monitors the adequacy and application of internal controls on a worldwide basis. To ensure that personnel continue to understand the system of internal controls and procedures, and policies concerning good and prudent business practices, annually all employees of the Company are required to complete Code of Conduct training, which includes financial stewardship. This training reinforces the importance and understanding of internal controls by reviewing key corporate policies, procedures and systems. In addition, the Company has compliance programs, including an ethical business practices program to reinforce the Companys long-standing commitment to high ethical standards in the conduct of its business. The financial statements and other financial information included in the Annual Report on Form 10-K fairly present, in all material respects, the Companys financial condition, results of operations and cash flows. Our formal certification to the Securities and Exchange Commission is included in this Form 10-K filing. Managements Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2017 . Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The effectiveness of the Companys internal control over financial reporting as of December 31, 2017 , has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Kenneth C. Frazier Robert M. Davis Chairman, President and Chief Executive Officer Executive Vice President, Chief Financial Officer Global Services " diff --git a/datasets/raw/meta.csv b/datasets/raw/meta.csv new file mode 100644 index 0000000..f20df0c --- /dev/null +++ b/datasets/raw/meta.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,fb-2,20211231," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. We build technology that helps people connect, find communities, and grow businesses. Our useful and engaging products enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality (VR) headsets, wearables, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products. Meta is moving beyond 2D screens toward immersive experiences like augmented and virtual reality to help build the metaverse, which we believe is the next evolution in social technology. We report financial results for two segments: Family of Apps (FoA) and Reality Labs (RL). For FoA, we generate substantially all of our revenue from selling advertising placements to marketers. Ads on our platforms enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. RL generates revenue from sales of consumer hardware products, software and content. Our products include: Family of Apps Facebook. Facebook helps give people the power to build community and bring the world closer together. It's a place for people to share life's moments and discuss what's happening, nurture and build relationships, discover and connect to interests, and create economic opportunity. They can do this through News Feed, Stories, Groups, Watch, Marketplace, Reels, Dating, and more. Instagram. Instagram brings people closer to the people and things they love. Instagram Feed, Stories, Reels, Video, Live, Shops, and messaging are places where people and creators can express themselves and push culture forward through photos, video, and private messaging, and connect with and shop from their favorite businesses. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, audio and video calls, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Reality Labs Reality Labs. Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Meta Quest lets people defy distance with cutting-edge VR hardware, software, and content. Facebook Portal video calling devices help friends and families stay connected and share the moments that matter in meaningful ways. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection, sharing, discovery, and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Alphabet (Google and YouTube), Amazon, Apple, ByteDance (TikTok), Microsoft, Snap (Snapchat), Tencent (WeChat), and Twitter. We compete to attract, engage, and retain people who use our products, to attract and retain businesses who use our free or paid business and advertising services, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual and augmented reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, including as part of efforts to develop the metaverse, we may become subject to additional competition. Technology Our product development philosophy centers on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video and VR increases, and as we deepen our investment in new technologies like artificial intelligence, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate in more than 80 cities around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, many of which are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These laws and regulations involve matters including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, civil rights, telecommunications, product liability, e-commerce, taxation, economic or other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, consumer protection, and other laws and regulations can impose different obligations, or penalties or fines for non-compliance, or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices, or otherwise relating to content that is made available on our products, could adversely affect our financial results. In the United States, there have been, and continue to be, various efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and any such changes may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect our business and financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. For example, the Privacy Shield, a transfer framework we relied upon for data transferred from the European Union to the United States, was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Meta relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. In August 2020, we received a preliminary draft decision from the Irish Data Protection Commission (IDPC) that preliminarily concluded that Meta Platforms Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the General Data Protection Regulation (GDPR) and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. We believe a final decision in this inquiry may issue as early as the first half of 2022. If a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or rely upon other alternative means of data transfers from Europe to the United States, we will likely be unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, which would materially and adversely affect our business, financial condition, and results of operations. We have been subject to other significant legislative and regulatory developments in the past, and proposed or new legislation and regulations could significantly affect our business. For example, the GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, requires submission of personal data breach notifications to our lead European Union privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The GDPR is still a relatively new law, its interpretation is still evolving, and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. In addition, Brazil, the United Kingdom, and other countries have enacted similar data protection regulations imposing data privacy-related requirements on products and services offered to users in their respective jurisdictions. The California Consumer Privacy Act, which took effect in January 2020, and its successor, the California Privacy Rights Act, which will take effect in January 2023, also establish certain transparency rules and create new data privacy rights for users. In addition, effective December 2020, the European Union's ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these or similar developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. For example, the proposed Digital Markets Act in the European Union and pending proposals to modify competition laws in the United States and other jurisdictions could cause us to incur significant compliance costs and could potentially impose new restrictions and requirements on companies like ours, including in areas such as the combination of data across services, mergers and acquisitions, and product design. In addition, some countries, such as India, are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. New legislation or regulatory decisions that restrict our ability to collect and use information about minors may also result in limitations on our advertising services or our ability to offer products and services to minors in certain jurisdictions. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, civil rights, content moderation, and competition, as we continue to grow and expand our operations. We are also currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into with the U.S. Federal Trade Commission (FTC), which took effect in April 2020 and, among other matters, requires us to maintain a comprehensive privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. For additional information about government regulation applicable to our business, see Part I, Item 1A, ""Risk Factors"" in this Annual Report on Form 10-K. Human Capital At Meta, we design products to bring the world closer together, one connection at a time. As a company, we believe that people are at the heart of every connection we build. We are proud of our unique company culture where ideas, innovation, and impact win, and we work hard to build strong teams across engineering, product design, marketing, and other areas to further our mission. We had a global workforce of 71,970 employees as of December 31, 2021, which represents a 23% year-over-year increase in employee headcount. We expect headcount growth to continue for the foreseeable future, particularly as we continue to focus on recruiting employees in technical functions. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. Our headquarters are located in Menlo Park, California and we have offices in more than 80 cities around the globe. The vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, and in the long term, we expect some personnel to continue to transition to working remotely on a regular basis. We offer most of our full-time employees the option to work remotely on a regular basis. Diversity, Equity and Inclusion Diversity, equity and inclusion are core to our work at Meta. We seek to build a diverse and inclusive workplace where we can leverage our collective cognitive diversity to build the best products and make the best decisions for the global community we serve. While we have made progress, we still have more work to do. As part of our diversity and inclusion report, we publish our global gender diversity and U.S. ethnic diversity workforce data annually. As of June 30, 2021, our global employee base was comprised of 36.7% females and 63.3% males, and our U.S. employee base was comprised of the following ethnicities: 45.7% Asian, 39.1% White, 6.5% Hispanic, 4.4% Black, 3.9% two or more ethnicities, and 0.4% additional groups (including American Indian or Alaska Native and Native Hawaiian or Other Pacific Islander). In recent years, we also announced our goals to have 50% of our workforce made up of underrepresented groups by 2024, and to increase the representation of people of color in leadership positions in the United States, including Black leadership, by 30% from 2020 to 2025. We will also continue our ongoing efforts to increase the representation of women in leadership. We work to support our goals of diversifying our workforce through recruiting, retention, people development, and inclusion. We employ our Diverse Slate Approach in our global recruitment efforts, which ensures that teams and hiring managers have the opportunity to consider qualified people from underrepresented groups for open roles. We have seen steady increases in hiring rates of people from underrepresented groups since we started testing this approach in 2015. We also continue to develop inclusive internship programs, and Meta University, our training program for college freshmen and sophomores with an interest in Computer Science, also utilizes a proactive and inclusive approach to promote participation by people from underrepresented groups. To help build community among our people and support their professional development, we invest in our internal Meta Resource Groups and our annual Community events such as Women's Community Summit, Black Community Summit, Latin Community Summit, and Pride Community Summit. We also offer Managing Unconscious Bias, Managing Inclusion, Be the Ally, and other trainings to promote an inclusive workplace by helping people understand the issues that affect underrepresented communities and how to reduce the effects of bias in the workplace. Compensation and Benefits We offer competitive compensation to attract and retain the best people, and we help care for our people so they can focus on our mission. Our employees' total compensation package includes market-competitive salary, bonuses or sales incentives, and equity. We generally offer full-time employees equity at the time of hire and through annual equity grants because we want them to be owners of the company and committed to our long-term success. We have conducted pay equity analyses for many years, and continue to be committed to pay equity. In 2021, we announced that our analyses indicate that we continue to have pay equity across genders globally and race in the United States for people in similar jobs, accounting for factors such as location, role, and level. Through Life@ Meta, our holistic approach to benefits, we provide our employees and their loved ones with resources to help them thrive. We offer a wide range of benefits across areas such as health, family, finance, community, and time away, including healthcare and wellness benefits, family building benefits, family care resources, retirement savings plans, access to tax and legal services, Meta Resource Groups to build community at Meta, family leave, and paid time off. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is currently listed on the Nasdaq Global Select Market under the symbol ""FB."" In October 2021, we changed our corporate name from Facebook, Inc. to Meta Platforms, Inc. We expect our Class A common stock to cease trading under the symbol ""FB"" and begin trading under the new symbol, ""META,"" on the Nasdaq Global Select Market in the first half of 2022. Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Meta, the Meta logo, Facebook, FB, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Meta Platforms, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and about.fb.com/news/ websites as well as Mark Zuckerberg's Facebook Page (www.facebook.com/zuck) and Instagram account (www.instagram.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission (FTC); Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding capital stock by our founder, Chairman, and CEO. Risks Related to Our Product Offerings If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement across our products are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products that deliver ad impressions, particularly for Facebook and Instagram. We anticipate that our active user growth rate will continue to generally decline over time as the size of our active user base increases. In addition, we have experienced, and expect to continue to experience, fluctuations and declines in the size of our active user base in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. User growth and engagement are also impacted by a number of other factors, including competitive products and services, such as TikTok, that have reduced some users' engagement with our products and services, as well as global and regional business and macroeconomic conditions. For example, beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen these pandemic-related trends subside. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and these trends may continue to be subject to volatility. In the fourth quarter of 2021, we experienced a slight decline on a quarter-over-quarter basis in the total number of DAUs on Facebook, as well as a slight decline on a quarter-over-quarter basis in the number of DAUs on Facebook in the United States Canada region. Any future declines in the size of our active user base may adversely impact our ability to deliver ad impressions and, in turn, our financial performance. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products, or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, concerns about the nature of content made available on our products, or concerns related to privacy, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with our products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely affect our products or users; we are unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, or are otherwise limited in our business operations, as a result of European regulators, courts, or legislative bodies determining that our reliance on Standard Contractual Clauses (SCCs) or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; there is decreased engagement with our products, or failure to accept our terms of service, as part of privacy-focused changes that we have implemented or may implement in the future, whether voluntarily, in connection with the General Data Protection Regulation (GDPR), the European Union's ePrivacy Directive, the California Consumer Privacy Act (CCPA), or other laws, regulations, or regulatory actions, or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, or we take, or fail to take, actions to enforce our policies, that are perceived negatively by our users or the general public, including as a result of decisions or recommendations from the independent Oversight Board regarding content on our platform; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement (for example, we have announced plans to focus product decisions on optimizing the young adult experience in the long term); we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are scaled back or discontinued, or the pricing of data plans otherwise increases; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, particularly for our significant revenue-generating products like Facebook and Instagram, our revenue and financial results may be adversely affected. Any significant decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our ability to deliver ad impressions and, accordingly, our revenue, business, financial condition, and results of operations. As our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives, or if they are not satisfied for any other reason. We have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, such as our feed and Stories products, including as a result of increased usage of our Reels or other video or messaging products; reductions of advertising by marketers due to our efforts to implement or enforce advertising policies that protect the security and integrity of our platform; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated, or otherwise more effective products; limitations on our ability to offer a number of our most significant products and services, including Facebook and Instagram, in Europe as a result of European regulators, courts, or legislative bodies determining that our reliance on SCCs or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; changes in our marketing and sales or other operations that we are required to or elect to make as a result of risks related to complying with foreign laws or regulatory requirements or other government actions; decisions by marketers to reduce their advertising as a result of announcements by us or adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, our interpretation, implementation, or enforcement of policies relating to content on our products (including as a result of decisions or recommendations from the independent Oversight Board), developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content made available on our products by third parties, questions about our user data practices or the security of our platform, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations (for example, a number of marketers announced that they paused advertising with us in July 2020 due to concerns about content on our products); the effectiveness of our ad targeting or degree to which users opt in or out of the use of data for ads, including as a result of product changes and controls that we have implemented or may implement in the future in connection with the GDPR, ePrivacy Directive, California Consumer Privacy Act (CCPA), other laws, regulations, regulatory actions, or litigation, or otherwise, that impact our ability to use data for advertising purposes; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; the success of technologies designed to block the display of ads or ad measurement tools; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic and geopolitical conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. For example, macroeconomic conditions have affected, and may in the future affect, marketers' ability or willingness to spend with us, as we experienced in 2020 with the regional and worldwide economic disruption related to the COVID-19 pandemic and associated declines in advertising activity on our products. The effects of the pandemic previously resulted in reduced demand for our ads, a related decline in pricing of our ads, and additional demands on our technical infrastructure as a result of increased usage of our services, and any similar occurrences in the future may impair our ability to maintain or increase the quantity or quality of ads shown to users and adversely affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory developments, such as the GDPR, ePrivacy Directive, and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In particular, we have seen an increasing number of users opt to control certain types of ad targeting in Europe following adoption of the GDPR, which will increase further with expanded control over certain third-party data as part of our ePrivacy Directive compliance, and we have introduced product changes that limit data signal use for certain users in California following adoption of the CCPA. Regulatory guidance or decisions or new legislation in these or other jurisdictions may require us to make additional changes to our products in the future that further reduce our ability to use these signals. In addition, mobile operating system and browser providers, such as Apple and Google, have implemented product changes and/or announced future plans to limit the ability of websites and application developers to collect and use these signals to target and measure advertising. For example, in 2021, Apple made certain changes to its products and data use policies in connection with changes to its iOS operating system that reduce our and other iOS developers' ability to target and measure advertising, which has negatively impacted, and we expect will continue to negatively impact, the size of the budgets marketers are willing to commit to us and other advertising platforms. In addition, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of certain product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform and negatively impacted our advertising revenue. For example, our advertising revenue in the second half of 2021 was negatively impacted by marketer reaction to targeting and measurement challenges associated with iOS changes. If we are unable to mitigate these developments as they take further effect in the future, our targeting and measurement capabilities will be materially and adversely affected, which would in turn significantly impact our future advertising revenue growth. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature our products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of our products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of our products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and also released changes to iOS that limit our ability to target and measure ads effectively. We expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers, and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use our products on their mobile devices, or if our users choose not to access or use our products on their mobile devices or use mobile products that do not offer access to our products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, other business partners, or advertisers, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. We have in the past experienced challenges in operating with mobile operating systems, networks, technologies, products, and standards that we do not control, and any such occurrences in the future may negatively impact our user growth, engagement, and monetization on mobile devices, which may in turn materially and adversely affect our business and financial results. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny, litigation, or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we are moving forward with plans to implement end-to-end encryption across our messaging services, as well as facilitate cross-app communication between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which reduces our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we also change the size, frequency, or relative prominence of ads as part of our product and monetization strategies. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on our products. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization, such as our feed products. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. For example, we plan to continue to promote Reels, which we do not currently monetize at the same rate as our feed or Stories products. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. We may not be successful in our metaverse strategy and investments, which could adversely affect our business, reputation, or financial results. We believe the metaverse, an embodied internet where people have immersive experiences beyond two-dimensional screens, is the next evolution in social technology. In 2021, we announced a shift in our business and product strategy to focus on helping to bring the metaverse to life. We expect this will be a complex, evolving, and long-term initiative that will involve the development of new and emerging technologies, continued investment in privacy, safety, and security efforts, and collaboration with other companies, developers, partners, and other participants. However, the metaverse may not develop in accordance with our expectations, and market acceptance of features, products, or services we build for the metaverse is uncertain. In addition, we have limited experience with consumer hardware products and virtual and augmented reality technology, which may enable other companies to compete more effectively than us. We may be unsuccessful in our research and product development efforts, including if we are unable to develop relationships with key participants in the metaverse or develop products that operate effectively with metaverse technologies, products, systems, networks, or standards. Our metaverse efforts may also divert resources and management attention from other areas of our business. We expect to continue to make significant investments in virtual and augmented reality and other technologies to support these efforts, and our ability to support these efforts is dependent on generating sufficient profits from other areas of our business. In addition, as our metaverse efforts evolve, we may be subject to a variety of existing or new laws and regulations in the United States and international jurisdictions, including in the areas of privacy and e-commerce, which may delay or impede the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. As a result of these or other factors, our metaverse strategy and investments may not be successful in the foreseeable future, or at all, which could adversely affect our business, reputation, or financial results. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, data use, encryption, content, product design, algorithms, advertising, competition, and other issues, including actions or decisions in connection with elections or the COVID-19 pandemic, which has in the past adversely affected, and may in the future adversely affect, our reputation and brands. For example, beginning in September 2021, we became the subject of media, legislative, and regulatory scrutiny as a result of a former employee's allegations and release of internal company documents relating to, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being. In addition, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise enforce our policies or address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the pandemic or elections in the United States and around the world, by decisions or recommendations regarding content on our platform from the independent Oversight Board, by research or media reports concerning the perceived or actual impacts of our products or services on user well-being, or by our decisions to remove content or suspend participation on our platform by persons who violate our community standards or terms of service. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our actions, such as the foregoing matter regarding developer misuse of data and concerns around our handling of political speech and advertising, hate speech, and other content, as well as user well-being issues, have eroded confidence in our brands and may continue to do so in the future. If we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we conduct investigations and audits of platform applications from time to time, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Risks Related to Our Business Operations and Financial Results The COVID-19 pandemic has previously had, and may in the future have, a significant adverse impact on our advertising revenue and also exposes our business to other risks. The COVID-19 pandemic has resulted in authorities implementing numerous preventative measures from time to time to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in certain affected countries and regions, which have previously significantly impacted our business and results of operations. For example, in the second quarter of 2020, our advertising revenue grew 10% year-over-year, which was the slowest growth rate for any fiscal quarter since our initial public offering. While our advertising revenue growth rate improved in subsequent quarters, there can be no assurance that it will not decrease again as a result of the effects of the pandemic. In addition, we believe that the pandemic previously contributed to an acceleration in the growth of online commerce, which in turn increased demand for our advertising services. More recently, we believe this growth has moderated in many regions, and we may experience reduced advertising demand and related declines in pricing in future periods to the extent this trend continues, which could adversely affect our advertising revenue growth. The demand for and pricing of our advertising services may be materially and adversely impacted by the pandemic for the foreseeable future, and we are unable to predict the duration or degree of such impact with any certainty. In addition to the impact on our advertising business, the pandemic exposes our business, operations, and workforce to a variety of other risks, including: volatility in the size of our user base and user engagement, particularly for our messaging products, whether as a result of shelter-in-place measures or other factors; delays in product development or releases, or reductions in manufacturing production and sales of consumer hardware, as a result of inventory shortages, supply chain or labor shortages; increased misuse of our products and services or user data by third parties, including improper advertising practices or other activity inconsistent with our terms, contracts, or policies, misinformation or other illicit or objectionable material on our platforms, election interference, or other undesirable activity; adverse impacts to our efforts to combat misuse of our products and services and user data as a result of limitations on our safety, security, and content review efforts while our workforce is working remotely, such as the necessity to rely more heavily on artificial intelligence to perform tasks that our workforce is unable to perform; significant volatility and disruption of global financial markets, which could cause fluctuations in currency exchange rates or negatively impact our ability to access capital in the future; negative impact on our workforce productivity, product development, and research and development due to difficulties resulting from our personnel working remotely; illnesses to key employees, or a significant portion of our workforce, which may result in inefficiencies, delays, and disruptions in our business; and increased volatility and uncertainty in the financial projections we use as the basis for estimates used in our financial statements. Any of these developments may adversely affect our business, harm our reputation, or result in legal or regulatory actions against us. The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business and may materially and adversely impact our business, financial condition, and results of operations. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies providing connection, sharing, discovery, and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Alphabet (Google and YouTube), Amazon, Apple, ByteDance (TikTok), Microsoft, Snap (Snapchat), Tencent (WeChat), and Twitter. We compete to attract, engage, and retain people who use our products, to attract and retain businesses that use our free or paid business and advertising services, and to attract and retain developers who build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual and augmented reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, including as part of efforts to develop the metaverse, we may become subject to additional competition. Some of our current and potential competitors may have greater resources, experience, or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. For example, some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. In addition, Apple has released changes to iOS that limit our ability, and the ability of others in the digital advertising industry, to target and measure ads effectively. As a result, our competitors may, and in some cases will, acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which would negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; our ability to attract and retain businesses who use our free or paid business and advertising services; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base, level of user engagement, and ability to deliver ad impressions may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Unfavorable media coverage negatively affects our business from time to time. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, terms of service, or other policies, the actions of our users, the quality and integrity of content shared on our platform, the perceived or actual impacts of our products or services on user well-being, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, we have been the subject of significant media coverage involving concerns around our handling of political speech and advertising, hate speech, and other content, as well as user well-being issues, and we continue to receive negative publicity related to these topics. Beginning in September 2021, we became the subject of significant media coverage as a result of allegations and the release of internal company documents by a former employee. In addition, we have been, and may in the future be, subject to negative publicity in connection with our handling of misinformation and other illicit or objectionable use of our products or services, including in connection with the COVID-19 pandemic and elections in the United States and around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and marketer demand for advertising on our products, which could result in decreased revenue and adversely affect our business and financial results, and we have experienced such adverse effects to varying degrees from time to time. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement, particularly for our products that deliver ad impressions; our ability to attract and retain marketers in a particular period; our ability to recognize revenue or collect payments from marketers in a particular period, including as a result of the effects of the COVID-19 pandemic; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, including the COVID-19 pandemic, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts, including as a result of implementing changes to our practices, whether voluntarily, in connection with laws, regulations, regulatory actions, or decisions or recommendations from the independent Oversight Board, or otherwise; costs and expenses related to the development, manufacturing, and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy, data protection, and content, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which is affected by the mix of income we earn in the U.S. and in jurisdictions with different tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, the effects of changes in our business or structure, and the effects of discrete items such as legal and tax settlements and tax elections; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our investments in marketable securities, in the valuation of our equity investments, and in interest rates; changes in U.S. generally accepted accounting principles; and changes in regional or global business or macroeconomic conditions, including as a result of the COVID-19 pandemic, which may impact the other factors described above. Our rates of growth may be volatile in the near term as a result of the COVID-19 pandemic, and we expect they will decline over time in the future. We have in the past experienced, and may in the future experience, volatility in our user and revenue growth rates as a result of the COVID-19 pandemic, although we are unable to predict the duration or degree of such volatility with any certainty. In the long term, we expect that our user growth rate will generally decline over time as the size of our active user base increases, and the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We also expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates experience volatility or decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments, particularly our investments in virtual and augmented reality, have the effect of reducing our operating margin and profitability. If our investments are not successful longer-term, our business and financial performance will be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies, including as we continue our efforts related to building the metaverse. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability, and we expect the adverse financial impact of such investments to continue for the foreseeable future. For example, our investments in Reality Labs reduced our 2021 overall operating profit by approximately $10 billion, and we expect our investments to increase in future periods. If our investments are not successful longer-term, our business and financial performance will be harmed. We plan to continue to make acquisitions and pursue other strategic transactions, which could impact our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies, and from time to time may enter into other strategic transactions such as investments and joint ventures. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions or other strategic transactions on favorable terms, or at all, including as a result of regulatory challenges. For example, in 2021, the United Kingdom Competition and Markets Authority issued an order directing us to divest our Giphy acquisition, which we have appealed. In some cases, the costs of such acquisitions or other strategic transactions may be substantial, and there is no assurance that we will realize expected synergies from future growth and potential monetization opportunities for our acquisitions or a favorable return on investment for our strategic investments. We may pay substantial amounts of cash or incur debt to pay for acquisitions or other strategic transactions, which has occurred in the past and could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions or other strategic transactions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities, deficiencies, or other claims associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition or other strategic transaction, including tax and accounting charges. Acquisitions or other strategic transactions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience, and we may not manage these processes successfully. We continue to make substantial investments of resources to support our acquisitions, which has in the past resulted, and we expect will in the future result, in significant ongoing operating expenses and the diversion of resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service, including as a result of the COVID-19 pandemic, could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. We have experienced such issues to varying degrees from time to time. For example, in October 2021, a combination of an error and a bug resulted in an approximately six-hour outage of our services. In addition, as the amount and types of information shared on our products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. Global climate change could result in certain types of natural disasters occurring more frequently or with more intense effects. Any such events may result in users being subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. We also have been, and may in the future be, subject to increased energy or other costs to maintain the availability or performance of our products in connection with any such events. In 2020, the increase in the use of our products as a result of the COVID-19 pandemic increased demands on our technical infrastructure. We may not be able to accommodate any such demands in the future, including as a result of our reduced data center operations and personnel working remotely during the pandemic. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. Due to the effects of the COVID-19 pandemic, we have experienced, and expect to continue to experience, supply and labor shortages and other disruptions in logistics and the supply chain for our technical infrastructure. As a result, we have had to make certain changes to our procurement practices, and in the future we may not be able to procure sufficient components, equipment, or services from third parties to satisfy our needs, or we may be required to procure such components, equipment, or services on unfavorable terms. Any of these developments may result in interruptions in the availability or performance of our products, require unfavorable changes to existing products, delay the introduction of future products, or otherwise adversely affect our business and financial results. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers, subsea and terrestrial fiber optic cable systems, and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations around the world, including in emerging markets that expose us to increased risks relating to anti-corruption compliance and political challenges, among others. We have in the past suspended, and may in the future suspend, certain of these projects as a result of the COVID-19 pandemic. Additional unanticipated delays or disruptions in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, whether as a result of the pandemic, trade disputes, or otherwise, may lead to increased project costs, operational inefficiencies, interruptions in the delivery or degradation of the quality or reliability of our products, or impairment of assets on our balance sheet. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Further, much of our technical infrastructure is located outside the United States, and it is possible that action by a foreign government, or our response to such government action, could result in the impairment of a portion of our technical infrastructure, which may interrupt the delivery or degrade the quality or reliability of our products and lead to a negative user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Family metrics (DAP, MAP, and average revenue per person (ARPP)) and Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Family metrics and Facebook metrics estimates will differ from estimates published by third parties due to differences in methodology. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. The timing and results of such user surveys have in the past contributed, and may in the future contribute, to changes in our reported Family metrics from period to period. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our reported Family metrics, as well as our ability to report these metrics at all. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2021, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. We also regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2021, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2021, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia, Nigeria, and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data may be unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics and estimates, including those relating to the reach and effectiveness of our ads. Many of our metrics involve the use of estimations and judgments, and our metrics and estimates are subject to software bugs, inconsistencies in our systems, and human error. Such metrics and estimates also change from time to time due to improvements or changes in our terminology or methodology, including as a result of loss of access to data signals we use in calculating such metrics and estimates. We have in the past been, and may in the future be, subject to litigation as well as marketer, regulatory, and other inquiries regarding the accuracy of such metrics and estimates. Where marketers, developers, or investors do not perceive our metrics or estimates to be accurate, or where we discover material inaccuracies in our metrics or estimates, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to our products that deliver ad impressions, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 71,970 as of December 31, 2021 from 58,604 as of December 31, 2020, and we expect headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. Additionally, the vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, which limits their ability to perform certain job functions and may negatively impact productivity. In the long term, we may experience such challenges to productivity and collaboration as some personnel transition to working remotely on a regular basis, and we may experience difficulties integrating recently hired personnel when our offices re-open. To effectively manage our growth, we must continue to adapt to a remote work environment; improve our operational, financial, and management processes and systems; and effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business, economic, and legal risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, several of our products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, supply chain, competition, consumer protection, intellectual property, environmental, health and safety, licensing, and infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, content moderation, data localization, data protection, e-commerce and payments, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations, including difficulties arising from personnel working remotely during the COVID-19 pandemic; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes and pandemics. In addition, we must manage the potential conflicts between locally accepted business practices in any given jurisdiction and our obligations to comply with laws and regulations, including anti-corruption laws or regulations applicable to us, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. We also must manage our obligations to comply with laws and regulations related to import and export controls, trade restrictions, and sanctions, including regulations established by the U.S. Office of Foreign Assets Control. Government agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against companies for violations of anti-corruption laws or regulations, import and export controls, trade restrictions, sanctions, and other laws, rules, and regulations. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We also may be required to or elect to cease or modify our operations or the offering of our products and services in certain regions, including as a result of the risks described above, which could adversely affect our business, user growth and engagement, and financial results. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell from time to time have had, and in the future may have, quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. Our brand and financial results could be adversely affected by any such quality issues, other failures to meet our customers' expectations, or findings of our consumer hardware products to be defective. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products, which subjects us to a number of risks that have been exacerbated as a result of the COVID-19 pandemic. We have experienced, and may in the future experience, supply or labor shortages or other disruptions in logistics and the supply chain, which could result in shipping delays and negatively impact our operations, product development, and sales. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties, manufacturing or supply constraints, or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing, distribution, and sale of our consumer hardware products also may be negatively impacted by macroeconomic conditions, geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, supply chain disruptions, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. The demand for our products can also change significantly between the time inventory or components are ordered and the date of sale. While we endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell, from time to time we have experienced difficulties in accurately predicting and meeting the consumer demand for our products. In addition, when we begin selling or manufacturing a new consumer hardware product or enter new international markets, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of the foregoing factors may adversely affect our operating results. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. We are involved in numerous lawsuits, including stockholder derivative lawsuits and putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user, advertiser, and developer base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user or entity harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on claims related to advertising, antitrust, privacy, biometrics, content, algorithms, employment, activities on our platform, consumer protection, or product performance or other claims related to the use of consumer hardware and software, including virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; our acquisitions of Instagram and WhatsApp, as well as other alleged anticompetitive conduct; and a former employee's allegations and release of internal company documents beginning in September 2021. The results of any such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Meta. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are litigating this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. The issuance of additional regulatory or accounting guidance related to the Tax Act, or other executive or Congressional actions in the United States or globally could materially increase our tax obligations and significantly impact our effective tax rate in the period such guidance is issued or such actions take effect, and in future periods. In addition, many countries have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. Over the last several years, the Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project that, if implemented, would change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. In 2021, more than 140 countries tentatively signed on to a framework that imposes a minimum tax rate of 15%, among other provisions. As this framework is subject to further negotiation and implementation by each member country, the timing and ultimate impact of any such changes on our tax obligations are uncertain. Similarly, the European Commission and several countries have issued proposals that would apply to various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several jurisdictions have proposed or enacted taxes applicable to digital services, which include business activities on digital advertising and online marketplaces, and which apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain member states, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2021, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.13 billion and our effective tax rate by two percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings. We review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at the reporting unit level at least annually. If such goodwill or intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or intangible assets is determined, which would negatively affect our results of operations. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly for engineering talent, whether as a result of competition with other companies or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. In addition, restrictive immigration policies or legal or regulatory developments relating to immigration may negatively affect our efforts to attract and hire new personnel as well as retain our existing personnel . If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or, in some cases, the replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Government Regulation and Enforcement Actions by governments that restrict access to Facebook or our other products in their countries, censor or moderate content on our products in their countries, or otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor or moderate content available on Facebook or our other products in their country, restrict access to our products from their country partially or entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. For example, in June 2020, Hong Kong adopted a National Security Law that provides authorities with the ability to obtain information, remove and block access to content, and suspend user services, and if we are found to be in violation of this law then the use of our products may be restricted. In addition, if we are required to or elect to make changes to our marketing and sales or other operations in Hong Kong as a result of the National Security Law, our revenue and business in the region will be adversely affected. It is also possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues or information requests in Hong Kong or elsewhere, or for other reasons, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. Similarly, if we are found to be out of compliance with certain legal requirements for social media companies in Turkey, the Turkish government could take action to reduce or eliminate our Turkey-based advertising revenue or otherwise adversely impact access to our products. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, we are required to or elect to make changes to our operations, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety and consumer protection, e-commerce, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our products and business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data use, data protection and personal information, biometrics, encryption, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, civil rights, telecommunications, product liability, e-commerce, taxation, economic or other trade controls including sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, consumer protection, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but the Privacy Shield was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Meta relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the CJEU considered the validity of SCCs as a basis to transfer user data from the European Union to the United States following a challenge brought by the Irish Data Protection Commission (IDPC). Although the CJEU upheld the validity of SCCs in July 2020, our continued reliance on SCCs will be the subject of future regulatory consideration. In particular, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Meta Platforms Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Meta Platforms Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. In May 2021, the court rejected Meta Platforms Ireland's procedural challenges and the inquiry subsequently recommenced. We believe a final decision in this inquiry may issue as early as the first half of 2022. If a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or rely upon other alternative means of data transfers from Europe to the United States, we will likely be unable to offer a number of our most significant products and services, including Facebook and Instagram, in Europe, which would materially and adversely affect our business, financial condition, and results of operations. In addition, we have been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Meta products and services, including a lawsuit currently pending before the Supreme Court of India, and also became subject to government inquiries and lawsuits regarding the 2021 update to WhatsApp's terms of service and privacy policy. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. We have been subject to other significant legislative and regulatory developments in the past, and proposed or new legislation and regulations could significantly affect our business in the future. For example, we have implemented a number of product changes and controls as a result of requirements under the European General Data Protection Regulation (GDPR), and may implement additional changes in the future. The GDPR also requires submission of personal data breach notifications to our lead European Union privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The GDPR is still a relatively new law, its interpretation is still evolving, and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. In addition, Brazil, the United Kingdom, and other countries have enacted similar data protection regulations imposing data privacy-related requirements on products and services offered to users in their respective jurisdictions. The California Consumer Privacy Act (CCPA), which took effect in January 2020, and its successor, the California Privacy Rights Act (CPRA), which will take effect in January 2023, also establish certain transparency rules and create new data privacy rights for users, including limitations on our use of certain sensitive personal information and more ability for users to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, regulators continue to issue guidance concerning the ePrivacy Directive's requirements regarding the use of cookies and similar technologies. In addition, effective December 2020, the ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these or similar developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. For example, the proposed Digital Markets Act in the European Union and pending proposals to modify competition laws in the United States and other jurisdictions could cause us to incur significant compliance costs and could potentially impose new restrictions and requirements on companies like ours, including in areas such as the combination of data across services, mergers and acquisitions, and product design. In addition, some countries, such as India, are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. New legislation or regulatory decisions that restrict our ability to collect and use information about minors may also result in limitations on our advertising services or our ability to offer products and services to minors in certain jurisdictions. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. We receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, civil rights, content moderation, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union and other jurisdictions have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing. Beginning in September 2018, we also became subject to IDPC and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. We also notify the IDPC, our lead European Union privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. In addition, we are subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions, which relate to many aspects of our business, including with respect to users and advertisers, as well as our industry. Such inquiries, investigations, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice and state attorneys general. Beginning in December 2020, we also became subject to lawsuits by the FTC and the attorneys general from 46 states, the territory of Guam, and the District of Columbia in the U.S. District Court for the District of Columbia alleging that we violated antitrust laws, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform, among other things. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to allegations and the release of internal company documents by a former employee. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business, and we have experienced some of these adverse effects to varying degrees from time to time. Compliance with our FTC consent order, the GDPR, the CCPA, the ePrivacy Directive, and other regulatory and legislative privacy requirements require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including in connection with our modified consent order with the FTC, requirements of the GDPR, and other regulatory and legislative requirements around the world, such as the CCPA and the ePrivacy Directive. In particular, we are maintaining a comprehensive privacy program in connection with the FTC consent order that includes substantial management and board of directors oversight, stringent operational requirements and reporting obligations, prohibitions against making misrepresentations relating to user data, a process to regularly certify our compliance with the privacy program to the FTC, and regular assessments of our privacy program by an independent third-party assessor, which has been and will continue to be challenging and costly to maintain and enhance. These compliance and oversight efforts are increasing demand on our systems and resources, and require significant new and ongoing investments, including investments in compliance processes, personnel, and technical infrastructure. We are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner has been and will continue to be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. The requirements of the FTC consent order and other privacy-related laws and regulations are complex and apply broadly to our business, and from time to time we notify relevant authorities of instances where we are not in full compliance with these requirements or otherwise discover privacy issues, and we expect to continue to do so as any such issues arise in the future. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, ePrivacy Directive, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other applicable requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. We may incur liability as a result of information retrieved from or transmitted over the internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices and may adversely affect our business and financial results. We have faced, currently face, and will continue to face claims relating to information or content that is published or made available on our products, including our policies and enforcement actions with respect to such information or content. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, harassment, intellectual property rights, rights of publicity and privacy, personal injury torts, laws regulating hate speech or other types of content, online safety, consumer protection, and breach of contract, among others. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive (the European Copyright Directive) expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states are currently implementing into their national laws. In addition, the European Union revised the European Audiovisual Media Service Directive to apply to online video-sharing platforms, which member states are expected to implement by 2021. In the United States, there have been, and continue to be, various legislative and executive efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, as well as to impose new obligations on online platforms with respect to commerce listings, user content, counterfeit goods and copyright-infringing material, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines, orders restricting or blocking our services in particular geographies, or other government-imposed remedies as a result of content hosted on our services. For example, legislation in Germany and India has resulted in the past, and may result in the future, in the imposition of fines or other penalties for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Numerous other countries in Europe, the Middle East, Asia-Pacific, and Latin America are considering or have implemented similar legislation imposing potentially significant penalties, including fines, service throttling, or advertising bans, for failure to remove certain types of content or follow certain processes. For example, we have been subject to fines and may in the future be subject to other penalties in connection with social media legislation in Russia and Turkey. Content-related legislation also has required us in the past, and may require us in the future, to change our products or business practices, increase our costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. Member states' laws implementing the European Copyright Directive may also require online platforms to pay for content. In addition, our compliance costs may significantly increase as a result of the Digital Services Act proposed in the European Union, which is expected to take effect in 2023, and other content-related legislative developments such as online safety bills in Ireland and the United Kingdom. In the United States, changes to Section 230 of the Communications Decency Act or new state or federal content-related legislation may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect user growth and engagement. Any of the foregoing events could adversely affect our business and financial results. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Several of our products offer Payments functionality, including enabling our users to purchase virtual and digital goods from developers that offer applications using our Payments infrastructure, send money to other users, and make donations to certain charitable organizations, among other activities. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, stored value, gift cards and other prepaid access instruments, electronic funds transfer, virtual currency, consumer protection, charitable fundraising, trade sanctions, and import and export restrictions. Depending on how our Payments products evolve, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain payments licenses in the United States, the European Economic Area, and other jurisdictions, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we are subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have also launched certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our digital payments initiatives subject us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. We are pursuing digital payments initiatives, such as Novi, a digital wallet that we expect to offer as both a standalone application and subsequently integrated in other Meta products. These initiatives may use blockchain-based assets, such as the USDP stablecoin issued by Paxos Trust Company, which is being used in a Novi pilot program in the United States and Guatemala beginning in October 2021. Our future initiatives to support commerce in the metaverse also may use blockchain-based assets in digital payments. Use of blockchain-based assets in payments are a relatively new and unproven technology, and the laws and regulations surrounding them are uncertain and evolving. These digital payments efforts have drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. We are participating in responses to inquiries from governments and regulators related to our digital payments initiatives, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As our digital payments initiatives evolve, we may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, virtual currency, anti-money laundering, counter-terrorism financing, trade sanctions, data protection, tax, consumer protection, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. In addition, Novi has also received state money transmitter licenses in the United States, with more pending approval, and has other financial services license applications pending in certain other countries that would allow us to conduct digital wallet activities in those countries. These licenses, laws, and regulations, as well as any associated inquiries or investigations, may delay or impede the development of digital payments products and services we offer, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of digital payments products and services is subject to significant uncertainty. As such, there can be no assurance that digital payments products and services we offer will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based technology, which may adversely affect our ability to successfully develop and market such digital payments products and services. We will also incur increased costs in connection with these efforts, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. Risks Related to Data, Security, and Intellectual Property Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (such as spear phishing attacks), scraping, and general hacking continue to be prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data and content on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from nation states and highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. The changes in our work environment as a result of the COVID-19 pandemic could also impact the security of our systems, as well as our ability to protect against attacks and detect and respond to them quickly. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with our products. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We experience such cyber-attacks and other security incidents of varying degrees from time to time, and we incur significant costs in protecting against or remediating such incidents. In addition, we are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under our modified consent order with the FTC. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. The events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications, as well as other enforcement efforts. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data or technical limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, challenges related to our personnel working remotely during the COVID-19 pandemic, the allocation of resources to other projects, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our modified consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper advertising practices, activities that threaten people's safety on- or offline, or instances of spamming, scraping, data harvesting, unsecured datasets, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Consequences of any of the foregoing developments include negative effects on user trust and engagement, harm to our reputation and brands, changes to our business practices in a manner adverse to our business, and adverse effects on our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Our products and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, or failures to address or mitigate technical limitations in our systems, could adversely affect our business. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely, or human error in using such systems, have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property or other data, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. In addition, any errors, bugs, vulnerabilities, or defects in our systems or the software and hardware on which we rely, failures to properly address or mitigate the technical limitations in our systems, or associated degradations or interruptions of service or failures to fulfill our commitments to our users, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, litigation, or liability for fines, damages, or other remedies, any of which could adversely affect our business and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $384.33 through December 31, 2021. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock has in the past fluctuated and may in the future fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results for either of our reportable segments; the financial projections we may provide to the public, any changes in these projections, or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; adverse government actions or legislative or regulatory developments relating to advertising, competition, content, privacy, or other matters, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war, incidents of terrorism, pandemics, and other disruptive external events, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; and a former employee's allegations and release of internal company documents beginning in September 2021. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2021, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 69 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Europe, the Middle East, Africa, Asia Pacific, and Latin America. We also own 18 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. On December 20, 2021, the district court granted our motion to dismiss the third amended complaint, with prejudice. On January 17, 2022, the plaintiffs filed a notice of appeal of the order dismissing their case. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020 and required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing and could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On July 16, 2021, a stockholder derivative action was filed in Delaware Chancery Court against certain of our directors and officers asserting breach of fiduciary duty and related claims relating to our historical platform and user data practices, as well as our settlement with the FTC. On July 20, 2021, other stockholders filed an amended derivative complaint in a related Delaware Chancery Court action, asserting breach of fiduciary duty and related claims against certain of our current and former directors and officers in connection with our historical platform and user data practices. On November 4, 2021, the lead plaintiffs filed a second amended and consolidated complaint in the stockholder derivative action. We believe the lawsuits described above are without merit, and we are vigorously defending them. We also notify the Irish Data Protection Commission (IDPC), our lead European Union privacy regulator under the General Data Protection Regulation (GDPR), of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. For example, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Meta Platforms Ireland's reliance on Standard Contractual Clauses in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Meta Platforms Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. On May 14, 2021, the court rejected Meta Platforms Ireland's procedural challenges, and the inquiry subsequently recommenced. We believe a final decision in this inquiry may issue as early as the first half of 2022. For additional information, see Part I, Item 1A, ""Risk FactorsOur business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, safety and consumer protection, e-commerce, and other matters"" in this Annual Report on Form 10-K. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleged that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. On June 28, 2021, the court granted our motions to dismiss the complaints filed by the FTC and attorneys general, dismissing the FTC's complaint with leave to amend and dismissing the attorneys general's case without prejudice. On July 28, 2021, the attorneys general filed a notice of appeal of the order dismissing their case. On August 19, 2021, the FTC filed an amended complaint, and on October 4, 2021, we filed a motion to dismiss this amended complaint. On January 11, 2022, the court denied our motion to dismiss the FTC's amended complaint. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking damages and unspecified injunctive relief. Several of the cases brought on behalf of certain advertisers and users were consolidated in the U.S. District Court for the Northern District of California. On January 14, 2022, the court granted, in part, and denied, in part, our motion to dismiss the consolidated actions. We believe these lawsuits are without merit, and we are vigorously defending them. The result of such litigation, investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to a former employee's allegations and release of internal company documents concerning, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being . Beginning on October 27, 2021, multiple putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the same matters. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil, Russia, and other countries in Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. We expect our Class A common stock to cease trading under the symbol ""FB"" and begin trading under the new symbol, ""META,"" on the Nasdaq Global Select Market in the first half of 2022. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2021, there were 3,258 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $336.35 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2021, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2021: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2021 21,703 $ 326.20 21,703 $ 50,893 November 1 - 30, 2021 21,606 $ 335.09 21,606 $ 43,653 December 1 - 31, 2021 14,728 $ 329.97 14,728 $ 38,793 58,037 58,037 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Meta Platforms, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2021. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2016 in the Class A common stock of Meta Platforms, Inc., the DJINET, the SP 500, and the Nasdaq Composite and data for the DJINET, the SP 500, and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States (GAAP), we present revenue on a constant currency basis and free cash flow, which are non-GAAP financial measures. Revenue on a constant currency basis is presented in the section entitled "" Revenue Foreign Exchange Impact on Revenue."" To calculate revenue on a constant currency basis, we translated revenue for the full year 2021 using 2020 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. For a full description of our free cash flow non-GAAP measure, see the section entitled "" Liquidity and Capital ResourcesFree Cash Flow."" These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from nonGAAP financial measures used by other companies, limiting their usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe these non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable comparison of financial results between periods where certain items may vary independent of business performance, and allow for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2021 Results Our key community metrics and financial results for 2021 are as follows: Family of Apps metrics: Family daily active people (DAP) was 2.82 billion on average for December 2021, an increase of 8% year-over-year. Family monthly active people (MAP) was 3.59 billion as of December 31, 2021, an increase of 9% year-over-year. Facebook daily active users (DAUs) were 1.93 billion on average for December 2021, an increase of 5% year-over-year. Facebook monthly active users (MAUs) were 2.91 billion as of December 31, 2021, an increase of 4% year-over-year. Ad impressions delivered across our Family of Apps increased by 10% year-over-year in 2021, and the average price per ad increased by 24% year-over-year in 2021. Consolidated and segment results: Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp, and other services. RL includes our augmented and virtual reality related consumer hardware, software, and content. Family of Apps Reality Labs Total Year Ended December 31, Year-over-Year % Change Year Ended December 31, Year-over-Year % Change Year Ended December 31, Year-over-Year % Change 2021 2020 2021 2020 2021 2020 (dollars in millions) Revenue $ 115,655 $ 84,826 36% $ 2,274 $ 1,139 100% $ 117,929 $ 85,965 37% Costs and expenses $ 58,709 $ 45,532 29% $ 12,467 $ 7,762 61% $ 71,176 $ 53,294 34% Income (loss) from operations $ 56,946 $ 39,294 45% $ (10,193) $ (6,623) (54)% $ 46,753 $ 32,671 43% Operating margin 49% 46% (448)% (581)% 40% 38% Net income was $39.37 billion with diluted earnings per share of $13.77 for the year ended December 31, 2021. Capital expenditures, including principal payments on finance leases, were $19.24 billion for the year ended December 31, 2021. Effective tax rate was 16.7% for the year ended December 31, 2021. Cash and cash equivalents and marketable securities were $48.0 billion as of December 31, 2021. Headcount was 71,970 as of December 31, 2021, an increase of 23% year-over-year. Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. In 2021, we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We also continued to invest based on the following company priorities: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. Our advertising revenue growth in the second half of 2021 was adversely affected by reduced marketer spending as a result of limitations on our ad targeting and measurement tools arising from changes to the iOS operating system. We expect that future advertising revenue growth will continue to be adversely affected by these and other limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers. Our business and results of operations have also been impacted by the COVID-19 pandemic and the preventative measures implemented by authorities from time to time to help limit the spread of the illness, which have caused, and are continuing to cause, business slowdowns or shutdowns in certain affected countries and regions. Beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen these pandemic-related trends subside, particularly in certain developed markets. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty and these trends may continue to be subject to volatility. The COVID-19 pandemic has also had a varied impact on the demand for and pricing of our ads from period to period. While we experienced a reduction in demand and a related decline in pricing during the onset of the pandemic, we believe the pandemic subsequently contributed to an acceleration in the growth of online commerce, particularly during the second half of 2020, and we experienced increasing demand for advertising as a result of this trend. More recently, we believe this growth has moderated in many regions, which to some extent adversely affected our advertising revenue growth in the second half of 2021. We may experience reduced advertising demand and related declines in pricing in future periods to the extent this trend continues, which could adversely affect our advertising revenue growth. However, the impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain for the foreseeable future. User growth and engagement were also impacted by a number of other factors in the second half of 2021. For example, competitive products and services have reduced some users' engagement with our products and services, and in response to competitive pressures, we have introduced new features such as Reels, which is growing in usage but is not currently monetized at the same rate as our feed or Stories products. We also saw a deceleration in our community growth rates as the size of our community continued to increase. In addition, we experienced year-over-year declines in ad impressions delivered in the United States Canada region. These trends adversely affected advertising revenue growth in the second half of 2021 and we expect will continue to affect our advertising revenue growth in the foreseeable future. Other global and regional business and macroeconomic conditions also have had, and we believe will continue to have, an impact on our user growth and engagement and advertising revenue growth. We anticipate that additional investments in our data center capacity, servers, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, including in our Reality Labs initiatives, will continue to drive expense growth in 2022. We expect 2022 capit al expenditures to be in the range of $29-34 billion and total expenses to be in the range of $90-95 billion. In 2022, we also expect that our year-over-year total expense growth rates may significantly exceed our year-over-year revenue growth rates, which would adversely affect our operating margin and profitability. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as DAP or MAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. DAP/MAP: 78% 79% 79% 79% 79% 79% 79% 78% 79% Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 40 million DAP to our reported worldwide DAP in June 2020. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 60 million DAP to our reported worldwide DAP in March 2021. Worldwide DAP increased 8% to 2.82 billion on average during December 2021 from 2.60 billion during December 2020. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 50 million MAP to our reported worldwide MAP in June 2020. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 70 million MAP to our reported worldwide MAP in March 2021. As of December 31, 2021, we had 3.59 billion MAP, an increase of 9% from 3.30 billion as of December 31, 2020. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. We estimate that the share of revenue from users who are not also MAP was not material. ARPP: $7.38 $6.03 $6.10 $6.76 $8.62 $7.75 $8.36 $8.18 $9.39 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Our annual worldwide ARPP in 2021, which represents the sum of quarterly ARPP during such period, was $33.68, an increase of 22% from 2020. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. DAU/MAU: 66% 67% 66% 66% 66% 66% 66% 66% 66% DAU/MAU: 77% 77% 77% 77% 76% 75% 75% 75% 74% DAU/MAU: 75% 75% 74% 74% 74% 73% 73% 73% 72% DAU/MAU: 62% 62% 61% 62% 62% 62% 62% 63% 63% DAU/MAU: 65% 65% 65% 65% 65% 65% 65% 66% 65% Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 5% to 1.93 billion on aver age during December 2021 from 1.84 billion during December 2020. Users in India, Bangladesh, and Vietnam represented the top three sources of growth in DAUs during December 2021, relative to the same period in 2020. Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2021, we had 2.91 billion MAUs, an increase of 4% from December 31, 2020. Users in India, Vietnam, and Bangladesh represented the top three sources of growth in 2021, relative to the same period in 2020. Trends in Our Monetization by Facebook User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware products are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. While the share of revenue from users who are not also Facebook or Messenger MAUs has grown over time, we estimate that revenue from users who are Facebook or Messenger MAUs represents the substantial majority of our total revenue. See ""Average Revenue Per Person (ARPP)"" above for our estimates of trends in our monetization of our Family products. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2021 in the United States Canada region was more than 12 times higher than in the Asia-Pacific region. ARPU: $8.52 $6.95 $7.05 $7.89 $10.14 $9.27 $10.12 $10.00 $11.57 ARPU: $ 41.41 $ 34.18 $ 36.49 $ 39.63 $ 53.56 $ 48.03 $ 53.01 $ 52.34 $ 60.57 ARPU: $13.21 $10.64 $11.03 $12.41 $16.87 $15.49 $17.23 $ 16.50 $ 19.68 ARPU: $3.57 $3.06 $2.99 $3.67 $4.05 $3.94 $4.16 $4.30 $4.89 ARPU: $2.48 $1.99 $1.78 $2.22 $2.77 $2.64 $3.05 $3.14 $3.43 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in Note 2 Revenue in our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplemental Data"" where revenue is geographically apportioned based on the addresses of our customers. Our annual worldwide ARPU in 2021, which represents the sum of quarterly ARPU during such period, was $40.96, an increase of 28% from 2020. For 2021, ARPU increased by 40% in Rest of World, 35% in Europe, 31% in the United States Canada, and 26% in AsiaPacific, as compared with 2020. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the impact of the estimates and assumptions on our consolidated financial statements is material. We believe that the assumptions and estimates associated with gross vs. net in revenue recognition, valuation of equity investments, income taxes, loss contingencies, and valuation of long-lived assets including goodwill, intangible assets, and property and equipment, and their associated estimated useful lives, when applicable, have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Gross vs. Net in Revenue Recognition For revenue generated from arrangements that involve third parties, there is significant judgment in evaluating whether we are the principal, and report revenue on a gross basis, or the agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. The assessment of whether we are considered the principal or the agent in a transaction could impact our revenue and cost of revenue recognized on the consolidated statements of income. Valuation of Equity Investments For our equity securities without readily determinable fair values accounted for using the measurement alternative, determining whether an equity security issued by the same issuer is similar to the equity security we hold may require judgment in (a) assessment of differences in rights and obligations associated with the instruments such as voting rights, distribution rights and preferences, and conversion features, and (b) adjustments to the observable price for differences such as, but not limited to, rights and obligations, control premium, liquidity, or principal or most advantageous markets. In addition, the identification of observable transactions will depend on the timely reporting of these transactions from our investee companies, which may occur in a period subsequent to when the transactions take place. Therefore, our fair value adjustment for these observable transactions may occur in a period subsequent to when the transaction actually occurred. For equity investments, we perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; regulatory, economic or technological environment; operational and financing cash flows; and other relevant events and factors affecting the investee. When indicators of impairment exist, we estimate the fair value of our equity investments using the market approach and/or the income approach and recognize impairment loss in the consolidated statements of income if the estimated fair value is less than the carrying value. Estimating fair value requires judgment and use of estimates such as discount rates, forecast cash flows, holding period, and market data of comparable companies, among others. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research and development tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world, and we regularly become subject to new laws and regulations in the jurisdictions in which we operate. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the merits of our defenses and the impact of negotiations, settlements, regulatory proceedings, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Certain factors, in particular, have resulted in significant changes to these estimates and judgments in prior quarters based on updated information available. For example, in certain jurisdictions where we operate, fines and penalties may be the result of new laws and preliminary interpretations regarding the basis of assessing damages, which may make it difficult to estimate what such fines and penalties would amount to if successfully asserted against us. In addition, certain government inquiries and investigations, such as matters before our lead European Union privacy regulator, the IDPC, are subject to review by other regulatory bodies before decisions are finalized, which can lead to significant changes in the outcome of an inquiry. As a result of these and other factors, we reasonably expect that our estimates and judgments with respect to our contingencies may continue to be revised in future quarters. The ultimate outcome of these matters, such as whether the likelihood of loss is remote, reasonably possible, or probable or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of losses, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 11 Commitments and Contingencies and Note 14 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets, and Property and Equipment and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill to reporting units based on the expected benefit from the business combination. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite-lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. We have two reporting units subject to goodwill impairment testing. As of December 31, 2021, no impairment of goodwill has been identified. Long-lived assets, including property and equipment and finite-lived intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any material impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of our server and network assets category. The effect of the 2021 change was a reduction in depreciation expense of $620 million and an increase in net income of $516 million, or $0.18 per diluted share. The impact from the changes in our estimates was calculated based on the asset bases existing as of the effective dates of the changes and applying the revised useful lives prospectively. See Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K, for additional information regarding changes in the estimated useful lives of our property and equipment. Components of Results of Operations Revenue Family of Apps (FoA) Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total advertising revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Reality Labs (RL) RL revenue is generated from the delivery of consumer hardware products, such as Meta Quest , Facebook Portal, and wearables, and related software and content. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as depreciation expense from servers, network infrastructure and buildings, as well as payroll and related expenses which include share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions; RL cost of products sold; and content costs. Research and development. Research and development expenses consist primarily of payroll and related expenses which include share-based compensation, facilities-related costs for employees on our engineering and technical teams who are responsible for developing new products as well as improving existing products, and professional services. Marketing and sales. Marketing and sales expenses consist primarily of marketing and promotional expenses and payroll and related expenses which include share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist primarily of legal-related costs, which include accruals for estimated fines, settlements, or other losses in connection with legal and related matters, as well as other legal fees; payroll and related expenses which include share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; other taxes, such as digital services taxes, other tax levies, and gross receipts taxes; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2021 compared to the year ended December 31, 2020. For a discussion of the year ended December 31, 2020 compared to the year ended December 31, 2019, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2020. The following table sets forth our consolidated statements of income data (in millions): Year Ended December 31, 2021 2020 2019 Revenue $ 117,929 $ 85,965 $ 70,697 Costs and expenses: Cost of revenue 22,649 16,692 12,770 Research and development 24,655 18,447 13,600 Marketing and sales 14,043 11,591 9,876 General and administrative 9,829 6,564 10,465 Total costs and expenses 71,176 53,294 46,711 Income from operations 46,753 32,671 23,986 Interest and other income, net 531 509 826 Income before provision for income taxes 47,284 33,180 24,812 Provision for income taxes 7,914 4,034 6,327 Net income $ 39,370 $ 29,146 $ 18,485 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, 2021 2020 2019 Revenue 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 19 18 Research and development 21 21 19 Marketing and sales 12 13 14 General and administrative 8 8 15 Total costs and expenses 60 62 66 Income from operations 40 38 34 Interest and other income, net 1 1 Income before provision for income taxes 40 39 35 Provision for income taxes 7 5 9 Net income 33 % 34 % 26 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses (in millions): Year Ended December 31, 2021 2020 2019 Cost of revenue $ 577 $ 447 $ 377 Research and development 7,106 4,918 3,488 Marketing and sales 837 691 569 General and administrative 644 480 402 Total share-based compensation expense $ 9,164 $ 6,536 $ 4,836 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, 2021 2020 2019 Cost of revenue % 1 % 1 % Research and development 6 6 5 Marketing and sales 1 1 1 General and administrative 1 1 1 Total share-based compensation expense 8 % 8 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue The following table sets forth our revenue by segment. For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Advertising $ 114,934 $ 84,169 $ 69,655 37 % 21 % Other revenue 721 657 541 10 % 21 % Family of Apps 115,655 84,826 70,196 36 % 21 % Reality Labs 2,274 1,139 501 100 % 127 % Total revenue $ 117,929 $ 85,965 $ 70,697 37 % 22 % Family of Apps FoA revenue in 2021 increased $30.83 billion, or 36%, compared to 2020. The increase was mostly driven by an increase in advertising revenue. Advertising Advertising revenue in 2021 increased $30.76 billion, or 37%, compared to 2020 as a result of increases in both the average price per ad and the number of ads delivered. In 2021, the average price per ad increased by 24%, as compared with a decrease of approximately 10% in 2020. The increase in average price per ad in 2021 was mainly caused by a recovery from declines in advertising demand in the first two quarters of 2020, due to the onset of the COVID-19 pandemic. Additionally, overall advertising demand increased, as compared to 2020, across our ad products and in all regions in part due to the continued growth of online commerce. In 2021, the number of ads delivered increased by 10%, as compared with an approximate 34% increase in 2020. The increase in the ads delivered in 2021 was driven by increases in users and the number and frequency of ads displayed across our products. We anticipate that future advertising revenue growth will be driven by a combination of price and the number of ads delivered. Reality Labs RL revenue increased $1.14 billion, or 100%, from 2020 to 2021, and $638 million, or 127%, from 2019 to 2020. The increases in both periods were mostly driven by increases in the volume of our consumer hardware products sold. Revenue Seasonality and Customer Concentration Revenue is traditionally seasonally strong in the fourth quarter of each year due in part to seasonal holiday demand. We believe that this seasonality in both advertising revenue and RL consumer hardware sales affects our quarterly results, which generally reflect significant growth in revenue between the third and fourth quarters and a decline between the fourth and subsequent first quarters. For instance, our total revenue increased 16%, 31%, and 19% between the third and fourth quarters of 2021, 2020, and 2019, respectively, while total revenue for the first quarters of 2021, 2020, and 2019 declined 7%, 16%, and 11% compared to the fourth quarters of 2020, 2019, and 2018, respectively. We note the decline in total revenue in the first quarter of 2020 was exacerbated by the non-seasonal impact of the onset of the COVID-19 pandemic. No customer represented 10% or more of total revenue during the years ended December 31, 2021, 2020, and 2019. Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2021 compared to the same period in 2020 had a favorable impact on revenue. If we had translated revenue for the full year 2021 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $116.29 billion and $113.31 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $1.64 billion and $1.62 billion lower than actual total revenue and advertising revenue, respectively, for the full year 2021. Using the same constant rates, full year 2021 total revenue and advertising revenue would have been $30.32 billion and $29.15 billion, respectively, higher than actual total revenue and advertising revenue for the full year 2020. Cost of revenue Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Cost of revenue $ 22,649 $ 16,692 $ 12,770 36 % 31% Percentage of revenue 19% 19% 18% Cost of revenue in 2021 increased $5.96 billion, or 36%, compared to 2020. The majority of the increase was due to an increase in Reality Labs cost of products sold and an increase in operational expenses related to our data centers and technical infrastructure, partially offset by a decrease in the depreciation growth rate mostly due to increases in the useful lives of servers and network assets. To a lesser extent, costs associated with partner arrangements, including traffic acquisition and payment processing costs, also increased. See Note 1 Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information regarding changes in the estimated useful lives of our servers and network assets. In 2022, we anticipate that cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth and engagement and the delivery of new products and services, and, to a lesser extent, due to higher content costs. Research and development Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Research and development $ 24,655 $ 18,447 $ 13,600 34 % 36 % Percentage of revenue 21% 21% 19% Research and development expenses in 2021 increased $6.21 billion, or 34%, compared to 2020. The increase was primarily due to an increase in payroll and related expenses as a result of a 30% growth in employee headcount from December 31, 2020 to December 31, 2021 in engineering and other technical functions supporting our continued investment in our family of products and Reality Labs. To a lesser extent, Realty Labs technology development costs also increased. In 2022, we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives in our family of products and in Reality Labs. Marketing and sales Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Marketing and sales $ 14,043 $ 11,591 $ 9,876 21 % 17% Percentage of revenue 12% 13% 14% Marketing and sales expenses in 2021 increased $2.45 billion, or 21%, compared to 2020. The increase was primarily due to increases in marketing and promotional expenses, payroll and related expenses, and product and community operations expenses. Our payroll and related expenses increased as a result of a 9% increase in employee headcount from December 31, 2020 to December 31, 2021 in our marketing and sales functions. In 2022, we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts, and we anticipate marketing expenses will increase. General and administrative Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Legal accrual related to FTC settlement $ $ $ 5,000 NM NM Other general and administrative 9,829 6,564 5,465 50 % 20 % General and administrative $ 9,829 $ 6,564 $ 10,465 50 % (37) % Percentage of revenue 8% 8% 15% General and administrative expenses in 2021 increased $3.27 billion, or 50%, compared to 2020. The increase was primarily due to increases in legal-related costs and payroll and related expenses. Our payroll and related expenses increased as a result of a 25% increase in employee headcount from December 31, 2020 to December 31, 2021 in our general and administrative functions. See Note 11 Commitments and Contingencies in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding estimated fines, settlements, or other losses in connection with legal-related costs. In 2022, we plan to continue to increase general and administrative expenses to support overall company growth. We may also incur significant discrete charges such as legal-related accruals and settlement costs in general and administrative expenses. Segment profitability The following table sets forth income (loss) from operations by segment. For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Family of Apps $ 56,946 $ 39,294 $ 28,489 45 % 38 % Reality Labs (10,193) (6,623) (4,503) (54) % (47) % Total income from operations $ 46,753 $ 32,671 $ 23,986 43 % 36 % Family of Apps FoA income from operations in 2021 increased $17.65 billion, or 45%, compared to 2020 . The increase was due to the growth in advertising revenue partially offset by an increase in costs and expenses, the majority of which was due to an increase in payroll and related expenses as a result of higher employee headcount, higher legal-related costs, and increases in costs related to our data centers and technical infrastructure. FoA income from operations in 2020 increased $10.81 billion, or 38%, compared to 2019. The increase was due to the growth in advertising revenue and a one-time $5.0 billion FTC settlement accrual recorded in 2019, partially offset by an increase in costs and expenses, the majority of which was due to an increase in payroll and related expenses as a result of higher employee headcount, increases in costs related to our data centers and technical infrastructure, and higher marketing and promotional expenses. Reality Labs RL loss from operations in 2021 increased $3.57 billion, or 54%, compared to 2020, and in 2020 increased $2.12 billion , or 47%, compared to 2019 . The majority of the increases in loss from operations in both periods were driven by increases in payroll and related expenses primarily due to the growth in RL research and development headcount and higher gross losses from increases in volume of consumer hardware sales. Interest and other income, net Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Interest income, net $ 461 $ 672 $ 904 (31) % (26) % Foreign currency exchange losses, net (140) (129) (105) (9) % (23) % Other income (expense), net 210 (34) 27 NM NM Interest and other income, net $ 531 $ 509 $ 826 4 % (38) % Interest and other income, net in 2021 increased $22 million, or 4%, compared to 2020. The increase was due to an increase in other income from net unrealized gains recognized for our equity investments, partially offset by a decrease in interest income as a result of lower interest rates compared to 2020. Provision for income taxes Year Ended December 31, 2021 2020 2019 2021 vs 2020 % Change 2020 vs 2019 % Change (dollars in millions) Provision for income taxes $ 7,914 $ 4,034 $ 6,327 96 % (36) % Effective tax rate 16.7% 12.2% 25.5% Our provision for income taxes in 2021 increased $3.88 billion, or 96%, compared to 2020, primarily due to an increase in income from operations and the effects of the tax election described below. Our effective tax rate in 2021 increased compared to 2020, mostly due to the effects of the tax election described below and tax effects of a shift in jurisdictional mix of earnings. In the third quarter of 2020, as part of finalizing our U.S. income tax return, we elected to capitalize and amortize certain research and development expenses for U.S. income tax purposes. As a result, we recorded a total of $1.07 billion income tax benefit for the year ended December 31, 2020. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion between the following items and income before provision for income taxes: U.S. tax benefits from foreign-derived intangible income, tax effects from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the effects of changes in tax law. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return, which depend upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 28, 2022 price, and absent U.S. tax legislation changes and other one-time events, we expect our effective tax rate for the full year 2022 to be similar to the effective tax rate for the full year 2021. This includes the effects of the mandatory capitalization and amortization of research and development expenses starting in 2022, as required by the 2017 Tax Cuts and Jobs Act (Tax Act). The mandatory capitalization requirement increases our cash tax liabilities but also decreases our effective tax rate due to increasing the foreign-derived intangible income deduction. If the mandatory capitalization requirement is deferred, our effective tax rate in 2022 could be a few percentage points higher when compared to current law and our cash tax liabilities could be several billion dollars lower. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. See Note 14 Income Taxes in the notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K for additional information regarding income tax contingencies. Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Cash and cash equivalents and marketable securities were $48.0 billion as of December 31, 2021, a decrease of $13.96 billion from December 31, 2020. The decrease was primarily due to $44.54 billion for repurchases of our Class A common stock, $19.24 billion for capital expenditures, including principal payments on finance leases, and $5.51 billion of taxes paid related to net share settlement of employee restricted stock units (RSU) awards, offset by $57.68 billion of cash generated from operations for the year ended December 31, 2021. Cash paid for income taxes was $8.52 billion for the year ended December 31, 2021. As of December 31, 2021, our federal net operating loss carryforward was $10.61 billion and our federal tax credit carryforward was $527 million. We anticipate the utilization of a significant portion of these net operating losses and credits within the next two years. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In 2021, we repurchased and subsequently retired 136 million shares of our Class A common stock for $44.81 billion. As of December 31, 2021, $38.79 billion remained available and authorized for repurchases. As of December 31, 2021, $10.61 billion of the $48.0 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds and cash flow from operations will be sufficient to meet our operational cash needs and fund our share repurchase program for at least the next 12 months and thereafter for the foreseeable future. The following table presents our cash flows (in millions): Year Ended December 31, 2021 2020 2019 Net cash provided by operating activities $ 57,683 $ 38,747 $ 36,314 Net cash used in investing activities $ (7,570) $ (30,059) $ (19,864) Net cash used in financing activities $ (50,728) $ (10,292) $ (7,299) Cash Provided by Operating Activities Cash provided by operating activities during 2021 mostly consisted of $39.37 billion net income adjusted for certain non-cash items, including $9.16 billion of share-based compensation expense and $7.97 billion of depreciation and amortization. The increase in cash flow from operating activities during 2021 compared to 2020 was primarily du e to higher net income as adjusted for certain non-cash items, such as share-based compensation expense and deferred income taxes, partially offset by changes in working capital. Cash Used in Investing Activities Cash used in investing activities during 2021 primarily consisted of $18.57 billion of purchases of property and equipment as we continued to invest in data centers, servers, office facilities, and network infrastructure offset by $12.18 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2021 compared to 2020 was mostly due to decreases in net purchases of marketable securities and equity investments, partially offset by an increase in purchases of property and equipment. We anticipate making capital expenditures of approximately $29 billion to $34 billion in 2022. Cash Used in Financing Activities Cash used in financing activities during 2021 mostly consisted of $44.54 billion for repurchases of our Class A common stock and $5.51 billion of taxes paid related to net share settlement of RSUs. The increase in cash used in financing activities during 2021 compared to 2020 was mostly due to the increase in repurchases of our Class A common stock. Free Cash Flow In addition to other financial measures presented in accordance with U.S. GAAP, we monitor free cash flow (FCF) as a non-GAAP measure to manage our business, make planning decisions, evaluate our performance, and allocate resources. We define FCF as net cash provided by operating activities reduced by net purchases of property and equipment and principal payments on finance leases. We believe that FCF is one of the key financial indicators of our business performance over the long term and provides useful information regarding how cash provided by operating activities compares to the property and equipment investments required to maintain and grow our business. We have chosen our definition for FCF because we believe that this methodology can provide useful supplemental information to help investors better understand underlying trends in our business. We use FCF in discussions with our senior management and board of directors. FCF has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash provided by operating activities. FCF is not intended to represent our residual cash flow available for discretionary expenses. Some of the limitations of FCF are: FCF does not reflect our future contractual commitments; and other companies in our industry present similarly titled measures differently than we do, limiting their usefulness as comparative measures. Management compensates for the inherent limitations associated with using the FCF measure through disclosure of such limitations, presentation of our financial statements in accordance with GAAP, and reconciliation of FCF to the most directly comparable GAAP measure, net cash provided by operating activities, as presented below. The following is a reconciliation of FCF to the most comparable GAAP measure, net cash provided by operating activities (in millions): Year Ended December 31, 2021 2020 2019 Net cash provided by operating activities $ 57,683 $ 38,747 $ 36,314 Less: Purchases of property and equipment (18,567) (15,115) (15,102) Less: Principal payments on finance leases (677) (604) (552) Free cash flow $ 38,439 $ 23,028 $ 20,660 Off-Balance Sheet Arrangements As of December 31, 2021, we did not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations Our principal commitments consist mostly of obligations under operating leases and other contractual commitments. Our operating lease obligations mostly include among others, certain of our offices, data centers, colocations and land. Our other contractual commitments are primarily related to our investments in servers, network infrastructure and Reality Labs. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2021 (in millions): Payment Due by Period Total 2022 2023-2024 2025-2026 Thereafter Operating lease obligations, including imputed interest (1) $ 25,410 $ 1,559 $ 3,966 $ 3,837 $ 16,048 Finance lease obligations, including imputed interest (1) 2,303 678 603 322 700 Transition tax payable 1,537 848 689 Other contractual commitments 23,080 14,502 5,426 609 2,543 Total contractual obligations $ 52,330 $ 16,739 $ 10,843 $ 5,457 $ 19,291 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. Additionally, as part of the normal course of business, we may also enter into multi-year agreements to purchase renewable energy that do not specify a fixed or minimum volume commitment or to purchase certain server components that do not specify a fixed or minimum price commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $8.06 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. Our other liabilities also include $4.40 billion related to the uncertain tax positions as of December 31, 2021. Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 11 Commitments and Contingencies and Note 14 Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and equity investment risk. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $140 million, $129 million, and $105 million were recognized in 2021, 2020, and 2019, respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $714 million and $794 million in the market value of our available-for-sale debt securities as of December 31, 2021 and December 31, 2020, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial markets, including recent and ongoing effects related to the impact of the COVID-19 pandemic, which requires significant judgments, could result in a material impairment charge on our equity investments. Equity investments accounted for under the equity method were immaterial as of December 31, 2021 and December 31, 2020. Our total equity investments had a carrying value of $6.78 billion and $6.23 billion as of December 31, 2021 and December 31, 2020, respectively. For additional information about our equity investments, see Note 1 Summary of Significant Accounting Policies, Note 5 Equity Investments, and Note 6 Fair Value Measurements in the notes to the consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part II, Item 7, ""Managements Discussion and Analysis of Financial Conditions and Results of Operations Critical Accounting Policies and Estimates"" contained in this Annual Report on Form 10-K. "," Item 8. Financial Statements and Supplementary Data META PLATFORMS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm (PCAOB ID No. 42 ) Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Meta Platforms, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Meta Platforms, Inc. (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 11 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above. When applicable, the Company discloses an estimate of the amount of loss or range of possible loss that may be incurred. However, for certain other matters, the Company discloses that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, these loss contingencies was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure regarding any range of possible losses, including when the Company believes it cannot be reasonably estimated at this time, we read the minutes or a summary of the meetings of the committees of the board of directors, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained representations from management. We also evaluated the appropriateness of the related disclosures included in Note 11 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 14 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 14 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California February 2, 2022 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Meta Platforms, Inc. Opinion on Internal Control over Financial Reporting We have audited Meta Platforms, Inc.'s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Meta Platforms, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2021, and the related notes and our report dated February 2, 2022 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California February 2, 2022 META PLATFORMS, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, 2021 2020 Assets Current assets: Cash and cash equivalents $ 16,601 $ 17,576 Marketable securities 31,397 44,378 Accounts receivable, net 14,039 11,335 Prepaid expenses and other current assets 4,629 2,381 Total current assets 66,666 75,670 Equity investments 6,775 6,234 Property and equipment, net 57,809 45,633 Operating lease right-of-use assets 12,155 9,348 Intangible assets, net 634 623 Goodwill 19,197 19,050 Other assets 2,751 2,758 Total assets $ 165,987 $ 159,316 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 4,083 $ 1,331 Partners payable 1,052 1,093 Operating lease liabilities, current 1,127 1,023 Accrued expenses and other current liabilities 14,312 11,152 Deferred revenue and deposits 561 382 Total current liabilities 21,135 14,981 Operating lease liabilities, non-current 12,746 9,631 Other liabilities 7,227 6,414 Total liabilities 41,108 31,026 Commitments and contingencies Stockholders' equity: Common stock, $ 0.000006 par value; 5,000 million Class A shares authorized, 2,328 million and 2,406 million shares issued and outstanding, as of December 31, 2021 and 2020, respectively; 4,141 million Class B shares authorized, 413 million and 443 million shares issued and outstanding, as of December 31, 2021 and 2020, respectively Additional paid-in capital 55,811 50,018 Accumulated other comprehensive income (loss) ( 693 ) 927 Retained earnings 69,761 77,345 Total stockholders' equity 124,879 128,290 Total liabilities and stockholders' equity $ 165,987 $ 159,316 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2021 2020 2019 Revenue $ 117,929 $ 85,965 $ 70,697 Costs and expenses: Cost of revenue 22,649 16,692 12,770 Research and development 24,655 18,447 13,600 Marketing and sales 14,043 11,591 9,876 General and administrative 9,829 6,564 10,465 Total costs and expenses 71,176 53,294 46,711 Income from operations 46,753 32,671 23,986 Interest and other income, net 531 509 826 Income before provision for income taxes 47,284 33,180 24,812 Provision for income taxes 7,914 4,034 6,327 Net income $ 39,370 $ 29,146 $ 18,485 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 13.99 $ 10.22 $ 6.48 Diluted $ 13.77 $ 10.09 $ 6.43 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,815 2,851 2,854 Diluted 2,859 2,888 2,876 Share-based compensation expense included in costs and expenses: Cost of revenue $ 577 $ 447 $ 377 Research and development 7,106 4,918 3,488 Marketing and sales 837 691 569 General and administrative 644 480 402 Total share-based compensation expense $ 9,164 $ 6,536 $ 4,836 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2021 2020 2019 Net income $ 39,370 $ 29,146 $ 18,485 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax ( 1,116 ) 1,056 ( 151 ) Change in unrealized gain (loss) on available-for-sale investments and other, net of tax ( 504 ) 360 422 Comprehensive income $ 37,750 $ 30,562 $ 18,756 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2018 2,854 $ $ 42,906 $ ( 760 ) $ 41,981 $ 84,127 Issuance of common stock for cash upon exercise of stock options 1 15 15 Issuance of common stock for settlement of RSUs 32 Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income 271 271 Net income 18,485 18,485 Balances at December 31, 2019 2,852 45,851 ( 489 ) 55,692 101,054 Issuance of common stock for settlement of RSUs 38 Shares withheld related to net share settlement ( 14 ) ( 2,369 ) ( 1,195 ) ( 3,564 ) Share-based compensation 6,536 6,536 Share repurchases ( 27 ) ( 6,298 ) ( 6,298 ) Other comprehensive income 1,416 1,416 Net income 29,146 29,146 Balances at December 31, 2020 2,849 50,018 927 77,345 128,290 Issuance of common stock for settlement of RSUs 45 Shares withheld related to net share settlement ( 17 ) ( 3,371 ) ( 2,144 ) ( 5,515 ) Share-based compensation 9,164 9,164 Share repurchases ( 136 ) ( 44,810 ) ( 44,810 ) Other comprehensive loss ( 1,620 ) ( 1,620 ) Net income 39,370 39,370 Balances at December 31, 2021 2,741 $ $ 55,811 $ ( 693 ) $ 69,761 $ 124,879 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Cash flows from operating activities Net income $ 39,370 $ 29,146 $ 18,485 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 7,967 6,862 5,741 Share-based compensation 9,164 6,536 4,836 Deferred income taxes 609 ( 1,192 ) ( 37 ) Other ( 127 ) 118 39 Changes in assets and liabilities: Accounts receivable ( 3,110 ) ( 1,512 ) ( 1,961 ) Prepaid expenses and other current assets ( 1,750 ) 135 47 Other assets ( 349 ) ( 34 ) 41 Accounts payable 1,436 ( 17 ) 113 Partners payable ( 12 ) 178 348 Accrued expenses and other current liabilities 3,357 ( 1,054 ) 7,300 Deferred revenue and deposits 187 108 123 Other liabilities 941 ( 527 ) 1,239 Net cash provided by operating activities 57,683 38,747 36,314 Cash flows from investing activities Purchases of property and equipment ( 18,567 ) ( 15,115 ) ( 15,102 ) Purchases of marketable securities ( 30,407 ) ( 33,930 ) ( 23,910 ) Sales of marketable securities 31,671 11,787 9,565 Maturities of marketable securities 10,915 13,984 10,152 Purchases of equity investments ( 47 ) ( 6,361 ) ( 61 ) Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 851 ) ( 388 ) ( 508 ) Other investing activities ( 284 ) ( 36 ) Net cash used in investing activities ( 7,570 ) ( 30,059 ) ( 19,864 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 5,515 ) ( 3,564 ) ( 2,337 ) Repurchases of Class A common stock ( 44,537 ) ( 6,272 ) ( 4,202 ) Principal payments on finance leases ( 677 ) ( 604 ) ( 552 ) Net change in overdraft in cash pooling entities 14 24 ( 223 ) Other financing activities ( 13 ) 124 15 Net cash used in financing activities ( 50,728 ) ( 10,292 ) ( 7,299 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash ( 474 ) 279 4 Net increase (decrease) in cash, cash equivalents, and restricted cash ( 1,089 ) ( 1,325 ) 9,155 Cash, cash equivalents, and restricted cash at beginning of the period 17,954 19,279 10,124 Cash, cash equivalents, and restricted cash at end of the period $ 16,865 $ 17,954 $ 19,279 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 16,601 $ 17,576 $ 19,079 Restricted cash, included in prepaid expenses and other current assets 149 241 8 Restricted cash, included in other assets 115 137 192 Total cash, cash equivalents, and restricted cash $ 16,865 $ 17,954 $ 19,279 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2021 2020 2019 Supplemental cash flow data Cash paid for income taxes, net $ 8,525 $ 4,229 $ 5,182 Non-cash investing and financing activities: Property and equipment in accounts payable and accrued expenses and other current liabilities $ 3,404 $ 2,201 $ 1,887 Acquisition of businesses in accrued expenses and other current liabilities and other liabilities $ 73 $ 118 $ Other current assets through financing arrangement in accrued expenses and other current liabilities $ 508 $ $ Repurchases of Class A common stock in accrued expenses and other current liabilities $ 340 $ 68 $ 43 See Accompanying Notes to Consolidated Financial Statements. META PLATFORMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business We were incorporated in Delaware in July 2004. In October 2021, we changed our corporate name from Facebook, Inc. to Meta Platforms, Inc. Our mission is to give people the power to build community and bring the world closer together. All of our products, including our apps, share the vision of helping to bring the metaverse to life. W e report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL) . The segment information aligns with how the chief operating decision maker (CODM), who is our Chief Executive Officer (CEO), reviews and manages the business. W e generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Meta Platforms, Inc., its subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill, intangible assets, and property and equipment, and their associated estimated useful lives, credit losses of available-for-sale (AFS) debt securities, credit losses of accounts receivable, fair value of financial instruments, and leases. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of selected cohorts of servers and network assets from three years to four years in prior years as well as in 2021 as a result of longer refresh cycles in our data centers. Prior year changes individually or in aggregate did not have a material impact to the consolidated financial statements. The effect of the 2021 changes was a reduction in depreciation expense of $ 620 million and an increase in net income of $ 516 million, or $ 0.18 per diluted share for the year ended December 31, 2021. The impact from the changes in our estimates was calculated based on the asset bases existing as of the effective dates of the changes and applying the revised estimated useful lives prospectively. Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition by applying the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. In general, we report advertising revenue on a gross basis, since we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers. For revenue generated from arrangements that involve third-party publishers, we evaluate whether we are the principal or the agent, and for those advertising revenue arrangements where we are the agent, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives, credits, or refunds, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We estimate these amounts and reduce revenue based on the amounts expected to be provided to customers. We believe that there will not be significant changes to our estimates of variable consideration. Reality Labs Revenue RL revenue is generated from the delivery of consumer hardware products, such as Meta Quest, Facebook Portal, and wearables, and related software and content. Revenue is recognized at the time control of the products is transferred to customers, which is generally at the time of delivery, in an amount that reflects the consideration RL expects to be entitled to in exchange for the products. Other Revenue Other revenue consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources. Deferred Revenue and Deposits Deferred revenue and deposits mostly consists of billings and payments we receive from marketers in advance of revenue recognition, revenue not yet recognized for unspecified software upgrades and updates for various RL products. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once the unused balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue and deposits balance for the year ended December 31, 2021 was driven by cash payments from customers in advance of satisfying our performance obligations in RL sales and advertising revenue, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We expense sales commissions when incurred if the amortization period is one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as depreciation expense from servers, network infrastructure and buildings, as well as payroll and related expenses which include share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions; RL cost of products sold; and content costs. Content Costs Our content costs are mostly related to payments to content providers from whom we license video and music to increase engagement on the platform. For licensed video, we expense the cost per title when the title is accepted and available for viewing if the capitalization criteria are not met. Video content costs that meet the criteria for capitalization were not material to date. For licensed music, we expense the license fees over the contractual license period. Expensed content costs are included in cost of revenue on the consolidated statements of income. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be marketed or sold to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Share-based Compensation Share-based compensation expense consists of the company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. We account for forfeitures as they occur. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses on the consolidated statements of income. We incurred advertising expenses of $ 2.99 billion, $ 2.26 billion, and $ 1.57 billion for the years ended December 31, 2021, 2020, and 2019, respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. We classify our marketable securities as available-for-sale (AFS) investments in our current assets because they represent investments of cash available for current operations. Our AFS investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. AFS debt securities with an amortized cost basis in excess of estimated fair value are assessed to determine what amount of that difference, if any, is caused by expected credit losses. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income, net on our consolidated statements of income, and any remaining unrealized losses, net of taxes, are included in accumulated other comprehensive income (loss) in stockholders' equity. The amounts of credit losses recorded for the years ended December 31, 2021 and 2020 were not material. There was no impairment charge for any unrealized losses in 2019. We determine realized gains or losses on sale of marketable securities on a specific identification method and include such gains or losses in interest and other income, net on the consolidated statements of income. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the consolidated balance sheets based upon the term of the remaining restrictions. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value from observable transactions for identical or similar investments of the same issuer as of the respective transaction dates. The change in carrying value, if any, is recognized in interest and other income, net on our consolidated statements of income. We periodically review our equity investments for impairment. If indicators exist and the estimated fair value of an investment is below the carrying amount, we will write down the investment to fair value. In addition, we also held equity investments accounted for under the equity method which were immaterial as of December 31, 2021 and 2020. Fair Value Measurements We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our cash equivalents and marketable securities are classified within Level 1 or Level 2 of the fair value hierarchy because their fair value is derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Our equity investments accounted for using the measurement alternative are recorded at fair value on a non-recurring basis. When indicators of impairment exist or observable price changes of qualified transactions occur, the respective equity investment would be classified within Level 3 of the fair value hierarchy because the valuation methods include a combination of the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates of expected credit and collectibility trends for the allowance for credit losses and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, reasonable and supportable forecasts of future economic conditions, and other factors that may affect our ability to collect from customers. Expected credit losses are recorded as general and administrative expenses on our consolidated statements of income. As of December 31, 2021 and 2020, the allowances for accounts receivable were immaterial. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, which are amortized, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment and amortization periods of finance lease right-of-use assets are described below: Property and Equipment Useful Life/ Amortization period Servers and network assets Four years Buildings 25 to 30 years Equipment and other One to 25 years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term We evaluate at least annually the recoverability of property and equipment for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount of property and equipment assets is not recoverable, and the asset's fair value is less than the carrying amount, an impairment charge is recognized. We have not recorded any material impairment charges during the years presented. The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. See section ""Use of Estimates"" above for additional information regarding changes in the estimated useful lives of our servers and network assets. Servers and network assets include property and equipment mostly in our data centers, which is used to support production traffic. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We have operating leases comprised of certain offices, data centers, land, colocations, network infrastructure, and other equipment. We also have finance leases for certain network infrastructure. We determine if an arrangement is a lease at inception. Most of our leases contain lease and non-lease components. Non-lease components include fixed payments for maintenance, utilities, real estate taxes, and management fees. We combine fixed lease and non-lease components and account for them as a single lease component. Our lease agreements may contain variable costs such as contingent rent escalations, common area maintenance, insurance, real estate taxes, or other costs. Such variable lease costs are expensed as incurred on the consolidated statements of income. For certain colocation and equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. For leases with a lease term greater than 12 months, ROU assets and lease liabilities are recognized on the consolidated balance sheets at the commencement date based on the present value of the remaining fixed lease payments and includes only payments that are fixed and determinable at the time of commencement. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be in a similar economic environment. Operating leases are included in operating lease ROU assets, operating lease liabilities, current, and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, net, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Operating lease costs are recognized on a straight-line basis over the lease terms. Finance lease assets are amortized on a straight-line basis over the shorter of the estimated useful lives of the assets or the lease terms. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world, and we regularly become subject to new laws and regulations in the jurisdictions in which we operate. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the merits of our defenses and the impact of negotiations, settlements, regulatory proceedings, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Certain factors, in particular, have resulted in significant changes to these estimates and judgments in prior quarters based on updated information available. For example, in certain jurisdictions where we operate, fines and penalties may be the result of new laws and preliminary interpretations regarding the basis of assessing damages, which may make it difficult to estimate what such fines and penalties would amount to if successfully asserted against us. In addition, certain government inquiries and investigations, such as matters before our lead European Union privacy regulator, the IDPC, are subject to review by other regulatory bodies before decisions can be finalized, which can lead to significant changes in the outcome of an inquiry. As a result of these and other factors, we reasonably expect that our estimates and judgments with respect to our contingencies may continue to be revised in future quarters. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill to reporting units based on the expected benefit from the business combination. Allocation of purchase consideration to identifiable assets and liabilities affects the amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite-lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Acquisition-related expenses are recognized separately from business combinations and are expensed as incurred. Goodwill and Intangibles Assets We allocate goodwill to reporting units based on the expected benefit from business combinations. We evaluate our reporting units annually, as well as when changes in our operating segments occur. For changes in reporting units, we reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. We have two reporting units subject to goodwill impairment testing. As of December 31, 2021, no impairment of goodwill has been identified. We evaluate the recoverability of finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation of these intangible assets are performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of finite-lived intangible assets is not recoverable, and the assets fair value is less than the carrying amount, an impairment charge is recognized. We have not recorded any material impairment charges during the years presented. Our finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. Indefinite-lived intangible assets are not amortized. If an indefinite-lived intangible asset is subsequently determined to have a finite useful life, the asset will be tested for impairment and accounted for as a finite-lived intangible asset prospectively over its estimated remaining useful life. We routinely review the remaining estimated useful lives of finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of stockholders' equity. As of December 31, 2021, we had a cumulative translation loss, net of tax of $ 677 million and as of December 31, 2020, we had a cumulative translation gain, net of tax of $ 439 million. Foreign currency transaction gains and losses from transactions denominated in a currency other than the functional currency of the subsidiary involved are recorded within interest and other income, net on our consolidated statements of income. Net losses resulting from foreign currency transactions were $ 140 million, $ 129 million, and $ 105 million for the years ended December 31, 2021, 2020, and 2019, respectively. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. The amount of credit losses recorded for the year ended December 31, 2021 was not material. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 41 %, 42 %, and 43 % of our revenue for the years ended December 31, 2021, 2020, and 2019, respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, Brazil, and Thailand. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses, and bad debt expense on these losses was not material during the years ended December 31, 2021, 2020, or 2019. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2021, 2020, and 2019. Recently Adopted Accounting Pronouncements On January 1, 2021, we adopted Accounting Standards Update (ASU) No. 2020-01, InvestmentsEquity Securities (Topic 321), InvestmentsEquity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) (ASU 2020-01), which clarifies the interaction of the accounting for equity securities under Topic 321, the accounting for equity method investments in Topic 323, and the accounting for certain forward contracts and purchased options in Topic 815. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2021, we early adopted ASU No. 2020-06, DebtDebt with Conversion and Other Options (Subtopic 470-20) and Derivatives and HedgingContracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entitys Own Equity (ASU 2020-06), which simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments. This guidance also eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. The new standard was effective for us beginning January 1, 2022, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2021, we early adopted ASU No. 2021-05, Leases (Topic 842): Lessors Certain Leases with Variable Lease Payments (ASU 2016-02), which requires a lessor to classify a lease with variable lease payments that do not depend on an index or rate as an operating lease if specified criteria are met. The new standard was effective for us beginning January 1, 2022, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Accounting Pronouncements Not Yet Adopted In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASU 2021-08), which clarifies that an acquirer of a business should recognize and measure contract assets and contract liabilities in a business combination in accordance with Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers (Topic 606) . This guidance will be effective for us in the first quarter of 2023 on a prospective basis, with early adoption permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. In November 2021, the FASB issued ASU No. 2021-10, Government Assistance (Topic 832): Disclosure by Business Entities about Government Assistance (ASU 2021-10), which improves the transparency of government assistance received by most business entities by requiring the disclosure of: (1) the types of government assistance received; (2) the accounting for such assistance; and (3) the effect of the assistance on a business entity's financial statements. This guidance will be effective for us in the year ended December 31, 2022, with early adoption permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source and by segment consists of the following (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 Advertising $ 114,934 $ 84,169 $ 69,655 Other revenue 721 657 541 Family of Apps $ 115,655 $ 84,826 $ 70,196 Reality Labs 2,274 1,139 501 Total revenue $ 117,929 $ 85,965 $ 70,697 Revenue disaggregated by geography, based on the addresses of our customers, consists of the following (in millions): Year Ended December 31, 2021 2020 2019 United States and Canada (1) $ 51,541 $ 38,433 $ 32,206 Europe (2) 29,057 20,349 16,826 Asia-Pacific 26,739 19,848 15,406 Rest of World (2) 10,592 7,335 6,259 Total revenue $ 117,929 $ 85,965 $ 70,697 _________________________ (1) United States revenue was $ 48.38 billion, $ 36.25 billion, and $ 30.23 billion for the years ended December 31, 2021, 2020, and 2019, respectively. (2) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Our total deferred revenue was $ 596 million and $ 371 million as of December 31, 2021 and 2020, respectively. As of December 31, 2021, we expect $ 517 million of our deferred revenue to be realized in less than a year. Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method. As the liquidation and dividend rights for both Class A and Class B common stock are identical, the undistributed earnings are allocated on a proportionate basis to the weighted-average number of common shares outstanding for the period. Basic EPS is computed by dividing net income by the weighted-average number of shares of our Class A and Class B common stock outstanding. For the calculation of diluted EPS, net income for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS is computed by dividing the resulting net income by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2021, 2020, and 2019. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, 2021 2020 2019 Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 33,328 $ 6,042 $ 24,607 $ 4,539 $ 15,569 $ 2,916 Denominator Shares used in computation of basic earnings per share 2,383 432 2,407 444 2,404 450 Basic EPS $ 13.99 $ 13.99 $ 10.22 $ 10.22 $ 6.48 $ 6.48 Diluted EPS: Numerator Net income $ 33,328 $ 6,042 $ 24,607 $ 4,539 $ 15,569 $ 2,916 Reallocation of net income as a result of conversion of Class B to Class A common stock 6,042 4,539 2,916 Reallocation of net income to Class B common stock ( 93 ) ( 58 ) ( 18 ) Net income for diluted EPS $ 39,370 $ 5,949 $ 29,146 $ 4,481 $ 18,485 $ 2,898 Denominator Shares used in computation of basic earnings per share 2,383 432 2,407 444 2,404 450 Conversion of Class B to Class A common stock 432 444 450 Weighted-average effect of dilutive RSUs 44 37 22 1 Shares used in computation of diluted earnings per share 2,859 432 2,888 444 2,876 451 Diluted EPS $ 13.77 $ 13.77 $ 10.09 $ 10.09 $ 6.43 $ 6.43 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, 2021 2020 Cash and cash equivalents: Cash $ 7,308 $ 6,488 Money market funds 8,850 9,755 U.S. government securities 25 1,016 U.S. government agency securities 108 Certificates of deposit and time deposits 250 305 Corporate debt securities 60 12 Total cash and cash equivalents 16,601 17,576 Marketable securities: U.S. government securities 10,901 20,921 U.S. government agency securities 5,927 11,698 Corporate debt securities 14,569 11,759 Total marketable securities 31,397 44,378 Total cash and cash equivalents and marketable securities $ 47,998 $ 61,954 The gross unrealized gains on our marketable securities were not material and $ 641 million as of December 31, 2021 and 2020, respectively. The gross unrealized losses and the allowance for credit losses on our marketable securities were not material as of December 31, 2021 and 2020. The following table classifies our marketable securities by contractual maturities (in millions): December 31, 2021 Due within one year $ 3,352 Due after one year to five years 28,045 Total $ 31,397 Note 5. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable fair values. On July 7, 2020, we completed our equity investment in Jio Platforms Limited (Jio), a subsidiary of Reliance Industries Limited, for $ 5.82 billion. The following table summarizes our equity investments that were measured using measurement alternative and equity method (in millions): December 31, 2021 2020 Equity investments under measurement alternative: Initial cost $ 6,480 $ 6,171 Cumulative upward adjustments 311 26 Cumulative impairment/downward adjustments ( 50 ) ( 25 ) Carrying value 6,741 6,172 Equity investments under equity method 34 62 Total equity investments $ 6,775 $ 6,234 Note 6. Fair Value Measurements The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2021 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents: Money market funds $ 8,850 $ 8,850 $ U.S. government securities 25 25 U.S. government agency securities 108 108 Certificates of deposit and time deposits 250 250 Corporate debt securities 60 60 Marketable securities: U.S. government securities 10,901 10,901 U.S. government agency securities 5,927 5,927 Corporate debt securities 14,569 14,569 Total cash equivalents and marketable securities $ 40,690 $ 25,811 $ 14,879 Fair Value Measurement at Reporting Date Using Description December 31, 2020 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Cash equivalents: Money market funds $ 9,755 $ 9,755 $ U.S. government securities 1,016 1,016 Certificates of deposit and time deposits 305 305 Corporate debt securities 12 12 Marketable securities: U.S. government securities 20,921 20,921 U.S. government agency securities 11,698 11,698 Corporate debt securities 11,759 11,759 Total cash equivalents and marketable securities $ 55,466 $ 43,390 $ 12,076 We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. We also have assets and liabilities classified within Level 3 because factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. As of December 31, 2021, included in the total $ 6.78 billion of equity investments, $ 913 million was measured at fair value and was classified within Level 3 of the fair value measurement hierarchy on a non-recurring basis. As of December 31, 2020, our Level 3 equity investments were not material. For information regarding equity investments, see Note 5 Equity Investments. Note 7. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, 2021 2020 Land $ 1,688 $ 1,326 Servers and network assets 25,584 20,544 Buildings 22,531 17,360 Leasehold improvements 5,795 4,321 Equipment and other 4,764 3,917 Finance lease right-of-use assets 2,840 2,295 Construction in progress 14,687 11,288 Property and equipment, gross 77,889 61,051 Less: Accumulated depreciation ( 20,080 ) ( 15,418 ) Property and equipment, net $ 57,809 $ 45,633 Construction in progress includes costs mostly related to construction of data centers, network infrastructure, and office buildings. Prior year balances of certain property and equipment categories have been reclassified to conform to the current year's presentation. Depreciation expense on property and equipment was $ 7.56 billion, $ 6.39 billion, and $ 5.18 billion for the years ended December 31, 2021, 2020, and 2019, respectively. The majority of the property and equipment depreciation expense was from servers and network assets depreciation of $ 4.94 billion, $ 4.38 billion, and $ 3.69 billion for the years ended December 31, 2021, 2020, and 2019, respectively. Note 8. Leases We have entered into various non-cancelable operating lease agreements mostly for certain of our offices, data centers, colocations, and land. We have also entered into various non-cancelable finance lease agreements for certain network infrastructure. Our leases have original lease periods expiring between 2022 and 2093. Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs are as follows (in millions): Year Ended December 31, 2021 2020 2019 Finance lease cost Amortization of right-of-use assets $ 344 $ 259 $ 195 Interest 15 14 12 Operating lease cost 1,540 1,391 1,139 Variable lease cost and other, net 272 269 160 Total lease cost $ 2,171 $ 1,933 $ 1,506 Supplemental balance sheet information related to leases is as follows: December 31, 2021 2020 Weighted-average remaining lease term Finance leases 13.9 years 14.9 years Operating leases 13.0 years 12.2 years Weighted-average discount rate Finance leases 2.7 % 2.9 % Operating leases 2.8 % 3.1 % The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2021 (in millions): Operating Leases Finance Leases 2022 $ 1,425 $ 90 2023 1,542 65 2024 1,513 45 2025 1,354 45 2026 1,295 45 Thereafter 9,995 406 Total undiscounted cash flows 17,124 696 Less: Imputed interest ( 3,251 ) ( 115 ) Present value of lease liabilities $ 13,873 $ 581 Lease liabilities, current $ 1,127 $ 75 Lease liabilities, non-current 12,746 506 Present value of lease liabilities $ 13,873 $ 581 The table above does not include lease payments that were not fixed at commencement or lease modification. As of December 31, 2021, we have additional operating and finance leases, that have not yet commenced, with lease obligations of approximately $ 8.34 billion and $ 1.62 billion, respectively, mostly for offices, data centers, and network infrastructure. These operating and finance leases will commence between 2022 and 2028 with lease terms of greater than one year to 30 years. Supplemental cash flow information related to leases is as follows (in millions): Year Ended December 31, 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows for operating leases $ 1,406 $ 1,208 $ 902 Operating cash flows for finance leases $ 15 $ 14 $ 12 Financing cash flows for finance leases $ 677 $ 604 $ 552 Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 4,466 $ 1,158 $ 5,081 Finance leases $ 160 $ 121 $ 193 Note 9. Goodwill and Intangible Assets During the year ended December 31, 2021, we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, individually and in aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2021 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. Changes in the carrying amount of goodwill by reportable segment for the years ended December 31, 2021 and 2020 are as follows (in millions): Family of Apps Reality Labs Total Balance as of December 31, 2019 $ 18,715 Acquisitions 322 Effect of currency translation adjustment 13 Balance as of December 31, 2020 19,050 Acquisitions 210 Adjustments/transfer ( 191 ) Effect of currency translation adjustment ( 4 ) Segment allocation in the fourth quarter of 2021 (1) $ 18,455 $ 610 19,065 Acquisitions in the fourth quarter of 2021 128 128 Effect of currency translation adjustment 3 1 4 Balance as of December 31, 2021 $ 18,458 $ 739 $ 19,197 _________________________ (1) Represents reallocation of goodwill as a result of our change in segments in the fourth quarter of 2021. See Note 15 Segment and Geographical Information for further details. The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2021 December 31, 2020 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 0.0 $ 2,057 $ ( 2,057 ) $ $ 2,057 $ ( 1,840 ) $ 217 Acquired technology 2.6 1,412 ( 1,169 ) 243 1,297 ( 1,088 ) 209 Acquired patents 3.4 827 ( 722 ) 105 805 ( 677 ) 128 Trade names 3.0 644 ( 633 ) 11 636 ( 622 ) 14 Other 12.1 176 ( 167 ) 9 223 ( 168 ) 55 Total finite-lived assets 5,116 ( 4,748 ) 368 5,018 ( 4,395 ) 623 Total indefinite-lived assets N/A 266 266 Total intangible assets, net $ 5,382 $ ( 4,748 ) $ 634 $ 5,018 $ ( 4,395 ) $ 623 Amortization expense of intangible assets for the years ended December 31, 2021, 2020, and 2019 was $ 407 million, $ 473 million, and $ 562 million, respectively. As of December 31, 2021, expected amortization expense for the unamortized finite-lived intangible assets for the next five years and thereafter is as follows (in millions): 2022 $ 164 2023 103 2024 61 2025 18 2026 13 Thereafter 9 Total $ 368 Note 10. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, 2021 2020 Legal-related accruals (1) $ 3,254 $ 1,622 Accrued compensation and benefits 3,152 2,609 Accrued property and equipment 1,392 1,414 Accrued taxes 1,256 2,038 Other current liabilities 5,258 3,469 Accrued expenses and other current liabilities $ 14,312 $ 11,152 _________________________ (1) Includes accruals for estimated fines, settlements, or other losses in connection with legal and related matters, as well as other legal fees. For further information, see Legal and Related Matters in Note 11 Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, 2021 2020 Income tax payable $ 5,938 $ 5,025 Other liabilities 1,289 1,389 Other liabilities $ 7,227 $ 6,414 Note 11. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Meta Platforms, Inc. Other Contractual Commitments We have $ 23.08 billion of non-cancelable contractual commitments as of December 31, 2021, which are primarily related to our investments in servers, network infrastructure, and Reality Labs. These commitments are primarily due within five years . Legal and Related Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. On December 20, 2021, the district court granted our motion to dismiss the third amended complaint, with prejudice. On January 17, 2022, the plaintiffs filed a notice of appeal of the order dismissing their case. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. We entered into a settlement and modified consent order to resolve the FTC inquiry, which took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $ 5.0 billion which was paid in April 2020 upon the effectiveness of the modified consent order. The state attorneys general inquiry and certain government inquiries in other jurisdictions remain ongoing. On July 16, 2021, a stockholder derivative action was filed in Delaware Chancery Court against certain of our directors and officers asserting breach of fiduciary duty and related claims relating to our historical platform and user data practices, as well as our settlement with the FTC. On July 20, 2021, other stockholders filed an amended derivative complaint in a related Delaware Chancery Court action, asserting breach of fiduciary duty and related claims against certain of our current and former directors and officers in connection with our historical platform and user data practices. On November 4, 2021, the lead plaintiffs filed a second amended and consolidated complaint in the stockholder derivative action. We believe the lawsuits described above are without merit, and we are vigorously defending them. We also notify the Irish Data Protection Commission (IDPC), our lead European Union privacy regulator under the General Data Protection Regulation (GDPR), of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations by the IDPC and other European regulators regarding various aspects of our regulatory compliance. The GDPR is still a relatively new law and draft decisions in investigations by the IDPC are subject to review by other European privacy regulators as part of the GDPR's consistency mechanism, which may lead to significant changes in the final outcome of such investigations. As a result, the interpretation and enforcement of the GDPR, as well as the imposition and amount of penalties for non-compliance, are subject to significant uncertainty. Although we are vigorously defending our regulatory compliance, we have accrued significant amounts for loss contingencies related to these inquiries and investigations in Europe, and we believe there is a reasonable possibility that additional accruals for losses related to these matters could be material in the aggregate. We are also subject to other government inquiries and investigations relating to our business activities and disclosure practices. For example, beginning in September 2021, we became subject to government investigations and requests relating to a former employee's allegations and release of internal company documents concerning, among other things, our algorithms, advertising and user metrics, and content enforcement practices, as well as misinformation and other undesirable activity on our platform, and user well-being. Beginning on October 27, 2021, multiple putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the same matters. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil, Russia, and other countries in Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. For example, we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as our acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act, including by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleged that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The complaints of the FTC and attorneys general both sought a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. On June 28, 2021, the court granted our motions to dismiss the complaints filed by the FTC and attorneys general, dismissing the FTC's complaint with leave to amend and dismissing the attorneys general's case without prejudice. On July 28, 2021, the attorneys general filed a notice of appeal of the order dismissing their case. On August 19, 2021, the FTC filed an amended complaint, and on October 4, 2021, we filed a motion to dismiss this amended complaint. On January 11, 2022, the court denied our motion to dismiss the FTC's amended complaint. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking damages and unspecified injunctive relief. Several of the cases brought on behalf of certain advertisers and users were consolidated in the U.S. District Court for the Northern District of California. On January 14, 2022, the court granted, in part, and denied, in part, our motion to dismiss the consolidated actions. We believe these lawsuits are without merit, and we are vigorously defending them. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these other legal proceedings, claims, regulatory, tax, or government inquiries and investigations, and other matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. The ultimate outcome of the legal and related matters described in this section, such as whether the likelihood of loss is remote, reasonably possible, or probable, or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of loss, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 14 Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2021, there was not a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2021. Note 12. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2021, we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2021, we have not declared any dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2021, there were 2,328 million shares of Class A common stock and 413 million shares of Class B common stock issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2020, $ 8.60 billion remained available and authorized for repurchases under this program. In January 2021 and October 2021, additional $ 25.0 billion and $ 50.0 billion of repurchases were authorized under this program, respectively. In 2021, we repurchased and subsequently retired 136 million shares of our Class A common stock for an aggregate amount of $ 44.81 billion. As of December 31, 2021, $ 38.79 billion remained available and authorized for repurchases. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans Since 2020, we have maintained one active share-based employee compensation plan, the 2012 Equity Incentive Plan, which was amended in each of June 2016, February 2018 (Amended 2012 Plan). Our Amended 2012 Plan provides for the issuance of incentive and nonqualified stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors, and consultants. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our stock plan are added to the reserves of the Amended 2012 Plan. As of December 31, 2021, there were 116 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. Pursuant to the automatic increase provision under our Amended 2012 Plan, the number of shares reserved for issuance increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 20 million shares of Class A common stock reserved for issuance effective January 1, 2022. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2021: Number of Shares Weighted-Average Grant Date Fair Value Per Share (in thousands) Unvested at December 31, 2020 96,733 $ 181.88 Granted 59,127 $ 305.40 Vested ( 44,574 ) $ 198.95 Forfeited ( 12,438 ) $ 211.58 Unvested at December 31, 2021 98,848 $ 244.32 The weighted-average grant date fair value of RSUs granted in the years ended December 31, 2020 and 2019 was $ 188.73 and $ 173.66 , respectively. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2021, 2020, and 2019 was $ 14.42 billion, $ 9.38 billion, and $ 6.01 billion, respectively. The income tax benefit recognized related to awards vested or exercised during the years ended December 31, 2021, 2020, and 2019 was $ 3.08 billion, $ 1.81 billion, and $ 0.98 billion, respectively. As of December 31, 2021, there was $ 22.77 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 13. Interest and Other Income, Net The following table presents the detail of interest and other income, net (in millions): Year Ended December 31, 2021 2020 2019 Interest income, net $ 461 $ 672 $ 904 Foreign currency exchange losses, net ( 140 ) ( 129 ) ( 105 ) Other income (expense), net 210 ( 34 ) 27 Interest and other income, net $ 531 $ 509 $ 826 Note 14. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, 2021 2020 2019 Domestic $ 43,669 $ 24,233 $ 5,317 Foreign 3,615 8,947 19,495 Income before provision for income taxes $ 47,284 $ 33,180 $ 24,812 The provision for income taxes consists of the following (in millions): Year Ended December 31, 2021 2020 2019 Current: Federal $ 4,971 $ 3,297 $ 4,321 State 548 523 565 Foreign 1,786 1,211 1,481 Total current tax expense 7,305 5,031 6,367 Deferred: Federal 585 ( 859 ) ( 39 ) State 43 ( 122 ) 19 Foreign ( 19 ) ( 16 ) ( 20 ) Total deferred tax (benefits)/expense 609 ( 997 ) ( 40 ) Provision for income taxes $ 7,914 $ 4,034 $ 6,327 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, 2021 2020 2019 U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 % State income taxes, net of federal benefit 1.0 0.8 1.8 Share-based compensation 0.5 0.2 4.5 Excess tax benefits related to share-based compensation ( 2.2 ) ( 1.6 ) ( 0.7 ) Research and development tax credits ( 1.3 ) ( 1.3 ) ( 0.8 ) Foreign-derived intangible income deduction ( 3.5 ) ( 1.9 ) Effect of non-U.S. operations 0.9 ( 2.4 ) ( 5.8 ) Non-deductible FTC settlement accrual 4.5 Research and development capitalization ( 3.0 ) Other 0.3 0.4 1.0 Effective tax rate 16.7 % 12.2 % 25.5 % Our deferred tax assets (liabilities) are as follows (in millions): December 31, 2021 2020 Deferred tax assets: Net operating loss carryforward $ 2,443 $ 2,437 Tax credit carryforward 1,385 1,055 Share-based compensation 319 243 Accrued expenses and other liabilities 1,195 1,108 Lease liabilities 2,597 2,058 Capitalized research and development 1,691 1,922 Other 449 340 Total deferred tax assets 10,079 9,163 Less: valuation allowance ( 1,586 ) ( 1,218 ) Deferred tax assets, net of valuation allowance 8,493 7,945 Deferred tax liabilities: Depreciation and amortization ( 4,425 ) ( 3,811 ) Right-of-use assets ( 2,339 ) ( 1,876 ) Total deferred tax liabilities ( 6,764 ) ( 5,687 ) Net deferred tax assets $ 1,729 $ 2,258 The valuation allowance was approximately $ 1.59 billion and $ 1.22 billion as of December 31, 2021 and 2020, respectively, primarily relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2021, the U.S. federal and state net operating loss carryforwards were $ 10.61 billion and $ 2.11 billion, which will begin to expire in 2028 and 2027, respectively, if not utilized. We have federal tax credit carryforwards of $ 527 million, which will begin to expire in 2029, if not utilized, and state tax credit carryforwards of $ 3.18 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, 2021 2020 2019 Gross unrecognized tax benefits beginning of period $ 8,692 $ 7,863 $ 4,678 Increases related to prior year tax positions 328 356 2,309 Decreases related to prior year tax positions ( 86 ) ( 253 ) ( 525 ) Increases related to current year tax positions 963 1,045 1,402 Decreases related to settlements of prior year tax positions ( 90 ) ( 319 ) ( 1 ) Gross unrecognized tax benefits end of period $ 9,807 $ 8,692 $ 7,863 These unrecognized tax benefits were primarily accrued for the uncertainties related to transfer pricing with our foreign subsidiaries, which include licensing of intellectual property, providing services and other transactions, as well as for the uncertainties with our research tax credits. During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2021 and 2020 were $ 960 million and $ 774 million, respectively. If the balance of gross unrecognized tax benefits of $ 9.81 billion as of December 31, 2021 were realized in a future period, this would result in a tax benefit of $ 5.70 billion within our provision of income taxes at such time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2019 tax years and by the Irish tax authorities for our 2016 through 2018 tax years. Our 2020 and subsequent tax years remain open to examination by the IRS. Our 2019 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010 and has done so in years covered by the second Notice described below. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS's amendment to answer was filed stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first session of the trial was completed in March 2020 and a second session commenced in October 2021. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes (ASC 740), that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act. As of December 31, 2021, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 15. Segment and Geographical Information Beginning in the fourth quarter of 2021, we report our financial results based on two reportable segments: Family of Apps (FoA) and Reality Labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp, and other services. RL includes augmented and virtual reality related consumer hardware, software, and content. As of December 31, 2021 , our operating segments are the same as our reportable segments. The CODM, who is our CEO, allocates resources to and assesses the performance of each operating segment using information about the operating segment's revenue and income (loss) from operations. The CODM does not evaluate operating segments using asset or liability information. Revenue and costs and expenses are generally directly attributed to our segments. These costs and expenses include certain product development related operating expenses, costs associated with the partnership arrangements, consumer hardware product costs, content costs, and legal-related costs. Indirect costs are allocated to segments based on a reasonable allocation methodology, when such costs are significant to the performance measures of the operating segments. Indirect cost of revenue is allocated to our segments based on usage, such as costs related to the operation of our data centers and technical infrastructure. Indirect operating expenses, such as facilities, information technology, certain shared research and development activities, recruiting, and physical security expenses, are mostly allocated based on headcount. The following table sets forth our segment information of revenue and income (loss) from operations (in millions). For comparative purposes, amounts in prior periods have been recast: Year Ended December 31, 2021 2020 2019 Revenue: Family of Apps $ 115,655 $ 84,826 $ 70,196 Reality Labs 2,274 1,139 501 Total revenue $ 117,929 $ 85,965 $ 70,697 Income (loss) from operations: Family of Apps $ 56,946 $ 39,294 $ 28,489 Reality Labs ( 10,193 ) ( 6,623 ) ( 4,503 ) Total income from operations $ 46,753 $ 32,671 $ 23,986 For information regarding revenue disaggregated by geography, see Note 2 Revenue. The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets (in millions): December 31, 2021 2020 United States $ 55,497 $ 43,128 Rest of the world (1) 14,467 11,853 Total long-lived assets $ 69,964 $ 54,981 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2021, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2021 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2021 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +1,fb-2,20201231," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook and build community, including Facebook News Feed, Stories, Groups, Shops, Marketplace, News, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, and connect with and shop from their favorite businesses and creators. They can do this through Instagram Feed, Stories, Reels, IGTV, Live, Shops, and messaging. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices through chat, video, and Rooms. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate and transact in a private way. Facebook Reality Labs. Facebook Reality Labs' augmented and virtual reality products help people feel connected, anytime, anywhere. Oculus Quest lets people defy distance with cutting-edge virtual reality (VR) hardware, software, and content, while Portal helps friends and families stay connected and share the moments that matter in meaningful ways. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies providing connection and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Google, Apple, YouTube, Tencent, Snap, Twitter, ByteDance, Microsoft, and Amazon. We compete to attract, engage, and retain people who use our products, to attract and retain businesses who use our free or paid business and advertising services, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video and VR increases, and as we deepen our investment in new technologies like artificial intelligence, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate in more than 80 cities around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, many of which are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These laws and regulations involve matters including privacy, data use, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, e-commerce, taxation, economic or other trade prohibitions or sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices, or otherwise relating to content that is made available on our products, could adversely affect our financial results. In the United States, there have been, and continue to be, various efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and any such changes may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect our business and financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. For example, the Privacy Shield, a transfer framework we relied upon for data transferred from the European Union to the United States, was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Facebook relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. In August 2020, we received a preliminary draft decision from the Irish Data Protection Commission (IDPC) that preliminarily concluded that Facebook Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020. While we also rely upon alternative legal bases for data transfers, if a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or validly rely upon other alternative means of data transfers from Europe to the United States, we may be unable to operate material portions of our business in Europe as a result of the CJEU's invalidation of the Privacy Shield and any final decision of IDPC, which would materially and adversely affect our business, financial condition, and results of operations. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. The Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements similar to GDPR on products and services offered to users in Brazil. The California Consumer Privacy Act, which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users. In addition, effective December 2020, the European Union's ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are also currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into with the U.S. Federal Trade Commission (FTC), which took effect in April 2020 and, among other matters, requires us to implement a comprehensive expansion of our privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. For additional information about government regulation applicable to our business, see Part I, Item 1A, ""Risk Factors"" in this Annual Report on Form 10-K. Human Capital At Facebook, we design products to bring the world closer together, one connection at a time. As a company, we believe that people are at the heart of every connection we build. We are proud of our unique company culture where ideas, innovation, and impact win, and we work hard to build strong teams across engineering, product design, marketing, and other areas to further our mission. We had a global workforce of 58,604 employees as of December 31, 2020, which represents a 30% year-over-year increase in employee headcount. We expect headcount growth to continue for the foreseeable future, particularly as we continue to focus on recruiting employees in technical functions. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. Our headquarters are located in Menlo Park, California and we have offices in more than 80 cities around the globe. The vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, and in the long term, we expect some personnel to transition to working remotely on a regular basis. Diversity and Inclusion Diversity and inclusion are core to our work at Facebook. We seek to build a diverse and inclusive workplace where we can leverage our collective cognitive diversity to build the best products and make the best decisions for the global community we serve. While we have made progress, we still have more work to do. We publish our global gender diversity and U.S. ethnic diversity workforce data annually. In 2020, we announced that as of June 30, 2020, our global employee base was comprised of 37% females and 63% males, and our U.S. employee base was comprised of the following ethnicities: 44.4% Asian, 41% White, 6.3% Hispanic, 4% two or more ethnicities, 3.9% Black, and 0.4% additional groups (including American Indian or Alaska Native and Native Hawaiian or Other Pacific Islander). We also announced our goals to have 50% of our workforce made up of underrepresented populations by 2024, and to increase the representation of people of color in leadership positions in the United States, including Black leadership, by 30% from 2020 to 2025. We will also continue our ongoing efforts to increase the representation of women in leadership. We work to support our goals of diversifying our workforce through recruiting, retention, people development, and inclusion. We employ our Diverse Slate Approach in our global recruitment efforts, which ensures that teams and hiring managers have the opportunity to consider qualified people from underrepresented groups for open roles. We have seen steady increases in hiring rates of people from underrepresented groups since we started testing this approach in 2015. We also continue to provide diversity and inclusion training for our recruiting team and develop inclusive internship programs. Facebook University, our training program for college freshmen and sophomores with an interest in Computer Science, also utilizes a proactive and inclusive approach to promote participation by people from underrepresented groups. To help build community among our people and support their professional development, we invest in our internal Facebook Resource Groups and our annual Community events such as Women's Community Summit, Black Community Summit, Latin Community Summit, and Pride Community Summit. We also offer Managing Unconscious Bias, Managing Inclusion, and Be the Ally trainings to promote an inclusive workplace by helping people understand the issues that affect underrepresented communities and how to reduce the effects of bias in the workplace. Compensation and Benefits We offer competitive compensation to attract and retain the best people, and we help care for our people so they can focus on our mission. Our employees' total compensation package includes market-competitive salary, bonuses or sales commissions, and equity. We generally offer full-time employees equity at the time of hire and through annual equity grants because we want them to be owners of the company and committed to our long-term success. We have conducted pay equity analyses for many years, and continue to be committed to pay equity. In 2020, we announced that our analyses indicate that we continue to have pay equity across gender globally and race in the United States for people in similar jobs, accounting for factors such as location, role, and level. Through Life@ Facebook, our holistic approach to benefits, we provide our employees and their loved ones resources to help them thrive. We offer a wide range of benefits across areas such as health, family, finance, community, and time away, including healthcare and wellness benefits, adoption and surrogacy assistance, family care resources, a 401(k) plan, access to tax and legal services, Facebook Resource Groups to build community at Facebook, family leave, and paid time off. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and about.fb.com/news/ websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Summary Risk Factors Our business is subject to a number of risks, including risks that may prevent us from achieving our business objectives or may adversely affect our business, financial condition, results of operations, cash flows, and prospects. These risks are discussed more fully below and include, but are not limited to, risks related to: Risks Related to Our Product Offerings our ability to add and retain users and maintain levels of user engagement with our products; the loss of, or reduction in spending by, our marketers; reduced availability of data signals used by our ad targeting and measurement tools; ineffective operation with mobile operating systems or changes in our relationships with mobile operating system partners; failure of our new products, or changes to our existing products, to attract or retain users or generate revenue; Risks Related to Our Business Operations and Financial Results the COVID-19 pandemic, including its impact on our advertising business; our ability to compete effectively; unfavorable media coverage and other risks affecting our ability to maintain and enhance our brands; volatile or slower user and revenue growth rates in the future; acquisitions and our ability to successfully integrate our acquisitions; our ability to build, maintain, and scale our technical infrastructure, and risks associated with disruptions in our service; operating our business in multiple countries around the world; litigation, including class action lawsuits; Risks Related to Government Regulation and Enforcement government restrictions on access to Facebook or our other products, or other actions that impair our ability to sell advertising, in their countries; complex and evolving U.S. and foreign privacy, data use and data protection, content, competition, consumer protection, and other laws and regulations; the impact of government investigations, enforcement actions, and settlements, including litigation and investigations by privacy and competition authorities; our ability to comply with regulatory and legislative privacy requirements, including our consent order with the Federal Trade Commission; Risks Related to Data, Security, and Intellectual Property the occurrence of security breaches, improper access to or disclosure of our data or user data, and other cyber incidents or undesirable activity on our platform; our ability to obtain, maintain, protect, and enforce our intellectual property rights; and Risks Related to Ownership of Our Class A Common Stock limitations on the ability of holders of our Class A Common Stock to influence corporate matters due to the dual class structure of our common stock and the control of a majority of the voting power of our outstanding capital stock by our founder, Chairman, and CEO. Risks Related to Our Product Offerings If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen user growth and engagement returning to pre-pandemic trends, and in each of the third and fourth quarters of 2020, we experienced slight declines on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and we expect these trends to continue to be subject to volatility. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products, or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, concerns about the nature of content made available on our products, or concerns related to privacy, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, government and regulatory authorities, or litigation that adversely affect our products or users; we are unable to operate material portions of our business in Europe, or are otherwise limited in such operations, as a result of European regulators, courts, or legislative bodies determining that our reliance on Standard Contractual Clauses (SCCs) or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; there is decreased engagement with our products, or failure to accept our terms of service, as part of privacy-focused changes that we have implemented or may implement in the future, whether voluntarily, in connection with the General Data Protection Regulation (GDPR), the European Union's ePrivacy Directive, the California Consumer Privacy Act (CCPA), or other laws, regulations, or regulatory actions, or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising, or take actions to enforce our policies, that are perceived negatively by our users or the general public, including as a result of decisions or recommendations from the independent Oversight Board regarding content on our platform; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, particularly for our significant revenue-generating products like Facebook and Instagram, our revenue and financial results may be adversely affected. Any significant decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of increased usage of the Stories format or our messaging products; reductions of advertising by marketers due to our efforts to implement or enforce advertising policies that protect the security and integrity of our platform; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated, or otherwise more effective products; limitations on our ability to operate material portions of our business in Europe as a result of European regulators, courts, or legislative bodies determining that our reliance on SCCs or other legal bases we rely upon to transfer user data from the European Union to the United States is invalid; changes in our marketing and sales or other operations that we are required to or elect to make as a result of risks related to complying with foreign laws or regulatory requirements or other government actions; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, our efforts to implement or enforce policies relating to content on our products (including as a result of decisions or recommendations from the independent Oversight Board), developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content made available on our products by third parties, questions about our user data practices, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations (for example, a number of marketers announced that they paused advertising with us in July 2020 due to concerns about content on our products); the effectiveness of our ad targeting or degree to which users opt out of the use of data for ads, including as a result of product changes and controls that we have implemented or may implement in the future in connection with the GDPR, ePrivacy Directive, California Consumer Privacy Act (CCPA), other laws, regulations, or regulatory actions, or otherwise, that impact our ability to use data for advertising purposes; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; the success of technologies designed to block the display of ads or ad measurement tools; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. For example, macroeconomic conditions have affected, and may in the future affect, marketers' ability or willingness to spend with us, as we have seen with the regional and worldwide economic disruption related to the COVID-19 pandemic and associated declines in advertising activity on our products. The effects of the pandemic previously resulted in reduced demand for our ads, a related decline in pricing of our ads, and additional demands on our technical infrastructure as a result of increased usage of our services, and any similar occurrences in the future may impair our ability to maintain or increase the quantity or quality of ads shown to users and adversely affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory developments, such as the GDPR, ePrivacy Directive, and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In particular, we have seen an increasing number of users opt out of certain types of ad targeting in Europe following adoption of the GDPR, and we have introduced product changes that limit data signal use for certain users in California following adoption of the CCPA. Regulatory guidance or decisions or new legislation may require us to make additional changes to our products in the future that further reduce our ability to use these signals. In addition, mobile operating system and browser providers, such as Apple and Google, have announced product changes as well as future plans to limit the ability of application developers to collect and use these signals to target and measure advertising. For example, in June 2020, Apple announced that it plans to make certain changes to its products and data use policies in connection with the release of its iOS 14 operating system that will reduce our and other iOS developers' ability to target and measure advertising, which we expect will in turn reduce the budgets marketers are willing to commit to us and other advertising platforms. In addition, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of certain product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform, and negatively impacted our advertising revenue, and if we are unable to mitigate these developments as they take further effect in the future, our targeting and measurement capabilities will be materially and adversely affected, which would in turn significantly impact our future advertising revenue growth. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and more recently announced changes to iOS 14 that will limit our ability to target and measure ads effectively. We expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers, and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, other business partners, or advertisers, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. We have in the past experienced challenges in operating with mobile operating systems, networks, technologies, products, and standards that we do not control, and any such occurrences in the future may negatively impact our user growth, engagement, and monetization on mobile devices, which may in turn materially and adversely affect our business and financial results. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny, litigation, or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we are moving forward with plans to implement end-to-end encryption across our messaging services, as well as facilitate cross-app communication between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which reduces our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook or our other products. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we previously introduced the Stories format, which we do not currently monetize at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, data use, encryption, content, advertising, competition, and other issues, including actions or decisions in connection with elections or the COVID19 pandemic, which has in the past adversely affected, and may in the future adversely affect, our reputation and brands. For example, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the pandemic or elections in the United States and around the world, by decisions or recommendations regarding content on our platform from the independent Oversight Board, or by our decisions to remove content or suspend participation on our platform by persons who violate our community standards or terms of service. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data and concerns around our handling of political speech and advertising, hate speech, and other content, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we conduct investigations and audits of platform applications from time to time, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Risks Related to Our Business Operations and Financial Results The COVID-19 pandemic has had, and may in the future have, a significant adverse impact on our advertising revenue and also exposes our business to other risks. The COVID-19 pandemic has resulted in authorities implementing numerous preventative measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas, both regionally and worldwide, which have significantly impacted our business and results of operations. For example, in the second quarter of 2020, our advertising revenue grew 10% year-over-year, which was the slowest growth rate for any fiscal quarter since our initial public offering. While our advertising revenue growth rate improved in subsequent quarters, there can be no assurance that it will not decrease again as a result of the effects of the pandemic. In addition, we believe that the pandemic has contributed to an acceleration in the shift of commerce from offline to online, as well as increasing consumer demand for purchasing products as opposed to services, which in turn have increased demand for our advertising services; however, it is possible that this increased demand may not continue in future periods and may even recede as the effects of the pandemic subside, which could adversely affect our advertising revenue growth. The demand for and pricing of our advertising services may be materially and adversely impacted by the pandemic for the foreseeable future, and we are unable to predict the duration or degree of such impact with any certainty. In addition to the impact on our advertising business, the pandemic exposes our business, operations, and workforce to a variety of other risks, including: volatility in the size of our user base and user engagement, particularly for our messaging products, whether as a result of shelter-in-place measures or other factors; decreased user engagement as a result of users' inability to purchase data packs or devices to access our products and services; interruptions in the accessibility or performance of our products and services due to capacity constraints from increased usage, or product changes we implement to maintain accessibility of our services, such as reducing the quality of video to reduce bandwidth usage; delays in product development or releases, or reductions in manufacturing production and sales of consumer hardware, as a result of inventory shortages, supply chain or labor shortages, or diversion of our efforts and resources to projects related to COVID-19; increased misuse of our products and services or user data by third parties, including improper advertising practices or other activity inconsistent with our terms, contracts, or policies, misinformation or other illicit or objectionable material on our platforms, election interference, or other undesirable activity; adverse impacts to our efforts to combat misuse of our products and services and user data as a result of limitations on our safety, security, and content review efforts while our workforce is working remotely, such as the necessity to rely more heavily on artificial intelligence to perform tasks that our workforce is unable to perform; our inability to recognize revenue, collect payment, or generate future revenue from marketers, including from those that have been or may be forced to close their businesses or are otherwise impacted by the economic downturn; increased expenses resulting from our initiatives or donations related to the pandemic; significant volatility and disruption of global financial markets, which could cause fluctuations in currency exchange rates or negatively impact our ability to access capital in the future; negative impact on our workforce productivity, product development, and research and development due to difficulties resulting from our personnel working remotely; illnesses to key employees, or a significant portion of our workforce, which may result in inefficiencies, delays, and disruptions in our business; and increased volatility and uncertainty in the financial projections we use as the basis for estimates used in our financial statements. Any of these developments may adversely affect our business, harm our reputation, or result in legal or regulatory actions against us. The persistence of COVID-19, and the preventative measures implemented to help limit the spread of the illness, have impacted, and will continue to impact, our ability to operate our business and may materially and adversely impact our business, financial condition, and results of operations. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies providing connection and communication products and services to users online, as well as companies that sell advertising to businesses looking to reach consumers and/or develop tools and systems for managing and optimizing advertising campaigns. We face significant competition in every aspect of our business, including, but not limited to, companies that facilitate the ability of users to share, communicate, and discover content and information online or enable marketers to reach their existing or prospective audiences, including, for example, Google, Apple, YouTube, Tencent, Snap, Twitter, ByteDance, Microsoft, and Amazon. We compete to attract, engage, and retain people who use our products, to attract and retain businesses that use our free or paid business and advertising services, and to attract and retain developers who build compelling mobile and web applications that integrate with our products. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. For example, some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. In addition, Apple has announced changes to iOS 14 that will limit our ability, and the ability of others in the digital advertising industry, to target and measure ads effectively. As a result, our competitors may, and in some cases will, acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which would negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; our ability to attract and retain businesses who use our free or paid business and advertising services; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Unfavorable media coverage negatively affects our business from time to time. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, we have been the subject of significant media coverage involving concerns around our handling of political speech and advertising, hate speech, and other content, and we continue to receive negative publicity related to these topics. In addition, we have been, and may in the future be, subject to negative publicity in connection with our handling of misinformation and other illicit or objectionable use of our products or services, including in connection with the COVID-19 pandemic and elections in the United States and around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and marketer demand for advertising on our products, which could result in decreased revenue and adversely affect our business and financial results, and we have experienced such adverse effects to varying degrees from time to time. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; our ability to recognize revenue or collect payments from marketers in a particular period, including as a result of the effects of the COVID-19 pandemic; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, including the COVID-19 pandemic, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising, including changes by mobile operating system and browser providers such as Apple and Google; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts, including as a result of implementing changes to our practices, whether voluntarily, in connection with laws, regulations, regulatory actions, or decisions or recommendations from the independent Oversight Board, or otherwise; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which is affected by the mix of income we earn in the U.S. and in jurisdictions with different tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, the effects of changes in our business or structure, and the effects of discrete items such as legal and tax settlements and tax elections; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our investments in marketable securities, in the valuation of our equity investments, and in interest rates; changes in U.S. generally accepted accounting principles; and changes in regional or global business or macroeconomic conditions, including as a result of the COVID-19 pandemic, which may impact the other factors described above. We expect our rates of growth to be volatile in the near term as a result of the COVID-19 pandemic and to decline over time in the future. We expect our user and revenue growth rates to be volatile in the near term as a result of the COVID-19 pandemic, although we are unable to predict the duration or degree of such volatility with any certainty. In the long term, we expect that our user growth rate will generally decline over time as the size of our active user base increases, and the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We also expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates experience volatility or decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments, particularly our investments in virtual and augmented reality, have the effect of reducing our operating margin and profitability. If our investments are not successful longer-term, our business and financial performance will be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability, and we expect the adverse financial impact of such investments to continue for the foreseeable future. If our investments are not successful longer-term, our business and financial performance will be harmed. We plan to continue to make acquisitions and pursue other strategic transactions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies, and from time to time may enter into other strategic transactions such as investments and joint ventures. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions or other strategic transactions on favorable terms, if at all, including as a result of regulatory challenges. In some cases, the costs of such acquisitions or other strategic transactions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions or other strategic transactions. We may pay substantial amounts of cash or incur debt to pay for acquisitions or other strategic transactions, which has occurred in the past and could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions or other strategic transactions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities, deficiencies, or other claims associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition or other strategic transaction, including tax and accounting charges. Acquisitions or other strategic transactions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service, including as a result of the COVID-19 pandemic, could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. For example, the increase in the use of our products as a result of the COVID-19 pandemic increased demands on our technical infrastructure. Additional product development efforts during this time have put additional pressure on our technical infrastructure. We may not be able to accommodate these demands, including as a result of our reduced data center operations and personnel working remotely during the pandemic. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. The effects of the COVID-19 pandemic have increased the risk of supply or labor shortages or other disruptions in logistics or the supply chain for our technical infrastructure. As a result, we may not be able to procure sufficient equipment or services from third parties to satisfy our needs, or we may be required to procure such services or equipment on unfavorable terms. Any of these developments may result in interruptions in the availability or performance of our products, require unfavorable changes to existing products, delay the introduction of future products, or otherwise adversely affect our business and financial results. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers, subsea and terrestrial fiber optic cable systems, and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations around the world, including in emerging markets that expose us to increased risks relating to anti-corruption compliance and political challenges, among others. We have in the past suspended, and may in the future suspend, certain of these projects as a result of the COVID-19 pandemic. Additional unanticipated delays or disruptions in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, whether as a result of the pandemic, trade disputes, or otherwise, may lead to increased project costs, operational inefficiencies, interruptions in the delivery or degradation of the quality or reliability of our products, or impairment of assets on our balance sheet. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Further, much of our technical infrastructure is located outside the United States, and it is possible that action by a foreign government, or our response to such government action, could result in the impairment of a portion of our technical infrastructure, which may interrupt the delivery or degrade the quality or reliability of our products and lead to a negative user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)) and Family metrics (DAP, MAP, and average revenue per person (ARPP)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Facebook metrics and Family metrics estimates will differ from estimates published by third parties due to differences in methodology. We regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2020, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2020, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. The timing and results of such user surveys have in the past contributed, and may in the future contribute, to changes in our reported Family metrics from period to period. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, limitations while our personnel work remotely during the COVID-19 pandemic, or other factors, also may impact the stability or accuracy of our reported Family metrics. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2020, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics and estimates, including those relating to the reach and effectiveness of our ads. Many of our metrics involve the use of estimations and judgments, and our metrics and estimates are subject to software bugs, inconsistencies in our systems, and human error. Where marketers, developers, or investors do not perceive our metrics or estimates to be accurate, or where we discover material inaccuracies in our metrics or estimates, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook or our other products, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 58,604 as of December 31, 2020 from 44,942 as of December 31, 2019, and we expect headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors to continue to bolster various privacy, safety, security, and content review initiatives as well as other functions to support our expected growth. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. Additionally, the vast majority of our personnel are currently working remotely as a result of the COVID-19 pandemic, which limits their ability to perform certain job functions and may negatively impact productivity. In the long term, we may experience such challenges to productivity and collaboration as some personnel transition to working remotely on a regular basis, and we may experience difficulties integrating recently hired personnel when our offices re-open. To effectively manage our growth, we must continue to adapt to a remote work environment; improve our operational, financial, and management processes and systems; and effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business, economic, and legal risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, competition, consumer protection, intellectual property, and infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, payments, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations, including difficulties arising from personnel working remotely during the COVID-19 pandemic; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes and pandemics. In addition, we must manage the potential conflicts between locally accepted business practices in any given jurisdiction and our obligations to comply with laws and regulations, including anti-corruption laws or regulations applicable to us, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act 2010. We also must manage our obligations to comply with laws and regulations related to export controls, sanctions, and embargoes, including regulations established by the U.S. Office of Foreign Assets Control. Government agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against companies for violations of anti-corruption laws or regulations, export controls, and other laws, rules, sanctions, embargoes, and regulations. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell from time to time have had, and in the future may have, quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. Our brand and financial results could be adversely affected by any such quality issues, other failures to meet our customers' expectations, or findings of our consumer hardware products to be defective. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products, which subjects us to a number of risks that have been exacerbated as a result of the COVID-19 pandemic. We may experience supply or labor shortages or other disruptions in logistics or the supply chain that could result in shipping delays and negatively impact our operations, product development, and sales. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties, manufacturing constraints, or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing, distribution, and sale of our consumer hardware products also may be negatively impacted by macroeconomic conditions, geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. The demand for our products can also change significantly between the time inventory or components are ordered and the date of sale. While we endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell, from time to time we have experienced difficulties in accurately predicting and meeting the consumer demand for our products. In addition, when we begin selling or manufacturing a new consumer hardware product or enter new international markets, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of the foregoing factors may adversely affect our operating results. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. We are involved in numerous lawsuits, including stockholder derivative lawsuits and putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user, advertiser, and developer base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user or entity harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on claims related to advertising, antitrust, privacy, content, employment, or product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies; the disclosure of our earnings results for the second quarter of 2018; and our acquisitions of Instagram and WhatsApp, as well as other alleged anticompetitive conduct. We also agreed to settle certain lawsuits in connection with the ""tag suggestions"" facial recognition feature on Facebook and a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. The results of any such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are litigating this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. The issuance of additional regulatory or accounting guidance related to the Tax Act, or other executive or Congressional actions in the United States, could materially affect our tax obligations and effective tax rate in the period such guidance is issued or such actions take effect. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and blueprints in 2020 that, if implemented, would change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would apply to various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several countries have proposed or enacted taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and which apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2020, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $656 million and our effective tax rate by two percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located, whether as a result of competition with other companies, challenges due to the high cost of living, facilities and infrastructure constraints, or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or, in some cases, the replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Government Regulation and Enforcement Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. For example, in June 2020, Hong Kong adopted a National Security Law that provides authorities with the ability to obtain information, remove and block access to content, and suspend user services, and if we are found to be in violation of this law then the use of our products may be restricted. In addition, if we are required to or elect to make changes to our marketing and sales or other operations in Hong Kong as a result of the National Security Law, our revenue and business in the region will be adversely affected. It is also possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues or information requests in Hong Kong or elsewhere, or for other reasons, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. Similarly, if we are found to be out of compliance with certain legal requirements for social media companies in Turkey, the Turkish government could take action to reduce or eliminate our Turkey-based advertising revenue or otherwise adversely impact access to our products. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, we are required to or elect to make changes to our operations, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data use and data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data use, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, data localization and storage, data disclosure, artificial intelligence, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, e-commerce, taxation, economic or other trade prohibitions or sanctions, anti-corruption and political law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to evolving laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but the Privacy Shield was invalidated in July 2020 by the Court of Justice of the European Union (CJEU). In addition, the other bases upon which Facebook relies to transfer such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the CJEU considered the validity of SCCs as a basis to transfer user data from the European Union to the United States following a challenge brought by the Irish Data Protection Commission (IDPC). Although the CJEU upheld the validity of SCCs in July 2020, our continued reliance on SCCs is contingent on SCCs being held to satisfy certain new conditions that are yet to be clearly defined and will be the subject of future regulatory guidance (and the European Commission has recently proposed new SCCs, which are currently subject to consultation). In addition, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Facebook Ireland's reliance on SCCs in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020, and the court ordered the IDPC not to take further steps in respect of the inquiry until the judicial review proceedings conclude (subject to the IDPC's right to apply to vary or lift this order), which we expect to occur in the coming months. While we also rely upon alternative legal bases for data transfers, if a new transatlantic data transfer framework is not adopted and we are unable to continue to rely on SCCs or validly rely upon other alternative means of data transfers from Europe to the United States, we may be unable to operate material portions of our business in Europe as a result of the CJEU's invalidation of the Privacy Shield and any final decision of IDPC, which would materially and adversely affect our business, financial condition, and results of operations. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect our ability to provide our services, the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of personal data breach notifications to our designated European privacy regulator, the IDPC, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. Similarly, the Brazilian General Data Protection Law recently took effect and imposes data privacy-related requirements on products and services offered to users in Brazil. The California Consumer Privacy Act (CCPA), which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users, including more ability to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, regulators have recently issued new guidance concerning the ePrivacy Directive's requirements regarding the use of cookies and similar technologies. In addition, effective December 2020, the ePrivacy Directive includes additional limitations on the use of data across messaging products and includes significant penalties for non-compliance. Changes to our products or business practices as a result of these developments may adversely affect our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union and other jurisdictions have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Beginning in September 2018, we also became subject to IDPC and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. From time to time we also notify the IDPC, our designated European privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. In addition, from time to time, we are subject to various litigation and formal and informal inquiries and investigations by competition authorities in the United States, Europe, and other jurisdictions, which relate to many aspects of our business, including with respect to users and advertisers, as well as our industry. Such inquiries, investigations, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice, the U.S. House of Representatives, and state attorneys general. In December 2020, the FTC and the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed complaints against us in the U.S. District Court for the District of Columbia alleging that we violated antitrust laws by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform, among other things. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the time and attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business, and we have experienced some of these adverse effects to varying degrees from time to time. Compliance with our FTC consent order, the GDPR, the CCPA, the ePrivacy Directive, and other regulatory and legislative privacy requirements require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including in connection with our modified consent order with the FTC, requirements of the GDPR, and other regulatory and legislative requirements around the world, such as the CCPA and the ePrivacy Directive. In particular, we are implementing a comprehensive expansion of our privacy program in connection with the FTC consent order, including substantial management and board of directors oversight, stringent operational requirements and reporting obligations, prohibitions against making misrepresentations relating to user data, a process to regularly certify our compliance with the privacy program to the FTC, and regular assessments of our privacy program by an independent third-party assessor, which has been and will continue to be challenging and costly to implement. These compliance and oversight efforts are increasing demand on our systems and resources, and require significant new and ongoing investments, including investments in compliance processes, personnel, and technical infrastructure. We are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner has been and will continue to be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. The requirements of the FTC consent order and other privacy-related laws and regulations are complex and apply broadly to our business, and from time to time we notify relevant authorities of instances where we are not in full compliance with these requirements or otherwise discover privacy issues, and we expect to continue to do so as any such issues arise in the future. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, ePrivacy Directive, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other applicable requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices and may adversely affect our business and financial results. We have faced, currently face, and will continue to face claims relating to information or content that is published or made available on our products, including our policies and enforcement actions with respect to such information or content. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, harassment, intellectual property rights, rights of publicity and privacy, personal injury torts, laws regulating hate speech or other types of content, and breach of contract, among others. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states are required to implement by June 2021. In addition, the European Union revised the European Audiovisual Media Service Directive to apply to online video-sharing platforms, which member states are expected to implement by 2021. In the United States, there have been, and continue to be, various Congressional and executive efforts to remove or restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, as well as to impose new obligations on online platforms with respect to commerce listings, counterfeit goods and copyright-infringing material, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines, orders restricting or blocking our services in particular geographies, or other government-imposed remedies as a result of content hosted on our services. For example, legislation in Germany has in the past, and may in the future, result in the imposition of fines for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Numerous other countries in Europe, Asia-Pacific, and Latin America are considering or have implemented similar legislation imposing penalties, including fines, service throttling, or advertising bans, for failure to remove certain types of content or follow certain processes. For example, we have been subject to fines and may in the future be subject to other penalties in connection with social media legislation in Turkey. In addition, Australia recently announced proposed legislation that would, among other matters, require us to pay publishers for certain news content that is shared on Facebook and Instagram. Content-related legislation also has required us in the past, and may require us in the future, to change our products or business practices, increase our compliance costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. In addition, changes to Section 230 of the Communications Decency Act may increase our costs or require significant changes to our products, business practices, or operations, which could adversely affect user growth and engagement. Any of the foregoing events could adversely affect our business and financial results. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger and WhatsApp, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we are subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have also launched certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our participation in the Diem Association subjects us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. In June 2019, we announced our participation in the Diem Association, which will oversee a proposed digital payments system powered by blockchain technology, and our plans for Novi, a digital wallet for Diem which we expect to launch as a standalone application and subsequently in Messenger and WhatsApp. Diem is based on relatively new and unproven technology, and the laws and regulations surrounding blockchain-based payments are uncertain and evolving. Diem has drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. As a sponsor of the initiative and a proposed digital wallet service provider, we are participating in responses to inquiries from governments and regulators, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As this initiative evolves, both Diem and Novi may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, anti-money laundering, counter-terrorism financing, economic sanctions, data protection, tax, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. To mitigate regulatory uncertainty, Diem has applied for a payment system operator license with the Swiss Financial Market Supervisory Authority (FINMA), and Novi has applied for money transmitter licenses in the United States and certain other countries, and other financial services licenses in certain other countries, that would allow us to conduct digital wallet activities in these countries using the Diem network. These licenses, laws, and regulations, as well as any associated inquiries or investigations, may delay or impede the launch of the Diem digital payments system as well as the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of such a digital payments system is subject to significant uncertainty. As such, there can be no assurance that Diem or our associated products and services will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based payments technology, which may adversely affect our ability to successfully develop and market these products and services. We will also incur increased costs in connection with our participation in the Diem Association and the development and marketing of associated products and services, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. Risks Related to Data, Security, and Intellectual Property Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), scraping, and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data and content on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from nation states and highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We experience such cyber-attacks and other security incidents of varying degrees from time to time, and we incur significant costs in protecting against or remediating such incidents. In addition, we are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under our modified consent order with the FTC. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. The events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, the changes in our work environment as a result of the COVID-19 pandemic could impact the security of our systems, as well as our ability to protect against attacks and detect and respond to them quickly. The rapid adoption of some third-party services designed to enable the transition to a remote workforce also may introduce security risk that is not fully mitigated prior to the use of these services. We may also be subject to increased cyber-attacks, such as phishing attacks by threat actors using the attention placed on the pandemic as a method for targeting our personnel. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data or technical limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, challenges related to our personnel working remotely during the COVID-19 pandemic, the allocation of resources to other projects, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our modified consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper advertising practices, activities that threaten people's safety on- or offline, or instances of spamming, scraping, data harvesting, unsecured datasets, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Our products and internal systems rely on software and hardware that is highly technical, and any errors, bugs, or vulnerabilities in these systems, or failures to address or mitigate technical limitations in our systems, could adversely affect our business. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property or other data, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. In addition, any errors, bugs, vulnerabilities, or defects in our systems or the software and hardware on which we rely, failures to properly address or mitigate the technical limitations in our systems, or associated degradations or interruptions of service or failures to fulfill our commitments to our users, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, litigation, or liability for fines, damages, or other remedies, any of which could adversely affect our business and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $304.67 through December 31, 2020. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections, or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; adverse government actions or legislative or regulatory developments relating to advertising, competition, content, privacy, or other matters, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war, incidents of terrorism, pandemics, and other disruptive external events, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2020, we owned and leased approximately 10 million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in more than 80 cities across North America, Latin America, Europe, the Middle East, Africa, and Asia Pacific. We also own 17 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Any other government inquiries regarding these matters could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which provided for a payment of $550 million by us and was subject to court approval. On or about May 8, 2020, the parties executed a formal settlement agreement, and plaintiffs filed a motion for preliminary approval of the settlement by the district court. On June 4, 2020, the district court denied the plaintiffs' motion without prejudice. On July 22, 2020, the parties executed an amended settlement agreement, which, among other terms, provides for a payment of $650 million by us. On August 19, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. On November 15, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. For example, in August 2020, we received a preliminary draft decision from the IDPC that preliminarily concluded that Facebook Ireland's reliance on Standard Contractual Clauses in respect of European user data does not achieve compliance with the GDPR and preliminarily proposed that such transfers of user data from the European Union to the United States should therefore be suspended. Facebook Ireland challenged procedural aspects of this IDPC inquiry in a judicial review commenced in the Irish High Court in September 2020, and the court ordered the IDPC not to take further steps in respect of the inquiry until the judicial review proceedings conclude (subject to the IDPC's right to apply to vary or lift this order), which we expect to occur in early 2021. For additional information, see Part I, Item 1A, ""Risk FactorsOur business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters"" in this Annual Report on Form 10-K. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleges that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. The result of such litigation, investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other structural or behavioral remedies that adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2020, there were 3,471 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $273.16 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2020, there were 32 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2020: Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2020 2,310 $ 270.12 2,310 $ 9,921 November 1 - 30, 2020 2,100 $ 276.32 2,100 $ 9,341 December 1 - 31, 2020 2,670 $ 276.38 2,670 $ 8,603 7,080 7,080 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In January 2021, an additional $25 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2020. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2015 in the Class A common stock of Facebook, Inc., the DJINET, the SP 500 and the Nasdaq Composite and data for the DJINET, the SP 500 and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2020 using 2019 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2020 Results Our key community metrics and financial results for 2020 are as follows: Community growth: Facebook daily active users (DAUs) were 1.84 billion on average for December 2020, an increase of 11% year-over-year. Facebook monthly active users (MAUs) were 2.80 billion as of December 31, 2020, an increase of 12% year-over-year. Family daily active people (DAP) was 2.60 billion on average for December 2020, an increase of 15% year-over-year. Family monthly active people (MAP) was 3.30 billion as of December 31, 2020, an increase of 14% year-over-year. Financial results: Revenue was $85.97 billion, up 22% year-over-year, and advertising revenue was $84.17 billion, up 21% year-over-year. Total costs and expenses were $53.29 billion. Income from operations was $32.67 billion and operating margin was 38%. Net income was $29.15 billion with diluted earnings per share of $10.09. Capital expenditures, including principal payments on finance leases, were $15.72 billion. Effective tax rate was 12.2%. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020. Headcount was 58,604 as of December 31, 2020, an increase of 30% year-over-year. Our mission is to give people the power to build community and bring the world closer together. In response to the COVID-19 pandemic, we have focused on helping people stay connected, assisting the public health response, and working on the economic recovery. We have also continued to invest based on the following company priorities: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. In 2020, we also continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. Our business has been impacted by the COVID-19 pandemic, which has resulted in authorities implementing numerous preventative measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas, both regionally and worldwide, which have significantly impacted our business and results of operations. Beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen user growth and engagement returning to pre-pandemic trends, particularly in the United States Canada region. We are unable to predict the impact of the pandemic on user growth and engagement with any certainty, and we expect these trends to continue to be subject to volatility. The COVID-19 pandemic has also previously caused a reduction in the demand for advertising, as well as a related decline in the pricing of our ads, particularly in the second quarter of 2020. More recently, we believe the pandemic has contributed to an acceleration in the shift of commerce from offline to online, as well as increasing consumer demand for purchasing products as opposed to services, and we experienced increasing demand for advertising as a result of these trends. However, it is possible that this increased demand may not continue in future periods and may even recede as the effects of the pandemic subside, which could adversely affect our advertising revenue growth. The impact of the pandemic on user growth and engagement, the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain for the foreseeable future. In addition, we expect that future advertising revenue growth will continue to be adversely affected by limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers. We intend to continue to invest in our business based on our company priorities, and we anticipate that additional investments in our data center capacity, servers, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, will continue to drive expense growth in 2021. We expect 2021 capital expenditures to be in the range of $21-23 billion and total expenses to be in the range of $68-73 billion. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. DAU/MAU: 66% 66% 66% 66% 66% 66% 66% 66% 66% 67% 66% 66% 66% DAU/MAU: 77% 77% 77% 76% 77% 77% 77% 77% 77% 77% 77% 77% 76% DAU/MAU: 75% 75% 74% 74% 74% 74% 74% 74% 75% 75% 74% 74% 74% DAU/MAU: 60% 61% 61% 61% 61% 61% 61% 62% 62% 62% 61% 62% 62% DAU/MAU: 64% 64% 64% 64% 64% 64% 64% 65% 65% 65% 65% 65% 65% Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 11% to 1.84 billion on average during December 2020 from 1.66 billion during December 2019. Users in India, the Philippines, and Indonesia represented key sources of growth in DAUs during December 2020, relative to the same period in 2019. Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2020, we had 2.80 billion MAUs, an increase of 12% from December 31, 2019. Users in India, Indonesia, and the Philippines represented key sources of growth in 2020, relative to the same period in 2019. Trends in Our Monetization by Facebook User Geography We calculate our revenue by Facebook user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. The share of revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2020 in the United States Canada region was more than 11 times higher than in the Asia-Pacific region. ARPU: $7.37 $6.42 $7.05 $7.26 $8.52 $6.95 $7.05 $7.89 $10.14 ARPU: $34.86 $30.12 $33.27 $34.55 $41.41 $34.18 $36.49 $39.63 $53.56 ARPU: $10.98 $9.55 $10.70 $10.68 $13.21 $10.64 $11.03 $12.41 $16.87 ARPU: $2.96 $2.78 $3.04 $3.24 $3.57 $3.06 $2.99 $3.67 $4.05 ARPU: $2.11 $1.89 $2.13 $2.24 $2.48 $1.99 $1.78 $2.22 $2.77 Note: Our revenue by Facebook user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our Facebook users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the billing address of the customer. Our annual worldwide ARPU in 2020, which represents the sum of quarterly ARPU during such period, was $32.03, an increase of 10% from 2019. Over this period, ARPU increased by 18% in the United States Canada, 15% in Europe, and 9% in AsiaPacific, and ARPU was flat in Rest of World. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as MAP or DAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. DAP/MAP: 77% 78% 78% 78% 78% 79% 79% 79% 79% Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 40 million DAP to our reported worldwide DAP in June 2020. Worldwide DAP increased 15% to 2.60 billion on average during December 2020 from 2.26 billion during December 2019. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 4% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. In the second quarter of 2020, we updated our Family metrics calculations to reflect recent data from a periodic WhatsApp user survey and to incorporate certain methodology improvements, and we estimate such updates contributed an aggregate of approximately 50 million MAP to our reported worldwide MAP in June 2020. As of December 31, 2020, we had 3.30 billion MAP, an increase of 14% from 2.89 billion as of December 31, 2019. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. The share of revenue from users who are not also MAP was not material. ARPP: $6.52 $5.66 $6.20 $6.33 $7.38 $6.03 $6.10 $6.76 $8.62 Our annual worldwide ARPP in 2020, which represents the sum of quarterly ARPP during such period, was $27.51, an increase of 8% from 2019. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the impact of the estimates and assumptions on our consolidated financial statements is material . We believe that the assumptions and estimates associated with gross vs. net in revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In response to the economic slowdown caused by the COVID-19 pandemic, we believe that the assumptions and estimates associated with collectibility assessment of revenue and credit losses of accounts receivable could have a material impact to our consolidated financial statements in future periods, depending on the duration or degree of the impact of the COVID-19 pandemic on the global economy. Collectibility Assessment of Revenue Under Topic 606, we recognize revenue using a five-step model. In step one, for a revenue contract to exist, it must be probable that substantially all of the consideration to which we are entitled to will be collected. In performing such collectibility assessment, we consider various facts and circumstances including future expectations about our customer's ability and intention to pay. Collectibility assessment uses a probable threshold which requires estimation based on several objective and subjective factors, such as probability of default, customers intention to pay, payment history, financial strength, geography, and industry sub-vertical risks. The collectibility assessment has become uncertain during the current economic environment caused by the COVID-19 pandemic, and our actual experience in the future may differ from our past experiences or current assessment. Credit Losses of Accounts Receivable On January 1, 2020, we adopted Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost that an entity does not expect to collect over the asset's contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions. For accounts receivable measured at amortized cost, we use aging analysis, probability of default methods and incorporate macroeconomic variables that are most relevant to evaluating and estimating the expected credit losses. These macroeconomic variables may vary by geography, customer-type, or industry sub-vertical. The contractual life of our trade accounts receivable is generally short-term; however, we may experience increasing credit loss risks from accounts receivable in future periods depending on the duration or degree of economic slowdown caused by the COVID-19 pandemic, and our actual experience in the future may differ from our past experiences or current assessment. Gross vs. Net in Revenue Recognition For revenue generated from arrangements that involve third-party publishers, there is significant judgment in evaluating whether we are the principal, and report revenue on a gross basis, or the agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. The assessment of whether we are considered the principal or the agent in a transaction could impact our revenue and cost of revenue recognized on the consolidated statements of income. Valuation of Equity Investments For our equity securities without readily determinable fair values accounted for using the measurement alternative, determining whether an equity security issued by the same issuer is similar to the equity security we hold may require judgment in (a) assessment of differences in rights and obligations associated with the instruments such as voting rights, distribution rights and preferences, and conversion features, and (b) adjustments to the observable price for differences such as, but not limited to, rights and obligations, control premium, liquidity, or principal or most advantageous markets. In addition, the identification of observable transactions will depend on the timely reporting of these transactions from our investee companies, which may occur in a period subsequent to when the transactions take place. Therefore, our fair value adjustment for these observable transactions may occur in a period subsequent to when the transaction actually occurred. For equity investments, we perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; regulatory, economic or technological environment; operational and financing cash flows; and other relevant events and factors affecting the investee. When indicators of impairment exist, we estimate the fair value of our equity investments using the market approach and/or the income approach and recognize impairment loss in the consolidated statements of income if the estimated fair value is less than the carrying value. Estimating fair value requires judgment and use of estimates such as discount rates, forecast cash flows, holding period, and market data of comparable companies, among others. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. The ultimate outcome of these matters, such as whether the likelihood of loss is remote, reasonably possible, or probable or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of losses, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 12Commitments and Contingencies and Note 15Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2020, no impairment of goodwill has been identified. Long-lived assets, including property and equipment and intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of revenue from the delivery of consumer hardware devices, net fees we receive from developers using our Payments infrastructure, and revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Research and development. Research and development expenses consist primarily of salaries and benefits, share-based compensation, and facilities-related costs for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. Marketing and sales. Marketing and sales expenses consist of salaries and benefits, and share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures and professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist of legal-related costs; salaries and benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2020 compared to the year ended December 31, 2019. For a discussion of the year ended December 31, 2019 compared to the year ended December 31, 2018, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2019. The following table sets forth our consolidated statements of income data (in millions): Year Ended December 31, 2020 2019 2018 Revenue $ 85,965 $ 70,697 $ 55,838 Costs and expenses: Cost of revenue 16,692 12,770 9,355 Research and development 18,447 13,600 10,273 Marketing and sales 11,591 9,876 7,846 General and administrative 6,564 10,465 3,451 Total costs and expenses 53,294 46,711 30,925 Income from operations 32,671 23,986 24,913 Interest and other income, net 509 826 448 Income before provision for income taxes 33,180 24,812 25,361 Provision for income taxes 4,034 6,327 3,249 Net income $ 29,146 $ 18,485 $ 22,112 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, 2020 2019 2018 Revenue 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 18 17 Research and development 21 19 18 Marketing and sales 13 14 14 General and administrative 8 15 6 Total costs and expenses 62 66 55 Income from operations 38 34 45 Interest and other income, net 1 1 1 Income before provision for income taxes 39 35 45 Provision for income taxes 5 9 6 Net income 34 % 26 % 40 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses (in millions): Year Ended December 31, 2020 2019 2018 Cost of revenue $ 447 $ 377 $ 284 Research and development 4,918 3,488 3,022 Marketing and sales 691 569 511 General and administrative 480 402 335 Total share-based compensation expense $ 6,536 $ 4,836 $ 4,152 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, 2020 2019 2018 Cost of revenue 1 % 1 % 1 % Research and development 6 5 5 Marketing and sales 1 1 1 General and administrative 1 1 1 Total share-based compensation expense 8 % 7 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue Year Ended December 31, 2020 vs 2019 % Change 2019 vs 2018 % Change 2020 2019 2018 (in millions) Advertising $ 84,169 $ 69,655 $ 55,013 21 % 27 % Other revenue 1,796 1,042 825 72 % 26 % Total revenue $ 85,965 $ 70,697 $ 55,838 22 % 27 % 2020 Compared to 2019. Revenue in 2020 increased $15.27 billion, or 22%, compared to 2019. The increase was mostly due to an increase in advertising revenue as a result of an increase in the number of ads delivered, partially offset by a decrease in the average price per ad. In 2020, the number of ads delivered increased by 34%, as compared with approximately 33% in 2019. The increase in the ads delivered was driven by an increase in the number and frequency of ads displayed across our products, and an increase in users. In 2020, the average price per ad decreased by 10%, as compared with a decrease of approximately 5% in 2019. The decrease in average price per ad during the year ended December 31, 2020 was primarily driven by a decrease in advertising demand globally during the first two quarters of 2020 due to the COVID-19 pandemic and, to a lesser extent, by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. In the near-term, we anticipate that future advertising revenue growth will be determined primarily by several factors: the extent to which we continue to see increasing advertising demand in connection with the shift of commerce from offline to online, as well as increased consumer demand for purchasing products as opposed to services, as a result of the COVID-19 pandemic; the status of the economic recovery from the slowdown caused by the COVID-19 pandemic and the magnitude of fiscal stimulus; and the extent to which changes to the regulatory environment and third-party mobile operating systems and browsers result in limitations on our ad targeting and measurement tools. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 28%, 19%, and 23% between the third and fourth quarters of 2020, 2019, and 2018, respectively, while advertising revenue for both the first quarters of 2020 and 2019 declined 16% and 10% compared to the fourth quarters of 2019 and 2018, respectively. No customer represented 10% or more of total revenue during the years ended December 31, 2020, 2019, and 2018. Foreign Exchange Impact on Revenue The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2020 compared to the same period in 2019, had an unfavorable impact on revenue. If we had translated revenue for the full year 2020 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $86.08 billion and $84.30 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $120 million and $129 million, respectively, higher than actual total revenue and advertising revenue for the full year 2020. Using the same constant rates, full year 2020 total revenue and advertising revenue would have been $15.39 billion and $14.64 billion, respectively, higher than actual total revenue and advertising revenue for the full year 2019. Cost of revenue Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Cost of revenue $ 16,692 $ 12,770 $ 9,355 31 % 37% Percentage of revenue 19% 18% 17% 2020 Compared to 2019. Cost of revenue in 2020 increased $3.92 billion, or 31%, compared to 2019. The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure, higher cost associated with partner arrangements, including traffic acquisition and content costs and, to a lesser extent, an increase in cost of consumer hardware devices sold. In 2021, we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with partner arrangements and consumer hardware devices. Research and development Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Research and development $ 18,447 $ 13,600 $ 10,273 36 % 32 % Percentage of revenue 21% 19% 18% 2020 Compared to 2019. Research and development expenses in 2020 increased $4.85 billion, or 36%, compared to 2019. The increase was primarily due to increases in payroll and benefits expenses as a result of a 40% growth in employee headcount from December 31, 2019 to December 31, 2020 in engineering and other technical functions supporting our continued investment in our Family of products and consumer hardware products. In 2021, we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Marketing and sales $ 11,591 $ 9,876 $ 7,846 17 % 26% Percentage of revenue 13% 14% 14% 2020 Compared to 2019. Marketing and sales expenses in 2020 increased $1.72 billion, or 17%, compared to 2019. The increase was primarily driven by increases in marketing expenses and payroll and benefits expenses, which were partially offset by a decrease in travel-related expenses due to the COVID-19 pandemic. Our payroll and benefits expenses increased as a result of a 16% increase in employee headcount from December 31, 2019 to December 31, 2020 in our marketing and sales functions. In 2021, we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts, and we anticipate marketing expenses will increase. General and administrative Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Legal accrual related to FTC settlement $ $ 5,000 $ NM NM Other general and administrative 6,564 5,465 3,451 20 % 58 % General and administrative $ 6,564 $ 10,465 $ 3,451 (37) % 203 % Percentage of revenue 8% 15% 6% 2020 Compared to 2019. Excluding the $5.0 billion FTC settlement accrual recorded in 2019, general and administrative expenses in 2020 increased $1.10 billion, or 20%, compared to 2019. The increase was primarily due to higher professional services costs and an increase in payroll and benefits expenses as a result of a 23% increase in employee headcount from December 31, 2019 to December 31, 2020 in our general and administrative functions. In 2021, we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income, net Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (in millions) Interest income, net $ 672 $ 904 $ 652 (26) % 39 % Foreign currency exchange losses, net (129) (105) (213) (23) % 51 % Other income (expense), net (34) 27 9 NM NM Interest and other income, net $ 509 $ 826 $ 448 (38) % 84 % 2020 Compared to 2019. Interest and other income, net in 2020 decreased $317 million compared to 2019. The majority of the decrease was due to a decrease in interest income related to lower interest rates compared to 2019. Provision for income taxes Year Ended December 31, 2020 2019 2018 2020 vs 2019 % Change 2019 vs 2018 % Change (dollars in millions) Provision for income taxes $ 4,034 $ 6,327 $ 3,249 (36) % 95 % Effective tax rate 12.2% 25.5% 12.8% 2020 Compared to 2019. Our provision for income taxes in 2020 decreased $2.29 billion, or 36%, compared to 2019, mostly due to the additional tax expense incurred in 2019 from the Altera Ninth Circuit Opinion and the effects of a tax election to capitalize and amortize certain research and development expenses for U.S. income tax purposes, both discussed below. Our effective tax rate in 2020 decreased compared to 2019, primarily due to the 2019 legal accrual related to the FTC settlement that was not tax-deductible, the additional tax expense incurred in 2019 from the Altera Ninth Circuit Opinion, and the effects of a tax election to capitalize and amortize certain research and development expenses for U.S. income tax purposes. In the third quarter of 2020, as part of finalizing our U.S. income tax return, we elected to capitalize and amortize certain research and development expenses for U.S. income tax purposes. As a result, we recorded a total of $1.07 billion income tax benefit for the year ended December 31, 2020. The income tax benefit resulted from recording a deferred income tax asset that was greater than the current income tax liability due to different tax rates applicable for the periods in which capitalized expenses will be amortized versus the period in which the increased current tax liability was accrued. We do not believe this election will materially affect our effective tax rate trend in the future. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer requested a hearing before the Supreme Court of the United States and the request was denied on June 22, 2020. Since we started to accrue income tax for share-based compensation cost-sharing expense in the second quarter of 2019, the denial of the request by the Supreme Court did not have a material impact to our financial results in 2020. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion between the following items and income before provision for income taxes: U.S. tax benefits from foreign derived intangible income, tax effects from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the effects of changes in tax law. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 22, 2021 price, we expect our effective tax rate for the full year of 2021 will be in the high-teens. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. Unrecognized Tax Benefits. As of December 31, 2020, we had net unrecognized tax benefits of $3.48 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a material change to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first sessions of the trial began in February 2020, and additional sessions are expected to continue in 2021. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2020, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740, Income Taxes, for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2020. We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 (in millions, except per share amounts) Revenue: Advertising $ 27,187 $ 21,221 $ 18,321 $ 17,440 $ 20,736 $ 17,383 $ 16,624 $ 14,912 Other revenue 885 249 366 297 346 269 262 165 Total revenue 28,072 21,470 18,687 17,737 21,082 17,652 16,886 15,077 Costs and expenses: Cost of revenue 5,210 4,194 3,829 3,459 3,492 3,155 3,307 2,816 Research and development 5,208 4,763 4,462 4,015 3,877 3,548 3,315 2,860 Marketing and sales 3,280 2,683 2,840 2,787 3,026 2,416 2,414 2,020 General and administrative 1,599 1,790 1,593 1,583 1,829 1,348 3,224 4,064 Total costs and expenses 15,297 13,430 12,724 11,844 12,224 10,467 12,260 11,760 Income from operations 12,775 8,040 5,963 5,893 8,858 7,185 4,626 3,317 Interest and other income (expense), net 280 93 168 (32) 311 144 206 165 Income before provision for income taxes 13,055 8,133 6,131 5,861 9,169 7,329 4,832 3,482 Provision for income taxes 1,836 287 953 959 1,820 1,238 2,216 1,053 Net income $ 11,219 $ 7,846 $ 5,178 $ 4,902 $ 7,349 $ 6,091 $ 2,616 $ 2,429 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 3.94 $ 2.75 $ 1.82 $ 1.72 $ 2.58 $ 2.13 $ 0.92 $ 0.85 Diluted $ 3.88 $ 2.71 $ 1.80 $ 1.71 $ 2.56 $ 2.12 $ 0.91 $ 0.85 The following tables set forth our consolidated statements of income data (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Revenue: Advertising 97 % 99 % 98 % 98 % 98 % 98 % 98 % 99 % Other revenue 3 1 2 2 2 2 2 1 Total revenue 100 % 100 % 100 % 100 % 100 % 100 % 100 % 100 % Costs and expenses: Cost of revenue 19 20 20 20 17 18 20 19 Research and development 19 22 24 23 18 20 20 19 Marketing and sales 12 12 15 16 14 14 14 13 General and administrative 6 8 9 9 9 8 19 27 Total costs and expenses 54 63 68 67 58 59 73 78 Income from operations 46 37 32 33 42 41 27 22 Interest and other income (expense), net 1 1 1 1 1 1 Income before provision for income taxes 47 38 33 33 43 42 29 23 Provision for income taxes 7 1 5 5 9 7 13 7 Net income 40 % 37 % 28 % 28 % 35 % 35 % 15 % 16 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 (in millions) Cost of revenue $ 120 $ 116 $ 117 $ 94 $ 90 $ 91 $ 109 $ 87 Research and development 1,361 1,297 1,261 999 931 907 927 723 Marketing and sales 175 180 187 149 147 148 160 113 General and administrative 128 129 130 93 105 103 107 87 Total share-based compensation expense $ 1,784 $ 1,722 $ 1,695 $ 1,335 $ 1,273 $ 1,249 $ 1,303 $ 1,010 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020 Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Cost of revenue % 1 % 1 % 1 % % 1 % 1 % 1 % Research and development 5 6 7 6 4 5 5 5 Marketing and sales 1 1 1 1 1 1 1 1 General and administrative 1 1 1 1 1 1 Total share-based compensation expense 6 % 8 % 9 % 8 % 6 % 7 % 8 % 7 % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Liquidity and Capital Resources Year Ended December 31, 2020 2019 2018 (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 38,747 $ 36,314 $ 29,274 Net cash used in investing activities $ (30,059) $ (19,864) $ (11,603) Net cash used in financing activities $ (10,292) $ (7,299) $ (15,572) Purchase of property and equipment and principal payments on finance leases $ 15,719 $ 15,654 $ 13,915 Depreciation and amortization $ 6,862 $ 5,741 $ 4,315 Share-based compensation $ 6,536 $ 4,836 $ 4,152 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents and marketable securities were $61.95 billion as of December 31, 2020, an increase of $7.10 billion from December 31, 2019. The increase was mostly due to $38.75 billion of cash generated from operations, offset by $15.72 billion for capital expenditures, including principal payments on finance leases, $6.36 billion for purchases of equity investments, $6.27 billion for repurchases of our Class A common stock, and $3.56 billion of taxes paid related to net share settlement of employee restricted stock units (RSU) awards. Cash paid for income taxes was $4.23 billion for the year ended December 31, 2020. As of December 31, 2020, our federal net operating loss carryforward was $10.62 billion and our federal tax credit carryforward was $424 million. We anticipate the utilization of a significant portion of these net operating losses and credits within the next three years. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $4.90 billion remained available and authorized for repurchases under this program. In 2020, we repurchased and subsequently retired 27 million shares of our Class A common stock for $6.30 billion. As of December 31, 2020, $8.60 billion remained available and authorized for repurchases. In January 2021, an additional $25 billion of repurchases was authorized under this program. As of December 31, 2020, $7.18 billion of the $61.95 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. In July 2019, we entered into a settlement and modified consent order to resolve the inquiry of the FTC into our platform and user data practices, which was approved by the federal court and took effect in April 2020. We paid the penalty of $5.0 billion in April 2020 upon the effectiveness of the modified consent order. On April 21, 2020, we entered into a definitive agreement to invest in Jio Platforms Limited, a subsidiary of Reliance Industries Limited. The transaction closed on July 7, 2020, and we paid approximately $5.8 billion at the then-current exchange rate. We currently anticipate that our available funds and cash flow from operations will be sufficient to meet our operational cash needs and fund our share repurchase program for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2020 mostly consisted of net income adjusted for certain non-cash items, including $6.86 billion of depreciation and amortization and $6.54 billion of share-based compensation expense, and offset by a cash payment of $5.0 billion for the FTC legal settlement. The increase in cash flow from operating activities during 2020 compared to 2019 was mostly due to higher net income as adjusted for certain non-cash items, such as depreciation and amortization, share-based compensation expense and deferred income tax, partially offset by the payment of $5.0 billion for the FTC legal settlement. Cash flow from operating activities during 2019 primarily consisted of net income, adjusted for certain non-cash items, including $5.74 billion of depreciation and amortization and $4.84 billion of share-based compensation expense. The increase in cash flow from operating activities during 2019 compared to 2018 was primarily due to higher net income prior to the effect of the $5.0 billion FTC legal settlement accrual, an increase in taxes payable as well as increases in the non-cash items, including depreciation and amortization, and share-based compensation expense. Cash Used in Investing Activities Cash used in investing activities during 2020 mostly resulted from $15.11 billion of purchases of property and equipment as we continued to invest in data centers, servers, office facilities, and network infrastructure, $8.16 billion of net purchases of marketable securities, and $6.36 billion of purchases of equity investments. The increase in cash used in investing activities during 2020 compared to 2019 was due to increases in purchases of equity investments and in net purchases of marketable securities. Cash used in investing activities during 2019 mostly resulted from $15.10 billion of net purchase of property and equipment as we continued to invest in data centers, servers, network infrastructure, and $4.19 billion of net purchases of marketable securities. The increase in cash used in investing activities during 2019 compared to 2018 was mostly due to increases in the net purchases of marketable securities and property and equipment. We anticipate making capital expenditures of approximately $21 billion to $23 billion in 2021. Cash Used in Financing Activities Cash used in financing activities during 2020 mostly consisted of $6.27 billion for repurchases of our Class A common stock and $3.56 billion of taxes paid related to net share settlement of RSUs. The increase in cash used in financing activities during 2020 compared to 2019 was due to increases in repurchases of our Class A common stock and in taxes paid related to net share settlement of RSUs. Cash used in financing activities during 2019 mostly consisted of $4.20 billion used to settle repurchases of our Class A common stock, and $2.34 billion of taxes paid related to net share settlement of equity awards, and $552 million of principal payments on finance leases. The decrease in cash used in financing activities during 2019 compared to 2018 was mostly due to a decrease in repurchases of our Class A common stock. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations Our principal commitments consist mostly of obligations under operating leases and other contractual commitments. Our obligations under operating leases include among others, certain of our offices, data centers, land, colocations, and equipment. Our other contractual commitments are mostly related to our investments in network infrastructure, consumer hardware, content costs, and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2020: Payment Due by Period Total 2021 2022-2023 2024-2025 Thereafter (in millions) Operating lease obligations, including imputed interest (1) $ 20,751 $ 1,316 $ 3,017 $ 3,065 $ 13,353 Finance lease obligations, including imputed interest (1) 1,088 249 214 100 525 Transition tax payable 1,543 300 1,243 Other contractual commitments 7,504 4,213 1,071 244 1,976 Total contractual obligations $ 30,886 $ 5,778 $ 4,602 $ 4,652 $ 15,854 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. Additionally, as part of the normal course of the business, we may also enter into multi-year agreements to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.94 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. Our other liabilities also include $3.48 billion related to net uncertain tax positions as of December 31, 2020. Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 12Commitments and Contingencies and Note 15Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, equity investment risk, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $129 million, $105 million, and $213 million were recognized in 2020, 2019, and 2018, respectively, as interest and other income (expense), net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $794 million and $525 million in the market value of our available-for-sale debt securities as of December 31, 2020 and December 31, 2019, respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. Equity Investment Risk Our equity investments are subject to a wide variety of market-related risks that could have a material impact on the carrying value of our holdings. We continually evaluate our equity investments in privately-held companies. Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our equity investments are complex due to the lack of readily available market data and observable transactions. Volatility in the global economic climate and financial markets, including recent and ongoing effects related to the impact of the COVID-19 pandemic, which requires significant judgments, could result in a material impairment charge on our equity investments. Equity investments accounted for under the equity method were immaterial as of December 31, 2020 and December 31, 2019. Our equity investments had a carrying value of $6.23 billion as of December 31, 2020. For additional information about our equity investments, see Note 1 Summary of Significant Accounting Policies, Note 5 Equity Investments, and Note 6 Fair Value Measurements in the notes to the consolidated financial statements included in Part II, Item 8, and ""Financial Statements and Supplementary Data"" and Part II, Item 7, ""Managements Discussion and Analysis of Financial Conditions and Results of Operations Critical Accounting Policies and Estimates"" contained in this Annual Report on Form 10-K. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 27, 2021 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 12 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory, tax or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above. For certain of these matters, the Company discloses an estimate of the amount of loss or range of possible loss that may be incurred. However, for certain other matters, the Company discloses that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, loss contingencies related to the various legal proceedings was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure regarding any range of possible losses, including when the Company believes it cannot be reasonably estimated at this time, we read the minutes or a summary of the meetings of the committees of the board of directors, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained representations from management. We also evaluated the appropriateness of the related disclosures included in Note 12 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 15 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 15 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California January 27, 2021 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.'s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated January 27, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California January 27, 2021 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, 2020 2019 Assets Current assets: Cash and cash equivalents $ 17,576 $ 19,079 Marketable securities 44,378 35,776 Accounts receivable, net of allowances of $ 114 million and $ 92 million as of December 31, 2020 and 2019, respectively 11,335 9,518 Prepaid expenses and other current assets 2,381 1,852 Total current assets 75,670 66,225 Equity investments 6,234 86 Property and equipment, net 45,633 35,323 Operating lease right-of-use assets, net 9,348 9,460 Intangible assets, net 623 894 Goodwill 19,050 18,715 Other assets 2,758 2,673 Total assets $ 159,316 $ 133,376 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 1,331 $ 1,363 Partners payable 1,093 886 Operating lease liabilities, current 1,023 800 Accrued expenses and other current liabilities 11,152 11,735 Deferred revenue and deposits 382 269 Total current liabilities 14,981 15,053 Operating lease liabilities, non-current 9,631 9,524 Other liabilities 6,414 7,745 Total liabilities 31,026 32,322 Commitments and contingencies Stockholders' equity: Common stock, $ 0.000006 par value; 5,000 million Class A shares authorized, 2,406 million and 2,407 million shares issued and outstanding, as of December 31, 2020 and 2019, respectively; 4,141 million Class B shares authorized, 443 million and 445 million shares issued and outstanding, as of December 31, 2020 and 2019, respectively Additional paid-in capital 50,018 45,851 Accumulated other comprehensive income (loss) 927 ( 489 ) Retained earnings 77,345 55,692 Total stockholders' equity 128,290 101,054 Total liabilities and stockholders' equity $ 159,316 $ 133,376 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, 2020 2019 2018 Revenue $ 85,965 $ 70,697 $ 55,838 Costs and expenses: Cost of revenue 16,692 12,770 9,355 Research and development 18,447 13,600 10,273 Marketing and sales 11,591 9,876 7,846 General and administrative 6,564 10,465 3,451 Total costs and expenses 53,294 46,711 30,925 Income from operations 32,671 23,986 24,913 Interest and other income, net 509 826 448 Income before provision for income taxes 33,180 24,812 25,361 Provision for income taxes 4,034 6,327 3,249 Net income 29,146 18,485 22,112 Less: Net income attributable to participating securities ( 1 ) Net income attributable to Class A and Class B common stockholders $ 29,146 $ 18,485 $ 22,111 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 10.22 $ 6.48 $ 7.65 Diluted $ 10.09 $ 6.43 $ 7.57 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,851 2,854 2,890 Diluted 2,888 2,876 2,921 Share-based compensation expense included in costs and expenses: Cost of revenue $ 447 $ 377 $ 284 Research and development 4,918 3,488 3,022 Marketing and sales 691 569 511 General and administrative 480 402 335 Total share-based compensation expense $ 6,536 $ 4,836 $ 4,152 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, 2020 2019 2018 Net income $ 29,146 $ 18,485 $ 22,112 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax 1,056 ( 151 ) ( 450 ) Change in unrealized gain (loss) on available-for-sale investments and other, net of tax 360 422 ( 52 ) Comprehensive income $ 30,562 $ 18,756 $ 21,610 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2017 2,906 $ $ 40,584 $ ( 227 ) $ 33,990 $ 74,347 Impact of the adoption of new accounting pronouncements ( 31 ) 172 141 Issuance of common stock for cash upon exercise of stock options 2 15 15 Issuance of common stock for settlement of RSUs 44 Shares withheld related to net share settlement ( 19 ) ( 1,845 ) ( 1,363 ) ( 3,208 ) Share-based compensation 4,152 4,152 Share repurchases ( 79 ) ( 12,930 ) ( 12,930 ) Other comprehensive loss ( 502 ) ( 502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 42,906 ( 760 ) 41,981 84,127 Issuance of common stock for cash upon exercise of stock options 1 15 15 Issuance of common stock for settlement of RSUs 32 Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income 271 271 Net income 18,485 18,485 Balances at December 31, 2019 2,852 45,851 ( 489 ) 55,692 101,054 Issuance of common stock for settlement of RSUs 38 Shares withheld related to net share settlement ( 14 ) ( 2,369 ) ( 1,195 ) ( 3,564 ) Share-based compensation 6,536 6,536 Share repurchases ( 27 ) ( 6,298 ) ( 6,298 ) Other comprehensive income 1,416 1,416 Net income 29,146 29,146 Balances at December 31, 2020 2,849 $ $ 50,018 $ 927 $ 77,345 $ 128,290 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Cash flows from operating activities Net income $ 29,146 $ 18,485 $ 22,112 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,862 5,741 4,315 Share-based compensation 6,536 4,836 4,152 Deferred income taxes ( 1,192 ) ( 37 ) 286 Other 118 39 ( 64 ) Changes in assets and liabilities: Accounts receivable ( 1,512 ) ( 1,961 ) ( 1,892 ) Prepaid expenses and other current assets 135 47 ( 690 ) Other assets ( 34 ) 41 ( 159 ) Accounts payable ( 17 ) 113 221 Partners payable 178 348 157 Accrued expenses and other current liabilities ( 1,054 ) 7,300 1,417 Deferred revenue and deposits 108 123 53 Other liabilities ( 527 ) 1,239 ( 634 ) Net cash provided by operating activities 38,747 36,314 29,274 Cash flows from investing activities Purchases of property and equipment ( 15,115 ) ( 15,102 ) ( 13,915 ) Purchases of marketable securities ( 33,930 ) ( 23,910 ) ( 14,656 ) Sales of marketable securities 11,787 9,565 12,358 Maturities of marketable securities 13,984 10,152 4,772 Purchases of equity investments ( 6,361 ) ( 61 ) ( 25 ) Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 388 ) ( 508 ) ( 137 ) Other investing activities ( 36 ) Net cash used in investing activities ( 30,059 ) ( 19,864 ) ( 11,603 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 3,564 ) ( 2,337 ) ( 3,208 ) Repurchases of Class A common stock ( 6,272 ) ( 4,202 ) ( 12,879 ) Principal payments on finance leases ( 604 ) ( 552 ) Net change in overdraft in cash pooling entities 24 ( 223 ) 500 Other financing activities 124 15 15 Net cash used in financing activities ( 10,292 ) ( 7,299 ) ( 15,572 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash 279 4 ( 179 ) Net increase (decrease) in cash, cash equivalents, and restricted cash ( 1,325 ) 9,155 1,920 Cash, cash equivalents, and restricted cash at beginning of the period 19,279 10,124 8,204 Cash, cash equivalents, and restricted cash at end of the period $ 17,954 $ 19,279 $ 10,124 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 17,576 $ 19,079 $ 10,019 Restricted cash, included in prepaid expenses and other current assets 241 8 10 Restricted cash, included in other assets 137 192 95 Total cash, cash equivalents, and restricted cash $ 17,954 $ 19,279 $ 10,124 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, 2020 2019 2018 Supplemental cash flow data Cash paid for income taxes $ 4,229 $ 5,182 $ 3,762 Non-cash investing activities: Acquisition of businesses in accrued expenses and other current liabilities and other liabilities $ 118 $ $ Property and equipment in accounts payable and accrued expenses and other current liabilities $ 2,201 $ 1,887 $ 1,955 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc., its subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Certain prior period amounts have been reclassified to conform to the current year's presentation. None of these reclassifications had a material impact to our consolidated financial statements. Use of Estimates Preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, valuation of equity investments, income taxes, loss contingencies, valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives, collectibility of accounts receivable, credit losses of available-for-sale (AFS) debt securities, fair value of financial instruments, and leases. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. The COVID-19 pandemic has created and may continue to create significant uncertainty in macroeconomic conditions, which may cause further business slowdowns or shutdowns, depress demand for our advertising business, and adversely impact our results of operations. During the year ended December 31, 2020, we faced uncertainties around our estimates of revenue collectibility and accounts receivable credit losses. We expect uncertainties around our key accounting estimates to continue to evolve depending on the duration and degree of impact associated with the COVID-19 pandemic . Our estimates may change as new events occur and additional information emerges, and such changes are recognized or disclosed in our consolidated financial statements . Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition by applying the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. In general, we report advertising revenue on a gross basis, since we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers. For revenue generated from arrangements that involve third-party publishers, we evaluate whether we are the principal or the agent, and for those advertising revenue arrangements where we are the agent, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives, credits, or refunds, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue. We believe that there will not be significant changes to our estimates of variable consideration. Other Revenue Other revenue consists of revenue from the delivery of Facebook Reality Labs (FRL) consumer hardware devices, net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue mostly consists of billings and payments we receive from marketers in advance of revenue recognition as well as revenue not yet recognized for unspecified software upgrades and updates for various FRL products. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2020 was driven by cash payments from customers in advance of satisfying our performance obligations in FRL sales and advertising revenue, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Content Costs Our content costs are mostly related to payments to content providers from whom we license video and music to increase engagement on the platform. For licensed video, we expense the cost per title when the title is accepted and available for viewing if the capitalization criteria are not met. Video content costs that meet the criteria for capitalization were not material to date. For licensed music, we expense the license fees over the contractual license period. Expensed content costs are included in cost of revenue on the consolidated statements of income. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be marketed or sold to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses on the consolidated statements of income. We incurred advertising expenses of $ 2.26 billion, $ 1.57 billion, and $ 1.10 billion for the years ended December 31, 2020, 2019, and 2018, respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. We classify our marketable securities as available-for-sale (AFS) investments in our current assets because they represent investments of cash available for current operations. Our AFS investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. AFS debt securities with an amortized cost basis in excess of estimated fair value are assessed to determine what amount of that difference, if any, is caused by expected credit losses. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income (expense), net on our consolidated statements of income, and any remaining unrealized losses, net of taxes, are included in accumulated other comprehensive income (loss) in stockholders' equity. The amount of credit losses recorded for the year ended December 31, 2020 was not material. There was no impairment charge for any unrealized losses in 2019 and 2018. We determine realized gains or losses on sale of marketable securities on a specific identification method and record such gains or losses as interest and other income (expense), net on the consolidated statements of income. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the consolidated balance sheets based upon the term of the remaining restrictions. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. We elected to account for most of our equity investments using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. The change in carrying value, if any, is recognized in interest and other income (expense), net on our consolidated statements of income. We periodically review our equity investments for impairment. If indicators exist and the estimated fair value of an investment is below the carrying amount, we will write down the investment to fair value. In addition, we also held equity investments accounted for under the equity method which were immaterial as of December 31, 2020 and 2019. Equity investments had a carrying value of $ 6.23 billion and $ 86 million as of December 31, 2020 and 2019, respectively. There was no material impairment in 2020, 2019 and 2018. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 - Quoted prices in active markets for identical assets or liabilities. Level 2 - Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of cash equivalents and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates of expected credit and collectibility trends for the allowance for credit losses and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, reasonable and supportable forecasts of future economic conditions, and other factors that may affect our ability to collect from customers. Expected credit losses are recorded as general and administrative expenses on our consolidated statements of income. As of December 31, 2020 and 2019, our accounts receivable, net were $ 11.33 billion and $ 9.52 billion, respectively, and the allowances of accounts receivable were immaterial. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We have operating leases comprised of certain offices, data center, land, colocations, and equipment leases. We also have finance leases for certain network equipment. We determine if an arrangement is a lease at inception. Most of our leases contain lease and non-lease components. Non-lease components include fixed payments for maintenance, utilities, real estate taxes, and management fees. We combine fixed lease and non-lease components and account for them as a single lease component. Our lease agreements may contain variable costs such as contingent rent escalations, common area maintenance, insurance, real estate taxes or other costs. Such variable lease costs are expensed as incurred on the consolidated statements of income. For certain colocation and equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. For leases that have greater than 12-month lease term, ROU assets and lease liabilities are recognized on the consolidated balance sheet at commencement date based on the present value of remaining fixed lease payments. We consider only payments that are fixed and determinable at the time of commencement. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be in a similar economic environment. Operating leases are included in operating lease ROU assets, operating lease liabilities, current and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, net, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under Topic 842 , while prior period amounts have not been adjusted and continue to be reported under Topic 840. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects Company amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-lived Assets Including Goodwill and Other Acquired Intangibles Assets We evaluate the recoverability of property and equipment and acquired finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2020, no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive income (loss) as a component of stockholders' equity. As of December 31, 2020 we had a cumulative translation gain, net of tax of $ 439 million and as of December 31, 2019, we had a cumulative translation loss, net of tax of $ 617 million. Net losses resulting from foreign exchange transactions were $ 129 million, $ 105 million, and $ 213 million for the years ended December 31, 2020, 2019, and 2018, respectively. These losses were recorded as interest and other income (expense), net on our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. The amount of credit losses recorded for the year ended December 31, 2020 was not material. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 42 % of our revenue for the year ended December 31, 2020 and 43 % of our revenue for the years ended December 31, 2019 and 2018 from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, Japan, Vietnam and Brazil. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses and bad debt expense on these losses was not material during the years ended December 31, 2020, 2019, or 2018. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2020, 2019, and 2018. Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements Fair Value Measurements On January 1, 2020, we adopted Accounting Standards Update No. 2018-13, Changes to Disclosure Requirements for Fair Value Measurements (Topic 820) , which improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard removes, modifies, and adds certain disclosure requirements. The adoption of this new standard did not have a material impact on our consolidated financial statements. Credit Losses On January 1, 2020, we adopted Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326) : Measurement of Credit Losses on Financial Instruments , using the modified retrospective transition method. Upon adoption, we changed our impairment model to utilize a current expected credit losses (CECL) model in place of the incurred loss methodology for financial instruments measured at amortized cost, including our accounts receivable. In addition, we modified our impairment model for AFS debt securities and to discontinue using the concept of ""other than temporary"" impairment on AFS debt securities. CECL estimates on accounts receivable are recorded as general and administrative expenses on our consolidated statements of income. Allowance for credit losses on AFS debt securities are recognized as a charge in interest and other income (expense), net on our consolidated statements of income. The cumulative effect adjustment from adoption was immaterial to our consolidated financial statements. We continue to monitor the financial implications of the COVID-19 pandemic on expected credit losses. Income Taxes On October 1, 2020, we early adopted Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes. This guidance was effective beginning January 1, 2021, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Accounting Pronouncements Not Yet Adopted In January 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2020-01, InvestmentsEquity Securities (Topic 321), InvestmentsEquity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) (ASU 2020-01), which clarifies the interaction of the accounting for equity securities under Topic 321, the accounting for equity method investments in Topic 323, and the accounting for certain forward contracts and purchased options in Topic 815. We will adopt the new standard effective January 1, 2021 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In August 2020, the FASB issued Accounting Standards Update No. 2020-06, DebtDebt with Conversion and Other Options (Subtopic 470-20) and Derivatives and HedgingContracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entitys Own Equity (ASU 2020-06), which simplifies the accounting for convertible instruments by reducing the number of accounting models available for convertible debt instruments. This guidance also eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. This guidance will be effective for us in the first quarter of 2022 on a full or modified retrospective basis, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source consists of the following (in millions): Year Ended December 31, 2020 2019 2018 Advertising $ 84,169 $ 69,655 $ 55,013 Other revenue 1,796 1,042 825 Total revenue $ 85,965 $ 70,697 $ 55,838 Revenue disaggregated by geography, based on the billing address of our customers, consists of the following (in millions): Year Ended December 31, 2020 2019 2018 Revenue: United States and Canada (1) $ 38,433 $ 32,206 $ 25,727 Europe (2) 20,349 16,826 13,631 Asia-Pacific 19,848 15,406 11,733 Rest of World (2) 7,335 6,259 4,747 Total revenue $ 85,965 $ 70,697 $ 55,838 _________________________ (1) United States revenue was $ 36.25 billion, $ 30.23 billion, and $ 24.10 billion for the years ended December 31, 2020, 2019, and 2018, respectively. (2) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Deferred revenue and deposits consists of the following (in millions): December 31, 2020 2019 Deferred revenue $ 335 $ 234 Deposits 47 35 Total deferred revenue and deposits $ 382 $ 269 Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In 2018, the calculation of diluted EPS also included the effect of inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2020, 2019, and 2018. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, 2020 2019 2018 Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,411 $ 3,701 Less: Net income attributable to participating securities ( 1 ) Net income attributable to common stockholders $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,410 $ 3,701 Denominator Weighted-average shares outstanding 2,407 444 2,404 450 2,406 484 Basic EPS $ 10.22 $ 10.22 $ 6.48 $ 6.48 $ 7.65 $ 7.65 Diluted EPS: Numerator Net income attributable to common stockholders $ 24,607 $ 4,539 $ 15,569 $ 2,916 $ 18,410 $ 3,701 Reallocation of net income attributable to participating securities 1 Reallocation of net income as a result of conversion of Class B to Class A common stock 4,539 2,916 3,701 Reallocation of net income to Class B common stock ( 58 ) ( 18 ) ( 16 ) Net income for diluted EPS $ 29,146 $ 4,481 $ 18,485 $ 2,898 $ 22,112 $ 3,685 Denominator Number of shares used for basic EPS computation 2,407 444 2,404 450 2,406 484 Conversion of Class B to Class A common stock 444 450 484 Weighted-average effect of dilutive RSUs and employee stock options 37 22 1 31 3 Number of shares used for diluted EPS computation 2,888 444 2,876 451 2,921 487 Diluted EPS $ 10.09 $ 10.09 $ 6.43 $ 6.43 $ 7.57 $ 7.57 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, 2020 2019 Cash and cash equivalents: Cash $ 6,488 $ 4,735 Money market funds 9,755 12,787 U.S. government securities 1,016 815 U.S. government agency securities 444 Certificate of deposits and time deposits 305 217 Corporate debt securities 12 81 Total cash and cash equivalents 17,576 19,079 Marketable securities: U.S. government securities 20,921 18,679 U.S. government agency securities 11,698 6,712 Corporate debt securities 11,759 10,385 Total marketable securities 44,378 35,776 Total cash and cash equivalents and marketable securities $ 61,954 $ 54,855 The gross unrealized gains on our marketable securities were $ 641 million and $ 205 million as of December 31, 2020 and 2019, respectively. The gross unrealized losses on our marketable securities were not material as of December 31, 2020 and 2019. The allowance for credit losses was not material as of December 31, 2020. The following table classifies our marketable securities by contractual maturities (in millions): December 31, 2020 2019 Due in one year $ 12,826 $ 12,803 Due after one year to five years 31,552 22,973 Total $ 44,378 $ 35,776 Note 5. Equity Investments Our equity investments are investments in equity securities of privately-held companies without readily determinable market values. On July 7, 2020, we completed our equity investment in Jio Platforms Limited (Jio), a subsidiary of Reliance Industries Limited, for $ 5.82 billion. There was no material impairment for the years ended December 31, 2020, 2019 or 2018. The changes in the carrying value of equity investments for the year ended December 31, 2019 were not material. The changes in the carrying value of equity investments for the year ended December 31, 2020 were as follows (in millions): Balance as of December 31, 2019 $ 86 Jio 5,824 Other investments 323 Adjustments 1 Balance as of December 31, 2020 $ 6,234 Note 6. Fair Value Measurement The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2020 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 9,755 $ 9,755 $ $ U.S. government securities 1,016 1,016 Certificate of deposits and time deposits 305 305 Corporate debt securities 12 12 Marketable securities: U.S. government securities 20,921 20,921 U.S. government agency securities 11,698 11,698 Corporate debt securities 11,759 11,759 Total cash equivalents and marketable securities $ 55,466 $ 43,390 $ 12,076 $ Fair Value Measurement at Reporting Date Using Description December 31, 2019 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 12,787 $ 12,787 $ $ U.S. government securities 815 815 U.S. government agency securities 444 444 Certificate of deposits and time deposits 217 217 Corporate debt securities 81 81 Marketable securities: U.S. government securities 18,679 18,679 U.S. government agency securities 6,712 6,712 Corporate debt securities 10,385 10,385 Total cash equivalents and marketable securities $ 50,120 $ 39,437 $ 10,683 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Beginning in 2020, we had other assets and liabilities classified within Level 3 because factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. The aggregate absolute value of these Level 3 assets and liabilities was not material to our consolidated financial statements as of December 31, 2020. On July 7, 2020, we completed our equity investment in Jio and noted observable transactions in similar securities subsequent to the date of our investment. Based on our assessment, we concluded no change in fair value from the initial carrying value of $ 5.82 billion was required as a result of these observable transactions. Had there been a change in the fair value, our investment in Jio would be classified within Level 3. For information regarding our investment in Jio, see Note 5 Equity Investments. Note 7. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, 2020 2019 Land $ 1,326 $ 1,097 Buildings 17,360 11,226 Leasehold improvements 4,321 3,112 Network equipment 22,003 17,004 Computer software, office equipment and other 2,458 1,813 Finance lease right-of-use assets 2,295 1,635 Construction in progress 11,288 10,099 Total 61,051 45,986 Less: Accumulated depreciation ( 15,418 ) ( 10,663 ) Property and equipment, net $ 45,633 $ 35,323 Depreciation expense on property and equipment were $ 6.39 billion, $ 5.18 billion, and $ 3.68 billion for the years ended December 31, 2020, 2019, and 2018, respectively. The majority of the property and equipment depreciation expense was from network equipment depreciation of $ 4.58 billion, $ 3.83 billion, and $ 2.94 billion for the years ended December 31, 2020, 2019, and 2018, respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. Note 8. Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data centers, land, colocations, and equipment. We have also entered into various non-cancelable finance lease agreements for certain network equipment. Our leases have original lease periods expiring between 2021 and 2093. Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs for the years ended December 31, 2020 and 2019 are as follows (in millions): December 31, 2020 2019 Finance lease cost Amortization of right-of-use assets $ 259 $ 195 Interest 14 12 Operating lease cost 1,391 1,139 Variable lease cost and other, net 269 160 Total lease cost $ 1,933 $ 1,506 Operating lease expense was $ 629 million for the year ended December 31, 2018 under Topic 840. Supplemental balance sheet information related to leases is as follows: December 31, 2020 2019 Weighted-average remaining lease term Operating leases 12.2 years 13.0 years Finance leases 14.9 years 15.3 years Weighted-average discount rate Operating leases 3.1 % 3.2 % Finance leases 2.9 % 3.1 % The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2020 (in millions): Operating Leases Finance Leases 2021 $ 1,300 $ 68 2022 1,394 51 2023 1,266 41 2024 1,163 41 2025 1,001 41 Thereafter 7,206 401 Total undiscounted cash flows 13,330 643 Less: Imputed interest ( 2,676 ) ( 120 ) Present value of lease liabilities $ 10,654 $ 523 Lease liabilities, current $ 1,023 $ 54 Lease liabilities, non-current 9,631 469 Present value of lease liabilities $ 10,654 $ 523 The table above does not include lease payments that were not fixed at commencement or lease modification. As of December 31, 2020, we have additional operating and finance leases, that have not yet commenced, with lease obligations of approximately $ 7.41 billion and $ 443 million, respectively, mostly for offices, data centers and network equipment. These operating and finance leases will commence between 2021 and 2025 with lease terms of greater than one year to 30 years. Supplemental cash flow information related to leases for the years ended December 31, 2020 and 2019 are as follows (in millions): December 31, 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows for operating leases $ 1,208 $ 902 Operating cash flows for finance leases $ 14 $ 12 Financing cash flows for finance leases $ 604 $ 552 Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 1,158 $ 5,081 Finance leases $ 121 $ 193 Note 9. Goodwill and Intangible Assets During the year ended December 31, 2020, we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2020 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2020 and 2019 are as follows (in millions): Balance as of December 31, 2018 $ 18,301 Goodwill acquired 408 Effect of currency translation adjustment 6 Balance as of December 31, 2019 18,715 Goodwill acquired 322 Effect of currency translation adjustment 13 Balance as of December 31, 2020 $ 19,050 The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2020 December 31, 2019 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 0.8 $ 2,057 $ ( 1,840 ) $ 217 $ 2,056 $ ( 1,550 ) $ 506 Acquired technology 2.8 1,297 ( 1,088 ) 209 1,158 ( 986 ) 172 Acquired patents 4.0 805 ( 677 ) 128 805 ( 625 ) 180 Trade names 1.4 636 ( 622 ) 14 635 ( 604 ) 31 Other 3.2 223 ( 168 ) 55 162 ( 157 ) 5 Total intangible assets $ 5,018 $ ( 4,395 ) $ 623 $ 4,816 $ ( 3,922 ) $ 894 Amortization expense of intangible assets for the years ended December 31, 2020, 2019, and 2018 was $ 473 million, $ 562 million, and $ 640 million, respectively. As of December 31, 2020, expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): 2021 $ 387 2022 121 2023 53 2024 29 2025 17 Thereafter 16 Total $ 623 Note 10. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, 2020 2019 Legal-related accruals (1) $ 1,622 $ 5,998 Accrued compensation and benefits 2,609 1,704 Accrued property and equipment 1,414 1,082 Accrued taxes 2,038 624 Other current liabilities 3,469 2,327 Accrued expenses and other current liabilities $ 11,152 $ 11,735 _________________________ (1) Includes accrued legal settlements and fines as well as other legal fees. In 2020 and 2019, the amounts include accrued legal settlement for Illinois Biometric Information Privacy Act (BIPA) of $ 650 million and $ 550 million, respectively. In 2019, the amount includes accrued legal settlements for U.S. Federal Trade Commission (FTC) of $ 5.0 billion. For further information, see Legal and Related Matters in Note 12 Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, 2020 2019 Income tax payable $ 5,025 $ 5,651 Other liabilities 1,389 2,094 Other liabilities $ 6,414 $ 7,745 Note 11. Long-term Debt In May 2016, we entered into a $ 2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility would be due and payable on May 20, 2021. No amount had been drawn down under this credit facility, and it was terminated on December 24, 2020. As of December 31, 2020, we had no outstanding long-term debt. Note 12. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other Contractual Commitments We also have $ 7.50 billion of non-cancelable contractual commitments as of December 31, 2020, which are mostly related to our investments in network infrastructure, consumer hardware, content costs and data center operations. The majority of these commitments are due within five years . Legal and Related Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, a second amended complaint was filed in the consolidated putative securities class action. On August 7, 2020, the district court granted our motion to dismiss the second amended complaint, with leave to amend. On October 16, 2020, a third amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which was approved by the federal court and took effect in April 2020. Among other matters, our settlement with the FTC required us to pay a penalty of $ 5.0 billion which was paid in April 2020 upon the effectiveness of the modified consent order. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which provided for a payment of $ 550 million by us and was subject to court approval. On or about May 8, 2020, the parties executed a formal settlement agreement, and plaintiffs filed a motion for preliminary approval of the settlement by the district court. On June 4, 2020, the district court denied the plaintiffs' motion without prejudice. On July 22, 2020, the parties executed an amended settlement agreement, which, among other terms, provides for a payment of $ 650 million by us. On August 19, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. The settlement amount is reflected in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2020. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. On November 15, 2020, the court granted preliminary approval of the settlement. The settlement is subject to final court approval. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Although we are vigorously defending our regulatory compliance, we believe there is a reasonable possibility that the ultimate potential loss related to the inquiries and investigations by the IDPC could be material in the aggregate. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. For example, from time to time we are subject to various litigation and government inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. Such investigations, inquiries, and lawsuits concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. On December 9, 2020, the FTC filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct and unfair methods of competition in violation of Section 5 of the Federal Trade Commission Act and Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. On December 9, 2020, the attorneys general from 46 states, the territory of Guam, and the District of Columbia filed a complaint against us in the U.S. District Court for the District of Columbia alleging that we engaged in anticompetitive conduct in violation of Section 2 of the Sherman Act by acquiring Instagram in 2012 and WhatsApp in 2014 and by maintaining conditions on access to our platform. The complaint also alleges that we violated Section 7 of the Clayton Act by acquiring Instagram and WhatsApp. The lawsuits of the FTC and attorneys general both seek a permanent injunction against our company's alleged violations of the antitrust laws, and other equitable relief, including divestiture or reconstruction of Instagram and WhatsApp. Multiple putative class actions have also been filed in state and federal courts in the United States against us alleging violations of antitrust laws and other causes of action in connection with these acquisitions and other alleged anticompetitive conduct, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. Additionally, we are required to comply with various legal and regulatory obligations around the world. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these other legal proceedings, claims, regulatory, tax, or government inquiries and investigations, and other matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. The ultimate outcome of the legal and related matters described in this section, such as whether the likelihood of loss is remote, reasonably possible, or probable, or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of loss, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 15Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2020, there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2020. Note 13. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2020, we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2020, we have not declared any dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2020, there were 2,406 million shares of Class A common stock and 443 million shares of Class B common stock issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $ 4.90 billion remained available and authorized for repurchases under this program. In January 2020, an additional $ 10.00 billion of repurchases was authorized under this program. In 2020, we repurchased and subsequently retired 27 million shares of our Class A common stock for $ 6.30 billion. As of December 31, 2020, $ 8.60 billion remained available and authorized for repurchases. In January 2021, an additional $ 25 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans In 2020, we maintained one active share-based employee compensation plan, the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan). Our Amended 2012 Plan provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our stock plan are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. Share-based compensation expense mostly consists of the Company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. As of December 31, 2020, there were 129 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. Pursuant to the automatic increase provision under our Amended 2012 Plan, the number of shares reserved for issuance increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 16 million shares reserved for issuance effective January 1, 2021. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2020: Number of Shares Weighted-Average Grant Date Fair Value (in thousands) Unvested at December 31, 2019 78,851 $ 165.74 Granted 62,032 $ 188.73 Vested ( 38,857 ) $ 162.27 Forfeited ( 5,293 ) $ 165.72 Unvested at December 31, 2020 96,733 $ 181.88 The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2020, 2019, and 2018 was $ 9.38 billion, $ 6.01 billion, and $ 7.57 billion, respectively. As of December 31, 2020, there was $ 16.50 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 14. Interest and Other Income, Net The following table presents the detail of interest and other income, net, is as follows (in millions): Year Ended December 31, 2020 2019 2018 Interest income, net $ 672 $ 904 $ 652 Foreign currency exchange losses, net ( 129 ) ( 105 ) ( 213 ) Other income (expense), net ( 34 ) 27 9 Interest and other income, net $ 509 $ 826 $ 448 Note 15. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, 2020 2019 2018 Domestic $ 24,233 $ 5,317 $ 8,800 Foreign 8,947 19,495 16,561 Income before provision for income taxes $ 33,180 $ 24,812 $ 25,361 The provision for income taxes consisted of the following (in millions): Year Ended December 31, 2020 2019 2018 Current: Federal $ 3,297 $ 4,321 $ 1,747 State 523 565 176 Foreign 1,211 1,481 1,031 Total current tax expense 5,031 6,367 2,954 Deferred: Federal ( 859 ) ( 39 ) 316 State ( 122 ) 19 34 Foreign ( 16 ) ( 20 ) ( 55 ) Total deferred tax (benefits)/expense ( 997 ) ( 40 ) 295 Provision for income taxes $ 4,034 $ 6,327 $ 3,249 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, 2020 2019 2018 U.S. federal statutory income tax rate 21.0 % 21.0 % 21.0 % State income taxes, net of federal benefit 0.8 1.8 0.7 Research and development tax credits ( 1.3 ) ( 0.8 ) ( 1.0 ) Share-based compensation 0.2 4.5 0.3 Excess tax benefits related to share-based compensation ( 1.6 ) ( 0.7 ) ( 2.6 ) Foreign-derived intangible income deduction ( 1.9 ) Effect of non-U.S. operations ( 2.4 ) ( 5.8 ) ( 5.9 ) Non-deductible FTC settlement accrual 4.5 Research and development capitalization ( 3.0 ) Other 0.4 1.0 0.3 Effective tax rate 12.2 % 25.5 % 12.8 % Our deferred tax assets (liabilities) are as follows (in millions): December 31, 2020 2019 Deferred tax assets: Net operating loss carryforward $ 2,437 $ 2,051 Tax credit carryforward 1,055 1,333 Share-based compensation 243 135 Accrued expenses and other liabilities 1,108 798 Lease liabilities 2,058 1,999 Capitalized research and development 1,922 Other 340 149 Total deferred tax assets 9,163 6,465 Less: valuation allowance ( 1,218 ) ( 1,012 ) Deferred tax assets, net of valuation allowance 7,945 5,453 Deferred tax liabilities: Depreciation and amortization ( 3,811 ) ( 2,387 ) Right-of-use assets ( 1,876 ) ( 1,910 ) Total deferred tax liabilities ( 5,687 ) ( 4,297 ) Net deferred tax assets $ 2,258 $ 1,156 The valuation allowance was approximately $ 1.22 billion and $ 1.01 billion as of December 31, 2020 and 2019, respectively, mostly relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2020, the U.S. federal and state net operating loss carryforwards were $ 10.62 billion and $ 2.19 billion, which will begin to expire in 2028 and 2027, respectively, if not utilized. We have federal tax credit carryforwards of $ 424 million, which will begin to expire in 2029, if not utilized, and state tax credit carryforwards of $ 2.65 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, 2020 2019 2018 Gross unrecognized tax benefits beginning of period $ 7,863 $ 4,678 $ 3,870 Increases related to prior year tax positions 356 2,309 457 Decreases related to prior year tax positions ( 253 ) ( 525 ) ( 396 ) Increases related to current year tax positions 1,045 1,402 831 Decreases related to settlements of prior year tax positions ( 319 ) ( 1 ) ( 84 ) Gross unrecognized tax benefits end of period $ 8,692 $ 7,863 $ 4,678 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2020 and 2019 were $ 774 million and $ 747 million, respectively. If the balance of gross unrecognized tax benefits of $ 8.69 billion as of December 31, 2020 were realized in a future period, this would result in a tax benefit of $ 4.85 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $ 1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer requested a hearing before the Supreme Court of the United States and the request was denied on June 22, 2020. Since we started to accrue income tax for share-based compensation cost-sharing expense in the second quarter of 2019, the denial of the request by the Supreme Court did not have a material impact to our financial results in 2020. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 and 2018 tax years and by the Irish tax authorities for our 2016 through 2018 tax years. Our 2017 and subsequent tax years remain open to examination by the IRS. Our 2019 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first session of the trial began in February 2020 and a second session is expected to continue in 2021. It is not clear how the IRS intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2020, we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 16. Geographical Information The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets, net (in millions): December 31, 2020 2019 Long-lived assets: United States $ 43,128 $ 35,858 Rest of the world (1) 11,853 8,925 Total long-lived assets $ 54,981 $ 44,783 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2020, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2020 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2020 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +2,fb-1,2019x10k," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. We build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, virtual reality headsets, and in-home devices. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest family members and friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed, Stories, Marketplace, and Watch. Instagram. Instagram brings people closer to the people and things they love. It is a place where people can express themselves through photos, videos, and private messaging, including through Instagram Feed and Stories, and explore their interests in businesses, creators and niche communities. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups, and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable, and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing heavily in other consumer hardware products and a number of longer-term initiatives, such as augmented reality, artificial intelligence (AI), and connectivity efforts, to develop technologies that we believe will help us better serve our mission over the long run. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. Companies that provide regional social networks and messaging products, many of which have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video increases, and as we deepen our investment in new technologies like AI, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security, privacy, and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate more than 70 offices around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing Historically, our communities have generally grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, anti-corruption law compliance, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. The Brazilian General Data Protection Law will impose requirements similar to GDPR on products and services offered to users in Brazil, effective in August 2020. The California Consumer Privacy Act, which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are, and expect to continue to be, the subject of investigations, inquiries, data requests, requests for information, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are currently, and may in the future be, subject to regulatory orders or consent decrees, including the modified consent order we entered into in July 2019 with the U.S. Federal Trade Commission (FTC) which is pending federal court approval and which, among other matters, will require us to implement a comprehensive expansion of our privacy program. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. Employees As of December 31, 2019 , we had 44,942 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and we expect that the size of our active user base will fluctuate or decline in one or more markets from time to time, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors can negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, or concerns related to privacy and sharing, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, regulatory authorities, or litigation that adversely affect our products or users; there is decreased engagement with our products, or failure to accept our terms of service, as part of changes that we implemented in connection with the General Data Protection Regulation (GDPR) in Europe, other similar changes that we implemented in the United States and around the world, or other changes we have implemented or may implement in the future in connection with other regulations, regulatory actions or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of products; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, internet shutdowns, or other actions by governments that affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. From time to time, certain of these factors have negatively affected user retention, growth, and engagement to varying degrees. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have recently implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue can also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of our efforts to promote the Stories format or increased usage of our messaging products; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated or otherwise more effective products; adverse government actions or legislative, regulatory, or other legal developments relating to advertising, including developments that may impact our ability to deliver, target, or measure the effectiveness of advertising; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties, questions about our user data practices, concerns about brand safety or potential legal liability, or uncertainty regarding their own legal and compliance obligations; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that we implemented in connection with the GDPR, California Consumer Privacy Act (CCPA), or other similar changes that we implemented in the United States and around the world (for example, we have seen an increasing number of users opt out of certain types of ad targeting in Europe following adoption of the GDPR), or other product changes or controls we have implemented or may implement in the future, whether in connection with other regulations, regulatory actions or otherwise, that impact our ability to target ads; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. From time to time, certain of these factors have adversely affected our advertising revenue to varying degrees. The occurrence of any of these or other factors in the future could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our advertising revenue is dependent on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control, and changes to the regulatory environment, third-party mobile operating systems and browsers, and our own products have impacted, and we expect will continue to impact, the availability of such signals, which will adversely affect our advertising revenue. We rely on data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue is dependent on targeting and measurement tools that incorporate these signals, and any changes in our ability to use such signals will adversely affect our business. For example, legislative and regulatory changes, such as the GDPR and CCPA, have impacted, and we expect will continue to impact, our ability to use such signals in our ad products. In addition, mobile operating system and browser providers, such as Apple and Google, have announced product changes as well as future plans to limit the ability of application developers to use these signals to target and measure advertising on their platforms. Similarly, we have implemented, and may continue to implement, product changes that give users the ability to limit our use of such data signals to improve ads and other experiences on our products and services, including our Off-Facebook Activity tool and our worldwide offering of product changes we implemented in connection with the GDPR. These developments have limited our ability to target and measure the effectiveness of ads on our platform, and any additional loss of such signals in the future will adversely affect our targeting and measurement capabilities and negatively impact our advertising revenue. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to update or distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple previously released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization, and we expect that any similar changes to its, Google's, or other browser or mobile platforms will further limit our ability to target and measure the effectiveness of ads and impact monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent and Snap in messaging and social media, Bytedance and Twitter in social media, and Amazon in advertising. We also compete with companies that provide regional social networks and messaging products, many of which have strong positions in particular countries. Some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, our products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China, and it is possible that the Chinese government could take action that reduces or eliminates our China-based advertising revenue, whether as a result of the trade dispute with the United States, in response to content issues, or otherwise, or take other action against us, such as imposing taxes or other penalties, which could adversely affect our financial results. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies. We continue to incur substantial costs, and we may not be successful in generating profits, in connection with these efforts. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products to support increasing usage of such products. We have historically monetized messaging in only a limited fashion, and we may not be successful in our efforts to generate meaningful revenue or profits from messaging over the long term. In addition, we have announced plans to implement end-to-end encryption across our messaging services, as well as facilitate interoperability between these platforms, which plans have drawn governmental and regulatory scrutiny in multiple jurisdictions. If our new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have recently implemented, and we will continue to implement, changes to our user data practices. Some of these changes reduce our ability to effectively target ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. For example, our Off-Facebook Activity tool enables users to place limits on our storage and use of information about their interactions with advertisers' apps and websites, which will reduce our ability to deliver the most relevant and effective ads to our users. Similarly, from time to time we update our News Feed ranking algorithm to optimize the user experience, and these changes have had, and may in the future have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we plan to continue to promote the Stories format, which is becoming increasingly popular for sharing content across our products, but our advertising efforts with this format are still under development and we do not currently monetize Stories at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of products, from time to time these efforts have reduced, and may in the future reduce, engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, encryption, content, advertising, and other issues, including actions or decisions in connection with elections, which may adversely affect our reputation and brands. For example, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which has occurred in the past and which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit or objectionable ends, including, for example, any such actions around the 2020 U.S. presidential election or other elections around the world. Maintaining and enhancing our brands will require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches, improper access to or disclosure of our data or user data, other hacking and phishing attacks on our systems, or other cyber incidents could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users' data or to disrupt our ability to provide service. Our products and services involve the collection, storage, processing, and transmission of a large amount of data. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss, modification, disclosure, destruction, or other misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, the types and volume of personal data on our systems, and the evolving nature of our products and services (including our efforts involving new and emerging technologies), we believe that we are a particularly attractive target for such breaches and attacks, including from highly sophisticated, state-sponsored, or otherwise well-funded actors. Our efforts to address undesirable activity on our platform also increase the risk of retaliatory attacks. Such breaches and attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive, and to disable undesirable activities on our platform, may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance, including defects or vulnerabilities in our vendors' information technology systems or offerings; government surveillance; breaches of physical security of our facilities or technical infrastructure; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, that we will be able to react in a timely manner, or that our remediation efforts will be successful. We experience cyber-attacks and other security incidents of varying degrees from time to time, and we may incur significant costs in protecting against or remediating such incidents. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. We are subject to a variety of laws and regulations in the United States and abroad relating to cybersecurity and data protection, as well as obligations under the modified consent order we entered into in July 2019 with the U.S. Federal Trade Commission (FTC), which is pending federal court approval. As a result, affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper access to or disclosure of data, which has occurred in the past and which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. While we took steps to remediate the attack, including fixing the vulnerability, resetting user access tokens and notifying affected users, we may discover and announce additional developments, which could further erode confidence in our brand. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing efforts related to privacy, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in privacy, safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications that previously accessed information of a large number of users of our services. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, whether as a result of our data limitations, including our lack of visibility over our encrypted services, the scale of activity on our platform, or other factors, and we may be notified of such incidents or activity by the independent privacy assessor required under our consent order with the FTC, the media, or other third parties. Such incidents and activities have in the past, and may in the future, include the use of user data or our systems in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten people's safety on- or offline, or instances of spamming, scraping, or spreading misinformation. We may also be unsuccessful in our efforts to enforce our policies or otherwise remediate any such incidents. Any of the foregoing developments may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such developments may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert management's time and attention, and lead to enhanced regulatory oversight. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, advertising policies, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit or objectionable ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, beginning in March 2018, we were the subject of intense media coverage involving the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and we have continued to receive negative publicity. In addition, we may be subject to negative publicity if we are not successful in our efforts to prevent the illicit or objectionable use of our products or services in connection with the 2020 U.S. presidential election or other elections around the world. Any such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; changes to third-party policies that limit our ability to deliver, target, or measure the effectiveness of advertising; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our privacy, safety, security, and content review efforts; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; refunds or other concessions provided to advertisers; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; trading activity in our share repurchase program; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, and some of our investments have the effect of reducing our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on privacy, safety, security, and content review. In addition, from time to time we are subject to settlements, judgments, fines, or other monetary penalties in connection with legal and regulatory developments that may be material to our business. We are also continuing to increase our investments in new platforms and technologies. Some of these investments, particularly our significant investments in virtual and augmented reality, have generated only limited revenue and reduced our operating margin and profitability. If our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2019 , excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $313 million and our effective tax rate by one percentage point as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, anti-corruption law compliance, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to a transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this framework is subject to an annual review that could result in changes to our obligations and also is subject to challenge by regulators and private parties, including a pending legal challenge by a private party. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has referred this challenge to the Court of Justice of the European Union for decision. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApp's terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated or the transfer frameworks are amended, if we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of personal data breach notifications to our designated European privacy regulator, the Irish Data Protection Commission, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The Brazilian General Data Protection Law will impose requirements similar to GDPR on products and services offered to users in Brazil, effective in August 2020. The California Consumer Privacy Act (CCPA), which took effect in January 2020, also establishes certain transparency rules and creates new data privacy rights for users, including more ability to control how their data is shared with third parties. These laws and regulations are evolving and subject to interpretation, and resulting limitations on our advertising services, or reductions of advertising by marketers, have to some extent adversely affected, and will continue to adversely affect, our advertising business. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations or limitations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated claims, inquiries, or investigations or any other government actions, have in the past led to, and may in the future lead to, unfavorable outcomes including increased compliance costs, delays or impediments in the development of new products, negative publicity and reputational harm, increased operating costs, diversion of management time and attention, and remedies that harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, requests for information, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection, competition, and consumer protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to FTC, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Beginning in September 2018, we also became subject to Irish Data Protection Commission (IDPC) and other government inquiries in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. From time to time we also notify the IDPC, our designated European privacy regulator under the GDPR, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. In addition, competition authorities in the United States, Europe, and other jurisdictions have initiated formal and informal inquiries and investigations into many aspects of our business, including with respect to users and advertisers, as well as our industry. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust inquiries and investigations by the U.S. Department of Justice, the U.S. House of Representatives, and state attorneys general. These inquiries and investigations concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary remedies), interrupt or require us to change our business practices in a manner materially adverse to our business, result in negative publicity and reputational harm, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. Compliance with our FTC consent order, the GDPR, the CCPA, and other regulatory and legislative privacy requirements will require significant operational resources and modifications to our business practices, and any compliance failures may have a material adverse effect on our business, reputation, and financial results. We are engaged in ongoing privacy compliance and oversight efforts, including as a result of the modified consent order we entered into in July 2019 with the FTC, as well as our efforts to comply with the GDPR and other regulatory and legislative requirements around the world, including the CCPA. In particular, we have agreed with the FTC to implement a comprehensive expansion of our privacy program, including substantial management and board of directors oversight, stringent operational requirements and reporting obligations, and a process to regularly certify our compliance with the privacy program to the FTC, which will be challenging and costly to implement. We expect that these enhancements will result in both improved privacy compliance and oversight and the discovery of additional privacy issues, at least in the near-term, and we expect to continue to notify the FTC of such issues from time to time in accordance with our reporting obligations under the consent order. These compliance and oversight efforts will increase demand on our systems and resources, and will require significant investments, including investments in compliance processes, personnel, and technical infrastructure. In the near-term, we are reallocating resources internally to assist with these efforts, and this has had, and will continue to have, an adverse impact on our other business initiatives. In addition, these efforts will require substantial modifications to our business practices and make some practices such as product and ads development more difficult, time-consuming, and costly. As a result, we believe our ability to develop and launch new features, products, and services in a timely manner will be adversely affected. We also expect that our privacy compliance and oversight efforts will require significant time and attention from our management and board of directors. In addition, regulatory and legislative privacy requirements are constantly evolving and can be subject to significant change and uncertain interpretation. If we are unable to successfully implement and comply with the mandates of the FTC consent order, GDPR, CCPA, or other regulatory or legislative requirements, or if we are found to be in violation of the consent order or other requirements, we may be subject to regulatory or governmental investigations or lawsuits, which may result in significant monetary fines, judgments, or other penalties, and we may also be required to make additional changes to our business practices. Any of these events could have a material adverse effect on our business, reputation, and financial results. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense, could result in less effective technology or practices or otherwise negatively affect the user experience, or may not be feasible. We have experienced unfavorable outcomes in such disputes and litigation in the past, and our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we have in the past, and may in the future, be subject to additional class action lawsuits based on advertiser claims, antitrust claims, employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We also recently agreed to settlements in principle to resolve certain lawsuits in connection with the ""tag suggestions"" facial recognition feature on Facebook and a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. We believe the remaining lawsuits are without merit and are vigorously defending them. However, the results of such lawsuits and claims cannot be predicted with certainty, and any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which has occurred in the past and which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products, and legislation regulating content on our platform may require us to change our products or business practices. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, in April 2019, the European Union passed a directive expanding online platform liability for copyright infringement and regulating certain uses of news content online, which member states must implement by June 2021. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, legislation in Germany has in the past, and may in the future, result in the imposition of fines for failure to comply with certain content removal, law enforcement cooperation, and disclosure obligations. Other countries, including Australia, France, Singapore, and the United Kingdom, are considering or have implemented similar legislation imposing penalties for failure to remove content or follow certain processes. Such legislation also has in the past, and may in the future, require us to change our products or business practices, increase our compliance costs, or otherwise impact our operations or our ability to provide services in certain geographies. For example, the European Copyright Directive requires certain online services to obtain authorizations for copyrighted content or to implement measures to prevent the availability of that content, which may require us to make substantial investments in compliance processes. If any of the foregoing events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, the technology and products we acquired from Oculus were relatively new to Facebook at the time of the acquisition, and we did not have significant experience with, or structure in place to support, such technology and products prior to the acquisition. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed or may not operate with the reliability and redundancy necessary to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted, any of which could adversely affect our business and financial performance. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, other physical security threats, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations. Unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, challenges in obtaining required government or regulatory approvals, or other geopolitical challenges or actions by governments, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Any of these events could adversely affect our business, reputation, or financial results. Our products and internal systems rely on software and hardware that is highly technical, and if these systems contain errors, bugs, or vulnerabilities, or if we are unsuccessful in addressing or mitigating technical limitations in our systems, our business could be adversely affected. Our products and internal systems rely on software and hardware, including software and hardware developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software and hardware to store, retrieve, process, and manage immense amounts of data. The software and hardware on which we rely has contained, and will in the future contain, errors, bugs, or vulnerabilities, and our systems are subject to certain technical limitations that may compromise our ability to meet our objectives. Some errors, bugs, or vulnerabilities inherently may be difficult to detect and may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, bugs, vulnerabilities, design defects, or technical limitations within the software and hardware on which we rely have in the past led to, and may in the future lead to, outcomes including a negative experience for users and marketers who use our products, compromised ability of our products to perform in a manner consistent with our terms, contracts, or policies, delayed product introductions or enhancements, targeting, measurement, or billing errors, compromised ability to protect the data of our users and/or our intellectual property, or reductions in our ability to provide some or all of our services. For example, we make commitments to our users as to how their data will be used within and across our products, and our systems are subject to errors, bugs and technical limitations that may prevent us from fulfilling these commitments reliably. If our systems contain bugs or errors or if we do not properly address or mitigate the technical limitations in our systems, we may fail to fulfill our commitments to our users and be subject to regulatory scrutiny or litigation that could harm our business and result in fines, damages, or other remedies. In addition, errors, bugs, vulnerabilities, or defects in the software and hardware on which we rely, and any associated degradations or interruptions of service, have in the past led to, and may in the future lead to, outcomes including damage to our reputation, loss of users, loss of marketers, loss of revenue, regulatory inquiries, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our community and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our Facebook metrics (DAUs, MAUs, and average revenue per user (ARPU)) and Family metrics (DAP, MAP, and average revenue per person (ARPP)), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. The methodologies used to measure these metrics require significant judgment and are also susceptible to algorithm or other technical errors. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly review our processes for calculating these metrics, and from time to time we discover inaccuracies in our metrics or make adjustments to improve their accuracy, which can result in adjustments to our historical metrics. Our ability to recalculate our historical metrics may be impacted by data limitations or other factors that require us to apply different methodologies for such adjustments. We generally do not intend to update previously disclosed Family metrics for any such inaccuracies or adjustments that are within the error margins disclosed below. In addition, our Facebook metrics and Family metrics estimates will differ from estimates published by third parties due to differences in methodology. We regularly evaluate our Facebook metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) violating accounts, which represent user profiles that we believe are intended to be used for purposes that violate our terms of service, such as bots and spam. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as identical IP addresses and similar user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Any loss of access to data signals we use in this process, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, or other factors, also may impact the stability or accuracy of our estimates of duplicate and false accounts. Our estimates also may change as our methodologies evolve, including through the application of new data signals or technologies or product changes that may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2019, we estimated that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2019, we estimated that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. Many people in our community have user accounts on more than one of our products, and some people have multiple user accounts within an individual product. Accordingly, for our Family metrics, we do not seek to count the total number of user accounts across our products because we believe that would not reflect the actual size of our community. Rather, our Family metrics represent our estimates of the number of unique people using at least one of Facebook, Instagram, Messenger, and WhatsApp. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. To calculate these metrics, we rely upon complex techniques, algorithms and machine learning models that seek to count the individual people behind user accounts, including by matching multiple user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. These techniques and models require significant judgment, are subject to data and other limitations discussed below, and inherently are subject to statistical variances and uncertainties. We estimate the potential error in our Family metrics primarily based on user survey data, which itself is subject to error as well. While we expect the error margin for our Family metrics to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. As a result, it is also possible that our Family metrics may indicate changes or trends in user numbers that do not match actual changes or trends. To calculate our estimates of Family DAP and MAP, we currently use a series of machine learning models that are developed based on internal reviews of limited samples of user accounts and calibrated against user survey data. We apply significant judgment in designing these models and calculating these estimates. For example, to match user accounts within individual products and across multiple products, we use data signals such as similar device information, IP addresses, and user names. We also calibrate our models against data from periodic user surveys of varying sizes and frequency across our products, which are inherently subject to error. In addition, our data limitations may affect our understanding of certain details of our business and increase the risk of error for our Family metrics estimates. Our techniques and models rely on a variety of data signals from different products, and we rely on more limited data signals for some products compared to others. For example, as a result of limited visibility into encrypted products, we have fewer data signals from WhatsApp user accounts and primarily rely on phone numbers and device information to match WhatsApp user accounts with accounts on our other products. Similarly, although Messenger Kids users are included in our Family metrics, we do not seek to match their accounts with accounts on our other applications for purposes of calculating DAP and MAP. Any loss of access to data signals we use in our process for calculating Family metrics, whether as a result of our own product decisions, actions by third-party browser or mobile platforms, regulatory or legislative requirements, or other factors, also may impact the stability or accuracy of our reported Family metrics. Our estimates of Family metrics also may change as our methodologies evolve, including through the application of new data signals or technologies, product changes, or other improvements in our user surveys, algorithms, or machine learning that may improve our ability to match accounts within and across our products or otherwise evaluate the broad population of our users. In addition, such evolution may allow us to identify previously undetected violating accounts (as defined below). We regularly evaluate our Family metrics to estimate the percentage of our MAP consisting solely of ""violating"" accounts. We define ""violating"" accounts as accounts which we believe are intended to be used for purposes that violate our terms of service, including bots and spam. In the fourth quarter of 2019, we estimated that approximately 3% of our worldwide MAP consisted solely of violating accounts. Such estimation is based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, we look for account information and behaviors associated with Facebook and Instagram accounts that appear to be inauthentic to the reviewers, but we have limited visibility into WhatsApp user activity due to encryption. In addition, if we believe an individual person has one or more violating accounts, we do not include such person in our violating accounts estimation as long as we believe they have one account that does not constitute a violating account. From time to time, we disable certain user accounts, make product changes, or take other actions to reduce the number of violating accounts among our users, which may also reduce our DAP and MAP estimates in a particular period. We intend to disclose our estimates of the percentage of our MAP consisting solely of violating accounts on an annual basis. Violating accounts are very difficult to measure at our scale, and it is possible that the actual number of violating accounts may vary significantly from our estimates. Other data limitations also may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure our metrics are also susceptible to algorithm or other technical errors, and our estimates for revenue by user location and revenue by user device are also affected by these factors. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook or our other products, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 44,942 as of December 31, 2019 from 35,587 as of December 31, 2018 , and we expect such headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors in order to address various privacy, safety, security, and content review initiatives. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant challenges in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located, whether as a result of competition with other companies, challenges due to the high cost of living, facilities and infrastructure constraints, or other factors. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our efforts related to privacy, safety, and security, we are conducting investigations and audits of a large number of platform applications, and we also have announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We also intend to launch certain payments functionality on WhatsApp and have announced plans to develop digital payments products and services, which may subject us to many of the foregoing risks and additional licensing requirements. Our participation in the Libra Association will subject us to significant regulatory scrutiny and other risks that could adversely affect our business, reputation, or financial results. In June 2019, we announced our participation in the Libra Association, which will oversee a proposed digital payments system powered by blockchain technology, and our plans for Calibra, a digital wallet for Libra which we expect to launch in Messenger, WhatsApp, and as a standalone application. Libra is based on relatively new and unproven technology, and the laws and regulations surrounding blockchain-based payments are uncertain and evolving. Libra has drawn significant scrutiny from governments and regulators in multiple jurisdictions and we expect that scrutiny to continue. As a primary sponsor of the initiative, we are participating in responses to inquiries from governments and regulators, and adverse government or regulatory actions or negative publicity resulting from such participation may adversely affect our reputation and harm our business. As this initiative evolves, we may be subject to a variety of laws and regulations in the United States and international jurisdictions, including those governing payments, financial services, anti-money laundering, counter-terrorism financing, economic sanctions, data protection, tax, and competition. In many jurisdictions, the application or interpretation of these laws and regulations is not clear, particularly with respect to evolving laws and regulations that are applied to blockchain and digital payments. These laws and regulations, as well as any associated inquiries or investigations, may delay or impede the launch of the Libra currency as well as the development of our products and services, increase our operating costs, require significant management time and attention, or otherwise harm our business. In addition, market acceptance of such currency is subject to significant uncertainty. As such, there can be no assurance that Libra or our associated products and services will be made available in a timely manner, or at all. We do not have significant prior experience with blockchain-based payments technology, which may adversely affect our ability to successfully develop and market these products and services. We will also incur increased costs in connection with our participation in the Libra Association and the development and marketing of associated products and services, and our investments may not be successful. Any of these events could adversely affect our business, reputation, or financial results. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, competition, consumer protection, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our consumer hardware products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products. We may experience supply shortages or other disruptions in logistics or the supply chain in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. The manufacturing and sale of our consumer hardware products also may be negatively impacted by geopolitical challenges, trade disputes, or other actions by governments that subject us to supply shortages, increased costs, or supply chain disruptions. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We face inventory risk with respect to our consumer hardware products. We are exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new consumer hardware product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017, and the issuance of additional regulatory or accounting guidance related to the Tax Act could materially affect our tax obligations and effective tax rate in the period issued. In addition, a three-judge panel from the Ninth Circuit Court of Appeals issued a decision in Altera Corp. v. Commissioner regarding the treatment of share-based compensation expense in a cost sharing arrangement, which had a material effect on our tax obligations and effective tax rate for the second quarter of 2019. As the taxpayer may appeal the decision to the Supreme Court of the United States, the final outcome of the case is uncertain and could have a material effect on our tax obligations and effective tax rate in future quarters. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and is expected to continue to issue guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would change various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, several countries have proposed or enacted taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and would likely apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $218.62 through December 31, 2019 . In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; developments in anticipated or new legislation or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee or an independent nominating function. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2019 , we owned and leased approximately nine million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 90 acres of land to be developed to accommodate anticipated future growth. In addition, we have offices in approximately 70 cities across North America, Latin America, Europe, the Middle East, Africa and Asia Pacific. We also own 15 data centers globally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, an amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. Any other government inquiries regarding these matters could subject us to additional substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $550 million by us and is subject to approval by the court. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Any such inquiries or investigations could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time we are subject to inquiries and investigations, formal or informal, by competition authorities in the United States, Europe, and other jurisdictions. For example, in June 2019 we were informed by the FTC that it had opened an antitrust investigation of our company. In addition, beginning in the third quarter of 2019, we became the subject of antitrust investigations by the U.S. Department of Justice and state attorneys general. These investigations and inquiries concern, among other things, our business practices in the areas of social networking or social media services, digital advertising, and/or mobile or online applications, as well as past acquisitions. The result of such investigations or inquiries could subject us to substantial monetary remedies and costs, interrupt or require us to change our business practices, divert resources and the attention of management from our business, or subject us to other remedies that adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2019 , there were 3,624 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $205.25 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2019 , there were 39 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2019 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2019 2,415 $ 184.42 2,415 $ 5,757 November 1 - 30, 2019 2,100 $ 195.74 2,100 $ 5,346 December 1 - 31, 2019 2,205 $ 202.02 2,205 $ 4,901 6,720 6,720 _________________________ (1) Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2019, $4.90 billion remained available and authorized for repurchases. In January 2020, an additional $10.0 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Dow Jones Internet Composite Index (DJINET), the Standard Poor's 500 Stock Index (SP 500) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2019 . The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2014 in the Class A common stock of Facebook, Inc., the DJINET, the SP 500 and the Nasdaq Composite and data for the DJINET, the SP 500 and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2019 using 2018 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from nonGAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2019 Results Our key community metrics and financial results for 2019 are as follows: Community growth: Facebook daily active users (DAUs) were 1.66 billion on average for December 2019 , an increase of 9% year-over-year. Facebook monthly active users (MAUs) were 2.50 billion as of December 31, 2019 , an increase of 8% year-over-year. Family daily active people (DAP) was 2.26 billion on average for December 2019 , an increase of 11% year-over-year. Family monthly active people (MAP) was 2.89 billion as of December 31, 2019 , an increase of 9% year-over-year. Financial results: Revenue was $70.70 billion , up 27% year-over-year, and advertising revenue was $69.66 billion , up 27% year-over-year. Total costs and expenses were $46.71 billion . Income from operations was $23.99 billion and operating margin was 34% . Net income was $18.48 billion with diluted earnings per share of $6.43 . Capital expenditures, including principal payments on finance leases, were $15.65 billion . Effective tax rate was 25.5% . Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 . Headcount was 44,942 as of December 31, 2019 , an increase of 26% year-over-year. In 2019 , we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We invested based on the following company priorities that we believe will further our mission to give people the power to build community and bring the world closer together: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world. We intend to continue to invest based on these priorities, and we anticipate that additional investments in our data center capacity, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, will continue to drive expense growth in 2020. Trends in Our Facebook User Metrics The numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 9% to 1.66 billion on average during December 2019 from 1.52 billion during December 2018 . Users in India, Indonesia, and the Philippines represented key sources of growth in DAUs during December 2019 , relative to the same period in 2018 . Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2019 , we had 2.50 billion MAUs, an increase of 8% from December 31, 2018 . Users in India, Indonesia, and the Philippines represented key sources of growth in 2019 , relative to the same period in 2018 . Trends in Our Monetization by Facebook User Geography We calculate our revenue by Facebook user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. The share of revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2019 in the United States Canada region was more than 11 times higher than in the Asia-Pacific region. Note: Our revenue by Facebook user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our Facebook users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the billing address of the customer. Our annual worldwide ARPU in 2019, which represents the sum of quarterly ARPU during such period, was $29.25 , an increase of 17% from 2018 . Over this period, ARPU increased by 24% in the United States Canada, 20% in Europe, 18% in AsiaPacific, and 16% in Rest of World. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as AsiaPacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as MAP or DAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our ""Family"" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Worldwide DAP increased 11% to 2.26 billion on average during December 2019 from 2.03 billion during December 2018. Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. As of December 31, 2019, we had 2.89 billion MAP, an increase of 9% from 2.64 billion as of December 31, 2018. Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. The share of revenue from users who are not also MAP was not material. Our annual worldwide ARPP in 2019, which represents the sum of quarterly ARPP during such period, was $ 25.57 , an increase of 14% from 2018. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and valuation of long-lived assets including goodwill and intangible assets and their associated estimated useful lives have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income, and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability of loss and the estimated amount of loss. The outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 11Commitments and Contingencies and Note 14Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Valuation of Long-lived Assets including Goodwill, Intangible Assets and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2019 , no impairment of goodwill has been identified. Long-lived assets, including property and equipment and intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of revenue from the delivery of consumer hardware devices and net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Research and development. Research and development expenses consist primarily of salaries and benefits, share-based compensation, and facilities-related costs for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We currently expense all of our research and development costs as they are incurred. Marketing and sales. Marketing and sales expenses consist of salaries and benefits, and share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures and professional services such as content reviewers to support our community and product operations. General and administrative. General and administrative expenses consist of legal-related costs; salaries and benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; and professional services. Results of Operations In this section, we discuss the results of our operations for the year ended December 31, 2019 compared to the year ended December 31, 2018. For a discussion of the year ended December 31, 2018 compared to the year ended December 31, 2017, please refer to Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of Operations"" in our Annual Report on Form 10-K for the year ended December 31, 2018. The following table sets forth our consolidated statements of income data: Year Ended December 31, (in millions) Revenue $ 70,697 $ 55,838 $ 40,653 Costs and expenses: Cost of revenue 12,770 9,355 5,454 Research and development 13,600 10,273 7,754 Marketing and sales 9,876 7,846 4,725 General and administrative 10,465 3,451 2,517 Total costs and expenses 46,711 30,925 20,450 Income from operations 23,986 24,913 20,203 Interest and other income, net Income before provision for income taxes 24,812 25,361 20,594 Provision for income taxes 6,327 3,249 4,660 Net income $ 18,485 $ 22,112 $ 15,934 The following table sets forth our consolidated statements of income data (as a percentage of revenue) (1) : Year Ended December 31, Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income, net Income before provision for income taxes Provision for income taxes Net income % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 3,488 3,022 2,820 Marketing and sales General and administrative Total share-based compensation expense $ 4,836 $ 4,152 $ 3,723 Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Revenue Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (in millions) Advertising $ 69,655 $ 55,013 $ 39,942 % % Other revenue 1,042 % % Total revenue $ 70,697 $ 55,838 $ 40,653 % % 2019 Compared to 2018 . Revenue in 2019 increased $14.86 billion , or 27% , compared to 2018 . The increase was almost entirely due to an increase in advertising revenue as a result of an increase in the number of ads delivered, partially offset by a slight decrease in the average price per ad. In 2019 , the number of ads delivered increased by 33% , as compared with approximately 22% in 2018 . The increase in the ads delivered was driven by an increase in the number and frequency of ads displayed across our products, and an increase in users and their engagement. In 2019 , the average price per ad decreased by 5% , as compared with an increase of approximately 13% in 2018 . The decrease in average price per ad was primarily driven by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. We anticipate that future advertising revenue growth will be determined by a combination of the number of ads delivered and price. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 19%, 23%, and 26% between the third and fourth quarters of 2019 , 2018 , and 2017 , respectively, while advertising revenue for both the first quarters of 2019 and 2018 declined 10% and 8% compared to the fourth quarters of 2018 and 2017 , respectively. No customer represented 10% or more of total revenue during the years ended December 31, 2019 , 2018 , and 2017 . Foreign Exchange Impact on Revenue The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2019 compared to the same period in 2018 , had an unfavorable impact on revenue. If we had translated revenue for the full year 2019 using the prior year's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $72.37 billion and $71.32 billion , respectively. Using these constant rates, total revenue and advertising revenue would have been $1.67 billion and $1.66 billion , respectively, higher than actual total revenue and advertising revenue for the full year 2019 , and $16.53 billion and $16.31 billion higher than actual total revenue and advertising revenue, respectively, for the full year 2018 . Cost of revenue Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Cost of revenue $ 12,770 $ 9,355 $ 5,454 % % Percentage of revenue % % % 2019 Compared to 2018 . Cost of revenue in 2019 increased $3.42 billion , or 37% , compared to 2018 . The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure, as well as higher cost of consumer hardware devices sold and traffic acquisition costs. In 2020 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with various partner arrangements. Research and development Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Research and development $ 13,600 $ 10,273 $ 7,754 % % Percentage of revenue % % % 2019 Compared to 2018 . Research and development expenses in 2019 increased $3.33 billion , or 32% , compared to 2018 . The increase was primarily due to increases in payroll and benefits expenses and facilities-related costs as a result of a 31% growth in employee headcount from December 31, 2018 to December 31, 2019 in engineering and other technical functions. In 2020 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Marketing and sales $ 9,876 $ 7,846 $ 4,725 % % Percentage of revenue % % % 2019 Compared to 2018 . Marketing and sales expenses in 2019 increased $2.03 billion , or 26% , compared to 2018 . The increase was primarily driven by increases in marketing expenses, payroll and benefits expenses, and community and product operations expenses. Our payroll and benefits expenses increased as a result of a 23% increase in employee headcount from December 31, 2018 to December 31, 2019 in our marketing and sales functions. In 2020 , we anticipate that marketing expense will increase and plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in community and product operations to support our security efforts. General and administrative Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Legal accrual related to FTC settlement $ 5,000 $ $ NM NM Other general and administrative 5,465 3,451 2,517 % % General and administrative $ 10,465 $ 3,451 $ 2,517 % % Percentage of revenue % % % 2019 Compared to 2018 . General and administrative expenses in 2019 increased $7.01 billion , or 203% , compared to 2018 . The majority of the increase was due to the $5.0 billion FTC settlement expense recorded in the first six months of 2019. In addition, other general and administrative expense increased in 2019 compared to 2018 primarily due to an increase in other legal-related costs and higher payroll and benefits expenses as a result of a 31% increase in employee headcount from December 31, 2018 to December 31, 2019 in our general and administrative functions. In 2020 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income, net Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (in millions) Interest income, net $ $ $ % % Other income (expense), net (78 ) (204 ) (1 ) NM NM Interest and other income, net $ $ $ % % 2019 Compared to 2018 . Interest and other income, net in 2019 increased $378 million compared to 2018 . The increase was due to an increase in interest income driven by higher investment balances and interest rates and a decrease in other expense as a result of lower foreign exchange losses as compared to 2018 due to foreign currency transactions and re-measurement. Provision for income taxes Year Ended December 31, 2019 vs 2018 % Change 2018 vs 2017 % Change (dollars in millions) Provision for income taxes $ 6,327 $ 3,249 $ 4,660 % (30 )% Effective tax rate 25.5 % 12.8 % 22.6 % 2019 Compared to 2018 . Our provision for income taxes in 2019 increased $3.08 billion , or 95% , compared to 2018 , a majority of which is due to an increase in income taxes from the Altera Ninth Circuit Opinion discussed below, an increase in income from operations prior to the effect of the legal accrual related to the FTC settlement that is not expected to be tax-deductible, and a decrease in excess tax benefits recognized from share-based compensation. Our effective tax rate in 2019 increased compared to 2018, primarily due to an increase in income taxes from the Altera Ninth Circuit Opinion, the legal accrual related to the FTC settlement that is not expected to be tax-deductible, and a decrease in excess tax benefits recognized from share-based compensation. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer has until February 10, 2020 to request a hearing before the Supreme Court of the United States. As a result, the final outcome of the case is uncertain. In November 2019, we made a $1.64 billion payment related to this matter and recorded the payment to net against the tax liability included within other liabilities in our consolidated balance sheets. If the Altera Ninth Circuit Opinion is reversed, we would anticipate recording an income tax benefit at that time. Effective Tax Rate Items . Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of changes in tax law. The proportion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 23, 2020 price, we expect our effective tax rate for 2020 will be in the high-teens. The range reflects expected effects from a transfer of intellectual property rights between Facebook entities that we anticipate implementing in 2020. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. Unrecognized Tax Benefits. As of December 31, 2019 , we had net unrecognized tax benefits of $3.74 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a material change to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. The case is scheduled for trial beginning in February 2020. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As of December 31, 2019 , we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740, Income Taxes, for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2019 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (in millions, except per share amounts) Revenue: Advertising $ 20,736 $ 17,383 $ 16,624 $ 14,912 $ 16,640 $ 13,539 $ 13,038 $ 11,795 Other revenue Total revenue 21,082 17,652 16,886 15,077 16,914 13,727 13,231 11,966 Costs and expenses: Cost of revenue 3,492 3,155 3,307 2,816 2,796 2,418 2,214 1,927 Research and development 3,877 3,548 3,315 2,860 2,855 2,657 2,523 2,238 Marketing and sales 3,026 2,416 2,414 2,020 2,467 1,928 1,855 1,595 General and administrative 1,829 1,348 3,224 4,064 Total costs and expenses 12,224 10,467 12,260 11,760 9,094 7,946 7,368 6,517 Income from operations 8,858 7,185 4,626 3,317 7,820 5,781 5,863 5,449 Interest and other income, net Income before provision for income taxes 9,169 7,329 4,832 3,482 7,971 5,912 5,868 5,610 Provision for income taxes 1,820 1,238 2,216 1,053 1,089 Net income $ 7,349 $ 6,091 $ 2,616 $ 2,429 $ 6,882 $ 5,137 $ 5,106 $ 4,988 Less: Net income attributable to participating securities (1 ) Net income attributable to Class A and Class B common stockholders $ 7,349 $ 6,091 $ 2,616 $ 2,429 $ 6,882 $ 5,137 $ 5,106 $ 4,987 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 2.58 $ 2.13 $ 0.92 $ 0.85 $ 2.40 $ 1.78 $ 1.76 $ 1.72 Diluted $ 2.56 $ 2.12 $ 0.91 $ 0.85 $ 2.38 $ 1.76 $ 1.74 $ 1.69 The following tables set forth our consolidated statements of income data (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (as a percentage of revenue) Revenue: Advertising % % % % % % % % Other revenue Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income, net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ 1,273 $ 1,249 $ 1,303 $ 1,010 $ $ 1,040 $ 1,186 $ Share-based compensation expense included in costs and expenses (as a percentage of revenue) (1) : Three Months Ended Dec 31, 2019 Sep 30, 2019 Jun 30, 2019 Mar 31, 2019 Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 (as a percentage of revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % _________________________ (1) Percentages have been rounded for presentation purposes and may differ from unrounded results. Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 36,314 $ 29,274 $ 24,216 Net cash used in investing activities $ (19,864 ) $ (11,603 ) $ (20,118 ) Net cash used in financing activities $ (7,299 ) $ (15,572 ) $ (5,235 ) Purchase of property and equipment and principal payments on finance leases $ 15,654 $ 13,915 $ 6,733 Depreciation and amortization $ 5,741 $ 4,315 $ 3,025 Share-based compensation $ 4,836 $ 4,152 $ 3,723 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents and marketable securities were $54.86 billion as of December 31, 2019 , an increase of $13.74 billion from December 31, 2018 . The majority of the increase was due to $36.31 billion of cash generated from operations, offset by $15.65 billion for capital expenditures, including principal payments on finance leases, $4.20 billion for repurchases of our Class A common stock, $4.19 billion for net purchases of marketable securities, and $2.34 billion of taxes paid related to net share settlement of equity awards. Cash paid for income taxes was $5.18 billion for the year ended December 31, 2019 , of which $1.64 billion was related to the Altera Ninth Circuit Opinion. As of December 31, 2019 , our federal net operating loss carryforward was $9.06 billion , and we anticipate that none of this amount will be utilized to offset our federal taxable income in 2019. As of December 31, 2019 , we had $357 million of federal tax credit carryforward, of which none will be available to offset our federal tax liabilities in 2019 . In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2019 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2018, $9.0 billion remained available and authorized for repurchases under this program. In 2019, we repurchased and subsequently retired 22 million shares of our Class A common stock for $4.10 billion . As of December 31, 2019 , $4.90 billion remained available and authorized for repurchases. In January 2020, an additional $10.0 billion of repurchases was authorized under this program. As of December 31, 2019 , $19.01 billion of the $54.86 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. In July 2019, we entered into a settlement and modified consent order to resolve the inquiry of the FTC into our platform and user data practices, which is pending federal court approval. The settlement requires us to pay a penalty of $5.0 billion, which is included in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2019 . We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2019 primarily consisted of net income adjusted for certain non-cash items, such as $5.74 billion of depreciation and amortization and $4.84 billion of share-based compensation expense. The increase in cash flow from operating activities during 2019 compared to 2018 was primarily due to higher net income prior to the effect of the $5.0 billion FTC legal settlement accrual, an increase in taxes payable, as well as increases in the non-cash items discussed above. Cash flow from operating activities during 2018 mostly consisted of net income, adjusted for certain non-cash items, such as total depreciation and amortization of $4.32 billion and share-based compensation expense of $4.15 billion. The increase in cash flow from operating activities during 2018 compared to 2017 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization, deferred income tax and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a higher tax liability in 2017, which partially offset the increase in cash flow from operating activities in 2018. Cash Used in Investing Activities Cash used in investing activities during 2019 mostly resulted from $15.10 billion of net purchases of property and equipment as we continued to invest in data centers, servers, office buildings, and network infrastructure, and $4.19 billion of net purchases of marketable securities. The increase in cash used in investing activities during 2019 compared to 2018 was mostly due to increases in net purchases of marketable securities and property and equipment. Cash used in investing activities during 2018 mostly resulted from $13.92 billion of capital expenditures as we continued to invest in data centers, servers, network infrastructure, and office buildings, offset by $2.47 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2018 compared to 2017 was mostly due to a decrease in the net purchases of marketable securities, partially offset by an increase in capital expenditures. We anticipate making capital expenditures of approximately $17 billion to $19 billion in 2020 . Cash Used in Financing Activities Cash used in financing activities during 2019 mostly consisted of $4.20 billion cash used to settle repurchases of our Class A common stock, $2.34 billion of taxes paid related to net share settlement of equity awards, and $552 million of principal payments on finance leases. The decrease in cash used in financing activities during 2019 compared to 2018 was mostly due to a decrease in repurchases of our Class A common stock. Cash used in financing activities during 2018 consisted of $12.88 billion paid for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by $500 million in overdraft balances in cash pooling entities. The increase in cash used in financing activities during 2018 compared to 2017 was mostly due to an increase in repurchases of our Class A common stock, partially offset by an increase in overdraft balances in cash pooling entities. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2019 . Contractual Obligations Our principal commitments consist primarily of obligations under operating leases, which include among others, certain of our offices, data centers, land, and colocation leases, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2019 : Payment Due by Period Total 2021-2022 2023-2024 Thereafter (in millions) Operating lease obligations, including imputed interest (1) $ 18,267 $ 1,085 $ 2,510 $ 2,577 $ 12,095 Finance lease obligations, including imputed interest (1) Transition tax payable 1,579 Other contractual commitments (2) 4,542 2,792 Total contractual obligations $ 25,308 $ 4,123 $ 3,242 $ 3,715 $ 14,228 _________________________ (1) Includes variable lease payments that were fixed subsequent to lease commencement or modification. (2) The majority of other contractual commitments were related to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.99 billion . The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities also include $3.74 billion related to net uncertain tax positions as of December 31, 2019 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 11Commitments and Contingencies and Note 14Income Taxes in the notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements For further information on recently issued accounting pronouncements, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have negatively affected, and may continue to negatively affect, our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency losses of $105 million , $213 million , and $6 million were recognized in 2019 , 2018 , and 2017 , respectively, as interest and other income, net in our consolidated statements of income. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $525 million and $468 million in the market value of our available-for-sale debt securities as of December 31, 2019 and December 31, 2018 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated January 29, 2020 expressed an unqualified opinion thereon. Adoption of ASU No. 2016-02 As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Risk Oversight Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Loss Contingencies Description of the Matter As described in Note 11 to the consolidated financial statements, the Company is party to various legal proceedings, claims, and regulatory, tax or government inquiries and investigations. The Company accrues a liability when it believes a loss is probable and the amount can be reasonably estimated. In addition, the Company believes it is reasonably possible that it will incur a loss in some of these cases, actions or inquiries described above, but that the amount of such losses or a range of possible losses cannot be reasonably estimated at this time. Auditing the Company's accounting for, and disclosure of, loss contingencies related to the various legal proceedings was especially challenging due to the significant judgment required to evaluate management's assessments of the likelihood of a loss, and their estimate of the potential amount or range of such losses. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the identification and evaluation of these matters, including controls relating to the Company's assessment of the likelihood that a loss will be realized and their ability to reasonably estimate the potential range of possible losses. To test the Company's assessment of the probability of incurrence of a loss, whether the loss was reasonably estimable, and the conclusion and disclosure that a range of possible losses cannot be reasonably estimated at this time, we read the minutes of the meetings of the board of directors and its committees, read the proceedings, claims, and regulatory, or government inquiries and investigations, or summaries as we deemed appropriate, requested and received internal and external legal counsel confirmation letters, met with internal and external legal counsel to discuss the nature of the various matters, and obtained a representation letter from the Company. We also evaluated the appropriateness of the related disclosures included in Note 11 to the consolidated financial statements. Uncertain Tax Positions Description of the Matter As discussed in Note 14 to the consolidated financial statements, the Company has received certain notices from the Internal Revenue Service (IRS) related to transfer pricing agreements with the Company's foreign subsidiaries for certain periods examined. The IRS has stated that it will also apply its position to tax years subsequent to those examined. If the IRS prevails in its position, it could result in an additional federal tax liability, plus interest and any penalties asserted. The Company uses judgment to (1) determine whether a tax position's technical merits are more-likely-than-not to be sustained and (2) measure the amount of tax benefit that qualifies for recognition. Auditing the Company's accounting for, and disclosure of, these uncertain tax positions was especially challenging due to the significant judgment required to assess management's evaluation of technical merits and the measurement of the tax position based on interpretations of tax laws and legal rulings. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to assess the technical merits of tax positions related to these transfer pricing agreements and to measure the benefit of those tax positions. As part of our audit procedures over the Company's accounting for these positions, we involved our tax professionals to assist with our assessment of the technical merits of the Company's tax positions. This included assessing the Company's correspondence with the relevant tax authorities, evaluating income tax opinions or other third-party advice obtained by the Company, and requesting and receiving confirmation letters from third-party advisors. We also used our knowledge of, and experience with, the application of international and local income tax laws by the relevant income tax authorities to evaluate the Company's accounting for those tax positions. We analyzed the Company's assumptions and data used to determine the amount of the federal tax liability recognized and tested the mathematical accuracy of the underlying data and calculations. We also evaluated the appropriateness of the related disclosures included in Note 14 to the consolidated financial statements in relation to these matters. /s/ Ernst Young LLP We have served as the Company's auditor since 2007. Redwood City, California January 29, 2020 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.'s internal control over financial reporting as of December 31, 2019 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019 , and the related notes and our report dated January 29, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP Redwood City, California January 29, 2020 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 19,079 $ 10,019 Marketable securities 35,776 31,095 Accounts receivable, net of allowances of $206 and $229 as of December 31, 2019 and December 31, 2018, respectively 9,518 7,587 Prepaid expenses and other current assets 1,852 1,779 Total current assets 66,225 50,480 Property and equipment, net 35,323 24,683 Operating lease right-of-use assets, net 9,460 Intangible assets, net 1,294 Goodwill 18,715 18,301 Other assets 2,759 2,576 Total assets $ 133,376 $ 97,334 Liabilities and stockholders' equity Current liabilities: Accounts payable $ 1,363 $ Partners payable Operating lease liabilities, current Accrued expenses and other current liabilities 11,735 5,509 Deferred revenue and deposits Total current liabilities 15,053 7,017 Operating lease liabilities, non-current 9,524 Other liabilities 7,745 6,190 Total liabilities 32,322 13,207 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,407 million and 2,385 million shares issued and outstanding, as of December 31, 2019 and December 31, 2018, respectively; 4,141 million Class B shares authorized, 445 million and 469 million shares issued and outstanding, as of December 31, 2019 and December 31, 2018, respectively. Additional paid-in capital 45,851 42,906 Accumulated other comprehensive loss ( 489 ) ( 760 ) Retained earnings 55,692 41,981 Total stockholders' equity 101,054 84,127 Total liabilities and stockholders' equity $ 133,376 $ 97,334 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 70,697 $ 55,838 $ 40,653 Costs and expenses: Cost of revenue 12,770 9,355 5,454 Research and development 13,600 10,273 7,754 Marketing and sales 9,876 7,846 4,725 General and administrative 10,465 3,451 2,517 Total costs and expenses 46,711 30,925 20,450 Income from operations 23,986 24,913 20,203 Interest and other income, net Income before provision for income taxes 24,812 25,361 20,594 Provision for income taxes 6,327 3,249 4,660 Net income $ 18,485 $ 22,112 $ 15,934 Less: Net income attributable to participating securities ( 1 ) ( 14 ) Net income attributable to Class A and Class B common stockholders $ 18,485 $ 22,111 $ 15,920 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 6.48 $ 7.65 $ 5.49 Diluted $ 6.43 $ 7.57 $ 5.39 Weighted-average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,854 2,890 2,901 Diluted 2,876 2,921 2,956 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 3,488 3,022 2,820 Marketing and sales General and administrative Total share-based compensation expense $ 4,836 $ 4,152 $ 3,723 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 18,485 $ 22,112 $ 15,934 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax ( 151 ) ( 450 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax ( 52 ) ( 90 ) Comprehensive income $ 18,756 $ 21,610 $ 16,410 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2016 2,892 $ $ 38,227 $ ( 703 ) $ 21,670 $ 59,194 Issuance of common stock related to acquisitions Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement ( 21 ) ( 1,702 ) ( 1,544 ) ( 3,246 ) Share-based compensation 3,723 3,723 Share repurchases ( 13 ) ( 2,070 ) ( 2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 40,584 ( 227 ) 33,990 74,347 Impact of the adoption of new accounting pronouncements ( 31 ) Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement ( 19 ) ( 1,845 ) ( 1,363 ) ( 3,208 ) Share-based compensation 4,152 4,152 Share repurchases ( 79 ) ( 12,930 ) ( 12,930 ) Other comprehensive loss ( 502 ) ( 502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 42,906 ( 760 ) 41,981 84,127 Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement and other ( 13 ) ( 1,906 ) ( 675 ) ( 2,581 ) Share-based compensation 4,836 4,836 Share repurchases ( 22 ) ( 4,099 ) ( 4,099 ) Other comprehensive income Net income 18,485 18,485 Balances at December 31, 2019 2,852 $ $ 45,851 $ ( 489 ) $ 55,692 $ 101,054 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 18,485 $ 22,112 $ 15,934 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,741 4,315 3,025 Share-based compensation 4,836 4,152 3,723 Deferred income taxes ( 37 ) ( 377 ) Other ( 64 ) Changes in assets and liabilities: Accounts receivable ( 1,961 ) ( 1,892 ) ( 1,609 ) Prepaid expenses and other current assets ( 690 ) ( 192 ) Other assets ( 159 ) Accounts payable Partners payable Accrued expenses and other current liabilities 7,300 1,417 Deferred revenue and deposits Other liabilities 1,239 ( 634 ) 3,083 Net cash provided by operating activities 36,314 29,274 24,216 Cash flows from investing activities Purchases of property and equipment, net ( 15,102 ) ( 13,915 ) ( 6,733 ) Purchases of marketable securities ( 23,910 ) ( 14,656 ) ( 25,682 ) Sales of marketable securities 9,565 12,358 9,444 Maturities of marketable securities 10,152 4,772 2,988 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets ( 508 ) ( 137 ) ( 122 ) Other investing activities, net ( 61 ) ( 25 ) ( 13 ) Net cash used in investing activities ( 19,864 ) ( 11,603 ) ( 20,118 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards ( 2,337 ) ( 3,208 ) ( 3,246 ) Repurchases of Class A common stock ( 4,202 ) ( 12,879 ) ( 1,976 ) Principal payments on finance leases ( 552 ) Net change in overdraft in cash pooling entities ( 223 ) Other financing activities, net ( 13 ) Net cash used in financing activities ( 7,299 ) ( 15,572 ) ( 5,235 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash ( 179 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 9,155 1,920 ( 905 ) Cash, cash equivalents, and restricted cash at beginning of the period 10,124 8,204 9,109 Cash, cash equivalents, and restricted cash at end of the period $ 19,279 $ 10,124 $ 8,204 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 19,079 $ 10,019 $ 8,079 Restricted cash, included in prepaid expenses and other current assets Restricted cash, included in other assets Total cash, cash equivalents, and restricted cash $ 19,279 $ 10,124 $ 8,204 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid for income taxes, net $ 5,182 $ 3,762 $ 2,117 Non-cash investing activities: Net change in prepaids and liabilities related to property and equipment $ ( 153 ) $ $ Property and equipment in accounts payable and accrued liabilities $ 1,887 $ 1,955 $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc., subsidiaries where we have controlling financial interests, and any variable interest entities for which we are deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to income taxes, loss contingencies, fair value of acquired intangible assets and goodwill, collectability of accounts receivable, fair value of financial instruments, leases, useful lives of intangible assets and property and equipment, and revenue recognition. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition through the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usagebased taxes where it has been determined that we are acting as a passthrough agent. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. We may accept lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We believe that there will not be significant changes to our estimates of variable consideration. Other Revenue Other revenue consists of revenue from the delivery of consumer hardware devices, net fees we receive from developers using our Payments infrastructure, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue mostly consists of billings and payments we receive from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, the majority of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2019 was driven by cash payments from customers in advance of satisfying our performance obligations, offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware devices sold. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, the capitalized amounts are limited to the greater of estimated net realizable value or cost on a per title basis. We expense the cost per title in cost of revenue on the consolidated statements of income when the title is accepted and available for viewing, and before the capitalization criteria are met. For original content, we expense costs associated with the production, including development costs and direct costs as incurred, unless those amounts are determined to be recoverable. Expensed original content costs are included in cost of revenue on the consolidated statements of income. Content acquisition costs that meet the criteria for capitalization were not material to date. Software Development Costs Software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, are expensed before the software or technology reach technological feasibility, which is typically reached shortly before the release of such products. Software development costs also include costs to develop software to be used solely to meet internal needs and applications used to deliver our services. These software development costs meet the criteria for capitalization once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended. Development costs that meet the criteria for capitalization were not material to date. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and operating results. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $ 1.57 billion , $ 1.10 billion , and $ 324 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents consist of cash on deposit with banks and highly liquid investments with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses are charged against interest and other income, net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income, net. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. We classify the overdraft balances within accrued expenses and other current liabilities on the accompanying consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of cash equivalents and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing observable market inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under finance leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Finance lease right-of-use assets Three to 20 years Leasehold improvements Lesser of estimated useful life or remaining lease term The useful lives of our property and equipment are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. Our current estimate of useful lives represents the best estimate of the useful lives based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised estimated useful life. Historically changes in useful lives have not resulted in material changes to our depreciation and amortization expense. Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations On January 1, 2019, we adopted Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02) using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application. Results and disclosure requirements for reporting periods beginning after January 1, 2019 are presented under Topic 842 , while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting under Topic 840. We elected the package of practical expedients permitted under the transition guidance, which allowed us to carryforward our historical lease classification, our assessment on whether a contract was or contains a lease, and our initial direct costs for any leases that existed prior to January 1, 2019. We also elected to combine our lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease right-of-use (ROU) assets and lease liabilities. Upon adoption, we recognized total ROU assets of $ 6.63 billion , with corresponding lease liabilities of $ 6.35 billion on the consolidated balance sheets. This included $ 761 million of pre-existing finance lease ROU assets previously reported in the network equipment within property and equipment, net. The ROU assets include adjustments for prepayments and accrued lease payments. The adoption did not impact our beginning retained earnings, or our prior year consolidated statements of income and statements of cash flows. Under Topic 842 , we determine if an arrangement is a lease at inception. ROU assets and lease liabilities are recognized at commencement date based on the present value of remaining lease payments over the lease term. For this purpose, we consider only payments that are fixed and determinable at the time of commencement. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our incremental borrowing rate is a hypothetical rate based on our understanding of what our credit rating would be. The ROU asset also includes any lease payments made prior to commencement and is recorded net of any lease incentives received. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. When determining the probability of exercising such options, we consider contract-based, asset-based, entity-based, and market-based factors. Our lease agreements may contain variable costs such as common area maintenance, insurance, real estate taxes or other costs. Variable lease costs are expensed as incurred on the consolidated statements of income. Our lease agreements generally do not contain any residual value guarantees or restrictive covenants. Operating leases are included in operating lease ROU assets, operating lease liabilities, current and operating lease liabilities, non-current on our consolidated balance sheets. Finance leases are included in property and equipment, accrued expenses and other current liabilities, and other liabilities on our consolidated balance sheets. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We evaluate the developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements to the extent material. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability of loss and the estimated amount of loss. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects Company amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-lived Assets Including Goodwill and Other Acquired Intangibles Assets We evaluate the recoverability of property and equipment and acquired finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2019, no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we change the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive loss as a component of stockholders' equity. As of December 31, 2019 and 2018 , we had a cumulative translation loss, net of tax of $ 617 million and $ 466 million , respectively. Net losses resulting from foreign exchange transactions were $ 105 million , $ 213 million , and $ 6 million for the years ended December 31, 2019 , 2018 , and 2017 , respectively. These losses were recorded as interest and other income, net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of money market funds, that primarily invest in U.S. government and agency securities. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities . Our investment portfolio in corporate debt securities is highly liquid and diversified among individual issuers. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 43 % of our revenue for the years ended December 31, 2019 and 2018 and 44 % of our revenue for the year ended December 31, 2017 from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Brazil, and Australia. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain an allowance for estimated credit losses. Bad debt expense was not material during the years ended December 31, 2019 , 2018 , or 2017 . In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2019 , 2018 , and 2017 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements On January 1, 2019, we adopted Topic 842 , as amended, which supersedes the lease accounting guidance under Topic 840, and generally requires lessees to recognize operating and financing lease liabilities and corresponding ROU assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We adopted the new guidance using the modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not restating comparative periods. The most significant impact was the recognition of ROU assets and lease liabilities for operating leases, while our accounting for finance leases remained substantially unchanged. For information regarding the impact of Topic 842 adoption, see Significant Accounting Policies - Leases above and Note 7 - Leases. On October 1, 2019, we early adopted Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04) using the prospective approach, which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance was effective beginning January 1, 2020, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. On October 1, 2019, we early adopted Accounting Standards Update No. 2019-02, Entertainment-Films-Other Assets-Film Costs (Subtopic 926-20) and Entertainment-Broadcasters-Intangibles-Goodwill and Other (Subtopic 920-350 ): Improvements to Accounting for Costs of Films and License Agreements for Program Materials (ASU 2019-02) using the prospective approach, which eliminates certain revenue-related constraints on capitalization of inventory costs for episodic television that existed under prior guidance. In addition, the balance sheet classification requirements that existed in prior guidance for film production costs and programming inventory were eliminated. This guidance was effective beginning January 1, 2020, with early adoption permitted. The adoption of this new standard did not have a material impact on our consolidated financial statements. Recent Accounting Pronouncements Not Yet Adopted In June 2016, the Financial Accounting Standards Board ( FASB) issued Accounting Standard Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. We will adopt the new standard effective January 1, 2020 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In August 2018, the FASB issued Accounting Standard Update No. 2018-13, Changes to Disclosure Requirements for Fair Value Measurements (Topic 820) (ASU 2018-13), which improved the effectiveness of disclosure requirements for recurring and nonrecurring fair value measurements. The standard removes, modifies, and adds certain disclosure requirements. We will adopt the new standard effective January 1, 2020 and do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In December 2019, the FASB issued Accounting Standard Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12), which simplifies the accounting for income taxes. This guidance will be effective for us in the first quarter of 2021 on a prospective basis, and early adoption is permitted. We are currently evaluating the impact of the new guidance on our consolidated financial statements. Note 2. Revenue Revenue disaggregated by revenue source consists of the following (in millions): Year Ended December 31, 2017 (1) Advertising $ 69,655 $ 55,013 $ 39,942 Other revenue 1,042 Total revenue $ 70,697 $ 55,838 $ 40,653 _________________________ (1) Prior period amounts have not been adjusted under the modified retrospective method of the adoption of Topic 606. Revenue disaggregated by geography, based on the billing address of our customers, consists of the following (in millions): Year Ended December 31, 2017 (1) Revenue: United States and Canada (2) $ 32,206 $ 25,727 $ 19,065 Europe (3) 16,826 13,631 10,126 Asia-Pacific 15,406 11,733 7,921 Rest of World (3) 6,259 4,747 3,541 Total revenue $ 70,697 $ 55,838 $ 40,653 _________________________ (1) Prior period amounts have not been adjusted under the modified retrospective method of the adoption of Topic 606. (2) United States revenue was $ 30.23 billion , $ 24.10 billion , and $ 17.73 billion for the years ended December 31, 2019 , 2018 , and 2017 . (3) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ Note 3. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under our equity compensation plans. In 2018 and 2017, the calculation of diluted EPS also included the effect of inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 15,569 $ 2,916 $ 18,411 $ 3,701 $ 13,034 $ 2,900 Less: Net income attributable to participating securities ( 1 ) ( 12 ) ( 2 ) Net income attributable to common stockholders $ 15,569 $ 2,916 $ 18,410 $ 3,701 $ 13,022 $ 2,898 Denominator Weighted-average shares outstanding 2,404 2,406 2,375 Less: Shares subject to repurchase ( 2 ) Number of shares used for basic EPS computation 2,404 2,406 2,373 Basic EPS $ 6.48 $ 6.48 $ 7.65 $ 7.65 $ 5.49 $ 5.49 Diluted EPS: Numerator Net income attributable to common stockholders $ 15,569 $ 2,916 $ 18,410 $ 3,701 $ 13,022 $ 2,898 Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 2,916 3,701 2,898 Reallocation of net income to Class B common stock ( 18 ) ( 16 ) ( 13 ) Net income attributable to common stockholders for diluted EPS $ 18,485 $ 2,898 $ 22,112 $ 3,685 $ 15,934 $ 2,885 Denominator Number of shares used for basic EPS computation 2,404 2,406 2,373 Conversion of Class B to Class A common stock Weighted-average effect of dilutive RSUs and employee stock options Shares subject to repurchase Number of shares used for diluted EPS computation 2,876 2,921 2,956 Diluted EPS $ 6.43 $ 6.43 $ 7.57 $ 7.57 $ 5.39 $ 5.39 Note 4. Cash and Cash Equivalents and Marketable Securities The following table sets forth the cash and cash equivalents and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 4,735 $ 2,713 Money market funds 12,787 6,792 U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 19,079 10,019 Marketable securities: U.S. government securities 18,679 13,836 U.S. government agency securities 6,712 8,333 Corporate debt securities 10,385 8,926 Total marketable securities 35,776 31,095 Total cash and cash equivalents and marketable securities $ 54,855 $ 41,114 The gross unrealized gains on our marketable securities were $ 205 million and $ 24 million as of December 31, 2019 and 2018 , respectively. The gross unrealized losses on our marketable securities were $ 24 million and $ 357 million as of December 31, 2019 and 2018 , respectively. In addition, gross unrealized losses that had been in a continuous loss position for 12 months or longer were $ 17 million and $ 332 million as of December 31, 2019 and 2018 , respectively. As of December 31, 2019 , we considered the unrealized losses on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 12,803 $ 9,746 Due after one year to five years 22,973 21,349 Total $ 35,776 $ 31,095 Note 5. Fair Value Measurement The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2019 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 12,787 $ 12,787 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 18,679 18,679 U.S. government agency securities 6,712 6,712 Corporate debt securities 10,385 10,385 Total cash equivalents and marketable securities $ 50,120 $ 39,437 $ 10,683 $ Fair Value Measurement at Reporting Date Using Description December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 6,792 $ 6,792 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 13,836 13,836 U.S. government agency securities 8,333 8,333 Corporate debt securities 8,926 8,926 Total cash equivalents and marketable securities $ 38,401 $ 29,105 $ 9,296 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Note 6. Property and Equipment Property and equipment, net consists of the following (in millions): December 31, Land $ 1,097 $ Buildings 11,226 7,401 Leasehold improvements 3,112 1,841 Network equipment 17,004 13,017 Computer software, office equipment and other 1,813 1,187 Finance lease right-of-use assets 1,635 Construction in progress 10,099 7,228 Total 45,986 31,573 Less: Accumulated depreciation ( 10,663 ) ( 6,890 ) Property and equipment, net $ 35,323 $ 24,683 Depreciation expense on property and equipment were $ 5.18 billion , $ 3.68 billion , and $ 2.33 billion for the years ended December 31, 2019 , 2018 , and 2017 , respectively. The majority of the property and equipment depreciation expense was from network equipment depreciation of $ 3.83 billion , $ 2.94 billion , and $ 1.84 billion for the years ended December 31, 2019 , 2018 , and 2017 , respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. No interest was capitalized for any period presented. Note 7. Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data center, land, colocations, and equipment. We have also entered into various non-cancelable finance lease agreements for certain network equipment. Our leases have original lease periods expiring between 2020 and 2093 . Many leases include one or more options to renew. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease commencement. Our lease agreements generally do not contain any material residual value guarantees or material restrictive covenants. The components of lease costs, lease term and discount rate for the year ended December 31, 2019 are as follows (in millions): Finance lease cost Amortization of right-of-use assets $ Interest Operating lease cost 1,139 Variable lease cost and other, net Total lease cost $ 1,506 Weighted-average remaining lease term Operating leases 13.0 years Finance leases 15.3 years Weighted-average discount rate Operating leases 3.2 % Finance leases 3.1 % Operating lease expense was $ 629 million and $ 363 million for the years ended December 31, 2018 and 2017, respectively, under Topic 840. The following is a schedule, by years, of maturities of lease liabilities as of December 31, 2019 (in millions): Operating Leases Finance Leases $ 1,060 $ 2021 1,244 2022 1,141 2023 1,116 2024 1,039 Thereafter 7,572 Total undiscounted cash flows 13,172 Less: Imputed interest ( 2,848 ) ( 120 ) Present value of lease liabilities $ 10,324 $ Lease liabilities, current $ $ Lease liabilities, non-current 9,524 Present value of lease liabilities $ 10,324 $ As of December 31, 2019 , we have additional operating and finance leases for facilities and network equipment that have not yet commenced with lease obligations of approximately $ 5.04 billion and $ 317 million , respectively. These operating and finance leases will commence between 2020 and 2023 with lease terms of greater than one year to 25 years. The table above does not include lease payments that were not fixed at commencement or lease modification. Supplemental cash flow information related to leases for the year ended December 31, 2019 are as follows (in millions): Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ Operating cash flows from finance leases $ Financing cash flows from finance leases $ Lease liabilities arising from obtaining right-of-use assets: Operating leases $ 5,081 Finance leases $ Note 8. Goodwill and Intangible Assets During the year ended December 31, 2019 , we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2019 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2019 and 2018 are as follows (in millions): Balance as of December 31, 2017 $ 18,221 Goodwill acquired Effect of currency translation adjustment ( 8 ) Balance as of December 31, 2018 18,301 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2019 $ 18,715 The following table sets forth the major categories of the intangible assets and the weighted-average remaining useful lives for those assets that are not already fully amortized (in millions): December 31, 2019 December 31, 2018 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 1.8 $ 2,056 $ ( 1,550 ) $ $ 2,056 $ ( 1,260 ) $ Acquired technology 2.6 1,158 ( 986 ) 1,002 ( 871 ) Acquired patents 4.6 ( 625 ) ( 565 ) Trade names 2.0 ( 604 ) ( 517 ) Other 3.3 ( 157 ) ( 147 ) Total intangible assets $ 4,816 $ ( 3,922 ) $ $ 4,654 $ ( 3,360 ) $ 1,294 Amortization expense of intangible assets for the years ended December 31, 2019 , 2018 , and 2017 was $ 562 million , $ 640 million , and $ 692 million , respectively. As of December 31, 2019 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2021 2022 2023 2024 Thereafter Total $ 93 Note 9. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued legal settlements for FTC and BIPA (1) $ 5,550 $ Accrued compensation and benefits 1,704 1,203 Accrued property and equipment 1,082 1,531 Accrued taxes Overdraft in cash pooling entities Other current liabilities 2,498 1,784 Accrued expenses and other current liabilities $ 11,735 $ 5,509 _________________________ (1) Includes accrued legal settlements for U.S. Federal Trade Commission (FTC) of $ 5.0 billion and Illinois Biometric Information Privacy Act (BIPA) of $ 550 million . For further information, see Legal Matters in Note. 11Commitments and Contingencies. The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 5,651 $ 4,655 Deferred tax liabilities 1,039 Other liabilities 1,055 Other liabilities $ 7,745 $ 6,190 Note 10. Long-term Debt In May 2016, we entered into a $ 2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2019 , no amounts had been drawn down and we were in compliance with the covenants under this facility. Note 11. Commitments and Contingencies Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other contractual commitments We also have $ 4.54 billion of non-cancelable contractual commitments as of December 31, 2019 , which is primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Legal Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018 and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. On September 25, 2019, the district court granted our motion to dismiss the consolidated putative securities class action, with leave to amend. On November 15, 2019, an amended complaint was filed in the consolidated putative securities class action. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission (FTC), state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. In July 2019, we entered into a settlement and modified consent order to resolve the FTC inquiry, which is pending federal court approval. Among other matters, our settlement with the FTC requires us to pay a penalty of $ 5.0 billion and to significantly enhance our practices and processes for privacy compliance and oversight. We have recognized the penalty in accrued expenses and other current liabilities on our consolidated balance sheet as of December 31, 2019. On April 1, 2015, a putative class action was filed against us in the U.S. District Court for the Northern District of California by Facebook users alleging that the ""tag suggestions"" facial recognition feature violates the Illinois Biometric Information Privacy Act, and seeking statutory damages and injunctive relief. On April 16, 2018, the district court certified a class of Illinois residents, and on May 14, 2018, the district court denied both parties' motions for summary judgment. On May 29, 2018, the U.S. Court of Appeals for the Ninth Circuit granted our petition for review of the class certification order and stayed the proceeding. On August 8, 2019, the Ninth Circuit affirmed the class certification order. On December 2, 2019, we filed a petition with the U.S. Supreme Court seeking review of the decision of the Ninth Circuit, which was denied. On January 15, 2020, the parties agreed to a settlement in principle to resolve the lawsuit, which will require a payment of $ 550 million by us and is subject to approval by the court. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebook's code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. The actions filed in the United States were consolidated in the U.S. District Court for the Northern District of California. On November 26, 2019, the district court certified a class for injunctive relief purposes, but denied certification of a class for purposes of pursuing damages. On January 16, 2020, the parties agreed to a settlement in principle to resolve the lawsuit. We believe the remaining lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission (IDPC) and other government inquiries. From time to time we also notify the IDPC, our designated European privacy regulator under the General Data Protection Regulation, of certain other personal data breaches and privacy issues, and are subject to inquiries and investigations regarding various aspects of our regulatory compliance. Although we are vigorously defending our regulatory compliance, we believe there is a reasonable possibility that the ultimate potential loss related to the inquiries and investigations by the IDPC could be material in the aggregate. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. With respect to the cases, actions, and inquiries described above, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these matters. With respect to the matters described above that do not include an estimate of the amount of loss or range of possible loss, such losses or range of possible losses either cannot be estimated or are not individually material, but we believe there is a reasonable possibility that they may be material in the aggregate. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these other matters, we evaluate the associated developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. In addition, we believe there is a reasonable possibility that we may incur a loss in some of these other matters. We believe that the amount of losses or any estimable range of possible losses with respect to these other matters will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. However, the outcome of the legal matters described in this section is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 14Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2019 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2019 . Note 12. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2019 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $ 0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2019 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2019 , there were 2,407 million shares and 445 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. As of December 31, 2018, $ 9.0 billion remained available and authorized for repurchases under this program. In 2019, we repurchased and subsequently retired 22 million shares of our Class A common stock for $ 4.10 billion . As of December 31, 2019 , $ 4.90 billion remained available and authorized for repurchases. In January 2020, an additional $ 10.0 billion of repurchases was authorized under this program. The timing and actual number of shares repurchased under the repurchase program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our Amended 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our Stock Plans are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. Share-based compensation expense mostly consists of the Company's restricted stock units (RSUs) expense. RSUs granted to employees are measured based on the grant-date fair value. In general, our RSUs vest over a service period of four years . Share-based compensation expense is generally recognized based on the straight-line basis over the requisite service period. As of December 31, 2019 , there were 111 million shares of our Class A common stock reserved for future issuance under our Amended 2012 Plan. The number of shares reserved for issuance under our Amended 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 , by a number of shares of Class A common stock equal to the lesser of (i) 2.5 % of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 60 million shares reserved for issuance effective January 1, 2020. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2019 : Number of Shares Weighted-Average Exercise Price Weighted-Average Remaining Contractual Term Aggregate Intrinsic Value (in thousands) (in years) (in millions) Balance as of December 31, 2018 1,137 $ 13.74 Stock options exercised ( 1,137 ) $ 13.74 Balances at December 31, 2019 $ $ There were no options granted, forfeited, or canceled for the year ended December 31, 2019 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2019 , 2018 , and 2017 was $ 185 million , $ 315 million , and $ 359 million , respectively. All of our outstanding options had vested by December 31, 2018 . The total grant date fair value of stock options vested during the years ended December 31, 2018 , and 2017 was not material. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2019 : Number of Shares Weighted-Average Grant Date Fair Value (in thousands) Unvested at December 31, 2018 67,298 $ 144.77 Granted 54,379 $ 173.66 Vested ( 33,501 ) $ 142.04 Forfeited ( 9,325 ) $ 145.86 Unvested at December 31, 2019 78,851 $ 165.74 The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2019 , 2018 , and 2017 was $ 6.01 billion , $ 7.57 billion , and $ 6.76 billion , respectively. As of December 31, 2019 , there was $ 12.21 billion of unrecognized share-based compensation expense related to RSUs awards. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 13. Interest and other income, net The following table presents the detail of interest and other income, net, for the years ended December 31, 2019 , 2018 , and 2017 are as follows (in millions): Year Ended December 31, Interest income $ $ $ Interest expense ( 20 ) ( 9 ) ( 6 ) Foreign currency exchange losses, net ( 105 ) ( 213 ) ( 6 ) Other Interest and other income, net $ $ $ 98 Note 14. Income Taxes The components of income before provision for income taxes are as follows (in millions): Year Ended December 31, Domestic $ 5,317 $ 8,800 $ 7,079 Foreign 19,495 16,561 13,515 Income before provision for income taxes $ 24,812 $ 25,361 $ 20,594 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 4,321 $ 1,747 $ 4,455 State Foreign 1,481 1,031 Total current tax expense 6,367 2,954 5,034 Deferred: Federal ( 39 ) ( 296 ) State ( 33 ) Foreign ( 20 ) ( 55 ) ( 45 ) Total deferred tax (benefits)/expense ( 40 ) ( 374 ) Provision for income taxes $ 6,327 $ 3,249 $ 4,660 A reconciliation of the U.S. federal statutory income tax rates to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 21.0 % 21.0 % 35.0 % State income taxes, net of federal benefit 1.8 0.7 0.6 Research tax credits ( 0.8 ) ( 1.0 ) ( 0.9 ) Share-based compensation 4.5 0.3 0.4 Excess tax benefits related to share-based compensation ( 0.7 ) ( 2.6 ) ( 5.8 ) Effect of non-U.S. operations ( 5.8 ) ( 5.9 ) ( 18.6 ) Effect of U.S. tax law change (1) 11.0 Non-deductible FTC settlement accrual 4.5 Other 1.0 0.3 0.9 Effective tax rate 25.5 % 12.8 % 22.6 % _________________________ (1) Due to the 2017 Tax Cuts and Jobs Act, provisional one-time mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 2,051 $ 1,825 Tax credit carryforward 1,333 Share-based compensation Accrued expenses and other liabilities Lease liabilities 1,999 Other Total deferred tax assets 6,465 3,403 Less: valuation allowance ( 1,012 ) ( 600 ) Deferred tax assets, net of valuation allowance 5,453 2,803 Deferred tax liabilities: Depreciation and amortization ( 2,387 ) ( 1,401 ) Right-of-use assets ( 1,910 ) Purchased intangible assets ( 195 ) Total deferred tax liabilities ( 4,297 ) ( 1,596 ) Net deferred tax assets $ 1,156 $ 1,207 The valuation allowance was approximately $ 1.01 billion and $ 600 million as of December 31, 2019 and 2018 , respectively, mostly relating to U.S. state tax credit carryforwards and U.S. foreign tax credits for which we do not believe a tax benefit is more likely than not to be realized. As of December 31, 2019 , the U.S. federal and state net operating loss carryforwards were $ 9.06 billion and $ 2.37 billion, which will begin to expire in 2033 and 2027 , respectively, if not utilized. We have federal tax credit carryforwards of $ 357 million, which will begin to expire in 2029 , if not utilized, and state tax credit carryforwards of $ 2.28 billion, most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50 % over a threeyear period. The 2017 Tax Cuts and Jobs Act (Tax Act) imposed a mandatory transition tax on accumulated foreign earnings and generally eliminated U.S. taxes on foreign subsidiary distribution. As a result, accumulated earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits beginning of period $ 4,678 $ 3,870 $ 3,309 Increases related to prior year tax positions 2,309 Decreases related to prior year tax positions ( 525 ) ( 396 ) ( 34 ) Increases related to current year tax positions 1,402 Decreases related to settlements of prior year tax positions ( 1 ) ( 84 ) ( 13 ) Gross unrecognized tax benefits end of period $ 7,863 $ 4,678 $ 3,870 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2019 and 2018 were $ 747 million and $ 340 million , respectively. If the balance of gross unrecognized tax benefits of $ 7.86 billion as of December 31, 2019 were realized in a future period, this would result in a tax benefit of $ 4.71 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court issued a decision (Tax Court Decision) in Altera Corp. v. Commissioner , which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Decision was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7, 2019, the Ninth Circuit issued an opinion ( Altera Ninth Circuit Opinion) that reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we recorded a cumulative income tax expense of $ 1.11 billion in the second quarter of 2019. On July 22, 2019, the taxpayer requested a rehearing before the full Ninth Circuit and the request was denied on November 12, 2019. The taxpayer has until February 10, 2020 to request a hearing before the Supreme Court of the United States. As a result, the final outcome of the case is uncertain. In November 2019, we made a $ 1.64 billion payment related to this matter and recorded the payment to net against the related tax liability included within other liabilities in our consolidated balance sheets. If the Altera Ninth Circuit Opinion is reversed, we would anticipate recording an income tax benefit at that time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 tax years and by the Ireland tax authorities for our 2012 through 2015 tax years. Our 2017 and subsequent tax years remain open to examination by the IRS. Our 2016 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. The case is scheduled for trial beginning in February 2020. On January 15, 2020, the IRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The IRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if the IRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $ 9.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $ 680 million in excess of the amounts in our originally filed U.S. returns, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes , that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices and its Pretrial Memorandum. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. As of December 31, 2019 , we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 15. Geographical Information The following table sets forth our long-lived assets by geographic area, which consist of property and equipment, net and operating lease right-of-use assets, net (in millions): December 31, Long-lived assets: United States $ 35,858 $ 18,950 Rest of the world (1) 8,925 5,733 Total long-lived assets $ 44,783 $ 24,683 _________________________ (1) No individual country, other than disclosed above, exceeded 10% of our total long-lived assets for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2019 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2019 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +3,fb-1,2018x10k," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, including News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram brings people closer to the people and things they love. It is a community for sharing photos, videos, and messages, and enables people to discover interests that they care about. Messenger. Messenger is a simple yet powerful messaging application for people to connect with friends, family, groups and businesses across platforms and devices. WhatsApp. WhatsApp is a simple, reliable and secure messaging application that is used by people and businesses around the world to communicate in a private way. Oculus. Our hardware, software, and developer ecosystem allows people around the world to come together and connect with each other through our Oculus virtual reality (VR) products. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in other consumer hardware products and a number of longer-term initiatives, such as connectivity efforts, artificial intelligence (AI), and augmented reality, to develop technologies that we believe will help us better serve our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on the web, mobile devices and online generally. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. Companies that provide regional social networks, many of which have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver consumer hardware and virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, as engagement with products like video increases, and as we deepen our investment in new technologies like AI, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, as well as through advertising agencies and resellers. We operate more than 60 offices around the globe, the majority of which have a sales presence. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing To date, our communities have grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to grow our brand and help build community around the world. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union, and includes significant penalties for non-compliance. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations in areas affecting our business, such as liability for copyright infringement. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits by government authorities and regulators in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. We are currently, and may in the future be, subject to regulatory orders or consent decrees. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. Employees As of December 31, 2018 , we had 35,587 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. Available Information Our website address is www.facebook.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment due to questions about the quality or usefulness of our products or our user data practices, or concerns related to privacy and sharing, safety, security, well-being, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; we are unable to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are changes mandated by legislation, regulatory authorities, or litigation that adversely affect our products or users; there is decreased engagement with our products, or failure to accept our terms of service, as part of changes that we implemented in connection with the General Data Protection Regulation (GDPR) in Europe, other similar changes that we implemented in the United States and around the world, or other changes we may implement in the future in connection with other regulations, regulatory actions or otherwise; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement; we make changes in how we promote different products and services across our family of apps; initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; third-party initiatives that may enable greater use of our products, including low-cost or discounted data plans, are discontinued; there is decreased engagement with our products as a result of taxes imposed on the use of social media or other mobile applications in certain countries, or other actions by governments that may affect the accessibility of our products in their countries; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity, including as a result of our or their user data practices; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. We have recently implemented, and we may continue to implement, changes to our user data practices. Some of these changes will reduce marketers ability to effectively target their ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue could also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; user behavior or product changes that may reduce traffic to features or products that we successfully monetize, including as a result of our efforts to promote the Stories format or increased usage of our messaging products; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver or target advertising; the availability, accuracy, utility, and security of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices to purchase our ads increase or if competitors offer lower priced, more integrated or otherwise more effective products; adverse government actions or legal developments relating to advertising, including legislative and regulatory developments and developments in litigation; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our user data practices, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties, questions about our user data practices, concerns about brand safety, or uncertainty regarding their own legal and compliance obligations; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that we implemented in connection with the GDPR, other similar changes that we implemented in the United States and around the world, or other product changes or controls we may implement in the future, whether in connection with other regulations, regulatory actions or otherwise, that impact our ability to target ads; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; changes in the composition of our marketer base or our inability to maintain or grow our marketer base; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. The occurrence of any of these or other factors could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, technologies, products, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, technologies, products, and standards that we do not control, such as the Android and iOS operating systems and mobile browsers. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, browser developers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. For example, Apple recently released an update to its Safari browser that limits the use of third-party cookies, which reduces our ability to provide the most relevant ads to our users and impacts monetization. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, products, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers, mobile carriers and browser developers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, products, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, browser developers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on the web, mobile devices and online generally. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, among other areas, we compete with Apple in messaging, Google and YouTube in advertising and video, Tencent in messaging and social media, and Amazon in advertising. We also compete with companies that provide regional social networks, many of which have strong positions in particular countries. Some of our competitors may be domiciled in different countries and subject to political, legal, and regulatory regimes that enable them to compete more effectively than us. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver consumer hardware and virtual reality products and services. Some of our current and potential competitors may have greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, Facebook products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult or impossible; by making it more difficult to communicate with our users; or by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, browsers, or e-commerce platforms. For example, each of Apple and Google have integrated competitive products with iOS and Android, respectively. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our safety and security efforts and our ability to protect user data and to provide users with control over their data; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Actions by governments that restrict access to Facebook or our other products in their countries, or that otherwise impair our ability to sell advertising in their countries, could substantially harm our business and financial results. Governments of one or more countries in which we operate from time to time seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is possible that government authorities could take action that impairs our ability to sell advertising, including in countries where access to our consumer-facing products may be blocked or restricted. For example, we generate meaningful revenue from a limited number of resellers representing advertisers based in China. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, we do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies, and we will incur increased costs in connection with the development and marketing of such products and technologies. In addition, the introduction of new products, or changes to existing products, may result in new or enhanced governmental or regulatory scrutiny or other complications that could adversely affect our business and financial results. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products. We have historically monetized messaging in only a very limited fashion, and we may not be successful in our efforts to generate meaningful revenue from messaging over the long term. If these or other new or enhanced products fail to engage users, marketers, or developers, or if our business plans are unsuccessful, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, we have recently implemented, and we may continue to implement, changes to our user data practices. Some of these changes will reduce marketers ability to effectively target their ads, which has to some extent adversely affected, and will continue to adversely affect, our advertising business. Similarly, we previously announced changes to our News Feed ranking algorithm to help our users have more meaningful interactions, and these changes have had, and we expect will continue to have, the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we may also change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. In addition, we have made, and we expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, we plan to continue to promote the Stories format, which is becoming increasingly popular for sharing content across our products, but our advertising efforts with this format are still under development and we do not currently monetize Stories at the same rate as News Feed. In addition, as we focus on growing users and engagement across our family of apps, it is possible that these efforts may from time to time reduce engagement with one or more products and services in favor of other products or services that we monetize less successfully or that are not growing as quickly. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our actions or decisions regarding user privacy, content, advertising, and other issues, including actions or decisions in connection with elections, which may adversely affect our reputation and brands. For example, we previously announced our discovery of certain ads and other content previously displayed on our products that may be relevant to government investigations relating to Russian interference in the 2016 U.S. presidential election. In addition, in March 2018, we announced developments regarding the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. We also may fail to respond expeditiously or appropriately to the sharing of objectionable content on our services or objectionable practices by advertisers or developers, or to otherwise address user concerns, which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit, objectionable, or illegal ends. Maintaining and enhancing our brands may require us to make substantial investments and these investments may not be successful. Certain of our past actions, such as the foregoing matter regarding developer misuse of data, have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches and improper access to or disclosure of our data or user data, or other hacking and phishing attacks on our systems, could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users data or to disrupt our ability to provide service. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content, or payment information from users, or information from marketers, could result in the loss or misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, and the types and volume of personal data on our systems, we believe that we are a particularly attractive target for such breaches and attacks. Our efforts to address undesirable activity on our platform may also increase the risk of retaliatory attacks. Such attacks may cause interruptions to the services we provide, degrade the user experience, cause users or marketers to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance; government surveillance; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, and we may incur significant costs in protecting against or remediating cyber-attacks. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. Affected users or government authorities could initiate legal or regulatory actions against us in connection with any actual or perceived security breaches or improper disclosure of data, which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents or our efforts to remediate such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens, which were then used to access certain profile information from approximately 29 million user accounts on Facebook. While we took steps to remediate the attack, including fixing the vulnerability, resetting user access tokens and notifying affected users, we may discover and announce additional developments, which could further erode confidence in our brand. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. We anticipate that our ongoing investments in safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform. In addition to our efforts to mitigate cybersecurity risks, we are making significant investments in safety, security, and content review efforts to combat misuse of our services and user data by third parties, including investigations and audits of platform applications that previously accessed information of a large number of users of our services. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of user data or other undesirable activity by third parties. We may not discover all such incidents or activity, including as a result of our data limitations or the scale of activity on our platform, and we may be notified of such incidents or activity via the media or other third parties. Such incidents and activities may include the use of user data in a manner inconsistent with our terms, contracts or policies, the existence of false or undesirable user accounts, election interference, improper ad purchases, activities that threaten peoples safety on- or offline, or instances of spamming, scraping, or spreading misinformation. The discovery of the foregoing may negatively affect user trust and engagement, harm our reputation and brands, require us to change our business practices in a manner adverse to our business, and adversely affect our business and financial results. Any such discoveries may also subject us to additional litigation and regulatory inquiries, which could subject us to monetary penalties and damages, divert managements time and attention, and lead to enhanced regulatory oversight. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit, objectionable, or illegal ends, the substance or enforcement of our community standards, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to ours, has in the past, and could in the future, adversely affect our reputation. For example, beginning in March 2018, we were the subject of intense media coverage involving the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and we have continued to receive negative publicity. Such negative publicity could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of our consumer hardware products or other products we may introduce in the future; changes to existing products or services or the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive, including costs related to our data centers and technical infrastructure; costs related to our safety, security, and content review efforts; costs and expenses related to the development and delivery of our consumer hardware products; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages or government blocking, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or actions by governments or regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax laws or judicial or regulatory interpretations of tax laws, which are recorded in the period such laws are enacted or interpretations are issued, and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth rate will generally decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will continue to decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, which could reduce our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we market new and existing products and promote our brands, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees and contractors to support our expanding operations, including our efforts to focus on safety, security, and content review. We will continue to invest in our messaging, video content, and global connectivity efforts, as well as other initiatives that may not have clear paths to monetization. In addition, we will incur increased costs in connection with the development and marketing of our consumer hardware and virtual and augmented reality products and technologies. Any such investments may not be successful, and any such increases in our costs may reduce our operating margin and profitability. In addition, if our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2018, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $717 million and our effective tax rate by approximately three percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to an alternative transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this new framework is subject to an annual review that could result in changes to our obligations and also is subject to challenge by regulators and private parties. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as Standard Contractual Clauses (SCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has referred this challenge to the Court of Justice of the European Union for decision. We have also been managing investigations and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApps terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated, if we are unable to transfer data between and among countries and regions in which we operate, or if we are restricted from sharing data among our products and services, it could affect the manner in which we provide our services or our ability to target ads, which could adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. For example, the European General Data Protection Regulation (GDPR) took effect in May 2018 and applies to all of our products and services used by people in Europe. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are different from those previously in place in the European Union. As a result, we implemented measures to change our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We also obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR requires submission of breach notifications to our designated European privacy regulator, the Irish Data Protection Commissioner, and includes significant penalties for non-compliance with the notification obligation as well as other requirements of the regulation. The California Consumer Privacy Act, or AB 375, was also recently passed and creates new data privacy rights for users, effective in 2020. Similarly, there are a number of legislative proposals in the European Union, the United States, at both the federal and state level, as well as other jurisdictions that could impose new obligations in areas affecting our business. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with and may delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquiries in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. In addition, we are currently, and may in the future be, subject to regulatory orders or consent decrees. For example, data protection and consumer protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to restrict the ways in which we collect and use information, or impose sanctions, and other authorities may do the same. In addition, beginning in March 2018, we became subject to U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies. Beginning in September 2018, we also became subject to Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense or may not be feasible. Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we may be subject to additional class action lawsuits based on employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. For example, we are currently the subject of multiple putative class action suits in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, the disclosure of our earnings results for the second quarter of 2018, and a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. We believe these lawsuits are without merit and are vigorously defending them. Any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. Although the results of such lawsuits and claims cannot be predicted with certainty, we do not believe that the final outcome of those matters relating to our products that we currently face will have a material adverse effect on our business, financial condition, or results of operations. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. For example, there have been recent legislative proposals in the European Union that could expose online platforms to liability for copyright infringement. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, recently enacted legislation in Germany may result in the imposition of significant fines for failure to comply with certain content removal and disclosure obligations, and other countries are considering or have implemented similar legislation imposing penalties for failure to remove content. If any of these events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial, and there is no assurance that we will receive a favorable return on investment for our acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, the technology and products we acquired from Oculus were relatively new to Facebook at the time of the acquisition, and we did not have significant experience with, or structure in place to support, such technology and products prior to the acquisition. We continue to make substantial investments of resources to support our acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed with the necessary reliability and redundancy to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted. As the amount and types of information shared on Facebook and our other products continue to grow and evolve, as the usage patterns of our global community continue to evolve, and as our internal operational demands continue to grow, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy our needs. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations, and unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Our products and internal systems rely on software that is highly technical, and if it contains undetected errors or vulnerabilities, our business could be adversely affected. Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immense amounts of data. The software on which we rely has contained, and will in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only be discovered after the code has been released for external or internal use. For example, in September 2018, we announced our discovery of a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook. Errors, vulnerabilities, or other design defects within the software on which we rely have in the past, and may in the future, result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in targeting, measurement, or billing errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or all of our services. In addition, any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our user and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our DAUs, MAUs, and average revenue per user (ARPU), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly evaluate these metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as similar IP addresses or user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Our estimates may change as our methodologies evolve, including through the application of new data signals or technologies, which may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates. In the fourth quarter of 2018, we estimate that duplicate accounts may have represented approximately 11% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as the Philippines and Vietnam, as compared to more developed markets. In the fourth quarter of 2018, we estimate that false accounts may have represented approximately 5% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia and Vietnam. From time to time, we may make product changes or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. Our data limitations may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. Our estimates for revenue by user location and revenue by user device are also affected by these factors. We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. In addition, our DAU and MAU estimates will differ from estimates published by third parties due to differences in methodology. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 35,587 as of December 31, 2018 from 25,105 as of December 31, 2017, and we expect such headcount growth to continue for the foreseeable future. In addition, we plan to continue to hire a number of employees and contractors in order to address various safety, security, and content review initiatives. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our personnel. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant competition from other companies in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located and where the cost of living is high. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully maintain or grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In addition, as part of our investment in safety and security, we are conducting investigations and audits of a large number of platform applications, and we also recently announced several product changes that restrict developer access to certain user data. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected, or will adversely affect, our relationships with developers. If we are not successful in our efforts to maintain or grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We also intend to launch certain payments functionality on WhatsApp, which may subject us to many of the foregoing risks. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; enhanced difficulty in reviewing content on our platform and enforcing our community standards across different languages and countries; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws, including laws related to taxation, content removal, data localization, and regulatory oversight; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; compliance with statutory equity requirements and management of tax consequences; and geopolitical events affecting us, our marketers or our industry, including trade disputes. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our consumer hardware products. For example, the consumer hardware products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our consumer hardware products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture and manage the logistics of transporting and distributing our consumer hardware products. We may experience supply shortages or other disruptions in logistics or the supply chain in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. We also require the suppliers and business partners of our consumer hardware products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws, fails to implement changes in accordance with newly enacted laws, or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, government action or fines, canceled orders, or damage to our reputation. We may face inventory risk with respect to our consumer hardware products. We may be exposed to inventory risks with respect to our consumer hardware products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our consumer hardware products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking consumer hardware products we may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new consumer hardware product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our tax obligations, including income and non-income taxes, are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property, and the valuations of our intercompany transactions. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. We are subject to regular review and audit by U.S. federal, state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken, including our methodologies for valuing developed technology or intercompany arrangements, and any adverse outcome of such a review or audit could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. For example, in 2016 and 2018, the IRS issued formal assessments relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 through 2013 tax years. Although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Although we believe that our provision for income taxes and estimates of our non-income tax liabilities are reasonable, the ultimate settlement may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. Our future income tax rates could be volatile and difficult to predict due to changes in jurisdictional profit split, changes in the amount and recognition of deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The tax regimes we are subject to or operate under, including income and non-income taxes, are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, the 2017 Tax Cuts and Jobs Act (Tax Act) enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017, and the issuance of additional regulatory or accounting guidance related to the Tax Act could materially affect our tax obligations and effective tax rate in the period issued. In addition, the Ninth Circuit Court of Appeals is expected to issue a decision in Altera Corp. v. Commissioner regarding the treatment of share-based compensation expense in a cost sharing arrangement, which could have a material effect on our tax obligations and effective tax rate for the quarter in which the decision is issued. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued a report in 2015, an interim report in 2018, and is expected to continue to issue guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Similarly, the European Commission and several countries have issued proposals that would change various aspects of the current tax framework under which we are taxed. These proposals include changes to the existing framework to calculate income tax, as well as proposals to change or impose new types of non-income taxes, including taxes based on a percentage of revenue. For example, the United Kingdom, Spain, Italy, and France have each proposed taxes applicable to digital services, which includes business activities on social media platforms and online marketplaces, and would likely apply to our business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities described above could increase our worldwide effective tax rate, increase the amount of non-income taxes imposed on our business, and harm our financial position, results of operations, and cash flows. Such changes may also apply retroactively to our historical operations and result in taxes greater than the amounts estimated and recorded in our financial statements. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and will diminish our cash reserves. Although our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares of our Class A common stock. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program will diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our initial public offering in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $218.62 through December 31, 2018. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us, or developments in pending lawsuits; developments in anticipated or new legislation or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our platform and user data practices and the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, as well as the disclosure of our earnings results for the second quarter of 2018. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business and fund our share repurchase program, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors determined not to have a separate and independent nominating function and chose to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2018 , we owned and leased approximately six million square feet of office and building space for our corporate headquarters and in the surrounding areas, and approximately 89 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately seven million square feet. We also own and lease data centers throughout the United States and in various locations internationally. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018, and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. Any such inquiries could subject us to substantial fines and costs, require us to change our business practices, divert resources and the attention of management from our business, or adversely affect our business. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business, and we may in the future be subject to additional legal proceedings and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. Our Class B common stock is not listed on any stock exchange nor traded on any public market. Holders of Record As of December 31, 2018 , there were 3,780 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $131.09 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018 , there were 41 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2018 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) (in thousands) (in thousands) (in millions) October 1 - 31, 2018 $ $ 3,544 November 1 - 30, 2018 $ $ 3,544 December 1 - 31, 2018 25,708 $ 137.87 25,708 $ 9,000 25,708 25,708 (1) In November 2016, our board of directors authorized a share repurchase program that commenced in January 2017 and does not have an expiration date. We completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock during the second quarter of 2018. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion, and we completed repurchases under this authorization during the fourth quarter of 2018. In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program, all of which remained available for future repurchases as of December 31, 2018. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison of the cumulative total return for our Class A common stock, the Standard Poor's 500 Stock Index (SP 500 Index) and the Nasdaq Composite Index (Nasdaq Composite) for the five years ended December 31, 2018. The graph assumes that $100 was invested at the market close on the last trading day for the fiscal year ended December 31, 2013 in the Class A common stock of Facebook, Inc., the SP 500 Index and the Nasdaq Composite and data for the SP 500 Index and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2018 using 2017 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2018 Results Our key user metrics and financial results for 2018 are as follows: User growth: Daily active users (DAUs) were 1.52 billion on average for December 2018 , an increase of 9% year-over-year. Monthly active users (MAUs) were 2.32 billion as of December 31, 2018 , an increase of 9% year-over-year. Financial results: Revenue was $55.84 billion , up 37% year-over-year, and ad revenue was $55.01 billion , up 38% year-over-year. Total costs and expenses were $30.93 billion . Income from operations was $24.91 billion . Net income was $22.11 billion with diluted earnings per share of $7.57 . Capital expenditures were $13.92 billion . Effective tax rate was 13% . Cash and cash equivalents, and marketable securities were $41.11 billion as of December 31, 2018 . Headcount was 35,587 as of December 31, 2018 , an increase of 42% year-over-year. In 2018 , we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers where they are and (ii) making our ads more relevant and effective. We continued to invest, based on our roadmap, in: (i) our most developed ecosystems, Facebook and Instagram, (ii) driving growth and building ecosystems around our products that already have significant user bases, such as Messenger and WhatsApp, as well as continuing to grow features like Stories, and (iii) long-term technology initiatives, such as connectivity, artificial intelligence, and augmented and virtual reality, that we believe will further our mission to give people the power to build community and bring the world closer together. We intend to continue to invest based on this roadmap and we anticipate that additional investments in the following areas will continue to drive significant year-over-year expense growth in 2019: (i) expanding our data center capacity, network infrastructure, and office facilities as well as scaling our headcount to support our growth, and (ii) investments in safety and security, marketing, video content, and our long-term technology initiatives. Expense growth exceeded revenue growth in 2018, which we anticipate will continue in 2019. Trends in Our User Metrics The numbers for our key metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 9% to 1.52 billion on average during December 2018 from 1.40 billion during December 2017 . Users in India, Indonesia, and the Philippines represented key sources of growth in DAUs during December 2018 , relative to the same period in 2017. Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2018 , we had 2.32 billion MAUs, an increase of 9% from December 31, 2017 . Users in India, Indonesia, and the Philippines represented key sources of growth in 2018 , relative to the same period in 2017. Trends in Our Monetization by User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. Revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2018 in the United States Canada region was more than ten times higher than in the Asia-Pacific region. Note: Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the location of the customer. For 2018 , worldwide ARPU was $24.96 , an increase of 24% from 2017 . Over this period, ARPU increased by 34% in Europe, 33% in United States Canada, 21% in Rest of World, and 20% in Asia-Pacific . In addition, user growth was more rapid in geographies with relatively lower ARPU, such as Asia-Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and business combinations and valuation of goodwill and other acquired intangible assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount of loss. The outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 9Commitments and Contingencies and Note 12Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Business Combinations and Valuation of Goodwill and Other Acquired Intangible Assets We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2018 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized over their estimated useful lives. We evaluate the recoverability of our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of our finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Payments and other fees. Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Our other fees revenue consists primarily of revenue from the delivery of consumer hardware devices, as well as revenue from various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware device inventory sold. Research and development. Research and development expenses consist primarily of share-based compensation, salaries, and benefits for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We expense all of our research and development costs as they are incurred. Marketing and sales. Our marketing and sales expenses consist of salaries, share-based compensation, and benefits for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures, and professional services such as content reviewers. General and administrative. The majority of our general and administrative expenses consist of salaries, benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees. In addition, general and administrative expenses include legal-related costs and professional services. Results of Operations The following tables set forth our consolidated statements of income data: Year Ended December 31, (in millions) Consolidated Statements of Income Data: Revenue $ 55,838 $ 40,653 $ 27,638 Costs and expenses: Cost of revenue 9,355 5,454 3,789 Research and development 10,273 7,754 5,919 Marketing and sales 7,846 4,725 3,772 General and administrative 3,451 2,517 1,731 Total costs and expenses 30,925 20,450 15,211 Income from operations 24,913 20,203 12,427 Interest and other income (expense), net Income before provision for income taxes 25,361 20,594 12,518 Provision for income taxes 3,249 4,660 2,301 Net income $ 22,112 $ 15,934 $ 10,217 Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 3,022 2,820 2,494 Marketing and sales General and administrative Total share-based compensation expense $ 4,152 $ 3,723 $ 3,218 The following tables set forth our consolidated statements of income data (as a percentage of revenue): Year Ended December 31, Consolidated Statements of Income Data: Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % Share-based compensation expense included in costs and expenses (as a percentage of revenue): Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % Revenue Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (in millions) Advertising $ 55,013 $ 39,942 $ 26,885 % % Payments and other fees % (6 )% Total revenue $ 55,838 $ 40,653 $ 27,638 % % 2018 Compared to 2017 . Revenue in 2018 increased $15.19 billion , or 37% , compared to 2017 . The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2018 , we estimate that mobile advertising revenue represented approximately 92% of total advertising revenue, as compared with approximately 88% in 2017 . The increase in advertising revenue for 2018 was due to increases in the number of ads delivered and the average price per ad. In 2018 compared to 2017 , the number of ads delivered increased by 22%, as compared with approximately 15% in 2017 , and the average price per ad increased by 13%, as compared with approximately 29% in 2017 . The increase in the ads delivered was driven by an increase in users and their engagement, and an increase in the number and frequency of ads displayed across our products. The increase in average price per ad was driven by an increase in demand for our ad inventory. Factors contributing to the increase in demand for our ad inventory include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. We anticipate that future advertising revenue growth will be driven by a combination of price and the number of ads displayed. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 23%, 26%, and 27% between the third and fourth quarters of 2018 , 2017 , and 2016 , respectively, while advertising revenue for both the first quarters of 2018 and 2017 declined 8% and 9% compared to the fourth quarters of 2017 and 2016 , respectively. 2017 Compared to 2016 . Revenue in 2017 increased $13.02 billion, or 47%, compared to 2016. The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2017, we estimate that mobile advertising revenue represented approximately 88% of total advertising revenue, as compared with approximately 83% in 2016. Factors that influenced our advertising revenue growth in 2017 included (i) an increase in average price per ad, (ii) an increase in users and their engagement, and (iii) an increase in the number and frequency of ads displayed on mobile devices. In 2017 compared to 2016, the average price per ad increased by 29%, as compared with approximately 5% in 2016, and the number of ads delivered increased by 15%, as compared with approximately 50% in 2016. The increase in average price per ad was driven by an increase in demand for our ad inventory; factors contributing to this include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. The increase in the ads delivered was driven by an increase in users and their engagement and an increase in the number and frequency of ads displayed on News Feed, partially offset by increasing user engagement with video content and other product changes. No customer represented 10% or more of total revenue during the years ended December 31, 2018 , 2017 , and 2016 . Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2018 compared to the same period in 2017 , and in the full year 2017 compared to the same period in 2016, had a favorable impact on our revenue. If we had translated revenue for the full year 2018 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $55.44 billion and $54.61 billion , respectively. If we had translated revenue for the full year 2017 using 2016 monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $40.36 billion and $39.65 billion, respectively. Using these constant rates, both total revenue and advertising revenue would have been $401 million lower than actual revenue and advertising revenue for the full year 2018 , and $293 million and $292 million lower than actual revenue and advertising revenue, respectively, for the full year 2017. Cost of revenue Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Cost of revenue $ 9,355 $ 5,454 $ 3,789 % % Percentage of revenue % % % 2018 Compared to 2017 . Cost of revenue in 2018 increased $3.90 billion , or 72% , compared to 2017 . The increase was mostly due to an increase in operational expenses related to our data centers and technical infrastructure and higher costs associated with partnership agreements, including traffic acquisition and content acquisition costs. 2017 Compared to 2016 . Cost of revenue in 2017 increased $1.67 billion, or 44%, compared to 2016. The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with partnership agreements, including content acquisition costs, and ads payment processing. In 2019 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with ads payment processing and various partnership agreements. Research and development Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Research and development $ 10,273 $ 7,754 $ 5,919 % % Percentage of revenue % % % 2018 Compared to 2017 . Research and development expenses in 2018 increased $2.52 billion , or 32% , compared to 2017 . The majority of the increase was due to an increase in payroll and benefits expense as a result of a 43% growth in employee headcount from December 31, 2017 to December 31, 2018 in engineering and other technical functions, and, to a lesser extent, an increase in professional service expenses. Payroll and benefits expense growth was less than headcount growth partially due to a $473 million decrease in share-based compensation related to the acquisitions completed in 2014. 2017 Compared to 2016 . Research and development expenses in 2017 increased $1.84 billion, or 31%, compared to 2016. The majority of the increase was due to an increase in payroll and benefits as a result of a 49% growth in employee headcount from December 31, 2016 to December 31, 2017 in engineering and other technical functions, partially offset by a $262 million decrease in share-based compensation related to the acquisitions completed in 2014. In 2019 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. We expect payroll and related expenses growth to be more consistent with headcount growth as share-based compensation related to the acquisitions completed in 2014 are now substantially recognized. Marketing and sales Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Marketing and sales $ 7,846 $ 4,725 $ 3,772 % % Percentage of revenue % % % 2018 Compared to 2017 . Marketing and sales expenses in 2018 increased $3.12 billion , or 66% , compared to 2017 . The increase was mostly driven by marketing, community operations, and payroll and benefits expenses. Our payroll and benefits expenses increased as a result of a 33% increase in employee headcount from December 31, 2017 to December 31, 2018 in our marketing and sales functions. 2017 Compared to 2016 . Marketing and sales expenses in 2017 increased $953 million, or 25%, compared to 2016. The majority of the increase was due to increases in payroll and benefits expenses as a result of a 35% increase in employee headcount from December 31, 2016 to December 31, 2017 in our marketing and sales functions, and increases in our consulting and other professional service fees. In 2019 , we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in community operations to support our security efforts. General and administrative Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) General and administrative $ 3,451 $ 2,517 $ 1,731 % % Percentage of revenue % % % 2018 Compared to 2017 . General and administrative expenses in 2018 increased $934 million , or 37% , compared to 2017 . The increase was primarily due to increases in payroll and benefits expenses as a result of a 32% increase in employee headcount from December 31, 2017 to December 31, 2018 in general and administrative functions. 2017 Compared to 2016 . General and administrative expenses in 2017 increased $786 million, or 45%, compared to 2016. The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 58% increase in employee headcount from December 31, 2016 to December 31, 2017 in general and administrative functions, and to a lesser extent, higher legal-related costs. In 2019 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income (expense), net Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (in millions) Interest income, net $ $ $ 66% 136% Other income (expense), net (204 ) (1 ) (75 ) NM 99% Interest and other income (expense), net $ $ $ 15% NM 2018 Compared to 2017 . Interest and other income, net in 2018 increased $57 million compared to 2017 . The increase in 2018 was due to an increase in interest income driven by higher interest rates, partially offset by an increase in other expense as a result of foreign exchange impact occurring from the periodic re-measurement of our foreign currency balances. 2017 Compared to 2016 . Interest and other income, net in 2017 increased $300 million compared to 2016. The majority of the increase in 2017 was due to an increase in interest income driven by higher invested cash balances and interest rates. In addition, foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities also contributed to the increase in 2017. Provision for income taxes Year Ended December 31, 2018 vs 2017 % Change 2017 vs 2016 % Change (dollars in millions) Provision for income taxes $ 3,249 $ 4,660 $ 2,301 (30 )% % Effective tax rate % % % 2018 Compared to 2017 . Our provision for income taxes in 2018 decreased $1.41 billion , or 30% , compared to 2017 , primarily due to a one-time expense of approximately $2.27 billion in 2017 resulting from the Tax Act, partially offset by an increase in income before provision for income taxes. Our effective tax rate in 2018 decreased compared to 2017, primarily due to a one-time tax expense of approximately $2.27 billion related to the Tax Act in 2017. 2017 Compared to 2016 . Our provision for income taxes in 2017 increased $2.36 billion , or 103% , compared to 2016 , mostly due to the effects of the Tax Act that was enacted on December 22, 2017 and an increase in income before provision for income taxes, partially offset by an increase in excess tax benefits recognized from share-based compensation. As a result of the Tax Act, we recognized a one-time mandatory transition tax on accumulated foreign subsidiary earnings, remeasured our U.S. deferred tax assets and liabilities, and reassessed the net realizability of our deferred tax assets and liabilities, which increased our provision for income taxes in 2017 by $2.27 billion. Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of changes in tax law. The proportion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. The accounting for share-based compensation will increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 28, 2019 price, we expect our effective tax rate for 2019 will be a few percentage points higher than our 2018 rate. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion in Altera Corp v. Commissioner (Tax Court Opinion), which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Opinion was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On July 24, 2018, the Ninth Circuit issued an opinion (Ninth Circuit Opinion) that reversed the Tax Court Opinion. The Ninth Circuit Opinion was subsequently withdrawn and the case is being reheard. Since the Ninth Circuit Opinion was withdrawn, we continue to treat our share-based compensation expense in accordance with the Tax Court Opinion. We also continue to monitor developments in this case and any impact the final opinion could have on our consolidated financial statements. Had the Ninth Circuit not withdrawn its opinion, our effective tax rate for 2018 would have been higher. Unrecognized Tax Benefits. As of December 31, 2018, we had net unrecognized tax benefits of $3.07 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below, the current status of tax audits in various jurisdictions, and excluding the effects of the Altera Corp v. Commissioner case that we are monitoring, we do not anticipate a significant impact to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices. In addition, if the IRS prevails in its positions, related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. As of December 31, 2018, we have not resolved these matters, and proceedings continue in Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2018 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (in millions, except per share amounts) Consolidated Statements of Income Data: Revenue: Advertising $ 16,640 $ 13,539 $ 13,038 $ 11,795 $ 12,779 $ 10,142 $ 9,164 $ 7,857 Payments and other fees Total revenue 16,914 13,727 13,231 11,966 12,972 10,328 9,321 8,032 Costs and expenses: Cost of revenue 2,796 2,418 2,214 1,927 1,611 1,448 1,237 1,159 Research and development 2,855 2,657 2,523 2,238 1,949 2,052 1,919 1,834 Marketing and sales 2,467 1,928 1,855 1,595 1,374 1,170 1,124 1,057 General and administrative Total costs and expenses 9,094 7,946 7,368 6,517 5,620 5,206 4,920 4,705 Income from operations 7,820 5,781 5,863 5,449 7,352 5,122 4,401 3,327 Interest and other income (expense), net Income before provision for income taxes 7,971 5,912 5,868 5,610 7,462 5,236 4,488 3,408 Provision for income taxes 1,089 3,194 Net income $ 6,882 $ 5,137 $ 5,106 $ 4,988 $ 4,268 $ 4,707 $ 3,894 $ 3,064 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 6,882 $ 5,137 $ 5,106 $ 4,987 $ 4,266 $ 4,704 $ 3,890 $ 3,059 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 2.40 $ 1.78 $ 1.76 $ 1.72 $ 1.47 $ 1.62 $ 1.34 $ 1.06 Diluted $ 2.38 $ 1.76 $ 1.74 $ 1.69 $ 1.44 $ 1.59 $ 1.32 $ 1.04 Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ $ 1,040 $ 1,186 $ $ $ 1,010 $ 1,032 $ Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (as a percentage of total revenue) Consolidated Statements of Income Data: Revenue: Advertising % % % % % % % % Payments and other fees Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2018 Sep 30, 2018 Jun 30, 2018 Mar 31, 2018 Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 (as a percentage of total revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 29,274 $ 24,216 $ 16,108 Net cash used in investing activities $ (11,603 ) $ (20,118 ) $ (11,792 ) Net cash used in financing activities $ (15,572 ) $ (5,235 ) $ (310 ) Purchases of property and equipment, net $ (13,915 ) $ (6,733 ) $ (4,491 ) Depreciation and amortization $ 4,315 $ 3,025 $ 2,342 Share-based compensation $ 4,152 $ 3,723 $ 3,218 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents, and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents, and marketable securities were $41.11 billion as of December 31, 2018 , a decrease of $597 million from December 31, 2017 , mostly due to $13.92 billion for purchases of property and equipment, $12.88 billion for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by $29.27 billion of cash generated from operations and a $500 million increase in overdraft in cash pooling entities. Cash paid for income taxes was $3.76 billion for the year ended December 31, 2018 . As of December 31, 2018 , our federal net operating loss carryforward was $7.88 billion , and we anticipate that none of this amount will be utilized to offset our federal taxable income in 2018. As of December 31, 2018 , we had $290 million of federal tax credit carryforward, of which none will be available to offset our federal tax liabilities in 2018. In addition, we are monitoring the Altera Corp. v. Commissioner case as it applies to our facts and circumstances as it could increase our cash paid for income taxes. In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2018 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. Our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date. During the second quarter of 2018, we completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion , and we completed repurchases under this authorization during the fourth quarter of 2018. In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program. During the year ended December 31, 2018 , we repurchased and subsequently retired 79 million shares of our Class A common stock for $12.93 billion . As of December 31, 2018 , $9.0 billion remained available and authorized for repurchases. In 2018, we paid $3.21 billion of taxes related to the net share settlement of equity awards. In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. See Note 9Commitments and Contingencies of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K for additional information regarding our notional cash pooling arrangement. As of December 31, 2018 , $16.28 billion of the $41.11 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminated U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2018 mostly consisted of net income, adjusted for certain non-cash items, such as total depreciation and amortization of $4.32 billion and share-based compensation expense of $4.15 billion . The increase in cash flow from operating activities during 2018 compared to 2017 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization, deferred income tax and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a higher tax liability in 2017, which partially offset the increase in cash flow from operating activities in 2018. Cash flow from operating activities during 2017 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.72 billion and total depreciation and amortization of $3.03 billion. The increase in cash flow from operating activities during 2017 compared to 2016 was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings, which also contributed to the increase in 2017 compared to 2016. Cash flow from operating activities during 2016 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.22 billion and total depreciation and amortization of $2.34 billion. The increase in cash flow from operating activities during 2016 compared to 2015, was mostly due to an increase in net income, including the impact of ASU 2016-09 adoption, as adjusted for depreciation and amortization, deferred income taxes, and share-based compensation expense. Cash Used in Investing Activities Cash used in investing activities during 2018 mostly resulted from $13.92 billion of capital expenditures as we continued to invest in data centers, servers, network infrastructure, and office buildings, offset by $2.47 billion of net sales and maturities of marketable securities. The decrease in cash used in investing activities during 2018 compared to 2017 was mostly due to a decrease in the net purchases of marketable securities, partially offset by an increase in capital expenditures. Cash used in investing activities during 2017 mostly resulted from $13.25 billion for net purchases of marketable securities and $6.73 billion for capital expenditures as we continued to invest in servers, data centers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2017 compared to 2016 was due to increases in net purchases of marketable securities and capital expenditures. Cash used in investing activities during 2016 mostly resulted from $7.19 billion for net purchases of marketable securities and $4.49 billion for capital expenditures as we continued to invest in data centers, servers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2016 compared to 2015 was mostly due to increases in capital expenditures and net purchases of marketable securities. We anticipate making capital expenditures in 2019 of approximately $18 billion to $20 billion. Cash Used in Financing Activities Cash used in financing activities during 2018 consisted of $12.88 billion paid for repurchases of our Class A common stock, and $3.21 billion of taxes paid related to net share settlement of equity awards, offset by a $500 million overdraft in cash pooling entities. The increase in cash used in financing activities during 2018 compared to 2017 was mostly due to an increase in repurchases of our Class A common stock, partially offset by an increase in overdraft balances in cash pooling entities. Cash used in financing activities during 2017 mostly consisted of $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion paid for repurchases of our Class A common stock. The increase in cash used in financing activities during 2017 compared to 2016 was mostly due to taxes paid related to net share settlement of equity awards and repurchases of our Class A common stock that commenced in 2017. Cash used in financing activities during 2016 mostly consisted of principal payments on capital lease and other financing obligations. The increase in cash used in financing activities was due to full repayment of our capital lease and other financing obligations in 2016. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2018 . Contractual Obligations Our principal commitments consist of obligations under operating leases, which include among others, certain of our offices, data centers, land, and colocation leases, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2018 (in millions): Payment Due by Period Total 2020-2021 2022-2023 Thereafter Operating lease obligations $ 14,651 $ $ 2,001 $ 2,102 $ 9,850 Transition tax payable 1,587 1,263 Other contractual commitments (1) 6,173 3,377 1,135 1,423 Total contractual obligations $ 22,411 $ 4,075 $ 3,136 $ 2,664 $ 12,536 (1) Other contractual commitments primarily relate to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $6.0 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities include $3.07 billion related to net uncertain tax positions as of December 31, 2018 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 9Commitments and Contingencies and Note 12Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding contingencies. Recently Issued Accounting Pronouncements In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We will adopt the new standard effective January 1, 2019 on a modified retrospective basis and will not restate comparative periods. We will elect the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification, our assessment on whether a contract is or contains a lease, and our initial direct costs for any leases that exist prior to adoption of the new standard. We will also elect to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. We estimate approximately $6 billion would be recognized as total right-of-use assets and total lease liabilities on our consolidated balance sheet as of January 1, 2019. Other than disclosed, we do not expect the new standard to have a material impact on our remaining consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $213 million , $6 million , and $76 million in 2018 , 2017 , and 2016 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $468 million and $611 million in the market value of our available-for-sale debt securities as of December 31, 2018 and December 31, 2017 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes (collectively referred to as the ""consolidated financial statements""). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2018 and 2017 , and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2007. San Francisco, California January 31, 2019 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2018 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017 , the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018 , and the related notes and our report dated January 31, 2019 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Francisco, California January 31, 2019 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 10,019 $ 8,079 Marketable securities 31,095 33,632 Accounts receivable, net of allowances of $229 and $189 as of December 31, 2018 and 2017, respectively 7,587 5,832 Prepaid expenses and other current assets 1,779 1,020 Total current assets 50,480 48,563 Property and equipment, net 24,683 13,721 Intangible assets, net 1,294 1,884 Goodwill 18,301 18,221 Other assets 2,576 2,135 Total assets $ 97,334 $ 84,524 Liabilities and stockholders' equity Current liabilities: Accounts payable $ $ Partners payable Accrued expenses and other current liabilities 5,509 2,892 Deferred revenue and deposits Total current liabilities 7,017 3,760 Other liabilities 6,190 6,417 Total liabilities 13,207 10,177 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,385 million and 2,397 million shares issued and outstanding, as of December 31, 2018 and December 31, 2017, respectively; 4,141 million Class B shares authorized, 469 million and 509 million shares issued and outstanding, as of December 31, 2018 and December 31, 2017, respectively. Additional paid-in capital 42,906 40,584 Accumulated other comprehensive loss (760 ) (227 ) Retained earnings 41,981 33,990 Total stockholders' equity 84,127 74,347 Total liabilities and stockholders' equity $ 97,334 $ 84,524 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 55,838 $ 40,653 $ 27,638 Costs and expenses: Cost of revenue 9,355 5,454 3,789 Research and development 10,273 7,754 5,919 Marketing and sales 7,846 4,725 3,772 General and administrative 3,451 2,517 1,731 Total costs and expenses 30,925 20,450 15,211 Income from operations 24,913 20,203 12,427 Interest and other income (expense), net Income before provision for income taxes 25,361 20,594 12,518 Provision for income taxes 3,249 4,660 2,301 Net income $ 22,112 $ 15,934 $ 10,217 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 22,111 $ 15,920 $ 10,188 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 7.65 $ 5.49 $ 3.56 Diluted $ 7.57 $ 5.39 $ 3.49 Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,890 2,901 2,863 Diluted 2,921 2,956 2,925 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 3,022 2,820 2,494 Marketing and sales General and administrative Total share-based compensation expense $ 4,152 $ 3,723 $ 3,218 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 22,112 $ 15,934 $ 10,217 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax (450 ) (152 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax (52 ) (90 ) (96 ) Comprehensive income $ 21,610 $ 16,410 $ 9,969 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2015 2,845 $ $ 34,886 $ (455 ) $ 9,787 $ 44,218 Impact of the adoption of new accounting pronouncement 1,666 1,705 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (6 ) (6 ) Share-based compensation, related to employee share-based awards 3,218 3,218 Other comprehensive loss (248 ) (248 ) Net income 10,217 10,217 Balances at December 31, 2016 2,892 38,227 (703 ) 21,670 59,194 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (21 ) (1,702 ) (1,544 ) (3,246 ) Share-based compensation, related to employee share-based awards 3,723 3,723 Share repurchases (13 ) (2,070 ) (2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 40,584 (227 ) 33,990 74,347 Impact of the adoption of new accounting pronouncements (31 ) Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (19 ) (1,845 ) (1,363 ) (3,208 ) Share-based compensation, related to employee share-based awards 4,152 4,152 Share repurchases (79 ) (12,930 ) (12,930 ) Other comprehensive loss (502 ) (502 ) Net income 22,112 22,112 Balances at December 31, 2018 2,854 $ $ 42,906 $ (760 ) $ 41,981 $ 84,127 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 22,112 $ 15,934 $ 10,217 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,315 3,025 2,342 Share-based compensation 4,152 3,723 3,218 Deferred income taxes (377 ) (457 ) Other (64 ) Changes in assets and liabilities: Accounts receivable (1,892 ) (1,609 ) (1,489 ) Prepaid expenses and other current assets (690 ) (192 ) (159 ) Other assets (159 ) Accounts payable Partners payable Accrued expenses and other current liabilities 1,417 1,014 Deferred revenue and deposits Other liabilities (634 ) 3,083 1,262 Net cash provided by operating activities 29,274 24,216 16,108 Cash flows from investing activities Purchases of property and equipment, net (13,915 ) (6,733 ) (4,491 ) Purchases of marketable securities (14,656 ) (25,682 ) (22,341 ) Sales of marketable securities 12,358 9,444 13,894 Maturities of marketable securities 4,772 2,988 1,261 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets (137 ) (122 ) (123 ) Other investing activities, net (25 ) (13 ) Net cash used in investing activities (11,603 ) (20,118 ) (11,792 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards (3,208 ) (3,246 ) (6 ) Principal payments on capital lease and other financing obligations (312 ) Repurchases of Class A common stock (12,879 ) (1,976 ) Net change in overdraft in cash pooling entities Other financing activities, net (13 ) Net cash used in financing activities (15,572 ) (5,235 ) (310 ) Effect of exchange rate changes on cash, cash equivalents, and restricted cash (179 ) (63 ) Net increase (decrease) in cash, cash equivalents, and restricted cash 1,920 (905 ) 3,943 Cash, cash equivalents, and restricted cash at beginning of the period 8,204 9,109 5,166 Cash, cash equivalents, and restricted cash at end of the period $ 10,124 $ 8,204 $ 9,109 Reconciliation of cash, cash equivalents, and restricted cash to the consolidated balance sheets Cash and cash equivalents $ 10,019 $ 8,079 $ 8,903 Restricted cash, included in prepaid expenses and other current assets Restricted cash, included in other assets Total cash, cash equivalents, and restricted cash $ 10,124 $ 8,204 $ 9,109 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid during the period for: Interest $ $ $ Income taxes, net $ 3,762 $ 2,117 $ 1,210 Non-cash investing and financing activities: Net change in prepaids and liabilities related to property and equipment additions $ $ $ Settlement of acquisition-related contingent consideration liability $ $ $ Change in unsettled repurchases of Class A common stock $ $ $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to income taxes, loss contingencies, fair value of acquired intangible assets and goodwill, collectability of accounts receivable, fair value of financial instruments, leases, useful lives of intangible assets and property and equipment, and revenue recognition. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition On January 1, 2018, we adopted Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) , which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) Topic 605, Revenue Recognition (Topic 605) , using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting under Topic 605. The impact of adopting the new revenue standard was not material to our condensed consolidated financial statements and there was no adjustment to beginning retained earnings on January 1, 2018. Under Topic 606, revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition through the following steps: identification of the contract, or contracts, with a customer; identification of the performance obligations in the contract; determination of the transaction price; allocation of the transaction price to the performance obligations in the contract; and recognition of revenue when, or as, we satisfy a performance obligation. Revenue excludes sales and usage-based taxes where it has been determined that we are acting as a pass-through agent. Revenue disaggregated by revenue source for the years ended December 31, 2018, 2017 and 2016 consists of the following (in millions): Year Ended December 31, 2017 (1) 2016 (1) Advertising $ 55,013 $ 39,942 $ 26,885 Payments and other fees Total revenue $ 55,838 $ 40,653 $ 27,638 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. Revenue disaggregated by geography, based on the billing address of our customer, consists of the following (in millions): Year Ended December 31, 2017 (1) 2016 (1) Revenue: US Canada (2) $ 25,727 $ 19,065 $ 13,432 Europe (3) 13,631 10,126 6,792 Asia-Pacific 11,733 7,921 5,037 Rest of World (3) 4,747 3,541 2,377 Total revenue $ 55,838 $ 40,653 $ 27,638 (1) As noted above, prior period amounts have not been adjusted under the modified retrospective method. (2) United States revenue was $24.10 billion , $17.73 billion , and $12.58 billion for the years ended December 31, 2018 , 2017 , and 2016 . (3) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East. Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. We may accept a lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We believe that there will not be significant changes to our estimates of variable consideration. Payments and Other Fees Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Other fees revenue consists primarily of revenue from the delivery of consumer hardware devices, as well as revenue from various other sources. Deferred Revenue and Deposits Deferred revenue consists of billings and payments from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users who primarily use these balances to make purchases in games on our platform. Once this balance is utilized by a user, approximately 70% of this amount would then be payable to the developer and the balance would be recognized as revenue. The increase in the deferred revenue balance for the year ended December 31, 2018 was driven by prepayments from marketers, partially offset by revenue recognized that was included in the deferred revenue balance at the beginning of the period. Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ 65 Practical Expedients and Exemptions We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within marketing and sales on our consolidated statements of income. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition and content acquisition costs, credit card and other transaction fees related to processing customer transactions, and cost of consumer hardware device inventory sold. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for viewing. The amounts capitalized are limited to estimated net realizable value or fair value on a per title basis. The portion available for viewing within one year is recognized as prepaid expenses and other current assets and the remaining portion as other assets on the consolidated balance sheets. For original content, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable. Capitalized original content costs are included in other assets on the consolidated balance sheets. Capitalized costs are amortized in cost of revenue on the consolidated statements of income based on historical and estimated viewing patterns. Capitalized content costs are reviewed when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than amortized cost. If such changes are identified, capitalized content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. Capitalized content acquisition costs have not been material to date. Income Taxes We record provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial position, results of operations, and cash flows. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. See Note 12 in these notes to the consolidated financial statements for additional information. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $1.10 billion , $324 million , and $310 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Cash and Cash Equivalents, Marketable Securities, and Restricted Cash Cash and cash equivalents primarily consist of cash on deposit with banks and investments in money market funds with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses are charged against interest and other income (expense), net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income (expense), net. We also maintain a multi-currency notional cash pool for our participating entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. We classify these overdraft balances within accrued expenses and other current liabilities on the accompanying consolidated balance sheets. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of money market funds and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing market observable inputs. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under capital leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 25 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Leased equipment and leasehold improvements Lesser of estimated useful life or remaining lease term Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We enter into lease arrangements for office space, land, facilities, data centers, and equipment under non-cancelable capital and operating leases. Certain of the operating lease agreements contain rent holidays, rent escalation provisions, and purchase options. Rent holidays and rent escalation provisions are considered in determining the straight-line rent expense to be recorded over the lease term. The lease term begins on the date of initial possession of the leased property for purposes of recognizing lease expense on a straight-line basis over the term of the lease. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease inception. We record assets and liabilities for the estimated construction costs incurred by third parties under build-to-suit lease arrangements to the extent that we are involved in the construction of structural improvements or bear construction risk prior to commencement of a lease. As of December 31, 2018, we completed our build-to-suit lease arrangements and properly derecognized the associated assets on our consolidated balance sheet. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-Lived Assets, Including Goodwill and Other Acquired Intangible Assets We evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2018 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Foreign Currency Generally, the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive (loss) income as a component of stockholders' equity. As of December 31, 2018 and 2017 , we had a cumulative translation loss, net of tax of $466 million and $16 million , respectively. Net losses resulting from foreign exchange transactions were $213 million , $6 million , and $76 million for the years ended December 31, 2018 , 2017 , and 2016 , respectively. These losses were recorded as interest and other income (expense), net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of short-term money market funds, which are managed by reputable financial institutions. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy limits investment instruments to U.S. government securities, U.S. government agency securities, and corporate debt securities with the main objective of preserving capital and maintaining liquidity. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 43% , 44% , and 46% of our revenue for the years ended December 31, 2018 , 2017 , and 2016 , respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, and Brazil. We perform ongoing credit evaluations of our customers, and generally do not require collateral. We maintain an allowance for estimated credit losses. During the years ended December 31, 2018 , 2017 , and 2016 , our bad debt expenses were $77 million , $48 million , and $66 million , respectively. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2018 , 2017 , and 2016 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recently Adopted Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Topic 606, which supersedes the revenue recognition requirements in Topic 605. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. See Revenue Recognition above for further details. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes ( Topic 740 ): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date, which was not material to our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows ( Topic 230 ): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statements of cash flows. We adopted the new standard effective January 1, 2018, using the retrospective transition approach. The reclassified restricted cash balances from investing activities to changes in cash, cash equivalents and restricted cash on the consolidated statements of cash flows were not material for all periods presented. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805) : Clarifying the Definition of a Business (ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We adopted the new standard effective January 1, 2018 on a prospective basis. The new standard did not have a material impact on our consolidated financial statements. In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income StatementReporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which allows companies to reclassify stranded tax effects resulting from the Tax Act, from accumulated other comprehensive income to retained earnings. The new standard is effective for us beginning January 1, 2019, with early adoption permitted. We elected to early adopt the new standard at the beginning of the third quarter of 2018 using the aggregate portfolio approach. The amount of stranded tax effects that were reclassified from accumulated other comprehensive loss to retained earnings was not material. Recent Accounting Pronouncements Not Yet Adopted In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), as amended, which generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. We will adopt the new standard effective January 1, 2019 on a modified retrospective basis and will not restate comparative periods. We will elect the package of practical expedients permitted under the transition guidance, which allows us to carryforward our historical lease classification, our assessment on whether a contract is or contains a lease, and our initial direct costs for any leases that exist prior to adoption of the new standard. We will also elect to combine lease and non-lease components and to keep leases with an initial term of 12 months or less off the balance sheet and recognize the associated lease payments in the consolidated statements of income on a straight-line basis over the lease term. We estimate approximately $6 billion would be recognized as total right-of-use assets and total lease liabilities on our consolidated balance sheet as of January 1, 2019. Other than disclosed, we do not expect the new standard to have a material impact on our remaining consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. Note 2. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, such as awards under our equity compensation plans and inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2018 , 2017 , and 2016 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 18,411 $ 3,701 $ 13,034 $ 2,900 $ 8,270 $ 1,947 Less: Net income attributable to participating securities Net income attributable to common stockholders $ 18,410 $ 3,701 $ 13,022 $ 2,898 $ 8,246 $ 1,942 Denominator Weighted average shares outstanding 2,406 2,375 2,323 Less: Shares subject to repurchase Number of shares used for basic EPS computation 2,406 2,373 2,317 Basic EPS $ 7.65 $ 7.65 $ 5.49 $ 5.49 $ 3.56 $ 3.56 Diluted EPS: Numerator Net income attributable to common stockholders $ 18,410 $ 3,701 $ 13,022 $ 2,898 $ 8,246 $ 1,942 Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 3,701 2,898 1,942 Reallocation of net income to Class B common stock (16 ) (13 ) Net income attributable to common stockholders for diluted EPS $ 22,112 $ 3,685 $ 15,934 $ 2,885 $ 10,217 $ 1,956 Denominator Number of shares used for basic EPS computation 2,406 2,373 2,317 Conversion of Class B to Class A common stock Weighted average effect of dilutive securities: Employee stock options RSUs Shares subject to repurchase and other Number of shares used for diluted EPS computation 2,921 2,956 2,925 Diluted EPS $ 7.57 $ 7.57 $ 5.39 $ 5.39 $ 3.49 $ 3.49 Note 3. Cash and Cash Equivalents, and Marketable Securities The following table sets forth the cash and cash equivalents, and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 2,713 $ 2,212 Money market funds 6,792 5,268 U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 10,019 8,079 Marketable securities: U.S. government securities 13,836 12,766 U.S. government agency securities 8,333 10,944 Corporate debt securities 8,926 9,922 Total marketable securities 31,095 33,632 Total cash and cash equivalents, and marketable securities $ 41,114 $ 41,711 The gross unrealized losses on our marketable securities were $357 million and $289 million as of December 31, 2018 and 2017 , respectively. The gross unrealized gains for both periods were not significant. In addition, gross unrealized losses that had been in a continuous loss position for 12 months or longer were $332 million and $169 million as of December 31, 2018 and 2017 , respectively. As of December 31, 2018 , we considered the decreases in market value on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 9,746 $ 7,976 Due after one year to five years 21,349 25,656 Total $ 31,095 $ 33,632 Note 4. Fair Value Measurement The following table summarizes, for assets or liabilities measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2018 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 6,792 $ 6,792 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 13,836 13,836 U.S. government agency securities 8,333 8,333 Corporate debt securities 8,926 8,926 Total cash equivalents and marketable securities $ 38,401 $ 29,105 $ 9,296 $ Fair Value Measurement at Reporting Date Using Description December 31, 2017 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3 Cash equivalents: Money market funds $ 5,268 $ 5,268 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 12,766 12,766 U.S. government agency securities 10,944 10,944 Corporate debt securities 9,922 9,922 Total cash equivalents and marketable securities $ 39,499 $ 29,069 $ 10,430 $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. Note 5. Property and Equipment Property and equipment consists of the following (in millions): December 31, Land $ $ Buildings 7,401 4,909 Leasehold improvements 1,841 Network equipment 13,017 7,998 Computer software, office equipment and other 1,187 Construction in progress 7,228 2,992 Total 31,573 18,337 Less: Accumulated depreciation (6,890 ) (4,616 ) Property and equipment, net $ 24,683 $ 13,721 Depreciation expense on property and equipment was $3.68 billion , $2.33 billion , and $1.59 billion during 2018 , 2017 , and 2016 , respectively. Property and equipment as of December 31, 2018 and 2017 includes $1.06 billion and $533 million , respectively, acquired under capital lease agreements, of which a substantial majority, is included in network equipment. Accumulated depreciation of property and equipment acquired under these capital leases was $217 million and $101 million at December 31, 2018 and 2017 , respectively. Construction in progress includes costs mostly related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. The construction of office buildings as of December 31, 2017 included our build-to-suit lease arrangements which were completed and derecognized during 2018. No interest was capitalized during the years ended December 31, 2018 , 2017 and 2016 . Note 6. Goodwill and Intangible Assets During the year ended December 31, 2018 , we purchased certain intangible assets and completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2018 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed during the year ended December 31, 2018 was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated during this period that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2018 and 2017 are as follows (in millions): Balance as of December 31, 2016 $ 18,122 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2017 $ 18,221 Goodwill acquired Effect of currency translation adjustment (8 ) Balance as of December 31, 2018 $ 18,301 Intangible assets consist of the following (in millions): December 31, 2018 December 31, 2017 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 2.8 $ 2,056 $ (1,260 ) $ $ 2,056 $ (971 ) $ 1,085 Acquired technology 1.2 1,002 (871 ) (711 ) Acquired patents 5.2 (565 ) (499 ) Trade names 1.4 (517 ) (406 ) Other 2.4 (147 ) (133 ) Total intangible assets 2.9 $ 4,654 $ (3,360 ) $ 1,294 $ 4,604 $ (2,720 ) $ 1,884 Amortization expense of intangible assets for the years ended December 31, 2018 , 2017 , and 2016 was $640 million , $692 million , and $751 million , respectively. As of December 31, 2018 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2020 2021 2022 2023 Thereafter Total $ 1,294 Note 7. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued compensation and benefits $ 1,203 $ Accrued property and equipment 1,531 Overdraft in cash pooling entities Accrued taxes Other current liabilities 1,784 1,077 Accrued expenses and other current liabilities $ 5,509 $ 2,892 The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 4,655 $ 5,372 Deferred tax liabilities Other liabilities Other liabilities $ 6,190 $ 6,417 Note 8. Long-term Debt In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2018 , no amounts had been drawn down and we were in compliance with the covenants under this facility. Note 9. Commitments and Contingencies Commitments Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, data centers, land, and colocations with original lease periods expiring between 2019 and 2093 . We are committed to pay a portion of the related actual operating expenses under certain of these lease agreements. Certain of these arrangements have free rent periods or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis. The following is a schedule, by years, of the future minimum lease payments required under non-cancelable operating leases as of December 31, 2018 (in millions): Operating Leases $ 2020 2021 1,055 1,048 1,054 Thereafter 9,850 Total minimum lease payments $ 14,651 Operating lease expense was $629 million , $363 million , and $269 million for the years ended December 31, 2018 , 2017 and 2016 , respectively. We fully repaid all our capital lease obligations during 2016. Guarantee In 2018, we established a multi-currency notional cash pool for certain of our entities with a third-party bank provider. Actual cash balances are not physically converted and are not commingled between participating legal entities. As part of the notional cash pool agreement, the bank extends overdraft credit to our participating entities as needed, provided that the overall notionally pooled balance of all accounts in the pool at the end of each day is at least zero. In the unlikely event of a default by our collective entities participating in the pool, any overdraft balances incurred would be guaranteed by Facebook, Inc. Other contractual commitments We also have $6.17 billion of non-cancelable contractual commitments as of December 31, 2018 , primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Contingencies Legal Matters Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with our platform and user data practices as well as the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. Beginning on July 27, 2018, two putative class actions were filed in federal court in the United States against us and certain of our directors and officers alleging violations of securities laws in connection with the disclosure of our earnings results for the second quarter of 2018, and seeking unspecified damages. These two actions subsequently were transferred and consolidated in the U.S. District Court for the Northern District of California with the putative securities class action described above relating to our platform and user data practices. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, our platform and user data practices, as well as the events surrounding the misuse of certain data by a developer, became the subject of U.S. Federal Trade Commission, Securities and Exchange Commission, state attorneys general, and other government inquiries in the United States, Europe, and other jurisdictions. Beginning on September 28, 2018, multiple putative class actions were filed in state and federal courts in the United States and elsewhere against us alleging violations of consumer protection laws and other causes of action in connection with a third-party cyber-attack that exploited a vulnerability in Facebooks code to steal user access tokens and access certain profile information from user accounts on Facebook, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this cyber-attack became the subject of Irish Data Protection Commission, U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. Although we believe that it is reasonably possible that we may incur a substantial loss in some of the cases, actions, or inquiries described above, we are currently unable to estimate the amount of such losses or a range of possible losses. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these matters, we evaluate the developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. We believe that the amount or any estimable range of reasonably possible or probable loss will not, either individually or in the aggregate, have a material adverse effect on our business and consolidated financial statements. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 12Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial statements. In our opinion, as of December 31, 2018 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2018 . Note 10. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2018 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2018 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2018 , there were 2,385 million shares and 469 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Share Repurchase Program Our board of directors has authorized a share repurchase program that commenced in 2017 and does not have an expiration date. During the second quarter of 2018, we completed repurchases under the original authorization to purchase up to $6.0 billion of our Class A common stock. In April 2018, the authorization for the repurchase of our Class A common stock was increased by an additional $9.0 billion , and we completed repurchases under this authorization during the fourth quarter of 2018. During the year ended December 31, 2018 , we repurchased and subsequently retired 79 million shares of our Class A common stock for $12.93 billion . In December 2018, our board of directors authorized an additional $9.0 billion of repurchases under this program. The timing and actual number of shares repurchased under this program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. As of December 31, 2018 , $9.0 billion remained available and authorized for repurchases. Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in each of June 2016 and February 2018 (Amended 2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our Amended 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. Shares that are withheld in connection with the net settlement of RSUs or forfeited under our Stock Plans are added to the reserves of the Amended 2012 Plan. We account for forfeitures as they occur. As of December 31, 2018 , there were 83 million shares reserved for future issuance under our Amended 2012 Plan. The number of shares reserved for issuance under our Amended 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through April 2026 unless terminated earlier by our board of directors or a committee thereof, by a number of shares of Class A common stock equal to the lesser of (i) 2.5% of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors approved an increase of 60 million shares reserved for issuance effective January 1, 2019. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2018 : Shares Subject to Options Outstanding Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value ( 1) (in thousands) (in years) (in millions) Balance as of December 31, 2017 3,078 $ 10.06 Stock options exercised (1,941 ) $ 7.90 Balances at December 31, 2018 1,137 $ 13.74 1.7 $ Stock options exercisable as of December 31, 2018 1,137 $ 13.74 1.7 $ (1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the official closing price of our Class A common stock of $131.09 , as reported on the Nasdaq Global Select Market on December 31, 2018 . There were no options granted, forfeited, or canceled for the year ended December 31, 2018 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2018 , 2017 , and 2016 was $315 million , $359 million , and $309 million , respectively. The total grant date fair value of stock options vested during the years ended December 31, 2018 , 2017 , and 2016 was not material. The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2018 : Unvested RSUs (1) Number of Shares Weighted Average Grant Date Fair Value (in thousands) Unvested at December 31, 2017 81,214 $ 110.49 Granted 38,283 $ 168.38 Vested (43,396 ) $ 106.59 Forfeited (8,803 ) $ 119.25 Unvested at December 31, 2018 67,298 $ 144.77 (1) Unvested shares at December 31, 2017 included an inducement award issued in connection with the WhatsApp acquisition in 2014, which was subject to the terms, restrictions, and conditions of a separate non-plan RSU award agreement. This inducement award was no longer outstanding as of December 31, 2018. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2018 , 2017 , and 2016 was $7.57 billion , $6.76 billion , and $4.92 billion , respectively. As of December 31, 2018 , there was $8.96 billion of unrecognized share-based compensation expense, which was related to RSUs. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Note 11. Interest and other income (expense), net The following table presents the detail of interest and other income (expense), net, for the periods presented (in millions): Year Ended December 31, Interest income $ $ $ Interest expense (9 ) (6 ) (10 ) Foreign currency exchange losses, net (213 ) (6 ) (76 ) Other Interest and other income (expense), net $ $ $ 80 Note 12. Income Taxes The components of income before provision for income taxes for the years ended December 31, 2018 , 2017 , and 2016 are as follows (in millions): Year Ended December 31, Domestic $ 8,800 $ 7,079 $ 6,368 Foreign 16,561 13,515 6,150 Income before provision for income taxes $ 25,361 $ 20,594 $ 12,518 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 1,747 $ 4,455 $ 2,384 State Foreign 1,031 Total current tax expense 2,954 5,034 2,758 Deferred: Federal (296 ) (414 ) State (33 ) (18 ) Foreign (55 ) (45 ) (25 ) Total deferred tax expense/(benefits) (374 ) (457 ) Provision for income taxes $ 3,249 $ 4,660 $ 2,301 A reconciliation of the U.S. federal statutory income tax rate of 21.0% to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 21.0 % 35.0 % 35.0 % State income taxes, net of federal benefit 0.7 0.6 1.0 Research tax credits (1.0 ) (0.9 ) (0.7 ) Share-based compensation 0.3 0.4 1.0 Excess tax benefits related to share-based compensation (2.6 ) (5.8 ) (7.0 ) Effect of non-U.S. operations (5.9 ) (18.6 ) (12.8 ) Effect of U.S. tax law change (1) 11.0 Other 0.3 0.9 1.9 Effective tax rate 12.8 % 22.6 % 18.4 % (1) Due to the Tax Act which was enacted in December 2017, provisional one-time mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 1,825 $ 1,300 Tax credit carryforward Share-based compensation Accrued expenses and other liabilities Other Total deferred tax assets 3,403 2,706 Less: valuation allowance (600 ) (438 ) Deferred tax assets, net of valuation allowance 2,803 2,268 Deferred tax liabilities: Depreciation and amortization (1,401 ) (622 ) Purchased intangible assets (195 ) (309 ) Deferred taxes on foreign income (88 ) Total deferred tax liabilities (1,596 ) (1,019 ) Net deferred tax assets $ 1,207 $ 1,249 The Tax Act reduces the U.S. statutory corporate tax rate from 35% to 21% for our tax years beginning in 2018, which resulted in the re-measurement of the federal portion of our deferred tax assets as of December 31, 2017 from the 35% to 21% tax rate. The valuation allowance was approximately $600 million and $438 million as of December 31, 2018 and 2017 , respectively, mostly related to state tax credits that we do not believe will ultimately be realized. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allowed us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. As a result, we previously provided a provisional estimate of the effect of the Tax Act in our financial statements. In the fourth quarter of 2018, we completed our analysis to determine the effect of the Tax Act and recorded immaterial adjustments as of December 31, 2018. As of December 31, 2018 , the U.S. federal and state net operating loss carryforwards were $7.88 billion and $2.22 billion , which will begin to expire in 2033 and 2032 , respectively, if not utilized. We have federal tax credit carryforwards of $290 million , which will begin to expire in 2033 , if not utilized, and state tax credit carryforwards of $1.91 billion , most of which do not expire. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three -year period. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and generally eliminates US taxes on foreign subsidiary distribution. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits-beginning of period $ 3,870 $ 3,309 $ 3,017 Increases related to prior year tax positions Decreases related to prior year tax positions (396 ) (34 ) (36 ) Increases related to current year tax positions Decreases related to settlements of prior year tax positions (84 ) (13 ) (11 ) Gross unrecognized tax benefits-end of period $ 4,678 $ 3,870 $ 3,309 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2018 and 2017 was $340 million and $154 million , respectively. If the balance of gross unrecognized tax benefits of $4.68 billion as of December 31, 2018 were realized in a future period, this would result in a tax benefit of $2.94 billion within our provision of income taxes at such time. On July 27, 2015, the United States Tax Court (Tax Court) issued an opinion in Altera Corp. v. Commissioner (Tax Court Opinion), which concluded that related parties in a cost sharing arrangement are not required to share expenses related to share-based compensation. The Tax Court Opinion was appealed by the Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On July 24, 2018, the Ninth Circuit issued an opinion (Ninth Circuit Opinion) that reversed the Tax Court Opinion. The Ninth Circuit Opinion was subsequently withdrawn and the case is being reheard. Since the Ninth Circuit Opinion was withdrawn, we continue to treat our share-based compensation expense in accordance with the Tax Court Opinion. We also continue to monitor developments in this case and any impact the final opinion could have on our consolidated financial statements. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 tax years and by the Ireland tax authorities for our 2012 through 2015 tax years. Our 2017 tax year remains open to examination by the IRS. Our 2016 and subsequent tax years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated, aggregate amount of approximately up to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the Tax Court challenging the Notice. As of December 31, 2018, we have not resolved this matter, and proceedings continue in the Tax Court. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices. In addition, if the IRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the Tax Act. We believe that adequate amounts have been reserved in accordance with ASC 740 for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. Note 13. Geographical Information The following table sets forth property and equipment, net by geographic area (in millions): December 31, Property and equipment, net: United States $ 18,950 $ 10,406 Rest of the world (1) 5,733 3,315 Total property and equipment, net $ 24,683 $ 13,721 (1) No individual country, other than disclosed above, exceeded 10% of our total property and equipment, net for any period presented. For information regarding revenue disaggregated by geography, see Note 1Summary of Significant Accounting Policies, Revenue Recognition. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2018 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2018 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2018 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " +4,fb-1,2017x10k," Item 1. Business Overview Our mission is to give people the power to build community and bring the world closer together. Our top priority is to build useful and engaging products that enable people to connect and share with friends and family through mobile devices, personal computers, and other surfaces. We also help people discover and learn about what is going on in the world around them, enable people to share their opinions, ideas, photos and videos, and other activities with audiences ranging from their closest friends to the public at large, and stay connected everywhere by accessing our products, including: Facebook. Facebook enables people to connect, share, discover, and communicate with each other on mobile devices and personal computers. There are a number of different ways to engage with people on Facebook, the most important of which is News Feed which displays an algorithmically-ranked series of stories and advertisements individualized for each person. Instagram. Instagram is a community for sharing visual stories through photos, videos, and direct messages. Instagram is also a place for people to stay connected with the interests and communities that they care about. Messenger. Messenger is a messaging application that makes it easy for people to connect with other people, groups and businesses across a variety of platforms and devices. WhatsApp. WhatsApp is a fast, simple, and reliable messaging application that is used by people around the world to connect securely and privately. Oculus. Our Oculus virtual reality technology and content platform power products that allow people to enter a completely immersive and interactive environment to train, learn, play games, consume content, and connect with others. We generate substantially all of our revenue from selling advertising placements to marketers. Our ads enable marketers to reach people based on a variety of factors including age, gender, location, interests, and behaviors. Marketers purchase ads that can appear in multiple places including on Facebook, Instagram, Messenger, and third-party applications and websites. We are also investing in a number of longer-term initiatives, such as connectivity efforts, artificial intelligence research, and augmented and virtual reality, to develop technologies that we believe will help us better serve our communities and pursue our mission to give people the power to build community and bring the world closer together. Competition Our business is characterized by innovation, rapid change, and disruptive technologies. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete to attract, engage, and retain people who use our products, to attract and retain marketers, and to attract and retain developers to build compelling mobile and web applications that integrate with our products. We also compete with the following: Companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. Companies that develop applications, particularly mobile applications, that provide social or other communications functionality, such as messaging, photo- and video-sharing, and micro-blogging. Companies that provide regional social networks that have strong positions in particular countries. Traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. Companies that develop and deliver virtual reality products and services. As we introduce or acquire new products, as our existing products evolve, or as other companies introduce new products and services, we may become subject to additional competition. Technology Our product development philosophy is centered on continuous innovation in creating and improving products that are social by design, which means that our products are designed to place people and their social interactions at the core of the product experience. As our user base grows, and the level of engagement from the people who use our products continues to increase, including with video, our computing needs continue to expand. We make significant investments in technology both to improve our existing products and services and to develop new ones, as well as for our marketers and developers. We are also investing in protecting the security and integrity of our platform by investing in both people and technology to strengthen our systems against abuse. Our technology investments included research and development expenses of $7.75 billion , $5.92 billion and $4.82 billion in 2017, 2016 and 2015, respectively. For information about our research and development expenses, see Part II, Item 7, ""Management's Discussion and Analysis of Financial Condition and Results of OperationsResults of OperationsResearch and development"" of this Annual Report on Form 10-K. Sales and Operations The majority of our marketers use our self-service ad platform to launch and manage their advertising campaigns. We also have a global sales force that is focused on attracting and retaining advertisers and providing support to them throughout the stages of the marketing cycle from pre-purchase decision-making to real-time optimizations to post-campaign analytics. We work directly with these advertisers, through traditional advertising agencies, and with an ecosystem of specialized agencies and partners. We currently operate six support offices and more than 40 sales offices around the globe. We also invest in and rely on self-service tools to provide direct customer support to our users and partners. Marketing To date, our communities have grown organically with people inviting their friends to connect with them, supported by internal efforts to stimulate awareness and interest. In addition, we have invested and will continue to invest in marketing our products and services to build our brand, grow our user base, and increase engagement around the world. We leverage the utility of our products and our social distribution channels as our most effective marketing tools. Intellectual Property To establish and protect our proprietary rights, we rely on a combination of patents, trademarks, copyrights, trade secrets, including know-how, license agreements, confidentiality procedures, non-disclosure agreements with third parties, employee disclosure and invention assignment agreements, and other contractual rights. In addition, to further protect our proprietary rights, from time to time we have purchased patents and patent applications from third parties. We do not believe that our proprietary technology is dependent on any single patent or copyright or groups of related patents or copyrights. We believe the duration of our patents is adequate relative to the expected lives of our products. Government Regulation We are subject to a number of U.S. federal and state and foreign laws and regulations that affect companies conducting business on the Internet. Many of these laws and regulations are still evolving and being tested in courts, and could be interpreted in ways that could harm our business. These may involve user privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. In particular, we are subject to federal, state, and foreign laws regarding privacy and protection of people's data. Foreign data protection, privacy, content, competition, and other laws and regulations can be more restrictive than those in the United States. U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. Proposed or new legislation and regulations could also significantly affect our business. There currently are a number of proposals pending before federal, state, and foreign legislative and regulatory bodies. In addition, the new European General Data Protection Regulation (GDPR) will take effect in May 2018 and will apply to all of our products and services that provide service in Europe. The GDPR will include operational requirements for companies that receive or process personal data of residents of the European Union that are different than those currently in place in the European Union, and will include significant penalties for non- compliance. Similarly, there are a number of legislative proposals in the United States, at both the federal and state level, that could impose new obligations in areas affecting our business, such as liability for copyright infringement by third parties. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. We are currently, and may in the future be, subject to regulatory orders or consent decrees. Violation of existing or future regulatory orders or consent decrees could subject us to substantial monetary fines and other penalties that could negatively affect our financial condition and results of operations. Various laws and regulations in the United States and abroad, such as the U.S. Bank Secrecy Act, the Dodd-Frank Act, the USA PATRIOT Act, and the Credit CARD Act, impose certain anti-money laundering requirements on companies that are financial institutions or that provide financial products and services. Under these laws and regulations, financial institutions are broadly defined to include money services businesses such as money transmitters, check cashers, and sellers or issuers of stored value or prepaid access products. Requirements imposed on financial institutions under these laws include customer identification and verification programs, record retention policies and procedures, and transaction reporting. To increase flexibility in how our online payments infrastructure (Payments) may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws relating to money transmission, gift cards and other prepaid access instruments, electronic funds transfers, anti-money laundering, charitable fundraising, counter-terrorist financing, gambling, banking and lending, financial privacy and data security, and import and export restrictions. Employees As of December 31, 2017 , we had 25,105 employees. Corporate Information We were incorporated in Delaware in July 2004. We completed our initial public offering in May 2012 and our Class A common stock is listed on The Nasdaq Global Select Market under the symbol ""FB."" Our principal executive offices are located at 1601 Willow Road, Menlo Park, California 94025, and our telephone number is (650) 543-4800. Facebook, the Facebook logo, FB, the Like button, Instagram, Oculus, WhatsApp, and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Facebook, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners. Information about Segment and Geographic Revenue Information about segment and geographic revenue is set forth in Notes 1 and 13 of our Notes to Consolidated Financial Statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Available Information Our website address is www.facebook.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are filed with the U.S. Securities and Exchange Commission (SEC). We are subject to the informational requirements of the Exchange Act and file or furnish reports, proxy statements, and other information with the SEC. Such reports and other information filed by us with the SEC are available free of charge on our website at investor.fb.com when such reports are available on the SEC's website. We use our investor.fb.com and newsroom.fb.com websites as well as Mark Zuckerberg's Facebook Page (https://www.facebook.com/zuck) as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. The public may read and copy any materials filed by Facebook with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The contents of the websites referred to above are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only. "," Item 1A. Risk Factors Certain factors may have a material adverse effect on our business, financial condition, and results of operations. You should consider carefully the risks and uncertainties described below, in addition to other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. If any of the following risks actually occurs, our business, financial condition, results of operations, and future prospects could be materially and adversely affected. In that event, the trading price of our Class A common stock could decline, and you could lose part or all of your investment. Risks Related to Our Business and Industry If we fail to retain existing users or add new users, or if our users decrease their level of engagement with our products, our revenue, financial results, and business may be significantly harmed. The size of our user base and our users' level of engagement are critical to our success. Our financial performance has been and will continue to be significantly determined by our success in adding, retaining, and engaging active users of our products, particularly for Facebook and Instagram. We anticipate that our active user growth rate will continue to decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly in markets where we have achieved higher penetration rates. For example, in the fourth quarter of 2017, we experienced a slight decline on a quarter-over-quarter basis in the number of daily active users on Facebook in the United States Canada region. If people do not perceive our products to be useful, reliable, and trustworthy, we may not be able to attract or retain users or otherwise maintain or increase the frequency and duration of their engagement. A number of other social networking companies that achieved early popularity have since seen their active user bases or levels of engagement decline, in some cases precipitously. There is no guarantee that we will not experience a similar erosion of our active user base or engagement levels. Our user engagement patterns have changed over time, and user engagement can be difficult to measure, particularly as we introduce new and different products and services. Any number of factors could potentially negatively affect user retention, growth, and engagement, including if: users increasingly engage with other competitive products or services; we fail to introduce new features, products or services that users find engaging or if we introduce new products or services, or make changes to existing products and services, that are not favorably received; users feel that their experience is diminished as a result of the decisions we make with respect to the frequency, prominence, format, size, and quality of ads that we display; users have difficulty installing, updating, or otherwise accessing our products on mobile devices as a result of actions by us or third parties that we rely on to distribute our products and deliver our services; user behavior on any of our products changes, including decreases in the quality and frequency of content shared on our products and services; we are unable to continue to develop products for mobile devices that users find engaging, that work with a variety of mobile operating systems and networks, and that achieve a high level of market acceptance; there are decreases in user sentiment about the quality or usefulness of our products or concerns related to privacy and sharing, safety, security, or other factors; we are unable to manage and prioritize information to ensure users are presented with content that is appropriate, interesting, useful, and relevant to them; we are unable to obtain or attract engaging third-party content; users adopt new technologies where our products may be displaced in favor of other products or services, or may not be featured or otherwise available; there are adverse changes in our products that are mandated by legislation, regulatory authorities, or litigation; there is decreased engagement or acceptance of product features on our service, or decreased acceptance of our terms of service, as part of changes that may be implemented in connection with the General Data Protection Regulation (GDPR) in Europe; technical or other problems prevent us from delivering our products in a rapid and reliable manner or otherwise affect the user experience, such as security breaches or failure to prevent or limit spam or similar content; we adopt terms, policies, or procedures related to areas such as sharing, content, user data, or advertising that are perceived negatively by our users or the general public; we elect to focus our product decisions on longer-term initiatives that do not prioritize near-term user growth and engagement, or if initiatives designed to attract and retain users and engagement are unsuccessful or discontinued, whether as a result of actions by us, third parties, or otherwise; we fail to provide adequate customer service to users, marketers, developers, or other partners; we, developers whose products are integrated with our products, or other partners and companies in our industry are the subject of adverse media reports or other negative publicity; or our current or future products, such as our development tools and application programming interfaces that enable developers to build, grow, and monetize mobile and web applications, reduce user activity on our products by making it easier for our users to interact and share on third-party mobile and web applications. If we are unable to maintain or increase our user base and user engagement, our revenue and financial results may be adversely affected. Any decrease in user retention, growth, or engagement could render our products less attractive to users, marketers, and developers, which is likely to have a material and adverse impact on our revenue, business, financial condition, and results of operations. If our active user growth rate continues to slow, we will become increasingly dependent on our ability to maintain or increase levels of user engagement and monetization in order to drive revenue growth. We generate substantially all of our revenue from advertising. The loss of marketers, or reduction in spending by marketers, could seriously harm our business. Substantially all of our revenue is currently generated from third parties advertising on Facebook and Instagram. For 2017, 2016, and 2015, advertising accounted for 98% , 97% and 95% , respectively, of our revenue. As is common in the industry, our marketers do not have long-term advertising commitments with us. Many of our marketers spend only a relatively small portion of their overall advertising budget with us. Marketers will not continue to do business with us, or they will reduce the budgets they are willing to commit to us, if we do not deliver ads in an effective manner, or if they do not believe that their investment in advertising with us will generate a competitive return relative to other alternatives. In addition, our advertising revenue growth has become increasingly dependent upon increased pricing of our ads. If we are unable to provide marketers with a suitable return on investment, the pricing of our ads may not increase, or may decline, in which case our revenue and financial results may be harmed. Our advertising revenue could also be adversely affected by a number of other factors, including: decreases in user engagement, including time spent on our products; our inability to continue to increase user access to and engagement with our mobile products; product changes or inventory management decisions we may make that change the size, format, frequency, or relative prominence of ads displayed on our products or of other unpaid content shared by marketers on our products; our inability to maintain or increase marketer demand, the pricing of our ads, or both; our inability to maintain or increase the quantity or quality of ads shown to users, including as a result of technical infrastructure constraints; reductions of advertising by marketers due to our efforts to implement advertising policies that protect the security and integrity of our platform; changes to third-party policies that limit our ability to deliver or target advertising on mobile devices; the availability, accuracy, and utility of analytics and measurement solutions offered by us or third parties that demonstrate the value of our ads to marketers, or our ability to further improve such tools; loss of advertising market share to our competitors, including if prices for purchasing ads increase or if competitors offer lower priced or more integrated products; adverse government actions or legal developments relating to advertising, including legislative and regulatory developments and developments in litigation; decisions by marketers to reduce their advertising as a result of adverse media reports or other negative publicity involving us, our advertising metrics or tools, content on our products, developers with mobile and web applications that are integrated with our products, or other companies in our industry; reductions of advertising by marketers due to objectionable content published on our products by third parties; the effectiveness of our ad targeting or degree to which users opt out of certain types of ad targeting, including as a result of product changes and controls that may be implemented in connection with the GDPR or other regulation or regulatory action; the degree to which users cease or reduce the number of times they engage with our ads; changes in the way advertising on mobile devices or on personal computers is measured or priced; and the impact of macroeconomic conditions, whether in the advertising industry in general, or among specific types of marketers or within particular geographies. The occurrence of any of these or other factors could result in a reduction in demand for our ads, which may reduce the prices we receive for our ads, or cause marketers to stop advertising with us altogether, either of which would negatively affect our revenue and financial results. Our user growth, engagement, and monetization on mobile devices depend upon effective operation with mobile operating systems, networks, and standards that we do not control. The substantial majority of our revenue is generated from advertising on mobile devices. There is no guarantee that popular mobile devices will continue to feature Facebook or our other products, or that mobile device users will continue to use our products rather than competing products. We are dependent on the interoperability of Facebook and our other products with popular mobile operating systems, networks, and standards that we do not control, such as the Android and iOS operating systems. Any changes, bugs, or technical issues in such systems, or changes in our relationships with mobile operating system partners, handset manufacturers, or mobile carriers, or in their terms of service or policies that degrade our products' functionality, reduce or eliminate our ability to distribute our products, give preferential treatment to competitive products, limit our ability to deliver, target, or measure the effectiveness of ads, or charge fees related to the distribution of our products or our delivery of ads could adversely affect the usage of Facebook or our other products and monetization on mobile devices. Additionally, in order to deliver high quality mobile products, it is important that our products work well with a range of mobile technologies, systems, networks, and standards that we do not control, and that we have good relationships with handset manufacturers and mobile carriers. We may not be successful in maintaining or developing relationships with key participants in the mobile ecosystem or in developing products that operate effectively with these technologies, systems, networks, or standards. In the event that it is more difficult for our users to access and use Facebook or our other products on their mobile devices, or if our users choose not to access or use Facebook or our other products on their mobile devices or use mobile products that do not offer access to Facebook or our other products, our user growth and user engagement could be harmed. From time to time, we may also take actions regarding the distribution of our products or the operation of our business based on what we believe to be in our long-term best interests. Such actions may adversely affect our users and our relationships with the operators of mobile operating systems, handset manufacturers, mobile carriers, or other business partners, and there is no assurance that these actions will result in the anticipated long-term benefits. In the event that our users are adversely affected by these actions or if our relationships with such third parties deteriorate, our user growth, engagement, and monetization could be adversely affected and our business could be harmed. Our business is highly competitive. Competition presents an ongoing threat to the success of our business. We compete with companies that sell advertising, as well as with companies that provide social, media, and communication products and services that are designed to engage users on mobile devices and online. We face significant competition in every aspect of our business, including from companies that facilitate communication and the sharing of content and information, companies that enable marketers to display advertising, companies that distribute video and other forms of media content, and companies that provide development platforms for applications developers. We compete with companies that offer products across broad platforms that replicate capabilities we provide. For example, Google has integrated social functionality into a number of its products, including search, video, and Android. We also compete with companies that develop applications, particularly mobile applications, that provide social or other communications functionality, such as messaging, photo- and video-sharing, and micro-blogging, as well as companies that provide regional social networks that have strong positions in particular countries. In addition, we face competition from traditional, online, and mobile businesses that provide media for marketers to reach their audiences and/or develop tools and systems for managing and optimizing advertising campaigns. We also compete with companies that develop and deliver virtual reality products and services. Some of our current and potential competitors may have significantly greater resources or stronger competitive positions in certain product segments, geographic regions, or user demographics than we do. These factors may allow our competitors to respond more effectively than us to new or emerging technologies and changes in market conditions. We believe that some users, particularly younger users, are aware of and actively engaging with other products and services similar to, or as a substitute for, Facebook products and services, and we believe that some users have reduced their use of and engagement with our products and services in favor of these other products and services. In the event that users increasingly engage with other products and services, we may experience a decline in use and engagement in key user demographics or more broadly, in which case our business would likely be harmed. Our competitors may develop products, features, or services that are similar to ours or that achieve greater acceptance, may undertake more far-reaching and successful product development efforts or marketing campaigns, or may adopt more aggressive pricing policies. In addition, developers whose mobile and web applications are integrated with Facebook or our other products may use information shared by our users through our products in order to develop products or features that compete with us. Some competitors may gain a competitive advantage against us in areas where we operate, including: by integrating competing platforms, applications, or features into products they control such as mobile device operating systems, search engines, or web browsers; by making acquisitions; by limiting our ability to deliver, target, or measure the effectiveness of ads; by imposing fees or other charges related to our delivery of ads; by making access to our products more difficult; or by making it more difficult to communicate with our users. As a result, our competitors may acquire and engage users or generate advertising or other revenue at the expense of our own efforts, which may negatively affect our business and financial results. In addition, from time to time, we may take actions in response to competitive threats, but we cannot assure you that these actions will be successful or that they will not negatively affect our business and financial results. We believe that our ability to compete effectively depends upon many factors both within and beyond our control, including: the popularity, usefulness, ease of use, performance, and reliability of our products compared to our competitors' products; the size and composition of our user base; the engagement of users with our products and competing products; the timing and market acceptance of products, including developments and enhancements to our or our competitors' products; our ability to distribute our products to new and existing users; our ability to monetize our products; the frequency, size, format, quality, and relative prominence of the ads displayed by us or our competitors; customer service and support efforts; marketing and selling efforts, including our ability to measure the effectiveness of our ads and to provide marketers with a compelling return on their investments; our ability to establish and maintain developers' interest in building mobile and web applications that integrate with Facebook and our other products; our ability to establish and maintain publisher interest in integrating their content with Facebook and our other products; changes mandated by legislation, regulatory authorities, or litigation, some of which may have a disproportionate effect on us; acquisitions or consolidation within our industry, which may result in more formidable competitors; our ability to attract, retain, and motivate talented employees, particularly software engineers, designers, and product managers; our ability to cost-effectively manage and grow our operations; and our reputation and brand strength relative to those of our competitors. If we are not able to compete effectively, our user base and level of user engagement may decrease, we may become less attractive to developers and marketers, and our revenue and results of operations may be materially and adversely affected. Action by governments to restrict access to Facebook or our other products in their countries could substantially harm our business and financial results. It is possible that governments of one or more countries may seek to censor content available on Facebook or our other products in their country, restrict access to our products from their country entirely, or impose other restrictions that may affect the accessibility of our products in their country for an extended period of time or indefinitely. For example, user access to Facebook and certain of our other products has been or is currently restricted in whole or in part in China, Iran, and North Korea. In addition, government authorities in other countries may seek to restrict user access to our products if they consider us to be in violation of their laws or a threat to public safety or for other reasons, and certain of our products have been restricted by governments in other countries from time to time. It is also possible that government authorities could take action to restrict our ability to sell advertising. In the event that content shown on Facebook or our other products is subject to censorship, access to our products is restricted, in whole or in part, in one or more countries, or other restrictions are imposed on our products, or our competitors are able to successfully penetrate new geographic markets or capture a greater share of existing geographic markets that we cannot access or where we face other restrictions, our ability to retain or increase our user base, user engagement, or the level of advertising by marketers may be adversely affected, we may not be able to maintain or grow our revenue as anticipated, and our financial results could be adversely affected. Our new products and changes to existing products could fail to attract or retain users or generate revenue and profits. Our ability to retain, increase, and engage our user base and to increase our revenue depends heavily on our ability to continue to evolve our existing products and to create successful new products, both independently and in conjunction with developers or other third parties. We may introduce significant changes to our existing products or acquire or introduce new and unproven products, including using technologies with which we have little or no prior development or operating experience. For example, in March 2016, we shipped our first virtual reality hardware product, the Oculus Rift. In addition, we have announced plans to develop augmented reality technology and products. We do not have significant experience with consumer hardware products or virtual or augmented reality technology, which may adversely affect our ability to successfully develop and market these products and technologies, and we will incur increased costs in connection with the development and marketing of such products and technologies. We have also invested, and expect to continue to invest, significant resources in growing our WhatsApp and Messenger products. We have historically monetized messaging in only a very limited fashion, and we may not be successful in our efforts to generate meaningful revenue from messaging over the long term. If these or other new or enhanced products fail to engage users, marketers, or developers, or if we are unsuccessful in our monetization efforts, we may fail to attract or retain users or to generate sufficient revenue, operating margin, or other value to justify our investments, and our business may be adversely affected. We make product and investment decisions that may not prioritize short-term financial results and may not produce the long-term benefits that we expect. We frequently make product and investment decisions that may not prioritize short-term financial results if we believe that the decisions are consistent with our mission and benefit the aggregate user experience and will thereby improve our financial performance over the long term. For example, from time to time we may change the size, frequency, or relative prominence of ads in order to improve ad quality and overall user experience. Similarly, we recently announced changes to our News Feed ranking algorithm to help our users have more meaningful social interactions, and we expect that these changes will have the effect of reducing time spent and some measures of user engagement with Facebook, which could adversely affect our financial results. From time to time, we have also made, and expect to continue to make, other changes to our products which may adversely affect the distribution of content of publishers, marketers, and developers, and could reduce their incentive to invest in their efforts on Facebook. We also may introduce new features or other changes to existing products, or introduce new stand-alone products, that attract users away from properties, formats, or use cases where we have more proven means of monetization. For example, the Stories format is becoming increasingly popular for sharing content across our products, and we do not currently monetize Stories at the same rate as News Feed. In addition, we plan to continue focusing on growing users and engagement on Instagram, Messenger, and WhatsApp, and we may also introduce other stand-alone applications in the future. These efforts may reduce engagement with the core Facebook application, where we have the most proven means of monetization and which serves as the platform for many of our new user experiences. These decisions may adversely affect our business and results of operations and may not produce the long-term benefits that we expect. If we are not able to maintain and enhance our brands, or if events occur that damage our reputation and brands, our ability to expand our base of users, marketers, and developers may be impaired, and our business and financial results may be harmed. We believe that our brands have significantly contributed to the success of our business. We also believe that maintaining and enhancing our brands is critical to expanding our base of users, marketers, and developers. Many of our new users are referred by existing users. Maintaining and enhancing our brands will depend largely on our ability to continue to provide useful, reliable, trustworthy, and innovative products, which we may not do successfully. We may introduce new products or terms of service or policies that users do not like, which may negatively affect our brands. Additionally, the actions of our developers or advertisers may affect our brands if users do not have a positive experience using third-party mobile and web applications integrated with our products or interacting with parties that advertise through our products. We will also continue to experience media, legislative, or regulatory scrutiny of our decisions regarding user privacy, content, advertising, and other issues, which may adversely affect our reputation and brands. For example, we previously announced our discovery of certain ads and other content previously displayed on our products that may be relevant to government investigations relating to Russian interference in the 2016 U.S. presidential election. We also may fail to respond expeditiously to the sharing of objectionable content on our services or objectionable practices by advertisers, or to otherwise address user concerns, which could erode confidence in our brands. Our brands may also be negatively affected by the actions of users that are deemed to be hostile or inappropriate to other users, by the actions of users acting under false or inauthentic identities, by the use of our products or services to disseminate information that is deemed to be misleading (or intended to manipulate opinions), by perceived or actual efforts by governments to obtain access to user information for security-related purposes or to censor certain content on our platform, or by the use of our products or services for illicit, objectionable, or illegal ends. Maintaining and enhancing our brands may require us to make substantial investments and these investments may not be successful. Certain of our past actions have eroded confidence in our brands, and if we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business and financial results may be adversely affected. Security breaches and improper access to or disclosure of our data or user data, or other hacking and phishing attacks on our systems, could harm our reputation and adversely affect our business. Our industry is prone to cyber-attacks by third parties seeking unauthorized access to our data or users data or to disrupt our ability to provide service. Any failure to prevent or mitigate security breaches and improper access to or disclosure of our data or user data, including personal information, content or payment information from users, could result in the loss or misuse of such data, which could harm our business and reputation and diminish our competitive position. In addition, computer malware, viruses, social engineering (predominantly spear phishing attacks), and general hacking have become more prevalent in our industry, have occurred on our systems in the past, and will occur on our systems in the future. We also regularly encounter attempts to create false or undesirable user accounts, purchase ads, or take other actions on our platform for purposes such as spamming, spreading misinformation, or other objectionable ends. As a result of our prominence, the size of our user base, and the types and volume of personal data on our systems, we believe that we are a particularly attractive target for such breaches and attacks. Such attacks may cause interruptions to the services we provide, degrade the user experience, cause users to lose confidence and trust in our products, impair our internal systems, or result in financial harm to us. Our efforts to protect our company data or the information we receive may also be unsuccessful due to software bugs or other technical malfunctions; employee, contractor, or vendor error or malfeasance; government surveillance; or other threats that evolve. In addition, third parties may attempt to fraudulently induce employees or users to disclose information in order to gain access to our data or our users' data. Cyber-attacks continue to evolve in sophistication and volume, and inherently may be difficult to detect for long periods of time. Although we have developed systems and processes that are designed to protect our data and user data, to prevent data loss, to disable undesirable accounts and activities on our platform, and to prevent or detect security breaches, we cannot assure you that such measures will provide absolute security, and we may incur significant costs in protecting against or remediating cyber-attacks. In addition, some of our developers or other partners, such as those that help us measure the effectiveness of ads, may receive or store information provided by us or by our users through mobile or web applications integrated with Facebook. We provide limited information to such third parties based on the scope of services provided to us. However, if these third parties or developers fail to adopt or adhere to adequate data security practices, or in the event of a breach of their networks, our data or our users' data may be improperly accessed, used, or disclosed. Affected users or government authorities could initiate legal or regulatory actions against us in connection with any security breaches or improper disclosure of data, which could cause us to incur significant expense and liability or result in orders or consent decrees forcing us to modify our business practices. Such incidents may also result in a decline in our active user base or engagement levels. Any of these events could have a material and adverse effect on our business, reputation, or financial results. Unfavorable media coverage could negatively affect our business. We receive a high degree of media coverage around the world. Unfavorable publicity regarding, for example, our privacy practices, terms of service, product changes, product quality, litigation or regulatory activity, government surveillance, the actions of our advertisers, the actions of our developers whose products are integrated with our products, the use of our products or services for illicit, objectionable, or illegal ends, the actions of our users, the quality and integrity of content shared on our platform, or the actions of other companies that provide similar services to us, has in the past, and could in the future, adversely affect our reputation. Such negative publicity also could have an adverse effect on the size, engagement, and loyalty of our user base and result in decreased revenue, which could adversely affect our business and financial results. Our financial results will fluctuate from quarter to quarter and are difficult to predict. Our quarterly financial results have fluctuated in the past and will fluctuate in the future. Additionally, we have a limited operating history with the current scale of our business, which makes it difficult to forecast our future results. As a result, you should not rely upon our past quarterly financial results as indicators of future performance. You should take into account the risks and uncertainties frequently encountered by companies in rapidly evolving markets. Our financial results in any given quarter can be influenced by numerous factors, many of which we are unable to predict or are outside of our control, including: our ability to maintain and grow our user base and user engagement; our ability to attract and retain marketers in a particular period; fluctuations in spending by our marketers due to seasonality, such as historically strong spending in the fourth quarter of each year, episodic regional or global events, or other factors; the frequency, prominence, size, format, and quality of ads shown to users; the success of technologies designed to block the display of ads; the pricing of our ads and other products; the diversification and growth of revenue sources beyond advertising on Facebook and Instagram; our ability to generate revenue from Payments, or the sale of Oculus products and services or other products we may introduce in the future; the development and introduction of new products or services by us or our competitors; user behavior or product changes that may reduce traffic to features or products that we successfully monetize; increases in marketing, sales, and other operating expenses that we will incur to grow and expand our operations and to remain competitive; costs and expenses related to the development and delivery of Oculus products and services; our ability to maintain gross margins and operating margins; costs related to acquisitions, including costs associated with amortization and additional investments to develop the acquired technologies; charges associated with impairment of any assets on our balance sheet; our ability to obtain equipment, components, and labor for our data centers and other technical infrastructure in a timely and cost-effective manner; system failures or outages, which could prevent us from serving ads for any period of time; breaches of security or privacy, and the costs associated with any such breaches and remediation; changes in the manner in which we distribute our products or inaccessibility of our products due to third-party actions; fees paid to third parties for content or the distribution of our products; share-based compensation expense, including acquisition-related expense; adverse litigation judgments, settlements, or other litigation-related costs; changes in the legislative or regulatory environment, including with respect to privacy and data protection, or enforcement by government regulators, including fines, orders, or consent decrees; the overall tax rate for our business, which may be affected by the mix of income we earn in the U.S. and in jurisdictions with comparatively lower tax rates, the effects of share-based compensation, the effects of integrating intellectual property from acquisitions, and the effects of changes in our business; the impact of changes in tax law, which are recorded in the period enacted and may significantly affect the effective tax rate of that period; tax obligations that may arise from resolutions of tax examinations, including the examination we are currently under by the Internal Revenue Service (IRS), that materially differ from the amounts we have anticipated; fluctuations in currency exchange rates and changes in the proportion of our revenue and expenses denominated in foreign currencies; fluctuations in the market values of our portfolio investments and in interest rates; changes in U.S. generally accepted accounting principles; and changes in global business or macroeconomic conditions. We expect our rates of growth to decline in the future. We expect that our user growth and revenue growth rates will decline over time as the size of our active user base increases, and it is possible that the size of our active user base may fluctuate or decline in one or more markets, particularly as we achieve greater market penetration. We expect our revenue growth rate will generally decline over time as our revenue increases to higher levels. As our growth rates decline, investors' perceptions of our business may be adversely affected and the trading price of our Class A common stock could decline. Our costs are continuing to grow, which could reduce our operating margin and profitability. If our investments are not successful, our business and financial performance could be harmed. Operating our business is costly, and we expect our expenses to continue to increase in the future as we broaden our user base, as users increase the amount and types of content they consume and the data they share with us, for example with respect to video, as we develop and implement new products, as we continue to expand our technical infrastructure, as we continue to invest in new and unproven technologies, and as we continue to hire additional employees to support our expanding operations. We will continue to invest in our messaging, security, video content, and global connectivity efforts, as well as other initiatives that may not have clear paths to monetization. In addition, we will incur increased costs in connection with the development and marketing of our Oculus products and services. Any such investments may not be successful, and any such increases in our costs may reduce our operating margin and profitability. In addition, if our investments are not successful, our ability to grow revenue will be harmed, which could adversely affect our business and financial performance. Given our levels of share-based compensation, our tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. For example, in 2017, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.25 billion and our effective tax rate by six percentage points as compared to the tax rate without such benefits. In future periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results. Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, content, competition, consumer protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or declines in user growth or engagement, or otherwise harm our business. We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including privacy, data protection and personal information, rights of publicity, content, intellectual property, advertising, marketing, distribution, data security, data retention and deletion, electronic contracts and other communications, competition, protection of minors, consumer protection, telecommunications, product liability, taxation, economic or other trade prohibitions or sanctions, securities law compliance, and online payment services. The introduction of new products, expansion of our activities in certain jurisdictions, or other actions that we may take may subject us to additional laws, regulations, or other government scrutiny. In addition, foreign data protection, privacy, content, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which in some cases can be enforced by private parties in addition to government entities, are constantly evolving and can be subject to significant change. As a result, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. For example, regulatory or legislative actions affecting the manner in which we display content to our users or obtain consent to various practices could adversely affect user growth and engagement. Such actions could affect the manner in which we provide our services or adversely affect our financial results. We are also subject to laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive certain data that is critical to our operations, including data shared between countries or regions in which we operate and data shared among our products and services. For example, in 2016, the European Union and United States agreed to an alternative transfer framework for data transferred from the European Union to the United States, called the Privacy Shield, but this new framework is subject to an annual review that could result in changes to our obligations and also may be challenged by national regulators or private parties. In addition, the other bases upon which Facebook relies to legitimize the transfer of such data, such as standard Model Contractual Clauses (MCCs), have been subjected to regulatory and judicial scrutiny. For example, the Irish Data Protection Commissioner has challenged the legal grounds for transfers of user data to Facebook, Inc., and the Irish High Court has agreed to refer this challenge to the Court of Justice of the European Union for decision. We also face multiple inquiries, investigations, and lawsuits in Europe, India, and other jurisdictions regarding the August 2016 update to WhatsApps terms of service and privacy policy and its sharing of certain data with other Facebook products and services, including a lawsuit currently pending before the Supreme Court of India. If one or more of the legal bases for transferring data from Europe to the United States is invalidated, if we are unable to transfer data between and among countries and regions in which we operate, or if we are prohibited from sharing data among our products and services, it could affect the manner in which we provide our services or adversely affect our financial results. Proposed or new legislation and regulations could also significantly affect our business. There currently are a number of proposals pending before federal, state, and foreign legislative and regulatory bodies. In addition, the new European General Data Protection Regulation (GDPR) will take effect in May 2018 and will apply to all of our products and services that provide service in Europe. The GDPR will include operational requirements for companies that receive or process personal data of residents of the European Union that are different than those currently in place in the European Union. For example, we may be required to implement measures to change our service or limit access to our service for minors under the age of 16 for certain countries in Europe that maintain the minimum age of 16 under the GDPR. We may also be required to obtain consent and/or offer new controls to existing and new users in Europe before processing data for certain aspects of our service. In addition, the GDPR will include significant penalties for non-compliance. Similarly, there are a number of legislative proposals in the United States, at both the federal and state level, that could impose new obligations in areas affecting our business, such as liability for copyright infringement by third parties. In addition, some countries are considering or have passed legislation implementing data protection requirements or requiring local storage and processing of data or similar requirements that could increase the cost and complexity of delivering our services. These laws and regulations, as well as any associated inquiries or investigations or any other government actions, may be costly to comply with and may delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to remedies that may harm our business, including fines or demands or orders that we modify or cease existing business practices. We have been subject to regulatory and other government investigations, enforcement actions, and settlements, and we expect to continue to be subject to such proceedings and other inquires in the future, which could cause us to incur substantial costs or require us to change our business practices in a manner materially adverse to our business. From time to time, we receive formal and informal inquiries from government authorities and regulators regarding our compliance with laws and regulations, many of which are evolving and subject to interpretation. We are and expect to continue to be the subject of investigations, inquiries, data requests, actions, and audits in the United States, Europe, and around the world, particularly in the areas of privacy, data protection, law enforcement, consumer protection, and competition, as we continue to grow and expand our operations. For example, several data protection authorities in the European Union have initiated actions, investigations, or administrative orders seeking to assert jurisdiction over Facebook, Inc. and our subsidiaries and to restrict the ways in which we collect and use information, and other data protection authorities may do the same. Orders issued by, or inquiries or enforcement actions initiated by, government or regulatory authorities could cause us to incur substantial costs, expose us to unanticipated civil and criminal liability or penalties (including substantial monetary fines), or require us to change our business practices in a manner materially adverse to our business. If we are unable to protect our intellectual property, the value of our brands and other intangible assets may be diminished, and our business may be adversely affected. We rely and expect to continue to rely on a combination of confidentiality, assignment, and license agreements with our employees, consultants, and third parties with whom we have relationships, as well as trademark, copyright, patent, trade secret, and domain name protection laws, to protect our proprietary rights. In the United States and internationally, we have filed various applications for protection of certain aspects of our intellectual property, and we currently hold a significant number of registered trademarks and issued patents in multiple jurisdictions and have acquired patents and patent applications from third parties. Third parties may knowingly or unknowingly infringe our proprietary rights, third parties may challenge proprietary rights held by us, and pending and future trademark and patent applications may not be approved. In addition, effective intellectual property protection may not be available in every country in which we operate or intend to operate our business. In any or all of these cases, we may be required to expend significant time and expense in order to prevent infringement or to enforce our rights. Although we have generally taken measures to protect our proprietary rights, there can be no assurance that others will not offer products or concepts that are substantially similar to ours and compete with our business. In addition, we regularly contribute software source code under open source licenses and have made other technology we developed available under other open licenses, and we include open source software in our products. For example, we have contributed certain specifications and designs related to our data center equipment to the Open Compute Project Foundation, a non-profit entity that shares and develops such information with the technology community, under the Open Web Foundation License. As a result of our open source contributions and the use of open source in our products, we may license or be required to license or disclose code and/or innovations that turn out to be material to our business and may also be exposed to increased litigation risk. If the protection of our proprietary rights is inadequate to prevent unauthorized use or appropriation by third parties, the value of our brands and other intangible assets may be diminished and competitors may be able to more effectively mimic our products, services, and methods of operations. Any of these events could have an adverse effect on our business and financial results. We are currently, and expect to be in the future, party to patent lawsuits and other intellectual property rights claims that are expensive and time consuming and, if resolved adversely, could have a significant impact on our business, financial condition, or results of operations. Companies in the Internet, technology, and media industries own large numbers of patents, copyrights, trademarks, and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. In addition, various ""non-practicing entities"" that own patents and other intellectual property rights often attempt to aggressively assert their rights in order to extract value from technology companies. Furthermore, from time to time we may introduce or acquire new products, including in areas where we historically have not competed, which could increase our exposure to patent and other intellectual property claims from competitors and non-practicing entities. From time to time, we receive notice from patent holders and other parties alleging that certain of our products and services, or user content, infringe their intellectual property rights. We presently are involved in a number of intellectual property lawsuits, and as we face increasing competition and gain an increasingly high profile, we expect the number of patent and other intellectual property claims against us to grow. Defending patent and other intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. In addition, plaintiffs may seek, and we may become subject to, preliminary or provisional rulings in the course of any such litigation, including potential preliminary injunctions requiring us to cease some or all of our operations. We may decide to settle such lawsuits and disputes on terms that are unfavorable to us. Similarly, if any litigation to which we are a party is resolved adversely, we may be subject to an unfavorable judgment that may not be reversed upon appeal. The terms of such a settlement or judgment may require us to cease some or all of our operations or pay substantial amounts to the other party. In addition, we may have to seek a license to continue practices found to be in violation of a third party's rights, which may not be available on reasonable terms, or at all, and may significantly increase our operating costs and expenses. As a result, we may also be required to develop alternative non-infringing technology or practices or discontinue the practices. The development of alternative non-infringing technology or practices could require significant effort and expense or may not be feasible. Our business, financial condition, and results of operations could be adversely affected as a result of an unfavorable resolution of the disputes and litigation referred to above. We are involved in numerous class action lawsuits and other litigation matters that are expensive and time consuming, and, if resolved adversely, could harm our business, financial condition, or results of operations. In addition to intellectual property claims, we are also involved in numerous other lawsuits, including putative class action lawsuits, many of which claim statutory damages and/or seek significant changes to our business operations, and we anticipate that we will continue to be a target for numerous lawsuits in the future. Because of the scale of our user base, the plaintiffs in class action cases filed against us typically claim enormous monetary damages even if the alleged per-user harm is small or non-existent. In addition, we may be subject to additional class action lawsuits based on employment claims, product performance or other claims related to the use of consumer hardware and software, as well as virtual reality technology and products, which are new and unproven. Any negative outcome from any such lawsuits could result in payments of substantial monetary damages or fines, or undesirable changes to our products or business practices, and accordingly our business, financial condition, or results of operations could be materially and adversely affected. Although the results of such lawsuits and claims cannot be predicted with certainty, we do not believe that the final outcome of those matters relating to our products that we currently face will have a material adverse effect on our business, financial condition, or results of operations. In addition, we are currently the subject of stockholder class action suits in connection with our initial public offering (IPO). We believe these lawsuits are without merit and are vigorously defending these lawsuits. There can be no assurances that a favorable final outcome will be obtained in all our cases, and defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of substantial monetary damages or fines, or we may decide to settle lawsuits on similarly unfavorable terms, which could adversely affect our business, financial conditions, or results of operations. We may incur liability as a result of information retrieved from or transmitted over the Internet or published using our products or as a result of claims related to our products. We have faced, currently face, and will continue to face claims relating to information that is published or made available on our products. In particular, the nature of our business exposes us to claims related to defamation, dissemination of misinformation or news hoaxes, discrimination, intellectual property rights, rights of publicity and privacy, personal injury torts, or laws regulating hate speech or other types of content. This risk is enhanced in certain jurisdictions outside the United States where our protection from liability for third-party actions may be unclear or where we may be less protected under local laws than we are in the United States. In addition, there have been various Congressional efforts to restrict the scope of the protections available to online platforms under Section 230 of the Communications Decency Act, and our current protections from liability for third-party content in the United States could decrease or change. We could incur significant costs investigating and defending such claims and, if we are found liable, significant damages. We could also face fines or orders restricting or blocking our services in particular geographies as a result of content hosted on our services. For example, recently enacted legislation in Germany may impose significant fines for failure to comply with certain content removal and disclosure obligations. If any of these events occur, our business and financial results could be adversely affected. Our CEO has control over key decision making as a result of his control of a majority of the voting power of our outstanding capital stock. Mark Zuckerberg, our founder, Chairman, and CEO, is able to exercise voting rights with respect to a majority of the voting power of our outstanding capital stock and therefore has the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentrated control could delay, defer, or prevent a change of control, merger, consolidation, or sale of all or substantially all of our assets that our other stockholders support, or conversely this concentrated control could result in the consummation of such a transaction that our other stockholders do not support. This concentrated control could also discourage a potential investor from acquiring our Class A common stock, which has limited voting power relative to the Class B common stock, and might harm the trading price of our Class A common stock. In addition, Mr. Zuckerberg has the ability to control the management and major strategic investments of our company as a result of his position as our CEO and his ability to control the election or replacement of our directors. In the event of his death, the shares of our capital stock that Mr. Zuckerberg owns will be transferred to the persons or entities that he has designated. As a board member and officer, Mr. Zuckerberg owes a fiduciary duty to our stockholders and must act in good faith in a manner he reasonably believes to be in the best interests of our stockholders. As a stockholder, even a controlling stockholder, Mr. Zuckerberg is entitled to vote his shares, and shares over which he has voting control as governed by a voting agreement, in his own interests, which may not always be in the interests of our stockholders generally. We plan to continue to make acquisitions, which could harm our financial condition or results of operations and may adversely affect the price of our common stock. As part of our business strategy, we have made and intend to continue to make acquisitions to add specialized employees and complementary companies, products, or technologies. We may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. In some cases, the costs of such acquisitions may be substantial. For example, in 2014 we paid approximately $4.6 billion in cash and issued 178 million shares of our Class A common stock in connection with our acquisition of WhatsApp, and we paid approximately $400 million in cash and issued 23 million shares of our Class B common stock in connection with our acquisition of Oculus. We also issued a substantial number of RSUs to help retain the employees of these companies. There is no assurance that we will receive a favorable return on investment for these or other acquisitions. We may pay substantial amounts of cash or incur debt to pay for acquisitions, which could adversely affect our liquidity. The incurrence of indebtedness would also result in increased fixed obligations and increased interest expense, and could also include covenants or other restrictions that would impede our ability to manage our operations. We may also issue equity securities to pay for acquisitions and we regularly grant RSUs to retain the employees of acquired companies, which could increase our expenses, adversely affect our financial results, and result in dilution to our stockholders. In addition, any acquisitions we announce could be viewed negatively by users, marketers, developers, or investors, which may adversely affect our business or the price of our Class A common stock. We may also discover liabilities or deficiencies associated with the companies or assets we acquire that were not identified in advance, which may result in significant unanticipated costs. The effectiveness of our due diligence review and our ability to evaluate the results of such due diligence are dependent upon the accuracy and completeness of statements and disclosures made or actions taken by the companies we acquire or their representatives, as well as the limited amount of time in which acquisitions are executed. In addition, we may fail to accurately forecast the financial impact of an acquisition transaction, including tax and accounting charges. Acquisitions may also result in our recording of significant additional expenses to our results of operations and recording of substantial finite-lived intangible assets on our balance sheet upon closing. Any of these factors may adversely affect our financial condition or results of operations. We may not be able to successfully integrate our acquisitions, and we may incur significant costs to integrate and support the companies we acquire. The integration of acquisitions requires significant time and resources, and we may not manage these processes successfully. Our ability to successfully integrate complex acquisitions is unproven, particularly with respect to companies that have significant operations or that develop products where we do not have prior experience. For example, Oculus and WhatsApp are larger and more complex than companies we have historically acquired. In particular, Oculus builds technology and products that are relatively new to Facebook and with which we did not have significant experience or structure in place to support prior to the acquisition. We continue to make substantial investments of resources to support these acquisitions, which will result in significant ongoing operating expenses and may divert resources and management attention from other areas of our business. We cannot assure you that these investments will be successful. If we fail to successfully integrate the companies we acquire, we may not realize the benefits expected from the transaction and our business may be harmed. If our goodwill or finite-lived intangible assets become impaired, we may be required to record a significant charge to earnings. We review our finite-lived intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable, such as a decline in stock price and market capitalization. We test goodwill for impairment at least annually. If such goodwill or finite-lived intangible assets are deemed to be impaired, an impairment loss equal to the amount by which the carrying amount exceeds the fair value of the assets would be recognized. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or finite-lived intangible assets is determined, which would negatively affect our results of operations. Our business is dependent on our ability to maintain and scale our technical infrastructure, and any significant disruption in our service could damage our reputation, result in a potential loss of users and engagement, and adversely affect our financial results. Our reputation and ability to attract, retain, and serve our users is dependent upon the reliable performance of our products and our underlying technical infrastructure. We have in the past experienced, and may in the future experience, interruptions in the availability or performance of our products from time to time. Our systems may not be adequately designed with the necessary reliability and redundancy to avoid performance delays or outages that could be harmful to our business. If our products are unavailable when users attempt to access them, or if they do not load as quickly as expected, users may not use our products as often in the future, or at all, and our ability to serve ads may be disrupted. As our user base and engagement continue to grow, and the amount and types of information shared on Facebook and our other products continue to grow and evolve, such as increased engagement with video, we will need an increasing amount of technical infrastructure, including network capacity and computing power, to continue to satisfy the needs of our users and advertisers. It is possible that we may fail to continue to effectively scale and grow our technical infrastructure to accommodate these increased demands, which may adversely affect our user engagement and advertising revenue growth. In addition, our business may be subject to interruptions, delays, or failures resulting from earthquakes, adverse weather conditions, other natural disasters, power loss, terrorism, geopolitical conflict, cyber-attacks, or other catastrophic events. If such an event were to occur, users may be subject to service disruptions or outages and we may not be able to recover our technical infrastructure and user data in a timely manner to restart or provide our services, which may adversely affect our financial results. A substantial portion of our network infrastructure is provided by third parties. Any disruption or failure in the services we receive from these providers could harm our ability to handle existing or increased traffic and could significantly harm our business. Any financial or other difficulties these providers face may adversely affect our business, and we exercise little control over these providers, which increases our vulnerability to problems with the services they provide. We could experience unforeseen difficulties in building and operating key portions of our technical infrastructure. We have designed and built our own data centers and key portions of our technical infrastructure through which we serve our products, and we plan to continue to significantly expand the size of our infrastructure primarily through data centers and other projects. The infrastructure expansion we are undertaking is complex and involves projects in multiple locations, and unanticipated delays in the completion of these projects, including due to any shortage of labor necessary in building portions of such projects, or availability of components, may lead to increased project costs, operational inefficiencies, or interruptions in the delivery or degradation of the quality of our products. In addition, there may be issues related to this infrastructure that are not identified during the testing phases of design and implementation, which may only become evident after we have started to fully utilize the underlying equipment, that could further degrade the user experience or increase our costs. Our products and internal systems rely on software that is highly technical, and if it contains undetected errors or vulnerabilities, our business could be adversely affected. Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immense amounts of data. The software on which we rely has contained, and will in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only be discovered after the code has been released for external or internal use. Errors, vulnerabilities, or other design defects within the software on which we rely have in the past, and may in the future, result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in targeting, measurement, or billing errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or all of our services. In addition, any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financial results. Technologies have been developed that can block the display of our ads, which could adversely affect our financial results. Technologies have been developed, and will likely continue to be developed, that can block the display of our ads or block our ad measurement tools, particularly for advertising displayed on personal computers. We generate substantially all of our revenue from advertising, including revenue resulting from the display of ads on personal computers. Revenue generated from the display of ads on personal computers has been impacted by these technologies from time to time. As a result, these technologies have had an adverse effect on our financial results and, if such technologies continue to proliferate, in particular with respect to mobile platforms, our future financial results may be harmed. Real or perceived inaccuracies in our user and other metrics may harm our reputation and negatively affect our business. The numbers for our key metrics, which include our DAUs, MAUs, and average revenue per user (ARPU), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology. We regularly evaluate these metrics to estimate the number of ""duplicate"" and ""false"" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide ""false"" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as similar IP addresses or user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Our estimates may change as our methodologies evolve, including through the application of new data signals or technologies, which may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. As such, our estimation of duplicate or false accounts may not accurately represent the actual number of such accounts. In particular, duplicate accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate accounts may vary significantly from our estimates. In the fourth quarter of 2017, we estimate that duplicate accounts may have represented approximately 10% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as India, Indonesia, and the Philippines, as compared to more developed markets. In the fourth quarter of 2017, we estimate that false accounts may have represented approximately 3-4% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia, Turkey, and Vietnam. From time to time, we may make product changes or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period. Our data limitations may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete. In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. Our estimates for revenue by user location and revenue by user device are also affected by these factors. We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. In addition, our DAU and MAU estimates will differ from estimates published by third parties due to differences in methodology. In addition, from time to time we provide, or rely on, certain other metrics, including those relating to the reach and effectiveness of our ads. All of our metrics are subject to software bugs, inconsistencies in our systems, and human error. If marketers, developers, or investors do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, we may be subject to liability, our reputation may be harmed, and marketers and developers may be less willing to allocate their budgets or resources to Facebook, which could negatively affect our business and financial results. We cannot assure you that we will effectively manage our growth. Our employee headcount and the scope and complexity of our business have increased significantly, with the number of employees increasing to 25,105 as of December 31, 2017 from 17,048 as of December 31, 2016, and we expect such headcount growth to continue for the foreseeable future. The growth and expansion of our business and products create significant challenges for our management, operational, and financial resources, including managing multiple relationships with users, marketers, developers, and other third parties. As our operations and the number of our third-party relationships continue to grow, our information technology systems or our internal controls and procedures may not be adequate to support such growth. In addition, some members of our management do not have significant experience managing a large global business operation, so our management may not be able to manage such growth effectively. To effectively manage our growth, we must continue to improve our operational, financial, and management processes and systems and to effectively expand, train, and manage our employee base. As our organization continues to grow, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the benefits of our corporate culture, including our ability to quickly develop and launch new and innovative products. This could negatively affect our business performance. The loss of one or more of our key personnel, or our failure to attract and retain other highly qualified personnel in the future, could harm our business. We currently depend on the continued services and performance of our key personnel, including Mark Zuckerberg and Sheryl K. Sandberg. Although we have entered into employment agreements with Mr. Zuckerberg and Ms. Sandberg, the agreements have no specific duration and constitute at-will employment. In addition, many of our key technologies and systems are custom-made for our business by our personnel. The loss of key personnel, including members of management as well as key engineering, product development, marketing, and sales personnel, could disrupt our operations and have an adverse effect on our business. As we continue to grow, we cannot guarantee we will continue to attract and retain the personnel we need to maintain our competitive position. In particular, we intend to continue to hire a significant number of technical personnel in the foreseeable future, and we expect to continue to face significant competition from other companies in hiring such personnel, particularly in the San Francisco Bay Area, where our headquarters are located and where the cost of living is high. As we continue to mature, the incentives to attract, retain, and motivate employees provided by our equity awards or by future arrangements may not be as effective as in the past, and if we issue significant equity to attract additional employees or to retain our existing employees, we would incur substantial additional share-based compensation expense and the ownership of our existing stockholders would be further diluted. Our ability to attract, retain, and motivate employees may also be adversely affected by stock price volatility. Additionally, we have a number of current employees whose equity ownership in our company has provided them a substantial amount of personal wealth, which could affect their decisions about whether or not to continue to work for us. As a result of these factors, it may be difficult for us to continue to retain and motivate our employees. If we do not succeed in attracting, hiring, and integrating excellent personnel, or retaining and motivating existing personnel, we may be unable to grow effectively. We may not be able to continue to successfully grow usage of and engagement with mobile and web applications that integrate with Facebook and our other products. We have made and are continuing to make investments to enable developers to build, grow, and monetize mobile and web applications that integrate with Facebook and our other products. Such existing and prospective developers may not be successful in building, growing, or monetizing mobile and/or web applications that create and maintain user engagement. Additionally, developers may choose to build on other platforms, including mobile platforms controlled by third parties, rather than building products that integrate with Facebook and our other products. We are continuously seeking to balance the distribution objectives of our developers with our desire to provide an optimal user experience, and we may not be successful in achieving a balance that continues to attract and retain such developers. For example, from time to time, we have taken actions to reduce the volume of communications from these developers to users on Facebook and our other products with the objective of enhancing the user experience, and such actions have reduced distribution from, user engagement with, and our monetization opportunities from, mobile and web applications integrated with our products. In some instances, these actions, as well as other actions to enforce our policies applicable to developers, have adversely affected our relationships with such developers. If we are not successful in our efforts to continue to grow the number of developers that choose to build products that integrate with Facebook and our other products or if we are unable to continue to build and maintain good relations with such developers, our user growth and user engagement and our financial results may be adversely affected. We currently generate substantially all of our Payments revenue from developers that use Facebook on personal computers, and we expect that our Payments revenue will continue to decline as usage of Facebook on personal computers continues to decline. We currently generate substantially all of our Payments revenue from developers that use Facebook on personal computers. Specifically, applications built by developers of social games are currently responsible for substantially all of our revenue derived from Payments, and the majority of the revenue from these applications has historically been generated by a limited number of the most popular games. We have experienced and expect to see the continued decline in usage of Facebook on personal computers, which we expect will result in a continuing decline in Payments revenue. In addition, only a relatively small percentage of our users have transacted with Facebook Payments. If the Facebook-integrated applications fail to grow or maintain their users and engagement, whether as a result of the continued decline in the usage of Facebook on personal computers or otherwise, if developers do not continue to introduce new applications that attract users and create engagement on Facebook, or if Facebook-integrated applications outside of social games do not gain popularity and generate significant revenue for us, our financial performance could be adversely affected. Payment transactions may subject us to additional regulatory requirements and other risks that could be costly and difficult to comply with or that could harm our business. Our users can purchase virtual and digital goods from developers that offer applications using our Payments infrastructure on the Facebook website. In addition, certain of our users can use our Payments infrastructure, including on Messenger, for other activities, such as sending money to other users and making donations to certain charitable organizations. We are subject to a variety of laws and regulations in the United States, Europe, and elsewhere, including those governing anti-money laundering and counter-terrorist financing, money transmission, gift cards and other prepaid access instruments, electronic funds transfer, charitable fundraising, and import and export restrictions. Depending on how our Payments product evolves, we may also be subject to other laws and regulations including those governing gambling, banking, and lending. In some jurisdictions, the application or interpretation of these laws and regulations is not clear. To increase flexibility in how our use of Payments may evolve and to mitigate regulatory uncertainty, we have received certain money transmitter licenses in the United States and an Electronic Money (E-Money) license that allows us to conduct certain regulated payment activities in the participating member countries of the European Economic Area, which will generally require us to demonstrate compliance with many domestic and foreign laws in these areas. Our efforts to comply with these laws and regulations could be costly and result in diversion of management time and effort and may still not guarantee compliance. In the event that we are found to be in violation of any such legal or regulatory requirements, we may be subject to monetary fines or other penalties such as a cease and desist order, or we may be required to make product changes, any of which could have an adverse effect on our business and financial results. In addition, we may be subject to a variety of additional risks as a result of Payments transactions, including: increased costs and diversion of management time and effort and other resources to deal with bad transactions or customer disputes; potential fraudulent or otherwise illegal activity by users, developers, employees, or third parties; restrictions on the investment of consumer funds used to transact Payments; and additional disclosure and reporting requirements. We have significant international operations and plan to continue expanding our operations abroad where we have more limited operating experience, and this may subject us to increased business and economic risks that could affect our financial results. We have significant international operations and plan to continue the international expansion of our business operations and the translation of our products. We currently make Facebook available in more than 100 different languages, and we have offices or data centers in more than 30 different countries. We may enter new international markets where we have limited or no experience in marketing, selling, and deploying our products. Our products are generally available globally through the web and on mobile, but some or all of our products or functionality may not be available in certain markets due to legal and regulatory complexities. For example, Facebook and certain of our other products are not generally available in China. We also outsource certain operational functions to third-party vendors globally. If we fail to deploy, manage, or oversee our international operations successfully, our business may suffer. In addition, we are subject to a variety of risks inherent in doing business internationally, including: political, social, or economic instability; risks related to legal, regulatory, and other government scrutiny applicable to U.S. companies with sales and operations in foreign jurisdictions, including with respect to privacy, tax, law enforcement, content, trade compliance, intellectual property, and terrestrial infrastructure matters; potential damage to our brand and reputation due to compliance with local laws, including potential censorship or requirements to provide user information to local authorities; fluctuations in currency exchange rates and compliance with currency controls; foreign exchange controls and tax and other regulations and orders that might prevent us from repatriating cash earned in countries outside the United States or otherwise limit our ability to move cash freely, and impede our ability to invest such cash efficiently; higher levels of credit risk and payment fraud; enhanced difficulties of integrating any foreign acquisitions; burdens of complying with a variety of foreign laws; reduced protection for intellectual property rights in some countries; difficulties in staffing, managing, and overseeing global operations and the increased travel, infrastructure, and legal compliance costs associated with multiple international locations; compliance with the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act, and similar laws in other jurisdictions; and compliance with statutory equity requirements and management of tax consequences. If we are unable to expand internationally and manage the complexity of our global operations successfully, our financial results could be adversely affected. We face design, manufacturing, and supply chain risks that, if not properly managed, could adversely impact our financial results. We face a number of risks related to design, manufacturing, and supply chain management with respect to our Oculus products. For example, the Oculus products we sell may have quality issues resulting from the design or manufacture of the products, or from the software used in the products. Sometimes, these issues may be caused by components we purchase from other manufacturers or suppliers. If the quality of our Oculus products does not meet our customers' expectations or such products are found to be defective, then our brand and financial results could be adversely affected. We rely on third parties to manufacture our Oculus products. We may experience supply shortages or other supply chain disruptions in the future that could result in shipping delays and negatively impact our operations. We could be negatively affected if we are not able to engage third parties with the necessary capabilities or capacity on reasonable terms, or if those we engage with fail to meet their obligations (whether due to financial difficulties or other reasons), or make adverse changes in the pricing or other material terms of such arrangements with them. We also require the suppliers and business partners of our Oculus products to comply with laws and certain company policies regarding sourcing practices and standards on labor, health and safety, the environment, and business ethics, but we do not control them or their practices and standards. If any of them violates laws or implements practices or standards regarded as unethical, corrupt, or non-compliant, we could experience supply chain disruptions, canceled orders, or damage to our reputation. In addition, the SECs conflict minerals rule requires disclosure by public companies of information relating to the origin, source and chain of custody of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured. We may incur significant costs associated with complying with the rule, such as costs related to the determination of the origin, source and chain of custody of the minerals used in Oculus products, the adoption of conflict minerals-related governance policies, processes and controls, and possible changes to products or sources of supply as a result of such activities. We may face inventory risk with respect to our Oculus products. We may be exposed to inventory risks with respect to our Oculus products as a result of rapid changes in product cycles and pricing, unsafe or defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to Oculus products, and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking products Oculus may sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new Oculus product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. Any one of these factors may adversely affect our operating results. We may have exposure to greater than anticipated tax liabilities. Our income tax obligations are based in part on our corporate operating structure and intercompany arrangements, including the manner in which we operate our business, develop, value, manage, protect, and use our intellectual property and the valuations of our intercompany transactions. We may also be subject to additional indirect or non-income taxes. The tax laws applicable to our business, including the laws of the United States and other jurisdictions, are subject to interpretation and certain jurisdictions are aggressively interpreting their laws in new ways in an effort to raise additional tax revenue from companies such as Facebook. The taxing authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could increase our worldwide effective tax rate and harm our financial position, results of operations, and cash flows. For example, in 2016, the IRS issued us a formal assessment relating to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year, and although we disagree with the IRS's position and are contesting this issue, the ultimate resolution is uncertain and, if resolved in a manner unfavorable to us, may adversely affect our financial results. We are subject to regular review and audit by U.S. federal and state, and foreign tax authorities. Tax authorities may disagree with certain positions we have taken and any adverse outcome of such a review or audit could have a negative effect on our financial position, results of operations, and cash flows. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain. Our provision for income taxes is also determined by the manner in which we operate our business, and any changes to such operations or laws applicable to such operations may affect our effective tax rate. Changes in accounting for intercompany transactions may also affect our effective tax rate. For example, with the adoption of Accounting Standards Update No. 2016-16, effective January 1, 2018, the income tax effects of an intercompany transfer will be recognized in the period in which the transfer occurs, rather than amortized over time, which may increase the impact of such transfers on our effective tax rate in a particular period. Although we believe that our provision for income taxes is reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. In addition, our future income tax rates could be adversely affected by earnings being lower than anticipated in jurisdictions that have lower statutory tax rates and higher than anticipated in jurisdictions that have higher statutory tax rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws, regulations, or accounting principles. For example, we have previously incurred losses in certain international subsidiaries that resulted in an effective tax rate that is significantly higher than the statutory tax rate in the United States and this could continue to happen in the future. Changes in tax laws or tax rulings could materially affect our financial position, results of operations, and cash flows. The income and non-income tax regimes we are subject to or operate under are unsettled and may be subject to significant change. Changes in tax laws or tax rulings, or changes in interpretations of existing laws, could materially affect our financial position, results of operations, and cash flows. For example, changes to U.S. tax laws enacted in December 2017 had a significant impact on our tax obligations and effective tax rate for the fourth quarter of 2017. In addition, many countries in Europe, as well as a number of other countries and organizations, have recently proposed or recommended changes to existing tax laws or have enacted new laws that could significantly increase our tax obligations in many countries where we do business or require us to change the manner in which we operate our business. The Organization for Economic Cooperation and Development has been working on a Base Erosion and Profit Shifting Project, and issued in 2015, and is expected to continue to issue, guidelines and proposals that may change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. The European Commission has conducted investigations in multiple countries focusing on whether local country tax rulings or tax legislation provides preferential tax treatment that violates European Union state aid rules and concluded that certain countries, including Ireland, have provided illegal state aid in certain cases. These investigations may result in changes to the tax treatment of our foreign operations. Due to the large and expanding scale of our international business activities, many of these types of changes to the taxation of our activities could increase our worldwide effective tax rate and harm our financial position, results of operations, and cash flows. Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax rate. The 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted on December 22, 2017, and significantly affected U.S. tax law by changing how the U.S. imposes income tax on multinational corporations. The U.S. Department of Treasury has broad authority to issue regulations and interpretative guidance that may significantly impact how we will apply the law and impact our results of operations in the period issued. The Tax Act requires complex computations not previously provided in U.S. tax law. As such, the application of accounting guidance for such items is currently uncertain. Further, compliance with the Tax Act and the accounting for such provisions require accumulation of information not previously required or regularly produced. As a result, we have provided a provisional estimate on the effect of the Tax Act in our financial statements. As additional regulatory guidance is issued by the applicable taxing authorities, as accounting treatment is clarified, as we perform additional analysis on the application of the law, and as we refine estimates in calculating the effect, our final analysis, which will be recorded in the period completed, may be different from our current provisional amounts, which could materially affect our tax obligations and effective tax rate. We cannot guarantee that our share repurchase program will be fully consummated or that it will enhance long-term stockholder value. Share repurchases could also increase the volatility of the trading price of our stock and could diminish our cash reserves. In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion of our Class A common stock that commenced in 2017 and does not have an expiration date. Although our board of directors has authorized this share repurchase program, the program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares. We cannot guarantee that the program will be fully consummated or that it will enhance long-term stockholder value. The program could affect the trading price of our stock and increase volatility, and any announcement of a termination of this program may result in a decrease in the trading price of our stock. In addition, this program could diminish our cash reserves. Risks Related to Ownership of Our Class A Common Stock The trading price of our Class A common stock has been and will likely continue to be volatile. The trading price of our Class A common stock has been, and is likely to continue to be, volatile. Since shares of our Class A common stock were sold in our IPO in May 2012 at a price of $38.00 per share, our stock price has ranged from $17.55 to $184.25 through December 31, 2017. In addition to the factors discussed in this Annual Report on Form 10-K, the trading price of our Class A common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including: actual or anticipated fluctuations in our revenue and other operating results; the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; actions of securities analysts who initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors; additional shares of our stock being sold into the market by us, our existing stockholders, or in connection with acquisitions, or the anticipation of such sales; investor sentiment with respect to our competitors, our business partners, and our industry in general; announcements by us or our competitors of significant products or features, technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments; announcements by us or estimates by third parties of actual or anticipated changes in the size of our user base, the level of user engagement, or the effectiveness of our ad products; changes in operating performance and stock market valuations of technology companies in our industry, including our developers and competitors; price and volume fluctuations in the overall stock market, including as a result of trends in the economy as a whole; the inclusion, exclusion, or deletion of our stock from any trading indices, such as the SP 500 Index; media coverage of our business and financial performance; lawsuits threatened or filed against us; developments in anticipated or new legislation and pending lawsuits or regulatory actions, including interim or final rulings by tax, judicial, or regulatory bodies; trading activity in our share repurchase program; and other events or factors, including those resulting from war or incidents of terrorism, or responses to these events. In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation in connection with our IPO. We may experience more such litigation following future periods of volatility. Any securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business. We do not intend to pay cash dividends for the foreseeable future. We have never declared or paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any cash dividends in the foreseeable future. As a result, you may only receive a return on your investment in our Class A common stock if the trading price of your shares increases. The dual class structure of our common stock and a voting agreement between certain stockholders have the effect of concentrating voting control with our CEO and certain other holders of our Class B common stock; this will limit or preclude your ability to influence corporate matters. Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. Stockholders who hold shares of Class B common stock, including certain of our executive officers, employees, and directors and their affiliates, together hold a substantial majority of the voting power of our outstanding capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, the holders of our Class B common stock collectively control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval so long as the shares of Class B common stock represent at least 9.1% of all outstanding shares of our Class A and Class B common stock. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future. Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning or charitable purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term. If, for example, Mr. Zuckerberg retains a significant portion of his holdings of Class B common stock for an extended period of time, he could, in the future, continue to control a majority of the combined voting power of our outstanding capital stock. Our status as a ""controlled company"" could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Because we qualify as a ""controlled company"" under the corporate governance rules for Nasdaq-listed companies, we are not required to have a majority of our board of directors be independent, nor are we required to have a compensation committee or an independent nominating function. In light of our status as a controlled company, our board of directors determined not to have a separate and independent nominating function and chose to have the full board of directors be directly responsible for nominating members of our board, and in the future we could elect not to have a majority of our board of directors be independent or not to have a compensation committee. Accordingly, should the interests of our controlling stockholder differ from those of other stockholders, the other stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance rules for Nasdaq-listed companies. Our status as a controlled company could make our Class A common stock less attractive to some investors or otherwise harm our stock price. Delaware law and provisions in our restated certificate of incorporation and bylaws could make a merger, tender offer, or proxy contest difficult, thereby depressing the trading price of our Class A common stock. Our status as a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay, or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our current restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult, including the following: until the first date on which the outstanding shares of our Class B common stock represent less than 35% of the combined voting power of our common stock, any transaction that would result in a change in control of our company requires the approval of a majority of our outstanding Class B common stock voting as a separate class; we currently have a dual class common stock structure, which provides Mr. Zuckerberg with the ability to control the outcome of matters requiring stockholder approval, even if he owns significantly less than a majority of the shares of our outstanding Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of common stock, certain amendments to our restated certificate of incorporation or bylaws will require the approval of two-thirds of the combined vote of our then-outstanding shares of Class A and Class B common stock; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, vacancies on our board of directors will be able to be filled only by our board of directors and not by stockholders; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our board of directors will be classified into three classes of directors with staggered three-year terms and directors will only be able to be removed from office for cause; when the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock, our stockholders will only be able to take action at a meeting of stockholders and not by written consent; only our chairman, our chief executive officer, our president, or a majority of our board of directors are authorized to call a special meeting of stockholders; advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders; our restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established, and shares of which may be issued, without stockholder approval; and certain litigation against us can only be brought in Delaware. ", Item 1B. Unresolved Staff Comments None. ," Item 2. Properties Our corporate headquarters are located in Menlo Park, California. As of December 31, 2017 , we owned and leased approximately three million square feet of office buildings for our corporate headquarters, and 130 acres of land to be developed to accommodate anticipated future growth. In addition, we leased offices around the world totaling approximately five million square feet. We also own and lease data centers throughout the United States and in various locations internationally. Further, we entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. As such, we have excluded the square footage from the total leased space and owned properties, disclosed above. We believe that our facilities are adequate for our current needs. "," Item 3. Legal Proceedings Beginning on May 22, 2012, multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the United States and in other jurisdictions against us, our directors, and/or certain of our officers alleging violation of securities laws or breach of fiduciary duties in connection with our initial public offering (IPO) and seeking unspecified damages. We believe these lawsuits are without merit, and we intend to continue to vigorously defend them. The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO, were ordered centralized for coordinated or consolidated pre-trial proceedings in the U.S. District Court for the Southern District of New York. In a series of rulings in 2013 and 2014, the court denied our motion to dismiss the consolidated securities class action and granted our motions to dismiss the derivative actions against our directors and certain of our officers. On July 24, 2015, the court of appeals affirmed the dismissal of the derivative actions. On December 11, 2015, the court granted plaintiffs' motion for class certification in the consolidated securities action. On April 14, 2017, we filed a motion for summary judgment. Trial is scheduled to begin on February 26, 2018. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. We are also involved in other legal proceedings, claims, and regulatory, tax or government inquiries and investigations arising from the ordinary course of our business, and we may in the future be subject to additional lawsuits and disputes. "," Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information for Common Stock Our Class A common stock has been listed on the Nasdaq Global Select Market under the symbol ""FB"" since May 18, 2012. Prior to that time, there was no public market for our stock. The following table sets forth for the indicated periods the high and low intra-day sales prices per share for our Class A common stock on the Nasdaq Global Select Market. High Low High Low First Quarter $ 142.95 $ 115.51 $ 117.59 $ 89.37 Second Quarter $ 156.50 $ 138.81 $ 121.08 $ 106.31 Third Quarter $ 175.49 $ 147.80 $ 131.98 $ 112.97 Fourth Quarter $ 184.25 $ 168.29 $ 133.50 $ 113.55 Our Class B common stock is not listed nor traded on any stock exchange. Holders of Record As of December 31, 2017 , there were 3,967 stockholders of record of our Class A common stock, and the closing price of our Class A common stock was $176.46 per share as reported on the Nasdaq Global Select Market. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2017 , there were 52 stockholders of record of our Class B common stock. Dividend Policy We have never declared or paid any cash dividend on our common stock. We intend to retain any future earnings and do not expect to pay cash dividends in the foreseeable future. Purchases of Equity Securities by the Issuer and Affiliated Purchasers The following table summarizes the share repurchase activity for the three months ended December 31, 2017 : Total Number of Shares Purchased (1) Average Price Paid Per Share (2) Total Number of Shares Purchased as Part of Publicly Announced Programs (1) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands) (in thousands) (in millions) October 1 31, 2017 1,008 $ 172.19 1,008 $ 4,788 November 1 30, 2017 $ $ 4,788 December 1 31, 2017 4,832 $ 177.64 4,832 $ 3,930 5,840 5,840 (1) In November 2016, our board of directors authorized a share repurchase program of up to $6.0 billion of our Class A common stock, which commenced in January 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Exchange Act. (2) Average price paid per share includes costs associated with the repurchases. Recent Sale of Unregistered Securities and Use of Proceeds Recent Sale of Unregistered Securities None. Stock Performance Graph This performance graph shall not be deemed ""soliciting material"" or to be ""filed"" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Facebook, Inc. under the Securities Act of 1933, as amended, or the Exchange Act. The following graph shows a comparison from May 18, 2012 (the date our Class A common stock commenced trading on the Nasdaq Global Select Market) through December 31, 2017 of the cumulative total return for our Class A common stock, the Standard Poor's 500 Stock Index (SP 500 Index) and the Nasdaq Composite Index (Nasdaq Composite). The graph assumes that $100 was invested at the market close on May 18, 2012 in the Class A common stock of Facebook, Inc., the SP 500 Index and the Nasdaq Composite and data for the SP 500 Index and the Nasdaq Composite assumes reinvestments of gross dividends. The stock price performance of the following graph is not necessarily indicative of future stock price performance. "," Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, ""Risk Factors."" For a discussion of limitations in the measurement of certain of our user metrics, see the section entitled ""Limitations of Key Metrics and Other Data"" in this Annual Report on Form 10-K. Certain revenue information in the section entitled "" Revenue Foreign Exchange Impact on Revenue"" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the full year 2017 using 2016 monthly exchange rates for our settlement currencies other than the U.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Full Year 2017 Results Our key user metrics and financial results for 2017 are as follows: User growth: Daily active users (DAUs) were 1.40 billion on average for December 2017 , an increase of 14% year-over-year. Monthly active users (MAUs) were 2.13 billion as of December 31, 2017 , an increase of 14% year-over-year. Financial results: Revenue was $40.65 billion , up 47% year-over-year, and ad revenue was $39.94 billion , up 49% year-over-year. Total costs and expenses were $20.45 billion . Income from operations was $20.20 billion . Net income was $15.93 billion with diluted earnings per share of $5.39 . Capital expenditures were $6.73 billion . Effective tax rate was 23% . Cash and cash equivalents, and marketable securities were $41.71 billion as of December 31, 2017 . Headcount was 25,105 as of December 31, 2017 . In 2017 , we continued to focus on our three main revenue growth priorities: (i) helping businesses expand their use of our mobile products, (ii) developing innovative ad products that help businesses get the most of their ad campaigns, and (iii) making our ads more relevant and effective through our targeting capabilities and outcome-based measurement. We continued to invest, based on our roadmap, in: (i) our most developed ecosystem, the Facebook app and platform as well as video, (ii) driving growth and building ecosystems around our products and features that already have significant user bases, such as Instagram, Messenger, and WhatsApp, and (iii) long-term technology initiatives, such as connectivity, artificial intelligence, and augmented and virtual reality, that we believe will further our mission to give people the power to build community and bring the world closer together. We intend to continue to invest based on this roadmap and we anticipate that additional investments in the following areas will drive significant year-over-year expense growth in 2018: (i) increased investments in security, video content, and our long-term technology initiatives, and (ii) scaling our headcount and expanding our data center capacity and office facilities to support our growth. Trends in Our User Metrics The numbers for our key metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated. Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement. Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. Worldwide DAUs increased 14% to 1.40 billion on average during December 2017 from 1.23 billion during December 2016 . Users in India, Indonesia, and Brazil represented key sources of growth in DAUs during December 2017, relative to the same period in 2016. Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community. As of December 31, 2017 , we had 2.13 billion MAUs, an increase of 14% from December 31, 2016 . Users in India, Indonesia, and Vietnam represented key sources of growth in 2017 , relative to the same period in 2016. Trends in Our Monetization by User Geography We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or virtual reality platform devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. Revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2017 in the United States Canada region was more than nine times higher than in the Asia-Pacific region. Note: Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue by geography disclosure in our consolidated financial statements where revenue is geographically apportioned based on the location of the marketer or developer. For 2017 , worldwide ARPU was $20.21 , an increase of 26% from 2016 . Over this period, ARPU increased by 41% in Europe, 36% in United States Canada, 33% in Rest of World, and 22% in Asia-Pacific. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as Asia-Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that the assumptions and estimates associated with income taxes, loss contingencies, and business combinations and valuation of goodwill and other acquired intangible assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1 Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K. Income Taxes We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We record a provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, we consider the accounting of the transition tax, deferred tax re-measurements, and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SAB 118. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount of loss. The outcome of litigation is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 9 Commitments and Contingencies and Note 12 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Business Combinations and Valuation of Goodwill and Other Acquired Intangible Assets We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives, and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2017 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized over their estimated useful lives. We evaluate the recoverability of our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. In addition to the recoverability assessment, we routinely review the remaining estimated useful lives of our finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance would be amortized over the revised estimated useful life. Components of Results of Operations Revenue Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. We calculate price per ad as total ad revenue divided by the number of ads delivered, representing the effective price paid per impression by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the primary obligor, we recognize revenue on a net basis. Payments and other fees. Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Our other fees revenue, which has not been significant in recent periods, consists primarily of revenue from the delivery of virtual reality platform devices, and various other sources. Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including content acquisition costs, credit card and other transaction fees related to processing customer transactions, cost of virtual reality platform device inventory sold, and amortization of intangible assets. Research and development. Research and development expenses consist primarily of share-based compensation, salaries, and benefits for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We expense all of our research and development costs as they are incurred. Marketing and sales. Our marketing and sales expenses consist of salaries, share-based compensation, and benefits for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include marketing and promotional expenditures, professional services such as content reviewers, as well as amortization of intangible assets. General and administrative. The majority of our general and administrative expenses consist of salaries, benefits, and share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees. In addition, general and administrative expenses include legal-related costs and professional services. Results of Operations The following tables set forth our consolidated statements of income data: Year Ended December 31, (in millions) Consolidated Statements of Income Data: Revenue $ 40,653 $ 27,638 $ 17,928 Costs and expenses: Cost of revenue 5,454 3,789 2,867 Research and development 7,754 5,919 4,816 Marketing and sales 4,725 3,772 2,725 General and administrative 2,517 1,731 1,295 Total costs and expenses 20,450 15,211 11,703 Income from operations 20,203 12,427 6,225 Interest and other income (expense), net (31 ) Income before provision for income taxes 20,594 12,518 6,194 Provision for income taxes 4,660 2,301 2,506 Net income $ 15,934 $ 10,217 $ 3,688 Share-based compensation expense included in costs and expenses: Year Ended December 31, (in millions) Cost of revenue $ $ $ Research and development 2,820 2,494 2,350 Marketing and sales General and administrative Total share-based compensation expense $ 3,723 $ 3,218 $ 2,969 The following tables set forth our consolidated statements of income data (as a percentage of revenue): Year Ended December 31, Consolidated Statements of Income Data: Revenue % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % Share-based compensation expense included in costs and expenses (as a percentage of revenue): Year Ended December 31, Cost of revenue % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % Revenue Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (in millions) Advertising $ 39,942 $ 26,885 $ 17,079 % % Payments and other fees (6 )% (11 )% Total revenue $ 40,653 $ 27,638 $ 17,928 % % 2017 Compared to 2016 . Revenue in 2017 increased $13.02 billion , or 47% , compared to 2016 . The increase was mostly due to an increase in advertising revenue, partially offset by the continuing decline in Payments revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For 2017 , we estimate that mobile advertising revenue represented approximately 88% of total advertising revenue, as compared with approximately 83% in 2016 . Factors that influenced our advertising revenue growth in 2017 included (i) an increase in average price per ad, (ii) an increase in users and their engagement, and (iii) an increase in the number and frequency of ads displayed on mobile devices. We anticipate that advertising revenue growth will continue to be driven primarily by price rather than increases in the number and frequency of ads displayed. In 2017 compared to 2016 , the average price per ad increased by 29%, as compared with approximately 5% in 2016, and the number of ads delivered increased by 15%, as compared with approximately 50% in 2016. The increase in average price per ad was driven by an increase in demand for our ad inventory; factors contributing to this include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. The increase in the ads delivered was driven by an increase in users and their engagement and an increase in the number and frequency of ads displayed on News Feed, partially offset by increasing user engagement with video content and other product changes. Advertising spending is traditionally seasonally strong in the fourth quarter of each year. We believe that this seasonality in advertising spending affects our quarterly results, which generally reflect significant growth in advertising revenue between the third and fourth quarters and a decline in advertising spending between the fourth and subsequent first quarters. For instance, our advertising revenue increased 26%, 27%, and 31% between the third and fourth quarters of 2017 , 2016 , and 2015 , respectively, while advertising revenue for both the first quarters of 2017 and 2016 declined 9% and 8% compared to the fourth quarters of 2016 and 2015 , respectively. Payments and other fees revenue in 2017 decreased $42 million , or 6% , compared to 2016 . The decline in Payments and other fees revenue was primarily due to decreased Payments revenue from games played on personal computers, partially offset by the revenue from the delivery of virtual reality platform devices. We anticipate Payments revenue will continue to decline, and such decline will be offset by increases in revenue from various other sources. 2016 Compared to 2015 . Revenue in 2016 increased $9.71 billion, or 54%, compared to 2015. The increase was mostly due to an increase in advertising revenue. The most important factor driving advertising revenue growth was an increase in revenue from ads in News Feed. For 2016, we estimate that mobile advertising revenue represented approximately 83% of total advertising revenue, as compared with approximately 77% in 2015. Factors that influenced our advertising revenue growth in 2016 included (i) an increase in demand for our ad inventory, in part driven by an increase in the number of marketers actively advertising on Facebook, (ii) an increase in user growth and engagement, and (iii) an increase in the number and frequency of ads displayed in News Feed, as well as the quality, relevance, and performance of those ads. In 2016 compared to 2015, the average price per ad increased by 5% and the number of ads delivered increased by 50%. The increase in average price per ad was driven by a continued mix shift towards a greater percentage of our ads being shown in News Feed while the increase in the ads delivered was driven by the same factors that influenced our advertising growth. Payments and other fees revenue in 2016 decreased $96 million, or 11%, compared to 2015. The majority of the decrease in Payments and other fees revenue was due to decreased Payments revenue from games played on personal computers. No customer represented 10% or more of total revenue during the years ended December 31, 2017 , 2016 , and 2015 . Foreign Exchange Impact on Revenue The general weakening of the U.S. dollar relative to certain foreign currencies in the full year 2017 compared to the same period in 2016 had a favorable impact on our revenue. If we had translated revenue for the full year 2017 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $40.36 billion and $39.65 billion , respectively. Using these constant rates, revenue and advertising revenue would have been $293 million and $292 million lower than actual revenue and advertising revenue, respectively, for the full year 2017 . The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2016 compared to the same period in 2015 had an unfavorable impact on our revenue. If we had translated revenue for the full year 2016 using 2015 monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $27.91 billion and $27.15 billion, respectively. Using these constant rates, revenue and advertising revenue would have been $270 million and $269 million higher than actual revenue and advertising revenue, respectively, for the full year 2016. Cost of revenue Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Cost of revenue $ 5,454 $ 3,789 $ 2,867 % % Percentage of revenue % % % 2017 Compared to 2016 . Cost of revenue in 2017 increased $1.67 billion , or 44% , compared to 2016 . The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with partnership agreements, including content acquisition costs, and ads payment processing. 2016 Compared to 2015 . Cost of revenue in 2016 increased $922 million, or 32%, compared to 2015. The majority of the increase was due to an increase in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with ads payment processing and various partnership agreements. In 2018 , we anticipate that the cost of revenue will increase as we continue to expand our data center capacity and technical infrastructure to support user growth, increased user engagement, and the delivery of new products and services and, to a lesser extent, due to higher costs associated with ads payment processing and various partnership agreements. Research and development Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Research and development $ 7,754 $ 5,919 $ 4,816 % % Percentage of revenue % % % 2017 Compared to 2016 . Research and development expenses in 2017 increased $1.84 billion , or 31% , compared to 2016 . The majority of the increase was due to an increase in payroll and benefits as a result of a 49% growth in employee headcount from December 31, 2016 to December 31, 2017 in engineering and other technical functions, partially offset by a $262 million decrease in share-based compensation related to the acquisitions completed in 2014. 2016 Compared to 2015 . Research and development expenses in 2016 increased $1.10 billion, or 23%, compared to 2015. The majority of the increase was due to an increase in payroll and benefits as a result of a 34% growth in employee headcount from December 31, 2015 to December 31, 2016 in engineering and other technical functions. Additionally, our equipment and related expenses in 2016 to support our research and development efforts increased $170 million compared to 2015. In 2018 , we plan to continue to hire software engineers and other technical employees, and to increase our investment to support our research and development initiatives. Marketing and sales Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Marketing and sales $ 4,725 $ 3,772 $ 2,725 % % Percentage of revenue % % % 2017 Compared to 2016 . Marketing and sales expenses in 2017 increased $953 million , or 25% , compared to 2016 . The majority of the increase was due to increases in payroll and benefits expenses as a result of a 35% increase in employee headcount from December 31, 2016 to December 31, 2017 in our marketing and sales functions, and increases in our consulting and other professional service fees. Additionally, our marketing expenses increased $196 million in 2017, compared to 2016. 2016 Compared to 2015 . Marketing and sales expenses in 2016 increased $1.05 billion, or 38%, compared to 2015. The majority of the increase was due to payroll and benefits expenses as a result of a 28% increase in employee headcount from December 31, 2015 to December 31, 2016 in our marketing and sales functions, and increases in our consulting and other professional service fees. Additionally, our marketing expenses increased $344 million in 2016, compared to 2015. In 2018 , we plan to continue the hiring of marketing and sales employees to support our marketing, sales, and partnership efforts and to increase our investment in security efforts through the hiring of employees and content reviewers. General and administrative Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) General and administrative $ 2,517 $ 1,731 $ 1,295 % % Percentage of revenue % % % 2017 Compared to 2016 . General and administrative expenses in 2017 increased $786 million , or 45% , compared to 2016 . The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 58% increase in employee headcount from December 31, 2016 to December 31, 2017 in general and administrative functions, and to a lesser extent, higher legal-related costs. 2016 Compared to 2015 . General and administrative expenses in 2016 increased $436 million, or 34%, compared to 2015. The majority of the increase was due to an increase in payroll and benefits expenses as a result of a 43% increase in employee headcount from December 31, 2015 to December 31, 2016 in general and administrative functions, and to a lesser extent, higher professional services and legal fees. In 2018 , we plan to continue to increase general and administrative expenses to support overall company growth. Interest and other income (expense), net Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (in millions) Interest income, net $ $ $ 136% NM Other expense, net (1 ) (75 ) (60 ) 99% (25)% Interest and other income (expense), net $ $ $ (31 ) NM NM 2017 Compared to 2016 . Interest and other income, net in 2017 increased $300 million compared to 2016 . The majority of the increase in 2017 was due to an increase in interest income driven by higher invested cash balances and interest rates. In addition, foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities also contributed to the increase in 2017. 2016 Compared to 2015 . Interest and other income (expense), net in 2016 increased $122 million compared to 2015. Interest income, net increased mostly due to increases in interest income driven by higher invested cash balances and interest rates. In addition, the majority of the increase in other expense, net was due to foreign exchange impact resulting from the periodic re-measurement of our foreign currency assets and liabilities. Provision for income taxes Year Ended December 31, 2017 vs 2016 % Change 2016 vs 2015 % Change (dollars in millions) Provision for income taxes $ 4,660 $ 2,301 $ 2,506 % (8 )% Effective tax rate % % % 2017 Compared to 2016 . Our provision for income taxes in 2017 increased $2.36 billion , or 103% , compared to 2016 , mostly due to the effects of the Tax Act that was enacted on December 22, 2017 and an increase in income before provision for income taxes, partially offset by an increase in excess tax benefits recognized from share-based compensation. As a result of the Tax Act, we recognized a one-time mandatory transition tax on accumulated foreign subsidiary earnings, remeasured our U.S. deferred tax assets and liabilities, and reassessed the net realizability of our deferred tax assets and liabilities, which increased our provision for income taxes in 2017 by $2.27 billion. Our effective tax rate in 2017 increased compared to 2016, mostly due to the Tax Act and a decrease in the tax rate benefit from share-based compensation compared to 2016. These effects were partially offset by an increase in income before provision for income taxes being earned in jurisdictions with tax rates lower than the U.S. statutory tax rate. In 2017, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $1.25 billion and our effective tax rate by six percentage points as compared to the tax rate without such benefits. For comparison, in 2016, excess tax benefits recognized from share-based compensation decreased our provision for income taxes by $934 million and our effective tax rate by seven percentage points, as compared to the tax rate without such benefits. 2016 Compared to 2015 . Our provision for income taxes in 2016 decreased $205 million , or 8% , compared to 2015 , primarily due to recognition of excess tax benefits from share-based compensation in our provision for income taxes resulting from the adoption of ASU 2016-09, partially offset by an increase in income before provision for income taxes. Our effective tax rate in 2016 decreased compared to 2015 due to more of our income before provision for income taxes being earned in jurisdictions with a tax rate lower than the U.S. statutory rate where we had asserted our intention to indefinitely reinvest certain of those earnings, as well as due to a lower increase in our unrecognized tax benefit in 2016 compared to 2015 and the adoption of ASU 2016-09 in 2016. Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, changes to our provisional accounting for the effects of the Tax Act during the measurement period, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the impact of new legislation. The portion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions. Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods. The accounting for share-based compensation will increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return which depends upon the stock price at the time of employee award vesting. Absent unanticipated events and unexpected effects of the Tax Act, we anticipate our effective tax rate in 2018 will be lower than it was in 2017. Our 2017 effective tax rate was significantly affected by the Tax Act. In addition, since we recognize excess tax benefits on a discrete basis, we anticipate that our effective tax rate will vary from quarter to quarter depending on our stock price in each period. If our stock price remains constant to the January 31, 2018 price, we anticipate that our effective tax rate will be lower in the first quarter of 2018 and increase in the remaining quarters throughout the year. Unrecognized Tax Benefits. As of December 31, 2017, we had net unrecognized tax benefits of $2.75 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties with our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a significant impact to such amounts within the next 12 months. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated aggregate amount of approximately $3.0 billion to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability of $3.0 billion to $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and penalties. If the IRS prevails in the assessment of additional tax due based on its position, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. As of December 31, 2017, we have not resolved this matter and proceedings continue in the United States Tax Court. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. We expect to continue to accrue unrecognized tax benefits for certain recurring tax positions and anticipate that the amount for future quarters accrued will be similar to amounts accrued in 2017. Absent unanticipated events, we do not expect our unrecognized tax benefits will have a significant impact on our effective tax rate in 2018. Quarterly Results of Operations Data The following tables set forth our unaudited quarterly consolidated statements of income data in dollars and as a percentage of total revenue for each of the eight quarters in the period ended December 31, 2017 . We have prepared the quarterly consolidated statements of income data on a basis consistent with the audited consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. In the opinion of management, the financial information reflects all adjustments, consisting only of normal recurring adjustments, which we consider necessary for a fair presentation of this data. This information should be read in conjunction with the audited consolidated financial statements and related notes included in Part II, Item 8, ""Financial Statements and Supplementary Data"" in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period. Three Months Ended Dec 31, 2017 Sep 30, Jun 30, Mar 31, Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (in millions) Consolidated Statements of Income Data: Revenue: Advertising $ 12,779 $ 10,142 $ 9,164 $ 7,857 $ 8,629 $ 6,816 $ 6,239 $ 5,201 Payments and other fees Total revenue 12,972 10,328 9,321 8,032 8,809 7,011 6,436 5,382 Costs and expenses: Cost of revenue 1,611 1,448 1,237 1,159 1,047 Research and development 1,949 2,052 1,919 1,834 1,563 1,542 1,471 1,343 Marketing and sales 1,374 1,170 1,124 1,057 1,118 General and administrative Total costs and expenses 5,620 5,206 4,920 4,705 4,243 3,894 3,702 3,372 Income from operations 7,352 5,122 4,401 3,327 4,566 3,117 2,734 2,010 Interest and other income (expense), net (33 ) Income before provision for income taxes 7,462 5,236 4,488 3,408 4,533 3,164 2,754 2,066 Provision for income taxes 3,194 Net income $ 4,268 $ 4,707 $ 3,894 $ 3,064 $ 3,568 $ 2,627 $ 2,283 $ 1,738 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 4,266 $ 4,704 $ 3,890 $ 3,059 $ 3,561 $ 2,620 $ 2,276 $ 1,732 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 1.47 $ 1.62 $ 1.34 $ 1.06 $ 1.24 $ 0.91 $ 0.80 $ 0.61 Diluted $ 1.44 $ 1.59 $ 1.32 $ 1.04 $ 1.21 $ 0.90 $ 0.78 $ 0.60 Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (in millions) Cost of revenue $ $ $ $ $ $ $ $ Research and development Marketing and sales General and administrative Total share-based compensation expense $ $ 1,010 $ 1,032 $ $ $ $ $ 48 Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (as a percentage of total revenue) Consolidated Statements of Income Data: Revenue: Advertising % % % % % % % % Payments and other fees Total revenue % % % % % % % % Costs and expenses: Cost of revenue Research and development Marketing and sales General and administrative Total costs and expenses Income from operations Interest and other income (expense), net Income before provision for income taxes Provision for income taxes Net income % % % % % % % % Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders % % % % % % % % Share-based compensation expense included in costs and expenses: Three Months Ended Dec 31, 2017 Sep 30, 2017 Jun 30, 2017 Mar 31, 2017 Dec 31, 2016 Sep 30, 2016 Jun 30, 2016 Mar 31, 2016 (as a percentage of total revenue) Cost of revenue % % % % % % % % Research and development Marketing and sales General and administrative Total share-based compensation expense % % % % % % % % Liquidity and Capital Resources Year Ended December 31, (in millions) Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 24,216 $ 16,108 $ 10,320 Net cash used in investing activities (20,038 ) (11,739 ) (9,434 ) Net cash used in financing activities (5,235 ) (310 ) (139 ) Purchases of property and equipment (6,733 ) (4,491 ) (2,523 ) Depreciation and amortization 3,025 2,342 1,945 Share-based compensation 3,723 3,218 2,960 Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents, and marketable securities consist primarily of cash on deposit with banks, investments in money market funds, and investments in U.S. government securities, U.S. government agency securities, and corporate debt securities. Cash and cash equivalents, and marketable securities were $41.71 billion as of December 31, 2017 , an increase of $12.26 billion from December 31, 2016 , mostly due to $24.22 billion of cash generated from operations, partially offset by $6.73 billion for purchases of property and equipment, $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion for repurchases of our Class A common stock. Cash paid for income taxes (net of refunds) was $2.12 billion for the year ended December 31, 2017 . We recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings which we intend to pay over an eight-year payment schedule as prescribed by the Tax Act. In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable on May 20, 2021. As of December 31, 2017 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. In November 2016, our board of directors authorized a $6.0 billion share repurchase program of our Class A common stock that commenced in 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During 2017, we repurchased and subsequently retired approximately 13 million shares of our Class A common stock for an aggregate amount of approximately $2.07 billion . In January 2017, we began funding withholding taxes due on employee equity awards by net share settlement, rather than our previous approach of requiring employees to sell shares of our common stock to cover taxes upon vesting of such awards. In 2017, we paid $3.25 billion of taxes related to the net share settlement of equity awards. As of December 31, 2017 , $15.89 billion of the $41.71 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates U.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during 2017 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.72 billion and total depreciation and amortization of $3.03 billion . The increase in cash flow from operating activities during 2017 compared to 2016 , was mostly due to an increase in net income, adjusted for certain non-cash items, such as depreciation and amortization and share-based compensation expense. Due to the enactment of the Tax Act in 2017, we recorded a provisional tax liability of $2.9 billion relating to the one-time mandatory transition tax on our accumulated foreign earnings,which also contributed to the increase in 2017 compared to 2016. Cash flow from operating activities during 2016 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $3.22 billion and total depreciation and amortization of $2.34 billion. The increase in cash flow from operating activities during 2016 compared to 2015, was mostly due to an increase in net income, including the impact of ASU 2016-09 adoption, as adjusted for depreciation and amortization, deferred income taxes, and share-based compensation expense. Cash flow from operating activities during 2015 mostly consisted of net income, adjusted for certain non-cash items, such as share-based compensation expense of $2.96 billion, total depreciation and amortization of $1.95 billion, and tax benefit from share-based award activity of $1.72 billion , which had been reclassified from financing activity as a result of ASU 2016-09 adoption. The increase in cash flow from operating activities during 2015 compared to 2014, was primarily due to an increase in net income, as adjusted for share-based compensation expense, and higher income tax payable as of December 31, 2015 compared to 2014. Cash Used in Investing Activities Cash used in investing activities during 2017 mostly resulted from $13.25 billion for net purchases of marketable securities and $6.73 billion for capital expenditures as we continued to invest in servers, data centers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2017 compared to 2016 was due to increases in net purchases of marketable securities and capital expenditures. Cash used in investing activities during 2016 mostly resulted from $7.19 billion for net purchases of marketable securities and $4.49 billion for capital expenditures as we continued to invest in data centers, servers, office buildings, and network infrastructure. The increase in cash used in investing activities during 2016 compared to 2015 was mostly due to increases in capital expenditures and net purchases of marketable securities. Cash used in investing activities during 2015 primarily resulted from $6.70 billion for net purchases of marketable securities and $2.52 billion for capital expenditures as we continued to invest in servers, data centers, network infrastructure, and office buildings. The increase in cash used in investing activities during 2015 compared to 2014 was mainly due to increases in net purchases of marketable securities, partially offset by a decrease in acquisitions of businesses and purchases of intangible assets. We anticipate making capital expenditures in 2018 of approximately $14.0 billion to $15.0 billion. Cash Used in Financing Activities Cash used in financing activities during 2017 mostly consisted of $3.25 billion of taxes paid related to net share settlement of equity awards, and $1.98 billion paid for repurchases of our Class A common stock. The increase in cash used in financing activities during 2017 compared to 2016 was mostly due to taxes paid related to net share settlement of equity awards and repurchases of our Class A common stock that commenced in 2017 . Cash used in financing activities during 2016 mostly consisted of principal payments on capital lease and other financing obligations. The increase in cash used in financing activities was due to full repayment of our capital lease and other financing obligations in 2016. Cash used in financing activities during 2015 primarily consisted of principal payments on capital lease obligations. The decrease in cash used in financing activities was primarily due to lower principal payments related to our capital lease transactions. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of December 31, 2017 . Contractual Obligations Our principal commitments consist of obligations under operating leases for offices, land, facilities, colocations, and data centers, as well as contractual commitments related to network infrastructure and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as of December 31, 2017 (in millions): Payment Due by Period Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Operating lease obligations $ 4,644 $ $ $ $ 2,423 Financing obligation - building in progress - leased facility (1) Other contractual commitments (2) 2,953 1,830 Total contractual obligations $ 7,792 $ 2,239 $ 1,296 $ 1,008 $ 3,249 (1) Financing obligation - building in progress - leased facility represents our commitments to lease certain office buildings that are currently under construction. As of December 31, 2017 , $72 million of the total obligation was recorded as a liability and is included in other liabilities on our consolidated balance sheets. See Note 9 of the accompanying notes to our consolidated financial statements for additional information related to this financing obligation. (2) Other contractual commitments primarily relate to network infrastructure and our data center operations. As part of the normal course of the business, we may enter into multi-year agreements to purchase certain network components that do not specify a fixed or minimum price commitment or to purchase renewable energy that do not specify a fixed or minimum volume commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately $4.0 billion. The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. In addition, our other liabilities include $2.75 billion related to uncertain tax positions as of December 31, 2017 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 9 Commitments and Contingencies and Note 12 Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" and Part I, Item 3, ""Legal Proceedings"" of this Annual Report on Form 10-K for additional information regarding these contingencies. Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date , which delays the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08) which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition method. We finalized our analysis and the adoption of this guidance will not have a material impact on our consolidated financial statements and our internal controls over financial reporting. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for us in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. We will adopt the new standard effective January 1, 2019. We have selected a lease accounting system and we are in the process of implementing such system as well as evaluating the use of the optional practical expedients. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, we expect our operating leases, as disclosed in Note 9 Commitments and Contingencies in the accompanying notes to the consolidated financial statements included in Part II, Item 8, ""Financial Statements and Supplementary Data"" of this Annual Report on Form 10-K, will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date. A cumulative-effect adjustment will capture the write-off of income tax consequences deferred from past intra-entity transfers involving assets other than inventory, new deferred tax assets, and other liabilities for amounts not currently recognized under U.S. GAAP. Based on transactions up to December 31, 2017, we do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We will adopt the new standard effective January 1, 2018, using the retrospective transition approach for all periods presented. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ( ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We will adopt the new standard effective January 1, 2018, on a prospective basis and do not expect the standard to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. "," Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and inflation. Foreign Currency Exchange Risk We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. In general, we are a net receiver of currencies other than the U.S. dollar. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have in the past, and may in the future, negatively affect our revenue and other operating results as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing certain current asset and current liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. We recognized foreign currency losses of $6 million , $76 million , and $66 million in 2017 , 2016 , and 2015 , respectively. Interest Rate Sensitivity Our exposure to changes in interest rates relates primarily to interest earned and market value on our cash and cash equivalents, and marketable securities. Our cash and cash equivalents and marketable securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash and cash equivalents and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in interest rates would have resulted in a decrease of $611 million and $403 million in the market value of our available-for-sale debt securities as of December 31, 2017 and December 31, 2016 , respectively. Any realized gains or losses resulting from such interest rate changes would only occur if we sold the investments prior to maturity. "," Item 8. Financial Statements and Supplementary Data FACEBOOK, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm Consolidated Financial Statements: Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Comprehensive Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements The supplementary financial information required by this Item 8, is included in Part II, Item 7 under the caption ""Quarterly Results of Operations Data,"" which is incorporated herein by reference. Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Facebook, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Facebook, Inc. (the Company) as of December 31, 2017 and 2016 , and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017 , and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2017 and 2016 , and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 , in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 1, 2018 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Ernst Young LLP We have served as the Companys auditor since 2007. San Francisco, California February 1, 2018 Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors of Facebook, Inc. Opinion on Internal Control over Financial Reporting We have audited Facebook, Inc.s internal control over financial reporting as of December 31, 2017 , based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Facebook, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017 , based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Facebook, Inc. as of December 31, 2017 and 2016 , and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017 of the Company and our report dated February 1, 2018 expressed an unqualified opinion thereon. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst Young LLP San Francisco, California February 1, 2018 FACEBOOK, INC. CONSOLIDATED BALANCE SHEETS (In millions, except for number of shares and par value) December 31, Assets Current assets: Cash and cash equivalents $ 8,079 $ 8,903 Marketable securities 33,632 20,546 Accounts receivable, net of allowances of $189 and $94 as of December 31, 2017 and 2016, respectively 5,832 3,993 Prepaid expenses and other current assets 1,020 Total current assets 48,563 34,401 Property and equipment, net 13,721 8,591 Intangible assets, net 1,884 2,535 Goodwill 18,221 18,122 Other assets 2,135 1,312 Total assets $ 84,524 $ 64,961 Liabilities and stockholders' equity Current liabilities: Accounts payable $ $ Partners payable Accrued expenses and other current liabilities 2,892 2,203 Deferred revenue and deposits Total current liabilities 3,760 2,875 Other liabilities 6,417 2,892 Total liabilities 10,177 5,767 Commitments and contingencies Stockholders' equity: Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,397 million and 2,354 million shares issued and outstanding, as of December 31, 2017 and December 31, 2016, respectively; 4,141 million Class B shares authorized, 509 million and 538 million shares issued and outstanding, as of December 31, 2017 and December 31, 2016, respectively. Additional paid-in capital 40,584 38,227 Accumulated other comprehensive loss (227 ) (703 ) Retained earnings 33,990 21,670 Total stockholders' equity 74,347 59,194 Total liabilities and stockholders' equity $ 84,524 $ 64,961 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF INCOME (In millions, except per share amounts) Year Ended December 31, Revenue $ 40,653 $ 27,638 $ 17,928 Costs and expenses: Cost of revenue 5,454 3,789 2,867 Research and development 7,754 5,919 4,816 Marketing and sales 4,725 3,772 2,725 General and administrative 2,517 1,731 1,295 Total costs and expenses 20,450 15,211 11,703 Income from operations 20,203 12,427 6,225 Interest and other income (expense), net (31 ) Income before provision for income taxes 20,594 12,518 6,194 Provision for income taxes 4,660 2,301 2,506 Net income $ 15,934 $ 10,217 $ 3,688 Less: Net income attributable to participating securities Net income attributable to Class A and Class B common stockholders $ 15,920 $ 10,188 $ 3,669 Earnings per share attributable to Class A and Class B common stockholders: Basic $ 5.49 $ 3.56 $ 1.31 Diluted $ 5.39 $ 3.49 $ 1.29 Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders: Basic 2,901 2,863 2,803 Diluted 2,956 2,925 2,853 Share-based compensation expense included in costs and expenses: Cost of revenue $ $ $ Research and development 2,820 2,494 2,350 Marketing and sales General and administrative Total share-based compensation expense $ 3,723 $ 3,218 $ 2,969 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In millions) Year Ended December 31, Net income $ 15,934 $ 10,217 $ 3,688 Other comprehensive income (loss): Change in foreign currency translation adjustment, net of tax (152 ) (202 ) Change in unrealized gain/loss on available-for-sale investments and other, net of tax (90 ) (96 ) (25 ) Comprehensive income $ 16,410 $ 9,969 $ 3,461 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In millions) Class A and Class B Common Stock Additional Paid-In Capital Accumulated Other Comprehensive Loss Retained Earnings Total Stockholders' Equity Shares Par Value Balances at December 31, 2014 2,797 $ $ 30,225 $ (228 ) $ 6,099 $ 36,096 Issuance of common stock for cash upon exercise of stock options Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (20 ) (20 ) Share-based compensation, related to employee share-based awards 2,960 2,960 Tax benefit from share-based award activity 1,721 1,721 Other comprehensive loss (227 ) (227 ) Net income 3,688 3,688 Balances at December 31, 2015 2,845 34,886 (455 ) 9,787 44,218 Cumulative-effect adjustment from adoption of ASU 2016-09 1,666 1,705 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (6 ) (6 ) Share-based compensation, related to employee share-based awards 3,218 3,218 Other comprehensive loss (248 ) (248 ) Net income 10,217 10,217 Balances at December 31, 2016 2,892 38,227 (703 ) 21,670 59,194 Issuance of common stock for cash upon exercise of stock options Issuance of common stock related to acquisitions Issuance of common stock for settlement of RSUs Shares withheld related to net share settlement (21 ) (1,702 ) (1,544 ) (3,246 ) Share-based compensation, related to employee share-based awards 3,723 3,723 Share repurchases (13 ) (2,070 ) (2,070 ) Other comprehensive income Net income 15,934 15,934 Balances at December 31, 2017 2,906 $ $ 40,584 $ (227 ) $ 33,990 $ 74,347 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Cash flows from operating activities Net income $ 15,934 $ 10,217 $ 3,688 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,025 2,342 1,945 Share-based compensation 3,723 3,218 2,960 Deferred income taxes (377 ) (457 ) (795 ) Tax benefit from share-based award activity 1,721 Other Changes in assets and liabilities: Accounts receivable (1,609 ) (1,489 ) (973 ) Prepaid expenses and other current assets (192 ) (159 ) (144 ) Other assets (3 ) Accounts payable Partners payable Accrued expenses and other current liabilities 1,014 Deferred revenue and deposits (9 ) Other liabilities 3,083 1,262 1,365 Net cash provided by operating activities 24,216 16,108 10,320 Cash flows from investing activities Purchases of property and equipment (6,733 ) (4,491 ) (2,523 ) Purchases of marketable securities (25,682 ) (22,341 ) (15,938 ) Sales of marketable securities 9,444 13,894 6,928 Maturities of marketable securities 2,988 1,261 2,310 Acquisitions of businesses, net of cash acquired, and purchases of intangible assets (122 ) (123 ) (313 ) Change in restricted cash and deposits Net cash used in investing activities (20,038 ) (11,739 ) (9,434 ) Cash flows from financing activities Taxes paid related to net share settlement of equity awards (3,246 ) (6 ) (20 ) Principal payments on capital lease and other financing obligations (312 ) (119 ) Repurchases of Class A common stock (1,976 ) Other financing activities, net (13 ) Net cash used in financing activities (5,235 ) (310 ) (139 ) Effect of exchange rate changes on cash and cash equivalents (63 ) (155 ) Net (decrease) increase in cash and cash equivalents (824 ) 3,996 Cash and cash equivalents at beginning of period 8,903 4,907 4,315 Cash and cash equivalents at end of period $ 8,079 $ 8,903 $ 4,907 See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions) Year Ended December 31, Supplemental cash flow data Cash paid during the period for: Interest $ $ $ Income taxes, net $ 2,117 $ 1,210 $ Non-cash investing and financing activities: Net change in accounts payable, accrued expenses and other current liabilities, and other liabilities related to property and equipment additions $ $ $ Promissory note payable issued in connection with an acquisition $ $ $ Settlement of acquisition-related contingent consideration liability $ $ $ Change in unsettled repurchases of Class A common stock $ $ $ See Accompanying Notes to Consolidated Financial Statements. FACEBOOK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Organization and Description of Business Facebook was incorporated in Delaware in July 2004. Our mission is to give people the power to build community and bring the world closer together. We generate substantially all of our revenue from advertising. Basis of Presentation We prepared the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The consolidated financial statements include the accounts of Facebook, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated. Use of Estimates Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, collectability of accounts receivable, commitments and contingencies, fair value of financial instruments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, leases, and income taxes. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates. Revenue Recognition We recognize revenue once all of the following criteria have been met: persuasive evidence of an arrangement exists; delivery of our obligations to our customer has occurred; the price is fixed or determinable; and collectability of the related receivable is reasonably assured. Revenue for the years ended December 31, 2017 , 2016 , and 2015 consists of the following (in millions): Year Ended December 31, Advertising $ 39,942 $ 26,885 $ 17,079 Payments and other fees Total revenue $ 40,653 $ 27,638 $ 17,928 Advertising Advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party affiliated websites or mobile applications. The arrangements are evidenced by either online acceptance of terms and conditions or contracts that stipulate the types of advertising to be delivered, the timing and the pricing. Marketers pay for ad products either directly or through their relationships with advertising agencies, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the primary obligor, we recognize revenue on a net basis. Payments and Other Fees Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Other fees revenue, which was not material for all periods presented in our financial statements, consists primarily of revenue from the delivery of virtual reality platform devices and various other sources. Revenue is recognized net of applicable sales and other taxes. Cost of Revenue Our cost of revenue consists primarily of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers, such as facility and server equipment depreciation, salaries, benefits, and share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including content acquisition costs, credit card and other transaction fees related to processing customer transactions, cost of virtual reality platform device inventory sold, and amortization of intangible assets. Content acquisition costs We license and pay to produce content in order to increase engagement on the platform. For licensed content, we capitalize the fee per title and record a corresponding liability at the gross amount of the liability when the license period begins, the cost of the title is known and the title is accepted and available for viewing. The amounts capitalized are limited to estimated net realizable value or fair value on a per title basis. The portion available for viewing within one year is recognized as prepaid expenses and other current assets and the remaining portion as other assets on the consolidated balance sheets. For original programming, we capitalize costs associated with the production, including development costs and direct costs, if those amounts are recoverable. Capitalized original programming costs are included in other assets on the consolidated balance sheets. Capitalized costs are amortized in cost of revenue on the consolidated statements of income based on historical and estimated viewing patterns. Capitalized content costs are reviewed when an event or change in circumstances indicates a change in the expected usefulness of the content or that the fair value may be less than amortized cost. If such changes are identified, capitalized content assets will be stated at the lower of unamortized cost, net realizable value or fair value. In addition, unamortized costs for assets that have been, or are expected to be, abandoned are written off. Capitalized content acquisition costs have not been material to date. Income Taxes We record provision for income taxes for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred income tax assets and liabilities for the expected future consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as for loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize the deferred income tax effects of a change in tax rates in the period of the enactment. We record a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing tax planning strategies in assessing the need for a valuation allowance. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate arms-length prices. Similarly, our estimates related to uncertain tax positions concerning research tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial position, results of operations, and cash flows. On December 22, 2017, the 2017 Tax Cuts and Jobs Act (the Tax Act) was enacted into law and the new legislation contains several key tax provisions that affected us, including a one-time mandatory transition tax on accumulated foreign earnings and a reduction of the corporate income tax rate to 21% effective January 1, 2018, among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation is expected over the next 12 months, we consider the accounting of the transition tax, deferred tax re-measurements, and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SAB 118. See Note 12 in these notes to the consolidated financial statements for additional information. Advertising Expense Advertising costs are expensed when incurred and are included in marketing and sales expenses in the accompanying consolidated statements of income. We incurred advertising expenses of $324 million , $310 million , and $281 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Cash and Cash Equivalents, and Marketable Securities Cash and cash equivalents primarily consist of cash on deposit with banks and investments in money market funds with maturities of 90 days or less from the date of purchase. We hold investments in marketable securities, consisting of U.S. government securities, U.S. government agency securities, and corporate debt securities . We classify our marketable securities as available-for-sale investments in our current assets because they represent investments of cash available for current operations. Our available-for-sale investments are carried at estimated fair value with any unrealized gains and losses, net of taxes, included in accumulated other comprehensive (loss) income in stockholders' equity. Unrealized losses are charged against interest and other income (expense), net when a decline in fair value is determined to be other-than-temporary. We have not recorded any such impairment charge in the periods presented. We determine realized gains or losses on sale of marketable securities on a specific identification method, and record such gains or losses as interest and other income (expense), net. We classify certain restricted cash balances within prepaid expenses and other current assets and other assets on the accompanying consolidated balance sheets based upon the term of the remaining restrictions. Fair Value of Financial Instruments We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as risks inherent in valuation techniques, transfer restrictions and credit risk. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement: Level 1 -Quoted prices in active markets for identical assets or liabilities. Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 -Inputs that are generally unobservable and typically reflect management's estimate of assumptions that market participants would use in pricing the asset or liability. Our valuation techniques used to measure the fair value of money market funds and marketable debt securities were derived from quoted market prices or alternative pricing sources and models utilizing market observable inputs. Our valuation technique used to measure the fair value of our contingent consideration liability as of December 31, 2016 was derived from the fair value of our common stock on such date. We settled this contingent consideration liability in July 2017. Accounts Receivable and Allowances Accounts receivable are recorded and carried at the original invoiced amount less an allowance for any potential uncollectible amounts. We make estimates for the allowance for doubtful accounts and allowance for unbilled receivables based upon our assessment of various factors, including historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect our ability to collect from customers. Property and Equipment Property and equipment, which includes amounts recorded under capital leases, are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of property and equipment are described below: Property and Equipment Useful Life Network equipment Three to 20 years Buildings Three to 30 years Computer software, office equipment and other Two to five years Leased equipment and leasehold improvements Lesser of estimated useful life or remaining lease term Land and assets held within construction in progress are not depreciated. Construction in progress is related to the construction or development of property and equipment that have not yet been placed in service for their intended use. The cost of maintenance and repairs is expensed as incurred. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in income from operations. Lease Obligations We enter into lease arrangements for office space, land, facilities, data centers, and equipment under non-cancelable capital and operating leases. Certain of the operating lease agreements contain rent holidays, rent escalation provisions, and purchase options. Rent holidays and rent escalation provisions are considered in determining the straight-line rent expense to be recorded over the lease term. The lease term begins on the date of initial possession of the leased property for purposes of recognizing lease expense on a straight-line basis over the term of the lease. We do not assume renewals in our determination of the lease term unless the renewals are deemed to be reasonably assured at lease inception. We record assets and liabilities for the estimated construction costs incurred by third parties under build-to-suit lease arrangements to the extent that we are involved in the construction of structural improvements or bear construction risk prior to commencement of a lease. Loss Contingencies We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be estimated, we disclose the possible loss in the notes to the consolidated financial statements. We review the developments in our contingencies that could affect the amount of the provisions that has been previously recorded, and the matters and related possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired users, acquired technology, and trade names from a market participant perspective, useful lives and discount rates. Managements estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Long-Lived Assets, Including Goodwill and Other Acquired Intangible Assets We evaluate the recoverability of property and equipment and finite-lived intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any significant impairment charges during the years presented. We review goodwill for impairment at least annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of our single reporting unit below its carrying value. As of December 31, 2017 , no impairment of goodwill has been identified. Acquired finite-lived intangible assets are amortized on a straight-line basis over the estimated useful lives of the assets. We routinely review the remaining estimated useful lives of property and equipment and finite-lived intangible assets. If we reduce the estimated useful life assumption for any asset, the remaining unamortized balance is amortized or depreciated over the revised estimated useful life. Deferred Revenue and Deposits Deferred revenue consists of billings and payments from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users. Once this balance is utilized by a user, approximately 70% of this amount would then be payable to the developer and the balance would be recognized as revenue. Deferred revenue and deposits consists of the following (in millions): December 31, Deferred revenue $ $ Deposits Total deferred revenue and deposits $ $ Foreign Currency Generally the functional currency of our international subsidiaries is the local currency. We translate the financial statements of these subsidiaries to U.S. dollars using month-end rates of exchange for assets and liabilities, and average rates of exchange for revenue, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive (loss) income as a component of stockholders' equity. As of December 31, 2017 and 2016 , we had a cumulative translation loss, net of tax of $16 million and $582 million , respectively. Net losses resulting from foreign exchange transactions were $6 million , $76 million , and $66 million for the years ended December 31, 2017 , 2016 , and 2015 , respectively. These losses were recorded as interest and other income (expense), net in our consolidated statements of income. Credit Risk and Concentration Our financial instruments that are potentially subject to concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash, marketable securities, and accounts receivable. The majority of cash equivalents consists of short-term money market funds, which are managed by reputable financial institutions. Marketable securities consist of investments in U.S. government securities, U.S. government agency securities, and corporate debt securities . Our investment policy limits investment instruments to U.S. government securities, U.S. government agency securities, and corporate debt securities with the main objective of preserving capital and maintaining liquidity. Accounts receivable are typically unsecured and are derived from revenue earned from customers across different industries and countries. We generated 44% , 46% , and 47% of our revenue for the years ended December 31, 2017 , 2016 , and 2015 , respectively, from marketers and developers based in the United States, with the majority of revenue outside of the United States coming from customers located in western Europe, China, Canada, Australia, and Brazil. We perform ongoing credit evaluations of our customers, and generally do not require collateral. We maintain an allowance for estimated credit losses. During the years ended December 31, 2017 , 2016 , and 2015 , our bad debt expenses were $48 million , $66 million , and $44 million , respectively. In the event that accounts receivable collection cycles deteriorate, our operating results and financial position could be adversely affected. No customer represented 10% or more of total revenue during the years ended December 31, 2017 , 2016 , and 2015 . Segments Our chief operating decision-maker is our Chief Executive Officer who makes resource allocation decisions and assesses performance based on financial information presented on a consolidated basis. There are no segment managers who are held accountable by the chief operating decision-maker, or anyone else, for operations, operating results, and planning for levels or components below the consolidated unit level. Accordingly, we have determined that we have a single reportable segment and operating segment structure. Recent Accounting Pronouncements Not Yet Adopted In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09), which amends the existing accounting standards for revenue recognition. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date , which delays the effective date of ASU 2014-09 by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date. In March 2016, the FASB issued Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (ASU 2016-08) which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition method. We finalized our analysis and the adoption of this guidance will not have a material impact on our consolidated financial statements and our internal controls over financial reporting. In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for us in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. We will adopt the new standard effective January 1, 2019. We have selected a lease accounting system and we are in the process of implementing such system as well as evaluating the use of the optional practical expedients. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, we expect our operating leases, as disclosed in Note 9 Commitments and Contingencies, will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities. In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We will adopt the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date. A cumulative-effect adjustment will capture the write-off of income tax consequences deferred from past intra-entity transfers involving assets other than inventory, new deferred tax assets, and other liabilities for amounts not currently recognized under U.S. GAAP. Based on transactions up to December 31, 2017, we do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We will adopt the new standard effective January 1, 2018, using the retrospective transition approach for all periods presented. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business ( ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We will adopt the new standard effective January 1, 2018, on a prospective basis and do not expect the standard to have a material impact on our consolidated financial statements. In January 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04), which eliminates step two from the goodwill impairment test. Under ASU 2017-04, an entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit. This guidance will be effective for us in the first quarter of 2020 on a prospective basis, and early adoption is permitted. We do not expect the standard to have a material impact on our consolidated financial statements. Note 2. Earnings per Share We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase. For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, such as awards under our equity compensation plans and inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding. RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the years ended December 31, 2017 , 2016 , and 2015 , respectively. Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights. The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts): Year Ended December 31, Class A Class B Class A Class B Class A Class B Basic EPS: Numerator Net income $ 13,034 $ 2,900 $ 8,270 $ 1,947 $ 2,959 $ Less: Net income attributable to participating securities Net income attributable to common stockholders $ 13,022 $ 2,898 $ 8,246 $ 1,942 $ 2,944 $ Denominator Weighted average shares outstanding 2,375 2,323 2,259 Less: Shares subject to repurchase Number of shares used for basic EPS computation 2,373 2,317 2,249 Basic EPS $ 5.49 $ 5.49 $ 3.56 $ 3.56 $ 1.31 $ 1.31 Diluted EPS: Numerator Net income attributable to common stockholders $ 13,022 $ 2,898 $ 8,246 $ 1,942 $ 2,944 $ Reallocation of net income attributable to participating securities Reallocation of net income as a result of conversion of Class B to Class A common stock 2,898 1,942 Reallocation of net income to Class B common stock (13 ) Net income attributable to common stockholders for diluted EPS $ 15,934 $ 2,885 $ 10,217 $ 1,956 $ 3,688 $ Denominator Number of shares used for basic EPS computation 2,373 2,317 2,249 Conversion of Class B to Class A common stock Weighted average effect of dilutive securities: Employee stock options RSUs Shares subject to repurchase and other Number of shares used for diluted EPS computation 2,956 2,925 2,853 Diluted EPS $ 5.39 $ 5.39 $ 3.49 $ 3.49 $ 1.29 $ 1.29 Note 3. Cash and Cash Equivalents, and Marketable Securities The following table sets forth the cash and cash equivalents, and marketable securities (in millions): December 31, Cash and cash equivalents: Cash $ 2,212 $ 1,364 Money market funds 5,268 5,409 U.S. government securities 1,463 U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Total cash and cash equivalents 8,079 8,903 Marketable securities: U.S. government securities 12,766 7,130 U.S. government agency securities 10,944 7,411 Corporate debt securities 9,922 6,005 Total marketable securities 33,632 20,546 Total cash and cash equivalents, and marketable securities $ 41,711 $ 29,449 The gross unrealized gains or losses on our marketable securities as of December 31, 2017 and 2016 were not significant. In addition, the gross unrealized loss that had been in a continuous loss position for 12 months or longer was not significant as of December 31, 2017 and 2016 . As of December 31, 2017 , we considered the decreases in market value on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. The following table classifies our marketable securities by contractual maturities (in millions): December 31, Due in one year $ 7,976 $ 4,966 Due in one to five years 25,656 15,580 Total $ 33,632 $ 20,546 Note 4. Fair Value Measurement The following table summarizes, for assets or liabilities measured at fair value, the respective fair value and the classification by level of input within the fair value hierarchy (in millions): Fair Value Measurement at Reporting Date Using Description December 31, 2017 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Cash equivalents: Money market funds $ 5,268 $ 5,268 $ $ U.S. government securities U.S. government agency securities Certificate of deposits and time deposits Corporate debt securities Marketable securities: U.S. government securities 12,766 12,766 U.S. government agency securities 10,944 10,944 Corporate debt securities 9,922 9,922 Total cash equivalents and marketable securities $ 39,499 $ 29,069 $ 10,430 $ Fair Value Measurement at Reporting Date Using Description December 31, 2016 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3 Cash equivalents: Money market funds $ 5,409 $ 5,409 $ $ U.S. government securities 1,463 1,463 U.S. government agency securities Marketable securities: U.S. government securities 7,130 7,130 U.S. government agency securities 7,411 7,411 Corporate debt securities 6,005 6,005 Total cash equivalents and marketable securities $ 28,085 $ 22,080 $ 6,005 $ Accrued expenses and other current liabilities: Contingent consideration liability $ $ $ We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value. In July 2017, we settled our Level 2 contingent consideration liability that was outstanding as of December 31, 2016. Note 5. Property and Equipment Property and equipment consists of the following (in millions): December 31, Land $ $ Buildings 4,909 3,109 Leasehold improvements Network equipment 7,998 5,179 Computer software, office equipment and other Construction in progress 2,992 1,890 Total 18,337 11,803 Less: Accumulated depreciation (4,616 ) (3,212 ) Property and equipment, net $ 13,721 $ 8,591 Depreciation expense on property and equipment was $2.33 billion , $1.59 billion , and $1.22 billion during 2017 , 2016 , and 2015 , respectively. Property and equipment as of December 31, 2017 and 2016 includes $533 million and $283 million , respectively, acquired under capital lease agreements, of which a substantial majority, is included in network equipment. Accumulated depreciation of property and equipment acquired under these capital leases was $101 million and $30 million at December 31, 2017 and 2016 , respectively. Construction in progress includes costs mostly related to construction of data centers, office buildings, and network equipment infrastructure to support our data centers around the world. The construction of office buildings includes leased office spaces for which we are considered to be the owner for accounting purposes. See Note 9 in these notes to the consolidated financial statements for additional information. No interest was capitalized during the years ended December 31, 2017 , 2016 and 2015 . Note 6. Goodwill and Intangible Assets During the year ended December 31, 2017 , we completed several business acquisitions that were not material to our consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the year ended December 31, 2017 have not been presented. We have included the financial results of these business acquisitions in our consolidated financial statements from their respective dates of acquisition. Goodwill generated from all business acquisitions completed during the year ended December 31, 2017 was primarily attributable to expected synergies from future growth and potential monetization opportunities. The amount of goodwill generated during this period that was deductible for tax purposes was not material. The changes in the carrying amount of goodwill for the years ended December 31, 2017 and 2016 are as follows (in millions): Balance as of December 31, 2015 $ 18,026 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2016 $ 18,122 Goodwill acquired Effect of currency translation adjustment Balance as of December 31, 2017 $ 18,221 Intangible assets consist of the following (in millions): December 31, 2017 December 31, 2016 Weighted-Average Remaining Useful Lives (in years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Acquired users 3.8 $ 2,056 $ (971 ) $ 1,085 $ 2,056 $ (678 ) $ 1,378 Acquired technology 1.8 (711 ) (518 ) Acquired patents 5.7 (499 ) (420 ) Trade names 2.2 (406 ) (293 ) Other 2.7 (133 ) (119 ) Total intangible assets 3.6 $ 4,604 $ (2,720 ) $ 1,884 $ 4,563 $ (2,028 ) $ 2,535 Amortization expense of intangible assets for the years ended December 31, 2017 , 2016 , and 2015 was $692 million , $751 million , and $730 million , respectively. As of December 31, 2017 , expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions): $ 2019 2020 2021 2022 Thereafter Total $ 1,884 Note 7. Liabilities The components of accrued expenses and other current liabilities are as follows (in millions): December 31, Accrued compensation and benefits $ $ Accrued property and equipment Accrued taxes payable Contingent consideration liability Other current liabilities 1,201 Accrued expenses and other current liabilities $ 2,892 $ 2,203 The components of other liabilities are as follows (in millions): December 31, Income tax payable $ 5,372 $ 2,431 Other liabilities 1,045 Other liabilities $ 6,417 $ 2,892 Note 8. Long-term Debt In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of December 31, 2017 , no amounts had been drawn down and we were in compliance with the covenants under the facility. Note 9. Commitments and Contingencies Commitments Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, land, facilities, colocations, and data centers with original lease periods expiring between 2018 and 2038 . We are committed to pay a portion of the related actual operating expenses under certain of these lease agreements. Certain of these arrangements have free rent periods or escalating rent payment provisions, and we recognize rent expense under such arrangements on a straight-line basis. The following is a schedule, by years, of the future minimum lease payments required under non-cancelable operating leases as of December 31, 2017 (in millions): Operating Leases Financing obligation, building in progress - leased facilities (1) $ $ 464 2020 2021 2022 Thereafter 2,423 Total minimum lease payments $ 4,644 $ (1) We entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. Financing obligation, building in progress - leased facilities represent the total expected financing and lease obligations associated with these leases and will be settled through monthly lease payments to the landlords when we occupy the office spaces upon completion. This amount includes $72 million that is included in property and equipment, net and other liabilities on our consolidated balance sheets as of December 31, 2017 . Operating lease expense was $363 million , $269 million , and $196 million for the years ended December 31, 2017 , 2016 and 2015 , respectively. We fully repaid all our capital lease obligations during 2016. Other contractual commitments We also have $2.95 billion of non-cancelable contractual commitments as of December 31, 2017 , primarily related to network infrastructure and our data center operations. These commitments are primarily due within five years . Contingencies Legal Matters Beginning on May 22, 2012, multiple putative class actions, derivative actions, and individual actions were filed in state and federal courts in the United States and in other jurisdictions against us, our directors, and/or certain of our officers alleging violation of securities laws or breach of fiduciary duties in connection with our initial public offering (IPO) and seeking unspecified damages. We believe these lawsuits are without merit, and we intend to continue to vigorously defend them. The vast majority of the cases in the United States, along with multiple cases filed against The NASDAQ OMX Group, Inc. and The Nasdaq Stock Market LLC (collectively referred to herein as NASDAQ) alleging technical and other trading-related errors by NASDAQ in connection with our IPO, were ordered centralized for coordinated or consolidated pre-trial proceedings in the U.S. District Court for the Southern District of New York. In a series of rulings in 2013 and 2014, the court denied our motion to dismiss the consolidated securities class action and granted our motions to dismiss the derivative actions against our directors and certain of our officers. On July 24, 2015, the court of appeals affirmed the dismissal of the derivative actions. On December 11, 2015, the court granted plaintiffs' motion for class certification in the consolidated securities action. On April 14, 2017, we filed a motion for summary judgment. Trial is scheduled to begin on February 26, 2018. In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. Although we believe that it is reasonably possible that we may incur a loss in some of these cases, we are currently unable to estimate the amount of such losses. We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these matters, we evaluate the developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. We believe that the amount or any estimable range of reasonably possible or probable loss will not, either individually or in the aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. For information regarding income tax contingencies, see Note 12 Income Taxes. Indemnifications In the normal course of business, to facilitate transactions of services and products, we have agreed to indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made by third parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers, directors, and certain employees, and our certificate of incorporation and bylaws contain similar indemnification obligations. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our consolidated financial position, results of operations or cash flows. In our opinion, as of December 31, 2017 , there was not at least a reasonable possibility we had incurred a material loss with respect to indemnification of such parties. We have not recorded any liability for costs related to indemnification through December 31, 2017 . Note 10. Stockholders' Equity Common Stock Our certificate of incorporation authorizes the issuance of Class A common stock and Class B common stock. As of December 31, 2017 , we are authorized to issue 5,000 million shares of Class A common stock and 4,141 million shares of Class B common stock, each with a par value of $0.000006 per share. Holders of our Class A common stock and Class B common stock are entitled to dividends when, as and if, declared by our board of directors, subject to the rights of the holders of all classes of stock outstanding having priority rights to dividends. As of December 31, 2017 , we have not declared any dividends and our credit facility contains restrictions on our ability to pay dividends. The holder of each share of Class A common stock is entitled to one vote, while the holder of each share of Class B common stock is entitled to ten votes. Shares of our Class B common stock are convertible into an equivalent number of shares of our Class A common stock and generally convert into shares of our Class A common stock upon transfer. Class A common stock and Class B common stock are referred to as common stock throughout the notes to these financial statements, unless otherwise noted. As of December 31, 2017 , there were 2,397 million shares and 509 million shares of Class A common stock and Class B common stock, respectively, issued and outstanding. Abandonment of the Reclassification In September 2017, our board of directors decided to abandon the proposal to create a new class of non-voting capital stock (Class C capital stock) and the intention to issue a dividend of two shares of Class C capital stock for each outstanding share of Class A and Class B common stock (the Reclassification). As a result, we will not proceed with the filing of our amended and restated certificate of incorporation which was approved by our stockholders on June 20, 2016. Share Repurchase Program In November 2016, our board of directors authorized a $6.0 billion share repurchase program of our Class A common stock, which commenced in 2017 and does not have an expiration date. The timing and actual number of shares repurchased depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2017 , we repurchased and subsequently retired approximately 13 million shares of our Class A common stock for an aggregate amount of approximately $2.07 billion . Share-based Compensation Plans We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended in June 2016 (2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan. We initially reserved 25 million shares of our Class A common stock for issuance under our 2012 Plan. The number of shares reserved for issuance under our 2012 Plan increases automatically on January 1 of each of the calendar years during the term of the 2012 Plan, which will continue through and including April 2026 unless terminated earlier by our board of directors or a committee thereof, by a number of shares of Class A common stock equal to the lesser of (i) 2.5% of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors. Pursuant to this automatic increase provision, our board of directors elected not to increase the number of shares reserved for issuance in 2017 and 2016, and approved an increase of 42 million shares reserved for issuance effective as of January 1, 2018. In addition, shares available for grant under the 2005 Stock Plan, which were reserved but not issued, forfeited or repurchased at their original issue price, or subject to outstanding awards under the 2005 Stock Plan as of the effective date of our IPO, were added to the reserves of the 2012 Plan and shares that are withheld in connection with the net settlement of RSUs are also added to the reserves of the 2012 Plan. The following table summarizes the activities of stock option awards under the Stock Plans for the year ended December 31, 2017 : Shares Subject to Options Outstanding Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term Aggregate Intrinsic Value ( 1) (in thousands) (in years) (in millions) Balance as of December 31, 2016 5,687 $ 7.78 Stock options exercised (2,609 ) 5.10 Balance as of December 31, 2017 3,078 $ 10.06 2.4 $ Stock options exercisable as of December 31, 2017 2,765 $ 9.50 2.3 $ (1) The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the official closing price of our Class A common stock of $176.46 , as reported on the Nasdaq Global Select Market on December 31, 2017 . There were no options granted, forfeited, or canceled for the year ended December 31, 2017 . The aggregate intrinsic value of the options exercised in the years ended December 31, 2017 , 2016 , and 2015 was $359 million , $309 million , and $403 million , respectively. The total grant date fair value of stock options vested during the years ended December 31, 2017 , 2016 , and 2015 was not material. The following table summarizes additional information regarding outstanding and exercisable options under the Stock Plans at December 31, 2017 : Options Outstanding Options Exercisable Exercise Price Number of Shares Weighted Average Remaining Contractual Term Weighted Average Exercise Price Number of Shares Weighted Average Exercise Price (in thousands) (in years) (in thousands) $1.85 1.0 $ 1.85 $ 1.85 $2.95 1.6 2.95 2.95 $10.39 1,000 2.6 10.39 1,000 10.39 $15.00 1,200 2.8 15.00 15.00 3,078 2.4 $ 10.06 2,765 $ 9.50 The following table summarizes the activities for our unvested RSUs for the year ended December 31, 2017 : Unvested RSUs (1) Number of Shares Weighted Average Grant Date Fair Value (in thousands) Unvested at December 31, 2016 98,586 $ 82.99 Granted 36,741 147.28 Vested (43,176 ) 83.74 Forfeited (10,937 ) 91.76 Unvested at December 31, 2017 81,214 $ 110.49 (1) Unvested shares include inducement awards issued in connection with the WhatsApp acquisition in 2014 and are subject to the terms, restrictions, and conditions of separate non-plan RSU award agreements. The fair value as of the respective vesting dates of RSUs that vested during the years ended December 31, 2017 , 2016 , and 2015 was $6.76 billion , $4.92 billion , and $4.23 billion , respectively. Starting in 2016, upon adoption of ASU 2016-09, we account for forfeitures as they occur. As of December 31, 2017 , there was $7.72 billion of unrecognized share-based compensation expense, substantially all of which was related to RSUs. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years . Included in this unrecognized share-based compensation expense are 9.5 million unvested shares as of December 31, 2017 , related to RSU inducement award granted to an employee in connection with the WhatsApp acquisition in 2014. This award is subject to acceleration if the recipient's employment is terminated without ""cause"" or if the recipient resigns for ""good reason"". Note 11. Interest and other income (expense), net The following table presents the detail of interest and other income (expense), net, for the periods presented (in millions): Year Ended December 31, Interest income $ $ $ Interest expense (6 ) (10 ) (23 ) Foreign currency exchange losses, net (6 ) (76 ) (66 ) Other Interest and other income (expense), net $ $ $ (31 ) Note 12. Income Taxes The components of income before provision for income taxes for the years ended December 31, 2017 , 2016 , and 2015 are as follows (in millions): Year Ended December 31, Domestic $ 7,079 $ 6,368 $ 2,802 Foreign 13,515 6,150 3,392 Income before provision for income taxes $ 20,594 $ 12,518 $ 6,194 The provision for income taxes consisted of the following (in millions): Year Ended December 31, Current: Federal $ 4,455 $ 2,384 $ 3,012 State Foreign Total current tax expense 5,034 2,758 3,318 Deferred: Federal (296 ) (414 ) (800 ) State (33 ) (18 ) (17 ) Foreign (45 ) (25 ) Total deferred tax benefit (374 ) (457 ) (812 ) Provision for income taxes $ 4,660 $ 2,301 $ 2,506 A reconciliation of the U.S. federal statutory income tax rate of 35.0% to our effective tax rate is as follows (in percentages): Year Ended December 31, U.S. federal statutory income tax rate 35.0 % 35.0 % 35.0 % State income taxes, net of federal benefit 0.6 1.0 2.0 Research tax credits (0.9 ) (0.7 ) (1.4 ) Share-based compensation 0.4 1.0 2.2 Excess tax benefits related to share-based compensation (1) (5.8 ) (7.0 ) Effect of non-U.S. operations (18.6 ) (12.8 ) (0.9 ) Effect of U.S. tax law change (2) 11.0 Other 0.9 1.9 3.5 Effective tax rate 22.6 % 18.4 % 40.4 % (1) Starting in 2016, excess tax benefits from share-based award activity are reflected as a reduction of the provision for income taxes, whereas they were previously recognized in equity. (2) Due to the Tax Act which was enacted in December 2017, provisional mandatory transition tax on accumulated foreign earnings was accrued as of December 31, 2017. In addition, deferred taxes were derecognized for previous estimated tax liabilities that would arise upon repatriation of a portion of these earnings in the foreign jurisdictions. Our U.S. deferred tax assets and liabilities as of December 31, 2017 were re-measured from 35% to 21% .The provisional effects of the Tax Act are $2.53 billion of current income tax expense and $257 million of deferred income tax benefit for the year ended December 31, 2017. Our deferred tax assets (liabilities) are as follows (in millions): December 31, Deferred tax assets: Net operating loss carryforward $ 1,300 $ 1,252 Tax credit carryforward Share-based compensation Accrued expenses and other liabilities Other Total deferred tax assets 2,706 2,692 Less: valuation allowance (438 ) (240 ) Deferred tax assets, net of valuation allowance 2,268 2,452 Deferred tax liabilities: Depreciation and amortization (622 ) (535 ) Purchased intangible assets (309 ) (706 ) Deferred taxes on foreign income (88 ) (357 ) Total deferred tax liabilities (1,019 ) (1,598 ) Net deferred tax assets $ 1,249 $ The Tax Act reduces the U.S. statutory corporate tax rate from 35% to 21% for our tax years beginning in 2018, which resulted in the re-measurement of the federal portion of our deferred tax assets as of December 31, 2017 from 35% to the new 21% tax rate. The valuation allowance was approximately $438 million and $240 million as of December 31, 2017 and 2016 , respectively, mostly related to state tax credits that we do not believe will ultimately be realized. As of December 31, 2017 , the U.S. federal and state net operating loss carryforwards were $5.36 billion and $2.50 billion , which will begin to expire in 2033 and 2032 , respectively, if not utilized. We have federal and state tax credit carryforwards of $142 million and $1.38 billion , respectively, which will begin to expire in 2033 and 2032 , respectively, if not utilized. Utilization of our net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such annual limitations could result in the expiration of the net operating loss and tax credit carryforwards before their utilization. The events that may cause ownership changes include, but are not limited to, a cumulative stock ownership change of greater than 50% over a three -year period. The Tax Act imposes a mandatory transition tax on accumulated foreign earnings and eliminates US taxes on foreign subsidiary distribution. As a result, earnings in foreign jurisdictions are available for distribution to the U.S. without incremental U.S. taxes. The following table reflects changes in the gross unrecognized tax benefits (in millions): Year Ended December 31, Gross unrecognized tax benefits-beginning of period $ 3,309 $ 3,017 $ 1,682 Increases related to prior year tax positions Decreases related to prior year tax positions (34 ) (36 ) (52 ) Increases related to current year tax positions 1,066 Decreases related to settlements of prior year tax positions (13 ) (11 ) (1 ) Gross unrecognized tax benefits-end of period $ 3,870 $ 3,309 $ 3,017 During all years presented, we recognized interest and penalties related to unrecognized tax benefits within the provision for income taxes on the consolidated statements of income. The amount of interest and penalties accrued as of December 31, 2017 and 2016 was $154 million and $80 million , respectively. If the balance of gross unrecognized tax benefits of $3.87 billion as of December 31, 2017 were realized in a future period, this would result in a tax benefit of $2.67 billion within our provision of income taxes at such time. We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2011 through 2013 tax years and Ireland for our 2012 through 2015 tax years. Our 2014 and subsequent years remain open to examination by the IRS. Our 2016 and subsequent years remain open to examination in Ireland. In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated aggregate amount of approximately $3.0 billion to $5.0 billion in excess of originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability of $3.0 billion to $5.0 billion in excess of the originally filed U.S. return, plus interest and penalties. If the IRS prevails in the assessment of additional tax due based on its position, the assessed tax, interest and penalties, if any, could have a material adverse impact on our financial position, results of operations, and cash flows. As of December 31, 2017 , we have not resolved this matter and proceedings continue in the United States Tax Court. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. We believe that adequate amounts have been reserved for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. Although the timing of the resolution, settlement, and closure of any audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. However, we do not anticipate a significant impact to such amounts within the next 12 months. Note 13. Geographical Information Revenue by geography is based on the billing address of the marketer or developer. The following tables set forth revenue and property and equipment, net by geographic area (in millions): Year Ended December 31, Revenue: United States $ 17,734 $ 12,579 $ 8,513 Rest of the world (1) 22,919 15,059 9,415 Total revenue $ 40,653 $ 27,638 $ 17,928 (1) No individual country, other than disclosed above, exceeded 10% of our total revenue for any period presented. December 31, Property and equipment, net: United States $ 10,406 $ 6,793 Rest of the world (1) 3,315 1,798 Total property and equipment, net $ 13,721 $ 8,591 (1) No individual country, other than disclosed above, exceeded 10% of our total property and equipment, net for any period presented. "," Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer (CEO) and chief financial officer (CFO), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), as of the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, our CEO and CFO have concluded that as of December 31, 2017 , our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC), and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on the assessment, management has concluded that its internal control over financial reporting was effective as of December 31, 2017 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. GAAP. Our independent registered public accounting firm, Ernst Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K. Changes in Internal Control There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the fourth quarter of 2017 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Limitations on Effectiveness of Controls and Procedures and Internal Control over Financial Reporting In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs. " diff --git a/datasets/raw/microsoft.csv b/datasets/raw/microsoft.csv new file mode 100644 index 0000000..95b9585 --- /dev/null +++ b/datasets/raw/microsoft.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,msft,20220630," ITEM 1. BUSINESSGENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. We are creating the tools and platforms that deliver better, faster, and more effective solutions to support new startups, improve educational and health outcomes, and empower human ingenuity. Microsoft is innovating and expanding our entire portfolio to help people and organizations overcome todays challenges and emerge stronger. We bring technology and products together into experiences and solutions that unlock value for our customers.In a dynamic environment, digital technology is the key input that powers the worlds economic output. Our ecosystem of customers and partners have learned that while hybrid work is complex, embracing flexibility, different work styles, and a culture of trust can help navigate the challenges the world faces today. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. Customers are looking to unlock value while simplifying security and management. From infrastructure and data, to business applications and collaboration, we provide unique, differentiated value to customers. We are building a distributed computing fabric across cloud and the edge to help every organization build, run, and manage mission-critical workloads anywhere. In the next phase of innovation, artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. We are enabling metaverse experiences at all layers of our stack, so customers can more effectively model, automate, simulate, and predict changes within their industrial environments, feel a greater sense of presence in the new world of hybrid work, and create custom immersive worlds to enable new opportunities for connection and experimentation. What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.PART I Item 1Our products include operating systems , cross-device productivity and collaboration applications , server applications , business solution applications , desktop and server management tools , software development tools , and video games. We also design and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. The Ambitions That Drive UsTo achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing. Reinvent Productivity and Business ProcessesAt Microsoft, we provide technology and resources to help our customers create a secure hybrid work environment. Our family of products plays a key role in the ways the world works, learns, and connects. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office 365, Dynamics 365, and LinkedIn. Microsoft 365 brings together Office 365, Windows, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase collaboration, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is a comprehensive platform for work, with meetings, calls, chat, collaboration, and business process automation. Microsoft Viva is an employee experience platform that brings together communications, knowledge, learning, resources, and insights powered by Microsoft 365. Together with the Microsoft Cloud, Dynamics 365, Microsoft Teams, and Azure Synapse bring a new era of collaborative applications that transform every business function and process. Microsoft Power Platform is helping domain experts drive productivity gains with low-code/no-code tools, robotic process automation, virtual agents, and business intelligence. In a dynamic labor market, LinkedIn is helping professionals use the platform to connect, learn, grow, and get hired. Build the Intelligent Cloud and Intelligent Edge PlatformAs digital transformation accelerates, organizations in every sector across the globe can address challenges that will have a fundamental impact on their success. For enterprises, digital technology empowers employees, optimizes operations, engages customers, and in some cases, changes the very core of products and services. Microsoft has a proven track record of delivering high value to our customers across many diverse and durable growth markets.We continue to invest in high performance and sustainable computing to meet the growing demand for fast access to Microsoft services provided by our network of cloud computing infrastructure and datacenters. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.The Microsoft Cloud is the most comprehensive and trusted cloud, providing the best integration across the technology stack while offering openness, improving time to value, reducing costs, and increasing agility. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from Internet of Things (IoT) sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. PART I Item 1Our hybrid infrastructure consistency spans security, compliance, identity, and management, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. Our industry clouds bring together capabilities across the entire Microsoft Cloud, along with industry-specific customizations, to improve time to value, increase agility, and lower costs. Azure Arc simplifies governance and management by delivering a consistent multi-cloud and on-premises management platform. Security, compliance, identity, and management underlie our entire tech stack. We offer integrated, end-to-end capabilities to protect people and organizations. In March 2022, we completed our acquisition of Nuance Communications, Inc. (Nuance). Together, Microsoft and Nuance will enable organizations across industries to accelerate their business goals with security-focused, cloud-based solutions infused with powerful, vertically optimized AI. We are accelerating our development of mixed reality solutions with new Azure services and devices. Microsoft Mesh enables presence and shared experiences from anywhere through mixed reality applications. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks new workloads and experiences to create common understanding and drive more informed decisions. The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. Azure Synapse brings together data integration, enterprise data warehousing, and big data analytics in a comprehensive solution. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. From GitHub to Visual Studio, we provide a developer tool chain for everyone, no matter the technical experience, across all platforms, whether Azure, Windows, or any other cloud or client platform.Additionally, we are extending our infrastructure beyond the planet, bringing cloud computing to space. Azure Orbital is a fully managed ground station as a service for fast downlinking of data.Create More Personal ComputingWe strive to make computing more personal by putting people at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working, learning, and playing. Windows also plays a critical role in fueling our cloud business with Windows 365, a desktop operating system thats also a cloud service. From another internet-connected device, including Android or macOS devices, you can run Windows 365, just like a virtual machine.With Windows 11, we have simplified the design and experience to empower productivity and inspire creativity. Windows 11 offers innovations focused on enhancing productivity and is designed to support hybrid work. It adds new experiences that include powerful task switching tools like new snap layouts, snap groups, and desktops new ways to stay connected through Microsoft Teams chat the information you want at your fingertips and more. Windows 11 security and privacy features include operating system security, application security, and user and identity security. Tools like search, news, and maps have given us immediate access to the worlds information. Today, through our Search, News, Mapping, and Browse services, Microsoft delivers unique trust, privacy, and safety features. Microsoft Edge is our fast and secure browser that helps protect your data, with built-in shopping tools designed to save you time and money. Organizational tools such as Collections, Vertical Tabs, and Immersive Reader help make the most of your time while browsing, streaming, searching, and sharing.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. The Surface family includes Surface Laptop Studio, Surface Laptop 4, Surface Laptop Go 2, Surface Laptop Pro 8, Surface Pro X, Surface Go 3, Surface Studio 2, and Surface Duo 2. PART I Item 1With three billion people actively playing games today, and a new generation steeped in interactive entertainment, Microsoft continues to invest in content, community, and cloud services . We have broadened our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played , including cloud gaming so players can stream across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers , including the acquisition of ZeniMax Media Inc., the parent company of Bethesda Softworks LLC . In January 2022, we announced plans to acquire Activision Blizzard , Inc., a leader in game development and an interactive entertainment content publisher . Xbox Game Pass is a community with access to a curated library of over 100 first- and third-party console and PC titles . Xbox Cloud Gaming is Microsofts game streaming technology that is complementary to our console hardware and gives fans the ultimate choice to play the games they want, with the people they want, on the devices they want. Our Future OpportunityThe case for digital transformation has never been more urgent. Customers are looking to us to help improve productivity and the affordability of their products and services. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications, drive deeper insights, and improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Tackling security from all angles with our integrated, end-to-end solutions spanning security, compliance, identity, and management, across all clouds and platforms. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment. Using Windows to fuel our cloud business, grow our share of the PC market, and drive increased engagement with our services like Microsoft 365 Consumer, Teams, Edge, Bing, Xbox Game Pass, and more. Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.Corporate Social ResponsibilityCommitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. We are accelerating progress toward a more sustainable future by reducing our environmental footprint, advancing research, helping our customers build sustainable solutions, and advocating for policies that benefit the environment. In January 2020, we announced a bold commitment and detailed plan to be carbon negative by 2030, and to remove from the environment by 2050 all the carbon we have emitted since our founding in 1975. This included a commitment to invest $1 billion over four years in new technologies and innovative climate solutions. We built on this pledge by adding commitments to be water positive by 2030, zero waste by 2030, and to protect ecosystems by developing a Planetary Computer. We also help our suppliers and customers around the world use Microsoft technology to reduce their own carbon footprint.Fiscal year 2021 was a year of both successes and challenges. While we continued to make progress on several of our goals, with an overall reduction in our combined Scope 1 and Scope 2 emissions, our Scope 3 emissions increased, due in substantial part to significant global datacenter expansions and growth in Xbox sales and usage as a result of the COVID-19 pandemic. Despite these Scope 3 increases, we will continue to build the foundations and do the work to deliver on our commitments, and help our customers and partners achieve theirs. We have learned the impact of our work will not all be felt immediately, and our experience highlights how progress wont always be linear.PART I Item 1While fiscal year 2021 presented us with some new learnings, we also made some great progress. A few examples that illuminate the diversity of our work include: We purchased the removal of 1.4 million metrics tons of carbon. Four of our datacenters received new or renewed Zero Waste certifications. We granted $100 million to Breakthrough Energy Catalyst to accelerate the development of climate solutions the world needs to reach net-zero across four key areas: direct air capture, green hydrogen, long duration energy storage, and sustainable aviation fuel. We joined the First Movers Coalition as an early leader and expert partner in the carbon dioxide removal sector, with a commitment of $200 million toward carbon removal by 2030. Sustainability is an existential priority for our society and businesses today. This led us to create our Microsoft Cloud for Sustainability, an entirely new business process category to help organizations monitor their carbon footprint across their operations. We also joined with leading organizations to launch the Carbon Call an initiative to mobilize collective action to solve carbon emissions and removal accounting challenges for a net zero future.The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment. Our cloud and AI services and datacenters help businesses cut energy consumption, reduce physical footprints, and design sustainable products.Addressing Racial Injustice and InequityWe are committed to addressing racial injustice and inequity in the United States for Black and African American communities and helping improve lived experiences at Microsoft, in employees communities, and beyond. Our Racial Equity Initiative focuses on three multi-year pillars, each containing actions and progress we expect to make or exceed by 2025. Strengthening our communities: using data, technology, and partnerships to help improve the lives of Black and African American people in the United States, including our employees and their communities. Evolving our ecosystem: using our balance sheet and relationships with suppliers and partners to foster societal change and create new opportunities. Increasing representation and strengthening inclusion: build on our momentum, adding a $150 million investment to strengthen inclusion and double the number of Black, African American, Hispanic, and Latinx leaders in the United States by 2025. Over the last year, we collaborated with partners and worked within neighborhoods and communities to launch and scale a number of projects and programs, including: working with 70 organizations in 145 communities on the Justice Reform Initiative, expanding access to affordable broadband and devices for Black and African American communities and key institutions that support them in major urban centers, expanding access to skills and education to support Black and African American students and adults to succeed in the digital economy, and increasing technology support for nonprofits that provide critical services to Black and African American communities.We have made meaningful progress on representation and inclusion at Microsoft. We are 90 percent of the way to our 2025 commitment to double the number of Black and African American people managers, senior individual contributors, and senior leaders in the U.S., and 50 percent of the way for Hispanic and Latinx people managers, senior individual contributors, and senior leaders in the U.S.We exceeded our goal on increasing the percentage of transaction volumes with Black- and African American-owned financial institutions and increased our deposits with Black- and African American-owned minority depository institutions, enabling increased funds into local communities. Additionally, we enriched our supplier pipeline, reaching more than 90 percent of our goal to spend $500 million with double the number of Black and African American-owned suppliers. We also increased the number of identified partners in the Black Partner Growth Initiative and continue to invest in the partner community through the Black Channel Partner Alliance by supporting events focused on business growth, accelerators, and mentorship.Progress does not undo the egregious injustices of the past or diminish those who continue to live with inequity. We are committed to leveraging our resources to help accelerate diversity and inclusion across our ecosystem and to hold ourselves accountable to accelerate change for Microsoft, and beyond.PART I Item 1Investing in Digital Skills The COVID-19 pandemic led to record unemployment, disrupting livelihoods of people around the world. After helping over 30 million people in 249 countries and territories with our global skills initiative, we introduced a new initiative to support a more skills-based labor market, with greater flexibility and accessible learning paths to develop the right skills needed for the most in-demand jobs. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. We previously invested $20 million in key non-profit partnerships through Microsoft Philanthropies to help people from underserved communities that are often excluded by the digital economy. We also launched a national campaign with U.S. community colleges to help skill and recruit into the cybersecurity workforce 250,000 people by 2025, representing half of the countrys workforce shortage. To that end, we are making curriculum available free of charge to all of the nations public community colleges, providing training for new and existing faculty at 150 community colleges, and providing scholarships and supplemental resources to 25,000 students. HUMAN CAPITAL RESOURCES OverviewMicrosoft aims to recruit, develop, and retain world-changing talent from a diversity of backgrounds. To foster their and our success, we seek to create an environment where people can thrive, where they can do their best work, where they can proudly be their authentic selves, guided by our values, and where they know their needs can be met. We strive to maximize the potential of our human capital resources by creating a respectful, rewarding, and inclusive work environment that enables our global employees to create products and services that further our mission to empower every person and every organization on the planet to achieve more.As of June 30, 2022, we employed approximately 221,000 people on a full-time basis, 122,000 in the U.S. and 99,000 internationally. Of the total employed people, 85,000 were in operations, including manufacturing, distribution, product support, and consulting services 73,000 were in product research and development 47,000 were in sales and marketing and 16,000 were in general and administration. Certain employees are subject to collective bargaining agreements.Our CultureMicrosofts culture is grounded in the growth mindset. This means everyone is on a continuous journey to learn and grow. We believe potential can be nurtured and is not pre-determined, and we should always be learning and curious trying new things without fear of failure. We identified four attributes that allow growth mindset to flourish: Obsessing over what matters to our customers. Becoming more diverse and inclusive in everything we do. Operating as one company, One Microsoft, instead of multiple siloed businesses. Making a difference in the lives of each other, our customers, and the world around us.Our employee listening systems enable us to gather feedback directly from our workforce to inform our programs and employee needs globally. Seventy percent of employees globally participated in our fiscal year 2022 Employee Signals survey, which covers a variety of topics such as thriving, inclusion, team culture, wellbeing, and learning and development. Throughout the fiscal year, we collect over 75,000 Daily Pulse employee survey responses. During fiscal year 2022, our Daily Pulse surveys gave us invaluable insights into ways we could support employees through the COVID-19 pandemic, addressing racial injustice, the war in Ukraine, and their general wellbeing. In addition to Employee Signals and Daily Pulse surveys, we gain insights through onboarding, internal mobility, leadership, performance and development, exit surveys, internal Yammer channels, employee QA sessions, and AskHR Service support.PART I Item 1Diversity and Inclusion At Microsoft we have an inherently inclusive mission: to empower every person and every organization on the planet to achieve more. We think of diversity and inclusion as core to our business model, informing our actions to impact economies and people around the world. There are billions of people who want to achieve more, but have a different set of circumstances, abilities, and backgrounds that often limit access to opportunity and achievement. The better we represent that diversity inside Microsoft, the more effectively we can innovate for those we seek to empower.We strive to include others by holding ourselves accountable for diversity, driving global systemic change in our workplace and workforce, and creating an inclusive work environment. Through this commitment we can allow everyone the chance to be their authentic selves and do their best work every day. We support multiple highly active Employee Resource Groups for women, families, racial and ethnic minorities, military, people with disabilities, and employees who identify as LGBTQIA+, where employees can go for support, networking, and community-building. As described in our 2021 Proxy Statement , annual performance and compensation reviews of our senior leadership team include an evaluation of their contributions to employee culture and diversity. To ensure accountability over time, we publicly disclose our progress on a multitude of workforce metrics including: Detailed breakdowns of gender, racial, and ethnic minority representation in our employee population, with data by job types, levels, and segments of our business. Our EEO-1 report (equal employment opportunity). Disability representation. Pay equity (see details below). Total Rewards We develop dynamic, sustainable, market-driven, and strategic programs with the goal of providing a highly differentiated portfolio to attract, reward, and retain top talent and enable our employees to thrive. These programs reinforce our culture and values such as collaboration and growth mindset. Managers evaluate and recommend rewards based on, for example, how well we leverage the work of others and contribute to the success of our colleagues. We monitor pay equity and career progress across multiple dimensions.As part of our effort to promote a One Microsoft and inclusive culture, in fiscal year 2021 we expanded stock eligibility to all Microsoft employees as part of our annual rewards process. This includes all non-exempt and exempt employees and equivalents across the globe including business support professionals and datacenter and retail employees. In response to the Great Reshuffle, in fiscal year 2022 we announced a sizable investment in annual merit and annual stock award opportunity for all employees below senior executive levels. We also invested in base salary adjustments for our datacenter and retail hourly employees and hourly equivalents outside the U.S. These investments have supported retention and help to ensure that Microsoft remains an employer of choice.Pay EquityIn our 2021 Diversity and Inclusion Report, we reported that all racial and ethnic minority employees in the U.S. combined earn $1.006 for every $1.000 earned by their white counterparts, that women in the U.S. earn $1.002 for every $1.000 earned by their counterparts in the U.S. who are men, and women in the U.S. plus our twelve other largest employee geographies representing 86.6% of our global population (Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, Romania, Singapore, and the United Kingdom) combined earn $1.001 for every $1.000 by men in these countries. Our intended result is a global performance and development approach that fosters our culture, and competitive compensation that ensures equitable pay by role while supporting pay for performance.Wellness and SafetyMicrosoft is committed to supporting our employees well-being and safety while they are at work and in their personal lives. We took a wide variety of measures to protect the health and well-being of our employees, suppliers, and customers during the COVID-19 pandemic and are now supporting employees in shifting to return to office and/or hybrid arrangements. We developed hybrid guidelines for managers and employees to support the transition and continue to identify ways we can support hybrid work scenarios through our employee listening systems.PART I Item 1We have invested significantly in holistic wellbeing, and offer a differentiated benefits package which includes many physical, emotional, and financial wellness programs including counseling through the Microsoft CARES Employee Assistance Program, mental wellbeing support, flexible fitness benefits, savings and investment tools, adoption assistance, and back-up care for children and elders. Finally, our Occupational Health and Safety program helps ensure employees can stay safe while they are working. We continue to strive to support our Ukrainian employees and their dependents during the Ukraine crisis with emergency relocation assistance, emergency leave, and other benefits.Learning and DevelopmentOur growth mindset culture begins with valuing learning over knowing seeking out new ideas, driving innovation, embracing challenges, learning from failure, and improving over time. To support this culture, we offer a wide range of learning and development opportunities. We believe learning can be more than formal instruction, and our learning philosophy focuses on providing the right learning, at the right time, in the right way. Opportunities include: Personalized, integrated, and relevant views of all learning opportunities on both our internal learning portal Learning (Viva Learning + LinkedIn Learning) and our external learning portal MS Learn are available to all employees worldwide. In-the-classroom learning, learning cohorts, our early-in-career Aspire program, and manager excellence communities. Required learning for all employees and managers on topics such as compliance, regulation, company culture, leadership, and management. This includes the annual Standards of Business Conduct training. On-the-job stretch and advancement opportunities. Managers holding conversations about employees career and development plans, coaching on career opportunities, and programs like mentoring and sponsorship. Customized manager learning to build people manager capabilities and similar learning solutions to build leadership skills for all employees including differentiated leadership development programs. New employee orientation covering a range of topics including company values, and culture, as well as ongoing onboarding programs. New tools to assist managers and employees in learning how to operate, be productive, and connect in the new flexible hybrid world of work. These include quick guides for teams to use, such as Creating Team Agreements, Reconnecting as a Team, and Running Effective Hybrid Meetings.Our employees embrace the growth mindset and take advantage of the formal learning opportunities as well as thousands of informal and on-the-job learning opportunities. In terms of formal on-line learning solutions, in fiscal year 2022 our employees completed over 4.7 million courses, averaging over 14 hours per employee. Given our focus on understanding core company beliefs and compliance topics, all employees complete required learning programs like Standards of Business Conduct, Privacy, Unconscious Bias, and preventing harassment courses. Our corporate learning portal has over 100,000 average monthly active users. We have over 27,000 people managers, all of whom must complete between 20-33 hours of required manager capability and excellence training and are assigned ongoing required training each year. In addition, all employees complete skills training based on the profession they are in each year.New Ways of Working The COVID-19 pandemic accelerated our capabilities and culture with respect to flexible work. We introduced a Hybrid Workplace Flexibility Guide to better support managers and employees as they adapt to new ways of working that shift paradigms, embrace flexibility, promote inclusion, and drive innovation. Our ongoing survey data shows employees value the flexibility related to work location, work site, and work hours, and while many have begun returning to worksites as conditions have permitted, they also continue to adjust hours and/or spend some of workweeks working at home, another site, or remotely. We are focused on building capabilities to support a variety of workstyles where individuals, teams, and our business can deliver success.PART I Item 1OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva. Office Consumer, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as frontline workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Talent Solutions also includes Learning Solutions, which help businesses close critical skills gaps in times where companies are having to do more with existing talent. Marketing Solutions help companies reach, engage, and convert their audiences at scale. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. LinkedIn has over 850 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed and applications consumed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications, including Power Apps and Power Automate.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Meta, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.Dynamics competes with cloud-based and on-premises business solution providers such as Oracle, Salesforce, and SAP.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHub. Enterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance professional services. Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product.Nuance and GitHub include both cloud and on-premises offerings. Nuance provides healthcare and enterprise AI solutions. GitHub provides a collaboration platform and code hosting service for developers. Enterprise ServicesEnterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance Professional Services, assist customers in developing, deploying, and managing Microsoft server solutions, Microsoft desktop solutions, and Nuance conversational AI and ambient intelligent solutions, along with providing training and certification to developers and IT professionals on various Microsoft products.CompetitionAzure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.PART I Item 1We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, Snowflake, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing and Windows Internet of Things. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services. Search and news advertising. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.PART I Item 1Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender for Endpoint, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year.Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. DevicesWe design and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Xbox Cloud Gaming, our game streaming service, and continued investment in gaming hardware. Xbox Cloud Gaming utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorite games with them and play on the device most convenient to them. Xbox enables people to connect and share online gaming experiences that are accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators. Search and News AdvertisingOur Search and news advertising business is designed to deliver relevant search, native, and display advertising to a global audience. We have several partnerships with other companies, including Yahoo, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings.On June 6, 2022, we acquired Xandr, Inc., a technology platform with tools to accelerate the delivery of our digital advertising solutions.Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. PART I Item 1Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs. Xbox and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Meta, Google, and Tencent. We also compete with other providers of entertainment services such as video streaming platforms. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our Search and news advertising business competes with Google and a wide array of websites, social platforms like Meta, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. For the majority of our products, we have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. However, some of our products contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers and/or manufacturers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, software development tools and services (including GitHub), AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Teams, con sumer web experiences (including search and news advertising), and the Surface line of devices. Security, Compliance, Identity, and Management , focuses on cloud platform and application security, identity and network access, enterprise mobility, information protection, and managed services. Technology and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, and applications. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction. PART I Item 1Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 69,000 U.S. and international patents issued and over 19,000 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We may also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, supporting societal and/or environmental efforts, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We plan to continue to make significant investments in a broad range of product research and development activities, and as appropriate we will coordinate our research and development across operating segments and leverage the results across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.PART I Item 1OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Dell, Hewlett-Packard, Lenovo, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In fiscal year 2021, we closed our Microsoft Store physical locations and opened our Microsoft Experience Centers. Microsoft Experience Centers are designed to facilitate deeper engagement with our partners and customers across industries. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and SA. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.PART I Item 1Volume Licensing Programs Enterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Customer AgreementA Microsoft Customer Agreement is a simplified purchase agreement presented, accepted, and stored through a digital experience. A Microsoft Customer Agreement is a non-expiring agreement that is designed to support all customers over time, whether purchasing through a partner or directly from Microsoft.Microsoft Online Subscription AgreementA Microsoft Online Subscription Agreement is designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Microsoft Products and Services Agreement Microsoft Products and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. Open ValueOpen Value agreements are a simple, cost-effective way to acquire the latest Microsoft technology. These agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a three-year period. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus A Select Plus agreement is designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.PART I Item 1CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1INFORMATION ABOUT OUR EXECUTIV E OFFICERS Our executive officers as of July 28, 2022 were as follows:NameAgePosition with the CompanySatya NadellaChairman of the Board and Chief Executive OfficerJudson AlthoffExecutive Vice President and Chief Commercial OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Vice ChairChristopher D. YoungExecutive Vice President, Business Development, Strategy, and VenturesMr. Nadella was appointed Chairman of the Board in June 2021 and Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Althoff was appointed Executive Vice President and Chief Commercial Officer in July 2021. He served as Executive Vice President, Worldwide Commercial Business from July 2017 until that time. Prior to that, Mr. Althoff served as the President of Microsoft North America. Mr. Althoff joined Microsoft in March 2013 as President of Microsoft North America.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Vice Chair in September 2021. Prior to that, he served as President and Chief Legal Officer since September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.Mr. Young has served as Executive Vice President, Business Development, Strategy, and Ventures since joining Microsoft in November 2020. Prior to Microsoft, he served as the Chief Executive Officer of McAfee, LLC from 2017 to 2020, and served as a Senior Vice President and General Manager of Intel Security Group from 2014 until 2017, when he led the initiative to spin out McAfee into a standalone company. Mr. Young also serves on the Board of Directors of American Express Company.PART I Item 1AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time. We publish a variety of reports and resources related to our Corporate Social Responsibility programs and progress on our Reports Hub website, www.microsoft.com/corporate-responsibility/reports-hub, including reports on sustainability, responsible sourcing, accessibility, digital trust, and public policy engagement. The information found on these websites is not part of, or incorporated by reference into, this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORSOur operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.STRATEGIC AND COMPETITIVE RISKS We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We embrace cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to meet our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other IoT endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1ARISKS RELATING TO THE EVOLUTION OF OUR BUSINESS We make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in March 2021 we completed our acquisition of ZeniMax Media Inc. for $8.1 billion, and in March 2022 we completed our acquisition of Nuance Communications, Inc. for $18.8 billion. In January 2022 we announced a definitive agreement to acquire Activision Blizzard , Inc. for $68.7 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that they raise new compliance-related obligations and challenges, that we have difficulty integrating and retaining new employees, business systems, and technology, that they distract management from our other businesses, or that announced transactions may not be completed. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones, as well as acquired companies ability to meet our policies and processes in areas such as data governance, privacy, and cybersecurity. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record, a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACYBERSECURITY, DATA PRIVACY, AND PLATFORM ABUSE RISKS Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technologyThreats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Nation-state and state-sponsored actors can deploy significant resources to plan and carry out exploits. Nation-state attacks against us or our customers may intensify during periods of intense diplomatic or armed conflict, such as the ongoing conflict in Ukraine. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems or reveal confidential information. Malicious actors may employ the IT supply chain to introduce malware through software updates or compromised supplier accounts or hardware.Cyberthreats are constantly evolving and becoming increasingly sophisticated and complex, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, subject us to ransomware attacks, require us to allocate more resources to improve technologies or remediate the impacts of attacks, or otherwise adversely affect our business.The cyberattacks uncovered in late 2020 known as Solorigate or Nobelium are an example of a supply chain attack where malware was introduced to a software providers customers, including us, through software updates. The attackers were later able to create false credentials that appeared legitimate to certain customers systems. We may be targets of further attacks similar to Solorigate/Nobelium as both a supplier and consumer of IT.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge, or emerging cybersecurity regulations in jurisdictions worldwide.PART I Item 1ASecurity of our products, services, devices, and customers data The security of our products and services is important in our customers decisions to purchase or use our products or services across cloud and on-premises environments. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. In addition, adversaries can attack our customers on-premises or cloud environments, sometimes exploiting previously unknown (zero day) vulnerabilities, such as occurred in early calendar year 2021 with several of our Exchange Server on-premises products. Vulnerabilities in these or any product can persist even after we have issued security patches if customers have not installed the most recent updates, or if the attackers exploited the vulnerabilities before patching to install additional malware to further compromise customers systems. Adversaries will continue to attack customers using our cloud services as customers embrace digital transformation. Adversaries that acquire user account information can use that information to compromise our users accounts, including where accounts share the same attributes such as passwords. Inadequate account security practices may also result in unauthorized access, and user activity may result in ransomware or other malicious software impacting a customers use of our products or services. We are increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.Our customers operate complex IT systems with third-party hardware and software from multiple vendors that may include systems acquired over many years. They expect our products and services to support all these systems and products, including those that no longer incorporate the strongest current security advances or standards. As a result, we may not be able to discontinue support in our services for a product, service, standard, or feature solely because a more secure alternative is available. Failure to utilize the most current security advances and standards can increase our customers vulnerability to attack. Further, customers of widely varied size and technical sophistication use our technology, and consequently may have limited capabilities and resources to help them adopt and implement state of the art cybersecurity practices and technologies. In addition, we must account for this wide variation of technical sophistication when defining default settings for our products and services, including security default settings, as these settings may limit or otherwise impact other aspects of IT operations and some customers may have limited capability to review and reset these defaults.Cyberattacks such as Solorigate/Nobelium may adversely impact our customers even if our production services are not directly compromised. We are committed to notifying our customers whose systems have been impacted as we become aware and have available information and actions for customers to help protect themselves. We are also committed to providing guidance and support on detection, tracking, and remediation. We may not be able to detect the existence or extent of these attacks for all of our customers or have information on how to detect or track an attack, especially where an attack involves on-premises software such as Exchange Server where we may have no or limited visibility into our customers computing environments.Development and deployment of defensive measuresTo defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls, anti-virus software, and advanced security and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our products and services.PART I Item 1AThe cost of measures to protect products and customer-facing services could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number, breadth, and scale of our cloud-based offerings, we store and process increasingly large amounts of personal data of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, marketplace, and gaming platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, Microsoft News, Microsoft Store, Bing, and Xbox, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, dissemination of information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AOther digital safety abuses Our hosted consumer services as well as our enterprise services may be used to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale, the limitations of existing technologies, and conflicting legal frameworks. When discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online have been enacted, and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the development and use of AI may result in reputational harm or liability . We are building AI into many of our offerings, including our productivity services, and we are also making first- and third-party AI available for our customers to use in solutions that they build. We expect these elements of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Ineffective or inadequate AI development or deployment practices by Microsoft or others could result in incidents that impair the acceptance of AI solutions or cause harm to individuals or society. These deficiencies and other failures of AI systems could subject us to competitive harm, regulatory action, legal liability, including under new proposed legislation regulating AI in jurisdictions such as the European Union (EU), and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social, economic, or political issues, we may experience brand or reputational harm. OPERATIONAL RISKS We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. Our datacenters depend on predictable energy and networking supplies, the cost or availability of which could be adversely affected by a variety of factors, including the transition to a clean energy economy and geopolitical disruptions. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Microsoft 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. PART I Item 1AWe may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. Our software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical business functions and multiple workloads. Many of our products and services are interdependent with one another. Each of these circumstances potentially magnifies the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge.There are limited suppliers for certain device and datacenter components. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If components are delayed or become unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes that restrict supply sources, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. LEGAL, REGULATORY, AND LITIGATION RISKS Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the EU, the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. PART I Item 1AGovernment regulatory actions and court decisions such as these may result in fines or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come s from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows post-sale monetization opportunities may be limited. Regulatory scrutiny may inhibit our ability to consummate acquisitions or impose conditions that reduce the ultimate value of such transactions. Our global operations subject us to potential consequences under anti-corruption, trade, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them, and also cooperate with investigations by U.S. and foreign law enforcement authorities. An example of increasing international regulatory complexity is the EU Whistleblower Directive, initiated in 2021, which may present compliance challenges to the extent it is implemented in different forms by EU member states. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Increasing trade laws, policies, sanctions, and other regulatory requirements also affect our operations in and outside the U.S. relating to trade and investment. Economic sanctions in the U.S., the EU, and other countries prohibit most business with restricted entities or countries such as Crimea, Cuba, Iran, North Korea, and Syria. U.S. export controls restrict Microsoft from offering many of its products and services to, or making investments in, certain entities in specified countries. U.S. import controls restrict us from integrating certain information and communication technologies into our supply chain and allow for government review of transactions involving information and communications technology from countries determined to be foreign adversaries. Periods of intense diplomatic or armed conflict, such as the ongoing conflict in Ukraine, may result in (1) new and rapidly evolving sanctions and trade restrictions, which may impair trade with sanctioned individuals and countries, and (2) negative impacts to regional trade ecosystems among our customers, partners, and us. Non-compliance with sanctions as well as general ecosystem disruptions could result in reputational harm, operational delays, monetary fines, loss of revenues, increased costs, loss of export privileges, or criminal sanctions.PART I Item 1AOther regulatory areas that may apply to our products and online services offerings include requirements related to user privacy, telecommunications, data storage and protection, advertising, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws , including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Regulators may assert that our collection, use, and management of customer data and other information is inconsistent with their laws and regulations , including laws that apply to the tracking of users via technology such as cookies . Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative and regulatory action is emerging in the area s of AI and content moderation, which could increase costs or restrict opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or global accessibility requirements, we could lose sales opportunities or face regulatory or legal actions.Laws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage. The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling continues to generate uncertainty about the legal requirements for data transfers from the EU under other legal mechanisms and has resulted in some EU data protection authorities blocking the use of U.S.-based services that involve the transfer of data to the U.S. The U.S. and the EU in March 2022 agreed in principle on a replacement framework for the Privacy Shield, called the Trans-Atlantic Data Privacy Framework. A failure of the U.S. and EU to finalize the Trans-Atlantic Data Privacy Framework could compound that uncertainty and result in additional blockages of data transfers. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. For example, the EU General Data Protection Regulation (GDPR) applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. More recently, the EU has been developing new requirements related to the use of data, including in the Digital Markets Act, the Digital Services Act, and the Data Act, that will add additional rules and restriction on the use of data in our products and services. Engineering efforts to build and maintain capabilities to facilitate compliance with these laws involve substantial expense and the diversion of engineering resources from other projects. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR and other data regulations, or if our implementation to comply with the GDPR makes our offerings less attractive. Compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply, or if regulators assert we have failed to comply (including in response to complaints made by customers), it may lead to regulatory enforcement actions, which can result in monetary penalties (of up to 4% of worldwide revenue in the case of GDPR), private lawsuits, reputational damage, blockage of international data transfers, and loss of customers. The highest fines assessed under GDPR have recently been increasing, especially against large technology companies. Jurisdictions around the world, such as China, India, and states in the U.S. have adopted, or are considering adopting or expanding, laws and regulations imposing obligations regarding the handling or transfer of personal data. PART I Item 1AThe Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) and possible future legislative changes may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA or possible future legislative changes, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. We earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. PART I Item 1AINTELLECTUAL PROPERTY RISKS We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing or cross-licensing our patents to others in return for a royalty and/or increased freedom to operate. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, price changes in products using licensed patents, greater value from cross-licensing, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.Third parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. GENERAL RISKS If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. PART I Item 1A Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced a decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict, such as the ongoing conflict in Ukraine, pose a risk of general economic disruption in affected countries, which may increase our operating costs and negatively impact our ability to sell to and collect from customers in affected markets. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory systems and requirements and market interventions that could impact our operating strategies, access to national, regional, and global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic such as COVID-19 may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic has had widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. The extent to which global pandemics impact our business going forward will depend on factors such as the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. PART I Item 1AMeasures to contain a global pandemic may intensify other risks described in these Risk Factors. Any of these measures may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions. We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.The long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational, economic, and geopolitical risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist and protectionist trends and concerns about human rights and political expression in specific countries may significantly alter the trade and commercial environments. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, and non-local sourcing restrictions, export controls, investment restrictions, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations. Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. Our global workforce is primarily non-unionized, but we have several unions and works councils outside of the United States. In the U.S., there has been a general increase in workers exercising their right to form or join a union. While Microsoft has not received such petitions in the U.S., the unionization of significant employee populations could result in higher costs and other operational changes necessary to respond to changing conditions and to establish new relationships with worker representatives. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2022 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately 5 million square feet of space we lease. In addition, we own and lease space domestically that includes office and datacenter space.We also own and lease facilities internationally for datacenters, research and development, and other operations. The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, and Singapore. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, the Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2022:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESMARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 25, 2022, there were 86,465 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2022:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet BePurchased Under the Plans or Programs(In millions)April 1, 2022 April 30, 20229,124,963$289.349,124,963$45,869May 1, 2022 May 31, 20229,809,727265.959,809,72743,260June 1, 2022 June 30, 20229,832,841259.429,832,84140,70928,767,53128,767,531All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards. Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2022: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 14, 2022August 18, 2022September 8, 2022$0.62$4,627We returned $12.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2022. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of our operations for the year ended June 30, 2022 compared to the year ended June 30, 2021. For a discussion of the year ended June 30, 2021 compared to the year ended June 30, 2020, please refer to Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended June 30, 2021.OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.Highlights from fiscal year 2022 compared with fiscal year 2021 included: Microsoft Cloud (formerly commercial cloud) revenue increased 32% to $91.2 billion. Office Commercial products and cloud services revenue increased 13% driven by Office 365 Commercial growth of 18%. Office Consumer products and cloud services revenue increased 11% and Microsoft 365 Consumer subscribers grew to 59.7 million. LinkedIn revenue increased 34%. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 39%. Server products and cloud services revenue increased 28% driven by Azure and other cloud services growth of 45%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 11%. Windows Commercial products and cloud services revenue increased 11%. Xbox content and services revenue increased 3%. Search and news advertising revenue excluding traffic acquisition costs increased 27%. Surface revenue increased 3%.On March 4, 2022, we completed our acquisition of Nuance Communications, Inc. (Nuance) for a total purchase price of $18.8 billion, consisting primarily of cash. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The financial results of Nuance have been included in our consolidated financial statements since the date of the acquisition. Nuance is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements ( Part II, Item 8 of this Form 10-K ) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.PART II Item 7Economic Conditions, Challenges, and Risks The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers and/or manufacturers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Fluctuations in the U.S. dollar relative to certain foreign currencies did not have a material impact on reported revenue or expenses from our international operations in fiscal year 2022.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on financial results prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), and growth comparisons relate to the corresponding period of last fiscal year.In the first quarter of fiscal year 2022, we made updates to the presentation and method of calculation for certain metrics, most notably changes to incorporate all current and anticipated revenue streams within our Office Consumer and Server products and cloud services metrics and changes to align with how we manage our Windows OEM and Search and news advertising businesses. None of these changes had a material impact on previously reported amounts in our MDA.PART II Item 7In the third quarter of fiscal year 2022, we completed our acquisition of Nuance. Nuance is included in all commercial metrics and our Server products and cloud services revenue growth metric. Azure and other cloud services revenue includes Nuance cloud services, and Server products revenue includes Nuance on-premises offerings. CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Microsoft Cloud revenue Revenue from Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Microsoft Cloud gross margin percentageGross margin percentage for our Microsoft Cloud business Productivity and Business Processes and Intelligent CloudMetrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft VivaOffice Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office servicesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionMicrosoft 365 Consumer subscribersThe number of Microsoft 365 Consumer subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applicationsLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales SolutionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHubPART II Item 7More Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM revenue growthRevenue from sales of Windows Pro and non-Pro licenses sold through the OEM channelWindows Commercial products and cloud services revenue growthRevenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenue growthRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud servicesSearch and news advertising revenue, excluding TAC, growthRevenue from search and news advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers and news partnersSUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change Revenue$198,270$168,08818%Gross margin135,620115,85617%Operating income83,38369,91619% Net income72,73861,27119%Diluted earnings per share9.658.0520%Adjusted net income (non-GAAP)69,44760,65115% Adjusted diluted earnings per share (non-GAAP)9.217.9716%Adjusted net income and adjusted diluted earnings per share (EPS) are non-GAAP financial measures which exclude the net income tax benefit related to transfer of intangible properties in the first quarter of fiscal year 2022 and the net income tax benefit related to an India Supreme Court decision on withholding taxes in the third quarter of fiscal year 2021 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results. See Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Fiscal Year 2022 Compared with Fiscal Year 2021Revenue increased $30.2 billion or 18% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure and other cloud services. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Search and news advertising and Windows. Cost of revenue increased $10.4 billion or 20% driven by growth in Microsoft Cloud.Gross margin increased $19.8 billion or 17% driven by growth across each of our segments. Gross margin percentage decreased slightly. Excluding the impact of the fiscal year 2021 change in accounting estimate for the useful lives of our server and network equipment, gross margin percentage increased 1 point driven by improvement in Productivity and Business Processes. Microsoft Cloud gross margin percentage decreased slightly to 70%. Excluding the impact of the change in accounting estimate, Microsoft Cloud gross margin percentage increased 3 points driven by improvement across our cloud services, offset in part by sales mix shift to Azure and other cloud services.PART II Item 7Operating expenses increased $ 6 .3 billion or 14 % driven by investments in cloud engineering , LinkedIn, Gaming, and commercial sales . Key changes in operating expenses were: Research and development expenses increased $3.8 billion or 18% driven by investments in cloud engineering, Gaming, and LinkedIn. Sales and marketing expenses increased $1.7 billion or 8% driven by investments in commercial sales and LinkedIn. Sales and marketing included a favorable foreign currency impact of 2%. General and administrative expenses increased $793 million or 16% driven by investments in corporate functions.Operating income increased $13.5 billion or 19% driven by growth across each of our segments.Current year net income and diluted EPS were positively impacted by the net tax benefit related to the transfer of intangible properties, which resulted in an increase to net income and diluted EPS of $3.3 billion and $0.44, respectively. Prior year net income and diluted EPS were positively impacted by the net tax benefit related to the India Supreme Court decision on withholding taxes, which resulted in an increase to net income and diluted EPS of $620 million and $0.08, respectively. Gross margin and operating income both included an unfavorable foreign currency impact of 2%. SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change RevenueProductivity and Business Processes$63,364$53,91518%Intelligent Cloud75,25160,08025%More Personal Computing59,65554,09310%Total $198,270$168,08818%Operating Income Productivity and Business Processes$29,687$24,35122%Intelligent Cloud32,72126,12625%More Personal Computing20,97519,4398%Total $83,383$69,91619%Reportable SegmentsFiscal Year 2022 Compared with Fiscal Year 2021 Productivity and Business Processes Revenue increased $9.4 billion or 18%. Office Commercial products and cloud services revenue increased $4.4 billion or 13%. Office 365 Commercial revenue grew 18% driven by seat growth of 14%, with continued momentum in small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Commercial products revenue declined 22% driven by continued customer shift to cloud offerings. Office Consumer products and cloud services revenue increased $641 million or 11% driven by Microsoft 365 Consumer subscription revenue. Microsoft 365 Consumer subscribers grew 15% to 59.7 million. LinkedIn revenue increased $3.5 billion or 34% driven by a strong job market in our Talent Solutions business and advertising demand in our Marketing Solutions business. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 39%. PART II Item 7Operating income increased $5.3 billion or 22%. Gross margin increased $7.3 billion or 17% driven by growth in Office 365 Commercial and LinkedIn. Gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate, gross margin percentage increased 2 points driven by improvement across all cloud services. Operating expenses increased $2.0 billion or 11% driven by investments in LinkedIn and cloud engineering. Gross margin and operating income both included an unfavorable foreign currency impact of 2%.Intelligent Cloud Revenue increased $15.2 billion or 25%. Server products and cloud services revenue increased $14.7 billion or 28% driven by Azure and other cloud services. Azure and other cloud services revenue grew 45% driven by growth in our consumption-based services. Server products revenue increased 5% driven by hybrid solutions, including Windows Server and SQL Server running in multi-cloud environments. Enterprise Services revenue increased $464 million or 7% driven by growth in Enterprise Support Services.Operating income increased $6.6 billion or 25%. Gross margin increased $9.4 billion or 22% driven by growth in Azure and other cloud services. Gross margin percentage decreased. Excluding the impact of the change in accounting estimate, gross margin percentage was relatively unchanged driven by improvement in Azure and other cloud services, offset in part by sales mix shift to Azure and other cloud services. Operating expenses increased $2.8 billion or 16% driven by investments in Azure and other cloud services. Revenue and operating income included an unfavorable foreign currency impact of 2% and 3%, respectively.More Personal Computing Revenue increased $5.6 billion or 10%. Windows revenue increased $2.3 billion or 10% driven by growth in Windows OEM and Windows Commercial. Windows OEM revenue increased 11% driven by continued strength in the commercial PC market, which has higher revenue per license. Windows Commercial products and cloud services revenue increased 11% driven by demand for Microsoft 365. Search and news advertising revenue increased $2.3 billion or 25%. Search and news advertising revenue excluding traffic acquisition costs increased 27% driven by higher revenue per search and search volume. Gaming revenue increased $860 million or 6% on a strong prior year comparable that benefited from Xbox Series X|S launches and stay-at-home scenarios, driven by growth in Xbox hardware and Xbox content and services. Xbox hardware revenue increased 16% due to continued demand for Xbox Series X|S. Xbox content and services revenue increased 3% driven by growth in Xbox Game Pass subscriptions and first-party content, offset in part by a decline in third-party content. Surface revenue increased $226 million or 3%.Operating income increased $1.5 billion or 8%. Gross margin increased $3.1 billion or 10% driven by growth in Windows and Search and news advertising. Gross margin percentage was relatively unchanged. Operating expenses increased $1.5 billion or 14% driven by investments in Gaming, Search and news advertising, and Windows marketing.PART II Item 7OPERATING EXPENSES Research and Development(In millions, except percentages)Percentage ChangeResearch and development$24,512$20,71618%As a percent of revenue12%12%0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Research and development expenses increased $3.8 billion or 18% driven by investments in cloud engineering, Gaming, and LinkedIn.Sales and Marketing(In millions, except percentages)Percentage ChangeSales and marketing$21,825$20,1178%As a percent of revenue11%12%(1)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses increased $1.7 billion or 8% driven by investments in commercial sales and LinkedIn. Sales and marketing included a favorable foreign currency impact of 2%.General and Administrative(In millions, except percentages)Percentage Change General and administrative$5,900$5,10716%As a percent of revenue3%3%0pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.General and administrative expenses increased $793 million or 16% driven by investments in corporate functions.PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,094$2,131Interest expense(2,063)(2,346)Net recognized gains on investments1,232Net gains (losses) on derivatives(52)Net gains (losses) on foreign currency remeasurements(75)Other, net(32)Total$$1,186We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Interest and dividends income decreased due to lower portfolio balances. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments decreased primarily due to lower gains on equity securities. INCOME TAXES Effective Tax RateOur effective tax rate for fiscal years 2022 and 2021 was 13% and 14%, respectively. The decrease in our effective tax rate was primarily due to a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties, offset in part by changes in the mix of our income before income taxes between the U.S. and foreign countries, as well as tax benefits in the prior year from the India Supreme Court decision on withholding taxes in the case of Engineering Analysis Centre of Excellent Private Limited vs The Commissioner of Income Tax, an agreement between the U.S. and India tax authorities related to transfer pricing, and final Tax Cuts and Jobs Act (TCJA) regulations.In the first quarter of fiscal year 2022, we transferred certain intangible properties from our Puerto Rico subsidiary to the U.S. The transfer of intangible properties resulted in a $3.3 billion net income tax benefit in the first quarter of fiscal year 2022, as the value of future U.S. tax deductions exceeds the current tax liability from the U.S. global intangible low-taxed income tax.We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016.Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the net income tax benefit related to the transfer of intangible properties, earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland, and tax benefits relating to stock-based compensation. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2022, our U.S. income before income taxes was $47.8 billion and our foreign income before income taxes was $35.9 billion. In fiscal year 2021, our U.S. income before income taxes was $35.0 billion and our foreign income before income taxes was $36.1 billion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017. As of June 30, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2021, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the net tax benefit related to the transfer of intangible properties in the first quarter of fiscal year 2022 and the net income tax benefit related to an India Supreme Court decision on withholding taxes in the third quarter of fiscal year 2021. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change Net income$72,738$61,27119%Net income tax benefit related to transfer of intangible properties(3,291)*Net income tax benefit related to India Supreme Court decision on withholding taxes(620)*Adjusted net income (non-GAAP)$69,447$60,65115%Diluted earnings per share$9.65$8.0520% Net income tax benefit related to transfer of intangible properties(0.44)*Net income tax benefit related to India Supreme Court decision on withholding taxes(0.08)*Adjusted diluted earnings per share (non-GAAP)$9.21$7.9716% * Not meaningful. PART II Item 7LIQUIDITY AND CAPITAL RESOURCES We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $104.8 billion and $130.3 billion as of June 30, 2022 and 2021, respectively. Equity investments were $6.9 billion and $6.0 billion as of June 30, 2022 and 2021, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Cash from operations increased $12.3 billion to $89.0 billion for fiscal year 2022, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees. Cash used in financing increased $10.4 billion to $58.9 billion for fiscal year 2022, mainly due to a $5.3 billion increase in common stock repurchases and a $5.3 billion increase in repayments of debt. Cash used in investing increased $2.7 billion to $30.3 billion for fiscal year 2022, mainly due to a $13.1 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $3.3 billion increase in additions to property and equipment, offset in part by a $15.6 billion increase in cash from net investment purchases, sales, and maturities.PART II Item 7Debt ProceedsWe issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2022:(In millions)Three Months EndingSeptember 30, 2022$17,691December 31, 202213,923March 31, 20239,491June 30, 20234,433Thereafter2,870Total$48,408If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. PART II Item 7Material Cash Requirements and Other Obligations Contractual ObligationsThe following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2022:(In millions)ThereafterTotalLong-term debt: (a) Principal payments$2,750$52,761$55,511Interest payments1,46821,13922,607Construction commitments (b) 7,9428,518Operating and finance leases, including imputed interest (c) 4,60944,04548,654Purchase commitments ( d ) 42,6692,98545,654Total$59,438$121,506$180,944( a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( d ) Purchase commitments primarily relate to datacenters and include open purchase orders and take-or-pay contracts that are not presented as construction commitments above. Income TaxesAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $6.2 billion, which included $1.5 billion for fiscal year 2022. The remaining transition tax of $12.0 billion is payable over the next four years, with $1.3 billion payable within 12 months. Provisions enacted in the TCJA related to the capitalization for tax purposes of research and experimental expenditures became effective on July 1, 2022. These provisions require us to capitalize research and experimental expenditures and amortize them on the U.S. tax return over five or fifteen years, depending on where research is conducted. The final foreign tax credit regulations, also effective on July 1, 2022, introduced significant changes to foreign tax credit calculations in the U.S. tax return. While these provisions are not expected to have a material impact on our fiscal year 2023 effective tax rate on a net basis, our cash paid for taxes would increase unless these provisions are postponed or modified through legislative processes.Share Repurchases During fiscal years 2022 and 2021, we repurchased 95 million shares and 101 million shares of our common stock for $28.0 billion and $23.0 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. As of June 30, 2022, $40.7 billion remained of our $60 billion share repurchase program. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends During fiscal year 2022, our Board of Directors declared quarterly dividends of $0.62 per share. We intend to continue returning capital to shareholders in the form of dividends, subject to declaration by our Board of Directors. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Other Planned Uses of Capital On January 18, 2022 , we entered into a definitive agreement to acquire Activision Blizzard , Inc. (Activision Blizzard ) for $ 95 .00 per share in an all-cash transaction valued at $ 68 .7 billion, inclusive of Activision Blizzards net cash. The acquisition has been approved by Activision Blizzards shareholders, and we expect it to close in fiscal year 2023, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.CRITICAL ACCOUNTING ESTIMATES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Critical accounting estimates are those estimates that involve a significant level of estimation uncertainty and could have a material impact on our financial condition or results of operations. We have critical accounting estimates in the areas of revenue recognition, impairment of investment securities, goodwill, research and development costs, legal and other contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. PART II Item 7Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. Impairment of Investment Securities We review debt investments quarterly for credit losses and impairment. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. This determination requires significant judgment. In making this judgment, we employ a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery, then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a periodic basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. PART II Item 7Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.CHANGE IN ACCOUNTING ESTIMATE In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years. This change in accounting estimate will be effective beginning fiscal year 2023. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2022, it is estimated this change will increase our fiscal year 2023 operating income by $3.7 billion. We had previously increased the estimated useful lives of both server and network equipment in July 2020.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerAlice L. JollaCorporate Vice President and Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKRISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency Revenue10% decrease in foreign exchange rates$(6,822)EarningsForeign currency Investments10% decrease in foreign exchange rates(94)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,536)Fair ValueCredit 100 basis point increase in credit spreads(350)Fair ValueEquity10% decrease in equity market prices(637)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS(In millions, except per share amounts)Year Ended June 30,Revenue:Product$72,732 $71,074 $68,041 Service and other125,538 97,014 74,974 Total revenue198,270 168,088 143,015 Cost of revenue:Product19,064 18,219 16,017 Service and other43,586 34,013 30,061 Total cost of revenue62,650 52,232 46,078 Gross margin135,620 115,856 96,937 Research and development24,512 20,716 19,269 Sales and marketing21,825 20,117 19,598 General and administrative5,900 5,107 5,111 Operating income83,383 69,916 52,959 Other income, net 1,186 Income before income taxes83,716 71,102 53,036 Provision for income taxes10,978 9,831 8,755 Net income$72,738 $61,271 $44,281 Earnings per share:Basic$9.70 $8.12 $5.82 Diluted$9.65 $8.05 $5.76 Weighted average shares outstanding:Basic7,496 7,547 7,610 Diluted7,540 7,608 7,683 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS(In millions)Year Ended June 30,Net income$72,738 $61,271 $44,281 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )Net change related to investments( 5,360 )( 2,266 )3,990 Translation adjustments and other( 1,146 )( 426 )Other comprehensive income (loss)( 6,500 )( 1,374 )3,526 Comprehensive income$66,238 $59,897 $47,807 Refer to accompanying notes. PART II Item 8BALANCE SHEETS (In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$13,931 $14,224 Short-term investments90,826 116,110 Total cash, cash equivalents, and short-term investments104,757 130,334 Accounts receivable, net of allowance for doubtful accounts of $ 633 and $ 751 44,261 38,043 Inventories3,742 2,636 Other current assets16,924 13,393 Total current assets169,684 184,406 Property and equipment, net of accumulated depreciation of $ 59,660 and $ 51,351 74,398 59,715 Operating lease right-of-use assets13,148 11,088 Equity investments6,891 5,984 Goodwill67,524 49,711 Intangible assets, net11,298 7,800 Other long-term assets21,897 15,075 Total assets$364,840 $333,779 Liabilities and stockholders equityCurrent liabilities:Accounts payable$19,000 $15,163 Current portion of long-term debt2,749 8,072 Accrued compensation10,661 10,057 Short-term income taxes4,067 2,174 Short-term unearned revenue45,538 41,525 Other current liabilities13,067 11,666 Total current liabilities95,082 88,657 Long-term debt47,032 50,074 Long-term income taxes26,069 27,190 Long-term unearned revenue2,870 2,616 Deferred income taxesOperating lease liabilities11,489 9,629 Other long-term liabilities15,526 13,427 Total liabilities198,298 191,791 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,464 and 7,519 86,939 83,111 Retained earnings84,281 57,055 Accumulated other comprehensive income (loss)( 4,678 )1,822 Total stockholders equity166,542 141,988 Total liabilities and stockholders equity$364,840 $333,779 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS(In millions)Year Ended June 30,OperationsNet income$72,738 $61,271 $44,281 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other14,460 11,686 12,796 Stock-based compensation expense7,502 6,118 5,289 Net recognized gains on investments and derivatives( 409 )( 1,249 )( 219 )Deferred income taxes( 5,702 )( 150 )Changes in operating assets and liabilities:Accounts receivable( 6,834 )( 6,481 )( 2,577 )Inventories( 1,123 )( 737 )Other current assets( 709 )( 932 )( 2,330 )Other long-term assets( 2,805 )( 3,459 )( 1,037 )Accounts payable2,943 2,798 3,018 Unearned revenue5,109 4,633 2,212 Income taxes( 2,309 )( 3,631 )Other current liabilities2,344 4,149 1,346 Other long-term liabilities1,402 1,348 Net cash from operations89,035 76,740 60,675 FinancingCash premium on debt exchange( 1,754 )( 3,417 )Repayments of debt( 9,023 )( 3,750 )( 5,518 )Common stock issued1,841 1,693 1,343 Common stock repurchased( 32,696 )( 27,385 )( 22,968 )Common stock cash dividends paid( 18,135 )( 16,521 )( 15,137 )Other, net( 863 )( 769 )( 334 )Net cash used in financing( 58,876 )( 48,486 )( 46,031 )InvestingAdditions to property and equipment( 23,886 )( 20,622 )( 15,441 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 22,038 )( 8,909 )( 2,521 )Purchases of investments( 26,456 )( 62,924 )( 77,190 )Maturities of investments16,451 51,792 66,449 Sales of investments28,443 14,008 17,721 Other, net( 2,825 )( 922 )( 1,241 )Net cash used in investing( 30,311 )( 27,577 )( 12,223 )Effect of foreign exchange rates on cash and cash equivalents( 141 )( 29 )( 201 )Net change in cash and cash equivalents( 293 )2,220 Cash and cash equivalents, beginning of period14,224 13,576 11,356 Cash and cash equivalents, end of period$13,931 $14,224 $13,576 Refer to accompanying notes.PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions, except per share amounts)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$83,111 $80,552 $78,520 Common stock issued1,841 1,963 1,343 Common stock repurchased( 5,688 )( 5,539 )( 4,599 )Stock-based compensation expense7,502 6,118 5,289 Other, net( 1 )Balance, end of period86,939 83,111 80,552 Retained earningsBalance, beginning of period57,055 34,566 24,150 Net income72,738 61,271 44,281 Common stock cash dividends( 18,552 )( 16,871 )( 15,483 )Common stock repurchased( 26,960 )( 21,879 )( 18,382 )Cumulative effect of accounting changes( 32 )Balance, end of period84,281 57,055 34,566 Accumulated other comprehensive income (loss)Balance, beginning of period1,822 3,186 ( 340 )Other comprehensive income (loss)( 6,500 )( 1,374 )3,526 Cumulative effect of accounting changesBalance, end of period( 4,678 )1,822 3,186 Total stockholders equity$166,542 $141,988 $118,304 Cash dividends declared per common share$2.48 $2.24 $2.04 Refer to accompanying notes. PART II Item 8NOTES TO FINANCIAL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties.In July 2022, we completed an assessment of the useful lives of our server and network equipment. Due to investments in software that increased efficiencies in how we operate our server and network equipment, as well as advances in technology, we determined we should increase the estimated useful lives of both server and network equipment from four years to six years . This change in accounting estimate will be effective beginning fiscal year 2023. We had previously increased the estimated useful lives of both server and network equipment in July 2020.Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, video games, and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances and Other Receivables Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future, LinkedIn subscriptions, Office 365 subscriptions, Xbox subscriptions, Windows post-delivery support, Dynamics business solutions, and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.As of June 30, 2022 and 2021, other receivables due from suppliers were $ 1.0 billion and $ 965 million, respectively, and are included in accounts receivable, net in our consolidated balance sheets.As of June 30, 2022 and 2021, long-term accounts receivable, net of allowance for doubtful accounts, was $ 3.8 billion and $ 3.4 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. PART II Item 8Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 245 )( 252 )( 178 )Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$ 816 We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2022 and 2021, our financing receivables, net were $ 4.1 billion and $ 4.4 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.5 billion, $ 1.5 billion, and $ 1.6 billion in fiscal years 2022, 2021, and 2020, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding credit losses and impairments, are recorded in other comprehensive income . Fair value is calculated based on publicly available market information or other estimates determined by management. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. To determine credit losses, we employ a systematic methodology that considers available quantitative and qualitative evidence. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery , then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a periodic basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in other income (expense), net with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities include certain over-the-counter forward, option, and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to four years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Accounting for Income TaxesIn December 2019, the Financial Accounting Standards Board issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. We adopted the standard effective July 1, 2021. Adoption of the standard did not have a material impact on our consolidated financial statements.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. The components of basic and diluted EPS were as follows: (In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$72,738 $61,271 $ 44,281 Weighted average outstanding shares of common stock (B)7,496 7,547 7,610 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,540 7,608 7,683 Earnings Per ShareBasic (A/B)$9.70 $8.12 $5.82 Diluted (A/C)$9.65 $8.05 $5.76 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,094 $2,131 $2,680 Interest expense( 2,063 )( 2,346 )( 2,591 )Net recognized gains on investments1,232 Net gains (losses) on derivatives( 52 )Net gains (losses) on foreign currency remeasurements( 75 )( 191 )Other, net( 32 )( 40 )Total$$1,186 $PART II Item 8Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 138 )( 40 )( 37 ) Impairments and allowance for credit losses( 81 )( 2 )( 17 ) Total$( 57 )$$( 4 ) Net recognized gains (losses) on equity investments were as follows:(In millions) Year Ended June 30,Net realized gains on investments sold$$$Net unrealized gains on investments still held1,057 69 Impairments of investments( 20 )( 11 )( 116 ) Total$$1,169 $ 36 PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2022Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$2,500 $$$2,500 $2,498 $$Certificates of depositLevel 22,071 2,071 2,032 U.S. government securitiesLevel 179,696 ( 2,178 )77,547 77,538 U.S. agency securitiesLevel 2( 9 )Foreign government bondsLevel 2( 24 )Mortgage- and asset-backed securitiesLevel 2( 30 )Corporate notes and bondsLevel 211,661 ( 554 )11,111 11,111 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 13 )Municipal securitiesLevel 3( 6 )Total debt investments$98,118 $$( 2,814 )$95,357 $4,539 $90,818 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,590 $1,134 $$Equity investmentsOther6,435 6,435 Total equity investments$8,025 $1,134 $$6,891 Cash$8,258 $8,258 $$Derivatives, net (a) Total$111,648 $13,931 $90,826 $6,891 PART II Item 8(In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2021Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,316 $$$4,316 $1,331 $2,985 $Certificates of depositLevel 23,615 3,615 2,920 U.S. government securitiesLevel 190,664 3,832 ( 111 )94,385 1,500 92,885 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,213 ( 2 )6,220 5,995 Mortgage- and asset-backed securitiesLevel 23,442 ( 6 )3,458 3,458 Corporate notes and bondsLevel 28,443 ( 9 )8,683 8,683 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3( 7 )Total debt investments$117,966 $4,177 $( 135 )$122,008 $5,976 $116,032 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,582 $$$Equity investmentsOther5,378 5,378 Total equity investments$6,960 $$$5,984 Cash$7,272 $7,272 $$Derivatives, net (a) Total$136,318 $14,224 $116,110 $5,984 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2022 and 2021, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 3.8 billion and $ 3.3 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2022U.S. government and agency securities$59,092 $( 1,835 )$2,210 $( 352 )$61,302 $( 2,187 )Foreign government bonds( 18 )( 6 )( 24 )Mortgage- and asset-backed securities( 26 )( 4 )( 30 )Corporate notes and bonds9,443 ( 477 )( 77 )10,229 ( 554 )Municipal securities( 12 )( 7 )( 19 )Total$69,641 $( 2,368 )$3,138 $( 446 )$72,779 $( 2,814 )PART II Item 8Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2021U.S. government and agency securities$5,294 $( 111 )$$$5,294 $( 111 )Foreign government bonds3,148 ( 1 )( 1 )3,153 ( 2 )Mortgage- and asset-backed securities1,211 ( 5 )( 1 )1,298 ( 6 )Corporate notes and bonds1,678 ( 8 )( 1 )1,712 ( 9 )Municipal securities( 7 )( 7 )Total$11,389 $( 132 )$$( 3 )$11,516 $( 135 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)AdjustedCost BasisEstimatedFair ValueJune 30, 2022Due in one year or less$26,480 $26,470 Due after one year through five years52,006 50,748 Due after five years through 10 years18,274 16,880 Due after 10 years1,358 1,259 Total$98,118 $95,357 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.PART II Item 8Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts . These contracts are not designated as hedging instruments and are included in Other contracts in the tables below. Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2022, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,081 Interest rate contracts purchased1,139 1,247 Not Designated as Hedging InstrumentsForeign exchange contracts purchased10,322 14,223 Foreign exchange contracts sold21,606 23,391 Other contracts purchased2,773 2,456 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 77 )$$( 8 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 362 )( 291 )Other contracts( 112 )( 36 )Gross amounts of derivatives( 551 )( 335 )Gross amounts of derivatives offset in the balance sheet( 130 )( 141 )Cash collateral received 0 ( 75 ) 0 ( 42 )Net amounts of derivatives$$( 493 )$$( 235 )Reported asShort-term investments$$$$Other current assetsOther long-term assetsOther current liabilities( 298 )( 182 )Other long-term liabilities( 195 )( 53 )Total$$( 493 )$$( 235 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 343 million and $ 550 million, respectively, as of June 30, 2022, and $ 395 million and $ 335 million, respectively, as of June 30, 2021. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2022Derivative assets$$$$Derivative liabilities( 551 )( 551 )June 30, 2021Derivative assetsDerivative liabilities( 335 )( 335 )PART II Item 8Gains (losses) on derivative instruments recognized in other income (expense), net were as follows:(In millions)Year Ended June 30,Designated as Fair Value Hedging InstrumentsForeign exchange contractsDerivatives$$$Hedged items( 50 )( 188 )Excluded from effectiveness assessmentInterest rate contractsDerivatives( 92 )( 37 )Hedged items( 93 )Designated as Cash Flow Hedging InstrumentsForeign exchange contractsAmount reclassified from accumulated other comprehensive income( 79 )Not Designated as Hedging InstrumentsForeign exchange contracts( 123 )Other contracts( 72 )Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$( 57 )$$( 38 )NOTE 6 INVENTORIES The components of inventories were as follows:(In millions)June 30,Raw materials$1,144 $1,190 Work in processFinished goods2,516 1,367 Total$3,742 $2,636 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$4,734 $3,660 Buildings and improvements55,014 43,928 Leasehold improvements7,819 6,884 Computer equipment and software60,631 51,250 Furniture and equipment5,860 5,344 Total, at cost134,058 111,066 Accumulated depreciation( 59,660 )( 51,351 )Total, net$ 74,398 $ 59,715 During fiscal years 2022, 2021, and 2020, depreciation expense was $ 12.6 billion, $ 9.3 billion, and $ 10.7 billion, respectively. We have committed $ 8.5 billion, primarily related to datacenters, for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2022. NOTE 8 BUSINESS COMBINATIONS Nuance Communications, Inc. On March 4, 2022 , we completed our acquisition of Nuance Communications, Inc. (Nuance) for a total purchase price of $ 18.8 billion, consisting primarily of cash. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The financial results of Nuance have been included in our consolidated financial statements since the date of the acquisition. Nuance is reported as part of our Intelligent Cloud segment.The purchase price allocation as of the date of acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:(In millions) Goodwill (a) $ 16,308 Intangible assets4,365 Other assetsOther liabilities (b) ( 1,971 )Total $18,761 (a) Goodwill was assigned to our Intelligent Cloud segment and was primarily attributed to increased synergies that are expected to be achieved from the integration of Nuance. None of the goodwill is expected to be deductible for income tax purposes. (b) Includes $ 986 million of convertible senior notes issued by Nuance in 2015 and 2017, of which $ 985 million was redeemed prior to June 30, 2022. The remaining $ 1 million of notes are redeemable through their respective maturity dates and are included in other current liabilities on our consolidated balance sheets as of June 30, 2022. PART II Item 8Following are the details of the purchase price allocated to the intangible assets acquired:(In millions, except average life)AmountWeightedAverage LifeCustomer-related$2,610 9 yearsTechnology-based1,540 5 yearsMarketing-related4 yearsTotal$4,365 7 yearsZeniMax Media Inc.On March 9, 2021 , we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC (Bethesda), for a total purchase price of $ 8.1 billion, consisting primarily of cash. The purchase price included $ 766 million of cash and cash equivalents acquired. Bethesda is one of the largest, privately held game developers and publishers in the world, and brings a broad portfolio of games, technology, and talent to Xbox. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment.The allocation of the purchase price to goodwill was completed as of December 31, 2021. The major classes of assets and liabilities to which we have allocated the purchase price were as follows:(In millions) Cash and cash equivalents$Goodwill 5,510 Intangible assets1,968 Other assetsOther liabilities( 244 ) Total $8,121 Goodwill was assigned to our More Personal Computing segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of ZeniMax. None of the goodwill is expected to be deductible for income tax purposes.Following are details of the purchase price allocated to the intangible assets acquired:(In millions, except average life)AmountWeightedAverage LifeTechnology-based$1,341 4 yearsMarketing-related11 yearsTotal$1,968 6 yearsActivision Blizzard, Inc.On January 18, 2022 , we entered into a definitive agreement to acquire Activision Blizzard , Inc. (Activision Blizzard ) for $ 95.00 per share in an all-cash transaction valued at $ 68.7 billion, inclusive of Activision Blizzards net cash. Activision Blizzard is a leader in game development and an interactive entertainment content publisher. The acquisition will accelerate the growth in our gaming business across mobile, PC, console, and cloud and will provide building blocks for the metaverse. The acquisition has been approved by Activision Blizzards shareholders, and we expect it to close in fiscal year 202 3 , subject to the satisfaction of certain regulatory approvals and other customary closing conditions.PART II Item 8NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows:(In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2022Productivity and Business Processes$24,190 $$$24,317 $$( 105 )$24,811 Intelligent Cloud12,697 13,256 16,879 (b) (b) 30,182 More Personal Computing6,464 5,556 (a) (a) 12,138 ( 255 )12,531 Total$43,351 $6,061 $299 $49,711 $18,126 $( 313 )$67,524 (a) Includes goodwill of $ 5.5 billion related to ZeniMax. See Note 8 Business Combinations for further information . (b) Includes goodwill of $ 16.3 billion related to Nuance. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill ImpairmentWe test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2022, May 1, 2021, or May 1, 2020 tests. As of June 30, 2022 and 2021, accumulated goodwill impairment was $ 11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$11,277 $( 6,958 )$4,319 $9,779 $( 7,007 )$2,772 Customer-related7,342 ( 3,171 )4,171 4,958 ( 2,859 )2,099 Marketing-related4,942 ( 2,143 )2,799 4,792 ( 1,878 )2,914 Contract-based( 7 )( 431 )Total$23,577 (a) $( 12,279 )$11,298 $19,975 (b) $( 12,175 )$7,800 (a) Includes intangible assets of $ 4.4 billion related to Nuance. See Note 8 Business Combinations for further information. (b) Includes intangible assets of $ 2.0 billion related to ZeniMax. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2022, 2021, or 2020. We estimate that we have no significant residual value related to our intangible assets.PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$2,611 4 years$1,628 4 yearsCustomer-related2,837 9 years4 yearsMarketing-related4 years6 yearsContract-based0 years3 yearsTotal$5,681 7 years$ 2,359 5 yearsIntangible assets amortization expense was $ 2.0 billion, $ 1.6 billion, and $ 1.6 billion for fiscal years 2022, 2021, and 2020, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2022:(In millions)Year Ending June 30,$2,654 2,385 1,631 1,227 Thereafter2,592 Total$11,298 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 4.50 %4.57 %2011 issuance of $ 2.3 billion (a) 5.30 %5.36 %2012 issuance of $ 2.3 billion (a) 2.13 %3.50 %2.24 %3.57 %1,204 1,204 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,814 2,814 2013 issuance of 4.1 billion2.63 %3.13 %2.69 %3.22 %2,404 4,803 2015 issuance of $ 23.8 billion (a) 2.65 %4.75 %2.72 %4.78 %10,805 12,305 2016 issuance of $ 19.8 billion (a) 2.00 %3.95 %2.10 %4.03 %9,430 12,180 2017 issuance of $ 17.0 billion (a) 2.88 %4.50 %3.04 %4.53 %8,945 10,695 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 10,000 2021 issuance of $ 8.2 billion (a) 2.92 %3.04 %2.92 %3.04 %8,185 8,185 Total face value55,511 63,910 Unamortized discount and issuance costs( 471 )( 511 )Hedge fair value adjustments ( b ) ( 68 )Premium on debt exchange (a) ( 5,191 )( 5,293 )Total debt49,781 58,146 Current portion of long-term debt( 2,749 )( 8,072 )Long-term debt$47,032 $50,074 (a) In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities. The premiums are amortized over the terms of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2022 and 2021, the estimated fair value of long-term debt, including the current portion, was $ 50.9 billion and $ 70.0 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. Cash paid for interest on our debt for fiscal years 2022, 2021, and 2020 was $ 1.9 billion, $ 2.0 billion, and $ 2.4 billion, respectively . The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2022: (In millions)Year Ending June 30,$2,750 5,250 2,250 3,000 8,000 Thereafter34,261 Total$55,511 PART II Item 8NOTE 12 INCOME TAXES Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$8,329 $3,285 $3,537 U.S. state and local1,679 1,229 Foreign6,672 5,467 4,444 Current taxes$16,680 $9,981 $8,744 Deferred TaxesU.S. federal$( 4,815 )$$U.S. state and local( 1,062 )( 204 )( 6 )Foreign( 41 )Deferred taxes$( 5,702 )$( 150 )$Provision for income taxes$10,978 $9,831 $8,755 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$47,837 $34,972 $24,116 Foreign 35,879 36,130 28,920 Income before income taxes$83,716 $71,102 $53,036 Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %21.0 %Effect of:Foreign earnings taxed at lower rates( 1.3 )%( 2.7 )%( 3.7 )%Impact of intangible property transfers( 3.9 )%%%Foreign-derived intangible income deduction( 1.1 )%( 1.3 )%( 1.1 )%State income taxes, net of federal benefit1.4 %1.4 %1.3 %Research and development credit( 0.9 )%( 0.9 )%( 1.1 )%Excess tax benefits relating to stock-based compensation( 1.9 )%( 2.4 )%( 2.2 )%Interest, net0.5 %0.5 %1.0 %Other reconciling items, net( 0.7 )%( 1.8 )%1.3 %Effective rate13.1 %13.8 %16.5 %In the first quarter of fiscal year 2022, we transferred certain intangible properties from our Puerto Rico subsidiary to the U.S. The transfer of intangible properties resulted in a $ 3.3 billion net income tax benefit in the first quarter of fiscal year 2022, as the value of future U.S. tax deductions exceeds the current tax liability from the U.S. global intangible low-taxed income (GILTI) tax.PART II Item 8We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $ 620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016 . The decrease from the federal statutory rate in fiscal year 2022 is primarily due to the net income tax benefit related to the transfer of intangible properties, earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations center in Ireland, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2021 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. In fiscal years 2022, 2021, and 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 71 %, 82 %, and 86 % of our foreign income before tax. Other reconciling items, net consists primarily of tax credits and GILTI tax, and in fiscal year 2021, includes tax benefits from the India Supreme Court decision on withholding taxes. In fiscal years 2022, 2021, and 2020, there were no individually significant other reconciling items.The decrease in our effective tax rate for fiscal year 2022 compared to fiscal year 2021 was primarily due to a $ 3.3 billion net income tax benefit in the first quarter of fiscal year 2022 related to the transfer of intangible properties, offset in part by changes in the mix of our income before income taxes between the U.S. and foreign countries, as well as tax benefits in the prior year from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing, and final Tax Cuts and Jobs Act (TCJA) regulations. The decrease in our effective tax rate for fiscal year 2021 compared to fiscal year 2020 was primarily due to tax benefits from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing, final TCJA regulations, and an increase in tax benefits relating to stock-based compensation.PART II Item 8The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,874 2,960 Loss and credit carryforwards1,546 1,090 Amortization10,656 6,346 Leasing liabilities4,557 4,060 Unearned revenue2,876 2,659 OtherDeferred income tax assets23,571 17,936 Less valuation allowance( 1,012 )( 769 )Deferred income tax assets, net of valuation allowance$22,559 $17,167 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 174 )$( 2,381 )Leasing assets( 4,291 )( 3,834 )Depreciation( 1,602 )( 1,010 )Deferred tax on foreign earnings( 3,104 )( 2,815 )Other( 103 )( 144 )Deferred income tax liabilities$( 9,274 )$( 10,184 )Net deferred income tax assets$13,285 $6,983 Reported AsOther long-term assets$13,515 $7,181 Long-term deferred income tax liabilities( 230 )( 198 )Net deferred income tax assets$13,285 $6,983 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2022, we had federal, state, and foreign net operating loss carryforwards of $ 318 million, $ 1.3 billion, and $ 2.1 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2023 through 2042 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation but are expected to be realized with the exception of those which have a valuation allowance. As of June 30, 2022, we had $ 1.3 billion federal capital loss carryforwards for U.S. tax purposes from our acquisition of Nuance. The federal capital loss carryforwards are subject to an annual limitation and will expire in various years from fiscal 2023 through 2025 .The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards, federal capital loss carryforwards, and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $ 16.0 billion, $ 13.4 billion, and $ 12.5 billion in fiscal years 2022, 2021, and 2020, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2022, 2021, and 2020, were $ 15.6 billion, $ 14.6 billion, and $ 13.8 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2022, 2021, and 2020 by $ 13.3 billion, $ 12.5 billion, and $ 12.1 billion, respectively.PART II Item 8As of June 30, 2022, 2021, and 2020, we had accrued interest expense related to uncertain tax positions of $ 4.3 billion, $ 4.3 billion, and $ 4.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2022, 2021, and 2020 included interest expense related to uncertain tax positions of $ 36 million, $ 274 million, and $ 579 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows: (In millions)Year Ended June 30,Beginning unrecognized tax benefits$14,550 $13,792 $13,146 Decreases related to settlements( 317 )( 195 )( 31 )Increases for tax positions related to the current year1,145 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 246 )( 297 )( 331 )Decreases due to lapsed statutes of limitations( 1 )( 5 )Ending unrecognized tax benefits$15,593 $14,550 $13,792 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $ 1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017 .As of June 30, 2022, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2021 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements. NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$24,558 $22,120 Intelligent Cloud19,371 17,710 More Personal Computing4,479 4,311 Total$48,408 $44,141 Changes in unearned revenue were as follows: (In millions)Year Ended June 30, 2022Balance, beginning of period$44,141 Deferral of revenue110,455 Recognition of unearned revenue( 106,188 )Balance, end of period$48,408 PART II Item 8Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 193 billion as of June 30, 2022, of which $ 189 billion is related to the commercial portion of revenue. We expect to recognize approximately 45 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. Our leases have remaining lease terms of 1 year to 19 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows: (In millions)Year Ended June 30,Operating lease cost$2,461 $2,127 $2,043 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$1,409 $1,307 $Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$2,368 $2,052 $1,829 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases5,268 4,380 3,677 Finance leases4,234 3,290 3,467 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$13,148 $11,088 Other current liabilities$2,228 $1,962 Operating lease liabilities11,489 9,629 Total operating lease liabilities$13,717 $11,591 Finance LeasesProperty and equipment, at cost$17,388 $14,107 Accumulated depreciation( 3,285 )( 2,306 )Property and equipment, net$14,103 $11,801 Other current liabilities$1,060 $Other long-term liabilities13,842 11,750 Total finance lease liabilities$14,902 $12,541 Weighted Average Remaining Lease TermOperating leases8 years8 yearsFinance leases12 years12 yearsWeighted Average Discount RateOperating leases2.1 %2.2 %Finance leases3.1 %3.4 %The following table outlines maturities of our lease liabilities as of June 30, 2022:(In millions)Year Ending June 30,OperatingLeasesFinanceLeases$2,456 $1,477 2,278 1,487 1,985 1,801 1,625 1,483 1,328 1,489 Thereafter5,332 9,931 Total lease payments15,004 17,668 Less imputed interest( 1,287 )( 2,766 )Total$13,717 $14,902 As of June 30, 2022, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 7.2 billion and $ 8.8 billion, respectively. These operating and finance leases will commence between fiscal year 2023 and fiscal year 2028 with lease terms of 1 year to 18 years .PART II Item 8NOTE 15 CONTINGENCIES Antitrust Litigation and Claims China State Administration for Market Regulation Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. In 2019, the SAMR presented preliminary views as to certain possible violations of Chinas Anti-Monopoly Law.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 46 lawsuits, including 45 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing on general causation is scheduled for September of 2022 . Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2022, we accrued aggregate legal liabilities of $ 364 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 600 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. PART II Item 8NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,519 7,571 7,643 IssuedRepurchased( 95 )( 101 )( 126 )Balance, end of year7,464 7,519 7,571 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020 and was completed in November 2021.On September 14, 2021, our Board of Directors approved a share repurchase program authorizing up to $ 60.0 billion in share repurchases. This share repurchase program commenced in November 2021, following completion of the program approved on September 18, 2019, has no expiration date, and may be terminated at any time. As of June 30, 2022, $ 40.7 billion remained of this $ 60.0 billion share repurchase program.We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$6,200 $5,270 $4,000 Second Quarter6,233 5,750 4,600 Third Quarter7,800 5,750 6,000 Fourth Quarter7,800 6,200 5,088 Total$28,033 $22,970 $19,688 All repurchases were made using cash resources. Shares repurchased during the fourth and third quarters of fiscal year 2022 were under the share repurchase program approved on September 14, 2021. Shares repurchased during the second quarter of fiscal year 2022 were under the share repurchase programs approved on both September 14, 2021 and September 18, 2019. Shares repurchased during the first quarter of fiscal year 2022, fiscal year 2021, and the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 4.7 billion, $ 4.4 billion, and $ 3.3 billion for fiscal years 2022, 2021, and 2020, respectively.PART II Item 8Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2022(In millions)September 14, 2021 November 18, 2021 December 9, 2021 $0.62 $4,652 December 7, 2021 February 17, 2022 March 10, 2022 0.62 4,645 March 14, 2022 May 19, 2022 June 9, 2022 0.62 4,632 June 14, 2022 August 18, 2022 September 8, 2022 0.62 4,627 Total$2.48 $18,556 Fiscal Year 2021September 15, 2020 November 19, 2020 December 10, 2020 $0.56 $4,230 December 2, 2020 February 18, 2021 March 11, 2021 0.56 4,221 March 16, 2021 May 20, 2021 June 10, 2021 0.56 4,214 June 16, 2021 August 19, 2021 September 9, 2021 0.56 4,206 Total$2.24 $16,871 The dividend declared on June 14, 2022 was included in other current liabilities as of June 30, 2022. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component :(In millions)Year Ended June 30,DerivativesBalance, beginning of period$( 19 )$( 38 )$Unrealized gains (losses), net of tax of $( 15 ) , $ 9 , and $( 10 )( 57 )( 38 )Reclassification adjustments for (gains) losses included in other income (expense), net( 17 )Tax expense (benefit) included in provision for income taxes( 16 )Amounts reclassified from accumulated other comprehensive income (loss)( 15 )Net change related to derivatives, net of tax of $ 1 , $ 7 , and $( 10 )( 38 )Balance, end of period$( 13 )$( 19 )$( 38 )InvestmentsBalance, beginning of period$3,222 $5,478 $1,488 Unrealized gains (losses), net of tax of $( 1,440 ) , $( 589 ), and $ 1,057 ( 5,405 )( 2,216 )3,987 Reclassification adjustments for (gains) losses included in other income (expense), net( 63 )Tax expense (benefit) included in provision for income taxes( 12 )( 1 )Amounts reclassified from accumulated other comprehensive income (loss)( 50 )Net change related to investments, net of tax of $( 1,428 ) , $( 602 ), and $ 1,058 ( 5,360 )( 2,266 )3,990 Cumulative effect of accounting changesBalance, end of period$( 2,138 )$3,222 $5,478 Translation Adjustments and OtherBalance, beginning of period$( 1,381 )$( 2,254 )$( 1,828 )Translation adjustments and other, net of tax of $ 0 , $( 9 ), and $ 1 ( 1,146 )( 426 )Balance, end of period$( 2,527 )$( 1,381 )$( 2,254 )Accumulated other comprehensive income (loss), end of period$( 4,678 )$1,822 $3,186 NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$7,502 $6,118 $5,289 Income tax benefits related to stock-based compensation1,293 1,065 Stock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.56 0.62 $0.51 0.56 $0.46 0.51 Interest rates0.03 %3.6 %0.01 %1.5 %0.1 %2.2 %During fiscal year 2022, the following activity occurred under our stock plans: SharesWeighted AverageGrant-Date FairValue(In millions)Stock AwardsNonvested balance, beginning of year$152.51 Granted (a) 291.22 Vested( 47 ) 143.10 Forfeited( 10 ) 189.88 Nonvested balance, end of year$227.59 (a) Includes 1 million, 2 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2022, 2021, and 2020, respectively. As of June 30, 2022, there was approximately $ 16.7 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 291.22 , $ 221.13 , and $ 140.49 for fiscal years 2022, 2021, and 2020, respectively. The fair value of stock awards vested was $ 14.1 billion, $ 13.4 billion, and $ 10.1 billion, for fiscal years 2022, 2021, and 2020, respectively. As of June 30, 2022, an aggregate of 211 million shares were authorized for future grant under our stock plans.Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Under the terms of the ESPP that were approved in 2012, the plan was set to terminate on December 31, 2022. At our 2021 Annual Shareholders Meeting, our shareholders approved a successor ESPP with a January 1, 2022 effective date and ten-year expiration of December 31, 2031. No additional shares were requested at this meeting.Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$259.55 $207.88 $142.22 As of June 30, 2022, 81 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plans We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We match a portion of each dollar a participant contributes into the plans. Employer-funded retirement benefits for all plans were $ 1.4 billion, $ 1.2 billion, and $ 1.0 billion in fiscal years 2022, 2021, and 2020, respectively, and were expensed as contributed.NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Microsoft Viva. Office Consumer, including Microsoft 365 Consumer subscriptions, Office licensed on-premises, and other Office services. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, and Sales Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure and other cloud services SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and Nuance and GitHub. Enterprise Services, including Enterprise Support Services, Microsoft Consulting Services, and Nuance professional services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing and Windows Internet of Things. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising first- and third-party content (including games and in-game content), Xbox Game Pass and other subscriptions, Xbox Cloud Gaming, third-party disc royalties, advertising, and other cloud services. Search and news advertising. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include legal, including settlements and fines, information technology, human resources, finance, excise taxes, field selling, shared facilities services, and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$63,364 $53,915 $46,398 Intelligent Cloud75,251 60,080 48,366 More Personal Computing59,655 54,093 48,251 Total$198,270 $168,088 $143,015 Operating Income Productivity and Business Processes$29,687 $24,351 $18,724 Intelligent Cloud32,721 26,126 18,324 More Personal Computing20,975 19,439 15,911 Total$83,383 $69,916 $52,959 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2022, 2021, or 2020. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $100,218 $83,953 $73,160 Other countries98,052 84,135 69,855 Total$198,270 $168,088 $143,015 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$67,321 $52,589 $41,379 Office products and cloud services44,862 39,872 35,316 Windows24,761 22,488 21,510 Gaming16,230 15,370 11,575 LinkedIn13,816 10,289 8,077 Search and news advertising11,591 9,267 8,524 Enterprise Services7,407 6,943 6,409 Devices6,991 6,791 6,457 Other 5,291 4,479 3,768 Total$198,270 $168,088 $143,015 We have recast certain previously reported amounts in the table above to conform to the way we internally manage and monitor our business.Our Microsoft Cloud (formerly commercial cloud) revenue, which includes Azure and other cloud services, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 91.2 billion, $ 69.1 billion and $ 51.7 billion in fiscal years 2022, 2021, and 2020, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$106,430 $76,153 $60,789 Ireland15,505 13,303 12,734 Other countries44,433 38,858 29,770 Total$166,368 $ 128,314 $ 103,293 PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2022 and 2021, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2022, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2022, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 28, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statementsCritical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: - Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.- Tested management's identification and treatment of contract terms. - Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statementsCritical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington July 28, 2022We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2022. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2022 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2022, based on criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended June 30, 2022, of the Company and our report dated July 28, 2022, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, WashingtonJuly 28, 2022PART II, III Item 9B, 9C, 10, 11, 12, 13, 14" +1,msft,20210630," ITEM 1. BUSINESSGENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We bring technology and products together into experiences and solutions that unlock value for our customers. Our ecosystem of customers and partners has stepped up to help people and organizations in every country use technology to be resilient and transform during the most trying of circumstances. Amid rapid change weve witnessed technology empower telehealth, remote manufacturing, and new ways of working from home and serving customers. These capabilities have relied on the public cloud, which is built on the investments we have made over time. We are living in the new era of the intelligent cloud and intelligent edge, which is being sharpened by rapid advances in distributed computing, ambient intelligence, and multidevice experiences. This means the places we go and the things we interact with will increasingly become digitized, creating new opportunities and new breakthroughs. In the next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, and video games. We also design and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The Ambitions That Drive Us To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesAt Microsoft, were providing technology and resources to help our customers navigate a remote environment. Were seeing our family of products play key roles in the ways the world is continuing to work, learn, and connect. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is enabling rapid digital transformation by giving people a single tool to chat, call, meet, and collaborate. Microsoft Viva is an employee experience platform that brings together communications, knowledge, learning, resources, and insights powered by Microsoft 365. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and discover new habits, while simplifying security and management. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. This creates an opportunity to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformIn the new remote world, companies have accelerated their own digital transformation to empower their employees, optimize their operations, engage customers, and in some cases, change the very core of their products and services. Partnering with organizations on their digital transformation during this period is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice their success is our success.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.The Microsoft Cloud is the most comprehensive and trusted cloud, providing the best integration across the technology stack while offering openness, improving time to value, reducing costs, and increasing agility. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans security, compliance, identity, and management, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. Azure Arc simplifies governance and management by delivering a consistent multi-cloud and on-premises management platform. Security, compliance, identity, and management underlie our entire tech stack. We offer integrated, end-to-end capabilities to protect people and organizations. In April 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc., a cloud and AI software provider with healthcare and enterprise AI experience. The acquisition will build on our industry-specific cloud offerings. PART I Item 1We are accelerating our development of mixed reality solutions with new Azure services and devices. Microsoft Mesh enables presence and shared experiences from anywhere through mixed reality applications. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads and experiences which we believe will shape the next era of computing. The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. Azure Synapse Analytics, a limitless analytics service, brings together data integration, enterprise data warehousing, and big data analytics for immediate business intelligence and machine learning needs. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. From GitHub to Visual Studio, we provide a developer tool chain for everyone, no matter the technical experience, across all platforms, whether Azure, Windows, or any other cloud or client platform.Create More Personal ComputingWe strive to make computing more personal by putting people at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. Microsoft 365 is empowering people and organizations to be productive and secure as they adapt to more fluid ways of working and learning. The PC has been mission-critical across work, school, and life to sustain productivity in a remote everything world. Windows 10 serves the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising. In June 2021, Microsoft announced the next generation of Windows Windows 11. Windows 11 builds on the strengths of productivity, versatility, and security on Windows 10 today and adds in new experiences that include powerful task switching tools like new snap layouts, snap groups, and desktops new ways to stay connected through chat the information you want at your fingertips and more. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge.Microsoft Edge is our fast and secure browser that helps protect your data, with built-in shopping tools designed to save you time and money. Organizational tools such as Collections, Vertical Tabs, and Immersive Reader help you make the most of your time while browsing, streaming, searching, sharing, and more.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. The Surface family includes Surface Book 3, Surface Laptop Go, Surface Go 2, Surface Pro 7, Surface Laptop 4, Surface Pro X, Surface Studio 2, and Surface Duo. To expand usage and deepen engagement, we continue to invest in content, community, and cloud services as we pursue the expansive opportunity in the gaming industry. We have broadened our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played, including cloud gaming so players can stream across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers, including the March 2021 acquisition of ZeniMax Media Inc., the parent company of Bethesda Softworks LLC, one of the largest, privately held game developers and publishers in the world. Xbox Game Pass is a community with access to a curated library of over 100 first- and third-party console and PC titles. Xbox Cloud Gaming is Microsofts game streaming technology that is complementary to our console hardware and gives fans the ultimate choice to play the games they want, with the people they want, on the devices they want. PART I Item 1Our Future Opportunity In a time of great disruption and uncertainty, customers are looking to us to accelerate their own digital transformations as software and cloud computing play a huge role across every industry and around the world. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business, grow our share of the PC market, and drive increased engagement with our services like Microsoft 365 Consumer, Teams, Edge, Bing, Xbox Game Pass , and more. Tackling security from all angles with our integrated, end-to-end solutions spanning security, compliance, identity, and management, across all clouds and platforms. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.COVID-19In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic. The COVID-19 pandemic continues to have widespread and unpredictable impacts on global society, economies, financial markets, and business practices, and continues to impact our business operations, including our employees, customers, partners, and communities. Refer to Managements Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7 of this Form 10-K) for further discussion regarding the impact of COVID-19 on our fiscal year 2021 financial results. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.Corporate Social ResponsibilityCommitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. We are accelerating progress toward a more sustainable future by reducing our environmental footprint, advancing research, helping our customers build sustainable solutions, and advocating for policies that benefit the environment. In January 2020, we announced a bold commitment and detailed plan to be carbon negative by 2030, and to remove from the environment by 2050 all the carbon we have emitted since our founding in 1975. This included a commitment to invest $1 billion over four years in new technologies and innovative climate solutions. We built on this pledge by adding commitments to be water positive by 2030, zero waste by 2030, and to protect ecosystems by developing a Planetary Computer. We also help our suppliers and customers around the world use Microsoft technology to reduce their own carbon footprint. In January 2021, we announced that in fiscal year 2020 we reduced Microsofts carbon emissions by 586,683 metric tons. We purchased the removal of 1.3 million metric tons of carbon from 26 projects around the world. Furthermore, we shared a commitment to transparency by subjecting the data in our annual sustainability report to third-party review and to accountability by including progress on sustainability goals as a factor in determining executive pay.PART I Item 1The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment . Our cloud and AI services and datacenters help businesses cut energy consumption, reduce physical footprints, and design sustainable products. We also pledged a $50 million investment in AI for Earth to accelerate innovation by putting AI in the hands of those working to directly address sustainability challenges. We are committed to playing our part to help accelerate the worlds transition to a more economically and environmentally sustainable future for us all . Addressing Racial Injustice and InequityOur future opportunity depends on reaching and empowering all communities, and we are committed to taking action to help address racial injustice and inequity. With significant input from employees and leaders who are members of the Black and African American community, our senior leadership team and board of directors announced in June 2020 that we had developed a set of actions to help improve the lived experience at Microsoft and drive change in the communities in which we live and work. These efforts include increasing our representation and strengthening our culture of inclusion by doubling the number of Black and African American people managers, senior individual contributors, and senior leaders in the United States by 2025 evolving our ecosystem with our supply chain, banking partners, and partner ecosystem and strengthening our communities by using data, technology, and partnerships to help address racial injustice and inequities of the Black and African American communities in the U.S. and improve the safety and wellbeing of our employees and their communities.Over the last year, we have collaborated with partners and worked within neighborhoods and communities to launch and scale a number of projects and programs including: expanding our existing justice reform work with a five-year, $50 million sustained effort, expanding access to affordable broadband and devices for Black and African American communities and key institutions that support them in major urban centers, expanding access to skills and education to support Black and African American students and adults to succeed in the digital economy, and increasing technology support for nonprofits that provide critical services to Black and African American communities.We have more than doubled our percentage share of transaction volume with Black- and African American-owned financial institutions and increased our deposits with Black- and African American-owned minority depository institutions, enabling increased funds into local communities. Additionally, we have seen growth in our Black- and African American-owned supplier base and in Black- and African American-owned technology partners in the Microsoft Partner Network, and we launched the Black Channel Partner Alliance community to support partners onboarding to the Microsoft Cloud and to unlock partner benefits for co-selling with Microsoft.We acknowledge we have more work ahead of us to address racial injustice and inequity, and are applying many of the programs above to help other underrepresented communities.Investing in Digital SkillsWith a continued focus on digital transformation, Microsoft is helping to ensure that no one is left behind, particularly as economies recover from the COVID-19 pandemic. We announced in June 2020 that we are expanding access to the digital skills that have become increasingly vital to many of the worlds jobs, and especially to individuals hardest hit by recent job losses. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. We also invested $20 million in key non-profit partnerships through Microsoft Philanthropies to help people from underserved communities that are often excluded by the digital economy. Over 42 million people across every continent have accessed free training through our skills initiative. The effort surpassed its initial goals and has been expanded with a new emphasis on connecting learners with jobs that help put their new training to use and connecting employers with skilled job seekers they might not find in traditional networks. PART I Item 1HUMAN CAPITAL RESOURCES OverviewMicrosoft aims to recruit, develop, and retain diverse, world-changing talent. To foster their and our success, we seek to create an environment where people can do their best work a place where they can proudly be their authentic selves, guided by our values, and where they know their needs can be met. We strive to maximize the potential of our human capital resources by creating a respectful, rewarding, and inclusive work environment that enables our global employees to create products and services that further our mission to empower every person and every organization on the planet to achieve more.As of June 30, 2021, we employed approximately 181,000 people on a full-time basis, 103,000 in the U.S. and 78,000 internationally. Of the total employed people, 67,000 were in operations, including manufacturing, distribution, product support, and consulting services 60,000 were in product research and development 40,000 were in sales and marketing and 14,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.Our CultureMicrosofts culture is grounded in the growth mindset. This means everyone is on a continuous journey to learn and grow. We believe potential can be nurtured and is not pre-determined, and we should always be learning and curious - trying new things without fear of failure. We identified four attributes that allow growth mindset to flourish: Obsessing over what matters to our customers. Becoming more diverse and inclusive in everything we do. Operating as one company, One Microsoft, instead of multiple siloed businesses. Making a difference in the lives of each other, our customers, and the world around us. Our employee listening systems enable us to gather feedback directly from our workforce to inform our programs and employee needs globally. 88% of employees globally participated in our fiscal year 2021 MS Poll engagement survey, which covers a variety of topics such as inclusion, pay and benefits, and learning and development. Throughout the fiscal year, we also collect nearly 75,000 Daily Pulse employee survey responses. During fiscal year 2021, our Daily Pulse surveys gave us invaluable insights into ways we could support employees through the COVID-19 pandemic and addressing racial injustice. In addition to poll and pulse surveys, we gain insights through onboarding and exit surveys, internal Yammer channels, employee QA sessions, and AskHR Service support.Diversity and InclusionAt Microsoft we have an inherently inclusive mission: to empower every person and every organization on the planet to achieve more. We think of diversity and inclusion as core to our business model, informing our actions to impact economies and people around the world. There are billions of people who want to achieve more, but have a different set of circumstances, abilities, and backgrounds that often limit access to opportunity and achievement. The better we represent that diversity inside Microsoft, the more effectively we can innovate for those we seek to empower.We strive to include others by holding ourselves accountable for diversity, driving global systemic change in our workplace and workforce, and creating an inclusive work environment. Through this commitment we can allow everyone the chance to be their authentic selves and do their best work every day. We support multiple highly active Employee Resource Groups for women, families, racial and ethnic minorities, military, people with disabilities, or who identify as LGBTQI+, where employees can go for support, networking, and community-building. As described in our 2020 Proxy Statement , annual performance and compensation reviews of our senior leadership team include an evaluation of their contributions to employee culture and diversity. To ensure accountability over time, we publicly disclose our progress on a multitude of workforce metrics including: Detailed breakdowns of gender, racial, and ethnic minority representation in our employee population, with data by job types, levels, and segments of our business. Our EEO-1 report (equal employment opportunity). Disability representation.PART I Item 1Total Rewards We develop dynamic, sustainable, and strategic programs with the goal of providing a highly differentiated portfolio to attract, reward, and retain top talent and enable our employees to do their best work. These programs reinforce our culture and values such as collaboration and growth mindset. Managers evaluate and recommend rewards based on, for example, how well we leverage the work of others and contribute to the success of our colleagues. We monitor pay equity and career progress across multiple dimensions.As part of our effort to promote a One Microsoft and inclusive culture, we expanded stock eligibility to all Microsoft employees as part of our annual rewards process. This includes all non-exempt and exempt employees and equivalents across the globe including business support professionals and datacenter and retail employees.Pay EquityIn our 2020 Diversity and Inclusion Report, we reported that all racial and ethnic minority employees in the U.S. combined earn $1.006 for every $1.000 earned by their white counterparts, that women in the U.S. earn $1.001 for every $1.000 earned by their counterparts in the U.S. who are men, and women in the U.S. plus our ten other largest employee geographies (Australia, Canada, China, France, Germany, India, Ireland, Israel, Japan, and United Kingdom) combined earn $1.000 for every $1.000 by men in these countries. Our intended result is a global performance and development approach that fosters our culture, and competitive compensation that ensures equitable pay by role while supporting pay for performance.Wellness and SafetyMicrosoft is committed to supporting our employees well-being and safety while they are at work and in their personal lives. We took a wide variety of measures to protect the health and well-being of our employees, suppliers, and customers during the COVID-19 pandemic. We made substantial modifications to employee travel policies and implemented office closures so non-essential employees could work remotely. We continued to pay hourly service providers such as cleaning and reception staff who may have otherwise been furloughed. We implemented a global Paid Pandemic School and Childcare Closure Leave to support working parents, added wellbeing days for those who needed to take time off for mental health and wellness, implemented on-demand COVID-19 testing and vaccinations on our Redmond, Washington campus, and extended full medical plan coverage for coronavirus testing, treatment, and telehealth services. We also expanded existing programs such as our Microsoft CARES Employee Assistance Program and family backup care.In addition to the extraordinary steps and programs relating to COVID-19, our comprehensive benefits package includes many physical, emotional, and financial wellness programs including counseling through the Microsoft CARES Employee Assistance Program, flexible fitness benefits, savings and investment tools, adoption assistance, and back-up care for children and elders. Finally, our Occupational Health and Safety program helps ensure employees can stay safe while they are working.Learning and DevelopmentOur growth mindset culture begins with valuing learning over knowing seeking out new ideas, driving innovation, embracing challenges, learning from failure, and improving over time. To support this culture, we offer a wide range of learning and development opportunities. We believe learning can be more than formal instruction, and our learning philosophy focuses on providing the right learning, at the right time, in the right way. Opportunities include: Personalized, integrated, and relevant views of all learning opportunities on our internal learning portal, our external learning portal MS Learn, and LinkedIn Learning that is available to all employees worldwide. In-the-classroom learning, learning pods, our early-in-career Aspire program, and manager excellence communities. On-the-job stretch and advancement opportunities. Managers holding conversations about employees career and development plans, coaching on career opportunities, and programs like mentoring and sponsorship. Customized manager learning to build people manager capabilities and similar learning solutions to build leadership skills for all employees including differentiated leadership development programs.PART I Item 1 New employee orientation covering a range of topics including company values, culture, and Standards of Business Conduct , as well as ongoing onboarding program . Our employees embrace the growth mindset and take advantage of the formal learning opportunities as well as thousands of informal and on-the-job learning opportunities. In terms of formal on-line learning solutions, in fiscal year 2021 our employees completed over 5 million courses, averaging over 18 hours per employee. Given our focus on understanding core company beliefs and compliance topics, all employees complete required learning programs like Standards of Business Conduct, Privacy, Unconscious Bias, and preventing harassment courses. Our corporate learning portal has over 100,000 average monthly active users. All of our approximately 23,000 people managers must complete between 25-30 hours of required manager capability and excellence training and are assigned ongoing required training each year. In addition, all employees complete skills training based on the profession they are in each year.New Ways of Working The global pandemic has accelerated our capabilities and culture with respect to flexible work. Microsoft has introduced a Hybrid Workplace Flexibility Guide to better support managers and employees as they adapt to new ways of working that shift paradigms, embrace flexibility, promote inclusion, and drive innovation. Our ongoing survey data shows employees value the flexibility related to work location, work site, and work hours, and while many indicate they intend to return to a worksite once conditions permit, they also intend to adjust hours or spend some portions of workweeks working remotely. We are focused on building capabilities to support a variety of workstyles where individuals, teams, and our business can be successful.OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business. Office Consumer, including Microsoft 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.PART I Item 1Office Commercial Office Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as frontline workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.LinkedInLinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Marketing Solutions help companies reach, engage, and convert their audiences at scale. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. Finally, Learning Solutions, including Glint, help businesses close critical skills gaps in times where companies are having to do more with existing talent. LinkedIn has over 750 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions , Learning Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed and applications consumed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications, including Power Apps and Power Automate.PART I Item 1Competition Competitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.Dynamics competes with cloud-based and on-premises business solution providers such as Oracle, Salesforce.com, and SAP.Intelligent CloudOur Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.PART I Item 1Competition Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows IoT and MSN advertising. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising. Search advertising. PART I Item 1Windows The Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Xbox Cloud Gaming, our game streaming service, and continued investment in gaming hardware. Xbox Cloud Gaming utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorites games with them and play on the device most convenient to them. PART I Item 1Xbox enables people to connect and share online gaming experiences that are accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators. Search AdvertisingOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.Xbox and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Facebook, Google, and Tencent. We also compete with other providers of entertainment services such as video streaming platforms. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. For the majority of our products, we have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. However, some of our products contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.PART I Item 1RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility + Security, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 65,000 U.S. and international patents issued and over 21,000 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We may also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, supporting societal and/or environmental efforts, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. PART I Item 1In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Dell, Hewlett-Packard, Lenovo, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In fiscal year 2021, we closed our Microsoft Store physical locations and opened our Microsoft Experience Centers. Microsoft Experience Centers are designed to facilitate deeper engagement with our partners and customers across industries. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. PART I Item 1We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and SA. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. PART I Item 1Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1INFORMATION ABOUT OUR EXECUTIV E OFFICERS Our executive officers as of July 29, 2021 were as follows:NameAgePosition with the CompanySatya NadellaChairman of the Board and Chief Executive OfficerJudson AlthoffExecutive Vice President and Chief Commercial OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Chief Legal OfficerChristopher D. YoungExecutive Vice President, Business Development, Strategy, and VenturesMr. Nadella was appointed Chairman of the Board in June 2021 and Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Althoff was appointed Executive Vice President and Chief Commercial Officer in July 2021. He served as Executive Vice President, Worldwide Commercial Business from July 2017 until that time. Prior to that, Mr. Althoff served as the President of Microsoft North America. Mr. Althoff joined Microsoft in March 2013 as President of Microsoft North America.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 28 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.Mr. Young joined Microsoft in November 2020 as Executive Vice President, Business Development, Strategy, and Ventures. Prior to Microsoft, he served as the Chief Executive Officer of McAfee, LLC from 2017 to 2020, and served as a Senior Vice President and General Manager of Intel Security Group from 2014 until 2017, when he led the initiative to spin out McAfee into a standalone company. Mr. Young also serves on the Board of Directors of American Express Company.PART I Item 1AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.We publish a variety of reports and resources related to our Corporate Social Responsibility programs and progress on our Reports hub website, www.microsoft.com/corporate-responsibility/reports-hub, including reports on sustainability, responsible sourcing, accessibility, digital trust, and public policy engagement. The information found on these websites is not part of, or incorporated by reference into, this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.STRATEGIC AND COMPETITIVE RISKS We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives.PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We embrace cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other IoT endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1ARISKS RELATING TO THE EVOLUTION OF OUR BUSINESS We make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, which could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in October 2018 we completed our acquisition of GitHub, Inc. (GitHub) for $7.5 billion, in March 2021 we completed our acquisition of ZeniMax Media Inc. for $8.1 billion, and in April 2021 we announced a definitive agreement to acquire Nuance Communications, Inc. for $19.7 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, that they distract management from our other businesses, or that announced transactions may not be completed. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record, a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACYBERSECURITY, DATA PRIVACY, AND PLATFORM ABUSE RISKS Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technologyThreats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Nation state and state sponsored actors can deploy significant resources to plan and carry out exploits. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems or reveal confidential information. Malicious actors may employ the IT supply chain to introduce malware through software updates or compromised supplier accounts or hardware.Cyberthreats are constantly evolving and becoming increasingly sophisticated and complex, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improve technologies or remediate the impacts of attacks, or otherwise adversely affect our business.The cyberattacks uncovered in late 2020 known as Solorigate or Nobelium are an example of a supply chain attack where malware was introduced to a software providers customers, including us, through software updates. The attackers were later able to create false credentials that appeared legitimate to certain customers systems. We may be targets of further attacks similar to Solorigate/Nobelium as both a supplier and consumer of IT.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.PART I Item 1ASecurity of our products, services, devices, and customers data The security of our products and services is important in our customers decisions to purchase or use our products or services across cloud and on-premises environments. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. In addition, adversaries can attack our customers on-premises or cloud environments, sometimes exploiting previously unknown (zero day) vulnerabilities, such as occurred in early calendar year 2021 with several of our Exchange Server on-premises products. Vulnerabilities in these or any product can persist even after we have issued security patches if customers have not installed the most recent updates, or if the attackers exploited the vulnerabilities before patching to install additional malware to further compromise customers systems. Adversaries will continue to attack customers using our cloud services as customers embrace digital transformation. Adversaries that acquire user account information can use that information to compromise our users accounts, including where accounts share the same attributes as passwords. Inadequate account security practices may also result in unauthorized access, and user activity may result in ransomware or other malicious software impacting a customers use of our products or services. We are increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.Our customers operate complex IT systems with third-party hardware and software from multiple vendors that may include systems acquired over many years. They expect our products and services to support all these systems and products, including those that no longer incorporate the strongest current security advances or standards. As a result, we may not be able to discontinue support in our services for a product, service, standard, or feature solely because a more secure alternative is available. Failure to utilize the most current security advances and standards can increase our customers vulnerability to attack. Further, customers of widely varied size and technical sophistication use our technology, and consequently may have limited capabilities and resources to help them adopt and implement state of the art cybersecurity practices and technologies. In addition, we must account for this wide variation of technical sophistication when defining default settings for our products and services, including security default settings, as these settings may limit or otherwise impact other aspects of IT operations and some customers may have limited capability to review and reset these defaults.The Solorigate/Nobelium or similar cyberattacks may adversely impact our customers even if our production services are not directly compromised. We are committed to notifying our customers whose systems have been impacted as we become aware and have available information and actions for customers to help protect themselves. We are also committed to providing guidance and support on detection, tracking, and remediation. We may not be able to detect the existence or extent of these attacks for all of our customers or have information on how to detect or track an attack, especially where an attack involves on-premises software such as Exchange Server where we may have no or limited visibility into our customers computing environments.Development and deployment of defensive measuresTo defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls, anti-virus software, and advanced security and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our product and services.PART I Item 1AThe cost of measures to protect products and customer-facing services could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, MSN, and Xbox, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1ADigital safety and service misuse Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. OPERATIONAL RISKS We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Microsoft 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical business functions and multiple workloads. Many of our products and services are interdependent with one another. Each of these circumstances potentially magnifies the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes that restrict supply sources, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. LEGAL, REGULATORY, AND LITIGATION RISKS Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows post-sale monetization opportunities may be limited. Our global operations subject us to potential consequences under anti-corruption, trade, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Increasing trade laws, policies, sanctions, and other regulatory requirements also affect our operations in and outside the U.S. relating to trade and investment. Economic sanctions in the U.S., the EU, and other countries prohibit most business with restricted entities or countries such as Crimea, Cuba, Iran, North Korea, and Syria. U.S. export controls restrict Microsoft from offering many of its products and services to, or making investments in, certain entities in specified countries. U.S. import controls restrict us from integrating certain information and communication technologies into our supply chain and allow for government review of transactions involving information and communications technology from countries determined to be foreign adversaries. Non-compliance could result in reputational harm, operational delays, monetary fines, loss of export privileges, or criminal sanctions.Other regulatory areas that may apply to our products and online services offerings include requirements related to user privacy, telecommunications, data storage and protection, advertising, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws, including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Regulators may assert that our collection, use, and management of customer and other data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative and regulatory action is emerging in the areas of AI and content moderation, which could increase costs or restrict opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or global accessibility requirements, we could lose sales opportunities or face regulatory or legal actions.PART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling has led to uncertainty about the legal requirements for data transfers from the EU under other l egal mechanisms. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, the EU General Data Protection Regulation (GDPR), became effective. The law, which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. Engineering efforts to build and maintain capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if our implementation to comply with the GDPR make s our offerings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to comply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits, reputational damage , and loss of customers . Countries around the world, and states in the U.S . such as California , Colorado, and Virginia , ha ve adopted, or are considering adopting or expanding , laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation. PART I Item 1AWe may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) and possible future legislative changes may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA or possible future legislative changes , and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. We earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. INTELLECTUAL PROPERTY RISKS We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing or cross-licensing our patents to others in return for a royalty and/or increased freedom to operate. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, price changes in products using licensed patents, greater value from cross-licensing, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. GENERAL RISKS If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced a decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.PART I Item 1ACatastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory systems and requirements and market interventions that could impact our operating strategies, access to national, regional, and global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic continues to have widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures to contain the virus, including social distancing, travel restrictions, and vaccination programs. Even as efforts to contain the pandemic have made progress and some restrictions have relaxed, new variants of the virus are causing additional outbreaks. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance.Measures to contain the virus that impact us, our partners, distributors, and suppliers may further intensify these impacts and other risks described in these Risk Factors. Any of these may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions.We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.PART I Item 1AThe long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services. Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational, economic, and geopolitical risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist and protectionist trends and concerns about human rights and political expression in specific countries may significantly alter the trade and commercial environments. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, and non-local sourcing restrictions, export controls, investment restrictions, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations. Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2021 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately 5 million square feet of space we lease. In addition, we own and lease space domestically that includes office and datacenter space.We also own and lease facilities internationally for datacenters, research and development, and other operations. The largest owned properties include space in the following locations: China, India, Ireland, the Netherlands, Singapore, and South Korea. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Israel, Japan, Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, and other facilities owned and leased domestically and internationally as of June 30, 2021:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company was required to make annual reports of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015 . The Final Order expired in April of 2021. During fiscal year 2021, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking) (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, prior to expiration of the Final Order, the Antitrust Compliance Officer reported to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings.Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESMARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 26, 2021, there were 89,291 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2021:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet bePurchased Under the Plans or Programs(In millions)April 1, 2021 April 30, 20217,493,732$255.237,493,732$13,030May 1, 2021 May 31, 20218,823,524247.368,823,52410,847June 1, 2021 June 30, 20218,155,857258.078,155,8578,74224,473,11324,473,113All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2021: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 16, 2021August 19, 2021September 9, 2021$0.56$4,211We returned $10.4 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2021. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K). This section generally discusses the results of our operations for the year ended June 30, 2021 compared to the year ended June 30, 2020. For a discussion of the year ended June 30, 2020 compared to the year ended June 30, 2019, please refer to Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended June 30, 2020.OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.As the world continues to respond to COVID-19, we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.Highlights from fiscal year 2021 compared with fiscal year 2020 included: Commercial cloud revenue increased 34% to $69.1 billion. Office Commercial products and cloud services revenue increased 13% driven by Office 365 Commercial growth of 22%. Office Consumer products and cloud services revenue increased 10% and Microsoft 365 Consumer subscribers increased to 51.9 million. LinkedIn revenue increased 27%. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 43%. Server products and cloud services revenue increased 27% driven by Azure growth of 50%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased slightly. Windows Commercial products and cloud services revenue increased 14%. Xbox content and services revenue increased 23%. Search advertising revenue, excluding traffic acquisition costs, increased 13%. Surface revenue increased 5%.On March 9, 2021, we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC, for a total purchase price of $8.1 billion, consisting primarily of cash. The purchase price included $768 million of cash and cash equivalents acquired. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements ( Part II, Item 8 of this Form 10-K ) for further discussion. PART II Item 7Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our devices are primarily manufactured by third-party contract manufacturers, some of which contain certain components for which there are very few qualified suppliers. For these components, we have limited near-term flexibility to use other manufacturers if a current vendor becomes unavailable or is unable to meet our requirements. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices on time to meet consumer demand.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Weakening of the U.S. dollar relative to certain foreign currencies increased reported revenue and did not have a material impact on reported expenses from our international operations in fiscal year 2021.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.COVID-19In fiscal year 2021, the COVID-19 pandemic continued to impact our business operations and financial results. Cloud usage and demand benefited as customers accelerate their digital transformation priorities. Our consumer businesses also benefited from the remote environment, with continued demand for PCs and productivity tools, as well as strong engagement across our Gaming platform. We saw improvement in customer advertising spend and savings in operating expenses related to COVID-19, but experienced weakness in transactional licensing. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is uncertainty in the nature and degree of its continued effects over time. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.PART II Item 7Change in Accounting Estimate In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years. This change in accounting estimate was effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2020, the effect of this change in estimate for fiscal year 2021 was an increase in operating income of $2.7 billion and net income of $2.3 billion, or $0.30 per both basic and diluted share. Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last fiscal year.CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Commercial cloud revenue Revenue from our commercial cloud business, which includes Azure, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Commercial cloud gross margin percentageGross margin percentage for our commercial cloud business PART II Item 7Productivity and Business Processes and Intelligent Cloud Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends.Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for BusinessOffice Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer subscriptions and Office licensed on-premisesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionMicrosoft 365 Consumer subscribersThe number of Microsoft 365 Consumer (formerly Office 365 Consumer) subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applicationsLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning SolutionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHubMore Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM Pro revenue growthRevenue from sales of Windows Pro licenses sold through the OEM channel, which primarily addresses demand in the commercial marketWindows OEM non-Pro revenue growthRevenue from sales of Windows non-Pro licenses sold through the OEM channel, which primarily addresses demand in the consumer marketPART II Item 7Windows Commercial products and cloud services revenue growth Revenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenueRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties, cloud services, and advertising Search advertising revenue, excluding TAC, growthRevenue from search advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change Revenue$168,088$143,01518%Gross margin115,85696,93720%Operating income69,91652,95932%Net income61,27144,28138%Diluted earnings per share8.055.7640%Adjusted net income (non-GAAP)60,65144,28137%Adjusted diluted earnings per share (non-GAAP)7.975.7638%Adjusted net income and adjusted diluted earnings per share (EPS) are non-GAAP financial measures which exclude tax benefits related to an India Supreme Court decision on withholding taxes in fiscal year 2021 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results. See Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Revenue increased $25.1 billion or 18% driven by growth across each of our segments. Intelligent Cloud revenue increased driven by Azure. Productivity and Business Processes revenue increased driven by Office 365 Commercial and LinkedIn. More Personal Computing revenue increased driven by Gaming. Cost of revenue increased $6.2 billion or 13% driven by growth in commercial cloud and Gaming, offset in part by a reduction in depreciation expense due to the change in estimated useful lives of our server and network equipment.Gross margin increased $18.9 billion or 20% driven by growth across each of our segments and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage decreased slightly driven by gross margin percentage reduction in More Personal Computing. Commercial cloud gross margin percentage increased 4 points to 71% driven by gross margin percentage improvement in Azure and the change in estimated useful lives of our server and network equipment, offset in part by sales mix shift to Azure.Operating expenses increased $2.0 billion or 4% driven by investments in cloud engineering and commercial sales, offset in part by savings related to COVID-19 across each of our segments, prior year charges associated with the closing of our Microsoft Store physical locations, and a reduction in bad debt expense.Key changes in operating expenses were: Research and development expenses increased $1.4 billion or 8% driven by investments in cloud engineering. Sales and marketing expenses increased $519 million or 3% driven by investments in commercial sales, offset in part by a reduction in bad debt expense. Sales and marketing included an unfavorable foreign currency impact of 2%. General and administrative expenses were relatively unchanged, driven by prior year charges associated with the closing of our Microsoft Store physical locations, offset in part by an increase in certain employee-related expenses and business taxes.PART II Item 7Operating income increased $17.0 billion or 32% driven by growth across each of our segments and the change in estimated useful lives of our server and network equipment. Current year net income and diluted EPS were positively impacted by the tax benefit related to the India Supreme Court decision on withholding taxes, which resulted in an increase to net income and diluted EPS of $620 million and $0.08, respectively. Revenue, gross margin, and operating income included a favorable foreign currency impact of 3%, 3%, and 4%, respectively. SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change RevenueProductivity and Business Processes$53,915$46,39816%Intelligent Cloud60,08048,36624%More Personal Computing54,09348,25112%Total $168,088$143,01518%Operating Income Productivity and Business Processes$24,351$18,72430%Intelligent Cloud26,12618,32443%More Personal Computing19,43915,91122%Total $69,916$52,95932%Reportable Segments Productivity and Business Processes Revenue increased $7.5 billion or 16%. Office Commercial products and cloud services revenue increased $4.0 billion or 13%. Office 365 Commercial revenue grew 22% driven by seat growth of 17% and higher revenue per user. Office Commercial products revenue declined 23% driven by continued customer shift to cloud offerings and transactional weakness. Office Consumer products and cloud services revenue increased $474 million or 10% driven by Microsoft 365 Consumer subscription revenue, on a strong prior year comparable that benefited from transactional strength in Japan. Microsoft 365 Consumer subscribers increased 22% to 51.9 million. LinkedIn revenue increased $2.2 billion or 27% driven by advertising demand in our Marketing Solutions business. Dynamics products and cloud services revenue increased 25% driven by Dynamics 365 growth of 43%. Operating income increased $5.6 billion or 30%. Gross margin increased $6.5 billion or 18% driven by growth in Office 365 Commercial and LinkedIn, and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage decreased slightly driven by a sales mix shift to cloud offerings, on a low prior year comparable impacted by increased usage. Operating expenses increased $839 million or 5% driven by investments in commercial sales, cloud engineering, and LinkedIn.Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively. PART II Item 7Intelligent Cloud Revenue increased $11.7 billion or 24%. Server products and cloud services revenue increased $11.2 billion or 27% driven by Azure. Azure revenue grew 50% due to growth in our consumption-based services. Server products revenue increased 6% driven by hybrid and premium solutions, on a strong prior year comparable that benefited from demand related to SQL Server 2008 and Windows Server 2008 end of support. Enterprise Services revenue increased $534 million or 8% driven by growth in Premier Support Services.Operating income increased $7.8 billion or 43%. Gross margin increased $9.7 billion or 29% driven by growth in Azure and the change in estimated useful lives of our server and network equipment. Gross margin percentage increased with the change in estimated useful lives of our server and network equipment. Excluding this impact, gross margin percentage was relatively unchanged driven by gross margin percentage improvement in Azure, offset in part by sales mix shift to Azure. Operating expenses increased $1.9 billion or 12% driven by investments in Azure. Revenue, gross margin, and operating income included a favorable foreign currency impact of 2%, 3%, and 4%, respectively.More Personal Computing Revenue increased $5.8 billion or 12%. Windows revenue increased $933 million or 4% driven by growth in Windows Commercial. Windows Commercial products and cloud services revenue increased 14% driven by demand for Microsoft 365. Windows OEM revenue increased slightly driven by consumer PC demand, on a strong prior year OEM Pro comparable that benefited from Windows 7 end of support. Windows OEM Pro revenue decreased 9% and Windows OEM non-Pro revenue grew 21%. Gaming revenue increased $3.8 billion or 33% driven by growth in Xbox content and services and Xbox hardware. Xbox content and services revenue increased $2.3 billion or 23% driven by growth in third-party titles, Xbox Game Pass subscriptions, and first-party titles. Xbox hardware revenue increased 92% driven by higher price of consoles sold due to the Xbox Series X|S launches. Search advertising revenue increased $788 million or 10%. Search advertising revenue excluding traffic acquisition costs increased 13% driven by higher revenue per search and search volume. Surface revenue increased $302 million or 5%.Operating income increased $3.5 billion or 22%. Gross margin increased $2.8 billion or 10% driven by growth in Windows, Gaming, and Search advertising. Gross margin percentage decreased driven by sales mix shift to Gaming hardware. Operating expenses decreased $752 million or 6% driven by prior year charges associated with the closing of our Microsoft Store physical locations and reductions in retail store expenses and marketing, offset in part by investments in Gaming.Gross margin and operating income included a favorable foreign currency impact of 2% and 3%, respectively.PART II Item 7OPERATING EXPENSES Research and Development(In millions, except percentages)Percentage ChangeResearch and development$20,716$19,2698%As a percent of revenue12%13%(1)pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Research and development expenses increased $1.4 billion or 8% driven by investments in cloud engineering.Sales and Marketing(In millions, except percentages)Percentage ChangeSales and marketing$20,117$19,5983%As a percent of revenue12%14%(2)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Sales and marketing expenses increased $519 million or 3% driven by investments in commercial sales, offset in part by a reduction in bad debt expense. Sales and marketing included an unfavorable foreign currency impact of 2%.General and Administrative(In millions, except percentages)Percentage Change General and administrative$5,107$5,1110%As a percent of revenue3%4%(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.General and administrative expenses were relatively unchanged, driven by prior year charges associated with the closing of our Microsoft Store physical locations, offset in part by an increase in certain employee-related expenses and business taxes.PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,131$2,680Interest expense(2,346)(2,591)Net recognized gains on investments1,232Net gains on derivativesNet gains (losses) on foreign currency remeasurements(191)Other, net(40)Total$1,186$We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Interest and dividends income decreased due to lower yields on fixed-income securities. Interest expense decreased due to a decrease in outstanding long-term debt due to debt maturities. Net recognized gains on investments increased due to higher gains on equity securities. Net gains on derivatives decreased due to lower gains on foreign currency contracts.INCOME TAXES Effective Tax RateOur effective tax rate for fiscal years 2021 and 2020 was 14% and 17%, respectively. The decrease in our effective tax rate was primarily due to tax benefits from a decision by the India Supreme Court on withholding taxes in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax, an agreement between the U.S. and India tax authorities related to transfer pricing, final Tax Cuts and Jobs Act (TCJA) regulations, and an increase in tax benefits relating to stock-based compensation.We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016.Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2021, our U.S. income before income taxes was $35.0 billion and our foreign income before income taxes was $36.1 billion. In fiscal year 2020, our U.S. income before income taxes was $24.1 billion and our foreign income before income taxes was $28.9 billion.Uncertain Tax PositionsWe settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017. PART II Item 7As of June 30, 202 1 , the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2020, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Adjusted net income and adjusted diluted EPS are non-GAAP financial measures which exclude the tax benefits related to the India Supreme Court decision on withholding taxes in fiscal year 2021. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change Net income$61,271$44,28138%Net income tax benefit related to India Supreme Court decision on withholding taxes(620)*Adjusted net income (non-GAAP)$60,651$44,28137%Diluted earnings per share$8.05$5.7640%Net income tax benefit related to India Supreme Court decision on withholding taxes(0.08)*Adjusted diluted earnings per share (non-GAAP)$7.97$5.7638%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $130.3 billion and $136.5 billion as of June 30, 2021 and 2020. Equity investments were $6.0 billion and $3.0 billion as of June 30, 2021 and 2020, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Cash from operations increased $16.1 billion to $76.7 billion for fiscal year 2021, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees. Cash used in financing increased $2.5 billion to $48.5 billion for fiscal year 2021, mainly due to a $4.4 billion increase in common stock repurchases and a $1.4 billion increase in dividends paid, offset in part by a $1.8 billion decrease in repayments of debt and a $1.7 billion decrease in cash premium paid on debt exchange. Cash used in investing increased $15.4 billion to $27.6 billion for fiscal year 2021, mainly due to a $6.4 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, a $5.2 billion increase in additions to property and equipment, and a $4.1 billion decrease in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2021:(In millions)Three Months EndingSeptember 30, 2021$15,922December 31, 202112,646March 31, 20228,786June 30, 20224,171Thereafter2,616Total$44,141If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases During fiscal years 2021 and 2020, we repurchased 101 million shares and 126 million shares of our common stock for $23.0 billion and $19.7 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated financial statements during the periods presented. PART II Item 7Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2021: (In millions)2023-20242025-2026ThereafterTotalLong-term debt: (a) Principal payments$8,075$8,000$5,250$42,585$63,910Interest payments1,6282,8472,43817,32024,233Construction commitments (b) 8,9279,456Operating leases, including imputed interest (c) 2,8014,9563,4696,74717,973Finance leases, including imputed interest (c) 1,3413,2563,77414,09622,467Transition tax (d) 1,4274,1058,03013,562Purchase commitments (e) 29,1291,70831,553Other long-term liabilities (f) Total$53,328$25,766$23,475$81,281$183,850(a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (e) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. (f) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.6 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital On April 11, 2021, we entered into a definitive agreement to acquire Nuance Communications, Inc. (Nuance) for $56.00 per share in an all-cash transaction valued at $19.7 billion, inclusive of Nuances net debt. The acquisition has been approved by Nuances shareholders, and we expect it to close by the end of calendar year 2021, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. LiquidityAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $4.7 billion, which included $1.5 billion for fiscal year 2021. The remaining transition tax of $13.6 billion is payable over the next five years with a final payment in fiscal year 2026. We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. PART II Item 7RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies, as well as uncertainty in the current economic environment due to COVID-19. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. Impairment of Investment Securities We review debt investments quarterly for credit losses and impairment. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. This determination requires significant judgment. In making this judgment, we employ a systematic methodology that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery, then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. PART II Item 7Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a periodic basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. PART II Item 7The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part I I , Item 8 of this Form 10-K) for further discussion. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerAlice L. JollaCorporate Vice President and Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currencyRevenue10% decrease in foreign exchange rates$(6,756)EarningsForeign currencyInvestments10% decrease in foreign exchange rates(136)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(3,511)Fair ValueCredit100 basis point increase in credit spreads(309)Fair ValueEquity10% decrease in equity market prices(602)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$71,074 $68,041 $66,069 Service and other97,014 74,974 59,774 Total revenue168,088 143,015 125,843 Cost of revenue:Product18,219 16,017 16,273 Service and other34,013 30,061 26,637 Total cost of revenue52,232 46,078 42,910 Gross margin115,856 96,937 82,933 Research and development20,716 19,269 16,876 Sales and marketing20,117 19,598 18,213 General and administrative5,107 5,111 4,885 Operating income69,916 52,959 42,959 Other income, net 1,186 Income before income taxes71,102 53,036 43,688 Provision for income taxes9,831 8,755 4,448 Net income$61,271 $44,281 $39,240 Earnings per share:Basic$8.12 $5.82 $5.11 Diluted$8.05 $5.76 $5.06 Weighted average shares outstanding:Basic7,547 7,610 7,673 Diluted7,608 7,683 7,753 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS (In millions)Year Ended June 30,Net income$61,271 $44,281 $39,240 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )( 173 )Net change related to investments( 2,266 )3,990 2,405 Translation adjustments and other( 426 )( 318 )Other comprehensive income (loss)( 1,374 )3,526 1,914 Comprehensive income$59,897 $47,807 $41,154 Refer to accompanying notes. PART II Item 8BALANCE SHEETS (In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$14,224 $13,576 Short-term investments116,110 122,951 Total cash, cash equivalents, and short-term investments130,334 136,527 Accounts receivable, net of allowance for doubtful accounts of $ 751 and $ 788 38,043 32,011 Inventories2,636 1,895 Other current assets13,393 11,482 Total current assets184,406 181,915 Property and equipment, net of accumulated depreciation of $ 51,351 and $ 43,197 59,715 44,151 Operating lease right-of-use assets11,088 8,753 Equity investments5,984 2,965 Goodwill49,711 43,351 Intangible assets, net7,800 7,038 Other long-term assets15,075 13,138 Total assets$333,779 $301,311 Liabilities and stockholders equityCurrent liabilities:Accounts payable$15,163 $12,530 Current portion of long-term debt8,072 3,749 Accrued compensation10,057 7,874 Short-term income taxes2,174 2,130 Short-term unearned revenue41,525 36,000 Other current liabilities11,666 10,027 Total current liabilities88,657 72,310 Long-term debt50,074 59,578 Long-term income taxes27,190 29,432 Long-term unearned revenue2,616 3,180 Deferred income taxesOperating lease liabilities9,629 7,671 Other long-term liabilities13,427 10,632 Total liabilities191,791 183,007 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,519 and 7,571 83,111 80,552 Retained earnings57,055 34,566 Accumulated other comprehensive income1,822 3,186 Total stockholders equity141,988 118,304 Total liabilities and stockholders equity$333,779 $301,311 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS (In millions)Year Ended June 30,OperationsNet income$61,271 $44,281 $39,240 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,686 12,796 11,682 Stock-based compensation expense6,118 5,289 4,652 Net recognized gains on investments and derivatives( 1,249 )( 219 )( 792 )Deferred income taxes( 150 )( 6,463 )Changes in operating assets and liabilities:Accounts receivable( 6,481 )( 2,577 )( 2,812 )Inventories( 737 )Other current assets( 932 )( 2,330 )( 1,718 )Other long-term assets( 3,459 )( 1,037 )( 1,834 )Accounts payable2,798 3,018 Unearned revenue4,633 2,212 4,462 Income taxes( 2,309 )( 3,631 )2,929 Other current liabilities4,149 1,346 1,419 Other long-term liabilities1,402 1,348 Net cash from operations76,740 60,675 52,185 FinancingCash premium on debt exchange( 1,754 )( 3,417 )Repayments of debt( 3,750 )( 5,518 )( 4,000 )Common stock issued1,693 1,343 1,142 Common stock repurchased( 27,385 )( 22,968 )( 19,543 )Common stock cash dividends paid( 16,521 )( 15,137 )( 13,811 )Other, net( 769 )( 334 )( 675 )Net cash used in financing( 48,486 )( 46,031 )( 36,887 )InvestingAdditions to property and equipment( 20,622 )( 15,441 )( 13,925 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 8,909 )( 2,521 )( 2,388 )Purchases of investments( 62,924 )( 77,190 )( 57,697 )Maturities of investments51,792 66,449 20,043 Sales of investments14,008 17,721 38,194 Other, net( 922 )( 1,241 )Net cash used in investing( 27,577 )( 12,223 )( 15,773 )Effect of foreign exchange rates on cash and cash equivalents( 29 )( 201 )( 115 )Net change in cash and cash equivalents2,220 ( 590 )Cash and cash equivalents, beginning of period13,576 11,356 11,946 Cash and cash equivalents, end of period$14,224 $13,576 $11,356 Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions, except per share amounts)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$80,552 $78,520 $71,223 Common stock issued1,963 1,343 6,829 Common stock repurchased( 5,539 )( 4,599 )( 4,195 )Stock-based compensation expense6,118 5,289 4,652 Other, net( 1 )Balance, end of period83,111 80,552 78,520 Retained earnings Balance, beginning of period34,566 24,150 13,682 Net income61,271 44,281 39,240 Common stock cash dividends( 16,871 )( 15,483 )( 14,103 )Common stock repurchased( 21,879 )( 18,382 )( 15,346 )Cumulative effect of accounting changes( 32 )Balance, end of period57,055 34,566 24,150 Accumulated other comprehensive income (loss)Balance, beginning of period3,186 ( 340 ) ( 2,187 )Other comprehensive income (loss)( 1,374 )3,526 1,914 Cumulative effect of accounting changes( 67 )Balance, end of period1,822 3,186 ( 340 )Total stockholders equity$141,988 $118,304 $102,330 Cash dividends declared per common share$2.24 $2.04 $1.84 Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to COVID-19.In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years . This change in accounting estimate was effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in property and equipment, net as of June 30, 2020, the effect of this change in estimate for fiscal year 2021 was an increase in operating income of $ 2.7 billion and net income of $ 2.3 billion, or $ 0.30 per both basic and diluted share. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems, cross-device productivity applications, server applications, business solution applications, desktop and server management tools, software development tools, video games, and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances and Other Receivables Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future, LinkedIn subscriptions, Office 365 subscriptions, Xbox subscriptions, Windows 10 post-delivery support, Dynamics business solutions, and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.As of June 30, 2021 and 2020, other receivables due from suppliers were $ 965 million and $ 442 million, respectively, and are included in accounts receivable, net in our consolidated balance sheets.As of June 30, 2021 and 2020, long-term accounts receivable, net of allowance for doubtful accounts, was $ 3.4 billion and $ 2.7 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. PART II Item 8Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 252 )( 178 )( 116 )Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$ 816 $ 434 We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2021 and 2020, our financing receivables, net were $ 4.4 billion and $ 5.2 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.5 billion, $ 1.6 billion, and $ 1.6 billion in fiscal years 2021, 2020, and 2019, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding credit losses and impairments, are recorded in other comprehensive income . Fair value is calculated based on publicly available market information or other estimates determined by management. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the extent to which the fair value is less than cost. To determine credit losses, we employ a systematic methodology that considers available quantitative and qualitative evidence. In addition, we consider specific adverse conditions related to the financial health of, and business outlook for, the investee. If we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery , then a decline in fair value below cost is recorded as an impairment charge in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a periodic basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to four years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceFinancial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We adopted the standard effective July 1, 2020. We use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities are recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. We applied a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. The adoption of the standard did not have a material impact on our consolidated financial statements.Recent Accounting Guidance Not Yet AdoptedAccounting for Income TaxesIn December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021. We have completed our assessment and concluded that adoption of the new standard will not have a material impact on our consolidated financial statements.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. The components of basic and diluted EPS were as follows: (In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$61,271 $44,281 $39,240 Weighted average outstanding shares of common stock (B)7,547 7,610 7,673 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,608 7,683 7,753 Earnings Per ShareBasic (A/B)$8.12 $5.82 $5.11 Diluted (A/C)$8.05 $5.76 $5.06 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,131 $2,680 $2,762 Interest expense( 2,346 )( 2,591 )( 2,686 )Net recognized gains on investments1,232 Net gains on derivativesNet gains (losses) on foreign currency remeasurements( 191 )( 82 )Other, net( 40 )( 57 )Total$1,186 $$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 40 )( 37 ) ( 93 ) Impairments and allowance for credit losses( 2 )( 17 ) ( 16 ) Total$$( 4 ) $( 97 ) Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$$Net unrealized gains on investments still held1,057 Impairments of investments( 11 )( 116 ) ( 10 )Total$1,169 $$PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2021Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,316 $$$4,316 $1,331 $2,985 $Certificates of depositLevel 23,615 3,615 2,920 U.S. government securitiesLevel 190,664 3,832 ( 111 )94,385 1,500 92,885 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,213 ( 2 )6,220 5,995 Mortgage- and asset-backed securitiesLevel 23,442 ( 6 )3,458 3,458 Corporate notes and bondsLevel 28,443 ( 9 )8,683 8,683 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3( 7 )Total debt investments$117,966 $4,177 $( 135 )$122,008 $5,976 $116,032 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,582 $$$Equity investmentsOther5,378 5,378 Total equity investments$6,960 $$$5,984 Cash$7,272 $7,272 $$Derivatives, net (a) Total$136,318 $14,224 $116,110 $5,984 PART II Item 8(In millions)Fair ValueLevelAdjustedCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2020Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,687 $$$4,688 $1,618 $3,070 $Certificates of depositLevel 22,898 2,898 1,646 1,252 U.S. government securitiesLevel 192,067 6,495 ( 1 )98,561 3,168 95,393 U.S. agency securitiesLevel 22,439 2,441 1,992 Foreign government bondsLevel 26,982 ( 3 )6,985 6,984 Mortgage- and asset-backed securitiesLevel 24,865 ( 6 )4,900 4,900 Corporate notes and bondsLevel 28,500 ( 17 )8,810 8,810 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 4 )Municipal securitiesLevel 3Total debt investments$122,900 $6,929 $( 31 )$129,798 $6,882 $122,916 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,198 $$$Equity investmentsOther2,551 2,551 Total equity investments$3,749 $$$2,965 Cash$5,910 $5,910 $$Derivatives, net (a) Total$139,492 $13,576 $122,951 $2,965 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2021 and 2020, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 3.3 billion and $ 1.4 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2021U.S. government and agency securities$5,294 $( 111 )$$$5,294 $( 111 )Foreign government bonds3,148 ( 1 )( 1 )3,153 ( 2 )Mortgage- and asset-backed securities1,211 ( 5 )( 1 )1,298 ( 6 )Corporate notes and bonds1,678 ( 8 )( 1 )1,712 ( 9 )Municipal securities( 7 )( 7 )Total$11,389 $( 132 )$$( 3 )$11,516 $( 135 )PART II Item 8Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2020U.S. government and agency securities$2,323 $( 1 )$$$2,323 $( 1 )Foreign government bonds( 3 )( 3 )Mortgage- and asset-backed securities1,014 ( 6 )1,014 ( 6 )Corporate notes and bonds( 17 )( 17 )Municipal securities( 4 )( 4 )Total$4,552 $( 31 )$$$4,552 $( 31 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)AdjustedCost BasisEstimatedFair ValueJune 30, 2021Due in one year or less$22,612 $22,676 Due after one year through five years67,541 70,315 Due after five years through 10 years25,212 26,327 Due after 10 years2,601 2,690 Total$117,966 $122,008 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.PART II Item 8Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts . These contracts are not designated as hedging instruments and are included in Other contracts in the tables below. Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2021, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,081 6,754 Interest rate contracts purchased1,247 1,295 Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,223 11,896 Foreign exchange contracts sold23,391 15,595 Other contracts purchased2,456 1,844 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 8 )$$( 54 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 291 )( 334 )Other contracts( 36 )( 11 )Gross amounts of derivatives( 335 )( 399 )Gross amounts of derivatives offset in the balance sheet( 141 )( 154 )Cash collateral received 0 ( 42 )( 154 )Net amounts of derivatives$$( 235 )$$( 395 )Reported asShort-term investments$$$$Other current assetsOther long-term assetsOther current liabilities( 182 )( 334 )Other long-term liabilities( 53 )( 61 )Total$$( 235 )$$( 395 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 395 million and $ 335 million, respectively, as of June 30, 2021, and $ 399 million and $ 399 million, respectively, as of June 30, 2020. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2021Derivative assets$$$$Derivative liabilities( 335 )( 335 )June 30, 2020Derivative assetsDerivative liabilities( 399 )( 399 )PART II Item 8Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows: (In millions)Year Ended June 30,2019RevenueOther Income(Expense), NetRevenueOther Income(Expense), NetRevenueOtherIncome(Expense),NetDesignated as Fair Value Hedging Instruments Foreign exchange contractsDerivatives$$$$$$( 130 )Hedged items( 188 )Excluded from effectiveness assessmentInterest rate contractsDerivatives( 37 )Hedged items( 93 )Designated as Cash Flow Hedging Instruments Foreign exchange contractsAmount reclassified from accumulated other comprehensive incomeExcluded from effectiveness assessment( 64 )Not Designated as Hedging Instruments Foreign exchange contracts( 123 )( 97 )Other contractsGains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$$( 38 )$NOTE 6 INVENTORIES The components of inventories were as follows:(In millions)June 30,Raw materials$1,190 $Work in processFinished goods1,367 1,112 Total$2,636 $1,895 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$3,660 $1,823 Buildings and improvements43,928 33,995 Leasehold improvements6,884 5,487 Computer equipment and software51,250 41,261 Furniture and equipment5,344 4,782 Total, at cost111,066 87,348 Accumulated depreciation( 51,351 )( 43,197 )Total, net$ 59,715 $44,151 During fiscal years 2021, 2020, and 2019, depreciation expense was $ 9.3 billion, $ 10.7 billion, and $ 9.7 billion, respectively. Depreciation expense declined in fiscal year 2021 due to the change in estimated useful lives of our server and network equipment. We have committed $ 9.5 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2021. During fiscal year 2020, we recorded an impairment charge of $ 186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.NOTE 8 BUSINESS COMBINATIONS ZeniMax Media Inc.On March 9, 2021 , we completed our acquisition of ZeniMax Media Inc. (ZeniMax), the parent company of Bethesda Softworks LLC (Bethesda), for a total purchase price of $ 8.1 billion, consisting primarily of cash. The purchase price included $ 768 million of cash and cash equivalents acquired. Bethesda is one of the largest, privately held game developers and publishers in the world, and brings a broad portfolio of games, technology, and talent to Xbox. The financial results of ZeniMax have been included in our consolidated financial statements since the date of the acquisition. ZeniMax is reported as part of our More Personal Computing segment.The purchase price allocation as of the date of acquisition was based on a preliminary valuation and is subject to revision as more detailed analyses are completed and additional information about the fair value of assets acquired and liabilities assumed becomes available.The major classes of assets and liabilities to which we have preliminarily allocated the purchase price were as follows:(In millions) Cash and cash equivalents$Goodwill 5,469 Intangible assets1,968 Other assetsOther liabilities( 223 ) Total $8,121 Goodwill was assigned to our More Personal Computing segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of ZeniMax. None of the goodwill is expected to be deductible for income tax purposes.PART II Item 8Following are details of the purchase price allocated to the intangible assets acquired:(In millions)AmountWeightedAverage LifeTechnology-based$1,341 4 yearsMarketing-related11 yearsTotal$1,968 6 yearsGitHub, Inc.On October 25, 2018 , we acquired GitHub, Inc. (GitHub), a software development platform, in a $ 7.5 billion stock transaction (inclusive of total cash payments of $ 1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497 Intangible assets1,267 Other assetsOther liabilities( 217 )Total$ 6,924 The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$ 648 8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,267 7 yearsTransactions recognized separately from the purchase price allocation were approximately $ 600 million, primarily related to equity awards recognized as expense over the related service period. Nuance Communications, Inc.On April 11, 2021 , we entered into a definitive agreement to acquire Nuance Communications, Inc. (Nuance) for $ 56.00 per share in an all-cash transaction valued at $ 19.7 billion, inclusive of Nuances net debt. Nuance is a cloud and artificial intelligence (AI) software provider with healthcare and enterprise AI experience, and the acquisition will build on our industry-specific cloud offerings. The acquisition has been approved by Nuances shareholders, and we expect it to close by the end of calendar year 2021, subject to the satisfaction of certain regulatory approvals and other customary closing conditions.PART II Item 8NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows:(In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2021Productivity and Business Processes$24,277 $$( 94 )$24,190 $$$24,317 Intelligent Cloud11,351 1,351 ( 5 )12,697 13,256 More Personal Computing6,398 ( 30 )6,464 5,556 (a) (a ) 12,138 Total$ 42,026 $1,454 $( 129 )$43,351 $6,061 $299 $49,711 (a) Includes goodwill of $ 5.5 billion related to ZeniMax. See Note 8 Business Combinations for further information . The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2021, May 1, 2020, or May 1, 2019 tests. As of June 30, 2021 and 2020, accumulated goodwill impairment was $ 11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$9,779 $( 7,007 )$2,772 $8,160 $( 6,381 )$1,779 Customer-related4,958 ( 2,859 )2,099 4,967 ( 2,320 )2,647 Marketing-related4,792 ( 1,878 )2,914 4,158 ( 1,588 )2,570 Contract-based( 431 )( 432 )Total$19,975 (a) $( 12,175 )$7,800 $17,759 $( 10,721 )$7,038 (a) Includes intangible assets of $ 2.0 billion related to ZeniMax. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2021, 2020, or 2019. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$1,628 4 years$6 yearsCustomer-related4 years5 yearsMarketing-related6 years2 yearsContract-based3 years0 yearsTotal$2,359 5 years$5 yearsIntangible assets amortization expense was $ 1.6 billion, $ 1.6 billion, and $ 1.9 billion for fiscal years 2021, 2020, and 2019, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2021:(In millions)Year Ending June 30,$1,683 1,722 1,415 Thereafter1,727 Total$7,800 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 4.50 %4.57 %1,571 2011 issuance of $ 2.3 billion (a) 5.30 %5.36 %1,270 2012 issuance of $ 2.3 billion (a) 2.13 %3.50 %2.24 %3.57 %1,204 1,650 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,814 2,919 2013 issuance of 4.1 billion2.13 %3.13 %2.23 %3.22 %4,803 4,549 2015 issuance of $ 23.8 billion (a) 2.38 %4.75 %2.47 %4.78 %12,305 15,549 2016 issuance of $ 19.8 billion (a) 1.55 %3.95 %1.64 %4.03 %12,180 16,955 2017 issuance of $ 17.0 billion (a) 2.40 %4.50 %2.52 %4.53 %10,695 12,385 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 10,000 2021 issuance of $ 8.2 billion (a) 2.92 %3.04 %2.92 %3.04 %8,185 Total face value63,910 67,407 Unamortized discount and issuance costs( 511 )( 554 )Hedge fair value adjustments ( b ) Premium on debt exchange (a) ( 5,293 )( 3,619 )Total debt58,146 63,327 Current portion of long-term debt( 8,072 )( 3,749 )Long-term debt$50,074 $59,578 (a) In March 2021 and June 2020, we exchanged a portion of our existing debt at a premium for cash and new debt with longer maturities. The premiums are amortized over the terms of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2021 and 2020, the estimated fair value of long-term debt, including the current portion, was $ 70.0 billion and $ 77.1 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. Cash paid for interest on our debt for fiscal years 2021, 2020, and 2019 was $ 2.0 billion, $ 2.4 billion, and $ 2.4 billion, respectively . The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2021: (In millions)Year Ending June 30,$8,075 2,750 5,250 2,250 3,000 Thereafter42,585 Total$63,910 PART II Item 8NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $ 13.7 billion related to the enactment of the TCJA in fiscal year 2018 and adjusted the provisional net charge by recording additional tax expense of $ 157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $ 2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (GILTI) tax. Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$3,285 $3,537 $4,718 U.S. state and local1,229 Foreign5,467 4,444 5,531 Current taxes$9,981 $8,744 $10,911 Deferred TaxesU.S. federal$$$( 5,647 )U.S. state and local( 204 )( 6 )( 1,010 )Foreign( 41 )Deferred taxes$( 150 )$$( 6,463 )Provision for income taxes$9,831 $8,755 $4,448 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$34,972 $24,116 $15,799 Foreign 36,130 28,920 27,889 Income before income taxes$71,102 $53,036 $43,688 PART II Item 8Effective Tax Rate The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %21.0 %Effect of:Foreign earnings taxed at lower rates( 2.7 )%( 3.7 )%( 4.1 )%Impact of the enactment of the TCJA0 %0 %0.4 %Impact of intangible property transfers0 %0 %( 5.9 )%Foreign-derived intangible income deduction( 1.3 )%( 1.1 )%( 1.4 )%State income taxes, net of federal benefit1.4 %1.3 %0.7 %Research and development credit( 0.9 )%( 1.1 )%( 1.1 )%Excess tax benefits relating to stock-based compensation( 2.4 )%( 2.2 )%( 2.2 )%Interest, net0.5 %1.0 %1.0 %Other reconciling items, net( 1.8 )%1.3 %1.8 %Effective rate13.8 %16.5 %10.2 %We have historically paid India withholding taxes on software sales through distributor withholding and tax audit assessments in India. In March 2021, the India Supreme Court ruled favorably in the case of Engineering Analysis Centre of Excellence Private Limited vs The Commissioner of Income Tax for companies in 86 separate appeals, some dating back to 2012, holding that software sales are not subject to India withholding taxes. Although we were not a party to the appeals, our software sales in India were determined to be not subject to withholding taxes. Therefore, we recorded a net income tax benefit of $ 620 million in the third quarter of fiscal year 2021 to reflect the results of the India Supreme Court decision impacting fiscal year 1996 through fiscal year 2016 . The decrease from the federal statutory rate in fiscal year 2021 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, tax benefits relating to stock-based compensation, and tax benefits from the India Supreme Court decision on withholding taxes. The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $ 2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. In fiscal year 2021 and 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % and 86 % of our foreign income before tax. In fiscal years 2019, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax, and in fiscal year 2021, includes tax benefits from the India Supreme Court decision on withholding taxes. In fiscal years 2021, 2020, and 2019, there were no individually significant other reconciling items.PART II Item 8The decrease in our effective tax rate for fiscal year 2021 compared to fiscal year 2020 was primarily due to tax benefits from the India Supreme Court decision on withholding taxes, an agreement between the U.S. and India tax authorities related to transfer pricing , final TCJA regulations, and an increase in tax benefits relating to stock-based compensation. The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $ 2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,960 2,721 Loss and credit carryforwards1,090 Amortization6,346 6,737 Leasing liabilities4,060 3,025 Unearned revenue2,659 1,553 OtherDeferred income tax assets18,160 15,716 Less valuation allowance( 769 )( 755 )Deferred income tax assets, net of valuation allowance$17,391 $14,961 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 2,605 )$( 2,642 )Leasing assets( 3,834 )( 2,817 )Depreciation( 1,010 )( 376 )Deferred GILTI tax liabilities( 2,815 )( 2,581 )Other( 144 )( 344 )Deferred income tax liabilities$( 10,408 )$( 8,760 )Net deferred income tax assets$6,983 $6,201 Reported AsOther long-term assets$7,181 $6,405 Long-term deferred income tax liabilities( 198 )( 204 )Net deferred income tax assets$6,983 $6,201 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2021, we had federal, state, and foreign net operating loss carryforwards of $ 304 million, $ 1.3 billion, and $ 2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2022 through 2041 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation but are expected to be realized with the exception of those which have a valuation allowance.The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $ 2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements.Income taxes paid, net of refunds, were $ 13.4 billion, $ 12.5 billion, and $ 8.4 billion in fiscal years 2021, 2020, and 2019, respectively. PART II Item 8Uncertain Tax Positions Gross unrecognized tax benefits related to uncertain tax positions as of June 30, 2021, 2020, and 2019, were $ 14.6 billion, $ 13.8 billion, and $ 13.1 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2021, 2020, and 2019 by $ 12.5 billion, $ 12.1 billion, and $ 12.0 billion, respectively.As of June 30, 2021, 2020, and 2019, we had accrued interest expense related to uncertain tax positions of $ 4.3 billion, $ 4.0 billion, and $ 3.4 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2021, 2020, and 2019 included interest expense related to uncertain tax positions of $ 274 million, $ 579 million, and $ 515 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$13,792 $13,146 $11,961 Decreases related to settlements( 195 )( 31 )( 316 )Increases for tax positions related to the current year2,106 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 297 )( 331 )( 1,113 )Decreases due to lapsed statutes of limitations( 1 )( 5 )Ending unrecognized tax benefits$14,550 $13,792 $13,146 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. In the second quarter of fiscal year 2021, we settled an additional portion of the IRS audits for tax years 2004 to 2013 and made a payment of $ 1.7 billion, including tax and interest. We remain under audit for tax years 2004 to 2017 .As of June 30, 2021, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved key transfer pricing issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2020 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$22,120 $18,643 Intelligent Cloud17,710 16,620 More Personal Computing4,311 3,917 Total$44,141 $39,180 PART II Item 8Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2021Balance, beginning of period$39,180 Deferral of revenue94,565 Recognition of unearned revenue( 89,604 )Balance, end of period$44,141 Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 146 billion as of June 30, 2021, of which $ 141 billion is related to the commercial portion of revenue. We expect to recognize approximately 50 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, Microsoft Experience Centers, and certain equipment. Our leases have remaining lease terms of 1 year to 15 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$2,127 $2,043 $1,707 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$1,307 $$Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$2,052 $1,829 $1,670 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases4,380 3,677 2,303 Finance leases3,290 3,467 2,532 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$11,088 $8,753 Other current liabilities$1,962 $1,616 Operating lease liabilities9,629 7,671 Total operating lease liabilities$11,591 $9,287 Finance LeasesProperty and equipment, at cost$14,107 $10,371 Accumulated depreciation( 2,306 )( 1,385 )Property and equipment, net$11,801 $8,986 Other current liabilities$$Other long-term liabilities11,750 8,956 Total finance lease liabilities$12,541 $9,496 Weighted Average Remaining Lease TermOperating leases8 years8 yearsFinance leases12 years13 yearsWeighted Average Discount RateOperating leases2.2 %2.7 %Finance leases3.4 %3.9 %The following table outlines maturities of our lease liabilities as of June 30, 2021:(In millions)Year Ending June 30,OperatingLeasesFinanceLeases$2,125 $1,179 1,954 1,198 1,751 1,211 1,463 1,537 1,133 1,220 Thereafter4,111 8,856 Total lease payments12,537 15,201 Less imputed interest( 946 )( 2,660 )Total$11,591 $12,541 As of June 30, 2021, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 5.4 billion and $ 7.3 billion, respectively. These operating and finance leases will commence between fiscal year 2022 and fiscal year 2026 with lease terms of 1 year to 15 years .During fiscal year 2020, we recorded an impairment charge of $ 161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.PART II Item 8NOTE 15 CONTINGENCIES Patent and Intellectual Property Claims There were 63 patent infringement cases pending against Microsoft as of June 30, 2021, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement and form of notice have been approved by the courts in British Columbia, Ontario, and Quebec. The ten-month claims period commenced on November 23, 2020 and will close on September 23, 2021.Other Antitrust Litigation and Claims China State Administration for Market Regulation Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. In 2019, the SAMR presented preliminary views as to certain possible violations of Chinas Anti-Monopoly Law.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 46 lawsuits, including 45 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing on general causation is scheduled for January and February of 2022 . PART II Item 8Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2021, we accrued aggregate legal liabilities of $ 339 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,571 7,643 7,677 IssuedRepurchased( 101 )( 126 )( 150 )Balance, end of year7,519 7,571 7,643 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2021, $ 8.7 billion remained of this $ 40.0 billion share repurchase program.PART II Item 8We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$5,270 $4,000 $2,600 Second Quarter5,750 4,600 6,100 Third Quarter5,750 6,000 3,899 Fourth Quarter6,200 5,088 4,200 Total$22,970 $19,688 $16,799 Shares repurchased during fiscal year 2021 and the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 4.4 billion, $ 3.3 billion, and $ 2.7 billion for fiscal years 2021, 2020, and 2019, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2021(In millions)September 15, 2020 November 19, 2020 December 10, 2020 $0.56 $4,230 December 2, 2020 February 18, 2021 March 11, 2021 0.56 4,221 March 16, 2021 May 20, 2021 June 10, 2021 0.56 4,214 June 16, 2021 August 19, 2021 September 9, 2021 0.56 4,211 Total$2.24 $16,876 Fiscal Year 2020September 18, 2019 November 21, 2019 December 12, 2019 $0.51 $3,886 December 4, 2019 February 20, 2020 March 12, 2020 0.51 3,876 March 9, 2020 May 21, 2020 June 11, 2020 0.51 3,865 June 17, 2020 August 20, 2020 September 10, 2020 0.51 3,856 Total$2.04 $15,483 The dividend declared on June 16, 2021 was included in other current liabilities as of June 30, 2021. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component :(In millions)Year Ended June 30,DerivativesBalance, beginning of period$( 38 )$$Unrealized gains (losses), net of tax of $ 9 , $( 10 ), and $ 2 ( 38 )Reclassification adjustments for gains included in earnings( 17 )( 341 )Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)( 15 )( 333 )Net change related to derivatives, net of tax of $ 7 , $( 10 ), and $( 6 )( 38 )( 173 )Balance, end of period$( 19 )$( 38 )$InvestmentsBalance, beginning of period$5,478 $1,488 $( 850 )Unrealized gains (losses), net of tax of $( 589 ) , $ 1,057 , and $ 616 ( 2,216 )3,987 2,331 Reclassification adjustments for (gains) losses included in other income (expense), net( 63 )Tax expense (benefit) included in provision for income taxes( 1 )( 19 )Amounts reclassified from accumulated other comprehensive income (loss)( 50 )Net change related to investments, net of tax of $( 602 ) , $ 1,058 , and $ 635 ( 2,266 )3,990 2,405 Cumulative effect of accounting changes( 67 )Balance, end of period$3,222 $5,478 $1,488 Translation Adjustments and OtherBalance, beginning of period$( 2,254 )$( 1,828 )$( 1,510 )Translation adjustments and other, net of tax effects of $( 9 ) , $ 1 , and $( 1 )( 426 )( 318 )Balance, end of period$( 1,381 )$( 2,254 )$( 1,828 )Accumulated other comprehensive income (loss), end of period$1,822 $3,186 $( 340 )NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2021, an aggregate of 251 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$6,118 $5,289 $4,652 Income tax benefits related to stock-based compensation1,065 Stock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.51 0.56 $0.46 0.51 $0.42 0.46 Interest rates0.01 %1.5 %0.1 %2.2 %1.8 %3.1 %During fiscal year 2021, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$ 105.23 Granted (a) 221.13 Vested( 58 ) 99.41 Forfeited( 8 ) 129.92 Nonvested balance, end of year$152.51 (a) Includes 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2021, 2020, and 2019. As of June 30, 2021, there was approximately $ 12.0 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 221.13 , $ 140.49 , and $ 107.02 for fiscal years 2021, 2020, and 2019, respectively. The fair value of stock awards vested was $ 13.4 billion, $ 10.1 billion, and $ 8.7 billion, for fiscal years 2021, 2020, and 2019, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Under the terms of the ESPP that were approved in 2012, the plan will terminate on December 31, 2022. We intend to request shareholder approval for a successor ESPP with a January 1, 2022 effective date and ten-year expiration of December 31, 2031 at our 2021 Annual Shareholders Meeting. No additional shares will be requested at this meeting. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$207.88 $142.22 $104.85 As of June 30, 2021, 88 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50 % of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $ 1.2 billion, $ 1.0 billion, and $ 877 million in fiscal years 2021, 2020, and 2019, respectively, and were expensed as contributed. NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial (Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises), comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business. Office Consumer, including Microsoft 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, Premium Subscriptions, Sales Solutions, and Learning Solutions. Dynamics business solutions, including Dynamics 365, comprising a set of intelligent, cloud-based applications across ERP, CRM, Customer Insights, Power Apps, and Power Automate and on-premises ERP and CRM applications.Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related Client Access Licenses (CALs) and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows Internet of Things and MSN advertising. Devices, including Surface and PC accessories. PART II Item 8 Gaming, including Xbox hardware and Xbox content and services, comprising digital transactions, Xbox Game Pass and other subscriptions, video games, third-party video game royalties , cloud services, and advertising . Search advertising. Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include legal, including settlements and fines, information technology, human resources, finance, excise taxes, field selling, shared facilities services, and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$53,915 $46,398 $41,160 Intelligent Cloud60,080 48,366 38,985 More Personal Computing54,093 48,251 45,698 Total$168,088 $143,015 $125,843 Operating Income Productivity and Business Processes$24,351 $18,724 $16,219 Intelligent Cloud26,126 18,324 13,920 More Personal Computing19,439 15,911 12,820 Total$69,916 $52,959 $42,959 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2021, 2020, or 2019. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $83,953 $73,160 $64,199 Other countries84,135 69,855 61,644 Total$168,088 $143,015 $ 125,843 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows:(In millions)Year Ended June 30,Server products and cloud services$52,589 $41,379 $32,622 Office products and cloud services39,872 35,316 31,769 Windows23,227 22,294 20,395 Gaming15,370 11,575 11,386 LinkedIn10,289 8,077 6,754 Search advertising8,528 7,740 7,628 Enterprise Services6,943 6,409 6,124 Devices6,791 6,457 6,095 Other4,479 3,768 3,070 Total$168,088 $143,015 $125,843 Our commercial cloud revenue, which includes Azure, Office 365 Commercial, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 69.1 billion, $ 51.7 billion and $ 38.1 billion in fiscal years 2021, 2020, and 2019, respectively. These amounts are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$76,153 $60,789 $55,252 Ireland13,303 12,734 12,958 Other countries38,858 29,770 25,422 Total$ 128,314 $ 103,293 $ 93,632 PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2021 and 2020, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2021, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2021, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 29, 2021, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: - Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.- Tested management's identification and treatment of contract terms. - Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statements Critical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLPSeattle, Washington July 29, 2021 We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2021. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2021 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2021, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the ""financial statements"") as of and for the year ended June 30, 2021, of the Company and our report dated July 29, 2021, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, Washington July 29, 2021PART II, III Item 9B, 10, 11, 12, 13, 14" +2,msft,20200630," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. As the world responds to the outbreak of a novel strain of the coronavirus (COVID-19), we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. Our unique role as a platform and tools provider allows us to connect the dots, bring together an ecosystem of partners, and enable organizations of all sizes to build the digital capability required to address these challenges.In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems cross-device productivity applications server applications business solution applications desktop and server management tools software development tools and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The Ambitions That Drive Us To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesAt Microsoft, were providing technology and resources to help our customers navigate a remote environment. Were seeing our family of products play key roles in the ways the world is continuing to work, learn, and connect. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is enabling rapid digital transformation by giving people a single tool to chat, call, meet, and collaborate. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and discover new habits, while simplifying security and management. Organizations of all sizes have digitized business-critical functions, redefining what they can expect from their business applications. This creates an opportunity to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformIn the new remote world, companies have accelerated their own digital transformation to empower their employees, optimize their operations, engage customers, and in some cases, change the very core of their products and services. Partnering with organizations on their digital transformation during this period is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice their success is our success.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions with new Azure services and devices. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for customers to take SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation helps every developer be an AI developer, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 serves the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently added several new products and accessories into the Surface family, including Surface Book 3 and Surface Go 2. These new Surface products join Surface Pro 7, Surface Laptop 3, and Surface Pro X. To expand usage and deepen engagement, we continue to invest in content, community, and cloud services as we pursue the expansive opportunity in the gaming industry. We are broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers. Xbox Game Pass, with over 10 million members from 41 countries, is a community with access to a curated library of over 100 first- and third-party console and PC titles. Project xCloud is Microsofts game streaming technology that is complementary to our console hardware and will give fans the ultimate choice to play the games they want, with the people they want, on the devices they want. Our Future OpportunityIn a time of great disruption and uncertainty, customers are looking to us to accelerate their own digital transformations as software and cloud computing play a huge role across every industry and around the world. We continue to develop complete, intelligent solutions for our customers that empower people to stay productive and collaborate, while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft.PART I Item 1COVID-19 In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic. The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes, and closure of non-essential businesses. To protect the health and well-being of our employees, suppliers, and customers, we have made substantial modifications to employee travel policies, implemented office closures as employees are advised to work from home, and cancelled or shifted our conferences and other marketing events to virtual-only through fiscal year 2021. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time. Refer to Managements Discussion and Analysis of Financial Condition and Results of Operations (Part II, Item 7 of this Form 10-K) for further discussion regarding the impact of COVID-19 on our fiscal year 2020 financial results.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.Commitment to SustainabilityWe work to ensure that technology is inclusive, trusted, and increases sustainability. Were empowering our customers and partners with new technology to help them drive efficiencies, transform their businesses, and create their own solutions for sustainability. In January 2020, we announced a bold new environmental sustainability strategy focused on carbon, water, waste, and ecosystems. As part of our commitment, we are investing $1 billion over the next four years in new technologies and innovative climate solutions. We set an ambitious goal to reduce and ultimately remove Microsofts carbon footprint. By 2030 Microsoft will be carbon negative, and by 2050 Microsoft will remove from the environment all the carbon the company has emitted directly or by electrical consumption since it was founded in 1975. We also launched a new initiative to use Microsoft technology to help our suppliers and customers around the world reduce their own carbon footprint. The investments we make in sustainability carry through to our products, services, and devices. We design our devices, from Surface to Xbox, to minimize their impact on the environment. Our cloud and AI services help businesses cut energy consumption, reduce physical footprints, and design sustainable products. We also pledged a $50 million investment in AI for Earth to accelerate innovation by putting AI in the hands of those working to directly address sustainability challenges. Lastly, this work is supported by using our voice to support policies we think can advance sustainability efforts.Addressing Racial InjusticeOur future opportunity depends on reaching and empowering all communities, and we are committed to taking action to help address racial injustice and inequity. With significant input from employees and leaders who are members of the Black and African American community, our senior leadership team and board of directors has developed a set of actions to help improve the lived experience at Microsoft and drive change in the communities in which we live and work. These efforts include increasing our representation and culture of inclusion by doubling the number of Black and African American people managers, senior individual contributors, and senior leaders in the United States by 2025 engaging our ecosystem by using our balance sheet and engagement with suppliers and partners to extend the vision for societal change and strengthening our communities by using the power of data, technology, and partnership to help improve the lives of Black and African American citizens across the United States.PART I Item 1Investing in Digital Skills With a continued focus on digital transformation, Microsoft is making efforts to help ensure that no one is left behind, particularly as economies start to recover from the COVID-19 pandemic. We are expanding access to the digital skills that have become increasingly vital to many of the worlds jobs, and especially to individuals hardest hit by recent job losses, including those with lower incomes, women, and underrepresented minorities. Our skills initiative brings together learning resources, certification opportunities, and job-seeker tools from LinkedIn, GitHub, and Microsoft Learn, and is built on data insights drawn from LinkedIns Economic Graph. This is combined with $20 million we are investing in key non-profit partnerships through Microsoft Philanthropies. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.PART I Item 1Office Consumer Office Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Microsoft 365 Consumer subscriptions. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.LinkedInLinkedIn connects the worlds professionals to make them more productive and successful and transforms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity for every member of the global workforce through the ongoing development of the worlds first Economic Graph, a digital representation of the global economy. In addition to LinkedIns free services, LinkedIn offers monetized solutions: Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Talent Solutions provide insights for workforce planning and tools to hire, nurture, and develop talent. Learning Solutions, including Glint, help businesses close critical skills gaps in times where companies are having to do more with existing talent. Marketing Solutions help companies grow relationships between businesses. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. Finally, Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. LinkedIn has over 700 million members and has offices around the globe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions , Learning Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and other application development platforms for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online professional networks, recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services job boards traditional recruiting firms and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers, and Sales Solutions competes with online and offline outlets for companies with lead generation and customer intelligence and insights.PART I Item 1Dynamics competes with vendors such as Oracle, Salesforce.com, and SAP to provide cloud-based and on-premise s business solutions for small, medium, and large organizations. Intelligent CloudOur Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesAzure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionAzure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.PART I Item 1We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows IoT and MSN advertising. Devices, including Surface and PC accessories. Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.PART I Item 1Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings.Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories.GamingOur gaming platform is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of first-party studios creating iconic and differentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 first- and third-party console and PC titles.The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities for gamers to engage both on- and off-console with both the launch of Project xCloud, our game streaming service, and continued investment in gaming hardware. Project xCloud utilizes Microsofts Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take their favorites games with them and play on the device most convenient to them. Project xCloud will provide players with more choice over how and where they play.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox revenue is mainly affected by subscriptions and sales of first- and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through first-party content creators.SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. PART I Item 1Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs. Xbox Live and our cloud gaming services face competition from various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Facebook, Google, and Tencent. We also compete with other providers of entertainment services such as Netflix and Hulu. Our gaming platform competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. We believe our gaming platform is effectively positioned against, and uniquely differentiated from, competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own first-party game franchises as well as other digital content offerings.Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. The majority of our hardware products contain components for which there is only one qualified supplier. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manufacture devices.RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility + Security, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction.PART I Item 1Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 63,000 U.S. and international patents issued and over 24,500 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we incorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations.While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main product research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. We plan to continue to make significant investments in a broad range of research and development efforts. PART I Item 1DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with commercial enterprises and public-sector organizations worldwide to identify and meet their technology and digital transformation requirements managing OEM relationships and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In June 2020, we announced a strategic change in our retail operations, including closing our Microsoft Store physical locations. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. PART I Item 1LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, training, and other licensing benefits to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows hosting service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.PART I Item 1The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users. CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 30, 2020 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 26 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003. Ms. Hogan also serves on the Board of Directors of Alaska Air Group, Inc.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2020, we employed approximately 163,000 people on a full-time basis, 96,000 in the U.S. and 67,000 internationally. Of the total employed people, 56,000 were in operations, including manufacturing, distribution, product support, and consulting services 55,000 were in product research and development 40,000 were in sales and marketing and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RISK FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. Competitors rules governing their content and applications marketplaces may restrict our ability to distribute products and services through them in accordance with our technical and business model objectives.PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data as well as help them meet their own compliance needs. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, SQL Server, Windows Server, Azure, Office 365, Xbox Live, LinkedIn, and other products and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may not be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Edge and Bing, that drive post-sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product experiences, which could negatively impact product and feature adoption, product design, and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. For example, in October 2018, we completed our acquisition of GitHub, Inc. (GitHub) for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge in our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improve technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes as passwords. Inadequate account security practices may also result in unauthorized access. User activity may also result in ransomware or other malicious software impacting a customers use of our products or services. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. Customers in certain industries such as financial services, health care, and government may have enhanced or specialized requirements to which we must engineer our product and services.PART I Item 1AThe cost of these steps could reduce our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers, and third parties granted access to their systems, may fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches, or may otherwise fail to adopt adequate security practices. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. Our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For platform products and services that provide content or host ads that come from or can be influenced by third parties, including GitHub, LinkedIn, Microsoft Advertising, MSN, and Xbox Live, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1ADigital safety and service misuse Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, civil or criminal liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex, and requires development of principles for datacenter builds in geographies with higher safety risks. It requires that we maintain an Internet connectivity infrastructure and storage and compute capacity that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data, insufficient Internet connectivity, or inadequate storage and compute capacity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophisticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described elsewhere in these risk factors. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow because of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Surface. To resolve these claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact in our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Crimea, Cuba, Iran, North Korea, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Microsoft Teams and Skype are covered by existing laws regulating telecommunications services, and some new laws, including EU Member State laws under the European Electronic Communications Code, are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us, or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For example, in July 2020 the Court of Justice of the EU invalidated a framework called Privacy Shield for companies to transfer data from EU member states to the United States. This ruling has led to uncertainty about the legal requirements for data transfers from the EU under other l egal mechanisms. Potential new rules and restrictions on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, the EU General Data Protection Regulation (GDPR), became effective. The law, which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of compliance obligations regarding the handling of personal data. Engineering efforts to build and maintain capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if our implementation to comply with the GDPR make s our offerings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to comply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits, reputational damage , and loss of customers . Countries around the world, and states in the U.S . such as California , ha ve adopted, or are considering adopting or expanding , laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location, movement, collection, and use of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements. If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Our business with government customers may present additional uncertainties. We derive substantial revenue from government contracts. Government contracts generally can present risks and challenges not present in private commercial agreements. For instance, we may be subject to government audits and investigations relating to these contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to terminate without cause and provide for higher liability limits for certain losses. Some contracts may be subject to periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products and services. These events could negatively impact our results of operations, financial condition, and reputation . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, pandemic, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. PART I Item 1AChallenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio comprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements.Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, pandemic, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages in our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The occurrence of regional epidemics or a global pandemic may adversely affect our operations, financial condition, and results of operations. The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal and state governments have implemented measures in an effort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, supply chain logistical changes, and closure of non-essential businesses. To protect the health and well-being of our employees, suppliers, and customers, we have made substantial modifications to employee travel policies, implemented office closures as employees are advised to work from home, and cancelled or shifted our conferences and other marketing events to virtual-only through fiscal year 2021. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued effects over time.In the third and fourth quarters of fiscal year 2020, we have experienced adverse impacts to our supply chain, a slowdown in transactional licensing, and lower demand for our advertising services. The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance.PART I Item 1AMeasures to contain the virus that impact us, our partners, distributors, and suppliers may further intensify these impacts and other risks described in these Risk Factors. Any of these may adversely impact our ability to: Maintain our operations infrastructure, including the reliability and adequate capacity of cloud services. Satisfy our contractual and regulatory compliance obligations as we adapt to changing usage patterns, such as through datacenter load balancing. Ensure a high-quality and consistent supply chain and manufacturing operations for our hardware devices and datacenter operations. Effectively manage our international operations through changes in trade practices and policies. Hire and deploy people where we most need them. Sustain the effectiveness and productivity of our operations including our sales, marketing, engineering, and distribution functions.We may incur increased costs to effectively manage these aspects of our business. If we are unsuccessful it may adversely impact our revenues, cash flows, market share growth, and reputation.The long-term effects of climate change on the global economy and the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in climate where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVED STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2020 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India our datacenters in Ireland, the Netherlands, and Singapore and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, France, Germany, India, Israel, Japan, Netherlands, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2020:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. This will be the last annual report under the Final Order. During fiscal year 2020, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking) (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 15 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 27, 2020, there were 91,674 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2020:PeriodTotal Number of SharesPurchasedAveragePrice Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares That May Yet bePurchased Under the Plans or Programs(In millions)April 1, 2020 April 30, 20208,906,563$165.908,906,563$35,323May 1, 2020 May 31, 20209,655,700182.319,655,70033,563June 1, 2020 June 30, 20209,648,400191.809,648,40031,71228,210,66328,210,663All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2020: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 17, 2020August 20, 2020September 10, 2020$0.51$3,861We returned $8.9 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2020. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses licensing and supporting an array of software products designing, manufacturing, and selling devices and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees designing, manufacturing, marketing, and selling our products and services datacenter costs in support of our cloud-based services and income taxes.As the world responds to the outbreak of a novel strain of the coronavirus (COVID-19), we are working to do our part by ensuring the safety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote.Highlights from fiscal year 2020 compared with fiscal year 2019 included: Commercial cloud revenue increased 36% to $51.7 billion. Office Commercial products and cloud services revenue increased 12%, driven by Office 365 Commercial growth of 24%. Office Consumer products and cloud services revenue increased 11%, with continued growth in Office 365 Consumer subscribers to 42.7 million. LinkedIn revenue increased 20%. Dynamics products and cloud services revenue increased 14%, driven by Dynamics 365 growth of 42%. Server products and cloud services revenue increased 27%, driven by Azure growth of 56%. Enterprise Services revenue increased 5%. Windows Commercial products and cloud services revenue increased 18%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 9%. Surface revenue increased 8%. Xbox content and services revenue increased 11%. Search advertising revenue, excluding traffic acquisition costs, was relatively unchanged.Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.PART II Item 7Economic Conditions, Challenges, and Risks The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019. Strengthening of the U.S. dollar relative to certain foreign currencies reduced reported revenue and expenses from our international operations in fiscal year 2020.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.COVID-19In fiscal year 2020, the COVID-19 pandemic impacted our business operations, including our employees, customers, partners, and communities, and we saw the following trends in our financial operating results. In the Productivity and Business Processes and Intelligent Cloud segments, cloud usage and demand increased as customers shifted to work and learn from home. We also experienced a slowdown in transactional licensing, particularly in small and medium businesses, and LinkedIn was negatively impacted by the weak job market and reductions in advertising spend. In the More Personal Computing segment, Windows OEM, Surface, and Gaming benefited from increased demand to support remote work-, play-, and learn-from-home scenarios, while Search was negatively impacted by reductions in advertising spend. The COVID-19 pandemic may continue to impact our business operations and financial operating results, and there is substantial uncertainty in the nature and degree of its continued effects over time.The extent to which the COVID-19 pandemic impacts our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic governmental, business, and individuals' actions in response to the pandemic and the impact on economic activity including the possibility of recession or financial market instability. These factors may adversely impact consumer, business, and government spending on technology as well as customers' ability to pay for our products and services on an ongoing basis. This uncertainty also affects managements accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and forward-looking guidance. Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.PART II Item 7Reportable Segments We report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 19 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). MetricsWe use metrics in assessing the performance of our business and to make informed decisions regarding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into performance trends, and reflect the continued evolution of our products and services. Our commercial and other business metrics are fundamentally connected based on how customers use our products and services. The metrics are disclosed in the MDA or the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last fiscal year.CommercialOur commercial business primarily consists of Server products and cloud services, Office Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynamics. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of future performance.Commercial remaining performance obligation Commercial portion of revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods Commercial cloud revenue Revenue from our commercial cloud business, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Commercial cloud gross margin percentageGross margin percentage for our commercial cloud business PART II Item 7Productivity and Business Processes and Intelligent Cloud Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics reflect our cloud and on-premises product strategies and trends. Office Commercial products and cloud services revenue growthRevenue from Office Commercial products and cloud services, including Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs)Office Consumer products and cloud services revenue growthRevenue from Office Consumer products and cloud services, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premisesOffice 365 Commercial seat growthThe number of Office 365 Commercial seats at end of period where seats are paid users covered by an Office 365 Commercial subscriptionOffice 365 Consumer subscribersThe number of Office 365 Consumer subscribers at end of periodDynamics products and cloud services revenue growthRevenue from Dynamics products and cloud services, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premisesLinkedIn revenue growthRevenue from LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium SubscriptionsServer products and cloud services revenue growthRevenue from Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHubEnterprise Services revenue growthRevenue from Enterprise Services, including Premier Support Services and Microsoft Consulting ServicesMore Personal ComputingMetrics related to our More Personal Computing segment assess the performance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the performance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are reflective of those varying motions.Windows OEM Pro revenue growthRevenue from sales of Windows Pro licenses sold through the OEM channel, which primarily addresses demand in the commercial marketWindows OEM non-Pro revenue growthRevenue from sales of Windows non-Pro licenses sold through the OEM channel, which primarily addresses demand in the consumer marketWindows Commercial products and cloud services revenue growthRevenue from Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offeringsSurface revenueRevenue from Surface devices and accessoriesXbox content and services revenue growth Revenue from Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties Search advertising revenue, excluding TAC, growthRevenue from search advertising excluding traffic acquisition costs (TAC) paid to Bing Ads network publishers PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2020Versus 2019Percentage Change 2019Versus 2018Revenue$143,015$125,843$110,36014%14%Gross margin96,93782,93372,00717%15%Operating income52,95942,95935,05823%23%Net income44,28139,24016,57113%137%Diluted earnings per share5.765.062.1314%138%Non-GAAP net income44,28136,83030,26720%22%Non-GAAP diluted earnings per share5.764.753.8821%22%Non-GAAP net income and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties in fiscal year 2019 and the net tax impact of the Tax Cuts and Jobs Act (TCJA) in fiscal years 2019 and 2018 . Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2020 Compared with Fiscal Year 2019Revenue increased $17.2 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office Commercial and LinkedIn. More Personal Computing revenue increased, driven by Windows and Surface.Gross margin increased $14.0 billion or 17%, driven by growth across each of our segments. Gross margin percentage increased, driven by sales mix shift to higher margin businesses. Commercial cloud gross margin percentage increased 4 points to 67%, primarily driven by improvement in Azure.Operating income increased $10.0 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $3.2 billion or 7%, driven by growth in commercial cloud. Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsoft Store physical locations, offset in part by a reduction in business taxes and legal expenses.Gross margin and operating income included an unfavorable foreign currency impact of 2% and 4%, respectively.Prior year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.PART II Item 7Operating income increased $7.9 billion or 23%, driven by growth across each of our segments. Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Fiscal year 2019 net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2020Versus 2019Percentage Change 2019Versus 2018RevenueProductivity and Business Processes$46,398$41,160$35,86513%15%Intelligent Cloud48,36638,98532,21924%21%More Personal Computing48,25145,69842,2766%8%Total $143,015$125,843$110,36014%14%Operating Income Productivity and Business Processes$18,724$16,219$12,92415%25%Intelligent Cloud18,32413,92011,52432%21%More Personal Computing15,91112,82010,61024%21%Total $52,959$42,959$35,05823%23%Reportable Segments Fiscal Year 2020 Compared with Fiscal Year 2019Productivity and Business Processes Revenue increased $5.2 billion or 13%. Office Commercial products and cloud services revenue increased $3.1 billion or 12%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial revenue grew 24%, due to seat growth and higher revenue per user. Office Consumer products and cloud services revenue increased $458 million or 11%, driven by Microsoft 365 Consumer subscription revenue and transactional strength in Japan. Office 365 Consumer subscribers increased 23% to 42.7 million with increased demand from remote work and learn scenarios. LinkedIn revenue increased $1.3 billion or 20%, driven by growth across all businesses. Dynamics products and cloud services revenue increased 14%, driven by Dynamics 365 growth of 42%. PART II Item 7Operating income increased $2 .5 billion or 15 %. Gross margin increased $4.1 billion or 13%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage was relatively unchanged, due to gross margin percentage improvement in LinkedIn, offset in part by an increased mix of cloud offerings. Operating expenses increased $1.6 billion or 11%, driven by investments in LinkedIn and cloud engineering. Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.Intelligent Cloud Revenue increased $9.4 billion or 24%. Server products and cloud services revenue increased $8.8 billion or 27%, driven by Azure. Azure revenue grew 56%, due to growth in our consumption-based services. Server products revenue increased 8% , due to hybrid and premium solutions, as well as demand related to SQL Server 2008 and Windows Server 2008 end of support. Enterprise Services revenue increased $285 million or 5% , driven by growth in Premier Support Services.Operating income increased $4.4 billion or 32%. Gross margin increased $6.9 billion or 26%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.5 billion or 19%, driven by investments in Azure. Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%, respectively.More Personal Computing Revenue increased $2.6 billion or 6%. Windows revenue increased $1.9 billion or 9%, driven by growth in Windows Commercial and Windows OEM. Windows Commercial products and cloud services revenue increased 18%, driven by increased demand for Microsoft 365. Windows OEM revenue increased 9%, ahead of PC market growth. Windows OEM Pro revenue grew 11%, driven by Windows 7 end of support and healthy Windows 10 demand, offset in part by weakness in small and medium businesses. Windows OEM non-Pro revenue grew 5%, driven by consumer demand from remote work and learn scenarios. Surface revenue increased $457 million or 8%, driven by increased demand from remote work and learn scenarios. Gaming revenue increased $189 million or 2%, driven by an increase in Xbox content and services, offset in part by a decrease in Xbox hardware. Xbox content and services revenue increased $943 million or 11% on a strong prior year comparable, driven by growth in Minecraft, third-party titles, and subscriptions, accelerated by higher engagement during stay-at-home guidelines. Xbox hardware revenue declined 31%, primarily due to a decrease in volume and price of consoles sold. Search advertising revenue increased $112 million or 1%. Search advertising revenue, excluding traffic acquisition costs, was relatively unchanged.Operating income increased $3.1 billion or 24%. Gross margin increased $3.0 billion or 12%, driven by growth in Windows, Gaming, and Surface. Gross margin percentage increased, due to sales mix shift to higher margin businesses and gross margin percentage improvement in Gaming. Operating expenses decreased $119 million or 1%, driven by the redeployment of engineering resources, offset in part by charges associated with the closing of our Microsoft Store physical locations and investments in Gaming.PART II Item 7Gross margin and operating income included an unfavorable foreign currency impact of 2% and 3%, respectively. Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial products and cloud services revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. Office Consumer products and cloud services revenue increased $286 million or 7%, driven by Microsoft 365 Consumer, due to recurring subscription revenue and transactional strength in Japan. LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics products and cloud services revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial products and cloud services revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer.PART II Item 7 Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018Research and development$19,269$16,876$14,72614%15%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2020 Compared with Fiscal Year 2019Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Sales and Marketing (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018Sales and marketing$19,598$18,213$17,4698%4%As a percent of revenue14%14%16%0ppt(2)pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2020 Compared with Fiscal Year 2019Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. General and Administrative (In millions, except percentages)PercentageChange 2020 Versus 2019Percentage Change 2019 Versus 2018General and administrative$5,111$4,885$4,7545%3%As a percent of revenue4%4%4%0ppt0pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2020 Compared with Fiscal Year 2019General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsoft Store physical locations, offset in part by a reduction in business taxes and legal expenses.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,680$2,762$2,214Interest expense(2,591)(2,686)(2,733)Net recognized gains on investments2,399Net gains (losses) on derivatives(187)Net losses on foreign currency remeasurements(191)(82)(218)Other, net(40)(57)(59)Total$$$1,416We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit enhance investment returns and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2020 Compared with Fiscal Year 2019Interest and dividends income decreased due to lower yields, offset in part by higher average portfolio balances on fixed-income securities. Interest expense decreased due to capitalization of interest expense and a decrease in outstanding long-term debt due to debt maturities, offset in part by debt exchange transaction fees and higher finance lease expense. Net recognized gains on investments decreased due to lower gains and higher other-than-temporary impairments on equity investments, offset in part by gains on fixed income securities in the current period compared to losses in the prior period. Net gains on derivatives increased due to higher gains on foreign exchange and equity derivatives.PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . INCOME TAXES Effective Tax RateFiscal Year 2020 Compared with Fiscal Year 2019Our effective tax rate for fiscal years 2020 and 2019 was 17% and 10%, respectively. The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2020, our U.S. income before income taxes was $24.1 billion and our foreign income before income taxes was $28.9 billion. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion.Fiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. In April 2020, the IRS commenced the audit for tax years 2014 to 2017. As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP net income and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties in fiscal year 2019 and the net tax impact of the TCJA in fiscal years 2019 and 2018. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2020 Versus 2019Percentage Change 2019 Versus 2018Net income$44,281$39,240$16,57113%137%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Non-GAAP net income$44,281$36,830$30,26720%22%Diluted earnings per share$5.76$5.06$2.1314%138%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Non-GAAP diluted earnings per share$5.76$4.75$3.8821%22%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $136.5 billion and $133.8 billion as of June 30, 2020 and 2019. Equity investments were $3.0 billion and $2.6 billion as of June 30, 2020 and 2019, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2020 Compared with Fiscal Year 2019Cash from operations increased $8.5 billion to $60.7 billion for fiscal year 2020, mainly due to an increase in cash from customers, offset in part by an increase in cash used to pay income taxes, suppliers, and employees. Cash used in financing increased $9.1 billion to $46.0 billion for fiscal year 2020, mainly due to a $3.4 billion cash premium on our debt exchange, a $3.4 billion increase in common stock repurchases, a $1.5 billion increase in repayments of debt, and a $1.3 billion increase in dividends paid. Cash used in investing decreased $3.6 billion to $12.2 billion for fiscal year 2020, mainly due to a $6.4 billion increase in cash from net investment purchases, sales, and maturities, offset in part by a $1.5 billion increase in additions to property and equipment and $1.2 billion in other investing to facilitate the purchase of components. PART II Item 7Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities to take advantage of favorable financing rates in the debt markets, reflecting our credit rating and the low interest rate environment. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2020:(In millions)Three Months EndingSeptember 30, 2020$13,884December 31, 202010,950March 31, 20217,476June 30, 20213,690Thereafter3,180Total$39,180If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2020, 2019, and 2018, we repurchased 126 million shares, 150 million shares, and 99 million shares of our common stock for $19.7 billion, $16.8 billion, and $8.6 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 16 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2020: (In millions)2022-20232024-2025ThereafterTotalLong-term debt: (a) Principal payments$3,750$10,716$7,500$45,441$67,407Interest payments2,0283,7363,29325,26534,322Construction commitments (b) 4,7615,041Operating leases, including imputed interest (c) 2,4203,9862,9294,40913,744Finance leases, including imputed interest (c) 2,2432,6769,61115,522Transition tax (d) 1,4502,8996,3434,53115,223Purchase commitments (e) 25,0591,32427,024Other long-term liabilities (f) Total$40,460 $25,478 $23,142$89,885 $178,965 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (c) Refer to Note 14 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (e) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. (f) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $15.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. LiquidityAs a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of $3.2 billion, which included $1.2 billion for fiscal year 2020. The remaining transition tax of $15.2 billion is payable over the next six years with a final payment in fiscal year 2026. During fiscal year 2020, we also paid $3.7 billion related to the transfer of intangible properties that occurred in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies, as well as uncertainty in the current economic environment due to the recent outbreak of COVID-19. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. PART II Item 7Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.CHANGE IN ACCOUNTING ESTIMATE In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years. This change in accounting estimate will be effective beginning fiscal year 2021. Based on the carrying amount of server and network equipment included in Property and equipment, net as of June 30, 2020, it is estimated this change will increase our fiscal year 2021 operating income by $2.7 billion.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currencyRevenue10% decrease in foreign exchange rates$(4,142)EarningsForeign currencyInvestments10% decrease in foreign exchange rates(119)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(3,951)Fair ValueCredit100 basis point increase in credit spreads(301)Fair ValueEquity10% decrease in equity market prices(239)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$68,041 $66,069 $ 64,497 Service and other74,974 59,774 45,863 Total revenue143,015 125,843 110,360 Cost of revenue:Product16,017 16,273 15,420 Service and other30,061 26,637 22,933 Total cost of revenue46,078 42,910 38,353 Gross margin96,937 82,933 72,007 Research and development19,269 16,876 14,726 Sales and marketing19,598 18,213 17,469 General and administrative5,111 4,885 4,754 Operating income52,959 42,959 35,058 Other income, net 1,416 Income before income taxes53,036 43,688 36,474 Provision for income taxes8,755 4,448 19,903 Net income$44,281 $39,240 $16,571 Earnings per share:Basic$5.82 $5.11 $2.15 Diluted$5.76 $5.06 $2.13 Weighted average shares outstanding:Basic7,610 7,673 7,700 Diluted7,683 7,753 7,794 Refer to accompanying notes. PART II Item 8COMPREHENSIVE INCOME STATEMENTS (In millions)Year Ended June 30,Net income$44,281 $39,240 $16,571 Other comprehensive income (loss), net of tax:Net change related to derivatives( 38 )( 173 )Net change related to investments3,990 2,405 ( 2,717 )Translation adjustments and other( 426 )( 318 )( 178 )Other comprehensive income (loss)3,526 1,914 ( 2,856 ) Comprehensive income$47,807 $41,154 $13,715 Refer to accompanying notes. PART II Item 8BALANCE SHEETS(In millions)June 30,AssetsCurrent assets:Cash and cash equivalents$13,576 $11,356 Short-term investments122,951 122,463 Total cash, cash equivalents, and short-term investments136,527 133,819 Accounts receivable, net of allowance for doubtful accounts of $ 788 and $ 411 32,011 29,524 Inventories1,895 2,063 Other current assets11,482 10,146 Total current assets181,915 175,552 Property and equipment, net of accumulated depreciation of $ 43,197 and $ 35,330 44,151 36,477 Operating lease right-of-use assets8,753 7,379 Equity investments2,965 2,649 Goodwill43,351 42,026 Intangible assets, net7,038 7,750 Other long-term assets13,138 14,723 Total assets$301,311 $286,556 Liabilities and stockholders equityCurrent liabilities:Accounts payable$12,530 $9,382 Current portion of long-term debt3,749 5,516 Accrued compensation7,874 6,830 Short-term income taxes2,130 5,665 Short-term unearned revenue36,000 32,676 Other current liabilities10,027 9,351 Total current liabilities72,310 69,420 Long-term debt59,578 66,662 Long-term income taxes29,432 29,612 Long-term unearned revenue3,180 4,530 Deferred income taxesOperating lease liabilities7,671 6,188 Other long-term liabilities10,632 7,581 Total liabilities183,007 184,226 Commitments and contingencies Stockholders equity:Common stock and paid-in capital shares authorized 24,000 outstanding 7,571 and 7,643 80,552 78,520 Retained earnings34,566 24,150 Accumulated other comprehensive income (loss)3,186 ( 340 ) Total stockholders equity118,304 102,330 Total liabilities and stockholders equity$301,311 $286,556 Refer to accompanying notes. PART II Item 8CASH FLOWS STATEMENTS (In millions)Year Ended June 30,OperationsNet income$44,281 $39,240 $16,571 Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other12,796 11,682 10,261 Stock-based compensation expense5,289 4,652 3,940 Net recognized gains on investments and derivatives( 219 )( 792 )( 2,212 )Deferred income taxes( 6,463 )( 5,143 )Changes in operating assets and liabilities:Accounts receivable( 2,577 )( 2,812 )( 3,862 )Inventories( 465 )Other current assets( 2,330 )( 1,718 )( 952 )Other long-term assets( 1,037 )( 1,834 )( 285 )Accounts payable3,018 1,148 Unearned revenue2,212 4,462 5,922 Income taxes( 3,631 )2,929 18,183 Other current liabilities1,346 1,419 Other long-term liabilities1,348 ( 20 )Net cash from operations60,675 52,185 43,884 FinancingRepayments of short-term debt, maturities of 90 days or less, net( 7,324 )Proceeds from issuance of debt7,183 Cash premium on debt exchange( 3,417 )Repayments of debt( 5,518 )( 4,000 )( 10,060 )Common stock issued1,343 1,142 1,002 Common stock repurchased( 22,968 )( 19,543 )( 10,721 )Common stock cash dividends paid( 15,137 )( 13,811 )( 12,699 )Other, net( 334 )( 675 )( 971 )Net cash used in financing( 46,031 )( 36,887 )( 33,590 )InvestingAdditions to property and equipment( 15,441 )( 13,925 )( 11,632 )Acquisition of companies, net of cash acquired, and purchases of intangible and other assets( 2,521 )( 2,388 )( 888 )Purchases of investments( 77,190 )( 57,697 )( 137,380 )Maturities of investments66,449 20,043 26,360 Sales of investments17,721 38,194 117,577 Other, net( 1,241 )( 98 )Net cash used in investing( 12,223 )( 15,773 )( 6,061 )Effect of foreign exchange rates on cash and cash equivalents( 201 )( 115 )Net change in cash and cash equivalents2,220 ( 590 )4,283 Cash and cash equivalents, beginning of period11,356 11,946 7,663 Cash and cash equivalents, end of period$13,576 $11,356 $11,946 Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQUITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$78,520 $71,223 $69,315 Common stock issued1,343 6,829 1,002 Common stock repurchased( 4,599 )( 4,195 )( 3,033 )Stock-based compensation expense5,289 4,652 3,940 Other, net( 1 )( 1 )Balance, end of period80,552 78,520 71,223 Retained earnings Balance, beginning of period24,150 13,682 17,769 Net income44,281 39,240 16,571 Common stock cash dividends( 15,483 )( 14,103 )( 12,917 )Common stock repurchased( 18,382 )( 15,346 )( 7,699 )Cumulative effect of accounting changes( 42 )Balance, end of period34,566 24,150 13,682 Accumulated other comprehensive income (loss)Balance, beginning of period( 340 )( 2,187 ) Other comprehensive income (loss)3,526 1,914 ( 2,856 )Cumulative effect of accounting changes( 67 )Balance, end of period3,186 ( 340 )( 2,187 )Total stockholders equity$ 118,304 $ 102,330 $ 82,718 Cash dividends declared per common share$2.04 $1.84 $1.68 Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds loss contingencies product warranties the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units product life cycles useful lives of our tangible and intangible assets allowances for doubtful accounts the market value of, and demand for, our inventory stock-based compensation forfeiture rates when technological feasibility is achieved for our products the potential outcome of uncertain tax positions that have been recognized in our consolidated financial statements or tax returns and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to the recent outbreak of a novel strain of the coronavirus (COVID-19).In July 2020, we completed an assessment of the useful lives of our server and network equipment and determined we should increase the estimated useful life of server equipment from three years to four years and increase the estimated useful life of network equipment from two years to four years . This change in accounting estimate will be effective beginning fiscal year 2021.Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems cross-device productivity applications server applications business solution applications desktop and server management tools software development tools video games and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office 365, Azure, Dynamics 365, and Xbox Live solution support and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 19 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2020 and 2019, long-term accounts receivable, net of allowance for doubtful accounts, was $ 2.7 billion and $ 2.2 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs( 178 )( 116 )( 98 )Balance, end of period$$$ 397 Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$ 816 $ 434 $ 397 PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future LinkedIn subscriptions Office 365 subscriptions Xbox Live subscriptions Windows 10 post-delivery support Dynamics business solutions Skype prepaid credits and subscriptions and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 13 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront. We record financing receivables when we offer certain of our customers the option to acquire our software products and services offerings through a financing program in a limited number of countries. As of June 30, 2020 and 2019, our financing receivables, net were $ 5.2 billion and $ 4.3 billion, respectively, for short-term and long-term financing receivables, which are included in other current assets and other long-term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed operating costs related to product support service centers and product distribution centers costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space costs incurred to support and maintain online products and services, including datacenter costs and royalties warranty costs inventory valuation adjustments costs associated with the delivery of consulting services and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $ 1.6 billion in fiscal years 2020, 2019, and 2018. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other comprehensive income . Debt investments are impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of , and business outlook , for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in other income (expense), net.For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded from the assessment of effectiveness are recognized in earnings. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. PART II Item 8 Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds , municipal securities , and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years computer equipment, two to three years buildings and improvements, five to 15 years leasehold improvements, three to 20 years and furniture and equipment, one to 10 years . Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment leases, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. PART II Item 8Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years . We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceFinancial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the Financial Accounting Standards Board (FASB) issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. We adopted the standard effective July 1, 2019. As we did not hold derivative instruments requiring an adjustment upon adoption, there was no impact in our consolidated financial statements. Adoption of the standard enhanced the presentation of the effects of our hedging instruments and the hedged items in our consolidated financial statements to increase the understandability of the results of our hedging strategies.Recent Accounting Guidance Not Yet AdoptedFinancial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivable, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We have evaluated the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems. We continue to monitor economic implications of the COVID-19 pandemic. Based on current market conditions, adoption of the standard will not have a material impact on our consolidated financial statements. Accounting for Income TaxesIn December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021, with early adoption permitted. We are currently evaluating the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems.NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.PART II Item 8The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$ 44,281 $ 39,240 $ 16,571 Weighted average outstanding shares of common stock (B)7,610 7,673 7,700 Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,683 7,753 7,794 Earnings Per ShareBasic (A/B)$5.82 $5.11 $2.15 Diluted (A/C)$5.76 $5.06 $2.13 Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,680 $2,762 $2,214 Interest expense( 2,591 )( 2,686 )( 2,733 )Net recognized gains on investments2,399 Net gains (losses) on derivatives( 187 )Net losses on foreign currency remeasurements( 191 )( 82 )( 218 )Other, net( 40 )( 57 )( 59 )Total$$$1,416 Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities( 37 )( 93 )( 987 )Other-than-temporary impairments of investments( 17 )( 16 )( 6 )Total$( 4 )$( 97 )$( 966 )Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$$3,406 Net unrealized gains on investments still held 69 479 Impairments of investments( 116 ) ( 10 ) ( 41 ) Total$ 36 $ 745 $ 3,365 PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2020Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$4,687 $$$4,688 $1,618 $3,070 $Certificates of depositLevel 22,898 2,898 1,646 1,252 U.S. government securitiesLevel 192,067 6,495 ( 1 )98,561 3,168 95,393 U.S. agency securitiesLevel 22,439 2,441 1,992 Foreign government bondsLevel 26,982 ( 3 )6,985 6,984 Mortgage- and asset-backed securitiesLevel 24,865 ( 6 )4,900 4,900 Corporate notes and bondsLevel 28,500 ( 17 )8,810 8,810 Corporate notes and bondsLevel 3Municipal securitiesLevel 2( 4 )Municipal securitiesLevel 3Total debt investments$122,900 $6,929 $( 31 )$129,798 $6,882 $122,916 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$1,198 $$$Equity investmentsOther2,551 2,551 Total equity investments$3,749 $$$2,965 Cash$5,910 $5,910 $$Derivatives, net (a) Total$139,492 $13,576 $122,951 $2,965 PART II Item 8(In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded in Other Comprehensive IncomeCommercial paperLevel 2$2,211 $$$2,211 $1,773 $$Certificates of depositLevel 22,018 2,018 1,430 U.S. government securitiesLevel 1104,925 1,854 ( 104 )106,675 105,906 U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350 ( 8 )6,346 2,506 3,840 Mortgage- and asset-backed securitiesLevel 23,554 ( 3 )3,561 3,561 Corporate notes and bondsLevel 27,437 ( 7 )7,541 7,541 Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747 $2,027 $( 122 )$129,652 $7,176 $122,476 $Changes in Fair Value Recorded in Net IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,085 2,085 Total equity investments$3,058 $$$2,649 Cash$3,771 $3,771 $$Derivatives, net (a) ( 13 )( 13 )Total$136,468 $11,356 $122,463 $2,649 (a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2020 and 2019, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $ 1.4 billion and $ 1.2 billion, respectively. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2020U.S. government and agency securities$2,323 $( 1 )$$$2,323 $( 1 )Foreign government bonds( 3 )( 3 )Mortgage- and asset-backed securities1,014 ( 6 )1,014 ( 6 )Corporate notes and bonds( 17 )( 17 )Municipal securities( 4 )( 4 )Total$4,552 $( 31 )$$$4,552 $( 31 )PART II Item 8Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2019U.S. government and agency securities$1,491 $( 1 )$39,158 $( 103 )$40,649 $( 104 )Foreign government bonds( 8 )( 8 )Mortgage- and asset-backed securities( 1 )( 2 )1,042 ( 3 )Corporate notes and bonds( 3 )( 4 )( 7 )Total$2,678 $( 5 )$39,989 $( 117 )$42,667 $( 122 )Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2020Due in one year or less$36,169 $36,276 Due after one year through five years51,465 54,700 Due after five years through 10 years32,299 35,674 Due after 10 years2,967 3,148 Total$122,900 $129,798 NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit to enhance investment returns and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currencies Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions.Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash flow hedging instruments.In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. PART II Item 8Interest Rate Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair value hedging instruments to effectively convert the fixed interest rates to floating interest rates.Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap and option contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Equity Securities held in our equity investments portfolio are subject to market price risk. At times, we may hold options, futures, and swap contracts. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. These contracts are not designated as hedging instruments and are included in Other contracts in the tables below.Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $ 1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2020, our long-term unsecured debt rating was AAA , and cash investments were in excess of $ 1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts purchased$$Foreign exchange contracts sold6,754 6,034 Interest rate contracts purchased1,295 Not Designated as Hedging InstrumentsForeign exchange contracts purchased11,896 14,889 Foreign exchange contracts sold15,595 15,614 Other contracts purchased1,844 2,007 Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts$$( 54 )$$( 93 )Interest rate contractsNot Designated as Hedging InstrumentsForeign exchange contracts( 334 )( 172 )Other contracts( 11 )( 7 )Gross amounts of derivatives( 399 )( 272 )Gross amounts of derivatives offset in the balance sheet( 154 )( 113 )Cash collateral received( 154 )( 78 )Net amounts of derivatives$$( 395 )$$( 236 )Reported asShort-term investments$$$( 13 )$Other current assetsOther long-term assetsOther current liabilities( 334 )( 221 )Other long-term liabilities( 61 )( 15 )Total$$( 395 )$$( 236 )Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $ 399 million and $ 399 million, respectively, as of June 30, 2020, and $ 247 million and $ 272 million, respectively, as of June 30, 2019. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1 Level 2 Level 3 TotalJune 30, 2020Derivative assets$$$$Derivative liabilities( 399 )( 399 )June 30, 2019Derivative assetsDerivative liabilities( 272 )( 272 )PART II Item 8Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows:(In millions)Year Ended June 30,2018RevenueOther Income(Expense), NetRevenueOther Income(Expense), NetRevenueOtherIncome(Expense),NetDesignated as Fair Value Hedging Instruments Foreign exchange contractsDerivatives$$$$( 130 )$$( 78 )Hedged itemsExcluded from effectiveness assessmentInterest rate contractsDerivativesHedged items( 93 )Equity contractsDerivatives( 324 )Hedged itemsExcluded from effectiveness assessmentDesignated as Cash Flow Hedging Instruments Foreign exchange contractsAmount reclassified from accumulated other comprehensive incomeExcluded from effectiveness assessment( 64 )( 255 )Not Designated as Hedging Instruments Foreign exchange contracts( 123 )( 97 )( 33 )Other contracts( 104 )Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as follows:(In millions)Year Ended June 30,Designated as Cash Flow Hedging InstrumentsForeign exchange contractsIncluded in effectiveness assessment$( 38 )$$NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,112 1,611 Total$1,895 $2,063 PART II Item 8NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,823 $1,540 Buildings and improvements33,995 26,288 Leasehold improvements5,487 5,316 Computer equipment and software41,261 33,823 Furniture and equipment4,782 4,840 Total, at cost87,348 71,807 Accumulated depreciation( 43,197 )( 35,330 )Total, net$ 44,151 $ 36,477 During fiscal years 2020, 2019, and 2018, depreciation expense was $ 10.7 billion, $ 9.7 billion, and $ 7.7 billion, respectively. We have committed $ 5.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2020. During fiscal year 2020, we recorded an impairment charge of $ 186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018 , we acquired GitHub, Inc. (GitHub), a software development platform, in a $ 7.5 billion stock transaction (inclusive of total cash payments of $ 1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497 Intangible assets1,267 Other assetsOther liabilities( 217 )Total$ 6,924 The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. PART II Item 8Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,267 7 yearsTransactions recognized separately from the purchase price allocation were approximately $ 600 million, primarily related to equity awards recognized as expense over the related service period. OtherDuring fiscal year 2020, we completed 15 acquisitions for $ 2.4 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. The effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2020Productivity and Business Processes$23,823 $$( 60 ) $24,277 $$( 94 )$24,190 Intelligent Cloud5,703 5,605 (a) (a) 11,351 1,351 ( 5 )12,697 More Personal Computing6,157 ( 48 ) 6,398 ( 30 )6,464 Total $ 35,683 $ 6,408 $( 65 )$ 42,026 $1,454 $( 129 )$ 43,351 (a) Includes goodwill of $ 5.5 billion related to GitHub. See Note 8 Business Combinations for further information . The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2020, May 1, 2019, or May 1, 2018 tests. As of June 30, 2020 and 2019, accumulated goodwill impairment was $ 11.3 billion.PART II Item 8NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$8,160 $( 6,381 )$1,779 $7,691 $( 5,771 )$1,920 Customer-related4,967 ( 2,320 )2,647 4,709 ( 1,785 )2,924 Marketing-related4,158 ( 1,588 )2,570 4,165 ( 1,327 )2,838 Contract-based( 432 )( 506 )Total$ 17,759 $( 10,721 )$7,038 $ 17,139 (a) $( 9,389 )$7,750 (a) Includes intangible assets of $ 1.3 billion related to GitHub. See Note 8 Business Combinations for further information . No material impairments of intangible assets were identified during fiscal years 2020, 2019, or 2018. We estimate that we have no significant residual value related to our intangible assets. The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$6 years$5 yearsCustomer-related5 years8 yearsMarketing-related2 years10 yearsContract-based0 years3 yearsTotal$ 836 5 years$1,708 7 yearsIntangible assets amortization expense was $ 1.6 billion, $ 1.9 billion, and $ 2.2 billion for fiscal years 2020, 2019, and 2018, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2020: (In millions)Year Ending June 30,$1,483 1,399 1,219 Thereafter1,639 Total$7,038 PART II Item 8NOTE 11 DEBT The components of debt were as follows: (In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,June 30,2009 issuance of $ 3.8 billion (a) 5.20 %5.24 %$$2010 issuance of $ 4.8 billion (a) 3.00 %4.50 %3.14 %4.57 %1,571 2,000 2011 issuance of $ 2.3 billion (a) 4.00 %5.30 %4.08 %5.36 %1,270 1,500 2012 issuance of $ 2.3 billion 2.13 %3.50 %2.24 %3.57 %1,650 1,650 2013 issuance of $ 5.2 billion (a) 2.38 %4.88 %2.47 %4.92 %2,919 3,500 2013 issuance of 4.1 billion2.13 %3.13 %2.23 %3.22 %4,549 4,613 2014 issuance 2015 issuance of $ 23.8 billion (a) 2.00 %4.75 %2.09 %4.78 %15,549 22,000 2016 issuance of $ 19.8 billion (a) 1.55 %3.95 %1.64 %4.03 %16,955 19,750 2017 issuance of $ 17.0 billion (a) 2.40 %4.50 %2.52 %4.53 %12,385 17,000 2020 issuance of $ 10.0 billion (a) 2.53 %2.68 %2.53 %2.68 %10,000 Total face value67,407 72,781 Unamortized discount and issuance costs( 554 )( 603 )Hedge fair value adjustments ( b ) Premium on debt exchange (a) ( 3,619 )Total debt63,327 72,178 Current portion of long-term debt( 3,749 )( 5,516 )Long-term debt$59,578 $66,662 (a) In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities. The premium will be amortized over the term of the new debt. (b) Refer to Note 5 Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2020 and 2019, the estimated fair value of long-term debt, including the current portion, was $ 77.1 billion and $ 78.9 billion, respectively. The estimated fair values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually. The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2020: (In millions)Year Ending June 30,$3,750 7,966 2,750 5,250 2,250 Thereafter45,441 Total$67,407 PART II Item 8NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $ 13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $ 157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $ 2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (GILTI) tax. Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$3,537 $4,718 $19,764 U.S. state and localForeign4,444 5,531 4,348 Current taxes$8,744 $10,911 $25,046 Deferred TaxesU.S. federal$$( 5,647 )$( 4,292 )U.S. state and local( 6 )( 1,010 )( 458 )Foreign( 41 )( 393 )Deferred taxes$$( 6,463 )$( 5,143 )Provision for income taxes$ 8,755 $ 4,448 $ 19,903 U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$24,116 $15,799 $11,527 Foreign 28,920 27,889 24,947 Income before income taxes$ 53,036 $ 43,688 $36,474 PART II Item 8Effective Tax Rate The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0 %21.0 %28.1 %Effect of:Foreign earnings taxed at lower rates( 3.7 )%( 4.1 )%( 7.8 )%Impact of the enactment of the TCJA0 %0.4 %37.7 %Impact of intangible property transfers0 %( 5.9 )%0 %Foreign-derived intangible income deduction( 1.1 )%( 1.4 )%0 %State income taxes, net of federal benefit1.3 %0.7 %1.3 %Research and development credit( 1.1 )%( 1.1 )%( 1.3 )%Excess tax benefits relating to stock-based compensation( 2.2 )%( 2.2 )%( 2.5 )%Interest, net1.0 %1.0 %1.2 %Other reconciling items, net1.3 %1.8 %( 2.1 )%Effective rate16.5 %10.2 %54.6 %The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $ 2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, offset in part by earnings taxed at lower rates in foreign jurisdictions. In fiscal year 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 86 % of our foreign income before tax. In fiscal years 2019 and 2018, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82 % and 87 % of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax. In fiscal years 2020, 2019, and 2018, there were no individually significant other reconciling items.The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $ 2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. PART II Item 8The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,721 2,287 Loss and credit carryforwards3,518 Depreciation and amortization6,361 7,046 Leasing liabilities3,025 1,594 Unearned revenue1,553 OtherDeferred income tax assets15,340 15,693 Less valuation allowance( 755 )( 3,214 )Deferred income tax assets, net of valuation allowance$14,585 $12,479 Deferred Income Tax LiabilitiesBook/tax basis differences in investments and debt$( 2,642 )$( 738 )Unearned revenue( 30 )Leasing assets( 2,817 )( 1,510 )Deferred GILTI tax liabilities( 2,581 )( 2,607 )Other( 344 )( 291 )Deferred income tax liabilities$( 8,384 )$( 5,176 )Net deferred income tax assets$6,201 $7,303 Reported AsOther long-term assets$6,405 $7,536 Long-term deferred income tax liabilities( 204 )( 233 )Net deferred income tax assets$6,201 $7,303 Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. As of June 30, 2020, we had federal, state, and foreign net operating loss carryforwards of $ 547 million, $ 975 million, and $ 2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2021 through 2040 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance.The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $ 2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements. Income taxes paid, net of refunds, were $ 12.5 billion, $ 8.4 billion, and $ 5.5 billion in fiscal years 2020, 2019, and 2018, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2020, 2019, and 2018, were $ 13.8 billion, $ 13.1 billion, and $ 12.0 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2020, 2019, and 2018 by $ 12.1 billion, $ 12.0 billion, and $ 11.3 billion, respectively.PART II Item 8As of June 30, 2020, 2019, and 2018, we had accrued interest expense related to uncertain tax positions of $ 4.0 billion, $ 3.4 billion, and $ 3.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2020, 2019, and 2018 included interest expense related to uncertain tax positions of $ 579 million, $ 515 million, and $ 688 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$13,146 $11,961 $11,737 Decreases related to settlements( 31 )( 316 )( 193 )Increases for tax positions related to the current year2,106 1,445 Increases for tax positions related to prior yearsDecreases for tax positions related to prior years( 331 )( 1,113 )( 1,176 )Decreases due to lapsed statutes of limitations( 5 )( 3 )Ending unrecognized tax benefits$ 13,792 $ 13,146 $ 11,961 We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013 . In April 2020, the IRS commenced the audit for tax years 2014 to 2017 .As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019 , some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$18,643 $16,831 Intelligent Cloud16,620 16,988 More Personal Computing3,917 3,387 Total$39,180 $37,206 Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2020Balance, beginning of period$37,206 Deferral of revenue78,922 Recognition of unearned revenue( 76,948 )Balance, end of period$39,180 PART II Item 8Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $ 111 billion as of June 30, 2020, of which $ 107 billion is related to the commercial portion of revenue. We expect to recognize approximately 50 % of this revenue over the next 12 months and the remainder thereafter.NOTE 14 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years , and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$2,043 $1,707 $1,585 Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$Supplemental cash flow information related to leases was as follows:(In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,829 $1,670 $1,522 Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases3,677 2,303 1,571 Finance leases3,467 2,532 1,933 PART II Item 8Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate)June 30,Operating LeasesOperating lease right-of-use assets$8,753 $7,379 Other current liabilities$1,616 $1,515 Operating lease liabilities7,671 6,188 Total operating lease liabilities$9,287 $7,703 Finance LeasesProperty and equipment, at cost$10,371 $7,041 Accumulated depreciation( 1,385 )( 774 )Property and equipment, net$8,986 $6,267 Other current liabilities$$Other long-term liabilities8,956 6,257 Total finance lease liabilities$9,496 $6,574 Weighted Average Remaining Lease TermOperating leases8 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases2.7 %3.0 %Finance leases3.9 %4.6 %Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,807 $1,652 1,474 1,262 1,000 1,236 Thereafter3,122 7,194 Total lease payments10,317 12,023 Less imputed interest( 1,030 )( 2,527 )Total$9,287 $9,496 As of June 30, 2020, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 3.4 billion and $ 3.5 billion, respectively. These operating and finance leases will commence between fiscal year 2021 and fiscal year 2023 with lease terms of 1 year to 16 years .During fiscal year 2020, we recorded an impairment charge of $ 161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.PART II Item 8NOTE 15 CONTINGENCIES Patent and Intellectual Property Claims There were 64 patent infringement cases pending against Microsoft as of June 30, 2020, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence once each court approves the form of notice to the class . Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to occur in the second quarter of fiscal year 2021 . PART II Item 8Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2020, we accrued aggregate legal liabilities of $ 306 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $ 500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 16 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,643 7,677 7,708 IssuedRepurchased( 126 )( 150 )( 99 )Balance, end of year7,571 7,643 7,677 Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $ 40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $ 31.7 billion remained of this $ 40.0 billion share repurchase program.PART II Item 8We repurchased the following shares of common stock under the share repurchase programs:(In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$4,000 $2,600 $1,600 Second Quarter4,600 6,100 1,800 Third Quarter6,000 3,899 3,100 Fourth Quarter5,088 4,200 2,100 Total$19,688 $16,799 $ 8,600 Shares repurchased during the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $ 3.3 billion, $ 2.7 billion, and $ 2.1 billion for fiscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2020 (In millions) September 18, 2019 November 21, 2019 December 12, 2019 $0.51 $3,886 December 4, 2019 February 20, 2020 March 12, 2020 0.51 3,876 March 9, 2020 May 21, 2020 June 11, 2020 0.51 3,865 June 17, 2020 August 20, 2020 September 10, 2020 0.51 3,861 Total$2.04 $15,488 Fiscal Year 2019September 18, 2018 November 15, 2018 December 13, 2018 $0.46 $3,544 November 28, 2018 February 21, 2019 March 14, 2019 0.46 3,526 March 11, 2019 May 16, 2019 June 13, 2019 0.46 3,521 June 12, 2019 August 15, 2019 September 12, 2019 0.46 3,510 Total$1.84 $14,101 The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020. PART II Item 8NOTE 17 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component : (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains (losses), net of tax of $( 10 ) , $ 2 , and $ 11 ( 38 )Reclassification adjustments for gains included in revenue( 341 )( 185 )Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)( 333 )( 179 )Net change related to derivatives, net of tax of $( 10 ) , $( 6 ), and $ 5 ( 38 )( 173 )Balance, end of period$( 38 )$$InvestmentsBalance, beginning of period$1,488 $( 850 )$1,825 Unrealized gains (losses), net of tax of $ 1,057 , $ 616 , and $( 427 )3,987 2,331 ( 1,146 )Reclassification adjustments for (gains) losses included in other income (expense), net( 2,309 )Tax expense (benefit) included in provision for income taxes( 1 )( 19 )Amounts reclassified from accumulated other comprehensive income (loss)( 1,571 )Net change related to investments, net of tax of $ 1,058 , $ 635 , and $( 1,165 )3,990 2,405 ( 2,717 )Cumulative effect of accounting changes( 67 )Balance, end of period$5,478 $1,488 $( 850 )Translation Adjustments and OtherBalance, beginning of period$( 1,828 )$( 1,510 )$( 1,332 )Translation adjustments and other, net of tax effects of $ 1 , $( 1 ), and $ 0 ( 426 )( 318 )( 178 )Balance, end of period$( 2,254 )$( 1,828 )$( 1,510 )Accumulated other comprehensive income (loss), end of period$3,186 $( 340 )$( 2,187 )NOTE 18 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2020, an aggregate of 283 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$5,289 $4,652 $ 3,940 Income tax benefits related to stock-based compensationStock PlansStock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years . PART II Item 8Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years . PSUs generally vest over a performance period of three years . The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions:Year ended June 30,Dividends per share (quarterly amounts)$0.46 0.51 $0.42 0.46 $0.39 0.42 Interest rates0.1 %2.2 %1.8 %3.1 %1.7 %2.9 %During fiscal year 2020, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$78.49 Granted (a) 140.49 Vested( 65 ) 75.35 Forfeited( 9 ) 90.30 Nonvested balance, end of year$105.23 (a) Includes 2 million, 2 million, and 3 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2020, 2019, and 2018, respectively. As of June 30, 2020, there was approximately $ 10.2 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years . The weighted average grant-date fair value of stock awards granted was $ 140.49 , $ 107.02 , and $ 75.88 for fiscal years 2020, 2019, and 2018, respectively. The fair value of stock awards vested was $ 10.1 billion, $ 8.7 billion, and $ 6.6 billion, for fiscal years 2020, 2019, and 2018, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90 % of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15 % of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$142.22 $104.85 $ 76.40 As of June 30, 2020, 96 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50 % of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $ 1.0 billion, $ 877 million, and $ 807 million in fiscal years 2020, 2019, and 2018, respectively, and were expensed as contributed. NOTE 19 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: Server products and cloud services, including Azure SQL Server, Windows Server, Visual Studio, System Center, and related CALs and GitHub. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings patent licensing Windows Internet of Things and MSN advertising. Devices, including Surface and PC accessories. PART II Item 8 Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live ( transactions, subscriptions, cloud services, and advertising ), video games, and third-party video game royalties. Search. Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines information technology human resources finance excise taxes field selling shared facilities services and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments. Segment revenue and operating income were as follows during the periods presented:(In millions)Year Ended June 30,RevenueProductivity and Business Processes$46,398 $41,160 $35,865 Intelligent Cloud48,366 38,985 32,219 More Personal Computing48,251 45,698 42,276 Total$143,015 $125,843 $110,360 Operating Income Productivity and Business Processes$18,724 $16,219 $12,924 Intelligent Cloud18,324 13,920 11,524 More Personal Computing15,911 12,820 10,610 Total$52,959 $42,959 $35,058 No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2020, 2019, or 2018. Revenue, classified by the major geographic areas in which our customers were located, was as follows: (In millions)Year Ended June 30,United States (a) $73,160 $64,199 $55,926 Other countries69,855 61,644 54,434 Total$143,015 $ 125,843 $ 110,360 (a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows:(In millions)Year Ended June 30,Server products and cloud services$41,379 $32,622 $26,129 Office products and cloud services35,316 31,769 28,316 Windows22,294 20,395 19,518 Gaming11,575 11,386 10,353 LinkedIn8,077 6,754 5,259 Search advertising7,740 7,628 7,012 Devices6,457 6,095 5,134 Enterprise Services6,409 6,124 5,846 Other3,768 3,070 2,793 Total$143,015 $125,843 $ 110,360 Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $ 51.7 billion, $ 38.1 billion and $ 26.6 billion in fiscal years 2020, 2019, and 2018, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$60,789 $55,252 $44,501 Ireland12,734 12,958 12,843 Other countries29,770 25,422 22,538 Total$ 103,293 $ 93,632 $ 79,882 PART II Item 8NOTE 20 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2020Revenue$ 33,055 $36,906 $35,021 $38,033 $143,015 Gross margin22,649 24,548 24,046 25,694 96,937 Operating income 12,686 13,891 12,975 13,407 52,959 Net income10,678 11,649 10,752 11,202 44,281 Basic earnings per share1.40 1.53 1.41 1.48 5.82 Diluted earnings per share1.38 1.51 1.40 1.46 5.76 Fiscal Year 2019Revenue 29,084 32,471 30,571 33,717 125,843 Gross margin19,179 20,048 20,401 23,305 82,933 Operating income9,955 10,258 10,341 12,405 42,959 Net income (a) 8,824 8,420 8,809 13,187 39,240 Basic earnings per share1.15 1.09 1.15 1.72 5.11 Diluted earnings per share (b) 1.14 1.08 1.14 1.71 5.06 (a) Reflects the $ 157 million net charge related to the enactment of the TCJA for the second quarter and the $ 2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $ 2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $ 0.02 for the second quarter, $( 0.34 ) for the fourth quarter, and $( 0.31 ) for fiscal year 2019 . PART II Item 8REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders' equity, for each of the three years in the period ended June 30, 2020, and the related notes (collectively referred to as the ""financial statements""). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.PART II Item 8Revenue Recognition Refer to Note 1 to the financial statements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services). Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. Given these factors and due to the volume of transactions, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated management's significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested management's identification and treatment of contract terms. Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of management's calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 12 to the financial statements Critical Audit Matter DescriptionThe Company's long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (""IRS""). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company's financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management's estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate management's estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of management's methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated management's documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of management's judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of management's estimates by considering how tax law, including statutes, regulations and case law, impacted management's judgments. /s/ D ELOITTE T OUCHE LLPSeattle, Washington July 30, 2020 We have served as the Company's auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2020. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2020 their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2020, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the ""financial statements"") as of and for the year ended June 30, 2020, of the Company and our report dated July 30, 2020, expressed an unqualified opinion on those financial statements.Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLPSeattle, Washington July 30, 2020 PART II, III Item 9B, 10, 11, 12, 13, 14" +3,msft,20190630," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The A mbitions T hat D rive U s To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesWe are in a unique position to empower people and organizations to succeed in a rapidly evolving workplace. Computing experiences are evolving, no longer bound to one device at a time. Instead, experiences are expanding to many devices as people move from home to work to on the go. These modern needs, habits, and expectations of our customers are motivating us to bring Microsoft Office 365, Windows platform, devices, including Microsoft Surface, and third-party applications into a more cohesive Microsoft 365 experience.Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Microsoft Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is core to our vision for the modern workplace as the digital hub that creates a single canvas for teamwork, conversations, meetings, and content. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and inspire teamwork, while simplifying security and management. Organizations of all sizes can now digitize business-critical functions, redefining what customers can expect from their business applications. This creates an opportunity for us to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformCompanies are looking to use digital technology to fundamentally reimagine how they empower their employees, engage customers, optimize their operations, and change the very core of their products and services. Partnering with organizations on their digital transformation is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Microsoft Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions, with new Azure services and devices such as HoloLens 2. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for cus tomers to take Microsoft SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation help s every developer be an AI d eveloper, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. On October 25, 2018, we completed our acquisition of GitHub, Inc. (GitHub), a service that millions of developers around the world rely on to write code together. The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences.Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently expanded our Surface family of devices with the Surface Hub 2S, which brings together Microsoft Teams, Windows, and Surface hardware to power teamwork for organizations. We are mobilizing to pursue our expansive opportunity in the gaming industry, broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed. We have a strong position with our Xbox One console, our large and growing highly engaged community of gamers on Xbox Live, and with Windows 10, the most popular operating system for PC gamers. We will continue to connect our gaming assets across PC, console, and mobile, and work to grow and engage the Xbox Live member network more deeply and frequently with services like Mixer and Xbox Game Pass. Our approach is to enable gamers to play the games they want, with the people they want, on the devices they want.Our Future OpportunityCustomers are looking to us to accelerate their own digital transformations and to unlock new opportunity in this era of intelligent cloud and intelligent edge. We continue to develop complete, intelligent solutions for our customers that empower users to be creative and work together while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.PART I Item 1Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Office 365. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the world's professionals to make them more productive and successful, and is the world's largest professional network on the Internet. LinkedIn offers services that can be used by customers to transform the way they hire, market, sell, and learn. In addition to LinkedIns free services, LinkedIn offers three categories of monetized solutions: Talent Solutions, Marketing Solutions, and Premium Subscriptions, which includes Sales Solutions. Talent Solutions is comprised of two elements: Hiring, and Learning and Development. Hiring provides services to recruiters that enable them to attract, recruit, and hire talent. Learning and Development provides subscriptions to enterprises and individuals to access online learning content. Marketing Solutions enables companies to advertise to LinkedIns member base. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Premium Subscriptions also includes Sales Solutions, which helps sales professionals find, qualify, and create sales opportunities and accelerate social selling capabilities. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions.On November 16, 2018, LinkedIn acquired Glint, an employee engagement platform, to expand its Talent Solutions offerings. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and analytics applications for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services; job boards; traditional recruiting firms; and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers.Dynamics competes with vendors such as Infor, NetSuite, Oracle, Salesforce.com, SAP, and The Sage Group to provide cloud-based and on-premise business solutions for small, medium, and large organizations.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesOur server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Azure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionOur server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. PART I Item 1We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware a nd software applications, security, and manageability. Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, Salesforce.com, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows IoT; and MSN advertising. Devices, including Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. PART I Item 1Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings. Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface, PC accessories, and other intelligent devices. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. GamingOur gaming platform is designed to provide a unique variety of entertainment using our devices, peripherals, applications, online services, and content. We released Xbox One S and Xbox One X in August 2016 and November 2017, respectively. With the launch of the Mixer service in May 2017, offering interactive live streaming, and Xbox Game Pass in June 2017, providing unlimited access to over 100 Xbox titles, we continue to open new opportunities for customers to engage both on- and off-console. With our acquisition of PlayFab in January 2018, we enable worldwide game developers to utilize game services, LiveOps, and analytics for player acquisition, engagement, and retention. We have also made these services available for developers outside of the gaming industry.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox Live revenue is mainly affected by subscriptions and sales of Xbox Live enabled content, as well as advertising. We also continue to design and sell gaming content to showcase our unique platform capabilities for Xbox consoles, Windows-enabled devices, and other devices. Growth of our Gaming business is determined by the overall active user base through Xbox Live enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences via online services including game streaming, downloadable content, and peripherals. SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.PART I Item 1Our gaming platform competes with console platforms from Nintendo and Sony , both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years. Nintendo released its latest generation console in March 2017 and Sony released its latest generation console in November 2013. We also compete with other providers of entertainment services through online marketplaces. We believe our gaming pla tform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our o wn game franchises as well as other digital content offerings. Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live and our cloud gaming services face competition from various online marketplaces, including those operated by Amazon, Apple, and Google. Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region; the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region; and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility and Management, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on connecting gaming assets across the range of devices to grow and engage the Xbox Live member network through game experiences, streaming content, and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. PART I Item 1We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internatio nally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and curren tly have a portfolio of over 61,000 U.S. and international patents issued and over 26,000 pending. While we employ much of our internally- developed intellectual property exclusively in our products and services, we also engage in outbound licensing of spec ific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we i ncorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with enterprises and public-sector organizations worldwide to identify and meet their technology requirements; managing OEM relationships; and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. PART I Item 1There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a di rect agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with ma ny regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces, online stores, and retail stores. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, and training to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. PART I Item 1Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, hosting partner, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 31, 2019 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerMargaret L. JohnsonExecutive Vice President, Business DevelopmentBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Ms. Johnson was appointed Executive Vice President, Business Development in September 2014. Prior to that Ms. Johnson spent 24 years at Qualcomm in various leadership positions across engineering, sales, marketing and business development. She most recently served as Executive Vice President of Qualcomm Technologies, Inc. Ms. Johnson also serves on the Board of Directors of BlackRock, Inc.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2019, we employed approximately 144,000 people on a full-time basis, 85,000 in the U.S. and 59,000 internationally. Of the total employed people, 47,000 were in operations, including manufacturing, distribution, product support, and consulting services; 47,000 were in product research and development; 38,000 were in sales and marketing; and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RIS K FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on personal computers. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end-users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Microsoft Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, Microsoft SQL Server, Windows Server, Azure, Office 365, Xbox Live, Mixer, LinkedIn, and other p roducts and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commerc ial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their p urchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may no t be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Microsoft Edge and Bing, that drive post- sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or prod uct experiences, which could negatively impact product and feature adoption, product design , and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. In December 2016, we completed our acquisition of LinkedIn Corporation (LinkedIn) for $27.0 billion, and in October 2018, we completed our acquisition of GitHub, Inc. for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge on our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. Our acquisition of LinkedIn resulted in a significant increase in our goodwill and intangible asset balances. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improved technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes like passwords. Inadequate account security practices may also result in unauthorized access. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. PART I Item 1AThe cost of these steps could reduc e our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future pu rchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers ma y fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilitie s may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. As illustrated by the Spectre and Meltdown threats, our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For LinkedIn, Microsoft Advertising, MSN, Xbox Live, and other products and services that provide content or host ads that come from or can be influenced by third parties, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AHarmful content online Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, substantial liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an Internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or insufficient Internet connectivity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophis ticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contai n provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described in the next paragraph. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow bec ause of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Microsoft Surface. To resolve thes e claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In s ome countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact on our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow; at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Iran, North Korea, Cuba, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Skype are covered by existing laws regulating telecommunications services, and some new laws are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us , or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve . For example, the EU and the U.S. formally entered into a new framework in July 2016 that provides a mechanism for companies to transfer data from EU member states to the U.S. This framework, called the Privacy Shield, is intended to address shortcomings identified by the European Court of Justice in a predecessor mechanism. The Privacy Shield and other mechanisms are currently subject to challenges in European courts, which may lead to uncertainty about the legal basis for data transfers across the Atlant ic. The Privacy Shield and other potential rules on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, a new EU law governing data practices and privacy , the General Data Protection Regulation (GDPR), bec a me effective. The law , which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of new compliance obligations regarding the handling of personal data. Engineering efforts to build new capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experien ce reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if the changes we implement to comply with the GDPR make our offe rings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to c omply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits , or reputational damage . In the U.S., California has adopted and several states are considering ad opting laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal reviews by regulators may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location and movement of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S . A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing juris dictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements . If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Substantial revenue comes from our U.S. government contracts. An extended federal government shutdown resulting from failing to pass budget appropriations, adopt continuing funding resolutions or raise the debt ceiling, and other budgetary decisions limiting or delaying federal government spending, could reduce government IT spending on our products and services and adversely affect our revenue. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. PART I Item 1AWe maintain an investment portfolio of various holdings, t ypes, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio c omprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements . Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages on our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The long-term effects of climate change on the global economy or the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other natural resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in weather where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVE D STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2019 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India; our datacenters in Ireland, the Netherlands, and Singapore; and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, Germany, India, Japan, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. These annual reports will continue through 2020. During fiscal year 2019, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking); (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts; and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 16 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 29, 2019, there were 94,069 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2019:PeriodTotal Number of SharesPurchasedAveragePrice Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares that May Yet bePurchased under the Plans or Programs(In millions)April 1, 2019 April 30, 20198,547,612$122.858,547,612$14,551May 1, 2019 May 31, 201914,029,339126.3214,029,33912,778June 1, 2019 June 30, 201910,469,682131.5910,469,68211,40133,046,63333,046,633All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2019: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 12, 2019August 15, 2019September 12, 2019$0.46$3,516We returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.Highlights from fiscal year 2019 compared with fiscal year 2018 included: Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties, increased 43% to $38.1 billion. Office Commercial revenue increased 13%, driven by Office 365 Commercial growth of 33%. Office Consumer revenue increased 7%, and Office 365 Consumer subscribers increased to 34.8 million. LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. Dynamics revenue increased 15%, driven by Dynamics 365 growth of 47%. Server products and cloud services revenue, including GitHub, increased 25%, driven by Azure growth of 72%. Enterprise Services revenue increased 5%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 4%. Windows Commercial revenue increased 14%. Microsoft Surface revenue increased 23%. Gaming revenue increased 10%, driven by Xbox software and services growth of 19%. Search advertising revenue, excluding traffic acquisition costs, increased 13%.We have recast certain prior period commercial cloud metrics to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations.On October 25, 2018, we acquired GitHub, Inc. (GitHub) in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional ne t charge related to the enactment of the TCJA of $13. 7 billion in fiscal year 2018 , and adjusted our provisional net charge by recording additional tax expense of $ 157 million in the second quarter of fiscal year 2019. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland, which resulted in a $2.6 billion net income tax benef it . Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of foreign currencies relative to the U.S. dollar throughout fiscal year 2018 positively impacted reported revenue and increased reported expenses from our international operations. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017Revenue$125,843$110,360$96,57114%14%Gross margin82,93372,00762,31015%16%Operating income42,95935,05829,02523%21%Net income39,24016,57125,489137%(35)%Diluted earnings per share5.062.133.25138%(34)%Non-GAAP operating income42,959 35,05829,33123% 20%Non-GAAP net income36,83030,26725,73222%18%Non-GAAP diluted earnings per share4.753.883.2922%18%Non-GAAP operating income, net income, and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.Operating income increased $7.9 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Current year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Prior year net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively. Fiscal Year 2018 Compared with Fiscal Year 2017Revenue increased $13.8 billion or 14%, driven by growth across each of our segments. Productivity and Business Processes revenue increased, driven by LinkedIn and higher revenue from Office. Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services. More Personal Computing revenue increased, driven by higher revenue from Gaming, Windows, Search advertising, and Surface, offset in part by lower revenue from Phone.PART II Item 7Gross margin increased $9.7 billion or 16%, due to growth across each of our segments. Gross margin percentage increased slightly, driven by favo rable segment sales mix and gross margin percentage improvement in More Personal Computing. Gross margin included a 7 percentage point improvement in commercial cloud, primarily from Azure. Operating income increased $6.0 billion or 21%, driven by growth across each of our segments. LinkedIn operating loss increased $63 million to $987 million, including $1.5 billion of amortization of intangible assets. Operating income included a favorable foreign currency impact of 2%.Key changes in expenses were: Cost of revenue increased $4.1 billion or 12%, mainly due to growth in our commercial cloud, Gaming, LinkedIn, and Search advertising, offset in part by a reduction in Phone cost of revenue. Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses.Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted earnings per share of $13.7 billion and $1.75, respectively. Fiscal year 2017 operating income, net income, and diluted EPS were negatively impacted by restructuring expenses, which resulted in a decrease to operating income, net income, and diluted EPS of $306 million, $243 million, and $0.04, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017RevenueProductivity and Business Processes$41,160$35,865$29,87015%20%Intelligent Cloud38,98532,21927,40721%18%More Personal Computing45,69842,27639,2948%8%Total $125,843$110,360$96,57114%14%Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,38925%13%Intelligent Cloud13,92011,5249,12721%26%More Personal Computing12,82010,6108,81521%20%Corporate and Other(306)**Total $42,959$35,058$29,02523%21%* Not meaningful. Reportable Segments Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. PART II Item 7 Office Consumer revenue increased $286 million or 7 %, driven by Office 365 Consumer, due to recurring subscription revenue and transactional strength in Japan . LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer. Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to a sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Productivity and Business Processes Revenue increased $6.0 billion or 20%. LinkedIn revenue increased $3.0 billion to $5.3 billion. Fiscal year 2018 included a full period of results, whereas fiscal year 2017 only included results from the date of acquisition on December 8, 2016. LinkedIn revenue primarily consisted of revenue from Talent Solutions. Office Commercial revenue increased $2.4 billion or 11%, driven by Office 365 Commercial revenue growth, mainly due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial. Office Consumer revenue increased $382 million or 11%, driven by Office 365 Consumer revenue growth, mainly due to growth in subscribers. Dynamics revenue increased 13%, driven by Dynamics 365 revenue growth. Operating income increased $1.5 billion or 13%, including a favorable foreign currency impact of 2%. Gross margin increased $4.4 billion or 19%, driven by LinkedIn and growth in Office Commercial. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Office 365 Commercial and LinkedIn. LinkedIn cost of revenue increased $818 million to $1.7 billion, including $888 million of amortization for acquired intangible assets. Operating expenses increased $2.9 billion or 25%, driven by LinkedIn expenses and investments in commercial sales capacity and cloud engineering. LinkedIn operating expenses increased $2.2 billion to $4.5 billion, including $617 million of amortization of acquired intangible assets. Intelligent CloudRevenue increased $4.8 billion or 18%. Server products and cloud services revenue increased $4.5 billion or 21%, driven by Azure and server products licensed on-premises revenue growth. Azure revenue grew 91%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products licensed on-premises revenue increased 5% , mainly due to a higher mix of premium licenses for Windows Server and Microsoft SQL Server. Enterprise Services revenue increased $304 million or 5% , driven by higher revenue from Premier Support Services and Microsoft Consulting Services, offset in part by a decline in revenue from custom support agreements.Operating income increased $2.4 billion or 26%. Gross margin increased $3.1 billion or 16%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage decreased, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Azure. Operating expenses increased $683 million or 7%, driven by investments in commercial sales capacity and cloud engineering.More Personal Computing Revenue increased $3.0 billion or 8%. Windows revenue increased $925 million or 5%, driven by growth in Windows Commercial and Windows OEM, offset by a decline in patent licensing revenue. Windows Commercial revenue increased 12%, driven by multi-year agreement revenue growth. Windows OEM revenue increased 5%. Windows OEM Pro revenue grew 11%, ahead of a strengthening commercial PC market. Windows OEM non-Pro revenue declined 4%, below the consumer PC market, driven by continued pressure in the entry-level price category. Gaming revenue increased $1.3 billion or 14%, driven by Xbox software and services revenue growth of 20%, mainly from third-party title strength. PART II Item 7 Search advertising revenue increased $793 million or 13%. Search advertising revenue, excluding traffic acquisition costs, increased 16%, driven by growth in Bing, due to higher revenue per search and search volume. Surface revenue increased $625 million or 16%, driven by a higher mix of premium devices and an increase in volumes sold, due to the latest editions of Surface. Phone revenue decreased $525 million.Operating income increased $1.8 billion or 20%, including a favorable foreign currency impact of 2%. Gross margin increased $2.2 billion or 11%, driven by growth in Windows, Surface, Search, and Gaming. Gross margin percentage increased, primarily due to gross margin percentage improvement in Surface. Operating expenses increased $391 million or 3%, driven by investments in Search, AI, and Gaming engineering and commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Corporate and Other Corporate and Other includes corporate-level activity not specifically allocated to a segment, including restructuring expenses.Fiscal Year 2019 Compared with Fiscal Year 2018 We did not incur Corporate and Other activity in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 Corporate and Other operating loss decreased $306 million, due to a reduction in restructuring expenses, driven by employee severance expenses primarily related to our sales and marketing restructuring plan in fiscal year 2017.OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Research and development$16,876$14,726$13,03715%13%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Fiscal Year 2018 Compared with Fiscal Year 2017Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. LinkedIn expenses increased $762 million to $1.5 billion.PART II Item 7Sales and Marketing (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Sales and marketing$18,213$17,469$15,4614%13%As a percent of revenue14%16%16%(2)ppt0pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2019 Compared with Fiscal Year 2018Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. Fiscal Year 2018 Compared with Fiscal Year 2017Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. LinkedIn expenses increased $1.2 billion to $2.5 billion, including $617 million of amortization of acquired intangible assets.General and Administrative (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017General and administrative$4,885$4,754$4,4813%6%As a percent of revenue4%4%5%0ppt(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.Fiscal Year 2018 Compared with Fiscal Year 2017General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses. LinkedIn expenses increased $234 million to $528 million.RESTRUCTURING EXPENSES Restructuring expenses include employee severance expenses and other costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities.Fiscal Year 2019 Compared with Fiscal Year 2018We did not incur restructuring expenses in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 During fiscal year 2017, we recorded $306 million of employee severance expenses, primarily related to our sales and marketing restructuring plan. PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2019 Compared with Fiscal Year 2018Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . Fiscal Year 2018 Compared with Fiscal Year 2017Dividends and interest income increased primarily due to higher average portfolio balances and yields on fixed-income securities. Interest expense increased primarily due to higher average outstanding long-term debt and higher finance lease expense. Net recognized gains on investments decreased primarily due to higher losses on sales of fixed-income securities, offset in part by higher gains on sales of equity securities. Net losses on derivatives decreased primarily due to lower losses on equity, foreign exchange, and commodity derivatives, offset in part by losses on interest rate derivatives in the current period as compared to gains in the prior period. INCOME TAXES Effective Tax RateFiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Our effective tax rate for fiscal years 2018 and 2017 was 55% and 15%, respectively. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA in fiscal year 2018 and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. Our effective tax rate was higher than the U.S. federal statutory rate primarily due to the net charge related to the enactment of the TCJA, offset in part by earnings taxed at lower rates in foreign jurisdictions resulting from our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion. In fiscal year 2017, our U.S. income before income taxes was $6.8 billion and our foreign income before income taxes was $23.1 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our global intangible low-taxed income (GILTI) effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months. As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP operating income, net income, and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2019 Versus 2018Percentage Change 2018 Versus 2017Operating income$42,959 $35,058$29,02523%21%Net tax impact of transfer of intangible properties **Net tax impact of the TCJA**Restructuring expenses**Non-GAAP operating income$42,959 $35,058$29,33123%20%Net income$39,240$16,571$25,489137%(35)%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Restructuring expenses**Non-GAAP net income$36,830$30,267$25,73222%18%Diluted earnings per share$5.06$2.13$3.25138%(34)%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Restructuring expenses0.04**Non-GAAP diluted earnings per share$4.75$3.88$3.2922%18%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $133.8 billion as of both June 30, 2019 and 2018. Equity investments were $2.6 billion and $1.9 billion as of June 30, 2019 and 2018, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Cash from operations increased $4.4 billion to $43.9 billion for fiscal year 2018, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees, net cash paid for income taxes, cash paid for interest on debt, and cash paid to suppliers. Cash used in financing was $33.6 billion for fiscal year 2018, compared to cash from financing of $8.4 billion for fiscal year 2017. The change was mainly due to a $41.7 billion decrease in proceeds from issuance of debt, net of repayments of debt, offset in part by a $1.1 billion decrease in cash used for common stock repurchases. Cash used in investing decreased $40.7 billion to $6.1 billion for fiscal year 2018, mainly due to a $25.1 billion decrease in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $19.1 billion increase in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2019:(In millions)Three Months Ending,September 30, 2019$12,353December 31, 20199,807March 31, 20206,887June 30, 20203,629Thereafter4,530Total$37,206If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2019, 2018, and 2017, we repurchased 150 million shares, 99 million shares, and 170 million shares of our common stock for $16.8 billion, $8.6 billion, and $10.3 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2019: (In millions)2021-20222023-2024ThereafterTotalLong-term debt: (a) Principal payments$5,518$11,744$8,000$47,519$72,781Interest payments2,2994,3093,81829,38339,809Construction commitments (b) 3,4433,958Operating leases, including imputed interest (c) 1,7903,1442,4133,64510,992Finance leases, including imputed interest (c) 2,0082,1659,87214,842Transition tax (d) 1,1802,9004,1688,15516,403Purchase commitments (e) 17,4781,18519,161Other long-term liabilities (f) Total$32,505 $25,877 $20,752 $99,237 $178,371 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( c ) Refer to Note 15 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( e ) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. ( f ) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. Liquidity As a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable interest free over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of approximately $2.0 billion, which included $1.5 billion for fiscal year 2019. The first installment of the transition tax was paid in fiscal year 2019, and the remaining transition tax of $16.4 billion is payable over the next seven years with a final payment in fiscal year 2026. During the first quarter of fiscal year 2020, we expect to pay $1.2 billion related to the second installment of the transition tax, and $3.5 billion related to the transfer of intangible properties in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be s ufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.PART II Item 7Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration; Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency - Revenue10% decrease in foreign exchange rates$(3,402)EarningsForeign currency - Investments10% decrease in foreign exchange rates(120)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,909)Fair ValueCredit100 basis point increase in credit spreads(224)Fair ValueEquity10% decrease in equity market prices(244)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATE MENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$66,069$64,497$63,811Service and other59,77445,86332,760Total revenue125,843110,36096,571Cost of revenue:Product16,27315,42015,175Service and other26,63722,93319,086Total cost of revenue42,91038,35334,261Gross margin82,93372,00762,310Research and development16,87614,72613,037Sales and marketing18,21317,46915,461General and administrative4,8854,7544,481RestructuringOperating income42,95935,05829,025Other income, net 1,416Income before income taxes43,68836,47429,901Provision for income taxes4,44819,9034,412Net income$39,240$16,571$25,489Earnings per share:Basic$5.11$2.15$3.29Diluted$5.06$2.13$3.25Weighted average shares outstanding:Basic7,6737,7007,746Diluted7,7537,7947,832Refer to accompanying notes. PART II Item 8COMPREHENSIVE IN COME STATEMENTS (In millions)Year Ended June 30,Net income$39,240$16,571$25,489Other comprehensive income (loss), net of tax:Net change related to derivatives(173)(218)Net change related to investments2,405(2,717)(1,116)Translation adjustments and other(318)(178)Other comprehensive income (loss)1,914(2,856) (1,167) Comprehensive income$41,154$13,715$24,322Refer to accompanying notes. Refer to Note 18 Accumulated Other Comprehensive Income (Loss) for further information.PART II Item 8BALANCE SHEETS (In millions)June 30, AssetsCurrent assets:Cash and cash equivalents$11,356$11,946Short-term investments122,463121,822Total cash, cash equivalents, and short-term investments133,819133,768Accounts receivable, net of allowance for doubtful accounts of $411 and $37729,52426,481Inventories2,0632,662Other10,1466,751Total current assets175,552169,662Property and equipment, net of accumulated depreciation of $35,330 and $29,22336,47729,460Operating lease right-of-use assets7,3796,686Equity investments2,6491,862Goodwill42,02635,683Intangible assets, net7,7508,053Other long-term assets14,7237,442Total assets$286,556$258,848Liabilities and stockholders equityCurrent liabilities:Accounts payable$9,382$8,617Current portion of long-term debt5,5163,998Accrued compensation6,8306,103Short-term income taxes5,6652,121Short-term unearned revenue32,67628,905Other9,3518,744Total current liabilities69,42058,488Long-term debt66,66272,242Long-term income taxes29,61230,265Long-term unearned revenue4,5303,815Deferred income taxesOperating lease liabilities6,1885,568Other long-term liabilities7,5815,211Total liabilities184,226176,130Commitments and contingenciesStockholders equity:Common stock and paid-in capital shares authorized 24,000; outstanding 7,643 and 7,67778,52071,223Retained earnings24,15013,682Accumulated other comprehensive loss(340)(2,187) Total stockholders equity102,33082,718Total liabilities and stockholders equity$286,556$258,848Refer to accompanying notes. PART II Item 8CASH FLOWS S TATEMENTS (In millions) Year Ended June 30,OperationsNet income$39,240$16,571$25,489Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,68210,2618,778Stock-based compensation expense4,6523,9403,266Net recognized gains on investments and derivatives(792)(2,212)(2,073)Deferred income taxes(6,463)(5,143)(829)Changes in operating assets and liabilities:Accounts receivable(2,812)(3,862)(1,216)Inventories(465)Other current assets(1,718)(952)1,028Other long-term assets(1,834)(285)(917)Accounts payable1,148Unearned revenue4,4625,9223,820Income taxes2,92918,1831,792Other current liabilities1,419Other long-term liabilities(20)(118)Net cash from operations52,18543,88439,507FinancingRepayments of short-term debt, maturities of 90 days or less, net(7,324)(4,963)Proceeds from issuance of debt7,18344,344Repayments of debt(4,000)(10,060)(7,922)Common stock issued1,1421,002Common stock repurchased(19,543)(10,721)(11,788)Common stock cash dividends paid(13,811)(12,699)(11,845)Other, net(675)(971)(190)Net cash from (used in) financing(36,887)(33,590)8,408InvestingAdditions to property and equipment(13,925)(11,632)(8,129)Acquisition of companies, net of cash acquired, and purchases of intangible and other assets(2,388)(888)(25,944)Purchases of investments(57,697)(137,380)(176,905)Maturities of investments20,04326,36028,044Sales of investments38,194117,577136,350Securities lending payable(98)(197)Net cash used in investing(15,773)(6,061)(46,781)Effect of foreign exchange rates on cash and cash equivalents(115)Net change in cash and cash equivalents(590)4,2831,153Cash and cash equivalents, beginning of period11,9467,6636,510Cash and cash equivalents, end of period$11,356$11,946$7,663Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQ UITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$71,223$69,315$68,178Common stock issued6,8291,002Common stock repurchased(4,195)(3,033)(2,987)Stock-based compensation expense4,6523,9403,266Other, net(1) Balance, end of period78,52071,22369,315Retained earnings Balance, beginning of period13,68217,76913,118Net income39,24016,57125,489Common stock cash dividends(14,103)(12,917)(12,040)Common stock repurchased(15,346)(7,699)(8,798)Cumulative effect of accounting changes(42)Balance, end of period24,15013,68217,769Accumulated other comprehensive income (loss)Balance, beginning of period(2,187) 1,794Other comprehensive income (loss)1,914(2,856) (1,167)Cumulative effect of accounting changes(67)Balance, end of period(340) (2,187)Total stockholders equity$102,330$82,718$87,711Cash dividends declared per common share$1.84$1.68$1.56Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts related to investments, derivatives, and fair value measurements to conform to the current period presentation based on our adoption of the new accounting standard for financial instruments. We have recast prior period commercial cloud revenue to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations. We have also recast components of the prior period deferred income tax assets and liabilities to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized on our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income (OCI). Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Microsoft Office 365, Microsoft Azure, Microsoft Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 20 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct pe rformance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell ea ch of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2019 and 2018, long-term accounts receivable, net of allowance for doubtful accounts, was $2.2 billion and $1.8 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs(116) (98)(106)Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recogni zed ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics busin ess solutions; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 14 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain online products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6 billion, $1.6 billion, and $1.5 billion in fiscal years 2019, 2018, and 2017, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in OCI. Debt investments are impaired whe n a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers avai lable quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specifi c adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method, or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. For derivative instruments designated as cash flow hedges, the effective portion of the gains and losses are initially reported as a component of OCI and subsequently recognized in revenue when the hedged exposure is recognized in revenue. Gains and losses on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. PART II Item 8 Level 2 inputs are based upon quoted prices for similar instr uments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corrobo rated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interes t rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed secur ities, corporate notes and bonds, and municipal securities . Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. PART II Item 8We have lease agreem ents with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment lease s, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceIncome Taxes Intra-Entity Asset TransfersIn October 2016, the Financial Accounting Standards Board (FASB) issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the guidance effective July 1, 2018. Adoption of the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We recorded a net cumulative-effect adjustment that resulted in an increase in retained earnings of $557 million, which reversed the previous deferral of income tax consequences and recorded new deferred tax assets from intra-entity transfers involving assets other than inventory, partially offset by a U.S. deferred tax liability related to global intangible low-taxed income (GILTI). Adoption of the standard resulted in an increase in long-term deferred tax assets of $2.8 billion, an increase in long-term deferred tax liabilities of $2.1 billion, and a reduction in other current assets of $152 million. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.Financial Instruments Recognition, Measurement, Presentation, and Disclosure In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than OCI. We adopted the standard effective July 1, 2018. Adoption of the standard was applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (AOCI) to retained earnings as of the effective date, and we elected to measure equity investments without readily determinable fair values at cost with adjustments for observable changes in price or impairments. The cumulative-effect adjustment included any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The impact on our consolidated balance sheets upon adoption was not material. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.PART II Item 8Recent Accounting Guid ance Not Yet Adopted Financial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We evaluated the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems, and do not expect the impact to be material upon adoption.Financial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems. NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$39,240$16,571$25,489Weighted average outstanding shares of common stock (B)7,6737,7007,746Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,7537,7947,832Earnings Per ShareBasic (A/B)$5.11$2.15$3.29Diluted (A/C)$5.06$2.13$3.25Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities(93)(987)(162)Other-than-temporary impairments of investments(16)(6)(14)Total$(97)$(966)$(68)Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$3,406$2,692Net unrealized gains on investments still heldImpairments of investments(10) (41) (41) Total$$3,365$2,651PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand Cash EquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,211$$$2,211$1,773$$Certificates of depositLevel 22,0182,0181,430U.S. government securitiesLevel 1104,9251,854(104)106,675105,906U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350(8)6,3462,5063,840Mortgage- and asset-backed securitiesLevel 23,554(3)3,5613,561Corporate notes and bondsLevel 27,437(7)7,5417,541Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747$2,027$(122)$129,652$7,176$122,476$Changes in Fair Value Recorded inNet IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,0852,085Total equity investments$3,058$$$2,649Cash$3,771$3,771$$Derivatives, net (a) (13)(13)Total$136,468$11,356$122,463$2,649PART II Item 8(In millions) Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2018Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,513$$$2,513$2,215$$Certificates of depositLevel 22,0582,0581,865U.S. government securitiesLevel 1108,120(1,167)107,0152,280104,735U.S. agency securitiesLevel 21,7421,7421,398Foreign government bondsLevel 1Foreign government bondsLevel 25,063(10)5,0545,054Mortgage- and asset-backed securitiesLevel 23,864(13)3,8553,855Corporate notes and bondsLevel 26,929(56)6,8946,894Corporate notes and bondsLevel 3Municipal securitiesLevel 2(1)Total debt investments$130,597$$(1,247)$129,475$7,758$121,717$Equity investmentsLevel 1$$$$Equity investmentsLevel 3Equity investmentsOther1,5581,557Total equity investments$2,109$$$1,862Cash$3,942$3,942$$Derivatives, net (a) Total$135,630$11,946$121,822$1,862(a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2019 and 2018, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.2 billion and $697 million, respectively. As of June 30, 2019, we had no collateral received under agreements for loaned securities. As of June 30, 2018, collateral received under agreements for loaned securities was $1.8 billion and primarily comprised U.S. government and agency securities. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2019U.S. government and agency securities$1,491$(1)$39,158$(103)$40,649$(104)Foreign government bonds(8)(8)Mortgage- and asset-backed securities(1)(2)1,042(3)Corporate notes and bonds(3)(4)(7)Total$2,678$(5)$39,989$(117)$42,667$(122)PART II Item 8 Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2018U.S. government and agency securities$82,352$(1,064)$4,459$(103)$86,811$(1,167)Foreign government bonds3,457(7)(3)3,470(10)Mortgage- and asset-backed securities2,072(9)(4)2,168(13)Corporate notes and bonds3,111(43)(13)3,412(56)Municipal securities(1)(1)Total$91,037$(1,124)$4,869$(123)$95,906$(1,247)Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2019Due in one year or less$53,200$53,124Due after one year through five years47,01647,783Due after five years through 10 years26,65827,824Due after 10 yearsTotal$127,747$129,652NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Equity Securities held in our equity investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. In the past, to hedge our price risk, we also used and designated equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. PART II Item 8Other Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2019, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts sold$6,034$11,101Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,8899,425Foreign exchange contracts sold15,61413,374Equity contracts purchasedEquity contracts soldOther contracts purchased1,327Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Changes in Fair Value Recorded in Other Comprehensive IncomeDesignated as Hedging InstrumentsForeign exchange contracts$$$$Changes in Fair Value Recorded in Net IncomeDesignated as Hedging InstrumentsForeign exchange contracts(93)Not Designated as Hedging InstrumentsForeign exchange contracts(172)(197)Equity contracts(7)Other contracts(7)(3)Gross amounts of derivatives(272)(207)Gross amounts of derivatives offset in the balance sheet(113)(152)Cash collateral received(78) (235)Net amounts of derivatives$$(236) $$(289)Reported asShort-term investments$(13)$$$Other current assetsOther long-term assetsOther current liabilities(221)(288)Other long-term liabilities(15)(1)Total$$(236)$$(289)Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $247 million and $272 million, respectively, as of June 30, 2019, and $533 million and $207 million, respectively, as of June 30, 2018. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1Level 2Level 3TotalJune 30, 2019Derivative assets$$$$Derivative liabilities(272)(272)June 30, 2018Derivative assetsDerivative liabilities(1)(206)(207)PART II Item 8Fair Value Hedge Gains (Losses) We recognized in other income (expense), net the following gains (losses) on contracts designated as fair value hedges and their related hedged items: (In millions)Year Ended June 30,Foreign Exchange ContractsDerivatives$$$Hedged items(386)Total amount of ineffectiveness$$$Equity ContractsDerivatives$$(324)$(74)Hedged itemsTotal amount of ineffectiveness$$$Amount of equity contracts excluded from effectiveness assessment$$$(80)Cash Flow Hedge Gains (Losses) We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges: (In millions)Year Ended June 30,Effective PortionGains recognized in other comprehensive income (loss), net of tax of $1 , $11, and $4$$$Gains reclassified from accumulated other comprehensive income (loss) into revenueAmount Excluded from Effectiveness Assessment and Ineffective PortionLosses recognized in other income (expense), net(64)(255)(389)We do not have any net derivative gains included in AOCI as of June 30, 2019 that will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during fiscal year 2019. Non-designated Derivative Gains (Losses) We recognized in other income (expense), net the following gains (losses) on derivatives not designated as hedging instruments: (In millions)Year Ended June 30,Foreign exchange contracts$(97)$(33)$(117)Equity contracts(87)(114)Other contracts(17)(3)Total$(59)$(137)$(234)PART II Item 8NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,6111,953Total$2,063$2,662NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,540$1,254Buildings and improvements26,28820,604Leasehold improvements5,3164,735Computer equipment and software33,82327,633Furniture and equipment4,8404,457Total, at cost71,80758,683Accumulated depreciation(35,330)(29,223)Total, net$36,477$29,460During fiscal years 2019, 2018, and 2017, depreciation expense was $9.7 billion, $7.7 billion, and $6.1 billion, respectively. We have committed $4.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2019. NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018, we acquired GitHub, Inc. (GitHub), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497Intangible assets1,267Other assetsOther liabilities(217)Total$6,924The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,2677 yearsTransactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period. LinkedIn CorporationOn December 8, 2016, we completed our acquisition of all issued and outstanding shares of LinkedIn Corporation (LinkedIn), the worlds largest professional network on the Internet, for a total purchase price of $27.0 billion. The purchase price consisted primarily of cash of $26.9 billion. The acquisition is expected to accelerate the growth of LinkedIn, Office 365, and Dynamics 365. The financial results of LinkedIn have been included in our consolidated financial statements since the date of the acquisition. PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2017. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash and cash equivalents$1,328Short-term investments2,110Other current assetsProperty and equipment1,529Intangible assets7,887Goodwill ( a ) 16,803Short-term debt (b) (1,323)Other current liabilities(1,117)Deferred income taxes(774)Other(131)Total purchase price$27,009(a) Goodwill was assigned to our Productivity and Business Processes segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of LinkedIn. None of the goodwill is expected to be deductible for income tax purposes. (b) Convertible senior notes issued by LinkedIn on November 12, 2014, substantially all of which were redeemed after our acquisition of LinkedIn. The remaining $18 million of notes are not redeemable and are included in long-term debt in our consolidated balance sheets. Refer to Note 11 Debt for further information. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$3,6077 yearsMarketing-related (trade names)2,14820 yearsTechnology-based2,1093 yearsContract-based5 yearsFair value of intangible assets acquired$7,8879 yearsOur consolidated income statements include the following revenue and operating loss attributable to LinkedIn since the date of acquisition:(In millions)Year Ended June 30,Revenue$2,271Operating loss(924)Following are the supplemental consolidated financial results of Microsoft Corporation on an unaudited pro forma basis, as if the acquisition had been consummated on July 1, 2015: (In millions, except per share amounts)Year Ended June 30,Revenue$98,291$94,490Net income25,17919,128Diluted earnings per share3.212.38These pro forma results were based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily amortization of intangible assets. Acquisition costs and other nonrecurring charges were immaterial and are included in the earliest period presented.PART II Item 8Other During fiscal year 2019, we completed 19 additional acquisitions for $1.6 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2019Productivity and Business Processes$23,739$$$23,823$$(60)$24,277Intelligent Cloud5,555(16)5,7035,605(a) (a) 11,351More Personal Computing5,828(65)6,157(48)6,398Total $35,122$$(69)$35,683$6,408$(65)$42,026(a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2019, May 1, 2018, or May 1, 2017 tests. As of June 30, 2019 and 2018, accumulated goodwill impairment was $11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$7,691$(5,771)$1,920$7,220$(5,018)$2,202Customer-related4,709(1,785)2,9244,031(1,205)2,826Marketing-related4,165(1,327)2,8384,006(1,071)2,935Contract-based(506)(589)Total$17,139(a) $(9,389)$7,750$15,936$(7,883)$8,053(a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 Business Combinations for further information. No material impairments of intangible assets were identified during fiscal years 2019, 2018, or 2017. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$5 years$4 yearsMarketing-related10 years5 yearsContract-based3 years4 yearsCustomer-related8 years5 yearsTotal$1,7087 years$5 yearsIntangible assets amortization expense was $1.9 billion, $2.2 billion, and $1.7 billion for fiscal years 2019, 2018, and 2017, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2019: (In millions)Year Ending June 30,$1,4881,2821,1871,053Thereafter2,003Total$7,750NOTE 11 DEBT Short-term DebtAs of June 30, 2019 and 2018, we had no commercial paper issued or outstanding. Effective August 31, 2018, we terminated our credit facilities, which served as back-up for our commercial paper program. Long-term DebtAs of June 30, 2019, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $72.2 billion and $78.9 billion, respectively. As of June 30, 2018, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $76.2 billion and $77.5 billion, respectively. These estimated fair values are based on Level 2 inputs. PART II Item 8The components of our long-term debt, including the current portion, and the associated interest rates were as follows: (In millions, except interest rates)Face Value June 30,Face Value June 30,StatedInterestRateEffectiveInterestRateNotesNovember 3, 2018$$1,7501.300%1.396%December 6, 20181,2501.625%1.824%June 1, 20191,0004.200%4.379%August 8, 2019 2,5002,5001.100%1.203%November 1, 2019 0.500%0.500%February 6, 2020 1,5001,5001.850%1.952%February 12, 20201,5001,5001.850%1.935%October 1, 20201,0001,0003.000%3.137%November 3, 20202,2502,2502.000%2.093%February 8, 20214.000%4.082%August 8, 2021 2,7502,7501.550%1.642%December 6, 2021 (a) 1,9942,0442.125%2.233%February 6, 2022 1,7501,7502.400%2.520%February 12, 20221,5001,5002.375%2.466%November 3, 20221,0001,0002.650%2.717%November 15, 20222.125%2.239%May 1, 20231,0001,0002.375%2.465%August 8, 2023 1,5001,5002.000%2.101%December 15, 20231,5001,5003.625%3.726%February 6, 2024 2,2502,2502.875%3.041%February 12, 20252,2502,2502.700%2.772%November 3, 20253,0003,0003.125%3.176%August 8, 2026 4,0004,0002.400%2.464%February 6, 2027 4,0004,0003.300%3.383%December 6, 2028 (a) 1,9932,0443.125%3.218%May 2, 2033 (a) 2.625%2.690%February 12, 20351,5001,5003.500%3.604%November 3, 20351,0001,0004.200%4.260%August 8, 2036 2,2502,2503.450%3.510%February 6, 2037 2,5002,5004.100%4.152%June 1, 20395.200%5.240%October 1, 20401,0001,0004.500%4.567%February 8, 20411,0001,0005.300%5.361%November 15, 20423.500%3.571%May 1, 20433.750%3.829%December 15, 20434.875%4.918%February 12, 20451,7501,7503.750%3.800%November 3, 20453,0003,0004.450%4.492%August 8, 2046 4,5004,5003.700%3.743%February 6, 20473,0003,0004.250%4.287%February 12, 20552,2502,2504.000%4.063%November 3, 20551,0001,0004.750%4.782%August 8, 20562,2502,2503.950%4.033%February 6, 2057 2,0002,0004.500%4.528%Total$72,781$76,898(a) Euro-denominated debt securities. The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. Cash paid for interest on our debt for fiscal years 2019, 2018, and 2017 was $2.4 billion, $2.4 billion, and $1.6 billion, respectively. As of June 30, 2019 and 2018, the aggregate debt issuance costs and unamortized discount associated with our long-term debt, including the current portion, were $603 million and $658 million, respectively. PART II Item 8Maturities of our long-term debt for each of the next five years and thereafter are as follows: (In millions)Year Ending June 30,$5,5183,7507,9942,7505,250Thereafter47,519Total$72,781NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our GILTI effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax. PART II Item 8Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$4,718$19,764$2,739U.S. state and localForeign5,5314,3482,472Current taxes$10,911$25,046$5,241Deferred TaxesU.S. federal$(5,647)$(4,292)$(554)U.S. state and local(1,010)(458)Foreign(393)(544)Deferred taxes$(6,463)$(5,143)$(829)Provision for income taxes$4,448$19,903$4,412U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$15,799$11,527$6,843Foreign 27,88924,94723,058Income before income taxes$43,688$36,474$29,901Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0%28.1%35.0%Effect of:Foreign earnings taxed at lower rates(4.1)%(7.8)%(11.6)%Impact of the enactment of the TCJA0.4%37.7%0%Phone business losses0%0%(5.7)%Impact of intangible property transfers(5.9)%0%0%Foreign-derived intangible income deduction(1.4)%0%0%Research and development credit(1.1)%(1.3)%(0.9)%Excess tax benefits relating to stock-based compensation(2.2)%(2.5)%(2.1)%Interest, net1.0%1.2%1.4%Other reconciling items, net2.5%(0.8)%(1.3)%Effective rate10.2%54.6%14.8%PART II Item 8The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers , and earnings taxed at lower rates in foreign jurisdictions resulting from producing and dis tributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico . The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 , offset in part by earnings taxed at lower rates in foreign jurisdictions. The decrease from the federal statutory rate in fiscal year 2017 is primarily due to earnings taxed at lower rates in foreign jurisdictions. Our foreign regional operating centers in Ireland, Singapore and Puerto Rico , which are taxed at rates lower than the U.S. rate, generated 82 %, 8 7 %, and 76 % of our foreign income b efore tax in fiscal years 2019, 2018, and 2017, respectively. Other reconciling items, net consists primarily of tax credits, GILTI, and U.S. state income taxes. In fiscal years 2019, 2018, and 2017, there were no individually significant other reconciling items. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,2871,832Loss and credit carryforwards3,5183,369Depreciation and amortization7,046Leasing liabilities1,5941,427Unearned revenueOtherDeferred income tax assets15,6937,495Less valuation allowance(3,214)(3,186)Deferred income tax assets, net of valuation allowance$12,479$4,309Deferred Income Tax LiabilitiesUnrealized gain on investments and debt$(738)$Unearned revenue(30)(639)Depreciation and amortization(1,164)Leasing assets(1,510)(1,366)Deferred GILTI tax liabilities(2,607)(61)Other(291)(251)Deferred income tax liabilities$(5,176)$(3,481)Net deferred income tax assets (liabilities)$7,303$Reported AsOther long-term assets$7,536$1,369Long-term deferred income tax liabilities(233)(541)Net deferred income tax assets (liabilities)$7,303$Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. PART II Item 8As of J une 30, 2019, we had federal, state and foreign net operating loss carryforwards of $ 978 million, $ 770 million, and $11. 6 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 20 20 through 203 9 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $8.4 billion, $5.5 billion, and $2.4 billion in fiscal years 2019, 2018, and 2017, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2019, 2018, and 2017, were $13.1 billion, $12.0 billion, and $11.7 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2019, 2018, and 2017 by $12.0 billion, $11.3 billion, and $10.2 billion, respectively.As of June 30, 2019, 2018, and 2017, we had accrued interest expense related to uncertain tax positions of $3.4 billion, $3.0 billion, and $2.3 billion, respectively, net of income tax benefits. The provision for (benefit from) income taxes for fiscal years 2019, 2018, and 2017 included interest expense related to uncertain tax positions of $515 million, $688 million, and $399 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$11,961$11,737$10,164Decreases related to settlements(316)(193)(4)Increases for tax positions related to the current year2,1061,4451,277Increases for tax positions related to prior yearsDecreases for tax positions related to prior years(1,113)(1,176)(49)Decreases due to lapsed statutes of limitations(3)(48)Ending unrecognized tax benefits$13,146$11,961$11,737We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 RESTRUCTURING CHARGES In June 2017, management approved a sales and marketing restructuring plan. In fiscal year 2017, we recorded employee severance expenses of $306 million primarily related to this sales and marketing restructuring plan. The actions associated with this restructuring plan were completed as of June 30, 2018.PART II Item 8NOTE 14 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$16,831$14,864Intelligent Cloud16,98814,706More Personal Computing3,3873,150Total$37,206$32,720Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2019Balance, beginning of period$32,720Deferral of revenue69,493Recognition of unearned revenue(65,007)Balance, end of period$37,206Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (contracted not recognized revenue), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $91 billion as of June 30, 2019, of which we expect to recognize approximately 50% of the revenue over the next 12 months and the remainder thereafter. Many customers are committing to our products and services for longer contract terms, which is increasing the percentage of contracted revenue that will be recognized beyond the next 12 months.NOTE 15 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$1,707$1,585$1,412Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$PART II Item 8Supplemental cash flow information related to leases was as follows: (In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,670$1,522$1,157Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases2,3031,5711,270Finance leases2,5321,9331,773Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate) June 30, Operating LeasesOperating lease right-of-use assets$7,379$6,686Other current liabilities$1,515$1,399Operating lease liabilities6,1885,568Total operating lease liabilities$7,703$6,967Finance LeasesProperty and equipment, at cost$7,041$4,543Accumulated depreciation(774)(404)Property and equipment, net$6,267$4,139Other current liabilities$$Other long-term liabilities6,2574,125Total finance lease liabilities$6,574$4,301Weighted Average Remaining Lease TermOperating leases7 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases3.0%2.7%Finance leases4.6%5.2%Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,678$1,4381,2351,036Thereafter2,4385,671Total lease payments8,6648,776Less imputed interest(961)(2,202)Total$7,703$6,574PART II Item 8As of June 30 , 201 9 , we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 2.3 billion and $ 6.1 billion, respectively. These operating and finance leases will commence between fiscal year 20 20 and fiscal year 202 2 with lease terms of 1 year to 15 years. NOTE 16 CONTINGENCIES Patent and Intellectual Property Claims There were 44 patent infringement cases pending against Microsoft as of June 30, 2019, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence. Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to be scheduled in the second half of calendar year 2019. PART II Item 8Employment-Related Lit igation Moussouris v. MicrosoftCurrent and former female Microsoft employees in certain engineering and information technology roles brought this class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an expert report showing no statistically significant disparity in pay and promotions between similarly situated men and women. In June 2018, the court denied the plaintiffs motion for class certification. Plaintiffs sought an interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit, which was granted in September 2018. Oral argument is scheduled for October 2019. Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2019, we accrued aggregate legal liabilities of $386 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.0 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 17 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,6777,7087,808IssuedRepurchased(150)(99)(170)Balance, end of year7,6437,6777,708Share Repurchases On September 16, 2013, our Board of Directors approved a share repurchase program (2013 Share Repurchase Program) authorizing up to $40.0 billion in share repurchases. The 2013 Share Repurchase Program became effective on October 1, 2013, and was completed on December 22, 2016. On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to an additional $40.0 billion in share repurchases (2016 Share Repurchase Program). This share repurchase program commenced on December 22, 2016 following completion of the 2013 Share Repurchase Program, has no expiration date, and may be suspended or discontinued at any time without notice. As of June 30, 2019, $11.4 billion remained of the 2016 Share Repurchase Program.PART II Item 8We repurchased the following shares of common stock under the share repurchase prog rams: (In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$2,600$1,600$3,550Second Quarter6,1001,8003,533Third Quarter3,8993,1001,600Fourth Quarter4,2002,1001,600Total$16,799$8,600$10,283Shares repurchased in the first and second quarter of fiscal year 2017 were under the 2013 Share Repurchase Program. All other shares repurchased were under the 2016 Share Repurchase Program. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $2.7 billion, $2.1 billion, and $1.5 billion for fiscal years 2019, 2018, and 2017, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2019 (In millions) September 18, 2018November 15, 2018December 13, 2018$0.46$3,544November 28, 2018February 21, 2019March 14, 20190.463,526March 11, 2019May 16, 2019June 13, 20190.463,521June 12, 2019August 15, 2019September 12, 20190.463,516Total$1.84$14,107Fiscal Year 2018September 19, 2017November 16, 2017December 14, 2017$0.42$3,238November 29, 2017February 15, 2018March 8, 20180.423,232March 12, 2018May 17, 2018June 14, 20180.423,226June 13, 2018August 16, 2018September 13, 20180.423,220Total$1.68$12,916The dividend declared on June 12, 2019 was included in other current liabilities as of June 30, 2019. PART II Item 8NOTE 1 8 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component: (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains, net of tax of $2 , $11, and $4Reclassification adjustments for gains included in revenue(341)(185)(555)Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)(333)(179)(546)Net change related to derivatives, net of tax of $(6), $5, and $(5)(173)(218)Balance, end of period$$$InvestmentsBalance, beginning of period$(850)$1,825$2,941Unrealized gains (losses), net of tax of $616 , $(427), and $2672,331(1,146)Reclassification adjustments for (gains) losses included in other income (expense), net(2,309)(2,513)Tax expense (benefit) included in provision for income taxes(19)Amounts reclassified from accumulated other comprehensive income (loss)(1,571)(1,633)Net change related to investments, net of tax of $635 , $(1,165), and $(613)2,405(2,717)(1,116)Cumulative effect of accounting changes(67)Balance, end of period$1,488$(850)$1,825Translation Adjustments and OtherBalance, beginning of period$(1,510)$(1,332)$(1,499)Translation adjustments and other, net of tax effects of $(1) , $0, and $9(318)(178)Balance, end of period$(1,828)$(1,510)$(1,332)Accumulated other comprehensive income (loss), end of period$(340)$(2,187)$NOTE 19 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2019, an aggregate of 327 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$4,652$3,940$3,266Income tax benefits related to stock-based compensation1,066PART II Item 8Stock Plans Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a four or five-year service period. Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a four-year service period. PSUs generally vest over a three-year performance period. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions: Year Ended June 30,Dividends per share (quarterly amounts)$0.42 - $0.46$0.39 - $0.42$0.36 - $0.39Interest rates1.8% - 3.1%1.7% - 2.9%1.2% - 2.2%During fiscal year 2019, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$57.85Granted (a) 107.02Vested(77) 57.08Forfeited(13) 69.35Nonvested balance, end of year$78.49(a) Includes 2 million, 3 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2019, 2018, and 2017, respectively. As of June 30, 2019, there was approximately $8.6 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of 3 years. The weighted average grant-date fair value of stock awards granted was $107.02, $75.88, and $55.64 for fiscal years 2019, 2018, and 2017, respectively. The fair value of stock awards vested was $8.7 billion, $6.6 billion, and $4.8 billion, for fiscal years 2019, 2018, and 2017, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$104.85$76.40$56.36As of June 30, 2019, 105 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $877 million, $807 million, and $734 million in fiscal years 2019, 2018, and 2017, respectively, and were expensed as contributed. NOTE 20 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things (IoT); and MSN advertising. Devices, including Microsoft Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including restructuring expenses. Segment revenue and operating income were as follows during the periods presented: (In millions)Year Ended June 30,RevenueProductivity and Business Processes$41,160$35,865$29,870Intelligent Cloud38,98532,21927,407More Personal Computing45,69842,27639,294Total$125,843$110,360$96,571Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,389Intelligent Cloud13,92011,5249,127More Personal Computing12,82010,6108,815Corporate and Other(306)Total$42,959$35,058$29,025Corporate and Other operating loss comprised restructuring expenses. No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2019, 2018, or 2017. Revenue, classified by the major geographic areas in which our customers were located, was as follows:(In millions)Year Ended June 30,United States (a) $64,199$55,926$51,078Other countries61,64454,43445,493Total$125,843$110,360$96,571(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$32,622$26,129$21,649Office products and cloud services31,76928,31625,573Windows20,39519,51818,593Gaming11,38610,3539,051Search advertising7,6287,0126,219LinkedIn6,7545,2592,271Enterprise Services6,1245,8465,542Devices6,0955,1345,062Other3,0702,7932,611Total$125,843$110,360$96,571Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $38.1 billion, $26.6 billion and $16.2 billion in fiscal years 2019, 2018, and 2017, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment; it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$55,252$44,501$42,730Ireland12,95812,84312,889Other countries25,42222,53819,898Total$93,632$79,882$75,517PART II Item 8NOTE 2 1 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2019Revenue$29,084$32,471$30,571$33,717$125,843Gross margin19,17920,04820,40123,30582,933Operating income 9,95510,25810,34112,40542,959Net income (a) 8,8248,4208,80913,18739,240Basic earnings per share1.151.091.151.725.11Diluted earnings per share (b) 1.141.081.141.715.06Fiscal Year 2018Revenue $24,538$28,918$26,819$30,085$110,360Gross margin16,26017,85417,55020,34372,007Operating income 7,7088,6798,29210,37935,058Net income (loss) ( c ) 6,576(6,302) 7,4248,87316,571Basic earnings (loss) per share0.85(0.82) 0.961.152.15Diluted earnings (loss) per share ( d ) 0.84(0.82)0.951.142.13(a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019. ( c ) Reflects the net charge (benefit) related to the enactment of the TCJA of $13.8 billion for the second quarter, $(104) million for the fourth quarter, and $13.7 billion for fiscal year 2018. ( d ) Reflects the net charge (benefit) related to the enactment of the TCJA, wh ich decreased (increased) diluted EPS $1.78 for the second quarter, $(0.01) for the fourth quarter, and $1.75 for fiscal year 2018. PART II Item 8REPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the Company) as of June 30, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows, for each of the three years in the period ended June 30, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 1, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the Companys Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. PART II Item 8Revenue Recognition Refer to Note 1 to the F inancial S tatements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Estimation of variable consideration when determining the amount of revenue to recognize (e.g., customer credits, incentives, and in certain instances, estimation of customer usage of products and services). Given these factors, the related audit effort in evaluating managements judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Companys revenue recognition for these customer agreements included the following: We tested the effectiveness of internal controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated managements significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested managements identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration. Assessed the terms in the customer agreement and evaluated the appropriateness of managements application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of managements estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of managements calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 1 2 to the F inancial S tatements Critical Audit Matter Description The Companys long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (IRS). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Companys financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating managements estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate managements estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of managements methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated managements documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of managements judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of managements estimates by considering how tax law, including statutes, regulations and case law, impacted managements judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019We have served as the Companys auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2019. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019; their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2019, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the financial statements) as of and for the year ended June 30, 2019, of the Company and our report dated August 1, 2019, expressed an unqualified opinion on those financial statements.Basis for OpinionThe Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019 PART II, III Item 9B, 10, 11, 12, 13, 14" +4,msft,20190630," ITEM 1. BUSINESS GENERAL Embracing Our FutureMicrosoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We continue to transform our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value for our customers. In this next phase of innovation, computing is more powerful and ubiquitous from the cloud to the edge. Artificial intelligence (AI) capabilities are rapidly advancing, fueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (IoT) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and their activities and relationships. A persons experience with technology spans a multitude of devices and has become increasingly more natural and multi-sensory with voice, ink, and gaze interactions.What We OfferFounded in 1975, we develop and support software, services, devices, and solutions that deliver new value for customers and help people and businesses realize their full potential.We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience.Our products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; and video games. We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories.PART I Item 1The A mbitions T hat D rive U s To achieve our vision, our research and development efforts focus on three interconnected ambitions: Reinvent productivity and business processes. Build the intelligent cloud and intelligent edge platform. Create more personal computing.Reinvent Productivity and Business ProcessesWe are in a unique position to empower people and organizations to succeed in a rapidly evolving workplace. Computing experiences are evolving, no longer bound to one device at a time. Instead, experiences are expanding to many devices as people move from home to work to on the go. These modern needs, habits, and expectations of our customers are motivating us to bring Microsoft Office 365, Windows platform, devices, including Microsoft Surface, and third-party applications into a more cohesive Microsoft 365 experience.Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Office, Microsoft Dynamics, and LinkedIn. Microsoft 365 brings together Office 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and fuel innovation, all the while enabling compliance coverage and data protection. Microsoft Teams is core to our vision for the modern workplace as the digital hub that creates a single canvas for teamwork, conversations, meetings, and content. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transform business to business sales through social selling. Dynamics 365 for Talent with LinkedIn Recruiter and Learning gives human resource professionals a complete solution to compete for talent. Microsoft Power Platform empowers employees to build custom applications, automate workflow, and analyze data no matter their technical expertise.These scenarios represent a move to unlock creativity and inspire teamwork, while simplifying security and management. Organizations of all sizes can now digitize business-critical functions, redefining what customers can expect from their business applications. This creates an opportunity for us to reach new customers and increase usage and engagement with existing customers.Build the Intelligent Cloud and Intelligent Edge PlatformCompanies are looking to use digital technology to fundamentally reimagine how they empower their employees, engage customers, optimize their operations, and change the very core of their products and services. Partnering with organizations on their digital transformation is one of our largest opportunities and we are uniquely positioned to become the strategic digital transformation platform and partner of choice.Our strategy requires continued investment in datacenters and other hybrid and edge infrastructure to support our services. Microsoft Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in.Our cloud business benefits from three economies of scale: datacenters that deploy computational resources at significantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy locations that lower application maintenance labor costs.As one of the two largest providers of cloud computing at scale, we believe we work from a position of strength. Being a global-scale cloud, Azure uniquely offers hybrid consistency, developer productivity, AI capabilities, and trusted security and compliance. We see more emerging use cases and needs for compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, from IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid infrastructure consistency spans identity, data, compute, management, and security, helping to support the real-world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions, with new Azure services and devices such as HoloLens 2. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential for entirely new workloads which we believe will shape the next era of computing. PART I Item 1The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible for cus tomers to take Microsoft SQL Server from their on-premises datacenter to a fully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations from research to products. Our innovation help s every developer be an AI d eveloper, with approachable new tools from Azure Machine Learning Studio for creating simple machine learning models, to the powerful Azure Machine Learning Workbench for the most advanced AI modeling and data science. On October 25, 2018, we completed our acquisition of GitHub, Inc. (GitHub), a service that millions of developers around the world rely on to write code together. The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences.Create More Personal ComputingWe strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Office, Windows, and devices together for an enhanced and more cohesive customer experience. Windows 10 continues to gain traction in the enterprise as the most secure and productive operating system. It empowers people with AI-first interfaces ranging from voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Windows also plays a critical role in fueling our cloud business and Microsoft 365 strategy, and it powers the growing range of devices on the intelligent edge. Our ambition for Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising.We are committed to designing and marketing first-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently expanded our Surface family of devices with the Surface Hub 2S, which brings together Microsoft Teams, Windows, and Surface hardware to power teamwork for organizations. We are mobilizing to pursue our expansive opportunity in the gaming industry, broadening our approach to how we think about gaming end-to-end, from the way games are created and distributed to how they are played and viewed. We have a strong position with our Xbox One console, our large and growing highly engaged community of gamers on Xbox Live, and with Windows 10, the most popular operating system for PC gamers. We will continue to connect our gaming assets across PC, console, and mobile, and work to grow and engage the Xbox Live member network more deeply and frequently with services like Mixer and Xbox Game Pass. Our approach is to enable gamers to play the games they want, with the people they want, on the devices they want.Our Future OpportunityCustomers are looking to us to accelerate their own digital transformations and to unlock new opportunity in this era of intelligent cloud and intelligent edge. We continue to develop complete, intelligent solutions for our customers that empower users to be creative and work together while safeguarding businesses and simplifying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing significant resources in: Transforming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. Building and running cloud-based services in ways that unleash new experiences and opportunities for businesses and individuals. Applying AI to drive insights and act on our customers behalf by understanding and interpreting their needs using natural methods of communication. Using Windows to fuel our cloud business and Microsoft 365 strategy, and to develop new categories of devices both our own and third-party on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love for games on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment.PART I Item 1Our future growth depends on our ability to transcend current product category definitions, business models, and sales motions. We have the opportunity to redefine what customers and partners can expect and are working to deliver new solutions that reflect the best of Microsoft. OPERATING SEGMENTS We operate our business and report our financial performance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.Additional information on our operating segments and geographic and product information is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).Our reportable segments are described below.Productivity and Business ProcessesOur Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.Office CommercialOffice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as first-line workers, small and medium businesses, and growth markets, as well as add value to our core product and service offerings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Office Commercial revenue is mainly affected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shift from Office licensed on-premises to Office 365. CALs provide certain Office Commercial products and services with access rights to our server products and CAL revenue is reported with the associated Office products and services.Office ConsumerOffice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets. Office Consumer revenue is mainly affected by the percentage of customers that buy Office with their new devices and the continued shift from Office licensed on-premises to Office 365. Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes.PART I Item 1LinkedIn LinkedIn connects the world's professionals to make them more productive and successful, and is the world's largest professional network on the Internet. LinkedIn offers services that can be used by customers to transform the way they hire, market, sell, and learn. In addition to LinkedIns free services, LinkedIn offers three categories of monetized solutions: Talent Solutions, Marketing Solutions, and Premium Subscriptions, which includes Sales Solutions. Talent Solutions is comprised of two elements: Hiring, and Learning and Development. Hiring provides services to recruiters that enable them to attract, recruit, and hire talent. Learning and Development provides subscriptions to enterprises and individuals to access online learning content. Marketing Solutions enables companies to advertise to LinkedIns member base. Premium Subscriptions enables professionals to manage their professional identity, grow their network, and connect with talent through additional services like premium search. Premium Subscriptions also includes Sales Solutions, which helps sales professionals find, qualify, and create sales opportunities and accelerate social selling capabilities. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue offering services that provide value for our members and increase their engagement. LinkedIn revenue is mainly affected by demand from enterprises and professional organizations for subscriptions to Talent Solutions and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Marketing Solutions.On November 16, 2018, LinkedIn acquired Glint, an employee engagement platform, to expand its Talent Solutions offerings. DynamicsDynamics provides cloud-based and on-premises business solutions for financial management, enterprise resource planning (ERP), customer relationship management (CRM), supply chain management, and analytics applications for small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shift to Dynamics 365, a unified set of cloud-based intelligent business applications.CompetitionCompetitors to Office include software and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proofpoint, Slack, Symantec, Zoom, and numerous web-based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration software. Zoom offers videoconferencing and cloud phone solutions. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises. Okta, Proofpoint, and Symantec provide security solutions across email security, information protection, identity, and governance. Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerful, flexible, secure, integrated industry-specific, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud.LinkedIn faces competition from online recruiting companies, talent management companies, and larger companies that are focusing on talent management and human resource services; job boards; traditional recruiting firms; and companies that provide learning and development products and services. Marketing Solutions competes with online and offline outlets that generate revenue from advertisers and marketers.Dynamics competes with vendors such as Infor, NetSuite, Oracle, Salesforce.com, SAP, and The Sage Group to provide cloud-based and on-premise business solutions for small, medium, and large organizations.PART I Item 1Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services.Server Products and Cloud ServicesOur server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system. This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. GitHub provides a collaboration platform and code hosting service for developers. Server products revenue is mainly affected by purchases through volume licensing programs, licenses sold to original equipment manufacturers (OEM), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Azure is a comprehensive set of cloud services that offer developers, IT professionals, and enterprises freedom to build, deploy, and manage applications on any platform or device. Customers can use Azure through our global network of datacenters for computing, networking, storage, mobile and web application services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software. Azure revenue is mainly affected by infrastructure-as-a-service and platform-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security.Enterprise ServicesEnterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.CompetitionOur server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications for PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platform providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products for software developers compete against offerings from Adobe, IBM, Oracle, and other companies, and also against open-source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. PART I Item 1We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware a nd software applications, security, and manageability. Azure faces diverse competition from companies such as Amazon, Google, IBM, Oracle, Salesforce.com, VMware, and open source offerings. Our Enterprise Mobility + Security offerings also compete with products from a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azures competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive infrastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our clouds global scale, coupled with our broad portfolio of identity and security solutions, allows us to effectively solve complex cybersecurity challenges for our customers and differentiates us from the competition.Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. More Personal ComputingOur More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing (Windows OEM) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows IoT; and MSN advertising. Devices, including Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. WindowsThe Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows OEM revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: The mix of computing devices based on form factor and screen size. Differences in device market demand between developed markets and growth markets. Attachment of Windows to devices shipped. Customer mix between consumer, small and medium businesses, and large enterprises. Changes in inventory levels in the OEM channel. Pricing changes and promotions, pricing variation that occurs when the mix of devices manufactured shifts from local and regional system builders to large multinational OEMs, and different pricing of Windows versions licensed. Constraints in the supply chain of device components. Piracy.Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsoft Defender Advanced Threat Protection, is affected mainly by the demand from commercial customers for volume licensing and Software Assurance (SA), as well as advanced security offerings. Windows Commercial revenue often reflects the number of information workers in a licensed enterprise and is relatively independent of the number of PCs sold in a given year. PART I Item 1Patent licensing includes our programs to license patents we own for use across a broad array of technology areas, including mobile devices and cloud offerings. Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services for use in embedded devices. MSN advertising includes both native and display ads. DevicesWe design, manufacture, and sell devices, including Surface, PC accessories, and other intelligent devices. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surface is designed to help organizations, students, and consumers be more productive. GamingOur gaming platform is designed to provide a unique variety of entertainment using our devices, peripherals, applications, online services, and content. We released Xbox One S and Xbox One X in August 2016 and November 2017, respectively. With the launch of the Mixer service in May 2017, offering interactive live streaming, and Xbox Game Pass in June 2017, providing unlimited access to over 100 Xbox titles, we continue to open new opportunities for customers to engage both on- and off-console. With our acquisition of PlayFab in January 2018, we enable worldwide game developers to utilize game services, LiveOps, and analytics for player acquisition, engagement, and retention. We have also made these services available for developers outside of the gaming industry.Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices. Xbox Live is designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. Xbox Live revenue is mainly affected by subscriptions and sales of Xbox Live enabled content, as well as advertising. We also continue to design and sell gaming content to showcase our unique platform capabilities for Xbox consoles, Windows-enabled devices, and other devices. Growth of our Gaming business is determined by the overall active user base through Xbox Live enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences via online services including game streaming, downloadable content, and peripherals. SearchOur Search business, including Bing and Microsoft Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings. Competition Windows faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Devices face competition from various computer, tablet, and hardware manufacturers who offer a unique combination of high-quality industrial design and innovative technologies across various price points. These manufacturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs.PART I Item 1Our gaming platform competes with console platforms from Nintendo and Sony , both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years. Nintendo released its latest generation console in March 2017 and Sony released its latest generation console in November 2013. We also compete with other providers of entertainment services through online marketplaces. We believe our gaming pla tform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our o wn game franchises as well as other digital content offerings. Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live and our cloud gaming services face competition from various online marketplaces, including those operated by Amazon, Apple, and Google. Our search business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users. OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and African region; the center in Singapore supports the Japan, India, Greater China, and Asia-Pacific region; and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, Nevada support Latin America and North America. In addition to the operations centers, we also operate datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Africa.To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. Our devices are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements. RESEARCH AND DEVELOPMENT Product and Service Development, and Intellectual Property We develop most of our products and services internally through the following engineering groups. Cloud and AI , focuses on making IT professionals, developers, and their systems more productive and efficient through development of cloud infrastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services for enterprises. Experiences and Devices , focuses on instilling a unifying product ethos across our end-user experiences and devices, including Office, Windows, Enterprise Mobility and Management, and Surface. AI and Research , focuses on our AI innovations and other forward-looking research and development efforts spanning infrastructure, services, applications, and search. LinkedIn , focuses on our services that transform the way customers hire, market, sell, and learn. Gaming , focuses on connecting gaming assets across the range of devices to grow and engage the Xbox Live member network through game experiences, streaming content, and social interaction.Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software and hardware design. Before releasing new software platforms, and as we make significant modifications to existing platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. PART I Item 1We protect our intellectual property investments in a variety of ways. We work actively in the U.S. and internatio nally to ensure the enforcement of copyright, trademark, trade secret, and other protections that apply to our software and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and curren tly have a portfolio of over 61,000 U.S. and international patents issued and over 26,000 pending. While we employ much of our internally- developed intellectual property exclusively in our products and services, we also engage in outbound licensing of spec ific patented technologies that are incorporated into licensees products. From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we i ncorporate into our products and services. At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. Our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. Investing in the Future Our success is based on our ability to create new and compelling products, services, and experiences for our users, to initiate and embrace disruptive technology trends, to enter new geographic and product markets, and to drive broad adoption of our products and services. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the Company. Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, AI, devices, and operating systems. While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.S. and around the world, including Canada, China, Czech Republic, India, Ireland, Israel, and the United Kingdom. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world. We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. In addition to our main research and development operations, we also operate Microsoft Research. Microsoft Research is one of the worlds largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of-the-art in computer science and a broad range of other disciplines, providing us a unique perspective on future trends and contributing to our innovation. We plan to continue to make significant investments in a broad range of research and development efforts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the following channels: OEMs, direct, and distributors and resellers. Our sales force performs a variety of functions, including working directly with enterprises and public-sector organizations worldwide to identify and meet their technology requirements; managing OEM relationships; and supporting system integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products and services.OEMs We distribute our products and services through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsoft products and services, including applications such as Office and the capability to subscribe to Office 365. PART I Item 1There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a di rect agreement between Microsoft and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with ma ny regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manufacturers, which source Microsoft software for pre-installation and local redistribution primarily through the Microsoft distributor channel rather than through a direct agreement or relationship with Microsoft. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support from system integrators, independent software vendors, web agencies, and partners that advise organizations on licensing our products and services (Enterprise Agreement Software Advisors or ESA). Microsoft offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those offered through the reseller channel. A large network of partner advisors support many of these sales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces, online stores, and retail stores. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (LSP), distributors, value-added resellers (VAR), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typically authorized as LSPs and operate as resellers for our other volume licensing programs. Microsoft Cloud Solution Provider is our main partner program for reselling cloud services. We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets. We distribute our devices through third-party retailers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We offer options for organizations that want to purchase our cloud services, on-premises software, and Software Assurance. We license software to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include those discussed below. SA conveys rights to new software and upgrades for perpetual licenses released over the contract period. It also provides support, tools, and training to help customers deploy and use software efficiently. SA is included with certain volume licensing agreements and is an optional purchase with others.Volume Licensing ProgramsEnterprise Agreement Enterprise Agreements offer large organizations a manageable volume licensing program that gives them the flexibility to buy cloud services and software licenses under one agreement. Enterprise Agreements are designed for medium or large organizations that want to license cloud services and on-premises software organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. PART I Item 1Microsoft Product and Services Agreement Microsoft Product and Services Agreements are designed for medium and large organizations that want to license cloud services and on-premises software as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional for customers that purchase perpetual licenses. OpenOpen agreements are a simple, cost-effective way to acquire the latest Microsoft technology. Open agreements are designed for small and medium organizations that want to license cloud services and on-premises software over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed for government and academic organizations to acquire on-premises licenses at any affiliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription AgreementMicrosoft Online Subscription Agreements are designed for small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions for cloud-based services.Partner Programs The Microsoft Cloud Solution Provider program offers customers an easy way to license the cloud services they need in combination with the value-added services offered by their systems integrator, hosting partner, or cloud reseller partner. Partners in this program can easily package their own products and services to directly provision, manage, and support their customer subscriptions.The Microsoft Services Provider License Agreement allows service providers and independent software vendors who want to license eligible Microsoft software products to provide software services and hosted applications to their end customers. Partners license software over a three-year period and are billed monthly based on consumption.The Independent Software Vendor Royalty program enables partners to integrate Microsoft products into other applications and then license the unified business solution to their end users.CUSTOMERS Our customers include individual consumers, small and medium organizations, large global enterprises, public-sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.PART I Item 1EXECUTIVE OFFICERS OF THE REGISTRANT Our executive officers as of July 31, 2019 were as follows:NameAgePosition with the CompanySatya NadellaChief Executive OfficerChristopher C. CaposselaExecutive Vice President, Marketing and Consumer Business, and Chief Marketing OfficerJean-Philippe CourtoisExecutive Vice President and President, Microsoft Global Sales, Marketing and OperationsKathleen T. HoganExecutive Vice President, Human ResourcesAmy E. HoodExecutive Vice President, Chief Financial OfficerMargaret L. JohnsonExecutive Vice President, Business DevelopmentBradford L. SmithPresident and Chief Legal OfficerMr. Nadella was appointed Chief Executive Officer in February 2014. He served as Executive Vice President, Cloud and Enterprise from July 2013 until that time. From 2011 to 2013, Mr. Nadella served as President, Server and Tools. From 2009 to 2011, he was Senior Vice President, Online Services Division. From 2008 to 2009, he was Senior Vice President, Search, Portal, and Advertising. Since joining Microsoft in 1992, Mr. Nadellas roles also included Vice President of the Business Division. Mr. Nadella also serves on the Board of Directors of Starbucks Corporation.Mr. Capossela was appointed Executive Vice President, Marketing and Consumer Business, and Chief Marketing Officer in July 2016. He had served as Executive Vice President, Chief Marketing Officer since March 2014. Previously, he served as the worldwide leader of the Consumer Channels Group, responsible for sales and marketing activities with OEMs, operators, and retail partners. In his more than 25 years at Microsoft, Mr. Capossela has held a variety of marketing leadership roles in the Microsoft Office Division. He was responsible for marketing productivity solutions including Microsoft Office, Office 365, SharePoint, Exchange, Skype for Business, Project, and Visio.Mr. Courtois was appointed Executive Vice President and President, Microsoft Global Sales, Marketing and Operations in July 2016. Before that he was President of Microsoft International since 2005. He was Chief Executive Officer, Microsoft Europe, Middle East, and Africa from 2003 to 2005. He was Senior Vice President and President, Microsoft Europe, Middle East, and Africa from 2000 to 2003. He was Corporate Vice President, Worldwide Customer Marketing from 1998 to 2000. Mr. Courtois joined Microsoft in 1984.Ms. Hogan was appointed Executive Vice President, Human Resources in November 2014. Prior to that Ms. Hogan was Corporate Vice President of Microsoft Services. She also served as Corporate Vice President of Customer Service and Support. Ms. Hogan joined Microsoft in 2003.Ms. Hood was appointed Executive Vice President and Chief Financial Officer in July 2013, subsequent to her appointment as Chief Financial Officer in May 2013. From 2010 to 2013, Ms. Hood was Chief Financial Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was General Manager, Microsoft Business Division Strategy. Since joining Microsoft in 2002, Ms. Hood has also held finance-related positions in the Server and Tools Business and the corporate finance organization. Ms. Hood also serves on the Board of Directors of 3M Corporation.Ms. Johnson was appointed Executive Vice President, Business Development in September 2014. Prior to that Ms. Johnson spent 24 years at Qualcomm in various leadership positions across engineering, sales, marketing and business development. She most recently served as Executive Vice President of Qualcomm Technologies, Inc. Ms. Johnson also serves on the Board of Directors of BlackRock, Inc.Mr. Smith was appointed President and Chief Legal Officer in September 2015. He served as Executive Vice President, General Counsel, and Secretary from 2011 to 2015, and served as Senior Vice President, General Counsel, and Secretary from 2001 to 2011. Mr. Smith was also named Chief Compliance Officer in 2002. Since joining Microsoft in 1993, he was Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. Mr. Smith also serves on the Board of Directors of Netflix, Inc.PART I Item 1EMPLOYEES As of June 30, 2019, we employed approximately 144,000 people on a full-time basis, 85,000 in the U.S. and 59,000 internationally. Of the total employed people, 47,000 were in operations, including manufacturing, distribution, product support, and consulting services; 47,000 were in product research and development; 38,000 were in sales and marketing; and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements.AVAILABLE INFORMATION Our Internet address is www.microsoft.com. At our Investor Relations website, www.microsoft.com/investor, we make available free of charge a variety of information for investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including: Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after we electronically file that material with or furnish it to the Securities and Exchange Commission (SEC) at www.sec.gov. Information on our business strategies, financial results, and metrics for investors. Announcements of investor conferences, speeches, and events at which our executives talk about our product, service, and competitive strategies. Archives of these events are also available. Press releases on quarterly earnings, product and service announcements, legal developments, and international news. Corporate governance information including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. Other news and announcements that we may post from time to time that investors might find useful or interesting. Opportunities to sign up for email alerts to have information pushed in real time.The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.PART I Item 1A"," ITEM 1A. RIS K FACTORS Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.We face intense competition across all markets for our products and services, which may lead to lower revenue or operating margins. Competition in the technology sectorOur competitors range in size from diversified global companies with significant research and development resources to small, specialized firms whose narrower product lines may let them be more effective in deploying technical, marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent introductions of new products and services. Our ability to remain competitive depends on our success in making innovative products, devices, and services that appeal to businesses and consumers. Competition among platform-based ecosystemsAn important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms that provide competing platforms. A competing vertically-integrated model, in which a single firm controls the software and hardware elements of a product and related services, has succeeded with some consumer products such as personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices. Competitors pursuing this model also earn revenue from services integrated with the hardware and software platform, including applications and content sold through their integrated marketplaces. They may also be able to claim security and performance benefits from their vertically integrated offer. We also offer some vertically-integrated hardware and software products and services. To the extent we shift a portion of our business to a vertically integrated model we increase our cost of revenue and reduce our operating margins. We derive substantial revenue from licenses of Windows operating systems on personal computers. We face significant competition from competing platforms developed for new devices and form factors such as smartphones and tablet computers. These devices compete on multiple bases including price and the perceived utility of the device and its platform. Users are increasingly turning to these devices to perform functions that in the past were performed by personal computers. Even if many users view these devices as complementary to a personal computer, the prevalence of these devices may make it more difficult to attract application developers to our PC operating system platforms. Competing with operating systems licensed at low or no cost may decrease our PC operating system margins. Popular products or services offered on competing platforms could increase their competitive strength. In addition, some of our devices compete with products made by our original equipment manufacturer (OEM) partners, which may affect their commitment to our platform. Competing platforms have content and application marketplaces with scale and significant installed bases. The variety and utility of content and applications available on a platform are important to device purchasing decisions. Users may incur costs to move data and buy new content and applications when switching platforms. To compete, we must successfully enlist developers to write applications for our platform and ensure that these applications have high quality, security, customer appeal, and value. Efforts to compete with competitors content and application marketplaces may increase our cost of revenue and lower our operating margins. PART I Item 1ABusiness model competition Companies compete with us based on a growing variety of business models. Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service business model, the license-based proprietary software model generates a substantial portion of our software revenue. We bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from licensing our products. Many of our competitors also develop and sell software to businesses and consumers under this model. Other competitors develop and offer free applications, online services and content, and make money by selling third-party advertising. Advertising revenue funds development of products and services these competitors provide to users at no or little cost, competing directly with our revenue-generating products. Some companies compete with us by modifying and then distributing open source software at little or no cost to end-users, and earning revenue on advertising or integrated products and services. These firms do not bear the full costs of research and development for the open source software. Some open source software mimics the features and functionality of our products. The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower revenue, gross margins, and operating income. Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an intelligent edge infused with artificial intelligence (AI). At the same time, our competitors are rapidly developing and deploying cloud-based services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors influence how users access services in the cloud and sometimes the users choice of which cloud-based services to use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge worldview is connected with the growth of the Internet of Things (IoT). Our success in the IoT will depend on the level of adoption of our offerings such as Microsoft Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may not establish market share sufficient to achieve scale necessary to achieve our business objectives. Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud computing services. These costs will reduce the operating margins we have previously achieved. Whether we succeed in cloud-based services depends on our execution in several areas, including: Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and market share. Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as sensors and other endpoints. Continuing to enhance the attractiveness of our cloud platforms to third-party developers. Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the security of their data. Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and ecosystems, including those of our competitors. It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the infrastructure and development investments described above. This may negatively impact gross margins and operating income. PART I Item 1AWe make significant investments in products and services that may not achieve expected returns. We will continue to make significant investments in research, development, and marketing for existing products, services, and technologies, including the Windows operating system, Microsoft 365, Office, Bing, Microsoft SQL Server, Windows Server, Azure, Office 365, Xbox Live, Mixer, LinkedIn, and other p roducts and services. We also invest in the development and acquisition of a variety of hardware for productivity, communication, and entertainment including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commerc ial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their p urchases of new software and hardware products or upgrades, unfavorably affecting revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for several years, if at all. New products and services may no t be profitable, and even if they are profitable, operating margins for some new products and businesses will not be as high as the margins we have experienced historically. We may not get engagement in certain features, like Microsoft Edge and Bing, that drive post- sale monetization opportunities. Our data handling practices across our products and services will continue to be under scrutiny and perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or prod uct experiences, which could negatively impact product and feature adoption, product design , and product quality. Developing new technologies is complex. It can require long development and testing periods. Significant delays in new releases or significant problems in creating new products or services could adversely affect our revenue. Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business. We expect to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term business strategy. In December 2016, we completed our acquisition of LinkedIn Corporation (LinkedIn) for $27.0 billion, and in October 2018, we completed our acquisition of GitHub, Inc. for $7.5 billion. These acquisitions and other transactions and arrangements involve significant challenges and risks, including that they do not advance our business strategy, that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new employees, business systems, and technology, or that they distract management from our other businesses. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements. If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in industry segments in which we participate. We have in the past recorded, and may in the future be required to record a significant charge on our consolidated financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. Our acquisition of LinkedIn resulted in a significant increase in our goodwill and intangible asset balances. PART I Item 1ACyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or harm to our reputation or competitive position. Security of our information technology Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations, including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our products and services or gain access to our networks and datacenters, using social engineering techniques to induce our employees, users, partners, or customers to disclose passwords or other sensitive information or take other actions to gain access to our data or our users or customers data, or acting in a coordinated manner to launch distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in unauthorized access to confidential data. For example, system administrators may fail to timely remove employee account access when no longer appropriate. Employees or third parties may intentionally compromise our or our users security or systems, or reveal confidential information.Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them. We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed across our internal networks and systems and those of our partners and customers. Breaches of our facilities, network, or data security could disrupt the security of our systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, result in product development delays, compromise confidential or technical business information harming our reputation or competitive position, result in theft or misuse of our intellectual property or other assets, require us to allocate more resources to improved technologies, or otherwise adversely affect our business.In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and technologies. We embrace new ways of sharing data and communicating internally and with partners and customers using methods such as social networking and other consumer-oriented technologies. Our business policies and internal security controls may not keep pace with these changes as new threats emerge.Security of our products, services, devices, and customers dataThe security of our products and services is important in our customers decisions to purchase or use our products or services. Security threats are a significant challenge to companies like us whose business is providing technology products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to continue. Adversaries that acquire user account information at other companies can use that information to compromise our users accounts where accounts share the same attributes like passwords. Inadequate account security practices may also result in unauthorized access. We are also increasingly incorporating open source software into our products. There may be vulnerabilities in open source software that may make our products susceptible to cyberattacks.To defend against security threats to our internal IT systems, our cloud-based services, and our customers systems, we must continuously engineer more secure products and services, enhance security and reliability features, improve the deployment of software updates to address security vulnerabilities in our own products as well as those provided by others, develop mitigation technologies that help to secure customers from attacks even when software updates are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and services, and provide security tools such as firewalls and anti-virus software and information about the need to deploy security measures and the impact of doing so. PART I Item 1AThe cost of these steps could reduc e our operating margins. If we fail to do these things well, actual or perceived security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our reputation and lead customers to reduce or delay future pu rchases of products or subscriptions to services, or to use competing products or services. Customers may also spend more on protecting their existing computer systems from attack, which could delay adoption of additional products or services. Customers ma y fail to update their systems, continue to run software or operating systems we no longer support, or may fail timely to install or enable security patches. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilitie s may lead to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial objectives, we may enter into agreements with larger liability exposure to customers. As illustrated by the Spectre and Meltdown threats, our products operate in conjunction with and are dependent on products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced revenue, or harm to our reputation or competitive position.Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers and users. The continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. Despite our efforts to improve the security controls across our business groups and geographies, it is possible our security controls over personal data, our training of employees and third parties on data security, and other practices we follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and manage. In addition, third parties who have limited access to our customer or user data may use this data in unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers and users to store and process personal data on-premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for transparency concerning these requests and appropriate limitations on government authority to compel disclosure. Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate datacenters in response to customer or user expectations or governmental rules or actions, may cause higher operating expenses or hinder growth of our products and services. We may not be able to protect information in our products and services from use by others . LinkedIn and other Microsoft products and services contain valuable information and content protected by contractual restrictions or technical measures. In certain cases, we have made commitments to our members and users to limit access to or use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third parties from scraping or gathering information or content through use of bots or other measures and using it for their own benefit, thus diminishing the value of our products and services. Abuse of our platforms may harm our reputation or user engagement. Advertising, professional, and social platform abuses For LinkedIn, Microsoft Advertising, MSN, Xbox Live, and other products and services that provide content or host ads that come from or can be influenced by third parties, our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate. This activity may come from users impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal ends. Preventing or responding to these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business and consolidated financial statements.PART I Item 1AHarmful content online Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be subject to enhanced regulatory oversight, substantial liability, or reputational damage if we fail to comply with content moderation regulations, adversely affecting our business and consolidated financial statements.The development of the IoT presents security, privacy, and execution risks. To support the growth of the intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI. The IoTs great potential also carries substantial risks. IoT products and services may contain defects in design, manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized, may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins. Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm. We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our products and services demand more computing power. We spend substantial amounts to build, purchase, or lease datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our websites and in our datacenters. These demands continue to increase as we introduce new products and services and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing our business of providing a platform and back-end hosting for services provided by third parties to their end users. Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an Internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or insufficient Internet connectivity, could diminish the quality of our products, services, and user experience resulting in contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our consolidated financial statements. We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices, and other devices we design, manufacture, and market are highly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through design, testing, or warranty repairs. PART I Item 1AOur software products and services also may experience quality or reliability problems. The highly sophis ticated software we develop may contain bugs and other defects that interfere with their intended operation. Our customers increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although our license agreements typically contai n provisions that eliminate or limit our exposure to liability, there is no assurance these provisions will withstand legal challenge. We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same suppliers and their demand for hardware components can affect the capacity available to us. If a component from a sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices, datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These same risks would apply to any other hardware and software products we may offer. We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. Although we license portions of our application and operating system source code to several licensees, we take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we might lose future trade secret protection for that code. It may then become easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could increase the security risks described in the next paragraph. Legal changes, our evolving business model, piracy, and other factors may decrease the value of our intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection for software intellectual property rights could adversely affect revenue. We expend significant resources to patent the intellectual property we create with the expectation that we will generate revenues by incorporating that intellectual property in our products or services or, in some instances, by licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to prevent the use of patented technology or collect revenue for licensing our patents. These include legislative changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our intellectual property may decline because of the evolution of technology, selling price changes in products using licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source software will also cause us to license our intellectual property rights broadly in certain situations and may negatively impact revenue.PART I Item 1AThird parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe their intellectual property rights. The number of these claims may grow bec ause of constant technological change in the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance of new patents, and our offering of first-party devices, such as Microsoft Surface. To resolve thes e claims, we may enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers. These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that have infringing technologies. In s ome countries, such as Germany, an injunction can be issued before the parties have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy to manage this risk, and may continue to do so. We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major new product releases such as Windows 10, significant business transactions, warranty or product claims, and employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are subject to inherent uncertainties and managements view of these matters may change in the future. A material adverse impact on our consolidated financial statements could occur for the period in which the effect of an unfavorable outcome becomes probable and reasonably estimable. Government litigation and regulatory activity relating to competition rules may limit how we design and market our products. As a leading global software and device maker, government agencies closely scrutinize us under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and this includes scrutiny in potentially large markets such as the European Union (EU), the U.S., and China. Some jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state antitrust authorities have previously brought enforcement actions and continue to scrutinize our business. The European Commission (the Commission) closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions of our Windows operating system that do not include certain multimedia technologies and to provide our competitors with specifications for how to implement certain proprietary Windows communications protocols in their own products. In 2009, the Commission accepted a set of commitments we offered to address the Commissions concerns relating to competition in web browsing software, including an undertaking to address Commission concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows platform, and increase our product development costs. The availability of licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of our products, which could hamper sales of our products. Our portfolio of first-party devices continues to grow; at the same time our OEM partners offer a large variety of devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain foreign governments, particularly in China and other countries in Asia, have advanced arguments under their competition laws that exert downward pressure on royalties for our intellectual property. Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the revenue that come from them. New competition law actions could be initiated, potentially using previous actions as precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including: We may have to choose between withdrawing products from certain geographies to avoid fines or designing and developing alternative versions of those products to comply with government rulings, which may entail a delay in a product release and removing functionality that customers want or on which developers rely. PART I Item 1A We may be required to make available licenses to our proprietary technologies on terms that do not reflect their fair market value or do not protect our associated intellectual property. We are subject to a variety of ongoing commitments because of court or administrative orders, consent decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may incur litigation costs and be subject to substantial fines or other remedial actions. Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited. Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws and regulations. The Foreign Corrupt Practices Act (FCPA) and other anti-corruption laws and regulations (Anti-Corruption Laws) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-prosecution agreement (NPA) with the U.S. Department of Justice (DOJ) and we agreed to the terms of a cease and desist order with the Securities and Exchange Commission.These agreements required us to pay $25.3 million in monetary penalties, disgorgement, and interest pertaining to activities at Microsofts subsidiary in Hungary. The NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce competition between themselves. While we devote substantial resources to our U.S. and international compliance programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as Iran, North Korea, Cuba, Sudan, and Syria. Other regulatory areas that may apply to our products and online services offerings include user privacy, telecommunications, data storage and protection, and online content. For example, some regulators are taking the position that our offerings such as Skype are covered by existing laws regulating telecommunications services, and some new laws are defining more of our services as regulated telecommunications services. This trend may continue and will result in these offerings being subjected to additional data protection, security, and law enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services. Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments approach to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of regulation may involve significant costs or require changes in products or business practices that result in reduced revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant activity. We strive to empower all people and organizations to achieve more, and accessibility of our products is an important aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and other stakeholders to make technology more accessible. If our products do not meet customer expectations or emerging global accessibility requirements, we could lose sales opportunities or face regulatory actionsPART I Item 1ALaws and regulations relating to the handling of personal data may impede the adoption of our services or result in increased costs, legal claims, fines against us , or reputational damage . The growth of our Internet- and cloud-based services internationally relies increasingly on the movement of data across national boundaries. Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve . For example, the EU and the U.S. formally entered into a new framework in July 2016 that provides a mechanism for companies to transfer data from EU member states to the U.S. This framework, called the Privacy Shield, is intended to address shortcomings identified by the European Court of Justice in a predecessor mechanism. The Privacy Shield and other mechanisms are currently subject to challenges in European courts, which may lead to uncertainty about the legal basis for data transfers across the Atlant ic. The Privacy Shield and other potential rules on the flow of data across borders could increase the cost and complexity of delivering our products and services in some markets. In May 2018, a new EU law governing data practices and privacy , the General Data Protection Regulation (GDPR), bec a me effective. The law , which applies to all of our activities conducted from an establishment in the EU or related to products and services offered in the EU, imposes a range of new compliance obligations regarding the handling of personal data. Engineering efforts to build new capabilities to facilitate compliance with the law have entailed substantial expense and the diversion of engineering resources from other projects and may continue to do so. We might experien ce reduced demand for our offerings if we are unable to engineer products that meet our legal duties or help our customers meet their obligations under the GDPR or other data regulations, or if the changes we implement to comply with the GDPR make our offe rings less attractive. The GDPR imposes significant new obligations and compliance with these obligations depends in part on how particular regulators interpret and apply them. If we fail to comply with the GDPR, or if regulators assert we have failed to c omply with the GDPR, it may lead to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private lawsuits , or reputational damage . In the U.S., California has adopted and several states are considering ad opting laws and regulations imposing obligations regarding the handling of personal data. The Companys investment in gaining insights from data is becoming central to the value of the services we deliver to customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede realizing the expected return from this investment. Ongoing legal reviews by regulators may result in burdensome or inconsistent requirements, including data sovereignty and localization requirements, affecting the location and movement of our customer and internal employee data as well as the management of that data. Compliance with applicable laws and regulations regarding personal data may require changes in services, business practices, or internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of management time and effort. We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. For example, compliance with the 2017 United States Tax Cuts and Jobs Act (TCJA) may require the collection of information not regularly produced within the Company, the use of estimates in our consolidated financial statements, and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from previous estimates and may materially affect our consolidated financial statements. We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially affect our consolidated financial statements in the period or periods in which that determination is made. PART I Item 1AWe earn a significant amount of our operating income outside the U.S . A change in the mix of earnings and losses in countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition, changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental law changes currently being considered by many countries, including in the U.S., and changes in taxing juris dictions administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated financial statements . If our reputation or our brands are damaged, our business and operating results may be harmed . Our reputation and brands are globally recognized and are important to our business. Our reputation and brands affect our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact and sustainability, supply chain practices, or human rights record. We may experience backlash from customers, government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things: The introduction of new features, products, services, or terms of service that customers, users, or partners do not like. Public scrutiny of our decisions regarding user privacy, data practices, or content. Data security breaches, compliance failures, or actions of partners or individual employees. The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most highly qualified employees.Our global business exposes us to operational and economic risks. Our customers are located throughout the world and a significant part of our revenue comes from international sales. The global nature of our business creates operational and economic risks. Our results of operations may be affected by global, regional, and local economic developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our international growth strategy includes certain markets, the developing nature of which presents several risks, including deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact demand for our products and services or increase operating costs. Although we hedge a portion of our international currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies may adversely affect our results of operations . Adverse economic or market conditions may harm our business. Worsening economic conditions, including inflation, recession, or other changes in economic conditions, may cause lower IT spending and adversely affect our revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for those products declines, our revenue will be adversely affected. Substantial revenue comes from our U.S. government contracts. An extended federal government shutdown resulting from failing to pass budget appropriations, adopt continuing funding resolutions or raise the debt ceiling, and other budgetary decisions limiting or delaying federal government spending, could reduce government IT spending on our products and services and adversely affect our revenue. Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our software have also been a significant means of distribution. The impact of economic conditions on our partners, such as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase. PART I Item 1AWe maintain an investment portfolio of various holdings, t ypes, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events that affect global financial markets. A significant part of our investment portfolio c omprises U.S. government securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely affect our consolidated financial statements . Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event could cause delays in completing sales, providing services, or performing other critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other essential business operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are seismically active regions. A catastrophic event that results in the destruction or disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power grids, could harm our ability to conduct normal business operations. Providing our customers with more services and solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity management plans, and magnifies the potential impact of prolonged service outages on our consolidated financial statements. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact our ability to do business in some markets or with some public-sector customers. Any of these changes may negatively impact our revenues. The long-term effects of climate change on the global economy or the IT industry in particular are unclear. Environmental regulations or changes in the supply, demand or available sources of energy or other natural resources may affect the availability or cost of goods and services, including natural resources, necessary to run our business. Changes in weather where we operate may increase the costs of powering and cooling computer hardware we use to develop software and provide cloud-based services.Our business depends on our ability to attract and retain talented employees. Our business is based on successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive, are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our workforce needs. PART I Item 1B, 2, 3, 4", ITEM 1B. UNRESOLVE D STAFF COMMENTS We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our fiscal year 2019 that remain unresolved. ," ITEM 2. PROPERTIES Our corporate headquarters are located in Redmond, Washington. We have approximately 15 million square feet of space located in King County, Washington that is used for engineering, sales, marketing, and operations, among other general and administrative purposes. These facilities include approximately 10 million square feet of owned space situated on approximately 520 acres of land we own at our corporate headquarters, and approximately five million square feet of space we lease. In addition, we own and lease space domestically that includes office, datacenter, and retail space.We also own and lease facilities internationally. The largest owned properties include: our research and development centers in China and India; our datacenters in Ireland, the Netherlands, and Singapore; and our operations and facilities in Ireland and the United Kingdom. The largest leased properties include space in the following locations: Australia, Canada, China, Germany, India, Japan, and the United Kingdom.In addition to the above locations, we have various product development facilities, both domestically and internationally, as described under Research and Development (Part I, Item 1 of this Form 10-K).The table below shows a summary of the square footage of our office, datacenter, retail, and other facilities owned and leased domestically and internationally as of June 30, 2019:(Square feet in millions)Location OwnedLeasedTotalU.S.InternationalTotal "," ITEM 3. LEGAL PROCEEDINGS While not material to the Company, the Company makes the following annual report of the general activities of the Companys Antitrust Compliance Office as required by the Final Order and Judgment in Barovic v. Ballmer et al, United States District Court for the Western District of Washington (Final Order). For more information see http://aka.ms/MSLegalNotice2015. These annual reports will continue through 2020. During fiscal year 2019, the Antitrust Compliance Office (a) monitored the Companys compliance with the European Commission Decision of March 24, 2004, (2004 Decision) and with the Companys Public Undertaking to the European Commission dated December 16, 2009 (2009 Undertaking); (b) monitored, in the manner required by the Final Order, employee, customer, competitor, regulator, or other third-party complaints regarding compliance with the 2004 Decision, the 2009 Undertaking, or other EU or U.S. laws or regulations governing tying, bundling, and exclusive dealing contracts; and, (c) monitored, in the manner required by the Final Order, the training of the Companys employees regarding the Companys antitrust compliance polices. In addition, the Antitrust Compliance Officer reports to the Regulatory and Public Policy Committee of the Board at each of its regularly scheduled meetings and to the full Board annually.Refer to Note 16 Contingencies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for information regarding legal proceedings in which we are involved. "," ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES MARKET AND STOCKHOLDERS Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On July 29, 2019, there were 94,069 registered holders of record of our common stock.SHARE REPURCHASES AND DIVIDENDS Following are our monthly share repurchases for the fourth quarter of fiscal year 2019:PeriodTotal Number of SharesPurchasedAveragePrice Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value ofShares that May Yet bePurchased under the Plans or Programs(In millions)April 1, 2019 April 30, 20198,547,612$122.858,547,612$14,551May 1, 2019 May 31, 201914,029,339126.3214,029,33912,778June 1, 2019 June 30, 201910,469,682131.5910,469,68211,40133,046,63333,046,633All share repurchases were made using cash resources. Our share repurchases may occur through open market purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards.Our Board of Directors declared the following dividends during the fourth quarter of fiscal year 2019: Declaration DateRecord DatePayment DateDividendPer ShareAmount(In millions)June 12, 2019August 15, 2019September 12, 2019$0.46$3,516We returned $7.7 billion to shareholders in the form of share repurchases and dividends in the fourth quarter of fiscal year 2019. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion regarding share repurchases and dividends.PART II Item 6"," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Managements Discussion and Analysis of Financial Condition and Results of Operations (MDA) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MDA is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying Notes to Financial Statements (Part II, Item 8 of this Form 10-K).OVERVIEW Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platforms and tools help drive small business productivity, large business competitiveness, and public-sector efficiency. They also support new startups, improve educational and health outcomes, and empower human ingenuity.We generate revenue by offering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering relevant online advertising to a global audience. Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.Highlights from fiscal year 2019 compared with fiscal year 2018 included: Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties, increased 43% to $38.1 billion. Office Commercial revenue increased 13%, driven by Office 365 Commercial growth of 33%. Office Consumer revenue increased 7%, and Office 365 Consumer subscribers increased to 34.8 million. LinkedIn revenue increased 28%, with record levels of engagement highlighted by LinkedIn sessions growth of 27%. Dynamics revenue increased 15%, driven by Dynamics 365 growth of 47%. Server products and cloud services revenue, including GitHub, increased 25%, driven by Azure growth of 72%. Enterprise Services revenue increased 5%. Windows original equipment manufacturer licensing (Windows OEM) revenue increased 4%. Windows Commercial revenue increased 14%. Microsoft Surface revenue increased 23%. Gaming revenue increased 10%, driven by Xbox software and services growth of 19%. Search advertising revenue, excluding traffic acquisition costs, increased 13%.We have recast certain prior period commercial cloud metrics to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations.On October 25, 2018, we acquired GitHub, Inc. (GitHub) in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. Refer to Note 8 Business Combinations of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional ne t charge related to the enactment of the TCJA of $13. 7 billion in fiscal year 2018 , and adjusted our provisional net charge by recording additional tax expense of $ 157 million in the second quarter of fiscal year 2019. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland, which resulted in a $2.6 billion net income tax benef it . Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Industry Trends Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models. Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.Economic Conditions, Challenges, and RisksThe markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services in the cloud, and in some cases, the users choice of which suite of cloud-based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working environment, broad customer reach, scale in resources, the ability to grow ones career across many different products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange rates may significantly affect revenue and expenses. Strengthening of foreign currencies relative to the U.S. dollar throughout fiscal year 2018 positively impacted reported revenue and increased reported expenses from our international operations. Strengthening of the U.S. dollar relative to certain foreign currencies did not significantly impact reported revenue or expenses from our international operations in the first and second quarters of fiscal year 2019, and reduced reported revenue and expenses from our international operations in the third and fourth quarters of fiscal year 2019.Refer to Risk Factors (Part I, Item 1A of this Form 10-K) for a discussion of these factors and other risks.SeasonalityOur revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period.Reportable SegmentsWe report our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MDA are presented on a basis consistent with our internal management reporting. All differences between our internal management reporting basis and accounting principles generally accepted in the United States of America (GAAP), along with certain corporate-level and other activity, are included in Corporate and Other.Additional information on our reportable segments is contained in Note 20 Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).PART II Item 7SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017Revenue$125,843$110,360$96,57114%14%Gross margin82,93372,00762,31015%16%Operating income42,95935,05829,02523%21%Net income39,24016,57125,489137%(35)%Diluted earnings per share5.062.133.25138%(34)%Non-GAAP operating income42,959 35,05829,33123% 20%Non-GAAP net income36,83030,26725,73222%18%Non-GAAP diluted earnings per share4.753.883.2922%18%Non-GAAP operating income, net income, and diluted earnings per share (EPS) exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. Refer to the Non-GAAP Financial Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP financial results.Fiscal Year 2019 Compared with Fiscal Year 2018Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Surface, Gaming, and Windows.Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and favorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily from Azure.Operating income increased $7.9 billion or 23%, driven by growth across each of our segments.Key changes in expenses were: Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surface, and Gaming. Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artificial intelligence (AI) engineering, Gaming, LinkedIn, and GitHub. Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Sales and marketing expenses included a favorable foreign currency impact of 2%.Current year net income included a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Prior year net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively. Fiscal Year 2018 Compared with Fiscal Year 2017Revenue increased $13.8 billion or 14%, driven by growth across each of our segments. Productivity and Business Processes revenue increased, driven by LinkedIn and higher revenue from Office. Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services. More Personal Computing revenue increased, driven by higher revenue from Gaming, Windows, Search advertising, and Surface, offset in part by lower revenue from Phone.PART II Item 7Gross margin increased $9.7 billion or 16%, due to growth across each of our segments. Gross margin percentage increased slightly, driven by favo rable segment sales mix and gross margin percentage improvement in More Personal Computing. Gross margin included a 7 percentage point improvement in commercial cloud, primarily from Azure. Operating income increased $6.0 billion or 21%, driven by growth across each of our segments. LinkedIn operating loss increased $63 million to $987 million, including $1.5 billion of amortization of intangible assets. Operating income included a favorable foreign currency impact of 2%.Key changes in expenses were: Cost of revenue increased $4.1 billion or 12%, mainly due to growth in our commercial cloud, Gaming, LinkedIn, and Search advertising, offset in part by a reduction in Phone cost of revenue. Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses.Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted earnings per share of $13.7 billion and $1.75, respectively. Fiscal year 2017 operating income, net income, and diluted EPS were negatively impacted by restructuring expenses, which resulted in a decrease to operating income, net income, and diluted EPS of $306 million, $243 million, and $0.04, respectively.SEGMENT RESULTS OF OPERATIONS (In millions, except percentages)Percentage Change 2019Versus 2018Percentage Change 2018Versus 2017RevenueProductivity and Business Processes$41,160$35,865$29,87015%20%Intelligent Cloud38,98532,21927,40721%18%More Personal Computing45,69842,27639,2948%8%Total $125,843$110,360$96,57114%14%Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,38925%13%Intelligent Cloud13,92011,5249,12721%26%More Personal Computing12,82010,6108,81521%20%Corporate and Other(306)**Total $42,959$35,058$29,02523%21%* Not meaningful. Reportable Segments Fiscal Year 2019 Compared with Fiscal Year 2018Productivity and Business Processes Revenue increased $5.3 billion or 15%. Office Commercial revenue increased $3.2 billion or 13%, driven by Office 365 Commercial, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to cloud offerings. Office 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. PART II Item 7 Office Consumer revenue increased $286 million or 7 %, driven by Office 365 Consumer, due to recurring subscription revenue and transactional strength in Japan . LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. Dynamics revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unfavorable foreign currency impact of 2%. Gross margin increased $4.1 billion or 15%, driven by growth in Office Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Office 365 Commercial, offset in part by an increased mix of cloud offerings. Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, offset in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products revenue increased 6% , due to continued demand for premium versions and hybrid solutions, GitHub, and demand ahead of end-of-support for SQL Server 2008 and Windows Server 2008. Enterprise Services revenue increased $278 million or 5% , driven by growth in Premier Support Services and Microsoft Consulting Services.Operating income increased $2.4 billion or 21%. Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings. Operating expenses increased $2.4 billion or 22%, driven by investments in cloud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, offset in part by a decline in patent licensing. Windows Commercial revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. Surface revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer. Gaming revenue increased $1.0 billion or 10%, driven by Xbox software and services growth of 19%, primarily due to third-party title strength and subscriptions growth, offset in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traffic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unfavorable foreign currency impact of 2%. Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to a sales mix shift to higher gross margin businesses in Windows and Gaming. Operating expenses decreased $172 million or 1%. PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Productivity and Business Processes Revenue increased $6.0 billion or 20%. LinkedIn revenue increased $3.0 billion to $5.3 billion. Fiscal year 2018 included a full period of results, whereas fiscal year 2017 only included results from the date of acquisition on December 8, 2016. LinkedIn revenue primarily consisted of revenue from Talent Solutions. Office Commercial revenue increased $2.4 billion or 11%, driven by Office 365 Commercial revenue growth, mainly due to growth in subscribers and average revenue per user, offset in part by lower revenue from products licensed on-premises, reflecting a continued shift to Office 365 Commercial. Office Consumer revenue increased $382 million or 11%, driven by Office 365 Consumer revenue growth, mainly due to growth in subscribers. Dynamics revenue increased 13%, driven by Dynamics 365 revenue growth. Operating income increased $1.5 billion or 13%, including a favorable foreign currency impact of 2%. Gross margin increased $4.4 billion or 19%, driven by LinkedIn and growth in Office Commercial. Gross margin percentage decreased slightly, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Office 365 Commercial and LinkedIn. LinkedIn cost of revenue increased $818 million to $1.7 billion, including $888 million of amortization for acquired intangible assets. Operating expenses increased $2.9 billion or 25%, driven by LinkedIn expenses and investments in commercial sales capacity and cloud engineering. LinkedIn operating expenses increased $2.2 billion to $4.5 billion, including $617 million of amortization of acquired intangible assets. Intelligent CloudRevenue increased $4.8 billion or 18%. Server products and cloud services revenue increased $4.5 billion or 21%, driven by Azure and server products licensed on-premises revenue growth. Azure revenue grew 91%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-based and per user-based services. Server products licensed on-premises revenue increased 5% , mainly due to a higher mix of premium licenses for Windows Server and Microsoft SQL Server. Enterprise Services revenue increased $304 million or 5% , driven by higher revenue from Premier Support Services and Microsoft Consulting Services, offset in part by a decline in revenue from custom support agreements.Operating income increased $2.4 billion or 26%. Gross margin increased $3.1 billion or 16%, driven by growth in server products and cloud services revenue and cloud services scale and efficiencies. Gross margin percentage decreased, due to an increased mix of cloud offerings, offset in part by gross margin percentage improvement in Azure. Operating expenses increased $683 million or 7%, driven by investments in commercial sales capacity and cloud engineering.More Personal Computing Revenue increased $3.0 billion or 8%. Windows revenue increased $925 million or 5%, driven by growth in Windows Commercial and Windows OEM, offset by a decline in patent licensing revenue. Windows Commercial revenue increased 12%, driven by multi-year agreement revenue growth. Windows OEM revenue increased 5%. Windows OEM Pro revenue grew 11%, ahead of a strengthening commercial PC market. Windows OEM non-Pro revenue declined 4%, below the consumer PC market, driven by continued pressure in the entry-level price category. Gaming revenue increased $1.3 billion or 14%, driven by Xbox software and services revenue growth of 20%, mainly from third-party title strength. PART II Item 7 Search advertising revenue increased $793 million or 13%. Search advertising revenue, excluding traffic acquisition costs, increased 16%, driven by growth in Bing, due to higher revenue per search and search volume. Surface revenue increased $625 million or 16%, driven by a higher mix of premium devices and an increase in volumes sold, due to the latest editions of Surface. Phone revenue decreased $525 million.Operating income increased $1.8 billion or 20%, including a favorable foreign currency impact of 2%. Gross margin increased $2.2 billion or 11%, driven by growth in Windows, Surface, Search, and Gaming. Gross margin percentage increased, primarily due to gross margin percentage improvement in Surface. Operating expenses increased $391 million or 3%, driven by investments in Search, AI, and Gaming engineering and commercial sales capacity, offset in part by a decrease in Windows marketing expenses. Corporate and Other Corporate and Other includes corporate-level activity not specifically allocated to a segment, including restructuring expenses.Fiscal Year 2019 Compared with Fiscal Year 2018 We did not incur Corporate and Other activity in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 Corporate and Other operating loss decreased $306 million, due to a reduction in restructuring expenses, driven by employee severance expenses primarily related to our sales and marketing restructuring plan in fiscal year 2017.OPERATING EXPENSES Research and Development (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Research and development$16,876$14,726$13,03715%13%As a percent of revenue13%13%13%0ppt0pptResearch and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Fiscal Year 2019 Compared with Fiscal Year 2018Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub.Fiscal Year 2018 Compared with Fiscal Year 2017Research and development expenses increased $1.7 billion or 13%, primarily due to investments in cloud engineering and LinkedIn expenses. LinkedIn expenses increased $762 million to $1.5 billion.PART II Item 7Sales and Marketing (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017Sales and marketing$18,213$17,469$15,4614%13%As a percent of revenue14%16%16%(2)ppt0pptSales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Fiscal Year 2019 Compared with Fiscal Year 2018Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, offset in part by a decrease in marketing. Expenses included a favorable foreign currency impact of 2%. Fiscal Year 2018 Compared with Fiscal Year 2017Sales and marketing expenses increased $2.0 billion or 13%, primarily due to LinkedIn expenses and investments in commercial sales capacity, offset in part by a decrease in Windows marketing expenses. LinkedIn expenses increased $1.2 billion to $2.5 billion, including $617 million of amortization of acquired intangible assets.General and Administrative (In millions, except percentages)PercentageChange 2019 Versus 2018Percentage Change 2018 Versus 2017General and administrative$4,885$4,754$4,4813%6%As a percent of revenue4%4%5%0ppt(1)pptGeneral and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.Fiscal Year 2019 Compared with Fiscal Year 2018General and administrative expenses increased $131 million or 3%.Fiscal Year 2018 Compared with Fiscal Year 2017General and administrative expenses increased $273 million or 6%, primarily due to LinkedIn expenses. LinkedIn expenses increased $234 million to $528 million.RESTRUCTURING EXPENSES Restructuring expenses include employee severance expenses and other costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities.Fiscal Year 2019 Compared with Fiscal Year 2018We did not incur restructuring expenses in fiscal years 2019 or 2018.Fiscal Year 2018 Compared with Fiscal Year 2017 During fiscal year 2017, we recorded $306 million of employee severance expenses, primarily related to our sales and marketing restructuring plan. PART II Item 7OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2019 Compared with Fiscal Year 2018Interest and dividends income increased primarily due to higher yields on fixed-income securities. Interest expense decreased primarily driven by a decrease in outstanding long-term debt due to debt maturities, offset in part by higher finance lease expense . Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on foreign exchange and interest rate derivatives in the current period as compared to losses in the prior period . Fiscal Year 2018 Compared with Fiscal Year 2017Dividends and interest income increased primarily due to higher average portfolio balances and yields on fixed-income securities. Interest expense increased primarily due to higher average outstanding long-term debt and higher finance lease expense. Net recognized gains on investments decreased primarily due to higher losses on sales of fixed-income securities, offset in part by higher gains on sales of equity securities. Net losses on derivatives decreased primarily due to lower losses on equity, foreign exchange, and commodity derivatives, offset in part by losses on interest rate derivatives in the current period as compared to gains in the prior period. INCOME TAXES Effective Tax RateFiscal Year 2019 Compared with Fiscal Year 2018 Our effective tax rate for fiscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. Our effective tax rate was lower than the U.S. federal statutory rate, primarily due to the tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2019, our U.S. income before income taxes was $15.8 billion and our foreign income before income taxes was $27.9 billion. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Our effective tax rate for fiscal years 2018 and 2017 was 55% and 15%, respectively. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA in fiscal year 2018 and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. Our effective tax rate was higher than the U.S. federal statutory rate primarily due to the net charge related to the enactment of the TCJA, offset in part by earnings taxed at lower rates in foreign jurisdictions resulting from our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The mix of income before income taxes between the U.S. and foreign countries impacted our effective tax rate as a result of the geographic distribution of, and customer demand for, our products and services. In fiscal year 2018, our U.S. income before income taxes was $11.5 billion and our foreign income before income taxes was $24.9 billion. In fiscal year 2017, our U.S. income before income taxes was $6.8 billion and our foreign income before income taxes was $23.1 billion.Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our global intangible low-taxed income (GILTI) effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax.Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Uncertain Tax Positions We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months. As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NON-GAAP FINANCIAL MEASURES Non-GAAP operating income, net income, and diluted EPS are non-GAAP financial measures which exclude the net tax impact of transfer of intangible properties, the net tax impact of the TCJA, and restructuring expenses. We believe these non-GAAP measures aid investors by providing additional insight into our operational performance and help clarify trends affecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance. These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP.The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:(In millions, except percentages and per share amounts)Percentage Change 2019 Versus 2018Percentage Change 2018 Versus 2017Operating income$42,959 $35,058$29,02523%21%Net tax impact of transfer of intangible properties **Net tax impact of the TCJA**Restructuring expenses**Non-GAAP operating income$42,959 $35,058$29,33123%20%Net income$39,240$16,571$25,489137%(35)%Net tax impact of transfer of intangible properties(2,567)**Net tax impact of the TCJA13,696**Restructuring expenses**Non-GAAP net income$36,830$30,267$25,73222%18%Diluted earnings per share$5.06$2.13$3.25138%(34)%Net tax impact of transfer of intangible properties (0.33)**Net tax impact of the TCJA0.021.75**Restructuring expenses0.04**Non-GAAP diluted earnings per share$4.75$3.88$3.2922%18%* Not meaningful. PART II Item 7FINANCIAL CONDITION Cash, Cash Equivalents, and Investments Cash, cash equivalents, and short-term investments totaled $133.8 billion as of both June 30, 2019 and 2018. Equity investments were $2.6 billion and $1.9 billion as of June 30, 2019 and 2018, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities. Valuation In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally-developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio. A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments. In addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2019 Compared with Fiscal Year 2018 Cash from operations increased $8.3 billion to $52.2 billion for fiscal year 2019, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to suppliers and employees and an increase in cash paid for income taxes. Cash used in financing increased $3.3 billion to $36.9 billion for fiscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, offset in part by a $6.2 billion decrease in repayments of debt, net of proceeds from issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion for fiscal year 2019, mainly due to a $6.0 billion decrease in cash from net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets.PART II Item 7Fiscal Year 2018 Compared with Fiscal Year 2017 Cash from operations increased $4.4 billion to $43.9 billion for fiscal year 2018, mainly due to an increase in cash received from customers, offset in part by an increase in cash paid to employees, net cash paid for income taxes, cash paid for interest on debt, and cash paid to suppliers. Cash used in financing was $33.6 billion for fiscal year 2018, compared to cash from financing of $8.4 billion for fiscal year 2017. The change was mainly due to a $41.7 billion decrease in proceeds from issuance of debt, net of repayments of debt, offset in part by a $1.1 billion decrease in cash used for common stock repurchases. Cash used in investing decreased $40.7 billion to $6.1 billion for fiscal year 2018, mainly due to a $25.1 billion decrease in cash used for acquisitions of companies, net of cash acquired, and purchases of intangible and other assets, and a $19.1 billion increase in cash from net investment purchases, sales, and maturities.Debt We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Software Assurance (SA) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments for other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.The following table outlines the expected future recognition of unearned revenue as of June 30, 2019:(In millions)Three Months Ending,September 30, 2019$12,353December 31, 20199,807March 31, 20206,887June 30, 20203,629Thereafter4,530Total$37,206If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For fiscal years 2019, 2018, and 2017, we repurchased 150 million shares, 99 million shares, and 170 million shares of our common stock for $16.8 billion, $8.6 billion, and $10.3 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Dividends Refer to Note 17 Stockholders Equity of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.PART II Item 7Off-Balance Sheet Arrangements We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented. Contractual Obligations The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, 2019: (In millions)2021-20222023-2024ThereafterTotalLong-term debt: (a) Principal payments$5,518$11,744$8,000$47,519$72,781Interest payments2,2994,3093,81829,38339,809Construction commitments (b) 3,4433,958Operating leases, including imputed interest (c) 1,7903,1442,4133,64510,992Finance leases, including imputed interest (c) 2,0082,1659,87214,842Transition tax (d) 1,1802,9004,1688,15516,403Purchase commitments (e) 17,4781,18519,161Other long-term liabilities (f) Total$32,505 $25,877 $20,752 $99,237 $178,371 (a) Refer to Note 11 Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (b) Refer to Note 7 Property and Equipment of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( c ) Refer to Note 15 Leases of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). (d) Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K). ( e ) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. ( f ) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $14.2 billion from the amounts presented as the timing of these obligations is uncertain. We have also excluded unearned revenue and non-cash items. Other Planned Uses of Capital We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources. Liquidity As a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable interest free over eight years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid transition tax of approximately $2.0 billion, which included $1.5 billion for fiscal year 2019. The first installment of the transition tax was paid in fiscal year 2019, and the remaining transition tax of $16.4 billion is payable over the next seven years with a final payment in fiscal year 2026. During the first quarter of fiscal year 2020, we expect to pay $1.2 billion related to the second installment of the transition tax, and $3.5 billion related to the transfer of intangible properties in the fourth quarter of fiscal year 2019.PART II Item 7We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be s ufficient to fund our operating activities and cash commitments for investing and financing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future. RECENT ACCOUNTING GUIDANCE Refer to Note 1 Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by managements application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand-alone selling price (SSP"") for each distinct performance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented. PART II Item 7Impairment of Investment Securities We review debt investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments. Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product. Once technological feasibility is established, software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of these costs is included in cost of revenue over the estimated life of the products. Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our consolidated financial statements.PART II Item 7Income Taxes The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. The TCJA significantly changes existing U.S. tax law and includes numerous provisions that affect our business. Refer to Note 12 Income Taxes of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.PART II Item 7STATEMENT OF MANAGEMENTS RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on managements estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Company engaged Deloitte Touche LLP, an independent registered public accounting firm, to audit and render an opinion on the consolidated financial statements and internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Deloitte Touche LLP and the internal auditors each have full and free access to the Audit Committee. Satya NadellaChief Executive OfficerAmy E. HoodExecutive Vice President and Chief Financial OfficerFrank H. BrodCorporate Vice President, Finance and Administration; Chief Accounting OfficerPART II Item 7A"," ITEM 7A. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global fixed-income indices. CreditOur fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. Equity Securities held in our equity investments portfolio are subject to price risk. SENSITIVITY ANALYSIS The following table sets forth the potential loss in future earnings or fair values, including associated derivatives, resulting from hypothetical changes in relevant market rates or prices: (In millions)Risk CategoriesHypothetical ChangeJune 30,ImpactForeign currency - Revenue10% decrease in foreign exchange rates$(3,402)EarningsForeign currency - Investments10% decrease in foreign exchange rates(120)Fair ValueInterest rate100 basis point increase in U.S. treasury interest rates(2,909)Fair ValueCredit100 basis point increase in credit spreads(224)Fair ValueEquity10% decrease in equity market prices(244)EarningsPART II Item 8"," ITEM 8. FINANCIAL STATE MENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts)Year Ended June 30,Revenue:Product$66,069$64,497$63,811Service and other59,77445,86332,760Total revenue125,843110,36096,571Cost of revenue:Product16,27315,42015,175Service and other26,63722,93319,086Total cost of revenue42,91038,35334,261Gross margin82,93372,00762,310Research and development16,87614,72613,037Sales and marketing18,21317,46915,461General and administrative4,8854,7544,481RestructuringOperating income42,95935,05829,025Other income, net 1,416Income before income taxes43,68836,47429,901Provision for income taxes4,44819,9034,412Net income$39,240$16,571$25,489Earnings per share:Basic$5.11$2.15$3.29Diluted$5.06$2.13$3.25Weighted average shares outstanding:Basic7,6737,7007,746Diluted7,7537,7947,832Refer to accompanying notes. PART II Item 8COMPREHENSIVE IN COME STATEMENTS (In millions)Year Ended June 30,Net income$39,240$16,571$25,489Other comprehensive income (loss), net of tax:Net change related to derivatives(173)(218)Net change related to investments2,405(2,717)(1,116)Translation adjustments and other(318)(178)Other comprehensive income (loss)1,914(2,856) (1,167) Comprehensive income$41,154$13,715$24,322Refer to accompanying notes. Refer to Note 18 Accumulated Other Comprehensive Income (Loss) for further information.PART II Item 8BALANCE SHEETS (In millions)June 30, AssetsCurrent assets:Cash and cash equivalents$11,356$11,946Short-term investments122,463121,822Total cash, cash equivalents, and short-term investments133,819133,768Accounts receivable, net of allowance for doubtful accounts of $411 and $37729,52426,481Inventories2,0632,662Other10,1466,751Total current assets175,552169,662Property and equipment, net of accumulated depreciation of $35,330 and $29,22336,47729,460Operating lease right-of-use assets7,3796,686Equity investments2,6491,862Goodwill42,02635,683Intangible assets, net7,7508,053Other long-term assets14,7237,442Total assets$286,556$258,848Liabilities and stockholders equityCurrent liabilities:Accounts payable$9,382$8,617Current portion of long-term debt5,5163,998Accrued compensation6,8306,103Short-term income taxes5,6652,121Short-term unearned revenue32,67628,905Other9,3518,744Total current liabilities69,42058,488Long-term debt66,66272,242Long-term income taxes29,61230,265Long-term unearned revenue4,5303,815Deferred income taxesOperating lease liabilities6,1885,568Other long-term liabilities7,5815,211Total liabilities184,226176,130Commitments and contingenciesStockholders equity:Common stock and paid-in capital shares authorized 24,000; outstanding 7,643 and 7,67778,52071,223Retained earnings24,15013,682Accumulated other comprehensive loss(340)(2,187) Total stockholders equity102,33082,718Total liabilities and stockholders equity$286,556$258,848Refer to accompanying notes. PART II Item 8CASH FLOWS S TATEMENTS (In millions) Year Ended June 30,OperationsNet income$39,240$16,571$25,489Adjustments to reconcile net income to net cash from operations:Depreciation, amortization, and other11,68210,2618,778Stock-based compensation expense4,6523,9403,266Net recognized gains on investments and derivatives(792)(2,212)(2,073)Deferred income taxes(6,463)(5,143)(829)Changes in operating assets and liabilities:Accounts receivable(2,812)(3,862)(1,216)Inventories(465)Other current assets(1,718)(952)1,028Other long-term assets(1,834)(285)(917)Accounts payable1,148Unearned revenue4,4625,9223,820Income taxes2,92918,1831,792Other current liabilities1,419Other long-term liabilities(20)(118)Net cash from operations52,18543,88439,507FinancingRepayments of short-term debt, maturities of 90 days or less, net(7,324)(4,963)Proceeds from issuance of debt7,18344,344Repayments of debt(4,000)(10,060)(7,922)Common stock issued1,1421,002Common stock repurchased(19,543)(10,721)(11,788)Common stock cash dividends paid(13,811)(12,699)(11,845)Other, net(675)(971)(190)Net cash from (used in) financing(36,887)(33,590)8,408InvestingAdditions to property and equipment(13,925)(11,632)(8,129)Acquisition of companies, net of cash acquired, and purchases of intangible and other assets(2,388)(888)(25,944)Purchases of investments(57,697)(137,380)(176,905)Maturities of investments20,04326,36028,044Sales of investments38,194117,577136,350Securities lending payable(98)(197)Net cash used in investing(15,773)(6,061)(46,781)Effect of foreign exchange rates on cash and cash equivalents(115)Net change in cash and cash equivalents(590)4,2831,153Cash and cash equivalents, beginning of period11,9467,6636,510Cash and cash equivalents, end of period$11,356$11,946$7,663Refer to accompanying notes. PART II Item 8STOCKHOLDERS EQ UITY STATEMENTS (In millions)Year Ended June 30,Common stock and paid-in capitalBalance, beginning of period$71,223$69,315$68,178Common stock issued6,8291,002Common stock repurchased(4,195)(3,033)(2,987)Stock-based compensation expense4,6523,9403,266Other, net(1) Balance, end of period78,52071,22369,315Retained earnings Balance, beginning of period13,68217,76913,118Net income39,24016,57125,489Common stock cash dividends(14,103)(12,917)(12,040)Common stock repurchased(15,346)(7,699)(8,798)Cumulative effect of accounting changes(42)Balance, end of period24,15013,68217,769Accumulated other comprehensive income (loss)Balance, beginning of period(2,187) 1,794Other comprehensive income (loss)1,914(2,856) (1,167)Cumulative effect of accounting changes(67)Balance, end of period(340) (2,187)Total stockholders equity$102,330$82,718$87,711Cash dividends declared per common share$1.84$1.68$1.56Refer to accompanying notes. PART II Item 8NOTES TO FINANCI AL STATEMENTS NOTE 1 ACCOUNTING POLICIES Accounting Principles Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). We have recast certain prior period amounts related to investments, derivatives, and fair value measurements to conform to the current period presentation based on our adoption of the new accounting standard for financial instruments. We have recast prior period commercial cloud revenue to include the commercial portion of LinkedIn to provide a comparable view of our commercial cloud business performance. The commercial portion of LinkedIn includes LinkedIn Recruiter, Sales Navigator, premium business subscriptions, and other services for organizations. We have also recast components of the prior period deferred income tax assets and liabilities to conform to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash from or used in operating, financing, or investing on our consolidated cash flows statements. Principles of Consolidation The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (SSP) of performance obligations, variable consideration, and other obligations such as product returns and refunds; loss contingencies; product warranties; the fair value of and/or potential impairment of goodwill and intangible assets for our reporting units; product life cycles; useful lives of our tangible and intangible assets; allowances for doubtful accounts; the market value of, and demand for, our inventory; stock-based compensation forfeiture rates; when technological feasibility is achieved for our products; the potential outcome of uncertain tax positions that have been recognized on our consolidated financial statements or tax returns; and determining the timing and amount of impairments for investments. Actual results and outcomes may differ from managements estimates and assumptions. Foreign Currencies Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are recorded to other comprehensive income (OCI). Revenue Product Revenue and Service and Other Revenue Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Microsoft Office 365, Microsoft Azure, Microsoft Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales from online advertising and LinkedIn.PART II Item 8Revenue Recognition Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. Nature of Products and ServicesLicenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. In cases where we allocate revenue to software updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated life of the related device or license.Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Software Assurance (SA). SA conveys rights to new software and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more efficiently. On-premises licenses are considered distinct performance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benefits, given that SA comprises distinct performance obligations that are satisfied over time. Cloud services, which allow customers to use hosted software over the contract period without taking possession of the software, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a significant level of integration and interdependency with software and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue from search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue from consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot function without the operating system. In these cases, the hardware and software license are accounted for as a single performance obligation and revenue is recognized at the point in time when ownership is transferred to resellers or directly to end customers through retail stores and online marketplaces. Refer to Note 20 Segment Information and Geographic Data for further information, including revenue by significant product and service offering.Significant JudgmentsOur contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When a cloud-based service includes both on-premises software licenses and cloud services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period in which the cloud services are provided.PART II Item 8Judgment is required to determine the SSP for each distinct pe rformance obligation. We use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell ea ch of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We typically have more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, we may use information such as the size of the customer and geographic region in determining the SSP. Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benefits across our portfolio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted for as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional information becomes available. Changes to our estimated variable consideration were not material for the periods presented.Contract Balances Timing of revenue recognition may differ from the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized for multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. As of June 30, 2019 and 2018, long-term accounts receivable, net of allowance for doubtful accounts, was $2.2 billion and $1.8 billion, respectively, and is included in other long-term assets in our consolidated balance sheets.The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Activity in the allowance for doubtful accounts was as follows: (In millions)Year Ended June 30,Balance, beginning of period$$$Charged to costs and otherWrite-offs(116) (98)(106)Balance, end of period$$$Allowance for doubtful accounts included in our consolidated balance sheets:(In millions)June 30,Accounts receivable, net of allowance for doubtful accounts$$$Other long-term assetsTotal$$$PART II Item 8Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period for multi-year agreements and recogni zed ratably over the coverage period. Unearned revenue also includes payments for consulting services to be performed in the future; LinkedIn subscriptions; Office 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics busin ess solutions; Skype prepaid credits and subscriptions; and other offerings for which we have been paid in advance and earn the revenue when we transfer control of the product or service. Refer to Note 14 Unearned Revenue for further information, including unearned revenue by segment and changes in unearned revenue during the period.Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with revenue recognized upfront.Assets Recognized from Costs to Obtain a Contract with a CustomerWe recognize an asset for the incremental costs of obtaining a contract with a customer if we expect the benefit of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities.Cost of Revenue Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by original equipment manufacturers (OEM), to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain online products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs. Capitalized software development costs are amortized over the estimated lives of the products. Product Warranty We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary. PART II Item 8Research and Development Research and development expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with product development. Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to production. Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and Marketing Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6 billion, $1.6 billion, and $1.5 billion in fiscal years 2019, 2018, and 2017, respectively. Stock-Based Compensation Compensation cost for stock awards, which include restricted stock units (RSUs) and performance stock units (PSUs), is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service or performance period. The fair value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the fair value of PSUs using a Monte Carlo valuation model. Compensation cost for RSUs is recognized using the straight-line method and for PSUs is recognized using the accelerated method.Compensation expense for the employee stock purchase plan (ESPP) is measured as the discount the employee is entitled to upon purchase and is recognized in the period of purchase.Income Taxes Income tax expense includes U.S. and international income taxes, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. Deferred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benefit will not be realized. All deferred income taxes are classified as long-term in our consolidated balance sheets. Financial InstrumentsInvestmentsWe consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general, investments with original maturities of greater than three months and remaining maturities of less than one year are classified as short-term investments. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. PART II Item 8Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in OCI. Debt investments are impaired whe n a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. We employ a systematic methodology on a quarterly basis that considers avai lable quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. In addition, we consider specifi c adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable fair values are measured at fair value. Equity investments without readily determinable fair values are measured using the equity method, or measured at cost with adjustments for observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. We lend certain fixed-income and equity securities to increase investment returns. These transactions are accounted for as secured borrowings and the loaned securities continue to be carried as investments on our consolidated balance sheets. Cash and/or security interests are received as collateral for the loaned securities with the amount determined based upon the underlying security lent and the creditworthiness of the borrower. Cash received is recorded as an asset with a corresponding liability. DerivativesDerivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as fair value hedges, gains and losses are recognized in other income (expense), net with offsetting gains and losses on the hedged items. For derivative instruments designated as cash flow hedges, the effective portion of the gains and losses are initially reported as a component of OCI and subsequently recognized in revenue when the hedged exposure is recognized in revenue. Gains and losses on derivatives representing either hedge components excluded from the assessment of effectiveness or hedge ineffectiveness are recognized in other income (expense), net. For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are primarily recognized in other income (expense), net.Fair Value MeasurementsWe account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1 inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and preferred stock, and mutual funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. PART II Item 8 Level 2 inputs are based upon quoted prices for similar instr uments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g. the Black-Scholes model) for which all significant inputs are observable in the market or can be corrobo rated by observable market data for substantially the full term of the assets or liabilities. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interes t rate curves, credit spreads, foreign exchange rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper, certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed secur ities, corporate notes and bonds, and municipal securities . Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. Level 3 inputs are generally unobservable and typically reflect managements estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, and goodwill and intangible assets, when they are recorded at fair value due to an impairment charge. Unobservable inputs used in the models are significant to the fair values of the assets and liabilities. We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. Our other current financial assets and current financial liabilities have fair values that approximate their carrying values.Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue. Property and Equipment Property and equipment is stated at cost less accumulated depreciation, and depreciated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. The estimated useful lives of our property and equipment are generally as follows: computer software developed or acquired for internal use, three to seven years; computer equipment, two to three years; buildings and improvements, five to 15 years; leasehold improvements, three to 20 years; and furniture and equipment, one to 10 years. Land is not depreciated. LeasesWe determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (ROU) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long-term liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. PART II Item 8We have lease agreem ents with lease and non-lease components, which are generally accounted for separately. For certain equipment leases, such as vehicles, we account for the lease and non-lease components as a single lease component. Additionally, for certain equipment lease s, we apply a portfolio approach to effectively account for the operating lease ROU assets and liabilities. Goodwill Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight-line method over their estimated period of benefit, ranging from one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of useful lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting GuidanceIncome Taxes Intra-Entity Asset TransfersIn October 2016, the Financial Accounting Standards Board (FASB) issued new guidance requiring an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the guidance effective July 1, 2018. Adoption of the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We recorded a net cumulative-effect adjustment that resulted in an increase in retained earnings of $557 million, which reversed the previous deferral of income tax consequences and recorded new deferred tax assets from intra-entity transfers involving assets other than inventory, partially offset by a U.S. deferred tax liability related to global intangible low-taxed income (GILTI). Adoption of the standard resulted in an increase in long-term deferred tax assets of $2.8 billion, an increase in long-term deferred tax liabilities of $2.1 billion, and a reduction in other current assets of $152 million. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.Financial Instruments Recognition, Measurement, Presentation, and Disclosure In January 2016, the FASB issued a new standard related to certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most prominent among the changes in the standard is the requirement for changes in the fair value of our equity investments, with certain exceptions, to be recognized through net income rather than OCI. We adopted the standard effective July 1, 2018. Adoption of the standard was applied using a modified retrospective approach through a cumulative-effect adjustment from accumulated other comprehensive income (AOCI) to retained earnings as of the effective date, and we elected to measure equity investments without readily determinable fair values at cost with adjustments for observable changes in price or impairments. The cumulative-effect adjustment included any previously held unrealized gains and losses held in AOCI related to our equity investments carried at fair value as well as the impact of recording the fair value of certain equity investments carried at cost. The impact on our consolidated balance sheets upon adoption was not material. Adoption of the standard had no impact on cash from or used in operating, financing, or investing on our consolidated cash flows statements.PART II Item 8Recent Accounting Guid ance Not Yet Adopted Financial Instruments Targeted Improvements to Accounting for Hedging Activities In August 2017, the FASB issued new guidance related to accounting for hedging activities. This guidance expands strategies that qualify for hedge accounting, changes how many hedging relationships are presented in the financial statements, and simplifies the application of hedge accounting in certain situations. The standard will be effective for us beginning July 1, 2019, with early adoption permitted for any interim or annual period before the effective date. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date. We evaluated the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems, and do not expect the impact to be material upon adoption.Financial Instruments Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. We will be required to use a forward-looking expected credit loss model for accounts receivables, loans, and other financial instruments. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the effective date for us beginning July 1, 2020. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. We are currently evaluating the impact of this standard on our consolidated financial statements, including accounting policies, processes, and systems. NOTE 2 EARNINGS PER SHARE Basic earnings per share (EPS) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.The components of basic and diluted EPS were as follows:(In millions, except earnings per share)Year Ended June 30,Net income available for common shareholders (A)$39,240$16,571$25,489Weighted average outstanding shares of common stock (B)7,6737,7007,746Dilutive effect of stock-based awardsCommon stock and common stock equivalents (C)7,7537,7947,832Earnings Per ShareBasic (A/B)$5.11$2.15$3.29Diluted (A/C)$5.06$2.13$3.25Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods presented.PART II Item 8NOTE 3 OTHER INCOME (EXPENSE), NET The components of other income (expense), net were as follows: (In millions)Year Ended June 30,Interest and dividends income$2,762$2,214$1,387Interest expense(2,686)(2,733)(2,222)Net recognized gains on investments2,3992,583Net gains (losses) on derivatives(187)(510)Net losses on foreign currency remeasurements(82)(218)(111)Other, net(57)(59)(251)Total$$1,416$Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as follows: (In millions)Year Ended June 30,Realized gains from sales of available-for-sale securities$$$Realized losses from sales of available-for-sale securities(93)(987)(162)Other-than-temporary impairments of investments(16)(6)(14)Total$(97)$(966)$(68)Net recognized gains (losses) on equity investments were as follows:(In millions)Year Ended June 30,Net realized gains on investments sold$$3,406$2,692Net unrealized gains on investments still heldImpairments of investments(10) (41) (41) Total$$3,365$2,651PART II Item 8NOTE 4 INVESTMENTS Investment Components The components of investments were as follows: (In millions)Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand Cash EquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2019Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,211$$$2,211$1,773$$Certificates of depositLevel 22,0182,0181,430U.S. government securitiesLevel 1104,9251,854(104)106,675105,906U.S. agency securitiesLevel 2Foreign government bondsLevel 26,350(8)6,3462,5063,840Mortgage- and asset-backed securitiesLevel 23,554(3)3,5613,561Corporate notes and bondsLevel 27,437(7)7,5417,541Corporate notes and bondsLevel 3Municipal securitiesLevel 2Municipal securitiesLevel 3Total debt investments$127,747$2,027$(122)$129,652$7,176$122,476$Changes in Fair Value Recorded inNet IncomeEquity investmentsLevel 1$$$$Equity investmentsOther2,0852,085Total equity investments$3,058$$$2,649Cash$3,771$3,771$$Derivatives, net (a) (13)(13)Total$136,468$11,356$122,463$2,649PART II Item 8(In millions) Fair Value LevelCost BasisUnrealizedGainsUnrealizedLossesRecordedBasisCashand CashEquivalentsShort-termInvestmentsEquityInvestmentsJune 30, 2018Changes in Fair Value Recorded inOther Comprehensive IncomeCommercial paperLevel 2$2,513$$$2,513$2,215$$Certificates of depositLevel 22,0582,0581,865U.S. government securitiesLevel 1108,120(1,167)107,0152,280104,735U.S. agency securitiesLevel 21,7421,7421,398Foreign government bondsLevel 1Foreign government bondsLevel 25,063(10)5,0545,054Mortgage- and asset-backed securitiesLevel 23,864(13)3,8553,855Corporate notes and bondsLevel 26,929(56)6,8946,894Corporate notes and bondsLevel 3Municipal securitiesLevel 2(1)Total debt investments$130,597$$(1,247)$129,475$7,758$121,717$Equity investmentsLevel 1$$$$Equity investmentsLevel 3Equity investmentsOther1,5581,557Total equity investments$2,109$$$1,862Cash$3,942$3,942$$Derivatives, net (a) Total$135,630$11,946$121,822$1,862(a) Refer to Note 5 Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as Other in the tables above include investments without readily determinable fair values measured using the equity method or measured at cost with adjustments for observable changes in price or impairments, and investments measured at fair value using net asset value as a practical expedient which are not categorized in the fair value hierarchy. As of June 30, 2019 and 2018, equity investments without readily determinable fair values measured at cost with adjustments for observable changes in price or impairments were $1.2 billion and $697 million, respectively. As of June 30, 2019, we had no collateral received under agreements for loaned securities. As of June 30, 2018, collateral received under agreements for loaned securities was $1.8 billion and primarily comprised U.S. government and agency securities. Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their related fair values were as follows: Less than 12 Months12 Months or GreaterTotal Unrealized Losses(In millions)Fair ValueUnrealized LossesFair ValueUnrealized LossesTotal Fair ValueJune 30, 2019U.S. government and agency securities$1,491$(1)$39,158$(103)$40,649$(104)Foreign government bonds(8)(8)Mortgage- and asset-backed securities(1)(2)1,042(3)Corporate notes and bonds(3)(4)(7)Total$2,678$(5)$39,989$(117)$42,667$(122)PART II Item 8 Less than 12 Months12 Months or GreaterTotalUnrealizedLosses(In millions)Fair ValueUnrealizedLossesFair ValueUnrealizedLossesTotalFair ValueJune 30, 2018U.S. government and agency securities$82,352$(1,064)$4,459$(103)$86,811$(1,167)Foreign government bonds3,457(7)(3)3,470(10)Mortgage- and asset-backed securities2,072(9)(4)2,168(13)Corporate notes and bonds3,111(43)(13)3,412(56)Municipal securities(1)(1)Total$91,037$(1,124)$4,869$(123)$95,906$(1,247)Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions)Cost BasisEstimatedFair ValueJune 30, 2019Due in one year or less$53,200$53,124Due after one year through five years47,01647,783Due after five years through 10 years26,65827,824Due after 10 yearsTotal$127,747$129,652NOTE 5 DERIVATIVES We use derivative instruments to manage risks related to foreign currencies, equity prices, interest rates, and credit; to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible. Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment. Foreign Currency Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions. Option and forward contracts are used to hedge a portion of forecasted international revenue and are designated as cash flow hedging instruments. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Foreign currency risks related to certain non-U.S. dollar denominated securities are hedged using foreign exchange forward contracts that are designated as fair value hedging instruments. Certain options and forwards not designated as hedging instruments are also used to manage the variability in foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. Equity Securities held in our equity investments portfolio are subject to market price risk. Market price risk is managed relative to broad-based global and domestic equity indices using certain convertible preferred investments, options, futures, and swap contracts not designated as hedging instruments. In the past, to hedge our price risk, we also used and designated equity derivatives as hedging instruments, including puts, calls, swaps, and forwards. PART II Item 8Other Interest Rate Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain broad-based fixed-income indices using exchange-traded option and futures contracts, and over-the-counter swap and option contracts, none of which are designated as hedging instruments. In addition, we use To Be Announced forward purchase commitments of mortgage-backed assets to gain exposure to agency mortgage-backed securities. These meet the definition of a derivative instrument in cases where physical delivery of the assets is not taken at the earliest available delivery date. Credit Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default swap contracts, not designated as hedging instruments, to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification. We use credit default swaps as they are a low-cost method of managing exposure to individual credit risks or groups of credit risks. Credit-Risk-Related Contingent Features Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post collateral, similar to the standard convention related to over-the-counter derivatives. As of June 30, 2019, our long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no collateral was required to be posted. The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents:(In millions)June 30,June 30,Designated as Hedging InstrumentsForeign exchange contracts sold$6,034$11,101Not Designated as Hedging InstrumentsForeign exchange contracts purchased14,8899,425Foreign exchange contracts sold15,61413,374Equity contracts purchasedEquity contracts soldOther contracts purchased1,327Other contracts soldPART II Item 8Fair Values of Derivative Instruments The following table presents our derivative instruments: DerivativeDerivativeDerivativeDerivative(In millions)AssetsLiabilitiesAssetsLiabilitiesJune 30,June 30,Changes in Fair Value Recorded in Other Comprehensive IncomeDesignated as Hedging InstrumentsForeign exchange contracts$$$$Changes in Fair Value Recorded in Net IncomeDesignated as Hedging InstrumentsForeign exchange contracts(93)Not Designated as Hedging InstrumentsForeign exchange contracts(172)(197)Equity contracts(7)Other contracts(7)(3)Gross amounts of derivatives(272)(207)Gross amounts of derivatives offset in the balance sheet(113)(152)Cash collateral received(78) (235)Net amounts of derivatives$$(236) $$(289)Reported asShort-term investments$(13)$$$Other current assetsOther long-term assetsOther current liabilities(221)(288)Other long-term liabilities(15)(1)Total$$(236)$$(289)Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have elected to offset were $247 million and $272 million, respectively, as of June 30, 2019, and $533 million and $207 million, respectively, as of June 30, 2018. The following table presents the fair value of our derivatives instruments on a gross basis:(In millions)Level 1Level 2Level 3TotalJune 30, 2019Derivative assets$$$$Derivative liabilities(272)(272)June 30, 2018Derivative assetsDerivative liabilities(1)(206)(207)PART II Item 8Fair Value Hedge Gains (Losses) We recognized in other income (expense), net the following gains (losses) on contracts designated as fair value hedges and their related hedged items: (In millions)Year Ended June 30,Foreign Exchange ContractsDerivatives$$$Hedged items(386)Total amount of ineffectiveness$$$Equity ContractsDerivatives$$(324)$(74)Hedged itemsTotal amount of ineffectiveness$$$Amount of equity contracts excluded from effectiveness assessment$$$(80)Cash Flow Hedge Gains (Losses) We recognized the following gains (losses) on foreign exchange contracts designated as cash flow hedges: (In millions)Year Ended June 30,Effective PortionGains recognized in other comprehensive income (loss), net of tax of $1 , $11, and $4$$$Gains reclassified from accumulated other comprehensive income (loss) into revenueAmount Excluded from Effectiveness Assessment and Ineffective PortionLosses recognized in other income (expense), net(64)(255)(389)We do not have any net derivative gains included in AOCI as of June 30, 2019 that will be reclassified into earnings within the following 12 months. No significant amounts of gains (losses) were reclassified from AOCI into earnings as a result of forecasted transactions that failed to occur during fiscal year 2019. Non-designated Derivative Gains (Losses) We recognized in other income (expense), net the following gains (losses) on derivatives not designated as hedging instruments: (In millions)Year Ended June 30,Foreign exchange contracts$(97)$(33)$(117)Equity contracts(87)(114)Other contracts(17)(3)Total$(59)$(137)$(234)PART II Item 8NOTE 6 INVENTORIES The components of inventories were as follows: (In millions)June 30,Raw materials$$Work in processFinished goods1,6111,953Total$2,063$2,662NOTE 7 PROPERTY AND EQUIPMENT The components of property and equipment were as follows: (In millions)June 30,Land$1,540$1,254Buildings and improvements26,28820,604Leasehold improvements5,3164,735Computer equipment and software33,82327,633Furniture and equipment4,8404,457Total, at cost71,80758,683Accumulated depreciation(35,330)(29,223)Total, net$36,477$29,460During fiscal years 2019, 2018, and 2017, depreciation expense was $9.7 billion, $7.7 billion, and $6.1 billion, respectively. We have committed $4.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2019. NOTE 8 BUSINESS COMBINATIONS GitHub, Inc.On October 25, 2018, we acquired GitHub, Inc. (GitHub), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsofts developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash, cash equivalents, and short-term investments$Goodwill 5,497Intangible assets1,267Other assetsOther liabilities(217)Total$6,924The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$8 yearsTechnology-based 5 yearsMarketing-related10 yearsContract-based2 yearsTotal$1,2677 yearsTransactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period. LinkedIn CorporationOn December 8, 2016, we completed our acquisition of all issued and outstanding shares of LinkedIn Corporation (LinkedIn), the worlds largest professional network on the Internet, for a total purchase price of $27.0 billion. The purchase price consisted primarily of cash of $26.9 billion. The acquisition is expected to accelerate the growth of LinkedIn, Office 365, and Dynamics 365. The financial results of LinkedIn have been included in our consolidated financial statements since the date of the acquisition. PART II Item 8The allocation of the purchase price to goodwill was completed as of June 30, 2017. The major classes of assets and liabilities to which we allocated the purchase price were as follows: (In millions)Cash and cash equivalents$1,328Short-term investments2,110Other current assetsProperty and equipment1,529Intangible assets7,887Goodwill ( a ) 16,803Short-term debt (b) (1,323)Other current liabilities(1,117)Deferred income taxes(774)Other(131)Total purchase price$27,009(a) Goodwill was assigned to our Productivity and Business Processes segment. The goodwill was primarily attributed to increased synergies that are expected to be achieved from the integration of LinkedIn. None of the goodwill is expected to be deductible for income tax purposes. (b) Convertible senior notes issued by LinkedIn on November 12, 2014, substantially all of which were redeemed after our acquisition of LinkedIn. The remaining $18 million of notes are not redeemable and are included in long-term debt in our consolidated balance sheets. Refer to Note 11 Debt for further information. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions)AmountWeightedAverage LifeCustomer-related$3,6077 yearsMarketing-related (trade names)2,14820 yearsTechnology-based2,1093 yearsContract-based5 yearsFair value of intangible assets acquired$7,8879 yearsOur consolidated income statements include the following revenue and operating loss attributable to LinkedIn since the date of acquisition:(In millions)Year Ended June 30,Revenue$2,271Operating loss(924)Following are the supplemental consolidated financial results of Microsoft Corporation on an unaudited pro forma basis, as if the acquisition had been consummated on July 1, 2015: (In millions, except per share amounts)Year Ended June 30,Revenue$98,291$94,490Net income25,17919,128Diluted earnings per share3.212.38These pro forma results were based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had we been a combined company during the periods presented and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily amortization of intangible assets. Acquisition costs and other nonrecurring charges were immaterial and are included in the earliest period presented.PART II Item 8Other During fiscal year 2019, we completed 19 additional acquisitions for $1.6 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. NOTE 9 GOODWILL Changes in the carrying amount of goodwill were as follows: (In millions)June 30,AcquisitionsOtherJune 30,AcquisitionsOtherJune 30, 2019Productivity and Business Processes$23,739$$$23,823$$(60)$24,277Intelligent Cloud5,555(16)5,7035,605(a) (a) 11,351More Personal Computing5,828(65)6,157(48)6,398Total $35,122$$(69)$35,683$6,408$(65)$42,026(a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 Business Combinations for further information. The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as Other in the table above. Also included in Other are business dispositions and transfers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses. No instances of impairment were identified in our May 1, 2019, May 1, 2018, or May 1, 2017 tests. As of June 30, 2019 and 2018, accumulated goodwill impairment was $11.3 billion.NOTE 10 INTANGIBLE ASSETS The components of intangible assets, all of which are finite-lived, were as follows: (In millions)Gross Carrying AmountAccumulated AmortizationNet Carrying AmountGross Carrying AmountAccumulated AmortizationNet Carrying AmountJune 30,Technology-based$7,691$(5,771)$1,920$7,220$(5,018)$2,202Customer-related4,709(1,785)2,9244,031(1,205)2,826Marketing-related4,165(1,327)2,8384,006(1,071)2,935Contract-based(506)(589)Total$17,139(a) $(9,389)$7,750$15,936$(7,883)$8,053(a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 Business Combinations for further information. No material impairments of intangible assets were identified during fiscal years 2019, 2018, or 2017. We estimate that we have no significant residual value related to our intangible assets. PART II Item 8The components of intangible assets acquired during the periods presented were as follows: (In millions)AmountWeightedAverage LifeAmountWeightedAverage LifeYear Ended June 30,Technology-based$5 years$4 yearsMarketing-related10 years5 yearsContract-based3 years4 yearsCustomer-related8 years5 yearsTotal$1,7087 years$5 yearsIntangible assets amortization expense was $1.9 billion, $2.2 billion, and $1.7 billion for fiscal years 2019, 2018, and 2017, respectively. The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2019: (In millions)Year Ending June 30,$1,4881,2821,1871,053Thereafter2,003Total$7,750NOTE 11 DEBT Short-term DebtAs of June 30, 2019 and 2018, we had no commercial paper issued or outstanding. Effective August 31, 2018, we terminated our credit facilities, which served as back-up for our commercial paper program. Long-term DebtAs of June 30, 2019, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $72.2 billion and $78.9 billion, respectively. As of June 30, 2018, the total carrying value and estimated fair value of our long-term debt, including the current portion, were $76.2 billion and $77.5 billion, respectively. These estimated fair values are based on Level 2 inputs. PART II Item 8The components of our long-term debt, including the current portion, and the associated interest rates were as follows: (In millions, except interest rates)Face Value June 30,Face Value June 30,StatedInterestRateEffectiveInterestRateNotesNovember 3, 2018$$1,7501.300%1.396%December 6, 20181,2501.625%1.824%June 1, 20191,0004.200%4.379%August 8, 2019 2,5002,5001.100%1.203%November 1, 2019 0.500%0.500%February 6, 2020 1,5001,5001.850%1.952%February 12, 20201,5001,5001.850%1.935%October 1, 20201,0001,0003.000%3.137%November 3, 20202,2502,2502.000%2.093%February 8, 20214.000%4.082%August 8, 2021 2,7502,7501.550%1.642%December 6, 2021 (a) 1,9942,0442.125%2.233%February 6, 2022 1,7501,7502.400%2.520%February 12, 20221,5001,5002.375%2.466%November 3, 20221,0001,0002.650%2.717%November 15, 20222.125%2.239%May 1, 20231,0001,0002.375%2.465%August 8, 2023 1,5001,5002.000%2.101%December 15, 20231,5001,5003.625%3.726%February 6, 2024 2,2502,2502.875%3.041%February 12, 20252,2502,2502.700%2.772%November 3, 20253,0003,0003.125%3.176%August 8, 2026 4,0004,0002.400%2.464%February 6, 2027 4,0004,0003.300%3.383%December 6, 2028 (a) 1,9932,0443.125%3.218%May 2, 2033 (a) 2.625%2.690%February 12, 20351,5001,5003.500%3.604%November 3, 20351,0001,0004.200%4.260%August 8, 2036 2,2502,2503.450%3.510%February 6, 2037 2,5002,5004.100%4.152%June 1, 20395.200%5.240%October 1, 20401,0001,0004.500%4.567%February 8, 20411,0001,0005.300%5.361%November 15, 20423.500%3.571%May 1, 20433.750%3.829%December 15, 20434.875%4.918%February 12, 20451,7501,7503.750%3.800%November 3, 20453,0003,0004.450%4.492%August 8, 2046 4,5004,5003.700%3.743%February 6, 20473,0003,0004.250%4.287%February 12, 20552,2502,2504.000%4.063%November 3, 20551,0001,0004.750%4.782%August 8, 20562,2502,2503.950%4.033%February 6, 2057 2,0002,0004.500%4.528%Total$72,781$76,898(a) Euro-denominated debt securities. The notes in the table above are senior unsecured obligations and rank equally with our other senior unsecured debt outstanding. Interest on these notes is paid semi-annually, except for the euro-denominated debt securities on which interest is paid annually. Cash paid for interest on our debt for fiscal years 2019, 2018, and 2017 was $2.4 billion, $2.4 billion, and $1.6 billion, respectively. As of June 30, 2019 and 2018, the aggregate debt issuance costs and unamortized discount associated with our long-term debt, including the current portion, were $603 million and $658 million, respectively. PART II Item 8Maturities of our long-term debt for each of the next five years and thereafter are as follows: (In millions)Year Ending June 30,$5,5183,7507,9942,7505,250Thereafter47,519Total$72,781NOTE 12 INCOME TAXES Tax Cuts and Jobs ActOn December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. In fiscal year 2018, the TCJA required us to incur a transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. In addition, the TCJA subjected us to a tax on our GILTI effective July 1, 2018.Under GAAP, we can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into our measurement of deferred taxes. We elected the deferred method, under which we recorded the corresponding deferred tax assets and liabilities on our consolidated balance sheets.During fiscal year 2018, we recorded a net charge of $13.7 billion related to the enactment of the TCJA, due to the impact of the one-time transition tax on the deemed repatriation of deferred foreign income of $17.9 billion, offset in part by the impact of changes in the tax rate of $4.2 billion, primarily on deferred tax assets and liabilities. During the second quarter of fiscal year 2019, we recorded additional tax expense of $157 million, which related to completing our provisional accounting for GILTI deferred taxes pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118. In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax. PART II Item 8Provision for Income Taxes The components of the provision for income taxes were as follows: (In millions)Year Ended June 30,Current TaxesU.S. federal$4,718$19,764$2,739U.S. state and localForeign5,5314,3482,472Current taxes$10,911$25,046$5,241Deferred TaxesU.S. federal$(5,647)$(4,292)$(554)U.S. state and local(1,010)(458)Foreign(393)(544)Deferred taxes$(6,463)$(5,143)$(829)Provision for income taxes$4,448$19,903$4,412U.S. and foreign components of income before income taxes were as follows: (In millions)Year Ended June 30,U.S.$15,799$11,527$6,843Foreign 27,88924,94723,058Income before income taxes$43,688$36,474$29,901Effective Tax RateThe items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows: Year Ended June 30,Federal statutory rate21.0%28.1%35.0%Effect of:Foreign earnings taxed at lower rates(4.1)%(7.8)%(11.6)%Impact of the enactment of the TCJA0.4%37.7%0%Phone business losses0%0%(5.7)%Impact of intangible property transfers(5.9)%0%0%Foreign-derived intangible income deduction(1.4)%0%0%Research and development credit(1.1)%(1.3)%(0.9)%Excess tax benefits relating to stock-based compensation(2.2)%(2.5)%(2.1)%Interest, net1.0%1.2%1.4%Other reconciling items, net2.5%(0.8)%(1.3)%Effective rate10.2%54.6%14.8%PART II Item 8The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers , and earnings taxed at lower rates in foreign jurisdictions resulting from producing and dis tributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico . The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018 , offset in part by earnings taxed at lower rates in foreign jurisdictions. The decrease from the federal statutory rate in fiscal year 2017 is primarily due to earnings taxed at lower rates in foreign jurisdictions. Our foreign regional operating centers in Ireland, Singapore and Puerto Rico , which are taxed at rates lower than the U.S. rate, generated 82 %, 8 7 %, and 76 % of our foreign income b efore tax in fiscal years 2019, 2018, and 2017, respectively. Other reconciling items, net consists primarily of tax credits, GILTI, and U.S. state income taxes. In fiscal years 2019, 2018, and 2017, there were no individually significant other reconciling items. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The increase in our effective tax rate for fiscal year 2018 compared to fiscal year 2017 was primarily due to the net charge related to the enactment of the TCJA and the realization of tax benefits attributable to previous Phone business losses in fiscal year 2017. The components of the deferred income tax assets and liabilities were as follows: (In millions)June 30,Deferred Income Tax AssetsStock-based compensation expense$$Accruals, reserves, and other expenses2,2871,832Loss and credit carryforwards3,5183,369Depreciation and amortization7,046Leasing liabilities1,5941,427Unearned revenueOtherDeferred income tax assets15,6937,495Less valuation allowance(3,214)(3,186)Deferred income tax assets, net of valuation allowance$12,479$4,309Deferred Income Tax LiabilitiesUnrealized gain on investments and debt$(738)$Unearned revenue(30)(639)Depreciation and amortization(1,164)Leasing assets(1,510)(1,366)Deferred GILTI tax liabilities(2,607)(61)Other(291)(251)Deferred income tax liabilities$(5,176)$(3,481)Net deferred income tax assets (liabilities)$7,303$Reported AsOther long-term assets$7,536$1,369Long-term deferred income tax liabilities(233)(541)Net deferred income tax assets (liabilities)$7,303$Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered. PART II Item 8As of J une 30, 2019, we had federal, state and foreign net operating loss carryforwards of $ 978 million, $ 770 million, and $11. 6 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 20 20 through 203 9 , if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. Income taxes paid, net of refunds, were $8.4 billion, $5.5 billion, and $2.4 billion in fiscal years 2019, 2018, and 2017, respectively. Uncertain Tax PositionsGross unrecognized tax benefits related to uncertain tax positions as of June 30, 2019, 2018, and 2017, were $13.1 billion, $12.0 billion, and $11.7 billion, respectively, which were primarily included in long-term income taxes in our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2019, 2018, and 2017 by $12.0 billion, $11.3 billion, and $10.2 billion, respectively.As of June 30, 2019, 2018, and 2017, we had accrued interest expense related to uncertain tax positions of $3.4 billion, $3.0 billion, and $2.3 billion, respectively, net of income tax benefits. The provision for (benefit from) income taxes for fiscal years 2019, 2018, and 2017 included interest expense related to uncertain tax positions of $515 million, $688 million, and $399 million, respectively, net of income tax benefits.The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:(In millions)Year Ended June 30,Beginning unrecognized tax benefits$11,961$11,737$10,164Decreases related to settlements(316)(193)(4)Increases for tax positions related to the current year2,1061,4451,277Increases for tax positions related to prior yearsDecreases for tax positions related to prior years(1,113)(1,176)(49)Decreases due to lapsed statutes of limitations(3)(48)Ending unrecognized tax benefits$13,146$11,961$11,737We settled a portion of the Internal Revenue Service (IRS) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within the next 12 months.As of June 30, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact on our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2018, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.NOTE 13 RESTRUCTURING CHARGES In June 2017, management approved a sales and marketing restructuring plan. In fiscal year 2017, we recorded employee severance expenses of $306 million primarily related to this sales and marketing restructuring plan. The actions associated with this restructuring plan were completed as of June 30, 2018.PART II Item 8NOTE 14 UNEARNED REVENUE Unearned revenue by segment was as follows: (In millions)June 30,Productivity and Business Processes$16,831$14,864Intelligent Cloud16,98814,706More Personal Computing3,3873,150Total$37,206$32,720Changes in unearned revenue were as follows:(In millions)Year Ended June 30, 2019Balance, beginning of period$32,720Deferral of revenue69,493Recognition of unearned revenue(65,007)Balance, end of period$37,206Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized (contracted not recognized revenue), which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods. Contracted not recognized revenue was $91 billion as of June 30, 2019, of which we expect to recognize approximately 50% of the revenue over the next 12 months and the remainder thereafter. Many customers are committing to our products and services for longer contract terms, which is increasing the percentage of contracted revenue that will be recognized beyond the next 12 months.NOTE 15 LEASES We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year. The components of lease expense were as follows:(In millions)Year Ended June 30,Operating lease cost$1,707$1,585$1,412Finance lease cost:Amortization of right-of-use assets$$$Interest on lease liabilitiesTotal finance lease cost$$$PART II Item 8Supplemental cash flow information related to leases was as follows: (In millions)Year Ended June 30,Cash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$1,670$1,522$1,157Operating cash flows from finance leasesFinancing cash flows from finance leasesRight-of-use assets obtained in exchange for lease obligations:Operating leases2,3031,5711,270Finance leases2,5321,9331,773Supplemental balance sheet information related to leases was as follows:(In millions, except lease term and discount rate) June 30, Operating LeasesOperating lease right-of-use assets$7,379$6,686Other current liabilities$1,515$1,399Operating lease liabilities6,1885,568Total operating lease liabilities$7,703$6,967Finance LeasesProperty and equipment, at cost$7,041$4,543Accumulated depreciation(774)(404)Property and equipment, net$6,267$4,139Other current liabilities$$Other long-term liabilities6,2574,125Total finance lease liabilities$6,574$4,301Weighted Average Remaining Lease TermOperating leases7 years7 yearsFinance leases13 years13 yearsWeighted Average Discount RateOperating leases3.0%2.7%Finance leases4.6%5.2%Maturities of lease liabilities were as follows:(In millions)Year Ending June 30,Operating LeasesFinance Leases$1,678$1,4381,2351,036Thereafter2,4385,671Total lease payments8,6648,776Less imputed interest(961)(2,202)Total$7,703$6,574PART II Item 8As of June 30 , 201 9 , we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $ 2.3 billion and $ 6.1 billion, respectively. These operating and finance leases will commence between fiscal year 20 20 and fiscal year 202 2 with lease terms of 1 year to 15 years. NOTE 16 CONTINGENCIES Patent and Intellectual Property Claims There were 44 patent infringement cases pending against Microsoft as of June 30, 2019, none of which are material individually or in aggregate. Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence. Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigatio n In 2014, Microsoft was informed that Chinas State Agency for Market Regulation (SAMR) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to Chinas Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and discussions are expected to continue.Product-Related Litigation U.S. Cell Phone Litigation Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokias Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (FCC Guidelines) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants motion to exclude the plaintiffs general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs expert reports. A hearing is expected to be scheduled in the second half of calendar year 2019. PART II Item 8Employment-Related Lit igation Moussouris v. MicrosoftCurrent and former female Microsoft employees in certain engineering and information technology roles brought this class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an expert report showing no statistically significant disparity in pay and promotions between similarly situated men and women. In June 2018, the court denied the plaintiffs motion for class certification. Plaintiffs sought an interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit, which was granted in September 2018. Oral argument is scheduled for October 2019. Other Contingencies We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact on our consolidated financial statements, these matters are subject to inherent uncertainties and managements view of these matters may change in the future. As of June 30, 2019, we accrued aggregate legal liabilities of $386 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $1.0 billion in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on our consolidated financial statements for the period in which the effects become reasonably estimable. NOTE 17 STOCKHOLDERS EQUITY Shares Outstanding Shares of common stock outstanding were as follows: (In millions)Year Ended June 30,Balance, beginning of year7,6777,7087,808IssuedRepurchased(150)(99)(170)Balance, end of year7,6437,6777,708Share Repurchases On September 16, 2013, our Board of Directors approved a share repurchase program (2013 Share Repurchase Program) authorizing up to $40.0 billion in share repurchases. The 2013 Share Repurchase Program became effective on October 1, 2013, and was completed on December 22, 2016. On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to an additional $40.0 billion in share repurchases (2016 Share Repurchase Program). This share repurchase program commenced on December 22, 2016 following completion of the 2013 Share Repurchase Program, has no expiration date, and may be suspended or discontinued at any time without notice. As of June 30, 2019, $11.4 billion remained of the 2016 Share Repurchase Program.PART II Item 8We repurchased the following shares of common stock under the share repurchase prog rams: (In millions)SharesAmountSharesAmountSharesAmountYear Ended June 30,First Quarter$2,600$1,600$3,550Second Quarter6,1001,8003,533Third Quarter3,8993,1001,600Fourth Quarter4,2002,1001,600Total$16,799$8,600$10,283Shares repurchased in the first and second quarter of fiscal year 2017 were under the 2013 Share Repurchase Program. All other shares repurchased were under the 2016 Share Repurchase Program. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $2.7 billion, $2.1 billion, and $1.5 billion for fiscal years 2019, 2018, and 2017, respectively. All share repurchases were made using cash resources.Dividends Our Board of Directors declared the following dividends: Declaration DateRecord Date Payment Date DividendPer Share Amount Fiscal Year 2019 (In millions) September 18, 2018November 15, 2018December 13, 2018$0.46$3,544November 28, 2018February 21, 2019March 14, 20190.463,526March 11, 2019May 16, 2019June 13, 20190.463,521June 12, 2019August 15, 2019September 12, 20190.463,516Total$1.84$14,107Fiscal Year 2018September 19, 2017November 16, 2017December 14, 2017$0.42$3,238November 29, 2017February 15, 2018March 8, 20180.423,232March 12, 2018May 17, 2018June 14, 20180.423,226June 13, 2018August 16, 2018September 13, 20180.423,220Total$1.68$12,916The dividend declared on June 12, 2019 was included in other current liabilities as of June 30, 2019. PART II Item 8NOTE 1 8 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The following table summarizes the changes in accumulated other comprehensive income (loss) by component: (In millions)Year Ended June 30,DerivativesBalance, beginning of period$$$Unrealized gains, net of tax of $2 , $11, and $4Reclassification adjustments for gains included in revenue(341)(185)(555)Tax expense included in provision for income taxesAmounts reclassified from accumulated other comprehensive income (loss)(333)(179)(546)Net change related to derivatives, net of tax of $(6), $5, and $(5)(173)(218)Balance, end of period$$$InvestmentsBalance, beginning of period$(850)$1,825$2,941Unrealized gains (losses), net of tax of $616 , $(427), and $2672,331(1,146)Reclassification adjustments for (gains) losses included in other income (expense), net(2,309)(2,513)Tax expense (benefit) included in provision for income taxes(19)Amounts reclassified from accumulated other comprehensive income (loss)(1,571)(1,633)Net change related to investments, net of tax of $635 , $(1,165), and $(613)2,405(2,717)(1,116)Cumulative effect of accounting changes(67)Balance, end of period$1,488$(850)$1,825Translation Adjustments and OtherBalance, beginning of period$(1,510)$(1,332)$(1,499)Translation adjustments and other, net of tax effects of $(1) , $0, and $9(318)(178)Balance, end of period$(1,828)$(1,510)$(1,332)Accumulated other comprehensive income (loss), end of period$(340)$(2,187)$NOTE 19 EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2019, an aggregate of 327 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.Stock-based compensation expense and related income tax benefits were as follows: (In millions)Year Ended June 30,Stock-based compensation expense$4,652$3,940$3,266Income tax benefits related to stock-based compensation1,066PART II Item 8Stock Plans Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a four or five-year service period. Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a four-year service period. PSUs generally vest over a three-year performance period. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.Activity for All Stock Plans The fair value of stock awards was estimated on the date of grant using the following assumptions: Year Ended June 30,Dividends per share (quarterly amounts)$0.42 - $0.46$0.39 - $0.42$0.36 - $0.39Interest rates1.8% - 3.1%1.7% - 2.9%1.2% - 2.2%During fiscal year 2019, the following activity occurred under our stock plans: SharesWeightedAverageGrant-DateFair Value(In millions)Stock AwardsNonvested balance, beginning of year$57.85Granted (a) 107.02Vested(77) 57.08Forfeited(13) 69.35Nonvested balance, end of year$78.49(a) Includes 2 million, 3 million, and 2 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2019, 2018, and 2017, respectively. As of June 30, 2019, there was approximately $8.6 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of 3 years. The weighted average grant-date fair value of stock awards granted was $107.02, $75.88, and $55.64 for fiscal years 2019, 2018, and 2017, respectively. The fair value of stock awards vested was $8.7 billion, $6.6 billion, and $4.8 billion, for fiscal years 2019, 2018, and 2017, respectively. Employee Stock Purchase Plan We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented: (Shares in millions)Year Ended June 30,Shares purchasedAverage price per share$104.85$76.40$56.36As of June 30, 2019, 105 million shares of our common stock were reserved for future issuance through the ESPP. PART II Item 8Savings Plan We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $877 million, $807 million, and $734 million in fiscal years 2019, 2018, and 2017, respectively, and were expensed as contributed. NOTE 20 SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises: Office Commercial, including Office 365 subscriptions and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (CALs). Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions. Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business. This segment primarily comprises: Server products and cloud services, including Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs, GitHub, and Azure. Enterprise Services, including Premier Support Services and Microsoft Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across all devices. This segment primarily comprises: Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things (IoT); and MSN advertising. Devices, including Microsoft Surface, PC accessories, and other intelligent devices. Gaming, including Xbox hardware and Xbox software and services, comprising Xbox Live transactions, subscriptions, cloud services, and advertising (Xbox Live), video games, and third-party video game royalties. Search. PART II Item 8Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments, including restructuring expenses. Segment revenue and operating income were as follows during the periods presented: (In millions)Year Ended June 30,RevenueProductivity and Business Processes$41,160$35,865$29,870Intelligent Cloud38,98532,21927,407More Personal Computing45,69842,27639,294Total$125,843$110,360$96,571Operating Income (Loss)Productivity and Business Processes$16,219$12,924$11,389Intelligent Cloud13,92011,5249,127More Personal Computing12,82010,6108,815Corporate and Other(306)Total$42,959$35,058$29,025Corporate and Other operating loss comprised restructuring expenses. No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2019, 2018, or 2017. Revenue, classified by the major geographic areas in which our customers were located, was as follows:(In millions)Year Ended June 30,United States (a) $64,199$55,926$51,078Other countries61,64454,43445,493Total$125,843$110,360$96,571(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue. PART II Item 8Revenue from external customers, classified by significant product and service offerings, was as follows: (In millions)Year Ended June 30,Server products and cloud services$32,622$26,129$21,649Office products and cloud services31,76928,31625,573Windows20,39519,51818,593Gaming11,38610,3539,051Search advertising7,6287,0126,219LinkedIn6,7545,2592,271Enterprise Services6,1245,8465,542Devices6,0955,1345,062Other3,0702,7932,611Total$125,843$110,360$96,571Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $38.1 billion, $26.6 billion and $16.2 billion in fiscal years 2019, 2018, and 2017, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment; it is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss. Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows: (In millions)June 30,United States$55,252$44,501$42,730Ireland12,95812,84312,889Other countries25,42222,53819,898Total$93,632$79,882$75,517PART II Item 8NOTE 2 1 QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts)Quarter EndedSeptember 30December 31March 31June 30TotalFiscal Year 2019Revenue$29,084$32,471$30,571$33,717$125,843Gross margin19,17920,04820,40123,30582,933Operating income 9,95510,25810,34112,40542,959Net income (a) 8,8248,4208,80913,18739,240Basic earnings per share1.151.091.151.725.11Diluted earnings per share (b) 1.141.081.141.715.06Fiscal Year 2018Revenue $24,538$28,918$26,819$30,085$110,360Gross margin16,26017,85417,55020,34372,007Operating income 7,7088,6798,29210,37935,058Net income (loss) ( c ) 6,576(6,302) 7,4248,87316,571Basic earnings (loss) per share0.85(0.82) 0.961.152.15Diluted earnings (loss) per share ( d ) 0.84(0.82)0.951.142.13(a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019. ( c ) Reflects the net charge (benefit) related to the enactment of the TCJA of $13.8 billion for the second quarter, $(104) million for the fourth quarter, and $13.7 billion for fiscal year 2018. ( d ) Reflects the net charge (benefit) related to the enactment of the TCJA, wh ich decreased (increased) diluted EPS $1.78 for the second quarter, $(0.01) for the fourth quarter, and $1.75 for fiscal year 2018. PART II Item 8REPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the Company) as of June 30, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows, for each of the three years in the period ended June 30, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2019, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 1, 2019, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Companys financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the Companys Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. PART II Item 8Revenue Recognition Refer to Note 1 to the F inancial S tatements Critical Audit Matter DescriptionThe Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services. Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately. The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. Estimation of variable consideration when determining the amount of revenue to recognize (e.g., customer credits, incentives, and in certain instances, estimation of customer usage of products and services). Given these factors, the related audit effort in evaluating managements judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures related to the Companys revenue recognition for these customer agreements included the following: We tested the effectiveness of internal controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. We evaluated managements significant accounting policies related to these customer agreements for reasonableness. We selected a sample of customer agreements and performed the following procedures: Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement. Tested managements identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration. Assessed the terms in the customer agreement and evaluated the appropriateness of managements application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. We evaluated the reasonableness of managements estimate of stand-alone selling prices for products and services that are not sold separately. We tested the mathematical accuracy of managements calculations of revenue and the associated timing of revenue recognized in the financial statements. PART II Item 8Income Taxes Uncertain Tax Positions Refer to Note 1 2 to the F inancial S tatements Critical Audit Matter Description The Companys long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (IRS). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Companys financial statements. Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating managements estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.How the Critical Audit Matter Was Addressed in the AuditOur principal audit procedures to evaluate managements estimates of uncertain tax positions related to unresolved transfer pricing issues included the following: We evaluated the appropriateness and consistency of managements methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls. We read and evaluated managements documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions. We tested the reasonableness of managements judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions. We evaluated the reasonableness of managements estimates by considering how tax law, including statutes, regulations and case law, impacted managements judgments. /s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019We have served as the Companys auditor since 1983.PART II Item 9, 9A"," ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected. Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Companys internal control over financial reporting was effective as of June 30, 2019. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte Touche LLP has audited our internal control over financial reporting as of June 30, 2019; their report is included in Item 9A. PART II Item 9AREPORT OF INDEPENDENT REGIST ERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the ""Company"") as of June 30, 2019, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2019, based on the criteria established in Internal Control Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the financial statements) as of and for the year ended June 30, 2019, of the Company and our report dated August 1, 2019, expressed an unqualified opinion on those financial statements.Basis for OpinionThe Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ D ELOITTE T OUCHE LLP Seattle, Washington August 1, 2019 PART II, III Item 9B, 10, 11, 12, 13, 14" diff --git a/datasets/raw/pepsico.csv b/datasets/raw/pepsico.csv new file mode 100644 index 0000000..ca93670 --- /dev/null +++ b/datasets/raw/pepsico.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,pep-,20211225," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global beverage and convenient food company with a complementary portfolio of brands, including Lays, Doritos, Cheetos, Gatorade, Pepsi-Cola, Mountain Dew, Quaker and SodaStream. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into seven reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded convenient food businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our branded convenient food businesses, such as cereal, rice, pasta and other branded food, in the United States and Canada; 3) PepsiCo Beverages North America (PBNA), which includes our beverage businesses in the United States and Canada; 4) Latin America (LatAm), which includes all of our beverage and convenient food businesses in Latin America; 5) Europe, which includes all of our beverage and convenient food businesses in Europe; Table of Contents 6) Africa, Middle East and South Asia (AMESA), which includes all of our beverage and convenient food businesses in Africa, the Middle East and South Asia; and 7) Asia Pacific, Australia and New Zealand and China Region (APAC), which includes all of our beverage and convenient food businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded convenient foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells branded convenient foods, which include cereals, rice, pasta and other branded products. QFNAs products include Capn Crunch cereal, Life cereal, Pearl Milling Company syrups and mixes, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker Simply Granola and Rice-A-Roni side dishes. QFNAs branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Gatorade Zero, Mountain Dew, Pepsi and Propel. PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. and Ocean Spray Cranberries, Inc. (Ocean Spray). In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture (Juice Transaction) that will operate across North America and Europe. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of convenient food brands including Cheetos, Doritos, Emperador, Lays, Mabel, Marias Gamesa, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded convenient foods. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Table of Contents Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of convenient food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Lubimy Sad, Mirinda, Pepsi and Pepsi Max. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, as part of its beverage business, manufactures and distributes SodaStream sparkling water makers and related products. Further, Europe makes, markets, distributes and sells a number of dairy products including Agusha, Chudo and Domik v Derevne. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. See Note 13 to our consolidated financial statements for further information. Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of convenient food brands including Chipsy, Doritos, Kurkure, Lays, Sasko, Spekko and White Star, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of convenient food brands including BaiCaoWei, Cheetos, Doritos, Lays and Smiths, as well as many Quaker-branded convenient foods, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi and Sting. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Table of Contents Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages and convenient foods directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and distribution centers, both company and third-party operated, to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages and convenient foods to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage and convenient food products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for convenient foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. During 2021, we experienced higher than anticipated commodity, packaging and other input costs and, in some instances, limited shortages due to global inflation, supply chain disruptions, labor shortages, increased demand and other regulatory and macroeconomic factors associated with the novel coronavirus (COVID-19) pandemic, which has continued into fiscal 2022. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Table of Contents We also maintain voluntary supply chain finance agreements with several participating global financial institutions, pursuant to which our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to such global financial institutions. These agreements did not have a material impact on our business or financial results. See Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewtr, BaiCaoWei, Bare, Bokomo, Bolt24, bubly, Capn Crunch, Ceres, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Driftwell, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Gatorade Zero, Gatorlyte, Grandmas, H2oh!, Health Warrior, Imunele, J7, Kas, Kurkure, Lays, Life, Lifewtr, Liquifruit, Lubimy, Mabel, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Moirs, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Game Fuel, Mountain Dew Kickstart, Mountain Dew Zero Sugar, MTN Dew Energy, Mug, Munchies, Muscle Milk, Near East, Off the Eaten Path, Paso de los Toros, Pasta Roni, Pearl Milling Company, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, PopCorners, Pronutro, Propel, Quaker, Quaker Chewy, Quaker Simply Granola, Rice-A-Roni, Rockstar Energy, Rold Gold, Ruffles, Sabritas, Safari, Sakata, Saladitas, San Carlos, Sandora, Santitas, Sasko, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Spekko, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, V Water, Vesely Molochnik, Walkers, Weetbix, White Star, Ya and Yachak. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Ocean Spray. We also distribute Bang Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. In addition, in the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. In 2022, we will also begin to distribute Hard MTN Dew, an alcoholic beverage manufactured and owned by the Boston Beer Company. We have licensed the use of the Hard MTN Dew trademark to the Boston Beer Company, which has appointed us as their distributor for this product. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as convenient food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. Our beverage and convenient food sales are generally highest in the third quarter due to seasonal and holiday-related patterns and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Table of Contents Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the continued growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the international expansion of hard discounters, and the current economic environment, including in light of the COVID-19 pandemic, continue to increase the importance of major customers. In 2021, sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 13% of our consolidated net revenue, with sales reported across all of our divisions, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. The loss of this customer would have a material adverse effect on our FLNA, QFNA and PBNA divisions. Our Competition Our beverage and convenient food products are in highly competitive categories and markets and compete against products of international beverage and convenient food companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage and convenient food competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Hormel Foods Corporation, Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Utz Brands, Inc. Many of our convenient food products hold significant leadership positions in the convenient food industry in the United States and worldwide. In 2021, we and The Coca-Cola Company represented approximately 22% and 19%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Table of Contents Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage and convenient food products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and sustainability and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting the needs of our customers and consumers and accelerating growth. These activities principally involve: innovations focused on creating consumer preferred products to grow and transform our portfolio through development of new technologies, ingredients, flavors and substrates; development and improvement of our manufacturing processes including reductions in cost and environmental footprint; implementing product improvements to our global portfolio that reduce added sugars, sodium or saturated fat; offering more products with functional ingredients and positive nutrition including whole grains, fruit, vegetables, dairy, protein, fiber, micronutrients and hydration; development of packaging technology and new package designs, including reducing the amount of plastic in our packaging and developing recyclable, compostable, biodegradable or otherwise sustainable packaging; development of marketing, merchandising and dispensing equipment; further expanding our beyond the bottle portfolio including innovation for our SodaStream business; investments in technology and digitalization, including artificial intelligence and data analytics to enhance our consumer insights and research; continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and efforts focused on reducing our impact on the environment, including reducing water use in our operations and our agricultural practices and reducing our climate impact in our operations throughout our value chain. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, South Africa, the United Kingdom and the United States, and leverage consumer insights, food science and engineering to meet our strategy to continually innovate our portfolio of beverages and convenient foods. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. Table of Contents The U.S. laws and regulations that we are subject to include, but are not limited to: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act and various state laws and regulations governing workplace health and safety; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; various state and federal laws pertaining to sale and distribution of alcohol beverages; data privacy and personal data protection laws and regulations, including the California Consumer Privacy Act of 2018 (as modified by the California Privacy Rights Act); customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from Table of Contents deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some types of single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over environmental, social and governance matters, including climate change, is expected to continue to result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, to limit or impose additional costs on commercial water use due to local water scarcity concerns or to expand mandatory reporting of certain environmental, social and governance metrics. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations and to achieve our sustainability goals. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and expenditures necessary to comply with such requirements or to achieve our sustainability goals, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Human Capital PepsiCo believes that human capital management, including attracting, developing and retaining a high quality workforce, is critical to our long-term success. Our Board of Directors (Board) and its Committees provide oversight on a broad range of human capital management topics, including corporate culture, diversity, equity and inclusion, pay equity, health and safety, training and development and compensation and benefits. We employed approximately 309,000 people worldwide as of December 25, 2021, including approximately 129,000 people within the United States. We are party to numerous collective bargaining agreements and believe that relations with our employees are generally good. Protecting the safety, health, and well-being of our associates around the world is PepsiCos top priority. We strive to achieve an injury-free work environment. We also continue to invest in emerging technologies to protect our employees from injuries, including leveraging fleet telematics and distracted driving technology, resulting in reductions in road traffic accidents, and deploying wearable ergonomic risk reduction devices. In addition, throughout the COVID-19 pandemic, we have remained focused on the health and safety of our associates, especially our frontline associates who continue to make, move and sell our products during this critical time, including by continuing to implement various safety protocols in our facilities, providing personal protective equipment and enabling testing. Table of Contents We believe that our culture of diversity, equity and inclusion is a competitive advantage that fuels innovation, enhances our ability to attract and retain talent and strengthens our reputation. We continually strive to improve the attraction, retention, and advancement of diverse associates to ensure we sustain a high-caliber pipeline of talent that also represents the communities we serve. As of December 25, 2021, our global workforce was approximately 27% female, while management roles were approximately 43% female. As of December 25, 2021, approximately 45% of our U.S. workforce was comprised of racially/ethnically diverse individuals, of which approximately 31% of our U.S. associates in managerial roles were racially/ethnically diverse individuals. Direct reports of our Chief Executive Officer include 7 executives globally who are racially/ethnically diverse and/or female. We are also committed to the continued growth and development of our associates. PepsiCo supports and develops its associates through a variety of global training and development programs that build and strengthen employees' leadership and professional skills, including career development plans, mentoring programs and in-house learning opportunities, such as PEP U Degreed, our internal global online learning resource. In 2021, PepsiCo employees completed over 1,000,000 hours of training. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. The following risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business or financial performance, which in turn can affect the price of our publicly traded securities. These are not the only risks we face. There may be other risks we are not currently aware of or that we currently deem not to be material but that may become material in the future. Business Risks The impact of COVID-19 continues to create considerable uncertainty for our business. Our global operations continue to expose us to risks associated with the COVID-19 pandemic. Numerous measures have been implemented around the world to try to reduce the spread of the virus and these measures have impacted and continue to impact us, our business partners and consumers. Table of Contents We have seen and could continue to see changes in consumer demand as a result of COVID-19, including the inability of consumers to purchase our products due to illness, quarantine or other restrictions, store closures, or financial hardship. We also have seen and could continue to see shifts in product and channel prefe rences, including an increase in demand in the e-commerce channel, which has impacted and could continue to impact our sales and profitability. Reduced demand for our products or changes in consumer purchasing patterns, as well as continued economic uncertainty, can adversely affect our customers financial condition, which can result in bankruptcy filings and/or an inability to pay for our products. In addition, we may also continue to experience business disruptions as a result of COVID-19, resulting from temporary closures of our facilities or facilities of our business partners or the inability of a significant portion of our or our business partners workforce to work because of illness, absenteeism, quarantine, vaccine mandates, or travel or other governmental restrictions. In addition, we and our business partners may also continue to see adverse impacts to our supply chain as a result of COVID-19 through raw material, packaging or other supply shortages, labor shortages or reduced availability of air or other commercial transport, port congestion and closures or border restrictions, any of which can impact our business. Any sustained interruption in our or our business partners operations, distribution network or supply chain or any significant continuous shortage of raw materials, packaging or other supplies can negatively impact our business. We have also incurred, and could continue to incur, increased employee and operating costs as a result of COVID-19, such as costs related to expanded benefits and frontline incentives, the provision of personal protective equipment and increased sanitation, allowances for credit losses, upfront payment reserves and inventory write-offs, and cost inflation in commodities, packaging, transportation and other input costs, which have negatively impacted and may continue to negatively impact our profitability. In addition, the increase in certain of our employees working remotely has resulted in increased demand on our information technology infrastructure, which can be subject to failure, disruption or unavailability, and increased vulnerability to cyberattacks and other cyber incidents. Also, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. The impact of COVID-19 has heightened, or in some cases manifested, certain of the other risks discussed below. The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the emergence and spread of new variants of the virus, including the omicron and delta variants, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus and evolving strains or variants of the virus, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in the future, in response to the pandemic, and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Reduction in future demand for our products would adversely affect our business. Demand for our products depends in part on our ability to innovate and anticipate and effectively respond to shifts in consumer trends and preferences, including the types of products our consumers want and how they browse for, purchase and consume them. Consumer preferences continuously evolve due to a variety of factors, including: changes in consumer demographics, consumption patterns and channel preferences (including continued increases in the e-commerce and online-to-offline channels); pricing; product quality; concerns or perceptions regarding packaging and its environmental impact (such as single-use and other plastic packaging); and concerns or perceptions regarding the nutrition profile and health effects of, or location of origin of, ingredients or substances in our products or packaging, including due to the results of third-party studies (whether or not scientifically valid). Concerns with any of the foregoing could lead consumers to reduce or publicly boycott the purchase or consumption of our products. Consumer Table of Contents preferences are also influenced by perception of our brand image or the brand images of our products, the success of our advertising and marketing campaigns, our ability to engage with our consumers in the manner they prefer, including through the use of digital media or assets, and the perception of our use, and the use of social media. These and other factors have reduced in the past and could continue to reduce consumers willingness to purchase certain of our products. Any inability on our part to anticipate or react to changes in consumer preferences and trends, or make the right strategic investments to do so, including investments in data analytics to understand consumer trends, can lead to reduced demand for our products, lead to inventory write-offs or erode our competitive and financial position, thereby adversely affecting our business. In addition, our business operations, including our supply chain, are subject to disruption by natural disasters or other events beyond our control that could negatively impact product availability and decrease demand for our products if our crisis management plans do not effectively resolve these issues. Damage to our reputation or brand image can adversely affect our business. Maintaining a positive reputation globally is critical to selling our products. Our reputation or brand image has in the past been, and could in the future be, adversely impacted by a variety of factors, including: any failure by us or our business partners to maintain high ethical, business and environmental, social and governance practices, including with respect to human rights, child labor laws, diversity, equity and inclusion, workplace conditions and employee health and safety; any failure to achieve our environmental, social and governance goals, including with respect to the nutrition profile of our products, diversity, equity and inclusion initiatives, packaging, water use and our impact on the environment; any failure to address health concerns about our products, products we distribute, or particular ingredients in our products, including concerns regarding whether certain of our products contribute to obesity or an increase in public health costs; our research and development efforts; any product quality or safety issues, including the recall of any of our products; any failure to comply with laws and regulations; consumer perception of our advertising campaigns, sponsorship arrangements, marketing programs, use of social media and our response to political and social issues or catastrophic events; or any failure to effectively respond to negative or inaccurate comments about us on social media or otherwise regarding any of the foregoing. Damage to our reputation or brand image has in the past and could in the future decrease demand for our products, thereby adversely affecting our business. Product recalls or other issues or concerns with respect to product quality and safety can adversely affect our business. We have and could in the future recall products due to product quality or safety issues, including actual or alleged mislabeling, misbranding, spoilage, undeclared allergens, adulteration or contamination. Product recalls have in the past and could in the future adversely affect our business by resulting in losses due to their cost, the destruction of product inventory or lost sales due to any unavailability of the product for a period of time. In addition, product quality or safety issues, whether as a result of failure to comply with food safety laws or otherwise, have in the past and could in the future also reduce consumer confidence and demand for our products, cause production and delivery disruptions, and result in increased costs (including payment of fines and/or judgments) and damage our reputation, particularly as we expand into new categories, such as nuts and meat convenient foods globally and the distribution of alcoholic beverages in the United States, all of which can adversely affect our business. Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries or civil or criminal proceedings, all of which may result in fines, penalties, damages or criminal liability. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Table of Contents Any inability to compete effectively can adversely affect our business. Our products compete against products of international beverage and convenient food companies that, like us, operate in multiple geographies, as well as regional, local and private label and economy brand manufacturers and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Our products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends. Our business can be adversely affected if we are unable to effectively promote or develop our existing products or introduce and effectively market new products, if we are unable to effectively adopt new technologies, including artificial intelligence and data analytics to develop new commercial insights and improve operating efficiencies, if we are unable to continuously strengthen and evolve our capabilities in digital marketing, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to supply disruptions, pricing pressure (including as a result of commodity inflation) or otherwise compete effectively, and we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures. Failure to attract, develop and maintain a highly skilled and diverse workforce can have an adverse effect on our business. Our business requires that we attract, develop and maintain a highly skilled and diverse workforce. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to attract, retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover, sustained labor shortage or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to attract, develop and maintain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. In addition, failure to attract, retain and develop associates from underrepresented communities can damage our business results and our reputation. Any of the foregoing can adversely affect our business. Water scarcity can adversely affect our business. We and our business partners use water in the manufacturing and sourcing of our products. Water is also essential to the production of the raw materials needed in our manufacturing process. Lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress, including due to the effects of climate change, may lead to: supply chain disruption; adverse effects on our operations or the operations of our business partners; higher compliance costs; capital expenditures (including investments in the development of technologies to enhance water efficiency and reduce consumption); higher production costs, including less favorable pricing for water; the interruption or cessation of operations at, or relocation of, our facilities or the facilities of our business partners; failure to achieve our goals relating to water use; perception of our failure to act responsibly with respect to water use or to effectively respond to legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business. Table of Contents Changes in the retail landscape or in sales to any key customer can adversely affect our business. The retail landscape continues to evolve, including continued growth in e-commerce channels and hard discounters. Our business will be adversely affected if we are unable to maintain and develop successful relationships with e-commerce retailers and hard discounters, while also maintaining relationships with our key customers operating in traditional retail channels (many of whom are also focused on increasing their e-commerce sales). Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers or we fail to find ways to create increasingly better digital tools and capabilities for our retail customers to enable them to grow their businesses. In addition, our business can be adversely affected if we are unable to profitably expand our own direct-to-consumer e-commerce capabilities. The retail industry is also impacted by increased consolidation of ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, impacting our ability to compete in these areas. Consolidation also adversely impacts our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, we must maintain mutually beneficial relationships with our key customers, including Walmart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business. Disruption of our manufacturing operations or supply chain, including increased commodity, packaging, transportation, labor and other input costs, can adversely affect our business. We have experienced and could continue to experience disruption in our manufacturing operations and supply chain. Many of the raw materials and supplies used in the production of our products are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions. Some raw materials and supplies, including packaging materials, are available only from a limited number of suppliers or from a sole supplier or are in short supply when seasonal demand is at its peak. There can be no assurance that we will be able to maintain favorable arrangements and relationships with suppliers or that our contingency plans will be effective to prevent disruptions that may arise from shortages or discontinuation of any raw materials and other supplies that we use in the manufacture, production and distribution of our products. Any sustained or significant disruption to the manufacturing or sourcing of products or materials could increase our costs and interrupt product supply, which can adversely impact our business. The raw materials and other supplies, including agricultural commodities, fuel and packaging materials, such as recycled PET, transportation, labor and other supply chain inputs that we use for the manufacturing, production and distribution of our products are subject to price volatility and fluctuations in availability caused by many factors, including changes in supply and demand, supplier capacity constraints, inflation, weather conditions (including potential effects of climate change), fire, natural disasters, disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks (including COVID-19), labor shortages (including the lack of availability of truck drivers or as a result of COVID-19), strikes or work stoppages, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), port congestions or delays, transport capacity constraints, cybersecurity incidents or other disruptions, loss or impairment of key manufacturing sites, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Many of our raw materials and supplies are purchased in the open market and the prices we pay for such items are subject to fluctuation. We experienced higher than anticipated commodity, packaging and transportation costs during 2021, which may continue. When input prices increase unexpectedly or significantly, we may Table of Contents be unwilling or unable to increase our product prices or unable to effectively hedge against price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. Political and social conditions can adversely affect our business. Political and social conditions in the markets in which our products are sold have been and could continue to be difficult to predict, resulting in adverse effects on our business. The results of elections, referendums or other political conditions (including government shutdowns or hostilities between countries) in these markets have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or result in uncertainty as to how such laws, regulations, programs or policies may change, including with respect to tariffs, sanctions, environmental and climate change regulations, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products, any of which can adversely affect our business. In addition, political and social conditions in certain cities throughout the U.S. as well as globally have resulted in demonstrations and protests, including in connection with political elections and civil rights and liberties. Our operations, including the distribution of our products and the ingredients or other raw materials used in the production of our products, may be disrupted if such events persist for a prolonged period of time, including due to actions taken by governmental authorities in affected cities and regions, which can adversely affect our business. Our business can be adversely affected if we are unable to grow in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, China, South Africa, Brazil and India. There can be no assurance that our products will be accepted or be successful in any particular developing or emerging market, due to competition, price, cultural differences, consumer preferences, method of distribution or otherwise. Our business in these markets has been and could continue in the future to be impacted by economic, political and social conditions; acts of war, terrorist acts, and civil unrest, including demonstrations and protests; competition; tariffs, sanctions or other regulations restricting contact with certain countries in these markets; foreign ownership restrictions; nationalization of our assets or the assets of our business partners; government-mandated closure, or threatened closure, of our operations or the operations of our business partners; restrictions on the import or export of our products or ingredients or substances used in our products; highly inflationary economies; devaluation or fluctuation or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with laws and regulations. Our business can be adversely affected if we are unable to expand our business in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets. Changes in economic conditions can adversely impact our business. Many of the jurisdictions in which our products are sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns, Table of Contents which have and could continue to result in adverse changes in interest rates, tax laws or tax rates; inflation; volatile commodity markets; labor shortages; highly inflationary economies, devaluation, fluctuation or demonetization of currency; contraction in the availability of credit; austerity or stimulus measures; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are sold; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our business partners, including financial institutions with whom we do business, and any negative impact on any of the foregoing may also have an adverse impact on our business. Future cyber incidents and other disruptions to our information systems can adversely affect our business. We depend on information systems and technology, including public websites and cloud-based services, for many activities important to our business, including communications within our company, interfacing with customers and consumers; ordering and managing inventory; managing and operating our facilities; protecting confidential information, including personal data we collect; maintaining accurate financial records and complying with regulatory, financial reporting, legal and tax requirements. Our business has in the past and could in the future be negatively affected by system shutdowns, degraded systems performance, systems disruptions or security incidents. These disruptions or incidents may be caused by cyberattacks and other cyber incidents, network or power outages, software, equipment or telecommunications failures, the unintentional or malicious actions of employees or contractors, natural disasters, fires or other catastrophic events. Cyberattacks and other cyber incidents are occurring more frequently, the techniques used to gain access to information technology systems and data, disable or degrade service or sabotage systems are constantly evolving and becoming more sophisticated in nature and are being carried out by groups and individuals with a wide range of expertise and motives. Cyberattacks and cyber incidents may be difficult to detect for periods of time and take many forms including cyber extortion, denial of service, social engineering, introduction of viruses or malware (such as ransomware), exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromise. As with other global companies, we are regularly subject to cyberattacks and other cyber incidents, including the types of attacks and incidents described above. If we do not allocate and effectively manage the resources necessary to continue building and maintaining our information technology infrastructure, or if we fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, our business has been and can continue to be adversely affected, which has resulted in and can continue to result in some or all of the following: transaction errors, processing inefficiencies, inability to access our data or systems, lost revenues or other costs resulting from disruptions or shutdowns of offices, plants, warehouses, distribution centers or other facilities, intellectual property or other data loss, litigation, claims, legal or regulatory proceedings, inquiries or investigations, fines or penalties, remediation costs, damage to our reputation or a negative impact on employee morale and the loss of current or potential customers. Similar risks exist with respect to third-party providers, including suppliers, software and cloud-based service providers, that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and the systems managed, hosted, provided and/or used by such third parties and their vendors. For example, malicious actors have employed and could continue to employ the information technology supply chain to introduce malware through software updates or compromised supplier accounts or hardware. The need to coordinate with various third-party service providers, including with respect to timely notification and access to personnel and information concerning an incident, may complicate our efforts to resolve issues that arise. As a result, we are subject to the risk that Table of Contents the activities associated with our third-party service providers can adversely affect our business even if the attack or breach does not directly impact our systems or information. Although the cyber incidents and other systems disruptions that we have experienced to date have not had a material effect on our business, such incidents or disruptions could have a material adverse effect on us in the future. While we devote significant resources to network security, disaster recovery, employee training and other measures to secure our information technology systems and prevent unauthorized access to or loss of data, there are no guarantees that they will be adequate to safeguard against all cyber incidents, systems disruptions, system compromises or misuses of data. In addition, while we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents and information systems failures, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Failure to successfully complete or manage strategic transactions can adversely affect our business. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, distribution agreements, divestitures, refranchisings and other strategic transactions. The success of these transactions, including the recent completion of the Juice Transaction, is dependent upon, among other things, our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; and receipt of necessary consents, clearances and approvals. Risks associated with strategic transactions include integrating manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company or difficulties separating such personnel, activities and systems in connection with divestitures; operating through new business models or in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming controls (including internal control over financial reporting and disclosure controls and procedures) and policies (including with respect to environmental compliance, health and safety compliance and compliance with anti-bribery laws); retaining existing customers and consumers and attracting new customers and consumers; managing tax costs or inefficiencies; maintaining good relations with divested or refranchised businesses in our supply or sales chain; inability to offset loss of revenue associated with divested brands or businesses; managing the impact of business decisions or other actions or omissions of our joint venture partners that may have different interests than we do; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. Strategic transactions that are not successfully completed or managed effectively, or our failure to effectively manage the risks associated with such transactions, have in the past and could continue to result in adverse effects on our business. Our reliance on third-party service providers and enterprise-wide systems can have an adverse effect on our business. We rely on third-party service providers, including cloud data service providers, for certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. Failure by these third parties to meet their contractual, regulatory and other obligations to us, or our failure to adequately monitor their performance, has in the past and could continue to result in our inability to achieve the expected cost savings or efficiencies and result in additional costs to correct errors made by such service providers. Depending on the function involved, such errors can also lead to business disruption, systems performance degradation, processing inefficiencies or other systems disruptions, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation, claims, legal or regulatory proceedings, inquiries or investigations, fines or penalties, remediation costs, Table of Contents damage to our reputation or have a negative impact on employee morale, all of which can adversely affect our business. In addition, we continue on our multi-year phased business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions and have begun to roll out these systems in certain countries and divisions. We have experienced and could continue to experience systems outages and operating inefficiencies following these planned implementations. In addition, if we do not continue to allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, our business could be adversely affected. Climate change or measures to address climate change can negatively affect our business or damage our reputation. Climate change may have a negative effect on agricultural productivity which may result in decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as potatoes, sugar cane, corn, wheat, rice, oats, oranges and other fruits (and fruit-derived oils). In addition, climate change may also increase the frequency or severity of natural disasters and other extreme weather conditions (including rising temperatures and drought), which could pose physical risks to our facilities, impair our production capabilities, disrupt our supply chain or impact demand for our products. Also, there is an increased focus in many jurisdictions in which our products are made, manufactured, distributed or sold regarding environmental policies relating to climate change, regulating greenhouse gas emissions, energy policies and sustainability, including single-use plastics. This increased focus may result in new or increased legal and regulatory requirements, such as potential carbon pricing programs, which could result in significant increased costs and require additional investments in facilities and equipment. As a result, the effects of climate change can negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception of a failure to act responsibly with respect to the environment or to effectively respond to regulatory requirements concerning climate change can lead to adverse publicity, which could adversely affect demand for our products or damage our reputation. Any of the foregoing can adversely affect our business. Strikes or work stoppages can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions have occurred and may occur in the future if we are unable to renew, or enter into new, collective bargaining agreements on satisfactory terms and can impair manufacturing and distribution of our products, lead to a loss of sales, increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy, all of which can adversely affect our business. Financial Risks Failure to realize benefits from our productivity initiatives can adversely affect our financial performance. Our future growth depends, in part, on our ability to continue to reduce costs and improve efficiencies, including our multi-year phased implementation of shared business service organizational models. We continue to identify and implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently. Some of these measures result in unintended consequences, such as business disruptions, distraction of management and employees, reduced morale and productivity, unexpected Table of Contents employee attrition, an inability to attract or retain key personnel and negative publicity. If we are unable to successfully implement our productivity initiatives as planned or do not achieve expected savings as a result of these initiatives, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our financial performance. A deterioration in our estimates and underlying assumptions regarding the future performance of our business can result in an impairment charge that can adversely affect our results of operations. We conduct impairment tests on our goodwill and other indefinite-lived intangible assets annually or more frequently if circumstances indicate that impairment may have occurred. In addition, amortizable intangible assets, property, plant and equipment and other long-lived assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. A deterioration in our underlying assumptions regarding the impact of competitive operating conditions, macroeconomic conditions or other factors used to estimate the future performance of any of our reporting units or assets, including any deterioration in the weighted-average cost of capital based on market data available at the time, can result in an impairment charge, which can adversely affect our results of operations. Fluctuations in exchange rates impact our financial performance. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Given our global operations, we also pay for the ingredients, raw materials and commodities used in our business in numerous currencies. Fluctuations in exchange rates, including as a result of inflation, central bank monetary policies, currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our financial performance. Our borrowing costs and access to capital and credit markets can be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us and their ratings are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the state of the economy and our industry. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. Any downgrade or announcement that we are under review for a potential downgrade of our credit ratings, especially any downgrade to below investment grade, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, result in a reduction in our liquidity, or impair our ability to access the commercial paper market with the same flexibility that we have experienced historically (and therefore require us to rely more heavily on more expensive types of debt financing), all of which can adversely affect our financial performance. Legal, Tax and Regulatory Risks Taxes aimed at our products can adversely affect our business or financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of certain of our products, particularly our beverages, as a result of the ingredients or substances contained in our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain amount of added sugar (or other sweetener), some apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and others apply a flat tax rate on beverages containing any amount of added sugar (or other sweetener). For example, certain provinces in Canada enacted a flat tax on all sugar-sweetened beverages, effective Table of Contents September 1, 2022, at a rate of 0.20 Canadian dollars (0.16 U.S. dollars) per liter . These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain of our products, reduce overall consumption of our products or lead to negative publicity, resulting in an adverse effect on our business and financial performance. Limitations on the marketing or sale of our products can adversely affect our business and financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, limitations on the marketing or sale of our products as a result of ingredients or substances in our products. These limitations require that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. For example, Argentina and Colombia enacted warning labeling requirements in 2021 to indicate whether a particular pre-packaged food or beverage product is considered to be high in sugar, sodium or saturated fat. Certain jurisdictions have imposed or are considering imposing color-coded labeling requirements where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat, in products. The imposition or proposed imposition of additional limitations on the marketing or sale of our products has in the past and could continue to reduce overall consumption of our products, lead to negative publicity or leave consumers with the perception that our products do not meet their health and wellness needs, resulting in an adverse effect on our business and financial performance. Laws and regulations related to the use or disposal of plastics or other packaging materials can adversely affect our business and financial performance. We rely on diverse packaging solutions to safely deliver products to our customers and consumers. Certain of our products are sold in packaging designed to be recyclable or commercially compostable. However, not all packaging is recycled, whether due to lack of infrastructure or otherwise, and certain of our packaging is not currently recyclable. Packaging waste not properly disposed of that displays one or more of our brands has in the past resulted in and could continue to result in negative publicity, litigation or reduced consumer demand for our products, adversely affecting our financial performance. Many jurisdictions in which our products are sold have imposed or are considering imposing regulations or policies intended to encourage the use of sustainable packaging, waste reduction or increased recycling rates or to restrict the sale of products utilizing certain packaging. These regulations vary in form and scope and include extended producer responsibility policies, plastic or packaging taxes, restrictions on certain products and materials, requirements for bottle caps to be tethered to bottles, bans on the use of single-use plastics and requirements to charge deposit fees. For example, the European Union, Peru and certain states in the United States, among other jurisdictions, have imposed a minimum recycled content requirement for beverage bottle packaging and similar legislation is under consideration in other jurisdictions. These laws and regulations have in the past and could continue to increase the cost of our products, impact demand for our products, result in negative publicity and require us and our business partners, including our independent bottlers, to increase capital expenditures to invest in minimizing the amount of plastic or other materials used in our packaging or to develop alternative packaging, all of which can adversely affect our business and financial performance. Failure to comply with personal data protection and privacy laws can adversely affect our business. We are subject to a variety of continuously evolving and developing laws and regulations in numerous jurisdictions regarding personal data protection and privacy laws. These laws and regulations may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with these laws and Table of Contents regulations, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation or residents of the state of California who are covered by the California Consumer Privacy Act (as modified by the California Privacy Rights Act), impose significant costs and challenges that are likely to continue to increase over time, particularly as additional jurisdictions adopt similar regulations. Failure to comply with these laws and regulations or to otherwise protect personal data from unauthorized access, use or other processing, have in the past and could in the future result in litigation, claims, legal or regulatory proceedings, inquiries or investigations, damage to our reputation, fines or penalties, all of which can adversely affect our business. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our financial performance. Increases in income tax rates or other changes in tax laws, including changes in how existing tax laws are interpreted or enforced, can adversely affect our financial performance. For example, economic and political conditions in countries where we are subject to taxes, including the United States, have in the past and could continue to result in significant changes in tax legislation or regulation, including those proposed and under consideration by the United States Congress and the Organization for Economic Co-operation and Development. For example, numerous countries have recently agreed to a statement in support of a global minimum tax rate of 15% as well as global profit reallocation. There can be no assurance that these changes will be adopted by individual countries, or that once adopted by individual countries, that they will not have adverse effects on our financial performance. This increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our financial performance. We are also subject to regular reviews, examinations and audits by numerous taxing authorities with respect to income and non-income based taxes. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, has made and could continue to make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. If we are unable to adequately protect our intellectual property rights, or if we are found to infringe on the intellectual property rights of others, our business can be adversely affected. We possess intellectual property rights that are important to our business, including ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets. The laws of various jurisdictions in which we operate have differing levels of protection of intellectual property. Our competitive position and the value of our products and brands can be reduced and our business adversely affected if we fail to obtain or adequately protect our intellectual property, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections afforded our intellectual property. Also, in the course of developing new products or improving the quality of existing products, we have in the past infringed or been alleged to have infringed, and could in the future infringe or be alleged to infringe, on the intellectual property rights of others. Such infringement or allegations of infringement could result in expensive litigation and damages, damage to our reputation, disruption to our operations, injunctions against development, manufacturing, use and/or sale of certain products, inventory write-offs or other limitations on our ability to introduce new products or improve the quality of existing products, resulting in an adverse effect on our business. Failure to comply with laws and regulations applicable to our business can adversely affect our business. The conduct of our business is subject to numerous laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content (including whether a product Table of Contents contains genetically engineered ingredients), quality, safety, transportation, traceability, sourcing (including pesticide use), packaging, disposal, recycling and use of our products or raw materials, employment and occupational health and safety, environmental, social and governance matters (including climate change) and data privacy and protection. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position, as is compliance with anti-corruption laws. The imposition of new laws, changes in laws or regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products or raw materials are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business. For example, increasing governmental and societal attention to environmental, social and governance matters has resulted and could continue to result in new laws or regulatory requirements. In addition, the entry into new markets or categories, including our planned entry into the alcoholic beverage industry as a distributor in the United States and expansion into the nuts and meat convenient foods categories globally, has resulted in and could continue to result in our business being subject to additional regulations resulting in higher compliance costs. If one jurisdiction imposes or proposes to impose new laws or regulations that impact the manufacture, distribution or sale of our products, other jurisdictions may follow. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, all of which can adversely affect our business. In addition, the results of third-party studies (whether or not scientifically valid) purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials have resulted in and could continue to result in our being subject to new taxes and regulations or lawsuits that can adversely affect our business. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients, personal injury and property damage, intellectual property rights, privacy, employment, tax and insurance matters, environmental, social and governance matters and matters relating to our compliance with applicable laws and regulations. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. Responding to these matters, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image. Any of the foregoing can adversely affect our business. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2021 year and that remain unresolved. Table of Contents ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: Property Type Location Owned/ Leased FLNA Research and development facility Plano, Texas Owned QFNA Convenient food plant Cedar Rapids, Iowa Owned PBNA Research and development facility Valhalla, New York Owned PBNA Concentrate plant Arlington, Texas Owned PBNA Tropicana plant (a) Bradenton, Florida Owned LatAm Convenient food plant Celaya, Mexico Owned LatAm Two convenient food plants Vallejo, Mexico Owned Europe Convenient food plant Kashira, Russia Owned Europe Manufacturing plant Lehavim, Israel Owned Europe Dairy plant Moscow, Russia Owned (b) AMESA Convenient food plant Riyadh, Saudi Arabia Owned (b) APAC Convenient food plant Wuhan, China Owned (b) FLNA, QFNA, PBNA Shared service center Winston Salem, North Carolina Leased PBNA, LatAm Concentrate plant Colonia, Uruguay Owned (b) PBNA, Europe, AMESA Two concentrate plants Cork, Ireland Owned PBNA, AMESA, APAC Concentrate plant Singapore Owned (b) All divisions Shared service center Hyderabad, India Leased (a) As of December 25, 2021, this property was reclassified as held for sale on the consolidated balance sheet in connection with our Juice Transaction. See Note 13 to our consolidated financial statements for further information. (b) The land on which these properties are located is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. Table of Contents "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP. Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 3, 2022, there were approximately 101,778 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 2, 2022, the Board of Directors declared a quarterly dividend of $1.075 per share payable March 31, 2022, to shareholders of record on March 4, 2022. For the remainder of 2022, the record dates for these dividend payments are expected to be June 3, September 2 and December 2, 2022, subject to approval of the Board of Directors. On February 10, 2022, we announced a 7% increase in our annualized dividend to $4.60 per share from $4.30 per share, effective with the dividend expected to be paid in June 2022. Additionally, on February 10, 2022, we announced a share repurchase program providing for the repurchase of up to $10.0 billion of PepsiCo common stock commencing on February 11, 2022 and expiring on February 28, 2026 (2022 share repurchase program). Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. We expect to return a total of approximately $7.7 billion to shareholders in 2022, comprising dividends of approximately $6.2 billion and share repurchases of approximately $1.5 billion. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. Table of Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview 30 Our Operations 31 Other Relationships 31 Our Business Risks 31 OUR FINANCIAL RESULTS Results of Operations Consolidated Review 36 Results of Operations Division Review 38 FLNA 40 QFNA 40 PBNA 40 LatAm 41 Europe 41 AMESA 42 APAC 42 Results of Operations Other Consolidated Results 43 Non-GAAP Measures 43 Items Affecting Comparability 46 Our Liquidity and Capital Resources 49 Return on Invested Capital 52 OUR CRITICAL ACCOUNTING POLICIES AND ESTIMATES Revenue Recognition 53 Goodwill and Other Intangible Assets 54 Income Tax Expense and Accruals 55 Pension and Retiree Medical Plans 56 CONSOLIDATED STATEMENT OF INCOME 59 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME 60 CONSOLIDATED STATEMENT OF CASH FLOWS 61 CONSOLIDATED BALANCE SHEET 63 CONSOLIDATED STATEMENT OF EQUITY 64 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Note 1 Basis of Presentation and Our Divisions 65 Note 2 Our Significant Accounting Policies 70 Note 3 Restructuring and Impairment Charges 73 Note 4 Intangible Assets 75 Note 5 Income Taxes 78 Note 6 Share-Based Compensation 81 Note 7 Pension, Retiree Medical and Savings Plans 85 Note 8 Debt Obligations 92 Note 9 Financial Instruments 94 Note 10 Net Income Attributable to PepsiCo per Common Share 99 Note 11 Accumulated Other Comprehensive Loss Attributable to PepsiCo 100 Note 12 Leases 101 Note 13 Acquisitions and Divestitures 103 Note 14 Supplemental Financial Information 106 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 108 GLOSSARY 112 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. Discussion in this Form 10-K includes results of operations and financial condition for 2021 and 2020 and year-over-year comparisons between 2021 and 2020. For discussion on results of operations and financial condition pertaining to 2019 and year-over-year comparisons between 2020 and 2019, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 26, 2020. OUR BUSINESS Executive Overview PepsiCo is a leading global beverage and convenient food company with a complementary portfolio of brands, including Lays, Doritos, Cheetos, Gatorade, Pepsi-Cola, Mountain Dew, Quaker and SodaStream. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories. As a global company with deep local ties, we faced many of the same challenges in 2021 as our consumers, customers, and competitors across the world, including the second year of the COVID-19 pandemic; a worsening climate crisis; supply chain disruptions; inflationary pressures; shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To meet the challenges of today and those of tomorrow we are driven by an approach called PepsiCo Positive (pep+). pep+ is a strategic end-to-end transformation of our business, with sustainability at the center of how the company will strive to create growth and value by operating within planetary boundaries and inspiring positive change for the planet and people. pep+ will guide how we will work to transform our business operations, from sourcing ingredients and making and selling products in a more sustainable way, to leveraging our more than one billion connections with consumers each day to take sustainability mainstream and engage people to make choices that are better for themselves and the planet. pep+ drives action and progress across three key pillars, bringing together a number of industry-leading 2030 sustainability goals under a comprehensive framework: Positive Agriculture : We are working to spread regenerative practices to restore the Earth across land equal to the company's entire agricultural footprint (approximately 7 million acres), sustainably source key crops and ingredients, and improve the livelihoods of more people in our agricultural supply chain. Positive Value Chain : We are working to build a circular and inclusive value chain through actions to: achieve net-zero emissions by 2040; become net water positive by 2030; and introduce more sustainable packaging into the value chain. Our packaging goals include cutting virgin plastic per serving, using recycled content in our plastic packaging, and scaling our SodaStream business globally, an innovative platform that almost entirely eliminates the need for beverage packaging, among other levers. Additionally, we are making progress on our diversity, equity and inclusion journey. And we have introduced a new global workforce volunteering program, One Smile at a Table of Contents Time, to encourage, support and empower each one of our approximately 309,000 employees to make positive impacts in their local communities. Positive Choices : We continue working to evolve our portfolio of beverage and convenient food products so that they are better for the planet and people, including by incorporating more diverse ingredients in both new and existing food products that are better for the planet and/or deliver nutritional benefits, prioritizing chickpeas, plant-based proteins and whole grains; expanding our position in the nuts seeds category, where PepsiCo is already the global branded leader, including leadership positions in Mexico, China and several Western European markets; and accelerating our reduction of added sugars and sodium through the use of science-based targets across our portfolio and cooking our food offerings with healthier oils. We are also continuing to scale new business models that require little or no single-use packaging, including SodaStream an icon of a Positive Choice and the largest sparkling water brand in the world by volume. SodaStream, already sold in more than 40 countries, and its new SodaStream Professional platform is expected to expand into functional beverages and reach additional markets by the end of 2022, part of the brand's effort to help consumers avoid plastic bottles. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers, competition and human capital. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks COVID-19 Our global operations continue to expose us to risks associated with the COVID-19 pandemic, which continues to result in challenging operating environments and has affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold. Numerous measures have been implemented around the world to try to reduce the spread of the virus, including travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns and closures. These measures have impacted and will continue to impact us, our customers (including foodservice customers), consumers, employees, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with whom we do business, which may continue to result in changes in demand for our products, increases in operating costs (whether as a result of changes to our supply chain or increases in employee costs, including expanded benefits and frontline incentives, costs associated with the provision of personal protective equipment and increased sanitation, or otherwise), or adverse impacts to our supply chain through labor shortages, raw Table of Contents material shortages or reduced availability of air or other commercial transport, port closures or border restrictions, any of which can impact our ability to make, manufacture, distribute and sell our products. In addition, measures that impact our ability to access our offices, plants, warehouses, distribution centers or other facilities, or that impact the ability of our business partners to do the same or the inability of a significant portion of our or our business partners workforce to work because of illness, absenteeism, quarantine, vaccine mandates, or travel or other governmental restrictions, may continue to impact the availability or productivity of our and their employees, many of whom are not able to perform their job functions remotely. Public concern regarding the risk of contracting COVID-19 has impacted and may continue to impact demand from consumers, including due to consumers not leaving their homes or leaving their homes less often than they did prior to the start of the pandemic or otherwise shopping for and consuming food and beverage products in a different manner than they historically have or because some of our consumers have lower discretionary income due to unemployment or reduced or limited work as a result of measures taken in response to the pandemic. Even as governmental restrictions are relaxed and economies gradually, partially, or fully reopen in certain of these jurisdictions and markets, the ongoing economic impacts and health concerns associated with the pandemic may continue to affect consumer behavior, spending levels and shopping and consumption preferences. Changes in consumer purchasing and consumption patterns may increase demand for our products in one quarter, resulting in decreased demand for our products in subsequent quarters, or in a lower-margin sales channel resulting in potentially reduced profit from sales of our products. We continue to see shifts in product and channel preferences as markets move through varying stages of restrictions and re-opening at different times, including changes in at-home consumption, in immediate consumption and away-from-home channels, such as convenience and gas and foodservice. In addition, we continue to see an increase in demand in the e-commerce and online-to-offline channels and any failure to capitalize on this demand could adversely affect our ability to maintain and grow sales or category share and erode our competitive position. Any reduced demand for our products or change in consumer purchasing and consumption patterns, as well as continued economic uncertainty (including supply chain disruptions and labor shortages), can adversely affect our customers and business partners financial condition, which can result in bankruptcy filings and/or an inability to pay for our products, reduced or canceled orders of our products, continued or additional closing of restaurants, stores, entertainment or sports complexes, schools or other venues in which our products are sold, or reduced capacity at any of the foregoing, or our business partners inability to supply us with ingredients or other items necessary for us to make, manufacture, distribute or sell our products. Such adverse changes in our customers or business partners financial condition have also resulted and may continue to result in our recording additional charges for our inability to recover or collect any accounts receivable, owned or leased assets, including certain foodservice and vending and other equipment, or prepaid expenses. In addition, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. While we have developed and implemented and continue to develop and implement health and safety protocols, business continuity plans and crisis management protocols in an effort to mitigate the negative impact of COVID-19 to our employees and our business, the extent of the impact of the pandemic on our business and financial results will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the emergence and spread of new variants of the virus, including the omicron and delta variants, the development and availability of effective treatments and vaccines, the speed at which vaccines are administered, the efficacy of vaccines against the virus and evolving strains or variants of the virus, global economic conditions during and after the pandemic, governmental actions that have been Table of Contents taken, or may be taken in the future, in response to the pandemic and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Risks Associated with Commodities and Our Supply Chain Many of the commodities used in the production and transportation of our products are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. During 2021, we experienced higher than anticipated transportation and commodity costs, which we expect to continue in 2022. A number of external factors, including the COVID-19 pandemic, adverse weather conditions, supply chain disruptions (including raw material shortages) and labor shortages, have impacted and may continue to impact transportation and commodity availability and costs. When prices increase, we may or may not pass on such increases to our customers without suffering reduced volume, revenue, margins and operating results. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Risks Associated with Climate Change Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased legal and regulatory requirements to reduce or mitigate the potential effects of climate change, including regulation of greenhouse gas emissions and potential carbon pricing programs. These new or increased legal or regulatory requirements could result in significant increased costs of compliance and additional investments in facilities and equipment. However, we are unable to predict the scope, nature and timing of any new or increased environmental laws and regulations and therefore cannot predict the ultimate impact of such laws and regulations on our business or financial results. We continue to monitor existing and proposed laws and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such laws or regulations. Risks Associated with International Operations We are subject to risks in the normal course of business that are inherent to international operations. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold, including in certain developing and emerging markets, operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. Imposition of Taxes and Regulations on our Products Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, COVID-19 has resulted in increased regulatory focus on labeling in certain jurisdictions, including in Mexico which enacted product labeling requirements and limitations on the marketing of certain of our products as a result of ingredients or substances contained in such products. Further, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, Table of Contents encourage waste reduction and increased recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages and convenient foods in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used vary by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. Retail Landscape Our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We have seen and expect to continue to see a further shift to e-commerce, online-to-offline and other online purchasing by consumers, including as a result of the COVID-19 pandemic. We continue to monitor changes in the retail landscape and seek to identify actions we may take to build our global e-commerce and digital capabilities, such as expanding our direct-to-consumer business, and distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to food safety and cybersecurity. During 2021, in addition to COVID-19 discussions as part of risk updates to the Board and the relevant Committees, the Board was provided with updates on COVID-19s impact to our business, financial condition and operations through memos, teleconferences or other appropriate means of communication. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; Table of Contents The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Sustainability, Diversity and Public Policy Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability (including climate change), diversity, equity and inclusion, and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board of Directors and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key market risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies and Estimates for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Table of Contents Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.6 billion as of December 25, 2021 and $1.1 billion as of December 26, 2020. At the end of 2021, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2021 by $177 million, which would generally be offset by a reduction in the cost of the underlying commodity purchases. Foreign Exchange Our operations outside of the United States generated 44% of our consolidated net revenue in 2021, with Mexico, Russia, Canada, China, the United Kingdom and South Africa, collectively, comprising approximately 23% of our consolidated net revenue in 2021. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business. During 2021, favorable foreign exchange contributed 1 percentage point to net revenue growth, primarily due to appreciation in the Mexican peso, Canadian dollar and South African rand. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. Our foreign currency derivatives had a total notional value of $2.8 billion as of December 25, 2021 and $1.9 billion as of December 26, 2020. At the end of 2021, we estimate that an unfavorable 10% change in the underlying exchange rates would have decreased our net unrealized gains in 2021 by $278 million, which would be significantly offset by an inverse change in the fair value of the underlying exposure. The total notional amount of our debt instruments designated as net investment hedges was $2.1 billion as of December 25, 2021 and $2.7 billion as of December 26, 2020. Interest Rates Our interest rate derivatives had a total notional value of $2.1 billion as of December 25, 2021 and $3.0 billion as of December 26, 2020. Assuming year-end 2021 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2021 by $47 million due to higher cash and cash equivalents and short-term investments levels, as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Physical or unit volume is one of the key metrics management uses internally to make operating and strategic decisions, including the preparation of our annual operating plan and the evaluation of our business performance. We believe volume provides additional information to facilitate the comparison of our historical operating performance and underlying trends, and provides additional transparency on how we evaluate our business because it measures demand for our products at the consumer level. Table of Contents Beverage volume includes volume of concentrate sold to independent bottlers and volume of finished products bearing company-owned or licensed trademarks and allied brand products and joint venture trademarks sold by company-owned bottling operations. Beverage volume also includes volume of finished products bearing company-owned or licensed trademarks sold by our noncontrolled affiliates. Concentrate volume sold to independent bottlers is reported in concentrate shipments and equivalents (CSE), whereas finished beverage product volume is reported in bottler case sales (BCS). Both CSE and BCS convert all beverage volume to an 8-ounce-case metric. Typically, CSE and BCS are not equal in any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our net revenue is not entirely based on BCS volume due to the independent bottlers in our supply chain, we believe that BCS is a better measure of the consumption of our beverage products. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Convenient food volume includes volume sold by our subsidiaries and noncontrolled affiliates of convenient food products bearing company-owned or licensed trademarks. Internationally, we measure convenient food product volume in kilograms, while in North America we measure convenient food product volume in pounds. FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Consolidated Net Revenue and Operating Profit 2021 2020 Change Net revenue $ 79,474 $ 70,372 13 % Operating profit $ 11,162 $ 10,080 11 % Operating margin 14.0 % 14.3 % (0.3) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. Operating profit grew 11% and operating margin declined 0.3 percentage points. Operating profit growth was primarily driven by net revenue growth and productivity savings, partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs, and higher advertising and marketing expenses. The operating margin decline primarily reflects higher commodity costs. Lower charges taken as a result of the COVID-19 pandemic compared to the prior year contributed 6 percentage points to operating profit growth. Additionally, lower acquisition and divestiture-related charges included in Items Affecting Comparability contributed 3 percentage points to operating profit growth. Juice Transaction In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners, while retaining a 39% noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. These juice businesses delivered approximately $3 billion in net revenue in 2021. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. See Note 13 to our consolidated financial statements for further information. Table of Contents Results of Operations Division Review See Our Business Risks, Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect mergers and acquisitions activity, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on this measure, see Non-GAAP Measures. 2021 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Organic volume (b) Effective net pricing FLNA 8 % (0.5) 7 % 2 5 QFNA % (1) % (7) 7 PBNA 12 % (0.5) (1) 10 % 5 5 LatAm 17 % (2) 15 % 4 10 Europe 9 % (0.5) 9 % 4.5 4 AMESA 33 % (4.5) (17) 12 % 7 4 APAC 34 % (6) (15) 13 % 12 1 Total 13 % (1) (2) 10 % 4 5 (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures, including the impact of an extra month of volume for our acquisitions of Pioneer Food Group Ltd. (Pioneer Foods) in our AMESA division and Hangzhou Haomusi Food Co., Ltd. (Be Cheery) in our APAC division as we aligned the reporting calendars of these acquisitions with those of our divisions. In certain instances, the impact of organic volume growth on net revenue growth differs from the unit volume growth disclosed in the following divisional discussions due to the impacts of acquisitions and divestitures, product mix, nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Table of Contents Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability 2021 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges (c) Core, Non-GAAP Measure (b) FLNA $ 5,633 $ $ 28 $ 2 $ 5,663 QFNA 578 578 PBNA 2,442 20 11 2,473 LatAm 1,369 37 1,406 Europe 1,292 81 8 1,381 AMESA 858 15 10 883 APAC 673 7 4 684 Corporate unallocated expenses (1,683) 19 49 (39) (1,654) Total $ 11,162 $ 19 $ 237 $ (4) $ 11,414 2020 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges (c) Core, Non-GAAP Measure (b) FLNA $ 5,340 $ $ 83 $ 29 $ 5,452 QFNA 669 5 674 PBNA 1,937 47 66 2,050 LatAm 1,033 31 1,064 Europe 1,353 48 1,401 AMESA 600 14 173 787 APAC 590 5 7 602 Corporate unallocated expenses (1,442) (73) 36 (20) (1,499) Total $ 10,080 $ (73) $ 269 $ 255 $ 10,531 (a) See Items Affecting Comparability. (b) Includes the charges taken as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. (c) The income amounts primarily relate to gains associated with the contingent consideration in connection with our acquisition of Rockstar Energy Beverages (Rockstar). In 2021, this impact is partially offset by divestiture-related charges associated with the Juice Transaction. See Note 13 to our consolidated financial statements for further information. Table of Contents Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis 2021 Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Acquisition and divestiture-related charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 5.5 % (1) (0.5) 4 % 3 % QFNA (14) % (0.5) (14) % (14) % PBNA 26 % (2) (4) 21 % (1) 20 % LatAm 33 % 32 % (4.5) 28 % Europe (4.5) % 2.5 1 (1.5) % (1.5) (3) % AMESA 43 % (31) 12 % (2) 10 % APAC 14 % 1 (1.5) 14 % (3) 10 % Corporate unallocated expenses 17 % (7) (1) 1 10 % 10 % Total 11 % 1 (3) 8 % (1) 7 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 8%, primarily driven by effective net pricing and organic volume growth. Unit volume grew 2%, primarily reflecting double-digit growth in variety packs and the impact of our BFY Brands, Inc. (BFY Brands) acquisition in the first quarter of 2020, partially offset by a low-single-digit decline in trademark Tostitos and a double-digit decline in trademark Santitas. Operating profit increased 5.5%, primarily reflecting the net revenue growth, productivity savings and a 3-percentage-point impact of lower charges taken as a result of the COVID-19 pandemic. These impacts were partially offset by certain operating cost increases, including strategic initiatives and incremental transportation costs, and a 4-percentage-point impact of higher commodity costs, primarily packaging material and cooking oil. QFNA Net revenue grew slightly and unit volume declined 7%. The net revenue growth reflects effective net pricing and a 1-percentage-point impact of favorable foreign exchange, largely offset by a decrease in organic volume. The unit volume decline was primarily driven by double-digit declines in pancake syrups and mixes and in ready-to-eat cereals and a high-single-digit decline in oatmeal, partially offset by growth in Cheetos macaroni and cheese, which was introduced in the third quarter of 2020, and double-digit growth in lite snacks. Operating profit declined 14%, primarily reflecting certain operating cost increases, including incremental transportation costs, and an 8-percentage-point impact of higher commodity costs, partially offset by productivity savings. The impact of the COVID-19 pandemic contributed to a current-year decrease in consumer demand, which had a negative impact on net revenue, unit volume and operating profit performance compared to the significant COVID-19 related surge in consumer demand in the prior year. PBNA Net revenue increased 12%, primarily driven by effective net pricing and an increase in organic volume. Unit volume increased 6%, driven by a 7% increase in non-carbonated beverage (NCB) volume and a 4% increase in CSD volume. The NCB volume increase primarily reflected double-digit increases in our Table of Contents overall water portfolio and our energy portfolio, a low-single-digit increase in Gatorade sports drinks and a mid-single-digit increase in Lipton ready-to-drink teas. Operating profit increased 26%, primarily reflecting the net revenue growth, a 15-percentage-point impact of lower charges taken as a result of the COVID-19 pandemic and productivity savings. These impacts were partially offset by certain operating cost increases, including incremental transportation costs, an 18-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Higher prior-year acquisition and divestiture-related charges contributed 4 percentage points to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. In 2020, we received a notice of termination without cause from Vital Pharmaceuticals, Inc., which would end our distribution rights of Bang Energy drinks, effective October 24, 2023. LatAm Net revenue increased 17%, primarily reflecting effective net pricing and organic volume growth. Convenient foods unit volume grew 3.5%, primarily reflecting low-single-digit growth in Brazil and Mexico. Beverage unit volume grew 8%, primarily reflecting double-digit growth in Argentina and Chile. Additionally, Brazil experienced low-single-digit growth, Mexico experienced mid-single-digit growth and Guatemala experienced high-single-digit growth. Operating profit increased 33%, primarily reflecting the net revenue growth, productivity savings and a 4.5-percentage-point impact of favorable foreign exchange. These impacts were partially offset by certain operating cost increases, a 30-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. A current-year recognition of certain indirect tax credits in Brazil and lower charges taken as a result of the COVID-19 pandemic contributed 6 percentage points and 4 percentage points, respectively, to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. Europe Net revenue increased 9%, primarily reflecting organic volume growth and effective net pricing. Convenient foods unit volume grew 4%, primarily reflecting double-digit growth in Turkey and mid-single-digit growth in Russia and Poland, partially offset by a mid-single-digit decline in the United Kingdom. Additionally, the Netherlands grew slightly and France experienced low-single-digit growth. Beverage unit volume grew 8%, primarily reflecting double-digit growth in Russia, Turkey and the United Kingdom and high-single-digit growth in France, partially offset by a low-single-digit decline in Germany. Operating profit decreased 4.5%, primarily reflecting certain operating cost increases, a 28-percentage-point impact of higher commodity costs and a 2.5-percentage-point impact each from higher restructuring and impairment charges and a gain on an asset sale in the prior year. These impacts were partially offset by the net revenue growth and productivity savings. Additionally, lower charges taken as a result of the COVID-19 pandemic and favorable settlements of promotional spending accruals compared to the prior Table of Contents year positively contributed 5 percentage points and 3 percentage points, respectively, to operating profit performance. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue and unit volume performance. During the fourth quarter of 2021, the implementation of an Enterprise Resource Planning (ERP) system in the United Kingdom caused a temporary disruption to our United Kingdom operations which had a negative impact on net revenue, unit volume and operating profit performance. These issues were largely resolved within the quarter and the business operations had resumed by year end. AMESA Net revenue increased 33%, reflecting a 14-percentage-point impact of our Pioneer Foods acquisition, which included the impact of an extra month of net revenue compared to the prior year as we aligned Pioneer Foods reporting calendar with that of our AMESA division, as well as organic volume growth and effective net pricing. Favorable foreign exchange contributed 4.5 percentage points to net revenue growth. Convenient foods unit volume grew 38%, primarily reflecting a 35-percentage-point impact of our Pioneer Foods acquisition, which included the impact of an extra month of unit volume as we aligned Pioneer Foods reporting calendar with that of our AMESA division, double-digit growth in India and Pakistan and high-single-digit growth in the Middle East, partially offset by a low-single-digit decline in South Africa (excluding our Pioneer Foods acquisition). Beverage unit volume grew 20%, primarily reflecting double-digit growth in India and Pakistan. Additionally, the Middle East experienced double-digit growth and Nigeria experienced high-single-digit growth. Operating profit increased 43%, primarily reflecting the net revenue growth, a 31-percentage-point impact of the prior-year acquisition and divestiture-related charges associated with our Pioneer Foods acquisition and productivity savings. These impacts were partially offset by certain operating cost increases, a 13-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Additionally, lower charges taken as a result of the COVID-19 pandemic and our Pioneer Foods acquisition contributed 3 percentage points and 2 percentage points, respectively, to operating profit growth. Changes in consumer behavior as a result of the COVID-19 pandemic contributed to a current-year increase in consumer demand, which had a positive impact on net revenue, unit volume and operating profit performance. APAC Net revenue increased 34%, reflecting a 15-percentage-point impact of our Be Cheery acquisition, which included the impact of an extra month of net revenue compared to the prior year as we aligned Be Cheerys reporting calendar with that of our APAC division, as well as organic volume growth, a 6- percentage-point impact of favorable foreign exchange and effective net pricing. Convenient foods unit volume grew 19%, primarily reflecting a 16-percentage-point impact of our Be Cheery acquisition, which included the impact of an extra month of unit volume as we aligned Be Cheerys reporting calendar with that of our APAC division, and double-digit growth in China (excluding our Be Cheery acquisition) and Thailand. Additionally, Australia, Indonesia and Taiwan each experienced low-single-digit growth. Table of Contents Beverage unit volume grew 13%, primarily reflecting double-digit growth in China, partially offset by a low-single-digit decline in Vietnam. Additionally, the Philippines experienced low-single-digit growth and Thailand experienced mid-single-digit growth. Operating profit increased 14%, primarily reflecting the net revenue growth, productivity savings and a 2- percentage-point contribution from our Be Cheery acquisition, partially offset by certain operating cost increases and higher advertising and marketing expenses. Additionally, impairment charges associated with an equity method investment reduced operating profit growth by 3 percentage points. Favorable foreign exchange contributed 3 percentage points to operating profit growth. Other Consolidated Results 2021 2020 Change Other pension and retiree medical benefits income $ 522 $ 117 $ 405 Net interest expense and other $ (1,863) $ (1,128) $ (735) Annual tax rate 21.8 % 20.9 % Net income attributable to PepsiCo (a) $ 7,618 $ 7,120 7 % Net income attributable to PepsiCo per common share diluted (a) $ 5.49 $ 5.12 7 % (a) In 2021, lower charges taken as a result of the COVID-19 pandemic contributed 7 percentage points to both net income attributable to PepsiCo growth and net income attributable to PepsiCo per common share growth. See Note 1 to our consolidated financial statements for further information. Other pension and retiree medical benefits income increased $405 million, primarily reflecting lower settlement charges in 2021, the recognition of fixed income gains on plan assets, the impact of plan changes approved in 2020, as discussed in Note 7 to our consolidated financial statements, and the impact of discretionary plan contributions, partially offset by a decrease in the expected rate of return on plan assets. Net interest expense and other increased $735 million, reflecting a charge of $842 million in connection with our cash tender offers. See Note 8 to our consolidated financial statements for further information. This impact was partially offset by lower interest rates on average debt balances. The reported tax rate increased 0.9 percentage points, primarily reflecting the net tax impact of adjustments to uncertain tax positions related to the final assessment from the Internal Revenue Service (IRS) audit for the tax years 2014 through 2016. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; costs associated with mergers, acquisitions, divestitures and other structural changes; gains associated with divestitures; pension and retiree medical-related amounts (including all settlement and curtailment gains and losses); charges or Table of Contents adjustments related to the enactment of new laws, rules or regulations, such as tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. Previously, certain immaterial pension and retiree medical-related settlement and curtailment gains and losses were not considered items affecting comparability. Pension and retiree medical-related service cost, interest cost, expected return on plan assets, and other net periodic pension costs will continue to be reflected in our core results. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures contained in this Form 10-K are discussed below: Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income, net interest expense and other, provision for income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 Multi-Year Productivity Plan (2019 Productivity Plan), costs associated with our acquisitions and divestitures, the impact of settlement and curtailment gains and losses related to pension and retiree medical plans, a charge related to cash tender offers and tax expense related to the Tax Cuts and Jobs Act (TCJ Act) (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance or that we believe impact comparability with the prior year. Organic revenue growth We define organic revenue growth as a measure that adjusts for the impacts of foreign exchange translation, acquisitions and divestitures, and where applicable, the impact of an additional week of results every five or six years (53 rd reporting week), including in our 2022 financial results. Adjusting for acquisitions and divestitures reflects mergers and acquisitions activity, including the impact in 2021 of an extra month of net revenue for our acquisitions of Pioneer Foods in our AMESA division and Be Cheery in our APAC division as we aligned the reporting calendars of these acquisitions with those of our divisions, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Table of Contents Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Table of Contents Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: 2021 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Net interest expense and other Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 37,075 $ 42,399 $ 31,237 $ 11,162 $ 522 $ (1,863) $ 2,142 $ 61 $ 7,618 Items Affecting Comparability Mark-to-market net impact (39) 39 20 19 5 14 Restructuring and impairment charges (29) 29 (208) 237 10 41 1 205 Acquisition and divestiture-related charges (1) 1 5 (4) 23 (27) Pension and retiree medical-related impact 12 1 11 Charge related to cash tender offers 842 165 677 Tax expense related to the TCJ Act (190) 190 Core, Non-GAAP Measure $ 37,006 $ 42,468 $ 31,054 $ 11,414 $ 544 $ (1,021) $ 2,187 $ 62 $ 8,688 2020 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 31,797 $ 38,575 $ 28,495 $ 10,080 $ 117 $ 1,894 $ 7,120 Items Affecting Comparability Mark-to-market net impact 64 (64) 9 (73) (15) (58) Restructuring and impairment charges (30) 30 (239) 269 20 58 231 Acquisition and divestiture-related charges (32) 32 (223) 255 18 237 Pension and retiree medical-related impact 205 47 158 Core, Non-GAAP Measure $ 31,799 $ 38,573 $ 28,042 $ 10,531 $ 342 $ 2,002 $ 7,688 (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. 2021 2020 Change Net income attributable to PepsiCo per common share diluted, GAAP measure $ 5.49 $ 5.12 7 % Mark-to-market net impact 0.01 (0.04) Restructuring and impairment charges 0.15 0.17 Acquisition and divestiture-related charges (0.02) 0.17 Pension and retiree medical-related impact 0.01 0.11 Charge related to cash tender offers 0.49 Tax expense related to the TCJ Act 0.14 Core net income attributable to PepsiCo per common share diluted, non-GAAP measure $ 6.26 (a) $ 5.52 (a) 13 % Impact of foreign exchange translation (1.5) Growth in core net income attributable to PepsiCo per common share diluted, on a constant currency basis, non-GAAP measure 12 % (a) (a) Does not sum due to rounding. Table of Contents Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. To build on the successful implementation of the 2019 Productivity Plan to date, we expanded and extended the program through the end of 2026 to take advantage of additional opportunities within the initiatives of the 2019 Productivity Plan. We now expect to incur pre-tax charges of approximately $3.15 billion, including cash expenditures of approximately $2.4 billion, as compared to our previous estimate of pre-tax charges of approximately $2.5 billion, which included cash expenditures of approximately $1.6 billion. Plan to date through December 25, 2021, we have incurred pre-tax charges of $1.0 billion, including cash expenditures of $776 million. In our 2022 financial results, we expect to incur pre-tax charges of approximately $350 million, including cash expenditures of approximately $300 million. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2022 and 2023 financial results, with the balance to be incurred through 2026. See Note 3 to our consolidated financial statements for further information related to our 2019 Productivity Plan. We regularly evaluate productivity initiatives beyond the productivity plan and other initiatives discussed above and in Note 3 to our consolidated financial statements. Acquisition and Divestiture-Related Charges Acquisition and divestiture-related charges primarily include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets, merger and integration charges and costs associated with divestitures. Merger and integration charges include liabilities to support socioeconomic programs in South Africa, closing costs, employee-related costs, gains associated with contingent consideration, contract termination costs and other integration costs. See Note 13 to our consolidated financial statements for further information. Pension and Retiree Medical-Related Impact Pension and retiree medical-related impact primarily includes settlement charges related to lump sum distributions exceeding the total of annual service and interest costs, as well as curtailment gains related to plan changes. See Note 7 to our consolidated financial statements for further information. Table of Contents Charge Related to Cash Tender Offers As a result of the cash tender offers for some of our long-term debt, we recorded a charge primarily representing the tender price paid over the carrying value of the tendered notes and loss on treasury rate locks used to mitigate the interest rate risk on the cash tender offers. See Note 8 to our consolidated financial statements for further information. Tax Expense Related to the TCJ Act Tax expense related to the TCJ Act reflects adjustments to the mandatory transition tax liability under the TCJ Act. See Note 5 to our consolidated financial statements for further information. Table of Contents Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs, including with respect to our net capital spending plans. Our primary sources of liquidity include cash from operations, pre-tax cash proceeds of approximately $3.5 billion from the Juice Transaction, proceeds obtained from issuances of commercial paper and long-term debt, and cash and cash equivalents. These sources of cash are available to fund cash outflows that have both a short- and long-term component, including debt repayments and related interest payments; payments for acquisitions, including support for socioeconomic programs in South Africa related to our acquisition of Pioneer Foods; operating leases; purchase, marketing, and other contractual commitments, including capital expenditures and the transition tax liability under the TCJ Act. In addition, these sources of cash fund other cash outflows including anticipated dividend payments and share repurchases. We do not have guarantees or off-balance sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our liquidity. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Our sources and uses of cash were not materially adversely impacted by COVID-19 and, to date, we have not identified any material liquidity deficiencies as a result of the COVID-19 pandemic. Based on the information currently available to us, we do not expect the impact of the COVID-19 pandemic to have a material impact on our future liquidity. We will continue to monitor and assess the impact the COVID-19 pandemic may have on our business and financial results. See Item 1A. Risk Factors, Our Business Risks and Note 1 to our consolidated financial statements for further information related to the impact of the COVID-19 pandemic on our business and financial results. As of December 25, 2021, cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a one-time mandatory transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 25, 2021, our mandatory transition tax liability was $2.9 billion, which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $309 million of this liability in 2022. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. As part of our evolving market practices, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with a majority of our suppliers generally range from 60 to 90 days, which we deem to be commercially reasonable. We will continue to monitor economic conditions and market practice working with our suppliers to adjust as necessary. We also maintain voluntary supply chain finance agreements with several participating global financial institutions. Under these agreements, our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to these participating global financial institutions. Supplier participation in these financing arrangements is voluntary. Our suppliers negotiate their financing agreements directly with the respective global financial institutions and we are not a party to these agreements. These financing arrangements allow participating suppliers to leverage PepsiCos creditworthiness in establishing credit spreads and associated costs, which generally provides our suppliers with more favorable terms than they would be able to secure on their own. Neither PepsiCo nor any of its subsidiaries provide any guarantees to any third party in connection with these financing arrangements. We have no economic interest in our suppliers decision to participate in these agreements. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. All Table of Contents outstanding amounts related to suppliers participating in such financing arrangements are recorded within accounts payable and other current liabilities in our consolidated balance sheet. We were informed by the participating financial institutions that as of December 25, 2021 and December 26, 2020, $1.5 billion and $1.2 billion, respectively, of our accounts payable to suppliers who participate in these financing arrangements are outstanding. These supply chain finance arrangements did not have a material impact on our liquidity or capital resources in the periods presented and we do not expect such arrangements to have a material impact on our liquidity or capital resources for the foreseeable future. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: 2021 2020 Net cash provided by operating activities $ 11,616 $ 10,613 Net cash used for investing activities $ (3,269) $ (11,619) Net cash (used for)/provided by financing activities $ (10,780) $ 3,819 Operating Activities In 2021, net cash provided by operating activities was $11.6 billion, compared to $10.6 billion in the prior year. The increase in operating cash flow primarily reflects favorable working capital comparisons and operating profit performance, partially offset by higher pre-tax pension and retiree medical plan contributions and higher net cash tax payments in the current year. Investing Activities In 2021, net cash used for investing activities was $3.3 billion, primarily reflecting net capital spending of $4.5 billion, partially offset by maturities of short-term investments with maturities greater than three months of $1.1 billion. In 2020, net cash used for investing activities was $11.6 billion, primarily reflecting net cash paid in connection with our acquisitions of Rockstar of $3.85 billion, Pioneer Foods of $1.2 billion and Be Cheery of $0.7 billion, net capital spending of $4.2 billion, as well as purchases of short-term investments with maturities greater than three months of $1.1 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities; and see Note 13 to our consolidated financial statements for further discussion of our acquisitions. We regularly review our plans with respect to net capital spending, including in light of the ongoing uncertainty caused by the COVID-19 pandemic on our business, and believe that we have sufficient liquidity to meet our net capital spending needs. Financing Activities In 2021, net cash used for financing activities was $10.8 billion, primarily reflecting the return of operating cash flow to our shareholders largely through dividend payments of $5.8 billion, cash tender offers/debt redemption of $4.8 billion, payments of long-term debt borrowings of $3.5 billion and Table of Contents payments of acquisition-related contingent consideration of $0.8 billion, partially offset by proceeds from issuances of long-term debt of $4.1 billion. In 2020, net cash provided by financing activities was $3.8 billion, primarily reflecting proceeds from issuances of long-term debt of $13.8 billion, partially offset by the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.5 billion, payments of long-term debt borrowings of $1.8 billion and debt redemptions of $1.1 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and expired on June 30, 2021. On February 10, 2022, we announced the 2022 share repurchase program. See Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities for further information. In addition, on February 10, 2022, we announced a 7% increase in our annualized dividend to $4.60 per share from $4.30 per share, effective with the dividend expected to be paid in June 2022. We expect to return a total of approximately $7.7 billion to shareholders in 2022, comprising dividends of approximately $6.2 billion and share repurchases of approximately $1.5 billion. Free Cash Flow The table below reconciles net cash provided by operating activities, as reflected on our cash flow statement, to our free cash flow. Free cash flow is a non-GAAP financial measure. For further information on free cash flow, see Non-GAAP Measures. 2021 2020 Change Net cash provided by operating activities, GAAP measure $ 11,616 $ 10,613 9 % Capital spending (4,625) (4,240) Sales of property, plant and equipment 166 55 Free cash flow, non-GAAP measure $ 7,157 $ 6,428 11 % We use free cash flow primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders primarily through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Material Changes in Line Items in Our Consolidated Financial Statements Material changes in line items in our consolidated statement of income are discussed in Results of Operations Division Review and Items Affecting Comparability. Table of Contents Material changes in line items in our consolidated statement of cash flows are discussed in Our Liquidity and Capital Resources. Material changes in line items in our consolidated balance sheet are discussed below: Total Assets In 2021, total assets were $92.4 billion, compared to $92.9 billion in the prior year. The decrease in total assets is primarily driven by the following line items: Change (a) Reference Cash and cash equivalents $ (2.6) Consolidated Statement of Cash Flows Short-term investments $ (1.0) Consolidated Statement of Cash Flows Assets held for sale $ 1.8 Note 13 Property, plant and equipment, net $ 1.0 Note 1, Note 14 Other indefinite-lived intangible assets $ (0.5) Note 4 Other assets $ 0.9 Note 14 Total Liabilities In 2021, total liabilities were $76.2 billion, compared to $79.4 billion in the prior year. The decrease in total liabilities is primarily driven by the following line items: Change (a) Reference Accounts payable and other current liabilities $ 1.6 Note 14 Liabilities held for sale $ 0.8 Note 13 Long-term debt obligations $ (4.3) Note 8 Other liabilities (b) $ (2.2) Note 7, Note 9 and Note 12 (a) In billions. (b) Reflects changes primarily related to pension and retiree medical plans, contingent consideration associated with our acquisition of Rockstar and leases. Total Equity Refer to our consolidated statement of equity for material changes in equity line items. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. 2021 2020 Net income attributable to PepsiCo $ 7,618 $ 7,120 Interest expense 1,988 1,252 Tax on interest expense (441) (278) $ 9,165 $ 8,094 Average debt obligations (a) $ 42,341 $ 41,402 Average common shareholders equity (b) 14,924 13,536 Average invested capital $ 57,265 $ 54,938 ROIC, non-GAAP measure 16.0 % 14.7 % (a) Includes a quarterly average of short-term and long-term debt obligations. (b) Includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. Table of Contents The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. 2021 2020 ROIC, non-GAAP measure 16.0 % 14.7 % Impact of: Average cash, cash equivalents and short-term investments 2.2 3.4 Interest income (0.2) (0.2) Tax on interest income 0.1 Mark-to-market net impact 0.1 (0.1) Restructuring and impairment charges 0.2 0.3 Acquisition and divestiture-related charges (0.1) 0.4 Pension and retiree medical-related impact (0.1) 0.2 Tax expense related to the TCJ Act 0.3 0.1 Other net tax benefits 1.0 Core Net ROIC, non-GAAP measure 18.4 % 19.9 % OUR CRITICAL ACCOUNTING POLICIES AND ESTIMATES An appreciation of our critical accounting policies and estimates is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, including those related to the COVID-19 pandemic, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies and estimates with our Audit Committee. Our critical accounting policies and estimates are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage and convenient food products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty Table of Contents related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions, including those related to the COVID-19 pandemic, based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre- Table of Contents existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is Table of Contents separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is not more likely than not that some portion or all of the deferred tax assets will be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. In 2021, our annual tax rate was 21.8% compared to 20.9% in 2020. See Other Consolidated Results for further information. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. See Items Affecting Comparability and Note 7 to our consolidated financial statements for information about changes and settlements within our pension plans. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected rate of return on assets in our funded plans; the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities; for pension expense, the rate of salary increases for plans where benefits are based on earnings; and for retiree medical expense, health care cost trend rates. Table of Contents Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans obligation and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: 2022 2021 2020 Pension Service cost discount rate 3.1 % 2.6 % 3.4 % Interest cost discount rate 2.4 % 1.9 % 2.8 % Expected rate of return on plan assets 6.1 % 6.2 % 6.6 % Expected rate of salary increases 3.1 % 3.1 % 3.2 % Retiree medical Service cost discount rate 2.8 % 2.3 % 3.2 % Interest cost discount rate 2.1 % 1.6 % 2.6 % Expected rate of return on plan assets 5.7 % 5.4 % 5.8 % Current health care cost trend rate 5.8 % 5.5 % 5.6 % Based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2022 primarily reflecting plan changes and related impacts, and higher discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2022 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ 37 Expected rate of return $ 49 Table of Contents Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. We made discretionary contributions to our U.S. qualified defined benefit plans of $75 million in January 2022 and expect to make an additional $75 million contribution in the third quarter of 2022. Our pension and retiree medical plan contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Table of Contents Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2021 2020 2019 Net Revenue $ 79,474 $ 70,372 $ 67,161 Cost of sales 37,075 31,797 30,132 Gross profit 42,399 38,575 37,029 Selling, general and administrative expenses 31,237 28,495 26,738 Operating Profit 11,162 10,080 10,291 Other pension and retiree medical benefits income/(expense) 522 117 ( 44 ) Net interest expense and other ( 1,863 ) ( 1,128 ) ( 935 ) Income before income taxes 9,821 9,069 9,312 Provision for income taxes 2,142 1,894 1,959 Net income 7,679 7,175 7,353 Less: Net income attributable to noncontrolling interests 61 55 39 Net Income Attributable to PepsiCo $ 7,618 $ 7,120 $ 7,314 Net Income Attributable to PepsiCo per Common Share Basic $ 5.51 $ 5.14 $ 5.23 Diluted $ 5.49 $ 5.12 $ 5.20 Weighted-average common shares outstanding Basic 1,382 1,385 1,399 Diluted 1,389 1,392 1,407 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Net income $ 7,679 $ 7,175 $ 7,353 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment ( 369 ) ( 650 ) 628 Net change on cash flow hedges 155 7 ( 90 ) Net pension and retiree medical adjustments 770 ( 532 ) 283 Other 22 ( 1 ) ( 2 ) 578 ( 1,176 ) 819 Comprehensive income 8,257 5,999 8,172 Less: Comprehensive income attributable to noncontrolling interests 61 55 39 Comprehensive Income Attributable to PepsiCo $ 8,196 $ 5,944 $ 8,133 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Operating Activities Net income $ 7,679 $ 7,175 $ 7,353 Depreciation and amortization 2,710 2,548 2,432 Operating lease right-of-use asset amortization 505 478 412 Share-based compensation expense 301 264 237 Restructuring and impairment charges 247 289 370 Cash payments for restructuring charges ( 256 ) ( 255 ) ( 350 ) Acquisition and divestiture-related charges ( 4 ) 255 55 Cash payments for acquisition and divestiture-related charges ( 176 ) ( 131 ) ( 10 ) Pension and retiree medical plan expenses 123 408 519 Pension and retiree medical plan contributions ( 785 ) ( 562 ) ( 716 ) Deferred income taxes and other tax charges and credits 298 361 453 Tax expense/(benefit) related to the TCJ Act 190 ( 8 ) Tax payments related to the TCJ Act ( 309 ) ( 78 ) ( 423 ) Change in assets and liabilities: Accounts and notes receivable ( 651 ) ( 420 ) ( 650 ) Inventories ( 582 ) ( 516 ) ( 190 ) Prepaid expenses and other current assets 159 26 ( 87 ) Accounts payable and other current liabilities 1,762 766 735 Income taxes payable 30 ( 159 ) ( 287 ) Other, net 375 164 ( 196 ) Net Cash Provided by Operating Activities 11,616 10,613 9,649 Investing Activities Capital spending ( 4,625 ) ( 4,240 ) ( 4,232 ) Sales of property, plant and equipment 166 55 170 Acquisitions, net of cash acquired, and investments in noncontrolled affiliates ( 61 ) ( 6,372 ) ( 2,717 ) Divestitures and sales of investments in noncontrolled affiliates 169 6 253 Short-term investments, by original maturity: More than three months - purchases ( 1,135 ) More than three months - maturities 1,135 16 More than three months - sales 62 Three months or less, net ( 58 ) 27 19 Other investing, net 5 40 ( 8 ) Net Cash Used for Investing Activities ( 3,269 ) ( 11,619 ) ( 6,437 ) (Continued on following page) Table of Contents Consolidated Statement of Cash Flows (continued) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions) 2021 2020 2019 Financing Activities Proceeds from issuances of long-term debt $ 4,122 $ 13,809 $ 4,621 Payments of long-term debt ( 3,455 ) ( 1,830 ) ( 3,970 ) Cash tender offers/debt redemption ( 4,844 ) ( 1,100 ) ( 1,007 ) Short-term borrowings, by original maturity: More than three months - proceeds 8 4,077 6 More than three months - payments ( 397 ) ( 3,554 ) ( 2 ) Three months or less, net 434 ( 109 ) ( 3 ) Payments of acquisition-related contingent consideration ( 773 ) Cash dividends paid ( 5,815 ) ( 5,509 ) ( 5,304 ) Share repurchases - common ( 106 ) ( 2,000 ) ( 3,000 ) Proceeds from exercises of stock options 185 179 329 Withholding tax payments on restricted stock units (RSUs) and performance stock units (PSUs) converted ( 92 ) ( 96 ) ( 114 ) Other financing ( 47 ) ( 48 ) ( 45 ) Net Cash (Used for)/Provided by Financing Activities ( 10,780 ) 3,819 ( 8,489 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 114 ) ( 129 ) 78 Net (Decrease)/Increase in Cash and Cash Equivalents and Restricted Cash ( 2,547 ) 2,684 ( 5,199 ) Cash and Cash Equivalents and Restricted Cash, Beginning of Year 8,254 5,570 10,769 Cash and Cash Equivalents and Restricted Cash, End of Year $ 5,707 $ 8,254 $ 5,570 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 25, 2021 and December 26, 2020 (in millions except per share amounts) 2021 2020 ASSETS Current Assets Cash and cash equivalents $ 5,596 $ 8,185 Short-term investments 392 1,366 Accounts and notes receivable, net 8,680 8,404 Inventories 4,347 4,172 Prepaid expenses and other current assets 980 874 Assets held for sale 1,788 Total Current Assets 21,783 23,001 Property, Plant and Equipment, net 22,407 21,369 Amortizable Intangible Assets, net 1,538 1,703 Goodwill 18,381 18,757 Other Indefinite-Lived Intangible Assets 17,127 17,612 Investments in Noncontrolled Affiliates 2,627 2,792 Deferred Income Taxes 4,310 4,372 Other Assets 4,204 3,312 Total Assets $ 92,377 $ 92,918 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 4,308 $ 3,780 Accounts payable and other current liabilities 21,159 19,592 Liabilities held for sale 753 Total Current Liabilities 26,220 23,372 Long-Term Debt Obligations 36,026 40,370 Deferred Income Taxes 4,826 4,284 Other Liabilities 9,154 11,340 Total Liabilities 76,226 79,366 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,383 and 1,380 shares, respectively) 23 23 Capital in excess of par value 4,001 3,910 Retained earnings 65,165 63,443 Accumulated other comprehensive loss ( 14,898 ) ( 15,476 ) Repurchased common stock, in excess of par value ( 484 and 487 shares, respectively) ( 38,248 ) ( 38,446 ) Total PepsiCo Common Shareholders Equity 16,043 13,454 Noncontrolling interests 108 98 Total Equity 16,151 13,552 Total Liabilities and Equity $ 92,377 $ 92,918 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 25, 2021, December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2021 2020 2019 Shares Amount Shares Amount Shares Amount Common Stock Balance, beginning of year 1,380 $ 23 1,391 $ 23 1,409 $ 23 Change in repurchased common stock 3 ( 11 ) ( 18 ) Balance, end of year 1,383 23 1,380 23 1,391 23 Capital in Excess of Par Value Balance, beginning of year 3,910 3,886 3,953 Share-based compensation expense 302 263 235 Stock option exercises, RSUs and PSUs converted ( 118 ) ( 143 ) ( 188 ) Withholding tax on RSUs and PSUs converted ( 92 ) ( 96 ) ( 114 ) Other ( 1 ) Balance, end of year 4,001 3,910 3,886 Retained Earnings Balance, beginning of year 63,443 61,946 59,947 Cumulative effect of accounting changes ( 34 ) 8 Net income attributable to PepsiCo 7,618 7,120 7,314 Cash dividends declared - common (a) ( 5,896 ) ( 5,589 ) ( 5,323 ) Balance, end of year 65,165 63,443 61,946 Accumulated Other Comprehensive Loss Balance, beginning of year ( 15,476 ) ( 14,300 ) ( 15,119 ) Other comprehensive income/(loss) attributable to PepsiCo 578 ( 1,176 ) 819 Balance, end of year ( 14,898 ) ( 15,476 ) ( 14,300 ) Repurchased Common Stock Balance, beginning of year ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) Share repurchases ( 1 ) ( 106 ) ( 15 ) ( 2,000 ) ( 24 ) ( 3,000 ) Stock option exercises, RSUs and PSUs converted 4 303 4 322 6 516 Other 1 1 1 Balance, end of year ( 484 ) ( 38,248 ) ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) Total PepsiCo Common Shareholders Equity 16,043 13,454 14,786 Noncontrolling Interests Balance, beginning of year 98 82 84 Net income attributable to noncontrolling interests 61 55 39 Distributions to noncontrolling interests ( 49 ) ( 44 ) ( 42 ) Acquisitions 5 Other, net ( 2 ) 1 Balance, end of year 108 98 82 Total Equity $ 16,151 $ 13,552 $ 14,868 (a) Cash dividends declared per common share were $ 4.2475 , $ 4.0225 and $ 3.7925 for 2021, 2020 and 2019, respectively. See accompanying notes to the consolidated financial statements. Table of Contents Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived intangible assets, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. Additionally, the business and economic uncertainty resulting from the COVID-19 pandemic has made such estimates and assumptions more difficult to calculate. As future events and their effect cannot be determined with precision, actual results could differ significantly from those estimates. Our fiscal year ends on the last Saturday of each December, resulting in a 53 rd reporting week every five or six years, including in our 2022 financial results. While our North America results are reported on a weekly calendar basis, substantially all of our international operations reported on a monthly calendar basis prior to the fourth quarter of 2021, and beginning in the fourth quarter of 2021, all of our international operations report on a monthly calendar basis. This change did not have a material impact on our consolidated financial statements. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Table of Contents Our Divisions We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded convenient food businesses in the United States and Canada; 2) QFNA, which includes our branded convenient food businesses, such as cereal, rice, pasta and other branded food, in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage and convenient food businesses in Latin America; 5) Europe, which includes all of our beverage and convenient food businesses in Europe; 6) AMESA, which includes all of our beverage and convenient food businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage and convenient food businesses in Asia Pacific, Australia and New Zealand, and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of beverages and convenient foods, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, China, the United Kingdom and South Africa. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: 2021 2020 2019 FLNA 13 % 13 % 13 % QFNA 1 % 1 % 1 % PBNA 19 % 18 % 17 % LatAm 5 % 6 % 7 % Europe 13 % 16 % 17 % AMESA 6 % 6 % 3 % APAC 2 % 2 % 5 % Corporate unallocated expenses 41 % 38 % 37 % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Table of Contents Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net Revenue and Operating Profit Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2021 2020 2019 2021 2020 2019 FLNA $ 19,608 $ 18,189 $ 17,078 $ 5,633 $ 5,340 $ 5,258 QFNA 2,751 2,742 2,482 578 669 544 PBNA 25,276 22,559 21,730 2,442 1,937 2,179 LatAm 8,108 6,942 7,573 1,369 1,033 1,141 Europe 13,038 11,922 11,728 1,292 1,353 1,327 AMESA (a) 6,078 4,573 3,651 858 600 671 APAC (b) 4,615 3,445 2,919 673 590 477 Total division 79,474 70,372 67,161 12,845 11,522 11,597 Corporate unallocated expenses ( 1,683 ) ( 1,442 ) ( 1,306 ) Total $ 79,474 $ 70,372 $ 67,161 $ 11,162 $ 10,080 $ 10,291 (a) The increase in net revenue reflects our acquisition of Pioneer Foods. See Note 13 for further information. (b) The increase in net revenue reflects our acquisition of Be Cheery. See Note 13 for further information. Our primary performance obligation is the distribution and sales of beverage and convenient food products to our customers. The following table reflects the approximate percentage of net revenue generated between our beverage business and our convenient food business for each of our international divisions, as well as our consolidated net revenue: 2021 2020 2019 Beverage (a) Convenient Food Beverage (a) Convenient Food Beverage (a) Convenient Food LatAm 10 % 90 % 10 % 90 % 10 % 90 % Europe 55 % 45 % 55 % 45 % 55 % 45 % AMESA (b) 30 % 70 % 30 % 70 % 40 % 60 % APAC 20 % 80 % 25 % 75 % 25 % 75 % PepsiCo 45 % 55 % 45 % 55 % 45 % 55 % (a) Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. (b) The increase in the approximate percentage of net revenue generated by our convenient food business in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 13 for further information. Table of Contents Operating profit in 2021 and 2020 includes certain pre-tax charges/credits taken as a result of the COVID-19 pandemic. These pre-tax charges/credits by division are as follows: 2021 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ ( 8 ) $ $ $ 35 $ 27 $ 2 $ 56 QFNA ( 1 ) 2 1 2 PBNA ( 19 ) ( 21 ) 31 14 ( 16 ) ( 11 ) LatAm 1 44 15 4 64 Europe ( 3 ) ( 2 ) 13 8 5 21 AMESA ( 1 ) ( 2 ) 1 3 6 7 APAC 2 2 5 9 Total $ ( 32 ) $ ( 23 ) $ ( 1 ) $ 128 $ 70 $ 6 $ 148 2020 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ 17 $ $ 8 $ 145 $ 59 $ $ 229 QFNA 2 9 3 1 15 PBNA 29 56 28 115 50 26 304 LatAm 1 19 56 18 8 102 Europe 5 3 11 23 22 24 88 AMESA 2 3 9 7 12 33 APAC 3 ( 7 ) 2 5 3 Total $ 56 $ 59 $ 72 $ 350 $ 161 $ 76 $ 774 (a) Reflects the expected impact of the global economic uncertainty caused by COVID-19, leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers, including foodservice and vending businesses. Income amounts represent reductions in the previously recorded reserves due to improved projected default rates and lower at-risk receivable balances. (b) Relates to promotional spending for which benefit is not expected to be received. Income amounts represent reductions in previously recorded reserves due to improved projected default rates and lower overall advance balances. (c) Income amount represents a true-up of inventory write-downs. Includes a reserve for product returns of $ 20 million in 2020. (d) Includes incremental frontline incentive pay, crisis child care and other leave benefits and labor costs. Income amount includes a social welfare relief credit of $ 11 million. (e) Includes costs associated with personal protective equipment, temperature scans, cleaning and other sanitization services. (f) Includes certain reserves for property, plant and equipment, donations of cash and product, and other costs. Income amount represents adjustments for changes in estimates of previously recorded amounts. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, tax-related contingent consideration, certain acquisition and divestiture-related charges, as well as certain other items. Table of Contents Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending 2021 2020 2021 2020 2019 FLNA $ 9,763 $ 8,730 $ 1,411 $ 1,189 $ 1,227 QFNA 1,101 1,021 92 85 104 PBNA 37,801 37,079 1,275 1,245 1,053 LatAm 7,272 6,977 461 390 557 Europe 18,472 17,917 752 730 613 AMESA 6,125 5,942 325 252 267 APAC 5,654 5,770 203 230 195 Total division 86,188 83,436 4,519 4,121 4,016 Corporate (a) 6,189 9,482 106 119 216 Total $ 92,377 $ 92,918 $ 4,625 $ 4,240 $ 4,232 (a) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2021, the change in assets was primarily due to a decrease in cash and cash equivalents and short-term investments. Refer to the cash flow statement for further information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization 2021 2020 2019 2021 2020 2019 FLNA $ 11 $ 10 $ 7 $ 594 $ 550 $ 492 QFNA 46 41 44 PBNA 25 28 29 926 899 857 LatAm 4 4 5 283 251 270 Europe 37 40 37 364 350 341 AMESA 5 3 2 181 149 116 APAC 9 5 1 102 91 76 Total division 91 90 81 2,496 2,331 2,196 Corporate 123 127 155 Total $ 91 $ 90 $ 81 $ 2,619 $ 2,458 $ 2,351 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) 2021 2020 2019 2021 2020 United States $ 44,545 $ 40,800 $ 38,644 $ 36,324 $ 36,657 Mexico 4,580 3,924 4,190 1,720 1,708 Russia 3,426 3,009 3,263 3,751 3,644 Canada 3,405 2,989 2,831 2,846 2,794 China (b) 2,679 1,732 1,300 1,745 1,649 United Kingdom 2,102 1,882 1,723 906 874 South Africa (c) 2,008 1,282 405 1,389 1,484 All other countries 16,729 14,754 14,805 13,399 13,423 Total $ 79,474 $ 70,372 $ 67,161 $ 62,080 $ 62,233 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. See Note 2 and Note 14 for further information on property, plant and equipment. See Note 2 and Note 4 for further information on goodwill and other intangible assets. Investments in noncontrolled affiliates are evaluated for Table of Contents impairment upon a significant change in the operating or macroeconomic environment. These assets are reported in the country where they are primarily used. (b) The increase in net revenue reflects our acquisition of Be Cheery. See Note 13 for further information. (c) The increase in net revenue reflects our acquisition of Pioneer Foods. See Note 13 for further information. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage and convenient food products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. In addition, we exclude from net revenue all sales, use, value-added and certain excise taxes assessed by government authorities on revenue producing transactions. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers. We are exposed to concentration of credit risk from our major customers, including Walmart. We have not experienced credit issues with these customers. In 2021, sales to Walmart and its affiliates (including Sams) represented approximately 13 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance Table of Contents levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed one year and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 262 million as of December 25, 2021 and $ 299 million as of December 26, 2020 are included in prepaid expenses and other current assets and other assets on our balance sheet. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 5.1 billion in 2021, $ 4.6 billion in 2020 and $ 4.7 billion in 2019, including advertising expenses of $ 3.5 billion in 2021 and $ 3.0 billion in both 2020 and 2019. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 53 million and $ 48 million as of December 25, 2021 and December 26, 2020, respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 13.7 billion in 2021, $ 11.9 billion in 2020 and $ 10.9 billion in 2019. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 135 million in 2021, $ 152 million in 2020 and $ 166 million in 2019. Net capitalized software and development costs were $ 809 million and $ 664 million as of December 25, 2021 and December 26, 2020, respectively. Table of Contents Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 752 million, $ 719 million and $ 711 million in 2021, 2020 and 2019, respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Income Taxes Note 5. Share-Based Compensation Note 6. Table of Contents Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Inventories Note 14. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO); or, in limited instances, last-in, first-out (LIFO) methods. Property, Plant and Equipment Note 14. Property, plant and equipment is recorded at historical cost. Depreciation is recognized on a straight-line basis over an assets estimated useful life. Construction in progress is not depreciated until ready for service. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2019, the Financial Accounting Standards Board (FASB) issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a step-up in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all of the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. We adopted the guidance in the first quarter of 2021. The adoption did not have a material impact on our consolidated financial statements or related disclosures. Note 3 Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. To build on the successful implementation of the 2019 Productivity Plan to date, we expanded and extended the plan through the end of 2026 to take advantage of additional opportunities within the initiatives described above. We now expect to incur pre-tax charges of approximately $ 3.15 billion, including cash expenditures of approximately $ 2.4 billion, as compared to our previous estimate of pre-tax charges of approximately $ 2.5 billion, which included cash expenditures of approximately $ 1.6 billion. These pre-tax charges are expected to consist of approximately 55 % of severance and other employee-related costs, 10 % for asset impairments (all non-cash) resulting from plant closures and related actions and 35 % for other costs associated with the implementation of our initiatives. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges 15 % 1 % 25 % 10 % 25 % 5 % 4 % 15 % Table of Contents A summary of our 2019 Productivity Plan charges is as follows: 2021 2020 2019 Cost of sales $ 29 $ 30 $ 115 Selling, general and administrative expenses 208 239 253 Other pension and retiree medical benefits expense 10 20 2 Total restructuring and impairment charges $ 247 $ 289 $ 370 After-tax amount $ 206 $ 231 $ 303 Impact on net income attributable to PepsiCo per common share $ ( 0.15 ) $ ( 0.17 ) $ ( 0.21 ) 2021 2020 2019 Plan to Date through 12/25/2021 FLNA $ 28 $ 83 $ 22 $ 164 QFNA 5 2 12 PBNA 20 47 51 158 LatAm 37 31 62 139 Europe 81 48 99 234 AMESA 15 14 38 70 APAC 7 5 47 61 Corporate 49 36 47 139 237 269 368 977 Other pension and retiree medical benefits expense 10 20 2 67 Total $ 247 $ 289 $ 370 $ 1,044 Plan to Date through 12/25/2021 Severance and other employee costs $ 564 Asset impairments 157 Other costs 323 Total $ 1,044 Severance and other employee costs primarily include severance and other termination benefits, as well as voluntary separation arrangements. Other costs primarily include costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. Table of Contents A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 29, 2018 $ 105 $ $ 1 $ 106 2019 restructuring charges 149 92 129 370 Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation 12 ( 92 ) 10 ( 70 ) Liability as of December 28, 2019 128 21 149 2020 restructuring charges 158 33 98 289 Cash payments (a) ( 138 ) ( 117 ) ( 255 ) Non-cash charges and translation ( 26 ) ( 33 ) 3 ( 56 ) Liability as of December 26, 2020 122 5 127 2021 restructuring charges 120 32 95 247 Cash payments (a) ( 163 ) ( 93 ) ( 256 ) Non-cash charges and translation ( 15 ) ( 32 ) ( 47 ) Liability as of December 25, 2021 $ 64 $ $ 7 $ 71 (a) Excludes cash expenditures of $ 2 million in both 2021 and 2020, and $ 4 million in 2019, reported in the cash flow statement in pension and retiree medical plan contributions. Substantially all of the restructuring accrual at December 25, 2021 is expected to be paid by the end of 2022. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 Productivity Plan. We regularly evaluate different productivity initiatives beyond the productivity plan and other initiatives described above. Note 4 Intangible Assets A summary of our amortizable intangible assets is as follows: 2021 2020 2019 Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights (a) 56 60 $ 976 $ ( 187 ) $ 789 $ 976 $ ( 173 ) $ 803 Customer relationships 10 24 623 ( 227 ) 396 642 ( 204 ) 438 Brands (b) 20 40 1,151 ( 989 ) 162 1,348 ( 1,099 ) 249 Other identifiable intangibles 10 24 451 ( 260 ) 191 474 ( 261 ) 213 Total $ 3,201 $ ( 1,663 ) $ 1,538 $ 3,440 $ ( 1,737 ) $ 1,703 Amortization expense $ 91 $ 90 $ 81 (a) Acquired franchise rights includes our distribution agreement with Vital Pharmaceuticals, Inc., with an expected residual value higher than our carrying value. The distribution agreements useful life is three years, in accordance with the three-year termination notice issued, and is not reflected in the average useful life above. (b) The change primarily reflects assets reclassified as held for sale in connection with our Juice Transaction. See Note 13 for further information. Table of Contents Amortization is recognized on a straight-line basis over an intangible assets estimated useful life. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 25, 2021 and using average 2021 foreign exchange rates, is expected to be as follows: 2022 2023 2024 2025 2026 Five-year projected amortization $ 84 $ 84 $ 83 $ 81 $ 72 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 25, 2021, December 26, 2020 and December 28, 2019. We did not recognize any impairment charges for indefinite-lived intangible assets in the year ended December 25, 2021. In 2020, we recognized a pre-tax impairment charge of $ 41 million related to a coconut water brand in PBNA. We did not recognize any material impairment charges for indefinite-lived intangible assets in the year ended December 28, 2019. As of December 25, 2021, the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia on the estimated fair value of our indefinite-lived intangible assets in Russia and have concluded that there are no impairments for the year ended December 25, 2021. The estimated fair value of indefinite-lived intangible assets is dependent on macroeconomic conditions (including a resulting increase in the weighted-average cost of capital used to estimate fair value), future revenues and their contributions to operating results and expected future cash flows (including perpetuity growth assumptions), and significant changes in the decisions regarding assets that do not perform consistent with our expectations. Subsequent to December 25, 2021, we discontinued or repositioned certain juice and dairy brands in Russia in our Europe segment. As a result, we will recognize pre-tax impairment charges of approximately $ 0.2 billion in the first quarter of 2022 in selling, general and administrative expenses. For further information on our policies for indefinite-lived intangible assets, see Note 2. Table of Contents The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2020 Acquisitions Translation and Other Balance, End of 2020 Acquisitions/(Divestitures) Translation and Other Balance, End of 2021 FLNA (a) Goodwill $ 299 $ 164 $ 2 $ 465 $ ( 8 ) $ 1 $ 458 Brands 162 179 ( 1 ) 340 340 Total 461 343 1 805 ( 8 ) 1 798 QFNA Goodwill 189 189 189 Brands 11 ( 11 ) Total 200 ( 11 ) 189 189 PBNA (b) (c) Goodwill 9,898 2,280 11 12,189 ( 216 ) 1 11,974 Reacquired franchise rights 7,089 18 7,107 7,107 Acquired franchise rights 1,517 16 3 1,536 1 1 1,538 Brands (d) 763 2,400 ( 41 ) 3,122 ( 290 ) ( 324 ) 2,508 Total 19,267 4,696 ( 9 ) 23,954 ( 505 ) ( 322 ) 23,127 LatAm Goodwill 501 ( 43 ) 458 ( 25 ) 433 Brands 125 ( 17 ) 108 ( 1 ) ( 7 ) 100 Total 626 ( 60 ) 566 ( 1 ) ( 32 ) 533 Europe (b) Goodwill (e) 3,961 ( 2 ) ( 153 ) 3,806 ( 28 ) ( 78 ) 3,700 Reacquired franchise rights (e) 505 ( 9 ) 496 ( 23 ) ( 32 ) 441 Acquired franchise rights (e) 157 15 172 ( 14 ) 158 Brands (f) 4,181 ( 109 ) 4,072 182 4,254 Total 8,804 ( 2 ) ( 256 ) 8,546 ( 51 ) 58 8,553 AMESA (g) Goodwill 446 560 90 1,096 ( 2 ) ( 31 ) 1,063 Brands 183 31 214 ( 9 ) 205 Total 446 743 121 1,310 ( 2 ) ( 40 ) 1,268 APAC (h) Goodwill 207 306 41 554 3 7 564 Brands (d) 100 309 36 445 31 476 Total 307 615 77 999 3 38 1,040 Total goodwill 15,501 3,308 ( 52 ) 18,757 ( 251 ) ( 125 ) 18,381 Total reacquired franchise rights 7,594 9 7,603 ( 23 ) ( 32 ) 7,548 Total acquired franchise rights 1,674 16 18 1,708 1 ( 13 ) 1,696 Total brands 5,342 3,071 ( 112 ) 8,301 ( 291 ) ( 127 ) 7,883 Total $ 30,111 $ 6,395 $ ( 137 ) $ 36,369 $ ( 564 ) $ ( 297 ) $ 35,508 (a) Acquisitions/divestitures in 2021 and acquisitions in 2020 primarily reflect our acquisition of BFY Brands. (b) Acquisitions/divestitures in 2021 primarily reflects assets reclassified as held for sale in connection with our Juice Transaction. See Note 13 for further information. (c) Acquisitions in 2020 primarily reflects our acquisition of Rockstar. See Note 13 for further information. (d) Translation and other in 2021 primarily reflects the allocation of the Rockstar brand to the respective divisions, which was finalized in 2021 as part of purchase price allocation. (e) Translation and other primarily reflects the depreciation of the euro in 2021 and depreciation of the Russian ruble in 2020. (f) Translation and other in 2021 reflects the allocation of the Rockstar brand from PBNA, which was finalized in 2021 as part of purchase price allocation, partially offset by the depreciation of the euro. Translation and other in 2020 primarily reflects the depreciation of the Russian ruble. Table of Contents (g) Acquisitions in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 13 for further information. (h) Acquisitions in 2020 primarily reflects our acquisition of Be Cheery. See Note 13 for further information. Note 5 Income Taxes The components of income before income taxes are as follows: 2021 2020 2019 United States $ 3,740 $ 4,070 $ 4,123 Foreign 6,081 4,999 5,189 $ 9,821 $ 9,069 $ 9,312 The provision for income taxes consisted of the following: 2021 2020 2019 Current: U.S. Federal $ 702 $ 715 $ 652 Foreign 955 932 807 State 44 110 196 1,701 1,757 1,655 Deferred: U.S. Federal 375 273 325 Foreign ( 14 ) ( 167 ) ( 31 ) State 80 31 10 441 137 304 $ 2,142 $ 1,894 $ 1,959 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: 2021 2020 2019 U.S. Federal statutory tax rate 21.0 % 21.0 % 21.0 % State income tax, net of U.S. Federal tax benefit 1.0 1.2 1.6 Lower taxes on foreign results ( 1.6 ) ( 0.8 ) ( 0.9 ) One-time mandatory transition tax - TCJ Act 1.9 ( 0.1 ) Other, net ( 0.5 ) ( 0.5 ) ( 0.6 ) Annual tax rate 21.8 % 20.9 % 21.0 % Tax Cuts and Jobs Act In 2021, we recorded $ 190 million ($ 0.14 per share) of net tax expense related to the TCJ Act as a result of adjustments related to the final assessment of the 2014 through 2016 IRS audit . There were no tax amounts recognized in 2020 related to the TCJ Act. In 2019, we recognized a net tax benefit totaling $ 8 million ($ 0.01 per share) related to the TCJ Act. As of December 25, 2021, our mandatory transition tax liability was $ 2.9 billion, which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 309 million in 2021, $ 78 million in 2020 and $ 663 million in 2019. We currently expect to pay approximately $ 309 million of this liability in 2022. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary Table of Contents differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. We elected to treat the tax effect of GILTI as a current-period expense when incurred. Other Tax Matters In 2021, we received a final assessment from the IRS audit for the tax years 2014 through 2016. The assessment included both agreed and unagreed issues. On October 29, 2021, we filed a formal written protest of the assessment and requested an appeals conference. As a result of the analysis of the 2014 through 2016 final assessment, we remeasured all applicable reserves for uncertain tax positions for all years open under the statute of limitations, including any correlating adjustments impacting the mandatory transition tax liability under the TCJ Act, resulting in a net non-cash tax expense of $ 112 million in 2021. On May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2021, no income tax adjustments related to the TRAF were recorded. During 2020, we recorded a net tax benefit of $ 72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded a net tax expense of $ 24 million related to the impact of the TRAF. While the accounting for the impacts of the TRAF are deemed to be complete, further adjustments to our financial statements and related disclosures could be made in future quarters, including in connection with final tax return filings. Deferred tax liabilities and assets are comprised of the following: 2021 2020 Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ 578 $ 578 Property, plant and equipment 2,036 1,851 Recapture of net operating losses 504 504 Pension liabilities 216 Right-of-use assets 450 371 Other 254 159 Gross deferred tax liabilities 4,038 3,463 Deferred tax assets Net carryforwards 4,974 5,008 Intangible assets other than nondeductible goodwill 1,111 1,146 Share-based compensation 98 90 Retiree medical benefits 147 153 Other employee-related benefits 379 373 Pension benefits 80 Deductible state tax and interest benefits 149 150 Lease liabilities 450 371 Other 842 866 Gross deferred tax assets 8,150 8,237 Valuation allowances ( 4,628 ) ( 4,686 ) Deferred tax assets, net 3,522 3,551 Net deferred tax liabilities/(assets) $ 516 $ ( 88 ) Table of Contents A summary of our valuation allowance activity is as follows: 2021 2020 2019 Balance, beginning of year $ 4,686 $ 3,599 $ 3,753 Provision ( 9 ) 1,082 ( 124 ) Other (deductions)/additions ( 49 ) 5 ( 30 ) Balance, end of year $ 4,628 $ 4,686 $ 3,599 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2020 2014-2019 Mexico 2014-2020 2014-2016 United Kingdom 2018-2020 None Canada (Domestic) 2016-2020 2016-2017 Canada (International) 2010-2020 2010-2017 Russia 2018-2020 None Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 25, 2021, the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.9 billion. We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 326 million as of December 25, 2021, of which $ 3 million of tax benefit was recognized in 2021. The gross amount of interest accrued, reported in other liabilities, was $ 338 million as of December 26, 2020, of which $ 93 million of tax expense was recognized in 2020. Table of Contents A reconciliation of unrecognized tax benefits is as follows: 2021 2020 Balance, beginning of year $ 1,621 $ 1,395 Additions for tax positions related to the current year 222 128 Additions for tax positions from prior years 681 153 Reductions for tax positions from prior years ( 558 ) ( 22 ) Settlement payments ( 25 ) ( 13 ) Statutes of limitations expiration ( 39 ) ( 23 ) Translation and other ( 2 ) 3 Balance, end of year $ 1,900 $ 1,621 Carryforwards and Allowances Operating loss carryforwards totaling $ 30.0 billion as of December 25, 2021 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.3 billion in 2022, $ 26.8 billion between 2023 and 2041 and $ 2.9 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is not more likely than not that some portion or all of the deferred tax assets will be realized. Undistributed International Earnings As of December 25, 2021, we had approximately $ 7 billion of undistributed international earnings. We intend to continue to reinvest $ 7 billion of earnings outside the United States for the foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs and PSUs. As of December 25, 2021, 44 million shares were available for future share-based compensation grants under the LTIP. Table of Contents The following table summarizes our total share-based compensation expense, which is primarily recorded in selling, general and administrative expenses, and excess tax benefits recognized: 2021 2020 2019 Share-based compensation expense - equity awards $ 301 $ 264 $ 237 Share-based compensation expense - liability awards 20 11 8 Restructuring charges 1 ( 1 ) ( 2 ) Total $ 322 $ 274 $ 243 Income tax benefits recognized in earnings related to share-based compensation $ 57 $ 48 $ 39 Excess tax benefits related to share-based compensation $ 38 $ 35 $ 50 As of December 25, 2021, there was $ 372 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: 2021 2020 2019 Expected life 7 years 6 years 5 years Risk-free interest rate 1.1 % 0.9 % 2.4 % Expected volatility 14 % 14 % 14 % Expected dividend yield 3.1 % 3.4 % 3.1 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. Table of Contents A summary of our stock option activity for the year ended December 25, 2021 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 26, 2020 10,640 $ 99.54 Granted 2,157 $ 134.25 Exercised ( 2,321 ) $ 79.87 Forfeited/expired ( 334 ) $ 125.35 Outstanding at December 25, 2021 10,142 $ 110.54 5.79 $ 600,755 Exercisable at December 25, 2021 5,407 $ 93.49 3.47 $ 412,524 Expected to vest as of December 25, 2021 4,419 $ 129.78 8.41 $ 176,771 (a) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. A summary of our RSU and PSU activity for the year ended December 25, 2021 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 26, 2020 6,127 $ 119.92 Granted 2,636 $ 131.81 Converted ( 2,229 ) $ 112.09 Forfeited ( 557 ) $ 126.70 Outstanding at December 25, 2021 (b) 5,977 $ 127.45 1.31 $ 1,014,854 Expected to vest as of December 25, 2021 (c) 6,016 $ 127.59 1.30 $ 1,021,312 (a) In thousands. Outstanding awards are disclosed at target. (b) The outstanding PSUs for which the vesting period has not ended as of December 25, 2021, at the threshold, target and maximum award levels were zero , 1 million and 2 million, respectively. (c) Represents the number of outstanding awards expected to vest, including estimated performance adjustments on all outstanding PSUs as of December 25, 2021. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and Table of Contents achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. A summary of our long-term cash activity for the year ended December 25, 2021 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 26, 2020 $ 47,513 Granted 16,507 Vested ( 16,567 ) Forfeited ( 1,661 ) Outstanding at December 25, 2021 (b) $ 45,792 $ 50,238 1.29 Expected to vest as of December 25, 2021 (c) $ 43,480 $ 47,771 1.27 (a) In thousands. Outstanding awards are disclosed at target. (b) The outstanding awards for which the vesting period has not ended as of December 25, 2021, at the threshold, target and maximum award levels based on the achievement of its market conditions were zero , $ 46 million and $ 92 million, respectively. (c) Represents the number of outstanding awards expected to vest, based on the most recent valuation as of December 25, 2021. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: 2021 2020 2019 Stock Options Total number of options granted (a) 2,157 1,847 1,286 Weighted-average grant-date fair value of options granted $ 9.88 $ 8.31 $ 10.89 Total intrinsic value of options exercised (a) $ 153,306 $ 155,096 $ 275,745 Total grant-date fair value of options vested (a) $ 10,605 $ 8,652 $ 9,838 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,636 2,496 2,754 Weighted-average grant-date fair value of RSUs/PSUs granted $ 131.81 $ 131.21 $ 116.87 Total intrinsic value of RSUs/PSUs converted (a) $ 273,878 $ 303,165 $ 333,951 Total grant-date fair value of RSUs/PSUs vested (a) $ 198,469 $ 235,523 $ 275,234 (a) In thousands. As of December 25, 2021 and December 26, 2020, there were approximately 299,000 and 287,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Table of Contents Note 7 Pension, Retiree Medical and Savings Plans In connection with our Juice Transaction subsequent to December 25, 2021, we transferred pension and retiree medical obligations of approximately $ 150 million and related assets to the newly formed joint venture. In 2021, we adopted a change to the Canadian defined benefit plans to freeze pension accruals for salaried participants, effective January 1, 2024, and to close the hourly plan to new non-union employees hired on or after January 1, 2022. After the effective date, all salaried participants will receive an employer contribution to the defined contribution plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. We also adopted a change to the U.K. defined benefit plan to freeze pension accruals for all participants effective March 31, 2022. After the effective date, participants will have the opportunity to receive employer contributions to match employee contributions up to defined limits. Pre-tax pension benefits expense will decrease after the effective dates, partially offset by contributions to defined contribution plans. In 2021, we adopted a change to the U.S. qualified defined benefit plans to transfer certain participants from PepsiCo Employees Retirement Plan A (Plan A) to PepsiCo Employees Retirement Plan I (Plan I), effective January 1, 2022. The benefits offered to the plans participants were unchanged. There is no material impact to pre-tax pension benefits expense from this transaction. In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A of $ 205 million ($ 158 million after-tax or $ 0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pre-tax pension benefits expense decreased $ 70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to Plan I and to a newly created plan, PepsiCo Employees Retirement Hourly Plan (Plan H), effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization facilitated a more targeted investment strategy and provided additional flexibility in evaluating opportunities to reduce risk and volatility. There was no material impact to pre-tax pension benefits expense as a result of this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pre-tax pension benefits expense increased $ 45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ($ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ($ 211 million after-tax or $ 0.15 per share). Table of Contents Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10 % of the greater of the market-related value of plan assets or plan obligations, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 9 years), Plan H (approximately 11 years) and retiree medical (approximately 9 years), and the remaining life expectancy for participants in Plan I (approximately 27 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in both Plan A and Plan H, except that prior service cost/(credit) for salaried participants subject to the freeze is amortized on a straight-line basis over the period up to the effective date of the freeze, or the remaining life expectancy for participants in Plan I. Table of Contents Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International 2021 2020 2021 2020 2021 2020 Change in projected benefit obligation Obligation at beginning of year $ 16,753 $ 15,230 $ 4,430 $ 3,753 $ 1,006 $ 988 Service cost 518 434 104 86 33 25 Interest cost 324 435 74 85 15 25 Plan amendments 23 ( 221 ) 3 ( 17 ) ( 25 ) Participant contributions 3 2 Experience (gain)/loss ( 215 ) 2,042 ( 178 ) 467 ( 17 ) 81 Benefit payments ( 976 ) ( 378 ) ( 106 ) ( 92 ) ( 83 ) ( 89 ) Settlement/curtailment ( 220 ) ( 808 ) ( 99 ) ( 24 ) Special termination benefits 9 19 Other, including foreign currency adjustment ( 56 ) 170 1 Obligation at end of year $ 16,216 $ 16,753 $ 4,175 $ 4,430 $ 954 $ 1,006 Change in fair value of plan assets Fair value at beginning of year $ 15,465 $ 14,302 $ 4,303 $ 3,732 $ 315 $ 302 Actual return on plan assets 1,052 1,908 387 401 20 47 Employer contributions/funding 580 387 158 120 47 55 Participant contributions 3 2 Benefit payments ( 976 ) ( 378 ) ( 106 ) ( 92 ) ( 83 ) ( 89 ) Settlement ( 217 ) ( 754 ) ( 52 ) ( 29 ) Other, including foreign currency adjustment ( 69 ) 169 Fair value at end of year $ 15,904 $ 15,465 $ 4,624 $ 4,303 $ 299 $ 315 Funded status $ ( 312 ) $ ( 1,288 ) $ 449 $ ( 127 ) $ ( 655 ) $ ( 691 ) Amounts recognized Other assets $ 692 $ 797 $ 564 $ 110 $ $ Other current liabilities ( 48 ) ( 53 ) ( 1 ) ( 1 ) ( 57 ) ( 51 ) Other liabilities ( 956 ) ( 2,032 ) ( 114 ) ( 236 ) ( 598 ) ( 640 ) Net amount recognized $ ( 312 ) $ ( 1,288 ) $ 449 $ ( 127 ) $ ( 655 ) $ ( 691 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,550 $ 4,116 $ 696 $ 1,149 $ ( 220 ) $ ( 212 ) Prior service (credit)/cost ( 63 ) ( 119 ) ( 11 ) ( 19 ) ( 34 ) ( 45 ) Total $ 3,487 $ 3,997 $ 685 $ 1,130 $ ( 254 ) $ ( 257 ) Changes recognized in net (gain)/loss included in other comprehensive loss Net (gain)/loss arising in current year $ ( 301 ) $ 1,009 $ ( 355 ) $ 268 $ ( 22 ) $ 50 Amortization and settlement recognition ( 265 ) ( 409 ) ( 95 ) ( 75 ) 14 23 Foreign currency translation (gain)/loss ( 3 ) 42 Total $ ( 566 ) $ 600 $ ( 453 ) $ 235 $ ( 8 ) $ 73 Accumulated benefit obligation at end of year $ 15,489 $ 15,949 $ 4,021 $ 4,108 The net gain arising in the current year is primarily attributable to the increase in discount rate offset by actual experience differing from demographic assumptions. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. Table of Contents The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Lump sum payouts are generally higher when interest rates are lower. Curtailments are recognized when events such as plant closures, the sale of a business, or plan changes result in a significant reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ 518 $ 434 $ 381 $ 104 $ 86 $ 73 $ 33 $ 25 $ 23 Other pension and retiree medical benefits (income)/expense: Interest cost $ 324 $ 435 $ 543 $ 74 $ 85 $ 97 $ 15 $ 25 $ 36 Expected return on plan assets ( 970 ) ( 929 ) ( 892 ) ( 231 ) ( 202 ) ( 188 ) ( 15 ) ( 16 ) ( 18 ) Amortization of prior service (credits)/cost ( 31 ) 12 10 ( 2 ) ( 11 ) ( 12 ) ( 19 ) Amortization of net losses/(gains) 224 196 161 77 61 32 ( 14 ) ( 23 ) ( 27 ) Settlement/curtailment losses/(gains) (a) 40 213 296 ( 11 ) 19 12 Special termination benefits 9 19 1 Total other pension and retiree medical benefits (income)/expense $ ( 404 ) $ ( 54 ) $ 119 $ ( 93 ) $ ( 37 ) $ ( 47 ) $ ( 25 ) $ ( 26 ) $ ( 28 ) Total $ 114 $ 380 $ 500 $ 11 $ 49 $ 26 $ 8 $ ( 1 ) $ ( 5 ) (a) In 2020, U.S. includes a settlement charge of $ 205 million ($ 158 million after-tax or $ 0.11 per share) related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million ($ 170 million after-tax or $ 0.12 per share) and a pension lump sum settlement charge of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Table of Contents The following table provides the weighted-average assumptions used to determine net periodic benefit cost and projected benefit obligation for our pension and retiree medical plans: Pension Retiree Medical U.S. International 2021 2020 2019 2021 2020 2019 2021 2020 2019 Net Periodic Benefit Cost Service cost discount rate 2.6 % 3.4 % 4.4 % 2.7 % 3.2 % 4.2 % 2.3 % 3.2 % 4.3 % Interest cost discount rate 2.0 % 2.9 % 4.1 % 1.7 % 2.4 % 3.2 % 1.6 % 2.6 % 3.8 % Expected return on plan assets 6.4 % 6.8 % 7.1 % 5.3 % 5.6 % 5.8 % 5.4 % 5.8 % 6.6 % Rate of salary increases 3.0 % 3.1 % 3.1 % 3.3 % 3.3 % 3.7 % Projected Benefit Obligation Discount rate 2.9 % 2.5 % 3.3 % 2.4 % 2.0 % 2.5 % 2.7 % 2.3 % 3.1 % Rate of salary increases 3.0 % 3.0 % 3.1 % 3.3 % 3.3 % 3.3 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit obligation in excess of plan assets: Pension Retiree Medical U.S. International 2021 2020 2021 2020 2021 2020 Selected information for plans with accumulated benefit obligation in excess of plan assets (a) Obligation for service to date $ ( 1,499 ) $ ( 5,537 ) $ ( 127 ) $ ( 172 ) Fair value of plan assets $ 705 $ 4,156 $ 102 $ 123 Selected information for plans with projected benefit obligation in excess of plan assets (a) Benefit obligation $ ( 1,709 ) $ ( 9,172 ) $ ( 286 ) $ ( 2,933 ) $ ( 954 ) $ ( 1,006 ) Fair value of plan assets $ 705 $ 7,088 $ 171 $ 2,696 $ 299 $ 315 (a) The decrease in U.S. pension plans with obligations in excess of plan assets primarily reflects employer contributions to Plan H. Of the total projected pension benefit obligation as of December 25, 2021, approximately $ 810 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2022 2023 2024 2025 2026 2027 - 2031 Pension $ 1,110 $ 960 $ 960 $ 995 $ 1,030 $ 5,385 Retiree medical (a) $ 95 $ 90 $ 90 $ 85 $ 80 $ 355 (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 1 million for each of the years from 2022 through 2026 and approximately $ 4 million in total for 2027 through 2031. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Table of Contents Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical 2021 2020 2019 2021 2020 2019 Discretionary (a) $ 525 $ 339 $ 417 $ $ $ Non-discretionary 213 168 255 47 55 44 Total $ 738 $ 507 $ 672 $ 47 $ 55 $ 44 (a) Includes $ 500 million contribution in 2021, $ 325 million contribution in 2020 and $ 400 million contribution in 2019 to fund our qualified defined benefit plans in the United States. We made a discretionary contribution of $ 75 million to our U.S. qualified defined benefit plans in January 2022 and expect to make an additional $ 75 million contribution in the third quarter of 2022. In addition, in 2022, we expect to make non-discretionary contributions of approximately $ 135 million to our U.S. and international pension benefit plans and approximately $ 55 million for retiree medical benefits. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We also regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan obligations, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected obligations. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2022 and 2021, our expected long-term rate of return on U.S. plan assets is 6.3 % and 6.4 %, respectively. Our target investment allocations for U.S. plan assets are as follows: 2022 2021 Fixed income 56 % 51 % U.S. equity 22 % 24 % International equity 18 % 21 % Real estate 4 % 4 % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets Table of Contents for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2021 and 2020 are categorized consistently by Level 1 (quoted prices in active markets for identical assets), Level 2 (significant other observable inputs) and Level 3 (significant unobservable inputs) in both years and are as follows: Fair Value Hierarchy Level 2021 2020 U.S. plan assets (a) Equity securities, including preferred stock (b) 1 $ 6,387 $ 7,179 Government securities (c) 2 2,523 2,177 Corporate bonds (c) 2 6,210 5,437 Mortgage-backed securities (c) 2 199 119 Contracts with insurance companies (d) 3 9 9 Cash and cash equivalents (e) 1, 2 352 278 Sub-total U.S. plan assets 15,680 15,199 Real estate commingled funds measured at net asset value (f) 478 517 Dividends and interest receivable, net of payables 45 64 Total U.S. plan assets $ 16,203 $ 15,780 International plan assets Equity securities (b) 1 $ 2,232 $ 2,119 Government securities (c) 2 1,053 937 Corporate bonds (c) 2 400 445 Fixed income commingled funds (g) 1 632 509 Contracts with insurance companies (d) 3 43 50 Cash and cash equivalents 1 34 33 Sub-total international plan assets 4,394 4,093 Real estate commingled funds measured at net asset value (f) 221 202 Dividends and interest receivable 9 8 Total international plan assets $ 4,624 $ 4,303 (a) Includes $ 299 million and $ 315 million in 2021 and 2020, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) Invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio was invested in domestic and international corporate preferred stock investments. The common and preferred stock investments are based on quoted prices in active markets. The commingled funds are based on the published price of the fund and include one large-cap fund that represents 11 % and 13 % of total U.S. plan assets for 2021 and 2020, respectively. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 32 % and 30 % of total U.S. plan assets for 2021 and 2020, respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 25, 2021 and December 26, 2020. (e) Includes Level 1 assets of $ 216 million and $ 178 million for 2021 and 2020, respectively, and Level 2 assets of $ 136 million and $ 100 million for 2021 and 2020, respectively. (f) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (g) Based on the published price of the fund. Table of Contents Retiree Medical Cost Trend Rates 2022 2021 Average increase assumed 6 % 6 % Ultimate projected increase 4 % 5 % Year of ultimate projected increase 2046 2040 These assumed health care cost trend rates have an impact on the retiree medical plan expense and obligation, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement and we make Company matching contributions for certain employees on a portion of employee contributions based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution based on age and years of service regardless of employee contribution. In 2021, 2020 and 2019, our total Company contributions were $ 246 million, $ 225 million and $ 197 million, respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2021 (a) 2020 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,872 $ 3,358 Commercial paper ( 0.1 % and 0.2 %) 400 396 Other borrowings ( 2.2 % and 1.7 %) 36 26 $ 4,308 $ 3,780 Long-term debt obligations (b) Notes due 2021 ( 2.2 %) $ $ 3,356 Notes due 2022 ( 2.4 % and 2.5 %) 3,868 3,867 Notes due 2023 ( 1.5 % and 1.5 %) 3,019 3,017 Notes due 2024 ( 2.1 % and 2.1 %) 2,986 3,067 Notes due 2025 ( 2.7 % and 2.7 %) 3,230 3,227 Notes due 2026 ( 3.2 % and 3.2 %) 2,450 2,492 Notes due 2027-2060 ( 2.6 % and 2.8 %) 24,313 24,673 Other, due 2021-2027 ( 1.3 % and 1.3 %) 32 29 39,898 43,728 Less: current maturities of long-term debt obligations 3,872 3,358 Total $ 36,026 $ 40,370 (a) Amounts are shown net of unamortized net discounts of $ 233 million and $ 260 million for 2021 and 2020, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. As of December 25, 2021 and December 26, 2020, our international debt of $ 38 million and $ 29 million, respectively, was related to borrowings from external parties, including various lines of credit. These lines Table of Contents of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2021, we issued the following senior notes: Interest Rate Maturity Date Amount (a) 0.750 % October 2033 1,000 1.950 % October 2031 $ 1,250 2.625 % October 2041 $ 750 2.750 % October 2051 $ 1,000 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. The net proceeds from the issuances of the above notes will be used for general corporate purposes, including the repurchase of outstanding indebtedness and the repayment of commercial paper. In 2021, we paid $ 4.8 billion in cash in connection with the tender of certain notes redeemed in the following amounts: Interest Rate Maturity Date Principal Amount Tendered 5.500 % May 2035 $ 8 5.500 % May 2035 $ 1 (a) 5.500 % January 2040 $ 26 3.500 % March 2040 $ 443 4.875 % November 2040 $ 30 4.000 % March 2042 $ 261 3.600 % August 2042 $ 210 4.250 % October 2044 $ 190 4.600 % July 2045 $ 203 4.450 % April 2046 $ 532 3.450 % October 2046 $ 622 4.000 % May 2047 $ 212 3.375 % July 2049 $ 508 3.625 % March 2050 $ 611 3.875 % March 2060 $ 240 (a) Series A. As a result of the cash tender offers, we recorded a pre-tax charge of $ 842 million ($ 677 million after-tax or $ 0.49 per share) to net interest expense and other, primarily representing the tender price paid over the carrying value of the tendered notes and loss on treasury rate locks used to mitigate the interest rate risk on the cash tender offers. See Note 9 to our consolidated financial statements for the mark-to-market impact of treasury rate locks associated with the cash tender offers. In 2021, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement), which expires on May 28, 2026. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). Additionally, we may, once a year, Table of Contents request renewal of the agreement for an additional one-year period. The Five-Year Credit Agreement replaced our $ 3.75 billion five year credit agreement, dated as of June 3, 2019. Also in 2021, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement), which expires on May 27, 2022. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which term loan would mature no later than the anniversary of the then effective termination date. The 364-Day Credit Agreement replaced our $ 3.75 billion 364-day credit agreement, dated as of June 1, 2020. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 25, 2021, there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2020, one of our international consolidated subsidiaries borrowed 21.7 billion South African rand, or approximately $ 1.3 billion, from our two unsecured bridge loan facilities (Bridge Loan Facilities) to fund our acquisition of Pioneer Foods. These borrowings were fully repaid in April 2020 and no further borrowings under these Bridge Loan Facilities are permitted. In 2021, we paid $ 750 million to redeem all $ 750 million outstanding principal amount of our 1.70 % senior notes due 2021 and terminated the associated interest rate swap with a notional amount of $ 250 million. In 2020, we paid $ 1.1 billion to redeem all $ 1.1 billion outstanding principal amount of our 2.15 % senior notes due 2020 and terminated associated interest rate swaps with a notional amount of $ 0.8 billion. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. We do not use derivative instruments for trading or speculative purposes. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other Table of Contents comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 25, 2021 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. Credit Risk We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below either of these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position as of December 25, 2021 was $ 247 million. We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 25, 2021. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.6 billion as of December 25, 2021 and $ 1.1 billion as of December 26, 2020. Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Table of Contents Our foreign currency derivatives had a total notional value of $ 2.8 billion as of December 25, 2021 and $ 1.9 billion as of December 26, 2020. The total notional amount of our debt instruments designated as net investment hedges was $ 2.1 billion as of December 25, 2021 and $ 2.7 billion as of December 26, 2020. For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 2.1 billion as of December 25, 2021 and $ 3.0 billion as of December 26, 2020. As of December 25, 2021, approximately 2 % of total debt was subject to variable rates, compared to approximately 3 %, after the impact of the related interest rate derivative instruments, as of December 26, 2020. Held-to-Maturity Debt Securities Investments in debt securities that we have the positive intent and ability to hold until maturity are classified as held-to-maturity. Highly liquid debt securities with original maturities of three months or less are recorded as cash equivalents. Our held-to-maturity debt securities consist of U.S. Treasury securities and commercial paper. As of December 25, 2021, we had no investments in U.S. Treasury securities. As of December 26, 2020, we had $ 2.1 billion of investments in U.S. Treasury securities with $ 2.0 billion recorded in cash and cash equivalents and $ 0.1 billion in short-term investments. As of December 25, 2021, we had $ 130 million of investments in commercial paper recorded in cash and cash equivalents. As of December 26, 2020, we had $ 260 million of investments in commercial paper with $ 75 million recorded in cash and cash equivalents and $ 185 million in short-term investments. Held-to-maturity debt securities are recorded at amortized cost, which approximates fair value, and realized gains or losses are reported in earnings. Our investments mature in less than one year. As of December 25, 2021 and December 26, 2020, gross unrecognized gains and losses and the allowance for expected credit losses were not material. Table of Contents Fair Value Measurements The fair values of our financial assets and liabilities as of December 25, 2021 and December 26, 2020 are categorized as follows: 2021 2020 Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Index funds (b) 1 $ 337 $ $ 231 $ Prepaid forward contracts (c) 2 $ 21 $ $ 18 $ Deferred compensation (d) 2 $ $ 505 $ $ 477 Contingent consideration (e) 3 $ $ $ $ 861 Derivatives designated as fair value hedging instruments: Interest rate (f) 2 $ $ $ 2 $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) 2 $ 29 $ 14 $ 9 $ 71 Interest rate (g) 2 14 264 13 307 Commodity (h) 2 70 5 32 $ 113 $ 283 $ 54 $ 378 Derivatives not designated as hedging instruments: Foreign exchange (g) 2 $ 19 $ 7 $ 4 $ 8 Commodity (h) 2 35 22 19 7 $ 54 $ 29 $ 23 $ 15 Total derivatives at fair value (i) $ 167 $ 312 $ 79 $ 393 Total $ 525 $ 817 $ 328 $ 1,731 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (c) Based primarily on the price of our common stock. (d) Based on the fair value of investments corresponding to employees investment elections. (e) In connection with our acquisition of Rockstar, we recorded a liability for tax-related contingent consideration payable over up to 15 years, with an option to accelerate all remaining payments, with estimated maximum payments of approximately $ 1.1 billion, using current tax rates. The fair value of the liability is estimated using probability-weighted, discounted future cash flows at current tax rates. In the fourth quarter of 2021, we exercised our option to accelerate all remaining payments. The change in the contingent consideration in 2021 is comprised of the fourth quarter payment of $ 773 million, a recognized pre-tax gain of $ 86 million ($ 66 million after-tax or $ 0.05 per share), recorded in selling, general and administrative expenses, and a fair value decrease of $ 2 million, recorded in goodwill as a result of the finalization of purchase price allocation. (f) Based on London Interbank Offered Rate forward rates. As of December 25, 2021, we had no hedged fixed-rate debt. As of December 26, 2020, the carrying amount of hedged fixed-rate debt was $ 0.2 billion and classified on our balance sheet within short-term debt obligations. As of December 25, 2021, there were no fair value hedging adjustments to hedged fixed-rate debt. As of December 26, 2020, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was a $ 2 million gain. As of December 25, 2021, the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 2 million net loss, which is being amortized over the remaining life of the related debt obligations. (g) Based on recently reported market transactions of spot and forward rates. (h) Primarily based on recently reported market transactions of swap arrangements. (i) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 25, 2021 and December 26, 2020 were not material. Collateral received or posted against our asset or liability positions was not material. Exchange-traded commodity futures are cash-settled on a daily basis and, therefore, not included in the table as of December 25, 2021. Table of Contents The carrying amounts of our cash and cash equivalents and short-term investments recorded at amortized cost approximate fair value (classified as Level 2 in the fair value hierarchy) due to their short-term maturity. The fair value of our debt obligations as of December 25, 2021 and December 26, 2020 was $ 43 billion and $ 50 billion, respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) 2021 2020 2021 2020 2021 2020 Foreign exchange $ ( 4 ) $ $ ( 7 ) $ ( 9 ) $ 82 $ ( 43 ) Interest 56 ( 6 ) 44 ( 96 ) 64 ( 129 ) Commodity ( 218 ) 53 ( 285 ) ( 21 ) ( 194 ) 56 Net investment ( 192 ) 235 Total $ ( 166 ) $ 47 $ ( 440 ) $ 109 $ ( 48 ) $ ( 116 ) (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from treasury rate locks, with a total notional value of $ 3.2 billion, to mitigate the interest rate risk on the cash tender offers and are included in net interest expense and other. See Note 8 to our consolidated financial statements for further information. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains on cross-currency interest rate swaps are included in selling, general and administrative expenses. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net gains of $ 176 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Table of Contents Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: 2021 2020 2019 Income Shares (a) Income Shares (a) Income Shares (a) Basic net income attributable to PepsiCo per common share $ 5.51 $ 5.14 $ 5.23 Net income available for PepsiCo common shareholders $ 7,618 1,382 $ 7,120 1,385 $ 7,314 1,399 Dilutive securities: Stock options, RSUs, PSUs and other (b) 7 7 8 Diluted $ 7,618 1,389 $ 7,120 1,392 $ 7,314 1,407 Diluted net income attributable to PepsiCo per common share $ 5.49 $ 5.12 $ 5.20 (a) Weighted-average common shares outstanding (in millions). (b) The dilutive effect of these securities is calculated using the treasury stock method. The weighted-average amount of antidilutive securities excluded from the calculation of diluted earnings per common share was immaterial for the years ended December 25, 2021, December 26, 2020 and December 28, 2019. Table of Contents Note 11 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Other (a) Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 29, 2018 (b) $ ( 11,918 ) $ 87 $ ( 3,271 ) $ ( 17 ) $ ( 15,119 ) Other comprehensive income/(loss) before reclassifications (c) 636 ( 131 ) ( 89 ) ( 2 ) 414 Amounts reclassified from accumulated other comprehensive loss 14 468 482 Net other comprehensive income/(loss) 636 ( 117 ) 379 ( 2 ) 896 Tax amounts ( 8 ) 27 ( 96 ) ( 77 ) Balance as of December 28, 2019 (b) ( 11,290 ) ( 3 ) ( 2,988 ) ( 19 ) ( 14,300 ) Other comprehensive (loss)/income before reclassifications (d) ( 710 ) 126 ( 1,141 ) ( 1 ) ( 1,726 ) Amounts reclassified from accumulated other comprehensive loss ( 116 ) 465 349 Net other comprehensive (loss)/income ( 710 ) 10 ( 676 ) ( 1 ) ( 1,377 ) Tax amounts 60 ( 3 ) 144 201 Balance as of December 26, 2020 (b) ( 11,940 ) 4 ( 3,520 ) ( 20 ) ( 15,476 ) Other comprehensive (loss)/income before reclassifications (e) ( 340 ) 248 702 22 632 Amounts reclassified from accumulated other comprehensive loss 18 ( 48 ) 299 269 Net other comprehensive (loss)/income ( 322 ) 200 1,001 22 901 Tax amounts ( 47 ) ( 45 ) ( 231 ) ( 323 ) Balance as of December 25, 2021 (b) $ ( 12,309 ) $ 159 $ ( 2,750 ) $ 2 $ ( 14,898 ) (a) The change in 2021 primarily comprises fair value increases in available-for-sale securities. (b) Pension and retiree medical amounts are net of taxes of $ 1,466 million as of December 29, 2018, $ 1,370 million as of December 28, 2019, $ 1,514 million as of December 26, 2020 and $ 1,283 million as of December 25, 2021. (c) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. (d) Currency translation adjustment primarily reflects the depreciation of the Russian ruble and Mexican peso. (e) Currency translation adjustment primarily reflects the depreciation of the Turkish lira, Swiss franc and Mexican peso. Table of Contents The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement 2021 2020 2019 Currency translation: Divestitures $ 18 $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ 6 $ $ 1 Net revenue Foreign exchange contracts 76 ( 43 ) 2 Cost of sales Interest rate derivatives 64 ( 129 ) 7 Selling, general and administrative expenses Commodity contracts ( 190 ) 50 3 Cost of sales Commodity contracts ( 4 ) 6 1 Selling, general and administrative expenses Net (gains)/losses before tax ( 48 ) ( 116 ) 14 Tax amounts 11 29 ( 2 ) Net (gains)/losses after tax $ ( 37 ) $ ( 87 ) $ 12 Pension and retiree medical items: Amortization of net prior service credit $ ( 44 ) $ $ ( 9 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses 289 238 169 Other pension and retiree medical benefits income/(expense) Settlement/curtailment losses 54 227 308 Other pension and retiree medical benefits income/(expense) Net losses before tax 299 465 468 Tax amounts ( 65 ) ( 101 ) ( 102 ) Net losses after tax $ 234 $ 364 $ 366 Total net losses reclassified for the year, net of tax $ 215 $ 277 $ 378 Note 12 Leases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years, some of which include options to extend the lease term for up to five years and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Table of Contents Components of lease cost are as follows: 2021 2020 2019 Operating lease cost (a) $ 563 $ 539 $ 474 Variable lease cost (b) $ 112 $ 111 $ 101 Short-term lease cost (c) $ 469 $ 436 $ 379 (a) Includes right-of-use asset amortization of $ 505 million, $ 478 million, and $ 412 million in 2021, 2020, and 2019, respectively. (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. In 2021, 2020 and 2019, we recognized gains of $ 42 million, $ 7 million and $ 77 million, respectively, on sale-leaseback transactions with terms under five years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: 2021 2020 2019 Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ 567 $ 555 $ 478 Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ 934 $ 621 $ 479 Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification 2021 2020 Right-of-use assets Other assets $ 2,020 $ 1,670 Current lease liabilities Accounts payable and other current liabilities $ 446 $ 460 Non-current lease liabilities Other liabilities $ 1,598 $ 1,233 Weighted-average remaining lease term and discount rate for our operating leases are as follows: 2021 2020 2019 Weighted-average remaining lease term 7 years 6 years 6 years Weighted-average discount rate 3 % 4 % 4 % Maturities of lease liabilities by year for our operating leases are as follows: 2022 $ 511 2023 402 2024 314 2025 245 2026 202 2027 and beyond 677 Total lease payments 2,351 Less: Imputed interest 307 Present value of lease liabilities $ 2,044 Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Table of Contents Note 13 Acquisitions and Divestitures 2020 Acquisitions On March 23, 2020, we acquired all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe, for 110.00 South African rand per share in cash. The total consideration transferred was approximately $ 1.2 billion and was funded by two unsecured bridge loan facilities entered into by one of our international consolidated subsidiaries, which were fully repaid in April 2020. In connection with our acquisition of Pioneer Foods, we have made certain commitments to the South Africa Competition Commission, including a commitment to provide the equivalent of 8.8 billion South African rand, or approximately $ 0.5 billion as of the acquisition date, in value for the benefit of our employees, agricultural development, education, developing Pioneer Foods operations and enterprise development programs in South Africa. Included in this commitment is 2.3 billion South African rand, or approximately $ 0.1 billion, relating to the implementation of an employee ownership plan and an agricultural, entrepreneurship and educational development fund, which is an irrevocable condition of the acquisition. This commitment was recorded in selling, general and administrative expenses primarily in the year ended December 26, 2020 and was primarily settled in the fourth quarter of 2021. The remaining commitment of 6.5 billion South African rand, or approximately $ 0.4 billion as of the acquisition date, relates to capital expenditures and/or business-related costs which will be incurred and recorded over a five-year period from the acquisition date. On April 24, 2020, we acquired Rockstar, an energy drink maker with whom we had a distribution agreement prior to the acquisition, for an upfront cash payment of approximately $ 3.85 billion and contingent consideration related to estimated future tax benefits associated with the acquisition of approximately $ 0.88 billion. In the fourth quarter of 2021, we exercised our option to accelerate all remaining payments due under the contingent consideration arrangement. See Note 9 for further information about the contingent consideration. On June 1, 2020, we acquired all of the outstanding shares of Be Cheery, one of the largest online convenient food companies in China, from Haoxiangni Health Food Co., Ltd. for cash. The total consideration transferred was approximately $ 0.7 billion. Table of Contents We accounted for the 2020 transactions as business combinations. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the respective dates of acquisition. The purchase price allocations for each of the 2020 acquisitions were finalized in the second quarter of 2021. The fair value of identifiable assets acquired and liabilities assumed in the acquisitions of Pioneer Foods, Rockstar and Be Cheery and the resulting goodwill as of the respective acquisition dates is summarized as follows: Pioneer Foods Rockstar Be Cheery Acquisition date March 23, 2020 April 24, 2020 June 1, 2020 Inventories $ 229 $ 52 $ 45 Property, plant and equipment 379 8 60 Amortizable intangible assets 52 98 Nonamortizable intangible assets 183 2,400 309 Other assets and liabilities ( 53 ) ( 9 ) ( 24 ) Net deferred income taxes ( 117 ) ( 99 ) Noncontrolling interest ( 5 ) Total identifiable net assets 668 2,451 389 Goodwill 558 2,278 309 Total purchase price $ 1,226 $ 4,729 $ 698 Goodwill is calculated as the excess of the aggregate of the fair value of the consideration transferred over the fair value of the net assets recognized. The goodwill recorded as part of the acquisition of Pioneer Foods primarily reflects synergies expected to arise from our combined brand portfolios and distribution networks, and is not deductible for tax purposes. All of the goodwill is recorded in the AMESA segment. The goodwill recorded as part of the acquisition of Rockstar primarily represents the value of PepsiCos expected new innovation in the energy category and is deductible for tax purposes. All of the goodwill is recorded in the PBNA segment. The goodwill recorded as part of the acquisition of Be Cheery primarily reflects growth opportunities for PepsiCo as we leverage Be Cheerys direct-to-consumer and supply chain capabilities and is not deductible for tax purposes. All of the goodwill is recorded in the APAC segment. Juice Transaction In the first quarter of 2022, we sold our Tropicana, Naked and other select juice brands to PAI Partners for approximately $ 3.5 billion in cash and a 39 % noncontrolling interest in a newly formed joint venture that will operate across North America and Europe. The North America portion of the transaction was completed on January 24, 2022 and the Europe portion of the transaction was completed on February 1, 2022. In the U.S., PepsiCo acts as the exclusive distributor for the new joint ventures portfolio of brands for small-format and foodservice customers with chilled direct-store-delivery. In connection with the sale, we entered into a transition services agreement with PAI Partners, under which we will provide certain services to the joint venture to help facilitate an orderly transition of the business following the sale. In return for these services, the new joint venture is required to pay certain agreed upon fees to reimburse us for our actual costs without markup. Subsequent to the transaction close date, the purchase price will be adjusted for net working capital and net debt amounts as of the transaction close date compared to targeted amounts set forth in the purchase agreement. We expect to record a pre-tax gain of approximately $ 3 billion in our PBNA and Europe segments in the first quarter of 2022 as a result of this transaction. We have reclassified $ 1.8 billion of assets, primarily accounts receivable, net, and inventories of $ 0.5 billion, goodwill and other intangible assets of $ 0.6 billion and property, plant and equipment of Table of Contents $ 0.5 billion, and liabilities of $ 0.8 billion, primarily accounts payable and other liabilities of $ 0.6 billion and deferred income taxes of $ 0.2 billion, related to the Juice Transaction as held for sale in our consolidated balance sheet as of December 25, 2021. The Juice Transaction does not meet the criteria to be classified as discontinued operations. Acquisition and Divestiture-Related Charges A summary of our acquisition and divestiture-related charges is as follows: 2021 2020 2019 Cost of sales $ 1 $ 32 $ 34 Selling, general and administrative expenses (a) ( 5 ) 223 21 Total $ ( 4 ) $ 255 $ 55 After-tax amount (b) $ ( 27 ) $ 237 $ 47 Impact on net income attributable to PepsiCo per common share $ 0.02 $ ( 0.17 ) $ ( 0.03 ) (a) The income amount primarily relates to the acceleration payment made in the fourth quarter of 2021 under the contingent consideration arrangement associated with our acquisition of Rockstar, which is partially offset by other acquisition and divestiture-related charges. (b) In 2021, includes a tax benefit related to contributions to socioeconomic programs in South Africa. Acquisition and divestiture-related charges primarily include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets (recorded in cost of sales), merger and integration charges and costs associated with divestitures (recorded in selling, general and administrative expenses). Merger and integration charges include liabilities to support socioeconomic programs in South Africa, closing costs, employee-related costs, gains associated with contingent consideration, contract termination costs and other integration costs. Acquisition and divestiture-related charges by division are as follows: 2021 2020 2019 Transaction FLNA $ 2 $ 29 $ BFY Brands PBNA 11 66 Juice Transaction, Rockstar Europe 8 46 Juice Transaction, SodaStream International Ltd. AMESA 10 173 7 Pioneer Foods APAC 4 7 Be Cheery Corporate (a) ( 39 ) ( 20 ) 2 Rockstar, Juice Transaction Total $ ( 4 ) $ 255 $ 55 (a) In 2021, the income amount primarily relates to the acceleration payment made in the fourth quarter of 2021 under the contingent consideration arrangement associated with our acquisition of Rockstar, which is partially offset by divestiture-related charges associated with the Juice Transaction. In 2020, the income amount primarily relates to the change in the fair value of the Rockstar contingent consideration. Table of Contents Note 14 Supplemental Financial Information Balance Sheet 2021 2020 2019 Accounts and notes receivable Trade receivables $ 7,172 $ 6,892 Other receivables 1,655 1,713 Total 8,827 8,605 Allowance, beginning of year 201 105 $ 101 Cumulative effect of accounting change 44 Net amounts charged to expense (a) ( 19 ) 79 22 Deductions (b) ( 25 ) ( 32 ) ( 30 ) Other (c) ( 10 ) 5 12 Allowance, end of year 147 201 $ 105 Net receivables $ 8,680 $ 8,404 Inventories (d) Raw materials and packaging $ 1,898 $ 1,720 Work-in-process 151 205 Finished goods 2,298 2,247 Total $ 4,347 $ 4,172 Property, plant and equipment, net (e) Average Useful Life (Years) Land $ 1,123 $ 1,171 Buildings and improvements 15 - 44 10,279 10,214 Machinery and equipment, including fleet and software 5 - 15 31,486 31,276 Construction in progress 3,940 3,679 46,828 46,340 Accumulated depreciation ( 24,421 ) ( 24,971 ) Total $ 22,407 $ 21,369 Depreciation expense $ 2,484 $ 2,335 $ 2,257 Other assets Noncurrent notes and accounts receivable $ 111 $ 109 Deferred marketplace spending 119 130 Pension plans (f) 1,260 910 Right-of-use assets (g) 2,020 1,670 Other 694 493 Total $ 4,204 $ 3,312 Accounts payable and other current liabilities Accounts payable (h) $ 9,834 $ 8,853 Accrued marketplace spending 3,087 2,935 Accrued compensation and benefits 2,324 2,059 Dividends payable 1,508 1,430 Current lease liabilities (g) 446 460 Other current liabilities 3,960 3,855 Total $ 21,159 $ 19,592 (a) 2021 includes reductions in the previously recorded reserves of $ 32 million, while 2020 includes an allowance for expected credit losses of $ 56 million, related to the COVID-19 pandemic. See Note 1 for further information. (b) Includes accounts written off. (c) Includes adjustments related primarily to currency translation and other adjustments. Table of Contents (d) Approximately 7 % and 6 % of the inventory cost in 2021 and 2020, respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. See Note 2 for further information. (e) See Note 2 for further information. (f) See Note 7 for further information. (g) See Note 12 for further information. (h) Increase reflects higher production payables due to strong business performance across a number of our divisions as well as higher commodity prices, partially offset by liabilities reclassified as held for sale in connection with our Juice Transaction. Statement of Cash Flows 2021 2020 2019 Interest paid (a) $ 1,184 $ 1,156 $ 1,076 Income taxes paid, net of refunds (b) $ 1,933 $ 1,770 $ 2,226 (a) In 2021, excludes the charge related to cash tender offers. See Note 8 for further information. (b) In 2021, 2020 and 2019, includes tax payments of $ 309 million, $ 78 million and $ 423 million, respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. 2021 2020 Cash and cash equivalents $ 5,596 $ 8,185 Restricted cash included in other assets (a) 111 69 Total cash and cash equivalents and restricted cash $ 5,707 $ 8,254 (a) Primarily relates to collateral posted against certain of our derivative positions. Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 25, 2021 and December 26, 2020, the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 25, 2021, and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 25, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 25, 2021 and December 26, 2020, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 25, 2021, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 25, 2021 based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Table of Contents Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Sales incentive accruals As discussed in Note 2 to the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the sales incentive process, including controls related to (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, Table of Contents based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 25, 2021 was $35.5 billion which represents 38% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 25, 2021. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the indefinite-lived assets impairment process, including controls related to the development of forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 25, 2021, the Company recorded reserves for unrecognized tax benefits of $1.9 billion. The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, new tax law, relevant court rulings or tax authority settlements. We identified the evaluation of certain of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is Table of Contents complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, associated external counsel opinions, information from tax examinations, relevant court rulings and tax authority settlements. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 9, 2022 Table of Contents GLOSSARY Acquisitions and divestitures : mergers and acquisitions activity, as well as divestitures and other structural changes, including changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver beverages and convenient foods directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by/used for operating activities less capital spending, plus sales of property, plant and equipment. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for the impacts of foreign exchange translation, acquisitions and divestitures, and where applicable, the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Table of Contents Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. Table of Contents ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 25, 2021. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. During our fourth quarter of 2021, we continued migrating certain of our financial processing systems to an ERP solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses in phases over the next several years. In connection with these ERP implementations, we are updating and will continue to update our internal control over financial reporting, as necessary, to accommodate modifications to our business processes and accounting procedures. Beginning in the fourth quarter of 2021 and continuing into the first quarter of 2022, we began implementing these systems, resulting in changes that materially affected our internal control over financial reporting. These system implementations did not have an adverse effect, nor do we expect will have an adverse effect, on our internal control over financial reporting. In addition, in connection with our 2019 multi-year productivity plan, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with this Table of Contents multi-year productivity plan and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes, to maintain effective controls over our financial reporting. These business process changes have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. Except with respect to the continued implementation of ERP systems, there have been no changes in our internal control over financial reporting during our fourth quarter of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We will continue to assess the impact on our internal control over financial reporting as we continue to implement our ERP solution and our 2019 multi-year productivity plan. " +1,pep-,20201226," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into seven reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PepsiCo Beverages North America (PBNA), which includes our beverage businesses in the United States and Canada; 4) Latin America (LatAm), which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) Africa, Middle East and South Asia (AMESA), which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and Table of Contents 7) Asia Pacific, Australia and New Zealand and China Region (APAC), which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. QFNAs branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel and Tropicana. PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). In 2020, we acquired Rockstar Energy Beverages (Rockstar), an energy drink maker with whom we had a distribution agreement prior to the acquisition. See Note 14 to our consolidated financial statements for further information about our acquisition of Rockstar. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Table of Contents Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Lubimy Sad, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, as part of its beverage business, manufactures and distributes SodaStream sparkling water makers and related products. Further, Europe makes, markets, distributes and sells a number of dairy products including Agusha, Chudo and Domik v Derevne. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of snack food brands including Chipsy, Doritos, Kurkure, Lays, Sasko, Spekko and White Star, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In 2020, we acquired Pioneer Food Group Ltd. (Pioneer Foods), a food and beverage company in South Africa with exports to countries across the globe. See Note 14 to our consolidated financial statements for further information about our acquisition of Pioneer Foods. Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of snack food brands including BaiCaoWei, Cheetos, Doritos, Lays and Smiths, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized and independent bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). In 2020, we acquired all of the outstanding shares of Hangzhou Haomusi Food Co., Ltd. (Be Cheery), one of the largest online snacks companies in China. See Note 14 to our consolidated financial statements for further information about our acquisition of Be Cheery. COVID-19 The novel coronavirus (COVID-19) pandemic in 2020 resulted in challenging operating environments and affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold, including as a result of travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns Table of Contents and closures. We expect that the COVID-19 pandemic will continue to impact our business operations, including our employees, customers, consumers, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with which we do business. The extent to which the COVID-19 pandemic will impact our future business operations and financial results remains uncertain and will continue to depend on numerous evolving factors outside our control. See Item 1A. Risk Factors for discussion of the risks and uncertainties associated with the COVID-19 pandemic. Also, see Our Business Risks in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 1 to our consolidated financial statements for further information related to the impact of COVID-19 on our 2020 financial results. Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and distribution centers, both company and third-party operated, to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure Table of Contents adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. We also maintain voluntary supply chain finance agreements with several participating global financial institutions, pursuant to which our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to such global financial institutions. These agreements have not had a material impact on our business or financial results. See Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewtr, Aunt Jemima, BaiCaoWei, Bare, Bokomo, Bolt24, bubly, Capn Crunch, Ceres, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Driftwell, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Liquifruit, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Moirs, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Game Fuel, Mountain Dew Ice, Mountain Dew Kickstart, Mountain Dew Zero Sugar, Mug, Munchies, Muscle Milk, Naked, Near East, Off the Eaten Path, O.N.E., Paso de los Toros, Pasta Roni, Pearl Milling Company, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, PopCorners, Pronutro, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rockstar Energy, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Safari, Sakata, Saladitas, San Carlos, Sandora, Santitas, Sasko, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Spekko, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers, Weetbix, White Star, Ya and Yachak. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Bang Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Table of Contents Seasonality Our businesses are affected by seasonal variations. Our beverage, food and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the international expansion of hard discounters, and the current economic environment, including in light of the COVID-19 pandemic, continue to increase the importance of major customers. In 2020, sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 14% of our consolidated net revenue, with sales reported across all of our divisions, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. The loss of this customer would have a material adverse effect on our FLNA, QFNA and PBNA divisions. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for further information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Table of Contents Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Utz Brands, Inc. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2020, we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting the needs of our customers and consumers and accelerating growth. These activities principally involve: innovations focused on creating consumer preferred products to grow and transform our portfolio through development of new technologies, ingredients, flavors and substrates; development and improvement of our manufacturing processes including reductions in cost and environmental footprint; implementing product improvements to our global portfolio that reduce added sugars, sodium or saturated fat; offering more products with functional ingredients and positive nutrition including whole grains, fruit, vegetables, dairy, protein, fiber, micronutrients and hydration; development of packaging technology and new package designs, including reducing the amount of plastic in our packaging and developing recyclable and sustainable packaging; development of marketing, merchandising and dispensing equipment; further expanding our beyond the bottle portfolio including innovation for our SodaStream business; investments in technology and digitalization including data analytics to enhance our consumer insights and research; continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and efforts focused on reducing our impact on the environment including reducing water use in our operations and our agricultural practices. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, South Africa, the United Kingdom and the United States, and leverage consumer insights, food science and engineering to meet our strategy to continually innovate our portfolio of convenient foods and beverages. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by Table of Contents government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include, but are not limited to: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act and various state laws and regulations governing workplace health and safety; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; data privacy and personal data protection laws and regulations, including the California Consumer Privacy Act of 2018; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. Table of Contents In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some types of single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Human Capital PepsiCo believes that human capital management, including attracting, developing and retaining a high quality workforce, is critical to our long-term success. Our Board and its Committees provide oversight on a broad range of human capital management topics, including corporate culture, diversity and inclusion, pay equity, health and safety, training and development and compensation and benefits. We employed approximately 291,000 people worldwide as of December 26, 2020, including approximately 120,000 people within the United States. We are party to numerous collective bargaining agreements and believe that relations with our employees are generally good. Protecting the safety, health, and well-being of our associates around the world is PepsiCos top priority. We strive to achieve an injury-free work environment. We also continue to invest in emerging technologies to protect our employees from injuries, including leveraging fleet telematics and distracted driving technology, resulting in reductions in road traffic accidents, and deploying wearable ergonomic risk reduction devices. In addition, throughout the COVID-19 pandemic, we have remained focused on the health and safety of our associates, especially our frontline associates who continue to make, move and sell our products during this critical time, including by implementing new safety protocols in our facilities, providing personal protective equipment and enabling testing. We believe that our culture of diversity and inclusion is a competitive advantage that fuels innovation, enhances our ability to attract and retain talent and strengthens our reputation. We continually strive to Table of Contents improve the attraction, retention, and advancement of diverse associates to ensure we sustain a high-caliber pipeline of talent that also represents the communities we serve. As of December 26, 2020, our global workforce was approximately 25% female, while management roles were approximately 41% female. As of December 26, 2020, approximately 43% of our U.S. workforce was comprised of racially/ethnically diverse individuals, of which approximately 30% of our U.S. associates in managerial roles were racially/ethnically diverse individuals. Direct reports of our Chief Executive Officer include 7 executives globally who are racially/ethnically diverse and/or female. We are also committed to the continued growth and development of our associates. PepsiCo supports and develops its associates through a variety of global training and development programs that build and strengthen employees' leadership and professional skills, including career development plans, mentoring programs and in-house learning opportunities, such as PEP U Degreed, our internal global online learning resource. In 2020, PepsiCo employees completed over 875,000 hours of training. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. The following risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business or financial performance, which in turn can affect the price of our publicly traded securities. These are not the only risks we face. There may be other risks we are not currently aware of or that we currently deem not to be material but may become material in the future. COVID-19 Risks The impact of COVID-19 continues to create considerable uncertainty for our business. Our global operations continue to expose us to risks associated with the COVID-19 pandemic. Authorities around the world have implemented numerous measures to try to reduce the spread of the virus and such measures have impacted and continue to impact us, our business partners and consumers. While some of these measures have been lifted or eased in certain jurisdictions, other jurisdictions have seen a resurgence of COVID-19 cases resulting in reinstitution or expansion of such measures. Table of Contents We have seen and could continue to see changes in consumer demand as a result of COVID-19, including the inability of consumers to purchase our products due to illness, quarantine or other restrictions, store closures, or financial hardship. We also continue to see shifts in product and channel prefe rences, particularly an increase in demand in the e-commerce channel, which has impacted and could continue to impact our sales and profitability. Reduced demand for our products or changes in consumer purchasing patterns, as well as continued economic uncertainty, can adversely affect our customers financial condition, which can result in bankruptcy filings and/or an inability to pay for our products. In addition, we may also continue to experience business disruptions as a result of COVID-19, resulting from temporary closures of our facilities or facilities of our business partners or the inability of a significant portion of our or our business partners workforce to work because of illness, quarantine, or travel or other governmental restrictions. Any sustained interruption in our or our business partners operations, distribution network or supply chain or any significant continuous shortage of raw materials or other supplies, including personal protective equipment or sanitization products, can negatively impact our business. We have also incurred, and expect to continue to incur, increased employee and operating costs as a result of COVID-19, such as costs related to expanded benefits and frontline incentives, the provision of personal protective equipment and increased sanitation, allowances for credit losses, upfront payment reserves and inventory write-offs, which have negatively impacted and may continue to negatively impact our profitability. In addition, the increase in certain of our employees working remotely has resulted in increased demand on our information technology infrastructure, which can be subject to failure, disruption or unavailability, and increased vulnerability to cyberattacks and other cyber incidents. Also, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. The impact of COVID-19 has heightened, or in some cases manifested, certain of the other risks discussed herein. The extent of the impact of the COVID-19 pandemic on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the development and availability of effective treatments and vaccines, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in the future, in response to the pandemic, and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Business Risks Reduction in future demand for our products would adversely affect our business. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including the types of products our consumers want and how they browse for, purchase and consume them. Consumer preferences continuously evolve due to a variety of factors, including: changes in consumer demographics, consumption patterns and channel preferences (including continued rapid increases in the e-commerce and online-to-offline channels); pricing; product quality; concerns or perceptions regarding packaging and its environmental impact (such as single-use and other plastic packaging); and concerns or perceptions regarding the nutrition profile and health effects of, or location of origin of, ingredients or substances in our products. Concerns with any of the foregoing could lead consumers to reduce or publicly boycott the purchase or consumption of our products. Consumer preferences are also influenced by perception of our brand image or the brand images of our products, the success of our advertising and marketing campaigns, our ability to engage with our consumers in the manner they prefer, including through the use of digital media, and the perception of our use, and the use of social media. These and other factors have reduced in the past and could continue to reduce consumers willingness to purchase certain of our products. Any inability on our part to anticipate Table of Contents or react to changes in consumer preferences and trends, or make the right strategic investments to do so, including investments in data analytics to understand consumer trends, can lead to reduced demand for our products, lead to inventory write-offs or erode our competitive and financial position, thereby adversely affecting our business. In addition, our business operations are subject to disruption by natural disasters or other events beyond our control that could negatively impact product availability and decrease demand for our products if our crisis management plans do not effectively resolve these issues. Damage to our reputation or brand image can adversely affect our business. Maintaining a positive reputation globally is critical to selling our products. Our reputation or brand image has in the past been, and could in the future be, adversely impacted by a variety of factors, including: any failure by us or our business partners to maintain high ethical, social, business and environmental practices, including with respect to human rights, child labor laws and workplace conditions and employee health and safety; any failure to achieve our sustainability goals, including with respect to the nutrition profile of our products, packaging, water use and our impact on the environment; any failure to address health concerns about our products or particular ingredients in our products, including concerns regarding whether certain of our products contribute to obesity; our research and development efforts; any product quality or safety issues, including the recall of any of our products; any failure to comply with laws and regulations; consumer perception of our advertising campaigns, sponsorship arrangements, marketing programs and use of social media; or any failure to effectively respond to negative or inaccurate comments about us on social media or otherwise regarding any of the foregoing. Damage to our reputation or brand image has in the past and could in the future decrease demand for our products, thereby adversely affecting our business. Issues or concerns with respect to product quality and safety can adversely affect our business. Product quality or safety issues, including alleged mislabeling, misbranding, spoilage, undeclared allergens, adulteration or contamination, whether as a result of failure to comply with food safety laws or otherwise, have in the past and could in the future reduce consumer confidence and demand for our products, cause production and delivery disruptions, require product recalls and result in increased costs (including payment of fines and/or judgments) and damage our reputation, all of which can adversely affect our business. Failure to maintain adequate oversight over product quality or safety can result in product recalls, litigation, government investigations or inquiries or civil or criminal proceedings, all of which may result in fines, penalties, damages or criminal liability. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any inability to compete effectively can adversely affect our business. Our products compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label and economy brand manufacturers and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Our products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends. Our business can be adversely affected if we are unable to effectively promote or develop our existing products or introduce new products, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively, and we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures. Table of Contents Failure to attract, develop and maintain a highly skilled and diverse workforce can have an adverse effect on our business. Our business requires that we attract, develop and maintain a highly skilled and diverse workforce. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to attract, retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to attract, develop and maintain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. In addition, failure to attract, retain and develop associates from underrepresented communities can damage our business results and our reputation. Any of the foregoing can adversely affect our business. Water scarcity can adversely affect our business. We and our business partners use water in the manufacturing and sourcing of our products. Lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations or the operations of our business partners; higher compliance costs; capital expenditures (including investments in the development of technologies to enhance water efficiency and reduce consumption); higher production costs, including less favorable pricing for water; the interruption or cessation of operations at, or relocation of, our facilities or the facilities of our business partners; failure to achieve our sustainability goals relating to water use; perception of our failure to act responsibly with respect to water use or to effectively respond to legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business. Changes in the retail landscape or in sales to any key customer can adversely affect our business. The retail landscape continues to evolve, including rapid growth in e-commerce channels and hard discounters. Our business will be adversely affected if we are unable to maintain and develop successful relationships with e-commerce retailers and hard discounters, while also maintaining relationships with our key customers operating in traditional retail channels (many of whom are also focused on increasing their e-commerce sales). Our business can be adversely affected if e-commerce channels and hard discounters take significant additional market share away from traditional retailers or we fail to find ways to create more powerful digital tools and capabilities for our retail customers to enable them to grow their businesses. In addition, our business can be adversely affected if we are unable to profitably expand our own direct-to-consumer e-commerce capabilities. The retail industry is also impacted by increased consolidation of ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, impacting our ability to compete in these areas. Consolidation also adversely impacts our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, we must maintain mutually beneficial relationships with our key customers, including Walmart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business. Table of Contents Disruption of our supply chain may adversely affect our business. Many of the raw materials and supplies used in the production of our products are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions. Some raw materials and supplies, including packaging materials such as recycled PET, are available only from a limited number of suppliers or from a sole supplier or are in short supply when seasonal demand is at its peak. There can be no assurance that we will be able to maintain favorable arrangements and relationships with suppliers or that our contingency plans will be effective to prevent disruptions that may arise from shortages or discontinuation of any raw materials and other supplies that we use in the manufacture, production and distribution of our products. The raw materials and other supplies, including agricultural commodities and fuel, that we use for the manufacturing, production and distribution of our products are subject to price volatility and fluctuations in availability caused by many factors, including changes in supply and demand, weather conditions (including potential effects of climate change), fire, natural disasters, disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Many of our raw materials and supplies are purchased in the open market. The prices we pay for such items are subject to fluctuation. If price changes result in unexpected or significant increases in the costs of any raw materials or other supplies, we may be unwilling or unable to increase our product prices or unable to effectively hedge against price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. Political and social conditions can adversely affect our business. Political and social conditions in the markets in which our products are sold have been and could continue to be difficult to predict, resulting in adverse effects on our business. The results of elections, referendums or other political conditions (including government shutdowns) in these markets, including the United Kingdoms withdrawal from the European Union, have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or result in uncertainty as to how such laws, regulations, programs or policies may change, including with respect to tariffs, sanctions, environmental and climate change regulations, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products, any of which can adversely affect our business. In addition, political and social conditions in certain cities throughout the U.S. as well as globally have resulted in demonstrations and protests, including in connection with political elections and civil rights and liberties. Our operations, including the distribution of our products and the ingredients or other raw materials used in the production of our products, may be disrupted if such events persist for a prolonged period of time, including due to actions taken by governmental authorities in affected cities and regions, which can adversely affect our business. Our business can be adversely affected if we are unable to grow in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China, South Africa and India. There can be no assurance that our products will be accepted or be successful in any particular developing or emerging market, due to competition, price, cultural differences, consumer preferences, method of distribution or otherwise. Our business in these markets has been and could continue in the future to be impacted by economic, political and social conditions; acts of war, terrorist acts, and civil unrest, including demonstrations and protests; competition; tariffs, sanctions or other regulations restricting contact with Table of Contents certain countries in these markets; foreign ownership restrictions; nationalization of our assets or the assets of our business partners; government-mandated closure, or threatened closure, of our operations or the operations of our business partners; restrictions on the import or export of our products or ingredients or substances used in our products; highly inflationary economies; devaluation or fluctuation or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with laws and regulations. Our business can be adversely affected if we are unable to expand our business in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets. Changes in economic conditions can adversely impact our business. Many of the jurisdictions in which our products are sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns, which have and could continue to result in adverse changes in interest rates, tax laws or tax rates; volatile commodity markets; highly inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit; demonetization, austerity or stimulus measures; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are sold; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our business partners, including financial institutions with whom we do business, and any negative impact on any of the foregoing may also have an adverse impact on our business. Future cyber incidents and other disruptions to our information systems can adversely affect our business. We depend on information systems and technology, including public websites and cloud-based services, for many activities important to our business, including communications within our company, interfacing with customers and consumers; ordering and managing inventory; managing and operating our facilities; protecting confidential information; maintaining accurate financial records and complying with regulatory, financial reporting, legal and tax requirements. Our business has in the past and could in the future be negatively affected by system shutdowns, degraded systems performance, systems disruptions or security incidents. These disruptions or incidents may be caused by cyberattacks and other cyber incidents, network or power outages, software, equipment or telecommunications failures, the unintentional or malicious actions of employees or contractors, natural disasters, fires or other catastrophic events. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals with a wide range of expertise and motives. Cyberattacks and cyber incidents take many forms including cyber extortion, denial of service, social engineering, introduction of viruses or malware, exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromise. As with other global companies, we are regularly subject to cyberattacks and other cyber incidents, including many of the types of attacks and incidents described above. If we do not allocate and effectively manage the resources necessary to continue to build and maintain our information technology infrastructure, or if Table of Contents we fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, our business can be adversely affected, resulting in transaction errors, processing inefficiencies, data loss, legal claims or proceedings, regulatory penalties, and the loss of sales and customers. Similar risks exist with respect to third-party providers, including cloud-based service providers, that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and the systems managed, hosted, provided and/or used by such third parties and their vendors. The need to coordinate with various third-party service providers, including with respect to timely notification and access to personnel and information concerning an incident, may complicate our efforts to resolve issues that arise. As a result, we are subject to the risk that the activities associated with our third-party service providers can adversely affect our business even if the attack or breach does not directly impact our systems or information. Although the cyber incidents and other systems disruptions that we have experienced to date have not had a material effect on our business, such incidents or disruptions could have a material adverse effect on us in the future. While we devote significant resources to network security, disaster recovery, employee training and other security measures to protect our systems and data, there are no assurances that such measures will protect us against all cyber incidents or systems disruptions. In addition, while we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents and information systems failures, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Failure to successfully complete or manage strategic transactions can adversely affect our business. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, distribution agreements, divestitures, refranchisings and other strategic transactions. The success of these transactions is dependent upon, among other things, our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals; and diversion of managements attention from day-to-day operations. Risks associated with strategic transactions include integrating manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; operating through new business models or in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming controls (including internal control over financial reporting and disclosure controls and procedures) and policies (including with respect to environmental compliance, health and safety compliance and compliance with anti-bribery laws); retaining existing customers and consumers and attracting new customers and consumers; managing tax costs or inefficiencies; maintaining good relations with divested or refranchised businesses in our supply or sales chain; managing the impact of business decisions or other actions or omissions of our joint venture partners that may have different interests than we do; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. Strategic transactions that are not successfully completed or managed effectively, or our failure to effectively manage the risks associated with such transactions, have in the past and could continue to result in adverse effects on our business. Our reliance on third-party service providers can have an adverse effect on our business. We rely on third-party service providers, including cloud data service providers, for certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. Failure by these third parties to meet their contractual, regulatory and other obligations to us, or our failure to adequately monitor their performance, has in the past and could Table of Contents continue to result in our inability to achieve the expected cost savings or efficiencies and result in additional costs to correct errors made by such service providers. Depending on the function involved, such errors can also lead to business disruption, systems performance degradation, processing inefficiencies or other systems disruptions, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, damage to our reputation or have a negative impact on employee morale, all of which can adversely affect our business. In addition, we continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, our business could be adversely affected. Climate change or measures to address climate change can negatively affect our business or damage our reputation. Climate change may have a negative effect on agricultural productivity which may result in decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as potatoes, sugar cane, corn, wheat, rice, oats, oranges and other fruits (and fruit-derived oils). In addition, climate change may also increase the frequency or severity of natural disasters and other extreme weather conditions, which could impair our production capabilities, disrupt our supply chain or impact demand for our products. Also, concern over climate change may result in new or increased legal and regulatory requirements to reduce or mitigate the effects of climate change, which could result in significant increased costs and require additional investments in facilities and equipment. As a result, the effects of climate change can negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception of a failure to act responsibly with respect to the environment or to effectively respond to regulatory requirements concerning climate change can lead to adverse publicity, resulting in an adverse effect on our business or damage to our reputation. Strikes or work stoppages can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions can occur if we are unable to renew, or enter into new, collective bargaining agreements on satisfactory terms and can impair manufacturing and distribution of our products, lead to a loss of sales, increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy, all of which can adversely affect our business. Financial Risks Failure to realize benefits from our productivity initiatives can adversely affect our financial performance. Our future growth depends, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models. We continue to identify and implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently. Some of these measures result in unintended consequences, such as business disruptions, distraction of management and employees, reduced morale and productivity, unexpected employee attrition, an inability to attract or retain key personnel and negative publicity. If we are unable to successfully implement our productivity initiatives as planned or do not achieve expected savings as a Table of Contents result of these initiatives, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our financial performance. A deterioration in our estimates and underlying assumptions regarding the future performance of our business can result in an impairment charge that can adversely affect our results of operations. We conduct impairment tests on our goodwill and other indefinite-lived intangible assets annually or more frequently if circumstances indicate that impairment may have occurred. In addition, amortizable intangible assets, property, plant and equipment and other long-lived assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. A deterioration in our underlying assumptions regarding the impact of competitive operating conditions, macroeconomic conditions or other factors used to estimate the future performance of any of our reporting units or assets, including any deterioration in the weighted-average cost of capital based on market data available at the time, can result in an impairment, which can adversely affect our results of operations. Fluctuations in exchange rates impact our financial performance. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Given our global operations, we also pay for the ingredients, raw materials and commodities used in our business in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our financial performance. Our borrowing costs and access to capital and credit markets can be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us and their ratings are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the state of the economy and our industry. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. Any downgrade or announcement that we are under review for a potential downgrade of our credit ratings, especially any downgrade to below investment grade, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, result in a reduction in our liquidity, or impair our ability to access the commercial paper market with the same flexibility that we have experienced historically (and therefore require us to rely more heavily on more expensive types of debt financing), all of which can adversely affect our financial performance. Legal, Tax and Regulatory Risks Taxes aimed at our products can adversely affect our business or financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of certain of our products, particularly our beverages, as a result of the ingredients or substances contained in our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain amount of added sugar (or other sweetener), some apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and others apply a flat tax rate on beverages containing any amount of added sugar (or other sweetener). For example, Poland enacted a graduated tax on all sweetened beverages, effective January 1, 2021, at a rate of PLN 0.5 (USD 0.12) per liter for drinks with a sugar (or other sweetener) content of up to 5g per 100ml and an additional PLN 0.05 (USD 0.01) for each gram of sugar (or other sweetener) over 5g . These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain Table of Contents of our products, reduce overall consumption of our products or lead to negative publicity, resulting in an adverse effect on our business and financial performance. Limitations on the marketing or sale of our products can adversely affect our business and financial performance. Certain jurisdictions in which our products are sold have either imposed, or are considering imposing, limitations on the marketing or sale of our products as a result of ingredients or substances in our products. These limitations require that we highlight perceived concerns about a product, warn consumers to avoid consumption of certain ingredients or substances present in our products, restrict the age of consumers to whom products are marketed or sold or limit the location in which our products may be available. For example, Mexico has imposed a stop-sign labeling scheme to signal the presence of non-caloric sweeteners and caffeine in pre-packaged foods and non-alcoholic beverages. Certain jurisdictions have imposed or are considering imposing color-coded labeling requirements where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat, in products. The imposition or proposed imposition of additional limitations on the marketing or sale of our products has in the past and could continue to reduce overall consumption of our products, lead to negative publicity or leave consumers with the perception that our products do not meet their health and wellness needs, resulting in an adverse effect on our business and financial performance. Laws and regulations related to the use or disposal of plastics or other packaging can adversely affect our business and financial performance. Certain of our products are sold in plastic or other packaging designed to be recyclable. However, not all packaging is recycled, whether due to lack of infrastructure or otherwise, and certain of our packaging is not currently recyclable. Packaging waste that displays one or more of our brands has in the past resulted in and could continue to result in negative publicity or reduced consumer demand for our products, adversely affecting our financial performance. Many jurisdictions in which our products are sold have imposed or are considering imposing regulations or policies intended to encourage the use of sustainable packaging, waste reduction or increased recycling rates or to restrict the sale of products utilizing certain packaging. These regulations vary in form and scope and include taxes to incentivize behavior, restrictions on certain products and materials, requirements for bottle caps to be tethered to bottles, bans on the use of single-use plastics, extended producer responsibility policies and requirements to charge deposit fees. For example, the European Union has imposed a minimum recycled content requirement for beverage bottles packaging and similar legislation is under consideration in several states in the United States. These laws and regulations have in the past and could continue to increase the cost of our products, impact demand for our products, result in negative publicity and require us and our business partners, including our independent bottlers, to increase our capital expenditures to invest in minimizing the amount of plastic or other materials used in our packaging or to develop alternative packaging, all of which can adversely affect our business and financial performance. Failure to comply with personal data protection and privacy laws can adversely affect our business. We are subject to a variety of continuously evolving and developing laws and regulations in numerous jurisdictions regarding personal data protection and privacy laws. These laws and regulations may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with these laws and regulations, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation or residents of the state of California who are covered by the California Consumer Privacy Act, impose significant costs and challenges that are likely to continue to increase over time. Failure to comply with these laws and regulations can result in litigation, claims, legal or regulatory proceedings, inquiries or investigations or damage to our reputation, all of which can adversely affect our business. Table of Contents Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our financial performance. Increases in income tax rates or other changes in tax laws, including changes in how existing tax laws are interpreted or enforced, can adversely affect our financial performance. For example, economic and political conditions in countries where we are subject to taxes, including the United States, have in the past and could continue to result in significant changes in tax legislation or regulation, including as a result of any changes enacted during the new U.S. presidential administration. The increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our financial performance. We are also subject to regular reviews, examinations and audits by numerous taxing authorities with respect to income and non-income based taxes. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse effect on our financial performance. If we are unable to adequately protect our intellectual property rights, or if we are found to infringe on the intellectual property rights of others, our business can be adversely affected. We possess intellectual property rights that are important to our business, including ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets. The laws of various jurisdictions in which we operate have differing levels of protection of intellectual property. Our competitive position and the value of our products and brands can be reduced and our business adversely affected if we fail to obtain or adequately protect our intellectual property, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections afforded our intellectual property. Also, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed on the intellectual property rights of others, directly or indirectly, such finding can damage our reputation and limit our ability to introduce new products or improve the quality of existing products, resulting in an adverse effect on our business. Failure to comply with laws and regulations applicable to our business can adversely affect our business. The conduct of our business is subject to numerous laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content (including whether a product contains genetically engineered ingredients), quality, safety, transportation, traceability, packaging, disposal, recycling and use of our products, employment and occupational health and safety, environmental matters (including pesticide use) and data privacy and protection. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position, as is compliance with anti-corruption laws. The imposition of new laws, changes in laws or regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business. In addition, if one jurisdiction imposes or proposes to impose new laws or regulations that impact the manufacture, distribution or sale of our products, other jurisdictions can often follow. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, all of which can adversely affect our business. Table of Contents Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients, intellectual property rights, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. Responding to these matters, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image. Any of the foregoing can adversely affect our business. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2020 year and that remain unresolved. Table of Contents ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: Property Type Location Owned/ Leased FLNA Research and development facility Plano, Texas Owned QFNA Food plant Cedar Rapids, Iowa Owned PBNA Research and development facility Valhalla, New York Owned PBNA Concentrate plant Arlington, Texas Owned PBNA Tropicana plant Bradenton, Florida Owned LatAm Snack plant Celaya, Mexico Owned LatAm Two snack plants Vallejo, Mexico Owned Europe Snack plant Kashira, Russia Owned Europe Manufacturing plant Lehavim, Israel Owned Europe Dairy plant Moscow, Russia Owned (a) AMESA Snack plant Riyadh, Saudi Arabia Owned (a) APAC Snack plant Wuhan, China Owned (a) FLNA, QFNA, PBNA Shared service center Winston Salem, North Carolina Leased PBNA, LatAm Concentrate plant Colonia, Uruguay Owned (a) PBNA, Europe, AMESA Two concentrate plants Cork, Ireland Owned PBNA, AMESA, APAC Concentrate plant Singapore Owned (a) All divisions Shared service center Hyderabad, India Leased (a) The land on which these plants are located is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 4, 2021, there were approximately 105,807 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 4, 2021, the Board of Directors declared a quarterly dividend of $1.0225 payable March 31, 2021, to shareholders of record on March 5, 2021. For the remainder of 2021, the record dates for these dividend payments are expected to be June 4, September 3 and December 3, 2021, subject to approval of the Board of Directors. On February 11, 2021, we announced a 5% increase in our annualized dividend to $4.30 per share from $4.09 per share, effective with the dividend expected to be paid in June 2021. We expect to return a total of approximately $5.9 billion to shareholders in 2021, comprised of dividends of approximately $5.8 billion and share repurchases of approximately $100 million. We have recently completed our share repurchase activity and do not expect to repurchase any additional shares for the balance of 2021. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2020 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/5/2020 $ 9,525 9/6/2020 - 10/3/2020 1.0 $ 134.59 1.0 (137) 9,388 10/4/2020 - 10/31/2020 0.9 $ 138.83 0.9 (125) 9,263 11/1/2020 - 11/28/2020 0.9 $ 141.82 0.9 (120) 9,143 11/29/2020 - 12/26/2020 0.4 $ 144.83 0.4 (59) Total 3.2 $ 139.04 3.2 $ 9,084 (a) All shares were repurchased in open market transactions pursuant to the $15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. Table of Contents "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview 29 Our Operations 30 Other Relationships 30 Our Business Risks 30 OUR FINANCIAL RESULTS Results of Operations Consolidated Review 35 Results of Operations Division Review 37 FLNA 39 QFNA 39 PBNA 39 LatAm 40 Europe 40 AMESA 41 APAC 41 Results of Operations Other Consolidated Results 42 Non-GAAP Measures 42 Items Affecting Comparability 44 Our Liquidity and Capital Resources 47 Return on Invested Capital 51 OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition 52 Goodwill and Other Intangible Assets 53 Income Tax Expense and Accruals 54 Pension and Retiree Medical Plans 55 Consolidated Statement of Income 58 Consolidated Statement of Comprehensive Income 59 Consolidated Statement of Cash Flows 60 Consolidated Balance Sheet 62 Consolidated Statement of Equity 63 Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions 64 Note 2 Our Significant Accounting Policies 68 Note 3 Restructuring and Impairment Charges 72 Note 4 Intangible Assets 76 Note 5 Income Taxes 78 Note 6 Share-Based Compensation 82 Note 7 Pension, Retiree Medical and Savings Plans 86 Note 8 Debt Obligations 92 Note 9 Financial Instruments 94 Note 10 Net Income Attributable to PepsiCo per Common Share 99 Note 11 Preferred Stock 99 Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo 100 Note 13 Leases 101 Note 14 Acquisitions and Divestitures 103 Note 15 Supplemental Financial Information 105 Report of Independent Registered Public Accounting Firm 107 GLOSSARY 111 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. Discussion in this Form 10-K includes results of operations and financial condition for 2020 and 2019 and year-over-year comparisons between 2020 and 2019. For discussion on results of operations and financial condition pertaining to 2018 and year-over-year comparisons between 2019 and 2018, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 28, 2019. OUR BUSINESS Executive Overview PepsiCo is a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories Everything we do is driven by an approach we call Winning with Purpose. Winning with Purpose is our guide for achieving accelerated, sustainable growth that includes our mission, to Create More Smiles with Every Sip and Every Bite; our vision, to Be the Global Leader in Convenient Foods and Beverages by Winning with Purpose; and The PepsiCo Way, seven behaviors that define our shared culture. This approach proved prescient and powerful in 2020 as we faced a worsening climate crisis, renewed calls for racial equality, and the first global pandemic in a century. Life in communities around the world was transformed, and our business was tested like never before. First and foremost, we had to protect the health of our associates, so that we could continue to serve our consumers, customers and communities. At the same time, we had to secure our supply chain; ensure continuity in manufacturing, distribution and sales; further strengthen our e-commerce and digital capabilities; reimagine our marketing; deliver positive outcomes for people, our shareholders and the planet; and much more. These challenges were in addition to the structural issues facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To meet this once in a generation moment and ensure our Companys long-term success, we will continue to focus on becoming Faster, Stronger, and Better: We will become Faster by sustaining or improving growth and market share in our high return foods and snacks businesses in North America; improving the profitability of our PBNA business and capturing our fair share of category growth; accelerating our growth and presence in international snacks and food while investing wisely in beverages to balance between growth and returns; and making the necessary investments in our manufacturing capacity, go-to-market systems and digital initiatives, such as improving our presence and scale in our e-commerce business. Table of Contents We will become Stronger by renewing our focus on driving holistic cost management throughout our organization to support our investments in advantaged capabilities, such as a highly agile and flexible end-to-end value chain; more precision around revenue management; and investing in data analytics that can provide more granularity around consumer insights. We also plan to continue investing to further expand global business services into new capabilities, which will enable better insight and support for our businesses at a lower cost. And we will remain focused on diversifying our workforce and reinforcing The PepsiCo Way, where we emphasize that employees act like owners to get things done quickly. We will become Better by further integrating purpose into our business strategy and brands by becoming planet positive, strengthening our roots in our communities, and advancing social justice. This includes supporting practices and technologies that improve farmer livelihoods and agricultural resiliency; using precious resources such as water more efficiently; accelerating our efforts to reduce greenhouse gas emissions throughout our value chain; driving progress toward a world where plastics need never become waste; advancing respect for human rights; and investing to promote shared prosperity in local communities where we live and work. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers, competition and human capital. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks COVID-19 Our global operations continue to expose us to risks associated with the COVID-19 pandemic, which continues to result in challenging operating environments and has affected almost all of the more than 200 countries and territories in which our products are made, manufactured, distributed or sold. Travel bans and restrictions, quarantines, curfews, restrictions on public gatherings, shelter in place and safer-at-home orders, business shutdowns and closures continue in many of these markets. These measures have impacted and will continue to impact us, our customers (including foodservice customers), consumers, employees, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties with whom we do business, which may result in changes in demand for our products, increases in operating costs (whether as a result of changes to our supply chain or increases in employee costs, including expanded benefits and frontline incentives, costs associated with the provision of personal protective equipment and increased sanitation, or otherwise), or adverse impacts to our supply chain through reduced availability of air or other commercial transport, port closures or border restrictions, any Table of Contents of which can impact our ability to make, manufacture, distribute and sell our products. In addition, measures that impact our ability to access our offices (several of which remain closed), plants, warehouses, distribution centers or other facilities, or that impact the ability of our customers (including our foodservice customers), consumers, bottlers, contract manufacturers, distributors, joint venture partners, suppliers and other third parties to do the same, may continue to impact the availability or productivity of our and their employees, many of whom are not able to perform their job functions remotely. Public concern regarding the risk of contracting COVID-19 has impacted and may continue to impact demand from consumers, including due to consumers not leaving their homes or leaving their homes less often than they did prior to the start of the pandemic or otherwise shopping for and consuming food and beverage products in a different manner than they historically have or because some of our consumers have lower discretionary income due to unemployment or reduced or limited work as a result of measures taken in response to the pandemic. Even as governmental restrictions are relaxed and economies gradually, partially, or fully reopen in certain of these jurisdictions and markets, the ongoing economic impacts and health concerns associated with the pandemic may continue to affect consumer behavior, spending levels and shopping and consumption preferences. In addition, as a result of COVID-19, certain jurisdictions, such as certain states in Mexico, have enacted or are considering enacting new or expanded product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. Changes in consumer purchasing and consumption patterns may increase demand for our products in one quarter, resulting in decreased demand for our products in subsequent quarters, or in a lower-margin sales channel resulting in potentially reduced profit from sales of our products. We continue to see shifts in product and channel preferences as markets move through varying stages of restrictions and re-opening at different times, including changes in at-home consumption, in immediate consumption and away-from-home channels, such as convenience and gas and foodservice. In addition, we continue to see a rapid increase in demand in the e-commerce and online-to-offline channels and any failure to capitalize on this demand could adversely affect our ability to maintain and grow sales or category share and erode our competitive position. Any reduced demand for our products or change in consumer purchasing and consumption patterns, as well as continued economic uncertainty, can adversely affect our customers and business partners financial condition, which can result in bankruptcy filings and/or an inability to pay for our products, reduced or canceled orders of our products, continued or additional closing of restaurants, stores, entertainment or sports complexes, schools or other venues in which our products are sold, or reduced capacity at any of the foregoing, or our business partners inability to supply us with ingredients or other items necessary for us to make, manufacture, distribute or sell our products. Such adverse changes in our customers or business partners financial condition have also resulted and may continue to result in our recording additional charges for our inability to recover or collect any accounts receivable, owned or leased assets, including certain foodservice and vending and other equipment, or prepaid expenses. In addition, continued economic uncertainty associated with the COVID-19 pandemic has resulted in volatility in the global capital and credit markets which can impair our ability to access these markets on terms commercially acceptable to us, or at all. While we have developed and implemented and continue to develop and implement health and safety protocols, business continuity plans and crisis management protocols in an effort to mitigate the negative impact of COVID-19 to our employees and our business, the extent of the impact of the pandemic on our business and financial results will continue to depend on numerous evolving factors that we are not able to accurately predict and which will vary by jurisdiction and market, including the duration and scope of the pandemic, the development and availability of effective treatments and vaccines, global economic conditions during and after the pandemic, governmental actions that have been taken, or may be taken in Table of Contents the future, in response to the pandemic and changes in consumer behavior in response to the pandemic, some of which may be more than just temporary. Coronavirus Aid, Relief, and Economic Security Act (CARES Act) The CARES Act was enacted on March 27, 2020 in the United States. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the Tax Cuts and Jobs Act (TCJ Act) and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. Refer to the COVID-19 discussion above and Note 5 to our consolidated financial statements for further information. Risks Associated with International Operations We are subject to risks in the normal course of business. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. Imposition of Taxes and Regulations on our Products Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, encourage waste reduction and increased recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used vary by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. The related provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. For further information, see Our Liquidity and Table of Contents Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded net tax expense of $24 million related to the impact of the TRAF. See Our Critical Accounting Policies and Note 5 to our consolidated financial statements for further information. Retail Landscape Our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We have seen and expect to continue to see a further shift to e-commerce, online-to-offline, and other online purchasing by consumers, including as a result of the COVID-19 pandemic. We continue to monitor changes in the retail landscape and seek to identify actions we may take to build our global e-commerce and digital capabilities, such as expanding our direct-to-consumer business, and distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. During 2020, in addition to COVID-19 discussions as part of risk updates to the Board and the relevant Committees, the Board was provided with updates on COVID-19s impact to our business, financial condition and operations through memos, teleconferences or other appropriate means of communication. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; Table of Contents The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Sustainability, Diversity and Public Policy Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability, diversity and inclusion, and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Table of Contents Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 26, 2020 and December 28, 2019. At the end of 2020, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2020 by $121 million, which would generally be offset by a reduction in the cost of the underlying commodity purchases. Foreign Exchange Our operations outside of the United States generated 42% of our consolidated net revenue in 2020, with Mexico, Russia, Canada, the United Kingdom, China and South Africa, collectively, comprising approximately 21% of our consolidated net revenue in 2020. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business. During 2020, unfavorable foreign exchange reduced net revenue growth by 2 percentage points, primarily due to declines in the Mexican peso, Russian ruble and Brazilian real. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms withdrawal from the European Union (Brexit), including the effects of the post-Brexit trade deal entered into between the United Kingdom and the European Union in December 2020, as well as the economic, operating and political environment in Russia and the potential impact for the Europe segment and our other businesses. Our foreign currency derivatives had a total notional value of $1.9 billion as of December 26, 2020 and December 28, 2019. At the end of 2020, we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2020 by $175 million, which would be significantly offset by an inverse change in the fair value of the underlying exposure. The total notional amount of our debt instruments designated as net investment hedges was $2.7 billion as of December 26, 2020 and $2.5 billion as of December 28, 2019. Interest Rates Our interest rate derivatives had a total notional value of $3.0 billion as of December 26, 2020 and $5.0 billion as of December 28, 2019. Assuming year-end 2020 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2020 by $80 million due to higher cash and cash equivalents and short-term investments levels, as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Physical or unit volume is one of the key metrics management uses internally to make operating and strategic decisions, including the preparation of our annual operating plan and the evaluation of our business performance. We believe volume provides additional information to facilitate the comparison of Table of Contents our historical operating performance and underlying trends, and provides additional transparency on how we evaluate our business because it measures demand for our products at the consumer level. Beverage volume includes volume of concentrate sold to independent bottlers and volume of finished products bearing company-owned or licensed trademarks and allied brand products and joint venture trademarks sold by company-owned bottling operations, including by our noncontrolled affiliates. Concentrate volume sold to independent bottlers is reported in concentrate shipments and equivalents (CSE), whereas finished beverage product volume is reported in bottler case sales (BCS). Both CSE and BCS convert all beverage volume to an 8-ounce-case metric. Typically, CSE and BCS are not equal in any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our net revenue is not entirely based on BCS volume due to the independent bottlers in our supply chain, we believe that BCS is a better measure of the consumption of our beverage products. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Food and snack volume includes volume sold by our subsidiaries and noncontrolled affiliates of snack products bearing company-owned or licensed trademarks. Internationally, we measure food and snack product volume in kilograms, while in North America we measure food and snack product volume in pounds. FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Consolidated Net Revenue and Operating Profit 2020 2019 Change Net revenue $ 70,372 $ 67,161 5 % Operating profit $ 10,080 $ 10,291 (2) % Operating profit margin 14.3 % 15.3 % (1.0) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. Operating profit decreased 2% and operating profit margin declined 1.0 percentage point. Operating profit performance was primarily driven by certain operating cost increases, partially offset by net revenue growth and productivity savings. The charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 7 percentage points. See Note 1 to our consolidated financial statements for further information. Additionally, higher inventory fair value adjustments and merger and integration charges included in Items Affecting Comparability and unfavorable foreign exchange each negatively impacted operating profit performance by 2 percentage points. Table of Contents Results of Operations Division Review See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on this measure, see Non-GAAP Measures. 2020 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Organic Volume (b) Effective net pricing FLNA 7 % (1) 6 % 3 3 QFNA 10 % 11 % 10 PBNA 4 % (2) 2 % (1) 3 LatAm (8) % 11 3 % 3 Europe 2 % 4 6 % 6 AMESA 25 % 1 (25) 1 % 1 APAC 18 % (10) 8 % 5 3 Total 5 % 2 (3) 4 % 2 2 (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, the impact of organic volume growth on net revenue growth differs from the unit volume growth disclosed in the following divisional discussions due to product mix, nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Table of Contents Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability 2020 Items Affecting Comparability (a) Reported, GAAP Measure (b) Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure (b) FLNA $ 5,340 $ $ 83 $ 29 $ 5,452 QFNA 669 5 674 PBNA 1,937 47 66 2,050 LatAm 1,033 31 1,064 Europe 1,353 48 1,401 AMESA 600 14 173 787 APAC 590 5 7 602 Corporate unallocated expenses (1,442) (73) 36 (20) (1,499) Total $ 10,080 $ (73) $ 269 $ 255 $ 10,531 2019 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure FLNA $ 5,258 $ $ 22 $ $ 5,280 QFNA 544 2 546 PBNA 2,179 51 2,230 LatAm 1,141 62 1,203 Europe 1,327 99 46 1,472 AMESA 671 38 7 716 APAC 477 47 524 Corporate unallocated expenses (1,306) (112) 47 2 (1,369) Total $ 10,291 $ (112) $ 368 $ 55 $ 10,602 (a) See Items Affecting Comparability. (b) Operating profit for 2020 includes the charges taken as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. Table of Contents Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis 2020 Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 2 % 1 1 3 % 3 % QFNA 23 % 24 % 24 % PBNA (11) % 3 (8) % (8) % LatAm (10) % (2) (12) % 11 % Europe 2 % (4) (3) (5) % 4 (0.5) % AMESA (11) % (3.5) 24 10 % 10 % APAC 24 % (10) 2 15 % 1 16 % Corporate unallocated expenses 10 % (6) 2 3.5 10 % 10 % Total (2) % (1) 2 (1) % 2 1 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 7% and unit volume grew 3%. The net revenue growth was driven by effective net pricing and organic volume growth. The unit volume growth primarily reflects double-digit growth in variety packs and dips, and high-single-digit growth in trademark Tostitos and Ruffles, partially offset by a double-digit decline in nuts and seeds. Operating profit increased 2%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases. Additionally, the charges taken as a result of the COVID-19 pandemic reduced operating profit growth by 4 percentage points. QFNA Net revenue and unit volume each increased 10%. The net revenue growth reflects organic volume growth and favorable pricing, partially offset by unfavorable mix. The unit volume growth was driven by double-digit growth in oatmeal and pancake syrup and mix and high-single-digit growth in ready-to-eat cereals. The COVID-19 pandemic drove an increase in consumer demand, which had a positive impact on both net revenue and unit volume growth. Operating profit grew 23%, reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases. Additionally, the charges taken as a result of the COVID-19 pandemic reduced operating profit growth by 3 percentage points. PBNA Net revenue increased 4%, primarily driven by effective net pricing, partially offset by a decrease in organic volume. Unit volume decreased 1%, driven by a 5% decrease in CSD volume, largely offset by a 4% increase in non-carbonated beverage (NCB) volume. The NCB volume increase primarily reflected a high-single-digit increase in Gatorade sports drinks, a double-digit increase in our energy portfolio, primarily due to acquisitions, and a low-single-digit increase in our overall water portfolio, partially offset by a mid-single-digit decrease in our juice and juice drinks portfolio. In addition, acquisitions contributed 2 percentage points to net revenue growth. Table of Contents Operating profit decreased 11%, reflecting certain operating cost increases, including incremental information technology costs, a 14-percentage-point impact of the charges taken as a result of the COVID-19 pandemic and the organic volume decrease. These impacts were partially offset by the effective net pricing, productivity savings, lower advertising and marketing expenses, and a 4-percentage-point impact of lower commodity costs. Prior-year gains associated with sales of assets negatively impacted operating profit performance by 2 percentage points. Additionally, impairment charges associated with a coconut water brand negatively impacted operating profit performance by 2 percentage points. Acquisitions positively contributed 4 percentage points to operating profit performance. In the fourth quarter of 2020, we received notice of termination without cause from Vital Pharmaceuticals, Inc., which would end our distribution rights of Bang Energy drinks, effective October 24, 2023. LatAm Net revenue decreased 8%, primarily reflecting an 11-percentage-point impact of unfavorable foreign exchange, partially offset by effective net pricing. Snacks unit volume grew slightly, primarily reflecting low-single-digit growth in Brazil, partially offset by a slight decline in Mexico. Beverage unit volume declined 1%, primarily reflecting a high-single-digit decline in Argentina, a mid-single-digit decline in Honduras and a low-single-digit decline in Guatemala, partially offset by double-digit growth in Brazil, low-single-digit growth in Mexico and mid-single-digit growth in Chile. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume performance. Operating profit decreased 10%, primarily reflecting certain operating cost increases and a 9-percentage-point impact of higher commodity costs due to transaction-related foreign exchange. These impacts were partially offset by productivity savings and the effective net pricing. Additionally, unfavorable foreign exchange and certain charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 11 percentage points and 8 percentage points, respectively. Europe Net revenue increased 2%, reflecting organic volume growth, partially offset by a 4-percentage-point impact of unfavorable foreign exchange. Snacks unit volume grew 4%, primarily reflecting double-digit growth in Turkey, high-single-digit growth in the United Kingdom and France and mid-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in Spain. Additionally, Russia and Poland each experienced low-single-digit growth. Beverage unit volume grew 11%, primarily reflecting double-digit growth in Germany and France, partially offset by a mid-single-digit decline in Poland and a low-single-digit decline in Turkey. Additionally, Russia experienced low-single-digit growth and the United Kingdom experienced mid-single-digit growth. Operating profit increased 2%, primarily reflecting the organic volume growth, productivity savings, a 4-percentage-point impact of lower restructuring and impairment charges, a 3-percentage-point impact of the prior-year inventory fair value adjustments and merger and integration charges primarily associated with our acquisition of SodaStream International Ltd. (SodaStream) and a 2-percentage-point impact of a gain on an asset sale. These impacts were partially offset by certain operating cost increases and a 2-percentage-point impact of higher commodity costs due to transaction-related foreign exchange. Additionally, the charges taken as a result of the COVID-19 pandemic and unfavorable foreign exchange reduced operating profit growth by 6 percentage points and 4 percentage points, respectively. Table of Contents AMESA Net revenue increased 25%, primarily reflecting a 28-percentage-point impact of the Pioneer Foods acquisition, partially offset by a 3-percentage-point impact of the prior-year refranchising of a portion of our beverage business in India. Net revenue was also negatively impacted by the COVID-19 pandemic. Snacks unit volume grew 199%, primarily reflecting a 195-percentage-point impact of the Pioneer Foods acquisition, double-digit growth in Pakistan and mid-single-digit growth in the Middle East. Additionally, India and South Africa (excluding our Pioneer Foods acquisition) each experienced low-single-digit growth. Beverage unit volume declined 5%, primarily reflecting a double-digit decline in India and a high-single-digit decline in Pakistan, partially offset by slight growth in the Middle East and low-single-digit growth in Nigeria. Our Pioneer Foods acquisition positively contributed 2 percentage points to beverage unit volume performance. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume performance. Operating profit decreased 11%, primarily reflecting certain operating cost increases, partially offset by productivity savings, lower advertising and marketing expenses and a 3-percentage-point impact of lower commodity costs. The inventory fair value adjustments and merger and integration charges associated with our Pioneer Foods acquisition negatively impacted operating profit performance by 24 percentage points and were partially offset by Pioneer Foods 9-percentage-point positive contribution to operating profit performance. Additionally, the charges taken as a result of the COVID-19 pandemic negatively impacted operating profit performance by 5 percentage points. APAC Net revenue increased 18%, primarily reflecting a 10-percentage-point impact of our Be Cheery acquisition, organic volume growth and effective net pricing. Snacks unit volume grew 17%, primarily reflecting a 10-percentage-point impact of our Be Cheery acquisition and double-digit growth in Indonesia, partially offset by a low-single-digit decline in Thailand. Additionally, China (excluding our Be Cheery acquisition) and Australia each experienced mid-single-digit growth and Taiwan experienced low-single-digit growth. Beverage unit volume grew 1%, primarily reflecting high-single-digit growth in China, partially offset by a double-digit decline in the Philippines, a mid-single-digit decline in Vietnam and a low-single-digit decline in Thailand. The COVID-19 pandemic contributed to a decrease in consumer demand, which had a negative impact on beverage unit volume growth. Operating profit increased 24%, primarily reflecting the net revenue growth, productivity savings and a 10-percentage-point impact of lower restructuring and impairment charges, partially offset by certain operating cost increases and higher advertising and marketing expenses. Table of Contents Other Consolidated Results 2020 2019 Change Other pension and retiree medical benefits income/(expense) $ 117 $ (44) $ 161 Net interest expense and other $ (1,128) $ (935) $ (193) Annual tax rate 20.9 % 21.0 % Net income attributable to PepsiCo (a) $ 7,120 $ 7,314 (3) % Net income attributable to PepsiCo per common share diluted (a) $ 5.12 $ 5.20 (2) % (a) The charges taken as a result of the COVID-19 pandemic negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 8 percentage points. See Note 1 to our consolidated financial statements for further information. Other pension and retiree medical benefits income increased $161 million, primarily reflecting the recognition of fixed income gains on plan assets, the impact of discretionary plan contributions and higher prior-year settlement losses, partially offset by the decrease in discount rates. Net interest expense and other increased $193 million, primarily due to higher average debt balances, lower interest rates on cash, as well as lower gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by lower interest rates on debt and higher average cash balances. The reported tax rate decreased 0.1 percentage points, primarily reflecting the net tax benefits related to the TRAF, partially offset by an increase in reserves for uncertain tax positions in foreign jurisdictions. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; amounts associated with mergers, acquisitions, divestitures and other structural changes; pension and retiree medical related items; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. Table of Contents The following non-GAAP financial measures contained in this Form 10-K are discussed below: Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income/expense, provision for income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit and net income attributable to PepsiCo per common share diluted, each adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 Multi-Year Productivity Plan (2019 Productivity Plan) and our 2014 Multi-Year Productivity Plan (2014 Productivity Plan), inventory fair value adjustments and merger and integration charges associated with our acquisitions, pension-related settlement charges and net tax related to the TCJ Act (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, each on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic revenue growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Table of Contents Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: 2020 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 31,797 $ 38,575 $ 28,495 $ 10,080 $ 117 $ 1,894 $ 7,120 Items Affecting Comparability Mark-to-market net impact 64 (64) 9 (73) (15) (58) Restructuring and impairment charges (30) 30 (239) 269 20 58 231 Inventory fair value adjustments and merger and integration charges (32) 32 (223) 255 18 237 Pension-related settlement charge 205 47 158 Core, Non-GAAP Measure $ 31,799 $ 38,573 $ 28,042 $ 10,531 $ 342 $ 2,002 $ 7,688 2019 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 30,132 $ 37,029 $ 26,738 $ 10,291 $ (44) $ 1,959 $ 39 $ 7,314 Items Affecting Comparability Mark-to-market net impact 57 (57) 55 (112) (25) (87) Restructuring and impairment charges (115) 115 (253) 368 2 67 5 298 Inventory fair value adjustments and merger and integration charges (34) 34 (21) 55 8 47 Pension-related settlement charges 273 62 211 Net tax related to the TCJ Act 8 (8) Core, Non-GAAP Measure $ 30,040 $ 37,121 $ 26,519 $ 10,602 $ 231 $ 2,079 $ 44 $ 7,775 Table of Contents (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. 2020 2019 Change Net income attributable to PepsiCo per common share diluted, GAAP measure $ 5.12 $ 5.20 (2) % Mark-to-market net impact (0.04) (0.06) Restructuring and impairment charges 0.17 0.21 Inventory fair value adjustments and merger and integration charges 0.17 0.03 Pension-related settlement charges 0.11 0.15 Net tax related to the TCJ Act (0.01) Core net income attributable to PepsiCo per common share diluted, non-GAAP measure $ 5.52 (a) $ 5.53 (a) % Impact of foreign exchange translation 2 Growth in core net income attributable to PepsiCo per common share diluted, on a constant currency basis, non-GAAP measure 2 % (a) Does not sum due to rounding. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $2.5 billion, including cash expenditures of approximately $1.6 billion. Plan to date through December 26, 2020, we have incurred pre-tax charges of $797 million, including cash expenditures of $518 million. In our 2021 financial results, we expect to incur pre-tax charges of approximately $500 million, including cash expenditures of approximately $400 million, with the balance to be reflected in our 2022 and 2023 financial results. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2021 and 2022 results. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan was completed in 2019. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $1.3 billion and $960 million, respectively. See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Inventory Fair Value Adjustments and Merger and Integration Charges In 2020, we recorded inventory fair value adjustments and merger and integration charges related to our acquisitions of BFY Brands, Inc. (BFY Brands), Rockstar, Pioneer Foods and Be Cheery. Inventory fair value adjustments and merger and integration charges include fair value adjustments to the acquired Table of Contents inventory included in the acquisition-date balance sheets and closing costs, employee-related costs, contract termination costs, changes in the fair value of contingent consideration and other integration costs. Merger and integration charges also include liabilities to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods. In 2019, we recorded inventory fair value adjustments and merger and integration charges primarily related to SodaStreams acquired inventory included in acquisition-date balance sheet, as well as merger and integration charges, including employee-related costs. See Note 14 to our consolidated financial statements for further information. Pension-Related Settlement Charges In 2020, we recorded a pension settlement charge related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, we recorded pension settlement charges related to the purchase of a group annuity contract and one-time lump sum payments to certain former employees who had vested benefits. See Note 7 to our consolidated financial statements for further information. Net Tax Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. We recognized net tax benefits in 2019 related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. Table of Contents Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs, including with respect to our net capital spending plans. Our primary sources of cash available to fund cash outflows, such as our anticipated dividend payments, debt repayments, payments for acquisitions, including the contingent consideration related to Rockstar, and the transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper and long-term debt and cash and cash equivalents. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further information. Our sources and uses of cash were not materially adversely impacted by COVID-19 in 2020 and, to date, we have not identified any material liquidity deficiencies as a result of the COVID-19 pandemic. Based on the information currently available to us, we do not expect the impact of COVID-19 to have a material impact on our liquidity. We will continue to monitor and assess the impact COVID-19 may have on our business and financial results. See Note 1 to our consolidated financial statements for further information. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the TCJ Act and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. See Item 1A. Risk Factors and Our Business Risks for further information related to the COVID-19 pandemic. As of December 26, 2020, cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 26, 2020, our mandatory transition tax liability was $3.2 billion, which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $309 million of this liability in 2021. See Credit Facilities and Long-Term Contractual Commitments. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. As part of our evolving market practices, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Our current payment terms with a majority of our suppliers generally range from 60 to 90 days, which we deem to be commercially reasonable. We will continue to monitor economic conditions and market practice working with our suppliers to adjust as necessary. We also maintain voluntary supply chain finance agreements with several participating global financial institutions. Under these agreements, our suppliers, at their sole discretion, may elect to sell their accounts receivable with PepsiCo to these participating global financial institutions. Supplier participation in these financing arrangements is voluntary. Our suppliers negotiate their financing agreements directly with the respective global financial institutions and we are not a party to these agreements. These financing arrangements allow participating suppliers to leverage PepsiCos creditworthiness in establishing credit spreads and associated costs, which generally provides our suppliers with more favorable terms than they would be able to secure on their own. Neither PepsiCo nor any of its subsidiaries provide any guarantees to any third party in connection with these financing arrangements. We have no economic interest in our suppliers decision to participate in these agreements. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. All outstanding amounts related to suppliers participating in such financing arrangements are recorded within Table of Contents accounts payable and other current liabilities in our consolidated balance sheet. We have been informed by the participating financial institutions that as of December 26, 2020 and December 28, 2019, $1.2 billion and $1.1 billion, respectively, of our accounts payable to suppliers who participate in these financing arrangements are outstanding. These supply chain finance arrangements did not have a material impact on our liquidity or capital resources in the periods presented and we do not expect such arrangements to have a material impact on our liquidity or capital resources for the foreseeable future. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: 2020 2019 Net cash provided by operating activities $ 10,613 $ 9,649 Net cash used for investing activities $ (11,619) $ (6,437) Net cash provided by/(used for) financing activities $ 3,819 $ (8,489) Operating Activities In 2020, net cash provided by operating activities was $10.6 billion, compared to $9.6 billion in the prior year. The increase in operating cash flow primarily reflects lower net cash tax payments and lower pre-tax pension and retiree medical plan contributions in the current year. Investing Activities In 2020, net cash used for investing activities was $11.6 billion, primarily reflecting net cash paid in connection with our acquisitions of Rockstar of $3.85 billion, Pioneer Foods of $1.2 billion and Be Cheery of $0.7 billion, net capital spending of $4.2 billion, as well as purchases of short-term investments with maturities greater than three months of $1.1 billion. In 2019, net cash used for investing activities was $6.4 billion, primarily reflecting $4.1 billion of net capital spending, as well as $1.9 billion of the remaining cash paid in connection with our acquisition of SodaStream. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities; and see Note 14 to our consolidated financial statements for further discussion of our acquisitions. We regularly review our plans with respect to net capital spending, including in light of the ongoing uncertainty caused by the COVID-19 pandemic on our business, and believe that we have sufficient liquidity to meet our net capital spending needs. Financing Activities In 2020, net cash provided by financing activities was $3.8 billion, primarily reflecting proceeds from issuances of long-term debt of $13.8 billion, partially offset by the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.5 billion, payments of long-term debt borrowings of $1.8 billion and debt redemptions of $1.1 billion. Table of Contents In 2019, net cash used for financing activities was $8.5 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $8.3 billion, payments of long-term debt borrowings of $4.0 billion and debt redemptions of $1.0 billion, partially offset by proceeds from issuances of long-term debt of $4.6 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. In addition, on February 11, 2021, we announced a 5% increase in our annualized dividend to $4.30 per share from $4.09 per share, effective with the dividend expected to be paid in June 2021. We expect to return a total of approximately $5.9 billion to shareholders in 2021, comprised of dividends of approximately $5.8 billion and share repurchases of approximately $100 million. We have recently completed our share repurchase activity and do not expect to repurchase any additional shares for the balance of 2021. Free Cash Flow The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. 2020 2019 Change Net cash provided by operating activities, GAAP measure $ 10,613 $ 9,649 10 % Capital spending (4,240) (4,232) Sales of property, plant and equipment 55 170 Free cash flow, non-GAAP measure $ 6,428 $ 5,587 15 % We use free cash flow primarily for acquisitions and financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Table of Contents Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2021 2022 2023 2024 2025 2026 and beyond Recorded Liabilities: Long-term debt obligations (b) $ 40,330 $ $ 6,895 $ 6,298 $ 27,137 Operating leases (c) 1,895 486 663 333 413 One-time mandatory transition tax - TCJ Act (d) 3,239 309 617 1,351 962 Other long-term liabilities (e) 1,277 159 135 140 843 Other: Interest on debt obligations (f) 15,988 1,160 2,043 1,771 11,014 Purchasing commitments (g) 2,295 894 1,034 246 121 Marketing commitments (h) 950 355 366 161 68 Other long-term contractual commitments (i) 347 85 167 95 Total contractual commitments $ 66,321 $ 3,448 $ 11,920 $ 10,395 $ 40,558 (a) Based on year-end foreign exchange rates. (b) Excludes $3,358 million related to current maturities of debt, $40 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $260 million related to unamortized net discounts. (c) Primarily reflects building leases. See Note 13 to our consolidated financial statements for further information on operating leases. (d) Reflects our transition tax liability as of December 26, 2020, which must be paid through 2026 under the provisions of the TCJ Act. (e) Reflects contingent consideration related to estimated future tax benefits associated with our acquisition of Rockstar. Also reflects commitments to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods. See Note 9 and Note 14 to our consolidated financial statements for further information. (f) Interest payments on floating-rate debt are estimated using interest rates effective as of December 26, 2020. Includes accrued interest of $352 million as of December 26, 2020. (g) Reflects non-cancelable commitments, primarily for the purchase of commodities and outsourcing services in the normal course of business and does not include purchases that we are likely to make based on our plans but are not obligated to incur. (h) Reflects non-cancelable commitments, primarily for sports marketing in the normal course of business. (i) Reflects our commitment to incur capital expenditures and/or business-related costs associated with our acquisition of Pioneer Foods. See Note 14 to our consolidated financial statements for further information. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. Bottler funding to independent bottlers is not reflected in the table above as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in the table above. See Note 7 to our consolidated financial statements for further information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Table of Contents Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. 2020 2019 Net income attributable to PepsiCo $ 7,120 $ 7,314 Interest expense 1,252 1,135 Tax on interest expense (278) (252) $ 8,094 $ 8,197 Average debt obligations (a) $ 41,402 $ 31,975 Average common shareholders equity (b) 13,536 14,317 Average invested capital $ 54,938 $ 46,292 ROIC, non-GAAP measure 14.7 % 17.7 % (a) Includes a quarterly average of short-term and long-term debt obligations. (b) Includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. 2020 2019 ROIC 14.7 % 17.7 % Impact of: Average cash, cash equivalents and short-term investments 3.4 3.0 Interest income (0.2) (0.5) Tax on interest income 0.1 0.1 Mark-to-market net impact (0.1) (0.2) Restructuring and impairment charges 0.3 0.5 Inventory fair value adjustments and merger and integration charges 0.4 0.1 Pension-related settlement charges 0.2 0.5 Net tax related to the TCJ Act 0.1 (1.0) Other net tax benefits 1.0 2.2 Charges related to cash tender and exchange offers (0.1) Net ROIC, excluding items affecting comparability 19.9 % 22.3 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, including those related to the COVID-19 pandemic, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Table of Contents Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. We recorded $20 million of reserves for product returns in 2020 as a result of the COVID-19 pandemic . See Note 1 to our consolidated financial statements for further information. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. There were no material changes in credit terms as a result of the COVID-19 pandemic. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers (including foodservice and vending businesses). We recorded an allowance for expected credit losses of $56 million in 2020 as a result of the COVID-19 pandemic. See Note 1 to our consolidated financial statements for further information. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Table of Contents Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions, including those related to the COVID-19 pandemic, based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. These Table of Contents assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. We recorded a net tax benefit of $28 million ($0.02 per share) in 2018 related to the TCJ Act. The related provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $8 million ($0.01 per share) related to the TCJ Act. See further information in Items Affecting Comparability. On May 19, 2019, a public referendum held in Switzerland passed the TRAF, effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $72 million related to the adoption of the TRAF in the Table of Contents Swiss Canton of Bern. During 2019, we recorded net tax expense of $24 million related to the impact of the TRAF. In 2020, our annual tax rate was 20.9% compared to 21.0% in 2019. See Other Consolidated Results for further information. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in the PepsiCo Employees Retirement Plan A (Plan A) of $205 million ($158 million after-tax or $0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pension benefits pre-tax expense is expected to decrease by approximately $70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to the PepsiCo Employees Retirement Plan I (Plan I) and to a newly created plan, the PepsiCo Employees Retirement Hourly Plan (Plan H), effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization will facilitate a more targeted investment strategy and provide additional flexibility in evaluating opportunities to reduce risk and volatility. No material impact to pension benefit pre-tax expense is expected from this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pension benefits pre-tax expense is expected to increase approximately $45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $220 million ($170 million after-tax or $0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $53 million ($41 million after-tax or $0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $273 million ($211 million after-tax or $0.15 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Table of Contents Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans obligation and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Table of Contents Weighted-average assumptions for pension and retiree medical expense are as follows: 2021 2020 2019 Pension Service cost discount rate 2.6 % 3.4 % 4.4 % Interest cost discount rate 1.9 % 2.8 % 3.9 % Expected rate of return on plan assets 6.2 % 6.6 % 6.8 % Expected rate of salary increases 3.1 % 3.2 % 3.2 % Retiree medical Service cost discount rate 2.3 % 3.2 % 4.3 % Interest cost discount rate 1.6 % 2.6 % 3.8 % Expected rate of return on plan assets 5.4 % 5.8 % 6.6 % Current health care cost trend rate 5.5 % 5.6 % 5.7 % In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A. In addition, based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2021 primarily reflecting the recognition of fixed income gains on plan assets, the impact of discretionary plan contributions and plan changes, partially offset by lower discount rates and lower rate of expected returns on U.S. plan assets. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2021 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ 55 Expected rate of return $ 50 Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. In November 2020, we received approval from our Board of Directors to make discretionary contributions of $500 million to our U.S. qualified defined benefit plans. We contributed $300 million of the approved amount in January 2021; we expect to contribute the remaining $200 million in the third quarter of 2021. We made discretionary contributions to our U.S. qualified defined benefit plans of $325 million in 2020 and $400 million in 2019. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Table of Contents Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions except per share amounts) 2020 2019 2018 Net Revenue $ 70,372 $ 67,161 $ 64,661 Cost of sales 31,797 30,132 29,381 Gross profit 38,575 37,029 35,280 Selling, general and administrative expenses 28,495 26,738 25,170 Operating Profit 10,080 10,291 10,110 Other pension and retiree medical benefits income/(expense) 117 ( 44 ) 298 Net interest expense and other ( 1,128 ) ( 935 ) ( 1,219 ) Income before income taxes 9,069 9,312 9,189 Provision for/(benefit from) income taxes (See Note 5) 1,894 1,959 ( 3,370 ) Net income 7,175 7,353 12,559 Less: Net income attributable to noncontrolling interests 55 39 44 Net Income Attributable to PepsiCo $ 7,120 $ 7,314 $ 12,515 Net Income Attributable to PepsiCo per Common Share Basic $ 5.14 $ 5.23 $ 8.84 Diluted $ 5.12 $ 5.20 $ 8.78 Weighted-average common shares outstanding Basic 1,385 1,399 1,415 Diluted 1,392 1,407 1,425 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Net income $ 7,175 $ 7,353 $ 12,559 Other comprehensive (loss)/income, net of taxes: Net currency translation adjustment ( 650 ) 628 ( 1,641 ) Net change on cash flow hedges 7 ( 90 ) 40 Net pension and retiree medical adjustments ( 532 ) 283 ( 467 ) Other ( 1 ) ( 2 ) 6 ( 1,176 ) 819 ( 2,062 ) Comprehensive income 5,999 8,172 10,497 Less: Comprehensive income attributable to noncontrolling interests 55 39 44 Comprehensive Income Attributable to PepsiCo $ 5,944 $ 8,133 $ 10,453 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Operating Activities Net income $ 7,175 $ 7,353 $ 12,559 Depreciation and amortization 2,548 2,432 2,399 Share-based compensation expense 264 237 256 Restructuring and impairment charges 289 370 308 Cash payments for restructuring charges ( 255 ) ( 350 ) ( 255 ) Inventory fair value adjustments and merger and integration charges 255 55 75 Cash payments for merger and integration charges ( 131 ) ( 10 ) ( 73 ) Pension and retiree medical plan expenses 408 519 221 Pension and retiree medical plan contributions ( 562 ) ( 716 ) ( 1,708 ) Deferred income taxes and other tax charges and credits 361 453 ( 531 ) Net tax related to the TCJ Act ( 8 ) ( 28 ) Tax payments related to the TCJ Act ( 78 ) ( 423 ) ( 115 ) Other net tax benefits related to international reorganizations ( 2 ) ( 4,347 ) Change in assets and liabilities: Accounts and notes receivable ( 420 ) ( 650 ) ( 253 ) Inventories ( 516 ) ( 190 ) ( 174 ) Prepaid expenses and other current assets 26 ( 87 ) 9 Accounts payable and other current liabilities 766 735 882 Income taxes payable ( 159 ) ( 287 ) 448 Other, net 642 218 ( 258 ) Net Cash Provided by Operating Activities 10,613 9,649 9,415 Investing Activities Capital spending ( 4,240 ) ( 4,232 ) ( 3,282 ) Sales of property, plant and equipment 55 170 134 Acquisitions, net of cash acquired, and investments in noncontrolled affiliates ( 6,372 ) ( 2,717 ) ( 1,496 ) Divestitures 4 253 505 Short-term investments, by original maturity: More than three months - purchases ( 1,135 ) ( 5,637 ) More than three months - maturities 16 12,824 More than three months - sales 62 1,498 Three months or less, net 27 19 16 Other investing, net 42 ( 8 ) 2 Net Cash (Used for)/Provided by Investing Activities ( 11,619 ) ( 6,437 ) 4,564 (Continued on following page) Table of Contents Consolidated Statement of Cash Flows (continued) PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions) 2020 2019 2018 Financing Activities Proceeds from issuances of long-term debt $ 13,809 $ 4,621 $ Payments of long-term debt ( 1,830 ) ( 3,970 ) ( 4,007 ) Debt redemption/cash tender and exchange offers ( 1,100 ) ( 1,007 ) ( 1,589 ) Short-term borrowings, by original maturity: More than three months - proceeds 4,077 6 3 More than three months - payments ( 3,554 ) ( 2 ) ( 17 ) Three months or less, net ( 109 ) ( 3 ) ( 1,352 ) Cash dividends paid ( 5,509 ) ( 5,304 ) ( 4,930 ) Share repurchases - common ( 2,000 ) ( 3,000 ) ( 2,000 ) Proceeds from exercises of stock options 179 329 281 Withholding tax payments on restricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted ( 96 ) ( 114 ) ( 103 ) Other financing ( 48 ) ( 45 ) ( 55 ) Net Cash Provided by/(Used for) Financing Activities 3,819 ( 8,489 ) ( 13,769 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 129 ) 78 ( 98 ) Net Increase/(Decrease) in Cash and Cash Equivalents and Restricted Cash 2,684 ( 5,199 ) 112 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 5,570 10,769 10,657 Cash and Cash Equivalents and Restricted Cash, End of Year $ 8,254 $ 5,570 $ 10,769 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 26, 2020 and December 28, 2019 (in millions except per share amounts) 2020 2019 ASSETS Current Assets Cash and cash equivalents $ 8,185 $ 5,509 Short-term investments 1,366 229 Accounts and notes receivable, net 8,404 7,822 Inventories 4,172 3,338 Prepaid expenses and other current assets 874 747 Total Current Assets 23,001 17,645 Property, Plant and Equipment, net 21,369 19,305 Amortizable Intangible Assets, net 1,703 1,433 Goodwill 18,757 15,501 Other Indefinite-Lived Intangible Assets 17,612 14,610 Investments in Noncontrolled Affiliates 2,792 2,683 Deferred Income Taxes 4,372 4,359 Other Assets 3,312 3,011 Total Assets $ 92,918 $ 78,547 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 3,780 $ 2,920 Accounts payable and other current liabilities 19,592 17,541 Total Current Liabilities 23,372 20,461 Long-Term Debt Obligations 40,370 29,148 Deferred Income Taxes 4,284 4,091 Other Liabilities 11,340 9,979 Total Liabilities 79,366 63,679 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,380 and 1,391 shares, respectively) 23 23 Capital in excess of par value 3,910 3,886 Retained earnings 63,443 61,946 Accumulated other comprehensive loss ( 15,476 ) ( 14,300 ) Repurchased common stock, in excess of par value ( 487 and 476 shares, respectively) ( 38,446 ) ( 36,769 ) Total PepsiCo Common Shareholders Equity 13,454 14,786 Noncontrolling interests 98 82 Total Equity 13,552 14,868 Total Liabilities and Equity $ 92,918 $ 78,547 See accompanying notes to the consolidated financial statements. Table of Contents Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 26, 2020, December 28, 2019 and December 29, 2018 (in millions except per share amounts) 2020 2019 2018 Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year $ $ 0.8 $ 41 Conversion to common stock ( 0.1 ) ( 6 ) Retirement of preferred stock ( 0.7 ) ( 35 ) Balance, end of year Repurchased Preferred Stock Balance, beginning of year ( 0.7 ) ( 197 ) Redemptions ( 2 ) Retirement of preferred stock 0.7 199 Balance, end of year Common Stock Balance, beginning of year 1,391 23 1,409 23 1,420 24 Shares issued in connection with preferred stock conversion to common stock 1 Change in repurchased common stock ( 11 ) ( 18 ) ( 12 ) ( 1 ) Balance, end of year 1,380 23 1,391 23 1,409 23 Capital in Excess of Par Value Balance, beginning of year 3,886 3,953 3,996 Share-based compensation expense 263 235 250 Equity issued in connection with preferred stock conversion to common stock 6 Stock option exercises, RSUs, PSUs and PEPunits converted ( 143 ) ( 188 ) ( 193 ) Withholding tax on RSUs, PSUs and PEPunits converted ( 96 ) ( 114 ) ( 103 ) Other ( 3 ) Balance, end of year 3,910 3,886 3,953 Retained Earnings Balance, beginning of year 61,946 59,947 52,839 Cumulative effect of accounting changes ( 34 ) 8 ( 145 ) Net income attributable to PepsiCo 7,120 7,314 12,515 Cash dividends declared - common (a) ( 5,589 ) ( 5,323 ) ( 5,098 ) Retirement of preferred stock ( 164 ) Balance, end of year 63,443 61,946 59,947 Accumulated Other Comprehensive Loss Balance, beginning of year ( 14,300 ) ( 15,119 ) ( 13,057 ) Other comprehensive (loss)/income attributable to PepsiCo ( 1,176 ) 819 ( 2,062 ) Balance, end of year ( 15,476 ) ( 14,300 ) ( 15,119 ) Repurchased Common Stock Balance, beginning of year ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) Share repurchases ( 15 ) ( 2,000 ) ( 24 ) ( 3,000 ) ( 18 ) ( 2,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted 4 322 6 516 6 469 Other 1 1 2 Balance, end of year ( 487 ) ( 38,446 ) ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) Total PepsiCo Common Shareholders Equity 13,454 14,786 14,518 Noncontrolling Interests Balance, beginning of year 82 84 92 Net income attributable to noncontrolling interests 55 39 44 Distributions to noncontrolling interests ( 44 ) ( 42 ) ( 49 ) Acquisitions 5 Other, net 1 ( 3 ) Balance, end of year 98 82 84 Total Equity $ 13,552 $ 14,868 $ 14,602 (a) Cash dividends declared per common share were $ 4.0225 , $ 3.7925 and $ 3.5875 for 2020, 2019 and 2018, respectively. See accompanying notes to the consolidated financial statements. Table of Contents Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. The business and economic uncertainty resulting from the COVID-19 pandemic has made such estimates and assumptions more difficult to calculate. As future events and their effect cannot be determined with precision, actual results could differ significantly from those estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. While our North America results are reported on a weekly calendar basis, substantially all of our international operations report on a monthly calendar basis. Certain operations in our Europe segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Table of Contents Our Divisions We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, the United Kingdom, China and South Africa. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: 2020 2019 2018 FLNA 13 % 13 % 13 % QFNA 1 % 1 % 1 % PBNA 18 % 17 % 18 % LatAm 6 % 7 % 8 % Europe 16 % 17 % 9 % AMESA 6 % 3 % 4 % APAC 2 % 5 % 4 % Corporate unallocated expenses 38 % 37 % 43 % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Table of Contents Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net Revenue and Operating Profit Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2020 2019 2018 2020 2019 2018 FLNA $ 18,189 $ 17,078 $ 16,346 $ 5,340 $ 5,258 $ 5,008 QFNA 2,742 2,482 2,465 669 544 637 PBNA 22,559 21,730 21,072 1,937 2,179 2,276 LatAm 6,942 7,573 7,354 1,033 1,141 1,049 Europe 11,922 11,728 10,973 1,353 1,327 1,256 AMESA (a) 4,573 3,651 3,657 600 671 661 APAC (b) 3,445 2,919 2,794 590 477 619 Total division 70,372 67,161 64,661 11,522 11,597 11,506 Corporate unallocated expenses ( 1,442 ) ( 1,306 ) ( 1,396 ) Total $ 70,372 $ 67,161 $ 64,661 $ 10,080 $ 10,291 $ 10,110 (a) In 2020, the increase in net revenue primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. (b) In 2020, the increase in net revenue primarily reflects our acquisition of Be Cheery. See Note 14 for further information. Our primary performance obligation is the distribution and sales of beverage and food and snack products to our customers. The following tables reflect the approximate percentage of net revenue generated between our beverage business and our food and snack business for each of our international divisions, as well as our consolidated net revenue: 2020 2019 2018 Beverage (a) Food/Snack Beverage (a) Food/Snack Beverage (a) Food/Snack LatAm 10 % 90 % 10 % 90 % 10 % 90 % Europe 55 % 45 % 55 % 45 % 50 % 50 % AMESA (b) 30 % 70 % 40 % 60 % 45 % 55 % APAC 25 % 75 % 25 % 75 % 25 % 75 % PepsiCo 45 % 55 % 45 % 55 % 45 % 55 % (a) Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue in 2020, 2019 and 2018. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. (b) The increase in the approximate percentage of net revenue generated by our food and snack business primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. Table of Contents Operating profit in 2020 includes certain pre-tax charges taken as a result of the COVID-19 pandemic. These pre-tax charges by division are as follows: 2020 Allowances for Expected Credit Losses (a) Upfront Payments to Customers (b) Inventory Write-Downs and Product Returns (c) Employee Compensation Expense (d) Employee Protection Costs (e) Other (f) Total FLNA $ 17 $ $ 8 $ 145 $ 59 $ $ 229 QFNA 2 9 3 1 15 PBNA 29 56 28 115 50 26 304 LatAm 1 19 56 18 8 102 Europe 5 3 11 23 22 24 88 AMESA 2 3 9 7 12 33 APAC (g) 3 ( 7 ) 2 5 3 Total $ 56 $ 59 $ 72 $ 350 $ 161 $ 76 $ 774 (a) Reflects the expected impact of the global economic uncertainty caused by COVID-19, leveraging estimates of creditworthiness, projections of default and recovery rates for certain of our customers, including foodservice and vending businesses. (b) Relates to promotional spending for which benefit is not expected to be received. (c) Includes a reserve for product returns of $ 20 million. (d) Includes incremental frontline incentive pay, crisis child care and other leave benefits and labor costs. (e) Includes costs associated with personal protective equipment, temperature scans, cleaning and other sanitization services. (f) Includes reserves for property, plant and equipment, donations of cash and product and other costs. (g) Income amount includes a social welfare relief credit of $ 11 million. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, tax-related contingent consideration and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending 2020 2019 2020 2019 2018 FLNA $ 8,730 $ 7,519 $ 1,189 $ 1,227 $ 840 QFNA 1,021 941 85 104 53 PBNA (a) 37,079 31,449 1,245 1,053 945 LatAm 6,977 7,007 390 557 492 Europe 17,917 17,814 730 613 466 AMESA (b) 5,942 3,672 252 267 198 APAC (c) 5,770 4,113 230 195 138 Total division 83,436 72,515 4,121 4,016 3,132 Corporate (d) 9,482 6,032 119 216 150 Total $ 92,918 $ 78,547 $ 4,240 $ 4,232 $ 3,282 (a) In 2020, the increase in assets was primarily related to our acquisition of Rockstar. See Note 14 for further information. (b) In 2020, the increase in assets was primarily related to our acquisition of Pioneer Foods. See Note 14 for further information. (c) In 2020, the increase in assets was primarily related to our acquisition of Be Cheery. See Note 14 for further information. (d) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2020, the change in assets was primarily due to an increase in cash and cash equivalents and short-term investments. Refer to the cash flow statement for further information. Table of Contents Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization 2020 2019 2018 2020 2019 2018 FLNA $ 10 $ 7 $ 7 $ 550 $ 492 $ 457 QFNA 41 44 45 PBNA 28 29 31 899 857 821 LatAm 4 5 5 251 270 253 Europe 40 37 23 350 341 319 AMESA 3 2 2 149 116 169 APAC 5 1 1 91 76 80 Total division 90 81 69 2,331 2,196 2,144 Corporate 127 155 186 Total $ 90 $ 81 $ 69 $ 2,458 $ 2,351 $ 2,330 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) 2020 2019 2018 2020 2019 United States (b) $ 40,800 $ 38,644 $ 37,148 $ 36,657 $ 30,601 Mexico 3,924 4,190 3,878 1,708 1,666 Russia 3,009 3,263 3,191 3,644 4,314 Canada 2,989 2,831 2,736 2,794 2,695 United Kingdom 1,882 1,723 1,743 874 827 China (c) 1,732 1,300 1,164 1,649 705 South Africa (d) 1,282 405 432 1,484 137 All other countries 14,754 14,805 14,369 13,423 12,587 Total $ 70,372 $ 67,161 $ 64,661 $ 62,233 $ 53,532 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. See Note 2 and Note 15 for further information on property, plant and equipment. See Note 2 and Note 4 for further information on goodwill and other intangible assets. Investments in noncontrolled affiliates are evaluated for impairment upon a significant change in the operating or macroeconomic environment. These assets are reported in the country where they are primarily used. (b) In 2020, the increase in long-lived assets was primarily related to our acquisition of Rockstar. See Note 14 for further information. (c) In 2020, the increase in net revenue and long-lived assets was primarily related to our acquisition of Be Cheery. See Note 14 for further information. (d) In 2020, the increase in net revenue and long-lived assets was primarily related to our acquisition of Pioneer Foods. See Note 14 for further information. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. In addition, we exclude from net revenue all sales, use, value-added and certain excise taxes assessed by government authorities on revenue producing transactions. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD, including certain chilled products, is to remove Table of Contents and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date produc ts. We recorded $ 20 million of reserves for product returns in 2020 as a result of the COVID-19 pandemic . See Note 1 for further information. As a result of the implementation of the revenue recognition guidance adopted in the first quarter of 2018, which did not have a material impact on our accounting policies, we recorded an adjustment in the first quarter of 2018 of $ 137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expected to be entitled to in line with revenue recognition. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. There were no material changes in credit terms as a result of the COVID-19 pandemic. We estimate and reserve for our expected credit loss exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable, our analysis of customer data, and forward-looking information (including the expected impact of the global economic uncertainty related to the COVID-19 pandemic), leveraging estimates of creditworthiness and projections of default and recovery rates for certain of our customers (including foodservice and vending businesses). We recorded an allowance for expected credit losses of $ 56 million in 2020 as a result of the COVID-19 pandemic. See Note 1 for further information. Expected credit loss expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2020, sales to Walmart and its affiliates (including Sams) represented approximately 14 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the Table of Contents shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 299 million as of December 26, 2020 and $ 272 million as of December 28, 2019 are included in prepaid expenses and other current assets and other assets on our balance sheet. We recorded reserves of $ 59 million for upfront payments to customers in 2020 as a result of the COVID-19 pandemic . See Note 1 for further information. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 4.6 billion in 2020, $ 4.7 billion in 2019 and $ 4.2 billion in 2018, including advertising expenses of $ 3.0 billion in both 2020 and 2019, and $ 2.6 billion in 2018. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 48 million and $ 55 million as of December 26, 2020 and December 28, 2019, respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 11.9 billion in 2020, $ 10.9 billion in 2019 and $ 10.5 billion in 2018. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 152 million in 2020, $ 166 million in 2019 and $ 204 million in 2018. Net capitalized software and development costs were $ 664 million and $ 572 million as of December 26, 2020 and December 28, 2019, respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Table of Contents Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 719 million, $ 711 million and $ 680 million in 2020, 2019 and 2018, respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic (including those related to the COVID-19 pandemic), industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors (including those related to the COVID-19 pandemic) to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Income Taxes Note 5. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Table of Contents Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO); or, in limited instances, last-in, first-out (LIFO) methods. Property, Plant and Equipment Note 15. Property, plant and equipment is recorded at historical cost. Depreciation is recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2016, the Financial Accounting Standards Board (FASB) issued guidance that changes the impairment model used to measure credit losses for most financial assets. Under the new model we are required to estimate expected credit losses over the life of our trade receivables, certain other receivables and certain other financial instruments. The new model replaced the existing incurred credit loss model and generally results in earlier recognition of allowances for credit losses. We adopted this guidance in the first quarter of 2020 and the adoption did not have a material impact on our consolidated financial statements or disclosures. On initial recognition, we recorded an after-tax cumulative effect decrease to retained earnings of $ 34 million ($ 44 million pre-tax) as of the beginning of 2020. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a step-up in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all of the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. The guidance is effective in the first quarter of 2021 with early adoption permitted. We will adopt the guidance when it becomes effective in the first quarter of 2021. The guidance is not expected to have a material impact on our consolidated financial statements or related disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2020 2019 2018 2019 Productivity Plan $ 289 $ 370 $ 138 2014 Productivity Plan 170 Total restructuring and impairment charges 289 370 308 Other productivity initiatives 3 8 Total restructuring and impairment charges and other productivity initiatives $ 289 $ 373 $ 316 Table of Contents 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $ 2.5 billion, including cash expenditures of approximately $ 1.6 billion. These pre-tax charges are expected to consist of approximately 65 % of severance and other employee-related costs, 15 % for asset impairments (all non-cash) resulting from plant closures and related actions and 20 % for other costs associated with the implementation of our initiatives. We expect to complete this plan by 2023. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges 15 % 1 % 30 % 10 % 25 % 5 % 3 % 11 % A summary of our 2019 Productivity Plan charges is as follows: 2020 2019 2018 Cost of sales $ 30 $ 115 $ 3 Selling, general and administrative expenses 239 253 100 Other pension and retiree medical benefits expense 20 2 35 Total restructuring and impairment charges $ 289 $ 370 $ 138 After-tax amount $ 231 $ 303 $ 109 Net income attributable to PepsiCo per common share $ 0.17 $ 0.21 $ 0.08 2020 2019 2018 Plan to Date through 12/26/2020 FLNA $ 83 $ 22 $ 31 $ 136 QFNA 5 2 5 12 PBNA 47 51 40 138 LatAm 31 62 9 102 Europe 48 99 6 153 AMESA 14 38 3 55 APAC 5 47 2 54 Corporate 36 47 7 90 269 368 103 740 Other pension and retiree medical benefits expense 20 2 35 57 Total $ 289 $ 370 $ 138 $ 797 Plan to Date through 12/26/2020 Severance and other employee costs $ 444 Asset impairments 125 Other costs 228 Total $ 797 Table of Contents Severance and other employee costs primarily include severance and other termination benefits, as well as voluntary separation arrangements. Other costs primarily include costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total 2018 restructuring charges $ 137 $ $ 1 $ 138 Non-cash charges and translation ( 32 ) ( 32 ) Liability as of December 29, 2018 105 1 106 2019 restructuring charges 149 92 129 370 Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation 12 ( 92 ) 10 ( 70 ) Liability as of December 28, 2019 128 21 149 2020 restructuring charges 158 33 98 289 Cash payments (a) ( 138 ) ( 117 ) ( 255 ) Non-cash charges and translation ( 26 ) ( 33 ) 3 ( 56 ) Liability as of December 26, 2020 $ 122 $ $ 5 $ 127 (a) Excludes cash expenditures of $ 2 million and $ 4 million for 2020 and 2019, respectively, reported in the cash flow statement in pension and retiree medical contributions. Substantially all of the restructuring accrual at December 26, 2020 is expected to be paid by the end of 2021. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, included the next generation of productivity initiatives that we believed would strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the plan through the end of 2019 to take advantage of additional opportunities within the initiatives described above that further strengthened our beverage, food and snack businesses. The 2014 Productivity Plan was completed in 2019. In 2019, there were no material pre-tax charges related to this plan and all cash payments were paid at year end. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $ 1.3 billion and $ 960 million, respectively. These total plan pre-tax charges consisted of 59 % of severance and other employee costs, 15 % of asset impairments and 26 % of other costs, including costs associated with the implementation of our initiatives, including certain consulting and other contract termination costs. These total plan pre-tax charges were incurred by division as follows: FLNA 14 %, QFNA 3 %, PBNA 29 %, LatAm 15 %, Europe 23 %, AMESA 3 %, APAC 3 % and Corporate 10 %. Table of Contents A summary of our 2014 Productivity Plan charges is as follows: 2018 Selling, general and administrative expenses $ 169 Other pension and retiree medical benefits expense 1 Total restructuring and impairment charges $ 170 After-tax amount $ 143 Net income attributable to PepsiCo per common share $ 0.10 2018 FLNA $ 8 QFNA 2 PBNA 51 LatAm 30 Europe 53 AMESA 15 APAC 12 Corporate (a) ( 1 ) Total $ 170 (a) Income amount primarily relates to other pension and retiree medical benefits. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 30, 2017 $ 212 $ $ 14 $ 226 2018 restructuring charges 86 28 56 170 Cash payments (a) ( 203 ) ( 52 ) ( 255 ) Non-cash charges and translation ( 4 ) ( 28 ) 5 ( 27 ) Liability as of December 29, 2018 91 23 114 Cash payments ( 77 ) ( 16 ) ( 93 ) Non-cash charges and translation ( 14 ) ( 7 ) ( 21 ) Liability as of December 28, 2019 $ $ $ $ (a) Excludes cash expenditures of $ 11 million reported in the cash flow statement in pension and retiree medical plan contributions. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. Table of Contents Note 4 Intangible Assets A summary of our amortizable intangible assets is as follows: 2020 2019 2018 Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights (a) 56 60 $ 976 $ ( 173 ) $ 803 $ 846 $ ( 158 ) $ 688 Customer relationships (b) 10 24 642 ( 204 ) 438 457 ( 177 ) 280 Brands 20 40 1,348 ( 1,099 ) 249 1,326 ( 1,066 ) 260 Other identifiable intangibles 10 24 474 ( 261 ) 213 459 ( 254 ) 205 Total $ 3,440 $ ( 1,737 ) $ 1,703 $ 3,088 $ ( 1,655 ) $ 1,433 Amortization expense $ 90 $ 81 $ 69 (a) The change in 2020 primarily reflects our distribution agreement with Vital Pharmaceuticals, Inc., with an expected residual value higher than our carrying value. The distribution agreements useful life is three years, in accordance with the three-year termination notice issued, and is not reflected in the average useful life above. (b) The change in 2020 primarily reflects our acquisitions of Pioneer Foods and Be Cheery. See Note 14 for further information. Amortization is recognized on a straight-line basis over an intangible assets estimated useful life. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 26, 2020 and using average 2020 foreign exchange rates, is expected to be as follows: 2021 2022 2023 2024 2025 Five-year projected amortization $ 92 $ 89 $ 87 $ 87 $ 84 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 26, 2020, December 28, 2019 and December 29, 2018. In 2020, we recognized a pre-tax impairment charge of $ 41 million related to a coconut water brand in PBNA. We did not recognize any material impairment charges for indefinite-lived intangible assets in each of the years ended December 28, 2019 and December 29, 2018. As of December 26, 2020, the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia on the estimated fair value of our indefinite-lived intangible assets in Russia and have concluded that there are no impairments for the year ended December 26, 2020. However, there could be an impairment of the carrying value of certain brands in Russia, including juice and dairy brands, if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows (including perpetuity growth assumptions), if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For further information on our policies for indefinite-lived intangible assets, see Note 2. Table of Contents The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2019 Acquisitions Translation and Other Balance, End of 2019 Acquisitions Translation and Other Balance, End of 2020 FLNA (a) Goodwill $ 297 $ ( 3 ) $ 5 $ 299 $ 164 $ 2 $ 465 Brands 161 1 162 179 ( 1 ) 340 Total 458 ( 3 ) 6 461 343 1 805 QFNA Goodwill 184 6 ( 1 ) 189 189 Brands 25 ( 14 ) 11 ( 11 ) Total 209 ( 8 ) ( 1 ) 200 ( 11 ) 189 PBNA (b) Goodwill 9,813 66 19 9,898 2,280 11 12,189 Reacquired franchise rights 7,058 31 7,089 18 7,107 Acquired franchise rights 1,510 7 1,517 16 3 1,536 Brands 353 418 ( 8 ) 763 2,400 ( 41 ) 3,122 Total 18,734 484 49 19,267 4,696 ( 9 ) 23,954 LatAm Goodwill 509 ( 8 ) 501 ( 43 ) 458 Brands 127 ( 2 ) 125 ( 17 ) 108 Total 636 ( 10 ) 626 ( 60 ) 566 Europe (c) (d) Goodwill 3,361 440 160 3,961 ( 2 ) ( 153 ) 3,806 Reacquired franchise rights 497 8 505 ( 9 ) 496 Acquired franchise rights 161 ( 4 ) 157 15 172 Brands 4,188 ( 139 ) 132 4,181 ( 109 ) 4,072 Total 8,207 301 296 8,804 ( 2 ) ( 256 ) 8,546 AMESA (e) Goodwill 437 11 ( 2 ) 446 560 90 1,096 Brands 183 31 214 Total 437 11 ( 2 ) 446 743 121 1,310 APAC (f) Goodwill 207 207 306 41 554 Brands 101 ( 1 ) 100 309 36 445 Total 308 ( 1 ) 307 615 77 999 Total goodwill 14,808 520 173 15,501 3,308 ( 52 ) 18,757 Total reacquired franchise rights 7,555 39 7,594 9 7,603 Total acquired franchise rights 1,671 3 1,674 16 18 1,708 Total brands 4,955 265 122 5,342 3,071 ( 112 ) 8,301 Total $ 28,989 $ 785 $ 337 $ 30,111 $ 6,395 $ ( 137 ) $ 36,369 (a) The change in acquisitions in 2020 primarily reflects our acquisition of BFY Brands. (b) The change in acquisitions in 2020 primarily reflects our acquisition of Rockstar. See Note 14 for further information. The change in acquisitions in 2019 primarily reflects our acquisition of CytoSport Inc. (c) The change in translation and other in 2020 primarily reflects the depreciation of the Russian ruble. The change in translation and other in 2019 primarily reflects the appreciation of the Russian ruble. (d) The change in acquisitions in 2019 primarily reflects our acquisition of SodaStream. See Note 14 for further information. (e) The change in acquisitions in 2020 primarily reflects our acquisition of Pioneer Foods. See Note 14 for further information. (f) The change in acquisitions in 2020 primarily reflects our acquisition of Be Cheery. See Note 14 for further information. Table of Contents Note 5 Income Taxes The components of income before income taxes are as follows: 2020 2019 2018 United States $ 4,070 $ 4,123 $ 3,864 Foreign 4,999 5,189 5,325 $ 9,069 $ 9,312 $ 9,189 The provision for/(benefit from) income taxes consisted of the following: 2020 2019 2018 Current: U.S. Federal $ 715 $ 652 $ 437 Foreign 932 807 378 State 110 196 63 1,757 1,655 878 Deferred: U.S. Federal 273 325 140 Foreign ( 167 ) ( 31 ) ( 4,379 ) State 31 10 ( 9 ) 137 304 ( 4,248 ) $ 1,894 $ 1,959 $ ( 3,370 ) A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: 2020 2019 2018 U.S. Federal statutory tax rate 21.0 % 21.0 % 21.0 % State income tax, net of U.S. Federal tax benefit 1.2 1.6 0.5 Lower taxes on foreign results ( 0.8 ) ( 0.9 ) ( 2.2 ) One-time mandatory transition tax - TCJ Act ( 0.1 ) 0.1 Remeasurement of deferred taxes - TCJ Act ( 0.4 ) International reorganizations ( 47.3 ) Tax settlements ( 7.8 ) Other, net ( 0.5 ) ( 0.6 ) ( 0.6 ) Annual tax rate 20.9 % 21.0 % ( 36.7 ) % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35 % to 21 %, effective January 1, 2018. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $ 2.5 billion ($ 1.70 per share) in the fourth quarter of 2017. Table of Contents The provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. As a result, in 2018, we recognized a net tax benefit of $ 28 million ($ 0.02 per share) related to the TCJ Act. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $ 8 million ($ 0.01 per share) related to the TCJ Act. There were no tax amounts recognized in 2020 related to the TCJ Act. As of December 26, 2020, our mandatory transition tax liability was $ 3.2 billion, which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 78 million in 2020, $ 663 million in 2019 and $ 150 million in 2018. We currently expect to pay approximately $ 309 million of this liability in 2021. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. Coronavirus Aid, Relief, and Economic Security Act The CARES Act was enacted on March 27, 2020 in the United States. The CARES Act and related notices include several significant provisions, such as delaying certain payroll tax payments, mandatory transition tax payments under the TCJ Act and estimated income tax payments. The CARES Act did not have a material impact on our financial results in 2020, including on our annual estimated effective tax rate or on our liquidity. We will continue to monitor and assess the impact similar legislation in other countries may have on our business and financial results. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the TRAF, effective January 1, 2020. The enactment of certain provisions of the TRAF resulted in adjustments to our deferred taxes. During 2020, we recorded a net tax benefit of $ 72 million related to the adoption of the TRAF in the Swiss Canton of Bern. During 2019, we recorded net tax expense of $ 24 million related to the impact of the TRAF. While the accounting for the impacts of the TRAF are deemed to be complete, further adjustments to our financial statements and related disclosures could be made in future quarters, including in connection with final tax return filings. In 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $ 4.3 billion ($ 3.05 per share) in 2018. The related deferred tax asset of $ 4.4 billion is being amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Table of Contents Deferred tax liabilities and assets are comprised of the following: 2020 2019 Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ 578 $ 578 Property, plant and equipment 1,851 1,583 Recapture of net operating losses 504 335 Right-of-use assets 371 345 Other 159 167 Gross deferred tax liabilities 3,463 3,008 Deferred tax assets Net carryforwards 5,008 4,168 Intangible assets other than nondeductible goodwill 1,146 793 Share-based compensation 90 94 Retiree medical benefits 153 154 Other employee-related benefits 373 350 Pension benefits 80 104 Deductible state tax and interest benefits 150 126 Lease liabilities 371 345 Other 866 741 Gross deferred tax assets 8,237 6,875 Valuation allowances ( 4,686 ) ( 3,599 ) Deferred tax assets, net 3,551 3,276 Net deferred tax assets $ ( 88 ) $ ( 268 ) A summary of our valuation allowance activity is as follows: 2020 2019 2018 Balance, beginning of year $ 3,599 $ 3,753 $ 1,163 Provision 1,082 ( 124 ) 2,639 Other additions/(deductions) 5 ( 30 ) ( 49 ) Balance, end of year $ 4,686 $ 3,599 $ 3,753 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2019 2014-2016 Mexico 2014-2019 2014-2016 United Kingdom 2017-2019 None Canada (Domestic) 2016-2019 2016-2017 Canada (International) 2010-2019 2010-2017 Russia 2017-2019 None Table of Contents In 2018, we recognized a non-cash tax benefit of $ 364 million ($ 0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, in 2018, we recognized non-cash tax benefits of $ 353 million ($ 0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $ 717 million ($ 0.50 per share) in 2018. Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws, relevant court cases or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 26, 2020, the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.6 billion. We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 338 million as of December 26, 2020, of which $ 93 million of tax expense was recognized in 2020. The gross amount of interest accrued, reported in other liabilities, was $ 250 million as of December 28, 2019, of which $ 84 million of tax expense was recognized in 2019. A reconciliation of unrecognized tax benefits is as follows: 2020 2019 Balance, beginning of year $ 1,395 $ 1,440 Additions for tax positions related to the current year 128 179 Additions for tax positions from prior years 153 93 Reductions for tax positions from prior years ( 22 ) ( 201 ) Settlement payments ( 13 ) ( 74 ) Statutes of limitations expiration ( 23 ) ( 47 ) Translation and other 3 5 Balance, end of year $ 1,621 $ 1,395 Carryforwards and Allowances Operating loss carryforwards totaling $ 28.3 billion as of December 26, 2020 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.2 billion in 2021, $ 25.2 billion between 2022 and 2040 and $ 2.9 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In 2018, we repatriated $ 20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability, related to the TCJ Act. As of December 26, 2020, we had approximately $ 6 billion of undistributed international earnings. We intend to continue to reinvest $ 6 billion of earnings outside the United States for the Table of Contents foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 26, 2020, 52 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense, which is primarily recorded in selling, general and administrative expenses, and excess tax benefits recognized: 2020 2019 2018 Share-based compensation expense - equity awards $ 264 $ 237 $ 256 Share-based compensation expense - liability awards 11 8 20 Restructuring charges ( 1 ) ( 2 ) ( 6 ) Total $ 274 $ 243 $ 270 Income tax benefits recognized in earnings related to share-based compensation $ 48 $ 39 $ 45 Excess tax benefits related to share-based compensation $ 35 $ 50 $ 48 As of December 26, 2020, there was $ 300 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Table of Contents Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: 2020 2019 2018 Expected life 6 years 5 years 5 years Risk-free interest rate 0.9 % 2.4 % 2.6 % Expected volatility 14 % 14 % 12 % Expected dividend yield 3.4 % 3.1 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 26, 2020 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 28, 2019 11,625 $ 89.03 Granted 1,847 $ 131.79 Exercised ( 2,440 ) $ 73.37 Forfeited/expired ( 392 ) $ 102.69 Outstanding at December 26, 2020 10,640 $ 99.54 5.26 $ 484,362 Exercisable at December 26, 2020 6,545 $ 85.84 3.31 $ 387,625 Expected to vest as of December 26, 2020 3,719 $ 120.67 8.31 $ 90,725 (a) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. Table of Contents A summary of our RSU and PSU activity for the year ended December 26, 2020 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 28, 2019 6,380 $ 111.53 Granted (b) 2,496 $ 131.21 Converted (c) ( 2,315 ) $ 109.61 Forfeited ( 434 ) $ 117.51 Outstanding at December 26, 2020 (d) 6,127 $ 119.92 1.27 $ 888,832 Expected to vest as of December 26, 2020 5,447 $ 119.72 1.26 $ 790,179 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Represents the number of PSUs that vested during the year, net of awards above and below target levels based on the achievement of its performance conditions. (d) The outstanding PSUs for which the vesting period has not ended as of December 26, 2020, at the threshold, target and maximum award levels were zero , 1 million and 2 million, respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three-year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model, which incorporates into the fair-value determination the possibility that the market condition may not be satisfied until actual performance is determined. PEPunits were last granted in 2015 and all outstanding PEPunits were converted to 278,000 shares in 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. Table of Contents A summary of our long-term cash activity for the year ended December 26, 2020 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 28, 2019 $ 44,224 Granted (b) 18,975 Vested (c) ( 15,686 ) Forfeited Outstanding at December 26, 2020 (d) $ 47,513 $ 45,669 1.23 Expected to vest as of December 26, 2020 $ 42,658 $ 41,318 1.14 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Represents the amount of long-term cash awards that vested during the year, net of awards above and below target levels based on the achievement of its market conditions. (d) The outstanding long-term cash awards for which the vesting period has not ended as of December 26, 2020, at the threshold, target and maximum award levels were zero , 48 million and 95 million, respectively . Other Share-Based Compensation Data The following is a summary of other share-based compensation data: 2020 2019 2018 Stock Options Total number of options granted (a) 1,847 1,286 1,429 Weighted-average grant-date fair value of options granted $ 8.31 $ 10.89 $ 9.80 Total intrinsic value of options exercised (a) $ 155,096 $ 275,745 $ 224,663 Total grant-date fair value of options vested (a) $ 8,652 $ 9,838 $ 15,506 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,496 2,754 2,634 Weighted-average grant-date fair value of RSUs/PSUs granted $ 131.21 $ 116.87 $ 108.75 Total intrinsic value of RSUs/PSUs converted (a) $ 303,165 $ 333,951 $ 260,287 Total grant-date fair value of RSUs/PSUs vested (a) $ 235,523 $ 275,234 $ 232,141 PEPunits Total intrinsic value of PEPunits converted (a) $ $ $ 30,147 Total grant-date fair value of PEPunits vested (a) $ $ $ 9,430 (a) In thousands. As of December 26, 2020 and December 28, 2019, there were approximately 287,000 and 269,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Table of Contents Note 7 Pension, Retiree Medical and Savings Plans In 2020, lump sum distributions exceeded the total of annual service and interest cost and triggered a pre-tax settlement charge in Plan A of $ 205 million ($ 158 million after-tax or $ 0.11 per share). In 2020, we adopted an amendment to the U.S. defined benefit pension plans to freeze benefit accruals for salaried participants, effective December 31, 2025. Since 2011, salaried new hires are not eligible to participate in the defined benefit plan. After the effective date, all salaried participants will receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution and will have the opportunity to receive employer contributions to match employee contributions up to defined limits. As a result of this amendment, pension benefits pre-tax expense is expected to decrease by approximately $ 70 million in 2021, primarily impacting corporate unallocated expenses. In 2020, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the transfer of certain participants from Plan A to Plan I and to a newly created plan, Plan H, effective January 1, 2021. The benefits offered to the plans participants were unchanged. The reorganization will facilitate a more targeted investment strategy and provide additional flexibility in evaluating opportunities to reduce risk and volatility. No material impact to pension benefit pre-tax expense is expected from this reorganization. In 2020, we adopted an amendment, effective January 1, 2021, to enhance the pay credit benefits of certain participants in Plan H. As a result of this amendment, pension benefits pre-tax expense is expected to increase approximately $ 45 million in 2021, primarily impacting service cost expense. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ($ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ($ 211 million after-tax or $ 0.15 per share). Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10 % of the greater of the market-related value of plan assets or plan obligations, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years ) and retiree medical (approximately 8 years), or the remaining life expectancy for participants in Plan I (approximately 23 years). In 2021, we expect the average remaining service life for participants in Plan A to be approximately 9 years , the remaining life expectancy for participants in Plan I to be approximately 27 years and the average remaining service life for participants in Plan H to be approximately 11 years . The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in both Plan A and Plan H, except that prior service cost/(credit) for salaried participants subject to the freeze will be amortized on a Table of Contents straight-line basis over the period up to the effective date of the freeze, or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International 2020 2019 2020 2019 2020 2019 Change in projected benefit obligation Obligation at beginning of year $ 15,230 $ 13,807 $ 3,753 $ 3,098 $ 988 $ 996 Service cost 434 381 86 73 25 23 Interest cost 435 543 85 97 25 36 Plan amendments ( 221 ) 15 ( 17 ) 1 ( 25 ) Participant contributions 2 2 Experience loss 2,042 2,091 467 515 81 36 Benefit payments ( 378 ) ( 341 ) ( 92 ) ( 100 ) ( 89 ) ( 105 ) Settlement/curtailment ( 808 ) ( 1,268 ) ( 24 ) ( 31 ) Special termination benefits 19 2 Other, including foreign currency adjustment 170 98 1 2 Obligation at end of year $ 16,753 $ 15,230 $ 4,430 $ 3,753 $ 1,006 $ 988 Change in fair value of plan assets Fair value at beginning of year $ 14,302 $ 12,258 $ 3,732 $ 3,090 $ 302 $ 285 Actual return on plan assets 1,908 3,101 401 551 47 78 Employer contributions/funding 387 550 120 122 55 44 Participant contributions 2 2 Benefit payments ( 378 ) ( 341 ) ( 92 ) ( 100 ) ( 89 ) ( 105 ) Settlement ( 754 ) ( 1,266 ) ( 29 ) ( 31 ) Other, including foreign currency adjustment 169 98 Fair value at end of year $ 15,465 $ 14,302 $ 4,303 $ 3,732 $ 315 $ 302 Funded status $ ( 1,288 ) $ ( 928 ) $ ( 127 ) $ ( 21 ) $ ( 691 ) $ ( 686 ) Amounts recognized Other assets $ 797 $ 744 $ 110 $ 99 $ $ Other current liabilities ( 53 ) ( 52 ) ( 1 ) ( 1 ) ( 51 ) ( 58 ) Other liabilities ( 2,032 ) ( 1,620 ) ( 236 ) ( 119 ) ( 640 ) ( 628 ) Net amount recognized $ ( 1,288 ) $ ( 928 ) $ ( 127 ) $ ( 21 ) $ ( 691 ) $ ( 686 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 4,116 $ 3,516 $ 1,149 $ 914 $ ( 212 ) $ ( 285 ) Prior service (credit)/cost ( 119 ) 114 ( 19 ) ( 45 ) ( 32 ) Total $ 3,997 $ 3,630 $ 1,130 $ 914 $ ( 257 ) $ ( 317 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ 1,009 $ ( 120 ) $ 268 $ 152 $ 50 $ ( 24 ) Amortization and settlement recognition ( 409 ) ( 457 ) ( 75 ) ( 44 ) 23 27 Foreign currency translation loss/(gain) 42 26 ( 1 ) Total $ 600 $ ( 577 ) $ 235 $ 134 $ 73 $ 2 Accumulated benefit obligation at end of year $ 15,949 $ 14,255 $ 4,108 $ 3,441 The net loss/(gain) arising in the current year is primarily attributable to the decrease in discount rate, offset by actual asset returns exceeding expected returns. Table of Contents The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Lump sum payouts are generally higher when interest rates are lower. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ 434 $ 381 $ 431 $ 86 $ 73 $ 92 $ 25 $ 23 $ 32 Other pension and retiree medical benefits (income)/expense: Interest cost $ 435 $ 543 $ 482 $ 85 $ 97 $ 93 $ 25 $ 36 $ 34 Expected return on plan assets ( 929 ) ( 892 ) ( 943 ) ( 202 ) ( 188 ) ( 197 ) ( 16 ) ( 18 ) ( 19 ) Amortization of prior service cost/(credits) 12 10 3 ( 12 ) ( 19 ) ( 20 ) Amortization of net losses/(gains) 196 161 179 61 32 45 ( 23 ) ( 27 ) ( 8 ) Settlement/curtailment losses (a) 213 296 8 19 12 6 Special termination benefits 19 1 36 2 1 Total other pension and retiree medical benefits (income)/expense $ ( 54 ) $ 119 $ ( 235 ) $ ( 37 ) $ ( 47 ) $ ( 51 ) $ ( 26 ) $ ( 28 ) $ ( 12 ) Total $ 380 $ 500 $ 196 $ 49 $ 26 $ 41 $ ( 1 ) $ ( 5 ) $ 20 (a) In 2020, U.S. includes a settlement charge of $ 205 million ($ 158 million after-tax or $ 0.11 per share) related to lump sum distributions exceeding the total of annual service and interest cost. In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million ($ 170 million after-tax or $ 0.12 per share) and a pension lump sum settlement charge of $ 53 million ($ 41 million after-tax or $ 0.03 per share). Table of Contents The following table provides the weighted-average assumptions used to determine net periodic benefit cost and projected benefit obligation for our pension and retiree medical plans: Pension Retiree Medical U.S. International 2020 2019 2018 2020 2019 2018 2020 2019 2018 Net Periodic Benefit Cost Service cost discount rate 3.4 % 4.4 % 3.8 % 3.2 % 4.2 % 3.5 % 3.2 % 4.3 % 3.6 % Interest cost discount rate 2.9 % 4.1 % 3.4 % 2.4 % 3.2 % 2.8 % 2.6 % 3.8 % 3.0 % Expected return on plan assets 6.8 % 7.1 % 7.2 % 5.6 % 5.8 % 6.0 % 5.8 % 6.6 % 6.5 % Rate of salary increases 3.1 % 3.1 % 3.1 % 3.3 % 3.7 % 3.7 % Projected Benefit Obligation Discount rate 2.5 % 3.3 % 4.4 % 2.0 % 2.5 % 3.4 % 2.3 % 3.1 % 4.2 % Rate of salary increases 3.0 % 3.1 % 3.1 % 3.3 % 3.3 % 3.7 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit obligation in excess of plan assets: Pension Retiree Medical U.S. International 2020 2019 2020 2019 2020 2019 Selected information for plans with accumulated benefit obligation in excess of plan assets (a) Obligation for service to date $ ( 5,537 ) $ ( 9,194 ) $ ( 172 ) $ ( 192 ) Fair value of plan assets $ 4,156 $ 8,497 $ 123 $ 151 Selected information for plans with projected benefit obligation in excess of plan assets Benefit obligation $ ( 9,172 ) $ ( 10,169 ) $ ( 2,933 ) $ ( 632 ) $ ( 1,006 ) $ ( 988 ) Fair value of plan assets $ 7,088 $ 8,497 $ 2,696 $ 512 $ 315 $ 302 (a) The decrease in U.S. pension plans in 2020 primarily reflects the approved reorganization of the U.S. qualified defined benefit plans, resulting in the transfer of obligations and plan assets relating to certain participants from Plan A to Plan I and Plan H. Of the total projected pension benefit obligation as of December 26, 2020, approximately $ 854 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2021 2022 2023 2024 2025 2026 - 2030 Pension $ 925 $ 1,080 $ 915 $ 960 $ 990 $ 5,270 Retiree medical (a) $ 95 $ 95 $ 90 $ 85 $ 80 $ 370 (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 1 million for each of the years from 2021 through 2025 and approximately $ 4 million in total for 2026 through 2030. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Table of Contents Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical 2020 2019 2018 2020 2019 2018 Discretionary (a) $ 339 $ 417 $ 1,417 $ $ $ 37 Non-discretionary 168 255 198 55 44 56 Total $ 507 $ 672 $ 1,615 $ 55 $ 44 $ 93 (a) Includes $ 325 million contribution in 2020, $ 400 million contribution in 2019 and $ 1.4 billion contribution in 2018 to fund Plan A in the United States. In November 2020, we received approval from our Board of Directors to make discretionary contributions of $ 500 million to our U.S. qualified defined benefit plans. We contributed $ 300 million of the approved amount in January 2021; we expect to contribute the remaining $ 200 million in the third quarter of 2021. In addition, in 2021, we expect to make non-discretionary contributions of approximately $ 160 million to our U.S. and international pension benefit plans and approximately $ 50 million for retiree medical benefits. We continue to monitor the impact of the COVID-19 pandemic and related global economic conditions and uncertainty on the net unfunded status of our pension and retiree medical plans. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan obligations, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected obligations. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2021 and 2020, our expected long-term rate of return on U.S. plan assets is 6.4 % and 6.8 %, respectively. Our target investment allocations for U.S. plan assets are as follows: 2021 2020 Fixed income 51 % 50 % U.S. equity 24 % 25 % International equity 21 % 21 % Real estate 4 % 4 % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the Table of Contents reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2020 and 2019 are categorized consistently by Level 1 (quoted prices in active markets for identical assets), Level 2 (significant other observable inputs) and Level 3 (significant unobservable inputs) in both years and are as follows: Fair Value Hierarchy Level 2020 2019 U.S. plan assets (a) Equity securities, including preferred stock (b) 1 $ 7,179 $ 6,605 Government securities (c) 2 2,177 2,154 Corporate bonds (c) 2 5,437 4,737 Mortgage-backed securities (c) 2 119 159 Contracts with insurance companies (d) 3 9 9 Cash and cash equivalents (e) 1, 2 278 275 Sub-total U.S. plan assets 15,199 13,939 Real estate commingled funds measured at net asset value (f) 517 605 Dividends and interest receivable, net of payables 64 60 Total U.S. plan assets $ 15,780 $ 14,604 International plan assets Equity securities (b) 1, 2 $ 2,119 $ 1,973 Government securities (c) 2 937 725 Corporate bonds (c) 2 445 331 Fixed income commingled funds (g) 1 509 437 Contracts with insurance companies (d) 3 50 42 Cash and cash equivalents 1 33 24 Sub-total international plan assets 4,093 3,532 Real estate commingled funds measured at net asset value (f) 202 193 Dividends and interest receivable 8 7 Total international plan assets $ 4,303 $ 3,732 (a) Includes $ 315 million and $ 302 million in 2020 and 2019, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) Invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The commingled funds are based on the published price of the fund and include one large-cap fund that represents 13 % and 16 % of total U.S. plan assets for 2020 and 2019, respectively. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. The international portfolio includes Level 1 assets of $ 2,119 million and $ 1,941 million for 2020 and 2019, respectively, and Level 2 assets of $ 32 million for 2019. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 30 % and 28 % of total U.S. plan assets for 2020 and 2019, respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 26, 2020 and December 28, 2019. (e) Cash and cash equivalents in the U.S. includes Level 1 assets of $ 178 million and $ 159 million for 2020 and 2019, respectively, and Level 2 assets of $ 100 million and $ 116 million for 2020 and 2019, respectively. (f) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (g) Based on the published price of the fund. Table of Contents Retiree Medical Cost Trend Rates 2021 2020 Average increase assumed 6 % 6 % Ultimate projected increase 5 % 5 % Year of ultimate projected increase 2040 2039 These assumed health care cost trend rates have an impact on the retiree medical plan expense and obligation, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement and we make Company matching contributions for certain employees on a portion of employee contributions based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution based on age and years of service regardless of employee contribution. In 2020, 2019 and 2018, our total Company contributions were $ 225 million, $ 197 million and $ 180 million, respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2020 (a) 2019 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,358 $ 2,848 Commercial paper ( 0.2 %) 396 Other borrowings ( 1.7 % and 6.4 %) 26 72 $ 3,780 $ 2,920 Long-term debt obligations (b) Notes due 2020 ( 2.7 %) 2,840 Notes due 2021 ( 2.2 % and 2.4 %) 3,356 3,276 Notes due 2022 ( 2.5 % and 2.7 %) 3,867 3,831 Notes due 2023 ( 1.5 % and 2.8 %) 3,017 1,272 Notes due 2024 ( 2.1 % and 3.4 %) 3,067 1,839 Notes due 2025 ( 2.7 % and 3.1 %) 3,227 1,691 Notes due 2026-2060 ( 2.9 % and 3.4 %) 27,165 17,219 Other, due 2020-2026 ( 1.3 % and 1.3 %) 29 28 43,728 31,996 Less: current maturities of long-term debt obligations ( 3,358 ) ( 2,848 ) Total $ 40,370 $ 29,148 (a) Amounts are shown net of unamortized net discounts of $ 260 million and $ 163 million for 2020 and 2019, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. Table of Contents As of December 26, 2020 and December 28, 2019, our international debt of $ 29 million and $ 69 million, respectively, was related to borrowings from external parties, including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2020, we issued the following senior notes: Interest Rate Maturity Date Amount (a) 2.250 % March 2025 $ 1,500 2.625 % March 2027 $ 500 2.750 % March 2030 $ 1,500 3.500 % March 2040 $ 750 3.625 % March 2050 $ 1,500 3.875 % March 2060 $ 750 0.750 % May 2023 $ 1,000 1.625 % May 2030 $ 1,000 0.250 % May 2024 1,000 0.500 % May 2028 1,000 0.400 % October 2023 $ 750 1.400 % February 2031 $ 750 0.400 % October 2032 750 1.050 % October 2050 750 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. The net proceeds from the issuances of the above notes will be used for general corporate purposes, including the repayment of commercial paper. In 2020, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on May 31, 2021. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion in U.S dollars and/or euros. We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which term loan would mature no later than the anniversary of the then effective termination date. The 364-Day Credit Agreement replaced our $ 3.75 billion 364-day credit agreement, dated as of June 3, 2019. The 364-Day Credit Agreement is in addition to the five-year unsecured revolving credit agreement (Five-Year Credit Agreement) we entered into in 2019, and which expires on June 3, 2024. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion in U.S. dollars and/or euros. Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Funds borrowed under the 364-Day Credit Agreement and Five-Year Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 26, 2020, there were no outstanding borrowings under the 364-Day Credit Agreement or the Five-Year Credit Agreement. In 2020, one of our international consolidated subsidiaries borrowed 21.7 billion South African rand, or approximately $ 1.3 billion, from our two unsecured bridge loan facilities (Bridge Loan Facilities) to fund Table of Contents our acquisition of Pioneer Foods. These borrowings were fully repaid in April 2020 and no further borrowings under these Bridge Loan Facilities are permitted. In 2020, we paid $ 1.1 billion to redeem all $ 1.1 billion outstanding principal amount of our 2.15 % senior notes due 2020 and terminated associated interest rate swaps with a notional amount of $ 0.8 billion. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. In 2018, we completed a cash tender offer to redeem $ 1.3 billion of certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $ 1.6 billion in cash. Also in 2018, we completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for newly issued PepsiCo notes. These notes were issued in an aggregate principal amount of $ 732 million, equal to the exchanged notes. As a result of the above transactions, we recorded a pre-tax charge of $ 253 million ($ 191 million after-tax or $ 0.13 per share) to interest expense in 2018, primarily representing the tender price paid over the carrying value of the tendered notes. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. We do not use derivative instruments for trading or speculative purposes. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 26, 2020 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. Credit Risk We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to Table of Contents be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position as of December 26, 2020 was $ 283 million. We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 26, 2020. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.1 billion as of December 26, 2020 and December 28, 2019. Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $ 1.9 billion as of December 26, 2020 and December 28, 2019. The total notional amount of our debt instruments designated as net investment hedges was $ 2.7 billion as of December 26, 2020 and $ 2.5 billion as of December 28, 2019. For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and Table of Contents swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 3.0 billion as of December 26, 2020 and $ 5.0 billion as of December 28, 2019. As of December 26, 2020, approximately 3 % of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 9 % as of December 28, 2019. Held-to-Maturity Debt Securities Investments in debt securities that we have the positive intent and ability to hold until maturity are classified as held-to-maturity. Highly liquid debt securities with original maturities of three months or less are recorded as cash equivalents. Our held-to-maturity debt securities consist of U.S. Treasury securities and commercial paper. As of December 26, 2020, we had $ 2.1 billion of investments in U.S. Treasury securities with $ 2.0 billion recorded in cash and cash equivalents and $ 0.1 billion in short-term investments. We had no investments in U.S. Treasury securities as of December 28, 2019. As of December 26, 2020, we had $ 260 million of investments in commercial paper with $ 75 million recorded in cash and cash equivalents and $ 185 million in short-term investments. As of December 28, 2019, we had $ 130 million of investments in commercial paper recorded in cash and cash equivalents. Held-to-maturity debt securities are recorded at amortized cost, which approximates fair value, and realized gains or losses are reported in earnings. Our investments mature in less than one year. As of December 26, 2020 and December 28, 2019, gross unrecognized gains and losses and the allowance for expected credit losses were not material. Table of Contents Fair Value Measurements The fair values of our financial assets and liabilities as of December 26, 2020 and December 28, 2019 are categorized as follows: 2020 2019 Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Index funds (b) 1 $ 231 $ $ 229 $ Prepaid forward contracts (c) 2 $ 18 $ $ 17 $ Deferred compensation (d) 2 $ $ 477 $ $ 468 Contingent consideration (e) 3 $ $ 861 $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) 2 $ 2 $ $ $ 5 Derivatives designated as cash flow hedging instruments: Foreign exchange (g) 2 $ 9 $ 71 $ 5 $ 32 Interest rate (g) 2 13 307 390 Commodity (h) 1 2 5 Commodity (i) 2 32 2 5 $ 54 $ 378 $ 9 $ 432 Derivatives not designated as hedging instruments: Foreign exchange (g) 2 $ 4 $ 8 $ 3 $ 2 Commodity (h) 1 23 7 Commodity (i) 2 19 7 6 24 $ 23 $ 15 $ 32 $ 33 Total derivatives at fair value (j) $ 79 $ 393 $ 41 $ 470 Total $ 328 $ 1,731 $ 287 $ 938 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (c) Based primarily on the price of our common stock. (d) Based on the fair value of investments corresponding to employees investment elections. (e) In connection with our acquisition of Rockstar, we recorded a liability for tax-related contingent consideration payable over up to 15 years, with an option to accelerate all remaining payments, with estimated maximum payments of approximately $ 1.1 billion, using current tax rates. The fair value of the liability is estimated using probability-weighted, discounted future cash flows at current tax rates. The significant unobservable inputs (Level 3) used to estimate the fair value include the expected future tax benefits associated with the acquisition, the probability that the option to accelerate all remaining payments will be exercised and discount rates. The expected annual future tax benefits range from approximately $ 40 million to $ 110 million, with an average of $ 70 million. The probability, in any given year, that the option to accelerate will be exercised ranges from 3 to 25 percent, with a weighted-average payment period of approximately 4 years. The discount rates range from less than 1 percent to 5 percent, with a weighted average of 3 percent. The contingent consideration measured at fair value using unobservable inputs as of December 26, 2020 is $ 861 million, comprised of an $ 882 million liability recognized at the acquisition date of Rockstar and a fair value decrease of $ 21 million in the year ended December 26, 2020, recorded in selling, general and administrative expenses. (f) Based on London Interbank Offered Rate forward rates. As of December 26, 2020 and December 28, 2019, the carrying amount of hedged fixed-rate debt was $ 0.2 billion and $ 2.2 billion, respectively, and classified on our balance sheet within short-term and long-term debt obligations. As of December 26, 2020 and December 28, 2019, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was a $ 2 million gain and $ 5 million loss, respectively. As of December 26, 2020, the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 19 million loss, which is being amortized over the remaining life of the related debt obligations. Table of Contents (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 26, 2020 and December 28, 2019 were not material. Collateral received or posted against our asset or liability positions was not material. Exchange-traded commodity futures are cash-settled on a daily basis and, therefore, not included in the table as of December 26, 2020. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. Our cash equivalents and short-term investments are classified as Level 2 in the fair value hierarchy. The fair value of our debt obligations as of December 26, 2020 and December 28, 2019 was $ 50 billion and $ 34 billion, respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) 2020 2019 2020 2019 2020 2019 Foreign exchange $ $ ( 1 ) $ ( 9 ) $ 57 $ ( 43 ) $ 3 Interest rate ( 6 ) ( 64 ) ( 96 ) 67 ( 129 ) 7 Commodity 53 ( 17 ) ( 21 ) 7 56 4 Net investment 235 ( 30 ) Total $ 47 $ ( 82 ) $ 109 $ 101 $ ( 116 ) $ 14 (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in net interest expense and other. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in net interest expense and other. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are included in cost of sales. Interest rate derivative losses/gains are included in net interest expense and other. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $ 7 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Table of Contents Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: 2020 2019 2018 Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 7,120 $ 7,314 $ 12,515 Preferred stock: Redemption premium (b) ( 2 ) Net income available for PepsiCo common shareholders $ 7,120 1,385 $ 7,314 1,399 $ 12,513 1,415 Basic net income attributable to PepsiCo per common share $ 5.14 $ 5.23 $ 8.84 Net income available for PepsiCo common shareholders $ 7,120 1,385 $ 7,314 1,399 $ 12,513 1,415 Dilutive securities: Stock options, RSUs, PSUs and other (c) 7 8 10 Employee stock ownership plan (ESOP) convertible preferred stock 2 Diluted $ 7,120 1,392 $ 7,314 1,407 $ 12,515 1,425 Diluted net income attributable to PepsiCo per common share $ 5.12 $ 5.20 $ 8.78 (a) Weighted-average common shares outstanding (in millions). (b) See Note 11 for further information. (c) The dilutive effect of these securities is calculated using the treasury stock method. The weighted-average amount of antidilutive securities excluded from the calculation of diluted earnings per common share was immaterial for the years ended December 26, 2020, December 28, 2019 and December 29, 2018. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. Activities of our preferred stock are included in the equity statement. Table of Contents Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 30, 2017 (a) $ ( 10,277 ) $ 47 $ ( 2,804 ) $ ( 23 ) $ ( 13,057 ) Other comprehensive (loss)/income before reclassifications (b) ( 1,664 ) ( 61 ) ( 813 ) 6 ( 2,532 ) Amounts reclassified from accumulated other comprehensive loss 44 111 218 373 Net other comprehensive (loss)/income ( 1,620 ) 50 ( 595 ) 6 ( 2,159 ) Tax amounts ( 21 ) ( 10 ) 128 97 Balance as of December 29, 2018 (a) ( 11,918 ) 87 ( 3,271 ) ( 17 ) ( 15,119 ) Other comprehensive (loss)/income before reclassifications (c) 636 ( 131 ) ( 89 ) ( 2 ) 414 Amounts reclassified from accumulated other comprehensive loss 14 468 482 Net other comprehensive (loss)/income 636 ( 117 ) 379 ( 2 ) 896 Tax amounts ( 8 ) 27 ( 96 ) ( 77 ) Balance as of December 28, 2019 (a) ( 11,290 ) ( 3 ) ( 2,988 ) ( 19 ) ( 14,300 ) Other comprehensive (loss)/income before reclassifications (d) ( 710 ) 126 ( 1,141 ) ( 1 ) ( 1,726 ) Amounts reclassified from accumulated other comprehensive loss ( 116 ) 465 349 Net other comprehensive (loss)/income ( 710 ) 10 ( 676 ) ( 1 ) ( 1,377 ) Tax amounts 60 ( 3 ) 144 201 Balance as of December 26, 2020 (a) $ ( 11,940 ) $ 4 $ ( 3,520 ) $ ( 20 ) $ ( 15,476 ) (a) Pension and retiree medical amounts are net of taxes of $ 1,338 million as of December 30, 2017, $ 1,466 million as of December 29, 2018, $ 1,370 million as of December 28, 2019 and $ 1,514 million as of December 26, 2020. (b) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. (c) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. (d) Currency translation adjustment primarily reflects the depreciation of the Russian ruble and Mexican peso. Table of Contents The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement 2020 2019 2018 Currency translation: Divestitures $ $ $ 44 Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ $ 1 $ ( 1 ) Net revenue Foreign exchange contracts ( 43 ) 2 ( 7 ) Cost of sales Interest rate derivatives ( 129 ) 7 119 Net interest expense and other Commodity contracts 50 3 3 Cost of sales Commodity contracts 6 1 ( 3 ) Selling, general and administrative expenses Net (gains)/losses before tax ( 116 ) 14 111 Tax amounts 29 ( 2 ) ( 27 ) Net (gains)/losses after tax $ ( 87 ) $ 12 $ 84 Pension and retiree medical items: Amortization of net prior service credit $ $ ( 9 ) $ ( 17 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses 238 169 216 Other pension and retiree medical benefits income/(expense) Settlement/curtailment losses 227 308 19 Other pension and retiree medical benefits income/(expense) Net losses before tax 465 468 218 Tax amounts ( 101 ) ( 102 ) ( 45 ) Net losses after tax $ 364 $ 366 $ 173 Total net losses reclassified for the year, net of tax $ 277 $ 378 $ 301 Note 13 Leases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years, some of which include options to extend the lease term for up to five years, and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Table of Contents Components of lease cost are as follows: 2020 2019 Operating lease cost (a) $ 539 $ 474 Variable lease cost (b) $ 111 $ 101 Short-term lease cost (c) $ 436 $ 379 (a) Includes right-of-use asset amortization of $ 478 million and $ 412 million in 2020 and 2019, respectively. (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. Rent expense for the year ended December 29, 2018 was $ 771 million. In 2020 and 2019, we recognized gains of $ 7 million and $ 77 million, respectively, on sale-leaseback transactions with terms under four years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: 2020 2019 Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ 555 $ 478 Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ 621 $ 479 Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification 2020 2019 Right-of-use assets Other assets $ 1,670 $ 1,548 Current lease liabilities Accounts payable and other current liabilities $ 460 $ 442 Non-current lease liabilities Other liabilities $ 1,233 $ 1,118 Weighted-average remaining lease term and discount rate for our operating leases are as follows: 2020 2019 Weighted-average remaining lease term 6 years 6 years Weighted-average discount rate 4 % 4 % Maturities of lease liabilities by year for our operating leases are as follows: 2021 $ 486 2022 385 2023 278 2024 194 2025 139 2026 and beyond 413 Total lease payments 1,895 Less: Imputed interest ( 202 ) Present value of lease liabilities $ 1,693 Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Table of Contents Note 14 Acquisitions and Divestitures Acquisition of Pioneer Food Group Ltd. On March 23, 2020, we acquired all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe, for 110.00 South African rand per share in cash. The total consideration transferred was approximately $ 1.2 billion and was funded by the Bridge Loan Facilities entered into by one of our international consolidated subsidiaries. See Note 8 for further information. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, in our AMESA segment. The assets acquired and liabilities assumed in Pioneer Foods as of the acquisition date, which primarily include goodwill and other intangible assets of $ 0.8 billion and property, plant and equipment of $ 0.4 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the second quarter of 2021. In connection with our acquisition of Pioneer Foods, we have made certain commitments to the South Africa Competition Commission, including a commitment to provide the equivalent of 7.7 billion South African rand, or approximately $ 0.4 billion as of the acquisition date, in value for the benefit of our employees, agricultural development, education, developing Pioneer Foods operations and enterprise development programs in South Africa. Included in this commitment is 2.2 billion South African rand, or approximately $ 0.1 billion, relating to the implementation of an employee ownership plan and an agricultural, entrepreneurship and educational development fund, which is an irrevocable condition of the acquisition and will primarily be settled within the twelve-month period from the acquisition date. This was recorded in selling, general and administrative expenses in 2020. The remaining commitment of 5.5 billion South African rand, or approximately $ 0.3 billion as of the acquisition date, relates to capital expenditures and/or business-related costs which will be incurred and recorded over a five-year period from the acquisition date. Acquisition of Rockstar Energy Beverages On April 24, 2020, we acquired Rockstar, an energy drink maker with whom we had a distribution agreement prior to the acquisition, for an upfront cash payment of approximately $ 3.85 billion and contingent consideration related to estimated future tax benefits associated with the acquisition of approximately $ 0.9 billion. See Note 9 for further information about the contingent consideration. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, primarily in our PBNA segment. The assets acquired and liabilities assumed in Rockstar as of the acquisition date, which primarily include goodwill and other intangible assets of $ 4.7 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the second quarter of 2021. Acquisition of Hangzhou Haomusi Food Co., Ltd. On June 1, 2020, we acquired all of the outstanding shares of Be Cheery, one of the largest online snacks companies in China, from Haoxiangni Health Food Co., Ltd. for cash. The total consideration transferred was approximately $ 0.7 billion. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, in our Table of Contents APAC segment. The assets acquired and liabilities assumed in Be Cheery as of the acquisition date, which primarily include goodwill and other intangible assets of $ 0.7 billion, are based on preliminary estimates that are subject to revisions and may result in adjustments to preliminary values as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the third quarter of 2021. Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $ 144.00 per share in cash, in a transaction valued at approximately $ 3.3 billion. The total consideration transferred was $ 3.3 billion (or $ 3.2 billion, net of cash and cash equivalents acquired). The purchase price allocation was finalized in the fourth quarter of 2019. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 144 million ($ 126 million after-tax or $ 0.09 per share) in selling, general and administrative expenses in our APAC segment as a result of this transaction. Refranchising in Czech Republic, Hungary and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in Czech Republic, Hungary and Slovakia. We recorded a pre-tax gain of $ 58 million ($ 46 million after-tax or $ 0.03 per share) in selling, general and administrative expenses in our Europe segment as a result of this transaction. Inventory Fair Value Adjustments and Merger and Integration Charges A summary of our inventory fair value adjustments and merger and integration charges is as follows: 2020 2019 2018 Cost of sales $ 32 $ 34 $ Selling, general and administrative expenses 223 21 75 Total $ 255 $ 55 $ 75 After-tax amount $ 237 $ 47 $ 75 Net income attributable to PepsiCo per common share $ 0.17 $ 0.03 $ 0.05 Inventory fair value adjustments and merger and integration charges include fair value adjustments to the acquired inventory included in the acquisition-date balance sheets (recorded in cost of sales) and closing costs, employee-related costs, contract termination costs, changes in the fair value of contingent consideration and other integration costs (recorded in selling, general and administrative expenses). Merger and integration charges also include liabilities to support socioeconomic programs in South Africa, which are irrevocable conditions of our acquisition of Pioneer Foods (recorded in selling, general and administrative expenses). Table of Contents Inventory fair value adjustments and merger and integration charges by division are as follows: 2020 2019 2018 Acquisition FLNA $ 29 $ $ BFY Brands PBNA 66 Rockstar Europe 46 57 SodaStream AMESA 173 7 Pioneer Foods APAC 7 Be Cheery Corporate (a) ( 20 ) 2 18 Rockstar, SodaStream Total $ 255 $ 55 $ 75 (a) In 2020, the income amount primarily relates to the change in the fair value of contingent consideration associated with our acquisition of Rockstar. Note 15 Supplemental Financial Information Balance Sheet 2020 2019 2018 Accounts and notes receivable Trade receivables $ 6,892 $ 6,447 Other receivables 1,713 1,480 Total 8,605 7,927 Allowance, beginning of year 105 101 $ 129 Cumulative effect of accounting change 44 Net amounts charged to expense (a) 79 22 16 Deductions (b) ( 32 ) ( 30 ) ( 33 ) Other (c) 5 12 ( 11 ) Allowance, end of year 201 105 $ 101 Net receivables $ 8,404 $ 7,822 Inventories (d) Raw materials and packaging $ 1,720 $ 1,395 Work-in-process 205 200 Finished goods 2,247 1,743 Total $ 4,172 $ 3,338 Property, plant and equipment, net (e) Average Useful Life (Years) Land $ 1,171 $ 1,130 Buildings and improvements 15 - 44 10,214 9,314 Machinery and equipment, including fleet and software 5 - 15 31,276 29,390 Construction in progress 3,679 3,169 46,340 43,003 Accumulated depreciation ( 24,971 ) ( 23,698 ) Total $ 21,369 $ 19,305 Depreciation expense $ 2,335 $ 2,257 $ 2,241 Other assets Noncurrent notes and accounts receivable $ 109 $ 85 Deferred marketplace spending 130 147 Pension plans (f) 910 846 Right-of-use assets (g) 1,670 1,548 Other 493 385 Total $ 3,312 $ 3,011 Table of Contents Accounts payable and other current liabilities Accounts payable $ 8,853 $ 8,013 Accrued marketplace spending 2,935 2,765 Accrued compensation and benefits 2,059 1,835 Dividends payable 1,430 1,351 Current lease liabilities (g) 460 442 Other current liabilities 3,855 3,135 Total $ 19,592 $ 17,541 (a) In 2020, includes an allowance for expected credit losses of $ 56 million related to the COVID-19 pandemic. See Note 1 for further information. (b) Includes accounts written off. (c) Includes adjustments related primarily to currency translation and other adjustments. (d) Approximately 6 % and 7 % of the inventory cost in 2020 and 2019, respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. See Note 2 for further information. (e) See Note 2 for further information. (f) See Note 7 for further information. (g) See Note 13 for further information. Statement of Cash Flows 2020 2019 2018 Interest paid (a) $ 1,156 $ 1,076 $ 1,388 Income taxes paid, net of refunds (b) $ 1,770 $ 2,226 $ 1,203 (a) In 2018, excludes the premiums paid in accordance with the debt transactions. See Note 8 for further information. (b) In 2020, 2019 and 2018, includes tax payments of $ 78 million, $ 423 million and $ 115 million, respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. 2020 2019 Cash and cash equivalents $ 8,185 $ 5,509 Restricted cash included in other assets (a) 69 61 Total cash and cash equivalents and restricted cash $ 8,254 $ 5,570 (a) Primarily relates to collateral posted against certain of our derivative positions. Table of Contents Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 26, 2020 and December 28, 2019, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 26, 2020 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 26, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 26, 2020 and December 28, 2019, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 26, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 26, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted by SEC guidance, the scope of management's assessment of the effectiveness of internal control over financial reporting as of December 26, 2020 excluded Pioneer Food Group Ltd. and its subsidiaries (Pioneer Foods) and Hangzhou Haomusi Food Co., Ltd. and its subsidiaries (Be Cheery), both of which the Company acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of the Company as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of the Company as of and for the year ended December 26, 2020. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Pioneer Foods and Be Cheery. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and Table of Contents performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Sales incentive accruals As discussed in Note 2 to the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation Table of Contents and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys sales incentive process, including (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 26, 2020 was $36.4 billion which represents 39% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 26, 2020. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys indefinite-lived assets impairment process to develop the forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Table of Contents Unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 26, 2020, the Company recorded reserves for unrecognized tax benefits of $1.6 billion. The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, new tax law, relevant court rulings or tax authority settlements. We identified the evaluation of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the critical audit matter. This included controls related to the Companys unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, associated external counsel opinions, information from tax examinations, relevant court rulings and tax authority settlements. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 10, 2021 Table of Contents GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, and where applicable, foreign exchange translation and the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Table of Contents Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. Table of Contents ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. ," Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 26, 2020. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2020, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue Table of Contents to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. Item 9B. Other Information. Not applicable. "," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 26, 2020. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 26, 2020 excluded Pioneer Foods and Be Cheery, both acquired in 2020. Pioneer Foods total assets and net revenue represented approximately 2.2% and 1.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Be Cheerys total assets and net revenue represented approximately 1.1% and 0.4%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 26, 2020. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2020, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue Table of Contents to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +2,peps,201910-k," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations Changes to Organizational Structure During the fourth quarter of 2019, we realigned our Europe Sub-Saharan Africa (ESSA) and Asia, Middle East and North Africa (AMENA) reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. As a result, our beverage, food and snack businesses in North Africa, the Middle East and South Asia that were part of our former AMENA segment and our businesses in Sub-Saharan Africa that were part of our former ESSA segment are now reported together as our Africa, Middle East and South Asia (AMESA) segment. The remaining beverage, food and snack businesses that were part of our former AMENA segment are now reported together as our Asia Pacific, Australia and New Zealand and China region (APAC) segment and our beverage, food and snack businesses in Europe are now reported as our Europe segment. These changes did not impact our Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), PepsiCo Beverages North America (PBNA), formerly named North America Beverages, or Latin America (LatAm) reportable segments or our consolidated financial results . Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand, and China region. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Pasta Roni, Quaker Chewy granola bars, Quaker grits, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. PepsiCo Beverages North America Either independently or in conjunction with third parties, PBNA makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel, Sierra Mist and Tropicana. PBNA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, PBNA manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). PBNA operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. PBNA also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, LatAm makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black, San Carlos and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. LatAm also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Europe Either independently or in conjunction with third parties, Europe makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, Europe makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. Further, as part of its beverage business, Europe manufactures and distributes sparkling water makers through SodaStream International Ltd. (SodaStream). See Note 14 to our consolidated financial statements for further information about our acquisition of SodaStream. Africa, Middle East and South Asia Either independently or in conjunction with third parties, AMESA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMESA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMESA operates its own bottling plants and distribution facilities. AMESA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In 2019, we entered into an agreement to acquire Pioneer Food Group Ltd. (Pioneer Foods), a food and beverage company in South Africa with exports to countries across the globe . The transaction is subject to certain regulatory approvals and other customary conditions and is expected to close in the first half of 2020. See Note 14 to our consolidated financial statements for further information about our acquisition of Pioneer Foods. Asia Pacific, Australia and New Zealand and China Region Either independently or in conjunction with third parties, APAC makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Doritos, Lays and Smiths, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. APAC also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew and Pepsi. These branded products are sold to authorized bottlers, independent distributors and retailers. APAC also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks and are also sold directly to consumers through e-commerce platforms and retailers. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. E-commerce Our products are also available and sold directly to consumers on a growing number of company-owned and third-party e-commerce websites and mobile commerce applications. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum, glass, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it further globally. See Note 9 to our consolidated financial statements for further information on how we manage our exposure to commodity prices. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including 1893, Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewater, Aunt Jemima, Bare, Bolt24, bubly, Capn Crunch, Cheetos, Chesters, Chipita, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Evolve, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mothers, Mountain Dew, Mountain Dew Amp Game Fuel, Mountain Dew Code Red, Mountain Dew Ice, Mountain Dew Kickstart, Mountain Dew Zero Sugar, Mug, Munchies, Muscle Milk, Naked, Near East, Off the Eaten Path, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Black, Pepsi Max, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, San Carlos, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Sierra Mist Zero Sugar, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. Our beverage, food and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services and other direct-to-consumer businesses, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2019 , sales to Walmart Inc. (Walmart) and its affiliates, including Sams Club (Sams), represented approximately 13% of our consolidated net revenue, with sales reported across all of our divisions. Our top five retail customers represented approximately 34% of our 2019 net revenue in North America, with Walmart and its affiliates (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2019 , we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity (including digital), packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, marketing and merchandising equipment, dispensing equipment, packaging technology (including investments in recycling-focused technologies), package design (including development of sustainable, bio-based packaging) and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of natural flavors, sweetener alternatives and flavor modifiers and innovation in existing sweeteners and flavoring, further expanding our beyond the bottle portfolio, including further growing our SodaStream business, and offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; investments in technology and digitalization, including data analytics to enhance our consumer insights; and efforts focused on reducing our impact on the environment, including improvements in energy efficiency, water use in our operations and our agricultural practices. Our research centers are located around the world, including Brazil, China, India, Ireland, Mexico, Russia, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to innovate in nutritious and convenient beverages, foods and snacks. In 2019 , we continued to make investments to further digitalize our business including: continuing to strengthen our omnichannel capabilities, particularly in e-commerce; and leveraging technology and data analytics to capture and analyze consumer level data to increasingly structure personalized communications with consumers and satisfy demand at the store level. In addition, we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our beyond the bottle offerings by offering bubly in fountain dispensing; developing 100% recycled PET packaging for LIFEWTR and aluminum can packaging for Aquafina; expanding our state of the art food and beverage healthy vending initiative to increase the availability of nutritious and convenient beverages, foods and snacks; further expanding our portfolio, through a combination of brand extensions, product reformulations, new product innovations and acquisitions to offer products with more of the nutritious ingredients and hydration our consumers are looking for, such as Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies), KeVita (probiotics, tonics and fermented teas), Bare (baked apple chips and other baked fruits and vegetables), Health Warrior (nutrition bars), Evolve (plant-based protein products) and Muscle Milk (protein shakes); further expanding our whole grain products globally; and further expanding our portfolio in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water in our agricultural supply chain), and by incorporating improvements in the sustainability and resources of our agricultural supply chain into our operations; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers, including through the use of data and technology to optimize yields and efficiency and promote responsible use of pesticides; and efforts to create a circular future for packaging, including the increased use of recycled content and alternative packaging, support for increased packaging recovery and recycling rates globally, optimization of packaging technology and design to minimize the amount of plastic in our packaging and to make our packaging increasingly recoverable or recyclable with lower environmental impact, and our continued investments in developing compostable and biodegradable packaging. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; data privacy and personal data protection laws and regulations, including the California Privacy Act of 2018; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; laws regulating our supply chain, including the 2010 California Transparency in Supply Chains Act and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, supply chain, including the U.K. Modern Slavery Act, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the level of such substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some plastic beverage bottles and other single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 28, 2019 , we and our consolidated subsidiaries employed approximately 267,000 people worldwide, including approximately 116,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K, including the Managements Discussion and Analysis of Financial Condition and Results of Operations section and the consolidated financial statements and related notes. These risks, some of which have occurred and any of which may occur in the future, can have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks described below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends are often not a reliable indicator of future operating results, financial and business performance, events or trends. Future demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics can result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers, including through e-commerce and hard discounters); or the location of origin or source of ingredients and products (including the environmental impact related to production and packaging of our products). Consumer preferences continuously evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending, consumption and purchasing habits; consumer concerns or perceptions regarding the nutrition profile of products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic, locally or sustainably sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including single-use and other plastic packaging, and their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or our respective social media posts, business practices or other information disseminated by or regarding them or us; product boycotts; or a downturn in economic conditions. These factors have in the past and could in the future reduce consumers willingness to purchase certain of our products and any inability on our part to anticipate or react to such changes can lead to reduced demand for our products or erode our competitive and financial position, resulting in adverse effects on our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories (through acquisitions and innovation, such as increasing non-carbonated beverage offerings and other alternatives to, or reformulations of, carbonated beverage offerings); respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients and packaging materials (including to respond to applicable regulations); develop sweetener alternatives and innovation; increase the recyclability or recoverability of our packaging; create more relevant and personalized experiences for consumers whether in a digital environment or through digital devices in an otherwise physical environment; improve the production and distribution of our products; enhance our data analytics capabilities to develop new commercial insights; respond to competitive product and pricing pressures and changes in distribution channels, including in the e-commerce channel; maintain our labeling certifications (e.g., non-GMO) from independent organizations and regulatory authorities for certain of our products; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including correctly anticipating or effectively reacting to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers, including through the use of digital technology. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively market or distribute our products can reduce demand for our products, result in inventory write-offs and erode our competitive and financial position and can adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to the use or disposal of plastics or other product packaging can increase our costs, reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our food and beverage products are sold in plastic or other packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to lack of infrastructure or otherwise. In addition, certain of our packaging is not currently recyclable, compostable or biodegradable. There is a growing concern with the accumulation of plastic, including microplastics, and other packaging waste in the environment, particularly in the worlds oceans and waterways. As a result, packaging waste that displays one or more of our brands has in the past and could continue to result in negative publicity (whether or not valid) or reduce consumer demand and overall consumption of our products, resulting in adverse effects on our business, financial condition or results of operations. In response to these concerns, the United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to increase the sustainability of packaging, encourage waste reduction and increase recycling rates or facilitate the waste management process or restrict the sale of products in certain packaging. These regulations vary in scope and form from taxes or fees designed to incentivize behavior to restrictions or bans on certain products and materials. For example, 24 countries in the European Union (EU) have established extended producer responsibility (EPR) policies, which make manufacturers such as us responsible for the costs of recycling beverage and food packaging after consumers have used them. EPR policies are also being contemplated in other jurisdictions around the world, including certain states in the United States. In addition, 10 states in the United States as well as a growing number of European countries have a bottle deposit return system in effect, which requires a deposit charged to consumers to incentivize the return of the beverage container. Further, certain jurisdictions have imposed or are considering imposing other types of regulations or policies, including packaging taxes, requirements for bottle caps to be tethered to the plastic bottle, minimum recycled content mandates, which would require packaging to include a certain percentage of post-consumer recycled material in a new package, and even bans on the use of some plastic beverage bottles and other single-use plastics. These laws and regulations, whatever their scope or form, have in the past and could continue to increase the cost of our products, reduce consumer demand and overall consumption of our products or result in negative publicity (whether or not valid), resulting in adverse effects on our business, financial condition or results of operations. While we continue to devote significant resources to increase the recyclability and sustainability of our packaging, the increased focus on reducing plastic waste has required and could continue to require us to increase capital expenditures, including requiring additional investments to minimize the amount of plastic across our packaging, including to increase the use of alternative packaging materials (e.g., glass and aluminum) in certain markets; increase the amount of recycled content in our packaging; and develop sustainable, bio-based packaging as a replacement for fossil fuel-based plastic packaging, including flexible film alternatives for our snacks packaging. Our failure to minimize our plastics use, increase the amount of recycled content in our packaging or develop sustainable packaging or consumers failure to accept such sustainable packaging has in the past and could continue to reduce consumer demand and overall consumption of our products and erode our competitive and financial position. Further, our reputation can be damaged for failure to achieve our sustainability goals with respect to our plastics use, including our goal to reduce 35% of virgin plastic content across our beverage portfolio by 2025, or if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations can adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to differing regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold, as is the packaging, disposal and recyclability of our products. For example, the EU has mandated tethered caps for all beverage bottles by 2024 and minimum recycled content of 25% for PET bottles by 2025 and 30% for all plastic bottles by 2030 and laws mandating various minimum recycled content thresholds for PET bottles are also in place in Turkey, Bolivia, Ecuador and Peru, while the use of recycled content in food and beverage packaging is prohibited in a range of countries, for example, in Asia. In addition, these laws and regulations and related interpretations have changed and could continue to change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes have included and could continue to include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices, including restrictions on the audience to whom products are marketed; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws related to pesticide used by farmers in our supply chain or residual amounts of pesticide that may be found in certain of our ingredients or products; laws related to traceability requirements for our supply chain; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, have in the past and could continue to result in higher compliance costs, capital expenditures and higher production costs, resulting in adverse effects on our business, reputation, financial condition or results of operations. The imposition of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product, production, recovery or recycling requirements, or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products, commodities used in the production of our products or use, disposal, recovery or recyclability of our products and their packaging, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, resulting in adverse effects on our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions often follow. For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing has in the past and could continue to result in decreased demand for certain of our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) have been and continue to be underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials, such as 4-MeI, acrylamide, caffeine, pesticides (e.g., glyphosate), furfuryl alcohol, added sugars, sodium, saturated fat and plastic. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and foods high in sugar, sodium or saturated fat. The results of these studies and documents have contributed to or resulted in and could continue to contribute to or result in an increase in consumer concerns (whether or not valid) about the health implications of consumption of certain of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, resulting in reduced demand for our products, our Company being subject to lawsuits or new regulations that can adversely affect sales of our products, and other adverse effects on our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business can take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or can fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Failure to comply with such laws or regulations can subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, any of which can adversely affect our business, reputation, financial condition or results of operations. In addition, certain regulatory authorities under whose laws we operate have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, resulting in an adverse effect on the sales of products in our portfolio or damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products can adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per ounce/liter on beverages containing over a certain level of added sugar (or other sweetener) while others apply a graduated tax rate depending upon the amount of added sugar (or other sweetener) in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient, regardless of the particular substance or ingredient levels. For example, Peru revised an existing threshold tax to become a graduated tax, effective June 2019, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per- ounce tax rate, while Saudi Arabia expanded an existing flat tax rate of 50% on the retail price of carbonated soft drinks to include all sweetened beverages, including non-caloric beverages, effective December 2019. These tax measures, whatever their scope or form, have in the past and could continue to increase the cost of certain of our products, reduce consumer demand and overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs, resulting in adverse effects on our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products could reduce demand for such products and can adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements has in the past and could continue to reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs, resulting in adverse effects on our business, financial condition or results of operations. Our business, financial condition or results of operations can suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors, including smaller companies developing and selling micro brands directly to consumers through e-commerce platforms or through retailers focused on locally-sourced products. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective, if we fail to invest in and incorporate technology and digital tools across all areas of our business (including the use of data analytics to enhance our ability to effectively market to consumers), if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which could adversely affect our business, financial condition or results of operations. Failure to realize anticipated benefits from our productivity or reinvestment initiatives or operating model can have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models while reinvesting back into the business. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure, improve decision-making and operate more efficiently in the highly competitive beverage, food and snack categories and markets. Some of these measures have yielded and could continue to yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, resulting in adverse effects on our business, financial condition or results of operations. Further, in order to continue to capitalize on our cost reduction efforts and operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. From time to time, we have in the past and could continue to implement these investment initiatives to enable us to compete more effectively, including investments to increase manufacturing capacity, improve innovation, transform our manufacturing, commercial and corporate operations through digital technologies and artificial intelligence, and enhance brand management through our use of data analytics to develop new commercial and consumer insights. If we fail to realize all or any of the anticipated benefits of these reinvestment initiatives, our business, financial condition or results of operations can be adversely affected. Our business, financial condition or results of operations can be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold have been and could continue to be difficult to predict, resulting in adverse effects on our business, financial condition and results of operations. The results of elections, referendums or other political conditions (including government shutdowns) in these markets have in the past and could continue to impact how existing laws, regulations and government programs or policies are implemented or create uncertainty as to how such laws, regulations and government programs or policies may change, including with respect to tariffs, sanctions, climate change regulation, taxes, benefit programs, the movement of goods, services and people between countries, relationships between countries, customer or consumer perception of a particular country or its government and other matters, and has resulted in and could continue to result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products. For example, the United Kingdoms withdrawal from the European Union (commonly referred to as Brexit) is likely to lead to differing laws and regulations in the United Kingdom and European Union and further global economic, trade and regulatory uncertainty. Any changes in, or the imposition of, new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions can have an adverse impact on our business, financial condition or results of operations. Our business, financial condition or results of operations can be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences as to distribution or otherwise. The following factors can reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; our inability to hire or retain a highly skilled workforce; imposition of new or increased tariffs and other impositions on imported goods or sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations or tariffs on the products of such corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions, tariffs or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly inflationary economies and potential highly inflationary economies, devaluation or fluctuation, such as the devaluation of the Russian ruble, Turkish lira, Brazilian real, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or can significantly affect our ability to effectively manage our operations in certain of these markets and can result in the deconsolidation of such businesses, such as occurred with respect to our Venezuelan businesses which were deconsolidated at the end of the third quarter of 2015; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our business, reputation, financial condition or results of operations can be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and could continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results have in the past and could continue to be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions, may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, can limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; can leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or can result in a decline in the market value of our investments in debt securities, resulting in an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, contract manufacturers, distributors and joint venture partners and can result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which can also have an adverse impact on our business, reputation, financial condition or results of operations. Our business and reputation can suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage and operate our facilities; to conduct research and development, including through the use of data analytics; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals (including criminal hackers, hacktivists, state-sponsored actors, criminal and terrorist organizations, individuals or groups participating in organized crime and insiders) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of computing resources, notoriety, financial fraud, operational disruption, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation and identity takeover attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware, exploiting vulnerabilities in hardware, software or other infrastructure, hacking, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromises. As with other global companies, we are regularly subject to cyberattacks, including many of the types of attacks described above. Although we incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, lapses in our controls or the malicious or negligent actions of employees (including misuse of information they are entitled to access), or from deliberate cyberattacks such as malicious or disruptive software, phishing, denial of service attacks, malicious social engineering, hackers or otherwise), our business can be disrupted and, among other things, be subject to: transaction errors or financial loss; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues or other costs resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which can cause errors or delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or business operations disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and those of our third-party providers, and the information stored therein can be compromised, including through cyberattacks or other external or internal methods, resulting in unauthorized parties accessing or extracting sensitive data or confidential information. In the ordinary course of business, we receive, process, transmit and store information relating to identifiable individuals, primarily employees and former employees. Privacy and data protection laws may be interpreted and applied differently from country to country or, within the United States, from state to state, and can create inconsistent or conflicting requirements. Our efforts to comply with privacy and data protection laws, including with respect to data from residents of the European Union who are covered by the General Data Protection Regulation, which went into effect in May 2018, and residents of the State of California covered by the California Consumer Privacy Act of 2018, which went into effect on January 1, 2020, impose significant costs or challenges that are likely to increase over time. Failure to comply with existing or future data privacy laws and regulations can result in litigation, claims, legal or regulatory proceedings, inquiries or investigations. We continue to devote significant resources to network security, backup and disaster recovery, enhancing our internal controls, and other security measures, including training, to protect our systems and data. In addition, our risk management program also includes periodic review and discussion by our Board of Directors of analyses of emerging cybersecurity threats and our plans and strategies to address them. However, these security measures and processes cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies has heightened these and other operational risks, as certain aspects of the security of such technologies are complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy and other supplies. We and our business partners use various raw materials, energy and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oats, oranges and other fruits, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. In addition, we continue to integrate recyclability into our product development process and support the increased use of recycled content, including recycled PET, in our packaging. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, the use of plastics and energy, animal welfare and human rights concerns and other risks associated with the global food system is leading to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and can adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake, wildfire or flooding), disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics or other contagious outbreaks, such as the recent coronavirus, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), limited or sole sources of supply, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. For example, concerns regarding trade relations between the United States and China escalated during fiscal 2019, with the United States imposing tariffs on the importation of certain Chinese goods and retaliatory Chinese tariffs on U.S. goods. Higher duties on existing tariffs or additional tariffs imposed by the United States on a broader range of imports, or further retaliatory trade measures taken by China or other countries in response, could result in an increase in supply chain costs that we are not able to offset or otherwise adversely impact our results of operations. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs can adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water scarcity can have an adverse impact on our business, financial condition or results of operations. We and our suppliers, bottlers, contract manufacturers, joint venture partners and other third parties use water in the manufacturing of our products. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality, increasing focus by governmental and non-governmental organizations, investors, customers and consumers on water scarcity and increasing pressure to conserve and replenish water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations or the operations of our suppliers, bottlers, contract manufacturers, distributor, joint venture partners or other third parties; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs, including less favorable pricing for water; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; failure to achieve our sustainability goals relating to water use; perception (whether or not valid) of our failure to act responsibly with respect to water use or to effectively respond to new, or changes in, legal or regulatory requirements concerning water scarcity; or damage to our reputation, any of which can adversely affect our business, financial condition or results of operations. Business disruptions can have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, distributors, joint venture partners and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations has occurred in the past and could continue to occur due to any of the following factors which can impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake, wildfire or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics or other contagious outbreaks, such as the recent coronavirus; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power, fuel or water shortages; strikes, labor disputes or lack of availability of qualified personnel, such as truck drivers; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, has in the past resulted and could continue to result in adverse effects on our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity can adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which can adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we can decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which can result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which can reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes can adversely affect our reputation or brands. Our business can also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing can adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts can materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image can adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image has in the past and could continue to be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals, including with respect to plastic packaging, or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, plastics or other packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, including the recyclability or recoverability of our packaging, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees or agents engage in or are believed to have engaged in improper activities, we have in the past and could continue to be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, resulting in damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information can also hurt our reputation. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, has in the past and could continue to also generate adverse publicity (whether or not valid) that can damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons has in the past and could continue to result in decreased demand for our products, resulting in adverse effects on our business, financial condition or results of operations, as well as requiring additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, can adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Issues associated with these activities have in the past and could continue to include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, the following factors also have in the past and could continue to pose additional risk risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees (both of the acquired company and our company); conforming standards, controls (including internal control over financial reporting and disclosure controls and procedures, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners have in the past and could continue to adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we have in the past and could continue to be unable to complete or effectively manage such transactions on terms commercially favorable to us or at all, resulting in failure to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain can adversely impact our sales or business performance. Acquisitions or joint ventures that are not successfully completed, integrated into our existing operations or managed effectively, or divestitures or refranchisings that are not successfully completed or managed effectively or do not result in the benefits or cost savings we expect, have in the past and could continue to result in adverse effects on our business, financial condition or results of operations. A change in our estimates and underlying assumptions regarding the future performance of our businesses can result in an impairment charge that materially affects our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable and have recorded impairments in the past. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, can adversely affect our results of operations. Factors considered to determine if an impairment exist include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that can result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. While no material impairment charges have been recorded in the periods presented in this Form 10-K, we may in the future record impairment charges that have a material adverse effect on our results of operations in the periods recognized. See Note 4 to our consolidated financial statements for further information. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities can adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction can reduce our after-tax income from such jurisdiction and adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, existing tax laws in the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have been and could in the future be subject to significant change. For example, in December 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and additional guidance issued by the Internal Revenue Service (IRS) may continue to impact our recorded amounts in future periods. In addition, o n May 19, 2019, a public referendum held in Switzerland passed the Federal Act on Tax Reform and AHV Financing (TRAF), effective January 1, 2020. Certain provisions of the TRAF were enacted in fiscal year 2019, resulting in adjustments to our deferred taxes. The future impact of the TRAF cannot currently be estimated and we continue to monitor and assess the impact of TRAF on our business and financial results. For further information regarding the impact and potential impact of the TCJ Act and the TRAF, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, can adversely affect our business, financial condition or results of operations. For example, the Organization for Economic Cooperation and Development (OECD) has recommended changes to numerous long-standing international tax principles through its base erosion and profit shifting (BEPS) project. These changes have been or are being adopted by many of the countries in which we do business. In connection with the OECDs BEPS project, the OECD has undertaken a new project focused on Addressing the Tax Challenges of the Digitalization of the Economy. This project may impact all multinational businesses by reallocating where some profits are taxed and implementing a global model for minimum taxation. The increasingly complex global tax environment has in the past and could continue to increase tax uncertainty, resulting in higher compliance costs and adverse effects on our provision for income taxes, results of operations and/or cash flow. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. In connection with the OECDs BEPS project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation can differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it can have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or failure to hire and retain a highly skilled and diverse workforce, including with key capabilities such as e-commerce and digital marketing and data analytic skills, can deplete our institutional knowledge base, erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing can adversely affect our business, reputation, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer can adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers can adversely affect our business, financial condition or results of operations. Disruption in the retail landscape, including rapid growth in the e-commerce channel and hard discounters, can adversely affect our business, financial condition or results of operations. Our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites, mobile commerce applications and subscription services as well as the integration of physical and digital operations among retailers. We continue to make significant investments in attracting talent to and building our global e-commerce and digital capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which can adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce and hard discounters may result in consumer price deflation, which may affect our relationships with key retail customers. Further, the ability of consumers to compare prices on a real-time basis using digital technology puts additional pressure on us to maintain competitive prices. If these e-commerce and hard discounter retailers were to take significant additional market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, including finding ways to create more powerful digital tools and capabilities for our retail customers to enable them to grow their businesses, our ability to maintain and grow our profitability, share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers or buying groups with increased purchasing power, which may impact our ability to compete in these areas. Such retailers or buying groups demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, such consolidation can continue to adversely impact our smaller customers ability to compete effectively, resulting in an inability on their part to pay for our products or reduced or canceled orders of our products. Further, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may continue to reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, can reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets would be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, can increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings can impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market can also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity can adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize information technology support services and administrative functions in certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. We may enter into new or additional agreements for shared services in other functions in the future to achieve cost savings and efficiencies as we continue to migrate to shared business service organizational models across our business operations. In addition, we increasingly utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. Failure by these third-party service providers or vendors to perform effectively, or our failure to adequately monitor their performance (including compliance with service level agreements or regulatory or legal requirements), has in the past and could continue to result in our inability to achieve the expected cost savings, additional costs to correct errors made by such service providers, damage to our reputation or our being subject to litigation, claims, legal or regulatory proceedings, inquiries or investigations. Depending on the function involved, such errors can also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, damage to our reputation or have a negative impact on employee morale. In addition, the management of multiple third-party service providers increases operational complexity and decreases our control. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which can result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, can lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom, China and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and could continue to have, an adverse impact on our business, financial condition and results of operations. Climate change or legal, regulatory or market measures to address climate change may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, tornado, earthquake, wildfire or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency, we may experience disruptions in, or significant increases in our costs of, operation and delivery and be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions can substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change can negatively affect our business and operations I n addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change can lead to adverse publicity, resulting in an adverse effect on our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact and recyclability or recoverability of packaging, including plastic. Our reputation can be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, can cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions can occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which can impair manufacturing and distribution of our products or lead to a loss of sales, resulting in an adverse impact on our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements can also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, can be reduced, resulting in an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property, although the laws of various jurisdictions have differing levels of protection of intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, can be reduced, resulting in an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding can have an adverse impact on our business, reputation, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations can have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, requires us to incur significant expense and devote significant resources, and may generate adverse publicity that damages our reputation or brand image, resulting in an adverse impact on our business, financial condition or results of operations. Many factors can adversely affect the price of our publicly traded securities. Many factors can adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, have in the past and could continue to include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, inquiries or investigations; changes in laws and regulations applicable to our products or business operations; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we have or have not taken in the past or may or may not take in the future as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, have not and may not in the future have the impact we intend, resulting in adversely effects on the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, can adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2019 year and that remain unresolved. ," Item 2. Properties. Our principal executive office located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. In connection with making, marketing, distributing and selling our products, each division utilizes manufacturing, processing, bottling and production plants, warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities, all of which are either owned or leased. Significant properties by division are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. PBNAs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. LatAms three snack plants in Mexico (one in Celaya and two in Vallejo), all of which are owned. Europes snack plant in Kashira, Russia, its dairy plant in Moscow, Russia, and its fruit juice plant in Zeebrugge, Belgium, all of which are owned. AMESAs snack plant in Riyadh, Saudi Arabia, which is leased. APACs snack plant in Wuhan, China, which is owned. Our primary concentrate plants in Cork, Ireland and in Singapore, all of which are either owned or leased. Our concentrate plants in Cork, Ireland are shared by our PBNA, Europe and AMESA segments and our concentrate plant in Singapore is shared by our PBNA and APAC segments. A shared service center in Winston-Salem, North Carolina, which is primarily shared by our FLNA, QFNA and PBNA segments, which is leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 6, 2020 , there were approximately 109,312 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 10, 2020 , the Board of Directors declared a quarterly dividend of $0.955 payable March 31, 2020 , to shareholders of record on March 6, 2020 . For the remainder of 2020 , the record dates for these dividend payments are expected to be June 5, September 4 and December 4, 2020 , subject to approval of the Board of Directors. On February 13, 2020 , we announced a 7% increase in our annualized dividend to $4.09 per share from $3.82 per share, effective with the dividend expected to be paid in June 2020 . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases of approximately $2 billion and dividends of approximately $5.5 billion. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2019 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/7/2019 $ 11,783 9/8/2019 - 10/5/2019 1.5 $ 135.74 1.5 (204 ) 11,579 10/6/2019 - 11/2/2019 1.3 $ 136.76 1.3 (170 ) 11,409 11/3/2019 - 11/30/2019 1.5 $ 133.90 1.5 (202 ) 11,207 12/1/2019 - 12/28/2019 0.9 $ 136.52 0.9 (123 ) Total 5.2 $ 135.58 5.2 $ 11,084 (a) All shares were repurchased in open market transactions pursuant to the $ 15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Shares repurchased under this program may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Results of Operations Division Review FLNA QFNA PBNA LatAm Europe AMESA APAC Results of Operations Other Consolidated Results Non-GAAP Measures Items Affecting Comparability Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Leases Note 14 Acquisitions and Divestitures Note 15 Supplemental Financial Information Note 16 Selected Quarterly Financial Data (unaudited) Report of Independent Registered Public Accounting Firm GLOSSARY 41 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Unless otherwise noted, tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview PepsiCo is a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories Everything we do is driven by an approach we call Winning with Purpose. Winning with Purpose is our guide for achieving accelerated, sustainable growth that includes our mission, to Create More Smiles with Every Sip and Every Bite; our vision, to Be the Global Leader in Convenient Foods and Beverages by Winning with Purpose; and The PepsiCo Way, seven behaviors that define our shared culture. Winning with Purpose is designed to help us meet the needs of our shareholders, customers, consumers, partners and communities, while caring for our planet and inspiring our associates. This strategy is also designed to address key challenges facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. To adapt to these challenges, we intend to continue to focus on becoming Faster, Stronger, and Better: Faster by winning in the marketplace, being more consumer-centric and accelerating investment for topline growth. This includes broadening our portfolios to win locally in convenient foods and beverages, fortifying our North American businesses, and accelerating our international expansion, with disciplined focus on markets where we see a strong likelihood of prevailing over our competition. Stronger by continuing to transform our capabilities, cost, and culture by leveraging scale and technology in global markets across our operations and winning locally. This includes continuing to focus on driving savings through holistic cost management to reinvest to succeed in the marketplace, developing and scaling core capabilities through technology, and building differentiated talent and culture. Better by continuing to focus our sustainability agenda on helping to build a more sustainable food system and investing in six priority areas: next generation agriculture, water stewardship, plastic packaging, products, climate change, and people. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for further information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During the periods presented in this report, certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency controls or fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging, encourage waste reduction and increased recycling rates or facilitate waste management process or restrict the sale of products in certain packaging. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. In addition, our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce and digital capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Our provisional measurement period ended in the fourth quarter of 2018 and while our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. For further information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. See Our Critical Accounting Policies and Note 5 to our consolidated financial statements for further information. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key sustainability and public policy matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors, the Audit Committee of the Board and other Committees of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 28, 2019 and December 29, 2018 . At the end of 2019 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2019 by $106 million . Foreign Exchange Our operations outside of the United States generated 42% of our consolidated net revenue in 2019 , with Mexico, Russia, Canada, the United Kingdom, China and Brazil , collectively, comprising approximately 22% of our consolidated net revenue in 2019 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases, foreign currency assets and liabilities created in the normal course of business, as well as the proposed acquisition of Pioneer Foods. During 2019 , unfavorable foreign exchange reduced net revenue growth by 2 percentage points, reflecting declines in the euro, Turkish lira, Brazilian real, Russian ruble and Argentine peso. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, Mexico, the Middle East, Russia and Turkey, and currency controls or fluctuations in certain of these international markets, continue to, and the threat or imposition of new or increased tariffs or sanctions or other impositions in or related to these international markets may, result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, as well as the economic, operating and political environment in Russia and the potential impact for the Europe segment and our other businesses. Our foreign currency derivatives had a total notional value of $1.9 billion as of December 28, 2019 and $2.0 billion as of December 29, 2018 . At the end of 2019 , we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2019 by $135 million . The total notional amount of our debt instruments designated as net investment hedges was $2.5 billion as of December 28, 2019 and $0.9 billion as of December 29, 2018 . Interest Rates Our interest rate derivatives had a total notional value of $5.0 billion as of December 28, 2019 and $10.5 billion as of December 29, 2018 . Assuming year-end 2019 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2019 by $25 million due to higher cash and cash equivalents as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review Volume Beverage volume reflects sales of concentrate and beverage products bearing company-owned or licensed trademarks to authorized bottlers, independent distributors and retailers. Concentrate beverage volume is sold to franchised-owned bottlers and independent distributors. Finished goods beverage volume is sold to retailers and independent distributors and includes direct shipments to retailers. Beverage volume is measured in bottler case sales (BCS), which converts all beverage volume to an 8-ounce-case metric. We believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the customer level. In our franchised-owned business, beverage revenue is based on concentrate shipments and equivalents (CSE), representing physical concentrate volume shipments to such customers. As a result, for our franchise-owned businesses, BCS and CSE are not typically equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. PBNA, LatAm, Europe, AMESA and APAC, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and PBNA, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, APAC licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Food and snack volume is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing company-owned or licensed trademarks. In addition, FLNA makes, markets, distributes and sells Sabra refrigerated dips and spreads through a joint venture with Strauss Group. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2019 , total servings increased 4% compared to 2018 , primarily reflecting our acquisition of SodaStream. In 2018, total servings increased 1% compared to 2017. Consolidated Net Revenue and Operating Profit Change Net revenue $ 67,161 $ 64,661 $ 63,525 % % Operating profit $ 10,291 $ 10,110 $ 10,276 % (2 )% Operating profit margin 15.3 % 15.6 % 16.2 % (0.3 ) (0.5 ) See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2019 Operating profit grew 2% and operating profit margin declined 0.3 percentage points. Operating profit growth was driven by productivity savings of more than $1 billion and net revenue growth, partially offset by certain operating cost increases, a 5-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. The operating profit margin decline primarily reflects higher advertising and marketing expenses. Favorable mark-to-market net impact on commodity derivatives included in corporate unallocated expenses (see Items Affecting Comparability) contributed 3 percentage points to operating profit growth. Gains on the refranchising of a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in the prior year reduced operating profit growth by 2 percentage points. Operating profit decreased 2% and operating profit margin declined 0.5 percentage points. The operating profit performance was driven by certain operating cost increases and a 6-percentage-point impact of higher commodity costs, partially offset by productivity savings of more than $1 billion and net revenue growth. The impact of refranchising a portion of our beverage business in Jordan in 2017 and a 2017 gain associated with the sale of our minority stake in Britvic negatively impacted operating profit performance by 2.5 percentage points. These impacts were offset by a 2-percentage-point positive impact of refranchising a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in 2018. Items affecting comparability (see Items Affecting Comparability) negatively impacted operating profit performance by 3 percentage points and decreased operating profit margin by 0.5 percentage points, primarily due to higher mark-to-market net impact on commodity derivatives included in corporate unallocated expenses. Results of Operations Division Review During the fourth quarter of 2019, we realigned certain of our reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. See Our Operations in Item 1. Business for further information. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding measures not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees . Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on organic revenue growth, see Non-GAAP Measures. Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Organic % Change, Non-GAAP Measure (a ) Volume (b) Effective net pricing FLNA 4.5 % 4.5 % QFNA % % PBNA % (1 ) % (1 ) LatAm % % Europe % (6 ) 5.5 % (1 ) AMESA % % 2.5 APAC 4.5 % % Total % (1 ) 4.5 % 0.5 Impact of Impact of Reported % Change, GAAP Measure Foreign exchange translation Acquisitions and divestitures Sales and certain other taxes Organic % Change, Non-GAAP Measure (a) Volume (b) Effective net pricing FLNA 3.5 % % QFNA (1.5 )% (2 )% (0.5 ) (1 ) PBNA % 0.5 % (1 ) LatAm % % Europe % 0.5 % AMESA (0.5 )% % 1.5 APAC (3 )% (1 ) 0.5 % Total % % (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our company-owned and franchise-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. Operating Profit, Operating Profit Adjusted for Items Affecting Comparability and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Operating profit adjusted for items affecting comparability and operating profit growth adjusted for items affecting comparability on a constant currency basis are both non-GAAP financial measures. For further information on these measures see Non-GAAP Measures and Items Affecting Comparability. Operating Profit and Operating Profit Adjusted for Items Affecting Comparability Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core, Non-GAAP Measure FLNA $ 5,258 $ $ $ $ 5,280 QFNA PBNA 2,179 2,230 LatAm 1,141 1,203 Europe 1,327 1,472 AMESA APAC Corporate unallocated expenses (1,306 ) (112 ) (1,369 ) Total $ 10,291 $ (112 ) $ $ $ 10,602 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Merger and integration charges Core, Non-GAAP Measure FLNA $ 5,008 $ $ $ $ 5,044 QFNA PBNA 2,276 2,364 LatAm 1,049 1,089 Europe 1,256 1,372 AMESA APAC Corporate unallocated expenses (1,396 ) (1,205 ) Total $ 10,110 $ $ $ $ 10,620 Items Affecting Comparability (a) Reported, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Core, Non-GAAP Measure FLNA $ 4,793 $ $ $ 4,847 QFNA PBNA 2,700 2,743 LatAm Europe 1,199 1,252 AMESA APAC (5 ) Corporate unallocated expenses (1,170 ) (15 ) (1,168 ) Total $ 10,276 $ (15 ) $ $ 10,490 (a) See Items Affecting Comparability. Operating Profit Growth and Operating Profit Growth Adjusted for Items Affecting Comparability on a Constant Currency Basis Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Inventory fair value adjustments and merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA % % % QFNA (15 )% (0.5 ) (15 )% (15 )% PBNA (4 )% (1 ) (6 )% (6 )% LatAm % % % Europe % (1 ) % % AMESA 1.5 % 5.5 % 2.5 % APAC (23 )% (17 )% (16 )% Corporate unallocated expenses (6 )% (3 ) % % Total % (3 ) % % Impact of Items Affecting Comparability (a) Impact of Reported % Change, GAAP Measure Mark-to-market net impact Restructuring and impairment charges Merger and integration charges Core % Change, Non-GAAP Measure (b) Foreign exchange translation Core Constant Currency % Change, Non-GAAP Measure (b) FLNA 4.5 % % % QFNA % (1 )% (1 )% PBNA (16 )% (14 )% (14 )% LatAm % (2 ) % % Europe % % % AMESA (16 )% (14 )% (14 )% APAC % % (2 ) % Corporate unallocated expenses % (15 ) (1.5 ) % % Total (2 )% % 0.5 % (a) See Items Affecting Comparability for further information. (b) Amounts may not sum due to rounding. FLNA Net revenue grew 4.5% and volume grew 1%. The net revenue growth was driven by effective net pricing and volume growth. The volume growth reflects mid-single-digit growth in trademark Doritos, Cheetos and Ruffles and low-single-digit growth in variety packs, partially offset by a double-digit decline in trademark Santitas. Operating profit grew 5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and higher advertising and marketing expenses. Additionally, a prior-year bonus extended to certain U.S. employees in connection with the TCJ Act contributed 1 percentage point to operating profit growth . 2018 Net revenue grew 3.5%, primarily reflecting effective net pricing and volume growth. Volume grew 1%, reflecting mid-single-digit growth in variety packs and low-single-digit growth in trademark Doritos, partially offset by a double-digit decline in trademark Santitas. Operating profit grew 4.5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and a 1-percentage-point impact of a bonus extended to certain U.S. employees related to the TCJ Act. QFNA Net revenue grew 1% and volume was flat. The net revenue growth primarily reflects favorable mix. The volume performance was driven by double-digit growth in trademark Gamesa and mid-single-digit growth in Aunt Jemima mixes and syrups, offset by a mid-single-digit decline in oatmeal and a low-single-digit decline in ready-to-eat cereals. Operating profit decreased 15%, reflecting certain operating cost increases, a 5-percentage-point impact of higher commodity costs, and higher advertising and marketing expenses. These impacts were partially offset by productivity savings. Net revenue declined 1.5% and volume declined 0.5%. The net revenue performance reflects unfavorable net pricing and mix and the volume decline. The volume decline was driven by a double-digit decline in trademark Gamesa and a mid-single-digit decline in ready-to-eat cereals, partially offset by mid-single-digit growth in oatmeal. Operating profit decreased slightly, reflecting certain operating cost increases, the net revenue performance and a 3-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1-percentage-point positive contribution from insurance settlement recoveries related to the 2017 earthquake in Mexico. PBNA Net revenue grew 3%, driven by effective net pricing, partially offset by a decline in volume. Acquisitions contributed 1 percentage point to the net revenue growth. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage (NCB) volume. The NCB volume increase primarily reflected a mid-single-digit increase in our overall water portfolio, partially offset by a low-single-digit decrease in our juice and juice drinks portfolio. Operating profit decreased 4%, reflecting certain operating cost increases, higher advertising and marketing expenses, an 8-percentage-point impact of higher commodity costs and the volume decline. These impacts were partially offset by the effective net pricing and productivity savings. Year-over-year gains on asset sales negatively contributed 1 percentage point to operating profit performance. A gain associated with an insurance recovery positively contributed 1 percentage point to current-year operating profit performance and was offset by less-favorable insurance adjustments compared to the prior year, which negatively impacted the current-year operating profit performance by 1 percentage point. Additionally, a prior-year bonus extended to certain U.S. employees in connection with the TCJ Act positively contributed 2 percentage points to operating profit performance. 2018 Net revenue grew 1%, driven by effective net pricing, partially offset by a decline in volume. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage volume. The non-carbonated beverage volume increase primarily reflected a high-single-digit increase in our overall water portfolio. Additionally, a low-single-digit increase in Gatorade sports drinks was offset by a low-single-digit decline in our juice and juice drinks portfolio. Operating profit decreased 16%, reflecting certain operating cost increases, including increased transportation costs, a 7-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. These impacts were partially offset by productivity savings and the net revenue growth. Higher gains on asset sales positively contributed 1.5 percentage points to operating profit performance. A bonus extended to certain U.S. employees related to the TCJ Act negatively impacted operating profit performance by 1.5 percentage points and was partially offset by 2017 costs related to hurricanes which positively contributed 1 percentage point to operating profit performance. LatAm Net revenue increased 3%, primarily reflecting effective net pricing, partially offset by a 4-percentage-point impact of unfavorable foreign exchange. Snacks volume experienced a slight decline, reflecting a high-single-digit decline in Brazil, partially offset by low-single-digit growth in Mexico. Beverage volume grew 4%, reflecting high-single-digit growth in Brazil and Guatemala, partially offset by a mid-single-digit decline in Argentina and a low-single-digit decline in Colombia. Additionally, Honduras experienced low-single-digit growth and Mexico and Chile each experienced mid-single-digit growth. Operating profit increased 9%, reflecting the effective net pricing and productivity savings, partially offset by certain operating cost increases and a 10-percentage-point impact of higher commodity costs largely due to transaction-related foreign exchange. Unfavorable foreign exchange and higher restructuring and impairment charges each reduced operating profit growth by 2 percentage points. Net revenue grew 2%, reflecting effective net pricing, partially offset by a 6-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, reflecting low-single-digit growth in Mexico, partially offset by a mid-single-digit decline in Brazil. Beverage volume declined 1%, reflecting a high-single-digit decline in Brazil, a low-single-digit decline in Mexico and a mid-single-digit decline in Argentina, partially offset by double-digit growth in Colombia, mid-single-digit growth in Guatemala and low-single-digit growth in Honduras. Operating profit increased 13%, reflecting the net revenue growth, productivity savings and a 4-percentage-point impact of insurance settlement recoveries related to the 2017 earthquake in Mexico. These impacts were partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Europe Net revenue increased 7%, reflecting an 8-percentage-point impact of our SodaStream acquisition and effective net pricing, partially offset by a 5-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, primarily reflecting mid-single-digit growth in Poland and France and low-single-digit growth in Spain and the Netherlands, partially offset by a mid-single-digit decline in Turkey and a slight decline in the United Kingdom. Additionally, Russia experienced slight growth. Beverage volume grew 23%, primarily reflecting a 24-percentage-point impact of our SodaStream acquisition, mid-single-digit growth in Poland and low-single-digit growth in the United Kingdom and Germany, partially offset by a mid-single-digit decline in Russia, a high-single-digit decline in Turkey and a slight decline in France. Operating profit increased 6%, reflecting the net revenue growth, productivity savings and a 10-percentage-point net impact of our SodaStream acquisition. These impacts were partially offset by certain operating cost increases, a 10-percentage-point impact of higher commodity costs largely due to transaction-related foreign exchange, higher advertising and marketing expenses, and a 4-percentage-point impact of a prior-year gain on the refranchising of our entire beverage bottling operations and snack distribution operations in CHS. Unfavorable foreign exchange reduced operating profit growth by 5 percentage points. Net revenue increased 4%, reflecting volume growth and effective net pricing, partially offset by a 2-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 4%, reflecting high-single-digit growth in Poland and France and mid-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Spain, Russia, and Turkey each experienced low-single-digit growth. Beverage volume grew 6%, reflecting double-digit growth in Germany and Poland and high-single-digit growth in France, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Russia and Turkey each experienced mid-single-digit growth. Operating profit increased 5%, reflecting the net revenue growth, productivity savings and a 4-percentage-point net impact of refranchising our entire beverage bottling operations and snack distribution operations in CHS. These impacts were partially offset by certain operating cost increases and a 9-percentage-point impact of higher commodity costs. Additionally, a 2017 gain on the sale of our minority stake in Britvic and the merger and integration charges related to our acquisition of SodaStream reduced operating profit growth by 8 percentage points and 4 percentage points, respectively. AMESA Net revenue decreased slightly, reflecting a 3-percentage-point impact of refranchising a portion of our beverage business in India, partially offset by volume growth and effective net pricing. Snacks volume grew 7%, reflecting double-digit growth in Pakistan and high-single-digit growth in the Middle East and India, partially offset by a low-single-digit decline in South Africa. Beverage volume grew 4%, reflecting high-single-digit growth in India and Nigeria, partially offset by low-single-digit declines in the Middle East and Pakistan. Operating profit increased 1.5%, reflecting productivity savings, the volume growth and the effective net pricing. These impacts were partially offset by certain operating cost increases, a 5-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. Higher restructuring and impairment charges and unfavorable foreign exchange reduced operating profit growth by 3 percentage points and 2.5 percentage points, respectively. 2018 Net revenue decreased 0.5%, reflecting a 4-percentage-point impact of the 2017 refranchising of a portion of our beverage business in Jordan, partially offset by effective net pricing and volume growth. Snacks volume grew 2.5%, reflecting double-digit growth in India and Pakistan, partially offset by a mid-single-digit decline in the Middle East and a low-single-digit decline in South Africa. Beverage volume grew 1%, reflecting mid-single-digit growth in India, high-single-digit growth in Nigeria and low-single-digit growth in Pakistan, partially offset by a mid-single-digit decline in the Middle East. Operating profit decreased 16%, reflecting a 22-percentage-point impact of the 2017 refranchising of a portion of our beverage business in Jordan, certain operating cost increases and a 6-percentage-point impact of higher commodity costs. These impacts were partially offset by the effective net pricing and productivity savings. APAC Net revenue increased 4.5%, reflecting volume growth and effective net pricing, partially offset by a 3-percentage-point impact of unfavorable foreign exchange and a 2-percentage-point impact of the prior-year refranchising of a portion of our beverage business in Thailand. Snacks volume grew 6%, reflecting double-digit growth in China and mid-single-digit growth in Thailand, partially offset by a low-single-digit decline in Indonesia. Additionally, Australia and Taiwan each experienced low-single-digit growth. Beverage volume grew 4%, reflecting double-digit growth in Vietnam and Thailand and mid-single-digit growth in the Philippines. Additionally, China experienced low-single-digit growth. Operating profit decreased 23%, primarily reflecting a 23-percentage-point impact of the gain on the prior-year refranchising of a portion of our beverage business in Thailand. Additionally, certain operating cost increases and higher advertising and marketing expenses negatively impacted operating profit performance. These impacts were partially offset by the net revenue growth and productivity savings. Higher restructuring and impairment charges negatively impacted operating profit performance by 6 percentage points. Net revenue decreased 3%, reflecting an 11-percentage-point impact of refranchising a portion of our beverage business in Thailand, partially offset by net volume growth and effective net pricing. Snacks volume grew 7%, reflecting double-digit growth in China, partially offset by a slight decline in Taiwan. Additionally, Thailand experienced high-single-digit growth and Indonesia and Australia each experienced low-single-digit growth. Beverage volume declined slightly, reflecting a double-digit decline in the Philippines, partially offset by double-digit growth in Vietnam, low-single-digit growth in China and mid-single-digit growth in Thailand. Operating profit increased 54%, reflecting a 35-percentage-point net impact of refranchising a portion of our beverage business in Thailand. The net volume growth, productivity savings and the effective net pricing also contributed to operating profit growth. These impacts were partially offset by higher advertising and marketing expenses and certain operating cost increases. Higher restructuring and impairment charges reduced operating profit growth by 5 percentage points. Other Consolidated Results Change Other pension and retiree medical benefits (expense)/income $ (44 ) $ $ $ (342 ) $ Net interest expense $ (935 ) $ (1,219 ) $ (907 ) $ $ (312 ) Annual tax rate (a) 21.0 % (36.7 )% 48.9 % Net income attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 (42 )% % Net income attributable to PepsiCo per common share diluted $ 5.20 $ 8.78 $ 3.38 (41 )% % Mark-to-market net impact (0.06 ) 0.09 (0.01 ) Restructuring and impairment charges 0.21 0.18 0.16 Inventory fair value adjustments and merger and integration charges 0.03 0.05 Pension-related settlement charges 0.15 Net tax related to the TCJ Act (a) (0.01 ) (0.02 ) 1.70 Other net tax benefits (a) (3.55 ) Charges related to cash tender and exchange offers 0.13 Net income attributable to PepsiCo per common share diluted, excluding above items (b) $ 5.53 (c) $ 5.66 $ 5.23 (2 )% % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (b) (1 )% % (a) See Note 5 to our consolidated financial statements for further information. (b) See Non-GAAP Measures. (c) Does not sum due to rounding. Other pension and retiree medical benefits expense increased $342 million, primarily reflecting settlement charges of $220 million related to the purchase of a group annuity contract and settlement charges of $53 million related to one-time lump sum payments to certain former employees who had vested benefits. Net interest expense decreased $284 million reflecting the prior-year charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. This decrease also reflects lower interest expense due to lower average debt balances. These impacts were partially offset by lower interest income due to lower average cash balances. The reported tax rate increased 57.7 percentage points, primarily reflecting the prior-year other net tax benefits related to the reorganization of our international operations, which increased the current-year reported tax rate by 47 percentage points. Additionally, the prior-year favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, increased the current-year reported tax rate by 8 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo decreased 42% and net income attributable to PepsiCo per common share decreased 41%. Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 38 percentage points. Other pension and retiree medical benefits income increased $65 million, reflecting the impact of the $1.4 billion discretionary pension contribution to the PepsiCo Employees Retirement Plan A (Plan A) in the United States, as well as the recognition of net asset gains, partially offset by higher amortization of net losses. Net interest expense increased $312 million reflecting a charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. This increase also reflects higher interest rates on debt balances, as well as losses on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest income due to higher interest rates on cash balances. The reported tax rate decreased 85.6 percentage points, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the 2017 provisional net tax expense related to the TCJ Act, which reduced the 2018 reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo increased 158% and net income attributable to PepsiCo per common share increased 160%. Items affecting comparability (see Items Affecting Comparability) positively contributed 150 percentage points to net income attributable to PepsiCo growth and 152 percentage points to net income attributable to PepsiCo per common share growth. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. GAAP. We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring plans; amounts associated with mergers, acquisitions, divestitures and other structural changes; pension and retiree medical related items; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; debt redemptions, cash tender or exchange offers; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures contained in this Form 10-K are discussed below. Cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits expense/income, interest expense, provision for/benefit from income taxes, net income attributable to noncontrolling interests and net income attributable to PepsiCo, each adjusted for items affecting comparability, operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 and 2014 Productivity Plans, inventory fair value adjustments and merger and integration charges primarily associated with our acquisition of SodaStream, pension-related settlement charges, net tax related to the TCJ Act, other net tax benefits and charges related to cash tender and exchange offers (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current-year U.S. dollar results by the current-year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic revenue growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. Starting in 2018, our reported results reflected the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excluded the impact of approximately $75 million of these taxes previously recognized in net revenue. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review for further information. Free cash flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment . Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources for further information. Return on invested capital (ROIC) and net ROIC, excluding items affecting comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that we believe are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources for further information. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 30,132 $ 37,029 $ 26,738 $ 10,291 $ (44 ) $ 1,959 $ $ 7,314 Items Affecting Comparability Mark-to-market net impact (57 ) (112 ) (25 ) (87 ) Restructuring and impairment charges (115 ) (253 ) Inventory fair value adjustments and merger and integration charges (34 ) (21 ) Pension-related settlement charges Net tax related to the TCJ Act (8 ) Core, Non-GAAP Measure $ 30,040 $ 37,121 $ 26,519 $ 10,602 $ $ 2,079 $ $ 7,775 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Interest expense (Benefit from)/provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 29,381 $ 35,280 $ 25,170 $ 10,110 $ $ 1,525 $ (3,370 ) $ $ 12,515 Items Affecting Comparability Mark-to-market net impact (83 ) (80 ) Restructuring and impairment charges (3 ) (269 ) Merger and integration charges (75 ) Net tax related to the TCJ Act (28 ) Other net tax benefits 5,064 (5,064 ) Charges related to cash tender and exchange offers (253 ) Core, Non-GAAP Measure $ 29,295 $ 35,366 $ 24,746 $ 10,620 $ $ 1,272 $ 1,878 $ $ 8,065 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,796 $ 34,729 $ 24,453 $ 10,276 $ $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (229 ) Provisional net tax related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,804 $ 34,721 $ 24,231 $ 10,490 $ $ 2,307 $ 7,524 (a) Provision for income taxes is the expected tax charge/benefit on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $2.5 billion , of which we have incurred $508 million plan to date through December 28, 2019 and cash expenditures of approximately $1.6 billion , of which we have incurred approximately $261 million plan to date through December 28, 2019 . We expect to incur pre-tax charges of approximately $450 million and cash expenditures of approximately $400 million in our 2020 financial results, with the balance to be reflected in our 2021 through 2023 financial results. These charges will be funded primarily through cash from operations. We expect to incur the majority of the remaining pre-tax charges and cash expenditures in our 2020 and 2021 results. 2014 Multi-Year Productivity Plan The 2014 Productivity Plan was completed in 2019. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $1.3 billion and $960 million , respectively. See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Inventory Fair Value Adjustments and Merger and Integration Charges In 2019 , we recorded inventory fair value adjustments and merger and integration charges of $55 million ( $47 million after-tax or $0.03 per share), including $46 million in our Europe segment, $7 million in our AMESA segment and $2 million in corporate unallocated expenses. These charges are primarily related to fair value adjustments to the acquired inventory included in SodaStreams balance sheet at the acquisition date, as well as merger and integration charges, including employee-related costs. In 2018 , we recorded merger and integration charges of $75 million ($0.05 per share), including $57 million in our Europe segment and $18 million in corporate unallocated expenses, related to our acquisition of SodaStream. These charges include closing costs, advisory fees and employee-related costs. See Note 14 to our consolidated financial statements for further information. Pension-Related Settlement Charges In 2019 , we recorded pension settlement charges of $273 million ($211 million after-tax or $0.15 per share), reflecting settlement charges of $220 million ( $170 million after-tax or $0.12 per share) related to the purchase of a group annuity contract and settlement charges of $53 million ( $41 million after-tax or $0.03 per share) related to one-time lump sum payments to certain former employees who had vested benefits. See Note 7 to our consolidated financial statements for further information. Net Tax Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. In 2017, we recorded a provisional net tax expense of $2.5 billion ( $1.70 per share) associated with the enactment of the TCJ Act. We recognized net tax benefits of $8 million ( $0.01 per share) and $28 million ( $0.02 per share) in 2019 and 2018 , respectively, related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. Other Net Tax Benefits In 2018, we reorganized our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). Also in 2018, we recognized non-cash tax benefits associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $717 million ($0.50 per share). See Note 5 to our consolidated financial statements for further information. Charges Related to Cash Tender and Exchange Offers In 2018, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements for further information. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities, bridge loan facilities, working capital lines and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments, debt repayments, the proposed acquisition of Pioneer Foods and the transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper, bridge loan facilities and long-term debt and cash and cash equivalents. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our revolving credit facilities and bridge loan facilities. See also Item 1A. Risk Factors and Our Business Risks for further discussion. As of December 28, 2019 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 28, 2019 , our mandatory transition tax liability was $3.3 billion , which must be paid through 2026 under the provisions of the TCJ Act; we currently expect to pay approximately $0.1 billion of this liability in 2020 . See Credit Facilities and Long-Term Contractual Commitments. Any additional guidance issued by the IRS may impact our recorded amounts for this transition tax liability. See Note 5 to our consolidated financial statements for further discussion of the TCJ Act. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,649 $ 9,415 $ 10,030 Net cash (used for)/provided by investing activities $ (6,437 ) $ 4,564 $ (4,403 ) Net cash used for financing activities $ (8,489 ) $ (13,769 ) $ (4,186 ) Operating Activities During 2019 , net cash provided by operating activities was $9.6 billion , compared to $9.4 billion in the prior year. The operating cash flow performance primarily reflects lower pre-tax pension and retiree medical plan contributions in the current year, partially offset by higher net cash tax payments in the current year. During 2018, net cash provided by operating activities was $9.4 billion, compared to $10.0 billion in 2017. The operating cash flow performance primarily reflects discretionary contributions of $1.5 billion to our pension and retiree medical plans in 2018, partially offset by lower net cash tax payments in 2018. Investing Activities During 2019 , net cash used for investing activities was $6.4 billion , primarily reflecting $4.1 billion of net capital spending, as well as $1.9 billion of the remaining cash paid in connection with our acquisition of SodaStream. During 2018, net cash provided by investing activities was $4.6 billion, primarily reflecting net maturities and sales of debt securities with maturities greater than three months of $8.7 billion, partially offset by net capital spending of $3.1 billion and $1.2 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of SodaStream. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2020 net capital spending to be approximately $5 billion . Financing Activities During 2019 , net cash used for financing activities was $8.5 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $8.3 billion, payments of long-term debt borrowings of $4.0 billion and debt redemptions of $1.0 billion, partially offset by proceeds from issuances of long-term debt of $4.6 billion. During 2018, net cash used for financing activities was $13.8 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.9 billion, payments of long-term debt borrowings of $4.0 billion, cash tender and exchange offers of $1.6 billion and net payments of short-term borrowings of $1.4 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. On February 13, 2020 , we announced a 7% increase in our annualized dividend to $4.09 per share from $3.82 per share, effective with the dividend expected to be paid in June 2020 . We expect to return a total of approximately $7.5 billion to shareholders in 2020 through share repurchases of approximately $2 billion and dividends of approximately $5.5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,649 $ 9,415 $ 10,030 2.5 (6 ) Capital spending (4,232 ) (3,282 ) (2,969 ) Sales of property, plant and equipment Free cash flow $ 5,587 $ 6,267 $ 7,241 (11 ) (13 ) We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2021 2022 2023 2024 2025 and beyond Recorded Liabilities: Long-term debt obligations (b) $ 29,142 $ $ 7,156 $ 3,110 $ 18,876 Operating leases (c) 1,763 One-time mandatory transition tax - TCJ Act (d) 3,317 1,737 Other: Interest on debt obligations (e) 12,403 1,730 1,388 8,289 Purchasing commitments (f) 2,032 Marketing commitments (g) 1,308 Total contractual commitments $ 49,965 $ 2,849 $ 11,549 $ 6,087 $ 29,480 (a) Based on year-end foreign exchange rates. (b) Excludes $2,848 million related to current maturities of debt, $6 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $163 million related to unamortized net discounts. (c) Primarily reflects building leases. See Note 13 to our consolidated financial statements for further information on operating leases. (d) Reflects our transition tax liability as of December 28, 2019 , which must be paid through 2026 under the provisions of the TCJ Act. (e) Interest payments on floating-rate debt are estimated using interest rates effective as of December 28, 2019 . Includes accrued interest of $ 305 million as of December 28, 2019. (f) Reflects non-cancelable commitments, primarily for the purchase of commodities and outsourcing services in the normal course of business and does not include purchases that we are likely to make based on our plans, but are not obligated to incur. (g) Reflects non-cancelable commitments, primarily for sports marketing in the normal course of business. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. Bottler funding to independent bottlers is not reflected in the table above as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in the table above. See Note 7 to our consolidated financial statements for further information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo (a) $ 7,314 $ 12,515 $ 4,857 Interest expense 1,135 1,525 1,151 Tax on interest expense (252 ) (339 ) (415 ) $ 8,197 $ 13,701 $ 5,593 Average debt obligations (b) $ 31,975 $ 38,169 $ 38,707 Average common shareholders equity (c) 14,317 11,368 12,004 Average invested capital $ 46,292 $ 49,537 $ 50,711 Return on invested capital 17.7 % 27.7 % 11.0 % (a) Results include the impact of the TCJ Act. Additionally, our 2018 results included other net tax benefits related to the reorganization of our international operations. See Note 5 to our consolidated financial statements for further information. (b) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (c) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 17.7 % 27.7 % 11.0 % Impact of: Average cash, cash equivalents and short-term investments 3.0 7.8 7.6 Interest income (0.5 ) (0.6 ) (0.5 ) Tax on interest income 0.1 0.1 0.2 Mark-to-market net impact (0.2 ) 0.2 Restructuring and impairment charges 0.5 0.4 0.3 Inventory fair value adjustments and merger and integration charges 0.1 0.1 Pension-related settlement charges 0.5 Net tax related to the TCJ Act (1.0 ) (1.1 ) 4.5 Other net tax benefits 2.2 (9.7 ) 0.1 Charges related to cash tender and exchange offers (0.1 ) (0.1 ) Charges related to the transaction with Tingyi (a) (0.1 ) Venezuela impairment charges (a) (0.2 ) Net ROIC, excluding items affecting comparability 22.3 % 24.8 % 22.9 % (a) See Item 6. Selected Financial Data for further information. OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year-end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. See Note 2 to our consolidated financial statements for further information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite-lived intangible assets and goodwill, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for further information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax structure and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws or tax authority settlements. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior-year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our consolidated financial statements. As a result, our annual tax rate reflected in our consolidated financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our consolidated financial statements. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our consolidated financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our consolidated financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ( $1.70 per share) in the fourth quarter of 2017. We recorded a net tax benefit of $28 million ( $0.02 per share) in 2018, related to the TCJ Act. Our provisional measurement period ended in the fourth quarter of 2018 and while our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $8 million ( $0.01 per share) related to the TCJ Act, including the impact of additional guidance issued by the IRS in the first quarter of 2019 and adjustments related to the filing of our 2018 U.S. federal tax return. See further information in Items Affecting Comparability. On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. In 2019 , our annual tax rate was 21.0% compared to (36.7)% in 2018 , as discussed in Other Consolidated Results. The tax rate increased 57.7 percentage points compared to 2018 , primarily reflecting the prior-year other net tax benefits related to the reorganization of our international operations, which increased the current-year reported tax rate by 47 percentage points. Additionally, the prior-year favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, increased the current-year reported tax rate by 8 percentage points. See Note 5 to our consolidated financial statements for further information. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $220 million ( $170 million after-tax or $0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $53 million ( $41 million after-tax or $0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $273 million ($211 million after-tax or $0.15 per share). Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and the PepsiCo Employees Retirement Plan I (Plan I) to facilitate a targeted investment strategy over time and provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, these assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 3.4 % 4.4 % 3.7 % Interest cost discount rate 2.8 % 3.9 % 3.2 % Expected rate of return on plan assets 6.6 % 6.8 % 6.9 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 3.2 % 4.3 % 3.6 % Interest cost discount rate 2.6 % 3.8 % 3.0 % Expected rate of return on plan assets 5.8 % 6.6 % 6.5 % Current health care cost trend rate 5.6 % 5.7 % 5.8 % In 2019, we incurred pension settlement charges related to the purchase of a group annuity contract of $220 million and one-time lump sum settlements of $53 million to certain former employees who had vested benefits. In addition, based on our assumptions, we expect our total pension and retiree medical expense to decrease in 2020 primarily driven by the recognition of fixed income gains on plan assets and the impact of approved plan contributions, primarily offset by the decrease in discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2020 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $ Expected rate of return $ Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. We made discretionary contributions to Plan A in the United States of $150 million in January 2020, $400 million in 2019 and $1.4 billion in 2018. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions except per share amounts) Net Revenue $ 67,161 $ 64,661 $ 63,525 Cost of sales 30,132 29,381 28,796 Gross profit 37,029 35,280 34,729 Selling, general and administrative expenses 26,738 25,170 24,453 Operating Profit 10,291 10,110 10,276 Other pension and retiree medical benefits (expense)/income ( 44 ) Interest expense ( 1,135 ) ( 1,525 ) ( 1,151 ) Interest income and other Income before income taxes 9,312 9,189 9,602 Provision for/(benefit from) income taxes (See Note 5) 1,959 ( 3,370 ) 4,694 Net income 7,353 12,559 4,908 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 Net Income Attributable to PepsiCo per Common Share Basic $ 5.23 $ 8.84 $ 3.40 Diluted $ 5.20 $ 8.78 $ 3.38 Weighted-average common shares outstanding Basic 1,399 1,415 1,425 Diluted 1,407 1,425 1,438 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Net income $ 7,353 $ 12,559 $ 4,908 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment ( 1,641 ) 1,109 Net change on cash flow hedges ( 90 ) ( 36 ) Net pension and retiree medical adjustments ( 467 ) ( 159 ) Net change on available-for-sale securities ( 2 ) ( 68 ) Other ( 2,062 ) Comprehensive income 8,172 10,497 5,770 Comprehensive income attributable to noncontrolling interests ( 39 ) ( 44 ) ( 51 ) Comprehensive Income Attributable to PepsiCo $ 8,133 $ 10,453 $ 5,719 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Operating Activities Net income $ 7,353 $ 12,559 $ 4,908 Depreciation and amortization 2,432 2,399 2,369 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges ( 350 ) ( 255 ) ( 113 ) Pension and retiree medical plan expenses Pension and retiree medical plan contributions ( 716 ) ( 1,708 ) ( 220 ) Deferred income taxes and other tax charges and credits ( 531 ) Net tax related to the TCJ Act ( 8 ) ( 28 ) 2,451 Tax payments related to the TCJ Act ( 423 ) ( 115 ) Other net tax benefits related to international reorganizations ( 2 ) ( 4,347 ) Change in assets and liabilities: Accounts and notes receivable ( 650 ) ( 253 ) ( 202 ) Inventories ( 190 ) ( 174 ) ( 168 ) Prepaid expenses and other current assets ( 87 ) Accounts payable and other current liabilities Income taxes payable ( 287 ) ( 338 ) Other, net ( 256 ) ( 305 ) Net Cash Provided by Operating Activities 9,649 9,415 10,030 Investing Activities Capital spending ( 4,232 ) ( 3,282 ) ( 2,969 ) Sales of property, plant and equipment Acquisition of SodaStream, net of cash and cash equivalents acquired ( 1,939 ) ( 1,197 ) Other acquisitions and investments in noncontrolled affiliates ( 778 ) ( 299 ) ( 61 ) Divestitures Short-term investments, by original maturity: More than three months - purchases ( 5,637 ) ( 18,385 ) More than three months - maturities 12,824 15,744 More than three months - sales 1,498 Three months or less, net Other investing, net ( 8 ) Net Cash (Used for)/Provided by Investing Activities ( 6,437 ) 4,564 ( 4,403 ) Financing Activities Proceeds from issuances of long-term debt 4,621 7,509 Payments of long-term debt ( 3,970 ) ( 4,007 ) ( 4,406 ) Debt redemption/cash tender and exchange offers ( 1,007 ) ( 1,589 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments ( 2 ) ( 17 ) ( 128 ) Three months or less, net ( 3 ) ( 1,352 ) ( 1,016 ) Cash dividends paid ( 5,304 ) ( 4,930 ) ( 4,472 ) Share repurchases - common ( 3,000 ) ( 2,000 ) ( 2,000 ) Share repurchases - preferred ( 2 ) ( 5 ) Proceeds from exercises of stock options Withholding tax payments on r estricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted ( 114 ) ( 103 ) ( 145 ) Other financing ( 45 ) ( 53 ) ( 76 ) Net Cash Used for Financing Activities ( 8,489 ) ( 13,769 ) ( 4,186 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash ( 98 ) Net (Decrease)/Increase in Cash and Cash Equivalents and Restricted Cash ( 5,199 ) 1,488 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 10,769 10,657 9,169 Cash and Cash Equivalents and Restricted Cash, End of Year $ 5,570 $ 10,769 $ 10,657 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 28, 2019 and December 29, 2018 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 5,509 $ 8,721 Short-term investments Restricted cash 1,997 Accounts and notes receivable, net 7,822 7,142 Inventories 3,338 3,128 Prepaid expenses and other current assets Total Current Assets 17,645 21,893 Property, Plant and Equipment, net 19,305 17,589 Amortizable Intangible Assets, net 1,433 1,644 Goodwill 15,501 14,808 Other indefinite-lived intangible assets 14,610 14,181 Indefinite-Lived Intangible Assets 30,111 28,989 Investments in Noncontrolled Affiliates 2,683 2,409 Deferred Income Taxes 4,359 4,364 Other Assets 3,011 Total Assets $ 78,547 $ 77,648 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 2,920 $ 4,026 Accounts payable and other current liabilities 17,541 18,112 Total Current Liabilities 20,461 22,138 Long-Term Debt Obligations 29,148 28,295 Deferred Income Taxes 4,091 3,499 Other Liabilities 9,979 9,114 Total Liabilities 63,679 63,046 Commitments and contingencies PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,391 and 1,409 shares, respectively) Capital in excess of par value 3,886 3,953 Retained earnings 61,946 59,947 Accumulated other comprehensive loss ( 14,300 ) ( 15,119 ) Repurchased common stock, in excess of par value (476 and 458 shares, respectively) ( 36,769 ) ( 34,286 ) Total PepsiCo Common Shareholders Equity 14,786 14,518 Noncontrolling interests Total Equity 14,868 14,602 Total Liabilities and Equity $ 78,547 $ 77,648 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 28, 2019 , December 29, 2018 and December 30, 2017 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year $ 0.8 $ 0.8 $ Conversion to common stock ( 0.1 ) ( 6 ) Retirement of preferred stock ( 0.7 ) ( 35 ) Balance, end of year 0.8 Repurchased Preferred Stock Balance, beginning of year ( 0.7 ) ( 197 ) ( 0.7 ) ( 192 ) Redemptions ( 2 ) ( 5 ) Retirement of preferred stock 0.7 Balance, end of year ( 0.7 ) ( 197 ) Common Stock Balance, beginning of year 1,409 1,420 1,428 Shares issued in connection with preferred stock conversion to common stock Change in repurchased common stock ( 18 ) ( 12 ) ( 1 ) ( 8 ) Balance, end of year 1,391 1,409 1,420 Capital in Excess of Par Value Balance, beginning of year 3,953 3,996 4,091 Share-based compensation expense Equity issued in connection with preferred stock conversion to common stock Stock option exercises, RSUs, PSUs and PEPunits converted ( 188 ) ( 193 ) ( 236 ) Withholding tax on RSUs, PSUs and PEPunits converted ( 114 ) ( 103 ) ( 145 ) Other ( 3 ) ( 4 ) Balance, end of year 3,886 3,953 3,996 Retained Earnings Balance, beginning of year 59,947 52,839 52,518 Cumulative effect of accounting changes ( 145 ) Net income attributable to PepsiCo 7,314 12,515 4,857 Cash dividends declared - common (a) ( 5,323 ) ( 5,098 ) ( 4,536 ) Retirement of preferred stock ( 164 ) Balance, end of year 61,946 59,947 52,839 Accumulated Other Comprehensive Loss Balance, beginning of year ( 15,119 ) ( 13,057 ) ( 13,919 ) Other comprehensive income/(loss) attributable to PepsiCo ( 2,062 ) Balance, end of year ( 14,300 ) ( 15,119 ) ( 13,057 ) Repurchased Common Stock Balance, beginning of year ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) ( 438 ) ( 31,468 ) Share repurchases ( 24 ) ( 3,000 ) ( 18 ) ( 2,000 ) ( 18 ) ( 2,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year ( 476 ) ( 36,769 ) ( 458 ) ( 34,286 ) ( 446 ) ( 32,757 ) Total PepsiCo Common Shareholders Equity 14,786 14,518 11,045 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests ( 42 ) ( 49 ) ( 62 ) Other, net ( 3 ) ( 1 ) Balance, end of year Total Equity $ 14,868 $ 14,602 $ 10,981 (a) Cash dividends declared per common share were $ 3.7925 , $ 3.5875 and $ 3.1675 for 2019 , 2018 and 2017 , respectively. See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50 % or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for indefinite-lived brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. While our North America results are reported on a weekly calendar basis, substantially all of our international operations report on a monthly calendar basis. Certain operations in our Europe segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule for the three years presented: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks September, October, November and December Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years consolidated financial statements to conform to the current year presentation. Our Divisions During the fourth quarter of 2019, we realigned our ESSA and AMENA reportable segments to be consistent with a recent strategic realignment of our organizational structure and how our Chief Executive Officer assesses the performance of, and allocates resources to, our reportable segments. As a result, our beverage, food and snack businesses in North Africa, the Middle East and South Asia that were part of our former AMENA segment and our businesses in Sub-Saharan Africa that were part of our former ESSA segment are now reported together as our AMESA segment. The remaining beverage, food and snack businesses that were part of our former AMENA segment are now reported together as our APAC segment and our beverage, food and snack businesses in Europe are now reported as our Europe segment. These changes did not impact our FLNA, QFNA, PBNA or LatAm reportable segments or our consolidated financial results. Our historical segment reporting presented in this report has been retrospectively revised to reflect the new organizational structure. We are organized into seven reportable segments (also referred to as divisions), as follows: 1) FLNA, which includes our branded food and snack businesses in the United States and Canada; 2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) PBNA, which includes our beverage businesses in the United States and Canada; 4) LatAm, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe, which includes all of our beverage, food and snack businesses in Europe; 6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the Middle East and South Asia; and 7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific, Australia and New Zealand and China region. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in the United States, Mexico, Russia, Canada, the United Kingdom, China and Brazil . The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: FLNA % % % QFNA % % % PBNA % % % LatAm % % % Europe % % % AMESA % % % APAC % % % Corporate unallocated expenses % % % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit 2019 (a) 2018 (a) FLNA $ 17,078 $ 16,346 $ 15,798 $ 5,258 $ 5,008 $ 4,793 QFNA 2,482 2,465 2,503 PBNA 21,730 21,072 20,936 2,179 2,276 2,700 LatAm 7,573 7,354 7,208 1,141 1,049 Europe 11,728 10,973 10,522 1,327 1,256 1,199 AMESA 3,651 3,657 3,674 APAC 2,919 2,794 2,884 Total division 67,161 64,661 63,525 11,597 11,506 11,446 Corporate unallocated expenses ( 1,306 ) ( 1,396 ) ( 1,170 ) Total $ 67,161 $ 64,661 $ 63,525 $ 10,291 $ 10,110 $ 10,276 (a) Our primary performance obligation is the distribution and sales of beverage products and food and snack products to our customers, with our food and snack business representing approximately 55 % of our consolidated net revenue. Internationally, LatAms food and snack business is approximately 90 % of the segments net revenue, Europes beverage business and food and snack business are approximately 55 % and 45 % , respectively, of the segments net revenue, AMESAs beverage business and food and snack business are approximately 40 % and 60 % , respectively, of the segments net revenue and APACs beverage business and food and snack business are approximately 25 % and 75 % , respectively, of the segments net revenue. Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our PBNA and Europe segments, is approximately 40 % of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. See Note 2 for further information. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 7,519 $ 6,577 $ 1,227 $ $ QFNA PBNA 31,449 29,878 1,053 LatAm 7,007 6,458 Europe 17,814 16,887 AMESA 3,672 3,252 APAC 4,113 3,704 Total division 72,515 67,626 4,016 3,132 2,883 Corporate (a) 6,032 10,022 Total $ 78,547 $ 77,648 $ 4,232 $ 3,282 $ 2,969 (a) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2019 , the change in assets was primarily due to a decrease in cash and cash equivalents and restricted cash. Refer to the cash flow statement for additional information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA PBNA LatAm Europe AMESA APAC Total division 2,196 2,144 2,107 Corporate Total $ $ $ $ 2,351 $ 2,330 $ 2,301 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 38,644 $ 37,148 $ 36,546 $ 30,601 $ 29,169 Mexico 4,190 3,878 3,650 1,666 1,404 Russia 3,263 3,191 3,232 4,314 3,926 Canada 2,831 2,736 2,691 2,695 2,565 United Kingdom 1,723 1,743 1,650 China 1,300 1,164 Brazil 1,295 1,335 1,427 All other countries 13,915 13,466 13,366 12,134 11,660 Total $ 67,161 $ 64,661 $ 63,525 $ 53,532 $ 50,631 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. As a result of the implementation of the revenue recognition guidance adopted in the first quarter of 2018, which did not have a material impact on our accounting policies, we recorded an adjustment in the first quarter of 2018 of $ 137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition. In addition, starting in 2018, we excluded from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions. The impact of these taxes previously recognized in net revenue and cost of sales was approximately $ 75 million for the fiscal year ended December 30, 2017, with no impact on operating profit. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, write-off history, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2019 , sales to Walmart and its affiliates (including Sams) represented approximately 13 % of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year, as products are delivered, for the expected payout, which may occur after year end once reconciled and settled. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer and consumer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $ 272 million as of December 28, 2019 and $ 218 million as of December 29, 2018 are included in prepaid expenses and other current assets and other assets on our balance sheet. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual consolidated financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $ 4.7 billion in 2019 , $ 4.2 billion in 2018 and $ 4.1 billion in 2017 , including advertising expenses of $ 3.0 billion in 2019 , $ 2.6 billion in 2018 and $ 2.4 billion in 2017 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $ 55 million and $ 47 million as of December 28, 2019 and December 29, 2018 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $ 10.9 billion in 2019 , $ 10.5 billion in 2018 and $ 9.9 billion in 2017 . Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (1) external direct costs of materials and services utilized in developing or obtaining computer software, (2) compensation and related benefits for employees who are directly associated with the software projects and (3) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $ 166 million in 2019 , $ 204 million in 2018 and $ 224 million in 2017 . Net capitalized software and development costs were $ 572 million and $ 577 million as of December 28, 2019 and December 29, 2018 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $ 711 million , $ 680 million and $ 737 million in 2019 , 2018 and 2017 , respectively, and are reported within selling, general and administrative expenses. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment for indefinite lived-intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates (including perpetuity growth assumptions) and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. A deterioration in these assumptions could adversely impact our results. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 4 for further information. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7. Financial Instruments Note 9. Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or, in limited instances, last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2018, the Financial Accounting Standards Board (FASB) issued guidance related to the TCJ Act for the optional reclassification of the residual tax effects, arising from the change in corporate tax rate, in accumulated other comprehensive loss to retained earnings. The reclassification is the difference between the amount previously recorded in other comprehensive income at the historical U.S. federal tax rate that remains in accumulated other comprehensive loss at the time the TCJ Act was effective and the amount that would have been recorded using the newly enacted rate. This guidance became effective during the first quarter of 2019; however, we did not elect to make the optional reclassification. In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. Under this guidance, certain of our derivatives used to hedge commodity price risk that did not previously qualify for hedge accounting treatment can now qualify prospectively. We adopted this guidance during the first quarter of 2019; the adoption did not have a material impact on our consolidated financial statements or disclosures. See Note 9 for further information. In 2016, the FASB issued guidance on leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet, but does not change the manner in which expenses are recorded in the income statement. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The two permitted transition methods under the guidance are the modified retrospective transition approach, which requires application of the guidance for all comparative periods presented, and the cumulative effect adjustment approach, which requires prospective application at the adoption date. We utilized a comprehensive approach to assess the impact of this guidance on our consolidated financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. We completed our comprehensive review of our lease portfolio, including significant leases by geography and by asset type that were impacted by the new guidance, and enhanced our controls. In addition, we implemented a new software platform, and corresponding controls, for administering our leases and facilitating compliance with the new guidance. We adopted the guidance prospectively during the first quarter of 2019. As part of our adoption, we elected not to reassess historical lease classification, recognize short-term leases on our balance sheet, nor separate lease and non-lease components for our real estate leases. In addition, we utilized the portfolio approach to group leases with similar characteristics and did not use hindsight to determine lease term. The adoption did not have a material impact on our consolidated financial statements, resulting in an increase of 2 % to each of our total assets and total liabilities on our balance sheet, and had an immaterial increase to retained earnings as of the beginning of 2019. See Note 13 for further information. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2019, the FASB issued guidance to simplify the accounting for income taxes. The guidance primarily addresses how to (1) recognize a deferred tax liability after we transition to or from the equity method of accounting, (2) evaluate if a stepup in the tax basis of goodwill is related to a business combination or is a separate transaction, (3) recognize all the effects of a change in tax law in the period of enactment, including adjusting the estimated annual tax rate, and (4) include the amount of tax based on income in the income tax provision and any incremental amount as a tax not based on income for hybrid tax regimes. The guidance is effective in the first quarter of 2021 with early adoption permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements and the timing of adoption. In 2016, the FASB issued guidance that changes the impairment model used to measure credit losses for most financial assets. For our trade, certain other receivables and certain other financial instruments, we will be required to use a new forward-looking expected credit loss model that will replace the existing incurred credit loss model, which would generally result in earlier recognition of allowances for credit losses. We will adopt the guidance when it becomes effective in the first quarter of 2020. The guidance is not expected to have a material impact on our consolidated financial statements or disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2019 Productivity Plan $ $ $ 2014 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 86 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; and simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this plan, we expect to incur pre-tax charges of approximately $ 2.5 billion and cash expenditures of approximately $ 1.6 billion . These pre-tax charges are expected to consist of approximately 70 % of severance and other employee-related costs, 15 % for asset impairments (all non-cash) resulting from plant closures and related actions, and 15 % for other costs associated with the implementation of our initiatives. We expect to complete this plan by 2023. The total expected plan pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA PBNA LatAm Europe AMESA APAC Corporate Expected pre-tax charges % % % % % % % % A summary of our 2019 Productivity Plan charges is as follows: Cost of sales $ $ Selling, general and administrative expenses Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ After-tax amount $ $ Net income attributable to PepsiCo per common share $ 0.21 $ 0.08 Plan to Date through 12/28/2019 FLNA $ $ $ QFNA PBNA LatAm Europe AMESA APAC Corporate Other pension and retiree medical benefits expense Total $ $ $ Plan to Date through 12/28/2019 Severance and other employee costs $ Asset impairments Other costs (a) Total $ (a) Includes other costs associated with the implementation of our initiatives, including contract termination costs, consulting and other professional fees. A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total 2018 restructuring charges $ $ $ $ Non-cash charges and translation ( 32 ) ( 32 ) Liability as of December 29, 2018 2019 restructuring charges Cash payments (a) ( 138 ) ( 119 ) ( 257 ) Non-cash charges and translation ( 92 ) ( 70 ) Liability as of December 28, 2019 $ $ $ $ (a) Excludes cash expenditures of $ 4 million reported in the cash flow statement in pension and retiree medical contributions. Substantially all of the restructuring accrual at December 28, 2019 is expected to be paid by the end of 2020 . 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, included the next generation of productivity initiatives that we believed would strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the plan through the end of 2019 to take advantage of additional opportunities within the initiatives described above that further strengthened our beverage, food and snack businesses. The 2014 Productivity Plan was completed in 2019. In 2019, there were no material pre-tax charges related to this plan and all cash payments were paid at year end. The total plan pre-tax charges and cash expenditures approximated the previously disclosed plan estimates of $ 1.3 billion and $ 960 million , respectively. These total plan pre-tax charges consisted of 59 % of severance and other employee costs, 15 % of asset impairments and 26 % of other costs, including costs associated with the implementation of our initiatives, including certain consulting and other contract termination costs. These total plan pre-tax charges were incurred by division as follows: FLNA 14 % , QFNA 3 % , PBNA 29 % , LatAm 15 % , Europe 23 % , AMESA 3 % , APAC 3 % and Corporate 10 % . A summary of our 2014 Productivity Plan charges is as follows: Selling, general and administrative expenses $ $ Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ After-tax amount $ $ Net income attributable to PepsiCo per common share $ 0.10 $ 0.16 FLNA $ $ QFNA PBNA LatAm Europe AMESA APAC (a) ( 5 ) Corporate (b) ( 1 ) Total $ $ (a) Income amount primarily reflects a gain on the sale of property, plant and equipment. (b) Income amount primarily relates to other pension and retiree medical benefits. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 31, 2016 $ $ $ $ 2017 restructuring charges ( 6 ) (a) Cash payments ( 91 ) ( 22 ) ( 113 ) Non-cash charges and translation ( 65 ) ( 21 ) ( 52 ) Liability as of December 30, 2017 2018 restructuring charges Cash payments (b) ( 203 ) ( 52 ) ( 255 ) Non-cash charges and translation ( 4 ) ( 28 ) ( 27 ) Liability as of December 29, 2018 Cash payments ( 77 ) ( 16 ) ( 93 ) Non-cash charges and translation ( 14 ) ( 7 ) ( 21 ) Liability as of December 28, 2019 $ $ $ $ (a) Income amount represents adjustments for changes in estimates and a gain on the sale of property, plant, and equipment. (b) Excludes cash expenditures of $ 11 million reported in the cash flow statement in pension and retiree medical plan contributions. Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,130 $ 1,078 Buildings and improvements 15 - 44 9,314 8,941 Machinery and equipment, including fleet and software 5 - 15 29,390 27,715 Construction in progress 3,169 2,430 43,003 40,164 Accumulated depreciation ( 23,698 ) ( 22,575 ) Total $ 19,305 $ 17,589 Depreciation expense $ 2,257 $ 2,241 $ 2,227 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Amortizable intangible assets, net Acquired franchise rights 56 60 $ $ ( 158 ) $ $ $ ( 140 ) $ Reacquired franchise rights 5 14 ( 105 ) ( 105 ) Brands 20 40 1,326 ( 1,066 ) 1,306 ( 1,032 ) Other identifiable intangibles (a) 10 24 ( 326 ) ( 288 ) Total $ 3,088 $ ( 1,655 ) $ 1,433 $ 3,209 $ ( 1,565 ) $ 1,644 Amortization expense $ $ $ (a) The change from 2018 to 2019 primarily reflects revisions to the purchase price allocation for our acquisition of SodaStream. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 28, 2019 and using average 2019 foreign exchange rates, is expected to be as follows: Five-year projected amortization $ $ $ $ $ Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . We did not recognize any material impairment charges for indefinite-lived intangible assets in each of the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . As of December 28, 2019 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at PBNA exceeded their carrying values. However, there could be an impairment of the carrying value of PBNAs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of PBNAs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there were no impairments for the year ended December 28, 2019 . However, there could be an impairment of the carrying value of certain brands in these countries, including juice and dairy brands in Russia, if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows (including perpetuity growth assumptions), if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For further information on our policies for indefinite-lived intangible assets, see Note 2. The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2018 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2018 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2019 FLNA Goodwill $ $ $ ( 11 ) $ $ ( 3 ) $ $ Brands ( 2 ) Total ( 13 ) ( 3 ) QFNA Goodwill ( 1 ) Brands ( 14 ) Total ( 8 ) ( 1 ) PBNA (a) Goodwill 9,854 ( 41 ) 9,813 9,898 Reacquired franchise rights 7,126 ( 68 ) 7,058 7,089 Acquired franchise rights 1,525 ( 15 ) 1,510 1,517 Brands ( 8 ) Total 18,858 ( 124 ) 18,734 19,267 LatAm Goodwill ( 46 ) ( 8 ) Brands ( 14 ) ( 2 ) Total ( 60 ) ( 10 ) Europe (b) (c) Goodwill 3,202 ( 367 ) 3,361 3,961 Reacquired franchise rights ( 1 ) ( 51 ) Acquired franchise rights ( 25 ) ( 9 ) ( 4 ) Brands 2,545 1,993 ( 350 ) 4,188 ( 139 ) 4,181 Total 6,491 2,493 ( 777 ) 8,207 8,804 AMESA Goodwill ( 2 ) Total ( 2 ) APAC Goodwill ( 34 ) Brands ( 10 ) ( 1 ) Total ( 44 ) ( 1 ) Total goodwill 14,744 ( 499 ) 14,808 15,501 Total reacquired franchise rights 7,675 ( 1 ) ( 119 ) 7,555 7,594 Total acquired franchise rights 1,720 ( 25 ) ( 24 ) 1,671 1,674 Total brands 3,175 2,156 ( 376 ) 4,955 5,342 Total $ 27,314 $ 2,693 $ ( 1,018 ) $ 28,989 $ $ $ 30,111 (a) The change in acquisitions/(divestitures) in 2019 is primarily related to our acquisition of CytoSport Inc. (b) The change in acquisitions/(divestitures) in 2019 and 2018 is primarily related to our acquisition of SodaStream. See Note 14 for further information. (c) The change in translation and other in 2019 primarily reflects the appreciation of the Russian ruble. The change in translation and other in 2018 primarily reflects the depreciation of the Russian ruble, euro and Pound sterling. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 4,123 $ 3,864 $ 3,452 Foreign 5,189 5,325 6,150 $ 9,312 $ 9,189 $ 9,602 The provision for/(benefit from) income taxes consisted of the following: Current: U.S. Federal $ $ $ 4,925 Foreign State 1,655 5,785 Deferred: U.S. Federal ( 1,159 ) Foreign ( 31 ) ( 4,379 ) ( 9 ) State ( 9 ) ( 4,248 ) ( 1,091 ) $ 1,959 $ ( 3,370 ) $ 4,694 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 21.0 % 21.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 1.6 0.5 0.9 Lower taxes on foreign results ( 0.9 ) ( 2.2 ) ( 9.4 ) One-time mandatory transition tax - TCJ Act ( 0.1 ) 0.1 41.4 Remeasurement of deferred taxes - TCJ Act ( 0.4 ) ( 15.9 ) International reorganizations ( 47.3 ) Tax settlements ( 7.8 ) Other, net ( 0.6 ) ( 0.6 ) ( 3.1 ) Annual tax rate 21.0 % ( 36.7 )% 48.9 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35 % to 21 % , effective January 1, 2018. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $ 2.5 billion ( $ 1.70 per share) in the fourth quarter of 2017. Included in the provisional net tax expense of $ 2.5 billion recognized in 2017, was a provisional mandatory one-time transition tax of approximately $ 4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $ 1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate , effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. The provisional measurement period allowed by the SEC ended in the fourth quarter of 2018. As a result, in 2018, we recognized a net tax benefit of $ 28 million ( $ 0.02 per share) related to the TCJ Act, primarily reflecting the impact of the final analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries, partially offset by additional transition tax guidance issued by the United States Department of Treasury, as well as the TCJ Act impact of both the conclusion of certain international tax audits and the resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, each discussed below. While our accounting for the recorded impact of the TCJ Act was deemed to be complete, additional guidance issued by the IRS impacted, and may continue to impact, our recorded amounts after December 29, 2018. In 2019, we recognized a net tax benefit totaling $ 8 million ( $ 0.01 per share) related to the TCJ Act, including the impact of additional guidance issued by the IRS in the first quarter of 2019 and adjustments related to the filing of our 2018 U.S. federal tax return. As of December 28, 2019 , our mandatory transition tax liability was $ 3.3 billion , which must be paid through 2026 under the provisions of the TCJ Act. We reduced our liability through cash payments and application of tax overpayments by $ 663 million in 2019 and $ 150 million in 2018. We currently expect to pay approximately $ 0.1 billion of this liability in 2020 . The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (GILTI), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. Other Tax Matters On May 19, 2019, a public referendum held in Switzerland passed the TRAF , effective January 1, 2020. The enactment of certain provisions of the TRAF in 2019 resulted in adjustments to our deferred taxes. During 2019 , we recorded net tax expense of $ 24 million related to the impact of the TRAF. Enactment of the TRAF provisions subsequent to December 28, 2019 is expected to result in adjustments to our consolidated financial statements and related disclosures in future periods. The future impact of the TRAF cannot currently be reasonably estimated; we will continue to monitor and assess the impact the TRAF may have on our business and financial results. In 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $ 4.3 billion ( $ 3.05 per share) in 2018. The related deferred tax asset of $ 4.4 billion is being amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Deferred tax liabilities and assets are comprised of the following: Deferred tax liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,583 1,303 Recapture of net operating losses Right-of-use assets Other Gross deferred tax liabilities 3,008 2,366 Deferred tax assets Net carryforwards 4,168 4,353 Intangible assets other than nondeductible goodwill Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Lease liabilities Other Gross deferred tax assets 6,875 6,984 Valuation allowances ( 3,599 ) ( 3,753 ) Deferred tax assets, net 3,276 3,231 Net deferred tax assets $ ( 268 ) $ ( 865 ) A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 3,753 $ 1,163 $ 1,110 Provision ( 124 ) 2,639 Other (deductions)/additions ( 30 ) ( 49 ) Balance, end of year $ 3,599 $ 3,753 $ 1,163 Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2018 2014-2016 Mexico 2017-2018 None United Kingdom 2017-2018 Canada (Domestic) 2015-2018 2015-2016 Canada (International) 2010-2018 2010-2016 Russia 2016-2018 None In 2018, we recognized a non-cash tax benefit of $ 364 million ( $ 0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, in 2018, we recognized non-cash tax benefits of $ 353 million ( $ 0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. The conclusion of certain international tax audits and the resolution with the IRS, collectively, resulted in non-cash tax benefits totaling $ 717 million ( $ 0.50 per share) in 2018. Our annual tax rate is based on our income, statutory tax rates and tax planning strategies and transactions, including transfer pricing arrangements, available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit, new tax laws or tax authority settlements. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. As of December 28, 2019 , the total gross amount of reserves for income taxes, reported in other liabilities, was $ 1.4 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $ 250 million as of December 28, 2019 , of which $ 84 million of tax expense was recognized in 2019 . The gross amount of interest accrued, reported in other liabilities, was $ 179 million as of December 29, 2018 , of which $ 64 million of tax benefit was recognized in 2018 . A reconciliation of unrecognized tax benefits is as follows: Balance, beginning of year $ 1,440 $ 2,212 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years ( 201 ) ( 822 ) Settlement payments ( 74 ) ( 233 ) Statutes of limitations expiration ( 47 ) ( 42 ) Translation and other ( 14 ) Balance, end of year $ 1,395 $ 1,440 Carryforwards and Allowances Operating loss carryforwards totaling $ 24.7 billion at year-end 2019 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $ 0.2 billion in 2020 , $ 20.3 billion between 2021 and 2039 and $ 4.2 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In 2018, we repatriated $ 20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability, related to the TCJ Act. As of December 28, 2019 , we had approximately $ 6 billion of undistributed international earnings. We intend to continue to reinvest $ 6 billion of earnings outside the United States for the foreseeable future and while future distribution of these earnings would not be subject to U.S. federal tax expense, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and are granted 66 % PSUs and 34 % long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 28, 2019 , 59 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense and excess tax benefits recognized: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring charges ( 2 ) ( 6 ) ( 2 ) Total (a) $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ $ $ (b) Excess tax benefits related to share-based compensation $ $ $ (a) Primarily recorded in selling, general and administrative expenses. (b) Reflects tax rates effective for the 2017 tax year. As of December 28, 2019 , there was $ 284 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years . Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years . Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 5 years 5 years Risk-free interest rate 2.4 % 2.6 % 2.0 % Expected volatility % % % Expected dividend yield 3.1 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 28, 2019 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 29, 2018 15,589 $ 79.94 Granted 1,286 $ 118.33 Exercised ( 4,882 ) $ 67.34 Forfeited/expired ( 368 ) $ 94.30 Outstanding at December 28, 2019 11,625 $ 89.03 4.68 $ 563,942 Exercisable at December 28, 2019 7,972 $ 78.27 3.13 $ 472,512 Expected to vest as of December 28, 2019 3,364 $ 112.25 8.04 $ 85,066 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs and PSUs are measured at the market price of the Companys stock on the date of grant. A summary of our RSU and PSU activity for the year ended December 28, 2019 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 29, 2018 7,175 $ 105.13 Granted (b) 2,754 $ 116.87 Converted ( 2,642 ) $ 99.35 Forfeited ( 852 ) $ 111.11 Actual performance change (c) ( 55 ) $ 108.32 Outstanding at December 28, 2019 (d) 6,380 $ 111.53 1.22 $ 877,487 Expected to vest as of December 28, 2019 5,876 $ 111.32 1.19 $ 808,220 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 28, 2019 , at the threshold, target and maximum award levels were zero , 0.7 million and 1.3 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three-year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model, which incorporates into the fair-value determination the possibility that the market condition may not be satisfied, until actual performance is determined. PEPunits were last granted in 2015 and all 248,000 units outstanding at December 30, 2017, with a weighted average grant date fair value of $ 68.94 , were converted to 278,000 shares in 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model. A summary of our long-term cash activity for the year ended December 28, 2019 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 29, 2018 $ 54,710 Granted (b) 16,112 Vested ( 15,438 ) Forfeited ( 9,465 ) Actual performance change (c) ( 1,695 ) Outstanding at December 28, 2019 (d) $ 44,224 $ 45,875 1.10 Expected to Vest at December 28, 2019 $ 42,998 $ 44,557 1.10 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Reflects the net number of long-term cash awards above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding long-term cash awards for which the performance period has not ended as of December 28, 2019 , at the threshold, target and maximum award levels were zero , 28.5 million and 57.1 million, respectively . Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,286 1,429 1,481 Weighted-average grant-date fair value of options granted $ 10.89 $ 9.80 $ 8.25 Total intrinsic value of options exercised (a) $ 275,745 $ 224,663 $ 327,860 Total grant-date fair value of options vested (a) $ 9,838 $ 15,506 $ 23,122 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,754 2,634 2,824 Weighted-average grant-date fair value of RSUs/PSUs granted $ 116.87 $ 108.75 $ 109.92 Total intrinsic value of RSUs/PSUs converted (a) $ 333,951 $ 260,287 $ 380,269 Total grant-date fair value of RSUs/PSUs vested (a) $ 275,234 $ 232,141 $ 264,923 PEPunits Total intrinsic value of PEPunits converted (a) $ $ 30,147 $ 39,782 Total grant-date fair value of PEPunits vested (a) $ $ 9,430 $ 18,833 (a) In thousands. As of December 28, 2019 and December 29, 2018 , there were approximately 269,000 and 248,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans In 2019, Plan A purchased a group annuity contract whereby a third-party insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. This transaction triggered a pre-tax settlement charge in 2019 of $ 220 million ( $ 170 million after-tax or $ 0.12 per share). Also in 2019, certain former employees who had vested benefits in our U.S. defined benefit pension plans were offered the option of receiving a one-time lump sum payment equal to the present value of the participants pension benefit. This transaction triggered a pre-tax settlement charge in 2019 of $ 53 million ( $ 41 million after-tax or $ 0.03 per share). Collectively, the group annuity contract and one-time lump sum payments to certain former employees who had vested benefits resulted in settlement charges in 2019 of $ 273 million ( $ 211 million after-tax or $ 0.15 per share). Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in other pension and retiree medical benefits (expense)/income for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years ) and retiree medical (approximately 8 years ), or the remaining life expectancy for participants in Plan I (approximately 23 years ). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits (expense)/income on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 13,807 $ 14,777 $ 3,098 $ 3,490 $ $ 1,187 Service cost Interest cost Plan amendments Participant contributions Experience loss/(gain) 2,091 ( 972 ) ( 230 ) ( 147 ) Benefit payments ( 341 ) ( 956 ) ( 100 ) ( 114 ) ( 105 ) ( 108 ) Settlement/curtailment ( 1,268 ) ( 74 ) ( 31 ) ( 35 ) Special termination benefits Other, including foreign currency adjustment ( 204 ) ( 3 ) Liability at end of year $ 15,230 $ 13,807 $ 3,753 $ 3,098 $ $ Change in fair value of plan assets Fair value at beginning of year $ 12,258 $ 12,582 $ 3,090 $ 3,460 $ $ Actual return on plan assets 3,101 ( 789 ) ( 136 ) ( 21 ) Employer contributions/funding 1,495 Participant contributions Benefit payments ( 341 ) ( 956 ) ( 100 ) ( 114 ) ( 105 ) ( 108 ) Settlement ( 1,266 ) ( 74 ) ( 31 ) ( 32 ) Other, including foreign currency adjustment ( 210 ) Fair value at end of year $ 14,302 $ 12,258 $ 3,732 $ 3,090 $ $ Funded status $ ( 928 ) $ ( 1,549 ) $ ( 21 ) $ ( 8 ) $ ( 686 ) $ ( 711 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities ( 52 ) ( 107 ) ( 1 ) ( 1 ) ( 58 ) ( 41 ) Other liabilities ( 1,620 ) ( 1,627 ) ( 119 ) ( 88 ) ( 628 ) ( 670 ) Net amount recognized $ ( 928 ) $ ( 1,549 ) $ ( 21 ) $ ( 8 ) $ ( 686 ) $ ( 711 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,516 $ 4,093 $ $ $ ( 285 ) $ ( 287 ) Prior service cost/(credit) ( 1 ) ( 32 ) ( 51 ) Total $ 3,630 $ 4,202 $ $ $ ( 317 ) $ ( 338 ) Changes recognized in net (gain)/loss included in other comprehensive loss Net (gain)/loss arising in current year $ ( 120 ) $ $ $ $ ( 24 ) $ ( 107 ) Amortization and settlement recognition ( 457 ) ( 187 ) ( 44 ) ( 56 ) Foreign currency translation loss/(gain) ( 49 ) ( 1 ) Total $ ( 577 ) $ $ $ ( 2 ) $ $ ( 98 ) Accumulated benefit obligation at end of year $ 14,255 $ 12,890 $ 3,441 $ 2,806 The net (gain)/loss arising in the current year is attributed to the change in discount rate, primarily offset by the actual asset returns different from expected returns. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International Service cost $ $ $ $ $ $ $ $ $ Other pension and retiree medical benefits expense/(income): Interest cost $ $ $ $ $ $ $ $ $ Expected return on plan assets ( 892 ) ( 943 ) ( 849 ) ( 188 ) ( 197 ) ( 176 ) ( 18 ) ( 19 ) ( 22 ) Amortization of prior service cost/(credits) ( 19 ) ( 20 ) ( 25 ) Amortization of net losses/(gains) ( 27 ) ( 8 ) ( 12 ) Settlement/curtailment losses (a) Special termination benefits Total other pension and retiree medical benefits expense/(income) $ $ ( 235 ) $ ( 189 ) $ ( 47 ) $ ( 51 ) $ ( 23 ) $ ( 28 ) $ ( 12 ) $ ( 21 ) Total $ $ $ $ $ $ $ ( 5 ) $ $ (a) In 2019, U.S. includes settlement charges related to the purchase of a group annuity contract of $ 220 million and a pension lump sum settlement charge of $ 53 million . The following table provides the weighted-average assumptions used to determine projected benefit liability and net periodic benefit cost for our pension and retiree medical plans: Pension Retiree Medical U.S. International Liability discount rate 3.3 % 4.4 % 3.7 % 2.5 % 3.4 % 3.0 % 3.1 % 4.2 % 3.5 % Service cost discount rate 4.4 % 3.8 % 4.5 % 4.2 % 3.5 % 3.6 % 4.3 % 3.6 % 4.0 % Interest cost discount rate 4.1 % 3.4 % 3.7 % 3.2 % 2.8 % 2.8 % 3.8 % 3.0 % 3.2 % Expected return on plan assets 7.1 % 7.2 % 7.5 % 5.8 % 6.0 % 6.0 % 6.6 % 6.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.3 % 3.7 % 3.7 % Expense rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.7 % 3.6 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ ( 9,194 ) $ ( 8,040 ) $ ( 192 ) $ ( 155 ) Fair value of plan assets $ 8,497 $ 7,223 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ ( 10,169 ) $ ( 8,957 ) $ ( 632 ) $ ( 514 ) $ ( 988 ) $ ( 996 ) Fair value of plan assets $ 8,497 $ 7,223 $ $ $ $ Of the total projected pension benefit liability as of December 28, 2019 , approximately $ 847 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2025 - 2029 Pension $ $ $ $ $ $ 5,275 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2020 through 2024 and approximately $ 4 million in total for 2025 through 2029. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ $ 1,417 $ $ $ $ Non-discretionary Total $ $ 1,615 $ $ $ $ (a) Includes $ 400 million contribution in 2019 and $ 1.4 billion contribution in 2018 to fund Plan A in the United States. In January 2020 , we made discretionary contributions of $ 150 million to Plan A in the United States. In addition, in 2020 , we expect to make non-discretionary contributions of approximately $ 150 million to our U.S. and international pension benefit plans and approximately $ 60 million for retiree medical benefits. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2020 and 2019 , our expected long-term rate of return on U.S. plan assets is 6.8 % and 7.1 % , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of year-end 2019 and 2018 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 6,605 $ 6,605 $ $ $ 5,605 Government securities (c) 2,154 2,154 1,674 Corporate bonds (c) 4,737 4,737 4,145 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 13,939 $ 6,880 $ 7,050 $ 11,860 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 14,604 $ 12,543 International plan assets Equity securities (b) $ 1,973 $ 1,941 $ $ $ 1,651 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 3,532 $ 2,349 $ 1,141 $ 2,981 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,732 $ 3,090 (a) 2019 and 2018 amounts include $ 302 million and $ 285 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The commingled funds are based on the published price of the fund and the U.S. commingled funds include one large-cap fund that represents 16 % and 15 % of total U.S. plan assets for 2019 and 2018 , respectively. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 28 % of total U.S. plan assets for both 2019 and 2018 . (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 28, 2019 and December 29, 2018 . (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Base d on the published price of the fund. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase 106 These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2019 , 2018 and 2017 , our total Company contributions were $ 197 million , $ 180 million and $ 176 million , respectively. Note 8 Debt Obligations The following table summarizes our debt obligations: 2019 (a) 2018 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 2,848 $ 3,953 Other borrowings (6.4% and 6.0%) $ 2,920 $ 4,026 Long-term debt obligations (b) Notes due 2019 (3.1%) 3,948 Notes due 2020 (2.7% and 3.9%) 2,840 3,784 Notes due 2021 (2.4% and 3.1%) 3,276 3,257 Notes due 2022 (2.7% and 2.8%) 3,831 3,802 Notes due 2023 (2.8% and 2.9%) 1,272 1,270 Notes due 2024 (3.4% and 3.2%) 1,839 1,816 Notes due 2025-2049 (3.4% and 3.7%) 18,910 14,345 Other, due 2019-2026 (1.3% and 1.3%) 31,996 32,248 Less: current maturities of long-term debt obligations ( 2,848 ) ( 3,953 ) Total $ 29,148 $ 28,295 (a) Amounts are shown net of unamortized net discounts of $ 163 million and $ 119 million for 2019 and 2018 , respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for further information regarding our interest rate derivative instruments. As of December 28, 2019 , our international debt of $ 69 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2019 , we issued the following senior notes: Interest Rate Maturity Date Amount (a) 0.750 % March 2027 (b) 1.125 % March 2031 (b) 2.625 % July 2029 $ 1,000 3.375 % July 2049 $ 1,000 0.875 % October 2039 (b) 2.875 % October 2049 $ 1,000 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. (b) These notes, issued in euros, were designated as net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. The net proceeds from the issuances of the above notes were used for general corporate purposes, including the repayment of commercial paper, except for an amount equivalent to the net proceeds from our 2.875 % senior notes due 2049 that will be used to fund, in whole or in part, eligible green projects in the categories of investments in sustainable plastics and packaging, decarbonizing our operations and supply chain and water sustainability, which promote our selected Sustainable Development Goals, as defined by the United Nations. In 2019, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 3, 2024. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, including a $ 0.75 billion swing line subfacility for euro-denominated borrowings permitted to be borrowed on a same-day basis, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. In 2019, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 1, 2020. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $ 3.75 billion in U.S. dollars and/or euros, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $ 4.5 billion (or the equivalent amount in euros). We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $ 3.75 billion five-year credit agreement and our $ 3.75 billion 364-day credit agreement, both dated as of June 4, 2018. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 28, 2019 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2019, we entered into two unsecured bridge loan facilities (Bridge Loan Facilities) which together enable one of our consolidated subsidiaries to borrow up to 25.0 billion South African rand, or approximately $ 1.8 billion , to provide potential funding for our acquisition of Pioneer Foods. Each facility is available from the date the conditions precedent are met for the acquisition up through July 30, 2020 in the case of one facility and July 31, 2020 in the case of the other facility. Borrowings under the facilities are for up to one year once drawn and can be prepaid at any time. Interest rates are reset either every one month or three months. As of December 28, 2019, there were no outstanding borrowings under the Bridge Loan Facilities. In 2019, we paid $ 1.0 billion to redeem all $ 1.0 billion outstanding principal amount of our 4.50 % senior notes due 2020. In 2018, we completed a cash tender offer for certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $ 1.6 billion in cash to redeem the following amounts: Interest Rate Maturity Date Amount Tendered 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ 4.875 % November 2040 $ 5.500 % January 2040 $ Also in 2018, we completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for the following newly issued PepsiCo notes. These notes were issued in an aggregate principal amount equal to the exchanged notes: Interest Rate Maturity Date Amount Exchanged 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $ 253 million ( $ 191 million after-tax or $ 0.13 per share) to interest expense in 2018, primarily representing the tender price paid over the carrying value of the tendered notes. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. The accounting for qualifying hedges allows changes in a hedging instruments fair value to offset corresponding changes in the hedged item in the same reporting period that the hedged item impacts earnings. Gains or losses on derivatives designated as cash flow hedges are recorded in accumulated other comprehensive loss and reclassified to our income statement when the hedged transaction affects earnings. If it becomes probable that the hedged transaction will not occur, we immediately recognize the related hedging gains or losses in earnings; such gains or losses reclassified during the year ended December 28, 2019 were not material. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Certain of our agreements with our counterparties require us to post full collateral on derivative instruments in a net liability position if our credit rating is at A2 (Moodys Investors Service, Inc.) or A (SP Global Ratings) and we have been placed on credit watch for possible downgrade or if our credit rating falls below these levels. The fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position on December 28, 2019 was $ 415 million . We have posted no collateral under these contracts and no credit-risk-related contingent features were triggered as of December 28, 2019. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years , to hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for energy, agricultural products and metals . Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $ 1.1 billion as of December 28, 2019 and December 29, 2018 . Foreign Exchange We are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years . Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $ 1.9 billion as of December 28, 2019 and $ 2.0 billion as of December 29, 2018 . The total notional amount of our debt instruments designated as net investment hedges was $ 2.5 billion as of December 28, 2019 and $ 0.9 billion as of December 29, 2018 . For foreign currency derivatives that do not qualify for hedge accounting treatment, gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our cross-currency interest rate swaps have terms of no more than twelve years . Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $ 5.0 billion as of December 28, 2019 and $ 10.5 billion as of December 29, 2018 . As of December 28, 2019 , approximately 9 % of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 29 % as of December 29, 2018 . Available-for-Sale Securities Investments in debt securities are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale debt securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 28, 2019 and December 29, 2018 were not material. Changes in the fair value of available-for-sale debt securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We recorded no other-than-temporary impairment charges on our available-for-sale debt securities for the years ended December 28, 2019 , December 29, 2018 and December 30, 2017 . In 2017, we recorded a pre-tax gain of $ 95 million ( $ 85 million after-tax or $ 0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. The gain on the sale of this equity investment was recorded in our Europe segment in selling, general and administrative expenses. Fair Value Measurements The fair values of our financial assets and liabilities as of December 28, 2019 and December 29, 2018 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale debt securities (b) $ $ $ 3,658 $ Short-term investments (c) $ $ $ $ Prepaid forward contracts (d) $ $ $ $ Deferred compensation (e) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) $ $ $ $ Interest rate (g) Commodity (h) Commodity (i) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (g) $ $ $ $ Commodity (h) Commodity (i) $ $ $ $ Total derivatives at fair value (j) $ $ $ $ Total $ $ $ 3,931 $ 1,018 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 29, 2018 , these debt securities were primarily classified as cash equivalents. The decrease in available-for-sale debt securities was due to maturities and sales during the current year. (c) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (d) Based primarily on the price of our common stock. (e) Based on the fair value of investments corresponding to employees investment elections. (f) Based on LIBOR forward rates. As of December 28, 2019 and December 29, 2018 , the carrying amount of hedged fixed-rate debt was $ 2.2 billion and $ 7.7 billion , respectively, and classified on our balance sheet within short-term and long-term debt obligations. As of December 28, 2019, the cumulative amount of fair value hedging adjustments to hedged fixed-rate debt was $ 5 million . As of December 28, 2019 , the cumulative amount of fair value hedging adjustments on discontinued hedges was a $ 49 million loss, which is being amortized over the remaining life of the related debt obligations. (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 28, 2019 and December 29, 2018 were not material. Collateral received or posted against our asset or liability positions is classified as restricted cash. See Note 15 for further information. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 28, 2019 and December 29, 2018 was $ 34 billion and $ 32 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ ( 1 ) $ $ $ ( 52 ) $ $ ( 8 ) Interest rate ( 64 ) Commodity ( 17 ) Net investment ( 30 ) ( 77 ) Total $ ( 82 ) $ $ $ ( 16 ) $ $ (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $ 47 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 7,314 $ 12,515 $ 4,857 Preferred stock: Redemption premium (b) ( 2 ) ( 4 ) Net income available for PepsiCo common shareholders $ 7,314 1,399 $ 12,513 1,415 $ 4,853 1,425 Basic net income attributable to PepsiCo per common share $ 5.23 $ 8.84 $ 3.40 Net income available for PepsiCo common shareholders $ 7,314 1,399 $ 12,513 1,415 $ 4,853 1,425 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other (c) Employee stock ownership plan (ESOP) convertible preferred stock Diluted $ 7,314 1,407 $ 12,515 1,425 $ 4,857 1,438 Diluted net income attributable to PepsiCo per common share $ 5.20 $ 8.78 $ 3.38 (a) Weighted-average common shares outstanding (in millions). (b) See Note 11 for further information. (c) The dilutive effect of these securities is calculated using the treasury stock method. Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.3 0.7 0.4 Average exercise price per option $ 117.55 $ 109.83 $ 110.12 (a) In millions. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. As of December 30, 2017, there were 3 million shares of convertible preferred stock authorized, 803,953 preferred shares issued and 114,753 shares outstanding. The outstanding preferred shares had a fair value of $ 68 million as of December 30, 2017. Activities of our preferred stock are included in the equity statement. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 31, 2016 (a) $ ( 11,386 ) $ $ ( 2,645 ) $ $ ( 35 ) $ ( 13,919 ) Other comprehensive (loss)/income before reclassifications (b) 1,049 ( 375 ) Amounts reclassified from accumulated other comprehensive loss ( 171 ) ( 99 ) ( 112 ) Net other comprehensive (loss)/income 1,049 ( 41 ) ( 217 ) ( 74 ) Tax amounts Balance as of December 30, 2017 (a) ( 10,277 ) ( 2,804 ) ( 4 ) ( 19 ) ( 13,057 ) Other comprehensive (loss)/income before reclassifications (c) ( 1,664 ) ( 61 ) ( 813 ) ( 2,532 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income ( 1,620 ) ( 595 ) ( 2,159 ) Tax amounts ( 21 ) ( 10 ) Balance as of December 29, 2018 (a) ( 11,918 ) ( 3,271 ) ( 19 ) ( 15,119 ) Other comprehensive (loss)/income before reclassifications (d) ( 131 ) ( 89 ) ( 2 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income ( 117 ) ( 2 ) Tax amounts ( 8 ) ( 96 ) ( 77 ) Balance as of December 28, 2019 (a) $ ( 11,290 ) $ ( 3 ) $ ( 2,988 ) $ $ ( 19 ) $ ( 14,300 ) (a) Pension and retiree medical amounts are net of taxes of $ 1,280 million as of December 31, 2016 , $ 1,338 million as of December 30, 2017 , $ 1,466 million as of December 29, 2018 and $ 1,370 million as of December 28, 2019 . (b) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. (c) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. (d) Currency translation adjustment primarily reflects the appreciation of the Russian ruble, Canadian dollar, Mexican peso and Pound sterling. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Divestitures $ $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ $ ( 1 ) $ Net revenue Foreign exchange contracts ( 7 ) Cost of sales Interest rate derivatives ( 184 ) Interest expense Commodity contracts Cost of sales Commodity contracts ( 3 ) ( 1 ) Selling, general and administrative expenses Net losses/(gains) before tax ( 171 ) Tax amounts ( 2 ) ( 27 ) Net losses/(gains) after tax $ $ $ ( 107 ) Pension and retiree medical items: Amortization of net prior service credit $ ( 9 ) $ ( 17 ) $ ( 24 ) Other pension and retiree medical benefits (expense)/income Amortization of net losses Other pension and retiree medical benefits (expense)/income Settlement/curtailment losses Other pension and retiree medical benefits (expense)/income Net losses before tax Tax amounts ( 102 ) ( 45 ) ( 44 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ $ $ ( 99 ) Selling, general and administrative expenses Tax amount Net gain after tax $ $ $ ( 89 ) Total net losses/(gains) reclassified for the year, net of tax $ $ $ ( 82 ) Note 13 L eases Lessee We determine whether an arrangement is a lease at inception. We have operating leases for plants, warehouses, distribution centers, storage facilities, offices and other facilities, as well as machinery and equipment, including fleet. Our leases generally have remaining lease terms of up to 20 years , some of which include options to extend the lease term for up to five years , and some of which include options to terminate the lease within one year . We consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We have lease agreements that contain both lease and non-lease components. For real estate leases, we account for lease components together with non-lease components (e.g., common-area maintenance). Components of lease cost are as follows: Operating lease cost (a) $ Variable lease cost (b) $ Short-term lease cost (c) $ (a) Includes right-of-use asset amortization of $ 412 million . (b) Primarily related to adjustments for inflation, common-area maintenance and property tax. (c) Not recorded on our balance sheet. In 2019, we recognized gains of $ 77 million on sale-leaseback transactions with terms under four years. Supplemental cash flow information and non-cash activity related to our operating leases are as follows: Operating cash flow information: Cash paid for amounts included in the measurement of lease liabilities $ Non-cash activity: Right-of-use assets obtained in exchange for lease obligations $ Supplemental balance sheet information related to our operating leases is as follows: Balance Sheet Classification Right-of-use assets Other assets $ 1,548 Current lease liabilities Accounts payable and other current liabilities $ Non-current lease liabilities Other liabilities $ 1,118 Weighted-average remaining lease term and discount rate for our operating leases are as follows: Weighted-average remaining lease term 6 years Weighted-average discount rate % Maturities of lease liabilities by year for our operating leases are as follows: $ 2021 2022 2023 2024 2025 and beyond Total lease payments 1,763 Less: Imputed interest ( 203 ) Present value of lease liabilities $ 1,560 As of December 29, 2018, minimum lease payments under non-cancelable operating leases by period were expected to be as follows: $ 2020 2021 2022 2023 2024 and beyond Total $ 1,840 A summary of rent expense for the years ended December 29, 2018 and December 30, 2017 is as follows: Rent expense $ $ Lessor We have various arrangements for certain foodservice and vending equipment under which we are the lessor. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material. Note 14 Acquisitions and Divestitures Acquisition of Pioneer Food Group Ltd. On July 19, 2019, we entered into an agreement to acquire all of the outstanding shares of Pioneer Foods, a food and beverage company in South Africa with exports to countries across the globe , for 110.00 South African rand per share in cash, in a transaction valued at approximately $ 1.7 billion . Also in 2019, one of our consolidated subsidiaries entered into Bridge Loan Facilities to provide potential funding for our acquisition of Pioneer Foods. See Note 8 for further information. The transaction is subject to certain regulatory approvals and other customary conditions and is expected to be recorded primarily in the AMESA segment. Closing is expected in the first half of 2020. Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $ 144.00 per share in cash, in a transaction valued at approximately $ 3.3 billion . The total consideration transferred was approximately $ 3.3 billion (or $ 3.2 billion , net of cash and cash equivalents acquired). We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The purchase price allocation was finalized in the fourth quarter of 2019. The following table summarizes the fair value of identifiable assets acquired and liabilities assumed in the acquisition of SodaStream and the resulting goodwill as of the acquisition date, all of which are recorded in the Europe segment. Inventories $ Property, plant and equipment Amortizable intangible assets Nonamortizable intangible asset (brand) 1,840 Other assets and liabilities Net deferred income taxes ( 303 ) Total identifiable net assets $ 2,400 Goodwill Total purchase price $ 3,343 Goodwill is calculated as the excess of the aggregate of the fair value of the consideration transferred over the fair value of the net assets recognized. The goodwill recorded as part of the acquisition of SodaStream primarily reflects the value of expected synergies from our product portfolios and is not deductible for tax purposes. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 144 million ( $ 126 million after-tax or $ 0.09 per share) in selling, general and administrative expenses in our APAC segment as a result of this transaction. Refranchising in Czech Republic, Hungary, and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in CHS. We recorded a pre-tax gain of $ 58 million ( $ 46 million after-tax or $ 0.03 per share) in selling, general and administrative expenses in our Europe segment as a result of this transaction. Refranchising in Jordan In 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $ 140 million ( $ 107 million after-tax or $ 0.07 per share) in selling, general and administrative expenses in our AMESA segment as a result of this transaction. Inventory Fair Value Adjustments and Merger and Integration Charges In 2019, we recorded inventory fair value adjustments and merger and integration charges of $ 55 million ( $ 47 million after-tax or $ 0.03 per share), including $ 46 million in our Europe segment, $ 7 million in our AMESA segment and $ 2 million in corporate unallocated expenses. These charges are primarily related to fair value adjustments to the acquired inventory included in SodaStreams balance sheet at the acquisition date, recorded in cost of sales, as well as merger and integration charges, including employee-related costs, recorded in selling, general and administrative expenses. In 2018, we recorded merger and integration charges of $ 75 million ( $ 0.05 per share), including $ 57 million in our Europe segment and $ 18 million in corporate unallocated expenses, related to our acquisition of SodaStream, recorded in selling, general and administrative expenses. These charges include closing costs, advisory fees and employee-related costs. Note 15 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 6,447 $ 6,079 Other receivables 1,480 1,164 Total 7,927 7,243 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) ( 30 ) ( 33 ) ( 35 ) Other (b) ( 11 ) Allowance, end of year $ Net receivables $ 7,822 $ 7,142 Inventories (c) Raw materials and packaging $ 1,395 $ 1,312 Work-in-process Finished goods 1,743 1,638 Total $ 3,338 $ 3,128 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Right-of-use assets (e) 1,548 Other Total $ 3,011 $ Accounts payable and other current liabilities Accounts payable $ 8,013 $ 7,213 Accrued marketplace spending 2,765 2,541 Accrued compensation and benefits 1,835 1,755 Dividends payable 1,351 1,329 SodaStream consideration payable 1,997 Current lease liabilities (e) Other current liabilities 3,077 3,277 Total $ 17,541 $ 18,112 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 7 % and 5 % of the inventory cost in 2019 and 2018 , respectively, were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for further information. (e) See Note 13 for further information. Statement of Cash Flows Interest paid (a) $ 1,076 $ 1,388 $ 1,123 Income taxes paid, net of refunds (b) $ 2,226 $ 1,203 $ 1,962 (a) In 2018, excludes the premiums paid in accordance with the debt transactions discussed in Note 8. (b) In 2019 and 2018, includes tax payments of $ 423 million and $ 115 million , respectively, related to the TCJ Act. The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. Cash and cash equivalents $ 5,509 $ 8,721 Restricted cash (a) 1,997 Restricted cash included in other assets (b) Total cash and cash equivalents and restricted cash $ 5,570 $ 10,769 (a) In 2018, primarily represents consideration held by our paying agent in connection with our acquisition of SodaStream. (b) Primarily relates to collateral posted against our derivative asset or liability positions. Note 16 Selected Quarterly Financial Data (unaudited) Selected financial data for 2019 and 2018 is summarized as follows and highlights certain items that impacted our quarterly results: First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter Net revenue $ 12,884 $ 16,449 $ 17,188 $ 20,640 $ 12,562 $ 16,090 $ 16,485 $ 19,524 Gross profit $ 7,196 $ 9,045 $ 9,494 $ 11,294 $ 6,907 $ 8,827 $ 8,958 $ 10,588 Operating profit $ 2,008 $ 2,729 $ 2,855 $ 2,699 $ 1,807 $ 3,028 $ 2,844 $ 2,431 Mark-to-market net impact (a) $ $ ( 6 ) $ ( 4 ) $ $ ( 31 ) $ $ ( 29 ) $ ( 106 ) Restructuring and impairment charges (b) $ ( 26 ) $ ( 158 ) $ ( 98 ) $ ( 88 ) $ ( 12 ) $ ( 32 ) $ ( 35 ) $ ( 229 ) Inventory fair value adjustments and merger and integration charges (c) $ ( 15 ) $ ( 24 ) $ ( 7 ) $ ( 9 ) $ ( 75 ) Pension-related settlement charges (d) $ ( 273 ) Net tax related to the TCJ Act (e) $ $ ( 21 ) $ ( 1 ) $ ( 777 ) $ ( 76 ) $ Gains on sale of assets (f) $ $ $ $ $ $ Other net tax benefits (g) $ $ $ 4,386 Charges related to cash tender and exchange offers (h) $ ( 253 ) Tax reform bonus (i) $ ( 87 ) Gains on beverage refranchising (j) $ $ Provision for/(benefit from) income taxes (e)(f) $ $ $ $ $ $ 1,070 $ $ ( 4,932 ) Net income attributable to PepsiCo $ 1,413 $ 2,035 $ 2,100 $ 1,766 $ 1,343 $ 1,820 $ 2,498 $ 6,854 Net income attributable to PepsiCo per common share Basic $ 1.01 $ 1.45 $ 1.50 $ 1.27 $ 0.94 $ 1.28 $ 1.77 $ 4.86 Diluted $ 1.00 $ 1.44 $ 1.49 $ 1.26 $ 0.94 $ 1.28 $ 1.75 $ 4.83 Cash dividends declared per common share $ 0.9275 $ 0.955 $ 0.955 $ 0.955 $ 0.805 $ 0.9275 $ 0.9275 $ 0.9275 (a) Mark-to-market net gains and losses on commodity derivatives in corporate unallocated expenses. (b) Expenses related to the 2019 and 2014 Productivity Plans. See Note 3 to our consolidated financial statements for further information. (c) In 2019, inventory fair value adjustments and merger and integration charges primarily related to our acquisition of SodaStream. In 2018, merger and integration charges related to our acquisition of SodaStream. See Note 14 to our consolidated financial statements for further information. (d) In 2019, pension settlement charges of $ 220 million related to the purchase of a group annuity contract and settlement charges of $ 53 million related to one-time lump sum payments to certain former employees who had vested benefits , recorded in other pension and retiree medical benefits expense/income. See Note 7 to our consolidated financial statements for further information. (e) Net tax related to the TCJ Act. See Note 5 to our consolidated financial statements for further information. (f) In 2019, gains associated with the sale of assets in the following segments: $ 31 million in FLNA and $ 46 million in PBNA. In 2018, gains associated with the sale of assets in the following segments: $ 64 million in PBNA and $ 12 million in AMESA. (g) In 2018, other net tax benefits of $ 4.3 billion resulting from the reorganization of our international operations, including the intercompany transfer of certain intangible assets. Also in 2018, non-cash tax benefits of $ 717 million associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. See Note 5 to our consolidated financial statements for further information. (h) In 2018, interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements for further information. (i) In 2018, bonus extended to certain U.S. employees related to the TCJ Act in the following segments: $ 44 million in FLNA, $ 2 million in QFNA and $ 41 million in PBNA. (j) In 2018, gains of $ 58 million and $ 144 million associated with refranchising our entire beverage bottling operations and snack distribution operations in CHS in the Europe segment and refranchising a portion of our beverage business in Thailand in the APAC segment, respectively. See Note 14 to our consolidated financial statements for further information. Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (the Company) as of December 28, 2019 and December 29, 2018 , and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 28, 2019 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 28, 2019 , based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2019 and December 29, 2018 , and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 28, 2019 , in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2019 , based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of certain sales incentive accruals As discussed in Note 2 of the consolidated financial statements, the Company offers sales incentives and discounts through various programs to customers and consumers. A number of the sales incentives are based on annual targets, resulting in the need to accrue for the expected liability. These incentives are accrued for in the Accounts payable and other current liabilities line on the balance sheet. These accruals are based on sales incentive agreements, expectations regarding customer and consumer participation and performance levels, and historical experience and trends. We identified the evaluation of certain of the Companys sales incentive accruals as a critical audit matter. Subjective and complex auditor judgment is required in evaluating these sales incentive accruals as a result of the timing difference between when the product is delivered and when the incentive is settled. This specifically related to (1) forecasted customer and consumer participation and performance level assumptions underlying the accrual, and (2) the impact of historical experience and trends. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys sales incentive process, including (1) the accrual methodology, (2) assumptions around forecasted customer and consumer participation, (3) performance levels, and (4) monitoring of actual sales incentives incurred compared to estimated sales incentives in respect of historical periods. To evaluate the timing and amount of certain accrued sales incentives we (1) analyzed the accrual by sales incentive type as compared to historical trends to identify specific sales incentives that may require additional testing, (2) recalculated expenses and closing accruals on a sample basis, based on volumes sold and terms of the sales incentives, (3) assessed the Companys ability to accurately estimate its sales incentive accrual by comparing previously established accruals to actual settlements, and (4) tested a sample of settlements or claims that occurred after period end, and compared them to the recorded sales incentive accrual. Assessment of the carrying value of certain reacquired and acquired franchise rights and certain juice and dairy brands As discussed in Notes 2 and 4 to the consolidated financial statements, the Company performs impairment testing of its indefinite-lived intangible assets on an annual basis during the third quarter of each fiscal year and whenever events and changes in circumstances indicate that there is a greater than 50% likelihood that the asset is impaired. The carrying value of indefinite-lived intangible assets as of December 28, 2019 was $30.1 billion which represents 38% of total assets, and includes PepsiCo Beverages North Americas (PBNA) reacquired and acquired franchise rights which had a carrying value of $8.6 billion as of December 28, 2019. We identified the assessment of the carrying value of PBNAs reacquired and acquired franchise rights and certain of Europes juice and dairy brands in Russia as a critical audit matter. Significant auditor judgment is necessary to assess the impact of competitive operating and macroeconomic factors on future levels of sales, operating profit and cash flows. The impairment analysis of these indefinite-lived intangible assets requires significant auditor judgment to evaluate the Companys forecasted revenue and profitability levels, including the expected long-term growth rates and the selection of the discount rates to be applied to the projected cash flows. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys indefinite-lived assets impairment process to develop the forecasted revenue, profitability levels, and expected long-term growth rates and select the discount rates to be applied to the projected cash flows. We also evaluated the sensitivity of the Companys conclusion to changes in assumptions, including the assessment of changes in assumptions from prior periods. To assess the Companys ability to accurately forecast, we compared the Companys historical forecasted results to actual results. We compared the cash flow projections used in the impairment tests with available external industry data and other internal information. We involved valuation professionals with specialized skills and knowledge who assisted in evaluating (1) the long-term growth rates used in the impairment tests by comparing against economic data and information specific to the respective assets, including projected long-term nominal Gross Domestic Product growth in the respective local countries, and (2) the discount rates used in the impairment tests by comparing them against discount rates that were independently developed using publicly available market data, including that of comparable companies. Evaluation of unrecognized tax benefits As discussed in Note 5 to the consolidated financial statements, the Companys global operating model gives rise to income tax obligations in the United States and in certain foreign jurisdictions in which it operates. As of December 28, 2019, the Company recorded reserves for unrecognized tax benefits of $1.4 billion . The Company establishes reserves if it believes that certain positions taken in its tax returns are subject to challenge and the Company likely will not succeed, even though the Company believes the tax return position is supportable under the tax law. The Company adjusts these reserves, as well as the related interest, in light of new information, such as the progress of a tax examination, or new tax law or tax authority settlements. We identified the evaluation of the Companys unrecognized tax benefits as a critical audit matter because the application of tax law and interpretation of a tax authoritys settlement history is complex and involves subjective judgment. Such judgments impact both the timing and amount of the reserves that are recognized, including judgments about re-measuring liabilities for positions taken in prior years tax returns in light of new information. The primary procedures that we performed to address this critical audit matter included the following. We tested certain internal controls over the Companys unrecognized tax benefits process, including controls to (1) identify uncertain income tax positions, (2) evaluate the tax law and tax authoritys settlement history used to estimate the unrecognized tax benefits, and (3) monitor for new information that may give rise to changes to the existing unrecognized tax benefits, such as progress of a tax examination, new tax law or tax authority settlements. We involved tax and valuation professionals with specialized skills and knowledge, who assisted in assessing the unrecognized tax benefits by (1) evaluating the Companys tax structure and transactions, including transfer pricing arrangements, and (2) assessing the Companys interpretation of existing tax law as well as new and amended tax laws, tax positions taken, and associated external counsel opinions. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 13, 2020 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees . Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending, plus sales of property, plant and equipment . Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net impact : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, foreign exchange translation and, when applicable, the impact of the 53 rd reporting week. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for further information. Starting in 2018, our reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of these taxes previously recognized in net revenue. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 28, 2019 . Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth quarter of 2019 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity plan, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +3,peps,201810-k," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into six reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) North America Beverages (NAB), which includes our beverage businesses in the United States and Canada; 4) Latin America, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe Sub-Saharan Africa (ESSA), which includes all of our beverage, food and snack businesses in Europe and Sub-Saharan Africa; and 6) Asia, Middle East and North Africa (AMENA), which includes all of our beverage, food and snack businesses in Asia, Middle East and North Africa. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oat squares, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. North America Beverages Either independently or in conjunction with third parties, NAB makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mountain Dew, Pepsi, Propel, Sierra Mist and Tropicana. NAB also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, NAB manufactures and distributes certain brands licensed from Keurig Dr Pepper Inc., including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). NAB operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. NAB also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, Latin America makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi, Pepsi Black and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Europe Sub-Saharan Africa Either independently or in conjunction with third parties, ESSA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, ESSA operates its own bottling plants and distribution facilities. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, ESSA makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. In December 2018, we acquired SodaStream International Ltd. (SodaStream), a manufacturer and distributor of sparkling water makers. SodaStream products are included within ESSAs beverage business. See Note 14 to our consolidated financial statements for additional information about our acquisition of SodaStream. Asia, Middle East and North Africa Either independently or in conjunction with third parties, AMENA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMENA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi, Sting and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMENA operates its own bottling plants and distribution facilities. AMENA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, we license the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. Our products are also available on a growing number of e-commerce websites and mobile commerce applications as consumer consumption patterns continue to change and retail increasingly expands online. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it globally. See Note 9 to our consolidated financial statements for additional information on how we manage our exposure to commodity costs. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including 1893, Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Arto Lifewater, Aunt Jemima, Bare, bubly, Capn Crunch, Cheetos, Chesters, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet Sierra Mist, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Health Warrior, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Ice, Mountain Dew Kickstart, Mug, Munchies, Naked, Near East, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Black, Pepsi Max, Pepsi Next, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Sierra Mist, Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SodaStream, Sonrics, Stacys, Sting, Stubborn Soda, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Farmstand, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks, Muscle Milk protein shakes and various Keurig Dr Pepper Inc. brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. For instance, our beverage sales are higher during the warmer months and certain food and dairy sales are higher in the cooler months. Weekly beverage and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2018 , sales to Walmart Inc. (Walmart), including Sams Club (Sams), represented approximately 13% of our consolidated net revenue. Our top five retail customers represented approximately 33% of our 2018 net revenue in North America, with Walmart (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2018 , we and The Coca-Cola Company represented approximately 22% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, the effectiveness of our advertising campaigns, marketing programs, product packaging, pricing, increased efficiency in production techniques, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, dispensing equipment, packaging technology (including investments in recycling-focused technologies), package design (including development of sustainable, bio-based packaging) and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of sweetener alternatives and flavor modifiers and innovation in existing sweeteners, further expanding our beyond the bottle portfolio (including through our acquisition of SodaStream) and offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; and improvements in energy efficiency and efforts focused on reducing our impact on the environment. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to develop nutritious and convenient beverages, foods and snacks. In 2018 , we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our state-of-the-art food and beverage healthy vending initiative to increase the availability of convenient and affordable nutrition; further expanding our portfolio of nutritious products by building on our important nutrition platforms and brands Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies), KeVita (probiotics, tonics and fermented teas), Bare (baked apple chips and other baked produce) and Health Warrior (nutrition bars); further expanding our whole grain products globally; and further expanding our portfolio of nutritious products in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water in our agricultural supply chain), and by incorporating improvements in the sustainability and resources of our agricultural supply chain into our operations; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to support increased packaging recovery, recycling rates and the amount of recycled content in our packaging; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers; and efforts to optimize packaging technology and design to minimize the amount of plastic in our packaging, and make our packaging increasingly recoverable or recyclable with lower environmental impact, including continuing to invest in developing compostable and biodegradable packaging. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; customs and foreign trade laws and regulations, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws regulating the sale of certain of our products in schools; and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are also subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, international trade and tariffs, occupational health and safety, competition, anti-corruption and data privacy, including the European Union General Data Protection Regulation. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. In addition, certain jurisdictions have either imposed or are considering imposing regulations designed to increase recycling rates or encourage waste reduction. These regulations vary in scope and form from deposit return systems designed to incentivize the return of beverage containers, to extended producer responsibility policies and even bans on the use of some plastic beverage bottles and other single-use plastics. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated onsite and sent to third-party owned and operated offsite licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 29, 2018 , we and our consolidated subsidiaries employed approximately 267,000 people worldwide, including approximately 114,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K, including the Managements Discussion and Analysis of Financial Condition and Results of Operations section and the consolidated financial statements and related notes. Any of the factors described below could occur or continue to occur and could have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and may also adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results, financial and business performance, events or trends. Demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics could result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers, including through e-commerce and hard discounters); or the location of origin or source of ingredients and products (including the environmental impact related to production of our products). Consumer preferences have been evolving, and are expected to continue to evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending, consumption and purchasing habits; consumer concerns or perceptions regarding the nutrition profile of products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic or locally sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including single-use and other plastic packaging, and their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or our respective social media posts, business practices or other information disseminated by or regarding them or us; product boycotts; or a downturn in economic conditions. Any of these factors may reduce consumers willingness to purchase our products and any inability on our part to anticipate or react to such changes could result in reduced demand for our products or erode our competitive and financial position and could adversely affect our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories (through acquisitions, such as SodaStream, and innovation, such as increasing non-carbonated beverage offerings and other alternatives to, or reformulations of, carbonated beverage offerings); respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients and packaging materials (including to respond to applicable regulations); develop sweetener alternatives and innovation; increase the recyclability or recoverability of our packaging; improve the production and distribution of our products; respond to competitive product and pricing pressures and changes in distribution channels, including in the e-commerce channel; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including correctly anticipating or effectively reacting to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively market or distribute our products could reduce demand for our products, result in inventory write-offs and erode our competitive and financial position and could adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to the use or disposal of plastics or other packaging of our products could continue to increase our costs, reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our food and beverage products are sold in plastic or other packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to low value, lack of infrastructure or otherwise. In addition, certain of our packaging may currently not be recyclable, compostable or biodegradable. There is a growing concern with the accumulation of plastic and other packaging waste in the environment, particularly in the worlds oceans and waterways. As a result, our branded packaging waste could result in negative publicity (whether or not valid) or reduce consumer demand and overall consumption of our products, which could adversely affect our business, financial condition or results of operations. In response to these concerns, the United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to increase the sustainability of packaging, encourage waste reduction and increase recycling rates or facilitate the waste management process or restricting the sale of products in certain packaging. These regulations vary in scope and form from taxes or fees designed to incentivize behavior to restrictions or bans on certain products and materials. For example, the state of California is one of 10 states in the United States that have a bottle deposit return system in effect, which requires a deposit charged to consumers to incentivize the return of the beverage container. In addition, 26 markets in the European Union have established extended producer responsibility policies, which make manufacturers such as us responsible for the costs of recycling products after consumers have used them. Further, certain jurisdictions are considering imposing other types of regulations or policies, including packaging taxes, requirements for bottle caps to be tethered to the plastic bottle, minimum recycled content mandates, which would require packaging to include a certain percentage of post-consumer recycled material in a new package, and even bans on the use of some plastic beverage bottles and other single-use plastics. These laws and regulations, whatever their scope or form, could increase the cost of our products, reduce consumer demand and overall consumption of our products or result in negative publicity (whether or not valid), which could adversely affect our business, financial condition or results of operations. While we continue to devote significant resources to increase the recyclability and sustainability of our packaging, the increased focus on reducing plastic waste may require us to increase capital expenditures, including requiring additional investments to minimize the amount of plastic across our packaging; increase the amount of recycled content in our packaging; and develop sustainable, bio-based packaging as a replacement for fossil fuel-based plastic packaging, including flexible film alternatives for our snacks packaging. Our failure to minimize our plastics use, increase the amount of recycled content in our packaging or develop sustainable packaging or consumers failure to accept such sustainable packaging could reduce consumer demand and overall consumption of our products and erode our competitive and financial position. Further, our reputation could be damaged for failure to achieve our sustainability goals with respect to our plastics use, including our goal to use 25% recycled content in our plastic packaging by 2025, or if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations could adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, packaging, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to differing regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold, as is the packaging, disposal and recyclability of our products. For example, five provinces in Canada, covering most of the Canadian market, have established extended producer responsibility policies, which make manufacturers such as us responsible for the costs of recycling products after consumers have used them. In addition, these laws and regulations and related interpretations may change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes may include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices, including restrictions on the audience to whom products are marketed; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements or changing interpretations thereof, and differing or competing regulations and standards across the markets where our products are made, manufactured, distributed or sold, may result in higher compliance costs, capital expenditures and higher production costs, which could adversely affect our business, reputation, financial condition or results of operations. The imposition of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product, production, recovery or recycling requirements, or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products, commodities used in the production of our products or use, disposal, recovery or recyclability of our products and their packaging, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, which could adversely affect our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions may follow. For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing may result in decreased demand for our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) have been and continue to be underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products or packaging materials, such as 4-MeI, acrylamide, caffeine, glyphosate, furfuryl alcohol, added sugars, sodium, saturated fat and plastic. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and foods high in sugar, sodium or saturated fat. If, as a result of these studies and documents or otherwise, there is an increase in consumer concerns (whether or not valid) about the health implications of consumption of certain of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, demand for our products could decline, or we could be subject to lawsuits or new regulations that could affect sales of our products, any of which could adversely affect our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business could take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or could fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Failure to comply with such laws or regulations could subject us to criminal or civil enforcement actions, including fines, injunctions, product recalls, penalties, disgorgement of profits or activity restrictions, any of which could adversely affect our business, reputation, financial condition or results of operations. In addition, regulatory authorities under whose laws we operate may have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, which could have an adverse effect on the sales of products in our portfolio or could lead to damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. For example, effective January 2018, the City of Seattle, Washington in the United States enacted a per-ounce surcharge on all sugar-sweetened beverages. By contrast, France revised an existing flat tax to become a graduated tax, effective July 2018, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per-ounce tax rate, while Saudi Arabia enacted, effective June 2017, a flat tax rate of 50%, and Jordan increased, effective January 2018, its flat tax from 10% to 20%, on the retail price of carbonated soft drinks. These tax measures, whatever their scope or form, could increase the cost of our products, reduce consumer demand and overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may reduce demand for such products and could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers and economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, Campbell Soup Company, Conagra Brands, Inc., Kellogg Company, Keurig Dr Pepper Inc., The Kraft Heinz Company, Link Snacks, Inc., Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A. and Red Bull GmbH. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective, if our competitors spend more aggressively than we do or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which may adversely affect our business, financial condition or results of operations. Failure to realize anticipated benefits from our productivity initiatives or operating model could have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies, including implementing shared business service organizational models. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement productivity initiatives that we believe will position our business for long-term sustainable growth by allowing us to achieve a lower cost structure and operate more efficiently in the highly competitive beverage, food and snack categories and markets. We are also continuing to implement our initiatives to improve efficiency, decision making, innovation and brand management across our global organization to enable us to compete more effectively. Further, in order to continue to capitalize on our cost reduction efforts and operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. Some of these measures could yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to continue to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, which could adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold may be difficult to predict and may adversely affect our business, financial condition and results of operations. The results of elections, referendums or other political conditions (including government shutdowns) in these markets could impact how existing laws, regulations and government programs or policies are implemented or create uncertainty as to how such laws, regulations and government programs or policies may change, including with respect to tariffs, sanctions, climate change regulation, taxes, benefit programs, the movement of goods, services and people between countries and other matters, and could result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty or adversely affect demand for our products. For example, the United Kingdoms pending withdrawal from the European Union (commonly referred to as Brexit) could lead to differing laws and regulations in the United Kingdom and European Union. Any changes in, or the imposition of new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions could have an adverse impact on our business, financial conditions and results of operations. Our business, financial condition or results of operations could be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences or otherwise. The following factors could reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; our inability to hire or retain a highly skilled workforce; imposition of new or increased tariffs and other impositions on imported goods or sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations or tariffs on the products of such corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions, tariffs or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly inflationary economies, devaluation or fluctuation, such as the devaluation of the Russian ruble, Turkish lira, Brazilian real, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or could significantly affect our ability to effectively manage our operations in certain of these markets and could result in the deconsolidation of such businesses, such as occurred with respect to our Venezuelan businesses which were deconsolidated at the end of the third quarter of 2015; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our business, reputation, financial condition or results of operations could be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and may, from time to time, continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results may be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly-inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, may limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; may leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or may result in a decline in the market value of our investments in debt securities, which could have an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, contract manufacturers, distributors and joint venture partners and could result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which could also have an adverse impact on our business, reputation, financial condition or results of operations. Our business and reputation could suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage and operate our facilities; to conduct research and development; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being carried out by groups and individuals (including criminal hackers, hacktivists, state-sponsored actors, criminal and terrorist organizations, individuals or groups participating in organized crime and insiders) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of computing resources, financial fraud, operational disruption, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and other credentials, unauthorized use of computing resources for digital currency mining and business email compromises. As with other global companies, we are regularly subject to cyberattacks, including many of the types of attacks described above. Although we may incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, lapses in our controls or the intentional or negligent actions of employees, or from deliberate cyberattacks such as malicious or disruptive software, denial of service attacks, malicious social engineering, hackers or otherwise), our business could be disrupted and we could, among other things, be subject to: transaction errors; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which could cause errors or delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or supply chain disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and those of our third-party providers, and the information stored therein could be compromised, including through cyberattacks or other external or internal methods, resulting in unauthorized parties accessing or extracting sensitive data or confidential information. Failure to comply with data privacy laws could result in litigation, claims, legal or regulatory proceedings, inquiries or investigations. We continue to devote significant resources to network security, backup and disaster recovery, enhancing our internal controls, and other security measures, including training, to protect our systems and data, but these security measures cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that may arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies could heighten these and other operational risks, as certain aspects of the security of such technologies may be complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that may arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. We and our business partners use various raw materials, energy, water and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oats, oranges and other fruits, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, water, animal welfare and human rights concerns and other risks associated with the global food system may lead to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and could adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake or flooding), disease or pests (including the impact of greening disease on the citrus industry), agricultural uncertainty, health epidemics or pandemics, governmental incentives and controls (including import/export restrictions, such as new or increased tariffs, sanctions, quotas or trade barriers), limited or sole sources of supply, political uncertainties, acts of terrorism, governmental instability or currency exchange rates. For example, in 2018, the United States imposed tariffs on steel and aluminum as well as on goods imported from China and certain other countries, which has resulted in retaliatory tariffs by China and other countries. Additional tariffs imposed by the United States on a broader range of imports, or further retaliatory trade measures taken by China or other countries in response, could result in an increase in supply chain costs that we may not be able to offset or otherwise adversely impact our results of operations. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs could adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality and increasing pressure to conserve water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; or damage to our reputation, any of which could adversely affect our business, financial condition or results of operations. Business disruptions could have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, distributors, joint venture partners and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations due to any of the following factors could impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power or water shortages; strikes, labor disputes or lack of availability of qualified personnel, such as truck drivers; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity could adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which could adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we could decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which could result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which could reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes could adversely affect our reputation or brands. Our business could also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts could materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image could adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image could be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals, including with respect to plastic packaging, or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, plastics or other packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, including the recyclability or recoverability of our packaging, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees engage in or are believed to have engaged in improper activities, we may be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, which may cause us to suffer damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information could also hurt our reputation. In addition, water is a limited resource in many parts of the world and demand for water continues to rise. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to water use. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, may also generate adverse publicity (whether or not valid) that could damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons could result in decreased demand for our products and could adversely affect our business, financial condition or results of operations, as well as require additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, could adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Potential issues associated with these activities could include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, including our recently completed acquisition of SodaStream, the following factors also pose potential risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees (both of the acquired company and our company); conforming standards, controls (including internal control over financial reporting and disclosure controls and procedures, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners may adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we may not be able to complete or effectively manage such transactions on terms commercially favorable to us or at all and may fail to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings may reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain may adversely impact our sales or business performance. If an acquisition or joint venture is not successfully completed, integrated into our existing operations or managed effectively, or if a divestiture or refranchising is not successfully completed or managed effectively or does not result in the benefits or cost savings we expect, our business, financial condition or results of operations may be adversely affected. A change in our estimates and underlying assumptions regarding the future performance of our businesses could result in an impairment charge, which could materially affect our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently if circumstances indicate that the carrying value may not be recoverable. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, could adversely affect our results of operations. Factors that could result in an impairment include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that may result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. Future impairment charges could have a significant adverse effect on our results of operations in the periods recognized. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction could reduce our after-tax income from such jurisdiction and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, in December 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the Internal Revenue Service (IRS) could impact our recorded amounts in future periods. For further information regarding the impact and potential impact of the TCJ Act, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations. For example, the Organization for Economic Cooperation and Development (OECD) has recommended changes to numerous long-standing international tax principles through its base erosion and profit shifting (BEPS) project. These changes, to the extent adopted, may increase tax uncertainty, result in higher compliance costs and adversely affect our provision for income taxes, results of operations and/or cash flow. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. In connection with the OECDs BEPS project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation could differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it could have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or to hire and retain a highly skilled and diverse workforce could deplete our institutional knowledge base and erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer could adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers could adversely affect our business, financial condition or results of operations. Disruption in the retail landscape, including rapid growth in hard discounters and the e-commerce channel, could adversely affect our business, financial condition or results of operations. Our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites, mobile commerce applications and subscription services as well as the integration of physical and digital operations among retailers. We continue to make significant investments in attracting talent to and building our global e-commerce capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which could adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce and hard discounters may result in consumer price deflation, which may affect our relationships with key retail customers. Further, the ability of consumers to compare prices on a real-time basis using digital technology puts additional pressure on us to maintain competitive prices. If these e-commerce and hard discounter retailers were to take significant market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, our ability to maintain and grow our profitability, share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers with increased purchasing power, which may impact our ability to compete in these areas. Such retailers may demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, could reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, could increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market could also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity could adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize information technology support services and administrative functions in certain areas of our business, including payroll processing, health and benefit plan administration and certain finance and accounting functions. We may enter into new or additional agreements for shared services in other functions in the future to achieve cost savings and efficiencies as we continue to migrate to shared business service organizational models across our business operations. In addition, we utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. If any of these third-party service providers or vendors do not perform effectively, or if we fail to adequately monitor their performance (including compliance with service level agreements or regulatory or legal requirements), we may not be able to achieve the expected cost savings, we may have to incur additional costs to correct errors made by such service providers, our reputation could be harmed or we could be subject to litigation, claims, legal or regulatory proceedings, inquiries or investigations. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, incorrect or adverse effects on financial reporting, litigation or remediation costs, or damage to our reputation, which could have a negative impact on employee morale. In addition, the management of multiple third-party service providers increases operational complexity and decreases our control. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which could result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and may continue to have, an adverse impact on our business, financial condition and results of operations. Climate change, water scarcity or legal, regulatory or market measures to address climate change or water scarcity may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, tornado, earthquake or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. The predicted effects of climate change may also exacerbate challenges regarding the availability and quality of water. As demand for water access continues to increase around the world, we may be subject to decreased availability of water, deteriorated quality of water or less favorable pricing for water, which could adversely impact our manufacturing and distribution operations. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency and water conservation, we may experience disruptions in, or significant increases in our costs of, operation and delivery and we may be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions could substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change or water scarcity could negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to water use and the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change or water scarcity could result in adverse publicity and could adversely affect our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact, water use and recyclability or recoverability of packaging, including plastic. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, could cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions could occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, could be reduced, which could have an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, could be reduced and there could be an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding could have an adverse impact on our business, reputation, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations could have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, may also require us to incur significant expense and devote significant resources, and may generate adverse publicity that may damage our reputation or brand image, which could have an adverse impact on our business, financial condition or results of operations. Many factors may adversely affect the price of our publicly traded securities. Many factors may adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, may include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, inquiries or investigations; changes in laws and regulations applicable to our products or business operations; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we may or may not take from time to time as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, may not have the impact we intend and may adversely affect the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, could adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2018 fiscal year and that remain unresolved. ," Item 2. Properties. Our principal executive offices located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products. The approximate number of such facilities utilized by each division is as follows: FLNA QFNA NAB Latin America ESSA AMENA Shared (a) Plants (b) Other Facilities (c) 1,660 (a) Shared properties are in addition to the other properties reported by our six divisions identified in this table. (b) Includes manufacturing and processing plants as well as bottling and production plants. (c) Includes warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities. Significant properties by division included in the table above are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. NABs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. Latin Americas three snack plants in Mexico (one in Vallejo, one in Celaya and one in Obregn) and one in Brazil (Sorocaba), all of which are owned. ESSAs snack plant in Leicester, United Kingdom, which is leased; its snack plant in Kashira, Russia, its fruit juice plant in Zeebrugge, Belgium, its beverage plant in Lebedyan, Russia and its dairy plant in Moscow, Russia, all of which are owned. AMENAs two beverage plants in Egypt (one in Tanta City and one in Sixth of October City) and its snack plant in Wuhan, China, all of which are owned; and its snack plant in Riyadh, Saudi Arabia, which is leased. Two concentrate plants in Cork, Ireland, which are shared by our NAB, ESSA and AMENA segments, both of which are owned; and one in Singapore, which is shared by our NAB and AMENA segments, which is leased. Shared service centers in Winston-Salem, North Carolina, and Plano, Texas, which are primarily shared by our FLNA, QFNA and NAB segments, both of which are leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. As previously disclosed, in April 2017, Corporacin Autnoma Regional de Cundinamarca, a Colombian environmental authority (the environmental authority), initiated an administrative proceeding regarding our subsidiary, PepsiCo Alimentos Z.F., Ltda. (PAZ), for allegedly delivering wastewater to a third party without first verifying that the third party had appropriate permits with respect to the discharge of such wastewater. In July 2018, the environmental authority initiated an administrative proceeding to impose a monetary sanction against PAZ with respect to the alleged permitting violation by the third party, and on August 13, 2018, PAZ submitted evidence of its defense to these allegations. If the environmental authority determines PAZ is responsible for the alleged permitting violations by the third party, the environmental authority may seek to impose monetary sanctions of up to $1.3 million, which PAZ would be entitled to appeal. In addition, we and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. Sanctions imposed by foreign authorities are levied in local currency and disclosed using the U.S. dollar equivalent at the time of imposition and are subject to currency fluctuations. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings The Nasdaq Global Select Market is the principal market for our common stock, which is also listed on the SIX Swiss Exchange. Shareholders As of February 8, 2019 , there were approximately 114,513 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 13, 2019, the Board of Directors declared a quarterly dividend of $0.9275 payable March 29, 2019, to shareholders of record on March 1, 2019. For the remainder of 2019, the dividend record dates for these payments are expected to be June 7, September 6 and December 6, 2019, subject to approval of the Board of Directors. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2018 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (b) 9/8/2018 $ 14,631 9/9/2018 - 10/6/2018 1.3 $ 112.64 1.3 (147 ) 14,484 10/7/2018 - 11/3/2018 1.3 $ 110.39 1.3 (145 ) 14,339 11/4/2018 - 12/1/2018 1.4 $ 116.68 1.4 (163 ) 14,176 12/2/2018 - 12/29/2018 0.8 $ 116.99 0.8 (92 ) Total 4.8 $ 113.91 4.8 $ 14,084 (a) All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs. (b) Represents shares authorized for repurchase under the $ 15 billion repurchase program authorized by our Board of Directors and publicly announced on February 13, 2018, which commenced on July 1, 2018 and will expire on June 30, 2021. Such shares may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Non-GAAP Measures Items Affecting Comparability Results of Operations Division Review Frito-Lay North America Quaker Foods North America North America Beverages Latin America Europe Sub-Saharan Africa Asia, Middle East and North Africa Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Restricted Cash Note 14 Acquisitions and Divestitures Note 15 Supplemental Financial Information Managements Responsibility for Financial Reporting Report of Independent Registered Public Accounting Firm GLOSSARY 43 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. At PepsiCo, we are focused on an approach called Winning with Purpose that will help make our company faster, stronger and better at meeting the needs of our customers, consumers, partners and communities, while caring for our planet and inspiring our associates. Our strategies are designed to address key challenges facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape. We intend to focus on the following areas to address and adapt to these challenges: Winning in the marketplace and accelerating growth by strengthening and broadening our portfolio, while focusing on locally meeting the needs of our consumers and customers; Continuing to implement our productivity initiatives to improve our operational efficiency and enhance our competitive advantage while continuing to transform our core capabilities with technology and building and retaining a talented workforce to drive cost savings; and Continuing to lead with purpose by focusing on our impact on the planet and our people, assisting in establishing a more sustainable food system, minimizing our impact on the environment, protecting human rights and securing supply while positioning our Company for sustainable growth. We believe these priorities will position our Company for long-term sustainable growth. See also Item 1A. Risk Factors for additional information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During 2018 and 2017 , certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging and encourage waste reduction and increased recycling rates. We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations. In addition, our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. In 2018, we recognized a net tax benefit of $28 million in connection with the TCJ Act. See further information in Items Affecting Comparability. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. For additional information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key public policy and sustainability matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors and the Audit Committee of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics and Law Departments lead and coordinate our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Item 1A. Risk Factors for further discussion of our market risks, and see Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017 . At the end of 2018 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2018 by $100 million . Foreign Exchange Our operations outside of the United States generated 43% of our consolidated net revenue in 2018 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our consolidated net revenue in 2018 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. During 2018 , unfavorable foreign exchange reduced net revenue growth by one percentage point due to declines in the Russian ruble, Turkish lira and Brazilian real. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, India, Mexico, the Middle East, Russia and Turkey, and currency fluctuations in certain of these international markets continue to result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, as well as the economic, operating and political environment in Russia, and the potential impact for the ESSA segment and our other businesses. Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017 . The total notional amount of our debt instruments designated as net investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017 . At the end of 2018 , we estimate that an unfavorable 10% change in the underlying exchange rates would have decreased our net unrealized gains in 2018 by $149 million . Interest Rates Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017 . Assuming year-end 2018 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have increased our net interest expense in 2018 by $7 million due to lower cash and cash equivalents and short-term investments levels as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures, except as otherwise noted, reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Volume Our beverage volume in the NAB, Latin America, ESSA and AMENA segments reflects sales to authorized bottlers, independent distributors and retailers, as well as the sale of beverages bearing Company-owned or licensed trademarks that have been sold through our authorized independent bottlers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our beverage revenues are not entirely based on BCS volume, as there are independent bottlers in the supply chain, we believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the consumer level. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. NAB, Latin America, ESSA and AMENA, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and NAB, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, AMENA licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Our food and snack volume in the FLNA, QFNA, Latin America, ESSA and AMENA segments is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2018 , total servings increased 1% compared to 2017 . In 2017 , total servings decreased 1% compared to 2016 . Excluding the impact of the 53 rd reporting week in 2016, total servings in 2017 was even with the prior year. Servings growth reflects adjustments to the prior year results for divestitures and other structural changes. Consolidated Net Revenue and Operating Profit Change Net revenue $ 64,661 $ 63,525 $ 62,799 % % Operating profit (a) $ 10,110 $ 10,276 $ 9,804 (2 )% % Operating profit margin (a) 15.6 % 16.2 % 15.6 % (0.5 ) 0.6 (a) In 2017 and 2016, operating profit and operating profit margin reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2018 Operating profit decreased 2% and operating profit margin declined 0.5 percentage points. The operating profit performance was driven by certain operating cost increases and a 6-percentage-point impact of higher commodity costs, partially offset by productivity savings of more than $1 billion and net revenue growth. The impact of refranchising a portion of our beverage business in Jordan in 2017 and a prior-year gain associated with the sale of our minority stake in Britvic negatively impacted operating profit performance by 2.5 percentage points. These impacts were offset by a 2-percentage-point positive impact of refranchising a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in 2018. Items affecting comparability (see Items Affecting Comparability) negatively impacted operating profit performance by 3 percentage points and decreased operating profit margin by 0.5 percentage points, primarily due to higher mark-to-market net impact on commodity derivatives included in corporate unallocated expenses. 2017 Operating profit increased 5% and operating profit margin improved 0.6 percentage points. Operating profit growth was driven by productivity savings of more than $1 billion and effective net pricing, partially offset by certain operating cost increases, a 7-percentage-point impact of higher commodity costs and unfavorable foreign exchange. The impact of refranchising a portion of our beverage business in Jordan and a gain associated with the sale of our minority stake in Britvic each contributed 1 percentage point to operating profit growth. Items affecting comparability (see Items Affecting Comparability) also contributed 2 percentage points to operating profit growth and increased operating profit margin by 0.2 percentage points, primarily reflecting a prior-year impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value. Other Consolidated Results Change Other pension and retiree medical benefits income/(expense) (a) $ $ $ (19 ) $ $ Net interest expense $ (1,219 ) $ (907 ) $ (1,232 ) $ (312 ) $ Annual tax rate (b) (36.7 )% 48.9 % 25.4 % Net income attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 % (23 )% Net income attributable to PepsiCo per common share diluted $ 8.78 $ 3.38 $ 4.36 % (23 )% Mark-to-market net impact 0.09 (0.01 ) (0.08 ) Restructuring and impairment charges 0.18 0.16 0.09 Merger and integration charges 0.05 Net tax (benefit)/expense related to the TCJ Act (b) (0.02 ) 1.70 Other net tax benefits (b) (3.55 ) Charges related to cash tender and exchange offers 0.13 Charge related to the transaction with Tingyi 0.26 Charge related to debt redemption 0.11 Pension-related settlement charge 0.11 Net income attributable to PepsiCo per common share diluted, excluding above items (c) $ 5.66 $ 5.23 $ 4.85 % % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (c) % % (a) In 2017 and 2016, reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Note 5 to our consolidated financial statements. (c) See Non-GAAP Measures. Other pension and retiree medical benefits income increased $65 million , reflecting the impact of the $1.4 billion discretionary pension contribution to the PepsiCo Employees Retirement Plan A (Plan A) in the United States, as well as the recognition of net asset gains, partially offset by higher amortization of net losses. Net interest expense increased $312 million reflecting a charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. This increase also reflects higher interest rates on debt balances, as well as losses on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest income due to higher interest rates on cash balances. The reported tax rate decreased 85.6 percentage points, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements for further information. Net income attributable to PepsiCo increased 158% and net income attributable to PepsiCo per common share increased 160% . Items affecting comparability (see Items Affecting Comparability) positively contributed 150 percentage points to net income attributable to PepsiCo growth and 152 percentage points to net income attributable to PepsiCo per common share growth. Other pension and retiree medical benefits income increased $252 million , primarily reflecting a settlement charge of $242 million related to the purchase of a group annuity contract in 2016. Net interest expense decreased $325 million reflecting a charge of $233 million in 2016 representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This decrease also reflects higher interest income due to higher interest rates and average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest expense due to higher average debt balances. The reported tax rate increased 23.5 percentage points primarily as a result of the provisional net tax expense related to the TCJ Act, which contributed 26 percentage points to the increase, partially offset by the impact of the 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in 2017. See Note 2 and Note 5 to our consolidated financial statements for additional information. Net income attributable to PepsiCo and net income attributable to PepsiCo per common share both decreased 23%. Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 30 percentage points, primarily as a result of the provisional net tax expense related to the TCJ Act. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring programs; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; gains or losses associated with mergers, acquisitions, divestitures and other structural changes; debt redemptions, cash tender or exchange offers; pension and retiree medical related items; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures are contained in this Form 10-K: cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income/expense, interest expense, benefit from/provision for income taxes and noncontrolling interests, each adjusted for items affecting comparability; operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates; organic revenue growth; free cash flow; and return on invested capital (ROIC) and net ROIC, excluding items affecting comparability. Cost of Sales, Gross Profit, Selling, General and Administrative Expenses, Other Pension and Retiree Medical Benefits Income/Expense, Interest Expense, Benefit from/Provision for Income Taxes, Annual Tax Rate and Noncontrolling Interests, Adjusted for Items Affecting Comparability; Operating Profit, Adjusted for Items Affecting Comparability, and Net Income Attributable to PepsiCo per Common Share Diluted, Adjusted for Items Affecting Comparability, and the Corresponding Constant Currency Growth Rates These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 and 2014 Productivity Plans, merger and integration charges associated with our acquisition of SodaStream, net tax benefit/expense associated with the enactment of the TCJ Act, other net tax benefits, charges related to cash tender and exchange offers, a charge related to the transaction with Tingyi, a charge related to debt redemption, and a pension-related settlement charge (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. We are not able to reconcile our full year projected 2019 annual tax rate, excluding items affecting comparability, to our full year projected 2019 reported annual tax rate because we are unable to predict the 2019 impact of foreign exchange or the mark-to-market net impact on commodity derivatives due to the unpredictability of future changes in foreign exchange rates and commodity prices. Therefore, we are unable to provide a reconciliation of this measure. Organic Revenue Growth We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of approximately $75 million of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. We believe organic revenue provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Net Revenue and Organic Revenue Growth in Results of Operations Division Review. Free Cash Flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources. ROIC and Net ROIC, Excluding Items Affecting Comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Interest expense (Benefit from)/provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 29,381 $ 35,280 $ 25,170 $ 10,110 $ $ 1,525 $ (3,370 ) $ $ 12,515 Items Affecting Comparability Mark-to-market net impact (83 ) (80 ) Restructuring and impairment charges (3 ) (269 ) Merger and integration charges (75 ) Net tax benefit related to the TCJ Act (28 ) Other net tax benefits 5,064 (5,064 ) Charges related to cash tender and exchange offers (253 ) Core, Non-GAAP Measure $ 29,295 $ 35,366 $ 24,746 $ 10,620 $ $ 1,272 $ 1,878 $ $ 8,065 2017 (b) Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits income Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,796 $ 34,729 $ 24,453 $ 10,276 $ $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (229 ) Provisional net tax expense related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,804 $ 34,721 $ 24,231 $ 10,490 $ $ 2,307 $ 7,524 2016 (b) Cost of sales Gross profit Selling, general and administrative expenses Operating profit Other pension and retiree medical benefits (expense)/income Interest expense Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 28,222 $ 34,577 $ 24,773 $ 9,804 $ (19 ) $ 1,342 $ 2,174 $ $ 6,329 Items Affecting Comparability Mark-to-market net impact (78 ) (167 ) (56 ) (111 ) Restructuring and impairment charges (155 ) Charge related to the transaction with Tingyi (373 ) Charge related to debt redemption (233 ) Pension-related settlement charge Core, Non-GAAP Measure $ 28,300 $ 34,499 $ 24,334 $ 10,165 $ $ 1,109 $ 2,301 $ $ 7,040 (a) Benefit from/provision for income taxes is the expected tax benefit/charge on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction and tax year. (b) Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2019 Multi-Year Productivity Plan Our 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this program, we expect to incur pre-tax charges of approximately $2.5 billion, of which $138 million is included in our 2018 results, approximately $800 million is expected to be reflected in our 2019 results and the balance to be reflected in our 2020 through 2023 results. These pre-tax charges will consist of approximately 70% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 15% for other costs associated with the implementation of our initiatives. We expect that these pre-tax charges will result in cash expenditures of approximately $1.6 billion, of which we expect approximately $450 million to be reflected in our 2019 cash flows and the balance to be reflected in our 2020 through 2023 cash flows. We expect to incur the majority of the pre-tax charges and cash expenditures in our 2019 and 2020 results. The total expected program pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA NAB Latin America ESSA AMENA Corporate Expected pre-tax charges % % % % % % % 2014 Multi-Year Productivity Plan To build on the successful implementation of the 2014 Productivity Plan, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives of the 2014 Productivity Plan to further strengthen our beverage, food and snack businesses. In connection with this program, we expect to incur pre-tax charges and cash expenditures of approximately $1.3 billion and $960 million, respectively. This total pre-tax charge is expected to consist of approximately 55% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 30% for other costs associated with the implementation of our initiatives. To date, we have incurred $1.2 billion of pre-tax charges and $814 million of cash expenditures. We expect to complete the program and incur the programs remaining pre-tax charges and cash expenditures before the end of 2019. The total expected program pre-tax charges are expected to be incurred by division approximately as follows: FLNA QFNA NAB Latin America ESSA AMENA Corporate Expected pre-tax charges % % % % % % % See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans. We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Merger and Integration Charges In 2018, we incurred merger and integration charges of $75 million ($0.05 per share) related to our acquisition of SodaStream, including $57 million recorded in the ESSA segment and $18 million recorded in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs . See Note 14 to our consolidated financial statements. Net Tax (Benefit)/Expense Related to the TCJ Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. In 2017, we recorded a provisional net tax expense of $2.5 billion ($1.70 per share) associated with the enactment of the TCJ Act. Included in the provisional net tax expense of $2.5 billion was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate. In 2018, we recorded a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act. See Note 5 to our consolidated financial statements. Other Net Tax Benefits In 2018, we reorganized our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). Also in 2018, we recognized non-cash tax benefits associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. The conclusion of certain international tax audits and the resolution with the IRS resulted in non-cash tax benefits of $364 million ($0.26 per share) and $353 million ($0.24 per share), respectively. See Note 5 to our consolidated financial statements. Charges Related to Cash Tender and Exchange Offers In 2018, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. See Note 8 to our consolidated financial statements. Charge Related to the Transaction with Tingyi In 2016, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in the AMENA segment to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair valu e. See Note 9 to our consolidated financial statements. Charge Related to Debt Redemption In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See Note 8 to our consolidated financial statements. Pension-Related Settlement Charge In 2016, we recorded a pre-tax pension settlement charge in corporate unallocated expenses of $242 million ($162 million after-tax or $0.11 per share) related to the purchase of a group annuity contract. See Note 7 to our consolidated financial statements. Results of Operations Division Review The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures. Net Revenue and Organic Revenue Growth Organic revenue growth is a non-GAAP financial measure. For further information on organic revenue growth, see Non-GAAP Measures. Impact of Impact of Net revenue growth Foreign exchange translation Acquisitions and divestitures Sales and certain other taxes Organic revenue growth (a ) Volume (b) Effective net pricing (c) FLNA 3.5 % % QFNA (1.5 )% (2 )% (0.5 ) (1 ) NAB % 0.5 % (1 ) Latin America % % ESSA % 0.5 % AMENA (2 )% % Total % % Impact of Impact of Net revenue growth Foreign exchange translation Acquisitions and divestitures 53rd reporting week (d) Organic revenue growth (a) Volume (b) Effective net pricing (c) FLNA % % 2.5 QFNA (2 )% (1 )% (1 ) NAB (2 )% (1 ) (2 )% (2.5 ) Latin America % (1 ) 0.5 % (2 ) ESSA % (3 ) % AMENA (5 )% % Total % % (a) Amounts may not sum due to rounding. (b) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our Company-owned and franchise-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. (c) Includes the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. (d) Our fiscal 2016 results included a 53rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. Frito-Lay North America % Change 2017 (a) 2016 (a) Net revenue $ 16,346 $ 15,798 $ 15,549 3.5 Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of 53 rd reporting week Organic revenue growth (b) (d) (d) Operating profit $ 5,008 $ 4,793 $ 4,612 4.5 Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 5,044 $ 4,847 $ 4,624 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 3.5%, primarily reflecting effective net pricing and volume growth. Volume grew 1%, reflecting mid-single-digit growth in variety packs and low-single-digit growth in trademark Doritos, partially offset by a double-digit decline in Santitas. Operating profit grew 4.5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and a 1-percentage-point impact of a bonus extended to certain U.S. employees in connection with the TCJ Act. 2017 Net revenue grew 2%, primarily reflecting effective net pricing, partially offset by the impact of the 53 rd reporting week in 2016, which reduced net revenue growth by 2 percentage points. Volume declined 1%, reflecting mid-single-digit declines in trademark Lays and Fritos and a low-single-digit decline in trademark Doritos, partially offset by high-single-digit growth in variety packs. The 53 rd reporting week in 2016 negatively impacted volume performance by 2 percentage points. Operating profit grew 4%, primarily reflecting productivity savings, the effective net pricing and a 1-percentage-point impact of 2016 incremental investments into our business. These impacts were partially offset by certain operating cost increases, including strategic initiatives, and a 1-percentage-point impact of higher commodity costs, primarily cooking oil. The 53 rd reporting week in 2016 reduced operating profit growth by 2 percentage points. Quaker Foods North America % Change 2017 (a) 2016 (a) Net revenue $ 2,465 $ 2,503 $ 2,564 (1.5 ) (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of 53 rd reporting week Organic revenue growth (b) (2 ) (d) (1 ) (d) Operating profit $ $ $ (1 ) Restructuring and impairment charges (c) Operating profit excluding above item (b) $ $ $ (1 ) Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (1 ) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue declined 1.5% and volume declined 0.5%. The net revenue performance reflects unfavorable net pricing and mix and the volume decline. The volume decline was driven by a double-digit decline in trademark Gamesa and a mid-single-digit decline in ready-to-eat cereals, partially offset by mid-single-digit growth in oatmeal. Operating profit decreased slightly, reflecting certain operating cost increases, the net revenue performance and a 3-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1-percentage-point positive contribution from insurance settlement recoveries related to the 2017 earthquake in Mexico. 2017 Net revenue declined 2%, reflecting the impact of the 53 rd reporting week in 2016, which negatively impacted net revenue performance by 2 percentage points, as well as unfavorable mix. Volume declined 2%, reflecting a low-single-digit decline in ready-to-eat cereals and high-single-digit declines in trademark Roni and Gamesa, in part reflecting the impact of the 53 rd reporting week in 2016 which negatively impacted volume performance by 2 percentage points. Operating profit decreased 1%, reflecting certain operating cost increases and the net revenue performance. The 53 rd reporting week in 2016 negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1.5-percentage-point impact of 2016 incremental investments into our business. Higher restructuring and impairment charges negatively impacted operating profit performance by 1 percentage point. North America Beverages % Change 2017 (a) 2016 (a) Net revenue $ 21,072 $ 20,936 $ 21,312 (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures (1 ) Impact of sales and certain other taxes (b) Impact of 53 rd reporting week Organic revenue growth (b) 0.5 (d) (2 ) Operating profit $ 2,276 $ 2,700 $ 2,947 (16 ) (8 ) Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 2,364 $ 2,743 $ 2,980 (14 ) (8 ) Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (14 ) (8 ) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 1%, driven by effective net pricing, partially offset by a decline in volume. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage volume. The non-carbonated beverage volume increase primarily reflected a high-single-digit increase in our overall water portfolio. Additionally, a low-single-digit increase in Gatorade sports drinks was offset by a low-single-digit decline in our juice and juice drinks portfolio. Operating profit decreased 16%, reflecting certain operating cost increases, including increased transportation costs, a 7-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. These impacts were partially offset by productivity savings and the net revenue growth. Higher gains on asset sales positively contributed 1.5 percentage points to operating profit performance. A bonus extended to certain U.S. employees in connection with the TCJ Act negatively impacted operating profit performance by 1.5 percentage points and was partially offset by prior-year costs related to hurricanes which positively contributed 1 percentage point to operating profit performance. 2017 Net revenue decreased 2%, primarily reflecting a decline in volume, partially offset by effective net pricing, as well as acquisitions which positively contributed 1 percentage point to the net revenue performance. The 53 rd reporting week in 2016 negatively impacted net revenue performance by 1 percentage point. Volume decreased 3.5%, driven by a 5% decline in CSD volume and a 1% decline in non-carbonated beverage volume. The non-carbonated beverage volume decrease primarily reflected mid-single-digit declines in Gatorade sports drinks and in our juice and juice drinks portfolio, partially offset by a mid-single-digit increase in our overall water portfolio and a low-single-digit increase in Lipton ready-to-drink teas. Acquisitions had a nominal positive contribution to the volume performance. The 53 rd reporting week in 2016 negatively impacted volume performance by 1.5 percentage points. Operating profit decreased 8%, primarily reflecting certain operating cost increases, the net revenue performance and a 2-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings and lower advertising and marketing expenses. Costs related to the hurricanes that occurred in 2017 negatively impacted operating profit performance by 1 percentage point and were offset by a gain associated with a sale of an asset. In addition, the 53 rd reporting week in 2016 negatively impacted operating profit performance by 1 percentage point and was offset by incremental investments in our business in 2016. Latin America % Change 2017 (a) 2016 (a) Net revenue $ 7,354 $ 7,208 $ 6,820 Impact of foreign exchange translation (1 ) Impact of acquisitions and divestitures 0.5 Organic revenue growth (b) (d) Operating profit $ 1,049 $ $ Restructuring and impairment charges (c) Operating profit excluding above item (b) $ 1,089 $ $ Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue grew 2%, reflecting effective net pricing, partially offset by a 6-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 1%, reflecting low-single-digit growth in Mexico, partially offset by a mid-single-digit decline in Brazil. Beverage volume declined 1%, reflecting a high-single-digit decline in Brazil, a low-single-digit decline in Mexico and a mid-single-digit decline in Argentina, partially offset by double-digit growth in Colombia, mid-single-digit growth in Guatemala and low-single-digit growth in Honduras. Operating profit increased 13%, reflecting the net revenue growth, productivity savings and a 4-percentage-point impact of insurance settlement recoveries related to the 2017 earthquake in Mexico. These impacts were partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. 2017 Net revenue increased 6%, reflecting effective net pricing, partially offset by volume declines. Favorable foreign exchange contributed 1 percentage point to net revenue growth. Snacks volume declined 1.5%, reflecting low-single-digit declines in Brazil and Mexico. Beverage volume declined 2%, reflecting a mid-single-digit decline in Brazil and a low-single-digit decline in Argentina, partially offset by high-single-digit growth in Guatemala. Additionally, Mexico experienced a slight decline. Operating profit increased 2%, reflecting the effective net pricing and productivity savings. These impacts were partially offset by certain operating cost increases, the volume declines and a 16-percentage-point impact of higher commodity costs. Higher restructuring and impairment charges reduced operating profit growth by 3 percentage points. Europe Sub-Saharan Africa % Change 2017 (a) 2016 (a) Net revenue $ 11,523 $ 11,050 $ 10,216 Impact of foreign exchange translation (3 ) Impact of acquisitions and divestitures Impact of sales and certain other taxes (b) 0.5 Impact of 53 rd reporting week Organic revenue growth (b) (d) (d) Operating profit $ 1,364 $ 1,316 $ 1,061 Restructuring and impairment charges (c) Merger and integration charges (c) Operating profit excluding above items (b) $ 1,484 $ 1,369 $ 1,121 Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (b) (a) In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. (b) See Non-GAAP Measures. (c) See Items Affecting Comparability. (d) Does not sum due to rounding. 2018 Net revenue increased 4%, reflecting volume growth and effective net pricing, partially offset by a 2-percentage-point impact of unfavorable foreign exchange. Snacks volume grew 3%, reflecting mid-single-digit growth in the Netherlands, partially offset by low-single-digit declines in the United Kingdom and South Africa. Additionally, Russia and Turkey experienced low-single-digit growth. Beverage volume grew 7%, reflecting double-digit growth in Germany and Poland and high-single-digit growth in France and Nigeria, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Russia and Turkey experienced mid-single-digit growth. Operating profit increased 4%, reflecting the net revenue growth, productivity savings and a 4-percentage-point net impact of refranchising our entire beverage bottling operations and snack distribution operations in CHS. These impacts were partially offset by certain operating cost increases and an 8-percentage-point impact of higher commodity costs. Additionally, a prior-year gain on the sale of our minority stake in Britvic and the merger and integration charges related to our acquisition of SodaStream reduced operating profit growth by 7 percentage points and 4 percentage points, respectively. 2017 Net revenue increased 8%, reflecting volume growth and effective net pricing, as well as favorable foreign exchange, which contributed 3 percentage points to net revenue growth. Snacks volume grew 5%, reflecting high-single-digit growth in Russia, partially offset by a slight decline in the United Kingdom and a low-single-digit decline in Spain. Additionally, Turkey, South Africa and the Netherlands experienced mid-single-digit growth. Beverage volume grew 1%, reflecting mid-single-digit growth in Poland and Nigeria and low-single-digit growth in Turkey and France, partially offset by mid-single-digit declines in Russia and Germany, and a low-single-digit decline in the United Kingdom. Operating profit increased 24%, reflecting the net revenue growth and productivity savings. Additionally, a gain on the sale of our minority stake in Britvic in 2017 contributed 8 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, higher advertising and marketing expenses and a 7-percentage-point impact of higher commodity costs. Asia, Middle East and North Africa % Change Net revenue $ 5,901 $ 6,030 $ 6,338 (2 ) (5 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Impact of sales and certain other taxes (a) Organic revenue growth (a) Operating profit $ 1,172 $ 1,073 $ Restructuring and impairment charges (b) (3 ) Charge related to the transaction with Tingyi (b) Operating profit excluding above items (a) $ 1,200 $ 1,070 $ 1,006 Impact of foreign exchange translation (1 ) Operating profit growth excluding above items, on a constant currency basis (a) (c) (a) See Non-GAAP Measures. (b) See Items Affecting Comparability. (c) Does not sum due to rounding. 2018 Net revenue declined 2%, reflecting an 8-percentage-point impact of refranchising a portion of our beverage businesses in Thailand in 2018 and Jordan in 2017, partially offset by net volume growth and effective net pricing. Snacks volume grew 5%, reflecting double-digit growth in India, China and Pakistan, partially offset by a mid-single-digit decline in the Middle East. Additionally, Australia experienced low-single-digit growth. Beverage volume declined slightly, reflecting a mid-single-digit decline in the Middle East and a double-digit decline in the Philippines, partially offset by double-digit growth in Vietnam, mid-single-digit growth in India and low-single-digit growth in Pakistan and China. Operating profit grew 9%, primarily reflecting the effective net pricing, productivity savings and the net volume growth, partially offset by certain operating cost increases, higher advertising and marketing expenses and a 4-percentage-point impact of higher commodity costs. The net impact of refranchising a portion of our beverage business in Thailand in 2018 contributed 13 percentage points to operating profit growth and was offset by a 16-percentage-point negative impact of the prior year refranchising of a portion of our beverage business in Jordan. 2017 Net revenue decreased 5%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 10 percentage points, primarily driven by a weak Egyptian pound. This impact was partially offset by effective net pricing. Snacks volume grew 5%, driven by high-single-digit growth in China and India and double-digit growth in Pakistan. Additionally, the Middle East experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume declined 1%, reflecting a double-digit decline in India and a mid-single-digit decline in the Middle East, partially offset by mid-single-digit growth in China, high-single-digit growth in Pakistan and low-single-digit growth in the Philippines. Operating profit improvement primarily reflected a 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value. The effective net pricing and productivity savings also increased operating profit growth. Additionally, the impact of refranchising a portion of our beverage business in Jordan contributed 14 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and a 32-percentage-point impact of higher commodity costs, primarily due to transaction-related foreign exchange on raw material purchases driven by the weak Egyptian pound. Unfavorable foreign exchange translation reduced operating profit growth by 8 percentage points. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments, debt repayments and transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper and long-term debt and cash, cash equivalents and short-term investments. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our credit facilities. See also Item 1A. Risk Factors and Our Business Risks for further discussion. As of December 29, 2018 , we had cash, cash equivalents, short-term investments and restricted cash in our consolidated subsidiaries of $5.7 billion outside the United States. The restricted cash of approximately $2.0 billion held outside the United States relates to our acquisition of SodaStream. Refer to Note 13 to our consolidated financial statements for further discussion of restricted cash. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 29, 2018, our mandatory transition tax liability is $3.8 billion. Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026. See Credit Facilities and Long-Term Contractual Commitments. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, this amount is based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amount in future periods. The IRS issued additional guidance in the first quarter of 2019 and we are currently evaluating the impact of this guidance. In connection with the TCJ Act, during 2018 we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. The repatriated cash was used primarily for repayment of commercial paper and to fund discretionary benefit plan contributions, debt repayments, dividend payments, share repurchases and our acquisition of SodaStream. See Item 1A. Risk Factors, Our Business Risks, Items Affecting Comparability, Our Critical Accounting Policies, as well as Note 5 to our consolidated financial statements. As of December 29, 2018 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,415 $ 10,030 $ 10,663 Net cash provided by/(used for) investing activities $ 4,564 $ (4,403 ) $ (7,150 ) Net cash used for financing activities $ (13,769 ) $ (4,186 ) $ (3,211 ) Operating Activities During 2018 , net cash provided by operating activities was $9.4 billion , compared to $10.0 billion in the prior year. The operating cash flow performance primarily reflects the discretionary contributions of $1.5 billion to our pension and retiree medical plans in the current year, partially offset by lower net cash tax payments in the current year. During 2017 , net cash provided by operating activities was $10 billion , compared to $10.7 billion in 2016. The operating cash flow performance primarily reflects unfavorable working capital comparisons to 2016. This decrease is mainly due to higher current year payments to vendors and customers, coupled with higher net cash tax payments in 2017, partially offset by lower pension and retiree medical plan contributions in 2017. See Note 7 to our consolidated financial statements for further discussion of pension contributions. Investing Activities During 2018 , net cash provided by investing activities was $4.6 billion , primarily reflecting net maturities and sales of debt securities with maturities greater than three months of $8.7 billion, partially offset by net capital spending of $3.1 billion and $1.2 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of SodaStream. During 2017 , net cash used for investing activities was $4.4 billion , primarily reflecting net capital spending of $2.8 billion and net purchases of debt securities with maturities greater than three months of $1.9 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2019 net capital spending to be approximately $4.5 billion . Financing Activities During 2018 , net cash used for financing activities was $13.8 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.9 billion, payments of long-term debt borrowings of $4.0 billion, cash tender and exchange offers of $1.6 billion and net payments of short-term borrowings of $1.4 billion. During 2017 , net cash used for financing activities was $4.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5 billion and net payments of short-term borrowings of $1.1 billion, partially offset by net proceeds from long-term debt of $3.1 billion and proceeds from exercises of stock options of $0.5 billion. See Note 8 to our consolidated financial statements for further discussion of debt obligations. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 11, 2015, we announced a share repurchase program providing for the repurchase of up to $12.0 billion of PepsiCo common stock which commenced on July 1, 2015 and expired on June 30, 2018 (2015 share repurchase program). The 2015 share repurchase program had approximately $4.3 billion of authorized repurchase capacity unused at expiration. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. On February 15, 2019, we announced a 3% increase in our annualized dividend to $3.82 per share from $3.71 per share, effective with the dividend expected to be paid in June 2019. We expect to return a total of approximately $8 billion to shareholders in 2019 through share repurchases of approximately $3 billion and dividends of approximately $5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,415 $ 10,030 $ 10,663 (6 ) (6 ) Capital spending (3,282 ) (2,969 ) (3,040 ) Sales of property, plant and equipment Free cash flow (a) $ 6,267 $ 7,241 $ 7,722 (13 ) (6 ) (a) See Non-GAAP Measures. In addition, when evaluating free cash flow, we also consider the following items impacting comparability: $1.5 billion , $6 million and $459 million in discretionary pension and retiree medical contributions and associated net cash tax benefits of $473 million, $1 million and $151 million in 2018, 2017 and 2016, respectively; $266 million , $113 million and $125 million of payments related to restructuring charges and associated net cash tax benefits of $45 million , $30 million and $22 million in 2018, 2017 and 2016, respectively; tax payments related to the TCJ Act of $115 million in 2018; certain other items of $47 million in 2018; net cash tax benefit related to debt redemption charge of $83 million in 2016; and net cash received related to interest rate swaps of $5 million in 2016. We will also consider payments related to the transition tax liability of $3.8 billion as of December 29, 2018, which we currently expect to be paid over the period 2019 to 2026 under the provisions of the TCJ Act, as an item impacting comparability. We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements for further discussion. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2020 2022 2024 and beyond Long-term debt obligations (b) $ 28,351 $ $ 7,166 $ 5,093 $ 16,092 Interest on debt obligations (c) 11,157 1,044 1,759 1,322 7,032 Operating leases (d) 1,840 Purchasing commitments (e) 2,602 1,221 Marketing commitments (e) 1,686 $ 45,636 $ 2,937 $ 11,642 $ 7,272 $ 23,785 (a) Based on year-end foreign exchange rates. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. However, under the provisions of the TCJ Act, our transition tax liability of $3.8 billion, of which $3.4 billion is recorded in other liabilities on our balance sheet, must be paid over eight years. We expect to pay approximately $0.4 billion in 2019, $0.3 billion per year in 2020-2023, $0.6 billion in 2024, $0.7 billion in 2025 and $0.9 billion in 2026 and these amounts are excluded from the table above. (b) Excludes $3,953 million related to current maturities of debt, $56 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $119 million related to unamortized net discounts. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 29, 2018 . (d) See Note 15 to our consolidated financial statements for additional information on operating leases. (e) Primarily reflects non-cancelable commitments as of December 29, 2018 . Long-term contractual commitments, except for our long-term debt obligations and transition tax liability, are generally not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges, orange juice and certain other commodities. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in our long-term contractual commitments. See Note 7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo $ 12,515 (a) $ 4,857 (a) $ 6,329 Interest expense 1,525 1,151 1,342 Tax on interest expense (339 ) (415 ) (483 ) $ 13,701 $ 5,593 $ 7,188 Average debt obligations (b) $ 38,169 $ 38,707 $ 35,308 Average common shareholders equity (c) 11,368 12,004 11,943 Average invested capital $ 49,537 $ 50,711 $ 47,251 Return on invested capital 27.7 % (a) 11.0 % (a) 15.2 % (a) Our fiscal 2018 results include other net tax benefits related to the reorganization of our international operations. Our fiscal 2018 and 2017 results include the impact of the TCJ Act. See Note 5 to our consolidated financial statements. (b) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (c) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 27.7 % 11.0 % 15.2 % Impact of: Average cash, cash equivalents and short-term investments 7.8 7.6 6.0 Interest income (0.6 ) (0.5 ) (0.2 ) Tax on interest income 0.1 0.2 0.1 Mark-to-market net impact 0.2 (0.2 ) Restructuring and impairment charges 0.4 0.3 0.1 Merger and integration charges 0.1 Net tax (benefit)/expense related to the TCJ Act (1.1 ) 4.5 Other net tax benefits (9.7 ) 0.1 0.1 Charges related to cash tender and exchange offers (0.1 ) Charges related to the transaction with Tingyi (0.1 ) 0.6 Pension-related settlement charge 0.3 Venezuela impairment charges (0.2 ) (0.5 ) Net ROIC, excluding items affecting comparability 24.8 % 22.9 % 21.5 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. See Note 2 to our consolidated financial statements for additional information on our revenue recognition and related policies, including total marketplace spending. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit. See Item 1A. Risk Factors for further discussion. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ($1.70 per share) in the fourth quarter of 2017. Included in the provisional net tax expense of $2.5 billion recognized in 2017 is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act and reflected in our provision for income taxes. During 2018, we recognized a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act. See further information in Items Affecting Comparability. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. As a result of the TCJ Act, we currently expect our annual tax rate, excluding items affecting comparability, in percentage terms, to be in the low twenties in 2019. However, we continue to evaluate the impact of the TCJ Act on our annual tax rate due to certain provisions, such as the global intangible low-tax income (GILTI) provision, which may impact our tax rate in future years. In 2018 , our annual tax rate was (36.7)% compared to 48.9% in 2017 , as discussed in Other Consolidated Results. The tax rate decreased 85.6 percentage points compared to 2017, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2016, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the combination of two plans effective December 31, 2016, and the spinoff of a portion of the combined plan into a pre-existing plan effective January 1, 2017. The benefits offered to the plans participants were unchanged. The result of the reorganization was the creation of Plan A and the PepsiCo Employees Retirement Plan I (Plan I). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Note 7 to our consolidated financial statements. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 4.4 % 3.7 % 4.3 % Interest cost discount rate 3.9 % 3.2 % 3.5 % Expected rate of return on plan assets 6.8 % 6.9 % 7.2 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 4.3 % 3.6 % 4.0 % Interest cost discount rate 3.8 % 3.0 % 3.2 % Expected rate of return on plan assets 6.6 % 6.5 % 7.5 % Current health care cost trend rate 5.7 % 5.8 % 5.9 % Based on our assumptions, we expect our total pension and retiree medical expense to increase in 2019 primarily driven by the recognition of prior experience losses on return on plan assets, partially offset by the impact of higher discount rates and discretionary plan contributions. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2019 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $42 Expected rate of return $40 Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions except per share amounts) Net Revenue $ 64,661 $ 63,525 $ 62,799 Cost of sales 29,381 28,796 28,222 Gross profit 35,280 34,729 34,577 Selling, general and administrative expenses 25,170 24,453 24,773 Operating Profit 10,110 10,276 9,804 Other pension and retiree medical benefits income/(expense) (19 ) Interest expense (1,525 ) (1,151 ) (1,342 ) Interest income and other Income before income taxes 9,189 9,602 8,553 (Benefit from)/provision for income taxes (See Note 5) (3,370 ) 4,694 2,174 Net income 12,559 4,908 6,379 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 Net Income Attributable to PepsiCo per Common Share Basic $ 8.84 $ 3.40 $ 4.39 Diluted $ 8.78 $ 3.38 $ 4.36 Weighted-average common shares outstanding Basic 1,415 1,425 1,439 Diluted 1,425 1,438 1,452 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Net income $ 12,559 $ 4,908 $ 6,379 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment (1,641 ) 1,109 (302 ) Net change on cash flow hedges (36 ) Net pension and retiree medical adjustments (467 ) (159 ) (316 ) Net change on available-for-sale securities (68 ) (24 ) Other (2,062 ) (596 ) Comprehensive income 10,497 5,770 5,783 Comprehensive income attributable to noncontrolling interests (44 ) (51 ) (54 ) Comprehensive Income Attributable to PepsiCo $ 10,453 $ 5,719 $ 5,729 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Operating Activities Net income $ 12,559 $ 4,908 $ 6,379 Depreciation and amortization 2,399 2,369 2,368 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges (255 ) (113 ) (125 ) Charge related to the transaction with Tingyi Pension and retiree medical plan expenses Pension and retiree medical plan contributions (1,708 ) (220 ) (695 ) Deferred income taxes and other tax charges and credits (531 ) Other net tax benefits related to international reorganizations (4,347 ) Net tax (benefit)/expense related to the TCJ Act (28 ) 2,451 Change in assets and liabilities: Accounts and notes receivable (253 ) (202 ) (349 ) Inventories (174 ) (168 ) (75 ) Prepaid expenses and other current assets Accounts payable and other current liabilities Income taxes payable (338 ) Other, net (256 ) (305 ) Net Cash Provided by Operating Activities 9,415 10,030 10,663 Investing Activities Capital spending (3,282 ) (2,969 ) (3,040 ) Sales of property, plant and equipment Acquisition of SodaStream, net of cash and cash equivalents acquired (1,197 ) Other acquisitions and investments in noncontrolled affiliates (299 ) (61 ) (212 ) Divestitures Short-term investments, by original maturity: More than three months - purchases (5,637 ) (18,385 ) (12,504 ) More than three months - maturities 12,824 15,744 8,399 More than three months - sales 1,498 Three months or less, net Other investing, net Net Cash Provided by/(Used for) Investing Activities 4,564 (4,403 ) (7,150 ) Financing Activities Proceeds from issuances of long-term debt 7,509 7,818 Payments of long-term debt (4,007 ) (4,406 ) (3,105 ) Cash tender and exchange offers/debt redemptions (1,589 ) (2,504 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments (17 ) (128 ) (27 ) Three months or less, net (1,352 ) (1,016 ) 1,505 Cash dividends paid (4,930 ) (4,472 ) (4,227 ) Share repurchases - common (2,000 ) (2,000 ) (3,000 ) Share repurchases - preferred (2 ) (5 ) (7 ) Proceeds from exercises of stock options Withholding tax payments on RSUs, PSUs and PEPunits converted (103 ) (145 ) (130 ) Other financing (53 ) (76 ) (58 ) Net Cash Used for Financing Activities (13,769 ) (4,186 ) (3,211 ) Effect of exchange rate changes on cash and cash equivalents and restricted cash (98 ) (252 ) Net Increase in Cash and Cash Equivalents and Restricted Cash 1,488 Cash and Cash Equivalents and Restricted Cash, Beginning of Year 10,657 9,169 9,119 Cash and Cash Equivalents and Restricted Cash, End of Year $ 10,769 $ 10,657 $ 9,169 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 29, 2018 and December 30, 2017 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 8,721 $ 10,610 Short-term investments 8,900 Restricted cash 1,997 Accounts and notes receivable, net 7,142 7,024 Inventories 3,128 2,947 Prepaid expenses and other current assets 1,546 Total Current Assets 21,893 31,027 Property, Plant and Equipment, net 17,589 17,240 Amortizable Intangible Assets, net 1,644 1,268 Goodwill 14,808 14,744 Other indefinite-lived intangible assets 14,181 12,570 Indefinite-Lived Intangible Assets 28,989 27,314 Investments in Noncontrolled Affiliates 2,409 2,042 Deferred Income Taxes 4,364 Other Assets Total Assets $ 77,648 $ 79,804 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 4,026 $ 5,485 Accounts payable and other current liabilities 18,112 15,017 Total Current Liabilities 22,138 20,502 Long-Term Debt Obligations 28,295 33,796 Deferred Income Taxes 3,499 3,242 Other Liabilities 9,114 11,283 Total Liabilities 63,046 68,823 Commitments and contingencies Preferred Stock, no par value Repurchased Preferred Stock (197 ) PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,409 and 1,420 shares, respectively) Capital in excess of par value 3,953 3,996 Retained earnings 59,947 52,839 Accumulated other comprehensive loss (15,119 ) (13,057 ) Repurchased common stock, in excess of par value (458 and 446 shares, respectively) (34,286 ) (32,757 ) Total PepsiCo Common Shareholders Equity 14,518 11,045 Noncontrolling interests Total Equity 14,602 10,981 Total Liabilities and Equity $ 77,648 $ 79,804 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock Balance, beginning of year 0.8 $ 0.8 $ 0.8 $ Conversion to common stock (0.1 ) (6 ) Retirement of preferred stock (0.7 ) (35 ) Balance, end of year 0.8 0.8 Repurchased Preferred Stock Balance, beginning of year (0.7 ) (197 ) (0.7 ) (192 ) (0.7 ) (186 ) Redemptions (2 ) (5 ) (6 ) Retirement of preferred stock 0.7 Balance, end of year (0.7 ) (197 ) (0.7 ) (192 ) Common Stock Balance, beginning of year 1,420 1,428 1,448 Share issued in connection with preferred stock conversion to common stock Change in repurchased common stock (12 ) (1 ) (8 ) (20 ) Balance, end of year 1,409 1,420 1,428 Capital in Excess of Par Value Balance, beginning of year 3,996 4,091 4,076 Share-based compensation expense Equity issued in connection with preferred stock conversion to common stock Stock option exercises, RSUs, PSUs and PEPunits converted (a) (193 ) (236 ) (138 ) Withholding tax on RSUs, PSUs and PEPunits converted (103 ) (145 ) (130 ) Other (3 ) (4 ) (6 ) Balance, end of year 3,953 3,996 4,091 Retained Earnings Balance, beginning of year 52,839 52,518 50,472 Cumulative effect of accounting changes (145 ) Net income attributable to PepsiCo 12,515 4,857 6,329 Cash dividends declared - common (b) (5,098 ) (4,536 ) (4,282 ) Cash dividends declared - preferred (1 ) Retirement of preferred stock (164 ) Balance, end of year 59,947 52,839 52,518 Accumulated Other Comprehensive Loss Balance, beginning of year (13,057 ) (13,919 ) (13,319 ) Other comprehensive (loss)/income attributable to PepsiCo (2,062 ) (600 ) Balance, end of year (15,119 ) (13,057 ) (13,919 ) Repurchased Common Stock Balance, beginning of year (446 ) (32,757 ) (438 ) (31,468 ) (418 ) (29,185 ) Share repurchases (18 ) (2,000 ) (18 ) (2,000 ) (29 ) (3,000 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year (458 ) (34,286 ) (446 ) (32,757 ) (438 ) (31,468 ) Total PepsiCo Common Shareholders Equity 14,518 11,045 11,246 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests (49 ) (62 ) (55 ) Currency translation adjustment Other, net (3 ) (1 ) (2 ) Balance, end of year Total Equity $ 14,602 $ 10,981 $ 11,199 (a) Includes total tax benefits of $110 million in 2016. (b) Cash dividends declared per common share were $3.5875 , $3.1675 and $2.96 for 2018, 2017 and 2016, respectively. See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50% or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. Our fiscal 2016 results included an extra week. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. Certain operations in our ESSA segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks (17 weeks for 2016) September, October, November and December See Our Divisions below, and for additional unaudited information on items affecting the comparability of our consolidated results, see further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years financial statements to conform to the current year presentation, including the adoption of the recently issued accounting pronouncements disclosed in Note 2. Our Divisions Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in North America, Mexico, Russia, the United Kingdom and Brazil. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions and are considered our reportable segments. For additional unaudited information on our divisions, see Our Operations contained in Item 1. Business. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense of each division is as follows: FLNA % % % QFNA % % % NAB % % % Latin America % % % ESSA % % % AMENA % % % Corporate unallocated expenses % % % The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit of each division are as follows: Net Revenue Operating Profit (b) 2018 (a) 2017 (c) 2016 (c) FLNA $ 16,346 $ 15,798 $ 15,549 $ 5,008 $ 4,793 $ 4,612 QFNA 2,465 2,503 2,564 NAB 21,072 20,936 21,312 2,276 2,700 2,947 Latin America 7,354 7,208 6,820 1,049 ESSA 11,523 11,050 10,216 1,364 1,316 1,061 AMENA 5,901 6,030 6,338 1,172 1,073 Total division 64,661 63,525 62,799 11,506 11,446 10,792 Corporate unallocated expenses (1,396 ) (1,170 ) (988 ) $ 64,661 $ 63,525 $ 62,799 $ 10,110 $ 10,276 $ 9,804 (a) Our primary performance obligation is the distribution and sales of beverage products and food and snack products to our customers, each comprising approximately 50% of our consolidated net revenue. Internationally, our Latin America segment is predominantly a food and snack business, ESSAs beverage business and food and snack business are each approximately 50% of the segments net revenue and AMENAs beverage business and food and snack business are approximately 35% and 65% , respectively, of the segments net revenue. Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our NAB and ESSA segments, is approximately 40% of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. See Note 2 for additional information. (b) For further unaudited information on certain items that impacted our financial performance, see Item 6. Selected Financial Data. (c) Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 for additional information. Corporate Unallocated Expenses Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 6,577 $ 5,979 $ $ $ QFNA NAB 29,878 28,592 Latin America 6,458 4,976 ESSA (a) 17,410 13,556 AMENA 6,433 5,668 Total division 67,626 59,575 3,132 2,883 2,938 Corporate (b) 10,022 20,229 $ 77,648 $ 79,804 $ 3,282 $ 2,969 $ 3,040 (a) In 2018, the change in assets was primarily related to our acquisition of SodaStream. (b) Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2018 , the change in assets was primarily due to a decrease in short-term investments and cash and cash equivalents. Refer to the cash flow statement for additional information. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA NAB Latin America ESSA AMENA Total division 2,144 2,107 2,120 Corporate $ $ $ $ 2,330 $ 2,301 $ 2,298 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 37,148 $ 36,546 $ 36,732 $ 29,169 $ 28,418 Mexico 3,878 3,650 3,431 1,404 1,205 Russia (b) 3,191 3,232 2,648 3,926 4,708 Canada 2,736 2,691 2,692 2,565 2,739 United Kingdom 1,743 1,650 1,737 Brazil 1,335 1,427 1,305 All other countries (c) 14,630 14,329 14,254 12,169 9,200 $ 64,661 $ 63,525 $ 62,799 $ 50,631 $ 47,864 (a) Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. (b) Change in net revenue in 2017 primarily reflects appreciation of the Russian ruble. Change in long-lived assets in 2018 primarily reflects depreciation of the Russian ruble. (c) Change in long-lived assets in 2018 primarily related to our acquisition of SodaStream. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. In addition, upon adoption of the revenue recognition guidance (see subsequent discussion of Recently Issued Accounting Pronouncements - Adopted), we exclude from net revenue and cost of sales, all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses on our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2018 , sales to Walmart (including Sams) represented approximately 13% of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $218 million as of December 29, 2018 and $262 million as of December 30, 2017 are included in prepaid expenses and other current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see Our Customers in Item 1. Business. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $4.2 billion in 2018 , $4.1 billion in 2017 and $4.2 billion in 2016 , including advertising expenses of $2.6 billion in 2018 , $2.4 billion in 2017 and $2.5 billion in 2016 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $47 million and $46 million as of December 29, 2018 and December 30, 2017 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $10.5 billion in 2018 , $9.9 billion in 2017 and $9.7 billion in 2016 . Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software projects and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $204 million in 2018 , $224 million in 2017 and $214 million in 2016 . Net capitalized software and development costs were $577 million and $686 million as of December 29, 2018 and December 30, 2017 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional unaudited information on our commitments, see Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $680 million , $737 million and $ 760 million in 2018 , 2017 and 2016 , respectively, and are reported within selling, general and administrative expenses. See Research and Development in Item 1. Business for additional unaudited information about our research and development activities. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment of indefinite lived-intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See also Note 4, and for additional unaudited information on goodwill and other intangible assets, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Financial Instruments Note 9, and for additional unaudited information, see Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Inventories Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or, in limited instances, last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2017, the Financial Accounting Standards Board (FASB) issued guidance to retrospectively present the service cost component of net periodic benefit cost for pension and retiree medical plans along with other compensation costs in operating profit and present the other components of net periodic benefit cost separately below operating profit in the income statement. The guidance also allows only the service cost component of net periodic benefit cost to be eligible for capitalization within inventory or fixed assets on a prospective basis. We adopted the provisions of this guidance retrospectively in the first quarter of 2018, using historical information previously disclosed in our pension and retiree medical benefits footnote as the estimation basis. We also updated our allocation of service costs to our divisions to better approximate actual service cost. The impact from retrospective adoption of this guidance resulted in an increase to cost of sales and selling, general and administrative expenses of $11 million and $222 million , respectively, for the year ended December 30, 2017 and an increase of $13 million and a decrease of $32 million , respectively, for the year ended December 31, 2016. We recorded a corresponding increase of $233 million and decrease of $19 million for the years ended December 30, 2017 and December 31, 2016, respectively, to other pension and retiree medical benefits income/(expense) below operating profit. The (decreases)/increases to operating profit for each division and to corporate unallocated expenses are as follows: 2017 (a) 2016 (b) FLNA $ (30 ) $ (47 ) QFNA (2 ) (4 ) NAB (7 ) (12 ) Latin America ESSA (38 ) (47 ) AMENA Corporate unallocated expenses (172 ) (c) Total $ (233 ) $ (a) Includes restructuring charges of $66 million , including $13 million in our FLNA segment, $2 million in our QFNA segment, $11 million in our NAB segment, $7 million in our Latin America segment and $33 million in corporate unallocated expenses. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. (b) Includes restructuring charges of $5 million , including $1 million in our FLNA segment, $2 million in our NAB segment and $2 million in corporate unallocated expenses. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. (c) Reflects a settlement charge of $242 million related to a group annuity contract purchase. See Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The changes described above had no impact on our consolidated net revenue, net income or earnings per share. See Note 7 for further information on our service cost and other components of net periodic benefit cost for pension and retiree medical plans. In 2016, the FASB issued guidance to clarify how restricted cash should be presented in the cash flow statement. We adopted the provisions of this guidance retrospectively during the first quarter of 2018; the adoption did not have a material impact on our financial statements and primarily related to collateral posted against our derivative asset or liability positions. See Note 9 and Note 13 for further information. In 2016, the FASB issued guidance that requires companies to account for the income tax effects of intercompany transfers of assets, other than inventory, when the transfer occurs versus deferring income tax effects until the transferred asset is sold to an outside party or otherwise recognized. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have a material impact on our financial statements and we recorded an adjustment of $8 million to beginning retained earnings. In 2016, the FASB issued guidance that requires companies to measure investments in certain equity securities at fair value and recognize any changes in fair value in net income. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have an impact on our financial statements. See Note 9 for further information on our investments in equity securities. In 2014, the FASB issued guidance on revenue recognition, with final amendments issued in 2016. The guidance provides for a five-step model to determine the revenue recognized for the transfer of goods or services to customers that reflects the expected entitled consideration in exchange for those goods or services. It also provides clarification for principal versus agent considerations and identifying performance obligations. In addition, the FASB introduced practical expedients related to disclosures of remaining performance obligations, as well as other amendments related to guidance on collectibility, non-cash consideration and the presentation of sales and other similar taxes. Financial statement disclosures required under the guidance will enable users to understand the nature, amount, timing, judgments and uncertainty of revenue and cash flows relating to customer contracts. The two permitted transition methods under the guidance are the full retrospective approach or a cumulative effect adjustment to the opening retained earnings in the year of adoption (cumulative effect approach). We adopted the guidance applied to all contracts using the cumulative effect approach during the first quarter of 2018; the adoption did not have a material impact on our financial statements. We utilized a comprehensive approach to assess the impact of the guidance on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the new requirements to our revenue contracts, including evaluation of our performance obligations, principal versus agent considerations and variable consideration. We completed our contract and business process reviews and implemented changes to our controls and disclosures under the new guidance. As a result of the implementation of the guidance, which did not have a material impact on our accounting policies upon adoption, in the first quarter of 2018, we recorded an adjustment of $137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition. In addition, we excluded from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions that were not already excluded. The impact of these taxes previously recognized in net revenue and cost of sales was approximately $75 million for the fiscal year ended December 30, 2017, with no impact on operating profit. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2018, the FASB issued guidance related to the TCJ Act for the optional reclassification of the residual tax effects, arising from the change in corporate tax rate, in accumulated other comprehensive loss to retained earnings. The reclassification is the difference between the amount previously recorded in other comprehensive income at the historical U.S. federal tax rate that remains in accumulated other comprehensive loss at the time the TCJ Act was effective and the amount that would have been recorded using the newly enacted rate. If elected, the guidance can be applied retrospectively to each period during which the impact of the TCJ Act is recognized or in the period of adoption. We will adopt the guidance when it becomes effective in the first quarter of 2019, but we are not planning to make the optional reclassification. In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. Under this guidance, certain of our derivatives used to hedge commodity price risk that did not previously qualify for hedge accounting treatment will qualify prospectively. We will adopt the guidance when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements or disclosures. See Note 9 for further information. In 2016, the FASB issued guidance on leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but record expenses in the income statement in a manner similar to current accounting. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The two permitted transition methods under the guidance are the modified retrospective transition approach, which requires application of the guidance for all comparative periods presented, and the cumulative effect adjustment approach, which requires prospective application at the adoption date. We continue to utilize a comprehensive approach to assess the impact of this guidance on our financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. We are substantially complete with our comprehensive review of our lease portfolio including significant leases by geography and by asset type that will be impacted by the new guidance, and enhancing our controls. In addition, we are progressing on the implementation of a new software platform, and corresponding controls, for administering our leases and facilitating compliance with the new guidance. As part of our adoption, we will not reassess historical lease classification, will not recognize short-term leases on our balance sheet, will utilize the portfolio approach to group leases with similar characteristics and will not separate lease and non-lease components for our real estate leases. We will adopt the guidance prospectively when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements, with an expected increase of approximately 2% to each of our total assets and total liabilities on our balance sheet, subject to completion of our assessment. See Note 15 for our minimum lease payments under non-cancelable operating leases. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2019 Productivity Plan $ $ $ 2014 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 2019 Multi-Year Productivity Plan The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint. A summary of our 2019 Productivity Plan charges is as follows: Costs of sales $ Selling, general and administrative expenses Other pension and retiree medical benefits expense Total restructuring and impairment charges $ After-tax amount $ Net income attributable to PepsiCo per common share $ 0.08 FLNA $ QFNA NAB Latin America ESSA AMENA Corporate Other pension and retiree medical benefits expense $ A summary of our 2019 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs (a) Total 2018 restructuring charges $ $ $ $ Non-cash charges and translation (32 ) (32 ) Liability as of December 29, 2018 $ $ $ $ (a) Includes other costs associated with the implementation of our initiatives, including consulting and other professional fees. Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019 . 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, includes the next generation of productivity initiatives that we believe will strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives described above to further strengthen our beverage, food and snack businesses. A summary of our 2014 Productivity Plan charges is as follows: Selling, general and administrative expenses $ $ $ Other pension and retiree medical benefits expense Total restructuring and impairment charges $ $ $ After-tax amount $ $ $ Net income attributable to PepsiCo per common share $ 0.10 $ 0.16 $ 0.09 Plan to Date FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA (a) (3 ) Corporate (b) (1 ) $ $ $ $ 1,204 (a) In 2017, income amount primarily reflects a gain on the sale of property, plant and equipment. (b) In 2018, income amount primarily relates to other pension and retiree medical benefits. Severance and Other Employee Costs Asset Impairments Other Costs (a) Total Plan to Date $ $ $ $ 1,204 (a) Includes other costs associated with the implementation of our initiatives, including certain consulting and contract termination costs. A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 26, 2015 $ $ $ $ 2016 restructuring charges Cash payments (46 ) (49 ) (95 ) Non-cash charges and translation (15 ) (36 ) (50 ) Liability as of December 31, 2016 2017 restructuring charges (6 ) (a) Cash payments (91 ) (22 ) (113 ) Non-cash charges and translation (65 ) (21 ) (52 ) Liability as of December 30, 2017 2018 restructuring charges Cash payments (b) (203 ) (52 ) (255 ) Non-cash charges and translation (4 ) (28 ) (27 ) Liability as of December 29, 2018 $ $ $ $ (a) Income amount represents adjustments for changes in estimates and a gain on the sale of property, plant, and equipment. (b) Excludes cash expenditures of $11 million reported in the cash flow statement in pension and retiree medical plan contributions. Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019 . Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. See additional unaudited information in Items Affecting Comparability and Results of Operations Division Review in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,078 $ 1,148 Buildings and improvements 15 - 44 8,941 8,796 Machinery and equipment, including fleet and software 5 - 15 27,715 27,018 Construction in progress 2,430 2,144 40,164 39,106 Accumulated depreciation (22,575 ) (21,866 ) $ 17,589 $ 17,240 Depreciation expense $ 2,241 $ 2,227 $ 2,217 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Amortizable intangible assets, net Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights 56 60 $ $ (140 ) $ $ $ (128 ) $ Reacquired franchise rights 5 14 (105 ) (104 ) Brands 20 40 1,306 (1,032 ) 1,322 (1,026 ) Other identifiable intangibles (a) 10 24 (288 ) (281 ) $ 3,209 $ (1,565 ) $ 1,644 $ 2,807 $ (1,539 ) $ 1,268 Amortization expense $ $ $ (a) The change in 2018 is primarily related to our acquisition of SodaStream. Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 29, 2018 and using average 2018 foreign exchange rates, is expected to be as follows: 2020 Five-year projected amortization $ $ $ $ $ Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our policies for amortizable brands, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Indefinite-Lived Intangible Assets We did not recognize any impairment charges for goodwill in each of the fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . We recognized no material impairment charges for indefinite-lived intangible assets in each of the fiscal years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . As of December 29, 2018 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at NAB exceeded their carrying values. However, there could be an impairment of the carrying value of NABs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of NABs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there were no material impairments for the year ended December 29, 2018 . However, there could be an impairment of the carrying value of certain brands in these countries if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows, if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For additional information on our policies for indefinite-lived intangible assets, see Note 2. The change in the book value of indefinite-lived intangible assets is as follows: Balance, Beginning 2017 Translation and Other Balance, End of 2017 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2018 FLNA Goodwill $ $ $ $ $ (11 ) $ Brands (2 ) 293 (13 ) QFNA Goodwill Brands NAB (a) Goodwill 9,843 9,854 (41 ) 9,813 Reacquired franchise rights 7,064 7,126 (68 ) 7,058 Acquired franchise rights 1,512 1,525 (15 ) 1,510 Brands 18,733 18,858 (124 ) 18,734 Latin America Goodwill (46 ) Brands (9 ) (14 ) 703 (7 ) (60 ) ESSA (b) Goodwill 3,177 3,452 (367 ) 3,611 Reacquired franchise rights (1 ) (51 ) Acquired franchise rights (25 ) (9 ) Brands 2,358 2,545 1,993 (350 ) 4,188 6,207 6,741 2,493 (777 ) 8,457 AMENA Goodwill (34 ) Brands (10 ) 515 (44 ) Total goodwill 14,430 14,744 (499 ) 14,808 Total reacquired franchise rights 7,552 7,675 (1 ) (119 ) 7,555 Total acquired franchise rights 1,696 1,720 (25 ) (24 ) 1,671 Total brands 2,948 3,175 2,156 (376 ) 4,955 $ 26,626 $ $ 27,314 $ 2,693 $ (1,018 ) $ 28,989 (a) The change in translation and other in 2018 primarily reflects the depreciation of the Canadian dollar. (b) The change in acquisitions/(divestitures) in 2018 is primarily related to the preliminary allocation of the purchase price for our acquisition of SodaStream. See Note 14 for further information. The change in translation and other in 2018 primarily reflects the depreciation of the Russian ruble, euro and Pound sterling. The change in translation and other in 2017 primarily reflects the appreciation of the Russian ruble and euro. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 3,864 $ 3,452 $ 2,630 Foreign 5,325 6,150 5,923 $ 9,189 $ 9,602 $ 8,553 The (benefit from)/provision for income taxes consisted of the following: Current: U.S. Federal $ $ 4,925 $ 1,219 Foreign State 5,785 2,120 Deferred: U.S. Federal (1,159 ) Foreign (4,379 ) (9 ) (33 ) State (9 ) (22 ) (4,248 ) (1,091 ) $ (3,370 ) $ 4,694 $ 2,174 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 21.0 % 35.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 0.5 0.9 0.4 Lower taxes on foreign results (2.2 ) (9.4 ) (8.0 ) One-time mandatory transition tax - TCJ Act 0.1 41.4 Remeasurement of deferred taxes - TCJ Act (0.4 ) (15.9 ) International reorganizations (47.3 ) Tax settlements (7.8 ) Other, net (0.6 ) (3.1 ) (2.0 ) Annual tax rate (36.7 )% 48.9 % 25.4 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ( $1.70 per share) in the fourth quarter of 2017. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Included in the provisional net tax expense of $2.5 billion recognized in the fourth quarter of 2017, was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. During 2018, we recognized a net tax benefit of $28 million ( $0.02 per share) primarily reflecting the impact of the final analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries, partially offset by additional transition tax guidance issued by the United States Department of Treasury, as well as the TCJ Act impact of both the conclusion of certain international tax audits and the resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, each discussed below. As of December 29, 2018, our mandatory transition tax liability is $ 3.8 billion . Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026. The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as GILTI, must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred. In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. The provisional measurement period ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. For further unaudited information and discussion, refer to Item 1A. Risk Factors, Our Business Risks, Our Liquidity and Capital Resources and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. International Reorganizations During the fourth quarter of 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ( $3.05 per share). The related deferred tax asset of $4.4 billion is expected to be amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance. Deferred tax liabilities and assets are comprised of the following: Deferred Tax Liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,303 1,397 Intangible assets other than nondeductible goodwill 3,169 Recapture of net operating losses Other Gross deferred tax liabilities 2,366 5,194 Deferred tax assets Net carryforwards 4,353 1,400 Intangible assets other than nondeductible goodwill Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Other Gross deferred tax assets 6,984 3,115 Valuation allowances (3,753 ) (1,163 ) Deferred tax assets, net 3,231 1,952 Net deferred tax (assets)/liabilities $ (865 ) $ 3,242 A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 1,163 $ 1,110 $ 1,136 Provision 2,639 Other (deductions)/additions (49 ) (39 ) Balance, end of year $ 3,753 $ 1,163 $ 1,110 For additional unaudited information on our income tax policies, including our reserves for income taxes, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2014-2017 2014-2016 Mexico None United Kingdom 2016-2017 None Canada (Domestic) 2014-2017 2014-2015 Canada (International) 2010-2017 2010-2015 Russia 2014-2017 2014-2017 During 2018, we recognized a non-cash tax benefit of $364 million ( $0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, during 2018, we recognized non-cash tax benefits of $353 million ( $0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. For further unaudited information on the impact of the resolution of open tax issues, see Other Consolidated Results in Managements Discussion and Analysis of Financial Condition and Results of Operations. As of December 29, 2018 , the total gross amount of reserves for income taxes, reported in other liabilities, was $1.4 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $179 million as of December 29, 2018 , which reflects a reduction of the prior year liability of $64 million of tax benefit that was recognized in 2018 . The gross amount of interest accrued, reported in other liabilities, was $283 million as of December 30, 2017 , of which $89 million of expense was recognized in 2017 . A reconciliation of unrecognized tax benefits is as follows: Balance, beginning of year $ 2,212 $ 1,885 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years (822 ) (51 ) Settlement payments (233 ) (4 ) Statutes of limitations expiration (42 ) (33 ) Translation and other (14 ) Balance, end of year $ 1,440 $ 2,212 Carryforwards and Allowances Operating loss carryforwards totaling $24.9 billion at year-end 2018 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2 billion in 2019 , $20.5 billion between 2020 and 2038 and $4.2 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings In connection with the enactment of the TCJ Act, during 2018, we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. As of December 29, 2018 , we had approximately $24 billion of undistributed international earnings. We intend to continue to reinvest $24 billion of earnings outside the United States for the foreseeable future and while U.S. federal tax expense has been recognized as a result of the TCJ Act, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, restricted stock units (RSUs), performance stock units (PSUs), PepsiCo equity performance units (PEPunits) and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and were granted 66% PSUs and 34% long-term cash, each of which are subject to pre-established performance targets. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 29, 2018 , 66 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense and excess tax benefits recognized: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring and impairment charges (6 ) (2 ) Total $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ $ (a) $ Excess tax benefits related to share-based compensation (b) $ $ $ (a) Reflects tax rates effective for the 2017 tax year. (b) Included in provision for income taxes in the income statement in 2018 and 2017; included in capital in excess of par value in the equity statement in 2016. As of December 29, 2018 , there was $282 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years. Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years. Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 5 years 6 years Risk-free interest rate 2.6 % 2.0 % 1.4 % Expected volatility % % % Expected dividend yield 2.7 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 29, 2018 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 30, 2017 19,013 $ 74.23 Granted 1,429 $ 108.88 Exercised (4,377 ) $ 62.95 Forfeited/expired (476 ) $ 94.85 Outstanding at December 29, 2018 15,589 $ 79.94 4.29 $ 474,746 Exercisable at December 29, 2018 11,547 $ 70.74 2.92 $ 457,529 Expected to vest as of December 29, 2018 3,713 $ 106.02 8.17 $ 16,606 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs is measured at the market price of the Companys stock on the date of grant. The fair value of PSUs is measured at the market price of the Companys stock on the date of grant with the exception of awards with market conditions, for which we use the Monte-Carlo simulation model to determine the fair value. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. A summary of our RSU and PSU activity for the year ended December 29, 2018 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 30, 2017 7,293 $ 102.30 Granted (b) 2,634 $ 108.75 Converted (2,362 ) $ 99.73 Forfeited (647 ) $ 105.21 Actual performance change (c) $ 98.92 Outstanding at December 29, 2018 (d) 7,175 $ 105.13 1.22 $ 791,878 Expected to vest as of December 29, 2018 6,667 $ 104.90 1.15 $ 735,813 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 29, 2018 , at the threshold, target and maximum award levels were zero , 0.9 million and 1.6 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three -year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model. PEPunits were last granted in 2015 and all 248,000 units outstanding at December 30, 2017, with a weighted average grant date fair value of $68.94 , were converted to 278,000 shares during fiscal year 2018. Long-Term Cash Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model until actual performance is determined. A summary of our long-term cash activity for the year ended December 29, 2018 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 30, 2017 $ 33,200 Granted (b) 20,926 Forfeited (2,292 ) Actual performance change (c) 2,876 Outstanding at December 29, 2018 (d) $ 54,710 $ 55,809 1.22 Expected to vest as of December 29, 2018 $ 51,159 $ 52,148 1.17 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) Reflects the net number of long-term cash awards above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding long-term cash awards for which the performance period has not ended as of December 29, 2018, at the threshold, target and maximum award levels were zero , 37.3 million and 74.5 million, respectively. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,429 1,481 1,743 Weighted-average grant-date fair value of options granted $ 9.80 $ 8.25 $ 6.94 Total intrinsic value of options exercised (a) $ 224,663 $ 327,860 $ 290,131 Total grant-date fair value of options vested (a) $ 15,506 $ 23,122 $ 18,840 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,634 2,824 3,054 Weighted-average grant-date fair value of RSUs/PSUs granted $ 108.75 $ 109.92 $ 99.06 Total intrinsic value of RSUs/PSUs converted (a) $ 260,287 $ 380,269 $ 359,401 Total grant-date fair value of RSUs/PSUs vested (a) $ 232,141 $ 264,923 $ 257,648 PEPunits Total intrinsic value of PEPunits converted (a) $ 30,147 $ 39,782 $ 38,558 Total grant-date fair value of PEPunits vested (a) $ 9,430 $ 18,833 $ 16,572 (a) In thousands. As of December 29, 2018 and December 30, 2017 , there were approximately 248,000 and 250,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ( $162 million after-tax or $0.11 per share). See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in other pension and retiree medical benefits income/(expense) for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years) and retiree medical (approximately 7 years), or the remaining life expectancy for participants in Plan I (approximately 25 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits income/(expense) on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 14,777 $ 13,192 $ 3,490 $ 3,124 $ 1,187 $ 1,208 Service cost Interest cost Plan amendments (5 ) Participant contributions Experience (gain)/loss (972 ) 1,529 (230 ) (147 ) Benefit payments (956 ) (825 ) (114 ) (104 ) (108 ) (107 ) Settlement/curtailment (74 ) (58 ) (35 ) (22 ) Special termination benefits Other, including foreign currency adjustment (204 ) (3 ) Liability at end of year $ 13,807 $ 14,777 $ 3,098 $ 3,490 $ $ 1,187 Change in fair value of plan assets Fair value at beginning of year $ 12,582 $ 11,458 $ 3,460 $ 2,894 $ $ Actual return on plan assets (789 ) 1,935 (136 ) (21 ) Employer contributions/funding 1,495 Participant contributions Benefit payments (956 ) (825 ) (114 ) (104 ) (108 ) (107 ) Settlement (74 ) (46 ) (32 ) (18 ) Other, including foreign currency adjustment (210 ) Fair value at end of year $ 12,258 $ 12,582 $ 3,090 $ 3,460 $ $ Funded status $ (1,549 ) $ (2,195 ) $ (8 ) $ (30 ) $ (711 ) $ (866 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities (107 ) (74 ) (1 ) (1 ) (41 ) (75 ) Other liabilities (1,627 ) (2,407 ) (88 ) (114 ) (670 ) (791 ) Net amount recognized $ (1,549 ) $ (2,195 ) $ (8 ) $ (30 ) $ (711 ) $ (866 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 4,093 $ 3,520 $ $ $ (287 ) $ (189 ) Prior service cost/(credit) (1 ) (3 ) (51 ) (71 ) Total $ 4,202 $ 3,549 $ $ $ (338 ) $ (260 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ $ $ $ (115 ) $ (107 ) $ (9 ) Amortization and settlement recognition (187 ) (131 ) (56 ) (60 ) Foreign currency translation (gain)/loss (49 ) Total $ $ $ (2 ) $ (102 ) $ (98 ) $ Accumulated benefit obligation at end of year $ 12,890 $ 13,732 $ 2,806 $ 2,985 The net loss/(gain) arising in the current year is attributed to actual asset returns different from expected returns, partially offset by the change in discount rate. The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year. The amounts we report below operating profit as pension and retiree medical cost consist of the following components: Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of total pension and retiree medical benefit costs are as follows: Pension Retiree Medical U.S. International Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (943 ) (849 ) (834 ) (197 ) (176 ) (163 ) (19 ) (22 ) (24 ) Amortization of prior service cost/(credits) (1 ) (20 ) (25 ) (38 ) Amortization of net losses/(gains) (8 ) (12 ) (1 ) Settlement/curtailment losses/(gain) (a) (14 ) Special termination benefits Total $ $ $ $ $ $ $ $ $ (4 ) (a) U.S. includes a settlement charge of $ 242 million related to the group annuity contract purchase in 2016. See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The following table provides the weighted-average assumptions used to determine projected benefit liability and net periodic benefit cost for our pension and retiree medical plans: Pension Retiree Medical U.S. International Liability discount rate 4.4 % 3.7 % 4.4 % 3.4 % 3.0 % 3.1 % 4.2 % 3.5 % 4.0 % Service cost discount rate 3.8 % 4.5 % 4.6 % 3.5 % 3.6 % 4.1 % 3.6 % 4.0 % 4.3 % Interest cost discount rate 3.4 % 3.7 % 3.8 % 2.8 % 2.8 % 3.5 % 3.0 % 3.2 % 3.3 % Expected return on plan assets 7.2 % 7.5 % 7.5 % 6.0 % 6.0 % 6.2 % 6.5 % 7.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.7 % 3.6 % Expense rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.6 % 3.6 % The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ (8,040 ) $ (8,355 ) $ (155 ) $ (161 ) Fair value of plan assets $ 7,223 $ 6,919 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ (8,957 ) $ (9,400 ) $ (514 ) $ (1,273 ) $ (996 ) $ (1,187 ) Fair value of plan assets $ 7,223 $ 6,919 $ $ 1,158 $ $ Of the total projected pension benefit liability as of December 29, 2018 , approximately $830 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2024 - 2028 Pension $ 1,060 $ $ $ $ $ 5,265 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2019 through 2023 and approximately $6 million in total for 2024 through 2028. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ 1,417 $ $ $ $ $ Non-discretionary Total $ 1,615 $ $ $ $ $ (a) Includes $1.4 billion contribution in 2018 to fund Plan A in the United States. Includes $ 452 million in 2016 relating to the funding of the group annuity contract purchase from an unrelated insurance company. In January 2019, we made discretionary contributions of $ 150 million to Plan A in the United States. In addition, in 2019, we expect to make non-discretionary contributions of approximately $205 million to our U.S. and international pension benefit plans and approximately $40 million for retiree medical benefits. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2019 and 2018 , our expected long-term rate of return on U.S. plan assets is 7.1% and 7.2% , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five -year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of fiscal year-end 2018 and 2017 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 5,605 $ 5,595 $ $ $ 6,904 Government securities (c) 1,674 1,674 1,365 Corporate bonds (c) 4,145 4,145 3,429 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 11,860 $ 5,810 $ 6,041 $ 12,159 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 12,543 $ 12,903 International plan assets Equity securities (b) $ 1,651 $ 1,621 $ $ $ 1,928 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 2,981 $ 2,004 $ $ 3,351 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,090 $ 3,460 (a) 2018 and 2017 amounts include $285 million and $ 321 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The U.S. commingled funds are based on fair values of the investments owned by these funds that are benchmarked against various U.S. large, mid-cap and small company indices, and includes one large-cap fund that represents 15% and 19% of total U.S. plan assets for 2018 and 2017 , respectively. The international commingled funds are based on the fair values of the investments owned by these funds that track various non-U.S. equity indices. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 28% and 23% of total U.S. plan assets for 2018 and 2017 , respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 29, 2018 and December 30, 2017. (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase 111 These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. Savings Plan Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2018 , 2017 and 2016 , our total Company contributions were $180 million , $176 million and $164 million , respectively. For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 8 Debt Obligations The following table summarizes the Companys debt obligations: 2018 (a) 2017 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 3,953 $ 4,020 Commercial paper (1.3%) 1,385 Other borrowings (6.0% and 4.7%) $ 4,026 $ 5,485 Long-term debt obligations (b) Notes due 2018 (2.4%) $ $ 4,016 Notes due 2019 (3.1% and 2.1%) 3,948 3,933 Notes due 2020 (3.9% and 3.1%) 3,784 3,792 Notes due 2021 (3.1% and 2.4%) 3,257 3,300 Notes due 2022 (2.8% and 2.6%) 3,802 3,853 Notes due 2023 (2.9% and 2.4%) 1,270 1,257 Notes due 2024-2047 (3.7% and 3.8%) 16,161 17,634 Other, due 2018-2026 (1.3% and 1.3%) 32,248 37,816 Less: current maturities of long-term debt obligations (3,953 ) (4,020 ) Total $ 28,295 $ 33,796 (a) Amounts are shown net of unamortized net discounts of $119 million and $155 million for 2018 and 2017, respectively. (b) The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for additional information regarding our interest rate derivative instruments. As of December 29, 2018 , our international debt of $62 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. In 2018 , we completed a cash tender offer for certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $1.6 billion in cash to redeem the following amounts: Interest Rate Maturity Date Amount Tendered 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ 4.875 % November 2040 $ 5.500 % January 2040 $ We also completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for the following newly issued PepsiCo notes. These notes were issued in an aggregate principal amount equal to the exchanged notes: Interest Rate Maturity Date Amount 7.290 % September 2026 $ 7.440 % September 2026 $ 7.000 % March 2029 $ 5.500 % May 2035 $ As a result of the above transactions, we recorded a pre-tax charge of $253 million ( $191 million after-tax or $0.13 per share) to interest expense, primarily representing the tender price paid over the carrying value of the tendered notes. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2018, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 4, 2023. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Also in 2018, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 3, 2019. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $3.75 billion five-year credit agreement and our $3.75 billion 364-day credit agreement, both dated as of June 5, 2017. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 29, 2018 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million , respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ( $156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. See Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our borrowings and long-term contractual commitments. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for energy, agricultural products and metals . Ineffectiveness for those derivatives that qualify for hedge accounting treatment was not material for all periods presented. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017 . Foreign Exchange Our operations outside of the United States generated 43% of our net revenue in 2018 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2018 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017 . The total notional amount of our debt instruments designated as net investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017 . Ineffectiveness for derivatives and non-derivatives that qualify for hedge accounting treatment was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017 . Ineffectiveness for derivatives that qualify for cash flow hedge accounting treatment was not material for all periods presented. As of December 29, 2018 , approximately 29% of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 43% as of December 30, 2017 . Available-for-Sale Securities Investments in debt securities are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale debt securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 29, 2018 and December 30, 2017 were not material. Changes in the fair value of available-for-sale debt securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We regularly review our investment portfolio to determine if any debt security is other-than-temporarily impaired. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a debt security is less than its cost; the financial condition of the issuer and any changes thereto; and our intent to sell, or whether we will more likely than not be required to sell, the debt security before recovery of its amortized cost basis. Our assessment of whether a debt security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular debt security. We recorded no other-than-temporary impairment charges on our available-for-sale debt securities for the years ended December 29, 2018 , December 30, 2017 and December 31, 2016 . In 2017, we recorded a pre-tax gain of $95 million ( $85 million after-tax or $0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. The gain on the sale of this equity investment was recorded in our ESSA segment in selling, general and administrative expenses. See Note 2 for additional information on investments in certain equity securities. KSF Beverage Holding Co., Ltd. During 2016, we concluded that the decline in estimated fair value of our 5% indirect equity interest in KSFB was other than temporary based on significant negative economic trends in China and changes in assumptions associated with KSFBs future financial performance arising from the disclosure by KSFBs parent company, Tingyi, regarding the operating results of its beverage business. As a result, we recorded a pre- and after-tax impairment charge of $373 million ( $0.26 per share) in 2016 in the AMENA segment. This charge was recorded in selling, general and administrative expenses on our income statement and reduced the value of our 5% indirect equity interest in KSFB to its estimated fair value. The estimated fair value was derived using both an income and market approach, and is considered a non-recurring Level 3 measurement within the fair value hierarchy. The carrying value of the investment in KSFB was $166 million as of December 29, 2018 and December 30, 2017 . We continue to monitor the impact of economic and other developments on the remaining value of our investment in KSFB. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Fair Value Measurements The fair values of our financial assets and liabilities as of December 29, 2018 and December 30, 2017 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale debt securities (b) $ 3,658 $ $ 14,510 $ Short-term investments (c) $ $ $ $ Prepaid forward contracts (d) $ $ $ $ Deferred compensation (e) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (f) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (g) $ $ $ $ Interest rate (g) Commodity (h) Commodity (i) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (g) $ $ $ $ Commodity (h) Commodity (i) $ $ $ $ Total derivatives at fair value (j) $ $ $ $ Total $ 3,931 $ 1,018 $ 14,901 $ (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 29, 2018 , these debt securities were primarily classified as cash equivalents. As of December 30, 2017 , $5.8 billion and $8.7 billion of debt securities were classified as cash equivalents and short-term investments, respectively. The decrease primarily reflects net maturities and sales of debt securities with maturities greater than three months. Refer to the cash flow statement and Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further discussion on use of these proceeds. (c) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (d) Based primarily on the price of our common stock. (e) Based on the fair value of investments corresponding to employees investment elections. (f) Based on LIBOR forward rates. (g) Based on recently reported market transactions of spot and forward rates. (h) Based on quoted contract prices on futures exchange markets. (i) Based on recently reported market transactions of swap arrangements. (j) Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 29, 2018 and December 30, 2017 were not material. Collateral received or posted against any of our asset or liability positions were not material. Collateral posted is classified as restricted cash. See Note 13 for further information. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 29, 2018 and December 30, 2017 was $32 billion and $41 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ $ (15 ) $ (52 ) $ $ (8 ) $ Interest rate (195 ) (184 ) Commodity (48 ) Net investment (77 ) Total $ $ $ (16 ) $ $ $ (171 ) (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net gains of $5 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 12,515 $ 4,857 $ 6,329 Preferred shares: Dividends (1 ) Redemption premium (2 ) (4 ) (5 ) Net income available for PepsiCo common shareholders $ 12,513 1,415 $ 4,853 1,425 $ 6,323 1,439 Basic net income attributable to PepsiCo per common share $ 8.84 $ 3.40 $ 4.39 Net income available for PepsiCo common shareholders $ 12,513 1,415 $ 4,853 1,425 $ 6,323 1,439 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other Employee stock ownership plan (ESOP) convertible preferred stock Diluted $ 12,515 1,425 $ 4,857 1,438 $ 6,329 1,452 Diluted net income attributable to PepsiCo per common share $ 8.78 $ 3.38 $ 4.36 (a) Weighted-average common shares outstanding (in millions). Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.7 0.4 0.7 Average exercise price per option $ 109.83 $ 110.12 $ 99.98 (a) In millions. Note 11 Preferred Stock In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001. In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock at the conversion ratio set forth in Exhibit A to our amended and restated articles of incorporation. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes. As of December 30, 2017 , there were 3 million shares of convertible preferred stock authorized, 803,953 preferred shares issued and 114,753 shares outstanding. The outstanding preferred shares had a fair value of $68 million as of December 30, 2017 . Activities of our preferred stock are included in the equity statement. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 26, 2015 (a) $ (11,080 ) $ $ (2,329 ) $ $ (35 ) $ (13,319 ) Other comprehensive (loss)/income before reclassifications (313 ) (74 ) (750 ) (43 ) (1,180 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income (313 ) (343 ) (43 ) (623 ) Tax amounts (30 ) Balance as of December 31, 2016 (a) (11,386 ) (2,645 ) (35 ) (13,919 ) Other comprehensive (loss)/income before reclassifications (b) 1,049 (375 ) Amounts reclassified from accumulated other comprehensive loss (171 ) (99 ) (112 ) Net other comprehensive (loss)/income 1,049 (41 ) (217 ) (74 ) Tax amounts Balance as of December 30, 2017 (a) (10,277 ) (2,804 ) (4 ) (19 ) (13,057 ) Other comprehensive (loss)/income before reclassifications (c) (1,664 ) (61 ) (813 ) (2,532 ) Amounts reclassified from accumulated other comprehensive loss Net other comprehensive (loss)/income (1,620 ) (595 ) (2,159 ) Tax amounts (21 ) (10 ) Balance as of December 29, 2018 (a) $ (11,918 ) $ $ (3,271 ) $ $ (19 ) $ (15,119 ) (a) Pension and retiree medical amounts are net of taxes of $1,253 million as of December 26, 2015, $1,280 million as of December 31, 2016, $1,338 million as of December 30, 2017 and $1,466 million as of December 29, 2018. (b) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. (c) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Divestitures $ $ $ Selling, general and administrative expenses Cash flow hedges: Foreign exchange contracts $ (1 ) $ $ Net revenue Foreign exchange contracts (7 ) (46 ) Cost of sales Interest rate derivatives (184 ) Interest expense Commodity contracts Cost of sales Commodity contracts (3 ) (1 ) Selling, general and administrative expenses Net losses/(gains) before tax (171 ) Tax amounts (27 ) (63 ) Net losses/(gains) after tax $ $ (107 ) $ Pension and retiree medical items: Amortization of net prior service credit $ (17 ) $ (24 ) $ (39 ) Other pension and retiree medical benefits income/(expense) Amortization of net losses Other pension and retiree medical benefits income/(expense) Settlement/curtailment Other pension and retiree medical benefits income/(expense) Net losses before tax Tax amounts (45 ) (44 ) (144 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ $ (99 ) $ Selling, general and administrative expenses Tax amount Net gain after tax $ $ (89 ) $ Total net losses/(gains) reclassified for the year, net of tax $ $ (82 ) $ Note 13 Restricted Cash The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement. Cash and cash equivalents $ 8,721 $ 10,610 Restricted cash (a) 1,997 Restricted cash included in other assets (b) Total cash and cash equivalents and restricted cash $ 10,769 $ 10,657 (a) Represents consideration held by our paying agent in connection with our acquisition of SodaStream. (b) Restricted cash included in other assets primarily relates to collateral posted against our derivative asset or liability positions. Note 14 Acquisitions and Divestitures Acquisition of SodaStream International Ltd. On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $144.00 per share in cash, in a transaction valued at approximately $3.3 billion . The total consideration transferred was approximately $3.3 billion (or $3.2 billion , net of cash and cash equivalents acquired), including $2.0 billion of consideration held by our paying agent in connection with this acquisition and reported as restricted cash as of December 29, 2018. We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The preliminary estimates of the fair value of the identifiable assets acquired and liabilities assumed in SodaStream as of the acquisition date include goodwill and other intangible assets of $3.0 billion and property, plant and equipment of $0.2 billion , all of which are recorded in our ESSA segment. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values discussed above as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the end of 2019. Under the guidance on accounting for business combinations, merger and integration costs are not included as components of consideration transferred but are accounted for as expenses in the period in which the costs are incurred. In 2018, we incurred merger and integration charges of $75 million ( $0.05 per share), including $57 million in our ESSA segment and $18 million in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs and were recorded in selling, general and administrative expenses. See Item 6. Selected Financial Data and Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Refranchising in Thailand In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $144 million ( $126 million after-tax or $0.09 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Refranchising in Czech Republic, Hungary, and Slovakia In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in CHS (included within our ESSA segment). We recorded a pre-tax gain of $58 million ( $46 million after-tax or $0.03 per share) in selling, general and administrative expenses in our ESSA segment as a result of this transaction. Refranchising in Jordan In 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $140 million ( $107 million after-tax or $0.07 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Note 15 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 6,079 $ 5,956 Other receivables 1,164 1,197 7,243 7,153 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) (33 ) (35 ) (30 ) Other (b) (11 ) (3 ) Allowance, end of year $ Net receivables $ 7,142 $ 7,024 Inventories (c) Raw materials and packaging $ 1,312 $ 1,344 Work-in-process Finished goods 1,638 1,436 $ 3,128 $ 2,947 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Other $ $ Accounts payable and other current liabilities Accounts payable $ 7,213 $ 6,727 Accrued marketplace spending 2,541 2,390 Accrued compensation and benefits 1,755 1,785 Dividends payable 1,329 1,161 SodaStream consideration payable 1,997 Other current liabilities 3,277 2,954 $ 18,112 $ 15,017 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 5% of the inventory cost in 2018 and 2017 were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for additional information regarding our pension plans. Statement of Cash Flows Interest paid (a) $ 1,388 $ 1,123 $ 1,102 Income taxes paid, net of refunds (b) $ 1,203 $ 1,962 $ 1,393 (a) In 2018 and 2016, excludes the premiums paid in accordance with the debt transactions discussed in Note 8. (b) In 2018, includes tax payments of $115 million related to the TCJ Act. Lease Information Rent expense $ $ $ Minimum lease payments under non-cancelable operating leases by period Operating Lease Payments $ 2020 2021 2022 2023 2024 and beyond Total minimum operating lease payments $ 1,840 Managements Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions the actions of all our associates are governed by our Global Code of Conduct. This Code is clearly aligned with our stated values a commitment to deliver sustained growth through empowered people acting with responsibility and building trust. Both the Code and our core values enable us to operate with integrity both within the letter and the spirit of the law. Our Code of Conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements, and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control Integrated Framework (2013). The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the United States. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Global Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Boards oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our Internal Auditor and with our General Counsel. We also have a Compliance Ethics Department, led by our Chief Compliance Ethics Officer, who coordinates our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the United States, which require estimates based on managements best judgment. PepsiCo has a strong history of doing whats right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. February 15, 2019 /s/ MARIE T. GALLAGHER Marie T. Gallagher Senior Vice President and Controller (Principal Accounting Officer) /s/ HUGH F. JOHNSTON Hugh F. Johnston Vice Chairman, Executive Vice President and Chief Financial Officer /s/ RAMON L. LAGUARTA Ramon L. Laguarta Chairman of the Board of Directors and Chief Executive Officer Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and Subsidiaries (the Company) as of December 29, 2018 and December 30, 2017, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 29, 2018 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 29, 2018 and December 30, 2017, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 29, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. As permitted by SEC guidance, the scope of managements assessment of the effectiveness of internal control over financial reporting as of December 29, 2018 excluded SodaStream International Ltd. and its subsidiaries (SodaStream), which the Company acquired in December 2018. SodaStreams total assets and net revenue represented approximately 5% and 1%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 29, 2018. Our audit of internal control over financial reporting of PepsiCo, Inc. also excluded an evaluation of the internal control over financial reporting of SodaStream. Basis for Opinions The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 15, 2019 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Derivatives : financial instruments, such as futures, swaps, Treasury locks, cross currency swaps and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates and foreign exchange rates. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending plus sales of property, plant and equipment. Hedge accounting : treatment for qualifying hedges that allows fluctuations in a hedging instruments fair value to offset corresponding fluctuations in the hedged item in the same reporting period. Hedge accounting is allowed only in cases where the hedging relationship between the hedging instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net gain or loss : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, and foreign exchange translation. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for additional information. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 29, 2018 . As permitted by SEC guidance, the scope of managements assessment of the effectiveness of our internal control over financial reporting as of December 29, 2018 excluded SodaStream International Ltd. and its subsidiaries (SodaStream), which we acquired in December 2018. SodaStreams total assets and net revenue represented approximately 5% and 1%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 29, 2018. Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. Except as discussed, there have been no changes in our internal control over financial reporting during our fourth fiscal quarter of 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth fiscal quarter of 2018 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In addition, in connection with our 2019 multi-year productivity program, we continue to migrate to shared business models across our operations to further simplify, harmonize and automate processes. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. These transitions have not materially affected, and we do not expect them to materially affect, our internal control over financial reporting. " +4,peps,201710-k," Item 1. Business. When used in this report, the terms we, us, our, PepsiCo and the Company mean PepsiCo, Inc. and its consolidated subsidiaries, collectively. Certain terms used in this Annual Report on Form 10-K are defined in the Glossary included in Item 7. of this report. Company Overview We were incorporated in Delaware in 1919 and reincorporated in North Carolina in 1986. We are a leading global food and beverage company with a complementary portfolio of enjoyable brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. Our Operations We are organized into six reportable segments (also referred to as divisions), as follows: 1) Frito-Lay North America (FLNA), which includes our branded food and snack businesses in the United States and Canada; 2) Quaker Foods North America (QFNA), which includes our cereal, rice, pasta and other branded food businesses in the United States and Canada; 3) North America Beverages (NAB), which includes our beverage businesses in the United States and Canada; 4) Latin America, which includes all of our beverage, food and snack businesses in Latin America; 5) Europe Sub-Saharan Africa (ESSA), which includes all of our beverage, food and snack businesses in Europe and Sub-Saharan Africa; and 6) Asia, Middle East and North Africa (AMENA), which includes all of our beverage, food and snack businesses in Asia, Middle East and North Africa. Our segment net revenue (in millions) and contributions to consolidated net revenue for each of the last three fiscal years were as follows: Net Revenue % of Total Net Revenue 2016 (a) FLNA $ 15,798 $ 15,549 $ 14,782 % % % QFNA 2,503 2,564 2,543 NAB 20,936 21,312 20,618 Latin America 7,208 6,820 8,228 ESSA 11,050 10,216 10,510 AMENA 6,030 6,338 6,375 $ 63,525 $ 62,799 $ 63,056 % % % (a) Our fiscal 2016 results included an extra week of results (53 rd reporting week). The 53 rd reporting week increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. See Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. See also Item 1A. Risk Factors below for a discussion of certain risks associated with our operations, including outside the United States. Frito-Lay North America Either independently or in conjunction with third parties, FLNA makes, markets, distributes and sells branded snack foods. These foods include branded dips, Cheetos cheese-flavored snacks, Doritos tortilla chips, Fritos corn chips, Lays potato chips, Ruffles potato chips, Santitas tortilla chips and Tostitos tortilla chips. FLNAs branded products are sold to independent distributors and retailers. In addition, FLNAs joint venture with Strauss Group makes, markets, distributes and sells Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third parties, QFNA makes, markets, distributes and sells cereals, rice, pasta and other branded products. QFNAs products include Aunt Jemima mixes and syrups, Capn Crunch cereal, Life cereal, Quaker Chewy granola bars, Quaker grits, Quaker oat squares, Quaker oatmeal, Quaker rice cakes, Quaker simply granola and Rice-A-Roni side dishes. These branded products are sold to independent distributors and retailers. North America Beverages Either independently or in conjunction with third parties, NAB makes, markets and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including Aquafina, Diet Mountain Dew, Diet Pepsi, Gatorade, Mist Twst, Mountain Dew, Pepsi, Propel and Tropicana. NAB also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks, respectively. Further, NAB manufactures and distributes certain brands licensed from Dr Pepper Snapple Group, Inc. (DPSG), including Crush, Dr Pepper and Schweppes, and certain juice brands licensed from Dole Food Company, Inc. (Dole) and Ocean Spray Cranberries, Inc. (Ocean Spray). NAB operates its own bottling plants and distribution facilities and sells branded finished goods directly to independent distributors and retailers. NAB also sells concentrate and finished goods for our brands to authorized and independent bottlers, who in turn sell our branded finished goods to independent distributors and retailers in certain markets. Latin America Either independently or in conjunction with third parties, Latin America makes, markets, distributes and sells a number of snack food brands including Cheetos, Doritos, Emperador, Lays, Marias Gamesa, Rosquinhas Mabel, Ruffles, Sabritas, Saladitas and Tostitos, as well as many Quaker-branded cereals and snacks. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Gatorade, H2oh!, Manzanita Sol, Mirinda, Pepsi and Toddy. These branded products are sold to authorized bottlers, independent distributors and retailers. Latin America also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). See Note 1 to our consolidated financial statements for information about the deconsolidation of our Venezuelan subsidiaries, which was effective as of the end of the third quarter of 2015. Europe Sub-Saharan Africa Either independently or in conjunction with third parties, ESSA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipita, Doritos, Lays, Ruffles and Walkers, as well as many Quaker-branded cereals and snacks, through consolidated businesses as well as through noncontrolled affiliates. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Diet Pepsi, Mirinda, Pepsi, Pepsi Max and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, ESSA operates its own bottling plants and distribution facilities. ESSA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, ESSA makes, markets, distributes and sells a number of leading dairy products including Agusha, Chudo and Domik v Derevne. Asia, Middle East and North Africa Either independently or in conjunction with third parties, AMENA makes, markets, distributes and sells a number of leading snack food brands including Cheetos, Chipsy, Crunchy, Doritos, Kurkure and Lays, as well as many Quaker branded cereals and snacks, through consolidated businesses, as well as through noncontrolled affiliates. AMENA also makes, markets, distributes and sells beverage concentrates, fountain syrups and finished goods under various beverage brands including 7UP, Aquafina, Mirinda, Mountain Dew, Pepsi and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, AMENA operates its own bottling plants and distribution facilities. AMENA also, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, we license the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi (Cayman Islands) Holding Corp. (Tingyi). Our Distribution Network Our products are primarily brought to market through direct-store-delivery (DSD), customer warehouse and distributor networks. The distribution system used depends on customer needs, product characteristics and local trade practices. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver beverages, foods and snacks directly to retail stores where the products are merchandised by our employees or our independent bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses. These less costly systems generally work best for products that are less fragile and perishable, and have lower turnover. Distributor Networks We distribute many of our products through third-party distributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For example, our foodservice and vending business distributes beverages, foods and snacks to restaurants, businesses, schools and stadiums through third-party foodservice and vending distributors and operators. Our products are also available on a growing number of e-commerce websites and mobile commerce applications as consumer consumption patterns continue to change and retail increasingly expands online. Ingredients and Other Supplies The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. We employ specialists to secure adequate supplies of many of these items and have not experienced any significant continuous shortages that would prevent us from meeting our requirements. Many of these ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. When prices increase, we may or may not pass on such increases to our customers. In addition, we continue to make investments to improve the sustainability and resources of our agricultural supply chain, including the development of our initiative to advance sustainable farming practices by our suppliers and expanding it globally. See Note 9 to our consolidated financial statements for additional information on how we manage our exposure to commodity costs. Our Brands and Intellectual Property Rights We own numerous valuable trademarks which are essential to our worldwide businesses, including Agusha, Amp Energy, Aquafina, Aquafina Flavorsplash, Aunt Jemima, Capn Crunch, Cheetos, Chesters, Chipsy, Chokis, Chudo, Cracker Jack, Crunchy, Diet Mist Twst, Diet Mountain Dew, Diet Mug, Diet Pepsi, Diet 7UP (outside the United States), Domik v Derevne, Doritos, Duyvis, Elma Chips, Emperador, Frito-Lay, Fritos, Fruktovy Sad, G2, Gamesa, Gatorade, Grandmas, H2oh!, Imunele, Izze, J-7 Tonus, Kas, KeVita, Kurkure, Lays, Life, Lifewtr, Lifewater, Lubimy, Manzanita Sol, Marias Gamesa, Matutano, Mirinda, Miss Vickies, Mist Twst, Mothers, Mountain Dew, Mountain Dew Code Red, Mountain Dew Kickstart, Mug, Munchies, Naked, Near East, O.N.E., Paso de los Toros, Pasta Roni, Pepsi, Pepsi Max, Pepsi Next, Pepsi Zero Sugar, Propel, Quaker, Quaker Chewy, Rice-A-Roni, Rold Gold, Rosquinhas Mabel, Ruffles, Sabritas, Sakata, Saladitas, Sandora, Santitas, 7UP (outside the United States), 7UP Free (outside the United States), Simba, Smartfood, Smiths, Snack a Jacks, SoBe, SoBe Lifewater, Sonrics, Stacys, Sting, SunChips, Toddy, Toddynho, Tostitos, Trop 50, Tropicana, Tropicana Farmstand, Tropicana Pure Premium, Tropicana Twister, V Water, Vesely Molochnik, Walkers and Ya. We also hold long-term licenses to use valuable trademarks in connection with our products in certain markets, including Dole and Ocean Spray. We also distribute Rockstar Energy drinks, Muscle Milk protein shakes and various DPSG brands, including Dr Pepper in certain markets, Crush and Schweppes. Joint ventures in which we have an ownership interest either own or have the right to use certain trademarks, such as Lipton, Sabra and Starbucks. Trademarks remain valid so long as they are used properly for identification purposes, and we emphasize correct use of our trademarks. We have authorized, through licensing arrangements, the use of many of our trademarks in such contexts as snack food joint ventures and beverage bottling appointments. In addition, we license the use of our trademarks on merchandise that is sold at retail, which enhances brand awareness. We either own or have licenses to use a number of patents which relate to certain of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. Some of these patents are licensed to others. Seasonality Our businesses are affected by seasonal variations. For instance, our beverage sales are higher during the warmer months and certain food and dairy sales are higher in the cooler months. Weekly beverage and snack sales are generally highest in the third quarter due to seasonal and holiday-related patterns, and generally lowest in the first quarter. However, taken as a whole, seasonality has not had a material impact on our consolidated financial results. Our Customers Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. We also grant distribution rights to our independent bottlers for certain beverage products bearing our trademarks for specified geographic areas. We rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products to the consumer. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Changes to the retail landscape, including increased consolidation of retail ownership, the rapid growth of sales through e-commerce websites and mobile commerce applications, the integration of physical and digital operations among retailers, as well as the growth in hard discounters, and the current economic environment continue to increase the importance of major customers. In 2017 , sales to Walmart Inc. (Walmart), including Sams Club (Sams), represented approximately 13% of our consolidated net revenue. Our top five retail customers represented approximately 33% of our 2017 net revenue in North America, with Walmart (including Sams) representing approximately 19% . These percentages include concentrate sales to our independent bottlers, which were used in finished goods sold by them to these retailers. See Off-Balance-Sheet Arrangements in Our Financial Results Our Liquidity and Capital Resources in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations for more information on our independent bottlers. Our Competition Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local and private label manufacturers, economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, DPSG, Kellogg Company, The Kraft Heinz Company, Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Snyders-Lance, Inc. Many of our food and snack products hold significant leadership positions in the food and snack industry in the United States and worldwide. In 2017 , we and The Coca-Cola Company represented approximately 23% and 20%, respectively, of the U.S. liquid refreshment beverage category by estimated retail sales in measured channels, according to Information Resources, Inc. However, The Coca-Cola Company has significant carbonated soft drink (CSD) share advantage in many markets outside the United States. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, the effectiveness of our advertising campaigns, marketing programs, product packaging, pricing, increased efficiency in production techniques, new vending and dispensing equipment and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Research and Development We engage in a variety of research and development activities and invest in innovation globally with the goal of meeting changing consumer demands and preferences and accelerating sustainable growth. These activities principally involve: development of new ingredients, flavors and products; reformulation and improvement in the quality and appeal of existing products; improvement and modernization of manufacturing processes, including cost reduction; improvements in product quality, safety and integrity; development of, and improvements in, dispensing equipment, packaging technology, package design and portion sizes; efforts focused on identifying opportunities to transform, grow and broaden our product portfolio, including by developing products with improved nutrition profiles that reduce added sugars, sodium or saturated fat, including through the use of sweetener alternatives and flavor modifiers and innovation in existing sweeteners, and by offering more products with positive nutrition including whole grains, fruits and vegetables, dairy, protein and hydration; investments in building our capabilities to support our global e-commerce business; and improvements in energy efficiency and efforts focused on reducing our impact on the environment. Our research centers are located around the world, including in Brazil, China, India, Ireland, Mexico, Russia, the United Arab Emirates, the United Kingdom and the United States, and leverage nutrition science, food science, engineering and consumer insights to meet our strategy to continue to develop nutritious and convenient beverages, foods and snacks. In 2017 , we continued to refine our beverage, food and snack portfolio to meet changing consumer demands by reducing added sugars in many of our beverages and sodium and saturated fat in many of our foods and snacks, and by developing a broader portfolio of product choices, including: continuing to expand our beverage options that contain no high-fructose corn syrup and that are made with natural flavors; expanding our state-of-the-art food and beverage healthy vending initiative to increase the availability of convenient, affordable and enjoyable nutrition; further expanding our portfolio of nutritious products by building on our important nutrition platforms and brands Quaker (grains), Tropicana (juices, lemonades, fruit and vegetable drinks), Gatorade (sports nutrition for athletes), Naked Juice (cold-pressed juices and smoothies) and KeVita (probiotics, tonics and fermented teas); further expanding our whole grain products globally; and further expanding our portfolio of nutritious products in growing categories, such as dairy, hummus and other refrigerated dips, and baked grain snacks. In addition, we continued to make investments to reduce our impact on the environment, including: efforts to conserve raw materials and energy, such as by working to achieve reductions in greenhouse gas emissions across our global businesses, by helping to protect and conserve global water supply especially in high-water-risk locations (including replenishing watersheds that source our operations in high-water-risk locations and promoting the efficient use of water use in our agricultural supply chain), and by incorporating into our operations, improvements in the sustainability and resources of our agricultural supply chain; efforts to reduce waste generated by our operations and disposed of in landfills; efforts to support increased packaging recovery and recycling rates; efforts to increase energy efficiency, including the increased use of renewable energy and resources; efforts to support sustainable agriculture by expanding best practices with our growers and suppliers; and efforts to optimize packaging technology and design to make our packaging increasingly recoverable or recyclable with lower environmental impact, including continuing to invest in developing compostable and biodegradable packaging. Research and development costs were $737 million , $760 million and $ 754 million in 2017 , 2016 and 2015 , respectively, and are reported within selling, general and administrative expenses. Consumer research is excluded from such research and development costs and included in other marketing costs. Regulatory Matters The conduct of our businesses, including the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, disposal, recycling and use of our products, as well as our occupational health and safety practices and protection of personal information, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies in the more than 200 other countries and territories in which our products are made, manufactured, distributed or sold. It is our policy to abide by the laws and regulations around the world that apply to our businesses. The U.S. laws and regulations that we are subject to include: the Federal Food, Drug and Cosmetic Act and various state laws governing food safety; the Food Safety Modernization Act; the Occupational Safety and Health Act; various federal, state and local environmental protection laws, as discussed below; the Federal Motor Carrier Safety Act; the Federal Trade Commission Act; the Lanham Act; various federal and state laws and regulations governing competition and trade practices; various federal and state laws and regulations governing our employment practices, including those related to equal employment opportunity, such as the Equal Employment Opportunity Act and the National Labor Relations Act and those related to overtime compensation, such as the Fair Labor Standards Act; customs and foreign trade laws and regulations; laws regulating the sale of certain of our products in schools; and laws relating to the payment of taxes. We are also required to comply with the Foreign Corrupt Practices Act and the Trade Sanctions Reform and Export Enhancement Act. We are also subject to various state and local statutes and regulations, including state consumer protection laws such as Proposition 65 in California, which requires that a specific warning appear on any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects, unless the amount of such substance in the product is below a safe harbor level. We are also subject to numerous similar and other laws and regulations outside the United States, including but not limited to laws and regulations governing food safety, occupational health and safety, competition, anti-corruption and data privacy. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws, including the U.K. Bribery Act. We rely on legal and operational compliance programs, as well as in-house and outside counsel and other experts, to guide our businesses in complying with the laws and regulations around the world that apply to our businesses. In addition, certain jurisdictions have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. In addition, certain jurisdictions have either imposed, or are considering imposing, product labeling or warning requirements or other limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products or the audience to whom products are marketed. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. Regulators may also restrict consumers ability to use benefit programs, such as the Supplemental Nutrition Assistance Program in the United States, to purchase certain beverages and foods. In addition, legislation has been enacted in certain U.S. states and in certain other countries where our products are sold that requires collection and recycling of containers or that prohibits the sale of our beverages in certain non-refillable containers, unless a deposit, ecotax or other fee is charged. It is possible that similar or more restrictive requirements may be proposed or enacted in the future. We are also subject to national and local environmental laws in the United States and in foreign countries in which we do business, including laws related to water consumption and treatment, wastewater discharge and air emissions. In the United States, our facilities must comply with the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act and other federal and state laws regarding handling, storage, release and disposal of wastes generated on-site and sent to third-party owned and operated off-site licensed facilities and our facilities outside the United States must comply with similar laws and regulations. In addition, continuing concern over climate change may result in new or increased legal and regulatory requirements (in or outside of the United States) to reduce or mitigate the potential effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. Our policy is to abide by all applicable environmental laws and regulations, and we have internal programs in place with respect to our global environmental compliance. We have made, and plan to continue making, necessary expenditures for compliance with applicable environmental laws and regulations. While these expenditures have not had a material impact on our business, financial condition or results of operations to date, changes in environmental compliance requirements, and any expenditures necessary to comply with such requirements, could adversely affect our financial performance. In addition, we and our subsidiaries are subject to environmental remediation obligations arising in the normal course of business, as well as remediation and related indemnification obligations in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. While these environmental remediation and indemnification obligations cannot be predicted with certainty, such obligations have not had, and are not expected to have, a material impact on our capital expenditures, earnings or competitive position. In addition to the discussion in this section, see also Item 1A. Risk Factors. Employees As of December 30, 2017 , we and our consolidated subsidiaries employed approximately 263,000 people worldwide, including approximately 113,000 people within the United States. In certain countries, our employment levels are subject to seasonal variations. We or our subsidiaries are party to numerous collective bargaining agreements. We expect that we will be able to renegotiate these collective bargaining agreements on satisfactory terms when they expire. We believe that relations with our employees are generally good. Available Information We are required to file annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). The public may read and copy any materials that we file with the SEC at the SECs Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are also available free of charge on our Internet site at http://www.pepsico.com as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Investors should note that we currently announce material information to our investors and others using filings with the SEC, press releases, public conference calls, webcasts or our corporate website ( www.pepsico.com ), including news and announcements regarding our financial performance, key personnel, our brands and our business strategy. Information that we post on our corporate website could be deemed material to investors. We encourage investors, the media, our customers, consumers, business partners and others interested in us to review the information we post on these channels. We may from time to time update the list of channels we will use to communicate information that could be deemed material and will post information about any such change on www.pepsico.com . The information on our website is not, and shall not be deemed to be, a part hereof or incorporated into this or any of our other filings with the SEC. "," Item 1A. Risk Factors. You should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K. Any of the factors described below could occur or continue to occur and could have a material adverse effect on our business, financial condition, results of operations or the price of our publicly traded securities. The risks below are not the only risks we face. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, may occur or become material in the future and may also adversely affect our business, reputation, financial condition, results of operations or the price of our publicly traded securities. Therefore, historical operating results, financial and business performance, events and trends may not be a reliable indicator of future operating results, financial and business performance, events or trends. Demand for our products may be adversely affected by changes in consumer preferences or any inability on our part to innovate, market or distribute our products effectively, and any significant reduction in demand could adversely affect our business, financial condition or results of operations. We are a global food and beverage company operating in highly competitive categories and markets. To generate revenues and profits, we rely on continued demand for our products and therefore must understand our customers and consumers and sell products that appeal to them in the sales channel in which they prefer to shop or browse for such products. In general, changes in consumption in our product categories or consumer demographics could result in reduced demand for our products. Demand for our products depends in part on our ability to anticipate and effectively respond to shifts in consumer trends and preferences, including increased demand for products that meet the needs of consumers who are concerned with: health and wellness (including products that have less added sugars, sodium and saturated fat); convenience (including responding to changes in in-home and on-the-go consumption patterns and methods of distribution of our products to customers and consumers); or the location of origin or source of the ingredients and products (including the environmental impact related to the production of our products). Consumer preferences have been evolving, and are expected to continue to evolve, due to a variety of factors, including: changes in consumer demographics, including the aging of the general population and the emergence of the millennial and younger generations who have differing spending and consumption habits; consumer concerns or perceptions regarding the nutrition profile of certain of our products, including the presence of added sugar, sodium and saturated fat in certain of our products; growing demand for organic or locally sourced ingredients, or consumer concerns or perceptions (whether or not valid) regarding the health effects of ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, artificial flavors and colors, artificial sweeteners, aspartame, caffeine, furfuryl alcohol, high-fructose corn syrup, partially hydrolyzed oils, saturated fat, sodium, sugar, trans fats or other product ingredients, substances or attributes, including genetically engineered ingredients; taxes or other restrictions, including labeling requirements, imposed on our products; consumer concerns or perceptions regarding packaging materials, including their environmental impact; changes in package or portion size; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; the continued acceleration of e-commerce and other methods of purchasing products; negative publicity (whether or not valid) resulting from regulatory actions, litigation against us or other companies in our industry or negative or inaccurate posts or comments in the media, including social media, about us, our employees, our products or advertising campaigns and marketing programs; perception of social media posts or other information disseminated by us or our employees and agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties; perception of our employees, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties or the business practices of such parties; product boycotts; or a downturn in economic conditions. Any of these factors may reduce consumers willingness to purchase our products and any inability on our part to anticipate or react to such changes could result in reduced demand for our products and erosion of our competitive and financial position and could adversely affect our business, reputation, financial condition or results of operations. Demand for our products is also dependent in part on product quality, product and marketing innovation and production and distribution, including our ability to: maintain a robust pipeline of new products; improve the quality of existing products; extend our portfolio of products in growing markets and categories; respond to cultural differences and regional consumer preferences (whether through developing or acquiring new products that are responsive to such preferences); monitor and adjust our use of ingredients (including to respond to applicable regulations); develop or acquire a broader portfolio of product choices, including by continuing to increase non-carbonated beverage offerings and other alternatives to traditional carbonated beverage offerings and, in some cases, reformulations of our traditional carbonated beverage offerings; develop sweetener alternatives and innovation; improve the production, packaging and distribution of our products; respond to competitive product and pricing pressures and changes in distribution channels, including in the rapidly growing e-commerce channel; and implement effective advertising campaigns and marketing programs, including successfully adapting to a rapidly changing media environment through the use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the items mentioned above, there can be no assurance as to our continued ability to develop, launch, maintain or distribute successful new products or variants of existing products in a timely manner (including to correctly anticipate or effectively react to changes in consumer preferences) or to develop and effectively execute advertising and marketing campaigns that appeal to customers and consumers. Our failure to make the right strategic investments to drive innovation or successfully launch new products or variants of existing products or effectively distribute our products could decrease demand for our existing products by negatively affecting consumer perception of our existing brands and may result in inventory write-offs and other costs that could adversely affect our business, financial condition or results of operations. Changes in, or failure to comply with, laws and regulations applicable to our products or our business operations could adversely affect our business, financial condition or results of operations. The conduct of our business is subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as government entities and agencies outside the United States, including laws and regulations relating to the production, storage, distribution, sale, display, advertising, marketing, labeling, content, quality, safety, transportation, disposal, recycling and use of our products, as well as our employment and occupational health and safety practices and protection of personal information. In addition, in many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions, as is compliance with anti-corruption laws. Many of these laws and regulations have differing or conflicting legal standards across the various markets where our products are made, manufactured, distributed or sold and, in certain markets, such as developing and emerging markets, may be less developed or certain. For example, products containing genetically engineered ingredients are subject to varying regulations and restrictions in the jurisdictions in which our products are made, manufactured, distributed or sold. In addition, these laws and regulations and related interpretations may change, sometimes dramatically and unexpectedly, as a result of a variety of factors, including political, economic or social events. Such changes may include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices; laws and treaties related to international trade, including laws regarding the import or export of our products or ingredients used in our products and tariffs; laws and programs restricting the sale and advertising of certain of our products, including restrictions on the audience to whom products are marketed; laws and programs aimed at reducing, restricting or eliminating ingredients or substances in, or attributes of, certain of our products; laws and programs aimed at discouraging the consumption or altering the package or portion size of certain of our products, including laws imposing restrictions on the use of government funds or programs, such as the Supplemental Nutrition Assistance Program (included within the Farm Bill in the United States), to purchase certain of our products; increased regulatory scrutiny of, and increased litigation involving product claims and concerns (whether or not valid) regarding the effects on health of ingredients or substances in, or attributes of, certain of our products, including without limitation those found in energy drinks; state consumer protection laws; laws regulating the protection of personal information; cyber-security regulations; regulatory initiatives, including the imposition or proposed imposition of new or increased taxes or other measures impacting the manufacture, distribution or sale of our products; accounting rules and interpretations; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating water rights and access to and use of water or utilities; environmental laws, including laws relating to the regulation of water treatment and discharge of wastewater and air emissions and laws relating to the disposal, recovery or recycling of our products and their packaging. Changes in regulatory requirements, and competing regulations and standards, where our products are made, manufactured, distributed or sold, may result in higher compliance costs, capital expenditures and higher production costs, which could adversely affect our business, reputation, financial condition or results of operations. The imposition by any jurisdiction in the United States or outside the United States of new laws, regulations or governmental policy and their related interpretations, or changes in any of the foregoing, including taxes, labeling, product or production requirements or other limitations on, or pertaining to, the sale or advertisement of certain of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products, may further alter the way in which we do business and, therefore, may continue to increase our costs or liabilities or reduce demand for our products, which could adversely affect our business, financial condition or results of operations. If one jurisdiction imposes or proposes to impose new requirements or restrictions, other jurisdictions may follow and the requirements or restrictions, or proposed requirements or restrictions, may also result in adverse publicity (whether or not valid). For example, if one jurisdiction imposes a tax on sugar-sweetened beverages or foods, or imposes a specific labeling or warning requirement, other jurisdictions may impose similar or other measures that impact the manufacture, distribution or sale of our products. The foregoing may result in decreased demand for our products, adverse publicity or increased concerns about the health implications of consumption of ingredients or substances in our products (whether or not valid). In addition, studies (whether or not scientifically valid) are underway by third parties purporting to assess the health implications of consumption of certain ingredients or substances present in certain of our products, such as 4-MeI, acrylamide, caffeine, furfuryl alcohol, added sugars, sodium and saturated fat. Third parties have also published documents or studies claiming (whether or not valid) that taxes can address consumer consumption of sugar-sweetened beverages and other foods high in sugar, sodium or saturated fat. If, as a result of these studies and documents or otherwise, there is an increase in consumer concerns (whether or not valid) about the health implications of consumption of our products, an increase in the number of jurisdictions that impose taxes on our products, or an increase in new labeling, product or production requirements or other restrictions on the manufacturing, sale or display of our products, demand for our products could decline, or we could be subject to lawsuits or new regulations that could affect sales of our products, any of which could adversely affect our business, financial condition or results of operations. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees, suppliers, or other third parties with whom we do business could take actions, intentional or not, that violate these policies and procedures or applicable laws or regulations or could fail to maintain required documentation sufficient to evidence our compliance with applicable laws or regulations. Violations of laws or regulations could subject us to criminal or civil enforcement actions, including fines, penalties, disgorgement of profits or activity restrictions, any of which could result in adverse publicity or affect our business, financial condition or results of operations. In addition, regulatory authorities under whose laws we operate may have enforcement powers that can subject us to actions such as product recall, seizure of products or assets or other sanctions, which could have an adverse effect on the sales of products in our portfolio or could lead to damage to our reputation. In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental remediation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations, including those of businesses acquired by us or our subsidiaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the potential exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our estimates or otherwise have an adverse effect on our business, financial condition or results of operations. The imposition or proposed imposition of new or increased taxes aimed at our products could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. For example, effective January 2018, the City of Seattle, Washington in the United States enacted a per-ounce surcharge on all sugar-sweetened beverages. By contrast, the United Kingdom enacted a graduated tax, effective April 2018, in which the per-ounce tax rate is tied to the amount of added sugar present in the beverage: the higher the amount of added sugar, the higher the per-ounce tax rate and Saudi Arabia enacted, effective June 2017, a flat tax rate of 50% on the retail price of carbonated soft drinks. These tax measures, whatever their scope or form, could increase the cost of our products, reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Significant additional labeling or warning requirements or limitations on the marketing or sale of our products may reduce demand for such products and could adversely affect our business, financial condition or results of operations. Certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, product labeling or warning requirements or limitations on the marketing or sale of certain of our products as a result of ingredients or substances contained in such products. These types of provisions have required that we provide a label that highlights perceived concerns about a product or warns consumers to avoid consumption of certain ingredients or substances present in our products. For example, in California in the United States, Proposition 65 requires a specific warning on or relating to any product that contains a substance listed by the State of California as having been found to cause cancer or birth defects or other reproductive harm, unless the level of such substance in the product is below a safe harbor level established by the State of California. In addition, a number of jurisdictions, both in and outside the United States, have imposed or are considering imposing labeling requirements, including color-coded labeling of certain food and beverage products where colors such as red, yellow and green are used to indicate various levels of a particular ingredient, such as sugar, sodium or saturated fat. The imposition or proposed imposition of additional product labeling or warning requirements could reduce overall consumption of our products, lead to negative publicity (whether based on scientific fact or not) or leave consumers with the perception (whether or not valid) that our products do not meet their health and wellness needs. Such factors could adversely affect our business, financial condition or results of operations. Changes in laws and regulations relating to packaging or disposal of our products could continue to increase our costs and reduce demand for our products or otherwise have an adverse impact on our business, reputation, financial condition or results of operations. Certain of our products are sold in packaging designed to be recoverable for recycling but not all packaging is recovered, whether due to low value, lack of infrastructure or otherwise. The United States and many other jurisdictions have imposed or are considering imposing regulations or policies designed to encourage recycling, including requiring that deposits or certain taxes or fees be charged in connection with the sale, distribution, marketing and use of certain packaging; extended producer responsibility policies which makes brand owners responsible for the costs of recycling products after consumers have used them; and adopting or extending product stewardship policies which could require brand owners to plan for and, if necessary, pay for the recycling or disposal of packaging after consumers have used them. In addition, these jurisdictions may elect to impose regulations or policies to ban the use of certain packaging, such as plastic beverage bottles. Compliance with these laws and regulations could continue to affect our costs or require changes in our distribution model, which could adversely affect our business, financial condition or results of operations. Further, our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to packaging or disposal of our products. Our business, financial condition or results of operations could suffer if we are unable to compete effectively. Our beverage, food and snack products are in highly competitive categories and markets and compete against products of international beverage, food and snack companies that, like us, operate in multiple geographies, as well as regional, local, and private label manufacturers, economy brands and other competitors. In many countries in which our products are sold, including the United States, The Coca-Cola Company is our primary beverage competitor. Other beverage, food and snack competitors include, but are not limited to, DPSG, Kellogg Company, The Kraft Heinz Company, Mondelz International, Inc., Monster Beverage Corporation, Nestl S.A., Red Bull GmbH and Snyders-Lance, Inc. Our beverage, food and snack products compete primarily on the basis of brand recognition and loyalty, taste, price, value, quality, product variety, innovation, distribution, advertising, marketing and promotional activity, packaging, convenience, service and the ability to anticipate and effectively respond to consumer preferences and trends, including increased consumer focus on health and wellness and the continued acceleration of e-commerce and other methods of distributing and purchasing products. If we are unable to effectively promote our existing products or introduce new products, if our advertising or marketing campaigns are not effective or if we are otherwise unable to effectively respond to pricing pressure or compete effectively (including in distributing our products effectively and cost efficiently through all existing and emerging channels of trade, including through e-commerce and hard discounters), we may be unable to grow or maintain sales or category share or we may need to increase capital, marketing or other expenditures, which may adversely affect our business, financial condition or results of operations. Our business, financial condition or results of operations could be adversely affected as a result of political conditions in the markets in which our products are made, manufactured, distributed or sold. Political conditions in the markets in which our products are made, manufactured, distributed or sold may be difficult to predict and may adversely affect our business, financial condition and results of operations. The results of elections, referendums or other political conditions in the markets in which our products are made, manufactured, distributed or sold could create uncertainty regarding how existing laws and regulations may change, including with respect to sanctions, climate change regulation, taxes, the movement of goods, services and people between countries and other matters, and could result in exchange rate fluctuation, volatility in global stock markets and global economic uncertainty. For example, there is continued uncertainty surrounding the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure. Any changes in, or the imposition of new laws, regulations or governmental policy and their related interpretations due to elections, referendums or other political conditions could have an adverse impact on our business, financial conditions and results of operations. Our business, financial condition or results of operations could be adversely affected if we are unable to grow our business in developing and emerging markets. Our success depends in part on our ability to grow our business in developing and emerging markets, including Mexico, Russia, the Middle East, Brazil, China and India. However, there can be no assurance that our existing products, variants of our existing products or new products that we make, manufacture, distribute or sell will be accepted or be successful in any particular developing or emerging market, due to local or global competition, product price, cultural differences, consumer preferences or otherwise. The following factors could reduce demand for our products or otherwise impede the growth of our business in developing and emerging markets: unstable economic, political or social conditions; acts of war, terrorist acts, and civil unrest; increased competition; volatility in the economic growth of certain of these markets and the related impact on developed countries who export to these markets; volatile oil prices and the impact on the local economy in certain of these markets; our inability to acquire businesses, form strategic business alliances or to make necessary infrastructure investments; our inability to complete divestitures or refranchisings; imposition of new or increased labeling, product or production requirements, or other restrictions; imposition of new or increased sanctions against, or other regulations restricting contact with, certain countries in these markets, or imposition of new or increased sanctions against U.S. multinational corporations operating in these markets; actions, such as removing our products from shelves, taken by retailers in response to U.S. trade sanctions or other governmental action or policy; foreign ownership restrictions; nationalization of our assets or the assets of our suppliers, bottlers, distributors, joint venture partners or other third parties; imposition of taxes on our products or the ingredients or substances used in our products; government-mandated closure, or threatened closure, of our operations or the operations of our suppliers, bottlers, distributors, joint venture partners, customers or other third parties; restrictions on the import or export of our products or ingredients or substances used in our products; regulations relating to the repatriation of funds currently held in foreign jurisdictions to the United States; highly-inflationary economies, devaluation or fluctuation, such as the devaluation of the Egyptian pound, Turkish lira, Pound sterling, Argentine peso and the Mexican peso, or demonetization of currency; regulations on the transfer of funds to and from foreign countries, currency controls or other currency exchange restrictions, which result in significant cash balances in foreign countries, from time to time, or could significantly affect our ability to effectively manage our operations in certain of these markets and could result in the deconsolidation of such businesses; the lack of well-established or reliable legal systems; increased costs of doing business due to compliance with complex foreign and U.S. laws and regulations that apply to our international operations, including the Foreign Corrupt Practices Act, the U.K. Bribery Act and the Trade Sanctions Reform and Export Enhancement Act; and adverse consequences, such as the assessment of fines or penalties, for any failure to comply with these laws and regulations. If we are unable to expand our businesses in developing and emerging markets, effectively operate, or manage the risks associated with operating, in these markets, or achieve the return on capital we expect from our investments in these markets, our reputation, business, financial condition or results of operations could be adversely affected. Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. Many of the countries in which our products are made, manufactured, distributed and sold have experienced and may, from time to time, continue to experience uncertain or unfavorable economic conditions, such as recessions or economic slowdowns. Our business or financial results may be adversely impacted by uncertain or unfavorable economic conditions in the United States and globally, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets, including speculative influences; highly-inflationary economies, devaluation, fluctuation or demonetization; contraction in the availability of credit in the marketplace due to legislation or economic conditions; the effects of government initiatives, including demonetization, austerity or stimulus measures to manage economic conditions and any changes to or cessation of such initiatives; the effects of any default by or deterioration in the creditworthiness of the countries in which our products are made, manufactured, distributed or sold or of countries that may then impact countries in which our products are made, manufactured, distributed or sold; reduced demand for our products resulting from volatility in general global economic conditions or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other lower-cost products, or to less profitable sales channels; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or future economic conditions will affect our customers, consumers, suppliers, bottlers, distributors, joint venture partners or other third parties and any negative impact on any of the foregoing may also have an adverse impact on our business, financial condition or results of operations. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. commercial banks, insurance companies, investment banks and other financial institutions, may be exposed to a ratings downgrade, bankruptcy, liquidity events, default or similar risks as a result of unfavorable economic conditions, changing regulatory requirements or other factors beyond our control. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution, or changes in the regulatory environment, may limit the ability or willingness of financial institutions to enter into financial transactions with us, including to provide banking or related cash management services, or to extend credit on terms commercially acceptable to us or at all; may leave us with reduced borrowing capacity or exposed to certain currencies or price risk associated with forecasted purchases of raw materials, including through our use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures; or may result in a decline in the market value of our investments in debt securities, which could have an adverse impact on our business, financial condition or results of operations. Similar risks exist with respect to our customers, suppliers, bottlers, distributors and joint venture partners and could result in their inability to obtain credit to purchase our products or to finance the manufacture and distribution of our products resulting in canceled orders and/or product delays, which could also have an adverse impact on our reputation, business, financial condition or results of operations. Our business and reputation could suffer if we are unable to protect our information systems against, or effectively respond to, cyberattacks or other cyber incidents or if our information systems, or those of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties, are otherwise disrupted. We depend on information systems and technology, some of which are provided by third parties, including public websites and cloud-based services, for many activities important to our business, including: to interface with our customers and consumers; to engage in marketing activities; to enable and improve the effectiveness of our operations; to order and manage materials from suppliers; to manage inventory; to manage our facilities; to conduct research and development; to maintain accurate financial records; to achieve operational efficiencies; to comply with regulatory, financial reporting, legal and tax requirements; to collect and store sensitive data and confidential information; to communicate electronically among our global operations and with our employees and the employees of our customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners and other third parties; and to communicate with our investors. As with other global companies, we are regularly subject to cyberattacks. Cyberattacks and other cyber incidents are occurring more frequently, are constantly evolving in nature, are becoming more sophisticated and are being made by groups and individuals (including criminal hackers, hacktivists, state-sponsored institutions, terrorist organizations and individuals or groups participating in organized crime) with a wide range of expertise and motives (including monetization of corporate, payment or other internal or personal data, theft of trade secrets and intellectual property for competitive advantage and leverage for political, social, economic and environmental reasons). Such cyberattacks and cyber incidents can take many forms including cyber extortion, denial of service, social engineering, such as impersonation attempts to fraudulently induce employees or others to disclose information or unwittingly provide access to systems or data, introduction of viruses or malware, such as ransomware through phishing emails, website defacement or theft of passwords and other credentials. Although we may incur significant costs in protecting against or remediating cyberattacks or other cyber incidents, no cyberattack or other cyber incident has, to our knowledge, had a material adverse effect on our business, financial condition or results of operations to date. If we do not allocate and effectively manage the resources necessary to build and maintain our information technology infrastructure, including monitoring networks and systems, upgrading our security policies and the skills and training of our employees, and requiring our third-party service providers, customers, suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties to do the same, if we or they fail to timely identify or appropriately respond to cyberattacks or other cyber incidents, or if our or their information systems are damaged, compromised, destroyed or shut down (whether as a result of natural disasters, fires, power outages, acts of terrorism or other catastrophic events, network outages, software, equipment or telecommunications failures, technology development defects, user errors, or from deliberate cyberattacks such as malicious or disruptive software, denial of service attacks, malicious social engineering, hackers or otherwise), our business could be disrupted and we could, among other things, be subject to: transaction errors; processing inefficiencies; the loss of, or failure to attract, new customers and consumers; lost revenues resulting from the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities, or the loss of a competitive advantage due to the unauthorized use, acquisition or disclosure of, or access to, confidential information; the incurrence of costs to restore data and to safeguard against future extortion attempts; the loss of, or damage to, intellectual property or trade secrets, including the loss or unauthorized disclosure of sensitive data or other assets; alteration, corruption or loss of accounting, financial or other data on which we rely for financial reporting and other purposes, which could cause delays in our financial reporting; damage to our reputation or brands; damage to employee, customer and consumer relations; litigation; regulatory enforcement actions or fines; unauthorized disclosure of confidential personal information of our employees, customers or consumers; the loss of information and/or supply chain disruption resulting from the failure of security patches to be developed and installed on a timely basis; violation of data privacy, security or other laws and regulations; and remediation costs. Further, our information systems and the information stored therein could be compromised by, and we could experience similar adverse consequences due to, unauthorized outside parties accessing or extracting sensitive data or confidential information, corrupting information or disrupting business processes (or demonstrating an ability to do so) or by inadvertent or intentional actions by our employees, agents or third parties. We continue to devote significant resources to network security, backup and disaster recovery, and other security measures, including training, to protect our systems and data, but these security measures cannot provide absolute security or guarantee that we will be successful in preventing or responding to every such breach or disruption. In addition, due to the constantly evolving nature of these security threats, the form and impact of any future incident cannot be predicted. Similar risks exist with respect to the cloud-based service providers and other third-party vendors that we rely upon for aspects of our information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and systems managed, hosted, provided and/or used by third parties and their vendors. The need to coordinate with various third-party vendors may complicate our efforts to resolve any issues that may arise. As a result, we are subject to the risk that the activities associated with our third-party vendors may adversely affect our business even if the attack or breach does not directly impact our systems or information. Moreover, our increased use of mobile and cloud technologies could heighten these and other operational risks, as certain aspects of the security of such technologies may be complex, unpredictable or beyond our control. While we currently maintain insurance coverage that, subject to its terms and conditions, is intended to address costs associated with certain aspects of cyber incidents, network failures and data privacy-related concerns, this insurance coverage may not, depending on the specific facts and circumstances surrounding an incident, cover all losses or all types of claims that may arise from an incident, or the damage to our reputation or brands that may result from an incident. Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. We and our business partners use various raw materials, energy, water and other supplies in our business. The principal ingredients we use in our beverage, food and snack products are apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit, oranges and other fruits, oats, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. We also use water in the manufacturing of our products. Our key packaging materials include plastic resins, including PET and polypropylene resins used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel, electricity and natural gas are also important commodities for our businesses due to their use in our and our business partners facilities and the vehicles delivering our products. Some of these raw materials and supplies are sourced from countries experiencing civil unrest, political instability or unfavorable economic conditions, and some are available from a limited number of suppliers or a sole supplier or are in short supply when seasonal demand is at its peak. We cannot assure that we will be able to maintain favorable arrangements and relationships with these suppliers or that our contingency plans, including development of ingredients, materials or supplies to replace ingredients, materials or supplies sourced from such suppliers, will be effective in preventing disruptions that may arise from shortages or discontinuation of any ingredient that is sourced from such suppliers. In addition, increasing focus on climate change, deforestation, water, animal welfare and human rights concerns and other risks associated with the global food system may lead to increased activism focusing on consumer goods companies, governmental intervention and consumer response, and could adversely affect our or our suppliers reputation and business and our ability to procure the materials we need to operate our business. The raw materials and energy, including fuel, that we use for the manufacturing, production and distribution of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by many factors, including changes in global supply and demand, weather conditions (including any potential effects of climate change), fire, natural disasters (such as a hurricane, tornado, earthquake or flooding), disease or pests, agricultural uncertainty, health epidemics or pandemics, governmental incentives and controls (including import/export restrictions), political uncertainties, acts of terrorism, governmental instability or currency exchange rates. Shortage of some of these raw materials and other supplies, sustained interruption in their supply or an increase in their costs could adversely affect our business, financial condition or results of operations. Many of our ingredients, raw materials and commodities are purchased in the open market. The prices we pay for such items are subject to fluctuation, and we manage this risk through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, including swaps and futures. If commodity price changes result in unexpected or significant increases in raw materials and energy costs, we may be unwilling or unable to increase our product prices or unable to effectively hedge against commodity price increases to offset these increased costs without suffering reduced volume, revenue, margins and operating results. In addition, certain of the derivatives used to hedge price risk do not qualify for hedge accounting treatment and, therefore, can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. Water is a limited resource in many parts of the world. The lack of available water of acceptable quality and increasing pressure to conserve water in areas of scarcity and stress may lead to: supply chain disruption; adverse effects on our operations; higher compliance costs; capital expenditures (including additional investments in the development of technologies to enhance water efficiency and reduce water consumption); higher production costs; the cessation of operations at, or relocation of, our facilities or the facilities of our suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties; or damage to our reputation, any of which could adversely affect our business, financial condition or results of operations. Business disruptions could have an adverse impact on our business, financial condition or results of operations. Our ability, and that of our suppliers and other third parties, including our bottlers, contract manufacturers, joint venture partners, distributors and customers, to make, manufacture, transport, distribute and sell products in our portfolio is critical to our success. Damage or disruption to our or their operations due to any of the following factors could impair the ability to make, manufacture, transport, distribute or sell products in our portfolio: adverse weather conditions (including any potential effects of climate change) or natural disasters, such as a hurricane, tornado, earthquake or flooding; government action; economic or political uncertainties or instability in countries in which such products are made, manufactured, distributed or sold, which may also affect our ability to protect the security of our assets and employees; fire; terrorism; outbreak or escalation of armed hostilities; food safety warnings or recalls, whether related to products in our portfolio or otherwise; health epidemics or pandemics; supply and commodity shortages; unplanned delays or unexpected problems associated with repairs or enhancements of facilities in which such products are made, manufactured, distributed or sold; loss or impairment of key manufacturing sites; cyber incidents, including the disruption or shutdown of computer systems or other information technology systems at our offices, plants, warehouses, distribution centers or other facilities or those of our suppliers and other third parties who make, manufacture, transport, distribute and sell products in our portfolio; industrial accidents or other occupational health and safety issues; telecommunications failures; power or water shortages; strikes and other labor disputes; or other reasons beyond our control or the control of our suppliers and other third parties. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition or results of operations, as well as require additional resources to restore operations. Product contamination or tampering or issues or concerns with respect to product quality, safety and integrity could adversely affect our business, reputation, financial condition or results of operations. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations (whether or not valid) of product quality issues, mislabeling, misbranding, spoilage, allergens, adulteration or contamination with respect to products in our portfolio may reduce demand for such products, and cause production and delivery disruptions or increase costs, which could adversely affect our business, reputation, financial condition or results of operations. If any of the products in our portfolio are mislabeled or become unfit for consumption or cause injury, illness or death, or if appropriate resources are not devoted to product quality and safety (particularly as we expand our portfolio into new categories) or to comply with changing food safety requirements, we could decide to, or be required to, recall products in our portfolio and/or we may be subject to liability or government action, which could result in payment of damages or fines, cause certain products in our portfolio to be unavailable for a period of time, result in destruction of product inventory, or result in adverse publicity (whether or not valid), which could reduce consumer demand and brand equity. Moreover, even if allegations of product contamination or tampering or suggestions that our products were not fit for consumption are meritless, the negative publicity surrounding assertions against us or products in our portfolio or processes could adversely affect our reputation or brands. Our business could also be adversely affected if consumers lose confidence in product quality, safety and integrity generally, even if such loss of confidence is unrelated to products in our portfolio. Any of the foregoing could adversely affect our business, reputation, financial condition or results of operations. In addition, if we do not have adequate insurance, if we do not have enforceable indemnification from suppliers, bottlers, contract manufacturers, distributors, joint venture partners or other third parties or if indemnification is not available, the liability relating to such product claims or disruption as a result of recall efforts could materially adversely affect our business, financial condition or results of operations. Any damage to our reputation or brand image could adversely affect our business, financial condition or results of operations. We are a leading global beverage, food and snack company with brands that are respected household names throughout the world. Maintaining a good reputation globally is critical to selling our branded products. Our reputation or brand image could be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental practices for all of our operations and activities, including with respect to human rights, child labor laws and workplace conditions and safety, or failure to require our suppliers or other third parties to do so; the failure to achieve our goals of reducing added sugars, sodium and saturated fat in certain of our products and of growing our portfolio of product choices; the failure to achieve our other sustainability goals or to be perceived as appropriately addressing matters of social responsibility; the failure to protect our intellectual property, including in the event our brands are used without our authorization; health concerns (whether or not valid) about our products or particular ingredients or substances in, or attributes of, our products, including concerns regarding whether certain of our products contribute to obesity; the imposition or proposed imposition of new or increased taxes, labeling requirements or other limitations on, or pertaining to, the sale, display or advertising of our products; any failure to comply, or perception of a failure to comply, with our policies and goals, including those regarding advertising to children and reducing calorie consumption from sugar-sweetened beverages; our research and development efforts; the recall (voluntary or otherwise) of any products in our portfolio; our environmental impact, including use of agricultural materials, packaging, water, energy use and waste management; any failure to achieve our goals with respect to reducing our impact on the environment, or perception of a failure to act responsibly with respect to water use and the environment; any failure to achieve our goals with respect to human rights throughout our value chain; the practices of our employees, agents, customers, distributors, suppliers, bottlers, contract manufacturers, joint venture partners or other third parties (including others in our industry) with respect to any of the foregoing, actual or perceived; consumer perception of our industry; consumer perception of our advertising campaigns, sponsorship arrangements or marketing programs; consumer perception of our use of social media; consumer perception of statements made by us, our employees and executives, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties (including others in our industry); or our responses or the responses of others in our industry to any of the foregoing. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without limitation, anti-corruption laws, competition laws and tax laws and regulations of the jurisdictions in which our products are made, manufactured, distributed or sold. In the event that we or our employees engage in or are believed to have engaged in improper activities, we may be subject to regulatory proceedings, including enforcement actions, litigation, loss of sales or other consequences, which may cause us to suffer damage to our reputation in the United States or abroad. Failure to comply with local laws and regulations, to maintain an effective system of internal control or to provide accurate and timely financial information could also hurt our reputation. In addition, water is a limited resource in many parts of the world and demand for water continues to rise. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to water use. Further, the popularity of social media and other consumer-oriented technologies has increased the speed and accessibility of information dissemination. As a result, negative or inaccurate posts or comments about us, our products, policies, practices, advertising campaigns and marketing programs or sponsorship arrangements; our use of social media or of posts or other information disseminated by us or our employees, agents, customers, suppliers, bottlers, distributors, joint venture partners or other third parties; consumer perception of any of the foregoing, or failure by us to respond effectively to any of the foregoing, may also generate adverse publicity (whether or not valid) that could damage our reputation. Damage to our reputation or brand image or loss of consumer confidence in our products or employees for any of these or other reasons could result in decreased demand for our products and could adversely affect our business, financial condition or results of operations, as well as require additional resources to rebuild our reputation. Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or effectively manage divestitures or refranchisings, could adversely affect our business, financial condition or results of operations. We regularly review our portfolio of businesses and evaluate potential acquisitions, joint ventures, divestitures, refranchisings and other strategic transactions. Potential issues associated with these activities could include, among other things: our ability to realize the full extent of the expected returns, benefits, cost savings or synergies as a result of a transaction, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with a transaction; and diversion of managements attention from day-to-day operations. With respect to acquisitions, the following factors also pose potential risks: our ability to successfully combine our businesses with the business of the acquired company, including integrating the acquired companys manufacturing, distribution, sales, accounting, financial reporting and administrative support activities and information technology systems with our company; our ability to successfully operate in new categories or territories; motivating, recruiting and retaining executives and key employees; conforming standards, controls (including internal control over financial reporting, environmental compliance, health and safety compliance and compliance with other laws and regulations), procedures and policies, business cultures and compensation structures between us and the acquired company; consolidating and streamlining corporate and administrative infrastructures and avoiding increased operating expenses; consolidating sales and marketing operations; retaining existing customers and attracting new customers; retaining existing distributors; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organizations; managing tax costs or inefficiencies associated with integrating our operations following completion of an acquisition; and other unanticipated problems or liabilities, such as contingent liabilities and litigation. With respect to joint ventures, we share ownership and management responsibility with one or more parties who may or may not have the same goals, strategies, priorities, resources or values as we do. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Business decisions or other actions or omissions of our joint venture partners may adversely affect the value of our investment, result in litigation or regulatory action against us or otherwise damage our reputation and brands and adversely affect our business, financial condition or results of operations. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws and laws and regulations outside the United States. With respect to divestitures and refranchisings, we may not be able to complete or effectively manage such transactions on terms commercially favorable to us or at all and may fail to achieve the anticipated benefits or cost savings from the divestiture or refranchising. Further, as divestitures and refranchisings may reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised businesses in our supply or sales chain may adversely impact our sales or business performance. If an acquisition or joint venture is not successfully completed or integrated into our existing operations, or if a divestiture or refranchising is not successfully completed or managed or does not result in the benefits or cost savings we expect, our business, financial condition or results of operations may be adversely affected. A change in our estimates and underlying assumptions regarding the future performance of our businesses could result in an impairment charge, which could materially affect our results of operations. We conduct impairment tests on our goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets annually, during our third quarter, or more frequently, if circumstances indicate that the carrying value may not be recoverable or that an other-than-temporary impairment exists. Any changes in our estimates or underlying assumptions regarding the future performance of our reporting units or in determining the fair value of any such reporting unit, including goodwill, indefinite-lived intangible assets, as well as other investments and other long-lived assets, could adversely affect our results of operations. Factors that could result in an impairment include, but are not limited to: significant negative economic or industry trends or competitive operating conditions; significant macroeconomic conditions that may result in a future increase in the weighted-average cost of capital used to estimate fair value; and significant changes in the nature and timing of decisions regarding assets or markets that do not perform consistent with our expectations, including factors we use to estimate future levels of sales, operating profit or cash flows. Future impairment charges could have a significant adverse effect on our results of operations in the periods recognized. Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. We are subject to income taxes in the United States and in certain foreign jurisdictions in which we operate. Increases in income tax rates or other changes in income tax laws in any particular jurisdiction could reduce our after-tax income from such jurisdiction and could adversely affect our business, financial condition or results of operations. Our operations outside the United States generate a significant portion of our income. In addition, the United States and many of the other countries in which our products are made, manufactured, distributed or sold, including countries in which we have significant operations, have recently made or are actively considering changes to existing tax laws. For example, on December 22, 2017, the Tax Cuts and Jobs Act (TCJ Act) was signed into law in the United States. The changes in the TCJ Act are broad and complex and we continue to examine the impact the TCJ Act may have on our business and financial results. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings regardless of whether they are repatriated, reduced the U.S. corporate income tax rate from 35% to 21%, imposed limitations on the deductibility of interest and certain other corporate deductions, and moved from a worldwide system of taxation that generally allows deferral of U.S. tax on international earnings until repatriated to a territorial/dividend exemption system with a minimum tax that will subject international earnings to U.S. tax when earned. In accordance with applicable SEC guidance, we recorded a provisional net tax expense in the fourth quarter of 2017 resulting from the enactment of the TCJ Act. This provisional expense is subject to change, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in Internal Revenue Service (IRS) interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For further information regarding the potential impact of the TCJ Act, see Our Liquidity and Capital Resources and Our Critical Accounting Policies in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Note 5 to our consolidated financial statements. Additional changes in the U.S. tax regime or in how U.S. multinational corporations are taxed on foreign earnings, including changes in how existing tax laws are interpreted or enforced, could adversely affect our business, financial condition or results of operations. We are also subject to regular reviews, examinations and audits by the IRS and other taxing authorities with respect to income and non-income based taxes both within and outside the United States. Economic and political pressures to increase tax revenues in jurisdictions in which we operate, or the adoption of new or reformed tax legislation or regulation, may make resolving tax disputes more difficult and the final resolution of tax audits and any related litigation could differ from our historical provisions and accruals, resulting in an adverse impact on our business, financial condition or results of operations. In addition, in connection with the Organisation for Economic Co-operation and Development Base Erosion and Profit Shifting project, companies are required to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny of profits earned in various countries. Failure to realize anticipated benefits from our productivity initiatives or global operating model could have an adverse impact on our business, financial condition or results of operations. Our future success and earnings growth depend, in part, on our ability to continue to reduce costs and improve efficiencies. Our productivity initiatives help support our growth initiatives and contribute to our results of operations. We continue to implement strategic plans that we believe will position our business for future success and long-term sustainable growth by allowing us to achieve a lower cost structure and operate more efficiently in the highly competitive beverage, food and snack categories and markets. We are also continuing to implement our global operating model to improve efficiency, decision making, innovation and brand management across the global PepsiCo organization to enable us to compete more effectively. Further, in order to continue to capitalize on our cost reduction efforts and our global operating model, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. Some of these measures could yield unintended consequences, such as business disruptions, distraction of management and employees, reduced employee morale and productivity, and unexpected additional employee attrition, including the inability to attract or retain key personnel. It is critical that we have the appropriate personnel in place to continue to lead and execute our plans, including to effectively manage personnel adjustments and transitions resulting from these initiatives and increased competition for employees with the skills necessary to implement our plans. If we are unable to successfully implement our productivity initiatives and global operating model as planned, fail to implement these initiatives as timely as we anticipate, do not achieve expected savings as a result of these initiatives or incur higher than expected or unanticipated costs in implementing these initiatives, fail to identify and implement additional productivity opportunities in the future, or fail to successfully manage business disruptions or unexpected employee consequences on our workforce, morale or productivity, we may not realize all or any of the anticipated benefits, which could adversely affect our business, financial condition or results of operations. If we are unable to recruit, hire or retain key employees or a highly skilled and diverse workforce, it could have a negative impact on our business, financial condition or results of operations. Our continued growth requires us to recruit, hire, retain and develop our leadership bench and a highly skilled and diverse workforce. We compete to recruit and hire new employees and then must train them and develop their skills and competencies. Our employees are highly sought after by our competitors and other companies and our continued ability to compete effectively depends on our ability to retain, develop and motivate highly skilled personnel for all areas of our organization. Any unplanned turnover or unsuccessful implementation of our succession plans to backfill current leadership positions, including the Chief Executive Officer, or to hire and retain a highly skilled and diverse workforce could deplete our institutional knowledge base and erode our competitive advantage or result in increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. Any of the foregoing could adversely affect our reputation, business, financial condition or results of operations. The loss of, or a significant reduction in sales to, any key customer or disruption in the retail landscape, including rapid growth in hard discounters and the e-commerce channel, could adversely affect our business, financial condition or results of operations. Our customers include wholesale and other distributors, foodservice customers, grocery stores, drug stores, convenience stores, discount/dollar stores, mass merchandisers, membership stores, hard discounters, e-commerce retailers and authorized independent bottlers, among others. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, to compete effectively. Any inability to resolve a significant dispute with any of our key customers, a change in the business condition (financial or otherwise) of any of our key customers, even if unrelated to us, a significant reduction in sales to any key customer, or the loss of any of our key customers could adversely affect our business, financial condition or results of operations. In addition, our industry has been affected by changes to the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications as well as the integration of physical and digital operations among retailers. We are making significant investments in attracting talent to and building our global e-commerce capabilities. Although we are engaged in e-commerce with respect to many of our products, if we are unable to maintain and develop successful relationships with existing and new e-commerce retailers or otherwise adapt to the growing e-commerce landscape, while simultaneously maintaining relationships with our key customers operating in traditional retail channels, we may be disadvantaged in certain channels and with certain customers and consumers, which could adversely affect our business, financial condition or results of operations. In addition, the growth in e-commerce may result in consumer price deflation, which may affect our relationships with key retail customers. If these e-commerce retailers were to take significant market share away from traditional retailers and/or we fail to adapt to the rapidly changing retail and e-commerce landscapes, our ability to maintain and grow our share of sales or volume and our business, financial condition or results of operations could be adversely affected. Further, the retail landscape continues to be impacted by the increased consolidation of retail ownership and purchasing power, particularly in North America, Europe and Latin America, resulting in large retailers with increased purchasing power, which may impact our ability to compete in these areas. Such retailers may demand improved efficiency, lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution networks, other distribution channels such as e-commerce, or private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. In addition, the growth of hard discounters that are focused on limiting the number of items they sell and selling predominantly private label brands may reduce our ability to sell our products through such retailers. Failure to appropriately respond to any of the foregoing, including failure to offer effective sales incentives and marketing programs to our customers, could reduce our ability to secure adequate shelf space and product availability at our retailers, adversely affect our ability to maintain or grow our share of sales or volume, and adversely affect our business, financial condition or results of operations. Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. Rating agencies routinely evaluate us, and their ratings of our long-term and short-term debt are based on a number of factors, including our cash generating capability, levels of indebtedness, policies with respect to shareholder distributions and our financial strength generally, as well as factors beyond our control, such as the then-current state of the economy and our industry generally. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether as a result of our actions or factors which are beyond our control, could increase our future borrowing costs, impair our ability to access capital and credit markets on terms commercially acceptable to us or at all, and result in a reduction in our liquidity. We expect to maintain Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global credit markets at favorable interest rates. However, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market could also be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. An increase in our borrowing costs, limitations on our ability to access the global capital and credit markets or a reduction in our liquidity could adversely affect our financial condition and results of operations. If we are not able to successfully implement shared services or utilize information technology systems and networks effectively, our ability to conduct our business may be negatively impacted. We have entered into agreements with third-party service providers to utilize certain information technology support services and administrative functions, including payroll processing, health and benefit plan administration and certain finance and accounting functions, and may enter into agreements for shared services in other functions in the future to achieve cost savings and efficiencies. In addition, we utilize cloud-based services and systems and networks managed by third-party vendors to process, transmit and store information and to conduct certain of our business activities and transactions with employees, customers, consumers and other third parties. If any of these third-party service providers or vendors do not perform effectively, or if we fail to adequately monitor their performance, we may not be able to achieve the expected cost savings or we may have to incur additional costs to correct errors made by such service providers and our reputation could be harmed. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property or sensitive data through security breaches or otherwise, adverse effects on financial reporting, litigation or remediation costs, or damage to our reputation, which could have a negative impact on employee morale. We continue on our multi-year business transformation initiative to migrate certain of our systems, including our financial processing systems, to enterprise-wide systems solutions. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, or if we fail to achieve the expected benefits from this initiative, it may impact our ability to process transactions accurately and efficiently, and remain in step with the changing needs of our business, which could result in the loss of customers or consumers and revenue. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers or consumers and revenue. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of business processes and controls, including our internal control over financial reporting processes, to maintain effective controls over our financial reporting. To date, this transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. Fluctuations in exchange rates impact our business, financial condition and results of operations. We hold assets, incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States, where the functional currency is other than the U.S. dollar, are translated into U.S. dollars. Our operations outside of the United States, particularly in Mexico, Russia, Canada, the United Kingdom and Brazil , generate a significant portion of our net revenue. In addition, we purchase many of the ingredients, raw materials and commodities used in our business in numerous markets and in numerous currencies. Fluctuations in exchange rates, including as a result of currency controls or other currency exchange restrictions have had, and may continue to have, an adverse impact on our business, financial condition and results of operations. Climate change, water scarcity or legal, regulatory or market measures to address climate change or water scarcity may negatively affect our business and operations or damage our reputation. There is concern that carbon dioxide and other greenhouse gases in the atmosphere have an adverse impact on global temperatures, weather patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are necessary for our products, such as sugar cane, corn, wheat, rice, oats, oranges and other fruits and potatoes. Natural disasters and extreme weather conditions, such as a hurricane, earthquake or flooding, may disrupt the productivity of our facilities or the operation of our supply chain and unfavorably impact the demand for, or our consumers ability to purchase, our products. The predicted effects of climate change may also exacerbate challenges regarding the availability and quality of water. As demand for water access continues to increase around the world, we may be subject to decreased availability of water, deteriorated quality of water or less favorable pricing for water, which could adversely impact our manufacturing and distribution operations. Concern over climate change may result in new or increased regional, federal and/or global legal and regulatory requirements to reduce or mitigate the effects of greenhouse gases, or to limit or impose additional costs on commercial water use due to local water scarcity concerns. In the event that such regulation is more stringent than current regulatory obligations or the measures that we are currently undertaking to monitor and improve our energy efficiency and water conservation, we may experience disruptions in, or significant increases in our costs of, operation and delivery and we may be required to make additional investments in facilities and equipment or relocate our facilities. In particular, increasing regulation of fuel emissions could substantially increase the cost of energy, including fuel, required to operate our facilities or transport and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, the effects of climate change or water scarcity could negatively affect our business and operations. In addition, any failure to achieve our goals with respect to reducing our impact on the environment or perception (whether or not valid) of our failure to act responsibly with respect to water use and the environment or to effectively respond to new, or changes in, legal or regulatory requirements concerning climate change or water scarcity could result in adverse publicity and could adversely affect our business, reputation, financial condition or results of operations. There is also increased focus, including by governmental and non-governmental organizations, investors, customers and consumers on these and other environmental sustainability matters, including deforestation, land use, climate impact and water use. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to our impact on the environment. A portion of our workforce is represented by unions. Failure to successfully negotiate collective bargaining agreements, or strikes or work stoppages, could cause our business to suffer. Many of our employees are covered by collective bargaining agreements, and other employees may seek to be covered by collective bargaining agreements. Strikes or work stoppages or other business interruptions could occur if we are unable to renew these agreements on satisfactory terms or enter into new agreements on satisfactory terms or if we are unable to otherwise manage changes in, or that affect, our workforce, which could impair manufacturing and distribution of our products or result in a loss of sales, which could adversely impact our business, financial condition or results of operations. The terms and conditions of existing, renegotiated or new collective bargaining agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency or to adapt to changing business needs or strategy. If we are not able to adequately protect our intellectual property rights or if we are found to infringe the intellectual property rights of others, the value of our products or brands, or our competitive position, could be reduced, which could have an adverse impact on our business, financial condition or results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets that are important to our business and relate to a variety of our products, their packaging, the processes for their production and the design and operation of various equipment used in our businesses. We protect our intellectual property rights globally through a combination of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property. If we fail to obtain or adequately protect our trademarks, copyrights, patents, business processes and trade secrets, including our ingredient formulas, or if there is a change in law that limits or removes the current legal protections of our intellectual property, the value of our products and brands, or our competitive position, could be reduced and there could be an adverse impact on our business, financial condition or results of operations. In addition, if, in the course of developing new products or improving the quality of existing products, we are found to have infringed the intellectual property rights of others, directly or indirectly, such finding could have an adverse impact on our reputation, business, financial condition or results of operations and may limit our ability to introduce new products or improve the quality of existing products. Potential liabilities and costs from litigation, claims, legal or regulatory proceedings, inquiries or investigations could have an adverse impact on our business, financial condition or results of operations. We and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations, including but not limited to matters related to our advertising, marketing or commercial practices, product labels, claims and ingredients including sugar, sodium and saturated fat, our intellectual property rights, alleged infringement or misappropriation by us of intellectual property rights of others, environmental, privacy, employment, tax and insurance matters and matters relating to our compliance with applicable laws and regulations. We evaluate such matters to assess the likelihood of unfavorable outcomes and estimate, if possible, the amount of potential losses and establish reserves as appropriate. These matters are inherently uncertain and there is no guarantee that we will be successful in defending ourselves in these matters, or that our assessment of the materiality of these matters and the likely outcome or potential losses and established reserves will be consistent with the ultimate outcome of such matters. In the event that managements assessment of actual or potential claims and proceedings proves inaccurate or litigation, claims, proceedings, inquiries or investigations that are material arise in the future, there may be a material adverse effect on our business, financial condition or results of operations. Responding to litigation, claims, proceedings, inquiries, and investigations, even those that are ultimately non-meritorious, may also require us to incur significant expense and devote significant resources, and may generate adverse publicity that may damage our reputation or brand image, which could have an adverse impact on our business, financial condition or results of operations. Many factors may adversely affect the price of our publicly traded securities. Many factors may adversely affect the price of our common stock and publicly traded debt. Such factors, some of which are beyond our control, may include, but are not limited to: unfavorable economic conditions; changes in financial or tax reporting and changes in accounting principles or practices that materially affect our reported financial condition and results; investor perceptions of our business, strategies and performance or those of our competitors; actions by shareholders or others seeking to influence our business strategies; speculation by the media or investment community regarding our business, strategies and performance or those of our competitors; developments relating to pending litigation, claims, investigations or inquiries; trading activity in our securities or trading activity in derivative instruments with respect to our securities; changes in our credit ratings; the impact of our share repurchase programs or dividend policy; and the outcome of referenda and elections. In addition, corporate actions, such as those we may or may not take from time to time as part of our continuous review of our corporate structure and our strategy, including as a result of business, legal, regulatory and tax considerations, may not have the impact we intend and may adversely affect the price of our securities. The above factors, as well as the other risks included in this Item 1A. Risk Factors, could adversely affect the price of our securities. ", Item 1B. Unresolved Staff Comments. We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our 2017 fiscal year and that remain unresolved. ," Item 2. Properties. Our principal executive offices located in Purchase, New York and our facilities located in Plano, Texas, all of which we own, are our most significant corporate properties. Each division utilizes plants, warehouses, distribution centers, storage facilities, offices and other facilities, either owned or leased, in connection with making, marketing, distributing and selling our products. The approximate number of such facilities utilized by each division is as follows: FLNA QFNA NAB Latin America ESSA AMENA Shared (a) Plants (b) Other Facilities (c) 1,680 (a) Shared properties are in addition to the other properties reported by our six divisions identified in this table. (b) Includes manufacturing and processing plants as well as bottling and production plants. (c) Includes warehouses, distribution centers, storage facilities, offices, including division headquarters, research and development facilities and other facilities. Significant properties by division included in the table above are as follows: FLNAs research and development facility in Plano, Texas, which is owned. QFNAs food plant in Cedar Rapids, Iowa, which is owned. NABs research and development facility in Valhalla, New York, and a Tropicana plant in Bradenton, Florida, both of which are owned. Latin Americas three snack plants in Mexico (one in Vallejo, one in Celaya and one in Monterrey) and one in Brazil (Sorocaba), all of which are owned. ESSAs snack plant in Leicester, United Kingdom, which is leased; its snack plant in Kashira, Russia, its fruit juice plant in Zeebrugge, Belgium, its beverage plant in Lebedyan, Russia and its dairy plant in Moscow, Russia, all of which are owned. AMENAs beverage plants in Tanta City, Egypt and Rayong, Thailand, and its snack plant in Sixth of October City, Egypt, all of which are owned; and its snack plant in Riyadh, Saudi Arabia, which is leased. Two concentrate plants in Cork, Ireland, which are shared by our NAB, ESSA and AMENA divisions, both of which are owned. Shared service centers in Winston-Salem, North Carolina, and Plano, Texas, which are primarily shared by our FLNA, QFNA and NAB divisions, both of which are leased. Most of our plants are owned or leased on a long-term basis. In addition to company-owned or leased properties described above, we also utilize a highly distributed network of plants, warehouses and distribution centers that are owned or leased by our contract manufacturers, co-packers, strategic alliances or joint ventures in which we have an equity interest. We believe that our properties generally are in good operating condition and, taken as a whole, are suitable, adequate and of sufficient capacity for our current operations. "," Item 3. Legal Proceedings. As previously disclosed, in January 2011, Wojewodzka Inspekcja Ochrony Srodowiska, the Polish environmental control authority, began an audit of a bottling plant of our subsidiary, Pepsi-Cola General Bottlers Poland SP, z.o.o. (PCGB), in Michrow, Poland. In July 2013, Wojewodzka Inspekcja Ochrony Srodowiska alleged that the plant was not in compliance in 2009 with applicable regulations governing the taking of water samples for analysis of the plants waste and sought monetary sanctions of $650,000 and, in August 2013, PCGB appealed this decision. In April 2015, the General Environmental Inspector for Environmental Protection upheld the sanctions against PCGB and, in May 2015, PCGB further appealed this decision. In October 2015, Viovodeship Administrative Court in Warsaw rejected our appeal and, in December 2015, PCGB filed an extraordinary appeal in the Supreme Administrative Court. In October 2017, the Supreme Administrative Court issued a final, non-appealable decision, rejecting our appeal and we agreed to invest funds up to the penalty amount(s) into the bottling plant to fully resolve the matter. In addition, we and our subsidiaries are party to a variety of litigation, claims, legal or regulatory proceedings, inquiries and investigations. While the results of such litigation, claims, legal or regulatory proceedings, inquiries and investigations cannot be predicted with certainty, management believes that the final outcome of the foregoing will not have a material adverse effect on our financial condition, results of operations or cash flows. Sanctions imposed by foreign authorities are levied in local currency and disclosed using the U.S. dollar equivalent at the time of imposition and are subject to currency fluctuations. See also Item 1. Business Regulatory Matters and Item 1A. Risk Factors. "," Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Stock Trading Symbol PEP Stock Exchange Listings Since December 20, 2017, our common stock has traded on The Nasdaq Global Select Market. Before December 20, 2017, our common stock traded on The New York Stock Exchange. Our common stock is also listed on the Chicago Stock Exchange and SIX Swiss Exchange. Stock Prices The quarterly composite high and low sales prices for PepsiCo common stock for each fiscal quarter of 2017 and 2016 as reported on The New York Stock Exchange through December 19, 2017 and The Nasdaq Global Select Market from December 20, 2017 through December 30, 2017, are contained in Item 6. Selected Financial Data. Shareholders As of February 6, 2018 , there were approximately 120,156 shareholders of record of our common stock. Dividends We have paid consecutive quarterly cash dividends since 1965. The declaration and payment of future dividends are at the discretion of the Board of Directors. Dividends are usually declared in February, May, July and November and paid at the end of March, June and September and the beginning of January. On February 5, 2018 , the Board of Directors declared a quarterly dividend of $0.805 payable March 30, 2018 , to shareholders of record on March 2, 2018 . For the remainder of 2018 , the dividend record dates for these payments are expected to be June 1 , September 7 and December 7 , 2018 , subject to approval of the Board of Directors. Information with respect to the quarterly dividends declared in 2017 and 2016 is contained in Item 6. Selected Financial Data. For information on securities authorized for issuance under our equity compensation plans, see Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. A summary of our common stock repurchases (in millions, except average price per share) during the fourth quarter of 2017 is set forth in the table below. Issuer Purchases of Common Stock Period Total Number of Shares Repurchased (a) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (b) 9/9/2017 $ 5,857 9/10/2017 - 10/7/2017 1.5 $ 112.85 1.5 (167 ) 5,690 10/8/2017 - 11/4/2017 1.3 $ 111.00 1.3 (139 ) 5,551 11/5/2017 - 12/2/2017 1.1 $ 114.32 1.1 (126 ) 5,425 12/3/2017 - 12/30/2017 0.6 $ 117.55 0.6 (72 ) Total 4.5 $ 113.34 4.5 $ 5,353 (a) All shares were repurchased in open market transactions pursuant to publicly announced repurchase programs. (b) Includes shares authorized for repurchase under the $ 12 billion repurchase program authorized by our Board of Directors and publicly announced on February 11, 2015, which commenced on July 1, 2015 and expires on June 30, 2018. On February 13, 2018, we publicly announced a new repurchase program of up to $15 billion of our common stock, which will commence on July 1, 2018 and expire on June 30, 2021, and such shares are excluded from the above table. Such shares may be repurchased in open market transactions, in privately negotiated transactions, in accelerated stock repurchase transactions or otherwise. In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an employee stock ownership plan (ESOP) fund established by Quaker. In the fourth quarter of 2017, PepsiCo repurchased shares of its convertible preferred stock from the ESOP in connection with share redemptions by ESOP participants. See Note 11 to our consolidated financial statements for additional information on our convertible preferred stock. The Company does not have any authorized, but unissued, blank check preferred stock. The following table summarizes our convertible preferred share repurchases during the fourth quarter of 2017 . Issuer Purchases of Convertible Preferred Stock Period Total Number of Shares Repurchased Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs 9/10/2017 - 10/7/2017 $ N/A N/A 10/8/2017 - 11/4/2017 1,000 $ 548.21 N/A N/A 11/5/2017 - 12/2/2017 $ N/A N/A 12/3/2017 - 12/30/2017 $ 578.48 N/A N/A Total 1,900 $ 562.55 N/A N/A "," Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations. OUR BUSINESS Executive Overview Our Operations Other Relationships Our Business Risks OUR FINANCIAL RESULTS Results of Operations Consolidated Review Non-GAAP Measures Items Affecting Comparability Results of Operations Division Review Frito-Lay North America Quaker Foods North America North America Beverages Latin America Europe Sub-Saharan Africa Asia, Middle East and North Africa Our Liquidity and Capital Resources Return on Invested Capital OUR CRITICAL ACCOUNTING POLICIES Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows Consolidated Balance Sheet Consolidated Statement of Equity Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring and Impairment Charges Note 4 Property, Plant and Equipment and Intangible Assets Note 5 Income Taxes Note 6 Share-Based Compensation Note 7 Pension, Retiree Medical and Savings Plans Note 8 Debt Obligations Note 9 Financial Instruments Note 10 Net Income Attributable to PepsiCo per Common Share Note 11 Preferred Stock Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 13 Supplemental Financial Information Note 14 Divestitures MANAGEMENTS RESPONSIBILITY FOR FINANCIAL REPORTING REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM GLOSSARY 44 Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary beginning on page 1 30. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts. OUR BUSINESS Executive Overview We are a leading global food and beverage company with a complementary portfolio of enjoyable brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories. At PepsiCo, we are focused on operating our company in a way that generates sustained financial growth and consistently strong returns and is also responsive to the needs of the world around us. We call this approach Performance with Purpose it is embedded into our business and our strategy and it enabled us to deliver another year of strong performance in 2017. As we look to 2018 and beyond, we believe our Performance with Purpose strategy will enable us to continue delivering strong performance while positioning our Company for long-term sustainable growth. Our strategies are designed to address key challenges facing our Company, including: macroeconomic and political volatility and the continued rebalancing of the economic world; shifting consumer preferences and increasing demand for more nutritious foods and beverages; the disruption of retail; the expansion of hard discounters; and the emergence of niche brands laying claim to large consumer segments, particularly in developed markets. We intend to focus on the following areas to address and adapt to these challenges: Utilizing the strength of our distribution system to offer consumers a wide array of choices, from fun-for-you to better-for-you to good-for-you products to meet consumers demand for more nutritious foods and beverages; Continuing to strengthen our retail and foodservice relationships to sell our products faster, increase cash flow and engage consumers; Minimizing our environmental footprint to streamline costs and mitigate our operational impact on the communities in which we operate; Continuing to invest in our associates so that we have the best talent to position our company for continued growth; and Continuing our investments in e-commerce and digital solutions to meet changing consumer consumption patterns and capture cost savings while streamlining our operations. See also Item 1A. Risk Factors for additional information about risks and uncertainties that the Company faces. Our Operations See Item 1. Business for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services. Our Business Risks We are subject to risks in the normal course of business. During 2017 and 2016 , certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results. The hurricanes and earthquakes which occurred in the third and fourth quarters of 2017 in North and Central America did not materially impact our consolidated financial results in 2017. In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes on the manufacture, distribution or sale of our products, ingredients or substances contained in, or attributes of, our products or commodities used in the production of our products. These taxes vary in scope and form: some apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). Similarly, some measures apply a single tax rate per liquid ounce while others apply a graduated tax rate depending upon the amount of added sugar in the beverage and some apply a flat tax rate on beverages containing a particular substance or ingredient. We sell a wide variety of beverages, foods and snack in more than 200 countries and territories and the profile of the products we sell, and the amount of revenue attributable to such products, varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes or other potential limitations on our products may take, and therefore cannot predict the impact of such taxes or limitations on our financial results. In addition, taxes and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes or limitations. In addition, our industry has been affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. The changes in the TCJ Act are broad and complex and we continue to examine the impact the TCJ Act may have on our business and financial results. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further information in Items Affecting Comparability. The recorded impact of the TCJ Act is provisional and the final amount may differ from the above estimate, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For additional information, see Our Liquidity and Capital Resources, Our Critical Accounting Policies and Note 5 to our consolidated financial statements. See also Item 1A. Risk Factors, Executive Overview above and Market Risks below for more information about these risks and the actions we have taken to address key challenges. Risk Management Framework The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Companys operations, we leverage an integrated risk management framework. This framework includes the following: PepsiCos Board of Directors has oversight responsibility for PepsiCos integrated risk management framework. One of the Boards primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Companys business, including risk assessment and risk mitigation of the Companys top risks. The Board receives updates on key risks throughout the year. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCos risk management and oversight processes, and assists the Boards oversight of financial, compliance and employee safety risks facing PepsiCo; The Compensation Committee of the Board reviews PepsiCos employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; The Nominating and Corporate Governance Committee assists the Board in its oversight of the Companys governance structure and other corporate governance matters, including succession planning; and The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCos policies, programs and related risks that concern key public policy and sustainability matters. The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCos Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; PepsiCos Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCos Board of Directors and the Audit Committee of the Board; PepsiCos Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and PepsiCos Compliance Ethics Department leads and coordinates our compliance policies and practices. Market Risks We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. and Our business, financial condition or results of operations may be adversely affected by increased costs, disruption of supply or shortages of raw materials, energy, water and other supplies. in Item 1A. Risk Factors. See Our Liquidity and Capital Resources for further information on our non-cancelable purchasing commitments. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See Our Critical Accounting Policies for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations. Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See Item 1A. Risk Factors for further discussion. Commodity Prices Our commodity derivatives had a total notional value of $0.9 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . At the end of 2017 , the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have decreased our net unrealized gains in 2017 by $96 million . Foreign Exchange Our operations outside of the United States generated 42% of our net revenue in 2017 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2017 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. During 2017 , unfavorable foreign exchange had a net nominal impact on net revenue growth due to declines in the Egyptian pound, Turkish lira and Pound sterling, offset by appreciation in the Russian ruble, Brazilian real and euro. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results. In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Brazil, China, India, Mexico, the Middle East, Russia and Turkey, and currency fluctuations in certain of these international markets continue to result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdoms pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, and the potential impact for the ESSA segment and our other businesses. Starting in 2014, Russia announced economic sanctions against the United States and other nations that include a ban on imports of certain ingredients and finished goods from specific countries. These sanctions have not had and are not expected to have a material impact on the results of our operations in Russia or our consolidated results or financial position, and we will continue to monitor the economic, operating and political environment in Russia closely. For the years ended December 30, 2017 , December 31, 2016 and December 26, 2015 , net revenue generated by our operations in Russia represented 5%, 4% and 4% of our consolidated net revenue, respectively. As of December 30, 2017 , our long-lived assets in Russia were $4.7 billion . Our foreign currency derivatives had a total notional value of $1.6 billion as of December 30, 2017 and December 31, 2016 . The total notional amount of our debt instruments designated as net investment hedges was $1.5 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . At the end of 2017 , we estimate that an unfavorable 10% change in the underlying exchange rates would have increased our net unrealized losses in 2017 by $125 million . Due to exchange restrictions and other conditions that significantly impact our ability to effectively manage our businesses in Venezuela and realize earnings generated by our Venezuelan businesses, effective at the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries and began accounting for our investments in our Venezuelan subsidiaries and joint venture using the cost method of accounting. In 2015, we recorded pre- and after-tax charges of $1.4 billion in our income statement to reduce the value of the cost method investments to their estimated fair values, resulting in a full impairment. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the end of 2017, and we expect these conditions will continue for the foreseeable future. We do not have any guarantees related to our Venezuelan entities, and our ongoing contractual commitments to our Venezuelan businesses are not material. We will recognize income from dividends and sales of inventory to our Venezuelan entities, which have not been and are not expected to be material, to the extent cash in U.S. dollars is received. We have not received any cash in U.S. dollars from our Venezuelan entities since our deconsolidation at the end of the third quarter of 2015. We continue to monitor the conditions in Venezuela and their impact on our accounting and disclosures. For further information, please refer to Note 1 to our consolidated financial statements and Items Affecting Comparability. Interest Rates Our interest rate derivatives had a total notional value of $14.2 billion as of December 30, 2017 and $11.2 billion as of December 31, 2016 . Assuming year-end 2017 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have decreased our net interest expense in 2017 by $25 million due to higher cash and cash equivalents and short-term investments levels as compared with our variable rate debt. OUR FINANCIAL RESULTS Results of Operations Consolidated Review In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries and net pricing reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, acquisitions and divestitures, except as otherwise noted, reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. The impact of the structural change related to the deconsolidation of our Venezuelan businesses is presented separately. Volume Our beverage volume in the NAB, Latin America, ESSA and AMENA segments reflects sales to authorized bottlers, independent distributors and retailers, as well as the sale of beverages bearing Company-owned or licensed trademarks that have been sold through our authorized independent bottlers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our beverage revenues are not entirely based on BCS volume, as there are independent bottlers in the supply chain, we believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the consumer level. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. NAB, Latin America, ESSA and AMENA, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and NAB further, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, AMENA licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi. Our food and snacks volume in the FLNA, QFNA, Latin America, ESSA and AMENA segments is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks. Servings Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. In 2017 , total servings decreased 1% compared to 2016 . In 2016 , total servings increased 3% compared to 2015 . Excluding the impact of the 53 rd reporting week in 2016, total servings in 2017 was even with the prior year and total servings in 2016 increased 2% compared to 2015. Servings growth reflects adjustments to the prior year results for divestitures and other structural changes, including the deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015. Consolidated Net Revenue and Operating Profit Change Net revenue $ 63,525 $ 62,799 $ 63,056 % % Operating profit $ 10,509 $ 9,785 $ 8,353 % % Operating profit margin 16.5 % 15.6 % 13.2 % 1.0 2.3 See Results of Operations Division Review for a tabular presentation and discussion of key drivers of net revenue. 2017 Operating profit increased 7% and operating margin improved 1.0 percentage points. Operating profit growth was driven by the benefit of actions associated with our productivity initiatives, which contributed more than $1 billion in cost reductions across a number of expense categories, as well as effective net pricing. Items affecting comparability (see Items Affecting Comparability) also contributed 4 percentage points to operating profit growth and increased operating profit margin by 0.5 percentage points, primarily reflecting a prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value. Additionally, the impact of refranchising our beverage business in Jordan and a gain associated with the sale of our minority stake in Britvic each contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, higher commodity costs and unfavorable foreign exchange. Commodity inflation reduced operating profit growth by 6 percentage points, primarily attributable to inflation in the AMENA, Latin America, ESSA, NAB and FLNA segments. Corporate unallocated expenses (see Note 1 to our consolidated financial statements) decreased 9%, reflecting the impact of higher prior-year contributions to The PepsiCo Foundation, Inc. to fund charitable and social programs. 2016 Operating profit increased 17% and operating margin increased 2.3 percentage points. Operating profit growth was driven by the benefit of actions associated with our productivity initiatives, which contributed more than $1 billion in cost reductions across a number of expense categories, effective net pricing and volume growth. Additionally, the impact of recording an impairment charge in 2015 and ceasing the operations of our MQD joint venture contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, higher advertising and marketing expenses, unfavorable foreign exchange and higher commodity costs, as well as the deconsolidation of our Venezuelan businesses, which reduced operating profit growth by 2 percentage points. Items affecting comparability (see Items Affecting Comparability) contributed 13 percentage points to operating profit growth and increased operating profit margin by 1.5 percentage points, primarily reflecting a 17-percentage-point contribution from the 2015 Venezuela impairment charges. Higher commodity inflation reduced operating profit growth by 1 percentage point, primarily attributable to inflation in the Latin America, ESSA and AMENA segments, partially offset by deflation in the NAB, FLNA and QFNA segments. The impact of our 53 rd reporting week was fully offset by incremental investments we made in our business. Corporate unallocated expenses (see Note 1 to our consolidated financial statements) decreased 1%, driven by lower pension expense reflecting the change to the full yield curve approach, lower foreign exchange transaction losses and decreases in other corporate expenses, partially offset by increased contributions to The PepsiCo Foundation, Inc. to fund charitable and social programs and the net impact of items affecting comparability mentioned above included in corporate unallocated expenses. Other Consolidated Results Change Net interest expense $ (907 ) $ (1,232 ) $ (911 ) $ $ (321 ) Annual tax rate (a) 48.9 % 25.4 % 26.1 % Net income attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 (23 )% % Net income attributable to PepsiCo per common share diluted $ 3.38 $ 4.36 $ 3.67 (23 )% % Mark-to-market net impact (0.01 ) (0.08 ) Restructuring and impairment charges 0.16 0.09 0.12 Provisional net tax expense related to the TCJ Act (a) 1.70 Charges related to the transaction with Tingyi 0.26 0.05 Charge related to debt redemption 0.11 Pension-related settlement charge/(benefits) 0.11 (0.03 ) Venezuela impairment charges 0.91 Tax benefit (0.15 ) Net income attributable to PepsiCo per common share diluted, excluding above items (b) $ 5.23 $ 4.85 $ 4.57 % % Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share diluted, excluding above items, on a constant currency basis (b) % % (a) See Note 5 to our consolidated financial statements. (b) See Non-GAAP Measures. Net interest expense decreased $325 million reflecting a prior-year charge of $233 million representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This decrease also reflects higher interest income due to higher interest rates and average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest expense due to higher average debt balances. The reported tax rate increased 23.5 percentage points primarily as a result of the provisional net tax expense related to the TCJ Act , which contributed 26 percentage points to the increase, partially offset by the impact of the prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in the current year. See Note 2 and Note 5 to our consolidated financial statements for additional information. Net income attributable to PepsiCo and net income attributable to PepsiCo per common share both decreased 23% . Items affecting comparability (see Items Affecting Comparability) negatively impacted both net income attributable to PepsiCo and net income attributable to PepsiCo per common share by 30 percentage points, primarily as a result of the provisional net tax expense related to the TCJ Act. 2016 Net interest expense increased $321 million reflecting a charge of $233 million representing the premium paid in accordance with the make-whole redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This increase also reflects higher average debt balances, partially offset by higher interest income due to higher average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. The reported tax rate decreased 0.7 percentage points due to the impact of the 2015 Venezuela impairment charges, which had no corresponding tax benefit, partially offset by the 2015 favorable resolution with the IRS of substantially all open matters related to the audits for taxable years 2010 and 2011, as well as the 2016 impairment charge recorded to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit. Net income attributable to PepsiCo increased 16% and net income attributable to PepsiCo per common share increased 19% . Items affecting comparability (see Items Affecting Comparability) positively contributed 12 percentage points to net income attributable to PepsiCo and 13 percentage points to net income attributable to PepsiCo per common share. Non-GAAP Measures Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends. We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring programs; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; gains or losses associated with mergers, acquisitions, divestitures and other structural changes; debt redemptions; pension and retiree medical related items; amounts related to the resolution of tax positions; asset impairments (non-cash); and remeasurements of net monetary assets. See below and Items Affecting Comparability for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K. Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies. The following non-GAAP financial measures are contained in this Form 10-K: cost of sales, gross profit, selling, general and administrative expenses, interest expense, noncontrolling interests and provision for income taxes, each adjusted for items affecting comparability; operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates; organic revenue; free cash flow; and return on invested capital (ROIC) and net ROIC, excluding items affecting comparability. Cost of Sales, Gross Profit, Selling, General and Administrative Expenses, Interest Expense, Noncontrolling Interests and Provision for Income Taxes, Adjusted for Items Affecting Comparability; Operating Profit/Loss, Adjusted for Items Affecting Comparability, and Net Income Attributable to PepsiCo per Common Share Diluted, Adjusted for Items Affecting Comparability, and the Corresponding Constant Currency Growth Rates Cost of sales, gross profit, selling, general and administrative expenses, interest expense, noncontrolling interests and provision for income taxes, adjusted for items affecting comparability; operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2014 and 2012 Productivity Plans, a provisional net tax expense associated with the enactment of the TCJ Act, charges related to the transaction with Tingyi, a charge related to debt redemption, pension-related settlements, Venezuela impairment charges and a tax benefit (see Items Affecting Comparability for a detailed description of each of these items). We also evaluate performance on operating profit/loss, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. Organic Revenue We define organic revenue as net revenue adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes, including the Venezuela deconsolidation, for the comparable period. The Venezuela deconsolidation impact excluded the results of our Venezuelan businesses for the first three quarters of 2015. In addition, our fiscal 2016 reported results included an extra week of results. Organic revenue excludes the impact of the 53 rd reporting week in the fourth quarter of 2016. We believe organic revenue provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year. See Organic Revenue Growth in Results of Operations Division Review. Free Cash Flow We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure. See Free Cash Flow in Our Liquidity and Capital Resources. ROIC and Net ROIC, Excluding Items Affecting Comparability We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency. See Return on Invested Capital in Our Liquidity and Capital Resources. Items Affecting Comparability Our reported financial results in this Form 10-K are impacted by the following items in each of the following years: Cost of sales Gross profit Selling, general and administrative expenses Operating profit Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,785 $ 34,740 $ 24,231 $ 10,509 $ 4,694 $ 4,857 Items Affecting Comparability Mark-to-market net impact (8 ) (15 ) (7 ) (8 ) Restructuring and impairment charges (295 ) Provisional net tax expense related to the TCJ Act (2,451 ) 2,451 Core, Non-GAAP Measure $ 28,793 $ 34,732 $ 23,943 $ 10,789 $ 2,307 $ 7,524 Cost of sales Gross profit Selling, general and administrative expenses Operating profit Interest expense Provision for income taxes (a) Net income attributable to noncontrolling interests Net income attributable to PepsiCo Reported, GAAP Measure $ 28,209 $ 34,590 $ 24,805 $ 9,785 $ 1,342 $ 2,174 $ $ 6,329 Items Affecting Comparability Mark-to-market net impact (78 ) (167 ) (56 ) (111 ) Restructuring and impairment charges (160 ) Charge related to the transaction with Tingyi (373 ) Charge related to debt redemption (233 ) Pension-related settlement charge (242 ) Core, Non-GAAP Measure $ 28,287 $ 34,512 $ 24,119 $ 10,393 $ 1,109 $ 2,301 $ $ 7,040 Cost of sales Gross profit Selling, general and administrative expenses Venezuela impairment charges Operating profit Provision for income taxes (a) Net income attributable to PepsiCo Reported, GAAP Measure $ 28,731 $ 34,325 $ 24,613 $ 1,359 $ 8,353 $ 1,941 $ 5,452 Items Affecting Comparability Mark-to-market net impact (18 ) (11 ) (3 ) (8 ) Restructuring and impairment charges (230 ) Charge related to the transaction with Tingyi (73 ) Pension-related settlement benefits (67 ) (25 ) (42 ) Venezuela impairment charges (1,359 ) 1,359 1,359 Tax benefit (230 ) Core, Non-GAAP Measure $ 28,713 $ 34,343 $ 24,406 $ $ 9,937 $ 2,189 $ 6,788 (a) Provision for income taxes is the expected tax benefit/charge on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction and tax year and, in 2017, the impact of the TCJ Act is presented separately. Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. Restructuring and Impairment Charges 2014 Multi-Year Productivity Plan To build on the successful implementation of the 2014 Productivity Plan to date, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives of the 2014 Productivity Plan to further strengthen our food, snack and beverage businesses. We now expect to incur pre-tax charges and cash expenditures of approximately $1.3 billion and $985 million, respectively, as compared to our previous estimate of pre-tax charges and cash expenditures of approximately $990 million and $705 million, respectively. The expected pre-tax charges and cash expenditures are summarized by year as follows: Charges Cash Expenditures $ $ (b) (b) 2018 (expected) 2019 (expected) $ 1,305 (a) $ (a) This total pre-tax charge is expected to consist of approximately $795 million of severance and other employee-related costs, approximately $165 million for asset impairments (all non-cash) resulting from plant closures and related actions, and approximately $345 million for other costs associated with the implementation of our initiatives, including contract termination costs. This charge is expected to impact reportable segments and Corporate approximately as follows: FLNA 14%, QFNA 3%, NAB 30%, Latin America 15%, ESSA 25%, AMENA 4% and Corporate 9%. (b) In 2015 and 2014, cash expenditures include $2 million and $10 million , respectively, reported on our cash flow statement in pension and retiree medical plan contributions. See Note 3 to our consolidated financial statements for further information related to our 2014 and 2012 Productivity Plans. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements. Provisional Net Tax Expense Related to the TCJ Act In 2017, we recorded a provisional net tax expense of $2.5 billion ($1.70 per share) associated with the enactment of the TCJ Act in the fourth quarter of 2017. Included in the net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate. See Note 5 to our consolidated financial statements. Charges Related to the Transaction with Tingyi In 2016, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in the AMENA segment to reduce the value of our 5% indirect equity interest in TAB to its estimated fair valu e. In 2015, we recorded a pre- and after-tax charge of $73 million ($0.05 per share) in the AMENA segment related to a write-off of the value of a call option to increase our holding in TAB to 20%. See Note 9 to our consolidated financial statements. Charge Related to Debt Redemption In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See Note 8 to our consolidated financial statements. Pension-Related Settlements In 2016, we recorded a pre-tax pension settlement charge in corporate unallocated expenses of $242 million ($162 million after-tax or $0.11 per share) related to the purchase of a group annuity contract. See Note 7 to our consolidated financial statements. In 2015, we recorded pre-tax benefits of $67 million ($42 million after-tax or $0.03 per share) in the NAB segment associated with the settlement of pension-related liabilities from previous acquisitions. These benefits were recognized in selling, general and administrative expenses. Venezuela Impairment Charges In 2015, we recorded pre- and after-tax charges of $1.4 billion ($0.91 per share) in the Latin America segment related to the impairment of investments in our wholly-owned Venezuelan subsidiaries and beverage joint venture. See Note 1 to our consolidated financial statements and Our Business Risks. Tax Benefit In 2015, we recognized a non-cash tax benefit of $ 230 million ($ 0.15 per share) associated with our agreement with the IRS resolving substantially all open matters related to the audits for taxable years 2010 through 2011, which reduced our reserve for uncertain tax positions for the tax years 2010 and 2011. See Note 5 to our consolidated financial statements. Results of Operations Division Review The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. Accordingly, volume growth measures for 2016 reflect adjustments to the base year for divestitures and other structural changes, including the deconsolidation of our Venezuelan businesses effective as of the end of the third quarter of 2015. See Non-GAAP Measures and Items Affecting Comparability for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures. FLNA QFNA NAB Latin America ESSA AMENA Total Net Revenue, 2017 $ 15,798 $ 2,503 $ 20,936 $ 7,208 $ 11,050 $ 6,030 $ 63,525 Net Revenue, 2016 $ 15,549 $ 2,564 $ 21,312 $ 6,820 $ 10,216 $ 6,338 $ 62,799 % Impact of: Volume (a) % % (2.5 )% (2 )% % % % Effective net pricing (b) 2.5 (1 ) Foreign exchange translation (10 ) Acquisitions and divestitures (0.5 ) 53 rd reporting week (c) (2 ) (2 ) (1 ) (1 ) Reported growth (e) % (2 )% (2 )% % % (5 )% % FLNA QFNA NAB Latin America ESSA AMENA Total Net Revenue, 2016 $ 15,549 $ 2,564 $ 21,312 $ 6,820 $ 10,216 $ 6,338 $ 62,799 Net Revenue, 2015 $ 14,782 $ 2,543 $ 20,618 $ 8,228 $ 10,510 $ 6,375 $ 63,056 % Impact of: Volume (a) % % % % 1.5 % % % Effective net pricing (b) (1 ) 2.5 (1 ) Foreign exchange translation (11 ) (7 ) (5 ) (3 ) Acquisitions and divestitures (1 ) Venezuela deconsolidation (d) (14 ) (2 ) 53 rd reporting week (c) 1.5 Reported growth (e) % % % (17 )% (3 )% (1 )% % (a) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our Company-owned and franchised-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our beverage businesses, is based on CSE. (b) Includes the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. (c) Our fiscal 2016 results included a 53 rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. (d) The impact of the exclusion of the 2015 results of our Venezuelan businesses, which were deconsolidated effective as of the end of the third quarter of 2015. (e) Amounts may not sum due to rounding. Organic Revenue Growth Organic revenue is a non-GAAP financial measure. For further information on organic revenue see Non-GAAP Measures. FLNA QFNA NAB Latin America ESSA AMENA Total Reported Growth % (2 )% (2 )% % % (5 )% % % Impact of: Foreign exchange translation (1 ) (3 ) Acquisitions and divestitures (1 ) 0.5 53 rd reporting week (a) Organic Growth (c) % (1 )% (2 )% % % % % FLNA QFNA NAB Latin America ESSA AMENA Total Reported Growth % % % (17 )% (3 )% (1 )% % % Impact of: Foreign exchange translation Acquisitions and divestitures Venezuela deconsolidation (b) 53 rd reporting week (a) (2 ) (2 ) (1.5 ) (1 ) Organic Growth (c) 3.5 % % % % % % % (a) Our fiscal 2016 results included a 53 rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. Our 2017 organic revenue growth excludes the impact of the 53 rd reporting week from our 2016 results. (b) The impact of the exclusion of the 2015 results of our Venezuelan businesses, which were deconsolidated effective as of the end of the third quarter of 2015. (c) Amounts may not sum due to rounding. Frito-Lay North America % Change Net revenue $ 15,798 $ 15,549 $ 14,782 Impact of foreign exchange translation Impact of 53 rd reporting week (2 ) Organic revenue growth (a) (b) 3.5 (b) Operating profit $ 4,823 $ 4,659 $ 4,304 3.5 Restructuring and impairment charges Operating profit excluding above item (a) $ 4,890 $ 4,672 $ 4,330 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) 4.5 (b) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue grew 2%, primarily reflecting effective net pricing, partially offset by the impact of the 53 rd reporting week in the prior year, which reduced net revenue growth by 2 percentage points. Volume declined 1%, reflecting mid-single-digit declines in trademark Lays and Fritos and a low-single-digit decline in trademark Doritos, partially offset by high-single-digit growth in variety packs. The 53 rd reporting week in the prior year negatively impacted volume performance by 2 percentage points. Operating profit grew 3.5%, primarily reflecting planned cost reductions across a number of expense categories and the effective net pricing, as well as the impact of prior-year incremental investments into our business, which contributed 1 percentage point to operating profit growth. These impacts were partially offset by certain operating cost increases, including strategic initiatives, as well as higher commodity costs, primarily cooking oil, which reduced operating profit growth by 1 percentage point. The 53 rd reporting week in the prior year reduced operating profit growth by 2 percentage points. 2016 Net revenue grew 5%, driven by volume growth and effective net pricing. The 53 rd reporting week contributed 2 percentage points to the net revenue growth. Volume grew 3%, reflecting high-single-digit growth in variety packs, and mid-single-digit growth in trademark Doritos and Cheetos. These gains were partially offset by a mid-single-digit decline in our Sabra joint venture products. The 53 rd reporting week contributed 2 percentage points to the volume growth. Operating profit grew 8%, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as lower commodity costs, which contributed 3 percentage points to operating profit growth, primarily fuel and cooking oil. These impacts were partially offset by certain operating cost increases, including strategic initiatives, and higher advertising and marketing expenses. The 53 rd reporting week contributed 2 percentage points to operating profit growth, partially offset by incremental investments in our business, which reduced operating profit growth by 1.5 percentage points. Quaker Foods North America % Change Net revenue $ 2,503 $ 2,564 $ 2,543 (2 ) Impact of foreign exchange translation Impact of 53 rd reporting week (2 ) Organic revenue growth (a) (1 ) (b) (b) Operating profit $ $ $ (2 ) Restructuring and impairment charges Operating profit excluding above item (a) $ $ $ Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue declined 2%, reflecting the impact of the 53 rd reporting week in the prior year, which negatively impacted net revenue performance by 2 percentage points, as well as unfavorable mix. Volume declined 2%, reflecting a low-single-digit decline in ready-to-eat cereals and high-single-digit declines in trademark Roni and Gamesa, in part reflecting the impact of the 53 rd reporting week in the prior year which negatively impacted volume performance by 2 percentage points. Operating profit decreased 2%, reflecting certain operating cost increases and the net revenue performance. The 53 rd reporting week in the prior year negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories and lower advertising and marketing expenses, as well as the impact of prior-year incremental investments into our business, which positively contributed 1.5 percentage points to operating profit performance. Restructuring and impairment charges in the above table (see Items Affecting Comparability) negatively impacted operating profit performance by 1.5 percentage points. 2016 Net revenue grew 1%, driven by the 53 rd reporting week which contributed 2 percentage points to the net revenue growth, partially offset by unfavorable net pricing and mix and unfavorable foreign exchange. Volume grew 2%, reflecting mid-single-digit growth in Aunt Jemima syrup and mix and low-single-digit growth in ready-to-eat cereals, oatmeal and bars. The 53 rd reporting week contributed 2 percentage points to the volume growth. Operating profit increased 16%, impacted by 2015 impairment charges related to our dairy joint venture and ceasing its operations, which contributed 17 percentage points to operating profit growth. This increase also reflects planned cost reductions across a number of expense categories, as well as lower commodity costs, which contributed 6 percentage points to operating profit growth. These impacts were partially offset by higher advertising and marketing expenses, certain operating cost increases and the unfavorable net pricing and mix. The 53 rd reporting week contributed 2 percentage points to operating profit growth, partially offset by incremental investments in our business, which reduced operating profit growth by 1.5 percentage points. North America Beverages % Change Net revenue $ 20,936 $ 21,312 $ 20,618 (2 ) Impact of foreign exchange translation Impact of acquisitions and divestitures (1 ) Impact of 53 rd reporting week (1.5 ) Organic revenue growth (a) (2 ) (b) Operating profit $ 2,707 $ 2,959 $ 2,785 (9 ) Restructuring and impairment charges Pension-related settlement benefits (67 ) Operating profit excluding above items (a) $ 2,761 $ 2,994 $ 2,751 (8 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (8 ) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue decreased 2%, primarily reflecting a decline in volume, partially offset by effective net pricing, as well as acquisitions which positively contributed 1 percentage point to the net revenue performance. The 53 rd reporting week in the prior year negatively impacted net revenue performance by 1 percentage point. Volume decreased 3.5%, driven by a 5% decline in CSD volume and a 1% decline in non-carbonated beverage volume. The non-carbonated beverage volume decrease primarily reflected mid-single-digit declines in Gatorade sports drinks and in our juice and juice drinks portfolio, partially offset by a mid-single-digit increase in our overall water portfolio and a low-single-digit increase in Lipton ready-to-drink teas. Acquisitions had a nominal positive contribution to the volume performance. The 53 rd reporting week in the prior year negatively impacted volume performance by 1.5 percentage points. Operating profit decreased 9%, primarily reflecting certain operating cost increases and the net revenue performance, as well as higher commodity costs which negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by planned cost reductions across a number of expense categories and lower advertising and marketing expenses. Costs related to the hurricanes that occurred in the current year negatively impacted operating profit performance by 1 percentage point and were offset by a gain associated with a sale of an asset. In addition, the 53 rd reporting week in the prior year negatively impacted operating profit performance by 1 percentage point and was offset by incremental investments in our business in the prior year. 2016 Net revenue increased 3%, primarily reflecting effective net pricing and volume growth. The 53 rd reporting week contributed 1.5 percentage points to the net revenue growth. Volume increased 2%, driven by a 7% increase in non-carbonated beverage volume, partially offset by a 1% decline in CSD volume. The non-carbonated beverage volume increase primarily reflected a double-digit increase in our overall water portfolio, a mid-single-digit increase in Gatorade sports drinks, and a high- single-digit increase in Lipton ready-to-drink teas. The 53 rd reporting week contributed 1.5 percentage points to the volume growth. Operating profit increased 6%, primarily reflecting the net revenue growth and planned cost reductions across a number of expense categories, as well as lower commodity costs which contributed 6 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses. The 53 rd reporting week contributed 1.5 percentage points to the operating profit growth. This was partially offset by incremental investments in our business which reduced operating profit growth by 1 percentage point. Items affecting comparability in the above table (see Items Affecting Comparability) reduced operating profit growth by 3 percentage points. Latin America % Change Net revenue $ 7,208 $ 6,820 $ 8,228 (17 ) Impact of foreign exchange translation (1 ) Impact of acquisitions and divestitures 0.5 Impact of Venezuela deconsolidation Organic revenue growth (a) (b) Operating profit/(loss) $ $ $ (206 ) n/m Restructuring and impairment charges Venezuela impairment charges 1,359 Operating profit excluding above items (a) $ $ $ 1,189 (23 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (9 ) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. n/m - Not meaningful due to the impact of impairment charges associated with a change in accounting for our Venezuela operations in 2015. 2017 Net revenue increased 6%, reflecting effective net pricing, partially offset by volume declines. Favorable foreign exchange contributed 1 percentage point to net revenue growth. Snacks volume declined 1.5%, reflecting low-single-digit declines in Brazil and Mexico. Beverage volume declined 2%, reflecting a mid-single-digit decline in Brazil and a low-single-digit decline in Argentina, partially offset by high-single-digit growth in Guatemala. Additionally, Mexico experienced a slight decline. Operating profit increased 2%, reflecting the effective net pricing and planned cost reductions across a number of expense categories. These impacts were partially offset by certain operating cost increases and the volume declines, as well as higher commodity costs which reduced operating profit growth by 17 percentage points. Restructuring and impairment charges in the above table (see Items Affecting Comparability) reduced operating profit growth by 4 percentage points. 2016 Net revenue decreased 17%, reflecting the impact of the deconsolidation of our Venezuelan businesses, effective as of the end of the third quarter of 2015, and unfavorable foreign exchange, which negatively impacted net revenue performance by 14 percentage points and 11 percentage points, respectively. These impacts were partially offset by effective net pricing and net volume growth. Snacks volume grew 3%, reflecting a mid-single-digit increase in Mexico. Additionally, Brazil experienced a slight increase. Beverage volume decreased 2%, reflecting a double-digit decline in Argentina and low-single-digit declines in Mexico and Honduras, partially offset by a low-single-digit increase in Brazil and a mid-single-digit increase in Guatemala. Operating profit improvement primarily reflected the 2015 Venezuela impairment charges, included in items affecting comparability in the above table (see Items Affecting Comparability). This improvement also reflects the effective net pricing, planned cost reductions across a number of expense categories and the net volume growth. Additionally, the impact of 2015 charges associated with productivity initiatives outside the scope of the 2014 and 2012 Productivity Plans contributed 4 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, as well as the deconsolidation of our Venezuelan businesses, which reduced operating profit growth by 19 percentage points. Additionally, higher commodity costs reduced operating profit growth by 22 percentage points, largely due to transaction-related foreign exchange on purchases of raw materials, driven by a strong U.S. dollar. Operating profit was also reduced by higher advertising and marketing expenses, as well as incremental investments in our business, which reduced operating profit growth by 4 percentage points. Unfavorable foreign exchange translation reduced operating profit growth by 14 percentage points. Europe Sub-Saharan Africa % Change Net revenue $ 11,050 $ 10,216 $ 10,510 (3 ) Impact of foreign exchange translation (3 ) Impact of 53 rd reporting week Organic revenue growth (a) (b) Operating profit $ 1,354 $ 1,108 $ 1,081 2.5 Restructuring and impairment charges Operating profit excluding above item (a) $ 1,407 $ 1,168 $ 1,170 Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis (a) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue increased 8%, reflecting volume growth and effective net pricing, as well as favorable foreign exchange, which contributed 3 percentage points to net revenue growth. Snacks volume grew 5%, reflecting high-single-digit growth in Russia, partially offset by a slight decline in the United Kingdom and a low-single-digit decline in Spain. Additionally, Turkey, South Africa and the Netherlands experienced mid-single-digit growth. Beverage volume grew 1%, reflecting mid-single-digit growth in Poland and Nigeria and low-single-digit growth in Turkey and France, partially offset by mid-single-digit declines in Russia and Germany, and a low-single-digit decline in the United Kingdom. Operating profit increased 22%, reflecting the net revenue growth and planned cost reductions across a number of expense categories. Additionally, a gain associated with the sale of our minority stake in Britvic in the second quarter of 2017 contributed 8 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and higher advertising and marketing expenses, as well as higher commodity costs, which reduced operating profit growth by 7 percentage points. 2016 Net revenue decreased 3%, primarily reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 7 percentage points. These impacts were partially offset by effective net pricing and volume growth. Snacks volume grew 3%, primarily reflecting mid-single-digit growth in South Africa and low-single-digit growth in the Netherlands, partially offset by a low-single-digit decline in Russia. Additionally, the United Kingdom, Turkey and Spain experienced low-single-digit growth. Beverage volume grew 2%, primarily reflecting double-digit growth in Nigeria and high-single-digit growth in the United Kingdom and Poland, partially offset by a mid-single-digit decline in Russia and a low-single-digit decline in Germany. Additionally, Turkey and France each experienced low-single-digit growth. Operating profit increased 2.5%, reflecting planned cost reductions across a number of expense categories, the effective net pricing and the volume growth. These impacts were partially offset by higher commodity costs, which reduced operating profit growth by 19 percentage points, largely due to transaction-related foreign exchange on purchases of raw materials led by a strong U.S. dollar. Additionally, certain operating cost increases and higher advertising and marketing expenses reduced operating profit growth. The impact of unfavorable foreign exchange translation and incremental investments in our business also reduced operating profit growth by 6 percentage points and 2 percentage points, respectively. Asia, Middle East and North Africa % Change Net revenue $ 6,030 $ 6,338 $ 6,375 (5 ) (1 ) Impact of foreign exchange translation Impact of acquisitions and divestitures Organic revenue growth (a) (b) Operating profit $ 1,073 $ $ (34 ) Restructuring and impairment charges (3 ) Charges related to the transaction with Tingyi Operating profit excluding above items (a) $ 1,070 $ 1,006 $ 1,044 (4 ) Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis (a) (b) (1.5 ) (b) (a) See Non-GAAP Measures. (b) Does not sum due to rounding. 2017 Net revenue decreased 5%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 10 percentage points, primarily driven by a weak Egyptian pound. This impact was partially offset by effective net pricing. Snacks volume grew 5%, driven by high-single-digit growth in China and India and double-digit growth in Pakistan. Additionally, the Middle East experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume declined 1%, reflecting a double-digit decline in India and a mid-single-digit decline in the Middle East, partially offset by mid-single-digit growth in China, high-single-digit growth in Pakistan and low-single-digit growth in the Philippines. Operating profit improvement primarily reflected a prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, included in items affecting comparability in the above table (see Items Affecting Comparability). The effective net pricing and planned cost reductions across a number of expense categories also increased operating profit growth. Additionally, the impact of refranchising our beverage business in Jordan contributed 14 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, as well as higher commodity costs, which reduced operating profit growth by 32 percentage points, primarily due to transaction-related foreign exchange on raw material purchases driven by the weak Egyptian pound. Unfavorable foreign exchange translation reduced operating profit growth by 8 percentage points. 2016 Net revenue declined 1%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 5 percentage points, as well as unfavorable net pricing. These impacts were partially offset by volume growth. Snacks volume grew 7%, reflecting double-digit growth in China and the Middle East and high-single-digit growth in Pakistan. Additionally, India experienced low-single-digit growth and Australia experienced mid-single-digit growth. Beverage volume grew 4%, driven by high-single-digit growth in Pakistan, double-digit growth in the Philippines and mid-single-digit growth in China. Additionally, the Middle East experienced low-single-digit growth and India experienced mid-single-digit growth. Operating profit decreased 34%, primarily reflecting the items affecting comparability in the above table (see Items Affecting Comparability). Additionally, operating profit performance was negatively impacted by certain operating cost increases, including strategic initiatives, higher advertising and marketing expenses and the unfavorable net pricing, partially offset by the volume growth and planned cost reductions across a number of expense categories. The impact from a 2015 gain related to the refranchising of a portion of our beverage business in India negatively impacted operating profit performance by 4 percentage points. This impact was partially offset by a 2015 impairment charge associated with a joint venture in the Middle East which positively contributed 3 percentage points to operating profit performance. Our Liquidity and Capital Resources We believe that our cash generating capability and financial condition, together with our revolving credit facilities and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments and scheduled debt maturities, include cash from operations and proceeds obtained from issuances of commercial paper and long-term debt. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our credit facilities. See also Our Business Risks and Uncertain or unfavorable economic conditions may have an adverse impact on our business, financial condition or results of operations. in Item 1A. Risk Factors. As of December 30, 2017 , we had cash, cash equivalents and short-term investments in our consolidated subsidiaries of $18.9 billion outside the United States. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including the $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017, as a result of which we recognized a provisional mandatory transition tax liability of approximately $4 billion in the fourth quarter of 2017. Under the provisions of the TCJ Act, this transition tax must be paid over eight years; we currently expect to pay this liability over the period 2019 to 2026 . The recorded impact of the TCJ Act is provisional and the final amount may differ from the above estimate, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. In addition, as a result of this transition tax, we may access and repatriate our cash, cash equivalents and short-term investments held in our foreign subsidiaries during 2018 without such funds being subject to further U.S. income tax liability. We are currently evaluating when to repatriate such funds currently held by our foreign subsidiaries and how to utilize such funds, including whether to utilize such funds or other available methods of debt financing, such as commercial paper borrowings, for our anticipated share repurchases, dividend payments, scheduled debt maturities, discretionary benefit plan contributions, capital expenditures, certain investments into our business or other uses. See Item 1A. Risk Factors, Our Business Risks, Items Affecting Comparability and Our Critical Accounting Policies as well as Note 5 to our consolidated financial statements. As of December 30, 2017 , cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material. Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 9,994 $ 10,673 $ 10,864 Net cash used for investing activities $ (4,403 ) $ (7,148 ) $ (3,569 ) Net cash used for financing activities $ (4,186 ) $ (3,211 ) $ (4,112 ) Operating Activities During 2017 , net cash provided by operating activities was approximately $10 billion , compared to $10.7 billion in the prior year. The operating cash flow performance primarily reflects unfavorable working capital comparisons to the prior year. This decrease is mainly due to higher current year payments to vendors and customers, coupled with higher net cash tax payments in the current year, partially offset by lower pension and retiree medical plan contributions in the current year. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to the PepsiCo Employees Retirement Plan A (Plan A) in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. During 2016 , net cash provided by operating activities was $10.7 billion , compared to $10.9 billion in the prior year. The operating cash flow performance reflects discretionary pension contributions of $459 million. In addition, working capital reflects unfavorable comparisons to the prior year. These decreases were partially offset by lower net cash tax payments in the current year. Investing Activities During 2017 , net cash used for investing activities was $4.4 billion , primarily reflecting net capital spending of $2.8 billion and net purchases of debt securities with maturities greater than three months of $1.9 billion. During 2016 , net cash used for investing activities was $7.1 billion , primarily reflecting net purchases of debt securities with maturities greater than three months of $4.1 billion and net capital spending of $2.9 billion. See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities. We expect 2018 net capital spending to be approximately $3.6 billion . Financing Activities During 2017 , net cash used for financing activities was $4.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5 billion and net payments of short-term borrowings of $1.1 billion, partially offset by net proceeds from long-term debt of $3.1 billion and proceeds from exercises of stock options of $0.5 billion. During 2016 , net cash used for financing activities was $3.2 billion , primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $7.2 billion, debt redemptions of $2.5 billion, and withholding tax payments on restricted stock units (RSUs), performance stock units (PSUs) and PepsiCo equity performance units (PEPunits) converted of $0.1 billion, partially offset by net proceeds from long-term debt of $4.7 billion, net proceeds from short-term borrowings of $1.5 billion, and proceeds from exercises of stock options of $0.5 billion. We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 11, 2015, we announced a share repurchase program providing for the repurchase of up to $12.0 billion of PepsiCo common stock commencing from July 1, 2015 and expiring on June 30, 2018. On February 13, 2018, we announced a new share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock commencing on July 1, 2018 and expiring on June 30, 2021. In addition, on February 13, 2018, we announced a 15.2% increase in our annualized dividend to $3.71 per share from $3.22 per share, effective with the dividend expected to be paid in June 2018. We expect to return a total of approximately $7 billion to shareholders in 2018 through share repurchases of approximately $2 billion and dividends of approximately $5 billion. Free Cash Flow Free cash flow is a non-GAAP financial measure. For further information on free cash flow see Non-GAAP Measures. The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow. % Change Net cash provided by operating activities $ 9,994 $ 10,673 $ 10,864 (6 ) (2 ) Capital spending (2,969 ) (3,040 ) (2,758 ) Sales of property, plant and equipment Free cash flow (a) $ 7,205 $ 7,732 $ 8,192 (7 ) (6 ) (a) See Non-GAAP Measures. In addition, when evaluating free cash flow, we also consider the following items impacting comparability: $6 million and $459 million in discretionary pension contributions and associated net cash tax benefits of $1 million and $151 million in 2017 and 2016, respectively; $113 million , $125 million and $214 million of payments related to restructuring charges and associated net cash tax benefits of $30 million, $22 million and $51 million in 2017, 2016 and 2015, respectively; net cash received related to interest rate swaps of $5 million in 2016; net cash tax benefit related to debt redemption charge of $83 million in 2016; and $88 million in pension-related settlements and associated net cash tax benefits of $31 million in 2015. We will also consider payments related to the provisional transition tax liability of approximately $4 billion, which we currently expect to be paid over the period 2019 to 2026 under the provisions of the TCJ Act, as an item impacting comparability. We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. in Item 1A. Risk Factors and Our Business Risks for certain factors that may impact our credit ratings or our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. in Item 1A. Risk Factors, Our Business Risks and Note 8 to our consolidated financial statements. Credit Facilities and Long-Term Contractual Commitments See Note 8 to our consolidated financial statements for a description of our credit facilities. The following table summarizes our long-term contractual commitments by period: Payments Due by Period (a) Total 2019 2021 2023 and beyond Long-term debt obligations (b) $ 33,793 $ $ 7,803 $ 7,209 $ 18,781 Interest on debt obligations (c) 13,371 1,114 1,966 1,637 8,654 Operating leases (d) 1,894 Purchasing commitments (e) 2,910 1,076 1,394 Marketing commitments (e) 1,886 $ 53,854 $ 3,052 $ 12,657 $ 10,043 $ 28,102 (a) Based on year-end foreign exchange rates. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. However, under the provisions of the TCJ Act, our provisional transition tax liability of approximately $4 billion, recorded in other liabilities on our balance sheet, must be paid over eight years. We expect to pay approximately $0.3 billion per year in 2019-2023, $0.6 billion in 2024, $0.9 billion in 2025 and $1.0 billion in 2026 and these amounts are excluded from the table above. (b) Excludes $4,020 million related to current maturities of debt, $3 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $155 million related to unamortized net discount. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 30, 2017 . (d) See Note 13 to our consolidated financial statements for additional information on operating leases. (e) Primarily reflects non-cancelable commitments as of December 30, 2017 . Long-term contractual commitments, except for our long-term debt obligations and provisional transition tax liability, are generally not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges, orange juice and certain other commodities. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in our long-term contractual commitments. See Note 7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations. Off-Balance-Sheet Arrangements We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity. We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote. Return on Invested Capital ROIC is a non-GAAP financial measure. For further information on ROIC, see Non-GAAP Measures. Net income attributable to PepsiCo $ 4,857 (a) $ 6,329 $ 5,452 (b) Interest expense 1,151 1,342 Tax on interest expense (415 ) (483 ) (349 ) $ 5,593 $ 7,188 $ 6,073 Average debt obligations (c) $ 38,707 $ 35,308 $ 31,169 Average common shareholders equity (d) 12,004 11,943 15,147 Average invested capital $ 50,711 $ 47,251 $ 46,316 Return on invested capital 11.0 % (a) 15.2 % 13.1 % (b) (a) Includes the provisional impact of the TCJ Act enacted in 2017. See Note 5 to our consolidated financial statements for additional information. (b) Reflects the impact of the Venezuela impairment charges in 2015. (c) Average debt obligations includes a quarterly average of short-term and long-term debt obligations. (d) Average common shareholders equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability. ROIC 11.0 % 15.2 % 13.1 % Impact of: Average cash, cash equivalents and short-term investments 7.6 6.0 4.1 Interest income (0.5 ) (0.2 ) (0.1 ) Tax on interest income 0.2 0.1 Commodity mark-to-market net impact (0.2 ) Restructuring and impairment charges 0.3 0.1 0.2 Provisional net tax expense related to the TCJ Act 4.5 Charges related to the transaction with Tingyi (0.1 ) 0.6 0.1 Pension-related settlement charge/(benefits) 0.3 (0.1 ) Venezuela impairment charges (0.2 ) (0.5 ) 2.7 Tax benefits 0.1 0.1 (0.4 ) Net ROIC, excluding items affecting comparability 22.9 % 21.5 % 19.6 % OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. With the exception of our provisional net tax expense related to the TCJ Act and the change in 2016 to the full yield approach to estimate the service and interest cost components for our pension and retiree medical plans described below, we applied our critical accounting policies and estimation methods consistently in all material respects, and for all periods presented. We have discussed our critical accounting policies with our Audit Committee. Our critical accounting policies are: revenue recognition; goodwill and other intangible assets; income tax expense and accruals; and pension and retiree medical plans. Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels. As discussed in Our Customers in Item 1. Business, we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers. See Note 2 to our consolidated financial statements for additional information on our revenue recognition and related policies, including total marketplace spending, and the transition to the new revenue recognition guidance, which becomes effective in the first quarter of 2018. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows. We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these perpetual brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold. In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived, with the balance amortized over the remaining contractual period of the contract in which the right was granted. Indefinite-lived intangible assets and goodwill are not amortized and are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. The quantitative assessment requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for nonamortizable intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in Item 1A. Risk Factors and Our Business Risks. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See Note 2 and Note 4 to our consolidated financial statements for additional information. Income Tax Expense and Accruals Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit. See Increases in income tax rates, changes in income tax laws or disagreements with tax authorities could adversely affect our business, financial condition or results of operations. in Item 1A. Risk Factors. An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be among such items. Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements. During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further information in Items Affecting Comparability. Included in the provisional net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act and reflected in our provision for income taxes. The recorded impact of the TCJ Act is provisional and the final amount may differ, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. In 2017 , our annual tax rate was 48.9% compared to 25.4% in 2016 , as discussed in Other Consolidated Results. The tax rate increased 23.5 percentage points compared to 2016, primarily as a result of the provisional net tax expense related to the TCJ Act, which contributed 26 percentage points to the increase, partially offset by the impact of the prior-year impairment charge to reduce the value of our 5% indirect equity interest in TAB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in the current year. See Note 2 and Note 5 to our consolidated financial statements for additional information. The TCJ Act is currently expected to reduce our annual tax rate, in percentage terms, to the low twenties in 2018. However, we continue to evaluate the impact of the TCJ Act on our annual tax rate due to certain provisions, such as the global intangible low-tax income (GILTI) provision which may impact our tax rate in future years. Pension and Retiree Medical Plans Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits. In 2016, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the combination of two plans effective December 31, 2016, and the spinoff of a portion of the combined plan into a pre-existing plan effective January 1, 2017. The benefits offered to the plans participants were unchanged. The result of the reorganization was the creation of Plan A and the PepsiCo Employees Retirement Plan I (Plan I). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Note 7 to our consolidated financial statements. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See Items Affecting Comparability and Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pension and retiree medical expenses include: certain employee-related demographic factors, such as turnover, retirement age and mortality; the expected return on assets in our funded plans; for pension expense, the rate of salary increases for plans where benefits are based on earnings; for retiree medical expense, health care cost trend rates; and for pension and retiree medical expense, the spot rates along the yield curve used to determine the present value of liabilities and, beginning in 2016, to determine service and interest costs. Certain assumptions reflect our historical experience and managements best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities. Beginning 2016, we changed the method we use to estimate the service and interest cost components of net periodic benefit cost for our U.S. and the majority of our significant international pension and retiree medical plans. Historically, we estimated the service and interest cost components using a single weighted-average discount rate derived from the yield curve used to measure the projected benefit obligation (or accumulated post-retirement benefit obligation for the retiree medical plans) at the beginning of the period. We now use a full yield curve approach in the estimation of these components of benefit cost by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows. We have made this change to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates, which we believe will result in a more precise measurement of service and interest costs. This change does not affect the measurement of our benefit obligation. We have accounted for this change in estimate on a prospective basis as of the beginning of 2016. The pre-tax reduction in net periodic benefit cost associated with this change was $125 million ($81 million after-tax or $0.06 per share) for the full year 2016. See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return. The health care trend rate used to determine our retiree medical plans liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: Pension Service cost discount rate 3.7 % 4.3 % 4.5 % Interest cost discount rate 3.2 % 3.5 % 3.8 % Expected rate of return on plan assets (a) 6.9 % 7.2 % 7.2 % Expected rate of salary increases 3.2 % 3.2 % 3.2 % Retiree medical Service cost discount rate 3.6 % 4.0 % 4.3 % Interest cost discount rate 3.0 % 3.2 % 3.3 % Expected rate of return on plan assets (a) 6.5 % 7.5 % 7.5 % Current health care cost trend rate 5.8 % 5.9 % 6.0 % (a) Expected rate of return on plan assets in 2018 reflects a $1.4 billion contribution to Plan A in the United States that we intend to invest in fixed income securities, as well as our 2018 target investment allocations disclosed in Note 7 to our consolidated financial statements. In general, lower discount rates increase the size of the projected benefit obligation and pension expense in the following year, while higher discount rates reduce the size of the projected benefit obligation and pension expense. Based on our assumptions, we expect our total pension and retiree medical expense to remain consistent in 2018 primarily driven by cost savings due to the recognition of prior experience gains on plan assets and the impact of approved plan contributions, partially offset by the change in discount rates. Sensitivity of Assumptions A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would increase 2018 pre-tax pension and retiree medical expense as follows: Assumption Amount Discount rates used in the calculation of expense $47 Expected rate of return $42 See Note 7 to our consolidated financial statements for additional information about the sensitivity of our retiree medical cost assumptions. Funding We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to Plan A in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. These contributions are reflected in our 2018 long-term expected rate of return on plan assets and target investment allocations. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions except per share amounts) Net Revenue $ 63,525 $ 62,799 $ 63,056 Cost of sales 28,785 28,209 28,731 Gross profit 34,740 34,590 34,325 Selling, general and administrative expenses 24,231 24,805 24,613 Venezuela impairment charges 1,359 Operating Profit 10,509 9,785 8,353 Interest expense (1,151 ) (1,342 ) (970 ) Interest income and other Income before income taxes 9,602 8,553 7,442 Provision for income taxes (See Note 5) 4,694 2,174 1,941 Net income 4,908 6,379 5,501 Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 Net Income Attributable to PepsiCo per Common Share Basic $ 3.40 $ 4.39 $ 3.71 Diluted $ 3.38 $ 4.36 $ 3.67 Weighted-average common shares outstanding Basic 1,425 1,439 1,469 Diluted 1,438 1,452 1,485 Cash dividends declared per common share $ 3.1675 $ 2.96 $ 2.7625 See accompanying notes to the consolidated financial statements. Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Net income $ 4,908 $ 6,379 $ 5,501 Other comprehensive income/(loss), net of taxes: Net currency translation adjustment 1,109 (302 ) (2,827 ) Net change on cash flow hedges (36 ) Net pension and retiree medical adjustments (159 ) (316 ) Net change on securities (68 ) (24 ) Other (596 ) (2,652 ) Comprehensive income 5,770 5,783 2,849 Comprehensive income attributable to noncontrolling interests (51 ) (54 ) (47 ) Comprehensive Income Attributable to PepsiCo $ 5,719 $ 5,729 $ 2,802 See accompanying notes to the consolidated financial statements. Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Operating Activities Net income $ 4,908 $ 6,379 $ 5,501 Depreciation and amortization 2,369 2,368 2,416 Share-based compensation expense Restructuring and impairment charges Cash payments for restructuring charges (113 ) (125 ) (208 ) Charges related to the transaction with Tingyi Venezuela impairment charges 1,359 Pension and retiree medical plan expenses Pension and retiree medical plan contributions (220 ) (695 ) (205 ) Deferred income taxes and other tax charges and credits Provisional net tax expense related to the TCJ Act 2,451 Change in assets and liabilities: Accounts and notes receivable (202 ) (349 ) (461 ) Inventories (168 ) (75 ) (244 ) Prepaid expenses and other current assets (50 ) Accounts payable and other current liabilities 1,692 Income taxes payable (338 ) Other, net (341 ) (134 ) Net Cash Provided by Operating Activities 9,994 10,673 10,864 Investing Activities Capital spending (2,969 ) (3,040 ) (2,758 ) Sales of property, plant and equipment Acquisitions and investments in noncontrolled affiliates (61 ) (212 ) (86 ) Reduction of cash due to Venezuela deconsolidation (568 ) Divestitures Short-term investments, by original maturity: More than three months - purchases (18,385 ) (12,504 ) (4,428 ) More than three months - maturities 15,744 8,399 4,111 More than three months - sales Three months or less, net Other investing, net (5 ) Net Cash Used for Investing Activities (4,403 ) (7,148 ) (3,569 ) Financing Activities Proceeds from issuances of long-term debt 7,509 7,818 8,702 Payments of long-term debt (4,406 ) (3,105 ) (4,095 ) Debt redemptions (2,504 ) Short-term borrowings, by original maturity: More than three months - proceeds More than three months - payments (128 ) (27 ) (43 ) Three months or less, net (1,016 ) 1,505 Cash dividends paid (4,472 ) (4,227 ) (4,040 ) Share repurchases - common (2,000 ) (3,000 ) (5,000 ) Share repurchases - preferred (5 ) (7 ) (5 ) Proceeds from exercises of stock options Withholding tax payments on RSUs, PSUs and PEPunits converted (145 ) (130 ) (151 ) Other financing (76 ) (58 ) (52 ) Net Cash Used for Financing Activities (4,186 ) (3,211 ) (4,112 ) Effect of exchange rate changes on cash and cash equivalents (252 ) (221 ) Net Increase in Cash and Cash Equivalents 1,452 2,962 Cash and Cash Equivalents, Beginning of Year 9,158 9,096 6,134 Cash and Cash Equivalents, End of Year $ 10,610 $ 9,158 $ 9,096 See accompanying notes to the consolidated financial statements. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 30, 2017 and December 31, 2016 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents $ 10,610 $ 9,158 Short-term investments 8,900 6,967 Accounts and notes receivable, net 7,024 6,694 Inventories 2,947 2,723 Prepaid expenses and other current assets 1,546 Total Current Assets 31,027 26,450 Property, Plant and Equipment, net 17,240 16,591 Amortizable Intangible Assets, net 1,268 1,237 Goodwill 14,744 14,430 Other nonamortizable intangible assets 12,570 12,196 Nonamortizable Intangible Assets 27,314 26,626 Investments in Noncontrolled Affiliates 2,042 1,950 Other Assets Total Assets $ 79,804 $ 73,490 LIABILITIES AND EQUITY Current Liabilities Short-term debt obligations $ 5,485 $ 6,892 Accounts payable and other current liabilities 15,017 14,243 Total Current Liabilities 20,502 21,135 Long-Term Debt Obligations 33,796 30,053 Other Liabilities 11,283 6,669 Deferred Income Taxes 3,242 4,434 Total Liabilities 68,823 62,291 Commitments and contingencies Preferred Stock, no par value Repurchased Preferred Stock (197 ) (192 ) PepsiCo Common Shareholders Equity Common stock, par value 1 2 / 3 per share (authorized 3,600 shares, issued, net of repurchased common stock at par value: 1,420 and 1,428 shares, respectively) Capital in excess of par value 3,996 4,091 Retained earnings 52,839 52,518 Accumulated other comprehensive loss (13,057 ) (13,919 ) Repurchased common stock, in excess of par value (446 and 438 shares, respectively) (32,757 ) (31,468 ) Total PepsiCo Common Shareholders Equity 11,045 11,246 Noncontrolling interests Total Equity 10,981 11,199 Total Liabilities and Equity $ 79,804 $ 73,490 See accompanying notes to the consolidated financial statements. Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 (in millions) Shares Amount Shares Amount Shares Amount Preferred Stock 0.8 $ 0.8 $ 0.8 $ Repurchased Preferred Stock Balance, beginning of year (0.7 ) (192 ) (0.7 ) (186 ) (0.7 ) (181 ) Redemptions (5 ) (6 ) (5 ) Balance, end of year (0.7 ) (197 ) (0.7 ) (192 ) (0.7 ) (186 ) Common Stock Balance, beginning of year 1,428 1,448 1,488 Change in repurchased common stock (8 ) (20 ) (40 ) (1 ) Balance, end of year 1,420 1,428 1,448 Capital in Excess of Par Value Balance, beginning of year 4,091 4,076 4,115 Share-based compensation expense Stock option exercises, RSUs, PSUs and PEPunits converted (a) (236 ) (138 ) (182 ) Withholding tax on RSUs, PSUs and PEPunits converted (145 ) (130 ) (151 ) Other (4 ) (6 ) (5 ) Balance, end of year 3,996 4,091 4,076 Retained Earnings Balance, beginning of year 52,518 50,472 49,092 Net income attributable to PepsiCo 4,857 6,329 5,452 Cash dividends declared - common (4,536 ) (4,282 ) (4,071 ) Cash dividends declared - preferred (1 ) (1 ) Balance, end of year 52,839 52,518 50,472 Accumulated Other Comprehensive Loss Balance, beginning of year (13,919 ) (13,319 ) (10,669 ) Other comprehensive income/(loss) attributable to PepsiCo (600 ) (2,650 ) Balance, end of year (13,057 ) (13,919 ) (13,319 ) Repurchased Common Stock Balance, beginning of year (438 ) (31,468 ) (418 ) (29,185 ) (378 ) (24,985 ) Share repurchases (18 ) (2,000 ) (29 ) (3,000 ) (52 ) (4,999 ) Stock option exercises, RSUs, PSUs and PEPunits converted Other Balance, end of year (446 ) (32,757 ) (438 ) (31,468 ) (418 ) (29,185 ) Total PepsiCo Common Shareholders Equity 11,045 11,246 12,068 Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests (62 ) (55 ) (48 ) Currency translation adjustment (2 ) Other, net (1 ) (2 ) (2 ) Balance, end of year Total Equity $ 10,981 $ 11,199 $ 12,030 (a) Includes total tax benefits of $110 million in 2016 and $107 million in 2015 . See accompanying notes to the consolidated financial statements. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation The accompanying financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50% or less. Intercompany balances and transactions are eliminated. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product are included in selling, general and administrative expenses. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates. Effective as of the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries from our consolidated financial statements and began accounting for our investments in our wholly-owned Venezuelan subsidiaries and joint venture using the cost method of accounting. See subsequent discussion of Venezuela. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. Our fiscal 2016 results included an extra week. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. Certain operations in our ESSA segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule: Quarter United States and Canada International First Quarter 12 weeks January, February Second Quarter 12 weeks March, April and May Third Quarter 12 weeks June, July and August Fourth Quarter 16 weeks (17 weeks for 2016) September, October, November and December See Our Divisions below, and for additional unaudited information on items affecting the comparability of our consolidated results, see further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years financial statements to conform to the current year presentation, including the adoption of the recently issued accounting pronouncements disclosed in Note 2. Our Divisions Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient and enjoyable beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in North America, Mexico, Russia, the United Kingdom and Brazil. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions and are considered our reportable segments. For additional unaudited information on our divisions, see Our Operations contained in Item 1. Business. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: share-based compensation expense; pension and retiree medical expense; and derivatives. Share-Based Compensation Expense Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of share-based compensation expense in 2017 was approximately 13% to FLNA, 1% to QFNA, 18% to NAB, 7% to Latin America, 9% to ESSA, 9% to AMENA and 43% to corporate unallocated expenses. In 2016 , the allocation of share-based compensation expense was approximately 14% to FLNA, 2% to QFNA, 22% to NAB, 7% to Latin America, 11% to ESSA, 10% to AMENA and 34% to corporate unallocated expenses. We had similar allocations of share-based compensation expense to our divisions in 2015 . The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses. Pension and Retiree Medical Expense Pension and retiree medical service costs measured at fixed discount rates, as well as amortization of costs related to certain pension plan amendments and gains and losses due to demographics (including mortality assumptions and salary experience) are reflected in division results. Division results also include interest costs, measured at fixed discount rates, for retiree medical plans. Interest costs for the pension plans, pension asset returns and the impact of pension funding, and gains and losses other than those due to demographics, are all reflected in corporate unallocated expenses. In addition, corporate unallocated expenses include the difference between the service costs included in division results and total service costs determined using the plans discount rates as disclosed in Note 7. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, energy and metals . Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes. Net revenue and operating profit/(loss) of each division are as follows: Net Revenue Operating Profit/(Loss) (a) FLNA $ 15,798 $ 15,549 $ 14,782 $ 4,823 $ 4,659 $ 4,304 QFNA 2,503 2,564 2,543 NAB 20,936 21,312 20,618 2,707 2,959 2,785 Latin America 7,208 6,820 8,228 (206 ) ESSA 11,050 10,216 10,510 1,354 1,108 1,081 AMENA 6,030 6,338 6,375 1,073 Total division 63,525 62,799 63,056 11,507 10,885 9,465 Corporate unallocated (998 ) (1,100 ) (1,112 ) $ 63,525 $ 62,799 $ 63,056 $ 10,509 $ 9,785 $ 8,353 (a) For further unaudited information on certain items that impacted our financial performance, see Item 6. Selected Financial Data. Corporate Unallocated Corporate unallocated includes costs of our corporate headquarters, centrally managed initiatives such as research and development projects, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, commodity derivative gains and losses, our ongoing business transformation initiatives and certain other items. Other Division Information Total assets and capital spending of each division are as follows: Total Assets Capital Spending FLNA $ 5,979 $ 5,731 $ $ $ QFNA NAB 28,592 28,172 Latin America 4,976 4,568 ESSA 13,556 12,302 AMENA 5,668 5,261 Total division 59,575 56,845 2,883 2,938 2,556 Corporate (a) 20,229 16,645 $ 79,804 $ 73,490 $ 2,969 $ 3,040 $ 2,758 (a) Corporate assets consist principally of certain cash and cash equivalents, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2017 , the change in total Corporate assets was primarily due to an increase in short-term investments and cash and cash equivalents. Amortization of intangible assets and depreciation and other amortization of each division are as follows: Amortization of Intangible Assets Depreciation and Other Amortization FLNA $ $ $ $ $ $ QFNA NAB Latin America ESSA AMENA Total division 2,107 2,120 2,175 Corporate $ $ $ $ 2,301 $ 2,298 $ 2,341 Net revenue and long-lived assets by country are as follows: Net Revenue Long-Lived Assets (a) United States $ 36,546 $ 36,732 $ 35,266 $ 28,418 $ 28,382 Mexico 3,650 3,431 3,687 1,205 Russia (b) 3,232 2,648 2,797 4,708 4,373 Canada 2,691 2,692 2,677 2,739 2,499 United Kingdom 1,650 1,737 1,966 Brazil 1,427 1,305 1,289 All other countries 14,329 14,254 15,374 9,200 8,504 $ 63,525 $ 62,799 $ 63,056 $ 47,864 $ 46,404 (a) Long-lived assets represent property, plant and equipment, nonamortizable intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. (b) Change in net revenue and long-lived assets in 2017 primarily reflects appreciation of the Russian ruble. Venezuela Due to exchange restrictions and other conditions that significantly impact our ability to effectively manage our businesses in Venezuela and realize earnings generated by our Venezuelan businesses, effective at the end of the third quarter of 2015, we deconsolidated our Venezuelan subsidiaries and began accounting for our investments in our Venezuelan subsidiaries and joint venture using the cost method of accounting. We recorded pre- and after-tax charges of $1.4 billion in our income statement to reduce the value of the cost method investments to their estimated fair values, resulting in a full impairment. The factors that led to our conclusions at the end of the third quarter of 2015 continued to exist through the end of 2017. We do not have any guarantees related to our Venezuelan entities, and our ongoing contractual commitments to our Venezuelan businesses are not material. We will recognize income from dividends and sales of inventory to our Venezuelan entities, which have not been and are not expected to be material, to the extent cash in U.S. dollars is received. We have not received any cash in U.S. dollars from our Venezuelan entities since our deconsolidation at the end of the third quarter of 2015. We continue to monitor the conditions in Venezuela and their impact on our accounting and disclosures. For further unaudited information, see Our Business Risks, Items Affecting Comparability and Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products. Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment. We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses in our income statement. We are exposed to concentration of credit risk from our major customers, including Walmart. In 2017 , sales to Walmart (including Sams) represented approximately 13% of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers. Total Marketplace Spending We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers. A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred. The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Up-front payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $262 million as of December 30, 2017 and $291 million as of December 31, 2016 are included in prepaid expenses and other current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see Our Customers in Item 1. Business and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim periods actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual financial statements are not impacted by this interim allocation methodology. Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $4.1 billion in 2017 , $4.2 billion in 2016 and $3.9 billion in 2015 , including advertising expenses of $2.4 billion in 2017 , $2.5 billion in 2016 and $2.4 billion in 2015 . Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments; promotional materials in inventory; and production costs of future media advertising. Deferred advertising costs of $46 million and $32 million as of December 30, 2017 and December 31, 2016 , respectively, are classified as prepaid expenses and other current assets on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $9.9 billion in 2017 , $9.7 billion in 2016 and $9.4 billion in 2015 . Cash Equivalents Cash equivalents are highly liquid investments with original maturities of three months or less. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include(i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software projects and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $224 million in 2017 , $214 million in 2016 and $202 million in 2015 . Net capitalized software and development costs were $686 million and $791 million as of December 30, 2017 and December 31, 2016 , respectively. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional unaudited information on our commitments, see Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $737 million , $760 million and $ 754 million in 2017 , 2016 and 2015 , respectively, and are reported within selling, general and administrative expenses. See Research and Development in Item 1. Business for additional unaudited information about our research and development activities. Goodwill and Other Intangible Assets Indefinite-lived intangible assets and goodwill are not amortized and are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed. In the quantitative assessment of indefinite-lived intangible assets, if the carrying amount of the indefinite-lived intangible asset exceeds its estimated fair value, as determined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. Quantitative assessment of goodwill is performed using a two-step impairment test at the reporting unit level. A reporting unit can be a division or business within a division. The first step compares the carrying value of a reporting unit, including goodwill, with its estimated fair value, as determined by its discounted cash flows. If the carrying value of a reporting unit exceeds its estimated fair value, we complete the second step to determine the amount of goodwill impairment loss that we should record, if any. In the second step, we determine an implied fair value of the reporting units goodwill by allocating the estimated fair value of the reporting unit to all of the assets and liabilities other than goodwill (including any unrecognized intangible assets). The amount of impairment loss is equal to the excess of the carrying value of the goodwill over the implied fair value of that goodwill. The quantitative assessment described above requires an analysis of several estimates including future cash flows or income consistent with managements strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for nonamortizable intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows. See also Note 4, and for additional unaudited information on goodwill and other intangible assets, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Basis of Presentation Note 1 - Basis of Presentation for a description of our policies regarding use of estimates, basis of presentation and consolidation. Property, Plant and Equipment Note 4. Income Taxes Note 5, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Share-Based Compensation Note 6. Pension, Retiree Medical and Savings Plans Note 7, and for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Financial Instruments Note 9, and for additional unaudited information, see Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations. Inventories Note 13. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. Translation of Financial Statements of Foreign Subsidiaries Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders equity as currency translation adjustment. Recently Issued Accounting Pronouncements - Adopted In 2017, the SEC issued guidance related to the TCJ Act which allows recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective during our fourth quarter of 2017, resulting in a provisional net tax expense of $2.5 billion . This provisional net tax expense was recorded based on information available to us prior to the issuance of our 2017 consolidated financial statements, may be subject to further revision as disclosed in Note 5, and will be finalized no later than the end of 2018. In 2016, the Financial Accounting Standards Board (FASB) issued guidance that changes the accounting for certain aspects of share-based payments to employees. We adopted the provisions of this guidance during our first quarter of 2017, resulting in the following impacts to our financial statements: Income tax effects of vested or settled awards were recognized in the provision for income taxes on our income statement on a prospective basis. Previously, these tax effects were recorded on our equity statement in capital in excess of par value. For the year ended December 30, 2017, our excess tax benefits were $115 million , resulting in a $0.08 increase to diluted net income attributable to PepsiCo per common share. For the years ended December 31, 2016 and December 26, 2015, our excess tax benefits recognized were $110 million and $107 million , respectively. If we had applied this standard in 2016 and 2015, there would have been a $0.07 increase to diluted net income attributable to PepsiCo per common share for both years. The ongoing impact on our financial statements is dependent on the timing of when awards vest or are exercised, our tax rate and the intrinsic value when awards vest or are exercised. Excess tax benefits are retrospectively presented within operating activities and withholding tax payments upon vesting of RSUs, PSUs and PEPunits are retrospectively presented within financing activities in the cash flow statement. The adoption resulted in an increase of $295 million , $269 million and $284 million in our operating cash flow with a corresponding decrease in our financing cash flow for the years ended December 30, 2017, December 31, 2016 and December 26, 2015, respectively. The guidance also allows for the employer to repurchase more of an employees shares, up to the maximum statutory rate, for tax withholding purposes and not classify the award as a liability that requires valuation on a mark-to-market basis. Our accounting treatment for outstanding awards was not impacted by our adoption of this provision. In addition, the guidance allows for a policy election to account for forfeitures as they occur. We will continue to apply our policy of estimating forfeitures. In 2016, the FASB issued guidance that eliminates the requirement that an investor retrospectively apply equity method accounting for an investment originally accounted for by another method. The guidance requires that an equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investors previously held interest and adopt the equity method of accounting as of the date the investors ability to exercise significant influence over the investment is achieved. We adopted the provisions of this guidance prospectively during our first quarter of 2017; the adoption did not impact our financial statements. In 2015, the FASB issued guidance that requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet. We adopted the provisions of this guidance retrospectively during our first quarter of 2017, resulting in the reclassification of $639 million of deferred taxes from current to non-current on our balance sheet as of December 31, 2016. Recently Issued Accounting Pronouncements - Not Yet Adopted In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. The guidance is effective beginning in 2019 with early adoption permitted. We are currently evaluating the impact of this guidance, including transition elections and required disclosures, on our financial statements and the timing of adoption. In 2017, the FASB issued guidance that requires companies to retrospectively present the service cost component of net periodic benefit cost for pension and retiree medical plans along with other compensation costs in operating profit and present the other components of net periodic benefit cost below operating profit in the income statement. The guidance also allows only the service cost component of net periodic benefit cost to be eligible for capitalization within inventory or fixed assets on a prospective basis. We will adopt the guidance when it becomes effective in the first quarter of 2018. We will also update our allocation of service costs to our divisions starting in 2018 to better approximate actual service cost. In connection with this adoption, we expect to record a decrease in operating profit of $ 233 million for the year ended December 30, 2017 and an increase in operating profit of $ 19 million for the year ended December 31, 2016, primarily impacting selling, general and administrative expenses. See Note 7 for further information on our service cost and other components of net periodic benefit cost for pension and retiree medical plans. In 2016, the FASB issued guidance to clarify how restricted cash should be presented in the cash flow statement. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In 2016, the FASB issued guidance that requires companies to account for the income tax effects of intercompany transfers of assets, other than inventory, when the transfer occurs versus deferring income tax effects until the transferred asset is sold to an outside party or otherwise recognized. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In 2016, the FASB issued guidance that requires lessees to recognize most leases on the balance sheet, but record expenses on the income statement in a manner similar to current accounting. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The guidance is effective beginning in 2019 with early adoption permitted. We are currently evaluating the impact of this guidance on our financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. To facilitate this, we are utilizing a comprehensive approach to review our lease portfolio, as well as assessing system requirements and control implications. We have identified our significant leases by geography and by asset type that will be impacted by the new guidance, as well as a software tool to begin tracking the requirements of the guidance. In addition, we are currently evaluating the timing of adoption of this guidance. See Note 13 for our minimum lease payments under non-cancelable operating leases. In 2016, the FASB issued guidance that requires companies to measure investments in certain equity securities at fair value and recognize any changes in fair value in net income. We will adopt the guidance when it becomes effective in the first quarter of 2018. The guidance is not expected to have a material impact on our financial statements. In the second quarter of 2017, we sold our minority stake in Britvic, representing all of our available-for-sale equity securities, which reduced the risk and volatility of these investments in our income statement in the future. See Note 9 for further information on our available-for-sale securities. In 2014, the FASB issued guidance on revenue recognition, with final amendments issued in 2016. The guidance provides for a five-step model to determine the revenue recognized for the transfer of goods or services to customers that reflects the expected entitled consideration in exchange for those goods or services. It also provides clarification for principal versus agent considerations and identifying performance obligations. In addition, the FASB introduced practical expedients related to disclosures of remaining performance obligations, as well as other amendments related to guidance on collectibility, non-cash consideration and the presentation of sales and other similar taxes. Financial statement disclosures required under the guidance will enable users to understand the nature, amount, timing, judgments and uncertainty of revenue and cash flows relating to customer contracts. The two permitted transition methods under the guidance are the full retrospective approach or a cumulative effect adjustment to the opening retained earnings in the year of adoption (cumulative effect approach). We will adopt the guidance using the cumulative effect approach when it becomes effective in the first quarter of 2018. We are utilizing a comprehensive approach to assess the impact of the guidance on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the new requirements to our revenue contracts, including evaluation of our performance obligations, principal versus agent considerations and variable consideration. We are substantially complete with our contract and business process reviews and implemented changes to our controls to support recognition and disclosures under the new guidance. As a result of implementing certain changes to our accounting policies upon adoption, we plan to record an adjustment to opening retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition; exclude all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions from net revenue and cost of sales; and to record shipping and handling activities that are performed after a customer obtains control of the product as a fulfillment cost. Based on the foregoing, we currently do not expect this guidance to have a material impact on our financial statements or disclosures. Note 3 Restructuring and Impairment Charges A summary of our restructuring and impairment charges and other productivity initiatives is as follows: 2014 Productivity Plan $ $ $ 2012 Productivity Plan Total restructuring and impairment charges Other productivity initiatives Total restructuring and impairment charges and other productivity initiatives $ $ $ 2014 Multi-Year Productivity Plan The 2014 Productivity Plan, publicly announced on February 13, 2014, includes the next generation of productivity initiatives that we believe will strengthen our food, snack and beverage businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the successful implementation of the 2014 Productivity Plan to date, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives described above to further strengthen our food, snack and beverage businesses. In 2017 , 2016 and 2015 , we incurred restructuring charges of $295 million ($ 224 million after-tax or $0.16 per share), $160 million ( $131 million after-tax or $0.09 per share) and $169 million ( $134 million after-tax or $0.09 per share), respectively, in conjunction with our 2014 Productivity Plan. All of these charges were recorded in selling, general and administrative expenses and primarily relate to severance and other employee-related costs, asset impairments (all non-cash), and other costs associated with the implementation of our initiatives, including contract termination costs. Substantially all of the restructuring accrual at December 30, 2017 is expected to be paid by the end of 2018 . A summary of our 2014 Productivity Plan charges is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Severance and Other Employee Costs Asset Impairments Other Costs Total Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA (a) $ $ $ $ $ $ $ $ $ $ (1 ) $ $ QFNA NAB Latin America (a) (10 ) (2 ) ESSA AMENA (b) (5 ) (3 ) Corporate $ $ $ (6 ) $ $ $ $ $ $ $ $ $ (a) Income amounts represent adjustments for changes in estimates. (b) Income amount primarily reflects a gain on the sale of property, plant and equipment. Since the inception of the 2014 Productivity Plan, we incurred restructuring charges of $1,034 million : 2014 Productivity Plan Costs to Date Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ 1,034 A summary of our 2014 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 27, 2014 $ $ $ $ 2015 restructuring charges Cash payments (76 ) (87 ) (163 ) Non-cash charges and translation (11 ) (24 ) (3 ) (38 ) Liability as of December 26, 2015 2016 restructuring charges Cash payments (46 ) (49 ) (95 ) Non-cash charges and translation (15 ) (36 ) (50 ) Liability as of December 31, 2016 2017 restructuring charges (6 ) Cash payments (91 ) (22 ) (113 ) Non-cash charges and translation (65 ) (21 ) (52 ) Liability as of December 30, 2017 $ $ $ $ 2012 Multi-Year Productivity Plan The 2012 Productivity Plan, publicly announced on February 9, 2012, included actions in every aspect of our business that we believe would strengthen our complementary food, snack and beverage businesses. In 2015 , we incurred restructuring charges of $61 million ( $50 million after-tax or $0.03 per share) in conjunction with our 2012 Productivity Plan. All of these charges were recorded in selling, general and administrative expenses and primarily related to severance and other employee-related costs, asset impairments (all non-cash) and contract termination costs. The 2012 Productivity Plan was completed in 2016 and all cash payments were paid by the end of 2016. A summary of our 2012 Productivity Plan charges in 2015 is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ 95 Since the inception of the 2012 Productivity Plan, we incurred restructuring charges of $894 million : 2012 Productivity Plan Costs to Date Severance and Other Employee Costs Asset Impairments Other Costs Total FLNA $ $ $ $ QFNA NAB Latin America ESSA AMENA Corporate $ $ $ $ A summary of our 2012 Productivity Plan activity is as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total Liability as of December 27, 2014 $ $ $ $ 2015 restructuring charges Cash payments (24 ) (21 ) (45 ) Non-cash charges and translation (8 ) (4 ) (11 ) Liability as of December 26, 2015 Cash payments (28 ) (2 ) (30 ) Non-cash charges and translation (7 ) (1 ) (8 ) Liability as of December 31, 2016 $ $ $ $ Other Productivity Initiatives There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2014 and 2012 Productivity Plans in 2017 and 2016. In 2015, we incurred charges of $90 million ( $66 million after-tax or $0.04 per share) related to other productivity and efficiency initiatives outside the scope of the 2014 and 2012 Productivity Plans. These charges were recorded in selling, general and administrative expenses and primarily reflect severance and other employee-related costs and asset impairments (all non-cash). These initiatives were not included in items affecting comparability. We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above. See additional unaudited information in Items Affecting Comparability and Results of Operations Division Review in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 4 Property, Plant and Equipment and Intangible Assets A summary of our property, plant and equipment is as follows: Average Useful Life (Years) Property, plant and equipment, net Land $ 1,148 $ 1,153 Buildings and improvements 15 - 44 8,796 8,306 Machinery and equipment, including fleet and software 5 - 15 27,018 25,277 Construction in progress 2,144 2,082 39,106 36,818 Accumulated depreciation (21,866 ) (20,227 ) $ 17,240 $ 16,591 Depreciation expense $ 2,227 $ 2,217 $ 2,248 Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. A summary of our amortizable intangible assets is as follows: Amortizable intangible assets, net Average Useful Life (Years) Gross Accumulated Amortization Net Gross Accumulated Amortization Net Acquired franchise rights 56 60 $ $ (128 ) $ $ $ (108 ) $ Reacquired franchise rights 5 14 (104 ) (102 ) Brands 20 40 1,322 (1,026 ) 1,277 (977 ) Other identifiable intangibles 10 24 (281 ) (308 ) $ 2,807 $ (1,539 ) $ 1,268 $ 2,732 $ (1,495 ) $ 1,237 Amortization expense $ $ $ Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 30, 2017 and using average 2017 foreign exchange rates, is expected to be as follows: 2019 Five-year projected amortization $ $ $ $ $ 96 Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our policies for amortizable brands, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Nonamortizable Intangible Assets We did not recognize any impairment charges for goodwill in each of the fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . We recognized no material impairment charges for nonamortizable intangible assets in each of the fiscal years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . As of December 30, 2017 , the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at NAB exceeded their carrying values. However, there could be an impairment of the carrying value of NABs reacquired and acquired franchise rights if future revenues and their contribution to the operating results of NABs CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there is no impairment as of December 30, 2017 . However, there could be an impairment of the carrying value of certain brands in these countries if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For additional information on our policies for nonamortizable intangible assets, see Note 2. The change in the book value of nonamortizable intangible assets is as follows: Balance, Beginning 2016 Translation and Other Balance, End of 2016 Translation and Other Balance, End of 2017 FLNA Goodwill $ $ $ $ $ Brands 289 QFNA Goodwill NAB Goodwill (a) 9,754 9,843 9,854 Reacquired franchise rights 7,042 7,064 7,126 Acquired franchise rights 1,507 1,512 1,525 Brands (a) 18,411 18,733 18,858 Latin America Goodwill Brands (9 ) 658 (7 ) ESSA (b) Goodwill 3,042 3,177 3,452 Reacquired franchise rights Acquired franchise rights (6 ) Brands 2,212 2,358 2,545 5,932 6,207 6,741 AMENA Goodwill (6 ) Brands (2 ) 523 (8 ) Total goodwill 14,177 14,430 14,744 Total reacquired franchise rights 7,530 7,552 7,675 Total acquired franchise rights 1,697 (1 ) 1,696 1,720 Total brands 2,584 2,948 3,175 $ 25,988 $ $ 26,626 $ $ 27,314 (a) The change in 2016 is primarily related to our acquisition of KeVita, Inc. (b) The change in 2017 primarily reflects the currency appreciation of the Russian ruble and euro. The change in 2016 primarily reflects the currency appreciation of the Russian ruble. Note 5 Income Taxes The components of income before income taxes are as follows: United States $ 3,452 $ 2,630 $ 2,879 Foreign 6,150 5,923 4,563 $ 9,602 $ 8,553 $ 7,442 The provision for income taxes consisted of the following: Current: U.S. Federal $ 4,925 $ 1,219 $ 1,143 Foreign State 5,785 2,120 1,981 Deferred: U.S. Federal (1,159 ) (14 ) Foreign (9 ) (33 ) (32 ) State (22 ) (1,091 ) (40 ) $ 4,694 $ 2,174 $ 1,941 A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows: U.S. Federal statutory tax rate 35.0 % 35.0 % 35.0 % State income tax, net of U.S. Federal tax benefit 0.9 0.4 0.6 Lower taxes on foreign results (9.4 ) (8.0 ) (10.5 ) Impact of Venezuela impairment charges 6.4 Provisional one-time mandatory transition tax - TCJ Act 41.4 Provisional remeasurement of deferred taxes - TCJ Act (15.9 ) Tax settlements (3.1 ) Other, net (3.1 ) (2.0 ) (2.3 ) Annual tax rate 48.9 % 25.4 % 26.1 % Tax Cuts and Jobs Act During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21% , effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Included in the provisional net tax expense of $2.5 billion is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes. The TCJ Act also creates a new requirement that certain income earned by foreign subsidiaries, known as GILTI, must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. Due to the complexity of calculating GILTI under the new law, we have not determined which method we will apply. Therefore, we have not made any adjustments related to potential GILTI tax in our financial statements. We expect to elect an accounting policy in the first quarter of 2018. The components of the provisional net tax expense recorded in 2017 are based on currently available information and additional information needs to be prepared, obtained and/or analyzed to determine the final amounts. The provisional tax expense for the mandatory repatriation of undistributed international earnings will require further analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as estimated cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries. The provisional tax benefit for the remeasurement of deferred taxes will require additional information necessary for the preparation of our U.S. federal tax return, and further analysis and interpretation of certain provisions of the TCJ Act impacting deferred taxes, for example 100% expensing of qualified assets as well as our accounting policy election for recognizing deferred taxes for GILTI, could impact our deferred tax balance as of December 30, 2017. Tax effects for these items will be recorded in subsequent quarters, as discrete adjustments to our income tax provision, once complete. The SEC has issued guidance that allows for a measurement period of up to one year after the enactment date of the TCJ Act to finalize the recording of the related tax impacts. We currently anticipate finalizing and recording any resulting adjustments by the end of 2018. The recorded impact of the TCJ Act is provisional and the final amount may differ, possibly materially, due to, among other things, changes in estimates, interpretations and assumptions we have made, changes in IRS interpretations, the issuance of new guidance, legislative actions, changes in accounting standards or related interpretations in response to the TCJ Act and future actions by states within the United States that have not currently adopted the TCJ Act. For further unaudited information and discussion of the potential impact of the TCJ Act, refer to Item 1A. Risk Factors, Our Business Risks, Our Liquidity and Capital Resources and Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Deferred tax liabilities and assets are comprised of the following: Deferred Tax Liabilities Debt guarantee of wholly-owned subsidiary $ $ Property, plant and equipment 1,397 1,967 Intangible assets other than nondeductible goodwill 3,169 4,124 Other Gross deferred tax liabilities 5,194 7,175 Deferred tax assets Net carryforwards 1,400 1,255 Share-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Other Gross deferred tax assets 3,115 3,851 Valuation allowances (1,163 ) (1,110 ) Deferred tax assets, net 1,952 2,741 Net deferred tax liabilities $ 3,242 $ 4,434 A summary of our valuation allowance activity is as follows: Balance, beginning of year $ 1,110 $ 1,136 $ 1,230 Provision/(benefit) (26 ) Other additions/(deductions) (39 ) (68 ) Balance, end of year $ 1,163 $ 1,110 $ 1,136 For additional unaudited information on our income tax policies, including our reserves for income taxes, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows: Jurisdiction Years Open to Audit Years Currently Under Audit United States 2012-2016 2012-2013 Mexico 2014-2016 United Kingdom 2014-2016 None Canada (Domestic) 2013-2016 2013-2014 Canada (International) 2010-2016 2010-2014 Russia 2012-2016 2012-2016 While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. For further unaudited information on the impact of the resolution of open tax issues, see Other Consolidated Results in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2015, we reached an agreement with the IRS resolving substantially all open matters related to the audits of taxable years 2010 and 2011. The agreement resulted in a 2015 non-cash tax benefit totaling $230 million . As of December 30, 2017 , the total gross amount of reserves for income taxes, reported in other liabilities, was $2.2 billion . We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $283 million as of December 30, 2017 , of which $89 million of expense was recognized in 2017 . The gross amount of interest accrued, reported in other liabilities, was $193 million as of December 31, 2016 , of which $61 million of expense was recognized in 2016 . A reconciliation of unrecognized tax benefits, is as follows: Balance, beginning of year $ 1,885 $ 1,547 Additions for tax positions related to the current year Additions for tax positions from prior years Reductions for tax positions from prior years (51 ) (70 ) Settlement payments (4 ) (26 ) Statutes of limitations expiration (33 ) (27 ) Translation and other (27 ) Balance, end of year $ 2,212 $ 1,885 Carryforwards and Allowances Operating loss carryforwards totaling $12.6 billion at year-end 2017 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2 billion in 2018 , $11.1 billion between 2019 and 2037 and $1.3 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings As of December 30, 2017 , we had approximately $42.5 billion of undistributed international earnings. We intend to repatriate approximately $20 billion of our foreign earnings back to the United States and have recognized all tax expense on these earnings in the fourth quarter of 2017. We intend to continue to reinvest the remaining $22.5 billion of earnings outside the United States for the foreseeable future and while U.S. federal tax expense has been recognized as a result of the TCJ Act, no deferred tax liabilities with respect to items such as certain foreign exchange gains or losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings. Note 6 Share-Based Compensation Our share-based compensation program is designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. PepsiCo has granted stock options, RSUs, PSUs, PEPunits and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and, beginning in 2016, were granted 66% PSUs and 34% long-term cash, each of which are subject to pre-established performance targets. Previously, they were granted a combination of 60% PEPunits measuring both absolute and relative stock price performance and 40% long-term cash based on achievement of specific performance operating metrics. The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits. As of December 30, 2017 , 74 million shares were available for future share-based compensation grants under the LTIP. The following table summarizes our total share-based compensation expense: Share-based compensation expense - equity awards $ $ $ Share-based compensation expense - liability awards Restructuring and impairment (credits)/charges (2 ) Total $ $ $ Income tax benefits recognized in earnings related to share-based compensation $ (a) $ $ (a) Reflects tax rates effective for the 2017 tax year. As of December 30, 2017 , there was $314 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years. Method of Accounting and Our Assumptions The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years. Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest. We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. Stock Options A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10 -year term. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life 5 years 6 years 7 years Risk-free interest rate 2.0 % 1.4 % 1.8 % Expected volatility % % % Expected dividend yield 2.7 % 2.7 % 2.7 % The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price. A summary of our stock option activity for the year ended December 30, 2017 is as follows: Options (a) Weighted-Average Exercise Price Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (b) Outstanding at December 31, 2016 25,190 $ 69.88 Granted 1,481 $ 110.15 Exercised (7,136 ) $ 65.31 Forfeited/expired (522 ) $ 88.36 Outstanding at December 30, 2017 19,013 $ 74.23 4.22 $ 868,750 Exercisable at December 30, 2017 14,589 $ 65.60 3.02 $ 792,560 Expected to vest as of December 30, 2017 3,994 $ 102.50 8.15 $ 69,578 (a) Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. (b) In thousands. Restricted Stock Units and Performance Stock Units Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCos performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable. The fair value of RSUs is measured at the market price of the Companys stock on the date of grant. The fair value of PSUs is measured at the market price of the Companys stock on the date of grant with the exception of awards with market conditions, for which we use the Monte-Carlo simulation model to determine the fair value. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. A summary of our RSU and PSU activity for the year ended December 30, 2017 is as follows: RSUs/PSUs (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 31, 2016 8,237 $ 91.81 Granted (b) 2,824 $ 109.92 Converted (3,226 ) $ 82.56 Forfeited (608 ) $ 100.17 Actual performance change (c) $ 100.33 Outstanding at December 30, 2017 (d) 7,293 $ 102.30 1.33 $ 874,517 Expected to vest as of December 30, 2017 6,695 $ 102.00 1.26 $ 802,826 (a) In thousands. (b) Grant activity for all PSUs are disclosed at target. (c) Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. (d) The outstanding PSUs for which the performance period has not ended as of December 30, 2017 , at the threshold, target and maximum award levels were zero , 0.9 million and 1.5 million , respectively. PEPunits PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCos absolute stock price as well as PepsiCos Total Shareholder Return relative to the SP 500 over a three -year performance period. The fair value of PEPunits is measured using the Monte-Carlo simulation model. A summary of our PEPunit activity for the year ended December 30, 2017 is as follows: PEPunits (a) Weighted-Average Grant-Date Fair Value Weighted-Average Contractual Life Remaining (years) Aggregate Intrinsic Value (a) Outstanding at December 31, 2016 $ 59.86 Converted (363 ) $ 49.11 Forfeited (13 ) $ 68.94 Actual performance change (b) $ 50.74 Outstanding at December 30, 2017 (c) $ 68.94 0.17 $ 29,734 Expected to vest as of December 30, 2017 $ 68.94 0.17 $ 28,034 (a) In thousands. (b) Reflects the net number of PEPunits above and below target levels based on actual performance measured at the end of the performance period. (c) The outstanding PEPunits for which the performance period has not ended as of December 30, 2017 , at the threshold, target and maximum award levels were zero , 0.2 million and 0.4 million , respectively. Long-Term Cash Beginning in 2016, certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCos Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period. Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model until actual performance is determined. A summary of our long-term cash activity for the year ended December 30, 2017 is as follows: Long-Term Cash Award (a) Balance Sheet Date Fair Value (a) Contractual Life Remaining (years) Outstanding at December 31, 2016 $ 15,670 Granted (b) 19,060 Forfeited (1,530 ) Outstanding at December 30, 2017 (c) $ 33,200 $ 32,592 1.73 Expected to vest as of December 30, 2017 $ 29,590 $ 29,092 1.71 (a) In thousands. (b) Grant activity for all long-term cash awards are disclosed at target. (c) The outstanding long-term cash awards for which the performance period has not ended as of December 30, 2017, at the threshold, target and maximum award levels were zero , $33.2 million and $66.4 million, respectively. Other Share-Based Compensation Data The following is a summary of other share-based compensation data: Stock Options Total number of options granted (a) 1,481 1,743 1,884 Weighted-average grant-date fair value of options granted $ 8.25 $ 6.94 $ 10.80 Total intrinsic value of options exercised (a) $ 327,860 $ 290,131 $ 366,188 Total grant-date fair value of options vested (a) $ 23,122 $ 18,840 $ 21,837 RSUs/PSUs Total number of RSUs/PSUs granted (a) 2,824 3,054 2,759 Weighted-average grant-date fair value of RSUs/PSUs granted $ 109.92 $ 99.06 $ 99.17 Total intrinsic value of RSUs/PSUs converted (a) $ 380,269 $ 359,401 $ 375,510 Total grant-date fair value of RSUs/PSUs vested (a) $ 264,923 $ 257,648 $ 257,831 PEPunits Total number of PEPunits granted (a) Weighted-average grant-date fair value of PEPunits granted $ $ $ 68.94 Total intrinsic value of PEPunits converted (a) $ 39,782 $ 38,558 $ 37,705 Total grant-date fair value of PEPunits vested (a) $ 18,833 $ 16,572 $ 22,286 (a) In thousands. As of December 30, 2017 and December 31, 2016 , there were approximately 250,000 and 254,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above. Note 7 Pension, Retiree Medical and Savings Plans Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic benefit cost decreased by $ 42 million ($ 27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $ 0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ( $162 million after-tax or $0.11 per share). See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Effective as of the beginning of 2016, we prospectively changed the method we use to estimate the service and interest cost components of net periodic benefit cost. The pre-tax reduction in net periodic benefit cost associated with this change in 2016 was $ 125 million ($ 81 million after-tax or $0.06 per share). See Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on this change in accounting estimate. Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in expense for the following year based upon the average remaining service life for participants in Plan A (approximately 11 years) and retiree medical (approximately 7 years), or the remaining life expectancy for participants in Plan I (approximately 27 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service (credit)/cost) is included in earnings on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. Selected financial information for our pension and retiree medical plans is as follows: Pension Retiree Medical U.S. International Change in projected benefit liability Liability at beginning of year $ 13,192 $ 13,033 $ 3,124 $ 2,872 $ 1,208 $ 1,300 Service cost Interest cost Plan amendments (5 ) (15 ) Participant contributions Experience loss/(gain) 1,529 (51 ) Benefit payments (825 ) (347 ) (104 ) (83 ) (107 ) (100 ) Settlement/curtailment (58 ) (1,014 ) (22 ) (19 ) Special termination benefits Other, including foreign currency adjustment (383 ) Liability at end of year $ 14,777 $ 13,192 $ 3,490 $ 3,124 $ 1,187 $ 1,208 Change in fair value of plan assets Fair value at beginning of year $ 11,458 $ 11,397 $ 2,894 $ 2,823 $ $ Actual return on plan assets 1,935 Employer contributions/funding Participant contributions Benefit payments (825 ) (347 ) (104 ) (83 ) (107 ) (100 ) Settlement (46 ) (1,013 ) (18 ) (22 ) Other, including foreign currency adjustment (353 ) Fair value at end of year $ 12,582 $ 11,458 $ 3,460 $ 2,894 $ $ Funded status $ (2,195 ) $ (1,734 ) $ (30 ) $ (230 ) $ (866 ) $ (888 ) Amounts recognized Other assets $ $ $ $ $ $ Other current liabilities (74 ) (42 ) (1 ) (1 ) (75 ) (54 ) Other liabilities (2,407 ) (1,692 ) (114 ) (280 ) (791 ) (834 ) Net amount recognized $ (2,195 ) $ (1,734 ) $ (30 ) $ (230 ) $ (866 ) $ (888 ) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) $ 3,520 $ 3,220 $ $ $ (189 ) $ (193 ) Prior service cost/(credit) (3 ) (5 ) (71 ) (91 ) Total $ 3,549 $ 3,240 $ $ $ (260 ) $ (284 ) Changes recognized in net loss/(gain) included in other comprehensive loss Net loss/(gain) arising in current year $ $ $ (115 ) $ $ (9 ) $ (57 ) Amortization and settlement recognition (131 ) (413 ) (60 ) (46 ) Foreign currency translation loss/(gain) (117 ) Total $ $ $ (102 ) $ $ $ (55 ) Accumulated benefit obligation at end of year $ 13,732 $ 12,211 $ 2,985 $ 2,642 The amounts we report as pension and retiree medical cost consist of the following components: Service cost is the value of benefits earned by employees for working during the year. Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. The components of benefit expense are as follows: Pension Retiree Medical U.S. International Components of benefit expense Service cost $ $ $ $ $ $ $ $ $ Interest cost Expected return on plan assets (849 ) (834 ) (850 ) (176 ) (163 ) (174 ) (22 ) (24 ) (27 ) Amortization of prior service cost/(credit) (1 ) (3 ) (25 ) (38 ) (39 ) Amortization of net loss/(gain) (12 ) (1 ) Settlement/curtailment loss/(gain) (a) (14 ) Special termination benefits Total $ $ $ $ $ $ $ $ (4 ) $ (a) U.S. includes a settlement charge of $ 242 million related to the group annuity contract purchase in 2016. See additional unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. The estimated amounts to be amortized from accumulated other comprehensive loss/(gain) into pre-tax expense in 2018 for our pension and retiree medical plans are as follows: Pension Retiree Medical U.S. International Net loss/(gain) $ $ $ (10 ) Prior service cost/(credit) (20 ) Total $ $ $ (30 ) The following table provides the weighted-average assumptions used to determine projected benefit liability and benefit expense for our pension and retiree medical plans: Pension Retiree Medical U.S. International Weighted-average assumptions Liability discount rate 3.7 % 4.4 % 4.5 % 3.0 % 3.1 % 4.0 % 3.5 % 4.0 % 4.2 % Expense discount rate (a) n/a n/a 4.2 % n/a n/a 3.8 % n/a n/a 3.8 % Service cost discount rate (a) 4.5 % 4.6 % n/a 3.6 % 4.1 % n/a 4.0 % 4.3 % n/a Interest cost discount rate (a) 3.7 % 3.8 % n/a 2.8 % 3.5 % n/a 3.2 % 3.3 % n/a Expected return on plan assets 7.5 % 7.5 % 7.5 % 6.0 % 6.2 % 6.5 % 7.5 % 7.5 % 7.5 % Liability rate of salary increases 3.1 % 3.1 % 3.1 % 3.7 % 3.6 % 3.6 % Expense rate of salary increases 3.1 % 3.1 % 3.5 % 3.6 % 3.6 % 3.6 % (a) Effective as of the beginning of 2016, we prospectively changed the method we use to estimate the service and interest cost components of pension and retiree medical expense. See additional unaudited information in Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets: Pension Retiree Medical U.S. International Selected information for plans with accumulated benefit obligation in excess of plan assets Liability for service to date $ (8,355 ) $ (12,211 ) $ (161 ) $ (134 ) Fair value of plan assets $ 6,919 $ 11,458 $ $ Selected information for plans with projected benefit liability in excess of plan assets Benefit liability $ (9,400 ) $ (13,192 ) $ (1,273 ) $ (2,773 ) $ (1,187 ) $ (1,208 ) Fair value of plan assets $ 6,919 $ 11,458 $ 1,158 $ 2,492 $ $ Of the total projected pension benefit liability as of December 30, 2017 , approximately $905 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments Our estimated future benefit payments are as follows: 2023 - 27 Pension $ $ $ $ $ $ 5,210 Retiree medical (a) $ $ $ $ $ $ (a) Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $ 2 million for each of the years from 2018 through 2022 and approximately $6 million in total for 2023 through 2027. These future benefit payments to beneficiaries include payments from both funded and unfunded plans. Funding Contributions to our pension and retiree medical plans were as follows: Pension Retiree Medical Discretionary (a) $ $ $ $ $ $ Non-discretionary Total $ $ $ $ $ $ (a) Includes $ 452 million in 2016 relating to the funding of the group annuity contract purchase from an unrelated insurance company. In February 2018, we received approval from our Board of Directors to make discretionary contributions of $1.4 billion to Plan A in the United States that we intend to invest in fixed income securities. As of February 13, 2018, we contributed $750 million of the approved amount; we expect to contribute the remaining $650 million in the first quarter of 2018. These contributions are reflected in our 2018 long-term expected rate of return on plan assets and target investment allocations. In addition, in 2018, we expect to make non-discretionary contributions of approximately $ 175 million to our U.S. and international plans for pension benefits and approximately $ 75 million for retiree medical benefits. Plan Assets Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards. For 2018 and 2017 , our expected long-term rate of return on U.S. plan assets is 7.2% and 7.5% , respectively. Our target investment allocations for U.S. plan assets are as follows: Fixed income % % U.S. equity % % International equity % % Real estate % % Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments. The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five -year period. This has the effect of reducing year-to-year volatility. Plan assets measured at fair value as of fiscal year-end 2017 and 2016 are categorized consistently by level, and are as follows: Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total U.S. plan assets (a) Equity securities, including preferred stock (b) $ 6,904 $ 6,896 $ $ $ 6,489 Government securities (c) 1,365 1,365 1,173 Corporate bonds (c) 3,429 3,429 3,012 Mortgage-backed securities (c) Contracts with insurance companies (d) Cash and cash equivalents Sub-total U.S. plan assets 12,159 $ 7,132 $ 5,019 $ 11,064 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable, net of payables Total U.S. plan assets $ 12,903 $ 11,778 International plan assets Equity securities (b) $ 1,928 $ 1,895 $ $ $ 1,556 Government securities (c) Corporate bonds (c) Fixed income commingled funds (f) Contracts with insurance companies (d) Cash and cash equivalents Sub-total international plan assets 3,351 $ 2,297 $ 1,018 $ 2,804 Real estate commingled funds measured at net asset value (e) Dividends and interest receivable Total international plan assets $ 3,460 $ 2,894 (a) 2017 and 2016 amounts include $321 million and $ 320 million , respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. (b) The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The U.S. commingled funds are based on fair values of the investments owned by these funds that are benchmarked against various U.S. large, mid-cap and small company indices, and includes one large-cap fund that represents 19% of total U.S. plan assets for 2017 and 2016 . The international commingled funds are based on the fair values of the investments owned by these funds that track various non-U.S. equity indices. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. (c) These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 23% and 22% of total U.S. plan assets for 2017 and 2016 , respectively. (d) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 30, 2017 and December 31, 2016. (e) The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. (f) Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. Retiree Medical Cost Trend Rates Average increase assumed % % Ultimate projected increase % % Year of ultimate projected increase These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact. A 1-percentage-point change in the assumed health care trend rate would have the following effects: 1% Increase 1% Decrease 2017 service and interest cost components $ $ (3 ) 2017 benefit liability $ $ (34 ) Savings Plan Certain U.S. employees are eligible to participate in 401(k) savings plans, which are voluntary defined contribution plans. The plans are designed to help employees accumulate additional savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service. Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution. In 2017 , 2016 and 2015 , our total Company contributions were $176 million , $164 million and $148 million , respectively. For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see Our Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations. Note 8 Debt Obligations The following table summarizes the Companys debt obligations: 2017 (a) 2016 (a) Short-term debt obligations (b) Current maturities of long-term debt $ 4,020 $ 4,401 Commercial paper (1.3% and 0.6%) 1,385 2,257 Other borrowings (4.7% and 4.4%) $ 5,485 $ 6,892 Long-term debt obligations (b) Notes due 2017 (1.4%) $ $ 4,398 Notes due 2018 (2.4% and 2.3%) 4,016 2,561 Notes due 2019 (2.1% and 1.7%) 3,933 2,837 Notes due 2020 (3.1% and 2.6%) 3,792 3,816 Notes due 2021 (2.4% and 2.4%) 3,300 2,249 Notes due 2022 (2.6% and 2.8%) 3,853 2,655 Notes due 2023-2047 (3.7% and 3.8%) 18,891 15,903 Other, due 2017-2026 (1.3% and 1.4%) 37,816 34,454 Less: current maturities of long-term debt obligations (4,020 ) (4,401 ) Total $ 33,796 $ 30,053 (a) Amounts are shown net of unamortized net discounts of $155 million and $142 million for 2017 and 2016, respectively. (b) The interest rates presented reflect weighted-average rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for additional information regarding our interest rate derivative instruments. In 2017 , we issued the following senior notes: Interest Rate Maturity Date Amount (a) Floating rate May 2019 $ Floating rate May 2022 $ 1.550 % May 2019 $ 2.250 % May 2022 $ 4.000 % May 2047 $ 2.150 % May 2024 C$ (b) Floating rate October 2018 $ 1,500 2.000 % April 2021 $ 1,000 3.000 % October 2027 $ 1,500 (a) Represents gross proceeds from issuances of long-term debt excluding debt issuance costs, discounts and premiums. (b) These notes, issued in Canadian dollars, were designated as a net investment hedge to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. The net proceeds from the issuances of the above notes were used for general corporate purposes, including the repayment of commercial paper. In 2017 , we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 5, 2022. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . Additionally, we may, once a year, request renewal of the agreement for an additional one-year period. Also in 2017 , we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 4, 2018. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion , subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion . We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $3.7225 billion five-year credit agreement and our $3.7225 billion 364-day credit agreement both dated as of June 6, 2016. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 30, 2017 , there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement. In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million , respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ( $156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the make-whole redemption provisions. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. In addition, as of December 30, 2017 , our international debt of $73 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings. See Our Liquidity and Capital Resources in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our borrowings and long-term contractual commitments. Note 9 Financial Instruments Derivatives and Hedging We are exposed to market risks arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy; foreign exchange rates and currency restrictions; and interest rates. In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See Our Business Risks in Managements Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for agricultural products, energy and metals . Ineffectiveness for those derivatives that qualify for hedge accounting treatment was not material for all periods presented. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Our commodity derivatives had a total notional value of $0.9 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . Foreign Exchange Our operations outside of the United States generated 42% of our net revenue in 2017 , with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2017 . As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries. Our foreign currency derivatives had a total notional value of $1.6 billion as of December 30, 2017 and December 31, 2016 . The total notional amount of our debt instruments designated as net investment hedges was $1.5 billion as of December 30, 2017 and $0.8 billion as of December 31, 2016 . Ineffectiveness for derivatives and non-derivatives that qualify for hedge accounting treatment was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions. Our interest rate derivatives had a total notional value of $14.2 billion as of December 30, 2017 and $11.2 billion as of December 31, 2016 . Ineffectiveness for derivatives that qualify for cash flow hedge accounting treatment was not material for all periods presented. As of December 30, 2017 , approximately 43% of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 38% as of December 31, 2016 . Available-for-Sale Securities Investments in debt and marketable equity securities, other than investments accounted for under the equity method, are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale securities are recognized in accumulated other comprehensive loss within common shareholders equity. Unrealized gains and losses on our investments in debt securities as of December 30, 2017 were not material. In 2017, we recorded a pre-tax gain of $95 million ( $85 million after-tax or $0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. This gain was recorded in our ESSA segment in selling, general and administrative expenses. The pre-tax unrealized gain on these available-for-sale equity securities was $72 million as of December 31, 2016 . See Note 2 for additional information on investments in certain equity securities. Changes in the fair value of available-for-sale securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We regularly review our investment portfolio to determine if any security is other-than-temporarily impaired. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a security is less than its cost; the financial condition of the issuer and any changes thereto; and our intent to sell, or whether we will more likely than not be required to sell, the security before recovery of its amortized cost basis. Our assessment of whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular security. We recorded no other-than-temporary impairment charges on our available-for-sale securities for the years ended December 30, 2017 , December 31, 2016 and December 26, 2015 . Tingyi-Asahi Beverages Holding Co. Ltd. During 2016, we concluded that the decline in estimated fair value of our 5% indirect equity interest in TAB was other than temporary based on significant negative economic trends in China and changes in assumptions associated with TABs future financial performance arising from the disclosure by TABs parent company, Tingyi, regarding the operating results of its beverage business. As a result, we recorded a pre- and after-tax impairment charge of $373 million ( $0.26 per share) in 2016 in the AMENA segment. This charge was recorded in selling, general and administrative expenses in our income statement and reduced the value of our 5% indirect equity interest in TAB to its estimated fair value. The estimated fair value was derived using both an income and market approach, and is considered a non-recurring Level 3 measurement within the fair value hierarchy. The carrying value of the investment in TAB was $166 million as of December 30, 2017 and December 31, 2016 . We continue to monitor the impact of economic and other developments on the remaining value of our investment in TAB. In connection with our transaction with Tingyi in 2012, we received a call option to increase our holding in TAB to 20% with an expiration date in 2015. Prior to its expiration, we concluded that the probability of exercising the option was remote and, accordingly, we recorded a pre- and after-tax charge of $73 million ( $0.05 per share) to write off the recorded value of this call option in 2015. See further unaudited information in Items Affecting Comparability in Managements Discussion and Analysis of Financial Condition and Results of Operations. Fair Value Measurements The fair values of our financial assets and liabilities as of December 30, 2017 and December 31, 2016 are categorized as follows: Fair Value Hierarchy Levels (a) Assets (a) Liabilities (a) Assets (a) Liabilities (a) Available-for-sale securities: Equity securities (b) $ $ $ $ Debt securities (c) 14,510 11,369 $ 14,510 $ $ 11,451 $ Short-term investments (d) $ $ $ $ Prepaid forward contracts (e) $ $ $ $ Deferred compensation (f) $ $ $ $ Derivatives designated as fair value hedging instruments: Interest rate (g) $ $ $ $ Derivatives designated as cash flow hedging instruments: Foreign exchange (h) $ $ $ $ Interest rate (h) Commodity (i) Commodity (j) $ $ $ $ Derivatives not designated as hedging instruments: Foreign exchange (h) $ $ $ $ Commodity (i) Commodity (j) $ $ $ $ Total derivatives at fair value (k) $ $ $ $ Total $ 14,901 $ $ 11,851 $ 1,001 (a) Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. (b) Based on the price of common stock. These equity securities were classified as investments in noncontrolled affiliates. (c) Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 30, 2017 , $5.8 billion and $8.7 billion of debt securities were classified as cash equivalents and short-term investments, respectively. As of December 31, 2016 , $4.6 billion and $6.8 billion of debt securities were classified as cash equivalents and short-term investments, respectively. All of our available-for-sale debt securities have maturities of one year or less. (d) Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. (e) Based primarily on the price of our common stock. (f) Based on the fair value of investments corresponding to employees investment elections. (g) Based on LIBOR forward rates. (h) Based on recently reported market transactions of spot and forward rates. (i) Based on quoted contract prices on futures exchange markets. (j) Based on recently reported market transactions of swap arrangements. (k) Unless otherwise noted, derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 30, 2017 and December 31, 2016 were not material. Collateral received against any of our asset positions was not material. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 30, 2017 and December 31, 2016 was $41 billion and $38 billion , respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs. Losses/(gains) on our hedging instruments are categorized as follows: Fair Value/Non- designated Hedges Cash Flow and Net Investment Hedges Losses/(Gains) Recognized in Income Statement (a) Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement (b) Foreign exchange $ (15 ) $ $ $ (24 ) $ $ (44 ) Interest rate (195 ) (184 ) Commodity (48 ) (52 ) Net investment (39 ) Total $ $ $ $ $ (171 ) $ (a) Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. (b) Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. Based on current market conditions, we expect to reclassify net losses of $33 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months. Note 10 Net Income Attributable to PepsiCo per Common Share The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: Income Shares (a) Income Shares (a) Income Shares (a) Net income attributable to PepsiCo $ 4,857 $ 6,329 $ 5,452 Preferred shares: Dividends (1 ) (1 ) Redemption premium (4 ) (5 ) (5 ) Net income available for PepsiCo common shareholders $ 4,853 1,425 $ 6,323 1,439 $ 5,446 1,469 Basic net income attributable to PepsiCo per common share $ 3.40 $ 4.39 $ 3.71 Net income available for PepsiCo common shareholders $ 4,853 1,425 $ 6,323 1,439 $ 5,446 1,469 Dilutive securities: Stock options, RSUs, PSUs, PEPunits and Other ESOP convertible preferred stock Diluted $ 4,857 1,438 $ 6,329 1,452 $ 5,452 1,485 Diluted net income attributable to PepsiCo per common share $ 3.38 $ 4.36 $ 3.67 (a) Weighted-average common shares outstanding (in millions). Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows: Out-of-the-money options (a) 0.4 0.7 1.5 Average exercise price per option $ 110.12 $ 99.98 $ 99.25 (a) In millions. Note 11 Preferred Stock As of December 30, 2017 and December 31, 2016 , there were 3 million shares of convertible preferred stock authorized. The preferred stock was issued for an ESOP established by Quaker. Quaker made the final award to its ESOP in June 2001. As of December 30, 2017 and December 31, 2016 , there were 803,953 preferred shares issued and 114,753 and 122,553 shares outstanding, respectively. The outstanding preferred shares had a fair value of $68 million as of December 30, 2017 and $64 million as of December 31, 2016 . Activities of our preferred stock are included in the equity statement. In January 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock at the conversion ratio set forth in Exhibit A to our amended and restated articles of incorporation. As a result, there are no shares of our convertible preferred stock outstanding as of February 13, 2018. Note 12 Accumulated Other Comprehensive Loss Attributable to PepsiCo The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows: Currency Translation Adjustment Cash Flow Hedges Pension and Retiree Medical Available-For-Sale Securities Other Accumulated Other Comprehensive Loss Attributable to PepsiCo Balance as of December 27, 2014 (a) $ (8,255 ) $ $ (2,500 ) $ $ (35 ) $ (10,669 ) Other comprehensive (loss)/income before reclassifications (b) (2,936 ) (95 ) (88 ) (3,116 ) Amounts reclassified from accumulated other comprehensive loss Net current year other comprehensive (loss)/income (2,825 ) (2,642 ) Tax amounts (7 ) (2 ) (8 ) Balance as of December 26, 2015 (a) (11,080 ) (2,329 ) (35 ) (13,319 ) Other comprehensive (loss)/income before reclassifications (313 ) (74 ) (750 ) (43 ) (1,180 ) Amounts reclassified from accumulated other comprehensive loss Net current year other comprehensive (loss)/income (313 ) (343 ) (43 ) (623 ) Tax amounts (30 ) Balance as of December 31, 2016 (a) (11,386 ) (2,645 ) (35 ) (13,919 ) Other comprehensive (loss)/income before reclassifications (c) 1,049 (375 ) Amounts reclassified from accumulated other comprehensive loss (171 ) (99 ) (112 ) Net current year other comprehensive (loss)/income 1,049 (41 ) (217 ) (74 ) Tax amounts Balance as of December 30, 2017 (a) $ (10,277 ) $ $ (2,804 ) $ (4 ) $ (19 ) $ (13,057 ) (a) Pension and retiree medical amounts are net of taxes of $1,260 million in 2014, $1,253 million in 2015, $1,280 million in 2016 and $ 1,338 million in 2017. (b) Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Brazilian real and Canadian dollar. (c) Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement: Amount Reclassified from Accumulated Other Comprehensive Loss Affected Line Item in the Income Statement Currency translation: Venezuelan entities $ $ $ Venezuela impairment charges Cash flow hedges: Foreign exchange contracts $ $ $ (3 ) Net revenue Foreign exchange contracts (46 ) (94 ) Cost of sales Interest rate derivatives (184 ) Interest expense Commodity contracts Cost of sales Commodity contracts (1 ) Selling, general and administrative expenses Net (gains)/losses before tax (171 ) Tax amounts (63 ) (47 ) Net (gains)/losses after tax $ (107 ) $ $ Pension and retiree medical items: Amortization of net prior service credit (a) $ (24 ) $ (39 ) $ (41 ) Amortization of net losses (a) Settlement/curtailment (a) Net losses before tax Tax amounts (44 ) (144 ) (74 ) Net losses after tax $ $ $ Venezuelan entities $ $ $ Venezuela impairment charges Tax amount (4 ) Net losses after tax $ $ $ Available-for-sale securities: Sale of Britvic securities $ (99 ) $ $ Selling, general and administrative expenses Tax amount Net gain after tax $ (89 ) $ $ Total net (gains)/losses reclassified for the year, net of tax $ (82 ) $ $ (a) These items are included in the components of net periodic benefit cost for pension and retiree medical plans (see Note 7 for additional details). Note 13 Supplemental Financial Information Balance Sheet Accounts and notes receivable Trade receivables $ 5,956 $ 5,709 Other receivables 1,197 1,119 7,153 6,828 Allowance, beginning of year $ Net amounts charged to expense Deductions (a) (35 ) (30 ) (27 ) Other (b) (3 ) (23 ) Allowance, end of year $ Net receivables $ 7,024 $ 6,694 Inventories (c) Raw materials and packaging $ 1,344 $ 1,315 Work-in-process Finished goods 1,436 1,258 $ 2,947 $ 2,723 Other assets Noncurrent notes and accounts receivable $ $ Deferred marketplace spending Pension plans (d) Other $ $ Accounts payable and other current liabilities Accounts payable $ 6,727 $ 6,158 Accrued marketplace spending 2,390 2,444 Accrued compensation and benefits 1,785 1,770 Dividends payable 1,161 1,097 Other current liabilities 2,954 2,774 $ 15,017 $ 14,243 (a) Includes accounts written off. (b) Includes adjustments related primarily to currency translation and other adjustments. (c) Approximately 5% of the inventory cost in 2017 and 2016 were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) See Note 7 for additional information regarding our pension plans. Statement of Cash Flows Interest paid (a) $ 1,123 $ 1,102 $ Income taxes paid, net of refunds $ 1,962 $ 1,393 $ 1,808 (a) In 2016, interest paid excludes the premium paid in accordance with the make-whole provisions of the debt redemption discussed in Note 8. Lease Information Rent expense $ $ $ Minimum lease payments under non-cancelable operating leases by period Operating Lease Payments $ 2019 2020 2021 2022 2023 and beyond Total minimum operating lease payments $ 1,894 Note 14 Divestitures Refranchising in Jordan During the fourth quarter of 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations. We recorded a pre-tax gain of $140 million ( $107 million after-tax or $0.07 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction. Refranchising in Thailand During the fourth quarter of 2017, we entered into an agreement to refranchise our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations (included within our AMENA segment). The transaction is expected to be completed in 2018. Refranchising in Czech Republic, Hungary, and Slovakia (CHS) During the first quarter of 2018, we entered into an agreement to refranchise our entire beverage bottling operations and snack distribution operations in CHS (included within our ESSA segment). The transaction is expected to be completed in 2018. Managements Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions the actions of all our associates are governed by our Global Code of Conduct. This Code is clearly aligned with our stated values a commitment to deliver sustained growth through empowered people acting with responsibility and building trust. Both the Code and our core values enable us to operate with integrity both within the letter and the spirit of the law. Our Code of Conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements, and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control Integrated Framework (2013). The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the United States. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Global Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Boards oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our Internal Auditor and with our General Counsel. We also have a Compliance Ethics Department, led by our Chief Compliance Ethics Officer, who coordinates our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the United States, which require estimates based on managements best judgment. PepsiCo has a strong history of doing whats right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. February 13, 2018 /s/ MARIE T. GALLAGHER Marie T. Gallagher Senior Vice President and Controller (Principal Accounting Officer) /s/ HUGH F. JOHNSTON Hugh F. Johnston Vice Chairman, Executive Vice President and Chief Financial Officer /s/ INDRA K. NOOYI Indra K. Nooyi Chairman of the Board of Directors and Chief Executive Officer Report of Independent Registered Public Accounting Firm To the Shareholders and Board of Directors PepsiCo, Inc.: Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and Subsidiaries (the Company) as of December 30, 2017 and December 31, 2016, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 30, 2017 and the related notes (collectively, the consolidated financial statements). We also have audited the Companys internal control over financial reporting as of December 30, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 30, 2017 and December 31, 2016, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 30, 2017, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 30, 2017, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Basis for Opinion The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys consolidated financial statements and an opinion on the Companys internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. Definition and Limitations of Internal Control over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP We have served as the Companys auditor since 1990. New York, New York February 13, 2018 GLOSSARY Acquisitions and divestitures : all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees. Bottler Case Sales (BCS) : measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers. Bottler funding : financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE) : measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors. Constant currency : financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. Consumers : people who eat and drink our products. CSD : carbonated soft drinks. Customers : authorized independent bottlers, distributors and retailers. Derivatives : financial instruments, such as futures, swaps, Treasury locks, cross currency swaps and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates and foreign exchange rates. Direct-Store-Delivery (DSD) : delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing : reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Free cash flow : net cash provided by operating activities less capital spending plus sales of property, plant and equipment. Hedge accounting : treatment for qualifying hedges that allows fluctuations in a hedging instruments fair value to offset corresponding fluctuations in the hedged item in the same reporting period. Hedge accounting is allowed only in cases where the hedging relationship between the hedging instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented. Independent bottlers : customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Mark-to-market net gain or loss : change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace. Organic : a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, including the Venezuela deconsolidation which was effective as of the end of the third quarter of 2015, and foreign exchange translation. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of Constant currency for additional information. This measure also excludes the impact of the 53 rd reporting week in 2016. Servings : common metric reflecting our consolidated physical unit volume. Our divisions physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Total marketplace spending : includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities. Transaction gains and losses : the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustment : the impact of converting our foreign affiliates financial statements into U.S. dollars for the purpose of consolidating our financial statements. ", Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Included in Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations Our Business Risks. , Item 8. Financial Statements and Supplementary Data. See Item 15. Exhibits and Financial Statement Schedules. ," Item 9A. Controls and Procedures. (a) Disclosure Controls and Procedures. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. (b) Managements Annual Report on Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon criteria established in Internal Control Integrated Framework (2013) by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 30, 2017 . Attestation Report of the Registered Public Accounting Firm . KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting during our fourth fiscal quarter of 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During our fourth fiscal quarter of 2017 , we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implementations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses. In connection with these implementations and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain effective controls over our financial reporting. This transition has not materially affected, and we do not expect it to materially affect, our internal control over financial reporting. " diff --git a/datasets/raw/pfizer.csv b/datasets/raw/pfizer.csv new file mode 100644 index 0000000..fa92658 --- /dev/null +++ b/datasets/raw/pfizer.csv @@ -0,0 +1,6 @@ +,Company,Reporting_Date,1,1A,1B,2,3,5,7,7A,8,9A +0,pfe-,20211231," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of biopharmaceutical products. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . Our purpose fuels everything we do and reflects both our passion for science and our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the digital race in pharma ; and 5. Lead the conversation . In addition, Pfizer continues to enhance its ESG strategy, which is focused on six areas where we see opportunities to create a meaningful impact over the next decade: product innovation; equitable access and pricing; product quality and safety; diversity, equity and inclusion; climate change; and business ethics. We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities in 2021 include, among others: (i) the July 2021 global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader (the estrogen receptor is a well-known disease driver in most breast cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the treatment of cancer; and (iv) the December 2021 research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. In addition, in December 2021, we entered into a definitive agreement to acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020 and 2021, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, the development of a vaccine to help prevent Pfizer Inc. 2021 Form 10-K COVID-19 and an oral COVID-19 treatment. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. COMMERCIAL OPERATIONS Following (i) the spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan in 2020, which created a new global pharmaceutical company, Viatris, and (ii) the formation of the Consumer Healthcare JV with GSK in 2019, we saw the culmination of Pfizers transformation into a more focused, global leader in science-based innovative medicines and vaccines, and beginning in the fourth quarter of 2020, we operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business, and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Our Biopharma business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Comirnaty/BNT162b2*, the Prevnar family*, Nimenrix, FSME/IMMUN-TicoVac and Trumenba Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Inlyta*, Sutent, Retacrit, Lorbrena and Braftovi Internal Medicine Includes innovative brands in cardiovascular metabolic and womens health, as well as regional brands. Eliquis* and the Premarin family Hospital** Includes our global portfolio of sterile injectable and anti-infective medicines, as well as an oral COVID-19 treatment. Sulperazon, Medrol, Zavicefta, Zithromax, Vfend, Panzyga and Paxlovid Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra, Eucrisa/Staquis and Cibinqo Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2021, 2020 and 2019. Each of Comirnaty/BNT162b2 and Inlyta recorded direct product and/or Alliance revenues of more than $1 billion in 2021. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2021 and 2020. Comirnaty/BNT162b2, Eliquis and Xtandi include Alliance revenues and direct sales. Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). ** Prior to the fourth quarter of 2021, PC1 had been managed within the Hospital therapeutic area. Also, on December 31, 2021, we completed the sale of our Meridian subsidiary, which was part of the Hospital therapeutic area prior to its sale. See Note 1A for additional information. For additional information on our operating segments and products, see Note 17 and for additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Comirnaty/BNT162b2 is an mRNA-based coronavirus vaccine to help prevent COVID-19, which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech equally share the costs of development for the Comirnaty program. Comirnaty/BNT162b2 has been granted an approval or an authorization in many countries around the world in populations varying by country. We also share gross profits equally from commercialization of Comirnaty/BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on Comirnaty/BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on Myfembree (relugolix 40 Pfizer Inc. 2021 Form 10-K mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) for heavy menstrual bleeding associated with uterine fibroids in premenopausal women and the management of moderate to severe pain associated with endometriosis. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and Myfembree, with Myovant bearing our share of allowable expenses up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for Comirnaty/BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, (i) with BioNTech to develop a modified mRNA-based vaccine for the prevention of varicella zoster (Shingles), and (ii) with Valneva to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. These collaboration, alliance and license agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances and license arrangements and investments, see Note 2 . Our RD Operations. In 2021, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units within WRDM are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. Our GPD organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for late-stage clinical assets in Pfizers pipeline. Science-based platform-services organizations within WRDM. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Examples of these platform organizations include Pharmaceutical Sciences and Medicine Design, and Worldwide Medical and Safety. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, composed of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA and Note 17 . Pfizer Inc. 2021 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 8, 2022, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Product Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $51.5 billion accounted for 63% of our total revenues in 2021. Revenues exceeded $500 million in each of 21, 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively, with the increase in the number of countries in 2021 primarily driven by Comirnaty/BNT162b2. By total revenues, Japan was our largest national market outside the U.S. in 2021. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17B . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery systems. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Certain of these government contracts may be renegotiated or terminated at the discretion of a government entity. In addition, our contracts with government and supranational organizations for the sales of Comirnaty/BNT162b2 and Paxlovid, which are on a committed basis, represented a significant amount of revenues in 2021. We also seek to gain access for our products on formularies, which are lists of approved medicines available to members of healthcare programs or PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our significant customers, see Note 17C . We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers and patients; MCOs that provide insurance coverage, such as hospitals, integrated delivery systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. In the U.S., we market directly to consumers through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. Pfizer Inc. 2021 Form 10-K PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs or vaccines upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Product U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 (2) 2022 Sutent 2021 (3) 2022 (3) 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (4) 2025 Prevnar 13/Prevenar 13 2026 (5) 2029 Eliquis (6) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (7) 2027 (7) (7) Vyndaqel/Vyndamax/Vynmac 2024 (2028 pending PTE) 2026 2026/2029 (8) Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (4) Braftovi (9) 2031 (2031 pending PTE) (9) (9) Mektovi (9) 2031 (10) (9) (9) Bavencio (11) 2033 2032 2033 Lorbrena 2033 2034 2036 Prevnar 20/Apexxnar 2033 (2035 pending PTE) 2033 2033 (12) Cibinqo 2034 2034 (13) 2034 (2038 pending PTE) Comirnaty (14) (14), (15) (14) Paxlovid (16) (16) (16) (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our product from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix expired in the U.S. in November 2020 and in Europe in September 2021. (3) The basic product patent for Sutent expired in the U.S. in August 2021 and in Europe in January 2022. (4) Expiry is provided by regulatory exclusivity in this market. (5) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and were the subject of patent infringement litigation. Prior to the resolution of the litigation in our favor on both challenged patents, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). As a result of the litigation, the remaining generic companies are not permitted to launch their products until the 2031 expiration date of the formulation patent. Under the terms of the settlement agreements, the permitted date of launch for the settled generic companies under these patents is April 1, 2028. Both patents may be subject to subsequent challenges. While we cannot predict the outcome of any potential future litigation, these are the alternatives that might occur: (a) if both patents are upheld in future litigation, through appeal, the permitted date of launch for the settled generic companies under these patents would remain April 1, 2028; (b) if the formulation patent is held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant could launch products immediately upon such an adverse decision. Refer to Note 16A1 for more information. Pfizer Inc. 2021 Form 10-K (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Vyndaqel (tafamidis meglumine) basic patent expiry in Japan is August 2026 for treatment of polyneuropathy. Vynmac (tafamidis) was approved in Japan for treatment of cardiomyopathy with regulatory exclusivity expiring March 2029. (9) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) Mektovi U.S. expiry is provided by a method of use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. (12) Product not yet approved or authorized in this market. (13) An SPC has been filed for Cibinqo in the U.K. with expected expiry in 2036 based on the September 2021 approval. Cibinqo was approved in other major European markets in December 2021. (14) The basic product patent application for Comirnaty has been filed in these markets. If granted, a full term is expected in these markets. Comirnaty is being developed and commercialized in collaboration with BioNTech . (15) Pfizer does not have co-promotion rights for Comirnaty in Germany. (16) The basic product patent application for Paxlovid has been filed in these markets. If granted, a full term is expected in these markets. Loss of Intellectual Property Rights. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Competitive Products, Intellectual Property Protection and Third-Party Intellectual Property Claims sections in this Form 10-K and Note 16A1 . Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat or prevent diseases or indications similar to those treated or prevented by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic drug and biosimilar manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug or vaccine approval as we seek to further demonstrate the value of our products for the conditions they treat or prevent, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines and vaccines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition, including from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars, which include biosimilars of certain inflammation immunology and oncology biologic medicines, compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We seek to maximize the opportunity to establish a first-to- Pfizer Inc. 2021 Form 10-K market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we expect to continue to face intensified competition by certain generic manufacturers in 2022 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Commercial Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. In light of the COVID-19 pandemic and related large-scale healthcare disruptions, we expect value-based payment models may have reduced participation if the incentives to participate are reduced or eliminated. Financially weakened hospitals may weigh their ability to take on the financial risk of downside models. In contrast, providers in more advanced value-based models, such as full capitation, a fixed amount paid in advance per patient per unit of time-period, generally found their revenues remained steady during the pandemic, which may ultimately encourage the growth of such models. We believe medicines and vaccines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines and vaccines within an efficient and affordable healthcare system. This includes assessing our go-to market model to address patient affordability challenges. We have engaged with major payors and the U.S. government to explore opportunities to improve access and reimbursement in an effort to drive pro-patient policies. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we are developing stronger internal capabilities focused on demonstrating the value of the medicines and vaccines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and vaccines and competitor medicines and vaccines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 302 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs and vaccines to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger MCOs, which enhances those MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates Pfizer Inc. 2021 Form 10-K pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2022. However, we are seeing an increase in overall demand in the industry for certain components and raw materials with the potential to constrain available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact, including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing the operations of biopharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and/or administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines and vaccines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. For a biopharmaceutical company to market a drug or a biologic product, including vaccines, in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or BLA (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals) and the Drug Supply Chain Security Act (the law that, among other things, sets forth requirements related to product tracing, product identifiers and verification for manufacturers, wholesale distributors, repackagers and dispensers to facilitate the tracing of product through the pharmaceutical distribution supply chain), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Authorization/Approval Data sections in this Form 10-K. In the context of public health emergencies, like the COVID-19 pandemic, we may apply to the FDA for an EUA, which if granted, allows for the distribution and use of our products during the declared emergency, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated by the government. Although the criteria for an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing obligations. The FDA generally expects EUA holders to work toward submission of full applications, such as a BLA or an NDA, as soon as possible. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws, as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits corruptly soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services, including to government payers, such as Medicare and Medicaid, that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State Pfizer Inc. 2021 Form 10-K attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Pricing, Reimbursement and Access Regulations. Pricing and reimbursement for our products depend in part on government regulation. Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded or more directly impose controls on drug pricing, government reimbursement, and access to medicines and vaccines on public and private insurance plans could have a material impact on us. In addition, in order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1H. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. We expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. In addition, changes to the Medicaid program or the federal 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could have a material impact on our business. For example, certain changes issued in a final rule by the Centers for Medicare Medicaid Services (CMS) in December 2020 to the Medicaid Drug Rebate Program could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities. Additional changes to the 340B program are undergoing review and their status is unclear. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid managed care programs typically is determined by the health plans with which state Medicaid agencies contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. States budgets were impacted less by the COVID-19 pandemic than expected and are generally growing. We expect states to seek cost cutting within Medicaid, which may focus on managed care capitation payments and/or formulary management. States may also advance drug-pricing initiatives with a focus on affordability review boards, financial penalties related to pricing practices, manufacturer pricing and reporting requirements, as well as regulation of prescription drug assistance or copay accumulator programs in the commercial market. Payers may promote generic drugs and biosimilars more aggressively to generate savings and attempt to stimulate additional price competition. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us is increasingly important to our business and is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory and other governmental bodies. Such laws and regulations continue to evolve and are increasingly being enforced vigorously. Outside the United States New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. In the U.K., the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. Health authorities in many middle- and lower-income countries require marketing approval by a recognized regulatory authority (e.g., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU, the EMAs PRAC is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., Japan, China, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments globally may use a variety of measures to control costs, including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations such as the WHO are increasing scrutiny of international pharmaceutical pricing through policy recommendations and sponsorship of programs, such as The Oslo Medicines Initiative which is planning a high-level meeting in 2022 to agree on WHO Europe Member States commitments to ensure affordability for high-priced medicines. In November 2020, the EC published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. Pfizer Inc. 2021 Form 10-K In China, pricing pressures have increased in recent years because of an overall focus on healthcare cost containment with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. For patented products, drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program, a tender process where a certain portion of included molecule volumes are guaranteed to tender winners and is intended to contain healthcare costs by driving utilization of generics that have passed QCE, has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to VBP qualification in future rounds. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or industry trade associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers and/or healthcare organizations, such as academic teaching hospitals. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The WTO Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent and other intellectual property-related protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property policy environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, pursuant to the ongoing review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Discussions are ongoing at the WTO that seek to limit intellectual property protections within the context of the COVID-19 pandemic response. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines and vaccines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including but not limited to, the EUs General Data Protection Regulations and Chinas Personal Information Protection Law. The legislative and regulatory framework for privacy and data protection issues worldwide is also rapidly evolving as countries continue to adopt new and updated privacy and data security laws. The interpretation and application of such laws and regulations remain uncertain and continue to evolve. In addition, enforcement of such laws and regulations is increasing. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2021 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $55 million in environment-related capital expenditures and $152 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, the potential for more frequent and severe weather events, and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2021, we employed approximately 79,000 people worldwide, with approximately 29,000 based in the U.S. Women compose approximately 49% of our global workforce, and approximately 34% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent, but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, Pfizer Inc. 2021 Form 10-K fostering career growth and internal mobility and offering competitive compensation and benefits programs that encourage mental and physical well being. Core Values. To fully realize Pfizers purpose we have established a clear set of goals regarding what we need to achieve for patients and how we will go about achieving them. The how is represented by four simple, powerful company values Courage , Excellence , Equity and Joy . Each value defines our company and our culture: Courage : Breakthroughs start by challenging convention especially in the face of uncertainty or adversity. This happens when we think big, speak up and are decisive. Excellence : We can only change patients lives when we perform at our best together. This happens when we focus on what matters, agree who does what and measure outcomes. Equity : Every person deserves to be seen, heard and cared for. This happens when we are inclusive, act with integrity and reduce health care disparities. Joy : We give ourselves to our work, and it also gives to us. We find joy when we take pride, recognize one another and have fun. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our commitments to equity consist of specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) building a more inclusive colleague experience through representation and meaningful connections; (ii) advancing equitable health outcomes by evaluating our work through the lens of the communities we serve, (iii) providing resources on allyship and the science behind inclusion to support all colleagues in having courageous conversations about equity, race and the avoidance of bias; (iv) working to help transform society with external diversity, equity and inclusion partnerships, including deploying capital, engaging diverse suppliers and amplifying equity initiatives; and (v) working to help ensure demographics of clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . To attract, develop and inspire the brightest talent, we aim to support our colleagues by engaging and partnering with them to help ensure they feel they are part of a community. We understand the importance of continuously listening and responding to colleague feedback and our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their colleague experience. Through this survey, we measure and track key areas of the overall colleague experience and equip leaders with actionable insights for discussion and follow up. Regular topics in the survey include: (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer; (ii) purpose, including how colleagues work connects with our purpose; (iii) inclusion, such as having a climate in which diverse perspectives are valued; and (iv) growth, including the ability for colleagues to gain new experiences that align with their individual career goals. In 2021, we continued to maintain low turnover rates relative to the pharmaceutical industry and in our 2021 Pfizer Pulse survey, on average , 90% of colleagues reported feeling engaged, as measured by pride in working at Pfizer, willingness to recommend Pfizer as a great place to work and intent to stay. In addition, 92% of the colleagues agreed that their daily work contributes to our purpose. While we are slightly behind in our Bold Moves goal to create room for meaningful work, we continue to make progress on simplifying processes and removing needless complexity. We have committed to tangible actions and principles that incorporate the similar behaviors and mindset we used to develop a COVID-19 vaccine in an accelerated timeline. These behaviors include working with urgency and overcoming bureaucracy, as well as believing in our purpose, trusting in one another and being transparent. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insightsis based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. Our commitments to colleague development consist of specific actions to encourage non-linear career growth paths for all colleagues, including (i) a common language around growthalong with a guiding frameworkto help colleagues identify their next best growth experience, (ii) tools and resources to encourage growth conversations and offer transparency on the sources of growth available, and (iii) a variety of programs including mentoring, job rotations, experiential project roles, skill-based volunteering and learning resources focused on various topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being . Protecting the health, safety and well-being of colleagues and contingent workers, all of whom are essential to delivering our business objectives, is an integral part of how we operate. Our Global Environment, Health Safety (EHS) Policy and supporting standards outline our approach to assessment, evaluation, elimination, and mitigation of EHS risks across our operations. COVID-19 pandemic preparedness and response continues to be a key focus to help ensure on-site workers at our commercial, manufacturing and research sites remain safe and healthy while continuing to support work from home arrangements for colleagues who can work remotely. As part of these efforts, we (i) implemented a vaccination program for colleagues and their families in the U.S. and 23 other countries where employer vaccination programs were possible, (ii) partnered with and launched Thrive Global, a wellness and organizational change initiative with a primary focus on colleague mental health and wellness, and (iii) hosted educational webinars and information sessions on mental health and well-being, nutrition and work life balance through our employee assistance program provider. Pay Equity. Our commitment to pay equity for all colleagues is based in our value of Equity and our intention to continue to build a diverse and inclusive workforce. We are committed to equitable pay practices at Pfizer for employees based on role, education, experience, performance, and location and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the About Careers section of Pfizers website and our ESG Report. "," ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is Pfizer Inc. 2021 Form 10-K not meant to be a complete discussion of all potential risks or uncertainties. Additionally, our business is subject to general risks applicable to any company, such as economic conditions, geopolitical events, extreme weather and natural disasters. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. The negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and value-based pricing/contracting to improve their cost containment efforts. Such payers are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Also, business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches continue to occur, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line products and product candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. The entry to the market of competing biosimilars is expected to increase pricing pressures on our biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or Alliance revenues of more than $1 billion for each of nine products that collectively accounted for 75% of our total revenues in 2021. In particular, Comirnaty/BNT162b2 accounted for 45% of our total revenues in 2021. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription or vaccination growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective product should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K. For Comirnaty/BNT162b2 and Pfizer Inc. 2021 Form 10-K Paxlovid, while we believe that these products have the potential to provide ongoing revenue streams for Pfizer for the foreseeable future, revenues of these products following the COVID-19 pandemic may not be at the similar levels as those being generated during the pandemic. For information on additional risks associated with Comirnaty/BNT162b2 and Paxlovid, see the COVID-19 Pandemic section below. In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17C . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, primarily through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. For example, our gene therapy product candidates are based on a novel technology with only a few gene therapies approved to date, which makes it difficult to predict the time and cost of development and the ability to obtain regulatory approval. Further, gene therapy may face difficulties in gaining the acceptance of patients or the medical community. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions including inflation, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 63% of our total 2021 revenues were derived from international operations, including 29% from Europe and 19% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA and Note 7E . For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Note 11 . From time to time, we issued variable rate debt based on LIBOR, or undertook interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month Pfizer Inc. 2021 Form 10-K LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend any contracts to accommodate the SOFR rate where required. We do not expect the transition to have significant impact on our business or financial condition. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in our supply chain, product manufacturing and distribution networks, as well as sales or marketing, due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on, reputational harm, the impact to our facilities due to health pandemics or natural or man-made disasters, including as a result of climate change, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain supply and/or appropriate quality standards throughout our supply network and/or comply with applicable regulations; inability to supply certain products due to voluntary product recalls (as is the case with Chantix); and supply chain disruptions at our facilities or at a supplier or vendor. In addition, we engage contract manufacturers, and, from time to time, our contract manufacturers may face difficulties or are unable to manufacture our products at the necessary quantity or quality levels. Regulatory agencies periodically inspect our manufacturing facilities, as well as third-party facilities that we rely on, to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. In July and August 2021, Pfizer recalled 16 lots of Chantix in the U.S. due to the presence of a nitrosamine, N-nitroso-varenicline, at or above the FDA interim acceptable intake limit. In September 2021, Pfizer expanded its voluntary recall in the U.S. to include all lots of Chantix. We currently also have a voluntary recall across multiple markets and a global pause in shipments of Chantix. Technical solutions are being pursued to reduce nitrosamine levels in Chantix to enable return to market. Nitrosamines are impurities common in water and foods and everyone is exposed to some level of nitrosamines. In response to requests from various regulatory authorities, manufacturers across the pharmaceutical industry, including Pfizer, are evaluating their product portfolios for the potential for the presence or formation of nitrosamines. This may lead to additional recalls or other market actions for Pfizer products. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For information on additional risks specific to our Consumer Healthcare JV, see the Consumer Healthcare JV with GSK section below. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines and vaccines prime targets for counterfeiters. Counterfeit medicines and vaccines pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact Pfizers patients, potentially causing them harm. This, in turn, may result in the loss of patient confidence in the Pfizer name and in the integrity of our medicines and vaccines, and potentially impact our business through lost sales, product recalls, and possible litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the internet in lieu of traditional brick and mortar pharmacies or authorized full-service internet pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of consumers misplaced trust with certain e-commerce retailers coupled with the anonymity the internet affords counterfeiters. While counterfeiters generally target any medicine or vaccine boasting strong demand, we have observed heightened counterfeit and fraud attempts to our COVID-19 vaccine, as well as other products potentially utilized in the treatment of COVID-19. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, investing in innovative technologies to detect and disrupt sophisticated internet offers and scams, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2021 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. We expect to see continued focus by the Federal government on regulating pricing which could result in legislative and regulatory changes designed to control costs. Some states have implemented, and others are considering, patient access constraints or cost cutting under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have continued to focus on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for COVID-19 treatments and vaccines. U.S. HEALTHCARE REGULATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare regulation, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. Any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may need to amend our clinical trial protocols or conduct additional clinical trials under certain circumstances, for example, to further assess appropriate dosage or collect additional safety data. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval for new products and indications from regulators. Regulatory approvals of our products depend on myriad factors, including regulatory determinations as to the products safety and efficacy. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency or conditional basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP or any FDA Advisory Committee that may be convened to review our applications such as EUAs, NDAs or BLAs, which may impact the potential marketing and use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, including regulator-directed risk evaluations and Pfizer Inc. 2021 Form 10-K assessments, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-AUTHORIZATION/APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies and clinical trials, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as other products in the class. The potential regulatory and commercial implications of post-marketing study results typically cannot immediately be determined. For example, in December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. Updates include a new boxed warning for major adverse cardiovascular events (MACE) and updated boxed warnings regarding mortality, malignancies and thrombosis (with corresponding updates to applicable warnings and precautions). In addition, indications for the treatment of adults with moderately to severely active RA or active PsA, and patients who are two years of age and older with active polyarticular course juvenile idiopathic arthritis have been revised; Xeljanz is now indicated in patients who have had inadequate response or intolerance to one or more tumor necrosis factor blockers. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. We continue to work with regulatory agencies to review the full results and analyses of ORAL Surveillance and their impact on product labeling. The terms of our EUA for Comirnaty require that we conduct post-authorization observational studies in patients at least 5 years of age or older who received a booster dose, or other populations of interest including healthcare workers, pregnant women, immunocompromised individuals, and subpopulations with specific comorbidities. Additionally, in relation to the FDA approval for Comirnaty, we are required to complete certain postmarketing study requirements and commitments by 2024 as identified in the August 2021 approval letter. The terms of our EUA for Paxlovid require monitoring for convergence of global viral variants of SARS-CoV-2 and potential assessment of Paxlovid activity against identified global variants of interest. Additionally, in relation to the potential FDA approval for Paxlovid, we are required to complete certain other analyses and studies as identified in the December 2021 authorization letter. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial and other asserted and unasserted matters, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. Pfizer Inc. 2021 Form 10-K We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, no guarantee exists that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. For example, in May 2021, the Brazilian Supreme Court voted to invalidate Article 40 of Brazils Patent Law, which guaranteed a minimum 10-year patent term from patent grant, and to give retroactive effect to such decision. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. Further, legal or regulatory action by various stakeholders or governments could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products. Discussions are ongoing at the WTO regarding the role of intellectual property in the context of the COVID-19 pandemic response. This includes a proposal that would release WTO members from their obligation under WTO-TRIPS to grant and enforce various types of intellectual property protection on health products and technology in relation to the prevention, containment or treatment of COVID-19. In May 2021 and again in November 2021, the Biden Administration called on countries to waive intellectual property protections on COVID-19 vaccines. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third-party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD-PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant royalty payments or damages. Pfizer Inc. 2021 Form 10-K For example, our RD in a therapeutic area may not be first and another company or entity may have obtained relevant patents before us. We are involved in patent-related disputes with third parties over our attempts to market pharmaceutical products. Once we have final regulatory approval of the related products, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems (including cloud services) to operate our business. We produce, collect, process, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality, integrity and availability of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party providers who may or could have access to our confidential information. We rely on technology developed, supplied and/or maintained by third-parties that may make us vulnerable to supply chain style cyber-attacks. Further, technology and security vulnerabilities of acquisitions, business partners or third-party providers may not be identified during due diligence or soon enough to mitigate exploitation. The size and complexity of our information technology and information security systems, and those of our third-party providers (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or contingent workers, providers, or malicious attackers. As a global pharmaceutical company, our systems and assets are the target of frequent cyber-attacks. Such cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions, extortion, theft of confidential or proprietary information, compromise of data integrity or unauthorized information disclosure. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris in November 2020, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. Pfizer Inc. 2021 Form 10-K In June 2021, GSK announced that it intends to demerge at least 80% of its 68% ownership interest in the JV in mid-2022, subject to GSK shareholder approval. Following the demerger, the JV is expected to be an independent, listed company on the London Stock Exchange with American Depositary Receipts to be listed in the U.S., in which Pfizer would initially hold a 32% ownership interest and GSK may hold up to a 13.6% ownership interest. Notwithstanding GSKs announcement, the demerger may not be completed within expected time periods or at all, and both the timing and success of the demerger (or any other separation and public listing transaction), will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to any separation and public listing transactions (including the announced demerger), their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others: impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain disruptions and shortages, including challenges related to reliance on third-party suppliers resulting in reduced availability of materials or components used in the development, manufacturing, distribution or administration of our products; disruptions to pipeline development and clinical trials, including difficulties or delays in enrolling certain clinical trials, retaining clinical trial participants, accessing needed supplies, and accruing a sufficient number of cases in certain clinical trials; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; reduced product demand as a result of unemployment or increased focus on COVID-19 vaccination; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce or being restricted from enforcing, intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; challenges related to our human capital and talent development, including challenges in attracting, hiring and retaining highly skilled and diverse workforce; challenges related to vaccine mandates; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines and vaccines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution, including, among others: uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical and clinical data (including the Phase 1/2/3 or Phase 4 data for BNT162b2 or any other vaccine candidate in the BNT162 program or Paxlovid or any other future COVID-19 treatment) in any of our studies in pediatrics, adolescents or adults or real world evidence, including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data or further information regarding the quality of pre-clinical, clinical or safety data, including by audit or inspection; the ability to produce comparable clinical or other results for BNT162b2 or Paxlovid, including the rate of effectiveness and/or efficacy, safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial for BNT162b2 or Paxlovid and additional studies, in real-world data studies or in larger, more diverse populations following commercialization; the ability of BNT162b2 or any future vaccine to prevent, or Paxlovid or any other future COVID-19 treatment to be effective against, COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine or Paxlovid will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program, Paxlovid or other programs will be published in scientific journal publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; whether and when submissions to request emergency use or conditional marketing authorizations for BNT162b2 or any potential future vaccines in additional populations, for a booster dose for BNT162b2 or any potential future vaccines (including potential future annual boosters or re-vaccinations), and/or biologics license and/or EUA applications or amendments to any such applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when submissions to request emergency use or conditional marketing authorizations for Paxlovid or any other future COVID-19 treatment and/or any drug applications for any indication for Paxlovid or any other future COVID-19 treatment may be filed in any jurisdiction, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any application that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program, Paxlovid or any other future COVID-19 treatment or any other COVID-19 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines or drugs benefits outweigh its known risks and determination of the vaccines or drugs efficacy and, if approved, whether it will be commercially successful; Pfizer Inc. 2021 Form 10-K decisions by regulatory authorities impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine or drug, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; the possibility that COVID-19 will diminish in severity or prevalence, or disappear entirely; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines formulation, dosing schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations, booster doses or potential future annual boosters or re-vaccinations or new variant-specific vaccines; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program, Paxlovid or any other COVID-19 program; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any treatment for COVID-19, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine or treatment courses of Paxlovid within the projected time periods; whether and when additional supply or purchase agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine or treatment advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public confidence or awareness of our COVID-19 vaccine or Paxlovid, including challenges driven by misinformation, access, concerns about clinical data integrity and prescriber and pharmacy education; trade restrictions; potential third-party royalties or other claims related to our COVID-19 vaccine or Paxlovid; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines and vaccines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the Pfizer Inc. 2021 Form 10-K business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, tax laws and regulations internationally and in the U.S. (including, among other things, any potential adoption of global minimum taxation requirements and any potential changes to existing tax law and regulations by the Biden Administration and Congress), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 1B. UNRESOLVED STAFF COMMENTS N/A ITEM 2. PROPERTIES ITEM 3. LEGAL PROCEEDINGS ITEM 4. MINE SAFETY DISCLOSURES N/A INFORMATION ABOUT OUR EXECUTIVE OFFICERS PART II ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ITEM 6. [RESERVED] ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ITEM 9A. CONTROLS AND PROCEDURES ITEM 9B. OTHER INFORMATION N/A ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS N/A PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 15(a)(1) Financial Statements 15(a)(2) Financial Statement Schedules 15(a)(3) Exhibits ITEM 16. FORM 10-K SUMMARY N/A = Not Applicable DEFINED TERMS Unless the context requires otherwise, references to Pfizer, the Company, we, us or our in this Form 10-K (defined below) refer to Pfizer Inc. and its subsidiaries. Pfizers fiscal year-end for subsidiaries operating outside the U.S. is as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. References to Notes in this Form 10-K are to the Notes to the consolidated financial statements in Item 8. Financial Statements and Supplementary Data in this Form 10-K. We also have used several other terms in this Form 10-K, most of which are explained or defined below. Form 10-K This Annual Report on Form 10-K for the fiscal year ended December 31, 2021 Proxy Statement Proxy Statement for the 2022 Annual Meeting of Shareholders, which will be filed no later than 120 days after December 31, 2021 AbbVie AbbVie Inc. ABO Accumulated benefit obligation represents the present value of the benefit obligation earned through the end of the year but does not factor in future compensation increases ACA (also referred to as U.S. Healthcare Legislation) U.S. Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act ACIP Advisory Committee on Immunization Practices Akcea Akcea Therapeutics, Inc. ALK anaplastic lymphoma kinase Alliance revenues Revenues from alliance agreements under which we co-promote products discovered or developed by other companies or us Anacor Anacor Pharmaceuticals, Inc. ASR accelerated share repurchase agreement Arena Arena Pharmaceuticals, Inc. Array Array BioPharma Inc. Arvinas Arvinas, Inc. Astellas Astellas Pharma Inc., Astellas US LLC and Astellas Pharma US, Inc. ATTR-CM transthyretin amyloid cardiomyopathy Beam Beam Therapeutics Inc. Biogen Biogen Inc. Biohaven Biohaven Pharmaceutical Holding Company Ltd., Biohaven Pharmaceutical Ireland DAC and BioShin Limited. (collectively, Biohaven) BioNTech BioNTech SE Biopharma Pfizer Biopharmaceuticals Group BLA Biologics License Application BMS Bristol-Myers Squibb Company BNT162b2* Pfizer-BioNTech COVID-19 Vaccine, also known as Comirnaty BOD Board of Directors BRCA BReast CAncer susceptibility gene CDC U.S. Centers for Disease Control and Prevention cGMPs current Good Manufacturing Practices Comirnaty* Pfizer-BioNTech COVID-19 Vaccine, also known as BNT162b2 Consumer Healthcare JV GSK Consumer Healthcare JV COVID-19 novel coronavirus disease of 2019 CMA conditional marketing authorisation CStone CStone Pharmaceuticals DEA U.S. Drug Enforcement Agency Developed Europe Includes the following markets: Western Europe, Scandinavian countries and Finland Developed Markets Includes the following markets: U.S., Developed Europe, Japan, Canada, South Korea, Australia and New Zealand Developed Rest of World Includes the following markets: Japan, Canada, South Korea, Australia and New Zealand EC European Commission EMA European Medicines Agency Emerging Markets Includes, but is not limited to, the following markets: Asia (excluding Japan and South Korea), Latin America, Central Europe, Eastern Europe, the Middle East, Africa and Turkey EPS earnings per share ESOP employee stock ownership plan EU European Union EUA emergency use authorization Exchange Act Securities Exchange Act of 1934, as amended FASB Financial Accounting Standards Board FCPA U.S. Foreign Corrupt Practices Act FDA U.S. Food and Drug Administration FFDCA U.S. Federal Food, Drug and Cosmetic Act Pfizer Inc. 2021 Form 10-K i GAAP Generally Accepted Accounting Principles GDFV grant-date fair value GIST gastrointestinal stromal tumors GPD Global Product Development organization GSK GlaxoSmithKline plc Hospira Hospira, Inc. Ionis Ionis Pharmaceuticals, Inc. IPRD in-process research and development IRC Internal Revenue Code IRS U.S. Internal Revenue Service JAK Janus kinase JV joint venture King King Pharmaceuticals LLC (formerly King Pharmaceuticals, Inc.) LIBOR London Interbank Offered Rate Lilly Eli Lilly and Company LOE loss of exclusivity MCO managed care organization mCRC metastatic colorectal cancer mCRPC metastatic castration-resistant prostate cancer mCSPC metastatic castration-sensitive prostate cancer mRNA messenger ribonucleic acid MDA Managements Discussion and Analysis of Financial Condition and Results of Operations Medivation Medivation LLC (formerly Medivation, Inc.) Meridian Meridian Medical Technologies, Inc. Moodys Moodys Investors Service MTM mark-to-market Mylan Mylan N.V. Mylan-Japan collaboration a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan that terminated on December 21, 2020 Myovant Myovant Sciences Ltd. NAV net asset value NDA new drug application nmCRPC non-metastatic castration-resistant prostate cancer NMPA National Medical Product Administration in China NSCLC non-small cell lung cancer NYSE New York Stock Exchange OPKO OPKO Health, Inc. OTC over-the-counter Paxlovid* an oral COVID-19 treatment (nirmatrelvir [PF-07321332] tablets and ritonavir tablets) PBM pharmacy benefit manager PBO Projected benefit obligation; represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases PC1 Pfizer CentreOne PGS Pfizer Global Supply Pharmacia Pharmacia Corporation PMDA Pharmaceuticals and Medical Device Agency in Japan PRAC Pharmacovigilance Risk Assessment Committee PsA psoriatic arthritis QCE quality consistency evaluation RA rheumatoid arthritis RCC renal cell carcinoma RD research and development ROU right of use Sandoz Sandoz, Inc., a division of Novartis AG SP Standard Poors SEC U.S. Securities and Exchange Commission Tax Cuts and Jobs Act or TCJA Legislation commonly referred to as the U.S. Tax Cuts and Jobs Act of 2017 Therachon Therachon Holding AG Trillium Trillium Therapeutics Inc. TSAs transition service arrangements UC ulcerative colitis Pfizer Inc. 2021 Form 10-K ii U.K. United Kingdom Upjohn Business Pfizers former global, primarily off-patent branded and generics business, which included a portfolio of 20 globally recognized solid oral dose brands, including Lipitor, Lyrica, Norvasc, Celebrex and Viagra, as well as a U.S.-based generics platform, Greenstone, that was spun-off on November 16, 2020 and combined with Mylan to create Viatris U.S. United States Valneva Valneva SE VBP volume-based procurement Viatris Viatris Inc. ViiV ViiV Healthcare Limited WHO World Health Organization WRDM Worldwide Research, Development and Medical WTO World Trade Organization * This Form 10-K includes discussion of the COVID-19 vaccine that Pfizer has co-developed with BioNTech (BNT162b2) and our oral COVID-19 treatment (Paxlovid). This Form 10-K may refer to the vaccine by its brand name, Comirnaty (approved under a BLA), or as BNT162b2 (authorized under EUA). The vaccine is FDA-approved to prevent COVID-19 in individuals 16 years of age and older. The vaccine is authorized by the FDA to prevent COVID-19 in individuals 5 years of age and older. In addition, Comirnaty/BNT162b2 is authorized by the FDA for a third dose in certain immunocompromised individuals 5 years of age and older and as a booster dose in individuals 12 years of age and older. Paxlovid has been authorized for emergency use by the FDA under an EUA, for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS CoV-2 viral testing, and who are at high-risk for progression to severe COVID-19, including hospitalization or death. The emergency uses are only authorized for the duration of the declaration that circumstances exist justifying the authorization of emergency use of the medical product under Section 564(b)(1) of the FFDCA unless the declaration is terminated or authorization revoked sooner. The FDA has issued EUAs to certain other companies for products intended for the prevention or treatment of COVID-19 and may continue to do so during the duration of the Declaration. Please see the EUA Fact Sheets at www.cvdvaccine-us.com and www.covid19oralrx.com . This Form 10-K includes discussion of certain clinical studies relating to various in-line products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. Some amounts in this Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks mentioned are the property of their owners. AVAILABLE INFORMATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 24, 2022. Our Proxy Statement will be available on our website on or about March 17, 2022. Our 2021 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 17, 2022. We also have a Pfizer Investor Insights website, which includes articles on the company, its products and its pipeline, located at insights.pfizer.com . Information in our ESG Report and on the Pfizer Investor Insights website are not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the About Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; information concerning our Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. Pfizer Inc. 2021 Form 10-K iii FORWARD-LOOKING INFORMATION AND FACTORS THAT MAY AFFECT FUTURE RESULTS This Form 10-K contains forward-looking statements. We also provide forward-looking statements in other materials we release to the public, as well as public oral statements. Given their forward-looking nature, these statements involve substantial risks, uncertainties and potentially inaccurate assumptions. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek, potential and other words and terms of similar meaning or by using future dates. We include forward-looking information in our discussion of the following, among other topics: our anticipated operating and financial performance, reorganizations, business plans, strategy and prospects; expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, clinical trial results and other developing data, revenue contribution, growth, performance, timing of exclusivity and potential benefits; strategic reviews, capital allocation objectives, dividends and share repurchases; plans for and prospects of our acquisitions, dispositions and other business development activities, and our ability to successfully capitalize on these opportunities; sales, expenses, interest rates, foreign exchange rates and the outcome of contingencies, such as legal proceedings; expectations for impact of or changes to existing or new government regulations or laws; our ability to anticipate and respond to macroeconomic, geopolitical, health and industry trends, pandemics, acts of war and other large-scale crises; and manufacturing and product supply. In particular, forward-looking information in this Form 10-K includes statements relating to specific future actions and effects, including, among others, our efforts to respond to COVID-19, including our development of a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, the forecasted revenue contribution of Comirnaty and the potential number of doses that we and BioNTech believe can be manufactured and/or delivered; the forecasted revenue contribution of Paxlovid and the potential number of treatment courses that we believe can be manufactured; our expectations regarding the impact of COVID-19 on our business; the expected patent term for Comirnaty and Paxlovid; the expectations for ongoing revenue streams from Comirnaty and Paxlovid; the expected impact of patent expiries and competition from generic manufacturers; the expected pricing pressures on our products and the anticipated impact to our business; the availability of raw materials for 2022; the expected charges and/or costs in connection with the spin-off of the Upjohn Business and its combination with Mylan; the benefits expected from our business development transactions; our anticipated liquidity position; the anticipated costs and savings from certain of our initiatives, including our Transforming to a More Focused Company program; our planned capital spending; and the expected benefit payments and employer contributions for our benefit plans. Given their nature, we cannot assure that any outcome expressed in these forward-looking statements will be realized in whole or in part. Actual outcomes may vary materially from past results and those anticipated, estimated, implied or projected. These forward-looking statements may be affected by underlying assumptions that may prove inaccurate or incomplete, or by known or unknown risks and uncertainties, including those described in this section and in the Item 1A. Risk Factors section in this Form 10-K. Therefore, you are cautioned not to unduly rely on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities law. You are advised, however, to consult any further disclosures we make on related subjects. Some of the factors that could cause actual results to differ are identified below, as well as those discussed in the Item 1A. Risk Factors section in this Form 10-K and within MDA. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. The occurrence of any of the risks identified below or in the Item 1A. Risk Factors section in this Form 10-K, or other risks currently unknown, could have a material adverse effect on our business, financial condition or results of operations, or we may be required to increase our accruals for contingencies. It is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties: Risks Related to Our Business, Industry and Operations, and Business Development: the outcome of RD activities, including, the ability to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, and/or regulatory approval and/or launch dates; the possibility of unfavorable pre-clinical and clinical trial results, including the possibility of unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; and whether and when additional data from our pipeline programs will be published in scientific journal publications, and if so, when and with what modifications and interpretations; our ability to successfully address comments received from regulatory authorities such as the FDA or the EMA, or obtain approval for new products and indications from regulators on a timely basis or at all; regulatory decisions impacting labeling, including the scope of indicated patient populations, product dosage, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities; the impact of recommendations by technical or advisory committees; and the timing of pricing approvals and product launches; claims and concerns that may arise regarding the safety or efficacy of in-line products and product candidates, including claims and concerns that may arise from the outcome of post-approval clinical trials, which could impact marketing approval, product labeling, and/or availability or commercial potential, including uncertainties regarding the commercial or other impact of the results of the Xeljanz ORAL Surveillance (A3921133) study or actions by regulatory authorities based on analysis of ORAL Surveillance or other data, including on other JAK inhibitors in our portfolio; the success and impact of external business development activities, including the ability to identify and execute on potential business development opportunities; the ability to satisfy the conditions to closing of announced transactions in the anticipated time frame or at all; the ability to realize the anticipated benefits of any such transactions in the anticipated time frame or at all; the Pfizer Inc. 2021 Form 10-K potential need for and impact of additional equity or debt financing to pursue these opportunities, which could result in increased leverage and/or a downgrade of our credit ratings; challenges integrating the businesses and operations; disruption to business and operations relationships; risks related to growing revenues for certain acquired products; significant transaction costs; and unknown liabilities; competition, including from new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat or prevent diseases and conditions similar to those treated or intended to be prevented by our in-line products and product candidates; the ability to successfully market both new and existing products, including biosimilars; difficulties or delays in manufacturing, sales or marketing; supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on; and legal or regulatory actions; the impact of public health outbreaks, epidemics or pandemics (such as the COVID-19 pandemic), including the impact of vaccine mandates where applicable, on our business, operations and financial condition and results, including impacts on our employees, manufacturing, supply chain, sales and marketing, RD and clinical trials; risks and uncertainties related to our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution; trends toward managed care and healthcare cost containment, and our ability to obtain or maintain timely or adequate pricing or favorable formulary placement for our products; interest rate and foreign currency exchange rate fluctuations, including the impact of possible currency devaluations in countries experiencing high inflation rates; any significant issues involving our largest wholesale distributors or government customers, which account for a substantial portion of our revenues; the impact of the increased presence of counterfeit medicines or vaccines in the pharmaceutical supply chain; any significant issues related to the outsourcing of certain operational and staff functions to third parties; and any significant issues related to our JVs and other third-party business arrangements; uncertainties related to general economic, political, business, industry, regulatory and market conditions including, without limitation, uncertainties related to the impact on us, our customers, suppliers and lenders and counterparties to our foreign-exchange and interest-rate agreements of challenging global economic conditions and recent and possible future changes in global financial markets; any changes in business, political and economic conditions due to actual or threatened terrorist activity, civil unrest or military action; the impact of product recalls, withdrawals and other unusual items, including uncertainties related to regulator-directed risk evaluations and assessments; trade buying patterns; the risk of an impairment charge related to our intangible assets, goodwill or equity-method investments; the impact of, and risks and uncertainties related to, restructurings and internal reorganizations, as well as any other corporate strategic initiatives, and cost-reduction and productivity initiatives, each of which requires upfront costs but may fail to yield anticipated benefits and may result in unexpected costs or organizational disruption; Risks Related to Government Regulation and Legal Proceedings : the impact of any U.S. healthcare reform or legislation or any significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs or changes in the tax treatment of employer-sponsored health insurance that may be implemented; U.S. federal or state legislation or regulatory action and/or policy efforts affecting, among other things, pharmaceutical product pricing, intellectual property, reimbursement or access or restrictions on U.S. direct-to-consumer advertising; limitations on interactions with healthcare professionals and other industry stakeholders; as well as pricing pressures for our products as a result of highly competitive insurance markets; legislation or regulatory action in markets outside of the U.S., including China, affecting pharmaceutical product pricing, intellectual property, reimbursement or access, including, in particular, continued government-mandated reductions in prices and access restrictions for certain biopharmaceutical products to control costs in those markets; the exposure of our operations globally to possible capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, as well as political unrest, unstable governments and legal systems and inter-governmental disputes; legal defense costs, insurance expenses, settlement costs and contingencies, including those related to actual or alleged environmental contamination; the risk and impact of an adverse decision or settlement and the adequacy of reserves related to legal proceedings; the risk and impact of tax related litigation; governmental laws and regulations affecting our operations, including, without limitation, changes in laws and regulations or their interpretation, including, among others, changes in tax laws and regulations internationally and in the U.S., including, among others, potential adoption of global minimum taxation requirements and potential changes to existing tax law by the current U.S. Presidential administration and Congress; Pfizer Inc. 2021 Form 10-K Risks Related to Intellectual Property, Technology and Security: any significant breakdown or interruption of our information technology systems and infrastructure (including cloud services); any business disruption, theft of confidential or proprietary information, extortion or integrity compromise resulting from a cyber-attack; the risk that our currently pending or future patent applications may not be granted on a timely basis or at all, or any patent-term extensions that we seek may not be granted on a timely basis, if at all; and our ability to protect our patents and other intellectual property, including against claims of invalidity that could result in LOE, unasserted intellectual property claims and in response to any pressure, or legal or regulatory action by, various stakeholders or governments that could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products, including our vaccine to help prevent COVID-19 and our oral COVID-19 treatment. PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of biopharmaceutical products. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . Our purpose fuels everything we do and reflects both our passion for science and our commitment to patients. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people ; 2. Deliver first-in-class science ; 3. Transform our go-to-market model ; 4. Win the digital race in pharma ; and 5. Lead the conversation . In addition, Pfizer continues to enhance its ESG strategy, which is focused on six areas where we see opportunities to create a meaningful impact over the next decade: product innovation; equitable access and pricing; product quality and safety; diversity, equity and inclusion; climate change; and business ethics. We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities in 2021 include, among others: (i) the July 2021 global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader (the estrogen receptor is a well-known disease driver in most breast cancers); (ii) the November 2021 collaboration and license agreement with Biohaven to acquire rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S. upon approval; (iii) the November 2021 acquisition of Trillium, a clinical stage immuno-oncology company developing innovative potential therapies for the treatment of cancer; and (iv) the December 2021 research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. In addition, in December 2021, we entered into a definitive agreement to acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020 and 2021, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, the development of a vaccine to help prevent Pfizer Inc. 2021 Form 10-K COVID-19 and an oral COVID-19 treatment. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. COMMERCIAL OPERATIONS Following (i) the spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan in 2020, which created a new global pharmaceutical company, Viatris, and (ii) the formation of the Consumer Healthcare JV with GSK in 2019, we saw the culmination of Pfizers transformation into a more focused, global leader in science-based innovative medicines and vaccines, and beginning in the fourth quarter of 2020, we operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business, and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Our Biopharma business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Comirnaty/BNT162b2*, the Prevnar family*, Nimenrix, FSME/IMMUN-TicoVac and Trumenba Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Inlyta*, Sutent, Retacrit, Lorbrena and Braftovi Internal Medicine Includes innovative brands in cardiovascular metabolic and womens health, as well as regional brands. Eliquis* and the Premarin family Hospital** Includes our global portfolio of sterile injectable and anti-infective medicines, as well as an oral COVID-19 treatment. Sulperazon, Medrol, Zavicefta, Zithromax, Vfend, Panzyga and Paxlovid Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra, Eucrisa/Staquis and Cibinqo Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2021, 2020 and 2019. Each of Comirnaty/BNT162b2 and Inlyta recorded direct product and/or Alliance revenues of more than $1 billion in 2021. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2021 and 2020. Comirnaty/BNT162b2, Eliquis and Xtandi include Alliance revenues and direct sales. Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). ** Prior to the fourth quarter of 2021, PC1 had been managed within the Hospital therapeutic area. Also, on December 31, 2021, we completed the sale of our Meridian subsidiary, which was part of the Hospital therapeutic area prior to its sale. See Note 1A for additional information. For additional information on our operating segments and products, see Note 17 and for additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Comirnaty/BNT162b2 is an mRNA-based coronavirus vaccine to help prevent COVID-19, which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech equally share the costs of development for the Comirnaty program. Comirnaty/BNT162b2 has been granted an approval or an authorization in many countries around the world in populations varying by country. We also share gross profits equally from commercialization of Comirnaty/BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on Comirnaty/BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on Myfembree (relugolix 40 Pfizer Inc. 2021 Form 10-K mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) for heavy menstrual bleeding associated with uterine fibroids in premenopausal women and the management of moderate to severe pain associated with endometriosis. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and Myfembree, with Myovant bearing our share of allowable expenses up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for Comirnaty/BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, (i) with BioNTech to develop a modified mRNA-based vaccine for the prevention of varicella zoster (Shingles), and (ii) with Valneva to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. These collaboration, alliance and license agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances and license arrangements and investments, see Note 2 . Our RD Operations. In 2021, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units within WRDM are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. Our GPD organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for late-stage clinical assets in Pfizers pipeline. Science-based platform-services organizations within WRDM. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Examples of these platform organizations include Pharmaceutical Sciences and Medicine Design, and Worldwide Medical and Safety. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, composed of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA and Note 17 . Pfizer Inc. 2021 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 8, 2022, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Product Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $51.5 billion accounted for 63% of our total revenues in 2021. Revenues exceeded $500 million in each of 21, 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively, with the increase in the number of countries in 2021 primarily driven by Comirnaty/BNT162b2. By total revenues, Japan was our largest national market outside the U.S. in 2021. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17B . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery systems. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Certain of these government contracts may be renegotiated or terminated at the discretion of a government entity. In addition, our contracts with government and supranational organizations for the sales of Comirnaty/BNT162b2 and Paxlovid, which are on a committed basis, represented a significant amount of revenues in 2021. We also seek to gain access for our products on formularies, which are lists of approved medicines available to members of healthcare programs or PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our significant customers, see Note 17C . We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers and patients; MCOs that provide insurance coverage, such as hospitals, integrated delivery systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. In the U.S., we market directly to consumers through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. Pfizer Inc. 2021 Form 10-K PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs or vaccines upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Product U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 (2) 2022 Sutent 2021 (3) 2022 (3) 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (4) 2025 Prevnar 13/Prevenar 13 2026 (5) 2029 Eliquis (6) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (7) 2027 (7) (7) Vyndaqel/Vyndamax/Vynmac 2024 (2028 pending PTE) 2026 2026/2029 (8) Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (4) Braftovi (9) 2031 (2031 pending PTE) (9) (9) Mektovi (9) 2031 (10) (9) (9) Bavencio (11) 2033 2032 2033 Lorbrena 2033 2034 2036 Prevnar 20/Apexxnar 2033 (2035 pending PTE) 2033 2033 (12) Cibinqo 2034 2034 (13) 2034 (2038 pending PTE) Comirnaty (14) (14), (15) (14) Paxlovid (16) (16) (16) (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our product from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix expired in the U.S. in November 2020 and in Europe in September 2021. (3) The basic product patent for Sutent expired in the U.S. in August 2021 and in Europe in January 2022. (4) Expiry is provided by regulatory exclusivity in this market. (5) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and were the subject of patent infringement litigation. Prior to the resolution of the litigation in our favor on both challenged patents, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). As a result of the litigation, the remaining generic companies are not permitted to launch their products until the 2031 expiration date of the formulation patent. Under the terms of the settlement agreements, the permitted date of launch for the settled generic companies under these patents is April 1, 2028. Both patents may be subject to subsequent challenges. While we cannot predict the outcome of any potential future litigation, these are the alternatives that might occur: (a) if both patents are upheld in future litigation, through appeal, the permitted date of launch for the settled generic companies under these patents would remain April 1, 2028; (b) if the formulation patent is held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in future litigation, through appeal, the settled generic companies and any successful future litigant could launch products immediately upon such an adverse decision. Refer to Note 16A1 for more information. Pfizer Inc. 2021 Form 10-K (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Vyndaqel (tafamidis meglumine) basic patent expiry in Japan is August 2026 for treatment of polyneuropathy. Vynmac (tafamidis) was approved in Japan for treatment of cardiomyopathy with regulatory exclusivity expiring March 2029. (9) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) Mektovi U.S. expiry is provided by a method of use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. (12) Product not yet approved or authorized in this market. (13) An SPC has been filed for Cibinqo in the U.K. with expected expiry in 2036 based on the September 2021 approval. Cibinqo was approved in other major European markets in December 2021. (14) The basic product patent application for Comirnaty has been filed in these markets. If granted, a full term is expected in these markets. Comirnaty is being developed and commercialized in collaboration with BioNTech . (15) Pfizer does not have co-promotion rights for Comirnaty in Germany. (16) The basic product patent application for Paxlovid has been filed in these markets. If granted, a full term is expected in these markets. Loss of Intellectual Property Rights. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Competitive Products, Intellectual Property Protection and Third-Party Intellectual Property Claims sections in this Form 10-K and Note 16A1 . Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat or prevent diseases or indications similar to those treated or prevented by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic drug and biosimilar manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug or vaccine approval as we seek to further demonstrate the value of our products for the conditions they treat or prevent, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines and vaccines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition, including from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars, which include biosimilars of certain inflammation immunology and oncology biologic medicines, compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We seek to maximize the opportunity to establish a first-to- Pfizer Inc. 2021 Form 10-K market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we expect to continue to face intensified competition by certain generic manufacturers in 2022 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Commercial Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. In light of the COVID-19 pandemic and related large-scale healthcare disruptions, we expect value-based payment models may have reduced participation if the incentives to participate are reduced or eliminated. Financially weakened hospitals may weigh their ability to take on the financial risk of downside models. In contrast, providers in more advanced value-based models, such as full capitation, a fixed amount paid in advance per patient per unit of time-period, generally found their revenues remained steady during the pandemic, which may ultimately encourage the growth of such models. We believe medicines and vaccines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines and vaccines within an efficient and affordable healthcare system. This includes assessing our go-to market model to address patient affordability challenges. We have engaged with major payors and the U.S. government to explore opportunities to improve access and reimbursement in an effort to drive pro-patient policies. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we are developing stronger internal capabilities focused on demonstrating the value of the medicines and vaccines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and vaccines and competitor medicines and vaccines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 302 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs and vaccines to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger MCOs, which enhances those MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates Pfizer Inc. 2021 Form 10-K pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2022. However, we are seeing an increase in overall demand in the industry for certain components and raw materials with the potential to constrain available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact, including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing the operations of biopharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and/or administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines and vaccines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. For a biopharmaceutical company to market a drug or a biologic product, including vaccines, in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or BLA (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals) and the Drug Supply Chain Security Act (the law that, among other things, sets forth requirements related to product tracing, product identifiers and verification for manufacturers, wholesale distributors, repackagers and dispensers to facilitate the tracing of product through the pharmaceutical distribution supply chain), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Authorization/Approval Data sections in this Form 10-K. In the context of public health emergencies, like the COVID-19 pandemic, we may apply to the FDA for an EUA, which if granted, allows for the distribution and use of our products during the declared emergency, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated by the government. Although the criteria for an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing obligations. The FDA generally expects EUA holders to work toward submission of full applications, such as a BLA or an NDA, as soon as possible. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws, as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits corruptly soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services, including to government payers, such as Medicare and Medicaid, that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State Pfizer Inc. 2021 Form 10-K attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Pricing, Reimbursement and Access Regulations. Pricing and reimbursement for our products depend in part on government regulation. Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded or more directly impose controls on drug pricing, government reimbursement, and access to medicines and vaccines on public and private insurance plans could have a material impact on us. In addition, in order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1H. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. We expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. In addition, changes to the Medicaid program or the federal 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could have a material impact on our business. For example, certain changes issued in a final rule by the Centers for Medicare Medicaid Services (CMS) in December 2020 to the Medicaid Drug Rebate Program could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities. Additional changes to the 340B program are undergoing review and their status is unclear. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid managed care programs typically is determined by the health plans with which state Medicaid agencies contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. States budgets were impacted less by the COVID-19 pandemic than expected and are generally growing. We expect states to seek cost cutting within Medicaid, which may focus on managed care capitation payments and/or formulary management. States may also advance drug-pricing initiatives with a focus on affordability review boards, financial penalties related to pricing practices, manufacturer pricing and reporting requirements, as well as regulation of prescription drug assistance or copay accumulator programs in the commercial market. Payers may promote generic drugs and biosimilars more aggressively to generate savings and attempt to stimulate additional price competition. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us is increasingly important to our business and is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory and other governmental bodies. Such laws and regulations continue to evolve and are increasingly being enforced vigorously. Outside the United States New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. In the U.K., the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. Health authorities in many middle- and lower-income countries require marketing approval by a recognized regulatory authority (e.g., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU, the EMAs PRAC is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., Japan, China, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments globally may use a variety of measures to control costs, including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations such as the WHO are increasing scrutiny of international pharmaceutical pricing through policy recommendations and sponsorship of programs, such as The Oslo Medicines Initiative which is planning a high-level meeting in 2022 to agree on WHO Europe Member States commitments to ensure affordability for high-priced medicines. In November 2020, the EC published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. Pfizer Inc. 2021 Form 10-K In China, pricing pressures have increased in recent years because of an overall focus on healthcare cost containment with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. For patented products, drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program, a tender process where a certain portion of included molecule volumes are guaranteed to tender winners and is intended to contain healthcare costs by driving utilization of generics that have passed QCE, has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to VBP qualification in future rounds. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or industry trade associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers and/or healthcare organizations, such as academic teaching hospitals. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The WTO Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent and other intellectual property-related protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property policy environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, pursuant to the ongoing review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Discussions are ongoing at the WTO that seek to limit intellectual property protections within the context of the COVID-19 pandemic response. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines and vaccines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including but not limited to, the EUs General Data Protection Regulations and Chinas Personal Information Protection Law. The legislative and regulatory framework for privacy and data protection issues worldwide is also rapidly evolving as countries continue to adopt new and updated privacy and data security laws. The interpretation and application of such laws and regulations remain uncertain and continue to evolve. In addition, enforcement of such laws and regulations is increasing. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2021 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $55 million in environment-related capital expenditures and $152 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, the potential for more frequent and severe weather events, and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2021, we employed approximately 79,000 people worldwide, with approximately 29,000 based in the U.S. Women compose approximately 49% of our global workforce, and approximately 34% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent, but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, Pfizer Inc. 2021 Form 10-K fostering career growth and internal mobility and offering competitive compensation and benefits programs that encourage mental and physical well being. Core Values. To fully realize Pfizers purpose we have established a clear set of goals regarding what we need to achieve for patients and how we will go about achieving them. The how is represented by four simple, powerful company values Courage , Excellence , Equity and Joy . Each value defines our company and our culture: Courage : Breakthroughs start by challenging convention especially in the face of uncertainty or adversity. This happens when we think big, speak up and are decisive. Excellence : We can only change patients lives when we perform at our best together. This happens when we focus on what matters, agree who does what and measure outcomes. Equity : Every person deserves to be seen, heard and cared for. This happens when we are inclusive, act with integrity and reduce health care disparities. Joy : We give ourselves to our work, and it also gives to us. We find joy when we take pride, recognize one another and have fun. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our commitments to equity consist of specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) building a more inclusive colleague experience through representation and meaningful connections; (ii) advancing equitable health outcomes by evaluating our work through the lens of the communities we serve, (iii) providing resources on allyship and the science behind inclusion to support all colleagues in having courageous conversations about equity, race and the avoidance of bias; (iv) working to help transform society with external diversity, equity and inclusion partnerships, including deploying capital, engaging diverse suppliers and amplifying equity initiatives; and (v) working to help ensure demographics of clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . To attract, develop and inspire the brightest talent, we aim to support our colleagues by engaging and partnering with them to help ensure they feel they are part of a community. We understand the importance of continuously listening and responding to colleague feedback and our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their colleague experience. Through this survey, we measure and track key areas of the overall colleague experience and equip leaders with actionable insights for discussion and follow up. Regular topics in the survey include: (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer; (ii) purpose, including how colleagues work connects with our purpose; (iii) inclusion, such as having a climate in which diverse perspectives are valued; and (iv) growth, including the ability for colleagues to gain new experiences that align with their individual career goals. In 2021, we continued to maintain low turnover rates relative to the pharmaceutical industry and in our 2021 Pfizer Pulse survey, on average , 90% of colleagues reported feeling engaged, as measured by pride in working at Pfizer, willingness to recommend Pfizer as a great place to work and intent to stay. In addition, 92% of the colleagues agreed that their daily work contributes to our purpose. While we are slightly behind in our Bold Moves goal to create room for meaningful work, we continue to make progress on simplifying processes and removing needless complexity. We have committed to tangible actions and principles that incorporate the similar behaviors and mindset we used to develop a COVID-19 vaccine in an accelerated timeline. These behaviors include working with urgency and overcoming bureaucracy, as well as believing in our purpose, trusting in one another and being transparent. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insightsis based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. Our commitments to colleague development consist of specific actions to encourage non-linear career growth paths for all colleagues, including (i) a common language around growthalong with a guiding frameworkto help colleagues identify their next best growth experience, (ii) tools and resources to encourage growth conversations and offer transparency on the sources of growth available, and (iii) a variety of programs including mentoring, job rotations, experiential project roles, skill-based volunteering and learning resources focused on various topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being . Protecting the health, safety and well-being of colleagues and contingent workers, all of whom are essential to delivering our business objectives, is an integral part of how we operate. Our Global Environment, Health Safety (EHS) Policy and supporting standards outline our approach to assessment, evaluation, elimination, and mitigation of EHS risks across our operations. COVID-19 pandemic preparedness and response continues to be a key focus to help ensure on-site workers at our commercial, manufacturing and research sites remain safe and healthy while continuing to support work from home arrangements for colleagues who can work remotely. As part of these efforts, we (i) implemented a vaccination program for colleagues and their families in the U.S. and 23 other countries where employer vaccination programs were possible, (ii) partnered with and launched Thrive Global, a wellness and organizational change initiative with a primary focus on colleague mental health and wellness, and (iii) hosted educational webinars and information sessions on mental health and well-being, nutrition and work life balance through our employee assistance program provider. Pay Equity. Our commitment to pay equity for all colleagues is based in our value of Equity and our intention to continue to build a diverse and inclusive workforce. We are committed to equitable pay practices at Pfizer for employees based on role, education, experience, performance, and location and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the About Careers section of Pfizers website and our ESG Report. ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is Pfizer Inc. 2021 Form 10-K not meant to be a complete discussion of all potential risks or uncertainties. Additionally, our business is subject to general risks applicable to any company, such as economic conditions, geopolitical events, extreme weather and natural disasters. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. The negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and value-based pricing/contracting to improve their cost containment efforts. Such payers are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Also, business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches continue to occur, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line products and product candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. The entry to the market of competing biosimilars is expected to increase pricing pressures on our biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or Alliance revenues of more than $1 billion for each of nine products that collectively accounted for 75% of our total revenues in 2021. In particular, Comirnaty/BNT162b2 accounted for 45% of our total revenues in 2021. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription or vaccination growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective product should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K. For Comirnaty/BNT162b2 and Pfizer Inc. 2021 Form 10-K Paxlovid, while we believe that these products have the potential to provide ongoing revenue streams for Pfizer for the foreseeable future, revenues of these products following the COVID-19 pandemic may not be at the similar levels as those being generated during the pandemic. For information on additional risks associated with Comirnaty/BNT162b2 and Paxlovid, see the COVID-19 Pandemic section below. In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17C . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, primarily through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. For example, our gene therapy product candidates are based on a novel technology with only a few gene therapies approved to date, which makes it difficult to predict the time and cost of development and the ability to obtain regulatory approval. Further, gene therapy may face difficulties in gaining the acceptance of patients or the medical community. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions including inflation, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 63% of our total 2021 revenues were derived from international operations, including 29% from Europe and 19% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA and Note 7E . For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Note 11 . From time to time, we issued variable rate debt based on LIBOR, or undertook interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month Pfizer Inc. 2021 Form 10-K LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend any contracts to accommodate the SOFR rate where required. We do not expect the transition to have significant impact on our business or financial condition. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in our supply chain, product manufacturing and distribution networks, as well as sales or marketing, due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs at our facilities or third-party facilities that we rely on, reputational harm, the impact to our facilities due to health pandemics or natural or man-made disasters, including as a result of climate change, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain supply and/or appropriate quality standards throughout our supply network and/or comply with applicable regulations; inability to supply certain products due to voluntary product recalls (as is the case with Chantix); and supply chain disruptions at our facilities or at a supplier or vendor. In addition, we engage contract manufacturers, and, from time to time, our contract manufacturers may face difficulties or are unable to manufacture our products at the necessary quantity or quality levels. Regulatory agencies periodically inspect our manufacturing facilities, as well as third-party facilities that we rely on, to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. In July and August 2021, Pfizer recalled 16 lots of Chantix in the U.S. due to the presence of a nitrosamine, N-nitroso-varenicline, at or above the FDA interim acceptable intake limit. In September 2021, Pfizer expanded its voluntary recall in the U.S. to include all lots of Chantix. We currently also have a voluntary recall across multiple markets and a global pause in shipments of Chantix. Technical solutions are being pursued to reduce nitrosamine levels in Chantix to enable return to market. Nitrosamines are impurities common in water and foods and everyone is exposed to some level of nitrosamines. In response to requests from various regulatory authorities, manufacturers across the pharmaceutical industry, including Pfizer, are evaluating their product portfolios for the potential for the presence or formation of nitrosamines. This may lead to additional recalls or other market actions for Pfizer products. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For information on additional risks specific to our Consumer Healthcare JV, see the Consumer Healthcare JV with GSK section below. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines and vaccines prime targets for counterfeiters. Counterfeit medicines and vaccines pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact Pfizers patients, potentially causing them harm. This, in turn, may result in the loss of patient confidence in the Pfizer name and in the integrity of our medicines and vaccines, and potentially impact our business through lost sales, product recalls, and possible litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the internet in lieu of traditional brick and mortar pharmacies or authorized full-service internet pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of consumers misplaced trust with certain e-commerce retailers coupled with the anonymity the internet affords counterfeiters. While counterfeiters generally target any medicine or vaccine boasting strong demand, we have observed heightened counterfeit and fraud attempts to our COVID-19 vaccine, as well as other products potentially utilized in the treatment of COVID-19. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, investing in innovative technologies to detect and disrupt sophisticated internet offers and scams, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2021 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. We expect to see continued focus by the Federal government on regulating pricing which could result in legislative and regulatory changes designed to control costs. Some states have implemented, and others are considering, patient access constraints or cost cutting under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have continued to focus on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for COVID-19 treatments and vaccines. U.S. HEALTHCARE REGULATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare regulation, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. Any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs, vaccines and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may need to amend our clinical trial protocols or conduct additional clinical trials under certain circumstances, for example, to further assess appropriate dosage or collect additional safety data. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval for new products and indications from regulators. Regulatory approvals of our products depend on myriad factors, including regulatory determinations as to the products safety and efficacy. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency or conditional basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters, including decisions relating to emerging developments regarding potential product impurities. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP or any FDA Advisory Committee that may be convened to review our applications such as EUAs, NDAs or BLAs, which may impact the potential marketing and use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, including regulator-directed risk evaluations and Pfizer Inc. 2021 Form 10-K assessments, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-AUTHORIZATION/APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies and clinical trials, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as other products in the class. The potential regulatory and commercial implications of post-marketing study results typically cannot immediately be determined. For example, in December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. Updates include a new boxed warning for major adverse cardiovascular events (MACE) and updated boxed warnings regarding mortality, malignancies and thrombosis (with corresponding updates to applicable warnings and precautions). In addition, indications for the treatment of adults with moderately to severely active RA or active PsA, and patients who are two years of age and older with active polyarticular course juvenile idiopathic arthritis have been revised; Xeljanz is now indicated in patients who have had inadequate response or intolerance to one or more tumor necrosis factor blockers. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. We continue to work with regulatory agencies to review the full results and analyses of ORAL Surveillance and their impact on product labeling. The terms of our EUA for Comirnaty require that we conduct post-authorization observational studies in patients at least 5 years of age or older who received a booster dose, or other populations of interest including healthcare workers, pregnant women, immunocompromised individuals, and subpopulations with specific comorbidities. Additionally, in relation to the FDA approval for Comirnaty, we are required to complete certain postmarketing study requirements and commitments by 2024 as identified in the August 2021 approval letter. The terms of our EUA for Paxlovid require monitoring for convergence of global viral variants of SARS-CoV-2 and potential assessment of Paxlovid activity against identified global variants of interest. Additionally, in relation to the potential FDA approval for Paxlovid, we are required to complete certain other analyses and studies as identified in the December 2021 authorization letter. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial and other asserted and unasserted matters, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. Pfizer Inc. 2021 Form 10-K We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, no guarantee exists that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. For example, in May 2021, the Brazilian Supreme Court voted to invalidate Article 40 of Brazils Patent Law, which guaranteed a minimum 10-year patent term from patent grant, and to give retroactive effect to such decision. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. Further, legal or regulatory action by various stakeholders or governments could potentially result in us not seeking intellectual property protection for or agreeing not to enforce or being restricted from enforcing intellectual property related to our products. Discussions are ongoing at the WTO regarding the role of intellectual property in the context of the COVID-19 pandemic response. This includes a proposal that would release WTO members from their obligation under WTO-TRIPS to grant and enforce various types of intellectual property protection on health products and technology in relation to the prevention, containment or treatment of COVID-19. In May 2021 and again in November 2021, the Biden Administration called on countries to waive intellectual property protections on COVID-19 vaccines. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third-party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD-PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant royalty payments or damages. Pfizer Inc. 2021 Form 10-K For example, our RD in a therapeutic area may not be first and another company or entity may have obtained relevant patents before us. We are involved in patent-related disputes with third parties over our attempts to market pharmaceutical products. Once we have final regulatory approval of the related products, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems (including cloud services) to operate our business. We produce, collect, process, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality, integrity and availability of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party providers who may or could have access to our confidential information. We rely on technology developed, supplied and/or maintained by third-parties that may make us vulnerable to supply chain style cyber-attacks. Further, technology and security vulnerabilities of acquisitions, business partners or third-party providers may not be identified during due diligence or soon enough to mitigate exploitation. The size and complexity of our information technology and information security systems, and those of our third-party providers (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or contingent workers, providers, or malicious attackers. As a global pharmaceutical company, our systems and assets are the target of frequent cyber-attacks. Such cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions, extortion, theft of confidential or proprietary information, compromise of data integrity or unauthorized information disclosure. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris in November 2020, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. Pfizer Inc. 2021 Form 10-K In June 2021, GSK announced that it intends to demerge at least 80% of its 68% ownership interest in the JV in mid-2022, subject to GSK shareholder approval. Following the demerger, the JV is expected to be an independent, listed company on the London Stock Exchange with American Depositary Receipts to be listed in the U.S., in which Pfizer would initially hold a 32% ownership interest and GSK may hold up to a 13.6% ownership interest. Notwithstanding GSKs announcement, the demerger may not be completed within expected time periods or at all, and both the timing and success of the demerger (or any other separation and public listing transaction), will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to any separation and public listing transactions (including the announced demerger), their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others: impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain disruptions and shortages, including challenges related to reliance on third-party suppliers resulting in reduced availability of materials or components used in the development, manufacturing, distribution or administration of our products; disruptions to pipeline development and clinical trials, including difficulties or delays in enrolling certain clinical trials, retaining clinical trial participants, accessing needed supplies, and accruing a sufficient number of cases in certain clinical trials; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; reduced product demand as a result of unemployment or increased focus on COVID-19 vaccination; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce or being restricted from enforcing, intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and an oral COVID-19 treatment; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; challenges related to our human capital and talent development, including challenges in attracting, hiring and retaining highly skilled and diverse workforce; challenges related to vaccine mandates; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines and vaccines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and an oral COVID-19 treatment, as well as challenges related to their manufacturing, supply and distribution, including, among others: uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical and clinical data (including the Phase 1/2/3 or Phase 4 data for BNT162b2 or any other vaccine candidate in the BNT162 program or Paxlovid or any other future COVID-19 treatment) in any of our studies in pediatrics, adolescents or adults or real world evidence, including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data or further information regarding the quality of pre-clinical, clinical or safety data, including by audit or inspection; the ability to produce comparable clinical or other results for BNT162b2 or Paxlovid, including the rate of effectiveness and/or efficacy, safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial for BNT162b2 or Paxlovid and additional studies, in real-world data studies or in larger, more diverse populations following commercialization; the ability of BNT162b2 or any future vaccine to prevent, or Paxlovid or any other future COVID-19 treatment to be effective against, COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine or Paxlovid will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program, Paxlovid or other programs will be published in scientific journal publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; whether and when submissions to request emergency use or conditional marketing authorizations for BNT162b2 or any potential future vaccines in additional populations, for a booster dose for BNT162b2 or any potential future vaccines (including potential future annual boosters or re-vaccinations), and/or biologics license and/or EUA applications or amendments to any such applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when submissions to request emergency use or conditional marketing authorizations for Paxlovid or any other future COVID-19 treatment and/or any drug applications for any indication for Paxlovid or any other future COVID-19 treatment may be filed in any jurisdiction, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any application that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program, Paxlovid or any other future COVID-19 treatment or any other COVID-19 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines or drugs benefits outweigh its known risks and determination of the vaccines or drugs efficacy and, if approved, whether it will be commercially successful; Pfizer Inc. 2021 Form 10-K decisions by regulatory authorities impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine or drug, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; the possibility that COVID-19 will diminish in severity or prevalence, or disappear entirely; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines formulation, dosing schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations, booster doses or potential future annual boosters or re-vaccinations or new variant-specific vaccines; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program, Paxlovid or any other COVID-19 program; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any treatment for COVID-19, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine or treatment courses of Paxlovid within the projected time periods; whether and when additional supply or purchase agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine or treatment advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public confidence or awareness of our COVID-19 vaccine or Paxlovid, including challenges driven by misinformation, access, concerns about clinical data integrity and prescriber and pharmacy education; trade restrictions; potential third-party royalties or other claims related to our COVID-19 vaccine or Paxlovid; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines and vaccines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the Pfizer Inc. 2021 Form 10-K business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, tax laws and regulations internationally and in the U.S. (including, among other things, any potential adoption of global minimum taxation requirements and any potential changes to existing tax law and regulations by the Biden Administration and Congress), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 2. PROPERTIES We own and lease space globally for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2021, we had 327 owned and leased properties, amounting to approximately 41 million square feet. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in the second half of 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2021, PGS had responsibility for 39 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in Note 16A . INFORMATION ABOUT OUR EXECUTIVE OFFICERS The executive officers of the Company are set forth in this table. Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2022 Annual Meeting of Shareholders, or until his or her earlier death, resignation or removal. Each of the executive officers is a member of the Pfizer Executive Leadership Team. Name Age Position Albert Bourla 60 Chairman of the Board since January 2020 and Chief Executive Officer since January 2019. Chief Operating Officer from January 2018 until December 2018. Group President, Pfizer Innovative Health from June 2016 until December 2017. Group President, Global Innovative Pharma Business (responsible for Vaccines, Oncology and Consumer Healthcare since 2014) from February 2016 until June 2016. President and General Manager of Established Products Business Unit from December 2010 until December 2013. Our Director since February 2018. William Carapezzi 64 Executive Vice President, Global Business Services and Transformation since June 2020. Senior Vice President of Global Business Operations from June 2013 until June 2020. Senior Vice President of Global Tax from 2008 until June 2013. Frank A. DAmelio 64 Chief Financial Officer, Executive Vice President since January 2022. Chief Financial Officer and Executive Vice President, Global Supply from June 2020 until December 2021. Chief Financial Officer, Executive Vice President, Business Operations and Global Supply from November 2018 until June 2020. Executive Vice President, Business Operations and Chief Financial Officer from December 2010 until October 2018. Senior Vice President and Chief Financial Officer from September 2007 until December 2010. Director of Zoetis Inc. and Humana Inc. and Chair of the Humana Inc. Board of Directors Audit Committee. Mikael Dolsten 63 Chief Scientific Officer, President, Worldwide Research, Development and Medical since January 2019. President of Worldwide Research and Development from December 2010 until December 2018. Senior Vice President; President of Worldwide Research and Development from May 2010 until December 2010. Senior Vice President; President of Pfizer BioTherapeutics Research Development Group from October 2009 until May 2010. Director of Agilent Technologies, Inc, and Vimian Group AB. Pfizer Inc. 2021 Form 10-K Name Age Position Lidia Fonseca 53 Chief Digital and Technology Officer, Executive Vice President since January 2019. Chief Information Officer and Senior Vice President of Quest Diagnostics Incorporated from 2014 to 2018. Senior Vice President of Laboratory Corporation of America Holdings from 2008 until March 2013. Director of Tegna, Inc. Angela Hwang 56 Group President, Pfizer Biopharmaceuticals Group since January 2019. Group President, Pfizer Essential Health from January 2018 until December 2018. Global President, Pfizer Inflammation and Immunology from January 2016 until December 2017. Regional Head, U.S. Vaccines from January 2014 until December 2015. Vice President, Emerging Markets for the Primary Care therapeutic area from September 2011 until December 2013. Director of United Parcel Service, Inc. Rady A. Johnson 60 Chief Compliance, Quality and Risk Officer, Executive Vice President since January 2019. Executive Vice President, Chief Compliance and Risk Officer from December 2013 until December 2018. Senior Vice President and Associate General Counsel from October 2006 until December 2013. Douglas M. Lankler 56 General Counsel, Executive Vice President since December 2013. Corporate Secretary from January 2014 until February 2014. Executive Vice President, Chief Compliance and Risk Officer from February 2011 until December 2013. Executive Vice President, Chief Compliance Officer from December 2010 until February 2011. Aamir Malik 46 Chief Business Innovation Officer, Executive Vice President since August 2021. Various U.S. geographic leadership roles with McKinsey Company from 2019 to 2021; previously co-led McKinsey Companys Global Pharmaceuticals Medical Products practice from 2015 to 2018. Michael McDermott 56 Chief Global Supply Officer, Executive Vice President since January 2022. President of Pfizer Global Supply from 2018 until 2021. Vice President of Pfizer Global Supply from 2014 until 2018. Vice President of the Biotechnology Unit from 2012 until 2014. Payal Sahni 47 Chief People Experience Officer, Executive Vice President since January 2022. Chief Human Resources Officer, Executive Vice President from June 2020 to December 2021. From May 2016 until June 2020 served as Senior Vice President of Human Resources for multiple operating units. Vice President of Human Resources, Vaccines, Oncology Consumer from 2015 until 2016. Ms. Sahni has served in a number of positions in the Human Resources organization with increasing responsibility since joining Pfizer in 1997. Sally Susman 60 Chief Corporate Affairs Officer, Executive Vice President since January 2019. Executive Vice President, Corporate Affairs (formerly Policy, External Affairs and Communications) from December 2010 until December 2018. Senior Vice President, Policy, External Affairs and Communications from December 2009 until December 2010. Director of WPP plc. PART II "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 22, 2022, there were 133,758 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2021 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) October 4 through October 31, 2021 8,817 $ 44.74 $ 5,292,881,709 November 1 through November 30, 2021 4,687 $ 44.71 $ 5,292,881,709 December 1 through December 31, 2021 33,186 $ 55.35 $ 5,292,881,709 Total 46,690 $ 52.27 (a) See Note 12 . (b) Represents (i) 44,604 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 2,086 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. Pfizer Inc. 2021 Form 10-K PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2016, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche Holding AG and Sanofi SA. Five Year Performance 2016 2017 2018 2019 2020 2021 PFIZER $100.0 $115.8 $144.5 $134.5 $139.1 $232.0 PEER GROUP $100.0 $117.3 $126.7 $154.0 $160.4 $186.9 SP 500 $100.0 $121.8 $116.5 $153.1 $181.3 $233.3 "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2021 Total Revenues$81.3 billion 2021 Net Cash Flow from Operations$32.6 billion An increase of 95% compared to 2020 An increase of 126% compared to 2020 2021 Reported Diluted EPS$3.85 2021 Adjusted Diluted EPS (Non-GAAP)$4.42* An increase of 137% compared to 2020 An increase of 96% compared to 2020 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our former Upjohn Business in the fourth quarter of 2020, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines and beginning in the fourth quarter of 2020 operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments: Biopharma and PC1. Biopharma is the only reportable segment. On December 31, 2021, we completed the sale of our Meridian subsidiary, and beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 75% has been incurred since inception and through December 31, 2021. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base and support model align appropriately with our new operating structure. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. We are taking steps to restructure our corporate enabling functions to appropriately support our business, RD and PGS platform functions. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA . RD: We believe we have a strong pipeline and are well-positioned for future growth. RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new Pfizer Inc. 2021 Form 10-K products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. See the Item 1. Business Research and Development section of this Form 10-K for our RD priorities and strategy. We seek to leverage a strong pipeline, organize around expected operational growth drivers and capitalize on trends creating long-term growth opportunities, including: an aging global population that is generating increased demand for innovative medicines and vaccines that address patients unmet needs; advances in both biological science and digital technology that are enhancing the delivery of breakthrough new medicines and vaccines; and the increasingly significant role of hospitals in healthcare systems. Our Business Development Initiatives We are committed to strategically capitalizing on growth opportunities, primarily by advancing our own product pipeline and maximizing the value of our existing products, but also through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will help advance our business strategy. Our significant recent business development activities that closed or are targeted to close in 2022 include: Acquisition of Arena In December 2021, we and Arena announced that the companies entered into a definitive agreement under which we will acquire Arena, a clinical stage company developing innovative potential therapies for the treatment of several immuno-inflammatory diseases. Under the terms of the agreement, we will acquire all outstanding shares of Arena for $100 per share in an all-cash transaction for a total equity value of approximately $6.7 billion. On February 2, 2022, Arena shareholders voted to approve the proposed acquisition, which is targeted to close in the first half of 2022, subject to review under antitrust laws and other customary closing conditions. Collaboration with Biohaven In November 2021, we entered into a collaboration and license agreement and related sublicense agreement with Biohaven Pharmaceutical Holding Company Ltd., Biohaven Pharmaceutical Ireland DAC and BioShin Limited (collectively, Biohaven) pursuant to which we acquired rights to commercialize rimegepant and zavegepant for the treatment and prevention of migraines outside of the U.S., subject to regulatory approval. Rimegepant is currently commercialized in the U.S., Israel, and the U.A.E. under the brand name Nurtec ODT, with certain additional applications pending outside of the U.S. Biohaven will continue to lead RD globally and we have the exclusive right to commercialization globally, outside of the U.S. Upon the closing of the transaction, which occurred on January 4, 2022, we paid Biohaven $500 million, including an upfront payment of $150 million and an equity investment of $350 million. Biohaven is also eligible to receive up to $740 million in non-U.S. commercialization milestone payments, in addition to tiered double-digit royalties on net sales outside of the U.S. In addition to the milestone payments and royalties above, we will also reimburse Biohaven for the portion of certain additional milestone payments and royalties due to third parties in accordance with preexisting Biohaven agreements, which are attributed to ex-U.S. sales. For additional information, including discussion of recent significant business development activities, see Note 2 . Our 2021 Performance Revenues Revenues increased $39.6 billion, or 95%, to $81.3 billion in 2021 from $41.7 billion in 2020, reflecting an operational increase of $38.4 billion, or 92%, as well as a favorable impact of foreign exchange of $1.2 billion, or 3%. Excluding direct sales and alliance revenues of Comirnaty and sales of Paxlovid, revenues increased 6% operationally, reflecting strong growth in Eliquis, Biosimilars, PC1, Vyndaqel/Vyndamax, the Hospital therapeutic area, Inlyta and Xtandi, partially offset by declines in the Prevnar family, Chantix/Champix, Enbrel and Sutent. The following outlines the components of the net change in revenues: See the Analysis of the Consolidated Statements of IncomeRevenues by Geography and RevenuesSelected Product Discussion sections within MDA for more information, including a discussion of key drivers of our revenue performance. For information regarding the primary indications or class of certain products, see Note 17C. Pfizer Inc. 2021 Form 10-K Income from Continuing Operations Before Provision/(Benefit) for Taxes on Income The increase in Income from continuing operations before provision/(benefit) for taxes on income of $17.3 billion in 2021, compared to 2020, was primarily attributable to: (i) higher revenues, (ii) net periodic benefit credits in 2021 versus net periodic benefit costs in 2020, (iii) lower asset impairment charges, and (iv) higher net gains on equity securities, partially offset by (v) increases in: Cost of sales, Research and development expenses and Selling, informational and administrative expenses. See the Analysis of the Consolidated Statements of Income within MDA and Note 4 for additional information. For information on our tax provision and effective tax rate, see the Provision/(Benefit) for Taxes on Income section within MDA and Note 5 . Our Operating Environment We, like other businesses in our industry, are subject to certain industry-specific challenges. These include, among others, the topics listed below. See also the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors sections of this Form 10-K. Regulatory EnvironmentPipeline Productivity Our product lines must be replenished to offset revenue losses when products lose exclusivity or market share or to respond to healthcare and innovation trends, as well as to provide for earnings growth. As a result, we devote considerable resources to our RD activities which, while essential to our growth, incorporate a high degree of risk and cost, including whether a particular product candidate or new indication for an in-line product will achieve the desired clinical endpoint or safety profile, will be approved by regulators or will be successful commercially. We conduct clinical trials to provide data on safety and efficacy to support the evaluation of a products overall benefit-risk profile for a particular patient population. In addition, after a product has been approved or authorized and launched, we continue to monitor its safety as long as it is available to patients. This includes postmarketing trials that may be conducted voluntarily or pursuant to a regulatory request to gain additional medical knowledge. For the entire life of the product, we collect safety data and report safety information to the FDA and other regulatory authorities. Regulatory authorities may evaluate potential safety concerns and take regulatory actions in response, such as updating a products labeling, restricting its use, communicating new safety information to the public, or, in rare cases, requiring us to suspend or remove a product from the market. The commercial potential of in-line products may be negatively impacted by post-marketing developments. Intellectual Property Rights and Collaboration/Licensing Rights The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face increased generic competition over the next few years. While additional patent expiries will continue, we expect a moderate impact of reduced revenues due to patent expiries from 2022 through 2025. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information on patent rights we consider most significant to our business as a whole, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. For a discussion of recent developments with respect to patent litigation, see Note 16A1. Regulatory Environment/Pricing and AccessGovernment and Other Payer Group Pressures The pricing of medicines by pharmaceutical manufacturers and the cost of healthcare, which includes medicines, medical services and hospital services, continues to be important to payers, governments, patients, and other stakeholders. Federal and state governments and private third-party payers in the U.S. continue to take action to manage the utilization of drugs and cost of drugs, including increasingly employing formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. We consider a number of factors impacting the pricing of our medicines and vaccines. Within the U.S., we often engage with patients, doctors and healthcare plans. We also often provide significant discounts from the list price to insurers, including PBMs and MCOs. The price that patients pay in the U.S. for prescribed medicines and vaccines is ultimately set by healthcare providers and insurers. Governments globally may use a variety of measures to control costs, including proposing pricing reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In the U.S., we expect to see continued focus by Congress and the Biden Administration on regulating pricing which could result in legislative and regulatory changes designed to control costs. For example, there is proposed legislation that, if enacted, would allow Medicare to negotiate prices for certain prescription drugs, as well as require that penalties be paid by manufacturers who raise drug prices faster than inflation. Also, certain changes proposed by the CMS in December 2020 to the Medicaid program and 340B drug pricing program, which imposes ceilings on prices that drug manufacturers can charge for medications sold to certain health care facilities, could increase our Medicaid rebate obligations and increase the discounts we extend to 340B covered entities if they go into effect. Additional changes to the 340B program are undergoing review and their status is unclear. We anticipate that these and similar initiatives will continue to increase pricing pressures globally. For additional information, see the Item 1. Business Pricing Pressures and Managed Care Organizations and Government Regulation and Price Constraints sections in this Form 10-K. Product Supply We periodically encounter supply delays, disruptions or shortages, including due to voluntary product recalls such as our recent Chantix recall. For information on our recent Chantix recall and risks related to product manufacturing, see the Item 1A. Risk FactorsProduct Manufacturing, Sales and Marketing Risks section in this Form 10-K. The Global Economic Environment In addition to the industry-specific factors discussed above, we, like other businesses of our size and global extent of activities, are exposed to economic cycles. Certain factors in the global economic environment that may impact our global operations include, among other things, currency fluctuations, capital and exchange controls, global economic conditions including inflation, restrictive government actions, changes in intellectual property, legal protections and remedies, trade regulations, tax laws and regulations and procedures and actions affecting approval, Pfizer Inc. 2021 Form 10-K production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest or military action, including the current conflict between Russia and Ukraine, terrorist activity, unstable governments and legal systems, inter-governmental disputes, public health outbreaks, epidemics, pandemics, natural disasters or disruptions related to climate change. Government pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria or other means of cost control. COVID-19 Pandemic The COVID-19 pandemic has impacted our business, operations and financial condition and results. Our Response to COVID-19 Pfizer has helped lead the global effort to confront the COVID-19 pandemic by advancing a vision for industry-wide collaboration while making significant investments in breakthrough science and global manufacturing. Comirnaty/BNT162b2 : We have collaborated with BioNTech to jointly develop Comirnaty/BNT162b2, a mRNA-based coronavirus vaccine to help prevent COVID-19. The FDA has approved Comirnaty in the U.S. to prevent COVID-19 in individuals 16 years of age and older as a two-dose primary series (30 g per dose). Comirnaty is the first COVID-19 vaccine to be granted approval by the FDA and had previously been available to this patient population in the U.S. under an EUA since December 2020. The vaccine is also available to individuals 5 to 15 years old under an EUA granted by the FDA in 2021 (10 g per dose for children 5 through 11 years of age (October 2021) and 30 g per dose for individuals 12 years of age and older (May 2021)). The FDA has also authorized for emergency use: (i) a third dose of Comirnaty/BNT162b2 in certain immunocompromised individuals 5 years of age and older and (ii) Comirnaty/BNT162b2 as a booster dose in individuals 12 years of age and older. Comirnaty/BNT162b2 has also been granted an approval or an authorization in many other countries around the world in populations varying by country. We continue to evaluate our vaccine, including for additional pediatric indications, and the short- and long-term efficacy of Comirnaty. We are also studying vaccine candidates to potentially prevent COVID-19 caused by new and emerging variants, such as the Omicron variant, or an updated vaccine as needed. In 2021, we manufactured more than three billion doses and, in fiscal 2021, delivered 2.2 billion doses around the world. Pfizer and BioNTech expect we can manufacture up to four billion doses in total by the end of 2022. The companies have entered into agreements to supply pre-specified doses of Comirnaty in 2022 with multiple developed and emerging countries around the world and are continuing to deliver doses of Comirnaty to governments under such agreements. We also signed agreements with multiple countries to supply Comirnaty doses in 2023 and are currently negotiating similar potential agreements with multiple other countries. We anticipate delivering at least two billion doses to low- and middle-income countries by the end of 2022one billion that was delivered in 2021 and one billion expected to be delivered in 2022, with the possibility to increase those deliveries if more orders are placed by these countries for 2022. One billion of the aforementioned doses to low- and middle-income countries are being supplied to the U.S. government at a not-for-profit price to be donated to the worlds poorest nations at no charge to those countries. As of February 8, 2022, we forecasted approximately $32 billion in revenues for Comirnaty in 2022, with gross profit to be split evenly with BioNTech, which includes doses expected to be delivered in fiscal 2022 under contracts signed as of late-January 2022. Paxlovid : In December 2021, the FDA authorized the emergency use of Paxlovid, a novel oral COVID-19 treatment, which is a SARS-CoV2-3CL protease inhibitor and is co-administered with a low dose of ritonavir, for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death. The FDA based its decision on clinical data from the Phase 2/3 EPIC-HR (Evaluation of Protease Inhibition for COVID-19 in High-Risk Patients), which enrolled non-hospitalized adults aged 18 and older with confirmed COVID-19 who are at increased risk of progressing to severe illness. Paxlovid has been granted an authorization or approval in many other countries. We continue to evaluate Paxlovid in other populations, including in patients with a confirmed diagnosis of SARS-CoV-2 infection who are at standard risk (i.e., low risk of hospitalization or death) (Phase 2/3 EPIC-SR (Evaluation of Protease Inhibition for COVID-19 in Standard Risk Patients)) and in adults living in the same household as someone with a confirmed COVID-19 infection (Phase 2/3 EPIC-PEP (Evaluation of Protease Inhibition for COVID-19 in Post-Exposure Prophylaxis)). We have entered into agreements with multiple countries to supply pre-specified courses of Paxlovid, such as the U.S. and U.K., and have initiated bilateral outreach to approximately 100 countries around the world. Additionally, we have signed a voluntary non-exclusive license agreement with the Medicines Patent Pool (MPP) for Paxlovid. Under the terms of the agreement, MPP can grant sublicenses to qualified generic medicine manufacturers worldwide to manufacture and supply Paxlovid to 95 low- and middle-income countries, covering up to approximately 53% of the worlds population. Pfizer plans to manufacture up to 120 million treatment courses by the end of 2022, depending on the global need, which will be driven by advance purchase agreements, with 30 million courses expected to be produced in the first half of 2022 and the remaining 90 million courses expected to be produced in the second half of 2022. As of February 8, 2022, we forecasted approximately $22 billion of revenues for Paxlovid in 2022, which includes treatment courses expected to be delivered in fiscal 2022, primarily relating to supply contracts signed or committed as of late-January 2022. IV Protease Inhibitor: In February 2022, we discontinued the global clinical development program for PF-07304814, an intravenously administered SARS-CoV-2 main protease inhibitor being evaluated in adults hospitalized with severe COVID-19. This decision was made based on a totality of information, including a careful review of early data and a thorough assessment of the candidates potential to successfully fulfill patient needs. Dosing of PF-07304814 in the National Institutes of Healths ongoing Accelerating COVID-19 Therapeutic Interventions and Vaccines (ACTIV)-3 study has ceased. Impact of COVID-19 on Our Business and Operations As part of our on-going monitoring and assessment, we have made certain assumptions regarding the pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, Pfizer Inc. 2021 Form 10-K as well as COVID-19 vaccine and oral COVID-19 treatment supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. We are focused on all aspects of our business and are implementing measures aimed at mitigating issues where possible, including by using digital technology to assist in operations for our commercial, manufacturing, RD and corporate enabling functions globally. Apart from our introduction of Comirnaty/BNT162b2 and Paxlovid, our business and operations have been impacted by the pandemic in various ways. Our portfolio of products experienced varying impacts from the pandemic in 2021. For example, certain of our vaccines such as the Prevnar family were impacted by disruptions to healthcare activity related to COVID-19, including the prioritization of primary and booster vaccination campaigns for COVID-19. For some products such as Vyndaqel/Vyndamax, we continued to see postponement of elective and diagnostic procedures in 2021 due to COVID-19, which may subside in 2022 as COVID-19 vaccination and booster rates continue to increase and/or if COVID-19 cases subside. On the other hand, some products such as Ibrance saw accelerating demand in 2021 as the delays in diagnosis and treatment initiations caused by the COVID-19 pandemic show signs of recovery across several international markets. For detail on the impact of the COVID-19 pandemic on certain of our products, see the Analysis of the Consolidated Statements of IncomeRevenues by Geography and RevenuesSelected Product Discussion sections within this MDA. In 2021, engagement with healthcare professionals started to return to pre-pandemic levels and we continue to review and assess epidemiological data to inform in-person engagements with healthcare professionals and to help ensure the safety of our colleagues, customers and communities. As part of our commitment to engaging our customers in the manner they prefer, we are also taking a hybrid approach of virtual and in person engagements and saw customer response to both approaches. During the pandemic, we adapted our promotional platform by amplifying our digital capabilities to reach healthcare professionals and customers to provide critical education and information, including increasing the scale of our remote engagement. Most of our colleagues who are able to perform their job functions outside of our facilities continue to temporarily work remotely, while certain colleagues in the PGS and WRDM organizations continue to work onsite and are subject to strict protocols intended to reduce the risk of transmission. As of December 31, 2021, more than 96% of our U.S. employee population had been fully vaccinated or received an approved exception. Also, in 2021 and to date, we have not seen a significant disruption to our supply chain, and all of our manufacturing sites globally have continued to operate at or near normal levels. However, we are seeing an increase in overall demand in the industry for certain components and raw materials potentially constraining available supply, which could have a future impact on our business. We are continuing to monitor and implement mitigation strategies in an effort to reduce any potential risk or impact including active supplier management, qualification of additional suppliers and advanced purchasing to the extent possible. Certain of our clinical trials were impacted by the COVID-19 pandemic in 2021, which included, in some cases, challenges related to recruiting clinical trial participants and accruing cases in certain studies. Our clinical trials also progressed in this challenging environment through innovation, such as decentralized visits (e.g., telemedicine and home visits) to accommodate participants ability to maintain scheduled visits, as well as working with suppliers to manage the shortage of certain clinical supplies. We will continue to pursue efforts to maintain the continuity of our operations while monitoring for new developments related to the pandemic. Future developments could result in additional favorable or unfavorable impacts on our business, operations or financial condition and results. If we experience significant disruption in our manufacturing or supply chains or significant disruptions in clinical trials or other operations, or if demand for our products is significantly reduced as a result of the COVID-19 pandemic, we could experience a material adverse impact on our business, operations and financial condition and results. For additional information, please see the Item 1A. Risk FactorsCOVID-19 Pandemic section of this Form 10-K. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS Following is a discussion about the critical accounting estimates and assumptions impacting our consolidated financial statements. Also, see Note 1D . For a description of our significant accounting policies, see Note 1 . Of these policies, the following are considered critical to an understanding of our consolidated financial statements as they require the application of the most subjective and the most complex judgments: Acquisitions ( Note 1E ); Fair Value ( Note 1F ); Revenues ( Note 1H ); Asset Impairments ( Note 1M ); Tax Assets and Liabilities and Income Tax Contingencies ( Note 1Q ); Pension and Postretirement Benefit Plans ( Note 1R ); and Legal and Environmental Contingencies ( Note 1S ). For a discussion of a recently adopted accounting standard and a change in accounting principle related to our pension and postretirement plans, see Notes 1B and 1C. Acquisitions We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair value as of the acquisition date. For further detail on acquisition accounting, see Note 1E . Historically, intangible assets have been the most significant fair values within our business combinations. For further information on our process to estimate the fair value of intangible assets, see Asset Impairments below. Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. If any of our ratios, factors, assessments, experiences or judgments are not indicative or accurate estimates of our future experience, our results could be materially affected. The potential of our estimates to vary (sensitivity) differs by program, product, type of customer and geographic location. However, estimates associated with U.S. Medicare, Medicaid and performance-based contract rebates are most at risk for material adjustment because of the extensive time delay Pfizer Inc. 2021 Form 10-K between the recording of the accrual and its ultimate settlement, an interval that can generally range up to one year. Because of this lag, our recording of adjustments to reflect actual amounts can incorporate revisions of several prior quarters. Rebate accruals are product specific and, therefore for any period, are impacted by the mix of products sold as well as the forecasted channel mix for each individual product. For further information, see the Analysis of the Consolidated Statements of IncomeRevenue Deductions section within MDA and Note 1H . Asset Impairments We review all of our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Our impairment review processes are described in Note 1M. Examples of events or circumstances that may be indicative of impairment include: A significant adverse change in legal factors or in the business climate that could affect the value of the asset. For example, a successful challenge of our patent rights would likely result in generic competition earlier than expected. A significant adverse change in the extent or manner in which an asset is used such as a restriction imposed by the FDA or other regulatory authorities that could affect our ability to manufacture or sell a product. An expectation of losses or reduced profits associated with an asset. This could result, for example, from a change in a government reimbursement program that results in an inability to sustain projected product revenues and profitability. This also could result from the introduction of a competitors product that impacts projected revenue growth, as well as the lack of acceptance of a product by patients, physicians and payers. For IPRD projects, this could result from, among other things, a change in outlook based on clinical trial data, a delay in the projected launch date or additional expenditures to commercialize the product. Identifiable Intangible Assets We use an income approach, specifically the discounted cash flow method to determine the fair value of intangible assets, other than goodwill. We start with a forecast of all the expected net cash flows associated with the asset, which incorporates the consideration of a terminal value for indefinite-lived assets, and then we apply an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions that impact our fair value estimates include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the projections and the impact of technological advancements and risk associated with IPRD assets, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic origin of the projected cash flows. While all intangible assets other than goodwill can face events and circumstances that can lead to impairment, those that are most at risk of impairment include IPRD assets (approximately $3.1 billion as of December 31, 2021) and newly acquired or recently impaired indefinite-lived brand assets. IPRD assets are high-risk assets, given the uncertain nature of RD. Newly acquired and recently impaired indefinite-lived assets are more vulnerable to impairment as the assets are recorded at fair value and are then subsequently measured at the lower of fair value or carrying value at the end of each reporting period. As such, immediately after acquisition or impairment, even small declines in the outlook for these assets can negatively impact our ability to recover the carrying value and can result in an impairment charge. Goodwill Our goodwill impairment review work as of December 31, 2021 concluded that none of our goodwill was impaired and we do not believe the risk of impairment is significant at this time. In our review, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors that we consider include, for example, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we then perform a quantitative fair value test. When we are required to determine the fair value of a reporting unit, we typically use the income approach. The income approach is a forward-looking approach to estimating fair value and relies primarily on internal forecasts. Within the income approach, we use the discounted cash flow method. We start with a forecast of all the expected net cash flows for the reporting unit, which includes the application of a terminal value, and then we apply a reporting unit-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of technological risk and competitive, legal and/or regulatory forces on the projections, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. For all of our reporting units, there are a number of future events and factors that may impact future results and that could potentially have an impact on the outcome of subsequent goodwill impairment testing. For a list of these factors, see the Forward-Looking Information and Factors That May Affect Future Result s and the Item 1A. Risk Factors sections in this Form 10-K. Benefit Plans For a description of our different benefit plans, see Note 11 . Our assumptions reflect our historical experiences and our judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our benefit plans can materially impact our results of operations. Pfizer Inc. 2021 Form 10-K The following provides (i) at the end of each year, the expected annual rate of return on plan assets for the following year, (ii) the actual annual rate of return on plan assets achieved in each year, and (iii) the weighted-average discount rate used to measure the benefit obligations at the end of each year for our U.S. pension plans and our international pension plans (a) : 2021 2020 2019 U.S. Pension Plans Expected annual rate of return on plan assets 6.3 % 6.8 % 7.0 % Actual annual rate of return on plan assets 9.2 14.1 22.6 Discount rate used to measure the plan obligations 2.9 2.6 3.3 International Pension Plans Expected annual rate of return on plan assets 3.1 3.4 3.6 Actual annual rate of return on plan assets 11.4 9.7 10.7 Discount rate used to measure the plan obligations 1.6 1.5 1.7 (a) For detailed assumptions associated with our benefit plans, see Note 11B . Expected Annual Rate of Return on Plan Assets The assumptions for the expected annual rate of return on all of our plan assets reflect our actual historical return experience and our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The expected annual rate of return on plan assets for our U.S. plans and the majority of our international plans is applied to the fair value of plan assets at each year-end and the resulting amount is reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs to a 50 basis point decline in our assumption for the expected annual rate of return on plan assets, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2022 Net Periodic Benefit Costs Expected annual rate of return on plan assets 50 basis point decline $133 The actual return on plan assets was approximately $2.6 billion during 2021 . Discount Rate Used to Measure Plan Obligations The weighted-average discount rate used to measure the plan obligations for our U.S. defined benefit plans is determined at least annually and evaluated and modified, as required, to reflect the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better, that reflect the rates at which the pension benefits could be effectively settled. The discount rate used to measure the plan obligations for our international plans is determined at least annually by reference to investment grade corporate bonds, rated AA/Aa or better, including, when there is sufficient data, a yield-curve approach. These discount rate determinations are made in consideration of local requirements. The measurement of the plan obligations at the end of the year will affect the amount of service cost, interest cost and amortization expense reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs and benefit obligations to a 10 basis point decline in our assumption for the discount rate, holding all other assumptions constant (in millions, pre-tax): Assumption Change Decrease in 2022 Net Periodic Benefit Costs Increase to 2021 Benefit Obligations Discount rate 10 basis point decline $16 $442 The change in the discount rates used in measuring our plan obligations as of December 31, 2021 resulted in a decrease in the measurement of our aggregate plan obligations by approximately $786 million. Income Tax Assets and Liabilities Income tax assets and liabilities include income tax valuation allowances and accruals for uncertain tax positions. For additional information, see Notes 1Q and 5, as well as the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA . Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax, legal contingencies and guarantees and indemnifications. For additional information, see Notes 1Q , 1S , 5D and 16 . Pfizer Inc. 2021 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF INCOME Revenues by Geography The following presents worldwide revenues by geography: Year Ended December 31, % Change Worldwide U.S. International Worldwide U.S. International (MILLIONS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 21/20 20/19 21/20 20/19 21/20 20/19 Operating segments: Biopharma $ 79,557 $ 40,724 $ 38,013 $ 29,221 $ 21,055 $ 18,901 $ 50,336 $ 19,670 $ 19,112 95 7 39 11 156 3 Pfizer CentreOne 1,731 926 810 524 400 437 1,206 526 374 87 14 31 (8) 129 41 Consumer Healthcare 2,082 988 1,094 (100) (100) (100) Total revenues $ 81,288 $ 41,651 $ 40,905 $ 29,746 $ 21,455 $ 20,326 $ 51,542 $ 20,196 $ 20,579 95 2 39 6 155 (2) 2021 v. 2020 The following provides an analysis of the change in worldwide revenues by geographic areas in 2021: (MILLIONS) Worldwide U.S. International Operational growth/(decline): Growth from Comirnaty, Eliquis, Biosimilars, Vyndaqel/Vyndamax, the Hospital therapeutic area, Inlyta and Xtandi, partially offset by a decline from the Prevnar family, while Xeljanz and Ibrance were flat. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis $ 38,546 $ 8,802 $ 29,744 Growth from PC1 primarily reflecting manufacturing of legacy Upjohn products for Viatris under manufacturing and supply agreements and certain Comirnaty-related manufacturing activities performed on behalf of BioNTech. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis 780 124 656 Lower revenues for Chantix/Champix, Enbrel and Sutent: The decrease for Chantix/Champix was driven by the voluntary recall across multiple markets in the second half of 2021 and the ongoing global pause in shipments of Chantix due to the presence of N-nitroso-varenicline above an acceptable level of intake set by various global regulators, the ultimate timing for resolution of which may vary by country, and the negative impact of the COVID-19 pandemic resulting in a decline in patient visits to doctors for preventive health purposes The decrease for Enbrel internationally primarily reflects continued biosimilar competition, which is expected to continue The decrease for Sutent primarily reflects lower volume demand in the U.S. resulting from its loss of exclusivity in August 2021, as well as continued erosion as a result of increased competition in certain international developed markets (869) (501) (368) Other operational factors, net (27) (134) 106 Operational growth, net 38,429 8,291 30,137 Favorable impact of foreign exchange 1,208 1,208 Revenues increase/(decrease) $ 39,637 $ 8,291 $ 31,346 Emerging markets revenues increased $12.3 billion, or 147%, in 2021 to $20.7 billion from $8.4 billion in 2020, reflecting an operational increase of $12.2 billion, or 145%, and a favorable impact from foreign exchange of approximately 2%. The operational increase in emerging markets was primarily driven by revenues from Comirnaty and growth from certain products in the Hospital therapeutic area, Eliquis and PC1, partially offset by a decline from the Prevnar family. Pfizer Inc. 2021 Form 10-K 2020 v. 2019 The following provides an analysis of the change in worldwide revenues by geographic areas in 2020: (MILLIONS) Worldwide U.S. International Operational growth/(decline): Growth from Vyndaqel/Vyndamax, Eliquis, Biosimilars, Ibrance, Inlyta, Xeljanz, Xtandi, the Hospital therapeutic area and the Prevnar family $ 3,560 $ 2,132 $ 1,428 Growth from PC1 in international markets driven by growth of certain key accounts as well new contract manufacturing activities 114 (36) 151 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations, and none in 2020 (2,082) (988) (1,094) Lower revenues for Enbrel internationally, primarily reflecting continued biosimilar competition in most developed Europe markets, as well as in Japan and Brazil, all of which is expected to continue (320) (320) Decline from Chantix/Champix reflecting the negative impact of the COVID-19 pandemic resulting in a decline in patient visits to doctors for preventive health purposes as well as the loss of patent protection in the U.S. in November 2020 (185) (183) (2) Other operational factors, net (9) 205 (214) Operational growth/(decline), net 1,078 1,129 (50) Unfavorable impact of foreign exchange (331) (331) Revenues increase/(decrease) $ 746 $ 1,129 $ (383) Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for the Prevnar family in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for Comirnaty. Emerging markets revenues decreased $456 million, or 5%, in 2020 to $8.4 billion, from $8.8 billion in 2019, and were relatively flat operationally, reflecting an unfavorable impact of foreign exchange of 5% on emerging markets revenues. The relatively flat operational performance was primarily driven by growth from Eliquis, the Prevnar family, Ibrance and Zavicefta, offset by lower revenues for Consumer Healthcare, reflecting the July 31, 2019 completion of the Consumer Healthcare JV transaction. Revenue Deductions Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. These deductions represent estimates of related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. The following presents information about revenue deductions: Year Ended December 31, (MILLIONS) 2021 2020 2019 Medicare rebates $ 726 $ 647 $ 628 Medicaid and related state program rebates 1,214 1,136 1,259 Performance-based contract rebates 3,253 2,660 2,332 Chargebacks 6,122 4,531 3,411 Sales allowances 4,809 3,835 3,776 Sales returns and cash discounts 1,054 924 878 Total $ 17,178 $ 13,733 $ 12,284 Revenue deductions are primarily a function of product sales volume, mix of products sold, contractual or legislative discounts and rebates. For information on our accruals for revenue deductions, including the balance sheet classification of these accruals, see Note 1H . Pfizer Inc. 2021 Form 10-K RevenuesSelected Product Discussion Biopharma Revenue (MILLIONS) Year Ended Dec. 31, % Change Product Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary Comirnaty (a) $36,781 * U.S. $ 7,809 $ 154 * Driven by global uptake, following a growing number of regulatory approvals and temporary authorizations. Intl. 28,972 * * Worldwide $ 36,781 $ 154 * * Eliquis $5,970 Up 19% (operationally) U.S. $ 3,160 $ 2,688 18 Global growth driven primarily by continued increased adoption in non-valvular atrial fibrillation and oral anti-coagulant market share gains, as well as a favorable adjustment related to the Medicare coverage gap provision resulting from lower than previously expected discounts in prior periods. Intl. 2,810 2,260 24 21 Worldwide $ 5,970 $ 4,949 21 19 Ibrance $5,437 Flat (operationally) U.S. $ 3,418 $ 3,634 (6) Flat performance driven primarily by accelerating demand internationally as the delays in diagnosis and treatment initiations caused by the COVID-19 pandemic show signs of recovery across several international markets, offset by a decline in the U.S., primarily driven by an increase in the proportion of patients accessing Ibrance through our Patient Assistance Program. Intl. 2,019 1,758 15 12 Worldwide $ 5,437 $ 5,392 1 Prevnar family $5,272 Down 11% (operationally) U.S. $ 2,701 $ 2,930 (8) Decline primarily resulting from: the normalization of demand in Germany and certain other developed markets following significantly increased adult demand in 2020 resulting from greater vaccine awareness for respiratory illnesses due to the COVID-19 pandemic; the adult indication due to disruptions to healthcare activity related to COVID-19, including the prioritization of primary and booster vaccination campaigns for COVID-19 in the U.S.; the continued impact of the lower remaining unvaccinated eligible adult population in the U.S. and the June 2019 change to the ACIP recommendation for the Prevnar 13 adult indication to shared clinical decision-making; and a decline in the pediatric indication internationally due to disruptions to healthcare activity related to COVID-19. This decline was partially offset by: U.S. growth in the pediatric indication, driven by government purchasing patterns, which was partially offset by disruptions to healthcare activity related to COVID-19. Intl. 2,571 2,920 (12) (13) Worldwide $ 5,272 $ 5,850 (10) (11) Xeljanz $2,455 Flat (operationally) U.S. $ 1,647 $ 1,706 (3) Flat performance as a decline in the U.S. was offset by operational growth internationally. The decline in the U.S. was primarily driven by: the negative impact of data from a long-term safety study, which resulted in JAK class labeling issued by the FDA in December 2021; an unfavorable change in channel mix toward lower-priced channels, despite a 2% increase in underlying demand, driven by growth in our UC and PsA indications; and continued investments to improve formulary positioning and unlock access to additional patient lives. The decline in the U.S. was offset by: operational growth internationally mainly driven by continued uptake in the UC indication in certain developed markets. Intl. 808 731 11 8 Worldwide $ 2,455 $ 2,437 1 Vyndaqel/ Vyndamax $2,015 Up 55% (operationally) U.S. $ 909 $ 613 48 Growth primarily driven by continued strong uptake of the ATTR-CM indication in the U.S., developed Europe and Japan. Intl. 1,106 675 64 61 Worldwide $ 2,015 $ 1,288 56 55 Xtandi $1,185 Up 16% (operationally) U.S. $ 1,185 $ 1,024 16 Growth primarily driven by strong demand across the mCRPC, nmCRPC and mCSPC indications. Intl. Worldwide $ 1,185 $ 1,024 16 16 Inlyta $1,002 Up 26% (operationally) U.S. $ 599 $ 523 15 Growth primarily reflects continued adoption in developed Europe and the U.S. of combinations of certain immune checkpoint inhibitors and Inlyta for the first-line treatment of patients with advanced RCC. Intl. 403 264 53 49 Worldwide $ 1,002 $ 787 27 26 Pfizer Inc. 2021 Form 10-K Revenue (MILLIONS) Year Ended Dec. 31, % Change Product Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary Biosimilars $2,343 Up 51% (operationally) U.S. $ 1,561 $ 899 74 Growth primarily driven by recent oncology monoclonal antibody biosimilar launches and growth from Retacrit in the U.S. Intl. 782 628 25 19 Worldwide $ 2,343 $ 1,527 53 51 Hospital $7,301 Up 5% (operationally) U.S. $ 2,688 $ 2,705 (1) Growth primarily driven by the anti-infectives portfolio in international markets, primarily as a result of recent launches of Zavicefta and Cresemba. Intl. 4,613 4,073 13 9 Worldwide $ 7,301 $ 6,777 8 5 Pfizer CentreOne Revenue (MILLIONS) Year Ended Dec. 31, % Change Operating Segment Global Revenues Region 2021 2020 Total Oper. Operational Results Commentary PC1 $1,731 Up 84% (operationally) U.S. $ 524 $ 400 31 Growth primarily reflects manufacturing of legacy Upjohn products for Viatris under manufacturing and supply agreements and certain Comirnaty-related manufacturing activities performed on behalf of BioNTech. Intl. 1,206 526 129 125 Worldwide $ 1,731 $ 926 87 84 (a) Comirnaty includes direct sales and alliance revenues related to sales of the Pfizer-BioNTech COVID-19 vaccine, which are recorded within our Vaccines therapeutic area. It does not include revenues for certain Comirnaty-related manufacturing activities performed on behalf of BioNTech, which are included in the PC1 contract development and manufacturing organization. Revenues related to these manufacturing activities totaled $320 million for 2021 and $0 million in 2020. * Calculation is not meaningful or results are equal to or greater than 100%. See the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K for information regarding the expiration of various patent rights, Note 16 for a discussion of recent developments concerning patent and product litigation relating to certain of the products discussed above and Note 17C for additional information regarding the primary indications or class of the selected products discussed above. Costs and Expenses Costs and expenses follow: Year Ended December 31, % Change (MILLIONS) 2021 2020 2019 21/20 20/19 Cost of sales $ 30,821 $ 8,484 $ 8,054 * 5 Percentage of Revenues 37.9 % 20.4 % 19.7 % Selling, informational and administrative expenses 12,703 11,597 12,726 10 (9) Research and development expenses 13,829 9,393 8,385 47 12 Amortization of intangible assets 3,700 3,348 4,429 11 (24) Restructuring charges and certain acquisition-related costs 802 579 601 38 (4) Other (income)/deductionsnet (4,878) 1,219 3,497 * (65) * Calculation is not meaningful or results are equal to or greater than 100%. Cost of Sales 2021 v. 2020 Cost of sales increased $22.3 billion, primarily due to: the impact of Comirnaty, which includes a charge for the 50% gross profit split with BioNTech and applicable royalty expenses; increased sales volumes of other products, driven mostly by PC1; and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory. The increase in Cost of sales as a percentage of revenues was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. 2020 v. 2019 Cost of sales increased $431 million, primarily due to: increased sales volumes; an increase in royalty expenses, due to an increase in sales of related products; an unfavorable impact of incremental costs incurred in response to the COVID-19 pandemic; and Pfizer Inc. 2021 Form 10-K an unfavorable impact of foreign exchange and hedging activity on intercompany inventory, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction. The increase in Cost of sales as a percentage of revenues was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. Selling, Informational and Administrative (SIA) Expenses 2021 v. 2020 SIA expenses increased $1.1 billion, mostly due to: increased product-related spending across multiple therapeutic areas; costs related to Comirnaty, driven by a higher provision for healthcare reform fees based on sales; and an increase in costs related to implementing our cost-reduction/productivity initiatives, partially offset by: lower spending on Chantix following the loss of patent protection in the U.S. in November 2020. 2020 v. 2019 SIA expenses decreased $1.1 billion, mostly due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; lower spending for corporate enabling functions; lower spending on sales and marketing activities due to the impact of the COVID-19 pandemic; and lower investments across the Internal Medicine and Inflammation Immunology portfolios, partially offset by: an increase in costs related to implementing our cost-reduction/productivity initiatives; and an increase in business and legal entity alignment costs. Research and Development (RD) Expenses 2021 v. 2020 RD expenses increased $4.4 billion, primarily due to: a charge for acquired IPRD related to our acquisition of Trillium; a net increase in charges for upfront and milestone payments on collaboration and licensing arrangements, driven by payments to Arvinas and Beam; and increased investments across multiple therapeutic areas, including additional spending related to the development of the oral COVID-19 treatment program. 2020 v. 2019 RD expenses increased $1.0 billion, mainly due to: costs related to our collaboration agreement with BioNTech to co-develop a COVID-19 vaccine, including an upfront payment to BioNTech and a premium paid on our equity investment in BioNTech; a net increase in upfront payments, mainly related to Myovant and Valneva; and increased investments towards building new capabilities and driving automation, partially offset by: a net reduction of upfront and milestone payments associated with the acquisition of Therachon and Akcea in 2019. Amortization of Intangible Assets 2021 v. 2020 Amortization of intangible assets increased $353 million, primarily due to amortization of capitalized Comirnaty sales milestones to BioNTech. 2020 v. 2019 Amortization of intangible assets decreased $1.1 billion, mainly due the non-recurrence of amortization of fully amortized assets and the impairment of Eucrisa in the fourth quarter of 2019, partially offset by the increase in amortization of intangible assets from our acquisition of Array. For additional information, see Notes 2A and 10A . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives Transforming to a More Focused Company Program For a description of our program, as well as the anticipated and actual costs, see Note 3. The program savings discussed below may be rounded and represent approximations. In connection with restructuring our corporate enabling functions, we expect gross cost savings of $1.0 billion, or net cost savings, excluding merit and inflation growth and certain real estate cost increases, of $700 million, to be achieved primarily from 2021 through 2022. In connection with transforming our marketing strategy, we expect net cost savings of $1.3 billion, to be achieved primarily from Pfizer Inc. 2021 Form 10-K 2022 through 2024. In connection with manufacturing network optimization, we expect net cost savings of $550 million to be achieved primarily from 2020 through 2023. Certain qualifying costs for this program were recorded in 2021 and 2020, and in the fourth quarter of 2019, and are reflected as Certain Significant Items and excluded from our non-GAAP measure of Adjusted Income. See the Non-GAAP Financial Measure: Adjusted Income section of this MDA. In addition to this program, we continuously monitor our operations for cost reduction and/or productivity opportunities, especially in light of the losses of exclusivity and the expiration of collaborative arrangements for various products. Other (Income)/DeductionsNet 2021 v. 2020 Other incomenet increased $6.1 billion, mainly due to: net periodic benefit credits recorded in 2021 versus net periodic benefit costs recorded in 2020; lower asset impairment charges; higher net gains on equity securities; and net gains on asset disposals in 2021 versus net losses in 2020. 2020 v. 2019 Other deductionsnet decreased $2.3 billion, mainly due to: lower asset impairment charges; lower business and legal entity alignment costs; higher Consumer Healthcare JV equity method income; lower charges for certain legal matters; and higher income from collaborations, out-licensing arrangements and sales of compound/product rights, partially offset by: higher net losses on asset disposals. See Note 4 for additional information . Provision/(Benefit) for Taxes on Income Year Ended December 31, % Change (MILLIONS) 2021 2020 2019 21/20 20/19 Provision/(benefit) for taxes on income $ 1,852 $ 370 $ 583 * (36) Effective tax rate on continuing operations 7.6 % 5.3 % 5.2 % * Indicates calculation not meaningful or result is equal to or greater than 100%. For information about our effective tax rate and the events and circumstances contributing to the changes between periods, as well as details about discrete elements that impacted our tax provisions, see Note 5 . Discontinued Operations For information about our discontinued operations, see Note 2B . PRODUCT DEVELOPMENTS A comprehensive update of Pfizers development pipeline was published as of February 8, 2022 and is available at www.pfizer.com/science/drug-product-pipeline. It includes an overview of our research and a list of compounds in development with targeted indication and phase of development, as well as mechanism of action for some candidates in Phase 1 and all candidates from Phase 2 through registration. The following provides information about significant marketing application-related regulatory actions by, and filings pending with, the FDA and regulatory authorities in the EU and Japan. The table below includes only approvals for products that have occurred in the last twelve months and does not include approvals that may have occurred prior to that time. The table includes filings with regulatory decisions pending (even if the filing occurred outside of the last twelve-month period). Pfizer Inc. 2021 Form 10-K PRODUCT DISEASE AREA APPROVED/FILED* U.S. EU JAPAN Comirnaty/BNT162b2 (PF-07302048) (a) Immunization to prevent COVID-19 (16 years of age and older) BLA Aug. CMA Dec. Approved Feb. Immunization to prevent COVID-19 (12-15 years of age) EUA May CMA May Approved May Immunization to prevent COVID-19 (booster) EUA Sep. CMA Oct. Approved Nov. Immunization to prevent COVID-19 (5-11 years of age) EUA Oct. CMA Nov. Approved Jan. Bavencio (avelumab) (b) First-line maintenance urothelial cancer Approved Jan. Approved Feb. Xtandi (enzalutamide) (c) mCSPC Approved April Cibinqo (abrocitinib) Atopic dermatitis Approved Jan. Approved Dec. Approved Sep. Xeljanz (tofacitinib) Ankylosing spondylitis Approved Dec. Approved Nov. Myfembree (relugolix fixed dose combination) (d) Uterine fibroids (combination with estradiol and norethindrone acetate) Approved May Endometriosis (combination with estradiol and norethindrone acetate) Filed Sep. Lorbrena/Lorviqua (lorlatinib) First-line ALK-positive NSCLC Approved Mar. Approved Jan. Approved Nov. Ngenla (somatrogon) (e) Pediatric growth hormone deficiency Filed Jan. Approved Feb. Approved Jan. Prevnar 20/Apexxnar (Vaccine) (f) Immunization to prevent invasive and non-invasive pneumococcal infections (adults) Approved June Approved Feb. TicoVac (Vaccine) Immunization to prevent tick-borne encephalitis Approved Aug. Paxlovid (g) (nirmatrelvir [PF-07321332]; ritonavir) COVID-19 infection (high risk population) EUA Dec. CMA Jan. Approved Feb. Rimegepant (h) Acute migraine Filed Feb. Migraine prevention Filed Feb. * For the U.S., the filing date is the date on which the FDA accepted our submission. For the EU, the filing date is the date on which the EMA validated our submission. (a) Being developed in collaboration with BioNTech. Prior to BLA, Comirnaty/BNT162b2 for ages 16 and up was available in the U.S. pursuant to an EUA from the FDA on December 11, 2020. In December 2021, a supplemental BLA was submitted to the FDA requesting to expand the approval of Comirnaty to include individuals ages 12 through 15 years. In February 2022, following a request from the FDA, a rolling submission seeking to amend the EUA to include children 6 months through 4 years of age (6 months to 5 years of age) was initiated as we wait for data evaluating a third 3 g dose given at least two months after the second dose of the two-dose series in this age group. A booster dose received EUA from the FDA on September 22, 2021 for individuals 65 years of age and older, individuals 18 through 64 years of age at high risk of severe COVID-19, and individuals 18 through 64 years of age with frequent institutional or occupational exposure to SARS-CoV-2. In addition, in October 2021, the FDA authorized for emergency use a booster dose to eligible individuals who have completed primary vaccination with a different authorized COVID-19 vaccine. Subsequently, the FDA expanded the booster EUA: (i) in November 2021 to include individuals 18 years of age and older, (ii) in December 2021 to include individuals 16 years of age and older and (iii) in January 2022 to include individuals 12 years of age and older as well as individuals 5 through 11 years of age who have been determined to have certain kinds of immunocompromise. A booster dose received conditional marketing authorization from the EMA in October 2021 for individuals 18 years of age and older and may be given to individuals 5 years and older with a severely weakened immune system, at least 28 days after their second dose. A booster dose received approval in Japan in November 2021 for 18 years of age and older. (b) Being developed in collaboration with Merck KGaA, Germany. (c) Being developed in collaboration with Astellas. (d) Being developed in collaboration with Myovant. (e) Being developed in collaboration with OPKO. In January 2022, Pfizer and OPKO received a Complete Response Letter (CRL) from the FDA for the BLA for somatrogon. Pfizer is evaluating the CRL and will work with the FDA to determine an appropriate path forward in the U.S. (f) In October 2021, the CDCs ACIP voted to recommend Prevnar 20 for routine use in adults. Specifically, the ACIP voted to recommend the following: (i) adults 65 years of age or older who have not previously received a pneumococcal conjugate vaccine or whose previous vaccination history is unknown should receive a pneumococcal conjugate vaccine (either pneumococcal 20-valent conjugate vaccine (PCV20) or pneumococcal 15-valent conjugate vaccine (PCV15)). If PCV15 is used, this should be followed by a dose of pneumococcal polysaccharide vaccine (PPSV23); and (ii) adults aged 19 years of age or older with certain underlying medical conditions or other risk factors who have not previously received a pneumococcal conjugate vaccine or whose previous vaccination history is unknown should receive a pneumococcal conjugate vaccine (either PCV20 or PCV15). If PCV15 is used, this should be followed by a dose of PPSV23. The Pfizer Inc. 2021 Form 10-K recommendations were published in the Morbidity and Mortality Weekly Report on January 28, 2022. The publication also notes for adults who have received pneumococcal conjugate vaccine (PCV13) but have not completed their recommended pneumococcal vaccine series with PPSV23, one dose of Prevnar 20 may be used if PPSV23 is not available. (g) In December 2021, the FDA authorized the emergency use of Paxlovid for the treatment of mild-to-moderate COVID-19 in adults and pediatric patients (12 years of age and older weighing at least 40 kg [88 lbs]) with positive results of direct SARS-CoV-2 viral testing, and who are at high risk for progression to severe COVID-19, including hospitalization or death. In January 2022, the EMA approved the CMA of Paxlovid for treating COVID-19 in adults who do not require supplemental oxygen and who are at increased risk of the disease becoming severe. (h) Under a commercialization arrangement with Biohaven. In September 2021, the FDA issued a Drug Safety Communication (DSC) related to Xeljanz/Xeljanz XR and two competitors arthritis medicines in the same drug class, based on its completed review of the ORAL Surveillance trial. The DSC stated that the FDA will require revisions to the Boxed Warnings for each of these medicines to include information about the risks of serious heart-related events, cancer, blood clots, and death. In addition, the DSC indicated the FDAs intention to limit approved uses of these products to certain patients who have not responded or cannot tolerate one or more tumor necrosis factor (TNF) blockers. In December 2021, in light of the results from the completed required postmarketing safety study of Xeljanz, ORAL Surveillance (A3921133), the U.S. label for Xeljanz was revised. In addition, at the request of the EC, the PRAC of the EMA has adopted a referral procedure under Article 20 of Regulation (EC) No 726/2004 to assess safety information relating to oral JAK inhibitors authorized for inflammatory diseases, including Xeljanz and Cibinqo, which is ongoing. For additional information, see Item 1A. Risk FactorsPost-Authorization/Approval Data . In China, the following products received regulatory approvals in the last twelve months: Cresemba for fungal infection and Besponsa for second line acute lymphoblastic leukemia, both in December 2021. The following provides information about additional indications and new drug candidates in late-stage development: PRODUCT/CANDIDATE PROPOSED DISEASE AREA LATE-STAGE CLINICAL PROGRAMS FOR ADDITIONAL USES AND DOSAGE FORMS FOR IN-LINE AND IN-REGISTRATION PRODUCTS Ibrance (palbociclib) (a) ER+/HER2+ metastatic breast cancer Xtandi (enzalutamide) (b) Non-metastatic high-risk castration sensitive prostate cancer Talzenna (talazoparib) Combination with Xtandi (enzalutamide) for first-line mCRPC Combination with Xtandi (enzalutamide) for DNA Damage Repair (DDR)-deficient mCSPC PF-06482077 (Vaccine) Immunization to prevent invasive and non-invasive pneumococcal infections (pediatric) somatrogon (PF-06836922) (c) Adult growth hormone deficiency Braftovi (encorafenib) and Erbitux (cetuximab) (d) First-line BRAF v600E -mutant mCRC Myfembree (relugolix fixed dose combination) (e) Combination with estradiol and norethindrone acetate for contraceptive efficacy Braftovi (encorafenib) and Mektovi (binimetinib) and Keytruda (pembrolizumab) (f) BRAF v600E -mutant metastatic or unresectable locally advanced melanoma Comirnaty / BNT162b2 (PF-07302048) (g) Immunization to prevent COVID-19 (children 2 to 5years of age) Immunization to prevent COVID-19 (infants 6 months to 24 months) Paxlovid (nirmatrelvir [PF-07321332]; ritonavir) COVID-19 Infection (standard risk population) COVID-19 Infection ( post exposure prophylaxis) NEW DRUG CANDIDATES IN LATE-STAGE DEVELOPMENT aztreonam-avibactam (PF-06947387) Treatment of infections caused by Gram-negative bacteria fidanacogene elaparvovec (PF-06838435) (h) Hemophilia B giroctocogene fitelparvovec (PF-07055480) (i) Hemophilia A PF-06425090 (Vaccine) Immunization to prevent primary clostridioides difficile infection PF-06886992 (Vaccine) Immunization to prevent serogroups meningococcal infection (adolescent and young adults) PF-06928316 (Vaccine) Immunization to prevent respiratory syncytial virus infection (maternal) Immunization to prevent respiratory syncytial virus infection (older adults) PF-07265803 Dilated cardiomyopathy due to Lamin A/C gene mutation ritlecitinib (PF-06651600) Alopecia areata sasanlimab (PF-06801591) Combination with Bacillus Calmette-Guerin for non-muscle-invasive bladder cancer fordadistrogene movaparvovec (PF-06939926) Duchenne muscular dystrophy marstacimab (PF-06741086) Hemophilia elranatamab (PF-06863135) Multiple myeloma, double-class exposed Omicron-based mRNA vaccine (g) Immunization to prevent COVID-19 (adults) (a) Being developed in collaboration with The Alliance Foundation Trials, LLC. (b) Being developed in collaboration with Astellas. (c) Being developed in collaboration with OPKO. (d) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (e) Being developed in collaboration with Myovant. (f) Keytruda is a registered trademark of Merck Sharp Dohme Corp. (g) Being developed in collaboration with BioNTech. Pfizer Inc. 2021 Form 10-K (h) Being developed in collaboration with Spark Therapeutics, Inc. (i) Being developed in collaboration with Sangamo Therapeutics, Inc. In February 2022, Pfizer and Merck KGaA, Darmstadt, Germany (Merck KGaA) provided an update on the Phase 3 JAVELIN Lung 100 trial, which assessed the safety and efficacy of two dosing regimens of avelumab monotherapy compared with platinum-based doublet chemotherapy as first-line treatment in patients with metastatic NSCLC whose tumors express PD-L1. While avelumab showed clinical activity in this population, the study did not meet the primary endpoints of overall survival and progression-free survival in the high PD-L1+population for either of the avelumab dosing regimens evaluated. The safety profile for avelumab in this trial was consistent with that observed in the overall JAVELIN clinical development program. Avelumab is not approved for the treatment of any patients with NSCLC. The outcome of the JAVELIN Lung 100 trial has no bearing on any of avelumabs currently-approved indications. Full results of the study will be shared at a future date. In the fourth quarter of 2021, enrollment was stopped in C4591015 Study (a Phase 2/3 placebo controlled randomized observer-blind study to evaluate the safety, tolerability, and immunogenicity of BNT162b2 against COVID-19 in healthy pregnant women 18 years of age and older). This study was developed prior to availability or recommendation for COVID-19 vaccination in pregnant women. The environment changed during 2021 and by September 2021, COVID-19 vaccines were recommended by applicable recommending bodies (e.g., ACIP in the U.S.) for pregnant women in all participating/planned countries, and as a result the enrollment rate declined significantly. With the declining enrollment, the study had insufficient sample size to assess the primary immunogenicity objective and continuation of this placebo controlled study could no longer be justified due to global recommendations. This proposal was shared with and agreed to by FDA and EMA. For additional information about our RD organization, see the Item 1. Business Research and Development section of this Form 10-K. NON-GAAP FINANCIAL MEASURE: ADJUSTED INCOME Adjusted income is an alternative measure of performance used by management to evaluate our overall performance in conjunction with other performance measures. As such, we believe that investors understanding of our performance is enhanced by disclosing this measure. We use Adjusted income, certain components of Adjusted income and Adjusted diluted EPS to present the results of our major operationsthe discovery, development, manufacture, marketing, sale and distribution of biopharmaceutical products worldwideprior to considering certain income statement elements as follows: Measure Definition Relevance of Metrics to Our Business Performance Adjusted income Net income attributable to Pfizer Inc. common shareholders (a) before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items Provides investors useful information to: evaluate the normal recurring operational activities, and their components, on a comparable year-over-year basis assist in modeling expected future performance on a normalized basis Provides investors insight into the way we manage our budgeting and forecasting, how we evaluate and manage our recurring operations and how we reward and compensate our senior management (b) Adjusted cost of sales, Adjusted selling, informational and administrative expenses, Adjusted research and development expenses, Adjusted amortization of intangible assets and Adjusted other (income)/deductions net Cost of sales, Selling, informational and administrative expenses, Research and development expenses, Amortization of intangible assets an d Other (income)/deductionsnet (a) , each before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items, which are components of the Adjusted income measure Adjusted diluted EPS EPS attributable to Pfizer Inc. common shareholdersdiluted (a) before the impact of purchase accounting for acquisitions, acquisition-related items, discontinued operations and certain significant items (a) Most directly comparable GAAP measure. (b) The short-term incentive plans for substantially all non-sales-force employees worldwide are funded from a pool based on our performance, measured in significant part by three metrics, one of which is Adjusted diluted EPS, which is derived from Adjusted income and accounts for 40% of the bonus pool funding tied to financial performance. Additionally, the payout for performance share awards is determined in part by Adjusted net income, which is derived from Adjusted income. The bonus pool funding, which is largely based on financial performance, may be modified by our RD performance as measured by four metrics relating to our pipeline and may be further modified by our Compensation Committees assessment of other factors. Adjusted income and its components and Adjusted diluted EPS are non-GAAP financial measures that have no standardized meaning prescribed by GAAP and, therefore, are limited in their usefulness to investors. Because of their non-standardized definitions, they may not be comparable to the calculation of similar measures of other companies and are presented to permit investors to more fully understand how management assesses performance. A limitation of these measures is that they provide a view of our operations without including all events during a period, and do not provide a comparable view of our performance to peers. These measures are not, and should not be viewed as, substitutes for their directly comparable GAAP measures of Net income attributable to Pfizer Inc. common shareholders , components of Net income attributable to Pfizer Inc. common shareholders and EPS attributable to Pfizer Inc. common shareholdersdiluted , respectively. See the accompanying reconciliations of certain GAAP reported to non-GAAP adjusted informationcertain line items for 2021, 2020 and 2019 below. We also recognize that, as internal measures of performance, these measures have limitations, and we do not restrict our performance-management process solely to these measures. We also use other tools designed to achieve the highest levels of performance. For example, our RD organization has productivity targets, upon which its effectiveness is measured. In addition, total shareholder return, both on an absolute basis and relative to a publicly traded pharmaceutical index, plays a significant role in determining payouts under certain of our incentive compensation plans. Pfizer Inc. 2021 Form 10-K Purchase Accounting Adjustments Adjusted income excludes certain significant purchase accounting impacts resulting from business combinations and net asset acquisitions. These impacts can include the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, and to a much lesser extent, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. Therefore, the Adjusted income measure includes the revenues earned upon the sale of the acquired products without considering the acquisition cost of those products. The exclusion of amortization attributable to acquired intangible assets provides management and investors an alternative view of our results by providing a degree of parity to internally developed intangible assets for which RD costs have been expensed. However, we have not factored in the impacts of any other differences that might have occurred if we had discovered and developed those intangible assets on our own, such as different RD costs, timelines or resulting sales; accordingly, this approach does not intend to be representative of the results that would have occurred if we had discovered and developed the acquired intangible assets internally. Acquisition-Related Items Adjusted income excludes acquisition-related items, which are comprised of transaction, integration, restructuring charges and additional depreciation costs for business combinations because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate businesses as a result of an acquisition. We have made no adjustments for resulting synergies. The significant costs incurred in connection with a business combination result primarily from the need to eliminate duplicate assets, activities or employeesa natural result of acquiring a fully integrated set of activities. For this reason, we believe that such costs incurred can be viewed differently in the context of an acquisition from those costs incurred in other, more normal, business contexts. The integration and restructuring costs for a business combination may occur over several years, with the more significant impacts typically ending within three years of the relevant transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. Discontinued Operations Adjusted income excludes the results of discontinued operations, as well as any related gains or losses on the disposal of such operations. We believe that this presentation is meaningful to investors because, while we review our therapeutic areas and product lines for strategic fit with our operations, we do not build or run our business with the intent to discontinue parts of our business. Restatements due to discontinued operations do not impact compensation or change the Adjusted income measure for the compensation in respect of the restated periods, but are presented for consistency across all periods. Certain Significant Items Adjusted income excludes certain significant items representing substantive and/or unusual items that are evaluated individually on a quantitative and qualitative basis. Certain significant items may be highly variable and difficult to predict. Furthermore, in some cases it is reasonably possible that they could reoccur in future periods. For example, although major non-acquisition-related cost-reduction programs are specific to an event or goal with a defined term, we may have subsequent programs based on reorganizations of the business, cost productivity or in response to LOE or economic conditions. Legal charges to resolve litigation are also related to specific cases, which are facts and circumstances specific and, in some cases, may also be the result of litigation matters at acquired companies that were inestimable, not probable or unresolved at the date of acquisition. Gains and losses on equity securities have a very high degree of inherent market volatility, which we do not control and cannot predict with any level of certainty and because we do not believe including these gains and losses assists investors in understanding our business or is reflective of our core operations and business. Unusual items represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis; items that would be non-recurring; or items that relate to products we no longer sell. See the Reconciliations of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items below for a non-inclusive list of certain significant items. Beginning in 2021, we exclude pension and postretirement actuarial remeasurement gains and losses from our measure of Adjusted income because of their inherent market volatility, which we do not control and cannot predict with any level of certainty and because we do not believe including these gains and losses assists investors in understanding our business or is reflective of our core operations and business. Pfizer Inc. 2021 Form 10-K Reconciliations of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items 2021 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 30,821 $ 12,703 $ 13,829 $ 3,700 $ (4,878) $ 21,979 $ 3.85 Purchase accounting adjustments (b) 25 (3) 6 (3,088) (114) 3,175 Acquisition-related items 52 Discontinued operations (c) 585 Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (108) (450) (1) 1,309 Certain asset impairments (e) (86) 86 Upfront and milestone payments on collaborative and licensing arrangements (f) (1,056) 1,056 (Gains)/losses on equity securities (g) 1,338 (1,338) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) 1,601 (1,601) Asset acquisitions of IPRD (h) (2,240) 2,240 Other (52) (141) (15) (334) (i) 542 Income tax provisionNon-GAAP items (2,848) Non-GAAP adjusted $ 30,685 $ 12,110 $ 10,523 $ 613 $ (2,473) $ 25,236 $ 4.42 2020 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 8,484 $ 11,597 $ 9,393 $ 3,348 $ 1,219 $ 9,159 $ 1.63 Purchase accounting adjustments (b) 18 (2) 5 (3,064) (75) 3,117 Acquisition-related items 44 Discontinued operations (c) (2,879) Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (61) (197) 2 791 Certain asset impairments (e) (1,691) 1,691 Upfront and milestone payments on collaborative and licensing arrangements (f) (454) 454 (Gains)/losses on equity securities (g) 557 (557) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) (1,092) 1,092 Asset acquisitions of IPRD (h) (50) 50 Other (56) (292) (j) (24) (697) (i) 1,063 Income tax provisionNon-GAAP items (1,299) Non-GAAP adjusted $ 8,386 $ 11,106 $ 8,872 $ 284 $ (1,779) $ 12,727 $ 2.26 Pfizer Inc. 2021 Form 10-K 2019 Data presented will not (in all cases) aggregate to totals. IN MILLIONS, EXCEPT PER COMMON SHARE DATA Cost of sales Selling, informational and administrative expenses Research and development expenses Amortization of intangible assets Other (income)/deductionsnet Net income attributable to Pfizer Inc. common shareholders (a) Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted GAAP reported $ 8,054 $ 12,726 $ 8,385 $ 4,429 $ 3,497 $ 16,026 $ 2.82 Purchase accounting adjustments (b) 19 2 4 (4,158) (21) 4,153 Acquisition-related items (2) 185 Discontinued operations (c) (6,056) Certain significant items: Restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring (d) (89) (73) (30) 611 Certain asset impairments (e) (2,757) 2,757 Upfront and milestone payments on collaborative and licensing arrangements (f) (279) 279 (Gains)/losses on equity securities (g) 415 (415) Actuarial valuation and other pension and postretirement plan (gains)/losses (g) (750) 750 (Gain) on completion of Consumer Healthcare JV transaction (8,107) Asset acquisitions of IPRD (h) (337) 337 Other (118) (190) (18) (1,007) (i) 1,333 Income tax provisionNon-GAAP items (797) Non-GAAP adjusted $ 7,865 $ 12,463 $ 7,726 $ 271 $ (623) $ 11,056 $ 1.95 (a) Items that reconcile GAAP Reported to Non-GAAP Adjusted balances are shown pre-tax and include discontinued operations. Our effective tax rates for GAAP reported income from continuing operations were: 7.6% in 2021, 5.3% in 2020 and 5.2% in 2019. See Note 5 . Our effective tax rates on Non-GAAP adjusted income were: 15.3% in 2021, 13.7% in 2020 and 16.0% in 2019. (b) Purchase accounting adjustments include items such as the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. For all years presented, primarily consists of amortization of intangible assets. (c) Relates primarily to the spin-off of our Upjohn Business, and our sale of Meridian. See Note 2B. (d) Includes employee termination costs, asset impairments and other exit costs related to our cost-reduction and productivity initiatives not associated with acquisitions. See Note 3. (e) Primarily includes intangible asset impairment charges. For 2020, $900 million is related to IPRD assets acquired from Array and $528 million is related to Eucrisa. For 2019, $2.6 billion is related to Eucrisa. See Note 4 . (f) Primarily includes the following charges: (i) for 2021, an upfront payment to Arvinas and a premium paid on our equity investment in Arvinas totaling $706 million, a $300 million upfront payment to Beam and a $50 million net upfront payment to BioNTech; (ii) for 2020, a payment of $151 million representing the expense portion of an upfront payment to Myovant, an upfront payment to Valneva of $130 million, an upfront payment to BioNTech and a premium paid on our equity investment in BioNTech totaling $98 million, as well as a $75 million milestone payment to Akcea; and (iii) for 2019, an upfront license fee payment of $250 million to Akcea. (g) (Gains)/losses on equity securities, and actuarial valuation and other pension and postretirement plan (gains)/losses are removed from adjusted earnings due to their inherent market volatility. (h) Primarily includes payments for acquired IPRD. For 2021, includes a $2.1 billion charge related to our acquisition of Trillium, which was accounted for as an asset acquisition, and a $177 million charge related to an asset acquisition completed in the second quarter of 2021. For 2019, included a $337 million charge related to our acquisition of Therachon, which was accounted for as an asset acquisition. (i) For 2021, the total of $334 million primarily includes: (i) charges representing our equity-method accounting pro rata share of restructuring charges and costs of preparing for separation from GSK of $185 million recorded by the Consumer Healthcare JV and (ii) charges for certain legal matters of $162 million. For 2020, the total of $697 million primarily included: (i) charges of $367 million, which represent our equity-method accounting pro rata share of transaction-specific restructuring and business combination accounting charges recorded by the Consumer Healthcare JV, and (ii) losses on asset disposals of $238 million. For 2019, the total of $1.0 billion primarily included: (i) $300 million of business and legal entity alignment costs for consulting, legal, tax and advisory services associated with the design, planning and implementation of our then new business structure, effective in the beginning of 2019, (ii) charges for certain legal matters of $291 million, (iii) charges of $152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity associated with the formation of the Consumer Healthcare JV, (iv) net losses on early retirement of debt of $138 million and (v) charges of $112 million representing our equity-method accounting pro rata share of restructuring and business combination accounting charges recorded by the Consumer Healthcare JV. (j) For 2020, amounts in Selling, informational and administrative expenses of $292 million primarily include costs for consulting, legal, tax and advisory services associated with a non-recurring internal reorganization of legal entities. Pfizer Inc. 2021 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF CASH FLOWS Cash Flows from Continuing Operations Year Ended December 31, (MILLIONS) 2021 2020 2019 Drivers of change Cash provided by/(used in): Operating activities from continuing operations $ 32,922 $ 10,540 $ 7,015 2021 v. 2020 The change was driven primarily by higher net income adjusted for non-cash items, the payment for the acquisition of Trillium, a decrease in contributions to pension plans, and the impact of timing of receipts and payments in the ordinary course of business, mostly from an increase in cash flows from Other current liabilities driven by: (i) a $9.7 billion accrual for the gross profit split due to BioNTech, (ii) an increase in royalties payable, as well as (iii) an increase in deferred revenues for advance payments in 2021 for Comirnaty. The change in Other Adjustments, net , is mostly due to an increase in unrealized gains on equity securities. 2020 v. 2019 The change was driven mainly by higher net income adjusted for non-cash items, advanced payments in 2020 for Comirnaty recorded in deferred revenue, the upfront cash payment associated with our acquisition of Therachon in 2019, and the upfront cash payment associated with our licensing agreement with Akcea in 2019, partially offset by an increase in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net was driven primarily by an increase in equity method dividends received, partially offset by an increase in equity income and increases in net unrealized gains on equity securities. Investing activities from continuing operations $ (22,534) $ (4,162) $ (3,825) 2021 v. 2020 The change was driven mainly by a $24.7 billion increase in purchases of short-term investments with original maturities of greater than three months and a $9.0 billion increase in net purchases of short-term investments with original maturities of three months or less, partially offset by a $16.4 billion increase in redemptions of short-term investments with original maturities of greater than three months. 2020 v. 2019 The change was driven mostly by a $6.0 billion decrease in net proceeds from short-term investments with original maturities of three months or less and $2.7 billion in net purchases of short-term investments with original maturities of greater than three months in 2020 (compared to $2.3 billion net proceeds from short-term investments with original maturities of greater than three months in 2019), partially offset by the cash used to acquire Array, net of cash acquired, of $10.9 billion in 2019. Financing activities from continuing operations $ (9,816) $ (21,640) $ (8,485) 2021 v. 2020 The change was driven mostly by a $9.8 billion net reduction in repayments of short-term borrowings with maturities of greater than three months, a $4.0 billion decrease in net payments on short-term borrowings with maturities of three months or less and a $2.0 billion reduction in repayments of long-term debt, partially offset by a $4.2 billion decrease in proceeds from issuances of long-term debt. 2020 v. 2019 The change was driven mostly by $14.0 billion net payments of short-term borrowings in 2020 (compared to $10.6 billion net proceeds raised from short-term borrowings in 2019) and an increase in cash dividends paid of $397 million, partially offset by a decrease in purchases of common stock of $8.9 billion, lower repayments on long-term debt of $2.8 billion, and an increase in issuances of long-term debt of $280 million. Cash Flows from Discontinued Operations Cash flows from discontinued operations primarily relate to our former Meridian subsidiary, Upjohn Business and the Mylan-Japan collaboration (see Note 2B ). In 2020, net cash provided by financing activities from discontinued operations primarily reflects issuances of long-term debt . ANALYSIS OF FINANCIAL CONDITION, LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK Due to our significant operating cash flows, which is a key strength of our liquidity and capital resources and our primary funding source, as well as our financial assets, access to capital markets, revolving credit agreements, and available lines of credit, we believe that we have, and will maintain, the ability to meet our liquidity needs to support ongoing operations, our capital allocation objectives, and our contractual and other obligations for the foreseeable future. Pfizer Inc. 2021 Form 10-K We focus efforts to optimize operating cash flows through achieving working capital efficiencies that target accounts receivable, inventories, accounts payable, and other working capital. Excess cash from operating cash flows is invested in money market funds and available-for-sale debt securities which consist of primarily high-quality, highly liquid, well-diversified debt securities. We have taken, and will continue to take, a conservative approach to our financial investments and monitoring of our liquidity position in response to market changes. We typically maintain cash and cash equivalent balances and short-term investments which, together with our available revolving credit facilities, are in excess of our commercial paper and other short-term borrowings. Additionally, we may obtain funding through short-term or long-term sources from our access to the capital markets, banking relationships and relationships with other financial intermediaries to meet our liquidity needs. Diverse sources of funds: Related disclosure presented in this Form 10-K Internal sources: Operating cash flows Consolidated Statements of Cash Flows Operating Activities and the Analysis of the Consolidated Statements of Cash Flows within MDA Cash and cash equivalents Consolidated Balance Sheets Money market funds Note 7A Available-for-sale debt securities Note 7A, 7B External sources: Short-term funding: Commercial paper Note 7C Revolving credit facilities Note 7C Lines of credit Note 7C Long-term funding: Long-term debt Note 7D Equity Consolidated Statements of Equity and Note 12 For additional information about the sources and uses of our funds and capital resources for the years ended December 31, 2021 and 2020, see the Analysis of the Consolidated Statements of Cash Flows in this MDA. In August 2021, we completed a public offering of $1 billion aggregate principal amount of senior unsecured sustainability notes. We are using the net proceeds to finance or refinance, in whole or in part as follows: RD expenses related to our COVID-19 vaccines, capital expenditures in connection with the manufacture and distribution of COVID-19 vaccines and our other projects that have environmental and/or social benefits. For additional information, see Note 7D . Credit Ratings The cost and availability of financing are influenced by credit ratings, and increases or decreases in our credit rating could have a beneficial or adverse effect on financing. Our long-term debt is rated high-quality by both SP and Moodys. In November 2020, upon the completion of the Upjohn separation, both Moodys and SP lowered our long-term debt rating one notch to A2 and A+, respectively, and our short-term rating remained unchanged. SP continues to rate our long-term debt rating outlook as Stable since November 2020, while Moodys recently upgraded our long-term debt rating outlook to Positive in December 2021. The current ratings assigned to our commercial paper and senior unsecured long-term debt: NAME OF RATING AGENCY Pfizer Short-Term Rating Pfizer Long-Term Rating Outlook/Watch Moodys P-1 A2 Positive SP A-1+ A+ Stable A security rating is not a recommendation to buy, sell or hold securities and the rating is subject to revision or withdrawal at any time by the rating organization. Each rating should be evaluated independently of any other rating. Capital Allocation Framework Our capital allocation framework is devised to facilitate (i) the achievement of medical breakthroughs through RD investments and business development activities and (ii) returning capital to shareholders through dividends and share repurchases. See the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business and Strategy section of this MDA. Our current and projected dividends provide a return to shareholders while maintaining sufficient capital to invest in growing our business. Our dividends are not restricted by debt covenants. While the dividend level remains a decision of Pfizers BOD and will continue to be evaluated in the context of future business performance, we currently believe that we can support future annual dividend increases, barring significant unforeseen events. In December 2021, our BOD declared a first-quarter dividend of $0.40 per share, payable on March 4, 2022, to shareholders of record at the close of business on January 28, 2022. The first-quarter 2022 cash dividend will be our 333rd consecutive quarterly dividend. See Note 12 for information on the shares of our common stock purchased and the cost of purchases under our publicly announced share-purchase plans, including our accelerated share repurchase agreements. At December 31, 2021, our remaining share-purchase authorization was approximately $5.3 billion. Off-Balance Sheet Arrangements, Contractual, and Other Obligations In the ordinary course of business, (i) we enter into off-balance sheet arrangements that may result in contractual and other obligations and (ii) in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that Pfizer Inc. 2021 Form 10-K may arise in connection with the transaction or that are related to events and activities. For more information on guarantees and indemnifications, see Note 16B . Additionally, certain of our co-promotion or license agreements give our licensors or partners the rights to negotiate for, or in some cases to obtain under certain financial conditions, co-promotion or other rights in specified countries with respect to certain of our products. Furthermore, collaboration, licensing or other RD arrangements may give rise to potential milestone payments. Payments under these agreements generally become due and payable only upon the achievement of certain development, regulatory and/or commercialization milestones, which may span several years and which may never occur. Our significant contractual and other obligations as of December 31, 2021 consisted of: Long-term debt, including current portion (see Note 7 ) and related interest payments; Estimated cash payments related to the TCJA repatriation estimated tax liability (see Note 5 ). Estimated future payments related to the TCJA repatriation tax liability that will occur after December 31, 2021 total $8.3 billion, of which an estimated $750 million is to be paid in the next twelve months and an estimated $7.6 billion is to be paid in periods thereafter; Certain commitments totaling $5.2 billion, of which an estimated $1.5 billion is to be paid in the next twelve months, and $3.7 billion in periods thereafter ( see Note 16C ); Purchases of property plant and equipment ( see Note 9 ). In 2022, we expect to spend approximately $3.3 billion on property, plant and equipment; and Future minimum rental commitments under non-cancelable operating leases (see Note 15 ). Gl o bal Economic Conditions Our Venezuela and Argentina operations function in hyperinflationary economies. The impact to Pfizer is not considered material. For additional information on the global economic environment, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. Market Risk We are subject to foreign exchange risk, interest rate risk, and equity price risk. The objective of our financial risk management program is to minimize the impact of foreign exchange rate and interest rate movements on our earnings. We address such exposures through a combination of operational means and financial instruments. For more information on how we manage our foreign exchange and interest rate risks, see Notes 1G and 7E , as well as the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K for key currencies in which we operate. Our sensitivity analyses of such risks are discussed below. Foreign Exchange Risk The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2021, the expected adverse impact on our net income would not be significant. Interest Rate Risk The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point decrease in interest rates as of December 31, 2021, the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. LIBOR For information on interest rate risk and LIBOR, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. We do not expect the transition to an alternative rate to have a material impact on our liquidity or financial resources. Pfizer Inc. 2021 Form 10-K NEW ACCOUNTING STANDARDS Recently Adopted Accounting Standard See Note 1B. Recently Issued Accounting Standards, Not Adopted as of December 31, 2021 Standard/Description Effective Date Effect on the Financial Statements Reference rate reform provides temporary optional expedients and exceptions to the guidance for contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued after 2021 because of reference rate reform. The new guidance provides the following optional expedients: 1. Simplify accounting analyses under current U.S. GAAP for contract modifications. 2. Simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. 3. Allow a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform. Elections can be adopted prospectively at any time through December 31, 2022. We are assessing the impact, but currently, we do not expect this new guidance to have a material impact on our consolidated financial statements. Accounting for contract assets and contract liabilities from contracts with customers requires contract assets and contract liabilities acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606. This new guidance will generally result in the acquirer recognizing contract assets and contract liabilities at the same amounts that were recorded by the acquiree. Previously, these amounts were recognized by the acquirer at fair value as of the acquisition date. January 1, 2023. Early adoption is permitted. We do not expect this new guidance to have a material impact on our consolidated financial statements. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk section within MDA. Pfizer Inc. 2021 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2022 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Change in Accounting Principle As discussed in Note 1C to the consolidated financial statements, the Company has elected to change its method of accounting for pension and postretirement plans in 2021 to immediately recognize actuarial gains and losses in the consolidated statements of income. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed in Note 1H to the consolidated financial statements, the Company records estimated deductions for Medicare, Medicaid, and performance-based contract rebates (collectively, U.S. rebates) as a reduction to gross product revenues. The accrual for U.S. rebates is recorded in the same period that the corresponding revenues are recognized. The length of time between when a sale is made and when the U.S. rebate is paid by the Company can be as long as one year, which increases the need for significant management judgment and knowledge of market conditions and practices in estimating the accrual. We identified the evaluation of the U.S. rebates accrual as a critical audit matter because the evaluation of the product-specific experience ratio assumption involved especially challenging auditor judgment. The product-specific experience ratio assumption relates to estimating which of the Companys revenue transactions will ultimately be subject to a related rebate. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys U.S. rebates accrual process related to the development of the product-specific experience ratio assumptions. We estimated the U.S. rebates accrual using internal information and historical data and compared the result to the Companys estimated U.S. rebates accrual. We evaluated the Companys ability to accurately estimate the accrual for U.S. rebates by comparing historically recorded accruals to the actual amount that was ultimately paid by the Company. Evaluation of gross unrecognized tax benefits As discussed in Notes 5D and 1 Q , the Companys tax positions are subject to audit by local taxing authorities in each respective tax jurisdiction, and the resolution of such audits may span multiple years. Since tax law is complex and often subject to varied interpretations and judgments, it is uncertain whether some of the Companys tax positions will be sustained upon audit. As of December 31, 2021, the Company has recorded gross unrecognized tax benefits, excluding associated interest, of $6.1 billion. Pfizer Inc. 2021 Form 10-K Report of Independent Registered Public Accounting Firm We identified the evaluation of the Companys gross unrecognized tax benefits as a critical audit matter because a high degree of audit effort, including specialized skills and knowledge, and complex auditor judgment was required in evaluating the Companys interpretation of tax law and its estimate of the ultimate resolution of its tax positions. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Companys liability for unrecognized tax position process related to (1) interpretation of tax law, (2) evaluation of which of the Companys tax positions may not be sustained upon audit, and (3) estimation and recording of the gross unrecognized tax benefits. We involved tax and valuation professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation of tax laws, including the assessment of transfer pricing practices in accordance with applicable tax laws and regulations. We inspected settlements with applicable taxing authorities, including assessing the expiration of statutes of limitations. We tested the calculation of the liability for uncertain tax positions, including an evaluation of the Companys assessment of the technical merits of tax positions and estimates of the amount of tax benefits expected to be sustained. Evaluation of product and other product-related litigation As discussed in Notes 1S and 16 to the consolidated financial statements, the Company is involved in product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others. Certain of these pending product and other product-related legal proceedings could result in losses that could be substantial. The accrued liability and/or disclosure for the pending product and other product-related legal proceedings requires a complex series of judgments by the Company about future events, which involves a number of uncertainties. We identified the evaluation of product and other product-related litigation as a critical audit matter. Challenging auditor judgment was required to evaluate the Companys judgments about future events and uncertainties. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys product liability and other product-related litigation processes, including controls related to (1) the evaluation of information from external and internal legal counsel, (2) forward-looking expectations, and (3) new legal proceedings, or other legal proceedings not currently reserved or disclosed. We read letters received directly from the Companys external and internal legal counsel that described the Companys probable or reasonably possible legal contingency to pending product and other product-related legal proceedings. We inspected the Companys minutes from meetings of the Audit Committee, which included the status of key litigation matters. We evaluated the Companys ability to estimate its monetary exposure to pending product and other product-related legal proceedings by comparing historically recorded liabilities to actual monetary amounts incurred upon resolution of prior legal matters. We analyzed relevant publicly available information about the Company, its competitors, and the industry. We have not been able to determine the specific year that we or our predecessor firms began serving as the Companys auditor, however, we are aware that we or our predecessor firms have served as the Companys auditor since at least 1942. New York, New York February 24, 2022 Pfizer Inc. 2021 Form 10-K Consolidated Statements of Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2021 2020 2019 Revenues $ 81,288 $ 41,651 $ 40,905 Costs and expenses: Cost of sales (a) 30,821 8,484 8,054 Selling, informational and administrative expenses (a) 12,703 11,597 12,726 Research and development expenses (a) 13,829 9,393 8,385 Amortization of intangible assets 3,700 3,348 4,429 Restructuring charges and certain acquisition-related costs 802 579 601 (Gain) on completion of Consumer Healthcare JV transaction ( 6 ) ( 8,107 ) Other (income)/deductionsnet ( 4,878 ) 1,219 3,497 Income from continuing operations before provision/(benefit) for taxes on income 24,311 7,036 11,321 Provision/(benefit) for taxes on income 1,852 370 583 Income from continuing operations 22,459 6,666 10,738 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income before allocation to noncontrolling interests 22,025 9,195 16,056 Less: Net income attributable to noncontrolling interests 45 36 29 Net income attributable to Pfizer Inc. common shareholders $ 21,979 $ 9,159 $ 16,026 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 4.00 $ 1.19 $ 1.92 Discontinued operationsnet of tax ( 0.08 ) 0.46 0.95 Net income attributable to Pfizer Inc. common shareholders $ 3.92 $ 1.65 $ 2.88 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.93 $ 1.18 $ 1.89 Discontinued operationsnet of tax ( 0.08 ) 0.45 0.94 Net income attributable to Pfizer Inc. common shareholders $ 3.85 $ 1.63 $ 2.82 Weighted-average sharesbasic 5,601 5,555 5,569 Weighted-average sharesdiluted 5,708 5,632 5,675 (a) Exclusive of amortization of intangible assets, except as disclosed in Note 1M. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Comprehensive Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2021 2020 2019 Net income before allocation to noncontrolling interests $ 22,025 $ 9,195 $ 16,056 Foreign currency translation adjustments, net ( 682 ) 772 675 Reclassification adjustments ( 17 ) ( 288 ) ( 682 ) 755 387 Unrealized holding gains/(losses) on derivative financial instruments, net 526 ( 582 ) 476 Reclassification adjustments for (gains)/losses included in net income (a) 134 21 ( 664 ) 660 ( 561 ) ( 188 ) Unrealized holding gains/(losses) on available-for-sale securities, net ( 355 ) 361 ( 1 ) Reclassification adjustments for (gains)/losses included in net income (b) ( 30 ) ( 188 ) 39 ( 384 ) 173 38 Benefit plans: prior service (costs)/credits and other, net 116 52 ( 7 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 154 ) ( 176 ) ( 181 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 74 ) ( 2 ) Other ( 2 ) 1 ( 113 ) ( 124 ) ( 189 ) Other comprehensive income/(loss), before tax ( 519 ) 243 48 Tax provision/(benefit) on other comprehensive income/(loss) 71 ( 227 ) 178 Other comprehensive income/(loss) before allocation to noncontrolling interests $ ( 589 ) $ 471 $ ( 130 ) Comprehensive income/(loss) before allocation to noncontrolling interests $ 21,435 $ 9,666 $ 15,926 Less: Comprehensive income/(loss) attributable to noncontrolling interests 43 27 18 Comprehensive income/(loss) attributable to Pfizer Inc. $ 21,393 $ 9,639 $ 15,908 (a) Reclassified into Other (income)/deductionsnet and Cost of sales . See Note 7E. (b) Reclassified into Other (income)/deductionsnet . See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Balance Sheets Pfizer Inc. and Subsidiary Companies As of December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2021 2020 Assets Cash and cash equivalents $ 1,944 $ 1,786 Short-term investments 29,125 10,437 Trade accounts receivable, less allowance for doubtful accounts: 2021$ 492 ; 2020$ 508 11,479 7,913 Inventories 9,059 8,020 Current tax assets 4,266 3,264 Other current assets 3,820 3,646 Total current assets 59,693 35,067 Equity-method investments 16,472 16,856 Long-term investments 5,054 3,406 Property, plant and equipment 14,882 13,745 Identifiable intangible assets 25,146 28,337 Goodwill 49,208 49,556 Noncurrent deferred tax assets and other noncurrent tax assets 3,341 2,383 Other noncurrent assets 7,679 4,879 Total assets $ 181,476 $ 154,229 Liabilities and Equity Short-term borrowings, including current portion of long-term debt: 2021$ 1,636 ; 2020$ 2,002 $ 2,241 $ 2,703 Trade accounts payable 5,578 4,283 Dividends payable 2,249 2,162 Income taxes payable 1,266 1,049 Accrued compensation and related items 3,332 3,049 Deferred revenues 3,067 1,113 Other current liabilities 24,939 11,561 Total current liabilities 42,671 25,920 Long-term debt 36,195 37,133 Pension benefit obligations 3,489 4,766 Postretirement benefit obligations 235 645 Noncurrent deferred tax liabilities 349 4,063 Other taxes payable 11,331 11,560 Other noncurrent liabilities 9,743 6,669 Total liabilities 104,013 90,756 Commitments and Contingencies Preferred stock, no par value, at stated value; 27 shares authorized; no shares issued or outstanding at December 31, 2021 and December 31, 2020 Common stock, $ 0.05 par value; 12,000 shares authorized; issued: 2021 9,471 ; 2020 9,407 473 470 Additional paid-in capital 90,591 88,674 Treasury stock, shares at cost: 2021 3,851 ; 2020 3,840 ( 111,361 ) ( 110,988 ) Retained earnings 103,394 90,392 Accumulated other comprehensive loss ( 5,897 ) ( 5,310 ) Total Pfizer Inc. shareholders equity 77,201 63,238 Equity attributable to noncontrolling interests 262 235 Total equity 77,462 63,473 Total liabilities and equity $ 181,476 $ 154,229 See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Equity Pfizer Inc. and Subsidiary Companies PFIZER INC. SHAREHOLDERS Preferred Stock Common Stock Treasury Stock (MILLIONS, EXCEPT PREFERRED SHARES) Shares Stated Value Shares Par Value Addl Paid-In Capital Shares Cost Retained Earnings Accum. Other Comp. Loss Share - holders Equity Non-controlling Interests Total Equity Balance, January 1, 2019 478 $ 19 9,332 $ 467 $ 86,253 ( 3,615 ) $ ( 101,610 ) $ 83,527 $ ( 5,249 ) $ 63,407 $ 351 $ 63,758 Net income 16,026 16,026 29 16,056 Other comprehensive income/(loss), net of tax ( 118 ) ( 118 ) ( 11 ) ( 130 ) Cash dividends declared, per share: $ 1.46 Common stock ( 8,174 ) ( 8,174 ) ( 8,174 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 6 ) ( 6 ) Share-based payment transactions 37 2 1,219 ( 8 ) ( 326 ) 894 894 Purchases of common stock ( 213 ) ( 8,865 ) ( 8,865 ) ( 8,865 ) Preferred stock conversions and redemptions ( 47 ) ( 2 ) ( 3 ) 1 ( 4 ) ( 4 ) Other ( 40 ) 19 ( 21 ) ( 60 ) ( 81 ) Balance, December 31, 2019 431 17 9,369 468 87,428 ( 3,835 ) ( 110,801 ) 91,397 ( 5,367 ) 63,143 303 63,447 Net income 9,159 9,159 36 9,195 Other comprehensive income/(loss), net of tax 480 480 ( 9 ) 471 Cash dividends declared, per share: $ 1.53 Common stock ( 8,571 ) ( 8,571 ) ( 8,571 ) Preferred stock Noncontrolling interests ( 91 ) ( 91 ) Share-based payment transactions 37 2 1,261 ( 6 ) ( 218 ) 1,044 1,044 Preferred stock conversions and redemptions (a) ( 431 ) ( 17 ) ( 15 ) 1 31 ( 1 ) ( 1 ) Distribution of Upjohn Business (b) ( 1,592 ) ( 423 ) ( 2,015 ) ( 3 ) ( 2,018 ) Other ( 1 ) ( 1 ) Balance, December 31, 2020 9,407 470 88,674 ( 3,840 ) ( 110,988 ) 90,392 ( 5,310 ) 63,238 235 63,473 Net income 21,979 21,979 45 22,025 Other comprehensive income/(loss), net of tax ( 587 ) ( 587 ) ( 3 ) ( 589 ) Cash dividends declared, per share: $ 1.57 Common stock ( 8,816 ) ( 8,816 ) ( 8,816 ) Preferred stock Noncontrolling interests ( 8 ) ( 8 ) Share-based payment transactions 64 3 1,917 ( 11 ) ( 373 ) ( 77 ) 1,470 1,470 Other ( 85 ) ( 85 ) ( 7 ) ( 92 ) Balance, December 31, 2021 $ 9,471 $ 473 $ 90,591 ( 3,851 ) $ ( 111,361 ) $ 103,394 $ ( 5,897 ) $ 77,201 $ 262 $ 77,462 (a) See Note 12 . (b) See Note 2B. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2021 2020 2019 Operating Activities Net income before allocation to noncontrolling interests $ 22,025 $ 9,195 $ 16,056 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income from continuing operations before allocation to noncontrolling interests 22,459 6,666 10,738 Adjustments to reconcile net income before allocation to noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 5,191 4,681 5,755 Asset write-offs and impairments 276 2,049 2,889 TCJA impact ( 323 ) Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed (a) ( 6 ) ( 8,254 ) Deferred taxes from continuing operations ( 4,293 ) ( 1,575 ) 561 Share-based compensation expense 1,182 755 687 Benefit plan contributions in excess of expense/income ( 3,123 ) ( 1,242 ) ( 55 ) Other adjustments, net ( 1,573 ) ( 479 ) ( 1,080 ) Other changes in assets and liabilities, net of acquisitions and divestitures: Trade accounts receivable ( 3,811 ) ( 1,275 ) ( 1,124 ) Inventories ( 1,125 ) ( 778 ) ( 1,071 ) Other assets ( 1,057 ) ( 137 ) 847 Trade accounts payable 1,242 355 ( 341 ) Other liabilities 18,721 2,768 861 Other tax accounts, net ( 1,166 ) ( 1,240 ) ( 3,074 ) Net cash provided by operating activities from continuing operations 32,922 10,540 7,015 Net cash provided by/(used in) operating activities from discontinued operations ( 343 ) 3,863 5,572 Net cash provided by operating activities 32,580 14,403 12,588 Investing Activities Purchases of property, plant and equipment ( 2,711 ) ( 2,226 ) ( 2,046 ) Purchases of short-term investments ( 38,457 ) ( 13,805 ) ( 6,835 ) Proceeds from redemptions/sales of short-term investments 27,447 11,087 9,183 Net (purchases of)/proceeds from redemptions/sales of short-term investments with original maturities of three months or less ( 8,088 ) 920 6,925 Purchases of long-term investments ( 1,068 ) ( 597 ) ( 201 ) Proceeds from redemptions/sales of long-term investments 649 723 232 Acquisitions of businesses, net of cash acquired ( 10,861 ) Other investing activities, net (a) ( 305 ) ( 265 ) ( 223 ) Net cash provided by/(used in) investing activities from continuing operations ( 22,534 ) ( 4,162 ) ( 3,825 ) Net cash provided by/(used in) investing activities from discontinued operations ( 12 ) ( 109 ) ( 120 ) Net cash provided by/(used in) investing activities ( 22,546 ) ( 4,271 ) ( 3,945 ) Financing Activities Proceeds from short-term borrowings 12,352 16,455 Principal payments on short-term borrowings ( 22,197 ) ( 8,378 ) Net (payments on)/proceeds from short-term borrowings with original maturities of three months or less ( 96 ) ( 4,129 ) 2,551 Proceeds from issuance of long-term debt 997 5,222 4,942 Principal payments on long-term debt ( 2,004 ) ( 4,003 ) ( 6,806 ) Purchases of common stock ( 8,865 ) Cash dividends paid ( 8,729 ) ( 8,440 ) ( 8,043 ) Other financing activities, net 16 ( 444 ) ( 342 ) Net cash provided by/(used in) financing activities from continuing operations ( 9,816 ) ( 21,640 ) ( 8,485 ) Net cash provided by/(used in) financing activities from discontinued operations 11,991 Net cash provided by/(used in) financing activities ( 9,816 ) ( 9,649 ) ( 8,485 ) Effect of exchange-rate changes on cash and cash equivalents and restricted cash and cash equivalents ( 59 ) ( 8 ) ( 32 ) Net increase/(decrease) in cash and cash equivalents and restricted cash and cash equivalents 159 475 125 Cash and cash equivalents and restricted cash and cash equivalents, at beginning of period 1,825 1,350 1,225 Cash and cash equivalents and restricted cash and cash equivalents, at end of period $ 1,983 $ 1,825 $ 1,350 - Continued - Pfizer Inc. 2021 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, 2021 2020 2019 Supplemental Cash Flow Information Cash paid/(received) during the period for: Income taxes $ 7,427 $ 3,153 $ 3,664 Interest paid 1,467 1,641 1,587 Interest rate hedges ( 2 ) ( 20 ) ( 42 ) Non-cash transactions: Right-of-use assets obtained in exchange for lease liabilities $ 1,943 $ 410 $ 314 32 % equity-method investment in the Consumer Healthcare JV received in exchange for contributing Pfizers Consumer Healthcare business (a) 15,711 (a) The $ 8.3 billion Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed reflects the receipt of a 32 % equity-method investment in the new company initially valued at $ 15.7 billion in exchange for net assets contributed of $ 7.6 billion and is presented in operating activities net of $ 146 million cash conveyed that is reflected in Other investing activities, net . See Note 2C. See Accompanying Notes. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 1. Basis of Presentation and Significant Accounting Policies A. Basis of Presentation The consolidated financial statements include the accounts of our parent company and all subsidiaries and are prepared in accordance with U.S. GAAP. The decision of whether or not to consolidate an entity for financial reporting purposes requires consideration of majority voting interests, as well as effective economic or other control over the entity. Typically, we do not seek control by means other than voting interests. For subsidiaries operating outside the U.S., the financial information is included as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. Substantially all unremitted earnings of international subsidiaries are free of legal and contractual restrictions. All significant transactions among our subsidiaries have been eliminated. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. See Note 17 . On December 31, 2021, we completed the sale of our Meridian subsidiary, the manufacturer of EpiPen and other auto-injector products. Prior to its sale, Meridian was managed within the Hospital therapeutic area. Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. On December 21, 2020, Pfizer and Viatris completed the termination of a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (the Mylan-Japan collaboration) pursuant to an agreement dated November 13, 2020, and we transferred related inventories and operations that were part of the Mylan-Japan collaboration to Viatris. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. The assets and liabilities associated with Meridian and the Mylan-Japan collaboration are classified as assets and liabilities of discontinued operations as of December 31, 2020. Upon completion of the spin-off of the Upjohn Business on November 16, 2020, the Upjohn assets and liabilities were derecognized from our consolidated balance sheet and are reflected in Retained Earnings Distribution of Upjohn Business in the consolidated statement of equity. Prior to the spin-off of the Upjohn Business in November 2020, the Upjohn Business, the Mylan-Japan collaboration and Meridian were managed as part of our former Upjohn operating segment. With the separation of the Upjohn Business, the Mylan-Japan collaboration and Meridian, as well as the formation of the Consumer Healthcare JV in 2019, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines. Certain prior year amounts have been reclassified to conform with the current year presentation. In addition, other acquisitions and business development activities completed in 2021, 2020 and 2019 impacted financial results in the periods presented. See Note 2. Certain amounts in the consolidated financial statements and associated notes may not add due to rounding. All percentages have been calculated using unrounded amounts. B . New Accounting Standard Adopted in 2021 On January 1, 2021, we adopted a new accounting standard for income tax that eliminates certain exceptions to the guidance related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The adoption of this guidance did not have a material impact on our consolidated financial statements. C. Change in Accounting Principle In the first quarter of 2021, we adopted a change in accounting principle to a more preferable policy under U.S. GAAP to immediately recognize actuarial gains and losses arising from the remeasurement of our pension and postretirement plans (MTM Accounting). Under the prior policy, we deferred recognition of these gains and losses in Accumulated other comprehensive loss . The accumulated actuarial gains/losses outside of a corridor were then amortized into net periodic benefit costs over the average remaining service period or the average life expectancy of participants. This change has been applied to all pension and postretirement plans on a retrospective basis for all prior periods presented, and as of January 1, 2019, resulted in a cumulative effect decrease to Retained earnings of $ 6.0 billion, with a corresponding offset to Accumulated other comprehensive loss . Each time a pension or postretirement plan is remeasured, the actuarial gain or loss is recognized immediately and classified as Other (income)/deductionsnet . We believe that MTM Accounting is a more preferable policy as it provides improved transparency of results and performance, better alignment with fair value accounting principles and a better reflection of current economic and interest rate trends on plan investments and assumptions and the actuarial impact of plan remeasurements. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The impacts of the adjustments on our consolidated financial statements are summarized as follows: Year Ended December 31, 2021 2020 2019 (MILLIONS, EXCEPT PER COMMON SHARE DATA) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Previous Accounting Principle Impact of Change As Adjusted Consolidated Statements of Income: (Gain) on completion of Consumer Healthcare JV transaction $ $ $ $ ( 6 ) $ $ ( 6 ) $ ( 8,086 ) $ ( 21 ) $ ( 8,107 ) Other (income)/deductionsnet ( 2,820 ) ( 2,058 ) ( 4,878 ) 672 547 1,219 3,264 233 3,497 Income from continuing operations before provision/(benefit) for taxes on income 22,253 2,058 24,311 7,584 ( 547 ) 7,036 11,533 ( 212 ) 11,321 Provision/(benefit) for taxes on income 1,399 453 1,852 496 ( 125 ) 370 631 ( 48 ) 583 Discontinued operationsnet of tax ( 434 ) ( 434 ) 2,564 ( 35 ) 2,529 5,400 ( 82 ) 5,318 Net income before allocation to noncontrolling interests 20,420 1,605 22,025 9,652 ( 457 ) 9,195 16,302 ( 246 ) 16,056 Net income attributable to Pfizer Inc. common shareholders 20,374 1,605 21,979 9,616 ( 457 ) 9,159 16,273 ( 246 ) 16,026 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.71 $ 0.29 $ 4.00 $ 1.27 $ ( 0.08 ) $ 1.19 $ 1.95 $ ( 0.03 ) $ 1.92 Discontinued operationsnet of tax ( 0.08 ) ( 0.08 ) 0.46 ( 0.01 ) 0.46 0.97 ( 0.01 ) 0.95 Net income attributable to Pfizer Inc. common shareholders 3.63 0.29 3.92 1.73 ( 0.08 ) 1.65 2.92 ( 0.04 ) 2.88 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 3.65 $ 0.28 $ 3.93 $ 1.25 $ ( 0.07 ) $ 1.18 $ 1.92 $ ( 0.03 ) $ 1.89 Discontinued operationsnet of tax ( 0.08 ) ( 0.08 ) 0.46 ( 0.01 ) 0.45 0.95 ( 0.01 ) 0.94 Net income attributable to Pfizer Inc. common shareholders 3.57 0.28 3.85 1.71 ( 0.08 ) 1.63 2.87 ( 0.04 ) 2.82 Year Ended December 31, 2021 2020 2019 (MILLIONS) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Previous Accounting Principle Impact of Change As Adjusted Consolidated Statements of Comprehensive Income: Foreign currency translation adjustments, net $ ( 731 ) $ 49 $ ( 682 ) $ 957 $ ( 185 ) $ 772 $ 654 $ 21 $ 675 Benefit plans: actuarial gains/(losses), net 1,565 ( 1,565 ) ( 1,128 ) 1,128 ( 826 ) 826 Reclassification adjustments related to amortization 285 ( 285 ) 276 ( 276 ) 241 ( 241 ) Reclassification adjustments related to settlements, net 209 ( 209 ) 278 ( 278 ) 274 ( 274 ) Other 49 ( 49 ) ( 189 ) 189 22 ( 22 ) Tax provision/(benefit) on other comprehensive income/(loss) 545 ( 475 ) 71 ( 349 ) 122 ( 227 ) 115 63 178 Consolidated Statements of Cash Flows: Deferred taxes from continuing operations $ ( 4,746 ) $ 453 $ ( 4,293 ) $ ( 1,449 ) $ ( 125 ) $ ( 1,575 ) $ 609 $ ( 48 ) $ 561 Benefit plan contributions in excess of expense/income ( 1,065 ) ( 2,058 ) ( 3,123 ) ( 1,790 ) 547 ( 1,242 ) ( 288 ) 233 ( 55 ) Year Ended December 31, 2021 2020 (MILLIONS) Previous Accounting Principle Impact of Change As Reported Previous Accounting Principle Impact of Change As Adjusted Consolidated Balance Sheets: Noncurrent deferred tax assets and other noncurrent tax assets $ 3,320 $ 22 $ 3,341 $ 2,383 $ $ 2,383 Other noncurrent assets 7,679 7,679 4,879 4,879 Pension benefit obligations 3,489 3,489 4,766 4,766 Retained earnings 101,789 1,605 103,394 96,770 ( 6,378 ) 90,392 Accumulated other comprehensive loss ( 4,313 ) ( 1,583 ) ( 5,897 ) ( 11,688 ) 6,378 ( 5,310 ) Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Estimates and Assumptions In preparing these financial statements, we use certain estimates and assumptions that affect reported amounts and disclosures. These estimates and assumptions can impact all elements of our financial statements. For example, in the consolidated statements of income, estimates are used when accounting for deductions from revenues, determining the cost of inventory that is sold, allocating cost in the form of depreciation and amortization, and estimating restructuring charges and the impact of contingencies, as well as determining provisions for taxes on income. On the consolidated balance sheets, estimates are used in determining the valuation and recoverability of assets, and in determining the reported amounts of liabilities, all of which also impact the consolidated statements of income. Certain estimates of fair value and amounts recorded in connection with acquisitions, revenue deductions, impairment reviews, restructuring-associated charges, investments and financial instruments, valuation allowances, pension and postretirement benefit plans, contingencies, share-based compensation, and other calculations can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. Our estimates are often based on complex judgments and assumptions that we believe to be reasonable, but that can be inherently uncertain and unpredictable. If our estimates and assumptions are not representative of actual outcomes, our results could be materially impacted. As future events and their effects cannot be determined with precision, our estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. We are subject to risks and uncertainties that may cause actual results to differ from estimated amounts, such as changes in the healthcare environment, competition, litigation, legislation and regulations. We regularly evaluate our estimates and assumptions using historical experience and expectations about the future. We adjust our estimates and assumptions when facts and circumstances indicate the need for change. E. Acquisitions Our consolidated financial statements include the operations of acquired businesses after the completion of the acquisitions. We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date and that the fair value of acquired IPRD be recorded on the balance sheet. Transaction costs are expensed as incurred. Any excess of the consideration transferred over the assigned values of the net assets acquired is recorded as goodwill. When we acquire net assets that do not constitute a business, as defined in U.S. GAAP, no goodwill is recognized and acquired IPRD is expensed in Research and development expenses . Contingent consideration in a business combination is included as part of the acquisition cost and is recognized at fair value as of the acquisition date. Fair value is generally estimated by using a probability-weighted discounted cash flow approach. See Note 16D . Any liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. These changes in fair value are recognized in earnings in Other (income)/deductionsnet . F. Fair Value We measure certain assets and liabilities at fair value, either upon initial recognition or for subsequent accounting or reporting. We estimate fair value using an exit price approach, which requires, among other things, that we determine the price that would be received to sell an asset or paid to transfer a liability in an orderly market. The determination of an exit price is considered from the perspective of market participants, considering the highest and best use of non-financial assets and, for liabilities, assuming that the risk of non-performance will be the same before and after the transfer. When estimating fair value, depending on the nature and complexity of the asset or liability, we may use one or all of the following techniques: Income approach, which is based on the present value of a future stream of net cash flows. Market approach, which is based on market prices and other information from market transactions involving identical or comparable assets or liabilities. Cost approach, which is based on the cost to acquire or construct comparable assets, less an allowance for functional and/or economic obsolescence. Our fair value methodologies depend on the following types of inputs: Quoted prices for identical assets or liabilities in active markets (Level 1 inputs). Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are directly or indirectly observable, or inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (Level 2 inputs). Unobservable inputs that reflect estimates and assumptions (Level 3 inputs). The following inputs and valuation techniques are used to estimate the fair value of our financial assets and liabilities: Available-for-sale debt securitiesthird-party matrix-pricing model that uses significant inputs derived from or corroborated by observable market data and credit-adjusted yield curves. Equity securities with readily determinable fair valuesquoted market prices and observable NAV prices. Derivative assets and liabilitiesthird-party matrix-pricing model that uses inputs derived from or corroborated by observable market data. Where applicable, these models use market-based observable inputs, including interest rate yield curves to discount future cash flow amounts, and forward and spot prices for currencies. The credit risk impact to our derivative financial instruments was not significant. Money market fundsobservable NAV prices. We periodically review the methodologies, inputs and outputs of third-party pricing services for reasonableness. Our procedures can include, for example, referencing other third-party pricing models, monitoring key observable inputs (like benchmark interest rates) and selectively performing test-comparisons of values with actual sales of financial instruments. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies G. Foreign Currency Translation For most of our international operations, local currencies have been determined to be the functional currencies. We translate functional currency assets and liabilities to their U.S. dollar equivalents at exchange rates in effect as of the balance sheet date and income and expense amounts at average exchange rates for the period. The U.S. dollar effects that arise from changing translation rates are recorded in Other comprehensive income/(loss) . The effects of converting non-functional currency monetary assets and liabilities into the functional currency are recorded in Other (income)/deductionsnet . For operations in highly inflationary economies, we translate monetary items at rates in effect as of the balance sheet date, with translation adjustments recorded in Other (income)/deductionsnet , and we translate non-monetary items at historical rates. H. Revenues and Trade Accounts Receivable Revenue Recognition We record revenues from product sales when there is a transfer of control of the product from us to the customer. We typically determine transfer of control based on when the product is shipped or delivered and title passes to the customer. Our Sales Contracts Sales on credit are typically under short-term contracts. Collections are based on market payment cycles common in various markets, with shorter cycles in the U.S. Sales are adjusted for sales allowances, chargebacks, rebates and sales returns and cash discounts. Sales returns occur due to LOE, product recalls or a changing competitive environment. Deductions from Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment is required when estimating the impact of these revenue deductions on gross sales for a reporting period. Provisions for pharmaceutical sales returns Provisions are based on a calculation for each market that incorporates the following, as appropriate: local returns policies and practices; historical returns as a percentage of sales; an understanding of the reasons for past returns; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, such as LOE, product recalls or a changing competitive environment. Generally, returned products are destroyed, and customers are refunded the sales price in the form of a credit. We record sales incentives as a reduction of revenues at the time the related revenues are recorded or when the incentive is offered, whichever is later. We estimate the cost of our sales incentives based on our historical experience with similar incentives programs to predict customer behavior. The following outlines our common sales arrangements: Customers Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Prescription pharmaceutical products that ultimately are used by patients are generally covered under governmental programs, managed care programs and insurance programs, including those managed through PBMs, and are subject to sales allowances and/or rebates payable directly to those programs. Those sales allowances and rebates are generally negotiated, but government programs may have legislated amounts by type of product (e.g., patented or unpatented). Specifically: In the U.S., we sell our products principally to distributors and hospitals. We also have contracts with managed care programs or PBMs and legislatively mandated contracts with the federal and state governments under which we provide rebates based on medicines utilized by the lives they cover. We record provisions for Medicare, Medicaid, and performance-based contract pharmaceutical rebates based upon our experience ratio of rebates paid and actual prescriptions written during prior periods. We apply the experience ratio to the respective periods sales to determine the rebate accrual and related expense. This experience ratio is evaluated regularly to ensure that the historical trends are as current as practicable. We estimate discounts on branded prescription drug sales to Medicare Part D participants in the Medicare coverage gap, also known as the doughnut hole, based on the historical experience of beneficiary prescriptions and consideration of the utilization that is expected to result from the discount in the coverage gap. We evaluate this estimate regularly to ensure that the historical trends and future expectations are as current as practicable. For performance-based contract rebates, we also consider current contract terms, such as changes in formulary status and rebate rates. Outside the U.S., the majority of our pharmaceutical sales allowances are contractual or legislatively mandated and our estimates are based on actual invoiced sales within each period, which reduces the risk of variations in the estimation process. In certain European countries, rebates are calculated on the governments total unbudgeted pharmaceutical spending or on specific product sales thresholds and we apply an estimated allocation factor against our actual invoiced sales to project the expected level of reimbursement. We obtain third-party information that helps us to monitor the adequacy of these accruals. Provisions for pharmaceutical chargebacks (primarily reimbursements to U.S. wholesalers for honoring contracted prices and legislated discounts to third parties) closely approximate actual amounts incurred, as we settle these deductions generally within two to five weeks of incurring the liability. We recorded direct product sales and/or Alliance revenues of more than $ 1 billion for each of nine products in 2021, for each of seven products in 2020 and for each of six products in 2019. In the aggregate, these direct products sales and/or alliance product revenues represented 75 % of our revenues in 2021, 54 % of our revenues in 2020 and 49 % of our revenues in 2019. See Note 17B for additional information. The loss or expiration of intellectual property rights can have a significant adverse effect on our revenues as our contracts with customers will generally be at lower selling prices and lower volumes due to added generic competition. We generally provide for higher sales returns during the period in which individual markets begin to near the loss or expiration of intellectual property rights. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Our accruals for Medicare, Medicaid and related state program and performance-based contract rebates, chargebacks, sales allowances and sales returns and cash discounts are as follows: As of December 31, (MILLIONS) 2021 2020 Reserve against Trade accounts receivable, less allowance for doubtful accounts $ 1,077 $ 861 Other current liabilities : Accrued rebates 3,811 3,017 Other accruals 528 432 Other noncurrent liabilities 433 399 Total accrued rebates and other sales-related accruals $ 5,850 $ 4,708 Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenues . Trade Accounts Receivable Trade accounts receivable are stated at their net realizable value. The allowance for credit losses reflects our best estimate of expected credit losses of the receivables portfolio determined on the basis of historical experience, current information, and forecasts of future economic conditions. In developing the estimate for expected credit losses, trade accounts receivables are segmented into pools of assets depending on market (U.S. versus international), delinquency status, and customer type (high risk versus low risk and government versus non-government), and fixed reserve percentages are established for each pool of trade accounts receivables. In determining the reserve percentages for each pool of trade accounts receivables, we considered our historical experience with certain customers and customer types, regulatory and legal environments, country and political risk, and other relevant current and future forecasted macroeconomic factors. These credit risk indicators are monitored on a quarterly basis to determine whether there have been any changes in the economic environment that would indicate the established reserve percentages should be adjusted, and are considered on a regional basis to reflect more geographic-specific metrics. Additionally, write-offs and recoveries of customer receivables are tracked against collections on a quarterly basis to determine whether the reserve percentages remain appropriate. When management becomes aware of certain customer-specific factors that impact credit risk, specific allowances for these known troubled accounts are recorded. Trade accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. During 2021 and 2020, additions to the allowance for credit losses, write-offs and recoveries of customer receivables were not material to our consolidated financial statements. I. Collaborative Arrangements Payments to and from our collaboration partners are presented in our consolidated statements of income based on the nature of the arrangement (including its contractual terms), the nature of the payments and applicable accounting guidance. Under co-promotion agreements, we record the amounts received for our share of gross profits from our collaboration partners as alliance revenues, a component of Revenues, when our collaboration partners are the principal in the transaction and we receive a share of their net sales or profits. Alliance revenues are recorded as we perform co-promotion activities for the collaboration and the collaboration partners sell the products to their customers. The related expenses for selling and marketing these products including reimbursements to or from our collaboration partners for these costs are included in Selling, informational and administrative expenses. In collaborative arrangements where we manufacture a product for our collaboration partners, we record revenues when we transfer control of the product to our collaboration partners. In collaboration arrangements where we are the principal in the transaction, we record amounts paid to collaboration partners for their share of net sales or profits earned, and all royalty payments to collaboration partners as Cost of sales . Royalty payments received from collaboration partners are included in Other (income)/deductionsnet. Reimbursements to or from our collaboration partners for development costs are typically recorded in Research and development expenses . Upfront payments and pre-approval milestone payments due from us to our collaboration partners in development stage collaborations are recorded as Research and development expenses . Milestone payments due from us to our collaboration partners after regulatory approval has been attained for a medicine are recorded in Identifiable intangible assetsDeveloped technology rights . Upfront and pre-approval milestone payments earned from our collaboration partners by us are recognized in Other (income)/deductionsnet over the development period for the products, when our performance obligations include providing RD services to our collaboration partners. Upfront, pre-approval and post-approval milestone payments earned by us may be recognized in Other (income)/deductionsnet immediately when earned or over other periods depending upon the nature of our performance obligations in the applicable collaboration. Where the milestone event is regulatory approval for a medicine, we generally recognize milestone payments due to us in the transaction price when regulatory approval in the applicable jurisdiction has been attained. We may recognize milestone payments due to us in the transaction price earlier than the milestone event in certain circumstances when recognition of the income would not be probable of a significant reversal. J. Cost of Sales and Inventories Inventories are recorded at the lower of cost or net realizable value. The cost of finished goods, work in process and raw materials is determined using average actual cost. We regularly review our inventories for impairment and reserves are established when necessary. K. Selling, Informational and Administrative Expenses Selling, informational and administrative costs are expensed as incurred. Among other things, these expenses include the internal and external costs of marketing, advertising, shipping and handling, information technology and legal defense. Advertising expenses totaled approximately $ 2.0 billion in 2021, $ 1.8 billion in 2020 and $ 2.3 billion in 2019. Production costs are expensed as incurred and the costs of TV, radio, and other electronic media and publications are expensed when the related advertising occurs. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies L. Research and Development Expenses RD costs are expensed as incurred. These expenses include the costs of our proprietary RD efforts, as well as costs incurred in connection with certain licensing arrangements. Before a compound receives regulatory approval, we record upfront and milestone payments we make to third parties under licensing arrangements as expense. Upfront payments are recorded when incurred, and milestone payments are recorded when the specific milestone has been achieved. Once a compound receives regulatory approval, we record any milestone payments in Identifiable intangible assets, less accumulated amortization and, unless the asset is determined to have an indefinite life, we typically amortize the payments on a straight-line basis over the remaining agreement term or the expected product life cycle, whichever is shorter. M. Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets Long-lived assets include: Property, plant and equipment , less accumulated depreciationThese assets are recorded at cost, including any significant improvements after purchase, less accumulated depreciation. Property, plant and equipment assets, other than land and construction in progress, are depreciated on a straight-line basis over the estimated useful life of the individual assets. Depreciation begins when the asset is ready for its intended use. For tax purposes, accelerated depreciation methods are used as allowed by tax laws. Identifiable intangible assets, less accumulated amortization These assets are recorded at fair value at acquisition. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite lives are not amortized until a useful life can be determined. Goodwill Goodwill represents the excess of the consideration transferred for an acquired business over the assigned values of its net assets. Goodwill is not amortized. Amortization of finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as these intangible assets benefit multiple business functions. Amortization of intangible assets that are for a single function and depreciation of property, plant and equipment are included in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses, as appropriate. We review our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Specifically: For finite-lived intangible assets, such as developed technology rights, and for other long-lived assets, such as property, plant and equipment, whenever impairment indicators are present, we calculate the undiscounted value of the projected cash flows for the asset, or asset group, and compare this estimated amount to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. In addition, in all cases of an impairment review, we reevaluate the remaining useful lives of the assets and modify them, as appropriate. For indefinite-lived intangible assets, such as brands and IPRD assets, when necessary, we determine the fair value of the asset and record an impairment loss, if any, for the excess of book value over fair value. In addition, in all cases of an impairment review other than for IPRD assets, we re-evaluate whether continuing to characterize the asset as indefinite-lived is appropriate. For goodwill, when necessary, we determine the fair value of each reporting unit and record an impairment loss, if any, for the excess of the book value of the reporting unit over the implied fair value. N. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives We may incur restructuring charges in connection with acquisitions when we implement plans to restructure and integrate the acquired operations or in connection with our cost-reduction and productivity initiatives. In connection with acquisition activity, we typically incur costs associated with executing the transactions, integrating the acquired operations (which may include expenditures for consulting and the integration of systems and processes), and restructuring the combined company (which may include charges related to employees, assets and activities that will not continue in the combined company); and In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges for site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. Included in Restructuring charges and certain acquisition-related costs are all restructuring charges, as well as certain other costs associated with acquiring and integrating an acquired business. If the restructuring action results in a change in the estimated useful life of an asset, that incremental impact is classified in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Employee termination costs are generally recorded when the actions are probable and estimable and include accrued severance benefits, pension and postretirement benefits, many of which may be paid out during periods after termination. Transaction costs, such as banking, legal, accounting and other similar costs incurred in connection with a business acquisition are expensed as incurred . Our business and platform functions may be impacted by these actions, including sales and marketing, manufacturing and RD, as well as our corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement). O. Cash Equivalents and Statement of Cash Flows Cash equivalents include items almost as liquid as cash, such as certificates of deposit and time deposits with maturity periods of three months or less when purchased. If items meeting this definition are part of a larger investment pool, we classify them as Short-term investments . Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Cash flows for financial instruments designated as fair value or cash flow hedges may be included in operating, investing or financing activities, depending on the classification of the items being hedged. Cash flows for financial instruments designated as net investment hedges are classified according to the nature of the hedging instrument. Cash flows for financial instruments that do not qualify for hedge accounting treatment are classified according to their purpose and accounting nature. P. Investments and Derivative Financial Instruments The classification of an investment depends on the nature of the investment, our intent and ability to hold the investment, and the degree to which we may exercise influence. Our investments are primarily comprised of the following: Public equity securities with readily determinable fair values, which are carried at fair value, with changes in fair value reported in Other (income)/deductionsnet. Available-for-sale debt securities, which are carried at fair value, with changes in fair value reported in Other comprehensive income/(loss) until realized. Held-to-maturity debt securities, which are carried at amortized cost. Private equity securities without readily determinable fair values and where we have no significant influence are measured at cost minus any impairment and plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. For equity investments in common stock or in-substance common stock where we have significant influence over the financial and operating policies of the investee, we use the equity-method of accounting. Under the equity-method, we record our share of the investees income and expenses in Other (income)/deductionsnet . The excess of the cost of the investment over our share of the underlying equity in the net assets of the investee as of the acquisition date is allocated to the identifiable assets and liabilities of the investee, with any remaining excess amount allocated to goodwill. Such investments are initially recorded at cost, which is the fair value of consideration paid and typically does not include contingent consideration. Realized gains or losses on sales of investments are determined by using the specific identification cost method. We regularly evaluate all of our financial assets for impairment. For investments in debt and equity, when a decline in fair value, if any, is determined, an impairment charge is recorded and a new cost basis in the investment is established. Derivative financial instruments are carried at fair value in various balance sheet categories (see Note 7A ), with changes in fair value reported in Net income or, for derivative financial instruments in certain qualifying hedging relationships, in Other comprehensive income/(loss) (see Note 7E ). Q. Tax Assets and Liabilities and Income Tax Contingencies Tax Assets and Liabilities Current tax assets primarily include (i) tax effects for intercompany transfers of inventory within our combined group, which are recognized in the consolidated statements of income when the inventory is sold to a third party and (ii) income tax receivables that are expected to be recovered either via refunds from taxing authorities or reductions to future tax obligations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws. We provide a valuation allowance when we believe that our deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax-planning strategies, that would be implemented, if necessary, to realize the deferred tax assets. Amounts recorded for valuation allowances requires judgments about future income which can depend heavily on estimates and assumptions. All deferred tax assets and liabilities within the same tax jurisdiction are presented as a net amount in the noncurrent section of our consolidated balance sheet. The TCJA subjects a U.S. shareholder to current tax on global intangible low-taxed income earned by certain foreign subsidiaries. The FASB Staff QA, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income , states that we are permitted to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as global intangible low-taxed income in future years or provide for the tax expense related to such income in the year the tax is incurred. We elected to recognize deferred taxes for temporary differences expected to reverse as global intangible low-taxed income in future years. Other non-current tax assets primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. Other taxes payable as of December 31, 2021 and 2020 include liabilities for uncertain tax positions and the noncurrent portion of the repatriation tax liability for which we elected payment over eight years through 2026. For additional information, see Note 5D for uncertain tax positions and Note 5A for the repatriation tax liability and other estimates and assumptions in connection with the TCJA. Income Tax Contingencies We account for income tax contingencies using a benefit recognition model. If we consider that a tax position is more likely than not to be sustained upon audit, based solely on the technical merits of the position, we recognize all or a portion of the benefit. We measure the benefit by determining the amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the taxing authority with full knowledge of all relevant information. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies We regularly monitor our position and subsequently recognize the unrecognized tax benefit: (i) if there are changes in tax law, analogous case law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) if the statute of limitations expires; or (iii) if there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. Liabilities for uncertain tax positions are classified as current only when we expect to pay cash within the next 12 months. Interest and penalties, if any, are recorded in Provision/(benefit) for taxes on income and are classified on our consolidated balance sheet with the related tax liability. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. R. Pension and Postretirement Benefit Plans The majority of our employees worldwide are covered by defined benefit pension plans, defined contribution plans or both. In the U.S., we have both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans, as well as other postretirement benefit plans consisting primarily of medical insurance for retirees and their eligible dependents. We recognize the overfunded or underfunded status of each of our defined benefit plans as an asset or liability. The obligations are generally measured at the actuarial present value of all benefits attributable to employee service rendered, as provided by the applicable benefit formula. Our pension and other postretirement obligations may be determined using assumptions such as discount rate, expected annual rate of return on plan assets, expected employee turnover and participant mortality. For our pension plans, the obligation may also include assumptions as to future compensation levels. For our other postretirement benefit plans, the obligation may include assumptions as to the expected cost of providing medical insurance benefits, as well as the extent to which those costs are shared with the employee or others (such as governmental programs). Plan assets are measured at fair value. Net periodic pension and postretirement benefit costs other than the service costs are recognized in Other (income)/deductionsnet . S. Legal and Environmental Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, such as patent litigation, product liability and other product-related litigation, commercial litigation, environmental claims and proceedings, government investigations and guarantees and indemnifications. In assessing contingencies related to legal and environmental proceedings that are pending against the Company, or unasserted claims that are probable of being asserted, we record accruals for these contingencies to the extent that we conclude that a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, we accrue that amount. Alternatively, when no amount within a range of loss appears to be a better estimate than any other amount, we accrue the lowest amount in the range. We record anticipated recoveries under existing insurance contracts when recovery is assured. T. Share-Based Payments Our compensation programs can include share-based payments. Generally, grants under share-based payment programs are accounted for at fair value and these fair values are generally amortized on a straight-line basis over the vesting terms with the related costs recorded in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Note 2. Acquisitions, Divestitures, Equity-Method Investments, Licensing Arrangements and Collaborative Arrangements A. Acquisitions Trillium On November 17, 2021, we acquired all of the issued and outstanding common stock not already owned by Pfizer of Trillium, a clinical stage immuno-oncology company developing therapies targeting cancer immune evasion pathways and specific cell targeting approaches, for a price of $ 18.50 per share in cash, for total consideration of $ 2.0 billion, net of cash acquired. As a result, Trillium became our wholly owned subsidiary. We previously held a 2 % ownership investment in Trillium. Trilliums lead program, TTI-622, is an investigational fusion protein that is designed to block the inhibitory activity of CD47, a molecule that is overexpressed by a wide variety of tumors. We accounted for the transaction as an asset acquisition since the lead asset, TTI-622, represented substantially all of the fair value of the gross assets acquired, which exclude cash acquired. At the acquisition date, we recorded a $ 2.1 billion charge representing an acquired IPRD asset with no alternative future use in Research and development expenses , of which the $ 2.0 billion net cash consideration is presented as a cash outflow from operating activities. In connection with this acquisition, we recorded $ 256 million of assets acquired primarily consisting of cash and investments. Liabilities assumed were approximately $ 81 million. Array On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $ 48 per share in cash. The total fair value of the consideration transferred was $ 11.2 billion ($ 10.9 billion, net of cash acquired). In addition, $ 157 million in payments to Array employees for the fair value of previously unvested stock options was recognized as post-closing compensation expense and recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). We financed the majority of the transaction with debt and the balance with existing cash. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Arrays portfolio includes Braftovi (encorafenib) and Mektovi (binimetinib), a broad pipeline of targeted cancer medicines in different stages of RD, as well as a portfolio of out-licensed medicines, which may generate milestones and royalties over time. The final allocation of the consideration transferred to the assets acquired and the liabilities assumed was completed in 2020. In connection with this acquisition, we recorded: (i) $ 6.3 billion in Identifiable intangible assets , consisting of $ 2.0 billion of Developed technology rights with a useful life of 16 years , $ 2.8 billion of IPRD and $ 1.5 billion of Licensing agreements and other ($ 1.2 billion for technology in development indefinite-lived licensing agreements and $ 360 million for developed technology finite-lived licensing agreements with a useful life of 10 years), (ii) $ 6.1 billion of Goodwill , (iii) $ 1.1 billion of net deferred tax liabilities and (iv) $ 451 million of assumed long-term debt, which was paid in full in 2019. In 2020, we recorded measurement period adjustments to the estimated fair values initially recorded in 2019, which resulted in a reduction in Identifiable intangible assets of approximately $ 900 million with a corresponding change to Goodwill and net deferred tax liabilities. The measurement period adjustments were recorded to better reflect market participant assumptions about facts and circumstances existing as of the acquisition date and did not have a material impact on our consolidated statement of income for the year ended December 31, 2020. Therachon On July 1, 2019, we acquired all the remaining shares of Therachon, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $ 340 million upfront, plus potential milestone payments of up to $ 470 million contingent on the achievement of key milestones in the development and commercialization of the lead asset. We accounted for the transaction as an asset acquisition since the lead asset represented substantially all the fair value of the gross assets acquired. The total fair value of the consideration transferred for Therachon was $ 322 million, which consisted of $ 317 million of cash and our previous $ 5 million investment in Therachon. In connection with this asset acquisition, we recorded a charge of $ 337 million in Research and development expenses. B. Divestitures Meridian On December 31, 2021, we completed the sale of our Meridian subsidiary for approximately $ 51 million in cash and recognized a loss of approximately $ 167 million, net of tax, in Discontinued operationsnet of tax . In connection with the sale, Pfizer and the purchaser of Meridian entered into various agreements to provide a framework for our relationship after the sale, including interim TSAs and a manufacturing supply agreement (MSA). The TSAs primarily involve Pfizer providing services related to information technology, among other activities, and are generally expected to be for terms of no more than 12 to 18 months post sale. The MSA is for a term of three years post sale with a two year extension period. No amounts were recorded under the above arrangements in 2021. Upjohn Separation and Combination with Mylan On November 16, 2020, we completed the spin-off and the combination of the Upjohn Business with Mylan (the Transactions) to form Viatris. The Transactions were structured as an all-stock, Reverse Morris Trust transaction. Specifically, (i) we contributed the Upjohn Business to a wholly owned subsidiary, which was renamed Viatris, so that the Upjohn Business was separated from the remainder of our business (the Separation), (ii) following the Separation, we distributed, on a pro rata basis, all of the shares of Viatris common stock held by Pfizer to Pfizer stockholders as of the November 13, 2020 record date, such that each Pfizer stockholder as of the record date received approximately 0.124079 shares of Viatris common stock per share of Pfizer common stock (the Distribution); and (iii) immediately after the Distribution, the Upjohn Business combined with Mylan in a series of transactions in which Mylan shareholders received one share of Viatris common stock for each Mylan ordinary share held by such shareholder, subject to any applicable withholding taxes (the Combination). Prior to the Distribution, Viatris made a cash payment to Pfizer equal to $ 12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris. As of the closing of the Combination, Pfizer stockholders owned approximately 57 % of the outstanding shares of Viatris common stock, and Mylan shareholders owned approximately 43 % of the outstanding shares of Viatris common stock, in each case on a fully diluted, as-converted and as-exercised basis. The Transactions are generally expected to be tax free to Pfizer and Pfizer stockholders for U.S. tax purposes. Beginning November 16, 2020, Viatris operates both the Upjohn Business and Mylan as an independent publicly traded company, which is traded under the symbol VTRS on the NASDAQ. In connection with the Transactions, in June 2020, Upjohn Inc. and Upjohn Finance B.V. completed privately placed debt offerings of $ 7.45 billion and 3.60 billion aggregate principal amounts, respectively, (approximately $ 11.4 billion) of senior unsecured notes and entered into other financing arrangements, including a $ 600 million delayed draw term loan agreement and a revolving credit facility agreement for up to $ 4.0 billion. Proceeds from the debt offerings and other financing arrangements were used to fund the $ 12.0 billion cash distribution Viatris made to Pfizer prior to the Distribution. We used the cash distribution proceeds to pay down commercial paper borrowings and redeem the $ 1.15 billion aggregate principal amount outstanding of our 1.95 % senior unsecured notes that were due in June 2021 and $ 342 million aggregate principal amount outstanding of our 5.80 % senior unsecured notes that were due in August 2023, before the maturity date. Interest expense for the $ 11.4 billion in debt securities incurred during 2020 is included in Discontinued operationsnet of tax . Following the Separation and Combination of the Upjohn Business with Mylan, we are no longer the obligor or guarantor of any Upjohn debt or Upjohn financing arrangements. As a result of the spin-off of the Upjohn Business, we distributed net assets of $ 1.6 billion as of November 16, 2020, which was reflected as a reduction to Retained earnings and reflects the change in accounting principle in the first quarter of 2021 to MTM Accounting. See Note 1C. Of this amount, $ 412 million represents cash transferred to the Upjohn Business, with the remainder considered a non-cash activity in the consolidated statement of cash flows for the year ended December 31, 2020. The spin-off also resulted in a net increase to Accumulated other comprehensive loss of $ 423 million for the derecognition of net gains on foreign currency translation adjustments of $ 397 million and prior service net credits associated with benefit plans of $ 26 million, which were reclassified to Retained earnings . As a result of the separation of Upjohn, we incurred separation-related costs of $ 434 million in 2020 and $ 83 million in 2019, which are included in Discontinued operationsnet of tax . These costs primarily relate to professional fees for regulatory filings and separation activities within finance, tax, legal and information system functions as well as investment banking fees. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In connection with the Transactions, Pfizer and Viatris entered into various agreements to effect the Separation and Combination to provide a framework for our relationship after the Combination, including a separation and distribution agreement, interim operating models, including agency arrangements, MSAs, TSAs, a tax matters agreement, and an employee matters agreement, among others. The interim agency operating model arrangements primarily include billings, collections and remittance of rebates that we are performing on a transitional basis on behalf of Viatris. Under the MSAs, Pfizer or Viatris, as the case may be, manufactures, labels and packages products for the other party. The terms of the MSAs range in initial duration from four to seven years post-Separation. The TSAs primarily involve Pfizer providing services to Viatris related to finance, information technology and human resource infrastructure and are generally expected to be for terms of no more than three years post-Separation. The amounts recorded under the above agreements were not material to our consolidated results of operations in 2021 and 2020. In addition, Pfizer and Mylan had a pre-existing arms-length commercial agreement, which is continuing with Viatris and is not material to Pfizers consolidated financial statements. Net amounts due from Viatris under the above agreements were $ 53 million as of December 31, 2021 and $ 401 million as of December 31, 2020. The cash flows associated with the above agreements are included in Net cash provided by operating activities from continuing operations, except for a $ 277 million payment to Viatris made in 2021 pursuant to terms of the separation agreement, which is reported in Other financing activities, net, and was recorded as a payable to Viatris in Other current liabilities as of December 31, 2020. Components of Discontinued operationsnet of tax: Year Ended December 31, (a) (MILLIONS) 2021 2020 2019 Revenues $ 277 $ 7,572 $ 10,845 Costs and expenses: Cost of sales 204 2,106 2,173 Selling, informational and administrative expenses 26 1,682 1,624 Research and development expenses 9 224 265 Amortization of intangible assets 45 224 181 Restructuring charges and certain acquisition-related costs 2 29 146 Other (income)/deductionsnet 365 428 401 Pre-tax income/(loss) from discontinued operations ( 375 ) 2,879 6,056 Provision/(benefit) for taxes on income ( 107 ) 349 738 Income/(loss) from discontinued operationsnet of tax ( 268 ) 2,529 5,318 Pre-tax loss on sale of discontinued operations ( 211 ) Benefit for taxes on income ( 44 ) Loss on sale of discontinued operationsnet of tax ( 167 ) Discontinued operationsnet of tax $ ( 434 ) $ 2,529 $ 5,318 (a) In 2021, Discontinued operationsnet of tax primarily includes (i) the operations of Meridian prior to its sale on December 31, 2021 recognized in Income/(loss) from discontinued operationsnet of tax, which includes a pre-tax amount for a Multi-District Litigation relating to EpiPen against the Company in the U.S. District Court for the District of Kansas for $ 345 million; and (ii) the after tax loss of $ 167 million related to the sale of Meridian recognized in Loss on sale of discontinued operationsnet of tax. To a much lesser extent, Discontinued operationsnet of tax in 2021 also includes the operations of the Mylan-Japan collaboration prior to its termination on December 21, 2020 and post-closing adjustments directly related to our former Upjohn and Nutrition discontinued businesses, including adjustments for tax, benefits and legal-related matters recognized in Income/(loss) from discontinued operationsnet of tax. In 2020 and 2019, Discontinued operationsnet of tax relates to the operations of the Upjohn Business, Meridian and the Mylan-Japan collaboration and includes the change in accounting principle in the first quarter of 2021 to MTM Accounting. See Note 1C . In 2020, Discontinued operationsnet of tax includes pre-tax interest expense of $ 116 million associated with the U.S. dollar and Euro denominated senior unsecured notes issued by Upjohn Inc. and Upjohn Finance B.V. in the second quarter of 2020 and pre-tax charges of $ 223 million related to the remeasurement of Euro debt issued by Upjohn Finance B.V. in the second quarter of 2020. Components of assets and liabilities of discontinued operations and other assets held for sale: As of December 31, (a) (MILLIONS) 2021 2020 Current assets of discontinued operations and other assets held for sale Other current assets $ 25 $ 215 Property, plant and equipment $ $ 155 Identifiable intangible assets 134 Other noncurrent assets 29 Noncurrent assets of discontinued operations Other noncurrent assets $ $ 319 Current liabilities of discontinued operations Other current liabilities $ $ 74 Noncurrent liabilities of discontinued operations Other noncurrent liabilities $ $ 16 (a) Amounts as of December 31, 2021 represent property, plant and equipment held for sale. Amounts as of December 31, 2020 primarily relate to discontinued operations of our former Meridian subsidiary and the Mylan-Japan collaboration. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Equity-Method Investments Formation of Consumer Healthcare JV On July 31, 2019, we completed a transaction in which we and GSK combined our respective consumer healthcare businesses into a new JV that operates globally under the GSK Consumer Healthcare name. In exchange, we received a 32 % equity stake in the new company and GSK owns the remaining 68 %. Upon closing, we deconsolidated our Consumer Healthcare business and recognized a pre-tax gain of $ 8.1 billion ($ 5.4 billion, net of tax) in the third quarter of 2019 in (Gain) on completion of Consumer Healthcare JV transaction for the difference in the fair value of our 32 % equity stake and the carrying value of our Consumer Healthcare business. Our financial results and our Consumer Healthcare segments operating results for 2019 reflect seven months of Consumer Healthcare segment domestic operations and eight months of Consumer Healthcare segment international operations. The financial results for 2021 and 2020 do not reflect any contribution from the Consumer Healthcare business. In valuing our investment in the Consumer Healthcare JV, we used discounted cash flow techniques. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which include the expected impact of competitive, legal or regulatory forces on the products; the long-term growth rate, which seeks to project the sustainable growth rate over the long term; the discount rate, which seeks to reflect our best estimate of the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. We are accounting for our interest in the Consumer Healthcare JV as an equity-method investment. The carrying value of our investment in the Consumer Healthcare JV is $ 16.3 billion as of December 31, 2021 and $ 16.7 billion as of December 31, 2020 and is reported as a private equity investment in Equity-method investments as of December 31, 2021 and 2020. The Consumer Healthcare JV is a foreign investee whose reporting currency is the U.K. pound, and therefore we translate its financial statements into U.S. dollars and recognize the impact of foreign currency translation adjustments in the carrying value of our investment and in other comprehensive income. The decrease in the value of our investment from December 31, 2020 to December 31, 2021 is primarily due to dividends totaling $ 499 million, as well as $ 384 million in pre-tax foreign currency translation adjustments (see Note 6 ), partially offset by our share of the JVs earnings. We record our share of earnings from the Consumer Healthcare JV on a quarterly basis on a one-quarter lag in Other (income)/deductionsnet commencing from August 1, 2019. Our total share of the JVs earnings generated in the fourth quarter of 2020 and the first nine months of 2021, which we recorded in our operating results in 2021, was $ 495 million. Our total share of the JVs earnings generated in the fourth quarter of 2019 and the first nine months of 2020, which we recorded in our operating results in 2020, was $ 417 million. Our total share of two months of the JVs earnings generated in the third quarter of 2019, which we recorded in our operating results in the fourth quarter of 2019, was $ 47 million. As of the July 31, 2019 closing date, we estimated that the fair value of our investment in the Consumer Healthcare JV was $ 15.7 billion and that 32 % of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was $ 11.2 billion, resulting in an initial basis difference of approximately $ 4.5 billion. In the fourth quarter of 2019, we preliminarily completed the allocation of the basis difference, which resulted from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV, primarily to inventory, definite-lived intangible assets, indefinite-lived intangible assets, related deferred tax liabilities and equity method goodwill within the investment account. During the fourth quarter of 2019, the Consumer Healthcare JV revised the initial carrying value of the net assets of the JV and our 32 % share of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was reduced to $ 11.0 billion and our initial basis difference was increased to $ 4.8 billion. The adjustment was allocated to equity method goodwill within the investment account. We began recording the amortization of basis differences allocated to inventory, definite-lived intangible assets and related deferred tax liabilities in Other (income)/deductionsnet commencing August 1, 2019. The total amortization and adjustment of basis differences resulting from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV is included in Other (income)/deductionsnet and was not material to our results of operations in the periods presented. See Note 4. Amortization of basis differences on inventory and related deferred tax liabilities was completely recognized by the second quarter of 2020. Basis differences on definite-lived intangible assets and related deferred tax liabilities are being amortized over the lives of the underlying assets, which range from 8 to 20 years. As a part of Pfizer in 2019, pre-tax income on a management basis for the Consumer Healthcare business was $ 654 million through July 31, 2019. Summarized financial information for our equity method investee, the Consumer Healthcare JV, as of September 30, 2021, the most recent period available, and as of September 30, 2020 and for the periods ending September 30, 2021, 2020, and 2019 is as follows: (MILLIONS) September 30, 2021 September 30, 2020 Current assets $ 6,890 $ 6,614 Noncurrent assets 39,445 38,361 Total assets $ 46,335 $ 44,975 Current liabilities $ 5,133 $ 5,246 Noncurrent liabilities 5,218 5,330 Total liabilities $ 10,351 $ 10,576 Equity attributable to shareholders $ 35,705 $ 34,154 Equity attributable to noncontrolling interests 279 245 Total net equity $ 35,984 $ 34,400 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies For the Twelve Months Ending For the Two Months Ending (MILLIONS) September 30, 2021 September 30, 2020 September 30, 2019 Net sales $ 12,836 $ 12,720 $ 2,161 Cost of sales ( 4,755 ) ( 5,439 ) ( 803 ) Gross profit $ 8,081 $ 7,281 $ 1,358 Income from continuing operations 1,614 1,350 152 Net income 1,614 1,350 152 Income attributable to shareholders 1,547 1,307 148 Investment in ViiV In 2009, we and GSK created ViiV, which is focused on research, development and commercialization of human immunodeficiency virus (HIV) medicines. We own approximately 11.7 % of ViiV, and prior to 2016 we accounted for our investment under the equity method due to the significant influence that we have over the operations of ViiV through our board representation and minority veto rights. We suspended application of the equity method to our investment in ViiV in 2016 when the carrying value of our investment was reduced to zero due to the recognition of cumulative equity method losses and dividends. Since 2016, we have recognized dividends from ViiV as income in Other (income)/deductionsnet when earned, including dividends of $ 166 million in 2021, $ 278 million in 2020 and $ 220 million in 2019 (see Note 4 ). Summarized financial information for our equity method investee, ViiV, as of December 31, 2021 and 2020 and for the years ending December 31, 2021, 2020, and 2019 is as follows: As of December 31, (MILLIONS) 2021 2020 Current assets $ 3,608 $ 3,283 Noncurrent assets 3,563 3,381 Total assets $ 7,171 $ 6,664 Current liabilities $ 3,497 $ 3,028 Noncurrent liabilities 6,536 6,370 Total liabilities $ 10,033 $ 9,398 Total net equity/(deficit) attributable to shareholders $ ( 2,862 ) $ ( 2,734 ) Year Ended December 31, (MILLIONS) 2021 2020 2019 Net sales $ 6,380 $ 6,224 $ 6,139 Cost of sales ( 682 ) ( 574 ) ( 516 ) Gross profit $ 5,698 $ 5,650 $ 5,623 Income from continuing operations 2,040 2,012 3,398 Net income 2,040 2,012 3,398 Income attributable to shareholders 2,040 2,012 3,398 D. Licensing Arrangements Agreement with Valneva On April 30, 2020, we signed an agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, which covers six serotypes that are prevalent in North America and Europe. Valneva and Pfizer will work closely together throughout the development of VLA15. Valneva is eligible to receive a total of up to $ 308 million in cash payments from us consisting of a $ 130 million upfront payment, which was paid and recorded in Research and development expenses in our second quarter of 2020, as well as $ 35 million in development milestones and $ 143 million in early commercialization milestones. Under the terms of the agreement, Valneva will fund 30 % of all development costs through completion of the development program, and in return we will pay Valneva tiered royalties. We will lead late-stage development and have sole control over commercialization. Agreement with Akcea On October 4, 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a wholly-owned subsidiary of Ionis. The transaction closed in November 2019 and we made an upfront payment of $ 250 million to Akcea, which was recorded in Research and development expenses in our fourth quarter of 2019. On January 31, 2022, we and Ionis announced the discontinuation of the Pfizer-led clinical development program for the licensed product and that we would be returning the rights to the licensed product to Ionis. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies E. Collaborative Arrangements We enter into collaborative arrangements with respect to in-line medicines, as well as medicines in development that require completion of research and regulatory approval. Collaborative arrangements are contractual agreements with third parties that involve a joint operating activity, typically a research and/or commercialization effort, where both we and our partner are active participants in the activity and are exposed to the significant risks and rewards of the activity. Our rights and obligations under our collaborative arrangements vary. For example, we have agreements to co-promote pharmaceutical products discovered by us or other companies, and we have agreements where we partner to co-develop and/or participate together in commercializing, marketing, promoting, manufacturing and/or distributing a drug product. Collaboration with Beam On December 24, 2021, we entered into a multi-year research collaboration with Beam to utilize Beams in vivo base editing programs, which use mRNA and lipid nanoparticles, for three targets for rare genetic diseases of the liver, muscle and central nervous system. Under the terms of the agreement, Beam conducts all research activities through development candidate selection for three undisclosed targets, which are not included in Beams existing programs, and we may opt in to obtain exclusive licenses to each development candidate. Beam has a right to opt in, at the end of phase 1/2 studies, upon the payment by Beam of an option exercise fee, to a global co-development and co-commercialization agreement with respect to one program licensed under the collaboration pursuant to which we and Beam would share net profits as well as development and commercialization costs in a 65 %/ 35 % ratio (Pfizer/Beam). Upon entering into the agreement, we recorded $ 300 million in Research and development expenses in the fourth quarter of 2021 for an upfront payment due to Beam, and if we exercise our opt in to licenses for all three targets, Beam would be eligible for up to an additional $ 1.05 billion in development, regulatory and commercial milestone payments for a potential total deal consideration of up to $ 1.35 billion. Beam is also eligible to receive royalties on global net sales for each licensed program. Collaboration with Arvinas On July 21, 2021, we entered into a global collaboration with Arvinas to develop and commercialize ARV-471, an investigational oral PROTAC (PROteolysis TArgeting Chimera) estrogen receptor protein degrader. The estrogen receptor is a well-known disease driver in most breast cancers. In connection with the agreement, we made an upfront cash payment of $ 650 million to Arvinas and we made a $ 350 million equity investment in the common stock of Arvinas. We recognized $ 706 million for the upfront payment and a premium paid on our equity investment in Research and development expenses in our third quarter of 2021. Arvinas is also eligible to receive up to $ 400 million in approval milestones and up to $ 1 billion in commercial milestones. The companies will equally share worldwide development costs, commercialization expenses and profits. As of December 31, 2021, we held a 6.5 % equity stake of Arvinas. Collaboration with Myovant On December 26, 2020, we entered into a collaboration with Myovant to jointly develop and commercialize Orgovyx (relugolix) in advanced prostate cancer and Myfembree (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health in the U.S. and Canada. We also received an exclusive option to commercialize relugolix in oncology outside the U.S. and Canada, excluding certain Asian countries, which we declined to exercise. Under the terms of the agreement, the companies will equally share profits and allowable expenses for Orgovyx and Myfembree in the U.S. and Canada, with Myovant bearing our share of allowable expenses up to a maximum of $ 100 million in 2021 and up to a maximum of $ 50 million in 2022. We record our share of gross profits as Alliance revenue. Myovant remains responsible for regulatory interactions and drug supply and continues to lead clinical development for Myfembree. Myovant is entitled to receive up to $ 4.35 billion, including an upfront payment of $ 650 million, which was made in December 2020, $ 200 million in potential regulatory milestones for FDA approvals for Myfembree in womens health, of which $ 100 million was paid to Myovant in July 2021 and recognized as Identifiable intangible assetsDeveloped technology rights , and tiered sales milestones of up to $ 3.5 billion in total for prostate cancer and for the combined womens health indications. In connection with this transaction, in 2020 we recognized $ 499 million in Identifiable intangible assetsDeveloped technology rights and $ 151 million in Research and development expenses representing the relative fair value of the portion of the upfront payment allocated to the approved indication and unapproved indications of the product, respectively. Collaboration with CStone On September 29, 2020, we entered into a strategic collaboration with CStone to address oncological needs in China. The collaboration encompasses our $ 200 million upfront equity investment in CStone, the development and commercialization of CStones sugemalimab (CS1001, PD-L1 antibody) in mainland China, and a framework between the companies to bring additional oncology assets to the Greater China market. The transaction closed on October 9, 2020. As of December 31, 2021, we held a 9.8 % equity stake of CStone. Collaborations with BioNTech On December 30, 2021, we entered into a new research, development and commercialization agreement to develop a potential first mRNA-based vaccine for the prevention of shingles (herpes zoster virus) based on BioNTechs proprietary mRNA technology and our antigen technology. Under the terms of the agreement, we agreed to pay BioNTech $ 225 million, including an upfront cash payment of $ 75 million and an equity investment of $ 150 million. BioNTech is eligible to receive future regulatory and sales milestone payments of up to $ 200 million. In return, BioNTech agreed to pay us $ 25 million for our proprietary antigen technology. The net upfront payment to BioNTech was recorded to Research and development expenses in our fourth quarter of 2021. We and BioNTech will share development costs. We will have commercialization rights to the potential vaccine worldwide, excluding Germany, Turkey and certain developing countries where BioNTech will have commercialization rights. We and BioNTech will share gross profits from commercialization of any product. On April 9, 2020, we signed a global agreement with BioNTech to co-develop a mRNA-based coronavirus vaccine program, BNT162b2, aimed at preventing COVID-19 infection. In connection with the April 2020 agreement, we made an upfront cash payment of $ 72 million and an equity investment in the common stock of BioNTech of $ 113 million. We recognized $ 98 million for the upfront payment and a premium paid on the equity investment in Research and development expenses in our second quarter of 2020. BioNTech became eligible to receive potential milestone payments of up to $ 563 million for a total consideration of $ 748 million. Under the terms of this agreement, we and BioNTech share gross profits and development costs equally after approval and successful commercialization of the vaccine, and we were responsible for all of Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies the development costs until commercialization of the vaccine. Thereafter, BioNTech was to repay us its 50 percent share of these development costs through reductions in gross profit sharing and milestone payments to BioNTech over time. On January 29, 2021, we and BioNTech signed an amended version of the April 2020 agreement. Under the January 2021 agreement, BioNTech paid us their 50 percent share of prior development costs in a lump sum payment during the first quarter of 2021. Further RD costs are being shared equally. We have commercialization rights to the vaccine worldwide, excluding Germany and Turkey where BioNTech markets and distributes the vaccine under the agreement with us, and excluding China, Hong Kong, Macau and Taiwan, which are subject to a separate collaboration between BioNTech and Shanghai Fosun Pharmaceutical (Group) Co., Ltd. We recognize Revenues and Cost of sales on a gross basis in markets where we are commercializing the vaccine and we record our share of gross profits related to sales of the vaccine by BioNTech in Germany and Turkey in Alliance revenues. We made an additional investment of $ 50 million in common stock of BioNTech as part of an underwritten equity offering by BioNTech, which closed in July 2020. As of December 31, 2021, we held an equity stake of 2.5 % of BioNTech. Summarized Financial Information for Collaborative Arrangements The following provides the amounts and classification of payments (income/(expense)) between us and our collaboration partners: Year Ended December 31, (MILLIONS) 2021 2020 2019 Revenues Revenues (a) $ 590 $ 284 $ 305 Revenue sAlliance revenues (b) 7,652 5,418 4,648 Total revenues from collaborative arrangements $ 8,241 $ 5,703 $ 4,953 Cost of sales (c) $ ( 16,169 ) $ ( 61 ) $ ( 52 ) Selling, informational and administrative expenses (d) ( 175 ) ( 194 ) ( 176 ) Research and development expenses (e) ( 742 ) ( 192 ) 104 Other income/(deductions)net (f) 820 567 362 (a) Represents sales to our partners of products manufactured by us. (b) Substantially all relates to amounts earned from our partners under co-promotion agreements. The increase in 2021 reflects increases in alliance revenues from Comirnaty, Eliquis and Xtandi, while the increase in 2020 reflects increases in alliance revenues from Eliquis and Xtandi. (c) Primarily relates to amounts paid to collaboration partners for their share of net sales or profits earned in collaboration arrangements where we are the principal in the transaction, and cost of sales for inventory purchased from our partners. The increase in 2021 is primarily related to Comirnaty. (d) Represents net reimbursements to our partners for selling, informational and administrative expenses incurred. (e) Primarily relates to upfront payments and pre-approval milestone payments earned by our partners as well as net reimbursements. (f) Primarily relates to royalties from our collaboration partners. The amounts outlined in the above table do not include transactions with third parties other than our collaboration partners, or other costs for the products under the collaborative arrangements. Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives In 2019, we substantially completed several multi-year initiatives focused on positioning us for future growth and creating a simpler, more efficient operating structure within each business. A. Transforming to a More Focused Company Program With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We have undertaken efforts to ensure our cost base and support model align appropriately with our new operating structure. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. This program is primarily composed of the following three initiatives: We are taking steps to restructure our corporate enabling functions to appropriately support our business, RD and PGS platform functions. We expect costs, primarily related to restructuring our corporate enabling functions, to total $ 1.6 billion, with substantially all costs to be cash expenditures. Actions include, among others, changes in location of certain activities, expanded use and co-location of centers of excellence and shared services, and increased use of digital technologies. The associated actions and the specific costs will primarily include severance and benefit plan impacts, exit costs as well as associated implementation costs. In addition, we are transforming our commercial go-to market model in the way we engage patients and physicians. We expect costs of $ 1.1 billion, with substantially all costs to be cash expenditures. Actions include, among others, centralization of certain activities and enhanced use of digital technologies. The costs for this effort primarily include severance and associated implementation costs. We are also optimizing our manufacturing network under this program and incurring one-time costs for cost-reduction initiatives related to our manufacturing operations. We expect to incur costs of $ 800 million, with approximately 25 % of the costs to be non-cash. The costs for this effort include, among other things, severance costs, implementation costs, product transfer costs, site exit costs, as well as accelerated depreciation. The program costs discussed above are expected to be incurred primarily from 2020 through 2022, and may be rounded and represent approximations. From the start of this program in the fourth quarter of 2019 through December 31, 2021, we incurred costs of $ 2.2 billion, of which $ 856 million is associated with Biopharma ($ 712 million in 2021, $ 79 million in 2020 and $ 64 million in 2019). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Key Activities In 2021 and 2020, we incurred costs of $ 1.3 billion and $ 838 million, respectively, composed primarily of the Transforming to a More Focused Company program. In 2019, we incurred costs of $ 820 million composed of $ 548 million for the 2017-2019 and Organizing for Growth initiatives, $ 288 million for the integration of Array, $ 94 million for the integration of Hospira, and $ 87 million for the Transforming to a More Focused Company program, partially offset by income of $ 197 million, primarily due to the reversal of certain accruals upon the effective favorable settlement of an IRS audit for multiple tax years and other acquisition-related initiatives. The following summarizes acquisitions and cost-reduction/productivity initiatives costs and credits: Year Ended December 31, (MILLIONS) 2021 2020 2019 Restructuring charges/(credits): Employee terminations $ 680 $ 474 $ 108 Asset impairments 53 66 69 Exit costs/(credits) 8 ( 6 ) 50 Restructuring charges/(credits) (a) 741 535 227 Transaction costs (b) 20 10 63 Integration costs and other (c) 41 34 311 Restructuring charges and certain acquisition-related costs 802 579 601 Net periodic benefit costs/(credits) recorded in Other (income)/deductionsnet (d) ( 63 ) 3 23 Additional depreciationasset restructuring recorded in our consolidated statements of income as follows (e) : Cost of sales 63 21 29 Selling, informational and administrative expenses 23 3 Research and development expenses ( 3 ) 8 Total additional depreciationasset restructuring 87 17 40 Implementation costs recorded in our consolidated statements of income as follows (f) : Cost of sales 45 40 61 Selling, informational and administrative expenses 426 197 73 Research and development expenses 1 1 22 Total implementation costs 472 238 156 Total costs associated with acquisitions and cost-reduction/productivity initiatives $ 1,298 $ 838 $ 820 (a) Represents acquisition-related costs ($ 9 million credit in 2021 and $ 192 million credit in 2019) and cost reduction initiatives ($ 750 million charge in 2021, $ 535 million charge in 2020, and $ 418 million charge in 2019). 2021 and 2020 charges mainly represent employee termination costs for our Transforming to a More Focused Company cost-reduction program. 2019 restructuring charges mainly represent employee termination costs for cost-reduction and productivity initiatives, partially offset by the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit for multiple tax years (see Note 5B ). The employee termination costs for 2019 were primarily for our improvements to operational effectiveness as part of the realignment of our business structure, and also included employee termination costs for the Transforming to a More Focused Company cost-reduction program. (b) Represents external costs for banking, legal, accounting and other similar services. (c) Represents external, incremental costs directly related to integrating acquired businesses, such as expenditures for consulting and the integration of systems and processes, and certain other qualifying costs. 2021 costs primarily related to our acquisition of Trillium. 2020 costs primarily related to our acquisition of Array. 2019 costs mainly related to our acquisitions of Array, including $ 157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense (see Note 2A ), and Hospira. (d) Amounts include the impact of a change in accounting principle. See Note 1C. (e) Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions. (f) Represents external, incremental costs directly related to implementing our non-acquisition-related cost-reduction/productivity initiatives. The following summarizes the components and changes in restructuring accruals: (MILLIONS) Employee Termination Costs Asset Impairment Charges Exit Costs Accrual Balance, January 1, 2020 $ 770 $ $ 46 $ 816 Provision 474 66 ( 6 ) 535 Utilization and other (a) ( 462 ) ( 66 ) ( 25 ) ( 554 ) Balance, December 31, 2020 (b) 782 15 798 Provision 680 53 8 741 Utilization and other (a) ( 449 ) ( 53 ) 34 ( 468 ) Balance, December 31, 2021 (c) $ 1,014 $ $ 57 $ 1,071 (a) Includes adjustments for foreign currency translation. (b) Included in Other current liabilities ($ 628 million) and Other noncurrent liabilities ($ 169 million). (c) Included in Other current liabilities ($ 816 million) and Other noncurrent liabilities ($ 255 million). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 4. Other (Income)/DeductionsNet Components of Other (income)/deductionsnet include: Year Ended December 31, (MILLIONS) 2021 2020 2019 Interest income $ ( 36 ) $ ( 73 ) $ ( 225 ) Interest expense (a) 1,291 1,449 1,573 Net interest expense 1,255 1,376 1,348 Royalty-related income ( 857 ) ( 770 ) ( 646 ) Net (gains)/losses on asset disposals ( 99 ) 237 ( 32 ) Net (gains)/losses recognized during the period on equity securities (b) ( 1,344 ) ( 540 ) ( 454 ) Income from collaborations, out-licensing arrangements and sales of compound/product rights (c) ( 396 ) ( 326 ) ( 168 ) Net periodic benefit costs/(credits) other than service costs (d) ( 2,547 ) 311 305 Certain legal matters, net (e) 182 28 292 Certain asset impairments (f) 86 1,691 2,792 Business and legal entity alignment costs (g) 300 Consumer Healthcare JV equity method (income)/loss (h) ( 471 ) ( 298 ) ( 17 ) Other, net (i) ( 687 ) ( 491 ) ( 224 ) Other (income)/deductionsnet $ ( 4,878 ) $ 1,219 $ 3,497 (a) Capitalized interest totaled $ 108 million in 2021, $ 96 million in 2020 and $ 88 million in 2019. (b) 2021 gains include, among other things, unrealized gains of $ 1.6 billion related to investments in BioNTech and Cerevel. 2020 gains included, among other things, unrealized gains of $ 405 million related to investments in BioNTech and SpringWorks Therapeutics, Inc. (SpringWorks). 2019 gains included, among other things, unrealized gains of $ 295 million related to investments in Cortexyme, Inc. and SpringWorks. (c) 2021 includes, among other things, $ 188 million of net collaboration income from BioNTech related to the COVID-19 vaccine and $ 97 million of milestone income from multiple licensees. 2020 included, among other things, (i) a $ 75 million upfront payment received from our sale of our CK1 assets to Biogen, (ii) $ 40 million of milestone income from Puma Biotechnology, Inc. related to Neratinib regulatory approvals in the EU, (iii) $ 30 million of milestone income from Lilly related to the first commercial sale in the U.S. of LOXO-292 for the treatment of RET fusion-positive NSCLC and (iv) $ 108 million in milestone income from multiple licensees. 2019 included, among other things, $ 78 million in milestone income from Mylan Pharmaceuticals Inc. related to the FDAs approval and launch of Wixela Inhub , a generic of Advair Diskus (fluticasone propionate and salmeterol inhalation powder) and $ 52 million in milestone income from multiple licensees. (d) Amounts include the impact of a change in accounting principle. See Notes 1C and 11 . In 2019, other non-service cost components activity related to the Consumer Healthcare JV transaction, such as gain on settlements, were recorded in (Gain) on completion of Consumer Healthcare JV transaction. (e) Includes legal reserves for certain pending legal matters. (f) 2020 represents intangible asset impairment charges associated with our Biopharma segment: (i) $ 900 million related to IPRD assets for unapproved indications of certain cancer medicines, acquired in our Array acquisition, and reflected, among other things, updated commercial forecasts; (ii) $ 528 million related to Eucrisa, a finite-lived developed technology right acquired in our Anacor acquisition, and reflected updated commercial forecasts mainly reflecting competitive pressures; and (iii) $ 263 million related to finite-lived developed technology rights for certain generic sterile injectables acquired in our Hospira acquisition, and reflected updated commercial forecasts mainly reflecting competitive pressures. 2019 primarily included intangible asset impairment charges of $ 2.8 billion, mainly composed of $ 2.6 billion, related to Eucrisa, and reflected updated commercial forecasts mainly reflecting competitive pressures. (g) Mainly represents incremental costs for the design, planning and implementation of our then new business structure, effective in the beginning of 2019, and primarily includes consulting, legal, tax and other advisory services. (h) See Note 2C . (i) 2021 includes, among other things, (i) income net of costs associated with TSAs of $ 288 million; (ii) dividend income of $ 166 million from our investment in ViiV and (iii) charges of $ 142 million, reflecting the change in the fair value of contingent consideration. 2020 included, among other things, (i) dividend income of $ 278 million from our investment in ViiV; (ii) income net of costs associated with TSAs of $ 114 million and (iii) charges of $ 105 million, reflecting the change in the fair value of contingent consideration. 2019 included, among other things, (i) dividend income of $ 220 million from our investment in ViiV; (ii) charges of $ 152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV; and (iii) net losses on early retirement of debt of $ 138 million. The asset impairment charges included in Other (income)/deductionsnet are based on estimates of fair value. Note 5. Tax Matters A. Taxes on Income from Continuing Operations Components of Income from continuing operations before provision/(benefit) for taxes on income include: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States $ 6,064 $ ( 2,887 ) $ 7,332 International 18,247 9,924 3,988 Income from continuing operations before provision/(benefit) for taxes on income ( a), (b) $ 24,311 $ 7,036 $ 11,321 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (a) 2021 v. 2020 The domestic income in 2021 versus domestic loss in 2020 was mainly related to Comirnaty income, lower asset impairment charges, net periodic benefit credits in 2021 versus net periodic benefit costs in 2020 and higher net gains from equity securities, partially offset by higher RD expenses. The increase in the international income was primarily related to Comirnaty income, net periodic benefit credits in 2021 versus net periodic benefit costs in 2020 and lower asset impairment charges. (b) 2020 v. 2019 The domestic loss in 2020 versus domestic income in 2019 was mainly related to the non-recurrence of the gain on the completion of the Consumer Healthcare JV transaction as well as higher asset impairment charges and higher RD expenses. The increase in the international income was primarily related to the non-recurrence of the write off of assets contributed to the Consumer Healthcare JV as well as lower asset impairment charges and lower amortization of intangible assets. Components of Provision/(benefit) for taxes on income based on the location of the taxing authorities include: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States Current income taxes: Federal $ 3,342 $ 372 $ ( 1,887 ) State and local 34 56 ( 186 ) Deferred income taxes: Federal ( 3,850 ) ( 1,164 ) 1,254 State and local ( 491 ) ( 131 ) 276 Total U.S. tax benefit ( 964 ) ( 867 ) ( 543 ) TCJA Current income taxes ( 135 ) Deferred Income taxes ( 187 ) Total TCJA tax benefit ( 323 ) International Current income taxes 2,769 1,517 2,418 Deferred income taxes 48 ( 279 ) ( 969 ) Total international tax provision 2,816 1,237 1,449 Provision/(benefit) for taxes on income $ 1,852 $ 370 $ 583 Amounts discussed below are rounded to the nearest hundred million and represent approximations. We elected, with the filing of our 2018 U.S. Federal Consolidated Income Tax Return, to pay our initial estimated $ 15 billion repatriation tax liability on accumulated post-1986 foreign earnings over eight years through 2026. The third annual installment of this liability was paid by its April 15, 2021 due date. The fourth annual installment is due April 18, 2022 and is reported in current Income taxes payable as of December 31, 2021. The remaining liability is reported in noncurrent Other taxes payable. Our obligations may vary as a result of changes in our uncertain tax positions and/or availability of attributes such as foreign tax and other credit carryforwards. The changes in Provision/(benefit) for taxes on income impacting the effective tax rate year-over-year are summarized below: 2021 v. 2020 The higher effective tax rate in 2021 was mainly the result of: the change in the jurisdictional mix of earnings primarily related to Comirnaty; and lower tax benefits related to the impairment of intangible assets, partially offset by: certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV with GSK based on estimates and assumptions that we believe to be reasonable. 2020 v. 2019 The higher effective tax rate in 2020 was mainly the result of: the non-recurrence of the $ 1.4 billion tax benefits, representing taxes and interest, recorded in 2019 due to the favorable settlement of an IRS audit for multiple tax years; the non-recurrence of the tax benefits related to certain tax initiatives associated with the implementation of our then new business structure; and the non-recurrence of the tax benefits recorded in 2019 as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA, as well as: lower tax benefits related to the impairment of intangible assets, partially offset by: the non-recurrence of the tax expense of $ 2.7 billion recorded in the third quarter of 2019 associated with the gain on the completion of the Consumer Healthcare JV transaction; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. In all years, federal, state and international net tax liabilities assumed or established as part of a business acquisition are not included in Provision/(benefit) for taxes on income (see Note 2A ). Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Tax Rate Reconciliation The reconciliation of the U.S. statutory income tax rate to our effective tax rate for Income from continuing operations follows: Year Ended December 31, 2021 2020 2019 U.S. statutory income tax rate 21.0 % 21.0 % 21.0 % TCJA impact (a) ( 2.9 ) Taxation of non-U.S. operations (b), (c) ( 4.3 ) ( 9.9 ) ( 4.7 ) Tax settlements and resolution of certain tax positions (a) ( 0.4 ) ( 2.7 ) ( 14.0 ) Completion of Consumer Healthcare JV transaction (a) 8.3 Certain Consumer Healthcare JV initiatives (a) ( 6.0 ) U.S. RD tax credit ( 0.5 ) ( 1.4 ) ( 0.8 ) Interest (d) 0.4 1.1 0.6 All other, net (e) ( 2.6 ) ( 2.8 ) ( 2.3 ) Effective tax rate for income from continuing operations 7.6 % 5.3 % 5.2 % (a) See Note 5A. (b) For taxation of non-U.S. operations, this rate impact reflects the income tax rates and relative earnings in the locations where we do business outside the U.S., together with the U.S. tax cost on our international operations, changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions, as well as changes in valuation allowances. Specifically: (i) the jurisdictional location of earnings is a significant component of our effective tax rate each year, and the rate impact of this component is influenced by the specific location of non-U.S. earnings and the level of such earnings as compared to our total earnings; (ii) the U.S. tax implications of our foreign operations is a significant component of our effective tax rate each year and generally offsets some of the reduction to our effective tax rate each year resulting from the jurisdictional location of earnings; (iii) the impact of certain tax initiatives; and (iv) the impact of changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions is a component of our effective tax rate each year that can result in either an increase or decrease to our effective tax rate. The jurisdictional mix of earnings, which includes the impact of the location of earnings as well as the U.S. tax cost on our international operations, can vary as a result of operating fluctuations in the normal course of business and as a result of the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on strategic business decisions. See also Note 5A for the components of pre-tax income and Provision/(benefit) for taxes on income, which is based on the location of the taxing authorities, and for information about settlements and other items impacting Provision/(benefit) for taxes on income . (c) In all years, the reduction in our effective tax rate is a result of the jurisdictional location of earnings and is largely due to lower tax rates in certain jurisdictions, as well as manufacturing and other incentives for our subsidiaries in Singapore and, to a lesser extent, in Puerto Rico. We benefit from Puerto Rican tax incentives pursuant to a grant that expires during 2029. Under such grant, we are partially exempt from income, property and municipal taxes. In Singapore, we benefit from incentive tax rates effective through 2047 on income from manufacturing and other operations. (d) Includes changes in interest related to our uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions. (e) All other, net is primarily due to routine business operations. C. Deferred Taxes Components of our deferred tax assets and liabilities, shown before jurisdictional netting, follow: 2021 Deferred Tax* 2020 Deferred Tax* (MILLIONS) Assets (Liabilities) Assets (Liabilities) Prepaid/deferred items (a) $ 4,086 $ ( 456 ) $ 3,114 $ ( 336 ) Inventories 408 ( 56 ) 276 ( 25 ) Intangible assets (b) 1,778 ( 4,577 ) 793 ( 5,355 ) Property, plant and equipment (c) 117 ( 1,647 ) 211 ( 1,220 ) Employee benefits (d) 1,594 ( 178 ) 1,981 ( 124 ) Restructurings and other charges 303 291 Legal and product liability reserves 373 382 Net operating loss/tax credit carryforwards (e) 1,431 1,761 Unremitted earnings ( 45 ) ( 46 ) State and local tax adjustments 197 171 Investments (f) 70 ( 689 ) 130 ( 3,545 ) All other 89 ( 68 ) 80 ( 76 ) 10,446 ( 7,714 ) 9,190 ( 10,726 ) Valuation allowances ( 1,462 ) ( 1,586 ) Total deferred taxes $ 8,983 $ ( 7,714 ) $ 7,604 $ ( 10,726 ) Net deferred tax asset/(liability) (g) $ 1,269 $ ( 3,123 ) * The deferred tax assets and liabilities associated with global intangible low-taxed income are included in the relevant categories. See Note 1Q . (a) The increase in net deferred tax assets in 2021 is primarily related to temporary differences associated with Comirnaty royalty accruals and the result of operating lease ROU liabilities recognized during the period. (b) The increase in the deferred tax assets is primarily due to the acquisition of intangible assets relating to Trillium and the decrease in the 2021 deferred tax liabilities is primarily the result of amortization of intangible assets. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (c) The increase in net deferred tax liabilities in 2021 is primarily the result of operating lease ROU assets recognized during the period. See Note 15 . (d) The decrease in net deferred tax assets in 2021 is primarily the result of favorable pension plan asset performance reported in the period. See Note 11A . (e) The amounts in 2021 and 2020 are reduced for unrecognized tax benefits of $ 3.0 billion and $ 3.0 billion, respectively, where we have net operating loss carryforwards, similar tax losses, and/or tax credit carryforwards that are available, under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position. (f) The decrease in net deferred tax liabilities in 2021 is primarily due to certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV. (g) In 2021, Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.6 billion), and Noncurrent deferred tax liabilities ($ 0.3 billion). In 2020, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.9 billion), and Noncurrent deferred tax liabilities ($ 4.1 billion). We have carryforwards, primarily related to net operating and capital losses, general business credits, foreign tax credits and charitable contributions, which are available to reduce future U.S. federal and/or state, as well as international, income taxes payable with either an indefinite life or expiring at various times from 2022 to 2041. Certain of our U.S. net operating losses and general business credits are subject to limitations under IRC Section 382. As of December 31, 2021, we have not made a U.S. tax provision on $ 55.0 billion of unremitted earnings of our international subsidiaries. As these earnings are intended to be indefinitely reinvested overseas, the determination of a hypothetical unrecognized deferred tax liability as of December 31, 2021 is not practicable. The amount of indefinitely reinvested earnings is based on estimates and assumptions and subject to management evaluation, and is subject to change in the normal course of business based on operational cash flow, completion of local statutory financial statements and the finalization of tax returns and audits, among other things. Accordingly, we regularly update our earnings and profits analysis for such events. D. Tax Contingencies For a description of our accounting policies associated with accounting for income tax contingencies, see Note 1Q. Uncertain Tax Positions As tax law is complex and often subject to varied interpretations, it is uncertain whether some of our tax positions will be sustained upon audit. As of December 31, 2021, we had $ 4.5 billion and as of December 31, 2020, we had $ 4.3 billion in net unrecognized tax benefits, excluding associated interest. Tax assets for uncertain tax positions primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. As of December 31, 2021, we had $ 1.5 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.4 billion) and Other taxes payable ($ 105 million). As of December 31, 2020, we had $ 1.3 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.1 billion), Noncurrent deferred tax liabilities ($ 122 million) and Other taxes payable ($ 46 million). Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. The reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows: (MILLIONS) 2021 2020 2019 Balance, beginning $ ( 5,595 ) $ ( 5,381 ) $ ( 6,259 ) Acquisitions 37 ( 44 ) Divestitures (a) 265 Increases based on tax positions taken during a prior period (b) ( 111 ) ( 232 ) ( 36 ) Decreases based on tax positions taken during a prior period (b), (c) 103 64 1,109 Decreases based on settlements for a prior period (d) 24 15 100 Increases based on tax positions taken during the current period (b) ( 550 ) ( 411 ) ( 383 ) Impact of foreign exchange 22 ( 72 ) 25 Other, net (b), (e) 40 120 107 Balance, ending (f) $ ( 6,068 ) $ ( 5,595 ) $ ( 5,381 ) (a) For 2020, related to the separation of Upjohn. See Note 2B . (b) Primarily included in Provision/(benefit) for taxes on income. (c) Primarily related to effectively settling certain issues with the U.S. and foreign tax authorities. See Note 5A. (d) Primarily related to cash payments and reductions of tax attributes. (e) Primarily related to decreases as a result of a lapse of applicable statutes of limitations. (f) In 2021, included in Income taxes payable ($ 19 million), Other current assets ($ 42 million) Noncurrent deferred tax assets and other noncurrent tax assets ($ 3.0 billion), Noncurrent deferred tax liabilities ($ 5 million) and Other taxes payable ($ 3.0 billion). In 2020, included in Income taxes payable ($ 34 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 18 million), Noncurrent deferred tax liabilities ($ 3.0 billion) and Other taxes payable ($ 2.5 billion). Interest related to our unrecognized tax benefits is recorded in accordance with the laws of each jurisdiction and is recorded primarily in Provision/(benefit) for taxes on income . In 2021 and 2020, we recorded net increases in interest of $ 108 million and $ 89 million, respectively. In 2019, we recorded a net decrease in interest of $ 564 million, resulting primarily from a settlement with the IRS. Gross accrued interest totaled $ 601 million as of December 31, 2021 (reflecting a decrease of $ 1 million as a result of cash payments) and gross Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies accrued interest totaled $ 493 million as of December 31, 2020 (reflecting a decrease of $ 5 million as a result of cash payments and a decrease of $ 75 million relating to the separation of Upjohn). In 2021 and 2020, these amounts were substantially all included in Other taxes payable. Accrued penalties are not significant. See also Note 5A. Status of Tax Audits and Potential Impact on Accruals for Uncertain Tax Positions The U.S. is one of our major tax jurisdictions, and we are regularly audited by the IRS. With respect to Pfizer, the IRS has issued Revenue Agents Reports (RARs) for tax years 2011-2013 and 2014-2015. We are not in agreement with the RARs and are currently appealing certain disputed issues. Tax years 2016-2018 are currently under audit. Tax years 2019-2021 are open, but not under audit. All other tax years are closed. In addition to the open audit years in the U.S., we have open audit years in certain major international tax jurisdictions such as Canada (2013-2021), Europe (2011-2021, primarily reflecting Ireland, the U.K., France, Italy, Spain and Germany), Asia Pacific (2011-2021, primarily reflecting China, Japan and Singapore) and Latin America (1998-2021, primarily reflecting Brazil). Any settlements or statutes of limitations expirations could result in a significant decrease in our uncertain tax positions. We estimate that it is reasonably possible that within the next 12 months, our gross unrecognized tax benefits, exclusive of interest, could decrease by as much as $ 75 million, as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant. E. Tax Provision/(Benefit) on Other Comprehensive Income/(Loss) Components of the Tax provision/(benefit) on other comprehensive income/(loss) include: Year Ended December 31, (MILLIONS) 2021 2020 2019 Foreign currency translation adjustments, net (a) $ 43 $ ( 119 ) $ 260 Unrealized holding gains/(losses) on derivative financial instruments, net 84 ( 88 ) 83 Reclassification adjustments for (gains)/losses included in net income 29 ( 25 ) ( 125 ) 114 ( 113 ) ( 42 ) Unrealized holding gains/(losses) on available-for-sale securities, net ( 44 ) 45 Reclassification adjustments for (gains)/losses included in net income ( 4 ) ( 24 ) 5 ( 48 ) 22 5 Benefit plans: prior service (costs)/credits and other, net 27 12 ( 1 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 47 ) ( 31 ) ( 43 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 17 ) ( 1 ) Other ( 1 ) 1 ( 38 ) ( 17 ) ( 45 ) Tax provision/(benefit) on other comprehensive income/(loss) $ 71 $ ( 227 ) $ 178 (a) Taxes are not provided for foreign currency translation adjustments relating to investments in international subsidiaries that are expected to be held indefinitely. Note 6. Accumulated Other Comprehensive Loss, Excluding Noncontrolling Interests The following summarizes the changes, net of tax, in Accumulated other comprehensive loss (a) : Net Unrealized Gains/(Losses) Benefit Plans (MILLIONS) Foreign Currency Translation Adjustments Derivative Financial Instruments Available-For-Sale Securities Prior Service (Costs)/ Credits and Other Accumulated Other Comprehensive Income/(Loss) Balance, January 1, 2019 $ ( 6,075 ) $ 167 $ ( 68 ) $ 728 $ ( 5,249 ) Other comprehensive income/(loss) (b) 139 ( 146 ) 33 ( 144 ) ( 118 ) Balance, December 31, 2019 ( 5,936 ) 20 ( 35 ) 584 ( 5,367 ) Other comprehensive income/(loss) (b) 883 ( 448 ) 151 ( 106 ) 480 Distribution of Upjohn Business (c) ( 397 ) ( 26 ) ( 423 ) Balance, December 31, 2020 ( 5,450 ) ( 428 ) 116 452 ( 5,310 ) Other comprehensive income/(loss) (b) ( 722 ) 547 ( 336 ) ( 75 ) ( 587 ) Balance, December 31, 2021 $ ( 6,172 ) $ 119 $ ( 220 ) $ 377 $ ( 5,897 ) (a) Amounts include the impact of a change in accounting principle. See Note 1C. (b) Amounts do not include foreign currency translation adjustments attributable to noncontrolling interests. Foreign currency translation adjustments include net losses in 2021 and net gains in 2020 and 2019 related to our equity-method investment in the Consumer Healthcare JV (see Note 2C ) , and the impact of our net investment hedging program. (c) For more information, see Note 2B. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 7. Financial Instruments A. Fair Value Measurements Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis and Fair Value Hierarchy, using a Market Approach: As of December 31, 2021 As of December 31, 2020 (MILLIONS) Total Level 1 Level 2 Total Level 1 Level 2 Financial assets: Short-term investments Classified as equity securities with readily determinable fair values: Money market funds $ 5,365 $ $ 5,365 $ 567 $ $ 567 Classified as available-for-sale debt securities: Government and agencynon-U.S. 17,318 17,318 7,719 7,719 Government and agencyU.S. 4,050 4,050 982 982 Corporate and other 647 647 1,008 1,008 22,014 22,014 9,709 9,709 Total short-term investments 27,379 27,379 10,276 10,276 Other current assets Derivative assets: Interest rate contracts 4 4 18 18 Foreign exchange contracts 704 704 234 234 Total other current assets 709 709 251 251 Long-term investments Classified as equity securities with readily determinable fair values (a) 3,876 3,849 27 2,809 2,776 32 Classified as available-for-sale debt securities: Government and agencynon-U.S. 465 465 6 6 Government and agencyU.S. 6 6 121 121 Corporate and other 50 50 521 521 128 128 Total long-term investments 4,397 3,849 548 2,936 2,776 160 Other noncurrent assets Derivative assets: Interest rate contracts 16 16 117 117 Foreign exchange contracts 242 242 5 5 Total derivative assets 259 259 122 122 Insurance contracts (b) 808 808 693 693 Total other noncurrent assets 1,067 1,067 814 814 Total assets $ 33,552 $ 3,849 $ 29,703 $ 14,278 $ 2,776 $ 11,501 Financial liabilities: Other current liabilities Derivative liabilities: Foreign exchange contracts $ 476 $ $ 476 $ 501 $ $ 501 Total other current liabilities 476 476 501 501 Other noncurrent liabilities Derivative liabilities: Foreign exchange contracts 405 405 599 599 Total other noncurrent liabilities 405 405 599 599 Total liabilities $ 881 $ $ 881 $ 1,100 $ $ 1,100 (a) Long-term equity securities of $ 194 million as of December 31, 2021 and $ 190 million as of December 31, 2020 were held in restricted trusts for U.S. non-qualified employee benefit plans. (b) Includes life insurance policies held in restricted trusts for U.S. non-qualified employee benefit plans. The underlying invested assets in these contracts are marketable securities, which are carried at fair value, with changes in fair value recognized in Other (income)/deductionsnet (see Note 4 ) . Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis The carrying value of Long-term debt, excluding the current portion was $ 36 billion as of December 31, 2021 and $ 37 billion as of December 31, 2020. The estimated fair value of such debt, using a market approach and Level 2 inputs, was $ 42 billion as of December 31, 2021 and $ 46 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The differences between the estimated fair values and carrying values of held-to-maturity debt securities, private equity securities, long-term receivables and short-term borrowings not measured at fair value on a recurring basis were not significant as of December 31, 2021 and 2020. The fair value measurements of our held-to-maturity debt securities and short-term borrowings are based on Level 2 inputs. The fair value measurements of our long-term receivables and private equity securities are based on Level 3 inputs. B. Investments Total Short-Term, Long-Term and Equity-Method Investments The following summarizes our investments by classification type: As of December 31, (MILLIONS) 2021 2020 Short-term investments Equity securities with readily determinable fair values (a) $ 5,365 $ 567 Available-for-sale debt securities 22,014 9,709 Held-to-maturity debt securities 1,746 161 Total Short-term investments $ 29,125 $ 10,437 Long-term investments Equity securities with readily determinable fair values $ 3,876 $ 2,809 Available-for-sale debt securities 521 128 Held-to-maturity debt securities 34 37 Private equity securities at cost (b) 623 432 Total Long-term investments $ 5,054 $ 3,406 Equity-method investments 16,472 16,856 Total long-term investments and equity-method investments $ 21,526 $ 20,262 Held-to-maturity cash equivalents $ 268 $ 89 (a) As of December 31, 2021 and 2020, includes money market funds primarily invested in U.S. Treasury and government debt. (b) Represent investments in the life sciences sector. Debt Securities At December 31, 2021, our investment portfolio consisted of debt securities issued across diverse governments, corporate and financial institutions, which are investment-grade. The contractual or estimated maturities, are as follows: As of December 31, 2021 As of December 31, 2020 Gross Unrealized Maturities (in Years) Gross Unrealized (MILLIONS) Amortized Cost Gains Losses Fair Value Within 1 Over 1 to 5 Over 5 Amortized Cost Gains Losses Fair Value Available-for-sale debt securities Government and agency non-U.S. $ 18,032 $ 13 $ ( 263 ) $ 17,783 $ 17,318 $ 465 $ $ 7,593 $ 136 $ ( 4 ) $ 7,725 Government and agency U.S. 4,056 ( 1 ) 4,055 4,050 6 1,104 ( 1 ) 1,103 Corporate and other 698 ( 1 ) 697 647 50 1,006 2 1,008 Held-to-maturity debt securities Time deposits and other 947 947 917 18 11 283 283 Government and agency non-U.S. 1,102 1,102 1,097 4 1 5 5 Total debt securities $ 24,835 $ 14 $ ( 265 ) $ 24,584 $ 24,029 $ 543 $ 13 $ 9,991 $ 138 $ ( 5 ) $ 10,124 Any expected credit losses to these portfolios would be immaterial to our financial statements. Equity Securities The following presents the calculation of the portion of unrealized (gains)/losses that relates to equity securities, excluding equity method investments, held at the reporting date: Year Ended December 31, (MILLIONS) 2021 2020 2019 Net (gains)/losses recognized during the period on equity securities (a) $ ( 1,344 ) $ ( 540 ) $ ( 454 ) Less: Net (gains)/losses recognized during the period on equity securities sold during the period ( 80 ) ( 24 ) ( 25 ) Net unrealized (gains)/losses during the reporting period on equity securities still held at the reporting date (b) $ ( 1,264 ) $ ( 515 ) $ ( 429 ) (a) Reported in Other (income)/deductions net. See Note 4 . (b) Included in net unrealized gains are observable price changes on equity securities without readily determinable fair values. As of December 31, 2021, there were cumulative impairments and downward adjustments of $ 97 million and upward adjustments of $ 156 million. Impairments, downward and upward adjustments were not significant in 2021, 2020 and 2019 . Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Short-Term Borrowings Short-term borrowings include: As of December 31, (MILLIONS) 2021 2020 Commercial paper $ $ 556 Current portion of long-term debt, principal amount 1,636 2,004 Other short-term borrowings, principal amount (a) 605 145 Total short-term borrowings, principal amount 2,241 2,705 Net unamortized discounts, premiums and debt issuance costs ( 2 ) Total Short-term borrowings, including current portion of long-term debt , carried at historical proceeds, as adjusted $ 2,241 $ 2,703 (a) Primarily includes cash collateral. See Note 7F . The weighted-average effective interest rate on commercial paper outstanding was approximately 0.13 % as of December 31, 2020. As of December 31, 2021, we had access to a $ 7 billion committed U.S. revolving credit facility expiring in 2026, which may be used for general corporate purposes including to support our commercial paper borrowings. In addition to the U.S. revolving credit facility, our lenders have provided us an additional $ 360 million in lines of credit, of which $ 322 million expire within one year. Essentially all lines of credit were unused as of December 31, 2021. D. Long-Term Debt The following outlines our senior unsecured long-term debt and the weighted-average stated interest rate by maturity: As of December 31, (MILLIONS) 2021 2020 Notes due 2022 ( 1.0 % for 2020) (a) $ $ 1,728 Notes due 2023 ( 3.2 % for 2021 and 2020) 2,550 2,550 Notes due 2024 ( 3.9 % for 2021 and 2020) 2,250 2,250 Notes due 2025 ( 0.8 % for 2021 and 2020) 750 750 Notes due 2026 ( 2.9 % for 2021 and 2020) 3,000 3,000 Notes due 2027 ( 2.1 % for 2021 and 2.0 % for 2020) 1,051 1,121 Notes due 2028-2032 ( 3.1 % for 2021 and 3.4 % for 2020) 6,660 5,660 Notes due 2033-2037 ( 5.6 % for 2021 and 2020) 4,250 4,250 Notes due 2038-2042 ( 5.5 % for 2021 and 2020) 6,079 6,086 Notes due 2043-2047 ( 3.7 % for 2021 and 2020) 4,858 4,878 Notes due 2048-2050 ( 3.6 % for 2021 and 2020) 3,500 3,500 Total long-term debt, principal amount 34,948 35,774 Net fair value adjustments related to hedging and purchase accounting 1,438 1,562 Net unamortized discounts, premiums and debt issuance costs ( 195 ) ( 207 ) Other long-term debt 4 4 Total long-term debt, carried at historical proceeds, as adjusted $ 36,195 $ 37,133 Current portion of long-term debt, carried at historical proceeds, as adjusted (not included above ( 1.0 % for 2021 and 2.6 % for 2020)) $ 1,636 $ 2,002 (a) Reclassified to the current portion of long-term debt. Our long-term debt outlined in the above table is generally redeemable by us at any time at varying redemption prices plus accrued and unpaid interest. Issuances In August 2021, we issued the following senior unsecured notes at an effective interest rate of 1.79 %: (MILLIONS) Principal Interest Rate Maturity Date As of December 31, 2021 1.750 % (a) August 18, 2031 $ 1,000 (a) The notes may be redeemed by us at any time, in whole, or in part, at a redemption price plus accrued and unpaid interest. In May 2020, we completed a public offering of $ 4.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 2.11 % and in March 2020, we completed a public offering of $ 1.25 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 2.67 %. In March 2019, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.57 %. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Retirements In November 2020, we repurchased all $ 1.15 billion and $ 342 million principal amount outstanding of the 1.95 % senior unsecured notes due June 2021 and 5.80 % senior unsecured notes due August 2023 and recorded a total net loss of $ 36 million, in Other (income)/deductionsnet. See Note 2B . In March 2020, we repurchased at par all $ 1.065 billion principal amount outstanding of our senior unsecured notes due in 2047. In January 2019, we repurchased all 1.1 billion ($ 1.3 billion) principal amount outstanding of the 5.75 % euro-denominated debt due June 2021 at a redemption value of 1.3 billion ($ 1.5 billion). We recorded a net loss of $ 138 million in Other (income)/deductionsnet , which included the related termination of cross currency swaps . E. Derivative Financial Instruments and Hedging Activities Foreign Exchange Risk A significant portion of our revenues, earnings and net investments in foreign affiliates is exposed to changes in foreign exchange rates. Where foreign exchange risk is not offset by other exposures, we manage our foreign exchange risk principally through the use of derivative financial instruments and foreign currency debt. These financial instruments serve to mitigate the impact on net income as a result of remeasurement into another currency, or against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions. The derivative financial instruments primarily hedge or offset exposures in the euro, U.K. pound, Japanese yen and Canadian dollar. We hedge a portion of our forecasted intercompany inventory sales denominated in euro, Japanese yen, Canadian dollar, Chinese renminbi, U.K. pound and Australian dollar for up to two years . Under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. Changes in fair value are reported in earnings or in Other comprehensive income/(loss) , depending on the nature and purpose of the financial instrument (hedge or offset relationship). For certain foreign exchange contracts, we exclude an amount from the assessment of hedge effectiveness and recognize the excluded amount through an amortization approach in earnings. The hedge relationships are as follows: Generally, we recognize the gains and losses on foreign exchange contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged item. We also recognize the offsetting foreign exchange impact attributable to the hedged item in earnings. Generally, we record in Other comprehensive income/(loss) gains or losses on foreign exchange contracts that are designated as cash flow hedges and reclassify those amounts into earnings in the same period or periods during which the hedged transaction affects earnings. We record in Other comprehensive income/(loss) Foreign currency translation adjustments, net the foreign exchange gains and losses related to foreign exchange-denominated debt and foreign exchange contracts designated as a hedge of our net investments in foreign subsidiaries and reclassify those amounts into earnings upon the sale or substantial liquidation of our net investments. For foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses immediately into earnings along with the earnings impact of the items they generally offset. These contracts take the opposite currency position of that reflected on the balance sheet to counterbalance the effect of any currency movement. Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt or investments to fixed rates. The derivative financial instruments primarily hedge U.S. dollar fixed-rate debt. We recognize the change in fair value on interest rate contracts that are designated as fair value hedges in earnings, as well as the offsetting earnings impact of the hedged risk attributable to the hedged item. The following summarizes the fair value of the derivative financial instruments and notional amounts (including those reported as part of discontinued operations): (MILLIONS) As of December 31, 2021 As of December 31, 2020 Fair Value Fair Value Notional Asset Liability Notional Asset Liability Derivatives designated as hedging instruments: Foreign exchange contracts (a) $ 29,576 $ 787 $ 717 $ 24,369 $ 145 $ 1,005 Interest rate contracts 2,250 21 1,950 135 808 717 280 1,005 Derivatives not designated as hedging instruments: Foreign exchange contracts $ 21,419 160 164 $ 15,063 94 95 Total $ 968 $ 881 $ 373 $ 1,100 (a) The notional amount of outstanding foreign exchange contracts hedging our intercompany forecasted inventory sales was $ 4.8 billion as of December 31, 2021 and $ 5.0 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes information about the gains/(losses) incurred to hedge or offset operational foreign exchange or interest rate risk exposures (including those reported as part of discontinued operations): Gains/(Losses) Recognized in OID (a) Gains/(Losses) Recognized in OCI (a) Gains/(Losses) Reclassified from OCI into OID and COS (a) Year Ended December 31, (MILLIONS) 2021 2020 2021 2020 2021 2020 Derivative Financial Instruments in Cash Flow Hedge Relationships: Foreign exchange contracts (b) $ $ $ 488 $ ( 649 ) $ ( 173 ) $ ( 77 ) Amount excluded from effectiveness testing and amortized into earnings (c) 38 55 38 57 Derivative Financial Instruments in Fair Value Hedge Relationships: Interest rate contracts ( 7 ) 369 Hedged item 7 ( 369 ) Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign exchange contracts 468 ( 501 ) Amount excluded from effectiveness testing and amortized into earnings (c) 52 181 109 154 Non-Derivative Financial Instruments in Net Investment Hedge Relationships: (d) Foreign currency short-term borrowings 78 8 Foreign currency long-term debt 86 ( 183 ) Derivative Financial Instruments Not Designated as Hedges: Foreign exchange contracts ( 192 ) 178 All other net (c) 1 12 1 ( 1 ) $ ( 192 ) $ 178 $ 1,210 $ ( 1,077 ) $ ( 25 ) $ 133 (a) OID = Other (income)/deductionsnet, included in Other (income)/deductionsnet in the consolidated statements of income . COS = Cost of Sales, included in Cost of sales in the consolidated statements of income. OCI = Other comprehensive income/(loss), included in the consolidated statements of comprehensive income . (b) The amounts reclassified from OCI into COS were: a net loss of $ 89 million in 2021; and a net gain of $ 172 million in 2020 (including a gain of $ 22 million reported in Discontinued operationsnet of tax ). The remaining amounts were reclassified from OCI into OID. Based on year-end foreign exchange rates that are subject to change, we expect to reclassify a pre-tax gain of $ 362 million within the next 12 months into income . The maximum length of time over which we are hedging our exposure to the variability in future foreign exchange cash flows is approximately 21 years and relates to foreign currency debt. (c) The amounts reclassified from OCI were reclassified into OID. (d) Short-term borrowings and long-term debt include foreign currency borrowings which are used as net investment hedges. The short-term borrowings carrying value as of December 31, 2021 was $ 1.1 billion. The long-term debt carrying values as of December 31, 2021 and December 31, 2020 were $ 844 million and $ 2.1 billion, respectively. The following summarizes cumulative basis adjustments to our long-term debt in fair value hedges: As of December 31, 2021 As of December 31, 2020 Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount (MILLIONS) Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Long-term debt $ 2,233 $ 16 $ 1,154 $ 2,016 $ 117 $ 1,149 (a) Carrying amounts exclude the cumulative amount of fair value hedging adjustments. F . Credit Risk On an ongoing basis, we monitor and review the credit risk of our customers, financial institutions and exposures in our investment portfolio. With respect to our trade accounts receivable, we monitor the creditworthiness of our customers to which we grant credit in the normal course of business. In general, there is no requirement for collateral from customers. For additional information on our trade accounts receivable and Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies allowance for credit losses, see Note 1H . A significant portion of our trade accounts receivable balances are due from wholesalers and governments. For additional information on our trade accounts receivables with significant customers, see Note 17C . With respect to our investments, we monitor concentrations of credit risk associated with government, government agency, and corporate issuers of securities. Investments are placed in instruments that are investment grade and are primarily short in duration. Exposure limits are established to limit a concentration with any single credit counterparty. As of December 31, 2021, the largest investment exposures in our portfolio represent primarily sovereign debt instruments issued by the U.S., Canada, Japan, U.K., Germany, France, Australia, and Switzerland. With respect to our derivative financial instrument agreements with financial institutions, we do not expect to incur a significant loss from failure of any counterparty. Derivative financial instruments are executed under International Swaps and Derivatives Association (ISDA) master agreements with credit-support annexes that contain zero threshold provisions requiring collateral to be exchanged daily depending on levels of exposure. As a result, there are no significant concentrations of credit risk with any individual financial institution. As of December 31, 2021, the aggregate fair value of these derivative financial instruments that are in a net payable position was $ 372 million, for which we have posted collateral of $ 382 million with a corresponding amount reported in Short-term investments . As of December 31, 2021, the aggregate fair value of our derivative financial instruments that are in a net receivable position was $ 477 million, for which we have received collateral of $ 581 million with a corresponding amount reported in Short-term borrowings, including current portion of long-term debt. Note 8. Other Financial Information A. Inventories The following summarizes the components of Inventories : As of December 31, (MILLIONS) 2021 2020 Finished goods $ 3,641 $ 2,867 Work in process 4,424 4,436 Raw materials and supplies 994 716 Inventories (a) $ 9,059 $ 8,020 Noncurrent inventories not included above (b) $ 939 $ 890 (a) The change from December 31, 2020 reflects increases for certain products, including inventory build for new product launches (primarily Comirnaty), network strategy and supply recovery, partially offset by decreases due to market demand. (b) Included in Other noncurrent assets . There are no recoverability issues for these amounts. B. Other Current Liabilities Other current liabilities includes, among other things, amounts payable to BioNTech for the gross profit split for Comirnaty, which totaled $ 9.7 billion as of December 31, 2021 and $ 25 million as of December 31, 2020. Note 9. Property, Plant and Equipment (PPE) The following summarizes the components of Property, plant and equipment : Useful Lives As of December 31, (MILLIONS) (Years) 2021 2020 Land - $ 423 $ 443 Buildings 33 - 50 9,001 8,998 Machinery and equipment 8 - 20 12,252 11,000 Furniture, fixtures and other 3 - 12.5 4,457 4,484 Construction in progress - 3,822 3,481 29,955 28,406 Less: Accumulated depreciation 15,074 14,661 Property, plant and equipment $ 14,882 $ 13,745 The following provides long-lived assets by geographic area: As of December 31, (MILLIONS) 2021 2020 Property, plant and equipment United States $ 8,385 $ 7,666 Developed Europe 5,094 4,775 Developed Rest of World 347 413 Emerging Markets 1,056 890 Property, plant and equipment $ 14,882 $ 13,745 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 10. Identifiable Intangible Assets and Goodwill A. Identifiable Intangible Assets The following summarizes the components of Identifiable intangible assets : As of December 31, 2021 As of December 31, 2020 (MILLIONS) Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Finite-lived intangible assets Developed technology rights (a) $ 73,346 $ ( 53,732 ) $ 19,614 $ 73,040 $ ( 50,532 ) $ 22,508 Brands 922 ( 807 ) 115 922 ( 774 ) 148 Licensing agreements and other 2,284 ( 1,299 ) 985 2,292 ( 1,187 ) 1,106 76,552 ( 55,838 ) 20,714 76,255 ( 52,493 ) 23,762 Indefinite-lived intangible assets Brands 827 827 827 827 IPRD 3,092 3,092 3,175 3,175 Licensing agreements and other 513 513 573 573 4,432 4,432 4,575 4,575 Identifiable intangible assets (b) $ 80,984 $ ( 55,838 ) $ 25,146 $ 80,830 $ ( 52,493 ) $ 28,337 (a) The increase in the gross carrying amount primarily reflects $ 500 million of capitalized Comirnaty sales milestones to BioNTech, partially offset by net losses from foreign currency translation adjustments. (b) The decrease is primarily due to amortization, partially offset by the capitalization of the Comirnaty milestones described above. Developed Technology Rights Developed technology rights represent the cost for developed technology acquired from third parties and can include the right to develop, use, market, sell and/or offer for sale the product, compounds and intellectual property that we have acquired with respect to products, compounds and/or processes that have been completed. We possess a well-diversified portfolio of hundreds of developed technology rights across therapeutic categories, representing our commercialized products. The significant components of developed technology rights are the following: Xtandi, Prevnar 13/Prevenar 13 Infant, Braftovi/Mektovi, Premarin, Prevnar 13/Prevenar 13 Adult, Eucrisa, Orgovyx, Zavicefta, Tygacil, Bavencio, Merrem/Meronem and Comirnaty. Also included in this category are the post-approval milestone payments made under our alliance agreements for certain prescription pharmaceutical products. Brands Brands represent the cost for tradenames and know-how, as the products themselves do not receive patent protection. Indefinite-lived brands include Medrol and Depo-Medrol, while finite-lived brands include Zavedos and Depo-Provera. IPRD IPRD assets represent RD assets that have not yet received regulatory approval in a major market. The significant components of IPRD are the following: the program for the oral poly adenosine diphosphate (ADP) ribose polymerase inhibitor for the treatment of patients with germline BRCA-mutated advanced breast cancer acquired as part of the Medivation acquisition and assets acquired in connection with the Array acquisition. IPRD assets are required to be classified as indefinite-lived assets until the successful completion or the abandonment of the associated RD effort. Accordingly, during the development period after the date of acquisition, these assets are not amortized until approval is obtained in a major market, typically either the U.S. or the EU, or in a series of other countries, subject to certain specified conditions and management judgment. At that time, we will determine the useful life of the asset, reclassify it out of IPRD and begin amortization. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. IPRD assets are high-risk assets, given the uncertain nature of RD. Accordingly, we expect that many of these IPRD assets will become impaired and be written-off at some time in the future. Licensing Agreements Licensing agreements for developed technology and for technology in development primarily relate to out-licensing arrangements acquired from third parties, including the Array acquisition. These assets represent the cost for the license, where we acquired the right to future royalties and/or milestones upon development or commercialization by the licensing partner. A significant component of the licensing arrangements are for out-licensing arrangements with a number of partners for oncology technology in varying stages of development that have not yet received regulatory approval in a major market. Accordingly, during the development period after the date of acquisition, each of these assets is classified as indefinite-lived intangible assets and will not be amortized until approval is obtained in a major market. At that time we will determine the useful life of the asset, reclassify the respective licensing arrangement asset to finite-lived intangible asset and begin amortization. If the development effort is abandoned, the related licensing asset will likely be written-off, and we will record an impairment charge. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Amortization The weighted-average life for each of our total finite-lived intangible assets is approximately 8 years, and for the largest component, developed technology rights, is approximately 7 years. Total amortization expense for finite-lived intangible assets was $ 3.7 billion in 2021, $ 3.4 billion in 2020 and $ 4.5 billion in 2019. The following provides the expected annual amortization expense: (MILLIONS) 2022 2023 2024 2025 2026 Amortization expense $ 3,279 $ 2,936 $ 2,686 $ 2,500 $ 2,449 B. Goodwill The following summarizes the components and changes in the carrying amount of Goodwill : (MILLIONS) Total (a) Balance, January 1, 2020 $ 48,181 Additions (b) 727 Other (c) 648 Balance, December 31, 2020 49,556 Additions Other (c) ( 348 ) Balance, December 31, 2021 $ 49,208 (a) As a result of the reorganization of our commercial operations during the fourth quarter of 2021 (see Note 17 ), we were required to estimate the relative fair values of our PC1 and Hospital organizations to determine any reallocation of goodwill. We completed this analysis and determined that no goodwill was required to be reallocated. As a result, our entire goodwill balance continues to be assigned within the Biopharma reportable segment. (b) Additions primarily represent the impact of measurement period adjustments related to our Array acquisition (see Note 2A ). (c) Other represents the impact of foreign exchange . Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans The majority of our employees worldwide are eligible for retirement benefits provided through defined benefit pension plans, defined contribution plans or both. In the U.S., we sponsor both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans. A qualified plan meets the requirements of certain sections of the IRC, and, generally, contributions to qualified plans are tax deductible. A qualified plan typically provides benefits to a broad group of employees with restrictions on discriminating in favor of highly compensated employees with regard to coverage, benefits and contributions. A supplemental (non-qualified) plan provides additional benefits to certain employees. In addition, we provide medical insurance benefits to certain retirees and their eligible dependents through our postretirement plans. As discussed in Note 1C , we adopted a change in accounting principle to a more preferable policy under U.S. GAAP to immediately recognize actuarial gains and losses arising from the remeasurement of pension and postretirement plans. This change has been applied to all pension and postretirement plans on a retrospective basis for all prior periods presented. A. Components of Net Periodic Benefit Costs and Changes in Other Comprehensive Income/(Loss) The following summarizes the components of net periodic benefit cost/(credit), including those reported as part of discontinued operations for 2020 and 2019, and the changes in Other comprehensive income/(loss) for our benefit plans: Pension Plans Postretirement Plans U.S. International Year Ended December 31, (MILLIONS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Service cost $ $ $ $ 130 $ 146 $ 125 $ 36 $ 38 $ 37 Interest cost 455 533 676 146 164 215 29 49 75 Expected return on plan assets ( 1,052 ) ( 1,015 ) ( 890 ) ( 327 ) ( 314 ) ( 318 ) ( 39 ) ( 36 ) ( 33 ) Amortization of prior service cost/(credit) ( 2 ) ( 3 ) ( 4 ) ( 1 ) ( 3 ) ( 4 ) ( 151 ) ( 170 ) ( 173 ) Actuarial (gains)/losses (a) ( 684 ) 1,152 284 ( 690 ) 148 669 ( 167 ) ( 165 ) ( 118 ) Curtailments ( 4 ) ( 4 ) ( 1 ) ( 82 ) ( 62 ) Special termination benefits 17 1 20 2 2 Net periodic benefit cost/(credit) reported in income ( 1,265 ) 668 82 ( 746 ) 141 686 ( 372 ) ( 282 ) ( 271 ) Cost/(credit) reported in Other comprehensive income/(loss) 2 5 4 4 5 21 107 114 164 Cost/(credit) recognized in Comprehensive income $ ( 1,264 ) $ 674 $ 86 $ ( 742 ) $ 145 $ 707 $ ( 265 ) $ ( 168 ) $ ( 107 ) (a) Reflects actuarial remeasurement gains in 2021, primarily due to favorable plan asset performance and increases in discount rates, and actuarial remeasurement losses in 2020 and 2019, primarily due to decreases in discount rates partially offset by favorable plan asset performance. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The components of net periodic benefit cost/(credit) other than the service cost component are included in Other (income)/deductionsnet (see Note 4 ). B. Actuarial Assumptions Pension Plans Postretirement Plans U.S. International Year Ended December 31, (PERCENTAGES) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Weighted-average assumptions used to determine net periodic benefit cost: Discount rate: Pension plans/postretirement plans 2.6 % 3.3 % 4.4 % 2.5 % 3.2 % 4.3 % Interest cost 1.2 % 1.5 % 2.2 % Service cost 1.4 % 1.6 % 2.4 % Expected return on plan assets 6.8 % 7.0 % 7.2 % 3.4 % 3.6 % 3.9 % 6.8 % 7.0 % 7.3 % Rate of compensation increase (a) 2.9 % 2.9 % 1.4 % Weighted-average assumptions used to determine benefit obligations at fiscal year-end: Discount rate 2.9 % 2.6 % 3.3 % 1.6 % 1.5 % 1.7 % 2.9 % 2.5 % 3.2 % Rate of compensation increase (a) 2.8 % 2.9 % 1.4 % (a) The rate of compensation increase is not used to determine the net periodic benefit cost and benefit obligation for the U.S. pension plans as these plans are frozen. All of the assumptions are reviewed on at least an annual basis. We revise these assumptions based on an annual evaluation of long-term trends as well as market conditions that may have an impact on the cost of providing retirement benefits. The weighted-average discount rate for our U.S. defined benefit plans is determined annually and evaluated and modified to reflect at year-end the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better that reflect the rates at which the pension benefits could be effectively settled. For our international plans, the discount rates are set by benchmarking against investment grade corporate bonds rated AA/Aa or better, including, when there is sufficient data, a yield curve approach. These rate determinations are made consistent with local requirements. Overall, the yield curves used to measure the benefit obligations at year-end 2021 resulted in higher discount rates as compared to the prior year. The following provides the healthcare cost trend rate assumptions for our U.S. postretirement benefit plans: As of December 31, 2021 2020 Healthcare cost trend rate assumed for next year 6.0 % 5.6 % Rate to which the cost trend rate is assumed to decline 4.0 % 4.5 % Year that the rate reaches the ultimate trend rate 2045 2037 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Obligations and Funded Status The following provides: (i) an analysis of the changes in our benefit obligations, plan assets and funded status of our benefit plans, including those reported as part of discontinued operations for 2020, (ii) the funded status recognized in our consolidated balance sheets and (iii) the pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Pension Plans Postretirement Plans U.S. International Year Ended December 31, (MILLIONS) 2021 2020 2021 2020 2021 2020 Change in benefit obligation (a) Benefit obligation, beginning $ 18,306 $ 17,886 $ 12,001 $ 11,059 $ 1,238 $ 1,667 Service cost 130 146 36 38 Interest cost 455 533 146 164 29 49 Employee contributions 10 8 78 88 Plan amendments 2 2 ( 116 ) ( 56 ) Changes in actuarial assumptions and other (b) ( 331 ) 2,112 89 702 ( 117 ) ( 132 ) Foreign exchange impact ( 298 ) 646 1 2 Upjohn spin-off (c) ( 1,016 ) 3 ( 320 ) ( 218 ) Acquisitions/divestitures/other, net Curtailments and special termination benefits 17 1 ( 2 ) ( 8 ) Settlements ( 785 ) ( 767 ) ( 47 ) ( 34 ) Benefits paid ( 512 ) ( 445 ) ( 374 ) ( 372 ) ( 147 ) ( 201 ) Benefit obligation, ending (a) 17,150 18,306 11,657 12,001 995 1,238 Change in plan assets Fair value of plan assets, beginning 16,094 14,586 9,811 8,956 588 519 Actual return on plan assets 1,405 1,974 1,106 868 89 69 Company contributions 143 1,433 451 197 145 113 Employee contributions 10 8 78 88 Foreign exchange impact ( 229 ) 462 Upjohn spin-off (c) ( 687 ) 2 ( 270 ) Acquisitions/divestitures, net ( 6 ) Settlements ( 785 ) ( 767 ) ( 47 ) ( 34 ) Benefits paid ( 512 ) ( 445 ) ( 374 ) ( 372 ) ( 147 ) ( 201 ) Fair value of plan assets, ending 16,346 16,094 10,729 9,811 753 588 Funded statusPlan assets less than benefit obligation $ ( 805 ) $ ( 2,211 ) $ ( 928 ) $ ( 2,191 ) $ ( 241 ) $ ( 651 ) Amounts recorded in our consolidated balance sheet: Noncurrent assets $ 447 $ $ 1,480 $ 522 $ $ Current liabilities ( 138 ) ( 127 ) ( 33 ) ( 31 ) ( 6 ) ( 6 ) Noncurrent liabilities ( 1,113 ) ( 2,084 ) ( 2,376 ) ( 2,681 ) ( 235 ) ( 645 ) Funded status $ ( 805 ) $ ( 2,211 ) $ ( 928 ) $ ( 2,191 ) $ ( 241 ) $ ( 651 ) Pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Prior service (costs)/credits $ ( 6 ) $ ( 4 ) $ ( 35 ) $ ( 31 ) $ 581 $ 688 Information related to the funded status of pension plans with an ABO in excess of plan assets (d) : Fair value of plan assets $ 120 $ 16,094 $ 1,304 $ 6,674 ABO 1,371 18,306 3,344 8,961 Information related to the funded status of pension plans with a PBO in excess of plan assets (d) : Fair value of plan assets $ 120 $ 16,094 $ 1,381 $ 6,735 PBO 1,371 18,306 3,789 9,447 (a) For the U.S. pension plans, the benefit obligation is both the PBO and ABO as these plans are frozen and future benefit accruals no longer increase with future compensation increases. For the international pension plans, the benefit obligation is the PBO. The ABO for our international pension plans was $ 11.2 billion in 2021 and $ 11.5 billion in 2020. For the postretirement plans, the benefit obligation is the ABO. (b) Primarily includes actuarial gains resulting from increases i n discount rates in 2021, offset by increases in inflation assumptions in 2021 for the international plans, and actuarial losses resulting from decreases in discount rates in 2020 . (c) For more information, see Note 2B . (d) Our main U.S. qualified plan and many of our international plans were overfunded as of December 31, 2021. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Plan Assets The following provides the components of plan assets, including those reported as part of discontinued operations for 2020: As of December 31, 2021 As of December 31, 2020 Fair Value Fair Value (MILLIONS EXCEPT TARGET ALLOCATION PERCENTAGE) Target Allocation Percentage Total Level 1 Level 2 Level 3 Assets Measured at NAV (a) Total Level 1 Level 2 Level 3 Assets Measured at NAV (a) U.S. pension plans Cash and cash equivalents 0-10% $ 1,326 $ 78 $ 1,248 $ $ $ 781 $ 70 $ 711 $ $ Equity securities: 20-40% Global equity securities 2,273 2,233 38 2 3,241 3,213 27 1 Equity commingled funds 1,352 1,152 200 1,325 1,110 215 Fixed income securities: 45-75% Corporate debt securities 5,566 18 5,548 6,499 23 6,476 Government and agency obligations (b) 2,533 2,533 1,555 1,555 Fixed income commingled funds 38 38 23 23 Other investments: 5-20% Partnership investments (c) 2,079 3 2,076 1,431 1,431 Insurance contracts 158 158 190 190 Other commingled funds (d) 1,019 10 1,009 1,049 11 1,038 Total 100 % $ 16,346 $ 2,332 $ 10,726 $ 2 $ 3,286 $ 16,094 $ 3,306 $ 10,103 $ 1 $ 2,684 International pension plans Cash and cash equivalents 0-10% $ 541 $ 191 $ 346 $ $ 3 $ 407 $ 61 $ 346 $ $ Equity securities: 10-20% Equity commingled funds 1,453 1,386 67 2,051 1,681 370 Fixed income securities: 45-70% Corporate debt securities 1,187 1,187 925 925 Government and agency obligations (b) 2,415 2,415 1,334 1,334 Fixed income commingled funds 2,266 1,138 1,128 2,484 1,217 1,267 Other investments: 15-35% Partnership investments (c) 107 2 106 69 3 66 Insurance contracts 1,329 56 1,273 1,027 57 969 1 Other (d) 1,431 141 404 886 1,514 117 393 1,003 Total 100 % $ 10,729 $ 191 $ 6,672 $ 1,677 $ 2,189 $ 9,811 $ 61 $ 5,681 $ 1,362 $ 2,707 U.S. postretirement plans (e) Cash and cash equivalents 0-5% $ 85 $ 3 $ 82 $ $ $ $ $ $ $ Insurance contracts 95-100% 669 669 588 588 Total 100 % $ 753 $ 3 $ 750 $ $ $ 588 $ $ 588 $ $ (a) Certain investments that are measured at NAV per share (or its equivalent) have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented for the total pension benefits plan assets. (b) Government and agency obligations are inclusive of repurchase agreements . (c) Mainly includes investments in private equity, private debt, public equity limited partnerships, and, to a lesser extent, real estate and venture capital. (d) Mostly includes investments in hedge funds and real estate. (e) Reflects postretirement plan assets, which support a portion of our U.S. retiree medical plans. The following provides an analysis of the changes in our more significant investments valued using significant unobservable inputs, including those reported as part of discontinued operations for 2020: International Pension Plans Year Ended December 31, (MILLIONS) 2021 2020 Fair value, beginning $ 1,362 $ 1,342 Actual return on plan assets: Assets held, ending 23 22 Purchases, sales, and settlements, net 52 ( 47 ) Transfer into/(out of) Level 3 265 ( 13 ) Exchange rate changes ( 24 ) 58 Fair value, ending $ 1,677 $ 1,362 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following methods and assumptions were used to estimate the fair value of our pension and postretirement plans assets: Cash and cash equivalents: Level 1 investments may include cash, cash equivalents and foreign currency valued using exchange rates. Level 2 investments may include short-term investment funds which are commingled funds priced at a stable NAV by the administrator of the funds. Equity securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 1 and Level 2 investments may include commingled funds that have a readily determinable fair value based on quoted prices on an exchange or a published NAV derived from the quoted prices in active markets of the underlying securities. Level 3 investments may include individual securities that are unlisted, delisted, suspended, or illiquid and are typically valued using their last available price. Fixed income securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include commingled funds that have a readily determinable fair value based on observable prices of the underlying securities. Level 2 investments may include corporate bonds, government and government agency obligations and other fixed income securities valued using bid evaluation pricing models or quoted prices of securities with similar characteristics. Level 3 investments may include securities that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Other investments: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include Insurance contracts which invest in interest bearing cash, U.S. government securities and corporate debt instruments. Level 3 investments may include securities or insurance contracts that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Equity securities, Fixed income securities and Other investments may each be combined into commingled funds. Most commingled funds are valued to reflect the interest in the fund based on the reported year-end NAV. Partnership and Other investments are valued based on year-end reported NAV (or its equivalent), with adjustments as appropriate for lagged reporting of up to three months. Certain investments are authorized to include derivatives, such as equity or bond futures, swaps, options and currency futures or forwards for managing risks and exposures. Global plan assets are managed with the objective of generating returns that will enable the plans to meet their future obligations, while seeking to manage net periodic benefit costs and cash contributions over the long-term. We utilize long-term asset allocation ranges in the management of our plans invested assets. Our long-term return expectations are developed based on a diversified, global investment strategy that takes into account historical experience, as well as the impact of portfolio diversification, active portfolio management, and our view of current and future economic and financial market conditions. As market conditions and other factors change, we may adjust our targets accordingly and our asset allocations may vary from the target allocations. E. Cash Flows It is our practice to fund amounts for our qualified pension plans that are at least sufficient to meet the minimum requirements set forth in applicable employee benefit laws and local tax laws. The following provides the expected future cash flow information related to our benefit plans: Pension Plans Postretirement Plans (MILLIONS) U.S. International Expected employer contributions: 2022 $ 138 $ 177 $ 74 Expected benefit payments: 2022 $ 1,296 $ 384 $ 78 2023 1,155 372 73 2024 1,140 383 69 2025 1,089 392 66 2026 1,058 397 68 20272031 4,908 2,124 359 The above table reflects the total U.S. and international plan benefits projected to be paid from the plans or from our general assets under the current actuarial assumptions used for the calculation of the benefit obligation. F. Defined Contribution Plans We have defined contribution plans in the U.S. and other countries. For the majority of the U.S. defined contribution plans, employees may contribute a portion of their salaries and bonuses to the plans, and we match, in cash, a portion of the employee contributions. We also offer a Retirement Savings Contribution (RSC) which is an annual non-contributory employer contribution in the U.S. and Puerto Rico. We recorded charges related to the employer contributions to global defined contribution plans of $ 732 million in 2021, $ 685 million in 2020 and $ 659 million in 2019. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 12. Equity A. Common Stock Purchases We purchase our common stock through privately negotiated transactions or in the open market as circumstances and prices warrant. Purchased shares under each of the share-purchase plans, which are authorized by our BOD, are available for general corporate purposes. In December 2017, the BOD authorized a $ 10 billion share repurchase program, which was exhausted in the first quarter of 2019. In December 2018, the BOD authorized another $ 10 billion share repurchase program to be utilized over time and share repurchases commenced thereunder in the first quarter of 2019. In February 2019, we entered into an ASR with Goldman Sachs Co. LLC to repurchase $ 6.8 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 6.8 billion and received an initial delivery of 130 million shares of common stock, which represented approximately 80 % of the notional amount of the ASR. In August 2019, the ASR with Goldman Sachs Co. LLC was completed resulting in Goldman Sachs Co. LLC owing us an additional 33.5 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 41.42 per share. The common stock received is included in Treasury stock . The following provides the number of shares of our common stock purchased and the cost of purchases under our publicly announced share purchase plans, including our ASR: Year Ended December 31, (SHARES IN MILLIONS, DOLLARS IN BILLIONS) 2021 2019 (a) Shares of common stock purchased 213 Cost of purchase $ $ $ 8.9 (a) Represents shares purchased pursuant to the ASR with Goldman Sachs Co. LLC entered into in February 2019, as well as open market share repurchases of $ 2.1 billion . Our remaining share-purchase authorization was approximately $ 5.3 billion at December 31, 2021. B. Preferred Stock and Employee Stock Ownership Plans Prior to May 4, 2020, we had outstanding Series A convertible perpetual preferred stock (the Series A Preferred Stock) that was held by an ESOP trust (the Trust). All outstanding shares of Series A Preferred Stock were converted, at the direction of the independent fiduciary under the Trust and in accordance with the certificate of designations for the Series A Preferred Stock, into shares of our common stock on May 4, 2020. The Trust received an aggregate of 1,070,369 shares of our common stock upon conversion, with zero shares of Series A Preferred Stock remaining outstanding as a result of the conversion. In December 2020, we filed a certificate of elimination and a restated certificate of incorporation with the Delaware Secretary of State, which eliminated the Series A Preferred Stock. Since May 4, 2020, we have one ESOP that holds common stock of the Company (Common ESOP). As of December 31, 2021, all shares of common stock held by the Common ESOP have been allocated to the Pfizer U.S. defined contribution plan participants. The compensation cost related to the Common ESOP was $ 19 million in 2021, $ 19 million in 2020 and $ 20 million in 2019. Note 13. Share-Based Payments Our compensation programs can include share-based payment awards with value that is determined by reference to the fair value of our shares and that provide for the grant of shares or options to acquire shares or similar arrangements. Our share-based awards are designed based on competitive survey data or industry peer groups used for compensation purposes, and are allocated between different long-term incentive awards, generally in the form of Total Shareholder Return Units (TSRUs), Restricted Stock Units (RSUs), Portfolio Performance Shares (PPSs), Performance Share Awards (PSAs), Breakthrough Performance Awards (BPAs) and Stock Options, as determined by the Compensation Committee. The 2019 Stock Plan (2019 Plan) replaced and superseded the 2014 Plan. It provides for 400 million shares, in addition to shares remaining under the 2014 Plan, to be authorized for grants. The 2019 Plan provides that the number of stock options, TSRUs, RSUs, or performance-based awards that may be granted to any one individual during any 36-month period is limited to 20 million shares, and that RSUs count as three shares, PPSs, PSAs and BPAs count as three shares times the maximum potential payout, while TSRUs and stock options count as one share, toward the maximum shares available under the 2019 Plan. As of December 31, 2021, 315 million shares were available for award. Although not required to do so, we have used authorized and unissued shares and, to a lesser extent, treasury stock to satisfy our obligations under these programs. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies A summary of the awards and valuation details: Awarded to Terms Valuation Recognition and Presentation Total Shareholder Return Units (TSRUs) (a), (b) Senior and other key management and select employees Entitle the holder to receive shares of our common stock with a value equal to the difference between the defined settlement price and the grant price, plus the dividend equivalents accumulated during the five or seven -year term, if and to the extent the total value is positive. Settlement price is the average closing price of our common stock during the 20 trading days ending on the fifth or seventh anniversary of the grant, as applicable; the grant price is the closing price of our common stock on the date of the grant. Automatically settle on the fifth or seventh anniversary of the grant but vest on the third anniversary of the grant. As of the grant date using a Monte Carlo simulation model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Restricted Stock Units (RSUs) Select employees Entitle the holder to receive a specified number of shares of our common stock, including dividend equivalents that are reinvested into additional RSUs. For RSUs granted, in virtually all instances, the units vest on the third anniversary of the grant date assuming continuous service from the grant date. As of the grant date using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Portfolio Performance Shares (PPSs) Select employees Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents earned on such shares. For PPSs granted, the awards vest on the third anniversary of the grant assuming continuous service from the grant date and the number of shares paid, if any, depends on the achievement of predetermined goals related to Pfizers long-term product portfolio during a three or five -year performance period from the year of the grant date, as applicable. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned, and managements assessment of the probability that the specified performance criteria will be achieved. Performance Share Awards (PSAs) Senior and other key management Entitle the holder to receive, at the end of the performance period, shares of our common stock (retirees) earned, if any, or an equal value in cash (active colleagues), including dividend equivalents on shares earned, dependent upon the achievement of predetermined goals related to two measures: a. Adjusted net income over three one -year periods; and b. TSR as compared to the NYSE ARCA Pharmaceutical Index (DRG Index) over the three -year performance period. PSAs vest on the third anniversary of the grant assuming continuous service from the grant date. The award that may be earned ranges from 0 % to 200 % of the target award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned and managements assessment of the probability that the specified performance criteria will be achieved. Breakthrough Performance Awards (BPAs) Select employees identified as instrumental in delivering medicines to patients (excluding executive officers) Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents earned on such shares. For BPAs granted, the awards, if earned/vested, are settled at the end of the performance period, but no earlier than the one -year anniversary of the date of grant and dependent upon the achievement of the respective predetermined performance goals related to advancing Pfizers product pipeline during the performance period. The number of shares that may be earned ranges from 0 % to 600 % of the target award depending on the level and timing of goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, the number of shares that are probable of being earned and managements assessment of the probability that the specified performance criteria will be achieved and/or managements assessment of the probable vesting term. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Awarded to Terms Valuation Recognition and Presentation Stock Options Select employees Entitle the holder to purchase a specified number of shares of our common stock at a price per share equal to the closing market price of our common stock on the date of grant, for a period of time when vested. Since 2016, only a limited set of non-U.S. employees received stock option grants. No stock options were awarded to senior and other key management in any period presented. Stock options vest on the third anniversary of the grant assuming continuous service from the grant date and have a contractual term of 10 years. As of the grant date using the Black-Scholes-Merton option-pricing model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. (a) Retirement-eligible holders, as defined in the grant terms, can convert their TSRUs, when vested, into Profit Units (PTUs) with a conversion ratio based on a calculation used to determine the shares at TSRU settlement. The PTUs are entitled to earn Dividend Equivalent Units (DEUs), and the PTUs and DEUs will be settled in our common stock on the TSRUs original settlement date and will be subject to the terms and conditions of the original grant including forfeiture provisions. (b) In 2017, Performance Total Shareholder Return Units (PTSRUs) were awarded to the Former Chairman and Chief Executive Officer ( 1,444,395 PTSRUs) and 361,099 PTSRUs were awarded to the Group President, Chief Business Officer (former role Group President Pfizer Innovative Health) at a grant price of $ 30.31 and at a GDFV of $ 5.54 per PTSRU. In addition to having the same characteristics and valuation methodology of TSRUs, PTSRU grants require special service and performance conditions . The following provides data related to all TSRU, RSU, PPS, PSA and stock option activity: (MILLIONS, EXCEPT FAIR VALUE OF SHARES VESTED PER TSRU AND STOCK OPTION) TSRUs RSUs PPSs PSAs Stock Options Year Ended December 31, 2021 2020 2019 2021 2020 2019 2021 2020 2019 2021 2020 2019 2021 2020 2019 Total fair value of shares vested (a) $ 7.26 $ 6.22 $ 8.52 $ 304 $ 334 $ 454 $ 181 $ 119 $ 136 $ 33 $ 25 $ 64 $ 4.86 $ 3.56 $ 5.98 Total intrinsic value of options exercised or share units converted $ 594 $ 84 $ 175 $ 228 $ 224 $ 245 $ 584 $ 293 $ 261 Cash received upon exercise $ 795 $ 425 $ 394 Tax benefits realized from exercise $ 106 $ 55 $ 47 Compensation cost recognized, pre-tax (b) $ 259 $ 287 $ 294 $ 281 $ 272 $ 275 $ 535 $ 180 $ 114 $ 76 $ 31 $ 28 $ 5 $ 6 $ 7 Total compensation cost related to nonvested awards not yet recognized, pre-tax $ 187 $ 224 $ 229 $ 271 $ 228 $ 241 $ 175 $ 104 $ 87 $ 54 $ 32 $ 34 $ 3 $ 4 $ 5 Weighted-average period over which cost is expected to be recognized (years) 1.6 1.6 1.6 1.8 1.7 1.7 1.8 1.8 1.8 1.8 1.9 1.8 1.6 1.7 1.6 (a) Weighted-average GDFV per TSRUs and stock options. (b) TSRU includes expense for PTSRUs, which is not significant for all years presented . Total share-based payment expense was $ 1.2 billion, $ 780 million and $ 718 million in 2021, 2020 and 2019, respectively, which includes pre-tax share-based payment expense included in Discontinued operations net of tax of $ 2 million, $ 25 million and $ 32 million in 2021, 2020 and 2019, respectively. Tax benefit for share-based compensation expense was $ 227 million, $ 141 million and $ 137 million in 2021, 2020 and 2019, respectively. The table above excludes total expense due to the modification for share-based awards in connection with our cost reduction/productivity initiatives, which was not significant for all years presented and is recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). Amounts capitalized as part of inventory cost were not significant for any period presented. Summary of the weighted-average assumptions used in the valuation of TSRUs and stock options: TSRUs Stock Options Year Ended December 31, 2021 2020 2019 2021 2020 2019 Expected dividend yield (based on a constant dividend yield during the expected term) 4.51 % 4.36 % 3.27 % 4.51 % 4.36 % 3.27 % Risk-free interest rate (based on interpolated yield on U.S. Treasury zero-coupon issues) 0.93 % 1.15 % 2.55 % 1.27 % 1.25 % 2.66 % Expected stock price volatility (based on implied volatility, after consideration of historical volatility) 26.53 % 20.99 % 18.34 % 26.54 % 20.97 % 18.34 % TSRUs contractual/stock options expected term, years (based on historical exercise and post-vesting termination patterns for stock options) 5.15 5.12 5.13 6.75 6.75 6.75 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summary of all TSRU, RSU, PPS, PSA and BPA activity during 2021 (with the shares granted representing the maximum award that could be achieved for PPSs, PSAs and BPAs): TSRUs RSUs PPSs (a) PSAs BPAs TSRUs Per TSRU, Weighted Average Shares Weighted Avg. GDFV per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share (Thousands) GDFV Grant Price (Thousands) (Thousands) (Thousands) (Thousands) Nonvested, December 31, 2020 129,844 $ 6.90 $ 32.94 23,692 $ 35.50 20,077 $ 36.81 5,264 $ 36.81 $ Granted 34,522 7.26 33.83 10,893 34.31 8,632 33.82 1,798 33.82 1,165 38.73 Vested ( 44,888 ) 7.21 30.54 ( 8,747 ) 34.66 ( 6,095 ) 33.88 ( 984 ) 33.85 Reinvested dividend equivalents 956 41.33 Forfeited ( 4,879 ) 6.77 33.78 ( 1,255 ) 35.17 ( 1,133 ) 41.45 ( 924 ) 34.43 ( 306 ) 47.47 Nonvested, December 31, 2021 114,599 $ 6.90 $ 34.12 25,540 $ 35.52 21,480 $ 59.05 5,154 $ 59.05 859 $ 59.05 (a) Vested and non-vested shares outstanding, but not paid as of December 31, 2021 were 34.1 million. Summary of TSRU and PTU information as of December 31, 2021 (a), (b) : TSRUs (Thousands) PTUs (Thousands) Weighted-Average Grant Price Per TSRU Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (Millions) TSRUs Outstanding 206,996 $ 31.71 2.2 $ 5,969 TSRUs Vested 92,398 28.72 0.8 2,946 TSRUs Expected to vest (c) 110,476 34.16 3.3 2,910 TSRUs exercised and converted to PTUs 3,074 $ 0.8 $ 182 (a) In 2021, we settled 46,060,346 TSRUs with a weighted-average grant price of $ 23.04 per unit. (b) In 2021, 7,093,787 TSRUs with a weighted-average grant price of $ 27.41 per unit were converted into 2,943,737 PTUs. (c) The number of TSRUs expected to vest takes into account an estimate of expected forfeitures. Summary of all stock option activity during 2021: Shares (Thousands) Weighted-Average Exercise Price Per Share Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (a) (Millions) Outstanding, December 31, 2020 75,402 $ 28.31 Granted 779 33.82 Exercised ( 31,036 ) 25.75 Forfeited ( 89 ) 34.39 Expired ( 181 ) 20.27 Outstanding, December 31, 2021 44,874 30.20 2.7 $ 1,295 Vested and expected to vest, December 31, 2021 (b) 44,747 30.19 2.7 1,291 Exercisable, December 31, 2021 41,583 $ 29.81 2.3 $ 1,216 (a) Market price of our underlying common stock less exercise price. (b) The number of options expected to vest takes into account an estimate of expected forfeitures. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 14. Earnings Per Common Share Attributable to Pfizer Inc. Common Shareholders The following presents the detailed calculation of EPS: Year Ended December 31, (IN MILLIONS) 2021 2020 2019 EPS NumeratorBasic Income from continuing operations attributable to Pfizer Inc. $ 22,414 $ 6,630 $ 10,708 Less: Preferred stock dividendsnet of tax 1 Income from continuing operations attributable to Pfizer Inc. common shareholders 22,414 6,630 10,708 Discontinued operationsnet of tax ( 434 ) 2,529 5,318 Net income attributable to Pfizer Inc. common shareholders $ 21,979 $ 9,159 $ 16,025 EPS NumeratorDiluted Income from continuing operations attributable to Pfizer Inc. common shareholders and assumed conversions $ 22,414 $ 6,630 $ 10,708 Discontinued operationsnet of tax, attributable to Pfizer Inc. common shareholders and assumed conversions ( 434 ) 2,529 5,318 Net income attributable to Pfizer Inc. common shareholders and assumed conversions $ 21,979 $ 9,159 $ 16,026 EPS Denominator Weighted-average number of common shares outstandingBasic 5,601 5,555 5,569 Common-share equivalents: stock options, stock issuable under employee compensation plans convertible preferred stock and accelerated share repurchase agreements 107 77 106 Weighted-average number of common shares outstandingDiluted 5,708 5,632 5,675 Anti-dilutive common stock equivalents (a) 2 4 2 (a) These common stock equivalents were outstanding for the periods presented, but were not included in the computation of diluted EPS for those periods because their inclusion would have had an anti-dilutive effect. Allocated shares held by the Common ESOP, including reinvested dividends, are considered outstanding for EPS calculations and the eventual conversion of allocated preferred shares held by the Preferred ESOP was assumed in the diluted EPS calculation until the conversion date, which occurred in May 2020. See Note 12 . Note 15. Leases We lease real estate, fleet, and equipment for use in our operations. Our leases generally have lease terms of 1 to 30 years, some of which include options to terminate or extend leases for up to 5 to 10 years or on a month-to-month basis. We include options that are reasonably certain to be exercised as part of the determination of lease terms. We may negotiate termination clauses in anticipation of any changes in market conditions, but generally these termination options have not been exercised. Residual value guarantees are generally not included within our operating leases with the exception of some fleet leases. In addition to base rent payments, the leases may require us to pay directly for taxes and other non-lease components, such as insurance, maintenance and other operating expenses, which may be dependent on usage or vary month-to-month. Variable lease payments amounted to $ 381 million in 2021, $ 380 million in 2020 and $ 326 million in 2019. We elected the practical expedient to not separate non-lease components from lease components in calculating the amounts of ROU assets and lease liabilities for all underlying asset classes. We determine if an arrangement is a lease at inception of the contract and we perform the lease classification test as of the lease commencement date. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. For operating leases, the ROU assets and liabilities in our consolidated balance sheets follows: As of December 31, (MILLIONS) Balance Sheet Classification 2021 2020 ROU assets Other noncurrent assets $ 2,839 $ 1,386 Lease liabilities (short-term) Other current liabilities 449 320 Lease liabilities (long-term) Other noncurrent liabilities 2,510 1,108 Components of total lease cost includes: Year Ended December 31, (MILLIONS) 2021 2020 2019 Operating lease cost $ 548 $ 432 $ 421 Variable lease cost 381 380 326 Sublease income ( 41 ) ( 40 ) ( 45 ) Total lease cost $ 888 $ 772 $ 702 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Other supplemental information follows: As of December 31, (MILLIONS) 2021 2020 Operating leases Weighted-Average Remaining Contractual Lease Term (Years) 12 6.9 Weighted-Average Discount Rate 2.8 % 2.9 % Year Ended December 31, (MILLIONS) 2021 2020 2019 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 387 $ 333 $ 338 (Gains)/losses on sale and leaseback transactions, net 1 ( 3 ) ( 29 ) The following reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the consolidated balance sheet as of December 31, 2021: (MILLIONS) Period Operating Lease Liabilities Next one year (a) $ 520 1-2 years 417 2-3 years 322 3-4 years 279 4-5 years 217 Thereafter 1,865 Total undiscounted lease payments 3,621 Less: Imputed interest 661 Present value of minimum lease payments 2,960 Less: Current portion 449 Noncurrent portion $ 2,510 (a) Reflects lease payments due within 12 months subsequent to the balance sheet date. Note 16. Contingencies and Certain Commitments We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax and legal contingencies. The following outlines our legal contingencies. For a discussion of our tax contingencies, see Note 5B. A. Legal Proceedings Our legal contingencies include, but are not limited to, the following: Patent litigation, which typically involves challenges to the coverage and/or validity of patents on various products, processes or dosage forms. An adverse outcome could result in loss of patent protection for a product, a significant loss of revenues from that product or impairment of the value of associated assets. We are the plaintiff in the majority of these actions. Product liability and other product-related litigation related to current or former products, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others, and often involves highly complex issues relating to medical causation, label warnings and reliance on those warnings, scientific evidence and findings, actual, provable injury and other matters. Commercial and other asserted or unasserted matters, which can include acquisition-, licensing-, intellectual property-, collaboration- or co-promotion-related and product-pricing claims and environmental claims and proceedings, can involve complexities that will vary from matter to matter. Government investigations, which often are related to the extensive regulation of pharmaceutical companies by national, state and local government agencies in the U.S. and in other jurisdictions. Certain of these contingencies could result in increased expenses and/or losses, including damages, royalty payments, fines and/or civil penalties, which could be substantial, and/or criminal charges. We believe that our claims and defenses in matters in which we are a defendant are substantial, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of matters, which could have a material adverse effect on our results of operations and/or our cash flows in the period in which the amounts are accrued or paid. We have accrued for losses that are both probable and reasonably estimable. Substantially all of our contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments, which result from a complex series of judgments about future events and uncertainties, are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. For proceedings under environmental laws to which a governmental authority is a party, we have adopted a disclosure threshold of $ 1 million in potential or actual governmental monetary sanctions. The principal pending matters to which we are a party are discussed below. In determining whether a pending matter is a principal matter, we consider both quantitative and qualitative factors to assess materiality, such as, among others, the amount of damages and the nature of other relief sought, if specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be, or is, a class action and, if not certified, our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; whether related actions have been transferred to multidistrict litigation; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a readers judgment about our financial statements in light of all of the information that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters in which we are the plaintiff, we consider, among other things, the financial significance of the product protected by the patent(s) at issue. Some of the matters discussed below include those which management believes that the likelihood of possible loss in excess of amounts accrued is remote. A1. Legal ProceedingsPatent Litigation We are involved in suits relating to our patents, including but not limited to, those discussed below. Most involve claims by generic drug manufacturers that patents covering our products (or those of our collaboration/licensing partners to which we have licenses or co-promotion rights and to which we may or may not be a party), processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. In addition to the challenges to the U.S. patents that are discussed below, patent rights to certain of our products or those of our collaboration/licensing partners are being challenged in various other jurisdictions. For example, some of our collaboration or licensing partners face challenges to the validity of their patent rights in non-U.S. jurisdictions. We are also party to patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for allegedly causing delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In 2017, the Patent Trial and Appeal Board (PTAB) initiated proceedings with respect to two of our pneumococcal vaccine patents. However, the PTAB declined to initiate proceedings as to two other pneumococcal vaccine patents; those two patents, and one other patent, were challenged in federal court in Delaware. In September 2021, Pfizer and a challenger entered into a settlement and license agreement, resolving all worldwide legal proceedings involving that challenger, related to our pneumococcal vaccine patents. Other challenges to pneumococcal vaccine patents remain pending at the PTAB and outside the U.S. The invalidation of any of the patents in our pneumococcal portfolio could potentially allow additional competitor vaccines into the marketplace. In the event that any of the patents are found valid and infringed, a competitors vaccine might be prohibited from entering the market or a competitor might be required to pay us a royalty. We are also subject to patent litigation pursuant to which one or more third parties seek damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities. For example, our Hospira subsidiaries are involved in patent and patent-related disputes over their attempts to bring generic pharmaceutical and biosimilar products to market. If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages or royalty payments, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. Actions In Which We Are The Plaintiff EpiPen In 2010, King, which we acquired in 2011 and is a wholly-owned subsidiary, brought a patent-infringement action against Sandoz in the U.S. District Court for the District of New Jersey in connection with Sandozs abbreviated new drug application (ANDA) filed with the FDA seeking approval to market an epinephrine injectable product. Sandoz is challenging patents, which expire in 2025, covering the next-generation autoinjector for use with epinephrine that is sold under the EpiPen brand name. Xeljanz (tofacitinib) Beginning in 2017, we brought patent-infringement actions against several generic manufacturers that filed separate ANDAs with the FDA seeking approval to market their generic versions of tofacitinib tablets in one or both of 5 mg and 10 mg dosage strengths, and in both immediate and extended release forms. To date, we have settled actions with several manufacturers on terms not material to us. The remaining actions continue in the U.S. District Court for the District of Delaware as described below. In January 2021, we brought a separate patent-infringement action against Aurobindo Pharma Limited (Aurobindo) asserting the infringement and validity of the patent covering the active ingredient expiring in December 2025 and the patent covering a polymorphic form of tofacitinib expiring in 2023, which Aurobindo challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg and 10 mg tablets. In October 2021, we brought a separate patent-infringement action against Sinotherapeutics Inc. (Sinotherapeutics) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Sinotherapeutics in its ANDA seeking approval to market a generic version of tofacitinib 11 mg extended release tablets. In February 2022, we brought a separate patent-infringement action against Teva Pharmaceuticals USA, Inc. (Teva) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Teva in its ANDA seeking approval to market a generic version of tofacitinib 22 mg extended release tablets. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In February 2022, we brought a separate patent-infringement action against Slayback Pharma LLC (Slayback) asserting the infringement and validity of our compound patent covering the active ingredient that was challenged by Slayback in its ANDA seeking approval to market a generic version of tofacitinib oral solution 1 mg/mL. Inlyta (axitinib) In 2019, Glenmark Pharmaceuticals Ltd. (Glenmark) notified us that it had filed an ANDA with the FDA seeking approval to market a generic version of Inlyta. Glenmark asserts the invalidity and non-infringement of the crystalline form patent for Inlyta that expires in 2030. In 2019, we filed suit against Glenmark in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the crystalline form patent for Inlyta. Ibrance (palbociclib) Beginning in September 2020, we received correspondence from several generic companies notifying us that they would seek approval to market generic versions of Ibrance capsules. The generic companies assert the invalidity and non-infringement of our crystalline form patent which expires in 2034. Beginning in October 2020, we brought patent infringement actions against each of these generic companies in various federal courts, asserting the validity and infringement of the crystalline form patent. We have settled with one of these generic companies on terms not material to the company. Beginning in January 2021, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Ibrance tablets. The generic companies are challenging some or all of the following patents: (i) the composition of matter patent expiring in 2027; (ii) the composition of matter patent expiring in 2023; (iii) the method of use patent expiring in 2023; (iv) the crystalline form patent expiring in 2034; and (v) a tablet formulation patent expiring in 2036. We brought patent infringement actions against each of the generic filers in various federal courts, asserting the validity and infringement of the patents challenged by the generic companies. Eucrisa Beginning in September 2021, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Eucrisa. The companies assert the invalidity and non-infringement of a composition of matter patent expiring in 2026, two method of use patents expiring in 2027, and one other method of use patent expiring in 2030. In September 2021, we brought patent infringement actions against the generic filers in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the patents challenged by the generic companies. Matter Involving Our Collaboration/Licensing Partners Eliquis In 2017, twenty-five generic companies sent BMS Paragraph-IV certification letters informing BMS that they had filed ANDAs seeking approval of generic versions of Eliquis, challenging the validity and infringement of one or more of the three patents listed in the Orange Book for Eliquis. One of the patents expired in December 2019 and the remaining patents currently are set to expire in 2026 and 2031. Eliquis has been jointly developed and is being commercialized by BMS and Pfizer. BMS and Pfizer filed patent-infringement actions against all generic filers in the U.S. District Court for the District of Delaware and the U.S. District Court for the District of West Virginia, asserting that each of the generic companies proposed products would infringe each of the patent(s) that each generic filer challenged. Some generic filers challenged only the 2031 patent, some challenged both the 2031 and 2026 patent, and one generic company challenged all three patents. In August 2020, the U.S. District Court for the District of Delaware ruled that both the 2026 patent and the 2031 patent are valid and infringed by the proposed generic products. In August and September 2020, the generic filers appealed the District Courts decision to the U.S. Court of Appeals for the Federal Circuit. Prior to the August 2020 ruling, we and BMS settled with certain of the companies on terms not material to us, and we and BMS may settle with other generic companies in the future. In September 2021, the U.S. Court of Appeals for the Federal Circuit affirmed the District Courts decision. A2. Legal ProceedingsProduct Litigation We are defendants in numerous cases, including but not limited to those discussed below, related to our pharmaceutical and other products. Plaintiffs in these cases seek damages and other relief on various grounds for alleged personal injury and economic loss. Asbestos Between 1967 and 1982, Warner-Lambert owned American Optical Corporation (American Optical), which manufactured and sold respiratory protective devices and asbestos safety clothing. In connection with the sale of American Optical in 1982, Warner-Lambert agreed to indemnify the purchaser for certain liabilities, including certain asbestos-related and other claims. Warner-Lambert was acquired by Pfizer in 2000 and is a wholly owned subsidiary of Pfizer. Warner-Lambert is actively engaged in the defense of, and will continue to explore various means of resolving, these claims. Numerous lawsuits against American Optical, Pfizer and certain of its previously owned subsidiaries are pending in various federal and state courts seeking damages for alleged personal injury from exposure to products allegedly containing asbestos and other allegedly hazardous materials sold by Pfizer and certain of its previously owned subsidiaries. There also are a small number of lawsuits pending in various federal and state courts seeking damages for alleged exposure to asbestos in facilities owned or formerly owned by Pfizer or its subsidiaries. Effexor Beginning in 2011, actions, including purported class actions, were filed in various federal courts against Wyeth and, in certain of the actions, affiliates of Wyeth and certain other defendants relating to Effexor XR, which is the extended-release formulation of Effexor. The plaintiffs in each of the class actions seek to represent a class consisting of all persons in the U.S. and its territories who directly purchased, indirectly purchased or reimbursed patients for the purchase of Effexor XR or generic Effexor XR from any of the defendants from June 14, 2008 until the time the defendants allegedly unlawful conduct ceased. The plaintiffs in all of the actions allege delay in the launch of generic Effexor XR in the U.S. and its territories, in violation of federal antitrust laws and, in certain of the actions, the antitrust, consumer protection and various other laws of certain states, as the result of Wyeth fraudulently obtaining and improperly listing certain patents for Effexor XR in the Orange Book, enforcing certain patents for Effexor XR and entering into a litigation settlement agreement with a generic drug manufacturer with respect to Effexor XR. Each of the plaintiffs seeks treble damages (for itself in the individual actions or on behalf of the putative class in the Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies purported class actions) for alleged price overcharges for Effexor XR or generic Effexor XR in the U.S. and its territories since June 14, 2008. All of these actions have been consolidated in the U.S. District Court for the District of New Jersey. In 2014, the District Court dismissed the direct purchaser plaintiffs claims based on the litigation settlement agreement, but declined to dismiss the other direct purchaser plaintiff claims. In 2015, the District Court entered partial final judgments as to all settlement agreement claims, including those asserted by direct purchasers and end-payer plaintiffs, which plaintiffs appealed to the U.S. Court of Appeals for the Third Circuit. In 2017, the U.S. Court of Appeals for the Third Circuit reversed the District Courts decisions and remanded the claims to the District Court. Lipitor Beginning in 2011, purported class actions relating to Lipitor were filed in various federal courts against, among others, Pfizer, certain Pfizer affiliates, and, in most of the actions, Ranbaxy Laboratories Ltd. (Ranbaxy) and certain Ranbaxy affiliates. The plaintiffs in these various actions seek to represent nationwide, multi-state or statewide classes consisting of persons or entities who directly purchased, indirectly purchased or reimbursed patients for the purchase of Lipitor (or, in certain of the actions, generic Lipitor) from any of the defendants from March 2010 until the cessation of the defendants allegedly unlawful conduct (the Class Period). The plaintiffs allege delay in the launch of generic Lipitor, in violation of federal antitrust laws and/or state antitrust, consumer protection and various other laws, resulting from (i) the 2008 agreement pursuant to which Pfizer and Ranbaxy settled certain patent litigation involving Lipitor and Pfizer granted Ranbaxy a license to sell a generic version of Lipitor in various markets beginning on varying dates, and (ii) in certain of the actions, the procurement and/or enforcement of certain patents for Lipitor. Each of the actions seeks, among other things, treble damages on behalf of the putative class for alleged price overcharges for Lipitor (or, in certain of the actions, generic Lipitor) during the Class Period. In addition, individual actions have been filed against Pfizer, Ranbaxy and certain of their affiliates, among others, that assert claims and seek relief for the plaintiffs that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. These various actions have been consolidated for pre-trial proceedings in a Multi-District Litigation in the U.S. District Court for the District of New Jersey. In September 2013 and 2014, the District Court dismissed with prejudice the claims of the direct purchasers. In October and November 2014, the District Court dismissed with prejudice the claims of all other Multi-District Litigation plaintiffs. All plaintiffs have appealed the District Courts orders dismissing their claims with prejudice to the U.S. Court of Appeals for the Third Circuit. In addition, the direct purchaser class plaintiffs appealed the order denying their motion to amend the judgment and for leave to amend their complaint to the Court of Appeals. In 2017, the Court of Appeals reversed the District Courts decisions and remanded the claims to the District Court. Also, in 2013, the State of West Virginia filed an action in West Virginia state court against Pfizer and Ranbaxy, among others, that asserts claims and seeks relief on behalf of the State of West Virginia and residents of that state that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. EpiPen (Direct Purchaser) In February 2020, a lawsuit was filed in the U.S. District Court for the District of Kansas against Pfizer, its affiliates King and Meridian, and various Mylan entities, on behalf of a purported U.S. nationwide class of direct purchaser plaintiffs who purchased EpiPen devices directly from the defendants. Plaintiffs in this action generally allege that Pfizer and Mylan conspired to delay market entry of generic EpiPen through the settlement of patent litigation regarding EpiPen, and thereby delayed market entry of generic EpiPen in violation of federal antitrust law. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In July 2021, the District Court granted defendants motion to dismiss the direct purchaser complaint, without prejudice. In September 2021, plaintiffs filed an amended complaint. Nexium 24HR and Protonix A number of individual and multi-plaintiff lawsuits have been filed against Pfizer, certain of its subsidiaries and/or other pharmaceutical manufacturers in various federal and state courts alleging that the plaintiffs developed kidney-related injuries purportedly as a result of the ingestion of certain proton pump inhibitors. The cases against Pfizer involve Protonix and/or Nexium 24HR and seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In 2017, the federal actions were ordered transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the District of New Jersey. As part of our Consumer Healthcare JV transaction with GSK, the JV has agreed to assume, and to indemnify Pfizer for, liabilities arising out of such litigation to the extent related to Nexium 24HR. Docetaxel Personal Injury Actions A number of lawsuits have been filed against Hospira and Pfizer in various federal and state courts alleging that plaintiffs who were treated with Docetaxel developed permanent hair loss. The significant majority of the cases also name other defendants, including the manufacturer of the branded product, Taxotere. Plaintiffs seek compensatory and punitive damages. In 2016, the federal cases were transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the Eastern District of Louisiana. Mississippi Attorney General Government Action In 2018, the Attorney General of Mississippi filed a complaint in Mississippi state court against the manufacturer of the branded product and eight other manufacturers including Pfizer and Hospira, alleging, with respect to Pfizer and Hospira, a failure to warn about a risk of permanent hair loss in violation of the Mississippi Consumer Protection Act. The action seeks civil penalties and injunctive relief. Zantac A number of lawsuits have been filed against Pfizer in various federal and state courts alleging that plaintiffs developed various types of cancer, or face an increased risk of developing cancer, purportedly as a result of the ingestion of Zantac. The significant majority of these cases also name other defendants that have historically manufactured and/or sold Zantac. Pfizer has not sold Zantac since 2006, and only sold an OTC version of the product. Plaintiffs seek compensatory and punitive damages. In February 2020, the federal actions were transferred for coordinated pre-trial proceedings to a Multi-District Litigation in the U.S. District Court for the Southern District of Florida. Plaintiffs in the Multi-District Litigation have filed against Pfizer and many other defendants a master personal injury complaint, a consolidated consumer class action complaint alleging, among other things, claims under consumer protection Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies statutes of all 50 states, and a medical monitoring complaint seeking to certify medical monitoring classes under the laws of 13 states. Plaintiffs previously had filed a consolidated third-party payor class action complaint alleging violation of the federal Racketeer Influenced and Corrupt Organizations Act (RICO) statute and seeking reimbursement for payments made for the prescription version of Zantac, but the Multi-District Litigation court dismissed that complaint; Plaintiffs have appealed the dismissal to the U.S. Court of Appeals for the Eleventh Circuit. In addition, (i) Pfizer has received service of Canadian class action complaints naming Pfizer and other defendants, and seeking compensatory and punitive damages for personal injury and economic loss, allegedly arising from the defendants sale of Zantac in Canada; and (ii) the State of New Mexico and the Mayor and City Council of Baltimore separately filed civil actions against Pfizer and many other defendants in state court, alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in those jurisdictions. In April 2021, a Judicial Council Coordinated Proceeding was created in the Superior Court of California in Alameda County to coordinate personal injury actions against Pfizer and other defendants filed in California state court. Chantix Beginning in August 2021, a number of putative class actions have been filed against Pfizer in various U.S. federal courts following Pfizers voluntary recall of Chantix due to the presence of a nitrosamine, N-nitroso-varenicline. Plaintiffs assert that they suffered economic harm purportedly as a result of purchasing Chantix or generic varenicline medicines sold by Pfizer. Plaintiffs seek to represent nationwide and state-specific classes and seek various remedies, including damages and medical monitoring. Similar putative class actions have been filed in Canada and Israel, where the product brand is Champix. A3. Legal ProceedingsCommercial and Other Matters Monsanto-Related Matters In 1997, Monsanto Company (Former Monsanto) contributed certain chemical manufacturing operations and facilities to a newly formed corporation, Solutia Inc. (Solutia), and spun off the shares of Solutia. In 2000, Former Monsanto merged with Pharmacia Upjohn Company to form Pharmacia. Pharmacia then transferred its agricultural operations to a newly created subsidiary, named Monsanto Company (New Monsanto), which it spun off in a two-stage process that was completed in 2002. Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. In connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities related to Pharmacias former agricultural business. New Monsanto has defended and/or is defending Pharmacia in connection with various claims and litigation arising out of, or related to, the agricultural business, and has been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. In connection with its spin-off in 1997, Solutia assumed, and agreed to indemnify Pharmacia for, liabilities related to Former Monsantos chemical businesses. As the result of its reorganization under Chapter 11 of the U.S. Bankruptcy Code, Solutias indemnification obligations relating to Former Monsantos chemical businesses are primarily limited to sites that Solutia has owned or operated. In addition, in connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities primarily related to Former Monsantos chemical businesses, including, but not limited to, any such liabilities that Solutia assumed. Solutias and New Monsantos assumption of, and agreement to indemnify Pharmacia for, these liabilities apply to pending actions and any future actions related to Former Monsantos chemical businesses in which Pharmacia is named as a defendant, including, without limitation, actions asserting environmental claims, including alleged exposure to polychlorinated biphenyls. Solutia and/or New Monsanto are defending Pharmacia in connection with various claims and litigation arising out of, or related to, Former Monsantos chemical businesses, and have been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. Environmental Matters In 2009, we submitted a revised site-wide feasibility study with regard to the Wyeth Holdings Corporation (formerly, American Cyanamid Company) discontinued industrial chemical facility in Bound Brook, New Jersey. In 2011, Wyeth Holdings Corporation executed an Administrative Settlement Agreement and Order on Consent for Removal Action (the 2011 Administrative Settlement Agreement) with the U.S. Environmental Protection Agency (EPA) with regard to the Bound Brook facility. In accordance with the 2011 Administrative Settlement Agreement, we completed construction of an interim remedy. In 2012, the EPA issued a final remediation plan for the Bound Brook facilitys main plant area. In 2013, Wyeth Holdings Corporation (now Wyeth Holdings LLC) entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the main plant area and to perform a focused feasibility study for two adjacent lagoons. In 2015, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey that allows Wyeth Holdings LLC to complete the design and to implement the remedy for the main plant area. The consent decree (which supersedes the 2011 Administrative Settlement Agreement) was entered by the District Court in 2015. In 2018, the EPA issued a final remediation plan for the two adjacent lagoons. In 2019, Wyeth Holdings LLC entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the lagoons. In September 2021, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey, which the court approved in November 2021, that will allow Wyeth Holdings LLC to complete the design and implement the remedy for the two adjacent lagoons. We have accrued for the estimated costs of the site remedies for the Bound Brook facility. We are a party to a number of other proceedings brought under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, and other state, local or foreign laws in which the primary relief sought is the cost of past and/or future remediation. Contracts with Iraqi Ministry of Health In 2017, a number of U.S. service members, civilians, and their families brought a complaint in the U.S. District Court for the District of Columbia against a number of pharmaceutical and medical devices companies, including Pfizer and certain of its subsidiaries, alleging that the defendants violated the U.S. Anti-Terrorism Act. The complaint alleges that the defendants provided funding for terrorist organizations through their sales practices pursuant to pharmaceutical and medical device contracts with the Iraqi Ministry of Health, and seeks monetary relief. In July 2020, the District Court granted defendants motions to dismiss and dismissed all of plaintiffs claims. In January 2022, the Court of Appeals reversed the District Courts decision. In February 2022, the defendants filed for en banc review of the Court of Appeals decision. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Allergan Complaint for Indemnity In 2019, Pfizer was named as a defendant in a complaint, along with King, filed by Allergan Finance LLC (Allergan) in the Supreme Court of the State of New York, asserting claims for indemnity related to Kadian, which was owned for a short period by King in 2008, prior to Pfizer's acquisition of King in 2010. This suit was voluntarily discontinued without prejudice in January 2021. Breach of ContractXalkori/Lorbrena We are a defendant in a breach of contract action brought by New York University (NYU) in the Supreme Court of the State of New York (Supreme Court). NYU alleges that it is entitled to royalties on Pfizers sales of Xalkori under the terms of a Research and License Agreement between NYU and Sugen, Inc. Sugen, Inc. was acquired by Pharmacia in August 1999, and Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. The action was originally filed in 2013. In 2015, the Supreme Court dismissed the action and, in 2017, the New York State Appellate Division reversed the decision and remanded the proceedings to the Supreme Court. In January 2020, the Supreme Court denied both parties summary judgment motions. In October 2020, NYU filed a separate breach of contract action against Pfizer alleging that it is entitled to royalties on sales of Lorbrena under the terms of the same NYU-Sugen, Inc. Research and Licensing Agreement. In February 2022, the parties reached an agreement to settle both breach of contract actions on terms not material to Pfizer. Viatris Securities Litigation In October 2021, a putative class action was filed in the Court of Common Pleas of Allegheny County, Pennsylvania on behalf of former Mylan N.V. shareholders who received Viatris common stock in exchange for Mylan shares in connection with the spin-off of the Upjohn Business and its combination with Mylan (the Transactions). Viatris, Pfizer, and certain of each companys current and former officers, directors and employees are named as defendants. The complaint alleges that the defendants violated certain provisions of the Securities Act of 1933 in connection with certain disclosures made in or omitted from the registration statement and related prospectus issued in connection with the Transactions. Plaintiff seeks damages, costs and expenses and other equitable and injunctive relief. A4. Legal ProceedingsGovernment Investigations We are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Among the investigations by government agencies are the matters discussed below. Greenstone Investigations U.S. Department of Justice Antitrust Division Investigation Since July 2017, the U.S. Department of Justice's Antitrust Division has been investigating our former Greenstone generics business. We believe this is related to an ongoing broader antitrust investigation of the generic pharmaceutical industry. We have produced records relating to this investigation. State Attorneys General and Multi-District Generics Antitrust Litigation In April 2018, Greenstone received requests for information from the Antitrust Department of the Connecticut Office of the Attorney General. In May 2019, Attorneys General of more than 40 states plus the District of Columbia and Puerto Rico filed a complaint against a number of pharmaceutical companies, including Greenstone and Pfizer. The matter has been consolidated with a Multi-District Litigation in the Eastern District of Pennsylvania. As to Greenstone and Pfizer, the complaint alleges anticompetitive conduct in violation of federal and state antitrust laws and state consumer protection laws. In June 2020, the State Attorneys General filed a new complaint against a large number of companies, including Greenstone and Pfizer, making similar allegations, but concerning a new set of drugs. This complaint was transferred to the Multi-District Litigation in July 2020. The Multi-District Litigation also includes civil complaints filed by private plaintiffs and state counties against Pfizer, Greenstone and a significant number of other defendants asserting allegations that generally overlap with those asserted by the State Attorneys General. Subpoena relating to Manufacturing of Quillivant XR In October 2018, we received a subpoena from the U.S. Attorneys Office for the Southern District of New York (SDNY) seeking records relating to our relationship with another drug manufacturer and its production and manufacturing of drugs including, but not limited to, Quillivant XR. We have produced records pursuant to the subpoena. Government Inquiries relating to Meridian Medical Technologies In February 2019, we received a civil investigative demand from the U.S. Attorneys Office for the SDNY. The civil investigative demand seeks records and information related to alleged quality issues involving the manufacture of auto-injectors at the Meridian site. In August 2019, we received a HIPAA subpoena from the U.S. Attorneys Office for the Eastern District of Missouri seeking similar records and information. We are producing records in response to these requests. U.S. Department of Justice/SEC Inquiry relating to Russian Operations In June 2019, we received an informal request from the U.S. Department of Justices FCPA Unit seeking documents relating to our operations in Russia. In September 2019, we received a similar request from the SECs FCPA Unit. We have produced records pursuant to these requests. Docetaxel Mississippi Attorney General Government Investigation See Legal Proceedings Product Litigation Docetaxel Mississippi Attorney General Government Investigation above for information regarding a government investigation related to Docetaxel marketing practices. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies U.S. Department of Justice Inquiries relating to India Operations In March 2020, we received an informal request from the U.S. Department of Justice's Consumer Protection Branch seeking documents relating to our manufacturing operations in India, including at our former facility located at Irrungattukottai in India. In April 2020, we received a similar request from the U.S. Attorneys Office for the SDNY regarding a civil investigation concerning operations at our facilities in India. We are producing records pursuant to these requests. U.S. Department of Justice/SEC Inquiry relating to China Operations In June 2020, we received an informal request from the U.S. Department of Justice's FCPA Unit seeking documents relating to our operations in China. In August 2020, we received a similar request from the SECs FCPA Unit. We are producing records pursuant to these requests. Zantac State of New Mexico and Mayor and City Council of Baltimore Civil Actions See Legal ProceedingsProduct LitigationZantac above for information regarding civil actions separately filed by the State of New Mexico and the Mayor and City Council of Baltimore alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in those jurisdictions. A5. Legal ProceedingsMatters Resolved During 2021 During 2021, certain matters, including the matter discussed below, were resolved or became the subject of definitive settlement agreements or settlement agreements-in-principle. EpiPen Beginning in 2017, purported class actions were filed in various federal courts by indirect purchasers of EpiPen against Pfizer, and/or its current and former affiliates King and Meridian, and/or various entities affiliated with Mylan, and Mylan former Chief Executive Officer, Heather Bresch. The plaintiffs in these actions represent U.S. nationwide classes comprising persons or entities who paid for any portion of the end-user purchase price of an EpiPen between 2009 until the cessation of the defendants allegedly unlawful conduct. Against Pfizer and/or its affiliates, plaintiffs in these actions generally allege that Pfizers and/or its affiliates settlement of patent litigation regarding EpiPen delayed market entry of generic EpiPen in violation of federal and various state antitrust laws. At least one lawsuit also alleges that Pfizer and/or Mylan violated RICO. Plaintiffs also filed various federal antitrust, state consumer protection and unjust enrichment claims against, and relating to conduct attributable solely to, Mylan and/or its affiliates regarding EpiPen. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In 2017, all of these indirect purchase actions were consolidated for coordinated pre-trial proceedings in a Multi-District Litigation in the U.S. District Court for the District of Kansas with other EpiPen-related actions against Mylan and/or its affiliates to which Pfizer, King and Meridian are not parties. In July 2021, Pfizer and plaintiffs filed a stipulation of settlement to resolve the Multi-District Litigation for $ 345 million. The District Court approved the settlement in November 2021, and the payment was made in accordance with the terms of the settlement agreement. B. Guarantees and Indemnifications In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities prior to or following a transaction. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we may be required to reimburse the loss. These indemnifications are generally subject to various restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of December 31, 2021, the estimated fair value of these indemnification obligations has been included in our financial statements and is not material to Pfizer. In addition, in connection with our entry into certain agreements and other transactions, our counterparties may agree to indemnify us. For example, in November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction and as previously disclosed, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of certain matters. We have also guaranteed the long-term debt of certain companies that we acquired and that now are subsidiaries of Pfizer. See Note 7D . C. Certain Commitments As of December 31, 2021, we had commitments totaling $ 5.2 billion that are legally binding and enforceable. These commitments include payments relating to potential milestone payments deemed reasonably likely to occur, and purchase obligations for goods and services. See Note 5A for information on the TCJA repatriation tax liability. D. Contingent Consideration for Acquisitions We may be required to make payments to sellers for certain prior business combinations that are contingent upon future events or outcomes. See Note 1E . The estimated fair value of contingent consideration as of December 31, 2021 is $ 697 million, of which $ 135 million is recorded in Other current liabilities and $ 563 million in Other noncurrent liabilities, and as of December 31, 2020 is $ 689 million, of which $ 123 million is recorded in Other current liabilities and $ 566 million in Other noncurrent liabilities . The increase in the contingent consideration balance from December 31, 2020 is primarily due to fair value adjustments, partially offset by payments made upon the achievement of certain sales-based milestones. E. Insurance Our insurance coverage reflects market conditions (including cost and availability) existing at the time it is written, and our decision to obtain insurance coverage or to self-insure varies accordingly. Depending upon the cost and availability of insurance and the nature of the risk involved, the amount of self-insurance may be significant. The cost and availability of coverage have resulted in self-insuring certain exposures, including product liability. If we incur substantial liabilities that are not covered by insurance or substantially exceed insurance Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies coverage and that are in excess of existing accruals, there could be a material adverse effect on our cash flows or results of operations in the period in which the amounts are paid and/or accrued. Note 17 . Segment, Geographic and Other Revenue Information A. Segment Information We regularly review our operating segments and the approach used by management to evaluate performance and allocate resources. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer transformed into a more focused, global leader in science-based innovative medicines and vaccines and beginning in the fourth quarter of 2020 operated as a single operating segment engaged in the discovery, development, manufacturing, marketing, sale and distribution of biopharmaceutical products worldwide. At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1, our global contract development and manufacturing organization and a leading supplier of specialty active pharmaceutical ingredients. Biopharma is a science-based medicines business that includes six therapeutic areas Oncology, Inflammation Immunology, Rare Disease, Hospital, Vaccines and Internal Medicine. The Hospital therapeutic area commercializes our global portfolio of sterile injectable and anti-infective medicines. Each operating segment has responsibility for its commercial activities. Regional commercial organizations market, distribute and sell our products and are supported by global platform functions that are responsible for the research, development, manufacturing and supply of our products and global corporate enabling functions. Biopharma receives its RD services from GPD and WRDM. These services include IPRD projects for new investigational products and additional indications for in-line products. Each business has a geographic footprint across developed and emerging markets. Our chief operating decision maker uses the revenues and earnings of the operating segments, among other factors, for performance evaluation and resource allocation. Biopharma is the only reportable segment. We have revised prior-period information (Revenues and Earnings, as defined by management) to conform to the current management structure. Other Costs and Business Activities Certain pre-tax costs are not allocated to our operating segment results, such as costs associated with the following: WRDMthe RD and Medical expenses managed by our WRDM organization, which is generally responsible for research projects for our Biopharma portfolio until proof-of-concept is achieved and then for transitioning those projects to the GPD organization for possible clinical and commercial development. RD spending may include upfront and milestone payments for intellectual property rights. The WRDM organization also has responsibility for certain science-based and other platform-services organizations, which provide end-to-end technical expertise and other services to the various RD projects, as well as the Worldwide Medical and Safety group, which ensures that Pfizer provides all stakeholdersincluding patients, healthcare providers, pharmacists, payers and health authoritieswith complete and up-to-date information on the risks and benefits associated with Pfizer products so that they can make appropriate decisions on how and when to use Pfizers medicines. GPDthe costs associated with our GPD organization, which is generally responsible for clinical trials from WRDM in the Biopharma portfolio, including late-stage portfolio spend. GPD also provides technical support and other services to Pfizer RD projects. GPD is responsible for facilitating all regulatory submissions and interactions with regulatory agencies. Corporate and Other Unallocatedthe costs associated with (i) corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement, among others), all strategy, business development, portfolio management and valuation capabilities, patient advocacy activities and certain compensation and other corporate costs, such as interest income and expense, and gains and losses on investments; (ii) overhead expenses primarily associated with our manufacturing (which include manufacturing variances associated with production) operations that are not directly assessed to an operating segment, as business unit (segment) management does not manage these costs; and (iii) our share of earnings from the Consumer Healthcare JV. Certain transactions and events such as (i) purchase accounting adjustments, where we incur expenses associated with the amortization of fair value adjustments to inventory, intangible assets and PPE; (ii) acquisition-related items, where we incur costs for executing the transaction, integrating the acquired operations and restructuring the combined company; and (iii) certain significant items, representing substantive and/or unusual, and in some cases recurring, items (such as pension and postretirement actuarial remeasurement gains and losses, gains on the completion of joint venture transactions, restructuring charges, legal charges or net gains and losses on investments in equity securities) that are evaluated on an individual basis by management and that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis. Such items can include, but are not limited to, non-acquisition-related restructuring costs, as well as costs incurred for legal settlements, asset impairments and disposals of assets or businesses, including, as applicable, any associated transition activities. The operating results of PC1, our global contract development and manufacturing organization, and through July 31, 2019 our former Consumer Healthcare business are included in Other business activities. Segment Assets We manage our assets on a total company basis, not by operating segment, as our operating assets are shared or commingled. Therefore, our chief operating decision maker does not regularly review any asset information by operating segment and, accordingly, we do not report asset information by operating segment. Total assets were $ 181 billion as of December 31, 2021 and $ 154 billion as of December 31, 2020. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Selected Income Statement Information The following table provides selected income statement information by reportable segment: Revenues Earnings (a) Depreciation and Amortization (b) Year Ended December 31, Year Ended December 31, Year Ended December 31, (MILLIONS OF DOLLARS) 2021 2020 2019 2021 2020 2019 2021 2020 2019 Reportable Segment: Biopharma $ 79,557 $ 40,724 $ 38,013 $ 40,226 $ 27,089 $ 24,419 $ 1,439 $ 1,013 $ 978 Other business activities (c) 1,731 926 2,892 ( 10,396 ) ( 12,308 ) ( 11,216 ) 598 603 592 Reconciling Items: Purchase accounting adjustments ( 3,175 ) ( 3,117 ) ( 4,153 ) 3,067 3,047 4,145 Acquisition-related costs ( 52 ) ( 44 ) ( 185 ) 3 Certain significant items (d) ( 2,292 ) ( 4,584 ) 2,456 87 18 37 $ 81,288 $ 41,651 $ 40,905 $ 24,311 $ 7,036 $ 11,321 $ 5,191 $ 4,681 $ 5,755 (a) Income from continuing operations before provision/(benefit) for taxes on income. Biopharmas earnings include dividend income from our investment in ViiV of $ 166 million in 2021, $ 278 million in 2020 and $ 220 million in 2019. (b) Certain production facilities are shared. Depreciation is allocated based on estimates of physical production. Amounts here relate solely to the depreciation and amortization associated with continuing operations. (c) Other business activities include revenues and costs associated with PC1, as well as costs associated with global WRDM and GPD platform functions, global corporate enabling functions and other corporate items, as noted above, that we do not allocate to our operating segments. In 2019, Other business activities also include revenues and costs associated with our former Consumer Healthcare business through July 31, 2019. See Note 2C. (d) Certain significant items are substantive and/or unusual, and in some cases recurring, items (as noted above) that, either as a result of their nature or size, would not be expected to occur as part of our normal business on a regular basis. For Earnings in 2021, includes, among other items: (i) a $ 2.1 billion charge for IPRD related to our acquisition of Trillium, which was accounted for as an asset acquisition and recorded in Research and development expenses , (ii) restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring of $ 1.3 billion ($ 450 million recorded in Selling, informational and administrative expenses and the remaining amount primarily recorded in Restructuring charges and certain acquisition-related costs ) and (iii) upfront and milestone payments on collaborative and licensing arrangements of $ 1.1 billion recorded in Research and development expenses , partially offset by (iv) actuarial valuation and other pension and postretirement plan gains of $ 1.6 billion recorded in Other (income)/deductionsnet and (v) gains on equity securities of $ 1.3 billion recorded in Other (income)/deductionsnet . For Earnings in 2020, includes, among other items; (i) charges of $ 1.7 billion related to certain asset impairments recorded in Other (income)/deductionsnet , (ii) actuarial valuation and other pension and postretirement plan losses of $ 1.1 billion recorded in Other (income)/deductionsnet and (iii) restructuring charges/(credits) and implementation costs and additional depreciationasset restructuring of $ 791 million ($ 197 million recorded in Selling, informational and administrative expenses and the remaining amount primarily recorded in Restructuring charges and certain acquisition-related costs ). For Earnings in 2019, includes, among other items: (i) a pre-tax gain of $ 8.1 billion recorded in (Gain) on completion of Consumer Healthcare JV transaction associated with the completion of the Consumer Healthcare JV transaction, partially offset by (ii) charges of $ 2.8 billion related to certain asset impairments recorded in Other (income)/deductionsnet and (iii) actuarial valuation and other pension and postretirement plan losses of $ 750 million recorded in Other (income)/deductionsnet. For additional information, see Notes 2A, 2C, 3 and 4 . B. Geographic Information The following summarizes revenues by geographic area: Year Ended December 31, (MILLIONS) 2021 2020 2019 United States $ 29,746 $ 21,455 $ 20,326 Developed Europe 18,336 7,788 7,729 Developed Rest of World 12,506 4,036 4,022 Emerging Markets 20,701 8,372 8,828 Revenues $ 81,288 $ 41,651 $ 40,905 Revenues exceeded $500 million in each of 21 , 8 and 10 countries outside the U.S. in 2021, 2020 and 2019, respectively. The U.S. is the only country to contribute more than 10 % of total revenue in 2021, 2020 and 2019. As a percentage of revenues, our largest national market outside the U.S. was Japan, which contributed 9 % of total revenue in 2021 and 6 % in each of 2020 and 2019. We and our collaboration partner, BioNTech, have entered into agreements to supply pre-specified doses of Comirnaty with multiple developed and emerging nations around the world and are continuing to deliver doses of Comirnaty under such agreements. We currently sell the Comirnaty vaccine directly to government and government sponsored customers. This includes supply agreements entered into in November 2020 and February and May 2021 with the EC on behalf of the different EU member states and certain other countries. Each EU member state submits its own Comirnaty vaccine order to us and is responsible for payment pursuant to terms of the supply agreements negotiated by the EC. C. Other Revenue Information Significant Customers Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccine products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes revenue, as a percentage of total revenues, for our three largest U.S. wholesaler customers: Year Ended December 31, 2021 2020 2019 McKesson, Inc. 9 % 16 % 15 % AmerisourceBergen Corporation 7 % 14 % 11 % Cardinal Health, Inc. 5 % 10 % 9 % Collectively, our three largest U.S. wholesaler customers represented 24 %, 30 % and 25 % of total trade accounts receivable as of December 31, 2021, 2020 and 2019. Additionally, revenues from the U.S. government represented 13 % of total revenues for 2021, and primarily represent sales of Comirnaty. Accounts receivable from the U.S. government represented 12 % of total trade accounts receivable as of December 31, 2021, and primarily relate to sales of Comirnaty. Significant Product Revenues The following provides detailed revenue information for several of our major products: (MILLIONS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2021 2020 2019 TOTAL REVENUES (a) $ 81,288 $ 41,651 $ 40,905 PFIZER BIOPHARMACEUTICALS GROUP (BIOPHARMA) (a), (b) $ 79,557 $ 40,724 $ 38,013 Vaccines $ 42,625 $ 6,575 $ 6,504 Comirnaty direct sales and alliance revenues Active immunization to prevent COVID-19 36,781 154 Prevnar family (c) Pneumococcal disease 5,272 5,850 5,847 Nimenrix Meningococcal ACWY disease 193 221 230 FSME-IMMUN/TicoVac Tick-borne encephalitis disease 185 196 220 Trumenba Meningococcal B disease 118 112 135 All other Vaccines Various 74 42 73 Oncology $ 12,333 $ 10,867 $ 9,014 Ibrance HR-positive/HER2-negative metastatic breast cancer 5,437 5,392 4,961 Xtandi alliance revenues mCRPC, nmCRPC, mCSPC 1,185 1,024 838 Inlyta Advanced RCC 1,002 787 477 Sutent Advanced and/or metastatic RCC, adjuvant RCC, refractory GIST (after disease progression on, or intolerance to, imatinib mesylate) and advanced pancreatic neuroendocrine tumor 673 819 936 Bosulif Philadelphia chromosomepositive chronic myelogenous leukemia 540 450 365 Xalkori ALK-positive and ROS1-positive advanced NSCLC 493 544 530 Ruxience (d) Non-hodgkins lymphoma, chronic lymphocytic leukemia, granulomatosis with polyangiitis (Wegeners Granulomatosis) and microscopic polyangiitis 491 170 ( 1 ) Retacrit (d) Anemia 444 386 225 Zirabev (d) Treatment of mCRC; unresectable, locally advanced, recurrent or metastatic NSCLC; recurrent glioblastoma; metastatic RCC; and persistent, recurrent or metastatic cervical cancer 444 143 1 Lorbrena ALK-positive metastatic NSCLC 266 204 115 Aromasin Post-menopausal early and advanced breast cancer 211 148 136 Trazimera (d) HER-positive breast cancer and metastatic stomach cancers 197 98 6 Besponsa Relapsed or refractory B-cell acute lymphoblastic leukemia 192 182 157 Braftovi In combination with Mektovi for metastatic melanoma in patients with a BRAF V600E/K mutation and, in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy 187 160 48 Bavencio alliance revenues Locally advanced or metastatic urothelial carcinoma; metastatic Merkel cell carcinoma; immunotherapy and tyrosine kinase inhibitor combination for patients with advanced RCC 178 80 49 Mektovi In combination with Braftovi for metastatic melanoma in patients with a BRAF V600E/K mutation 155 142 49 All other Oncology Various 238 137 122 Internal Medicine $ 9,329 $ 9,003 $ 8,790 Eliquis alliance revenues and direct sales Nonvalvular atrial fibrillation, deep vein thrombosis, pulmonary embolism 5,970 4,949 4,220 Premarin family Symptoms of menopause 563 680 734 Chantix/Champix An aid to smoking cessation treatment in adults 18 years of age or older 398 919 1,107 BMP2 Development of bone and cartilage 266 274 287 Toviaz Overactive bladder 238 252 250 Pristiq Depression 187 171 176 All other Internal Medicine Various 1,706 1,758 2,016 Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (MILLIONS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2021 2020 2019 Hospital (a) $ 7,301 $ 6,777 $ 6,695 Sulperazon Bacterial infections 683 618 684 Medrol Anti-inflammatory glucocorticoid 432 402 469 Zavicefta Bacterial infections 413 212 108 Fragmin Treatment/prevention of venous thromboembolism 305 252 253 Zithromax Bacterial infections 278 276 336 Vfend Fungal infections 267 270 346 Tygacil Bacterial infections 200 160 197 Precedex Sedation agent in surgery or intensive care 177 260 155 Zyvox Bacterial infections 173 222 251 Paxlovid COVID-19 Infection ( high risk population) 76 IVIg Products (e) Various 430 376 275 All other Anti-infectives Various 1,453 1,294 1,396 All other Hospital Various 2,412 2,435 2,225 Inflammation Immunology (II) $ 4,431 $ 4,567 $ 4,733 Xeljanz RA, PsA, UC, active polyarticular course juvenile idiopathic arthritis, ankylosing spondylitis 2,455 2,437 2,242 Enbrel (Outside the U.S. and Canada) RA, juvenile idiopathic arthritis, PsA, plaque psoriasis, pediatric plaque psoriasis, ankylosing spondylitis and nonradiographic axial spondyloarthritis 1,185 1,350 1,699 Inflectra/Remsima (d) Crohns disease, pediatric Crohns disease, UC, pediatric UC, RA in combination with methotrexate, ankylosing spondylitis, PsA and plaque psoriasis 657 659 625 All other II Various 134 121 167 Rare Disease $ 3,538 $ 2,936 $ 2,278 Vyndaqel/Vyndamax ATTR-cardiomyopathy and polyneuropathy 2,015 1,288 473 BeneFIX Hemophilia B 438 454 488 Genotropin Replacement of human growth hormone 389 427 498 Refacto AF/Xyntha Hemophilia A 304 370 426 Somavert Acromegaly 277 277 264 All other Rare Disease Various 115 120 129 PFIZER CENTREONE (b) $ 1,731 $ 926 $ 810 CONSUMER HEALTHCARE BUSINESS (f) $ $ $ 2,082 Total Alliance revenues $ 7,652 $ 5,418 $ 4,648 Total Biosimilars (d) $ 2,343 $ 1,527 $ 911 Total Sterile Injectable Pharmaceuticals (g) $ 5,746 $ 5,315 $ 5,013 (a) On December 31, 2021, we completed the sale of our Meridian subsidiary. Prior to its sale, Meridian was managed as part of the Hospital therapeutic area. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. On December 21, 2020, Pfizer and Viatris completed the termination of the Mylan-Japan collaboration. Beginning in the fourth quarter of 2021, the financial results of Meridian are reflected as discontinued operations for all periods presented. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and Mylan-Japan collaboration were reflected as discontinued operations for all periods presented. Prior-period financial information has been restated, as appropriate. See Note 1A . (b) At the beginning of our fiscal fourth quarter of 2021, we reorganized our commercial operations and began to manage our commercial operations through a new global structure consisting of two operating segments, each led by a single manager: Biopharma, our innovative science-based biopharmaceutical business and PC1. PC1, which previously had been managed within the Hospital therapeutic area, includes revenues from our contract manufacturing, including certain Comirnaty-related manufacturing activities performed on behalf of BioNTech ($ 320 million for 2021 and $ 0 million for 2020 and 2019), and active pharmaceutical ingredient sales operation, as well as revenues related to our manufacturing and supply agreements with former legacy Pfizer businesses/partnerships, including but not limited to, transitional manufacturing and supply agreements with Viatris following the spin-off of the Upjohn Business. We have revised prior period information to conform to the current management structure. (c) Prevnar family include revenues from Prevnar 13/Prevenar 13 (pediatric and adult) and Prevnar 20 (adult). (d) Biosimilars are highly similar versions of approved and authorized biological medicines and primarily include revenues from Inflectra/Remsima, Ruxience, Retacrit, Zirabev and Trazimera. (e) Intravenous immunoglobulin (IVIg) products include the revenues from Panzyga, Octagam and Cutaquig. (f) On July 31, 2019, our Consumer Healthcare business, an OTC medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare JV. See Note 2C . (g) Total Sterile Injectable Pharmaceuticals represents the total of all branded and generic injectable products in the Hospital therapeutic area, including anti-infective sterile injectable pharmaceuticals. Remaining Performance Obligations Contracted revenue expected to be recognized from remaining performance obligations for firm orders in long-term contracts to supply Comirnaty to our customers totals $ 34.4 billion as of December 31, 2021, which includes amounts received in advance and deferred and amounts that will be invoiced as we deliver the product to our customers in future periods. Of this amount, we expect to recognize revenue of Pfizer Inc. 2021 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies $ 22.3 billion in 2022, $ 11.8 billion in 2023 and $ 265 million in 2024. Remaining performance obligations exclude arrangements with an original expected contract duration of less than one year. Deferred Revenues Our deferred revenues primarily relate to advance payments received or receivable in connection with contracts that we entered into during 2021 and 2020 with various government or government sponsored customers in international markets for supply of Comirnaty. The deferred revenues associated with the advance payments related to Comirnaty total $ 3.3 billion as of December 31, 2021 and $ 957 million as of December 31, 2020, with $ 3.0 billion and $ 249 million recorded in current liabilities and noncurrent liabilities, respectively as of December 31, 2021, and $ 957 million recorded in current liabilities as of December 31, 2020. The increase in the Comirnaty deferred revenues during 2021 was the result of additional advance payments received as we entered into new or amended contracts or as we invoiced customers in advance of vaccine deliveries less amounts recognized in Revenues as we delivered doses to our customers. During 2021, we recognized in revenue substantially all of the balance of Comirnaty deferred revenues as of December 31, 2020. The Comirnaty deferred revenues as of December 31, 2021 will be recognized in Revenues proportionately as we deliver doses of the vaccine to our customers and satisfy our performance obligation under the contracts, with the amounts included in current liabilities expected to be recognized in Revenues within the next 12 months, and the amounts included in noncurrent liabilities expected to be recognized in Revenues in 2023 and in the first quarter of 2024. Deferred revenues associated with contracts for other products were not significant as of December 31, 2021 or 2020. Pfizer Inc. 2021 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2021 (a) Revenues $ 14,516 $ 18,899 $ 24,035 $ 23,838 Costs and expenses (b) 8,802 11,951 15,546 19,876 Restructuring charges and certain acquisition-related costs (c) 22 (1) 646 135 Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 5,692 6,949 7,843 3,827 Provision/(benefit) for taxes on income/(loss) (d) 808 1,123 (328) 249 Income/(loss) from continuing operations 4,885 5,825 8,171 3,578 Discontinued operationsnet of tax (e) 1 (236) (13) (187) Net income/(loss) before allocation to noncontrolling interests 4,886 5,589 8,159 3,391 Less: Net income attributable to noncontrolling interests 9 26 12 (2) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 4,877 $ 5,563 $ 8,146 $ 3,393 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.87 $ 1.04 $ 1.45 $ 0.64 Discontinued operationsnet of tax (0.04) (0.03) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.87 $ 0.99 $ 1.45 $ 0.60 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.86 $ 1.02 $ 1.43 $ 0.62 Discontinued operationsnet of tax (0.04) (0.03) Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.86 $ 0.98 $ 1.42 $ 0.59 (a) Business development activities impacted our results of operations in 2021 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Cost of sales for all quarters reflects higher costs for Comirnaty. The fourth quarter includes a $2.1 billion charge for IPRD expense associated with the acquisition of Trillium, as well as other upfront and milestone payments on collaboration and licensing arrangements. See Notes 2A, D and E. (c) The third and fourth quarters of 2021 primarily include employee termination costs associated with our Transforming to a More Focused Company program. See Note 3. (d) All periods reflect a change in the jurisdictional mix of earnings primarily related to Comirnaty. The third quarter of 2021 reflects benefits resulting from certain initiatives executed in the third quarter of 2021 associated with our investment in the Consumer Healthcare JV with GSK. See Note 5A. (e) All periods include the operating results of Meridian prior to its sale on December 31, 2021 and to a lesser extent post-closing adjustments directly related to prior discontinued businesses. The second quarter of 2021 includes a pre-tax charge of $345 million to resolve a legal matter related to Meridian and the fourth quarter of 2021 includes an after tax loss of $167 million related to the sale of Meridian. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. Pfizer Inc. 2021 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2020 (a) Revenues $ 10,007 $ 9,795 $ 10,215 $ 11,634 Costs and expenses (b) 7,100 6,389 9,635 10,917 Restructuring charges and certain acquisition-related costs 54 360 2 163 (Gain) on completion of Consumer Healthcare JV transaction (6) Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,859 3,046 577 554 Provision/(benefit) for taxes on income/(loss) 358 425 (334) (80) Income/(loss) from continuing operations 2,501 2,621 911 634 Discontinued operationsnet of tax (c) 863 876 566 224 Net income/(loss) before allocation to noncontrolling interests 3,364 3,497 1,477 857 Less: Net income attributable to noncontrolling interests 9 8 8 11 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,355 $ 3,489 $ 1,469 $ 847 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.45 $ 0.47 $ 0.16 $ 0.11 Discontinued operationsnet of tax 0.16 0.16 0.10 0.04 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.60 $ 0.63 $ 0.26 $ 0.15 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.47 $ 0.16 $ 0.11 Discontinued operationsnet of tax 0.15 0.16 0.10 0.04 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.60 $ 0.62 $ 0.26 $ 0.15 (a) Business development activities impacted our results of operations in 2020 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Certain asset impairments totaled $900 million in the third quarter of 2020 and $791 million in the fourth quarter of 2020 recorded in Other (income)/deductionsnet . See Note 4. (c) Operating results of the Upjohn Business through November 16, 2020, the date of the spin-off and combination with Mylan, the Mylan-Japan collaboration and Meridian are presented as discontinued operations in all periods presented. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures As of the end of the period covered by this Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. Pfizer Inc. 2021 Form 10-K Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pfizer Inc.: Opinion on Internal Control Over Financial Reporting We have audited Pfizer Inc. and Subsidiary Companies (the Company) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes (collectively, the consolidated financial statements), and our report dated February 24, 2022 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. New York, New York February 24, 2022 Pfizer Inc. 2021 Form 10-K Managements Report on Internal Control Over Financial Reporting Managements Report We prepared and are responsible for the financial statements that appear in this Form 10-K. These financial statements are in conformity with accounting principles generally accepted in the United States of America and, therefore, include amounts based on informed judgments and estimates. We also accept responsibility for the preparation of other financial information that is included in this document. Report on Internal Control Over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) . Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2021. The Companys independent auditors have issued their auditors report on the Companys internal control over financial reporting. That report appears above in this Form 10-K . Albert Bourla Chairman and Chief Executive Officer Frank DAmelio Jennifer B. Damico Principal Financial Officer Principal Accounting Officer February 24, 2022 Pfizer Inc. 2021 Form 10-K PART III " +1,pfe-,20201231," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of our products, principally biopharmaceutical products, and to a lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people; 2. Deliver first-in-class science; 3. Transform our go-to-market model; 4. Win the digital race in pharma; and 5. Lead the conversation. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. Following (i) the recent spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan, which created a new global pharmaceutical company, Viatris, in November 2020 and (ii) the formation of the Consumer Healthcare JV in 2019, we saw the culmination of Pfizers transformation into a more focused, innovative science-based biopharmaceutical products business. Our significant recent business development activities in 2020 include: (i) the April 2020 agreement with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody, sugemalimab, and to bring additional oncology assets to China, (iv) the November 2020 spin-off and combination of the Upjohn Business with Mylan, and (v) the December 2020 entry into a collaboration with Myovant to jointly develop and commercialize relugolix in advanced prostate cancer and womens health in the U.S. and Canada. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, among others, the development of a vaccine to help prevent COVID-19. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsDevelopment, Regulatory Approval and Marketing of Products and COVID-19 Pandemic sections in this Form 10-K. COMMERCIAL OPERATIONS In 2020, we managed our commercial operations through a global structure consisting of two businessesBiopharma, and, through November 16, 2020, Upjohn, each led by a single manager. On November 16, 2020, we completed the spin-off and combination of the Upjohn Business with Mylan. Following the combination, we now operate as a focused innovative biopharmaceutical company engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. In 2019, Consumer Healthcare, which was our OTC medicines business, was Pfizer Inc. 2020 Form 10-K combined with GSKs consumer healthcare business to form a consumer healthcare JV in which we own a 32% equity stake. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Notes 1A and 2C. Our business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis*, Chantix/Champix* and the Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Sutent*, Inlyta, Retacrit, Lorbrena and Braftovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Zithromax, Vfend and Panzyga Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Prevnar 13/Prevenar 13 (pediatric/adult)*, Nimenrix, FSME/IMMUN-TicoVac, Trumenba and the Pfizer-BioNTech COVID-19 vaccine Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra and Eucrisa/Staquis Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2020, 2019 and 2018. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2020, Chantix/Champix recorded direct product revenues of more than $1 billion in 2019 and 2018 and Sutent recorded direct product revenues of more than $1 billion in 2018. Eliquis includes Alliance revenues and direct sales. For additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Pfizer-BioNTech COVID-19 Vaccine (BNT162b2) is an mRNA-based coronavirus vaccine to help prevent COVID-19 which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech will equally share the costs of development for the BNT162 program. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. We will also share gross profits equally from commercialization of BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist approved by the FDA for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and the relugolix combination tablet, with Myovant bearing our share of allowable expenses up to a maximum of $100 million in 2021 and up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, with Lilly to jointly develop and globally commercialize tanezumab for the treatment of osteoarthritis pain and cancer pain, under which the companies share equally the ongoing development costs and, if successful, will co-commercialize and share equally in profits and certain expenses in the U.S., while Pfizer will be responsible for commercialization activities and costs outside the U.S., with Lilly having the right to Pfizer Inc. 2020 Form 10-K receive certain tiered royalties outside the U.S. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. We also have arrangements with third parties that fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive future payments, such as milestone-based, revenue sharing, or profit-sharing payments or royalties. These collaboration, alliance, license and funding agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances, license and funding arrangements and investments, see Note 2 . Our RD Operations. In 2020, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. GPD is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in our portfolio. Science-based platform-services organizations. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions (which are part of our WRDM organization) such as Pharmaceutical Sciences and Medicine Design. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Another platform-service organization is the Worldwide Medical and Safety (WMS) group, which includes worldwide safety surveillance, medical information and the Chief Medical Office. The WMS group provides patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information about the risks and benefits associated with Pfizers RD programs and marketed products so they can make appropriate decisions on how and when to use our products. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. In 2020, the RD organization within Upjohn supported the off-patent branded and generic established medicines and managed its resources separately from the WRDM and GPD organizations. Following the spin-off and combination of the Upjohn Business with Mylan to create Viatris, we have agreed to provide certain transition services to Viatris including support for RD, pharmacovigilance and safety surveillance. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA. Pfizer Inc. 2020 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 2, 2021, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $20.2 billion accounted for 48% of our total revenues in 2020. Revenues exceeded $500 million in each of 8, 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17A . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. A portion of our government contracts are subject to renegotiation or termination of contracts or subcontracts at the discretion of a government entity. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our largest biopharmaceutical wholesalers, see Note 17B . Pfizer Inc. 2020 Form 10-K We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Drug U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 2022 Sutent 2021 2022 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (3) 2025 Prevnar 13/Prevenar 13 2026 __(4) 2029 Eliquis (5) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (6) 2027 * (6) * (6) Vyndaqel/Vyndamax 2024 (2028 pending PTE) 2026 2026 Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (7) Braftovi (8) 2031 (2031 pending PTE) * (8) * (8) Mektovi (8) 2031 (9) * (8) * (8) Bavencio (10) 2033 2032 2033 Lorbrena 2033 2034 2036 (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our drug from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix in the U.S. expired in November 2020. (3) Xeljanz Europe expiry is provided by regulatory exclusivity. (4) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (5) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and are the subject of patent infringement litigation. Prior to the August 2020 ruling referenced in the following sentence, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). In August 2020, the U.S. District Court for the District of Delaware decided that the two challenged Eliquis patents are both valid and infringed by the remaining generic companies. The remaining generic companies have appealed the Delaware court decision and the final decision in this case could determine when generic versions of Eliquis will come on the market. While we cannot predict the outcome of this pending litigation, these are the alternatives that might occur: (a) If the district courts decision is upheld in the current appeal with respect to both patents, under the terms of previously executed settlement agreements with the settled generic companies, the permitted date of launch for the settled generic companies under these patents is April 1, 2028; (b) if the formulation patent is held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies could launch products immediately upon such an adverse decision. In addition, both patents may be subject to subsequent challenges by parties other than the remaining generic companies. If this were to occur, depending on the outcome of the subsequent challenge, the potential launch by generic companies, including challengers, if successful, could occur on timelines similar to those discussed above. Pfizer Inc. 2020 Form 10-K Refer to Note 16A1 for more information. (6) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (7) Besponsa Japan expiry is provided by regulatory exclusivity. (8) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (9) Mektovi U.S. expiry is provided by a method of use patent. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Intellectual Property Protection, Third Party Intellectual Property Claims and Competitive Products sections in this Form 10-K and Note 16A1 . Losses of Product Exclusivity. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. The basic product patent for Chantix in the U.S. expired on November 10, 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug approval as we seek to further demonstrate the value of our products for the conditions they treat, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We sell biosimilars of certain inflammation immunology and oncology biologic medicines. We seek to maximize the opportunity to establish a first-to-market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Pfizer Inc. 2020 Form 10-K Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2021 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 299 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger entities, which enhances MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Pfizer Inc. 2020 Form 10-K Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. We have supplier management activities in place to monitor supply channels and to take action as needed to secure necessary volumes. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2021. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing pharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. Many of our activities are subject to the jurisdiction of the SEC. For a biopharmaceutical company to market a drug or a biologic product in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or Biologics License Application (BLA) (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. Once a drug or biologic is approved, the FDA must be notified of any product modifications and may require additional studies or clinical trials. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Approval Data section in this Form 10-K. In the context of public health emergencies like the COVID-19 pandemic, we may apply for EUA with the FDA, which when granted, allows for the distribution and use of our products during the term declared and extended by the government, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated at the governments discretion. Although the criteria of an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing compliance obligations. The FDA expects EUA holders to work toward submission of full applications, such as a BLA, as soon as possible. For BNT162b2, we are working towards submitting a BLA for possible full regulatory approval. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Healthcare Reform . Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. This includes potential replacements for the ACA, if it is ultimately invalidated by the U.S. Supreme Court in California v. Texas , as well as efforts at the state level to develop additional public insurance options or implement a single payer healthcare system. We do not expect that invalidation of the ACA itself would have a material impact on our business given the modest revenues the health insurance exchanges and Medicaid expansion generate for us. However, a future replacement of the ACA or other healthcare reform efforts may adversely affect our business and financial results, particularly if such replacement or reform reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Pfizer Inc. 2020 Form 10-K Pricing and Reimbursement . Pricing and reimbursement for our products depend in part on government regulation. In order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1G. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. In the Fall of 2020, the Trump Administration finalized an importation pathway from Canada and a payment model to tie Medicare Part B physician reimbursement to international prices, though ultimate implementation of both is uncertain due to legal challenges. We expect to see continued focus on regulating pricing resulting in additional legislation and regulation under the newly elected Congress and the Biden Administration. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid and Medicare managed care programs typically is determined by the health plans with which state Medicaid agencies and Medicare contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us as part of our business activities is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. Such laws and regulations have the potential to affect our business materially, continue to evolve and are increasingly being enforced vigorously. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. From January 1, 2021, as a consequence of the U.K. leaving the EU (Brexit), the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority for the U.K. In China, following significant regulatory reforms in recent years, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle- and lower-income require marketing approval by a recognized regulatory authority (i.e., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU/EEA, the EMAs Pharmacovigilance Risk Assessment Committee is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., China, Japan, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of measures including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations, such as the World Health Organization and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. On November 25, 2020, the European Commission published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. In China, pricing pressures have increased in recent years, with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. Drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program has also been initiated and expanded nationwide, under which a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to Pfizer Inc. 2020 Form 10-K implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, following a review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including the EUs General Data Protection Regulations. The legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2020 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $42 million in environment-related capital expenditures and $120 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is clear: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2020, we employed approximately 78,500 people worldwide, with approximately 29,400 based in the U.S. Women compose approximately 48% of our workforce, and approximately 32% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, and offering competitive compensation and benefits programs that encourage healthy work-life balance, so that all colleagues feel ready, equipped and energized to deliver innovative breakthroughs that extend and significantly improve patients lives. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our new and expanded commitments to equity include specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) increasing the representation of both women and underrepresented ethnic groups; (ii) providing resources to support managers in having courageous conversations about equity, race and the avoidance of bias within their teams; (iii) revising our Political Action Committee (PAC) bylaws to help ensure that PAC recipients consistently demonstrate conduct that align with our core values; and (iv) working to help ensure recruitment demographics of all clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . We understand the importance of continuously listening and responding to colleague feedback. Our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their Pfizer experience and equips leaders with Pfizer Inc. 2020 Form 10-K actionable insights for discussion and follow up. Regular topics in the survey include (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer, and (ii) purpose, including how colleagues work connects with our purpose. Through these surveys, we can measure and track the degree to which colleagues are proud to work at Pfizer, would recommend Pfizer as a great place to work to others and intend to stay with Pfizer. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insights is based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. We strive to ensure that all colleagues have an equal opportunity to grow and offer a variety of programs including mentoring, job rotations, experiential project roles, skill based volunteering and learning programs focused on many topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being. We are committed to the health, safety and well-being of our colleagues and continue to advance a comprehensive occupational injury and illness prevention program. During 2020, our COVID-19 pandemic preparedness and response was a primary focus. Our comprehensive pandemic response plan incorporates guidance issued by external health authorities and is designed to keep onsite workers at our manufacturing and research sites safe and healthy. A global employee assistance program provides stress management, mental health, emotional, resiliency and pandemic guidance and support to our colleagues. Pay Equity. We are committed to pay equity, based on gender or race/ethnicity, and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the Careers section of Pfizers website. AVAILABLE INFORM ATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 25, 2021. Our Proxy Statement will be available on our website on or about March 11, 2021. Our 2020 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 11, 2021. Information in our ESG Report is not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. "," ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is not meant to be a complete discussion of all potential risks or uncertainties. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. Negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line drugs and drug candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. While multi-source generic competition for Chantix has not yet begun, it could commence at anytime. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against JJ alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or alliance revenues of more than $1 billion for each of seven products that collectively accounted for 53% of our total revenues in 2020. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and other Intellectual Property Rights section in this Form 10-K. Pfizer Inc. 2020 Form 10-K In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17B . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, either through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political or civil unrest, terrorist activity, unstable governments and legal systems and inter-governmental disputes. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. In addition, since a significant portion of our business is conducted in the EU, as well as the U.K., the changes resulting from Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 48% of our total 2020 revenues were derived from international operations, including 23% from Europe and 17% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Notes 7E and 11 . From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend Pfizer Inc. 2020 Form 10-K any contracts to accommodate the SOFR rate where required. While our exposure to LIBOR is very low, market volatility related to the transition may adversely affect the trading market for securities linked to such benchmarks. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in product manufacturing, sales or marketing due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, damage to our facilities due to natural or man-made disasters, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain appropriate quality standards throughout our supply network and/or comply with applicable regulations; and supply chain disruptions at our facilities or at a supplier or vendor. Regulatory agencies periodically inspect our manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. For example, in September 2017, our subsidiary, Meridian, received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as Official Action Indicated (OAI). Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines prime targets for counterfeiters. Counterfeit medicines pose a significant risk to patient health and safety because of the conditions under which they are manufactured often in unregulated, unlicensed, uninspected and unsanitary sites as well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact our business, by, among other things, causing patient harm, the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the Internet in lieu of traditional brick and mortar pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of the anonymity it affords counterfeiters. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. Some states have implemented, and others are considering, price controls or patient access constraints under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have recently focused on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, Pfizer Inc. 2020 Form 10-K could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for new COVID-19 therapies and vaccines. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare reform, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending that could affect pharmaceutical utilization and pricing as does the Medicare Payment Advisory Commission. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval from regulators. Regulatory approvals of our products depend on myriad factors, including a regulator making a determination as to whether a product is safe and efficacious. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP, that may impact the use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as Pfizer Inc. 2020 Form 10-K other products in the class. The potential regulatory and commercial implications of post-marketing study results, for approved indications and potential new indications of an in-line product, typically cannot immediately be determined. For example, the potential impact of the co-primary endpoint results from a recently completed post-marketing required safety study of Xeljanz, ORAL Surveillance (A3921133), announced in January 2021, and related results, analyses and discussions with and reviews by regulators, remain uncertain. We are working with the FDA and other regulatory agencies to review the full results and analyses as they become available. The terms of our EUA for the BNT162b2 vaccine require that we conduct post-authorization observational studies. In addition, the FDA expects EUA holders to work towards submission of full application, such as a BLA, as soon as possible. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices Pfizer Inc. 2020 Form 10-K that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems to operate our business. We collect, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party vendors who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or malicious attackers. Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent cyber-attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may result in additional expenses and may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. GSK has indicated that it intends to separate the JV as an independent company listed on the U.K. equity market. Until July 31, 2024, GSK has the exclusive right to initiate a separation and listing transaction. We have the option to participate in a separation and listing transaction initiated by GSK. However, the separation and public listing transaction may not be initiated or completed within expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for us or our shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others, impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain interruptions, including challenges related to reliance on third-party suppliers; disruptions to pipeline development and clinical trials, including difficulties or delays in enrollment of certain clinical trials and in access to needed supplies; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; further reduced product demand as a result of increased unemployment; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; potential increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce, Pfizer Inc. 2020 Form 10-K intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution, including, among others, uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical or clinical data (including the in vitro and Phase 3 data for the Pfizer-BioNTech COVID-19 vaccine (BNT162b2)), including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data; the ability to produce comparable clinical or other results, including the rate of vaccine effectiveness and safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial and additional studies or in larger, more diverse populations upon commercialization; the ability of BNT162b2 to prevent COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program or other programs will be published in scientific publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; when other biologics license and/or EUA applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines that may arise from the BNT162 program, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any applications that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines benefits outweigh its known risks and determination of the vaccines efficacy and, if approved, whether it will be commercially successful; regulatory decisions impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines ultra-low temperature formulation, two-dose schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program or potential treatment for COVID-19; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any potential approved treatment, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine within the projected time periods as previously indicated; whether and when additional supply agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public vaccine confidence or awareness; trade restrictions; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. Pfizer Inc. 2020 Form 10-K INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, taxation requirements, competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 1B. UNRESOLVED STAFF COMMENTS N/A ITEM 2. PROPERTIES ITEM 3. LEGAL PROCEEDINGS ITEM 4. MINE SAFETY DISCLOSURES N/A INFORMATION ABOUT OUR EXECUTIVE OFFICERS PART II ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES ITEM 6. SELECTED FINANCIAL DATA ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ITEM 9A. CONTROLS AND PROCEDURES ITEM 9B. OTHER INFORMATION N/A PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 15(a)(1) Financial Statements 15(a)(2) Financial Statement Schedules 15(a)(3) Exhibits ITEM 16. FORM 10-K SUMMARY N/A = Not Applicable DEFINED TERMS Unless the context requires otherwise, references to Pfizer, the Company, we, us or our in this Form 10-K (defined below) refer to Pfizer Inc. and its subsidiaries. The financial information included in our consolidated financial statements for our subsidiaries operating outside the U.S. is as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. References to Notes in this Form 10-K are to the Notes to the consolidated financial statements in Item 8. Financial Statements and Supplementary Data in this Form 10-K. We also have used several other terms in this Form 10-K, most of which are explained or defined below. 2018 Financial Report Exhibit 13 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2018 Form 10-K This Annual Report on Form 10-K for the fiscal year ended December 31, 2020 Proxy Statement Proxy Statement for the 2021 Annual Meeting of Shareholders, which will be filed no later than 120 days after December 31, 2020 AbbVie AbbVie Inc. ABO Accumulated benefit obligation represents the present value of the benefit obligation earned through the end of the year but does not factor in future compensation increases ACA (also referred to as U.S. Healthcare Legislation) U.S. Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act ACIP Advisory Committee on Immunization Practices Akcea Akcea Therapeutics, Inc. ALK anaplastic lymphoma kinase Alliance revenues Revenues from alliance agreements under which we co-promote products discovered or developed by other companies or us Allogene Allogene Therapeutics, Inc. AML Acute Myeloid Leukemia Anacor Anacor Pharmaceuticals, Inc. AOCI Accumulated Other Comprehensive Income Array Array BioPharma Inc. Astellas Astellas Pharma Inc., Astellas US LLC and Astellas Pharma US, Inc. ATTR-CM transthyretin amyloid cardiomyopathy Bain Capital Bain Capital Private Equity and Bain Capital Life Sciences Biogen Biogen Inc. BioNTech BioNTech SE Biopharma Pfizer Biopharmaceuticals Group BMS Bristol-Myers Squibb Company BNT162b2 Pfizer-BioNTech COVID-19 Vaccine BOD Board of Directors BRCA BReast CAncer susceptibility gene CAR T chimeric antigen receptor T cell CDC U.S. Centers for Disease Control and Prevention Cellectis Cellectis S.A. Cerevel Cerevel Therapeutics, LLC cGMPs current Good Manufacturing Practices CIAS cognitive impairment associated with schizophrenia Consumer Healthcare JV GSK Consumer Healthcare JV COVID-19 novel coronavirus disease of 2019 CMA conditional marketing authorization CStone CStone Pharmaceuticals DEA U.S. Drug Enforcement Agency Developed Europe Includes the following markets: Western Europe, Scandinavian countries and Finland Developed Markets Includes the following markets: U.S., Developed Europe, Japan, Canada, Australia, South Korea and New Zealand Developed Rest of World Includes the following markets: Japan, Canada, Australia, South Korea and New Zealand EMA European Medicines Agency Emerging Markets Includes, but is not limited to, the following markets: Asia (excluding Japan and South Korea), Latin America, Eastern Europe, Africa, the Middle East, Central Europe and Turkey EPS earnings per share ESOP employee stock ownership plan EU European Union EUA emergency use authorization Exchange Act Securities Exchange Act of 1934, as amended FASB Financial Accounting Standards Board FCPA U.S. Foreign Corrupt Practices Act FDA U.S. Food and Drug Administration Pfizer Inc. 2020 Form 10-K i FFDCA U.S. Federal Food, Drug and Cosmetic Act GAAP Generally Accepted Accounting Principles GDFV grant-date fair value GIST gastrointestinal stromal tumors GPD Global Product Development organization GSK GlaxoSmithKline plc Hospira Hospira, Inc. Ionis Ionis Pharmaceuticals, Inc. IPRD in-process research and development IRC Internal Revenue Code IRS U.S. Internal Revenue Service IV intravenous JJ Johnson Johnson JV joint venture King King Pharmaceuticals LLC (formerly King Pharmaceuticals, Inc.) LDL low density lipoprotein LIBOR London Interbank Offered Rate Lilly Eli Lilly Company LOE loss of exclusivity MCO managed care organization mCRC metastatic colorectal cancer mCRPC metastatic castration-resistant prostate cancer mCSPC metastatic castration-sensitive prostate cancer mRNA messenger ribonucleic acid MDA Managements Discussion and Analysis of Financial Condition and Results of Operations Medivation Medivation LLC (formerly Medivation Inc.) Meridian Meridian Medical Technologies, Inc. Moodys Moodys Investors Service Mylan Mylan N.V. Mylan-Japan collaboration a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan that terminated on December 21, 2020 Myovant Myovant Sciences Ltd. NAV net asset value NDA new drug application nmCRPC non-metastatic castration-resistant prostate cancer NMPA National Medical Product Administration in China NYSE New York Stock Exchange OTC over-the-counter PBM pharmacy benefit manager PBO Projected benefit obligation; represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases PCPP Pfizer Consolidated Pension Plan PGS Pfizer Global Supply Pharmacia Pharmacia Corporation PMDA Pharmaceuticals and Medical Device Agency in Japan PsA psoriatic arthritis QCE quality consistency evaluation RA rheumatoid arthritis RCC renal cell carcinoma RD research and development ROU right of use Sandoz Sandoz, Inc., a division of Novartis AG SP Standard Poors SEC U.S. Securities and Exchange Commission Servier Les Laboratoires Servier SAS Shire Shire International GmbH Tax Cuts and Jobs Act or TCJA Legislation commonly referred to as the U.S. Tax Cuts and Jobs Act of 2017 Teva Teva Pharmaceuticals USA, Inc. Therachon Therachon Holding AG Pfizer Inc. 2020 Form 10-K ii Upjohn Business Pfizers global, primarily off-patent branded and generics business, which includes a portfolio of 20 globally recognized solid oral dose brands, including Lipitor, Lyrica, Norvasc, Celebrex and Viagra, as well as a U.S.-based generics platform, Greenstone, that was spun-off on November 16, 2020 and combined with Mylan to create Viatris UC ulcerative colitis U.K. United Kingdom U.S. United States VAI Voluntary Action Indicated Valneva Valneva SE VBP volume-based procurement Viatris Viatris Inc. ViiV ViiV Healthcare Limited WRDM Worldwide Research, Development and Medical This Form 10-K includes discussion of certain clinical studies relating to various in-line products and/or product candidates. These studies typically are part of a larger body of clinical data relating to such products or product candidates, and the discussion herein should be considered in the context of the larger body of data. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. Some amounts in this Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks mentioned are the property of their owners. FORWARD-LOOKING INFORMATION AND FACTORS THAT MAY AFFECT FUTURE RESULTS This Form 10-K contains forward-looking statements. We also provide forward-looking statements in other materials we release to the public, as well as public oral statements. Given their forward-looking nature, these statements involve substantial risks, uncertainties and potentially inaccurate assumptions. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek and other words and terms of similar meaning or by using future dates. We include forward-looking information in our discussion of the following, among other topics: our anticipated operating and financial performance, reorganizations, business plans and prospects; expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, post-approval clinical trial results and other developing data that become available, revenue contribution, growth, performance, timing of exclusivity and potential benefits; strategic reviews, capital allocation objectives, dividends and share repurchases; plans for and prospects of our acquisitions, dispositions and other business development activities, and our ability to successfully capitalize on these opportunities; sales, expenses, interest rates, foreign exchange rates and the outcome of contingencies, such as legal proceedings; expectations for impact of or changes to existing or new government regulations or laws; our ability to anticipate and respond to macroeconomic, geopolitical, health and industry trends, pandemics, acts of war and other large-scale crises; and manufacturing and product supply. In particular, forward-looking information in this Form 10-K includes statements relating to specific future actions and effects, including, among others, our efforts to respond to COVID-19, including our development of a vaccine to help prevent COVID-19, the forecasted revenue contribution of BNT162b2 and the potential number of doses that we and BioNTech believe can be delivered; our expectations regarding the impact of COVID-19 on our business; the expected impact of patent expiries and competition from generic manufacturers; the expected pricing pressures on our products and the anticipated impact to our business; the availability of raw materials for 2021; the expected charges and/or costs in connection with the spin-off of the Upjohn Business and its combination with Mylan; the benefits expected from our business development transactions; our anticipated liquidity position; the anticipated costs and savings from certain of our initiatives, including our Transforming to a More Focused Company program; our planned capital spending; the expectations for our quarterly dividend payments; and the expected benefit payments and employer contributions for our benefit plans. Given their nature, we cannot assure that any outcome expressed in these forward-looking statements will be realized in whole or in part. Actual outcomes may vary materially from past results and those anticipated, estimated, implied or projected. These forward-looking statements may be affected by underlying assumptions that may prove inaccurate or incomplete, or by known or unknown risks and uncertainties, including those described in this section and in the Item 1A. Risk Factors section in this Form 10-K. Therefore, you are cautioned not to unduly rely on forward-looking statements, which speak only as of the date of this Form 10-K. We undertake no obligation to update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities law. You are advised, however, to consult any further disclosures we make on related subjects. Some of the factors that could cause actual results to differ are identified below, as well as those discussed in the Item 1A. Risk Factors section in this Form 10-K and within MDA. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. The occurrence of any of the risks identified below or in the Item 1A. Risk Factors section in this Form 10-K, or other risks currently unknown, could have a material adverse effect on our business, financial condition or results of operations, or we may be required to increase our accruals for contingencies. It is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties: Pfizer Inc. 2020 Form 10-K iii Risks Related to Our Business, Industry and Operations, and Business Development: the outcome of RD activities, including, the ability to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, and/or regulatory approval and/or launch dates, as well as the possibility of unfavorable pre-clinical and clinical trial results, including the possibility of unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data; our ability to successfully address comments received from regulatory authorities such as the FDA or the EMA, or obtain approval from regulators on a timely basis or at all; regulatory decisions impacting labeling, manufacturing processes, safety and/or other matters; the impact of recommendations by technical or advisory committees; and the timing of pricing approvals and product launches; claims and concerns that may arise regarding the safety or efficacy of in-line products and product candidates, including claims and concerns that may arise from the outcome of post-approval clinical trials, which could impact marketing approval, product labeling, and/or availability or commercial potential, including uncertainties regarding the commercial or other impact of the results of the Xeljanz ORAL Surveillance (A3921133) study or any potential actions by regulatory authorities based on analysis of ORAL Surveillance or other data; the success and impact of external business development activities, including the ability to identify and execute on potential business development opportunities; the ability to satisfy the conditions to closing of announced transactions in the anticipated time frame or at all; the ability to realize the anticipated benefits of any such transactions in the anticipated time frame or at all; the potential need for and impact of additional equity or debt financing to pursue these opportunities, which could result in increased leverage and/or a downgrade of our credit ratings; challenges integrating the businesses and operations; disruption to business and operations relationships; risks related to growing revenues for certain acquired products; significant transaction costs; and unknown liabilities; competition, including from new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates; the ability to successfully market both new and existing products, including biosimilars; difficulties or delays in manufacturing, sales or marketing; supply disruptions, shortages or stock-outs at our facilities; and legal or regulatory actions; the impact of public health outbreaks, epidemics or pandemics (such as the COVID-19 pandemic) on our business, operations and financial condition and results; risks and uncertainties related to our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution; trends toward managed care and healthcare cost containment, and our ability to obtain or maintain timely or adequate pricing or favorable formulary placement for our products; interest rate and foreign currency exchange rate fluctuations, including the impact of possible currency devaluations in countries experiencing high inflation rates; any significant issues involving our largest wholesale distributors, which account for a substantial portion of our revenues; the impact of the increased presence of counterfeit medicines in the pharmaceutical supply chain; any significant issues related to the outsourcing of certain operational and staff functions to third parties; and any significant issues related to our JVs and other third-party business arrangements; uncertainties related to general economic, political, business, industry, regulatory and market conditions including, without limitation, uncertainties related to the impact on us, our customers, suppliers and lenders and counterparties to our foreign-exchange and interest-rate agreements of challenging global economic conditions and recent and possible future changes in global financial markets; any changes in business, political and economic conditions due to actual or threatened terrorist activity, civil unrest or military action; the impact of product recalls, withdrawals and other unusual items; trade buying patterns; the risk of an impairment charge related to our intangible assets, goodwill or equity-method investments; the impact of, and risks and uncertainties related to, restructurings and internal reorganizations, as well as any other corporate strategic initiatives, and cost-reduction and productivity initiatives, each of which requires upfront costs but may fail to yield anticipated benefits and may result in unexpected costs or organizational disruption; Risks Related to Government Regulation and Legal Proceedings : the impact of any U.S. healthcare reform or legislation or any significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs or changes in the tax treatment of employer-sponsored health insurance that may be implemented; U.S. federal or state legislation or regulatory action and/or policy efforts affecting, among other things, pharmaceutical product pricing, intellectual property, reimbursement or access or restrictions on U.S. direct-to-consumer advertising; limitations on interactions with healthcare professionals and other industry stakeholders; as well as pricing pressures for our products as a result of highly competitive insurance markets; legislation or regulatory action in markets outside of the U.S., including China, affecting pharmaceutical product pricing, intellectual property, reimbursement or access, including, in particular, continued government-mandated reductions in prices and access restrictions for certain biopharmaceutical products to control costs in those markets; the exposure of our operations outside of the U.S. to possible capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, as well as political unrest, unstable governments and legal systems and inter-governmental disputes; Pfizer Inc. 2020 Form 10-K iv legal defense costs, insurance expenses, settlement costs and contingencies, including those related to actual or alleged environmental contamination; the risk and impact of an adverse decision or settlement and the adequacy of reserves related to legal proceedings; the risk and impact of tax related litigation; governmental laws and regulations affecting our operations, including, without limitation, changes in laws and regulations or their interpretation, including, among others, changes in taxation requirements; Risks Related to Intellectual Property, Technology and Security: any significant breakdown, infiltration or interruption of our information technology systems and infrastructure; the risk that our currently pending or future patent applications may not be granted on a timely basis or at all, or any patent-term extensions that we seek may not be granted on a timely basis, if at all; and our ability to protect our patents and other intellectual property, including against claims of invalidity that could result in LOE and in response to any pressure, or legal or regulatory action by, various stakeholders or governments that could potentially result in us not seeking intellectual property protection for or agreeing not to enforce intellectual property related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19. Pfizer Inc. 2020 Form 10-K v PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwide. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. Most of our revenues come from the manufacture and sale of our products, principally biopharmaceutical products, and to a lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. We believe that our medicines and vaccines provide significant value for healthcare providers and patients, through improved treatment of diseases, improvements in health, wellness and productivity as well as by reducing other healthcare costs, such as emergency room or hospitalization. We seek to enhance the value of our medicines and vaccines and actively engage in dialogues about how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We seek to maximize patient access and evaluate our pricing arrangements and contracting methods with payers to minimize adverse impact on our revenues within the current legal and pricing structures. We are committed to fulfilling our purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. Pfizers growth strategy is driven by five Bold Moves that help us deliver breakthroughs for patients and create value for shareholders and other stakeholders: 1. Unleash the power of our people; 2. Deliver first-in-class science; 3. Transform our go-to-market model; 4. Win the digital race in pharma; and 5. Lead the conversation. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. Following (i) the recent spin-off and combination of the Upjohn Business (which was our global, primarily off-patent branded and generics business) with Mylan, which created a new global pharmaceutical company, Viatris, in November 2020 and (ii) the formation of the Consumer Healthcare JV in 2019, we saw the culmination of Pfizers transformation into a more focused, innovative science-based biopharmaceutical products business. Our significant recent business development activities in 2020 include: (i) the April 2020 agreement with BioNTech to develop, manufacture and commercialize an mRNA-based coronavirus vaccine program, BNT162, aimed at preventing COVID-19, (ii) the June 2020 agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, (iii) the September 2020 entry into a strategic collaboration with CStone to develop and commercialize a PD-L1 antibody, sugemalimab, and to bring additional oncology assets to China, (iv) the November 2020 spin-off and combination of the Upjohn Business with Mylan, and (v) the December 2020 entry into a collaboration with Myovant to jointly develop and commercialize relugolix in advanced prostate cancer and womens health in the U.S. and Canada. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Note 2 . In 2020, our business, operations and financial condition and results were impacted by the COVID-19 pandemic. To confront the public health challenge posed by the pandemic, we have made some important advances, including, among others, the development of a vaccine to help prevent COVID-19. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA and the Item 1A. Risk FactorsDevelopment, Regulatory Approval and Marketing of Products and COVID-19 Pandemic sections in this Form 10-K. COMMERCIAL OPERATIONS In 2020, we managed our commercial operations through a global structure consisting of two businessesBiopharma, and, through November 16, 2020, Upjohn, each led by a single manager. On November 16, 2020, we completed the spin-off and combination of the Upjohn Business with Mylan. Following the combination, we now operate as a focused innovative biopharmaceutical company engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. In 2019, Consumer Healthcare, which was our OTC medicines business, was Pfizer Inc. 2020 Form 10-K combined with GSKs consumer healthcare business to form a consumer healthcare JV in which we own a 32% equity stake. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook section within MDA and Notes 1A and 2C. Our business includes the following therapeutic areas and key products: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis*, Chantix/Champix* and the Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies and biosimilars across a wide range of cancers. Ibrance*, Xtandi*, Sutent*, Inlyta, Retacrit, Lorbrena and Braftovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Zithromax, Vfend and Panzyga Vaccines Includes innovative vaccines across all agesinfants, adolescents and adultsin pneumococcal disease, meningococcal disease, tick-borne encephalitis and COVID-19, with a pipeline focus on infectious diseases with significant unmet medical need. Prevnar 13/Prevenar 13 (pediatric/adult)*, Nimenrix, FSME/IMMUN-TicoVac, Trumenba and the Pfizer-BioNTech COVID-19 vaccine Inflammation Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz*, Enbrel (outside the U.S. and Canada)*, Inflectra and Eucrisa/Staquis Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia and endocrine diseases. Vyndaqel/Vyndamax*, BeneFIX and Genotropin * Each of Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz and Enbrel recorded direct product and/or Alliance revenues of more than $1 billion in 2020, 2019 and 2018. Each of Xtandi and Vyndaqel/Vyndamax recorded direct product and/or Alliance revenues of more than $1 billion in 2020, Chantix/Champix recorded direct product revenues of more than $1 billion in 2019 and 2018 and Sutent recorded direct product revenues of more than $1 billion in 2018. Eliquis includes Alliance revenues and direct sales. For additional information on the key operational revenue drivers of our business, see the Analysis of the Consolidated Statements of Income section within MDA. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk FactorsConcentration section in this Form 10-K. COLLABORATION AND CO-PROMOTION We use collaboration and/or co-promotion arrangements to enhance our development, RD, sales and distribution of certain biopharmaceutical products, which include, among others, the following: Pfizer-BioNTech COVID-19 Vaccine (BNT162b2) is an mRNA-based coronavirus vaccine to help prevent COVID-19 which is being jointly developed and commercialized with BioNTech. Pfizer and BioNTech will equally share the costs of development for the BNT162 program. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. We will also share gross profits equally from commercialization of BNT162b2 and are working jointly with BioNTech in our respective territories to commercialize the vaccine worldwide (excluding China, Hong Kong, Macau and Taiwan), subject to regulatory authorizations or approvals market by market. For discussion on BNT162b2, see the Overview of Our Performance, Operating Environment, Strategy and OutlookCOVID-19 Pandemic section within MDA. Eliquis (apixaban) is part of the Novel Oral Anticoagulant market and was jointly developed and commercialized with BMS as an alternative treatment option to warfarin in appropriate patients. We fund between 50% and 60% of all development costs depending on the study, and profits and losses are shared equally except in certain countries where we commercialize Eliquis and pay a percentage of net sales to BMS. In certain smaller markets we have full commercialization rights and BMS supplies the product to us at cost plus a percentage of the net sales to end-customers. Xtandi (enzalutamide) is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells that is being developed and commercialized in collaboration with Astellas. We share equally in the gross profits and losses related to U.S. net sales and also share equally all Xtandi commercialization costs attributable to the U.S. market, subject to certain exceptions. In addition, we share certain development and other collaboration expenses. For international net sales we receive royalties based on a tiered percentage. Bavencio (avelumab) is a human anti-programmed death ligand-1 (PD-L1) antibody that is being developed and commercialized in collaboration with Merck KGaA. We jointly fund the majority of development and commercialization costs and split profits equally related to net sales generated from any products containing avelumab. Orgovyx (relugolix) is an oral gonadotropin-releasing hormone (GnRH) receptor antagonist approved by the FDA for the treatment of adult patients with advanced prostate cancer that is being developed and commercialized with Myovant. The companies are also collaborating on relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health. The companies will equally share profits and allowable expenses in the U.S. and Canada for Orgovyx and the relugolix combination tablet, with Myovant bearing our share of allowable expenses up to a maximum of $100 million in 2021 and up to a maximum of $50 million in 2022. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Revenues associated with these arrangements are included in Alliance revenues (except in certain markets where we have direct sales and except for the majority of revenues for BNT162b2, which are included as direct product revenues). In addition, we have collaboration arrangements for the development and commercialization of certain pipeline products that are in development stage, including, among others, with Lilly to jointly develop and globally commercialize tanezumab for the treatment of osteoarthritis pain and cancer pain, under which the companies share equally the ongoing development costs and, if successful, will co-commercialize and share equally in profits and certain expenses in the U.S., while Pfizer will be responsible for commercialization activities and costs outside the U.S., with Lilly having the right to Pfizer Inc. 2020 Form 10-K receive certain tiered royalties outside the U.S. For further discussion of collaboration and co-promotion agreements, see the Item 1A. Risk FactorsCollaborations and Other Relationships with Third Parties section in this Form 10-K and Notes 2 and 17 . RESEARCH AND DEVELOPMENT RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. The discovery and development of drugs and biological products are time consuming, costly and unpredictable. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. Our RD Priorities and Strategy. Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where we have a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position us for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on our main therapeutic areas. While a significant portion of our RD is internal, we also seek promising chemical and biological lead molecules and innovative technologies developed by others to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with universities, biotechnology companies and other firms as well as through acquisitions and investments. We also have arrangements with third parties that fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive future payments, such as milestone-based, revenue sharing, or profit-sharing payments or royalties. These collaboration, alliance, license and funding agreements and investments allow us to share knowledge, risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For information on certain of these collaborations, alliances, license and funding arrangements and investments, see Note 2 . Our RD Operations. In 2020, we continued to strengthen our global RD operations and pursue strategies to improve RD productivity to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time . Our RD activity is conducted through various platform functions that operate in parallel within our global operations, including the following: WRDM. Research units are generally responsible for research and early-stage development assets for our business (assets that have not yet achieved proof-of-concept) and are organized by therapeutic area to enhance flexibility, cohesiveness and focus. We can rapidly redeploy resources within a research unit and between various projects to leverage, as necessary, common skills, expertise or focus. GPD. GPD is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in our portfolio. Science-based platform-services organizations. These organizations provide technical expertise and other services to various RD projects, and are organized into science-based functions (which are part of our WRDM organization) such as Pharmaceutical Sciences and Medicine Design. These organizations allow us to react more quickly and effectively to evolving needs by sharing resources among projects, candidates and targets across therapeutic areas and phases of development. Another platform-service organization is the Worldwide Medical and Safety (WMS) group, which includes worldwide safety surveillance, medical information and the Chief Medical Office. The WMS group provides patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information about the risks and benefits associated with Pfizers RD programs and marketed products so they can make appropriate decisions on how and when to use our products. We manage RD operations on a total-company basis through our platform functions described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. We do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. In 2020, the RD organization within Upjohn supported the off-patent branded and generic established medicines and managed its resources separately from the WRDM and GPD organizations. Following the spin-off and combination of the Upjohn Business with Mylan to create Viatris, we have agreed to provide certain transition services to Viatris including support for RD, pharmacovigilance and safety surveillance. For additional information, see the Costs and Expenses Research and Development (RD) Expenses section within MDA. Pfizer Inc. 2020 Form 10-K Our RD Pipeline. The process of drug and biological product discovery from initiation through development and to potential regulatory approval is lengthy and can take more than ten years. As of February 2, 2021, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While our drug candidates may or may not receive regulatory approval, new candidates entering clinical development phases are the foundation for future products. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments section within MDA. For information on the risks associated with RD, see the Item 1A. Risk FactorsResearch and Development section of this Form 10-K. INTERNATIONAL OPERATIONS Our operations are conducted globally, and we sell our products in over 125 countries. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets provide potential growth opportunities for our products. Revenues from operations outside the U.S. of $20.2 billion accounted for 48% of our total revenues in 2020. Revenues exceeded $500 million in each of 8, 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and the table captioned Geographic Information in Note 17A . Our international operations are subject to risks inherent in carrying on business in other countries. For additional information, see the Item 1A. Risk Factors Global Operations and Item 1. Business Government Regulation and Price Constraints sections in this Form 10-K. SALES AND MARKETING Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. A portion of our government contracts are subject to renegotiation or termination of contracts or subcontracts at the discretion of a government entity. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. For information on our largest biopharmaceutical wholesalers, see Note 17B . Pfizer Inc. 2020 Form 10-K We promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues and our patient assistance programs. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Patents . We own or license a number of patents covering pharmaceutical and other products, their uses, formulations, and product manufacturing processes. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The scope of protection afforded by a patent can vary from country to country and depends on the patent type, the scope of its patent claims and the availability of legal remedies. Patent term extensions (PTE) may be available in some countries to compensate for a loss of patent term due to delay in a products approval due to the regulatory requirements. One of the primary considerations in limiting our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products, although international and U.S. free trade agreements have included some improved global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. In various markets, a period of regulatory exclusivity may be provided for drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. Based on current sales, and considering the competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires, are as follows: Drug U.S. Basic Product Patent Expiration Year (1) Major Europe Basic Product Patent Expiration Year (1) Japan Basic Product Patent Expiration Year (1) Chantix/Champix 2020 (2) 2021 2022 Sutent 2021 2022 2024 Inlyta 2025 2025 2025 Xeljanz 2025 2028 (3) 2025 Prevnar 13/Prevenar 13 2026 __(4) 2029 Eliquis (5) 2026 2026 2026 Ibrance 2027 2028 2028 Xtandi (6) 2027 * (6) * (6) Vyndaqel/Vyndamax 2024 (2028 pending PTE) 2026 2026 Xalkori 2029 2027 2028 Besponsa 2030 2028 2028 (7) Braftovi (8) 2031 (2031 pending PTE) * (8) * (8) Mektovi (8) 2031 (9) * (8) * (8) Bavencio (10) 2033 2032 2033 Lorbrena 2033 2034 2036 (1) Unless otherwise indicated, the years pertain to the basic product patent expiration, including granted PTEs, supplementary protection certificates (SPC) or pediatric exclusivity periods. SPCs are included when granted in three out of five major European markets (France, Germany, Italy, Spain and the U.K.). Noted in parentheses is the projected year of expiry of the earliest pending patent term extension in the U.S. or Japan and/or SPC application in Europe, the term of which, if granted, may be shorter than originally requested due to a number of factors. In some instances, there are later-expiring patents relating to our products which may or may not protect our drug from generic or biosimilar competition after the expiration of the basic patent. (2) The basic product patent for Chantix in the U.S. expired in November 2020. (3) Xeljanz Europe expiry is provided by regulatory exclusivity. (4) The Europe patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other Europe patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (5) Eliquis was developed and is being commercialized in collaboration with BMS. For Eliquis in the U.S., two patents listed in the FDA Orange Book, the composition of matter patent claiming apixaban specifically and a formulation patent, were challenged by numerous generic companies and are the subject of patent infringement litigation. Prior to the August 2020 ruling referenced in the following sentence, we and BMS settled with a number of these generic companies (settled generic companies) while continuing to litigate against three remaining generic companies (remaining generic companies). In August 2020, the U.S. District Court for the District of Delaware decided that the two challenged Eliquis patents are both valid and infringed by the remaining generic companies. The remaining generic companies have appealed the Delaware court decision and the final decision in this case could determine when generic versions of Eliquis will come on the market. While we cannot predict the outcome of this pending litigation, these are the alternatives that might occur: (a) If the district courts decision is upheld in the current appeal with respect to both patents, under the terms of previously executed settlement agreements with the settled generic companies, the permitted date of launch for the settled generic companies under these patents is April 1, 2028; (b) if the formulation patent is held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies would be permitted to launch on November 21, 2026; or (c) if both patents are held invalid or not infringed in the current appeal, the settled generic companies and the remaining generic companies could launch products immediately upon such an adverse decision. In addition, both patents may be subject to subsequent challenges by parties other than the remaining generic companies. If this were to occur, depending on the outcome of the subsequent challenge, the potential launch by generic companies, including challengers, if successful, could occur on timelines similar to those discussed above. Pfizer Inc. 2020 Form 10-K Refer to Note 16A1 for more information. (6) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (7) Besponsa Japan expiry is provided by regulatory exclusivity. (8) We have exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. We receive royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (9) Mektovi U.S. expiry is provided by a method of use patent. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. Also, if one of our product-related patents is found to be invalid by judicial, court or regulatory or administrative proceedings, generic or biosimilar products could be introduced, resulting in the erosion of sales of our existing products. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to help ensure appropriate patient access. For additional information, see the Item 1A. Risk Factors Intellectual Property Protection, Third Party Intellectual Property Claims and Competitive Products sections in this Form 10-K and Note 16A1 . Losses of Product Exclusivity. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. The basic product patent for Chantix in the U.S. expired on November 10, 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. For additional information on the impact of LOEs on our revenues, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion section within MDA. Trademarks . Our products are sold under brand-name and logo trademarks and trade dress. Registrations generally are for fixed, but renewable, terms and protection is provided in some countries for as long as the mark is used while in others, for as long as it is registered. Protecting our trademarks is of material importance to Pfizer. COMPETITION Our business is conducted in intensely competitive and often highly regulated markets. Many of our products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use and cost. Though the means of competition vary among our products, demonstrating the value of our products is a critical factor for success. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. These competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. Our competitors also may devote substantial funds and resources to RD and their successful RD could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. To address competitive trends we continually emphasize innovation, which is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research continues even after drug approval as we seek to further demonstrate the value of our products for the conditions they treat, as well as potential new applications. We educate patients, physicians, payers and global health authorities on the benefits and risks of our medicines, and seek to continually enhance the organizational effectiveness of our biopharmaceutical functions, including to accurately and ethically launch and market our products to our customers. Operating conditions have also shifted as a result of increased global competitive pressures, industry regulation and cost containment. We continue to evaluate, adapt and improve our organization and business practices in an effort to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through our support for better healthcare solutions. Our vaccines may face competition from the introduction of alternative vaccines or next-generation vaccines prior to or after the expiration of their patents, which may adversely affect our future results. Our biosimilars compete with branded products from competitors, as well as other generics and biosimilars manufacturers. We sell biosimilars of certain inflammation immunology and oncology biologic medicines. We seek to maximize the opportunity to establish a first-to-market or early market position for our biosimilars to provide customers a lower-cost alternative immediately when available and also to potentially provide us with higher levels of sales and profitability until other competitors enter the market. Pfizer Inc. 2020 Form 10-K Generic Products . Generic pharmaceutical manufacturers pose one of the biggest competitive challenges to our branded small molecule products because they can market a competing version of our product after the expiration or loss of our patent and often charge much less. Several competitors regularly challenge our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2021 and beyond, which may result in price cuts and volume loss of some of our products. In addition, generic versions of competitors branded products may also compete with our products. MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S., and U.S. laws generally allow, and in some cases require, pharmacists to substitute generic drugs for brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Biosimilars. Certain of our biologic products, including Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to innovative biologic medicines. In the U.S., biosimilars referencing innovative biologic products are approved under the U.S. Public Health Service Act. PRICING PRESSURES AND MANAGED CARE ORGANIZATIONS Pricing Pressures. Pricing and access pressures in the commercial sector continue to be significant. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This trend is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures also may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Longer term, we foresee a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and help ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs. For information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this Form 10-K. Managed Care Organizations. The evolution of managed care in the U.S. has been a major factor in the competitiveness of the healthcare marketplace. Approximately 299 million people in the U.S. now have some form of health insurance coverage, and the marketing of prescription drugs to both consumers and the entities that manage coverage in the U.S. continues to grow in importance. In particular, the influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, consolidation in the MCO industry has resulted in fewer, even larger entities, which enhances MCOs ability to negotiate pricing and increases their importance to our business. Since MCOs seek to contain and reduce healthcare expenditures, their growing influence has increased pressure on drug prices as well as revenues. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to MCO members), clinical protocols (which require prior authorization for a branded product if a generic product is available or require the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier or non-preferred status in their formularies, MCOs transfer a portion of the cost to the patient, resulting in significant patient out-of-pocket expenses. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as ways to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed, and drugs that can reduce the need for hospitalization, professional therapy or surgery may become favored first-line treatments for certain diseases. Pfizer Inc. 2020 Form 10-K Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products, typically on the basis of unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, as well as the overall cost of the therapy. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. RAW MATERIALS We procure raw materials essential to our business from numerous suppliers worldwide. In general, these materials have been available in sufficient quantities to support our demand and in many cases are available from multiple suppliers. We have supplier management activities in place to monitor supply channels and to take action as needed to secure necessary volumes. No significant impact to our operations due to the availability of raw materials is currently anticipated in 2021. GOVERNMENT REGULATION AND PRICE CONSTRAINTS We are subject to extensive regulation by government authorities in the countries in which we do business. This includes laws and regulations governing pharmaceutical companies, such as the approval, manufacturing and marketing of products, pricing (including discounts and rebates) and health information privacy, among others. These laws and regulations may require administrative guidance for implementation, and a failure to comply could subject us to legal and administrative actions. Enforcement measures may include substantial fines and/or penalties, orders to stop non-compliant activities, criminal charges, warning letters, product recalls or seizures, delays in product approvals, exclusion from participation in government programs or contracts as well as limitations on conducting business in applicable jurisdictions, and could result in harm to our reputation and business. For additional information, see Note 16A. Compliance with these laws and regulations may be costly, and may require significant technical expertise and capital investment to ensure compliance. While capital expenditures or operating costs for compliance with government regulations cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. In the United States Drug and Biologic Regulation . The FDA, pursuant to the FFDCA, the Public Health Service Act and other federal statutes and regulations, extensively regulates pre- and post-marketing activities related to our biopharmaceutical products. The regulations govern areas such as the safety and efficacy of medicines, clinical trials, advertising and promotion, quality control, manufacturing, labeling, distribution, post-marketing safety surveillance and reporting, and record keeping. Other U.S. federal agencies, including the DEA, also regulate certain of our products and activities. Many of our activities are subject to the jurisdiction of the SEC. For a biopharmaceutical company to market a drug or a biologic product in the U.S., the FDA must evaluate whether the product is safe and effective for its intended use. If the FDA determines that the drug or biologic is safe and effective, the FDA will approve the products NDA or Biologics License Application (BLA) (or supplemental NDA or supplemental BLA), as appropriate. A drug or biologic may be subject to postmarketing commitments, which are studies or clinical trials that the product sponsor agrees to conduct, or postmarketing requirements, which are studies or clinical trials that are required as a condition of approval. Once a drug or biologic is approved, the FDA must be notified of any product modifications and may require additional studies or clinical trials. In addition, we are also required to report adverse events and comply with cGMPs (the FDA regulations that govern all aspects of manufacturing quality for pharmaceuticals), as well as advertising and promotion regulations. For additional information, see the Item 1A. Risk Factors Development, Regulatory Approval and Marketing of Products and Post-Approval Data section in this Form 10-K. In the context of public health emergencies like the COVID-19 pandemic, we may apply for EUA with the FDA, which when granted, allows for the distribution and use of our products during the term declared and extended by the government, in accordance with the conditions set forth in the EUA, unless the EUA is otherwise terminated at the governments discretion. Although the criteria of an EUA differ from the criteria for approval of an NDA or BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, and a number of ongoing compliance obligations. The FDA expects EUA holders to work toward submission of full applications, such as a BLA, as soon as possible. For BNT162b2, we are working towards submitting a BLA for possible full regulatory approval. Biosimilar Regulation. The FDA is responsible for approval of biosimilars. Innovator biologics are entitled to 12 years of market exclusivity by statute, and biosimilars applications may not be submitted until four years after the approval of the reference innovator biologic. Sales and Marketing Regulations . Our marketing practices are subject to state laws as well as federal laws, such as the Anti-Kickback Statute and False Claims Act, intended to prevent fraud and abuse in the healthcare industry. The Anti-Kickback Statute generally prohibits soliciting, offering, receiving, or paying anything of value to generate business. The False Claims Act generally prohibits anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. The federal government and states also regulate sales and marketing activities and financial interactions between manufacturers and healthcare providers, requiring disclosure to government authorities and the public of such interactions, and the adoption of compliance standards or programs. State attorneys general have also taken action to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Healthcare Reform . Any significant efforts at the federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. This includes potential replacements for the ACA, if it is ultimately invalidated by the U.S. Supreme Court in California v. Texas , as well as efforts at the state level to develop additional public insurance options or implement a single payer healthcare system. We do not expect that invalidation of the ACA itself would have a material impact on our business given the modest revenues the health insurance exchanges and Medicaid expansion generate for us. However, a future replacement of the ACA or other healthcare reform efforts may adversely affect our business and financial results, particularly if such replacement or reform reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Pfizer Inc. 2020 Form 10-K Pricing and Reimbursement . Pricing and reimbursement for our products depend in part on government regulation. In order to have our products covered by Medicaid, we must offer discounts or rebates on purchases of pharmaceutical products under various federal and state programs. We also must report specific prices to government agencies. The calculations necessary to determine the prices reported are complex and the failure to do so accurately may expose us to enforcement measures. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues by Geography section within MDA and Note 1G. Government and private payers routinely seek to manage utilization and control the costs of our products, and there is considerable public and government scrutiny of pharmaceutical pricing. Efforts by states and the federal government to regulate prices or payment for pharmaceutical products, including proposed actions to facilitate drug importation, limit reimbursement to lower international reference prices, require deep discounts, and require manufacturers to report and make public price increases and sometimes a written justification for the increase, could adversely affect our business if implemented. In the Fall of 2020, the Trump Administration finalized an importation pathway from Canada and a payment model to tie Medicare Part B physician reimbursement to international prices, though ultimate implementation of both is uncertain due to legal challenges. We expect to see continued focus on regulating pricing resulting in additional legislation and regulation under the newly elected Congress and the Biden Administration. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors Pricing and Reimbursement section in this Form 10-K. A majority of states use preferred drug lists to manage access to pharmaceutical products under Medicaid, including some of our products. For example, access to our products under the Medicaid and Medicare managed care programs typically is determined by the health plans with which state Medicaid agencies and Medicare contract to provide services to beneficiaries. States seek to control healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains, wholesalers and PBMs will increase pricing pressures in the industry. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this Form 10-K. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. The collection and use of personal data by us as part of our business activities is subject to various federal and state privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. Such laws and regulations have the potential to affect our business materially, continue to evolve and are increasingly being enforced vigorously. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our innovative medicinal products, and employs a centralized procedure for approval for the EU and the European Economic Area (EEA) countries. From January 1, 2021, as a consequence of the U.K. leaving the EU (Brexit), the Medicines and Healthcare products Regulatory Agency is the sole regulatory authority for the U.K. In China, following significant regulatory reforms in recent years, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle- and lower-income require marketing approval by a recognized regulatory authority (i.e., the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. Pharmacovigilance. In the EU/EEA, the EMAs Pharmacovigilance Risk Assessment Committee is responsible for reviewing and making recommendations on product safety issues. Outside developed markets, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . Certain governments, including in the different EU member states, the U.K., China, Japan, Canada and South Korea, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of measures including proposing price reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. In addition, the international patchwork of price regulation, differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. Several important multilateral organizations, such as the World Health Organization and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. On November 25, 2020, the European Commission published its new Pharmaceutical Strategy for Europe which envisions a broad range of new initiatives and legislation including a significant focus on affordability and access to medicines. In China, pricing pressures have increased in recent years, with government officials emphasizing improved health outcomes, healthcare reform and decreased drug prices as key indicators of progress towards reform. Drug prices have decreased dramatically as a result of adding innovative drugs (including oncology medicines) to the National Reimbursement Drug List (NRDL). In the off-patent space, numerous local generics have been officially deemed bioequivalent under a QCE process that required domestically-manufactured generic drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). A centralized VBP program has also been initiated and expanded nationwide, under which a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines, which the government currently plans to Pfizer Inc. 2020 Form 10-K implement within the next few years. We and most off-patent originators have mostly not been successful in the VBP bidding process. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. While certain details of future QCE expansion have been made available, we are unable to determine the impact on our business and financial condition until the initiation of these future rounds. Healthcare Provider Transparency and Disclosures. Several countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. Intellectual Property . Reliable patent protection and enforcement around the world are among the key factors we consider for continued business and RD investment. The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) requires participant countries to provide patent protection for pharmaceutical products by law, with an exemption provided for least-developed countries until 2033. While some countries have made improvements, we still face patent grant, enforcement and other intellectual property challenges in many countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our growth and ability to bring new product innovation to patients depends on further progress in intellectual property protection. In certain developed international markets, governments maintain relatively effective intellectual property policies. However, in the EU, following a review of pharmaceutical intellectual property and regulatory incentives, legislative change may result in the reduction of certain protections. In several emerging market countries, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to advance industrial policy and localization goals. Considerable political and economic pressure has weakened current intellectual property protection in some countries and has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions, revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a fair and transparent business environment for foreign manufacturers, underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. Data Privacy. Outside of the U.S., many countries have privacy and data security laws and regulations concerning the collection and use of personal data, including the EUs General Data Protection Regulations. The legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. ENVIRONMENTAL MATTERS Our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. We incurred capital and operational expenditures in 2020 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: $42 million in environment-related capital expenditures and $120 million in other environment-related expenses. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. See also Note 16A3 . Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities or supply chain due to climate change will not occur in the future. We periodically review our vulnerability to potential weather-related risks and other natural disasters and update our assessments accordingly. Based on our reviews, we do not believe these potential risks are material to our operations at this time. HUMAN CAPITAL Our purpose is clear: Breakthroughs that change patients lives . These breakthroughs are delivered through the relentless collaboration of our talented workforce. As of December 31, 2020, we employed approximately 78,500 people worldwide, with approximately 29,400 based in the U.S. Women compose approximately 48% of our workforce, and approximately 32% of our U.S.-based employees are individuals with ethnically diverse backgrounds. Our continued success links directly to the commitment, engagement and performance of our employees. It is important that we not only attract and retain the best and brightest diverse talent but also ensure they remain engaged and can thrive in an environment that is committed to helping them grow, succeed and contribute directly to achieving our purpose. As part of these efforts, we strive for an inclusive and empowering work environment, adopting practices to simplify processes and remove needless complexity, rewarding both performance and leadership skills, and offering competitive compensation and benefits programs that encourage healthy work-life balance, so that all colleagues feel ready, equipped and energized to deliver innovative breakthroughs that extend and significantly improve patients lives. Diversity, Equity and Inclusion. At Pfizer, every person deserves to be seen, heard and cared for, and we work to further this goal by bringing together people with different backgrounds, perspectives and experiences. Our new and expanded commitments to equity include specific actions to help foster a more inclusive environment within Pfizer, including, among others: (i) increasing the representation of both women and underrepresented ethnic groups; (ii) providing resources to support managers in having courageous conversations about equity, race and the avoidance of bias within their teams; (iii) revising our Political Action Committee (PAC) bylaws to help ensure that PAC recipients consistently demonstrate conduct that align with our core values; and (iv) working to help ensure recruitment demographics of all clinical trials correlate to those of the countries where trials are taking place. Colleague Engagement . We understand the importance of continuously listening and responding to colleague feedback. Our annual engagement survey, Pfizer Pulse, provides a forum for our colleagues to give structured feedback about their Pfizer experience and equips leaders with Pfizer Inc. 2020 Form 10-K actionable insights for discussion and follow up. Regular topics in the survey include (i) employee engagement, such as colleagues commitment to and advocacy for Pfizer, and (ii) purpose, including how colleagues work connects with our purpose. Through these surveys, we can measure and track the degree to which colleagues are proud to work at Pfizer, would recommend Pfizer as a great place to work to others and intend to stay with Pfizer. Performance, Leadership and Growth. We are committed to helping our colleagues reach their full potential by rewarding both their performance and leadership skills and by providing opportunities for growth and development. Our performance management approachcalled Performance and Leadership Insights is based on six-month semesters during which our colleagues and their managers set goals, receive feedback and meet to discuss performance. These conversations are meant to help colleagues grow and develop by evaluating performance (what the colleague achieved, measured by outcomes), leadership (how they achieved it, taking into account Pfizers values of courage, excellence, equity and joy), and identifying areas of growth that help move colleagues towards fulfilling their career goals and their potential. We strive to ensure that all colleagues have an equal opportunity to grow and offer a variety of programs including mentoring, job rotations, experiential project roles, skill based volunteering and learning programs focused on many topics, including leadership and management skills and industry- and job-specific learning, as well as general business, manufacturing, finance and technology skills. Health, Safety and Well-Being. We are committed to the health, safety and well-being of our colleagues and continue to advance a comprehensive occupational injury and illness prevention program. During 2020, our COVID-19 pandemic preparedness and response was a primary focus. Our comprehensive pandemic response plan incorporates guidance issued by external health authorities and is designed to keep onsite workers at our manufacturing and research sites safe and healthy. A global employee assistance program provides stress management, mental health, emotional, resiliency and pandemic guidance and support to our colleagues. Pay Equity. We are committed to pay equity, based on gender or race/ethnicity, and we conduct and report publicly on pay equity on an annual basis. Additional information regarding our human capital programs and initiatives is available in the Careers section of Pfizers website. AVAILABLE INFORM ATION Our website is located at www.pfizer.com . This Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and our proxy statements, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our Proxy Statement. Please refer to this information. This Form 10-K will be available on our website on or about February 25, 2021. Our Proxy Statement will be available on our website on or about March 11, 2021. Our 2020 Environmental, Social and Governance (ESG) report, which provides enhanced ESG disclosures, will be available on our website on or about March 11, 2021. Information in our ESG Report is not incorporated by reference into this Form 10-K. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following our press releases, SEC filings, public conference calls and webcasts, as well as our social media channels (our Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts, or any third-party website, is not incorporated by reference into this Form 10-K. Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. ITEM 1A. RISK FACTORS This section describes the material risks to our business, which should be considered carefully in addition to the other information in this report and our other filings with the SEC. Investors should be aware that it is not possible to predict or identify all such factors and that the following is not meant to be a complete discussion of all potential risks or uncertainties. If known or unknown risks or uncertainties materialize, our business operations, financial condition, operating results (including components of our financial results), cash flows, prospects, reputation or credit ratings could be adversely affected now and in the future, potentially in a material way. The following discussion of risk factors contains forward-looking statements, as discussed in the Forward-Looking Information and Factors that May Affect Future Results section in this Form 10-K. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS: MANAGED CARE TRENDS Private payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization and costs of drugs. Negotiating power of MCOs and other private third-party payers has increased due to consolidation, and they, along with governments, increasingly employ formularies to control costs and encourage utilization of certain drugs, including through the use of formulary inclusion or favorable formulary placement. These initiatives have increased consumers interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause them to favor lower-cost generic alternatives. We may fail to obtain or maintain timely or adequate pricing or formulary placement of our products, or fail to obtain such formulary placement at favorable pricing. The growing availability and use of innovative specialty pharmaceutical medicines that treat rare or life-threatening conditions, which typically have smaller patient populations, combined with their relative higher cost as compared to other types of pharmaceutical products, also has generated increased payer interest in developing cost-containment strategies targeted to this sector. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, we may face greater pricing pressure from private third-party payers as they continue to drive more of their patients to use lower cost generic alternatives. Business arrangements in this area are subject to a high degree of government scrutiny, and available safe harbors under applicable federal and state fraud and abuse laws are subject to change through legislative and regulatory action, as well as evolving judicial interpretations. Our approach to these arrangements may also be informed by such government and industry guidance. COMPETITIVE PRODUCTS Competitive product launches may erode future sales of our products, including our existing products and those currently under development, or result in unanticipated product obsolescence. Such launches have recently occurred, and potentially competitive products are in various stages of development. We cannot predict with accuracy the timing or impact of the introduction of competitive products that treat diseases and conditions like those treated by our in-line drugs and drug candidates. In addition, competition from manufacturers of generic drugs, including from generic versions of competitors branded products that lose their market exclusivity, is a major challenge for our branded products. Certain of our products have experienced significant generic competition over the last few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. While multi-source generic competition for Chantix has not yet begun, it could commence at anytime. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. In China, we expect to continue to face intense competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic manufacturers have filed applications with the FDA seeking approval of product candidates that they claim do not infringe our patents or claim that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. We may become subject to competition from biosimilars referencing our biologic products if competitors are able to obtain marketing approval for such biosimilars. We also commercialize biosimilar products that compete with products of others, including other biosimilar products. Uptake of our biosimilars may be lower due to various factors, such as anti-competitive practices, access challenges where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to an innovator product, physician reluctance to prescribe biosimilars for existing patients taking the innovative product, or misaligned financial incentives. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against JJ alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. For additional information on competition our products face, see the Item 1. Business Competition section in this Form 10-K. CONCENTRATION We recorded direct product and/or alliance revenues of more than $1 billion for each of seven products that collectively accounted for 53% of our total revenues in 2020. For additional information, see Notes 1 and 17 . If these products or any of our other major products were to experience loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects or safety concerns, regulatory proceedings, negative publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures or supply shortages or if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. In particular, certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling products are, or have been, the subject of pending legal challenges. For additional information on our patents, see the Item 1. Business Patents and other Intellectual Property Rights section in this Form 10-K. Pfizer Inc. 2020 Form 10-K In addition, we sell our prescription pharmaceutical products principally through wholesalers in the U.S. For additional information, see Note 17B . If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, it might decrease the amount of business the wholesaler does with us and/or we might be unable to timely collect all the amounts that the wholesaler owes us or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. RESEARCH AND DEVELOPMENT The discovery and development of new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our business. Our product lines must be replenished over time to offset revenue losses when products lose exclusivity or market share, as well as to provide for earnings growth, either through internal RD or through collaborations, acquisitions, JVs, licensing or other arrangements. Growth depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The costs of product development continue to be high, as are regulatory requirements in many therapeutic areas, which may affect the number of candidates we are able to fund as well as the sustainability of the RD portfolio. Decisions made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if the candidate receives regulatory approval. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no assurance that an optimal balance between trial conduct, speed and desired outcome will be achieved. Additionally, our product candidates can fail at any stage of the RD process, and may not receive regulatory approval even after many years of RD. We may fail to correctly identify indications for which our science is promising or allocate RD investment resources efficiently, and failure to invest in the right technology platforms, therapeutic areas, product classes, geographic markets and/or licensing opportunities could adversely impact the productivity of our pipeline. Further, even if we identify areas with the greatest commercial potential, the scientific approach may not succeed despite the significant investment required for RD, and the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. GLOBAL OPERATIONS We operate on a global scale and could be affected by currency fluctuations, capital and exchange controls, global economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political or civil unrest, terrorist activity, unstable governments and legal systems and inter-governmental disputes. Some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. As a result of these and other factors, our strategy to grow in emerging markets may not be successful, and growth rates in these markets may not be sustainable. In addition, since a significant portion of our business is conducted in the EU, as well as the U.K., the changes resulting from Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU. Government financing and economic pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through health technology assessments) or other means of cost control. For additional information on government pricing pressures, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We continue to monitor the global trade environment and potential trade conflicts and impediments that could impact our business. If trade restrictions or tariffs reduce global economic activity, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. We operate in many countries and transact in over 100 different currencies. Changes in the value of those currencies relative to the U.S. dollar, or high inflation in these countries, can impact our revenues, costs and expenses and our financial guidance. Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to exchange rate changes. 48% of our total 2020 revenues were derived from international operations, including 23% from Europe and 17% from China, Japan and the rest of Asia. Future changes in exchange rates or economic conditions and the impact they may have on our results of operations, financial condition or business are difficult to predict. For additional information about our exposure to foreign currency risk, see the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. In addition, our borrowing, pension benefit and postretirement benefit obligations and interest-bearing investments, are subject to risk from changes in interest and exchange rates. The risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. For additional details on critical accounting estimates and assumptions for our benefit plans, see the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section within MDA and Notes 7E and 11 . From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. This deadline was extended until June 2023 for a number of key U.S. dollar benchmark maturities (including the 1-month and 3-month LIBOR rates). The U.S. Federal Reserve has selected the Secured Overnight Funding Rate (SOFR) as the preferred alternate rate and the transition away from LIBOR will continue despite the extended timeline. We are planning for this transition and will amend Pfizer Inc. 2020 Form 10-K any contracts to accommodate the SOFR rate where required. While our exposure to LIBOR is very low, market volatility related to the transition may adversely affect the trading market for securities linked to such benchmarks. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS We could encounter difficulties or delays in product manufacturing, sales or marketing due to regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, damage to our facilities due to natural or man-made disasters, product liability or unanticipated costs. Examples of such difficulties or delays include the inability to increase production capacity commensurate with demand; challenges related to component materials to maintain appropriate quality standards throughout our supply network and/or comply with applicable regulations; and supply chain disruptions at our facilities or at a supplier or vendor. Regulatory agencies periodically inspect our manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, product recalls, delays or denials of product approvals, import bans or denials of import certifications. For example, in September 2017, our subsidiary, Meridian, received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as Official Action Indicated (OAI). Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into JVs and other business development transactions. To achieve expected longer-term benefits, we may make substantial upfront payments as part of these transactions, which may negatively impact our reported earnings or cash flows. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services, including activities related to transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of the third-party collaborators, service providers and others to complete activities on schedule or in accordance with our expectations or to meet their contractual or other obligations to us; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between us and these parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, expose us to suboptimal quality of service delivery or deliverables, result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or subject us to reputational harm, all with potential negative implications for our product pipeline and business. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. COUNTERFEIT PRODUCTS Our reputation and promising pipeline render our medicines prime targets for counterfeiters. Counterfeit medicines pose a significant risk to patient health and safety because of the conditions under which they are manufactured often in unregulated, unlicensed, uninspected and unsanitary sites as well as the lack of regulation of their contents. Failure to mitigate this threat could adversely impact our business, by, among other things, causing patient harm, the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. The prevalence of counterfeit medicines is an industry-wide issue due to a variety of factors, including the adoption of e-commerce, which increased during the COVID-19 pandemic, greatly enhancing consumers ability to obtain prescriptions and other medical treatments via the Internet in lieu of traditional brick and mortar pharmacies. The internet exposes patients to greater risk as it is a preferred vehicle for dangerous counterfeit offers and scams because of the anonymity it affords counterfeiters. We consistently invest in an enterprise-wide strategy to aggressively combat counterfeit threats by educating patients and health care providers about the risks, proactively monitoring and interdicting supply with the help of law enforcement; and advising legislators and regulators. However, our efforts and those of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS: PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls or limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. The adoption of restrictive price controls in new jurisdictions, more restrictive controls in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. We expect pricing pressures will continue globally. In the U.S., pharmaceutical product pricing is subject to government and public scrutiny and calls for reform, and many of our products are subject to increasing pricing pressures as a result. Some states have implemented, and others are considering, price controls or patient access constraints under the Medicaid program, and some are considering measures that would apply to broader segments of their populations that are not Medicaid-eligible. State legislatures also have recently focused on addressing drug costs, generally by increasing price transparency or limiting drug price increases. Measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, Pfizer Inc. 2020 Form 10-K could adversely affect our business. For additional information on U.S. pricing and reimbursement, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We encounter similar regulatory and legislative issues in most other countries in which we operate. In certain markets, such as in EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria, or impose other means of cost control, particularly as a result of recent global financing pressures. For example, the QCE and VBP tender process in China has resulted in dramatic price cuts for off-patent medicines. For additional information regarding these government initiatives, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. We anticipate that these and similar initiatives will continue to increase pricing pressures in China and elsewhere in the future. In addition, in many countries, with respect to our vaccines, we participate in a tender process for selection in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. We also anticipate pricing pressures will be amplified by COVID-19 induced budget deficits and focus on pricing for new COVID-19 therapies and vaccines. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. Any significant efforts at the U.S. federal or state levels to reform the healthcare system by changing the way healthcare is provided or funded could have a material impact on us. For additional information on U.S. healthcare reform, see the Item 1. BusinessGovernment Regulation and Price Constraints section in this Form 10-K. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs to the U.S. at prices that are regulated by foreign governments, revisions to reimbursement of biopharmaceuticals under government programs that could reference international prices or require new discounts, restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals and other industry stakeholders, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. A reduction of U.S. federal spending on entitlement programs, including Medicare and Medicaid, may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending that could affect pharmaceutical utilization and pricing as does the Medicare Payment Advisory Commission. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS The discovery and development of drugs and biological products are time consuming, costly and unpredictable. The outcome is inherently uncertain and involves a high degree of risk due to the following factors, among others: The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Product candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new pre-clinical or clinical data and further analyses of existing pre-clinical or clinical data, including results that may not support further clinical development of the product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. We may not be able to successfully address all the comments received from regulatory authorities such as the FDA and the EMA, or be able to obtain approval from regulators. Regulatory approvals of our products depend on myriad factors, including a regulator making a determination as to whether a product is safe and efficacious. In the context of public health emergencies like the COVID-19 pandemic, regulators evaluate various factors and criteria to potentially allow for marketing authorization on an emergency basis. Additionally, clinical trial and other product data are subject to differing interpretations and assessments by regulatory authorities. As a result of regulatory interpretations and assessments or other developments that occur during the review process, and even after a product is authorized or approved for marketing, a products commercial potential could be adversely affected by potential emerging concerns or regulatory decisions regarding or impacting labeling or marketing, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the ACIP, that may impact the use of our products. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can negatively impact product sales, and potentially lead to product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Further regulatory agency requirements may result in a more challenging, expensive and lengthy regulatory approval process than anticipated due to requests for, among other things, additional or more extensive clinical trials prior to granting approval, or increased post-approval requirements. For these and other reasons discussed in this Risk Factors section, we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing authorization or approval of a product, the FDA may require additional clinical trials or other studies. The results generated in these trials could result in the loss of marketing approval, changes in labeling, and/or new or increased concerns about the side effects, efficacy or safety. Regulatory agencies in countries outside the U.S. often have similar regulations and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others, whether mandated by regulatory agencies or conducted voluntarily, and other emerging data about products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, if safety or efficacy concerns are raised about a product in the same class as one of our products, those concerns could implicate the entire class; and this, in turn, could have an adverse impact on the availability or commercial viability of our product(s) as well as Pfizer Inc. 2020 Form 10-K other products in the class. The potential regulatory and commercial implications of post-marketing study results, for approved indications and potential new indications of an in-line product, typically cannot immediately be determined. For example, the potential impact of the co-primary endpoint results from a recently completed post-marketing required safety study of Xeljanz, ORAL Surveillance (A3921133), announced in January 2021, and related results, analyses and discussions with and reviews by regulators, remain uncertain. We are working with the FDA and other regulatory agencies to review the full results and analyses as they become available. The terms of our EUA for the BNT162b2 vaccine require that we conduct post-authorization observational studies. In addition, the FDA expects EUA holders to work towards submission of full application, such as a BLA, as soon as possible. LEGAL MATTERS We are and may be involved in various legal proceedings, including patent litigation, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. There can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Government investigations and actions could result in substantial fines and/or criminal charges and civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements and other disciplinary actions, as well as reputational harm, including as a result of increased public interest in the matter. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our sales and marketing activities and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this Form 10-K, as well as the Anti-Kickback Statute, anti-bribery laws, the False Claims Act, and similar laws in international jurisdictions. In addition to the potential for changes to relevant laws, the compliance and enforcement landscape is informed by government litigation, settlement precedent, advisory opinions, and special fraud alerts. Our approach to certain practices may evolve over time in light of these types of developments. Requirements or industry standards in the U.S. and certain jurisdictions abroad require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers and can increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. Like many companies in our industry, we have from time-to-time received, and may receive in the future, inquiries and subpoenas and other types of information demands from government authorities. In addition, we have been subject to claims and other actions related to our business activities, brought by governmental authorities, as well as consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. Such claims, actions and inquiries may relate to alleged non-compliance with laws and regulations associated with the dissemination of product (approved and unapproved) information, potentially resulting in government enforcement action and reputational damage. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. We and certain of our subsidiaries are also subject to numerous contingencies arising in the ordinary course of business relating to legal claims and proceedings, including environmental contingencies. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide legal liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. For additional information, including information regarding certain legal proceedings in which we are involved in, see Note 16A . RISKS RELATED TO INTELLECTUAL PROPERTY, TECHNOLOGY AND SECURITY: INTELLECTUAL PROPERTY PROTECTION Our success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, from using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against claims regarding validity, enforceability, scope and effective term made by parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws, and our ability to enforce our patents depends on the laws of each country, its enforcement practices, and the extent to which certain countries engage in policies or practices Pfizer Inc. 2020 Form 10-K that weaken a countrys intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, uses, processes or dosage forms are invalid and/or do not cover the product of the generic or biosimilar drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents or a competitors patents is found to be invalid in such proceedings, generic or biosimilar products could be introduced into the market resulting in the erosion of sales of our existing products. For additional information, including information regarding certain legal proceedings in which we are involved, see Note 16A1 . Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, our operating results and financial condition could be adversely affected. We currently hold trademark registrations and have trademark applications pending in many jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and, as a result, our business could be adversely affected if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our rights. We seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their relationship with us. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by others that we believe were improperly granted, including challenges through negotiation and litigation, and such challenges may not always be successful. Part of our business depends upon identifying biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired or been declared invalid, or where products do not infringe the patents of others. In some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by them. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our business. We extensively rely upon sophisticated information technology systems to operate our business. We collect, store and transmit large amounts of confidential information (including personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We have outsourced significant elements of our operations, including significant elements of our information technology infrastructure and, as a result, we manage relationships with many third-party vendors who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or malicious attackers. Cyber-attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent cyber-attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2020 Form 10-K RISKS RELATED TO BUSINESS DEVELOPMENT: BUSINESS DEVELOPMENT ACTIVITIES We expect to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, JVs, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. The success of these activities is dependent on the availability and accurate cost/benefit evaluation of appropriate opportunities, competition from others that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy closing conditions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, which could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, the value of those securities will fluctuate, and may depreciate. We may not control a company in which we invest, and, as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such efforts fail to discover, that are not disclosed to us, or that we inadequately assess. The success of any of our acquisitions will depend, when applicable, on our ability to realize anticipated benefits from integrating these businesses with us. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the expected revenue growth for the acquired business. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. SPIN-OFF AND COMBINATION OF UPJOHN WITH MYLAN We may not realize some or all of the expected benefits of the spin-off and combination (the Transactions) of the Upjohn Business with Mylan, which resulted in the creation of Viatris, due to many factors, including, among others, strategic adjustments required to reflect the nature of our business following the Transactions, increased risks resulting from us becoming a company that is a more focused, innovative science-based biopharmaceutical products business and the possibility that we may not achieve our strategic objectives. In addition, we have agreed to provide certain transition services to Viatris, generally for an initial period of 24 months following the completion of the Transactions (with certain possibilities for extension). These obligations under the transition services agreements may result in additional expenses and may divert our focus and resources that would otherwise be invested into maintaining or growing our business. CONSUMER HEALTHCARE JV WITH GSK In 2019, we and GSK combined our respective consumer healthcare businesses into a JV that operates globally under the GSK Consumer Healthcare name. Although we have certain consent, board representation and other governance rights, we are a minority owner of the JV and do not control the JV, its management or its policies. As a result, our ability to realize the anticipated benefits of the transaction depend upon GSKs operation and management of the JV. In addition, the JV is subject to risks that are different than the risks associated with our business. Many of these risks are outside GSKs or the JVs control and could materially impact the business, financial condition and results of operations of the JV. GSK has indicated that it intends to separate the JV as an independent company listed on the U.K. equity market. Until July 31, 2024, GSK has the exclusive right to initiate a separation and listing transaction. We have the option to participate in a separation and listing transaction initiated by GSK. However, the separation and public listing transaction may not be initiated or completed within expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for us or our shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Any future distribution or sale of our stake in the JV will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Our ability to complete any such future distribution or sale may also be impacted by the size of our retained stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the JVs business may subject us and the JV to risks and uncertainties that may adversely affect our business and financial results. GENERAL RISKS: COVID-19 PANDEMIC Our business, operations and financial condition and results have been and may continue to be impacted by the COVID-19 pandemic to varying degrees. The pandemic has presented a number of risks and challenges for our business, including, among others, impacts due to travel limitations and mobility restrictions; manufacturing disruptions and delays; supply chain interruptions, including challenges related to reliance on third-party suppliers; disruptions to pipeline development and clinical trials, including difficulties or delays in enrollment of certain clinical trials and in access to needed supplies; decreased product demand, due to reduced numbers of in-person meetings with prescribers, patient visits with physicians, vaccinations and elective surgeries, resulting in fewer new prescriptions or refills of existing prescriptions and reduced demand for products used in procedures; further reduced product demand as a result of increased unemployment; challenges presented by reallocating personnel and RD, manufacturing and other resources to assist in responding to the pandemic; costs associated with the COVID-19 pandemic, including practices intended to reduce the risk of transmission, increased supply chain costs and additional RD costs incurred in our efforts to develop a vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to our business development initiatives, including potential delays or disruptions related to regulatory approvals; interruptions or delays in the operations of regulatory authorities, which may delay potential approval of new products we are developing, potential label expansions for existing products and the launch of newly-approved products; challenges operating in a virtual work environment; potential increased cyber incidents such as phishing, social engineering and malware attacks; challenges related to our intellectual property, both domestically and internationally, including in response to any pressure or legal or regulatory action that could potentially result in us not seeking intellectual property protection for, licensing, or agreeing not to enforce, Pfizer Inc. 2020 Form 10-K intellectual property rights related to our products, including our vaccine to help prevent COVID-19 and potential treatments for COVID-19; challenges related to conducting oversight and monitoring of regulated activities in a remote or virtual environment; and other challenges presented by disruptions to our normal operations in response to the pandemic, as well as uncertainties regarding the duration and severity of the pandemic and its impacts, and government or regulatory actions to contain the virus or control the supply of medicines. We also face risks and uncertainties related to our efforts to develop and commercialize a vaccine to help prevent COVID-19 and potential treatments for COVID-19, as well as challenges related to their manufacturing, supply and distribution, including, among others, uncertainties inherent in RD, including the ability to meet anticipated clinical endpoints, commencement and/or completion dates for clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates, as well as risks associated with pre-clinical or clinical data (including the in vitro and Phase 3 data for the Pfizer-BioNTech COVID-19 vaccine (BNT162b2)), including the possibility of unfavorable new pre-clinical, clinical or safety data and further analyses of existing pre-clinical, clinical or safety data; the ability to produce comparable clinical or other results, including the rate of vaccine effectiveness and safety and tolerability profile observed to date, in additional analyses of the Phase 3 trial and additional studies or in larger, more diverse populations upon commercialization; the ability of BNT162b2 to prevent COVID-19 caused by emerging virus variants; the risk that more widespread use of the vaccine will lead to new information about efficacy, safety or other developments, including the risk of additional adverse reactions, some of which may be serious; the risk that pre-clinical and clinical trial data are subject to differing interpretations and assessments, including during the peer review/publication process, in the scientific community generally, and by regulatory authorities; whether and when additional data from the BNT162 mRNA vaccine program or other programs will be published in scientific publications and, if so, when and with what modifications and interpretations; whether regulatory authorities will be satisfied with the design of and results from these and any future pre-clinical and clinical studies; when other biologics license and/or EUA applications may be filed in particular jurisdictions for BNT162b2 or any other potential vaccines that may arise from the BNT162 program, and if obtained, whether or when such EUA or licenses will expire or terminate; whether and when any applications that may be pending or filed for BNT162b2 or other vaccines that may result from the BNT162 program may be approved by particular regulatory authorities, which will depend on myriad factors, including making a determination as to whether the vaccines benefits outweigh its known risks and determination of the vaccines efficacy and, if approved, whether it will be commercially successful; regulatory decisions impacting labeling or marketing, manufacturing processes, safety and/or other matters that could affect the availability or commercial potential of a vaccine, including development of products or therapies by other companies; disruptions in the relationships between us and our collaboration partners, clinical trial sites or third-party suppliers, including our relationship with BioNTech; the risk that other companies may produce superior or competitive products; the risk that demand for any products may be reduced or no longer exist; risks related to the availability of raw materials to manufacture or test any such products; challenges related to our vaccines ultra-low temperature formulation, two-dose schedule and attendant storage, distribution and administration requirements, including risks related to storage and handling after delivery by us; the risk that we may not be able to successfully develop other vaccine formulations; the risk that we may not be able to recoup costs associated with our RD and manufacturing efforts; risks associated with any changes in the way we approach or provide research funding for the BNT162 program or potential treatment for COVID-19; challenges and risks associated with the pace of our development programs; the risk that we may not be able to maintain or scale up manufacturing capacity on a timely basis or maintain access to logistics or supply channels commensurate with global demand for our vaccine or any potential approved treatment, which would negatively impact our ability to supply the estimated numbers of doses of our vaccine within the projected time periods as previously indicated; whether and when additional supply agreements will be reached; uncertainties regarding the ability to obtain recommendations from vaccine advisory or technical committees and other public health authorities and uncertainties regarding the commercial impact of any such recommendations; pricing and access challenges for such products; challenges related to public vaccine confidence or awareness; trade restrictions; and competitive developments. Further, the COVID-19 pandemic, and the volatile global economic conditions stemming from the pandemic, could precipitate or amplify the other risks that we identify in this Risk Factors section, which could adversely affect our business, operations and financial condition and results. We are continuing to monitor the latest developments regarding the COVID-19 pandemic and its effects on our business, operations and financial condition and results, and have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally, the emergence of additional virus variants, the duration of the pandemic, new information regarding the severity and incidence of COVID-19, the safety, efficacy and availability of vaccines and treatments for COVID-19, the rate at which the population becomes vaccinated against COVID-19, the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. The pandemic may also affect our business, operations or financial condition and results in a manner that is not presently known to us or that we currently do not consider as presenting significant risks. MARKET FLUCTUATIONS IN OUR EQUITY AND OTHER INVESTMENTS Changes in fair value of certain equity investments need to be recognized in net income that may result in increased volatility of our income. For additional information, see Note 4 and the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Our pension benefit obligations and postretirement benefit obligations are subject to volatility from changes in fair value of equity investments and other investment risk in the assets funding these plans. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section within MDA and Note 11. COST AND EXPENSE CONTROL AND NONORDINARY EVENTS Growth in costs and expenses, changes in product and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of our cost-reduction and productivity initiatives, other corporate strategic initiatives and any acquisitions, divestitures or other initiatives, as well as potential disruption of ongoing business. Pfizer Inc. 2020 Form 10-K INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including IPRD and goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and/or be written off at some time in the future if the associated RD effort is abandoned or is curtailed. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment. Our equity-method investments may also be subject to impairment charges that may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. Any such impairment charge of our intangible assets, goodwill and equity-method investments may be significant. For additional details, see the S ignificant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section within MDA. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in laws and regulations or their interpretation, including, among others, changes in accounting standards, taxation requirements, competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information on changes in tax laws or rates or accounting standards, see the Provision/(Benefit) for Taxes on Income and New Accounting Standards sections within MDA and Note 1B . "," ITEM 2. PROPERTIES We own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution and corporate enabling functions. In many locations, our business and operations are co-located to achieve synergy and operational efficiencies. Our global headquarters are located in New York City. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. As of December 31, 2020, we had 363 owned and leased properties, amounting to approximately 43 million square feet. In 2020, we reduced the number of properties in our portfolio by 90 sites and 4 million square feet, primarily due to the spin-off and combination of the Upjohn Business with Mylan to form Viatris. We expect to relocate our global headquarters to the Spiral, an office building in the Hudson Yards neighborhood of New York City, with occupancy expected beginning in 2022. In April 2018, we entered into an agreement to lease space at this property. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. Our PGS platform function is headquartered in various locations, with leadership teams primarily in New York City and in Peapack, New Jersey. As of December 31, 2020, PGS had responsibility for 43 plants around the world, including in Belgium, Germany, India, Ireland, Italy, Japan, Singapore and the U.S., which manufacture products for our business. PGS expects to exit five of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties, including the principal properties described above, are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See Note 9 for amounts invested in land, buildings and equipment. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in Note 16A . INFORMATION ABOUT OUR EXECUTIVE OFFICERS The executive officers of the Company are set forth in this table. Each holds the office or offices indicated until his or her successor is chosen and qualified at the regular meeting of the BOD to be held on the date of the 2021 Annual Meeting of Shareholders, or until his or her earlier death, resignation or removal. Each of the executive officers is a member of the Pfizer Executive Leadership Team. Name Age Position Albert Bourla 59 Chairman of the Board since January 2020 and Chief Executive Officer since January 2019. Chief Operating Officer from January 2018 until December 2018. Group President, Pfizer Innovative Health from June 2016 until December 2017. Group President, Global Innovative Pharma Business (responsible for Vaccines, Oncology and Consumer Healthcare since 2014) from February 2016 until June 2016. President and General Manager of Established Products Business Unit from December 2010 until December 2013. Our Director since February 2018. Board member of Pharmaceutical Research and Manufacturers of America (PhRMA). Board member of The Pfizer Foundation, which promotes access to quality healthcare. Director of the Partnership for New York City and Catalyst, a global non-profit organization accelerating progress for the advancement of women into leadership. William Carapezzi 63 Executive Vice President, Global Business Services and Transformation since June 2020. Senior Vice President of Global Business Operations from June 2013 until June 2020. Senior Vice President of Global Tax from 2008 until June 2013. Pfizer Inc. 2020 Form 10-K Name Age Position Frank A. DAmelio 63 Chief Financial Officer and Executive Vice President, Global Supply since June 2020. Chief Financial Officer, Executive Vice President, Business Operations and Global Supply from November 2018 until June 2020. Executive Vice President, Business Operations and Chief Financial Officer from December 2010 until October 2018. Senior Vice President and Chief Financial Officer from September 2007 until December 2010. Director of Zoetis Inc. and Humana Inc. and Chair of the Humana Inc. Board of Directors Audit Committee. Director of the Independent College Fund of New Jersey. Mikael Dolsten 62 Chief Scientific Officer, President, Worldwide Research, Development and Medical since January 2019. President of Worldwide Research and Development from December 2010 until December 2018. Senior Vice President; President of Worldwide Research and Development from May 2010 until December 2010. Senior Vice President; President of Pfizer BioTherapeutics Research Development Group from October 2009 until May 2010. He was Senior Vice President of Wyeth and President, Wyeth Research from June 2008 until October 2009. Director of Karyopharm Therapeutics Inc. Director of PhRMA Foundation and Governor of New York Academy of Science (NYAS). Lidia Fonseca 52 Chief Digital and Technology Officer, Executive Vice President since January 2019. Chief Information Officer and Senior Vice President of Quest Diagnostics Incorporated from 2014 to 2018. Senior Vice President of Laboratory Corporation of America Holdings from 2008 until March 2013. Director of Tegna, Inc. Angela Hwang 55 Group President, Pfizer Biopharmaceuticals Group since January 2019. Group President, Pfizer Essential Health from January 2018 until December 2018. Global President, Pfizer Inflammation and Immunology from January 2016 until December 2017. Regional Head, U.S. Vaccines from January 2014 until December 2015. Vice President, Emerging Markets for the Primary Care therapeutic area from September 2011 until December 2013. Vice President, U.S. Brands commercial organization within Essential Health from October 2009 until August 2011. Director of United Parcel Service, Inc. Rady A. Johnson 59 Chief Compliance, Quality and Risk Officer, Executive Vice President since January 2019. Executive Vice President, Chief Compliance and Risk Officer from December 2013 until December 2018. Senior Vice President and Associate General Counsel from October 2006 until December 2013. Douglas M. Lankler 55 General Counsel, Executive Vice President since December 2013. Corporate Secretary from January 2014 until February 2014. Executive Vice President, Chief Compliance and Risk Officer from February 2011 until December 2013. Executive Vice President, Chief Compliance Officer from December 2010 until February 2011. Senior Vice President and Chief Compliance Officer from January 2010 until December 2010. Senior Vice President, Deputy General Counsel and Chief Compliance Officer from August 2009 until January 2010. A. Rod MacKenzie 61 Chief Development Officer, Executive Vice President since June 2016. Senior Vice President, Chief Development Officer from March 2016 until June 2016. Group Senior Vice President and Head, Pharma Therapeutics Research and Development from 2010 until March 2016. Dr. MacKenzie represents Pfizer as a member of the Board of Directors of ViiV Healthcare Limited, TransCelerate Biopharma Inc. and the National Health Council. Payal Sahni 46 Chief Human Resources Officer, Executive Vice President since June 2020. From May 2016 until June 2020 served as Senior Vice President of Human Resources for multiple operating units. Vice President of Human Resources, Vaccines, Oncology Consumer from 2015 until 2016. Ms. Sahni has served in a number of positions in the Human Resources organization with increasing responsibility since joining Pfizer in 1997. Sally Susman 59 Chief Corporate Affairs Officer, Executive Vice President since January 2019. Executive Vice President, Corporate Affairs (formerly Policy, External Affairs and Communications) from December 2010 until December 2018. Senior Vice President, Policy, External Affairs and Communications from December 2009 until December 2010. Director of WPP plc. John D. Young 56 Chief Business Officer, Group President since January 2019. Group President, Pfizer Innovative Health from January 2018 until December 2018. Group President, Pfizer Essential Health from June 2016 until December 2017. Group President, Global Established Pharma Business from January 2014 until June 2016. President and General Manager, Pfizer Primary Care from June 2012 until December 2013. Primary Care Business Units Regional President for Europe and Canada from 2009 until June 2012. Director of Johnson Controls International plc. Mr. Young represents Pfizer as a member of the Board of Directors of the Consumer Healthcare JV. Director of Biotechnology Innovation Organization (BIO). PART II "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 23, 2021, there were 139,582 holders of record of our common stock. The following summarizes purchases of our common stock during the fourth quarter of 2020 (a) : Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Value of Shares that May Yet Be Purchased Under the Plan (a) September 28 through October 25, 2020 26,921 $ 36.99 $ 5,292,881,709 October 26 through November 30, 2020 84,279 $ 37.48 $ 5,292,881,709 December 1 through December 31, 2020 69,317 $ 37.39 $ 5,292,881,709 Total 180,517 $ 37.37 Pfizer Inc. 2020 Form 10-K (a) See Note 12 . (b) Represents (i) 174,555 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,962 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who deferred receipt of performance share awards. PEER GROUP PERFORMANCE GRAPH The following graph assumes a $100 investment on December 31, 2015, and reinvestment of all dividends, in each of the Companys Common Stock, the SP 500 Index, and a composite peer group of the major U.S. and European-based pharmaceutical companies, which are: AbbVie Inc., Amgen Inc., AstraZeneca PLC, Bristol-Myers Squibb Company, Eli Lilly and Company, GlaxoSmithKline plc, Johnson Johnson, Merck Co., Inc., Novartis AG, Roche and Sanofi. Five Year Performance 2015 2016 2017 2018 2019 2020 PFIZER $100.0 $104.5 $120.9 $151.0 $140.5 $145.4 PEER GROUP $100.0 $100.8 $118.1 $127.8 $155.3 $161.7 SP 500 $100.0 $112.0 $136.4 $130.4 $171.4 $203.0 Pfizer Inc. 2020 Form 10-K "," ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW OF OUR PERFORMANCE, OPERATING ENVIRONMENT, STRATEGY AND OUTLOOK Financial Highlights The following is a summary of certain financial performance metrics (in billions, except per share data): 2020 Total Revenues$41.9 billion 2020 Net Cash Flow from Operations$14.4 billion An increase of 2% compared to 2019 An increase of 14% compared to 2019 2020 Reported Diluted EPS$1.71 2020 Adjusted Diluted EPS (Non-GAAP)$2.22* A decrease of 40% compared to 2019 An increase of 16% compared to 2019 * For additional information regarding Adjusted diluted EPS (which is a non-GAAP financial measure), including reconciliations of certain GAAP reported to non-GAAP adjusted information, see the Non-GAAP Financial Measure: Adjusted Income section within MDA. Pfizer Inc. 2020 Form 10-K References to operational variances pertain to period-over-period changes that exclude the impact of foreign exchange rates. Although foreign exchange rate changes are part of our business, they are not within our control and since they can mask positive or negative trends in the business, we believe presenting operational variances excluding these foreign exchange changes provides useful information to evaluate our results. Our Business and Strategy Most of our revenues come from the manufacture and sale of biopharmaceutical products. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off and combination of our Upjohn Business with Mylan in November 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We now operate as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. See Note 1A and Item 1. BusinessCommercial Operations of this Form 10-K for additional information. We expect to incur costs of approximately $700 million in connection with separating Upjohn, of which, approximately 70% has been incurred since inception and through December 31, 2020. These charges include costs and expenses related to separation of legal entities and transaction costs. Transforming to a More Focused Company: We have undertaken efforts to ensure our cost base aligns appropriately with our revenue base. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. In addition, we are taking steps to restructure our corporate enabling functions to appropriately support and drive the purpose of our focused innovative biopharmaceutical products business and RD and PGS platform functions. See the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section of this MDA. RD: We believe we have a strong pipeline and are well-positioned for future growth. RD is at the heart of fulfilling our purpose to deliver breakthroughs that change patients lives as we work to translate advanced science and technologies into the therapies that may be the most impactful for patients. Innovation, drug discovery and development are critical to our success. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness and ease of dosing and by discovering potential new indications. See the Item 1. Business Research and Development section of this Form 10-K for our RD priorities and strategy. We seek to leverage a strong pipeline, organize around expected operational growth drivers and capitalize on trends creating long-term growth opportunities, including: an aging global population that is generating increased demand for innovative medicines and vaccines that address patients unmet needs; advances in both biological science and digital technology that are enhancing the delivery of breakthrough new medicines and vaccines; and the increasingly significant role of hospitals in healthcare systems. We are committed to strategically capitalizing on growth opportunities by advancing our own product pipeline and maximizing the value of our existing products, as well as through various business development activities. We view our business development activity as an enabler of our strategies and seek to generate growth by pursuing opportunities and transactions that have the potential to strengthen our business and our capabilities. We assess our business, assets and scientific capabilities/portfolio as part of our regular, ongoing portfolio review process and also continue to consider business development activities that will advance our business. For additional information, including discussion of recent significant business development activities, see Note 2 . Our 2020 Performance Revenues Revenues increased $736 million, or 2%, to $41.9 billion in 2020 from $41.2 billion in 2019, reflecting an operational increase of $1.1 billion, or 3%, and an unfavorable impact of foreign exchange of $331 million, or 1%. Excluding the impact of the Consumer Healthcare transaction, revenues increased 8% operationally, reflecting strong growth in Vyndaqel/Vyndamax, Eliquis, Ibrance outside developed Europe, Inlyta, Xeljanz, Xtandi, Prevenar 13 outside the U.S., oncology biosimilars and certain products in the Hospital therapeutic area in the U.S., partially offset by Enbrel internationally and Prevnar 13 and Chantix in the U.S. Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for Prevenar 13 in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for BNT162b2. Pfizer Inc. 2020 Form 10-K The following outlines the components of the net change in revenues: For worldwide revenues, including a discussion of key drivers of our revenue performance and revenues by geography, see the discussion in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion and Revenues by Geography sections within MDA. For additional information regarding the primary indications or class of certain products, see Note 17B. Income from Continuing Operations Before Provision/(Benefit) for Taxes on Income The following provides an analysis of the change in Income from continuing operations before provision/(benefit) for taxes on income for 2020: (MILLIONS OF DOLLARS) Income from continuing operations before provision/(benefit) for taxes on income for the year ended December 31, 2019 $ 11,485 Favorable change in revenues 736 Favorable/(Unfavorable) changes: Non-recurrence of (Gain) on completion of Consumer Healthcare JV transaction (8,080) Higher Cost of sales (a) (441) Lower Selling, information and administrative expenses (a) 1,136 Higher Research and development expenses (a) (1,010) Lower Amortization of intangible assets (a) 1,026 Lower asset impairment charges (b) 1,152 Higher net periodic benefit credits other than service costs (b) 308 Lower business and legal entity alignment costs (b) 300 Higher Consumer Healthcare JV equity method income (b) 281 Lower charges for certain legal matters (b) 264 Higher income from collaborations, out-licensing arrangements and sales of compound/product rights (b) 158 Lower charges to separate our Consumer Healthcare business into a separate legal entity (b) 152 Lower interest expense (b) 125 Higher royalty-related income (b) 124 Lower net losses on early retirement of debt (b) 101 Higher net gains recognized during the period on equity securities (b) 86 Higher ViiV dividend income (b) 58 Higher net losses on asset disposals (b) (268) Lower interest income (b) (153) All other items, net (44) Income from continuing operations before provision/(benefit) for taxes on income for the year ended December 31, 2020 $ 7,497 (a) See the Costs and Expenses section within MDA . (b) See Note 4 . For information on our tax provision and effective tax rate, see the Provision/(Benefit) for Taxes on Income section within MDA and Note 5A . Our Operating Environment We, like other businesses in our industry, are subject to certain industry-specific challenges. These include, among others, the topics listed below. See also the Item 1. BusinessGovernment Regulation and Price Constraints section of this Form 10-K. Regulatory EnvironmentPipeline Productivity Our product lines must be replenished to offset revenue losses when products lose their market exclusivity, respond to healthcare and innovation trends and provide for earnings growth. As a result, we devote considerable resources to our RD activities which, while essential to our growth, incorporate a high degree of risk and cost, including whether a particular product candidate or new indication for an in-line product will achieve the desired clinical endpoint or safety profile, will be approved by regulators or will be successful commercially. We conduct clinical trials to Pfizer Inc. 2020 Form 10-K provide data on safety and efficacy to support the evaluation of a drugs overall benefit-risk profile for a particular patient population. In addition, after a product has been approved and launched, we continue to monitor its safety as long as it is available to patients. This includes postmarketing trials that may be conducted voluntarily or pursuant to a regulatory request to gain additional medical knowledge. For the entire life of the product, we collect safety data and report safety information to the FDA and other regulatory authorities. Regulatory authorities may evaluate potential safety concerns and take regulatory actions in response, such as updating a products labeling, restricting its use, communicating new safety information to the public, or, in rare cases, requiring us to suspend or remove a product from the market. The commercial potential of in-line products may be negatively impacted by post-marketing developments. Intellectual Property Rights and Collaboration/Licensing Rights The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a material adverse effect on our revenues. Certain of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. For example, the basic product patent for Chantix in the U.S. expired in November 2020. Also, the basic product patent for Sutent in the U.S. will expire in August 2021. While additional patent expiries will continue, we expect a moderate impact of reduced revenues due to patent expiries from 2021 through 2025. We continue to vigorously defend our patent rights against infringement, and we will continue to support efforts that strengthen worldwide recognition of patent rights while taking necessary steps to ensure appropriate patient access. For additional information on patent rights we consider most significant to our business as a whole, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this Form 10-K. For a discussion of recent developments with respect to patent litigation, see Note 16A1. Regulatory Environment/Pricing and AccessU.S. Healthcare Legislation In March 2010, the ACA was enacted in the U.S. We recorded the following amounts to reflect the impact of the ACA legislation: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Reduction to Revenues , related to the Medicare coverage gap discount provision $ 1,175 $ 761 $ 418 Selling, informational and administrative expenses , related to the fee payable to the federal government 195 210 134 Regulatory Environment/Pricing and AccessGovernment and Other Payer Group Pressures The pricing of medicines by pharmaceutical manufacturers and the cost of healthcare, which includes medicines, medical services and hospital services, continues to be important to payers, governments, patients, and other stakeholders. Federal and state governments and private third-party payers in the U.S. continue to take action to manage the utilization of drugs and cost of drugs, including increasingly employing formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. We consider a number of factors impacting the pricing of our medicines. Within the U.S., we often engage with patients, doctors and healthcare plans. We also often provide significant discounts from the list price to insurers, including PBMs and MCOs. The price that patients pay in the U.S. for prescribed medicines is ultimately set by healthcare providers and insurers. On average, insurers impose a higher out-of-pocket burden on patients for prescription medicines than for comparably priced medical services. Certain governments outside the U.S. provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to effectively regulate prices or patient reimbursement levels to control costs for the government-sponsored healthcare system. Governments may use a variety of measures, including proposing pricing reform or legislation, cross country collaboration and procurement, price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), QCE processes and VBP. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this Form 10-K. The Global Economic Environment In addition to the industry-specific factors discussed above, we, like other businesses of our size and global extent of activities, are exposed to the economic cycle. Certain factors in the global economic environment that may impact our global operations include, among other things, currency fluctuations, capital and exchange controls, global economic conditions, restrictive government actions, changes in intellectual property, legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as impacts of political or civil unrest, terrorist activity, unstable governments and legal systems, inter-governmental disputes and public health outbreaks, epidemics and pandemics. Government pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria or other means of cost control. COVID-19 Pandemic The continuation of the COVID-19 pandemic has impacted our business, operations and financial condition and results. For additional information on the impact of COVID-19 on our revenues, please see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur 2020 Performance section of this MDA. Our Response to COVID-19 We are committed to confronting the public health challenge posed by the pandemic by collaborating with industry partners and academic institutions to develop potential approaches to prevent and treat COVID-19. In March 2020, we issued a five-point plan calling on the biopharmaceutical industry to join us in committing to unprecedented collaboration to combat COVID-19. Subsequently, we have made some important advances, including, among others: Entry into a global agreement (except for China, Hong Kong, Macau and Taiwan) with BioNTech for the development, manufacture and commercialization of an mRNA-based coronavirus vaccine, BNT162, to help prevent COVID-19. In November 2020, the companies announced that after conducting the final efficacy analysis in the Phase 3 study, BNT162b2 met both of the studys primary efficacy endpoints. Pfizer Inc. 2020 Form 10-K Analysis of the data indicated a vaccine efficacy rate against COVID-19 of 95% in participants without prior SARS-CoV-2 infection (first primary objective) and also in participants with and without prior SARS-CoV-2 infection (second primary objective), in each case measured from seven days after the second dose. The FDA authorized the distribution and use of BNT162b2 in the U.S. to help prevent COVID-19 for individuals 16 years of age and older under an EUA issued in December 2020. BNT162b2 has not been approved or licensed by the FDA. The EUA authorizes distribution and use of this product subject to the conditions set forth in the EUA, and only for the duration of the declaration by the Department of Health Human Services that circumstances exist justifying authorization of emergency use of drugs and biological products (such as BNT162b2) during the COVID-19 pandemic under Section 564 of the FFDCA (the Declaration), or until revocation of the EUA by the FDA. The FDA has issued EUAs to certain other companies for products intended for the prevention or treatment of COVID-19 and may continue to do so during the duration of the Declaration. The FDA expects EUA holders to work towards submission of a BLA as soon as possible. BNT162b2 has now been granted a CMA, EUA or temporary authorization in more than 50 countries worldwide. The companies continue to study BNT162b2, including studies evaluating it in additional populations, booster doses and emerging variants. Based on the updated 6-dose labeling and subject to continuous process improvements, expansion at current facilities and adding new suppliers and contract manufacturers, the companies believe that they can potentially manufacture at least 2 billion doses in total by the end of 2021. The companies have entered into agreements to supply pre-specified doses of BNT162b2 with multiple developed and emerging nations around the world and are continuing to deliver doses of BNT162b2 to governments under such agreements. As of February 2, 2021, based on the doses to be delivered in 2021 primarily under agreements entered into as of February 2, 2021 (including, among others, agreements with the U.S. government to supply 200 million doses, the European Commission to supply 300 million doses, the Japanese government to supply 144 million doses and COVID-19 Vaccines Global Access (COVAX) for up to 40 million doses in 2021, subject to the negotiation and execution of additional agreements under the COVAX Facility structure), we forecasted approximately $15 billion in revenues in 2021 from BNT162b2, with gross margin to be split evenly with BioNTech. This forecast was based on doses mostly covered under agreements entered into as of February 2, 2021 and did not include all of the doses we can potentially deliver by the end of 2021. The companies continue to enter into agreements with governments for additional doses, including, among others, the exercise by the U.S. government of an option for an additional 100 million doses and an agreement with the European Commission for an additional 200 million doses to be delivered in 2021. Accordingly, this forecast may change based, in part, on these and future additional agreements that may be signed and as circumstances warrant. For additional information on our COVID-19 vaccine development program, see Note 2 and the Item 1A. Risk FactorsCOVID-19 Pandemic section in this Form 10-K. Initiation, in September 2020, of a Phase 1b clinical trial in hospitalized participants with COVID-19 to evaluate the safety, tolerability and pharmacokinetics of a novel investigational protease inhibitor for COVID-19, PF-07304814, which is a phosphate prodrug of a 3C-like (3CL) protease inhibitor, PF-00835231. Despite our significant investments and efforts, any of our ongoing development programs related to COVID-19 may not be successful as the risk of failure is significant, and there can be no certainty these efforts will yield a successful product or that costs will ultimately be recouped. Impact of COVID-19 on Our Business and Operations The following discussion summarizes our current views of key business and operational areas impacted by the pandemic and its effects on our business, operations, and financial condition and results. As part of our on-going monitoring and assessment, we have made certain assumptions regarding the COVID-19 pandemic for purposes of our operational planning and financial projections, including assumptions regarding the duration, severity and the global macroeconomic impact of the pandemic, as well as COVID-19 vaccine supply and contracts, which remain dynamic. Despite careful tracking and planning, we are unable to accurately predict the extent of the impact of the pandemic on our business, operations and financial condition and results due to the uncertainty of future developments. In particular, we believe the ultimate impact on our business, operations and financial condition and results will be affected by the speed and extent of the continued spread of the coronavirus globally; the emergence of additional virus variants; the duration of the pandemic; new information regarding the severity and incidence of COVID-19; the safety, efficacy and availability of vaccines and treatments for COVID-19; the rate at which the population becomes vaccinated against COVID-19; the global macroeconomic impact of the pandemic and governmental or regulatory actions to contain the virus or control supply of medicines. We are focused on all aspects of our business and are implementing measures aimed at mitigating issues where possible, including by using digital technology to assist in operations for our commercial, manufacturing, RD and enabling functions globally. Our business and operations have been impacted by the pandemic in various ways. For example: At this time, most of our colleagues who are able to perform their job functions outside of our facilities continue to work remotely, while certain colleagues in the PGS and WRDM organizations continue to work onsite and are subject to strict protocols intended to reduce the risk of transmission. While engagement with healthcare professionals has started to return to pre-pandemic levels due to our virtual engagement capabilities, our sales force colleagues continue to encounter mixed access as a result of ongoing restrictions on in-person meetings. We are actively reviewing and assessing epidemiological data and our colleagues remain ready to resume in-person engagements with healthcare professionals on a location-by-location basis as soon as it is safe to do so. During the pandemic, we have adapted our promotional platform by amplifying our existing digital capabilities to reach healthcare professionals and customers to provide critical education and information, including increasing the scale of our remote engagement. We have not seen a significant disruption to our supply chain to date, and all of our manufacturing sites globally have continued to operate at or near normal levels. After a brief pause to the recruitment portion of certain ongoing clinical studies and a delay to most new study starts, we restarted recruitment across the development portfolio (including new study starts) in late-April 2020. Our portfolio of products experienced varying impacts from the pandemic. Some of our products are medically necessary but also more reliant on maintenance therapy with continuing patients in addition to new patients, some of our products are more reliant on new patient starts and typically require doctor visits, including wellness visits, and some of our products are identified as medically necessary for treatment in the pandemic. A large proportion of our portfolio comprises oral or self-injected medicines that do not require a visit to an infusion center or a physicians office for administration, but vaccines and physician-administered medicines, which do require office visits, were impacted in 2020 by COVID-19-related mobility restrictions or limitations and decline in patient visits to doctors. In addition, certain of our vaccines such as Prevnar 13/Prevenar 13 may be impacted by recommendations by certain health officials to not co-administer such vaccines alongside the COVID-19 vaccines. For additional detail on the impact of the COVID-19 pandemic on our products, see the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussio n section within MDA. Pfizer Inc. 2020 Form 10-K Notwithstanding the foregoing impact of the pandemic, given our significant operating cash flows, as well as our financial assets, access to capital markets and revolving credit agreements, we believe we have, and expect to maintain, the ability to meet liquidity needs for the foreseeable future. We will continue to pursue efforts to maintain the continuity of our operations while monitoring for new developments related to the pandemic. Future developments could result in additional favorable or unfavorable impacts on our business, operations or financial condition and results. If we experience significant disruption in our manufacturing or supply chains or significant disruptions in clinical trials or other operations, or if demand for our products is significantly reduced as a result of the COVID-19 pandemic, we could experience a material adverse impact on our business, operations and financial condition and results. See the Item 1A. Risk FactorsCOVID-19 Pandemic section of this Form 10-K. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS Following is a discussion about the critical accounting estimates and assumptions impacting our consolidated financial statements. Also, see Note 1C . For a description of our significant accounting policies, see Note 1 . Of these policies, the following are considered critical to an understanding of our consolidated financial statements as they require the application of the most subjective and the most complex judgments: Acquisitions ( Note 1D ); Fair Value ( Note 1E ); Revenues ( Note 1G ); Asset Impairments ( Note 1L ); Tax Assets and Liabilities and Income Tax Contingencies ( Note 1P ); Pension and Postretirement Benefit Plans ( Note 1Q ); and Legal and Environmental Contingencies ( Note 1R ). Acquisitions and Fair Value For discussions about the application of fair value, see the following: recent acquisitions ( Note 2A ); investments ( Note 7A) ; benefit plan assets ( Note 11D ); and Asset Impairments below. Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. If any of our ratios, factors, assessments, experiences or judgments are not indicative or accurate estimates of our future experience, our results could be materially affected. The potential of our estimates to vary (sensitivity) differs by program, product, type of customer and geographic location. However, estimates associated with U.S. Medicare, Medicaid and performance-based contract rebates are most at risk for material adjustment because of the extensive time delay between the recording of the accrual and its ultimate settlement, an interval that can generally range up to one year. Because of this lag, our recording of adjustments to reflect actual amounts can incorporate revisions of several prior quarters. Asset Impairments We review all of our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record charges for impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Our impairment review processes are described in Note 1L. Examples of events or circumstances that may be indicative of impairment include: A significant adverse change in legal factors or in the business climate that could affect the value of the asset. For example, a successful challenge of our patent rights would likely result in generic competition earlier than expected. A significant adverse change in the extent or manner in which an asset is used such as a restriction imposed by the FDA or other regulatory authorities that could affect our ability to manufacture or sell a product. An expectation of losses or reduced profits associated with an asset. This could result, for example, from a change in a government reimbursement program that results in an inability to sustain projected product revenues and profitability. This also could result from the introduction of a competitors product that impacts projected revenue growth, as well as the lack of acceptance of a product by patients, physicians and payers. For IPRD projects, this could result from, among other things, a change in outlook based on clinical trial data, a delay in the projected launch date or additional expenditures to commercialize the product. Identifiable Intangible Assets We use an income approach, specifically the discounted cash flow method to determine the fair value of intangible assets, other than goodwill. We start with a forecast of all the expected net cash flows associated with the asset, which incorporates the consideration of a terminal value for indefinite-lived assets, and then we apply an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions that impact our fair value estimates include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the projections and the impact of technological advancements and risk associated with IPRD assets, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic origin of the projected cash flows. While all intangible assets other than goodwill can face events and circumstances that can lead to impairment, those that are most at risk of impairment include IPRD assets (approximately $3.2 billion as of December 31, 2020) and newly acquired or recently impaired indefinite-lived brand assets. IPRD assets are high-risk assets, given the uncertain nature of RD. Newly acquired and recently impaired indefinite-lived assets are more vulnerable to impairment as the assets are recorded at fair value and are then subsequently measured at the lower of fair value or Pfizer Inc. 2020 Form 10-K carrying value at the end of each reporting period. As such, immediately after acquisition or impairment, even small declines in the outlook for these assets can negatively impact our ability to recover the carrying value and can result in an impairment charge. Goodwill Our goodwill impairment review work as of December 31, 2020 concluded that none of our goodwill was impaired and we do not believe the risk of impairment is significant at this time. In our review, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors that we consider include, for example, macroeconomic and industry conditions, overall financial performance and other relevant entity-specific events. If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we then perform a quantitative fair value test. When we are required to determine the fair value of a reporting unit, we mainly use the income approach but may also use the market approach, or a weighted-average combination of both approaches. The income approach is a forward-looking approach to estimating fair value and relies primarily on internal forecasts. Within the income approach, we use the discounted cash flow method. We start with a forecast of all the expected net cash flows for the reporting unit, which includes the application of a terminal value, and then we apply a reporting unit-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of technological risk and competitive, legal and/or regulatory forces on the projections, as well as the selection of a long-term growth rate; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. The market approach is a historical approach to estimating fair value and relies primarily on external information. We may use two alternative methods within the market approach: Guideline public company methodthis method employs market multiples derived from market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market and the application of the identified multiples to the corresponding measure of our reporting units financial performance. Guideline transaction methodthis method relies on pricing multiples derived from transactions of significant interests in companies engaged in the same or similar lines of business and the application of the identified multiples to the corresponding measure of our reporting units financial performance. The market approach is only appropriate when the available external information is robust and deemed to be a reliable proxy for the specific reporting unit being valued; however, these assessments may prove to be incomplete or inaccurate. Some of the more significant estimates and assumptions inherent in this approach include: the selection of appropriate guideline companies and transactions and the determination of applicable premiums and discounts based on any differences in ownership percentages, ownership rights, business ownership forms or marketability between the reporting unit and the guideline companies and transactions. For all of our reporting units, there are a number of future events and factors that may impact future results and that could potentially have an impact on the outcome of subsequent goodwill impairment testing. For a list of these factors, see the Forward-Looking Information and Factors That May Affect Future Results and the Item 1A. Risk Factors sections in this Form 10-K. Benefit Plans For a description of our different benefit plans, see Note 11 . Effective January 1, 2018, accruals for future benefits under the PCPP (our largest U.S. defined benefit plan) and the defined benefit section of the Pfizer Group Pension Scheme (our largest pension plan in the U.K.) were frozen and resulted in elimination of future service costs for the plans. The Pfizer defined contribution savings plan provides additional annual contributions to those previously accruing benefits under the PCPP and active members of the Pfizer Group Pension Scheme started accruing benefits under the defined contribution section of that plan. Our assumptions reflect our historical experiences and our judgment regarding future expectations that have been deemed reasonable by management. The judgments made in determining the costs of our benefit plans can materially impact our results of operations. The following provides (i) at the end of each year, the expected annual rate of return on plan assets for the following year, (ii) the actual annual rate of return on plan assets achieved in each year, and (iii) the weighted-average discount rate used to measure the benefit obligations at the end of each year for our U.S. qualified pension plans and our international pension plans (a) : 2020 2019 2018 U.S. Qualified Pension Plans Expected annual rate of return on plan assets 6.8 % 7.0 % 7.2 % Actual annual rate of return on plan assets 14.1 22.6 (5.3) Discount rate used to measure the plan obligations 2.6 3.3 4.4 International Pension Plans Expected annual rate of return on plan assets 3.4 3.6 3.9 Actual annual rate of return on plan assets 9.7 10.7 (0.9) Discount rate used to measure the plan obligations 1.5 1.7 2.5 (a) For detailed assumptions associated with our benefit plans, see Note 11B . Pfizer Inc. 2020 Form 10-K Expected Annual Rate of Return on Plan Assets The assumptions for the expected annual rate of return on all of our plan assets reflect our actual historical return experience and our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The expected annual rate of return on plan assets for our U.S. plans and the majority of our international plans is applied to the fair value of plan assets at each year-end and the resulting amount is reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs to a 50 basis point decline in our assumption for the expected annual rate of return on plan assets, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2021 Net Periodic Benefit Costs Expected annual rate of return on plan assets 50 basis point decline $116 The actual return on plan assets was approximately $2.9 billion during 2020 . Discount Rate Used to Measure Plan Obligations The weighted-average discount rate used to measure the plan obligations for our U.S. defined benefit plans is determined at least annually and evaluated and modified, as required, to reflect the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better, that reflect the rates at which the pension benefits could be effectively settled. The discount rate used to measure the plan obligations for our international plans is determined at least annually by reference to investment grade corporate bonds, rated AA/Aa or better, including, when there is sufficient data, a yield-curve approach. These discount rate determinations are made in consideration of local requirements. The measurement of the plan obligations at the end of the year will affect the amount of service cost, interest cost and amortization expense reflected in our net periodic benefit costs in the following year. The following illustrates the sensitivity of net periodic benefit costs and benefit obligations to a 10 basis point decline in our assumption for the discount rate, holding all other assumptions constant (in millions, pre-tax): Assumption Change Increase in 2021 Net Periodic Benefit Costs 2020 Benefit Obligations Increase Increase Discount rate 10 basis point decline $2 $483 The change in the discount rates used in measuring our plan obligations as of December 31, 2020 resulted in an increase in the measurement of our aggregate plan obligations by approximately $1.9 billion. Anticipated Change in Accounting Policy We anticipate making a change in our pension accounting policy under which we would begin recognizing actuarial gains and losses immediately in the income statement compared to our current accounting policy that recognizes such gains and losses in stockholders equity and amortizes them as a component of net periodic benefit cost/(credit) over future periods. This anticipated change is expected to go into effect in the first quarter of 2021 and if adopted, will require recasting prior period amounts to conform to the new accounting policy. Income Tax Assets and Liabilities Income tax assets and liabilities include income tax valuation allowances and accruals for uncertain tax positions. For additional information, see Notes 1P and 5, as well as the Analysis of Financial Condition, Liquidity, Capital Resources and Market Risk Selected Measures of Liquidity and Capital Resources section within MDA . Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax, legal contingencies and guarantees and indemnifications. For additional information, see Notes 1P , 1R , 5D and 16 . Pfizer Inc. 2020 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF INCOME Revenues by Geography The following presents worldwide revenues by geography: Year Ended December 31, % Change Worldwide U.S. International Worldwide U.S. International (MILLIONS OF DOLLARS) 2020 2019 2018 2020 2019 2018 2020 2019 2018 20/19 19/18 20/19 19/18 20/19 19/18 Total revenues $ 41,908 $ 41,172 $ 40,825 $ 21,712 $ 20,593 $ 20,119 $ 20,196 $ 20,579 $ 20,705 2 1 5 2 (2) (1) 2020 v. 2019 The following provides an analysis of the change in worldwide revenues by geographic areas in 2020: (MILLIONS OF DOLLARS) Worldwide U.S. International Operational growth/(decline): Growth from Prevnar 13/Prevenar 13, Ibrance, Eliquis, Xeljanz, Vyndaqel/Vyndamax, Xtandi, Inlyta, Biosimilars and the Hospital therapeutic area, partially offset by Chantix/Champix. See the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product Discussion within MDA for additional analysis $ 3,479 $ 1,902 $ 1,577 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations, and none in 2020 (2,082) (988) (1,094) Lower revenues for Enbrel internationally, primarily reflecting continued biosimilar competition in most developed Europe markets, as well as in Japan and Brazil, all of which is expected to continue (320) (320) Other operational factors, net (10) 205 (214) Operational growth/(decline), net 1,068 1,119 (50) Unfavorable impact of foreign exchange (331) (331) Revenues increase/(decrease) $ 736 $ 1,119 $ (383) Revenues for 2020 included an estimated unfavorable impact of approximately $700 million, or 2%, due to COVID-19, primarily reflecting lower demand for certain products in China and unfavorable disruptions to wellness visits for patients in the U.S., which negatively impacted prescribing patterns for certain products, partially offset by increased U.S. demand for certain sterile injectable products and increased adult uptake for Prevenar 13 in certain international markets, resulting from greater vaccine awareness for respiratory illnesses, and U.S. revenues for BNT162b2. Emerging markets revenues decreased $456 million, or 5%, in 2020 to $8.4 billion from $8.8 billion in 2019, and were relatively flat operationally, reflecting an unfavorable impact of foreign exchange of 5% on emerging markets revenues. The relatively flat operational performance was primarily driven by growth from Eliquis, Prevenar 13, Ibrance and Zavicefta, offset by lower revenues for Consumer Healthcare, reflecting the July 31, 2019 completion of the Consumer Healthcare JV transaction. Pfizer Inc. 2020 Form 10-K 2019 v. 2018 The following provides an analysis of the change in worldwide revenues by geographic areas in 2019: (MILLIONS OF DOLLARS) Worldwide U.S. International Operational growth/(decline): Growth from Ibrance, Eliquis, Xeljanz and Prevnar/Prevenar 13 $ 2,495 $ 914 $ 1,581 Higher revenues for certain Hospital products as a result of: continued growth of anti-infective products in China, driven by increased demand for Sulperazon and new launches; the 2018 U.S. launches of our immune globulin IV products (Panzyga and Octagam); and the launches of certain anti-infectives products (Zavicefta, Zinforo and Cresemba) in international developed and emerging markets 472 174 298 Higher revenues for Inlyta, primarily in the U.S. driven by increased demand resulting from the second quarter of 2019 U.S. FDA approvals for the combinations of certain immune checkpoint inhibitors plus Inlyta for the first-line treatment of patients with advanced RCC 190 175 14 Higher revenues for Biosimilars, primarily in the U.S. 168 185 (17) Higher revenues for rare disease products driven by: the U.S. launches in May 2019 of Vyndaqel and in September 2019 of Vyndamax for the treatment of ATTR-CM; continued uptake for the transthyretin amyloid polyneuropathy indication, primarily in developed Europe; and the March 2019 launch of the ATTR-CM indication in Japan, partially offset by: lower revenues for certain rare disease products, including the hemophilia franchises (Refacto AF/Xyntha and BeneFIX), primarily due to competitive pressures, and Genotropin in developed markets, mainly due to unfavorable channel mix in the U.S. 159 108 51 Impact of completion of the Consumer Healthcare JV transaction. Revenues in 2019 only reflect seven months of Consumer Healthcare business domestic operations and eight months of international operations (1,436) (889) (547) Lower revenues from other Hospital products, primarily reflecting declines in developed markets, mostly due to the continued expected negative impact from generic competition for products that have previously lost marketing exclusivity (447) (200) (247) Lower revenues for Enbrel, primarily in most developed Europe markets due to continued biosimilar competition (292) (292) Other operational factors, net 141 6 136 Operational growth, net 1,450 473 976 Unfavorable impact of foreign exchange (1,103) (1,103) Revenues increase/(decrease) $ 347 $ 473 $ (127) Emerging markets revenues increased $210 million, or 2%, in 2019 to $8.8 billion, from $8.6 billion in 2018, reflecting an operational increase of $820 million, or 10%. Foreign exchange had an unfavorable impact of 7% on emerging markets revenues. The operational increase in emerging markets was primarily driven by Prevenar 13, Ibrance and Eliquis. Revenue Deductions Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. These deductions represent estimates of related obligations and, as such, knowledge and judgment are required when estimating the impact of these revenue deductions on gross sales for a reporting period. Historically, adjustments to these estimates to reflect actual results or updated expectations, have not been material to our overall business and generally have been less than 1% of revenues. Product-specific rebates, however, can have a significant impact on year-over-year individual product revenue growth trends. The following presents information about revenue deductions: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Medicare rebates $ 647 $ 628 $ 495 Medicaid and related state program rebates 1,136 1,259 984 Performance-based contract rebates 2,660 2,332 1,758 Chargebacks 4,531 3,411 2,954 Sales allowances 3,841 3,782 3,536 Sales returns and cash discounts 924 878 1,128 Total $ 13,739 $ 12,290 $ 10,854 Revenue deductions are primarily a function of product sales volume, mix of products sold, contractual or legislative discounts and rebates. For information on our accruals for revenue deductions, including the balance sheet classification of these accruals, see Note 1G . Pfizer Inc. 2020 Form 10-K RevenuesSelected Product Discussion Revenue (MILLIONS OF DOLLARS) Year Ended Dec. 31, % Change Product Global Revenues Region 2020 2019 Total Oper. Operational Results Commentary Prevnar 13/ Prevenar 13 $5,850 Up 1% (operationally) U.S. $ 2,930 $ 3,209 (9) Operational growth internationally primarily reflects increased adult uptake in certain international markets resulting from greater vaccine awareness for respiratory illnesses, including specifically pneumococcal disease, due to the COVID-19 pandemic, as well as continued strong pediatric uptake in China, partially offset by a decline in the U.S., primarily driven by the expected unfavorable impact of disruptions to wellness visits for pediatric and adult patients due to COVID-19-related mobility restrictions or limitations as well as the continued impact of a lower remaining eligible adult population and the impact of the revised ACIP recommendation for the adult indication to shared clinical decision making, which means the decision to vaccinate should be made at the individual level between health care providers and their patients. Intl. 2,920 2,638 11 13 Worldwide $ 5,850 $ 5,847 1 Ibrance $5,392 Up 9% (operationally) U.S. $ 3,634 $ 3,250 12 Primarily driven by continued strong volume growth in most markets, partially offset by pricing pressures in certain developed Europe markets. Intl. 1,758 1,710 3 5 Worldwide $ 5,392 $ 4,961 9 9 Eliquis $4,949 Up 18% (operationally) U.S. $ 2,688 $ 2,343 15 Primarily driven by continued increased adoption in non-valvular atrial fibrillation as well as oral anti-coagulant market share gains, partially offset by a lower net price due to an increased impact from the Medicare coverage gap and unfavorable channel mix in the U.S. Intl. 2,260 1,877 20 22 Worldwide $ 4,949 $ 4,220 17 18 Xeljanz $2,437 Up 9% (operationally) U.S. $ 1,706 $ 1,636 4 Higher volumes in the U.S. within the RA, PsA and UC indications driven by reaching additional patients through improvements in formulary access, partially offset by increased discounts from recently-signed contracts which were entered into in order to unlock access to additional patient lives. Also reflects operational growth internationally mainly driven by continued uptake in the RA indication and, to a lesser extent, from the recent launch of the UC indication in certain developed markets. Intl. 731 606 21 23 Worldwide $ 2,437 $ 2,242 9 9 Vyndaqel/ Vyndamax $1,288 * U.S. $ 613 $ 191 * Driven by the U.S. launches of Vyndaqel in May 2019 and Vyndamax in September 2019 for the treatment of ATTR-CM and by the March 2019 launch of the ATTR-CM indication in Japan and the February 2020 approval of the ATTR-CM indication in the EU. Intl. 675 282 * * Worldwide $ 1,288 $ 473 * * Xtandi $1,024 Up 22% (operationally) U.S. $ 1,024 $ 838 22 Primarily driven by continued strong demand for Xtandi in the mCRPC and nmCRPC indications, as well as the mCSPC indication, which was approved in the U.S. in December 2019. Intl. Worldwide $ 1,024 $ 838 22 22 Chantix/ Champix $919 Down 17% (operationally) U.S. $ 716 $ 899 (20) Driven by the U.S. and primarily reflects expected lower demand resulting from reduced doctor visits, including wellness visits when Chantix is typically prescribed, due to COVID-19-related mobility restrictions or limitations as well as the loss of patent protection in the U.S. in November 2020, partially offset by increased demand in Spain as a result of government reimbursement starting in January 2020. Intl. 203 208 (2) (1) Worldwide $ 919 $ 1,107 (17) (17) Inlyta $787 Up 66% (operationally) U.S. $ 523 $ 295 78 Primarily due to increased demand in the U.S. and certain developed international markets, following the approvals in 2019 for combinations of certain immune checkpoint inhibitors plus Inlyta for the first-line treatment of patients with advanced RCC. Intl. 264 182 45 47 Worldwide $ 787 $ 477 65 66 Biosimilars $1,527 Up 68% (operationally) U.S. $ 899 $ 451 99 Primarily driven by recent oncology biosimilar launches in the U.S. and other global markets and continued growth from Retacrit, primarily in the U.S. Intl. 628 460 36 37 Worldwide $ 1,527 $ 911 68 68 Hospital $7,961 Up 3% (operationally) U.S. $ 3,362 $ 3,081 9 Higher revenues in the U.S., primarily driven by increased demand for certain sterile injectable products utilized in the intubation and ongoing treatment of mechanically-ventilated COVID-19 patients, continued growth from Panzyga and recent anti-infective launches, as well as Pfizer CentreOne business in international markets, partially offset by lower demand for certain anti-infective products in China due to lower infection rates driven by fewer elective surgical procedures, shorter in-patient hospital stays and improved infection control. Intl. 4,599 4,691 (2) Worldwide $ 7,961 $ 7,772 2 3 * Calculation is not meaningful or results are equal to or greater than 100%. See the Item 1. Business Patents and Other Intellectual Property Rights section in this Form 10-K for information regarding the expiration of various patent rights. See Note 16 for a discussion of recent developments concerning patent and product litigation relating to certain of the products discussed above. See Note 17B for additional information regarding the primary indications or class of the selected products discussed above. Pfizer Inc. 2020 Form 10-K Product Developments A comprehensive update of Pfizers development pipeline was published as of February 2, 2021 and is available at www.pfizer.com/science/drug-product-pipeline. It includes an overview of our research and a list of compounds in development with targeted indication and phase of development, as well as mechanism of action for some candidates in Phase 1 and all candidates from Phase 2 through registration. The following provides information about significant marketing application-related regulatory actions by, and filings pending with, the FDA and regulatory authorities in the EU and Japan. The table below includes only approvals for products that have occurred in the last twelve months and does not include approvals that may have occurred prior to that time. The table includes filings with regulatory decisions pending (even if the filing occurred outside of the last twelve-month period). PRODUCT DISEASE AREA APPROVED/FILED* U.S. EU JAPAN PF-07302048 (COVID-19 Vaccine) (a) Immunization to prevent COVID-19 (16 years of age and older) EUA Dec. CMA Dec. Approved Feb. Bavencio (avelumab) (b) First-line maintenance urothelial cancer Approved June Approved Jan. Filed May First-line RCC (combination with Inlyta (axitinib)) Approved Dec. Nyvepria (pegfilgrastim-apgf) Neutropenia in patients undergoing cancer chemotherapy (biosimilar) Approved June Approved Nov. Braftovi (encorafenib) (c) Second or third-line BRAF v600E -mutant mCRC (combination with Erbitux (cetuximab)) Approved April Approved June Approved Nov. Braftovi (encorafenib) and Mektovi (binimetinib) (c) Second or third-line BRAF V600E -mutant mCRC (combination with Erbitux (cetuximab)) Approved Nov. Xtandi (enzalutamide) (d) mCSPC Approved Dec. Filed July Abrilada (U.S.); Amsparity (EU) (adalimumab-afzb) (e) RA (biosimilar) Approved Nov. Approved Feb. abrocitinib (PF-04965842) Atopic dermatitis Filed Oct. Filed Oct. Filed Dec. Infliximab Pfizer (infliximab) Ankylosing spondylitis (biosimilar) Approved Oct. Bevacizumab Pfizer (bevacizumab) Non-small cell lung cancer (biosimilar) Approved Sept. Rituximab Pfizer (rituximab) Chronic idiopathic thrombocytopenic purpura (biosimilar) Approved Aug. tanezumab (f) Chronic pain due to moderate-to-severe osteoarthritis Filed March Filed March Filed Aug. Bosulif (bosutinib) First-line chronic myelogenous leukemia Approved June Daurismo (glasdegib) Combination with low-dose cytarabine for AML Approved June Ruxience (rituximab) Follicular lymphoma (biosimilar) Approved April Staquis (crisaborole) Atopic dermatitis Approved March Vyndaqel (tafamidis free acid) ATTR-CM Approved Feb. Xeljanz (tofacitinib) Modified release 11 mg tablet for RA (combination with methotrexate) Approved Dec. Ankylosing spondylitis Filed Aug. Relugolix (g) Uterine fibroids (combination with estradiol and norethindrone acetate) Filed Aug. Lorbrena (lorlatinib) First- line ALK-positive non-small cell lung cancer Filed Dec. somatrogon (PF-06836922) (h) Pediatric growth hormone deficiency Filed Jan. PF-06482077 (Vaccine) Invasive and non-invasive pneumococcal infections (adults) Filed Dec. Pfizer Inc. 2020 Form 10-K * For the U.S., the filing date is the date on which the FDA accepted our submission. For the EU, the filing date is the date on which the EMA validated our submission. (a) PF-07302048 or BNT162b2 (Pfizer/BioNTech COVID-19 vaccine) received EUA from the FDA and CMA from the EMA. (b) Being developed in collaboration with Merck KGaA, Germany. (c) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (d) Being developed in collaboration with Astellas. (e) We are working to make Abrilada available to U.S. patients as soon as feasible based on the terms of our agreement with AbbVie. Current plans are to launch Abrilada in 2023. We do not currently plan to commercialize Amsparity in the EU due to unfavorable market conditions. (f) Being developed in collaboration with Lilly. (g) Being developed in collaboration with Myovant. (h) Being developed in collaboration with OPKO Health, Inc. In China, the following products received regulatory approvals in the last twelve months: Eucrisa for atopic dermatitis in July 2020 and Vyndaqel for cardiac amyloidosis in September 2020. The following provides information about additional indications and new drug candidates in late-stage development: PRODUCT/CANDIDATE PROPOSED DISEASE AREA LATE-STAGE CLINICAL PROGRAMS FOR ADDITIONAL USES AND DOSAGE FORMS FOR IN-LINE AND IN-REGISTRATION PRODUCTS Bavencio (avelumab) (a) First-line non-small cell lung cancer Ibrance (palbociclib) (b) ER+/HER2+ metastatic breast cancer Xtandi (enzalutamide) (c) Non-metastatic high-risk castration sensitive prostate cancer Talzenna (talazoparib) Combination with Xtandi (enzalutamide) for first-line mCRPC PF-06482077 (Vaccine) Invasive and non-invasive pneumococcal infections (pediatric) somatrogon (PF-06836922) (d) Adult growth hormone deficiency tanezumab (e) Cancer pain Braftovi (encorafenib) and Erbitux (cetuximab) (f) First-line BRAF v600E -mutant mCRC Relugolix (g) Combination with estradiol and norethindrone acetate for endometriosis NEW DRUG CANDIDATES IN LATE-STAGE DEVELOPMENT aztreonam-avibactam (PF-06947387) Treatment of infections caused by Gram-negative bacteria for which there are limited or no treatment options fidanacogene elaparvovec (PF-06838435) Hemophilia B Giroctocogene fitelparvovec (SB-525 or PF-07055480) Hemophilia A PF-06425090 (Vaccine) Primary clostridioides difficile infection PF-06886992 (Vaccine) Serogroups meningococcal (adolescent and young adults) PF-06928316 (Vaccine) Respiratory syncytial virus infection (maternal) PF-07265803 Dilated cardiomyopathy due to Lamin A/C gene mutation ritlecitinib (PF-06651600) Alopecia areata sasanlimab (PF-06801591) Non-muscle-invasive bladder cancer PF-06939926 Duchenne muscular dystrophy marstacimab (PF-06741086) Hemophilia (a) Being developed in collaboration with Merck KGaA, Germany. (b) Being developed in collaboration with the Alliance Foundation Trial. (c) Being developed in collaboration with Astellas. (d) Being developed in collaboration with OPKO Health, Inc. (e) Being developed in collaboration with Lilly. (f) Erbitux is a registered trademark of ImClone LLC. In the EU, we are developing in collaboration with the Pierre Fabre Group. In Japan, we are developing in collaboration with Ono Pharmaceutical Co., Ltd. (g) Being developed in collaboration with Myovant. For additional information about our RD organization, see the Item 1. Business Research and Development section of this Form 10-K. COSTS AND EXPENSES The changes in costs and expenses below reflect, among other things, a decline in expenses resulting from the July 31, 2019 completion of the Consumer Healthcare JV transaction (see Note 2C ). In addition, the COVID-19 pandemic impacted certain operating expenses in 2020. Pfizer Inc. 2020 Form 10-K Costs and expenses follow: Year Ended December 31, % Change (MILLIONS OF DOLLARS) 2020 2019 2018 20/19 19/18 Cost of sales $ 8,692 $ 8,251 $ 8,987 5 (8) Percentage of Revenues 20.7 % 20.0 % 22.0 % Selling, informational and administrative expenses 11,615 12,750 12,612 (9) 1 Percentage of Revenues 27.7 % 31.0 % 30.9 % Research and development expenses 9,405 8,394 7,760 12 8 Percentage of Revenues 22.4 % 20.4 % 19.0 % Amortization of intangible assets 3,436 4,462 4,736 (23) (6) Percentage of Revenues 8.2 % 10.8 % 11.6 % Restructuring charges and certain acquisition-related costs 600 601 1,058 (43) Percentage of Revenues 1.4 % 1.5 % 2.6 % Other (income)/deductionsnet 669 3,314 2,077 (80) 60 Cost of Sales 2020 v. 2019 Cost of sales increased $441 million, primarily due to: increased sales volumes; the increase in royalty expenses, due to an increase in sales of related products; the unfavorable impact of incremental costs incurred in response to the COVID-19 pandemic; and the unfavorable impact of foreign exchange and hedging activity on intercompany inventory, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction. The increase in Cost of sales as a percentage of revenues in 2020, compared to 2019, was primarily due to all of the factors discussed above, partially offset by an increase in alliance revenues, which have no associated cost of sales. 2019 v. 2018 Cost of sales decreased $736 million, primarily due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; the favorable impact of foreign exchange; and the favorable impact of hedging activity of intercompany inventory, partially offset by: the unfavorable change in product mix; and the increase in royalty expenses, due to an increase in sales of related products. The decrease in Cost of sales as a percentage of revenues in 2019, compared to 2018, was primarily due to all of the factors discussed above, as well an increase in alliance revenues, which have no associated cost of sales. Selling, Informational and Administrative (SIA) Expenses 2020 v. 2019 SIA expenses decreased $1.1 billion, mostly due to: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV transaction; lower spending for corporate enabling functions; lower spending on sales and marketing activities due to the impact of the COVID-19 pandemic; and lower investments across the Internal Medicine and Inflammation Immunology portfolios, partially offset by: the increase in external, incremental costs directly related to implementing our cost-reduction/productivity initiatives; and the increase in business and legal entity alignment costs. 2019 v. 2018 SIA expenses increased $138 million, primarily due to: additional investment in emerging markets; additional investment in the Oncology portfolio in developed markets; increased employee deferred compensation as a result of savings plan gains; the increase due to the timing of expenses (i.e., insurance recoveries and product donations); marketing and promotional expenses for the U.S. launches of Vyndaqel in May 2019 and Vyndamax in September 2019; Pfizer Inc. 2020 Form 10-K increased business and legal entity alignment costs; costs to separate Consumer Healthcare; and increased healthcare reform expenses, partially offset by: the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV; and the favorable impact of foreign exchange. Research and Development (RD) Expenses 2020 v. 2019 RD expenses increased $1.0 billion, mainly due to: costs related to our collaboration agreement with BioNTech to co-develop a COVID-19 vaccine, including an upfront payment to BioNTech; a net increase in upfront payments, mainly related to Myovant and Valneva; and increased investments towards building new capabilities and driving automation, partially offset by: the net reduction of upfront and milestone payments associated with the acquisition of Therachon in July 2019 and Akcea in October 2019. 2019 v. 2018 RD expenses increased $635 million, mainly due to: upfront payments to Therachon and Akcea; increased investments towards building new capabilities and driving automation; increased spending on our Inflammation Immunology and Rare Disease portfolios due to several Phase 3 programs and investment in gene therapy; increased spending related to assets acquired from our acquisition of Array; and increased medical spend for new and growing products, partially offset by: decreased spending across the Oncology, Vaccines and Internal Medicine portfolios, as select programs have reached completion; the decrease in the value of the portfolio performance share grants reflecting changes in the price of Pfizers common stock, as well as managements assessment of the probability that the specified performance criteria will be achieved; the discontinuation of the Staphylococcus aureus vaccine trial; the favorable impact of the July 31, 2019 completion of the Consumer Healthcare JV; and the favorable impact of foreign exchange. Amortization of Intangible Assets 2020 v. 2019 Amortization of intangible assets decreased $1.0 billion, primarily due to: the non-recurrence of amortization of fully amortized assets and the impairment of Eucrisa in the fourth quarter of 2019, partially offset by: the increase in amortization of intangible assets from our acquisition of Array. 2019 v. 2018 Amortization of intangible assets decreased $274 million, mainly due to: the non-recurrence of amortization as a result of the impairment of sterile injectable products in the fourth quarter of 2018; fully amortized assets; and the contribution of our Consumer Healthcare business to the Consumer Healthcare JV, partially offset by: the increase in amortization related to assets recorded as a result of the approval of Xtandi in the U.S. for the treatment of nmCRPC in July of 2018; and amortization of intangible assets from our acquisition of Array. For additional information, see Notes 2A , 2C , and 10A . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives Transforming to a More Focused Company Program For a description of our program, as well as the anticipated and actual costs, see Note 3. The program savings discussed below may be rounded and represent approximations. In connection with the costs primarily related to the corporate enabling functions initiatives, we expect gross cost savings of $1.0 billion, or net cost savings, excluding merit and inflation growth and certain real estate cost increases, of $700 million, to be achieved primarily over the two-year period 2021-2022. In connection with manufacturing network optimization, including legacy cost reduction initiatives, we expect targeted net cost savings of $300 million to be achieved primarily from 2020 through 2022. Pfizer Inc. 2020 Form 10-K Certain qualifying costs for this program were recorded in 2020, and in the fourth quarter of 2019, and are reflected as Certain Significant Items and excluded from our non-GAAP measure of Adjusted Income. See the Non-GAAP Financial Measure: Adjusted Income section of this MDA. In addition to this program, we continuously monitor our operations for cost reduction and/or productivity opportunities, especially in light of the losses of exclusivity and the expiration of collaborative arrangements for various products. Other (Income)/DeductionsNet 2020 v. 2019 Other deductionsnet decreased $2.6 billion, mainly due to: lower asset impairment charges; higher net periodic benefit credits other than service costs; lower business and legal entity alignment costs; higher Consumer Healthcare JV equity method income; and lower charges for certain legal matters, partially offset by: higher net losses on asset disposals. 2019 v. 2018 Other deductionsnet increased $1.2 billion, mainly due to: higher net periodic benefits costs other than service costs; lower income from collaborations, out-licensing arrangements and sales of compound/product rights; higher interest expense mainly as a result of an increased commercial paper balance due to the acquisition of Array, as well as the retirement of lower-coupon debt and the issuance of new debt with a higher coupon than the debt outstanding for the comparative prior year period; and higher business and legal entity alignment costs, partially offset by: lower asset impairment charges. See Note 4 for additional information . PROVISION/(BENEFIT) FOR TAXES ON INCOME Year Ended December 31, % Change (MILLIONS OF DOLLARS) 2020 2019 2018 20/19 19/18 Provision/(benefit) for taxes on income $ 477 $ 618 $ (266) (23) * Effective tax rate on continuing operations 6.4 % 5.4 % (7.4) % * Indicates calculation not meaningful or result is equal to or greater than 100%. For information about our effective tax rate and the events and circumstances contributing to the changes between periods, as well as details about discrete elements that impacted our tax provisions, see Note 5 . DISCONTINUED OPERATIONS For information about our discontinued operations, see Note 2B . NON-GAAP FINANCIAL MEASURE: ADJUSTED INCOME Adjusted income is an alternative measure of performance used by management to evaluate our overall performance in conjunction with other performance measures. As such, we believe that investors understanding of our performance is enhanced by disclosing this measure. We use Adjusted income, certain components of Adjusted income and Adjusted diluted EPS to present the results of our major operationsthe discovery, development, manufacture, marketing, sales and distribution of biopharmaceutical products worldwideprior to considering certain income statement elements as follows: Measure Definition Illustrative Use Adjusted income Net income attributable to Pfizer Inc. common shareholders (a) before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items Monthly managerial analysis of our operating results and our annual budgets are prepared using these non-GAAP measures Senior managements compensation is determined, in part, using these non-GAAP measures (b) Adjusted cost of sales, Adjusted selling, informational and administrative expenses, Adjusted research and development expenses, Adjusted other (income)/deductions net Cost of sales, Selling, informational and administrative expenses, Research and development expenses, Amortization of intangible assets an d Other (income)/deductionsnet (a) , each before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items, which are components of the Adjusted income measure Adjusted diluted EPS EPS attributable to Pfizer Inc. common shareholdersdiluted (a) before the impact of purchase accounting for acquisitions, acquisition-related costs, discontinued operations and certain significant items Pfizer Inc. 2020 Form 10-K (a) Most directly comparable GAAP measure. (b) The short-term incentive plans for substantially all non-sales-force employees worldwide are funded from a pool based on our performance, measured in significant part by three metrics, one of which is Adjusted diluted EPS, which is derived from Adjusted income and accounts for 40% of the bonus pool funding. Additionally, the payout for Performance Share Awards is determined in part by Adjusted net income, which is derived from Adjusted income. Effective for the 2020 performance year and consistent with shareholder feedback received in 2019, the Compensation Committee of the BOD approved adding an RD pipeline achievement factor to the existing short-term incentive financial metrics. Adjusted income, and its components and Adjusted diluted EPS, are non-GAAP financial measures that have no standardized meaning prescribed by GAAP and, therefore, are limited in their usefulness to investors. Because of their non-standardized definitions, they may not be comparable to the calculation of similar measures of other companies and are presented solely to permit investors to more fully understand how management assesses performance. A limitation of these measures is that they provide a view of our operations without including all events during a period, and do not provide a comparable view of our performance to peers. These measures are not, and should not be viewed as, substitutes for their directly comparable GAAP measures of Net income attributable to Pfizer Inc. common shareholders , components of Net income attributable to Pfizer Inc. common shareholders and EPS attributable to Pfizer Inc. common shareholdersdiluted , respectively. See the accompanying reconciliations of certain GAAP reported to non-GAAP adjusted information for 2020, 2019 and 2018 below. We also recognize that, as internal measures of performance, these measures have limitations, and we do not restrict our performance-management process solely to these measures. We also use other tools designed to achieve the highest levels of performance. For example, our RD organization has productivity targets, upon which its effectiveness is measured. In addition, total shareholder return, both on an absolute basis and relative to a publicly traded pharmaceutical index, plays a significant role in determining payouts under certain of our incentive compensation plans. Purchase Accounting Adjustments Adjusted income excludes certain significant purchase accounting impacts resulting from business combinations and net asset acquisitions. These impacts can include the incremental charge to cost of sales from the sale of acquired inventory that was written up to fair value, amortization related to the increase in fair value of the acquired finite-lived intangible assets, and to a much lesser extent, depreciation related to the increase/decrease in fair value of the acquired fixed assets, amortization related to the increase in fair value of acquired debt, and the fair value changes for contingent consideration. Therefore, the Adjusted income measure includes the revenues earned upon the sale of the acquired products without considering the acquisition cost of those products. The exclusion of amortization attributable to acquired intangible assets provides management and investors an alternative view of our results by providing a degree of parity to internally developed intangible assets for which RD costs have been expensed. However, we have not factored in the impacts of any other differences that might have occurred if we had discovered and developed those intangible assets on our own, such as different RD costs, timelines or resulting sales; accordingly, this approach does not intend to be representative of the results that would have occurred if we had discovered and developed the acquired intangible assets internally. Acquisition-Related Costs Adjusted income excludes acquisition-related costs, which are comprised of transaction, integration, restructuring charges and additional depreciation costs for business combinations because these costs are unique to each transaction and represent costs that were incurred to restructure and integrate businesses as a result of an acquisition. We have made no adjustments for resulting synergies. The significant costs incurred in connection with a business combination result primarily from the need to eliminate duplicate assets, activities or employeesa natural result of acquiring a fully integrated set of activities. For this reason, we believe that such costs incurred can be viewed differently in the context of an acquisition from those costs incurred in other, more normal, business contexts. The integration and restructuring costs for a business combination may occur over several years, with the more significant impacts typically ending within three years of the relevant transaction. Because of the need for certain external approvals for some actions, the span of time needed to achieve certain restructuring and integration activities can be lengthy. Discontinued Operations Adjusted income excludes the results of discontinued operations, as well as any related gains or losses on the disposal of such operations. We believe that this presentation is meaningful to investors because, while we review our therapeutic areas and product lines for strategic fit with our operations, we do not build or run our business with the intent to discontinue parts of our business. Restatements due to discontinued operations do not impact compensation or change the Adjusted income measure for the compensation in respect of the restated periods, but are presented for consistency across all periods. Certain Significant Items Adjusted income excludes certain significant items representing substantive and/or unusual items that are evaluated individually on a quantitative and qualitative basis. Certain significant items may be highly variable and difficult to predict. Furthermore, in some cases it is reasonably possible that they could reoccur in future periods. For example, although major non-acquisition-related cost-reduction programs are specific to an event or goal with a defined term, we may have subsequent programs based on reorganizations of the business, cost productivity or in response to LOE or economic conditions. Legal charges to resolve litigation are also related to specific cases, which are facts and circumstances specific and, in some cases, may also be the result of litigation matters at acquired companies that were inestimable, not probable or unresolved at the date of acquisition. Unusual items represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis; items that would be non-recurring; or items that relate to products we no longer sell. For a non-inclusive list of certain significant items see Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income below. Pfizer Inc. 2020 Form 10-K Reconciliation of GAAP Reported to Non-GAAP Adjusted InformationCertain Line Items 2020 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 41,908 $ $ $ $ $ 41,908 Cost of sales 8,692 18 (118) 8,592 Selling, informational and administrative expenses 11,615 (2) (489) 11,124 Research and development expenses 9,405 5 (526) 8,884 Amortization of intangible assets 3,436 (3,152) 284 Restructuring charges and certain acquisition-related costs 600 (44) (556) (Gain) on completion of Consumer Healthcare JV transaction (6) 6 Other (income)/deductionsnet 669 (75) (2,068) (1,474) Income from continuing operations before provision/(benefit) for taxes on income 7,497 3,206 44 3,752 14,499 Provision/(benefit) for taxes on income (b) 477 668 9 803 1,957 Income from continuing operations 7,021 2,537 35 2,948 12,541 Income from discontinued operationsnet of tax 2,631 (2,631) Net income attributable to noncontrolling interests 36 36 Net income attributable to Pfizer Inc. common shareholders 9,616 2,537 35 (2,631) 2,948 12,506 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 1.71 0.45 0.01 (0.47) 0.52 2.22 2019 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 41,172 $ $ $ $ $ 41,172 Cost of sales 8,251 19 (208) 8,062 Selling, informational and administrative expenses 12,750 2 (2) (263) 12,488 Research and development expenses 8,394 4 (663) 7,736 Amortization of intangible assets 4,462 (4,191) 271 Restructuring charges and certain acquisition-related costs 601 (183) (418) (Gain) on completion of Consumer Healthcare JV transaction (8,086) 8,086 Other (income)/deductionsnet 3,314 (21) (3,563) (270) Income from continuing operations before provision/(benefit) for taxes on income 11,485 4,186 185 (2,971) 12,885 Provision/(benefit) for taxes on income (b) 618 823 59 539 2,039 Income from continuing operations 10,867 3,363 126 (3,510) 10,846 Income from discontinued operationsnet of tax 5,435 (5,435) Net income attributable to noncontrolling interests 29 29 Net income attributable to Pfizer Inc. common shareholders 16,273 3,363 126 (5,435) (3,510) 10,817 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 2.87 0.59 0.02 (0.96) (0.62) 1.91 Pfizer Inc. 2020 Form 10-K 2018 IN MILLIONS, EXCEPT PER COMMON SHARE DATA GAAP Reported Purchase Accounting Adjustments (a) Acquisition-Related Costs (a) Discontinued Operations (a) Certain Significant Items (a) Non-GAAP Adjusted Revenues $ 40,825 $ $ $ $ $ 40,825 Cost of sales 8,987 3 (10) (105) 8,874 Selling, informational and administrative expenses 12,612 2 (2) (191) 12,420 Research and development expenses 7,760 3 (47) 7,716 Amortization of intangible assets 4,736 (4,456) 280 Restructuring charges and certain acquisition-related costs 1,058 (299) (759) (Gain) on completion of Consumer Healthcare JV transaction Other (income)/deductionsnet 2,077 (182) (7) (2,520) (631) Income from continuing operations before provision/(benefit) for taxes on income 3,594 4,630 318 3,622 12,164 Provision/(benefit) for taxes on income (b) (266) 888 54 1,509 2,185 Income from continuing operations 3,861 3,741 264 2,113 9,979 Income from discontinued operationsnet of tax 7,328 (7,328) Net income attributable to noncontrolling interests 36 36 Net income attributable to Pfizer Inc. common shareholders 11,153 3,741 264 (7,328) 2,113 9,944 Earnings per common share attributable to Pfizer Inc. common shareholdersdiluted 1.87 0.63 0.04 (1.23) 0.35 1.66 (a) For details of adjustments, see Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income . (b) The effective tax rate on Non-GAAP Adjusted income was 13.5% in 2020, 15.8% in 2019 and 18.0% in 2018. The decrease in 2020, compared with 2019, was primarily due to a favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. The decrease in 2019, compared with 2018, was primarily due to a favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business, partially offset by a decrease in tax benefits for the resolution of certain tax positions, principally non-U.S., pertaining to prior years. Pfizer Inc. 2020 Form 10-K Details of Income Statement Items Included in GAAP Reported but Excluded from Non-GAAP Adjusted Income Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Purchase accounting adjustments Amortization, depreciation and other (a) $ 3,224 $ 4,205 $ 4,633 Cost of sales (18) (19) (3) Total purchase accounting adjustmentspre-tax 3,206 4,186 4,630 Income taxes (b) (668) (823) (888) Total purchase accounting adjustmentsnet of tax 2,537 3,363 3,741 Acquisition-related items Restructuring charges/(credits) (c) (192) 37 Transaction costs (c) 10 63 1 Integration costs and other (c) 34 311 260 Net periodic benefit costs/(credits) other than service costs (d) 7 Additional depreciationasset restructuring (e) 3 12 Total acquisition-related itemspre-tax 44 185 318 Income taxes (f) (9) (59) (54) Total acquisition-related itemsnet of tax 35 126 264 Discontinued operations Income from discontinued operationsnet of tax (g) (2,631) (5,435) (7,328) Certain significant items Restructuring charges/(credits) cost reduction initiatives (h) 556 418 759 Implementation costs and additional depreciationasset restructuring (i) 257 192 212 Net (gains)/losses on asset disposals (d) 238 Net (gains)/losses recognized during the period on equity securities (d) (557) (415) (586) Certain legal matters, net (d) 24 291 84 Certain asset impairments (d) 1,691 2,798 3,101 Business and legal entity alignment costs (j) 270 412 63 (Gain) on completion of Consumer Healthcare JV transaction (k) (6) (8,086) Other (l) 1,278 1,418 (10) Total certain significant itemspre-tax 3,752 (2,971) 3,622 Income taxes (m) (803) (539) (1,509) Total certain significant itemsnet of tax 2,948 (3,510) 2,113 Total purchase accounting adjustments, acquisition-related items, discontinued operations and certain significant itemsnet of tax, attributable to Pfizer Inc. $ 2,890 $ (5,455) $ (1,209) (a) Included primarily in Amortization of intangible assets . (b) Included in Provision/(benefit) for taxes on income. Includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying that applicable tax rate. (c) Included in Restructuring charges and certain acquisition-related costs . See Note 3. (d) Included in Other (income)/deductionsnet. See Note 4 . (e) In 2019, primarily included in Selling, informational and administrative expenses. In 2018, primarily included in C ost of sales. Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions related to acquisitions. (f) Included in Provision/(benefit) for taxes on income. Income taxes includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying the applicable tax rate. 2019 includes the impact of the non-taxable reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of a U.S. IRS audit for multiple tax years. (g) Included in Income from discontinued operationsnet of tax and relates to the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan . See Note 2B. (h) Amounts relate to employee termination costs, asset impairments and other exit costs not associated with acquisitions, which are included in Restructuring charges and certain acquisition-related costs (see Note 3 ) . (i) Amounts relate to our cost-reduction/productivity initiatives not related to acquisitions (see Note 3 ) . For 2020, primarily included in Cost of sales ($62 million) and Selling, informational and administrative expenses ($197 million). For 2019, included in Cost of sales ($89 million), Selling, informational and administrative expenses ($73 million) and Research and development expenses ($30 million). For 2018, included in Cost of sales ($101 million), Selling, informational and administrative expenses ($71 million) and Research and development expenses ($39 million). (j) In 2020, included in Cost of sales ($51 million), Selling, informational and administrative expenses ($206 million) and Research and development expenses ($13 million) and primarily represents costs for consulting, legal, tax and advisory services associated with internal reorganization of legal entities. In 2019, primarily included in Cost of sales ($15 million), Selling, informational and administrative expenses ($96 million) and Other (income)/deductionsnet ($300 million) and in 2018, included in Other (income)/deductionsnet and represents costs for consulting, legal, tax and other advisory services associated with the design, planning and implementation of our then new business structure, effective in the beginning of 2019. (k) Included in (Gain) on completion of Consumer Healthcare JV transaction (see Note 2C ). Pfizer Inc. 2020 Form 10-K (l) For 2020, primarily included in Selling, informational and administrative expenses ($86 million) , Research and development expenses ($515 million) and Other (income)/deductionsnet ($672 million). For 2019, included in Cost of sales ($104 million), Selling, informational and administrative expenses ($94 million), Research and development expenses ($632 million) and Other (income)/deductionsnet ($589 million). For 2018, primarily included in Selling, informational and administrative expenses ($120 million) and Other (income)/deductionsnet ($142 million income). 2020 includes the following charges recorded in Research and development expenses: (i) $151 million, representing the expense portion of our upfront payment to Myovant, (ii) an upfront payment of $130 million to Valneva, (iii) a $75 million milestone payment to Akcea, (iv) a $72 million upfront payment to BioNTech and (v) a $50 million milestone payment to Therachon. 2020 also includes, among other things, the following charges recorded in Other (income)/deductionsnet: (i) charges of $367 million, primarily representing our pro rata share of restructuring and business combination accounting charges recorded by the Consumer Healthcare JV, partially offset by gains from the divestiture of certain of the JVs brands recorded by the Consumer Healthcare JV, and our write-off and amortization of equity method basis differences primarily related to those brand divestitures and to inventory, and (ii) $198 million of settlement losses within the U.S. PCPP. 2019 included, among other things, (i) a $337 million charge in Research and development expenses related to our acquisition of Therachon, (ii) an upfront license fee payment of $250 million to Akcea, recorded in Research and development expenses, (iii) charges of $240 million, primarily in Selling, informational and administrative expenses ($87 million) and Other (income)/deductionsnet ($152 million), for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity associated with the formation of the Consumer Healthcare JV, (iv) net losses on early retirement of debt of $138 million in Other (income)/deductionsnet, (v) charges of $112 million recorded in Other (income)/deductionsnet representing our pro rata share of primarily restructuring and business combination accounting charges recorded by the Consumer Healthcare JV and (vi) a $99 million charge in Cost of sales related to rivipansel, primarily for inventory manufactured for expected future sale. For 2018, included, among other things, (i) a non-cash $343 million pre-tax gain in Other (income)/deductionsnet associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system, (ii) an $88 million charge, in the aggregate, in Selling, informational and administrative expenses for a special, one-time bonus paid to virtually all Pfizer colleagues, excluding executives, which was one of several actions taken by us after evaluating the expected positive net impact of the December 2017 enactment of the TCJA and (iii) a non-cash $50 million pre-tax gain in Other (income)/deductionsnet as a result of the contribution of our allogeneic CAR T therapy development program assets in connection with our contribution agreement entered into with Allogene (see Note 2B ) . (m) Included in Provision/(benefit) for taxes on income. Income taxes includes the tax effect of the associated pre-tax amounts, calculated by determining the jurisdictional location of the pre-tax amounts and applying the applicable tax rate. The amount in 2020 was favorably impacted by tax benefits associated with intangible asset impairment charges (see Note 4 ). The amount in 2019 was favorably impacted by a benefit of $1.4 billion, representing tax and interest, resulting from the favorable settlement of a U.S. IRS audit for multiple tax years, the benefits related to certain tax initiatives for the implementation of our then new business structure, as well as the tax benefit recorded as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA and unfavorably impacted by the tax expense of approximately $2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV transaction. The amount in 2018 was favorably impacted primarily by tax benefits related to the TCJA, including certain 2018 tax initiatives as well as adjustments to the provisional estimate of the legislation, reported and disclosed within the applicable measurement period, in accordance with guidance issued by the SEC. Pfizer Inc. 2020 Form 10-K ANALYSIS OF THE CONSOLIDATED STATEMENTS OF CASH FLOWS Cash Flows from Continuing Operations Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Drivers of change Cash provided by/(used in): Operating activities from continuing operations $ 10,586 $ 7,011 $ 8,875 2020 v. 2019 The change is driven mainly by higher net income adjusted for non-cash items, advanced payments in 2020 for BNT162b2 recorded in deferred revenue, the upfront cash payment associated with our acquisition of Therachon in 2019, and the upfront cash payment associated with our licensing agreement with Akcea in 2019, partially offset by an increase in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net is driven primarily by an increase in equity method dividends received, partially offset by an increase in equity income and increases in net unrealized gains on equity securities. 2019 v. 2018 The change is driven mostly by the upfront cash payments in 2019 associated with our acquisition of Therachon and our licensing agreement with Akcea, partially offset by a decrease in benefit plan contributions. The change also reflects the impact of timing of receipts and payments in the ordinary course of business. The change in Other adjustments, net is driven primarily by a non-cash gain in 2018 associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, and a non-cash gain in 2018 on the contribution of Pfizers allogeneic CAR T developmental program assets, partially offset by net gains on foreign exchange hedging of our intercompany inventory sales. Investing activities from continuing operations $ (4,188) $ (3,852) $ 4,584 2020 v. 2019 The change is driven mostly by a $6.0 billion decrease in net proceeds from short-term investments with original maturities of three months or less and $2.7 billion in net purchases of short-term investments with original maturities of greater than three months in 2020 (compared to $2.3 billion net proceeds from short-term investments with original maturities of greater than three months in 2019), partially offset by the cash used to acquire Array, net of cash acquired, of $10.9 billion in 2019. 2019 v. 2018 The change is driven primarily by cash used for the acquisition of Array, net of cash acquired, of $10.9 billion in 2019, partially offset by an increase in net proceeds generated from the sale of investments of $2.9 billion for cash needs, including financing the acquisition of Array. Financing activities from continuing operations $ (21,640) $ (8,485) $ (20,441) 2020 v. 2019 The change is driven primarily by $14.0 billion net payments on short-term borrowings in 2020 (compared to $10.6 billion net proceeds raised from short-term borrowings in 2019) and an increase in cash dividends paid of $397 million, partially offset by a decrease in purchases of common stock of $8.9 billion, lower repayments on long-term debt of $2.8 billion, and an increase in issuances of long-term debt of $280 million. 2019 v. 2018 The change is driven mostly by $10.6 billion of net proceeds raised from short-term borrowings in 2019, primarily in connection with the acquisition of Array (compared to net payments on short-term borrowings of $2.3 billion in 2018) and lower purchases of common stock of $3.3 billion, partially offset by higher repayments on long-term debt of $3.2 billion and lower proceeds from the exercise of stock options of $864 million. Cash Flows from Discontinued Operations Cash flows from discontinued operations relate to the Upjohn Business (see Note 2B ). In 2020, net cash provided by financing activities from discontinued operations primarily reflects issuances of long-term debt . Pfizer Inc. 2020 Form 10-K ANALYSIS OF FINANCIAL CONDITION, LIQUIDITY, CAPITAL RESOURCES AND MARKET RISK We rely largely on operating cash flows, short-term investments or commercial paper borrowings and long-term debt to provide for our liquidity requirements. We continue our efforts to improve cash inflows through working capital efficiencies. We target specific areas of focus including accounts receivable, inventories, accounts payable, and other working capital, which allows us to optimize our operating cash flows. Due to our significant operating cash flows as well as our financial assets, access to capital markets and available lines of credit and revolving credit agreements, we believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future, which can include, among others: the working capital requirements of our operations, including our RD activities; investments in our business; dividend payments and potential increases in the dividend rate; share repurchases; the cash requirements for our cost-reduction/productivity initiatives; paying down outstanding debt; contributions to our pension and postretirement plans; and business development activities. Our long-term debt is rated high-quality by both SP and Moodys. See the Credit Ratings section below. We have taken, and will continue to take, a conservative approach to our financial investments and monitoring of our liquidity position in response to market changes. Our debt investments consist primarily of high-quality, highly liquid, well-diversified available-for-sale debt securities. Debt CapacityLines of Credit We have available lines of credit and revolving credit agreements with a group of banks and other financial intermediaries. We typically maintain cash and cash equivalent balances and short-term investments which, together with our available revolving credit facilities, are in excess of our commercial paper and other short-term borrowings. See Note 7C . Selected Measures of Liquidity and Capital Resources The following presents certain relevant measures of our liquidity and capital resources: As of December 31, (MILLIONS OF DOLLARS, EXCEPT RATIOS) 2020 2019 Selected financial assets (a) : Cash and cash equivalents $ 1,784 $ 1,121 Short-term investments 10,437 8,525 Long-term investments, excluding private equity securities at cost 2,973 2,258 15,195 11,905 Debt: Short-term borrowings, including current portion of long-term debt 2,703 16,195 Long-term debt 37,133 35,955 39,835 52,150 Selected net financial liabilities $ (24,641) $ (40,245) Working capital (b) $ 9,147 $ (4,501) Ratio of current assets to current liabilities 1.35:1 0.88:1 (a) See Note 7 for a description of certain assets held and for a description of credit risk related to our financial instruments held. (b) The increase in working capital was primarily driven by the use of Upjohn cash distribution proceeds to pay down short-term commercial paper borrowings. See Note 2B . On November 16, 2020, we received $12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris (see Note 2B ). In November 2020, we used the cash proceeds to pay down commercial paper and redeem, before the maturity date, the $1.15 billion aggregate principal amount outstanding of 1.95% senior unsecured notes that were due in June 2021 and $342 million aggregate principal amount of 5.80% senior unsecured notes that were due in August 2023. In May 2020, we completed a public offering of $4.0 billion aggregate principal amount of senior unsecured notes. In March 2020, we: completed a public offering of $1.25 billion aggregate principal amount of senior unsecured sustainability notes. The proceeds were initially used to repay outstanding commercial paper and subsequently will be used to help manage our environmental impact and support increased patient access to our medicines and vaccines, especially among underserved populations, and strengthen healthcare systems; and repurchased at par all $1.065 billion principal amount outstanding of senior unsecured notes that were due in 2047 before the maturity date. For additional information about these issuances and retirements, see Note 7D. For additional information about the sources and uses of our funds, see the Analysis of the Consolidated Statements of Cash Flows within MDA. Pfizer Inc. 2020 Form 10-K Credit Ratings Two major corporate debt-rating organizations, Moodys and SP, assign ratings to our short-term and long-term debt. A security rating is not a recommendation to buy, sell or hold securities and the rating is subject to revision or withdrawal at any time by the rating organization. Each rating should be evaluated independently of any other rating. The current ratings assigned to our commercial paper and senior unsecured long-term debt: NAME OF RATING AGENCY Pfizer Short-Term Pfizer Long-Term Outlook/Watch Date of Last Rating Change Rating Rating Moodys P-1 A2 Stable November 2020 SP A-1+ A+ Stable November 2020 Both Moodys and SP lowered Pfizers long-term debt rating one notch to A2 and A+, respectively, upon completion of the Upjohn separation in November 2020. Pfizers short-term rating remained unchanged. Additionally, both rating agencies removed Pfizers long-term debt rating from under review and assigned a stable outlook. LIBOR For information on interest rate risk and LIBOR, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. We do not expect the transition to an alternative rate to have a material impact on our liquidity or financial resources. Gl o bal Economic Conditions Our Venezuela and Argentina operations function in hyperinflationary economies. The impact to Pfizer is not considered material. For additional information on the global economic environment, see the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K. Market Risk The objective of our financial risk management program is to minimize the impact of foreign exchange rate and interest rate movements on our earnings. We address these exposures through a combination of operational means and financial instruments. We adapt our practices periodically as economic conditions change. For more information, see Notes 1F and 7E , as well as the Item 1A. Risk FactorsGlobal Operations section in this Form 10-K for key currencies in which we operate. Foreign Exchange Risk We are subject to foreign exchange risk in our commercial operations, assets and liabilities that are denominated in foreign currencies and our net investments in foreign subsidiaries. On the commercial side, a significant portion of our revenues and earnings is exposed to changes in exchange rates. Where foreign exchange risk is not offset by other exposures, we may use foreign currency forward-exchange contracts and/or foreign currency swaps to manage that risk. With respect to our financial assets and liabilities, our primary foreign exchange exposure arises from intercompany receivables and payables, and, to a lesser extent, from investments and debt denominated in currencies other than the functional currency of the business entity. In addition, under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. In these cases, we may use foreign exchange contracts and/or foreign currency debt. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2020, the expected adverse impact on our net income would not be significant. Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk which may have an impact on net income. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt (or investments) to fixed rates. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point decrease in interest rates as of December 31, 2020, the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. Pfizer Inc. 2020 Form 10-K Contractual Obligations Payments due under contractual obligations as of December 31, 2020, mature as follows: Years (MILLIONS OF DOLLARS) Total 2021 2023 2025 There-after Long-term debt, including current portion (a) $ 39,135 $ 2,002 $ 4,346 $ 3,068 $ 29,719 Consists of senior unsecured notes (including fixed and floating rate, foreign currency denominated, and other notes). Commitments under financing leases are not significant. Interest payments on long-term debt obligations (a) 21,122 1,390 2,746 2,455 14,530 Incorporates only current period assumptions for interest rates, foreign currency translation rates and hedging strategies, and assumes that interest is accrued through the maturity date or expiration of the related instrument. Other long-term liabilities (b) 2,070 383 451 381 855 Includes expected payments relating to our unfunded U.S. supplemental (non-qualified) pension plans, postretirement plans and deferred compensation plans. Excludes amounts relating to our U.S. qualified pension plans and international pension plans, all of which have a substantial amount of plan assets, because the required funding obligations are not expected to be material and/or because such liabilities do not necessarily reflect future cash payments, as the impact of changes in economic conditions on the fair value of the pension plan assets and/or liabilities can be significant. Also, excludes $4.2 billion of liabilities related to the fair value of derivative financial instruments, legal matters and employee terminations, among other liabilities, most of which do not represent contractual obligations. Operating leases (c) 3,312 357 638 460 1,856 Includes future minimum rental commitments under non-cancelable operating leases, including an agreement to lease space in an office building in New York City. Purchase obligations and other (d) 3,793 847 1,470 933 543 Includes agreements to purchase goods and services that are enforceable and legally binding and includes amounts relating to advertising, information technology services, employee benefit administration services, and potential milestone payments deemed reasonably likely to occur. Other taxes payabledeemed repatriated accumulated post-1986 earnings of foreign subsidiaries (e) 9,000 700 1,700 3,700 2,900 Represents estimated cash payments related to the TCJA repatriation tax liability. Uncertain tax positions (e) 42 42 Includes only income tax amounts currently payable. We are unable to predict the timing of tax settlements related to our noncurrent obligations for uncertain tax positions as tax audits can involve complex issues and the resolution of those issues may span multiple years, particularly if subject to negotiation or litigation. (a) See Note 7 . (b) See Notes 3 , 7A , 11E and 16 . (c) See Note 15 . (d) Also includes obligations to make guaranteed fixed annual payments over the next six years in connection with the U.S. and EU approvals for Besponsa ($401 million) and an obligation to make guaranteed fixed annual payments over the next seven years for Bosulif ($195 million), both associated with RD arrangements. (e) See Note 5. The above table includes amounts for potential milestone payments under collaboration, licensing or other arrangements, if the payments are deemed reasonably likely to occur. Payments under these agreements generally become due and payable only upon the achievement of certain development, regulatory and/or commercialization milestones, which may span several years and which may never occur. In 2021, we expect to spend approximately $3.0 billion on property, plant and equipment. We rely largely on operating cash flows to fund our capital investment needs. Off-Balance Sheet Arrangements In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities. For more information on guarantees and indemnifications, see Note 16B . Additionally, certain of our co-promotion or license agreements give our licensors or partners the rights to negotiate for, or in some cases to obtain under certain financial conditions, co-promotion or other rights in specified countries with respect to certain of our products. Share-Purchase Plans and Accelerated Share Repurchase Agreements See Note 12 for information on the shares of our common stock purchased and the cost of purchases under our publicly announced share-purchase plans, including our accelerated share repurchase agreements. At December 31, 2020, our remaining share-purchase authorization was approximately $5.3 billion. Pfizer Inc. 2020 Form 10-K Dividends on Common Stock In December 2020, our BOD declared a first-quarter dividend of $0.39 per share, payable on March 5, 2021, to shareholders of record at the close of business on January 29, 2021. The first-quarter 2021 cash dividend will be our 329th consecutive quarterly dividend. Our current and projected dividends provide a return to shareholders while maintaining sufficient capital to invest in growing our business. Our dividends are not restricted by debt covenants. While the dividend level remains a decision of Pfizers BOD and will continue to be evaluated in the context of future business performance, we currently believe that we can support future annual dividend increases, barring significant unforeseen events. Viatris is expected to begin paying a quarterly dividend in the second quarter of 2021, at which time Pfizers quarterly dividend is expected to be reduced such that the combined dividend dollar amount received by Pfizer shareholders, based upon the combination of continued Pfizer ownership and approximately 0.124079 shares of Viatris common stock which were granted for each Pfizer share in the spin-off, will equate to Pfizers dividend amount in effect immediately prior to the initiation of the Viatris dividend. NEW ACCOUNTING STANDARDS Recently Adopted Accounting Standards See Note 1B. Recently Issued Accounting Standards, Not Adopted as of December 31, 2020 Standard/Description Effective Date Effect on the Financial Statements Accounting for income taxes eliminates certain exceptions to the guidance, related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. January 1, 2021. We do not expect this guidance to have a material impact on our consolidated financial statements. Reference rate reform provides temporary optional expedients and exceptions to the guidance for contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued after 2021 because of reference rate reform. The new guidance provides the following optional expedients: 1. Simplify accounting analyses under current U.S. GAAP for contract modifications. 2. Simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. 3. Allow a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform. Elections can be adopted prospectively at any time in the first quarter of 2020 through December 31, 2022. We are assessing the impact of the provisions of this new guidance on our consolidated financial statements. "," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is incorporated by reference to the discussion in the Analysis of Financial Condition, Liquidity, Capital Resources and Market RiskSelected Measures of Liquidity and Capital Resources section within MDA. Pfizer Inc. 2020 Form 10-K "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Pfizer Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pfizer Inc. and Subsidiary Companies (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Companys internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 25, 2021 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the U.S. Medicare, Medicaid, and performance-based contract rebates accrual As discussed in Note 1G to the consolidated financial statements, the Company records estimated deductions for Medicare, Medicaid, and performance-based contract rebates (collectively, U.S. rebates) as a reduction to gross product revenues. The accrual for U.S. rebates is recorded in the same period that the corresponding revenues are recognized. The length of time between when a sale is made and when the U.S. rebate is paid by the Company can be as long as one year, which increases the need for significant management judgment and knowledge of market conditions and practices in estimating the accrual. We identified the evaluation of the U.S. rebates accrual as a critical audit matter because the evaluation of the product-specific experience ratio assumption involved especially challenging auditor judgment. The product-specific experience ratio assumption relates to estimating which of the Companys revenue transactions will ultimately be subject to a related rebate. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys U.S. rebates accrual process related to the development of the product-specific experience ratio assumptions. We estimated the U.S. rebates accrual using internal information and historical data and compared the result to the Companys estimated U.S. rebates accrual. We evaluated the Companys ability to accurately estimate the accrual for U.S. rebates by comparing historically recorded accruals to the actual amount that was ultimately paid by the Company. Evaluation of gross unrecognized tax benefits As discussed in Notes 5D and 1P, the Companys tax positions are subject to audit by local taxing authorities in each respective tax jurisdiction, and the resolution of such audits may span multiple years. Since tax law is complex and often subject to varied interpretations and judgments, it is uncertain whether some of the Companys tax positions will be sustained upon audit. As of December 31, 2020, the Company has recorded gross unrecognized tax benefits, excluding associated interest, of $5.6 billion. We identified the evaluation of the Companys gross unrecognized tax benefits as a critical audit matter because a high degree of audit effort, including specialized skills and knowledge, and complex auditor judgment was required in evaluating the Companys interpretation of tax law and its estimate of the ultimate resolution of its tax positions. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Companys liability for unrecognized tax position process related to (1) interpretation Pfizer Inc. 2020 Form 10-K Report of Independent Registered Public Accounting Firm of tax law, (2) evaluation of which of the Companys tax positions may not be sustained upon audit, and (3) estimation and recording of the gross unrecognized tax benefits. We involved tax and valuation professionals with specialized skills and knowledge who assisted in evaluating the Companys interpretation of tax laws, including the assessment of transfer pricing practices in accordance with applicable tax laws and regulations. We inspected settlements with applicable taxing authorities, including assessing the expiration of statutes of limitations. We tested the calculation of the liability for uncertain tax positions, including an evaluation of the Companys assessment of the technical merits of tax positions and estimates of the amount of tax benefits expected to be sustained. Evaluation of product and other product-related litigation As discussed in Notes 1R and 16 to the consolidated financial statements, the Company is involved in product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others. Certain of these pending product and other product-related legal proceedings could result in losses that could be substantial. The accrued liability and/or disclosure for the pending product and other product-related legal proceedings requires a complex series of judgments by the Company about future events, which involves a number of uncertainties. We identified the evaluation of product and other product-related litigation as a critical audit matter. Challenging auditor judgment was required to evaluate the Companys judgments about future events and uncertainties. The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Companys product liability and other product-related litigation processes, including controls related to (1) the evaluation of information from external and internal legal counsel, (2) forward-looking expectations, and (3) new legal proceedings, or other legal proceedings not currently reserved or disclosed. We read letters received directly from the Companys external and internal legal counsel that described the Companys probable or reasonably possible legal contingency to pending product and other product-related legal proceedings. We inspected the Companys minutes from meetings of the Audit Committee, which included the status of key litigation matters. We evaluated the Companys ability to estimate its monetary exposure to pending product and other product-related legal proceedings by comparing historically recorded liabilities to actual monetary amounts incurred upon resolution of prior legal matters. We analyzed relevant publicly available information about the Company, its competitors, and the industry. KPMG LLP We have not been able to determine the specific year that KPMG and our predecessor firms began serving as the Companys auditor, however, we are aware that KPMG and our predecessor firms have served as the Companys auditor since at least 1942. New York, New York February 25, 2021 Pfizer Inc. 2020 Form 10-K Consolidated Statements of Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS, EXCEPT PER COMMON SHARE DATA) 2020 2019 2018 Revenues $ 41,908 $ 41,172 $ 40,825 Costs and expenses: Cost of sales (a) 8,692 8,251 8,987 Selling, informational and administrative expenses (a) 11,615 12,750 12,612 Research and development expenses (a) 9,405 8,394 7,760 Amortization of intangible assets 3,436 4,462 4,736 Restructuring charges and certain acquisition-related costs 600 601 1,058 (Gain) on completion of Consumer Healthcare JV transaction ( 6 ) ( 8,086 ) Other (income)/deductionsnet 669 3,314 2,077 Income from continuing operations before provision/(benefit) for taxes on income 7,497 11,485 3,594 Provision/(benefit) for taxes on income 477 618 ( 266 ) Income from continuing operations 7,021 10,867 3,861 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income before allocation to noncontrolling interests 9,652 16,302 11,188 Less: Net income attributable to noncontrolling interests 36 29 36 Net income attributable to Pfizer Inc. common shareholders $ 9,616 $ 16,273 $ 11,153 Earnings per common sharebasic : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 1.26 $ 1.95 $ 0.65 Income from discontinued operationsnet of tax 0.47 0.98 1.25 Net income attributable to Pfizer Inc. common shareholders $ 1.73 $ 2.92 $ 1.90 Earnings per common sharediluted : Income from continuing operations attributable to Pfizer Inc. common shareholders $ 1.24 $ 1.91 $ 0.64 Income from discontinued operationsnet of tax 0.47 0.96 1.23 Net income attributable to Pfizer Inc. common shareholders $ 1.71 $ 2.87 $ 1.87 Weighted-average sharesbasic 5,555 5,569 5,872 Weighted-average sharesdiluted 5,632 5,675 5,977 (a) Exclusive of amortization of intangible assets, except as disclosed in Note 1L. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Comprehensive Income Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2020 2019 2018 Net income before allocation to noncontrolling interests $ 9,652 $ 16,302 $ 11,188 Foreign currency translation adjustments, net $ 957 $ 654 $ ( 799 ) Reclassification adjustments ( 17 ) ( 288 ) ( 22 ) 940 366 ( 821 ) Unrealized holding gains/(losses) on derivative financial instruments, net ( 582 ) 476 220 Reclassification adjustments for (gains)/losses included in net income (a) 21 ( 664 ) 27 ( 561 ) ( 188 ) 247 Unrealized holding gains/(losses) on available-for-sale securities, net 361 ( 1 ) ( 185 ) Reclassification adjustments for (gains)/losses included in net income (b) ( 188 ) 39 124 Reclassification adjustments for unrealized gains included in Retained earnings (c) ( 462 ) 173 38 ( 522 ) Benefit plans: actuarial gains/(losses), net ( 1,128 ) ( 826 ) ( 649 ) Reclassification adjustments related to amortization 276 241 242 Reclassification adjustments related to settlements, net 278 274 142 Other ( 189 ) 22 112 ( 763 ) ( 289 ) ( 153 ) Benefit plans: prior service (costs)/credits and other, net 52 ( 7 ) ( 9 ) Reclassification adjustments related to amortization of prior service costs and other, net ( 176 ) ( 181 ) ( 181 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 2 ) ( 19 ) Other 1 2 ( 124 ) ( 189 ) ( 207 ) Other comprehensive income/(loss), before tax ( 335 ) ( 262 ) ( 1,457 ) Tax provision/(benefit) on other comprehensive income/(loss) (d) ( 349 ) 115 518 Other comprehensive income/(loss) before allocation to noncontrolling interests $ 14 $ ( 376 ) $ ( 1,975 ) Comprehensive income before allocation to noncontrolling interests $ 9,666 $ 15,926 $ 9,214 Less: Comprehensive income/(loss) attributable to noncontrolling interests 27 18 16 Comprehensive income attributable to Pfizer Inc. $ 9,639 $ 15,908 $ 9,198 (a) Reclassified into Other (income)/deductionsnet and Cost of sales . See Note 7E. (b) Reclassified into Other (income)/deductionsnet . (c) See Note 1B in our 2018 Financial Report. (d) See Note 5E. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Balance Sheets Pfizer Inc. and Subsidiary Companies As of December 31, (MILLIONS, EXCEPT PREFERRED STOCK ISSUED AND PER COMMON SHARE DATA) 2020 2019 Assets Cash and cash equivalents $ 1,784 $ 1,121 Short-term investments 10,437 8,525 Trade accounts receivable, less allowance for doubtful accounts: 2020$ 508 ; 2019$ 493 7,930 6,772 Inventories 8,046 7,068 Current tax assets 3,264 2,736 Other current assets 3,438 2,357 Current assets of discontinued operations and other assets held for sale 167 4,224 Total current assets 35,067 32,803 Equity-method investments 16,856 17,133 Long-term investments 3,406 3,014 Property, plant and equipment 13,900 12,969 Identifiable intangible assets 28,471 33,936 Goodwill 49,577 48,202 Noncurrent deferred tax assets and other noncurrent tax assets 2,383 1,911 Other noncurrent assets 4,569 4,199 Noncurrent assets of discontinued operations 13,427 Total assets $ 154,229 $ 167,594 Liabilities and Equity Short-term borrowings, including current portion of long-term debt: 2020$ 2,002 ; 2019$ 1,462 $ 2,703 $ 16,195 Trade accounts payable 4,309 3,887 Dividends payable 2,162 2,104 Income taxes payable 1,049 980 Accrued compensation and related items 3,058 2,390 Other current liabilities 12,640 9,334 Current liabilities of discontinued operations 2,413 Total current liabilities 25,920 37,304 Long-term debt 37,133 35,955 Pension benefit obligations 4,766 5,291 Postretirement benefit obligations 645 926 Noncurrent deferred tax liabilities 4,063 5,652 Other taxes payable 11,560 12,126 Other noncurrent liabilities 6,669 6,894 Total liabilities 90,756 104,148 Commitments and Contingencies Preferred stock, no par value, at stated value; 27 shares authorized; issued: 2020 0 ; 2019 431 17 Common stock, $ 0.05 par value; 12,000 shares authorized; issued: 2020 9,407 ; 2019 9,369 470 468 Additional paid-in capital 88,674 87,428 Treasury stock, shares at cost: 2020 3,840 ; 2019 3,835 ( 110,988 ) ( 110,801 ) Retained earnings 96,770 97,670 Accumulated other comprehensive loss ( 11,688 ) ( 11,640 ) Total Pfizer Inc. shareholders equity 63,238 63,143 Equity attributable to noncontrolling interests 235 303 Total equity 63,473 63,447 Total liabilities and equity $ 154,229 $ 167,594 See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Equity Pfizer Inc. and Subsidiary Companies PFIZER INC. SHAREHOLDERS Preferred Stock Common Stock Treasury Stock (MILLIONS, EXCEPT PREFERRED SHARES AND PER SHARE AMOUNTS) Shares Stated Value Shares Par Value Addl Paid-In Capital Shares Cost Retained Earnings Accum. Other Comp. Loss Share - holders Equity Non-controlling Interests Total Equity Balance, January 1, 2018 524 $ 21 9,275 $ 464 $ 84,278 ( 3,296 ) $ ( 89,425 ) $ 85,291 $ ( 9,321 ) $ 71,308 $ 348 $ 71,656 Net income 11,153 11,153 36 11,188 Other comprehensive income/(loss), net of tax ( 1,955 ) ( 1,955 ) ( 20 ) ( 1,975 ) Cash dividends declared, per share: $ 1.38 Common stock ( 8,060 ) ( 8,060 ) ( 8,060 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 12 ) ( 12 ) Share-based payment transactions 57 3 1,977 ( 12 ) 13 1,993 1,993 Purchases of common stock ( 307 ) ( 12,198 ) ( 12,198 ) ( 12,198 ) Preferred stock conversions and redemptions ( 46 ) ( 2 ) ( 3 ) ( 4 ) ( 4 ) Other (a) 1,172 1,172 1,172 Balance, December 31, 2018 478 19 9,332 467 86,253 ( 3,615 ) ( 101,610 ) 89,554 ( 11,275 ) 63,407 351 63,758 Net income 16,273 16,273 29 16,302 Other comprehensive income/(loss), net of tax ( 365 ) ( 365 ) ( 11 ) ( 376 ) Cash dividends declared, per share: $ 1.46 Common stock ( 8,174 ) ( 8,174 ) ( 8,174 ) Preferred stock ( 1 ) ( 1 ) ( 1 ) Noncontrolling interests ( 6 ) ( 6 ) Share-based payment transactions 37 2 1,219 ( 8 ) ( 326 ) 894 894 Purchases of common stock ( 213 ) ( 8,865 ) ( 8,865 ) ( 8,865 ) Preferred stock conversions and redemptions ( 47 ) ( 2 ) ( 3 ) 1 ( 4 ) ( 4 ) Other ( 40 ) 19 ( 21 ) ( 60 ) ( 81 ) Balance, December 31, 2019 431 17 9,369 468 87,428 ( 3,835 ) ( 110,801 ) 97,670 ( 11,640 ) 63,143 303 63,447 Net income 9,616 9,616 36 9,652 Other comprehensive income/(loss), net of tax 23 23 ( 9 ) 14 Cash dividends declared, per share: $ 1.53 Common stock ( 8,571 ) ( 8,571 ) ( 8,571 ) Preferred stock Noncontrolling interests ( 91 ) ( 91 ) Share-based payment transactions 37 2 1,261 ( 6 ) ( 218 ) 1,044 1,044 Preferred stock conversions and redemptions (b) ( 431 ) ( 17 ) ( 15 ) 1 31 ( 1 ) ( 1 ) Distribution of Upjohn Business (c) ( 1,944 ) ( 71 ) ( 2,015 ) ( 3 ) ( 2,018 ) Other ( 1 ) ( 1 ) Balance, December 31, 2020 $ 9,407 $ 470 $ 88,674 ( 3,840 ) $ ( 110,988 ) $ 96,770 $ ( 11,688 ) $ 63,238 $ 235 $ 63,473 (a) Primarily represents the cumulative effect of the adoption of new accounting standards in 2018 for revenues, financial assets and liabilities, income tax accounting, and the reclassification of certain tax effects. See Note 1B in our 2018 Financial Report. (b) See Note 12 . (c) See Note 2B . See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, (MILLIONS) 2020 2019 2018 Operating Activities Net income before allocation to noncontrolling interests $ 9,652 $ 16,302 $ 11,188 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income from continuing operations before allocation to noncontrolling interests 7,021 10,867 3,861 Adjustments to reconcile net income before allocation to noncontrolling interests to net cash provided by operating activities: Depreciation and amortization 4,777 5,795 6,150 Asset write-offs and impairments 2,049 2,941 3,398 TCJA impact ( 323 ) ( 596 ) Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed (a) ( 6 ) ( 8,233 ) Deferred taxes from continuing operations ( 1,468 ) 596 ( 2,204 ) Share-based compensation expense 756 688 923 Benefit plan contributions in excess of expense/income ( 1,790 ) ( 288 ) ( 1,057 ) Other adjustments, net ( 478 ) ( 1,080 ) ( 1,266 ) Other changes in assets and liabilities, net of acquisitions and divestitures: Trade accounts receivable ( 1,249 ) ( 1,140 ) ( 458 ) Inventories ( 736 ) ( 1,080 ) ( 432 ) Other assets ( 146 ) 840 ( 52 ) Trade accounts payable 353 ( 340 ) 404 Other liabilities 2,741 851 367 Other tax accounts, net ( 1,238 ) ( 3,084 ) ( 163 ) Net cash provided by operating activities from continuing operations 10,586 7,011 8,875 Net cash provided by operating activities from discontinued operations 3,817 5,576 6,952 Net cash provided by operating activities 14,403 12,588 15,827 Investing Activities Purchases of property, plant and equipment ( 2,252 ) ( 2,072 ) ( 1,984 ) Purchases of short-term investments ( 13,805 ) ( 6,835 ) ( 11,677 ) Proceeds from redemptions/sales of short-term investments 11,087 9,183 17,581 Net (purchases of)/proceeds from redemptions/sales of short-term investments with original maturities of three months or less 920 6,925 ( 3,917 ) Purchases of long-term investments ( 597 ) ( 201 ) ( 1,797 ) Proceeds from redemptions/sales of long-term investments 723 232 6,244 Acquisitions of businesses, net of cash acquired ( 10,861 ) Acquisitions of intangible assets ( 539 ) ( 418 ) ( 152 ) Other investing activities, net (a) 274 195 287 Net cash provided by/(used in) investing activities from continuing operations ( 4,188 ) ( 3,852 ) 4,584 Net cash provided by/(used in) investing activities from discontinued operations ( 82 ) ( 94 ) ( 60 ) Net cash provided by/(used in) investing activities ( 4,271 ) ( 3,945 ) 4,525 Financing Activities Proceeds from short-term borrowings 12,352 16,455 3,711 Principal payments on short-term borrowings ( 22,197 ) ( 8,378 ) ( 4,437 ) Net (payments on)/proceeds from short-term borrowings with original maturities of three months or less ( 4,129 ) 2,551 ( 1,617 ) Proceeds from issuance of long-term debt 5,222 4,942 4,974 Principal payments on long-term debt ( 4,003 ) ( 6,806 ) ( 3,566 ) Purchases of common stock ( 8,865 ) ( 12,198 ) Cash dividends paid ( 8,440 ) ( 8,043 ) ( 7,978 ) Proceeds from exercise of stock options 425 394 1,259 Other financing activities, net ( 869 ) ( 736 ) ( 588 ) Net cash provided by/(used in) financing activities from continuing operations ( 21,640 ) ( 8,485 ) ( 20,441 ) Net cash provided by/(used in) financing activities from discontinued operations 11,991 Net cash provided by/(used in) financing activities ( 9,649 ) ( 8,485 ) ( 20,441 ) Effect of exchange-rate changes on cash and cash equivalents and restricted cash and cash equivalents ( 8 ) ( 32 ) ( 116 ) Net increase/(decrease) in cash and cash equivalents and restricted cash and cash equivalents 475 125 ( 205 ) Cash and cash equivalents and restricted cash and cash equivalents, at beginning of period 1,350 1,225 1,431 Cash and cash equivalents and restricted cash and cash equivalents, at end of period $ 1,825 $ 1,350 $ 1,225 - Continued - Pfizer Inc. 2020 Form 10-K Consolidated Statements of Cash Flows Pfizer Inc. and Subsidiary Companies Year Ended December 31, 2020 2019 2018 Supplemental Cash Flow Information Cash paid (received) during the period for: Income taxes $ 3,153 $ 3,664 $ 3,655 Interest paid 1,641 1,587 1,311 Interest rate hedges ( 20 ) ( 42 ) ( 38 ) Non-cash transactions: 32 % equity-method investment in the Consumer Healthcare JV received in exchange for contributing Pfizers Consumer Healthcare business (a) $ $ 15,711 $ Equity investment in Allogene received in exchange for Pfizer's allogeneic CAR T developmental program assets 92 Equity investment in Cerevel in exchange for Pfizers portfolio of clinical and preclinical neuroscience assets 343 (a) The $ 8.2 billion Gain on completion of Consumer Healthcare JV transaction, net of cash conveyed reflects the receipt of a 32 % equity-method investment in the new company initially valued at $ 15.7 billion in exchange for net assets contributed of $ 7.6 billion and is presented in operating activities net of $ 146 million cash conveyed that is reflected in Other investing activities, net . See Note 2C. See Accompanying Notes. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 1. Basis of Presentation and Significant Accounting Policies A. Basis of Presentation The consolidated financial statements include the accounts of our parent company and all subsidiaries and are prepared in accordance with U.S. GAAP. The decision of whether or not to consolidate an entity for financial reporting purposes requires consideration of majority voting interests, as well as effective economic or other control over the entity. Typically, we do not seek control by means other than voting interests. For subsidiaries operating outside the U.S., the financial information is included as of and for the year ended November 30 for each year presented. Pfizer's fiscal year-end for U.S. subsidiaries is as of and for the year ended December 31 for each year presented. Substantially all unremitted earnings of international subsidiaries are free of legal and contractual restrictions. All significant transactions among our subsidiaries have been eliminated. On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan. Prior to the separation of the Upjohn Business, beginning in 2020, the Upjohn Business, Meridian, which is the manufacturer of EpiPen and other auto-injector products, and a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (the Mylan-Japan collaboration) were managed as part of our former Upjohn operating segment. Revenues and expenses associated with Meridian and the Mylan-Japan collaboration were included in the Upjohn operating segment results along with the results of operations of the Upjohn Business in Pfizers historical consolidated financial statements. Meridian, which remains with Pfizer, supplies EpiPen Auto-Injectors to Viatris under a supply agreement expiring December 31, 2024, with an option for Viatris to extend for an additional one-year term. On December 21, 2020, which falls in Pfizers international 2021 fiscal year, Pfizer and Viatris completed the termination, under the previously disclosed agreement dated November 13, 2020, of the Mylan-Japan collaboration and we transferred related inventories and operations that were part of the Mylan-Japan collaboration to Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reflected as discontinued operations for all periods presented. The financial results of Meridian are now included in our Hospital therapeutic area for all periods presented. Upon completion of the spin-off of the Upjohn Business on November 16, 2020, the Upjohn assets and liabilities were derecognized from our consolidated balance sheet and are reflected in Retained Earnings Distribution of Upjohn Business in the consolidated statement of equity. The assets and liabilities associated with the Upjohn Business and the Mylan-Japan collaboration are classified as assets and liabilities of discontinued operations. Certain prior year amounts have been reclassified to conform with the current year presentation. In addition, other acquisitions and business development activities completed in 2020, 2019 and 2018, including the acquisitions of Array and Therachon, and the contribution of our Consumer Healthcare business to the Consumer Healthcare JV, impacted financial results in the periods presented. See Note 2. Prior to the separation of the Upjohn Business, we managed our commercial operations through three distinct business segments: (i) our innovative science-based biopharmaceutical products business (Biopharma); (ii) our global, primarily off-patent branded and generics business (Upjohn); and (iii) through July 31, 2019, Pfizers consumer healthcare business. With the formation of the Consumer Healthcare JV in 2019 and the completion of the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We now operate as a single operating segment engaged in the discovery, development, manufacturing, marketing, sales and distribution of biopharmaceutical products worldwide. Regional commercial organizations market, distribute and sell our products. Our commercial organization is supported by global platform functions that are responsible for the research, development, manufacturing and supply of our products. The business is also supported by global corporate enabling functions. Our determination that we operate as a single segment is consistent with the financial information regularly reviewed by the chief operating decision maker for purposes of evaluating performance, allocating resources, setting incentive compensation targets, and planning and forecasting for future periods. Our chief operating decision maker allocates resources and assesses financial performance on a consolidated basis. Prior-period information has been restated to reflect our current organizational structure following the separation of the Upjohn Business. For information about product and geographic revenues, see Note 17 . Certain amounts in the consolidated financial statements and associated notes may not add due to rounding. All percentages have been calculated using unrounded amounts. B . New Accounting Standards Adopted in 2020 On January 1, 2020, we adopted the following accounting standards: Credit Losses on Financial Instruments We adopted a new accounting standard for credit losses on financial instruments, which replaces the probable initial recognition threshold for incurred loss estimates under prior guidance with a methodology that reflects expected credit loss estimates. The standard generally impacts financial assets that have a contractual right to receive cash and are not accounted for at fair value through net income, such as accounts receivable and held-to-maturity debt securities. The new guidance requires us to identify, analyze, document and support new methodologies for quantifying expected credit loss estimates for certain financial instruments, using information such as historical experience, current economic conditions and information, and the use of reasonable and supportable forecasted information. The standard also amends existing impairment guidance for available-for-sale debt securities to incorporate a credit loss allowance and allows for reversals of credit impairments in the event the issuers credit improves. We adopted the new accounting standard utilizing the modified retrospective method and, therefore, no adjustments were made to prior period financial statements. The cumulative effect of adopting the standard as an adjustment to the opening balance of Retained earnings was not material. The adoption of this standard did not have a material impact on our consolidated statement of income or consolidated statement of cash flows for the year ended December 31, 2020, nor on our consolidated balance sheet as of December 31, 2020. For additional information, see Note 1G. Goodwill Impairment Testing We prospectively adopted the new standard, which eliminates the requirement to perform a hypothetical purchase price allocation to measure goodwill impairment. Under the new guidance, the goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and recognizing an impairment charge for the amount by which the carrying amount Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies of the reporting unit exceeds its fair value. There was no impact to our consolidated financial statements from the adoption of this new standard. Implementation Costs in a Cloud Computing Arrangement We prospectively adopted the new standard related to customers accounting for implementation costs incurred in a cloud computing arrangement that is considered a service contract. The new guidance aligns the requirements for capitalizing implementation costs in such arrangements with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The adoption of this guidance did not have a material impact on our consolidated financial statements. Collaboration Agreements We prospectively adopted the new standard, which provides guidance clarifying the interaction between the accounting for collaborative arrangements and revenue from contracts with customers. There was no impact to our consolidated financial statements from the adoption of this new standard. C. Estimates and Assumptions In preparing these financial statements, we use certain estimates and assumptions that affect reported amounts and disclosures. These estimates and assumptions can impact all elements of our financial statements. For example, in the consolidated statements of income, estimates are used when accounting for deductions from revenues, determining the cost of inventory that is sold, allocating cost in the form of depreciation and amortization, and estimating restructuring charges and the impact of contingencies, as well as determining provisions for taxes on income. On the consolidated balance sheets, estimates are used in determining the valuation and recoverability of assets, and in determining the reported amounts of liabilities, all of which also impact the consolidated statements of income. Certain estimates of fair value and amounts recorded in connection with acquisitions, revenue deductions, impairment reviews, restructuring-associated charges, investments and financial instruments, valuation allowances, pension and postretirement benefit plans, contingencies, share-based compensation, and other calculations can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. Our estimates are often based on complex judgments and assumptions that we believe to be reasonable, but that can be inherently uncertain and unpredictable. If our estimates and assumptions are not representative of actual outcomes, our results could be materially impacted. As future events and their effects cannot be determined with precision, our estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. We are subject to risks and uncertainties that may cause actual results to differ from estimated amounts, such as changes in the healthcare environment, competition, litigation, legislation and regulations. We regularly evaluate our estimates and assumptions using historical experience and expectations about the future. We adjust our estimates and assumptions when facts and circumstances indicate the need for change. D. Acquisitions Our consolidated financial statements include the operations of acquired businesses after the completion of the acquisitions. We account for acquired businesses using the acquisition method of accounting, which requires, among other things, that most assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date and that the fair value of acquired IPRD be recorded on the balance sheet. Transaction costs are expensed as incurred. Any excess of the consideration transferred over the assigned values of the net assets acquired is recorded as goodwill. When we acquire net assets that do not constitute a business, as defined in U.S. GAAP, no goodwill is recognized and acquired IPRD is expensed. Contingent consideration in a business combination is included as part of the acquisition cost and is recognized at fair value as of the acquisition date. Fair value is generally estimated by using a probability-weighted discounted cash flow approach. See Note 16D . Any liability resulting from contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. These changes in fair value are recognized in earnings in Other (income)/deductionsnet . E. Fair Value We measure certain assets and liabilities at fair value, either upon initial recognition or for subsequent accounting or reporting. We estimate fair value using an exit price approach, which requires, among other things, that we determine the price that would be received to sell an asset or paid to transfer a liability in an orderly market. The determination of an exit price is considered from the perspective of market participants, considering the highest and best use of non-financial assets and, for liabilities, assuming that the risk of non-performance will be the same before and after the transfer. When estimating fair value, depending on the nature and complexity of the asset or liability, we may use one or all of the following techniques: Income approach, which is based on the present value of a future stream of net cash flows. Market approach, which is based on market prices and other information from market transactions involving identical or comparable assets or liabilities. Cost approach, which is based on the cost to acquire or construct comparable assets, less an allowance for functional and/or economic obsolescence. Our fair value methodologies depend on the following types of inputs: Quoted prices for identical assets or liabilities in active markets (Level 1 inputs). Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are directly or indirectly observable, or inputs that are derived principally from, or corroborated by, observable market data by correlation or other means (Level 2 inputs). Unobservable inputs that reflect estimates and assumptions (Level 3 inputs). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following inputs and valuation techniques are used to estimate the fair value of our financial assets and liabilities: Available-for-sale debt securitiesthird-party matrix-pricing model that uses significant inputs derived from or corroborated by observable market data and credit-adjusted yield curves. Equity securities with readily determinable fair valuesquoted market prices and observable NAV prices. Derivative assets and liabilitiesthird-party matrix-pricing model that uses inputs derived from or corroborated by observable market data. Where applicable, these models use market-based observable inputs, including interest rate yield curves to discount future cash flow amounts, and forward and spot prices for currencies. The credit risk impact to our derivative financial instruments was not significant. Money market fundsobservable NAV prices. We periodically review the methodologies, inputs and outputs of third-party pricing services for reasonableness. Our procedures can include, for example, referencing other third-party pricing models, monitoring key observable inputs (like benchmark interest rates) and selectively performing test-comparisons of values with actual sales of financial instruments. F. Foreign Currency Translation For most of our international operations, local currencies have been determined to be the functional currencies. We translate functional currency assets and liabilities to their U.S. dollar equivalents at exchange rates in effect as of the balance sheet date and income and expense amounts at average exchange rates for the period. The U.S. dollar effects that arise from changing translation rates are recorded in Other comprehensive income/(loss) . The effects of converting non-functional currency monetary assets and liabilities into the functional currency are recorded in Other (income)/deductionsnet . For operations in highly inflationary economies, we translate monetary items at rates in effect as of the balance sheet date, with translation adjustments recorded in Other (income)/deductionsnet , and we translate non-monetary items at historical rates. G . Revenues and Trade Accounts Receivable Revenue Recognition We record revenues from product sales when there is a transfer of control of the product from us to the customer. We determine transfer of control based on when the product is shipped or delivered and title passes to the customer. Our Sales Contracts Sales on credit are typically under short-term contracts. Collections are based on market payment cycles common in various markets, with shorter cycles in the U.S. Sales are adjusted for sales allowances, chargebacks, rebates and sales returns and cash discounts. Sales returns occur due to LOE, product recalls or a changing competitive environment. Deductions from Revenues Our gross product revenues are subject to a variety of deductions, which generally are estimated and recorded in the same period that the revenues are recognized. Such variable consideration represents chargebacks, rebates, sales allowances and sales returns. These deductions represent estimates of the related obligations and, as such, knowledge and judgment is required when estimating the impact of these revenue deductions on gross sales for a reporting period. Provisions for pharmaceutical sales returns Provisions are based on a calculation for each market that incorporates the following, as appropriate: local returns policies and practices; historical returns as a percentage of sales; an understanding of the reasons for past returns; estimated shelf life by product; an estimate of the amount of time between shipment and return or lag time; and any other factors that could impact the estimate of future returns, such as LOE, product recalls or a changing competitive environment. Generally, returned products are destroyed, and customers are refunded the sales price in the form of a credit. We record sales incentives as a reduction of revenues at the time the related revenues are recorded or when the incentive is offered, whichever is later. We estimate the cost of our sales incentives based on our historical experience with similar incentives programs to predict customer behavior. The following outlines our common sales arrangements: Customers Our biopharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies. In the U.S., we primarily sell our vaccines products directly to the federal government, CDC, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. Outside the U.S., we primarily sell our vaccines to government and non-government institutions. Customers for our consumer healthcare business, which were part of the business that was combined with GSKs Consumer Healthcare business included retailers and, to a lesser extent, wholesalers and distributors. Biopharmaceutical products that ultimately are used by patients are generally covered under governmental programs, managed care programs and insurance programs, including those managed through PBMs, and are subject to sales allowances and/or rebates payable directly to those programs. Those sales allowances and rebates are generally negotiated, but government programs may have legislated amounts by type of product (e.g., patented or unpatented). Specifically: In the U.S., we sell our products principally to distributors and hospitals. We also have contracts with managed care programs or PBMs and legislatively mandated contracts with the federal and state governments under which we provide rebates based on medicines utilized by the lives they cover. We record provisions for Medicare, Medicaid, and performance-based contract pharmaceutical rebates based upon our experience ratio of rebates paid and actual prescriptions written during prior periods. We apply the experience ratio to the respective periods sales to determine the rebate accrual and related expense. This experience ratio is evaluated regularly to ensure that the historical trends are as current as practicable. We estimate discounts on branded prescription drug sales to Medicare Part D participants in the Medicare coverage gap, also known as the doughnut hole, based on the historical experience of beneficiary prescriptions and consideration of the utilization that is expected to result from the discount in the coverage gap. We evaluate this estimate regularly to ensure that the historical trends and future expectations are as current as practicable. For performance-based contract rebates, we also consider current contract terms, such as changes in formulary status and rebate rates. Outside the U.S., the majority of our pharmaceutical sales allowances are contractual or legislatively mandated and our estimates are based on actual invoiced sales within each period, which reduces the risk of variations in the estimation process. In certain European countries, Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies rebates are calculated on the governments total unbudgeted pharmaceutical spending or on specific product sales thresholds and we apply an estimated allocation factor against our actual invoiced sales to project the expected level of reimbursement. We obtain third-party information that helps us to monitor the adequacy of these accruals. Provisions for pharmaceutical chargebacks (primarily reimbursements to U.S. wholesalers for honoring contracted prices to third parties) closely approximate actual amounts incurred, as we settle these deductions generally within two to five weeks of incurring the liability. We recorded direct product sales and/or alliance revenues of more than $ 1 billion for each of seven products in 2020, for each of six products in 2019 and for each of seven products in 2018. In the aggregate, these direct products sales and/or alliance product revenues represent 53 % of our revenues in 2020, 49 % of our revenues in 2019 and 47 % of our revenues in 2018. See Note 17B for additional information. The loss or expiration of intellectual property rights can have a significant adverse effect on our revenues as our contracts with customers will generally be at lower selling prices due to added competition and we generally provide for higher sales returns during the period in which individual markets begin to near the loss or expiration of intellectual property rights. Our accruals for Medicare, Medicaid and related state program and performance-based contract rebates, chargebacks, sales allowances and sales returns and cash discounts are as follows: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Reserve against Trade accounts receivable, less allowance for doubtful accounts $ 861 $ 823 Other current liabilities : Accrued rebates 3,017 2,512 Other accruals 436 379 Other noncurrent liabilities 399 384 Total accrued rebates and other sales-related accruals $ 4,712 $ 4,098 Taxes collected from customers relating to product sales and remitted to governmental authorities are excluded from Revenues . Trade Accounts Receivable Trade accounts receivable are stated at their net realizable value. The allowance for credit losses reflects our best estimate of expected credit losses of the receivables portfolio determined on the basis of historical experience, current information, and forecasts of future economic conditions. In developing the estimate for expected credit losses, trade accounts receivables are segmented into pools of assets depending on market (U.S. versus international), delinquency status, and customer type (high risk versus low risk and government versus non-government), and fixed reserve percentages are established for each pool of trade accounts receivables. In determining the reserve percentages for each pool of trade accounts receivables, we considered our historical experience with certain customers and customer types, regulatory and legal environments, country and political risk, and other relevant current and future forecasted macroeconomic factors. These credit risk indicators are monitored on a quarterly basis to determine whether there have been any changes in the economic environment that would indicate the established reserve percentages should be adjusted, and are considered on a regional basis to reflect more geographic-specific metrics. Additionally, write-offs and recoveries of customer receivables are tracked against collections on a quarterly basis to determine whether the reserve percentages remain appropriate. When management becomes aware of certain customer-specific factors that impact credit risk, specific allowances for these known troubled accounts are recorded. Trade accounts receivable are written off after all reasonable means to collect the full amount (including litigation, where appropriate) have been exhausted. During 2020, additions to the allowance for credit losses, write-offs and recoveries of customer receivables were not material to our consolidated financial statements. H. Collaborative Arrangements Payments to and from our collaboration partners are presented in our consolidated statements of income based on the nature of the arrangement (including its contractual terms), the nature of the payments and applicable accounting guidance. Under co-promotion agreements, we record the amounts received for our share of gross profits from our collaboration partners as alliance revenues, a component of Revenues, when our collaboration partners are the principal in the transaction and we receive a share of their net sales or profits. Alliance revenues are recorded as we perform co-promotion activities for the collaboration and the collaboration partners sell the products to their customers. The related expenses for selling and marketing these products including reimbursements to or from our collaboration partners for these costs are included in Selling, informational and administrative expenses. In collaborative arrangements where we manufacture a product for our collaboration partners, we record revenues when we transfer control of the product to our collaboration partners. In collaboration arrangements where we are the principal in the transaction, we record amounts paid to collaboration partners for their share of net sales or profits earned, and all royalty payments to collaboration partners as Cost of sales . Royalty payments received from collaboration partners are included in Other (income)/deductionsnet. Reimbursements to or from our collaboration partners for development costs are recorded in Research and development expenses . Upfront payments and pre-approval milestone payments due from us to our collaboration partners in development stage collaborations are recorded as Research and development expenses . Milestone payments due from us to our collaboration partners after regulatory approval has been attained for a medicine are recorded in Identifiable intangible assetsDeveloped technology rights . Upfront and pre-approval milestone payments earned from our collaboration partners by us are recognized in Other (income)/deductionsnet over the development period for the products, when our performance obligations include providing RD services to our collaboration partners. Upfront, pre-approval and post-approval milestone payments earned by us may be recognized in Other (income)/deductionsnet immediately when earned or over other periods depending upon the nature of our performance obligations in the applicable collaboration. Where the milestone event is regulatory approval for a medicine, we generally recognize milestone payments due to us in the transaction price when regulatory approval in the applicable jurisdiction has been attained. We may recognize milestone payments due to us in the transaction price earlier than the milestone event in certain circumstances when recognition of the income would not be probable of a significant reversal. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies I. Cost of Sales and Inventories Inventories are recorded at the lower of cost or net realizable value. The cost of finished goods, work in process and raw materials is determined using average actual cost. We regularly review our inventories for impairment and reserves are established when necessary. J. Selling, Informational and Administrative Expenses Selling, informational and administrative costs are expensed as incurred. Among other things, these expenses include the internal and external costs of marketing, advertising, shipping and handling, information technology and legal defense. Advertising expenses totaled approximately $ 1.8 billion in 2020, $ 2.4 billion in 2019 and $ 2.7 billion in 2018. Production costs are expensed as incurred and the costs of TV, radio, and other electronic media and publications are expensed when the related advertising occurs. K. Research and Development Expenses RD costs are expensed as incurred. These expenses include the costs of our proprietary RD efforts, as well as costs incurred in connection with certain licensing arrangements. Before a compound receives regulatory approval, we record upfront and milestone payments we make to third parties under licensing arrangements as expense. Upfront payments are recorded when incurred, and milestone payments are recorded when the specific milestone has been achieved. Once a compound receives regulatory approval, we record any milestone payments in Identifiable intangible assets, less accumulated amortization and, unless the asset is determined to have an indefinite life, we amortize the payments on a straight-line basis over the remaining agreement term or the expected product life cycle, whichever is shorter. L. Amortization of Intangible Assets, Depreciation and Certain Long-Lived Assets Long-lived assets include: Property, plant and equipment, less accumulated depreciationThese assets are recorded at cost, including any significant improvements after purchase, less accumulated depreciation. Property, plant and equipment assets, other than land and construction in progress, are depreciated on a straight-line basis over the estimated useful life of the individual assets. Depreciation begins when the asset is ready for its intended use. For tax purposes, accelerated depreciation methods are used as allowed by tax laws. Identifiable intangible assets, less accumulated amortization These assets are recorded at fair value at acquisition. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. Intangible assets with indefinite lives are not amortized until a useful life can be determined. Goodwill Goodwill represents the excess of the consideration transferred for an acquired business over the assigned values of its net assets. Goodwill is not amortized. Amortization of finite-lived acquired intangible assets that contribute to our ability to sell, manufacture, research, market and distribute products, compounds and intellectual property is included in Amortization of intangible assets as these intangible assets benefit multiple business functions. Amortization of intangible assets that are for a single function and depreciation of property, plant and equipment are included in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses, as appropriate. We review our long-lived assets for impairment indicators throughout the year. We perform impairment testing for indefinite-lived intangible assets and goodwill at least annually and for all other long-lived assets whenever impairment indicators are present. When necessary, we record impairments of long-lived assets for the amount by which the fair value is less than the carrying value of these assets. Specifically: For finite-lived intangible assets, such as developed technology rights, and for other long-lived assets, such as property, plant and equipment, whenever impairment indicators are present, we calculate the undiscounted value of the projected cash flows for the asset, or asset group, and compare this estimated amount to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. In addition, in all cases of an impairment review, we reevaluate the remaining useful lives of the assets and modify them, as appropriate. For indefinite-lived intangible assets, such as Brands and IPRD assets, when necessary, we determine the fair value of the asset and record an impairment loss, if any, for the excess of book value over fair value. In addition, in all cases of an impairment review other than for IPRD assets, we re-evaluate whether continuing to characterize the asset as indefinite-lived is appropriate. For goodwill, when necessary, we determine the fair value of each reporting unit and record an impairment loss, if any, for the excess of the book value of the reporting unit over the implied fair value. M. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives We may incur restructuring charges in connection with acquisitions when we implement plans to restructure and integrate the acquired operations or in connection with our cost-reduction and productivity initiatives. In connection with acquisition activity, we typically incur costs associated with executing the transactions, integrating the acquired operations (which may include expenditures for consulting and the integration of systems and processes), and restructuring the combined company (which may include charges related to employees, assets and activities that will not continue in the combined company); and In connection with our cost-reduction/productivity initiatives, we typically incur costs and charges for site closings and other facility rationalization actions, workforce reductions and the expansion of shared services, including the development of global systems. Included in Restructuring charges and certain acquisition-related costs are all restructuring charges, as well as certain other costs associated with acquiring and integrating an acquired business. If the restructuring action results in a change in the estimated useful life of an asset, that incremental impact is classified in Cost of sales, Selling, informational and administrative expenses and/or Research and development Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies expenses , as appropriate. Employee termination costs are generally recorded when the actions are probable and estimable and include accrued severance benefits, pension and postretirement benefits, many of which may be paid out during periods after termination. Transaction costs, such as banking, legal, accounting and other similar costs incurred in connection with a business acquisition are expensed as incurred . Our business and platform functions may be impacted by these actions, including sales and marketing, manufacturing and RD, as well as our corporate enabling functions (such as digital, global real estate operations, legal, finance, human resources, worldwide public affairs, compliance and worldwide procurement). N. Cash Equivalents and Statement of Cash Flows Cash equivalents include items almost as liquid as cash, such as certificates of deposit and time deposits with maturity periods of three months or less when purchased. If items meeting this definition are part of a larger investment pool, we classify them as Short-term investments . Cash flows for financial instruments designated as fair value or cash flow hedges may be included in operating, investing or financing activities, depending on the classification of the items being hedged. Cash flows for financial instruments designated as net investment hedges are classified according to the nature of the hedge instrument. Cash flows for financial instruments that do not qualify for hedge accounting treatment are classified according to their purpose and accounting nature. O. Investments and Derivative Financial Instruments The classification of an investment depends on the nature of the investment, our intent and ability to hold the investment, and the degree to which we may exercise influence. Our investments are primarily comprised of the following: Public equity securities with readily determinable fair values, which are carried at fair value, with changes in fair value reported in Other (income)/deductionsnet. Available-for-sale debt securities, which are carried at fair value, with changes in fair value reported in Other comprehensive income/(loss) until realized. Held-to-maturity debt securities, which are carried at amortized cost. Private equity securities without readily determinable fair values and where we have no significant influence are measured at cost minus any impairment and plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. For equity investments in common stock or in-substance common stock where we have significant influence over the financial and operating policies of the investee, we use the equity-method of accounting. Under the equity-method, we record our share of the investees income and expenses in Other (income)/deductionsnet . The excess of the cost of the investment over our share of the underlying equity in the net assets of the investee as of the acquisition date is allocated to the identifiable assets and liabilities of the investee, with any remaining excess amount allocated to goodwill. Such investments are initially recorded at cost, which is the fair value of consideration paid and typically does not include contingent consideration. Realized gains or losses on sales of investments are determined by using the specific identification cost method. We regularly evaluate all of our financial assets for impairment. For investments in debt and equity, when a decline in fair value, if any, is determined, an impairment charge is recorded and a new cost basis in the investment is established. Derivative financial instruments are carried at fair value in various balance sheet categories (see Note 7A ), with changes in fair value reported in Net income or, for derivative financial instruments in certain qualifying hedging relationships, in Other comprehensive income/(loss) (see Note 7E ). P . Tax Assets and Liabilities and Income Tax Contingencies Tax Assets and Liabilities Current tax assets primarily includes (i) tax effects for intercompany transfers of inventory within our combined group, which are recognized in the consolidated statements of income when the inventory is sold to a third party and (ii) income tax receivables that are expected to be recovered either via refunds from taxing authorities or reductions to future tax obligations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates and laws. We provide a valuation allowance when we believe that our deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax-planning strategies, that would be implemented, if necessary, to realize the deferred tax assets. Amounts recorded for valuation allowances requires judgments about future income which can depend heavily on estimates and assumptions. All deferred tax assets and liabilities within the same tax jurisdiction are presented as a net amount in the noncurrent section of our consolidated balance sheet. Other non-current tax assets primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Other taxes payable as of December 31, 2020 and 2019 include liabilities for uncertain tax positions and the noncurrent portion of the repatriation tax liability for which we elected payment over eight years through 2026. For additional information, see Note 5D for uncertain tax positions and Note 5A for the repatriation tax liability and other estimates and assumptions in connection with the TCJA. Income Tax Contingencies We account for income tax contingencies using a benefit recognition model. If we consider that a tax position is more likely than not to be sustained upon audit, based solely on the technical merits of the position, we recognize all or a portion of the benefit. We measure the benefit by determining the amount that is greater than 50% likely of being realized upon settlement, presuming that the tax position is examined by the taxing authority with full knowledge of all relevant information. We regularly monitor our position and subsequently recognize the unrecognized tax benefit: (i) if there are changes in tax law, analogous case law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to more likely than not; (ii) if the statute of limitations expires; or (iii) if there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. Liabilities for uncertain tax positions are classified as current only when we expect to pay cash within the next 12 months. Interest and penalties, if any, are recorded in Provision/(benefit) for taxes on income and are classified on our consolidated balance sheet with the related tax liability. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Q. Pension and Postretirement Benefit Plans The majority of our employees worldwide are covered by defined benefit pension plans, defined contribution plans or both. In the U.S., we have both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans, as well as other postretirement benefit plans consisting primarily of medical insurance for retirees and their eligible dependents. We recognize the overfunded or underfunded status of each of our defined benefit plans as an asset or liability. The obligations are generally measured at the actuarial present value of all benefits attributable to employee service rendered, as provided by the applicable benefit formula. Our pension and other postretirement obligations may be determined using assumptions such as discount rate, expected annual rate of return on plan assets, expected employee turnover and participant mortality. For our pension plans, the obligation may also include assumptions as to future compensation levels. For our other postretirement benefit plans, the obligation may include assumptions as to the expected cost of providing medical insurance benefits, as well as the extent to which those costs are shared with the employee or others (such as governmental programs). Plan assets are measured at fair value. Net periodic pension and postretirement benefit costs other than the service costs are recognized in Other (income)/deductionsnet . R. Legal and Environmental Contingencies We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, such as patent litigation, product liability and other product-related litigation, commercial litigation, environmental claims and proceedings, government investigations and guarantees and indemnifications. We record accruals for these contingencies to the extent that we conclude that a loss is both probable and reasonably estimable. If some amount within a range of loss appears to be a better estimate than any other amount within the range, we accrue that amount. Alternatively, when no amount within a range of loss appears to be a better estimate than any other amount, we accrue the lowest amount in the range. We record anticipated recoveries under existing insurance contracts when recovery is assured. S. Share-Based Payments Our compensation programs can include share-based payments. Generally, grants under share-based payment programs are accounted for at fair value and these fair values are generally amortized on a straight-line basis over the vesting terms with the related costs recorded in Cost of sales, Selling, informational and administrative expenses and/or Research and development expenses , as appropriate. Note 2. Acquisitions, Divestitures, Equity-Method Investments, Licensing Arrangements and Collaborative Arrangements A. Acquisitions Array On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $ 48 per share in cash. The total fair value of the consideration transferred was $ 11.2 billion ($ 10.9 billion, net of cash acquired). In addition, $ 157 million in payments to Array employees for the fair value of previously unvested stock options was recognized as post-closing compensation expense and recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). We financed the majority of the transaction with debt and the balance with existing cash. Arrays portfolio includes Braftovi (encorafenib) and Mektovi (binimetinib), a broad pipeline of targeted cancer medicines in different stages of RD, as well as a portfolio of out-licensed medicines, which may generate milestones and royalties over time. The final allocation of the consideration transferred to the assets acquired and the liabilities assumed was completed in 2020. In connection with this acquisition, we recorded: (i) $ 6.3 billion in Identifiable intangible assets , consisting of $ 2.0 billion of Developed technology rights with Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies a useful life of 16 years , $ 2.8 billion of IPRD and $ 1.5 billion of Licensing agreements ($ 1.2 billion for technology in development indefinite-lived licensing agreements and $ 360 million for developed technology finite-lived licensing agreements with a useful life of 10 years), (ii) $ 6.1 billion of Goodwill , (iii) $ 1.1 billion of net deferred tax liabilities and (iv) $ 451 million of assumed long-term debt, which was paid in full in 2019. In 2020, we recorded measurement period adjustments to the estimated fair values initially recorded in 2019, which resulted in a reduction in Identifiable intangible assets of approximately $ 900 million with a corresponding change to Goodwill and net deferred tax liabilities. The measurement period adjustments were recorded to better reflect market participant assumptions about facts and circumstances existing as of the acquisition date and did not have a material impact on our consolidated statement of income for the year ended December 31, 2020. Therachon On July 1, 2019, we acquired all the remaining shares of Therachon, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $ 340 million upfront, plus potential milestone payments of up to $ 470 million contingent on the achievement of key milestones in the development and commercialization of the lead asset. In 2018, we acquired approximately 3 % of Therachons outstanding shares for $ 5 million. We accounted for the transaction as an asset acquisition since the lead asset represented substantially all the fair value of the gross assets acquired. The total fair value of the consideration transferred for Therachon was $ 322 million, which consisted of $ 317 million of cash and our previous $ 5 million investment in Therachon. In connection with this asset acquisition, we recorded a charge of $ 337 million in Research and development expenses. B . Divestitures Upjohn Separation and Combination with Mylan On November 16, 2020, we completed the spin-off and the combination of the Upjohn Business with Mylan (the Transactions) to form Viatris. The Transactions were structured as an all-stock, Reverse Morris Trust transaction. Specifically, (i) we contributed the Upjohn Business to a wholly owned subsidiary, which was renamed Viatris, so that the Upjohn Business was separated from the remainder of our business (the Separation), (ii) following the Separation, we distributed, on a pro rata basis, all of the shares of Viatris common stock held by Pfizer to Pfizer stockholders as of the November 13, 2020 record date, such that each Pfizer stockholder as of the record date received approximately 0.124079 shares of Viatris common stock per share of Pfizer common stock (the Distribution); and (iii) immediately after the Distribution, the Upjohn Business combined with Mylan in a series of transactions in which Mylan shareholders received one share of Viatris common stock for each Mylan ordinary share held by such shareholder, subject to any applicable withholding taxes (the Combination). Prior to the Distribution, Viatris made a cash payment to Pfizer equal to $ 12.0 billion as partial consideration for the contribution of the Upjohn Business to Viatris. As of the closing of the Combination, Pfizer stockholders owned approximately 57 % of the outstanding shares of Viatris common stock, and Mylan shareholders owned approximately 43 % of the outstanding shares of Viatris common stock, in each case on a fully diluted, as-converted and as-exercised basis. The Transactions are generally expected to be tax free to Pfizer and Pfizer stockholders for U.S. tax purposes. Beginning November 16, 2020, Viatris operates both the Upjohn Business and Mylan as an independent publicly traded company, which is traded under the symbol VTRS on the NASDAQ. In connection with the Transactions, in June 2020, Upjohn Inc. and Upjohn Finance B.V. completed privately placed debt offerings of $ 7.45 billion and 3.60 billion aggregate principal amounts, respectively, (approximately $ 11.4 billion) of senior unsecured notes and entered into other financing arrangements, including a $ 600 million delayed draw term loan agreement and a revolving credit facility agreement for up to $ 4.0 billion. Proceeds from the debt offerings and other financing arrangements were used to fund the $ 12.0 billion cash distribution Viatris made to Pfizer prior to the Distribution. We used the cash distribution proceeds to pay down commercial paper borrowings and redeem the $ 1.15 billion aggregate principal amount outstanding of our 1.95 % senior unsecured notes that were due in June 2021 and $ 342 million aggregate principal amount outstanding of our 5.80 % senior unsecured notes that were due in August 2023, before the maturity date. Interest expense for the $ 11.4 billion in debt securities incurred during 2020 is included in Income from discontinued operationsnet of tax . Following the Separation and Combination of the Upjohn Business with Mylan, we are no longer the obligor or guarantor of any Upjohn debt or Upjohn financing arrangements. As a result of the separation of Upjohn, we incurred separation-related costs of $ 434 million in 2020 and $ 83 million in 2019, which are included in Income from discontinued operationsnet of tax . These costs primarily relate to professional fees for regulatory filings and separation activities within finance, tax, legal and information system functions as well as investment banking fees. In connection with the Transactions, Pfizer and Viatris entered into various agreements to effect the Separation and Combination to provide a framework for our relationship after the Combination, including a separation and distribution agreement, manufacturing and supply agreements (MSAs), transition service agreements (TSAs), a tax matters agreement, and an employee matters agreement, among others. Under the MSAs, Pfizer or Viatris, as the case may be, manufactures, labels, and packages products for the other party. The terms of the MSAs range in initial duration from 4 to 7 years post-Separation. The TSAs primarily involve Pfizer providing services to Viatris related to finance, information technology and human resource infrastructure and are generally expected to be for terms of no more than 3 years post-Separation. In addition, we are also party to various commercial agreements with Viatris. The amounts billed for net manufacturing supply and transition services provided under the above agreements as well as sales to and purchases from Viatris are not material to our results of continuing operations in 2020. Included in our consolidated balance sheet as of December 31, 2020 are net amounts due from Viatris primarily related to various interim agency operating models and transitional services, partially offset by net amounts due to Viatris for unsettled intercompany balances as of the closing date of the spin-off, transaction-related indemnifications and a contractual cash payment pursuant to terms of the separation and distribution agreement, totaling approximately $ 401 million. The interim agency operating model primarily includes billings, collections and remittance of rebates that we are performing on a transitional basis on behalf of Viatris. The operating results of the Upjohn Business are reported as Income from discontinued operationsnet of tax through November 16, 2020, the date of the spin-off and combination with Mylan. In addition, as of December 31, 2019, the assets and liabilities associated with this business are classified as assets and liabilities of discontinued operations. Prior-period financial information has been restated, as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Components of Income from discontinued operationsnet of tax: Year Ended December 31, (a) (MILLIONS OF DOLLARS) 2020 2019 2018 Revenues $ 7,314 $ 10,578 $ 12,822 Costs and expenses: Cost of sales 1,899 1,976 2,261 Selling, informational and administrative expenses 1,665 1,599 1,842 Research and development expenses 212 255 246 Amortization of intangible assets 136 148 157 Restructuring charges and certain acquisition-related costs 7 146 ( 14 ) Other (income)/deductionsnet 400 253 30 Pre-tax income from discontinued operations 2,995 6,201 8,300 Provision for taxes on income 364 766 973 Income from discontinued operationsnet of tax $ 2,631 $ 5,435 $ 7,328 (a) Virtually all Income from discontinued operations net of tax relates to the Upjohn Business and the Mylan-Japan collaboration in all periods presented. Components of assets and liabilities of discontinued operations and other assets held for sale: As of December 31, (a) (MILLIONS OF DOLLARS) 2020 2019 Cash and cash equivalents $ $ 184 Trade accounts receivable, less allowance for doubtful accounts 1,952 Inventories 86 1,215 Other current assets 852 Other assets held for sale 82 21 Current assets of discontinued operations and other assets held for sale $ 167 $ 4,224 Property, plant and equipment $ $ 998 Identifiable intangible assets 1,434 Goodwill 10,451 Other noncurrent assets 544 Noncurrent assets of discontinued operations $ $ 13,427 Trade accounts payable $ $ 334 Accrued compensation and related items 330 Other current liabilities 1,749 Current liabilities of discontinued operations $ $ 2,413 Pension and postretirement benefit obligations $ $ 545 Other noncurrent liabilities 403 Noncurrent liabilities of discontinued operations (b) $ $ 948 (a) Amounts relate to discontinued operations of the Upjohn Business and the Mylan-Japan collaboration, except for amounts in Other assets held for sale, which represent unrelated property, plant and equipment held for sale. (b) Included in Other noncurrent liabilities . As a result of the spin-off of the Upjohn Business, we distributed net assets of $ 1.9 billion as of November 16, 2020, which has been reflected as a reduction to Retained earnings . Of this amount, $ 412 million represents cash transferred to the Upjohn Business, with the remainder considered a non-cash activity in the consolidated statement of cash flows for the year ended December 31, 2020. The spin-off also resulted in a net increase to Accumulated other comprehensive loss of $ 71 million for the derecognition of net gains on foreign currency translation adjustments of $ 397 million and actuarial losses net of prior service credits associated with benefit plans of $ 326 million, which were reclassified to Retained earnings . Contribution Agreement Between Pfizer and Allogene In April 2018, Pfizer and Allogene announced that the two companies entered into a contribution agreement for Pfizers portfolio of assets related to allogeneic CAR T therapy, an investigational immune cell therapy approach to treating cancer. Under this agreement, we received an equity investment in Allogene and Allogene received our rights to pre-clinical and clinical CAR T assets, all of which were previously licensed to us from French cell therapy company, Cellectis, beginning in 2014 and French pharmaceutical company, Servier, beginning in 2015. Allogene assumed responsibility for all potential financial obligations to both Cellectis and Servier. In connection with the Allogene transaction, we recognized a non-cash $ 50 million pre-tax gain in Other (income)/deductionsnet in the second quarter of 2018 , representing the difference between the $ 127 million fair value of the equity investment received and the book value of assets transferred (including an allocation of goodwill) (see Note 4 ). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies As of December 31, 2020, we held a 15.7 % equity stake in Allogene, and our investment in Allogene is being measured at fair value with changes in fair value recognized in net income. Sale of Phase 2b Ready AMPA Receptor Potentiator for CIAS to Biogen In April 2018, we sold our Phase 2b ready AMPA receptor potentiator for CIAS to Biogen. We received $ 75 million upfront which was recognized in Other (income)/deductionsnet (see Note 4 ) and may receive up to $ 515 million in total development and commercialization milestones, as well as tiered royalties in the low-to-mid-teen percentages. Divestiture of Neuroscience Assets In September 2018, we and Bain Capital entered into a transaction to create a new biopharmaceutical company, Cerevel (formerly known as Cerevel Therapeutics, LLC), to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system including Parkinsons disease, epilepsy, Alzheimers disease, schizophrenia and addiction. In connection with this transaction, we out-licensed the portfolio to Cerevel in exchange for a 25 % ownership stake in Cerevels parent company, Cerevel Therapeutics, Inc., and potential future regulatory and commercial milestone payments and royalties. In connection with the transaction, we recognized a non-cash $ 343 million pre-tax gain in Other (income)/deductionsnet in the third quarter of 2018, representing the fair value of the equity investment received as the assets transferred had a book value of $ 0 (see Note 4 ). On October 27, 2020, Cerevel Therapeutics, Inc. completed a merger with ARYA Sciences Acquisition Corp II, a publicly-traded special purpose acquisition corporation, and a concurrent private investment in public equity PIPE transaction to form Cerevel Therapeutics Holdings, Inc. Our existing shares in Cerevel Therapeutics, Inc. converted into common shares of Cerevel Therapeutics Holdings, Inc. as part of the merger transaction, and we purchased an additional $ 12 million in common shares as part of the PIPE transaction. The common shares of Cerevel Therapeutics Holdings, Inc. trade publicly on the NASDAQ stock market (ticker symbol CERE). As of December 31, 2020, we continue to hold a 21.5 % equity stake in Cerevel Therapeutics Holdings, Inc. for which we have elected the fair value option and which we measure at fair value with changes in fair value recognized in net income. In the fourth quarter of 2020, we remeasured our investment based on the market price of Cerevel Therapeutics Holdings, Inc. common shares as of December 31, 2020 less a discount for lack of marketability, and we recognized a gain of $ 20 million in Other income/(deductions)net. C. Equity-Method Investments Formation of Consumer Healthcare JV On July 31, 2019, we completed a transaction in which we and GSK combined our respective consumer healthcare businesses into a new JV that operates globally under the GSK Consumer Healthcare name. In exchange, we received a 32 % equity stake in the new company and GSK owns the remaining 68 %. Upon closing, we deconsolidated our Consumer Healthcare business and recognized a pre-tax gain of $ 8.1 billion ($ 5.4 billion, net of tax) in the third quarter of 2019 in (Gain) on completion of Consumer Healthcare JV transaction for the difference in the fair value of our 32 % equity stake and the carrying value of our Consumer Healthcare business. Our financial results and our Consumer Healthcare segments operating results for 2019 reflect seven months of Consumer Healthcare segment domestic operations and eight months of Consumer Healthcare segment international operations. The financial results for 2020 do not reflect any contribution from the Consumer Healthcare business. In valuing our investment in the Consumer Healthcare JV, we used discounted cash flow techniques. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which include the expected impact of competitive, legal or regulatory forces on the products; the long-term growth rate, which seeks to project the sustainable growth rate over the long term; the discount rate, which seeks to reflect our best estimate of the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. We are accounting for our interest in the Consumer Healthcare JV as an equity-method investment. The carrying value of our investment in the Consumer Healthcare JV is $ 16.7 billion as of December 31, 2020 and $ 17.0 billion as of December 31, 2019 and is reported as a private equity investment in Equity-method investments as of December 31, 2020 and 2019. The Consumer Healthcare JV is a foreign investee whose reporting currency is the U.K. pound, and therefore we translate its financial statements into U.S. dollars and recognize the impact of foreign currency translation adjustments in the carrying value of our investment and in other comprehensive income. The decrease in the value of our investment from December 31, 2019 to December 31, 2020 is primarily due to dividends of $ 932 million, which were received from the Consumer Healthcare JV in June, September and November 2020, largely offset by our share of the JVs earnings of $ 417 million and $ 345 million in pre-tax foreign currency translation adjustments (see Note 6 ). We record our share of earnings from the Consumer Healthcare JV on a quarterly basis on a one-quarter lag in Other (income)/deductionsnet commencing from August 1, 2019. Our total share of the JVs earnings generated in the fourth quarter of 2019 and the first nine months of 2020, which we recorded in our operating results in 2020, was $ 417 million. Our total share of two months of the JVs earnings generated in the third quarter of 2019, which we recorded in our operating results in the fourth quarter of 2019, was $ 47 million. As of the July 31, 2019 closing date, we estimated that the fair value of our investment in the Consumer Healthcare JV was $ 15.7 billion and that 32 % of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was $ 11.2 billion, resulting in an initial basis difference of approximately $ 4.5 billion. In the fourth quarter of 2019, we preliminarily completed the allocation of the basis difference, which resulted from the excess of the initial fair value of our investment over the underlying equity in the carrying value of the net assets of the JV, primarily to inventory, definite-lived intangible assets, indefinite-lived intangible assets, related deferred tax liabilities and equity method goodwill within the investment account. During the fourth quarter of 2019, the Consumer Healthcare JV revised the initial carrying value of the net assets of the JV and our 32 % share of the underlying equity in the carrying value of the net assets of the Consumer Healthcare JV was reduced to $ 11.0 billion and our initial basis difference was increased to $ 4.8 billion. The adjustment was allocated to equity method goodwill within the investment account. We began recording the amortization of basis differences allocated to inventory, definite-lived intangible assets and related deferred tax liabilities in Other (income)/deductionsnet commencing August 1, 2019. During the third and fourth quarters of 2020, we recognized write-offs of a portion of our basis differences allocated to indefinite-lived and definite-lived intangible assets and related deferred tax liabilities for the divestiture of certain brands by the Consumer Healthcare JV during its second quarter of 2020. The total amortization and write-off of these basis differences for the fourth quarter of 2019 and the first nine months of 2020, which was included in Other (income)/deductions Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies net in 2020, was $ 119 million of expense. The amortization of basis differences for two months of the third quarter of 2019 totaling approximately $ 31 million is included in our operating results in the fourth quarter of 2019. See Note 4. Amortization of basis differences on inventory and related deferred tax liabilities was completely recognized by the second quarter of 2020. Basis differences on definite-lived intangible assets and related deferred tax liabilities are being amortized over the lives of the underlying assets, which range from 8 to 20 years. While we have received our full 32 % interest in the Consumer Healthcare JV as of the July 31, 2019 closing and transferred control of our Consumer Healthcare business to the Consumer Healthcare JV, the contribution of the business was not completed in certain non-U.S. jurisdictions due to temporary regulatory or operational constraints. In these jurisdictions, we have continued to operate the business for the net economic benefit of the Consumer Healthcare JV, and we are indemnified against risks associated with such operations in the interim period, subject to our obligations under the definitive transaction agreements. We expect the contribution in these jurisdictions to be completed by the second half of 2021. As such, we have treated these jurisdictions as sold for accounting purposes. In connection with the contribution, we entered into certain transitional agreements designed to facilitate the orderly transition of the business to the Consumer Healthcare JV. These agreements primarily relate to administrative services, which are generally to be provided for a period of up to 24 months after closing. We will also manufacture and supply certain consumer products for the Consumer Healthcare JV and the Consumer Healthcare JV will manufacture and supply certain retained Pfizer products for us after closing, generally for a term of up to six years . These agreements are not material to Pfizer. As a part of Pfizer, pre-tax income on a management basis for the Consumer Healthcare business was $ 654 million through July 31, 2019 and $ 977 million in 2018. Summarized financial information for our equity method investee, the Consumer Healthcare JV, as of and for the twelve months ending September 30, 2020, the most recent period available, and as of and for the two months ending September 30, 2019 is as follows: (MILLIONS OF DOLLARS) September 30, 2020 September 30, 2019 Current assets $ 6,614 $ 7,505 Noncurrent assets 38,361 38,575 Total assets $ 44,975 $ 46,081 Current liabilities $ 5,246 $ 5,241 Noncurrent liabilities 5,330 5,536 Total liabilities $ 10,576 $ 10,776 Equity attributable to shareholders $ 34,154 $ 35,199 Equity attributable to noncontrolling interests 245 105 Total net equity $ 34,400 $ 35,304 For the Twelve Months Ending For the Two Months Ending (MILLIONS OF DOLLARS) September 30, 2020 September 30, 2019 Net sales $ 12,720 $ 2,161 Cost of sales ( 5,439 ) ( 803 ) Gross profit $ 7,281 $ 1,358 Income from continuing operations 1,350 152 Net income 1,350 152 Income attributable to shareholders 1,307 148 Investment in ViiV In 2009, we and GSK created ViiV, which is focused on research, development and commercialization of human immunodeficiency virus (HIV) medicines. We own approximately 11.7 % of ViiV, and prior to 2016 we accounted for our investment under the equity method due to the significant influence that we have over the operations of ViiV through our board representation and minority veto rights. We suspended application of the equity method to our investment in ViiV in 2016 when the carrying value of our investment was reduced to zero due to the recognition of cumulative equity method losses and dividends. Since 2016, we have recognized dividends from ViiV as income in Other (income)/deductionsnet when earned, including dividends of $ 278 million in 2020, $ 220 million in 2019 and $ 253 million in 2018 (see Note 4 ). Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summarized financial information for our equity method investee, ViiV, as of December 31, 2020 and 2019 and for the years ending December 31, 2020, 2019, and 2018 is as follows: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Current assets $ 3,283 $ 3,839 Noncurrent assets 3,381 3,437 Total assets $ 6,664 $ 7,276 Current liabilities $ 3,028 $ 2,904 Noncurrent liabilities 6,370 5,860 Total liabilities $ 9,398 $ 8,765 Total net equity/(deficit) attributable to shareholders $ ( 2,734 ) $ ( 1,489 ) Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Net sales $ 6,224 $ 6,139 $ 6,219 Cost of sales ( 574 ) ( 516 ) ( 462 ) Gross profit $ 5,650 $ 5,623 $ 5,757 Income from continuing operations 2,012 3,398 2,154 Net income 2,012 3,398 2,154 Income attributable to shareholders 2,012 3,398 2,154 D. Licensing Arrangements Agreement with Valneva 2 On April 30, 2020, we signed an agreement to co-develop and commercialize Valnevas Lyme disease vaccine candidate, VLA15, which covers six serotypes that are prevalent in North America and Europe. Valneva and Pfizer will work closely together throughout the development of VLA15. Valneva is eligible to receive a total of up to $ 308 million in cash payments from us consisting of a $ 130 million upfront payment, which was paid and recorded in Research and development expenses in our second quarter of 2020, as well as $ 35 million in development milestones and $ 143 million in early commercialization milestones. Under the terms of the agreement, Valneva will fund 30 % of all development costs through completion of the development program, and in return we will pay Valneva tiered royalties. We will lead late-stage development and have sole control over commercialization. Agreement with BioNTech In August 2018, a multi-year RD arrangement went into effect between BioNTech and Pfizer to develop mRNA-based vaccines for prevention of influenza (flu). In relation to this RD arrangement, in September 2018, we made an upfront payment of $ 50 million to BioNTech, which was recorded in Research and development expenses, and BioNTech became eligible to receive up to $ 325 million in development and sales-based milestones and royalty payments associated with worldwide sales. As part of the transaction, we also purchased 169,670 newly-issued ordinary shares of BioNTech for $ 50 million in the third quarter of 2018. Akcea On October 4, 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a wholly-owned subsidiary of Ionis. The transaction closed in November 2019 and we made an upfront payment of $ 250 million to Akcea, which was recorded in Research and development expenses in our fourth quarter of 2019. We may be required to make development, regulatory and sales milestone payments of up to $ 1.3 billion and pay tiered, double-digit royalties on annual worldwide net sales upon marketing approval of AKCEA-ANGPTL3-LRx. E. Collaborative Arrangements In the normal course of business, we enter into collaborative arrangements with respect to in-line medicines, as well as medicines in development that require completion of research and regulatory approval. Collaborative arrangements are contractual agreements with third parties that involve a joint operating activity, typically a research and/or commercialization effort, where both we and our partner are active participants in the activity and are exposed to the significant risks and rewards of the activity. Our rights and obligations under our collaborative arrangements vary. For example, we have agreements to co-promote pharmaceutical products discovered by us or other companies, and we have agreements where we partner to co-develop and/or participate together in commercializing, marketing, promoting, manufacturing and/or distributing a drug product. Agreement with Myovant On December 26, 2020, we entered into a collaboration to jointly develop and commercialize Orgovyx (relugolix) in advanced prostate cancer and, if approved, relugolix combination tablet (relugolix 40 mg, estradiol 1.0 mg, and norethindrone acetate 0.5 mg) in womens health in the U.S. and Canada. We will also receive an exclusive option to commercialize relugolix in oncology outside the U.S. and Canada, excluding certain Asian countries. Under the terms of the agreement, the companies will equally share profits and allowable expenses for Orgovyx and the relugolix combination tablet in the U.S. and Canada, with Myovant bearing our share of allowable expenses up to a maximum Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies of $ 100 million in 2021 and up to a maximum of $ 50 million in 2022. We will record our share of gross profits as Alliance revenue. Myovant will remain responsible for regulatory interactions and drug supply and continue to lead clinical development for the relugolix combination tablet. Myovant will be entitled to receive up to $ 4.35 billion, including an upfront payment of $ 650 million, which was made in December 2020, $ 200 million in potential regulatory milestones for FDA approvals for relugolix combination tablet in womens health, and tiered sales milestones of up to $ 3.5 billion for prostate cancer and also for the combined womens health indications. If we exercise the option to commercialize relugolix in oncology outside of the U.S. and Canada, excluding certain Asian countries, Myovant will receive $ 50 million and be entitled to receive double-digit royalties on sales. In connection with this transaction, we recognized $ 499 million in Identifiable intangible assetsDeveloped technology rights and $ 151 million in Research and development expenses representing the relative fair value of the portion of the upfront payment allocated to the approved indication and unapproved indications of the product, respectively. Agreement with CStone On September 29, 2020, we entered into a strategic collaboration with CStone to address oncological needs in China. The collaboration encompasses our $ 200 million upfront equity investment in CStone, a collaboration between the companies for the development and commercialization of CStones sugemalimab (CS1001, PD-L1 antibody) in mainland China, and a framework between the companies to bring additional oncology assets to the Greater China market. The transaction closed on October 9, 2020. As of December 31, 2020, we held a 9.9 % stake in CStone. Agreement with BioNTech On April 9, 2020, we signed a global agreement with BioNTech to co-develop a mRNA-based coronavirus vaccine program, BNT162b2, aimed at preventing COVID-19 disease. The collaboration rapidly advanced a COVID-19 vaccine candidate into human clinical testing based on BioNTechs proprietary mRNA vaccine platforms, and the vaccine has been granted EUA in the U.S., the EU and the U.K., among other countries. We are working with BioNTech to manufacture and help ensure rapid worldwide access to the vaccine. The collaboration leverages our broad expertise in vaccine RD, regulatory capabilities, and global manufacturing and distribution network. In connection with the April 2020 agreement, we paid BioNTech an upfront cash payment of $ 72 million, which was recorded in Research and development expenses in our second quarter of 2020, and we made an additional equity investment of $ 113 million in common stock of BioNTech. BioNTech became eligible to receive potential milestone payments of up to $ 563 million for a total consideration of $ 748 million. Under the terms of this agreement, we and BioNTech will share gross profits and development costs equally after the vaccine is approved and successfully commercialized, and we were responsible for all of the development costs until commercialization of the vaccine. Thereafter, BioNTech was to repay us its 50 percent share of these development costs through reductions in gross profit sharing and milestone payments to BioNTech over time. On January 29, 2021, we and BioNTech signed an amended version of the April 2020 agreement. Under the January 2021 agreement, BioNTech will pay us their 50 percent share of prior development costs in a lump sum payment during the first quarter of 2021. Further RD costs will be shared equally. We have commercialization rights to the vaccine worldwide (excluding Germany and Turkey where BioNTech will market and distribute the vaccine under the agreement with us, and excluding China, Hong Kong, Macau and Taiwan, which are subject to a separate collaboration between BioNTech and Shanghai Fosun Pharmaceutical (Group) Co., Ltd). We recognize Revenues and Cost of sales on a gross basis in markets where we are commercializing the vaccine and we will record our share of gross profits related to sales of the vaccine by BioNTech in Germany and Turkey in Alliance revenues . We made an additional investment of $ 50 million in common stock of BioNTech as part of an underwritten equity offering by BioNTech, which closed in July 2020. As of December 31, 2020, we held an equity stake of 2.5 % in BioNTech. Summarized Financial Information for Collaborative Arrangements The following provides the amounts and classification of payments (income/(expense)) between us and our collaboration partners: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Revenues Revenues (a) $ 284 $ 305 $ 268 Revenue sAlliance revenues (b) 5,418 4,648 3,838 Total revenues from collaborative arrangements $ 5,703 $ 4,953 $ 4,107 Cost of sales (c) $ ( 61 ) $ ( 52 ) $ ( 34 ) Selling, informational and administrative expenses (d) ( 194 ) ( 176 ) ( 92 ) Research and development expenses (e) ( 192 ) 104 162 Other income/(deductions)net (f) 567 362 281 (a) Represents sales to our partners of products manufactured by us. (b) Substantially all relates to amounts earned from our partners under co-promotion agreements. The increases in each of the periods presented reflect increases in alliance revenues from Eliquis and Xtandi. (c) Primarily relates to amounts paid to collaboration partners for their share of net sales or profits earned in collaboration arrangements where we are the principal in the transaction, and cost of sales for inventory purchased from our partners. (d) Represents net reimbursements to our partners for selling, informational and administrative expenses incurred. (e) Primarily relates to upfront payments and pre-approval milestone payments earned by our partners as well as net reimbursements. (f) Primarily relates to royalties from our collaboration partners. The amounts outlined in the above table do not include transactions with third parties other than our collaboration partners, or other costs for the products under the collaborative arrangements. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives In 2019, we substantially completed several multi-year initiatives focused on positioning us for future growth and creating a simpler, more efficient operating structure within each business. Transforming to a More Focused Company Program With the formation of the Consumer Healthcare JV in 2019 and the spin-off of our Upjohn Business in the fourth quarter of 2020, Pfizer has transformed into a more focused, global leader in science-based innovative medicines and vaccines. We have undertaken efforts to ensure our cost base aligns appropriately with our revenue base. While certain direct costs transferred to the Consumer Healthcare JV and to the Upjohn Business in connection with the spin-off, there are indirect costs which did not transfer. In addition, we are taking steps to restructure our corporate enabling functions to appropriately support and drive the purpose of our focused innovative biopharmaceutical products business and RD and PGS platform functions. The program costs discussed below may be rounded and represent approximations. We expect costs for this program, primarily related to corporate enabling functions, to be incurred from 2020 through 2022 and to total $ 1.6 billion on a pre-tax basis, with substantially all costs to be cash expenditures. Actions will include, among others, changes in location of certain activities, expanded use and co-location of centers of excellence and shared services, and increased use of digital technologies. The associated actions and the specific costs will primarily include severance and benefit plan impacts, exit costs as well as associated implementation costs. Also as part of this program, we expect to incur costs related to manufacturing network optimization, including certain legacy cost-reduction initiatives, of $ 500 million, with approximately 20 % of the costs to be non-cash. The costs for this effort are expected to be incurred primarily from 2020 through 2022, and will include, among other things, implementation costs, product transfer costs, site exit costs, as well as accelerated depreciation. From the start of this program in the fourth quarter of 2019 through December 31, 2020, we incurred costs of $ 900 million. Key Activities In 2020, we incurred costs of $ 896 million, composed primarily of the Transforming to a More Focused Company program. In 2019, we incurred costs of $ 820 million composed of $ 548 million for the 2017-2019 and Organizing for Growth initiatives, $ 288 million for the integration of Array, $ 94 million for the integration of Hospira, and $ 87 million for the Transforming to a More Focused Company program, partially offset by income of $ 197 million, primarily due to the reversal of certain accruals upon the effective favorable settlement of an IRS audit for multiple tax years and other acquisition-related initiatives. The following summarizes acquisitions and cost-reduction/productivity initiatives costs and credits: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Restructuring charges/(credits): Employee terminations $ 474 $ 108 $ 473 Asset impairments (a) 88 69 290 Exit costs/(credits) ( 6 ) 50 33 Restructuring charges (b) 556 227 796 Transaction costs (c) 10 63 1 Integration costs and other (d) 34 311 260 Restructuring charges and certain acquisition-related costs 600 601 1,058 Net periodic benefit costs recorded in Other (income)/deductionsnet 39 23 144 Additional depreciationasset restructuring recorded in our consolidated statements of income as follows (e) : Cost of sales 23 29 36 Selling, informational and administrative expenses 3 2 Research and development expenses ( 3 ) 8 Total additional depreciationasset restructuring 19 40 38 Implementation costs recorded in our consolidated statements of income as follows (f) : Cost of sales 40 61 75 Selling, informational and administrative expenses 197 73 71 Research and development expenses 1 22 39 Total implementation costs 238 156 186 Total costs associated with acquisitions and cost-reduction/productivity initiatives $ 896 $ 820 $ 1,426 (a) 2018 charges are largely for cost-reduction initiatives not associated with acquisitions. (b) Represents acquisition-related costs ($ 192 million credit in 2019, and $ 37 million charge in 2018) and cost reduction initiatives ($ 556 million charge in 2020, $ 418 million charge in 2019, and $ 759 million charge in 2018). 2020 charges mainly represent employee termination costs for our Transforming to a More Focused Company cost-reduction program. 2019 restructuring charges mainly represent employee termination costs for cost-reduction and productivity initiatives, partially offset by the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit for multiple tax years (see Note 5B ). 2018 charges were primarily related to employee termination costs and asset write downs. The employee termination costs for Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies 2019 and 2018 were primarily for our improvements to operational effectiveness as part of the realignment of our business structure, and for 2019, also includes employee termination costs for the Transforming to a More Focused Company cost-reduction program. (c) Represents external costs for banking, legal, accounting and other similar services. (d) Represents external, incremental costs directly related to integrating acquired businesses, such as expenditures for consulting and the integration of systems and processes, and certain other qualifying costs. 2020 costs primarily related to our acquisition of Array. 2019 costs mainly related to our acquisitions of Array, including $ 157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense (see Note 2A ), and Hospira. 2018 costs mostly related to our acquisition of Hospira. (e) Represents the impact of changes in the estimated useful lives of assets involved in restructuring actions. (f) Represents external, incremental costs directly related to implementing our non-acquisition-related cost-reduction/productivity initiatives. The following summarizes the components and changes in restructuring accruals: (MILLIONS OF DOLLARS) Employee Termination Costs Asset Impairment Charges Exit Costs Accrual Balance, January 1, 2019 $ 1,113 $ $ 49 $ 1,161 Provision (a) 108 69 50 227 Utilization and other (b) ( 450 ) ( 69 ) ( 53 ) ( 572 ) Balance, December 31, 2019 (c) 770 46 816 Provision 474 88 ( 6 ) 556 Utilization and other (b) ( 462 ) ( 88 ) ( 25 ) ( 575 ) Balance, December 31, 2020 (d) $ 782 $ $ 15 $ 798 (a) Includes the reversal of certain accruals related to our acquisition of Wyeth upon the favorable settlement of an IRS audit for multiple tax years. See Note 5D . (b) Includes adjustments for foreign currency translation. (c) Included in Other current liabilities ($ 641 million) and Other noncurrent liabilities ($ 175 million). (d) Included in Other current liabilities ($ 628 million) and Other noncurrent liabilities ($ 169 million). Note 4. Other (Income)/DeductionsNet Components of Other (income)/deductionsnet include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Interest income $ ( 73 ) $ ( 225 ) $ ( 333 ) Interest expense (a) 1,449 1,573 1,316 Net interest expense 1,376 1,348 983 Royalty-related income ( 770 ) ( 646 ) ( 485 ) Net (gains)/losses on asset disposals 237 ( 32 ) ( 71 ) Net (gains)/losses recognized during the period on equity securities (b) ( 540 ) ( 454 ) ( 586 ) Net realized (gains)/losses on sales of investments in debt securities (c) 141 Income from collaborations, out-licensing arrangements and sales of compound/product rights (d) ( 326 ) ( 168 ) ( 476 ) Net periodic benefit costs/(credits) other than service costs (e) ( 236 ) 72 ( 270 ) Certain legal matters, net (f) 28 292 84 Certain asset impairments (g) 1,691 2,843 3,115 Business and legal entity alignment costs (h) 300 63 Consumer Healthcare JV equity method (income)/loss (i) ( 298 ) ( 17 ) Other, net (j) ( 493 ) ( 226 ) ( 421 ) Other (income)/deductionsnet $ 669 $ 3,314 $ 2,077 (a) Capitalized interest totaled $ 96 million in 2020, $ 88 million in 2019 and $ 73 million in 2018. (b) 2020 gains include, among other things, unrealized gains of $ 405 million related to investments in BioNTech and SpringWorks Therapeutics, Inc. (SpringWorks). 2019 gains included, among other things, unrealized gains of $ 295 million related to investments in Cortexyme, Inc. and SpringWorks. 2018 gains included unrealized gains on equity securities of $ 477 million, reflecting the adoption of a new accounting standard in 2018 and were primarily driven by unrealized gains of $ 466 million related to our investment in Allogene. See Notes 2B and 7B. (c) 2018 primarily included gross realized losses on sales of available-for-sale debt securities of $ 402 million and a net loss of $ 18 million from derivative financial instruments used to hedge the foreign exchange component of the matured available-for-sale debt securities, partially offset by gross realized gains on sales of available-for-sale debt securities of $ 280 million. Proceeds from the sale of available-for-sale debt securities were $ 5.7 billion in 2018. (d) 2020 includes, among other things, (i) an upfront payment to us of $ 75 million from our sale of our CK1 assets to Biogen, (ii) $ 40 million of milestone income from Puma Biotechnology, Inc. related to Neratinib regulatory approvals in the EU, (iii) $ 30 million of milestone income from Lilly related to the first commercial sale in the U.S. of LOXO-292 for the treatment of RET fusion-positive NSCLC and (iv) $ 108 million in milestone income from multiple licensees. 2019 includes, among other things, $ 78 million in milestone income from Mylan Pharmaceuticals Inc. related to the FDAs approval and launch of Wixela Inhub , a generic of Advair Diskus (fluticasone propionate and salmeterol inhalation powder) and $ 52 million in milestone income from multiple licensees. 2018 includes, among other things, (i) $ 118 million in milestone income from multiple licensees, (ii) $ 110 million in milestone payments received from Shire, of which $ 75 million related to their first dosing of a patient in a Phase 3 clinical trial for the treatment of UC and $ 35 million related to their first dosing of a patient in a Phase 3 clinical trial Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies for the treatment of Crohns disease, (iii) an upfront payment to us and a recognized milestone totaling $ 85 million for the sale of an AMPA receptor potentiator for CIAS to Biogen, (iv) $ 50 million in gains related to sales of compound/product rights and (v) a $ 40 million milestone payment from Merck Co., Inc. in conjunction with the approval of ertugliflozin in the EU. (e) See Note 11 . In 2019, other non-service cost components activity related to the Consumer Healthcare JV transaction, such as gain on settlements, were recorded in (Gain) on completion of Consumer Healthcare JV transaction. (f) 2019 mostly included legal reserves for certain pending legal matters. 2018 primarily included legal reserves for certain pending legal matters, partially offset by the reversal of a legal accrual where a loss was no longer deemed probable. (g) 2020 primarily includes intangible asset impairment charges of $ 1.7 billion, mainly composed of: (i) $ 900 million related to IPRD assets for unapproved indications of certain cancer medicines, acquired in our Array acquisition, and reflect, among other things, updated commercial forecasts; (ii) $ 528 million related to Eucrisa, a finite-lived developed technology right acquired in our Anacor acquisition, and reflects updated commercial forecasts mainly reflecting competitive pressures; and (iii) $ 263 million related to finite-lived developed technology rights for certain generic sterile injectables acquired in our Hospira acquisition, and reflects updated commercial forecasts mainly reflecting competitive pressures. 2019 primarily included intangible asset impairment charges of $ 2.8 billion, mainly composed of $ 2.6 billion, related to Eucrisa, and reflects updated commercial forecasts mainly reflecting competitive pressures. 2018 primarily included intangible asset impairment charges of $ 3.1 billion, mainly composed of (i) $ 2.6 billion related to developed technology rights, $ 242 million related to licensing agreements and $ 80 million related to IPRD, all of which were acquired in our Hospira acquisition, for generic sterile injectable products associated with various indications; and (ii) $ 117 million related to a multi-antigen vaccine IPRD program for adults undergoing elective spinal fusion surgery. The intangible asset impairment charges for the generic sterile injectable products reflect, among other things, updated commercial forecasts, reflecting an increased competitive environment as well as higher manufacturing costs, largely stemming from manufacturing and supply issues. The intangible asset impairment charge for the multi-antigen vaccine IPRD program was the result of the Phase 2b trial reaching futility at a pre-planned interim analysis. (h) Mainly represents incremental costs for the design, planning and implementation of our then new business structure, effective in the beginning of 2019, and primarily includes consulting, legal, tax and other advisory services. (i) See Note 2C . (j) 2020 includes, among other things, (i) dividend income of $ 278 million from our investment in ViiV and (ii) charges of $ 105 million, reflecting the change in the fair value of contingent consideration. 2019 included, among other things, (i) dividend income of $ 220 million from our investment in ViiV; (ii) charges of $ 152 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV; and (iii) net losses on early retirement of debt of $ 138 million. 2018 included, among other things, (i) a non-cash $ 343 million pre-tax gain associated with our transaction with Bain Capital to create a new biopharmaceutical company, Cerevel, to continue development of a portfolio of clinical and preclinical stage neuroscience assets primarily targeting disorders of the central nervous system; (ii) dividend income of $ 253 million from our investment in ViiV; (iii) a non-cash $ 50 million pre-tax gain related to our contribution agreement entered into with Allogene (see Note 2B ); (iv) charges of $ 207 million, reflecting the change in the fair value of contingent consideration, and (vi) charges of $ 112 million for external incremental costs, such as transaction costs and costs to separate our Consumer Healthcare business into a separate legal entity, associated with the formation of the Consumer Healthcare JV. The asset impairment charges included in Other (income)/deductionsnet are based on estimates of fair value. Additional information about the intangible assets that were impaired during 2020 (impairment recorded in Other (income)/deductionsnet ) follows: Year Ended December 31, Fair Value (a) 2020 (MILLIONS OF DOLLARS) Amount Level 1 Level 2 Level 3 Impairment Intangible assets IPRD (b) $ 1,100 $ $ $ 1,100 $ 900 Intangible assetsDeveloped technology rights (b) 740 740 791 Total $ 1,840 $ $ $ 1,840 $ 1,691 (a) The fair value amount is presented as of the date of impairment, as these assets are not measured at fair value on a recurring basis. See also Note 1E. (b) Reflects intangible assets written down to fair value in 2020. Fair value was determined using the income approach, specifically the multi-period excess earnings method, also known as the discounted cash flow method. We started with a forecast of all the expected net cash flows for the asset and then applied an asset-specific discount rate to arrive at a net present value amount. Some of the more significant estimates and assumptions inherent in this approach include: the amount and timing of the projected net cash flows, which includes the expected impact of competitive, legal and/or regulatory forces on the product; the discount rate, which seeks to reflect the various risks inherent in the projected cash flows; and the tax rate, which seeks to incorporate the geographic diversity of the projected cash flows. Note 5. Tax Matters A. Taxes on Income from Continuing Operations Components of Income from continuing operations before provision/(benefit) for taxes on income include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States $ ( 2,488 ) $ 7,064 $ ( 6,111 ) International 9,986 4,420 9,706 Income from continuing operations before provision/(benefit) for taxes on income ( a), (b) $ 7,497 $ 11,485 $ 3,594 (a) 2020 v. 2019 The domestic loss in 2020 versus domestic income in 2019 was mainly related to the non-recurrence of the gain on the completion of the Consumer Healthcare JV transaction as well as higher certain asset impairments and higher RD expenses. The increase in the international income was primarily related to the non-recurrence of the write off of assets contributed to the Consumer Healthcare JV as well as lower certain asset impairments and lower amortization of intangible assets. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (b) 2019 v. 2018 The domestic income in 2019 versus domestic loss in 2018 was mainly related to the completion of the Consumer Healthcare JV transaction as well as lower certain asset impairments, partially offset by higher business and legal entity alignment costs as well as increased costs related to certain legal matters. The decrease in the international income was primarily related to higher certain asset impairments as well as the write off of assets contributed to the Consumer Healthcare JV. Components of Provision/(benefit) for taxes on income based on the location of the taxing authorities include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States Current income taxes: Federal $ 371 $ ( 1,886 ) $ 388 State and local 58 ( 187 ) ( 49 ) Deferred income taxes: Federal ( 1,061 ) 1,193 ( 1,641 ) State and local ( 115 ) 266 15 Total U.S. tax benefit ( 747 ) ( 613 ) ( 1,287 ) TCJA (a) Current income taxes ( 135 ) ( 3,035 ) Deferred Income taxes ( 187 ) 2,439 Total TCJA tax benefit ( 323 ) ( 596 ) International Current income taxes 1,517 2,418 2,195 Deferred income taxes ( 292 ) ( 863 ) ( 579 ) Total international tax provision 1,224 1,555 1,617 Provision/(benefit) for taxes on income $ 477 $ 618 $ ( 266 ) (a) The 2018 current tax benefit and deferred tax expense primarily relate to the utilization of tax credit carryforwards against the repatriation tax liability associated with the enactment of the TCJA. See discussion below. Amounts discussed below are rounded to the nearest hundred million and represent approximations. In 2018, we finalized our provisional accounting for the tax effects of the TCJA, based on our best estimates of available information and data. We reported and disclosed the impacts within the applicable measurement period, in accordance with SEC guidance, and recorded a favorable adjustment of $ 100 million to Provision/(benefit) for taxes on income . We elected, with the filing of our 2018 U.S. Federal Consolidated Income Tax Return, to pay our initial estimated $ 15 billion repatriation tax liability on accumulated post-1986 foreign earnings over eight years through 2026. The third annual installment of this liability, which is due to be paid in April 2021, is reported in current Income taxes payable , and the remaining liability is reported in noncurrent Other taxes payable as of December 31, 2020. Our obligations may vary as a result of changes in our uncertain tax positions and/or availability of attributes such as foreign tax and other credit carryforwards. The TCJA subjects a U.S. shareholder to current tax on global intangible low-taxed income earned by certain foreign subsidiaries. The FASB Staff QA, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income , states that we are permitted to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as global intangible low-taxed income in future years or provide for the tax expense related to such income in the year the tax is incurred. We elected to recognize deferred taxes for temporary differences expected to reverse as global intangible low-taxed income in future years. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law in the U.S. to provide certain relief as a result of the COVID-19 pandemic. In addition, governments around the world have enacted or implemented various forms of tax relief measures in response to the economic conditions in the wake of COVID-19. As of December 31, 2020, neither the CARES Act nor changes to income tax laws or regulations in other jurisdictions had a significant impact on our effective tax rate. The changes in Provision/(benefit) for taxes on income impacting the effective tax rate year-over-year are summarized below: 2020 v. 2019 The higher effective tax rate in 2020 was mainly the result of: the non-recurrence of the $ 1.4 billion tax benefits, representing taxes and interest, recorded in 2019 due to the favorable settlement of an IRS audit for multiple tax years; the non-recurrence of the tax benefits related to certain tax initiatives associated with the implementation of our then new business structure; and the non-recurrence of the tax benefits recorded in 2019 as a result of additional guidance issued by the U.S. Department of Treasury related to the TCJA, as well as: lower tax benefits related to the impairment of intangible assets, partially offset by: the non-recurrence of the tax expense of $ 2.7 billion recorded in the third quarter of 2019 associated with the gain related to the completion of the Consumer Healthcare JV transaction; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies 2019 v. 2018 The higher effective tax rate was primarily the result of: the tax expense of $ 2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV transaction; and the non-recurrence of certain tax initiatives and favorable adjustments to the provisional estimate of the TCJA, partially offset by: an increase in tax benefits associated with the resolution of certain tax positions pertaining to prior years, primarily due to a benefit of $ 1.4 billion, representing tax and interest, resulting from the favorable settlement of an IRS audit; benefits related to certain tax initiatives associated with the implementation of our then new business structure; the tax benefits recorded as a result of additional guidance issued by the U.S. Department of Treasury related to the enactment of the TCJA; and the favorable change in the jurisdictional mix of earnings as a result of operating fluctuations in the normal course of business. In all years, federal, state and international net tax liabilities assumed or established as part of a business acquisition are not included in Provision/(benefit) for taxes on income (see Note 2A ). B. Tax Rate Reconciliation The reconciliation of the U.S. statutory income tax rate to our effective tax rate for Income from continuing operations follows: Year Ended December 31, 2020 2019 2018 U.S. statutory income tax rate 21.0 % 21.0 % 21.0 % TCJA impact (a) ( 2.8 ) ( 16.6 ) Taxation of non-U.S. operations (b), (c) ( 9.6 ) ( 4.5 ) 1.2 Tax settlements and resolution of certain tax positions (d) ( 2.5 ) ( 13.8 ) ( 19.3 ) Completion of Consumer Healthcare JV transaction (d) 8.2 U.S. Healthcare Legislation (e) 0.1 ( 1.1 ) U.S. RD tax credit ( 1.3 ) ( 0.8 ) ( 2.2 ) Interest (f) 1.1 0.6 5.7 All other, net (g) ( 2.4 ) ( 2.5 ) 3.9 Effective tax rate for income from continuing operations 6.4 % 5.4 % ( 7.4 ) % (a) See Note 5A. (b) For taxation of non-U.S. operations, this rate impact reflects the income tax rates and relative earnings in the locations where we do business outside the U.S., together with the U.S. tax cost on our international operations, changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions, as well as changes in valuation allowances. Specifically: (i) the jurisdictional location of earnings is a significant component of our effective tax rate each year, and the rate impact of this component is influenced by the specific location of non-U.S. earnings and the level of such earnings as compared to our total earnings; (ii) the U.S. tax implications of our foreign operations is a significant component of our effective tax rate each year and generally offsets some of the reduction to our effective tax rate each year resulting from the jurisdictional location of earnings; (iii) the impact of certain tax initiatives; and (iv) the impact of changes in uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions is a component of our effective tax rate each year that can result in either an increase or decrease to our effective tax rate. The jurisdictional mix of earnings, which includes the impact of the location of earnings as well as the U.S. tax cost on our international operations, can vary as a result of operating fluctuations in the normal course of business and as a result of the extent and location of other income and expense items, such as restructuring charges, asset impairments and gains and losses on strategic business decisions. See also Note 5A for the components of pre-tax income and Provision/(benefit) for taxes on income, which is based on the location of the taxing authorities, and for information about settlements and other items impacting Provision/(benefit) for taxes on income . (c) In all years, the impact on our effective tax rate is the result of the jurisdictional location of earnings. In 2020 and 2019, the reduction in our effective tax rate resulting from the jurisdictional location of earnings is largely due to lower tax rates in certain jurisdictions, as well as manufacturing and other incentives for our subsidiaries in Singapore and to a lesser extent in Puerto Rico. We benefit from Puerto Rican tax incentives pursuant to a grant that expires during 2029. Under such grant, we are partially exempt from income, property and municipal taxes. In Singapore, we benefit from incentive tax rates effective through 2045 on income from manufacturing and other operations. (d) For a discussion about tax settlements and resolution of certain tax positions and the impact of the gain on the completion of the Consumer Healthcare JV transaction, see Note 5A. (e) The favorable rate impact in 2018 is a result of the updated 2017 invoice received from the federal government, which reflected a lower expense than what was previously estimated for invoiced periods, as well as certain tax initiatives. (f) Includes changes in interest related to our uncertain tax positions not included in the reconciling item called Tax settlements and resolution of certain tax positions. (g) All other, net is primarily due to routine business operations. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Deferred Taxes Components of our deferred tax assets and liabilities, shown before jurisdictional netting, follow: 2020 Deferred Tax* 2019 Deferred Tax* (MILLIONS OF DOLLARS) Assets (Liabilities) Assets (Liabilities) Prepaid/deferred items (a) $ 3,094 $ ( 352 ) $ 1,918 $ ( 204 ) Inventories 276 ( 25 ) 267 ( 10 ) Intangible assets (b) 793 ( 5,355 ) 718 ( 6,784 ) Property, plant and equipment 211 ( 1,219 ) 177 ( 1,204 ) Employee benefits 1,981 ( 127 ) 2,115 ( 37 ) Restructurings and other charges 291 212 Legal and product liability reserves 382 469 Net operating loss/tax credit carryforwards (c) 1,761 2,003 Unremitted earnings ( 46 ) ( 77 ) State and local tax adjustments 171 152 Investments (d) 128 ( 3,545 ) 11 ( 3,318 ) All other 102 ( 57 ) 167 ( 9 ) 9,189 ( 10,726 ) 8,208 ( 11,643 ) Valuation allowances ( 1,586 ) ( 1,526 ) Total deferred taxes $ 7,603 $ ( 10,726 ) $ 6,682 $ ( 11,643 ) Net deferred tax liability (e) $ ( 3,123 ) $ ( 4,961 ) * The deferred tax assets and liabilities associated with global intangible low-taxed income are included in the relevant categories. See Note 5A . (a) The increase in 2020 is primarily related to the capitalization of certain RD-related expenses. (b) The decrease in 2020 is primarily the result of amortization of intangible assets and certain impairment charges. (c) The amounts in 2020 and 2019 are reduced for unrecognized tax benefits of $ 3.0 billion and $ 2.9 billion, respectively, where we have net operating loss carryforwards, similar tax losses, and/or tax credit carryforwards that are available, under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position. (d) The amounts in 2020 and 2019 are primarily related to the Consumer Healthcare JV. See Note 2C. (e) In 2020, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.9 billion), and Noncurrent deferred tax liabilities ($ 4.1 billion). In 2019, Noncurrent deferred tax assets and other noncurrent tax assets ($ 0.7 billion), and Noncurrent deferred tax liabilities ($ 5.7 billion). We have carryforwards, primarily related to net operating and capital losses, general business credits, foreign tax credits and charitable contributions, which are available to reduce future U.S. federal and/or state, as well as international, income taxes payable with either an indefinite life or expiring at various times from 2021 to 2040. Certain of our U.S. net operating losses and general business credits are subject to limitations under IRC Section 382. As of December 31, 2020, we have not made a U.S. tax provision on $ 55.0 billion of unremitted earnings of our international subsidiaries. As these earnings are intended to be indefinitely reinvested overseas, the determination of a hypothetical unrecognized deferred tax liability as of December 31, 2020 is not practicable. The amount of indefinitely reinvested earnings is based on estimates and assumptions and subject to management evaluation, and is subject to change in the normal course of business based on operational cash flow, completion of local statutory financial statements and the finalization of tax returns and audits, among other things. Accordingly, we regularly update our earnings and profits analysis for such events. D. Tax Contingencies For a description of our accounting policies associated with accounting for income tax contingencies, see Note 1P. Uncertain Tax Positions As tax law is complex and often subject to varied interpretations, it is uncertain whether some of our tax positions will be sustained upon audit. As of December 31, 2020, we had $ 4.3 billion and as of December 31, 2019, we had $ 4.2 billion in net unrecognized tax benefits, excluding associated interest. Tax assets for uncertain tax positions primarily represent our estimate of the potential tax benefits in one tax jurisdiction that could result from the payment of income taxes in another tax jurisdiction. These potential benefits generally result from cooperative efforts among taxing authorities, as required by tax treaties to minimize double taxation, commonly referred to as the competent authority process. The recoverability of these assets, which we believe to be more likely than not, is dependent upon the actual payment of taxes in one tax jurisdiction and, in some cases, the successful petition for recovery in another tax jurisdiction. As of December 31, 2020, we had $ 1.3 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.1 billion), Noncurrent deferred tax liabilities ($ 122 million) and Other taxes payable ($ 46 million). As of December 31, 2019, we had $ 1.2 billion in assets associated with uncertain tax positions. These amounts were included in Noncurrent deferred tax assets and other noncurrent tax assets ($ 1.0 billion) and Noncurrent deferred tax liabilities ($ 109 million). Substantially all of these unrecognized tax benefits, if recognized, would impact our effective income tax rate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows: (MILLIONS OF DOLLARS) 2020 2019 2018 Balance, beginning $ ( 5,381 ) $ ( 6,259 ) $ ( 6,558 ) Acquisitions (a) 37 ( 44 ) Divestitures (b) 265 Increases based on tax positions taken during a prior period (c) ( 232 ) ( 36 ) ( 192 ) Decreases based on tax positions taken during a prior period (c), (d) 64 1,109 561 Decreases based on settlements for a prior period (e) 15 100 123 Increases based on tax positions taken during the current period (c) ( 411 ) ( 383 ) ( 370 ) Impact of foreign exchange ( 72 ) 25 56 Other, net (c), (f) 120 107 121 Balance, ending (g) $ ( 5,595 ) $ ( 5,381 ) $ ( 6,259 ) (a) For 2020 and 2019, primarily related to the acquisition of Array (goodwill adjustment made within the measurement period). See Note 2A . (b) For 2020, related to the separation of Upjohn. See Note 2B . (c) Primarily included in Provision/(benefit) for taxes on income. (d) Primarily related to effectively settling certain issues with the U.S. and foreign tax authorities. See Note 5A. (e) Primarily related to cash payments and reductions of tax attributes. (f) Primarily related to decreases as a result of a lapse of applicable statutes of limitations. (g) In 2020, included in Income taxes payable ($ 34 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 18 million), Noncurrent deferred tax liabilities ($ 3.0 billion) and Other taxes payable ($ 2.5 billion). In 2019, included in Income taxes payable ($ 108 million), Current tax assets ($ 2 million), Noncurrent deferred tax assets and other noncurrent tax assets ($ 51 million), Noncurrent deferred tax liabilities ($ 2.8 billion) and Other taxes payable ($ 2.4 billion). Interest related to our unrecognized tax benefits is recorded in accordance with the laws of each jurisdiction and is recorded primarily in Provision/(benefit) for taxes on income . In 2020, we recorded a net increase in interest of $ 89 million. In 2019, we recorded a net decrease in interest of $ 564 million, resulting primarily from a settlement with the IRS; and in 2018, we recorded a net increase in interest of $ 103 million. Gross accrued interest totaled $ 493 million as of December 31, 2020 (reflecting a decrease of $ 5 million as a result of cash payments and a decrease of $ 75 million relating to the separation of Upjohn) and gross accrued interest totaled $ 485 million as of December 31, 2019 (reflecting a decrease of $ 13 million as a result of cash payments). In 2020, this amount was included in Income taxes payable ($ 7 million) and Other taxes payable ($ 486 million). In 2019, this amount was included in Income taxes payable ($ 20 million) and Other taxes payable ($ 465 million). Accrued penalties are not significant. See also Note 5A. Status of Tax Audits and Potential Impact on Accruals for Uncertain Tax Positions The U.S. is one of our major tax jurisdictions, and we are regularly audited by the IRS. With respect to Pfizer, the IRS has issued a Revenue Agents Report (RAR) for tax years 2011-2013. We are not in agreement with the RAR and are currently appealing certain disputed issues. Tax years 2014-2015 are currently under audit. Tax years 2016-2020 are open, but not under audit. All other tax years are closed. In addition to the open audit years in the U.S., we have open audit years in other major tax jurisdictions, such as Canada (2013-2020), Japan (2017-2020), Europe (2011-2020, primarily reflecting Ireland, the U.K., France, Italy, Spain and Germany), Latin America (1998-2020, primarily reflecting Brazil) and Puerto Rico (2016-2020). Any settlements or statutes of limitations expirations could result in a significant decrease in our uncertain tax positions. We estimate that it is reasonably possible that within the next 12 months, our gross unrecognized tax benefits, exclusive of interest, could decrease by as much as $ 50 million, as a result of settlements with taxing authorities or the expiration of the statutes of limitations. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire, as we treat these events as discrete items in the period of resolution. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies E. Tax Provision/(Benefit) on Other Comprehensive Income/(Loss) Components of the Tax provision/(benefit) on other comprehensive income/(loss) include: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Foreign currency translation adjustments, net (a) $ ( 79 ) $ 254 $ 94 Unrealized holding gains/(losses) on derivative financial instruments, net ( 88 ) 83 21 Reclassification adjustments for (gains)/losses included in net income ( 25 ) ( 125 ) 27 Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) 1 ( 113 ) ( 42 ) 50 Unrealized holding gains/(losses) on available-for-sale securities, net 45 ( 23 ) Reclassification adjustments for (gains)/losses included in net income ( 24 ) 5 16 Reclassification adjustments for tax on unrealized gains from AOCI to Retained earnings (c) ( 45 ) 22 5 ( 53 ) Benefit plans: actuarial gains/(losses), net ( 281 ) ( 169 ) ( 141 ) Reclassification adjustments related to amortization 62 55 55 Reclassification adjustments related to settlements, net 65 65 33 Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) 637 Other ( 8 ) ( 10 ) 29 ( 161 ) ( 58 ) 612 Benefit plans: prior service (costs)/credits and other, net 12 ( 1 ) 2 Reclassification adjustments related to amortization of prior service costs and other, net ( 31 ) ( 43 ) ( 39 ) Reclassification adjustments related to curtailments of prior service costs and other, net ( 1 ) ( 4 ) Reclassification adjustments of certain tax effects from AOCI to Retained earnings (b) ( 144 ) Other 1 ( 17 ) ( 45 ) ( 185 ) Tax provision/(benefit) on other comprehensive income/(loss) $ ( 349 ) $ 115 $ 518 (a) Taxes are not provided for foreign currency translation adjustments relating to investments in international subsidiaries that are expected to be held indefinitely. (b) For additional information on the adoption of a new accounting standard related to reclassification of certain tax effects from AOCI, see Note 1B in our 2018 Financial Report. (c) For additional information on the adoption of a new accounting standard related to financial assets and liabilities, see Note 1B in our 2018 Financial Report. Note 6. Accumulated Other Comprehensive Loss, Excluding Noncontrolling Interests The following summarizes the changes, net of tax, in Accumulated other comprehensive loss : Net Unrealized Gains/(Losses) Benefit Plans (MILLIONS OF DOLLARS) Foreign Currency Translation Adjustments Derivative Financial Instruments Available-For-Sale Securities Actuarial Gains/(Losses) Prior Service (Costs)/ Credits and Other Accumulated Other Comprehensive Income/(Loss) Balance, January 1, 2018 $ ( 5,180 ) $ ( 30 ) $ 401 $ ( 5,262 ) $ 750 $ ( 9,321 ) Other comprehensive income/(loss) due to the adoption of new accounting standards (a) ( 2 ) ( 1 ) ( 416 ) ( 637 ) 144 ( 913 ) Other comprehensive income/(loss) (b) ( 893 ) 198 ( 53 ) ( 128 ) ( 166 ) ( 1,041 ) Balance, December 31, 2018 ( 6,075 ) 167 ( 68 ) ( 6,027 ) 728 ( 11,275 ) Other comprehensive income/(loss) (b) 123 ( 146 ) 33 ( 231 ) ( 144 ) ( 365 ) Balance, December 31, 2019 ( 5,952 ) 20 ( 35 ) ( 6,257 ) 584 ( 11,640 ) Other comprehensive income/(loss) (b) 1,028 ( 448 ) 151 ( 602 ) ( 106 ) 23 Distribution of Upjohn Business (c) ( 397 ) 352 ( 26 ) ( 71 ) Balance, December 31, 2020 $ ( 5,321 ) $ ( 428 ) $ 116 $ ( 6,507 ) $ 452 $ ( 11,688 ) (a) Represent the cumulative effect adjustments as of January 1, 2018 from the adoption of accounting standards related to (i) financial assets and liabilities and (ii) the reclassification of certain tax effects from AOCI. See Note 1B in our 2018 Financial Report. (b) Amounts do not include foreign currency translation adjustments attributable to noncontrolling interests of $ 9 million loss in 2020, $ 11 million loss in 2019 and $ 20 million loss in 2018. Foreign currency translation adjustments in 2020 primarily include gains from the strengthening of the euro, Japanese yen, Australian dollar and U.K. pound against the U.S. dollar, and net gains related to foreign currency translation adjustments related to our equity method investment in the Consumer Healthcare JV (see Note 2C ) , partially offset by the impact of our net investment hedging program. Foreign currency translation adjustments in 2019 primarily include a gain of approximately $ 1.3 billion pre-tax ($ 978 million after-tax) related to foreign currency translation adjustments attributable to our equity method investment in the Consumer Healthcare JV (see Note 2C ), partially offset by the strengthening of the U.S. dollar against the euro and the Australian dollar, and the results of our net investment hedging program. Amounts in 2018 primarily reflect the strengthening of the U.S. dollar against the euro, U.K. pound and Chinese renminbi. (c) For more information, see Note 2B. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 7. Financial Instruments A. Fair Value Measurements Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis and Fair Value Hierarchy, using a Market Approach: As of December 31, 2020 As of December 31, 2019 (MILLIONS OF DOLLARS) Total Level 1 Level 2 Total Level 1 Level 2 Financial assets: Short-term investments Classified as equity securities with readily determinable fair values: Money market funds $ 567 $ $ 567 $ 705 $ $ 705 Classified as available-for-sale debt securities: Government and agencynon-U.S. 7,719 7,719 4,863 4,863 Government and agencyU.S. 982 982 811 811 Corporate and other 1,008 1,008 1,013 1,013 9,709 9,709 6,687 6,687 Total short-term investments 10,276 10,276 7,392 7,392 Other current assets Derivative assets: Interest rate contracts 18 18 53 53 Foreign exchange contracts 234 234 413 413 Total other current assets 251 251 465 465 Long-term investments Classified as equity securities with readily determinable fair values (a) 2,809 2,776 32 1,902 1,863 39 Classified as available-for-sale debt securities: Government and agencynon-U.S. 6 6 Government and agencyU.S. 121 121 303 303 Corporate and other 11 11 128 128 315 315 Total long-term investments 2,936 2,776 160 2,216 1,863 354 Other noncurrent assets Derivative assets: Interest rate contracts 117 117 266 266 Foreign exchange contracts 5 5 261 261 Total derivative assets 122 122 526 526 Insurance contracts (b) 693 693 575 575 Total other noncurrent assets 814 814 1,102 1,102 Total assets $ 14,278 $ 2,776 $ 11,501 $ 11,176 $ 1,863 $ 9,313 Financial liabilities: Other current liabilities Derivative liabilities: Foreign exchange contracts $ 501 $ $ 501 $ 114 $ $ 114 Total other current liabilities 501 501 114 114 Other noncurrent liabilities Derivative liabilities: Foreign exchange contracts 599 599 604 604 Total other noncurrent liabilities 599 599 604 604 Total liabilities $ 1,100 $ $ 1,100 $ 718 $ $ 718 (a) Long-term equity securities of $ 190 million as of December 31, 2020 and $ 176 million as of December 31, 2019 were held in restricted trusts for employee benefit plans. (b) Includes life insurance policies held in restricted trusts for U.S. non-qualified employee benefit plans. The underlying invested assets in these contracts are marketable securities, which are carried at fair value, with changes in fair value recognized in Other (income)/deductionsnet (see Note 4 ) . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Financial Assets and Liabilities Not Measured at Fair Value on a Recurring Basis Carrying values and estimated fair values using a market approach: As of December 31, 2020 As of December 31, 2019 Carrying Value Estimated Fair Value Carrying Value Estimated Fair Value (MILLIONS OF DOLLARS) Total Level 2 Total Level 2 Financial Liabilities Long-term debt, excluding the current portion $ 37,133 $ 45,533 $ 45,533 $ 35,955 $ 40,842 $ 40,842 The differences between the estimated fair values and carrying values for held-to-maturity debt securities, private equity securities, long-term receivables and short-term borrowings not measured at fair value on a recurring basis were not significant as of December 31, 2020 and 2019. The fair value measurements of our held-to-maturity debt securities and short-term borrowings are based on Level 2 inputs. The fair value measurements of our long-term receivables and private equity securities are based on Level 3 inputs using a market approach. B. Investments Total Short-Term and Long-Term Investments and Equity-Method Investments The following summarizes our investments by classification type: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Short-term investments Equity securities with readily determinable fair values (a) $ 567 $ 705 Available-for-sale debt securities 9,709 6,687 Held-to-maturity debt securities 161 1,133 Total Short-term investments $ 10,437 $ 8,525 Long-term investments Equity securities with readily determinable fair values $ 2,809 $ 1,902 Available-for-sale debt securities 128 315 Held-to-maturity debt securities 37 42 Private equity securities at cost (b) 432 756 Total Long-term investments $ 3,406 $ 3,014 Equity-method investments 16,856 17,133 Total long-term investments and equity-method investments $ 20,262 $ 20,147 Held-to-maturity cash equivalents $ 89 $ 163 (a) As of December 31, 2020 and 2019, includes money market funds primarily invested in U.S. Treasury and government debt. (b) Represent investments in the life sciences sector. Debt Securities At December 31, 2020, our investment securities portfolio consisted of diverse, primarily investment-grade, debt securities. The contractual maturities, or estimated maturities, of the debt securities are as follows: As of December 31, 2020 As of December 31, 2019 Gross Unrealized Maturities (in Years) Gross Unrealized (MILLIONS OF DOLLARS) Amortized Cost Gains Losses Fair Value Within 1 Over 1 to 5 Over 5 Amortized Cost Gains Losses Fair Value Available-for-sale debt securities Government and agency non-U.S. $ 7,593 $ 136 $ ( 4 ) $ 7,725 $ 7,719 $ 6 $ $ 4,895 $ 6 $ ( 38 ) $ 4,863 Government and agency U.S. 1,104 ( 1 ) 1,103 982 121 1,120 ( 6 ) 1,114 Corporate and other (a) 1,006 2 1,008 1,008 1,027 ( 2 ) 1,025 Held-to-maturity debt securities Time deposits and other 283 283 251 9 24 535 535 Government and agency non-U.S. 5 5 5 803 803 Total debt securities $ 9,991 $ 138 $ ( 5 ) $ 10,124 $ 9,959 $ 136 $ 29 $ 8,380 $ 6 $ ( 47 ) $ 8,340 (a) Primarily issued by a diverse group of corporations . For our portfolio of available-for-sale and held-to-maturity debt securities, any expected credit losses would be immaterial to the financial statements. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Equity Securities The following presents the calculation of the portion of unrealized (gains)/losses that relate to equity securities, excluding equity method investments, held at the reporting date: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 Net (gains)/losses recognized during the period on equity securities (a) $ ( 540 ) $ ( 454 ) $ ( 586 ) Less: Net (gains)/losses recognized during the period on equity securities sold during the period ( 24 ) ( 25 ) ( 109 ) Net unrealized (gains)/losses during the reporting period on equity securities still held at the reporting date (b) $ ( 515 ) $ ( 429 ) $ ( 477 ) (a) Reported in Other (income)/deductions net. See Note 4 . (b) Included in net unrealized gains are observable price changes on equity securities without readily determinable fair values. Since January 1, 2018, there were cumulative impairments and downward adjustments of $ 81 million and upward adjustments of $ 61 million. Impairments, downward and upward adjustments were not significant in 2020, 2019 and 2018 . C. Short-Term Borrowings Short-term borrowings include: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Commercial paper (a) $ 556 $ 13,915 Current portion of long-term debt, principal amount (b) 2,004 1,458 Other short-term borrowings, principal amount (c) 145 860 Total short-term borrowings, principal amount 2,705 16,233 Net fair value adjustments related to hedging and purchase accounting 5 Net unamortized discounts, premiums and debt issuance costs ( 2 ) ( 43 ) Total Short-term borrowings, including current portion of long-term debt , carried at historical proceeds, as adjusted $ 2,703 $ 16,195 (a) See Note 2B . (b) See Note 7D . (c) Primarily includes cash collateral. See Note 7F . The weighted-average effective interest rate on commercial paper outstanding was approximately 0.13 % as of December 31, 2020 and 1.92 % as of December 31, 2019. As of December 31, 2020, we had access to a total of $ 11 billion in U.S. revolving credit facilities consisting of a $ 7 billion facility expiring in 2025 and a $ 4 billion facility expiring in September 2021, which may be used to support our commercial paper borrowings. In January 2021, the $ 4 billion facility was terminated at our request. In addition to the U.S. revolving credit facilities, our lenders have provided us an additional $ 332 million in lines of credit, of which $ 300 million expire within one year. Of these total lines of credit, $ 11.3 billion were unused as of December 31, 2020. D. Long-Term Debt The following outlines our senior unsecured long-term debt and the weighted-average stated interest rate by maturity: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Notes due 2021 ( 2.4 % for 2019) (a) $ $ 3,153 Notes due 2022 ( 1.0 % for 2020 and 2019) 1,728 1,624 Notes due 2023 ( 3.2 % for 2020 and 3.7 % for 2019) 2,550 2,892 Notes due 2024 ( 3.9 % for 2020 and 2019) 2,250 2,250 Notes due 2025 ( 0.8 % for 2020) 750 Notes due 2026 ( 2.9 % for 2020 and 2019) 3,000 3,000 Notes due 2027-2030 ( 3.1 % for 2020 and 3.6 % for 2019) 6,781 4,453 Notes due 2034-2036 ( 5.3 % for 2020 and 2019) 2,250 2,250 Notes due 2037-2040 ( 5.6 % for 2020 and 6.0 % for 2019) 8,086 7,066 Notes due 2043-2046 ( 3.7 % for 2020 and 2019) 4,878 4,818 Notes due 2047-2050 ( 3.6 % for 2020 and 4.1 % for 2019) 3,500 3,315 Total long-term debt, principal amount 35,774 34,820 Net fair value adjustments related to hedging and purchase accounting 1,562 1,305 Net unamortized discounts, premiums and debt issuance costs ( 207 ) ( 176 ) Other long-term debt 4 5 Total long-term debt, carried at historical proceeds, as adjusted $ 37,133 $ 35,955 Current portion of long-term debt, carried at historical proceeds, as adjusted (not included above ( 2.6 % and 1.2 %)) $ 2,002 $ 1,462 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (a) Reclassified to the current portion of long-term debt. Our long-term debt outlined in the above table is generally redeemable by us at any time at varying redemption prices plus accrued and unpaid interest. Issuances In 2020, we issued the following: (MILLIONS OF DOLLARS) Principal Interest Rate Maturity Date As of December 31, 2020 0.800 % (a) May 28, 2025 $ 750 1.700 % (a) May 28, 2030 1,000 2.550 % (a) May 28, 2040 1,000 2.700 % (a) May 28, 2050 1,250 $ 4,000 2.625 % (b) April 1, 2030 $ 1,250 (a) May be redeemed by us at any time, in whole, or in part, at varying redemption prices plus accrued and unpaid interest. The weighted-average effective interest rate for the notes at issuance was 2.11 %. (b) May be redeemed by us at any time, in whole, or in part, at a redemption price plus accrued and unpaid interest. The weighted average effective interest rate for the notes at issuance was 2.67 %. In March 2019, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.57 %. In September 2018, we completed a public offering of $ 5.0 billion aggregate principal amount of senior unsecured notes with a weighted-average effective interest rate of 3.56 %. Retirements In November 2020, we repurchased all $ 1.15 billion and $ 342 million principal amount outstanding of the 1.95 % senior unsecured notes due June 2021 and 5.80 % senior unsecured notes due August 2023 and recorded a total net loss of $ 36 million, in Other (income)/deductionsnet. See Note 2B . In March 2020, we repurchased at par all $ 1.065 billion principal amount outstanding of our senior unsecured notes due in 2047. In January 2019, we repurchased all 1.1 billion ($ 1.3 billion) principal amount outstanding of the 5.75 % euro-denominated debt due June 2021 at a redemption value of 1.3 billion ($ 1.5 billion). We recorded a net loss of $ 138 million in Other (income)/deductionsnet , which included the related termination of cross currency swaps . E. Derivative Financial Instruments and Hedging Activities Foreign Exchange Risk A significant portion of our revenues, earnings and net investments in foreign affiliates is exposed to changes in foreign exchange rates. We manage our foreign exchange risk predominately through the use of derivative financial instruments and foreign currency debt. These financial instruments serve to mitigate the impact on net income as a result of remeasurement into another currency, or against the impact of translation into U.S. dollars of certain foreign exchange-denominated transactions. The derivative financial instruments primarily hedge or offset exposures in the euro, U.K. pound, Japanese yen, Swedish krona and Canadian dollar. Additionally, we hedge a portion of our forecasted intercompany inventory sales denominated in euro, Japanese yen, Chinese renminbi, Canadian dollar, U.K. pound and Australian dollar for up to two years . Changes in fair value are reported in earnings or in Other comprehensive income/(loss) , depending on the nature and purpose of the financial instrument (hedge or offset relationship). For certain foreign exchange contracts, we exclude an amount from the assessment of hedge effectiveness and recognize the excluded amount through an amortization approach in earnings. The hedge relationships are as follows: Generally, we recognize the gains and losses on foreign exchange contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged item. We also recognize the offsetting foreign exchange impact attributable to the hedged item in earnings. Generally, we record in Other comprehensive income/(loss) gains or losses on foreign exchange contracts that are designated as cash flow hedges and reclassify those amounts into earnings in the same period or periods during which the hedged transaction affects earnings. We record in Other comprehensive income/(loss) Foreign currency translation adjustments, net the foreign exchange gains and losses related to foreign exchange-denominated debt and foreign exchange contracts designated as a hedge of our net investments in foreign subsidiaries and reclassify those amounts into earnings upon the sale or substantial liquidation of our net investments. For certain foreign exchange contracts not designated as hedging instruments, we recognize the gains and losses on contracts that are used to offset foreign currency assets or liabilities immediately into earnings along with the earnings impact of the items they generally offset. These contracts essentially take the opposite currency position of that reflected in the month-end balance sheet to counterbalance the effect of any currency movement. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Interest Rate Risk Our interest-bearing investments and borrowings are subject to interest rate risk. Depending on market conditions, we may change the profile of our outstanding debt or investments by entering into derivative financial instruments like interest rate swaps, either to hedge or offset the exposure to changes in the fair value of hedged items with fixed interest rates, or to convert variable rate debt or investments to fixed rates. The derivative financial instruments primarily hedge U.S. dollar fixed-rate debt. We recognize the gains and losses on interest rate contracts that are designated as fair value hedges in earnings upon the recognition of the change in fair value of the hedged risk. We also recognize the offsetting earnings impact attributable to the hedged item. The following summarizes the fair value of the derivative financial instruments and the related notional amounts (including those reported as part of discontinued operations): (MILLIONS OF DOLLARS) As of December 31, 2020 As of December 31, 2019 Fair Value Fair Value Notional Asset Liability Notional Asset Liability Derivatives designated as hedging instruments: Foreign exchange contracts (a) $ 24,369 $ 145 $ 1,005 $ 25,193 $ 591 $ 662 Interest rate contracts 1,950 135 6,645 318 280 1,005 909 662 Derivatives not designated as hedging instruments: Foreign exchange contracts $ 15,063 94 95 $ 19,623 82 55 Total $ 373 $ 1,100 $ 992 $ 718 (a) The notional amount of outstanding foreign exchange contracts hedging our intercompany forecasted inventory sales was $ 5.0 billion as of December 31, 2020 and $ 5.9 billion as of December 31, 2019 . The following summarizes information about the gains/(losses) incurred to hedge or offset operational foreign exchange or interest rate risk (including gains/(losses) reported as part of discontinued operations). Amount of Gains/(Losses) Recognized in OID (a) Amount of Gains/(Losses) Recognized in OCI (a) Amount of Gains/(Losses) Reclassified from OCI into OID and COS (a) As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 Derivative Financial Instruments in Cash Flow Hedge Relationships: Foreign exchange contracts (b) $ $ $ ( 649 ) $ 339 $ ( 77 ) $ 525 Amount excluded from effectiveness testing recognized in earnings based on an amortization approach (c) 55 136 57 140 Derivative Financial Instruments in Fair Value Hedge Relationships: Interest rate contracts 369 900 Hedged item ( 369 ) ( 900 ) Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign exchange contracts ( 501 ) ( 313 ) The portion on foreign exchange contracts excluded from the assessment of hedge effectiveness (c) 181 188 154 144 Non-Derivative Financial Instruments in Net Investment Hedge Relationships: Foreign currency short-term borrowings 8 34 Foreign currency long-term debt (d) ( 183 ) 36 Derivative Financial Instruments Not Designated as Hedges: Foreign exchange contracts 178 ( 172 ) All other net (c) 12 ( 1 ) ( 1 ) $ 178 $ ( 172 ) $ ( 1,077 ) $ 421 $ 133 $ 808 (a) OID = Other (income)/deductionsnet, included in Other (income)/deductionsnet in the consolidated statements of income . COS = Cost of Sales, included in Cost of sales in the consolidated statements of income. OCI = Other comprehensive income/(loss), included in the consolidated statements of comprehensive income . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (b) The amounts reclassified from OCI into COS were: a net gain of $ 172 million in 2020 (including a gain of $ 22 million reported in Income from discontinued operationsnet of tax ); and a net gain of $ 247 million in 2019 (including a gain of $ 46 million reported in Income from discontinued operationsnet of tax ). The remaining amounts were reclassified from OCI into OID. Based on year-end foreign exchange rates that are subject to change, we expect to reclassify a pre-tax loss of $ 341 million within the next 12 months into income . The maximum length of time over which we are hedging future foreign exchange cash flow relates to our $ 1.8 billion U.K. pound debt maturing in 2043. (c) The amounts reclassified from OCI were reclassified into OID. (d) Long-term debt includes foreign currency borrowings with carrying values of $ 2.1 billion as of December 31, 2020, which are used as hedging instruments in net investment hedge relationships. The following summarizes the amounts recorded in our consolidated balance sheet related to cumulative basis adjustments for fair value hedges: As of December 31, 2020 As of December 31, 2019 Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount Cumulative Amount of Fair Value Hedging Adjustment Increase/(Decrease) to Carrying Amount (MILLIONS OF DOLLARS) Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Carrying Amount of Hedged Assets/Liabilities (a) Active Hedging Relationships Discontinued Hedging Relationships Long-term debt $ 2,016 $ 117 $ 1,149 $ 7,092 $ 266 $ 690 (a) Carrying amounts exclude the cumulative amount of fair value hedging adjustments. F . Credit Risk On an ongoing basis, we monitor and review the credit risk of our customers, financial institutions and exposures in our investment portfolio. With respect to our trade accounts receivable, we monitor the creditworthiness of our customers to which we grant credit in the normal course of business. In general, there is no requirement for collateral from customers. For additional information on our trade accounts receivable and allowance for credit losses, see Note 1G . A significant portion of our trade accounts receivable balances are due from drug wholesalers. For additional information on our trade accounts receivables with significant customers, see Note 17B . With respect to our investments, we monitor concentrations of credit risk associated with government, government agency, and corporate issuers of securities. Investments are placed in instruments that are investment grade and are primarily short in duration. Exposure limits are established to limit a concentration with any single credit counterparty. As of December 31, 2020, the largest investment exposures in our portfolio represent primarily sovereign debt instruments issued by the U.S., France, Canada, Japan, Sweden and Germany. With respect to our derivative financial instrument agreements with financial institutions, we do not expect to incur a significant loss from failure of any counterparty. Derivative financial instruments are executed under International Swaps and Derivatives Association (ISDA) master agreements with credit-support annexes that contain zero threshold provisions requiring collateral to be exchanged daily depending on levels of exposure. As a result, there are no significant concentrations of credit risk with any individual financial institution. As of December 31, 2020, the aggregate fair value of these derivative financial instruments that are in a net payable position was $ 946 million, for which we have posted collateral of $ 821 million with a corresponding amount reported in Short-term investments . As of December 31, 2020, the aggregate fair value of our derivative financial instruments that are in a net receivable position was $ 137 million, for which we have received collateral of $ 142 million with a corresponding amount reported in Short-term borrowings, including current portion of long-term debt. Note 8. Inventories The following summarizes the components of Inventories : As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Finished goods $ 2,878 $ 2,265 Work in process 4,430 4,131 Raw materials and supplies 738 672 Inventories (a) $ 8,046 $ 7,068 Noncurrent inventories not included above (b) $ 890 $ 638 (a) The change from December 31, 2019 reflects increases for certain products, including inventory build for new product launches, supply recovery, market demand and network strategy, and an increase due to foreign exchange. (b) Included in Other noncurrent assets . There are no recoverability issues for these amounts. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Note 9. Property, Plant and Equipment The following summarizes the components of Property, plant and equipment : Useful Lives As of December 31, (MILLIONS OF DOLLARS) (Years) 2020 2019 Land - $ 444 $ 495 Buildings 33 - 50 9,022 9,181 Machinery and equipment 8 - 20 11,153 10,648 Furniture, fixtures and other 3 - 12.5 4,541 4,840 Construction in progress - 3,552 2,794 28,711 27,959 Less: Accumulated depreciation 14,812 14,990 Property, plant and equipment $ 13,900 $ 12,969 The following provides long-lived assets by geographic area: As of December 31, (MILLIONS OF DOLLARS) 2020 2019 Property, plant and equipment United States $ 7,821 $ 7,194 Developed Europe 4,775 4,238 Developed Rest of World 413 453 Emerging Markets 890 1,083 Property, plant and equipment $ 13,900 $ 12,969 Note 10. Identifiable Intangible Assets and Goodwill A. Identifiable Intangible Assets The following summarizes the components of Identifiable intangible assets : As of December 31, 2020 As of December 31, 2019 (MILLIONS OF DOLLARS) Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Gross Carrying Amount Accumulated Amortization Identifiable Intangible Assets, less Accumulated Amortization Finite-lived intangible assets Developed technology rights (a) $ 73,545 $ ( 50,902 ) $ 22,643 $ 72,449 $ ( 47,092 ) $ 25,357 Brands 922 ( 774 ) 148 922 ( 741 ) 181 Licensing agreements and other (b) 2,292 ( 1,186 ) 1,106 1,687 ( 1,108 ) 579 76,759 ( 52,862 ) 23,896 75,058 ( 48,941 ) 26,117 Indefinite-lived intangible assets Brands 827 827 827 827 IPRD (c) 3,175 3,175 5,919 5,919 Licensing agreements and other (b) 573 573 1,073 1,073 4,575 4,575 7,819 7,819 Identifiable intangible assets (d) $ 81,334 $ ( 52,862 ) $ 28,471 $ 82,877 $ ( 48,941 ) $ 33,936 (a) The increase in the gross carrying amount primarily reflects the transfer of $ 600 million from IPRD to Developed technology rights to reflect the approval of Braftovi in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy, as well as a $ 499 million capitalized portion of an upfront payment to Myovant (see Note 2E ) and an increase from a $ 200 million measurement period adjustment related to the acquisition of Array (see Note 2A ), partially offset by a $ 528 million impairment of Eucrisa (see Note 4 ) and a $ 263 million impairment of certain generic sterile injectables acquired in connection with our acquisition of Hospira (see Note 4 ). (b) The changes in the gross carrying amounts primarily reflect the transfer of $ 600 million from indefinite-lived Licensing agreements and other to finite-lived Licensing agreements and other to reflect the approval in the U.S. of several products subject to out-licensing arrangements acquired from Array, as well as measurement period adjustments related to the acquisition of Array. (c) The decrease in the gross carrying amount primarily reflects a decrease from a $ 1.2 billion measurement period adjustment related to the acquisition of Array, a $ 900 million impairment of IPRD (see Note 4 ), and the transfer of $ 600 million from IPRD to Developed technology rights to reflect the approval of Braftovi in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy. (d) The decrease is primarily due to amortization, impairments , and measurement period adjustments related to the acquisition of Array, partially offset by the capitalization of an upfront payment to Myovant (see Note 2E ). Nearly all of our identifiable intangible assets are managed by our commercial organization, with only 9 % of total cost of IPRD managed by our RD organization. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Developed Technology Rights Developed technology rights represent the cost for developed technology acquired from third parties and can include the right to develop, use, market, sell and/or offer for sale the product, compounds and intellectual property that we have acquired with respect to products, compounds and/or processes that have been completed. We possess a well-diversified portfolio of hundreds of developed technology rights across therapeutic categories, representing our commercialized products. The significant components of developed technology rights are the following: Xtandi, Prevnar 13/Prevenar 13 Infant, Braftovi/Mektovi, Premarin, Prevnar 13/Prevenar 13 Adult, Eucrisa, Orgovyx, and, to a lesser extent Zavicefta, Tygacil, Merrem/Meronem, Refacto AF/Xyntha, Pristiq and Bosulif. Also included in this category are the post-approval milestone payments made under our alliance agreements for certain biopharmaceutical products. Brands Brands represent the cost for tradenames and know-how, as the products themselves do not receive patent protection. Indefinite-lived brands include Medrol and Depo-Medrol, while finite-lived brands include Depo-Provera and Zavedos. IPRD IPRD assets represent RD assets that have not yet received regulatory approval in a major market. The significant components of IPRD are the following: the program for the oral poly ADP ribose polymerase inhibitor for the treatment of patients with germline BRCA-mutated advanced breast cancer acquired as part of the Medivation acquisition and assets acquired in connection with the Array acquisition. IPRD assets are required to be classified as indefinite-lived assets until the successful completion or the abandonment of the associated RD effort. Accordingly, during the development period after the date of acquisition, these assets are not amortized until approval is obtained in a major market, typically either the U.S. or the EU, or in a series of other countries, subject to certain specified conditions and management judgment. At that time, we will determine the useful life of the asset, reclassify it out of IPRD and begin amortization. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. IPRD assets are high-risk assets, given the uncertain nature of RD. Accordingly, we expect that many of these IPRD assets will become impaired and be written-off at some time in the future. Licensing Agreements Licensing agreements for developed technology and for technology in development primarily relate to out-licensing arrangements acquired from third parties, including the Array acquisition. These assets represent the cost for the license, where we acquired the right to future royalties and/or milestones upon development or commercialization by the licensing partner. A significant component of the licensing arrangements are for out-licensing arrangements with a number of partners for oncology technology in varying stages of development that have not yet received regulatory approval in a major market. Accordingly, during the development period after the date of acquisition, each of these assets is classified as indefinite-lived intangible assets and will not be amortized until approval is obtained in a major market. At that time we will determine the useful life of the asset, reclassify the respective licensing arrangement asset to finite-lived intangible asset and begin amortization. If the development effort is abandoned, the related licensing asset will likely be written-off, and we will record an impairment charge. Amortization The weighted-average life for each of our total finite-lived intangible assets and the largest component, developed technology rights, is approximately 9 years. Total amortization expense for finite-lived intangible assets was $ 3.5 billion in 2020, $ 4.5 billion in 2019 and $ 4.8 billion in 2018. The following provides the expected annual amortization expense: (MILLIONS OF DOLLARS) 2021 2022 2023 2024 2025 Amortization expense $ 3,372 $ 3,249 $ 2,921 $ 2,642 $ 2,492 B. Goodwill At the beginning of 2019, we reorganized our commercial operations and began to manage our businesses through three different operating segmentsBiopharma, Upjohn and Consumer Healthcare. As a result of the reorganization of our commercial operations, our remaining goodwill was required to be reallocated amongst the then new Biopharma and Upjohn operating segments by determining the fair value of each reporting unit under our old and new management structure and the portions being transferred. We completed this re-allocation based on relative fair value in the second quarter of 2019 and retrospectively presented goodwill according to the operating structure. Our Consumer Healthcare business was classified as held for sale as of December 31, 2018 and, upon closing of the transaction with GSK during the third quarter of 2019, we deconsolidated our Consumer Healthcare business and derecognized Consumer Healthcare goodwill. For additional information, see Note 2C . On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan. Upon closing, we deconsolidated the Upjohn business and derecognized $ 10.6 billion in Upjohn goodwill. In addition, at December 31, 2019, the goodwill associated with the Upjohn Business was classified as Noncurrent assets of discontinued operations . For additional information, see Note 2B . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following summarizes the components and changes in the carrying amount of Goodwill : (MILLIONS OF DOLLARS) Total Balance, January 1, 2019 $ 42,927 Additions (a) 5,411 Other (b) ( 136 ) Balance, December 31, 2019 48,202 Additions (c) 727 Other (b) 648 Balance, December 31, 2020 $ 49,577 (a) Additions relate to our acquisition of Array (see Note 2A ). (b) Other represents the impact of foreign exchange. (c) Additions primarily represent the impact of measurement period adjustments related to our Array acquisition (see Note 2A ). Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans The majority of our employees worldwide are eligible for retirement benefits provided through defined benefit pension plans, defined contribution plans or both. In the U.S., we sponsor both IRC-qualified and supplemental (non-qualified) defined benefit plans and defined contribution plans. A qualified plan meets the requirements of certain sections of the IRC, and, generally, contributions to qualified plans are tax deductible. A qualified plan typically provides benefits to a broad group of employees with restrictions on discriminating in favor of highly compensated employees with regard to coverage, benefits and contributions. A supplemental (non-qualified) plan provides additional benefits to certain employees. In addition, we provide medical insurance benefits to certain retirees and their eligible dependents through our postretirement plans. A. Components of Net Periodic Benefit Costs and Changes in Other Comprehensive Income/(Loss) The following provides the annual (credit)/cost (including costs reported as part of discontinued operations) and changes in Other comprehensive income/(loss) for our benefit plans: Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 Service cost $ $ $ $ $ $ $ 146 $ 125 $ 136 $ 38 $ 37 $ 39 Interest cost 499 629 598 34 47 55 164 215 212 49 75 72 Expected return on plan assets ( 1,015 ) ( 890 ) ( 1,040 ) ( 306 ) ( 317 ) ( 360 ) ( 36 ) ( 33 ) ( 37 ) Amortization of: Actuarial losses 136 147 120 15 11 13 125 80 101 3 7 Prior service cost/(credit) ( 3 ) ( 3 ) 2 ( 1 ) ( 1 ) ( 1 ) ( 3 ) ( 4 ) ( 4 ) ( 170 ) ( 173 ) ( 178 ) Curtailments 12 1 ( 1 ) ( 4 ) ( 47 ) ( 17 ) Settlements 223 230 113 49 27 26 6 16 4 ( 10 ) Special termination benefits ( 1 ) 4 6 2 17 10 2 2 Net periodic benefit cost/(credit) reported in income ( 161 ) 116 ( 189 ) 99 100 103 132 115 84 ( 118 ) ( 146 ) ( 111 ) (Credit)/cost reported in Other comprehensive income/(loss) 640 ( 246 ) 361 95 115 ( 189 ) 202 570 84 ( 50 ) 38 105 (Credit)/cost recognized in Comprehensive income $ 479 $ ( 129 ) $ 171 $ 194 $ 215 $ ( 86 ) $ 333 $ 685 $ 168 $ ( 168 ) $ ( 107 ) $ ( 6 ) Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Actuarial Assumptions The following provides the weighted-average actuarial assumptions of our benefit plans: Year Ended December 31, (PERCENTAGES) 2020 2019 2018 Weighted-average assumptions used to determine benefit obligations Discount rate: U.S. qualified pension plans 2.6 % 3.3 % 4.4 % U.S. non-qualified pension plans 2.4 % 3.2 % 4.3 % International pension plans 1.5 % 1.7 % 2.5 % Postretirement plans 2.5 % 3.2 % 4.3 % Rate of compensation increase (a) : International pension plans 2.9 % 1.4 % 1.4 % Weighted-average assumptions used to determine net periodic benefit cost Discount rate: U.S. qualified pension plans 3.3 % 4.4 % 3.8 % U.S. non-qualified pension plans 3.2 % 4.3 % 3.7 % International pension plans interest cost 1.5 % 2.2 % 2.0 % International pension plans service cost 1.6 % 2.4 % 2.3 % Postretirement plans 3.2 % 4.3 % 3.7 % Expected return on plan assets: U.S. qualified pension plans 7.0 % 7.2 % 7.5 % International pension plans 3.6 % 3.9 % 4.4 % Postretirement plans 7.0 % 7.3 % 7.5 % Rate of compensation increase: U.S. qualified pension plans (a) 2.8 % U.S. non-qualified pension plans (a) 2.8 % International pension plans 2.9 % 1.4 % 2.5 % (a) Effective January 1, 2018, we froze the defined benefit plans to future benefit accruals in the U.S. and members accrued benefits to that date no longer increase in line with future compensation increases. The rate of compensation increase is therefore no longer an assumption used to determine the benefit obligation and net periodic benefit cost for the U.S. qualified and non-qualified pension plans. The assumptions above are used to develop the benefit obligations at each fiscal year-end. All of the assumptions are reviewed on at least an annual basis. We revise these assumptions based on an annual evaluation of long-term trends as well as market conditions that may have an impact on the cost of providing retirement benefits. The weighted-average discount rate for our U.S. defined benefit plans is determined annually and evaluated and modified to reflect at year-end the prevailing market rate of a portfolio of high-quality fixed income investments, rated AA/Aa or better that reflect the rates at which the pension benefits could be effectively settled. For our international plans, the discount rates are set by benchmarking against investment grade corporate bonds rated AA/Aa or better, including, when there is sufficient data, a yield curve approach. These rate determinations are made consistent with local requirements. Overall, the yield curves used to measure the benefit obligations at year-end 2020 resulted in lower discount rates as compared to the prior year. The following provides the healthcare cost trend rate assumptions for our U.S. postretirement benefit plans: As of December 31, 2020 2019 Healthcare cost trend rate assumed for next year (up to age 65) 5.4 % 5.6 % Healthcare cost trend rate assumed for next year (age 65 and older) 5.6 % 6.0 % Rate to which the cost trend rate is assumed to decline 4.5 % 4.5 % Year that the rate reaches the ultimate trend rate 2037 2037 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies C. Obligations and Funded Status The following provides an analysis of the changes in our benefit obligations, plan assets and funded status of our benefit plans (including those reported as part of discontinued operations): U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Change in benefit obligation (a) Benefit obligation, beginning $ 16,535 $ 15,141 $ 1,351 $ 1,280 $ 11,059 $ 9,952 $ 1,667 $ 1,870 Service cost 146 125 38 37 Interest cost 499 629 34 47 164 215 49 75 Employee contributions 8 7 88 84 Plan amendments 2 2 18 ( 56 ) ( 56 ) Changes in actuarial assumptions and other (b) 1,953 2,001 159 152 702 1,224 ( 132 ) ( 87 ) Foreign exchange impact 646 ( 33 ) 2 ( 1 ) Upjohn spin-off (c) ( 1,016 ) ( 320 ) ( 218 ) Acquisitions/divestitures/other, net ( 4 ) ( 1 ) ( 55 ) ( 36 ) Curtailments ( 2 ) Settlements ( 650 ) ( 692 ) ( 117 ) ( 70 ) ( 34 ) ( 34 ) Special termination benefits ( 1 ) 4 2 17 2 Benefits paid ( 383 ) ( 544 ) ( 62 ) ( 74 ) ( 372 ) ( 360 ) ( 201 ) ( 221 ) Benefit obligation, ending (a) 16,940 16,535 1,366 1,351 12,001 11,059 1,238 1,667 Change in plan assets Fair value of plan assets, beginning 14,586 13,051 8,956 8,215 519 469 Actual gain/(loss) on plan assets 1,974 2,760 868 873 69 50 Company contributions 1,253 11 179 144 197 230 113 137 Employee contributions 8 7 88 84 Foreign exchange impact 462 42 Upjohn spin-off (c) ( 687 ) ( 270 ) Acquisitions/divestitures, net ( 6 ) ( 16 ) Settlements ( 650 ) ( 692 ) ( 117 ) ( 70 ) ( 34 ) ( 34 ) Benefits paid ( 383 ) ( 544 ) ( 62 ) ( 74 ) ( 372 ) ( 360 ) ( 201 ) ( 221 ) Fair value of plan assets, ending 16,094 14,586 9,811 8,956 588 519 Funded statusPlan assets less than benefit obligation $ ( 845 ) $ ( 1,949 ) $ ( 1,366 ) $ ( 1,351 ) $ ( 2,191 ) $ ( 2,103 ) $ ( 651 ) $ ( 1,148 ) (a) The PBO represents the present value of the benefit obligation earned through the end of the year and factors in future compensation increases. The ABO is similar to the PBO but does not factor in future compensation increases. For the U.S. qualified and supplemental (non-qualified) pension plans, the benefit obligation is the PBO, which is also equal to the ABO. For the international pension plans, the benefit obligation is the PBO. The ABO for our international pension plans was $ 11.5 billion in 2020 and $ 10.6 billion in 2019. For the postretirement plans, the benefit obligation is the ABO. (b) Primarily includes actuarial losses resulting from decreases in discount rates in 2020 and 2019 . (c) For more information, see Note 2B . The following provides information as to how the funded status is recognized in our consolidated balance sheets: Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Noncurrent assets (a) $ $ $ $ $ 522 $ 453 $ $ Current liabilities (b) ( 127 ) ( 189 ) ( 31 ) ( 30 ) ( 6 ) ( 24 ) Noncurrent liabilities (c) ( 845 ) ( 1,949 ) ( 1,239 ) ( 1,162 ) ( 2,681 ) ( 2,526 ) ( 645 ) ( 1,124 ) Funded status $ ( 845 ) $ ( 1,949 ) $ ( 1,366 ) $ ( 1,351 ) $ ( 2,191 ) $ ( 2,103 ) $ ( 651 ) $ ( 1,148 ) (a) Included in Other noncurrent assets . (b) Included in Accrued compensation and related items . (c) Included in Pension benefit obligations , Postretirement benefit obligations , and Other noncurrent liabilities , as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following provides the pre-tax components of cumulative amounts recognized in Accumulated other comprehensive loss : Pension Plans U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 2020 2019 Actuarial losses (a) $ ( 5,062 ) $ ( 4,812 ) $ ( 579 ) $ ( 484 ) $ ( 3,056 ) $ ( 2,921 ) $ 58 $ ( 76 ) Prior service (costs)/credits ( 3 ) ( 2 ) ( 1 ) ( 31 ) ( 21 ) 688 830 Total (b) $ ( 5,065 ) $ ( 4,814 ) $ ( 580 ) $ ( 485 ) $ ( 3,087 ) $ ( 2,942 ) $ 746 $ 754 (a) Primarily represent the impact of changes in discount rates and other assumptions that result in cumulative changes in our PBO, as well as the cumulative difference between the expected return and actual return on plan assets. These accumulated actuarial losses are recognized in Accumulated other comprehensive loss and are amortized into net periodic benefit costs primarily over the average remaining service period for active participants for plans that are not frozen or the average life expectancy of plan participants for frozen plans, primarily using the corridor approach. (b) The change from December 31, 2019 includes the derecognition of $ 388 million of pre-tax actuarial losses, net of prior service credits associated with benefit plans distributed as a result of the spin-off and the combination of the Upjohn Business with Mylan on November 16, 2020. The following provides information related to the funded status of selected benefit plans (including those reported as part of liabilities of discontinued operations): U.S. Qualified U.S. Supplemental (Non-Qualified) International As of December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 2020 2019 Pension plans with an ABO in excess of plan assets: Fair value of plan assets $ 16,094 $ 14,586 $ $ $ 6,674 $ 5,843 ABO 16,940 16,535 1,366 1,351 8,961 7,960 Pension plans with a PBO in excess of plan assets: Fair value of plan assets 16,094 14,586 6,735 5,947 PBO 16,940 16,535 1,366 1,351 9,447 8,503 All of our U.S. plans and many of our international plans were underfunded as of December 31, 2020. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies D. Plan Assets The following provides the components of plan assets (including those reported as part of discontinued operations): Fair Value Fair Value (MILLIONS OF DOLLARS) As of December 31, 2020 Level 1 Level 2 Level 3 Assets Measured at NAV (a) As of December 31, 2019 Level 1 Level 2 Level 3 Assets Measured at NAV (a) U.S. qualified pension plans Cash and cash equivalents $ 781 $ 70 $ 711 $ $ $ 363 $ 80 $ 284 $ $ Equity securities: Global equity securities 3,241 3,213 27 1 3,464 3,406 57 Equity commingled funds 1,325 1,110 215 1,179 819 360 Fixed income securities: Corporate debt securities 6,499 23 6,476 5,292 10 5,281 1 Government and agency obligations (b) 1,555 1,555 1,799 1,799 Fixed income commingled funds 23 23 6 6 Other investments: Partnership investments (c) 1,431 1,431 1,212 1,212 Insurance contracts 190 190 196 196 Other commingled funds (d) 1,049 11 1,038 1,075 9 1,066 Total $ 16,094 $ 3,306 $ 10,103 $ 1 $ 2,684 $ 14,586 $ 3,496 $ 8,451 $ 1 $ 2,638 International pension plans Cash and cash equivalents $ 407 $ 61 $ 346 $ $ $ 221 $ 33 $ 187 $ $ Equity securities: Equity commingled funds 2,051 1,681 370 1,922 1,548 374 Fixed income securities: Corporate debt securities 925 925 796 796 Government and agency obligations (b) 1,334 1,334 1,200 1,200 Fixed income commingled funds 2,484 1,217 1,267 2,201 1,031 1,171 Other investments: Partnership investments (c) 69 3 66 66 3 63 Insurance contracts 1,027 57 969 1 1,027 82 944 1 Other (d) 1,514 117 393 1,003 1,524 82 398 1,043 Total $ 9,811 $ 61 $ 5,681 $ 1,362 $ 2,707 $ 8,956 $ 33 $ 4,929 $ 1,342 $ 2,652 U.S. postretirement plans (e) Insurance contracts $ 588 $ $ 588 $ $ $ 519 $ $ 519 $ $ (a) Certain investments that are measured at NAV per share (or its equivalent) have not been classified in the fair value hierarchy. The NAV amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented for the total pension benefits plan assets. (b) Government and agency obligations are inclusive of repurchase agreements . (c) Mainly includes investments in private equity, private debt, public equity limited partnerships, and, to a lesser extent, real estate and venture capital. (d) Mostly includes investments in hedge funds and real estate. (e) Reflects postretirement plan assets, which support a portion of our U.S. retiree medical plans. The following provides an analysis of the changes in our more significant investments valued using significant unobservable inputs (including those reported as part of discontinued operations): International Pension Plans Insurance contracts Other Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2020 2019 Fair value, beginning $ 944 $ 684 $ 398 $ 382 Actual return on plan assets: Assets held, ending 32 50 ( 10 ) 6 Purchases, sales, and settlements, net ( 38 ) ( 40 ) ( 10 ) 6 Transfer into/(out of) Level 3 ( 11 ) 247 ( 2 ) Exchange rate changes 42 2 16 4 Fair value, ending $ 969 $ 944 $ 393 $ 398 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Equity securities, Fixed income securities and Other investments may each be combined into commingled funds. Most commingled funds are valued to reflect the interest in the fund based on the reported year-end NAV. Partnership and Other investments are valued based on year-end reported NAV (or its equivalent), with adjustments as appropriate for lagged reporting of up to three months. The following methods and assumptions were used to estimate the fair value of our pension and postretirement plans assets: Cash and cash equivalents: Level 1 investments may include cash, cash equivalents and foreign currency valued using exchange rates. Level 2 investments may include short-term investment funds which are commingled funds priced at a stable NAV by the administrator of the funds. Equity securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 1 and Level 2 investments may include commingled funds that have a readily determinable fair value based on quoted prices on an exchange or a published NAV derived from the quoted prices in active markets of the underlying securities. Level 3 investments may include individual securities that are unlisted, delisted, suspended, or illiquid and are typically valued using their last available price. Fixed income securities: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include commingled funds that have a readily determinable fair value based on observable prices of the underlying securities. Level 2 investments may include corporate bonds, government and government agency obligations and other fixed income securities valued using bid evaluation pricing models or quoted prices of securities with similar characteristics. Level 3 investments may include securities that are valued using alternative pricing sources, such as investment managers or brokers, which use proprietary pricing models that incorporate unobservable inputs. Other investments: Level 1 investments may include individual securities that are valued at the closing price or last trade reported on the major market on which they are traded. Level 2 investments may include Insurance contracts which invest in interest bearing cash, U.S. government securities and corporate debt instruments. Certain investments are authorized to include derivatives, such as equity or bond futures, swaps, options and currency futures or forwards for managing risks and exposures. The following provides the long-term target asset allocations ranges and the percentage of the fair value of plan assets for benefit plans: Target Allocation Percentage Percentage of Plan Assets As of December 31, (PERCENTAGES) 2020 2020 2019 U.S. qualified pension plans Cash and cash equivalents 0 - 10 % 4.9 % 2.5 % Equity securities 35 - 55 % 28.4 % 31.8 % Fixed income securities 28 - 53 % 50.2 % 48.7 % Other investments 5 - 20 % 16.6 % 17.0 % Total 100 % 100 % 100 % International pension plans Cash and cash equivalents 0 - 10 % 4.2 % 2.5 % Equity securities 20 - 40 % 20.9 % 21.5 % Fixed income securities 35 - 60 % 48.4 % 46.9 % Other investments 10 - 35 % 26.6 % 29.2 % Total 100 % 100 % 100 % U.S. postretirement plans Cash and cash equivalents 0 - 5 % Other investments 95 - 100 % 100 % 100 % Total 100 % 100 % 100 % Global plan assets are managed with the objective of generating returns that will enable the plans to meet their future obligations, while seeking to manage net periodic benefit costs and cash contributions over the long-term. We utilize long-term asset allocation ranges in the management of our plans invested assets. Our long-term return expectations are developed based on a diversified, global investment strategy that takes into account historical experience, as well as the impact of portfolio diversification, active portfolio management, and our view of current and future economic and financial market conditions. As market conditions and other factors change, we may adjust our targets accordingly and our asset allocations may vary from the target allocations. Our long-term asset allocation ranges reflect our asset class return expectations and tolerance for investment risk within the context of the respective plans long-term benefit obligations. These ranges are supported by analysis that incorporates historical and expected returns by asset class, as well as volatilities and correlations across asset classes and our liability profile. Each pension plan is overseen by a local committee or board that is responsible for the overall investment of the pension plan assets. In determining investment policies and associated target allocations, each committee or board considers a wide variety of factors. As such, the target asset allocation for each of our international pension plans is set on a standalone basis by the relevant board or committee. The target Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies asset allocation ranges shown for the international pension plans seek to reflect the combined target allocations across all such plans, while also showing the range within which the target allocations for each plan typically falls. The investment managers of certain separately managed accounts, commingled funds and private equity funds may be permitted to use repurchase agreements and derivative securities, including U.S. Treasury and equity futures contracts as described in each respective investment management, subscription, partnership or other governing agreement. E. Cash Flows It is our practice to fund amounts for our qualified pension plans that are at least sufficient to meet the minimum requirements set forth in applicable employee benefit laws and local tax laws. The following provides the expected future cash flow information related to our benefit plans: Pension Plans (MILLIONS OF DOLLARS) U.S. Qualified U.S. Supplemental (Non-Qualified) International Postretirement Plans Expected employer contributions: 2021 $ $ 127 $ 282 $ 90 Expected benefit payments: 2021 $ 1,139 $ 127 $ 371 $ 97 2022 1,036 121 375 94 2023 1,032 116 375 92 2024 1,030 106 385 89 2025 986 100 393 86 20262030 4,625 424 2,086 430 The above table reflects the total U.S. and international plan benefits projected to be paid from the plans or from our general assets under the current actuarial assumptions used for the calculation of the benefit obligation and, therefore, actual benefit payments may differ from projected benefit payments. F. Defined Contribution Plans We have defined contribution plans in the U.S. and several other countries. For the majority of the U.S. defined contribution plans, employees may contribute a portion of their salaries and bonuses to the plans, and we match, in cash, a portion of the employee contributions. Beginning on January 1, 2011, for newly hired non-union employees, rehires and transfers to the U.S. or Puerto Rico, we no longer offer a defined benefit pension plan and, instead, offer a Retirement Savings Contribution (RSC) in the defined contribution plan. The RSC is an annual non-contributory employer contribution (that is not dependent upon the participant making a contribution) determined based on each employees eligible compensation, age and years of service. Beginning on January 1, 2018, all non-union employees in the U.S. and Puerto Rico defined benefit plans transitioned to the RSC in the defined contribution plans. We recorded charges related to the employer contributions to global defined contribution plans of $ 685 million in 2020, $ 659 million in 2019 and $ 622 million in 2018. Note 12. Equity A. Common Stock Purchases We purchase our common stock through privately negotiated transactions or in the open market as circumstances and prices warrant. Purchased shares under each of the share-purchase plans, which are authorized by our BOD, are available for general corporate purposes. In December 2015, the BOD authorized an $ 11 billion share repurchase program, which was exhausted in the third quarter of 2018. In December 2017, the BOD authorized an additional $ 10 billion share repurchase program, which was exhausted in the first quarter of 2019. In December 2018, the BOD authorized another $ 10 billion share repurchase program to be utilized over time and share repurchases commenced thereunder in the first quarter of 2019. In March 2018, we entered into an accelerated share repurchase agreement (ASR) with Citibank, N.A. to repurchase $ 4 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 4 billion and received an initial delivery of 87 million shares of stock at a price of $ 36.61 per share, which represented approximately 80 % of the notional amount of the ASR. In September 2018, the ASR was completed resulting in Citibank owing us an additional 21 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 36.86 per share. The common stock received is included in Treasury stock . In February 2019, we entered into an ASR with Goldman Sachs Co. LLC to repurchase $ 6.8 billion of our common stock pursuant to our previously announced share repurchase authorization. We paid $ 6.8 billion and received an initial delivery of 130 million shares of common stock, which represented approximately 80 % of the notional amount of the ASR. In August 2019, the ASR with Goldman Sachs Co. LLC was completed resulting in Goldman Sachs Co. LLC owing us an additional 33.5 million shares of our common stock. The average price paid for all of the shares delivered under the ASR was $ 41.42 per share. The common stock received is included in Treasury stock . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies The following provides the number of shares of our common stock purchased and the cost of purchases under our publicly announced share purchase plans, including our ASRs: Year Ended December 31, (SHARES IN MILLIONS, DOLLARS IN BILLIONS) 2020 2019 (a) 2018 (b) Shares of common stock purchased 213 307 Cost of purchase $ $ 8.9 $ 12.2 (a) Represents shares purchased pursuant to the ASR with Goldman Sachs Co. LLC entered into in February 2019, as well as open market share repurchases of $ 2.1 billion . (b) Represents shares purchased pursuant to the ASR with Citibank entered into in March 2018, as well as open market share repurchases of $ 8.2 billion . Our remaining share-purchase authorization was approximately $ 5.3 billion at December 31, 2020. B. Preferred Stock and Employee Stock Ownership Plans Prior to May 4, 2020, our Series A convertible perpetual preferred stock (the Series A Preferred Stock) was held by an ESOP trust (the Trust). All outstanding shares of Series A Preferred Stock were converted, at the direction of the independent fiduciary under the Trust and in accordance with the certificate of designations for the Series A Preferred Stock, into shares of our common stock on May 4, 2020. The Trust received an aggregate of 1,070,369 shares of our common stock upon conversion, with zero shares of Series A Preferred Stock remaining outstanding as a result of the conversion. In December 2020, we filed a certificate of elimination and a restated certificate of incorporation with the Delaware Secretary of State, which eliminated the Series A Preferred Stock. Since May 4, 2020, we have one ESOP that holds common stock of the Company (Common ESOP). Prior to that there was also an ESOP that held the Series A Preferred Stock. As of December 31, 2020, all shares of common stock held by the Common ESOP have been allocated to the Pfizer U.S. defined contribution plan participants. The compensation cost related to the Common ESOP was $ 19 million in 2020, $ 20 million in 2019 and $ 19 million in 2018. Note 13. Share-Based Payments Our compensation programs can include share-based payment awards with value that is determined by reference to the fair value of our shares and that provide for the grant of shares or options to acquire shares or similar arrangements. Our share-based awards are designed based on competitive survey data or industry peer groups used for compensation purposes; and are allocated between different long-term incentive awards, generally in the form of Total Shareholder Return Units (TSRUs), Restricted Stock Units (RSUs), Portfolio Performance Shares (PPSs), Performance Share Awards (PSAs) and Stock Options, as determined by the Compensation Committee. The 2019 Stock Plan (2019 Plan) replaced and superseded the 2014 Plan. It provides for 400 million shares, in addition to shares remaining under the 2014 Plan, to be authorized for grants. The 2019 Plan provides that the number of stock options, TSRUs, RSUs, or performance-based awards that may be granted to any one individual during any 36-month period is limited to 20 million shares, and that RSUs, PPSs and PSAs count as three shares, while TSRUs and stock options count as one share, toward the maximum shares available under the 2019 Plan. As of December 31, 2020, 411 million shares were available for award. Although not required to do so we have used authorized and unissued shares and, to a lesser extent, treasury stock to satisfy our obligations under these programs. A summary of the awards and valuation details: Awarded to Terms Valuation Recognition and Presentation Total Shareholder Return Units (TSRUs) (a), (b) Senior and other key management and select employees Entitle the holder to receive shares of our common stock with a value equal to the difference between the defined settlement price and the grant price, plus the dividends accumulated during the five or seven -year term, if and to the extent the total value is positive. Settlement price is the average closing price of our common stock during the 20 trading days ending on the fifth or seventh anniversary of the grant, as applicable; the grant price is the closing price of our common stock on the date of the grant. Automatically settled on the fifth or seventh anniversary of the grant but vest on the third anniversary of the grant, after which time there is no longer a substantial likelihood of forfeiture. As of the grant date using a Monte Carlo simulation model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Restricted Stock Units (RSUs) Select employees Entitle the holder to receive a specified number of shares of our common stock, including shares resulting from dividend equivalents paid on such RSUs. For RSUs granted during the periods presented, in virtually all instances, the units vest after three years of continuous service from the grant date. As of the grant date using the closing price of our common stock Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Awarded to Terms Valuation Recognition and Presentation Portfolio Performance Shares (PPSs) Select employees Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents paid on such shares. For PPSs granted during the period presented, the awards vest after three years of continuous service from the grant date and the number of shares paid, if any, depends on the achievement of predetermined goals related to Pfizers long-term product portfolio during a five -year performance period from the year of the grant date. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, changes in the number of shares that are probable of being earned and changes in managements assessment of the probability that the specified performance criteria will be achieved and/or changes in managements assessment of the probable vesting term. Performance Share Awards (PSAs) Senior and other key management Entitle the holder to receive, at the end of the performance period, shares of our common stock, if any, including shares resulting from dividend equivalents, dependent upon the achievement of predetermined goals related to two measures: a. Adjusted operating income (for performance years through 2018) or adjusted net income (for 2019 and later years, except for the 2017 PSAs) over three one-year periods; and b. TSR as compared to the NYSE ARCA Pharmaceutical Index (DRG Index) over the three -year performance period. PSAs vest after three years of continuous service from the grant date. The number of shares that may be earned ranges from 0 % to 200 % of the initial award depending on goal achievement over the performance period. As of the grant date using the intrinsic value method using the closing price of our common stock Amortized on a straight-line basis over the probable vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate, and adjusted each reporting period, as necessary, to reflect changes in the price of our common stock, changes in the number of shares that are probable of being earned and changes in managements assessment of the probability that the specified performance criteria will be achieved. Stock Options Select employees Entitle the holder to purchase a specified number of our common stock at a price per share equal to the closing market price of our common stock on the date of grant, when vested. Beginning in 2016, only a limited set of non-U.S. employees received stock option grants. No stock options were awarded to senior and other key management in any period presented. Stock options vest after three years of continuous service from the grant date and have a contractual term of 10 years. As of the grant date using the Black-Scholes-Merton option-pricing model Amortized on a straight-line basis over the vesting term into Cost of sales , Selling, informational and administrative expenses , and/or Research and development expenses , as appropriate. (a) Retirement-eligible holders, as defined in the grant terms, can convert their TSRUs, when vested, into Profit Units (PTUs) with a conversion ratio based on a calculation used to determine the shares at TSRU settlement. The PTUs are entitled to earn Dividend Equivalent Units (DEUs), and the PTUs and DEUs will be settled in our common stock on the TSRUs original settlement date and will be subject to the terms and conditions of the original grant including forfeiture provisions. (b) In 2017, Performance Total Shareholder Return Units (PTSRUs) were awarded to the Former Chairman and Chief Executive Officer ( 1,444,395 PTSRUs) and 361,099 PTSRUs were awarded to the Group President, Chief Business Officer (former role Group President Pfizer Innovative Health) at a grant price of $ 30.31 and at a GDFV of $ 5.54 per PTSRU. All these amounts have been adjusted for the Upjohn spin-off discussed in Note 2B . In addition to having the same characteristics and valuation methodology of TSRUs, PTSRU grants require special service and performance conditions . The following provides data related to all TSRU, RSU, PPS, PSA and stock option activity: (MILLIONS OF DOLLARS, EXCEPT FAIR VALUE OF SHARES VESTED PER TSRU AND STOCK OPTION) TSRUs RSUs PPSs PSAs Stock Options Year Ended December 31, 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 2020 2019 2018 Total fair value of shares vested (a) $ 6.22 $ 8.52 $ 7.42 $ 334 $ 454 $ 146 $ 119 $ 136 $ 169 $ 25 $ 64 $ 4 $ 3.56 $ 5.98 $ 5.06 Total intrinsic value of options exercised or share units converted $ 84 $ 175 $ 151 $ 224 $ 245 $ 194 $ 293 $ 261 $ 625 Cash received upon exercise $ 425 $ 394 $ 1,259 Tax benefits realized from exercise $ 55 $ 47 $ 115 Compensation cost recognized, pre-tax (b) $ 287 $ 294 $ 302 $ 272 $ 275 $ 286 $ 180 $ 114 $ 276 $ 31 $ 28 $ 62 $ 6 $ 7 $ 12 Total compensation cost related to nonvested awards not yet recognized, pre-tax $ 224 $ 229 $ 246 $ 228 $ 241 $ 256 $ 104 $ 87 $ 102 $ 32 $ 34 $ 41 $ 4 $ 5 $ 5 Weighted-average period over which cost is expected to be recognized (years) 1.6 1.6 1.6 1.7 1.7 1.7 1.8 1.8 1.8 1.9 1.8 1.8 1.7 1.6 1.7 (a) Weighted-average GDFV per TSRUs and stock options. (b) TSRU includes expense for PTSRUs, which is not significant for all years presented . Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Total share-based payment expense was $ 780 million, $ 718 million and $ 949 million in 2020, 2019 and 2018, respectively, which includes pre-tax share-based payment expense included in Income from discontinued operations net of tax of $ 23 million, $ 30 million and $ 27 million in 2020, 2019 and 2018, respectively. Tax benefit for share-based compensation expense was $ 141 million, $ 137 million and $ 180 million in 2020, 2019 and 2018, respectively. The table above excludes total expense due to the modification for share-based awards in connection with our cost reduction/productivity initiatives, which was not significant for all years presented and is recorded in Restructuring charges and certain acquisition-related costs (see Note 3 ). Amounts capitalized as part of inventory cost were not significant for any period presented. Summary of the weighted-average assumptions used in the valuation of TSRUs and stock options: TSRUs Stock Options Year Ended December 31, 2020 2019 2018 2020 2019 2018 Expected dividend yield (based on a constant dividend yield during the expected term) 4.36 % 3.27 % 3.73 % 4.36 % 3.27 % 3.73 % Risk-free interest rate (based on interpolated yield on U.S. Treasury zero-coupon issues) 1.15 % 2.55 % 2.60 % 1.25 % 2.66 % 2.85 % Expected stock price volatility (based on implied volatility, after consideration of historical volatility) 20.99 % 18.34 % 20.00 % 20.97 % 18.34 % 20.02 % TSRUs contractual/stock options expected term, years (based on historical exercise and post-vesting termination patterns for stock options) 5.12 5.13 5.12 6.75 6.75 6.75 Summary of all TSRU, RSU, PPS and PSA activity during 2020 (with the shares granted representing the maximum award that could be achieved for PPSs and PSAs): TSRUs RSUs PPSs (a) PSAs TSRUs Per TSRU, Weighted Average Shares Weighted Avg. GDFV per share Shares Weighted Avg. Intrinsic Value per share Shares Weighted Avg. Intrinsic Value per share (Thousands) GDFV Grant Price (Thousands) (Thousands) (Thousands) Nonvested, December 31, 2019 (b) 122,654 $ 7.53 $ 38.01 23,407 $ 37.54 17,694 $ 39.18 5,061 $ 39.18 Granted (b) 51,158 6.22 34.12 8,423 34.22 8,150 34.10 1,713 34.10 Vested (b) ( 45,757 ) 6.40 34.11 ( 9,321 ) 34.70 ( 6,393 ) 34.73 ( 728 ) 34.65 Reinvested dividend equivalents (b) 955 37.32 Forfeited (b) ( 4,782 ) 7.27 37.20 ( 999 ) 37.91 ( 713 ) 36.78 ( 1,052 ) 35.00 Upjohn spin-off adjustment (c) 6,571 6.88 32.94 1,228 35.55 1,338 36.69 270 36.69 Nonvested, December 31, 2020 129,844 $ 6.90 $ 32.94 23,692 $ 35.50 20,077 $ 36.81 5,264 $ 36.81 (a) Vested and non-vested shares outstanding, but not paid as of December 31, 2020 were 33.9 million. (b) Activity prior to the Upjohn Business spin-off has not been adjusted. (c) In connection with the Upjohn Business spin-off, the Company made adjustments to preserve the intrinsic value of the awards immediately before and after the spin-off. The terms of the outstanding awards remain the same and continue to vest over the original vesting periods. Certain outstanding awards at the time of the spin-off held by employees of Upjohn were prorated for services performed and the remaining portion forfeited at the time of the separation. The share-based awards held as of November 16, 2020 were adjusted as follows: The number of outstanding TSRUs was increased and the grant price was decreased. The number of shares of common stock subject to each outstanding RSUs, PPSs, and PSAs was increased. The adjustments to the stock-based compensation awards did not result in additional compensation cost. Summary of TSRU and PTU information as of December 31, 2020 (a), (b) : TSRUs (Thousands) PTUs (Thousands) Weighted-Average Grant Price Per TSRU Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (Millions) TSRUs Outstanding 230,539 $ 29.57 2.3 $ 1,737 TSRUs Vested 100,696 25.22 0.8 1,168 TSRUs Expected to vest (c) 124,594 32.94 3.3 547 TSRUs exercised and converted to PTUs 1,467 $ 0.3 $ 54 (a) In 2020, we settled 5,478,547 TSRUs with a weighted-average grant price of $ 30.93 per unit. (b) In 2020, 2,217,044 TSRUs with a weighted-average grant price of $ 29.26 per unit were converted into 757,285 PTUs. (c) The number of TSRUs expected to vest takes into account an estimate of expected forfeitures. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Summary of all stock option activity during 2020: Shares (Thousands) Weighted-Average Exercise Price Per Share Weighted-Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (a) (Millions) Outstanding, December 31, 2019 (b) 88,600 $ 28.39 Granted (b) 1,755 34.10 Exercised (b) ( 18,492 ) 23.05 Forfeited (b) ( 160 ) 35.49 Expired (b) ( 326 ) 24.91 Upjohn spin-off adjustment (c) 4,024 28.08 Outstanding, December 31, 2020 75,402 28.31 3.1 $ 645 Vested and expected to vest, December 31, 2020 (d) 75,226 28.30 3.0 645 Exercisable, December 31, 2020 71,732 $ 27.97 2.8 $ 635 (a) Market price of our underlying common stock less exercise price. (b) Activity prior to the Upjohn Business spin-off has not been adjusted. (c) In connection with the Upjohn business spin-off discussed above, the number of shares of common stock subject to each outstanding stock option was increased and the exercise price was decreased. These adjustments did not result in additional compensation cost. (d) The number of options expected to vest takes into account an estimate of expected forfeitures. Note 14. Earnings Per Common Share Attributable to Pfizer Inc. Common Shareholders The following presents the detailed calculation of EPS: Year Ended December 31, (IN MILLIONS) 2020 2019 2018 EPS NumeratorBasic Income from continuing operations attributable to Pfizer Inc. $ 6,985 $ 10,838 $ 3,825 Less: Preferred stock dividendsnet of tax 1 1 Income from continuing operations attributable to Pfizer Inc. common shareholders 6,984 10,837 3,824 Income from discontinued operationsnet of tax 2,631 5,435 7,328 Net income attributable to Pfizer Inc. common shareholders $ 9,616 $ 16,272 $ 11,152 EPS NumeratorDiluted Income from continuing operations attributable to Pfizer Inc. common shareholders and assumed conversions $ 6,985 $ 10,838 $ 3,825 Income from discontinued operationsnet of tax, attributable to Pfizer Inc. common shareholders and assumed conversions 2,631 5,435 7,328 Net income attributable to Pfizer Inc. common shareholders and assumed conversions $ 9,616 $ 16,273 $ 11,153 EPS Denominator Weighted-average number of common shares outstandingBasic 5,555 5,569 5,872 Common-share equivalents: stock options, stock issuable under employee compensation plans convertible preferred stock and accelerated share repurchase agreements 77 106 105 Weighted-average number of common shares outstandingDiluted 5,632 5,675 5,977 Anti-dilutive common stock equivalents (a) 4 2 2 (a) These common stock equivalents were outstanding for the periods presented, but were not included in the computation of diluted EPS for those periods because their inclusion would have had an anti-dilutive effect. Allocated shares held by the Common ESOP, including reinvested dividends, are considered outstanding for EPS calculations and the eventual conversion of allocated preferred shares held by the Preferred ESOP was assumed in the diluted EPS calculation until the conversion date, which occurred in May 2020. See Note 12 . Note 15. Leases We lease real estate, fleet, and equipment for use in our operations. Our leases generally have lease terms of 1 to 30 years, some of which include options to terminate or extend leases for up to 5 to 10 years or on a month-to-month basis. We include options that are reasonably certain to be exercised as part of the determination of lease terms. We may negotiate termination clauses in anticipation of any changes in market conditions, but generally these termination options have not been exercised. Residual value guarantees are generally not included within our operating leases with the exception of some fleet leases. In addition to base rent payments, the leases may require us to pay directly for taxes and other non-lease components, such as insurance, maintenance and other operating expenses, which may be dependent on usage or vary month-to-month. Variable lease payments amounted to $ 380 million in 2020 and $ 327 million in 2019. We elected the practical expedient in the new standard to not separate non-lease components from lease components in calculating the amounts of ROU assets and lease liabilities for all underlying asset classes. We determine if an arrangement is a lease at inception of the contract and we perform the lease classification test as of the lease commencement date. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. For operating leases, the ROU assets and liabilities in our consolidated balance sheets follows: As of December 31, (MILLIONS OF DOLLARS) Balance Sheet Classification 2020 2019 ROU assets Other noncurrent assets $ 1,393 $ 1,289 Lease liabilities (short-term) Other current liabilities 321 269 Lease liabilities (long-term) Other noncurrent liabilities 1,114 1,030 Components of total lease cost includes: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 Operating lease cost $ 433 $ 422 Variable lease cost 380 327 Sublease income ( 40 ) ( 45 ) Total lease cost $ 773 $ 704 Other supplemental information for 2020 follows: Weighted-Average Remaining Contractual Lease Term (Years) Weighted-Average Discount Rate (MILLIONS OF DOLLARS) As of December 31, 2020 Year Ended December 31, Operating leases 6.9 2.9 % Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 334 (Gains)/losses on sale and leaseback transactions, net ( 3 ) ROU assets obtained in exchange for new operating lease liabilities 413 Other supplemental information for 2019 follows: Weighted-Average Remaining Contractual Lease Term (Years) Weighted-Average Discount Rate (MILLIONS OF DOLLARS) As of December 31, 2019 Year Ended December 31, Operating leases 6.9 3.5 % Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 339 (Gains)/losses on sale and leaseback transactions, net ( 29 ) ROU assets obtained in exchange for new operating lease liabilities 318 The following reconciles the undiscounted cash flows for the first five years and total of the remaining years to the operating lease liabilities recorded in the consolidated balance sheet as of December 31, 2020: (MILLIONS OF DOLLARS) Period Operating Lease Liabilities Next one year (a) $ 357 1-2 years 299 2-3 years 250 3-4 years 167 4-5 years 137 Thereafter 408 Total undiscounted lease payments 1,618 Less: Imputed interest 183 Present value of minimum lease payments 1,435 Less: Current portion 321 Noncurrent portion $ 1,114 (a) Reflects lease payments due within 12 months subsequent to the balance sheet date. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In April 2018, we entered an agreement to lease space in an office building in New York City. We expect to take control of the property in 2021 and relocate our global headquarters to this new office building in 2022. Our future minimum rental commitment under this 20-year lease is approximately $ 1.6 billion. Prior to our adoption of the new lease standard, rental expense, net of sublease income, was $ 301 million in 2018. Note 16. Contingencies and Certain Commitments We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business, including tax and legal contingencies. The following outlines our legal contingencies. For a discussion of our tax contingencies, see Note 5B. A. Legal Proceedings Our legal contingencies include, but are not limited to, the following: Patent litigation, which typically involves challenges to the coverage and/or validity of patents on various products, processes or dosage forms. We are the plaintiff in the majority of these actions. An adverse outcome in actions in which we are the plaintiff could result in loss of patent protection for a drug, a significant loss of revenues from that drug or impairment of the value of associated assets. Product liability and other product-related litigation, which can include personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, among others, often involves highly complex issues relating to medical causation, label warnings and reliance on those warnings, scientific evidence and findings, actual, provable injury and other matters. Commercial and other matters, which can include acquisition-, licensing-, collaboration- or co-promotion-related and product-pricing claims and environmental claims and proceedings, can involve complexities that will vary from matter to matter. Government investigations, which often are related to the extensive regulation of pharmaceutical companies by national, state and local government agencies in the U.S. and in other jurisdictions. Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, which could be substantial, and/or criminal charges. We believe that our claims and defenses in matters in which we are a defendant are substantial, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of matters, which could have a material adverse effect on our results of operations and/or our cash flows in the period in which the amounts are accrued or paid. We have accrued for losses that are both probable and reasonably estimable. Substantially all of our contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments, which result from a complex series of judgments about future events and uncertainties, are based on estimates and assumptions that have been deemed reasonable by management, but that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. In August 2020, the SEC amended its disclosure rules regarding the threshold for disclosure of proceedings under environmental laws to which a governmental authority is a party. In accordance with the amended rule, we have adopted a disclosure threshold for such proceedings of $ 1 million in potential or actual governmental monetary sanctions. The principal pending matters to which we are a party are discussed below. In determining whether a pending matter is a principal matter, we consider both quantitative and qualitative factors to assess materiality, such as, among others, the amount of damages and the nature of other relief sought, if specified; our view of the merits of the claims and of the strength of our defenses; whether the action purports to be, or is, a class action and, if not certified, our view of the likelihood that a class will be certified by the court; the jurisdiction in which the proceeding is pending; whether related actions have been transferred to multidistrict litigation; any experience that we or, to our knowledge, other companies have had in similar proceedings; whether disclosure of the action would be important to a reader of our financial statements, including whether disclosure might change a readers judgment about our financial statements in light of all of the information that is available to the reader; the potential impact of the proceeding on our reputation; and the extent of public interest in the matter. In addition, with respect to patent matters in which we are the plaintiff, we consider, among other things, the financial significance of the product protected by the patent(s) at issue. Some of the matters discussed below include those which management believes that the likelihood of possible loss in excess of amounts accrued is remote. A1. Legal ProceedingsPatent Litigation We are involved in suits relating to our patents, including but not limited to, those discussed below. Most involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. In addition to the challenges to the U.S. patents that are discussed below, patent rights to certain of our products are being challenged in various other jurisdictions. We are also party to patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for allegedly causing delay of generic entry. Additionally, our licensing and collaboration partners face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In 2017, the Patent Trial and Appeal Board (PTAB) initiated proceedings, which remain pending, with respect to two of our pneumococcal vaccine patents. However, the PTAB declined to initiate proceedings as to two other pneumococcal vaccine patents. Various legal challenges to other pneumococcal vaccine patents remain pending in jurisdictions outside the U.S. The invalidation of all of the patents in our pneumococcal portfolio could potentially allow a competitors pneumococcal vaccine into the marketplace. In the event that any of the patents are found valid and infringed, a competitors pneumococcal vaccine might be prohibited from entering the market or a competitor might be required to pay us a royalty. We are also subject to patent litigation pursuant to which one or more third parties seek damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities. For example, our Hospira subsidiaries are involved in patent disputes over their attempts to bring generic pharmaceutical and biosimilar products to market. If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold if we or one of our subsidiaries is found to have willfully infringed valid patent rights of a third party. Actions In Which We Are The Plaintiff EpiPen In 2010, King, which we acquired in 2011 and is a wholly-owned subsidiary, brought a patent-infringement action against Sandoz in the U.S. District Court for the District of New Jersey in connection with Sandozs abbreviated new drug application (ANDA) filed with the FDA seeking approval to market an epinephrine injectable product. Sandoz is challenging patents, which expire in 2025, covering the next-generation autoinjector for use with epinephrine that is sold under the EpiPen brand name. Xeljanz (tofacitinib) Beginning in 2017, we brought patent-infringement actions against several generic manufacturers that filed separate ANDAs with the FDA seeking approval to market their generic versions of tofacitinib tablets in one or both of 5 mg and 10 mg dosage strengths, and in both immediate and extended release forms. To date, we have settled actions with several generic manufacturers on terms not material to Pfizer. The remaining actions continue in the U.S. District Court for the District of Delaware as described below. In 2017, we brought a patent-infringement action against Zydus Pharmaceuticals (USA) Inc. and Cadila Healthcare Ltd. (collectively, Zydus) asserting the infringement and validity of three patents: the patent covering the active ingredient expiring in December 2025 (the 2025 Patent), the patent covering an enantiomer of tofacitinib expiring in 2022, and the patent covering a polymorphic form of tofacitinib expiring in 2023 (the 2023 Patent), which Zydus challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg tablets. In November 2020, we settled the case against Zydus on terms not material to Pfizer. In February 2021, we brought a separate patent-infringement action against Zydus asserting the infringement and validity of our composition of matter and crystalline form patents challenged by Zydus in its ANDA seeking approval to market a generic version of tofacitinib 22 mg extended release tablets. In 2018, we brought a separate patent infringement action against Teva Pharmaceuticals USA, Inc. (Teva) asserting the infringement and validity of our patent covering extended release formulations of tofacitinib that was challenged by Teva in its ANDA seeking approval to market a generic version of tofacitinib 11 mg extended release tablets. In January 2021, we brought a separate patent-infringement action against Aurobindo Pharma Limited (Aurobindo) asserting the infringement and validity of the 2025 Patent and the 2023 Patent, which Aurobindo challenged in its ANDA seeking approval to market a generic version of tofacitinib 5 mg and 10 mg tablets. Inlyta (axitinib) In 2019, Glenmark Pharmaceuticals Limited (Glenmark) notified us that it had filed an ANDA with the FDA seeking approval to market a generic version of Inlyta. Glenmark asserts the invalidity and non-infringement of the crystalline form patent for Inlyta that expires in 2030. In June 2019, we filed suit against Glenmark in the U.S. District Court for the District of Delaware, asserting the validity and infringement of the crystalline form patent for Inlyta. Ibrance (palbociclib) In March 2019, several generic companies notified us that they had filed ANDAs with the FDA seeking approval to market generic versions of Ibrance. The generic companies assert the invalidity and non-infringement of two composition of matter patents, one of which expires in 2023 and one of which expires in 2027, as a result of a U.S. Patent Term Extension certificate issued in January 2021, and a method of use patent covering palbociclib, which expires in 2023. In April 2019, we brought patent infringement actions against each of the generic filers in various federal courts, asserting the validity and infringement of the patents challenged by the generic companies. Beginning in September 2020, we received correspondence from several generic companies notifying us that they would seek approval to market generic versions of Ibrance. The generic companies assert the invalidity and non-infringement of our crystalline form patent which expires in 2034. Beginning in October 2020, we brought patent infringement actions against each of these generic companies in various federal courts, asserting the validity and infringement of the crystalline form patent. Lyrica (pregabalin) U.K. In June 2014, Generics (U.K.) Ltd (trading as Mylan) filed an invalidity action against the Lyrica pain use patent in the High Court of Justice in London. Subsequently, Actavis Group PTC ehf filed an invalidity action in the same court, and Pfizer sued Actavis Group PTC ehf, Actavis U.K. Ltd and Caduceus Pharma Ltd (together, Actavis) for infringement and requested preliminary relief. Our request for preliminary relief was denied in a January 2015 hearing, and the denial subsequently was confirmed on appeal. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies In February 2015, the National Health Service (NHS) England was ordered by the High Court, as an intermediary, to issue guidance for prescribers and pharmacists directing the prescription and dispensing of Lyrica by brand when pregabalin was prescribed for the treatment of neuropathic pain. NHS Wales and NHS Northern Ireland also issued prescribing guidance. The guidance to prescribe and dispense Lyrica for neuropathic pain was withdrawn upon patent expiration in July 2017. We also filed infringement actions against (i) Teva UK Ltd, and (ii) Dr. Reddys Laboratories (UK) Ltd and Caduceus Pharma Ltd (together, Dr. Reddys) in February 2015, seeking the same relief as in the action against Actavis. Dr. Reddys filed an invalidity counterclaim. These actions were stayed pending the outcome of the Mylan and Actavis cases. The Mylan and Actavis invalidity actions were heard in the High Court at the same time as the Actavis infringement action. The High Court ruled against us, holding that the asserted claims were either not infringed or invalid, and appeals followed. In November 2018, the U.K. Supreme Court ruled that all the relevant claims directed to neuropathic pain were invalid. In October 2015, after Sandoz GmbH and Sandoz Ltd (together, Sandoz) launched a full label generic pregabalin product, we obtained from the High Court a preliminary injunction enjoining Sandoz from further sales of the product and ordering Sandoz to identify the parties holding its product. Sandoz identified wholesaler AAH Pharmaceuticals Ltd and pharmacy chain Lloyds Pharmacy Ltd (supplied by AAH), and we requested that these parties cease further sales and withdraw the Sandoz full label product. In October 2015, Lloyds was added to the Sandoz action, and we obtained a preliminary order from the High Court requiring Lloyds to advise its pharmacists that the Sandoz full label product should not be dispensed. In November 2015, the High Court confirmed the preliminary injunction against Sandoz and Lloyds. Sandoz filed an invalidity counterclaim. Upon agreement of the parties, in December 2015, the proceedings against Lloyds were discontinued, and the proceedings against Sandoz were stayed pending outcome of the Mylan and Actavis cases. The preliminary injunction against Sandoz remained in place until patent expiration in July 2017. In May 2020, Dr. Reddys filed a claim for damages in connection with the above-referenced legal actions. In July 2020, the Scottish Ministers and fourteen Scottish Health Boards (together, NHS Scotland) filed a claim for damages in connection with the above-referenced legal action concerning Sandoz. In September 2020, Teva, Sandoz, Ranbaxy, Inc. (Ranbaxy), Actavis, and the Secretary of State for Health and Social Care, together with 32 other National Health Service entities (together, NHS England, Wales, and Northern Ireland) filed claims for damages in the above-referenced legal actions. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Japan In January 2017, Sawai Pharmaceutical Company Limited (a Japanese generic company) (Sawai) filed an invalidation action against the Lyrica pain use patent in the Japanese Patent Office (JPO). Hexal AG has filed a separate invalidation action that was stayed pending the result of the Sawai action. Multiple parties were allowed to intervene in the Sawai case. In July 2020, the JPO recognized the validity of certain amended claims of the patent covering Lyrica. We are appealing the decision. In August 2020, the Japanese regulatory authority granted regulatory approval to multiple generic companies and we filed legal actions against the generic companies seeking preliminary and permanent injunctions to prevent infringement of our patent. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Matter Involving Our Collaboration/Licensing Partners Eliquis In February, March, and April 2017, twenty-five generic companies sent BMS Paragraph-IV certification letters informing BMS that they had filed ANDAs seeking approval of generic versions of Eliquis, challenging the validity and infringement of one or more of the three patents listed in the Orange Book for Eliquis. One of the patents expired in December 2019 and the remaining patents currently are set to expire in 2026 and 2031. Eliquis has been jointly developed and is being commercialized by BMS and Pfizer. In April 2017, BMS and Pfizer filed patent-infringement actions against all generic filers in the U.S. District Court for the District of Delaware and the U.S. District Court for the District of West Virginia, asserting that each of the generic companies proposed products would infringe each of the patent(s) that each generic filer challenged. Some generic filers challenged only the 2031 patent, some challenged both the 2031 and 2026 patent, and one generic company challenged all three patents. In August 2020, the U.S. District Court for the District of Delaware ruled that both the 2026 patent and the 2031 patent are valid and infringed by the proposed generic products. In August and September 2020, the generic filers appealed the District Courts decision to the U.S. Court of Appeals for the Federal Circuit. Prior to the August 2020 ruling, we and BMS settled with certain of the generic companies on terms not material to Pfizer, and we and BMS may settle with other generic companies in the future. A2. Legal ProceedingsProduct Litigation We are defendants in numerous cases, including but not limited to those discussed below, related to our pharmaceutical and other products. Plaintiffs in these cases seek damages and other relief on various grounds for alleged personal injury and economic loss. Asbestos Between 1967 and 1982, Warner-Lambert owned American Optical Corporation (American Optical), which manufactured and sold respiratory protective devices and asbestos safety clothing. In connection with the sale of American Optical in 1982, Warner-Lambert agreed to indemnify the purchaser for certain liabilities, including certain asbestos-related and other claims. Warner-Lambert was acquired by Pfizer in 2000 and is a wholly owned subsidiary of Pfizer. Warner-Lambert is actively engaged in the defense of, and will continue to explore various means of resolving, these claims. Numerous lawsuits against American Optical, Pfizer and certain of its previously owned subsidiaries are pending in various federal and state courts seeking damages for alleged personal injury from exposure to products allegedly containing asbestos and other allegedly hazardous materials sold by Pfizer and certain of its previously owned subsidiaries. There also are a small number of lawsuits pending in various federal and state courts seeking damages for alleged exposure to asbestos in facilities owned or formerly owned by Pfizer or its subsidiaries. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Effexor Beginning in May 2011, actions, including purported class actions, were filed in various federal courts against Wyeth and, in certain of the actions, affiliates of Wyeth and certain other defendants relating to Effexor XR, which is the extended-release formulation of Effexor. The plaintiffs in each of the class actions seek to represent a class consisting of all persons in the U.S. and its territories who directly purchased, indirectly purchased or reimbursed patients for the purchase of Effexor XR or generic Effexor XR from any of the defendants from June 14, 2008 until the time the defendants allegedly unlawful conduct ceased. The plaintiffs in all of the actions allege delay in the launch of generic Effexor XR in the U.S. and its territories, in violation of federal antitrust laws and, in certain of the actions, the antitrust, consumer protection and various other laws of certain states, as the result of Wyeth fraudulently obtaining and improperly listing certain patents for Effexor XR in the Orange Book, enforcing certain patents for Effexor XR and entering into a litigation settlement agreement with a generic drug manufacturer with respect to Effexor XR. Each of the plaintiffs seeks treble damages (for itself in the individual actions or on behalf of the putative class in the purported class actions) for alleged price overcharges for Effexor XR or generic Effexor XR in the U.S. and its territories since June 14, 2008. All of these actions have been consolidated in the U.S. District Court for the District of New Jersey. In October 2014, the District Court dismissed the direct purchaser plaintiffs claims based on the litigation settlement agreement, but declined to dismiss the other direct purchaser plaintiff claims. In January 2015, the District Court entered partial final judgments as to all settlement agreement claims, including those asserted by direct purchasers and end-payer plaintiffs, which plaintiffs appealed to the U.S. Court of Appeals for the Third Circuit. In August 2017, the U.S. Court of Appeals for the Third Circuit reversed the District Courts decisions and remanded the claims to the District Court. Lipitor Antitrust Actions Beginning in November 2011, purported class actions relating to Lipitor were filed in various federal courts against, among others, Pfizer, certain Pfizer affiliates, and, in most of the actions, Ranbaxy and certain Ranbaxy affiliates. The plaintiffs in these various actions seek to represent nationwide, multi-state or statewide classes consisting of persons or entities who directly purchased, indirectly purchased or reimbursed patients for the purchase of Lipitor (or, in certain of the actions, generic Lipitor) from any of the defendants from March 2010 until the cessation of the defendants allegedly unlawful conduct (the Class Period). The plaintiffs allege delay in the launch of generic Lipitor, in violation of federal antitrust laws and/or state antitrust, consumer protection and various other laws, resulting from (i) the 2008 agreement pursuant to which Pfizer and Ranbaxy settled certain patent litigation involving Lipitor and Pfizer granted Ranbaxy a license to sell a generic version of Lipitor in various markets beginning on varying dates, and (ii) in certain of the actions, the procurement and/or enforcement of certain patents for Lipitor. Each of the actions seeks, among other things, treble damages on behalf of the putative class for alleged price overcharges for Lipitor (or, in certain of the actions, generic Lipitor) during the Class Period. In addition, individual actions have been filed against Pfizer, Ranbaxy and certain of their affiliates, among others, that assert claims and seek relief for the plaintiffs that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. These various actions have been consolidated for pre-trial proceedings in a Multi-District Litigation ( In re Lipitor Antitrust Litigation MDL-2332 ) in the U.S. District Court for the District of New Jersey. In September 2013 and 2014, the District Court dismissed with prejudice the claims of the direct purchasers. In October and November 2014, the District Court dismissed with prejudice the claims of all other Multi-District Litigation plaintiffs. All plaintiffs have appealed the District Courts orders dismissing their claims with prejudice to the U.S. Court of Appeals for the Third Circuit. In addition, the direct purchaser class plaintiffs appealed the order denying their motion to amend the judgment and for leave to amend their complaint to the Court of Appeals. In August 2017, the Court of Appeals reversed the District Courts decisions and remanded the claims to the District Court. Also, in January 2013, the State of West Virginia filed an action in West Virginia state court against Pfizer and Ranbaxy, among others, that asserts claims and seeks relief on behalf of the State of West Virginia and residents of that state that are substantially similar to the claims asserted and the relief sought in the purported class actions described above. Personal Injury Actions A number of individual and multi-plaintiff lawsuits have been filed against Pfizer in various federal and state courts alleging that the plaintiffs developed type 2 diabetes purportedly as a result of the ingestion of Lipitor. Plaintiffs seek compensatory and punitive damages. In February 2014, the federal actions were transferred for consolidated pre-trial proceedings to a Multi-District Litigation ( In re Lipitor (Atorvastatin Calcium) Marketing, Sales Practices and Products Liability Litigation (No. II) MDL-2502 ) in the U.S. District Court for the District of South Carolina. Since 2016, certain cases in the Multi-District Litigation were remanded to certain state courts. In January 2017, the District Court granted our motion for summary judgment, dismissing substantially all of the remaining cases pending in the Multi-District Litigation. In January 2017, the plaintiffs appealed the District Courts decision to the U.S. Court of Appeals for the Fourth Circuit. In June 2018, the Court of Appeals affirmed the District Courts decision. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Viagra Since April 2016, a Multi-District Litigation has been pending in the U.S. District Court for the Northern District of California ( In Re: Viagra (Sildenafil Citrate) Products Liability Litigation, MDL-2691 ), in which plaintiffs allege that they developed melanoma and/or the exacerbation of melanoma purportedly as a result of the ingestion of Viagra. Additional cases filed against Lilly with respect to Cialis have also been consolidated in the Multi-District Litigation (In re: Viagra (Sildenafil Citrate) and Cialis (Tadalafil) Products Liability Litigation, MDL-2691 ). In January 2020, the District Court granted our and Lillys motion to exclude all of plaintiffs general causation opinions. As a result, in April 2020, the District Court entered summary judgment in favor of defendants and dismissed all of plaintiffs claims. In April 2020, plaintiffs filed a notice of appeal in the U.S. Court of Appeals for the Ninth Circuit. In November 2020, we and Mylan completed the transaction to spin-off our Upjohn Business and combine it with Mylan to form Viatris. As part of the transaction, Viatris has agreed to assume, and to indemnify Pfizer for, liabilities arising out of this matter. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies EpiPen Beginning in February 2017, purported class actions were filed in various federal courts by indirect purchasers of EpiPen against Pfizer, and/or its affiliates King and Meridian, and/or various entities affiliated with Mylan, and Mylan Chief Executive Officer, Heather Bresch. The plaintiffs in these actions seek to represent U.S. nationwide classes comprising persons or entities who paid for any portion of the end-user purchase price of an EpiPen between 2009 until the cessation of the defendants allegedly unlawful conduct. In February 2020, a similar lawsuit was filed in the U.S. District Court for the District of Kansas against Pfizer, King, Meridian and the Mylan entities on behalf of a purported U.S. nationwide class of direct purchaser plaintiffs who purchased EpiPen devices directly from the defendants (the 2020 Lawsuit). Against Pfizer and/or its affiliates, plaintiffs in these actions generally allege that Pfizers and/or its affiliates settlement of patent litigation regarding EpiPen delayed market entry of generic EpiPen in violation of federal antitrust laws and various state antitrust laws. At least one lawsuit also alleges that Pfizer and/or Mylan violated the federal Racketeer Influenced and Corrupt Organizations Act (RICO). Plaintiffs also filed various federal antitrust, state consumer protection and unjust enrichment claims against, and relating to conduct attributable solely to, Mylan and/or its affiliates regarding EpiPen. Plaintiffs seek treble damages for alleged overcharges for EpiPen since 2011. In August 2017, all of these actions, except for the 2020 Lawsuit, were consolidated for coordinated pre-trial proceedings in a Multi-District Litigation ( In re: EpiPen (Epinephrine Injection, USP) Marketing, Sales Practices and Antitrust Litigation, MDL-2785 ) in the U.S. District Court for the District of Kansas with other EpiPen-related actions against Mylan and/or its affiliates to which Pfizer, King and Meridian are not parties. In July 2020, a new lawsuit was filed in the U.S. District Court for the District of Colorado on behalf of indirect purchasers. Plaintiff represents a putative U.S. nationwide class of persons or entities who paid for any portion of the end-user purchase price of certain refill or replacement EpiPens since 2010. Plaintiff alleges that Pfizer and Meridian misrepresented the shelf-life and expiration date of EpiPen, in violation of the federal RICO statute. Plaintiff seeks treble damages for alleged unnecessary replacement or refill purchases of EpiPens by members of the putative class. Nexium 24HR and Protonix A number of individual and multi-plaintiff lawsuits have been filed against Pfizer, certain of its subsidiaries and/or other pharmaceutical manufacturers in various federal and state courts alleging that the plaintiffs developed kidney-related injuries purportedly as a result of the ingestion of certain proton pump inhibitors. The cases against Pfizer involve Protonix and/or Nexium 24HR and seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In August 2017, the federal actions were ordered transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re: Proton-Pump Inhibitor Products Liability Litigation (No. II)) in the U.S. District Court for the District of New Jersey. In 2019, we and GSK combined our respective consumer healthcare businesses into a new Consumer Healthcare JV that operates globally under the GSK Consumer Healthcare name. As part of the JV transaction, the JV has agreed to assume, and to indemnify Pfizer for, liabilities arising out of such litigation to the extent related to Nexium 24HR. Docetaxel Personal Injury Actions A number of lawsuits have been filed against Hospira and Pfizer in various federal and state courts alleging that plaintiffs who were treated with Docetaxel developed permanent hair loss. The significant majority of the cases also name other defendants, including the manufacturer of the branded product, Taxotere. Plaintiffs seek compensatory and punitive damages. In October 2016, the federal cases were transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re Taxotere (Docetaxel) Products Liability Litigation, MDL-2740 ) in the U.S. District Court for the Eastern District of Louisiana. Mississippi Attorney General Government Action In October 2018, the Attorney General of Mississippi filed a complaint in Mississippi state court against the manufacturer of the branded product and eight other manufacturers including Pfizer and Hospira, alleging, with respect to Pfizer and Hospira, a failure to warn about a risk of permanent hair loss in violation of the Mississippi Consumer Protection Act. The action seeks civil penalties and injunctive relief. Array Securities Litigation In November 2017, two purported class actions were filed in the U.S. District Court for the District of Colorado alleging that Array, which we acquired in July 2019 and is our wholly owned subsidiary, and certain of its former officers violated federal securities laws in connection with certain disclosures made, or omitted, by Array regarding the NRAS-mutant melanoma program. In March 2018, the actions were consolidated into a single proceeding. Zantac A number of lawsuits have been filed against Pfizer in various federal and state courts alleging that plaintiffs developed various types of cancer, or face an increased risk of developing cancer, purportedly as a result of the ingestion of Zantac. The significant majority of these cases also name other defendants that have historically manufactured and/or sold Zantac. Pfizer has not sold Zantac since 2006, and only sold an OTC version of the product. Plaintiffs seek compensatory and punitive damages and, in some cases, treble damages, restitution or disgorgement. In February 2020, the federal actions were transferred for coordinated pre-trial proceedings to a Multi-District Litigation ( In re Zantac/Ranitidine NDMA Litigation, MDL-2924 ) in the U.S. District Court for the Southern District of Florida. From June to December 2020: (i) plaintiffs in the Multi-District Litigation filed against Pfizer and many other defendants a consolidated consumer class action complaint alleging, among other things, violations of the RICO statute and consumer protection statutes of all 50 states, and a consolidated third-party payor class action complaint alleging violation of the RICO statute and seeking reimbursement for payments made for the prescription version of Zantac; (ii) Pfizer received service of two Canadian class action complaints naming Pfizer and other defendants, and seeking compensatory and punitive damages for personal injury and economic loss, allegedly arising from the defendants sale of Zantac in Canada; (iii) the State of New Mexico filed a civil action against Pfizer and many other defendants, alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in New Mexico; and (iv) Pfizer received service of a suit filed by the Mayor and City Council of Baltimore naming Pfizer and other defendants alleging various claims under Maryland law. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies A3. Legal ProceedingsCommercial and Other Matters Monsanto-Related Matters In 1997, Monsanto Company (Former Monsanto) contributed certain chemical manufacturing operations and facilities to a newly formed corporation, Solutia Inc. (Solutia), and spun off the shares of Solutia. In 2000, Former Monsanto merged with Pharmacia Upjohn Company to form Pharmacia. Pharmacia then transferred its agricultural operations to a newly created subsidiary, named Monsanto Company (New Monsanto), which it spun off in a two-stage process that was completed in 2002. Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. In connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities related to Pharmacias former agricultural business. New Monsanto has defended and/or is defending Pharmacia in connection with various claims and litigation arising out of, or related to, the agricultural business, and has been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. In connection with its spin-off in 1997, Solutia assumed, and agreed to indemnify Pharmacia for, liabilities related to Former Monsantos chemical businesses. As the result of its reorganization under Chapter 11 of the U.S. Bankruptcy Code, Solutias indemnification obligations relating to Former Monsantos chemical businesses are primarily limited to sites that Solutia has owned or operated. In addition, in connection with its spin-off that was completed in 2002, New Monsanto assumed, and agreed to indemnify Pharmacia for, any liabilities primarily related to Former Monsantos chemical businesses, including, but not limited to, any such liabilities that Solutia assumed. Solutias and New Monsantos assumption of, and agreement to indemnify Pharmacia for, these liabilities apply to pending actions and any future actions related to Former Monsantos chemical businesses in which Pharmacia is named as a defendant, including, without limitation, actions asserting environmental claims, including alleged exposure to polychlorinated biphenyls. Solutia and/or New Monsanto are defending Pharmacia in connection with various claims and litigation arising out of, or related to, Former Monsantos chemical businesses, and have been indemnifying Pharmacia when liability has been imposed or settlement has been reached regarding such claims and litigation. Environmental Matters In 2009, we submitted to the U.S. Environmental Protection Agency (EPA) a corrective measures study report with regard to Pharmacias discontinued industrial chemical facility in North Haven, Connecticut. In September 2010, our corrective measures study report was approved by the EPA, and we commenced construction of the site remedy in late 2011 under an Updated Administrative Order on Consent with the EPA. In September 2019, the EPA acknowledged that construction of the site remedy has been completed. Also in 2009, we submitted a revised site-wide feasibility study with regard to Wyeth Holdings Corporations (formerly, American Cyanamid Company) discontinued industrial chemical facility in Bound Brook, New Jersey. In July 2011, Wyeth Holdings Corporation executed an Administrative Settlement Agreement and Order on Consent for Removal Action (the 2011 Administrative Settlement Agreement) with the EPA with regard to the Bound Brook facility. In accordance with the 2011 Administrative Settlement Agreement, we completed construction of an interim remedy to address the discharge of impacted groundwater from the facility to the Raritan River. In September 2012, the EPA issued a final remediation plan for the Bound Brook facilitys main plant area, which is generally in accordance with one of the remedies evaluated in our revised site-wide feasibility study. In March 2013, Wyeth Holdings Corporation (now Wyeth Holdings LLC) entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the main plant area and to perform a focused feasibility study for two adjacent lagoons. In September 2015, the U.S., on behalf of the EPA, filed a complaint and consent decree with the federal District Court for the District of New Jersey that allows Wyeth Holdings LLC to complete the design and to implement the remedy for the main plant area. The consent decree (which supersedes the 2011 Administrative Settlement Agreement) was entered by the District Court in December 2015. In September 2018, the EPA issued a final remediation plan for the two adjacent lagoons, which is generally in accordance with one of the remedies evaluated in our focused feasibility study, and, in September 2019, Wyeth Holdings LLC entered into an Administrative Settlement Agreement and Order on Consent with the EPA to allow us to undertake detailed engineering design of the remedy for the lagoons. We have accrued for the estimated costs of the site remedies for the North Haven and Bound Brook facilities. We are a party to a number of other proceedings brought under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, and other state, local or foreign laws in which the primary relief sought is the cost of past and/or future remediation. Contracts with Iraqi Ministry of Health In October 2017, a number of U.S. service members, civilians, and their families brought a complaint in the U.S. District Court for the District of Columbia against a number of pharmaceutical and medical devices companies, including Pfizer and certain of its subsidiaries, alleging that the defendants violated the U.S. Anti-Terrorism Act. The complaint alleges that the defendants provided funding for terrorist organizations through their sales practices pursuant to pharmaceutical and medical device contracts with the Iraqi Ministry of Health, and seeks monetary relief. In July 2020, the District Court granted defendants motions to dismiss and dismissed all of plaintiffs claims. The plaintiffs are appealing the District Courts decision. Allergan Complaint for Indemnity In August 2018, Pfizer was named as a defendant in a third-party complaint for indemnity, along with King, filed by Allergan Finance LLC (Allergan) in a Multi-District Litigation ( In re National Prescription Opiate Litigation MDL 2804 ) in the U.S. District Court for the Northern District of Ohio. The lawsuit asserted claims for indemnity related to Kadian, which was owned for a short period by King in 2008, prior to Pfizer's acquisition of King in 2010. In December 2018, the District Court dismissed the lawsuit. In February 2019, Allergan filed a similar complaint in the Supreme Court of the State of New York, asserting claims for indemnity related to Kadian. That suit was voluntarily discontinued without prejudice in January 2021. Breach of ContractXalkori/Lorbrena We are a defendant in a breach of contract action brought by New York University (NYU) in the Supreme Court of the State of New York (Supreme Court). NYU alleges that it is entitled to royalties on Pfizers sales of Xalkori under the terms of a Research and License Agreement between NYU and Sugen, Inc. Sugen, Inc. was acquired by Pharmacia in August 1999, and Pharmacia was acquired by Pfizer in 2003 and is a wholly owned subsidiary of Pfizer. The action was originally filed in 2013. In December 2015, the Supreme Court dismissed the action and, in Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies May 2017, the New York State Appellate Division reversed the decision and remanded the proceedings to the Supreme Court. In January 2020, the Supreme Court denied both parties summary judgment motions. In October 2020, NYU filed a separate breach of contract action against Pfizer alleging that it is entitled to royalties on sales of Lorbrena under the terms of the same NYU-Sugen, Inc. Research and Licensing Agreement. A4. Legal ProceedingsGovernment Investigations We are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Among the investigations by government agencies are the matters discussed below. Greenstone Investigations U.S. Department of Justice Antitrust Division Investigation Since July 2017, the U.S. Department of Justice's Antitrust Division has been investigating our former Greenstone generics business. We believe this is related to an ongoing broader antitrust investigation of the generic pharmaceutical industry. The government has been obtaining information from Greenstone relating to this investigation. State Attorneys General Generics Antitrust Litigation In April 2018, Greenstone received requests for information from the Antitrust Department of the Connecticut Office of the Attorney General. In May 2019, Attorneys General of more than 40 states plus the District of Columbia and Puerto Rico filed a complaint against a number of pharmaceutical companies, including Greenstone and Pfizer. The matter has been consolidated with a Multi-District Litigation ( In re: Generic Pharmaceuticals Pricing Antitrust Litigation MDL No. 2724) in the Eastern District of Pennsylvania. As to Greenstone and Pfizer, the complaint alleges anticompetitive conduct in violation of federal and state antitrust laws and state consumer protection laws. In June 2020, the State Attorneys General filed a new complaint against a large number of companies, including Greenstone and Pfizer, making similar allegations, but concerning a new set of drugs. This complaint was transferred to the Multi-District Litigation in July 2020. Subpoena relating to Manufacturing of Quillivant XR In October 2018, we received a subpoena from the U.S. Attorneys Office for the Southern District of New York (SDNY) seeking records relating to our relationship with another drug manufacturer and its production and manufacturing of drugs including, but not limited to, Quillivant XR. We have produced records pursuant to the subpoena. Government Inquiries relating to Meridian Medical Technologies In February 2019, we received a civil investigative demand from the U.S. Attorneys Office for the SDNY. The civil investigative demand seeks records and information related to alleged quality issues involving the manufacture of auto-injectors at our Meridian site. In August 2019, we received a HIPAA subpoena from the U.S. Attorneys Office for the Eastern District of Missouri seeking similar records and information. We are producing records in response to these requests. U.S. Department of Justice/SEC Inquiry relating to Russian Operations In June 2019, we received an informal request from the U.S. Department of Justices Foreign Corrupt Practices Act (FCPA) Unit seeking documents relating to our operations in Russia. In September 2019, we received a similar request from the SECs FCPA Unit. We have produced records pursuant to these requests. Docetaxel Mississippi Attorney General Government Investigation See Note 16A2. Contingencies and Certain Commitments: Legal Proceedings Product Litigation Docetaxel Mississippi Attorney General Government Investigation above for information regarding a government investigation related to Docetaxel marketing practices. U.S. Department of Justice Inquiries relating to India Operations In March 2020, we received an informal request from the U.S. Department of Justice's Consumer Protection Branch seeking documents relating to our manufacturing operations in India, including at our former facility located at Irrungattukottai in India. In April 2020, we received a similar request from the U.S. Attorneys Office for the SDNY regarding a civil investigation concerning operations at our facilities in India. We are producing records pursuant to these requests. U.S. Department of Justice/SEC Inquiry relating to China Operations In June 2020, we received an informal request from the U.S. Department of Justice's FCPA Unit seeking documents relating to our operations in China. In August 2020, we received a similar request from the SECs FCPA Unit. We are producing records pursuant to these requests. Zantac State of New Mexico Civil Action See Note 16A2. Contingencies and Certain Commitments: Legal ProceedingsProduct LitigationZantac above for information regarding a civil action filed by the State of New Mexico alleging various state statutory and common law claims in connection with the defendants alleged sale of Zantac in New Mexico. A5. Legal ProceedingsMatters Resolved During 2020 During the full-year 2020, certain matters, including the matter discussed below, were resolved or became the subject of definitive settlement agreements or settlement agreements-in-principle. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies Hormone Therapy Consumer Class Action A certified consumer class action was pending against Wyeth in the U.S. District Court for the Southern District of California based on the alleged off-label marketing of its hormone therapy products. The case was originally filed in December 2003. The class consisted of California consumers who purchased Wyeths hormone-replacement products between January 1995 and January 2003 and who did not seek personal injury damages therefrom. The class sought compensatory and punitive damages, including a full refund of the purchase price. In March 2020, the parties reached an agreement, and obtained preliminary court approval, to resolve this matter for $ 200 million, which was paid in full in the second quarter of 2020. B. Guarantees and Indemnifications In the ordinary course of business and in connection with the sale of assets and businesses and other transactions, we often indemnify our counterparties against certain liabilities that may arise in connection with the transaction or that are related to events and activities prior to or following a transaction. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we may be required to reimburse the loss. These indemnifications are generally subject to various restrictions and limitations. Historically, we have not paid significant amounts under these provisions and, as of December 31, 2020, the estimated fair value of these indemnification obligations was not significant. In addition, in connection with our entry into certain agreements and other transactions, our counterparties may agree to indemnify us. For example, our collaboration agreement with EMD Serono, Inc. to co-promote Rebif in the U.S. expired at the end of 2015 and included certain indemnity provisions. Patent litigation brought by Biogen Idec MA Inc. against EMD Serono Inc. and Pfizer is pending in the U.S. District Court for the District of New Jersey and the United States Court of Appeals for the Federal Circuit. EMD Serono Inc. has acknowledged that it is obligated to satisfy any award of damages. We have also guaranteed the long-term debt of certain companies that we acquired and that now are subsidiaries of Pfizer. See Note 7D . C. Certain Commitments As of December 31, 2020, we had agreements totaling $ 3.8 billion to purchase goods and services that are enforceable and legally binding and include amounts relating to advertising, information technology services, employee benefit administration services, and potential milestone payments deemed reasonably likely to occur. See Note 5A for information on the TCJA repatriation tax liability. D. Contingent Consideration for Acquisitions We may be required to make payments to sellers for certain prior business combinations that are contingent upon future events or outcomes. See Note 1D . The estimated fair value of contingent consideration as of December 31, 2020 is $ 689 million, of which $ 123 million is recorded in Other current liabilities and $ 566 million in Other noncurrent liabilities and $ 711 million, of which $ 160 million is recorded in Other current liabilities and $ 551 million in Other noncurrent liabilities as of December 31, 2019. The decrease in the contingent consideration balance from December 31, 2019 is primarily due to payments made upon the achievement of certain sales-based milestones, partially offset by fair value adjustments. E. Insurance Our insurance coverage reflects market conditions (including cost and availability) existing at the time it is written, and our decision to obtain insurance coverage or to self-insure varies accordingly. Depending upon the cost and availability of insurance and the nature of the risk involved, the amount of self-insurance may be significant. The cost and availability of coverage have resulted in self-insuring certain exposures, including product liability. If we incur substantial liabilities that are not covered by insurance or substantially exceed insurance coverage and that are in excess of existing accruals, there could be a material adverse effect on our cash flows or results of operations in the period in which the amounts are paid and/or accrued. Note 17 . Product, Geographic and Other Revenue Information A. Geographic Information The following summarizes revenues by geographic area: Year Ended December 31, (MILLIONS OF DOLLARS) 2020 2019 2018 United States $ 21,712 $ 20,593 $ 20,119 Developed Europe 7,788 7,729 7,997 Developed Rest of World 4,036 4,022 4,090 Emerging Markets 8,372 8,828 8,618 Revenues $ 41,908 $ 41,172 $ 40,825 Revenues exceeded $500 million in each of 8 , 10 and 10 countries outside the U.S. in 2020, 2019 and 2018, respectively. The U.S. is the only country to contribute more than 10 % of total revenue in 2020, 2019 and 2018. As a percentage of revenues, our two largest national markets outside the U.S. were China, which contributed 6 % of total revenue in each of 2020, 2019 and 2018, and Japan, which contributed 6 % of total revenue in 2020 and 5 % in each of 2019 and 2018. Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies B. Other Revenue Information Significant Customers We sell our biopharmaceutical products primarily to customers in the wholesale sector. The following summarizes revenue, as a percentage of total revenues, for our three largest U.S. wholesaler customers: Year Ended December 31, 2020 2019 2018 McKesson, Inc. 16 % 15 % 13 % AmerisourceBergen Corporation 13 % 11 % 8 % Cardinal Health, Inc. 10 % 9 % 8 % Collectively, our three largest U.S. wholesaler customers represented 30 %, 25 % and 29 % of total trade accounts receivable as of December 31, 2020, 2019 and 2018. Significant Product Revenues The following provides detailed revenue information for several of our major products: (MILLIONS OF DOLLARS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2020 2019 2018 TOTAL REVENUES (a) $ 41,908 $ 41,172 $ 40,825 Internal Medicine (a) $ 9,003 $ 8,790 $ 8,548 Eliquis alliance revenues and direct sales Nonvalvular atrial fibrillation, deep vein thrombosis, pulmonary embolism 4,949 4,220 3,434 Chantix/Champix An aid to smoking cessation treatment in adults 18 years of age or older 919 1,107 1,085 Premarin family Symptoms of menopause 680 734 832 BMP2 Development of bone and cartilage 274 287 279 Toviaz Overactive bladder 252 250 271 All other Internal Medicine Various 1,930 2,192 2,648 Oncology $ 10,867 $ 9,014 $ 7,471 Ibrance Metastatic breast cancer 5,392 4,961 4,118 Xtandi alliance revenues mCRPC, nmCRPC, mCSPC 1,024 838 699 Sutent Advanced and/or metastatic RCC, adjuvant RCC, refractory GIST (after disease progression on, or intolerance to, imatinib mesylate) and advanced pancreatic neuroendocrine tumor 819 936 1,049 Inlyta Advanced RCC 787 477 298 Xalkori ALK-positive and ROS1-positive advanced NSCLC 544 530 524 Bosulif Philadelphia chromosomepositive chronic myelogenous leukemia 450 365 296 Retacrit (b) Anemia 386 225 82 Lorbrena ALK-positive metastatic NSCLC 204 115 11 Ruxience (b) Non-hodgkins lymphoma, chronic lymphocytic leukemia, granulomatosis with polyangiitis (Wegeners Granulomatosis) and microscopic polyangiitis 170 ( 1 ) Braftovi In combination with Mektovi for metastatic melanoma for patients who test positive for a BRAF genetic mutation and, in combination with Erbitux (cetuximab), for the treatment of BRAF V600E -mutant mCRC after prior therapy 160 48 Zirabev (b) Treatment of mCRC; unresectable, locally advanced, recurrent or metastatic NSCLC; recurrent glioblastoma; metastatic RCC; and persistent, recurrent or metastatic cervical cancer 143 1 Mektovi In combination with Braftovi for metastatic melanoma for patients who test positive for a BRAF genetic mutation 142 49 All other Oncology Various 645 470 395 Hospital (a), (c) $ 7,961 $ 7,772 $ 7,955 Sulperazon Bacterial infections 618 684 613 Medrol Anti-inflammatory glucocorticoid 402 469 493 EpiPen (a) Epinephrine injection used in treatment of life-threatening allergic reactions 297 303 303 Zithromax Bacterial infections 276 336 326 Vfend Fungal infections 270 346 392 Panzyga Primary humoral immunodeficiency 269 183 39 Precedex Sedation agent in surgery or intensive care 260 155 213 Fragmin Treatment/prevention of venous thromboembolism 252 253 293 Zyvox Bacterial infections 222 251 236 Zavicefta Bacterial infections 212 108 46 Pfizer CentreOne (d) Various 926 810 755 All other Anti-infectives Various 1,455 1,592 1,661 Pfizer Inc. 2020 Form 10-K Notes to Consolidated Financial Statements Pfizer Inc. and Subsidiary Companies (MILLIONS OF DOLLARS) Year Ended December 31, PRODUCT PRIMARY INDICATION OR CLASS 2020 2019 2018 All other Hospital (c) Various 2,502 2,281 2,584 Vaccines $ 6,575 $ 6,504 $ 6,332 Prevnar 13/Prevenar 13 Pneumococcal disease 5,850 5,847 5,802 Nimenrix Meningococcal disease 221 230 140 FSME/IMMUN-TicoVac Tick-borne encephalitis disease 196 220 184 BNT162b2 Active immunization to prevent COVID-19 in individuals 16 years of age and older 154 All other Vaccines Various 154 207 206 Inflammation Immunology (II) $ 4,567 $ 4,733 $ 4,720 Xeljanz RA, PsA, UC, active polyarticular course juvenile idiopathic arthritis 2,437 2,242 1,774 Enbrel (Outside the U.S. and Canada) RA, juvenile idiopathic arthritis, PsA, plaque psoriasis, pediatric plaque psoriasis, ankylosing spondylitis and nonradiographic axial spondyloarthritis 1,350 1,699 2,112 Inflectra/Remsima (b) Crohns disease, pediatric Crohns disease, UC, pediatric UC, RA in combination with methotrexate, ankylosing spondylitis, PsA and plaque psoriasis 659 625 642 All other II Various 121 167 192 Rare Disease $ 2,936 $ 2,278 $ 2,211 Vyndaqel/Vyndamax ATTR-cardiomyopathy and polyneuropathy 1,288 473 148 BeneFIX Hemophilia B 454 488 554 Genotropin Replacement of human growth hormone 427 498 558 Refacto AF/Xyntha Hemophilia A 370 426 514 Somavert Acromegaly 277 264 267 All other Rare Disease Various 120 129 170 Consumer Healthcare Business (e) $ $ 2,082 $ 3,587 Total Alliance revenues $ 5,418 $ 4,648 $ 3,838 Total Biosimilars (b) $ 1,527 $ 911 $ 769 Total Sterile Injectable Pharmaceuticals (a). (f) $ 5,315 $ 5,013 $ 5,173 (a) On November 16, 2020, we completed the spin-off and the combination of our Upjohn Business with Mylan to form Viatris. On December 21, 2020, Pfizer and Viatris completed the termination of a pre-existing strategic collaboration between Pfizer and Mylan for generic drugs in Japan (Mylan-Japan) and we transferred the operations that were part of the Mylan-Japan collaboration to Viatris. Beginning in the fourth quarter of 2020, the financial results of the Upjohn Business and the Mylan-Japan collaboration are reported as Income from discontinued operationsnet of tax for all periods presented. Prior-period financial information has been restated, as appropriate. Prior to the separation of the Upjohn Business, and beginning in 2020, Upjohn began managing our Meridian subsidiary, the manufacturer of EpiPen and other auto-injector products, and the Mylan-Japan collaboration. As a result, revenues associated with our Meridian subsidiary, except for product revenues for EpiPen sold in Canada, and Mylan-Japan were reported in Upjohn beginning in the first quarter of 2020. Beginning in the fourth quarter of 2020, the results of our Meridian subsidiary are reported in the Hospital therapeutic area for all periods presented in our consolidated financial statements. (b) Biosimilars are highly similar versions of approved and authorized biological medicines and primarily include revenues from Inflectra/Remsima, Retacrit, Ruxience and Zirabev. (c) Hospital is a therapeutic area that commercializes our global portfolio of sterile injectable and anti-infective medicines. Hospital also includes Pfizer CentreOne (d) . All other Hospital primarily includes revenues from legacy Sterile Injectable Pharmaceuticals (SIP) products (that are not anti-infective products) and, to a much lesser extent, solid oral dose products (that are not anti-infective products). SIP anti-infective products that are not individually listed above are recorded in All other Anti-infectives. (d) Pfizer CentreOne includes revenues from our contract manufacturing and active pharmaceutical ingredient sales operation, including sterile injectables contract manufacturing, and revenues related to our manufacturing and supply agreements. (e) On July 31, 2019, our Consumer Healthcare business, an OTC medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare JV. See Note 2C . (f) Total Sterile Injectable Pharmaceuticals represents the total of all branded and generic injectable products in the Hospital therapeutic area, including anti-infective sterile injectable pharmaceuticals . Contract Liabilities Our contract liabilities primarily relate to advance payments received or receivable in connection with contracts that we entered into during 2020 with various government or government sponsored customers in international markets for supply of BNT162b2. The deferred revenue associated with these advance payments totals approximately $ 957 million as of December 31, 2020 and are recorded in Other current liabilities . The deferred revenue will be recognized in Revenues proportionately as we deliver doses of the vaccine to our customers and satisfy our performance obligation under the contracts, which we expect to fully occur during 2021. Contract liabilities associated with other customer contracts were not significant as of December 31, 2020 or 2019. Pfizer Inc. 2020 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS OF DOLLARS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2020 (a) Revenues $ 10,083 $ 9,864 $ 10,277 $ 11,684 Costs and expenses (b) 7,219 6,559 8,716 11,323 Restructuring charges and certain acquisition-related costs 54 360 2 184 (Gain) on completion of Consumer Healthcare JV transaction (6) Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,817 2,944 1,559 178 Provision/(benefit) for taxes on income/(loss) 355 396 (104) (170) Income/(loss) from continuing operations 2,462 2,548 1,663 348 Income from discontinued operationsnet of tax (c) 948 887 539 257 Net income/(loss) before allocation to noncontrolling interests 3,410 3,434 2,202 605 Less: Net income attributable to noncontrolling interests 9 8 8 11 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,401 $ 3,426 $ 2,194 $ 594 Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.46 $ 0.30 $ 0.06 Income from discontinued operationsnet of tax (c) 0.17 0.16 0.10 0.05 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.61 $ 0.62 $ 0.39 $ 0.11 Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.44 $ 0.45 $ 0.29 $ 0.06 Income from discontinued operationsnet of tax (c) 0.17 0.16 0.10 0.05 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.61 $ 0.61 $ 0.39 $ 0.10 (a) Business development activities impacted our results of operations in 2020 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. Certain asset impairments totaled $900 million in the third quarter of 2020 and $791 million in the fourth quarter of 2020 recorded in Other (income)/deductionsnet . See Note 4. (c) Operating results of the Upjohn Business and the Mylan-Japan collaboration are presented as discontinued operations in all periods presented following the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan and the December 21, 2020 termination of the Mylan-Japan collaboration. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. Pfizer Inc. 2020 Form 10-K Selected Quarterly Financial Data (Unaudited) Pfizer Inc. and Subsidiary Companies Quarter (MILLIONS OF DOLLARS, EXCEPT PER COMMON SHARE DATA) First Second Third Fourth 2019 (a) Revenues $ 9,957 $ 10,363 $ 10,402 $ 10,449 Costs and expenses (b) 7,839 8,257 8,695 12,380 Restructuring charges and certain acquisition-related costs (c), (d) 39 (122) 351 333 (Gain) on completion of Consumer Healthcare JV transaction (d) (8,087) 1 Income/(loss) from continuing operations before provision/(benefit) for taxes on income/(loss) 2,079 2,228 9,442 (2,264) Provision/(benefit) for taxes on income/(loss) (e) 142 (1,169) 2,866 (1,221) Income/(loss) from continuing operations 1,937 3,397 6,576 (1,043) Income from discontinued operationsnet of tax (f) 1,952 1,659 1,107 716 Net income/(loss) before allocation to noncontrolling interests 3,889 5,056 7,684 (327) Less: Net income attributable to noncontrolling interests 6 10 4 10 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 3,884 $ 5,046 $ 7,680 $ (337) Earnings/(loss) per common sharebasic: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.34 $ 0.61 $ 1.19 $ (0.19) Income from discontinued operationsnet of tax (f) 0.35 0.30 0.20 0.13 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.69 $ 0.91 $ 1.38 $ (0.06) Earnings/(loss) per common sharediluted: Income/(loss) from continuing operations attributable to Pfizer Inc. common shareholders $ 0.34 $ 0.60 $ 1.16 $ (0.19) Income from discontinued operationsnet of tax (f) 0.34 0.29 0.20 0.13 Net income/(loss) attributable to Pfizer Inc. common shareholders $ 0.68 $ 0.89 $ 1.36 $ (0.06) (a) Business development activities impacted our results of operations in 2019 . See Note 1A. (b) The fourth quarter historically reflects higher costs in Cost of sales, Selling, informational and administrative expenses and Research and development expenses. The fourth quarter of 2019 includes $2.6 billion in certain asset impairments recorded in Other (income)/deductionsnet . See Note 4. (c) The second quarter of 2019 includes the reversal of certain accruals related to our acquisition of Wyeth upon the effective favorable settlement of an IRS audit from multiple tax years. See Note 5B . The third quarter of 2019 includes $217 million of integration costs and other, primarily including $157 million in payments to Array employees for the fair value of previously unvested stock options that was recognized as post-closing compensation expense. See Note 2A . The fourth quarter of 2019 primarily includes employee termination costs, asset impairments and other exit costs associated with cost reduction initiatives. The employee termination costs are mostly associated with our improvements to operational effectiveness as part of the realignment of our organizational structure and for the Transforming to a More Focused Company program. See Note 3. (d) See Note 2C. (e) During the second quarter of 2019, Pfizer reached settlement of disputed issues at the IRS Office of Appeals, thereby settling all issues related to U.S. tax returns of Pfizer for the years 2009-2010. As a result of settling these years, in the second quarter of 2019 we recorded a benefit of approximately $1.4 billion, representing tax and interest. The third quarter of 2019 reflects tax expense of approximately $2.7 billion associated with the gain related to the completion of the Consumer Healthcare JV. (f) Operating results of the Upjohn Business and the Mylan-Japan collaboration are presented as discontinued operations in all periods presented following the November 16, 2020 spin-off and combination of our Upjohn Business with Mylan and the December 21, 2020 termination of the Mylan-Japan collaboration. See Note 2B. Basic and diluted EPS are computed independently for each of the periods presented. Accordingly, the sum of the quarterly EPS amounts may not agree to the total for the year. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures As of the end of the period covered by this Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. Pfizer Inc. 2020 Form 10-K Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting The Board of Directors and Shareholders of Pfizer Inc.: Opinion on Internal Control Over Financial Reporting We have audited Pfizer Inc. and Subsidiary Companies (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Pfizer Inc. and Subsidiary Companies as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated February 25, 2021 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. KPMG LLP New York, New York February 25, 2021 Pfizer Inc. 2020 Form 10-K Managements Report on Internal Control Over Financial Reporting Managements Report We prepared and are responsible for the financial statements that appear in this Form 10-K. These financial statements are in conformity with accounting principles generally accepted in the United States of America and, therefore, include amounts based on informed judgments and estimates. We also accept responsibility for the preparation of other financial information that is included in this document. Report on Internal Control Over Financial Reporting The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. The Companys internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal ControlIntegrated Framework (2013) . Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020. The Companys independent auditors have issued their auditors report on the Companys internal control over financial reporting. That report appears above in this Form 10-K . Albert Bourla Chairman and Chief Executive Officer Frank DAmelio Jennifer B. Damico Principal Financial Officer Principal Accounting Officer February 25, 2021 Pfizer Inc. 2020 Form 10-K PART III " +2,pfe-,10kshell," Item 1. BusinessAbout Pfizer section in this 2019 Form 10-K. ** As of January 28, 2020 Pfizer Inc. 2019 Form 10-K iv PART I ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development, manufacture and distribution of healthcare products, including innovative medicines and vaccines. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us . The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our Companys purpose: Breakthroughs that change patients lives . By doing so, we expect to create value for the patients we serve and for our colleagues and shareholders. With the formation of the GSK Consumer Healthcare joint venture and the pending combination of Upjohn with Mylan, which are further discussed below, Pfizer is transforming itself into a more focused, global leader in science-based innovative medicines. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: License Agreement with Akcea Therapeutics, Inc. In October 2019, we entered into a worldwide exclusive licensing agreement for AKCEA-ANGPTL3-LRx, an investigational antisense therapy being developed to treat patients with certain cardiovascular and metabolic diseases, with Akcea, a majority-owned affiliate of Ionis. The transaction closed in November 2019 and we made an upfront payment of $250 million to Akcea and Ionis. Formation of a New Consumer Healthcare Joint Venture On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates globally under the GSK Consumer Healthcare name. The joint venture is a category leader in pain relief, respiratory and vitamins, minerals and supplements, and therapeutic oral health and is the largest global OTC consumer healthcare business. In exchange for contributing our Consumer Healthcare business to the joint venture, we received a 32% equity stake in the new company and GSK owns the remaining 68% . Acquisition of Array BioPharma Inc. On July 30, 2019, we acquired Array, a commercial stage biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule medicines to treat cancer and other diseases of high unmet need, for $48 per share in cash. The total fair value of the consideration transferred for Array was approximately $11.2 billion ($10.9 billion, net of cash acquired). Agreement to Combine Upjohn with Mylan N.V. On July 29, 2019, we announced that we entered into a definitive agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, Viatris. Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, Upjohn is expected to be spun off or split off to Pfizers shareholders and, immediately thereafter, combined with Mylan. Pfizer shareholders would own 57% of the combined new company, and former Mylan shareholders would own 43%. The transaction is expected to be tax free to Pfizer and Pfizer shareholders. The transaction is anticipated to close in mid-2020, subject to Mylan shareholder approval and satisfaction of other customary closing conditions, including receipt of regulatory approvals. Pfizer Inc. 2019 Form 10-K Acquisition of Therachon Holding AG On July 1, 2019, we acquired all the remaining shares of Therachon Holding AG, a privately-held clinical-stage biotechnology company focused on rare diseases, with assets in development for the treatment of achondroplasia, a genetic condition and the most common form of short-limb dwarfism, for $340 million upfront, plus potential milestone payments of up to $470 million, contingent on the achievement of key milestones in the development and commercialization of the lead asset. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Development Initiatives and Our Strategy sections and the Notes to Consolidated Financial Statements Note 2 . Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements in our 2019 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA conducts the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of medicines for the EU and the European Economic Area countries. In China, the NMPA is the primary regulatory authority for approving and supervising medicines. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Item 1. Business Government Regulation and Price Constraints section in this 2019 Form 10-K. Some amounts in this 2019 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. All trademarks in this 2019 Form 10-K are the property of their respective owners. AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2019 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are, or will be, available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this 2019 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2020 Proxy Statement and our 2019 Financial Report, portions of which are filed as Exhibit 13 to this 2019 Form 10-K, and which also will be contained in Appendix A to our 2020 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to this information. Our 2019 Annual Report to Shareholders consists of our 2019 Financial Report and the Corporate and Shareholder Information attached to the 2020 Proxy Statement. Our 2019 Financial Report will be available on our website on or about February 27, 2020. Our 2020 Proxy Statement will be available on our website on or about March 13, 2020. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts is not incorporated by reference into this 2019 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2019 Form 10-K COMMERCIAL OPERATIONS At the beginning of our 2019 fiscal year, we began to manage our commercial operations through a new global structure consisting of three businessesPfizer Biopharmaceuticals Group (Biopharma), Upjohn and, through July 31, 2019, Consumer Healthcare, each led by a single manager. We have revised prior-period segment information in our 2019 Form 10-K to reflect the 2019 reorganization. Biopharma and Upjohn are the only reportable segments. For additional information regarding the 2019 reorganization, as well as our Organizing for Growth initiative, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyOrganizing for Growth section and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report. On July 31, 2019, Pfizers Consumer Healthcare business, an over-the-counter medicines business, was combined with GSKs consumer healthcare business to form a new consumer healthcare joint venture in which we own a 32% equity stake. For additional information, see the Notes to Consolidated Financial Statements Note 1A. Basis of Presentation and Significant Accounting Policies: Basis of Presentation and Note 2C. Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements: Equity-Method Investments and Assets and Liabilities Held for Sale in our 2019 Financial Report . Some additional information about our Biopharma and Upjohn business segments follows: Pfizer Biopharmaceuticals Group Biopharma is a science-based medicines business that includes six business units Oncology, Inflammation Immunology, Rare Disease, Hospital, Vaccines and Internal Medicine. The Hospital unit commercializes our global portfolio of sterile injectable and anti-infective medicines and includes Pfizers contract manufacturing operation, Pfizer CentreOne. At the beginning of our 2019 fiscal year, we also incorporated our biosimilar portfolio into the Oncology and Inflammation Immunology business units and certain legacy established products into the Internal Medicine business unit. Each business unit is committed to delivering breakthroughs that change patients lives. Upjohn is a global, primarily off-patent branded and generic medicines business, which includes a portfolio of 20 globally recognized solid oral dose brands, as well as a U.S.-based generics platform, Greenstone. Select products include: - Prevnar 13/Prevenar 13 - Ibrance - Eliquis - Xeljanz - Enbrel (outside the U.S. and Canada) - Chantix/Champix - Sutent - Xtandi - Vyndaqel/Vyndamax Select products include: - Lyrica - Lipitor - Norvasc - Celebrex - Viagra - Certain generic medicines On July 29, 2019, we announced that we entered into a definitive agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, Viatris. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Business Development Initiatives and Our Strategy sections in our 2019 Financial Report. For a further discussion of these operating segments, see the Pfizer Biopharmaceuticals Group (Biopharma) and Upjohn sections in this 2019 Form 10-K, the table captioned Revenues by Operating Segment and Geography in the Analysis of the Consolidated Statements of Income section and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , in our 2019 Financial Report, which are incorporated by reference. Pfizer Inc. 2019 Form 10-K PFIZER BIOPHARMACEUTICALS GROUP (BIOPHARMA) The key therapeutic areas comprising our Biopharma business segment include: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Pain, as well as regional brands. Eliquis, Chantix/Champix and Premarin family Oncology Includes innovative oncology brands of biologics, small molecules, immunotherapies, and biosimilars across a wide range of cancers. Ibrance, Sutent, Xtandi, Xalkori, Inlyta and Braftovi + Mektovi Hospital Includes our global portfolio of sterile injectable and anti-infective medicines, as well as Pfizer CentreOne, our contract manufacturing and active pharmaceutical ingredient sales operation. Sulperazon, Medrol, Vfend and Zithromax Vaccines Includes innovative vaccines brands across all agesinfants, adolescents and adultsin pneumococcal disease, Meningococcal disease and tick-borne encephalitis, with a pipeline focus on healthcare-acquired infections and maternal health. Prevnar 13/Prevenar 13 (pediatric/adult), FSME-IMMUN, Nimenrix and Trumenba Inflammation and Immunology Includes innovative brands and biosimilars for chronic immune and inflammatory diseases. Xeljanz, Enbrel (outside the U.S. and Canada), Inflectra and Eucrisa Rare Disease Includes innovative brands for a number of therapeutic areas with rare diseases, including amyloidosis, hemophilia, and endocrine diseases. Vyndaqel/Vyndamax, BeneFIX, Genotropin and Refacto AF/Xyntha We recorded direct product and/or alliance revenues of more than $1 billion for each of six Biopharma products in 2019 , seven Biopharma products in 2018 and six Biopharma products in 2017 : Biopharma $1 Billion+ Products 2018 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Ibrance Ibrance Ibrance Eliquis* Eliquis * Eliquis * Xeljanz Enbrel Enbrel Enbrel Xeljanz Xeljanz Chantix/Champix Chantix/Champix Sutent Sutent * Eliquis includes alliance revenues and direct sales in 2019, 2018 and 2017. For a discussion of certain Biopharma products and additional information regarding collaboration and/or co-promotion agreements involving certain of these Biopharma products, see the Item 1A. Business Collaboration and Co-Promotion Agreements and Patents and Other Intellectual Property Rights sections of this 2019 Form 10-K; for additional information regarding the revenues of our Biopharma business, including revenues by geography and of significant Biopharma products, see the Analysis of the Consolidated Statements of Income Revenues Overview, Revenues by Operating Segment and Geography and RevenuesSelected Product Discussion sections and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report; and for additional information on the key operational revenue drivers of our Biopharma business, see the Analysis of Operating Segment Information Biopharma Operating Segment section in our 2019 Financial Report. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K UPJOHN Upjohns products are used to treat non-communicable diseases across a broad range of therapeutic areas, including: Cardiovascular (Lipitor, Norvasc and Revatio); Pain and neurology (Lyrica and Celebrex); Psychiatry (Effexor, Zoloft and Xanax); Urology (Viagra); and Ophthalmology (Xalatan/Xalacom). We recorded direct product revenues of more than $1 billion for two Upjohn products in 2019 , three Upjohn products in 2018 , and three Upjohn products in 2017 : Upjohn $1 Billion+ Products Lyrica Lyrica Lyrica Lipitor Lipitor Lipitor Norvasc Viagra For a discussion of certain Upjohn products and additional information regarding the revenues of our Upjohn business, including revenues by geography and of significant Upjohn products, see the Analysis of the Consolidated Statements of Income Revenues Overview, Revenues by Operating Segment and Geography and RevenuesSelected Product Discussion sections and the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report; and for additional information on the key operational revenue drivers of our Upjohn business, see the Analysis of Operating Segment Information Upjohn Operating Segment section in our 2019 Financial Report. For a discussion of the risks associated with our dependence on certain of our major products, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. COLLABORATION AND CO-PROMOTION AGREEMENTS We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including, among others, Eliquis, Xtandi and Bavencio. Revenues from Eliquis (except in certain markets where we have direct sales) , Xtandi and Bavencio are included in alliance revenues. Eliquis has been jointly developed and is commercialized by Pfizer and BMS. Pfizer funds between 50% and 60% of all development costs depending on the study. Profits and losses are shared equally on a global basis, except in certain countries where Pfizer commercializes Eliquis and pays BMS compensation based on a percentage of net sales. We have full commercialization rights in certain smaller markets. BMS supplies the product to us at cost plus a percentage of the net sales to end-customers in these markets. Eliquis is part of the Novel Oral Anticoagulant market; the agents in this class were developed as alternative treatment options to warfarin in appropriate patients. Xtandi is being developed and commercialized through a collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi. Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. In addition, Pfizer and Astellas share certain development and other collaboration expenses, and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (income)/deductionsnet ). Xtandi is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells. Bavencio (avelumab) is being developed and commercialized in collaboration with Merck KGaA. Both companies jointly fund the majority of development and commercialization costs, and split equally any profits related to net sales generated from selling any products containing avelumab from this collaboration. Bavencio is a human anti-programmed death ligand-1 (PD-L1) antibody. Pfizer Inc. 2019 Form 10-K RESEARCH AND DEVELOPMENT Innovation is critical to the success of our Company, and drug discovery and development are time-consuming, expensive and unpredictable. Pfizers purpose is to deliver breakthroughs that change patients lives. RD is at the heart of fulfilling Pfizers purpose as we work to translate advanced science and technologies into the therapies that matter most. Our RD Priorities and Strategy Our RD priorities include: delivering a pipeline of highly differentiated medicines and vaccines where Pfizer has a unique opportunity to bring the most important new therapies to patients in need; advancing our capabilities that can position Pfizer for long-term RD leadership; and advancing new models for partnerships with creativity, flexibility and urgency to deliver innovation to patients as quickly as possible. To that end, our RD primarily focuses on: Oncology; Inflammation and Immunology; Vaccines; Internal Medicine; Rare Diseases; and Hospital . While a significant portion of RD is done internally, we continue to seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines. We do so by entering into collaboration, alliance and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. These agreements enable us to co-develop, license or acquire promising compounds, technologies and/or capabilities. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. Collaboration, alliance, license and funding agreements and equity- or debt-based investments allow us to share risk and cost. They also enable us to access external scientific and technological expertise, as well as provide us the opportunity to advance our own products and in-licensed or acquired products. For additional information, see the Notes to Consolidated Financial Statements Note 2 . Acquisitions, Divestitures, Equity-Method Investments and Assets and Liabilities Held for Sale, Licensing Arrangements and Research and Development and Collaborative Arrangements in our 2019 Financial Report. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. In 2019, we continued to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that is positioned to deliver value in the near term and over time. Our RD spending is conducted through a number of matrix organizations: Research Units within our WRDM organization are generally responsible for research and early-stage development assets for our Biopharma business (assets that have not yet achieved proof-of-concept). Our Research Units are organized by therapeutic area to enhance flexibility, cohesiveness and focus. Because of our structure, we are able to rapidly redeploy resources within a Research Unit between various projects as necessary because in many instances the workforce shares similar skills, expertise and/or focus. Our science-based and other platform-services organizations provide technical expertise and other services to the various RD projects, and are organized into science-based functions (which are part of our WRDM organization), such as Pharmaceutical Sciences, Medicine Design, and non-science-based functions, such as Facilities, Digital and Finance. Within each of these functions, we are able to migrate resources among projects, candidates and/or targets in any therapeutic area and in most phases of development, allowing us to react quickly in response to evolving needs. In addition, the Worldwide Medical and Safety group, within WRDM, ensures that Pfizer provides all stakeholders including patients, healthcare providers, pharmacists, payers and health authorities with complete and up-to-date information on the risks and benefits associated with Pfizer products so that they can make appropriate decisions on how and when to use Pfizers medicines. Our RD organization within Upjohn supports the off-patent branded and generic established medicines and helps to develop product enhancements, new indications and new market registrations for these medicines. Pfizer Inc. 2019 Form 10-K Our Global Product Development (GPD) organization is a unified center for clinical development and regulatory activities that is generally responsible for the clinical development strategy and operational execution of clinical trials for both early-stage assets in the WRDM portfolio as well as late-stage assets in the Biopharma portfolio. We manage RD operations on a total-company basis through our matrix organizations described above. Specifically, the Portfolio Strategy Investment committee, comprised of senior executives, is accountable for aligning resources among all of our WRDM, GPD and Biopharma RD projects and for seeking to ensure optimal capital allocation across the innovative RD portfolio. We believe that this approach also serves to maximize accountability and flexibility. Our Upjohn RD organization manages its resources separately from the WRDM and GPD organizations, with operational support from GPD for select clinical development regulatory activities and from WRDM for clinical supply operations and global pharmacovigilance processing. Generally, we do not disaggregate total RD expense by development phase or by therapeutic area since, as described above, we do not manage our RD operations by development phase or by therapeutic area. Further, as we are able to adjust a significant portion of our spending quickly, we believe that any prior-period information about RD expense by development phase or by therapeutic area would not necessarily be representative of future spending. For additional information on our RD operations and expenses, see the Costs and Expenses Research and Development (RD) Expenses section in our 2019 Financial Report. Our RD Pipeline and Competition The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. The process from discovery to development to regulatory approval can take more than ten years. As of January 28, 2020 , we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of Income Product DevelopmentsBiopharmaceutical section in our 2019 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. In 2019, operations in developed and emerging markets were managed through our business segments: Biopharma, Upjohn and, through July 31, 2019, Consumer Healthcare. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. Urbanization and the rise of the middle class in emerging markets, particularly in Asia, provide growth opportunities for our medicines. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $27.9 billion accounted for 54% of our total revenues in 2019 . Revenues exceeded $500 million in each of eleven countries outside the U.S. in 2019, 2018 and 2017. By total revenues, China and Japan are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the Analysis of the Consolidated Statements of Income Revenues Overview and Revenues by Operating Segment and Geography sections and the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 17. Segment, Geographic and Other Revenue Information in our 2019 Financial Report. Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries, including, among other things, currency fluctuations, capital and exchange control regulations and expropriation and other restrictive government actions. See the Item 1A. Risk Factors International Operations section in this 2019 Form 10-K. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See the Item 1. Business Government Regulation and Price Constraints Outside the United States section in this 2019 Form 10-K for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7 F . Financial Instruments : Derivative Financial Instruments and Hedging Activities in our 2019 Financial Report, which is incorporated by reference, as well as Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the U.S. Centers for Disease Control and Prevention, wholesalers, individual provider offices, retail pharmacies, and integrated delivery networks. We seek to gain access for our products on healthcare authority and PBM formularies, which are lists of approved medicines available to members of the PBMs. PBMs use various benefit designs, such as tiered co-pays for formulary Pfizer Inc. 2019 Form 10-K products, to drive utilization of products in preferred formulary positions. We may also work with payers on disease management programs that help to develop tools and materials to educate patients and physicians on key disease areas. In 2019 , our top three biopharmaceutical wholesalers accounted for approximately 37% of our total revenues (and approximately 79% of our total U.S. revenues). % of 2019 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see the Item 1. Business Government Regulation and Price Constraints Outside the United States Intellectual Property section in this 2019 Form 10-K. In various markets, a period of regulatory exclusivity may be provided to certain drugs upon approval. The scope and term of such exclusivity will vary but, in general, the period of regulatory exclusivity will run concurrently with the term of any existing patent rights associated with the drug at the time of approval. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, grant of an additional six-month pediatric extension and/or the granted patent term extension in the U.S. and Japan and Supplementary Patent Certificate in Europe), are those for the medicines set forth in the table below. Unless otherwise indicated, the years set forth in the table below pertain to the basic product patent expiration for the respective products. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Pfizer Inc. 2019 Form 10-K Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Lyrica 2019 (1) 2014 (2) 2022 (3) Chantix/Champix Sutent Ibrance Vyndaqel/Vyndamax Inlyta Xeljanz 2028 (4) Prevnar 13/Prevenar 13 __(5) Eliquis (6) Xtandi (7) * (7) * (7) Xalkori Besponsa 2028 (8) Braftovi (9) * (9) * (9) Mektovi (9) 2031 (10) * (9) * (9) Bavencio (11) (1) Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. (2) Lyrica regulatory exclusivity in the EU expired in July 2014. (3) Lyrica is covered by a Japanese method-of-use patent which expires in 2022. The patent is currently subject to an invalidation action. (4) Xeljanz EU expiry is provided by regulatory exclusivity. (5) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 was revoked following an opposition and has now been withdrawn. There are other EU patents and pending applications covering the formulation, various aspects of the manufacturing process, and the combination of serotype conjugates of Prevenar 13 that remain in force. (6) Eliquis was developed and is being commercialized in collaboration with BMS. (7) Xtandi is being developed and commercialized in collaboration with Astellas, which has exclusive commercialization rights for Xtandi outside the U.S. Pfizer receives tiered royalties as a percentage of international Xtandi net sales. (8) Besponsa Japan expiry is provided by regulatory exclusivity. (9) Pfizer has exclusive rights to Braftovi and Mektovi in the U.S. The Pierre Fabre Group has exclusive rights to commercialize both products in Europe and Ono Pharmaceutical Co., Ltd. has exclusive rights to commercialize both products in Japan. Pfizer receives royalties from The Pierre Fabre Group and Ono Pharmaceutical Co., Ltd. on sales of Braftovi and Mektovi outside the U.S. (10) The U.S. expiration date in the table for Mektovi is provided by a method-of-use patent. (11) Bavencio is being developed and commercialized in collaboration with Merck KGaA. The loss, expiration or invalidation of intellectual property rights, patent litigation settlements with manufacturers and the expiration of co-promotion and licensing rights can have a significant adverse effect on our revenues. Many of our branded products have multiple patents that expire at varying dates, thereby strengthening our overall patent protection. However, once patent protection has expired or has been lost prior to the expiration date as a result of a legal challenge, we typically lose exclusivity on these products, and generic and biosimilar pharmaceutical manufacturers generally produce identical or highly similar products and sell them for a lower price. The date at which generic or biosimilar competition commences may be different from the date that the patent or regulatory exclusivity expires. However, when generic or biosimilar competition does commence, the resulting price competition can substantially decrease our revenues for the impacted products, often in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Also, if one of our patents is found to be invalid by judicial, court or administrative proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. For additional information, see the Item 1A. Risk Factors Patent Protection section in this 2019 Form 10-K. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim either do not infringe our patents or our patents are invalid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. We will continue to aggressively defend our patent rights whenever we deem appropriate. For additional Pfizer Inc. 2019 Form 10-K information, see the Notes to Consolidated Financial Statements Note 16 A1 . Contingencies and Certain Commitments Legal ProceedingsPatent Litigation in our 2019 Financial Report. Recent Losses and Expected Losses of Product Exclusivity Certain of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and we expect certain products to face significantly increased generic competition over the next few years. For example, as a result of a patent litigation settlement, Teva launched a generic version of Viagra in the U.S. in December 2017. Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. See the table above for the basic product patent expiries of our most significant products. We expect the impact of reduced revenues due to patent expiries will be significant in 2020, then moderating downward to a much lower level from 2021 through 2025. For additional information, see the Item 1A. Risk Factors Dependence on Key In-Line Products section in this 2019 Form 10-K. The following table provides information about certain products recently experiencing, or expected to experience in 2020 , patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan. Our financial results in 2019 and our financial guidance for 2020 reflect the impact of the loss of exclusivity of various products discussed below: (MILLIONS OF DOLLARS) Product Revenues in Markets Impacted Products Key Dates (a) Markets Impacted Year Ended December 31, Viagra (b) June 2013 May 2014 December 2017 Major European markets Japan U.S. $ $ $ Lyrica (c) July 2014 June 2019 Major European markets U.S. 2,208 3,852 3,901 Pristiq (d) March 2017 U.S. Chantix (e) November 2020 U.S. (a) Unless otherwise noted, Key Dates indicate patent-based expiration dates. (b) As a result of a patent litigation settlement, Teva launched a generic version of Viagra in the U.S. in December 2017. (c) Lyrica lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. (d) As a result of a patent litigation settlement with several generic manufacturers, generic versions of Pristiq launched in the U.S. in March 2017. (e) The basic product patent for Chantix in the U.S. will expire in November 2020, which includes the FDAs grant of pediatric exclusivity that extended the period of market exclusivity in the U.S. for Chantix for an additional six months from May 2020. Biologic Products Our biologic products, including BeneFIX, ReFacto, Xyntha, Bavencio, Prevnar 13/Prevenar 13 and Enbrel (we market Enbrel outside the U.S. and Canada), already face, or may face in the future, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference our originator biologic products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin, that was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be highly similar to the original biologic in terms of safety and efficacy and that have no clinically meaningful differences in safety, purity or potency. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA in 2010, a framework for such approval exists in the U.S. In Europe, the European Commission grants marketing authorizations for biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop and commercialize biosimilar medicines. Some of the biosimilars that we currently market include Inflectra, Nivestym, Retacrit, Zirabev, Ruxience and Trazimera in the U.S.; Inflectra, Retacrit, Nivestim and Trazimera in the EU; and Ixifi, Trazimera, Zirabev and Ruxience in Japan. See the Item 1A. Risk Factors Biosimilars section in this 2019 Form 10-K. Pfizer Inc. 2019 Form 10-K We may face litigation with respect to the validity and/or scope of patents relating to our biologic products. Likewise, as we develop, manufacture and seek to launch biosimilars, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, we have seen some improvement in global protection of intellectual property rights. For additional information, see the Item 1. Business Government Regulation and Price Constraints Outside the United States Intellectual Property section in this 2019 Form 10-K. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus and generic and biosimilar drug manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further demonstrating the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians, payers and global health authorities. We also seek to continually enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our efforts to accurately and ethically launch and promote our products to our customers. Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising, interactions with, and payments to, healthcare professionals, and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our vaccines business may face competition from the introduction of alternative vaccines. For example, Prevnar 13 may face competition in the form of competitor vaccines, including vaccines with additional serotypes or next-generation pneumococcal conjugate vaccines prior to or after the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products. We also sell biosimilars of certain inflammation immunology and oncology biologic medicines globally. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with potentially higher levels of sales and profitability until other generic or biosimilar competitors enter the market. Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 300 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see the Item 1. Business Government Regulation and Price Constraints In the United States section in this 2019 Form 10-K), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using Pfizer Inc. 2019 Form 10-K formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing and copay accumulator programs to improve their cost containment efforts. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population and beyond. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. For additional information, see the Item 1. Business Government Regulation and Price Constraints In the United StatesHealthcare Reform section in this 2019 Form 10-K. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors can market a competing version of our product after the expiration or loss of our patent and often charge much less. In China, for example, we are expected to face further intensified competition by certain generic manufacturers in 2020, which may result in price cuts and volume loss of some of our products. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. Favoring generics may reduce sales of our branded products. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. In 2019 , we experienced periodic shortages of select materials due to constrained capacity or operational challenges with the associated suppliers. Supplier management activities are ongoing to work to ensure the necessary supply to meet our requirements for these materials. No significant impact to our operations is anticipated in 2020. Pfizer Inc. 2019 Form 10-K GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, delays in product approvals, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulation by the FDA, including regulations that govern, among other things, the safety and efficacy of our medicines, clinical trials, advertising and promotion, manufacturing, labeling and record keeping. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. Other U.S. federal agencies, including the DEA, also regulate certain of our products. Many of our activities also are subject to the jurisdiction of the SEC. Biopharmaceutical companies seeking to market a product in the U.S. must first test the product to demonstrate that it is safe and effective for its intended use. If, after evaluation, the FDA determines the product is safe (i.e., its benefits outweigh its known risks) and effective, then the FDA will approve the product for marketing, issuing a New Drug Application or Biologics License Application, as appropriate. Companies seeking to market a generic prescription drug must scientifically demonstrate that the generic drug is bioequivalent to the innovator drug. The Abbreviated New Drug Application, or generic drug application, must show, among other things, that the generic drug is pharmaceutically equivalent to the brand, the manufacturer is capable of making the drug correctly, and the proposed label is the same as that of the innovator/brand drugs label. Even after a drug or biologic is approved for marketing, it may still be subject to postmarketing commitments or postmarketing requirements. Postmarketing commitments are studies or clinical trials that the drug or biologic sponsor has agreed to conduct, but are not required by law and/or regulation. Postmarketing requirements include studies and clinical trials that sponsors are required to conduct, by law and/or regulation, as a condition of approval. Postmarketing studies or clinical trials can be required in order to assess a known risk or demonstrate clinical benefit for drugs or biologics approved pursuant to accelerated approval. If a company fails to meet its postmarketing requirements, the FDA may assess a civil monetary penalty, issue a warning letter or deem the drug or biologic misbranded. Once a drug or biologic is approved, the FDA must be notified of any modifications to the product and the FDA may also require a manufacturer to submit additional studies or conduct clinical trials. In addition, we are also required to report adverse events and comply with cGMPs, as well as advertising and promotion regulations. Failure to comply with the FFDCA may subject us to administrative and/or judicial sanctions, including warning letters, product recalls, seizures, delays in product approvals, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference innovator biologic. The FDA is responsible for implementation of the legislation and approval of new biosimilars. Through FDA approvals and the issuance of draft and final guidance, the FDA has addressed a number of issues related to the biosimilars approval pathway, such as the labeling expectations for biosimilars. For example, in 2019, the FDA issued final guidance regarding the standards for demonstrating interchangeability with a U.S.-licensed reference product. In addition, in 2017, the Biosimilar User Fee Act was reauthorized for a five-year period, which led to a significant increase in the FDAs biosimilar user fee revenues, thereby providing the FDA with additional resources to process biosimilar applications. For example, since the enactment of the newly authorized fee structure, the FDA estimates its revenues from biosimilar user fees generally will exceed $40 million. Sales and Marketing Laws and Regulations . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended, among other things, to prevent fraud and abuse in the healthcare industry and to protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying anything of value to generate business, including purchasing or prescribing of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs or biologics) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal healthcare programs (including Medicare and Medicaid). The federal government Pfizer Inc. 2019 Form 10-K and various states also have enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and healthcare providers, require disclosure to the federal or state government and the public of such interactions, and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing and reimbursement for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section and the Notes to Consolidated Financial Statements Note 1 G . Basis of Presentation and Significant Accounting Policies : Revenues and Trade Accounts Receivable in our 2019 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including proposed action on drug importation, could adversely affect our business if implemented. There continues to be considerable public and government scrutiny of pharmaceutical pricing, and measures to address the perceived high cost of pharmaceuticals are being considered by Congress, the Presidential Administration and select states. For example, recent legislation revised how manufacturers calculate the average manufacturer price on branded drugs with authorized generics under the Medicaid drug rebate program, which the Congressional Budget Office has estimated will reduce Medicaid costs by over $3 billion over the next decade. Proposals for even more far-reaching reform, such as immediately eliminating or phasing out private health insurance, are being proposed by some Democratic candidates for U.S. President. In particular, several states have enacted or are considering transparency laws that require prescription drug manufacturers to report to the state and make public price increases, and sometimes to provide a written justification for the increase. In addition to new state transparency laws and the introduction of several Federal pricing bills, we have also seen the Presidential Administration introduce proposals related to importation and express interest in international reference pricing in Medicare Part B. We expect to see continued focus in regulating pricing resulting in additional legislation and regulation that could adversely impact revenue. In addition, U.S. government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services associated with the provision of our products. For additional information, see the Item 1A. Risk Factors U.S. Entitlement Reform section in this 2019 Form 10-K. Also, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products under certain state Medicaid programs. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. States continue to explore options for controlling healthcare costs related to Medicaid and other state healthcare programs, including the implementation of supplemental rebate agreements under the Medicaid drug rebate program that are tied to patient outcomes. In addition, we expect that consolidation and integration among pharmacy chains and wholesalers, who collectively are the primary purchasers of our pharmaceutical products in the U.S., and PBMs will increase pricing pressures on pharmaceutical manufacturers, including us. For additional information, see the Item 1A. Risk Factors Managed Care Trends section in this 2019 Form 10-K. The potential for additional pricing and access pressures in the commercial sector continues to be significant. Many employers have adopted high deductible health plans, which can increase out-of-pocket costs for medicines. This is a trend that is likely to continue. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. Overall, there is increasing pressure on U.S. providers to deliver healthcare at a lower cost and to ensure that those expenditures deliver demonstrated value in terms of health outcomes. Longer term, we are seeing a shift in focus away from fee-for-service payments towards outcomes-based payments and risk-sharing arrangements that reward providers for cost reductions and improved patient outcomes. These new payment models can, at times, lead to lower prices for, and restricted access to, new medicines. At the same time, these models can also promote utilization of drugs by encouraging physicians to screen and diagnose and consider drugs as a means of forestalling more costly medical interventions. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and ensure access to medicines within an efficient and affordable healthcare system. In addition, in response to the evolving U.S. and global healthcare spending landscape, we work with health authorities, health technology assessment and quality measurement bodies and major U.S. payers throughout the product-development process to better Pfizer Inc. 2019 Form 10-K understand how these entities value our compounds and products. Further, we seek to develop stronger internal capabilities focused on demonstrating the value of the medicines that we discover or develop, register and manufacture, by recognizing patterns of usage of our medicines and competitor medicines along with patterns of healthcare costs . Healthcare Reform. There have been significant efforts at the federal and state levels to reform the healthcare system by enhancing access to healthcare, improving the delivery of healthcare and further rationalizing payment for healthcare. We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is additional uncertainty given the ruling in December 2019 by the U.S. Circuit Court of Appeals for the Fifth Circuit in Texas v. Azar that the individual mandate, which is a significant provision of the ACA, is unconstitutional. The case has been remanded to a lower court to determine whether the individual mandate is inseparable from the entire ACA, in which case the ACA as a whole would be rendered unconstitutional. In the meantime, the remaining provisions of the law remain in effect. The revenues generated for Pfizer by the health insurance exchanges and Medicaid expansion under the ACA are not material, so the impact of full invalidation of the law is expected to be limited. However, any future replacement for the ACA may adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Any future healthcare reform efforts may adversely affect our business and financial results. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Data Privacy. Pfizer collects personal data as part of its regular business activities. The collection and use of this data is subject to privacy and data security laws and regulations, including oversight by various regulatory or other governmental bodies. For example, we are subject to the California Consumer Privacy Act (CCPA). The CCPA, which came into effect on January 1, 2020, imposes numerous obligations on us, including a duty to disclose the categories of personal data that we collect, sell, or share about California consumers, and gives those consumers rights regarding their personal data. Noncompliance with any of these laws could result in the imposition of fines, penalties, or orders to stop non-compliant activities, and could damage our reputation and harm our business. Outside the United States We encounter similar regulatory and legislative issues in most countries outside the U.S. New Drug Approvals. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU, which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In China, the regulatory system historically presented numerous challenges for the pharmaceutical industry, as its requirements for drug development and registration were often inconsistent with U.S. or other international standards. In recent years, however, China has introduced reforms and draft reforms, which are discussed in more detail below, that attempt to address these challenges. Furthermore, in 2017, the China regulatory authority, the National Medical Products Administration (NMPA), became a member of the International Council for Harmonization (ICH), which has resulted in greater adoption of international technical guidelines and practices by the government. 2019 was another active year in this respect, with a number of reforms coming into effect, and more proposals and drafts being issued for consultation. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, postmarketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. Pharmacovigilance. In the EU, the EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pfizer Inc. 2019 Form 10-K Pricing and Reimbursement . Certain governments, including the different EU member states, the U.K., China, Japan, Canada, South Korea and some other international markets, provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global financing pressures. Governments may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, health technology assessments, forced localization as a condition of market access, international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries), quality consistency evaluation processes and volume-based procurement. In addition, the international patchwork of price regulation and differing economic conditions and incomplete value assessments across countries has led to varying access to quality medicines in many markets and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and hinders patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations, including the World Health Organization (WHO), and the Organization for Economic Cooperation and Development, are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations. In 2019, the WHO continued exerting pressure on pharmaceutical pricing practices by supporting strategies to reduce medicine prices, including calling for greater transparency around the cost of research and development and production of medicines, as well as disclosure of net prices. In Japan, the pricing environment for innovative medicines further deteriorated in 2019 with the introduction of a health technology assessment (HTA) system to inform price adjustments of healthcare technologies after launch. Expansion of this system for reimbursement decisions, as seen in other HTA markets, remains a risk. While significant challenges remain, the 2020 Drug Pricing Reform Package, unlike the last reform package in 2018, is not expected to fundamentally change the access landscape. Furthermore, the eligibility criteria for the Price Maintenance Premium, a key policy that protects against price erosion for certain products, is expected to be somewhat enhanced while expedited regulatory pathways are codified in law. In Canada, the Patented Medicine Prices Review Board (PMPRB) released draft guidelines to implement new pricing regulations in November 2019, which will go into force in July 2020. These regulations drop the U.S. from the reference basket of countries used to determine price and add economic factors for setting ceiling prices for new medicines. An initial analysis of the potential impact of these proposed changes to the PMPRB regulations estimated an approximately $26 billion reduction in industry revenues over the next decade. China Pricing Pressures . In China, healthcare is largely driven by a public payer system, with public medical insurance as the largest single payer for pharmaceuticals, and pricing pressures have increased in recent years. Government officials have consistently emphasized the importance of improved health outcomes, the need for healthcare reform and decreased drug prices as key indicators of progress towards reform. While the government provides basic health insurance for the vast majority of Chinese citizens, that insurance is not adequate to cover many innovative medicines, and alternative funding sources for innovative medicines remain suboptimal. In 2019, Chinas government negotiated with companies to add approximately 90 innovative drugs (mainly oncology medicines) to the National Reimbursement Drug List. This builds on 60 drugs already added through negotiation in 2017 and 2018. Prices for drugs have been reduced dramatically through this government-led process. While these negotiations have included a path to access for companies, market access is not assured. In addition, significant questions about the processes and negotiations for provincial tendering remain, as well as the need for multi-layered negotiations across provincial, municipal and hospital levels. In the off-patent space, in 2013, China began to implement a quality consistency evaluation (QCE) process in order to improve the quality of domestically-manufactured generic drugs, primarily by requiring such drugs to pass a test to assess their bioequivalence to a qualified reference drug (typically the originator drug). In 2018, numerous local generics were officially deemed bioequivalent under QCE. A pilot project for centralized volume-based procurement (VBP) was then initiated including 25 molecules of drugs covering 11 major Chinese cities. Under this procurement model, a tender process has been established where a certain portion of included molecule volumes are guaranteed to tender winners. The program is intended to contain healthcare costs by driving utilization of generics that have passed QCE, which has resulted in dramatic price cuts for off-patent medicines. Upjohn and most off-patent originators were not successful in the first bidding process under this pilot, which was finalized in December 2018 and implemented in March 2019, and most contracts went to local generic companies. The first bidding process resulted in significant price cuts by the successful bidders, with some bidders reducing the price of their products by as much as 96 percent, as companies attempted to secure volumes on the Chinese pharmaceutical market. The drugs that lost the bidding were also requested to reduce their selling price up to 30 percent based on the price difference with the successful bidder. Chinas government began nationwide expansion of the VBP pilot in December 2019. The expanded model, which is being implemented nationwide, applies to certain drugs that are purchased for public hospitals as well as some military and private medical institutions. As in the first bidding process, our Upjohn business unit and most originator brands were not successful in Pfizer Inc. 2019 Form 10-K the bidding process for this nationwide expansion, and those contracts mostly went to local Chinese generic companies. The QCE-qualified generic makers of atorvastatin and amlodipine bid aggressively, lowering prices even further from the March 2019 tender. Our Upjohn business unit continues to take steps to mitigate the revenue impact of these initiatives but anticipates that they will continue to affect our Upjohn business in China in the future. We expect to utilize our presence in the retail channel, private hospitals and tendering capabilities to mitigate some of these pricing pressures. In addition, we believe that our geographic expansion to under-penetrated and lower-tiered cities and counties and additional focus on non-tendered products will increase sales volumes in greater China and partially mitigate pressures from QCE. In late 2019, China announced another round of expansion of the national VBP program, which covers 33 new molecules, including Biopharmas Zithromax tablets and Diflucan tablets and no Upjohn products. Biopharma was not successful in the bidding process for this expansion. Furthermore, the Chinese government has discussed moving toward efforts to unify the reimbursement price between QCE-approved generic medicines and the applicable original medicines. The government currently plans to implement this universal reimbursement price initiative within the next two to three years. If this policy is implemented, the new reimbursement level for Upjohns products will likely be lower than the current reimbursement level, placing additional pressures on price and/or patient copays. There remains uncertainty as to whether, when and how this policy may be officially implemented. The Chinese government could also enact other policies that may increase pricing pressures or have the effect of reducing the volume of sales available to Upjohns products. This potential policy, and any other policies like it that could increase pricing and copay pressures on Upjohns drug products in China, could have an adverse effect on our business, financial condition and results of operations. The government has indicated that additional post-LOE drugs could be subjected to QCE qualification in future rounds, which could also be tied to volume-based procurement. The scope of future QCE products and timing of any program expansion is currently unknown, making it difficult to determine the impact on Pfizers business and financial condition. We will continue to monitor the market for developments. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, but its implementation has been delayed by the need for the EU authorities to establish new technical systems. This regulation is aimed at simplifying and harmonizing the administrative processes and governance of clinical trials in the EU and will require increased public posting of clinical trial results. It is currently not anticipated to be fully implemented until the first half of 2022 at the earliest. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. The U.K. left the EU on January 31, 2020 with status quo arrangements through a transition period scheduled to end on December 31, 2020. The consequences of the U.K. leaving the EU and the terms of the future trading relationship continue to be highly uncertain, which may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. However, both the U.K. and the EU have issued detailed guidance for the industry on how medicines, medical devices and clinical trials will be separately regulated in their respective territories. Pfizer has substantially completed its preparations for Brexit, having made the changes necessary to meet relevant regulatory requirements in the EU and the U.K., through the transition period and afterwards, especially in the regulatory, research, manufacturing and supply chain areas. Between 2018 and 2021, we expect to spend up to approximately $60 million in one-time costs to make these adaptations. For additional information on Brexit, see the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce backlogs for existing applications for drug approval, in recent years, the NMPA has unveiled numerous reform initiatives for Chinas drug approval system and engaged in significant efforts to build its capabilities. The NMPA divides drugs into new drugs and generics, with the definition for new drugs changed from China New to Global New. This means that drugs previously approved in other markets (such as the U.S. or Europe) are not considered new drugs under Chinas regulatory regime. This change in definition creates more opportunities for Chinas domestic drug manufacturers than for multinational firms, because multinational firms have historically had significant competitive advantage in successfully achieving regulatory approvals for drugs first approved outside of China. Revisions in 2019 made clear, however, that regulatory approval from the FDA or the EMA would no longer be required for approval of imported drugs, though a notable exception persists for imported vaccines, which still require prior approval from a reference regulatory agency such as the FDA. In 2019, China published a revision to its Drug Administration Law and introduced a marketing authorization holder system, which grants the NMPA more authority over regulating manufacturers and provides manufacturers more flexibility in contract manufacturing arrangements and manufacturing site transfers. While challenges remain, a number of other policy changes are streamlining and accelerating approvals of domestic and imported drugs in China. These reforms, along with Chinas June 2018 elevation to the ICH Management Committee, are expected to pave the way for integration of Chinese regulations with global practices. These changes include introducing more streamlined processes for maintaining renewal of product registrations, reduction in importing testing requirements, and establishing an expedited registration pathway for drugs to treat rare diseases and serious, life-threatening illnesses with no effective treatment. Though certain details on implementation are unclear (e.g., evolving list of qualified rare diseases and no guidance on what qualifies as serious, life threatening), the NMPA aims to build expedited pathways for certain categories of products similar to the U.S. and European regulatory systems. Additionally, the NMPA published changes to Chinas registration requirements that align more with international practices, including a 60-day review timeline for clinical trial authorizations and Pfizer Inc. 2019 Form 10-K guidance for acceptance of foreign clinical data and the utilization of real world data in drug development and regulatory decision making. Although a number of regulatory changes better support Chinas inclusion in simultaneous global drug development, unique regulatory requirements continue to pose challenges for multinational companies, including Chinas Human Genetic Resources process for exporting clinical trial samples (which adds months to starting a clinical trial in China); mismatched China Pharmacopoeia and manufacturing data requirements that require standards exceeding acceptable practices in the U.S., EU, and Japan; and unpredictable and inconsistent clinical trial inspection practices. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, the European Federation of Pharmaceutical Industries and Associations disclosure code requires all members, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property Rights (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, some countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool to force innovators to accept less than fair value for medicines, as well as to protect their local pharmaceutical industries. Considerable political and economic pressure exists to weaken current intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, laws or regulations that promote or provide broad discretion to issue a compulsory license, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries and helping improve patients access to innovative medicines. In developed countries as well, including the EU, we are facing an increasingly challenging intellectual property environment. As part of the Canada/EU Comprehensive Economic Trade Agreement (CETA), Canada now provides sui generis protection, commonly referred to as patent term restoration, for patent term extensions for basic patents; however, the extension is capped at two years, whereas the international norm is five years. In addition, the implementing regulations may create obstacles for patentees applying for patent term restoration via a Certificate of Supplementary Protection (CSP), and Canadas proposed drug pricing reforms may negatively impact the benefit of a CSP. Furthermore, the United States-Mexico-Canada Agreement (USMCA) will, when implemented, require Canada and Mexico to make certain improvements to their current intellectual property regimes, including the establishment of patent term adjustment for unreasonable delays in the grant of patents. In China, the intellectual property environment has improved in recent years, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, although China remained on the U.S. Trade Representatives Priority Watch List for 2019 due to ongoing enforcement challenges and Chinas failure to make certain structural reforms. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In 2019, the regulatory authority granted marketing approval to generic products while the reference product in each case are still subject to patent protection, and there is no effective legal means to resolve patent disputes prior to the marketing of those infringing drugs. The U.S. and China recently signed an initial agreement in which China has committed to address some patent-related concerns, and both governments have indicated that they will continue bilateral discussions on implementation of these commitments and other intellectual property issues in 2020. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. Additionally, an increased threat of issuance of compulsory licenses for biopharmaceutical products exists, which adds to business uncertainty. In India, we have seen some progress in terms of expediting patent approval processes to reduce pendency rates and implementing training programs to enhance enforcement. Despite these positive steps, gaps remain in terms of addressing longstanding intellectual property concerns. For example, policies favoring compulsory licensing of patents, the tendency of the Pfizer Inc. 2019 Form 10-K Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. Data Privacy. Outside of the U.S., many countries where we conduct business, including the EU, have privacy and data security laws and regulations concerning the collection and use of personal data, and we must comply with these laws and regulations as well. One applicable law is the EUs General Data Protection Regulation (GDPR). The GDPR imposes detailed obligations on companies that collect, use, or otherwise process personal data and penalties for noncompliance may include fines of up to 4 percent of the companys global annual revenue. Additionally, the legislative and regulatory framework for privacy and data protection issues worldwide is rapidly evolving as countries continue to adopt privacy and data security laws. Any inability to comply with applicable laws, regulations, policies, industry standards or other legal obligations regarding data protection or privacy could result in additional costs and liability to Pfizer as well as reputational harm and may adversely affect our business. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 16 A3 . Contingencies and Certain Commitments Legal ProceedingsCommercial and Other Matters in our 2019 Financial Report. As a result, we incurred capital and operational expenditures in 2019 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $31 million ; and other environment-related expenses $136 million . While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. For example, in 2017, our manufacturing and commercial operations in Puerto Rico were impacted by hurricanes as our three manufacturing sites in Puerto Rico sustained damage and became inoperable due to issues impacting Puerto Rico overall. All three sites resumed operations, and remediation activities were completed in 2018. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to potential weather-related risks and other natural disasters and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5 . Tax Matters in our 2019 Financial Report is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We generally believe we have good relationships with our employees. As of December 31, 2019 , we employed approximately 88,300 people in our operations throughout the world. DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2019 , our activities included supplying medicine and medical products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2019 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2019 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2019 Form 10-K and in our 2019 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim, seek and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, expectations for our product pipeline, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, study starts, approvals, revenue contribution, growth, performance, timing of exclusivity and potential benefits, strategic reviews, capital allocation objectives, plans for and prospects of our acquisitions and other business-development activities, benefits anticipated from the reorganization of our commercial operations in 2019, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, government regulation, our ability to successfully capitalize on growth opportunities or prospects, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, including, among others, the expected timing, benefits, charges and/or costs in connection with our agreement to combine Upjohn with Mylan to create a new global pharmaceutical company, Viatris, set forth in the Item 1. BusinessAbout Pfizer and Item 1A. Risk FactorsPending Combination of Upjohn with Mylan sections in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Business Development Initiatives and Our Strategy sections and the Notes to Consolidated Financial StatementsNote 1A. Basis of Presentation and Significant Accounting PoliciesBasis of Presentation in our 2019 Financial Report; the expected impact of patent expiries on our business set forth in the Item 1. BusinessPatents and Other Intellectual Property Rights section in this 2019 Form 10-K and in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Operating EnvironmentIndustry-Specific ChallengesIntellectual Property Rights and Collaboration/Licensing Rights section in our 2019 Financial Report; the expected competition from certain generic manufacturers in China in the Item 1. BusinessCompetitionGeneric Products and Item 1A. Risk FactorsGeneric Competition sections in this 2019 Form 10-K; the anticipated costs related to our preparations for Brexit set forth in the Item 1. BusinessGovernment Regulation and Price ConstraintsOutside the United StatesBrexit section in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment section in our 2019 Financial Report; the availability of raw materials for 2020 set forth in Item 1. Business Raw Materials in this 2019 Form 10-K; the expected pricing pressures on our products in the U.S. and internationally and the anticipated impact to our business set forth in the Item 1. BusinessGovernment Regulation and Price Constraints and Item 1A. Risk Factors Pricing and Reimbursement sections in this 2019 Form 10-K; the anticipated impact of climate change on Pfizer set forth in Item 1. BusinessEnvironmental Matters in this 2019 Form 10-K; the expected demerger of the GSK Consumer Healthcare joint venture set forth in the Item 1A. Risk Factors Consumer Healthcare Joint Venture with GSK section in this 2019 Form 10-K; the benefits expected from the reorganization of our commercial operations in 2019 and our expectations regarding growth set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Organizing for Growth section in our 2019 Financial Report; our anticipated liquidity position set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment and the Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2019 Financial Report; the anticipated costs and savings from certain of our initiatives, including Transforming to a More Focused Company initiative, set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Transforming to a More Focused Company and Costs and Expenses Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives sections and the Notes to Consolidated Financial Statements Note 3 . Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives in our 2019 Financial Report; our plans for increasing investment in the U.S. set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyCapital Allocation and Expense ManagementIncreasing Investment in the U.S. section in our 2019 Financial Report; the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Financial Guidance for 2020 section in our 2019 Financial Report; the expected impact of the Advisory Committee on Immunization Practices recommendation for Prevnar 13 for adults 65 and older on Prevnar 13s revenues set forth in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product DiscussionPrevnar 13/Prevenar 13 (Biopharma) section in our 2019 Financial Report; the expected impact of updates to the prescribing information for Xeljanz on its growth set forth in the Analysis of the Consolidated Statements of IncomeRevenuesSelected Product DiscussionXeljanz (Biopharma) section in our 2019 Financial Report; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources Contractual Obligations section in our 2019 Financial Report; the expected payments to our unfunded U.S. supplemental (non-qualified) pension plans, postretirement plans and deferred compensation plans and expected funding obligations set forth in the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources Contractual Obligations section; and the voluntary contribution we expect to make during 2020 for the U.S. qualified plans set forth in the Notes to Consolidated Financial Statements Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report. Pfizer Inc. 2019 Form 10-K We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Private third-party payers, such as health plans, and other managed care entities, such as PBMs, continue to take action to manage the utilization of drugs and control the cost of drugs. Consolidation among MCOs has increased the negotiating power of MCOs and other private third-party payers. Private third-party payers, as well as governments, increasingly employ formularies to control costs by taking into account discounts in connection with decisions about formulary inclusion or favorable formulary placement. Failure to obtain or maintain timely or adequate pricing or favorable formulary placement for our products, or failure to obtain such formulary placement at favorable pricing, could adversely impact revenue. Private third-party payers often implement formularies with copayment tiers to encourage utilization of certain drugs and have also been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. Private third-party payers are also implementing new initiatives like so-called copay accumulators (policies that provide that the value of copay assistance does not count as out-of-pocket costs that are applied toward deductibles) that can shift more of the cost burden to manufacturers and patients. This cost shifting has increased consumer interest and input in medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. Third-party payers also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts, and are also increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. private third-party payer market consolidates further and as more drugs become available in generic form, biopharmaceutical companies may face greater pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. In addition, our patented products may face generic competition before patent exclusivity expires, including upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a manufacturer of a generic version of one of our patented products. Generic competition could lead to our loss of a major portion of revenues for that product in a very short period of time. A number of our products have experienced significant generic competition over the last few years. For example, Lyrica (a product in our Upjohn business) lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. In China, we are expected to face further intensified competition by certain generic manufacturers, which may result in price cuts and volume loss of some of our products. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents or that our patents are not valid; these include candidates that would compete with, among other products, Eliquis, Ibrance and Xeljanz. Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. Pfizer Inc. 2019 Form 10-K COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development. Some of these have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with products from competitors, including other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before the anticipated formation of the generic or biosimilar marketplace is important to that products profitability. With increasing competition in the generic or biosimilar product markets, our success will depend on our ability to bring new products to market quickly. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which may result in delayed approvals of new generic products over the next few years. Also, we may face access challenges for our biosimilar products where our product may not receive appropriate coverage/reimbursement access or remains in a disadvantaged position relative to the innovator product. For example, Inflectra has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against Johnson Johnson (JJ) alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product and/or alliance revenues of more than $1 billion for each of eight biopharmaceutical products in 2019: Prevnar 13/Prevenar 13, Ibrance, Eliquis, Lyrica, Xeljanz, Lipitor, Enbrel and Chantix/Champix. Those products accounted for 49% of our total revenues in 2019 . If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, pricing and access pressures, supply shortages or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. A number of our products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years, and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra (a product in our Upjohn business) in the U.S. in December 2017. In addition, Lyrica (a product in our Upjohn business) lost patent protection in the U.S. in June 2019 and multi-source generic competition began in July 2019. Also, the basic product patent for Chantix in the U.S. will expire in November 2020. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Item 1. BusinessPatents and Other Intellectual Property Rights section in this 2019 Form 10-K. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the scientific approach may not succeed for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that is positioned to deliver value in the near-term and over time. These strategies may not deliver the desired result, which could affect growth and profitability in the future. Pfizer Inc. 2019 Form 10-K BIOSIMILARS Abbreviated legal pathways for the approval of biosimilars exist in many international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biologic products, our biologic products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. For example, Enbrel faces ongoing biosimilar competition in most European markets. The loss of patent rights, due to patent expiration or litigation, could trigger competition. We are developing and commercializing biosimilar medicines. Risks related to our commercialization of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower uptake for biosimilars due to various factors that may vary for different biosimilars (e.g., anti-competitive practices, physician reluctance to prescribe biosimilars for existing patients taking the originator product, or misaligned financial incentives). See also the Competitive Products risk factor above. RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication and its reimbursement potential must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and manufacturing and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and adequately addressed could affect our future results. INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, economic conditions, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets. However, our strategies in emerging markets may not be successful and these countries may not continue to sustain these growth rates. For example, even though China is growing faster than most emerging markets, we face certain challenges in China due to government imposed pricing controls affecting certain Pfizer medicines. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. The impact of payers efforts to control access to and pricing of specialty pharmaceuticals is increasing. A number of factors create a more challenging paradigm for Pfizer given our growing specialty business portfolio such as formulary restrictions and increasing use of utilization management tools such as step edits, which can lead to higher negotiated rebates or discounts to health plans and PBMs in the U.S., as well as the increasing use of health technology assessments and government pressures in markets around the world. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS Difficulties or delays in product manufacturing, sales or marketing could affect future results through regulatory actions, shut-downs, work stoppages or strikes, approval delays, withdrawals, recalls, penalties, supply disruptions, shortages or stock-outs, reputational harm, product liability or unanticipated costs. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of component materials is delayed or unavailable and that the quality of such materials are substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout our internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); Pfizer Inc. 2019 Form 10-K risks to supply chain continuity and commercial operations as a result of natural (including hurricanes, earthquakes and floods) or man-made disasters (including arson or terrorist attacks) at our facilities or at a supplier or vendor, including those that may be related to climate change; failure to maintain the integrity of our supply chains against economic adulteration, product diversion, product theft, counterfeit goods and cyberattacks. As an example, we have been experiencing production issues with Genotropin that will decrease revenue from that product. Regulatory agencies periodically inspect our drug manufacturing facilities to evaluate compliance with cGMP or other applicable requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment, recall of a product, delays or denials of product approvals, import bans or denials of import certifications, any of which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, for example, we received a warning letter from the FDA communicating the FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. We undertook corrective actions to address the concerns raised by the FDA. In January 2018, the FDA upgraded the status of Pfizers McPherson manufacturing facility to VAI based on an October 2017 inspection. The change to VAI status lifted the compliance hold that the FDA placed on approval of pending applications. In June 2018, the FDA informed us that it had completed an evaluation of corrective actions and closed out the February 2017 warning letter issued to our McPherson manufacturing facility after determining that we had addressed the violations contained in the warning letter. In July-August 2018, the FDA conducted a follow-up inspection of our McPherson facility and issued an inspection report noting several findings. Pfizer responded to the FDAs findings, and is in the process of implementing a corrective and preventive action plan to address the FDAs concerns. On the basis of the July-August 2018 FDA inspection, the FDA changed the inspection classification of the McPherson site to Official Action Indicated (OAI). Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. Communication with the FDA on the status of the McPherson site is ongoing. As a result of the current OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our McPherson site until the site status is upgraded, which upgrade would be based on a re-inspection by the FDA. We have been experiencing shortages of products from the legacy Hospira portfolio, among others, largely driven by capacity constraints, technical issues, supplier quality concerns or unanticipated increases in demand. We have made considerable progress in remediating issues at legacy Hospira facilities manufacturing sterile injectables and have substantially improved supply from most of these sites. Continuing product shortage interruption at these manufacturing facilities could negatively impact our financial results. In addition, in September 2017, Meridian Medical Technologies, Inc., a subsidiary of Pfizer Inc., received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri and classifying the site as OAI. Meridian responded to the warning letter and committed to making improvements across the sites. We have made considerable progress addressing the concerns raised by the FDA, and communication with the FDA is ongoing. Future FDA inspections and regulatory activities will further assess the adequacy and sustainability of these corrections implemented at the site. As a result of the OAI classification, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis sites. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development, manufacturing and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. We also outsource certain services to other parties, including transaction processing, accounting, information technology, manufacturing, clinical trial recruitment and execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. Failure by one or more of these third parties to complete activities on schedule or in accordance with our expectations; failure by one or more of these parties to meet their contractual or other obligations to Pfizer; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between Pfizer and one or more of these third parties, could delay or prevent the development, approval, manufacturing or commercialization of our products and product candidates, could expose us to suboptimal quality of service delivery or deliverables, could result in repercussions such as missed deadlines or other timeliness issues, erroneous data and supply disruptions, and could also result in non-compliance with legal or regulatory requirements or industry standards or reputational harm, all with potential negative implications for our product pipeline and business. BIOPHARMACEUTICAL WHOLESALERS In 2019 , our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 32% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 37% of our total revenues (and approximately 79% of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact Pfizer Inc. 2019 Form 10-K our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, divestments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframes or at all, and successfully integrate acquisitions. Pursuing these opportunities may require us to obtain additional equity or debt financing, and could result in increased leverage and/or a downgrade of our credit ratings. Where we acquire debt or equity securities as all or part of the consideration for business development activities, such as in connection with our contribution agreement entered into with Allogene Therapeutics, Inc., the value of those securities will fluctuate, and may depreciate in value. We may not control the company in which we acquire securities, such as in connection with a divestiture or collaborative arrangement, and as a result, we will have limited ability to determine its management, operational decisions and policies. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Legal proceedings or regulatory issues often arise as a result of activities that occurred at acquired companies, their partners and other third parties. In 2016, for example, we paid $784.6 million to resolve allegations related to Wyeths reporting of prices to the government with respect to Protonix for activities that occurred prior to our acquisition of Wyeth. For these and other reasons, we may not realize the anticipated benefits of such transactions, and expected synergies and accretion may not be realized within the expected timeframes, or at all. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; the tendency to misuse and abuse medicines; and the relatively modest risk of penalties faced by counterfeiters compared to the large profits that can be earned by them from the sale of counterfeit medicines. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines continue to pose a significant risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Counterfeiters have been recently evolving to counterfeit life sustaining medications such as oncology medicines. This shift significantly increases the risk to patients who, for instance, unsuspectingly purchase counterfeit oncology medications from illicit online pharmacies operated by criminal counterfeiting organizations. Failure to mitigate this new threat posed by counterfeit biopharma medicines could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We have an enterprise-wide strategy to counteract the threats associated with counterfeit medicines, and focused on educating patients and health care providers to reduce demand through awareness; increasing engagement and education of global law enforcement, customs and regulatory agencies about the growing prevalence of counterfeit life sustaining medicines; enhancing online identification and disruption efforts in partnership with pharmaceutical associations to optimize resources and impact; educating legislators about the risk to the security of the international drug supply chain by illicit manufacturing and distribution networks operated by transnational criminal organizations; supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; and using data analytics and risk assessment tools to better target the factors that give rise to the counterfeiting problem in the first place. However, our efforts and the efforts of others may not be entirely successful, and the presence of counterfeit medicines may continue to increase. Pfizer Inc. 2019 Form 10-K RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. There have also been recent state legislative efforts to address drug costs, which generally have focused on increasing transparency around drug costs or limiting drug prices. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. See the discussion regarding pricing and reimbursement in the Item 1. Business Government Regulation and Price Constraints In the United States Pricing and Reimbursement section in this 2019 Form 10-K. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as the different EU member states, the U.K., China, Japan, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. For example, China, in 2013, began to implement a QCE process, under which numerous local generics have officially been deemed bioequivalents of a qualified reference drug. Chinas government subsequently initiated a pilot project for centralized VBP in 2018, which included 25 molecules of drugs and covered 11 major Chinese cities. Under this procurement model, a tender process was established whereby a certain portion of included molecule volumes were guaranteed to tender winners. This tender process was intended to contain healthcare costs by driving utilization of generics and bioequivalents that had passed QCE, and has resulted in dramatic price cuts for off-patent medicines. Chinas government began nationwide expansion of the VBP pilot in December 2019. See the discussion regarding these government initiatives in China in the Item 1. Business Government Regulation and Price Constraints Outside the United States China Pricing Pressures section in this 2019 Form 10-K. We anticipate that these initiatives will continue to increase pricing pressures on our drug products in China in the future. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions or the failure to obtain or maintain timely or adequate pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of healthcare coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion in the Item 1. Business Government Regulation and Price Constraints In the United States section in this 2019 Form 10-K. We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is additional uncertainty given the ruling in December 2019 by the U.S. Circuit Court of Appeals for the Fifth Circuit in Texas v. Azar that the individual mandate, which is a significant provision of the ACA, is unconstitutional. The case has been remanded to a lower court to determine whether the individual mandate is inseparable from the entire ACA, in which case the ACA as a whole would be rendered unconstitutional. In the meantime, the remaining provisions of the law remain in effect. The revenues generated for Pfizer by the health insurance exchanges and Medicaid expansion under the ACA are not material, so the impact of full invalidation of the law is expected to be limited. However, any future replacement of the ACA may adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage or dramatically increases industry taxes and fees. Any future healthcare reform efforts may adversely affect our business and financial results. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, general budget control actions, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. Presidential Administrations policy proposals), revisions to reimbursement of biopharmaceuticals under government programs (such as the implementation of international reference pricing for Medicare Part B drugs, or changes to protected class criteria for Part D drugs), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. Pfizer Inc. 2019 Form 10-K U.S. ENTITLEMENT REFORM In the U.S., government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending, and the December 2018 release includes proposals to cap federal Medicaid payments to the states, and to require manufacturers to pay a minimum rebate on drugs covered under Medicare Part D for low-income beneficiaries. Significant Medicare reductions could also result if, for example, Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or Congress chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, corporate integrity or deferred prosecution agreements or exclusion from future participation in government healthcare programs, as well as reputational harm. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our Company, and drug discovery and development are time-consuming, expensive and unpredictable. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. The process from early discovery to design and adequate implementation of clinical trials to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, or unfavorable new clinical data and further analyses of existing clinical data, including results that may not support further clinical development of the applicable product candidate or indication. We may not be able to meet anticipated pre-clinical or clinical endpoints, commencement and/or completion dates for our pre-clinical or clinical trials, regulatory submission dates, regulatory approval dates and/or launch dates. Similarly, we may not be able to successfully address all of the comments received from regulatory authorities such as the FDA and the EMA, or obtain approval from regulators. Regulatory approval of drug or biologic products depends on myriad factors, including a regulator making a determination as to whether a products benefits outweigh its known risks and a determination of the products efficacy. Additionally, clinical trial data are subject to differing interpretations and assessments by regulatory authorities. Even after a drug or biologic is approved, it could be adversely affected by regulatory decisions impacting labeling, manufacturing processes, safety and/or other matters. We may not be able to receive or maintain favorable recommendations by technical or advisory committees, such as the Advisory Committee on Immunization Practices that may impact the use of our vaccines. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional or more extensive clinical trials prior to granting approval or increased post-approval requirements. For these and other reasons discussed in Item 1A. Risk Factors , we may not obtain the approvals we expect within the timeframe we anticipate, or at all. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. For example, in July and December 2019, the FDA updated the U.S. prescribing information for Xeljanz to include three additional boxed warnings as well as changes to the indication and dosing for ulcerative colitis. In January 2020, the EMA revised the summary of product characteristics (SmPC) for Xeljanz to include new warnings and recommendations for use of Xeljanz due to an increased risk of venous thromboembolism and, due to an increased risk of infections, revised warnings in patients older than 65 years of age. These updates were based on the FDAs and EMAs review of data from the ongoing post-marketing requirement rheumatoid arthritis study A3921133. Postmarketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products could implicate the entire class of products; and this, in turn, could have an adverse effect on the availability or commercial viability of our product(s) as well as other products in the class. Pfizer Inc. 2019 Form 10-K INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide, offer, or promise something of value to a healthcare professional, other healthcare provider and/or government official. Requirements or industry standards in the U.S. and certain jurisdictions abroad that require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers increase government and public scrutiny of such financial interactions. If an interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as both U.S. and foreign enforcement agencies adopt or increase enforcement efforts in respect of existing and new laws and regulations governing product promotion, marketing, anti-bribery and kickbacks, industry regulations, and codes of conduct. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory clarifications and/or interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals, including further clarifications and/or interpretations of or changes to the U.S. Tax Cuts and Jobs Act of 2017), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision/(Benefit) for Taxes on Income Changes in Tax Laws and New Accounting Standards sections, and the Notes to Consolidated Financial Statements Note 1 B. Basis of Presentation and Significant Accounting Policies : Adoption of New Accounting Standards in 2019 in our 2019 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various legal proceedings, including patent litigation, such as claims that our patents are invalid and/or do not cover the product of the generic drug manufacturer or where one or more third parties seeks damages and/or injunctive relief to compensate for alleged infringement of its patents by our commercial or other activities, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings, including various means for resolving asbestos litigation, that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe that our claims and defenses in matters in which we are a defendant are substantial, we could in the future incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, corporate integrity or deferred prosecution agreements, as well as reputational harm and increased public interest in the matter could result from government investigations in the U.S. and other jurisdictions in which we do business. In addition, in a qui tam lawsuit in which the government declines to intervene, the relator may still pursue a suit for the recovery of civil damages and penalties on behalf of the government. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2019 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. In connection with the resolution of a U.S. government investigation concerning independent copay assistance organizations that provide financial assistance to Medicare patients, in May 2018, we entered into a Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the U.S. Department of Health and Human Services, which is effective for a period of five Pfizer Inc. 2019 Form 10-K years. In the CIA, we agreed to implement and/or maintain certain compliance program elements to promote compliance with federal healthcare program requirements. Breaches of the CIA could result in severe sanctions against us. For additional information, including information regarding certain legal proceedings in which we are involved in, see the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for legal and environmental contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic or biosimilar versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in policies or practices that may weaken its intellectual property framework (e.g., laws or regulations that promote or provide broad discretion to issue a compulsory license). In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches that challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid in such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio were challenged in inter partes review and post-grant review proceedings in the U.S. In October 2017, the Patent Trial and Appeal Board (PTAB) refused to initiate proceedings as to two patents. In June 2018, the PTAB ruled on another patent, holding that one claim was valid and that all other claims were invalid. The party challenging that patent has appealed the decision. In November 2019, the Federal Circuit vacated the PTABs ruling and requested that the PTAB redecide the challenge. In March and June 2019, an additional patent was found invalid in separate proceedings by the PTAB. We have appealed. Challenges to other patents remain pending in jurisdictions outside the U.S. The invalidation of all of these patents in our pneumococcal portfolio could potentially allow a competitor pneumococcal vaccine into the marketplace. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks Pfizer Inc. 2019 Form 10-K and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not always be successful. Part of our business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others, and in some circumstances we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable in order to achieve a first-to-market or early market position for our products. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold in the event that we or one of our subsidiaries, like Hospira, is found to have willfully infringed valid patent rights of a third party. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, our efforts may not prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however, this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. Pfizer Inc. 2019 Form 10-K RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of any of our strategic acquisitions will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with certain of these acquisitions, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from certain of these acquisitions may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions and substantial regulatory scrutiny due to quality issues. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Development Initiatives section in our 2019 Financial Report. PENDING COMBINATION OF UPJOHN WITH MYLAN Pfizer, Mylan and Upjohn may be unable to satisfy the conditions or obtain the approvals required to complete the combination of Upjohn with Mylan (the Combination), and regulatory agencies may delay or impose conditions on approval of the Combination, which may diminish the anticipated benefits of the Combination. The consummation of the Combination is subject to numerous conditions, including the receipt by Pfizer of an Internal Revenue Service ruling and an opinion of its tax counsel to the effect that, among other things, certain transactions related to the Combination and certain related transactions will constitute a tax-free reorganization within the meaning of Section 368(a)(1)(D) of the Internal Revenue Code, the approval of the Combination by Mylan shareholders, and other customary conditions, certain of which are dependent upon the actions of third parties. As a result of such conditions, Pfizer cannot make any assurances that the Combination will be consummated on the terms or timeline currently contemplated, or at all. Completion of the Combination is also conditioned upon the receipt of certain required government consents and approvals, including certain approvals required from regulatory agencies. While Pfizer, Mylan and Upjohn intend to pursue vigorously all required governmental approvals, the requirement to receive these approvals prior to the consummation of the Combination could delay the completion of the Combination, possibly for a significant period of time. Any delay in the completion of the Combination could diminish the anticipated benefits of the Combination or result in additional transaction costs, loss of revenue or other effects associated with uncertainty about the Combination, including delaying Pfizers ability to capitalize on its strategy of becoming a more focused, innovative company as well as Upjohns ability to optimize the execution of its growth strategies. Pfizer may be subject to shareholder lawsuit, or other actions filed in connection with or in opposition to the Combination or any related transactions. Such litigation could have an adverse effect on the business, financial condition and results of operations of Pfizer and could prevent or delay the consummation of the Combination. Pfizer has expended and will continue to expend significant management time and resources and has incurred and will continue to incur significant expenses due to legal, advisory, printing and financial services fees related to the Combination, including costs required to obtain the required government consents or defend or settle actions noted above. We expect to incur costs of approximately $500 million in connection with fully separating Upjohn, inclusive of $145 million incurred in 2019. Such charges will include costs and expenses related to separation of legal entities and anticipated transaction costs. Many of these expenses must be paid regardless of whether the Combination is consummated, and even if the expected benefits of the Combination are not achieved. Additionally, the completion of the Combination, including for example, obtaining regulatory approvals, will require significant time and attention from Pfizer management and may divert attention from the day-to-day operations of our business. Even if the Combination is completed as anticipated, Pfizer may not realize some or all of the expected benefits. Furthermore, Upjohn may experience operational challenges in integrating the Upjohn and Mylan businesses, which may also diminish the anticipated benefits of the Combination. Even if the Combination is completed, the anticipated operational, financial, strategic and other benefits of the Combination may not be achieved. There are many factors that could impact the anticipated benefits from the Combination, including, among others, strategic adjustments required to reflect the nature of our business following the Combination, any negative reaction to the Combination by our customers and business partners, and increased risks resulting from Pfizer becoming a company that is more focused on innovative medicines. In addition, Pfizer has agreed to provide certain transition services to the combined company, generally for an initial period of 24 months following the completion of the Combination (with certain possibilities for extension). These obligations under the transition agreements may result in additional expenses and may divert Pfizer Inc. 2019 Form 10-K Pfizers focus and resources that would otherwise be invested into maintaining or growing Pfizers business. An inability to realize the full extent of the anticipated benefits of the Combination, as well as any delays encountered in the process, could have an adverse effect on the revenues, level of expenses and operating results of our business. Furthermore, the Combination is a complex, costly and time-consuming process. Even if Upjohn and Mylan successfully integrate, Pfizer, Upjohn and Mylan cannot predict with certainty if or when the anticipated synergies, growth opportunities and benefits resulting from the Combination will occur, or the extent to which they actually will be achieved. For example, the benefits from the Combination may be offset by costs incurred in integrating the companies or by required capital expenditures related to the combined businesses. In addition, the quantification of synergies expected to result from the Combination is based on significant estimates and assumptions that are subjective in nature and inherently uncertain. Realization of any benefits and synergies could be affected by a number of factors beyond Pfizers, Mylans, Upjohns or the combined companys control, including, without limitation, general economic conditions, increased operating costs, regulatory developments and the other risks described in these risk factors. The amount of synergies actually realized in the Combination, if any, and the time periods in which any such synergies are realized, could differ materially from the synergies anticipated to be realized, regardless of whether the two business operations are combined successfully. If the integration is unsuccessful or if the combined company is unable to realize the anticipated synergies and other benefits of the Combination, there could be a material adverse effect on the combined companys share price, business, financial condition and results of operations. CONSUMER HEALTHCARE JOINT VENTURE WITH GSK On July 31, 2019, we completed the transaction in which we and GSK combined our respective consumer healthcare businesses into a new consumer healthcare joint venture that operates globally under the GSK Consumer Healthcare name. Following the integration of the combined business, GSK intends to separate the joint venture as an independent company via a demerger of its equity interest to its shareholders and a listing of the combined business on the U.K. equity market. In February 2020, GSK announced the initiation of a two-year program to prepare for the separation of GSK into two companies, including a standalone Consumer Healthcare company. Until the fifth anniversary of the closing of the transaction, GSK will have the sole right to decide whether and when to initiate a separation and listing, and may also sell all or part of its stake in the joint venture in a contemporaneous initial public offering. Should a separation and listing occur during the first five years after closing, Pfizer has the option to participate through the distribution of some or all of its equity interest in the joint venture to its shareholders. Following a separation or listing, and subject to customary lock-up or similar restrictions, Pfizer will also have the ability to sell its equity interest in the joint venture through the capital markets. After the fifth anniversary of the closing of the transaction, both GSK and Pfizer will have the right to decide whether and when to initiate a separation and public listing of the joint venture. The planned separation and public listing transactions may not be initiated or completed within the expected time periods or at all, and both the timing and success of any separation and public listing transaction, as well as the value generated for Pfizer or its shareholders in any such transaction, will be subject to prevailing market conditions and other factors at the time of such transaction. Although Pfizer is entitled to participate in any separation and listing transaction initiated by GSK prior to the fifth anniversary of the closing, it is not required to do so, and any future distribution or sale of Pfizers equity stake in the joint venture will similarly be subject to prevailing market conditions and other factors at the time of such transaction. Pfizers ability to complete any such future distribution or sale may also be impacted by the size of Pfizers retained equity stake at the time. The uncertainty relating to the separation and public listing transactions, their implementation, their timing and their yet to be determined effects on the joint ventures business may subject us and the joint venture to risks and uncertainties that may adversely affect our business and financial results. Moreover, although we have certain consent, board representation and other governance rights with respect to the joint venture, Pfizer is a minority owner of the joint venture. As a result, Pfizer does not have control over the joint venture, its management or its policies and we may have business interests, strategies and goals that differ in certain respects from those of GSK or the joint venture. In addition, the joint venture will be subject to the risks associated with the joint ventures consumer healthcare business, and the business, financial condition and results of operations of the joint venture may be affected by factors that are different from or in addition to those that previously affected the business, financial condition and results of operations of Pfizers historical consumer healthcare business. Many of these factors are outside of our and the joint ventures control, and could materially impact the business, financial condition and results of operations of the joint venture. The success of the transaction will also depend, in part, on the joint ventures ability to realize the anticipated benefits and cost synergies from the transaction. These anticipated benefits and cost savings may not be realized or may not be realized within the expected time period. The joint ventures integration of Pfizers and GSKs historic consumer healthcare businesses may result in material unanticipated problems, costs, expenses, liabilities, competitive responses, and loss of customer and other business relationships. Any material unanticipated issues arising from the integration process could negatively impact our stock price and our or the joint ventures future business and financial results . Pfizer Inc. 2019 Form 10-K OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses of our size, we are exposed to both global and industry-specific economic conditions. Governments, corporations, and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic or biosimilar products, delay treatments, skip doses or use less effective treatments. As discussed above, government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications for our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. Details on how Brexit will be finally executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report. Public health epidemics or outbreaks could adversely impact our business. In December 2019, a novel strain of coronavirus (COVID-19) emerged in Wuhan, Hubei Province, China . While initially the outbreak was largely concentrated in China and caused significant disruptions to its economy, it has now spread to several other countries and infections have been reported globally. The extent to which the coronavirus impacts our operations will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the outbreak, new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or treat its impact, among others. In particular, the continued spread of the coronavirus globally could adversely impact our operations, including among others, our manufacturing and supply chain, sales and marketing and clinical trial operations and could have an adverse impact on our business and our financial results. We also continue to monitor the global trade environment and potential trade conflicts and impediments. If trade restrictions or tariffs reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 54% of our total 2019 revenues were derived from international operations, including 21% from Europe and 24% from China, Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Chinese renminbi, the Japanese yen, the Canadian dollar, the U.K. pound and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations, including Venezuela and Argentina, can impact our results and financial guidance . For additional information about our exposure to foreign currency risk, see the Item 7A. Quantitative and Qualitative Disclosures About Market RiskForeign Exchange Risk section in this 2019 Form 10-K and the Overview of Our Performance, Operating Environment, Strategy and Pfizer Inc. 2019 Form 10-K Outlook Our Financial Guidance for 2020 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2019 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks related to interest-bearing investments and borrowings and the measures we have taken to help contain them are discussed in the Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section and the Notes to Consolidated Financial Statements Note 7 F . Financial Instruments : Derivative Financial Instruments and Hedging Activities and Note 11 . Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report, which are incorporated by reference. From time to time, we issue variable rate debt based on LIBOR, or undertake interest rate swaps that contain a variable element based on LIBOR. The U.K. Financial Conduct Authority announced in July 2017 that it will no longer compel banks to submit rates that are currently used to calculate LIBOR after 2021. Various governing parties, including government agencies, are working on a benchmark transition plan for LIBOR (and other interbank offered rates globally) . We are monitoring their progress, and we will likely amend contracts to accommodate any replacement rate where it is not already provided. As a result, our interest expense could increase and our available cash flow for general corporate requirements may be adversely affected. Additionally, uncertainty as to the nature of a potential discontinuance, modification, alternative reference rates or other reforms may materially adversely affect the trading market for securities linked to such benchmarks. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Selected Measures of Liquidity and Capital Resources LIBOR section in our 2019 Financial Report. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. MARKET FLUCTUATIONS IN OUR EQUITY INVESTMENTS In 2018, we adopted a new accounting standard whereby certain equity investments are measured at fair value with changes in fair value now recognized in net income. We expect the adoption of this new accounting standard may increase the volatility of our income in future periods due to changes in the fair value of certain equity investments. For additional information, see the Notes to Consolidated Financial Statements Note 4. Other (Income)/Deductions Net in our 2019 Financial Report and the Item 7A. Quantitative and Qualitative Disclosures About Market Risk Financial Risk Management section in this 2019 Form 10-K. Our pension benefit obligations and postretirement benefit obligations, net of our plan assets, are subject to volatility from changes in fair value of equity investments and other investment risk. For additional information, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions Benefit Plans section and the Notes to Consolidated Financial Statements Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2019 Financial Report. COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) the reorganization of our commercial operations in 2019; (iii) any other corporate strategic initiatives; and (iv) any acquisitions, divestitures or other initiatives, such as our agreement to combine Upjohn with Mylan, creating a new global pharmaceutical company, which is anticipated to close in mid-2020, our acquisition of Array and the formation of the new consumer healthcare joint venture with GSK. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. If the associated RD effort is abandoned, the related IPRD assets will likely be written-off, and we will record an impairment charge. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible Pfizer Inc. 2019 Form 10-K assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2019 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. Pfizer Inc. 2019 Form 10-K ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES As of December 31, 2019 , we had 453 owned and leased properties, amounting to approximately 47 million square feet. In 2019, we reduced the number of properties in our portfolio by 45 sites and 6 million square feet, which reflects the divestment of properties in connection with the formation of the GSK Consumer Healthcare joint venture and the addition of properties in connection with the acquisition of Array. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to approximately 90 countries. In April 2018, we entered an agreement to lease space at the Spiral, an office building in the Hudson Yards neighborhood of New York City. We will relocate our global headquarters to this property with occupancy expected beginning in 2022. In July 2018, we completed the sale of our current headquarters in New York City. We remain in a lease-back arrangement with the buyer while we complete our relocation. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2019, we operationalized the new RD facilities in St. Louis, Missouri and Andover, Massachusetts. We also purchased an RD property in Durham, North Carolina in 2019 and expect to renovate and fit out the space over the next several years. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2019 , PGS had responsibility for 42 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of two of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In 2019, seven manufacturing plants transferred from PGSs responsibility to Upjohns responsibility, and an additional two plants are expected to be fully migrated from PGSs responsibility to Upjohns responsibility over the next several years. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9 . Property, Plant and Equipment in our 2019 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 16 A . Contingencies and Certain Commitments Legal Proceedings in our 2019 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 25, 2020 , there were 142,524 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Selected Quarterly Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2019 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2019 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) September 30, 2019 through October 27, 2019 32,848 $ 36.06 $ 5,292,881,709 October 28, 2019 through November 30, 2019 13,399 $ 37.50 $ 5,292,881,709 December 1, 2019 through December 31, 2019 67,767 $ 38.86 $ 5,292,881,709 Total 114,014 $ 37.89 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12 . Equity in our 2019 Financial Report, which is incorporated by reference. (b) These columns represent (i) 108,367 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs and (ii) the open market purchase by the trustee of 5,647 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards. Pfizer Inc. 2019 Form 10-K ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2019 Financial Report. ," ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial Risk Management The objective of our financial risk management program is to minimize the impact of foreign exchange rate movements and interest rate movements on our earnings. We manage these financial exposures through operational means and through the use of third-party instruments. These practices may change as economic conditions change. Foreign Exchange Risk We operate globally and, as such, we are subject to foreign exchange risk in our commercial operations, as well as in our financial assets (investments) and liabilities (borrowings). Our net investments in foreign subsidiaries are also subject to currency risk. On the commercial side, a significant portion of our revenues and earnings is exposed to changes in foreign exchange rates. See the Overview of Our Performance, Operating Environment, Strategy and Outlook The Global Economic Environment section in our 2019 Financial Report for the key currencies in which we operate. We seek to manage our foreign exchange risk, in part, through operational means, including managing same-currency revenues in relation to same-currency costs and same-currency assets in relation to same-currency liabilities. Where foreign exchange risk cannot be mitigated via operational means, we may use foreign currency forward-exchange contracts and/or foreign currency swaps to manage that risk. With respect to our financial assets and liabilities, our primary foreign exchange exposure arises predominantly from short-term and long-term intercompany receivables and payables, and, to a lesser extent, from short-term and long-term investments and debt, where the assets and/or liabilities are denominated in currencies other than the functional currency of the business entity. We also hedge some forecasted intercompany sales denominated in euro, Japanese yen, Chinese renminbi, U.K. pound, Canadian dollar, and Australian dollar to protect against longer-term movements. In addition, under certain market conditions, we may seek to protect against possible declines in the reported net investments of our foreign business entities. In these cases, we may use foreign currency swaps, foreign currency forward-exchange contracts and/or foreign currency debt. For details about these and other financial instruments, including fair valuation methodologies, see the Notes to Consolidated Financial Statements Note 7A. Financial Instruments : Fair Value Measurements in our 2019 Financial Report. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to foreign exchange rate changes. In this sensitivity analysis, holding all other assumptions constant and assuming that a change in one currencys rate relative to the U.S. dollar would not have any effect on another currencys rates relative to the U.S. dollar, if the dollar were to appreciate against all other currencies by 10%, as of December 31, 2019 , the expected adverse impact on our net income would not be significant. Interest Rate Risk We are subject to interest rate risk on our investments and on our borrowings. We manage interest rate risk in the aggregate, while focusing on Pfizers immediate and intermediate liquidity needs. With respect to our investments, we strive to maintain a predominantly floating-rate basis position, but our strategy may change based on prevailing market conditions. Our floating-rate assets are subject to the risk that short-term interest rates may fall and, as a result, the investments would generate less interest income. Fixed-rate investments provide a known amount of interest income regardless of a change in interest rates. We sometimes use interest rate swaps in our financial investment portfolio. Pfizer Inc. 2019 Form 10-K We borrow primarily on a long-term, fixed-rate basis. From time to time, depending on market conditions, we will change the profile of our outstanding debt by entering into derivative financial instruments like interest rate swaps. For details about these and other financial instruments, including fair valuation methodologies, see the Notes to Consolidated Financial Statements Note 7A. Financial Instruments : Fair Value Measurements in our 2019 Financial Report. The fair values of our financial instrument holdings are analyzed at year-end to determine their sensitivity to interest rate changes. In this sensitivity analysis, holding all other assumptions constant and assuming a parallel shift in the interest rate curve for all maturities and for all instruments, if there were a one hundred basis point increase in interest rates as of December 31, 2019 , the expected adverse impact on our net income would not be significant. Equity Price Risk We hold equity securities with readily determinable fair values in life science companies as a result of certain business development transactions. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. From time to time, we will sell such equity securities based on our business considerations, which may include limiting our price risk. Our equity securities with readily determinable fair values are analyzed at year-end to determine their sensitivity to equity price rate changes. In this sensitivity analysis, the expected adverse impact on our net income would not be significant. "," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm in our 2019 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2019 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2019 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2019 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. " +3,pfe-,10kshell," ITEM 1. BUSINESS ABOUT PFIZER Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. Our significant recent business development activities include: On February 3, 2017, we completed the sale of our global infusion systems net assets, HIS, to ICU Medical for up to approximately $900 million , composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS, which was acquired as part of the Hospira acquisition in September 2015, includes IV pumps, solutions and devices. On December 22, 2016, for $1,045 million we acquired the development and commercialization rights to AstraZenecas small molecule anti-infectives business, primarily outside the U.S., which includes the newly approved EU drug Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ( $13.9 billion , net of cash acquired). Medivation is a biopharmaceutical company focused on developing and commercializing small molecules for oncology. On June 24, 2016, we acquired Anacor for approximately $4.9 billion in cash ( $4.5 billion net of cash acquired), plus $698 million debt assumed. Anacor is a biopharmaceutical company focused on novel small-molecule therapeutics derived from its boron chemistry platform. On September 3, 2015, we acquired Hospira, a leading provider of sterile injectable drugs and infusion technologies as well as a provider of biosimilars, for approximately $16.1 billion in cash ( $15.7 billion , net of cash acquired). For a further discussion of our strategy and our business development initiatives, see the Notes to Consolidated Financial Statements Note 2. Acquisitions, Sale of Hospira Infusion Systems Net Assets, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment and the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Our Business Development Initiatives section in our 2017 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA regulates the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of drugs for the EU and the European Economic Area countries. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or EMA) before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Government Regulation and Price Constraints section below. Note: Some amounts in this 2017 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2017 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Throughout this 2017 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2018 Proxy Statement and the 2017 Financial Report, portions of which are filed as Exhibit 13 to this 2017 Form 10-K, and which also will be contained in Appendix A to our 2018 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to this information. Our 2017 Annual Report to Shareholders consists of the 2017 Financial Report and the Corporate and Shareholder Information attached to the 2018 Proxy Statement. Our 2017 Financial Report will be available on our website on or about February 22, 2018. Our 2018 Proxy Statement will be available on our website on or about March 15, 2018. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers; as well as Chief Executive Officer and Chief Financial Officer certifications, are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts does not, and shall not be deemed to, constitute a part of this 2017 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2017 Form 10-K COMMERCIAL OPERATIONS We manage our commercial operations through two distinct business segments: Pfizer Innovative Health (IH) and Pfizer Essential Health (EH). The IH and EH operating segments are each led by a single manager. Each operating segment has responsibility for its commercial activities and for certain IPRD projects for new investigational products and additional indications for in-line products that generally have achieved proof-of-concept. Each business has a geographic footprint across developed and emerging markets. Some additional information about our business segments as of the date of the filing of this 2017 Form 10-K follows: IH focuses on developing and commercializing novel, value-creating medicines and vaccines that significantly improve patients lives, as well as products for consumer healthcare. Key therapeutic areas include internal medicine, vaccines, oncology, inflammation immunology, rare disease and consumer healthcare. EH includes legacy brands that have lost or will soon lose market exclusivity in both developed and emerging markets, branded generics, generic sterile injectable products, biosimilars, select branded products including anti-infectives and, through February 2, 2017, HIS. EH also includes an RD organization, as well as our contract manufacturing business. We expect that the IH biopharmaceutical portfolio of innovative, largely patent-protected, in-line and newly launched products will be sustained by ongoing investments to develop promising assets and targeted business development in areas of focus to help ensure a pipeline of highly-differentiated product candidates in areas of unmet medical need. The assets managed by IH are science-driven, highly differentiated and generally require a high-level of engagement with healthcare providers and consumers. EH is expected to generate strong consistent cash flow by providing patients around the world with access to effective, lower-cost, high-value treatments. EH leverages our biologic development, regulatory and manufacturing expertise to seek to advance its biosimilar development portfolio. Additionally, EH leverages capabilities in formulation development and manufacturing expertise to help advance its generic sterile injectables portfolio. EH may also engage in targeted business development to further enable its commercial strategies. IH will have continued focus on RD productivity and pipeline strength while maximizing the value of our recently launched brands and in-line portfolio. Our acquisitions of Anacor and Medivation expanded our pipeline in the high priority therapeutic areas of inflammation and immunology and oncology. For EH, we continue to invest in growth drivers and manage the portfolio to extract additional value while seeking opportunities for operating efficiencies. This strategy includes active management of our portfolio; maximizing growth of core product segments; acquisitions to strengthen core areas of our portfolio further, such as our recent acquisition of AstraZenecas small molecule anti-infectives business; and divestitures to increase focus on our core strengths. In line with this strategy, on February 3, 2017, we completed the sale of Pfizers global infusion systems net assets, representing the infusion systems net assets that we acquired as part of the Hospira transaction, HIS, to ICU Medical. Leading brands include: - Prevnar 13/Prevenar 13 - Xeljanz - Eliquis - Lyrica (U.S., Japan and certain other markets) - Enbrel (outside the U.S. and Canada) - Ibrance - Xtandi - Several OTC consumer healthcare products (e.g., Advil and Centrum ) Leading brands include: - Lipitor - Premarin family - Norvasc - Lyrica (Europe, Russia, Turkey, Israel and Central Asia countries) - Celebrex - Viagra* - Inflectra/Remsima - Several sterile injectable products * Viagra lost exclusivity in the U.S. in December 2017. Beginning in the first quarter of 2018, revenues for Viagra in the U.S. and Canada, which were reported in IH through December 2017, will be reported in EH (which reported all other Viagra revenues excluding the U.S. and Canada through 2017). Therefore, total Viagra worldwide revenues will be reported in EH from 2018 forward. For a further discussion of these operating segments, see the Innovative Health and Essential Health sections below and the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , the table captioned Revenues by Segment and Geography in the Analysis of the Consolidated Statements of Income section, and the Analysis of Operating Segment Information section in our 2017 Financial Report, which are incorporated by reference. Pfizer Inc. 2017 Form 10-K INNOVATIVE HEALTH The key therapeutic areas comprising our IH business segment include: Therapeutic Area Description Key Products Internal Medicine Includes innovative brands from two therapeutic areas, Cardiovascular Metabolic and Neuroscience and Pain, as well as regional brands. Lyrica (outside Europe, Russia, Turkey, Israel and Central Asia countries), Chantix/Champix and Eliquis (jointly developed and commercialized with BMS) Vaccines Includes innovative vaccines brands across all agesinfants, adolescents and adultsin pneumococcal disease, meningitis and tick borne encephalitis, with a focus on healthcare-acquired infections and maternal health. Prevnar 13/Prevenar 13 (pediatric/adult), Trumenba and FSME-IMMUN Oncology Includes innovative oncology brands of biologics, small molecules and immunotherapies across a wide range of cancers. Ibrance, Sutent, Xalkori, Inlyta and Xtandi (jointly developed and commercialized with Astellas) Inflammation and Immunology Includes innovative brands for chronic immune and inflammatory diseases. Enbrel (outside the U.S. and Canada), Xeljanz and Eucrisa Rare Disease Includes innovative brands for a number of rare diseases, including hematology, neuroscience, and inherited metabolic disorders. BeneFix , Genotropin , and Refacto AF/Xyntha Consumer Healthcare Includes over-the-counter (OTC) brands with a focus on dietary supplements, pain management, gastrointestinal and respiratory and personal care. According to Euromonitor Internationals retail sales data, in 2017, Pfizers Consumer Healthcare business was the fifth-largest branded multi-national, OTC consumer healthcare business in the world and produced two of the ten largest selling consumer healthcare brands ( Centrum and Advil ) in the world. Dietary Supplements: Centrum brands, Caltrate and Emergen-C Pain Management: Advil brands and ThermaCare Gastrointestinal: Nexium 24HR/Nexium Control and Preparation H Respiratory and Personal Care: Robitussin , Advil Cold Sinus and ChapStick In October 2017, we announced that we are reviewing strategic alternatives for our Consumer Healthcare business. A range of options will be considered, including a full or partial separation of the Consumer Healthcare business from Pfizer through a spin-off, sale or other transaction, and we may ultimately determine to retain the business. We expect that any decision regarding strategic alternatives for Consumer Healthcare would be made during 2018. We recorded direct product and/or alliance revenues of more than $1 billion for each of seven IH products in 2017 and 2016 and for each of five IH products in 2015 : Innovative Health $1B+ Products 2016 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Prevnar 13/Prevenar 13 Lyrica IH Lyrica IH Lyrica IH Ibrance Enbrel Enbrel Eliquis* Ibrance Viagra IH Enbrel Eliquis* Sutent Xeljanz Viagra IH Sutent Sutent * Eliquis includes alliance revenues and direct sales in 2017 and 2016. Geographic Revenues for Innovative Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For a discussion of certain IH products and additional information regarding the revenues of our IH business, including revenues of major IH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Discussion sections in our 2017 Financial Report; and for additional information on the key operational revenue drivers of our IH business, see the Analysis of Operating Segment Information Innovative Health Operating Segment section of our 2017 Financial Report. For a discussion on the risks associated with our dependence on certain of our major products, see Item 1A. Risk FactorsDependence on Key In-Line Products below. ESSENTIAL HEALTH The product categories in our EH business segment include: Product Category Description Key Products Global Brands Legacy Established Products Includes products that have lost patent protection (excluding Sterile Injectable Pharmaceuticals and Peri-LOE Products). Lipitor , Premarin family and Norvasc Global Brands Peri-LOE Products Includes products that have recently lost or are anticipated to soon lose patent protection. Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Viagra* , Celebrex , Pristiq , Zyvox , Vfend , Revatio and Inspra Sterile Injectable Pharmaceuticals Includes generic injectables and proprietary specialty injectables (excluding Peri-LOE Products). Medrol , Sulperazon , Fragmin and Tygacil Biosimilars Includes recombinant and monoclonal antibodies, primarily in inflammation, oncology and supportive care. Inflectra / Remsima (biosimilar infliximab) (U.S. and certain international markets), Nivestim (biosimilar filgrastim) (certain European, Asian and Africa/Middle East markets) and Retacrit (biosimilar epoetin zeta) (certain European and Africa/Middle East markets) Pfizer CentreOne Includes revenues from our contract manufacturing and active pharmaceutical ingredient sales operation, including sterile injectables contract manufacturing, and revenues related to our manufacturing and supply agreements, including with Zoetis Inc. -- * Viagra lost exclusivity in the U.S. in December 2017. Beginning in the first quarter of 2018, revenues for Viagra in the U.S. and Canada, which were reported in IH through December 2017, will be reported in EH (which reported all other Viagra revenues excluding the U.S. and Canada through 2017). Therefore, total Viagra worldwide revenues will be reported in EH from 2018 forward. Through February 2, 2017, our EH business segment also included HIS, which includes Medication Management products composed of infusion pumps and related software and services, as well as intravenous infusion products, including large volume intravenous solutions and their associated administration sets. On February 3, 2017, we completed the sale of HIS to ICU Medical. For additional information, see the Notes to Consolidated Financial Statements Note 2B. Sale of Hospira Infusion Systems Net Assets to ICU Medical, Inc. (EH). We recorded direct product revenues of more than $1 billion for one EH product in 2017 , two EH products in 2016 and three EH products in 2015 : Essential Health $1B+ Products Lipitor Lipitor Lipitor Premarin family of products Lyrica EH Premarin family of products Geographic Revenues for Essential Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For a discussion of certain EH products and additional information regarding the revenues of our EH business, including revenues of major EH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Discussion sections in our 2017 Financial Report; and for additional information on the key operational revenue drivers of our EH business, see the Analysis of Operating Segment Information Essential Health Operating Segment section of our 2017 Financial Report. For a discussion on the risks associated with our dependence on certain of our major products, see Item 1A. Risk FactorsDependence on Key In-Line Products below. COLLABORATION AND CO-PROMOTION AGREEMENTS We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including Eliquis , Xtandi and Bavencio . Eliquis has been jointly developed and is being commercialized in collaboration with BMS. Pfizer funds between 50% and 60% of all development costs depending on the study. Profits and losses are shared equally on a global basis, except in certain countries where Pfizer commercializes Eliquis and pays BMS compensation based on a percentage of net sales. We have full commercialization rights in certain smaller markets. BMS supplies the product to us at cost plus a percentage of the net sales to end-customers in these markets. Eliquis is part of the Novel Oral Anticoagulant market; the agents in this class were developed as alternative treatment options to warfarin in appropriate patients. Xtandi is being developed and commercialized through a collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi . Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. In addition, Pfizer and Astellas share certain development and other collaboration expenses, and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (Income)/Deductions Net ). Xtandi is an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells. Bavencio is being developed and commercialized in collaboration with Merck KGaA. Both companies jointly fund all development and commercialization costs, and split equally any profits generated from selling any anti-PD-L1 or anti-PD-1 Pfizer Inc. 2017 Form 10-K products from this collaboration. Bavencio is currently approved in metastatic Merkel cell carcinoma in the U.S., Europe and Japan, as well as received accelerated approval for second line treatment of locally advanced or metastatic urothelial carcinoma in the U.S. Collaboration rights for Enbrel (in the U.S. and Canada), Spiriva and Rebif have expired. For additional information, including a description of certain of these expired collaboration and co-promotion agreements, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2017 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products and Collaborations and Other Relationships with Third Parties sections below. RESEARCH AND DEVELOPMENT Our goal is to discover, develop and bring to market innovative products that address major unmet medical needs. Our RD Priorities and Strategy Our RD priorities include delivering a pipeline of differentiated therapies and vaccines with the greatest medical and commercial potential, advancing our capabilities that can position Pfizer for long-term leadership and creating new models for biomedical collaboration that will expedite the pace of innovation and productivity. To that end, our research and development primarily focuses on: Biosimilars; Inflammation and Immunology; Metabolic Disease and Cardiovascular Risks; Oncology; Rare Diseases; and Vaccines. In January 2018, we announced our decision to end internal neuroscience discovery and early development efforts and re-allocate funding to other areas where we have stronger scientific leadership. We plan to create a dedicated neuroscience venture fund to support continued efforts to advance the field. The development of tanezumab and potential treatments for rare neuromuscular disorders is not impacted by this decision. While a significant portion of RD is done internally, we continue to seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines, by entering into collaborations, alliances and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. For additional information on these collaborations, agreements and investments, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Description of Research and Development Operations section in our 2017 Financial Report. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. Our RD spending is conducted through a number of matrix organizations. Research Units within our Worldwide Research and Development (WRD) organization are generally responsible for research and early-stage development assets for our IH business (assets that have not yet achieved proof-of-concept). Our science-based and other platform-services organizations, where a significant portion of our RD spending occurs, provide end-to-end scientific and technical expertise and other services to the various RD projects, and are organized into science-based functions (which are part of our WRD organization), such as Pharmaceutical Sciences, Medicinal Chemistry, Regulatory and Drug Safety, and non-science-based functions, such as Facilities, Business Technology and Finance. Our RD organization within the EH business supports the large base of EH products and is expected to develop potential new sterile injectable drugs and therapeutic solutions, as well as biosimilars. Our Global Product Development organization is a unified center for late-stage development for our innovative products and is generally responsible for the operational execution of clinical development of assets that are in clinical trials for our WRD and Innovative portfolios. For discussion regarding these RD matrix organizations and additional information on our RD operations, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Description of Research and Development Operations and Costs and Expenses Research and Development (RD) Expenses sections in our 2017 Financial Report. Our RD Pipeline and Competition Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. According to the Pharmaceutical Benchmarking Forum, out of 17 compounds entering preclinical development, on average, only one is approved by a regulatory authority in a major market (U.S., the EU or Japan). The process from early discovery or design to development to regulatory approval can take more than ten years. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. As of January 30, 2018 , we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments Biopharmaceutical section in our 2017 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections below. Pfizer Inc. 2017 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. Operations in developed and emerging markets are managed through our two business segments: IH and EH. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $26.5 billion accounted for 50% of our total revenues in 2017 . By total revenues, Japan and China are our two largest national markets outside the U.S. For a geographic breakdown of revenues, see the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information in our 2017 Financial Report, and the table captioned Revenues by Segment and Geography in our 2017 Financial Report. Those tables are incorporated by reference. Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries, including, among other things, currency fluctuations, capital and exchange control regulations and expropriation and other restrictive government actions. See Item 1A. Risk Factors Risks Affecting International Operations below. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See Government Regulation and Price Constraints Outside the United States below for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7F. Financial Instruments: Derivative Financial Instruments and Hedging Activities in our 2017 Financial Report, as well as the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2017 Financial Report. Those sections of our 2017 Financial Report are incorporated by reference. Pfizer Inc. 2017 Form 10-K MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; Managed Care Organizations that provide insurance coverage, such as hospitals, Integrated Delivery Systems, Pharmacy Benefit Managers and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the Centers for Disease Control and Prevention, wholesalers and individual provider offices. We seek to gain access for our products on healthcare authority and MCO formularies, which are lists of approved medicines available to members of the MCOs. MCOs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We also work with MCOs to assist them with disease management, patient education and other tools that help their medical treatment routines. In 2017 , our top three biopharmaceutical wholesalers accounted for approximately 38% of our total revenues (and approximately 79% of our total U.S. revenues). % of 2017 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers Our global Consumer Healthcare business uses its own sales and marketing organizations to promote its products, and occasionally uses distributors and agents, principally in smaller markets. The advertising and promotions for our Consumer Healthcare business are generally disseminated to consumers through television, print, digital and other media advertising, as well as through in-store promotion. Consumer Healthcare products are sold through a wide variety of channels, including distributors, pharmacies, retail chains and grocery and convenience stores. Our Consumer Healthcare business generates a significant portion of its sales from several large customers, the loss of any one of which could have a material adverse effect on the Consumer Healthcare business. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see Government Regulation and Price ConstraintsIntellectual Property below. In various markets, a period of regulatory exclusivity may be provided to certain therapeutics upon approval. The scope and term of such exclusivity will vary but, in general, the period of regulatory exclusivity will run concurrently with the term of any existing patent rights associated with the therapeutic. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, the additional six-month pediatric exclusivity period and/or the granted patent term extension), are those for the medicines set forth in the table below. Unless otherwise indicated, the years set forth in the table below pertain to the basic product patent expiration for the respective products. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Viagra 2012 (1) 2013 (1) Lyrica 2014 (2) 2022 (3) Chantix Sutent Ibrance Inlyta Xeljanz 2027 (4) Prevnar 13/Prevenar 13 2026 (5) Eucrisa N/A (6) N/A (6) Eliquis (7) Xtandi (8) * (8) * (8) Besponsa 2028 (9) Xalkori Bavencio (10) (1) In addition to the basic product patent covering Viagra , which expired in 2012, Viagra is covered by a U.S. method-of-treatment patent which, including the six-month pediatric exclusivity period associated with Revatio (which has the same active ingredient as Viagra ), expires in 2020. As a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra in the U.S. in December 2017. The corresponding method-of-treatment patent covering Viagra in Japan expired in May 2014. (2) For Lyrica , regulatory exclusivity in the EU expired in July 2014. (3) Lyrica is covered by a Japanese method-of-use patent which expires in 2022. The patent is currently subject to an invalidation action. (4) Xeljanz EU expiry is provided by regulatory exclusivity. (5) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 has been revoked following an opposition proceeding. This first instance decision has been appealed. There are other EU patents and pending applications covering the formulation and various aspects of the manufacturing process of Prevenar 13 that remain in force. (6) Eucrisa is not approved in the EU and Japan. (7) Eliquis was developed and is being commercialized in collaboration with BMS. (8) Xtandi is being developed and commercialized in collaboration with Astellas, who has exclusive commercialization rights for Xtandi outside the U.S. (9) Besponsa Japan expiry is provided by regulatory exclusivity. (10) Bavencio is being developed and commercialized in collaboration with Merck KGaA. A number of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years. For additional information, including a description of certain of our expired co-promotion agreements, and a further discussion of our products experiencing, or expected to experience in 2018 , patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2017 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. For additional information, see the Notes to Consolidated Financial Statements Note 17A1. Commitments and ContingenciesLegal ProceedingsPatent Litigation in our 2017 Financial Report. The expiration of a basic product patent or loss of patent protection resulting from a legal challenge normally results in significant competition from generic products against the originally patented product and can result in a significant reduction in revenues for that product in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Biotechnology Products Our biotechnology products, including BeneFIX , ReFacto , Xyntha , Bavencio , Prevnar 13/Prevenar 13 and Enbrel (we market Enbrel outside the U.S. and Canada), may face in the future, or already face, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference biotechnology products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin , which was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be similar to the original biologic in terms of safety and efficacy and to have no clinically meaningful differences. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage in 2010 of the ACA, a framework for such approval exists in the U.S. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop biosimilar medicines. See Item 1A. Risk Factors Biotechnology Products below. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. Likewise, as we develop and manufacture biosimilars and seek to launch products, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, global protection of intellectual property rights has been improving. For additional information, see Government Regulation and Price Constraints Intellectual Property below. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus, generic and biosimilar drug manufacturers and consumer healthcare manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further understanding the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians and global health authorities. We also seek to continually Pfizer Inc. 2017 Form 10-K enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our salespersons efforts to accurately and ethically launch and promote our products to our customers. Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising; interactions with, and payments to, healthcare professionals; and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our vaccines business may face competition from the introduction of alternative or next generation vaccines. For example, Prevnar 13 may face competition in the form of alternative 13-valent or additional valent next-generation pneumococcal conjugate vaccines prior to the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products, as well as biosimilars. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with potentially higher levels of sales and profitability until other generic or biosimilar competitors enter the market. Our Consumer Healthcare business faces competition from OTC business units in other major pharmaceutical and consumer packaged goods companies, and retailers who carry their own private label brands. Our competitive position is affected by several factors, including the amount and effectiveness of our and our competitors promotional resources; customer acceptance; product quality; our and our competitors introduction of new products, ingredients, claims, dosage forms, or other forms of innovation; and pricing, regulatory and legislative matters (such as product labeling, patient access and prescription to OTC switches). Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 291 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see Government Regulation and Price Constraints In the United States below), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, copay accumulator programs and value-based pricing/contracting to improve their cost containment efforts. We are closely monitoring these newer approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. MCOs are currently evaluating the appropriate placement of biosimilars on their formularies. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. Pfizer Inc. 2017 Form 10-K MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. Under the Trump administration, there have been ongoing efforts to modify or repeal all or certain provisions of the ACA, although the current likelihood of repeal of the ACA appears low given the failure of the Senates multiple attempts to repeal various combinations of ACA provisions. We are monitoring any such actions to see if any changes to the ACA will be enacted that would impact our business. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors do not generally need to conduct clinical trials and can market a competing version of our product after the expiration or loss of our patent and often charge much less. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. In 2017 , we experienced periodic shortages of select materials due to constrained capacity or operational challenges with the associated suppliers. Supplier management activities are ongoing to work to ensure the necessary supply to meet our requirements for these materials. No significant impact to our operations is anticipated in 2018. GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2017 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, delays in product approvals, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulations by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling and storage of our products, record keeping, advertising and promotion. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. The FDA also regulates our Consumer Healthcare products. Other U.S. federal agencies, including the DEA, also regulate certain of our products. The U.S. Federal Trade Commission has the authority to regulate the advertising of consumer healthcare products, including OTC drugs and dietary supplements. Many of our activities also are subject to the jurisdiction of the SEC. Before a new biopharmaceutical product may be marketed in the U.S., the FDA must approve an NDA for a new drug or a BLA for a biologic. The steps required before the FDA will approve an NDA or BLA generally include preclinical studies followed by multiple stages of clinical trials conducted by the study sponsor; sponsor submission of the application to the FDA for review; the FDAs review of the data to assess the drugs safety and effectiveness; and the FDAs inspection of the facilities where the product will be manufactured. Before a generic drug may be marketed in the U.S., the FDA must approve an ANDA. The ANDA review process typically does not require new preclinical and clinical studies, because it relies on the studies establishing safety and efficacy conducted for the referenced drug previously approved through the NDA process. The ANDA process, however, does require the sponsor to conduct one or more bioequivalence studies to show that the ANDA drug is bioequivalent to the previously approved referenced brand drug, submission of an application to the FDA for review, and the FDAs inspection of the facilities where the product will be manufactured. As a condition of product approval, the FDA may require a sponsor to conduct post-marketing clinical studies, known as Phase 4 studies, and surveillance programs to monitor the effect of the approved product. The FDA may limit further marketing of a product based on the results of these post-market studies and programs. Any modifications to a drug or biologic, including new indications or changes to labeling or manufacturing processes or facilities, may require the submission and approval of a new or supplemental NDA or BLA before the modification can be implemented, which may require that we develop additional data or conduct additional preclinical studies and clinical trials. Our ongoing manufacture and distribution of drugs and biologics is subject to continuing regulation by the FDA, including recordkeeping requirements, reporting of adverse experiences associated with the product, and adherence to cGMPs, which regulate all aspects of the manufacturing process. We are also subject to numerous regulatory requirements relating to the advertising and promotion of drugs and biologics, including, but not limited to, standards and regulations for direct-to-consumer advertising. Failure to comply with the applicable regulatory requirements governing the manufacture and marketing of our products may subject us to administrative or judicial sanctions, including warning letters, product recalls or seizures, delays in product approvals, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference, innovator biologic. The FDA is responsible for implementation of the legislation and approval of new biosimilars. Through those approvals and the issuance of draft and final guidance, the FDA has begun to address open questions about the naming convention for biosimilars and the use of data from a non-U.S.-licensed comparator to demonstrate biosimilarity and/or interchangeability with a U.S.-licensed reference product. Over the next several years, the FDA is expected to issue additional draft and final guidance documents impacting biosimilars. In addition, in 2017, the Biosimilar User Fee Act was reauthorized for a five-year period, which should lead to a significant increase in the FDAs biosimilar user fee revenues, thereby providing the FDA with additional resources to process biosimilar applications. Also, there have been ongoing federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. While none of those efforts have focused on changes to the provisions of the ACA related to the biosimilar regulatory framework, if those efforts continue in 2018 and if the ACA is repealed, substantially modified, or invalidated, it is unclear what, if any, impact such action would have on biosimilar regulation. Sales and Marketing . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended to prevent fraud and abuse in the healthcare industry and protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying any remuneration to generate business, including the purchase or prescription of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent and generally treat claims generated through kickbacks as false or fraudulent. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal healthcare programs (including Medicare and Medicaid). The federal government and various states also have enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and healthcare providers; require disclosure to the federal or state government and public of such interactions; and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section in our 2017 Financial Report and in the Notes to Consolidated Financial Statements Note 1G. Basis of Presentation and Significant Accounting Policies: Revenues and Trade Accounts Receivable in our 2017 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. For example, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products in certain states. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. Given certain states current and potential ongoing fiscal crises, a growing number of states are considering a variety of cost-control strategies, including capitated managed care plans that typically contain cost by restricting access to certain treatments. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers, who are the primary purchasers of our pharmaceutical products in the U.S., will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. Efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. Recently, there has been considerable public and government scrutiny of pharmaceutical pricing and proposals to address the perceived high cost of pharmaceuticals. There have also been recent state legislative efforts to address drug costs, which generally have focused on increasing transparency around drug costs or limiting drug prices. Recent legislation enacted includes, for example, a 2017 Maryland law that prohibits a generic drug manufacturer or wholesale distributor from engaging in price gouging in the sale of certain off-patent or generic drugs, and a 2017 California law that requires manufacturers to provide advanced notification of price increases to certain purchasers and report specified drug pricing information to the state. Certain state legislation, like the Maryland law, has been subject to legal challenges . Adoption of new legislation at the federal or state level could further affect demand for, or pricing of, our products. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We will continue to work with law makers and advocate for solutions that effectively improve patient health outcomes, lower costs to the healthcare system, and ensure access to medicines within an efficient and affordable healthcare system. Healthcare Reform. The U.S. and state governments continue to propose and pass legislation designed to regulate the healthcare industry. For example, in March 2010, the U.S. Congress enacted the ACA that expanded healthcare coverage through Medicaid expansion and the implementation of the individual health insurance exchanges and which included changes to the coverage and reimbursement of drug products under government healthcare programs. Under President Trumps administration, there have been ongoing efforts to modify or repeal all or certain provisions of the ACA, although the current likelihood of repeal of the ACA appears low given the failure of the Senates multiple attempts to repeal various combinations of ACA provisions. In October 2017, the President signed an Executive Order directing federal agencies to look for ways to authorize more health plans that could be less expensive because the plans would not have to meet all of the ACAs coverage requirements, and announced that his administration will withhold the cost-sharing subsidies paid to health insurance exchange plans serving low-income enrollees. In December 2017, the comprehensive tax reform package signed into law, the Tax Cuts and Jobs Act, includes a provision that effectively repealed the ACAs individual mandate by removing the penalties. These and similar actions by the administration are widely expected to lead to fewer Americans having comprehensive ACA-compliant health insurance, even in the absence of a full legislative repeal. The revenues generated for Pfizer by the health insurance exchanges under the ACA are minor, so the impact of the recent administration actions is expected to be limited. We also may face uncertainties if our industry is looked to for savings to fund certain legislation, such as lifting the debt ceiling. One recent example is the Bipartisan Budget Act of 2018, which increased the discount we pay in the Medicare Part D coverage gap from 50% to 70%, which will modestly reduce our future Medicare Part D revenues. We cannot predict the ultimate content, timing or effect of any changes to the ACA or other federal and state reform efforts. There is no assurance that federal or state healthcare reform will not adversely affect our future business and financial results. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Outside the United States We encounter similar regulatory and legislative issues in most other countries. New Drug Approvals. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Historically, Chinas regulatory system has presented numerous challenges for the pharmaceutical industry, as its requirements for drug development and registration have not always been consistent with U.S. or other international standards. The CFDA, however, has introduced reforms and draft reforms in recent years, which are discussed in more detail below, that attempt to address these challenges, with 2017 being an especially active year in this respect. In the past, it has been common to see treatments entering the Chinese market two to eight years behind first marketing in the U.S. and Europe, because historically China has only issued import drug licenses to treatments approved by mature regulatory authorities such as the FDA or the EMA. In addition, to obtain marketing approvals for new drugs in China, a clinical trial authorization issued by the CFDA has historically been required for the conduct of Phase I to III clinical trials. Applications for approval of imported drugs that included China-originated data in their Multi-Regional Clinical Trials and met the relevant technical review requirements were allowed to receive local clinical trial waivers on a case-by-case basis. Historically, oral generics only had to undergo bioequivalence studies upon a filing for record with the CFDA, while sterile injectable generics often needed local confirmatory trials for regulatory approval. A Chinese drug license would only be granted if, following review, the CFDA determines that the clinical data confirm the drugs safety and effectiveness. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. These requirements delay marketing authorization in those countries relative to the U.S. and Europe. Pharmacovigilance. In the EU, there is detailed legislation and guidance on pharmacovigilance, which has been increased and strengthened in recent years. The EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . In Europe, Japan, China, Canada, South Korea and some other international markets, governments provide healthcare at low-to-zero direct cost to consumers at the point of care and have significant power as large single payers to regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global economic pressures. Governments, including the different EU Member States, may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, health technology assessments, and international reference pricing (i.e., the practice of a country linking its regulated medicine prices to those of other countries). This international patchwork of price regulation and differing economic conditions and assessments of value across countries has led to different prices in different countries, varying health outcomes and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and can hinder patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations (UN) and the Organization for Economic Cooperation and Development (OECD), are increasing scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations (e.g., 2016 UN High Level Panel Report on Access to Medicines and 2017 OECD Report on New Health Technologies Managing Access, Value and Sustainability ). Government adoption of these recommendations may lead to additional pricing pressures. In Japan, the government recently released a basic framework for pharmaceutical pricing that will lead to the adoption of cost effectiveness assessments in some form, quarterly pricing reviews for new indications, and severe narrowing of the criteria to gain a price maintenance premium. In China, despite removal of government-set price caps the government continues to exercise indirect price control by setting reimbursement standards through a negotiation mechanism between drug manufacturers and social insurance administrations. Provincial biddings, cross-regional procurement and secondary hospital price negotiations are likely to intensify as government cost containment efforts continue. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, which is expected to come into effect some time in late 2019. This regulation is aimed at simplifying and harmonizing the governance of clinical trials in the EU and will require increased public posting of clinical trial results. Under its Publication of Clinical Data for Medicinal Products for Human Use policy, the EMA proactively publishes clinical trial data from application dossiers for new marketing authorizations, including data from trials taking place outside the EU, after the EMA has made a decision on the marketing authorization. The policy includes limited exceptions for commercially confidential information and the exclusion of any protected personal data. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. In March 2017, the U.K. government formally notified the European Council of its intention to leave the EU after it triggered Article 50 of the Lisbon Treaty to begin the two-year negotiation process establishing the terms of the exit and outlining the future relationship between the U.K. and the EU. Formal negotiations officially started in June 2017. This process continues to be highly complex and the end result of these negotiations may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. It was announced in November 2017 that the EMA will be relocating from London, U.K. to Amsterdam, Netherlands by the expected date of Brexit in March 2019. At present, it is still unclear whether and to what extent the U.K. will remain within or aligned to the EU system of medicines regulation, and/or what separate requirements will be imposed in the U.K. after it leaves the EU. For additional information on Brexit, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. in our 2017 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce backlogs for existing applications for drug approval, the CFDA has unveiled numerous reform initiatives for Chinas drug approval system, and engaged in significant efforts to build its capabilities. The CFDA now divides drugs into new drugs and generics, with the definition for new drugs changed from China New to Global New. This means that drugs previously approved in other markets (such as the U.S. or Europe) will not be considered new drugs under Chinas regulatory regime, with the exception of drugs introduced within one year of approval in mature markets. This change in definition creates more opportunities for Chinas domestic drug manufacturers than for multinational firms, because multinational firms have historically had significant competitive advantage in successfully achieving regulatory approvals for drugs first approved outside of China. The 2017 revisions made clear, however, that regulatory approval from the FDA or the EMA would no longer be required for approval of imported drugs, though a notable exception persists for imported vaccines, which still require prior approval from a relevant regulatory agency. The marketing authorization holder system, which will allow for more flexibility in contract manufacturing arrangements and asset transfers, now applies to all drugs developed and manufactured in China, but not yet to imported drugs. While challenges remain, a number of other policy changes are streamlining and accelerating approvals of domestic and imported drugs in China. These reforms, along with Chinas June 2017 entry into the International Council for Harmonisation of Technical Requirements for Pharmaceuticals for Human Use, are expected to pave the way for integration of CFDAs regulations with global practices. These changes include introducing an umbrella clinical trial authorization for all three phases of registration studies (instead of the original phase-by-phase approvals), a filing/recordation system for bioequivalence studies on generics (instead of the original review and approval system), admitting more categories of drugs as innovative drugs eligible for the fast track/green channel approval pathway and ongoing implementation of previously announced regulatory reforms. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, the EFPIAs disclosure code requires all members, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, some countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has generally improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool for reducing the price of imported medicines, as well as to protect their local pharmaceutical industries. There is considerable political and economic pressure to weaken existing intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, issuance (and threat of issuance) of compulsory licenses, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries. In developed countries as well, including the EU, we are facing an increasingly challenging intellectual property environment. Canadas intellectual property regime for drugs provides some level of patent protection and data exclusivity (eight years plus six-month pediatric extension), but it lacks the predictability and stability that otherwise comparable countries provide. Through intense negotiations as part of the Canada/EU Comprehensive Economic Trade Agreement (CETA), Canadian authorities reluctantly agreed to introduce a right of appeal, a form of patent term restoration and to elevate the current data protection to a treaty obligation, further aligning its intellectual property regime to the EU. In particular, CETA Article 20.25 provides sui generis protection for patent term extensions of two to five years for basic patents, subject to various rules and limitations. In China, the intellectual property environment has improved, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, and several companies, including Pfizer, have established RD centers in China due to increased confidence in Chinas intellectual property environment. Despite this, China remained on the U.S. Trade Representatives Priority Watch List for 2017. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. In India, we have seen some progress in terms of expediting patent approval processes to reduce pendency rates and implementing training programs to enhance enforcement. Despite these positive steps, gaps remain in terms of addressing longstanding intellectual property concerns. For example, policies favoring compulsory licensing of patents, the tendency of the Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 17A3. Commitments and ContingenciesLegal ProceedingsCommercial and Other Matters in our 2017 Financial Report. As a result, we incurred capital and operational expenditures in 2017 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $30 million ; and other environment-related expenses $142 million . While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. For example, in 2017, our manufacturing and commercial operations in Puerto Rico were impacted by hurricanes. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Impact of Recent Hurricanes in Puerto Rico section of the 2017 Financial Report. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to potential weather-related risks and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5. Tax Matters in our 2017 Financial Report, is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We believe we have good relationships with our employees. As of December 31, 2017 , we employed approximately 90,200 people in our operations throughout the world. Pfizer Inc. 2017 Form 10-K DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224 (the Executive Orders). In some instances, ITRSHRA requires companies to disclose these types of transactions, even if they were permissible under U.S. law or were conducted by a non-U.S. affiliate in accordance with the local law under which such entity operates. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2017 , our activities included supplying life-saving medicines, medical products and consumer products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2017 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2017 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2017 Form 10-K and in our 2017 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, assume, target, forecast, guidance, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated operating and financial performance, business plans and prospects, in-line products and product candidates, including anticipated regulatory submissions, data read-outs, approvals, performance, timing of exclusivity and potential benefits of Pfizers products and product candidates, strategic reviews, capital allocation, business-development plans, manufacturing and product supply and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions and other business development activities, the disposition of the HIS net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the availability of raw materials for 2018 set forth in Item 1. BusinessRaw Materials in this 2017 Form 10-K; the expected impact of the recent hurricanes in Puerto Rico set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessImpact of Recent Hurricanes in Puerto Rico section in our 2017 Financial Report; the anticipated progress in remediation efforts at certain of our Hospira manufacturing facilities set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur BusinessProduct Manufacturing section in our 2017 Financial Report; the anticipated timeframe for any decision regarding strategic alternatives for Pfizer Consumer Healthcare set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyOur Business Development Initiatives section in our 2017 Financial Report; our anticipated liquidity position set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment and the Analysis of Financial Condition, Liquidity and Capital Resources sections in the 2017 Financial Report; the financial impact of the recently passed Tax Cuts and Jobs Act set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookThe Global Economic Environment, Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsIncome Tax Assets and Liabilities, Provision/(Benefit) for Taxes on IncomeChanges in Tax Laws and Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations sections in our 2017 Financial Report and in Notes to Consolidated Financial StatementsNote 1. Basis of Presentation and Significant Accounting Policies and Note 5. Tax Matters; plans relating to increasing investment in the U.S. following the expected positive net impact of the Tax Cuts and Jobs Act set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur StrategyCapital Allocation and Expense Management section in our 2017 Financial Report; the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2018 section in our 2017 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section in our 2017 Financial Report and in the Notes to Consolidated Financial StatementsNote 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives; the expected plan for repatriating the majority of our cash held internationally in 2018 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesDomestic and International Short-Term Funds section in our 2017 Financial Report; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section in our 2017 Financial Report; and the contributions that we expect to make from our general assets to the Companys pension and postretirement plans during 2018 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section and in the Notes to Consolidated Financial StatementsNote 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2017 Financial Report. We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors Pfizer Inc. 2017 Form 10-K for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Consolidation among MCOs has increased the negotiating power of MCOs and other private insurers. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. They are also trying newer programs like copay accumulators to shift more of the cost burden to manufacturers and patients. This cost shifting has given consumers greater control of medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. MCOs also use additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. payer market concentrates further and as more drugs become available in generic form, biopharmaceutical companies may face greater pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. The date at which generic competition commences may be different from the date that the patent or regulatory exclusivity expires. However, upon the loss or expiration of patent protection for one of our products, or upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a generic manufacturer of a generic version of one of our patented products, we can lose the major portion of revenues for that product in a very short period of time, which can adversely affect our business. A number of our products are expected to face significantly increased generic competition over the next few years. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering products for which we have licenses or co-promotion rights. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development, some of which have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with products from competitors, including other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before the anticipated formation of the generic or biosimilar marketplace is important to that products profitability. Prices for products typically decline, sometimes dramatically, following generic or biosimilar entry, and as additional companies receive approvals to market that product, competition intensifies. If a companys generic or biosimilar product can be first-to-market such that its only competition is the branded drug for a period of time, higher levels of sales and profitability can be achieved until other generic or biosimilar competitors enter the market. With increasing competition in the generic or biosimilar product market, the timeliness with which we can market new generic or biosimilar products will increase in importance. Our success will depend on our ability to bring new products to market quickly. Also, we may face access challenges for our biosimilar products where our product may not receive access at parity to the innovator product and remains in a disadvantaged position. For example, Inflectra/Remsima has experienced access challenges among commercial payers. In September 2017, Pfizer filed suit in the U.S. District Court for the Eastern District of Pennsylvania against Johnson Johnson (JJ) alleging that JJs exclusionary contracts and other anticompetitive practices concerning Remicade (infliximab) violate federal antitrust laws. Pfizer Inc. 2017 Form 10-K DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product and/or alliance revenues of more than $1 billion for each of nine biopharmaceutical products in 2017: Prevnar 13/Prevenar 13 , Lyrica , Ibrance , Eliquis , Enbrel , Lipitor , Xeljanz , Viagra and Sutent . Those products accounted for 46% of our total revenues in 2017 . If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling, access pressures or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. Patents covering several of our best-selling medicines have recently expired or will expire in the next few years (including some of our billion-dollar and previously billion-dollar products), and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. launched a generic version of Viagra in the U.S. in December 2017. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses and Expected Losses of Product Exclusivity section in our 2017 Financial Report. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For additional information on recent losses of collaborations rights, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses of Collaboration Rights section in our 2017 Financial Report. RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities in order to deliver a robust pipeline could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the science may not work for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. There can be no assurance that these strategies will deliver the desired result, which could affect profitability in the future. BIOTECHNOLOGY PRODUCTS Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. For example, Enbrel faces ongoing biosimilar competition in most developed Europe markets, which is expected to continue. The expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant regulatory exclusivity period has expired. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. We are developing biosimilar medicines. The evolving pathway for registration and approval of biosimilar products by the FDA and regulatory authorities in certain other countries could diminish the value of our investments in biosimilars. Other risks related to our development of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with high costs associated with clinical development or intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower prescriptions for biosimilars due to potential concerns over comparability with innovator medicines. See also the Competitive Products risk factor above. Pfizer Inc. 2017 Form 10-K RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and addressed could affect our future results. RISKS AFFECTING INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets. However, there is no assurance that our strategies in emerging markets will be successful or that these countries will continue to sustain these growth rates. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets, as discussed above, can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. The impact of payers efforts to control access to and pricing of specialty pharmaceuticals is increasing. For Pfizer to date, a number of factors create a more challenging paradigm given our growing specialty business portfolio. These include formulary restrictions and dispensation barriers, such as step edits, leading to higher negotiated rebates or discounts to health plans and PBMs in the U.S., as well as the increasing use of health technology assessments in markets around the world. CONSUMER HEALTHCARE The Consumer Healthcare business may be impacted by economic volatility, the timing and severity of the cough, cold and flu season, generic or store brand competition affecting consumer spending patterns and market share gains of competitors branded products or generic store brands. In addition, regulatory and legislative outcomes regarding the safety, efficacy or unintended uses of specific ingredients in our Consumer Healthcare products may require withdrawal, reformulation and/or relabeling of certain products (e.g., cough/cold products). See The Global Economic Environment and Strategic Alternatives for Pfizer Consumer Healthcare risk factors below. PRODUCT MANUFACTURING, SALES AND MARKETING RISKS Difficulties or delays in product manufacturing, sales or marketing could affect future results through regulatory actions, shut-downs, approval delays, withdrawals, recalls, penalties, supply disruptions or shortages, reputational harm, product liability, unanticipated costs or otherwise. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of incoming materials may be delayed or become unavailable and that the quality of incoming materials may be substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout the internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); risks to supply chain continuity and commercial operations as a result of natural (including hurricanes, earthquakes and floods) or man-made disasters at our facilities or at a supplier or vendor, including those that may be related to climate change; or failure to maintain the integrity of our supply chains against intentional and criminal acts such as economic adulteration, product diversion, product theft, counterfeit goods and cyberattacks. Regulatory agencies periodically inspect our drug manufacturing facilities to evaluate compliance with applicable cGMP requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions, debarment or voluntary recall of a product, any of Pfizer Inc. 2017 Form 10-K which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, we received a warning letter from the FDA communicating the FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. We are undertaking corrective actions to address the concerns raised by the FDA. In January 2018, the FDA upgraded the status of Pfizers McPherson, Kansas manufacturing facility to Voluntary Action Indicated (VAI) based on an October 2017 inspection. The change to VAI status will lift the compliance hold that the FDA placed on approval of pending applications, and is an important step toward resolving the issues cited in the February 2017 FDA warning letter. In addition, in September 2017, Meridian, a subsidiary of Pfizer Inc., received a warning letter from the FDA asserting the FDAs view that certain violations of cGMP and Quality System Regulations exist at Meridians manufacturing sites in St. Louis, Missouri. We are undertaking corrective actions to address the concerns raised by the FDA, and communication with the FDA is ongoing. Until the corrective actions are implemented and approved by the FDA, the FDA may refuse to grant premarket approval of applications and/or the FDA may refuse to grant export certificates related to products manufactured at our St. Louis, Missouri sites. OUTSOURCING AND ENTERPRISE RESOURCE PLANNING We outsource certain services to third parties in areas including transaction processing, accounting, information technology, manufacturing, clinical trial execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. For example, in 2017, we placed the majority of our clinical trial execution services with four Clinical Research Organizations (CROs). Service performance issues with these CROs may adversely impact the progression of our clinical trial programs. Outsourcing of services to third parties could expose us to sub-optimal quality of service delivery or deliverables, which may result in repercussions such as missed deadlines or other timeliness issues, erroneous data, supply disruptions, non-compliance (including with applicable legal requirements and industry standards) or reputational harm, with potential negative implications for our results. We are migrating to a consistent enterprise resource planning system across the organization. These are enhancements of ongoing activities to standardize our financial systems. If any difficulties in the migration to or in the operation of our enterprise resource planning system were to occur, they could adversely affect our operations, including, among other ways, through a failure to meet demand for our products, or adversely affect our ability to meet our financial reporting obligations. COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the research, development and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development, manufacturing and commercialization activities, but we do not control many aspects of those activities. Third parties may not complete activities on schedule or in accordance with our expectations. Failure by one or more of these third parties to meet their contractual or other obligations to Pfizer; failure of one or more of these parties to comply with applicable laws or regulations; or any disruption in the relationships between Pfizer and one or more of these third parties, could delay or prevent the development, approval or commercialization of our products and product candidates and could also result in non-compliance or reputational harm, all with potential negative implications for our product pipeline and business. BIOPHARMACEUTICAL WHOLESALERS In 2017 , our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 33% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 38% of our total revenues (and approximately 79% of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact our results of operations. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through collaborations, alliances, license and funding agreements, joint ventures, equity- or debt-based investments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframe or at all, and integrate acquisitions. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Legal proceedings or regulatory issues often arise as a result of activities that occurred at acquired companies, their partners and other third parties. In 2016, for example, we paid $784.6 million to resolve allegations related to Wyeths reporting of prices to the government with respect to Protonix for activities that occurred prior to our Pfizer Inc. 2017 Form 10-K acquisition of Wyeth. Additionally, we may not realize the anticipated benefits of such transactions, including the possibility that expected synergies and accretion will not be realized or will not be realized within the expected time frame. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; and the relatively modest risk of penalties faced by counterfeiters compared to the large profits that can be earned by them from the sale of counterfeit medicines. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines pose a risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate the threat of counterfeit medicines, which is exacerbated by the complexity of the supply chain, could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We undertake significant efforts to counteract the threats associated with counterfeit medicines, including, among other things, working with the FDA and other regulatory authorities and multinational coalitions to combat the counterfeiting of medicines and supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; implementing business practices designed to protect patient health; promoting public policies intended to hinder counterfeiting; working diligently to raise public awareness about the dangers of counterfeit medicines; and working collaboratively with wholesalers, pharmacies, customs offices, and law enforcement agencies to increase inspection coverage, monitor distribution channels, and improve surveillance of distributors and repackagers. No assurance can be given, however, that our efforts and the efforts of others will be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. Efforts by government officials or legislators to implement measures to regulate prices or payments for pharmaceutical products, including legislation on drug importation, could adversely affect our business if implemented. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as Europe, Japan, China, Canada and South Korea, governments have significant power as large single payers to regulate prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions, failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many Pfizer Inc. 2017 Form 10-K countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM/HEALTHCARE LEGISLATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of healthcare coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion under the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Regulatory Environment/Pricing and Access U.S. Healthcare Legislation section in our 2017 Financial Report and in Item 1. Business under the caption Government Regulation and Price ConstraintsIn the United States . We face uncertainties due to federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. The likelihood of such a repeal currently appears low given the recent failure of the Senates multiple attempts to repeal various combinations of such ACA provisions. In October 2017, the President signed an Executive Order directing federal agencies to look for ways to authorize more health plans that could be less expensive because the plans would not have to meet all of the ACAs coverage requirements, and announced that his administration will withhold the cost-sharing subsidies paid to health insurance exchange plans serving low-income enrollees. These and similar actions by the administration are widely expected to lead to fewer Americans having comprehensive ACA-compliant health insurance, even in the absence of a legislative repeal. The revenues generated for Pfizer by the health insurance exchanges under the ACA are minor, so the impact of the recent administration actions is expected to be limited. There is no assurance that any future replacement, modification or repeal of the ACA will not adversely affect our business and financial results, particularly if the legislation reduces incentives for employer-sponsored insurance coverage, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. presidential administrations policy proposals), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. U.S. ENTITLEMENT REFORM In the U.S., government action to reduce federal spending on entitlement programs including Medicare and Medicaid may affect payment for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing federal spending, and the December 2016 release includes proposals to cap Medicaid grants to the states, and to require manufacturers to pay a minimum rebate on drugs covered under part D of Medicare for low-income beneficiaries. Significant Medicare reductions could also result if Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or Congress chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health programs that may be implemented could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, or exclusion from future participation in government healthcare programs. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. The process from early discovery or design to development to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, including unfavorable new clinical data and additional analyses of existing clinical data. There can be no assurance regarding our ability to meet anticipated pre-clinical and clinical trial commencement and completion dates, regulatory submission and approval dates, and launch dates for product candidates, or as to whether or when we will receive regulatory approval for new products or for new indications or dosage forms for existing products, which will depend on the assessment by regulatory authorities of the benefit-risk profile suggested by the totality of the efficacy and safety information submitted. Decisions by regulatory authorities regarding labeling, ingredients and other matters could adversely affect the availability or commercial potential of our products. There is no assurance that we will be able to address Pfizer Inc. 2017 Form 10-K the comments received by us from regulatory authorities such as the FDA and the EMA with respect to certain of our drug applications to the satisfaction of those authorities, that any of our pipeline products will receive regulatory approval and, if approved, be commercially successful or that recently approved products will be approved in other markets and/or be commercially successful. There is also a risk that we may not adequately address existing regulatory agency findings concerning the adequacy of our regulatory compliance processes and systems or implement sustainable processes and procedures to maintain regulatory compliance and to address future regulatory agency findings, should they occur. In addition, there are risks associated with preliminary, early stage or interim data, including the risk that final results of studies for which preliminary, early stage or interim data have been provided and/or additional clinical trials may be different from (including less favorable than) the preliminary, early stage or interim data results and may not support further clinical development of the applicable product candidate or indication. In addition, clinical trial data are subject to differing interpretations, and, even when we view data as sufficient to support the safety and/or effectiveness of a product candidate or a new indication for an in-line product, regulatory authorities may not share our views and may require additional data or may deny approval altogether. There are many considerations that can affect the marketing of our products around the world. Regulatory delays, the inability to successfully complete or adequately design and implement clinical trials within the anticipated quality, time and cost guidelines or in compliance with applicable regulatory expectations, claims and concerns about safety and efficacy, new discoveries, patent disputes and claims about adverse side effects are a few of the factors that can adversely affect our business. Further, claims and concerns that may arise regarding the safety and efficacy of in-line products and product candidates can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional clinical trials prior to granting approval or increased post-approval requirements, such as risk evaluation and mitigation strategies. In addition, failure to put in place adequate controls and/or resources for effective collection, reporting and management of adverse events from clinical trials and post-marketing surveillance, in compliance with current and evolving regulatory requirements could result in risks to patient safety, regulatory actions and risks to product sales. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which may result in delayed approvals of new generic products. While the FDA is taking steps to address the backlog of pending applications, continued approval delays may be experienced by generic drug applicants over the next few years. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products that implicate (or are perceived to implicate) an entire class of products could have an adverse effect on the availability or commercial potential of the affected products. Accordingly, new data about our products, or products similar to our products, could negatively impact demand for our products due to real or perceived side effects or uncertainty regarding efficacy and, in some cases, could result in updated labeling, restrictions on use, product withdrawal or recall. INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide something of value to a healthcare professional, other healthcare provider and/or government official. If the interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as non-U.S. jurisdictions adopt or increase enforcement efforts of new anti-bribery laws and regulations. Requirements or industry standards in the U.S. and certain jurisdictions abroad that require pharmaceutical manufacturers to track and disclose financial interactions with healthcare professionals and healthcare providers increase government and public scrutiny of such financial interactions. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory clarifications and/or interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals, including further clarifications and/or interpretations of the recently passed Tax Cuts and Jobs Act), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision/(Benefit) for Taxes on Income Changes in Tax Laws and New Accounting Standards sections, and Notes to Consolidated Financial Pfizer Inc. 2017 Form 10-K Statements Note 1B. Basis of Presentation and Significant Accounting Policies: Adoption of New Accounting Standards in 2017 in our 2017 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various legal proceedings, including patent, product liability and other product-related litigation, including personal injury, consumer, off-label promotion, securities, antitrust and breach of contract claims, commercial, environmental, government investigations, employment, tax litigation and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe we have substantial defenses in these matters, we could in the future incur judgments, enter into settlements of claims or revise our expectations regarding the outcomes of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to investigations and extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. As a result, we have interactions with government agencies on an ongoing basis. Criminal charges, substantial fines and/or civil penalties, limitations on our ability to conduct business in applicable jurisdictions, as well as reputational harm and increased public interest in the matter could result from government investigations. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2017 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Pfizer Inc. 2017 Form 10-K Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in a policy of routine compulsory licensing of pharmaceutical intellectual property as a result of local political pressure or in the case of national emergencies. In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches to challenge our patent rights. Most of the suits involve claims by generic drug manufacturers that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Independent actions have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. Such claims may also be brought as counterclaims to actions we bring to enforce our patents. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. We also are often involved in other proceedings, such as inter partes review, post-grant review, re-examination or opposition proceedings, before the U.S. Patent and Trademark Office, the European Patent Office, or other foreign counterparts relating to our intellectual property or the intellectual property rights of others. Also, if one of our patents is found to be invalid by such proceedings, generic or competitive products could be introduced into the market resulting in the erosion of sales of our existing products. For example, several of the patents in our pneumococcal vaccine portfolio have been challenged in inter partes review and post-grant review proceedings in the U.S. The invalidation of these patents could potentially allow a competitor pneumococcal vaccine into the marketplace. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not be successful. Part of our EH business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others. To achieve a first-to-market or early market position for generic pharmaceutical products and biosimilars, we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If one of our marketed products is found to infringe valid patent rights of a third party, such third party may be awarded significant damages, or we may be prevented from further sales of that product. Such damages may be enhanced as much as three-fold in the event that we or one of our subsidiaries, like Hospira, is found to have willfully infringed valid patent rights of a third party. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. Pfizer Inc. 2017 Form 10-K RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with the acquisition of Hospira, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from the acquisitions of Hospira, Anacor and Medivation may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges may adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions and substantial regulatory scrutiny due to quality issues, including receiving a warning letter from the FDA in February 2017 communicating the FDA s view that certain violations of cGMP regulations exist at Hospira s manufacturing facility in McPherson, Kansas. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Business Product Manufacturing section in our 2017 Financial Report. Also, the success of our acquisition of Medivation depends on our ability to grow revenues for Xtandi and expand Xtandi into the non-metastatic castration-resistant prostate cancer setting. STRATEGIC ALTERNATIVES FOR PFIZER CONSUMER HEALTHCARE In October 2017, we announced plans to review a range of strategic alternatives for our Consumer Healthcare business, including a full or partial separation of the Consumer Healthcare business from Pfizer through a spin-off, sale or other transaction, as well as the possibility that we may ultimately determine to retain the business. We expect that a decision regarding strategic alternatives for the Consumer Healthcare business would be made in 2018. We will incur expenses in connection with the review of strategic alternatives and are likely to incur significant expenses if we determine to move forward with any strategic alternatives. Our future results may be affected by the impact of our review and, if applicable, consummation of strategic alternatives for our Consumer Healthcare business, which are subject to certain risks and uncertainties, including, among other things, the ability to realize the anticipated benefits of any strategic alternatives we may pursue, the potential for disruption to our business and diversion of managements attention from other aspects of our business, the possibility that such strategic alternatives will not be completed on terms that are advantageous to Pfizer and the possibility that we may be unable to realize a higher value for our Consumer Healthcare through strategic alternatives. Pfizer Inc. 2017 Form 10-K OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses, we are exposed to both global and industry-specific economic conditions. Governments, corporations and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic or biosimilar products, delay treatments, skip doses or use less effective treatments. Government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. Examples include Europe, Japan, China, Canada, South Korea and a number of other international markets. The U.S. continues to maintain competitive insurance markets, but has also seen significant increases in patient cost-sharing and growing government influence as government programs continue to grow as a source of coverage. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications to our research, commercial and general business operations in the U.K. and the EU, including the approval and supply of our products. Details on how Brexit will be executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. section in our 2017 Financial Report. We also continue to monitor the global trade environment and potential trade conflicts. If trade restrictions reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues, costs and expenses, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 50% of our total 2017 revenues were derived from international operations, including 21% from Europe and 20% from Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Japanese yen, the Chinese renminbi, the U.K. pound, the Canadian dollar and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations can impact our results and financial guidance. For additional information about our exposure to foreign currency risk, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2018 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2017 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks and the measures we have taken to help contain them are discussed in the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2017 Financial Report. For additional details, see the Notes to Consolidated Financial Statements Note 7F. Financial Instruments: Derivative Financial Instruments and Hedging Activities and Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2017 Financial Report and the Pfizer Inc. 2017 Form 10-K Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section in our 2017 Financial Report. Those sections of our 2017 Financial Report are incorporated by reference. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) our internal separation of our commercial operations into our current operating structure; (iii) any other corporate strategic initiatives, such as our evaluation of strategic alternatives for our Consumer Healthcare business; and (iv) any acquisitions, divestitures or other initiatives, such as our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business. INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2017 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. INTERNAL CONTROL OVER FINANCIAL REPORTING The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. Pfizer Inc. 2017 Form 10-K ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES In 2017 , we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2017 , we had 501 owned and leased properties, amounting to approximately 53 million square feet. In 2017 , we reduced the number of properties in our portfolio by 66 sites and 4.2 million square feet, which includes the divestment of properties in connection with the sale of the HIS net assets to ICU Medical, the disposal of surplus real property assets and the reduction of operating space in all regions. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2018 , we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. We continue to advance our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2018 , we continue to advance construction of new RD facilities in St. Louis, Missouri and Andover, Massachusetts. Our PGS division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2017 , PGS had responsibility for 58 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of three of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2017 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2017 Financial Report, which is also incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2017 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. Our common stock currently trades on the NYSE under the symbol PFE. As of February 20, 2018 , there were 158,190 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2017 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2017 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 2, 2017 through October 29, 2017 31,838 $ 35.61 $ 6,355,862,076 October 30, 2017 through November 30, 2017 17,257 $ 35.11 $ 6,355,862,076 December 1, 2017 through December 31, 2017 15,332 $ 36.09 $ 16,355,862,076 Total 64,427 $ 35.59 (a) For additional information, see the Notes to Consolidated Financial Statements Note 12. Equity in our 2017 Financial Report, which is incorporated by reference. (b) These columns reflect (i) 59,102 shares of common stock surrendered to the Company to satisfy tax withholding obligations in connection with the vesting of awards under our long-term incentive programs; and (ii) the open market purchase by the trustee of 5,325 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards. ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2017 Financial Report. , ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2017 Financial Report. ," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2017 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2017 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2017 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2017 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. " +4,pfe-,10kshell," ITEM 1. BUSINESS GENERAL Pfizer Inc. is a research-based, global biopharmaceutical company. We apply science and our global resources to bring therapies to people that extend and significantly improve their lives through the discovery, development and manufacture of healthcare products. Our global portfolio includes medicines and vaccines, as well as many of the worlds best-known consumer healthcare products. We work across developed and emerging markets to advance wellness, prevention, treatments and cures that challenge the most feared diseases of our time. We collaborate with healthcare providers, governments and local communities to support and expand access to reliable, affordable healthcare around the world. Our revenues are derived from the sale of our products and, to a much lesser extent, from alliance agreements, under which we co-promote products discovered or developed by other companies or us. The majority of our revenues come from the manufacture and sale of biopharmaceutical products. The Company was incorporated under the laws of the State of Delaware on June 2, 1942. We believe that our medicines provide significant value for both healthcare providers and patients, not only from the improved treatment of diseases but also from a reduction in other healthcare costs, such as emergency room or hospitalization costs, as well as improvements in health, wellness and productivity. We continue to actively engage in dialogues about the value of our medicines and how we can best work with patients, physicians and payers to prevent and treat disease and improve outcomes. We continue to work within the current legal and pricing structures, as well as continue to review our pricing arrangements and contracting methods with payers, to maximize patient access and minimize any adverse impact on our revenues. We remain firmly committed to fulfilling our companys purpose of innovating to bring therapies to patients that extend and significantly improve their lives. By doing so, we expect to create value for the patients we serve and for our shareholders. We are committed to capitalizing on growth opportunities by advancing our own pipeline and maximizing the value of our in-line products, as well as through various forms of business development, which can include alliances, licenses, joint ventures, collaborations, equity- or debt-based investments, dispositions, mergers and acquisitions. We view our business development activity as an enabler of our strategies, and we seek to generate earnings growth and enhance shareholder value by pursuing a disciplined, strategic and financial approach to evaluating business development opportunities. On February 3, 2017, we completed the sale of our global infusion therapy net assets, HIS, to ICU Medical for up to approximately $900 million, composed of cash and contingent cash consideration, ICU Medical common stock and seller financing. HIS includes IV pumps, solutions and devices. Under the terms of the agreement, we received 3.2 million newly issued shares of ICU Medical common stock, which we valued at approximately $430 million (based upon the closing price of ICU Medical common stock on the closing date less a discount for lack of marketability), a promissory note from ICU Medical in the amount of $75 million and net cash of approximately $200 million before customary adjustments for net working capital. In addition, we are entitled to receive a contingent amount of up to an additional $225 million in cash based on ICU Medicals achievement of certain cumulative performance targets for the combined company through December 31, 2019. After receipt of the ICU Medical shares, we own approximately 16.4% of ICU Medical as of the closing date. We have agreed to certain restrictions on transfer of our ICU Medical shares for 18 months. For additional information, see Notes to Consolidated Financial Statements Note 2B. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Assets and Liabilities Held for Sale in our 2016 Financial Report. On December 22, 2016, which falls in the first fiscal quarter of 2017 for our international operations, we acquired the development and commercialization rights to AstraZenecas small molecule anti-infectives business, primarily outside the U.S., including the commercialization and development rights to the newly approved EU drug Zavicefta (ceftazidime-avibactam), the marketed agents Merrem/Meronem (meropenem) and Zinforo (ceftaroline fosamil), and the clinical development assets aztreonam-avibactam and ceftaroline fosamil-avibactam. Under the terms of the agreement, we made an upfront payment of approximately $550 million to AstraZeneca upon the close of the transaction and will make a deferred payment of $175 million in January 2019. In addition, AstraZeneca is eligible to receive up to $250 million in milestone payments, up to $600 million in sales-related payments, as well as tiered royalties on sales of Zavicefta and aztreonam-avibactam in certain markets. On September 28, 2016, we acquired Medivation for approximately $14.3 billion in cash ($13.9 billion, net of cash acquired). Medivation is now a wholly-owned subsidiary of Pfizer. Medivation is a biopharmaceutical company focused on developing and commercializing small molecules for oncology. Medivations portfolio includes Xtandi (enzalutamide), an androgen receptor inhibitor that blocks multiple steps in the androgen receptor signaling pathway within tumor cells, and two development-stage oncology assets. Xtandi is being developed and commercialized through a collaboration between Pfizer and Astellas. Astellas has exclusive commercialization rights for Xtandi outside the U.S. For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Acquisitions in our 2016 Financial Report. On June 24, 2016, we acquired Anacor for approximately $4.9 billion in cash ($4.5 billion net of cash acquired), plus $698 million debt assumed. Anacor is now a wholly-owned subsidiary of Pfizer. Anacor is a biopharmaceutical company focused on novel small-molecule therapeutics derived from its boron chemistry platform. Anacors crisaborole, a non-steroidal topical PDE-4 inhibitor with anti-inflammatory properties, was approved by the FDA on December 14, 2016 under the trade name, Eucrisa . For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment: Acquisitions in our 2016 Financial Report. On September 3, 2015, we acquired Hospira, a leading provider of sterile injectable drugs and infusion technologies as well as a provider of biosimilars, for approximately $16.1 billion in cash ( $15.7 billion , net of cash acquired). The combination of local Pfizer and Hospira entities may be pending in various jurisdictions and integration is subject to completion of various local legal and regulatory steps. For additional information, see the Notes to Consolidated Financial Statements Note 2A. Acquisitions, Assets and Liabilities Held for Sale, Licensing Agreements, Research and Development and Collaborative Arrangements, Equity-Method Investments and Cost-Method Investment : Acquisitions in our 2016 Financial Report. For a further discussion of our strategy and our business development initiatives, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Our Business Development Initiatives section in our 2016 Financial Report. Our businesses are heavily regulated in most of the countries in which we operate. In the U.S., the principal authority regulating our operations is the FDA. The FDA regulates the safety and efficacy of the products we offer and our research, quality, manufacturing processes, product promotion, advertising and product labeling. Similar regulations exist in most other countries, and in many countries the government also regulates our prices. In the EU, the EMA regulates the scientific evaluation, supervision and safety monitoring of our products, and employs a centralized procedure for approval of drugs for the EU and the European Economic Area countries. In Japan, the PMDA is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceutical safety. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority, such as the FDA or EMA, before they begin to conduct their application review process and/or issue their final approval. For additional information, see the Government Regulation and Price Constraints section below. Note: Some amounts in this 2016 Form 10-K may not add due to rounding. All percentages have been calculated using unrounded amounts. Pfizer Inc. 2016 Form 10-K AVAILABLE INFORMATION AND PFIZER WEBSITE Our website is located at www.pfizer.com . This 2016 Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available (free of charge) on our website, in text format and, where applicable, in interactive data file format , as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Throughout this 2016 Form 10-K, we incorporate by reference certain information from other documents filed or to be filed with the SEC, including our 2017 Proxy Statement and the 2016 Financial Report, portions of which are filed as Exhibit 13 to this 2016 Form 10-K, and which also will be contained in Appendix A to our 2017 Proxy Statement. The SEC allows us to disclose important information by referring to it in that manner. Please refer to such information. Our 2016 Annual Report to Shareholders consists of the 2016 Financial Report and the Corporate and Shareholder Information attached to the 2017 Proxy Statement. Our 2016 Financial Report will be available on our website on or about February 23, 2017. Our 2017 Proxy Statement will be available on our website on or about March 16, 2017. We may use our website as a means of disclosing material information and for complying with our disclosure obligations under Regulation Fair Disclosure promulgated by the SEC. These disclosures are included on our website in the Investors or News sections. Accordingly, investors should monitor these portions of our website, in addition to following Pfizers press releases, SEC filings, public conference calls and webcasts, as well as Pfizers social media channels (Pfizers Facebook, YouTube and LinkedIn pages and Twitter accounts ( @Pfizer and @Pfizer_News )). Information relating to corporate governance at Pfizer, including our Corporate Governance Principles; Director Qualification Standards; Pfizer Policies on Business Conduct (for all of our employees, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer); Code of Business Conduct and Ethics for Members of the Board of Directors; information concerning our Directors; ways to communicate by e-mail with our Directors; Board Committees; Committee Charters; Charter of the Lead Independent Director; and transactions in Pfizer securities by Directors and Officers; as well as Chief Executive Officer and Chief Financial Officer certifications, are available on our website. We will provide any of the foregoing information without charge upon written request to our Corporate Secretary, Pfizer Inc., 235 East 42nd Street, New York, NY 10017-5755. We will disclose any future amendments to, or waivers from, provisions of the Pfizer Policies on Business Conduct affecting our Chief Executive Officer, Chief Financial Officer and Controller on our website as promptly as practicable, as may be required under applicable SEC and NYSE rules. Information relating to shareholder services, including the Computershare Investment Program, book-entry share ownership and direct deposit of dividends, is also available on our website. The information contained on our website, our Facebook, YouTube and LinkedIn pages or our Twitter accounts does not, and shall not be deemed to, constitute a part of this 2016 Form 10-K. Pfizers references to the URLs for websites are intended to be inactive textual references only. Pfizer Inc. 2016 Form 10-K COMMERCIAL OPERATIONS We manage our commercial operations through two distinct business segments: Pfizer Innovative Health (IH) and Pfizer Essential Health (EH), which was previously known as Established Products. Beginning in the second quarter of 2016, we reorganized our operating segments to reflect that we now manage our innovative pharmaceutical and consumer healthcare operations as one business segment, IH . From the beginning of our fiscal year 2014 until the second quarter of 2016, these operations were managed as two business segments: the Global Innovative Products segment and the Vaccines, Oncology and Consumer Healthcare segment. We have revised prior-period information to reflect the reorganization. The IH and EH operating segments are each led by a single manager. Each operating segment has responsibility for its commercial activities and for certain IPRD projects for new investigational products and additional indications for in-line products that generally have achieved proof of concept. Each business has a geographic footprint across developed and emerging markets. Some additional information about our business segments follows: Pfizer Innovative Health Pfizer Essential Health IH focuses on developing and commercializing novel, value-creating medicines and vaccines that significantly improve patients lives, as well as products for consumer healthcare. Key therapeutic areas include internal medicine, vaccines, oncology, inflammation immunology, rare diseases and consumer healthcare. EH includes legacy brands that have lost or will soon lose market exclusivity in both developed and emerging markets, branded generics, generic sterile injectable products, biosimilars and, through February 2, 2017, infusion systems. EH also includes an RD organization, as well as our contract manufacturing business. Leading brands include: - Prevnar 13 - Xeljanz - Eliquis - Lyrica (U.S., Japan and certain other markets) - Enbrel (outside the U.S. and Canada) - Viagra (U.S. and Canada) - Ibrance - Xtandi - Several OTC consumer products (e.g., Advil and Centrum ) Leading brands include: - Lipitor - Premarin family - Norvasc - Lyrica (Europe, Russia, Turkey, Israel and Central Asia countries) - Celebrex - Pristiq - Several sterile injectable products We expect that the IH biopharmaceutical portfolio of innovative, largely patent-protected, in-line and newly launched products will be sustained by ongoing investments to develop promising assets and targeted business development in areas of focus to ensure a pipeline of highly-differentiated product candidates in areas of unmet medical need. The assets managed by IH are science-driven, highly differentiated and generally require a high level of engagement with healthcare providers and consumers. EH is expected to generate strong consistent cash flow by providing patients around the world with access to effective, lower-cost, high-value treatments. EH leverages our biologic development, regulatory and manufacturing expertise to seek to advance its biosimilar development portfolio. Additionally, EH leverages capabilities in formulation development and manufacturing expertise to help advance its generic sterile injectables portfolio. EH may also engage in targeted business development to further enable its commercial strategies. For a further discussion of these operating segments, see the Innovative Health and Essential Health sections below and the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information , including the tables therein captioned Selected Income Statement Information , Geographic Information and Significant Product Revenues , the table captioned Revenues by Segment and Geographic Area in the Analysis of the Consolidated Statements of Income section, and the Analysis of Operating Segment Information section in our 2016 Financial Report, which are incorporated by reference. Pfizer Inc. 2016 Form 10-K INNOVATIVE HEALTH We recorded direct product sales of more than $1 billion for each of six IH products in 2016 ( Prevnar 13/Prevenar 13 , Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Enbrel (outside the U.S. and Canada), Ibrance , Viagra (U.S. and Canada) and Sutent ), and for each of five IH products in 2015 and 2014 ( Prevnar 13/Prevenar 13, Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Enbrel (outside the U.S. and Canada), Viagra (U.S. and Canada) and Sutent ). We also recorded more than $1 billion in IH Alliance revenues in 2016 and 2015 (primarily Eliquis ). See Item 1A. Risk Factors Dependence on Key In-Line Products below. Geographic Revenues for Innovative Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets For additional information regarding the revenues of our IH business, including revenues of major IH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Descriptions sections in our 2016 Financial Report; and for additional information on the key operational revenue drivers of our IH business, see the Analysis of Operating Segment Information Innovative Health Operating Segment section of our 2016 Financial Report. The key therapeutic areas comprising our IH business segment include: Internal Medicine For a discussion of certain of our key Internal Medicine products, including Lyrica (outside all of Europe, Russia, Turkey, Israel and Central Asia countries), Viagra (U.S. and Canada), Chantix/Champix and Eliquis (jointly developed and commercialized with BMS), see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Vaccines For a discussion of certain of our key Vaccine products, including Prevnar 13/Prevenar 13 , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Oncology For a discussion of certain of our key Oncology products, including Ibrance, Sutent, Xalkori, Inlyta and Xtandi (jointly developed and commercialized with Astellas), see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Inflammation and Immunology For a discussion of certain of our key Inflammation and Immunology products, including Enbrel (outside the U.S. and Canada) and Xeljanz , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Rare Diseases For a discussion of certain of our key Rare Diseases products, including BeneFix , Genotropin , and Refacto AF/Xyntha , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. Consumer Healthcare According to Euromonitor Internationals retail sales data, in 2016 , Pfizers Consumer Healthcare business was the fourth-largest branded multi-national, OTC consumer healthcare business in the world and produced two of the ten largest selling consumer healthcare brands ( Centrum and Advil ) in the world. Major categories and product lines in our Consumer Healthcare business include: Dietary Supplements : Centrum brands (including Centrum , Centrum Silver , Centrum Mens and Womens , Centrum MultiGummies , Centrum VitaMints , Centrum Specialist , Centrum Flavor Burst and Centrum Kids ), Caltrate and Emergen-C ; Pain Management : Advil brands (including Advil , Advil PM , Advil Liqui-Gels , Advil Film Coated , Advil Menstrual Pain , Childrens Advil , Infants Advil and Advil Migraine) and ThermaCare ; Gastrointestinal : Nexium 24HR/Nexium Control and Preparation H ; and Respiratory and Personal Care : Robitussin , Advil Cold Sinus , Advil Sinus Congestion Pain, Dimetapp and ChapStick . ESSENTIAL HEALTH We recorded direct product sales of more than $1 billion for each of two EH products in 2016 ( Lipitor and the Premarin family of products), three EH products in 2015 ( Lipitor , Lyrica (Europe, Russia, Turkey, Israel and Central Asia) and the Premarin family of products) and six EH products in 2014 ( Celebrex , Lipitor , Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Zyvox , Norvasc and the Premarin family of products). See Item 1A. Risk Factors Dependence on Key In-Line Products below. Geographic Revenues for Essential Health* * Dev Intl = Developed Markets except U.S.; Em Mkts = Emerging Markets Pfizer Inc. 2016 Form 10-K For additional information regarding the revenues of our EH business, including revenues of major EH products, see the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information and the Analysis of the Consolidated Statements of Income Revenues Major Products and Revenues Selected Product Descriptions sections in our 2016 Financial Report; and for additional information on the key operational revenue drivers of our EH business, see the Analysis of Operating Segment Information Essential Health Operating Segment section of our 2016 Financial Report. The product categories in our EH business segment include: Global Brands , which includes: Legacy Established Products : includes products that have lost patent protection (excluding Sterile Injectable Pharmaceuticals and Peri-LOE Products); and Peri-LOE Products : includes products that have recently lost or are anticipated to soon lose patent protection. These products primarily include Lyrica in certain developed Europe markets, Pristiq globally, Celebrex , Zyvox and Revatio in most developed markets, Vfend and Viagra in certain developed Europe markets and Japan, and Inspra in the EU; Sterile Injectable Pharmaceuticals : includes generic injectables and proprietary specialty injectables (excluding Peri-LOE Products); Infusion Systems (through February 2, 2017): includes Medication Management Systems products composed of infusion pumps and related software and services, as well as intravenous infusion products, including large volume intravenous solutions and their associated administration sets; Biosimilars : includes Inflectra / Remsima (biosimilar infliximab) in the U.S. and certain international markets, Nivestim (biosimilar filgrastim) in certain European, Asian and Africa/Middle East markets and Retacrit (biosimilar epoetin zeta) in certain European and Africa/Middle East markets; and Pfizer CentreOne : includes (i) revenues from legacy Pfizers contract manufacturing and active pharmaceutical ingredient sales operation (previously known as Pfizer CentreSource), including revenues related to our manufacturing and supply agreements with Zoetis Inc.; and (ii) revenues from legacy Hospiras One-2-One sterile injectables contract manufacturing operation. For a discussion of certain of our key EH products, including Lipitor , the Premarin family of products, Norvasc , Lyrica (Europe, Russia, Turkey, Israel and Central Asia), Celebrex , Pristiq, Zyvox and Inflectra , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions section in our 2016 Financial Report. ALLIANCE REVENUES We are party to collaboration and/or co-promotion agreements relating to certain biopharmaceutical products, including Eliquis and Xtandi. Eliquis has been jointly developed and is being commercialized in collaboration with BMS. The two companies share commercialization expenses and profit/losses equally on a global basis. In April 2015, we signed an agreement with BMS to transfer full commercialization rights in certain smaller markets to us, beginning in the third quarter of 2015. Xtandi is being developed and commercialized in collaboration with Astellas. The two companies share equally in the gross profits (losses) related to U.S. net sales of Xtandi . Subject to certain exceptions, Pfizer and Astellas also share equally all Xtandi commercialization costs attributable to the U.S. market. Pfizer and Astellas also share certain development and other collaboration expenses and Pfizer receives tiered royalties as a percentage of international Xtandi net sales (recorded in Other (Income)/Deductions Net). Collaboration rights for Enbrel (in the U.S. and Canada), Spiriva and Rebif have expired. For additional information, including a description of certain of these collaboration and co-promotion agreements and their expiration dates, see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions and the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights sections in our 2016 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Pfizer Inc. 2016 Form 10-K RESEARCH AND DEVELOPMENT Innovation by our RD organization is very important to our success. Our goal is to discover, develop and bring to market innovative products that address major unmet medical needs. Our RD Operations We conduct RD internally and also through contracts with third parties, through collaborations with universities and biotechnology companies and in cooperation with other pharmaceutical firms. Our RD spending is conducted through a number of matrix organizations. Our WRD organization is generally responsible for research projects for our IH business until proof-of-concept is achieved and then for transitioning those projects to the IH segment via the GPD organization, which was formed in early 2016, for possible clinical and commercial development. The GPD organization is a new, unified center for late-stage development for our innovative products. GPD is expected to enable more efficient and effective development and enhance our ability to accelerate and progress assets through our pipeline. GPD combines certain previously separate development-related functions from the IH business and the WRD organization to achieve a development capability that is expected to deliver high-quality, efficient, and well-executed clinical programs by enabling greater speed, greater cost efficiencies, and reduced complexity across our development portfolio. The WRD and GPD organizations also have responsibility for certain science-based and other end-to-end platform-services organizations, which provide technical expertise and other services to the various RD projects, including EH RD projects. These organizations include science-based functions (which are part of our WRD organization), such as Pharmaceutical Sciences, Medicinal Chemistry, Regulatory and Drug Safety. As a result, within each of these functions, we are able to migrate resources among projects, candidates and/or targets in any therapeutic area and in most phases of development, allowing us to react quickly in response to evolving needs. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. For additional information regarding our RD operations, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Strategy Research and Development Operations and Costs and Expenses Research and Development (RD) Expenses Description of Research and Development Operations sections in our 2016 Financial Report. Our RD Priorities and Strategy Our RD priorities include delivering a pipeline of differentiated therapies and vaccines with the greatest medical and commercial promise, innovating new capabilities that can position Pfizer for long-term leadership and creating new models for biomedical collaboration that will expedite the pace of innovation and productivity. To that end, our research primarily focuses on: Biosimilars; Inflammation and Immunology; Metabolic Disease and Cardiovascular Risks; Neuroscience; Oncology; Rare Diseases; and Vaccines. We also seek out promising chemical and biological lead molecules and innovative technologies developed by third parties to incorporate into our discovery and development processes or projects, as well as our product lines, by entering into collaborations and alliance and license agreements with other companies, as well as leveraging acquisitions and equity- or debt-based investments. These agreements enable us to co-develop, license or acquire promising compounds, technologies or capabilities. We also enter into agreements pursuant to which a third party agrees to fund a portion of the development costs of one or more of our pipeline products in exchange for rights to receive potential milestone payments, revenue sharing payments, profit sharing payments and/or royalties. Collaboration, alliance, license and funding agreements and equity- or debt-based investments allow us to share risk and cost and to access external scientific and technological expertise, and enable us to advance our own products as well as in-licensed or acquired products. Our RD Pipeline and Competition Innovation is critical to the success of our company, and drug discovery and development is time-consuming, expensive and unpredictable. According to the Pharmaceutical Benchmarking Forum, out of 20 compounds entering preclinical development, only one is approved by a regulatory authority in a major market (U.S., the EU or Japan). The process from early discovery or design to development to regulatory approval can take more than ten years. Drug candidates can fail at any stage of the process, and candidates may not receive regulatory approval even after many years of research and development. As of January 31, 2017, we had the following number of projects in various stages of RD: Development of a single compound is often pursued as part of multiple programs. While these drug candidates may or may not eventually receive regulatory approval, new drug candidates entering clinical development phases are the foundation for future products. In addition to discovering and developing new products, our RD efforts seek to add value to our existing products by improving their effectiveness, enhancing ease of dosing and by discovering potential new indications for them. Information concerning several of our drug candidates in development, as well as supplemental filings for existing products, is set forth in the Analysis of the Consolidated Statements of IncomeProduct Developments Biopharmaceutical section in our 2016 Financial Report, which is incorporated by reference. Our competitors also devote substantial funds and resources to RD. We also compete against numerous small biotechnology companies in developing potential drug candidates. The extent to which our competitors are successful in their research could result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. In addition, several of our competitors operate without large RD expenses and make a regular practice of challenging our product patents before their expiration. For additional information, see the Competition and Item 1A. Risk Factors Competitive Products sections below. Pfizer Inc. 2016 Form 10-K INTERNATIONAL OPERATIONS We have significant operations outside the U.S. Operations in developed and emerging markets are managed through our two business segments: IH and EH. Emerging markets are an important component of our strategy for global leadership, and our commercial structure recognizes that the demographics and rising economic power of the fastest-growing emerging markets are becoming more closely aligned with the profile found within developed markets. We sell our products in over 125 countries. Revenues from operations outside the U.S. of $26.5 billion accounted for 50% of our total revenues in 2016 . Japan is our largest national market outside the U.S. For a geographic breakdown of revenues, see the table captioned Geographic Information in the Notes to Consolidated Financial Statements Note 18. Segment, Geographic and Other Revenue Information in our 2016 Financial Report, and the table captioned Revenues by Segment and Geographic Area in our 2016 Financial Report. Those tables are incorporated by reference. Revenues by National Market Our international operations are subject, in varying degrees, to a number of risks inherent in carrying on business in other countries. These include, among other things, currency fluctuations, capital and exchange control regulations, expropriation and other restrictive government actions. See Item 1A. Risk Factors Risks Affecting International Operations below. Our international businesses are also subject to government-imposed constraints, including laws and regulations on pricing, reimbursement, and access to our products. See Government Regulation and Price Constraints Outside the United States below for a discussion of these matters. Depending on the direction of change relative to the U.S. dollar, foreign currency values can increase or decrease the reported dollar value of our net assets and results of operations. While we cannot predict with certainty future changes in foreign exchange rates or the effect they will have on us, we attempt to mitigate their impact through operational means and by using various financial instruments, depending upon market conditions. For additional information, see the Notes to Consolidated Financial Statements Note 7E. Financial Instruments: Derivative Financial Instruments and Hedging Activities in our 2016 Financial Report, as well as the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2016 Financial Report. Those sections of our 2016 Financial Report are incorporated by reference. MARKETING In our global biopharmaceutical businesses, we promote our products to healthcare providers and patients. Through our marketing organizations, we explain the approved uses, benefits and risks of our products to healthcare providers, such as doctors, nurse practitioners, physician assistants and pharmacists; MCOs that provide insurance coverage, such as hospitals, Integrated Delivery Systems, PBMs and health plans; and employers and government agencies who hire MCOs to provide health benefits to their employees. We also market directly to consumers in the U.S. through direct-to-consumer advertising that seeks to communicate the approved uses, benefits and risks of our products while motivating people to have meaningful conversations with their doctors. In addition, we sponsor general advertising to educate the public on disease awareness, prevention and wellness, important public health issues, and our patient assistance programs. Pfizer Inc. 2016 Form 10-K Our prescription pharmaceutical products are sold principally to wholesalers, but we also sell directly to retailers, hospitals, clinics, government agencies and pharmacies, and, in the case of our vaccines products in the U.S., we primarily sell directly to the Centers for Disease Control and Prevention, wholesalers and individual provider offices. We seek to gain access for our products on healthcare authority and MCO formularies, which are lists of approved medicines available to members of the MCOs. MCOs use various benefit designs, such as tiered co-pays for formulary products, to drive utilization of products in preferred formulary positions. We also work with MCOs to assist them with disease management, patient education and other tools that help their medical treatment routines. In 2016, our top three biopharmaceutical wholesalers accounted for approximately 39 % of our total revenues (and approximately 76 % of our total U.S. revenues). % of 2016 Total Revenues and U.S. Revenues from Major Biopharmaceutical Wholesalers and Other Customers Our global Consumer Healthcare business uses its own sales and marketing organizations to promote its products, and occasionally uses distributors and agents, principally in smaller markets. The advertising and promotions for our Consumer Healthcare business are generally disseminated to consumers through television, print, digital and other media advertising, as well as through in-store promotion. Consumer Healthcare products are sold through a wide variety of channels, including distributors, pharmacies, retail chains and grocery and convenience stores. Our Consumer Healthcare business generates a significant portion of its sales from several large customers, the loss of any one of which could have a material adverse effect on the Consumer Healthcare business. PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS Our products are sold around the world under brand-name, logo and certain product design trademarks that we consider, in the aggregate, to be of material importance to Pfizer. Trademark protection continues in some countries for as long as the mark is used and, in other countries, for as long as it is registered. Registrations generally are for fixed, but renewable, terms. We own or license a number of U.S. and foreign patents. These patents cover pharmaceutical and other products and their uses, pharmaceutical formulations, product manufacturing processes and intermediate chemical compounds used in manufacturing. Patents for individual products extend for varying periods according to the date of patent filing or grant and the legal term of patents in the various countries where patent protection is obtained. The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Further, patent term extension may be available in many major countries to compensate for a regulatory delay in approval of the product. For additional information, see Government Regulation and Price Constraints Intellectual Property below. In the aggregate, our patent and related rights are of material importance to our businesses in the U.S. and most other countries. Based on current product sales, and considering the vigorous competition with products sold by our competitors, the patent rights we consider most significant in relation to our business as a whole, together with the year in which the basic product patent expires (including, where applicable, the additional six-month pediatric exclusivity period and/or the granted patent term extension), are those for the medicines set forth in the table below. Patent term extensions, supplementary protection certificates and pediatric exclusivity periods are not reflected in the expiration dates listed in the table below, unless they have been granted by the issuing authority. In some instances, there are later-expiring patents relating to our products directed to particular forms or compositions, to methods of manufacturing, or to use of the drug in the treatment of particular diseases or conditions. However, in some cases, such patents may not protect our drug from generic or, as applicable, biosimilar competition after the expiration of the basic patent. Drug U.S. Basic Product Patent Expiration Year Major EU Basic Product Patent Expiration Year Japan Basic Product Patent Expiration Year Viagra 2012 (1) 2013 (1) Lyrica 2014 (2) Chantix 2021 Xeljanz N/A (3) Sutent 2021 Eliquis (4) 2026 Ibrance 2023 N/A (5) Inlyta 2025 Prevnar 13/Prevenar 13 2026 (6) Eucrisa N/A (7) N/A (7) Xtandi (8) * (8) * (8) Xalkori 2027 (1) In addition to the basic product patent covering Viagra , which expired in 2012, Viagra is covered by a U.S. method-of-treatment patent which, including the six-month pediatric exclusivity period associated with Revatio (which has the same active ingredient as Viagra ), expires in 2020. However, as a result of a patent litigation settlement, Teva Pharmaceuticals USA, Inc. will be allowed to launch a generic version of Viagra in the U.S. in December 2017, or earlier under certain circumstances. The corresponding method-of-treatment patent covering Viagra in Japan expired in May 2014. (2) For Lyrica , regulatory exclusivity in the EU expired in July 2014. (3) The Xeljanz marketing authorization application has been filed and is under review in the EU. (4) Eliquis was developed and is being commercialized in collaboration with BMS. (5) The Ibrance marketing authorization application has been filed and is under review in Japan. (6) The EU patent that covers the combination of the 13 serotype conjugates of Prevenar 13 has been revoked following an opposition proceeding. This first instance decision has been appealed. There are other EU patents and pending applications covering the formulation and various aspects of the manufacturing process of Prevenar 13 that remain in force. (7) Eucrisa is not approved in the EU and Japan. (8) Xtandi is being developed and commercialized in collaboration with Astellas, who has exclusive commercialization rights for Xtandi outside the U.S. A number of our current products have experienced patent-based expirations or loss of regulatory exclusivity in certain markets in the last few years. For additional information, including a description of certain of our co-promotion agreements and their expiration dates, and a further discussion of our products experiencing, or expected to experience in 2017, patent expirations or loss of regulatory exclusivity in the U.S., Europe or Japan, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights section in our 2016 Financial Report and Item 1A. Risk Factors Dependence on Key In-Line Products below. Companies have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . For additional information, see the Notes to Consolidated Financial Statements Note 17A1. Commitments and ContingenciesLegal ProceedingsPatent Litigation in our 2016 Financial Report. The expiration of a basic product patent or loss of patent protection resulting from a legal challenge normally results in significant competition from generic products against the originally patented product and can result in a significant reduction in revenues for that product in a very short period of time. In some cases, however, we can continue to obtain commercial benefits from product manufacturing trade secrets; patents on uses for products; patents on processes and intermediates for the economical manufacture of the active ingredients; patents for special formulations of the product or delivery mechanisms; or conversion of the active ingredient to OTC products. Biotechnology Products Our biotechnology products, including BeneFIX , ReFacto , Xyntha and Enbrel (we market Enbrel outside the U.S. and Canada), may face in the future, or already face, competition from biosimilars (also referred to as follow-on biologics). In the U.S., such biosimilars would reference biotechnology products approved under the U.S. Public Health Service Act. Additionally, the FDA has approved a follow-on recombinant human growth hormone that referenced our biotechnology product, Genotropin , which was approved under the FFDCA. Biosimilars are versions of biologic medicines that have been developed and proven to be similar to the original biologic in terms of safety and efficacy and to have no clinically meaningful differences. Biosimilars have the potential to offer high-quality, lower-cost alternatives to biologic medicines. Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage in 2010 of the ACA, a framework for such approval exists in the U.S. The regulatory implementation of these ACA provisions is ongoing, and, since 2015, the FDA approved a number of biosimilars, including Inflectra (infliximab-dyyb). Pfizer has exclusive commercialization rights to Inflectra from Celltrion Inc. and Celltrion Healthcare, Co., Ltd. (collectively, Celltrion) in the U.S., Canada and certain other territories. Pfizer also shares Inflectra commercialization rights with Celltrion in Europe. For additional information on Inflectra , see the Analysis of the Consolidated Statements of Income Revenues Selected Product Descriptions Inflectra/Remsima section in our 2016 Financial Report. For additional information on the ACAs approval framework for biosimilars, see Government Regulation and Price Constraints Biosimilar Regulation below. In Europe, the European Commission has granted marketing authorizations for several biosimilars pursuant to a set of general and product class-specific guidelines for biosimilar approvals issued over the past few years. In 2013, the EMA approved the first biosimilar of a monoclonal antibody, and in January 2016, the European Commission approved an etanercept biosimilar referencing Pfizers Enbrel . In Japan, the regulatory authority has granted marketing authorizations for certain biosimilars pursuant to a guideline for biosimilar approvals issued in 2009. If competitors are able to obtain marketing approval for biosimilars that reference our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. Expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant exclusivity period has expired. However, biosimilar manufacturing is complex. At least initially upon approval of a biosimilar competitor, biosimilar competition with respect to biologics may not be as significant as generic competition with respect to small molecule drugs. As part of our business strategy, we are capitalizing on our expertise in biologics manufacturing, as well as our regulatory and commercial strengths, to develop biosimilar medicines. As such, a better-defined biosimilars approval pathway will assist us in pursuing approval of our own biosimilar products in the U.S. See Item 1A. Risk Factors Biotechnology Products below. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. Likewise, as we develop and manufacture biosimilars and seek to launch products, patents may be asserted against us. International One of the main limitations on our operations in some countries outside the U.S. is the lack of effective intellectual property protection for our products. Under international and U.S. free trade agreements in recent years, global protection of intellectual property rights has been improving. For additional information, see Government Regulation and Price Constraints Intellectual Property below. COMPETITION Our businesses are conducted in intensely competitive and often highly regulated markets. Many of our prescription pharmaceutical products face competition in the form of branded or generic drugs or biosimilars that treat similar diseases or indications. The principal forms of competition include efficacy, safety, ease of use, and cost effectiveness. Though the means of competition vary among product categories and business groups, demonstrating the value of our products is a critical factor for success in all of our principal businesses. Our competitors include other worldwide research-based biopharmaceutical companies, smaller research companies with more limited therapeutic focus, generic and biosimilar drug manufacturers and consumer healthcare manufacturers. We compete with other companies that manufacture and sell products that treat diseases or indications similar to those treated by our major products. This competition affects our core product business, which is focused on applying innovative science to discover and market products that satisfy unmet medical needs and provide therapeutic improvements. Our emphasis on innovation is underscored by our multi-billion-dollar investment in RD, as well as our business development transactions, both designed to result in a strong product pipeline. Our investment in research does not stop with drug approval; we continue to invest in further understanding the value of our products for the conditions they treat, as well as potential new applications. We seek to protect the health and well-being of patients by striving to ensure that medically sound knowledge of the benefits and risks of our medicines is understood and communicated to patients, physicians and global health authorities. We also seek to continually enhance the organizational effectiveness of all of our biopharmaceutical functions, including coordinating support for our salespersons efforts to accurately and ethically launch and promote our products to our customers. Pfizer Inc. 2016 Form 10-K Operating conditions have become more challenging under mounting global pressures of competition, industry regulation and cost containment. We continue to take measures to evaluate, adapt and improve our organization and business practices to better meet customer and public needs. We believe that we have taken an industry-leading role in evolving our approaches to U.S. direct-to-consumer advertising; interactions with, and payments to, healthcare professionals; and medical education grants. We also continue to sponsor programs to address patient affordability and access barriers, as we strive to advance fundamental health system change through support for better healthcare solutions. Our Consumer Healthcare business faces competition from OTC business units in other major pharmaceutical and consumer packaged goods companies, and retailers who carry their own private label brands. Our competitive position is affected by several factors, including the amount and effectiveness of our and our competitors promotional resources; customer acceptance; product quality; our and our competitors introduction of new products, ingredients, claims, dosage forms, or other forms of innovation; and pricing, regulatory and legislative matters (such as product labeling, patient access and prescription to OTC switches). Our vaccines business may face competition from the introduction of alternative or next generation vaccines. For example, Prevnar 13 may face competition in the form of alternative 13-valent or additional valent next-generation pneumococcal conjugate vaccines prior to the expiration of its patents, which may adversely affect our future results. Our generics and biosimilars businesses compete with branded products from competitors, as well as other generics and biosimilars manufacturers. Globally, Pfizer sells generic versions of Pfizers, as well as certain competitors, solid oral dose and sterile injectable pharmaceutical products, as well as biosimilars. We seek to maximize the opportunity to establish a first-to-market or early market position for our generic injectable drugs and biosimilars, as a first-to-market position provides customers a lower-cost alternative immediately when available and also may provide us with a period of exclusivity as the only generic or biosimilar provider. Managed Care Organizations The evolution of managed care in the U.S. has been a major factor in the competitive makeup of the healthcare marketplace. Approximately 283 million people in the U.S. now have some form of health insurance coverage. Due to the expansion of health insurance coverage (see Government Regulation and Price Constraints In the United States below), the marketing of prescription drugs to both consumers and the entities that manage this expanded coverage in the U.S. continues to grow in importance. The influence of MCOs has increased in recent years due to the growing number of patients receiving coverage through MCOs. At the same time, those organizations have been consolidating into fewer, even larger entities. This consolidation enhances both their ability to negotiate, as well as their importance to Pfizer. The growth of MCOs has increased pressure on drug prices as well as revenues. One objective of MCOs is to contain and, where possible, reduce healthcare expenditures. MCOs typically negotiate prices with pharmaceutical providers by using formularies (which are lists of approved medicines available to members of the MCOs), clinical protocols (requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine), volume purchasing, long-term contracts and their ability to influence volume and market share of prescription drugs. In addition, by placing branded medicines on higher-tier status in their formularies (leading to higher patient co-pays) or non-preferred tier status, MCOs transfer a portion of the cost of the medicine to the patient, resulting in significant out-of-pocket expenses for the patient, especially for chronic treatments. This financial disincentive is a tool for MCOs to manage drug costs and channel patients to medicines preferred by the MCOs. MCOs have recently introduced additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. We are closely monitoring these new approaches and developing appropriate strategies to respond to them. Due to their generally lower cost, generic medicines typically are placed in lowest cost tiers of MCO formularies. The breadth of the products covered by formularies can vary considerably from one MCO to another, and many formularies include alternative and competitive products for treatment of particular medical problems. In 2015, the FDA approved the first biosimilar and MCOs are evaluating the appropriate placement of these new agents on their formularies. Exclusion of a product from a formulary or other MCO-implemented restrictions can significantly impact drug usage in the MCO patient population. Consequently, pharmaceutical companies compete to gain access to formularies for their products. Unique product features, such as greater efficacy, better patient ease of use, or fewer side effects, are generally beneficial to achieving access to formularies. However, lower overall cost of therapy is also an important factor. We have been generally, although not universally, successful in having our major products included on MCO formularies. However, increasingly our branded products are being placed on the higher tiers or in a non-preferred status. MCOs also emphasize primary and preventive care, out-patient treatment and procedures performed at doctors offices and clinics as another way to manage costs. Hospitalization and surgery, typically the most expensive forms of treatment, are Pfizer Inc. 2016 Form 10-K carefully managed. Since the use of certain drugs can reduce the need for hospitalization, professional therapy, or even surgery, such drugs can become favored first-line treatments for certain diseases. The ACA has accelerated payment reform by distributing risk across MCOs and other stakeholders in care delivery with the intent of improving quality while reducing costs, which creates pressure on MCOs to tie reimbursement to defined outcomes. In 2017, there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. We are monitoring any such actions to see if any changes to the ACA will be enacted that would impact our business. Generic Products One of the biggest competitive challenges that our branded products face is from generic pharmaceutical manufacturers. Upon the expiration or loss of patent protection for a product, especially a small molecule product, we can lose the major portion of revenues for that product in a very short period of time. Several competitors make a regular practice of challenging our product patents before their expiration. Generic competitors often operate without large RD expenses, as well as without costs of conveying medical information about products to the medical community. In addition, the FDA approval process exempts generics from costly and time-consuming clinical trials to demonstrate their safety and efficacy, allowing generic manufacturers to rely on the safety and efficacy data of the innovator product. Generic competitors do not generally need to conduct clinical trials and can market a competing version of our product after the expiration or loss of our patent and often charge much less. In addition, our patent-protected products can face competition in the form of generic versions of competitors branded products that lose their market exclusivity. As noted above, MCOs that focus primarily on the immediate cost of drugs often favor generics over brand-name drugs. Many governments also encourage the use of generics as alternatives to brand-name drugs in their healthcare programs, including Medicaid in the U.S. Laws in the U.S. generally allow, and in some cases require, pharmacists to substitute, for brand-name drugs, generic drugs that have been rated under government procedures to be chemically and therapeutically equivalent to brand-name drugs. In a small subset of states, prescribing physicians are able to expressly prevent such substitution. RAW MATERIALS Raw materials essential to our businesses are purchased worldwide in the ordinary course of business from numerous suppliers. In general, these materials are available from multiple sources. No serious shortages or delays of raw materials were encountered in 2016 , and none are expected in 2017 . We have successfully secured the materials necessary to meet our requirements where there have been short-term imbalances between supply and demand, but generally at higher prices than those historically paid. GOVERNMENT REGULATION AND PRICE CONSTRAINTS Pharmaceutical companies are subject to extensive regulation by government authorities in the countries in which they do business. Certain laws and regulations that govern Pfizers business are discussed below. General . Our business has been and will continue to be subject to numerous laws and regulations. Failure to comply with these laws and regulations, including those governing the manufacture and marketing of our products, could subject us to administrative and legal proceedings and actions by various governmental bodies. For additional information on these proceedings and actions, see the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2016 Financial Report. Criminal charges, substantial fines and/or civil penalties, warning letters and product recalls or seizures, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from such proceedings and actions. In the United States Drug Regulation . In the U.S., biopharmaceutical products are subject to extensive pre- and post-market regulations by the FDA, including regulations that govern the testing, manufacturing, safety, efficacy, labeling and storage of our products, record keeping, advertising and promotion. Our products are also subject to post-market surveillance under the FFDCA and its implementing regulations with respect to drugs, as well as the Public Health Service Act and its implementing regulations with respect to biologics. The FDA also regulates our Consumer Healthcare products. Other U.S. federal agencies, including the DEA, also regulate certain of our products. The U.S. Federal Trade Commission has the authority to regulate the advertising of consumer healthcare products, including OTC drugs and dietary supplements. Many of our activities also are subject to the jurisdiction of the SEC. Before a new biopharmaceutical product may be marketed in the U.S., the FDA must approve an NDA for a new drug or a BLA for a biologic. The steps required before the FDA will approve an NDA or BLA generally include preclinical studies followed by multiple stages of clinical trials conducted by the study sponsor; sponsor submission of the application to the FDA for review; the FDAs review of the data to assess the drugs safety and effectiveness; and the FDAs inspection of the facilities where the product will be manufactured. Before a generic drug may be marketed in the U.S., the FDA must approve an ANDA. The ANDA review process typically does not require new preclinical and clinical studies, because it relies on the studies establishing safety and efficacy conducted for the referenced drug previously approved through the NDA process. The ANDA process, however, does require the sponsor to conduct one or more bioequivalence studies to show that the ANDA drug is bioequivalent to the previously approved referenced brand drug, submission of an application to the FDA for review, and the FDAs inspection of the facilities where the product will be manufactured. As a condition of product approval, the FDA may require a sponsor to conduct post-marketing clinical studies, known as Phase 4 studies, and surveillance programs to monitor the effect of the approved product. The FDA may limit further marketing of a product based on the results of these post-market studies and programs. Any modifications to a drug or biologic, including new indications or changes to labeling or manufacturing processes or facilities, may require the submission and approval of a new or supplemental NDA or BLA before the modification can be implemented, which may require that we develop additional data or conduct additional preclinical studies and clinical trials. Our ongoing manufacture and distribution of drugs and biologics is subject to continuing regulation by the FDA, including recordkeeping requirements, reporting of adverse experiences associated with the product, and adherence to cGMPs, which regulate all aspects of the manufacturing process. We are also subject to numerous regulatory requirements relating to the advertising and promotion of drugs and biologics, including, but not limited to, standards and regulations for direct-to-consumer advertising. Failure to comply with the applicable regulatory requirements governing the manufacture and marketing of our products may subject us to administrative or judicial sanctions, including warning letters, product recalls or seizures, injunctions, fines, civil penalties and/or criminal prosecution. Biosimilar Regulation. The ACA created a framework for the approval of biosimilars (also known as follow-on biologics) following the expiration of 12 years of exclusivity for the innovator biologic, with a potential six-month pediatric extension. Under the ACA, biosimilar applications may not be submitted until four years after the approval of the reference, innovator biologic. The FDA is responsible for implementation of the legislation and, since 2015, approved a number of biosimilars, including Inflectra . Through those approvals and the issuance of draft and final guidance, the FDA has begun to address open questions about the naming convention for biosimilars and the use of data from a non-U.S.-licensed comparator to demonstrate biosimilarity and/or interchangeability with a U.S.-licensed reference product. Over the next several years, the FDA is expected to issue additional draft and final guidance documents impacting biosimilars. In 2017, there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. If the ACA is repealed, substantially modified, or invalidated, it is unclear what, if any, impact such action would have on biosimilar regulation. Sales and Marketing . The marketing practices of U.S. biopharmaceutical companies are generally subject to various federal and state healthcare laws that are intended to prevent fraud and abuse in the healthcare industry and protect the integrity of government healthcare programs. These laws include anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a biopharmaceutical company from soliciting, offering, receiving, or paying any remuneration to generate business, including the purchase or prescription of a particular product. False claims laws generally prohibit anyone from knowingly and willingly presenting, or causing to be presented, any claims for payment for goods (including drugs) or services to third-party payers (including Medicare and Medicaid) that are false or fraudulent. Although the specific provisions of these laws vary, their scope is generally broad and there may not be regulations, guidance or court decisions that apply the laws to any particular industry practices, including the marketing practices of pharmaceutical companies. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions and/or exclusion from federal health care programs (including Medicare and Medicaid). The federal government and various states have also enacted laws to regulate the sales and marketing practices of pharmaceutical companies. The laws and regulations generally limit financial interactions between manufacturers and health care providers; require disclosure to the federal or state government and public of such interactions; and/or require the adoption of compliance standards or programs. Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation. Individual states, acting through their attorneys general, have become active as well, seeking to regulate the marketing of prescription drugs under state consumer protection and false advertising laws. Given the lack of clarity in laws and their implementation, our activities could be subject to the penalties under the pertinent laws and regulations. Pricing and Reimbursement . Pricing for our pharmaceutical products depends in part on government regulation. Pfizer must offer discounted pricing or rebates on purchases of pharmaceutical products under various federal and state healthcare programs, such as the Medicaid Drug Rebate Program, the federal ceiling price drug pricing program, the 340B drug pricing program and the Medicare Part D Program. Pfizer must also report specific prices to government agencies under healthcare programs, such as the Medicaid Drug Rebate Program and Medicare Part B. The calculations necessary to determine the prices reported are complex and the failure to report prices accurately may expose Pfizer to penalties. See the discussion regarding rebates in the Analysis of the Consolidated Statements of Income Revenues Overview section in our 2016 Financial Report and in the Notes to Consolidated Financial Statements Note 1G. Basis of Presentation and Significant Accounting Policies: Revenues and Trade Accounts Receivable in our 2016 Financial Report, which are incorporated by reference. Government and private third-party payers routinely seek to manage utilization and control the costs of our products. For example, the majority of states use preferred drug lists to restrict access to certain pharmaceutical products under Medicaid. Restrictions exist for some Pfizer products in certain states. As another example, access to our products under the Medicaid managed care program is typically determined by the health plans with which state Medicaid agencies contract to provide services to Medicaid beneficiaries. Given certain states current and potential ongoing fiscal crises, a growing number of states are considering a variety of cost-control strategies, including capitated managed care plans that typically contain cost by restricting access to certain treatments. In addition, we expect that consolidation and integration of pharmacy chains and wholesalers, who are the primary purchasers of our pharmaceutical products in the U.S., will increase competitive and pricing pressures on pharmaceutical manufacturers, including us. Healthcare Reform. The U.S. and state governments continue to propose and pass legislation designed to regulate the healthcare industry. In March 2010, the U.S. Congress enacted the ACA, which included changes that significantly affected the pharmaceutical industries, such as: increasing drug rebates paid to state Medicaid programs under the Medicaid Drug Rebate Program for brand name and generic prescription drugs and extending those rebates to Medicaid managed care; requiring pharmaceutical manufacturers to provide discounts on brand name prescription drugs sold to Medicare beneficiaries whose prescription drug costs cause the beneficiaries to be subject to the Medicare Part D coverage gap; and imposing an annual fee on manufacturers and importers of brand name prescription drugs reimbursed under certain government programs, including Medicare and Medicaid. The ACA included provisions designed to increase the number of Americans covered by health insurance. Specifically, since 2014, the ACA has required most individuals to maintain health insurance coverage or potentially to pay a penalty for noncompliance and has offered states the option of expanding Medicaid coverage to additional individuals. The implementation of the coverage expansion had a negligible impact on Pfizers 2016 revenues. The ACA also establishes an Independent Payment Advisory Board (IPAB) to reduce the per capita rate of growth in Medicare spending by proposing changes to Medicare payments if expenditures exceed certain targets. The threshold for triggering IPAB proposals was not reached in 2016, so no adjustments will be made under the IPAB until 2019 at the earliest. If no IPAB members are nominated, the duties of the IPAB will default to the Secretary of the Department of Health and Human Services. Additionally, efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products could adversely affect our business if implemented. There has recently been considerable public and government scrutiny of pharmaceutical pricing and proposals to address the perceived high cost of pharmaceuticals. We believe medicines are the most efficient and effective use of healthcare dollars based on the value they deliver to the overall healthcare system. We continue to work with stakeholders to ensure access to medicines within an efficient and affordable healthcare system. Adoption of other new legislation at the federal or state level could further affect demand for, or pricing of, our products. In 2017, we may face uncertainties because there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. There is no assurance that the ACA, as currently enacted or as amended in the future, will not adversely affect our business and financial results, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. We will continue to actively work with law makers and advocate for solutions that effectively improve patient health outcomes and lower costs to the healthcare system. Anti-Corruption. The FCPA prohibits U.S. corporations and their representatives from offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations. Outside the United States We encounter similar regulatory and legislative issues in most other countries. New Drug Approvals and Pharmacovigilance. In the EU, the approval of new drugs may be achieved using the Mutual Recognition Procedure, the Decentralized Procedure or the EU Centralized Procedure. These procedures apply in the EU member states, plus the European Economic Area countries, Norway, Iceland and Liechtenstein. The Centralized Procedure, managed by the EMA, results in one single authorization for the whole EU which provides the most rapid and efficient means of gaining approval across the EU and is the one most commonly used for new products. In Japan, the PMDA is the point of entry for businesses looking to sell drugs in the country. The PMDA, which is involved in a wide range of regulatory activities, including clinical studies, approvals, post-marketing reviews and pharmaceuticals safety, must approve an application before a new drug product may be marketed in Japan. The PMDA also offers consultations on clinical trials of new drugs and provides advice on product classifications and approvals. Health authorities in many middle and lower income countries require marketing approval by a recognized regulatory authority (i.e., similar to the authority of the FDA or the EMA) before they begin to conduct their application review process and/or issue their final approval. Many authorities also require local clinical data in the countrys population in order to receive final marketing approval. These requirements delay marketing authorization in those countries relative to the U.S. and Europe. Chinas regulatory system is unique in many ways, and its drug development and registration requirements are not always consistent with U.S. or other international standards. It is common to see treatments entering the Chinese market two to eight years behind first marketing in the U.S. and Europe, because historically China has only issued import drug licenses to treatments approved by a foreign regulatory authority. In addition, to obtain marketing approvals for new drugs in China, a clinical trial authorization issued by the CFDA is required for the conduct of Phase I to III clinical trials. Foreign applicants of imported drugs, if including China-originated data in their Multi-Regional Clinical Trials and meeting the relevant technical review requirements, may receive case-by-case additional local clinical trial waivers. Oral generics, on the other hand, only need to undergo bioequivalence studies upon a filing for record with the CFDA, while sterile injectable generics may need local confirmatory trials for regulatory approval. A Chinese drug license will only be granted if, following review, the CFDA determines that the clinical data confirm the drugs safety and effectiveness. In the EU, there is detailed legislation and guidance on pharmacovigilance, which has been increased and strengthened in recent years. The EMAs Pharmacovigilance Risk Assessment Committee has the responsibility for reviewing and making recommendations on product safety issues for the EU authorities. EU regulators may require pharmaceutical companies to conduct post-authorization safety and efficacy studies at the time of approval, or at any time afterwards in light of scientific developments. There are also additional extensive requirements regarding adverse drug reaction reporting and additional monitoring of products. Outside developed markets such as the EU and Japan, pharmacovigilance requirements vary and are generally not as extensive, but there is a trend toward increasing regulation. Pricing and Reimbursement . In Europe, Japan, China, Canada, South Korea and some other international markets, governments provide healthcare at low direct cost to consumers and regulate pharmaceutical prices or patient reimbursement levels to control costs for the government-sponsored healthcare system, particularly under recent global economic pressures. Governments, including the different EU Member States, may use a variety of cost-containment measures for our pharmaceutical products, including price cuts, mandatory rebates, value-based pricing, and international reference pricing (i.e., the practice of many countries linking their regulated medicine prices to those of other countries). This international patchwork of price regulation and differing economic conditions and assessments of value across countries has led to different prices in different countries and some third-party trade in our products between countries. In particular, international reference pricing adds to the regional impact of price cuts in individual countries and hinders patient access and innovation. Price variations, exacerbated by international reference pricing systems, also have resulted from exchange rate fluctuations. The downward pricing pressure resulting from this dynamic can be expected to continue as a result of reforms to international reference pricing policies and measures targeting pharmaceuticals in some European countries. In addition, several important multilateral organizations, such as the United Nations (UN) and the Organization for Economic Co-operation and Development (OECD), are increasing policy pressures and scrutiny of international pharmaceutical pricing through issuing reports and policy recommendations (e.g., 2016 UN High Level Panel Report on Access to Medicines , and 2017 OECD Report on New Health Technologies Managing Access, Value and Sustainability ). Government adoption of these recommendations may lead to additional pricing pressures. In Japan, the government recently released a basic framework for pharmaceutical pricing that may lead to the adoption of cost effectiveness assessments and pricing reviews. In China, government-set price caps were lifted for the vast majority of drug products on June 1, 2015. However, the government continues to exercise indirect price control by setting reimbursement standards through a negotiation mechanism between drug manufacturers and social insurance administrations. In addition, the CFDA is now asking some companies to enter into pricing commitments as a condition for regulatory approval. EU Regulatory Changes . The EU adopted a new Clinical Trials Regulation in May 2014, which is expected to come into effect by October 2018. This new regulation is aimed at simplifying and harmonizing the governance of clinical trials in the EU and will require increased public posting of clinical trial results. In another effort to increase the public availability of clinical trial results, the EMA adopted a new policy on Publication of Clinical Data for Medicinal Products for Human Use, which became effective January 1, 2015 and is now being actively implemented. Under this policy, the EMA now proactively publishes clinical trial data from application dossiers for new marketing authorizations, including data from trials taking place outside the EU, after the EMA has made a decision on the marketing authorization. The policy includes limited exceptions for commercially confidential information and the exclusion of any protected personal data. Brexit . In June 2016, the U.K. electorate voted in a referendum to leave the EU, which is commonly referred to as Brexit. At present, it is unclear whether the U.K. will remain within, or affiliated to, the EU system of medicines approval and regulation, or separate itself completely. Immediately following Brexit, EU laws are expected to continue to apply until amended or repealed by the U.K. Parliament. It is however probable that the EMA, currently in London, will have to relocate to an EU member state, many of which have already bid to become the new host country. For additional information on Brexit, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. in our 2016 Financial Report . China Regulatory Changes . In an effort to encourage drug innovation and reduce the existing drug approval backlogs, the CFDA unveiled several reform initiatives for Chinas drug approval system. The regulator now divides drugs into new drugs and generics, with the definition for new drugs changed from drugs never marketed in China to drugs that are neither marketed in or outside China. This change in definition creates more incentives for Chinas domestic drug manufacturers than for multinational firms, because imported drugs first marketed outside China are no longer considered new drugs. Furthermore, the revised rules do not clarify whether foreign regulatory approval is still required for imported drug final approval in China. Another major initiative is the piloting of the marketing authorization holder system in ten provinces in China, where the market authorization/drug license holders are no longer required to be the actual manufacturers. The marketing authorization holder system will allow for more flexibilities in contract manufacturing arrangements and asset transfers, but it is not applicable to imported drugs. A number of other policy changes are expected to be able to streamline and accelerate domestic and imported drug approvals in China. These changes include introducing an umbrella clinical trial authorization for all three phases of registration studies (instead of the original phase-by-phase approvals), implementing a filing/recordation system for bioequivalence studies on generics (instead of the original review and approval system), and admitting more types of drugs as innovative drugs eligible for the fast track/green channel approval pathway. Healthcare Provider Transparency and Disclosures. A number of countries have implemented laws requiring (or their industry associations have recommended) disclosure of transfers of value made by pharmaceutical companies to healthcare providers. For example, in 2013, the EFPIA released its disclosure code of transfers of value to healthcare professionals and organizations. The code requires all members of EFPIA, including Pfizer, to disclose transfers of value to healthcare professionals and healthcare organizations beginning in 2016, covering the relevant transfers in 2015. Intellectual Property . The World Trade Organization Agreement on Trade Related Aspects of Intellectual Property (WTO-TRIPS) required participant countries to amend their intellectual property laws to provide patent protection for pharmaceutical products by 2005, with an extension until 2033 for least-developed countries. While we still face patent grant, enforcement and other intellectual property challenges around the world, a number of countries have made improvements. We include stronger patent protection among the factors we consider for continued business expansion in other participant countries. While the global intellectual property environment has improved following WTO-TRIPS and bilateral/multilateral trade agreements, our future business growth depends on further progress in intellectual property protection. In emerging market countries in particular, governments have used intellectual property policies as a tool for reducing the price of imported medicines, as well as to protect their local pharmaceutical industries. There is considerable political and economic pressure to weaken existing intellectual property protection and resist implementation of any further protection, which has led to policies such as more restrictive standards for obtaining patents and more difficult procedures for patenting biopharmaceutical inventions, restrictions on patenting certain types of inventions (e.g., new medical treatment methods), revocation of patents, issuance (and threat of issuance) of compulsory licenses, weak intellectual property enforcement and failure to implement effective regulatory data protection. Our industry advocacy efforts focus on seeking a more balanced business environment for foreign manufacturers, as well as on underscoring the importance of strong intellectual property systems for local innovative industries. Canadas intellectual property regime for drugs provides some level of patent protection and data exclusivity (eight years plus six-month pediatric extension), but it lacks the predictability and stability that otherwise comparable countries provide. Through intense negotiations as part of the Canada/EU Comprehensive Economic Trade Agreement, Canadian authorities reluctantly agreed to introduce a right of appeal, a form of patent term restoration and to elevate the current data protection to a treaty obligation, further aligning its intellectual property regime to the EU. In China, the intellectual property environment has improved, although effective enforcement and adequate legal remedies remain areas of concern. The government has taken steps to protect intellectual property rights in conformity with World Trade Organization provisions, and several companies, including Pfizer, have established RD centers in China due to increased confidence in Chinas intellectual property environment. Despite this, China remained on the U.S. Trade Representatives Priority Watch List for 2016. Further, the standards for patentability in China remain more restrictive than in other major markets, including the U.S., Europe and Japan. Also, while a framework exists for protecting patents for 20 years, enforcement mechanisms are often lacking or inconsistent. For example, the absence of effective patent linkage mechanisms and preliminary injunctions, impractical evidentiary burdens, and heightened sufficiency standards have been used to invalidate patents at the enforcement stage. In Brazil and other Latin American countries, the role of health regulatory authorities in reviewing patents (e.g., National Health Surveillance Agency in Brazil), restrictive patentability rules, ambiguity regarding the term of certain patents and backlogs at patent agencies may limit our ability to protect our products through patents. The lack of regulatory data protection and difficulties in protecting certain types of inventions, such as new medical uses of drug products, may limit the commercial lifespan of some pharmaceutical products. In India, policies favoring compulsory licensing of patents, the increasing tendency of the Indian Patent Office to revoke pharmaceutical patents in opposition proceedings (both pre- and post-grant), and restrictive standards for patentability of pharmaceutical products have made it difficult to safeguard many of our inventions and our investments in innovation. These policies heighten the risk of additional patent challenges targeting innovative pharmaceutical products, especially in areas perceived as being important to the public health of the population. Challenges against Pfizer patents in India are ongoing. In South Korea, the laws and regulations for the patent-regulatory approval linkage system was implemented as part of the U.S.-Korea Free Trade Agreement in 2012. The Korean patent-regulatory approval linkage system includes biologics. ENVIRONMENTAL MATTERS Most of our operations are affected by national, state and/or local environmental laws. We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws. We also are cleaning up environmental contamination from past industrial activity at certain sites. See the Notes to Consolidated Financial Statements Note 17A3. Commitments and ContingenciesLegal ProceedingsCommercial and Other Matters in our 2016 Financial Report. As a result, we incurred capital and operational expenditures in 2016 for environmental compliance purposes and for the clean-up of certain past industrial activity as follows: environment-related capital expenditures $27 million; and other environment-related expenses $126 million. While capital expenditures or operating costs for environmental compliance cannot be predicted with certainty, we do not currently anticipate they will have a material effect on our capital expenditures or competitive position. Climate change presents risks to our operations, including the potential for additional regulatory requirements and associated costs, and the potential for more frequent and severe weather events and water availability challenges that may impact our facilities and those of our suppliers. We cannot provide assurance that physical risks to our facilities and supply chain due to climate change will not occur in the future; however, we have a program for reviewing our vulnerability to these potential risks and we update our assessments periodically. To date, we have concluded that, because of our facility locations, our existing distribution networks and our controls, we do not anticipate that these risks will have a material impact on Pfizer in the near term. TAX MATTERS The discussion of tax-related matters in the Notes to Consolidated Financial Statements Note 5. Tax Matters in our 2016 Financial Report, is incorporated by reference. EMPLOYEES In our innovation-intensive business, our employees are vital to our success. We believe we have good relationships with our employees. As of December 31, 2016 , we employed approximately 96,500 people in our operations throughout the world. DISCLOSURE PURSUANT TO SECTION 219 OF THE IRAN THREAT REDUCTION AND SYRIA HUMAN RIGHTS ACT OF 2012 Section 219 of Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRSHRA) requires disclosure by public companies of certain transactions involving the Government of Iran, as well as entities and individuals designated under Executive Order 13382 and Executive Order 13224 (the Executive Orders). In some instances, ITRSHRA requires companies to disclose these types of transactions, even if they were permissible under U.S. law or were conducted by a non-U.S. affiliate in accordance with the local law under which such entity operates. As a global biopharmaceutical company, we conduct business in multiple jurisdictions throughout the world. During 2016 , our activities included supplying life-saving medicines, medical products and consumer products (Pfizer products) for patient and consumer use in Iran. We ship Pfizer products to Iran, and conduct related activities, in accordance with licenses issued by the U.S. Department of the Treasurys Office of Foreign Assets Control and other U.S. and non-U.S. governmental entities, and in line with our corporate policies. We will continue our global activities to improve the health and well-being of patients and consumers in a manner consistent with applicable laws and our corporate policies. To our knowledge, none of our activities during 2016 are required to be disclosed pursuant to ITRSHRA. Pfizer Inc. 2016 Form 10-K "," ITEM 1A. RISK FACTORS The statements in this Section describe the major risks to our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995. Our disclosure and analysis in this 2016 Form 10-K and in our 2016 Annual Report to Shareholders contain forward-looking statements. From time to time, we also provide forward-looking statements in other materials we release to the public, as well as oral forward-looking statements. Such forward-looking statements involve substantial risks and uncertainties. We have tried, wherever possible, to identify such statements by using words such as will, may, could, likely, ongoing, anticipate, estimate, expect, project, intend, plan, believe, target, forecast, goal, objective, aim and other words and terms of similar meaning or by using future dates in connection with any discussion of, among other things, our anticipated future operating and financial performance, business plans and prospects, in-line products and product candidates, strategic reviews, capital allocation, business-development plans, and plans relating to share repurchases and dividends. In particular, these include statements relating to future actions, business plans and prospects, our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business, the disposition of the Hospira Infusion Systems net assets, prospective products or product approvals, future performance or results of current and anticipated products, sales efforts, expenses, interest rates, foreign exchange rates, the outcome of contingencies, such as legal proceedings, plans relating to share repurchases and dividends, government regulation and financial results, including, in particular, the financial guidance set forth in the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 section in our 2016 Financial Report; the anticipated costs and cost savings, including from our acquisition of Hospira and our cost-reduction/productivity initiatives, set forth in the Costs and ExpensesRestructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives section in our 2016 Financial Report and in the Notes to Consolidated Financial StatementsNote 3. Restructuring Charges and Other Costs Associated with Acquisitions and Cost-Reduction/Productivity Initiatives; the benefits expected from our business development transactions; the planned capital spending set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section in our 2016 Financial Report; and the contributions that we expect to make from our general assets to the Companys pension and postretirement plans during 2017 set forth in the Analysis of Financial Condition, Liquidity and Capital ResourcesSelected Measures of Liquidity and Capital ResourcesContractual Obligations section and in the Notes to Consolidated Financial StatementsNote 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2016 Financial Report. We cannot guarantee that any forward-looking statement will be realized. Achievement of anticipated results is subject to substantial risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements, and you are cautioned not to put undue reliance on forward-looking statements. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or by the rules and regulations of the SEC. You are advised, however, to consult any further disclosures we make on related subjects. Also note that we provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that, individually or in the aggregate, may cause our actual results to differ materially from expected, projected or historical results. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. RISKS RELATED TO OUR BUSINESS, INDUSTRY AND OPERATIONS : MANAGED CARE TRENDS Consolidation among MCOs has increased the negotiating power of MCOs and other private insurers. Private third-party insurers, as well as governments, increasingly employ formularies to control costs by negotiating discounted prices in exchange for formulary inclusion. Failure to obtain or maintain timely or adequate pricing or formulary placement for our products or obtaining such pricing or placement at unfavorable pricing could adversely impact revenue. In addition to formulary tier co-pay differentials, private health insurance companies and self-insured employers have been raising co-payments required from beneficiaries, particularly for branded pharmaceuticals and biotechnology products. This cost shifting has given consumers greater control of medication choices, as they pay for a larger portion of their prescription costs and may cause consumers to favor lower cost generic alternatives to branded pharmaceuticals. MCOs have recently introduced additional measures such as new-to-market blocks, exclusion lists, indication-based pricing, and value-based pricing/contracting to improve their cost containment efforts. Private health insurance companies also are increasingly imposing utilization management tools, such as clinical protocols, requiring prior authorization for a branded product if a generic product is available or requiring the patient to first fail on one or more generic products before permitting access to a branded medicine. As the U.S. payer market concentrates further and as more drugs become available in generic form, biopharmaceutical companies may face greater Pfizer Inc. 2016 Form 10-K pricing pressure from private third-party payers, who will continue to drive more of their patients to use lower cost generic alternatives. GENERIC COMPETITION Competition from manufacturers of generic drugs is a major challenge for our branded products around the world, and the loss or expiration of intellectual property rights can have a significant adverse effect on our revenues. The date at which generic competition commences may be different from the date that the patent or regulatory exclusivity expires. However, upon the loss or expiration of patent protection for one of our products, or upon the at-risk launch (despite pending patent infringement litigation against the generic product) by a generic manufacturer of a generic version of one of our patented products, we can lose the major portion of revenues for that product in a very short period of time, which can adversely affect our business. A number of our products are expected to face significantly increased generic competition over the next few years. Also, generic manufacturers have filed applications with the FDA seeking approval of product candidates that such companies claim do not infringe our patents; these include candidates that would compete with, among other products, Xeljanz and Xtandi . Our licensing and collaboration partners also face challenges by generic drug manufacturers to patents covering several of their products that may impact our licenses or co-promotion rights to such products. In addition, our patent-protected products may face competition in the form of generic versions of competitors branded products that lose their market exclusivity. COMPETITIVE PRODUCTS We cannot predict with accuracy the timing or impact of the introduction of competitive products, including new product entrants, in-line branded products, generic products, private label products, biosimilars and product candidates that treat diseases and conditions similar to those treated by our in-line drugs and drug candidates. The introduction of competitive products can result in erosion of the sales of our existing products and potential sales of products in development, as well as unanticipated product obsolescence. Competitive product launches have occurred in recent years, and certain potentially competitive products are in various stages of development, some of which have been filed for approval with the FDA and with regulatory authorities in other countries. We also produce generic and biosimilar pharmaceutical products that compete with branded products from competitors, as well as other generic and biosimilar manufacturers. The ability to launch a generic or biosimilar pharmaceutical product at or before anticipated generic or biosimilar market formation is important to that products profitability. Prices for products typically decline, sometimes dramatically, following generic market formation, and as additional companies receive approvals to market that product, competition intensifies. If a companys generic or biosimilar product can be first-to-market such that its only competition is the branded drug for a period of time, higher levels of sales and profitability can be achieved until other generic or biosimilar competitors enter the market. With increasing competition in the generic or biosimilar product market, the timeliness with which we can market new generic or biosimilar products will increase in importance. Our success will depend on our ability to bring new products to market quickly. DEPENDENCE ON KEY IN-LINE PRODUCTS We recorded direct product revenues of more than $1 billion for each of eight biopharmaceutical products: Prevnar 13/Prevenar 13 , Lyrica , Enbrel , Ibrance , Lipitor , Viagra , Sutent and the Premarin family of products, as well as more than $1 billion in Alliance revenues (primarily Eliquis ) in 2016. Those products and Alliance revenues accounted for 43% of our total revenues in 2016. If these products or any of our other major products were to become subject to problems such as loss of patent protection (if applicable), changes in prescription growth rates, material product liability litigation, unexpected side effects, regulatory proceedings, publicity affecting doctor or patient confidence, pressure from existing competitive products, changes in labeling or, if a new, more effective treatment should be introduced, the adverse impact on our revenues could be significant. Patents covering several of our best-selling medicines have recently expired or will expire in the next few years (including some of our billion-dollar and previously billion-dollar products), and patents covering a number of our best-selling medicines are, or have been, the subject of pending legal challenges. For example, pursuant to terms of a settlement agreement, certain formulations of Zyvox became subject to generic competition in the U.S. in January 2015. In addition, our revenues could be significantly impacted by the timing and rate of commercial acceptance of key new products. For additional information, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses and Expected Losses of Product Exclusivity section in our 2016 Financial Report. Further, our Alliance revenues will be adversely affected by the termination or expiration of collaboration and co-promotion agreements that we have entered into and that we may enter into from time to time. For additional information on recent losses of collaborations rights, see the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Intellectual Property Rights and Collaboration/Licensing Rights Recent Losses of Collaboration Rights section in our 2016 Financial Report. Pfizer Inc. 2016 Form 10-K RESEARCH AND DEVELOPMENT INVESTMENT The discovery and development of safe, effective new products, as well as the development of additional uses for existing products, are necessary for the continued strength of our businesses. Our product lines must be replenished over time in order to offset revenue losses when products lose their market exclusivity, as well as to provide for earnings growth. Our growth potential depends in large part on our ability to identify and develop new products or new indications for existing products that address unmet medical needs and receive reimbursement from payers, either through internal RD or through collaborations, acquisitions, joint ventures or licensing or other arrangements with third parties. However, balancing current growth, investment for future growth and the delivery of shareholder return remains a major challenge. The average costs of product development continue to rise, as do the regulatory requirements in many therapeutic areas, which may affect the number of candidates funded as well as the sustainability of the RD portfolio. Our ongoing investments in new product introductions and in RD for new products and existing product extensions could exceed corresponding sales growth. Additionally, our RD investment plans and resources may not be correctly matched between science and markets, and failure to invest in the right technology platforms, therapeutic segments, product classes, geographic markets and/or in-licensing and out-licensing opportunities in order to deliver a robust pipeline could adversely impact the productivity of our pipeline. Further, even if the areas with the greatest market attractiveness are identified, the science may not work for any given program despite the significant investment required for RD, and the commercial potential of the product may not be as competitive as expected because of the highly dynamic market environment and the hurdles in terms of access and reimbursement. We continue to strengthen our global RD organization and pursue strategies intended to improve innovation and overall productivity in RD to achieve a sustainable pipeline that will deliver value in the near term and over time. There can be no assurance that these strategies will deliver the desired result, which could affect profitability in the future. BIOTECHNOLOGY PRODUCTS Abbreviated legal pathways for the approval of biosimilars exist in certain international markets and, since the passage of the ACA, a framework for such approval exists in the U.S. If competitors are able to obtain marketing approval for biosimilars referencing our biotechnology products, our biotechnology products may become subject to competition from these biosimilars, with attendant competitive pressure, and price reductions could follow. The expiration or successful challenge of applicable patent rights could trigger this competition, assuming any relevant exclusivity period has expired. We may face litigation with respect to the validity and/or scope of patents relating to our biotechnology products. We are developing biosimilar medicines. The evolving pathway for registration and approval of biosimilar products by the FDA and regulatory authorities in certain other countries could diminish the value of our investments in biosimilars. Other risks related to our development of biosimilars include the potential for steeper than anticipated price erosion due to increased competitive intensity, coupled with high costs associated with clinical development or intellectual property challenges that may preclude timely commercialization of our potential biosimilar products. There is also a risk of lower prescriptions of biosimilars due to potential concerns over comparability with innovator medicines. RESEARCH STUDIES Decisions about research studies made early in the development process of a drug or vaccine candidate can have a substantial impact on the marketing strategy and payer reimbursement possibilities if it receives regulatory approval. For example, a wider range of studies can lead to approval for a broader set of indications that may impact the marketing and payer reimbursement process. However, each additional indication must be balanced against the time and resources required to demonstrate benefit, the increased complexity of development and the potential delays to approval of the lead indication. We try to plan clinical trials prudently and to reasonably anticipate and address challenges, but there is no guarantee that an optimal balance between trial conduct, speed and desired outcome will be achieved each time. The degree to which such potential challenges are foreseen and addressed could affect our future results. RISKS AFFECTING INTERNATIONAL OPERATIONS Our international operations could be affected by currency fluctuations, capital and exchange controls, expropriation and other restrictive government actions, changes in intellectual property legal protections and remedies, trade regulations and procedures and actions affecting approval, production, pricing, and marketing of, reimbursement for and access to our products, as well as by political unrest, unstable governments and legal systems and inter-governmental disputes. Any of these changes could adversely affect our business. Many emerging markets have experienced growth rates in excess of developed markets, leading to an increased contribution to the industrys global performance. As a result, we have been employing strategies to grow in emerging markets, including the full integration of emerging markets into each of our two distinct operating segments: IH and EH. However, there is no assurance that our strategies in emerging markets will be successful or that these countries will continue to sustain these growth rates. In addition, some emerging market countries may be particularly vulnerable to periods of financial or political instability or significant currency fluctuations or may have limited resources for healthcare spending. Even though we constantly Pfizer Inc. 2016 Form 10-K monitor the evolving emerging markets for any unanticipated risk to Pfizer, certain financial or political events in such markets, as discussed above, can adversely affect our results. SPECIALTY PHARMACEUTICALS Specialty pharmaceuticals are medicines that treat rare or life-threatening conditions that typically have smaller patient populations. The growing availability and use of innovative specialty pharmaceuticals, combined with their relative higher cost as compared to other types of pharmaceutical products, has generated payer interest in developing cost-containment strategies targeted to this sector. While the impact of payers efforts to control access to and pricing of specialty pharmaceuticals has had limited impact on Pfizer to date, a number of factors may lead to a more significant adverse business impact in the future given our growing specialty business portfolio. These include the increasing use of health technology assessments in markets around the world, U.S. PBMs seeking to negotiate greater discounts, deteriorating finances of certain governments, the uptake of biosimilars as they become available and efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products. CONSUMER HEALTHCARE The Consumer Healthcare business may be impacted by economic volatility, the timing and severity of the cough, cold and flu season, generic or store brand competition affecting consumer spending patterns and market share gains of competitors branded products or generic store brands. In addition, regulatory and legislative outcomes regarding the safety, efficacy or unintended uses of specific ingredients in our Consumer Healthcare products may require withdrawal, reformulation and/or relabeling of certain products (e.g., cough/cold products). See The Global Economic Environment risk factor below. PRODUCT MANUFACTURING AND MARKETING RISKS Difficulties or delays in product manufacturing or marketing could affect future results through regulatory actions, shut-downs, approval delays, withdrawals, recalls, penalties, supply disruptions or shortages, reputational harm, product liability, unanticipated costs or otherwise. Examples of such difficulties or delays include, but are not limited to, the inability to increase production capacity commensurate with demand; the failure to predict market demand for, or to gain market acceptance of, approved products; the possibility that the supply of incoming materials may be delayed or become unavailable and that the quality of incoming materials may be substandard and not detected; the possibility that we may fail to maintain appropriate quality standards throughout the internal and external supply network and/or comply with cGMPs and other applicable regulations such as serialization (which allows for track and trace of products in the supply chain to enhance patient safety); risks to supply chain continuity as a result of natural or man-made disasters at our facilities or at a supplier or vendor, including those that may be related to climate change; or failure to maintain the integrity of our supply chains against intentional and criminal acts such as economic adulteration, product diversion, product theft, and counterfeit goods. Regulatory agencies periodically inspect our drug manufacturing facilities to ensure compliance with applicable cGMP requirements. Failure to comply with these requirements may subject us to possible legal or regulatory actions, such as warning letters, suspension of manufacturing, seizure of product, injunctions or voluntary recall of a product, any of which could have a material adverse effect on our business, financial condition and results of operations. In February 2017, we received a warning letter from the FDA communicating FDAs view that certain violations of cGMP regulations exist at Hospiras manufacturing facility in McPherson, Kansas. Hospira is undertaking corrective actions to address the concerns raised by the FDA. Communication with the FDA is ongoing. Until the violations are corrected, the FDA may refuse to grant premarket approval applications and/or the FDA may refuse to grant export certificates related to products manufactured at McPherson, Kansas. OUTSOURCING AND ENTERPRISE RESOURCE PLANNING We outsource certain services to third parties in areas including transaction processing, accounting, information technology, manufacturing, clinical trial execution, clinical lab services, non-clinical research, safety services, integrated facilities management and other areas. For example, in 2016, we placed the majority of our clinical trial execution services with four strategic Clinical Research Organizations (CROs). Service performance issues with these CROs may adversely impact the progression of our clinical trial programs. Outsourcing of services to third parties could expose us to sub-optimal quality of service delivery or deliverables, which may result in repercussions such as missed deadlines or other timeliness issues, erroneous data, supply disruptions, non-compliance (including with applicable legal requirements and industry standards) or reputational harm, with potential negative implications for our results. We continue to pursue a multi-year initiative to outsource some transaction-processing activities within certain accounting processes and are migrating to a consistent enterprise resource planning system across the organization. These are enhancements of ongoing activities to support the growth of our financial shared service capabilities and standardize our financial systems. If any difficulties in the migration to or in the operation of our enterprise resource planning system were to occur, they could adversely affect our operations, including, among other ways, through a failure to meet demand for our products, or adversely affect our ability to meet our financial reporting obligations. Pfizer Inc. 2016 Form 10-K COLLABORATIONS AND OTHER RELATIONSHIPS WITH THIRD PARTIES We depend on third-party collaborators, service providers, and others in the development and commercialization of our products and product candidates and also enter into joint ventures and other business development transactions in connection with our business. To achieve expected longer term benefits, we may make substantial upfront payments in such transactions, which may negatively impact our reported earnings. We rely heavily on these parties for multiple aspects of our drug development and commercialization activities, but we do not control many aspects of those activities. Third parties may not complete activities on schedule or in accordance with our expectations. Failure by one or more of these third parties to meet their contractual, regulatory or other obligations to Pfizer, or any disruption in the relationships between Pfizer and these third parties, could delay or prevent the development, approval or commercialization of our products and product candidates and could also result in non-compliance or reputational harm, all with potential negative implications for our product pipeline and business. DIFFICULTIES OF OUR BIOPHARMACEUTICAL WHOLESALERS In 2016, our largest biopharmaceutical wholesaler accounted for approximately 16% of our total revenues (and approximately 31% of our total U.S. revenues), and our top three biopharmaceutical wholesalers accounted for approximately 39 % of our total revenues (and approximately 76 % of our total U.S. revenues). If one of our significant biopharmaceutical wholesalers should encounter financial or other difficulties, such wholesaler might decrease the amount of business that it does with us, and we might be unable to collect all the amounts that the wholesaler owes us on a timely basis or at all, which could negatively impact our results of operations. BUSINESS DEVELOPMENT ACTIVITIES We expect to continue to enhance our in-line products and product pipeline through collaborations, alliances, licenses, joint ventures, equity- or debt-based investments, mergers and acquisitions. However, these enhancement plans are subject to the availability and cost of appropriate opportunities, competition from other pharmaceutical companies that are seeking similar opportunities and our ability to successfully identify, structure and execute transactions, including the ability to satisfy the conditions to closing of announced transactions in the anticipated timeframe or at all, and integrate acquisitions. Further, while we seek to mitigate risks and liabilities of such transactions through, among other things, due diligence, there may be risks and liabilities that such due diligence efforts fail to discover, that are not disclosed to us, or that we inadequately assess. Additionally, we may not realize the anticipated benefits of such transactions, including the possibility that expected synergies and accretion will not be realized or will not be realized within the expected time frame. COUNTERFEIT PRODUCTS A counterfeit medicine is one that has been deliberately and fraudulently mislabeled as to its identity and source. A counterfeit Pfizer medicine, therefore, is one manufactured by someone other than Pfizer, but which appears to be the same as an authentic Pfizer medicine. The prevalence of counterfeit medicines is a significant and growing industry-wide issue due to a variety of factors, including, but not limited to, the following: the widespread use of the Internet, which has greatly facilitated the ease by which counterfeit medicines can be advertised, purchased and delivered to individual patients; the availability of sophisticated technology that makes it easier for counterfeiters to make counterfeit medicines; the growing involvement in the medicine supply chain of under-regulated wholesalers and repackagers; the lack of adequate inspection at certain international postal facilities as counterfeit medicines are increasingly delivered direct to customers in small parcel packages; and the relatively modest risk of penalties faced by counterfeiters. Further, laws against pharmaceutical counterfeiting vary greatly from country to country, and the enforcement of existing law varies greatly from jurisdiction to jurisdiction. For example, in some countries, pharmaceutical counterfeiting is not a crime; in others, it may result in only minimal sanctions. In addition, those involved in the distribution of counterfeit medicines use complex transport routes in order to evade customs controls by disguising the true source of their products. Pfizers global reputation makes its medicines prime targets for counterfeiting organizations. Counterfeit medicines pose a risk to patient health and safety because of the conditions under which they are manufacturedoften in unregulated, unlicensed, uninspected and unsanitary sitesas well as the lack of regulation of their contents. Failure to mitigate the threat of counterfeit medicines, which is exacerbated by the complexity of the supply chain, could adversely impact our business, by, among other things, causing the loss of patient confidence in the Pfizer name and in the integrity of our medicines, potentially resulting in lost sales, product recalls, and an increased threat of litigation. We undertake significant efforts to counteract the threats associated with counterfeit medicines, including, among other things, working with the FDA and other regulatory authorities and multinational coalitions to combat the counterfeiting of medicines and supporting efforts by law enforcement authorities to prosecute counterfeiters; assessing new and existing technologies to seek to make it more difficult for counterfeiters to copy our products and easier for patients and healthcare providers to distinguish authentic from counterfeit medicines; implementing business practices designed to protect patient health; promoting public policies intended to hinder counterfeiting; working diligently to raise public awareness about the dangers of counterfeit medicines; and working collaboratively with wholesalers, pharmacies, customs offices, and law enforcement agencies to increase inspection coverage, monitor distribution channels, and improve surveillance of distributors and repackagers. No Pfizer Inc. 2016 Form 10-K assurance can be given, however, that our efforts and the efforts of others will be entirely successful, and the presence of counterfeit medicines may continue to increase. RISKS RELATED TO GOVERNMENT REGULATION AND LEGAL PROCEEDINGS : PRICING AND REIMBURSEMENT U.S. and international governmental regulations that mandate price controls and limitations on patient access to our products or establish prices paid by government entities or programs for our products impact our business, and our future results could be adversely affected by changes in such regulations or policies. In the U.S., many of our products are subject to increasing pricing pressures. Pharmaceutical product pricing is subject to enhanced government and public scrutiny and calls for reform. Some states have implemented, and other states are considering, pharmaceutical price controls or patient access constraints under the Medicaid program, and some states are considering price-control regimes that would apply to broader segments of their populations that are not Medicaid-eligible. Additionally, efforts by government officials or legislators to implement measures to regulate prices or payment for pharmaceutical products could adversely affect our business if implemented. Private third-party payers, such as health plans, increasingly challenge pharmaceutical product pricing, which could result in lower prices, lower reimbursement rates and a reduction in demand for our products. Pricing pressures for our products may occur as a result of highly competitive insurance markets. Healthcare provider purchasers, directly or through group purchasing organizations, are seeking enhanced discounts or implementing more rigorous bidding or purchasing review processes. We encounter similar regulatory and legislative issues in most other countries. In certain international markets, such as Europe, Japan, China, Canada and South Korea, governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control, particularly under recent global financing pressures. As a result, we expect that pressures on the pricing component of operating results will continue. The adoption of restrictive price controls in new jurisdictions or more restrictive ones in existing jurisdictions, failure to obtain timely or adequate government-approved pricing or formulary placement where required for our products or obtaining such pricing or placement at unfavorable pricing could also adversely impact revenue. In our vaccines business, we participate in a tender process in many countries for participation in national immunization programs. Failure to secure participation in national immunization programs or to obtain acceptable pricing in the tender process could adversely affect our business. U.S. HEALTHCARE REFORM/HEALTHCARE LEGISLATION The U.S. healthcare industry is highly regulated and subject to frequent and substantial changes. For example, the ACA was enacted by Congress in March 2010 and established a major expansion of health care coverage, financed in part by a number of new rebates, discounts, and taxes that had a significant effect on our expenses and profitability. See the discussion under the Overview of Our Performance, Operating Environment, Strategy and Outlook Our Operating Environment Industry-Specific Challenges Regulatory Environment/Pricing and Access U.S. Healthcare Legislation section in our 2016 Financial Report and in Item 1. Business under the caption Government Regulation and Price ConstraintsIn the United States . In 2017, we may face uncertainties because there likely will be federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the ACA. Although the revenues generated for Pfizer by the Medicaid expansion and health insurance exchanges under the ACA have been exceeded by the new rebates, discounts, and taxes, there is no assurance that repeal or replacement of the ACA will not adversely affect our business and financial results, particularly if replacement legislation reduces incentives for employer-sponsored insurance coverage, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business. Other U.S. federal or state legislative or regulatory action and/or policy efforts could adversely affect our business, including, among others, changes in patent laws, the importation of prescription drugs from outside the U.S. at prices that are regulated by governments of various foreign countries (which is among the U.S. presidential administrations policy proposals), restrictions on U.S. direct-to-consumer advertising, limitations on interactions with healthcare professionals, or the use of comparative effectiveness methodologies that could be implemented in a manner that focuses primarily on cost differences and minimizes the therapeutic differences among pharmaceutical products and restricts access to innovative medicines. U.S. DEFICIT-REDUCTION ACTIONS In the U.S., government actions to reduce the national deficit may affect payment by government programs for our products or services provided using our products. The Congressional Budget Office routinely releases options for reducing the federal deficit, and the December 2016 release includes proposals to cap Medicaid grants to the states, and to require manufacturers to pay a minimum rebate on drugs covered under part D of Medicare for low-income beneficiaries. Significant Medicare reductions could also result if Congress proceeds with certain proposals to convert the Medicare fee-for-service program into a premium support program, or it chooses to implement the recommendations made annually by the Medicare Payment Advisory Commission, which are primarily intended to extend the fiscal solvency of the Medicare program. These and any other significant spending reductions or cost controls affecting Medicare, Medicaid or other publicly funded or subsidized health Pfizer Inc. 2016 Form 10-K programs that may be implemented, and/or any significant additional taxes or fees that may be imposed on us, as part of any broad deficit-reduction effort could have an adverse impact on our results of operations. SUBSTANTIAL REGULATION We are subject to extensive, complex, costly and evolving regulation by federal and state governmental authorities in the U.S., principally by the FDA and the DEA, and foreign regulatory authorities. Failure to comply with all applicable regulatory requirements may subject us to operating restrictions and criminal prosecution, monetary penalties and other disciplinary actions, including, sanctions, warning letters, product seizures, recalls, fines, injunctions, suspension, revocation of approvals, or exclusion from future participation in government healthcare programs. DEVELOPMENT, REGULATORY APPROVAL AND MARKETING OF PRODUCTS Innovation is critical to the success of our company. The outcome of the lengthy and complex process of identifying new compounds and developing new products is inherently uncertain and involves a high degree of risk and cost. Drug discovery and development is time-consuming, expensive and unpredictable. The process from early discovery or design to development to regulatory approval can take many years. Drug candidates can and do fail at any stage of the process, including as the result of unfavorable pre-clinical and clinical trial results, including unfavorable new clinical data and additional analyses of existing clinical data. There can be no assurance regarding our ability to meet anticipated pre-clinical and clinical trial commencement and completion dates, regulatory submission and approval dates, and launch dates for product candidates, or as to whether or when we will receive regulatory approval for new products or for new indications or dosage forms for existing products, which will depend on the assessment by regulatory authorities of the benefit-risk profile suggested by the totality of the efficacy and safety information submitted. Decisions by regulatory authorities regarding labeling, ingredients and other matters could adversely affect the availability or commercial potential of our products. There is no assurance that we will be able to address the comments in complete response letters received by us with respect to certain of our drug applications to the satisfaction of the FDA, that any of our late stage pipeline products will receive regulatory approval and/or be commercially successful or that recently approved products will be approved in other markets and/or be commercially successful. There is also a risk that we may not adequately address existing regulatory agency findings concerning the adequacy of our regulatory compliance processes and systems or implement sustainable processes and procedures to maintain regulatory compliance and to address future regulatory agency findings, should they occur. In addition, there are risks associated with interim data, including the risk that final results of studies for which interim data have been provided and/or additional clinical trials may be different from (including less favorable than) the interim data results and may not support further clinical development of the applicable product candidate or indication. There are many considerations that can affect the marketing of our products around the world. Regulatory delays, the inability to successfully complete or adequately design and implement clinical trials within the anticipated quality, time and cost guidelines or in compliance with applicable regulatory expectations, claims and concerns about safety and efficacy, new discoveries, patent disputes and claims about adverse side effects are a few of the factors that can adversely affect our business. Further, claims and concerns about safety and efficacy can result in a negative impact on product sales, product recalls or withdrawals, and/or consumer fraud, product liability and other litigation and claims. Increasing regulatory scrutiny of drug safety and efficacy, with regulatory authorities increasingly focused on product safety and the risk/benefit profile of products as they relate to already-approved products, has resulted in a more challenging, expensive and lengthy regulatory approval process due to requests for, among other things, additional clinical trials prior to granting approval or increased post-approval requirements, such as risk evaluation and mitigation strategies. In addition, failure to put in place adequate controls and/or resources for effective collection, reporting and management of adverse events from clinical trials and post-marketing surveillance, in compliance with current and evolving regulatory requirements could result in risks to patient safety, regulatory actions and risks to product sales. The FDA, along with other regulatory agencies around the world, has been experiencing a backlog of generic drug applications, which has delayed approvals of new generic products. These delays have become longer, and while the FDA has stated that it is taking steps to address the backlog of pending applications, continued approval delays may be experienced by generic drug applicants over the next few years. POST-APPROVAL DATA As a condition to granting marketing approval of a product, the FDA may require a company to conduct additional clinical trials. The results generated in these Phase 4 trials could result in the loss of marketing approval, changes in product labeling, and/or new or increased concerns about the side effects or efficacy of a product. Regulatory agencies in countries outside the U.S. often have similar authority and may impose comparable requirements. Post-marketing studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other emerging data about marketed products, such as adverse event reports, may also adversely affect the availability or commercial potential of our products. Further, the discovery of significant problems with a product similar to one of our products that implicate (or are perceived to implicate) an entire class of products could have an adverse effect on the availability or commercial potential of the affected products. Accordingly, new data about our products, or products similar to our products, could negatively impact demand for our products due to real or Pfizer Inc. 2016 Form 10-K perceived side effects or uncertainty regarding efficacy and, in some cases, could result in updated labeling, restrictions on use, product withdrawal or recall. INTERACTIONS WITH HEALTHCARE PROFESSIONALS AND GOVERNMENT OFFICIALS Risks and uncertainties apply if we provide something of value to a healthcare professional and/or government official. If the interaction is found to be improper, government enforcement actions and penalties could result. These risks may increase as non-U.S. jurisdictions adopt or increase enforcement efforts of new anti-bribery laws and regulations. CHANGES IN LAWS AND ACCOUNTING STANDARDS Our future results could be adversely affected by changes in interpretations of existing laws and regulations, or changes in laws and regulations, including, among others, changes in accounting standards, taxation requirements (including tax rate changes, new tax laws, changes to existing tax laws and revised tax law and regulatory interpretations, including changes affecting the taxation by the U.S. of income earned outside the U.S. that may result from pending and possible future proposals), competition laws, privacy laws and environmental laws in the U.S. and other countries. For additional information, see the Provision for Taxes on Income Changes in Tax Law and New Accounting Standards sections, and Notes to Consolidated Financial Statements Note 1B. Basis of Presentation and Significant Accounting Policies: Adoption of New Accounting Standards in our 2016 Financial Report. LEGAL PROCEEDINGS We and certain of our subsidiaries are involved in various patent, product liability, consumer, commercial, securities, antitrust, environmental, employment and tax litigations and claims, government investigations and other legal proceedings that arise from time to time in the ordinary course of our business. Litigation is inherently unpredictable, and excessive verdicts do occur. Although we believe we have substantial defenses in these matters, we could in the future incur judgments, enter into settlements of claims or revise our expectations regarding the outcomes of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid. Claims against our patents include challenges to the coverage and/or validity of our patents on various products or processes. Although we believe we have substantial defenses to these challenges with respect to all of our material patents, there can be no assurance as to the outcome of these matters, and a loss in any of these cases could result in a loss of patent protection for the product at issue, which could lead to a significant loss of sales of that product and could materially affect future results of operations. Like other pharmaceutical companies, we are subject to investigations and extensive regulation by government agencies in the U.S., other developed markets and multiple emerging markets in which we operate. As a result, we have interactions with government agencies on an ongoing basis. Criminal charges, and substantial fines and/or civil penalties, as well as limitations on our ability to conduct business in applicable jurisdictions, could result from government investigations. Our activities relating to the sale and marketing and the pricing of our products are subject to extensive regulation under the FFDCA, the Medicaid Drug Rebate Program, the FCPA and other federal and state statutes, including those discussed elsewhere in this 2016 Form 10-K, as well as anti-kickback and false claims laws, and similar laws in international jurisdictions. Like many companies in our industry, we have from time to time received inquiries and subpoenas and other types of information demands from government authorities, and been subject to claims and other actions related to our business activities brought by governmental authorities, as well as by consumers and private payers. In some instances, we have incurred significant expense, civil payments, fines and other adverse consequences as a result of these claims, actions and inquiries. For example, these claims, actions and inquiries may relate to alleged failures to accurately interpret or identify or prevent non-compliance with the laws and regulations associated with the dissemination of product information (approved and unapproved), potentially resulting in government enforcement and damage to our reputation. This risk may be heightened by digital marketing, including social media, mobile applications and blogger outreach. ENVIRONMENTAL CLAIMS AND PROCEEDINGS We and certain of our subsidiaries are subject to numerous contingencies arising in the ordinary course of business relating to environmental claims and proceedings. Amounts recorded for contingencies can result from a complex series of judgments about future events and uncertainties and can rely heavily on estimates and assumptions. While we have accrued for worldwide environmental liabilities, there is no guarantee that additional costs will not be incurred beyond the amounts accrued. If we fail to properly manage the safety of our facilities and the environmental risks associated therewith or if we are required to increase our accruals for contingencies for environmental claims and proceedings in the future, it could potentially have an adverse effect on our results of operations. Pfizer Inc. 2016 Form 10-K RISKS RELATED TO INTELLECTUAL PROPERTY : PATENT PROTECTION Our long-term success largely depends on our ability to market technologically competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate intellectual property protection, we may not be able to prevent third parties from launching generic versions of our branded products, using our proprietary technologies or from marketing products that are very similar or identical to ours. Our currently pending or future patent applications may not result in issued patents, or be granted on a timely basis. Similarly, any term extensions that we seek may not be granted on a timely basis, if at all. In addition, our issued patents may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area. The scope of our patent claims also may vary between countries, as individual countries have distinct patent laws. We may be subject to challenges by third parties regarding our intellectual property, including, among others, claims regarding validity, enforceability, scope and effective term. Our ability to enforce our patents also depends on the laws of individual countries and each countrys practice with respect to enforcement of intellectual property rights, and the extent to which certain sovereigns may seek to engage in a policy of routine compulsory licensing of pharmaceutical intellectual property as a result of local political pressure or in the case of national emergencies. In countries that provide some form of regulatory exclusivity, mechanisms exist permitting some form of challenge to our patents by competitors or generic drug marketers prior to or immediately following the expiration of such regulatory exclusivity, and generic companies are increasingly employing aggressive strategies, such as at risk launches to challenge our patent rights. Most of the suits by generic drug manufacturers involve claims that patents covering our products, processes or dosage forms are invalid and/or do not cover the product of the generic drug manufacturer. Also, counterclaims, as well as various independent actions, have been filed alleging that our assertions of, or attempts to enforce, patent rights with respect to certain products constitute unfair competition and/or violations of antitrust laws. We are also party to other patent damages suits in various jurisdictions pursuant to which generic drug manufacturers, payers, governments or other parties are seeking damages from us for alleged delay of generic entry. Further, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements expire or are terminated, our operating results and financial condition could be materially adversely affected. Likewise, in the U.S. and other countries, we currently hold issued trademark registrations and have trademark applications pending, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks and trade dress to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering or using trademarks and trade dress that infringe, dilute or otherwise violate our trademark rights, our business could be materially adversely affected. We actively seek to protect our proprietary information, including our trade secrets and proprietary know-how, by requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization, and legal remedies in some countries may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise. THIRD PARTY INTELLECTUAL PROPERTY CLAIMS A properly functioning intellectual property regime is essential to our business model. We are committed to respecting the valid intellectual property rights of other companies, but the patent granting process is imperfect. Accordingly, the pursuit of valid business opportunities may require us to challenge intellectual property rights held by other companies that we believe were improperly granted. Such challenges may include negotiation and litigation, which may not be successful. Part of our EH business depends upon successfully identifying generic pharmaceutical product and biosimilar opportunities and launching products to take advantage of those opportunities, which may involve litigation, associated costs and time delays, and may ultimately not be successful. These opportunities may arise in situations where patent protection of equivalent branded products has expired, where patents have been declared invalid, or where products do not infringe the patents of others. To achieve a first-to-market or early market position for generic pharmaceutical products and biosimilars, we may take action, such as litigation, asserting that our products do not infringe patents of existing products or that those patents are invalid or unenforceable. Third parties may claim that our products infringe one or more patents owned or controlled by the third party. Claims of intellectual property infringement can be costly and time-consuming to resolve, may delay or prevent product launches, and may result in significant damages. We are involved in patent-related disputes with third parties over our attempts to market generic pharmaceutical products and biosimilars. Once we have final regulatory approval of the related generic Pfizer Inc. 2016 Form 10-K pharmaceuticals products or biosimilars, we may decide to commercially market these products even though associated legal proceedings (including any appeals) have not been resolved (i.e., at-risk launch). If those proceedings ultimately determine that our products infringe the patent rights of third parties, we may face patent infringement damages, including the possibility of owing the third party a reasonable royalty or the lost profits from the sale of the branded product. Remedies also may include or consist of an injunction preventing us from further manufacture or sales of the affected product during the term of one or more of the valid, infringed patents. Any of these adverse consequences could have a material adverse effect on our profitability and financial condition. RISK RELATED TO TECHNOLOGY : INFORMATION TECHNOLOGY AND SECURITY Significant disruptions of information technology systems or breaches of information security could adversely affect our businesses. We rely to a large extent upon sophisticated information technology systems to operate our businesses. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including, but not limited to, personal information and intellectual property), and we deploy and operate an array of technical and procedural controls to maintain the confidentiality and integrity of such confidential information. We also have outsourced significant elements of our operations to third parties, including significant elements of our information technology infrastructure and, as a result, we are managing many independent vendor relationships with third parties who may or could have access to our confidential information. The size and complexity of our information technology and information security systems, and those of our third-party vendors with whom we contract (and the large amounts of confidential information that is present on them), make such systems potentially vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including, but not limited to, industrial espionage) and expertise, including organized criminal groups, hacktivists, nation states and others. As a global pharmaceutical company, our systems are subject to frequent attacks. Due to the nature of some of these attacks, there is a risk that they may remain undetected for a period of time. While we have invested in the protection of data and information technology, there can be no assurance that our efforts will prevent service interruptions or security breaches. Any such interruption or breach of our systems could adversely affect our business operations and/or result in the loss of critical or sensitive confidential information or intellectual property, and could result in financial, legal, business and reputational harm to us. We maintain cyber liability insurance; however this insurance may not be sufficient to cover the financial, legal, business or reputational losses that may result from an interruption or breach of our systems. RISKS RELATED TO OUR STRATEGIC TRANSACTIONS : STRATEGIC ACQUISITIONS The success of our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business will depend, in large part, on our ability to realize anticipated benefits from combining these businesses with Pfizer. We, for example, may fail to achieve cost savings anticipated with the acquisition of Hospira, or such cost savings within the expected time frame. Similarly, the accretive impact anticipated from the acquisitions of Hospira, Anacor and Medivation may not be realized or may be delayed. Integration of these businesses may result in the loss of key employees, the disruption of ongoing business, including third-party relationships, or inconsistencies in standards, controls, procedures and policies. We also may fail to generate the revenue growth for the acquired business that we expected at the time of entering into the transaction. Expected revenue from acquired products and product candidates also may be constrained by developments outside of our control. Unsuccessful clinical trials, regulatory hurdles and commercialization challenges regularly adversely impact revenue and income contribution from products and product candidates, including those acquired in these acquisitions. Hospira, for example, has experienced manufacturing disruptions, device remediations and substantial regulatory scrutiny due to quality issues, including receiving a warning letter from the FDA in February 2017 communicating FDA s view that certain violations of cGMP regulations exist at Hospira s manufacturing facility in McPherson, Kansas. Manufacturing problems, as well as any corrective actions and their operational implementation, could adversely impact the revenue we generate from products acquired from Hospira and result in substantial unanticipated costs. OTHER RISKS: THE GLOBAL ECONOMIC ENVIRONMENT Like all businesses, we are exposed to both global and industry-specific economic conditions. Governments, corporations and insurance companies, which provide insurance benefits to patients, have implemented increases in cost-sharing and restrictions on access to medicines, potentially causing patients to switch to generic products, delay treatments, skip doses or use less effective treatments. Government financing pressures can lead to negative pricing pressure in various markets where governments take an active role in setting prices, access criteria (e.g., through public or private health technology assessments), or other means of cost control. Examples include Europe, Japan, China, Canada, South Korea and a number of other international markets. The U.S. continues to maintain competitive insurance markets, but has also seen significant Pfizer Inc. 2016 Form 10-K increases in patient cost-sharing and growing government influence as government programs continue to grow as a source of coverage. The global economic environment has not had, nor do we anticipate that it will have, a material impact on our liquidity or capital resources. Due to our significant operating cash flows, financial assets, access to capital markets and available lines of credit and revolving credit agreements, we continue to believe that we have, and will maintain, the ability to meet our liquidity needs for the foreseeable future. We monitor our liquidity position continuously in the face of evolving economic conditions, but there can be no guarantee that changes in global financial markets and global economic conditions will not affect our liquidity or capital resources or impact our ability to obtain financing in the future. We continue to monitor credit, capital restrictions and economic situations in volatile regions and markets, especially where the ability to obtain U.S. dollars for local currency is unpredictable and challenging. We cannot predict the likelihood of future changes in these economic conditions, or what impact they may have on our results of operations, financial condition or business. In addition, given that a significant portion of our business is conducted in the EU, including the U.K., the formal change in the relationship between the U.K. and the EU caused by Brexit may pose certain implications to our research, commercial and general business operations in the U.K. and the EU. Details on how Brexit will be executed and the impact on the remaining EU countries will dictate how and whether the broader EU will be impacted and what the resulting impact on our business may be, especially in EU nations with weaker economic conditions such as Greece. For additional information, see the Analysis of Financial Condition, Liquidity and Capital Resources Global Economic Conditions U.K. section in our 2016 Financial Report. We also continue to monitor the global trade environment and potential trade conflicts. If trade restrictions reduce global economic activity, or if other factors lead to a general economic downturn, potential impacts could include declining sales; increased costs; volatility in foreign exchange rates; a decline in the value of our financial assets and pension plan investments; required increases of our pension funding obligations; increased government cost control efforts; delays or failures in the performance of customers, suppliers, and other third parties on whom we may depend for the performance of our business; and the risk that our allowance for doubtful accounts may not be adequate. FOREIGN EXCHANGE AND INTEREST RATE RISK Significant portions of our revenues and earnings, as well as our substantial international net assets, are exposed to changes in foreign exchange rates. 50% of our total 2016 revenues were derived from international operations, including 21% from Europe and 20% from Japan and the rest of Asia. As we operate in multiple foreign currencies, including the euro, the Japanese yen, the Chinese renminbi, the U.K. pound, the Canadian dollar and approximately 100 other currencies, changes in those currencies relative to the U.S. dollar will impact our revenues and expenses. If the U.S. dollar were to weaken against another currency, assuming all other variables remained constant, our revenues would increase, having a positive impact on earnings, and our overall expenses would increase, having a negative impact on earnings. Conversely, if the U.S. dollar were to strengthen against another currency, assuming all other variables remained constant, our revenues would decrease, having a negative impact on earnings, and our overall expenses would decrease, having a positive impact on earnings. Therefore, significant changes in foreign exchange rates, including those changes resulting from the volatility following the U.K. referendum in which voters approved Brexit, can impact our results and our financial guidance. The impact of possible currency devaluations in countries experiencing high inflation rates or significant exchange fluctuations can impact our results and financial guidance. For additional information about our exposure to foreign currency risk, see the Overview of Our Performance, Operating Environment, Strategy and OutlookOur Financial Guidance for 2017 and Analysis of Financial Condition, Liquidity and Capital Resources sections in our 2016 Financial Report. In addition, our interest-bearing investments and borrowings, and our pension benefit obligations, net, and our postretirement benefit obligations, net, are subject to risk from changes in interest rates and foreign exchange rates. These risks and the measures we have taken to help contain them are discussed in the Forward-Looking Information and Factors That May Affect Future Results Financial Risk Management section in our 2016 Financial Report. For additional details, see the Notes to Consolidated Financial Statements Note 7E. Financial Instruments: Derivative Financial Instruments and Hedging Activities and Note 11. Pension and Postretirement Benefit Plans and Defined Contribution Plans in our 2016 Financial Report and the Significant Accounting Policies and Application of Critical Accounting Estimates and AssumptionsBenefit Plans section in our 2016 Financial Report. Those sections of our 2016 Financial Report are incorporated by reference. Notwithstanding our efforts to foresee and mitigate the effects of changes in external fiscal circumstances, we cannot predict with certainty changes in currency and interest rates, inflation or other related factors affecting our businesses. Pfizer Inc. 2016 Form 10-K COST AND EXPENSE CONTROL/UNUSUAL EVENTS/FAILURE TO REALIZE THE ANTICIPATED BENEFITS OF STRATEGIC INITIATIVES AND ACQUISITIONS/INTANGIBLE ASSETS, GOODWILL AND EQUITY-METHOD INVESTMENTS Growth in costs and expenses, changes in product, segment and geographic mix and the impact of acquisitions, divestitures, restructurings, internal reorganizations, product withdrawals, recalls and other unusual events that could result from evolving business strategies, evaluation of asset realization and organizational restructuring could adversely affect future results. Such risks and uncertainties include, in particular, our ability to realize the projected benefits of (i) our cost-reduction and productivity initiatives; (ii) our internal separation of our commercial operations into our current operating structure; (iii) any other corporate strategic initiatives; and (iv) any acquisitions, divestitures or other initiatives, such as our acquisitions of Hospira, Anacor, Medivation and AstraZenecas small molecule anti-infectives business. In addition, our consolidated balance sheet contains significant amounts of intangible assets, including goodwill. For IPRD assets, the risk of failure is significant, and there can be no certainty that these assets ultimately will yield successful products. The nature of the biopharmaceutical business is high-risk and requires that we invest in a large number of projects in an effort to achieve a successful portfolio of approved products. Our ability to realize value on these significant investments is often contingent upon, among other things, regulatory approvals and market acceptance. As such, we expect that many of these IPRD assets will become impaired and be written off at some time in the future. For goodwill, all reporting units can confront events and circumstances that can lead to a goodwill impairment charge (such as, among other things, unanticipated competition, an adverse action or assessment by a regulator, a significant adverse change in legal matters or in the business climate and/or a failure to replace the contributions of products that lose exclusivity). Any such charge may be significant. Our other intangible assets, including developed technology rights and brands, face similar risks for impairment and charges related to such assets may be significant as well. For additional details, see the Significant Accounting Policies and Application of Critical Accounting Estimates and Assumptions section in our 2016 Financial Report. We also regularly review our equity-method investments for impairment. An impairment charge may result from the occurrence of unexpected adverse events or management decisions that impact our estimates of expected cash flows to be generated from these investments. We may recognize impairment charges as a result of a weak economic environment, events related to particular customers or asset types, challenging market conditions or decisions by management. INTERNAL CONTROL OVER FINANCIAL REPORTING The accuracy of our financial reporting depends on the effectiveness of our internal control over financial reporting. Internal control over financial reporting can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements and may not prevent or detect misstatements. Failure to maintain effective internal control over financial reporting, or lapses in disclosure controls and procedures, could undermine the ability to provide accurate disclosure (including with respect to financial information) on a timely basis, which could cause investors to lose confidence in our disclosures (including with respect to financial information), require significant resources to remediate the lapse or deficiency, and expose us to legal or regulatory proceedings. TERRORIST ACTIVITY Our future results could be adversely affected by changes in business, political and economic conditions, including the cost and availability of insurance, due to the threat of terrorist activity in the U.S. and other parts of the world and related U.S. military action overseas. ", ITEM 1B. UNRESOLVED STAFF COMMENTS Not applicable. ," ITEM 2. PROPERTIES In 2016, we continued to consolidate operations to achieve efficiencies and dispose of excess space. As of December 31, 2016, we had 567 owned and leased properties, amounting to approximately 57 million square feet. In 2016, we reduced the number of properties in our portfolio by 28 sites and 2.3 million square feet with the disposal of surplus real property assets and with reductions of operating space in all regions. These reductions include partial offsets due to acquisitions of Anacor, Bamboo Therapeutics Inc., substantially all of the assets of BIND Therapeutics, Inc. and Medivation. Pfizer continues to own and lease space around the world for sales and marketing, customer service, regulatory compliance, RD, manufacturing and distribution, and administrative support functions. In many locations, business lines and operations are co-located to achieve synergy and operational efficiencies. Pfizer Inc. 2016 Form 10-K Pfizers corporate headquarters are in New York City and Pfizers properties extend internationally to over 90 countries. In 2017, we intend to progress our plans to relocate from our current New York City corporate headquarters to a more modern facility in Manhattan. In addition, we plan continued execution on consolidating properties related to Hospira and other acquired companies. We also plan to further expand our global workplace strategy to provide workplaces that enable collaboration and foster innovation. We have numerous facilities across the world to support our RD organizations, with a heavy concentration in North America. In 2017, we will continue to consolidate our RD operations in Cambridge, Massachusetts into the Kendall Square neighborhood, and continue to advance our operations in St. Louis, Missouri and Andover, Massachusetts. Our Pfizer Global Supply (PGS) division is headquartered in various locations, with leadership teams primarily in New York City, New York and in Peapack, New Jersey. As of December 31, 2016, PGS operated 63 plants around the world, which manufacture products for our commercial divisions. Locations with major manufacturing facilities include Belgium, China, Germany, India, Ireland, Italy, Japan, Puerto Rico, Singapore and the U.S. Our PGS divisions plant network strategy is expected to result in the exit of eight of these sites over the next several years. PGS also operates multiple distribution facilities around the world. In general, we believe that our properties are well-maintained, adequate and suitable for their current requirements and for our operations in the foreseeable future. See the Notes to Consolidated Financial Statements Note 9. Property, Plant and Equipment in our 2016 Financial Report, which provides amounts invested in land, buildings and equipment and which is incorporated by reference. See also the discussion in the Notes to Consolidated Financial Statements Note 15. Lease Commitments in our 2016 Financial Report, which is also incorporated by reference. "," ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings in which we are involved are discussed in the Notes to Consolidated Financial Statements Note 17A. Commitments and ContingenciesLegal Proceedings in our 2016 Financial Report, which is incorporated by reference. "," ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The principal market for our common stock is the NYSE. The stock currently trades on the NYSE under the symbol PFE. As of February 21, 2017 , there were 166,694 holders of record of our common stock. Additional information required by this item is incorporated by reference from the Quarterly Consolidated Financial Data (Unaudited) and Peer Group Performance Graph sections in our 2016 Financial Report. The following table provides certain information with respect to our purchases of shares of the Companys common stock during the fourth fiscal quarter of 2016 : Issuer Purchases of Equity Securities (a) Period Total Number of Shares Purchased (b) Average Price Paid per Share (b) Total Number of Shares Purchased as Part of Publicly Announced Plan (a) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plan (a) October 3, 2016 through October 30, 2016 33,946 $ 33.64 $ 11,355,862,076 October 31, 2016 through November 30, 2016 14,578 $ 31.57 $ 11,355,862,076 December 1, 2016 through December 31, 2016 25,816 $ 32.28 $ 11,355,862,076 Total 74,340 $ 32.76 (a) On October 23, 2014, we announced that the Board of Directors had authorized an $11 billion share-purchase plan (the October 2014 Stock Purchase Plan), and share purchases commenced thereunder in January 2015. In December 2015, the Board of Directors authorized a new $11 billion share repurchase program to be utilized over time. On March 8, 2016, we entered into an accelerated share repurchase agreement with Goldman, Sachs Co. (GSCo.) to repurchase $5 billion of our common stock. Pursuant to the terms of the agreement, on March 10, 2016, we paid $5 billion to GSCo. and received an initial delivery of approximately 136 million shares of our common stock from GSCo. based on a price of $29.36 per share, which represented, based on the closing share price of our common stock on the NYSE on March 8, 2016, approximately 80% of the notional amount of the accelerated share repurchase agreement. On June 20, 2016, the accelerated share repurchase agreement with GSCo. was completed, which, per the terms of the agreement, resulted in GSCo. owing us a certain number of shares of Pfizer common stock. Pursuant to the agreements settlement terms, we received an additional 18 million shares of our common stock from GSCo. on June 20, 2016. The average price paid for all of the shares delivered under the accelerated share repurchase agreement was $32.38 per share. The common stock received is included in Treasury stock . This agreement was entered into pursuant to our previously announced share repurchase authorization. At December 31, 2016, our remaining share-purchase authorization was approximately $11.4 billion at December 31, 2016 . (b) These columns reflect the following transactions during the fourth fiscal quarter of 2016 : (i) the surrender to Pfizer of 70,024 shares of common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock units issued to employees; (ii) the surrender to Pfizer of 2,105 shares of common stock to satisfy tax withholding obligations in connection with the vesting of performance share awards issued to employees; (iii) the surrender to Pfizer of 1,669 shares of common stock to pay the exercise price and to satisfy tax withholding obligations in connection with the exercise of employee stock options issued to employees; (iv) the open market purchase by the trustee of 532 shares of common stock in connection with the reinvestment of dividends paid on common stock held in trust for employees who were granted performance share awards and who deferred receipt of such awards; and (v) the surrender of 10 shares of common stock to satisfy withholding obligations in connection with the settlement of total shareholder return units. On February 2, 2017, we entered into an accelerated share repurchase agreement with Citibank N.A. This agreement was entered into pursuant to Pfizers previously announced share repurchase authorization. For additional information, see the Notes to Consolidated Financial Statements Note 19. Subsequent Events in our 2016 Financial Report, which is incorporated by reference. ", ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required by this item is incorporated by reference from the discussion under the heading Financial Review in our 2016 Financial Report. Pfizer Inc. 2016 Form 10-K , ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information required by this item is incorporated by reference from the discussion under the Forward-Looking Information and Factors That May Affect Future ResultsFinancial Risk Management section in our 2016 Financial Report. ," ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information required by this item is incorporated by reference from the Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements in our 2016 Financial Report and from the consolidated financial statements, related notes and supplementary data in our 2016 Financial Report. "," ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls As of the end of the period covered by this 2016 Form 10-K, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be disclosed in our periodic reports filed with the SEC. Internal Control over Financial Reporting Managements report on the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), and the related report of our independent registered public accounting firm, are included in our 2016 Financial Report under the headings Managements Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting , respectively, and are incorporated by reference. Changes in Internal Controls During our most recent fiscal quarter, there has not been any change in the Companys internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting. "